CFTC close to fixing Dodd-Frank commodity option woes

The Commodity Futures Trading Commission is said to be exploring solutions for the so-called 'seventh prong' problem created by its definition of a swap under the Dodd-Frank Act

CFTC chairman Timothy Massad

The US Commodity Futures Trading Commission (CFTC) and its new chairman, Timothy Massad, are said to be moving closer to resolving an ambiguity in the agency's Dodd-Frank Act regulations that is causing major headaches for energy companies.

The ambiguity lies in the definition of a swap, which was finalised in July 2012. Specifically, the CFTC designed a seven-part test to help companies determine whether physical contracts with embedded volumetric optionality should be classified as swaps or not. Such contracts might include a natural gas supply deal through which utilities can buy additional volumes in the event of cold weather, for example. Due to the ambiguity, energy firms have been unable to agree with each other on the proper regulatory treatment of such contracts, leading to protracted negotiations and steep compliance costs, say industry groups.

Trade associations for energy companies repeatedly complained about the so-called 'seventh prong' problem during the tenure of former CFTC chairman Gary Gensler, although their appeals did not result in any action. But under Massad, who was sworn in on June 5, they appear to be making some long-awaited headway.

According to two Washington, DC-based sources familiar with the agency's deliberations, a majority of its commissioners, including Massad, are exploring potential ways to resolve the ambiguity and address the problems arising from the seven-factor test.

"They are definitely aware of the issue and they are trying to figure out a way to make it workable," one of the sources told Energy Risk. Massad and the other commissioners have discussed the issue with representatives of the energy industry, the sources say.

They are definitely aware of the issue and they are trying to figure out a way to make it workable

It remains unclear what approach the CFTC will take in resolving the issue or how soon the agency will act. Complicating the CFTC's task, the definition of a swap was agreed jointly with the US Securities and Exchange Commission (SEC). That means amending the rule would require further co-ordination with the SEC.

On April 17, a broad range of trade associations – representing electric utilities, natural gas suppliers and corn farmers, among others – submitted comments to the CFTC proposing a potential solution to the problems of embedded volumetric options. The industry groups suggested the CFTC issue new guidance on how to interpret the seventh part of the seven-part test, an approach the agency could pursue independently without working with the SEC.

A CFTC spokesman did not respond to requests for comment. However, in public statements, Massad has indicated he is open to adjusting the agency's Dodd-Frank regulations so they do not impose an undue burden on end-users.

"In fine-tuning existing rules, and in finishing the remaining rules that [the US Congress] has required us to implement, we must make sure that commercial businesses like farmers, ranchers, manufacturers, and other companies can continue to use these markets effectively," noted Massad in his prepared testimony for a hearing of the US Senate Committee on Banking, Housing, and Urban Affairs on September 9.