deprive the transaction of the exclusion, absent evasion.\297\
---------------------------------------------------------------------------

    \296\ See Letter from Michelle Chan, Director, Economic Policy
Programs, Friends of the Earth, dated July 22, 2011.
    \297\ While the commenter contended that ``the intangible nature
of carbon makes it much easier for speculators or those simply
seeking to hedge carbon price risk to take delivery of the carbon
itself rather than enter into a derivatives transaction,'' as the
CFTC states in section VII.A.2.c), infra, deciding to enter into a
forward transaction rather than a swap does not constitute evasion.
Thus, if the transaction in question is a forward contract, that is
the end of the analysis, absent the presence of other factors that
may indicate evasion. See AWEA Letter.
---------------------------------------------------------------------------

    One commenter stated that ``[i]n the solar industry, RECs are often
traded by an individual consumer as an assignment of a right owned by
that consumer.'' \298\ This commenter also advised that many individual
consumers transact forward contracts through solar REC (``SREC'')
aggregators at a fixed price. The CFTC notes \299\ that a transaction
entered into by a consumer cannot be a forward transaction, and
accordingly should not be the subject of an interpretation of the
forward exclusion.\300\
---------------------------------------------------------------------------

    \298\ See Letter from Katherine Gensler, Director, Regulatory
Affairs, SEIA, dated August 5, 2011 (``SEIA Letter'').
    \299\ See Proposing Release at 29832 n.104.
    \300\ However, in section II.B.3., infra, the Commissions
provide an interpretation regarding the applicability of the swap
definition to consumer transactions.
---------------------------------------------------------------------------

    One commenter takes the position that, because EPA emission
allowances are issued in transactions with the EPA, only resales of
such allowances (secondary market transactions) could be swaps because
the EPA's initial issuance of allowances would be excluded from the
swap definition under CEA section 1a(47)(B)(ix).\301\ The CFTC declines
to address the commenter's legal conclusion regarding the application
of CEA section 1a(47)(B)(ix), but agrees that an emission allowance
created by the EPA is a nonfinancial commodity and that agreements,
contracts and transactions in such allowances may fall within the
forward exclusion from the swap definition.
---------------------------------------------------------------------------

    \301\ See Letter from Lauren Newberry, Jeffrey C. Fort, Jeremy
D. Weinstein, and Christopher B. Berendt, Environmental Markets
Association, dated July 21, 2011.
---------------------------------------------------------------------------

(iv) Physical Exchange Transactions
    The Commissions received a comment letter seeking clarification
that physical exchange transactions are forward contracts excluded from
the swap definition.\302\ As described by the commenter, physical
exchange transactions involve ``a gas utility entering into a
transaction with another gas utility or other market participant to
take delivery of natural gas at one delivery point in exchange for the
same quantity of gas to be delivered at an alternative delivery point *
* * for the primary purpose of transferring ownership of the physical
commodity in order to rationalize the delivery of physical supplies to
where they are needed'' at a price ``generally reflecting the
difference in value at the delivery points.'' \303\ This commenter
stated that ``exchange transactions create binding obligations on each
party to make and take delivery of physical commodities [, i]n essence
constituting paired forward contracts that are intended to go to
physical delivery.'' \304\ The commenter added that, to the extent an
exchange transaction payment is based on an index price, such pricing
is not severable from the physical exchange.\305\
---------------------------------------------------------------------------

    \302\ See AGA Letter.
    \303\ Id. This commenter noted that gas utilities often can
receive gas at more than one interconnection or delivery point on a
pipeline.
    \304\ Id.
    \305\ Id.
---------------------------------------------------------------------------

    The CFTC interprets the exchange transactions described by the
commenter, to the extent they are for deferred delivery, as examples of
transactions in nonfinancial commodities that are within the forward
exclusion from the definition of the terms ``swap'' and ``future
delivery.'' Based on the information supplied by the commenter, they
are commercial merchandising transactions, the primary purpose of which
is to transfer

ownership of natural gas between two parties who intend to physically
settle such transactions. That exchange transactions may involve, in
addition to gas deliveries at two separate delivery points, a cash
payment by one party to the other reflecting the difference in value of
the gas at different delivery points, or that such payment may be based
on an index, does not necessarily affect the nature of the transactions
as forward transactions.\306\ For an exchange transaction to fall
within the forward exclusion, though, the parties to the transaction
must intend for the transaction to be physically settled, and the
exchange transaction must satisfy all applicable interpretations set
forth herein, including that relating to book-outs.\307\
---------------------------------------------------------------------------

    \306\ However, if such payment stems from an embedded option,
the interpretation set forth in the embedded option section of this
release, see infra part II.B.2(b)(v), also would be relevant to
determining whether an exchange transaction were covered by the
forward exclusion from the swap definition.
    \307\ While the commenter also states that ``[g]as utilities
contract with interstate pipelines for capacity rights to have their
gas supplies delivered to specific delivery points,'' its discussion
of exchange transactions appears unrelated to such capacity rights.
Therefore, the CFTC's guidance on exchange transactions does not
address exchange transactions with capacity elements, which,
depending on their structures, may be covered by the guidance set
forth in the embedded option section of this release or by the
CFTC's recent Commodity Options release. See infra note 317.
Conversely, that parties to an exchange transaction separately enter
into a capacity transaction with a pipeline operator to transport
natural gas delivered via an exchange transaction is not relevant to
today's guidance regarding exchange transactions.
---------------------------------------------------------------------------

(v) Fuel Delivery Agreements
    The CFTC understands that fuel delivery agreements can generally be
described as agreements whereby two or more parties agree to divide the
cost of acquiring fuel for generation facilities based on some formula
or factors, which can include, for example, their respective financial
contributions to developing the source of the fuel (e.g., a natural gas
field). One example of a fuel delivery agreement could involve a joint
power agency providing to a municipal utility a long-term supply of
natural gas from a natural gas project developed by the joint power
agency and other entities to provide fuel for, among others, the joint
power agency's and the municipal utility's natural gas-fired electric
generating facilities. The municipal utility would pay the joint power
agency through direct capital contributions to the entity formed to
develop the natural gas project for the cost of developing it. In
addition, the municipal utility would pay the joint power agency a
monthly fee for the natural gas supplied from the natural gas project.
The monthly fee would be composed of an operating cost fee component,
an interstate pipeline transportation cost fee component and an
operating reserve cost fee component. The municipal utility's natural
gas-fired electric generating facility would be used to supply a
portion of its expected retail electric load.
    Such agreements are forward transactions if they otherwise meet the
interpretation set forth in this release regarding the forward
exclusions (e.g., no optionality other than as permitted by the
interpretation). Monthly or other fees that are not in the nature of
option premiums do not convert the transactions from forwards to
options. Because the transactions as described above do not appear to
exhibit optionality as to delivery, and no other aspect of the
transactions as described above seem to exhibit optionality, the fees
would not seem to resemble option premiums.\308\
---------------------------------------------------------------------------

    \308\ This interpretation is limited to the facts and
circumstances described herein; the CFTC is not opining on different
facts or circumstances, which could change the CFTC's
interpretation.
---------------------------------------------------------------------------

(vi) Cleared/Exchange-Traded Forwards
    In the Proposing Release, the Commissions requested comment
regarding whether forwards executed on trading platforms should fall
within the forward exclusion from the swap definition and, if so,
subject to what parameters.\309\ One commenter requested that the CFTC
adopt a non-exclusive safe harbor providing that exchange-traded
contracts with respect to which more than 50 percent of contracts, on
average on a rolling three-month basis, go to delivery and where 100
percent of the counterparties are commercial counterparties, are
neither futures nor swaps (``50/100 Forward Safe Harbor'').\310\ This
commenter further requested that the CFTC provide an appropriate
transition period once those thresholds are breached. This commenter
contended that two hallmarks of the exchange-traded forward markets,
which it characterized as ``a relatively new development,'' are that
the participants generally are commercials and a high percentage of
contracts go to delivery, notwithstanding netting of delivery
obligations.\311\ This commenter added that, while parties to such
contracts intend to go to delivery when they enter into them, their
delivery needs may change as time passes.
---------------------------------------------------------------------------

    \309\ See Proposing Release at 29831-29832, Request for Comment
30.
    \310\ See Letter from Peter Krenkel, President and CEO, NGX,
dated Nov. 4, 2010, resubmitted by email to CFTC staff on Sept. 14,
2011 (``NGX Letter''). One other commenter addressed a related
issue, asserting that the Commissions should clarify that cleared
forwards between commercial participants should be permitted under
the forward contract exclusion. See Ex Parte Communication among
Evolution Markets Inc. (``Evolution''), Ogilvy Government Relations
(``Ogilvy'') and CFTC staff on May 18, 2011 at http://comments.cftc.gov/PublicComments/ViewExParte.aspx?id=197&SearchText=.
    \311\ Id.
---------------------------------------------------------------------------

    The CFTC declines to address this request for the 50/100 Forward
Safe Harbor, which raises policy issues that are beyond the scope of
this rulemaking. Should the CFTC consider the implications of the
requested 50/100 Forward Safe Harbor, including possible additional
conditions for relief, it would be appropriate for the CFTC to obtain
further comment from the public on this discrete proposal. For the same
reasons, the CFTC declines to address at this time the comment
requesting that the CFTC take the view that cleared forwards between
commercial participants fall within the scope of the forward contract
exclusion.
(b) Commodity Options and Commodity Options Embedded in Forward
Contracts
(i) Commodity Options \312\
---------------------------------------------------------------------------

    \312\ As used in this release, the term ``commodity option''
refers to an option that is subject to the CEA.
---------------------------------------------------------------------------

    The CFTC noted in the Proposing Release \313\ that the statutory
swap definition explicitly provides that commodity options are swaps,
that it had proposed revisions to its existing options rules in parts
32 and 33 of its regulations \314\ with respect to the treatment of
commodity options under the Dodd-Frank Act, and that it had requested
comment on those proposed revisions in that rulemaking proceeding.\315\
Accordingly, the CFTC did not propose an additional interpretation in
the Proposing Release with respect to commodity options.
---------------------------------------------------------------------------

    \313\ See Proposing Release at 29829-30.
    \314\ 17 CFR Parts 32 and 33.
    \315\ See Commodity Options and Agricultural Swaps, 76 FR 6095
(Feb. 3, 2011) (proposed).
---------------------------------------------------------------------------

    The CFTC reaffirms that commodity options are swaps under the
statutory swap definition, and is not providing an additional
interpretation regarding commodity options in this release. The CFTC
recently addressed commodity options in the context of a separate final
rulemaking and interim final rulemaking, under its plenary options
authority in CEA section 4c(b).\316\ There, the CFTC adopted a modified
trade option exemption, and has invited

public comment on the interim final rules.\317\
---------------------------------------------------------------------------

    \316\ 7 U.S.C. 6c(b).
    \317\ See Commodity Options, 77 FR 25320 (Apr. 27, 2012).
---------------------------------------------------------------------------

Comments
    Several commenters in response to the Proposing Release argued that
commodity options should not be regulated as swaps.\318\ In general,
these commenters believed that commodity options should qualify for the
forward exclusion from the swap definition, emphasizing similarities
between commodity options and forward contracts on nonfinancial
commodities.\319\
---------------------------------------------------------------------------

    \318\ See Letter from Brian Knapp, Policy Advisor, American
Petroleum Institute (``API''), dated January 31, 2012 (``API
Letter''); BGA Letter; COPE Letter; ETA Letter; Just Energy Letter;
NGSA/NCGA Letter; and WGCEF Letter.
    \319\ For example, one commenter asserted that, similar to a
forward contract on a nonfinancial commodity, a commodity option
conveys no ability for a party to unilaterally require a financial
settlement. Reasoning that both commodity options and forward
contracts on nonfinancial commodities are intended to settle by
physical delivery, this commenter contended that they should have
the same regulatory treatment. See COPE Letter. Similarly, another
commenter argued that the forward exclusion ``plainly covers''
commodity options because they are: (i) Contracts for the sale of
physical, nonfinancial commodities, (ii) for deferred delivery, and
(iii) intended to be physically settled, given that purchasers have
an absolute right to physical delivery and sellers have an absolute
obligation to physically deliver the amounts called for by the
purchasers if the option is exercised. See NGSA/NCGA Letter. A third
commenter recommended that the CFTC interpret the forward exclusion
``broadly'' to include options that, if exercised, become forwards
in nonfinancial commodities in light of the particular circumstances
of the electricity industry, where electric companies use commodity
options to efficiently meet the demands of electric customers by
hedging or mitigating commercial risks due to seasonal and
geographically unique weather and load patterns and fluctuations.
See ETA letter. In the alternative, a fourth commenter requested
that the CFTC exercise its plenary options authority under CEA
section 4c(b), 7 U.S.C. 6c(b), to establish a separate regulatory
regime for commodity options analogous to the trade option exemption
under former CFTC Rule 32.4. See WGCEF Letter. See 17 CFR 32.4
(2011).
---------------------------------------------------------------------------

