The Commodity Futures Trading Commission has approved, by a vote, a final rule regulating commodity options as "swaps" under The Dodd—Frank Wall Street Reform and Consumer Protection Act the Dodd-Frank Act , and an interim final rule IFR 1 establishing a "trade option exemption" that exempts certain physical option transactions from most, but not all, regulations related to swaps.
Commodity options are illegal unless and until the CFTC specifically authorizes them. The Commodity Options Final Rule 1 repeals and replaces prior CFTC regulations regarding commodity options; 2 authorizes market participants to engage in commodity options; and 3 subjects commodity options to the same rules applicable to all other swaps.
The CFTC retained certain pre-Dodd-Frank Act antifraud provisions to ensure that it has the regulatory tools to police the commodity options market. Section of the Dodd-Frank Act defines the term "swap" to include "a put, call, cap, floor, collar, or similar option of any kind that is for the purchase or sale, or based on the value, of 1 or more However, options on physical commodities are included in the statutory definition of "swap.
According to the CFTC, the final Swap Definitional Rule will contain guidance to assist market participants in determining whether a physical transaction that contains optionality is a swap. The CFTC addressed many of the core comments submitted by market participants.
The principal change that the CFTC adopted, in response to comments, was to rescind its prior proposal to withdraw the trade option exemption and to effectively restore that exemption through the IFR with modifications to reflect its authority over swaps. In further response to concerns about impacts on commercial end users, the CFTC underscored the discussion of physical forward transactions in its February Swap Definitional Rule. Additionally, the CFTC discussed the comments it received regarding transactions regulated by the Federal Energy Regulatory Commission, but it did not make any policy decision regarding these transactions in the Commodity Options Final Rule.
The Commodity Options Final Rule contains an IFR that establishes a new "trade option exemption" for certain physical delivery commodity options. The proposed rule would have removed the trade option exemption without implementing a replacement. As discussed above, the Commodity Options Final Rule permits commodity options to be transacted pursuant to all rules applicable to swaps. Commenters noted that many non-ECPs enter into commodity options transactions and thus the rule would have prohibited those participants from transacting in OTC physical options unless granted exemptive relief.
To address these concerns, the new trade option exemption exempts qualifying trade options from many, but not all, of the rules that apply to swaps. To qualify for the new trade option exemption, a transaction must meet the following three requirements:.
The offeror must "reasonably believe" that the offeree meets the requirements for being an offeree under the regulation. In determining whether the option, if exercised, is a "forward," the CFTC pointed out, as instructive, the discussion of "forwards" in the proposed Swap Definitional Rule and "such other guidance" that may be adopted in the final Swap Definitional Rule.
The IFR applies only to an option that, if exercised, is intended for physical delivery and that is purchased by a commercial end user of the underlying commodity. Conversely, commodity option transactions that include embedded optionality that affect volume but do not allow for zero physical delivery should be addressed under the forward contract exclusion in the final Swap Definitional Rule. Although the trade option exemption provides a general exemption from the rules otherwise applicable to swaps, such as mandatory clearing and exchange trading, the IFR subjects exempted trade options to certain enumerated rules otherwise applicable to swaps.
Under the IFR, all trade options are subject to the recordkeeping requirements of 17 C. In relation to reporting trade options, market participants that must comply with the swap reporting rules for other swaps besides trade options will be required to report trade options just like the other swaps it reports. If neither counterparty is required to report a trade option under part 45, then both counterparties must submit an annual filing to the CFTC, described further below.
If only one counterparty previously had to comply with part 45, then that counterparty is the reporting counterparty. If both counterparties had to previously report, then the determination of which counterparty will report is determined pursuant to the normal hierarchy in the swap reporting rules.
If neither party is required to report under this rule, then both counterparties must make an. Filers must provide the following information in Form TO:. Specifically, the CFTC requests comments on the costs and benefits of the annual notice filing and its relation to the goal of ensuring CFTC visibility of trade option positions. Comments are due June 26, Accordingly, market participants may want to comment on the IFR, especially with respect to its relation to the final Swap Definitional Rule.
Participants may also want to comment on those alternatives. The first Form TO will be due by March 1, for transactions entered into between January 1, and December 31, There is no Form TO filing requirement for transactions entered into between January 1, and December 31, For more information about the Final Rule and the comment process, please contact:. A copy of the final rule, approved on April 18, is available here.
An IFR allows interested parties to submit comments during the comment period and the agency will consider those comments in determining whether to revise the final rule.
The scienter standard under the antifraud provision of the final rule remains "intentionally or with reckless disregard. If both counterparties are of the same level i. To qualify for the new trade option exemption, a transaction must meet the following three requirements: The Offeror 5 must be either 1 an ECP or 2 a commercial end user. The Offeree 7 must be a commercial end user. The commodity option, if exercised, must be intended to be physically settled. If exercised, the transaction must either be a "spot" or "forward" transaction.
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