2014-22966
Federal Register, Volume 79 Issue 187 (Friday, September 26, 2014)
[Federal Register Volume 79, Number 187 (Friday, September 26, 2014)]
[Rules and Regulations]
[Pages 57767-57782]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-22966]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AE19
Exclusion of Utility Operations-Related Swaps With Utility
Special Entities From De Minimis Threshold for Swaps With Special
Entities
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is amending its regulations (Amendments) in order to permit a person to
exclude utility operations-related swaps entered into with utility
special entities in calculating the aggregate gross notional amount of
the person's swap positions, solely for purposes of the de minimis
exception applicable to swaps with special entities.
DATES: Effective October 27, 2014.
FOR FURTHER INFORMATION CONTACT: Gary Barnett, Director, (202) 418-
6700, [email protected]; Erik Remmler, Deputy Director, (202) 418-7630,
[email protected]; Christopher W. Cummings, Special Counsel, (202) 418-
5445, [email protected]; or Israel Goodman, Special Counsel, (202)
418-6715, [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, 1155 21st Street NW.,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. De Minimis Exception From Swap Dealer Definition
Section 1a(49) \1\ of the Commodity Exchange Act (CEA or Act)
defines the term ``swap dealer.'' CEA Section 1a(49)(D) requires the
Commission to exempt from swap dealer designation an entity that
engages in a de minimis quantity of swap dealing, and to promulgate
regulations to establish factors for making a determination to so
exempt such an entity. Pursuant to this mandate, on April 27, 2012, the
Commission adopted Regulation 1.3(ggg), which further defines the term
``swap dealer.'' \2\ Regulation 1.3(ggg) became effective on July 23,
2012, and
[[Page 57768]]
registration of swap dealers began in December, 2012.\3\
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\1\ 7 U.S.C. 1a(49) (2012). The CEA is found at 7 U.S.C. 1 et
seq. (2012) and can be accessed through the Commission's Web site,
www.cftc.gov.
\2\ See 77 FR 30596 (Swap Dealer Definition Adopting Release).
\3\ The further definition of the term ``swap'' is found in
Regulation 1.3(xxx), which became effective October 12, 2012. See 77
FR 48208. See also Regulation 3.10(a)(1)(v)(C), which establishes
that each person who comes within the swap dealer definition from
and after the effective date of that definition is subject to
registration as a swap dealer with the Commission.
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Specifically, the Commission adopted in Regulation 1.3(ggg)(4) an
exception from the swap dealer definition for a person that has entered
into swap positions connected with its swap dealing activities that, in
the aggregate, do not exceed, during the preceding twelve-month period,
either of two aggregate gross notional amount thresholds: (i) $3
billion, subject to a phase in level of $8 billion \4\ (General De
Minimis Threshold), and (ii) $25 million with regard to swaps in which
the counterparty is a ``special entity'' (Special Entity De Minimis
Threshold). CEA Section 4s(h)(2)(C) and Regulation 23.401(c) define the
term ``special entity'' to include: a Federal agency; a State, State
agency, city, county, municipality, or other political subdivision of a
State; any employee benefit plan as defined under the Employee
Retirement Income Security Act of 1974 (ERISA); any government plan as
defined under ERISA; and any endowment. Regulation 23.401(c) adds to
the special entity definition ``any instrumentality, department, or a
corporation of or established by a State or subdivision of a State.''
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\4\ The Commission set the General De Minimis Threshold at an
initial phase-in level of $8 billion as of July 23, 2012, the
effective date of the Swap Dealer Definition Adopting Release. Upon
termination of the phase-in period this amount will decrease to $3
billion (or such alternative amount as the Commission may adopt by
rulemaking) in accordance with the phase-in procedure outlined in
Regulation 1.3(ggg)(4)(ii).
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B. Petition for Rulemaking
On July 12, 2012, the Commission received a petition for rulemaking
that sought an amendment of Regulation 1.3(ggg)(4) (Petition).\5\ The
Petition requested that the Commission amend the regulation to exclude
from consideration, in determining whether a person has exceeded the
Special Entity De Minimis Threshold, swaps to which the Petitioners and
certain other special entities (collectively defined in the Petition as
``utility special entities'') \6\ are counterparties and that relate to
the Petitioners' and other utility special entities' utility operations
(defined in the Petition as ``utility operations-related swaps'').\7\
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\5\ Petition for Rulemaking to Amend CFTC Regulation
1.3(ggg)(4), dated July 12, 2012. The Petition was filed by the
American Public Power Association, the Large Public Power Council,
the American Public Gas Association, the Transmission Access Policy
Study Group and the Bonneville Power Administration (Petitioners).
The Petition and the comment letters that were submitted in support
of it are available at http://sirt.cftc.gov/sirt/sirt.aspx?Topic=PendingFilingsandActionsAD&Key=23845.
\6\ The Petition defined the term ``utility special entity'' to
mean a government special entity that ``owns or operates electric or
natural gas facilities or electric or natural gas operations (or
anticipated facilities or operations), supplies natural gas and/or
electric energy to other utility special entities, has public
service obligations (or anticipated public service obligations)
under Federal, State or local law or regulation to deliver electric
energy and/or natural gas service to utility customers, or is a
Federal power marketing agency as defined in Section 3 of the
Federal Power Act (16 U.S.C. 796(19)).''
\7\ The Petition defined the term ``utility operations-related
swap'' to mean any swap that a utility special entity enters into
``to hedge or mitigate commercial risk'' (as that phrase is used in
CEA Section 2(h)(7)(A)(ii)) ``intrinsically related to the electric
or natural gas facilities that the utility special entity owns or
operates or its electric or natural gas operations (or anticipated
facilities or operations), or to the utility special entity's supply
of natural gas and/or electric energy to other utility special
entities or to its public service obligations (or anticipated public
service obligations) to deliver electric energy or natural gas
service to utility customers.''
The Petition defined the term ``intrinsically related'' to
include all transactions related to ``(i) the generation or
production, purchase or sale, and transmission or transportation of
electric energy or natural gas, or the supply of natural gas and/or
electric energy to other utility special entities, or delivery of
electric energy or natural gas service to utility customers, (ii)
all fuel supply for the utility special entity's electric facilities
or operations, (iii) compliance with electric system reliability
obligations applicable to the utility special entity, its electric
facilities or operations, (iv) compliance with energy, energy
efficiency, conservation or renewable energy or environmental
statutes, regulations or government orders applicable to the utility
special entity, its facilities or operations, or (v) any other
electric or natural gas utility operations-related swap to which the
utility special entity is a party.''
Finally, the Petition stated that a ``utility operations-related
swap'' did not include ``a swap based or derived on, or referencing,
commodities in the interest rates, credit, equity or currency asset
classes, or a product type or category in the `other commodity'
asset class that is based or derived on, or referencing, metals, or
agricultural commodities or crude oil or gasoline commodities of any
grade not used as fuel for electric generation.''
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The amendment requested by the Petition would have had the effect
of allowing a person, in any rolling twelve-month period, to engage in
utility operations-related swaps with utility special entities up to an
aggregate gross notional amount not to exceed (together with other
swaps in which the person was engaged) the General De Minimis Threshold
(currently $8 billion) without being required to register as a swap
dealer. In support of this amendment, the Petition claimed that:
The rule amendment is necessary in order to preserve
uninterrupted and cost-effective access to the customized,
nonfinancial commodity swaps that Petitioners and other Utility
Special Entities [as defined in the Petition] use to hedge or
mitigate commercial risks arising from their utility facilities,
operations and public service obligations.\8\
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\8\ Petition at 2.
The Petition further explained that this amendment was needed in order
to increase the number of counterparties available to utility special
entities to enter into swaps that are necessary for the efficient
conduct of the businesses and operations of utility special entities.
C. CFTC Staff Letter No. 12-18 \9\
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\9\ October 12, 2012. This letter can be accessed on the
Commission's Web site at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-18.pdf.
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As the October 12, 2012 effective date for Regulation 1.3(xxx)
(defining the term ``swap'') approached,\10\ Petitioners requested no-
action relief from the de minimis threshold for swaps with certain
special entities. In CFTC Staff Letter No. 12-18 (Staff Letter 12-18),
the Commission's Division of Swap Dealer and Intermediary Oversight
(Division) \11\ concluded that, in light of the representations made in
support of the request and in view of the impending effective date for
the swap dealer registration requirement, it was appropriate to provide
certain registration no-action relief with respect to the Special
Entity De Minimis Threshold for persons entering into utility related
swaps with utility special entities. Thus, in Staff Letter 12-18 the
Division stated that it would not recommend that the Commission
commence an enforcement action against a person for failure to apply to
be registered as a swap dealer, if:
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\10\ See 77 FR 48208. Swaps entered into after the effective
date of the final rule defining the term ``swap'' were required to
be counted for purposes of determining whether a person's dealing
activity exceeded the Special Entity De Minimis Threshold and the
General De Minimis Threshold. See Regulation 1.3(ggg)(4)(i).
\11\ The Division is responsible for, among other things,
overseeing compliance with the registration requirements applicable
to swap dealers.
(1) The utility commodity swaps connected with the person's swap
dealing activities into which the person--or any other entity
controlling, controlled by or under common control with the person--
enters over the course of the immediately preceding 12 months (or
following October 12, 2012, if that period is less than 12 months)
have an aggregate gross notional amount of no more than $800
million;
(2) the person is not otherwise within the definition of the
term ``swap dealer,'' as provided in 17 CFR 1.3(ggg) (i.e., the
person--or any other entity controlling, controlled by or under
common control with the person--has not entered into swaps as a
result of its swap dealing activities in excess of the general de
minimis threshold or (not
[[Page 57769]]
counting utility commodity swaps) the special entity de minimis
threshold); \12\ and
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\12\ Division staff emphasized in the letter that the aggregate
gross notional amount of a person's utility commodity swaps would
reduce the $8 billion aggregate gross notional amount under the
General De Minimis Threshold for that person.
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(3) the person is not a ``financial entity,'' as defined in
section 2(h)(7)(C)(i) of the CEA.
For purposes of Staff Letter 12-18, Division staff defined the term
``utility commodity swap'' to mean a swap where: (1) A party to the
swap is a utility special entity; (2) a utility special entity is using
the swap in the manner described in Regulation 1.3(ggg)(6)(iii); \13\
and (3) the swap is related to an exempt commodity in which both
parties to the swap transact as part of the normal course of their
physical energy businesses. The relief made available by Staff Letter
12-18 was not self-executing. Rather, to take advantage of the no-
action relief, a person was required to claim the relief by filing with
the Division a notice that, among other things, identified each utility
special entity with which the person has entered into utility commodity
swaps connected with the person's swap dealing activities, and that
stated with respect to each such utility special entity the total gross
notional amount of such utility commodity swaps. Quarterly notice
filings were also required.
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\13\ That is, the utility special entity is using the swap to
hedge a physical position, as described in Regulation
1.3(ggg)(6)(iii).
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D. CFTC Staff Letter No. 14-34 \14\
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\14\ This letter can be accessed on the Commission's Web site,
at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-34.pdf.
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Subsequent to the issuance of CFTC Staff Letter 12-18, certain of
the Petitioners claimed that specific features of Staff Letter 12-18
(e.g., the requirement to establish that the utility special entity is
using the swap to hedge a physical position in an exempt commodity, and
the requirement to establish that the counterparty seeking relief is
not a ``financial entity'') imposed administrative costs or created
legal uncertainty such that would-be counterparties were dissuaded from
entering into relevant swaps.\15\ The Petitioners' Letter renewed their
request for the relief sought in the previously-filed Petition.
