CFTC Adopts Large Trader Reporting Rules

On July 7, 2011, the Commodity Futures Trading Commission (CFTC) adopted final large trader reporting rules for physical commodity swaps and swaptions. See Large Trader Reporting for Physical Commodity Swaps, Final Rules, 76 Fed. Reg. 43851 (July 22, 2011) (Final Rules). The rules apply to swaps and swaptions that are linked, or priced at a differential, to either the price of any of the 46 physical commodity futures contracts the CFTC enumerates (Covered Futures Contracts)¹ or the price of the physical commodity at the delivery location of any of the Covered Futures Contracts. The Final Rules require regular position reporting and recordkeeping by clearing organizations, clearing members, and swap dealers for any principal or counterparty accounts that contain physical commodity swaps or swaptions that meet or exceed the “reportable position” threshold set by the CFTC. Recordkeeping and special call reporting requirements also apply to persons with positions in physical commodity swaps or swaptions that exceed a minimum threshold that is lower than the “reportable position” threshold.

These special reporting rules will take effect on September 20, 2011. At that time, the rules will impose routine reporting obligations on clearing organizations for cleared swaps and on clearing members (including positions of affiliates that are currently understood to be swap dealers) for both cleared and uncleared swaps. The rule will not take effect for swap dealers that are not clearing members until some time in the future when the CFTC finalizes the definition, registration requirements and applicable regulations for swap dealers.

What Are “Swaps”?

Until the CFTC adopts a final definition of the term “swap” and that definition becomes effective, Final Rule 20.1 defines the term “swap” by restating a portion of the definition of “swap agreement” in CFTC Rule 35.1(b)(1). As restated, the term “swap” means “an agreement (including terms and conditions incorporated by reference therein) which is a commodity swap (including any option to enter into such swap) within the meaning of ‘swap agreement’ under [Rule 35.1(b)(1)], or a master agreement for a commodity swap together with all supplements thereto.” In other words, “a ‘swap’ as used in this rulemaking refers to an agreement between two parties to exchange one or more cash flows measured by different rates or prices with payments calculated by reference to a principal base (notional amount).” See Final Rules at 43854, note 11.

Once the CFTC’s definition of swap in the CFTC-SEC Product Definition proposal is finalized and becomes effective, that definition will supersede the CFTC’s reliance on Rule 35.1(b)(1) in the Final Rules.

Which Swaps Are “Reportable Positions”?

The Final Rules will require clearing members and swap dealers in one or more paired swaps or swaptions (what the CFTC calls “reporting entities”) as well as clearing organizations to report data to the CFTC on “reportable positions” in physical commodity swaps and swaptions. Calculating which physical commodity swaps and swaptions are “reportable positions” will require three steps. Final Rule 20.1. First, one must identify any open swaps and swaptions in a principal or a counterparty account that are linked to the price of either a Covered Futures Contract or the same commodity for delivery at the same location or locations as that of a Covered Futures Contract (each, a “paired swap” or a “paired swaption”). This includes swaps and swaptions that are:

• settled by direct or indirect reference (which may include a partial reference) to the price of either a Covered Futures Contract or the same commodity for delivery at the same location or locations as an underlying commodity in a Covered Futures Contract (the underlying commodity of a Covered Futures Contract); and
• priced at a differential to a Covered Futures Contract or the underlying commodity of a Covered Futures Contract. Final Rule 20.1; see Final Rules at 43854 - 43855.

Second, one must calculate the “futures equivalent” for each month for all paired swaps and paired swaptions, which is the number of economically equivalent futures contracts for each position or transaction in any paired swaps or paired swaptions. In general, the futures equivalent is calculated for swaps by multiplying the total notional quantity of the swap by its remaining duration and then dividing by the number of units that make up one futures contract.² The number of futures equivalent contracts is then allocated pro rata to each month or fraction of a month (based upon the number of days remaining in each month) remaining on the swap. The futures equivalent for a swaption is generally calculated the same way, but the monthly futures equivalent is adjusted by the option delta.

