On September 17, 2014, at the first Open Meeting of the Commodity Futures Trading Commission chaired by Timothy Massad, the CFTC approved an important amendment to its Dodd-Frank Act rules for government-owned electric and natural gas utilities (“utility special entities,” in the parlance of the Dodd-Frank world) and their swap counterparties. The rule amendment provides a permanent regulatory fix to a serious problem for utility special entities arising out of the CFTC rules published in 2012 defining which entities must register with the CFTC as “swap dealers.”
The CFTC’s fact sheet summarizing the final rule amendment is here, and the CFTC’s Q&A is here. The final rule amendment will be effective when published in the Federal Register. The rule amendment is in response to a Petition originally filed by government-owned utilities in July of 2012 (a copy of the Petition is here), and it codifies a no-action letter issued by the CFTC staff in March of 2014 (a copy of the no-action letter is here).
The CFTC swap dealer rules include two de minimis thresholds which permit an entity to engage in a certain amount of swap dealing activity before the entity is required to register with the CFTC as a swap dealer. For swap dealing transactions in general, the de minimis threshold is currently $8 billion per rolling 12-month period. By contrast, for swap dealing transactions with “special entities,” the CFTC established a much, much lower de minimis threshold --$25 million. However, the operations-related swaps used by a utility special entity to hedge the ongoing risks of its utility business have relatively large notional amounts, due to the utilities’ customer service obligations, the weather fluctuations and commodity price volatility in certain regional markets (especially during times of market stress like a winter “polar vortex”), and the long-term nature of utility hedging swaps. If a non-registered swap dealer counterparty entered into one swap with one utility special entity, that counterparty might decide not to offer any more swaps to utility special entities for 12 months. As a result, the $25 million threshold was severely limiting utility special entities’ ability to cost-effectively hedge their (and their utility customers’) commercial risks.
In the rule amendment, the CFTC was responsive to both the utility special entities’ 2012 Petition, as well as to public comments on the proposed rule amendment issued in June of 2014. In remarks at the Open Meeting, Chairman Massad and each of the other Commissioners noted that this rule amendment is an example of the need for the Commission to “tweak” or “fine-tune” the complex web of swaps rules, to accommodate the needs and concerns of commercial end-users who depend on the derivatives markets to cost-effectively hedge their ongoing business risks – particularly commercial end-users in the energy industry.
Different end-user groups have asked for clarifications, exemptions and no-action relief from rules and interpretations that simply don’t make sense for commercial enterprises trying to hedge ongoing business operations and commercial risks. The CFTC might also consider suspending the applicability of some of the rules to commercial end-users, until the rules are beta-tested on financial commodities and market professionals. Commercial end-users, including the energy companies and utilities, have been inundated with new CFTC regulatory requirements. The Swap Report is hopeful that the new Chairman and the CFTC will continue to be responsive to end-user concerns, and will propose rule amendments, clarify ambiguous interpretations, and provide exemptive relief, keeping in mind that nonfinancial commodity swaps must remain available, affordable and accessible for commercial businesses seeking to hedge customized business risks.