[Federal Register Volume 76, Number 23 (Thursday, February 3, 2011)]
[Proposed Rules]
[Pages 6095-6110]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-1685]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 3, 32, 33, and 35
Commodity Options and Agricultural Swaps
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is charged with proposing rules to implement new statutory
provisions enacted by Title VII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act (``Dodd-Frank Act''). The Dodd-Frank Act
provides that swaps in an agricultural commodity (as defined by the
Commission) are prohibited unless entered into pursuant to a rule,
regulation or order of the Commission adopted pursuant to Commodity
Exchange Act (``CEA'' or ``Act''). The Dodd-Frank Act also includes
options (other than an option on a futures contract) in its definition
of swaps. Broadly speaking, the rules proposed herein would implement
regulations whereby swaps in agricultural commodities and all commodity
options (including options on both agricultural and non-agricultural
commodities), other than options on futures, may transact subject to
the same rules as all other swaps. The proposed rules for swaps in an
agricultural commodity would repeal and replace the Commission's
regulations concerning the exemption of swap agreements. Because the
Dodd-Frank Act defines commodity options (other than options on
futures) as swaps, the proposed rules for options would substantially
amend the Commission's regulations regarding commodity option
transactions. Also, current regulations on domestic exchange-traded
commodity option transactions applies not only to exchange-traded
options on futures (which are excluded from the Dodd-Frank definition
of a swap), but also to exchange-traded options on physical commodities
(which are within the Dodd-Frank swap definition). Therefore, the
proposed rules would remove references to options on physical
commodities from the Commission's regulations for exchange-traded
options on futures.
DATES: Written comments must be received on or before April 4, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AD21,
by any of the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act, a petition for confidential treatment of
the exempt information may be submitted according to the procedures
established in Sec. 145.9 of the Commission's Regulations.\1\
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\1\ 17 CFR 145.9. Unless otherwise indicated, the rules and
regulations referenced in this notice are found in chapter 1 of
title 17 of the Code of Federal Regulations; 17 CFR Chapter 1 et
seq.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT: Donald Heitman, Senior Special
Counsel, (202) 418-5041, [email protected], or Ryne Miller, Attorney
Advisor, (202) 418-5921, [email protected], Division of Market
Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Introduction
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street
Reform and Consumer Protection Act.\2\ Title VII of the Dodd-Frank Act
\3\ amended the CEA \4\ to establish a comprehensive new regulatory
framework for swaps and security-based swaps. The legislation was
enacted to reduce risk, increase transparency, and promote market
integrity within the financial system by, among other things: (1)
Providing for the registration and comprehensive regulation of swap
dealers and major swap participants; (2) imposing clearing and trade
execution requirements on standardized derivative products; (3)
creating robust recordkeeping and real-time reporting regimes; and (4)
enhancing the Commission's rulemaking and enforcement authorities with
respect to, among others, all registered entities and intermediaries
subject to the Commission's oversight.
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\2\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov./
LawRegulation/OTCDERIVATIVES/index.htm.
\3\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\4\ 7 U.S.C. 1 et seq.
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Section 723(c)(3) of the Dodd-Frank Act provides that swaps in an
agricultural commodity (as defined by the Commission) \5\ are
prohibited unless entered into pursuant to a rule, regulation or order
of the Commission adopted pursuant to CEA section 4(c).
[[Page 6096]]
Further, section 733 of the Dodd-Frank Act, new CEA section 5h(b)(2),
provides that a swap execution facility (``SEF'') may not list for
trading or confirm the execution of any swap in an agricultural
commodity (as defined by the Commission) except pursuant to a rule or
regulation of the Commission allowing the swap under such terms and
conditions as the Commission shall prescribe.
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\5\ As discussed below, in accordance with the mandate of the
Dodd-Frank Act, the Commission has recently proposed a definition of
the term ``agricultural commodity.'' See 75 FR 65586, Oct. 26, 2010.
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In addition to the provisions on swaps in an agricultural
commodity, the Dodd-Frank Act definition of ``swap'' includes options
(other than options on futures). Section 721 of the Dodd-Frank Act adds
new section 1a(47) to the CEA, defining ``swap'' to include not only
``any agreement, contract, or transaction commonly known as,'' among
other things, ``an agricultural swap'' or ``a commodity swap,'' but
also ``[an] option of any kind that is for the purchase or sale, or
based on the value, of * * * commodities * * *.'' \6\ As a result of
the Dodd-Frank changes, the Commission is issuing this notice
proposing: (1) To withdraw and replace current part 35; \7\ (2) to
substantially amend current part 32; \8\ (3) to withdraw rule 3.13,
which will be rendered moot by the withdrawal of rule 32.13; and (4) to
amend part 33 \9\ to remove references to options on physical
commodities. As proposed, new part 35 and revised parts 32 and 33 will
provide the regulatory authority under which market participants may
enter into, respectively, swaps in an agricultural commodity
(``agricultural swaps'') \10\ and commodity options.\11\
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\6\ See new CEA section 1a(47), as added by section 721 of the
Dodd-Frank Act. The Dodd-Frank swap definition excludes exchange-
traded options on futures, but not exchange-traded options on
physical commodities (see new CEA section 1a(47)(B)(i)).
Accordingly, the Commission is amending part 33 of its regulations,
``Regulation of Domestic Exchange-Traded Commodity Option
Transactions,'' to the extent that Part 33 applies to exchange-
traded options on physical commodities, which are swaps under the
Dodd-Frank definition. The rules proposed herein would remove any
reference in part 33 to ``options on physicals,'' and such
transactions would become subject to the regulations in revised part
32, discussed below. Other options excluded from the definition of
swap are options on any security, certificate of deposit, or group
or index of securities, including any interest therein or based on
the value thereof, that is subject to the Securities Act of 1933 and
the Securities Exchange Act of 1934 (see new CEA section
1a(47)(B)(iii)) and foreign currency options entered into on a
national securities exchange registered pursuant to section 6(a) of
the Securities Exchange Act of 1934 (see new CEA section
1a(47)(B)(iv)).
\7\ 17 CFR Part 35.
\8\ 17 CFR Part 32.
\9\ 17 CFR Part 33.
\10\ When this notice refers to ``agricultural swaps,'' it is
referring to swaps in an agricultural commodity, as identified in
section 723(c)(3) of the Dodd-Frank Act.
\11\ ``Commodity option'' and ``commodity option transaction''
are defined in 17 CFR 1.3(hh). When this notice refers generally to
``commodity options'' or ``options,'' the terms will refer to all
commodity options transactions other than those options on futures
that are excluded from the Dodd-Frank definition of swap (see
footnote 6, above).
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To that end, this notice includes a background discussion of the
statutory and regulatory framework governing agricultural swaps and
commodity options. The notice also provides an overview and summary of
the comments received on the Commission's Advanced Notice of Proposed
Rulemaking regarding the agricultural swaps provisions in the Dodd-
Frank Act.\12\ Finally, the notice includes an explanation of the
rulemakings proposed herein, a discussion of CEA section 4(c) as the
authority for the agricultural swaps aspect of this rulemaking, a
request for comment on the proposed rulemaking, and a section
addressing related matters.
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\12\ See Agricultural Swaps, 75 FR 59666, Sept. 28, 2010.
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II. Background
A. Agricultural Swaps
i. Pre Dodd-Frank
Since 2000, bilateral swaps \13\ between certain sophisticated
counterparties have been generally exempted from the Commission's
jurisdiction pursuant to current CEA section 2(g),\14\ which was added
to the CEA by the Commodity Futures Modernization Act of 2000
(``CFMA'').\15\ However, current section 2(g) specifically excludes an
``agreement, contract, or transaction'' in an ``agricultural
commodity'' from the CFMA swaps exemption.\16\
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\13\ Prior to the Dodd-Frank Act, the Commission had defined a
``swap'' as follows: ``A swap is a privately negotiated exchange of
one asset or cash flow for another asset or cash flow. In a
commodity swap [including an agricultural swap], at least one of the
assets or cash flows is related to the price of one or more
commodities.'' (See 72 FR 66099, note 7, Nov. 27, 2007). As
discussed above, see new CEA section 1a(47) for the statutory
definition of a ``swap,'' as added to the CEA by section 721 of the
Dodd-Frank Act.
\14\ Current section 2(g) provides:
No provision of this Act (other than section 5a (to the extent
provided in section 5a(g)), 5b, 5d, or 12(e)(2)) shall apply to or
govern any agreement, contract, or transaction in a commodity other
than an agricultural commodity if the agreement, contract, or
transaction is--
(1) Entered into only between persons that are eligible contract
participants at the time they enter into the agreement, contract, or
transaction;
(2) Subject to individual negotiation by the parties; and
(3) Not executed or traded on a trading facility.
CEA section 2(g).
\15\ Current CEA section 2(g) was added to the CEA as section
105(b) of the CFMA, enacted as Appendix E to Public Law 106-554.
\16\ Notably, current CEA section 2(g) is not the only statutory
provision added by the CFMA that excludes or exempts bilateral swaps
between eligible contract participants from the Commission's
jurisdiction. Current CEA section 2(d)(1) excludes any such
bilateral ``agreement, contract, or transaction'' in excluded
commodities from Commission jurisdiction, while CEA section 2(h)(1)
creates a similar exemption for a ``contract, agreement or
transaction'' in exempt commodities.
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While the term ``agricultural commodity'' is not specifically
defined in the Act,\17\ it is used in the Act in conjunction with the
definition of the term ``exempt commodity,'' which is defined as
neither an ``agricultural commodity'' nor an ``excluded commodity.''
\18\ The effect of current CEA section 2(g) was that swaps involving
exempt and excluded commodities were allowed to transact largely
outside of the Commission's jurisdiction or oversight. And while the
Dodd-Frank Act largely rewrites the world of law and regulation
applicable to swaps in non-agricultural commodities,\19\ swaps
involving agricultural commodities,\20\ including both the enumerated
agricultural commodities and other non-enumerated agricultural
commodities,\21\ remain subject to the Commission's pre-CFMA swaps
regulations as set forth in part 35.\22\
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\17\ Note that the Commission has proposed for comment a formal
definition of agricultural commodity. See Agricultural Commodity
Definition, 75 FR 65586, Oct. 26, 2010.
\18\ ``The term `exempt commodity' means a commodity that is not
an excluded commodity or an agricultural commodity.'' Current CEA
section 1a(14). An ``excluded commodity'' is defined in current CEA
section 1a(13) to include financial commodities such as interest
rates, currencies, economic indexes, and other similar items.
\19\ See Dodd-Frank non-agricultural swaps discussion, below.
\20\ See 75 FR 59666, at 59667, Sept. 28, 2010, for an
explanation of the legislative history discussing ``agricultural
commodity'' as used in CEA section 2(g).
\21\ ``Enumerated agricultural commodities'' typically refers to
the list of commodities specifically enumerated in the CEA
definition of ``commodity'' at current CEA Section 1a(4) (renumbered
as section 1a(9) under Dodd-Frank): Wheat, cotton, rice, corn, oats,
barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs,
Solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils
(including lard, tallow, cottonseed oil, peanut oil, soybean oil,
and all other fats and oils), cottonseed meal, cottonseed, peanuts,
soybeans, soybean meal, livestock, livestock products, and frozen
concentrated orange juice (but not onions).
\22\ 17 CFR Part 35 remains in effect for agricultural swaps
because it was originally adopted under the Commission's CEA section
4(c) exemptive authority, and section 723(c)(3)(B) of the Dodd-Frank
Act grandfathers existing 4(c) exemptions in the context of
agricultural swaps.
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Part 35 provides a broad exemption for certain swap agreements. As
noted, part 35 originally applied to swaps in all
[[Page 6097]]
commodities.\23\ After the CFMA amendments to the CEA, which
statutorily exempted swaps on ``exempt'' and ``excluded'' commodities
from virtually all of the Commission's jurisdiction, part 35 remained
relevant only for agricultural swaps. With the exception of three
outstanding exemptive orders related to cleared agricultural basis and
calendar swaps \24\ (which exempt certain swaps transactions from part
35's non-fungibility and counterparty creditworthiness requirements),
part 35 is the sole existing authority under which market participants
may transact agricultural swaps that are not options.\25\
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\23\ Part 35 provides eligible swap participants (as defined in
Sec. 35.1(b)(2)) with a general exemption from the CEA for a swap
that is not part of a fungible class of agreements that are
standardized as to their material economic terms, where the
creditworthiness of each counterparty is a material consideration in
entering into or determining the terms of the swap, and the swap is
not entered into and traded on or through a multilateral transaction
execution facility. See Sec. 35.2.
