Daily Rules, Proposed Rules, and Notices of the Federal Government
On July 21, 2010, President Obama signed the Dodd-Frank Act into law.
To apply its regulatory regime to the swap activity of intermediaries, the Commission must make a number of changes to its regulations to conform them to the Dodd-Frank Act. On June 7, 2011, the Commission published in the
The Commission is mindful of, and continues to consider, the comments received on the Proposal's amendments to regulation 1.35 (records of commodity interest and cash commodity transactions). Those comments were submitted by various groups, including DCMs, representatives of the FCM and IB communities, energy
The amendments adopted by this rulemaking primarily affect part 1 of the Commission's regulations, but also affect parts 4, 5, 7, 8, 15, 16, 18, 21, 22, 36, 41, 140, 145, 155, and 166. This rulemaking contains amendments of three different types: ministerial, accommodating, and substantive. Many of the amendments are purely ministerial—for instance, several changes update definitions to conform them to the CEA as amended by the Dodd-Frank Act; add to the Commission's regulations new terms created by the Dodd-Frank Act; remove all regulations and references pertaining to derivatives transaction execution facilities (“DTEFs”), a category of trading facility added to the CEA by section 111 of the Commodity Futures Modernization Act of 2000 (“CFMA”),
The accommodating amendments are essential to the implementation of the DFA in that they propose to add swaps, swap markets, and swap entities to numerous definitions and regulations, but are more than ministerial because they require some judgment in drafting. Accommodating amendments include, among other things, amending numerous definitions in regulation 1.3 to reference or include swaps; creating new definitions as necessary in regulation 1.3; amending recordkeeping requirements to include information on swap transactions; adding references to swaps and swap execution facilities (“SEFs”) in various part 1 regulations; and amending parts 15, 18, 21, and 36 to implement the DFA's grandfathering and phase-out of exempt boards of trade and exempt commercial markets.
The substantive amendments are changes that align requirements or procedures across futures and swap markets. They consist of amendments to regulation 1.31 that harmonize some of the current part 1 recordkeeping requirements with some of those applicable to SDs and MSPs under part 23 regulations
To aid the public in understanding the numerous changes to different parts of the CFTC's regulations adopted by this release, the Commission will also publish on its Web site a “redline” of the affected regulations which will clearly reflect the additions and deletions.
Several commenters argued that the Proposal was premature because many other rules remained to be proposed and finalized,
The Commission believes it was appropriate to have published the Proposal when it did. The purpose of this rulemaking is to conform the Commission's regulations to the CEA as
The Commission believes it is appropriate to make these conforming changes at this time. In adopting this final rule, the Commission is incorporating any changes necessitated by other final Dodd-Frank Act rulemakings.
The Commission is revising regulation 1.3 so that its definitions, which are used throughout the Commission's regulations, incorporate relevant provisions of the DFA. For instance, amended regulation 1.3 updates current definitions to conform them to the Dodd-Frank Act's amendments of the same terms in the CEA's definitions section,
In response to the proposed conforming amendments to the definition of “introducing broker,” Financial Services Roundtable (“FSR”) commented that a small commercial lender facilitating a swap transaction between a borrower and a third party, solely in connection with the lender's loan origination or syndication, should not have to register as an introducing broker (“IB”), but could possibly be required to do so under the amended definition. FSR commented further that such a result would be inconsistent with a 2004 staff no-action letter,
The Commission declines to further define the term “introducing broker” as FSR requested, and is adopting the term as proposed. However, the Commission believes that in the situation described by FSR, the small commercial lender would not be required to register as an IB, as long as it did not receive compensation from the third party with whom the lender arranges the borrower's swap. This analysis is based solely on the facts as presented by FSR in its comment letter and is consistent with previously issued staff no-action or interpretative letters.