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\15\ Letter from Petitioners to Gary Gensler, CFTC Chairman,
dated Nov. 19, 2013 (Petitioners' Letter), available at http://sirt.cftc.gov/sirt/sirt.aspx?Topic=PendingFilingsandActionsAD&Key=23845. (One of the
original Petitioners did not, however, participate in this follow up
letter.)
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In response to these concerns, on March 21, 2014, the Division
issued CFTC Staff Letter No. 14-34 (Staff Letter 14-34), which
superseded and broadened the relief provided in Staff Letter 12-18.
Specifically, in Staff Letter 14-34 the Division stated that it would
not recommend that the Commission commence an enforcement action
against a person for failure to apply to be registered as a swap dealer
if the person--or any other entity controlling, controlled by, or under
common control with the person--does not include ``utility operations-
related swaps,'' as defined in Staff Letter 14-34, in calculating
whether it has exceeded the Special Entity De Minimis Threshold,
provided that the person's swap dealing activities have not exceeded
the General De Minimis Threshold.
II. The Proposal
On June 2, 2014, the Commission published for comment in the
Federal Register a proposal to amend Regulation 1.3(ggg)(4) to permit a
person to exclude ``utility operations-related swaps'' (as proposed to
be defined) transacted with ``utility special entities'' (as also
proposed to be defined) in calculating the aggregate gross notional
amount of the person's swap positions, solely for purposes of the
Special Entity De Minimis Threshold (Proposal).\16\ Under the Proposal,
such utility operations-related swaps would be subject to the higher
General De Minimis Threshold applicable to swaps with persons that are
not special entities. The Commission is adopting the Proposal subject
to certain changes, as noted below.
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\16\ 79 FR 31238.
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In issuing the Proposal, the Commission recognized that utility
special entities have a specialized purpose--i.e., they provide
electricity and natural gas production and/or distribution to their
customers--and they thus have a unique obligation, in that the
commodity services they provide must be continuous, and those services
are important to public safety. The Commission also expressed the view
that utility operations-related swaps have become an integral part of
providing continuous service and managing costs in connection
therewith.\17\
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\17\ 79 FR at 31241.
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Further, the Commission noted that:
[t]he specialized nature of utility special entities distinguishes
them from other types of special entities (e.g., public pension
plans or municipal governments) in that the conduct of their
business routinely involves, and indeed often depends upon access
to, specific types of swap transactions that permit them to manage
the risks of their businesses and to be able to provide electricity
and natural gas consistently. As a consequence, they not only need
regular access to swaps that directly affect the smooth operation of
their business activities, but also are more likely to have
developed expertise with swaps directly related to their operations.
While the Special Entity De Minimis Threshold may represent a
reasonable protection for other types of special entities that enter
into swaps intermittently and whose activities do not depend on a
consistent use of particular swaps, for the reasons stated above,
the Commission believes that its application to utility operations-
related swaps with utility special entities is not as necessary for
their regular operation.\18\
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\18\ Id. The Commission did not propose to alter, and is not now
altering, the Special Entity De Minimis Threshold with respect to
other types of swaps or special entities.
The Commission also stated in the Proposal its belief that, because
the swaps used by utility special entities are typically conducted in
localized and specialized markets and the number of available
counterparties may be limited, the $25 million amount of the existing
Special Entity De Minimis Threshold may deter those counterparties from
engaging in utility operations-related swaps. Given the obligations of
utility special entities to provide continuous service to customers,
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the Commission concluded that:
the public interest would be better served if the likely
counterparties for utility operations-related swaps are able to
provide liquidity to this limited segment of the market without
registering as swap dealers solely on account of exceeding the
Special Entity De Minimis Threshold. In addition, given the
expertise utility special entities are likely to have with utility
operations-related swaps, the need for a lower de minimis threshold
for dealing activity in such swaps with utility special entities is
reduced.\19\
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\19\ Id.
Accordingly, the Commission proposed to amend its regulations in
order to permit a person to exclude specified swaps (i.e., utility
operations-related swaps) entered into with a defined subset of special
entities (i.e., utility special entities) when calculating whether the
person's swap dealing activities exceed the Special Entity De Minimis
Threshold. As stated above, the Commission is adopting the Proposal,
subject to certain changes discussed below.
A. Adding an Exclusion for Utility Operations-Related Swaps With
Utility Special Entities
Regulation 1.3(ggg) defines the term ``swap dealer.'' The Proposal
sought to amend Regulation 1.3(ggg)(4)(i) to permit persons engaging in
utility operations-related swaps with utility special entities to
exclude such swaps solely for purposes of determining
[[Page 57770]]
whether they have exceeded the Special Entity De Minimis Threshold.
This was to be done by redesignating existing Regulation 1.3(ggg)(4)(i)
as Regulation 1.3(ggg)(4)(i)(A), placing the text ``In General'' before
the redesignated regulation and adding a new Regulation
1.3(ggg)(4)(i)(B), captioned ``Utility Special Entities.''
As proposed, Regulation 1.3(ggg)(4)(i)(B)(1) provided that solely
for purposes of determining whether a person's swap dealing activity
has exceeded the $25 million aggregate gross notional amount threshold
set forth in Regulation 1.3(ggg)(4)(i)(A) for swaps in which the
counterparty is a special entity, a person may exclude utility
operations-related swaps in which the counterparty is a utility special
entity. Proposed Regulation 1.3(ggg)(4)(i)(B)(1) would not, however,
have permitted a person to exclude the aggregate gross notional amount
of such utility operations-related swaps in determining whether the
person had exceeded the General De Minimis Threshold.
Proposed Regulation 1.3(ggg)(4)(i)(B)(4) would have required a
person to file a one-time notice with the National Futures Association
(NFA) to rely on the exclusion provided by the new rule.\20\ The
proposed notice provision would have required a representation from the
person claiming the exclusion (i.e., the counterparty to the utility
special entity) that the person meets the criteria of the exclusion for
utility operations-related swaps with utility special entities.
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\20\ NFA is a futures association registered as such with the
Commission pursuant to CEA Section 17.
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The Commission noted in the Proposal that while Congress adopted
additional protections for special entities when engaging in swap
transactions, such as the heightened business conduct requirements
imposed on swap dealers advising and dealing with special entities,\21\
the Proposal would permit persons to engage in a greater aggregate
gross notional amount of swaps with utility special entities without
registering as a swap dealer. As a result, utility special entities
engaging in such swaps with persons not registered as swap dealers
would not have the protections provided by the statutory and regulatory
provisions applicable to registered swap dealers, both general and
specific to dealing activities with special entities. Accordingly, the
Commission explained that it proposed the notice filing requirement as
a measure to help the Commission monitor compliance with the swap
dealer registration requirement, and to better ensure that the
exclusion under the Proposal would serve its intended purpose.\22\
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\21\ See CEA Sections 4s(h)(4) and 4s(h)(5).
\22\ See 79 FR 31238, 31242.
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However, as explained below, after considering the comments it
received on this issue, the Commission has determined not to adopt in
Regulation 1.3(ggg)(4)(i)(B) the proposed notice filing requirement.
Additionally, a person relying on the exclusion under the Proposal
would have been required to maintain in accordance with Regulation 1.31
books and records that substantiate its eligibility to rely on this
exclusion.\23\ As explained below, the Commission has adopted in
Regulation 1.3(ggg)(4)(i)(B)(4) a provision that requires the person to
maintain specifically the written representations, if any, provided to
it by utility special entities and upon which it has relied in
determining that the utility special entities and the utility
operations-related swaps the person engages in meet the criteria of the
exclusion in Regulation 1.3(ggg)(4)(i)(B)(1).
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\23\ This requirement is consistent with the requirements of
other similar Commission regulations, such as the requirement in
Regulation 4.7 that commodity pool operators and commodity trading
advisors claiming relief under that regulation maintain books and
records relating to their eligibility to claim that relief.
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B. New Definitions
1. ``Utility Special Entity''
Proposed Regulation 1.3(ggg)(4)(i)(B)(2) defined the term ``utility
special entity'' to mean a special entity \24\ that owns or operates
electric or natural gas facilities, electric or natural gas operations
or anticipated electric or natural gas facilities or operations;
supplies natural gas or electric energy to other utility special
entities; has public service obligations or anticipated public service
obligations under Federal, State or local law or regulation to deliver
electric energy or natural gas service to utility customers; or is a
Federal power marketing agency as defined in Section 3 of the Federal
Power Act, 16 U.S.C. 796(19).
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\24\ As noted above, CEA Section 4s(h)(2)(c) and Regulation
23.401(c) define the term ``special entity.''
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2. ``Utility Operations-Related Swap''
Proposed Regulation 1.3(ggg)(4)(i)(B)(3) defined the term ``utility
operations-related swap'' to mean a swap to which at least one of the
parties is a utility special entity that is using the swap to hedge or
mitigate commercial risk,\25\ and that is related to an exempt
commodity.\26\ In addition, the swap would have to be an electric
energy or natural gas swap, or associated with the operations or
compliance obligations of a utility special entity in a manner more
fully set forth in proposed Regulation 1.3(ggg)(4)(i)(B)(3)(iv).
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\25\ As explained below, in Regulation 1.3(ggg)(4)(i)(B)(3)(ii)
as adopted, the Commission revised the language from what was
proposed to read ``(ii) A utility special entity is using the swap
to hedge or mitigate a commercial risk as defined in Sec. 50.50(c)
of this chapter'' (instead of ``in the manner described in Sec.
50.50(c)'').
\26\ As noted below, the regulation as adopted would permit the
swap to be related to an agricultural commodity insofar as such
commodity is used for fuel for generation of electricity or is
otherwise used in the normal operations of the utility special
entity.
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The Commission noted in the Proposal that:
in determining whether a person may rely on the proposed exclusion
for utility operations-related swaps with utility special entities,
it may not always be possible for the person to establish with
absolute certainty that a counterparty is a utility special entity,
that the counterparty is using a swap to hedge or mitigate
commercial risk, that the swap is related to an exempt commodity, or
that the swap meets the other requirements to come within the
definition of a utility operations-related swap. Therefore, the
Commission intends to take the position that a person seeking to
rely on the (proposed) exclusion may reasonably rely upon a
representation by the utility special entity that it is a utility
special entity and that the swap is a utility operations-related
swap, as such terms are defined in proposed Regulation
1.3(ggg)(4)(i)(B), so long as the person was not aware, and should
not reasonably have been aware, of facts indicating the
contrary.\27\
\27\ 79 FR 32138, 31242. This position is consistent with the
Commission's approach to permitting reliance on representations for
other purposes, such as the requirement in Regulation 50.50(b)(3)
that a reporting party have a reasonable basis to believe that its
counterparty meets the requirements for the exception to the
clearing requirement for end-users. See 77 FR 42560, 42570.
As noted below, the Commission has adopted this position in
Regulation 1.3(ggg)(4)(i)(B)(4).
III. Comments and Responses
In the Proposal, the Commission sought comments generally regarding
the nature and application of the proposed exclusion for utility
operations-related swaps with utility special entities for purposes of
determining whether a person's swap dealing activities exceed the
Special Entity De Minimis Threshold. The Proposal also set forth a non-
exclusive list of questions to which the Commission sought
responses.\28\
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\28\ 79 FR 31238, 31242-31423. In the Proposal, the Commission
asked for and received comments on the possible benefits of revising
its interpretation regarding forward contracts with embedded
volumetric optionality. The Commission has decided that this matter
is outside the scope of the present rulemaking. Accordingly, the
Commission has asked staff to evaluate this issue separately and to
consider the comments received in undertaking the evaluation.
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[[Page 57771]]
The Commission received ten comment letters in response to the
Proposal, from or on behalf of entities identifying themselves as
utility special entities, companies engaged in providing physical
energy and related activities, industry and trade associations and
commercial end users of energy provided by utility special
entities.\29\ All of the comment letters were supportive of the
proposed amendments to Regulation 1.3(ggg)(4)(i) in general, although
some recommended revisions to, or deletion of, specific provisions.
