by I Oversight · 2012 — “bona fide hedging” for the separate purpose of exclusion from position limits for futures and swaps. Following the adoption of amended 4.5, the
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U.S. COMMODITY FUTURES TRADING COMMISSION Three Lafayette Centre 1155 21st Street, NW, Washington, DC 20581 Telephone: (202) 418 – 5977 Facsimile: (202) 418 – 5407 gbarnett@cftc.gov Division of Swap Dealer and Intermediary Oversight Gary Barnett Director CFTC Letter No. 12 – 19 Interpretation October 12, 2012 Division of Swap Dealer and Intermediary Oversight Re: Interpretation of Bona Fide Hedging in Commission Regulation 4.5 : Restatement of Terms Incorporated by Reference Ladies and Gentlemen : This letter is in response to requests from multiple parties received by the Division of Commodity Futures Tr ading Com requesting clarification regarding the bona fide hedging exclusion from the threshold calculation of Commission Regulation 4.5. On February 24, 201 2, the Commission adopted amendments to Commission Regulation 4.5 in the release 1 The Commission amended Regulation 4.5 to include, among other things, a commodity interest trading threshold above which the operator of a registered investment 2 Specifically, these commodity interest trading thresholds were established as an aggregate initial o. The release excluded from the calculation of these thresholds any positions that would within the Commission Regulations 1.3(z) (1) and 151.5 , regulations defining te purpose of exclusion from position limits for futures and swaps . Following the adoption of amended 4.5, the position limits rule that promulgated Commission Regulation 151.5 , and amended Commission Regulation 1.3(z) (1) , was vacated by a court of law. See , _ F. Supp. 2d. _, 2012 ISDA However, the context indicates , that , in promulgating amended R egulation 4.5 , the Commission intended to incorporate the substance o f amended Regulation 1.3(z)(1) and new Regulation 151.5 as an exception to the trading threshold 1 77 FR 11252 (Feb. 24, 2012); correction 77 FR 17328 (March 26, 2012). 2 17 CFR 4.5(c)(2)(iii)(A) and 17 CFR 4.5(c)(2)(iii)(B).
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Bona Fide Hedging in Commission Regulation 4.5 Page 2 test in Commission R egulation 4.5(c)(2)(iii) , in dependently of whether amended R egulation 1.3(z)(1) and Regulation 151.5 remain effective in connection with po sition limits. This intent of the Commission is not inconsistent with the judgment in ISDA , because the appropriate standard for bona fide hedging in the context of the definition of a CPO was not before the court in that not purport to address the issue. 3 Accordingly, the Division interprets Commission Regulations 4.5(c)(2)(iii)(A) and (B) as continuing to incorporate the substance of amended Commission Regulation 1.3(z) (1) and Commission Regulation 151.5, for purposes of that provision. The Division further states that, in any event, the Division will not recommend that the Commission commence an enforcement action against any person based on any application of the trading threshold test of Commission Regu lation 4.5(c)(2)(iii) that exclude s transactions falling within the substance of amended Commission Regulation s 1.3(z) ( 1) and 151. 5 . 4 By this guidance, the Division restates those terms that were incorporated by reference in the adopting release for Commission Regulation 4.5, which are as follows 5 : Commission Regulation 1.3(z) (1) (z) Bona fide hedging transactions and positions for excluded commodities. (1) General definition. Bona fide hedging transactions and positions shall mean any agreement, c ontract or transaction in an excluded commodity on a designated contract market or swap execution facility that is a trading facility, where such transactions or positions normally represent a substitute for transactions to be made or positions to be taken at a later time in a physical marketing channel, and where they are economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise, and where they arise from: (i) The potential change in the value of assets wh ich a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising, (ii) The potential change in the value of liabilities which a person owns or anticipates incurring, or (i ii) The potential change in the value of services which a person provides, purchases, or anticipates providing or purchasing. 3 Regulation 151.5, were enumerated in Commission Regulation 151.2; the terms of which the Commission implicitly also adopted by reference. Commission Regulati on 151.2 was also subject to vacatur. Accordingly, the terms of vacated Commission Regulation 151.2 will, as will the terms of Commission Regulation 151.5, be restated infra in separate sections. 4 See generally 17 C.F.R. § 140.99. 5 The sections below ar e restatements of Commission Regulations 1.3(z)(1), 151.5, and 151.2 as they existed prior to vacatur, and as incorporated by reference by the Commission in Commission Regulation 4.5.
