Natural gas utilities, commercial firms and state regulators have called on the Commodity Futures Trading Commission (CFTC) to refine its proposed definitions for swap dealers and major swap participants, which -- unlike commodity end-users -- will be subject to mandatory clearing of swaps under the agency's proposed reforms.
Atmos Energy Corp., a gas utility that serves customers in Mississippi, said it believes that the CFTC's "proposed definition of a swap dealer, when coupled with the proposed 'end-user' exception to the mandatory clearing of swaps, will generally allow Atmos and similarly situated local distribution companies to continue to employ a wide variety of methods to hedge natural gas, without being considered swap dealers."
However, it said it's unclear whether the hedging it carries out under its "Spot-Gas Program" could cause Atmos to meet the CFTC's definition of swap dealer. Through the program, which the utility initiated in 1987, Atmos Energy goes out into the financial markets to hedge natural gas on behalf of its largest customers. "The customers pay a nominal fee to Atmos to participate in this program, and Atmos shares that revenue with the ratepayers of Mississippi. In calendar year 2010, 24 customers participated in [the] program, initiating a total of 73 separate spot hedge contracts of various duration," Atmos Energy said in comments filed at the CFTC.
The total notional value of swaps outstanding under the Spot-Gas Program for a 12-month period has never exceeded $10 million, according to the utility. And except for this program, Atmos Energy said it only hedges on its own behalf.
Nevertheless, the utility said it is "concerned that the hedging occurring pursuant to the Spot-Gas Program could cause Atmos to meet the proposed definition of a swap dealer. If this were to occur, the regulatory costs of being a swap dealer could cause the Spot-Gas Program to become uneconomic, frustrating the ability of large gas customers to hedge their gas supplies and depriving the ratepayers of Mississippi of the Spot-Gas Program's financial benefits."
Atmos Energy requests that the CFTC's final rule "clarify that to the extent a state-regulated local distribution company facilitates hedging for its largest customers, that this not be considered entering into swaps as part of a regular business."
The "counterparties in these transactions are large customers, which are generally sophisticated entities well versed in hedging natural gas. Additionally the counterparties are all end-users of natural gas [that are] hedging their own gas supply. There is no speculative trading relating to the Spot-Gas Program," the utility said.
The National Association of Regulatory Utility Commissioners also saw flaws with the CFTC's definition of swap dealer. "The swap dealer definition leaves uncertainty as to whether or not [gas and electric] utilities may be determined to be swap dealers. We are concerned that if regulated utilities are swept into the swap dealer definition in the course of pursuing legitimate hedges for their business, and are therefore subject to capital requirements and compliance costs, this will result in unnecessary increases in customer costs and reduce the capital available for essential investments," the group of state regulators said.
Kraft Foods expressed concern that two wholly owned affiliates -- Kraft Foods Finance Europe AG and Taloca GmbH -- could be considered swap dealers or major swap participants. The two companies enter into swap transactions with Kraft Foods affiliates and then enter into offsetting swap transactions with traditional swap dealers. In effect they act as intermediaries.
"We urge the CFTC to define the 'end-user' exception to mandatory clearing of swaps so as to make it available to companies like Kraft Foods that hedge their commercial risk through wholly owned affiliates, and clarify that such companies are not 'major swap participants' or 'swap dealers," Kraft Foods said.
In comments filed Tuesday, the Natural Gas Supply Association (NGSA) and the National Corn Growers Association (NCGA) said the CFTC's definitions of swap dealers sand major swap participants were "overly expansive in numerous respects," and called for modifications.
"The Commission's proposed definitions of 'swap dealer' and 'major swap participant' extend significantly beyond what Congress provided for in the [Dodd-Frank] Act. The Commission's definitions would likely capture many physical energy companies and agricultural producers that do not pose a systemic risk to the U.S. financial system," the trade groups said.
The CFTC "identified certain 'distinguishing characteristics' of swap dealers, including that swap dealers 'tend to accommodate demand for swaps' and serve as 'points of connection' in a market. These proposed characteristics, which are not provided for in the Dodd-Frank Act itself, are overly expansive...If not reworked entirely, the Commission's proposed framework must be considerably narrowed...to avoid inadvertently capturing entities Congress did not intend to be included in the swap dealer definition," the NGSA and NCGA said.
Moreover, the CFTC's proposed rule implementing Dodd-Frank Wall Street Reform Act's de minimis exception to the swap dealer definition has two basic flaws, the NGSA and NCGA said. "First it fails to conform to the act's structural elements. Second, it establishes de minimis thresholds that are far lower than necessary to address the primary purpose of the act's swap regulation provisions -- eliminating systemic risk to the U.S. financial system."
Under the CFTC's definition, a person who satisfies any one of the following qualifications is a major swap participant:
The Dodd-Frank Act, which President Obama signed into law in July, requires swap dealers and major swap participants to clear their swaps, but it provides a de minimis exemption for companies that use over-the-counter derivatives to mitigate their commercial risk (see Daily GPI, Dec. 2, 2010).
To qualify for the exemption, the joint proposal said the trading in swaps over a 12-month period must be limited to a aggregate notional amount not exceeding $100 million, of which no more than $25 million can be with "special entities," such as government agencies; the person must not enter into swaps with more than 15 counterparties, other than security-based swap dealers, over the prior 12 months; and a person must not enter into more than 20 swaps over the prior 12 months. The de minimis proposal requires that a person meet all of the conditions.
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