Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

Energy Trading Under Dodd-Frank

Wall Street reform hits the utility business.

Fortnightly Magazine - October 2010

Utilities, long accustomed to regulation by FERC and state PUCs, now face extensive regulation of their energy trading activities by the Commodity Futures Trading Commission (CFTC). Under the Wall Street Reform and Consumer Protection Act —commonly known as Dodd-Frank—signed into law July 21, 2010, energy swap contracts may be subject to new capital, margin, reporting, business conduct, and other requirements that likely will increase their trading costs and create new compliance concerns.

Utilities and other energy companies should be particularly interested in the scope and applicability of an end-user exemption tied to the hedging of “commercial risk”—a term that’s expected to be further defined in one of the more than 60 implementing rulemakings the CFTC will be undertaking within the next year. Close monitoring of these rulemakings will be important for any company trading in energy contracts to ensure compliance with the final CFTC requirements.

Capital and Margin Requirements

Under Dodd-Frank, all standardized “swaps” (broadly defined to include virtually all derivative contracts except already-regulated futures) must be submitted for clearing to a derivatives clearing organization and executed on a swap execution facility or designated contract market. Clearing organizations will be required to impose margin requirements and other risk-control mechanisms on participants—effectively tying up cash and capital of participants and increasing the costs of trading. Nonetheless, an exception from the clearing requirement and its attendant burdens is available for swaps in which one of the counterparties isn’t a “swap dealer” or “major swap participant;” is using swaps to hedge or mitigate commercial risk; and provides certain required notification to the CFTC. Note, then, that even if utilities qualify for the exemption, they still must comply with a new notification requirement, to be further defined by the CFTC.

Comprehensive Regulation

The act subjects entities that qualify as “swap dealers” or “major swap participants” to comprehensive regulation by the CFTC, including registration, reporting, recordkeeping, business conduct, and independent capital and margin requirements. A swap dealer is an entity that holds itself out as a dealer or makes a market in swaps or “regularly enters into swaps with counterparties as an ordinary course of business for its own account,” subject to a de minimis exception.

A “major swap participant” is an entity that meets certain qualitative criteria involving the creation of systemic risk or that maintains a “substantial position” (a term to be further defined) in swaps, exclusive of hedging commercial risk. Thus, the commercial hedging exemption has additional significance, and those looking to qualify for this exemption should be prepared to substantiate the hedging character of their transactions to the CFTC. Nevertheless, even traders who avoid regulation as major swap participants or swap dealers likely will experience increased costs passed on by those who qualify as such entities.

Reporting and Recordkeeping

Dodd-Frank requires swaps not accepted for clearing to be reported to either a

Pages