Swaps Definition Delay Irks Markets

Terry Flanagan

CFTC and SEC postpone joint rulemaking on critical definitions.

The U.S. Commodity Futures Trading Commission declined last week to take up a final rule, proposed jointly with the Securities and Exchange Commission that would provide legal definitions of the various players in the U.S. derivatives market.

Yet, where the two agencies end up will have enormous impacts on energy companies and other major traders this market.

“We had thought was the definitions might have come out [last week] because the CFTC had announced it would release its final definition,” Andrea Kramer, partner and head of the financial products, trading and derivatives group at McDermott Will & Emery, told Markets Media.

The Securities and Exchange Commission reportedly wasn’t ready with its definitions, and since the definitions require a joint rulemaking, the CFTC had no choice but to delay.

There are many self-effectuating provisions that, although they technically became effective last July 16, nevertheless reference other provisions or definitions within Dodd-Frank for which further rulemaking is required.

“The CFTC has been coming out with rules on business conduct rules and duties of swap dealers and major swap participants,” said Kramer. “These rules assume that the definitions of swap dealer or major swap participant are already in place.”

“Position limit rules, for example, have been finalized, but don’t take effect until the definitions come out,” Kramer said.

The CTFC temporarily exempted entities from complying with self-effectuating provisions that reference terms that require further definition, such as “swap,” “swap dealer,” “major swap participant,” or “eligible contract participant, until Dec. 31, 2011 or the effective date of the definitional rulemaking for such terms, whichever is earlier.

The definitions of swap dealer and major swap participant are of particular concern to the derivatives industry because it believes that certain types of highly-regulated entities should not be regulated as dealers or MSPs.

“Energy companies have taken the position that their trading activities are not dealer activities and should therefore be exempt,” Kramer said.

The American Petroleum Institute said that physical options contracts that contemplate physical delivery should be excluded from the definition of a swap.

Physical option contracts are routine, commercial transactions that help energy companies manage changing physical commodity needs and allow companies involved in the entire energy value changing to balance customer or supplier demands, the API said in a comment letter.

Most physical volume options do not incorporate any financial settlement contingencies.

As compared to financial options or options on futures, the natural purchasers or sellers of physical options are those entities that transact in the underlying commodity, including producers, consumers, marketers, and those engaged in storage or transportation.

“We believe a broad interpretation of the statutory language excluding physical options from the definition of ‘swap’ would be consistent with the primary purposes of Dodd-Frank,” the API said.

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