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To begin this story, it is important to know that the CFTC consists of 5 politically appointed commissioners.
Now, we must introduce Bart Chilton and Gary Gensler.
Gary Gensler is the chairman of the commission. He is a Wharton School grad who was appointed by President Barack Obama. A diminutive man in his mid 50s, Gary has three daughters in their teens to early 20s. He unfortunately lost his wife to breast cancer and is now a widow. His family are relatively big in the finance world. His twin brother runs an actively traded fund at T. Rowe Price. Gary worked for 18 years at Goldman Sachs and was instrumental in exempting credit default swaps from regulation. He also recently had to step aside in the MF Global investigation of Jon Corzine because of their personal relationship.
Bart Chilton is a member of the commission. He is a Perdue grad who was appointed as a Democrat by President George W. Bush. Having been described as a "gadfly" by the Wall Street Journal, he is known for his shoulder-length blond hair, propensity for playing the guitar at the office, and ever-present cowboy boots. Having ties to the DuPonts in Delaware, Bart spent his career bouncing around the federal bureaucracy and political world, generally dealing with agricultural matters. He has been an outspoken advocate for swaps and derivatives position limits and has called for criminal investigations into the manipulation of the silver market. He also recently penned the book "Ponzimonium - How Scam Artists Are Ripping Off America."
As one might imagine, these two men do not always get along.
Enter Dodd-Frank.
Dodd-Frank required by law for the CFTC to establish rules requiring position limits on swaps within six months of its passage. A year and a half later, an outline of the rules was established. But today, approximately two years later, they still have not gone into effect.
Now there are some serious issues with the regulations. We will get into those later, but for now, suffice it to say that there are three constituencies that are upset. They are 1) the domestic financial sector, who are suing and lobbying to stop this, 2) the foreign financial sectors, who must be brought into compliance somehow, and 3) domestic energy companies who are not swaps dealers by trade, but who do have to hedge costs, and may end up being regulated twice.
With this established, let us get into the news. I am posting this today because it flashed across my Reuters desk this morning:
Hmmm. Why is Gensler dragging his feet again? This was to be an important meeting to try to get over the hurdle with international finance. In fact, just two days ago, Gensler announced that he would seek to exempt some foreign financial companies compliance standards. I'll call this the "Save the London Whales" proposal:
CFTC may propose Dodd-Frank exemptions for non-U.S. swap participants
Published on June 18, 2012 by Alexandra Villarreal
The Commodity Futures Trading Commission may consider extensions of Dodd-Frank collateral exemptions for some U.S. financial subsidiaries.
Under the still uncertain proposal, non-U.S. affiliates with less than five percent of a bank’s aggregate notional swap business would be exempt from some clearing and collateral requirements mandated under the 2010 Dodd-Frank Act, though the institutions would still be subject to reporting requirements, Bloomberg reports.
Dodd-Frank was enacted to curb risks related to causes of the recent financial crisis, including those in the $708 trillion swaps market. CFTC Chairman Gary Gensler has advocated for increased transparency in the swaps market.
“During a default or crisis, risk of overseas’ branches and affiliates inevitably flows back into the United States,” CFTC Chairman Gary Gensler said last week during a speech at the Institute of International Bankers conference, according to Bloomberg.
Swaps trading serves as a major revenue generator for America’s big banks, some of which have conducted about 50 percent of all trades outside of the U.S. through affiliates or subsidiaries.
The financial industry has advocated against the imposition of Dodd-Frank requirements on non-U.S. swaps, saying that doing so would likely damage the ability of U.S. institutions to serve the financial needs of overseas clients, Bloomberg reports.
But just last weak, Gensler called not for exempting foreign dealers, but rather, for delaying the implementation of the rule for foreign dealers. He even cited the J.P. Morgan multi-billion dollar blunder:
Oddly enough, also two days ago, Chilton did the equivalent of going off the rails, and as opposed to Gensler, called for the Treasury Department to establish a panel to expedite the process and get these rules in place:
Clearly there is dissension in the ranks.
And then there is Bernie Sanders. Earlier this month he directly called for Gensler's ouster. There has never been love-loss between the two. Bernie Sanders attempted to block Gensler's nomination, taking issue with Gensler's instrumental role in deregulating credit default swaps, which led to the AIG disaster. Then Sen. Sanders got together a group of 70 legislators to sign onto a letter demanding the CFTC obey Dodd-Frank. As of two weeks ago today, Bernie wants blood:
Senator implores President Obama to replace CFTC Chairman Gensler
A U.S. Senator implored President Barack Obama to replace the current U.S. Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler on June 4. The CFTC plays an important role in U.S. derivatives regulations.
Senator Bernie Sanders, an independent from Vermont, criticized the government official for not quickly imposing limits on the size of the bets that commodities traders can make in raw materials like copper, oil and gold, according to Reuters. The caps on the amounts for bets were set forth in the Dodd–Frank Wall Street Reform and Consumer Protection Act.
"In blatant disregard of the law, Chairman Gensler has allowed oil and gasoline prices to be dictated by Wall Street speculators instead of supply-and-demand fundamentals," Sanders wrote in the letter, the media outlet reports. "As a result, the American people continue to pay much higher prices for gasoline than they should."
The CFTC's final rules on position limits were completed in October and are scheduled to be implemented later in 2012.
Gensler recently stated that the derivatives regulations affecting swaps contracts will most likely be applied to the foreign branches of U.S. banks, as well as affiliates of those lending institutions.
Meanwhile, unlike financial companies, energy companies are making cogent, reasonable arguments for regulation tweaks that probably won't require litigation:
Moreover, the CFTC moved just yesterday to define high-frequency trading. It's a precursor to being able to regulate the activities. But that's neither here nor there.
