CFTC EEMAC Meeting
Commodity
Futures Trading Commission (CFTC)
Energy
and Environmental Markets Advisory Committee Meeting
Wednesday, July 29, 2015
Key
Topics & Takeaways
-
Inflexible Rules:
Commissioner Giancarlo noted that the Commission “must be absolutely certain
that [the CFTC] does not make it more difficult” for American agricultural and
energy producers to protect themselves against declines in commodity prices
because of inflexible rule.
-
Non-Enumerated Hedges:
Chairman Massad said he is willing to consider the topic of non-enumerated
hedges and expects that if the Commission did seek to take action it would be
via a proposal and a public comment period.
-
Leveraging Exchanges:
Commissioner Wetjen said he is interested in hearing about flexible approaches
to granting non-enumerated bona fide hedges, “especially in light of the
Commission’s resource constraints,” and that “leveraging the resources of
expertise of the exchanges to assist in analyzing those transactions could be
quite useful.”
- Position Limits
Comments: Commissioner Bowen stated that she did not
believe the comment period should be reopened for the position limits proposal,
unless there is need for further public input on new approaches.
Panel I: How Can Exchanges Help
Implement Federal Position Limits?
-
Erik Haas,
ICE Futures U.S.
-
Tom LaSala,
CME
-
Ron Oppenheimer,
Commercial Energy Working Group, CFTC
Panel II: A Phased in
Approach to Position Limits
-
Stephen Berger,
Managed Funds Association
-
Y.J. Bourgeois,
Natural Gas Supply Association
-
William McCoy,
Futures Industry Association
Panel III: Trade Options
and Forwards with Embedded Volumetric Opportunity
-
Paul Hughes,
Southern Company
-
Arushi Sharma-Frank,
Electric Power Supply Association
-
Amy Fisher, GE
Energy Financial Services Inc. on behalf of Cogen Technologies Linden Venture,
L.P.
Opening Remarks
Commissioner
Giancarlo
Commissioner
Christopher Giancarlo, in his opening remarks, recapped discussions held
at the last Energy and Environmental Markets Advisory Committee (EEMAC) meeting
in February of 2015 regarding the impact of federal position limits on energy
markets. He noted the meeting identified several areas “where the current
position limits proposal would be especially harmful”: 1) the limitation of the
bona fide hedging exemption to only a limited number of enumerated hedges,
which would not take into account many legitimate “bread and butter” risk
management strategies; 2) the increasing evidence of a lack of liquidity and
widened bid/ask spreads, which may be the result of insufficient speculation in
markets (which the CFTC’s position limits proposal might exacerbate); and 3)
the need for finding an approach that works and allows market participants to
manage risk.
Giancarlo
went on to describe concerns amongst agricultural producers regarding falling
commodity prices. This concern led Giancarlo to request data from the
Commission’s Office of the Chief Economist detailing which of the 28
commodities covered by the proposed position limits regime were impacted.
The results, he noted, indicated that across the 28 covered commodities, there
had been a “dramatic decrease in prices since December 2010, the year
Dodd-Frank was signed into law.” As such, Giancarlo noted that the
Commission “must be absolutely certain that [the CFTC] does not make it more
difficult” for American agricultural and energy producers to protect themselves
against 40 percent declines in commodity prices because of inflexible
rules. He added that “if the current collapse in commodity prices
continues and the position limits rules are not made workable, [the CFTC] may
be imposing more burdens on hedging risk at precisely the wrong time.”
Chairman
Massad
Chairman
Tim Massad noted his desire for any position limits rule to address the
Congressional mandate to reduce the risk of excessive speculation, while still
allowing for legitimate commercial hedging. With regard to addressing
issues associated with non-enumerated hedges, he stated that he was willing to
consider the topic, and would expect that if the Commission did seek to take
action it would be via a proposal and a public comment period. He lastly
noted his hope that the CFTC could move forward on issues regarding trade
options, and that he shares the concerns expressed by Commissioner Giancarlo
regarding falling commodity prices.
Commissioner
Wetjen
Commissioner
Mark Wetjen, in his remarks, commented that he continued to see
the need for hedging strategies that are flexible and responsive to
“continually changing” dynamics in agricultural markets. He further noted
that he is interested in hearing about flexible approaches to granting
non-enumerated bona fide hedges, “especially in light of the Commission’s
resource constraints,” and that “leveraging the resources of expertise of the
exchanges to assist in analyzing those transactions could be quite useful.”
Commissioner
Bowen
Commissioner
Sharon Bowen expressed support for CFTC efforts to provide legal clarity to
issues surrounding embedded volumetric
optionality contracts. She further expressed concern regarding the fact
that the Commission has still not finalized its position limits regime, four
years since it was first proposed. Bowen stated that she did not believe
the comment period should be reopened for the position limits proposal, unless
there is need for further public input on new approaches.
Panel 1: How
Can Exchanges Help Implement Federal Position Limits?
Tom
LaSala, CME
Tom
LaSala began the panel discussing an “impact analysis” covering the period of
June 1, 2014 through June 30, 2015, in order to illustrate further thoughts on
Table 11-A of the CFTC’s position limits rulemaking, with a focus on single-month
and all-months for energy contracts. In Table 11-A of its position limits
rulemaking, he said, the CFTC attempted detailed “impact points” regarding how
many market participants would have been affected by the imposition of position
limits.
LaSala
noted that “to further enhance liquidity while being mindful of concentration,
[exchanges] effectively set certain thresholds for open interest in monitoring
all these markets.” He explained that when certain thresholds are met,
exchanges look to manage concentration in those contracts, with a focus on
those in near term months with “sensitive” open interest positions.
LaSala
then walked through examples which highlighted that the “accountability
paradigm” and formulas used in managing these positions operated
effectively. He then explained that “positions were allowed to exist in
excess of what the would-be limit would have been,” but there was no
“ill-affecting” market impact. Rather, LaSala stated, non-commercial
market participants were “providing valuable liquidity … taking on positions,
positions opposite commercials in the marketplace who need that liquidity,”
yielding open interest, which yields more liquidity to allow these markets to
function properly.
LaSala
pointed out that there were 44 instances within the “impact analysis” period where
CME reached out to participants who crossed certain thresholds to point out
“sensitive points” in terms of concentration. He expressed that by doing
so, “the marketplace understood where sensitive points are,” thus allowing for
aversion of circumstances where market participants would be forced to either
reduce, increase, or hold.
Lastly,
LaSala pointed out that market circumstances change, and if the CFTC
administered strict limits with narrowly construed bona fide hedging
exemptions, many commercials would not be able to maintain the positions they
currently do.
