Forward Contracts With Embedded Volumetric Optionality, 28239-28244 [2015-11946]
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Federal Register / Vol. 80, No. 95 / Monday, May 18, 2015 / Notices
notified of the Council’s intent to take
final action to address the emergency.
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Authority: 16 U.S.C. 1801 et seq.
Dated: May 13, 2015.
Tracey L. Thompson,
Acting Deputy Director, Office of Sustainable
Fisheries, National Marine Fisheries Service.
[FR Doc. 2015–11949 Filed 5–15–15; 8:45 am]
BILLING CODE 3510–22–P
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October 2013, and considered revised
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they still provide an adequate basis to
support the fishery management
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Items to be addressed during this
meeting.
Blueline Tilefish Stock Projections
Dated: May 13, 2015.
Tracey L. Thompson,
Acting Deputy Director, Office of Sustainable
Fisheries, National Marine Fisheries Service.
[FR Doc. 2015–11951 Filed 5–15–15; 8:45 am]
BILLING CODE 3510–22–P
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FOR FURTHER INFORMATION CONTACT:
Kitty M. Simonds, Executive Director;
telephone: (808) 522–8220.
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Schedule and Agenda for the P* WG
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June 4, 2015—1 p.m.–5 p.m.
1. Introductions
2. Recap of previous meeting
3. Review of the P* Dimensions and
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a. Assessment information
b. Uncertainty characterization
c. Stock status
d. Productivity and susceptibility
4. Revisit Productivity and
Susceptibility scores
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5 days prior to the meeting date.
Authority: 16 U.S.C. 1801 et seq.
Dated: May 13, 2015.
Tracey L. Thompson,
Acting Deputy Director, Office of Sustainable
Fisheries, National Marine Fisheries Service.
[FR Doc. 2015–11954 Filed 5–15–15; 8:45 am]
BILLING CODE 3510–22–P
COMMODITY FUTURES TRADING
COMMISSION
RIN 3038–AE24
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–74936; File No. S7–16–11]
RIN 3235–AK65
Forward Contracts With Embedded
Volumetric Optionality
Commodity Futures Trading
Commission; Securities and Exchange
Commission.
ACTION: Final interpretation.
AGENCY:
In accordance with section
712(d)(4) of the Dodd-Frank Wall Street
SUMMARY:
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Federal Register / Vol. 80, No. 95 / Monday, May 18, 2015 / Notices
Reform and Consumer Protection Act
(the ‘‘Dodd-Frank Act’’), the Commodity
Futures Trading Commission (the
‘‘CFTC’’) and the Securities and
Exchange Commission (‘‘SEC’’), after
consultation with the Board of
Governors of the Federal Reserve
System (‘‘Board of Governors’’), are
jointly issuing the CFTC’s clarification
of its interpretation concerning forward
contracts with embedded volumetric
optionality.
DATES: This interpretation is effective on
May 18, 2015.
FOR FURTHER INFORMATION CONTACT:
CFTC: Elise Pallais, Counsel, (202) 418–
5577, epallais@cftc.gov; Mark Fajfar,
Assistant General Counsel, (202) 418–
6636, mfajfar@cftc.gov, Office of the
General Counsel, Commodity Futures
Trading Commission, 1155 21st Street
NW., Washington, DC 20581. SEC: Carol
McGee, Assistant Director, (202) 551–
5870, mcgeec@sec.gov, Office of
Derivatives Policy, Division of Trading
and Markets, Securities and Exchange
Commission, 100 F Street NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
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I. Introduction
In Further Definition of ‘‘Swap,’’
Security-Based Swap,’’ and ‘‘SecurityBased Swap Agreement’’; Mixed Swaps;
Security-Based Swap Agreement
Recordkeeping (the ‘‘Products Release’’),
the CFTC provided an interpretation, in
response to requests from commenters,
with respect to forward contracts that
provide for variations in delivery
amount (i.e., that contain ‘‘embedded
volumetric optionality’’).1 Specifically,
1 See 77 FR 48207, 48238–42 (Aug. 13, 2012). As
described in the Products Release, the
interpretation included the following seven
elements:
1. The embedded optionality does not undermine
the overall nature of the agreement, contract, or
transaction as a forward contract;
2. The predominant feature of the agreement,
contract, or transaction is actual delivery;
3. The embedded optionality cannot be severed
and marketed separately from the overall
agreement, contract, or transaction in which it is
embedded;
4. The seller of a nonfinancial commodity
underlying the agreement, contract, or transaction
with embedded volumetric optionality intends, at
the time it enters into the agreement, contract, or
transaction to deliver the underlying nonfinancial
commodity if the optionality is exercised;
5. The buyer of a nonfinancial commodity
underlying the agreement, contract or transaction
with embedded volumetric optionality intends, at
the time it enters into the agreement, contract, or
transaction, to take delivery of the underlying
nonfinancial commodity if it exercises the
embedded volumetric optionality;
6. Both parties are commercial parties; and
7. The exercise or non-exercise of the embedded
volumetric optionality is based primarily on
physical factors, or regulatory requirements, that are
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the CFTC identified when an agreement,
contract, or transaction would fall
within the forward contract exclusion
from the ‘‘swap’’ and ‘‘future delivery’’
definitions in the Commodity Exchange
Act (the ‘‘CEA’’) 2 notwithstanding that
it contains embedded volumetric
optionality.3 In providing its
interpretation, the CFTC was guided by
and sought to reconcile agency
precedent regarding forward contracts
containing embedded options 4 with the
statutory definition of ‘‘swap’’ in section
1a(47) of the CEA, which provides,
among other things, that commodity
options are swaps, even if physically
settled.5
In response to requests from market
participants,6 the CFTC proposed in
November 2014 to clarify its
interpretation of when an agreement,
contract, or transaction with embedded
outside the control of the parties and are
influencing demand for, or supply of, the
nonfinancial commodity.
2 See 7 U.S.C. 1a(47)(B)(ii) (excluding from the
definition of ‘‘swap’’ ‘‘any sale of a nonfinancial
commodity or security for deferred shipment or
delivery, so long as the transaction is intended to
be physically settled’’); 1a(27) (excluding from the
definition of ‘‘future delivery’’ ‘‘any sale of any cash
commodity for deferred shipment or delivery’’)
(emphasis added).
3 See 77 FR at 48238–42 & n.335. As explained
in the Products Release, the CFTC interprets the
exclusions in CEA sections 1a(47)(B)(ii) and 1a(27)
as coextensive and thus requiring a consistent
interpretation. See id. at 48227–8. See also id. at
48227–36 (discussing the CFTC’s interpretation
regarding the forward contract exclusion for
nonfinancial commodities).
4 See id. at 48237–39 (citing In re Wright, CFTC
Docket No. 97–02, 2010 WL 4388247 (CFTC Oct. 25,
2010), and Characteristics Distinguishing Cash and
Forward Contracts and ‘‘Trade’’ Options, 50 FR
39656 (Sept. 30, 1985) (‘‘1985 CFTC OGC
Interpretation’’)).
5 See id. at 48236–37; 7 U.S.C. 1a(47)(A)(i)
(defining ‘‘swap’’ to include ‘‘[an] option of any
kind that is for the purchase or sale, or based on
the value, of 1 or more * * * commodities * * *’’).
CEA section 1a(47)(A)(i) does not differentiate
between financially- and physically-settled options.
Certain physically-settled options, termed ‘‘trade
options,’’ are nevertheless exempt from most
requirements applicable to swaps. See 17 CFR 32.3.
Additionally, the CFTC is proposing to amend its
trade option exemption to further reduce the
reporting and recordkeeping requirements
applicable to certain commercial end users. See
Trade Options, 80 FR 26200 (May 7, 2015).
6 The Products Release included a request for
comment on the CFTC’s interpretation regarding
forward contracts with embedded volumetric
optionality. See 77 FR at 48241–42. CFTC staff also
solicited comments in connection with a public
roundtable on issues concerning end users and the
Dodd-Frank Act. These comments are available at
https://comments.cftc.gov/PublicComments/
CommentList.aspx?id=1256 and https://
comments.cftc.gov/PublicComments/
CommentList.aspx?id=1485, respectively. In
general, commenters asserted that uncertainty with
regard to the CFTC’s interpretation, particularly the
seventh element, has led to confusion over whether
to characterize certain transactions as excluded
forward contracts with embedded volumetric
optionality or regulated trade options.
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volumetric optionality would be
considered a forward contract.7 In
particular, the CFTC proposed to (a)
modify the fourth and fifth elements of
its interpretation to clarify that the
interpretation applies to embedded
volumetric optionality in the form of
both puts and calls 8 and (b) modify the
seventh element to clarify that the
embedded volumetric optionality must
be primarily intended, at the time the
parties enter into the agreement,
contract, or transaction, to address
physical factors or regulatory
requirements that reasonably influence
demand for, or supply of, the
nonfinancial commodity.9 The CFTC
requested comment on all aspects of its
proposal.10
7 Forward Contracts With Embedded Volumetric
Optionality, 79 FR 69073 (Nov. 20, 2014) (the
‘‘Proposed Interpretation’’). Section 712(d)(4) of the
Dodd-Frank Act provides that ‘‘[a]ny interpretation
of, or guidance by either Commission regarding, a
provision of this title, shall be effective only if
issued jointly by the Commodity Futures Trading
Commission and the Securities and Exchange
Commission, after consultation with the Board of
Governors, if this title requires the Commodity
Futures Trading Commission and the Securities and
Exchange Commission to issue joint regulations to
implement the provision.’’ While the Dodd-Frank
Act requires this interpretation, which was
originally included in the Products Release, to be
issued jointly by the CFTC and the SEC, it is an
interpretation solely of the CFTC and does not
apply to the exclusion from the swap and securitybased swap definitions for security forwards or to
the distinction between security forwards and
security futures products.
