CFTC And SEC Issue Final Interpretation Regarding Forward Contracts With Embedded Volumetric Optionality

On May 12, 2015, the Commodity Futures Trading Commission ("CFTC") and Securities and Exchange Commission ("SEC") jointly issued the CFTC's final interpretation clarifying its interpretation concerning forward contracts with embedded volumetric optionality ("Final Interpretation"). The Final Interpretation appears to signal that, going forward, the CFTC will take a more relaxed view of which transactions constitute "forward contracts" that are not subject to regulation as swaps. This view should be helpful to many commercial parties entering into contracts that provide for volumetric optionality, which means the right to receive or deliver a commodity in an amount that is more or less than was originally contracted for, including many types of energy supply contracts. The Final Interpretation is available here.1

BACKGROUND

The Final Interpretation modifies the interpretation concerning forward contracts with embedded volumetric optionality contained in the CFTC's and SEC's product definitions release further defining the terms "swap" and "security-based swap," published in 2012 (the "Product Definitions Release").here.2 It follows, with some minor clarifications, the CFTC's and SEC's proposed interpretation to amend the interpretation in the Product Definitions Release that was published in November 2014.3 For more information about the proposed interpretation and further background, please see our client alert here.

The Final Interpretation's amendments to the interpretation contained in the Product Definitions Release focus primarily on the seventh element of the seven-element test intended to determine whether a transaction with embedded volumetric optionality falls within the forward contract exclusion.4 That last element has proven controversial, with some commenters suggesting that it is difficult to apply in practise.

FINAL INTERPRETATION

Under the Final Interpretation, an agreement, contract, or transaction that contains embedded volumetric optionality will fall within the forward contract exclusion from the swap and future delivery definitions (and thus not be a swap or futures contract) when:

The embedded optionality does not undermine the overall nature of the agreement, contract, or transaction as a forward contract; The predominant feature of the agreement, contract, or transaction is actual delivery; The embedded optionality cannot be severed and marketed separately from the overall agreement, contract, or transaction in which it is embedded; The seller of a nonfinancial commodity underlying the agreement, contract, or transaction with embedded volumetric optionality intends, at the...