On June 2, 2014, the Commodity Futures Trading Commission (CFTC) published in the Federal Register a notice of a proposed amendment to the de minimis exception from the definition of “swap dealer” with respect to certain swaps entered into with government-owned utilities. As explained below, the adoption of this proposal would expand the number of entities that would be willing to enter into swaps with those utilities. The text of the Federal Register notice can be found here.
The Dodd-Frank Act created new regulatory obligations for certain participants in the Over-the-Counter (OTC) derivatives market that are required to register as swap dealers, by subjecting them to extensive business conduct, reporting, and recordkeeping requirements. The CFTC adopted a rule in 2012 that provided that a firm is excluded from the definition of “swap dealer” if its level of swap dealing activity during the preceding twelve-month period did not exceed a specified threshold known as the de minimis threshold. The general de minimis threshold was initially set at $8 billion of aggregate notional amount of swaps so that only firms dealing with large numbers of swaps would be required to register. However, the CFTC rule also provided a separate de minimis threshold for swaps entered into with “special entities.” The term “special entity” is defined to include, among other things, a State, municipality, political subdivision of a State, or any instrumentality, department, or corporation established by a State or subdivision of a State. Government-owned gas and electric utilities thus are deemed to be “special entities” under the CFTC’s rule.
At the time when Congress adopted the Dodd-Frank Act, certain municipalities had recently been burned by entering into unsuitable derivatives transactions. In response to those events, Congress added certain provisions to the Act that provide special protections for municipalities and other special entities in connection with their derivatives transactions. For that reason, the CFTC adopted a much lower de minimis threshold of $25 million for swaps entered into with special entities, as compared with the general de minimis threshold of $8 billion. The rationale for this much lower threshold was that any firm entering into a swap with a special entity (other than a small, isolated transaction) should be required to register as a swap dealer, so that the special entity would be protected by the regulatory requirements applicable to swap dealers.
This approach, however, had unintended consequences. It had the effect of limiting the types of firms willing to enter into swaps with special entities only to large banks that were registered as swap dealers. Other potential counterparties, who did not wish to register as swap dealers, refused to deal with special entities. This situation led a group of trade associations representing utility special entities to file a Petition with the CFTC seeking to amend the de minimis threshold as applied to utility special entities. The Petition pointed out that utility special entities purchase electric energy, fuel, and gas supplies in the physical delivery markets and enter into bilateral commodity swaps with customized terms to hedge their operational risks. The terms for these customized swaps vary from one regional geographic market to the next, and different counterparties are active in these different markets. Accordingly, the Petition asked the CFTC to amend its de minimis threshold applicable to utility special entities so that more counterparties would be willing to deal with them and thus provide greater liquidity and price competition for their swap transactions.
The CFTC’s current proposal responds to the Petition. Under the proposal, swaps with utility special entities would count against the larger $8 billion general de minimis threshold rather than the smaller $25 million de minimis threshold, provided that the swaps were used for hedging a utility special entity’s risk in connection with (i) the generation, production, purchase, or sale of natural gas or electric energy; (ii) the supply of natural gas or electric energy to a utility special entity; (iii) the delivery of natural gas or electric energy service to customers of a utility special entity; (iv) the fuel supply for the facilities or operations of a utility special entity; (v) compliance with an electric system reliability obligation; or (vi) compliance with an energy, energy efficiency, conservation, renewable energy, or environmental statute or regulation applicable to a utility special entity.
The public comment period for the CFTC proposal ends on July 2, 2014.