On May 7, 2015, the CFTC published in the Federal Register a proposal to eliminate the odd-yet-burdensome Form TO, which for the past two years has been required of derivatives end-users to report certain information to the CFTC regarding their trading in commodity trade options. If the proposal is adopted as final after the close of the comment period on June 8, few will mourn the passing of Form TO.
The history of Form TO
The Dodd-Frank Act defined “swap” to include a “put, call, cap, floor, collar, or similar option of any kind.” Despite industry arguments that physical delivery options were not intended to be regulated as swaps, the CFTC concluded that physical commodity options may fall within the Dodd-Frank swap definition.
However, to avoid burdensome, and probably unworkable, regulation of physical commodity contracts, the CFTC exempted certain commodity options – namely, those qualifying as “trade options” – from most Dodd-Frank requirements. Under “interim final” Rule 32.3, to qualify as a trade option, a commodity option must satisfy certain offeree and offeror conditions, and must also, if exercised, be intended to be physically settled such that the resulting sale would be a spot or forward transaction.
Rule 32.3 was an attempt at “regulation lite,” as it exempts trade options from most, but not all, swap requirements that otherwise would apply to them by virtue of being defined as swaps. One requirement that the CFTC retained for trade options was reporting. But it was quite a byzantine reporting regime.
In the typical scenario, under Rule 32.3 (as later modified by staff no-action letter 13-08), trade options are reported as follows: i) if one of the option counterparties is a swap dealer or a major swap participant (MSP), the swap dealer or MSP must report the trade option to a swap data repository (SDR), just as they report all their other swaps (namely, under the CFTC’s “Part 45” swap reporting rules); and ii) if both option counterparties are end-users (i.e., non-swap dealers/MSPs), both end-users must file an annual Form TO in lieu of Part 45 reporting.
The oddities of Form TO
Form TO was an odd Form right from the start. Although it is required to be filed for any calendar year in which an end-user enters into a trade option with a fellow end-user, the trade option data called for by Form TO relates to the end-user’s exercise of trade options during that calendar year. Thus, if an end-user does not enter into any trade options with other end-users during the year, it is not required to file a Form TO even if it exercises a substantial number of trade options during the same year. Conversely, if an end-user enters into a trade option with another end-user during the year, it must file a Form TO that is devoid of information if it does not exercise any trade options during the same year.
Nevertheless, the CFTC viewed Form TO as an accommodation to end-users that objected to applying the Part 45 swap reporting rules to trade options. After all, Form TO requires only the aggregate notional values of trade options exercised in a given calendar year (if any) to be reported, whereas Part 45 would require the reporting of significant detail regarding the date, time, parties, etc. of the trade option.
What the CFTC did not appreciate at the time, though, was the burden that Form TO places on end-users required to file it. In its recent proposal to eliminate From TO, the CFTC noted the comments it had received explaining that, because trade options are physical delivery instruments, the systems and processes used by many end-users to create, store, and track their trade options are separate and distinct from their financial systems, and typically are not designed to track the kind of information required by Form TO.
The proposal to eliminate Form TO
The CFTC’s recent proposal would put Form TO out of its misery – and the misery of end-users that are required to track the information necessary to file it. The proposal would eliminate Form TO in its entirety — there are no circumstances in which it still would be required. Nor would end-users be required to report trade options under the Part 45 swap reporting rules.
In addition, the proposal provides that:
- End-users would have to notify the CFTC by e-mail no later than 30 days after entering into trade options (whether or not they are reported to an SDR) having an aggregate notional value greater than $1 billion during any calendar year (valued when the trade option is entered into, not when it is exercised); alternatively, they may provide e-mail notice that they reasonably expect to do so (they would not have to demonstrate whether that actually occurs);
- Notional value would be calculated by multiplying the maximum quantity expressed in the option by the contract price, which, for index-priced options, is measured by the market price at the execution date; for non-liquid index points, this could prove complicated – and, thus, parties close to the threshold would likely decide to provide advance e-mail notice to the CFTC in order to avoid complex calculations;
- The existing recordkeeping requirements applicable to trade options still would apply;
- End-users must have a Legal Entity Identifier (LEI) number, but they do not need a Unique Swap Identifier (USI) or a Unique Product Identifier (UPI) for trade options;
- The CFTC’s enforcement authorities, including its existing rules against market manipulation, would continue to apply to trade options; and
- The question of whether trade options are subject to speculative position limits will be addressed later in the CFTC’s separate position limits rulemaking.
The Big Picture
In a supporting statement, CFTC Chairman Timothy Massad noted that this proposal to eliminate Form TO is part of his commitment to “fine-tun[e] our rules so that commercial companies can continue to conduct their daily operations efficiently,” and to “make sure that the new regulatory framework for swaps does not impose unintended consequences or burdens for [commercial end-users.]”
Eliminating Form TO would go far towards re-focusing the CFTC on the causes of the financial crisis, and away from its overzealous emphasis on commercial businesses that often were its victims.