Use of the “end-user exception” to the Dodd-Frank clearing requirements for swaps subject to a clearing determination by the Commodity Futures Trading Commission (“CFTC”) requires that the end-user, among other things, not be a “financial entity” under the Commodity Exchange Act (“CEA”).[1] The definition of “financial entity” encompasses, among other persons, commodity pools.[2] In turn, the CEA defines a “commodity pool” as “any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests[.]”[3] The Dodd-Frank Act expanded the scope of such “commodity interests” to include “swaps,”[4] which has broadened the term significantly. Moreover, the CFTC has long interpreted the requirement that an enterprise be operated “for the purpose” of trading in commodity interests quite broadly, such that almost any trading in swaps or other commodity interests could bring an entity within the definition of a commodity pool.[5] Recently the CFTC stated, “any swaps activities undertaken by a [commodity pool operator] would result in that entity being required to register because there would be no de minimis exclusion for such activity. As a result, one swap contract would be enough to trigger the registration requirement.”[6] Additionally, the CFTC recently noted that “it is the staff’s position that wholly owned subsidiaries of commodity pools trading in derivatives are themselves commodity pools.”[7] Therefore, taken together, these provisions and guidance suggest that an entity that is a wholly owned subsidiary of a commodity pool and enters into a swap may itself constitute a “commodity pool” and, therefore, would not be eligible to use the end-user exception to the clearing requirement.
However, the CFTC has indicated at various times that an operating company should not be considered a commodity pool. For example, under the CFTC’s rules further defining the term “swap dealer” and certain other critical terms under the Dodd-Frank Act, the CFTC appears to have drawn a distinction between commodity pools and “entities other than commodity pools (e.g., operating companies).”[8] Also, the CFTC concluded that a limited partnership engaged in pork products was not a commodity pool despite hedging its production costs.[9] More recently, the CFTC provided an interpretation that certain real estate investment trusts that hold income producing real estate and engage in real estate management activities (known as “equity REITs”) did not constitute commodity pools under the CEA, despite their use of derivatives because, generally, the REITs primarily derived their income from the ownership and operation of real estate and used derivatives for the limited purpose of mitigating currency and interest rate risk.[10]
It remains unclear whether an entity exhibiting characteristics of an operating company (for example, a project company having the primary purpose of constructing and operating an energy plant) that enters into swaps constitutes a commodity pool, particularly if that company is a wholly owned subsidiary of an investment fund or other entity that is a commodity pool. However, despite the lack of definitive guidance, the CFTC’s longtime indications that operating companies are not commodity pools may suggest that even such a project company does not constitute a commodity pool.
[1] See CFTC Regulation 39.6.
[2] 7 U.S.C. § 2(h)(7)(C)(i).
[3] 7 U.S.C. § 1a(10).
[4] See id.
[5] See, e.g., Revisions of Commodity Pool Operator and Commodity Trading Advisor Regulations; Delegation of Authority, 46 Fed. Reg. 26004 (May 8, 1981).
[6] Commodity Pool Operations and Commodity Trading Advisors: Compliance Obligations; Harmonization of Compliance Obligations for Registered Investment Companies Required To Register as Commodity Pool Operators; Final Rule and Proposed Rule, 77 Fed. Reg. 11,252, 11,258 (February 24, 2012).
[7] Division of Swap Dealer and Intermediary Oversight Responds to Frequently Asked Questions – CPO/CTA: Amendments to Compliance Obligations (available at: http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/faq_cpocta.pdf).
[8] Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant”, 77 Fed. Reg. 30,596, 30,653 (May 23, 2012).
[9] CFTC Staff Letter No. 00-89 (September 11, 2000).
[10] CFTC Letter No. 12-13, Re: Request for Interpretation of the Definition of “Commodity Pool” under Section 1a(10) of the Commodity Exchange Act (October 11, 2012).