Last week the Commodity Futures Trading Commission (CFTC) issued a notice of proposed order and request for comment proposing to allow a private right of action to enforce violations of the anti-manipulation, anti-fraud or scienter based provisions (Anti-fraud provisions) of the Commodity Exchange Act (CEA) in organized electricity markets. The proposal is a controversial reversal of policy that critics say could open electricity market participants to increased costs and liability. Continue Reading CFTC Proposes Reversing Course, Granting Private Right of Action in Energy Market Manipulation
Primary regulators of energy transactions, the Federal Energy Regulatory and Commodity Futures Trading Commissions (FERC, CFTC or jointly Participating Agencies) began the new year by entering on January 2 two overdue Memoranda of Understanding (MOU), one on overlapping jurisdictions, the other on sharing of information generated in connection with market surveillance and investigations into suspected market manipulation, fraud or abuse. Both MOUs became effective immediately.
FERC, with jurisdiction over physical natural gas and power transactions, and the CFTC, with jurisdiction over financially settled products such as energy futures and swaps, had battled in recent years over the reach of each other’s jurisdiction, culminating in a March 2013 decision of the U.S. Court of Appeals for the D.C. Circuit finding that FERC improperly invaded CFTC’s jurisdiction when, under authority of the Energy Policy Act of 2005, it sought to fine Amaranth Advisors trader Brian Hunter for allegedly manipulating natural gas futures in order to increase the profitability of corresponding physical natural gas transactions. When the Participating Agencies failed to meet the 2011 deadline of the Dodd-Frank Wall Street Reform Act for reaching the jurisdictional understanding, a troika of western-state senators with energy committee portfolios – Dianne Feinstein (D-CA), Ron Wyden (D-OR) and Lisa Murkowski (R-AK) – expressed concern and called on the two commissions to expedite action on an MOU.
The MOUs put in place procedures that replace a reactive status quo ante in which the two agencies collaborated and shared information, if at all, only upon the request of one or the other, with a proactive framework that obliges the staffs of both agencies to notify each other of requests from within their regulated community for authorizations or exemptions from authorization requirements that may implicate the other’s regulatory responsibilities. Once so notified, the Notified Agency must promptly inform the Notifying Agency that it (1) has no interest, (2) has an interest, triggering a consultative process between the staffs of the Participating Agencies, or (3) wants to revisit the issue once a regulated company has filed request for an authorization or exemption or the Notifying Agency has instigated sua sponte an authorization or exemption. If (2) is selected, then the triggered consultative process will seek to determine whether the CFTC has jurisdiction under the Commodity Exchange Act or FERC has jurisdiction under the Federal Power, Natural Gas or Natural Gas Policy Acts, with disputes elevated from staff to directors and ultimately to the respective commissioners. While the jurisdictional MOU imposes these obligations on the Participating Agencies, it expressly creates no private right of action that could be enforced by a regulated company or other third party.
The MOU on information sharing obligates the Participating Agencies to share information needed in connection with each other’s market surveillance or investigations into suspected manipulation, fraud or market power abuse in markets that the requesting Participating Agency regulates. FERC is authorized to seek from the CFTC information from (1) designated contract markets, (2) registered swap execution facilities, (3) registered derivatives clearing organizations, (4) boards of trade and (5) market participants. The CFTC, on the other hand, is authorized to seek from FERC information from (1) regional transmission organizations or independent system operators, (2) the North American Electric Reliability Corporation, (3) interstate natural gas pipelines and storage facility operators, and (4) market participants. Specific provisions of the MOU obligate both Participating Agencies to take all actions reasonably necessary to preserve, protect and maintain privileges and claims of confidentiality for non-public information. Sharing information pursuant to the MOU expressly does not constitute a waiver of any privilege or protection attached to the shared information.
by Simone Goligorsky and David McDonnell
On 11 July 2013, the European Commission (EC) and the United States Commodity Futures Trading Commission (CFTC) announced a high-level joint understanding, known as the “Path Forward”, which details the shared future vision on the cross-border regulation of over-the-counter (OTC) derivatives (click here for the full announcement). This is a welcome announcement, given the concerns that many market participants had regarding the possibility of certain derivative transactions being subject to regulation on both sides of the Atlantic. The Path Forward has been produced as part of the package that was developed in order to promote the transparency of OTC derivatives markets and to lower the risks associated with them.