    The CFTC is not providing an interpretation that commodity options
qualify as forward contracts in nonfinancial commodities. Such an
approach would be contrary to the plain language of the statutory swap
definition, which explicitly provides that commodity options are
swaps.\320\ This approach also would be a departure from the CFTC's and
its staff's longstanding interpretation of the forward exclusion with
respect to the term ``future delivery,'' \321\ which the CFTC has
determined above to apply to the forward exclusion from the swap
definition as well.\322\ Further, the CFTC notes that it has recently
issued final and interim final rules adopting a modified version of the
CFTC's existing trade option exemption.\323\
---------------------------------------------------------------------------

    \320\ See CEA section 1a(47)(A)(i), 7 U.S.C. 1a(47)(A)(i)
(defining a swap as, among other things, ``a put, call * * * or
option of any kind * * * for the purchase or sale * * * of * * *
commodities'') and CEA section 1a(47)(B), 7 U.S.C. 1a(47)(B) (not
excluding commodity options from the swap definition).
    \321\ See 1985 CFTC OGC Interpretation, supra note 245. In this
regard, an option cannot be a forward under the CFTC's precedent,
because under the terms of the contract the optionee has the right,
but not the obligation, to make or take delivery, while under a
forward contract, both parties must have binding delivery
obligations: one to make delivery and the other to take delivery.
    \322\ See supra part II.B.2(a)(i)(A).
    \323\ See supra note 317.
---------------------------------------------------------------------------

(ii) Commodity Options Embedded in Forward Contracts
    The CFTC is restating the interpretation regarding forwards with
embedded options from the Proposing Release, but with certain
modifications based on comments received. The CFTC is providing
additional interpretations regarding forwards with embedded volumetric
optionality, optionality in the form of evergreen and renewal
provisions, and optionality with respect to delivery points and
delivery dates.
    As was noted in the Proposing Release, the question of the
application of the forward exclusion from the swap definition with
respect to nonfinancial commodities, where commodity options are
embedded in forward contracts (including embedded options to cash
settle such contracts), is similar to that arising under the CEA's
existing forward contract exclusion from the definition of the term
``future delivery.'' \324\ The CFTC's Office of General Counsel
addressed forward contracts that contained embedded options in the 1985
CFTC OGC Interpretation,\325\ which recently was adhered to by the CFTC
in its adjudicatory Order in the Wright case.\326\ While both were
issued prior to the effective date of the Dodd-Frank Act, the CFTC
believes that, as was stated in the Proposing Release, it is
appropriate to apply this interpretation to the treatment of forward
contracts in nonfinancial commodities that contain embedded options
under the Dodd-Frank Act.\327\
---------------------------------------------------------------------------

    \324\ See Proposing Release at 29830.
    \325\ See 1985 CFTC OGC Interpretation, supra note 245.
    \326\ Wright, supra note 214.
    \327\ See Proposing Release at 29830.
---------------------------------------------------------------------------

    In Wright, the CFTC stated that it traditionally has engaged in a
two-step analysis of ``embedded options'' in which the first step
focuses on whether the option operates on the price or the delivery
term of the forward contract and the second step focuses on secondary
trading.\328\ As was stated in the Proposing Release, these same
principles can be applied with respect to the forward contract
exclusion from the swap definition for nonfinancial commodities in the
Dodd-Frank Act, too.\329\ Utilizing these principles, the CFTC is
providing a final interpretation that a forward contract that contains
an embedded commodity option or options \330\ will be considered an
excluded nonfinancial commodity forward contract (and not a swap) if
the embedded option(s):
---------------------------------------------------------------------------

    \328\ Wright, supra note 214, at n.5. In Wright, the CFTC
affirmed the Administrative Law Judge's holding that an option
embedded in a hedge-to-arrive contract did not violate CFTC rules
regarding the sale of agricultural trade options. The CFTC first
concluded that the puts at issue operated to adjust the forward
price and did not render the farmer's overall obligation to make
delivery optional. Then, turning to the next step of the analysis,
the CFTC explained that ``the put and [hedge-to-arrive contract]
operated as a single contract, and in most cases were issued
simultaneously * * *. We do not find that any put was severed from
its forward or that either of [the put or the hedge-to-arrive
contract] was traded separately from the other. We hold that in
these circumstances, no freestanding option came into being * * *.''
Id. at *7.
    \329\ See Proposing Release at 29830.
    \330\ Options in the plural would include, for example, a
situation in which the embedded optionality involves option
combinations, such as costless collars, that operate on the price
term of the agreement, contract, or transaction.
---------------------------------------------------------------------------

    1. May be used to adjust the forward contract price,\331\ but do
not undermine the overall nature of the contract as a forward contract;
---------------------------------------------------------------------------

    \331\ For example, a forward with an embedded option with a
formulaic strike price based on an index value that may not be known
until after exercise would be a forward if it meets the rest of the
3 components of this interpretation. Triggering an option to buy or
sell one commodity based on the price of a different commodity
reaching a specified level, such as in a cross-commodity
transaction, does not constitute an adjustment to the forward
contract price within the meaning of this 3-part interpretation.
---------------------------------------------------------------------------

    2. Do not target the delivery term, so that the predominant feature
of the contract is actual delivery; and
    3. Cannot be severed and marketed separately from the overall
forward contract in which they are embedded.\332\
---------------------------------------------------------------------------

    \332\ See Wright, supra note 214, at **6-7.

In evaluating whether an agreement, contract, or transaction qualifies
for the forward contract exclusions from the swap definition for
nonfinancial commodities, the CFTC will look to the specific facts and
circumstances of the transaction as a whole to evaluate whether any
embedded optionality operates on the price or delivery term of the
contract, and whether an embedded commodity option is marketed or
traded separately from the underlying contract.\333\ Such an approach
will help

assure that commodity options that should be regulated as swaps do not
circumvent the protections established in the Dodd-Frank Act through
the forward contract exclusion for nonfinancial commodities instead.
---------------------------------------------------------------------------

    \333\ This facts and circumstances approach to determining
whether a particular embedded option takes a transaction out of the
forward contract exclusion for nonfinancial commodities is
consistent with the CFTC's historical approach to determining
whether a particular embedded option takes a transaction out of the
forward contract exclusion from the definition of the term ``future
delivery'' in the CEA. See id. at *5 (``As we have held since
Stovall, the nature of a contract involves a multi-factor analysis *
* *.'').
---------------------------------------------------------------------------

    The CFTC also is providing an interpretation, in response to
commenters,\334\ with respect to forwards with embedded volumetric
optionality.\335\ Several commenters asserted that agreements,
contracts, and transactions that contain embedded ``volumetric
options,'' and that otherwise satisfy the terms of the forward
exclusions, should qualify as excluded forwards, notwithstanding their
embedded optionality.\336\ The CFTC believes that agreements,
contracts, and transactions with embedded volumetric optionality may
satisfy the forward exclusions from the swap and future delivery
definitions under certain circumstances. Accordingly, the CFTC is
providing an interpretation that an agreement, contract, or transaction
falls within the forward exclusion from the swap and future delivery
definitions, notwithstanding that it contains embedded volumetric
optionality, when:
---------------------------------------------------------------------------

    \334\ The CFTC requested comment on, among other things: whether
there are other factors that should be considered in determining how
to characterize forward contracts with embedded options with respect
to nonfinancial commodities; and whether there are provisions in
forward contracts with respect to nonfinancial commodities, other
than delivery and price, containing embedded optionality. See
Proposing Release at 29832.
    \335\ One commenter characterized ``volumetric optionality'' as
the optionality in a contract settling by physical delivery and used
to meet varying customer demand for a commodity.'' See WGCEF Letter.
See also BGA Letter (stating that ``it is commonplace for energy
suppliers to enter into commercial transactions with customers
(local distribution companies, electric utility companies,
industrial, commercial and residential customers, power plants,
etc.), which provide volumetric, price and delivery-related
flexibility and variability''). BGA claims that commercial
transactions containing embedded volumetric optionality ``include,
but are not limited to, full requirements contracts, interruptible
load agreements, capacity contracts, tolling agreements, energy
management agreements, natural gas transportation contracts and
natural gas storage contracts.'' Id.
    \336\ See, e.g., WGCEF Letter (submitting that ```volumetric
optionality' is [a] separate and distinct concept from
`deliverability optionality'''); BGA Letter; AGA Letter; Letter from
Jeffrey Perryman, Director, Contracts and Compliance, Atmos Energy
Holdings, Inc. (``Atmos''), dated July 22, 2011 (``Atmos Letter'');
NGSA/NCGA Letter; Letter from Paul M. Architzel, Wilmer Hale LLP on
behalf of ONEOK, Inc. (``ONEOK''), dated July 22, 2011 (``ONEOK
Letter''); COPE Letter.
---------------------------------------------------------------------------

    1. The embedded optionality does not undermine the overall nature
of the agreement, contract, or transaction as a forward contract;
    2. The predominant feature of the agreement, contract, or
transaction is actual delivery;
    3. The embedded optionality cannot be severed and marketed
separately from the overall agreement, contract, or transaction in
which it is embedded; \337\
---------------------------------------------------------------------------

    \337\ When a forward contract includes an embedded option that
is severable from the forward contract, the forward can remain
subject to the forward contract exclusion, if the parties document
the severance of the embedded option component and the resulting
transactions, i.e. a forward and an option. Such an option would be
subject to the CFTC's regulations applicable to commodity options.
---------------------------------------------------------------------------

    4. The seller of a nonfinancial commodity underlying the agreement,
contract, or transaction with embedded volumetric optionality intends,
at the time it enters into the agreement, contract, or transaction to
deliver the underlying nonfinancial commodity if the optionality is
exercised;
    5. The buyer of a nonfinancial commodity underlying the agreement,
contract or transaction with embedded volumetric optionality intends,
at the time it enters into the agreement, contract, or transaction, to
take delivery of the underlying nonfinancial commodity if it exercises
the embedded volumetric optionality;
    6. Both parties are commercial parties; \338\ and
---------------------------------------------------------------------------

    \338\ See discussion in section II.B.2.(a)(i)(B), supra.
---------------------------------------------------------------------------

    7. The exercise or non-exercise of the embedded volumetric
optionality is based primarily on physical factors,\339\ or regulatory
requirements,\340\ that are outside the control of the parties and are
influencing demand for, or supply of, the nonfinancial commodity.\341\
---------------------------------------------------------------------------

