CFTC Reporting and Recordkeeping Obligations: What General Counsels Need to Know AGA Legal Forum 2014 July 14, 2014 Presented By Julian E. Hammar 2014 Morrison & Foerster LLP All Rights Reserved mofo.com
Overview Trade Option Reporting CFTC Form 40 reporting for large traders Accelerated reporting of swaps to swap data repositories for end user to end user transactions Recordkeeping Recent CFTC updates 2
Trade Options Background An option involves the right, but not the obligation, upon the part of the option buyer to perform, whereas the option grantor must perform if the option holder makes an election. An option to purchase or sell a commodity is a swap, whether physically or financially settled. Forward contracts with embedded volumetric optionality that fail to meet the 7-part test promulgated by the CFTC in the Product Definitions Release will be considered commodity options: Peaking natural gas contracts with no minimum delivery requirement fail the 7- part test, and are considered commodity options. Other contracts that have volumetric optionality the exercise of which is not primarily due to physical factors or regulatory requirements outside the parties control, are commodity options. 3
Trade Option Exemption Relief from the full panoply of swap requirements under the Dodd- Frank Wall Street Reform and Consumer Protection Act ( Dodd- Frank ) is provided for commodity options under the trade option exemption. A commodity option qualifies for the trade option exemption if: The offeror (sometimes called the grantor of the commodity option) is either: (i) an eligible contract participant or (ii) a producer, processor, commercial user or merchant handling the commodity that is subject to the commodity option, or the products or byproducts thereof, and offers or enters into the commodity option solely for purposes related to its business; 4
Trade Option Exemption (cont d) The offeree (sometimes called the buyer) of the commodity option is: a producer, processor, commercial user of, or merchant handling the commodity that is subject to the commodity option, or the products or by-products thereof, and the offeree is offered or enters into the commodity option solely for purposes related to its business; and The option is intended to be physically settled so that, if exercised, it results in a commodity spot or forward contract (i.e., cash settlement is not permitted). 5
Trade Option Exemption (cont d) Trade options that meet these conditions are exempt from many of the regulations applicable to swaps and are subject only to certain requirements specified in CFTC Regulation 32.3. These requirements include reporting, recordkeeping, swaps large trader reporting, certain requirements applicable to swap dealers and major swap participants, anti-fraud and anti-manipulation rules, and position limits. The CFTC has requested comment upon whether position limits should apply to trade options. 6
Trade Option Reporting: Form TO A trade option generally must be reported to a swap data repository (or, if one is not available, to the CFTC) if, during the 12 months prior to the trade option being entered into, one of the counterparties has been obligated to report a non-trade option swap under Part 45 of the CFTC s regulations. If neither counterparty has had to report non-trade option swaps under Part 45 during that period, then both counterparties may report their trade option transactions annually on the CFTC s Form TO. This form is less burdensome to market participants than Part 45 reporting because it only needs to be filed annually (and therefore not on a transaction-by-transaction basis) and only requires aggregate data (as opposed to data for each transaction). 7
Form TO (cont d) Eligibility to use Form TO has been extended by a CFTC staff noaction letter so that if one of the parties were required to report nontrade option swaps under Part 45 during the 12-month period (and thus could not use Form TO under the rule) and that party is not a swap dealer or major swap participant, then it may use Form TO, provided that it notifies CFTC staff by email no later than 30 days after entering into trade options having an aggregate notional value in excess of $1 billion in any calendar year at TOreportingrelief@cftc.gov. The first annual filing of Form TO was due March 1, 2014 for options entered into for the period from April 10 through December 31, 2013. Thereafter, it will be due March 1 after the calendar year for which reporting is required. 8
Form TO (cont d) Note that Form TO requires reporting of options exercised during the reporting period. This means that if no options were entered into during the reporting period, then even though options may have been exercised during that period, there is no Form TO filing requirement. Staff FAQ document states that Form TO requirements apply to non- U.S. commercial end users that enter into trade options with U.S. commercial end users, such as LDCs. 9
