Three associations representing electric and natural gas utilities and power providers have called on Congress to exempt end-users from having to clear over-the-counter (OTC) derivative transactions that are used to hedge against commodity price risk. While supporting the clearing of derivative transactions involving large dealers in OTC legislation being considered by Congress, they said they opposed any mandate requiring "all or most" OTC derivative transactions to be centrally cleared or traded on regulated exchanges, saying this ultimately would increase prices to retail gas and electric customers.
"While we support the goals of the administration and the Congress to improve transparency and stability in OTC derivatives markets, it is essential that policymakers preserve the ability of companies to access critical OTC energy derivatives products and markets. Our members rely on these products and markets to manage price risk and help keep rates stable and affordable for retail consumers," said the American Gas Association (AGA), Edison Electric Institute (EEI) and Electric Power Supply Association (EPSA), and about 70 member companies, in a letter to the heads of the Senate Banking Committee and House Agriculture Committee.
"It is important to note that these transactions are not the source of systemic risk in the broader economy. In fact, the entire commodity market is less than 1% of the global OTC derivative market, and the energy commodity portion is yet a fraction of that 1%. Therefore, Congress should maintain an appropriate balance between establishing market oversight rules that allow for prudent use of market-based risk management tools and providing regulators with the ability to establish a high level of transparency and the tools needed to protect consumers against market manipulation and systemic risk," they said.
First on their wish list was an exemption from the clearing for end-users of OTC derivatives, such as electric and gas utilities that use OTC derivatives markets to hedge against commodity price risk for natural gas and wholesale electric power. Bills passed out of two House committees last month grant end-users this exemption, and a measure proposed by Senate Banking Chairman Christopher Dodd (D-CT) would do the same (see NGI, Nov. 16; Oct. 26; Oct. 19).
In addition, OTC reform legislation should "promote clearing of standardized derivatives between large financial dealers, where appropriate, through regulated central counterparties to reduce systemic risk and bring additional transparency through information regarding pricing, volume and risk," the group said. "However our members are opposed to mandates that would require all or most OTC derivatives transactions to be centrally cleared or executed on exchanges.
"The available evidence shows that clearing would not bring pricing benefits that would offset the cost of margining for gas and power derivatives, as some have suggested. In fact, the high cash margin requirements of clearing would significantly increase transaction costs for our members and, ultimately, their retail customers. In addition, it would tie up needed cash at a time when the cost of capital is high, access to capital markets is uncertain, and our industry needs to invest billions in renewable energy sources and new energy infrastructure. As a result, our more capital-constrained members may choose to hedge fewer of their transactions, thereby increasing their risks and passing potentially volatile pricing onto retail customers," said AGA, EEI and EPSA.
The groups said they believe greater regulatory oversight and transparency of OTC derivatives can be achieved through increased financial reporting and authority to the Commodity Futures Trading Commission (CFTC) to combat manipulation in the derivatives markets. "We [also] believe that this transparency can be achieved in a much more cost-effective way through mechanisms such as a central data repository, as opposed to mandatory clearing."
Moreover, OTC reform legislation should clearly delineate the authorities and functions of the CFTC and the Federal Energy Regulatory Commission (FERC), said the AGA, EEI and EPSA. Specifically, "we believe that all regional transmission organization products and services provided under a FERC-approved tariff and subject to regulatory oversight by the FERC should be exempt from duplicative regulation by the CFTC."
The groups also recommended that Congress amend the proposed definition of a swap to ensure that financially settled physical transactions are excluded from the definition of swap. Specifically, they asked to change the definition of swap, which "currently reads 'a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is physically settled' to 'nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction contains an enforceable delivery obligation.' In order to avoid unnecessary costs...and for administrative convenience, many physical transactions are settled through a book-out, which is an agreement between two parties to a forward contract to settle their respective obligations with a cash payment, as opposed to making and taking physical delivery. Book-outs have been exempted under CFTC rules since 1984."
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