CFTC Clarifies Exclusions and Exceptions for Non-Financial Energy and Environmental Commodities

July 11, 2012

On July 10, 2012, the Commodity Futures Trading Commission (CFTC) issued final rule clarifications and interpretations of relative importance for companies involved in trading or managing risks associated with any kind of energy and environmental commodities. CFTC’s rulemakings were made pursuant to its obligation to implement certain purposes and requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).

End-User Clearing Exception

CFTC implemented an exception (with accompanying criteria) for non-financial entities and small financial institutions engaging in swap transactions as a hedge against business or commercial risk. Mandatory clearing requirements will not apply to such transactions if one of the counterparties is a non-financial entity (e.g., energy utility or company) using the swap to hedge or mitigate commercial risk. The final rule establishes criteria for determining whether a swap hedges or mitigates commercial risk for purposes of electing the exception. The rule also specifies the information that counterparties taking the exception must report to CFTC.

Forward Contract Exclusion, Applicability to Swap Definition

CFTC also released an interpretation clarifying the scope of the “forward contract exclusion” and its applicability to the new “swap” definition. CFTC extended its historical “Brent Interpretation” of the applicability of the exclusion with respect to futures contracts to all non-financial commodities for purposes of the swap definition. Book-out transactions that apply the forward exclusion from the definition of “future delivery” will now apply the exclusion from the swap definition for all non-financial commodities. Market participants that make or take delivery of an energy or environmental commodity in the course of business, for example, where book-out is effectuated by a subsequent negotiated agreement, should be excluded from the statutory swap definition.

Environmental Commodities Are Not Swaps

CFTC importantly provided key guidance regarding what is and is not a non-financial commodity. CFTC concluded that non-financial commodities that may be physically delivered are exempt or agricultural commodities. This clarification extends to environmental commodities like carbon offset credits, emission allowances and renewable energy credits (RECs), which therefore qualify as non-financial commodities for purposes of exclusion from the statutory swap definition.

Additional Energy Transaction Guidance

CFTC provided guidance regarding forwards with embedded volumetric optionality. If the volumetric optionality is due to physical factors or regulatory requirements beyond the control of parties, that agreement, contract or transaction may be considered a “forward” qualifying for the exclusion. CFTC is requesting further public comment on the issue.

Finally, CFTC provided guidance on an array of other energy industry topics. For example, the agency clarified that certain types of arrangements, like fuel delivery agreements and physical exchange transactions, are not swaps, nor are physical commercial arrangements that are similar to leases (fact and circumstance dependent). CFTC also clarified that certain energy management agreements do not alter the nature of the energy transactions being managed.