On July 14, 2011, the Commodity Futures Trading Commission (“CFTC” or “Commission”) issued a Final Order on Effective Date for Swap Regulation (“CFTC Order”) that provides temporary exemptive relief (i) delaying implementation of various provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) that the CFTC determined would otherwise take effect on July 16, 2011, and (ii) permitting certain over-the-counter (“OTC”) derivatives trading activity to continue notwithstanding the repeal on July 16, 2011 of the statutory exemptions and exclusions added to the Commodity Exchange Act (“CEA”) in 2000 that are commonly relied upon by market participants for such trading activities. The CFTC Divisions of Clearing & Intermediary Oversight and Market Oversight also issued a joint staff no-action letter that same day covering certain of the Dodd-Frank amendments to the CEA that may be outside the CFTC's exemptive authority (“Staff No-Action”). The CFTC Order and Staff No-Action are available online at http://tinyurl.com/6fgagfr and http://tinyurl.com/63uq3t8.
The CFTC largely followed the approach set out in the proposed order it issued in June. 76 FR 35372 (June 17, 2011). The CFTC Order groups the Dodd-Frank provisions into four categories and provides exemptive relief for provisions covered by two of them, as summarized below:
Category 1-Provisions That Do Not Take Effect July 16; No Relief Is Required
Category 1 Provisions. Category 1 covers statutory provisions which by their express terms require rulemaking to implement and for which no exemption is provided. A list of the Category 1 provisions is included in the appendix to the CFTC Order. Category 1 provisions identified by the CFTC include, among others, the definitions of "eligible contract participant," "swap," "swap dealer," and "major swap participant;" registration of swap dealers and major swap participants; provisions prohibiting agricultural swaps except pursuant to CFTC rules; margin requirements for uncleared swaps; and large trader reporting.
No Relief: The CFTC is not granting relief from Category 1 provisions because the earliest they may take effect is 60 days after the corresponding final rules are published in the Federal Register.
Category 2-Provisions for Which Rulemaking Is Not Required; Temporary Exemption Delaying Effectiveness
Category 2 Provisions. Category 2 covers statutory provisions which do not by their express terms require rulemaking to implement, but which reference one or more of the terms listed in Section 712(d) or 721(c) of Dodd-Frank, for which rulemaking is required to provide further definition, including “swap,” “swap dealer,” “major swap participant,” “eligible contract participant,” and “security-based swap agreement” (the “referenced terms”).
A list of the Category 2 provisions is included in the appendix to the CFTC Order. Examples of Category 2 provisions include the expanded definitions of commodity pool operator and commodity trading, which Dodd-Frank amended to cover activities with respect to swaps; mandatory clearing of swaps; segregation requirements with respect to holding of margin funds for cleared and uncleared swaps (but see below the inclusion of the latter in the Staff No-Action, as well); and real-time reporting of swap transactions.
Temporary Exemption: The CFTC takes the position that Category 2 provisions take effect July 16 unless the CFTC grants an exemption. The CFTC Order grants exemption from those provisions, but only to the extent that such provisions specifically relate to a referenced term. Thus, if a Category 2 provision also applies to futures or options on futures, the provision takes effect on July 16 as it applies to futures or options on futures.
Temporary Exemption Expiration Date: The temporary exemption expires on the earlier of (i) December 31, 2011 or (ii) the effective date of the applicable final rule defining the referenced term in the Category 2 provision.
Category 3-Self-Effectuating Provisions That Repeal Provisions of Current Law; Temporary Exemption for Transactions in Exempt and Excluded Commodities (i.e., Non-Agricultural Commodities) and Clarification of Ongoing Effectiveness of Part 35 and Part 32 Rules
Category 3 Provisions. Category 3 covers Sections 723(a)(1) and 734(a) of Dodd-Frank, which repeal (among other CEA provisions) the statutory exemptions and exclusions that were added to the CEA in 2000 covering OTC derivatives transactions in non-agricultural commodities, specifically, CEA Sections 2(d), 2(g) and 2(h).
Clarification and Temporary Exemption: The CFTC Order provides both exemptive relief and clarification of the availability of existing rules, to allow existing trading practices to continue without being "unduly disrupted" during the transition period between July 16, 2011 and effectiveness of the various required rulemakings to implement the Dodd-Frank provisions.
Part 35 Clarification. The CFTC confirms that parties may continue to rely upon the CFTC Part 35 Rules exempting certain transactions in swap agreements from regulation under the CEA, until such time as those rules are withdrawn, amended or replaced. The CFTC also expressly addresses use of Part 35 for contracts based on agricultural commodities or other physical commodities.
Commodity Options: Physical Commodities and Non-Enumerated Agricultural Commodities. Notably, the CFTC states that Part 35 may be relied upon for OTC transactions in options on physical commodities, with the exception of certain enumerated agricultural commodities. (Part 35 by its express terms covers financial options.) Specifically:
- Enumerated Agricultural Commodities. Parties may not rely on Part 35 for options on any of the following agricultural commodities, called the “enumerated agricultural commodities:” wheat, cotton, rice, corn, oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, Irish potatoes, wool, wool tops, fats and oils, cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, livestock, livestock products, and frozen concentrated orange juice.
- Other Agricultural Commodities. Parties may rely upon Part 35 for options on other agricultural commodities, such as sugar or coffee.
