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Dodd-Frank Almost 6 Years Later: Where Are We Now? Energy-Related Derivatives Regulation | Latham & Watkins LLP - JDSupra
In the almost six years since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the US Commodity Futures Trading Commission (CFTC) has, in large part, finalized its rulemakings to implement the new comprehensive regulatory framework for swaps. The CFTC’s Dodd-Frank Act rulemakings do impose certain compliance obligations that affect commercial end-users and other unregistered entities — including companies in the energy sector — that transact in CFTC-regulated products to hedge the commercial risks associated with their businesses. Because of the potential impact of any such regulation on the energy industry, the CFTC has continued to meet with market participants from the energy sector and is currently refining existing regulations and interpretations in order to ensure that any such finalized rules align with the CFTC’s market regulation goals without hindering commercial business and development. To this end, the CFTC has stated that it expects to release final position limit rules in 2016. Regarding other relevant rules, the CFTC has further clarified embedded volumetric optionality for forward contracts and proposed to relieve end-users of certain reporting requirements for trade options.
Originally published in Bloomberg BNA's Securities Regulation & Law Report - February 29, 2016.
Reproduced with permission from Securities Regulation & Law Report, 48 SRLR 421, 2/29/16. Copyright  2016 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com DER I VAT I V E S Dodd-Frank Almost 6 Years Later: Where Are We Now? Energy-Related Derivatives Regulation Assessing the practical implications of recent and upcoming rulemakings on position limits, volumetric optionality, trade options and more BY YVETTE D. VALDEZ, BRETT M. ACKERMAN AND J. ASHLEY WEEKS I n the almost six years since the enactment of theDodd-Frank Wall Street Reform and Consumer Pro-tection Act (Dodd-Frank Act), the US Commodity Futures Trading Commission (CFTC) has, in large part, finalized its rulemakings to implement the new compre- hensive regulatory framework for swaps. The CFTC’s Dodd-Frank Act rulemakings do impose certain compli- ance obligations that affect commercial end-users and other unregistered entities — including companies in the energy sector — that transact in CFTC-regulated products to hedge the commercial risks associated with their businesses. Because of the potential impact of any such regulation on the energy industry, the CFTC has continued to meet with market participants from the energy sector and is currently refining existing regula- tions and interpretations in order to ensure that any such finalized rules align with the CFTC’s market regu- lation goals without hindering commercial business and development. To this end, the CFTC has stated that it expects to release final position limit rules in 2016. Re- garding other relevant rules, the CFTC has further clari- fied embedded volumetric optionality for forward con- tracts and proposed to relieve end-users of certain re- porting requirements for trade options. The following summarizes how far we have come and current topics in energy-related derivatives regulation since the passage of the Dodd-Frank Act and the prac- tical implications for energy producers, processors, manufacturers, merchandisers and other commercial end-users in the energy sector (collectively, energy firms). Proposed Position Limits and Aggregation Requirements. The CFTC’s proposed rules on position limits and ag- gregation are among the more controversial rulemak- ings under the Dodd-Frank Act and would establish specific limits on positions in 28 physical commodity fu- tures and option contracts, as well as on swaps that are economically equivalent to such contracts.1 1 The 28 physical commodity futures contracts (Core Refer- enced Futures Contracts) include: s Chicago Board of Trade: Corn (C); Oats (O); Soybeans (S); Soybean Meal (SM); Soybean Oil (SO); Wheat (W); COPYRIGHT  2016 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0037-0665 Securities Regulation & Law Report™ The CFTC initially proposed position limits in 2011, but faced litigation and extensive public comment which led the CFTC to re-propose its position limits rule in late 2013 (the Proposed Position Limits Rule).2 In ad- dition, the