On June 2, the US Commodity Futures Trading Commission (the “CFTC”) proposed changes to its swap dealer registration rules in order to provide relief to public utilities and participants in power markets. Since the initial publication of the swap dealer regulations, public power utilities have been concerned that swap dealer registration requirements could force all but the largest banks to discontinue serving as counterparties to the sector, thus inhibiting public power’s ability to hedge risk and ensure steady supplies of energy. The proposed rule change would allow market-making counterparties to exclude “utility operations-related swaps” with “utility special entities” from the determination of whether they meet the $25 million de minimis threshold for swaps with special entities, as more fully described below.
CFTC Regulation 1.3(ggg) provides that persons engaged in de minimis levels of swap dealing activity are not required to register as swap dealers, thus relieving them from the significant regulatory burden imposed by the Dodd-Frank Act and the regulations thereunder.
The current regulations provide that “de minimis” swap dealing consists of swap dealing activities that in the aggregate do not exceed, during the preceding twelve-month period, either of two aggregate gross notional amount thresholds. The first gross notional amount threshold is $3 billion (with a phase-in level of $8 billion) (the “General De Minimis Threshold”). However, an entity could be required to register as a swap dealer even if it does not meet this threshold, if it meets a $25 million gross notional threshold for swaps with “special entities” (the “Special Entity Threshold”).
Special entities are defined in the Commodity Exchange Act (the “CEA”) to include federal agencies, states, state agencies, cities, counties, municipalities, other political subdivisions of a state, employee benefit plans, and endowments. By regulation, the CFTC also included “any instrumentality, department, or a corporation of or established by a State or subdivision of a State,” which had the effect of characterizing state-owned utility companies as special entities.
Because state-owned utilities engage in significant hedging activity related to commercial risks inherent in their businesses, many industry participants raised concerns regarding the addition of state-owned corporations, particularly utilities, to the definition of “special entity.” In particular, these industry participants were concerned that rather than deal with the burdens of registration, dealers in swap transactions with utilities would decide to either reduce their positions so as to fall below the Special Entity Threshold or more likely avoid special entities altogether.
A number of industry participants filed a petition with the CFTC requesting that swaps with utility special entities not be counted toward the Special Entity Threshold. This petition led to the issuance of two no-action letters by the CFTC, as well as the introduction of legislation in the House and Senate that would allow potential swap dealers to exclude swaps with utilities that are related to their commercial operations from the Special Entity Threshold (but not the General De Minimis Threshold).
Now, the CFTC has proposed to exclude from the Special Entity Threshold (but not the General De Minimis Threshold) certain swaps with utility special entities, as follows:
- “Utility special entity” would be defined as a special entity that:
- Owns or operates (or anticipates owning or operating) electric or natural gas facilities;
- Supplies natural gas or electric energy to other utility special entities;
- Has public service obligations or anticipated public service obligations under federal, state or local law to deliver electric energy or natural gas service to utility customers; or
- Is a federal power marketing agency (as defined in the Federal Power Act).
- Only “utility operations-related swaps” would be excluded from the Special Entity Threshold, defined as swaps with a utility special entity where:
- The utility special entity is using the swap to hedge or mitigate commercial risk (as described in the exceptions to the swaps clearing requirement at 17 CFR 50.50);
- The swap is related to an exempt commodity (as defined in Section 1a20 of the CEA – note that interest rate, exchange rate, currency, security and inflation swaps are not considered “exempt commodities” and thus swaps related to those commodities would still count towards the Special Entity De Minimis Threshold); and
- The swap is an electric energy or natural gas swap, or is associated with the generation, production, purchase, delivery, storage or sale of natural gas or electric energy, or is related to energy efficiency, conservation, or environmental laws.
Persons wishing to exclude utility operations-related swaps from the determination of whether their swap dealing activities meet the Special Entity Threshold would be required to file a one-time notice with the National Futures Association.
The full text of the CFTC’s release regarding the proposed rule can be found here. Comments must be received on or before July 2, 2014.