\24\ Part 35, at Sec. 35.2(d), also provides that ``any person
may apply to the Commission for exemption from any of the provisions
of the Act (except 2(a)(1)(B) [liability of principal for act of
agent]) for other arrangements or facilities, on such terms and
conditions as the Commission deems appropriate, including but not
limited to, the applicability of other regulatory regimes.'' See 17
CFR 35.2(d). The Commission has granted three such exemptions, which
have in each instance been styled as exemptive orders pursuant to
CEA section 4(c). See,
Order (1) Pursuant to Section 4(c) of the Commodity Exchange Act
(a) Permitting Eligible Swap Participants To Submit for Clearing and
ICE Clear U.S., Inc. and Futures Commission Merchants To Clear
Certain Over-The-Counter Agricultural Swaps and (b) Determining
Certain Floor Brokers and Traders To Be Eligible Swap Participants;
and (2) Pursuant to Section 4d of the Commodity Exchange Act,
Permitting Certain Customer Positions in the Foregoing Swaps and
Associated Property To Be Commingled With Other Property Held in
Segregated Accounts, 73 FR 77015, Dec. 18, 2008;
Order (1) Pursuant to Section 4(c) of the Commodity Exchange
Act, Permitting the Chicago Mercantile Exchange to Clear Certain
Over-the-Counter Agricultural Swaps and (2) Pursuant to Section 4d
of the Commodity Exchange Act, Permitting Customer Positions in Such
Cleared-Only Contracts and Associated Funds To Be Commingled With
Other Positions and Funds Held in Customer Segregated Accounts, 74
FR 12316, Mar. 24, 2009; and
Order (1) Pursuant to Section 4(c) of the Commodity Exchange
Act, Permitting the Kansas City Board of Trade Clearing Corporation
To Clear Over-the-Counter Wheat Calendar Swaps and (2) Pursuant to
Section 4d of the Commodity Exchange Act, Permitting Customer
Positions in Such Cleared-Only Swaps and Associated Funds To Be
Commingled With Other Positions and Funds Held in Customer
Segregated Accounts, 75 FR 34983, June 21, 2010.
\25\ Options on agricultural commodities are reviewed in detail
in the options discussion of this notice.
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ii. Dodd-Frank Swaps Provisions
a. Non-Agricultural Swaps
Under the CEA, as amended by the Dodd-Frank Act, only eligible
contract participants (``ECPs'') \26\ may enter into a swap, unless
such swap is entered into on a designated contract market
(``DCM''),\27\ in which case any person may enter into the swap.\28\
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\26\ ``Eligible contract participant'' is defined in current CEA
section 1a(12). Generally speaking, an eligible contract participant
is considered to be a sophisticated investor.
\27\ A designated contract market is a board of trade designated
as a contract market under CEA section 5.
\28\ See new CEA section 2(e) as added by section 723(a)(2) of
the Dodd-Frank Act.
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New CEA section 2(h), as added by section 723(a)(3) of the Dodd-
Frank Act, establishes a clearing requirement for swaps. Under that
subsection, the Commission would determine, based on factors listed in
the statute, whether a swap, or a group, category, type, or class of
swaps, should be required to be cleared. A swap that is required to be
cleared must be executed on a DCM or a SEF,\29\ if a DCM or SEF makes
the swap available for trading. Swaps that are not required to be
cleared may be executed bilaterally. Notwithstanding the above, a swap
entered into by a commercial end user \30\ is not subject to the
mandatory clearing requirement; however an end user may opt to submit
the swap for clearing.
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\29\ The requirements for SEFs are set forth in new CEA section
5h.
\30\ Generally, a commercial end user is described in new CEA
section 2(h)(7) as a non-financial entity that is using swaps to
hedge or mitigate commercial risk and that notifies the Commission
as to how it generally meets its financial obligations associated
with entering into non-cleared swaps.
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Section 731 of the Dodd-Frank Act adds a new section 4s to the CEA
that provides for the registration and regulation of swap dealers and
major swap participants.\31\ The new requirements for swap dealers and
major swap participants include, in part, capital and margin
requirements, business conduct standards, and reporting, recordkeeping,
and documentation requirements.
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\31\ ``Swap dealer'' is defined in new CEA section 1a(49), as
added by section 721(a)(21) of the Dodd-Frank Act. ``Major swap
participant'' is defined in new CEA section 1a(33), as added by
section 721(a)(16) of the Dodd-Frank Act.
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Section 737 of the Dodd-Frank Act amends current CEA section 4a
regarding position limits. Under the Dodd-Frank provisions and amended
CEA section 4a, the Commission is directed to adopt position limits for
futures and options traded on or subject to the rules of a designated
contract market, and swaps that are economically equivalent to such
futures and exchange-traded options for both exempt and agricultural
commodities.
b. Agricultural Swaps
As noted above, under section 723(c)(3) of the Dodd-Frank Act,
swaps in an ``agricultural commodity'' (as defined by the Commission)
\32\ are prohibited unless the swap is entered into pursuant to an
exemption granted under CEA section 4(c). The requirements of section
4(c) are discussed in greater detail, below.\33\
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\32\ See proposed definition of agricultural commodity at 75 FR
65586, Oct. 26, 2010.
\33\ Generally speaking, section 4(c) provides that, in order to
grant an exemption, the Commission must determine that: (1) The
exemption would be consistent with the public interest and the
purposes of the CEA; (2) any agreement, contract, or transaction
affected by the exemption would be entered into by ``appropriate
persons'' as defined in section 4(c); and (3) any agreement,
contract, or transaction affected by the exemption would not have a
material adverse effect on the ability of the Commission or any
contract market to discharge its regulatory or self-regulatory
duties under the CEA.
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Dodd-Frank section 723(c)(3)(B) includes a ``grandfather'' clause
providing that any rule, regulation, or order regarding agricultural
swaps that was issued pursuant to the Commission's exemptive authority
in CEA section 4(c), and that was in effect on the date of enactment of
the Dodd-Frank Act, would continue to be permitted under such terms and
conditions as the Commission may prescribe. Such rules, regulations or
orders would include part 35 with respect to agricultural swaps and the
agricultural basis and calendar swaps noted above, but would not
include options entered into pursuant to part 32.\34\
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\34\ Part 32 was not issued pursuant to the Commission's section
4(c) exemptive authority and thus does not qualify for the Dodd-
Frank grandfather provision for existing 4(c) exemptions. See
section 723(c)(3)(B) of the Dodd-Frank Act.
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In addition to the provisions in section 723(c)(3), section 733 of
the Dodd-Frank Act, new CEA section 5h(b), provides that a SEF may not
list for trading or confirm the execution of any swap in an
agricultural commodity (as defined by the Commission) except pursuant
to a rule or regulation of the Commission allowing the swap under such
terms and conditions as the Commission shall prescribe.
B. Commodity Options
i. Commodity Options Are Swaps
The Dodd-Frank Act defines the term ``swap'' to include not only
the various types of swaps listed in the definition, including
commodity swaps and agricultural swaps, but also options of any kind
(other than options on
[[Page 6098]]
futures).\35\ Even before the Dodd-Frank Act, commodity options have
been subject to the Commission's plenary authority under CEA section
4c(b).\36\ Based on that general prohibition of any option transactions
contrary to any Commission rule, regulation or order prohibiting
options, or allowing them under such conditions as the Commission may
prescribe, the only options currently authorized under the CEA are
those specifically provided for in the Commission's regulations.
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\35\ See new CEA section 1a(47)(B), as added to the CEA by
section 721 of the Dodd-Frank Act. But see also footnote 6, above,
for the list of certain options that are excluded from the swap
definition.
\36\ Section 4c(b) provides:
No person shall offer to enter into, enter into or confirm the
execution of, any transaction involving any commodity regulated
under this Act which is of the character of, or is commonly known to
the trade as, an ``option'', ``privilege'', ``indemnity'', ``bid'',
``offer'', ``put'', ``call'', ``advance guaranty'', or ``decline
guaranty'', contrary to any rule, regulation, or order of the
Commission prohibiting any such transaction or allowing any such
transaction under such terms and conditions as the Commission shall
prescribe. Any such order, rule, or regulation may be made only
after notice and opportunity for hearing, and the Commission may set
different terms and conditions for different markets. CEA section
4c(b); 7 U.S.C. 6c(b).
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ii. Options on Agricultural Commodities; Trade Options
As noted above, the Commission maintains plenary authority over
options and has used that authority to, among other things, issue part
32 of the Commission's regulations. Part 32 includes a general ban on
commodity options,\37\ but allows for commodity option transactions
under certain conditions. Part 32 specifically allows for options on
agricultural commodities in two instances.\38\
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\37\ See Commission regulation 32.11, 17 CFR 32.11.
\38\ Note that part 32 was not issued under the Commission's
section 4(c) exemptive authority. After the effective date of the
Dodd-Frank Act, options on agricultural commodities will also fall
under the Dodd-Frank Act's provisions governing the trading of swaps
(and, specifically, agricultural swaps) since options on commodities
fall within the Act's definition of a swap. Accordingly, it is
important to identify which options on agricultural commodities are
currently being traded pursuant to part 32 and, where appropriate,
to implement rules to preserve that market (in addition to rules
proposed herein that will preserve the majority of the existing non-
agricultural trade option market, subject to the same laws and rules
as all other swaps).
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First, rule 32.13 establishes rules for trading bilateral options
on the ``enumerated'' agricultural commodities (``agricultural trade
options'' or ``ATOs'') whereby ATOs may only be sold by an Agricultural
Trade Option Merchant (``ATOM''), who must first register with the
Commission as such pursuant to CFTC rule 3.13. Since its 1998 adoption
and one amendment in 1999,\39\ the ATOM registration scheme has
attracted only one registrant, which registrant has since withdrawn its
ATOM registration. Accordingly, ATOs currently may only be transacted
pursuant to an exemptive provision found at Sec. 32.13(g)(1). The
exemption at Sec. 32.13(g)(1) allows ATOs to be sold when: (1) The
option is offered to a commercial (``a producer, processor, or
commercial user of, or a merchant handling'' the underlying commodity);
(2) the commercial enters the transaction solely for purposes related
to its business as such; and (3) each party to the option contract has
a net worth of not less than $10 million.
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\39\ 63 FR 18821, Apr. 16, 1998; and 64 FR 68011, Dec. 6, 1999,
respectively.
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In either case (whether transacted pursuant to the ATOM
registration scheme or accomplished via the exemption at Sec.
32.13(g)), the phrase ``agricultural trade option'' refers specifically
to a trade option on an agricultural commodity enumerated in Sec.
32.2.
In addition to the ATO rules in Sec. 32.13, part 32 includes, at
Sec. 32.4, a basic trade option exemption applicable to options on
commodities other than the enumerated agricultural commodities. The
terms of the Sec. 32.4 exemption are essentially the same as those of
the Sec. 32.13(g) exemption with one significant difference--the Sec.
32.4 trade option exemption does not include any net worth requirement.
Under Sec. 32.4, the option must be offered to a producer, processor,
or commercial user of, or a merchant handling, the commodity, who
enters into the commodity option transaction solely for purposes
related to its business as such.