CFTC proposed a separate rule to address the circumstances under which market participants would be required to aggregate their positions with other entities under common ownership or control (the Proposed Aggregation Requirements)3 for purposes of the position limits, and published a further supplement to the Proposed Aggregation Requirements (the Aggre- gation Supplement) on September 29, 2015.4 For energy firms, the Proposed Position Limits Rule and the Proposed Aggregation Requirements may sig- nificantly impact their commercial businesses. The rules would require energy firms to monitor their posi- tions as well as those of their affiliates to assess whether the position limit levels have been exceeded, and to confirm whether an exemption is available and proper notices have been filed. Key Aspects of the Proposed Position Limit Rule. Contracts Subject to Position Limits The Proposed Position Limits Rule would apply to 28 physical commodity futures and option contracts (Core Referenced Futures Contracts), as well as to swaps that are economically equivalent to such contracts. The des- ignated Core Referenced Futures Contracts are con- tracts transacted on a specified futures exchange. For example, in the energy industry, the Core Referenced Futures Contracts relevant for energy firms are: s NYMEX Light Sweet Crude Oil s NYMEX NY Harbor ULSD s NYMEX RBOB Gasoline s NYMEX Henry Hub Natural Gas Contracts related to power and other energy com- modities would not be subject to the CFTC’s position limit rules, although the CFTC has indicated that it may expand the position limit requirements to those con- tracts in further rulemakings.5 (See endnote 1 for a full list of the Core Referenced Futures Contracts.) For purposes of the Proposed Position Limits Rule, a swap would be considered ‘‘economically equivalent’’ to a Core Referenced Futures Contract if it is either linked or priced at a fixed differential to the price of a particular Core Referenced Futures Contract. The Core Referenced Futures Contracts together with their eco- nomically equivalent swaps are referred to in the Pro- posed Position Limits Rule collectively as ‘‘Referenced Contracts.’’ Under the Proposed Position Limits Rule, however, the definition of Referenced Contract would not include a guarantee of a swap, a basis contract or a commodity index contract.6 The CFTC has also sought public comment on whether instruments that qualify as trade options (dis- cussed below) should be exempt from position limits.7 While trade options are exempt from many of the CFTC’s regulatory requirements applicable to ‘‘swaps,’’ trade options would be subject to position limits under the Proposed Position Limits Rule. Accordingly, absent a further exemption, market participants would be re- quired to count trade options toward the position limit levels. Position Limit Levels. The Proposed Position Limits Rule sets the maximum number of Referenced Contracts that a market partici- pant may hold or control, either net long or net short, unless an exemption applies. Separate position limits would apply for: (a) spot months (i.e., the trading pe- riod immediately preceding the delivery period for physically-delivered futures contracts as well as for any cash-settled contracts that are linked to such physically- delivered contracts); and (b) non-spot months (i.e., lim- its applied to positions in all contract months combined or in any single contract month). The levels of the ini- tial spot month limits are set forth in an appendix to the current proposal and would be adjusted after two years. In contrast to spot month limits, which are set based on estimated deliverable supply, non-spot month limits would be based on total open interest for all Referenced Contracts in a commodity. Last year, at a CFTC Energy and Environmental Mar- kets Advisory Committee (EEMAC) meeting, the CFTC and market participants discussed possible alternatives to the CFTC’s proposed position limit levels.8 The first alternative would call on the CFTC to use a system of position accountability, as opposed to actual limits. With this alternative, the CFTC (or the relevant ex- change) would obtain information from market partici- pants when the participants reach a certain threshold, Rough Rice (RR). s Chicago Mercantile Exchange: Class III Milk (DA); Feeder Cattle (FC); Lean Hog (LH); Live Cattle (LC). s Kansas City Board of Trade: Hard Winter Wheat (KW). s ICE Futures U.S.: Cotton No. 2 (CT); Cocoa (CC); Coffee C (KC); FCOJ–A (OJ); U.S. Sugar No. 11 (SB); U.S. Sugar No. 16 (SF). s Minneapolis Grain Exchange: Hard Red Spring Wheat (MWE). s New York Mercantile Exchange: Light Sweet Crude Oil (CL); NY Harbor ULSD (HO); RBOB Gasoline (RB); Henry Hub Natural Gas (NG); Palladium (PA); Platinum (PL). s Commodity Exchange, Inc.: Gold (GC); Silver (SI); Cop- per (HG). 