Ron
Oppenheimer, Commercial Energy Working Group
Ron
Oppenheimer spoke next (see Presentation), describing concerns relating
to the narrow definition of bona fide hedging and the resulting impact of
limiting risk-reducing behavior. He noted that eliminating strategies
which reduce risk would increase costs that would ultimately be borne by the
consumers of energy products. Oppenheimer expressed support for the
consideration of a solution which relies on exchanges “to consider where
non-enumerated hedges might fit into the framework of a position limits rule,”
as they have the knowledge, expertise, and regulatory incentive to “carefully
scrutinize the exemption process.” Further, he noted that exchanges
“already engage in a parallel process for their own interest in self-regulating
and ensuring convergence and orderly liquidation of futures contracts.”
Oppenheimer
highlighted the benefits of relying on exchanges to engage in such activity,
including the avoidance of resource duplication, insight into the breadth and
depth of markets, and familiarity with hedging strategies. He further
noted that such a framework would not be disruptive to current end-user hedging
practices. If the narrow definition of bona fide hedge was implemented,
however, Oppenheimer warned that exchange-granted hedging exemptions market
participants rely on today, which include “over 80 in natural gas” and
additional exemptions in other commodities would all be impacted. Thus,
he said, flexibility for market innovation and evolution is necessary.
Moving
forward, Oppenheimer stated the Commission must take three key steps: 1) to
address and revise the list of enumerated hedges to include unlisted hedges
which market participants have commented and petitioned on; 2) that the CFTC
provide historically granted exemptions for positions and strategies which
exchanges have currently employed in their rules be continued going forward;
and 3) for the Commission to take official action which states that in
the event an exchange recognized a particular strategy as being a valid
non-enumerated hedge to be used under exemption in their markets, “that a party
could also take similar positions and strategies in OTC markets, and rely on a
non-enumerated exemption for those positions as well.”
Regarding
the application process, Oppenheimer explained it would essentially follow
current practices. The only new step, he said, would be that “for any
non-enumerated hedge exemption granted by the DCM, the DCM would provide a
notice to the Commission,” which indicated that a non-enumerated hedge had been
granted, including the DCM’s reasoning as to the size of the party’s exposure
to that position or strategy and the size of the exemption granted (subject to
confidentiality restrictions).
Erik
Haas, ICE Futures U.S.
Erik
Hass next discussed the details of a joint ICE/CME presentation, describing “cornerstone
points” from the perspective of exchanges regarding the exemption process for
non-enumerated hedges. First and foremost, he expressed their desire to
see the list of recognized enumerated hedges expanded. Next, they
expressed the view that the CFTC should authorize exchanges to determine what
constitutes a permissible non-enumerated hedge as exempt from federal and
exchange speculative position limits (subject to Commission review).
LaSala
next walked through the current exchange exemption process, and how this
process could be expanded to include exemptions for non-enumerated
hedges. Under both current practice and the proposed extension, he
explained, an application is filed prior to a market participant exceeding
exchange limits, which includes supporting documentation. Next under both
processes, the exchange would review the application and make a determination
to approve, deny or conditionally approve the exemption (subject to numerical
limits), he said. For non-enumerated hedges, Hass explains that, under
the proposal, any hedger granted an exemption from DCM/SEF speculative position
limits for a non-enumerated hedge would “also be permitted by Commission rule,
to effect exemption from federal speculative position limits for OTC
transactions with respect to the strategy underlying the
transactions/positions.” He explained that any numerical limits to
overall exposure to a particular strategy would serve “as a boundary for the
hedger which the CFTC can rely upon in monitoring the hedger’s OTC positions or
their impact on the hedger’s compliance with federal speculative position
limits.”
LaSala
next provided an example to show how the process would
work. First, he said, an applicant would request a non-enumerated hedge
position of 8,000 lots of future exposure to CME and ICE. Following
analysis, he continued, CME and ICE decided that 6,000 futures equivalence is
more accurate, but based on their markets, approve an exemption for 4,000 lots
of futures equivalence. He added that this would allow the hedger to
enter 6,000 lot total positions the exchanges, but not for more than 4,000 on
one single exchange.
Discussion
Chairman
Massad expressed concern over a situation where the exchanges approve different
exemption levels, and whether this creates an opportunity for arbitrage.
He noted that any such issue would need to be addressed.
Chairman
Massad next asked whether confidentiality concerns existed regarding
applications by market participants for non-enumerated hedges. LaSala
explained that only general information about the non-enumerated strategy would
be provided (not including who received the exemption or for amounts).
Oppenheimer noted that the CFTC would most likely be interested in reviewing
general strategy (as opposed to amounts), however it would be problematic if a
unique strategy would help to identify a market participant. Massad
questioned whether the public would have an interest in amounts. Oppenheimer
replied that he did not believe so, as market participants are most interested
in learning whether a generally strategy they may be interested in utilizing
was approved or denied.
Tyson
Slocum (Director, Energy Program, Public Citizen) expressed concerns with
delegating Dodd-Frank functions to “private, for-profit exchanges,” instead of
the CFTC. Hass noted that the proposed framework discussed is not a
“delegation,” but rather allows current practices to continue, while also
allowing the CFTC to consider extending exemptions to OTC positions from
federal speculative limits. LaSala further noted the CFTC would have the
ability to modify any exchange-granted exemptions, and that in most instances,
the exchanges set boundaries lower than those requested by market
participants.
Slocum
asked whether firewall protections exist, and if they are independent, to
prevent exchanges from providing exemptions solely to increase trading volume,
in order to gain fees. LaSala noted that firewalls are in place,
subject to strict standards and internal audit reviews, and that the CFTC
independently ensures the efficacy of these internal structures. Benjamin
Jackson, President & CEO, ICE Futures U.S., further explained that ICE’s
Board of Directors, comprising independent outside members, reviews these
barrier structures and processes as well.
Todd
Creek, President, ICAP Energy, expressed concern regarding the treatment of
cross commodity hedges, noting that heat rates are an integral part of trading
communities today. As natural gas is being impacted, he noted, there need
to exemptions granted or consideration for inclusion as an enumerated hedge.
Lopa
Parikh, Director of Federal Regulatory Affairs for Energy Supply, Edison
Electric Institute, expressed support for the current and successful exchange
review process, and encouraged the CFTC to look further into the possibility.
Mike
Gill, Representative, Independent Petroleum Association of America, noted that
independent producers of oil are also experiencing a market price drop, and are
sensitive to limitations on hedging that impact liquidity. He highlighted
that discussions are currently constructive, and participants are no longer
arguing whether positions limited are necessary, but instead are moving to a
workable implementation. He noted the importance of such dialogue in this
regard, and that “grief” on further comment periods should not deter the
Commission.
