CFTC commits to ensuring a properly functioning derivative markets during COVID-19 pandemic
According to its mission statement, the purpose of the Commodity Futures Trading Commission (the “CFTC”) is to “promote the integrity, resilience, and vibrancy of the US derivatives markets through sound regulation”.[1] After over three decades of existence, and in response to the Great Recession of 2008, the Dodd-Frank bill gave the CFTC greater power to regulate derivatives (creating a definition for “swaps” under the Commodity Exchange Act[2]), increase transparency and improve pricing in the derivative marketplace and lower risk through regulated central clearinghouses for standardized derivatives.[3] Now, during the first substantial economic downturn since the Great Recession of 2008, the CFTC is able to use the powers granted by the Dodd-Frank bill to mitigate market upheaval.
In contrast with the Great Recession, the downturn of the economy in 2020 was not caused by a subprime mortgage crises but by the coronavirus disease 2019 (COVID-19) pandemic. There are no market regulations that could have prevented the emergence and spread of the COVID-19. However, the CFTC has and will use its powers to help stabilize the commodity market to the greatest extent possible during the COVID-19 pandemic.
On March 24, 2020, when the extensive effects of the COVID-19 pandemic were just starting to be felt in the United States, CFTC Chairman Heath P. Tarbert commented in the Wall Street Journal on the strength of the CFTC to prevent a different kind of contagion, financial contagion.[4] He emphasized the importance of post-2008 margin reporting requirements: “The CFTC’s swap margin rules are important because they remove the guesswork about who is solvent, marking a critical distinction from 2008.”[5] Chairman Talbert went on to state that, though the current market volatility caused by the COVID-19 pandemic is challenging, the CFTC is in a much better place than it was in 2008 to regulate markets and introduce some stability.[6]
In addition to its margin reporting requirements, the CFTC also looks closely at any irregular market activity. On April 20, 2020, one market irregularity made international headlines. For the first time in history, due in part to dramatic decreases in demand caused by the COVID-19 pandemic, American oil futures contracts plummeted to negative prices.[7] With oil prices already low for months, oil storage capacity in the Unites States was filling up; this, coupled with the decrease in demand from airlines and others, made investors desperate to sell their oil futures contracts before having to take physical possession of the oil.”[8]
The dramatic $40 drop in oil futures contracts within the span of half an hour raised alarm bells for the CFTC.[9] The CFTC has begun to investigate this dramatic nose-dive in prices “to ensure the market functioned properly and rule out foul play.”[10] According to Chairman Tarbert, the market drop is likely due to supply and demand rather than issues with the financial markets. However, the worries of many, including billionaire oilman Harold Hamm, that the fall in prices could be the result “of potential foul or system failures” have encouraged the CFTC to launch a formal investigation.[11]
The CTFC will seek to understand the what is behind the dramatic price move and look closely for any violations of the Commodity Exchange Act.[12] Through reviewing trading data, the CFTC will try to identify any irregularities and work to “assess whether the contract is working as a tool to determine fair and accurate oil prices, and any other factors that may have exacerbated volatility.”[13] However, a quick resolution should not be excepted as similar probes in the past have taken years of investigation.[14]
If the pattern of negative oil prices repeats itself in the coming months, the CFTC may be forced to take more aggressive actions.[15] Commissioner Dan M. Berkovitz “suggested the CFTC's Energy and Environmental Markets Advisory Panel could help analyze the matter and advise the CFTC on future actions to take.”[16]
As the end of the month draws near, and June contracts get closer to expiration, the CFTC warns that “registrants should remain vigilant and prepare accordingly.”[17] Commodity traders should be aware that the CFTC is exercising its regulatory powers during the COVID-19 pandemic and make sure that they are properly following regulations.
If you have any questions regarding these new requirements and their implications, please contact the authors, any member of our Energy Sector team, or your DLA Piper relationship attorney.
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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.
[1] https://cftc.gov/About/Mission/index.htm
[2] 7 U.S.C §1a (47)
[3] https://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm
[4] https://www.cftc.gov/PressRoom/PressReleases/8138-20
[5] Id.
[6] Id.
[7] https://www.forbes.com/sites/sarahhansen/2020/04/21/heres-what-negative-oil-prices-really-mean/#7f4efe645a85
[8] Id.
[9] https://www.reuters.com/article/usa-cftc-oil-idUSL2N2CC0TS
[10] Id.
[11] Id.
[12] Id.
[13] Id.
[14] Id.
[15] https://www.spglobal.com/marketintelligence/en/news-insights/blog/credit-risk-identifying-early-warning-signals-in-the-oil-and-gas-industry
[16] Id.
[17] https://www.offshore-technology.com/features/what-is-oil-contract-trading-prices-negative/