2 Position Limits for Derivatives, 78 Fed. Reg. 75680 (pro- posed Dec. 12, 2013) (proposing amendment of 17 C.F.R. pts. 1, 15, 17, 19, 32, 37, 38, 140, 150), available at http:// www.gpo.gov/fdsys/pkg/FR-2013-12-12/pdf/2013-27200.pdf (Proposed Position Limits Rule). 3 Aggregation of Positions, 78 Fed. Reg. 68946 (proposed Nov. 15, 2013) (proposing amendment of 17 C.F.R. pt. 150), available at http://www.gpo.gov/fdsys/pkg/FR-2013-11-15/pdf/ 2013-27339.pdf (Aggregation Proposal). 4 Aggregation of Positions, 80 Fed. Reg. 58365 (proposed Sept. 29, 2015), available at http://www.gpo.gov/fdsys/pkg/FR- 2015-09-29/pdf/2015-24596.pdf (Aggregation Supplement). For further discussion, please refer to our Client Alert on the Pro- posed Position Limits Rule and the Aggregation Proposal. CFTC Re-Proposes Position Limits Rule and Proposes Revised Aggregation Requirements, Client Alert No. 1624 (Dec. 18, 2013), available at http://www.lw.com/thoughtLeadership/LW- CFTC-reproposes-rule-making-aggregation. 5 See Proposed Position Limits Rule, 78 Fed. Reg. at 75726. 6 See Proposed Position Limits Rule, 78 Fed. Reg. at 75701. 7 See Proposed Position Limits Rule, 78 Fed. Reg. at 75711. 8 See EEMAC Meeting Transcript (July 29, 2015), available at http://www.cftc.gov/idc/groups/public/@aboutcftc/ documents/file/emactranscript072915.pdf. For more informa- tion on the EEMAC meeting, visit the CFTC website: http:// www.cftc.gov/PressRoom/Events/opaevent_eemac072915. 2 2-29-16 COPYRIGHT  2016 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 and based on such information the CFTC (or the rel- evant exchange) could order the participant to cap, re- duce or even liquidate a position. This would be similar to the accountability regime futures exchanges cur- rently use. The second alternative would necessitate a review and update of the CFTC’s deliverable supply es- timates, which market participants suggest may be out- dated and based on unreliable data. However, whether the CFTC intends to address either concern in its final rulemaking remains unclear. Exemptions from the Position Limits. The proposed position limits are subject to numerous exemptions, most notably for contracts that qualify as ‘‘bona fide hedging transactions.’’ Any position must meet two general requirements to qualify as a bona fide hedging position: (a) the purpose of the position must be to offset price risks incidental to commercial cash operations; and (b) the position must be established and liquidated in an orderly manner in accordance with sound commercial practices.9 Addi- tional requirements would also apply to certain transac- tions — for instance: s Physical Commodities: For physical commodity positions, the Proposed Position Limits Rule would require the position to: – Represent a substitute for transactions or positions taken, or to be taken at a later time, in a physical marketing channel – Be economically appropriate to the reduction of risks – Arise from the potential change in value of: (a) as- sets that the person owns, produces, manufactures, processes or merchandises, or for which the person anticipates any of the foregoing; (b) liabilities that the person owes or anticipates incurring; or (c) ser- vices provided or purchased, or anticipated to be provided or purchased, by such person, provided the position is also ‘‘enumerated’’ as described be- low10 s Enumerated Hedges: In addition to the above re- quirements, positions in physical commodities must qualify as ‘‘enumerated hedges’’ in order to qualify as bona fide hedging positions. Enumer- ated hedges include: hedges of inventory and cash commodity purchase contracts; hedges of cash commodity sales contracts; hedges of unfilled an- ticipated requirements and hedges by agents. Hedges of unsold anticipated production, antici- pated royalty hedges, service hedges and cross- commodity hedges are also enumerated hedges.11 s Cross-Commodity Hedges: The Proposed Position Limits Rule would require that the fluctuation in the value of a position be ‘‘substantially related’’ to the fluctuations in the value of the actual or antici- pated cash position.12 In particular, there must be a reason that the prices of the two commodities move in relation to each other, rather than a corre- lation that does not have a clear cause. The Pro- posed Position Limits Rule provides for a non- exclusive safe harbor for cross-commodity hedges that are deemed to meet the substantially related test based on certain qualitative and quantitative factors. If a cross-commodity hedge does not sat- isfy the safe harbor, the CFTC would presume that the positions are not bona fide cross-commodity hedging positions. A market participant may, how- ever, rebut this presumption by presenting facts and circumstances demonstrating a reasonable re- lationship between the spot price series for the commodity to be hedged and either (a) the spot price series for the commodity underlying the commodity derivative contract or (b) the price se- ries for the commodity derivative contract to be used for hedging.13 With respect to non-enumerated hedges, the CFTC Chairman has indicated that the CFTC may consider the possibility of exchanges reviewing and granting ex- emptions (rather than the CFTC). Again, however, whether or how the CFTC will address this topic in its final rulemaking remains unclear. Recordkeeping and Reporting. Under the Proposed Position Limits Rule, market participants claiming an exemption would be required to maintain complete books and records in connection with all of their related cash, forward, futures, option and swap positions.14 The CFTC would be entitled to make ‘‘special calls’’ for such records, requiring market participants to provide the CFTC with such information upon request. In addition, market participants seeking exemptions from the Proposed Position Limits Rule could be required to submit a report to the CFTC (in some instances on a monthly basis). Proposed Aggregation Requirements. Under the Proposed Aggregation Requirements, a market participant is generally required to aggregate all Referenced Contract positions for which that partici- pant controls the trading decisions with all such posi- tions for which that participant has a 10% or greater ownership interest in an account or position. Positions of two or more persons acting pursuant to an express or implied agreement or understanding would also be re- quired to be aggregated.15 The CFTC has suggested that market participants manage aggregation issues by allocating the position limits among multiple entities and requiring each to trade within their share of the limit. In many cases, however, this may not be a work- able solution. Accordingly, the Proposed Position Lim- its Rule would require companies to either (a) ensure that all or most Referenced Contracts are entered into for bona fide hedging purposes (and that the proper no- tices are filed) or (b) seek an exemption for position limits aggregation, in particular, under the ‘‘owned en- tity exemption,’’ which, as a practical matter, imposes certain conditions and may require certain filings with the CFTC. Under the owned-entity exemption, which the recent Aggregation Supplement revised, a person would be permitted to disaggregate the positions of an entity in 9 See Proposed Position Limits Rule, 78 Fed. Reg. at 75706. 10 See Proposed Position Limits Rule, 78 Fed. Reg. at 75708. 11 See Proposed Position Limits Rule, 78 Fed. Reg. at 75712. 12 See Proposed Position Limits Rule, 78 Fed. Reg. at 75716. 13 See Proposed Position Limits Rule, 78 Fed. Reg. at 75717. 14 See Proposed Position Limits Rule, 78 Fed. Reg. at 75741. 15 See Aggregation Proposal, 78 Fed. Reg. at 68951. 3 SECURITIES REGULATION & LAW REPORT ISSN 0037-0665 BNA 2-29-16 which the person has greater than a 10% ownership or equity interest, provided that the persons, among other requirements, do not have knowledge of the trading de- cisions of one another, trade under independent trading systems, maintain and enforce written procedures to preclude each other from having knowledge of the oth- ers’ trades, do not share employees that control trading decisions and do not have systems that permit sharing of risk management strategies.16 To rely on the exemp- tion, the relevant owner would be required to file a no- tice with the CFTC and provide certain information about itself and the owned entity. Embedded Volumetric Optionality. Last year, the CFTC further clarified certain aspects of the