Because the term ``agricultural commodity'' as used in section
723(c)(3) of the Dodd-Frank Act refers to more than just the enumerated
commodities, the Commission recognizes that certain options authorized
under Sec. 32.4 (e.g. options on coffee, sugar, cocoa, and other
agricultural products that do not appear in the enumerated commodity
list) would be considered options on an agricultural commodity. As
such, and without adopting the rules proposed herein, those options
would be swaps on an agricultural commodity and would thereby fall
under the Dodd-Frank Act's general prohibition of agricultural swaps.
iii. Remainder of Part 32
In addition to the foregoing provisions regarding Sec. 32.13
agricultural trade options and Sec. 32.4 general trade options, part
32 contains various other provisions that have been rendered obsolete,
either by the Dodd-Frank Act, by subsequent Commission rulemaking
actions, or by the passage of time. The amendments proposed herein
would substantially update and revise part 32 and remove these
unnecessary provisions.
iv. Part 33
As noted above, current part 33 applies to both exchange-traded
options on futures and exchange-traded options on physical commodities.
However, Dodd-Frank exempts only options on futures from the swaps
definition. Therefore, options on physical commodities, even if traded
on a DCM, are to be regulated as swaps. Accordingly, these proposed
rules would remove all references to exchange-traded options on
physicals from part 33.
III. The ANPRM
A. General Description of the ANPRM
On September 28, 2010 (75 FR 59666), the Commission published an
advanced notice of proposed rulemaking (``ANPRM'') and request for
comment on the appropriate conditions, restrictions or protections to
be included in any rule, regulation or order of the Commission adopted
pursuant to section 4(c) of the Act governing the trading of swaps in
an ``agricultural commodity,'' \40\ as defined by the Commission.\41\
The Commission requested specific input pertaining to five topics:
Current Agricultural Swaps Business (overall size, the types of
entities, and any unique characteristics of agricultural swaps that
distinguish them from other types of physical commodity swaps);
Agricultural Swaps Clearing (the extent to which existing swaps are
cleared or uncleared, whether existing swaps would generally qualify
for a commercial end-user exemption, and the desirability of a clearing
requirement for swaps that do not qualify for such an exemption);
Trading (description of any significant trading problems encountered in
this market); Agricultural Swaps Purchasers (whether agricultural swaps
participants need
[[Page 6099]]
more protections than other physical commodity swaps participants, or
whether special provisions are needed to make it easier for producers
to participate); Designated Contract Markets (should agricultural swaps
be permitted on DCMs to the same extent as other swaps); Swap Execution
Facilities (should agricultural swaps be permitted on SEFs to the same
extent as other swaps); and Trading Outside of DCMs and SEFs (should
agricultural swaps be permitted to trade outside of a DCM or SEF to the
same extent as other swaps, and generally should agricultural swaps be
treated any differently than other types of physical commodity swaps).
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\40\ The Commission also informally solicited comments on its
Web site at http://www.cftc.gov/LawRegulation/DoddFrankAct/OTC_19_AgSwaps.html. In addition, Commission staff has met with market
participants and other interested parties. A complete list of
external meetings held at the Commission may be found on the
Commission's Web site at http://www.cftc.gov/LawRegulation/DoddFrankAct/ExternalMeetings/index.htm.
\41\ The Commission has published for comment a proposed
regulatory definition of the term, ``agricultural commodity'' (See:
75 FR 65586, Oct. 26, 2010, and plans to publish a final definition
in the near future.
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B. Summary of Comments
Nineteen formal comment letters representing a broad range of
interests, including producers, merchants, swap dealers, commodity
funds, futures industry organizations, and academics/think tanks,
responded to the ANPRM. In particular, comment letters were received
from: The American Farm Bureau Federation, the American Soybean
Association, the Commodity Markets Council, the National Association of
Wheat Growers, the National Cattlemen's Beef Association, and the
National Corn Growers Association, who filed a joint statement
(collectively, ``the Ag Associations''); the National Grain and Feed
Association (``NGFA''); the Commodity Markets Council (``CMC,'' which
filed a separate letter in addition to signing onto the joint statement
noted above); the National Milk Producers Federation (``NMPF''); the
Dairy Farmers of America (``DFA''); the National Council of Farmer
Cooperatives (``NCFC''); the Gavilon Group, LLC (``Gavilon''), a feed
manufacturer; Cargill, an agricultural commodities merchant; Allenberg
Cotton, a cotton merchant; the Agricultural Commodity Swaps Working
Group (``Ag Swap Working Group''), comprised of financial institutions
that provide risk management and investment products to agricultural
end users; the International Swaps and Derivatives Association
(``ISDA''); United States Commodity Funds (``USCF''); the Alternative
Investment Management Association, Ltd. (``AIMA''); International
Assets Holding Corporation (``IAHC''); Teucrium Trading; the Futures
Industry Association (``FIA''); the CME Group, Inc. (``CME''); the
Institute for Agriculture and Trade Policy (``IATP''); and Dr. Robert
Pollin, a university professor.\42\
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\42\ In addition, two comments were received that did not
directly address the ANPRM.
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The vast majority of commenters supported the equal treatment of
agricultural swaps (including trade options) under the same regulatory
scheme as other categories of swaps. The following statement from the
Ag Associations is representative of this sentiment:
Ag swaps are used, to varying degrees, by our members because
they provide a targeted, customized, cost-effective, and efficient
risk management strategy * * * In a world with increasing inherent
volatility, the need for risk management instruments has never been
greater.
We urge the Commission to treat swaps for all commodities
harmoniously. We believe the comprehensive regulation of swaps
should not be based on distinctions among commodity types. The
generally applicable protections under the Dodd-Frank Bill--such as
reporting, mandatory clearing, mandatory trading of standardized
swaps, minimum capital requirements, and the CFTC's authority to
impose position limits, determine which swaps are subject to
clearing and trading and to exercise emergency powers--will protect
ag swaps from fraud and manipulation.
Two commenters (Dr. Pollin and the IATP) were generally opposed to
the trading of agricultural swaps under the same conditions as other
physical commodity swaps. Both commenters expressed the belief that
speculative investment in agricultural derivatives has increased price
volatility, to the detriment of producers and consumers of agricultural
products, and that trading in agricultural swaps could potentially
exacerbate this problem.
Commenters offered the following specific information and/or
individual perspectives on the five topic areas outlined above:
Current Agricultural Swaps Business. Regarding the state of the
current agricultural swaps business (including trade options),
commenters generally noted that agricultural swaps are used to a
considerable extent, but they were unable to quantify the overall size
of this market. Swap participants include commercial end users
(producers, processors and merchants), hedge funds, swap dealers, and
financial institutions. Generally, commenters did not believe that the
characteristics of agricultural swaps were significantly different from
the characteristics of other types of physical commodity swaps.
Agricultural Swaps Clearing. According to the commenters, most
agricultural swap activity (including trade options) is not cleared
(for example, the NCFC estimated that less than one percent of its
members' swaps are cleared). Several commenters pointed to the small
amount of swaps cleared by DCOs under existing 4(c) exemptions,
relative to the presumed size of the market, as evidence of how few
swaps are cleared. Commenters representing agricultural producers and
merchants indicated that virtually all of their swaps would qualify for
the end-user exemption from the mandatory clearing requirement of the
Dodd-Frank Act. Furthermore, most commenters suggested that
agricultural swaps should be individually scrutinized as to their
clearability, rather than subjecting all agricultural swaps to a
clearing requirement. (NCFC, for example, observed that, ``the low
volume, small sizes and odd lots [of many agricultural swaps] would not
be attractive for exchanges or clearing houses to offer those specific
products.'' Thus, ``if all entities are required to clear agricultural
swaps through an exchange or standardize a non-standard transaction
(both in terms of quantity and structure), costs would likely increase
to a point where the use of swaps as a bona fide hedge/risk management
tool would not be available to segments of the agricultural
marketplace.'') IATP, however, supported mandatory clearing for all
agricultural swaps as a means of discouraging producers from
participating directly in this market.
Trading Practices and Issues. Commenters generally were not aware
of any specific problems pertaining to the existing trade in
agricultural swaps and most saw no need for additional requirements for
trading agricultural swaps relative to other types of swaps. Some
commenters did observe that the Commission's existing regulatory
requirements governing agricultural trade options in the enumerated
agricultural commodities (as distinct from other types of physical
commodities) have restricted the development of this market to the
detriment of commercial end users (see, for example, comments by CMC,
Gavilon and DFA).
Additional Protections for Agricultural Swaps Purchasers. Most
commenters did not believe that agricultural swaps participants need
more protection than participants in other types of commodity swaps.
Most commenters also believed that the Dodd-Frank Act requirement,
limiting swap purchasers to ``eligible contract participants''
(``ECPs''), is appropriate to apply to the purchasers of agricultural
commodity swaps. However, several commenters suggested that
transactions within farmer cooperatives (that is,
[[Page 6100]]
between individual farmer members and their local elevator cooperative,
and between affiliated cooperatives at the local, regional or national
levels) should not be subject to the ECP requirement (for example, the
NCFC states that individual members who do not meet the ECP requirement
should be permitted to purchase swaps directly from their producer
cooperatives, and the NMPF argues that transactions between members and
their cooperatives are internal transactions and should be treated as
such, rather than be subject to provisions that govern transactions
between unaffiliated parties). In addition, one commenter favored
making agricultural trade options (but not other types of swaps)
available from registered swap dealers to non-ECPs who enter into them
explicitly for commercial risk management purposes (see Cargill
comment).
Trading on DCMs and SEFs. Commenters generally supported the
listing and trading of agricultural swaps (including options) on DCMs
and SEFs to the same extent as other physical commodity swaps, with the
exception of Dr. Pollin and the IATP.
Trading off of DCMs and SEFs. Commenters generally expressed the
opinion that agricultural swaps (including options) should be permitted
to trade outside of DCMs and SEFs under the same conditions that apply
to other types of physical commodity swaps (again, with the exception
of the IATP and Dr. Pollin). Most commenters did not believe there were
any specific agricultural commodities that would require special or
different protections. IATP expressed the opinion that ``A higher
collateral and capital requirement should be applied to any bilateral
swaps a CFTC rule would allow.'' Dr. Pollin argued that there is no
good reason for offering any exemptions from the blanket prohibition on
agricultural swaps contained in the Dodd-Frank Act.
In addition to comments addressing the five specific topic areas
directly related to the ANPRM, several commenters requested that the
Commission provide clarity on the treatment of certain types of swap
participants and transactions within the overall regulatory scheme for
swaps. In this regard, several commenters requested that the Commission
clarify that agricultural producer cooperatives that enter into swaps
with their own members or third parties in the course of marketing
their members' agricultural products should be considered to be end
users for purposes of the clearing exception, and further that the
Commission should clarify that producer cooperatives are excluded from
the definitions of swap dealer and major swap participant (see, for
example, comments from NGFA, NCFC, NMPF, and DFA). These issues are
beyond the scope of this proposed rulemaking. The Commission has issued
proposed rules regarding: (1) The end-user exception to mandatory
clearing of swaps pursuant to Sec. 723 of the Dodd-Frank Act; \43\ and
(2) further definition of certain terms regarding market participants,
including the terms ``swap dealer'' and ``major swap participant,''
pursuant to Sec. 712(d) of the Dodd-Frank Act.\44\ The Commission
encourages all interested parties to submit comments addressing these
proposed rules, including responses to the requests for comment set
forth therein.
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\43\ See: End User Exception to Mandatory Clearing of Swaps, 75
FR 80747, Dec. 23, 2010 (comment period closes February 22, 2011).
\44\ See: Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-
Based Swap Participant'' and ``Eligible Contract Participant,'' 75
FR 80174, Dec. 21, 2010 (joint rulemaking with Securities and
Exchange Commission (``SEC''), comment period closes February 22,
2011).
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Some commenters also requested that the Commission clarify that
certain types of transactions (embedded options in forward contracts
\45\ and book-outs \46\) fall within the definition of an excluded
forward contract rather than the definition of a swap. These issues,
too, are beyond the scope of this proposed rulemaking. Commission
staff, jointly with staff of the SEC, is also considering further
definition of terms regarding certain products, including the term
``swap,'' pursuant to Sec. 712(d) of the Dodd-Frank Act. Any comment
addressing the distinction between swaps and forward contracts will be
shared with appropriate staff.
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\45\ See: Characteristics Distinguishing Cash and Forward
Contracts and ``Trade'' Options, Interpretive Statement of the
Commission's General Counsel, 50 FR 39656, Sept. 30, 1985, regarding
the differences between forward contracts and options.
