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. (more…)
Transatlantic Derivatives Consensus: Landmark Step for EC/US Cooperation
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.
Electricity Industry May Escape Regulation Under New Swaps Rule
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 [...]