8 Id. at 69074.
9 Id. at 69074–76.
10 See id. at 69076. The CFTC also requested
comment in response to specific questions relating
to its proposal. Id. The comment file, which
includes 22 unique comments and one (1) ex parte
communication, is available at https://
comments.cftc.gov/PublicComments/
CommentList.aspx?id=1541. Commenters include
American Gas Association; American Petroleum
Institute; American Public Power Association,
Edison Electric Institute, Electric Power Supply
Association, Large Public Power Council, and
National Rural Electric Cooperative Association;
Americans for Financial Reform; Barnard, Chris;
Better Markets Inc.; Business Council for
Sustainable Energy; Coalition for Derivatives EndUsers; Coalition of Physical Energy Companies;
Cogen Technologies Linden Venture LP;
Commercial Energy Working Group and
Commodity Markets Council; Dairy Farmers of
America; EDF Trading North America LLC; Federal
Energy Regulatory Commission staff; Fig, Willem;
International Energy Credit Association;
International Swaps and Derivatives Association
Inc.; National Association of Manufacturers;
National Corn Growers Association and Natural Gas
Supply Association; National Energy Marketers
Association; Public Citizen; and Southern Company
Services Inc., acting on behalf of and as agent for
Alabama Power Co., Georgia Power Co., Gulf Power
Co., Mississippi Power Co., and Southern Power Co.
None of the commenters requested any revisions to
SEC rules or regulations (or interpretations thereof),
but rather addressed issues relating solely to the
CFTC’s interpretation.
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II. Overview
After a careful review of the
comments received, the CFTC has
determined to finalize its interpretation
as proposed with some additional
clarifications. Accordingly, an
agreement, contract, or transaction falls
within the forward exclusion from the
swap and future delivery definitions,
notwithstanding that it contains
embedded volumetric optionality,
when:
1. The embedded optionality does not
undermine the overall nature of the
agreement, contract, or transaction as a
forward contract;
2. The predominant feature of the
agreement, contract, or transaction is
actual delivery;
3. The embedded optionality cannot
be severed and marketed separately
from the overall agreement, contract, or
transaction in which it is embedded;
4. The seller of a nonfinancial
commodity underlying the agreement,
contract, or transaction with embedded
volumetric optionality intends, at the
time it enters into the agreement,
contract, or transaction to deliver the
underlying nonfinancial commodity if
the embedded volumetric optionality is
exercised;
5. The buyer of a nonfinancial
commodity underlying the agreement,
contract or transaction with embedded
volumetric optionality intends, at the
time it enters into the agreement,
contract, or transaction, to take delivery
of the underlying nonfinancial
commodity if the embedded volumetric
optionality is exercised;
6. Both parties are commercial parties;
and
7. The embedded volumetric
optionality is primarily intended, at the
time that the parties enter into the
agreement, contract, or transaction, to
address physical factors or regulatory
requirements that reasonably influence
demand for, or supply of, the
nonfinancial commodity.
As stated in the Proposed
Interpretation, the first six elements of
this interpretation are largely
unchanged from the Products Release.11
Among them, only the fourth and fifth
elements have been modified, as
proposed, to clarify that the CFTC’s
interpretation applies to embedded
volumetric optionality in the form of
both puts and calls.12 Accordingly, the
11 See
77 FR at 48238.
described in the Products Release, the fifth
element did not appear to contemplate
circumstances where the seller of the nonfinancial
commodity might exercise the embedded
volumetric optionality. See 77 FR at 48238 (‘‘The
buyer of a nonfinancial commodity underlying the
12 As
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CFTC’s discussion of these six elements
in the Products Release remains relevant
and applicable.13 The seventh element
of the interpretation is discussed further
below.
As a general matter, the CFTC clarifies
that its interpretation with respect to
forward contracts with embedded
volumetric optionality should not be
read to alter or expand the historic
interpretation of the forward contract
exclusion. As the first two elements
affirm, the interpretation presupposes
the existence of an underlying forward
contract, as determined by applying the
historic interpretation of the forward
contract exclusion.14 The CFTC’s
interpretation, as provided herein,
merely identifies the circumstances
under which volumetric optionality
embedded in such a forward contract
would not operate to take the contract
outside the forward contract
exclusion.15 As explained in the
Products Release, the historic
interpretation of the forward contract
exclusion remains relevant and
applicable.16
In response to commenters, the CFTC
clarifies that the fourth and fifth
elements of the interpretation do not
preclude bandwidth (a.k.a. ‘‘swing’’)
contracts, which provide for delivery of
a nonfinancial commodity within a
certain minimum and maximum range,
from falling within the forward contract
exclusion from the swap and future
delivery definitions.17 As indicated in
the Products Release, the fourth and
fifth elements merely require that the
intent to make or take delivery (as
agreement, contract or transaction with embedded
volumetric optionality intends, at the time it enters
into the agreement, contract, or transaction, to take
delivery of the underlying nonfinancial commodity
if it exercises the embedded volumetric
optionality.’’) (emphasis added).
13 See 77 FR at 48238–39.
14 See id. at 48227–36.
15 The CFTC’s interpretation only addresses when
a forward contract with embedded volumetric
optionality would be excluded from the swap or
future delivery definitions in the CEA; it does not
address whether a contract would otherwise fall
within the swap definition. In other words, a
contract that does not meet one or more elements
of the CFTC’s interpretation may or may not be a
swap depending on the characteristics of the
contract. See, e.g., id. at 48246–52 (discussing
application of the swap definition to consumer and
commercial agreements).
16 See, e.g., id. at 48228.
17 See Letter from Coalition of Physical Energy
Companies (Dec. 22, 2014) at 4; Letter from
Commercial Energy Working Group and
Commodity Markets Council (Dec. 22, 2014) at 3–
4; Letter from EDF Trading North America LLC
(‘‘EDFTNA’’) (Dec. 22, 2014) at 15–17; Letter from
International Energy Credit Association (‘‘IECA’’)
(Dec. 22, 2014) at 4–5; Letter from International
Swaps and Derivatives Association Inc. (Dec. 22,
2014) at 3 (each requesting clarification that the
fourth and fifth elements permit both increases and
decreases in volume).
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28241
applicable) required of the underlying
forward contract extends to the
embedded volumetric optionality, such
that both parties to the contract intend
to make or take delivery (as applicable)
of the nonfinancial commodity under
the contract if the embedded volumetric
optionality is exercised.18 The
embedded volumetric optionality may
therefore operate to increase and/or
decrease the quantity delivered under
the underlying forward contract and
still not take the contract out of the
forward exclusion provided that all
elements of the CFTC’s interpretation,
as provided herein, are satisfied.
III. The Seventh Element
As stated in the Proposed
Interpretation, the seventh element
addresses the primary reason for
including embedded volumetric
optionality in a forward contract.19
Embedded volumetric optionality offers
commercial parties the flexibility to
vary the amount of the nonfinancial
commodity delivered during the life of
the contract in response to uncertainty
in the demand for or supply of the
nonfinancial commodity.20 The seventh
element ensures that this purpose,
consistent with the historical
interpretation of a forward contract,21 is
the primary purpose for including
embedded volumetric optionality in the
contract. In other words, the embedded
volumetric optionality must primarily
be intended as a means of assuring a
supply source or providing delivery
flexibility in the face of uncertainty
regarding the quantity of the
nonfinancial commodity that may be
needed or produced in the future,
consistent with the purposes of a
forward contract.22
18 See 77 FR at 48239 (‘‘The fourth and fifth
elements are designed to ensure that both parties
intend to make or take delivery (as applicable),
subject to the relevant physical factors or regulatory
requirements, which may lead the parties to deliver
more or less than originally intended.’’) (emphasis
added).
19 See 79 FR at 69074–75.
20 See, e.g., Letter from the Commodity Markets
Council, the National Corn Growers Association,
and the Natural Gas Supply Association (‘‘CMC/
NCGA/NGA’’) (April 17, 2014) at 2 (‘‘Physical endusers need these contracts to address supply input
or production output uncertainty associated with
the operation of a physical business.’’); Letter from
the Plains All American Pipeline, L.P. (April 17,
2014) at 2 (‘‘Such contracts provide us with the
ability to allow our customers flexibility to increase
or decrease the amount of purchase or sale of a
commodity in response to prevailing market
conditions.’’).
21 See 77 FR 48228 (describing a forward contract
as a ‘‘commercial merchandising transaction’’ in
which delivery is delayed for ‘‘commercial
convenience or necessity’’).
22 See 77 FR at 48228 (‘‘The primary purpose of
a forward contract is to transfer ownership of the
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As indicated in the Proposed
Interpretation, the focus of the seventh
element is the intent of the party with
the right to exercise the embedded
volumetric optionality at the time of
contract initiation.23 In line with the
CFTC’s historical interpretation of the
forward contract exclusion, as discussed
in the Products Release, such intent may
be ascertained by the relevant facts and
circumstances surrounding the contract,
including the parties’ course of
performance thereunder.24
Nevertheless, commercial parties may
rely on counterparty representations
with respect to the intended purpose for
embedding volumetric optionality in the
contract provided they do not have
information that would cause a
reasonable person to question the
accuracy of the representation. In
response to commenters, the CFTC
clarifies that commercial parties are not
required to conduct due diligence in
order to rely on such representations.25
The CFTC clarifies that the seventh
element’s reference to ‘‘physical factors’’
commodity and not to transfer solely its price
risk.’’). See also Letter from the CMC/NCGA/NGA
(April 17, 2014) at 2 (‘‘[Contracts with volumetric
optionality] exist to permit end-users to have
agreements in place so that they can effectively and
economically manage the purchase or sale of
commodities related to their commercial
businesses, not as a substitute for a financially
settled contract or for speculative purposes.’’);
Letter from ONEOK, Inc. (July 22, 2011) at 7 (stating
that ‘‘[a]lthough the amounts that can be taken on
delivery may vary, the primary intent of the
contracts is not to provide price protection’’).