\46\ A book-out is a separate, subsequent agreement whereby two
commercial parties to a forward contract, who find themselves in a
delivery chain or circle at the same delivery point, can agree to
settle (or ``book-out'') their delivery obligations by exchanging a
net payment. See: Statutory Interpretation Regarding Forward
Transactions, 55 FR 39188, Sept. 25, 1990.
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IV. Explanation of the Proposed Rules
A. Introduction
After considering the complete record in this matter, including all
comments on the ANPRM, the Commission is proposing the rulemaking
contained herein. Broadly speaking, the proposed rules would implement
regulations whereby (1) swaps in agricultural commodities, and (2) all
commodity options (including options on both agricultural and non-
agricultural commodities), other than options on futures, may transact
subject to the same rules as all other swaps.
First, the proposal would withdraw existing part 35 of the
Commission's regulations--thus withdrawing the provisions originally
adopted in 1993 to provide legal certainty for the bilateral swaps
market by largely exempting bilateral swaps transactions from CEA
regulation.\47\ Second, pursuant to the exemptive authority in CEA
section 4(c), the proposed rules would adopt a new part 35 to provide
the primary authority for transacting swaps in an agricultural
commodity (``agricultural swaps'') as authorized by Sections 723(c)(3)
and 733 of the Dodd-Frank Act. Third, the proposed rulemaking would
substantially update and revise the existing framework for off-exchange
options in existing part 32. In part pursuant to the exemptive
authority in CEA section 4(c) and in part pursuant to the Commission's
general rulemaking authority set out at CEA section 8a(5) and the
Commission's plenary authority over options, revised part 32 would
affirm that all commodity options (other than options on futures) are
swaps, and as such will be subject to all provisions of the CEA
otherwise applicable to swaps, including any rule, regulation, or order
thereunder. The proposed rulemaking would also withdraw rule 3.13,
which sets out procedures for the registration of agricultural trade
option merchants and their associated persons. Rule 3.13 will become
moot upon the withdrawal of rule 32.13, which includes the underlying
registration requirement. Finally, the proposed rules would revise part
33 to delete references to exchange-traded options on physical
commodities (which will now be regulated as swaps), leaving only
exchange-traded options on futures subject to part 33.
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\47\ ``[Part 35 * * *] exempt[s] swap agreements (as defined
herein) meeting specified criteria from regulation under the
Commodity Exchange Act (the ``Act''). This rule was proposed
pursuant to authority recently granted the Commission, a purpose of
which is to give the Commission a means of improving the legal
certainty of the market for swaps agreements.'' 58 FR 5587, Jan. 22,
1993.
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B. Withdrawal of Current Part 35
In enacting the Futures Trading Practices Act of 1992 (the ``1992
Act''),\48\ Congress added section 4(c) to the CEA and authorized the
Commission, by rule, regulation, or order, to exempt any agreement,
contract or transaction, or class thereof, from the exchange-trading
[[Page 6101]]
requirement of CEA section 4(a), or (with minor exceptions not relevant
here) from any other provision of the Act.\49\ Pursuant to its new
authority in section 4(c), the Commission proposed in 1992 \50\ and
adopted in 1993 \51\ part 35 of the Commission's regulations, generally
exempting certain swap agreements from the CEA. As explained above,
part 35 originally applied to all commodities. However, certain
amendments to the CEA made by the CFMA had the effect of making part 35
relevant only for swaps in agricultural commodities.
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\48\ Public Law 102-546 (Oct. 28, 1992).
\49\ While section 4(c) was amended by the Dodd-Frank Act, for
the purposes of this rulemaking its function and effect have not
changed. See 4(c) discussion, below.
\50\ See the original proposal at 57 FR 53627, Nov. 12, 1992.
See also 57 FR 58423, Dec. 28, 1992, extending the comment period
for an additional fourteen days.
\51\ 58 FR 5587, Jan. 22, 1993.
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The Dodd-Frank Act amends, repeals, or replaces many CEA sections
added by the CFMA (including the statutory exemptions for swaps in
excluded and exempt commodities at current CEA sections 2(d), 2(g), and
2(h)). To avoid any uncertainty as to whether the Commission will allow
bilateral swaps in non-agricultural commodities to revert to reliance
on existing part 35 for exemption from the CEA and the Dodd-Frank
amendments, the Commission is proposing to revoke current part 35 in
its entirety. Once part 35 is revoked, the only swaps authorized under
the CEA or the Commission's rules will be those swaps that comport with
the requirements of the CEA, as amended by the Dodd-Frank Act.\52\
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\52\ Section 723(c)(3)(B) of the Dodd-Frank Act grandfathers
existing 4(c) orders that relate to agricultural swaps unless
superseded by subsequent Commission order. This notice of proposed
rulemaking is not taking any action to alter the continued
effectiveness of the orders identified in footnote 24 above. See
also, 76 FR [ ---------- ] n. 38Jan. 20, 2011.
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C. Proposed New Part 35
The provisions of proposed new part 35 would generally provide that
agricultural swaps may be transacted subject to all provisions of the
CEA, and any Commission rule, regulation or order thereunder, that is
otherwise applicable to swaps. New part 35 would also clarify that by
issuing a rule allowing agricultural swaps to transact subject to the
laws and rules applicable to all other swaps, the Commission is
allowing agricultural swaps to transact on DCMs, SEFs, or otherwise to
the same extent that all other swaps are allowed to trade on DCMs,
SEFs, or otherwise.
D. Revisions to Part 32
Because commodity options (other than options on futures) clearly
fall within the Dodd-Frank Act definition of swap,\53\ the Commission
is proposing to substantially update and revise the now duplicative
off-exchange commodity option regulations set forth in current part 32.
Revised part 32, authorized by the Commission's plenary options
authority, will provide legal certainty for the commodity options
market by making it clear that commodity options (other than options on
futures) are authorized to continue subject to all provisions of the
CEA, and any rule, regulation, or order thereunder, that is otherwise
applicable to swaps.
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\53\ See footnote 6 above.
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In order to support the revisions to part 32, including the
withdrawal of several sections in their entirety, the Commission
reviewed and analyzed each provision of existing part 32, including the
corresponding history of the Commission's development of commodity
options regulation. Based on its review, the Commission has determined
that there would be little practical effect and no detrimental
consequences in adopting the proposed revisions to the existing
commodity options regime in part 32.
i. 1978 Suspension of Commodity Options (Sec. 32.11)
From a historical perspective, the Commission adopted its first
broad anti-fraud rule applicable to commodity options transactions on
June 24, 1975.\54\ After an unsuccessful effort to generally permit
off-exchange commodity options subject to certain rules and regulations
(that is, original part 32),\55\ the Commission issued a general
suspension of commodity options transactions in 1978.\56\ The
suspension was adopted by the Commission on April 17, 1978 and was
added to the original part 32 as Sec. 32.11.\57\ Upon its adoption in
1978, Sec. 32.11 suspended all commodity option transactions (except
for those trade options authorized by Sec. 32.4) \58\ that had been
otherwise authorized by original part 32. Aside from later amendments
that authorized commodity options conducted on or subject to the rules
of a contract market \59\ or a foreign board of trade,\60\ current
Sec. 32.11 remains in the same form as when originally adopted in
1978. Accordingly, the bulk of original part 32, as discussed below,
has been obsolete and/or irrelevant since the adoption of Sec. 32.11
in 1978. This includes the registration requirements in Sec. 32.3, the
disclosure requirements in Sec. 32.5, the segregation requirements in
Sec. 32.6, and the books and recordkeeping requirements in Sec. 32.7.
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\54\ 40 FR 26504, June 24, 1975. Originally designated as 17 CFR
30.01, the provision was re-designated as Sec. 32.9 and
incorporated into the original part 32 regulations adopted on
November 24, 1976.
\55\ See discussion and review of original part 32 below.
\56\ Exchange-traded options on futures were not affected since
they were not available at the time and only later became available
when the Commission initiated a pilot program to allow exchange-
traded options on futures in 1981. See 46 FR 54500, Nov. 3, 1981.
\57\ See 43 FR 16153, Apr. 17, 1978.
\58\ Dealer options, which were also being traded at the time,
were also subsequently exempted from the general options ban. See 43
FR 23704, June 1, 1978. Dealer options are discussed below in
connection with the withdrawal of rule 32.12.
\59\ See 47 FR at 57016, Dec. 22, 1982.
\60\ See 52 FR at 29003, Aug. 5, 1987.
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ii. Original Part 32 (Sec. Sec. 32.1-32.10)
Original part 32 was adopted by the Commission on November 24,
1976, and included substantially the same provisions as they exist in
current Sec. Sec. 32.1-32.10.\61\
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\61\ See 43 FR 51808, Nov. 24, 1976.
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a. 32.1
The definitions section, Sec. 32.1, has been substantively
modified only once \62\ since its adoption in 1976. That revision added
a scope provision as Sec. 32.1(a). The purpose of adding the scope
provision was to make clear that part 32 applied only to off-exchange
bilateral options, and that it would not apply to commodity options
conducted on or subject to the rules of a contract market. The Sec.
32.1(a) scope provision was amended once in 1987 to also exclude from
part 32 commodity options conducted on or subject to the rules of a
foreign board of trade.\63\ Beyond that, Sec. 32.1 has not been
substantively amended since its adoption in 1976.
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\62\ See 47 FR at 57016, Dec. 22, 1982.
\63\ See 52 FR at 29003, Aug. 5, 1987.
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Because commodity options (other than options on futures) are now
swaps and will be authorized to transact subject to the swaps rules,
the scope provision in Sec. 32.1 has been updated and retained in
revised part 32 as appropriate. The proposal would delete the
definitions in current Sec. 32.1 as duplicative--the terms therein are
already defined elsewhere, either in other Commission regulations or in
the CEA, and there is no need for their repetition in part 32.
b. 32.2
As originally adopted, Sec. 32.2(a) prohibited commodity options
transactions on a list of enumerated
[[Page 6102]]
agricultural commodities and Sec. 32.2(b) prohibited commodity options
involving any contract of sale of any commodity for future delivery
traded on or subject to the rules of any contract market or involving
the prices of such contracts, unless done pursuant to a subsequent
Commission rulemaking. Section 32.2 was amended once in 1992 to remove
Sec. 32.2(b),\64\ and Sec. 32.2 was amended again in 1998 to
reference the Commission's newly adopted Agricultural Trade Option
rules in Sec. 32.13. Because this proposal would treat agricultural
swaps the same as swaps in any other commodity, and because all
commodity options (other than options on futures) are now swaps, it is
no longer necessary to distinguish between agricultural and non-
agricultural commodities for the purposes of the Commission's options
regulations, and thus the Commission is proposing to withdraw Sec.
32.2.
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\64\ See 57 FR 27925, June 23, 1992. At that time, original
Sec. 32.2(a) was re-designated as simply Sec. 32.2.
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c. 32.3, 32.5, 32.6, and 32.7
As adopted in 1976, Sec. 32.3 provided that only firms registered
as futures commission merchants, or registered associated persons of
such firms, could offer or sell commodity options under part 32.
Section 32.5 imposed certain disclosure requirements for options
sellers, Sec. 32.6 addressed segregation of funds, and Sec. 32.7 set
forth the books and recordkeeping requirements. Because the 1978
suspension of commodity options in Sec. 32.11 remains in effect, the
requirements in Sec. Sec. 32.3, 32.5, 32.6, and 32.7 (the ``abandoned
sections'') are of no practical effect--there are no authorized
transactions subject to these abandoned sections. The commodity options
that are allowed to transact outside of the Sec. 32.11 suspension
(e.g., Sec. 32.4 trade options, Sec. 32.12 dealer options, Sec.
32.13 agricultural trade options, and commodity option transactions
conducted on or subject to the rules of a contract market or a foreign
board of trade) are each exempted from the requirements of the
abandoned sections. Accordingly, the proposal would withdraw Sec. Sec.
