Update on CFTC Actions under Dodd-Frank as
they Affect the Electric Power Industry
Prepared for APPA 2011 Legal Conference by
Lisa G. Dowden
Stephen C. Pearson
Melissa E. Birchard
Spiegel & McDiarmid LLP
1333 New Hampshire Avenue, NW
Washington, DC 20036
www.spiegelmcd.com
[email protected]
[email protected]
[email protected]
(202) 879-4000
November 9, 2011
Last year at about this time, we discussed the Dodd-Frank Wall Street Reform and
Consumer Protection Act (“Dodd-Frank Act”)1 that was signed into law on July 21, 2010, as a
set of major amendments to the Commodity Exchange Act (“CEA”).2 Although Congress set a
one-year goal for the Commodity Futures Trading Commission (“CFTC”) to complete the
necessary rulemakings to implement the Dodd-Frank Act, the CFTC, underfunded and
understaffed, could not finish this task in time, and is struggling to get major elements in place
by the end of this calendar year. Fortunately, the statute permits the CFTC to defer effectiveness
of the requirements, within limits, until the new rules are finalized.
Before Dodd-Frank, the CEA contained a pre-existing categorical exemption for energy
commodities and their derivatives, which shielded most utility industry products from regulation
by the CFTC. Dodd-Frank revokes that exemption. Unfortunately, the new law left a great deal
to be defined in terms of what energy commodity derivatives are, how they should now be
treated and what kind of entities are intended to be regulated.
The CFTC has made clear that it views its jurisdiction to extend to more energy market
transactions rather than fewer, and that the agency is willing to pursue that authority into areas
once exclusively regulated by FERC. FERC, meanwhile, seeks to retain its jurisdiction over a
range of energy-related contracts, including products bought and sold in Regional Transmission
Organization (“RTO”)3 organized markets that FERC regulates. At the same time, APPA
together with NRECA, TAPS, and others have strongly advocated that the CFTC exercise
restraint in regulating not-for-profit utilities. APPA and NRECA also coordinate with EEI,
EPSA and others on issues common to the utility industry. The regulatory backlog and the
1
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010)
(“Dodd-Frank Act”).
2
Commodity Exchange Act, ch. 545, 49 Stat. 1491 (1936) (“CEA”).swap
3
We use the term RTO to refer to RTOs and Independent System Operators (“ISOs”).
2
volume of comments have forced the CFTC to re-open comment deadlines and to extend
exemptions from the original implementation deadline envisioned by the statute. Although it
remains somewhat unclear exactly when different parts of the new regulatory regime will be
implemented, the CFTC’s latest proposal4 would extend the energy commodity exclusion
through July 16, 2012, a full year past the general effective date of the statute.
While the CFTC has begun to issue final rules implementing the Dodd-Frank Act, very
few of them thus far have clarified matters for public power entities. In particular, key
definitions such as “Swap” remain unfinished, making it difficult for potentially regulated
entities to know which of their transactions will be covered, or whether proposed rules using
these terms will apply to them. The same proposed rule postpones the effectiveness of
requirements depending on those definitions until the earlier of July 16, 2012 or sixty days after
the definitions are finalized.5
A.
Projected Timeline
The CFTC anticipates considering and finalizing the remaining rules on a specific
timeframe and has laid out a staggered implementation schedule under which regulated entities
falling into three different categories would be required to comply with the law at defined points
throughout 2012, with larger, more active traders coming into compliance first.
The agency has reserved the right to amend its timeline6 at any point. Consistent with the
most recent proposed extensions, the CFTC would have until July 16, 2012 to complete and
begin to implement any rule that turns on a term which requires further definition, such as
4
Effective Date for Swap Regulation, 76 Fed. Reg. 65,999 (Oct. 25, 2011).
Id.
6
See Outline of Final Dodd-Frank Title VII Rules the CFTC May Consider in 2011 and the First Quarter of 2012,
CFTC, available at http://www.cftc.gov/PressRoom/SpeechesTestimony/genslerstatement090811c.
5
3
“Swap” or “Swap Dealer,” as well as to implement the statute with regard to previously excluded
commodities, including energy.7 The asterisks indicate rules likely to be of interest to many
public power entities.
Remainder of
2011
• Clearinghouse Rules
• Data Recordkeeping and Reporting*
• End-User Exception*
• Entity Definitions/Registration*
• External Business Conduct
• Internal Business Conduct (Duties,
Recordkeeping and Chief Compliance
Officers)
• Position Limits
• Product Definitions/Commodity Options*
• Real-Time Reporting*
• Segregation for Cleared Swaps
• Trading – Designated Contract Markets and
Foreign Boards of Trade
First Quarter
2012
• Capital and Margin*
• Client Clearing Documentation and Risk
Management
• Conforming Rules
• Disruptive Trading Practices
• Governance and Conflict of Interest
• Internal Business Conduct (Documentation)
• Investment of Customer Funds
• Swap Execution Facilities
• Segregation for Uncleared Swaps
• Straight-Through Trade Processing
This projected timeline puts both the end-user exception rule and the product definition
rule on the table before the close of 2011, as well as the record-keeping and reporting rule.
7
See http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101811b.pdf
4
According to this agenda, other rules significant to the electric power industry, such as the rule
on capital and margin requirements, are not expected to be finalized until sometime in the first
quarter of 2012. It is rumored that the Swap definition may be voted out at the December CFTC