    \339\ See, e.g., BGA Letter (advising that ``[v]ariability
associated with an energy customer's physical demand is influenced
by factors outside the control of * * * energy suppliers (and
sometimes * * * consumers) * * * including, but not limited to, load
growth, weather and certain operational considerations (e.g.,
available transportation capacity to deliver physical natural gas
purchased on the spot market)'').
    \340\ Volumetric optionality in this category would include, for
example, a supply contract entered into to satisfy a regulatory
requirement that a supplier procure, or be able to provide upon
demand, a specified volume of commodity (e.g., electricity). To the
extent the optionality covers an amount of the commodity in excess
of the regulatory requirement, such optionality would not
necessarily be covered by this aspect of the guidance, though it may
nevertheless be covered by the guidance if such excess volumetric
optionality is based on physical factors within the meaning of the
guidance. For example, the California Utilities explained that the
California Public Utilities Commission (``CPUC'') requires them to
file a supply plan with the CPUC demonstrating that they have
procured sufficient capacity resources (including reserves) needed
to serve their aggregate system load on a monthly and yearly basis.
See California Utilities Letter. Each utility's system requirement
is 100 percent of its peak-hourly forecast load plus a 15-17 percent
reserve margin. The California Utilities enter into resource
adequacy agreements to procure electric power generating capacity to
meet these requirements. The ability to call on the additional 15 to
17% reserve reflected in such an agreement is covered by the
regulatory requirements part of this element. To the extent the
California Utilities may have a business need to procure additional
capacity resources beyond the foregoing regulatory requirement
(e.g., because they wish to maintain a slightly larger reserve
margin than required due to a recent upswing in unscheduled plant
outages due to aging plants), that may be covered under the
interpretation if the additional capacity is required due to
physical factors beyond the control of the parties (i.e., the
unscheduled outage, in the foregoing example).
    \341\ In other words, the predominant basis for failing to
exercise the option would be that the demand or supply (as
applicable) that the optionality was intended to satisfy, if needed,
never materialized, materialized at a level below that for which the
parties contracted or changed due to physical factors or regulatory
requirements outside the parties' control. Such failure to exercise,
or an exercise for a reduced amount of the underlying commodity,
could, for example, be due to colder than expected weather during
the summer decreasing demand for air conditioning, in turn
decreasing demand for power to run the air conditioning. The
Commission does not interpret this to mean that absolutely all
factors involved in the decision to exercise an option must be
beyond the parties' control, but rather the decision must be
predominantly driven by factors affecting supply and demand that are
beyond a parties control. This also means that the forward contract
with embedded volumetric optionality needs to be a commercially
appropriate method for securing the purchase or sale of the
nonfinancial commodity for deferred shipment at the time it is
entered into. The CFTC cautions market participants that, to the
extent a party relies on the forward exclusion from the swap or
future delivery definitions, notwithstanding that there is
volumetric optionality, if that volumetric optionality is
inconsistent with the seventh element of the interpretation, the
agreement, contract or transaction may be an option.
---------------------------------------------------------------------------

    The first two elements of the interpretation for embedded
volumetric optionality, which mirror the CFTC's historical embedded
option interpretation discussed above, have been modified to reflect
that embedded volumetric optionality relates to delivery rather than
price. As noted above, the predominant feature of a forward contract is
a binding, albeit deferred, delivery obligation. It is essential that
any embedded option in a forward contract as to volume must not
undermine a forward contract's overall purpose.\342\ The CFTC
recognizes that the nature of commercial operations are such that
supply and demand requirements cannot always be accurately predicted
and that forward contracts that allow for some optionality as to the
amount of a nonfinancial commodity actually delivered offer a great
deal of value to commercial

participants. Where an agreement, contract, or transaction requires
delivery of a non-nominal volume of a nonfinancial commodity, even if
an embedded volumetric option is exercised, the CFTC believes that the
predominant feature of the contract, notwithstanding the embedded
volumetric optionality, is actual delivery. This is the case in many
forward contracts that have an embedded option that allows a party to
buy or sell an additional amount of a commodity beyond the fixed amount
called for in the underlying forward contract. For instance, a forward
contract could call for the delivery of 10,000 bushels of wheat and
include an option for an additional 5,000 bushels of wheat.\343\
---------------------------------------------------------------------------

    \342\ See discussion in part II.B.2.(a)(i)(B), supra. See also
supra note 321.
    \343\ In evaluating whether the predominant feature of a
transaction is actual delivery, the CFTC will look at the contract
as a whole. Thus, with respect to this contract, the CFTC would
consider the intent element of the forward exclusions to be
satisfied because the contract requires the seller to deliver a non-
nominal volume of a commodity (i.e., 10,000 bushels of wheat),
viewing the contract as a whole. As a result, if the other elements
of the guidance above are satisfied, this contract would be a
forward contract, even if the party did not exercise the option for
the additional 5,000 bushels.
---------------------------------------------------------------------------

    The third element is substantially the same as the third element of
the interpretation above with respect to commodity options embedded in
forward contracts generally.
    The fourth and fifth elements are designed to ensure that both
parties intend to make or take delivery (as applicable), subject to the
relevant physical factors or regulatory requirements, which may lead
the parties to deliver more or less than originally intended. This
distinguishes a forward contract from a commodity option, where only
the option seller must at all times be prepared to deliver during the
term of the option. The sixth element is intended to ensure that the
interpretation is not abused by market participants not engaged in a
commercial business involving the nonfinancial commodity underlying the
embedded volumetric optionality.\344\
---------------------------------------------------------------------------

    \344\ The fact that the CFTC is expressly including the fourth
through sixth elements in the embedded optionality guidance for
volumetric options but not elsewhere does not mean that intent to
deliver and the ability to make or take delivery expressed in these
elements are not part of the facts and circumstances the CFTC will
consider in the context of determining whether other agreements,
contracts, and transactions qualify for the forward exclusions.
Intent to deliver and the ability to make or take delivery have long
been a part of the CFTC's facts-and-circumstances approach to making
that determination, and they remain so. The CFTC is emphasizing
these elements in this guidance because the CFTC has not previously
expressed the view that an agreement, contract, or transaction with
embedded volumetric optionality which affects the delivery term may
qualify as a forward if these facts and circumstances are present.
---------------------------------------------------------------------------

    The seventh element is based on comments stating that parties to
agreements, contracts, and transactions with embedded volumetric
optionality intend to make or take delivery (as applicable) of a
commodity, and that it is merely the volume of a commodity that would
be required to be delivered if the option is exercised, that varies. It
is designed to ensure that the volumetric optionality is primarily
driven by physical factors or regulatory requirements that influence
supply and demand and that are outside the parties' control, and that
the optionality is a commercially reasonable way to address uncertainty
associated with those factors.\345\ Element seven must be interpreted
with the other elements set forth here. For instance, even if the
optionality is consistent with element seven, such optionality cannot
undermine the overall nature of the contract as a forward contract as
discussed above.
---------------------------------------------------------------------------

    \345\ See, e.g., AGA Letter (advising that ``[i]n general,
retail demand for natural gas is weather driven * * * as a result
[of which], a gas utility's peaking supplies must have significant
flexibility * * * [and g]as utilities * * * use a variety of
contracts with gas suppliers to physically deal with peak periods of
demand''); BGA Letter (citing gas supply curtailment due to a
pipeline outage and power generation curtailment by an Independent
System Operator for operational reasons as factors outside the
control of energy suppliers and which could impact the amount of a
commodity delivered). The CFTC understands BGA's comment to address
involuntary curtailments, but also recognizes that power buyers may
agree in advance that the relevant Regional Transmission
Organization or Independent System Operator may, in order to
maintain system reliability, curtail power deliveries to the buyers.
While voluntary curtailments are within the control of the power
buyer, the potential system reliability issue is not. Therefore,
such voluntary curtailments would be within the guidance because, if
triggered, they would be based on a physical factor (e.g., supply
constraints).
---------------------------------------------------------------------------

    As discussed in the interpretation regarding forwards with embedded
optionality discussed above, in evaluating whether an agreement,
contract or transaction with embedded volumetric optionality qualifies
for the forward exclusions, the CFTC will look to the relevant facts
and circumstances of the transaction as a whole to evaluate whether the
transaction qualifies for the forward exclusions from the definitions
of the terms ``swap'' and ``future delivery.''
    The CFTC is providing further interpretations to explain how it
would treat some of the specific contracts described in the comment
letters. According to one commenter, a ``full requirements contract''
can be described as a ``contract where the seller agrees to provide all
requirements for a specific customer's location or delivery point.''
\346\ According to another commenter, ``[a] full requirements contract
* * * is a well-established concept in contract law'' and ``[i]n a
requirements contract, the purchaser * * * deals exclusively with one
supplier.'' \347\ This commenter added that, while the amount of
commodity delivered can vary, it is based on an objective need and that
the Uniform Commercial Code imposes on the buyer ``an obligation to act
in good faith with respect to the varying amount that is called for
delivery.'' \348\ Based upon this description, the CFTC believes that a
going commercial concern with an exclusive supply contract has no
option but to get its supply requirements met through that exclusive
supplier consistent with the terms of the contract. Any instance where
nominal or zero delivery occurred would have to be because the
commercial requirements changed or did not materialize. Furthermore,
any variability in delivery amounts under the contract appears to be
driven directly by the buyer's commercial requirements and is not
dependent upon the exercise of any commodity option by the contracting
parties.
---------------------------------------------------------------------------

    \346\ See Letter from Keith M. Sappenfield, II, Director, US
Regulatory Affairs, Encana Marketing (USA) Inc. (``Encana''), dated
July 22, 2011 (``Encana Letter'').
    \347\ See ONEOK Letter. The CFTC notes that this commenter
discussed full requirements contracts in the context of supply
agreements between one of its affiliates and retail customers. If
such customers are non-commercial customers, such contracts are not
forwards, but nevertheless they may not be swaps under the
Commissions' guidance regarding the non-exhaustive list of consumer
transactions, or otherwise if they have characteristics or factors
described under the consumer transaction interpretation, see infra
part II.B.3.
    \348\ See, e.g., NY UCC Sec.  2-306(1) (stating that ``[a] term
which measures the quantity by the output of the seller or the
requirements of the buyer means such actual output or requirements
as may occur in good faith.* * *''). This commenter cited Corbin on
Contracts for the proposition that the mere fact that the quantity
term of the contract is ``the buyer's needs or requirements'' does
not render the requirements contract ``a mere options contract''
because ``the buyer's promise is not illusory * * * [but] is
conditional upon the existence of an objective need for the
commodity.'' See ONEOK Letter (citing Corbin on Contracts Sec.  6.5
at 240-53 (1995)).
---------------------------------------------------------------------------

    Accordingly, full requirements contracts, as described above,
appear not to contain embedded volumetric options. Therefore, a full
requirements contract may qualify for the forward exclusion under the
same facts and circumstances analysis applicable to all other
agreements, contracts, and transactions that might be forwards. The
same analysis would apply to an output

contract satisfying the terms of this interpretation.\349\
---------------------------------------------------------------------------

    \349\ See Letter from Phillip g. Lookadoo, Esq., Reed Smith LLP
and Jeremy D. Weinstein, Esq. on behalf of IECA dated May 23, 2012
(suggesting that output contracts, in addition to full requirements
contracts, should be within the forward exclusion). An output
contract has been defined as ``a contract pursuant to which the
obligor's duty to supply the promised commodity is quantified (and
therefore limited) by reference to its production thereof.'' See
Boyd v. Kmart Corp., 110 F.3d 73 (10th Cir. 1997).
---------------------------------------------------------------------------

    With respect to capacity contracts, transmission (or
transportation) services agreements, and tolling agreements, the CFTC
understands that: (i) Capacity contracts are generally products
designed to ensure that sufficient physical generation capacity is
available to meet the needs of an electrical system;\350\ (ii)
transmission (or transportation) services agreements are generally
agreements for the use of electricity transmission lines (or gas
pipelines) that allow a power generator to transmit electricity (or gas
supplier to transport gas) to a specific location;\351\ and (iii)
tolling agreements, as described by commenters, provide a purchaser the
right to the capacity, energy, ancillary services and any other product
derived from a specified generating unit, all based upon a delivered
fuel price and agreed heat rate.\352\
---------------------------------------------------------------------------

    \350\ See California Utilities Letter.
    \351\ See NEMA Letter.
    \352\ See California Utilities Letter.
---------------------------------------------------------------------------

    Such agreements, contracts and transactions, may have features that
will satisfy the ``forwards with embedded volumetric optionality''
interpretation discussed above, or, like full requirements contracts,
may not contain embedded volumetric options and may satisfy other
portions of the forward interpretations herein. For example, according
to one commenter, the delivery obligations in some tolling agreements
are not optional which is indicative that the predominant feature of
such tolling agreements is actual delivery.\353\ It is also possible,
based on descriptions provided to the CFTC, that tolling agreements
could fit within the interpretation concerning certain physical
agreements, contracts, or transactions,\354\ or other interpretations
herein.
---------------------------------------------------------------------------

    \353\ Id.
    \354\ See infra part II.B.2.(b)(iii).
---------------------------------------------------------------------------

