Commissioner Scott O'Malia of the Commodity Futures Trading Commission (CFTC), a frequent critic of the agency's Dodd-Frank actions, says many of the rules approved by the agency so far are "unnecessarily complicated, confusing and, in some cases, redundant."
In a recent speech to the Annual Nuclear Industry Conference in Charlotte, NC, he said, "the Commission needs to make its rules more black and white." The "Commission's objective in implementing the Dodd-Frank Act should be compliance, not enforcement. Commercial firms utilizing the futures and swaps markets to mitigate risk should be focused on managing that risk, and not on [whether] they will take a misstep into a regulatory trap."
The "poster-child" for this regulatory confusion is the swap dealer definition rule, which the CFTC approved in April (see NGI, April 23). Under the final rule, companies that trade less than an aggregate of $8 billion in swaps annually during an initial phase-in period will be exempt from many of the CFTC's regulations issued as a result of the Dodd-Frank Wall Street Reform Act. Included in the rule was an interim final initiative that would exempt hedging of physical commodities, such as energy, from the definition of swap dealing.
The de minimis exemption of $8 billion is expected to remain in effect during the phase-in period and then fall to $3 billion after the CFTC conducts a study on the swap markets.
O'Malia said he doesn't believe the swap dealer rule provides end-users with sufficient regulatory certainty. "In implementing the massive Dodd-Frank Act, I believe the Commission has the responsibility to implement clear rules that provide end-users with bright regulatory lines. Unfortunately, I believe we have not achieved that objective and instead have crafted a definition for swap dealers that is vague and complex. Ultimately, this definition will drive some firms out of the market or force them to reduce their market exposure and hurt liquidity."
While the swap dealer definition rule establishes a general de minimis exemption of $8 billion applicable to all entities, it also provides a $25 million sub-threshold exemption for a swap dealer's dealing with so-called "special entities," such as municipal utilities. This latter exemption will create "huge problems" for large municipal utility entities," which are represented by the Large Public Power Council (LPPC), O'Malia said. The LPPC represents 24 of the largest public power systems in the nation.
"To date, the majority of LPPC's utility operations-related swaps are executed with non-bank firms in the regional electric and natural gas industry that are prepared to offer the necessary customized arrangements. Given the size of their operations, the $25 million de minimis threshold was set at an unworkable level, which will drive many non-bank firms...away from trading with municipal firms in order to avoid the dreaded dealer designation," he said.
According to O'Malia, "a single one-year 100 MW swap or a single three-year 10,000 MMBtu/d swap (at 62% capacity factor) may have a notional value of $25 million. Therefore, a single swap could trigger the requirement that a firm register as a swap dealer for trading as a result of its trade with a municipal utility. This could not possibly have been what Congress intended."
Given the $25 million threshold, O'Malia predicts that "municipalities will be left to trade with the likes of J.P. Morgan, Bank of America, Citigroup and Goldman Sachs."
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