CFTC Releases Final Interpretation of Forward Contracts with Embedded Volumetric Optionality (with Lofchie Comment)

The CFTC released its final interpretation of "Forward Contracts with Embedded Volumetric Optionality" (the "Interpretation").

The Interpretation consists of seven elements that clarify when an agreement, contract or transaction falls within the forward contract exclusion from the "swap" and "future delivery" definitions in the CEA, notwithstanding that it contains embedded volumetric optionality. While most of the seven elements of the Interpretation remain largely unchanged from those in the original release, the fourth, fifth and seventh elements were modified for clarity. The seven elements now include the following distinctions:

1. The embedded optionality does not undermine the overall nature of the agreement, contract or transaction as a forward contract;
2. The predominant feature of the agreement, contract or transaction is actual delivery;
3. The embedded optionality cannot be severed and marketed separately from the overall agreement, contract or transaction in which it is embedded;
4. The seller of a nonfinancial commodity underlying the agreement, contract or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract or transaction, to deliver the underlying nonfinancial commodity if the embedded volumetric optionality is exercised;
5. The buyer of a nonfinancial commodity underlying the agreement, contract or transaction with embedded volumetric optionality intends, at the time it enters into the agreement, contract or transaction, to take delivery of the underlying nonfinancial commodity if the embedded volumetric optionality is exercised;
6. Both parties are commercial parties; and
7. At the time that the parties enter into the agreement, contract or transaction, the embedded volumetric optionality is intended primarily to address physical factors or regulatory requirements that reasonably influence demand for, or supply of, the nonfinancial commodity.

The CFTC noted that the Interpretation was issued jointly with the SEC after consultation with the Board of Governors of the Federal Reserve System. However, it is an interpretation solely by the CFTC and does not apply to the exclusion from the swap and security-based swap definitions for security forwards, or to the distinction between security forwards and security futures products.

CFTC Chair Massad issued a statement of support, adding that the Interpretation will "alleviate ambiguity and allow contracts with volumetric optionality that truly are intended to address uncertainty."

Commissioner Bowen issued a concurring statement of support. However, she expressed concern that the Interpretation "does not provide the clarity that may be required." She explained that statutory restrictions involving the definitions of forwards and options place limits on the relief available through interpretations, and added that the industry would benefit from the kind of "broader relief" that provides greater legal certainty.

Lofchie Comment: Commissioner Bowen's statement of support is both a thoughtful exposition of the law and wonderfully honest in its allowance that the new interpretation, while improved, does not resolve all questions of definitional ambiguity. Her statement also suggests that Congress should consider amending the CEA to expand the authority of the CFTC to provide exemptive relief from Dodd-Frank in order to reduce the costs that the statute imposes on nonfinancial institutions.

See: Fact Sheet; Final Interpretation; Chair Massad's Statement; Commissioner Bowen's Concurring Statement.Related news: CFTC Proposes to Clarify Its Interpretation of Forward Contracts with Embedded Volumetric Optionality (Fed. Reg.) (November 20, 2014); CFTC Approves Rule Proposals and Product Interpretation (with Delta Strategy Group Summary and Lofchie Comment) (November 3, 2014).