At the core of the Path Forward is the objective of avoiding what was viewed by some market participants as the ‘double treatment’ of derivatives, whereby the derivatives would have been subject to the simultaneous application of both European and US legislative requirements, potentially leading to inconsistency, conflicts of law, and legal uncertainty. Considering the level of similarity between the European and US regimes, the EC and CFTC have agreed that such a duplicative approach may be, to the greatest extent possible, avoided.
Instead, the EC and CFTC will, where appropriate, defer to the regulatory requirements in either Europe or the United States, as applicable. For example, under the European Market Infrastructure Regulation (EMIR), the EC has adopted risk mitigation rules that have a high-degree of similarity to the CFTC’s business conduct standards. Important action has been taken on bilateral, uncleared swaps, so that the regulatory rules in both jurisdictions will be viewed as comparable and as comprehensive as one another. The net result is that market participants are likely to now benefit from these equivalence rules.
In addition to the progress made to date, the EC, CFTC, and the European Securities and Markets Authority (ESMA) will continue to work together, and with other global regulators, on the harmonisation of international rules on posted margins for uncleared swaps, with a view to implementing a uniform system across as many jurisdictions as possible.
It is worth noting that while the Path Forward heralds a significant step for enhanced cross-border regulation, market stability, and confidence, it was relatively light on concrete details. As such, market participants subject to European regulations, as well as US counterparties governed by Dodd-Frank, should continue to monitor collaboration between both regulatory authorities closely.
On February 7, 2013, it was announced that the Economic and Monetary Affairs (ECON) Committee of the European Parliament (EP) was withdrawing its objection to the technical standards (TS) for the regulation on over-the-counter derivatives, central counterparties and trade repositories, commonly known as the European Markets Infrastructure Regulation (EMIR).
The TS supplement the level 1 text of EMIR, which came into force in August 2012. It is the TS that define who exactly will be affected by EMIR, and how.
Following the endorsement of the TS in December 2012 by the European Commission (EC), after they were published by the European Securities and Markets Authority in September 2012, the TS were undergoing the last review prior to their publication in the Official Journal of the European Union. Many market participants expected the EP’s review to a procedural, rubber-stamping exercise.
However, on January 24, 2013, it was confirmed that the ECON Committee was to publish a motion for a resolution to reject certain TS. One of the reasons given for mooting the rejection was the view that the EC had gone beyond its remit for the TS, set out for it in the level 1 text of EMIR, when drafting the TS.
The TS in question related to matters including, inter alia:
- The clearing threshold for non-financial counterparties, particularly the condition that if the clearing threshold for one asset class was exceeded by a counterparty, then the counterparty would be automatically held to have exceeded the threshold for all asset classes; and
- The requirement for timely confirmations, in particular how this obligation would affect smaller, non-financial counterparties.
If the TS had been rejected, then the EC would have been required to put forward new TS. This may have, in turn, have delayed the publication of the TS, and ultimately, the coming into force of EMIR.
However, on February 7, 2013, the EP withdrew the resolution calling for the rejection of the draft TS. The withdrawal of the objection was based on certain assurances given by the EC, including the assurance that the EC would publish frequent ‘questions and answer’ booklets to cover any matters over which there arose legal uncertainty.
EMIR has been tabled as the US equivalent of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank). As currently drafted, market participants undertaking activities in both the US and European markets may be subject to both Dodd Frank and EMIR, requiring, them, for example, to report trades to both European and US regulators.
To avoid market participants having to report to two sets of regulators, European regulators are meeting with their US counterparts over the course of Q1 and Q2 2013, to advise the United States that EMIR should be accepted as being as strict as Dodd Frank. If accepted, market participants complying with EMIR would be deemed to comply with Dodd Frank, and vice versa.
As the publication of the TS will not be delayed as much as initially thought, EMIR’s entry into force is not expected to be delayed. The first obligations (the reporting of credit and interest rate derivatives) is expected to apply from July 2013. The remaining obligations will come into force periodically, with EMIR expected to be fully in force by Summer 2014.
The Dodd-Frank Act was signed into law more than two years ago, but the energy industry remains mired in uncertainty as the U.S. Commodity Futures Trading Commission (CFTC) continues to finalize inter-related rules in a piecemeal fashion even as compliance obligations have taken effect. At least 14 proposed rulemakings (see table below) have yet to be finalized due to pending resolution on comments and petitions, and the CFTC is still sitting on proposed orders and petitions. In a joint filing, leading associations for the electric and natural gas industries requested a stay of the application of the rules because of the uncertainty caused by the Commission’s implementation schedule. On the first day of compliance, the CFTC provided limited relief through a number of no-action letters, but the request for a more comprehensive stay has been ignored. Below are some of the key proceedings for the energy industry.