This is a lot of hand-wringing, position changing, and general drama for less than a month in the life of the CFTC. It seems that things are heading towards a boiling point. As always, it should be interesting to watch.
I'd welcome any thoughts for others here who are more intimately acquainted with the topic.
Now, we must introduce Bart Chilton and Gary Gensler.
Gary Gensler is the chairman of the commission. He is a Wharton School grad who was appointed by President Barack Obama. A diminutive man in his mid 50s, Gary has three daughters in their teens to early 20s. He unfortunately lost his wife to breast cancer and is now a widow. His family are relatively big in the finance world. His twin brother runs an actively traded fund at T. Rowe Price. Gary worked for 18 years at Goldman Sachs and was instrumental in exempting credit default swaps from regulation. He also recently had to step aside in the MF Global investigation of Jon Corzine because of their personal relationship.
Bart Chilton is a member of the commission. He is a Perdue grad who was appointed as a Democrat by President George W. Bush. Having been described as a "gadfly" by the Wall Street Journal, he is known for his shoulder-length blond hair, propensity for playing the guitar at the office, and ever-present cowboy boots. Having ties to the DuPonts in Delaware, Bart spent his career bouncing around the federal bureaucracy and political world, generally dealing with agricultural matters. He has been an outspoken advocate for swaps and derivatives position limits and has called for criminal investigations into the manipulation of the silver market. He also recently penned the book "Ponzimonium - How Scam Artists Are Ripping Off America."
As one might imagine, these two men do not always get along.
Enter Dodd-Frank.
Dodd-Frank required by law for the CFTC to establish rules requiring position limits on swaps within six months of its passage. A year and a half later, an outline of the rules was established. But today, approximately two years later, they still have not gone into effect.
Now there are some serious issues with the regulations. We will get into those later, but for now, suffice it to say that there are three constituencies that are upset. They are 1) the domestic financial sector, who are suing and lobbying to stop this, 2) the foreign financial sectors, who must be brought into compliance somehow, and 3) domestic energy companies who are not swaps dealers by trade, but who do have to hedge costs, and may end up being regulated twice.
With this established, let us get into the news. I am posting this today because it flashed across my Reuters desk this morning:
CFTC cancels meeting on international swaps rules
WASHINGTON | Thu Jun 21, 2012 9:46am EDT
(Reuters) - The U.S. Commodity Futures Trading Commission called off the Thursday meeting during which it had planned to vote on how its swaps rules would apply to overseas market activity.
The CFTC had planned to consider proposed guidance on the international reach of U.S. swaps rules and a proposal that would give overseas swaps players more time to comply with CFTC regulations.
The agency did not immediately give a reason for cancelling the meeting.
(Reporting By Karey Wutkowski; Editing by Gerald E. McCormick)
WASHINGTON | Thu Jun 21, 2012 9:46am EDT
(Reuters) - The U.S. Commodity Futures Trading Commission called off the Thursday meeting during which it had planned to vote on how its swaps rules would apply to overseas market activity.
The CFTC had planned to consider proposed guidance on the international reach of U.S. swaps rules and a proposal that would give overseas swaps players more time to comply with CFTC regulations.
The agency did not immediately give a reason for cancelling the meeting.
(Reporting By Karey Wutkowski; Editing by Gerald E. McCormick)
CFTC may propose Dodd-Frank exemptions for non-U.S. swap participants
Published on June 18, 2012 by Alexandra Villarreal
The Commodity Futures Trading Commission may consider extensions of Dodd-Frank collateral exemptions for some U.S. financial subsidiaries.
Under the still uncertain proposal, non-U.S. affiliates with less than five percent of a bank’s aggregate notional swap business would be exempt from some clearing and collateral requirements mandated under the 2010 Dodd-Frank Act, though the institutions would still be subject to reporting requirements, Bloomberg reports.
Dodd-Frank was enacted to curb risks related to causes of the recent financial crisis, including those in the $708 trillion swaps market. CFTC Chairman Gary Gensler has advocated for increased transparency in the swaps market.
“During a default or crisis, risk of overseas’ branches and affiliates inevitably flows back into the United States,” CFTC Chairman Gary Gensler said last week during a speech at the Institute of International Bankers conference, according to Bloomberg.
Swaps trading serves as a major revenue generator for America’s big banks, some of which have conducted about 50 percent of all trades outside of the U.S. through affiliates or subsidiaries.
The financial industry has advocated against the imposition of Dodd-Frank requirements on non-U.S. swaps, saying that doing so would likely damage the ability of U.S. institutions to serve the financial needs of overseas clients, Bloomberg reports.
But just last weak, Gensler called not for exempting foreign dealers, but rather, for delaying the implementation of the rule for foreign dealers. He even cited the J.P. Morgan multi-billion dollar blunder:
CFTC may delay some derivatives rules for foreign banks
by Karen Bretell
NEW YORK | Thu Jun 14, 2012 5:09pm EDT
(Reuters) - The U.S. Commodity Futures Trading Commission may delay by up to a year some rules including capital requirements for foreign banks that are active in the $650 trillion derivatives markets, but is likely to require the banks to comply with other rules earlier, when it issues guidance as early as next week.
The U.S. regulation of foreign banks with big derivatives desks is among the most hotly debated pieces of the new swaps regime mandated by the 2010 Dodd Frank law, written in response to the 2007-2009 financial crisis.
Large foreign banks that are active in United States are seeking relief from some U.S. regulations if they are subject to comparable rules overseas.
Chairman Gary Gensler said on Thursday that the CFTC may delay introducing some so-called "entity level" requirements to allow international regulators more time to develop rules.