Several letters provided responses to certain of the specific questions
the Commission posed in the Proposal.
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\29\ Comment letters were submitted by: Arizona Utility Special
Entities (AZ Entities Comment Letter) (July 2, 2014); Electrical
District No. 3 of Pinal County, Arizona (ED3 Comment Letter) (June
26, 2014); City of Redding, CA (City of Redding Comment Letter)
(July 1, 2014); Coalition of Physical Energy Companies (COPE Comment
Letter) (July 2, 2014); EDF Trading North America LLC (EDFTNA
Comment Letter) (July 2, 2014); Edison Electric Institute (EEI
Comment Letter) (July 2, 2014); The Commercial Energy Working Group
(Working Group Comment Letter) (July 2, 2014); Electric Power Supply
Association (EPSA Comment Letter) (July 2, 2014); the International
Energy Credit Association (IECA Comment Letter) (July 2, 2014); and
NFP Electric Coalition (NFP Comment Letter) (July 2, 2014).
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Commenters generally agreed that the proposed exclusion was
necessary to address the issues facing utility special entities, and
that the proposed exclusion would benefit utility special entities and
the public interest without compromising the regulatory policy of
protecting special entities generally.
Specifically, a number of commenters agreed that utility special
entities serve a unique role in the energy commodity markets; namely,
utility special entities have an obligation to provide continuous and
reliable electric and natural gas service to the public, which is
crucial to public safety.\30\
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\30\ See, e.g., Working Group Comment Letter; ED3 Comment
Letter; City of Redding Comment Letter.
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Commenters also stated that utility special entities require access
to the swap markets in order to hedge or mitigate their commercial
risks, and a lack of available counterparties imposes costs on utility
special entities that ultimately are passed on to consumers. Commenters
similarly stated that the number of potential counterparties for
utility operations-related swaps was generally limited due to the
unique nature of the energy markets in which utility special entities
operate, and that the Special Entity De Minimis Threshold, and the
regulatory burdens associated with it, discouraged this already limited
number of potential counterparties from entering into swaps with
utility special entities.\31\ Many commenters noted further that
utility special entities are sophisticated market participants who have
expertise in physical and financial energy markets, and that hedging
and managing commercial risk is a core competency of utility special
entities.\32\ For these reasons, commenters asserted that utility
operations-related swaps with utility special entities should be
treated differently than other swaps with special entities.\33\ In the
view of these commenters, utility special entities should be treated
the same way as investor-owned utilities with regard to the application
of the General De Minimis Threshold.
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\31\ See, e.g., AZ Utility Special Entities Comment Letter; NFP
Comment Letter; Working Group Comment Letter; ED3 Comment Letter.
\32\ See, e.g., Id.; EEI Comment Letter.
\33\ See Id.
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A. Proposed Regulation 1.3(ggg)(4)(i)(B)(2): ``Utility Special Entity''
The Commission received few comments specifically directed to its
proposed definition of ``utility special entity.'' One commenter stated
its agreement with the Commission's definition as proposed.\34\ Another
asked the Commission to expand the definition of ``utility special
entity'' to include governmental entities, such as school districts,
housing authorities, fire departments, water and waste management
utilities, involved in large-scale competitive physical procurement of
electric energy or natural gas.\35\ Like utility special entities, the
commenter asserted, these governmental entities have a critical and
continuous need for natural gas and electricity, and they face unique,
regional market structures wherein the universe of potential
counterparties may be further limited to market participants active in
a particular geographic region.
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\34\ See NFP Comment Letter.
\35\ See Working Group Comment Letter.
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The Commission has not, however, so expanded the definition of
``utility special entity'' in Regulation 1.3(ggg)(4)(i)(B) as adopted.
In declining to make this change, the Commission notes that utility
special entities are a distinct subset of special entities, for which
the Commission believes it is appropriate to relax the safeguards that
would otherwise apply with respect to their swap transactions, but
solely in the context of utility operations-related swaps. As stated in
the preamble of the Proposal, utility special entities provide electric
or natural gas energy to customers, and this is the primary purpose
for, and business of, utility special entities; and they typically have
public service obligations to provide uninterrupted service to such
customers. In order to meet their obligations and to provide continuous
service to customers in a cost-effective manner, utility special
entities have an ongoing need to hedge their commercial risks through
utility operations-related swaps. Moreover, utility special entities
have significant experience and expertise with respect to utility
operations-related swaps and the commodities to which those swaps
relate. The other types of special entities mentioned by the commenter
are more in the nature of end users of electric or natural gas energy.
While they may have a limited need to hedge electric and natural gas
purchases, doing so is not a fundamental aspect of their general
operations (e.g., education, housing, firefighting, etc.); neither
their operations nor their obligations are analogous to those of
utility special entities; and they are less likely to have the same
level of experience with utility operations-related swaps and the
commodities underlying those swaps as utility special entities. In
balancing the public interest of providing additional regulatory
protections for special entities against the public interest that
utility special entities be able to effectively manage their commercial
risk, the Commission is providing a targeted and tailored exclusion,
based on the unique characteristics of utility special entities
discussed above. However, the special entities as to which the
commenter recommended expanding the Proposal do not have the same
characteristics as utility special entities, and do not implicate the
same policy considerations. Therefore, an exclusion from the Special
Entity De Minimis Threshold for such special entities is not in the
public interest as it is for utility special entities. Accordingly, the
Commission has not expanded the definition of ``utility special
entity'' in Regulation 1.3(ggg)(4)(i)(B) as adopted.
B. Proposed Regulation 1.3(ggg)(4)(i)(B)(3): ``Utility Operations-
Related Swap''
One commenter recommended that the Commission adopt the definition
of utility operations-related swap as proposed, stating that the
definition encompasses the range of utility supply commodities
necessary to provide
[[Page 57772]]
utility special entities the relief intended by the Proposal.\36\
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\36\ See City of Redding Comment Letter.
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Another commenter recommended that the Commission should not
include the requirement in proposed Regulation
1.3(ggg)(4)(i)(B)(3)(iii) that the swap be related to an ``exempt
commodity'' in order to be a utility operations-related swap. This
requirement, in the view of the commenter, would add ambiguity to the
definition because the Commission's regulations and interpretations
implementing its jurisdiction over swaps do not consistently use the
pre-Dodd-Frank Act \37\ categorizations of ``exempt commodity,''
``agricultural commodity'' and ``excluded commodity'' to classify
swaps.\38\ The commenter expressed the view that the Dodd-Frank Act and
the Commission's regulations regarding the definition of ``swap'' do
not use the term ``exempt commodity'' but instead distinguish swaps
involving ``nonfinancial commodities'' from four asset classes of
financial commodity swaps (involving rates, credit, currencies and
equities); therefore, the definition of utility operations-related swap
should also follow that approach. Alternatively, the commenter
recommended that if the Commission retained in the definition, as
adopted, the proposed requirement that the swap be related to an exempt
commodity, then the Commission: (1) Should clarify that all
``nonfinancial commodities'' (other than agricultural commodities) are
exempt commodities; and (2) should expand the proposed definition of
utility operations-related swap to include swaps related to
agricultural commodities, as, the commenter claimed, there are
agricultural commodities that are used for fuel for electric
generation, or that may otherwise be ``associated with utility
operations.''
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\37\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. No. 111-203, 124 Stat. 1376 (2010).
\38\ See NFP Comment Letter.
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Several other commenters similarly recommended that the Commission
conform the proposed definition of utility operations-related swap to
the definition of the term ``Exempt Non-Financial Energy Transaction''
contained in the Commission's Order Exempting, Pursuant to Authority of
the Commodity Exchange Act, Certain Transactions Between Entities
Described in the Federal Power Act, and Other Electric Cooperatives,
(April 2nd Order).\39\ In the view of these commenters, conforming the
definition with the April 2nd Order would provide greater clarity to
market participants and would allow for a more seamless implementation
of the exclusion in proposed Regulation 1.3(ggg)(4)(i)(B), since market
participants are already familiar with the ``Exempt Non-Financial
Energy Transaction'' definition in the April 2nd Order.
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\39\ 78 FR 19670. See EPSA, IECA and NFP Comment Letters. The
April 2nd Order provides that the term ``Exempt Non-Financial Energy
Transaction'' means ``any agreement, contract, or transaction based
upon a `commodity,' as such term is defined in CEA section 1a(9) and
Commission regulation 1.3(e), that would not have been entered into,
but for an Exempt Entity's need to manage supply and/or price risks
arising from its existing or anticipated public service obligations
to physically generate, transmit, and/or deliver electric energy
service to customers. The term `Exempt Non-Financial Energy
Transaction' excludes agreements, contracts, and transactions based
upon, derived from, or referencing any interest rate, credit, equity
or currency asset class, or any grade of a metal, or any
agricultural product, or any grade of crude oil or gasoline that is
not used as fuel for electric energy generation. The term `Exempt
Non-Financial Energy Transaction' also excludes agreements,
contracts, or transactions entered into on or subject to the rules
of a registered entity, submitted for clearing to a derivatives
clearing organization, and/or reported to a swap data repository.''
Id. at 19688.
The April 2nd Order limits Exempt Non-Financial Energy
Transactions to specifically defined categories of transactions,
which the April 2nd Order provides may exist as stand-alone
agreements or as components of larger agreements that combine these
categories. The April 2nd Order identifies these categories of
transactions as follows: (1) Electric energy delivered; (2)
generation capacity; (3) transmission services; (4) fuel delivered;
(5) cross-commodity pricing; and (6) other goods and services. Id.
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The Commission is addressing these comments in two parts: (1)
Whether the Commission should adopt as proposed a utility operations-
related swap definition requiring that the swap be ``related to an
exempt commodity, as that term is defined in Section 1a(20) of the
Act,'' or the Commission should adopt in the definition another type of
limiting criteria, as identified by the commenters; and (2) whether the
Commission should adopt a definition of utility operations-related swap
that includes certain ``agricultural commodities'' as that term is
defined in Regulation 1.3(zz).
After considering the commenters' arguments, the Commission has
determined to adopt in Regulation 1.3(ggg)(4)(i)(B)(3) the proposed
requirement that a utility operations-related swap must relate to an
exempt commodity.\40\ The Proposal responded to the request in the
Petition to provide relief for counterparties to certain types of swaps
used by utility special entities to hedge their day-to-day operational
activities. The Proposal noted that: utility special entities have a
greater need for these swaps than for other types of swaps and that
need is ongoing; the underlying commodities identified in such swaps
and the counterparties for such swaps are often regional (e.g., the
location for delivery of the commodity and the location of the
operations of the counterparties); these swaps relate to underlying
commodities which utility special entities regularly use as part of
their normal operations; and with respect to such swaps, utility
special entities generally have a level of expertise and
sophistication. Given these factors, the Proposal allowed for a limited
reduction in the protections that the Special Entity De Minimis
Threshold would provide for utility special entities, in order to
increase the number of counterparties available for utility special
entities that need to use these types of swaps.
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\40\ The requirement that a swap must relate to an exempt
commodity was included in Staff Letter 12-18.
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However, as stated in the preamble to the Proposal, the Commission
recognizes that the Special Entity De Minimis Threshold is generally
appropriate in light of the special protections that Title VII of the
Dodd-Frank Act provides to special entities.\41\ In keeping with the
statutory and regulatory objective of providing additional protections
for special entities generally, the Commission believes that the
definition of utility operations-related swap in Regulation
1.3(ggg)(4)(i)(B)(3) should be written to exclude swaps that are not
related to commodities used by utility special entities in the ordinary
course of their daily operations. In this way, utility special entities
would be treated in the same way as other special entities with regard
to swaps that do not implicate the policies underlying the proposed
exclusion.