Dena
Wiggins, President & CEO, Natural Gas Supply Association, supported further
consideration of the proposed framework, noting that addressing confidentiality
concerns would be key.
Vincent
Johnson, Head of Regulatory and Policy Affairs, BP Integrated Solutions, asked
how exchanges would handle a situation in which an exchange grants an
exemption, a market participant transacts according to that exemption for
several months, and the CFTC later disagrees with the exchange’s
decision. LaSala noted that if the CFTC determined a strategy was not
allowable, the exchanges would need to determine what actions are appropriate,
which may include some type of orderly liquidation.
Russ
Wasson, Director of Tax, Finance and Accounting Policy, National Rural Electric
Cooperative Association, expressed the view that entities that do not speculate
should have an exemption under CFTC rules. He cautioned that even a 10
percent increase in the process of electricity would have a detrimental impact
on rural America, resulting in a loss of 500,000 jobs and would take 20 years
to recoup the economic benefit. He stated that if the position limits rules
are meant to regulate hedging of commercial end users, consideration must be
given to the increase on operational costs that will be passed down to rural
America.
Paul
Hughes, Manager of Risk Control, Southern Company, sought clarification that
discussions at the current EEMAC meeting assumed that position limits would not
include trade options. Hass noted that discussions and analysis were not
meant to consider what would happen if trade options were to be considered
swaps.
Panel II: A Phased in Approach to Position Limits
Remarks-
Y.J. Bourgeois, Natural Gas Supply Association
Y.J.
Bourgeois focused his remarks around providing an end-user’s perspective in
navigating position limits placed on its operations, using Anadarko as an
example firm who actively uses derivatives to reduce price risk associated with
future production.
The
first step in any CFTC position limit rulemaking, he said, is to focus on
appropriate spot month position limit to prevent damage to market liquidity
which is critical to price discovery and orderly convergence of spot month
futures since the outer months are not as crucial to the futures convergence
process. He also noted that the focus should be on physically settled futures
contracts which present the greatest potential for market manipulation due to
the physical delivery mechanism.
A
measured phased-in approach which focuses initial rulemakings on spot month
issues, Bourgeois said, would allow the CFTC to evaluate the effects of those
position limits overtime in critical market periods. Supplemental rulemakings
can be initiated for non-spot month position limits if information gathered in
the initial phase deems such limits appropriate.
The
key, Bourgeois emphasized, is to provide a framework for a “healthy, liquid, transparent,
and fully functional marketplace” that is not hampered by restrictive position
limits, burdensome regulations, or cumbersome restrictions.
In
response to a question from Michael Cosgrove, Vectra Capital LLC, as to whether
Andarko has any speculative activities, Bourgeois responded in the negative,
noting that Andarko’s portfolio of assets seeks to hedge forward production.
Remarks-
William McCoy, FIA
William
McCoy expressed the concern that proposed position limits would disrupt markets
and noted the potential hazards of “putting the cart before the horse” in
imposing such limits without the requisite information on the impact they will
have on the market.
He
also recommended a phased-in approach where spot month regulations would
precede any non-spot month limits if the CFTC deemed the latter limits
appropriate. He noted that the CFTC issues position limits differently than the
exchanges and the proposed monthly reporting requirements in energy, metals,
and agriculture will take time to implement.
McCoy
noted that the CFTC should use the first phase to determine whether non-spot
month phases are necessary, taking into account that liquidity for energy
products decreases the further out on the yield curve one goes. In determining
whether limits are appropriate, McCoy cited the need to use open interest data
to provide a comprehensive view of the futures and swaps market. If the
CFTC is too narrow or inaccurate in setting these limits, he cautioned,
liquidity will be unduly restricted and price discovery will be impacted.
The
benefits of this phased in approach, McCoy said, are that it 1) focuses the
CFTC’s limited resources where the risk for excessive speculation is greatest;
2) allows continued data collection to help determine if position limits are
necessary for other time periods; 3) allows market participants to adjust to
spot month limits before a wholesale change is made; and 4) allows for an appropriate
evaluation of bona fide hedging.
McCoy
closed by noting that a phased-in approach is already within the authority of
the CFTC and added that after the first phase spot month limits were
implemented, the CFTC could evaluate whether accountability levels might be
more appropriate than hard limits outside the spot month.
Remarks-
Stephen Berger, Managed Funds Association
Stephen
Berger also outlined a two-phase process for position limits that would allow
the CFTC to finalize an approach to bona fide hedging transactions and utilize
data obtained for non-spot month rulemaking determinations in the first phase.
The
benefits of such an approach, he said, are that it 1) gives the CFTC more time
to gather data; 2) minimizes the risk of unintended consequences; 3) decreases
the risk of market disruption; 4) allows use of phase 1 data to determine
non-spot month accountability levels; and 5) strikes a better balance between
effective oversight and preserving liquidity and price discovery.
The
main concerns about the current CFTC proposal, Berger outlined, include that
the proposal is based on incomplete data, which has led to inappropriately low
position limits and said that the one-size-fits-all approach does not work
across different commodity markets.
Berger
used the example of crude oil contracts and gasoline contracts to illustrate
that despite a two to one differential in the demand in the marketplace for
these products, the proposed limits represent a ten to one ratio (109,000
contracts permitted, versus 11,800 contracts permitted). He also noted that
where open interest is concentrated is significantly different in agricultural
markets and energy markets.
Discussion
Proposed
Phase-In Approach
When
asked for clarification about whether the panelists were asking for two
separate rulemakings, McCoy indicated that the non-spot month rulemaking should
be separate to provide opportunity for additional comment and provide
experiences on spot month implementation for the CFTC. Bourgeois and McCoy
added that the data gathered in phase 1 will help establish limits that are
reasonable and allow for an examination of the OTC markets as well.
Ben
Jackson, ICE Futures U.S., highlighted the importance of getting the rulemaking
correct in the spot month to prevent slowing down the execution of charges
while genuinely reducing risk. He noted the definitions of enumerated hedge and
deliverable supply need to be accurate and up-to-date with market realities. He
expressed concern that the overall pace of these changes has the potential to
drain liquidity from bilateral OTC markets which is counter to the objectives
of Dodd-Frank.
Lopa
Parikh, Edison Electric Institute, agreed, noting that the CFTC needs at
minimum 12 to 18 months worth of data prior to considering limits outside the
spot month, especially for OTC swaps.
Russell
Wasson, National Rural Electric Cooperative Association, expressed skepticism
that these concerns apply to electricity as a constant delivery product.
Market
Liquidity Concerns
In
response to a question on whether changes have been seen in access to markets
for hedging, Bourgeois noted that the liquidity for elongated hedges is “simply
not there,” forcing firms to stay within the 12 to 18 month time period for
their hedges. He added that the availability of counterparties for hedging has
leveled out, and said additional burdensome restrictions on position limits
could further limit liquidity in the marketplace.