23 For example, in choosing whether to obtain
additional supply by exercising the embedded
volumetric optionality under a given contract or
turning to another supply source—whether storage,
the spot market, or another forward contract with
embedded volumetric optionality—commercial
parties would be able to consider a variety of
factors, including price, provided that the intended
purpose for including the embedded volumetric
optionality in the contract at contract initiation was
to address physical factors or regulatory
requirements influencing the demand for or supply
of the commodity. See also Letter from EDFTNA
(Dec. 22, 2014) at 20 (requesting further clarification
that the seventh element only addresses the intent
of the party with the right to exercise the embedded
volumetric optionality.)
24 See 77 FR 48228 (‘‘In assessing the parties’
expectations or intent regarding delivery, the CFTC
consistently has applied a ‘facts and circumstances’
test.’’). For example, if one party has an option to
settle a contract financially based upon a value
change in an underlying cash market, then the
contract may be a swap. See id. at 48241 n. 370.
See also Letter from ONEOK, Inc. (July 22, 2011)
at 6 (acknowledging that ‘‘[t]he intent of the parties
to defer delivery of a varying amount can be
ascertained based on objective criteria, such as the
pattern of deliveries in relation to variation in
weather, customer demand, or other similar
factors.’’).
25 See Letter from EDFTNA (Dec. 22, 2014) at 22–
23 (arguing that requiring counterparties to conduct
due diligence in order to ensure that facts
suggesting an alternate purpose for the embedded
volumetric optionality are not present would be
‘‘infeasible’’ and may undercut the utility of the
Proposed Interpretation).
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should be construed broadly to include
any fact or circumstance that could
reasonably influence supply of or
demand for the nonfinancial commodity
under the contract. Such facts and
circumstances could include not only
environmental factors, such as weather
or location, but relevant ‘‘operational
considerations’’ (e.g., the availability of
reliable transportation or technology)
and broader social forces, such as
changes in demographics or
geopolitics.26 The CFTC further clarifies
that the parties’ having some influence
over such physical factors (e.g., the
scheduling of plant maintenance, plans
for business expansion) would not be
inconsistent with the seventh element,
provided that the embedded volumetric
optionality is included in the contract at
initiation primarily to address potential
variability in a party’s supply of or
demand for the nonfinancial
commodity, consistent with the
purposes of a forward contract.
The CFTC reiterates, however, that if
the embedded volumetric optionality is
primarily intended, at contract
initiation, to address concerns about
price risk (e.g., to protect against
increases or decreases in the cash
market price), the seventh element
would not be satisfied absent an
applicable regulatory requirement,
including guidance, whether formal or
informal, received from a public utility
commission or other similar governing
body, to obtain or provide the lowest
price (e.g., the buyer is an energy
company regulated on a cost-of-service
basis).27 The CFTC recognizes that, as
commenters have pointed out, price is
likely to be a consideration when
entering into any contract, including a
forward contract.28 However, to ensure
26 As stated in the Products Release, system
reliability issues that lead to voluntary supply
curtailments would be considered ‘‘physical
factors’’ within the scope of the seventh element.
See 77 FR at 48239 n.345.
27 The CFTC confirms that, as stated in the
Proposed Interpretation and in the Products
Release, the deliverable quantities allowable under
embedded volumetric optionality may be justified
by a combination of regulatory requirements and
physical factors, such that the quantity provided for
by the embedded volumetric optionality may
reasonably exceed quantities required by regulation.
See 77 FR at 48238 n.340.
28 See 77 FR at 48228 (‘‘The primary purpose of
a forward contract is to transfer ownership of the
commodity and not to transfer solely its price risk.’’)
(emphasis added). See also Letter from American
Gas Association (‘‘AGA’’) (Dec. 22, 2014) at 8–10;
Letter from Coalition for Derivatives End-Users
(Dec. 22, 2014) at 6; Letter from American Public
Power Association, Edison Electric Institute,
Electric Power Supply Association, Large Public
Power Council, and National Rural Electric
Cooperative Association (‘‘Joint Associations’’)
(Dec. 22, 2014) at 4–5; Letter from Southern
Company Services Inc., acting on behalf of and as
agent for Alabama Power Co., Georgia Power Co.,
PO 00000
Frm 00024
Fmt 4703
Sfmt 4703
that, as required by the first element, the
overall nature of the contract as a
forward is not undermined,29 the
embedded volumetric optionality must,
as stated above, be primarily intended
as a means of securing a supply source
in the face of uncertainty (arising from
physical factors or regulatory
requirements, such as an obligation to
ensure system reliability) regarding the
volume of the nonfinancial commodity
to be needed or produced.30
Additionally, as stated in the
Proposed Interpretation, the CFTC
understands that in certain retail
electric market demand-response
programs, electric utilities have the right
to interrupt or curtail service to a
customer to support system reliability.31
The CFTC clarifies that, given that a key
function of an electricity system
operator is to ensure grid reliability,
demand response agreements, even if
not specifically mandated by a system
operator, may be properly characterized
as the product of regulatory
requirements within the meaning of the
seventh element.32
Finally, in response to requests from
commenters, the CFTC clarifies that
commercial parties may choose to either
rely on their good faith characterization
of an existing contract (e.g., as an
excluded forward contract with
embedded volumetric optionality or an
exempt trade option) and or
recharacterize it in accordance with this
final interpretation.33
Gulf Power Co., Mississippi Power Co., and
Southern Power Co. (Dec. 22, 2014) at 2–3.
29 See 77 FR at 48227–36.
30 See 1985 CFTC OGC Interpretation, 50 FR at
39658. But see supra note 23; Letter from National
Corn Growers Association and Natural Gas Supply
Association (Dec. 22, 2014) (recognizing that price
concerns are acceptable ‘‘if they arise subsequent to
execution or are motivated by an applicable
regulatory requirement’’).
31 See Letter from the National Rural Electric
Cooperative Association, the American Public
Power Association, the Large Public Power
Association, and the Transmission Access Policy
Study Group (Oct. 12, 2012) at 9.
32 The CFTC further clarifies that its
interpretations regarding full requirements and
output contracts, as provided in the Products
Release, remain relevant and unaffected by the
discussion herein. See 77 FR at 48239–40.
Similarly, the CFTC reiterates that, depending on
the relevant facts and circumstances, capacity
contracts, transmission (or transportation) service
agreements, tolling agreements, and peaking supply
contracts, as discussed in the Products Release, may
qualify as forward contracts with embedded
volumetric optionality provided they meet the
elements of the CFTC’s proposed interpretation. See
77 FR 48240.
33 Letter from AGA (Dec. 22, 2104) at 12, 19
(requesting relief for market participants who
reported transactions as trade options that,
following adoption of the Proposed Interpretation,
they would consider excluded forwards); Letter
from EDFTNA (Dec. 22, 2014) at 5–7 (arguing that
reassessment of the legal character of an existing
E:\FR\FM\18MYN1.SGM
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Federal Register / Vol. 80, No. 95 / Monday, May 18, 2015 / Notices
Commodity Futures Trading
Commission (CFTC) Appendices to
Forward Contracts With Embedded
Volumetric Optionality—Commission
Voting Summary, Chairman’s
Statement, and Commissioner’s
Statement
regulatory purposes, the interpretation
should make it easier for commercial
companies to continue to use these types of
contracts in their daily operations.
In certain situations, commercial parties
are unable to predict at the time a contract
is entered into the exact quantities of the
commodity that they may need or be able to
supply, and the embedded volumetric
optionality offers them the flexibility to vary
the quantities delivered accordingly. The
CFTC put out an interpretation, consisting of
seven factors, to provide clarity as to when
such contracts would fall within the forward
contract exclusion from the swap definition,
but some market participants have felt this
interpretation, in particular the seventh
factor, was hard to apply. In some cases, the
two parties would reach different
conclusions about the same contract.
Today we are finalizing clarifications to the
interpretation that I believe will alleviate this
ambiguity and allow contracts with
volumetric optionality that truly are intended
to address uncertainty with respect to the
parties’ future production capacity or
delivery needs, and not for speculative
purposes or as a means to obtain one-way
price protection, to fall within the exclusion.
Appendix 1—Commodity Futures
Trading Commission Voting Summary
Appendix 3—Concurring Statement of
CFTC Commissioner Sharon Y. Bowen
On this matter, Chairman Massad and
Commissioners Wetjen, Bowen, and
Giancarlo voted in the affirmative. No
Commissioner voted in the negative.
Today we are approving a final
interpretation regarding forward contracts
with embedded optionality. This
interpretation is improved compared to the
proposed interpretation and I am voting in
favor of it. However, I am concerned that this
interpretation does not provide the clarity
that may be required.
Staff has done a remarkable job in
considering the comments received and
drafting this final interpretation and they
deserve ample praise for their hard work.
Yet, staff, and this Commission, face
statutory restrictions regarding the
definitions of forwards and options that place
limits on the relief available through
interpretations of the forward contract
exclusion. There is no interpretation, by this
Commission or its staff, which can turn an
option into a forward.
Given the interpretive questions about the
final rule defining ‘‘swap’’ and the
difficulties in classifying forward contracts
with embedded optionality, I think it is
important to be clear on what this
interpretation can and cannot do—I do not
want people to make business decisions
based upon a mistaken belief that they have
received relief when they have not.
The central issue industry faces is that, in
the manufacturing, agriculture and energy
sectors, a wide variety of physicallydelivered instruments are used to secure
companies’ commercial needs for a physical
commodity. These instruments often contain
elements of both a forward contract and a
commodity option. These contracts,
particularly in the energy sector, are all
commonly referred to as physical contracts,
and they, according to what I have been told,
often receive similar treatment from both a
business operations and an accounting
standpoint within the entities that use them.
