New CFTC rules

[This is a message I sent internally to all V&E lawyers. I know there is a
lot in here that some of you already know about, but I thought I'd share it
with you]. Except for the clearing organization rules, which appear to me
to be a mess, I think this should make life simpler for Sara and Jim in
dealing with equity derivatives, for Mark Taylor, Sara and others in dealing
with principal-to-principal negotiated derivatives, and perhaps for
EnronOnline. Nora, this may pose some interesting questions relative to
DealBench. And, of course, if and to the extent that Enron wants to set up
or otherwise get involved in multiple participant B2B Internet trading sites
that involve transactions that will be completed on-line, there will be some
issues that need to be addressed]

This should be viewed as a very preliminary report because I have not had a
chance to study the new rules carefully. I will send more complete
information later.

Last week the Commodities Futures Trading Commission adopted its "new
regulatory framework," a series of rules that I believe will greatly expand
the breadth, depth, height, weight and size of the CFTC's bureaucracy and
the scope of the CFTC's regulatory involvement in all sorts of things
(including financial guarantees) that it has not attempted to regulate
heretofore. The CFTC described this rule making as a "regulatory
reinvention." Indeed, the CFTC has reinvented itself without Congressional
authorization to do so. In particular, under the new rules, for the first
time the CFTC's "board of trade" regulation is not confined to markets in
which "speculators" participate. In effect, it has extended its "board of
trade" regulatory reach into a portion of the over-the-counter market that
involves only business participants.

Probably the biggest headache for all of us will be the new rules relating
to Clearing Organizations, defined as "a person who provides credit
enhancement functions" with respect to certain transactions, including
transactions that rely on the new bilateral contract exemption discussed
below. In many cases it will be illegal for a company that does not
register with and become regulated by the CFTC as a Recognized Clearing
Organization (RCO) to provide credit enhancement functions. I obviously
need to study the rules further, but my initial read is that the rules are a
disaster in drafting. For example, I don't think that the CFTC intended to
say that a parent company cannot guarantee a swap entered into by its
subsidiary unless the parent company registers as an RCO, but on my initial
reading it appears to me that the rule is not at all clear and could be read
that way. So if you are working on any transaction that involves a
guarantee of a swap or other transaction that is exempt under the new
exemption for bilateral contracts, you need to run this issue to ground
before you close. The rules don't become effective, however, until 60 days
after they are published in the Federal Register.

There are some good things about the new rules. The new exemption for
bilateral contracts greatly liberalizes the swaps exemption and expands it
so that it covers contracts other than swaps. It provides greater certainty
regarding the enforceability of derivatives and, in most cases, of contracts
for physical delivery of commodities.

The bilateral contracts exemption, however, is unavailable for contracts
entered into through "Multiple Transaction Execution Facilities" or MTEFs.
Multiple participant B2B Internet trading sites will be classified as MTEFs,
unless participants are required to go off-line to complete the contracts
(as, for example, CheMatch requires its participants to do). Under the new
rules, multiple participant B2B Internet trading sites that involve swaps
and other derivative contracts completed on-line must submit themselves to
CFTC regulation as "Derivatives Transaction Facilities" or DTFs. Moreover,
an MTEF that trades only in physical delivery contracts can achieve contract
enforcement certainty of the type offered by the exemption for bilateral
contracts only if it submits itself to regulation as a DTF. The MTEF
definition excludes any Internet trading site, such as EnronOnline, that
involves a single party offering to enter into trades with multiple parties,
and therefore the sponsor of such a site can take advantage of the exemption
for bilateral contracts without submitting itself to CFTC regulation. DTFs
must not permit any person other than an "eligible commercial participant"
to trade. The term "eligible commercial participant" is defined in the rule
and includes, generally, commercial counterparties and financial
intermediaries.

Although the CFTC promises that its regulation of DTFs will be more
light handed that that historically applied to U.S. futures exchanges, the
new regulatory framework is likely to result in significant regulatory
oversight of multiple participant B2B Internet trading sites that register
as DTFs. Under the new rules, each sponsor must determine whether to
restrict trading on its site to avoid CFTC regulation or to submit to
regulation.

Robert S. Baird
Vinson & Elkins L.L.P.
One American Center
600 Congress
Austin, Texas 78701
Telephone: (512)495-8451
When calling from Houston (713)758-2414
Fax: (512)236-3210
Email: rbaird@velaw.com
Home telephone (512)347-8066
Car phone: (512)627-8065
Home fax: (512)347-8065
Pager: 1-888-487-2651

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