meeting.
B.
What Do We Fear?
To understand the issues involved for the typical public power transaction, it may help to
refer to a slide from last year’s presentation about the differences between transacting in an overthe-counter market world, as most utilities do now, and in a CFTC-regulated world designed to
minimize systemic market risk.
Platform Clearing
Over the Counter (“OTC”) Trading
Market participants must be
capitalized against the risks they have
assumed and this is enforced by
exchanges.
Margin requirements; cash collateral
only; mark to market.
Companies rely on credit ratings,
balance sheets and their own analyses
of credit quality of their
counterparties.
Unsecured credit available; letter of
credit between counterparties above
unsecured credit limits.
Registered entity/platform
In RTO markets, mutualization of
collateralized to withstand default of risk.
largest participant.
Position limits – regulation of
No oversight of positions not cleared
positions that may be taken; questions through a registered entity.
about hedging strategy.
Very liquid markets with active
Less fungible products, often very
trading, minimal negotiation.
location specific, with less frequent
trading, more negotiation.
Reporting and recordkeeping
Minimal reporting or recordkeeping
requirements.
obligations.
The requirements to use a clearing platform would increase costs due primarily to the
capitalization and margining requirements, and the requirement for cash collateral.
5
C.
Key Definitions
As noted above, many of the key definitions necessary to implement the statute have not
yet been finalized. However, the CFTC has many proposed rules pending, and this has enabled
public power entities to identify and comment on a number of potential problems.
1.
Swap
The industry hoped for clarity in the long-awaited proposed rule8 that would supply
definitions of key terms such as “Swap.” The term is far more flexible than one might suppose.
While forward contracts for physical commodities are (and have been) exempt, there is
considerable fuzziness over where a transaction crosses the line from physical forward to
“Swap.” While the CFTC continues to recognize that forward contacts with an obligation to
deliver a fixed quantity of a physical commodity are beyond its jurisdiction, the certainty stops
there. Immediate concerns include the treatment of options and “bookout” transactions, as well
as the definition of Eligible Contract Participants.
a)
Physical Forwards
The statute itself excludes physical forward contracts from CFTC regulation and from the
definition of “Swap.” These contracts include “any sale of a non-financial commodity or
security for deferred shipment or delivery, so long as the transaction is intended to be physically
settled.”9 Utility commenters sought clarification that CFTC precedent related to “bookouts”10
would still apply and that “bookouts” – the practice of sometimes settling physical forward
contracts financially when the primary purpose of the transactions is to transfer ownership of the
8
Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement;” “Mixed Swaps;”
Security-Based Swap Agreement Recordkeeping, 76 Fed. Reg. 29,818 (May 23, 2011) (“Proposed Swap
Definition”).
9
CEA § 1a(47)(B)(ii), 7 U.S.C. § 1a(47)(B)(ii).
10
Statutory Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39,188 (Sept. 25, 1990) (commonly
referred to as “Brent Interpretation”).
6
physical commodity – would not be treated as swaps. While the CFTC has indicated that its
longstanding precedent on bookouts should continue to stand,11 it also noted that the question of
whether a transaction involves an intent to go to delivery is one to be based on the facts and
circumstances of each case.12 A binding delivery obligation is a key factor in this analysis for
any contract.13 Unfortunately, fact-specific inquiries tend to create uncertainty for buyers and
sellers, who would prefer to know if their agreements are regulated in this manner before they
sign them. It remains doubtful whether additional clarity on this matter will be forthcoming.
b)
Trade Option Exemption
Electric industry commenters have been concerned that commodity options, especially
commodity options embedded in forward contracts, might prevent a forward physical contract
from being exempted from the proposed Swap definition. According to CEA Section
1a(47)(A)(i), commodity options, other than options on futures, are Swaps, and are to be
regulated as such. The CFTC has also proposed eliminating an existing exemption for “trade
options” (option transactions by commercial users of the commodity in their underlying
business, in other words, for “end-users”) that formerly exempted such options from exchange
trading requirements.14
Unfortunately, this approach presents problems for industry participants. If options are
Swaps, they cannot be traded outside of an exchange by an entity that is not an “Eligible
Contract Participant” (discussed below), another non-final defined term. It is also not clear what
utility is achieved by requiring such options to be cleared through an exchange, because no mark
to market or capitalization requirements exist until a buyer exercises the option, in which case
11
Proposed Swap Definition at 29,828.
Id.
13
Id. at 29,829.
14
Commodity Options and Agricultural Swaps, 76 Fed. Reg. 6095, 6100 (Feb. 3, 2011).
12
7
physical delivery and payment occur. If the buyer does not exercise the option, it expires and
there is nothing to settle. Foreclosing entities from using anything more complex than a
straightforward option on a commodity for future delivery would be a serious problem for the
electric markets.
Under pre-Dodd-Frank Act statutory interpretation,15 the CFTC found that a forward
contract with an embedded option (such as a put) was an excluded contract (i.e. not a Swap) if
the embedded option