    Some commenters focused on forwards with embedded volumetric
optionality in the natural gas industry. For example, one commenter
stated that ``peaking supply'' natural gas contracts do not render
delivery optional. Although the purchaser has the option to specify
when and if the quantity of gas will be delivered on any given day,
this commenter asserted that there is no cash settlement alternative.
If the purchaser does not exercise the right to purchase, then the
right is terminated. The seller under the transaction must deliver the
entire quantity of gas that the purchaser specifies, or pay liquidated
damages. Moreover, the option is not severable and cannot be marketed
separately from the supply agreement itself.\355\ Similarly, another
commenter said that there is no ability to sever an embedded option
from a natural gas forward contract. Moreover, it stated that the
ability for a gas purchaser to specify a quantity of gas for a certain
day is not to encourage speculative activity; rather, it is because the
exact quantity of gas to be needed on that future day is unknown, and
many gas purchasers have weather-dependent needs that cannot accurately
be predicted in advance.\356\
---------------------------------------------------------------------------

    \355\ See AGA Letter.
    \356\ See Atmos Letter.
---------------------------------------------------------------------------

    Depending on the relevant facts and circumstances, these types of
agreements, contracts, and transactions--capacity contracts,
transmission (or transportation) services agreements, tolling
agreements, and peaking supply contracts--may satisfy the elements of
the ``forwards with embedded volumetric options'' interpretation set
forth above, or may satisfy other portions of this interpretation. If
they do, they would fall within the forward exclusions from the swap
and future delivery definitions.
    In addition, the CFTC is providing an interpretation in response to
a comment that contracts with evergreen or extension terms should be
considered forwards.\357\ The CFTC is clarifying that an extension term
in a commercial contract, such as a renewal term in a five year power
purchase agreement (which, due to the renewal, would require additional
deliveries), is not an option on the delivery term within the meaning
of the CFTC's interpretation, and consequently would not render such a
contract ineligible for the forward exclusions from the definitions of
the terms ``swap'' and ``future delivery.'' Similarly, an evergreen
provision, which automatically renews a contract (and, as such, would
require additional deliveries)\358\ absent the parties affirmatively
terminating it, would not render such a contract ineligible for the
forward exclusions from the swap or future delivery definitions.\359\
When the Proposing Release stated that a forward contract containing an
embedded option that does not ``target the delivery term'' is an
excluded forward contract,\360\ it meant that the embedded option does
not affect the delivery amount.\361\
---------------------------------------------------------------------------

    \357\ See IECA Letter.
    \358\ The CFTC refers in this and the prior sentence to
``additional deliveries'' because the IECA's example involves an
agreement calling for delivery of a physical nonfinancial commodity.
    \359\ Using extension or evergreen provisions to avoid delivery,
however, as was the case with the ``rolling spot'' contracts at
issue in CFTC v. Zelener, 373 F.3d 861 (7th Cir. 2004), could
constitute evasion or violate other provisions of the CEA (e.g., CEA
section 4(a), 7 U.S.C. 6(a)). This interpretation does not limit the
CFTC's other interpretations in this release regarding when delivery
does not occur (e.g., the Brent Interpretation).
    \360\ See NGSA/NCGA Letter (requesting clarification of the
phrase ``target the delivery term.'').
    \361\ See Proposing Release at 29830, n.81.
---------------------------------------------------------------------------

    Also, in response to a commenter,\362\ the CFTC clarifies that
embedded optionality as to delivery points and delivery dates will not
cause a transaction that otherwise qualifies as a forward contract to
be considered a swap. The CFTC emphasizes, however, that delivery must
occur at some delivery point and on some date, or the lack of delivery
must be due to the transaction being booked out or otherwise be
consistent with the CFTC's interpretation regarding the forward
exclusions from the swap and future delivery definitions.
---------------------------------------------------------------------------

    \362\ See COPE Letter.
---------------------------------------------------------------------------

Comments
    Commenters generally supported the CFTC's proposed interpretation
regarding forwards with embedded options, but many believed that it
should be modified or expanded. As noted above, several commenters
believed that forward contracts with embedded options that contain
optionality as to the quantity/volume of the nonfinancial commodity to
be delivered should qualify as forwards, and that the CFTC's proposed
interpretation (which only mentions price optionality) should be
modified accordingly.\363\ In this regard, several commenters focused
on forwards with embedded volumetric options in the natural gas
industry.\364\ One commenter noted that, although the 1985 CFTC OGC
Interpretation distinguishes forward contracts from trade options, it
is based on a limited number of agricultural contract examples, so
additional guidance is needed, particularly in light of the wide range
of cash market and commercial merchandising contracting practices in

which delivery terms and amounts vary.\365\
---------------------------------------------------------------------------

    \363\ See AGA Letter; API Letter; Atmos Letter; ONEOK Letter;
NGSA/NCGA Letter; WGCEF Letter.
    \364\ See AGA Letter; Atmos Letter.
    \365\ See ONEOK Letter. This commenter noted that it offers its
customers a number of types of contracts for delivery of natural gas
under which the amount called for delivery may vary. In each of
these types of contracts, this commenter stated that both parties
intend the contracts to result in delivery of the commodity, as
needed. The purpose of these contracts is to ensure that customers,
most of which are gas or electric utilities, have an adequate supply
of natural gas regardless of day-to-day changes in demand that may
be caused by variation in weather, operational considerations, or
other factors. They are not designed for one-way price protection as
would be the case with an option. See ONEOK Letter.
---------------------------------------------------------------------------

    In addition, another commenter requested more generally that any
embedded option (for example, price, quantity, delivery point, delivery
date, contract term) that does not permit a unilateral election of
financial settlement based upon the value change in an underlying cash
market should not render the contract a swap.\366\
---------------------------------------------------------------------------

    \366\ See COPE Letter, Appendix.
---------------------------------------------------------------------------

    As discussed above, the CFTC has provided an additional
interpretation with respect to forwards with embedded volumetric
options to address commenters' concerns. The CFTC also has provided an
interpretation above, regarding price optionality, optionality with
respect to delivery points and delivery dates specifically in response
to this commenter, and optionality as to certain contract terms (such
as evergreen and renewal provisions) to address particular concerns
raised by commenters. The CFTC declines to adopt a more expansive
approach with respect to ``any'' embedded option.
    One commenter requested that an option to purchase or sell a
physical commodity, whether embedded in a forward contract or stand
alone, should either (i) fall within the statutory forward exclusion
from the swap definition, or (ii) alternatively, if deemed by the CFTC
to be a swap, should be exempt from the swap definition pursuant to a
modified trade option exemption pursuant to CEA section 4c(b).\367\ The
CFTC has modified its proposed interpretation regarding forwards with
embedded options as discussed above; contracts with embedded options
that are swaps under this final interpretation may nevertheless qualify
for the modified trade option exemption recently adopted by the CFTC
and discussed above.\368\
---------------------------------------------------------------------------

    \367\ See WGCEF Letter; 7 U.S.C. 6c(b).
    \368\ 77 FR 25320 (Aug. 27, 2012). Encana believed that the
guidance on forwards with embedded options should include embedded
physical delivery options because it asserted that many of the
contracts currently used by participants in the wholesale natural
gas market contain an option for the physical delivery of natural
gas. See Encana Letter. To the extent that Encana's comment goes
beyond volumetric optionality, commodity options are discussed supra
in section II.B.2(b).
---------------------------------------------------------------------------

    Another commenter urged the CFTC to broadly exempt commercial
forward contracting from swap regulation by generally excluding from
the swap definition any forward contract with embedded optionality
between end users ``whose primary purpose is consistent with that of an
`end user', and in which any embedded option is directly related to
`end use.' '' \369\ The CFTC believes that this interpretation is vague
and overbroad, and declines to adopt it.
---------------------------------------------------------------------------

    \369\ See Letter from Roger Cryan, Vice President for Milk
Marketing and Economics, National Milk Producers Federation
(``NMPF''), dated July 22, 2011 (``NMPF Letter'').
---------------------------------------------------------------------------

    Another commenter believed that the CFTC's ``facts and
circumstances'' approach to forwards with embedded options does not
provide the legal certainty required by nonfinancial entities engaging
in commercial contracts in the normal course of business.\370\ This
commenter further argued that many option-like contract terms could be
determined to ``target the delivery term'' under a facts and
circumstances analysis.\371\
---------------------------------------------------------------------------

    \370\ See ETA Letter. Similarly, COPE comments that a
nonfinancial commodity forward contract that, ``by its terms,'' is
intended to settle physically should be permitted to contain
optionality without being transformed into a swap unless such
optionality negates the physical settlement element of the contract.
That is, if one party can exercise an option to settle the contract
financially based upon the value change in an underlying cash
market, then the intent for physical settlement is not contained in
``the four corners of the contract'' and may render the contract a
swap. See COPE Letter. As discussed elsewhere in this release, the
CFTC historically has eschewed approaches to the forward exclusion
that rely on the ``four corners of the contract,'' which can provide
a roadmap to evasion of statutory requirements.
    \371\ Accordingly, this commenter believed that the CFTC should
provide in its rules that an embedded option or embedded optionality
will not result in a nonfinancial forward being a swap unless: (i)
Delivery is optional; (ii) financial settlement is allowed; and
(iii) transfer and trading of the option separately from the forward
is permitted. See ETA Letter.
---------------------------------------------------------------------------

    The CFTC has long applied a facts-and-circumstances approach to the
forward exclusion, including with respect to forwards with embedded
options, and thus it is an approach with which market participants are
familiar. That approach balances the need for legal certainty against
the risk of providing opportunities for evasion.\372\ The CFTC's
additional interpretation noted above, including clarification about
the meaning of the phrase ``target the delivery term,'' and forwards
with embedded volumetric optionality, provides enhanced legal certainty
in response to the commenter's concerns. \373\
---------------------------------------------------------------------------

    \372\ See also NCFC Letter (supporting the CFTC's guidance
because it provides legal certainty).
    \373\ See also Commodity Options, 77 FR 25320, 25324 n. 25 (Apr.
27, 2012) (discussing the CFTC's conclusion that an ``option[] to
redeem'' under the USDA Commodity Credit Corporation's marketing
loan program constitutes a cotton producer's contractual right to
repay its marketing loan and ``redeem'' the collateral (cotton) to
sell in the open market).
---------------------------------------------------------------------------

Request for Comment
    The CFTC's interpretation regarding forwards with volumetric
options is an interpretation of the CFTC and may be relied upon by
market participants. However, the CFTC believes that it would benefit
from public comment about its interpretation, and therefore requests
public comment on all aspects of its interpretation regarding forwards
with embedded volumetric options,\374\ and on the following questions:
---------------------------------------------------------------------------

    \374\ Separately, it is expected that CFTC staff will be issuing
no-action relief with respect to the conditions of the modified
trade option exemption (except the enforcement provisions retained
in Sec.  32.3(d)) until December 31, 2012. This extension will
afford the CFTC an opportunity to review and evaluate the comments
received on both the interpretation above regarding embedded
volumetric optionality, and the modified trade option exemption, in
order to determine whether any changes thereto are appropriate.
---------------------------------------------------------------------------

