In the wake of the financial crisis of 2008, the G20 nations agreed to comprehensively regulate derivatives transactions (financial agreements – such as futures and swaps – to exchange certain payments based on the value of an underlying asset). In the US, this was implemented through the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, known as the Dodd-Frank Act.
While this new legal regime is primarily targeted towards the regulation of Wall Street banks, it also has had an adverse, unintended impact on other market participants such as agribusiness companies that use derivatives to lock in prices and hedge their commercial risks. In some ways, these new laws and regulations have made it more difficult for agribusinesses and other commercial entities to manage these risks.
Recently, however, things have begun to change. The Congress that took office in 2015 has already begun introducing amendments to the Dodd-Frank Act that will benefit end-users of derivatives. And Timothy Massad, the new Chairman of the Commodity Futures Trading Commission (CFTC) – the agency that oversees the commodity derivatives markets – has pledged to ‘fine-tune’ the Dodd-Frank regulations in order to ensure that they do not impose undue burdens on commercial companies. Two recent legislative initiatives in Congress, and two CFTC rule-making initiatives, illustrate this trend.
In Congress, one amendment to the Dodd-Frank Act was included in the Terrorism Risk Insurance Reauthorization Act of 2015 (TRIA). This amendment protects commercial end-users, cooperatives and certain ‘treasury affiliates’ (i.e., entities that enter into swaps to hedge the risk of multiple affiliated entities) from having to post collateral in connection with swaps that are not cleared. The CFTC and US banking regulators have already proposed rules that would achieve a similar result, but the TRIA amendment codifies this in statute and expands upon the proposed rules in certain ways.
Another bill that has passed the House, but not yet the Senate, would confirm and clarify that treasury affiliates are excepted from any mandatory clearing requirement for derivatives when they are entering into derivatives to hedge risk on behalf of their commercial end-user affiliates. This is an important exception in that it spares these treasury affiliates, and the corporate groups of which they are an integral part, from the high costs of clearing.
At the CFTC, meanwhile, chairman Timothy Massad has acted on his pledge to fine-tune the agency’s regulations in order to ensure that commercial end-users, particularly those in the agricultural and energy sectors, can use the derivatives markets effectively. First, the CFTC proposed amendments to a prior interpretation regarding the circumstances under which a typical commercial merchandising agreement would become a regulated swap due to certain elements of the transaction. Specifically, the CFTC interpretation addresses whether a forward contract remains unregulated even though it allows the parties to adjust the volume of the commodity to be delivered under the contract (referred to as ‘embedded volumetric optionality’).
The CFTC previously adopted a ‘seven-part’ interpretation for such forwards to be excluded from the agency’s swap regulations, but the requirements in that test are confusing, and have limited market participants’ ability to use this type of embedded volumetric optionality. The CFTC’s recent proposal to amend this interpretation would remove much of this ambiguity.
The CFTC also has proposed to amend some of the record-keeping requirements that it adopted after the Dodd-Frank Act in order to address concerns that they are too burdensome for certain commercial business operations. Currently, CFTC regulations subject all members of derivatives trading platforms and futures exchanges (among others) to more onerous record-keeping requirements than other market participants, even if such members are commercial end-users and not registered swap dealers or other regulated financial institutions. The CFTC’s recent proposal would ease these requirements for members of derivatives trading platforms and exchanges that are not required to register with the CFTC, largely treating them the same as other commercial users of derivatives.
Congress and the CFTC therefore appear willing to make common-sense amendments to the Dodd-Frank Act and its implementing regulations to reduce their adverse effects on commercial entities. Congress will have an opportunity to adopt more such amendments as it considers reauthorisation of the CFTC’s governing statute – the Commodity Exchange Act – during the year ahead.
It is thus an opportune time for agribusiness companies that participate in derivatives markets to engage with Congress and the CFTC to make their voices heard regarding any changes they deem appropriate. At a minimum, commercial companies should monitor this space closely, as the law continues to evolve rapidly.
By Terry Arbit, partner, and Jon Ammons, associate in the Washington DC office of global legal practice, Norton Rose Fulbright