United States: CFTC No-Action Relief From Potentially Burdensome Requirement For Automated Form 40S Response To CFTC ‘Special Calls

Last Updated: July 29 2014
Article by Patricia Dondanville and Thomas H. Watterson

Most Read Contributor in United States, October 2017

On July 23, the CFTC staff issued No-Action Letter 14-95 (available here) extending the compliance date from August 15, 2014 to February 11, 2016 for use of new Forms 40/40S—reports solicited from market participants by "special call" of the CFTC—and the CFTC's automated filing interface for such Forms. For swap dealers and other market professionals, the relevant effective dates for similar forms have been extended into early 2015. What are these Forms, and under what circumstances might a commercial entity receive such a "special call" from the CFTC?

Periodically, the CFTC Division of Market Oversight issues "special call" letters, seeking information from entities that may hold "reportable positions" in physical (nonfinancial) commodity derivatives. These physical commodity derivatives positions may include futures contracts or exchange-traded options, and may also now include "swaps" that are linked to certain identified futures contracts or the commodity underlying such futures contracts. In the U.S. energy industry, the relevant futures contract is often NYMEX Henry Hub natural gas. Other energy commodity futures contracts (called "covered futures contracts") that may subject a commercial entity to such a special call are: NYMEX No. 2 Heating Oil, New York Harbor, NYMEX Gasoline Blendstock, NYMEX Brent Financial and NYMEX Central Appalachian Coal. CBOT Ethanol is also a covered futures contract.

The CFTC special call letter typically asks the "trader" to comply with its regulatory obligation to file Form 40 or Form 40S, required under Part 20 of the CFTC rules—called the Large Trader Reporting Rules. Smaller commercial market participants tend to be confused by these special calls. These commercial entities, including most electric and natural gas utilities, are not derivatives dealers or futures market professionals. Some do not even trade on futures exchanges, so they have no experience with CFTC's special call process for Form 40 regarding futures contracts. But many such electric and natural gas utilities do regularly enter into over-the-counter energy commodity "swaps," that may be considered by the CFTC to be linked to a covered futures contract or to the underlying physical commodity. These commercial market participants also do not consider themselves large "traders"—many use CFTC-regulated derivatives (now including "swaps") ONLY to hedge or mitigate the commodity-related commercial risks of ongoing energy business operations.

Prior to Dodd-Frank Act amendments to the CFTC rules, the CFTC identified potential recipients of its special calls from futures commission merchant and CFTC-registered intermediary reports of customers that held futures positions. In 2011, the CFTC's new Large Trader Reporting Rules became effective. The CFTC then began receiving reports from swap dealers that identify the swap dealers' counterparties to relevant categories of swaps (including commercial end-users such as energy companies). As a result, if a commercial entity has entered into natural gas swaps (or swaps that may be linked to another covered futures contract or underlying commodity) with a swap dealer—and the swaps were over a certain size—the commercial entity's name is in the CFTC's database to potentially receive a special call.

During the last few years, because the CFTC had not yet finalized a new series of Large Trader Reporting "S" forms (revised to include swaps), the CFTC's special calls have asked commercial end-users to fill out the OLD or "legacy" pre-printed CFTC Form 40 as if it were a Form 40S—covering OTC "swaps" as well as natural gas futures contracts and exchange-traded options. The CFTC has allowed commercial end-users to send the pre-printed form to the CFTC by fax or email. We note that submitting Form 40S has required reading the legacy Form 40 and the instructions thereto as if all the questions in the Form requested information about "swaps." That process has been a considerable challenge for commercial end-users, as it assumes experience in the futures markets, and requires understanding the significant differences in market structure, terminology and concepts between the futures markets and the OTC swaps markets. It also requires an understanding of the many ambiguities in the CFTC's new rules, interpretations and guidance concerning "swaps." The recipient of the special call then must formulate accurate answers to the questions the Form 40S is likely asking about the entity's use of "swaps" in the context of the CFTC's new and evolving regulatory regime.

In November 2013, the CFTC published its final new Large Trader Reporting FORMS—including new Form 40S to be used for its special call authority in respect of "swaps." The new Form 40S wording is substantially similar to the legacy Form 40 (so the form itself continues to be confusing—see the translation issues noted above). In addition, the new Form 40S requirements are different in several ways from the prior Form 40 rules. For example, once effective, the new CFTC rules will require Form 40S to be submitted electronically to the CFTC via an automated web interface. The new Form 40S rules also require the commercial entity that receives such a special call once to CONTINUE TO SUPPLEMENT AND UPDATE its Form 40S, whether or not the entity receives another periodic special call from the CFTC. Energy trade associations objected to the confusing form language, the new electronic interface requirement and the ongoing regulatory update burden for non-CFTC registrants (see the comment letter filed by the NRECA, LPPC and EPSA here). The CFTC rejected those comments in promulgating its final rules.

In the last six months, the CFTC has increased its use of special calls to commercial energy companies that transact in natural gas futures, exchange-traded options and swaps. Some commentators believe that the CFTC is trying to understand the interplay between the regional U.S. natural gas and power markets during the "polar vortex" in the early months of 2014, which corresponded with significant price volatility in certain markets. Other commentators believe the CFTC staff is seeking to update its understanding of the physical commodity markets (and related futures and swaps markets) in general, in anticipation of finalizing the Commission's speculative position limits rules for natural gas and certain other nonfinancial commodities.

Concurrently with this increase in staff activity, the new automated Large Trader Reporting form system is still being built and tested. The new Forms and the automated interface were scheduled to go live on August 15, 2014. Consequently, No-Action Letter 14-95 represents welcome relief.

NOTE: There are conditions to the CFTC staff no-action relief. If an entity (a "trader") receives a special call, it must still respond and file legacy Form 40, or a Form 40S in accordance with the "Legacy 40S reporting practice," described above. Due to the continuing regulatory uncertainty and the ambiguities noted above, commercial end-users are encouraged to consult counsel before responding to such a special call. This is especially important because the Dodd-Frank Act amendments to the CFTC enforcement authority significantly increased the penalties to which corporations and individuals may be subject for submitting inaccurate reports to the CFTC. Also, all the recordkeeping requirements included in the Large Trader Reporting Rules will be effective from and after August 15, 2014. These recordkeeping rules are different than the ordinary course swap transaction recordkeeping rules for non-CFTC registrants that are found in Rule 45.2. Therefore, if you've received a special call for Form 40/40S in the past, or have other reasons to believe that your company may receive such a special call in the future, you should review those recordkeeping rules carefully.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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