Lael
Campell, Constellation, expressed concern that any future crisis in the market
will be as a result of a lack of liquidity triggered by the trickle down of
financial reform in the markets. In the electricity markets, he noted, trading
is not occurring outside one year or three month spans. Studying the impact of
position limits in the spot month on market liquidity, he said, is paramount
before establishing blanket limits.
Mike
Prokop, Deloitte & Touche, LLP, concurred, noting that this phase-in
provides the opportunity for a bona fide economic study of the impacts generated
by the proposal, especially considering the previous ruling by the CFTC on
position limits was vacated in the courts.
James
Allison, ConocoPhillips, cited research that demonstrated while the bid-ask
spreads have remained relatively tight in the natural gas markets, the depth of
the market had reduced significantly to where traders can only move one
contract daily without moving the market, compared to five contracts three
years ago. This is problematic for consumers, he said, because with low prices
and low volatility, there is little incentive to hedge, however, if conditions
change, the market depth does not exist to support additional hedging.
Physically
vs. Financially Settled Products
Bryan
Durkin, CME, noting the commonality in approaches to this issue, emphasized
that CME is not supportive of different position limits for physically or
financially settled products because the failure to have one-for-one parity
treatment could have a detrimental effect on the overall performance of the
physically settled contracts.
Craig
Pirrong, Professor of Finance and Energy Markets, University of Houston,
agreed, noting that there is no rationale for such a distinction when the
manipulation of physically settled contracts is the same as that of financially
settled contracts.
Allison
disagreed, noting that the question is not whether the products are similarly
manipulated since manipulation is illegal and presumably an effective
manipulation regime is already in place. The concern, he said, is whether there
is a propensity to create the threat of excessive speculation, for which
financially settled swaps have a far lower potential than physically delivered
swaps.
Panel III: Trade Options and Forwards with
Embedded Volumetric Optionality – Where Do We Stand?
Remarks
– Paul Hughes, Southern Company
Paul
Hughes, noting that the energy industry is generally supportive of the proposed
trade options (TO) rule released by the industry, highlighted the importance of
clarifying how the TO rule applies to capacity contracts and contracts that
allow for zero or nominal delivery. He illustrated concerns of different
understandings for nomenclature on these contracts which can lead to confusion
when some contracts entered into by the energy sector can appear to have embedded
optionality when in fact the contracts are to be use for physical settlement
explicitly.
Hughes
used Southern Company’s own model to illustrate the role of power purchase
agreements (PPAs), an agreement to derive a portion of their energy dispatch
from a physical plant despite not owning it in wholesale. The multifactor
dispatch model used by the industry, Hughes cited, leverages a host of factors
including efficiency, availability, and fuel costs to determine whether that
agreement will be exercised in a given time period. The result, he said, is
that the company needs to be able to retain the ability to not exercise that
contract in a given time period, without eliminating it.
While
PPAs can look like derivatives, Hughes said, these contracts are intended for
physical agreement. He advocated for a “facts and circumstances” analysis on a
contract-by-contract basis to determine whether those contracts apply under the
TO rule.
Remarks
– Arushi Sharma-Frank, Electric Power Supply Association
Arushi
Sharma-Frank continued by providing an example of a similar phenomenon in the
physical gas contracting space. Any natural gas utility local distribution
company, she said, will enter into a master base contract that reflects
everything except the transaction pricing and quantity terms of the agreement.
This master contract, Sharma-Frank noted, makes no obligation of any
transaction to ever occur between the parties, but leaves the door option for
additional agreements if desired.
At
some point in the future, Sharma-Frank illustrated, the utility will perform a
formal solicitation for delivery confirmation in t he future at which point the
additional terms relating to pricing and quantity are established. These
contracts exist in three forms: 1) interruptible delivery; 2) firm variable
agreement; and 3) firm contract.
In
the market, she expressed, treatment of firm contracts is inconsistent amongst
market participants pursuant to an “agree to disagree” model. Essentially,
Sharma-Frank noted, where one counterparty might decide a firm contract
agreement is a TO, the other might disagree.
She
highlighted that this is especially problematic in terms of small end users
dealing with larger end users since smaller end users are less acclimated to
the uncertainty of zero delivery contracts and compliance costs associated with
Dodd-Frank,if a contract is classified as a TO. The negotiation that results
from this uncertainty, she said, is an extensive burden for the industry.
The
current TO proposed rule, Sharma-Frank noted, is an appropriate starting point
to attempt to entice smaller end users back in the market if TO registration is
no longer required. She expressed concerns about the $1 billion notional reporting
requirement in the proposal, noting that quantification challenges for
valuation of TOs for that requirement is especially challenging.
Sharma-Frank
established that the final rule presents an opportunity for further clarity.
She encouraged the CFTC to affirm that physical contracts that allow for zero
or nominal delivery satisfy CFTC’s interpretation and guidance on forward
contracts which exclusively intend physical settlement. The goal, she said, is
to engage the compliance regime using a “facts and circumstances” analysis that
applies broadly across the physical contracting sphere to diminish compliance
uncertainty as much as possible.
She
also noted clarification of the status of capacity contracts and whether TOs
are excluded from future position limits rules as areas for improvement in the
final rulemaking. The exclusion of TOs from future position limits is key to
generate market entry from currently hesitant firms fearing future position
limit applicability.
Sharma-Frank
closed by noting that, in terms of market liquidity, it is key to consider the
timeframe of impact since the industry is still dealing with a new statute in
the form of Dodd-Frank relative to the traditional statutes in gas and power
that are nearly 80 years old.
Remarks
– Amy Fisher, GE Energy Financial Services Inc. on behalf of Cogen Technologies
Linden Venture, L.P.
Amy
Fisher said that relief is needed under the trade option rule because,
according to her company’s outside counsel, the natural gas products they trade
in are commodity options subject to swap rules, even though they are not
options of her company. She said this has caused significant accounting
issues and that tracking these trade options separately from other commercial
arrangements has been “very problematic.” She said that these natural gas
products should be taken out of the trade option category through a change in
the rule itself.
Discussion
Wasson
expressed similar concern with trade options being deemed as swaps, noting that
the CFTC requirement “throw us” into record keeping and reporting for swaps and
into “the deep end of the pool” with swap dealers and major swap participants.
Andrew Soto, American Gas Association, also stressed that trade options
should not be swaps because they are intended to be physically settled. He said
the CFTC should not lose sight of where the market will end up and said that
innovation of the market should not be prevented.
Sharma-Frank
said that the market is looking for “very clear statements” from the CFTC to allow
counterparties to negotiate deals.