    1. Are the elements set forth in the interpretation to distinguish
forwards with embedded volumetric optionality from commodity options
appropriate? Why or why not?
    2. Are there additional elements that would be appropriate? Please
describe and provide support for why such elements would serve to
distinguish forwards with embedded volumetric optionality from
commodity options.
    3. Is the seventh element that, to ensure that an agreement,
contract, or transaction with embedded volumetric optionality is a
forward and not an option, the volumetric optionality is based
primarily on physical factors, or regulatory requirements, that are
outside the control of the parties and are influencing demand for, or
supply of, the nonfinancial commodity, necessary and appropriate? Why
or why not? Is the statement of this element sufficiently clear and
unambiguous? If not, what adjustments would be appropriate?
    4. Are there circumstances where volumetric optionality is based on
other factors? Please describe. Would such factors, if made a part of
the interpretation, serve to distinguish forwards with embedded
volumetric optionality from commodity options? If so, how?
    5. Does the interpretation provide sufficient guidance as to
whether agreements, contracts, or transactions

with embedded volumetric optionality permitting a nominal amount, or no
amount, of a nonfinancial commodity to be delivered are forwards or
options, viewing the agreements, contracts, or transactions as a whole,
if they satisfy the seven elements of the interpretation? Why or why
not? Does this interpretation encourage evasion, or do the seven
elements sufficiently distinguish forwards from agreements, contracts,
and transactions that may evade commodity options regulation?
    6. Is the interpretation sufficiently clear with respect to
capacity contracts, transmission (or transportation) services
agreements, peaking supply contracts, or tolling agreements? Why or why
not? Do capacity contracts, transmission (or transportation) services
agreements, peaking supply contracts, or tolling agreements generally
have features that satisfy the forwards with volumetric options
interpretation included in this release? If so, which ones? If not, why
not? Could these types of agreements, contracts, and transactions
qualify for the forward exclusions under other parts of the
interpretation set forth above? Are there material differences in the
structure, operation, or economic effect of these types of agreements,
contracts, and transactions as compared to full requirements contracts
that are relevant to whether such agreements, contracts, and
transactions are options under the CEA? Please explain. If so, what are
the material differences?
    7. Do the agreements, contracts, and transactions listed in
question No. 6 above have embedded optionality in the first instance?
Based on descriptions by commenters, it appears that they may have a
binding obligation for delivery, but have no set amount specified for
delivery. Instead, delivery (including the possibility of nominal or
zero delivery) is determined by the terms and conditions contained
within the agreement, contract, or transaction (including, for example,
the satisfaction of a condition precedent to delivery, such as a
commodity price or temperature reaching a level specified in the
agreement, contract, or transaction). That is, the variation in
delivery is not driven by the exercise of embedded optionality by the
parties. Do the agreements, contracts, and transactions listed in
question No. 6 exhibit these kinds of characteristics? If so, should
the CFTC consider them in some manner other than its forward
interpretation? Why or why not?
(iii) Certain Physical Commercial Agreements, Contracts or Transactions
    The CFTC is providing an interpretation in response to comments
regarding certain physical commercial agreements for the supply and
consumption of energy that provide flexibility, such as tolls on power
plants, transportation agreements on natural gas pipelines, and natural
gas storage agreements.\375\ Commenters recognized that these types of
agreements, contracts or transactions may have option-like features,
but analogized them to leases and concluded that they were forwards
rather than swaps. One commenter, for example, characterized taking
power produced pursuant to a physical tolling agreement--which can
involve one party thereto providing fuel for a generation plant and
having the exclusive right to take the power produced by that plant
from the fuel provided--thus, in effect, ``renting'' the plant to the
extent the plant is used to produce power from the fuel provided--as
more akin to a lease than to an option.\376\
---------------------------------------------------------------------------

    \375\ See BGA Letter and California Utilities Letter. This
interpretation also may apply to firm transmission agreements
pursuant to which transmission service may not be interrupted for
any reason except during an emergency when continued delivery of
power is not possible. See http://www.interwest.org/wiki/index.php?title=Firm_transmission_service.
    \376\ See California Utilities Letter.
---------------------------------------------------------------------------

    The CFTC will interpret an agreement, contract or transaction not
to be an option if the following three elements are satisfied: (1) The
subject of the agreement, contract or transaction is usage of a
specified facility or part thereof rather than the purchase or sale of
the commodity that is to be created, transported, processed or stored
using the specified facility; (2) the agreement, contract or
transaction grants the buyer the exclusive use of the specified
facility or part thereof during its term, and provides for an
unconditional obligation on the part of the seller to grant the buyer
the exclusive use of the specified facility or part thereof; \377\ and
(3) the payment for the use of the specified facility or part thereof
represents a payment for its use rather than the option to use it. In
such agreements, contracts and transactions, while there is optionality
as to whether the person uses the specified facility, the person's
right to do so is legally established, does not depend upon any further
exercise of an option and merely represents a decision to use that for
which the lessor already has paid. In this context, the CFTC would not
consider actions such as scheduling electricity transmission, gas
transportation or injection of gas into storage to be exercising an
option if all three elements of the interpretation above are satisfied.
As with the interpretation regarding forwards with embedded options
generally, discussed above, in evaluating whether flexible physical
commercial agreements that meet the 3-part test qualify for the forward
exclusions, the CFTC will look to the specific facts and circumstances
of the agreement, contract or transaction as a whole to evaluate
whether the agreement, contract or transaction qualifies for the
forward exclusions from the definitions of ``swap'' and ``future
delivery.''
---------------------------------------------------------------------------

    \377\ In this regard, the usage rights offered for sale should
be limited to the capacity of the specified facility. While
overselling such capacity would not per se be inconsistent with
satisfying the terms of this interpretation, the CFTC cautions
market participants that overselling not based on reasonable
commercial expectations of the use of the specified facility could
lead the contract to be deemed evasion and lead to an agreement,
contract or transaction being considered a swap, as it would
undermine the ``right'' being offered. For example, given physical
constraints of the power grid and gas pipelines, overselling
transmission or transportation capacity would be per se inconsistent
with satisfying the terms of this interpretation.
---------------------------------------------------------------------------

    However, in the alternative, if the right to use the specified
facility is only obtained via the payment of a demand charge or
reservation fee, and the exercise of the right (or use of the specified
facility or part thereof) entails the further payment of actual storage
fees, usage fees, rents, or other analogous service charges not
included in the demand charge or reservation fee, such agreement,
contract or transaction is a commodity option subject to the swap
definition.
Comments
    Two commenters addressed ``lease-like'' physical agreements,
contracts or transactions.\378\ One of these commenters asserted that
there are many physical commercial agreements for the supply and
consumption of energy that effectively provide leases on flexible
energy assets, such as tolls on power plants, transportation agreements
on natural gas pipelines and natural gas storage agreements.\379\
According to this commenter, these assets have the capability to be
turned on and off to meet fluctuating demand due to weather and other
factors; physical contracts around these assets transfer that delivery
flexibility to the contract holder. The commenter believed that these
types of commercial arrangements should not be considered commodity
options, but rather should be excluded forwards. The other commenter
described tolling agreements as having the characteristics of a lease,
in that the

purchasing entity obtains the exclusive right to the use of the power
plant during the term of the agreement.\380\ This commenter asserted
that such agreements should not be considered commodity options, but
rather forwards because the obligations are not contingent. The CFTC is
providing the above interpretation that these types of agreements,
contracts and transactions are not commodity options if the above
conditions are satisfied, but may qualify for the forward exclusions
under the facts and circumstances, in response to these commenters'
concerns.
---------------------------------------------------------------------------

    \378\ See BGA Letter and California Utilities Letter.
    \379\ See BGA Letter.
    \380\ See California Utilities Letter.
---------------------------------------------------------------------------

(iv) Effect of Interpretation on Certain Agreements, Contracts and
Transactions
    In the Proposing Release,\381\ the CFTC requested comment regarding
how its proposed interpretation concerning the forward contract
exclusion would affect full requirements contracts, reserve sharing
agreements, tolling agreements, energy management agreements and
ancillary services. The CFTC asked whether such agreements, contracts
or transactions have optionality as to delivery and, if so, whether
they, or any other agreement, contract or transaction in a nonfinancial
commodity, should be excluded from the swap definition.\382\
---------------------------------------------------------------------------

    \381\ See Request for Comment 35, which stated: How would the
proposed interpretive guidance set forth in this section affect full
requirements contracts, capacity contracts, reserve sharing
agreements, tolling agreements, energy management agreements, and
ancillary services? Do these agreements, contracts, or transactions
have optionality as to delivery? If so, should they--or any other
agreement, contract, or transaction in a nonfinancial commodity that
has optionality as to delivery--be excluded from the swap
definition? If so, please provide a detailed analysis of such
agreements, contracts, or transactions and how they can be
distinguished from options that are to be regulated as swaps
pursuant to the Dodd-Frank Act. To what extent are any such
agreements, contracts, or transactions in the electric industry
regulated by the Federal Energy Regulatory Commission (``FERC''),
State regulatory authorities, regional transmission organizations
(``RTOs''), independent system operators (``ISOs'') or market
monitoring units associated with RTOs or ISOs?
    See Proposing Release at 29832.
    \382\ Id.
---------------------------------------------------------------------------

    Commenters generally believed that such types of agreements,
contracts and transactions, although they may contain delivery
optionality, should be considered forwards rather than swaps or
commodity options.\383\ By contrast, one commenter believed that traded
power markets involve many types of contracts that are actually
exchanges of cash flows based on referenced values and that have no
relevant characteristics of physical delivery.\384\
---------------------------------------------------------------------------

    \383\ See Atmos Letter; BGA Letter; California Utilities Letter;
COPE Letter; ETA Letter; Encana Letter; FERC Staff Letter; IECA
Letter; NEMA Letter; ONEOK Letter; and Letter from Kenneth R.
Carretta, General Regulatory Counsel--Markets, PSEG Services Corp.,
on behalf of the Public Service Electric and Gas Company, PSEG Power
LLC, and PSEG Energy Resources & Trade LLC (``PSEG Companies''),
dated July 22, 2011 (``PSEG Letter'').
    \384\ See Better Markets Letter. This commenter stated that
ancillary services are in substance swaps based on congestion costs
between two transmission points, measured by the difference between
actual prices assigned at those points by the grid operator.
Capacity contracts are often documented using trading agreements for
transactions in physicals, but this commenter believed that they
constitute swaps that are used to hedge the price risk associated
with periodic auctions of the contracts to provide reliable capacity
to the grid operator. This commenter asserted that such contracts do
not meet the CFTC's appropriate tests to exclude them, which should
be made explicit in the guidance. This commenter stated that basic
power contracts often do not meet the intent to deliver test because
power buyers and sellers each schedule delivery to/from the grid,
and such transactions can be settled based on readily available
price differentials rather than scheduling capacity and load as a
pair. At a minimum, this commenter believed that guidance should be
provided to require that, in order to demonstrate intent to deliver,
secondary delivery-related costs (e.g., congestion charges and
penalties to which those scheduling capacity and load on the grid
are subject) must be allocated by contract. Id.
---------------------------------------------------------------------------

    With the exception of energy management agreements, which are
discussed below, the interpretations that the CFTC has already provided
above may apply to such types of agreements, contracts and
transactions. Specifically, to the extent that such types of
agreements, contracts and transactions are forwards with embedded
volumetric options, the CFTC has provided an additional interpretation
in section II.B.2.b(iii) above. To the extent such types of agreements,
contracts or transactions are physical commercial agreements, contracts
or transactions discussed in section II.B.2.b(iii), supra, the CFTC has
provided an interpretation in that section. To the extent such types of
agreements, contracts and transactions are considered commodity
options, the CFTC has addressed commodity options under the separate
rulemaking establishing a modified trade option exemption.\385\ And to
the extent that such types of agreements, contracts, and transactions,
such as ancillary services, occur in Regional Transmission
Organizations or Independent System Operators, or entered into between
entities described in section 201(f) of the Federal Power Act,\386\
they may be addressed through the public interest waiver process in CEA
section 4(c)(6).\387\
---------------------------------------------------------------------------

    \385\ See supra note 317.
    \386\ 16 U.S.C. 824(f).
    \387\ 7 U.S.C. 6(c)(6).
---------------------------------------------------------------------------

    With regard to Energy Management Agreements (``EMAs''), in general,
commenters expressed the view that EMAs are forwards, and not swaps,
although they did not provide analysis to support that conclusion.\388\
They also did not provide a working definition of EMAs. The CFTC
understands that EMAs can cover a number of services and transactions,
which can include spot, forward and swap transactions. EMAs can include
services such as: (i) Acting as a financial intermediary by
substituting one party's credit and liquidity for those of a less
credit worthy owner of illiquid energy producing assets (i.e. the other
party to the EMA) to facilitate the owner's purchase of fuel and sale
of power; \389\ (ii) providing market information to assist the owner
in developing and refining a risk-management plan for the plant; \390\
and (iii) procuring fuel, arranging delivery and storage, selling
excess power not needed to serve load for another party.\391\ The
entity carrying out these activities may receive a portion of the
revenue generated from such activities as compensation for its efforts.
Because commenters did not provide a working definition of EMAs, the
CFTC cannot state categorically that EMAs are or are not swaps.
However, if the fuel acquisition, sales of excess generation and any
other transactions executed under the auspices of an EMA are not swaps,
nothing about the fact that the transactions are executed as a result
of or pursuant to an EMA transforms the transactions into swaps. For
example, if one party hires another party to enter into spot or forward
transactions on its behalf, the fact that their relationship is
governed by an EMA does not render those transactions swaps.\392\
Conversely, were swaps to be executed by one party on behalf of another
party as a result of, or pursuant to, an EMA, the parties thereto would
need to consider their respective roles thereunder (e.g. principal
versus agent) and whether commodity trading advisor, introducing
broker, futures commission merchant, or other registration or other
elements of the Dodd-Frank Act regime were implicated. At a minimum,
the fact that a swap was executed would implicate

reporting and recordkeeping requirements.\393\
---------------------------------------------------------------------------

