the Commodity Futures Trading Commission (CFTC) issued proposed guidance that two products – common in competitive wholesale electric and natural gas markets – would not be considered swaps under the Dodd-Frank Act. More specifically, the CFTC proposed that the following contracts would not be considered swaps – and therefore would not be subject to the reporting, recordkeeping and other requirements associated with a swap under Dodd-Frank: (i) capacity contracts in wholesale electric markets and (ii) contracts by electric generators to replace gas supplies at peak.1
The CFTC said “capacity contracts in electric power markets are used in situations where regulatory requirements from a state public utility commission (PUC)2 obligate load serving entities (LSE) and load serving electric utilities in that state to purchase “capacity” (sometimes referred to as “resource adequacy”) from suppliers to secure grid management and on-demand deliverability of power to consumers.”3 The CFTC described a peaking supply contract to be “a contract that enables an electric utility to purchase natural gas from another natural gas provider on those days when its local natural gas distribution companies curtail its natural gas transportation service” in order to serve higher priority residential customers.4
The CFTC’s so-called Products Release Order5 lists the characteristics and factors common to commercial transactions that are not swaps:
- they do not contain payment obligations, whether or not contingent, that are severable from the agreement, contract or transaction;
- they are not traded on an organized market or over-the-counter; and
- in the case commercial arrangements, they are entered into:
- by commercial or nonprofit entities as principals (or by their agents) to serve an independent commercial, business or nonprofit purpose, and
- other than for speculative, hedging or investments purposes.
Applying those standards to the facts and circumstances of capacity contracts and contracts for peaking gas supplies, the CFTC said such contracts were not swaps.6 The CFTC said capacity contracts and contracts for peaking gas supplies are “customary commercial contracts”7 entered into by commercial or nonprofit entities. In addition, such contracts are not traded on an organized market or over-the-counter and do not have severable payment obligations.8 Further similar to sales, servicing and distribution arrangements and contracts for the purchase of equipment and inventory, the contracts are “entered into in response to regulatory requirements, the need to maintain reliable supplies and practical considerations of storage or transport which arise in the course of at least one party’s business.”9 Finally, these contracts are not entered into to “hedge against risks arising from a future change in price for the commodity or to serve a speculative or investment purpose” but rather “to assure availability of a commodity.”10
The CFTC seeks comment on the proposed guidance by May 9, 2016, including whether there are other contracts, either within or outside the electric power and natural gas markets that should similarly not be considered swaps.
In approving the Proposed Guidance, CFTC Chairman Massad said the “proposed guidance is an important complement”11 to the CFTC’s final rule regarding Trade Options,12 further “reduc[ing] burdens on end-users” and “allow[ing] them to better address commercial risk.”13 You can read Chairman Massad’s full statement here.
1 Even if these contracts might have been considered swaps, they might then be considered trade options, which are also subject to reduced Dodd-Frank requirements. See CFTC Further Reduces Regulatory Burdens on Commodity Options, Cozen O’Connor Energy, Environmental and Utilities Alert, March 24, 2016 (Cozen O’Connor Trade Option Alert)
2 The CFTC cited the California Public Utility Commission. Such a requirement could also come from a Federal Energy Regulatory Commission regulated Regional Transmission Organization.
3 See Certain Natural Gas and Electric Power Contracts, Proposed Guidance, Proposed Guidance 81 Fed. Reg. 20583, 20584 (April 8, 2016)(Proposed Guidance)
4 Id. at 20584-20585
5 See Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48207, 48246 (August 13, 2012)
6 The CFTC analogized these contracts to other commercial agreements that the CFTC has deemed not be swaps under the Products Release Order, such as employment contracts; sales, servicing or distribution arrangements; certain fixed or variable interstate rate commercial loans or mortgages; and certain agreements, contracts, or transactions related to business combination transactions, real property, intellectual property and warehouse lending arrangements. Proposed Guidance at 20585
7 Proposed Guidance at 20583
8 Id. at 20586
11 Statement of Chairman Timothy Massad on Proposed Guidance on Certain Natural Gas and Proposed Electric Contracts, April 4, 2016 (Chairman Massad Statement)
12 Cozen O’Connor Trade Option Alert
13 Chairman Massad Statement