On March 16, 2016 the Commodity Futures Trading Commission (CFTC) issued a Final Rule to further limit its oversight of commodity trade options. The Final Rule removes all reporting and recordkeeping requirements for trade option counterparties that are neither swap dealers (SDs) nor major swap participants (MSPs), including commercial end-users that transact in trade options in connection with their businesses.
Trade options are physically delivered commodity options purchased by commercial end-users of the commodities underlying the options. Trade options are distinct from forward contracts, which are defined by the Commodity Exchange Act (CEA) as “any sale of any cash commodity for deferred shipment or delivery.” Where forward contracts are excluded from the CEA and CFTC regulation, trade options are only partially exempt. The CFTC has long provided special treatment of trade options, dating back to its original trade option exemption in 1976. Under the more recent Dodd-Frank swaps regime, trade options have been generally exempt from the swap requirements of the CEA and CFTC regulations, subject to certain conditions.
To qualify for the trade option exemption, a commodity option transaction must meet the following requirements:
- The offeror is either an eligible contract participant (ECP) or a producer, processor, commercial user of, or merchant handling the commodity that is the subject of the commodity option transaction, or the products or byproducts thereof (a commercial party) that offers or enters into the commodity option transaction solely for purposes related to its business as such;
- the offeree is, and the offeror reasonably believes the offeree to be, a commercial party that is offered or enters into the transaction solely for purposes related to its business as such; and
- the option is intended to be physically settled so that, if exercised, the option would result in the sale of an exempt or agricultural commodity for immediate or deferred shipment or delivery.
The Final Rule amends the trade option exemption to eliminate any potential obligation of commercial end-users to report trade options to the CFTC and to swap data repositories, pursuant to 10 CFR part 45 or 10 CFR section 32.3(b). The Final Rule also eliminates the standard Form TO on which commercial end-users have reported their trade option activities since 2013. Under the Final Rule, commercial end-users will no longer be required to keep records of their trade option activities and will also not need to provide notice to the CFTC if the end users’ trade options activities reach a value of more than US$1 billion in a calendar year.
While the Final Rule removes end-users’ obligations with respect to reporting and recordkeeping, trade options will remain subject to CFTC antifraud and anti-manipulation oversight, as well as certain requirements applicable solely to SDs and MSPs.
In addition, the Final Rule makes a “non-substantive” amendment to the existing trade options regulations to eliminate the reference to the now-vacated part 151 position limits requirements. However, in response to comments filed by a number of organizations representing end-users, the Final Rule also provided assurance that the CFTC “believes that federal speculative position limits should not apply to trade options.” The CFTC will thus not include trade options in the pending position limits rule, if the rule is adopted – an assurance that will be broadly welcomed by the end-user community.
As summarized by Chairman Massad, the Final Rule introduces changes to trade options regulation intended to “reduce burdens and costs for trade option counterparties that are not SDs or MSPs and, in particular, for smaller end-users.” Massad also noted that the changes “followed careful consideration of the benefits of such information to the Commission, as compared with the difficulties commercial end-users would face in valuating, tracking, and classifying their trade options.”
Included in the information that trade option reporting provided in the past few years is the following, provided at footnote 24 of the Final Rule, which may be of interest to those commercial end-users that submitted at Form TO:
In 2014, approximately 330 Non-SD/MSPs submitted Form TO filings to the Commission, approximately 200 of which indicated delivering or receiving less than US$10 million worth of physical commodities in connection with exercising unreported trade options in 2013, which was the first year in which § 32.3 and Form TO reporting became effective. In 2015, approximately 349 Non-SD/MSPs submitted Form TO filings to the Commission, approximately 150 of which indicated delivering or receiving less than US$10 million worth of physical commodities.
Commissioner Bowen also released a statement on the Final Rule addressing the difficulty faced by market participants in classifying commodity transactions as swaps, trade options or forward contracts. Bowen noted of the forward contract exclusion that:
If a particular contract or an element of a contract serves an economic purpose similar to an option, I believe the best course of action is to exercise caution and not assume your contract is outside of our jurisdiction based on an interpretation. While it may seem fine for a person using these contracts to hope that the interpretation is not called into question, I believe it would be wise, as a backstop, to make sure it also falls within the trade option exemption.
Bowen’s caution against evasion of CFTC swap regulations suggest that end-users should to continue to review and classify physical contracts with elements of optionality and keep record the process for compliance purposes. Any transaction that an end-user would claim is excluded as a forward contract should, according to Bowen’s statement, also qualify as a trade option.