    \388\ See, e.g., Encana Letter and BGA Letter.
    \389\ See, e.g., The Royal Bank of Scotland Group plc, Order
Approving Notice To Engage in Activities Complementary to a
Financial Activity, 2008 Federal Reserve Bulletin volume 94.
    \390\ Id.
    \391\ See, e.g., Energy Management Agreement between Long Island
Lighting Company and Long Island Power Authority, available at
http://www.lipower.org/pdfs/company/papers/contract/energy.pdf.
    \392\ Similarly, using an EMA would not render swaps entered as
a result of or pursuant to an EMA spot or forward transactions.
    \393\ This interpretation is limited to the facts and
circumstances described herein; the CFTC is not opining on different
facts or circumstances, which could change the CFTC's
interpretation.
---------------------------------------------------------------------------

(v) Liquidated Damages Provisions
    The Commissions also received several comments discussing
contractual liquidated damages provisions. The CFTC is clarifying that
the presence, in an agreement, contract, or transaction involving
physical settlement of a nonfinancial commodity, of a liquidated
damages provision (which may be referred to by another name, such as a
``cover costs'' or ``cover damages'' provision) does not necessarily
render such an agreement, contract, or transaction ineligible for the
forward exclusion.\394\ Such a provision in an agreement, contract, or
transaction is consistent with the use of the forward exclusion,
provided that the parties intend the transaction to be physically
settled.\395\ However, liquidated damages provisions can be used to
mask a lack of intent to deliver.\396\ In light of the possibility for
evasion of the Dodd-Frank Act, the CFTC will continue to utilize its
historical facts-and-circumstances approach in determining whether the
parties to a particular agreement, contract, or transaction with a
liquidated damage provision have the requisite intent to deliver.
---------------------------------------------------------------------------

    \394\ With respect to performance guarantees, the fact that a
failure to deliver a nonfinancial commodity triggers a payment under
a performance guaranty does not excuse the performance, nor render
delivery optional. Accordingly, such a payment trigger would not
itself preclude an agreement, contract, or transaction from being
covered by the forward exclusion from the swap or future delivery
definitions. But see supra part II.B.1.g, which provides that the
CFTC is interpreting the term ``swap'' (that is not a security-based
swap or mixed swap) to include a guarantee of such swap, to the
extent that a counterparty to a swap position would have recourse to
the guarantor in connection with the position.
    \395\ See 1985 CFTC OGC Interpretation, supra note 245 (stating
generally that while ``[s]ome contracts provide for a liquidated
damages of penalty clause if the producer fails to deliver, the
presence of such clauses in a contract does not change the analysis
of the nature of the contract [if] * * * it is intended that
delivery of the physical crop occur, absent destruction of all or a
portion of the crop by forces which neither party can control'').
See generally Corbin on Contracts Sec.  58.1 (characterizing
liquidated damages provisions as designed to ``[d]etermin[e] the
amount of damages that are recoverable for a breach of contract'').
    \396\ In that regard, see 1985 CFTC OGC Interpretation, supra
note 245 (stating that ``a contract provision which permitted a
producer to avoid delivery for a reason other than for an
intervening condition not in the control of either party could
change any conclusion about the nature of the contract'').
---------------------------------------------------------------------------

Comments
    One commenter notes that a commercial merchandising arrangement
involving a nonfinancial commodity may provide that the remedy for a
failure to make or take delivery is the payment of a market-rate
replacement price, a payment on a performance guaranty, or ``cover
damages'' to compensate the non-breaching party for the failure of the
other party to fulfill its contractual obligations.\397\ Such a
contractual damages or remedy provision, this commenter contended, is
not analogous to a financial settlement option in a trading
instrument.\398\ This commenter further asserted that one party or the
other may be unable to perform, or excused or prevented for commercial
reasons from performing, its contractual obligations to make or take
delivery of a nonfinancial commodity, and therefore may be liable to
the other party for a monetary payment, calculated in accordance with
the contract.\399\
---------------------------------------------------------------------------

    \397\ See ETA Letter.
    \398\ Id. This commenter cited FERC Order No. 890, which
recognizes that ``[w]hile any party to any contract can choose to
fail to perform, that does not convey a contractual right to fail to
perform'' and that the Edison Electric Institute Master Power
Purchase and Sale Agreement (``EEI MPPSA'') clearly obligates the
supplier to provide power, except in cases of force majeure. As the
ETA explains, ``[t]he EEI MPPSA is a master agreement frequently
used to document transactions for deferred delivery and receipt of
nonfinancial electric energy, and the terms of the ISDA North
American Power Annex contain substantially identical master
agreement provisions * * *.'' Id.
    \399\ According to this commenter, parties typically include
liquidated damages provisions in their agreements, contracts and
transactions to address situations in which ``one party or the other
may be unable, excused or prevented for commercial reasons from
performing its contractual obligations to deliver or receive [the
relevant commodity],'' not to serve as ``a financial settlement
`option' analogous to a financial settlement option in a trading
instrument.'' Id.
---------------------------------------------------------------------------

    Another commenter noted that physically settled gas contracts,
including peaking contracts (both for daily and monthly supply), bullet
day contracts and weather contracts, use the NAESB Base Contract, which
does not provide for financial settlement other than a liquidated
damages provision, which would compensate a utility for its cost of
obtaining alternative supply at the prevailing market price if the
seller fails to deliver.\400\ This commenter stated its view that the
seller has no real opportunity to arbitrage its obligation to deliver
based on changes in price, and the purchaser has no incentive to fail
to take delivery of its specified quantities of gas, because they are
needed for the physical operations of its system.\401\
---------------------------------------------------------------------------

    \400\ See AGA Letter.
    \401\ Id. See also Atmos Letter (stating that there is no
financial incentive for a seller to fail to deliver natural gas
under contracts used in the natural gas industry, as the standard
remedy for such a failure to deliver is to pay liquidated damages
sufficient to compensate the purchaser for having to obtain its
required natural gas).
---------------------------------------------------------------------------

    The CFTC generally agrees with these comments regarding liquidated
damages provisions, and has provided the final interpretation described
above to address them.
(c) Security Forwards \402\
---------------------------------------------------------------------------

    \402\ The discussion above regarding the exclusion from the swap
definition for forward contracts on nonfinancial commodities does
not apply to the exclusion from the swap and security-based swap
definitions for security forwards or to the distinction between
security forwards and security futures products.
---------------------------------------------------------------------------

    As the Commissions stated in the Proposing Release, the Commissions
believe it is appropriate to address how the exclusions from the swap
and security-based swap definitions apply to security forwards and
other purchases and sales of securities.\403\ The Commissions are
restating the interpretation set out in the Proposing Release without
modification.
---------------------------------------------------------------------------

    \403\ See Proposing Release at 29830.
---------------------------------------------------------------------------

    The Dodd-Frank Act excludes purchases and sales of securities from
the swap and security-based swap definitions in a number of different
clauses.\404\ Under these exclusions, purchases and sales of securities
on a fixed or contingent basis \405\ and sales of securities for
deferred shipment or delivery that are intended to be physically
delivered \406\ are explicitly excluded from the swap and security-
based swap definitions.\407\ The exclusion from the swap and security-
based swap definitions of a sale of a security for deferred shipment or
delivery involves an agreement to purchase one or more securities, or
groups or indexes of securities, at a future date at a certain price.
---------------------------------------------------------------------------

    \404\ See sections 1a(47)(B)(ii), (v), and (vi) of the CEA, 7
U.S.C. 1a(47)(B)(ii), (v), and (vi).
    \405\ See section 1a(47)(B)(v) of the CEA, 7 U.S.C. 1a(47)(B)(v)
(excluding from the swap and security-based swap definitions ``any
agreement, contract, or transaction providing for the purchase or
sale of 1 or more securities on a fixed basis that is subject to
[the Securities Act and Exchange Act]''); and section 1a(47)(B)(vi)
of the CEA, 7 U.S.C. 1a(47)(B)(vi) (excluding from the swap and
security-based swap definitions ``any agreement, contract, or
transaction providing for the purchase or sale of 1 or more
securities on a contingent basis that is subject to [the Securities
Act and Exchange Act], unless the agreement, contract, or
transaction predicates the purchase or sale on the occurrence of a
bona fide contingency that might reasonably be expected to affect or
be affected by the creditworthiness of a party other than a party to
the agreement, contract, or transaction'').
    \406\ See section 1a(47)(B)(ii) of the CEA, 7 U.S.C.
1a(47)(B)(ii).
    \407\ The Commissions note that calling an agreement, contract,
or transaction a swap or security-based swap does not determine its
status. See supra part II.D.1.
---------------------------------------------------------------------------

    As with other purchases and sales of securities, security forwards
are

excluded from the swap and security-based swap definitions. The sale of
the security in this case occurs at the time the forward contract is
entered into with the performance of the contract deferred or
delayed.\408\ If such agreement, contract, or transaction is intended
to be physically settled, the Commissions believe it would be within
the security forward exclusion and therefore outside the swap and
security-based swap definitions.\409\ Moreover, as a purchase or sale
of a security, the Commissions believe it also would be within the
exclusions for the purchase or sale of one or more securities on a
fixed basis (or, depending on its terms, a contingent basis) and,
therefore, outside the swap and security-based swap definitions.\410\
---------------------------------------------------------------------------

    \408\ A purchase or sale of a security occurs at the time the
parties become contractually bound, not at the time of settlement
(regardless of whether cash or physically settled). See Securities
Offering Reform, 70 FR 44722 (Aug. 3, 2005).
    \409\ See section 1a(47)(B)(ii) of the CEA, 7 U.S.C.
1a(47)(B)(ii).
    \410\ See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C.
1a(47)(B)(v) and (vi).
---------------------------------------------------------------------------

    In the Proposing Release, the Commissions provided the following
specific interpretation in the context of forward sales of mortgage-
backed securities (``MBS'') guaranteed or sold by the Federal National
Mortgage Association (``Fannie Mae''), the Federal Home Loan Mortgage
Corporation (``Freddie Mac''), and the Government National Mortgage
Association (``Ginnie Mae'').\411\ The Commissions are restating their
interpretation regarding such forward sales.
---------------------------------------------------------------------------

    \411\ The Commissions provided the interpretation in the
Proposing Release in response to commenters on the ANPR. See
Proposing Release at 29830. These commenters requested clarification
that forward sales of MBS guaranteed or sold by Fannie Mae, Freddie
Mac and Ginnie Mae would not be included in the swap and security-
based swap definitions in order to provide the certainty needed to
avoid unnecessary disruption of this market. Id.
---------------------------------------------------------------------------

    MBS guaranteed or sold by Fannie Mae, Freddie Mac and Ginnie Mae
are eligible to be sold in the ``To-Be-Announced'' (``TBA'') market,
which is essentially a forward or delayed delivery market.\412\ The TBA
market has been described as one that ``allows mortgage lenders
essentially to sell the loans they intend to fund even before the loans
are closed.'' \413\ In the TBA market, the lender enters into a forward
contract to sell MBS and agrees to deliver MBS on the settlement date
in the future. The specific MBS that will be delivered in the future
may not yet be created at the time the forward contract is entered
into.\414\ In a TBA transaction, the seller and the buyer agree to five
terms before entering into the transaction: (i) The type of security,
which will usually be a certain type of MBS guaranteed or sold by
Fannie Mae, Freddie Mac or Ginnie Mae and the type of mortgage
underlying the MBS; (ii) the coupon or interest rate; (iii) the face
value (the total dollar amount of MBS the purchaser wishes to
purchase); (iv) the price; and (v) the settlement date.\415\ The
purchaser will contract to acquire a specified dollar amount of MBS,
which may be satisfied when the seller delivers one or more MBS pools
at settlement.\416\
---------------------------------------------------------------------------