Additionally, the Proposal revised the definition of “self-regulatory organization” (“SRO”) (regulation 1.3(ee)) to include SEFs, a new category of regulated markets under the DFA, and derivatives clearing organizations (“DCOs”). The Commission did not receive any comments concerning its proposal to amend this definition. Today's final rulemaking amends the definition of SRO by including SEFs. However, it does not amend the definition of SRO to include DCOs. Upon further reflection, the Commission has determined that the part 1 regulations applicable to SROs need not apply to DCOs in light of recently finalized regulations in part 39 implementing the Act's Core Principles for DCOs.
The Commission is (1) simplifying or clarifying certain existing regulation 1.3 definitions, and (2) adding several new definitions to regulation 1.3, pursuant to amendments to the CEA by the Dodd-Frank Act, existing regulations, and other amendments in the Proposal.
The term “contract market,” for instance, is not defined under the CEA, and is currently defined under regulation 1.3(h) as “a board of trade designated by the Commission as a contract market under the Commodity Exchange Act or in accordance with the provisions of part 33 of this chapter.” In certain provisions throughout the Commission's regulations, contract markets are also referred to as “designated contract markets.” Because both terms are used interchangeably within the regulations, the Commission has decided to revise the definition to mean contract market and designated contract market (“DCM”). Proposed regulation 1.3(h) contained one definition identified by the title “Contract market; designated contract market.” The proposed definition also corrected an erroneous cross-reference to part 33 as the regulations applicable to DCMs, which the Commission is correcting by changing it to a reference to part 38 of the Commission's regulations. No commenters addressed these changes. The Commission is adopting the definition in regulation 1.3(h) as proposed with one modification to reflect the fact that the Commission designates a board of trade as a contract market “under the Act and in accordance with part 38” as opposed to “under the Act or in accordance with part 38.”
The Proposal contained a similar clarification regarding the definition of “customer.” It simplified the definition of “customer” by combining two existing definitions, “customer; commodity customer” in regulation 1.3(k) and “option customer” in regulation 1.3(jj), and by adding swaps to the proposed definition. Therefore, the proposed definition included swap customers, commodity customers, and option customers, referring to them all with the single term, “customer.” Furthermore, the Commission proposed to revise all references to “commodity customer” and “option customer” throughout the Commission's regulations, but particularly in part 1, to simply refer to “customer.”
ETA commented that counterparties to electricity swap contracts are not customers analogous to futures customers, and, therefore, by expanding the “customer” concept to include entities that execute swaps, the Commission would impose “significant and inappropriate obligations” on swap counterparties. The Commission has decided to finalize the definition of customer, as proposed. ETA is correct that counterparties to bilaterally-executed swaps are principals, which is unlike trading futures, where FCMs are agents of their customers. However, FCMs will execute and clear swap transactions, as agents, equivalently to the manner in which they currently execute and clear futures transactions.
The Commission proposed to define the term “confirmation” to reflect its differing use in various regulations depending on whether a transaction is executed by an FCM, IB or CTA on the one hand, or by an SD or MSP on the other hand. In the first case, the registrant is acting as an agent. In the second, it is acting as a principal.
The Commission proposed to add to regulation 1.3 a definition of the term “registered entity,” currently provided in CEA section 1a(40), as revised by the Dodd-Frank Act. The proposed definition of “registered entity” is identical to its CEA counterpart and would include DCOs, DCMs, SEFs, swap data repositories (“SDRs”) and certain electronic trading facilities. To correspond with this new definition, the Commission also proposed to replace the current “Member of a contract market” definition with a new definition of “Member,” in regulation 1.3(q), which would be nearly identical to the “Member of a registered entity” definition provided in CEA section 1a(34), also as revised by the Dodd-Frank Act.
The ETA commented that the Commission should wait to define “registered entity,” “organized exchange,” “electronic trading facility,” and “trading facility” until the Commission enters into an MOU with FERC and publishes rules defining the scope of its jurisdiction over nonfinancial energy commodity swaps. According to the ETA, a SEF should not be deemed a registered entity. In addition, the ETA does not believe SEF participants should fall within the Commission's proposed definition of “member,” suggesting that it is inappropriate or premature to require SEF participants to have the same recordkeeping requirements as DCM members under regulation 1.35.