embedded volumetric optionality interpretation under the forward contract exclusion for nonfinancial commodities. This interpretation provides relief from CFTC regulation for nonfinancial forward contracts that are intended to be physically-delivered, notwith- standing the presence of certain embedded optionality in the contract terms. Physically-delivered forward contracts with optional- ity have characteristics of both a commodity option (which is subject to CFTC regulation) and a physically- delivered nonfinancial forward contract (which is ex- empt from CFTC regulation). In 2012, the CFTC set out criteria that nonfinancial forward contracts with em- bedded volumetric optionality must satisfy in order to be exempt from CFTC regulation (the volumetric op- tionality test).17 For example, a forward contract with embedded volumetric optionality (e.g., variable supply rights based on capacity or production under natural gas supply contracts) may avoid being fully regulated as a commodity option (i.e., swaps) if the contract satisfies certain conditions which the CFTC enumerated. In practice, however, the application of these criteria cre- ated uncertainty for numerous market participants, par- ticularly in the energy markets, and end-users struggled to decipher the CFTC rules to determine whether and under what circumstances a forward contract with em- bedded volumetric optionality would fall within the for- ward contract exclusion or should be treated instead as a swap or a trade option — each of which implicates dif- ferent regulatory requirements. Among other concerns, the original seventh prong of the volumetric optionality test — i.e., that the exercise or non-exercise of the embedded volumetric optionality be based primarily on physical factors or regulatory re- quirements that are outside the control of the parties — was inconsistent with market practice, as the actual ex- ercise of volumetric optionality in a contract for physi- cal delivery is often based on a combination of factors that may or may not be within the parties’ control. Ac- cordingly, in May 2015, the CFTC finalized a revised in- terpretation further clarifying the requirements for a forward contract with embedded volumetric optionality to be excluded from the definition of a ‘‘swap’’ (the Em- bedded Volumetric Optionality Interpretation).18 Under the Embedded Volumetric Optionality Inter- pretation, the CFTC revised its previous interpretation to clarify that a forward contract involving the actual delivery of a commodity that contains embedded volu- metric optionality may be treated as an excluded for- ward contract under the Commodity Exchange Act, if the following, revised seven-part test is satisfied: s The embedded optionality does not undermine the overall nature of such contract as a forward con- tract. s The predominant feature of such contract is actual delivery. s The embedded optionality cannot be severed and marketed separately from such overall contract in which it is embedded. s The seller of a nonfinancial commodity underlying such contract with embedded volumetric optional- ity intends, at the time it enters into such contract, to deliver the underlying nonfinancial commodity, if the embedded volumetric optionality is exer- cised. s The buyer of a nonfinancial commodity underly- ing such contract with embedded volumetric op- tionality intends, at the time it enters into such contract, to take delivery of the underlying nonfi- nancial commodity if the embedded volumetric optionality is exercised. s Both parties to such contract are commercial par- ties. s The embedded volumetric optionality is primarily intended, at the time that the parties enter into such contract, to address physical factors or regu- latory requirements that reasonably influence de- mand for, or supply of, the nonfinancial commod- ity (such requirement referred to herein as the sev- enth element). The CFTC further clarified in the Embedded Volu- metric Optionality Interpretation that bandwidth con- tracts (i.e., swing contracts) providing for delivery of a nonfinancial commodity ranging within a certain mini- mum and maximum quantity may fall within the for- ward contract exclusion, so long as all seven elements are satisfied.19 Similarly, a natural gas supply contract where one party may obtain additional supply by exer- cising the embedded volumetric optionality under the contract or turning to another supply source — whether storage, the spot market, or another forward contract — may fall within the forward contract exclusion where the intended purpose for including the embedded volu- metric optionality at the contract’s initiation was to ad- dress physical factors or regulatory requirements influ- 16 See Aggregation Supplement, 80 Fed. Reg. at 58371. 