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US airline wins Dodd-Frank real-time reporting delay

Southwest Airlines no-action letter could lead to wider relief

A no-action letter issued by the US Commodity Futures Trading Commission (CFTC) to Texas-based Southwest Airlines on November 6 may herald a broader shift in the CFTC’s policy of requiring commodity derivatives end-users to report their swap trades in real time.

The letter effectively exempts Southwest from the requirement that all swap trades must be reported within a matter of hours to swap data repositories (SDRs) – giant warehouses of data designed to give regulators an insight into the market for over-the-counter derivatives. The requirement was originally implemented by the CFTC as a result of the US Dodd-Frank Act of 2010.

Under the CFTC’s rules, SDRs are required to publish the trading data they receive from market participants with the identities of companies removed, in order to preserve the anonymity of firms engaging in OTC trades. But Southwest had complained that the public dissemination of its trading data made it obvious the company was entering into fuel hedging transactions with dealers, even though the data published by SDRs is supposed to be anonymous.

The problem, says Southwest, is that many of its hedging transactions involve long-dated oil derivatives with maturities of two or more years – typically swaps or options on West Texas Intermediate (WTI) or Brent North Sea crude oil. Since trading in such long-dated WTI or Brent derivatives is relatively infrequent, reports of the trades in SDR public data feeds can alert the market that Southwest is putting on a hedge, the airline says.

“Only a few market participants trade that far out the curve,” said Southwest treasurer Chris Monroe in prepared testimony submitted to the US House of Representatives Committee on Agriculture, which oversees the CFTC, in July 2013. “Additionally, Southwest has a particularly identifiable trading strategy, a hedging ‘DNA’ if you will, which makes us quite visible in a market with few participants. This is particularly harmful.”

The harm arose because Southwest’s dealers might not have sufficient time to lay off their risk before the initial hedging transaction is revealed, Monroe said. As a result, the positions of Southwest’s counterparties can be exploited by opportunistic traders who know Southwest’s oil hedge is about to move the market.

The November 6 no-action letter directly addresses those concerns. In the letter, the CFTC’s Division of Market Oversight says it will not recommend taking an enforcement action against Southwest or its counterparties for taking additional time to report their long-dated oil hedges, as long as the trades are reported to an SDR within 15 days. Effectively, that gives Southwest’s dealers a much longer time to report trades with the airline than under current rules. At the moment, most swap dealers have just two hours to report trades that are not cleared to an SDR.

Southwest expressed satisfaction with the CFTC’s relief. “We applaud the CFTC’s action today that recognises the importance of managing risk through our effective fuel hedging programme,” the airline said in a statement on November 6. “The CFTC action ensures that Southwest will continue to have the flexibility to manage our risk in a responsible way, which helps us to keep fares low.”

It is unusual for the CFTC to issue such a targeted no-action letter affecting a single end-user. That has led some observers to wonder if the commission will issue similar relief to a wider array of firms, given that Southwest’s concerns about real-time reporting in illiquid markets are not unique.

“Many times when a regulator issues a no-action letter, the relief granted is industry-wide,” says Steven Lofchie, a New York-based partner with law firm Cadwalader, Wickersham Taft. “This is not a case like that. But, of course, any firm that has a similar fact situation will want similar relief, and I expect the firm would be able to get the same treatment. And then at some point, if enough firms request the relief, the CFTC, as a commission, would likely propose a broader market-wide exemption or rule amendment.”

The CFTC, which declined to comment for this article, said in its letter that the decision to give no-action relief to Southwest came in response to a request submitted by the airline on October 29, roughly a week before the letter was issued. But it appears the CFTC was pushed along by a deft lobbying campaign by Southwest, which began soon after the commission’s real-time reporting rule took effect in early 2013.

In June last year, Southwest sent a letter to the heads of the agriculture committees of the US House and Senate proposing a legislative fix to address the airline’s concerns about real-time reporting. Under Southwest’s proposal, non-financial firms executing hedges in illiquid markets would enjoy a grace period of at least 30 days before those trades would need to be reported to an SDR. Then, in June 2014, the Republican-controlled House passed a CFTC reauthorisation bill that included a provision roughly similar to Southwest’s proposal, allowing a 30-day delay for reporting end-user hedging transactions in illiquid markets.

The Senate has yet to act on its own version of the CFTC reauthorisation bill. Under Democratic control, the Senate consistently refused to take any actions that might be seen as softening Dodd-Frank rules. But following the US midterm elections held on November 4, the Senate is set to shift to Republican control in January, making it much more likely the US Congress will pass a CFTC reauthorisation bill including such provisions.

Meanwhile, the CFTC’s new chairman, Timothy Massad, has moved to implement regulatory fixes to address some of the most pressing concerns of commercial end-users. Massad, who joined the commission in June, has vowed to ‘fine-tune’ Dodd-Frank regulations to ensure they do not impose an undue burden on hedgers – a shift that has been welcomed by the energy industry.

The issue of real-time reporting and its impact on hedgers recently gained widespread attention when the start of Mexico’s annual oil hedging programme was revealed by a September 19 article in the Financial Times. The programme is usually conducted in great secrecy, but the country’s cover was blown after a five-million-barrel put options trade on Maya crude oil was published by an SDR.

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