On July 29, 2015, the CFTC’s Energy and Environmental Markets Advisory Committee met and heard from a panel on the impact that the initiatives regarding trade options and forwards with embedded volumetric optionality (EVO) will have on energy and environmental markets. In May 2015, the CFTC amended its seven-part guidance on distinguishing forward contracts with embedded volumetric optionality from commodity options and, in a separate rulemaking, the CFTC proposed to narrow the trade option exemption to the swaps regulations applicable to commodity options.
The panelists included market participants from Southern Company, Electric Power Supply Association (EPSA), and Cogen Technologies Linden Venture, L.P. The panelists agreed that the final EVO interpretation is an improvement over the prior guidance, but argued there is still a lack of clarity in a number of areas. Specifically, they indicated that there is a need to allow contracts for zero or nominal delivery (as well as capacity contracts) and that these should not be considered trade options. It was noted that confusion by end users can frequently cause disagreements, or “agree to disagree” provisions, on how to categorize those energy contracts that have the potential for zero delivery and whether to file a Form TO. The concern was that these disagreements discourage market participation and ultimately reduce liquidity in these markets.
The EPSA highlighted industry confusion regarding how the CFTC “facts and circumstances” analysis would apply to three different factual situations. If a local gas distribution company enters into three distinct confirms pursuant to a standard gas supply contract, EPSA is concerned that, under the CFTC’s current guidance, the parties may reach different conclusions regarding CFTC jurisdiction. For example, the parties could “agree to disagree” with respect to CFTC jurisdiction over:
- A fully interruptible delivery obligation,
- A firm obligation pursuant to which the supplier will provide gas to meet specific needs (such as weather), or
- A firm “swing” obligation pursuant to which the supply obligation may be zero or nominal.
EPSA suggested that the CFTC make clear that “swing” contracts calling for physical delivery, which allow for zero or nominal deliveries, are not swaps in order to entice smaller end-users to re-enter energy markets.
Discussion following the panel included comments that treating trade options as swaps results in additional recordkeeping and reporting requirements originally intended for traditional swaps, and that trade options are intended to be physically settled and should not be treated as swaps.
If you would like to learn more about the CFTC trade option proposal, or have concerns about the embedded volumetric optionality interpretation, please contact a member of Schiff Hardin’s Financial Markets and Products Practice Group or its Energy Group.