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Bona Fide Hedging in Commission Regulation 4.5 Page 3 (iv) Notwithstanding the foregoing, no transactions or positions shall be classified as bona fide hedging unless their purpose is to offset price risks incidental to commercial cash or spot operations and such positions are established and liquidated in an orderly manner in accordance with sound commercial practices and, for transactions or positions on contract markets subject to t rading and position limits in effect pursuant to section 4a of the Act, unless the provisions of paragraphs (z)(2) and (3) of this section have been satisfied. Commission Regulation 151.5 Bona fide hedging and other exemptions for Referenced Contracts. (a) Bona fide hedging transactions or positions. (1) Any person that complies with the requirements of this section may exceed the position limits set forth in § 151.4 to the extent that a transaction or position in a Referenced Contract: (i) Represents a substitute for transactions made or to be made or positions taken or to be taken at a later time in a physical marketing channel; (ii) Is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise; and (iii) Arises from the potential change in the value of one or several (A) Assets that a person owns, produces, manufactures, processes, or merchandises or anticipates owning, producing, manufacturing, processing, or merchandising; (B) Liabilities that a person owns or anticipates incurring; or (C) Services that a person provides, purchases, or anticipates providing or purchasing; or (iv) Reduces risks attendant to a position resulting from a swap that (A) Was executed opposite a counterparty for whic h the transaction would qualify as a bona fide hedging transaction pursuant to paragraph (a)(1)(i) through (iii) of this section; or (B) Meets the requirements of paragraphs (a)(1)(i) through (iii) of this section. (v) Notwithstanding the foregoing, no t ransactions or positions shall be classified as bona fide hedging for purposes of § 151.4 unless such transactions or positions are established and liquidated in an orderly manner in accordance with sound commercial practices and the provisions of paragrap h (a)(2) of this section regarding enumerated hedging transactions and positions or paragraphs (a)(3) or (4) of this section regarding pass – through swaps of this section have been satisfied.
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Bona Fide Hedging in Commission Regulation 4.5 Page 4 (2) Enumerated hedging transactions and positions. Bona fide hed ging transactions and positions for the purposes of this paragraph mean any of the following specific transactions and positions: (i) Sales of Referenced Contracts that do not exceed in quantity: (A) Ownership or fixed – price purchase of the contract’s un derlying cash commodity by the same person; and (B) Unsold anticipated production of the same commodity, which may not exceed one year of production for an agricultural commodity, by the same person provided that no such position is maintained in any phys ical – delivery Referenced Contract during the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – delivery contracts. (ii) Purchases of Referenced Contracts that do not exceed in quantity: (A) The fixed – price sale of the contract’s underlying cash commodity by the same person; (B) The quantity equivalent of fixed – price sales of the cash products and by – products of such commodity by the same person; and (C) Unfilled anticipated requirements of the same cash commodity, which may not exceed one year for agricultural Referenced Contracts, for processing, manufacturing, or use by the same person, provided that no such position is maintained in any physical – delive ry Referenced Contract during the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – delivery contracts. (iii) Offsetting sales and purchases in Referenced Co ntracts that do not exceed in quantity that amount of the same cash commodity that has been bought and sold by the same person at unfixed prices basis different delivery months, provided that no such position is maintained in any physical – delivery Referenc ed Contract during the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – delivery contracts. (iv) Purchases or sales by an agent who does not own or has not contracted to sell or purchase the offsetting cash commodity at a fixed price, provided that the agent is responsible for the merchandising of the cash positions that is being offset in Referenced Contracts and the agent has a contractual arrangement with the person who owns the commodity or holds the cash market commitment being offset. (v) Anticipated merchandising hedges. Offsetting sales and purchases in Referenced Contracts that do not exceed in quantity the amount of the same cash commodity that is a nticipated to be merchandised, provided that:
