The CFTC has proposed several important changes that would alleviate the reporting and recordkeeping obligations of end users with respect to trade options (or provide by rule certain relief currently only available under no-action letter) and alter certain other aspects of the existing trade option rule in Section 32.3 of the CFTC’s regulations. Trade options are commodity options for which: (1) the offeror and offeree are both producers, processors or commercial users of, or merchants handling, the subject commodity and are entering into the transaction solely for purposes related to their business (alternatively, this prong can be satisfied with respect to the offeror if the offeror qualifies as an “eligible contract participant” under Section 1a(18) of the Commodity Exchange Act); and (2) the parties intend to physically settle the transaction if the option is exercised.
Reporting and Recordkeeping Requirements
The CFTC proposes to make the following changes to its trade option reporting and recordkeeping requirements:
- Eliminate the Part 45 swap data reporting requirement for Non-Swap Dealer/Major Swap Participants (such non-SD/MSPs referred to herein as “end users”) with respect to trade options (this requirement was already generally inapplicable to end users under CFTC No-Action Letter No. 13-08);
- Eliminate the annual Form TO filing requirement with respect to unreported trade options;
- Clarify that end users are required to comply with only the swap data recordkeeping requirements under Section 45.2 of the CFTC’s regulations with respect to trade options (which requires market participants to maintain full, complete, and systematic records, together with all pertinent data and memoranda, on subject transactions and to open their records to inspection upon the Commission’s request), as opposed to all Part 45 recordkeeping requirements (which would require identifying each transaction by a unique swap identifier (“USI”) and unique product identifier (“UPI”) and each counterparty by a legal entity identifier (“LEI”)—also requirements from which end users already had relief under No-Action Letter No. 13-08);
In addition, the proposed changes would eliminate reference to application of the now-vacated Part 151 position limits rule, although the CFTC has effectively left open whether its currently pending position limits rulemaking might extend to trade options.
To preserve some level of visibility into end users’ trade option activity, the proposal would require those end users that enter into trade options (whether reported or unreported) with aggregate notional value in excess of $1 billion in any calendar year to provide notice to the CFTC within 30 days after exceeding such threshold—or, alternatively, in advance if they expect to exceed such threshold during the year. In addition, the rule would require end users engaging in any trade options with a SD/MSP counterparty to obtain a LEI (if they do not already have one) and to provide that LEI to such counterparty (this was also a condition of the relief under No-Action Letter No. 13-08).
Insight into Market Practices Regarding Trade Option Reporting
The CFTC’s rulemaking release also offered some insight into market participants’ existing practices with respect to trade option reporting. In 2014, approximately 330 Non-SD/MSPs submitted Form TO filings to the Commission, approximately 200 of which indicated delivering or receiving less than $10 million worth of physical commodities in connection with exercising unreported trade options in 2013. Joint comments from several energy associations (APPA, NRECA, EEI, EPSA, and LPPC) stated that one member spent more than $100,000 in information technology costs to implement a mechanism to track exercises of nonfinancial commodity options. Southern Power Company estimated that Form TO reporting required two of its full-time employees to spend 30 minutes to two hours per contract to complete Form TO, at an average cost of $200 per contract and a total annual cost of about $12,000. Roundtable comments from ConocoPhillips included an estimate that the marginal cost of Form TO reporting was “on the order of” one full-time employee and possibly higher for smaller entities with less in the way of compliance systems and procedures.