CFTC And SEC Propose Interpretation Concerning Forward Contracts With Embedded Volumetric Optionality

On November 13, 2014, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) approved for publication in the Federal Register a proposed interpretation clarifying the CFTC's interpretation regarding forwards with embedded volumetric optionality contained in the Product Definitions Release.here.1 The Proposed Interpretation is available. 2The CFTC has requested comment on all aspects of the proposed interpretation, with the comment period ending on December 22, 2014.

BACKGROUND

On August 12, 2012, the CFTC and SEC jointly published final rules and interpretations further defining the terms "swap" and "security-based swap" among other terms (the "Product Definitions Release"). The Product Definitions Release included an interim final interpretation and request for comment with respect to forward contracts that provide for optionality with respect to the amount of commodity to be delivered (i.e., volumetric optionality). Forward contracts that meet the requirements of the interpretation are considered to be forward contracts excluded from the definition of the term "swap" contained in section 1a(47) of the Commodity Exchange Act (CEA), as well as the definition of the term "future delivery" contained in section 1a(27) of the CEA, notwithstanding that they contain embedded volumetric optionality.

Contracts that do not satisfy the elements of the test are considered to be commodity options. Commodity options are included in the definition of the term "swap," whether they are physically or financially settled, although they may qualify for the trade option exemption.3 The interpretation included seven elements that were required to be satisfied in order for an agreement, contract, or transaction to satisfy the exclusions from the "swap" and "future delivery" definitions despite containing volumetric optionality.

A number of comments were received by the CFTC that, in particular, the seventh element of the test created uncertainty among industry participants about how to categorize certain transactions as excluded forward contracts or trade options. Under the seventh element, an agreement, contract, or transaction falls within the forward exclusion if:

the exercise or non-exercise of the embedded volumetric optionality is based primarily on physical factors, or regulatory requirements, that are outside the control of the parties and are influencing demand for, or supply of, the nonfinancial commodity.4

...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT