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Commodity Option Exemption under Dodd-Frank Temporarily Expanded by CFTC
Practical Law Legal Update 5-521-0024 (Approx. 4 pages)
Commodity Option Exemption under Dodd-Frank Temporarily Expanded by CFTC
| Published on 28 Aug 2012 • USA (National/Federal) |
The CFTC's Division of Market Oversight issued a no-action letter allowing market participants to temporarily rely on the recently issued exemption from Dodd-Frank swaps rules for physically delivered commodity option contracts without complying with all of its specified provisions.
On August 15, 2012, the CFTC's Division of Market Oversight issued No-action letter 12-06 permitting certain counterparties that enter into physically settled options on physical commodities to temporarily rely on the exemption, referred to as the "trade option exemption" (TOE), included in the final Dodd-Frank rules on commodity options (final commodity options rules) without complying with certain conditions to the TOE (see Legal Update, Final Rules on Commodity Options under Dodd-Frank Issued by CFTC).
To rely on the no-action relief:
- The transaction must satisfy the conditions for qualifying as a "trade option" found in CFTC regulation 32.3, which include, among other things:
- the offeror of the option must be either an eligible contract participant (ECP), as defined in the Commodity Exchange Act (CEA). or a producer, processor, commercial user of, or a merchant handling, the commodity that is the subject of the commodity option transaction;
- the offeree to whom the option is offered must be a producer, processor, commercial user of, or a merchant handling, the commodity that is the subject of the commodity option transaction; and
- the commodity option must be intended to be physically settled so that execution of the transaction would result in the sale of an exempt or agricultural (non-financial) commodity for immediate or deferred shipment or delivery.
- The parties must adhere to Dodd-Frank speculative position limits for physical commodities and their equivalents (see Practice Note, The Dodd-Frank Act: Commodity Position Limits).
- The parties must abide by applicable prohibitions on fraud, manipulation and other abusive trade practices and related enforcement provisions (see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Non-security-based Swap Antifraud Rules).
The final commodity options rules state that commodity options are subject to Dodd-Frank swaps rules because they are statutorily defined as swaps. However, an interim final rule was included in the final commodity options rules that allows commodity options meeting certain conditions to be exempt from most swaps provisions of the Dodd-Frank Act, the Commodity Exchange Act (CEA) and CFTC regulations (referred to as the trade option exemption).
The parties to these exempt commodity options need not comply with the following requirements specified in the trade option exemption:
- Large-trader reporting and other Dodd-Frank swap data reporting and recordkeeping rules (see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Swap Data Reporting Requirements).
- Certain requirements for swap dealers and major swap participants (see Practice Note, Summary of the Dodd-Frank Act: Swaps and Derivatives: Requirements for Swap Dealers and Major Swap Participants (MSPs)).
The final commodity options rules noted that final rules defining the term "swap" published in the Federal Register on August 13, 2012 (final definitional rules) specify that if a commodity option or a transaction with optionality constitutes a forward contract, it is excluded from the scope of the swap definition and, as such, exempt from Dodd-Frank swaps regulations. A footnote to the final definitional rules noted that the CFTC would be issuing this no-action relief with respect to conditions of the trade option exception to provide the CFTC the opportunity to evaluate comments received on both embedded volumetric optionality and the trade option exemption.
The no-action relief is effective from August 15, 2012 through and including the earlier of either:
- December 31, 2012.
- The effective date of any final action, in the form of either a final rule, interpretation or order, taken by the CFTC as a result of comments received in response to volumetric optionality and the modified trade option exemption.
The no-action letter does not bind the CFTC and the Division of Market Oversight retains the authority to condition, modify, suspend, terminate or otherwise restrict the terms of the no-action relief provided.
For information on options generally, as well as forward contracts and more, see Practice Notes, Derivatives: Overview (US) and Equity Derivatives: Overview (US).
Update: On April 5, 2013, the CFTC issued No-action Letter 13-08 extending relief from reporting obligations in connection with the TOE grated under No-action Letter 12-06. No-action relief had already extended the TOE relief from Part 45 SDR reporting obligations to SDs and MSPs (see Legal Update, Making Sense of All the No-action Swaps Action: Further Changes to Swap Data Reporting Compliance Dates), and No-action Letter 13-08 extended that relief to non-SDs and non-MSPs, provided certain conditions are met.