For
more information on this meeting, please click here.
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Commodity
Futures Trading Commission (CFTC)
Energy
and Environmental Markets Advisory Committee Meeting
Wednesday, July 29, 2015
Key
Topics & Takeaways
-
Inflexible Rules:
Commissioner Giancarlo noted that the Commission “must be absolutely certain
that [the CFTC] does not make it more difficult” for American agricultural and
energy producers to protect themselves against declines in commodity prices
because of inflexible rule. -
Non-Enumerated Hedges:
Chairman Massad said he is willing to consider the topic of non-enumerated
hedges and expects that if the Commission did seek to take action it would be
via a proposal and a public comment period.
-
Leveraging Exchanges:
Commissioner Wetjen said he is interested in hearing about flexible approaches
to granting non-enumerated bona fide hedges, “especially in light of the
Commission’s resource constraints,” and that “leveraging the resources of
expertise of the exchanges to assist in analyzing those transactions could be
quite useful.” - Position Limits
Comments: Commissioner Bowen stated that she did not
believe the comment period should be reopened for the position limits proposal,
unless there is need for further public input on new approaches.
Panel I: How Can Exchanges Help
Implement Federal Position Limits?
-
Erik Haas,
ICE Futures U.S. -
Tom LaSala,
CME -
Ron Oppenheimer,
Commercial Energy Working Group, CFTC
Panel II: A Phased in
Approach to Position Limits
-
Stephen Berger,
Managed Funds Association -
Y.J. Bourgeois,
Natural Gas Supply Association -
William McCoy,
Futures Industry Association
Panel III: Trade Options
and Forwards with Embedded Volumetric Opportunity
-
Paul Hughes,
Southern Company -
Arushi Sharma-Frank,
Electric Power Supply Association -
Amy Fisher, GE
Energy Financial Services Inc. on behalf of Cogen Technologies Linden Venture,
L.P.
Opening Remarks
Commissioner
Giancarlo
Commissioner
Christopher Giancarlo, in his opening remarks, recapped discussions held
at the last Energy and Environmental Markets Advisory Committee (EEMAC) meeting
in February of 2015 regarding the impact of federal position limits on energy
markets. He noted the meeting identified several areas “where the current
position limits proposal would be especially harmful”: 1) the limitation of the
bona fide hedging exemption to only a limited number of enumerated hedges,
which would not take into account many legitimate “bread and butter” risk
management strategies; 2) the increasing evidence of a lack of liquidity and
widened bid/ask spreads, which may be the result of insufficient speculation in
markets (which the CFTC’s position limits proposal might exacerbate); and 3)
the need for finding an approach that works and allows market participants to
manage risk.
Giancarlo
went on to describe concerns amongst agricultural producers regarding falling
commodity prices. This concern led Giancarlo to request data from the
Commission’s Office of the Chief Economist detailing which of the 28
commodities covered by the proposed position limits regime were impacted.
The results, he noted, indicated that across the 28 covered commodities, there
had been a “dramatic decrease in prices since December 2010, the year
Dodd-Frank was signed into law.” As such, Giancarlo noted that the
Commission “must be absolutely certain that [the CFTC] does not make it more
difficult” for American agricultural and energy producers to protect themselves
against 40 percent declines in commodity prices because of inflexible
rules. He added that “if the current collapse in commodity prices
continues and the position limits rules are not made workable, [the CFTC] may
be imposing more burdens on hedging risk at precisely the wrong time.”
Chairman
Massad
Chairman
Tim Massad noted his desire for any position limits rule to address the
Congressional mandate to reduce the risk of excessive speculation, while still
allowing for legitimate commercial hedging. With regard to addressing
issues associated with non-enumerated hedges, he stated that he was willing to
consider the topic, and would expect that if the Commission did seek to take
action it would be via a proposal and a public comment period. He lastly
noted his hope that the CFTC could move forward on issues regarding trade
options, and that he shares the concerns expressed by Commissioner Giancarlo
regarding falling commodity prices.
Commissioner
Wetjen
Commissioner
Mark Wetjen, in his remarks, commented that he continued to see
the need for hedging strategies that are flexible and responsive to
“continually changing” dynamics in agricultural markets. He further noted
that he is interested in hearing about flexible approaches to granting
non-enumerated bona fide hedges, “especially in light of the Commission’s
resource constraints,” and that “leveraging the resources of expertise of the
exchanges to assist in analyzing those transactions could be quite useful.”
Commissioner
Bowen
Commissioner
Sharon Bowen expressed support for CFTC efforts to provide legal clarity to
issues surrounding embedded volumetric
optionality contracts. She further expressed concern regarding the fact
that the Commission has still not finalized its position limits regime, four
years since it was first proposed. Bowen stated that she did not believe
the comment period should be reopened for the position limits proposal, unless
there is need for further public input on new approaches.
Panel 1: How
Can Exchanges Help Implement Federal Position Limits?
Tom
LaSala, CME
Tom
LaSala began the panel discussing an “impact analysis” covering the period of
June 1, 2014 through June 30, 2015, in order to illustrate further thoughts on
Table 11-A of the CFTC’s position limits rulemaking, with a focus on single-month
and all-months for energy contracts. In Table 11-A of its position limits
rulemaking, he said, the CFTC attempted detailed “impact points” regarding how
many market participants would have been affected by the imposition of position
limits.
LaSala
noted that “to further enhance liquidity while being mindful of concentration,
[exchanges] effectively set certain thresholds for open interest in monitoring
all these markets.” He explained that when certain thresholds are met,
exchanges look to manage concentration in those contracts, with a focus on
those in near term months with “sensitive” open interest positions.
LaSala
then walked through examples which highlighted that the “accountability
paradigm” and formulas used in managing these positions operated
effectively. He then explained that “positions were allowed to exist in
excess of what the would-be limit would have been,” but there was no
“ill-affecting” market impact. Rather, LaSala stated, non-commercial
market participants were “providing valuable liquidity … taking on positions,
positions opposite commercials in the marketplace who need that liquidity,”
yielding open interest, which yields more liquidity to allow these markets to
function properly.
LaSala
pointed out that there were 44 instances within the “impact analysis” period where
CME reached out to participants who crossed certain thresholds to point out
“sensitive points” in terms of concentration. He expressed that by doing
so, “the marketplace understood where sensitive points are,” thus allowing for
aversion of circumstances where market participants would be forced to either
reduce, increase, or hold.
Lastly,
LaSala pointed out that market circumstances change, and if the CFTC
administered strict limits with narrowly construed bona fide hedging
exemptions, many commercials would not be able to maintain the positions they
currently do.