These would relate to subjects including bank capital levels, risk management, record keeping and trade reporting.
"During that time, the CFTC would be moving to complete the cross-border interpretive guidance and would work with market participants and foreign regulators on plans for substituted compliance," Gensler said at an Institute of International Bankers luncheon in New York.
Foreign banks active in the United States or those that have any U.S.-backed operations, however, would likely need to comply with other rules earlier, including those relating to central clearing, trade margin requirements, and public real-time price reporting, Gensler said.
"We'll get a lot of protection early on," Gensler told reporters after the luncheon.
JPMORGAN REMINDER
JPMorgan Chase & Co's recent losses from outsized credit derivatives trades made out of its London office are a strong reminder that risks from derivatives trades entered into overseas can quickly reverberate back to U.S. shores, Gensler said.
"We've seen this movie before. Financial institutions set up hundreds, if not thousands of legal entities around the globe. During a default or crisis, risk of overseas' branches and affiliates inevitably flows back into the United States," he said.
Gensler cited the examples of failed bank Lehman Brothers and insurer American International Group Inc.,which needed a government bailout, as among London-based operations that caused losses in the U.S.
U.S. rules would likely apply to foreign banks that have large trading exposures to U.S. counterparties, in addition to any foreign entities that are guaranteed by U.S. firms, Gensler said.
Banks that have over $8 billion in derivatives trading activity with U.S. market participants will likely need to register with the CFTC as a swap dealer and be subject to U.S. rules, he said.
INTERNATIONAL DIFFERENCES
International regulators are close to agreeing on key rules such as bank capital requirements, Gensler said, but he noted that greater disparity between nations exists relating to issues such as price transparency.
Price transparency, both before and after trades, is also among the most contested rules.
Large banks and some fund managers argue that revealing prices ahead of trades will reduce liquidity as it could give away investors positions before they are executed.
Gensler and others say that transparency is vital to bringing new players to the market, which would boost volumes and help central clearinghouses manage the risks of trades that they clear.
"Promoting transparency to the public in the swaps market is critical to both lowering the risk of the financial system, as well as to reducing costs to end users," Gensler said.
"Starting as early as September, real-time reporting to the public and to regulators will become a reality," he said.
A vote on guidance and the phase-in for rules relating to foreign banks are expected next Thursday at a CFTC open meeting, Gensler said.
The delay in some rules was first reported by Reuters on Wednesday.
(Additional reporting by Alexandra Alper; Editing by David Gregorio)
by Karen Bretell
NEW YORK | Thu Jun 14, 2012 5:09pm EDT
(Reuters) - The U.S. Commodity Futures Trading Commission may delay by up to a year some rules including capital requirements for foreign banks that are active in the $650 trillion derivatives markets, but is likely to require the banks to comply with other rules earlier, when it issues guidance as early as next week.
The U.S. regulation of foreign banks with big derivatives desks is among the most hotly debated pieces of the new swaps regime mandated by the 2010 Dodd Frank law, written in response to the 2007-2009 financial crisis.
Large foreign banks that are active in United States are seeking relief from some U.S. regulations if they are subject to comparable rules overseas.
Chairman Gary Gensler said on Thursday that the CFTC may delay introducing some so-called "entity level" requirements to allow international regulators more time to develop rules.
These would relate to subjects including bank capital levels, risk management, record keeping and trade reporting.
"During that time, the CFTC would be moving to complete the cross-border interpretive guidance and would work with market participants and foreign regulators on plans for substituted compliance," Gensler said at an Institute of International Bankers luncheon in New York.
Foreign banks active in the United States or those that have any U.S.-backed operations, however, would likely need to comply with other rules earlier, including those relating to central clearing, trade margin requirements, and public real-time price reporting, Gensler said.
"We'll get a lot of protection early on," Gensler told reporters after the luncheon.
JPMORGAN REMINDER
JPMorgan Chase & Co's recent losses from outsized credit derivatives trades made out of its London office are a strong reminder that risks from derivatives trades entered into overseas can quickly reverberate back to U.S. shores, Gensler said.
"We've seen this movie before. Financial institutions set up hundreds, if not thousands of legal entities around the globe. During a default or crisis, risk of overseas' branches and affiliates inevitably flows back into the United States," he said.
Gensler cited the examples of failed bank Lehman Brothers and insurer American International Group Inc.,which needed a government bailout, as among London-based operations that caused losses in the U.S.
U.S. rules would likely apply to foreign banks that have large trading exposures to U.S. counterparties, in addition to any foreign entities that are guaranteed by U.S. firms, Gensler said.
Banks that have over $8 billion in derivatives trading activity with U.S. market participants will likely need to register with the CFTC as a swap dealer and be subject to U.S. rules, he said.
INTERNATIONAL DIFFERENCES
International regulators are close to agreeing on key rules such as bank capital requirements, Gensler said, but he noted that greater disparity between nations exists relating to issues such as price transparency.
Price transparency, both before and after trades, is also among the most contested rules.
Large banks and some fund managers argue that revealing prices ahead of trades will reduce liquidity as it could give away investors positions before they are executed.
Gensler and others say that transparency is vital to bringing new players to the market, which would boost volumes and help central clearinghouses manage the risks of trades that they clear.
"Promoting transparency to the public in the swaps market is critical to both lowering the risk of the financial system, as well as to reducing costs to end users," Gensler said.
"Starting as early as September, real-time reporting to the public and to regulators will become a reality," he said.
A vote on guidance and the phase-in for rules relating to foreign banks are expected next Thursday at a CFTC open meeting, Gensler said.
The delay in some rules was first reported by Reuters on Wednesday.