affected the price term, not the delivery term, and

could not be severed from the contract in which it was embedded.
The CFTC proposes to continue this interpretation under the new rules.16 The difficulty
here is that electricity options may affect the delivery term due to the unpredictability or timing
of load, and they may be severable. If these contracts are not exempt, and must happen on
exchanges or be limited to ECPs, they may be more expensive, and less available.
The existing “trade option exemption” formerly exempted commercial hedgers from
exchange trading requirements for commodity options. The CFTC believes that this exemption
is not used much, and that it can therefore be eliminated. Of course, since most energy
transactions were exempt from any CFTC regulation prior to Dodd-Frank, there was no need for
utilities to use this exemption. However, options beyond plain vanilla futures are commonly
used in the electric industry and are often employed by end-users. Limiting their accessibility off
exchange is likely to pose a problem.
15
Characteristics Distinguishing Cash and Forward Contracts and “Trade” Options, 50 Fed. Reg. 39656 (Sept. 30,
1985); In re Wright, CFTC Docket No. 97-02, 2010 WL 4388247 (CFTC Oct. 25, 2010).
16
Proposed Swap Definitionat 29,830.
8
2.
Eligible Contract Participant
The term “Eligible Contract Participant” (“ECP”) is not new.17 Those of you who have
used form contracts to deal with counterparties in electric and gas trades have likely seen it
before, and you may well have represented to counterparties that your utility is an ECP. By and
large, that is generally an accurate statement. ECP status has not previously had much day to
day significance for your transactions, and most public power entities have not struggled with the
term.
However, the significance of being an ECP changes under the Dodd-Frank Act, because
when those provisions become effective, it will be illegal for a non-ECP to execute any swap
outside of a designated contract market or exchange.18 Unfortunately, the statutory language
creates a circular situation where a public power utility must qualify as an “Eligible Commercial
Entity” (“ECE”) to qualify as an ECP, but must be a qualified ECP to qualify as an ECE. The
CFTC’s proposed definitions19 have so far not clarified this irregularity. APPA and its not-forprofit coalition members have asked the CFTC to define ECP in terms of the underlying
commercial functions an entity performs, to ensure that all members will still have the ability to
engage in over the counter trades.
3.
Swap Dealers and Major Swap Participants
The definitions of “Swap Dealer” (“SD”) and “Major Swap Participant” (“MSP”)
encompass entities that make markets in swaps and that hold substantial positions in swaps. In
general, they must follow many of the same requirements for registration, capitalization,
margining, recordkeeping and reporting applicable to exchange trading, even if they may do
17
CEA § 1(a).
CEA § 2(e).
19
Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major SecurityBased Swap Participant” and “Eligible Contract Participant,” 75 Fed. Reg. 80,174 (Dec. 21, 2010) (“Proposed Entity
Definition”).
18
9
trades off-exchange. These entities will be highly regulated and the costs of being designated as
such an entity would likely be high. The proposed definitions20 are not final, and many questions
remain unresolved. Few APPA members are likely to be large enough to trigger these
definitions. Concerns for public power are the substantial costs associated with doing deals with
such entities, whether joint action agencies will be captured by the definitions due to aggregation
of deals made on behalf of their members and, in organized markets, whether RTOs may be
captured by the definitions. Questions remain as to how exceptions for de minimis participation
and exclusions for swaps used to hedge or mitigate commercial risks will work.
The CFTC must exempt from designation as a “Swap Dealer” any entity that engages in
only a de minimis level of swaps dealing “in connection with transactions with or on behalf of
customers.”21 Under the CFTC’s proposed rule, an entity would qualify for the de minimis
exemption if:22

The aggregated gross notional value of swaps engaged in during the preceding 12
months was less than or equal to $100 million;

The aggregated gross notional value of swaps engaged in with “special entities”
such as political subdivisions in the preceding 12 months was less than or equal to
$25 million;

It entered into swaps “as a dealer” with no more than 15 counterparties (apart
from security-based swap dealers) in the past 12 months; and

It entered into no more than 20 swaps as a swap dealer in the past 12 months.
20
Id.
CEA § 1a(49)(D). Proposed Entity Definition at 80,183.
22
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/defs_factsheet.pdf.
21
10
As proposed, this exemption would be self-executing. In other words, a utility would be
exempted from designation as a “swap dealer” automatically if it qualified under the terms
enumerated above, and would not have to apply to the CFTC to receive explicit authority to
invoke the exemption.23 While this approach has benefits, it may also carry with it risks if, for
example, one assumes an exemption that is later contested.
According to the CFTC’s proposed definition of “Major Swap Participant (MSP)”, an
entity that meets any one of three qualifications will be considered an MSP for purposes of
regulation under the CEA. An MSP is an entity:24

That holds a “substantial position” in swaps,25 excluding positions held for the
purpose of hedging or mitigating commercial risk; or

Whose positions create “substantial counterparty exposure” with potential
“serious adverse effects” on the financial stability of domestic financial markets
or banking; or