Furthermore, my understanding is that
these physical contracts are often handled
The CFTC believes that these
modifications are appropriately
measured to clarify the meaning of
certain language in the seventh element
and should not be construed as a shift
in the CFTC’s longstanding precedent
on the difference between forward
contracts and options.
By the Securities and Exchange
Commission.
Dated: May 12, 2015.
Brent J. Fields,
Secretary.
Issued in Washington, DC, on May 12,
2015, by the Commodity Futures Trading
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
asabaliauskas on DSK5VPTVN1PROD with NOTICES
Appendix 2—Statement of Support of
CFTC Chairman Timothy G. Massad
I support the staff’s recommendations to
finalize a proposal we made in November
regarding contracts with embedded
volumetric optionality—a contractual right to
receive more or less of a commodity at the
negotiated contract price.
As I said in my statement on the proposal,
with reforms as significant as these, it is
inevitable that there will be a need for some
minor adjustments. And that is what we are
doing. The changes we are proposing today
help ensure that as we regulate the potential
for excessive risks in these markets, we make
sure that the 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.
Specifically, we proposed to clarify when
a contract with embedded volumetric
optionality will be excluded from being
considered a swap. We received a number of
comments on this and we have incorporated
some of the concerns in the final
clarification. Today, following action by the
SEC last week, we are posting to the Federal
Register the final interpretation. By clarifying
how these agreements will be treated for
contract is impractical) Letter from IECA (Dec. 22,
2014) at 3 (arguing that requiring parties to
reclassify their existing contracts following
adoption of the Proposed Interpretation would be
unduly burdensome); Letter from Joint Associations
(Dec. 22, 2014) at 11 (requesting that the CFTC
allow counterparties to reclassify their transactions
following adoption of the Proposed Interpretation).
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PO 00000
Frm 00025
Fmt 4703
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28243
and accounted for separately from other
derivatives, such as futures contracts or cashsettled swaps. Treating some portion of these
physical contracts as swaps simply because
they may contain some characteristics of
commodity options can lead to significant
costs and difficulties. For instance,
companies may have to reconfigure their
business systems to parse transactions where
there was, before Dodd Frank, no need to
undertake such a reconfiguration.
I have studied this issue closely, meeting
with industry and the public and reviewing
the comments we have received. In the case
of these transactions which are used to
address physical commodity needs, I have
doubts about whether any public interest is
served by requiring manufacturing,
agricultural and energy companies to
undertake such a burden and reconfigure
processes to comply with Commission swap
regulations.
The limits on relief through this
interpretation flow from the statutory lines
drawn between options and forward
contracts. Under the CEA, options and
forwards are discrete, mutually exclusive
categories. Options are subject to the
Commission’s plenary, exclusive jurisdiction.
Forward contracts, on the other hand, are
almost entirely excluded from the
Commission’s jurisdiction. If a contract, or
some portion of a contract, meets the
definition of an ‘‘option,’’ that portion which
is an option inherently cannot be a forward
contract.
Under the CEA, a critical difference
between a physically-delivered option and a
forward contract is the nature of the delivery
obligation. A forward contract binds both
parties to make and take delivery of a
commodity at some date in the future. The
contract may only be offset through a
separate negotiation of the parties. In a
physically-settled option contract, only the
party offering the option is bound to make or
take delivery at the time of contract.
The forward contract exclusion from the
swap definition, applies only to a ‘‘[A] sale
of a nonfinancial commodity or security for
deferred shipment or delivery, so long as the
transaction is intended to be physically
settled.’’ The key part of this definition is
that it only applies to a ‘‘sale’’ of a
commodity. A ‘‘sale’’ means that one party
has agreed to make and the other to take
delivery of that commodity.1
1 The phrase, ‘‘so long as the transaction is
intended to by physically settled,’’ has been
interpreted by the Commission to be consistent
with its traditional approach to determining
whether an instrument is a forward contract. As
was stated in the Commission’s proposed rule,
The CFTC believes that the forward contract
exclusion in the Dodd-Frank Act with respect to
nonfinancial commodities should be read
consistently with th[e] established, historical
understanding that a forward contract is a
commercial merchandising transaction.
Many commenters discussed the issue of whether
the requirement in the Dodd-Frank Act that a
transaction be ‘‘intended to be physically settled’’
in order to qualify for the forward exclusion from
the swap definition with respect to nonfinancial
commodities reflects a change in the standard for
determining whether a transaction is a forward
E:\FR\FM\18MYN1.SGM
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18MYN1
28244
Federal Register / Vol. 80, No. 95 / Monday, May 18, 2015 / Notices
An option, in contrast, is only the option
to undertake such a ‘‘sale’’, not the sale itself.
The sale occurs only when the option is
exercised. The option to buy or sell a
commodity at some later point simply is not
the same thing as the sale of that commodity
itself. The Commission’s Office of the
General Counsel memorialized this
interpretation in 1985:
[T]he [forward] contract must be a binding
agreement on both parties to the contract:
One must agree to make delivery and the
other to take delivery of the commodity.
Second, because forward contracts are
commercial, merchandizing transactions
which result in delivery, the courts and the
Commission have looked for evidence of the
transactions’ use in commerce. Thus, the
courts and the Commission have examined
whether the parties to the contracts are
commercial entities that have the capacity to
make or take delivery and whether delivery,
in fact, routinely occurs under such contracts
*
*
*
*
*
asabaliauskas on DSK5VPTVN1PROD with NOTICES
Thus, an option is a contract in which only
the grantor is obligated to perform. As a
result, the option purchaser has a limited risk
from adverse price movements. This
characteristic distinguishes an option from a
forward contract in which both parties must
routinely perform and face the full risk of
loss from adverse price changes since one
party must make and the other take delivery
of the commodity. In contrast, in an option,
only the grantor of a call (put) is required to
sell (buy) a given quantity of a commodity (or
a futures contract on that commodity) on or
by a specified date in the future if the option
is exercised. ‘‘Characteristics Distinguishing
Cash and Forward Contracts and ‘Trade
Options’ ’’, 50 FR 39656–02 (September 30,
1985)
The Commission ratified this interpretation
in 1990 in its ‘‘Statutory Interpretation
Concerning Forward Transactions’’, 55 FR
39188–03 (September 25, 1990) (‘‘Brent
Interpretation’’) and again in 2012 its final
rule, ‘‘Further Definition of ‘Swap,’ ‘SecurityBased Swap,’ and ‘Security-Based Swap
Agreement’; Mixed Swaps; Security-Based
contract. Because a forward contract is a
commercial merchandising transaction, intent to
deliver historically has been an element of the
CFTC’s analysis of whether a particular contract is
a forward contract. In assessing the parties’
expectations or intent regarding delivery, the CFTC
consistently has applied a ‘‘facts and
circumstances’’ test. Therefore, the CFTC reads the
‘‘intended to be physically settled’’ language in the
swap definition with respect to nonfinancial
commodities to reflect a directive that intent to
deliver a physical commodity be a part of the
analysis of whether a given contract is a forward
contract or a swap, just as it is a part of the CFTC’s
analysis of whether a given contract is a forward
contract or a futures contract. Proposed Rule on
‘‘Further Definition of ‘Swap,’ ‘Security-Based
Swap,’ and ‘Security-Based Swap Agreement’;
Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, 76 FR 29818, 29828 (May 23, 2011)
(‘‘Proposed Products Release’’).
This interpretation was ratified in the final rule,
‘‘Further Definition of ‘Swap,’ ‘Security-Based
Swap,’ and ‘Security-Based Swap Agreement’;
Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, 77 FR 48208, 48227–48228 (August
13, 2012) (‘‘Products Release’’).
VerDate Sep<11>2014
18:52 May 15, 2015
Jkt 235001
Swap Agreement Recordkeeping, 77 FR
48208, 48227–48235 (August 13, 2012)
(‘‘Products Release’’). In doing so, the
Commission explicitly rejected the argument
that physically-delivered commodity options
could fall within the forward contract
exclusion.2
The interpretation being promulgated
today does not change this, and therein lays
my concern regarding this interpretation’s
limits.
I think much of the confusion regarding the
seven-part test has been based upon a failure
to recognize the difference between forward
and option contracts under the Commodity
Exchange Act. The fact that a forward
contract element and a commodity option are
packaged together does not change the
regulatory treatment of the different
components. Hybrid or packaged instruments
are common throughout the industry. There
are hybrid or packaged instruments which
may have characteristics of futures contracts
and securities, swaps and security-based
swaps, futures and forward transactions, and
even forward contracts and commodity
options. Each portion of the contract might
be subject to different regulatory treatment. A
security does not become a future, nor does
a future become a security simply by virtue
of being packaged in the same instrument.
Relevant to the instruments we are
discussing today, forward contracts with
embedded volumetric optionality, it seems
that most of them, as described in the
comments, have at least two separate,
identifiable contractual obligations, each of
which must be considered on their own
merits. There is a forward contract element
which binds the parties to make and take
delivery of a set amount of a commodity. In
addition, there is an embedded volumetric
optionality element that binds the forward
contract offeror to make or take delivery of
an additional amount of the commodity if the
embedded volumetric optionality is
exercised by the forward contract offeree.
The latter contractual obligation looks like a
classic option.
The difficulty this interpretation faces in
providing the relief industry seeks is this:
Even though the embedded optionality has
the form of an option, can it somehow fit
within the forward exclusion? The answer
this interpretation gives is, essentially, yes, it
can, if it can be demonstrated that, despite
the embedded optionality having the form of
an option, it is utilized, in practice, as a
forward contract. While the seven-prong test
and the interpretive guidance around it do
not provide an exact roadmap for
determining when embedded volumetric
optionality included in a forward contract
may or may not fall into the option
definition, or when embedded volumetric
optionality may undermine a forward
contract, I think it does provide a good sense
of the factors that parties must consider in
making those determinations for themselves.