(Additional reporting by Alexandra Alper; Editing by David Gregorio)
Oddly enough, also two days ago, Chilton did the equivalent of going off the rails, and as opposed to Gensler, called for the Treasury Department to establish a panel to expedite the process and get these rules in place:
SEC Delaying Dodd-Frank Swap Rules, Says CFTC’s Chilton
By Silla Brush - Jun 19, 2012 6:00 PM ET
A council of U.S. financial regulators should speed up Dodd-Frank Act rules delayed by inaction at the Securities and Exchange Commission, said Bart Chilton, a Democrat on the Commodity Futures Trading Commission.
The commissions are required by Dodd-Frank to jointly define which derivatives contracts are swaps and will fall under clearing, trading and reporting requirements. The definition is needed before limits on speculation in oil, natural gas, wheat and other commodities can take effect, Chilton said in a speech prepared for a conference of the Mutual Fund Directors Forum in Washington.
"We have been continually reassured we are going to consider this joint rule with the SEC ‘next month’,” Chilton said. “I see no promise of movement from the SEC on this. We are two years into this new law, and position limits were supposed to be implemented after six months.”
Chilton said the 10-member Financial Stability Oversight Council, led by Treasury Secretary Timothy F. Geithner, should intervene to speed up the process. The council includes the heads of the CFTC, SEC, Federal Reserve and Federal Deposit Insurance Corp. among other members.
SEC Chairman Mary Schapiro told the senate Banking Committee on May 22 that her agency and the CFTC are cooperating. “Although the timing and sequencing of the CFTC’s commission’s proposal and adoption of rules may vary, they are the subject of extensive interagency discussions,” she said.
The speculation limits are among the most controversial requirements in Dodd-Frank and spurred more than 13,000 comments to the CFTC from supporters such as Delta Air Lines Inc. (DAL) and opponents such as Barclays Capital. CFTC commissioners voted 3-2 at an Oct. 18 meeting to approve the final regulation.
Suits Filed
The International Swaps and Derivatives Association Inc. and Securities Industry and Financial Markets Association filed a lawsuit in December challenging the rule. The associations’ members include JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS) and Morgan Stanley. (MS) The groups argue that the CFTC never studied whether the regulation was “necessary and appropriate” or quantified the costs tied to implementing the rule. A judgment is pending.
The case is International Swaps and Derivatives Association v. U.S. Commodity Futures Trading Commission, 11-02146, U.S. District Court, District of Columbia (Washington).
To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net
To contact the editor responsible for this story: Maura Reynolds atmreynolds34@bloomberg.net
By Silla Brush - Jun 19, 2012 6:00 PM ET
A council of U.S. financial regulators should speed up Dodd-Frank Act rules delayed by inaction at the Securities and Exchange Commission, said Bart Chilton, a Democrat on the Commodity Futures Trading Commission.
The commissions are required by Dodd-Frank to jointly define which derivatives contracts are swaps and will fall under clearing, trading and reporting requirements. The definition is needed before limits on speculation in oil, natural gas, wheat and other commodities can take effect, Chilton said in a speech prepared for a conference of the Mutual Fund Directors Forum in Washington.
"We have been continually reassured we are going to consider this joint rule with the SEC ‘next month’,” Chilton said. “I see no promise of movement from the SEC on this. We are two years into this new law, and position limits were supposed to be implemented after six months.”
Chilton said the 10-member Financial Stability Oversight Council, led by Treasury Secretary Timothy F. Geithner, should intervene to speed up the process. The council includes the heads of the CFTC, SEC, Federal Reserve and Federal Deposit Insurance Corp. among other members.
SEC Chairman Mary Schapiro told the senate Banking Committee on May 22 that her agency and the CFTC are cooperating. “Although the timing and sequencing of the CFTC’s commission’s proposal and adoption of rules may vary, they are the subject of extensive interagency discussions,” she said.
The speculation limits are among the most controversial requirements in Dodd-Frank and spurred more than 13,000 comments to the CFTC from supporters such as Delta Air Lines Inc. (DAL) and opponents such as Barclays Capital. CFTC commissioners voted 3-2 at an Oct. 18 meeting to approve the final regulation.
Suits Filed
The International Swaps and Derivatives Association Inc. and Securities Industry and Financial Markets Association filed a lawsuit in December challenging the rule. The associations’ members include JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS) and Morgan Stanley. (MS) The groups argue that the CFTC never studied whether the regulation was “necessary and appropriate” or quantified the costs tied to implementing the rule. A judgment is pending.
The case is International Swaps and Derivatives Association v. U.S. Commodity Futures Trading Commission, 11-02146, U.S. District Court, District of Columbia (Washington).
To contact the reporter on this story: Silla Brush in Washington at sbrush@bloomberg.net
To contact the editor responsible for this story: Maura Reynolds atmreynolds34@bloomberg.net
Clearly there is dissension in the ranks.
And then there is Bernie Sanders. Earlier this month he directly called for Gensler's ouster. There has never been love-loss between the two. Bernie Sanders attempted to block Gensler's nomination, taking issue with Gensler's instrumental role in deregulating credit default swaps, which led to the AIG disaster. Then Sen. Sanders got together a group of 70 legislators to sign onto a letter demanding the CFTC obey Dodd-Frank. As of two weeks ago today, Bernie wants blood:
Senator implores President Obama to replace CFTC Chairman Gensler
Thursday, 07 June 2012 02:00
A U.S. Senator implored President Barack Obama to replace the current U.S. Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler on June 4. The CFTC plays an important role in U.S. derivatives regulations.