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\41\ See 79 FR at 31245.
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The commenters' recommendation that the definition of utility
operations-related swaps conform to the definition of the term ``Exempt
Non-Financial Energy Transaction'' contained in the April 2nd Order is
misplaced, because the April 2nd Order addresses transactions between a
limited set of counterparties and was based on different underlying
policy considerations. In accordance with CEA Section 4(c)(6),\42\ the
April 2nd Order
[[Page 57773]]
broadly exempts from most requirements of the CEA and Commission
regulations all ``Exempt Non-Financial Energy Transactions'' entered
into solely between Exempt Entities.\43\ The scope of the transactions
covered by the exemption was defined in the context of both this unique
``closed loop'' market (i.e., transactions where both parties are
Exempt Entities) and also the underlying policies for the exemption.
More specifically, the Commission determined that such transactions
between not-for-profit utilities (in a closed loop) will not materially
impair price discovery or the functioning of markets regulated by the
Commission.\44\ The Commission also determined that the not-for-profit
structure and governance model of all Exempt Entities reduce the
incentives and other conditions that traditionally lead to fraudulent
or manipulative trading activity, and should therefore mitigate the
need for prescriptive federal oversight.\45\ Thus, the transactions and
circumstances addressed by the April 2nd Order--and the underlying
statutory and regulatory policy considerations--are not analogous to
those addressed and implicated by the Proposal.\46\
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\42\ As discussed by the Commission in the preamble to the April
2nd Order, CEA Section 4(c)(6) ``builds upon the Commission's
existing 4(c) exemptive authority by providing that the Commission
`shall . . . exempt from the requirements of th[e] Act an agreement,
contract, or transaction that is entered into * * * between entities
described in section 201(f) of the Federal Power Act (16 U.S.C.
824(f)),' but only `[i]f the Commission determines that the
exemption would be consistent with the public interest and the
purposes of [the Act].' '' 78 FR at 19671.
\43\ The term ``Exempt Entity'' is defined in the April 2nd
Order as ``(i) any electric facility or utility that is wholly owned
by a government entity, as described in Federal Power Act (`FPA')
section 201(f), 16 U.S.C. 824(f); (ii) any electric facility or
utility that is wholly owned by an Indian tribe recognized by the
U.S. government pursuant to section 104 of the Act of November 2,
1994, 25 U.S.C. 479a-1; (iii) any electric facility or utility that
is wholly owned by a cooperative, regardless of such cooperative's
status pursuant to FPA section 201(f), so long as the cooperative is
treated as such under Internal Revenue Code section 501(c)(12) or
1381(a)(2)(C), 26 U.S.C. 501(c)(12), 1381(a)(2)(C), and exists for
the primary purpose of providing electric energy service to its
member/owner customers at cost; or (iv) any other entity that is
wholly owned, directly or indirectly, by any one or more of the
foregoing. The term `Exempt Entity' does not include any `financial
entity,' as defined in CEA section 2(h)(7)(C).'' 78 FR at 19688.
\44\ Id. at 19679.
\45\ Id. This rationale is not applicable to transactions
between a utility special entity and a counterparty that is not a
utility special entity.
\46\ The NFP Comment Letter asserts that ``Members of [NFP]
(including utility special entities) are `Exempt Entities' as such
term is defined in the [April 2nd Order].'' Even assuming this would
be the case with respect to all utility special entities, not just
NFP members, the April 2nd Order is limited to transactions ``solely
between Exempt Entities,'' whereas the exclusion in Regulation
1.3(ggg)(4)(i)(B) will apply to swaps where only one party is a
utility special entity.
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Similarly, the commenters' recommendation that the Commission base
the definition of utility operations-related swap on the distinction
between nonfinancial commodities and commodities related to the four
financial asset classes would allow for swaps related to commodities
that are not regularly used by utility special entities to be included
in the definition of utility operations-related swap.\47\ While the
Commission believes that all of the types of swaps that fall within the
four financial asset classes noted should be excluded from the defined
term, there are many other swaps--both financial and non-financial--
that also should not be included in the definition given the rationale
for providing the exclusion for utility special entities in a way that
is balanced with the need to maintain appropriate protections for
special entities generally.
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\47\ The Commission employed the term ``nonfinancial commodity''
in the preamble of the Federal Register release adopting the
definition of the term ``swap'' to discuss a category of
transactions for which the forward exclusion would apply. See 77 FR
48208, 48227 et seq., n.205. As such, that term serves a purpose in
the swap definition regulation that is functionally different from
the utility operations-related swap definition that the Commission
is adopting in this Federal Register release.
---------------------------------------------------------------------------
This can be illustrated by considering the definition in the April
2nd Order to which the commenters referred. The definition of the term
``Exempt Non-Financial Energy Transaction'' in the April 2nd Order
excludes transactions ``referencing any interest rate, credit, equity
or currency asset class or any grade of a metal, or any agricultural
product, or any grade of crude oil or gasoline that is not used as fuel
for electric energy generation.'' As such, the April 2nd Order carves
out from the relief it provided both swaps in the four delineated
financial asset classes and swaps related to certain physical
commodities, to the extent those commodities are not used by the
utility special entities for electric energy generation.
However, the April 2nd Order criteria may create gaps and
uncertainty in the definition of utility operations-related swaps that
could both result in ambiguity for market participants and overly
reduce the general protections intended for special entities, including
utility special entities. The April 2nd Order does not define the terms
``interest rate asset class,'' ``credit asset class,'' ``equity asset
class'' or ``currency asset class.'' Although the meaning of these
terms may be generally understood, the lack of a definition creates a
degree of ambiguity. For example, it is generally understood that the
exclusion provided in the final regulation should not include interest
rate swaps that special entities might use to hedge interest rate risk
related to their bonds. However, such a hedge could be accomplished
indirectly by entering into a bond price swap either on their bonds or
less directly, on a bond price index. As another example, it is also
unclear whether the definition in the April 2nd Order would exclude a
total return swap on a utility special entity's bonds (or any other
bonds for that matter). Although special entities should not be barred
from entering into such swaps, in the absence of an exclusion for such
swaps, the low Special Entity De Minimis Threshold would require that a
person dealing in such swaps with a special entity (in excess of the
$25 million amount) be registered as a swap dealer, irrespective of
whether the special entity is a utility special entity. This is
consistent with the statutory intent to provide greater protections for
special entities generally. In this way, the protections provided for
special entities by the swap dealer regulations would apply to swaps of
this nature to which any kind of special entity is a party, including
utility special entities.
Finally, while the criteria in the April 2nd Order except out
certain specified physical commodities as described above, those
exceptions are fairly specific and would not except out a swap
referencing any other physical commodity to the extent the swap might
be shown to ``manage supply and/or price risks arising from [an
entity's] existing or anticipated public service obligations.'' That
approach provides a significant amount of flexibility in determining
which swaps fit within the definition. For some purposes, this
flexibility can be helpful in that determining when a swap is being
used to ``manage,'' or ``hedge or mitigate'' (the term in Regulation
1.3(ggg)(4)(i)(B)(3)(ii) as adopted that serves a similar function)
risk can be highly fact specific and to a degree subjective. This
flexibility, while beneficial in some contexts, can create a degree of
ambiguity because it allows for different interpretations based on the
facts and circumstances. This ambiguity may have been acceptable in the
context of the April 2nd Order because it addressed only swaps between
``Exempt Entities'' (e.g., not involving commercial dealers or
financial entities) and because the April 2nd Order involves different
public policy considerations, as described above. On the other hand,
this ambiguity could result in overly-weakened protections for special
entities if incorporated into the Amendments.
Maintaining in Regulation 1.3(ggg)(4)(i)(B)(3)(iii) the requirement
that utility operations-related swaps must relate to exempt commodities
mitigates this ambiguity and helps maintain the protections intended
for
[[Page 57774]]
special entities by the Dodd-Frank Act and the Commission's
regulations. The term ``exempt commodity'' is defined as a commodity
that is not an ``excluded commodity'' or an ``agricultural commodity.''
Briefly stated, excluded commodities (agricultural commodities are
addressed below) encompass swaps referencing the four financial classes
identified in the April 2nd Order and swaps related to: debt
instruments; indexes or measures of inflation or other macroeconomic
indexes or measures; commodities based on rates, differentials, indexes
or measures of economic or commercial risk, return or value that are
not based in substantial part on the value of a narrow group of
commodities or are based solely on one or more commodities that have no
cash market; or commodities based on any occurrence or contingency that
is out of the control of the parties and associated with an economic
consequence.\48\ Accordingly, maintaining in Regulation
1.3(ggg)(4)(i)(B)(3)(iii) as adopted the proposed requirement that the
swap relate to an ``exempt commodity'' would limit the final regulation
to types of swaps that a utility special entity may need to operate
effectively while at the same time excluding swaps that relate to many
types of commodities that are not generally used in special utility
entity operations.
---------------------------------------------------------------------------
\48\ See 7 U.S.C. 1a(19).
---------------------------------------------------------------------------
Notwithstanding the foregoing, the term ``excluded commodity'' has
a degree of complexity. Accordingly, by this Federal Register release,
the Commission is taking the position that the requirement in
Regulation 1.3(ggg)(4)(i)(B)(3)(iii) that the swap ``relate to an
exempt commodity'' includes swaps that reference any physical commodity
involved in a utility special entity's normal operations. For example,
the requirement in Regulation 1.3(ggg)(4)(i)(B)(3)(iii) as adopted
would include a swap based on: the price of a grade of oil or coal that
the utility special entity purchases to fuel its power generation
facilities; a narrow index of grades of oil or coal that includes that
grade of oil or coal; electricity generated or distributed by a utility
special entity or potentially needed for peak power; or water needed to
power hydroelectric generating facilities of the entity.\49\ On the
other hand, a swap based on a broad commodity index, a bond price,
inflation indexes or weather occurrences would not meet the requirement
in Regulation 1.3(ggg)(4)(i)(B)(3)(iii).
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\49\ The foregoing list of examples is not intended to be an
exhaustive list of commodities on which a swap must be based such
that the swap would come within the definition of the term ``utility
operations-related swap.'' Rather, it is being provided to
illustrate how to apply the definition in the context of utility
special entity operations.
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Regarding the commenter's request to include in the final utility
operations-related swap definition agricultural commodities used for
certain utility purposes,\50\ the Commission acknowledges that it is
possible that a utility special entity may use agricultural
commodities, such as ethanol or wood chips, in its normal operations
and therefore the definition could be expanded for this purpose. The
Commission is concerned, however, that including agricultural
commodities generally in the definition may broaden the definition too
much because generally, agricultural commodities are not used in energy
utility operations. Accordingly, the Commission is adopting in
Regulation 1.3(ggg)(4)(i)(B)(3)(iii) a definition of utility
operations-related swap that includes swaps relating to agricultural
commodities that are used for fuel for electric generation or are
otherwise used in the normal operations of the utility special entity.
---------------------------------------------------------------------------
\50\ See NFP Comment Letter.
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One commenter recommended that the Commission adopt in lieu of the
proposed term and definition of ``utility operations-related swap'' a
term and definition of ``utility operations-related transaction,''
which would include all non-financial commodity transactions for
deferred shipment or delivery where the parties intend physical
settlement at the time the transaction was executed (including stand-
alone or embedded options or optionalities), claiming this was
necessary to provide utility special entities with the relief they
required.\51\ Alternatively, the commenter asked that prior to, or
concurrently with, the issuance of a regulation adopting the ``utility
operations-related swap'' definition, the Commission act on the
commenter's request for reconsideration of the Commission's
interpretation of CEA Section 1a(47) that all commodity options are
swaps, and clarify the scope of the Commission's jurisdiction over
nonfinancial commodity swaps.\52\ Further, the commenter urged the
Commission to provide guidance that all transactions used by a utility
special entity to hedge or mitigate commercial risks, and that have the
benefit of Commission exclusion by interpretation or an order exempting
them from the Commission's jurisdiction over swaps, are also excluded
from the Special Entity De Minimis Threshold.