32.3, 32.5, 32.6, and 32.7.
d. 32.4
From its adoption, part 32 has included, in Sec. 32.4, an
exemption for commodity options used by commercial entities entering
into the commodity option transactions solely for purposes related to
their business.\65\ The so-called ``trade option exemption'' has
remained unchanged since 1976 and has provided legal certainty for that
segment of the commodity options market available to commercial end
users. This notice proposes revising the trade option exemption to
provide that commodity options may transact subject to the same laws,
rules, regulations, and orders otherwise applicable to all swaps. The
rationale for the revision is that the swaps rules already allow for
the equivalent of a trade option--the Dodd-Frank amendments permit
bilateral swaps, where both parties are ECPs,\66\ to remain uncleared
at the election of a commercial end user. The primary substantive
change to this market will be that, while current Sec. 32.4 imposes no
minimum net worth requirement on participants, both purchasers and
sellers of commodity options under revised Sec. 32.4 will have to
qualify as ECPs, just as swaps (other than swaps on a DCM) may only be
entered into by ECPs. The Commission is specifically requesting comment
as to whether this distinction will significantly affect hedging
opportunities available to currently active market participants.
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\65\ Sec. 32.4(a) exempts a commodity option when it is offered
to ``a producer, processor, or commercial user of, or a merchant
handling, the commodity which is the subject of the commodity option
transaction, or the products or by-products thereof, and that such
producer, processor, commercial user or merchant is offered or
enters into the commodity option transaction solely for purposes
related to its business as such.'' See Sec. 32.4(a).
\66\ See footnote 26, above.
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e. 32.8 and 32.9
Sections 32.8 and 32.9 address unlawful representations and fraud
in connection with commodity option transactions. These two consumer
protection provisions are important to both the Commission and the
commodity options markets. Even though commodity options are now swaps,
subject to the swaps rules and any anti-fraud or other customer
protection rules otherwise applicable to swaps, the Commission views
Sec. Sec. 32.8 and 32.9 as important protections for commodity options
participants. With the exception of a minor revision expanding the
unlawful representation prohibition of Sec. 32.8(a) to all Commission
registrants, Sec. Sec. 32.8 and 32.9 will be retained in substantially
the same form as they currently exist. The retention of Sec. Sec. 32.8
and 32.9 will not affect the applicability to options of any anti-fraud
or other similar rule that is applicable to a swap. That is, Sec. Sec.
32.8 and 32.9 are being retained in addition to any other protections
provided by the general swaps rules.
f. 32.10
Section 32.10 grandfathered commodity options transactions
occurring prior to the effective adoption of original part 32. Revised
part 32 would update the current text with a similar grandfather
provision for existing commodity options transacted pursuant to current
part 32. Generally, commodity options transacted pursuant to current
part 32 (and prior to the effective date of any revision to current
part 32) will remain enforceable upon the adoption of any revision to
part 32.
iii. Subsequent Additions to Part 32--Sec. Sec. 32.12 and 32.13
a. 32.12--Dealer Options
Section 32.12, commonly known as the dealer options exemption, was
added to original part 32 on June 1, 1978.\67\ The dealer options rules
provided an exemption from the Commission's then recently adopted
options ban at Sec. 32.11 (recall that the Sec. 32.11 options ban was
originally adopted on April 17, 1978).\68\ Amended two times shortly
after its adoption--once to adjust a net worth requirement \69\ and
again to include certain reporting requirements \70\--the Sec. 32.12
dealer options rules were intended to grandfather the ongoing
businesses of certain commercial option grantors who, as of May 1,
1978, were both in the business of granting options on a physical
commodity and in the business of buying, selling, producing, or
otherwise utilizing that commodity.
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\67\ See 43 FR 23704, June 1, 1978.
\68\ See 43 FR 16153, Apr. 17, 1978.
\69\ See 43 FR 47492, Oct. 16, 1978.
\70\ See 43 FR 52467, Nov. 13, 1978.
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The primary factor in the Commission's determination to withdraw
Sec. 32.12 at this time is that the dealer option business has
apparently ceased to exist. Since at least September 11, 2001,\71\ and
likely for at least another decade before that,\72\ the Commission has
not received a single report required to be filed by an entity
transacting dealer options under Sec. 32.12. That observation, in
conjunction with
[[Page 6103]]
the requirement that to rely on Sec. 32.12 a dealer has to have been
in this business as of May 1, 1978, implies that no entity is legally
relying on Sec. 32.12 for any currently transacted business activity.
The Commission is specifically requesting comment as to whether there
is any reason not to withdraw Sec. 32.12 in its entirety, and whether
any person, group of persons, or class of transactions is prejudiced or
otherwise harmed by such action.
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\71\ September 11, 2001 is, of course, the day that the
Commission's hard copy records contained in its New York regional
office in the World Trade Center were lost. The records would have
included any Sec. 32.12 reports, which were required to be filed
with and retained at the Commission's New York regional office in
hard copy form.
\72\ Interviews of long-serving Commission staff indicate no
recollections of entities transacting pursuant to the Sec. 32.12
dealer options exemption for at least the past 20 years. The
apparent cessation of the dealer options business should not come as
a surprise. It was widely expected at the time that when exchange-
traded options became available (which happened starting in 1981)
the dealer option business would fade away. It appears that this is,
in fact, what happened.
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b. 32.13--Agricultural Trade Options
Section 32.13 and agricultural trade options are described in the
Background section above. Added to part 32 in 1998,\73\ and amended
once thereafter,\74\ the ATOM registration regime has been largely
unused. It has attracted only one registrant, which registrant has
since withdrawn its registration. However, the exemption for
agricultural trade options meeting certain conditions as specified in
Sec. 32.13(g) appears to be widely used. Because the Commission is
proposing to authorize agricultural swaps in new part 35, and to re-
authorize commodity options to transact as swaps (with no distinction
as between agricultural and non-agricultural commodities) in revised
Sec. 32.4, the Commission is proposing to withdraw Sec. 32.13 in its
entirety.\75\ The primary effect of the change would be to remove the
$10 million net worth requirement for parties relying on the Sec.
32.13(g) exemption for agricultural trade options. Under revised Sec.
32.4, parties need only qualify as ECPs, which category would include
certain persons with a net worth of less than $10 million.
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\73\ See 63 FR 18832, Apr. 16, 1998.
\74\ See 64 FR 68011, Dec. 6, 1999.
\75\ In addition, the proposal would withdraw Sec. 3.13 in its
entirety. Section 3.13 outlines the registration procedures for
ATOMs, and will become be moot upon the withdrawal of Sec. 32.13.
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E. Part 33
As noted above, the Commission is proposing to amend part 33 to
remove references to options on physical commodities. All options on
physicals would now be regulated as swaps, leaving only exchange-traded
options on futures subject to part 33. Treating options on physicals
that are traded on a DCM as swaps would have little practical effect
since anyone (including non-ECPs) could continue to trade such
instruments on a DCM. In addition, qualified persons (ECPs) could trade
similar options on physical commodities in the non-DCM environment,
including on SEFs, subject to the same rules as other physical
commodity swaps.
V. Findings Pursuant to Section 4(c)
As noted above, section 723(c)(3)(A) of the Dodd-Frank Act
prohibits swaps in an agricultural commodity. However, section
723(c)(3)(B) of the Dodd-Frank Act explicitly provides that the
Commission may permit swaps in an agricultural commodity pursuant to
CEA section 4(c), the Commission's general exemptive authority, ``under
such terms and conditions as the Commission shall prescribe.''
Accordingly, certain of the amendments proposed herein are proposed for
adoption pursuant to section 4(c), as amended by the Dodd-Frank Act.
Section 4(c)(1) of the CEA authorizes the CFTC to exempt any
transaction or class of transactions from any of the provisions of the
CEA (subject to exceptions not relevant here) in order to ``promote
responsible economic or financial innovation and fair competition.''
\76\ The Commission may grant such an exemption by rule, regulation, or
order, after notice and opportunity for hearing, and may do so on
application of any person or on its own initiative. In enacting section
4(c), Congress noted that the goal of the provision ``is to give the
Commission a means of providing certainty and stability to existing and
emerging markets so that financial innovation and market development
can proceed in an effective and competitive manner.'' \77\
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\76\ New section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), as
amended by the Dodd-Frank Act, provides in full that:
In order to promote responsible economic or financial
innovation and fair competition, the Commission by rule, regulation,
or order, after notice and opportunity for hearing, may (on its own
initiative or on application of any person, including any board of
trade designated or registered as a contract market or derivatives
transaction execution facility for transactions for future delivery
in any commodity under section 5 of this Act) exempt any agreement,
contract, or transaction (or class thereof) that is otherwise
subject to subsection (a) (including any person or class of persons
offering, entering into, rendering advice or rendering other
services with respect to, the agreement, contract, or transaction),
either unconditionally or on stated terms or conditions or for
stated periods and either retroactively or prospectively, or both,
from any of the requirements of subsection (a), or from any other
provision of this Act (except subparagraphs (C)(ii) and (D) of
section 2(a)(1), except that--
(A) unless the Commission is expressly authorized by any
provision described in this subparagraph to grant exemptions, with
respect to amendments made by subtitle A of the Wall Street
Transparency and Accountability Act of 2010--
(i) with respect to--
(I) paragraphs (2), (3), (4), (5), and (7), paragraph
(18)(A)(vii)(III), paragraphs (23), (24), (31), (32), (38), (39),
(41), (42), (46), (47), (48), and (49) of section 1a, and sections
2(a)(13), (2)(c)(1)(D), 4a(a), 4a(b), 4d(c), 4d(d), 4r, 4s, 5b(a),
5b(b), 5(d), 5(g), 5(h), 5b(c), 5b(i), 8e, and 21; and
(II) section 206(e) of the Gramm-Leach-Bliley Act (Pub. L. 106-
102; 15 U.S.C. 78c note); and
(ii) in sections 721(c) and 742 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act; and
(B) the Commission and the Securities and Exchange Commission
may by rule, regulation, or order jointly exclude any agreement,
contract, or transaction from section 2(a)(1)(D)) if the Commissions
determine that the exemption would be consistent with the public
interest.
\77\ House Conf. Report No. 102-978, 1992 U.S.C.C.A.N. 3179,
3213.
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In order to analyze the effect of permitting agricultural swaps to
trade under the same terms and conditions as other swaps, it is
appropriate to examine some of the major components of the Dodd-Frank
Act that apply to swaps generally. Section 727 of the Dodd-Frank Act
adds, among other things, a new CEA section 2(a)(13) that mandates that
swap transaction and pricing data be made available to the public.
Section 723(a)(3) of the Dodd-Frank Act adds a new CEA section 2(h)
that provides that the Commission shall determine which swaps are
subject to a mandatory clearing requirement. New CEA section 2(h) also
provides that swaps that are required to be cleared must be executed on
a DCM or SEF, if a DCM or SEF makes the swap available for trading. As
noted above, part 35, as it is currently written, does not permit
clearing of agricultural swaps and does not contemplate any reporting
of agricultural swaps data.
Permitting agricultural swaps to trade under the same terms and
conditions as other swaps should provide greater certainty and
stability to existing and emerging markets so that financial innovation
and market development can proceed in an effective and competitive
manner. Treating all swaps, including agricultural swaps, in a
consistent manner should provide greater certainty to markets. The
Dodd-Frank Act reporting and trade execution requirements should lead
to greater market and price transparency, which may improve market
competition, innovation, and development. Centralized clearing of
agricultural swaps by robustly regulated central clearinghouses should
reduce systemic risk and provide greater certainty and stability to
markets by reducing counterparty risk.
The Commission is requesting comment on whether swaps in
agricultural commodities should be subject to the same legal
requirements as swaps in other commodities.