Ron
Oppenheimer, Commercial Energy Working Group
Ron
Oppenheimer spoke next (see Presentation), describing concerns relating
to the narrow definition of bona fide hedging and the resulting impact of
limiting risk-reducing behavior. He noted that eliminating strategies
which reduce risk would increase costs that would ultimately be borne by the
consumers of energy products. Oppenheimer expressed support for the
consideration of a solution which relies on exchanges “to consider where
non-enumerated hedges might fit into the framework of a position limits rule,”
as they have the knowledge, expertise, and regulatory incentive to “carefully
scrutinize the exemption process.” Further, he noted that exchanges
“already engage in a parallel process for their own interest in self-regulating
and ensuring convergence and orderly liquidation of futures contracts.”
Oppenheimer
highlighted the benefits of relying on exchanges to engage in such activity,
including the avoidance of resource duplication, insight into the breadth and
depth of markets, and familiarity with hedging strategies. He further
noted that such a framework would not be disruptive to current end-user hedging
practices. If the narrow definition of bona fide hedge was implemented,
however, Oppenheimer warned that exchange-granted hedging exemptions market
participants rely on today, which include “over 80 in natural gas” and
additional exemptions in other commodities would all be impacted. Thus,
he said, flexibility for market innovation and evolution is necessary.
Moving
forward, Oppenheimer stated the Commission must take three key steps: 1) to
address and revise the list of enumerated hedges to include unlisted hedges
which market participants have commented and petitioned on; 2) that the CFTC
provide historically granted exemptions for positions and strategies which
exchanges have currently employed in their rules be continued going forward;
and 3) for the Commission to take official action which states that in
the event an exchange recognized a particular strategy as being a valid
non-enumerated hedge to be used under exemption in their markets, “that a party
could also take similar positions and strategies in OTC markets, and rely on a
non-enumerated exemption for those positions as well.”
Regarding
the application process, Oppenheimer explained it would essentially follow
current practices. The only new step, he said, would be that “for any
non-enumerated hedge exemption granted by the DCM, the DCM would provide a
notice to the Commission,” which indicated that a non-enumerated hedge had been
granted, including the DCM’s reasoning as to the size of the party’s exposure
to that position or strategy and the size of the exemption granted (subject to
confidentiality restrictions).
Erik
Haas, ICE Futures U.S.
Erik
Hass next discussed the details of a joint ICE/CME presentation, describing “cornerstone
points” from the perspective of exchanges regarding the exemption process for
non-enumerated hedges. First and foremost, he expressed their desire to
see the list of recognized enumerated hedges expanded. Next, they
expressed the view that the CFTC should authorize exchanges to determine what
constitutes a permissible non-enumerated hedge as exempt from federal and
exchange speculative position limits (subject to Commission review).
LaSala
next walked through the current exchange exemption process, and how this
process could be expanded to include exemptions for non-enumerated
hedges. Under both current practice and the proposed extension, he
explained, an application is filed prior to a market participant exceeding
exchange limits, which includes supporting documentation. Next under both
processes, the exchange would review the application and make a determination
to approve, deny or conditionally approve the exemption (subject to numerical
limits), he said. For non-enumerated hedges, Hass explains that, under
the proposal, any hedger granted an exemption from DCM/SEF speculative position
limits for a non-enumerated hedge would “also be permitted by Commission rule,
to effect exemption from federal speculative position limits for OTC
transactions with respect to the strategy underlying the
transactions/positions.” He explained that any numerical limits to
overall exposure to a particular strategy would serve “as a boundary for the
hedger which the CFTC can rely upon in monitoring the hedger’s OTC positions or
their impact on the hedger’s compliance with federal speculative position
limits.”
LaSala
next provided an example to show how the process would
work. First, he said, an applicant would request a non-enumerated hedge
position of 8,000 lots of future exposure to CME and ICE. Following
analysis, he continued, CME and ICE decided that 6,000 futures equivalence is
more accurate, but based on their markets, approve an exemption for 4,000 lots
of futures equivalence. He added that this would allow the hedger to
enter 6,000 lot total positions the exchanges, but not for more than 4,000 on
one single exchange.
Discussion
Chairman
Massad expressed concern over a situation where the exchanges approve different
exemption levels, and whether this creates an opportunity for arbitrage.
He noted that any such issue would need to be addressed.
Chairman
Massad next asked whether confidentiality concerns existed regarding
applications by market participants for non-enumerated hedges. LaSala
explained that only general information about the non-enumerated strategy would
be provided (not including who received the exemption or for amounts).
Oppenheimer noted that the CFTC would most likely be interested in reviewing
general strategy (as opposed to amounts), however it would be problematic if a
unique strategy would help to identify a market participant. Massad
questioned whether the public would have an interest in amounts. Oppenheimer
replied that he did not believe so, as market participants are most interested
in learning whether a generally strategy they may be interested in utilizing
was approved or denied.
Tyson
Slocum (Director, Energy Program, Public Citizen) expressed concerns with
delegating Dodd-Frank functions to “private, for-profit exchanges,” instead of
the CFTC. Hass noted that the proposed framework discussed is not a
“delegation,” but rather allows current practices to continue, while also
allowing the CFTC to consider extending exemptions to OTC positions from
federal speculative limits. LaSala further noted the CFTC would have the
ability to modify any exchange-granted exemptions, and that in most instances,
the exchanges set boundaries lower than those requested by market
participants.
Slocum
asked whether firewall protections exist, and if they are independent, to
prevent exchanges from providing exemptions solely to increase trading volume,
in order to gain fees. LaSala noted that firewalls are in place,
subject to strict standards and internal audit reviews, and that the CFTC
independently ensures the efficacy of these internal structures. Benjamin
Jackson, President & CEO, ICE Futures U.S., further explained that ICE’s
Board of Directors, comprising independent outside members, reviews these
barrier structures and processes as well.
Todd
Creek, President, ICAP Energy, expressed concern regarding the treatment of
cross commodity hedges, noting that heat rates are an integral part of trading
communities today. As natural gas is being impacted, he noted, there need
to exemptions granted or consideration for inclusion as an enumerated hedge.
Lopa
Parikh, Director of Federal Regulatory Affairs for Energy Supply, Edison
Electric Institute, expressed support for the current and successful exchange
review process, and encouraged the CFTC to look further into the possibility.
Mike
Gill, Representative, Independent Petroleum Association of America, noted that
independent producers of oil are also experiencing a market price drop, and are
sensitive to limitations on hedging that impact liquidity. He highlighted
that discussions are currently constructive, and participants are no longer
arguing whether positions limited are necessary, but instead are moving to a
workable implementation. He noted the importance of such dialogue in this
regard, and that “grief” on further comment periods should not deter the
Commission.