    \412\ Task Force on Mortgage-Backed Securities Disclosure,
``Staff Report: Enhancing Disclosure in the Mortgage-Backed
Securities Markets,'' part II.E.2 (Jan. 2003), which is available at
http://www.sec.gov/news/studies/mortgagebacked.htm (``MBS Staff
Report'').
    \413\ Id.
    \414\ Id.
    \415\ Id.
    \416\ Id. The good delivery guidelines, titled ``Uniform
Practices for the Clearance and Settlement of Mortgage-Backed
Securities and Other Related Securities,'' which govern the
mechanics of trading and settling MBS, contain specific guidelines
for trading and settling MBS guaranteed or sold by Fannie Mae,
Freddie Mac and Ginnie Mae in the TBA market. The good delivery
guidelines outline the basic terms and conditions for trading,
confirming, delivering and settling MBS. The good delivery
guidelines set forth the basic characteristics that MBS guaranteed
or sold by Fannie Mae, Freddie Mac and Ginnie Mae must have to be
able to be delivered to settle an open TBA transaction. Id. The
Securities Industry and Financial Markets Association (``SIFMA'') is
the successor to the Bond Market Association and publishes the good
delivery guidelines, which are available at http://www.sifma.org/services/standard-forms-and-documentation/securitized-products/.
---------------------------------------------------------------------------

    The Commissions are confirming that such forward sales of MBS in
the TBA market would fall within the exclusion for sales of securities
on a deferred settlement or delivery basis even though the precise MBS
are not in existence at the time the forward MBS sale is entered
into.\417\ Moreover, as the purchase or sale of a security, the
Commissions also are confirming that such forward sales of MBS in the
TBA market would fall within the exclusions for the purchase or sale of
one or more securities on a fixed basis (or, depending on its terms, a
contingent basis) and therefore would fall outside the swap and
security-based swap definitions.\418\
---------------------------------------------------------------------------

    \417\ See section 1a(47)(B)(ii) of the CEA, 7 U.S.C.
1a(47)(B)(ii).
    \418\ See sections 1a(47)(B)(v) and (vi) of the CEA, 7 U.S.C.
1a(47)(B)(v) and (vi).
---------------------------------------------------------------------------

Comments
    The Commissions received two comments on the interpretation
regarding security forwards. One commenter recommended that the
Commissions codify in the text of the final rules the interpretation
regarding forward sales of MBS in the TBA market.\419\ The Commissions
are not codifying the interpretation because codification will create a
bright-line test. The Commissions note that the analysis as to whether
any product falls within the exclusion for sales of securities on a
deferred settlement or delivery basis requires flexibility, including
the consideration of applicable facts and circumstances. Because the
interpretation regarding forward sales of MBS in the TBA market is
based on particular facts and circumstances, the Commissions do not
believe that a bright-line test is appropriate.
---------------------------------------------------------------------------

    \419\ See Letter from Lisa M. Ledbetter, Vice President and
General Counsel, Legislative & Regulatory Affairs, Freddie Mac, Jul.
21, 2011.
---------------------------------------------------------------------------

    Another commenter suggested that the Commissions narrow the
exclusion for contracts for the purchase and sale of securities for
subsequent delivery as applied to security-based swaps because parties
can use the formal characterization of a delivery contract for
securities to disguise a transaction that is substantively a security-
based swap.\420\ This commenter was concerned because this commenter
believes that the securities subject to such a delivery obligation are
often easily convertible into cash, which facilitates cash settlement
without actual delivery.\421\ As such, this commenter suggested that
the Commissions should provide a test for determining whether parties
have a bona fide intent to deliver.\422\ This commenter recommended
that such test should prohibit cash settlement options in contracts for
subsequent delivery and should not consider a party that frequently
unwinds physical positions with cash settlements using side agreements
as having the requisite intent to deliver.\423\ The Commissions are not
providing a test at this time for determining whether parties have a
bona fide intent to deliver because the analysis as to whether sales of
securities for deferred shipment or delivery are intended to be
physically delivered is a facts and circumstances determination and a
bright-line test will not allow for the flexibility needed in such
analysis. Further, the Commissions note that the purchase and sale of a
security occurs at the time the forward contract is entered into.\424\
---------------------------------------------------------------------------

    \420\ See Better Markets Letter.
    \421\ Id.
    \422\ Id.
    \423\ Id.
    \424\ See supra note 408.

---------------------------------------------------------------------------

3. Consumer and Commercial Agreements, Contracts, and Transactions
    The Commissions noted in the Proposing Release that ``[c]onsumers
enter into various types of agreements, contracts, and transactions as
part of their household and personal lives that may have attributes
that could be viewed as falling within the swap or security-based swap
definition.\425\ Similarly, businesses and other entities, whether or
not for profit, also enter into agreements, contracts, and transactions
as part of their operations relating to, among other things,
acquisitions or sales of property (tangible and intangible), provisions
of services, employment of individuals, and other matters that could be
viewed as falling within the definitions.'' \426\
---------------------------------------------------------------------------

    \425\ See Proposing Release at 29832.
    \426\ Id.
---------------------------------------------------------------------------

    Commenters on the ANPR pointed out a number of areas in which a
broad reading of the swap and security-based swap definitions could
cover certain consumer and commercial arrangements that historically
have not been considered swaps or security-based swaps.\427\ Examples
of such instruments cited by those commenters included evidences of
indebtedness with a variable rate of interest; commercial contracts
containing acceleration, escalation, or indexation clauses; agreements
to acquire personal property or real property, or to obtain mortgages;
employment, lease, and service agreements, including those that contain
contingent payment arrangements; and consumer mortgage and utility rate
caps.\428\
---------------------------------------------------------------------------

    \427\ Id.
    \428\ Id.
---------------------------------------------------------------------------

    The Commissions also stated in the Proposing Release that they ``do
not believe that Congress intended to include these types of customary
consumer and commercial agreements, contracts, or transactions in the
swap or security-based swap definition, to limit the types of persons
that can enter into or engage in them, or to otherwise to subject these
agreements, contracts, or transactions to the regulatory scheme for
swaps and security-based swaps.'' \429\
---------------------------------------------------------------------------

    \429\ Id. If these types of arrangements were subject to Title
VII, the persons that could enter into or engage in them could be
restricted because Title VII imposes restrictions on entering into
swaps and security-based swaps with persons who are not eligible
contract participants (``ECPs''). See sections 723(1), 763(e), and
768(b) of the Dodd-Frank Act. The Dodd-Frank Act amended the
Securities Act and the Exchange Act to require that security-based
swap transactions involving a person that is not an ECP must be
registered under the Securities Act and effected on a national
securities exchange, and also amended the CEA to require that swap
transactions involving a person that is not an ECP must be entered
into on, or subject to the rules of, a board of trade designated as
a contract market. Id. The Commissions note that many consumers and
commercial and non-profit entities may not be ECPs. See section
1a(18) of the CEA, 7 U.S.C. 1a(18). Further, if these types of
arrangements were subject to Title VII, they would be subject to the
full regulatory scheme for swaps and security-based swaps created by
Title VII. These requirements could increase costs for consumers and
commercial and non-profit entities and potentially disrupt their
ability to enter into these arrangements.
---------------------------------------------------------------------------

    Accordingly, the Commissions proposed an interpretation in the
Proposing Release to assist consumers and commercial and non-profit
entities in understanding whether certain agreements, contracts, or
transactions that they enter into would be regulated as swaps or
security-based swaps.\430\ The Commissions are adopting the
interpretation set out in the Proposing Release with certain
modifications in response to commenters.\431\
---------------------------------------------------------------------------

    \430\ See Proposing Release at 29832-33.
    \431\ See infra note 447 and accompanying text.
---------------------------------------------------------------------------

    With respect to consumers, the Commissions have determined that the
types of agreements, contracts, or transactions that will not be
considered swaps or security-based swaps when entered into by consumers
(natural persons) as principals (or by their agents)\432\ primarily for
personal, family, or household purposes, include:\433\
---------------------------------------------------------------------------

    \432\ For example, a mortgage broker may arrange a rate lock on
behalf of a consumer borrower.
    \433\ The Commissions are not addressing here the applicability
of any other provisions of the CEA, the Federal securities laws or
the Commissions' regulations to such agreements, contracts or
transactions.
---------------------------------------------------------------------------

     Agreements, contracts, or transactions to acquire or lease
real or personal property, to obtain a mortgage, to provide personal
services, or to sell or assign rights owned by such consumer (such as
intellectual property rights);
     Agreements, contracts, or transactions to purchase
products or services for personal, family or household purposes at a
fixed price or a capped or collared price, at a future date or over a
certain time period (such as agreements to purchase for personal use or
consumption nonfinancial energy commodities, including agreements to
purchase home heating fuel or agreements involving residential fuel
storage, in either case, where the consumer takes delivery of and uses
the fuel, and the counterparty is a merchant that delivers in the
service area where the consumer resides);\434\
---------------------------------------------------------------------------

    \434\ These agreements, contracts, or transactions require the
parties respectively to make and take delivery of the underlying
commodity to each other directly; delivery may be deferred for
convenience or necessity. But see section 2(c)(2)(D) of the CEA, 7
U.S.C. 2(c)(2)(D), generally prohibiting certain leveraged, margined
or financed agreements, contracts and transactions with non-ECPs
when actual delivery does not occur within 28 days). The Commissions
view consumer agreements, contracts, and transactions involving
periodic or future purchases of consumer products and services as
transactions that are not swaps. This interpretation does not extend
to consumer agreements, contracts or transactions containing
embedded optionality or embedded derivatives other than those
discussed in the text associated with this footnote. This analysis
of consumer contracts is separate from the forward contract analysis
for commercial merchandising transactions discussed in supra part
II.B.2. The CFTC continues to view the forward contract exclusion
for nonfinancial commodities as limited to commercial merchandising
transactions.
---------------------------------------------------------------------------

     Agreements, contracts, or transactions that provide for an
interest rate cap or lock on a consumer loan or mortgage, where the
benefit of the rate cap or lock is realized only if the loan or
mortgage is made to the consumer;
     Consumer loans or mortgages with variable rates of
interest or embedded interest rate options, including such loans with
provisions for the rates to change upon certain events related to the
consumer, such as a higher rate of interest following a default; \435\
---------------------------------------------------------------------------

    \435\ An example of a consumer loan with a variable rate of
interest is credit card debt that includes a ``teaser'' rate. The
teaser rate is a low, adjustable introductory interest rate that is
temporary.
---------------------------------------------------------------------------

     Service agreements, contracts, or transactions that are
consumer product warranties, extended service plans, or buyer
protection plans, such as those purchased with major appliances and
electronics; \436\
---------------------------------------------------------------------------

    \436\ One commenter indicated that such service agreements,
contracts, or transactions may be regulated as insurance in some but
not all states. However, the Commissions believe that it is
appropriate to address these agreements, contracts, or transactions
in the context of their guidance regarding consumer and commercial
arrangements. See NAIC Letter.
---------------------------------------------------------------------------

     Consumer options to acquire, lease, or sell real or
personal property, such as options to lease apartments or purchase rugs
and paintings, and purchases made through consumer layaway plans; \437\
---------------------------------------------------------------------------

    \437\ The Commissions believe that options entered into by
consumers that result in physical delivery of the commodity, if
exercised, are not the type of agreements, contracts or transactions
that Congress intended to regulate as swaps or security-based swaps.
Conversely, options entered into by consumers that cash settle based
on the difference between the market price and the contract price of
a commodity are not within the scope of this interpretation.
---------------------------------------------------------------------------

     Consumer agreements, contracts, or transactions where, by
law or regulation, the consumer may cancel the transaction without
legal cause; \438\ and
---------------------------------------------------------------------------

    \438\ Examples of these types of transactions include consumer
transactions that may be cancelled pursuant to the Federal Reserve
Board's Regulation Z, 12 CFR Part 226 (i.e. certain consumer credit
transactions that involve a lien on the consumer's principal
dwelling), consumer mail/telephone orders that may be cancelled when
orders have not been filled under 16 CFR Part 435, and other
consumer transactions that have cancellations rights conferred by
statute or regulation.

---------------------------------------------------------------------------

     Consumer guarantees of credit card debt, automobile loans,
---------------------------------------------------------------------------
and mortgages of a friend or relative.