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\51\ Id.
\52\ In its October 12, 2012, comment letter on the Commission's
proposed regulations to further define the terms ``swap'' and ``swap
dealer,'' NFP had asked the Commission to reconsider its conclusion
that ``commodity options are swaps under the statutory swap
definition.'' See 77 FR 48208, 48236 (Aug. 13, 2012). NFP's letter
may be accessed at: http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59235&SearchText=.
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The Commission is declining to adopt any of these recommendations.
An entity may be a swap dealer (and be subject to regulation as such)
if that entity is dealing in ``swaps,'' as defined in the CEA and the
Commission's regulations. Whether any particular transaction of the
types identified by the commenter is or is not a swap may be fact-
dependent. Accordingly, the broad statements requested from the
Commission by the comment could effectively amount to an interpretation
or modification of the definition of the term ``swap.'' The Commission
did not also propose to modify or interpret the definition of the term
``swap'' when it issued the Proposal. Rather, in proposing Regulation
1.3(ggg)(4)(i)(B)(3), the Commission intended to define a subset of
swaps as utility operations-related swaps. Thus, the commenter
effectively has asked the Commission to go beyond the scope of the
Proposal and to interpret or modify the definition of the term ``swap''
in order to provide relief that is broader than what the Proposal
contemplated. The Commission notes, however, that under the definition
of swap dealer in Regulation 1.3(ggg), any transactions identified in
the comment that are not ``swaps,'' as defined in the CEA and the
Commission's regulations, are not counted for purposes of the Special
Entity De Minimis Threshold or the General De Minimis Threshold.
Another commenter \53\ recommended that in lieu of the proposed
text of Regulation 1.3(ggg)(4)(i)(B)(3)(ii) the Commission should adopt
the following text: ``(ii) A utility special entity is using the swap
to hedge or mitigate commercial risk as defined in Sec. 50.50(c) of
this chapter.'' \54\ Otherwise, the commenter claimed, the requirement
could be misinterpreted to mean that a utility operations-related swap
must be used to invoke an exception to the mandatory clearing
requirement in order to qualify for the proposed exclusion.
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\53\ See Working Group Comment Letter.
\54\ The proposed text read: ``(ii) A utility special entity is
using the swap in the manner described in Sec. 50.50(c) of this
chapter.''
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The Commission finds that this recommendation is consistent with
the intent of the Proposal and that it would provide greater clarity.
Accordingly, the
[[Page 57775]]
Commission is adopting in Regulation 1.3(ggg)(4)(i)(B)(3)(ii) the
recommended text quoted above.
The same commenter also recommended that the Commission confirm
that proposed Regulation 1.3(ggg)(4)(i)(B) would apply to a swap that
unwinds an existing hedge. The commenter expressed the view that market
participants often hedge dynamically to optimize the value of
underlying physical assets or portfolios, and may modify hedging
structures related to a physical asset or position when the relevant
pricing relationships applicable to the asset change. Dynamic hedging,
according to the commenter, may involve leaving an asset or position
unhedged when necessary to mitigate lost opportunity cost risk, which
may require hedges to be established, unwound, and re-established on an
iterative basis over time. The commenter noted that in the preamble of
the Federal Register release announcing the adoption of Regulation
50.50(c), the Commission stated that ``qualification as bona fide
hedging does not require hedges, once entered into, to remain static.
The Commission recognizes that entities may update their hedges
periodically when pricing relationships or market factors applicable to
the hedges change.'' \55\ In light of this statement, the Commission
agrees with the recommendation. Accordingly, the Commission confirms
that the language quoted above concerning bona fide hedging is equally
applicable to transactions qualifying under Regulation
1.3(ggg)(4)(i)(B).
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\55\ 77 FR 42560, 42575 n. 69.
---------------------------------------------------------------------------
C. Comments Addressing Both Definitions
A commenter \56\ urged the Commission to ensure that the
definitions of ``utility special entity'' and ``utility operations-
related swap'' follow as closely as possible the analogous provisions
of Staff Letter 14-34 (which provides relief for utility special
entities pending a final rulemaking by the Commission), in order to
minimize the burden on counterparties in transitioning from reliance on
that no-action letter to reliance on the new regulation. In this
regard, the commenter asked the Commission to determine whether the
benefits associated with any proposed deviation from the terms of Staff
Letter 14-34 outweigh the costs and burdens of the deviation to market
participants.
---------------------------------------------------------------------------
\56\ See EDFTNA Comment Letter.
---------------------------------------------------------------------------
In response, the Commission notes that the text of the analogous
provisions in Staff Letter 14-34 is similar, but less specific (e.g.,
it does not require that the swap be related to an exempt commodity),
and therefore the wording of the letter is subject to greater
interpretive flexibility that could lead to unintended consequences.
Staff Letter 14-34 was intended to provide short-term relief until
regulatory changes could be implemented, whereas the final regulation
will be a more permanent solution. While the Commission is sympathetic
to the concerns expressed by the commenter regarding continuity, it is
more important to define these terms precisely to effect the regulatory
and policy purposes of the regulation.
Accordingly, from and after the effective date of the Amendments,
the relief made available by Staff Letter 14-34 will terminate, except
with respect to swaps entered into in reliance upon Staff Letter 14-34
prior to such effective date. In recognition of the fact that some
persons may have entered into swaps in reliance on Staff Letter 14-34,
the Commission is clarifying that such persons may continue to rely
upon the relief provided in Staff Letter 14-34 with respect to swaps
entered into prior to the effective date of the Amendments.\57\
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\57\ Such swaps would, however, need to be counted for purposes
of the General De Minimis Threshold, as provided in Staff Letter 14-
34.
---------------------------------------------------------------------------
Five commenters \58\ asked that the Commission include in the text
of the final rule (and not just in the preamble text of the adopting
release) a provision that a person seeking to rely on the exclusion
from the $25 million Special Entity De Minimis Threshold be able to
rely on representations from the utility special entity for the basis
of the exclusion, provided the reliance is made in good faith. One of
the five commenters \59\ also suggested the representations be in
writing and another of these commenters \60\ suggested text for the
purpose.
---------------------------------------------------------------------------
\58\ See EEI, COPE, EDFTNA, IECA and NFP Comment Letters.
\59\ See COPE Comment Letter.
\60\ See NFP Comment Letter.
---------------------------------------------------------------------------
The Commission believes that explicitly stating in Regulation
1.3(ggg)(4)(i)(B) that a person may rely upon a written representation
from a utility special entity will ensure that prospective
counterparties are aware that such reliance is permitted under the
regulation, and the Commission is doing so in Regulation
1.3(ggg)(4)(i)(B)(4).
D. Proposed Regulation 1.3(ggg)(4)(i)(B)(4): Notice Filing Requirement
In the Proposal, the Commission solicited comment on the proposed
notice requirement provision, specifically asking whether it would
enable the Commission to achieve the objectives of the notice
provision, as stated in the Proposal. One commenter supported the
notice provision, stating that the requirement will provide the
Commission with visibility to monitor the entities utilizing the
exclusion.\61\ Another commenter voiced support for the purposes of the
notice provision, stating that the Commission should be able to
identify the entities that elect to rely on the exclusion in order to
ensure that the exclusion serves the intended purpose of enabling
utility special entities to manage operational risks in a cost-
effective manner while simultaneously monitoring compliance with the
swap dealer registration requirements.\62\
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\61\ See City of Redding Comment Letter.
\62\ See EDFTNA Comment Letter. The commenter did not agree,
however, that the Commission's objective of identifying relying
entities would be served by requiring such entities to file a notice
with NFA.
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Six commenters \63\ stated that the Commission should not adopt the
proposed notice provision because it would impose unnecessary
regulatory risks and burdens in that the proposed attestation
requirement would create personal liability regarding factual issues
that are in the control of the utility special entity, not the person
making the attestation, and because the criteria would relate to swaps
to be executed in the future. The commenters predicted that these risks
and burdens would discourage persons from serving as counterparties to
utility special entities, which would be contrary to the purpose of the
Proposal. They also pointed out that counterparties relying on any
other de minimis exclusion are not subject to a notice requirement and
asserted that the Commission had not provided any justification for
treating persons who serve as counterparties to utility special
entities any differently.
---------------------------------------------------------------------------
\63\ See EPSA, EDFTNA, Working Group, IECA, NFP and EEI Comment
Letters.
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Three of the six commenters \64\ disputed the rationale for the
proposed notice provision set forth in the Proposal (that Congress has
determined that special entities need additional protection and the
notice filing will help the Commission monitor these transactions),
stating that the Commission acknowledged in the
[[Page 57776]]
Proposal that utility special entities are sophisticated and
experienced market participants, and contending that utility
operations-related swaps will be reported to swap data repositories
(``SDRs'') and, as such, the Commission can already see which entities
are entering into swap transactions with utility special entities.
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\64\ See EEI, Working Group and NFP Comment Letters.
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After considering the comments it received on this issue, the
Commission has determined not to retain the notice filing requirement
in the final regulation.\65\ However, the Commission believes that it
is important that it obtain information regarding whether
counterparties to utility special entities are relying on the exclusion
in Regulation 1.3(ggg)(4)(i)(B) and therefore do not need to register
as swap dealers and generally how the exclusion is affecting the
markets for utility operations-related swaps. Accordingly, the
Commission has directed its staff to assess possible amendments to the
Commission's regulations that would provide the Commission with such
information, including, potentially, amendments to Part 45 of the
Commission's regulations to add a data reporting field identifying
utility operations-related swaps when they are reported to SDRs.
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\65\ Accordingly proposed Regulation 1.3(ggg)(4)(i)(B)(5) (which
set forth the requirement to keep certain records) is renumbered as
Regulation 1.3(ggg)(4)(i)(B)(4) in the final regulation.
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E. Proposed Regulation 1.3(ggg)(4)(i)(B)(5): Books and Records
Requirement
Seven commenters stated that the Commission should not adopt any
recordkeeping requirement in the final regulation, claiming that such a
requirement would be unnecessary and redundant.\66\ Counterparties to
swaps are already required to maintain appropriate records for purposes
of demonstrating compliance with the General De Minimis Threshold. As
such, the commenters said, the Commission has access to this
information and additional recordkeeping requirements for utility
operations-related swap transactions are not needed.
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\66\ See EEI, EPSA, NFP, COPE, Working Group, IECA, and EDFTNA
Comment Letters.
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Two of the seven commenters \67\ went on to recommend that if the
Commission were to specify any additional books and records to be kept,
it should not repeat the deliberate vagueness of Regulation 45.2. One
commenter \68\ suggested that the Commission should specify that a
record of a counterparty's representation that it is eligible for the
exclusion should be sufficient, because, it asserted, a counterparty
relying on such a representation may not necessarily have any other
records demonstrating that the exclusion applies.
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\67\ See COPE and Working Group Comment Letters.
\68\ See COPE Comment Letter.
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The Commission believes that, while the general recordkeeping
requirement in the Proposal would provide greater oversight
capabilities, it could be burdensome relative to the benefits it would
provide. As commenters noted, Part 45 of the Commission's regulations
imposes general recordkeeping requirements upon persons that are
counterparties to swaps, whether or not such persons are within the
swap dealer definition and therefore subject to the requirement to
register as such,\69\ and the Commission agrees that such records would
include those necessary to demonstrate the person's compliance with the
General De Minimis Threshold. Accordingly, a record of each utility
special entity's representation that it is a utility special entity and
that the swap is a utility operations-related swap, together with the
general recordkeeping requirements under Part 45, should provide the
Commission with sufficient information for compliance purposes.