Dena
Wiggins, President & CEO, Natural Gas Supply Association, supported further
consideration of the proposed framework, noting that addressing confidentiality
concerns would be key.
Vincent
Johnson, Head of Regulatory and Policy Affairs, BP Integrated Solutions, asked
how exchanges would handle a situation in which an exchange grants an
exemption, a market participant transacts according to that exemption for
several months, and the CFTC later disagrees with the exchange’s
decision. LaSala noted that if the CFTC determined a strategy was not
allowable, the exchanges would need to determine what actions are appropriate,
which may include some type of orderly liquidation.
Russ
Wasson, Director of Tax, Finance and Accounting Policy, National Rural Electric
Cooperative Association, expressed the view that entities that do not speculate
should have an exemption under CFTC rules. He cautioned that even a 10
percent increase in the process of electricity would have a detrimental impact
on rural America, resulting in a loss of 500,000 jobs and would take 20 years
to recoup the economic benefit. He stated that if the position limits rules
are meant to regulate hedging of commercial end users, consideration must be
given to the increase on operational costs that will be passed down to rural
America.
Paul
Hughes, Manager of Risk Control, Southern Company, sought clarification that
discussions at the current EEMAC meeting assumed that position limits would not
include trade options. Hass noted that discussions and analysis were not
meant to consider what would happen if trade options were to be considered
swaps.
Panel II: A Phased in Approach to Position Limits
Remarks-
Y.J. Bourgeois, Natural Gas Supply Association
Y.J.
Bourgeois focused his remarks around providing an end-user’s perspective in
navigating position limits placed on its operations, using Anadarko as an
example firm who actively uses derivatives to reduce price risk associated with
future production.
The
first step in any CFTC position limit rulemaking, he said, is to focus on
appropriate spot month position limit to prevent damage to market liquidity
which is critical to price discovery and orderly convergence of spot month
futures since the outer months are not as crucial to the futures convergence
process. He also noted that the focus should be on physically settled futures
contracts which present the greatest potential for market manipulation due to
the physical delivery mechanism.
A
measured phased-in approach which focuses initial rulemakings on spot month
issues, Bourgeois said, would allow the CFTC to evaluate the effects of those
position limits overtime in critical market periods. Supplemental rulemakings
can be initiated for non-spot month position limits if information gathered in
the initial phase deems such limits appropriate.
The
key, Bourgeois emphasized, is to provide a framework for a “healthy, liquid, transparent,
and fully functional marketplace” that is not hampered by restrictive position
limits, burdensome regulations, or cumbersome restrictions.
In
response to a question from Michael Cosgrove, Vectra Capital LLC, as to whether
Andarko has any speculative activities, Bourgeois responded in the negative,
noting that Andarko’s portfolio of assets seeks to hedge forward production.
Remarks-
William McCoy, FIA
William
McCoy expressed the concern that proposed position limits would disrupt markets
and noted the potential hazards of “putting the cart before the horse” in
imposing such limits without the requisite information on the impact they will
have on the market.
He
also recommended a phased-in approach where spot month regulations would
precede any non-spot month limits if the CFTC deemed the latter limits
appropriate. He noted that the CFTC issues position limits differently than the
exchanges and the proposed monthly reporting requirements in energy, metals,
and agriculture will take time to implement.
McCoy
noted that the CFTC should use the first phase to determine whether non-spot
month phases are necessary, taking into account that liquidity for energy
products decreases the further out on the yield curve one goes. In determining
whether limits are appropriate, McCoy cited the need to use open interest data
to provide a comprehensive view of the futures and swaps market. If the
CFTC is too narrow or inaccurate in setting these limits, he cautioned,
liquidity will be unduly restricted and price discovery will be impacted.
The
benefits of this phased in approach, McCoy said, are that it 1) focuses the
CFTC’s limited resources where the risk for excessive speculation is greatest;
2) allows continued data collection to help determine if position limits are
necessary for other time periods; 3) allows market participants to adjust to
spot month limits before a wholesale change is made; and 4) allows for an appropriate
evaluation of bona fide hedging.
McCoy
closed by noting that a phased-in approach is already within the authority of
the CFTC and added that after the first phase spot month limits were
implemented, the CFTC could evaluate whether accountability levels might be
more appropriate than hard limits outside the spot month.
Remarks-
Stephen Berger, Managed Funds Association
Stephen
Berger also outlined a two-phase process for position limits that would allow
the CFTC to finalize an approach to bona fide hedging transactions and utilize
data obtained for non-spot month rulemaking determinations in the first phase.
The
benefits of such an approach, he said, are that it 1) gives the CFTC more time
to gather data; 2) minimizes the risk of unintended consequences; 3) decreases
the risk of market disruption; 4) allows use of phase 1 data to determine
non-spot month accountability levels; and 5) strikes a better balance between
effective oversight and preserving liquidity and price discovery.
The
main concerns about the current CFTC proposal, Berger outlined, include that
the proposal is based on incomplete data, which has led to inappropriately low
position limits and said that the one-size-fits-all approach does not work
across different commodity markets.
Berger
used the example of crude oil contracts and gasoline contracts to illustrate
that despite a two to one differential in the demand in the marketplace for
these products, the proposed limits represent a ten to one ratio (109,000
contracts permitted, versus 11,800 contracts permitted). He also noted that
where open interest is concentrated is significantly different in agricultural
markets and energy markets.
Discussion
Proposed
Phase-In Approach
When
asked for clarification about whether the panelists were asking for two
separate rulemakings, McCoy indicated that the non-spot month rulemaking should
be separate to provide opportunity for additional comment and provide
experiences on spot month implementation for the CFTC. Bourgeois and McCoy
added that the data gathered in phase 1 will help establish limits that are
reasonable and allow for an examination of the OTC markets as well.
Ben
Jackson, ICE Futures U.S., highlighted the importance of getting the rulemaking
correct in the spot month to prevent slowing down the execution of charges
while genuinely reducing risk. He noted the definitions of enumerated hedge and
deliverable supply need to be accurate and up-to-date with market realities. He
expressed concern that the overall pace of these changes has the potential to
drain liquidity from bilateral OTC markets which is counter to the objectives
of Dodd-Frank.
Lopa
Parikh, Edison Electric Institute, agreed, noting that the CFTC needs at
minimum 12 to 18 months worth of data prior to considering limits outside the
spot month, especially for OTC swaps.
Russell
Wasson, National Rural Electric Cooperative Association, expressed skepticism
that these concerns apply to electricity as a constant delivery product.
Market
Liquidity Concerns
In
response to a question on whether changes have been seen in access to markets
for hedging, Bourgeois noted that the liquidity for elongated hedges is “simply
not there,” forcing firms to stay within the 12 to 18 month time period for
their hedges. He added that the availability of counterparties for hedging has
leveled out, and said additional burdensome restrictions on position limits
could further limit liquidity in the marketplace.
