Dodd-Frank: Unintended Consequences For Municipal Utility Swaps

by: John Saucer


Dodd Frank rules, intended to shelter public entities, unintentionally drove potential counterparties away from municipal utilities swap markets.

CFTC proposed rule, “Exclusion of Utility Operations-Related Swaps with Utility Special Entities From De Minimis Threshold for Swaps With Special Entities” seeks to rectify unintended consequences of original rule.

The new proposed rule relieves counterparties of the more onerous compliance requirements, but places additional burdens on municipal utilities. Will the changes lure counterparties back to the table?

Dodd-Frank Unintended Consequences

In a section of the Dodd-Frank law, Congress directed that measures be taken to provide extra protection to government agencies, pension funds, and the like. The CFTC, having the responsibility to implement the wishes of Congress, produced a set of regulations that complied with the letter of the law and the intent of Congress, but in doing so made it more difficult for publicly owned utilities to serve the public interest. Over the past several years, many public and investor-owned utility companies have been able to hold down volatility in natural gas and electricity rates by employing a range of energy swaps in their day-to-day business activities. The CFTC made regulatory demands upon entities doing business with public utilities that were sufficiently onerous that many potential counterparties withdrew from the utilities swaps market.

Spoiler Alert

In the end, the CFTC does now appear to have taken the necessary steps to amend the Federal Code to soften the extraordinary treatment of the swaps that utilities use to hedge or mitigate commercial risk arising from their facility operations and public service obligations. These rule changes are not yet final, and it remains to be seen if they are sufficient to lure swap counterparties back to the table.

The Problem

Congress established a $25 million threshold to apply to any counterparty of the category of swap users known as "special entities" (as defined in the Commodity Exchange Act) that generally include Federal Agencies, State, County, Municipalities, or City Agencies, pension plans or endowments. Upon reaching the $25 million (gross notional amount) aggregate threshold, any counterparty to swaps with special entities would be required to register as a swap dealer (SD), which would then subject the counterparty to additional responsibilities in compliance with Dodd-Frank regulation.

For swaps positions taken with non-special counterparties, the threshold for SD registration is $3 billion. For those parties that conduct a swaps business and would be natural counterparties for the utilities, but are under the $3 billion threshold, it just did not make sense to take on the added administrative load and scrutiny that comes with the SD designation. As a result, many otherwise qualified counterparties fled the space, and utilities were left with a limited number of potential counterparties, resulting in greater costs and the potential loss of access to the customized commodity swaps that utilities use to mitigate risk.

First Attempt At Relief Was Inadequate

The CFTC was petitioned by industry groups for immediate relief and for changes to the special entity rules. CFTC recognized the problem and issued a "no-action letter" (CFTC Staff Letter 12-18) which suspended enforcement of a portion of the existing rule to the extent that the de minimis threshold was raised from $25 million to $800 million. The new threshold applied narrowly to a new category, "utility special entity", that use swaps to hedge a physical position in certain defined "exempt commodities" which "both parties to the swap transact as part of the normal course of their physical energy businesses". These quoted conditions and other key provisions in the staff letter 12-18 added yet another administrative layer in tracking the swaps subject to the new de minimis threshold, and injected legal uncertainties into swaps with "utility special entities". Faced with these uncertainties, most of the potential counterparties that had fled the market earlier did not return.

Second Try

CFTC's second attempt to come to the aid of the utilities was by Staff Letter 14-34 issued in March 2014. The letter appears to have been a trial balloon preceding a new proposed rule "Exclusion of Utility Operations-Related Swaps with Utility Special Entities From De Minimis Threshold for Swaps With Special Entities" issued June 2, 2014. The proposed rule codifies some key elements of the earlier staff letter 14-34, removes legal uncertainty introduced in earlier attempts at relief, and defines the Dodd Frank obligations for both parties to the swap.

New Key Provisions

The proposed rule excludes qualified swaps from the $25 million threshold that applies to all special entities, and treats a new class of utility-related swaps in much the same manner as similarly situated non- utility swaps are treated under Dodd Frank regulations. The proposed rule created a specific type of swap, "Utility Operations-Related Swap" which is defined as an electric energy or natural gas swap, or a swap associated with specific utility operations. Qualifying swaps must be used to hedge or mitigate commercial risk in accordance with the definitions and qualifications commonly known in the Dodd- Frank world as the "end user exception". In addition, the swap counterparty may rely on representations made by the Utility that it meets the necessary conditions set out by the rule, reducing the legal uncertainty imposed earlier. The swap counterparty exercising the exception to the de minimis threshold must file electronic notifications with the National Futures Association for each swap qualifying under the proposed rule. The filing requirement has drawn vehement opposition to the proposed rule during the statutory comment period, which may well lead to relaxation or elimination of the requirement in the final rule.


For Utilities finding suitable swap counterparties and entering the swaps market under the new proposed rule, there will be an added layer of administrative and record keeping responsibilities. For the counterparty, the administrative burden specific to utility-related swaps will be reduced, while their responsibilities for Dodd Frank compliance will be mostly in line with swaps executed by other non-utility counterparties. Typically, the non-utility counterparty tracks their own swaps exposure relative to the $25 million threshold and the $3 billion general de minimis threshold.


All parties to swaps are required to keep records of all their swap transactions, whether they are the reporting party or the non- reporting party. Swaps records include an extensive collection of data items descriptive of the swap counterparties involved, and of the financial details of the swap. Records must be maintained electronically, with standards for timely retrieval of the records upon request, and for preservation of these records.

End User Exception

The "end user exception" is the exception to the Dodd Frank mandatory swap-clearing requirement. The end user exception was established to relieve qualified end users from the burden of having to clear trades and post margin on a daily basis. The utility may qualify to exercise the end user exception by means of an annual compliance filing with the CFTC or its designated agency. In the filing, the utility must represent that it is electing the exception to hedge or mitigate commercial risk, and provide supporting documentation that the swap is economically appropriate to the reduction of risks in the conduct and management of its utility operations, or qualifies for hedging treatment. A further requirement is a current approval by a governing board for the utility to engage in swaps that are exempt from the clearing process.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.