By Scott DiSavino
July 11 The U.S. power industry gave a cautious
thumbs up to new rules defining what constitutes a "swap", a
designation that some feared could raise costs or impose new
limits on a large swathe of the nation's electricity markets.
Power traders, utilities and other big players worried the
Commodity Futures Trading Commission (CFTC) might count
transactions intended for physical delivery -- such as commodity
"forward" contracts typically held until delivery -- as swaps
that must be reported and may require margin or clearing costs.
But the CFTC on Tuesday appears to have excluded physically
deliverable forward contracts from the swaps definition and
included a seven-part test for determining the distinction
between a physical "forward" and a purely financial "swap".
"We think that the CFTC did a good job of coming up with
rules that seem to be well balanced and in line with the
direction of congress," Richard McMahon, VP of finance at Edison
Electric Institute (EEI), the trade group representing U.S.
investor owned power companies.
Contracts involving environmental commodities such as
emissions allowance offsets and renewable energy credits may
also qualify for the forward exclusion, the CFTC said.
The CFTC approved of the swaps definition on Tuesday but
full details of the rule may not be published for several days.
The commission also approved regulations governing end-user
exemptions to the clearing of swaps.
"The power industry is satisfied with how the rule came out.
It will not draw in a lot of transactions that the industry did
not consider swaps," William Hederman, director at Deloitte &
Touche's Enterprise Risk Services practice told Reuters.
"There are some remaining uncertainties but most firms can
work with the swap rules and move forward," Hederman said.
Power companies enter into long- and short-term physical
transactions to buy and sell electricity, natural gas and other
fuels to serve customer needs, and sometimes use financial
hedges to manage volatile prices.
The CFTC drafted the swaps rules pursuant to the Dodd-Frank
financial reform act of 2010 to lower risk and promote
transparency in commodities and other markets, seeking more
standardized derivatives that could be traded on open platforms
and guaranteed through clearinghouses.
But the power industry uses several derivative contracts
that can't be standardized or easily traded on an exchange
because they need to be flexible in the timing and volume that
can vary with changes in weather related demand.
Some of these transactions include customized deals in
remote hubs that are only traded by a couple of local entities
with too little volume for an exchange to be possible.
Power companies are also concerned about so-called bookouts
where parties commit to a physical delivery but end up closing
the contract in a financial or paper transaction.
CFTC Chairman Gary Gensler however said the commission was
still seeking additional comments on forwards with embedded
"Transactions with embedded optionality may satisfy this
test and therefore qualify for the forward exclusion if the
predominate feature of the transaction is actual delivery," CFTC
Commissioner Scott O'Malia said in a statement Tuesday.
Not everyone however was happy about the power exclusions.
"This rule falls short with energy markets," Tyson Slocum,
director of the Energy Program at Public Citizen, a consumer
rights advocacy group, said in a release.
"With progressive Commissioner Bart Chilton dissenting, the
CFTC opened a big loophole to certain types of energy forward
contracts, exempting them from reporting requirements entirely.
The CFTC should deploy its full authority to police this crucial
market," Slocum said.
Now that the CFTC has defined what a swap is, the so-called
swap dealers, mostly banks with more than $8 billion in swap
trades annually, will have 60 days to register after the final
rule is published.
The CFTC has estimated about 125 companies will have to
register as swap dealers or major swap participants, including
about 25 to 50 energy companies, Deloitte's Hederman said.
The issuance of the swap definition will likely result in a
period of significantly reduced activity in energy commodity
markets as companies determine whether they need to restructure
their businesses, processes and compliance procedures, Diane
Moody, Director of Statistical Analysis at American Public Power
Association (APPA) said.
APPA is a trade group representing more than 2,000
community-owned electric companies.
Even if a power company is not a "swap dealer" under the
CFTC definition, they still need to report and monitor
transactions and may need to post margin or clear their swaps,
Evan Koster, a partner at the Hogan Lovells US LLP law firm in
New York, told Reuters.
"If the transaction is a swap, it will be subject to some
requirements. The extent depends on who the entities are. The
key for the companies is to make sure they meet their
obligations under the new rules," Koster said.
One thing power companies sought and received to reduce
their exposure to the swaps rules was the end-user exception.
Under the end-user exception, swaps do not have to go
through a clearinghouse if at least one party in the trade is a
"non-financial" entity and is using the swap to hedge against
DECISIONS STILL TO COME
Even though the clock is ticking to comply with the swap
rules, the CFTC still has some important decisions to make.
Power grid operators, like PJM, were still waiting for the
CFTC to decide whether grid traded products like financial
transmission rights (FTRs) and ancillary services that are
already regulated by the U.S. Federal Energy Regulatory
Commission (FERC) were swaps.
PJM, the biggest power grid in the nation serving more than
60 million people in all or parts of 13 Mid-Atlantic and Midwest
states, said they expect to hear from the CFTC on their
exemption request for FTRs later in July.
In addition, a couple CFTC commissioners said municipal
utilities needed some relief from the commission's earlier swap
dealer rule that classified the munis as "special entities."
Under that rule, which was designed to protect the
municipalities, any party doing more than $25 million of swaps
with a "special entity" would be deemed a "swap dealer" and
subject to strict regulation.
"Given the size of their operations, the $25 million de
minimis threshold is an unworkable level that will drive many
nonbank firms away from dealing with municipal utilities to
avoid the swap dealer designation," Commissioner O'Malia said.
"Commercial end-users in general and municipal utilities in
particular, did not cause or advance the financial crisis of
2008 ... it is difficult to justify imposing increased
operational costs on them without adding any significant
protection to the broader financial markets," O'Malia said.
(Additional reporting by Edward McAllister;editing by Sofina