The Commodity Futures Trading Commission (CFTC) today issued two critical and highly anticipated final rules under the Dodd-Frank financial reform law: definition of a “swap” and “end-user” exemption to the clearing requirement.
“The final rules appear to put the interests of consumers first by allowing utilities to continue hedging against commodity price volatility in a cost-effective manner,” EEI President Tom Kuhn said. “Similar to the commission’s “swap dealer” rule issued in April, the CFTC’s new rules will help protect utility customers from wholesale price volatility in electricity markets—this is essential to consumers who depend on an affordable supply of electricity.
Swaps: EEI believes that the final swap definition correctly recognizes that many utility transactions should not be considered swaps. Transactions defined as swaps by the commission are subject to heavy CFTC regulation and oversight—these include reporting and clearing requirements that require the posting of collateral as commodity prices change in the markets every day.
Utilities engage in over-the-counter (OTC) bilateral transactions with other utilities and in transactions within the financial markets in order to lock in a guaranteed price for commodities such as electricity, natural gas and coal for future delivery. This gives utilities the ability to hedge against and protect their customers from price volatility.
The CFTC is expected to clarify the scope of the “forward contract exclusion,” which states that sales of physical commodities like electricity for deferred shipment or delivery are not swaps. This is consistent with the intent of the Dodd-Frank Act to impose additional regulations only on entities posing a systemic risk to the economy—and not on entities that are in the markets primarily to hedge against volatility. Utility and customer costs would have increased significantly had the commission defined utility transactions as swaps.
Through this clarification, the CFTC excluded “book-outs,” which allows a company that finds itself in a logistics or delivery “chain” to enter into a financial settlement with the other parties in the chain—rather than requiring the company to arrange for inefficient scheduling or delivery.
The Commission in the final rule also included new interpretive guidance to clarify that contracts that include embedded volumetric optionality, such as full-requirements contracts, are forward contracts and not swaps when a seven-factor test is met. EEI appreciates the recognition of EEI’s comments in this area and the recognition that these contracts, which are frequently used by EEI members, may not be swaps.
However, some significant uncertainties remain. Transactions in the organized electricity markets (i.e., the RTOs/ISOs) are not addressed in this rule and instead will be addressed by a CFTC proposed exemptive order at a later date.
End-User Exception: The CFTC’s final rule implementing the end-user exception to the clearing requirement reduces the regulatory burden on utilities that choose not clear. In general, the rule allows EEI members to avoid the margin requirements associated with clearing and allows them to continue to use derivatives to insulate customers from price volatility.
Other than notification that they are using the exception, utilities will not be subject to transaction-by-transaction reporting requirements, and they instead will be allowed to report most information related to their use of the exception on an annual basis. This will significantly reduce the burden and cost of utilities’ reporting obligations.
“We’ll need to closely examine the rules once published, but based on what we know so far, the CFTC is to be commended for recognizing the importance of protecting consumers as it moves forward with implementation of the Dodd-Frank financial reform law,” Kuhn said.