At a recent speech at an energy industry conference CFTC Commissioner Scott D. O’Malia highlighted energy market participant concerns with the CFTC’s Dodd-Frank Rulemakings. These concerns indicate potential regulatory changes at the CFTC that could impact energy market participants.
Commissioner O’Malia noted that the CFTC must re-visit the swap dealer definition rule to “establish a clear regulatory regime” to exclude end-users from CFTC regulation. Commissioner O’Malia stated that “the Commission has applied inconsistent and incoherent requirements around bona fide hedging as part of the swap dealer threshold calculation.”
Commissioner O’Malia highlighted energy end-user concerns related to the interaction of forward contracts and the swap definition. Forward contracts are excluded from the swap definition and, therefore, generally are not regulated by the CFTC. A forward contract is generally the sale of an energy commodity, such as natural gas, for deferred shipment or delivery. However, if a forward contract includes “embedded optionality,” which targets the price term, the forward contract must meet a three-part test so that it is not regulated as a swap. There is a second test for forward contracts with “embedded volumetric optionality,” which targets the amount of commodity to be delivered. Commissioner O’Malia noted that the latter test “is in complete contradiction as to how volumetric options have been traditionally used by market participants.” Therefore, Commissioner O’Malia stated that it is his hope that the Commission will address this issue in the near term.
Commissioner O’Malia discussed the energy trading volume during what he called the “post-futurization” time period. The “post-futurization” time period refers to the time period after October 2012 when market participants began to use energy futures instead of energy swaps. This product change was due, among other things, to the uncertainty in the energy industry regarding the implementation and costs associated with the new swaps regulations that went into effect in October 2012. The market statistics provided by the CFTC’s Division of Market Oversight show that 80 percent of total monthly volume in low to medium volume contracts (i.e., contracts with an average daily volume less than 200 contracts and 200 to 100,000 contracts, respectively) were conducted via block trades. In contrast, trading in a central limit order book was the dominant trading for high-volume energy, which are contracts with an average daily volume of 100,000 contracts or greater. Commissioner O’Malia noted that “[t]he Commission is about to have a very serious debate regarding the way commercial participants are able to trade and hedge in the markets to manage their risk.” Related to Commissioner O’Malia’s comment, Acting Chairman Wetjen has stated that a futures block size rule may be proposed by the CFTC in the near future.
Commissioner O’Malia also noted some statistics of interest during his speech:
- High-frequency traders (HFTs) are estimated to make up 52 percent of the global futures markets and 56 percent of U.S. equities markets and
- The CFTC’s surveillance team is not looking at roughly 90 percent of the market activity, specifically order message data.
Given the above, Commissioner O’Malia noted that more resources must be devoted to technology at the CFTC.
While the CFTC continues to be in a period of transition, as the industry awaits full Senate confirmation of the anticipated Chairman Timothy Massad, Commissioner O’Malia’s speech provides a view into upcoming agenda items related to energy market participants.