Such a test, however, is necessarily a facts
and circumstances test with no bright lines.
Ensuring compliance with this interpretation
poses a challenge, and, therefore, that is an
area where I would like to see greater legal
certainty for these contracts.
2 See
PO 00000
also, Products Release at 4236–37.
Frm 00026
Fmt 4703
Sfmt 4703
In closing, I support this final
interpretation, but I think industry would
benefit from broader relief that provides
greater legal certainty. I look forward to
continuing to work with my fellow
Commissioners and staff to make sure that
commercial entities have access to the tools
they need to manage the commercial risks of
their operations.
[FR Doc. 2015–11946 Filed 5–15–15; 8:45 am]
BILLING CODE 8011–01–p 6351–01–P
BUREAU OF CONSUMER FINANCIAL
PROTECTION
[Docket No. CFPB–2015–0020]
Agency Information Collection
Activities: Comment Request
Bureau of Consumer Financial
Protection.
ACTION: Notice and request for comment.
AGENCY:
In accordance with the
Paperwork Reduction Act of 1995
(PRA), the Consumer Financial
Protection Bureau (Bureau) is requesting
to renew the approval for an existing
information collection titled, ‘‘Mortgage
Acts and Practices (Regulation N) 12
CFR 1014.’’
DATES: Written comments are
encouraged and must be received on or
before July 17, 2015 to be assured of
consideration.
SUMMARY:
You may submit comments,
identified by the title of the information
collection, OMB Control Number (see
below), and docket number (see above),
by any of the following methods:
• Electronic: https://
www.regulations.gov. Follow the
instructions for submitting comments.
• Mail: Consumer Financial
Protection Bureau (Attention: PRA
Office), 1700 G Street NW., Washington,
DC 20552.
• Hand Delivery/Courier: Consumer
Financial Protection Bureau (Attention:
PRA Office), 1275 First Street NE.,
Washington, DC 20002.
Please note that comments submitted
after the comment period will not be
accepted. In general, all comments
received will become public records,
including any personal information
provided. Sensitive personal
information, such as account numbers
or social security numbers, should not
be included.
FOR FURTHER INFORMATION CONTACT:
Documentation prepared in support of
this information collection request is
available at www.regulations.gov.
Requests for additional information
should be directed to the Consumer
Financial Protection Bureau, (Attention:
ADDRESSES:
E:\FR\FM\18MYN1.SGM
18MYN1
]]>Agencies
[Federal Register Volume 80, Number 95 (Monday, May 18, 2015)]
[Notices]
[Pages 28239-28244]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-11946]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
RIN 3038-AE24
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-74936; File No. S7-16-11]
RIN 3235-AK65
Forward Contracts With Embedded Volumetric Optionality
AGENCY: Commodity Futures Trading Commission; Securities and Exchange
Commission.
ACTION: Final interpretation.
-----------------------------------------------------------------------
SUMMARY: In accordance with section 712(d)(4) of the Dodd-Frank Wall
Street
[[Page 28240]]
Reform and Consumer Protection Act (the ``Dodd-Frank Act''), the
Commodity Futures Trading Commission (the ``CFTC'') and the Securities
and Exchange Commission (``SEC''), after consultation with the Board of
Governors of the Federal Reserve System (``Board of Governors''), are
jointly issuing the CFTC's clarification of its interpretation
concerning forward contracts with embedded volumetric optionality.
DATES: This interpretation is effective on May 18, 2015.
FOR FURTHER INFORMATION CONTACT: CFTC: Elise Pallais, Counsel, (202)
418-5577, epallais@cftc.gov; Mark Fajfar, Assistant General Counsel,
(202) 418-6636, mfajfar@cftc.gov, Office of the General Counsel,
Commodity Futures Trading Commission, 1155 21st Street NW., Washington,
DC 20581. SEC: Carol McGee, Assistant Director, (202) 551-5870,
mcgeec@sec.gov, Office of Derivatives Policy, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Introduction
In Further Definition of ``Swap,'' Security-Based Swap,'' and
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping (the ``Products Release''), the CFTC provided
an interpretation, in response to requests from commenters, with
respect to forward contracts that provide for variations in delivery
amount (i.e., that contain ``embedded volumetric optionality'').\1\
Specifically, the CFTC identified when an agreement, contract, or
transaction would fall within the forward contract exclusion from the
``swap'' and ``future delivery'' definitions in the Commodity Exchange
Act (the ``CEA'') \2\ notwithstanding that it contains embedded
volumetric optionality.\3\ In providing its interpretation, the CFTC
was guided by and sought to reconcile agency precedent regarding
forward contracts containing embedded options \4\ with the statutory
definition of ``swap'' in section 1a(47) of the CEA, which provides,
among other things, that commodity options are swaps, even if
physically settled.\5\
---------------------------------------------------------------------------
\1\ See 77 FR 48207, 48238-42 (Aug. 13, 2012). As described in
the Products Release, the interpretation included the following
seven elements:
1. The embedded optionality does not undermine the overall
nature of the agreement, contract, or transaction as a forward
contract;
2. The predominant feature of the agreement, contract, or
transaction is actual delivery;
3. The embedded optionality cannot be severed and marketed
separately from the overall agreement, contract, or transaction in
which it is embedded;
4. The seller of a nonfinancial commodity underlying the
agreement, contract, or transaction with embedded volumetric
optionality intends, at the time it enters into the agreement,
contract, or transaction to deliver the underlying nonfinancial
commodity if the optionality is exercised;
5. The buyer of a nonfinancial commodity underlying the
agreement, contract or transaction with embedded volumetric
optionality intends, at the time it enters into the agreement,
contract, or transaction, to take delivery of the underlying
nonfinancial commodity if it exercises the embedded volumetric
optionality;
6. Both parties are commercial parties; and
7. The exercise or non-exercise of the embedded volumetric
optionality is based primarily on physical factors, or regulatory
requirements, that are outside the control of the parties and are
influencing demand for, or supply of, the nonfinancial commodity.
\2\ See 7 U.S.C. 1a(47)(B)(ii) (excluding from the definition of
``swap'' ``any sale of a nonfinancial commodity or security for
deferred shipment or delivery, so long as the transaction is
intended to be physically settled''); 1a(27) (excluding from the
definition of ``future delivery'' ``any sale of any cash commodity
for deferred shipment or delivery'') (emphasis added).
\3\ See 77 FR at 48238-42 & n.335. As explained in the Products
Release, the CFTC interprets the exclusions in CEA sections
1a(47)(B)(ii) and 1a(27) as coextensive and thus requiring a
consistent interpretation. See id. at 48227-8. See also id. at
48227-36 (discussing the CFTC's interpretation regarding the forward
contract exclusion for nonfinancial commodities).
\4\ See id. at 48237-39 (citing In re Wright, CFTC Docket No.
97-02, 2010 WL 4388247 (CFTC Oct. 25, 2010), and Characteristics
Distinguishing Cash and Forward Contracts and ``Trade'' Options, 50
FR 39656 (Sept. 30, 1985) (``1985 CFTC OGC Interpretation'')).
\5\ See id. at 48236-37; 7 U.S.C. 1a(47)(A)(i) (defining
``swap'' to include ``[an] option of any kind that is for the
purchase or sale, or based on the value, of 1 or more * * *
commodities * * *''). CEA section 1a(47)(A)(i) does not
differentiate between financially- and physically-settled options.
Certain physically-settled options, termed ``trade options,'' are
nevertheless exempt from most requirements applicable to swaps. See
17 CFR 32.3. Additionally, the CFTC is proposing to amend its trade
option exemption to further reduce the reporting and recordkeeping
requirements applicable to certain commercial end users. See Trade
Options, 80 FR 26200 (May 7, 2015).
---------------------------------------------------------------------------
In response to requests from market participants,\6\ the CFTC
proposed in November 2014 to clarify its interpretation of when an
agreement, contract, or transaction with embedded volumetric
optionality would be considered a forward contract.\7\ In particular,
the CFTC proposed to (a) modify the fourth and fifth elements of its
interpretation to clarify that the interpretation applies to embedded
volumetric optionality in the form of both puts and calls \8\ and (b)
modify the seventh element to clarify that the embedded volumetric
optionality must be primarily intended, at the time the parties enter
into the agreement, contract, or transaction, to address physical
factors or regulatory requirements that reasonably influence demand
for, or supply of, the nonfinancial commodity.\9\ The CFTC requested
comment on all aspects of its proposal.\10\
---------------------------------------------------------------------------
\6\ The Products Release included a request for comment on the
CFTC's interpretation regarding forward contracts with embedded
volumetric optionality. See 77 FR at 48241-42. CFTC staff also
solicited comments in connection with a public roundtable on issues
concerning end users and the Dodd-Frank Act. These comments are
available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1256 and https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1485, respectively. In general,
commenters asserted that uncertainty with regard to the CFTC's
interpretation, particularly the seventh element, has led to
confusion over whether to characterize certain transactions as
excluded forward contracts with embedded volumetric optionality or
regulated trade options.
\7\ Forward Contracts With Embedded Volumetric Optionality, 79
FR 69073 (Nov. 20, 2014) (the ``Proposed Interpretation''). Section
712(d)(4) of the Dodd-Frank Act provides that ``[a]ny interpretation
of, or guidance by either Commission regarding, a provision of this
title, shall be effective only if issued jointly by the Commodity
Futures Trading Commission and the Securities and Exchange
Commission, after consultation with the Board of Governors, if this
title requires the Commodity Futures Trading Commission and the
Securities and Exchange Commission to issue joint regulations to
implement the provision.'' While the Dodd-Frank Act requires this
interpretation, which was originally included in the Products
Release, to be issued jointly by the CFTC and the SEC, it is an
interpretation solely of the CFTC and does not apply to the
exclusion from the swap and security-based swap definitions for
security forwards or to the distinction between security forwards
and security futures products.
