The Commodity Futures Trading Commission (the “CFTC”) recently published a concept release in the form of an advance notice of proposed rulemaking requesting comment on whether to eliminate the bona fide hedge exemption for swap dealers and replace it with a more limited risk management exemption. 74 Fed. Reg. 12282 (March 24, 2009) (hereinafter, the “Concept Release.”) The new risk management exemption would be conditioned upon, among other things, (i) an obligation to report to the CFTC and applicable self-regulatory organizations when certain “noncommercial” swap counterparties reach a specified position level and/or (ii) a certification that none of a swap dealer’s “noncommercial” swap counterparties exceed applicable speculative position limits in the related exchange-traded futures contracts. For this purpose, a “noncommercial” counterparty would include any entity other than a traditional commercial hedger involved in the production, processing or marketing of a commodity. The Concept Release is implementing Recommendation Five contained in the Staff Report on Commodity Swap Dealers and Index Traders with Commission Recommendations, Commodity Futures Trading Commission, September 2008 at 6 (the “September 2008 Report”). Comments are due on or before May 26, 2009.  

SUMMARY  

As a starting point, the Concept Release summarizes the statutory and regulatory background for CFTC and exchange speculative position limits, existing exemptions from the limits (including for bona fide hedging and certain risk management transactions), and the CFTC’s policy on aggregating commonly owned or controlled positions for purposes of applying the limits. Id. at 12283-84. In particular, the Concept Release describes the CFTC staff’s policy of granting bona fide hedging exemptions to a number of swap dealers for positions in exchange-traded futures contracts on certain agricultural commodities (e.g., wheat, corn and soybeans) entered into to offset price risk incurred in connection with dealer activities in commodity price swap and similar over-the-counter (“OTC”) transactions. Id. at 12284. It should be noted that the existing bona fide hedge exemptions granted by the CFTC staff extend only to those agricultural commodities subject to Federal speculative position limits in Rule 150.2, but exchanges have granted similar exemptions with respect to other physical commodities, which are subject to exchange position limits.

The Concept Release also reviews certain issues relating to the appropriate classification of trading activity by swap dealers and commodity index traders in the futures markets in the context of the CFTC’s Commitments of Traders reports and the concerns expressed by Congress and others relating to commodity price volatility and the growth of trading activity by swap dealers and index traders. Id. at 12284-85. Such factors led the CFTC to issue a special call to certain swap dealers and index traders to elicit information about their trading activities, including both on-exchange and OTC. The September 2008 Report was prepared on the basis of the initial data gathered in response to this special call, which remains ongoing.  

As noted, the CFTC is moving to address the September 2008 Report’s Recommendation Five through publication of the Concept Release. In essence, unlike under existing bona fide hedge exemptions, swap dealers would be required to monitor and restrict the trading activity of their counterparties as a condition of obtaining and maintaining an exemption from speculative position limits to assure that “noncommercial” swap counterparties are not circumventing the oversight and position limits of the CFTC and exchanges or engaging in price manipulation. The stated objective is to bring greater transparency and accountability to the marketplace by looking through swap dealers to their counterparties.  

Request for Comments  

The Concept Release is requesting general views and comments regarding the appropriate regulatory treatment of swap dealers with respect to existing bona fide hedge exemptions and a potential conditional, limited risk management exemption. Also, the CFTC is requesting comments on a number of specific questions relating to (a) the general advisability of eliminating the existing bona fide hedge exemption for swap dealers in favor of a limited risk management exemption, (b) the scope of a potential new limited risk management exemption for swap dealers, and (c) the terms of a potential new limited risk management exemption for swap dealers.  

Among others, these questions include how existing futures positions that no longer qualify for a position limit exemption should be treated; whether a reinterpretation of bona fide hedging and any new limited risk management exemption should extend to other physical commodities such as energy and metals which are subject to exchange position limits; how new rules should define what constitutes a commercial entity; how the commercial status of a swap dealer’s counterparties should be verified; whether new rules should distinguish between different classes of noncommercial counterparties; what futures equivalent position level should trigger a reporting requirement to the CFTC for a new limited risk management exemption; whether there should be an overall limit on a swap dealer’s futures and option positions in any one market regardless of the commercial or noncommercial nature of its counterparties; and what information should be required in a swap dealer’s application for a limited risk management exemption. The CFTC is also requesting comment on how two commodity indexing traders who have received noaction relief from Federal speculative position limits should be treated under any new regulatory scheme. Id. at 12286.

CONCLUSION  

The CFTC’s issuance of the Concept Release is not an unexpected development, but it likely portends a significant change in longstanding policy which has been in effect for nearly twenty years. The specific questions on which comments are requested may also signal a new regulatory approach in other related areas within the CFTC’s jurisdiction.