The proposal furthers an ongoing effort to minimize Dodd-Frank burdens on commercial end users.
On April 4, the US Commodity Futures Trading Commission (CFTC) issued an order proposing guidance about the Dodd-Frank regulatory treatment of certain gas and power contracts. As issued, the CFTC’s proposed guidance would provide clarity and welcome relief concerning the application of the Dodd-Frank Act to capacity contracts and/or natural gas peaking supply contractual arrangements entered into by investor-owned utilities and independent power producers. The CFTC has requested that interested entities submit comments concerning the proposed guidance on or before 30 days after the CFTC’s April 4 issuance is published in the Federal Register.
Since the Dodd-Frank Act’s enactment in 2010, considerable uncertainty has existed about whether some contracts used among energy market participants will be treated as swaps under Dodd-Frank. In 2012, the CFTC issued a final rule defining the term “swap” and adopting other definitions required pursuant to the Dodd-Frank Act (Definitional Rule). The regulation of a contract as a “swap” can entail regulation of either or both contract parties, and the contract itself, by the CFTC under Dodd-Frank. In the 2012 issuance, the CFTC also adopted an interpretation regarding the facts and circumstances in which certain contracts should not be considered swaps under Dodd-Frank because they are, instead, customary commercial arrangements.
The CFTC’s Definitional Rule listed several specific types of contracts that constitute customary commercial arrangements exempt from treatment as a swap. Examples include employment contracts, service arrangements, certain commercial loans and mortgages, intellectual property agreements, and warehouse lending arrangements. However, the CFTC’s Definitional Rule was not intended to provide an exhaustive list of examples. The April 4 issuance proposes to build on that list.
The proposed guidance is intended to address some of the questions concerning the regulatory treatment of commonly used agreements in the energy industry. However, the CFTC’s guidance is limited: the CFTC proposes that two specific types of contracts should not be considered or otherwise treated as swaps because they are customary commercial arrangements.
First, the CFTC proposed that capacity contracts in the power markets be excluded from treatment as a swap under Dodd-Frank (e.g., implement state-mandated capacity requirements imposed on load-serving entities (LSEs), such as utilities). Contracts entered into under the California Public Utilities Commission–mandated resource adequacy program are examples of such contracts.
Second, the CFTC proposed that gas peaking supply contracts entered into by electric utilities be excluded from treatment as a swap under Dodd-Frank. Under these arrangements, a utility has entered into gas supply arrangements to ensure adequate supply in cases where its local utility (or in some cases, other) gas supplier curtails service.
The CFTC noted that the contracts above are entered into by commercial market participants to maintain reliable supplies or comply with regulatory requirements, and those parties contemplate physical settlement of the transactions. The CFTC stated that the two types of contracts listed above preliminarily satisfy the elements set forth in the definitional rule as to when a contract should not be considered a swap. The contracts
- do not contain payment obligations that are severable from the contract,
- are not traded on an organized market or over the counter, and
- are entered into by commercial or nonprofit entities to serve commercial and/or business purposes.
The CFTC’s proposal represents another step in the CFTC’s effort to reduce burdens on end users (i.e., entities that are neither swap dealers nor major swap participants) that might otherwise apply by virtue of the Dodd-Frank Act and the CFTC’s implementing regulations. Since the Dodd-Frank Act’s enactment, the CFTC has taken several steps to minimize or eliminate the applicability of potentially burdensome and resource-intensive Dodd-Frank Act regulations on commercial end users.
For example, the mandatory clearing requirement arising under the Dodd-Frank Act took effect in September 2013 for many commercial end users. However, many commercial end users have relied on the so called “end-user exception” from the clearing mandate to continue executing uncleared swaps with their dealer counterparties.
More recently, in March 2016, the CFTC issued a final rule eliminating the requirement for commercial end users to report trade options, whether on Form TO or pursuant to Part 45. In that final rule, the CFTC also determined that commercial end users are no longer required to comply with Part 45 recordkeeping requirements in connection with trade option activities.
In addition, in its March 2016 issuance, the CFTC stated that trade options would not be subject to CFTC-established speculative position limits if and when such limits are established. The CFTC explained that “that federal speculative position limits should not apply to trade options” and that the CFTC intends to address the matter in the context of the pending position limits proposal.
Turning to the present, the CFTC’s April 4 proposal provides a degree of clarity to generation owners and operators and the extent to which the Dodd-Frank Act applies to certain transactions.
The CFTC explained that the proposed guidance does not preclude the CFTC from issuing further guidance that considers other commodity contracts under the interpretation in the Definitional Rule. The CFTC has invited public comment concerning its proposed guidance, requesting that interested entities address specific questions. In particular, the CFTC has asked the following:
- Should the proposed guidance be limited to contracts that only qualify as trade options (i.e., are there any contracts that do not qualify as trade options, that would meet the above test, but warrant treatment as a swap?)?
- Does the guidance provide sufficient clarity regarding the contracts listed above or, if not, how should the guidance be revised?
- Are there other facts and circumstances that the CFTC should consider when determining whether the contracts above are swaps?
- Are there contracts (other than those described above) that are entered into by participants in the electric power and natural gas markets and necessitated by, or closely tied to, compliance with regulatory obligations or frameworks similar to those above?
- Are there other types of commodity contracts, outside of the electric power and natural gas markets, that are necessitated by, or closely tied to, compliance with regulatory obligations or frameworks that should be considered under the interpretation in the definitional rule? If so, please describe these contracts and the regulatory obligations and frameworks to which they are closely tied.
- With respect to natural gas peaking contracts, are there natural gas providers other than local distribution companies, such as intrastate and interstate natural gas pipelines (which are subject to regulatory obligations to prioritize and serve residential demand for natural gas, such that the providers are obligated to curtail service to electric utilities under certain circumstances)?
Now that Dodd-Frank is nearly six years old, the CFTC’s proposal presents energy industry market participants with an opportunity to draw on the experience obtained over the last six years to respond to the CFTC’s questions. In particular, the CFTC’s invitation to comment provides an opportunity to solicit guidance and/or certainty from the CFTC about the proper regulatory treatment of other gas and power arrangements not addressed in the issuance that might also constitute customary commercial arrangements.