External Meetings: Definitions Meeting with Electric Companies

The agenda of the meeting was to discuss the following questions:  1) Assuming some financially-settled instruments related to electricity are swaps, are swap dealers active in this market?  If so, what are the identifying characteristics of the swap dealers? 2) Assuming there are swap dealers in this market, how should a “de minimis” level of swap dealing be defined? 3) How are other applicable state or federal regulatory regimes relevant in identifying swap dealers?  The meeting discussed issues covered in comment letters submitted by the “Utility Group” (Comment No. 27861) and jointly by the Edison Electric Institute and the Electric Power Supply Association (Comment No. 27918).
The electric companies described the differences between swaps related to electricity and other types of swaps as arising from two elements – availability of reliable price indices in liquid markets through regional transmission organizations, and participation by a very large number of suppliers and consumers of electricity so that swap users do not have to rely on central entities in order to enter into swaps.  The swaps are primarily “plain vanilla” fixed/floating swaps that mitigate price volatility by matching to physical delivery or purchase requirements.  Speculative use of swaps is very limited, including swaps to check pricing and other price discovery.
In terms of which market participants could be swap dealers, the electric companies suggested that Enron Online’s operations in the late 1990’s would qualify as a swap dealer because Enron Online made a market in swaps, quoted bid and offer prices and profited from a spread between bid and offer.  The electric companies also suggested that electric companies that engaged in similar activities, especially in the time period from 2005 to 2008, have since curtailed that activity in part because of changes in the financial markets due to the 2008 financial crisis.  For example, loan covenants frequently bar utilities from using swaps to speculate and require board approval of swaps.  They also noted that in the present market, swap users require that swap dealers have very strong balance sheets, which electric companies generally do not have.
The meeting also discussed rule text defining “swap dealer” proposed in the Utility Group’s comment letter.  The electric companies said that each of them could demonstrate through records whether its swaps are entered into to hedge a commercial risk (or to take a speculative position).  Conversely, the electric companies said that they generally would not enter into a swap to accommodate demand from another party or to respond to another party’s interest, unless the swap could be shown to be part of their hedging (or speculative) programs.  Therefore, the electric companies believe that their proposal is a workable method of defining the activities that do, and do not, constitute swap dealing. 
Some companies do use swaps to speculate in the market.  They assert this is not swap dealing activity because they enter into swaps on one side of the market based on a view of market fundamentals until the market moves and the positions are released, in contrast to a dealer which enters into swaps on both sides of the market.
It was noted at the meeting that this discussion is limited to electricity swaps and may not be applicable to other types of swaps.  In general, the electric companies believe that trading activity related to electricity is more limited than trading in commodities such as oil or natural gas.  Because of that more limited activity, the electric companies could say definitively whether their activity falls within the definition of swap dealer they propose.
Regarding swaps which are entered into other than to hedge or speculate, the electric companies explained these could be used for price discovery, or for a limited extent of accommodating demand or responding to interest from others.  The electric companies believe that this activity could be below a reasonable de minimis threshold such as the one proposed in the comment letters noted above.  They are concerned that a de minimis threshold for the number of swaps or counterparties should be significantly higher because of the large number of counterparties and frequent use of swaps related to electricity.
The electric companies also said that they do not believe that responding to a request for quotes or proposals for swaps (RFQ or RFP) is in itself an indicator of swap dealing, if the response to the RFQ/RFP is within the electric company’s hedging or speculative program.  The electric companies also noted that the difficulty for them in registering as swap dealers arises from the business conduct, reporting and other regulatory requirements that would be very burdensome.