The Commissions have included in the interpretation above several
additional examples of consumer arrangements that the Commissions do
not consider to be swaps or security-based swaps. These additional
examples have been included in response to commenters \439\ and the
Commissions' determination that such additional examples would assist
consumers in identifying other agreements, contracts, or transactions
that they enter into that would not be regulated as swaps or security-
based swaps.\440\
---------------------------------------------------------------------------

    \439\ See supra note 96 and accompanying text. See also infra
notes 436, 454 and 455 and accompanying text.
    \440\ The additional example regarding consumer options to
acquire, lease, or sell real or personal property was added in
response to a commenter on the ANPR. See Letter from White & Case
LLP, dated September 20, 2010. The Commissions also are providing as
additional examples consumer agreements, contracts, or transactions
where, by law or regulation, the consumer may cancel the transaction
without legal cause, and consumer guarantees of credit card debt,
automobile loans, and mortgages of a friend or relative.
---------------------------------------------------------------------------

    The types of commercial agreements, contracts, or transactions that
involve customary business arrangements (whether or not involving a
for-profit entity) and will not be considered swaps or security-based
swaps under this interpretation include:
     Employment contracts and retirement benefit arrangements;
     Sales, servicing, or distribution arrangements;
     Agreements, contracts, or transactions for the purpose of
effecting a business combination transaction; \441\
---------------------------------------------------------------------------

    \441\ These business combination transactions include, for
example, a reclassification, merger, consolidation, or transfer of
assets as defined under the Federal securities laws or any tender
offer subject to section 13(e) and/or section 14(d) or (e) of the
Exchange Act, 15 U.S.C. 78m(e) and/or 78n(d) or (e). These business
combination agreements, contracts, or transactions can be contingent
on the continued validity of representations and warranties and can
contain earn-out provisions and contingent value rights.
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     The purchase, sale, lease, or transfer of real property,
intellectual property, equipment, or inventory;
     Warehouse lending arrangements in connection with building
an inventory of assets in anticipation of a securitization of such
assets (such as in a securitization of mortgages, student loans, or
receivables); \442\
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    \442\ The Commissions believe that such lending arrangements
included in this category are traditional borrower/lender
arrangements documented using, for example, a loan agreement or
indenture, as opposed to a synthetic lending arrangement documented
in the form of, for example, a total return swap. The Commissions
also note that securitization transaction agreements also may
contain contingent obligations if the representations and warranties
about the underlying assets are not satisfied.
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     Mortgage or mortgage purchase commitments, or sales of
installment loan agreements or contracts or receivables;
     Fixed or variable interest rate commercial loans or
mortgages entered into by banks \443\ and non-banks, including the
following:
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    \443\ While the Commissions have included fixed or variable
interest rate commercial loans entered into by banks, the
Commissions understand that the CEA does not apply to, and the CFTC
may not exercise regulatory authority over, identified banking
products, and that the definitions of the terms ``security-based
swap'' and ``security-based swap agreement'' do not include
identified banking products. See infra note 488, regarding
identified banking products. However, such loans and mortgages
provided by certain banks may not qualify as identified banking
products because those banks may not satisfy the definition of
``bank'' for purposes of the ``identified banking products''
definition. See 7 U.S.C. 27(a).
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     Fixed or variable interest rate commercial loans or
mortgages entered into by the Farm Credit System institutions and
Federal Home Loan Banks;
     Fixed or variable interest rate commercial loans or
mortgages with embedded interest rate locks, caps, or floors, provided
that such embedded interest rate locks, caps, or floors are included
for the sole purpose of providing a lock, cap, or floor on the interest
rate on such loan or mortgage and do not include additional provisions
that would provide exposure to enhanced or inverse performance, or
other risks unrelated to the interest rate risk being addressed;
     Fixed or variable interest rate commercial loans or
mortgages with embedded interest rate options, including such loans or
mortgages that contain provisions causing the interest rate to change
upon certain events related to the borrower, such as a higher rate of
interest following a default, provided that such embedded interest rate
options do not include additional provisions that would provide
exposure to enhanced or inverse performance, or other risks unrelated
to the primary reason the embedded interest rate option is included;
and
     Commercial agreements, contracts, and transactions
(including, but not limited to, leases, service contracts, and
employment agreements) containing escalation clauses linked to an
underlying commodity such as an interest rate or consumer price index.

In response to commenters,\444\ the Commissions have included in the
interpretation above several additional examples of commercial
arrangements that the Commissions do not consider to be swaps or
security-based swaps.
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    \444\ See infra notes 456 and 461 and accompanying text.
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    The Commissions intend for this interpretation to enable consumers
to engage in transactions relating to their households and personal or
family activities without concern that such arrangements would be
considered swaps or security-based swaps. Similarly, with respect to
commercial business arrangements, this interpretation should allow
commercial and non-profit entities to continue to operate their
businesses and operations without significant disruption and provide
that the swap and security-based swap definitions are not read to
include commercial and non-profit operations that historically have not
been considered to involve swaps or security-based swaps.
    The types of agreements, contracts, and transactions discussed
above are not intended to be exhaustive of the customary consumer or
commercial arrangements that should not be considered to be swaps or
security-based swaps. There may be other, similar types of agreements,
contracts, and transactions that also should not be considered to be
swaps or security-based swaps. In determining whether similar types of
agreements, contracts, and transactions entered into by consumers or
commercial entities are swaps or security-based swaps, the Commissions
intend to consider the characteristics and factors that are common to
the consumer and commercial transactions listed above:
     They do not contain payment obligations, whether or not
contingent, that are severable from the agreement, contract, or
transaction;
     They are not traded on an organized market or over-the-
counter; and
     In the case of consumer arrangements, they:

--Involve an asset of which the consumer is the owner or beneficiary,
or that the consumer is purchasing, or they involve a service provided,
or to be provided, by or to the consumer, or
     In the case of commercial arrangements, they are entered
into:

--By commercial or non-profit entities as principals (or by their
agents) to serve an independent commercial, business, or non-profit
purpose, and
--Other than for speculative, hedging, or investment purposes.
    Two of the key components reflected in these characteristics that
distinguish these agreements, contracts, and transactions from swaps
and security-based swaps are that: (i) The payment provisions of the
agreement, contract, or transaction are not severable; and (ii)

the agreement, contract, or transaction is not traded on an organized
market or over-the-counter, and therefore such agreement, contract, or
transaction does not involve risk-shifting arrangements with financial
entities, as would be the case for swaps and security-based swaps.\445\
In response to commenters,\446\ the Commissions clarify that merely
because an agreement, contract, or transaction is assignable does not
mean that it is ``traded'' or that the agreement, contract, or
transaction is a swap or security-based swap. An assignment of a
contractual obligation must be analyzed to assure that the result is
not to sever the payment obligations.
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    \445\ There also are alternative regulatory regimes that have
been enacted as part of the Dodd-Frank Act specifically to provide
enhanced protections to consumers relating to various consumer
transactions. See, e.g., the Consumer Financial Protection Act of
2010, Public Law 111-203, tit. X, 124 Stat. 1376 (Jul. 21, 2010)
(establishing the Bureau of Consumer Financial Protection to
regulate a broad category of consumer products and amending certain
laws under the jurisdiction of the Federal Trade Commission); the
Mortgage Reform and Anti-Predatory Lending Act, Public Law 111-203,
tit. XIV, 124 Stat. 1376 (Jul. 21, 2010) (amending existing laws,
and adding new provisions, related to certain mortgages). Some of
these agreements, contracts, or transactions are subject to
regulation by the Federal Trade Commission and other Federal
financial regulators and state regulators.
    \446\ See infra note 470.
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    This interpretation is not intended to be the exclusive means for
consumers and commercial or non-profit entities to determine whether
their agreements, contracts, or transactions fall within the swap or
security-based swap definition. If there is a type of agreement,
contract, or transaction that is not enumerated above, or does not have
all the characteristics and factors that are listed above (including
new types of agreements, contracts, or transactions that may be
developed in the future), the agreement, contract, or transaction will
be evaluated based on its particular facts and circumstances. Parties
to such an agreement, contract or transaction may also seek an
interpretation from the Commissions as to whether the agreement,
contract or transaction is a swap or security-based swap.
Comments
    Eleven commenters provided comments on the proposed interpretation
set forth in the Proposing Release regarding consumer and commercial
arrangements.\447\ While most commenters supported the proposed
interpretation, these commenters suggested certain changes.
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    \447\ See BGA Letter; Letter from The Coalition for Derivatives
End-Users, Jul. 22, 2011, (``CDEU Letter''); ETA Letter; Letter from
Robbie Boone, Vice President, Government Affairs, Farm Credit
Council, Jul. 22, 2011 (``FCC Letter''); FERC Staff Letter; Letter
from Warren N. Davis, Of Counsel, Sutherland Asbill & Brennan LLP,
on behalf of the Federal Home Loan Banks, Jul. 22, 2011 (``FHLB
Letter''); IECA Letter; ISDA Letter; Just Energy Letter; PMAA/NEFI
Letter; and SEIA Letter.
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    Four commenters recommended that the Commissions codify the
proposed interpretation regarding consumer and commercial
arrangements.\448\ The Commissions are not codifying the
interpretation. The interpretation is intended to provide guidance to
assist consumers and commercial and non-profit entities in evaluating
whether certain arrangements that they enter into will be regulated as
swaps or security-based swaps. The interpretation is intended to allow
the flexibility necessary, including the consideration of the
applicable facts and circumstances by the Commissions, in evaluating
consumer and commercial arrangements to ascertain whether they may be
swaps or security-based swaps. The representative characteristics and
factors taken together are indicators that a consumer or commercial
arrangement is not a swap or security-based swap and the Commissions
have provided specific examples demonstrating how these characteristics
and factors apply to some common types of consumer and commercial
arrangements. However, as the interpretation is not intended to be a
bright-line test for determining whether a particular consumer or
commercial arrangement is a swap or security-based swap, if the
particular arrangement does not meet all of the identified
characteristics and factors, the arrangement will be evaluated based on
its particular facts and circumstances.
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    \448\ See ETA Letter; FERC Letter; IECA Letter; and Just Energy
Letter.
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    One commenter was concerned that the interpretation itself
implicitly suggests that many types of consumer and commercial
arrangements could be swaps, although none of these arrangements
historically has been considered a swap.\449\ The Commissions do not
intend to suggest that many types of consumer and commercial
arrangements that historically have not been considered swaps are
within the swap or security-based swap definitions. The Commissions
provided the interpretation in response to comments received on the
ANPR. Commenters on the ANPR identified areas in which a broad reading
of the swap and security-based swap definitions could cover certain
consumer and commercial arrangements that historically have not been
considered swaps or security-based swaps.\450\ The Commissions believe
it is appropriate to provide the interpretation to allow consumers and
commercial and non-profit entities to engage in such transactions
without concern that such arrangements would be considered swaps or
security-based swaps.
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    \449\ See IECA Letter.
    \450\ See Proposing Release at 29832.
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    One commenter requested that the Commissions remove the term
``customary'' from the description of consumer and commercial
arrangements in the interpretation.\451\ The Commissions note that the
use of the term ``customary'' was not intended to limit the
interpretation, but rather was used to describe certain types of
arrangements that consumers and businesses may normally or generally
enter into. The Commissions also note that the term ``customary'' is
itself not a separate representative characteristic or factor for
purposes of the interpretation.
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    \451\ See ISDA Letter.
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    This commenter also requested that specific examples of consumer
and commercial arrangements that are not swaps or security-based swaps
include ``any other similar agreements, contracts, or transactions.''
\452\ The specific examples are not intended to be an exhaustive list
and the Commissions do not believe that it is necessary to include a
general catchall provision. The interpretation also includes a list of
representative characteristics and factors to be used to analyze other
consumer and commercial arrangements.
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    \452\ Id.
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    Several commenters suggested additional examples of consumer and
commercial arrangements that the Commissions should not consider to be
swaps or security-based swaps.\453\ One commenter suggested that the
Commissions should expand the example of ``consumer agreements,
contracts, or transactions to purchase products or services at a fixed
price or a capped or collared price, at a future date or over a certain
time period (such as agreements to purchase home heating fuel)'' to
include all nonfinancial energy commodities in the parenthetical
example.\454\ The Commissions have modified the identified consumer