On June 9, 2015, the U.S. House of Representatives passed the Commodity End-User Relief Act (CEURA), a bill that would reauthorize the Commodity Futures Trading Commission (CFTC) through 2019 and direct the CFTC to revisit several key aspects of the financial regulations and related guidance it has promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).1 CEURA faces an uncertain fate in the Senate, and President Obama has indicated he will veto the bill if it reaches his desk in its current form. However, this legislation is noteworthy as an indication of those aspects of the Dodd-Frank swaps regulatory regime that may be open to reevaluation and reform in the months and years ahead.
As suggested by the bill’s name, much of CEURA is aimed at providing relief from various Dodd-Frank regulatory requirements to commercial end-users of commodity derivatives. It would expand the availability of the “End-User Exception” to Dodd-Frank’s swap clearing and trade execution requirements. Under existing law, the End-User Exception is generally available to end-users who use swaps to hedge or mitigate commercial risk, provided that they are not “Financial Entities.” CEURA would narrow the Commodity Exchange Act (CEA) definition of “Financial Entity” to exclude the “centralized treasury units” often present within the corporate affiliate families of commercial end-users, as well as “commercial market participants”—e.g., producers, processors, merchants or commercial users of agricultural or energy commodities or byproducts—which may otherwise engage in activities sufficiently financial in nature to be classified as “Financial Entities” under the current definition.
Other end-user relief provided by CEURA includes: an expansion of the definition of “bona fide hedging” to include transactions designed to reduce anticipated risks; an exclusion from the “swaps” definition for forward contracts with volumetric optionality; relief from certain recordkeeping requirements for commercial end-users that are members of swap execution facilities (SEFs) or designated contract markets; and relief from the real-time swap data reporting requirement for certain illiquid transactions entered into by non-financial entities.
On the dealer-side, CEURA would halt—absent a further CFTC rulemaking—the automatic reduction of the de minimis exemption from the definition of a swap dealer for persons whose aggregate gross notional swaps dealing activities over the prior 12 months do not exceed $8 billion. Absent such a provision, the threshold will be lowered from $8 billion to $3 billion after the end of a phase-in period,2 potentially requiring a large number of market participants not already registered as swap dealers to so register.3 It also would permit swap dealers to exclude “utility operations-related swaps” entered into with “utility special entities” from their $25 million de minimis cap on swaps with “special entities.” Additionally, CEURA calls for the CFTC and the Securities and Exchange Commission (SEC) to work together with the prudential regulators to establish margin and capital rules for non-bank swap dealers and major swap participants and instructs the CFTC to follow the SEC’s and prudential regulators’ lead in permitting the use of financial models in setting such requirements.
CPO and CTA Registration
CEURA would provide relief from the commodity pool operator (CPO) and commodity trading advisor (CTA) registration requirements for certain investment advisers. Specifically, investment advisers to registered investment companies whose commodity interest trading activities are limited to “Financial Commodity Interests”—a term that effectively encompasses any futures, futures options or swaps on interest rates, exchange rates, currency, securities, security indices, credit risk, and debt and equity instruments—would no longer be required to register as a CPO or CTA. Relief from classification as a “commodity pool” would also be granted to investment funds maintained by charitable organizations and church plans that are otherwise excluded from the SEC’s definition of “investment company” under Section 3(c)(10) or 3(c)(14) of the Investment Company Act, regardless of the fund’s commodity interest trading activity.
Additionally, CEURA calls for the CFTC to harmonize its rules with the Jumpstart Our Business Startups Act (JOBS Act).4 CEURA would lift the CFTC’s current prohibition on CPOs relying on the CFTC Rule 4.13(a)(3) or 4.7 exemptions from marketing their funds to the public, permitting them to take advantage of opportunities for general solicitation provided by the JOBS Act without losing their CFTC exemptions. This provision would codify and expand on CFTC Letter 14-116, which permitted certain CFTC Rule 4.7 and 4.13(a)(3)-exempt CPOs to engage in general solicitation through offerings conducted pursuant to SEC Rule 506(c) under Regulation D or using SEC Rule 144A resellers.
CEURA also addresses how the CFTC should apply its swaps regulations in the cross-border context, directing the CFTC to issue new rules that would jettison certain aspects of the cross-border regulatory approach articulated in its July 2013 interpretive guidance (Cross-Border Guidance).5 Specifically, CEURA instructs the CFTC in its new cross-border rules to not take into account the territorial location of the personnel that arrange, negotiate or execute a swap when determining the applicability of its swaps regulations. This would effectively repeal Footnote 513 of the Cross-Border Guidance, which stated that a U.S. branch of a non-U.S. swap dealer would generally be subject to the CFTC’s transaction-level requirements, and CFTC Advisory Letter 13-69, which stated that a non-U.S. swap dealer who regularly used U.S.-located personnel to arrange, negotiate or execute swaps would generally be subject to the CFTC’s transaction-level requirements.6
CEURA would pressure the CFTC to broaden its substituted compliance regime, which allows, under limited circumstances, an entity’s compliance with a foreign jurisdiction’s equivalent swap regulations to exempt it from compliance with the CFTC’s requirements. Starting 18 months after CEURA’s enactment, the eight foreign jurisdictions with the largest swaps markets would be automatically deemed equivalent to the United States and eligible for substituted compliance, unless the CFTC has conducted an assessment of the foreign jurisdiction’s swaps regulations and by formal rulemaking suspended substituted compliance for the specific jurisdiction. This would be a significant change to the CFTC’s current approach, where a foreign jurisdiction is effectively assumed to be non-equivalent absent a CFTC rulemaking concluding otherwise.