\8\ Id. at 69074.
\9\ Id. at 69074-76.
\10\ See id. at 69076. The CFTC also requested comment in
response to specific questions relating to its proposal. Id. The
comment file, which includes 22 unique comments and one (1) ex parte
communication, is available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1541. Commenters include American
Gas Association; American Petroleum Institute; American Public Power
Association, Edison Electric Institute, Electric Power Supply
Association, Large Public Power Council, and National Rural Electric
Cooperative Association; Americans for Financial Reform; Barnard,
Chris; Better Markets Inc.; Business Council for Sustainable Energy;
Coalition for Derivatives End-Users; Coalition of Physical Energy
Companies; Cogen Technologies Linden Venture LP; Commercial Energy
Working Group and Commodity Markets Council; Dairy Farmers of
America; EDF Trading North America LLC; Federal Energy Regulatory
Commission staff; Fig, Willem; International Energy Credit
Association; International Swaps and Derivatives Association Inc.;
National Association of Manufacturers; National Corn Growers
Association and Natural Gas Supply Association; National Energy
Marketers Association; Public Citizen; and Southern Company Services
Inc., acting on behalf of and as agent for Alabama Power Co.,
Georgia Power Co., Gulf Power Co., Mississippi Power Co., and
Southern Power Co. None of the commenters requested any revisions to
SEC rules or regulations (or interpretations thereof), but rather
addressed issues relating solely to the CFTC's interpretation.
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[[Page 28241]]
II. Overview
After a careful review of the comments received, the CFTC has
determined to finalize its interpretation as proposed with some
additional clarifications. Accordingly, an agreement, contract, or
transaction falls within the forward exclusion from the swap and future
delivery definitions, notwithstanding that it contains embedded
volumetric optionality, when:
1. The embedded optionality does not undermine the overall nature
of the agreement, contract, or transaction as a forward contract;
2. The predominant feature of the agreement, contract, or
transaction is actual delivery;
3. The embedded optionality cannot be severed and marketed
separately from the overall agreement, contract, or transaction in
which it is embedded;
4. The seller of a nonfinancial commodity underlying the agreement,
contract, or transaction with embedded volumetric optionality intends,
at the time it enters into the agreement, contract, or transaction to
deliver the underlying nonfinancial commodity if the embedded
volumetric optionality is exercised;
5. The buyer of a nonfinancial commodity underlying the agreement,
contract or transaction with embedded volumetric optionality intends,
at the time it enters into the agreement, contract, or transaction, to
take delivery of the underlying nonfinancial commodity if the embedded
volumetric optionality is exercised;
6. Both parties are commercial parties; and
7. The embedded volumetric optionality is primarily intended, at
the time that the parties enter into the agreement, contract, or
transaction, to address physical factors or regulatory requirements
that reasonably influence demand for, or supply of, the nonfinancial
commodity.
As stated in the Proposed Interpretation, the first six elements of
this interpretation are largely unchanged from the Products
Release.\11\ Among them, only the fourth and fifth elements have been
modified, as proposed, to clarify that the CFTC's interpretation
applies to embedded volumetric optionality in the form of both puts and
calls.\12\ Accordingly, the CFTC's discussion of these six elements in
the Products Release remains relevant and applicable.\13\ The seventh
element of the interpretation is discussed further below.
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\11\ See 77 FR at 48238.
\12\ As described in the Products Release, the fifth element did
not appear to contemplate circumstances where the seller of the
nonfinancial commodity might exercise the embedded volumetric
optionality. See 77 FR at 48238 (``The buyer of a nonfinancial
commodity underlying the agreement, contract or transaction with
embedded volumetric optionality intends, at the time it enters into
the agreement, contract, or transaction, to take delivery of the
underlying nonfinancial commodity if it exercises the embedded
volumetric optionality.'') (emphasis added).
\13\ See 77 FR at 48238-39.
---------------------------------------------------------------------------
As a general matter, the CFTC clarifies that its interpretation
with respect to forward contracts with embedded volumetric optionality
should not be read to alter or expand the historic interpretation of
the forward contract exclusion. As the first two elements affirm, the
interpretation presupposes the existence of an underlying forward
contract, as determined by applying the historic interpretation of the
forward contract exclusion.\14\ The CFTC's interpretation, as provided
herein, merely identifies the circumstances under which volumetric
optionality embedded in such a forward contract would not operate to
take the contract outside the forward contract exclusion.\15\ As
explained in the Products Release, the historic interpretation of the
forward contract exclusion remains relevant and applicable.\16\
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\14\ See id. at 48227-36.
\15\ The CFTC's interpretation only addresses when a forward
contract with embedded volumetric optionality would be excluded from
the swap or future delivery definitions in the CEA; it does not
address whether a contract would otherwise fall within the swap
definition. In other words, a contract that does not meet one or
more elements of the CFTC's interpretation may or may not be a swap
depending on the characteristics of the contract. See, e.g., id. at
48246-52 (discussing application of the swap definition to consumer
and commercial agreements).
\16\ See, e.g., id. at 48228.
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In response to commenters, the CFTC clarifies that the fourth and
fifth elements of the interpretation do not preclude bandwidth (a.k.a.
``swing'') contracts, which provide for delivery of a nonfinancial
commodity within a certain minimum and maximum range, from falling
within the forward contract exclusion from the swap and future delivery
definitions.\17\ As indicated in the Products Release, the fourth and
fifth elements merely require that the intent to make or take delivery
(as applicable) required of the underlying forward contract extends to
the embedded volumetric optionality, such that both parties to the
contract intend to make or take delivery (as applicable) of the
nonfinancial commodity under the contract if the embedded volumetric
optionality is exercised.\18\ The embedded volumetric optionality may
therefore operate to increase and/or decrease the quantity delivered
under the underlying forward contract and still not take the contract
out of the forward exclusion provided that all elements of the CFTC's
interpretation, as provided herein, are satisfied.
---------------------------------------------------------------------------
\17\ See Letter from Coalition of Physical Energy Companies
(Dec. 22, 2014) at 4; Letter from Commercial Energy Working Group
and Commodity Markets Council (Dec. 22, 2014) at 3-4; Letter from
EDF Trading North America LLC (``EDFTNA'') (Dec. 22, 2014) at 15-17;
Letter from International Energy Credit Association (``IECA'') (Dec.
22, 2014) at 4-5; Letter from International Swaps and Derivatives
Association Inc. (Dec. 22, 2014) at 3 (each requesting clarification
that the fourth and fifth elements permit both increases and
decreases in volume).
\18\ See 77 FR at 48239 (``The fourth and fifth elements are
designed to ensure that both parties intend to make or take delivery
(as applicable), subject to the relevant physical factors or
regulatory requirements, which may lead the parties to deliver more
or less than originally intended.'') (emphasis added).
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III. The Seventh Element
As stated in the Proposed Interpretation, the seventh element
addresses the primary reason for including embedded volumetric
optionality in a forward contract.\19\ Embedded volumetric optionality
offers commercial parties the flexibility to vary the amount of the
nonfinancial commodity delivered during the life of the contract in
response to uncertainty in the demand for or supply of the nonfinancial
commodity.\20\ The seventh element ensures that this purpose,
consistent with the historical interpretation of a forward
contract,\21\ is the primary purpose for including embedded volumetric
optionality in the contract. In other words, the embedded volumetric
optionality must primarily be intended as a means of assuring a supply
source or providing delivery flexibility in the face of uncertainty
regarding the quantity of the nonfinancial commodity that may be needed
or produced in the future, consistent with the purposes of a forward
contract.\22\
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\19\ See 79 FR at 69074-75.
\20\ See, e.g., Letter from the Commodity Markets Council, the
National Corn Growers Association, and the Natural Gas Supply
Association (``CMC/NCGA/NGA'') (April 17, 2014) at 2 (``Physical
end-users need these contracts to address supply input or production
output uncertainty associated with the operation of a physical
business.''); Letter from the Plains All American Pipeline, L.P.
(April 17, 2014) at 2 (``Such contracts provide us with the ability
to allow our customers flexibility to increase or decrease the
amount of purchase or sale of a commodity in response to prevailing
market conditions.'').
\21\ See 77 FR 48228 (describing a forward contract as a
``commercial merchandising transaction'' in which delivery is
delayed for ``commercial convenience or necessity'').
\22\ See 77 FR at 48228 (``The primary purpose of a forward
contract is to transfer ownership of the commodity and not to
transfer solely its price risk.''). See also Letter from the CMC/
NCGA/NGA (April 17, 2014) at 2 (``[Contracts with volumetric
optionality] exist to permit end-users to have agreements in place
so that they can effectively and economically manage the purchase or
sale of commodities related to their commercial businesses, not as a
substitute for a financially settled contract or for speculative
purposes.''); Letter from ONEOK, Inc. (July 22, 2011) at 7 (stating
that ``[a]lthough the amounts that can be taken on delivery may
vary, the primary intent of the contracts is not to provide price
protection'').