Senator Bernie Sanders, an independent from Vermont, criticized the government official for not quickly imposing limits on the size of the bets that commodities traders can make in raw materials like copper, oil and gold, according to Reuters. The caps on the amounts for bets were set forth in the Dodd–Frank Wall Street Reform and Consumer Protection Act.
"In blatant disregard of the law, Chairman Gensler has allowed oil and gasoline prices to be dictated by Wall Street speculators instead of supply-and-demand fundamentals," Sanders wrote in the letter, the media outlet reports. "As a result, the American people continue to pay much higher prices for gasoline than they should."
The CFTC's final rules on position limits were completed in October and are scheduled to be implemented later in 2012.
Gensler recently stated that the derivatives regulations affecting swaps contracts will most likely be applied to the foreign branches of U.S. banks, as well as affiliates of those lending institutions.
Meanwhile, unlike financial companies, energy companies are making cogent, reasonable arguments for regulation tweaks that probably won't require litigation:
Energy companies moving forward with CFTC compliance despite uncertainties
MAY 31, 2012
By Thomas A. Utzinger (U.S.)
NEW YORK, May 31 (Business Law Currents) – Electric utilities and natural gas companies are facing new regulatory uncertainties involving the jurisdictional reaches of two agencies overseeing futures and derivatives trading as well as wholesale energy transactions: the U.S. Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC). Recent rulemaking efforts and litigation have raised questions as to the overlap and division of powers of these two entities over certain financial transactions and enforcement actions of interest to the energy industry.
DODD-FRANK REFORM AND EXPANDED CFTC JURISDICTION
The financial industry is witnessing a marathon of rulemakings required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). These actions include a new joint final rulemaking by the CFTC and SEC further defining and regulating “swap dealers” and similar parties under Title VII of the Dodd-Frank Act (Swap Dealer Rule). The Swap Dealer Rule, recently published in the Federal Register on May 23, 2012, subjects these parties and related swap transactions to numerous registration and clearing requirements, and may have far-reaching effects on industries that make use of derivative transactions to hedge risks.
(The Dodd-Frank Act’s treatment of over-the-counter derivative markets and entities participating in those markets is described in more detail by energy investment company Energy Transfer Equity, L.P. in its Quarterly Report. In addition, the Swap Dealer Rule’s new requirements were recently addressed by Business Law Currents in Swap dealers, major swap participants and everyone else under Dodd-Frank: who’s who and why we care.)
Historically, the CFTC has exclusive jurisdiction over accounts, agreements, and transactions involving contracts for sale of a commodity for future delivery (futures contracts). Futures contracts can include natural gas, electricity, or other energy products traded or executed subject to a designated contract market or other market or exchange under section 2(a)(1)(A) of the Commodity Exchange Act (CEA).
In turn, FERC has exclusive jurisdiction over the transportation of natural gas in interstate commerce and sales for resale of natural gas, under section 1of the Natural Gas Act (NGA). FERC also regulates the transmission of electric energy in interstate commerce and wholesale electric energy transactions by public utilities, under section 201 of the Federal Power Act (FPA). FERC maintains exclusive ratemaking jurisdiction over wholesale sales and interstate transmission of electricity under the FPA, as noted by Western-U.S. utility Black Hills Corporation in its Annual Report.
Given existing regulation of electric and natural gas energy futures trading, many parties feared that the finalized Swap Dealer Rule would be so broad in scope that previously unregulated swap transactions routinely employed by energy companies would become subject to the CFTC’s jurisdiction and its new registration and exchange requirements. While the energy industry functioned with the regulation of futures markets, the routine use of swaps to hedge market volatility due to weather, unforeseen demand, and other factors would be severely disrupted if regulated by the CFTC.
Energy companies use swaps with financial institutions and other commodity market customers to exchange floating price streams with fixed price streams. For example, as explained by Exelon Corporation in comments submitted to the CFTC during the rulemaking process, an electric utility’s annual revenue is based in part by the spot prices paid by a Regional Transmission Organization (RTO) or Independent System Operator (ISO) for the power generated. Without the swap, that annual revenue could vary widely based on demand. With a swap, however, the utility enters into an agreement whereby the variable price paid for the power generated (revenue) is transferred to another counterparty in exchange for a fixed revenue stream for the year, or vice versa depending on the specific circumstances.
Swaps work when counterparties have opposing views of the risks involved, and therefore agree to trade revenue streams. In the case of electric power, for example, the utility may believe that revenue in 2012 will be lower than average (and therefore the fixed rate it receives from the counterparty to the swap will be greater than actual revenue), whereas the counterparty believes that 2012 revenues will be higher than average (and therefore the revenues it receives from the utility will be greater than the fixed payments made to the utility). Utilities may also enter into opposite “fixed-for-floating” swaps to hedge against power generation unit failures and other situations in which it is preferable to receive payments based on floating spot prices instead of fixed revenue streams.
During the CFTC’s rulemaking process, energy companies were concerned that the final Swap Dealer Rule could categorize the companies making these daily swap transactions as “swap dealers,” subjecting them to mandatory capital, margin, and clearing requirements, as noted by NextEra Energy, Inc. in comments submitted to the CFTC. The other concern was that the CFTC’s exemption of smaller “de minimis” swap transactions would be set too low at $100 million, so that the total amount of a utility’s swap transactions in one year would greatly exceed that exemption amount. NextEra noted in its Annual Report that the rules could negatively affect the company’s ability to hedge commodity and interest rate risks.
Although the final Swap Dealer Rule raises the original de minimis exemption from $100 million to a satisfactory $8 billion for “swap dealers,” falling to $3 billion within three to five years as noted by major Mid-Western electric utility PPL Corporation (PPL), energy companies remain cautious. Exelon Corporation, for example, states in its recent Quarterly Report that the company is evaluating whether its derivatives activities will be regulated in any manner.