Last, if the futures equivalent amount of any paired swaps or paired swaptions in any one month is equal to 50 or more contracts, such paired swaps or swaptions are “reportable positions.” The CFTC based its decision to set the threshold at 50 contracts on “industry inquiries regarding what reporting level would make 95% of the economically equivalent swaps markets visible to the Commission.” See Final Rules at 43853. The CFTC notes that this threshold is comparable to the minimum 25-contract reporting levels in effect for futures positions under CFTC Rule 15.03. See Final Rules at 43860.

If a paired swap or paired swaption position attributable to a clearing member or a swap dealer as principal or to such person’s counterparty meets or exceeds the 50-contract threshold, all other positions in that trader’s consolidated account on the same commodity that renders the account reportable will become part of the relevant reportable position. Final Rule 20.1; see Final Rules at 43856. Once positions in a person’s account become reportable, positions in that account will be treated as reportable positions until and including the first reporting day on which the account no longer includes a reportable position. Final Rule 20.1; see Final Rules at 43856, note 19.

The CFTC acknowledges that this threshold calculation “may be complex or costly” and provides an alternative definition of “reportable position” that allows a reporting entity to bypass this calculation. Final Rule 20.1; see Final Rules at 43856. A reporting entity may instead identify a “reportable position” as all positions on a gross basis in a consolidated account that are based on the same commodity (in accordance with Final Rule 20.4(a)), provided that the reporting entity applies this approach consistently to all consolidated accounts.

What Reporting Is Required?

Each reporting entity will be required to report daily to the CFTC data on its principal reportable positions in one consolidated account. Final Rule 20.4.³ Each reporting entity must also report daily data on reportable positions in each counterparty’s consolidated account. When a particular counterparty’s consolidated account first becomes reportable, the reporting entity must submit a Form 102S filing to the CFTC (which provides basic identifying information regarding that counterparty) under Final Rule 20.5(a). The CFTC may place a special call directly upon any person with physical commodity swap or swaption positions sufficient to trigger the recordkeeping requirement (as discussed below). This special call would require such person to file a Form 40S, which requires detailed information about the filer and its positions. Final Rule 20.5(b); see also Final Rules at 43856.

Each clearing organization will be required to report daily to the CFTC aggregate data on paired swaps or swaptions for each clearing member’s proprietary and customer accounts. End of reporting day settlement prices must be provided for each cleared product and for each futures equivalent month. Final Rule 20.3.

What Recordkeeping Is Required?

Each clearing organization, clearing member and swap dealer will be required to keep all records of transactions in paired swaps or swaptions. Final Rule 20.6(a)-(b). Records must include methods used to convert paired swaps or swaptions into futures equivalents in accordance with CFTC Rule 1.31 (a generally applicable CFTC recordkeeping requirement). The recordkeeping requirements also apply directly to certain physical commodity swap market participants. Specifically, any person with 50 or more gross all-months-combined futures equivalent positions in paired swaps or swaptions on a particular commodity⁴ shall keep books and records that show all records for:

• transactions resulting in such positions; and
• transactions in the cash commodity underlying such positions or its products and byproducts, and all commercial activities that are hedged or that have risks that are mitigated by such position. Final Rule 20.6(c).

Upon request by the CFTC, books and records required by Final Rule 20.6 must be furnished, along with any pertinent information concerning such positions, transactions or activities. Final Rule 20.6(d).

When Do the Final Rules Take Effect?

