On September 30, 2013, the Division of Market Oversight of the US Commodity Futures Trading Commission (CFTC) released responses to Frequently Asked Questions regarding Commodity Options (FAQ). While intended to be provide non-binding guidance to affected market participants, the FAQ also serves to highlight the significant complexity of the current analysis required for commodity options.
Andrew K. Soto, Senior Managing Counsel for Regulatory Affairs of the American Gas Association (AGA), in written testimony before the US House of Representatives Committee on Agriculture Subcommittee on General Farm Commodities and Risk Management at a recent hearing regarding the Future of the CFTC: End-User Perspectives effectively summarized this complexity as follows:
“Nevertheless, transactions that contain some option or choice for one or the other counterparty, raise questions for some as to whether they would be considered commodity options regulated as swaps, meet a three-part test and a seven-part test to be excluded as options embedded in forward contracts, be viewed as trade options subject to a lessened reporting burden, or be considered facility use agreement that meet a three-part tests and then a five-part test and not subject to regulation at all.”
Affected industry participants have previously complained about the bewildering complexity of this analysis and also suggest that there likely will be inconsistent application, disagreement and confusion regarding this analysis among participants across the varied and often complex contractual and other arrangements common in energy markets with the real risk of inferior reporting quality. Mr. Soto’s testimony began by drawing attention to the fact that many of the AGA members are end-users who use commodity options to hedge and mitigate commercial risk, including price volatility associated with procuring natural gas supplies for their customers and that, as such, their swaps were not contributors to the systemic risks that caused the credit crisis that prompted the overhaul of over-the-counter derivatives markets.
Mr. Soto also stated in his testimony that the AGA and many AGA members have sought further interpretive guidance and/or no-action letters from the CFTC staff as deadlines for reporting and other compliance obligations have approached with respect to such transactions and noted that many remain outstanding without having been acted upon by the CFTC staff. The FAQ will likely not satisfy Mr. Soto or the other AGA members who have requested additional guidance and/or interpretative relief, since the FAQ contain relatively modest additional guidance and, for the most part, simply restate the current analysis and other requirements under the existing rules. As a result, it seems that the CFTC staff will have to issue a few more letters before required analysis of commodity options can be efficiently and consistently applied by energy industry participants and robust reporting expected from such participants.
Through September 30 of this year, the CFTC staff have issued 62 separate interpretation and/or no-action letters, while the CFTC staff issued a total of 79 last year (although only 26 letters were issued through the corresponding period last year).