17 Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48208 (Aug. 13, 2012), available at http://www.gpo.gov/fdsys/ pkg/FR-2012-08-13/pdf/2012-18003.pdf (Final Products Rule). For further discussion, please refer to our Client Alert regard- ing the Final Products Rule. CFTC and SEC Issue Final Rule Defining Certain Swap Products and Triggering Several Dodd- Frank Obligations Relating to Swaps, Client Alert No. 1396 (Sept. 19, 2012), available at http://www.lw.com/ thoughtLeadership/defining-certain-swap-products. 18 Forward Contracts with Embedded Volumetric Optional- ity, 80 Fed. Reg. 28239 (May 18, 2015), available at http:// www.gpo.gov/fdsys/pkg/FR-2015-05-18/pdf/2015-11946.pdf (Embedded Volumetric Optionality Interpretation); see also Fi- nal Products Rule. 19 See Embedded Volumetric Optionality Interpretation, 80 Fed. Reg. at 28241. 4 2-29-16 COPYRIGHT  2016 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 encing the demand for or supply of the natural gas. In addition, the CFTC provided the following points of clarification in the Embedded Volumetric Optionality Interpretation with regard to the seventh element: s Reliance on Counterparty Representations: Com- mercial parties are not required to conduct due diligence in order to rely on counterparty repre- sentations regarding the intended purpose for em- bedding volumetric optionality in the contract, provided the parties do not otherwise have infor- mation that would cause a reasonable person to question the accuracy of the representation. s Physical Factors: The reference in the seventh el- ement to ‘‘physical factors’’ is to be construed broadly to include any fact or circumstance that could reasonably influence the supply of and de- mand for a nonfinancial commodity (e.g., environ- mental factors, operational considerations, changes in demographics or geopolitics); the CFTC clarified that having some influence over such a physical factor would not be inconsistent with the seventh element. s Price as a Consideration: So long as the embed- ded volumetric optionality is primarily intended as a means of securing a supply source in the face of uncertainty regarding future supply and demand, taking price into consideration is not itself a bar to a contract qualifying for the forward exclusion. s Characterization of Existing Contracts: When characterizing existing contracts (e.g., as an ex- cluded forward contract with embedded volumet- ric optionality or as a trade option), commercial parties may either (a) rely on their good faith char- acterization of such existing contract or (b) re- characterize the contract in accordance with the Embedded Volumetric Optionality Interpreta- tion.20 Proposed Treatment of Trade Options. On April 30, 2015, the CFTC proposed a rule that would revise the existing trade option rules to reduce the reporting and recordkeeping requirements for enti- ties that are not swap dealers or major swap partici- pants by, inter alia, eliminating the Form TO annual no- tice reporting requirement for otherwise unreported trade options (Proposed Trade Options Rule).21 The modified reporting and recordkeeping requirements which the CFTC proposed for commercial end-users en- tering into trade options are summarized below: s Proposed Modified Reporting Requirements: – Eliminate Part 45 reporting requirements for commercial-end users – Eliminate the Form TO notice filing requirement – Add $1 Billion Notice (defined below) requirement to CFTC regulation 32.3(b)22 s Proposed Modified Recordkeeping Requirements: Trade option counterparties that are commercial end-users would be subject to the less stringent re- cordkeeping requirements of CFTC regulation 45.2(b) (rather than the recordkeeping require- ments in CFTC regulation 45.2(a), which are appli- cable to trade option counterparties that are regis- tered swap dealers or major swap participants), plus the following additional Part 45 recordkeep- ing requirements: – Each swap must be identified in all recordkeeping by the use of a unique swap identifier (USI). – Each counterparty to any swap must be identified in all recordkeeping