Similarly, many electric utility companies like NRG Energy, Inc. (NRG) and Public Service Enterprise Group Incorporated (PSEG) are taking a cautious approach and further evaluating the rulemakings. NRG states in its Quarterly Report that the company is reviewing whether the Swap Dealer Rule applies to its business, while PSEG states in its Quarterly Report that the company is carefully monitoring the new rules as they are developed, to determine whether any impact on the company’s swap and derivative transactions exist.
Given this de minimis exemption increase, PPL notes in its Quarterly Report that the “definition of swap dealer is an amount that would not currently result in the Registrants being deemed swap dealers.” However, the company cautions that there “are numerous other provisions in the Final Rule . . . that the Registrants have not yet analyzed that could result in their being subject to the more onerous compliance requirements applicable to swap dealers.” Furthermore, legal issues and challenges could arise with respect to thede minimis levels set in the Swap Dealer Rule, as recently addressed by Business Law Currents in CFTC and SEC swap dealer rule raises legal questions along with thresholds. One such issue is that the threshold for government-owned public utilities remains at a miniscule $25 million instead of $8 billion, which would severely limit swap deals with such companies.
In addition, electric utility Dominion Resources, Inc. proposes in its recent Quarterly Report that if the company’s derivative activities are not exempted from all the potential clearing, exchange trading, and margin requirements associated with the Dodd-Frank rulemakings, the company could become subject to higher costs. Likewise, independent power producer Calpine Corporation, in its Quarterly Report, notes that a number of features in Title VII of Dodd-Frank could impact its energy business. Natural gas companies are also concerned, as seen in the recent Prospectus Supplement ofWilliams Partners L.P., stating that the company makes extensive use of swaps and other hedging transactions to manage financial exposure.
While the end result of the Swap Dealer Rule may not be a sea change in energy company hedging transactions, the full extent of the Dodd-Frank reforms on the energy industry remain to be seen, as many rules remain in development. This causes a level of uncertainty as energy companies and other participants in electric and natural gas transactions move forward with regulatory compliance initiatives, preferring to know whether or not traditionally unregulated practices will be subject to CFTC requirements.
CFTC AND FERC ENFORCEMENT AUTHORITY
In an ongoing matter previously reported by Business Law Currents in Amaranth settles class action market manipulation suit, a turf war between the CFTC and FERC with respect to market manipulation enforcement involving natural gas (NG) Futures Contracts has become the subject of extensive litigation currently in the D.C. Circuit Court of Appeals. At issue is the apparent overlap of the CFTC’s and FERC’s authority over manipulative trading of NG Futures Contracts.
NG Futures Contracts are standardized agreements to purchase or sell a volume of natural gas at a predetermined price in the future, and are bought and sold on the New York Mercantile Exchange (NYMEX). NG Futures Contracts specify delivery of 10,000 MMBtus of natural gas at the Henry Hub in Louisiana in the month in which the contract matures. Sellers of futures contracts have a short position, benefitting if the price of natural gas drops before the delivery date. Buyers have a long position, benefitting if the price increases. Traders also enter into swaps, in which a swap buyer agrees to pay a fixed price, and the seller agrees to pay a floating price which is the final settlement price of NG Futures Contracts.
Section 315 of the Energy Policy Act of 2005 added a market-manipulation provision to the NGA. Codified at NGA section 4A, the law prohibits “any entity” from “directly or indirectly” manipulating the market “in connection with” FERC jurisdictional transactions, such as sales of natural gas in interstate commerce for resale. FERC implements NGA section 4A in Order No. 670, “Prohibition of Energy Market Manipulation,” set forth at 18 C.F.R. 1c.1, the Commission’s Anti-Manipulation Rule. FERC’s civil penalty powers under the 2005 amendments to the NGA are described in further detail in the Annual Report of independent oil and natural gas company Energy Partners, Ltd., and the Amended Annual Report of exploration and production company Antero Resources LLC.
FERC originally determined that former trader Brian Hunter intentionally manipulated NG Futures Contract settlement process by selling large amounts of contracts in the final half-hour of trading on three occasions. This manipulation was intended to benefit Hunter’s opposing swap positions (i.e., a decrease in NG Futures Contract settlement prices led to gains in the swap transactions). The close relationship between the financial and physical natural gas markets meant that Hunter’s manipulation of the futures market (under CFTC’S jurisdiction) had a direct effect on the settlement price of natural gas going to delivery and price indices (under FERC’s jurisdiction).
Hunter and the CFTC contend that FERC’s interpretation of NGA section 4A conflicts with the CFTC’s jurisdiction under CEA section 2(a)(1)(A), which provides the CFTC with exclusive jurisdiction “with respect to accounts, agreements [of various types] and transactions involving contracts of sale of a commodity for future delivery.” FERC argues, however, that its anti-manipulation authority coexists and complements the CFTC’s authority.
FERC rejects Hunter’s argument that the CFTC has exclusive jurisdiction that precludes FERC’s jurisdiction and enforcement action. The commission states that while FERC does not directly regulate NG Futures Contracts, the settlement price of those contracts directly affects the price of natural gas sales which are under FERC’s jurisdiction. Therefore Hunter’s trading activities fell under NGA section 4A’s prohibition of natural gas market manipulation “in connection with” FERC-jurisdictional sales.
At this time it is unclear whether both commissions may share authority when NG Futures Contracts, which are exclusively regulated by the CFTC, are manipulated in a manner affecting the larger wholesale natural gas markets regulated by FERC. This is important to many market participants, not only in the natural gas industry but also to electric power companies as well, because the two commissions maintain different priorities and objectives, and parties engaging in these transactions deserve to have certainty with respect to which entity, or both, can initiate and pursue enforcement actions.
