The Commodity Futures Trading Commission (“CFTC,” or the “Commission”) has begun a process to assess the de minimis exception to the Commodity Exchange Act’s swap dealer definition in connection with the end of the definition’s phase-in period in December 2017. At that time the swap dealer de minimis threshold will automatically fall from $8 billion to $3 billion, unless the Commission specifies a different de minimis threshold.
On November 18, 2015, the staff of the CFTC released a preliminary report that addresses the de minimis exception. Of potential concern to some end-users, the preliminary report also considers more generally what it means to be a “swap dealer.” As the end of the comment period approaches, we have been reflecting on the findings of the CFTC staff, the questions posed and what impact a shift in policy consideration may have on our end-user energy clients. While the Commission’s adjustment of the gross notional de minimis threshold upward or downward is a lingering consideration, our attention has been focused primarily on whether the CFTC will (i) depart from its final interpretation of what constitutes swap dealing activity and (ii) adopt an alternative approach to the calculation of the de minimis threshold.
The report plainly states that whether a person is a swap dealer depends upon two questions: (1) does the person engage in activity that constitutes “swap dealing”; and (2) is that swap dealing activity more than de minimis? The concept of “swap dealing” initially caused some anxiety among end-users. Many people in the energy industry regularly entered into swaps as an ordinary course of business, but that surely did not mean that you were a swap dealer….or did it? Thankfully, this anxiety was relieved when the CFTC issued the joint final rule further defining the term “swap dealer” and adopted the classic demarcation between “dealing” and “trading” that the Securities and Exchange Commission has long used in its regulation of broker-dealers under the Securities Exchange Act. However, this reliance may be in jeopardy for companies that regularly enter into swaps with counterparties in the ordinary course of business for their own account. If the distinction between “dealing” and “trading” is blurred or altogether removed, there is a risk that more trades could be considered “dealing,” thereby affecting the trader’s de minimis calculation. While this risk is low, we recommend monitoring the final report for any further elaboration or interpretation.
In addition to seeking comments on the definition of “swap dealing”, the report seeks comments on four alternatives to the single gross notional threshold approach to the de minimis exception calculation. Without going into detail on each approach, what is important to note is that the CFTC staff seems to be considering a de minimis threshold based upon the number of a person’s trading counterparties or trading transactions. Depending upon the threshold numbers that the Commission establishes, this approach could be highly problematic for many end users. If the Commission decides to move away from the gross notional threshold approach, and move towards an approach based purely on number of counterparties or transactions, many end-users may face the difficult choice between either decreasing the end user’s swap activity to stay under the threshold or becoming a swap dealer. We recommend reviewing the methodologies based upon your circumstances, and monitoring the final report to see whether the Commission’s ultimate determination may affect your eligibility for the de minimis exception.
The Commission’s report doesn’t mean that the sky is falling, but some energy companies with large volumes of swap transactions might perceive a few clouds on the horizon. The report is preliminary and provides a means for the CFTC staff to get input from market participants on its analysis of the swap data it reviewed. A final report will be released later this year, so if you have missed the January 19 comment deadline don’t worry — there will be another opportunity to comment. We will continue to monitor and update you on the CFTC staff’s assessment of the de minimis exception. For reference, the CFTC’s preliminary report can be found here.