by means of a single legal en- tity identifier (LEI). – Each swap must be identified in all recordkeeping by means of a unique product identifier (UPI) and product classification system.23 Currently, trade options must be reported pursuant to the CFTC’s regulatory reporting rules for swaps if: one of the counterparties is registered as a swap dealer or major swap participant; or both parties to the trade op- tion are not swap dealers or major swap participants but at least one of the parties has been required to re- port non-trade option swaps during the previous 12 months. If neither party has been required to report non-trade option swaps within with previous 12 months, then each counterparty must: (a) file a form TO reporting each trade option entered into during the pre- vious 12-month period; and (b) notify the CFTC no later than 30 days after entering into trade options having an aggregate notional value in excess of US$1 billion dur- ing any calendar year ($1 Billion Notice). In a separate no-action letter (CFTC No-Action Letter 13-08), the CFTC provided relief to those end-users that were re- quired to report non-trade options from the reporting requirements for trade options if they also satisfied the conditions in (a) and (b) above.24 Note that, if the Proposed Trade Options Rule is ad- opted as proposed, the relief CFTC staff provided in CFTC No-Action Letter 13-08 would be terminated.25 Trade options are commodity options that, if exer- cised, would result in the sale of a non-financial com- modity for immediate (i.e., spot) or deferred (i.e., for- ward) shipment or delivery. An instrument must meet the following conditions to qualify as a trade option: s The offeror of such commodity option is either (a) an eligible contract participant (ECP)26 or (b) a producer, processor or commercial user of, or merchant handling the commodity that is the sub- 20 See Embedded Volumetric Optionality Interpretation, 80 Fed. Reg. at 28242. For further discussion, please refer to our Client Alert on the Embedded Volumetric Optionality Interpre- tation. UPDATED: CFTC Clarifies Regulation of Forward Con- tracts with Embedded Volumetric Optionality, Client Alert No. 1788 (June 22, 2015), available at http://www.lw.com/ thoughtLeadership/lw-update-cftc-regulation-forward- contacts-embedded-volumetric-optionality. 21 Trade Options, 80 Fed. Reg. 26200 (proposed May 7, 2015) (proposing amendment of 17 C.F.R. pt. 32), available at http://www.gpo.gov/fdsys/pkg/FR-2015-05-07/pdf/2015- 11020.pdf (Proposed Trade Options Rule). 22 Proposed Trade Options Rule, 80 Fed. Reg. at 26202- 26204. 23 Proposed Trade Options Rule, 80 Fed. Reg. at 26204. 24 See CFTC No-Action Letter 13-08 (Apr. 5, 2013), avail- able at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/ documents/letter/13-08.pdf. 25 Proposed Trade Options Rule, 80 Fed. Reg. at 26202, n. 23. 26 For a definition of ‘‘eligible contract participant,’’ see 7 U.S.C. § 1a(18); 17 C.F.R. § 1.3(m). 5 SECURITIES REGULATION & LAW REPORT ISSN 0037-0665 BNA 2-29-16 ject of the commodity option, or the products or by-products thereof (referred to as a commercial party), and is offering or entering into such com- modity option for purposes related to its business as such. s The offeree of such commodity option: (a) is a pro- ducer, processor or commercial user of, or a mer- chant handling the commodity that is the subject of the commodity option, or the products or by- products thereof; and (b) is offered or is entering into the commodity option solely for purposes re- lated to its business as such. s Such commodity option is intended to be physi- cally settled so that, if exercised, the option would result in the sale of an exempt commodity (e.g., energy commodities)27 for immediate or deferred shipment or delivery28 Like physically-delivered nonfinancial forward con- tracts, trade options are exempt from most of the CFTC’s regulatory requirements, but remain subject to reporting and recordkeeping requirements and certain other requirements, including, as noted above, position limits. Margin Requirements for Uncleared Swaps. At the end of October 2015, federal banking regula- tors voted to adopt rules implementing margin require- ments for uncleared swaps (the PR Margin Rules).29 The PR Margin Rules apply to (among other entities) prudentially-regulated entities, such as certain banks, depositary institutions and insurance companies that are registered swap