What Energy-Focused Private Equity Sponsors Need to Know About The CFTC’s Proposed Position Limits and Final Rules Regarding Aggregation of Commodity Positions

Author: Mark Proctor, Partner, Mergers & Acquisitions and Private Equity, Vinson & Elkins LLP

On December 5, 2016, the U.S. Commodity Futures Trading Commission (the “CFTC”) adopted final rules concerning aggregation under the CFTC’s position limits trading regime.  The CFTC simultaneously proposed position limits on speculative positions in 25 core physical commodity futures and their “economically equivalent” options and swaps (collectively, “Contracts”).  These position limits impose caps on the number of Contracts in NYMEX Henry Hub Natural Gas (“NG”), NYMEX Light Sweet Crude Oil (“CL”), NYMEX NY Harbor ULSD (i.e., diesel) (“HO”), and NYMEX RBOB Gasoline (“RB”) (among other commodities) that a trader could own in the current (i.e., “spot”) month and in any single non-spot month and all months combined.  In this context the trader could either be a portfolio company or the fund itself.

The following table shows position limits for the above-referenced commodities as currently proposed:

Contract Spot-Month Single and All-Months
NYMEX Henry Hub Natural Gas (NG) 2,000[1] 200,900
NYMEX Light Sweet Crude Oil (CL) 10,400 148,800
NYMEX NY Harbor ULSD (HO) 2,900 21,300
NYMEX RBOB Gasoline (RB) 6,800 15,300

 

Under existing CFTC position limit rules, unless a particular exemption applies, a person must aggregate all accounts for which it controls trading decisions with the accounts of all entities in which that person has a 10% or greater ownership interest.  Importantly, absent the exemption discussed below, a private equity fund would need to aggregate the positions in Contracts held by all of its portfolio companies for purposes of determining its own compliance with the CFTC’s position limits.

The new aggregation rules adopted by the CFTC stipulate that an owner of a 10% or greater interest in one or more traders is not required to aggregate the Contract positions of its traders with its own positions as long as the owner and traders have no knowledge of each other’s trading and enforce written procedures to preclude such knowledge.  Employees who control trading decisions cannot overlap, and cannot have knowledge about each other’s trades.  However, employees who do not direct or participate in trading decisions (such as compliance officers, accountants, and risk management personnel) would not be prohibited from sharing information.

In addition, knowledge that an entity acquires about another entity’s trading strategy when carrying out due diligence under a fiduciary duty would not require aggregation, nor would knowledge that a party gains concerning its counterparty during execution of a transaction (e.g., if a fund and its portfolio company were on opposite sides of a trade), in each case so long as the knowledge is not directly used to affect the party’s trading strategy.

A private equity sponsor seeking to rely on this exemption from aggregation would need to ensure that the sponsor does not share employees that control trading decisions with its portfolio companies.  Attorneys, accountants, risk managers, compliance, and other mid- and back-office personnel may be shared so long as these employees do not control, direct, or participate in trading decisions.  A sponsor can appoint personnel to a portfolio company’s board as long as the board member does not influence or direct the portfolio company’s trading decisions.  (The CFTC’s release does not contemplate situations where a sponsor-appointed board member gets involved in trading decisions in extraordinary circumstances.)

In order to rely on the exemption the private equity fund must file a notice with the commission within 60 days of acquiring the ownership interest in the portfolio company.  The filing must describe the relevant circumstances that warrant disaggregation, including, for instance, a description of the ownership structure and policies in place to ensure separation of trading decisions.

The aggregation rules, as adopted, represent a good outcome for the industry as they will alleviate a large potential burden for private equity sponsors, funds, and portfolio companies.  The American Investment Council advocated for such a change for five years and deserves credit for helping to obtain this favorable result.  Now that the CFTC has acted, the commodity exchanges will need to re-assess their own rules regarding aggregation in light of the CFTC’s actions to ensure that their rules are no more burdensome than the CFTC’s approach.

Although the CFTC’s new aggregation rules are set to become effective on February 14, 2017, the Trump Administration’s recently announced regulatory freeze, may lead the CFTC to delay the rules’ effective date further into the future [NOTE – while the freeze does not explicitly apply to independent agencies, the expectation is that the freeze will have some practical effect on them].  This would be a welcome development for businesses affected by the new rules and would also allow the CFTC to consider whether a notice filing should be required at all in order for aggregation relief to be allowed.

[1] NG is also subject to a conditional spot-month limit exemption of 10,000 cash-settled contracts.

Vinson & Elkins is an AIC Tier 2 Associate Member.

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