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Enron Mail |
Here is your conversation with my revisions marked (deletions struck through,
insertions in bold). Hope this helps but feel free to call or write with any questions or comments: A: The CFTC regulates futures contracts and certain kinds of option contracts. SP: What's a futures contract? A: It is a contract for the sale of a certain kind of commodity through a regulated exchange. SP: How is the contract different than a non-futures contract? A: Ahem, just for your information, we call the non-futures contracts forward or over the counter contracts. The big difference is that the forward contract does not must go to delivery while futures contracts do not. SP: I though the futures contracts went to delivery. I remember getting all messed up on the gas side with delivery of NYMEX futures gas at the Henry Hub, and what about those stories of a guys getting a load of soy beans dumped in their front yards? A: Well, er, yes they do sometimes go to delivery, but they are not really supposed to relatively few of them go to delivery. They are supposed to more frequently (actually the vast majority of the time) net out as financial transactions. It's that option of settling financially that distinguishes the futures contract. SP: Well lets get to the point, why are physical buy sells so bad? A: That's easy. Because they look like futures contracts. They are not intended to go to delivery. And if you are trading in futures contracts you are supposed to be doing it on a CFTC regulated exchange. SP: So what you are saying is that if we deliberately net out our physical deals and never intend to even try to schedule delivery under them we are trading in futures contracts and could be subject to regulation by the CFTC? A: You've got it. But it's even worse than that - federal law says that a futures contract which is not traded on a regulated exchange is illegal: not only could the CFTC come after you but your counterparties could use that law against you to get out of performing. So you can think of each contract like that as having written a free option. SP: Well how much physicality do we have to have to make it a forward contract? A: What do you mean? SP: Well, if we settled physically one day a month but financially the other 29 days, would we have a futures contract? A: Oh for Christ's sake I've had it. I'm telling you once and for all that physical buy sells are futures contracts and you can't do them now get the hell out of my office!-- Is this the basic idea and if so, how much can we blend physical into it to cross the line into the domain of the forward contract? --Christian Basically, yes. A lot has to do with the look and feel of the thing but also the parties' intentions. If we do not intend to make and take delivery, if we intend to settle financially - or even intend to just have the option to settle financially, we have a problem. The closest thing we have to an exception to this is the provision for cover damages when one party fails to deliver. That is a provision in the contract that might be argued gives one party the right to settle financially just by failing to perform. We argue that this is still a forward and not a future because the parties in good faith intend initially that delivery will be made and a default occurs when there is a failure to make or take delivery. Unfortunately, in the power world a large percentage of contracts may in fact get booked out. However, each party enters into those contracts knowing that they have an obligation to make or take delivery and the book-outs may or may not happen - we do not enter into those contracts knowing that they will be booked out. The book-outs occur after the fact by mutual agreement at the time of the book-out. In fact, if we didn't want to book them out, we could stand on our legal rights and require all of our counterparties to make and take delivery (although I assume this might not go over well with many of them or with our scheduling desk if a book-out would be more convenient at the time).
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