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Bona Fide Hedging in Commission Regulation 4.5 Page 5 (A) The quantity of offsetting sales and purchases is not larger than the current or anticipated unfilled storage capacity owned or leased by the same person during the period of anticipated merchandising acti vity, which may not exceed one year; (B) The offsetting sales and purchases in Referenced Contracts are in different contract months, which settle in not more than one year; and (C) No such position is maintained in any physical – delivery Referenced Contr act during the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – delivery contracts. (vi) Anticipated royalty hedges. Sales or purchases in Referenced Contra cts offset by the anticipated change in value of royalty rights that are owned by the same person provided that: (A) The royalty rights arise out of the production, manufacturing, processing, use, or transportation of the commodity underlying the Referen ced Contract, which may not exceed one year for agricultural Referenced Contracts; and (B) No such position is maintained in any physical – delivery Referenced Contract during the last five days of trading of the Core Referenced Futures Contract in an agric ultural or metal commodity or during the spot month for other physical – delivery contracts. (vii) Service hedges. Sales or purchases in Referenced Contracts offset by the anticipated change in value of receipts or payments due or expected to be due under a n executed contract for services held by the same person provided that: (A) The contract for services arises out of the production, manufacturing, processing, use, or transportation of the commodity underlying the Referenced Contract, which may not exceed one year for agricultural Referenced Contracts; (B) The fluctuations in the value of the position in Referenced Contracts are substantially related to the fluctuations in value of receipts or payments due or expected to be due under a contract for services; and (C) No such position is maintained in any physical – delivery Referenced Contract during the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – de livery contracts. (viii) Cross – commodity hedges. Sales or purchases in Referenced Contracts described in paragraphs (a)(2)(i) through (vii) of this section may also be offset other than by the same quantity of the same cash commodity, provided that: (A) The fluctuations in value of the position in Referenced Contracts are substantially related to the fluctuations in value of the actual or anticipated cash position; and
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Bona Fide Hedging in Commission Regulation 4.5 Page 6 (B) No such position is maintained in any physical – delivery Referenced Contract durin g the last five days of trading of the Core Referenced Futures Contract in an agricultural or metal commodity or during the spot month for other physical – delivery contracts. (3) Pass – through swaps. Bona fide hedging transactions and positions for the purp oses of this paragraph include the purchase or sales of Referenced Contracts that reduce the risks attendant to a position resulting from a swap that was executed opposite a counterparty for whom the swap transaction would qualify as a bona fide hedging tr ansaction pursuant to paragraph – physical – delivery Referenced Contract during the last five days of trading of the Core Referenced Futures Contract in an agri cultural or metal commodity or during the spot month for other physical – delivery contracts unless such pass – through swap position continues to offset the cash market commodity price risk of the bona fide hedging counterparty. (4) Pass – through swap offsets . For swaps executed opposite a counterparty for whom the swap transaction would qualify as a bona fide hedging transaction pursuant to paragraph (a)(2) of this section (pass – through swaps), such pass – through swaps shall also be classified as a bona fide h edging transaction for the counterparty for whom the swap would not otherwise qualify as a – hedging – hedging counterparty purchases or sell s Referenced Contracts that reduce the risks attendant to such pass – through swaps. Provided further, that the pass – through swap shall constitute a bona fide hedging transaction only to the extent the non – hedging counterparty purchases or sells Referenced C ontracts that reduce the risks attendant to the pass – through swap. (5) Any person engaging in other risk – reducing practices commonly used in the market which they believe may not be specifically enumerated in § 151.5(a)(2) may request relief from Commissi on staff under § 140.99 of this chapter or the Commission under section 4a(a)(7) of the Act concerning the applicability of the bona fide hedging transaction exemption. (b) Aggregation of accounts. Entities required to aggregate accounts or positions unde r § 151.7 shall be considered the same person for the purpose of determining whether a person or persons are eligible for a bona fide hedge exemption under § 151.5(a). (c) Information on cash market commodity activities. Any person with a position that ex ceeds the position limits set forth in § 151.4 pursuant to paragraphs (a)(2)(i)(A), (a)(2)(ii)(A), (a)(2)(ii)(B), (a)(2)(iii), or (a)(2)(iv) of this section shall submit to the Commission a 404 filing, in the form and manner provided for in § 151.10. (1) The 404 filing shall contain the following information with respect to such position for each business day the same person exceeds the limits set forth in § 151.4, up to and through the day the person’s position first falls below the position limits:
