8 February 2011
The United States Commodity Futures Trading Commission (CFTC) published a notice of proposed rulemaking (NOPR) regarding its proposed rules for agricultural swaps on February 3, 2011. The proposed rules implement Section 723(c)(3) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which provides that agricultural swaps are prohibited unless entered into pursuant to a rule, regulation or order that was adopted by the CFTC pursuant to Section 4(c) of the Commodity Exchange Act (CEA).
The NOPR’s proposed rules follow the earlier advanced notice of proposed rulemaking (ANPR) published on September 28, 2010. In the NOPR, the CFTC analyzes some of the 19 comment letters received thereon.
Unfortunately, the NOPR again illustrates the awkward sequencing of the CFTC’s various rulemakings: it notes the CFTC’s earlier notice of proposed rulemaking, published on October 26, 2010, regarding a proposed definition for the term “agricultural swap” and states that the CFTC plans to publish a final definition for that term in the “near future.”1 Ideally, one would know what this definition was before having to analyze and possibly comment on the NOPR’s proposed rules. The CFTC (jointly with the Securities and Exchange Commission, and in consultation with the United States Treasury) has yet to propose a definition of the term “swap,” which will be of particular interest to agricultural commodity producers, merchants, cooperatives and others that deal with agricultural commodities, as many ordinary-course transactions by such market participants have informed our understanding of swaps, options and futures. The comment period for the CFTC’s proposed rulemaking regarding definitions for certain key terms used in Title VII of the Dodd-Frank Act (including the terms “eligible contract participant,” “swap dealer” and “major swap participant”) remains open until February 22, 2011; however, the comment period for the NOPR expires on April 4, 2011, and probably before the CFTC will have issued its final rules under Section 723(c)(3) of the Dodd-Frank Act.
As several ANPR commenters had urged,2 the NOPR would eliminate the idiosyncratic treatment for certain agricultural swaps (including options thereon, but not options on futures) due to the comprehensive regulatory scheme of Title VII of the Dodd-Frank Act.3 The NOPR generally would require that swaps of agricultural commodities and options thereon (other than options on futures) be treated in the same way as are other non-agricultural commodity swaps.
Of course, this similar treatment would, among other things, require that eligible swaps be, in fact, cleared (unless the end-user exception to mandatory clearing applies), and that all swaps either be transacted on a board of trade that is a designated contract market4 or be between “eligible contract participants,” as defined in the CEA5 (ECP). Although various ANPR commenters6 stated that they only transact agricultural swaps with eligible contract participants, it is not clear that this is universally the case. We expect that there are current counterparties to agricultural swaps that are not ECPs (at least not as amended by the Dodd-Frank Act, which materially tightened certain of the requirements therefor, including the threshold for qualifying individuals), who will then be “forced” to use exchange-traded equivalents with the attendant requirement for cash margin.
Specifically, the proposed rules eliminate most of the largely redundant Part 32 (dealing with commodity options) and withdraw Part 35 (dealing with commodity swaps). Notably, the NOPR proposes that the current anti-fraud provisions in Sections 32.8 and 32.9 be retained due to their “importance” to the CFTC and the commodity options markets. This importance is stated without demonstration, and the retention of these provisions is potentially inconsistent with the CFTC’s other anti-fraud proposals7 and certainly with the CFTC’s stated desire that all swaps, including agricultural swaps, be treated in the same way.
In addition, parties to agricultural swaps that are swap dealers or major swap participants will be subject to comprehensive registration, business conduct, recordkeeping and reporting requirements under Title VII of the Dodd-Frank Act.
The full import of the NOPR’s proposed rules is difficult to gauge at this time, especially in the noted absence of a proposed definition of “swap,” final rules defining “eligible contract participant,” “swap dealer” and “major swap participant,” and final rules that establish the CFTC’s proposed end-user exception to mandatory clearing. However, it is reasonably clear that all affected agricultural commodity swap market participants will need to closely review their current swap practices and regulatory compliance arrangements and, if necessary or appropriate, submit comments on the NOPR (which are due on or before April 4, 2011). Failing that, affected participants must be prepared to modify these practices and arrangements so as to comply with the NOPR’s proposed rules when finally adopted.
Unfortunately, the CFTC failed to take up the whimsical suggestion of Philip McBride Johnson that “brussels sprouts” (sic), cauliflower and certain other specified “agricultural commodities” join onions and movie box office receipts as non-commodities in the “public interest.”
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