Special Calls and CFTC Form 40/40S Trade options, as well as other swaps and futures, are subject to a special call from the CFTC if the entity trading such instruments has a reportable position. 6 NYMEX energy contracts are currently listed in the list of covered futures under CFTC rules: (i) Brent Financial, (ii) Central Appalachian Coal, (iii) Light Sweet Crude, (iv) NYMEX RBOB Gasoline, (v) NYMEX Natural Gas and (vi) NYMEX NY Harbor ULSD. Applies to paired swaps and swaptions and trade options that are directly or indirectly linked to these futures contracts. If a special call is issued, CFTC requires filing of Form 40 (for futures) or Form 40S (for swaps, including trade options). 10
CFTC Form 40/40S (cont d) Current Form 40S is in fact Form 40, with instructions to treat any references to futures or option contracts as references to paired swaps or swaptions. Under rules promulgated last November, electronic filing of Form 40/40S will be required, as well as an ongoing obligation to file updates when the information changes (unlike with current Form 40/40S). The compliance date is August 15, 2014. LDCs and other end users who are subject to the filing requirement are also subjected to certain recordkeeping requirements. Failure to make the filing, if required, can subject the end user to fines and penalties. 11
Swap Data Repository Reporting In most cases, an LDC will not be responsible for reporting to a swap data repository ( SDR ) as its counterparty will be a swap dealer (e.g., a bank) or other financial entity upon which the reporting obligation falls. However, in swaps between 2 LDCs, one of them must report to an SDR (and the counterparties must agree upon who will be the reporting party as a term of the swap). Beginning April 10, 2014, end user counterparties deadlines for reporting was reduced from within 48 business hours of execution to 36 business hours. On April 10, 2015, the deadline is further reduced to 24 business hours. 12
Records/Recordkeeping CFTC Regulation 45.2(b): Full, complete and systematic records, together with all pertinent data and memoranda for swaps. Applies to trade options as well as inter-affiliate swaps. Must have a Legal Entity Identifier ( LEI ), known as an LEI/Global Markets Entity Identifier ( GMEI ) (formerly known as a LEI/CICI). Once an LEI/GMEI has been issued, it must be kept current, which means re-certifying it at least annually and paying the associated fee. See https://www.gmeiutility.org/attachments/gmei_guide.pdf When applicable, records demonstrating compliance with the end user exception from the clearing requirement. April 10, 2013 was the recordkeeping compliance date for non-swap dealers/major swap participants, such as LDCs. 13
Records (cont d) Recordkeeping for trading on swap execution facilities, such as ICAP SEF, is subject to recordkeeping under CFTC Regulation 1.35 and SEF rules (see, e.g., ICAP Rule 208). If an LDC trades on a SEF, then under CFTC Reg. 1.35 it must keep: Original source documents, or all documents on which trade information is originally recorded; Full, complete and systematic records for any cash or forward transactions related to (i.e. hedged by) the swap; Written records must be kept in a form and manner identifiable and searchable by transaction; and 14
Records (cont d) All written communications provided or received concerning quotes, solicitations, bids, offers, instructions, trading, and prices that lead to the execution of a transaction in a commodity interest (e.g., swaps) and related cash or forward transactions, whether communicated by facsimile, instant messaging, chat rooms, electronic mail, mobile device, or other digital or electronic media. CFTC staff has provided no-action relief from the requirement to keep electronic text messages and records in a form and manner identifiable and searchable by transaction for members of SEFs that are not required to be registered with the CFTC. 15
Recent CFTC Updates CFTC staff held a roundtable on the Position Limits and Aggregation Proposals on June 19 and the comment period was reopened until July 3, 2014. This deadline recently was extended by the CFTC. Among other things, CFTC requested comment on the hedging exemptions. In the proposal, CFTC stated that natural gas is not a crosscommodity hedge for power. Proposed Rule to amend rules for entities entering into swaps with utility special entities: codifies staff position that would exclude utility operations-related swaps (generally natural gas and power swaps) with utility special entities (e.g., public utilities owned by the State) from having to be counted toward the special entity de minimis threshold of $25 million from swap dealing activity (instead, they count toward the generally applicable $8 billion de minimis threshold). 16
Questions? Julian E. Hammar Of Counsel Morrison & Foerster LLP 2000 Pennsylvania Ave., NW Washington, DC 20006 Office: (202) 887-1679 Cell: (202) 617-8132 jhammar@mofo.com 17
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