CEURA would impose several new procedural requirements for the CFTC that are aimed at producing a more robust rulemaking process and would increase the Commissioners’ oversight of its staff’s activities. For example, all CFTC rules and orders would be subject to additional cost-benefit analysis, consistent with the requirements outlined in President Obama’s Executive Order 13563,7 which is applicable to Executive Branch agencies but not independent agencies like the CFTC. This cost-benefit analysis would be bolstered by data and analysis provided by the CFTC’s Office of the Chief Economist, which also would be created by the legislation. All CFTC policy statements, guidance, interpretive rules or procedural rules that are voted on by the Commission and have the force of law would also be required to undergo the public notice-and-comment procedures normally required of agency rulemakings. Furthermore, CEURA would establish a streamlined judicial review process similar to the SEC’s, permitting those parties affected by the CFTC’s rulemakings to petition for review by a U.S. Court of Appeals within 60 days after a rule’s publication, rather than requiring review to commence in the U.S. District Courts, as is the case today.
The CFTC’s no-action letter process would also be reformed, with CEURA requiring the agency to formally publish internal procedures that ensure that the Commissioners have an opportunity to oversee and review the final version of any staff exemptive, no-action or interpretive letters prior to publication. Moreover, CFTC staff would be forbidden from using indefinite omnibus orders of investigation without periodic renewal by the Commissioners. CEURA would also formally clarify that while CFTC division directors are appointed by the CFTC’s Chairman, they ultimately serve at the pleasure of the entire Commission.
Other Derivatives Reforms
CEURA touches upon numerous other areas of derivatives regulation, including amendments to the core principles applicable to SEFs, removal of requirements that foreign regulators provide indemnification before accessing data from a swap data repository, and several enhancements to the CFTC’s customer protection rules designed to facilitate regulators’ electronic access to a futures commission merchant’s (FCM) customer fund account balances and to increase certainty that sufficient funds would be available to satisfy customer claims in the event of an FCM bankruptcy. CEURA would also adjust the “residual interest deadline”—that is, the time at which an FCM is required to deposit funds into its customer accounts to the extent an account is determined to be undermargined—and require that at the end of each business day FCMs meet their residual interest requirement calculated as of the close of business of the prior business day. Adjusting this deadline has the effect of allowing the FCM’s customers a full business day to meet their own margin requirements with the FCM, decreasing the need for such customers to overfund their accounts.
The Path Ahead
CEURA is a complex legislative effort that touches upon numerous aspects of the CFTC’s swaps regulatory regime, as well as the CFTC’s internal procedures. While it appears that CEURA in its current form will not become law, its passage by the House is a reminder that several aspects of the Dodd-Frank framework remain open to debate. CEURA and other similar legislative efforts may provide a roadmap for how the CFTC’s regulation of the swaps markets may still evolve in the future.
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|Nathan A. Howell
|Ellen P. Pesch
|Michael S. Sackheim
|Michael E. Borden
2 This phase-in period will end at the “phase-in termination date,” which the CFTC is supposed to publish after it completes a staff report on the definition of “swap dealer” and the potential impact of modifying the de minimis threshold. However, if the CFTC fails to publish a phase-in termination date prior to the fifth anniversary of the date that a swap data repository first received swap data in accordance with Part 45, then the phase-in termination date will be deemed to have occurred on such fifth anniversary. CFTC Chairman Timothy Massad has recently indicated that such fifth anniversary date will otherwise occur in December 2017.
3 In conjunction with the December 2014 omnibus appropriations legislation that provided funding for the CFTC, a nonbinding explanatory statement was inserted into the Congressional Record that called for the CFTC to halt this automatic reduction of the de minimis exception. This being a nonbinding directive, the CFTC has so far not taken up this task, and Chairman Massad has indicated that the CFTC would not undertake such a change without first completing further study regarding the costs and benefits of such a change.
4 See Sidley Securities Law Update, SEC Adopts Significant Changes to Private Offering Rules (July 19, 2013).
5 78 F.R. 45292 (July 26, 2013).
6 The SEC is currently addressing similar issues regarding its own cross-border jurisdiction over security-based swaps. For more information, please see Sidley Derivatives Update, SEC Rule Proposal Addresses Important Elements of Its Security-Based Swap Cross-Border Jurisdiction; Related CFTC Action Remains Under Consideration (May 26, 2015), available here.
7 76 Fed. Reg. 3821 (January 18, 2011).
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