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\69\ See, e.g., Regulation 45.2(b) (``All non-SD/MSP
counterparties subject to the jurisdiction of the Commission shall
keep full, complete, and systematic records, together with all
pertinent data and memoranda, with respect to each swap in which
they are a counterparty . . . .'')
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Therefore, the Commission is including in the regulation as adopted
the change suggested by one of the commenters \70\ by requiring in
Regulation 1.3(ggg)(4)(i)(B)(4) as adopted only that each person who
relies on the written representation of a utility special entity retain
such representation among its required records, in accordance with
Regulation 1.31. Including this requirement in the final regulation
makes clear that records of such written representations, if received,
are a necessary element of the records required to be kept pursuant to
the general requirements of Part 45.
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\70\ See COPE Comment Letter.
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F. Comments Addressing Specific Questions Asked by the Commission
1. Question 8--Appropriateness of the De Minimis Threshold
The Commission asked whether the $8 billion General De Minimis
Threshold was appropriate in the context of utility operations-related
swaps or whether a higher or lower threshold should be adopted.
Two commenters offered support for the Commission's application of
the General De Minimis Threshold to utility operations-related swaps,
stating that applying that threshold strikes the appropriate regulatory
policy balance,\71\ and that it would level the playing field between
utility special entities and investor-owned utilities.\72\
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\71\ See NFP Comment Letter.
\72\ See City of Redding Comment Letter.
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Five commenters encouraged the Commission to revisit the General De
Minimis Threshold and to eliminate any automatic reset to any lower
threshold.\73\ These commenters also stated that the Commission should
not adopt a separate threshold for utility operations-related swaps
with utility special entities that was lower than the General De
Minimis Threshold, as it would create confusion and serve to limit the
number of counterparties willing to transact with utility special
entities.
---------------------------------------------------------------------------
\73\ See EEI, EDFTNA, Working Group, IECA, and NFP Comment
Letters.
---------------------------------------------------------------------------
The second comment (eliminating an automatic reset of the General
De Minimis Threshold) is beyond the scope of the Proposal and this
rulemaking. With regard to the third comment, the Commission did not
propose and is not adopting a separate threshold below the General De
Minimis Threshold, and accordingly no changes to the Proposal are
called for by these comments.
2. Question 9--Appropriateness of Limiting Counterparty Eligibility
Question 9 in the Proposal asked whether the nature of the person
entering into swaps with a utility special entity should be a factor in
determining whether the person can rely on the exclusion (e.g., by
limiting the exclusion to persons who are not ``financial entities,''
as provided in Staff Letter 12-18). Two commenters \74\ asserted that
the Commission should not impose limitations on the types of
counterparties eligible to rely on Regulation 1.3(ggg)(4)(i)(B),
arguing that such limitations would likely restrict the number of
counterparties available to utility special entities without providing
an associated benefit. The commenters believed that the substantial
costs and burdens associated with registration as a swap dealer would
likely cause an entity with even the slightest reservation regarding
its ability to rely on the exclusion to err on the side of caution and
decline to transact otherwise qualifying swaps with utility special
entities.
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\74\ See EDFTNA and Working Group Comment Letters.
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The Commission has concluded that restrictions such as excluding
financial entities from relying on the exclusion
[[Page 57777]]
would have a chilling effect on some potential market participants who
provide energy merchant services without providing significant
regulatory benefits. Given that such entities would be subject to
registration as a swap dealer if they exceed the $8 billion General De
Minimis Threshold, the Commission agrees that barring financial
entities from taking advantage of the exclusion could thwart the
purpose of the rulemaking while providing minimal additional regulatory
protections. Therefore, the Commission is not adopting in Regulation
1.3(ggg)(4)(i)(B) any limitations on the persons who are permitted to
rely upon the exclusion provided by the regulation.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \75\ requires that Federal
agencies consider whether the rules they propose will have a
significant economic impact on a substantial number of small entities
and, if so, they must provide a regulatory flexibility analysis
respecting the impact. Whenever an agency publishes a general notice of
proposed rulemaking for any rule, pursuant to the notice-and-comment
provisions of the Administrative Procedure Act \76\ a regulatory
flexibility analysis or certification typically is required.\77\
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\75\ 5 U.S.C. 601 et seq.
\76\ 5 U.S.C. 553. The Administrative Procedure Act is found at
5 U.S.C. 500 et seq.
\77\ See 5 U.S.C. 601(2), 603-05.
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The Commission stated in the Proposal that the proposed amendments,
if adopted, would not have a significant economic impact on affected
persons because they would primarily relieve such persons from
regulatory obligations (e.g., reporting, recordkeeping and business
conduct requirements) that would otherwise apply to them if they had to
register as swap dealers. The Commission further stated that to the
extent that any small entities opted to rely on the exclusion, the
notice requirement would not have a significant economic impact on
those entities. Finally, it noted that the number of potential
counterparties seeking to rely on the proposed exclusion may be
limited, given the local nature of the relevant markets.
Accordingly, the Chairman, on behalf of the Commission, certified
pursuant to 5 U.S.C. 605(b) that the Proposal will not have a
significant economic impact on a substantial number of small
entities.\78\
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\78\ 79 FR 31238 at 31243-31244.
---------------------------------------------------------------------------
Two commenters addressed the Commission's RFA discussion.\79\ Both
commenters argued that the Commission's preliminary estimate that 100
persons would seek to rely upon the exclusion provided in Regulation
1.3(ggg)(4)(i)(B) was low, with one commenter positing that the
Commission underestimated the number of counterparties by a factor of
twenty.\80\ The commenters argued that even an inconsequential notice
filing could dissuade a potential counterparty from engaging in swaps
with a utility special entity, given the lack of any comparable filing
requirement if the counterparty were to offer the same swap to an
investor-owned utility. The commenters argued that the vast majority of
utility special entities are small entities, and that the cumulative
economic impact on those small entities would be significant.
---------------------------------------------------------------------------
\79\ See NFP and IECA Comment Letters.
\80\ This estimate is contained in NFP's letter to the Office of
Information and Regulatory Affairs of the Office of Management and
Budget concerning the Commission's PRA analysis. A copy of the
letter is attached as Attachment C to the NFP Comment Letter.
---------------------------------------------------------------------------
In response, the Commission notes first that the RFA does not
require the Commission to consider whether a proposed rulemaking will
have a significant economic impact on persons indirectly affected by
that rulemaking. The entities directly affected by the Amendments are
counterparties to utility special entities, not the utility special
entities themselves. Furthermore, the Commission is not required to
conduct a full regulatory flexibility analysis under the RFA because
the Amendments will not have a significant economic impact on any such
small entities.
The Commission's preliminary estimate of the number of persons who
would rely on Regulation 1.3(ggg)(4)(i)(B) was based on the information
available to the Commission at the time and was provided with the hope
of generating industry comment. The Commission questions the accuracy
of the one commenter's estimate of the number of persons who will rely
on Regulation 1.3(ggg)(4)(i)(B), which appears to have been based, at
least in part, on a limited sampling of a handful of utility special
entities and does not appear to sufficiently factor in the possibility
that utility special entities may transact with many of the same
counterparties. However, even accepting the commenter's estimate
(which, for the reasons stated above, the Commission believes may be
high), the Commission believes that the Amendments will not have a
significant economic impact on small entities.
While it may be that some counterparties to utility special
entities are small entities, not all of them may find need to rely on
Regulation 1.3(ggg)(4)(i)(B). For example, counterparties who are small
entities may be entering into swaps with utility special entities to
hedge physical positions as set forth in Regulation 1.3(ggg)(6)(iii).
Such swaps would not be counted toward any de minimis threshold.
For those small entities who, as counterparties to utility special
entities, do rely on Regulation 1.3(ggg)(4)(i)(B), the Commission does
not believe the burdens of Regulation 1.3(ggg)(4)(i)(B) will be
significant. As discussed above, the Commission has not included in
Regulation 1.3(ggg)(4)(i)(B) as adopted the proposed notice filing
requirement. With respect to any recordkeeping obligations arising out
of Regulation 1.3(ggg)(4)(i)(B), the Commission believes that many
counterparties will rely on a representation by the utility special
entity that it and the swap meet the requirements of the final
regulation, and such a representation will most likely be included in
swap documentation that a counterparty is already required to keep
under existing regulations. Thus, the Commission believes that the
economic impact resulting from the obligations imposed by the
Amendments for record keeping purposes will not be significant.
B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA) \81\ provides that an agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a valid control number
from the Office of Management and Budget (OMB). The Proposal contained
notification and recordkeeping requirements that are collections of
information within the meaning of the PRA. Accordingly, the Commission
submitted the required information collection requests to OMB.
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\81\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
1. Collections of Information
Regulation 1.3(ggg)(4)(i)(B) creates an exclusion from the Special
Entity De Minimis Threshold with regard to specified swaps (utility
operations-related swaps) entered into with a defined subset of special
entities (utility special entities). As noted, the Proposal contained
two elements that would qualify as collections of information. First,
as proposed, a person seeking to rely on the exclusion would have been
[[Page 57778]]
required to file a one-time notice, to be filed electronically with
NFA, and containing the person's name, address, and a contact, as well
as a signed representation that the person meets the criteria of the
exclusion for utility operations-related swaps in Regulation
1.3(ggg)(4)(i)(B). Based upon the limited information available to the
Commission at the time of the Proposal, the Commission preliminarily
used a conservative estimate of 100 potential counterparties of utility
special entities, estimated that the filing of the notice and ongoing
verification of compliance would take 1.2 hours annually, and
calculated an annual reporting burden of $79,680. On that basis, the
Commission requested a new collection of information control number
from OMB and invited public comment on its paperwork burden
calculations or the notice filing requirement.
Second, as proposed, Regulation 1.3(ggg)(4)(i)(B) also required a
person seeking to rely on the proposed exclusion for utility
operations-related swaps to maintain books and records in accordance
with Regulation 1.31 to substantiate its eligibility. As noted above,
the Commission preliminarily estimated that 100 persons may seek to
rely on the exclusion for utility operations-related swaps, if adopted.
The Commission estimated that the recordkeeping requirement would take
one hour annually, and calculated an annual recordkeeping burden of
$16,100. On this basis, the Commission submitted a request to amend OMB
Control Number 3038-0090 and invited public comment on its paperwork
burden calculations and the recordkeeping requirement.
2. Information Collection Comments
The Commission invited comment on any aspect of the information
collection requirements discussed in the Proposal. One commenter
addressed the Commission's PRA estimates.\82\ The commenter expressed
the view that the Commission had failed to explain the need for the
notice filing requirement or the ways in which the Commission would use
the information so obtained, and predicted that the costs of utility
operations-related swaps would be increased due to regulatory risk to
potential counterparties, costs of collecting data, and arranging to
file the notice with NFA. The commenter further stated that the
Commission had not identified the additional books or records that
would be required to be kept, over and above the existing requirements
applicable to persons engaging in swaps, or how the Commission would
use that additional information. Moreover, the commenter asserted that
the Commission had underestimated the gross annual reporting burden by
a factor of twenty.
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\82\ See NFP Comment Letter.
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In response to these comments, the Commission notes that in
adopting Regulation 1.3(ggg)(4)(i)(B) it has made significant changes
to the regulation as proposed. After consideration of the comments
received, and as stated above, the Commission has determined not to
adopt in Regulation 1.3(ggg)(4)(i)(B) a notice filing requirement.