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Bona Fide Hedging in Commission Regulation 4.5 Page 8 (ii) The time period for which the person claims the anticipatory hedge exemption is required, which may not exceed one year for agricultural commodities or one year for anticipated merchandising activity; (iii) The actual use, production, processing, merchandising (bought and sold), royalties and service payments and receipts of that cash market commodity during each of the three complete fiscal years preceding the current fiscal year; (iv) The anticipated use production, or commercial or merchandising requirements (purchases and sales), anticipated royalties, or service contract receipts or payments of that cash mar ket commodity which are applicable to the anticipated activity to be hedged for the period specified in (d)(1)(ii) of this section; (v) The unsold anticipated production or unfilled anticipated commercial or merchandising requirements of that cash market commodity which are applicable to the anticipated activity to be hedged for the period specified in (d)(1)(ii) of this section; (vi) The maximum number of Referenced Contracts long and short (on an all – months – combined basis) that are expected to be used f or each anticipatory hedging activity for the period specified in (d)(1)(ii) of this section on a futures equivalent basis; (vii) If the hedge exemption sought is for anticipated merchandising pursuant to (a)(2)(v) of this section, a description of the storage capacity related to the anticipated merchandising transactions, including: (A) The anticipated total storage capacity, the anticipated merchandising quantity, and purchase and sales commitments for the period specified in (d)(1)(ii) of this sectio n; (B) Current inventory; and (C) The total storage capacity and quantity of commodity moved through the storage capacity for each of the three complete fiscal years preceding the current fiscal year; and (viii) Cross – commodity hedging information as re quired under paragraph (g) of this section. (2) Notice filing. Persons seeking an exemption under this paragraph shall file a notice with the Commission. Such a notice shall be filed at least ten days in advance of a date the person expects to exceed the position limits established under this part, and shall be effective after that ten day period unless otherwise notified by the Commission. (3) Supplemental reports for 404A filings. Whenever a person intends to exceed the amounts determined by the Commiss ion to constitute a bona fide hedge for anticipated activity in the most recent statement or filing, such person shall file with the Commission a statement that
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Bona Fide Hedging in Commission Regulation 4.5 Page 9 updates the information provided in the person’s most recent filing at least ten days in advanc e of the date that person wishes to exceed those amounts. (e) Review of notice filings. (1) The Commission may require persons submitting notice filings provided for under paragraphs (c)(2) and (d)(2) of this section to submit such other information, befo re or after the effective date of a notice, which is necessary to enable the Commission to make a determination whether the transactions or positions under the notice filing fall within the scope of bona fide hedging transactions or positions described und er paragraph (a) of this section. (2) The transactions and positions described in the notice filing shall not be considered, in part or in whole, as bona fide hedging transactions or positions if such person is so notified by the Commission. (f) Addition al information from swap counterparties to bona fide hedging transactions. All persons that maintain positions in excess of the limits set forth in § 151.4 in reliance upon the exemptions set forth in paragraphs (a)(3) and (4) of this section shall submit to the Commission a 404S filing, in the form and manner provided for in § 151.10. Such 404S filing shall contain the following information with respect to such position for each business day that the same person exceeds the limits set forth in § 151.4, up to and through the day the person’s position first falls below the position limit that was exceeded: (1) By Referenced Contract; (2) By commodity reference price and units of measurement used for the swaps that would qualify as a bona fide hedging transa ction or position gross long and gross short positions; and (3) Cross – commodity hedging information as required under paragraph (g) of this section. (g) Conversion methodology for cross – commodity hedges. In addition to the information required under this section, persons who avail themselves of cross – commodity hedges pursuant to (a)(2)(viii) of this section shall submit to the Commission a form 404, 404A, or 404S filing, as appropriate. The first time such a form is filed where a cross – commodity hedge is claimed, it should contain a description of the conversion methodology. That description should explain the conversion from the actual commodity used in the person’s normal course of business to the Referenced Contract that is being used for hedging, inclu ding an explanation of the methodology used for determining the ratio of conversion between the actual or anticipated cash positions and the person’s positions in the Referenced Contract. (h) Recordkeeping. Persons who avail themselves of bona fide hedge exemptions shall keep and maintain complete books and records concerning all of their related cash, futures, and swap positions and transactions and make such books and records, along with a list of pass – through swap counterparties for pass – through swap exemptions under (a)(3) of this section, available to the Commission upon request.
