CFTC’s Office of General Counsel Responds to Questions Regarding Certain Physical Commercial Agreements
On November 14, 2012, the Officer of the General Counsel (the “OGC”) of the Commodity Futures Trading Commission (the “CFTC”) issued a response to frequently asked questions (the “FAQ”)1 in which it clarified the scope of the definition of the term “swap” in response to comments received on the CFTC’s August 13, 2012 final rules (the “Final Swap Definitions”) further defining that term.2 In Final Swap Definitions (issued jointly with the Securities and Exchange Commission), the CFTC explained in an interpretation (the “General Option Interpretation”) that it will not treat an agreement, contract or transaction (a “transaction”) as a commodity option subject to regulation as a swap so long as the transaction satisfies the following three conditions:
- the subject of the transaction is the usage of a specified facility or part thereof (such transaction, a “Usage Contract”) rather than the purchase or sale of the commodity that is to be created, transported, processed or stored using the specified facility;
- the Usage Contract grants the buyer the exclusive use of the specified facility or part thereof during its term, and provides for an unconditional obligation on the part of the seller to grant the buyer the exclusive use of the specified facility or part thereof; and
- the payment for the use of the specified facility or part thereof represents a payment for its use rather than the option to use it.
In this same section and in connection with the General Option Interpretation, the CFTC went on to state:
However, in the alternative, if the right to use the specified facility is only obtained via the payment of a demand charge or reservation fee, and the exercise of the right (or use of the specified facility or part thereof) entails the further payment of actual storage fees, usage fees, rents, or other analogous service charges not included in the demand charge or reservation fee, such agreement, contract or transaction is a commodity option subject to the swap definition.3
Many market participants expressed concern that this interpretation (the “However Paragraph”) implied that any Usage Contract with both fixed costs and variable costs would be a commodity option subject to regulation as a swap.4 The types of Usage Contract that are the cause of this concern include certain storage agreements and electric generation tolling agreements as well as certain liquefied natural gas re-gasification, marine vessel chartering and terminal arrangements.
In response to industry concern, the OGC has issued an interpretation in the FAQ (the “FAQ Interpretation”) stating that a Usage Contract will not be within the scope of the However Paragraph and would not be a commodity option subject to the swap definition if the Usage Contract satisfies the following five conditions:
- the Usage Contract includes a two-part fee structure;
- the right to use the specified portion of the facility for the term of the transaction is legally established upon entering into the Usage Contract;
- the party who has legally established the right to use the specified portion of the facility for the term of the Usage Contract pays the up-front fixed costs in a commercially reasonable timeframe;
- the use of the facility does not depend on the further exercise of an option; and
- the variable component of the price paid is in the nature of a reimbursement for the variable costs incurred by the operator of the facility in rendering the service.
Any Usage Contract excluded from the definition of commodity option pursuant to the FAQ Interpretation would still be subject to the CFTC’s residual anti-fraud, anti-manipulation and other authority over forward contracts. If a Usage Contract fails to meet one or more of these conditions, it may or may not be a commodity option depending on the facts and circumstances of the Usage Contract taken as a whole. In this context, the OGC expressed the opinion that, if a transaction “to provide physical commodity creation, transportation, processing or storage service includes a payment of a premium for the ‘entitle[ment]’ . . . (i.e., the right to buy or sell, as the case may be, a physical commodity, which commodity could be creating, transporting, processing or storing an agricultural or exempt commodity that can be physically delivered) rather than payment for the commodity, it is likely to be a commodity option within the CFTC’s jurisdiction.”5
In the FAQ, the OGC also explained that it believed that the creation, transportation, processing, or storage of a commodity could be a nonfinancial commodity as such term is used in the Final Swap Definitions. The OGC reasoned that these services can be physically delivered, and that the services themselves may be commodities. Therefore, a Usage Contract involving one of these services that does not satisfy the conditions of the FAQ Interpretation and is otherwise determined to be a commodity option could, insofar as it involves physical delivery, nevertheless qualify for treatment as a “trade option” under the CFTC’s regulations.6
The FAQ, including the FAQ Interpretation, represents only the views of the OGC and is not binding on the CFTC or any Commissioner.