The Final Rules will take effect on September 20, 2011 for clearinghouses, clearing members and persons with books and records obligations. For the first six months, the CFTC may allow the requisite reports to include different content and to be submitted in a different form or manner than that specified in the Final Rules, so long as the submitter is making a good-faith effort to comply with all provisions in Part 20. Final Rule 20.10(a), (c). For swap dealers, the Final Rules will take effect on the effective date of the new swap dealer regulations.⁵ For the first six months that the Final Rules are effective for swap dealers, the CFTC may accept modified reports from a swap dealer that is not affiliated with a bank holding company, not registered as either a futures commission merchant or a broker-dealer, and not supervised by a federal banking regulator. Final Rule 20.10(e). The Final Rules contain a sunset provision allowing the CFTC to render the Final Rules, or portions thereof, ineffective and unenforceable by order after swap data repositories are processing swap positional data in a way that enables the CFTC to effectively surveil trading. Final Rule 20.9.

Will Reported Data Receive Confidential Treatment?

The CFTC notes that it will protect proprietary information reported to it under the Final Rules according to the Freedom of Information Act and CFTC Part 145 (Commission Records and Information). See Final Rules at 43854. Commodity Exchange Act (CEA) § 8(a)(1) strictly prohibits the CFTC from making public “data and information that would separately disclose the business transactions or market positions of any person and trade secrets or names of customers” unless otherwise specifically authorized under the CEA. Further, the Privacy Act of 1974 requires the CFTC to protect certain information contained in a government system of records. See Final Rules at 43854.

How Do the Final Rules Compare to the Proposed Rules?

The Final Rules differ in a few ways from the rules as proposed last November. Position Reports for Physical Commodity Swaps, 75 FR 67258 (Nov. 2, 2010) (Proposed Rules). The CFTC removed from the definition of “paired swaps” swaps based on the same commodity as that of a referenced DCM contract that are deliverable at different locations that nonetheless have the same supply and demand fundamentals as the referenced DCM contract’s delivery point.⁶ The required data fields for swap dealers for cleared and non-cleared swaptions have been harmonized to simplify the reporting process.⁷ Instead of requiring reporting entities to report all the specified data in the Proposed Rules related to consolidated accounts, the Final Rules require data to be provided by the direct legal counterparty of the clearing member or swap dealer.⁸

The CFTC received one comment regarding the Proposed Rules that data for cleared swaps should only be submitted by clearing members, rather than by both clearing members and swap dealers, to avoid double counting. The CFTC made no responsive changes and instead notes in the Final Rules (p. 43853) that the required double reporting of cleared positions by both swap dealers and clearing members is intentional as there is a “need to verify submitted data.”

The CFTC received one comment from an end-user coalition that the recordkeeping requirements should not apply to end-users. The CFTC made no responsive changes and instead notes in the Final Rules (p. 43854) that the recordkeeping requirements for end-users with swap positions that meet or exceed the relevant thresholds are consistent with requirements under current CFTC Rule 18.05.

Exhibit One: Covered Futures Contracts Listed in Final Rule 20.2

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1 The complete list of Covered Futures Contracts listed in Final Rule 20.2 is provided in Exhibit One (see page 5).

2 Appendix A of the Final Rules provides additional guidelines and illustrative examples for determining futures equivalency of swap and swaption positions.

3 The content of the information that must be reported is detailed in the rules. Appendix B of the rules provides explanatory guidance on the content and layout of the required reports.

4 This threshold is lower than the “reportable position” threshold.

5 Final Rule 20.10(b), (c). If the Final Rules become effective for swap dealers within the first six months that the Final Rules become effective for clearing members (as well as clearinghouses and persons with book and record requirements), the CFTC may be similarly flexible with respect to the content that is submitted and the form or manner in which it is submitted until such time that the Final Rules have been in effect for six months with respect to clearing members.

6 See discussion of removal in Final Rules at 43853 and 43855.

7 See discussion of harmonization in Final Rules at 43853.

8 See discussion of consolidated accounts in Final Rules at 43853.

9 A diversified commodity index that references a Covered Futures Contract is itself a Covered Futures Contract, which, if the index is commonly known with publicly available weightings, may be reported as if such index underlies a single futures contract with monthly expirations for each calendar month and year. Final Rule 20.11.

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