Firms shy away from public utilities despite CFTC relief

No-action letter not enough to convince counterparties to trade with public utilities

Utility counterparties fear being caught on the wrong side of the line

US public utilities claim they are still being avoided by counterparties in the over-the-counter derivatives market as a result of the Dodd-Frank Act, despite a recent no-action letter from the Commodity Futures Trading Commission (CFTC).

On October 12, the CFTC released a no-action letter that would make it easier for firms to do business with public utilities without being labelled ‘swap dealers’. Dodd-Frank brings in stricter oversight for swap dealers, which will become subject to additional requirements in areas such as registration, margin, capital and business conduct.

But public utilities say the letter has had little effect on their counterparties, many of which are still refusing to enter into hedging transactions with them. “The no-action relief came very late and a number of counterparties had already told our members they couldn’t interact with them anymore, or they could interact purely on the basis of physical transactions rather than financial transactions. When the no-action letter came out, they said they had already moved on,” explains Diane Moody, Washington, DC-based director of statistical analysis at the American Public Power Association (APPA).

For firms that deal in a smaller volume of OTC derivatives, Dodd-Frank includes a de minimis exemption that allows them to avoid having to register as a swap dealer. In May, the CFTC issued a final rule that spells out which companies would be able to take advantage of the exemption. Initially, the threshold is set at $8 billion, meaning firms that transacted swaps totalling less than $8 billion in gross notional over the preceding 12 months would not be defined as swap dealers. But for firms that deal with so-called special entities, the bar is much lower, at just $25 million in gross notional. Special entities include entities such as federal agencies, endowments, municipalities and agencies of state and local governments, meaning any OTC derivatives transacted with public utilities will be included in the lower $25 million threshold.

Since the rule was finalised, utilities have complained that hedging counterparties have eschewed them as a result of the CFTC’s tougher de minimis exemption for special entities. Utilities that spoke to Energy Risk expressed consternation about the CFTC rule, saying it could dramatically reduce their range of potential counterparties and push up the cost of hedging in the OTC market.

When the no-action letter came out, [counterparties] said they had already moved on

The CFTC’s no-action letter provides temporary relief to firms transacting with “utility special entities”, raising the de minimis threshold for transactions with these entities to $800 million. “A significant reduction in the number of swap counterparties available to the utility special entities could be especially harmful to the public interest,” the letter states.

But the no-action letter attaches too many conditions for it to be effective, believes Moody at APPA. “A lot of [counterparties] don’t say why they’re not going to do business with our members, they just say they’ve already made the decision and moved on. Our conclusion is that if the relief were simple and said you could now do business of up to $800 million, that wouldn’t have been an issue. But the number of conditions attached means they’re just not going to bother.”

Following an original petition for relief in July this year, the APPA submitted a further letter to the CFTC on November 19, along with three other organisations: the Bonneville Power Administration, Large Public Power Council and Transmission Access Policy Study Group. Together, the groups call on the CFTC to reconsider their July petition, which argues public utilities should be taken out of the definition of special entities entirely.

The letter identifies various reasons why the no-action letter has failed to have the desired impact, including stipulations that derivatives must be used to hedge physical exposures and the fact that firms are required to report any transactions above the original $25 million threshold to the agency. The cost of complying with these conditions could be seen as prohibitive, the letter argues, given the relatively small slice of the market represented by public utilities.

A Washington, DC-based spokesman at the CFTC would not comment for this article, noting the matter remained “under staff review”. Industry groups believe that review ought to come to a swift conclusion. “They should do it sooner rather than later, because the no-action relief doesn’t appear to be working,” says Moody at APPA.