This eliminates the first collection described above.\83\ In
addition, as adopted, Regulation 1.3(ggg)(4)(i)(B)(4) permits a person
to rely upon a written representation obtained from a utility special
entity that it is a utility special entity under the regulation, and
that the swap the person engages in with the utility special entity is
a utility operations-related swap. The regulation does not, then,
contain a general recordkeeping requirement to substantiate a person's
eligibility to rely on the exclusion. Instead, the only recordkeeping
requirement the Commission has adopted is that the person keep, in
accordance with Regulation 1.31, any written representations the person
may have obtained from utility special entities in accordance with
Regulation 1.3(ggg)(4)(i)(B)(4) as adopted. As commenters noted,
counterparties to swaps are already subject to recordkeeping
requirements under Part 45 of the Commission's regulations, and those
requirements, together with the requirement in Regulation
1.3(ggg)(4)(i)(B)(4) to retain any such written representations, should
be sufficient for the Commission's compliance purposes. This is a
reduction from the paperwork burden for the second collection described
above and as proposed.
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\83\ In response to the Commission's request for a new control
number for this collection, OMB granted new OMB Control Number 3038-
0109. However, because the Commission has determined not to adopt
the proposed notice filing requirement, Commission staff will
request that OMB discontinue that control number.
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The PRA requires, in part, that each collection of information
submitted to OMB is necessary for the proper performance of the
functions of the agency, including that the information has practical
utility. In the submissions to OMB for the Proposal, the Commission
identified the reasons why the collection is necessary for the agency
and how it will use the information.
The requirement to keep a record of the written representation that
a counterparty obtains from a utility special entity and on which the
counterparty relies in determining that it is eligible for the
exclusion in Regulation 1.3(ggg)(4)(i)(B) will enable the Commission to
quickly and efficiently confirm that persons relying on the exclusion
are eligible to rely on the exclusion.
As the Commission stated in the Proposal, the number of 100
potential respondents for PRA purposes (i.e., counterparties to engage
in utility operations-related swaps with utility special entities) was
a preliminary and conservative estimate based on the limited
information available to the Commission at the time. One commenter
argued that this estimate understated the actual PRA burden by a factor
of 20.\84\ As mentioned above, the Commission questions the accuracy of
this estimate, which appears to have been based, at least in part, on a
limited sampling of a handful of utility special entities and does not
appear to sufficiently factor in the possibility that utility special
entities may transact with many of the same counterparties.
Nevertheless, the Commission has recalculated its PRA burden estimates
using the commenter's estimate. The recalculation takes into account
the Commission's determination not to adopt in Regulation
1.3(ggg)(4)(i)(B) the proposed notice filing requirement. The
recalculation also takes into account a reduction in the estimate from
the Proposal of the average burden hours due to the Commission's belief
that any additional recordkeeping costs imposed by the Amendments are
likely to be small, as most of the costs are most likely already being
incurred.\85\
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\84\ See NFP Comment Letter.
\85\ The Commission believes that the costs that are already
being incurred include costs to the person using the exclusion to
monitor its swap trading activity with special entities. Prior to
the adoption of this exclusion, these persons would be subject to
registration as a swap dealer if their swap dealing exceeded the
Special Entity De Minimis Threshold. Therefore, these persons are
likely already monitoring their dealing activity with all special
entities. The additional costs would only be the cost of separately
monitoring their dealing in utility operations-related swaps with
utility special entities.
---------------------------------------------------------------------------
Accordingly, the Commission has recalculated the estimated burden
from that set forth in the Proposal, using an estimate of 2,000
respondents and reducing the annual burden hours \86\ by half, as
follows:
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\86\ The hourly rate used in the burden estimate of the
recordkeeping requirement is the same as the hourly rate for a
financial analyst ($161/hour), which was used for purposes of the
Commission's cost benefit considerations in the swap dealer
definition regulations that are being amended by the Amendments. See
77 FR at 30715, n.1359.
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[[Page 57779]]
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Recordkeeping requirement:
Number of Respondents: 2,000.
Frequency of Response: Annually.
Average Burden Hours per Response: 0.5.
Estimated Gross Annual Reporting Burden: $161,000.
On this basis, the Commission is amending its requests to OMB with
respect to Control Number 3038-0090 for the recordkeeping requirement.
C. Cost-Benefit Considerations
CEA Section 15(a) requires the Commission to consider the costs and
benefits of its actions before promulgating a regulation under the CEA
or issuing certain orders. CEA Section 15(a) further specifies that the
costs and benefits shall be evaluated in light of five broad areas of
market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
considers the costs and benefits resulting from its discretionary
determinations with respect to the Section 15(a) factors, and seeks
comments from interested persons regarding the nature and extent of
such costs and benefits.
1. Background. The Commission is amending its regulations to permit
a person to exclude utility operations-related swaps with utility
special entities in calculating the aggregate gross notional amount of
the person's swap positions for purposes of the Special Entity De
Minimis Threshold.
As discussed above, CEA Section 1a(49) defines the term ``swap
dealer,'' and Regulation 1.3(ggg) further defines that term. A person
who comes within the swap dealer definition is subject to registration
as such with the Commission and the regulatory requirements applicable
to swap dealers.\87\ Regulation 1.3(ggg)(4)(i) provides an exception
from the swap dealer definition for persons who engage in a de minimis
amount of swap dealing activity. Without the adoption of Regulation
1.3(ggg)(4)(i)(B), persons who engage in swap dealing activity with
special entities, including utility special entities, are excepted from
the swap dealer definition so long as the swap positions connected with
those dealing activities into which the person enters over the course
of the immediately preceding 12 months have an aggregate gross notional
amount of no more than $25 million (i.e., the Special Entity De Minimis
Threshold). These regulatory provisions set the baseline for the
Commission's consideration of the costs and benefits of the Amendments.
That is, the Commission considered the costs and benefits that would
result from allowing persons to exclude utility operations-related
swaps with utility special entities from the Special Entity De Minimis
Threshold ($25 million), such that the de minimis threshold with
respect to such swaps would be the same as for swaps not involving a
special entity (i.e., the General De Minimis Threshold, currently set
at $8 billion), subject to the requirements set forth in the
Amendments.\88\
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\87\ See, e.g., Part 23 of the Commission's regulations.
\88\ While Staff Letter 14-34 provided no-action relief in
certain circumstances, and subject to certain requirements, that are
similar to those of the Amendments, the Commission believes that
Staff Letter 14-34 did not set or affect the baseline from which the
Commission considered the costs and benefits of the Proposal. This
is because Staff Letter 14-34 only stated the position of the
Division that it would not recommend enforcement action to the
Commission and, further, that the letter and the positions taken
therein do not necessarily represent the position or view of the
Commission or any other office or division of the Commission.
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The Commission invited comments from the public on all aspects of
its preliminary consideration of costs and benefits associated with the
Proposal, and the Cost-Benefit Considerations section of the Proposal
was followed by a set of specific questions. While those who commented
on the Proposal did not specifically address the Cost-Benefit
Considerations section of the Proposal, certain of the comments raised
issues with respect to the Commission's cost-benefit considerations.
Accordingly, although the Commission has addressed those comments above
in connection with the specific proposed regulatory provision of the
Amendments to which they referred, the Commission is also referencing
those comments in the discussion that follows.
2. Costs. As noted by the Commission in the Swap Dealer Definition
Adopting Release, ``a de minimis exception, by its nature, will
eliminate key counterparty protections provided by Title VII for
particular users of swaps . . . [and] [t]he broader the exception, the
greater the loss of protection.'' \89\ In adopting the Special Entity
De Minimis Threshold, the Commission explained that the $25 million
threshold was ``appropriate in light of the special protections that
Title VII affords to special entities.'' The Commission also recognized
the ``serious concerns raised by commenters'' regarding the application
of the de minimis exception to swap dealing with special entities in
light of losses that special entities have incurred in the financial
markets.\90\
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\89\ See 77 FR at 30596, 30627-30628.
\90\ See 77 FR at 30633.
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One effect of the Amendments is that a greater quantity of swap
dealing with utility special entities will potentially be undertaken
without the benefits to utility special entities of that dealing
activity being subject to swap dealer regulation.\91\ In addition, the
Amendments will impose costs associated with ascertaining whether a
person is eligible to rely on the proposed exclusion for utility
operations-related swaps. Finally, to the extent that a person relying
on the exclusion would be required to keep books and records it would
not otherwise keep, that represents another potential cost. The
Commission invited comment regarding the extent of all of these costs,
and any other costs that would result from adoption of the Proposal,
including estimates of monetary or other measurements thereof.
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\91\ See 77 FR at 30707 (stating that the benefits of swap
dealing regulation include customer protection, market orderliness
and market transparency).
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Certain comments characterized the compliance and other costs of
making the notice filing and keeping the books and records called for
under the Proposal as excessive, not justified, and likely to deter
counterparties from engaging in swaps with utility special
entities.\92\ As noted above, the Commission has determined not to
adopt the proposed notice filing requirement, and has reduced the scope
of the recordkeeping requirement under the final regulation to only
include a requirement to keep the written representations, if any, from
utility special entities.\93\ As a result, the costs associated with
the proposed notice requirement have been eliminated, and the
Commission believes the costs associated with the recordkeeping
requirement on an individual basis will be less than the estimate
contained in the Proposal.\94\
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\92\ See, e.g., NFP and IECA Comment Letters.
\93\ The Commission notes that acquiring written representations
to verify that a counterparty is a utility special entity and the
swap is a utility operations-related swap in accordance with
Regulation 1.3(ggg)(4)(i)(B)(4) is elective.
\94\ The Commission has provided above an estimate of the annual
costs associated with the recordkeeping requirement for purposes of
the PRA.
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3. Benefits. With respect to benefits, the Commission explained in
the Proposal its belief that the exclusion in Regulation
1.3(ggg)(4)(i)(B) will benefit utility special entities and the public
by
[[Page 57780]]
encouraging a greater number of prospective counterparties to engage
with utility special entities in utility operations-related swaps.\95\
Because of the local and particularized nature of electric and natural
gas production and distribution, the number of potential swap
counterparties for utility special entities seeking to hedge commercial
risk is more limited than for other special entities seeking to hedge
non-physical commodities. The number of counterparties to utility
special entities may be further limited due to the unique obligation of
these utilities to provide continuous service to the public. These
considerations may be more critical given the important role energy
services play in public safety and commerce. Thus, potentially
increasing the number of counterparties to utility special entities may
be in the public interest.
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\95\ The Commission explained in the Swap Dealer Definition
Adopting Release that ``[i]n principle, a higher [de minimis]
threshold would promote a larger pool of swap-dealing entities
(since entities with swap dealing activity below the threshold need
not incur costs to comply with swap dealer regulations), meaning
more potential counterparties available to swap users.'' See 77 FR
at 30707.
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Accordingly, increasing the number of potential counterparties
available for utility special entities to engage in operations-related
hedging transactions may (i) result in a lower cost to hedge (i.e.,
lower spreads) and (ii) enable utility special entities to better
manage their business. This should, in turn, help utility special
entities meet their obligations to provide continuous services to the
public in a cost-effective manner, and will help protect the public
interest and safety that is dependent on such energy services. The
Commission sought comments regarding these benefits and any other
benefits resulting from adoption of the Proposal, and to the extent
they can be quantified, estimates of the monetary or other value
thereof.
While commenters did not specifically address the Commission's
consideration of the costs and benefits of the Proposal, certain of the
comments raise issues with respect to the Commission's costs and
benefits considerations. Specifically, as discussed with respect to the
comments the Commission received on its RFA analysis, the proper
baseline from which to consider the costs and benefits of the
regulation is the state of affairs at the time the regulation is to be
adopted (i.e., a counterparty to a utility special entity is required
to register as a swap dealer if they exceed the Special Entity De
Minimis Threshold). Registration as a swap dealer entails costs that a
person who can take advantage of the exclusion in Regulation
1.3(ggg)(4)(i)(B) would not have to incur.
