CFTC Eliminates Trade Option Reporting For Commercial Market Participants
On March 16, 2016, the Commodity Futures Trading Commission (the “CFTC”) adopted a final rule that eliminates reporting and recordkeeping requirements by “end-user” counterparties to trade option transactions. The final rule will become effective upon publication in the Federal Register. The immediate impact of the final rule is that end-users will not have to file Form TO by April 1, 2016, as would have been required by an earlier no-action letter issued by the CFTC. The final rule appears to be mainly good news for commercial energy firms. End-users don’t have to file Form TO and they are relieved from certain recordkeeping requirements for trade options. Further, end-users’ swap reporting counterparties (formed by entering into bilateral swaps with other end-users) are no longer required to report trade options. Also, the CFTC indicated that it will not require trade options to be subject to position limits in the much-anticipated final rule on position limits. Finally, the CFTC removed a requirement to file a notice with its Division of Market Oversight when any market participant’s aggregate notional value of trade options, in a calendar year, reaches $1 billion.
Unfortunately, it took the CFTC over three years to arrive to this point, despite repeated filings by various market participants and organizations that all along argued the very same conclusions the CFTC has reached in this final rule. In the meantime, commercial market participants spent countless hours and resources vetting various physically settled transactions such as tolling agreements, take-or-pay contracts, baseload plus swing load transactions, natural gas peaking transactions, commercial and industrial full requirement agreements, seasonal exchange agreements, asset management agreements, and other similar agreements and transactions, in order to determine whether they had to be designated as trade options. Also, many buyers and sellers who disagreed with their counterparties regarding the appropriate designation of certain transactions, experienced additional burdens on their commercial, risk, compliance, and legal resources. After experiencing unnecessary burdens to comply with trade option evaluation and reporting, market participants will certainly have to spend additional resources to update their relevant policies, procedures, training, and contracts documentation in order to implement the final rule. Hopefully, the regulatory evolution of trade options will be a good teaching moment for both the CFTC and market participants, and each side will listen to the other a little more and talk past each other a little less.
The CFTC pointed out in the final rule that the definition of a trade option is not open to discussion. In other words, trade options are here to stay and the CFTC is using its exemptive authority to remove some of the reporting and recordkeeping requirements for some market participants (end-users) at this time. Swap dealers and major swap participants are still required to report trade options just as they report swaps. In her concurring statement to the final rule, CFTC Commissioner Bowen pointed out that “[t]rade options have been caught in a difficult legal bind. Congress sought to ensure that people could not evade our swaps regulations. It did so by both having a very broad definition of a swap, while also limiting this Commission’s authority to exempt swaps by regulation. Fortunately, however, Congress preserved the Commission’s authority to exempt trade options, which is the authority we are once again using today. Importantly, this exemption provides additional legal certainty that our interpretations cannot. But we cannot overrule the Commodity Exchange Act with regulations and interpretations; we will always be bound by that statute. Therefore, I want to caution anyone tempted to rely on an interpretation to avoid CFTC jurisdiction when it comes to options. I fully recognize the difficulty in distinguishing between different types of physical contracts. If a particular contract or an element of a contract serves an economic purpose similar to an option, I believe the best course of action is to exercise caution and not assume your contract is outside of our jurisdiction based on an interpretation. While it may seem fine for a person using these contracts to hope that the interpretation is not called into question, I believe it would be wise, as a backstop, to make sure it also falls within the trade option exemption.” At the end of the day, legislative action may be needed to either clarify or eliminate the very definition of trade option. While the final rule is an important chapter in the trade option saga, there is no doubt that we are still far from the final chapter.