Major industry trade associations petitioned the CFTC to exclude certain energy-related swaps with “Special Entities” (government entities, such as state agencies) from being included in the calculation of the de minimis threshold for Swap Dealer registration. The trade associations argued that the low threshold amount for swaps with Special Entities would decrease the number of potential counterparties to the swaps and raise costs.
While the CFTC has not acted on that petition, the CFTC did issue no-action relief on October 12 to companies who remain under a threshold of $800 million for swaps with “Utility Special Entities” (special entities that are Federal power marketing agencies or that own/operate electric or natural gas facilities with public service obligations under Federal, state or local law), up from the rule’s $25 million threshold applicable to swaps with all Special Entities. To rely on the no-action relief, entities must provide notice of the exemption election to the CFTC by December 31, 2012, and thereafter on a quarterly basis, along with a list of relevant transactions. The CFTC’s no-action relief will remain in effect until the CFTC acts on the petition.
The energy industry has also been waiting for a final determination from the CFTC that energy products traded in FERC-recognized regional transmission organization (RTO) and independent system operator (ISO) markets will be exempt from CFTC regulation (other than provisions relating to the CFTC’s general anti-fraud, anti-manipulation and enforcement authority). In August, the CFTC published a proposed order that would exempt certain energy transactions, forward capacity transactions, financial transmission rights (FTR) transactions and certain other ISO/RTO transactions in FERC-recognized wholesale markets, including CAISO, PJM, NYISO, ISO-NE, MISO and ERCOT. The CFTC has not finalized the proposed order, but it did provide temporary relief on October 11, issuing a no-action letter for these energy products, which will remain in place until the earlier of the date the CFTC acts on the proposed order or March 31, 2013.
The CFTC issued additional no-action relief to provide for the Intercontinental Exchange’s (ICE) transition of all ICE swap products to CFTC-regulated futures. ICE announced in September that all of its cleared over-the-counter (OTC) energy swaps and options would be transitioned to futures on October 15, three days after the initial compliance date for entities to begin calculating whether the volume of swaps that they trade would require them to register with the CFTC as a Swap Dealer or Major Swap Participant. In response to industry requests for a delay of enforcement, the CFTC provided temporary no-action relief on October 12, allowing companies to exclude from notional value calculation all swaps executed prior to October 20.
Proposed Rulemakings that Have Yet to be Finalized
|Date Proposed||Proposed Rules|
|To be proposed||Revised Position Limits Rule|
|10/23/12||Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations|
|8/21/12||Clearing Exemption for Swaps Between Certain Affiliated Entities (CEA)|
|8/7/12||Clearing Requirement Determination under Section 2(h) of the CEA|
|7/17/12||Clearing Exemption for Certain Swaps Entered into by Cooperatives|
|7/12/12||Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act|
|3/15/12||Procedures to Establish Appropriate Minimum Block Sizes for Large Notional Off-Facility Swaps and Block Trades|
|2/24/12||Harmonization of Compliance Obligations for Registered Investment Companies Required to Register as Commodity Pool Operators|
|2/14/12||Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Covered Funds|
|12/14/11||Process for a Designated Contract Market or Swap Execution Facility to Make a Swap Available to Trade under Section 2(h)(8) of the Commodity Exchange Act|
|9/20/11||Swap Transaction Compliance and Implementation Schedule; Trading Documentation and Margining Requirements under Section 4s of the CEA|
|5/12/11||Capital Requirements of Swap Dealers and Major Swap Participants|
|4/28/11||Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants|
|1/7/11||Core Principles and Other Requirements for Swap Execution Facilities|
|1/6/11||Governance Requirements for Derivates Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities; Additional Requirements Regarding the Mitigation of Conflicts of Interests|
Christopher Bloom, associate in McDermott’s Energy Advisory practice, contributed to this article.
The Federal Energy Regulatory Commission (FERC) General Counsel recently argued to the Commodity Futures Trading Commission (CFTC) that “[a]pplying Dodd-Frank swap regulations to [regional transmission organization] RTO and [independent system operator] ISO products and services is not only unnecessary but also potentially harmful.” Transactions entered under RTO and ISO tariffs, according to the FERC General Counsel, should be exempt from the definition of “swap.”
