A few may have wanted regulators to delay it forever and some questions were left unanswered, but it's hard to argue that the highly anticipated swap definition the US Commodity Futures Trading Commission approved this week was anything but a major victory for the energy industry.
The industry won a regulatory exemption it had fought hard for; environmental commodities will remain outside the new regulatory regime entirely; and the CFTC's most vocal supporter of heavy regulation of energy markets voted against a final rule for the first time ever.
"I don't see loopholes that people can leap through, but there's now a situation where you can say 'OK, I have some requirements, I even have some deadlines and I can move forward,'" said Bill Hederman, the director of regulatory compliance for the energy and resources practice at Deloitte & Touche, in an interview Wednesday. "I think it's time for people to move forward."
In an effort to move forward, it's probably a good idea to understand what the CFTC did Tuesday when it passed its final swap definition in a 4-1 vote, nearly two years after the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, and why the energy industry was so involved in the process in the first place.
On Tuesday, in a 4-1 vote, the CFTC approved its definition of swap, the financial products that make up part of the roughly $650 million global market the agency was given powers to regulate in the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The final rules, which were developed jointly with the Securities and Exchange Commission, include interpretations that will keep a variety of insurance products, consumer transactions and loan participation agreements from being defined as swaps and, in turn, subject to new CFTC regulations.
Most important for the energy industry, a number of energy market transactions, including environmental commodities, peaking supply contracts, tolling agreements and many natural gas supply contracts, will not be defined as swaps. That leaves a large swath of the energy market from facing new reporting, recordkeeping and clearing rules, at least for now.
What took them so long?
It's a good question and one that lobbyists and lawmakers have made into a running narrative as the agency's Dodd-Frank rulemaking process has languished over the past year. How can the CFTC make new swaps rules if they haven't even defined swaps yet?
CFTC officials have been quick to point out that it's all about resources and priorities. The agency couldn't afford to wait until the complex and voluminous swap definition was finalized before moving forward. If it had waited to start drafting the dozens of Dodd-Frank rules after the definition was final, the rules may not have been done before President Obama leaves the White House, even if he wins a second term this fall.
What were the big wins for the energy industry?
Perhaps the biggest victory is a somewhat controversial interpretation of the agency's long-standing forward exclusion, which Tyson Slocum, director of Public Citizen's energy program, called a "big loophole." "This rule falls short with energy markets," Slocum said Tuesday.
The CFTC has jurisdiction over swaps and options, but not forwards. There was a great deal of worry that under the new rules, the CFTC would be classifying forwards with options as swaps. They won't be.
The interpretation essentially keeps transactions in energy markets with volumetric optionality out of the swap definition. Volumetric optionality essentially means that parties to a given agreement have the option to change the volume of natural gas, electricity or other energy commodities during the course of the agreement.
These include peaking supply contracts, tolling agreements and full-requirements contracts. But it could also cover common natural gas supply deals, for example, where the amount of gas purchased per month may vary, according to Andrea Kramer, the co-chair of the energy services group at McDermott Will & Emery.
Numerous industry groups, including the American Petroleum Institute and the American Gas Association, lobbied the CFTC to keep these forwards from being defined as swaps.
Why did Commissioner Chilton vote against the rule?
In the somewhat insulated and, at times, obscure world of the CFTC, Chilton's vote against the final rule was downright shocking. Chilton, one of the most vocal supporters of derivatives reform in the agency's history, had yet to vote against CFTC final rule, so this was certainly a first.
Chilton argued that the forward interpretation within the rule could become the agency's next "Enron loophole," which exempted most over-the-counter derivatives and electronic energy trading from regulation.
In an eight-page formal dissent of the rule which Chilton provided to Platts Wednesday, Chilton wrote that the CFTC was ceding jurisdiction it had been granted by Congress nearly four decades ago because of industry pressure and increasing the probability of abuse in power, natural gas and other energy markets.
"As I can predict with absolute certainty, bad actors (a la Amaranth) will be drawn to dark markets in search of spoils," Chilton wrote. "Less ill-intentioned or 'grey' actors may follow them in search of lower compliance costs. The Commission should not cede swaths of jurisdiction because such markets have not hitherto given rise to concerns." (Amaranth was a hedge fund whose Canadian-based trader Brian Hunter lost billions of dollars in the natural gas market.)
Did anyone quote Washington Nationals 19-year-old phenom outfielder Bryce Harper during Tuesday's meeting?
"Do we need Dodd-Frank?" Chilton asked at the start of Tuesday's meeting. "That's a clown question, bro."
What part of this will no one remember six months from now?
The issue was resolved so quietly and with so little public debate that few will likely remember there was even a possibility that environmental commodities might have been defined as swaps.
Under the definition, carbon offsets, emissions allowances and renewable energy credits, will fall under the agency's forward exclusion and will not be subject to CFTC regulations.
Numerous groups, including the Coalition for Emission Reduction Policy, the Environmental Markets Association and the American Wind Energy Association, had lobbied the CFTC to keep these environmental commodities from being defined as swaps.
Their fight may have been relatively one-sided, however, since no CFTC official publicly said they were doing more than studying the issue.
In the end, whatever support there may have been for subjecting offsets and RECs to swaps rules, never surfaced and everyone quickly moved on.
What questions remain?
The CFTC punted on the long-standing question over whether transactions in regional transmission organizations and independent system operators will be subject to CFTC oversight for the first time.
Lawyers have argued that transactions in RTOs and ISOs, particularly financial transmission rights, could be defined as swaps, an outcome Federal Energy Regulatory Commission officials have pushed against.
Rather than defining these deals as swaps or exempting them from the definition entirely, the CFTC said it will deal with this issue under a separate public interest waiver process.
CFTC Chairman Gary Gensler said Tuesday that he expects that agency staff will provide recommendations on this issue "within a week." He said a separate application for exemptions for transactions between rural electric cooperatives and municipal public power providers is expected later, but said he did not know when.
What comes next?
"With completing this definition, the first domino in this process has been tipped over," said Hederman.
A number of rules the CFTC already has finalized, such as new position limits, registration, real-time reporting, business conduct and commodity options rules, will go into effect in a matter of weeks, now that the definition is finalized.
"The new swap regulatory regime is on the verge of becoming a reality," said CFTC Commissioner Mark Wetjen.
This article was wrtitten by Brian Scheid and originally appeared on Platts' The Barrel.