(This article was first published by Thomson Reuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at http://currents.westlawbusiness.com)
MAY 31, 2012
By Thomas A. Utzinger (U.S.)
NEW YORK, May 31 (Business Law Currents) – Electric utilities and natural gas companies are facing new regulatory uncertainties involving the jurisdictional reaches of two agencies overseeing futures and derivatives trading as well as wholesale energy transactions: the U.S. Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission (FERC). Recent rulemaking efforts and litigation have raised questions as to the overlap and division of powers of these two entities over certain financial transactions and enforcement actions of interest to the energy industry.
DODD-FRANK REFORM AND EXPANDED CFTC JURISDICTION
The financial industry is witnessing a marathon of rulemakings required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). These actions include a new joint final rulemaking by the CFTC and SEC further defining and regulating “swap dealers” and similar parties under Title VII of the Dodd-Frank Act (Swap Dealer Rule). The Swap Dealer Rule, recently published in the Federal Register on May 23, 2012, subjects these parties and related swap transactions to numerous registration and clearing requirements, and may have far-reaching effects on industries that make use of derivative transactions to hedge risks.
(The Dodd-Frank Act’s treatment of over-the-counter derivative markets and entities participating in those markets is described in more detail by energy investment company Energy Transfer Equity, L.P. in its Quarterly Report. In addition, the Swap Dealer Rule’s new requirements were recently addressed by Business Law Currents in Swap dealers, major swap participants and everyone else under Dodd-Frank: who’s who and why we care.)
Historically, the CFTC has exclusive jurisdiction over accounts, agreements, and transactions involving contracts for sale of a commodity for future delivery (futures contracts). Futures contracts can include natural gas, electricity, or other energy products traded or executed subject to a designated contract market or other market or exchange under section 2(a)(1)(A) of the Commodity Exchange Act (CEA).
In turn, FERC has exclusive jurisdiction over the transportation of natural gas in interstate commerce and sales for resale of natural gas, under section 1of the Natural Gas Act (NGA). FERC also regulates the transmission of electric energy in interstate commerce and wholesale electric energy transactions by public utilities, under section 201 of the Federal Power Act (FPA). FERC maintains exclusive ratemaking jurisdiction over wholesale sales and interstate transmission of electricity under the FPA, as noted by Western-U.S. utility Black Hills Corporation in its Annual Report.
Given existing regulation of electric and natural gas energy futures trading, many parties feared that the finalized Swap Dealer Rule would be so broad in scope that previously unregulated swap transactions routinely employed by energy companies would become subject to the CFTC’s jurisdiction and its new registration and exchange requirements. While the energy industry functioned with the regulation of futures markets, the routine use of swaps to hedge market volatility due to weather, unforeseen demand, and other factors would be severely disrupted if regulated by the CFTC.
Energy companies use swaps with financial institutions and other commodity market customers to exchange floating price streams with fixed price streams. For example, as explained by Exelon Corporation in comments submitted to the CFTC during the rulemaking process, an electric utility’s annual revenue is based in part by the spot prices paid by a Regional Transmission Organization (RTO) or Independent System Operator (ISO) for the power generated. Without the swap, that annual revenue could vary widely based on demand. With a swap, however, the utility enters into an agreement whereby the variable price paid for the power generated (revenue) is transferred to another counterparty in exchange for a fixed revenue stream for the year, or vice versa depending on the specific circumstances.
Swaps work when counterparties have opposing views of the risks involved, and therefore agree to trade revenue streams. In the case of electric power, for example, the utility may believe that revenue in 2012 will be lower than average (and therefore the fixed rate it receives from the counterparty to the swap will be greater than actual revenue), whereas the counterparty believes that 2012 revenues will be higher than average (and therefore the revenues it receives from the utility will be greater than the fixed payments made to the utility). Utilities may also enter into opposite “fixed-for-floating” swaps to hedge against power generation unit failures and other situations in which it is preferable to receive payments based on floating spot prices instead of fixed revenue streams.
During the CFTC’s rulemaking process, energy companies were concerned that the final Swap Dealer Rule could categorize the companies making these daily swap transactions as “swap dealers,” subjecting them to mandatory capital, margin, and clearing requirements, as noted by NextEra Energy, Inc. in comments submitted to the CFTC. The other concern was that the CFTC’s exemption of smaller “de minimis” swap transactions would be set too low at $100 million, so that the total amount of a utility’s swap transactions in one year would greatly exceed that exemption amount. NextEra noted in its Annual Report that the rules could negatively affect the company’s ability to hedge commodity and interest rate risks.
Although the final Swap Dealer Rule raises the original de minimis exemption from $100 million to a satisfactory $8 billion for “swap dealers,” falling to $3 billion within three to five years as noted by major Mid-Western electric utility PPL Corporation (PPL), energy companies remain cautious. Exelon Corporation, for example, states in its recent Quarterly Report that the company is evaluating whether its derivatives activities will be regulated in any manner.
Similarly, many electric utility companies like NRG Energy, Inc. (NRG) and Public Service Enterprise Group Incorporated (PSEG) are taking a cautious approach and further evaluating the rulemakings. NRG states in its Quarterly Report that the company is reviewing whether the Swap Dealer Rule applies to its business, while PSEG states in its Quarterly Report that the company is carefully monitoring the new rules as they are developed, to determine whether any impact on the company’s swap and derivative transactions exist.