dealers, security-based swap deal- ers, major swap participants or major security-based swap participants. The CFTC has also adopted margin rules for uncleared swaps that apply to non- prudentially-regulated entities that are CFTC-registered swap dealers (e.g., large energy firms with a swap deal- ing arm).30 The Dodd-Frank Act mandates the margining of un- cleared swaps and requires federal regulators to imple- ment rules that cause swap dealers (such as banks) and certain other entities to collect and post initial and variation margin with certain counterparties. Legisla- tion adopted earlier this year amended provisions of the Dodd-Frank Act to exempt certain counterparties from the margin requirements for uncleared swaps.31 Spe- cifically, the law prohibits applying any margin require- ments promulgated under the Dodd-Frank Act to un- cleared swaps with commercial end-users, including treasury affiliates acting as agents, so long as such counterparty is using the uncleared swaps to hedge commercial risk. Consistent with these requirements, the Prudential Regulators and the CFTC published, concurrently with the PR Margin Rules and the CFTC Margin Rules, in- terim final rules (the Interim Final Rules) exempting from the PR Margin Rules and the CFTC Margin Rules certain uncleared swaps and uncleared security-based swaps entered into with exempted end-users. The In- terim Final Rules are scheduled to go into effect on April 1, 2016. We expect the Interim Final Rules to be finalized in substantially similar form. As a practical matter, this means that most energy firms will not be required—by regulation—to post margin in connection with their uncleared swaps. Nevertheless, energy firms should review the margin rules, once finalized, to con- firm that they (and their affiliates) are, in fact, exempt from the margin requirements. * * * * * Yvette D. Valdez is a counsel in the New York office of Latham & Watkins and a member of the Financial Institutions Group and Derivatives Practice. As head of the firm’s US derivatives regulatory efforts, her practice focuses on legal, regulatory and compliance matters under the Dodd-Frank Act and other CFTC, SEC and prudential regulation. Ms. Valdez represents clients in structuring finance-linked derivatives and other hedg- ing strategies in the energy, infrastructure and asset fi- nance industry, and she represents financial institu- tions in structuring investment derivatives. She also ad- vises on cryptocurrencies. Brett M. Ackerman is an associate in the Washing- ton, D.C. office of Latham & Watkins and a member of the Financial Institutions Group and Derivatives Prac- tice. Mr. Ackerman’s practice focuses on regulatory, compliance and transactional issues relating to com- modities, securities and derivatives products. J. Ashley Weeks is an associate in the New York of- fice of Latham & Watkins and a member of the Finan- cial Institutions Group and Derivatives Practice. Ms. Weeks’s practice focuses on regulatory, compliance and transactional issues relating to commodities, secu- rities and derivatives products. 27 For a definition of ‘‘exempt commodity,’’ see 7 U.S.C. § 1a(20). 28 See 17 C.F.R. § 32.3(a). 29 Margin and Capital Requirements for Covered Swap En- tities (Nov. 30, 2015) (to be codified at 12 C.F.R. pts. 45, 237, 349, 624, 1221), available at http://www.gpo.gov/fdsys/pkg/FR- 2015-11-30/pdf/2015-28671.pdf (PR Margin Rules). For further discussion, please refer to our Client Alert on the finalized PR Margin Rules. Prudential Regulators Are First to Finalize Un- cleared Swap Margin Rules, Client Alert No. 1896 (Nov. 20, 2015), available at https://www.lw.com/thoughtLeadership/ LW-prudential-regulators-finalize-uncleared-swap-margin- rules. 30 SeeMargin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed. Reg. 636 (Jan. 6, 2016) (to be codified at 17 C.F.R. pts. 23, 140), available at https://www.gpo.gov/fdsys/pkg/FR-2016-01-06/pdf/2015- 32320.pdf (CFTC Margin Rules). For further discussion, please refer to our Client Alert on the finalized CFTC Margin Rules. CFTC Uncleared Swap Margin Rules to Take Effect in Septem- ber, Client Alert No. 1928 (Feb. 19, 2016), available at https:// www.lw.com/thoughtLeadership/lw-cftc-uncleared-swap- margin-september. 31 See Terrorism Risk Insurance Program Reauthorization Act of 2015, Pub. L. No. 114-1, § 302 (2015). 6 2-29-16 COPYRIGHT  2016 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665