Section 4(c)(2) of the CEA provides: That the Commission may grant
exemptions only when it determines that the requirements for which an
exemption is being provided should not be applied to the agreements,
contracts or transactions at issue; that the exemption is consistent
with the public
[[Page 6104]]
interest and the purposes of the CEA; that the agreements, contracts or
transactions will be entered into solely between appropriate persons;
and that the exemption will not have a material adverse effect on the
ability of the Commission or Commission-regulated markets to discharge
their regulatory or self-regulatory responsibilities under the CEA.\78\
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\78\ Section 4(c)(2) of the CEA, 7 U.S.C. 6(c)(2), provides in
full that:
The Commission shall not grant any exemption under paragraph
(1) from any of the requirements of subsection (a) of this section
unless the Commission determines that--
(A) The requirement should not be applied to the agreement,
contract, or transaction for which the exemption is sought and that
the exemption would be consistent with the public interest and the
purposes of this Act; and
(B) The agreement, contract, or transaction--
(i) Will be entered into solely between appropriate persons;
and
(ii) Will not have a material adverse effect on the ability of
the Commission or any contract market or derivatives transaction
execution facility to discharge its regulatory or self-regulatory
duties under this Act.
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The purposes of the CEA include ``ensur[ing] the financial
integrity of all transactions subject to this Act and the avoidance of
systemic risk'' and ``promot[ing] responsible innovation and fair
competition among boards of trade, other markets and market
participants.'' \79\ As noted above, centralized clearing of
agricultural swaps (which is not permitted under the current part 35
rules) should reduce systemic risk. Also, allowing agricultural swaps
to trade under the general swaps rules contained in the Dodd-Frank Act
would allow agricultural swaps to trade on SEFs and DCMs (which is
prohibited under the current part 35 rules) which may result in
increased innovation and competition in the agricultural swaps market.
Reducing systemic risk and increasing innovation and competition by
permitting agricultural swaps to trade under the same terms and
conditions as other swaps would be consistent with the purposes listed
above, the general purposes of the CEA, and the public interest. The
Commission is requesting comment on this issue.
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\79\ CEA section 3(b), (7 U.S.C. 5(b)).
---------------------------------------------------------------------------
As noted above, the Dodd-Frank Act contains substantial new
clearing and trade execution requirements for swaps. The clearing
requirement is designed, among other things, to reduce the counterparty
risk of a swap, and therefore systemic risk. The swap reporting and
trade execution requirements should provide additional market
information to the Commission, the markets, and the public. Thus,
treating agricultural swaps in the same manner as other swaps may
enhance the ability of the Commission or Commission-regulated markets
to discharge their regulatory or self-regulatory responsibilities under
the CEA.
Section 4(c)(3) of the CEA includes within the term ``appropriate
persons'' a number of specified categories of persons, and also in
subparagraph (K) thereof ``such other persons that the Commission
determines to be appropriate in light of * * * the applicability of
appropriate regulatory protections.'' Section 723(a)(2) of the Dodd-
Frank Act adds, among other things, a new CEA section 2(e) that
provides: ``It shall be unlawful for any person, other than an eligible
contract participant, to enter into a swap unless the swap is entered
into on, or subject to the rules of, a [DCM].'' \80\ In light of the
comprehensive new regulatory scheme for swaps and the enhancements made
to the already robust regulatory system concerning DCMs \81\ that are
contained in the Dodd-Frank Act, the limitation on participation to
eligible contract participants outside of a DCM, and the ability of
others to enter into a swap on a DCM, should limit participation to
appropriate persons. The Commission requests comment on this issue.
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\80\ New CEA section 2(e), (7 U.S.C. 2(e)).
\81\ See, for example, new CEA section 5(d) (7 U.S.C. 7(d)) as
added by section 735(b) of the Dodd-Frank Act and amended CEA
section 5c (7 U.S.C. 7a-2) as amended by section 745 of the Dodd-
Frank Act.
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VI. Request for Comments Regarding the Proposed Rules
In addition to specifically requesting comment on the foregoing
questions related to the issuance of a 4(c) order, and the other
questions set out in the preceding sections of this notice of proposed
rulemaking, the Commission poses the following questions:
1. Generally, will the rule changes and amendments proposed herein
provide an appropriate regulatory framework for the transacting of (a)
agricultural swaps, and (b) trade options on all commodities?
2. Does the proposal for new part 35 appropriately address all
outstanding issues as they relate to the transaction of swaps in an
agricultural commodity?
3. Regarding the proposed revisions to part 32, and specifically
the revised Sec. 32.4 trade option exemption, will such revisions
significantly affect hedging opportunities available to currently
active users of the trade options market? In other words, is there any
reason not to revise Sec. 32.4 as proposed? In particular, are there
persons who offer or purchase trade options on non-enumerated
agricultural commodities (e.g., coffee, sugar, cocoa) under current
Sec. 32.4 who would not qualify as ECPs and would therefore be
ineligible to participate in such options under revised Sec. 32.4? If
so, should such participants be excepted from the general requirement
that all swaps participants must be ECPs unless the transaction takes
place on a DCM?
4. Regarding the proposed withdrawal of Sec. 32.12 in its
entirety, would such action (in conjunction with the adoption of the
new rules proposed herein) prejudice or otherwise harm any person,
group of persons, or class of transactions? In other words, is there
any reason not to withdraw Sec. 32.12 as proposed?
5. Similarly, and regarding the proposed withdrawal of Sec. 32.13
(the agricultural trade option provision) in its entirety, would such
action (in conjunction with the adoption of the new rules proposed
herein) prejudice or otherwise harm any person, group of persons, or
class of transactions? In other words, is there any reason not to
withdraw Sec. 32.13 as proposed?
6. Do the proposals as they relate to part 33 appropriately limit
the scope of part 33 to DCM-traded options on futures, leaving DCM-
traded options on physical commodities subject to part 32?
7. Do the proposals outlined herein omit or fail to appropriately
consider any other areas of concern regarding agricultural swaps and
options in any commodity?
VII. Related Matters
A. Cost Benefit Analysis
Section 15(a) of the CEA \82\ requires the Commission to consider
the costs and benefits of its actions before issuing a rulemaking under
the Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of the rulemaking or to determine
whether the benefits of the rulemaking outweigh its costs; rather, it
requires that the Commission ``consider'' the costs and benefits of its
actions. Section 15(a) further specifies that the costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: (1) Protection of market participants and the public; (2)
efficiency, competitiveness and financial integrity of futures markets;
(3) price discovery; (4) sound risk management practices; and (5) other
public interest considerations. The
[[Page 6105]]
Commission may in its discretion give greater weight to any one of the
five enumerated areas and could in its discretion determine that,
notwithstanding its costs, a particular rule is necessary or
appropriate to protect the public interest or to effectuate any of the
provisions or accomplish any of the purposes of the Act.
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\82\ 7 U.S.C. 19(a).
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i. Summary of proposed requirements. The proposed rule would
replace the swap exemption in part 35 and the commodity options
provisions in part 32 with new rules providing, in general, that
agricultural swaps and options (other than options on futures) would be
treated the same as all other swaps. The proposed rule would also amend
part 33 to remove references to options on physical commodities. While
the proposed rule does not contain the substantive requirements that
govern swaps generally (those requirements are found in the swaps-
related rulemakings that implement the Dodd-Frank Act), for purposes of
this analysis, it is appropriate to consider the costs and benefits of
treating agricultural swaps and options as all other swaps are treated.
ii. Costs. With respect to costs, the Commission has determined
that allowing agricultural swaps to continue to trade under the
requirements of the current part 35 would result in substantial costs.
The Dodd-Frank Act added numerous provisions to the CEA to protect
market participants and the public, such as the segregation of funds
for uncleared swaps, swap dealer registration and regulation, including
business conduct standards, and limitations on conflicts of interest.
Current part 35 exempts qualifying swaps from nearly all sections of
the CEA, so that these and other protections contained in Dodd-Frank
would not apply to agricultural swaps entered into under part 35.
The Dodd-Frank Act contains numerous provisions designed to improve
price discovery and foster sound risk management practices, such as the
provisions encouraging the clearing of swaps and trading of swaps on
DCMs and SEFs. Current part 35, by its terms, would not allow for the
clearing or trade execution provisions contained in Dodd-Frank.
Other alternatives to current part 35 could include writing a new
part that made agricultural swaps subject to some of the provisions
contained in the Dodd-Frank Act, but not other provisions, or accepting
all of the provisions of Dodd-Frank and adding additional requirements.
The costs of either of these alternatives (and of retaining current
part 35, as well) would be to the efficiency of markets, of swap
participants, and of the Commission. Since many users of agricultural
swaps would likely engage in other types of swaps also, those users
would be subject to two regulatory regimes and the compliance costs
that would accompany following both regimes. Moreover, the Commission
would be required to develop and implement two regimes. Also, several
of those who commented regarding the ANPRM noted that the new Dodd-
Frank Act regulatory regime is robust and comprehensive and provides
significant protections to market participants, so that any concerns
regarding agricultural swaps that may have existed under the provisions
of the CFMA should be allayed. Several commenters noted that
agricultural swaps are important risk management tools and that such
swaps should be available on the same terms and conditions as other
swaps that are used to manage risk.
With respect to options generally, the Commission has determined
that retaining the current parts 32 and 33 would have substantial
costs. As noted above, new CEA Sec. 1a(47) defines swaps to include
options, other than options on futures. The options rules contained in
part 32 are a confusing tangle of largely obsolete rules and, even more
important, the general option rules in parts 32 and 33 do not conform
to the requirements in the Dodd-Frank Act.
iii. Benefits. With respect to benefits, the Commission has
determined that replacing parts 32 and 35 with rules that allow
agricultural swaps and options to trade under the same terms and
conditions as other swaps and amending part 33 to delete references to
options on physical commodities will have substantial benefits.
Treating agricultural swaps the same as other swaps would subject
those swaps to the numerous provisions in the Dodd-Frank Act that
protect market participants and the public, such as the segregation of
funds for uncleared swaps, limitations on conflicts of interest, and
swap dealer registration and regulation, including business conduct
standards. Moreover, the clearing requirement in the Dodd-Frank Act is
intended to reduce systemic risk which should further protect the
public.
The provisions in the Dodd-Frank Act encouraging the clearing of
swaps and trading of swaps on DCMs and SEFs should improve price
discovery and foster sound risk management practices. The current
provisions of part 35 do not permit such clearing or trade execution.
The Dodd-Frank Act mandates that swap transaction and pricing data
be made available to the public. The reporting and trade execution
requirements should lead to greater market and price transparency.
Also, having a single set of regulations governing all swap
transactions should improve efficiency and compliance costs for markets
and market participants.
With respect to options generally, the Commission has determined
that replacing part 32 and allowing options (other than options on
futures) to trade in the same manner as other swaps will have
substantial benefits similar to those for agricultural swaps discussed
above. Moreover, the current part 32 is outdated and largely obsolete
under its own terms. Finally, the current language of parts 32 and 33
regarding options generally does not comply with the swap provisions of
the Dodd-Frank Act and must be replaced.
iv. Conclusion. After considering the section 15(a) factors, the
Commission has determined that the benefits of the proposed parts 32
and 35, and the amendments to part 33, outweigh the costs. Accordingly,
the Commission has determined to propose parts 32 and 35, and the
amendments to part 33. The Commission invites public comment on its
cost-benefit considerations. Commenters are also invited to submit any
data or other information that they may have quantifying or qualifying
the costs and benefits of the Proposal with their comment letters.
B. Regulatory Flexibility Analysis
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the rules they propose will have a significant
economic impact on a substantial number of small entities and, if so,
provide a regulatory flexibility analysis respecting the impact.\83\
The proposed rule, in replacing part 35, would affect eligible swap
participants (``ESPs'') (by eliminating the ESP category and requiring
agricultural swap participants to be eligible contract participants
(``ECPs''), unless the transaction occurs on a designated contract
market (``DCM'')). Regarding options, the proposed rule, in amending
part 33, would affect entities that currently engage in options on
physical commodities on a DCM, and, in replacing part 32, would affect
those entities that currently engage in options under Sec. 32.4 and
Sec. 32.13(g). By mandating that agricultural swaps and options be
treated as all other swaps, the effect of the proposed rule has the
potential to affect DCMs, derivatives
[[Page 6106]]
clearing organizations (``DCOs''), futures commission merchants
(``FCMs''), large traders and ECPs, as well as swap dealers (``SDs''),
major swap participants (``MSPs''), commodity pool operators
(``CPOs''), swap execution facilities (``SEFs''), and swap data
repositories (``SDRs'').