The Commission disagrees with the ETA's comment that it should wait to define the terms “registered entity,” “organized exchange,” “electronic trading facility” and “trading facility” until the Commission enters into an MOU with FERC and publishes rules defining the scope of its jurisdiction
With respect to the ETA's assertion that SEFs should not be deemed “registered entities,” the Commission notes that SEFs are already deemed “registered entities” under section 1a(40) of the CEA. Lastly, the term “member,” as defined under the CEA, includes “with respect to a registered entity * * * an individual, association, partnership, corporation or trust * * * having trading privileges on the registered entity.”
The Commission also proposed to add a definition of the term “order.” This term had not previously been defined by Commission regulations, although it is used in several of them,
Because proposed amendments to regulation 1.31 incorporated the term “prudential regulator,” as added to the CEA by the Dodd-Frank Act, the Commission proposed to define the term in regulation 1.3.
The Commission also proposed to add the term “registrant” to regulation 1.3 so that certain regulations in part 1 could refer to various intermediaries (
The Commission also proposed, and is hereby adopting, a definition of the term “retail forex customer” in regulation 1.3 because it appears in several regulations in part 1 and currently is only defined in part 5. The definition is identical in all material respects to the definition of this term as it currently appears in regulation 5.1(k).
The Commission is also finalizing the revised definition of “strike price” (regulation 1.3(kk)) as proposed so that this definition encompasses swaps in addition to futures. The Commission received no comments about this proposal.
The Proposal changed the defined term from “open contract” to “open position” and added provisions for commodity option transactions and swaps. CME commented that it is unclear whether the proposed definition is intended to cover options on swaps. If so, then the word “commodity” should be deleted from the phrase, “commodity option transaction.” According to CME's comment letter to the Proposal, the Commission should also clarify whether, or which, options are covered by proposed paragraph (t)(3) (swaps). CME also argues that proposed paragraph (t)(3) does not adequately characterize open positions in cleared swaps. Proposed paragraph (t)(1)'s terminology, CME believes, more appropriately characterizes cleared swaps because, like futures, cleared swaps may be fulfilled by delivery or they may be offset.
The Commission has decided to finalize the definition with a few modifications. The final definition retains the original title of the term, “open contract.” It also narrows its applicability from all swaps to only Cleared Swaps, as regulation 22.1 defines that term.
The Commission notes that the option component of the definition (paragraph (t)(2)) covers all options:
Because the only references in the regulations to the term “open contracts” apply to cleared contracts,
In the Proposal, pursuant to the revision of the definition of “open contract” in regulation 1.3(t), the Commission proposed to change “open contract” to “open position” in regulations 1.33 (“Monthly and confirmation statements”) and 1.34 (“Monthly record, `point balance' ”). The Commission did not receive comments about these changes. In light of the fact that the Commission is retaining the title “open contract,” in the final revisions to regulation 1.3(t), the Commission is preserving those references to “open contract” in regulations 1.33 and 1.34.
As part of the Proposal, the Commission explained that current regulation 1.3(ll) defines “physical” as “any good, article, service, right or interest upon which a commodity option may be traded in accordance with the Act and these regulations.”
In the Proposal, the Commission also traced the history of the term “physical” in its regulations, noting that the definition of “physical” was first added to its regulations “to enable trading, on DCMs, in options to buy or sell an underlying commodity” and that the definition had not been substantively amended.
In light of (1) The overlapping definitions of “commodity” and “physical” in Commission regulation 1.3, (2) the fact that options now are written on a wide range of non-physical commodities, and (3) the Commission's desire that the term “physical” not be interpreted to permit cash settled transactions to rely on the forward exclusion from the swap definition (unless otherwise permitted by Commission interpretations with respect to such exclusion, such as those discussed in the Commission's rulemaking jointly (with the Securities and Exchange Commission) further defining “swap”), the Commission, in the Proposal, requested comment on various possible approaches to the definition of “physical” in regulation 1.3(ll). One possible approach on which the Commission requested comment was whether it should eliminate the definition, on the theory that its meaning is self-evident, and rely on the ability of interested parties to interpret the term “physical.” The Commission also requested comment on not amending the definition in reliance upon the introductory language in regulation 1.3, which applies the regulation 1.3(ll) definition of “physical” unless the context otherwise requires.
