The Commodity Futures Trading Commission ("CFTC" or "Commission") has explicitly recognized that contracts for intangible, non-financial commodities, including environmental commodities, can qualify for the forward contract exclusion if physical delivery is a predominant feature of the contract.1 However, the historical characterization of "virtual" power purchase agreements ("PPAs") as contracts-for-differences, and therefore swaps, has led the industry to report most virtual PPAs as swaps even when the predominant feature of many virtual PPAs is the deferred physical delivery of renewable energy certificates ("RECs").
This article considers the scope of the forward contract exclusion and discusses its potential application to virtual PPAs. Section I discusses virtual PPAs and describes a transition from contracts primarily used as power hedging agreements to agreements primarily for the purpose of the purchase and sale of RECs. Because little has been written about the history of virtual PPAs, this section is based largely on the authors' personal experience. Section II considers the scope of the forward contract exclusion by (i) examining courts' attempts to define futures contracts and contrast forward contracts, (ii) exploring the CFTC's application of and interpretative guidance regarding the exclusion, and (iii) drawing parallels from the CFTC's guidance regarding "actual delivery" in the context of digital assets. Finally, Section III applies the concepts discussed in Section II and concludes certain virtual PPAs qualify for the forward contract exclusion and therefore should not be regulated as swaps.
I. Introduction: Virtual PPAs as RECs Purchase and Sale Agreements
Over the past 10 or more years, there has been a shift in the United States from traditional PPAs that involve physical delivery of electricity to synthetic or virtual PPAs, which do not require physical delivery of electricity but often may involve the physical delivery of the associated environmental attributes. This shift from traditional PPAs to virtual PPAs has paralleled an increase in corporate off-takers and the displacement of utility off-takers. At the same time, the primary value and purpose of PPAs has increasingly become the associated environmental attributes more than the electricity output or the hedging of electricity prices.
Whereas traditional utility off-takers are in the business of making and taking physical delivery of power in wholesale markets, can anticipate consistent and contiguous load, and might even be forced to purchase electricity from Qualifying Facilities (QFs) pursuant to the Public Utility Regulatory Policies Act of 1978, corporate off-takers historically have lacked the experience and/or interest in owning and scheduling electricity in wholesale markets, may have highly variant and geographically decentralized consumption, and may prefer to avoid participating in the physical wholesale markets subject to the regulations of the Federal Energy Regulatory Commission ("FERC").
The virtual PPA became an attractive alternative as corporate end-users began to see opportunities to hedge electricity costs and potentially reduce their carbon footprint but were not interested in receiving intermittent electricity at a single location (often not near the off-taker's load centers). Rather than purchasing the output and physically scheduling it or trading it for energy delivered to the corporate end-user's various locations, the virtual PPA enabled the off-taker to fix energy prices (subject to basis risk) and obtain the environmental attributes of the renewable energy produced without having the inconvenience of receiving electricity at inconvenient locations.
With this backdrop, virtual PPAs have often been characterized as contracts-for-differences or financial hedges. Over time, although virtual PPAs have continued to be drafted and characterized by the industry as though they are contracts-for-differences and financially settled electricity contracts, the primary purpose of virtual PPAs today often seems to be the purchase and sale of the associated environmental attributes such as RECs. In fact, although the financial terms of virtual PPAs can resemble a contract-for-differences with the off-taker paying a fixed price and receiving a market-based index price based on the output of the resource, this fixed-for-float pricing may be better understood as reflecting the value of the RECs. That is, the RECs are purchased at a fixed price minus the value of the associated energy, which will be sold separately.
II. Futures, Swaps, and Forward Contracts
The Commodity Exchange Act (the "CEA") grants the CFTC exclusive jurisdiction over, inter alia, transactions involving "contracts of sale of a commodity for future delivery" and "swaps."2 The CEA does not define "contract[s] of sale of a commodity for future delivery" (i.e., futures contracts) but does define "future delivery" to exclude "any sale of any cash commodity for deferred shipment or delivery."3 This exclusion is commonly referred to as the "forward contract exclusion."
The CEA defines the term "swap," but the definition is so broad that its limits often are best understood by reference to enumerated exclusions, including the exclusion of "any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled."4 This exclusion is recognized as another expression of the forward contract exclusion.5 In the Swaps Definition Final Rule, the CFTC announced its intent to apply the forward contract exclusion to swaps "consistent with the entire body of CFTC precedent."6
Most of the case law interpreting the forward contract exclusion predates the creation of the regulatory regime for swaps developed post-Dodd-Frank, and the most recent cases focus on distinguishing foreign exchange transactions and spot transactions from futures and do not directly address the forward contract exclusion or its application in the context of potential swaps.7 Nevertheless, the efforts to define futures and apply the forward contract exclusion add color to the analysis of virtual PPAs and RECs purchase and sale agreements.
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Footnotes
1. Further Definition of "Swap," "Security-Based Swap," and "Security-Based Swap Agreement"; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Final Rule, 77 Fed. Reg. 48208, 48232-35 (Aug. 13, 2012) (providing an interpretation that intangible commodities, including environmental commodities, can qualify as forwards) (hereinafter "Swaps Definition Final Rule").
2. 7 U.S.C.A. § 2 (2023). Proper classification of contracts is important. Pursuant to the CEA, all futures transactions must be conducted on or subject to the rules of a registered board of trade, 7 U.S.C.A. § 6, and it is unlawful for any person other than an eligible contract participant (ECP) to enter into a swap except pursuant to the rules of a designated contract market. 7 U.S.C.A. § 2. All swaps are subject to regulation pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Public Law 111-203, 124 Stat. 1376 (2010).
3. 7 U.S.C.A. § 1a.
4. Id.
5. Swaps Definition Final Rule at 48227, citing Further Definition of "Swap," "Security-Based Swap," and "Security-Based Swap Agreement"; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 Fed. Reg. 29818, 29827 (May 23, 2011) ("The wording of the forward contract exclusion from the swap definition with respect to nonfinancial commodities is similar, but not identical, to the forward contract exclusion from the definition of 'future delivery' in the CEA.").
6. Swaps Definition Final Rule at 48227.
7. See, e.g., Commodity Futures Trading Commission v. Monex Credit Company, 311 F. Supp. 3d 1173, 1182 (C.D. Cal. 2018), rev'd and remanded, 931 F.3d 966, Comm. Fut. L. Rep. (CCH) P 34538 (9th Cir. 2019) (discussing "actual delivery" exception for retail commodity transactions).
Originally published by Futures and Derivatives Law Report.
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