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\83\ 5 U.S.C. 601 et seq.
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i. DCMs, DCOs, FCMs, CPOs, large traders, ECPs, and ESPs. The
Commission has previously determined that DCMs, DCOs, FCMs, CPOs, large
traders, ECPs, and ESPs are not small entities for purposes of the
Regulatory Flexibility Act.\84\ Accordingly, the Chairman, on behalf of
the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed rules will not have a significant economic impact on a
substantial number of small entities with respect to these entities.
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\84\ See, respectively and as indicated, 47 FR 18618, 18619,
Apr. 30, 1982 (DCMs, CPOs, FCMs, and large traders); 66 FR 45604, at
45609, Aug. 29, 2001 (DCOs); 66 FR 20740, 20743, Apr. 25, 2001
(ECPs); and 57 FR 53627, 53630, Nov. 12, 1992 and 58 FR 5587, 5593,
Jan. 22, 1993 (ESPs).
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ii. SDs, MSPs, SEFs, and SDRs. SDs, MSPs, SEFs, and SDRs are new
categories of registrant under the Dodd-Frank Act. Therefore, the
Commission has not previously addressed the question of whether SDs,
MSPs, SEFs, and SDRs are, in fact, ``small entities'' for purposes of
the RFA. For the reasons that follow, the Commission is hereby
determining that none of these entities would be small entities.
Accordingly, the Chairman, on behalf of the Commission, hereby
certifies pursuant to 5 U.S.C. 605(b) that the proposed rules, with
respect to SDs, MSPs, SEFs, and SDRs, will not have a significant
impact on a substantial number of small entities.
a. SDs: As noted above, the Commission previously has determined
that FCMs are not small entities for the purpose of the RFA based upon,
among other things, the requirements that FCMs meet certain minimum
financial requirements that enhance the protection of customers'
segregated funds and protect the financial condition of FCMs
generally.\85\ SDs similarly will be subject to minimum capital and
margin requirements, and are expected to comprise the largest global
financial firms. Entities that engage in a de minimis quantity of swap
dealing in connection with transactions with or on behalf of its
customers will be exempted from designation as an SD. For purposes of
the RFA in this proposed rulemaking, the Commission is hereby
determining that SDs not be considered to be ``small entities'' for
essentially the same reasons that FCMs have previously been determined
not to be small entities.
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\85\ 47 FR, at 18619.
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b. MSPs: The Commission also has determined that large traders are
not small entities for the purpose of the RFA.\86\ The Commission
considered the size of a trader's position to be the only appropriate
test for purposes of large trader reporting.\87\ MSPs, among other
things, maintain substantial positions in swaps, creating substantial
counterparty exposure that could have serious adverse effects on the
financial stability of the United States banking system or financial
markets. For purposes of the RFA, the Commission is hereby determining
that MSPs not be considered to be ``small entities'' for essentially
the same reasons that large traders have previously been determined not
to be small entities.
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\86\ Id. at 18620.
\87\ Id.
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c. SEFs: The Dodd-Frank Act defines a SEF to mean a trading system
or platform in which multiple participants have the ability to accept
bids and offers made by multiple participants in the facility or
system, through any means of interstate commerce, including any trading
facility that facilitates the execution of swaps between persons and is
not a DCM. The Commission previously determined that a DCM is not a
small entity because, among other things, it may only be designated
when it meets specific criteria, including expenditure of sufficient
resources to establish and maintain adequate self-regulatory programs.
Likewise, the Commission will register an entity as a SEF only after it
has met specific criteria, including the expenditure of sufficient
resources to establish and maintain an adequate self-regulatory
program. Accordingly, as with DCMs, the Commission is hereby
determining that SEFs are not ``small entities'' for purposes of the
RFA.
d. SDRs: The Commission previously determined DCMs and DCOs not to
be small entities because of ``the central role'' they play in ``the
regulatory scheme concerning futures trading.'' \88\ Because of the
``importance of futures trading in the national economy,'' to be
designated as a contract market or registered as a DCO, the respective
entity must meet stringent requirements set forth in the CEA.\89\
Similarly, swap transactions that are reported and disseminated by SDRs
are an important part of the national economy. SDRs will receive data
from market participants and will be obligated to facilitate swaps
execution by reporting real-time data.\90\ Similar to DCOs and DCMs,
SDRs will play a central role both in the regulatory scheme covering
swaps trading and in the overall market for swap transactions.
Additionally, the Dodd-Frank Act allows DCOs to register as SDRs.
Accordingly, for essentially the same reasons that DCOs and DCMs have
previously been determined not to be small entities, the Commission is
hereby determining that SDRs are not ``small entities'' for purposes of
the RFA.
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\88\ 47 FR at 18619 (DCMs) and 66 FR at 45609 (DCOs).
\89\ See new CEA section 5(d), as added by section 735(b) of the
Dodd-Frank Act regarding DCM core principles and new CEA section
5b(c)(2), as added by section 725(c) of the Dodd-Frank Act regarding
DCO core principles.
\90\ See new CEA section 21, as added by section 728 of the
Dodd-Frank Act.
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iii. Entities Eligible to Engage in Options on Physical Commodities
on DCMs under Part 33. Under the current part 33, there is no
regulatory financial threshold that must be met in order to engage in
options on physical commodities on a DCM, so small entities would be
eligible to engage in such transactions. In fact, there is no
regulatory financial threshold that must be met in order to engage in
any type of transaction on a DCM. As noted above, new CEA section
1a(47) provides that options are swaps, other than options on futures.
New CEA section 2(e) provides that non-ECPs may enter into swaps, if
the swaps are effected on a DCM. Therefore, even though an option on a
physical commodity is defined to be a swap under the Dodd-Frank Act,
small entities will continue to be eligible to enter into such options
on a DCM under the rules proposed herein, just as they are eligible to
enter into such options on a DCM under the current part 33. Thus, the
rule will have no effect on the eligibility of small entities to enter
into an option on a physical commodity on a DCM. Accordingly, the
Chairman, on behalf of the Commission, hereby certifies pursuant to 5
U.S.C. 605(b) that the proposed rules will not have a significant
economic impact on a substantial number of small entities with respect
to entities eligible to engage in options on physical commodities on
DCMs under part 33.
iv. Entities Engaged in Options under Sec. 32.13(g). The
Commission has not previously addressed the question of whether
entities engaged in agricultural trade options under Sec. 32.13(g)
are, in fact, ``small entities'' for purposes of the RFA. For the
reasoning that follows, the Commission is hereby determining that
entities engaged in options under Sec. 32.13(g) would not be small
entities.
As noted above, the Commission previously has determined that ECPs
are
[[Page 6107]]
not small entities for the purpose of the RFA based upon, among other
things, the financial and institutional requirements contained in the
definition. Also as noted above, the exemption at Sec. 32.13(g) allows
for options on the enumerated agricultural commodities to be sold when:
(1) The option is offered to a commercial (``a producer, processor, or
commercial user of, or a merchant handling'' the underlying commodity);
(2) the commercial enters the transaction solely for purposes related
to its business as such; and (3) each party to the option contract has
a net worth of not less than $10 million. There are two analogous
provisions in the ECP definition, new CEA sections 1a(18)(A)(v)(III)
and 1a(18)(A)(xi)(II). New CEA section 1a(18)(A)(v)(III) provides that
an ECP includes a corporation, partnership, proprietorship,
organization, trust, or other entity that has a net worth exceeding
$1,000,000 and enters into a swap in connection with the entity's
business or to manage the risk associated with an asset or liability
owned or incurred or reasonably likely to be owned or incurred by the
entity in the conduct of the entity's business. New CEA section
1a(18)(A)(xi)(II) provides that an ECP includes an individual who has
assets invested on a discretionary basis, the aggregate of which is in
excess of $5,000,000 and who enters the swap in order to manage the
risk associated with an asset owned or liability incurred, or
reasonably likely to be owned or incurred, by the individual. The
participation requirements of Sec. 32.13(g)(1) are similar to, if not
more restrictive than, the analogous ECP provisions.
For purposes of the RFA in this proposed rulemaking, the Commission
is hereby determining that entities engaged in options under Sec.
32.13(g) not be considered to be ``small entities'' for essentially the
same reasons that ECPs have previously been determined not to be small
entities. Accordingly, the Chairman, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed rules,
with respect to entities engaged in options under Sec. 32.13(g), will
not have a significant impact on a substantial number of small
entities.
v. Entities Engaged in Options under Sec. 32.4. The Commission has
not previously addressed the question of whether entities engaged in
trade options under Sec. 32.4 are, in fact, ``small entities'' for
purposes of the RFA. As noted above, under Sec. 32.4, an option must
be offered to a producer, processor, or commercial user of, or a
merchant handling, the commodity, who enters into the commodity option
transaction solely for purposes related to its business as such. The
Sec. 32.4 trade option exemption does not include any net worth
requirement.
Because there is no net worth requirement in Sec. 32.4, thus
allowing commercial entities of any economic status to effect option
transactions, the Commission is not in a position to determine whether
entities engaged in options under Sec. 32.4 include a substantial
number of small entities on which the proposed rule would have a
significant economic impact. Therefore, the Commission offers, pursuant
to 5 U.S.C. 603, the following initial regulatory flexibility analysis,
which it shall transmit to the Chief Counsel for Advocacy of the Small
Business Administration as Sec. 603 requires:
A description of the reasons why action by the agency is
being considered. The Commission is taking this regulatory action to
withdraw Sec. 32.4 because the Dodd-Frank Act has defined the term
``swap'' to include options. This new definition renders Sec. 32.4
obsolete in its current form.
A succinct statement of the objectives of, and legal basis
for, the proposed rule. The objective of the withdrawal of Sec. 32.4
is to make the Commission's regulations comport with the CEA as revised
by the Dodd-Frank Act. As stated previously, the legal basis for the
proposed withdrawal is the new CEA definition of swap, new section
1a(47)(A)(i), and the agricultural swaps provisions in section
723(c)(3) of the Dodd-Frank Act.
A description of and, where feasible, an estimate of the
number of small entities to which the proposed rule will apply. The
small entities to which the proposed withdrawal of Sec. 32.4 may apply
are those commercial small entities that would be smaller than an ECP
and additionally would have annual receipts of less than $750,000, the
threshold for the definition of small entity in the RFA.\91\ Because
there are no reporting or registration requirements in Sec. 32.4, it
is difficult to quantify the exact number of small entities, if any, to
which the proposed rule may apply.
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\91\ 5 U.S.C. 601(6).
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A description of the projected reporting, recordkeeping,
and other compliance requirements of the proposed rule, including an
estimate of the classes of small entities which will be subject to the
requirement and the type of professional skills necessary for
preparation of the report or record. The proposed withdrawal of Sec.
32.4 does not contain any reporting, recordkeeping, or other compliance
requirements. However, because the Dodd-Frank Act provides that options
are swaps, the swaps rules being promulgated under the Dodd-Frank Act
in other rulemakings will contain reporting, recordkeeping, and other
compliance requirements. However, the withdrawal of 32.4 and the
application of the Dodd-Frank Act swaps rules will limit option
transactions to eligible contract participants, which have been
determined not to be small entities. Therefore, any entity that is not
an ECP will be unable to enter into option transactions except on a
DCM. Thus, there will be no reporting, recordkeeping or compliance
requirements applicable to any small entity.
An identification, to the extent practicable, of all
relevant Federal rules which may duplicate, overlap or conflict with
the proposed rule. Small entities that do not qualify as ECPs will be
unable to engage in options transactions except on a DCM under an
existing regulatory scheme. Accordingly, there will be no rules
applicable to them that could duplicate, overlap, or conflict with any
other Federal rules.
Description of any significant alternatives to the
proposed rule which accomplish the stated objectives of applicable
statutes and which minimize any significant economic impact of the
proposed rule on small entities. These may include, for example, (1)
the establishment of differing compliance or reporting requirements or
timetables that take into account the resources available to small
entities; (2) the clarification, consolidation, or simplification of
compliance and reporting requirements under the rule for such small
entities; (3) the use of performance rather than design standards; and
(4) an exemption from coverage of the rule, or any part thereof, for
such small entities.
