CFTC General Counsel Clarifies Application of “Swap” Definition to Energy Transportation and Storage Contracts

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Explore:  CFTC Dodd-Frank Energy Swaps

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The CFTC Office of General Counsel (“OGC”) issued an interpretation today regarding application of the “swap” definition (and forward contract exclusion thereunder) to energy transportation and storage contracts, in response to numerous industry comments. Although the interpretation is not binding on the Commission and did not provide an explicit exception for transportation and storage contracts using a two-part fee structure, the interpretation should provide a significant measure of comfort to industry participants that, barring unusual provisions, such industry-standard contracts will not be subject to CFTC regulation under Dodd-Frank.

Background

The Commission had stated in its final swap definition rule that a transaction would not be subject to regulation as a commodity option if three elements are satisfied:

(1) the subject of the agreement, contract or transaction is usage of a specified facility or part thereof rather than the purchase or sale of the commodity that is to be created, transported, processed or stored using the specified facility;
(2) the agreement, contract or transaction grants the buyer the exclusive use of the specified facility or part thereof during its term, and provides for an unconditional obligation on the part of the seller to grant the buyer the exclusive use of the specified facility or part thereof; and
(3) the payment for the use of the specified facility or part thereof represents a payment for its use rather than the option to use it.

Numerous commenters expressed concern regarding the “however” paragraph that followed the above three-element test in the final rule:

However, in the alternative, if the right to use the specified facility is only obtained via the payment of a demand charge or reservation fee, and the exercise of the right (or use of the specified facility or part thereof) entails the further payment of actual storage fees, usage fees, rents, or other analogous service charges not included in the demand charge or reservation fee, such agreement, contract or transaction is a commodity option subject to the swap definition.

To many, this seemed to suggest that every facility usage contract that entails separate payments for fixed and variable costs, the standard fee structure for a wide variety of usage contracts in the industry, including FERC-regulated interstate transportation of natural gas, would be considered an option subject to regulation under Dodd-Frank.

The OGC Interpretation

The OGC’s interpretation represents a clear attempt to step back from such an expansive application of the rule. The intepretation states:

In OGC’s view, the ‘however paragraph’ was not intended to apply to agreements, contracts or transactions in which the buyer pays for a commodity in two parts, paying the seller’s fixed/known costs upfront and the seller’s variable costs associated with that commodity later once those costs are established or incurred.

The OGC went on to provide a new 5-part safe harbor test for such contracts:

In OGC’s view, if (1) a facility usage agreement, contract or transaction discussed herein includes a two-part fee structure, (2) the right to use the specified portion of the facility for the term of the agreement, contract or transaction is legally established upon entering into the agreement, contract or transaction, (3) the party who has legally established the right to use the specified portion of the facility for the term of the agreement, contract or transaction pays the Demand Charge/Reservation Fee in a commercially reasonable timeframe, (4) the use of the facility does not depend on the further exercise of an option and (5) the Usage Fee is in the nature of a reimbursement for the variable costs incurred by the operator of the facility in rendering the service, such a facility usage agreement, contract or transaction is not an option and is not intended to be covered by the “however paragraph.”

While clause (4) in the statement may be somewhat circular, clause (5) does not provide a bright line, and the CFTC continues to adhere to a “facts and circumstances” test for each contract, the OGC’s interpretation should provide some comfort to the industry that the CFTC will not view standard transportation and storage contracts with two-part fees as options/swaps.

Topics:  CFTC, Dodd-Frank, Energy, Swaps

Published In: Administrative Agency Updates, General Business Updates, Energy & Utilities Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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