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[[Page 28242]]
As indicated in the Proposed Interpretation, the focus of the
seventh element is the intent of the party with the right to exercise
the embedded volumetric optionality at the time of contract
initiation.\23\ In line with the CFTC's historical interpretation of
the forward contract exclusion, as discussed in the Products Release,
such intent may be ascertained by the relevant facts and circumstances
surrounding the contract, including the parties' course of performance
thereunder.\24\ Nevertheless, commercial parties may rely on
counterparty representations with respect to the intended purpose for
embedding volumetric optionality in the contract provided they do not
have information that would cause a reasonable person to question the
accuracy of the representation. In response to commenters, the CFTC
clarifies that commercial parties are not required to conduct due
diligence in order to rely on such representations.\25\
---------------------------------------------------------------------------
\23\ For example, in choosing whether to obtain additional
supply by exercising the embedded volumetric optionality under a
given contract or turning to another supply source--whether storage,
the spot market, or another forward contract with embedded
volumetric optionality--commercial parties would be able to consider
a variety of factors, including price, provided that the intended
purpose for including the embedded volumetric optionality in the
contract at contract initiation was to address physical factors or
regulatory requirements influencing the demand for or supply of the
commodity. See also Letter from EDFTNA (Dec. 22, 2014) at 20
(requesting further clarification that the seventh element only
addresses the intent of the party with the right to exercise the
embedded volumetric optionality.)
\24\ See 77 FR 48228 (``In assessing the parties' expectations
or intent regarding delivery, the CFTC consistently has applied a
`facts and circumstances' test.''). For example, if one party has an
option to settle a contract financially based upon a value change in
an underlying cash market, then the contract may be a swap. See id.
at 48241 n. 370. See also Letter from ONEOK, Inc. (July 22, 2011) at
6 (acknowledging that ``[t]he intent of the parties to defer
delivery of a varying amount can be ascertained based on objective
criteria, such as the pattern of deliveries in relation to variation
in weather, customer demand, or other similar factors.'').
\25\ See Letter from EDFTNA (Dec. 22, 2014) at 22-23 (arguing
that requiring counterparties to conduct due diligence in order to
ensure that facts suggesting an alternate purpose for the embedded
volumetric optionality are not present would be ``infeasible'' and
may undercut the utility of the Proposed Interpretation).
---------------------------------------------------------------------------
The CFTC clarifies that the seventh element's reference to
``physical factors'' should be construed broadly to include any fact or
circumstance that could reasonably influence supply of or demand for
the nonfinancial commodity under the contract. Such facts and
circumstances could include not only environmental factors, such as
weather or location, but relevant ``operational considerations'' (e.g.,
the availability of reliable transportation or technology) and broader
social forces, such as changes in demographics or geopolitics.\26\ The
CFTC further clarifies that the parties' having some influence over
such physical factors (e.g., the scheduling of plant maintenance, plans
for business expansion) would not be inconsistent with the seventh
element, provided that the embedded volumetric optionality is included
in the contract at initiation primarily to address potential
variability in a party's supply of or demand for the nonfinancial
commodity, consistent with the purposes of a forward contract.
---------------------------------------------------------------------------
\26\ As stated in the Products Release, system reliability
issues that lead to voluntary supply curtailments would be
considered ``physical factors'' within the scope of the seventh
element. See 77 FR at 48239 n.345.
---------------------------------------------------------------------------
The CFTC reiterates, however, that if the embedded volumetric
optionality is primarily intended, at contract initiation, to address
concerns about price risk (e.g., to protect against increases or
decreases in the cash market price), the seventh element would not be
satisfied absent an applicable regulatory requirement, including
guidance, whether formal or informal, received from a public utility
commission or other similar governing body, to obtain or provide the
lowest price (e.g., the buyer is an energy company regulated on a cost-
of-service basis).\27\ The CFTC recognizes that, as commenters have
pointed out, price is likely to be a consideration when entering into
any contract, including a forward contract.\28\ However, to ensure
that, as required by the first element, the overall nature of the
contract as a forward is not undermined,\29\ the embedded volumetric
optionality must, as stated above, be primarily intended as a means of
securing a supply source in the face of uncertainty (arising from
physical factors or regulatory requirements, such as an obligation to
ensure system reliability) regarding the volume of the nonfinancial
commodity to be needed or produced.\30\
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\27\ The CFTC confirms that, as stated in the Proposed
Interpretation and in the Products Release, the deliverable
quantities allowable under embedded volumetric optionality may be
justified by a combination of regulatory requirements and physical
factors, such that the quantity provided for by the embedded
volumetric optionality may reasonably exceed quantities required by
regulation. See 77 FR at 48238 n.340.
\28\ See 77 FR at 48228 (``The primary purpose of a forward
contract is to transfer ownership of the commodity and not to
transfer solely its price risk.'') (emphasis added). See also Letter
from American Gas Association (``AGA'') (Dec. 22, 2014) at 8-10;
Letter from Coalition for Derivatives End-Users (Dec. 22, 2014) at
6; Letter from American Public Power Association, Edison Electric
Institute, Electric Power Supply Association, Large Public Power
Council, and National Rural Electric Cooperative Association
(``Joint Associations'') (Dec. 22, 2014) at 4-5; Letter from
Southern Company Services Inc., acting on behalf of and as agent for
Alabama Power Co., Georgia Power Co., Gulf Power Co., Mississippi
Power Co., and Southern Power Co. (Dec. 22, 2014) at 2-3.
\29\ See 77 FR at 48227-36.
\30\ See 1985 CFTC OGC Interpretation, 50 FR at 39658. But see
supra note 23; Letter from National Corn Growers Association and
Natural Gas Supply Association (Dec. 22, 2014) (recognizing that
price concerns are acceptable ``if they arise subsequent to
execution or are motivated by an applicable regulatory
requirement'').
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Additionally, as stated in the Proposed Interpretation, the CFTC
understands that in certain retail electric market demand-response
programs, electric utilities have the right to interrupt or curtail
service to a customer to support system reliability.\31\ The CFTC
clarifies that, given that a key function of an electricity system
operator is to ensure grid reliability, demand response agreements,
even if not specifically mandated by a system operator, may be properly
characterized as the product of regulatory requirements within the
meaning of the seventh element.\32\
---------------------------------------------------------------------------
\31\ See Letter from the National Rural Electric Cooperative
Association, the American Public Power Association, the Large Public
Power Association, and the Transmission Access Policy Study Group
(Oct. 12, 2012) at 9.
\32\ The CFTC further clarifies that its interpretations
regarding full requirements and output contracts, as provided in the
Products Release, remain relevant and unaffected by the discussion
herein. See 77 FR at 48239-40. Similarly, the CFTC reiterates that,
depending on the relevant facts and circumstances, capacity
contracts, transmission (or transportation) service agreements,
tolling agreements, and peaking supply contracts, as discussed in
the Products Release, may qualify as forward contracts with embedded
volumetric optionality provided they meet the elements of the CFTC's
proposed interpretation. See 77 FR 48240.
---------------------------------------------------------------------------
Finally, in response to requests from commenters, the CFTC
clarifies that commercial parties may choose to either rely on their
good faith characterization of an existing contract (e.g., as an
excluded forward contract with embedded volumetric optionality or an
exempt trade option) and or recharacterize it in accordance with this
final interpretation.\33\
---------------------------------------------------------------------------
\33\ Letter from AGA (Dec. 22, 2104) at 12, 19 (requesting
relief for market participants who reported transactions as trade
options that, following adoption of the Proposed Interpretation,
they would consider excluded forwards); Letter from EDFTNA (Dec. 22,
2014) at 5-7 (arguing that reassessment of the legal character of an
existing contract is impractical) Letter from IECA (Dec. 22, 2014)
at 3 (arguing that requiring parties to reclassify their existing
contracts following adoption of the Proposed Interpretation would be
unduly burdensome); Letter from Joint Associations (Dec. 22, 2014)
at 11 (requesting that the CFTC allow counterparties to reclassify
their transactions following adoption of the Proposed
Interpretation).
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[[Page 28243]]
The CFTC believes that these modifications are appropriately
measured to clarify the meaning of certain language in the seventh
element and should not be construed as a shift in the CFTC's
longstanding precedent on the difference between forward contracts and
---------------------------------------------------------------------------
options.
By the Securities and Exchange Commission.
Dated: May 12, 2015.
Brent J. Fields,
Secretary.
Issued in Washington, DC, on May 12, 2015, by the Commodity
Futures Trading Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Commodity Futures Trading Commission (CFTC) Appendices to Forward
Contracts With Embedded Volumetric Optionality--Commission Voting
Summary, Chairman's Statement, and Commissioner's Statement
Appendix 1--Commodity Futures Trading Commission Voting Summary
On this matter, Chairman Massad and Commissioners Wetjen, Bowen,
and Giancarlo voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2--Statement of Support of CFTC Chairman Timothy G. Massad
I support the staff's recommendations to finalize a proposal we
made in November regarding contracts with embedded volumetric
optionality--a contractual right to receive more or less of a
commodity at the negotiated contract price.
As I said in my statement on the proposal, with reforms as
significant as these, it is inevitable that there will be a need for
some minor adjustments. And that is what we are doing. The changes
we are proposing today help ensure that as we regulate the potential
for excessive risks in these markets, we make sure that the
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.
Specifically, we proposed to clarify when a contract with
embedded volumetric optionality will be excluded from being
considered a swap. We received a number of comments on this and we
have incorporated some of the concerns in the final clarification.
Today, following action by the SEC last week, we are posting to the
Federal Register the final interpretation. By clarifying how these
agreements will be treated for regulatory purposes, the
interpretation should make it easier for commercial companies to
continue to use these types of contracts in their daily operations.
In certain situations, commercial parties are unable to predict
at the time a contract is entered into the exact quantities of the
commodity that they may need or be able to supply, and the embedded
volumetric optionality offers them the flexibility to vary the
quantities delivered accordingly. The CFTC put out an
interpretation, consisting of seven factors, to provide clarity as
to when such contracts would fall within the forward contract
exclusion from the swap definition, but some market participants
have felt this interpretation, in particular the seventh factor, was
hard to apply. In some cases, the two parties would reach different
conclusions about the same contract.