As noted above, some of the commenters were of the view that the
notice filing and recordkeeping requirements are unjustified or
inadequately supported by the explanation in the Proposal. The
commenters further stated that the Commission could monitor use of the
exclusion by using existing data reported to the SDRs. As noted above,
the Commission has not included a notice filing requirement in
Regulation 1.3(ggg)(4)(i)(B) as adopted. As a result, the costs
associated with the notice filing requirement that were identified in
the Proposal have been eliminated.
Although there are additional costs associated with maintaining
records pertaining to the use of the exclusion, such costs are likely
to be incremental since most persons relying on the exclusion are
likely to rely on a representation from their counterparty, a utility
special entity, that it qualifies as a utility special entity and that
the swap transaction is a utility operations-related swap within the
meaning of the final regulation. Such a representation would likely be
added to the swap documentation that counterparties are already
required to maintain under existing regulations or that they maintain
in the normal course of their business.
The general recordkeeping requirement that was included in the
Proposal has been reduced to a requirement to retain only the written
representations, if any, that a person receives from a utility special
entity. Accordingly, the recordkeeping costs of the Amendments on an
individual basis will be less than as estimated in the Proposal. The
requirement to keep those written representations will enable the
Commission to quickly and efficiently confirm that persons relying on
the exclusion are eligible to rely on the exclusion.
Additionally, expanding the definition of utility operations-
related swap to include swaps related to certain agricultural
commodities will provide benefits to utility special entities that use
such swaps in their normal operations, and in a manner consistent with
the purposes of the regulation. However, the Commission notes that
there may be costs associated with expanding the definition.
Specifically, an overbroad definition that does not properly balance
the need to provide additional regulatory protections for special
entities, including utility special entities, against the policies for
the exclusion would be contrary to the public interest.
4. Section 15(a). Section 15(a) of the CEA requires the Commission
to consider the effects of its actions in light of the following five
factors:
a. Protection of Market Participants and the Public. Again, as
noted by the Commission in the Swap Dealer Definition Adopting Release,
``a de minimis exception, by its nature, will eliminate key
counterparty protections provided by Title VII for particular users of
swaps . . . [and] [t]he broader the exception, the greater the loss of
protection.'' \96\ In adopting the Special Entity De Minimis Threshold,
the Commission explained that the $25 million threshold was
``appropriate in light of the special protections that Title VII
affords to special entities.'' \97\ The Commission also recognized the
``serious concerns raised by commenters'' regarding the application of
the de minimis exception to swap dealing with special entities in light
of losses that special entities had incurred in the financial markets
in connection with the 2008 financial crisis.\98\ By allowing more
persons who are not registered as swap dealers to engage in certain
swaps with utility special entities, fewer special entities will have
the benefit of the special entity protections as a result of the
Amendments. However, given the narrow tailoring of the exclusion and
the requirements persons must meet to rely on the exclusion, the
Commission believes the costs of such reduced protections to the
affected utilities, market participants and the public may be limited.
Moreover, these costs will be counteracted by the benefits the
Amendments will provide to utility special entities and the public,
namely, enabling utility special entities to efficiently hedge and
manage risk, and to meet their obligations to provide vital energy
services to the public in a consistent and cost-effective manner.
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\96\ 77 FR at 30596, 30627-30628.
\97\ Id. at 30633.
\98\ Id.
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b. Efficiency, Competitiveness, and Financial Integrity of Markets.
The Commission believes that the Amendments will enhance efficiency and
competitiveness in the electricity and natural gas markets by
encouraging prospective counterparties to engage in swap transactions
with utility special entities. The availability of additional swap
counterparties in these markets will enhance competition between
counterparties, which will, in turn, benefit utility special entities
by potentially lowering their transaction
[[Page 57781]]
costs. Further, because the exclusion is narrowly tailored, the
Commission believes that removing the protections provided by swap
dealer registration and regulation for some utility special entity
counterparties will not noticeably impact the integrity of the swaps
market.
c. Price Discovery. It is unlikely that facilitating more
counterparties for utility special entities to trade with will have a
significant impact on price discovery. Price discovery is the process
by which prices for underlying commodities may be determined or
inferred through market prices. The addition of more counterparties
willing to trade with utility special entities may improve, and should
not adversely impact, the prices that the utility special entities
receive on their swap contract transactions. Better pricing might
enhance price discovery if the bid-ask spreads in transactions
involving utility special entities narrow due to more competition, but
the Commission cannot be sure this will be the case as the potential
improved pricing might not occur or could be negligible.
d. Sound Risk Management. The Commission believes that if
counterparties refrain from transacting in swaps with utility special
entities because of the regulatory costs associated with swap dealer
registration and regulation, the ability of utility special entities to
hedge commercial risks will be impaired, particularly in cases for
which the number of counterparties available becomes very limited.
Mitigating the costs and regulatory concerns of potential
counterparties by permitting them to transact with utility special
entities without being subject to swap dealer registration and
regulation will enable utility special entities to better manage their
commercial risk.
e. Other Public Interest Considerations. As discussed above, the
Commission believes the Amendments will enable utility special entities
to practice sound, cost-effective risk management and to more
effectively operate and conduct their business. This may, in turn, help
utility special entities meet their obligations to provide continuous
services to the public in a more cost-effective manner.
List of Subjects in 17 CFR Part 1
De minimis exception, Registration, Special entities, Swap dealers,
Swaps, Utility operations-related swaps, Utility special entities.
For the reasons discussed in the preamble, the Commission amends 17
CFR part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 9,
10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 (2012).
0
2. In Sec. 1.3, revise paragraph (ggg)(4)(i) to read as follows:
Sec. 1.3 Definitions.
* * * * *
(ggg) * * *
(4) De minimis exception--(i)(A) In general. Except as provided in
paragraph (ggg)(4)(vi) of this section, a person that is not currently
registered as a swap dealer shall be deemed not to be a swap dealer as
a result of its swap dealing activity involving counterparties, so long
as the swap positions connected with those dealing activities into
which the person--or any other entity controlling, controlled by or
under common control with the person--enters over the course of the
immediately preceding 12 months (or following the effective date of
final rules implementing Section 1a(47) of the Act, 7 U.S.C. 1a(47), if
that period is less than 12 months) have an aggregate gross notional
amount of no more than $3 billion, subject to a phase in level of an
aggregate gross notional amount of no more than $8 billion applied in
accordance with paragraph (ggg)(4)(ii) of this section, and an
aggregate gross notional amount of no more than $25 million with regard
to swaps in which the counterparty is a ``special entity'' (as that
term is defined in Section 4s(h)(2)(C) of the Act, 7 U.S.C.
6s(h)(2)(C), and Sec. 23.401(c) of this chapter), except as provided
in paragraph (ggg)(4)(i)(B) of this section. For purposes of this
paragraph, if the stated notional amount of a swap is leveraged or
enhanced by the structure of the swap, the calculation shall be based
on the effective notional amount of the swap rather than on the stated
notional amount.
(B) Utility Special Entities. (1) Solely for purposes of
determining whether a person's swap dealing activity has exceeded the
$25 million aggregate gross notional amount threshold set forth in
paragraph (ggg)(4)(i)(A) of this section for swaps in which the
counterparty is a special entity, a person may exclude ``utility
operations-related swaps'' in which the counterparty is a ``utility
special entity.''
(2) For purposes of this paragraph (4)(i)(B), a ``utility special
entity'' is a special entity, as that term is defined in Section
4s(h)(2)(C) of the Act, 7 U.S.C. 6s(h)(2)(C), and Sec. 23.401(c) of
this chapter, that:
(i) Owns or operates electric or natural gas facilities, electric
or natural gas operations or anticipated electric or natural gas
facilities or operations;
(ii) Supplies natural gas or electric energy to other utility
special entities;
(iii) Has public service obligations or anticipated public service
obligations under Federal, State or local law or regulation to deliver
electric energy or natural gas service to utility customers; or
(iv) Is a Federal power marketing agency as defined in Section 3 of
the Federal Power Act, 16 U.S.C. 796(19).
(3) For purposes of this paragraph (ggg)(4)(i)(B), a ``utility
operations-related swap'' is a swap that meets the following
conditions:
(i) A party to the swap is a utility special entity;
(ii) A utility special entity is using the swap to hedge or
mitigate commercial risk as defined in Sec. 50.50(c) of this chapter;
(iii) The swap is related to an exempt commodity, as that term is
defined in Section 1a(20) of the Act, 7 U.S.C. 1a(20), or to an
agricultural commodity insofar as such agricultural commodity is used
for fuel for generation of electricity or is otherwise used in the
normal operations of the utility special entity; and
(iv) The swap is an electric energy or natural gas swap, or the
swap is associated with: The generation, production, purchase or sale
of natural gas or electric energy, the supply of natural gas or
electric energy to a utility special entity, or the delivery of natural
gas or electric energy service to customers of a utility special
entity; fuel supply for the facilities or operations of a utility
special entity; compliance with an electric system reliability
obligation; or compliance with an energy, energy efficiency,
conservation, or renewable energy or environmental statute, regulation,
or government order applicable to a utility special entity.
(4) A person seeking to rely on the exclusion in paragraph
(ggg)(4)(i)(B)(1) of this section may rely on the written
representations of the utility special entity that it is a utility
special entity and that the swap is a utility operations-related swap,
as such terms are defined in paragraphs (ggg)(4)(i)(B)(2) and (3) of
this section, respectively, unless it has information that would cause
a reasonable person to question the accuracy of the representation. The
[[Page 57782]]
person must keep such representation in accordance with Sec. 1.31.
* * * * *
Issued in Washington, DC, on September 23, 2014, by the
Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Exclusion of Utility Operations-Related Swaps With
Utility Special Entities From De Minimis Threshold for Swaps With
Special Entities--Commission Voting Summary and Chairman's Statement
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioners Wetjen, Bowen,
and Giancarlo voted in the affirmative. No Commissioner voted in the
negative.
Appendix 2--Statement of Chairman Timothy G. Massad
I support this final rule pertaining to the swap activities of
small utility companies. These companies are responsible for keeping
the lights on in communities across our country, for heating and
cooling our homes, and powering the kitchen appliances that we use
every day to feed our families. To do their job, they must manage
the risk of their own fuel costs, and to do that, they must be able
to access the energy commodity markets. This final rule will help
make sure they can do so.
In the Dodd-Frank Act, Congress directed the Commission to
impose heightened standards on swap dealers in their swap activities
with Federal, state and municipal government agencies and certain
other so-called ``special entities.'' This was in response to the
instances where swap dealers may have failed to disclose material
risks of swap transactions to municipal entities or otherwise acted
improperly, which often resulted in massive losses to the
municipality.
Because Congress defined ``special entity'' broadly, when the
Commission implemented this Congressional directive through a
previous rulemaking, the rule was applied to many utility companies
that are government-owned. These companies, which serve communities
across our nation, engage in energy swaps. The counterparties with
whom they transact business were often not registered swap dealers,
nor were they the dealers that engaged in the abusive practices that
led to Congress's concerns. The imposition of these requirements
through a designation as a swap dealer could unduly burden their
business and thereby threaten the ability of our local utility
companies to manage their risks. This rule fixes that problem.
This final rule benefited from public comment. In key respects,
we made adjustments to our initial proposal to address concerns
raised during the notice and comment process.
Implementing this final rule is an important step in our effort
to finish the job of implementing the Dodd-Frank Act and will help
us achieve the full benefit of the new regulatory framework, while
at the same time protecting the interests of--and minimizing the
burdens on--commercial end-users who depend on the derivatives
markets to hedge normal business risks.
[FR Doc. 2014-22966 Filed 9-25-14; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: September 26, 2014