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Bona Fide Hedging in Commission Regulation 4.5 Page 10 (i) Additional requirements for pass – through swap counterparties. A party seeking to rely upon § 151.5(a)(3 ) to exceed the position limits of § 151.4 with respect to such a swap may only do so if its counterparty provides a written representation ( e.g., in the form of a field or other representation contained in a mutually executed trade confirmation) that, as to such counterparty, the swap qualifies in good faith as a bona fide hedging transaction under paragraph (a)(3) of this section at the time the swap was executed. That written representation shall be retained by the parties to the swap for a period of at least two years following the expiration of the swap and furnished to the Commission upon request. Any person that represents to another person that the swap qualifies as a pass – through swap under paragraph (a)(3) of this section shall keep and make avail able to the Commission upon request all relevant books and records supporting such a representation for a period of at least two years following the expiration of the swap. (j) Financial distress exemption. Upon specific request made to the Commission, th e Commission may exempt a person or related persons under financial distress circumstances for a time certain from any of the requirements of this part. Financial distress circumstances are situations involving the potential default or bankruptcy of a cust omer of the requesting person or persons, affiliate of the requesting person or persons, or potential acquisition target of the requesting person or persons. Such exemptions shall be granted by Commission order. Commission Regulation 151.2 Core Referenc ed Futures Contracts. (a) Agricultural commodities. Core Referenced Futures Contracts in agricultural commodities include the following futures contracts and options thereon: (1) Core Referenced Futures Contracts in legacy agricultural commodities: (i) Chicago Board of Trade Corn (C); (ii) Chicago Board of Trade Oats (O); (iii) Chicago Board of Trade Soybeans (S); (iv) Chicago Board of Trade Soybean Meal (SM); (v) Chicago Board of Trade Soybean Oil (BO); (vi) Chicago Board of Trade Wheat (W); (vii) ICE Futures U.S. Cotton No. 2 (CT); (viii) Kansas City Board of Trade Hard Winter Wheat (KW); and (ix) Minneapolis Grain Exchange Hard Red Spring Wheat (MWE). (2) Core Referenced Futures Contracts in non – legacy agricultural commodities: (i) Chicago Me rcantile Exchange Class III Milk (DA); (ii) Chicago Mercantile Exchange Feeder Cattle (FC); (iii) Chicago Mercantile Exchange Lean Hog (LH); (iv) Chicago Mercantile Exchange Live Cattle (LC); (v) Chicago Board of Trade Rough Rice (RR); (vi) ICE Futures U.S. Cocoa (CC); (vii) ICE Futures U.S. Coffee C (KC);
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Bona Fide Hedging in Commission Regulation 4.5 Page 11 (viii) ICE Futures U.S. FCOJ – A(OJ); (ix) ICE Futures U.S. Sugar No. 11 (SB); and (x) ICE Futures U.S. Sugar No. 16 (SF). (b) Metal commodities. Core Referenced Futures Contracts i n metal commodities include the following futures contracts and options thereon: (1) Commodity Exchange, Inc. Copper (HG); (2) Commodity Exchange, Inc. Gold (GC); (3) Commodity Exchange, Inc. Silver (SI); (4) New York Mercantile Exchange Palladium (PA) ; and (5) New York Mercantile Exchange Platinum (PL). (c) Energy commodities. The Core Referenced Futures Contracts in energy commodities include the following futures contracts and options thereon: (1) New York Mercantile Exchange Henry Hub Natural Gas (NG); (2) New York Mercantile Exchange Light Sweet Crude Oil (CL); (3) New York Mercantile Exchange New York Harbor Gasoline Blendstock (RB); and (4) New York Mercantile Exchange New York Harbor Heating Oil (HO). Therefore, despite the vacatur of Com mission Regulation 151.5 and the amendments to Commission Regulation 1.3(z) (1) , the Division reaffirms that the provisions of Commission Regulation 4.5 permit any operator of a registered investment company to exc lude from the trading thresholds as those definition s appear as restated above. This letter, and the positions taken herein, represent the view of this Division only, and do not necessarily represent the position or view of the Commission or of any other office or division of the Commission. The interpretation issued by this letter d oes not excuse any registrant from compliance with any other applicable requirements contained in the Act or in the Should you have any questions, please do not hesitate to contact Amanda Olear, Special Counsel , at 202 – 418 – 5283 or Michael Ehrstein, Attorney Advisor, at 202 – 418 – 5957. Very truly yours, Gary Barnett
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