The FERC General Counsel made these arguments in August 21 comments, partially supporting the petition of the nation’s six RTO/ISOs asking the CFTC to exempt them from swaps regulation under the Commodity Exchange Act in connection with four types of electricity purchases and sales they offer pursuant to FERC- or Public Utility Commission of Texas-approved tariffs. The FERC General Counsel had to resort to comment in order to make the Commission’s views known because the FERC and CFTC have yet to enter into a memorandum of understanding for “resolv[ing] conflicts concerning overlapping jurisdiction between the [two] agencies,” as required by § 720 of Dodd-Frank Wall Street Reform and Consumer Protection Act.
All RTO/ISO activities, from planning and operating transmission grids to dispatching generation resources to complying with reliability standards are governed by explicit tariffs that FERC must approve before they take effect. FERC staff also monitors RTO/ISO market operations, and ensures that they comply with FERC reporting requirements and credit practices. Consequently, according to the FERC General Counsel “[i]t makes little sense to subject organized electricity markets and transactions that are conducted pursuant to FERC-approved tariffs, subject to extensive reporting, as well as to FERC’s enforcement authority, to an entirely different regulatory model” under Dodd-Frank.
The FERC General Counsel also took issue with the scope of the exemptions that the RTO/ISOs sought, which would exempt only four categories of RTO/ISO transactions: (1) financial transmission rights, (2) energy transactions, (3) forward capacity transactions and (4) reserve or regulation transactions. The FERC General Counsel argued that all purchases and sales of products that are a logical outgrowth of the ISO or RTO’s core functions should be exempt in order to allow the ISOs/RTOs flexibility to adapt their products over time.
The CFTC is expected to make a ruling on the RTO/ISO petition and the FERC General Counsel’s comments by the end of the year.
The Commodity Futures Trading Commission (CFTC) has met resistance in its attempt to implement parts of the Dodd-Frank financial reform less than two weeks before they were scheduled to go into effect. On September 28, U.S. District Judge Robert L. Wilkins issued an opinion vacating the CFTC’s position limits rule and remanding it to the Commission. Judge Wilkins’ problem with the rule was not its substance but rather that the CFTC did not make necessary factual findings mandated by the Dodd-Frank Act.
The position limits rule was finalized in November and set spot-month position limits for both physical delivery and cash-settled contracts tied to 28 physical commodities, including natural gas and crude oil. The U.S. District Court for the District of Columbia vacated and remanded the rule because the CFTC made no findings about whether position limits were “necessary and appropriate” to “diminish, eliminate, or prevent excessive speculation” before imposing them, as the Dodd-Frank Act required. The CFTC contended that the Dodd-Frank Act mandated that the agency set position limits and went so far as argue that the CFTC had no discretion not to impose the limits.
The court disagreed with the CFTC’s interpretation and instead determined that Congress “clearly and unambiguously” required the Commission to make a finding of necessity prior to imposing position limits. The court found that the Commission has a longstanding requirement to make a finding of necessity under the Commodity Exchange Act (CEA). The CEA contains substantially similar language to Dodd-Frank, and the CFTC has made necessity findings before promulgating regulations for 45 years under the CEA. Given this history and the similarity in Congress’s mandate between the two statutes, the court was not convinced there was any reason the Commission should deviate from its previous practices. The court concluded that Dodd-Frank unambiguously requires that the Commission find that position limits are necessary prior to their imposition.
The court’s opinion leaves open the possibility of issuing a new rule about position limits after the CFTC makes a finding of necessity. Gary Gensler, Chairman of the CFTC, says the agency is “considering ways to proceed.” Gary Chilton, a Commission member, has called for a new proposal on position limits that satisfies the court’s objections. In a statement, Mr. Chilton vowed to continue the push for a position limits rule. Michael V. Dunn, the commissioner who provided the third vote in favor of the rule, has since left the CFTC.
The court did not rule on whether the agency must conduct a full cost-benefit analysis, leaving the question open to a future challenge should the Commission pass a new rule on position limits.
On August 22, 2012, the U.S. Securities and Exchange Commission (SEC) issued final rules on Section 1504 of the Dodd-Frank Act, which requires resource extraction issuers to publicly disclose certain payments made to the U.S. and to foreign governments that are more than $100,000 in a fiscal year. Payments must be detailed by type and total amount and must be reported on a project-by-project basis. Intended to bring greater transparency and accountability to the industry, these new rules are controversial and have raised concerns about the added cost of compliance and whether there are competitive disadvantages to issuers. Companies with reporting requirements under this new rule should begin as soon as possible to determine how and whether these new rules apply.
