On Monday, November 3, 2014, the U.S. Commodity Futures Trading Commission (CFTC) held an open meeting to consider three proposed rule amendments addressing the residual interest deadline (CFTC Rule 1.22), recordkeeping requirements for commodity interest and related cash or forward transactions (CFTC Rule 1.35), and forward contracts with embedded volumetric optionality (CFTC Products Release ). In passing the amendments, the CFTC, acting under a new chairman, demonstrated a willingness to re-visit prior rulemaking under the Dodd-Frank Act.
The meeting began with opening statements by Chairman Massad and Commissioners Wetjen and Bowen. Chairman Massad vocalized support of the amendments and stressed that the proposals were only minor adjustments to former rules that would “fine-tune” various procedures to ensure that as regulation increases, commercial parties can continue to operate profitably. Chairman Massad stated, “[t]he changes we are proposing today help ensure that as we regulate the potential for excessive risks in these markets, we make sure that commercial businesses—whether they are farmers, ranchers, manufacturers or others—that rely on these markets to hedge routine risks, can continue to do so efficiently and effectively.” Commissioner Wetjen echoed Chairman Massad, and further emphasized that any new rules “should not place additional costs and compliance burdens on firms operating in the real economy, unless necessary to achieve the purposes of the post-crisis reforms.”
In October 2013, the CFTC previously amended Rule 1.22 to require FCMs to deposit funds into segregated customer accounts, where the customer’s account is under-margined, by 6:00 p.m. on the day following a trade, referred to as the residual interest deadline. The October 2013 amendments to Rule 1.22 provided on December 31, 2018, the 6:00 p.m. deadline would automatically be terminated and moved up to 9:00 a.m. the morning after a trade. The most recent proposal sought to eliminate the automatic termination of the 6:00 pm residual interest deadline, and instead require a formal rulemaking proceeding if the CFTC later determined to adjust the time after studying the impact of the 6:00 p.m. deadline. After the CFTC staff presentation, Commissioner Wetjen questioned what the biggest obstacle may be in adjusting the residual interest deadline in the future, and proposed that perhaps issues related to time zones, particularly with respect to Asia, may create difficulty in moving the residual interest deadline forward by 9 hours. He also questioned whether the CFTC would investigate the availability of new technology that may expedite and simplify the moving of funds. Commissioner Giancarlo expressed support of the rule and stressed his opposition to a shift to 9:00 a.m., highlighting the burden it would place on small businesses, in particular farmers. The rule was passed 4-0.
The second proposal addressed recordkeeping requirements and sought to amend the CFTC’s recordkeeping requirements under Rule 1.35(a) to limit the requirement that records must be “identifiable and searchable” to merely “searchable.” The revisions also clarified that “searchable by transaction” does not include all oral and written communications leading to the execution of a transaction. Those communications must still be searchable, but need not be kept in a form and manner that identifies the particular transaction that the communication is related to. Commissioner Giancarlo noted that the revisions “go a long way towards addressing the Rule’s difficulties,” but pointed out various shortcomings to the proposed adjustments, including the organization of the proposed rule, continued ambiguity related to the term “searchable,” and the burdens that the rule generally places on FCMs and the markets in which they hedge the risks and costs of production. Commissioner Giancarlo asserted that his constituents felt that, “Washington does not listen to ordinary American farmers, energy producers, coal miners and manufacturers.” He called on the CFTC to take bolder action to amend this rule because though the Dodd-Frank Act was intended to “reform ‘Wall Street . . . [i]nstead, we are harming ‘Main Street’ by forcing burdensome new compliance costs onto our county grain elevators, farmers, and small FCMs.” The rule passed 3-1, with Commissioner Giancarlo voting against the proposal because of the perceived shortcomings noted above.
The final proposal sought to provide clarification of the embedded volumetric optionality test utilized to determine if a particular transaction falls within the forward contract exclusion from the definition of a swap. The proposal modified the fourth, fifth, and seventh elements of the 7-part test applied to determine when contracts fall within the forward contract exclusion. Most significantly, the seventh factor was broadened so that “physical factors” could be construed to include any factor that could reasonable influence supply or demand of the commodity under the contract, such as environmental issues, operational considerations, social forces, geopolitics, and more. The definition would still exclude concerns about price risk. Comments on the rule were limited. Commissioners Giancarlo and Wetjen expressed support and anticipated additional clarification during the comment period and rulemaking. Though Commissioner Bowen had previously made clear during her opening statements that she preferred the trade option exemption because it would provide “a much clearer and cleaner approach to address the issues raised regarding volumetric optionality,” she nevertheless voted yes to the proposed rule. The final proposal was passed 4-0.
Michael Sefton is a Senior Associate at Baker & McKenzie LLP and can be reached at michael.sefton@bakermckenzie.com and (312) 861-2884.
Matthew Kluchenek is a Partner at Baker & McKenzie LLP and leads the firm’s Derivatives & Futures practice group. He can be reached at matt.kluchenek@bakermckenzie.com and (312) 861-8803.
Elizabeth Graffeo is an Associate at Baker & McKenzie LLP and can be reached at elizabeth.graffeo@bakermckenzie.com and (202) 835-6213.