- Other Physical Commodities. Parties may rely upon Part 35 for options on other physical commodities, such as energy commodities or metals
- Commodity Options: Physical Commodities and Non-Enumerated Agricultural Commodities. Notably, the CFTC states that Part 35 may be relied upon for OTC transactions in options on physical commodities, with the exception of certain enumerated agricultural commodities. (Part 35 by its express terms covers financial options.) Specifically:
- Commodity Swaps: All Physical Commodities, Including All Agricultural Commodities. Apart from options, the CFTC confirms that parties may continue to rely upon Part 35 for swap agreements (as defined in Part 35) on any agricultural commodity or other physical commodity.
- Part 32 Clarification: OTC Options on Enumerated Agricultural Commodities. The CFTC Order also confirms that parties may continue to rely upon the existing CFTC Part 32 Rules governing commodity options until such time as those rules are withdrawn, amended, or replaced. This is relevant for options on the enumerated agricultural commodities, which are not covered by Part 35. For options on the enumerated agricultural commodities, parties may continue to rely upon CFTC Rule 32.13(g), which as a general matter permits OTC options between producers, processors, commercial users or merchants of the commodity or its products or by-products that have a net worth of at least $10 million.
Temporary Exemption; Agricultural Commodities Not Covered. The CFTC Order grants a temporary exemption for transactions that expands the relief available under the Part 35 Rules, but limits this temporary exemption to transactions in non-agricultural commodities. The temporary exemption:
- Permits (i) swap transactions to be executed on a multilateral execution facility, (ii) swap transactions to be cleared, and (iii) swaps to be part of a fungible class of agreements that are standardized as to material economic terms, notwithstanding the prohibitions against the foregoing set out in Part 35, so long as the transaction otherwise meets the requirements of Part 35.
- Expands the persons who may rely upon Part 35 to include eligible contract participants as defined in the CEA prior to enactment of Dodd-Frank, in addition to eligible swap participants as defined in Part 35. (Although there is substantial overlap, the two definitions are not coextensive.)
- Waives for one, but no more than one, party to a transaction the requirement that the party must be an eligible contract participant or eligible swap participant, provided that (i) the party is entering into the transaction in connection with its line of business and (ii) the contract or transaction is not marketed to the public.
Temporary Exemption Expiration Date: The temporary exemption expires on the earlier of (i) December 31, 2011 or (ii) the CFTC's repeal, withdrawal or replacement of the Part 35 Rules.
Category 4-Self-Effectuating Provisions That Take Effect July 16, 2011; No Relief Granted
Category 4Provisions. Category 4 covers statutory provisions that are self-effectuating and for which no relief is being granted. A list of the Category 4 provisions is included in the appendix to the CFTC Order. Many of the Category 4 provisions are not directly applicable to market users, for example provisions requiring the CFTC to undertake studies.
Notably, Category 4 includes the amendments to CEA Section 2(c) governing OTC retail forex trading activities, and thus those provisions take effect on July 16. However, the CFTC Order clarifies that the term eligible contract participant as used in Section 2(c) (and elsewhere in the CEA) will continue to have the meaning set out in the CEA definition prior to enactment of Dodd-Frank, until the effective date of the CFTC's rulemaking to further define that term. Thus, the Dodd-Frank amendments increasing the dollar thresholds for certain governmental entities and changing the total assets test to a discretionary investments test for certain individuals are postponed until at least 60 days after the CFTC publishes a final definitional rule for eligible contract participant; likewise, it appears that effectiveness of the Dodd-Frank “look through” provision under which certain commodity pools will have to require all participants to be eligible contract participants for the pool itself to be an eligible contract participant is also so postponed.
No Relief; No Postponement of Effective Date: Because the CFTC has not provided any relief for Category 4 provisions, they take effect on July 16, 2011.
The Staff No-Action addresses several Dodd-Frank provisions which are also covered by the CFTC Order as Category 2 provisions, to address the concern that the CFTC's exemptive authority under CEA Section 4(c) may not extend to those provisions. Specifically, the Staff No-Action states that the Divisions, on a temporary basis, will not recommend enforcement action to the Commission against any person for failure to comply with the following provisions:
- Uncleared Swaps-Segregation Requirements. New Section 4s(l) of the CEA, which imposes segregation requirements on swap dealers and major swap participants with respect to holding collateral for uncleared swaps.
- DCO Registration for Swaps Clearing. Dodd-Frank amendments to CEA Section 5b(a), to the extent they prohibit a derivatives clearing organization (“DCO”) from performing the functions of a DCO with respect to swaps unless registered with the CFTC as a DCO.
- Swap Dealer and Major Swap Participant-Chief Compliance Officer. New Section 4s(k) of the CEA, which provides for the designation and duties of a chief compliance officer for a swap dealer or major swap participant.
No-Action Expiration Date: Consistent with the expiration date for the temporary exemption in the CFTC Order for Category 2 provisions, the no-action relief expires on the earlier of (i) December 31, 2011 or (ii) the effective date of the applicable final rule defining the referenced term used in the foregoing provisions.
The CFTC states that the temporary exemptions for Categories 2 and 3 do not limit its anti-fraud enforcement authority or affect any effective date (or compliance date) prescribed in any rulemaking issued by the CFTC to implement the Dodd-Frank provisions. The Staff No-Action also contains comparable statements.