Is a financial entity holding a substantial position in swaps and who is “highly
leveraged” but is not subject to capital requirements.
Most public power entities are highly unlikely to qualify as MSPs under this definition.
For public power, the key issue is likely to be whether RTOs will qualify as MSPs. Under credit
policy reforms required by the CFTC and FERC, RTOs that are required to assume a
counterparty role in all transactions in their markets will certainly hold substantial positions in
23
See Proposed Entity Definition discussion at 80,181.
See http://www.sec.gov/rules/proposed/2010/34-63452.pdf at 48-49. See also
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/defs_factsheet.pdf.
25
The CFTC has set forth two tests for quantifying a “substantial position,” in accordance with the current
uncollateralized exposure and potential future exposure associated with swaps held. See
http://www.sec.gov/rules/proposed/2010/34-63452.pdf. at 60-67; see also
http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/defs_factsheet.pdf.
24
11
Swaps. The CFTC could exempt them under the statute, but the requirements to be imposed as a
condition of such an exemption are not yet entirely clear. This issue is discussed further below.
D.
The End-User Exception and Capital and Margining Requirements
Section 723 of the Dodd-Frank Act adds Section 2(h)(7) to the CEA. This amendment is
commonly referred to as the “end-user clearing exception” or the “end-user exception.” The
end-user exception is particularly important with respect to certain requirements the new rules
would impose on parties to swaps, especially the capitalization and margining requirements. The
end-user exception is supposed to protect entities who hedge in order to mitigate their
commercial risks (as opposed to hedging for speculative purposes) from the more onerous
requirements that apply to entities in the swaps business. It is supposed to allow end-users to
continue to use hedges without having to absorb the heavy costs of full compliance including
exchange clearing, margining and capitalization that will apply to Swap Dealers and Major Swap
Participants.
To be clear, the term “end-user” means something different to the CFTC than it does to
FERC. In the utility industry, an end-user generally refers to the retail customer, whether
residential, commercial or industrial, who actually consumes the electricity. The CEA does not
precisely define the term, but the end-user exception we discuss here is available to nonfinancial26 entities that use swaps to hedge or mitigate commercial risk (as opposed to
speculation). In most cases, a distribution utility would be an end-user, and APPA and others
have argued that joint action agencies and marketers such as The Energy Authority, should be
able to use the exception on behalf of the end-users for whom they act.
26
“Non-financial” means entities that are not Swap Dealers, Major Swap Participants or banks.
12
The good news is that if the rules are drafted as Congress intended, end-user swaps
should be exempt from an otherwise applicable mandatory clearing requirement, and the
minimum capitalization and margining requirements that go with it. As amended, CEA Section
2(h)(1) would make it illegal to transact in swaps without submitting them for clearing to a
designated clearing organization, assuming clearing is required for those swaps. However,
Section 2(h)(7) provides an elective exception from clearing when one party to the swap is not a
financial entity, is using swaps to hedge or mitigate commercial risk, and notifies the
Commission, in a manner set forth by the Commission, how it generally meets its financial
obligations associated with entering into non-cleared swaps. Unfortunately, the CFTC has
considerable discretion under the statute for how it implements the end-user exemption.
The CFTC has issued a proposed rule to implement the end-user exception to clearing.27
The NOPR proposes that end-users register with a Swap Data Repository (“SDR”) and also
submit individual applications for case-by-case (swap-by-swap) exceptions to the clearing
requirement. The CFTC proposes to grant exceptions from the clearing requirement for swaps
that are used to hedge or mitigate risk. While there are three paths by which a transaction might
qualify, the one likely to be relevant for most APPA members is whether the transaction is
“economically appropriate to the reduction of risks in the conduct and management of a
commercial enterprise,” where the commercial risk falls into any one of six enumerated
categories.28 Qualifying commercial risks include risks arising from a potential change in the
value of assets, liabilities, or services.29
27
End-User Exception to Mandatory Clearing of Swaps, 75 Fed. Reg. 80,747 (Dec. 23, 2010).
Id. at 80,752, 80,757. More than one counterparty to a swap can elect to apply for (and potentially can receive)
the exemption.
29
Id. 80,757.
28
13
The NOPR states the CFTC’s preference for making a case-by-case determination, and
clarifies that “commercial risk” can include risk suffered by non-profit and governmental
entities:30
As a general matter, the Commission preliminarily believes that
whether a position is used to hedge or mitigate commercial risk
should be determined by the facts and circumstances at the time
the swap is entered into, and should take into account the person's
overall hedging and risk mitigation strategies. The Commission
expects that a person’s overall hedging and risk management
strategies will help inform whether or not a particular position is
properly considered to hedge or mitigate commercial risk for
purposes of the clearing exception. In this regard, the Commission
preliminarily believes the question whether an activity is
commercial should not be determined solely by an entity's
organizational status as a for-profit company, a non-profit
organization, or a governmental entity. Instead, the determinative
factor should be whether the underlying activity to which the swap
relates is commercial in nature.
However, a swap will be excluded from eligibility for the clearing exception if it is held
for speculative, investing, or trading purposes, or if it hedges another swap, unless that swap
itself is held for hedging purposes. Id. Needless to say, having to seek case-by-case approval of
end-use transactions could be expensive and problematic, and it would be especially burdensome
if the CFTC were to start second-guessing whether a particular hedge was “economically
appropriate” after the fact.
APPA and its allies have several other concerns with the proposed rule, including the fact
that it requires the use of a credit support agreement or collateral annex. We know that a number
of public power entities do not enter into transactions with counterparties who demand use of the
credit support annex, so these transactions could be jeopardized.
30
Id. at 80,753.
14
Although the legislative intent of the end-user exception is definitive that end-users are to
be exempt from clearing, the credit support agreement or collateral annex must address matters
such as margin (initial amounts and intervals for revaluing, or marking to market) and types of
collateral.31 No margining or one-way margining are both expected to be permissible, and
parties may set a threshold below which collateral need not be required.32 The proposed rule
would also permit the use of certain non-cash collateral for end-users, 33 though these types of
collateral are likely to receive “haircuts.” A haircut means that non-cash collateral may be
discounted from its full value to recognize that it presents more risk than cash in hand.
Obviously, public power hedgers need maximum flexibility in this regard. For example,
it would not be desirable for the CFTC to set inflexible conditions, such as a requirement for
daily or weekly margining for all types of transactions, or to mandate haircuts for specific types
of non-cash collateral. The more flexibility market participants have to design credit support
appropriate for their risks and needs, the better off small end-users will be.
While the CFTC should allow end-users to engage in swaps without posting collateral (or
margining) below a certain threshold, SD or MSP counterparties may be less willing to agree to
such transactions. This is particularly likely to be true if the CFTC imposes stringent
requirements on entities that deal with end-users without requiring them to use margining or post
cash collateral. For example, SDs and MSPs are subject to capitalization requirements, and if
they do business with end-users without requiring cash collateral, the SD or MSP itself could be
required to maintain additional capital to “balance” the risk of engaging in an unsecured,
31
Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 Fed. Reg. 23,732
(Apr. 28, 2011).
32
Id. §§ 23.151(b)(4) and (5); § 23.154.
33
Id. §§ 23.151 and 23.154.
15
uncleared swap.34 Proposed Rule Section 23.100 defines “additional market risk exposure
requirement” as the amount of additional capital an SD or MSP must maintain for the total
potential market risk associated with uncleared, over-the-counter swaps. Naturally, those costs
would be passed along to end-user counterparties.
The CFTC proposed at § 39.6(b) of its regulations to require non-financial entities to
notify the Commission each time the end-user clearing exception is elected by reporting a slate
of specified information to a SDR. The reporting counterparty, as defined in the swap data
recordkeeping and reporting rules, would deliver the information to the SDR together with other
information about the swap. The CFTC might also require your counterparty to obtain
documentation from end-users to prove they are qualified end-users,35 thus putting more burdens
on counterparties that deal directly with end-users.
At the time the swap is executed, notification containing the following information would
be required:

information regarding the methods used to mitigate counterparty credit risk in the
absence of clearing,

whether an affiliate or financial entity is involved,

the identity of the end user,

a statement that the swap is being used for hedging purposes, and

other information about the swap itself.
34
CEA § 4s(e)(3)(A).
Swap Trading Relationship Documentation Requirements for Swap Dealers and Major Swap Participants, 76 Fed.
Reg. 6715, 6726 (Feb. 8, 2011).
35
16
E.
Recordkeeping and Reporting
The Dodd-Frank Act requires recordkeeping and reporting of information about all
“Swaps” that were in effect on, or entered into after, July 21, 2010.36 The CFTC will register
new entities called Swap Data Repositories (“SDR”) that will collect and store the required
information and make that information available in electronic format to regulators.37 The CFTC
has issued a number of proposed rules and interim final rules specifying, among other things, the
types of information that must be kept and how and when it should be reported. However, these
requirements are still in flux. In a nutshell:

keep all information and documentation related to any transaction that might be a
“Swap” until the rules become clear; and

be prepared, because the final rules on recordkeeping and reporting may well
require quick action and expenditures for new equipment and software.
1.
Historical and Transition Swaps
The CFTC has issued two Interim Final Rules to govern recordkeeping and reporting of
Swaps that existed on, or were entered into after, Dodd-Frank’s enactment date but before the
final, forward-looking recordkeeping and reporting rule goes into effect. The Interim Final
Rules,38 require Swap counterparties to retain the following information, to the extent and in the
form the information already exists, for Swaps that were in effect on, or entered into after, July
21, 2010:

any information necessary to identify and value the transaction;

the date and time of execution of the transaction;
36
Dodd-Frank Act §§ 723, 729.
Dodd-Frank Act § 728.
38
Interim Final Rule for Reporting Pre-Enactment Swap Transactions, 75 Fed. Reg. 63,080 (Oct. 14, 2010); Interim
Final Rule for Reporting Post-Enactment Swap Transactions, 75 Fed. Reg. 78,892 (Dec. 17, 2010)
37
17

information relevant to the price of the transaction;

whether the transaction was accepted for clearing by any clearing agency or
derivatives clearing organization and if so, the identity of such agency or
organization;

any modification(s) to the terms of the transaction; and

the final confirmation of the transaction.
In addition, counterparties must maintain information regarding the volume (e.g.,
notional or principal amount) of swaps entered into after July 21, 2010.
The CFTC has also issued a proposed rule that, when final, will replace the Interim Final
Rules and set the rules for recordkeeping and reporting “historical” Swaps – that is, Swaps
entered into before the Dodd-Frank Act was passed and still in effect on July 21, 2010 (“PreEnactment Swaps”) as well as those entered into after the Act was passed but before the date of
implementation of the Recordkeeping and Reporting Final Rule discussed below (“Transition
Swaps”).39 For historical swaps that expired before April 25, 2011, counterparties will need to
keep all information and documents relating to the terms of each Swap in its possession on or
after October 14, 2010 for Pre-Enactment Swaps, and on or after December 17, 2010 for
Transition Swaps, in whatever form that data has been kept. For all historical Swaps still in
effect on April 25, 2011, a counterparty must keep:

minimum primary economic terms data, such as contract type, transaction date,
quantity, start and end dates, buyer and seller pay indices, buyer and seller
identities, price and price unit, commodity grade, etc.;

records and terms of a confirmation;

any governing master agreements including modifications if in your possession on
or after April 25, 2011;

any credit support agreements including modifications if in your possession on or
after April 25, 2011; and

