CFTC Announces Three Actions to Clean up Problems with Swaps Regulations (with Lofchie Comment) (CFTC Letter 14-72)

The CFTC announced three actions to address problems in prior rulemakings: (i) a proposed rule amendment to the swap dealer de minimis provisions that would allow parties to enter into a meaningful volume of swaps with utility special entities before being required to register with the CFTC, (ii) an extension of the comment period on the CFTC's proposed position limits as applied to commercial market participants, and (iii) the promotion of end-user trading on swap execution facilities ("SEFs") and designated contract markets ("DCMs").

Both Acting Chairman Wetjen and Commissioner O'Malia applauded the actions, noting that the proposals mark a significant victory for the end-user community. Commissioner O'Malia stated he is pleased that the CFTC "has chosen to confront the shortcomings in its rules by using the proper process that is consistent with the Administrative Procedures Act." The three actions are summarized below.

Proposal to Amend Regulations for Entities Entering into Swaps with Utility Special Entities

The proposed rule amendment would adjust the de minimis threshold for determining if an entity that enters into swaps with utility special entities must register as a swap dealer. It would also amend the CFTC's swap dealer definition to permit a person dealing in "utility operations-related swaps" with "utility special entities" to exclude those swaps in determining whether that person has exceeded the de minimis threshold specific to dealing with special entities. Under the proposal, however, such swaps would be considered to determine whether the general dealing de minimis threshold applies.

Comments on the proposal will be due 30 days after it is published in the Federal Register.

Notice Opening Comment Period to Further Consider Certain Issues Related to Hedging of Physical Commodities

The CFTC reopened the comment periods for the Position Limits Proposal and the Aggregation of Positions Proposal for a three-week period beginning June 12, 2014, and ending July 3, 2014, requesting that market participants comment on:

• hedges of a physical commodity by a commercial enterprise, including gross hedging, cross-commodity hedging, anticipatory hedging, and the process for obtaining a non-enumerated exemption;
• the setting of spot month limits in physical-delivery and cash-settled contracts and a conditional spot-month limit exemption;
• the setting of non-spot limits for wheat contracts;
• the aggregation exemption for certain ownership interests of greater than 50 percent in an owned entity; and
• aggregation based on substantially identical trading strategies.

The CFTC will also hold a public roundtable on June 19, 2014, to consider certain hedging issues relating to market practices in physical commodity derivatives.

No-Action Relief from Compliance with Certain Requirements under Rule 1.35(a) for Certain Members of DCMs or SEFs

The CFTC Division of Swap Dealer and Intermediary Oversight and Division of Market Oversight issued a no-action letter that provides relief with respect to compliance with certain recordkeeping provisions of Rule 1.35(a) ("Records of Commodity, Interest and Related Cash or Forward Transactions") to members of DCMs or SEFs that are not registered or required to be registered with the CFTC ("Covered Members").

The letter provides relief, pending further CFTC action, to Covered Members with respect to complying with the requirements under Rule 1.35(a) to keep electronic text messages and to keep records in a form and manner identifiable and searchable by transaction.

Lofchie Comment: These three actions are significant steps forward in cleaning up rules adopted under the CFTC's former leadership.

The proposed rule amendment applicable to swaps with utilities will greatly expand the universe of entities with which utilities are able to trade, as utilities will no longer be limited (as a practical matter) to trading with CFTC-registered swap dealers.

The extension of the comment period as to physical commodities is a move to head off the likelihood of litigation that would result if the CFTC re-adopts its prior position limit rules without going through a more significant comment process and/or without performing a meaningful cost-benefit analysis. (Note that the extension of the comment period does not apply to the whole release, but only to those portions that relate to "hedges of a physical commodity by a commercial enterprise"; i.e., not to the use of swaps by financial institutions.)

The third action provides no-action relief (not time-limited!) from certain aspects of the Rule 1.35 recordkeeping requirements for firms that are not otherwise registered with the CFTC. The relief in the letter is not available to CFTC registrations even though the letter notes that it is not clear whether there exists a technology that can fulfill the requirements of the rule that is not "cost-prohibitive."

These three actions will help clean up problems with the existing rules. A next welcome step would see the CFTC extend this clean up beyond commercial users of swaps to include financial market participants. Lessening the burdens of Rule 1.35 for commercial users may induce more such users to trade on swap execution facilities ("SEFs"); however, they are less likely to find good prices there if Rule 1.35 discourages the use of SEFs by CFTC registrants.

See: Proposed Rule Regarding Swaps with Utility Special Entities; Extension of Comment Period for Position Limits; CFTC No-Action Letter 14-72; CFTC Press Release.
Related news for Proposal to Amend De Minimis Threshold: House Agriculture Committee Reps. Issue Statement on Swaps with Public Utilities (with Lofchie Comment) (March 26, 2014); CFTC Issues No-Action Letter on the Treatment of Swap Transactions by Certain Non-U.S. Persons for Purposes of Making Calculations under the Swap Dealer Definition (CFTC Letter 13-64) (October 17, 2013); Senators Submit Letter to CFTC Demanding More Regulation in the Energy Swap Markets (May 21, 2013).
Related news for Opening of Comment Period: CFTC Issues Proposed Position Limits Rule (Fed. Reg.) (December 12, 2013); CFTC Issues Proposed Position Limits Rule for Derivatives (Pre-Fed. Reg.) (with Zwirb Comment)(December 3, 2013); CFTC Publishes Proposed Rules for Aggregation of Positions (Fed. Reg. Version) (November 15, 2013) Key Differences between the Recent CFTC Position Limits Proposal and the Previously Vacated Final Position Limits Rule (with Delta Strategy Group Summary) (November 18, 2013); Cadwalader Memo on Proposed Position Limits and Aggregation Rules (with Lofchie Comment) (November 6, 2013); CFTC Approves Position Limits Proposal (with Lofchie and Zwirb Comments and Delta Strategy Group Summary) (November 5, 2013).
Related news for No-Action Relief for DCMs and SEFs: CFTC Staff Issues Time-Limited No-Action Letter on the Applicability of Oral Recording Requirements for Certain Members of DCMs or SEFs (CFTC Letter 14-60) (with Lofchie Comment) (April 25, 2014); CFTC Issues No-Action Letter on Applicability of Oral Recording Requirements for Certain Members of SEFs (CFTC Letter 13-77) (December 23, 2013); CFTC Issues No-Action Relief to Two FCMs with Regard to Oral Recording Requirements (CFTC Letter 13-72) (with Lofchie Comment) (December 18, 2013).