CME Group on April 14, 2014, announced a rule amendment that will ban all transitory Exchange of Futures for Related Positions. However, without calling such transactions “transitory,” CME will permit what effectively are equivalent to transitory EFRPs in connection with certain inventory financing, as well as foreign currency futures.
In addition, as part of its Market Regulation Advisory Notice announcing its rule change, CME issued helpful Frequently Asked Questions (and Answers) related to EFRPs.
The new rule is effective June 2, 2014.
Currently, CME permits transitory EFRPs related to inventory financing of certain non-financial commodities (i.e., storable agricultural, energy or metals commodities), as well CME foreign currency products, NYMEX energy products and COMEX and NYMEX metals products.
EFRPs encompass a number of transactions including Exchange of Futures for Physicals, Exchange of Futures for Risk (i.e. an OTC swap or other OTC derivative transaction) and an Exchange of Option for Option (i.e. an OTC option or other OTC instrument with similar characteristics).
EFRPs typically involve one party buying the exchange-trade future or option and selling the related position, and an unrelated party selling the exchange-traded futures or option and buying the related position. The opposite parties to an EFRP must be (1) independently controlled accounts with different beneficial owners; (2) independently controlled accounts of distinct legal entities with common beneficial ownership; or (3) independently controlled accounts of the same legal entity if the controllers operate in separate business units. The notional amount of the exchange traded future or option must approximately equal the notional amount of the related position. Other requirements apply too.
Authorized inventory financing transactions may be structured such that the party providing financing of an approved non-financial commodity through an EFP purchases the commodity and sells the equivalent quantity of a futures contract to a counterparty, while at the same time granting the counterparty a non-transferrable right (but not obligation) to execute a second EFP that reverses the initial EFP during an agreed time period in the future.
Going forward in connection with FX EFRPs, there may be an immediate offset of the physical transaction. This is not technically a transitory EFRP, says the CME in its FAQ, “because the offsetting physical transaction is not contingent on the EFP in any way.” According to the CME,
“If, for example, the futures leg of an immediately offsetting EFP in foreign currency is not accepted for clearing, the futures transaction is void ab initio and the counterparties would be left with the stand-alone physical transaction.”
However, certain new requirements apply in connection with offsetting FX EFRP transactions.
The CME MRAN also provides helpful guidance regarding authorized trading hours for EFRPs (i.e., any time); multi-party EFRPs; acceptable instruments to serve as “related positions;” recordkeeping requirements; and reporting, among other topics.
The CME recently brought a number of disciplinary actions for failure to follow its EFRP rule (CME Rule 538). (See “CME Publicizes a Plethora of EFRP fines Involving Incomplete Documents, Late Submissions and Improper Parties” on this website; click Here to access.
Compliance Weeds: The CME has devised a clever way to maintain what are effectively transitory EFRPs in certain limited circumstances by not calling them as such (reminiscent of not referencing Lord Voldemort in Harry Potter; however even when prohibiting reference to him by name, he still existed). However, the most useful aspect of the CME’s MRAN announcing its amended rule is the FAQ. Compliance officers should use this publication to remind relevant firm staff regarding the requirements regarding approved EFRPs and ensure their policies and procedures are appropriate. Importantly, EFRP rules vary from exchange to exchange. Off exchange transactions such as EFRPs and block trades are prohibited under Commodity Futures Trading Commission rule unless undertaken precisely in accordance with exchange requirements.
For more information, see:
CME MRAN re: Rule 538:
The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of April 14, 2014, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.
Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office.
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