Given this de minimis exemption increase, PPL notes in its Quarterly Report that the “definition of swap dealer is an amount that would not currently result in the Registrants being deemed swap dealers.” However, the company cautions that there “are numerous other provisions in the Final Rule . . . that the Registrants have not yet analyzed that could result in their being subject to the more onerous compliance requirements applicable to swap dealers.” Furthermore, legal issues and challenges could arise with respect to thede minimis levels set in the Swap Dealer Rule, as recently addressed by Business Law Currents in CFTC and SEC swap dealer rule raises legal questions along with thresholds. One such issue is that the threshold for government-owned public utilities remains at a miniscule $25 million instead of $8 billion, which would severely limit swap deals with such companies.
In addition, electric utility Dominion Resources, Inc. proposes in its recent Quarterly Report that if the company’s derivative activities are not exempted from all the potential clearing, exchange trading, and margin requirements associated with the Dodd-Frank rulemakings, the company could become subject to higher costs. Likewise, independent power producer Calpine Corporation, in its Quarterly Report, notes that a number of features in Title VII of Dodd-Frank could impact its energy business. Natural gas companies are also concerned, as seen in the recent Prospectus Supplement ofWilliams Partners L.P., stating that the company makes extensive use of swaps and other hedging transactions to manage financial exposure.
While the end result of the Swap Dealer Rule may not be a sea change in energy company hedging transactions, the full extent of the Dodd-Frank reforms on the energy industry remain to be seen, as many rules remain in development. This causes a level of uncertainty as energy companies and other participants in electric and natural gas transactions move forward with regulatory compliance initiatives, preferring to know whether or not traditionally unregulated practices will be subject to CFTC requirements.
CFTC AND FERC ENFORCEMENT AUTHORITY
In an ongoing matter previously reported by Business Law Currents in Amaranth settles class action market manipulation suit, a turf war between the CFTC and FERC with respect to market manipulation enforcement involving natural gas (NG) Futures Contracts has become the subject of extensive litigation currently in the D.C. Circuit Court of Appeals. At issue is the apparent overlap of the CFTC’s and FERC’s authority over manipulative trading of NG Futures Contracts.
NG Futures Contracts are standardized agreements to purchase or sell a volume of natural gas at a predetermined price in the future, and are bought and sold on the New York Mercantile Exchange (NYMEX). NG Futures Contracts specify delivery of 10,000 MMBtus of natural gas at the Henry Hub in Louisiana in the month in which the contract matures. Sellers of futures contracts have a short position, benefitting if the price of natural gas drops before the delivery date. Buyers have a long position, benefitting if the price increases. Traders also enter into swaps, in which a swap buyer agrees to pay a fixed price, and the seller agrees to pay a floating price which is the final settlement price of NG Futures Contracts.
Section 315 of the Energy Policy Act of 2005 added a market-manipulation provision to the NGA. Codified at NGA section 4A, the law prohibits “any entity” from “directly or indirectly” manipulating the market “in connection with” FERC jurisdictional transactions, such as sales of natural gas in interstate commerce for resale. FERC implements NGA section 4A in Order No. 670, “Prohibition of Energy Market Manipulation,” set forth at 18 C.F.R. 1c.1, the Commission’s Anti-Manipulation Rule. FERC’s civil penalty powers under the 2005 amendments to the NGA are described in further detail in the Annual Report of independent oil and natural gas company Energy Partners, Ltd., and the Amended Annual Report of exploration and production company Antero Resources LLC.
FERC originally determined that former trader Brian Hunter intentionally manipulated NG Futures Contract settlement process by selling large amounts of contracts in the final half-hour of trading on three occasions. This manipulation was intended to benefit Hunter’s opposing swap positions (i.e., a decrease in NG Futures Contract settlement prices led to gains in the swap transactions). The close relationship between the financial and physical natural gas markets meant that Hunter’s manipulation of the futures market (under CFTC’S jurisdiction) had a direct effect on the settlement price of natural gas going to delivery and price indices (under FERC’s jurisdiction).
Hunter and the CFTC contend that FERC’s interpretation of NGA section 4A conflicts with the CFTC’s jurisdiction under CEA section 2(a)(1)(A), which provides the CFTC with exclusive jurisdiction “with respect to accounts, agreements [of various types] and transactions involving contracts of sale of a commodity for future delivery.” FERC argues, however, that its anti-manipulation authority coexists and complements the CFTC’s authority.
FERC rejects Hunter’s argument that the CFTC has exclusive jurisdiction that precludes FERC’s jurisdiction and enforcement action. The commission states that while FERC does not directly regulate NG Futures Contracts, the settlement price of those contracts directly affects the price of natural gas sales which are under FERC’s jurisdiction. Therefore Hunter’s trading activities fell under NGA section 4A’s prohibition of natural gas market manipulation “in connection with” FERC-jurisdictional sales.
At this time it is unclear whether both commissions may share authority when NG Futures Contracts, which are exclusively regulated by the CFTC, are manipulated in a manner affecting the larger wholesale natural gas markets regulated by FERC. This is important to many market participants, not only in the natural gas industry but also to electric power companies as well, because the two commissions maintain different priorities and objectives, and parties engaging in these transactions deserve to have certainty with respect to which entity, or both, can initiate and pursue enforcement actions.
(This article was first published by Thomson Reuters’ Business Law Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Business Law Currents online at http://currents.westlawbusiness.com)
Moreover, the CFTC moved just yesterday to define high-frequency trading. It's a precursor to being able to regulate the activities. But that's neither here nor there.
This is a lot of hand-wringing, position changing, and general drama for less than a month in the life of the CFTC. It seems that things are heading towards a boiling point. As always, it should be interesting to watch.
I'd welcome any thoughts for others here who are more intimately acquainted with the topic.
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