To read the full article, click here.
by Ari Peskoe
IntercontinentalExchange (ICE) announced June 30 that it will convert all of its cleared over-the-counter (OTC) derivative products listed on its OTC energy market to futures. Cleared North American natural gas, electric power, environmental products and natural gas liquids swaps will be listed as futures on the energy division of ICE Futures; cleared oil products will be listed as futures on ICE Futures Europe. The transition is in reaction to new regulations being phased in pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which are expected to make OTC swap trades more costly.
Currently, traders can exchange futures products, cleared OTC products, and uncleared OTC products on ICE’s platforms. ICE’s cleared OTC products provide access to centralized clearing and settlement arrangements while reducing bilateral credit risk and capital required for OTC trades. ICE currently offers over 760 cleared OTC energy contracts. Since both futures and many cleared OTC swaps currently offered by ICE are standardized contracts, the transition to futures will allow traders to use similar products but avoid the more costly regulations being phased in under Dodd-Frank. Traders will continue to be able to exchange uncleared OTC products or bilateral contracts on ICE’s OTC platform, which will become a swap execution facility regulated by the Commodity Futures Trading Commission (CFTC).
Under new CFTC regulations, OTC products, — whether standardized and cleared products or uncleared bilateral contracts — will become subject to more extensive and burdensome regulation than standard futures contracts. The increased regulation is to include reporting requirements and higher margin and collateral requirements. Additionally, firms with more than a de minimis number of OTC transactions can be subject to regulation as swap dealers. Because of regulatory burdens attached to OTC products, it is anticipated that other exchange operators that clear swaps will follow ICE’s lead in transitioning to less burdensome futures.
The new regulations and ICE’s transition to futures stand to benefit ICE since traders may opt to use proprietary listed futures products in lieu of customized contracts that can be sent through any clearinghouse. Conversely, the banking sector stands to lose market share since historically it has sold customized bilateral swaps to customers who are now likely to turn to futures contracts whenever possible.
The transition from OTC swaps to futures is subject to approvals from the CFTC and the Financial Services Authority.
*Jessica Bayles, a summer associate in the McDermott’s Washington D.C. office, contributed to this article.
by Ari Peskoe
In a joint-rulemaking finalized last month, the Commodities Future Trading Commission (CFTC) and the Securities Exchange Commission (SEC) declined to adopt specific exemptions for the electricity industry in its definitions of “swap dealers” and “major swap participants.” It is likely, however, that many industry participants will be able to take advantage of exemptions for swaps entered into for the purpose of hedging price risks related to physical positions and the de minimis exception, or that relevant transactions will be excluded from the definition of the term “swap.”
Comments submitted by the industry on the proposed rule argued that the many unique characteristics of swaps related to electricity markets entitled them to special treatment by regulators. For example, as opposed to many other physical commodities, electricity must be generated and transmitted at the instant it is needed, and while demand for electricity is relatively price inelastic, demand at any moment in time can fluctuate based on a range of variables, such as weather and time of day. As a result, the use of swaps related to electricity is different from the use of swaps for other physical commodities in that electricity swaps are more highly customized to a particular place and time and are more likely to relate to a short time period or be more frequently entered into. Commenters also noted that electricity markets are already subject to regulation by Federal, regional and state regulators. In addition, electric cooperatives requested that they be excluded from the definition of a swap dealer because they are not-for-profit entities that enter into swaps for the benefit of their members, do not hold themselves out as swap dealers, do not make markets and their swaps are not necessarily reflective of market rates.
While the final rule does not include any exemptions specific to the electricity industry, the preamble notes that “a significant portion of the financial instruments used for risk management by such persons [who transact in swaps related to the generation, transmission and distribution of electricity] are forward contracts in nonfinancial commodities that are excluded from the definition of the term swap.” The CFTC has not yet released the final version of another rule defining the term “swap.”
With regard to swaps entered into for hedging purposes, the CFTC adopted the principles of bona fide hedging that it has long applied to identify when a financial instrument is used for hedging purposes, and excluded from the swap dealer analysis swaps entered into for the purpose of hedging physical positions. The CFTC adopted the physical hedging exclusion on an interim basis and is still seeking comment on how swaps entered into for hedging may be distinguished from swaps entered into for other reasons, such as speculation. Note that the Commodity Exchange Act explicitly excludes positions held for “hedging or mitigating commercial risk” in the determination of whether an entity is a major swap participant.
Many industry participants can be expected to use the de minimis exception to avoid regulation as a swap dealer. The final rule sets a de minimis threshold for swap dealing activity over the prior 12 months at a gross national value of $3 billion. An interim $8 billion limit will be in effect for at least the first few years after the rule is implemented.