United States: CFTC Approves Amendment To Trade Options Exemption

Executive Summary The CFTC recently amended its trade option exemption to exclude certain reporting and recordkeeping requirements if a party to the option is a commercial end user of the underlying commodity. The broadened exemption provides relief to such commercial end users by reducing the compliance burden and costs associated with tracking and reporting certain transactions.

On March 16, 2016, the U.S. Commodity Futures Trading Commission ("CFTC") unanimously voted to approve a final amendment (the "Amendment") to the trade option exemption for the benefit of commercial end users of commodity trade options that are not swap dealers ("SD") or major swap participants ("MSP") (referred to hereafter as "End Users"). Under the rule prior to the Amendment and CFTC staff no-action guidance, End Users were exempted from many of the CFTC rules implementing the Dodd-Frank Act swaps regulatory regime with respect to such option transactions, so long as the transaction and the parties met certain conditions. The Amendment expands the exemption, and codifies the no-action guidance, to eliminate any reporting requirement for End-User-to-End-User trade options, and to modify the recordkeeping requirements applicable to End Users.

Background and Existing Rules Under the existing CFTC interpretations adopted in 2012,1 and pursuant to no-action guidance issued in 2013,2 trade options are "swaps" for purposes of Dodd-Frank. Provided that a transaction meets the commodity trade option definition, it is generally exempt from the Commodity Exchange Act and any CFTC rule promulgated thereunder, except those listed in Section 32.3(b)-(d) of the CFTC's rules relating to reporting and recordkeeping requirements.3 To be a "Trade Option," a commodity option and the parties to it must meet certain conditions: the transaction must involve a physical commodity and (i) be offered by either an eligible contract participant or a producer, processor, or commercial user of, or a merchant handling the commodity that is the subject of the commodity option transaction, or the products or by-products thereof (a "Commercial Entity"); (ii) be offered to a Commercial Entity; and (iii) be intended to be physically settled where the option, when exercised, results in the sale of an exempt or agricultural commodity for immediate or deferred delivery.

With respect to reporting, End Users may currently take advantage of no-action relief with respect of their Trade Options provided they (i) report all unreported Trade Options through an annual Form TO filing and (ii) notify the CFTC no later than 30 days after entering into Trade Options having an aggregate notional value in excess of $1 billion during any calendar year.4

Rule 32.3 recordkeeping obligations involve End Users keeping certain business records—what CFTC rules refer to as "full, complete and systematic records, together with all pertinent data and memoranda, with respect to each [trade option] in which they are a counterparty."5 Existing rules also require End Users to obtain a legal entity identifier ("LEI") if they transact with an SD/MSP and identify their Trade Options with either a unique swap identifier ("USI") or unique product identifier ("UPI") under Sections 45.5 and 45.7 of the CFTC's rules.6 Finally, the existing, pre-amendment rule contemplates that Trade Options would be subject to position limits, pending finalization of the position limits rule.7

The Amendment The Amendment does not change the three conditions for parties and transactions to benefit from the trade option exemption. However, if such conditions are satisfied, the Amendment eliminates the reporting and recordkeeping requirements for End Users that are parties to the Trade Option discussed above. The CFTC's intent, as stated, is to "reduce reporting burdens for [End User] trade option counterparties" and to recognize that certain recordkeeping requirements may be burdensome for End Users—particularly where multiple and costly recordkeeping systems are used.8

Accordingly, with respect to reporting, the Amendment completely eliminates the Form TO reporting requirement along with the obligation to report Trade Options having an aggregate notional value in excess of $1 billion during any calendar year.9 Further, the CFTC's press release related to the Amendment (though not the Amendment itself or adopting release) expresses its view that an End User is not required to report its otherwise unreported calendar year 2015 Trade Options on Form TO.10

The Amendment amends the recordkeeping requirements by eliminating the obligation to identify such options by either a USI or UPI, but retains the obligation to obtain an LEI if an End User's counterparty is an SD or MSP.11 The Amendment also recognizes that the CFTC's Part 151 position limits requirements are vacated—and removes reference to such requirements from amended Section 32.3(c).12 Moreover, the CFTC signaled its intent to exclude Trade Options from position limits in the future—and will address that matter in more detail in any final position-limits rule.13

Conclusion The Amendment provides regulatory relief to End Users that use Trade Options to mitigate commercial risks arising from ongoing business operations or otherwise related to the use of an underlying commodity. However, it will be important for End Users to carefully scrutinize their options transactions to ensure that they meet the requirements of a Trade Option. So, while the Amendment significantly reduces End Users' obligations, End Users should nonetheless carefully review the Amendment and the Trade Option exemption, as amended, in determining whether their transactions are ones to which the exemption may apply.14

Footnotes

1  Trade Options Final Rule, available at http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister031616b.pdf [hereinafter Amendment]. The Amendment is effective upon its publication in the Federal Register. Id. at 1. At the time of this alert's release, the Amendment is not yet effective; accordingly, citations to the Amendment are to the non-Federal Register release found at the above URL.

2 CFTC No-Action Letter No. 13-08 (Apr. 5, 2013), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-08.pdf.

3 See Trade Options, 17 C.F.R. § 32.3.

4 CFTC No-Action Letter No. 13-08 (Apr. 5, 2013), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-08.pdf.

5 Swap Recordkeeping, 17 C.F.R. § 45.2(b).

6 See 17 C.F.R. §§ 32.3(b), 45.5, 45.7.

7 See 17 C.F.R. § 32.3(c). Although the position-limits rule referenced in the pre-Amendment trade option exemption was vacated by the courts, end-users requested in comments that the CFTC confirm that any final position-limits rule would not be applicable to trade options.

8 Amendment at 12, 17-18.

9 Amendment at 12-17.
CFTC Approves Final Rule to Amend the Trade Option Exemption, CFTC (Mar. 16, 2016), http://www.cftc.gov/PressRoom/PressReleases/pr7343-16.

10 Amendment at 33 (to be codified at 17 C.F.R. § 32.3(b)).

11 Amendment at 21.

12 Id.

13 The CFTC, in the adopting release, declined to address certain interpretive requests made by the Electric Associations, seeking to make consistent the wording of the amended trade option exemption and the CFTC's interpretations with respect to forward contracts with embedded volumetric optionality. Compare Amendment at 32-33 (to be codified at 17 C.F.R. § 32.3) with CFTC and SEC Forward Contracts with Embedded Volumetric Optionality, 80 Fed. Reg. 28,239, 28,241 (May 18, 2015), available at http://www.cftc.gov/ucm/groups/public/@lrfederalregister/documents/file/2015-11946a.pdf. See also Comment from Russell Wasson, CFTC (June 19, 2015), http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1580.

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

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