Today we are finalizing clarifications to the interpretation
that I believe will alleviate this ambiguity and allow contracts
with volumetric optionality that truly are intended to address
uncertainty with respect to the parties' future production capacity
or delivery needs, and not for speculative purposes or as a means to
obtain one-way price protection, to fall within the exclusion.
Appendix 3--Concurring Statement of CFTC Commissioner Sharon Y. Bowen
Today we are approving a final interpretation regarding forward
contracts with embedded optionality. This interpretation is improved
compared to the proposed interpretation and I am voting in favor of
it. However, I am concerned that this interpretation does not
provide the clarity that may be required.
Staff has done a remarkable job in considering the comments
received and drafting this final interpretation and they deserve
ample praise for their hard work. Yet, staff, and this Commission,
face statutory restrictions regarding the definitions of forwards
and options that place limits on the relief available through
interpretations of the forward contract exclusion. There is no
interpretation, by this Commission or its staff, which can turn an
option into a forward.
Given the interpretive questions about the final rule defining
``swap'' and the difficulties in classifying forward contracts with
embedded optionality, I think it is important to be clear on what
this interpretation can and cannot do--I do not want people to make
business decisions based upon a mistaken belief that they have
received relief when they have not.
The central issue industry faces is that, in the manufacturing,
agriculture and energy sectors, a wide variety of physically-
delivered instruments are used to secure companies' commercial needs
for a physical commodity. These instruments often contain elements
of both a forward contract and a commodity option. These contracts,
particularly in the energy sector, are all commonly referred to as
physical contracts, and they, according to what I have been told,
often receive similar treatment from both a business operations and
an accounting standpoint within the entities that use them.
Furthermore, my understanding is that these physical contracts
are often handled and accounted for separately from other
derivatives, such as futures contracts or cash-settled swaps.
Treating some portion of these physical contracts as swaps simply
because they may contain some characteristics of commodity options
can lead to significant costs and difficulties. For instance,
companies may have to reconfigure their business systems to parse
transactions where there was, before Dodd Frank, no need to
undertake such a reconfiguration.
I have studied this issue closely, meeting with industry and the
public and reviewing the comments we have received. In the case of
these transactions which are used to address physical commodity
needs, I have doubts about whether any public interest is served by
requiring manufacturing, agricultural and energy companies to
undertake such a burden and reconfigure processes to comply with
Commission swap regulations.
The limits on relief through this interpretation flow from the
statutory lines drawn between options and forward contracts. Under
the CEA, options and forwards are discrete, mutually exclusive
categories. Options are subject to the Commission's plenary,
exclusive jurisdiction. Forward contracts, on the other hand, are
almost entirely excluded from the Commission's jurisdiction. If a
contract, or some portion of a contract, meets the definition of an
``option,'' that portion which is an option inherently cannot be a
forward contract.
Under the CEA, a critical difference between a physically-
delivered option and a forward contract is the nature of the
delivery obligation. A forward contract binds both parties to make
and take delivery of a commodity at some date in the future. The
contract may only be offset through a separate negotiation of the
parties. In a physically-settled option contract, only the party
offering the option is bound to make or take delivery at the time of
contract.
The forward contract exclusion from the swap definition, applies
only to a ``[A] sale of a nonfinancial commodity or security for
deferred shipment or delivery, so long as the transaction is
intended to be physically settled.'' The key part of this definition
is that it only applies to a ``sale'' of a commodity. A ``sale''
means that one party has agreed to make and the other to take
delivery of that commodity.\1\
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\1\ The phrase, ``so long as the transaction is intended to by
physically settled,'' has been interpreted by the Commission to be
consistent with its traditional approach to determining whether an
instrument is a forward contract. As was stated in the Commission's
proposed rule,
The CFTC believes that the forward contract exclusion in the
Dodd-Frank Act with respect to nonfinancial commodities should be
read consistently with th[e] established, historical understanding
that a forward contract is a commercial merchandising transaction.
Many commenters discussed the issue of whether the requirement
in the Dodd-Frank Act that a transaction be ``intended to be
physically settled'' in order to qualify for the forward exclusion
from the swap definition with respect to nonfinancial commodities
reflects a change in the standard for determining whether a
transaction is a forward contract. Because a forward contract is a
commercial merchandising transaction, intent to deliver historically
has been an element of the CFTC's analysis of whether a particular
contract is a forward contract. In assessing the parties'
expectations or intent regarding delivery, the CFTC consistently has
applied a ``facts and circumstances'' test. Therefore, the CFTC
reads the ``intended to be physically settled'' language in the swap
definition with respect to nonfinancial commodities to reflect a
directive that intent to deliver a physical commodity be a part of
the analysis of whether a given contract is a forward contract or a
swap, just as it is a part of the CFTC's analysis of whether a given
contract is a forward contract or a futures contract. Proposed Rule
on ``Further Definition of `Swap,' `Security-Based Swap,' and
`Security-Based Swap Agreement'; Mixed Swaps; Security-Based Swap
Agreement Recordkeeping, 76 FR 29818, 29828 (May 23, 2011)
(``Proposed Products Release'').
This interpretation was ratified in the final rule, ``Further
Definition of `Swap,' `Security-Based Swap,' and `Security-Based
Swap Agreement'; Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, 77 FR 48208, 48227-48228 (August 13, 2012)
(``Products Release'').
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[[Page 28244]]
An option, in contrast, is only the option to undertake such a
``sale'', not the sale itself. The sale occurs only when the option
is exercised. The option to buy or sell a commodity at some later
point simply is not the same thing as the sale of that commodity
itself. The Commission's Office of the General Counsel memorialized
---------------------------------------------------------------------------
this interpretation in 1985:
[T]he [forward] contract must be a binding agreement on both
parties to the contract: One must agree to make delivery and the
other to take delivery of the commodity. Second, because forward
contracts are commercial, merchandizing transactions which result in
delivery, the courts and the Commission have looked for evidence of
the transactions' use in commerce. Thus, the courts and the
Commission have examined whether the parties to the contracts are
commercial entities that have the capacity to make or take delivery
and whether delivery, in fact, routinely occurs under such contracts
* * * * *
Thus, an option is a contract in which only the grantor is
obligated to perform. As a result, the option purchaser has a
limited risk from adverse price movements. This characteristic
distinguishes an option from a forward contract in which both
parties must routinely perform and face the full risk of loss from
adverse price changes since one party must make and the other take
delivery of the commodity. In contrast, in an option, only the
grantor of a call (put) is required to sell (buy) a given quantity
of a commodity (or a futures contract on that commodity) on or by a
specified date in the future if the option is exercised.
``Characteristics Distinguishing Cash and Forward Contracts and
`Trade Options' '', 50 FR 39656-02 (September 30, 1985)
The Commission ratified this interpretation in 1990 in its
``Statutory Interpretation Concerning Forward Transactions'', 55 FR
39188-03 (September 25, 1990) (``Brent Interpretation'') and again
in 2012 its final rule, ``Further Definition of `Swap,' `Security-
Based Swap,' and `Security-Based Swap Agreement'; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, 77 FR 48208, 48227-
48235 (August 13, 2012) (``Products Release''). In doing so, the
Commission explicitly rejected the argument that physically-
delivered commodity options could fall within the forward contract
exclusion.\2\
---------------------------------------------------------------------------
\2\ See also, Products Release at 4236-37.
---------------------------------------------------------------------------
The interpretation being promulgated today does not change this,
and therein lays my concern regarding this interpretation's limits.
I think much of the confusion regarding the seven-part test has
been based upon a failure to recognize the difference between
forward and option contracts under the Commodity Exchange Act. The
fact that a forward contract element and a commodity option are
packaged together does not change the regulatory treatment of the
different components. Hybrid or packaged instruments are common
throughout the industry. There are hybrid or packaged instruments
which may have characteristics of futures contracts and securities,
swaps and security-based swaps, futures and forward transactions,
and even forward contracts and commodity options. Each portion of
the contract might be subject to different regulatory treatment. A
security does not become a future, nor does a future become a
security simply by virtue of being packaged in the same instrument.
Relevant to the instruments we are discussing today, forward
contracts with embedded volumetric optionality, it seems that most
of them, as described in the comments, have at least two separate,
identifiable contractual obligations, each of which must be
considered on their own merits. There is a forward contract element
which binds the parties to make and take delivery of a set amount of
a commodity. In addition, there is an embedded volumetric
optionality element that binds the forward contract offeror to make
or take delivery of an additional amount of the commodity if the
embedded volumetric optionality is exercised by the forward contract
offeree. The latter contractual obligation looks like a classic
option.
The difficulty this interpretation faces in providing the relief
industry seeks is this: Even though the embedded optionality has the
form of an option, can it somehow fit within the forward exclusion?
The answer this interpretation gives is, essentially, yes, it can,
if it can be demonstrated that, despite the embedded optionality
having the form of an option, it is utilized, in practice, as a
forward contract. While the seven-prong test and the interpretive
guidance around it do not provide an exact roadmap for determining
when embedded volumetric optionality included in a forward contract
may or may not fall into the option definition, or when embedded
volumetric optionality may undermine a forward contract, I think it
does provide a good sense of the factors that parties must consider
in making those determinations for themselves.
Such a test, however, is necessarily a facts and circumstances
test with no bright lines. Ensuring compliance with this
interpretation poses a challenge, and, therefore, that is an area
where I would like to see greater legal certainty for these
contracts.
In closing, I support this final interpretation, but I think
industry would benefit from broader relief that provides greater
legal certainty. I look forward to continuing to work with my fellow
Commissioners and staff to make sure that commercial entities have
access to the tools they need to manage the commercial risks of
their operations.
[FR Doc. 2015-11946 Filed 5-15-15; 8:45 am]
BILLING CODE 8011-01-p 6351-01-P
