The Commodity Futures Trading Commission (CFTC) hosted a roundtable on April 3, 2014, to discuss three topics. First, the CFTC wanted to speak with market participants on the effects of Regulation 1.35 regarding recordkeeping obligations. Second, the Commission wanted to solicit feedback on whether contracts with embedded volumetric optionality should be considered futures subject to the Commission’s regulations. Finally, the CFTC wanted to hear thoughts on the “special entities” de minimis threshold for trading with government-owned electric companies.
Regarding Regulation 1.35, the Commission asked the panel about the definitions of “related cash or forward transactions” and “membership” and how these definitions affected the industry in relation to recordkeeping requirements. The panel expressed serious concerns with the definition of “member” and its interpretation, noting that the definition had been intended very differently than it was now being applied. The initial definition referred to market participants acting as intermediaries between financial markets and customers. Modern members, however, are not necessarily customer-facing, so the public is no better protected by imposing cumbersome recordkeeping regulations. The panel also asserted that the recordkeeping requirements for written communications related to cash or forward transactions were overly burdensome and required technological overhauls for which the costs far outweighed any potential benefits.
Acting Chairman Wetjen noted that the purpose behind these recordkeeping regulations was to enhance the enforcement capabilities of the Commission, by providing a deterrent and helping with investigative action. In response to the Acting Chairman’s prompting whether there were other policy considerations, the panel noted that the regulation pushed participants to trade outside its scope through less-efficient media, thereby undermining the regulation’s effectiveness while creating inefficiencies in the industry. The panel also observed that the distinction established between commodity pool operators (CPOs) and commodity trading advisors (CTAs) was meaningless and that both groups should benefit from the carve-outs established by the Commission. In response to further questions, the panelists explained that their interpretation of the current regulation was that it captured all conversation or dialogue that may be linked to a transaction. This breadth could create a stigma in dealing with regulated parties and diminish their competitiveness in the market, as well as provide disincentives for joining regulated designated contract markets (DCMs) or swap execution facilities (SEFs). Finally, the panel suggested that the Commission provide further guidance and advisories on the definition of “member” and the scope of recordkeeping obligations. The Commission stated that market participants may submit comments over the course of the next two weeks through the Commission’s website. For further discussion on the current issues surrounding Regulation 1.35, please see here.
In the second panel, discussing embedded volumetric optionality, the Commission sought feedback on its seven-part test to categorize transactions as swaps. The panel overwhelmingly expressed concerns with the seventh part of the test, which the panelists argued was too ambiguous to provide effective guidance. The panel also noted that the Commission must clearly distinguish between physically settled contracts and financial instruments. While financial instruments may fall under the regulatory framework established by the Commission, the panelists asserted that physically settled contracts should not and that they must be free of this burdensome regulatory oversight. When Acting Chairman Wetjen asked about the issues created by these ambiguities and how burdensome the effects on market participants were, the panelists observed that problematic regulatory restrictions slow down the commercial process and make the market function less efficiently by imposing unnecessary costs on participants, even when the parties are able to navigate around the problems in the regulations. The panelists suggested that options to ameliorate these issues include the Commission providing interpretive guidance and advisories on which market participants could rely to distinguish between physically settled and financial contracts.
Finally, the Commission discussed the “special entity” de minimis threshold for swap dealers transacting with government-owned electric companies. In response to the Commission’s request for thoughts on the threshold and its functioning, the panelists observed that these entities must be able to use swaps to hedge against market risks and energy volatility in order to insulate customers from these price variations. Without the shelter of the threshold, energy providers face difficulties in finding counterparties because counterparties do not want to be subject to the Commission’s regulations. Additionally, because of uncertainties in the definition of special entities, transacting parties cannot rely on counterparty representations. The panelists suggested that transforming the previous no-action relief into a rule would be a positive development, but that, at a minimum, increased clarity from the Commission regarding the definition of special entities and enforcement was necessary.
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This article was originally published by Bingham McCutchen LLP.