On March 16, 2016, the U.S. Commodity Futures Trading Commission (CFTC) took action to further reduce the regulatory requirements associated with commodity trade options through issuance of a final rule that took effect on March 21, 2016. The final rule expands CFTC’s “trade option exemption” and ensures that commodity options, which may be used to hedge risks in energy markets, will not be subject to the full panoply of regulatory requirements associated with swaps under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).
When Dodd-Frank was signed into law in 2010, it amended the Commodity Exchange Act to define the word “swap” to include commodity options. This subjected commodity options to the potentially onerous regulatory requirements Dodd-Frank imposed on swaps. In 2012, CFTC acted to exempt such physically delivered commodity options, purchased by commercial users of the commodities underlying the options (the trade option exemption). As a result of the trade option exemption, commodity options generally became exempt from the regulatory requirements imposed on swaps as long as the commodity option met the following requirements: (1) the offeror was either an eligible contract participant (ECP)1 or a “commercial party”2 that offered or entered into the commodity option solely for business purposes; (2) the offeree was, and the offeror reasonably believed the offeree to be, a commercial party that offered or entered into the transaction solely for business purposes; and (3) the option was intended to be physically settled so that, if exercised, the option would result in the sale of an exempt commodity, such as energy, for immediate shipment or delivery. Thus, as a general matter, the 2012 trade option exemption provided that commodity trade options entered into by commercial parties for commercial purposes qualified for the trade option exemption.
CFTC’s newly issued final rule amending the trade option exemption provides additional regulatory relief to commercial parties by, among other things:3 (1) eliminating any potential obligation of commercial participants who are not swap dealers (SD) or major swap participants (MSP) (a non-SD/MSP), to report trade options to a swap data repository; (2) eliminating the CFTC Form TO (an annual notice filing for parties to report unreported trade options to CFTC) and providing that non-SD/MSP commercial participants are not required to report their trade option activities on a Form TO4; (3) removing the swap-related record-keeping requirements for non-SD/MSP commercial participants in connection with their trade option activities;5 and (4) providing that non-SD/MSP commercial participants are not required to provide notice to the CFTC Department of Market Oversight within 30 days of entering into trade options valued in excess of $1 billion in a calendar year. The rule also provides that Non-SD/MSP commercial participants must continue to maintain records on trade options as they would in the ordinary course of their business.6
In sum, after the final rule, the most significant regulatory burden associated with the commodity options will be to ensure that the options actually qualify for the trade option exemption. As CFTC Commissioner Bowen noted in her statement: “If a particular contract or an element of a contract serves an economic purpose similar to an option … the best course of action is to exercise caution and not assume [the] contract is outside of [CFTC’s] 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 … it would be wise, as a backstop, to make sure it also falls within the trade option exemption.”