Three commenters addressed the definition of physical in regulation 1.3(ll). The ETA commented that the proposed definition of “physical” should be withdrawn because addressing it in terms of swaps is premature prior to the Commission publishing the further definition of “swap,” including, in particular, defining the term “nonfinancial commodity,” which the ETA characterized as a key component of the forward exclusion from the swap definition. The ETA stated that, in proposing such a substantive rule, the Commission must explain how defining “physical” would affect all of its regulations and requested that the Commission re-propose any revised definition of “physical” with a “comprehensive analysis of the way such word, whether used as an adjective or an adverb, interrelates with the Dodd-Frank statutory term `nonfinancial commodity,' as well as the concepts of `cash market,' `physical market channels' and the `bona fide hedging exemption'.”
The Environmental Markets Association (“EMA”) believes that the “very broad” definition of the word “physical” in current Commission regulations “certainly” encompasses environmental commodities, which the EMA states are subject to the forward exclusion from the definition of swap. The EMA requested that the CFTC issue a final rule clarifying that environmental commodities are not swaps even though intangible, that they are nonfinancial commodities that can rely on the forward exclusion, and that intangibility of a commodity does not prevent it from being “physically settled.” The Coalition for Emission Reduction Policy (“CERP”) similarly argued that environmental and other intangible commodity transactions that result in actual delivery of a commodity, intangible or not, as opposed to transactions that settle in cash, can be subject to the forward exclusion because such transactions can be physically settled. CERP also claimed that the Commission's proposed interpretation of forward contracts in nonfinancial commodities in the definition of “swap” supports its interpretation of “physically settled” in that forward sales of environmental commodities are commercial merchandising transactions because both buyer and seller ultimately need and intend the transfer of ownership of the emission allowances or offset credits.
EMA also expressed that the Commission's request for comment with regard to whether the definition of “physical” should rely on the “common sense meaning” of the word was unclear. In particular, EMA argued that environmental commodities traded in the spot or forward markets are physically delivered via a registry or an exchange of paperwork and eventually consumed through retirement. Further, according to EMA, environmental commodities are goods because Uniform Commercial Code (“UCC”) section 2105(1) defines “good” as “anything that can be moved other than money.”
The Commission is removing from regulation 1.3(ll) the definition of “physical,” which term will therefore have the meaning dictated by the context of the individual Commission regulations in which it appears. In addition, the Commission is adopting conforming changes to other regulations to address the deletion of the definition. The Commission is adopting these changes for ease of reference for market participants and to reduce confusion in interpreting the Commission's regulations, consistent with the spirit of Executive Order 13563, which seeks, among other goals, to eliminate agency regulations that have outlived their usefulness.
When the Commission added the definition of “physical” to regulation 1.3 in 1982, the intent was to distinguish between options on futures contracts and other options subject to the Commission's jurisdiction; the Commission termed such other options “options on physicals.” The Commission added the “physical” definition because, while the 1982 rulemaking including provisions applicable both to DCM-listed options on futures and DCM-listed options on commodities, it also contained regulations applicable solely to options on futures. Thus, the purpose of the definition was “principally to enable the Commission to differentiate, where necessary, between references to options on physicals and options on futures contracts.”
The Commission did not intend, when it promulgated the definition in regulation 1.3(ll), to apply it to circumstances such as the definition of “physically” settled. Given the intent of the definition of the term “physical” (to distinguish options on futures from other options) and the introductory language in regulation 1.3 regarding contextual interpretations of the defined terms therein, in regulations where it is not necessary to distinguish between different types of options, the definition of “physical” in Commission regulation 1.3(ll) is not useful and can be overbroad. For example, the definition of “physical” is not useful with respect to the term “physical safeguards” in regulation 160.30, which pertains to procedures to safeguard customer records and information. Because the scope of the definition of “physical” essentially includes options on any commodity, which would include non-physical commodities such as temperatures and interest rates, effectively, the restriction that “physical” in regulation 1.3(ll) is limited to any goods, article, service, right or interest upon which a commodity may be traded in accordance with the CEA and the Commission's regulations is not much of a restriction at all.
The Commission also notes that it recently promulgated final and interim final rules amending parts 32 and 33 of the Commission's regulations.
In light of these considerations, the Commission believes that deleting the definition of physical will reduce the potential for confusion on the part of market participants, as the appropriate definition of that term will be based on the context of the individual rules in which the term is utilized. These amendments will also serve the goals of Executive Order 13563 by amending the Commission's regulations because they no longer are “effective in achieving the objectives for which they were adopted.”
Further, various Commission regulations relating to options also refer to a “physical” when discussing an option on a commodity. In order to conform those regulations with the adapting changes discussed above, the Commission is adopting a number of non-substantive changes including, but not limited to, replacing certain references to “physical” with references to “commodity.” Where appropriate, the Commission is also replacing references to “underlying physical” with references to “underlying commodity.”
For the reasons discussed above, these conforming amendments will not result in substantive changes. Therefore, the Commission is amending the following regulations as described above: Regulations 1.3(kk); 1.3(ll); 1.17(c)(1)(iii), (c)(5)(ii)(A), and (c)(5)(xiii)(C); 1.33; 1.34(b); 1.35(b)(2)(iii), (b)(3), (d) and (e); 1.39(a) and (a)(3); 1.46(a)(1)(iii) and (iv); 4.23(a) and (b); 4.33(b)(1); 15.00(p)(1)(ii); 16.00(a); and 16.01(a)(1)(ii) and (iv), and (b)(1)(ii) and (iv). The Commission is leaving unchanged other references to “physical” in its existing definitions because, given the context in which the term is used in those rules, such
The Commission is replacing the word “physical” in regulations 1.17(c)(1)(iii) and 1.17(c)(5)(xi) with the word “commodity,” and is replacing the word “physical” in regulation 1.17(c)(5)(ii)(A) with the term “physical commodity.” In so doing, the Commission does not intend to change the meaning of any of these paragraphs. Thus, final regulations 1.17(c)(1)(iii) and 1.17(c)(5)(xi) will continue to apply to options that overly any commodity, not just a tangible commodity. By contrast, final regulation 1.17(c)(5)(ii)(A) will continue to apply to the options described therein, which cover tangible commodities only.
While some commenters requested that the Commission interpret “physical” for purposes of the term “physically settled” within the forward exclusion for swaps, or generally address the definition of “physical” as it relates to other terms, the Commission declines to do so for purposes of this release. The conforming amendments to the definition of physical are non-substantive changes that are designed to increase clarity for market participants. As noted above, rather than have a definition of physical that applies unless the context “otherwise requires,” the Commission will apply the definition based on the particular context of the applicable regulation. Because the current definition already applies in this manner, the modifications addressed herein do not amount to a substantive change in the regulations.
The Commission proposed to amend the definition of foreign board of trade to mean “any board of trade, exchange or market located outside the United States, its territories or possessions, whether incorporated or unincorporated where foreign futures, foreign options, or foreign swap transactions are entered into.” The Commission received no comments regarding the proposed definition of “foreign board of trade” and is modifying the proposed definition to make it consistent with the definition provided in the final rulemaking for Registration of Foreign Boards of Trade.
The Commission proposed adding “swap” to the definition of “commodity interest” in regulation 1.3(yy).
The Dodd-Frank Act added a definition of the term “swap” to the CEA.
In their comment letter, the ETA objected to the Proposal's addition of the term “swap” to the definition of commodity interest because, as dis