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Leadership change may tip scale on CFTC policies

The Trump administration: A Platts news and analysis feature

By Maya Weber

Published online 03 January 2017

The new year could bring a new political reality to the Commodity Futures Trading Commission, where a few final pieces of the Dodd-Frank regulatory regime that could have ripple effects on energy companies are pending.

Chairman Timothy Massad in early December pushed off until the next administration a decision on the biggest missing piece: a position limits rule meant to ward off excessive speculation in commodity markets. That leaves a future Republican-led CFTC to make the call on the contentious regulation that has been years in the making.

After the election, the Republican on the commission, J. Christopher Giancarlo, resisted Massad's plan to release a final rule by the end of year, but agreed to vote for a re-proposal of the policy.

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Action on the rule next year is expected to lag some in the transition to the new administration, with new commissioners waiting to be confirmed, not to mention needing to get up to speed on the roughly 900-page proposal.

Large energy industry players have welcomed flexibility added to the rule in the latest proposal, and are likely to push for more changes under a Republican-led commission.

“There will be a new audience at the CFTC, which will provide more opportunity for industry participants to weigh in and continue with their advocacy efforts,” said Meghan Gruegner, an associate at Sutherland. “We potentially could see a very different regulatory landscape than what we would have seen under the Democrat-led commission.”

Not everyone is happy about the outcome. Tyson Slocum of Public Citizen casts the current proposal as providing weaker limits that allow companies to hold bigger positions and have more flexibility on hedge exemptions. "These were big priorities for energy companies and financial companies. This is a significant victory for them."

Debate seen on whether to advance position limits

Even so, some industry participants may return to the argument that there is no economic justification for imposing federal position limits on all non- financial commodities, and it remains to be seen where a Republican chairman will land in that debate.

"On position limits, there is a definite split" in the industry, said Phil Lookadoo, a partner at Haynes and Boone. "There are people who fundamentally say there's never been an economic justification for imposing position limits on all non-financial commodities, so why are we even doing this."

That viewpoint would more likely get a chance to be heard under a commission led by Giancarlo, said Lookadoo, who believes there were valuable procedures developed in the current proposal to enable energy companies to hedge and mitigate their risks.

So far, Giancarlo has supported the December 7 re-proposal as providing "the basis of implementation of a final position limits rule that I could support."

If Giancarlo were named chairman by the Trump administration, as many suspect, he would face additional vetting and a vote in the Senate Agriculture Committee.

"There are people who think that in a Republican administration we might not have a position limits rule, said Paul Pantano, a partner at Cadwalader, Wickersham & Taft. "I do not share that view." Instead, he said the commission might issue a rule that is more favorable to commercial companies seeking to hedge their risks.

Along the same lines, Alexander Holtan, counsel at Sutherland, suggested that Giancarlo, if nominated and confirmed as chairman, might "ultimately seek to issue a rule that "sets reasonable standards and provides flexibility at the same time," considering the time and resources already invested in the rulemaking.

For some commercial end users, concerns continue over the definition of bona fide hedges that will be exempted from position limits and the commission's approach to the so-called economically appropriate test used to decide whether a transaction is a bona fide hedge. Debate has centered on whether that test should be done at the level of the corporate enterprise or the level of the entity entering the hedge.

Some may also push the idea of using the more flexible "accountability levels" on positions, as currently relied upon by the exchanges. Those trigger a review of a traders' position with the potential of action to alter it, as opposed to the hard limits the CFTC has proposed.

Another go at CFTC reauthorization

Elsewhere, Congress is expected to try once again to reauthorize the Commodity Exchange Act and tweak the Dodd-Frank title affecting derivatives, possibly taking a more aggressive approach than last year — although an effort to tear up the title is generally viewed as unlikely.

"Next Congress, the committee will focus on reauthorizing the commission and ensuring the commission implements the law in a way that fosters market confidence, preserves liquidity, and protects end-users," said House Agriculture Committee Chairman, Michael Conaway, Republican-Texas, in an emailed statement.

The volume of pushback from the right on position limits will depend in part on how much the industry advocates on the Hill, said one industry advocate. If Giancarlo comes up with rule deemed reasonable, industry might be willing to put it to bed and not re-litigate these issues.

Under Massad, commercial end users of derivatives have gained concessions to ease their regulatory burdens -- they were exempted from having to post margin for uncleared swaps, they gained a clarification on how contracts with volumetric optionality would be treated as forward contracts, and gained reporting and record-keeping relief under a trade options rule, among other fixes. But there could still be efforts to enshrine such fixes into law.

De minimis threshold seen unlikely to plummet

On another area of interest to energy companies, Chris Schindler, a partner at Hogan Lovells, said it was unlikely that a Republican-led CFTC would drop from $8 billion to $3 billion the de minimis threshold of annual swap dealing that triggers registration with the commission as a swap dealer. Giancarlo has been critical of even the $8 billion figure as an arbitrary threshold, he noted.

Energy industry groups have been seeking to do away with an automatic drop to the lower level, warning it could drive away hedging counterparties who have avoided the swap dealer designation that carries with it stiffer regulatory burdens such as capital, margin and reporting requirements. Earlier this year, the commission delayed by one year the automatic drop that was to take effect at the end of 2017.

Also pending at the CFTC is a proposed regulation on algorithmic trading, which is facing pushback over how proprietary source code will be safeguarded and on whether many commercial end users would have to register with the commission. Giancarlo voted against the supplemental proposal when the CFTC moved ahead with it in November, calling the source code provisions a turn in the direction of "unchecked state authority." He also criticized an "unworkable compliance process" for regulated entities that use software from third-party vendors. Nonetheless, in a recent speech he said he keeps an open mind on the matter and that there will be time "to establish well-considered policy responses to the digitization of contemporary markets."

Giancarlo has also made known his concern about an upcoming March 1 deadline for posting of variation margin for uncleared swaps, calling the deadline "unrealistic" and a challenge to market participants.

Also closely watched at the CFTC is a proposed rule setting capital requirements for swap dealers, and on that proposal too, Giancarlo has raised qualms. Lookadoo said the ultimate outlines of the capital rule could have major impact on whether swap dealers that are provisionally registered as dealers stay in that business or choose to "unregister," affecting the diversity of parties available to help commercial entities hedge their risks.

Lastly, Giancarlo has on multiple occasions spoken more broadly of his concerns about increased liquidity risk in the global financial system and how multiple rules were affecting liquidity. In addition, he has criticized what he sees as a mismatch between the CFTC's overall swaps trading regulatory framework and the distinct liquidity and trading dynamics of the global swaps market. The parameters of policies that might flow from those far- reaching concerns are yet to be seen.

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