possible additional records.
39
Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps, 76 Fed. Reg.
22,833 (Apr. 25, 2011) (“Historical Swaps”).
18
Because the definition of Swap is not yet clear, we recommend keeping all records
relating to your transactions until all of the relevant rules are finalized. This means the contracts
themselves and information relating to the transaction and transaction terms such as emails and
recordings of phone conversations with counterparties. At some point, this information about
“historical” Swaps will have to be reported to the CFTC or to an SDR. The CFTC will likely
require initial reports detailing transaction terms, primary economic terms, and counterparty and
master agreement identifiers, as well as ongoing reporting of “Swap continuation data” for those
Swaps which have not expired as of the (yet-to-be-determined) reporting compliance date.40
2.
Future Swaps
The Interim Final Rules and Historical Swaps proposals discussed above are all, in some
sense, backward-looking in that they deal with Swaps that were entered into in the past. The
going-forward “Swap Data Recordkeeping and Reporting Requirements” proposed rule (
“Recordkeeping and Reporting”) will set the rules for recordkeeping and reporting of all Swaps
entered into on and after the rule’s effective date.41
This proposal provides more detail about the data that must be kept for transactions in
various asset types and classes, and when and how it must be reported. With respect to the
records that must be kept, Swap counterparties who are not Swap Dealers or Major Swap
Participants must keep “full, complete, and systematic records, including all pertinent data and
memoranda, with respect to each swap in which they are a counterparty” throughout the life of
40
Historical Swaps at 22,837-38.
Swap Data Recordkeeping and Reporting Requirements, 75 Fed. Reg. 76,574 (Dec. 8, 2010) (“Recordkeeping and
Reporting”).
41
19
those swaps and for five years afterwards, and stored so that the information is “retrievable by
the counterparty within three business days during the required retention period.”42
This “pertinent data” is separated into a variety of categories, including “Swap creation
data” which consists of “minimum primary economic terms” of the Swap: including, for
example, unique swap and counterparty identifying numbers, time and date of execution,
quantity, settlement method, buyer and seller identities, price, start/end date, settlement method,
and “any other primary economic term(s) of the Swap matched by the counterparties in verifying
the Swap.”43 Other data categories include “confirmation data” and “Swap continuation data.”
The most startling aspect of the rule is the extent and frequency of the reporting of that data.
Note that if your counterparty is a Swap Dealer or Major Swap Participant, it will be responsible
for meeting the reporting requirements for those transactions.44 However, if neither party to the
transaction is a SD or MSP, the parties must agree which one will report the required
information.45
Reporting timelines will also be a concern. The CFTC deals with automated exchanges
that can report Swaps nearly instantaneously. The not-for-profit group has struggled to make the
CFTC understand that public power entities lack those capabilities, and the money to pay for
such extensive capabilities. These reporting requirements could be burdensome and expensive to
implement, especially for municipal utilities with limited staffing. Given these potentially
overwhelming requirements, the not-for-profit coalition has asked the CFTC to apply impose
reduced reporting requirements to their members. The CFTC’s final recordkeeping and
reporting rule is expected to be released later this year.
42
Id. at 76,579.
Id. at 76,598-99.
44
See Dodd-Frank Act § 729.
45
Id.
43
20
F.
CFTC and FERC Relationship
The Dodd-Frank Act provided remarkably limited guidance on how FERC and the CFTC
were to manage their respective exclusive jurisdictions over aspects of energy transactions.
However, the legislation did provide for negotiation between the agencies, and provided the
CFTC with some discretion to exempt certain FERC-regulated transactions from its regulatory
purview.
1.
Memorandum of Understanding
The Dodd-Frank Act requires FERC and the CFTC to execute two Memorandums of
Understanding (“MOU”).46 One would establish procedures for each agency to exercise its
respective jurisdictional authority, provide methods to resolve conflicts and avoid, to the extent
possible, duplicative or overlapping regulation. The second would outline procedures for sharing
information during investigations. Those MOUs were supposed to be provided to the relevant
jurisdictional committees in Congress by January 17, 2011. We are now nearly ten months past
that deadline, with no MOUs in sight. Since the process of inter-agency negotiations is not
public, there is little information by which to assess progress, beyond public statements by
Commissioners that the negotiations are continuing. Recently, FERC Commissioner La Fleur
stated publicly that the reason for the delay was that the CFTC was too busy, too understaffed
and too budget-constrained by the press of rulemakings to finalize the MOUs.47 Given the
aversion federal agencies have toward ceding any authority, this situation may continue for some
time, probably until the first open jurisdictional clash, which could be triggered by a CFTC final
rule that infringes on FERC’s authority, or by a specific enforcement case.
46
47
Dodd-Frank § 722(e).
Martin Coyne, LaFleur explains delays on agreements with CFTC at 1, Inside FERC (Sept. 26, 2011).
21
2.
Exemption Requests
Congress provided a potential avenue for relief from regulation for transactions regulated
by FERC, states, or municipalities. Specifically, Section 722(f) of the Dodd-Frank Act provides
that the CFTC shall exempt “an agreement, contract or transaction” from the requirements of the
Act if the CFTC “determines that the exemption would be consistent with the public interest and
the purposes of this Act” and is entered into “(A) pursuant to a tariff or rate schedule approved or
permitted to take effect by the Federal Energy Regulatory Commission; (B) pursuant to a tariff
or rate schedule establishing rates or charges for, or protocols governing, the sale of electric
energy approved or permitted to take effect by the regulatory authority of the State or
municipality having jurisdiction to regulate rates and charges for the sale of electric energy
within the State or municipality; or (C) between entities described in section 201(f) of the
Federal Power Act (16 U.S.C. 824(f)).”
The CFTC thus has discretion to grant exemptions under Dodd-Frank Act Section 722(f)
(new CEA Section 4(c)(6)). FERC or industry participants may submit petitions to the CFTC for
such exemptions. The RTOs are planning on submitting a petition or petitions seeking
exemption for products traded in their markets, including FTRs (or their equivalents), capacity,