Lael
Campell, Constellation, expressed concern that any future crisis in the market
will be as a result of a lack of liquidity triggered by the trickle down of
financial reform in the markets. In the electricity markets, he noted, trading
is not occurring outside one year or three month spans. Studying the impact of
position limits in the spot month on market liquidity, he said, is paramount
before establishing blanket limits.
Mike
Prokop, Deloitte & Touche, LLP, concurred, noting that this phase-in
provides the opportunity for a bona fide economic study of the impacts generated
by the proposal, especially considering the previous ruling by the CFTC on
position limits was vacated in the courts.
James
Allison, ConocoPhillips, cited research that demonstrated while the bid-ask
spreads have remained relatively tight in the natural gas markets, the depth of
the market had reduced significantly to where traders can only move one
contract daily without moving the market, compared to five contracts three
years ago. This is problematic for consumers, he said, because with low prices
and low volatility, there is little incentive to hedge, however, if conditions
change, the market depth does not exist to support additional hedging.
Physically
vs. Financially Settled Products
Bryan
Durkin, CME, noting the commonality in approaches to this issue, emphasized
that CME is not supportive of different position limits for physically or
financially settled products because the failure to have one-for-one parity
treatment could have a detrimental effect on the overall performance of the
physically settled contracts.
Craig
Pirrong, Professor of Finance and Energy Markets, University of Houston,
agreed, noting that there is no rationale for such a distinction when the
manipulation of physically settled contracts is the same as that of financially
settled contracts.
Allison
disagreed, noting that the question is not whether the products are similarly
manipulated since manipulation is illegal and presumably an effective
manipulation regime is already in place. The concern, he said, is whether there
is a propensity to create the threat of excessive speculation, for which
financially settled swaps have a far lower potential than physically delivered
swaps.
Panel III: Trade Options and Forwards with
Embedded Volumetric Optionality – Where Do We Stand?
Remarks
– Paul Hughes, Southern Company
Paul
Hughes, noting that the energy industry is generally supportive of the proposed
trade options (TO) rule released by the industry, highlighted the importance of
clarifying how the TO rule applies to capacity contracts and contracts that
allow for zero or nominal delivery. He illustrated concerns of different
understandings for nomenclature on these contracts which can lead to confusion
when some contracts entered into by the energy sector can appear to have embedded
optionality when in fact the contracts are to be use for physical settlement
explicitly.
Hughes
used Southern Company’s own model to illustrate the role of power purchase
agreements (PPAs), an agreement to derive a portion of their energy dispatch
from a physical plant despite not owning it in wholesale. The multifactor
dispatch model used by the industry, Hughes cited, leverages a host of factors
including efficiency, availability, and fuel costs to determine whether that
agreement will be exercised in a given time period. The result, he said, is
that the company needs to be able to retain the ability to not exercise that
contract in a given time period, without eliminating it.
While
PPAs can look like derivatives, Hughes said, these contracts are intended for
physical agreement. He advocated for a “facts and circumstances” analysis on a
contract-by-contract basis to determine whether those contracts apply under the
TO rule.
Remarks
– Arushi Sharma-Frank, Electric Power Supply Association
Arushi
Sharma-Frank continued by providing an example of a similar phenomenon in the
physical gas contracting space. Any natural gas utility local distribution
company, she said, will enter into a master base contract that reflects
everything except the transaction pricing and quantity terms of the agreement.
This master contract, Sharma-Frank noted, makes no obligation of any
transaction to ever occur between the parties, but leaves the door option for
additional agreements if desired.
At
some point in the future, Sharma-Frank illustrated, the utility will perform a
formal solicitation for delivery confirmation in t he future at which point the
additional terms relating to pricing and quantity are established. These
contracts exist in three forms: 1) interruptible delivery; 2) firm variable
agreement; and 3) firm contract.
In
the market, she expressed, treatment of firm contracts is inconsistent amongst
market participants pursuant to an “agree to disagree” model. Essentially,
Sharma-Frank noted, where one counterparty might decide a firm contract
agreement is a TO, the other might disagree.
She
highlighted that this is especially problematic in terms of small end users
dealing with larger end users since smaller end users are less acclimated to
the uncertainty of zero delivery contracts and compliance costs associated with
Dodd-Frank,if a contract is classified as a TO. The negotiation that results
from this uncertainty, she said, is an extensive burden for the industry.
The
current TO proposed rule, Sharma-Frank noted, is an appropriate starting point
to attempt to entice smaller end users back in the market if TO registration is
no longer required. She expressed concerns about the $1 billion notional reporting
requirement in the proposal, noting that quantification challenges for
valuation of TOs for that requirement is especially challenging.
Sharma-Frank
established that the final rule presents an opportunity for further clarity.
She encouraged the CFTC to affirm that physical contracts that allow for zero
or nominal delivery satisfy CFTC’s interpretation and guidance on forward
contracts which exclusively intend physical settlement. The goal, she said, is
to engage the compliance regime using a “facts and circumstances” analysis that
applies broadly across the physical contracting sphere to diminish compliance
uncertainty as much as possible.
She
also noted clarification of the status of capacity contracts and whether TOs
are excluded from future position limits rules as areas for improvement in the
final rulemaking. The exclusion of TOs from future position limits is key to
generate market entry from currently hesitant firms fearing future position
limit applicability.
Sharma-Frank
closed by noting that, in terms of market liquidity, it is key to consider the
timeframe of impact since the industry is still dealing with a new statute in
the form of Dodd-Frank relative to the traditional statutes in gas and power
that are nearly 80 years old.
Remarks
– Amy Fisher, GE Energy Financial Services Inc. on behalf of Cogen Technologies
Linden Venture, L.P.
Amy
Fisher said that relief is needed under the trade option rule because,
according to her company’s outside counsel, the natural gas products they trade
in are commodity options subject to swap rules, even though they are not
options of her company. She said this has caused significant accounting
issues and that tracking these trade options separately from other commercial
arrangements has been “very problematic.” She said that these natural gas
products should be taken out of the trade option category through a change in
the rule itself.
Discussion
Wasson
expressed similar concern with trade options being deemed as swaps, noting that
the CFTC requirement “throw us” into record keeping and reporting for swaps and
into “the deep end of the pool” with swap dealers and major swap participants.
Andrew Soto, American Gas Association, also stressed that trade options
should not be swaps because they are intended to be physically settled. He said
the CFTC should not lose sight of where the market will end up and said that
innovation of the market should not be prevented.
Sharma-Frank
said that the market is looking for “very clear statements” from the CFTC to allow
counterparties to negotiate deals.
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