A potential alternative to limiting trade options under Sec. 32.4
to ECPs would be to create a special rule to allow non-ECPs to engage
in such transactions. However, the vast majority of commenters
responding to the ANPRM, including both agricultural and non-
agricultural interests,\92\ supported treating agricultural swaps the
same as other swaps, which would entail limiting participation in trade
options (other than options on a DCM) to ECPs.
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\92\ See summary of comments at III B above.
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Given these facts, the Commission has determined to treat all trade
options in the same manner as any other swap and
[[Page 6108]]
thus limit participation to ECPs, unless the swap is transacted on a
DCM.
C. Paperwork Reduction Act
Under the Paperwork Reduction Act (PRA),\93\ an agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number from the Office of Management and Budget (OMB). The Commission
believes that these proposed rules will not impose any new information
collection requirements that require approval of OMB under the PRA. The
Commission notes that these proposed rules will involve the withdrawal
of certain provisions related to Commission forms, and will ultimately
result in the expiration, cancellation, or removal of such forms.\94\
Because the proposals would ultimately result in removing or deleting
form filing and/or recordkeeping burdens, it will not result in the
creation of any new information collection subject to OMB review or
approval under the PRA.
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\93\ 44 U.S.C. 3501 et seq.
\94\ The affected forms include any forms that relate to the
agricultural trade option rules in current 17 CFR 32.13 and the
dealer option rules in current 17 CFR 32.12.
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As a general matter, these proposed rules would allow agricultural
swaps and options to trade under the same terms and conditions as all
other swaps and these proposed rules do not, by themselves, impose any
new information collection requirements. Collections of information
that may be associated with engaging in agricultural swaps or options
are, or will be, addressed within each of the general swap-related
rulemakings implementing the Dodd-Frank Act. The Commission invites
public comment on the accuracy of its estimate that no additional
information collection requirements or changes to existing collection
requirements would result from the rules proposed herein.
VIII. Proposed Rules
List of Subjects
17 CFR Part 3
Administrative practice and procedure, Brokers, Commodity futures,
Reporting and recordkeeping requirements.
17 CFR Part 32
Commodity futures, Consumer protection, Fraud, Reporting and
recordkeeping requirements.
17 CFR Part 33
Commodity futures, Consumer protection, Fraud, Reporting and
recordkeeping requirements.
17 CFR Part 35
Commodity futures.
In consideration of the foregoing and pursuant to the authority
contained in the Act, as indicated herein, the Commission hereby
proposes to amend chapter I of title 17 of the Code of Federal
Regulations as follows:
PART 3--REGISTRATION
1. The authority citation for part 3 continues to read as follows:
Authority: 5 U.S.C. 522, 522b; 7 U.S.C. 1a, 2, 6, 6a, 6b, 6c,
6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 13b,
13c, 16a, 18, 19, 21, 23.
Sec. 3.13 [Removed and Reserved]
2. Remove and reserve Sec. 3.13.
3. Revise part 32 to read as follows:
PART 32--REGULATION OF COMMODITY OPTION TRANSACTIONS
Sec.
32.1 Scope.
32.2 [Reserved.]
32.3 [Reserved.]
32.4 Commodity option transactions; general authorization.
32.5 [Reserved.]
32.6 [Reserved.]
32.7 [Reserved.]
32.8 Unlawful representations; execution of orders.
32.9 Fraud in connection with commodity option transactions.
32.10 Option transactions entered into prior to the effective date
of this part.
32.11 [Reserved.]
32.12 [Reserved.]
32.13 [Reserved.]
Authority: 7 U.S.C. 1a, 2 note, 6c(b), and 6(c), unless
otherwise noted.
Sec. 32.1 Scope.
The provisions of this part shall apply to all commodity option
transactions, except for commodity option transactions on a contract of
sale of a commodity for future delivery conducted or executed on or
subject to the rules of either a designated contract market or a
foreign board of trade.
Sec. 32.2 [Reserved]
Sec. 32.3 [Reserved]
Sec. 32.4 Commodity option transactions; general authorization.
Subject to the provisions of this part, any person or group of
persons may offer to enter into, enter into, confirm the execution of,
maintain a position in, or otherwise conduct activity related to any
transaction in interstate commerce that is a commodity option
transaction, subject to all provisions of the Act, including any
Commission rule, regulation, or order thereunder, otherwise applicable
to any other swap.
Sec. 32.5 [Reserved]
Sec. 32.6 [Reserved]
Sec. 32.7 [Reserved]
Sec. 32.8 Unlawful representations; execution of orders.
It shall be unlawful for:
(a) Any person required to be registered with the Commission in
accordance with the Act expressly or impliedly to represent that the
Commission, by declaring effective the registration of such person or
otherwise, has directly or indirectly approved such person, or any
commodity option transaction solicited or accepted by such person;
(b) Any person in or in connection with an offer to enter into, the
entry into, or the confirmation of the execution of, any commodity
option transaction expressly or impliedly to represent that compliance
with the provisions of this part constitutes a guarantee of the
fulfillment of the commodity option transaction;
(c) Any person, upon receipt of an order for a commodity option
transaction, unreasonably to fail to secure prompt execution of such
order.
Sec. 32.9 Fraud in connection with commodity option transactions.
It shall be unlawful for any person directly or indirectly:
(a) To cheat or defraud or attempt to cheat or defraud any other
person;
(b) To make or cause to be made to any other person any false
report or statement thereof or cause to be entered for any person any
false record thereof; or
(c) To deceive or attempt to deceive any other person by any means
whatsoever; in or in connection with an offer to enter into, the entry
into, or the confirmation of the execution of, any commodity option
transaction.
Sec. 32.10 Option transactions entered into prior to [effective date
of final rule].
Nothing contained in this part shall be construed to affect any
lawful activities that occurred prior to [effective date of final
rule].
[[Page 6109]]
Sec. 32.11 [Reserved]
Sec. 32.12 [Reserved]
Sec. 32.13 [Reserved]
PART 33--REGULATION OF COMMODITY OPTION TRANSACTIONS THAT ARE
OPTIONS ON CONTRACTS OF SALE OF A COMMODITY FOR FUTURE DELIVERY
4. The authority citation for part 33 is revised to read as
follows:
Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 12c, 13a, 13a-
1, 13b, 19, and 21, unless otherwise noted.
5. Revise the part heading to read as set forth above.
6. In Sec. 33.2, revise paragraph (b) to read as follows:
Sec. 33.2 Applicability of Act and rules; scope of part 33.
* * * * *
(b) The provisions of this part apply to commodity option
transactions that are options on contracts of sale of a commodity for
future delivery except for commodity option transactions that are
options on contracts of sale of a commodity for future delivery
conducted or executed on or subject to the rules of a foreign board of
trade.
* * * * *
Sec. 33.4 [Amended]
7. Amend Sec. 33.4 as follows:
a. Remove the words ``or for options on physicals in any commodity
regulated under the Act,'' in the introductory text;
b. Remove and reserve paragraph (a)(4);
c. Remove and reserve paragraph (a)(5)(iv);
d. Remove the words ``or underlying physical'' from paragraph
(b)(1)(iii); and
e. Remove the words ``, options on physicals,'' from paragraph
(d)(3).
8. Amend Sec. 33.7 as follows:
a. Revise the second paragraph of the Options Disclosure Statement
in paragraph (b) introductory text;
b. Remove the phrase ``or underlying physical commodity'' from
paragraph (b)(1) each time it appears;
c. Remove the phrase ``(e.g., commitment to sell the physical)''
from paragraph (b)(1) the first time it appears;
d. Designate the undesignated paragraphs following paragraph (b)(1)
as paragraphs (b)(1)(i), (ii), (iii), (iv), and (v), and revise newly
designated paragraph (b)(1)(v);
e. Remove the phrase ``or physical commodity'' from paragraph
(b)(2) introductory text and from paragraph (b)(2)(i);
f. Designate the undesignated paragraphs following paragraph (b)(3)
as paragraphs (b)(3)(i), (ii), and (iii);
g. Designate paragraph (b)(4) as paragraph (b)(4)(i) and the
undesignated paragraph that follows as paragraph (b)(4)(ii);
h. Designate paragraph (b)(5) as paragraph (b)(5)(i) and the
undesignated paragraph that follows as paragraph (b)(5)(ii), and remove
the phrase ``or underlying physical commodity'' from newly designated
paragraph (b)(5)(i) both times it appears;
i. Revise newly designated paragraph (b)(5)(ii);
j. Remove the phrase ``or underlying physical commodity'' from
paragraph (b)(6);
k. Remove the phrase ``or the physical commodity'' and the phrase
``or underlying physical commodity'' from paragraph (b)(7)(ii);
l. Remove and reserve paragraph (b)(7)(iv);
m. Remove the phrase ``or underlying physical commodity'' from
paragraph (b)(7)(v); and
n. Remove the phrase ``or underlying physical commodity'' from
paragraph (b)(7)(x).
The revisions read as follows:
Sec. 33.7 Disclosure.
* * * * *
(b) * * *
BOTH THE PURCHASER AND THE GRANTOR SHOULD KNOW THAT THE OPTION IF
EXERCISED, RESULTS IN THE ESTABLISHMENT OF A FUTURES CONTRACT (AN
``OPTION ON A FUTURES CONTRACT'').
* * * * *
(1) * * *
(v) The grantor of a put option on a futures contract who has a
short position in the underlying futures contract is subject to the
full risk of a rise in the price in the underlying position reduced by
the premium received for granting the put. In exchange for the premium
received for granting a put option on a futures contract, the option
grantor gives up all of the potential gain resulting from a decrease in
the price of the underlying futures contract below the option strike
price upon exercise or expiration of the option.
(5) * * *
(ii) Also, an option customer should be aware of the risk that the
futures price prevailing at the opening of the next trading day may be
substantially different from the futures price which prevailed when the
option was exercised.
* * * * *
9. Revise part 35 to read as follows:
PART 35--SWAPS IN AN AGRICULTURAL COMMODITY (AGRICULTURAL SWAPS)
Authority: 7 U.S.C. 2 note, 6c(b), and 6(c), unless otherwise
noted.
Sec. 35.1 Agricultural swaps, generally.
(a) Any person or group of persons may offer to enter into, enter
into, confirm the execution of, maintain a position in, or otherwise
conduct activity related to, any transaction in interstate commerce
that is a swap in an agricultural commodity subject to all provisions
of the Act, including any Commission rule, regulation, or order
thereunder, otherwise applicable to any other swap; and
(b) In addition to paragraph (a) of this section, any transaction
in interstate commerce that is a swap in an agricultural commodity may
be transacted on a swap execution facility, designated contract market,
or otherwise in accordance with all provisions of the Act, including
any Commission rule, regulation, or order thereunder, applicable to any
other swap eligible to be transacted on a swap execution facility,
designated contract market, or otherwise.
Issued in Washington, DC on January 20, 2011 by the Commission.
David A. Stawick,
Secretary of the Commission.
Appendices to Commodity Options and Agricultural Swaps--Commission
Voting Summary and Statements of Commissioners
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Dunn,
Sommers, Chilton and O'Malia voted in the affirmative; no
Commissioner voted in the negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the proposed rulemaking to authorize agricultural swap
and commodity option transactions and subject them to the same rules
applicable to all other swaps. The Dodd-Frank Act prohibits such
transactions if the Commission does not specifically authorize them.
The Commission was informed on this proposal by the public comments
received in response to an advanced notice of proposed rulemaking
published in September of last year that addressed agricultural
swaps. Those comments overwhelmingly supported treating agricultural
swaps similarly to the treatment of other swaps brought under
[[Page 6110]]
regulation by the Dodd-Frank Act. Agricultural producers, packers,
processers and handlers will benefit from the ability to use
agricultural swaps to hedge their risk and also will benefit from
the transparency brought forth under the Dodd-Frank Act. I believe
this proposed rulemaking provides an appropriate regulatory
framework for the transaction of agricultural swaps and commodity
options, and I look forward to hearing the public's views on this
matter.
[FR Doc. 2011-1685 Filed 2-2-11; 8:45 am]
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