and day ahead/real time energy. 48 FERC has supported the concept of such an exemption.49
Note that an exemption is not the same thing as a disclaimer of jurisdiction. If the CFTC saw a
reason to revoke the exemption and assert jurisdiction, it could still do so. The timeline for this
filing (or filings, if the RTOs file separately) is uncertain, but the RTOs have been engaged in
talks with the CFTC for the better part of this year. Recently, CFTC Chairman Gensler indicated
48
See, e.g., Juliana Brint, RTOs Working on plans to verify FTR players’ risk management; programs may be
different, Electric Utility Week (July 18, 2011).
49
Comments of Michael Bardee, General Counsel, Federal Energy Regulatory Commission, Re “Further Definition
of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement,” Mixed Swaps, Security-Based Swap
Agreement Recordkeeping at 4 (File No. S-16-11) (July 22, 2011).
22
that he hoped the RTO exemption petitions were filed in time to put the requests up for public
comment sometime this fall.50
The CFTC will undoubtedly impose various conditions on any approval of the RTO
petition. One example is a requirement that the RTO take a counterparty position to all of its
transactions in order to attain set off rights in the event of a bankruptcy of any market
participant.51 It is also likely that the CFTC will require RTOs to report market anomalies to the
CFTC for potential investigation.52
Market participants in organized markets have already seen the impact of CFTC
requirements on their respective stakeholder processes. The recent credit policy changes FERC
ordered for organized markets in Order No. 74153 provide one example. FERC is not only
attempting to demonstrate its capability to regulate as well as the CFTC, but to require changes
that the CFTC will likely impose anyway as the price of exemptions. There is little room for
stakeholders to affect RTO polices if the CFTC and FERC are dictating those policies as a
condition for receiving a CFTC exemption. It will not matter if the RTO doesn’t want to impose
a particular requirement.
For example, a recent policy change requiring RTOs to independently verify the risk
management policies of their market participants was imposed. Although most RTOs included
this policy change in the credit policy filings they made to comply with Order No. 741, the
requirement was not originally proposed by FERC. Instead, it apparently emerged as a condition
50
Brian Scheid, CFTC’s Gensler eyes ISO/RTO exemption process launch, Inside FERC (Sept. 12, 2011).
As noted above, if the RTOs take positions in the market, they would likely qualify as MSPs , with all the
capitalization and margining requirements attached. This would seriously increase RTO administrative costs and
charges. Obtaining the exemption is very important for this reason.
52
See id.
53
Credit Reforms in Wholesale Electric Markets, Order No. 741,75 Fed. Reg. 65,942 (Oct. 27, 2010), FERC Stats.
& Regs. ¶ 31,317 (2010), order on reh’g, Order No. 741-A, 76 Fed. Reg. 10,492 (Feb. 25, 2011) FERC Stats. &
Regs. ¶ 31,320 (2011), order denying reh’g, Order No. 741-B, 135 FERC ¶ 61,242 (2011).
51
23
on which the CFTC insisted during the exemption talks with the RTOs.54 The RTOs did not
necessarily wish to be in the independent verification business, which they would have to
contract out, and the PTOs, who usually drive RTO policymaking, did not wish to submit to such
verification. However, the CFTC reportedly made clear that it would not accept self-certification
by market participants but would insist on independent verification.55 In the orders accepting
Order No. 741 compliance filings, FERC found, not surprisingly, that self-certification programs
were insufficient without a robust verification component.56
FERC is also seeking to beef up its raw data collection capability from organized markets
to enhance its monitoring and enforcement capabilities with respect to anti-competitive or
manipulative behavior in both the physical markets and the financial markets represented by
electricity swaps.57
A coalition of 201(f) entities led by APPA and NRECA has had preliminary discussions,
which are ongoing, with CFTC staff about what a “between 201(f) entities” exemption request
might cover. Chairman Gensler hoped this public comment process might begin late this year or
early next year.58
It is not yet known whether any entity or group of entities will file for exemptions for
other transactions entered into pursuant to FERC tariffs that occur outside of RTOs or within
RTOs but not within the scope of the potential RTO exemption (e.g., bilateral power transactions
in RTO markets).
54
ISOs are moving to verify risk management policies at 1, Platts Electric Power Daily (July 15, 2011).
Id. at 13.
56
Cal. Indep. Sys. Operator Corp., 136 FERC ¶ 61,194, P 49 (2011); N.Y. Indep. Sys. Operator, Inc., 136 FERC ¶
61,193, P 47 (2011); Midwest Indep. Transmission Sys. Operator, Inc., 136 FERC ¶ 61,188, P 41 (2011); Sw. Power
Pool, Inc., 136 FERC ¶ 61,189, P 42 (2011); ISO New England, Inc. & New England Power Pool, 136 FERC ¶
61,191, P 52 (2011); PJM Interconnection, L.L.C., 136 FERC ¶ 61,190 (2011).
57
Enhancement of Electricity Market Surveillance and Analysis through Ongoing Electronic Delivery of Data from
Regional Transmission Organizations and Independent System Operators, 137 FERC ¶ 61,066 (2011).
58
Brian Scheid, CFTC’s Gensler eyes ISO/RTO exemption process launch at 2, Inside FERC (Sept. 12, 2011).
55
24
Of course, there would be much less need for these waivers if “Swap” were to be defined
to exclude transactions for hedging physical commodities, or if the end-users exemption were to
be properly implemented. Given the circumstances, however, it makes sense to actively pursue
waivers.
G.
Whistleblower Rule
The Dodd-Frank Act added § 23 to the CEA,59 which provides that a bounty of 10-30%
of “monetary sanctions”60 will be paid to a whistleblower that provides “original information”61
if a “covered judicial or administrative action”62 recovers in excess of $1 million. The $1 million
can be “penalties, disgorgement, restitution, and interest”63 and it can be recovered from judicial
or administrative actions,64 including a settlement of such an action.65 The biggest issue with
this rule is that your employees can collect, even if they don’t report the problem to you first.66
The whistleblower provisions consider use of internal compliance processes as a factor that can
increase the bounty67 and the rules punish interference with the compliance process as a factor
that may decrease the bounty.68
The whistleblower rule also highlights the importance of a regulated entity using the
information it gains through internal compliance and audit processes. The rules do not pose a
categorical bar against an entities’ attorneys, external accountants, or compliance officers
receiving the bounty. For example, in jurisdictions that have created a crime-fraud exception to
59
7 U.S.C. § 26(b)(1).
7 U.S.C. § 26(a)(3).
61
7 U.S.C. § 26(a)(4).
62
7 U.S.C. § 26(a)(1).
63
7 U.S.C. § 26(a)(3)(A).
64
7 U.S.C. § 26(a)(1).
65
7 U.S.C. § 26(a)(6).
66
Whistleblower Incentives and Protection, 76 Fed. Reg. 53,172, 53,173 (Aug. 25, 2011) (“Whistleblower
Incentives and Protection”). However, an employee cannot profit by reporting his or her own illegal acts.
67
17 C.F.R. § 165.9(b)(4).
68
17 C.F.R. § 165.9(c)(3).
60
25
the attorney-client privilege, an attorney may be found to have “independent knowledge” of
misconduct.69 While the SEC has adopted rules that prevent outside accountants from being
deemed to have independent knowledge, the CFTC did not exclude employee of public
accounting firms from eligibility to claim “independent knowledge” because the Dodd-Frank Act
did not require that exclusion.70 Finally, persons who learn about misconduct as part of their
duties in compliance roles for a regulated entity are only excluded from the bounty for a 120 day
period. If the regulated entity waits longer that 120 days to self report to the CFTC, the
employee can receive a bounty for reporting the employer to the CFTC.71
In addition to providing bounties, the whistleblower rule also protects informants from
retaliation. An employer may not “discharge, demote, suspend, threaten, harass, directly or
indirectly, or in any other manner discriminate against, a whistleblower in the terms and
conditions of employment because of any lawful act done by the whistleblower” in connection
with the whistleblowers actions reporting misconduct to the CFTC or in assisting any
investigation by the CFTC.72 It does not matter whether the CFTC (or a court) ultimately makes
a finding of misconduct, the CFTC’s rules make clear that one who reports potential violations is
protected from retaliation.73 The consequences for retaliation can be severe and include
reinstatement, backpay, as well as special damages including attorney’s fees.74 Of course,
retaliation is prohibited for “any lawful act,” so an employer is not precluded from taking action
against an employee-informant for other legitimate reasons such as when the employeeinformant was guilty of the underlying misconduct.
69
17 C.F.R. § 165.2(g)(2) and (3).
Whistleblower Incentives and Protection at 53,177.
71
17 C.F.R. §§ 165.2(g)(4) and (5).
72
7 U.S.C. § 26(h)(1)(A).
73
17 C.F.R. § 165.2(p).
74
7 U.S.C. § 26(h)(1)(C).
70
26
H.
Recommendations and Protective Measures
While we do not yet know the exact form many of the proposed rules will take, the
degree to which the CFTC may seek to assert authority over organized electricity markets, or the
outcome of any future jurisdictional clash between the CFTC and FERC, we can make a few
predictions about likely future developments and recommend a few actions to prepare public
power utilities for the future.
First, the final rules will undoubtedly require substantial rewriting of the ISDA, EEI,
WSPP and NAESB form contracts for power and gas transactions. This can be an expensive and
time-consuming process, but it cannot be left up to chance and the goodwill of counterparties.
With respect to current transactions, you should review your exit options, in case when the rules
finally go into effect, you find yourself in a transaction that does not meet requirements, or that
will cost you substantial sums to continue.
Concurrent with contract review, you will also wish to overhaul your risk management
policies and market compliance programs, and to train your employees on the new rule.
You can start now to gather information on your counterparties. Will they be SDs, MSPs
or Special Entities? Banks are likely to be subject to significant and less flexible requirements.
Your obligations can also change depending on who (or what) your counterparty is.
Finally, keep all paper related to these transactions, until the recordkeeping and reporting
rules are clear. You may have to report on short notice.
27
Appendix
Section 722 of Dodd-Frank, dealing with the jurisdiction of the CFTC, references FERC
in subsections 722(e) – (f):
(e) FEDERAL ENERGY REGULATORY COMMISSION.—
Section 2(a)(1) of the Commodity Exchange Act (7 U.S.C. 2(a)(1))
is amended by adding at the end the following:
“(I)(i) Nothing in this Act shall limit or affect any statutory
authority of the Federal Energy Regulatory Commission or
a State regulatory authority (as defined in section 3(21) of
the Federal Power Act (16 U.S.C. 796(21)) with respect to
an agreement, contract, or transaction that is entered into
pursuant to a tariff or rate schedule approved by the Federal
Energy Regulatory Commission or a State regulatory
authority and is—
“(I) not executed, traded, or cleared on a registered
entity or trading facility; or
“(II) executed, traded, or cleared on a registered
entity or trading facility owned or operated by a
regional transmission organization or independent
system operator.
“(ii) In addition to the authority of the Federal Energy
Regulatory Commission or a State regulatory authority
described in clause (i), nothing in this subparagraph shall
limit or affect—
“(I) any statutory authority of the Commission with
respect to an agreement, contract, or transaction
described in clause (i); or
“(II) the jurisdiction of the Commission under
subparagraph (A) with respect to an agreement,
contract, or transaction that is executed, traded, or
cleared on a registered entity or trading facility that
is not owned or operated by a regional transmission
organization or independent system operator (as
defined by sections 3(27) and (28) of the Federal
Power Act (16 U.S.C. 796(27), 796(28)).”
(f) PUBLIC INTEREST WAIVER.—Section 4(c) of the
Commodity Exchange Act (7 U.S.C. 6(c)) (as amended by section
721(d)) is amended by adding at the end the following:
“(6) If the Commission determines that the exemption
would be consistent with the public interest and the
purposes of this Act, the Commission shall, in accordance
with paragraphs (1) and (2), exempt from the requirements
of this Act an agreement, contract, or transaction that is
entered into—
“(A) pursuant to a tariff or rate schedule approved
or permitted to take effect by the Federal Energy
Regulatory Commission;
“(B) pursuant to a tariff or rate schedule
establishing rates or charges for, or protocols
governing, the sale of electric energy approved or
permitted to take effect by the regulatory authority
of the State or municipality having jurisdiction to
regulate rates and charges for the sale of electric
energy within the State or municipality; or
“(C) between entities described in section 201(f) of
the Federal Power Act (16 U.S.C. 824(f)).”
(g) AUTHORITY OF FERC.—Nothing in the Wall Street
Transparency and Accountability Act of 2010 or the amendments
to the Commodity Exchange Act made by such Act shall limit or
affect any statutory enforcement authority of the Federal Energy
Regulatory Commission pursuant to section 222 of the Federal
Power Act and section 4A of the Natural Gas Act that existed prior
to the date of enactment of the Wall Street Transparency and
Accountability Act of 2010.
29