The US Supreme Court rarely opines on policy matters related to derivatives. From time to time, however, one of its decisions has such profound effects on our understanding of the law that everyone involved in policy matters related to derivatives needs to understand the implications.
The Supreme Court's recent decision in West Virginia v EPA is one such decision. Although the case itself has nothing to do with derivatives, the decision affects the rulemaking process for the entire executive branch of the US government, including the federal agencies with oversight over financial and commodity markets. While the full impact of this decision is still unknown, there is no doubt that regulatory agencies are evaluating it closely – and so should market participants.
New approach to deference
At the highest level, the decision changes our understanding of the legal boundaries of the administrative state. Ever since the Chevron case in 1984, disputes over how a government agency interprets the laws that it administers have been addressed through the application of the "Chevron deference" doctrine. Essentially this doctrine holds that when there is some ambiguity in how to interpret the law, the courts should defer to the government agency that administers that law.
The West Virginia v EPA decision sets out an additional line of analysis called the "major questions" doctrine. The Supreme Court held in a 6-3 decision that when a government agency takes an action that has a large economic or political impact on the nation, the courts should not defer to the agency's interpretation unless that interpretation is clearly rooted in the statute.
From a derivatives market perspective, the main implication is that federal agencies may need to be more careful to avoid overstepping their authority as defined by Congress – or risk being challenged in court. In practical terms, the process for the proposal, review, and approval of rules for derivatives markets is likely to change, particularly in developing areas such as carbon and crypto.
Roots of the case
The case underpinning the decision goes back to the Clean Power Plan, a set of rules promulgated by the Environmental Protection Agency during the Obama Administration that was aimed at curbing fossil fuel use in electricity generation. After a tumultuous legal and regulatory history, the Supreme Court decided to strike down the rules for not honing closely enough to the statutory foundation in the terminology of the Clean Air Act as that text has generally been interpreted since its passage in 1990. But the court did more than simply address the specific issues raised in this case. The decision explicitly cited the major questions doctrine and explained how it applied the doctrine in considerable detail.
The major questions doctrine has been bubbling up through various levels of the US legal system for more than a decade, but the West Virginia v EPA decision marked the first time that the Supreme Court— the highest court in the US — invoked this doctrine to formally strike down an agency rule. This also marked the first time that it fleshed out the doctrine in detail. In effect, the decision could be read as laying out a blueprint for future challenges to any regulations issued by federal agencies.
Simply put, the doctrine posits that federal agencies cannot apply their authority without a clear and explicit authorization from Congress in policy areas that raise "major questions" in terms of their economic or political impact.
The effect of this departure from the long-standing Chevron deference is to move away from reliance upon subject matter specialists at the agencies and, instead, require more from Congress on areas intended for federal regulation. The move also further empowers courts in agency challenges, as the arbiter of whether any given statute is explicit enough when such major questions arise. This approach significantly alters the balance of responsibilities among the judicial, executive and legislative branches, restricting federal agencies of interpretive and policy outcomes on which it had previously enjoyed significant deference
Implications for the CFTC
The July decision has potentially huge implications for the federal agencies with oversight over derivatives markets. In August, FIA held a discussion on this issue with an expert panel of lawyers, focusing in particular on the implications for the Securities and Exchange Commission and the Federal Energy Regulatory Commission, both of which have jurisdiction over certain parts of the US commodities and derivatives markets. The primary regulator of these markets, however, is the Commodity Futures Trading Commission, and in this article I will outline some potential implications for the CFTC.
The CFTC is blessed with a modern governing statute in the Commodity Exchange Act that allows for principles-based governance of highly specialized markets. This flexible approach to regulation, combined with the importance placed within the statute on supporting innovation, have been very beneficial in supporting the growth and development of the US derivatives markets. But this unusual quality of its authorizing statute could make the CFTC's rulemaking particularly vulnerable to challenges under the major questions doctrine.
In some areas, the CEA was drafted with intentional breadth. For instance, terms such as "commodity" are so broadly defined that the agency is well-equipped to regulate markets that have evolved far beyond their origins in the agricultural sector in the late 1800s. Second, with the CEA’s express charge to the agency to “promote innovation”, it would appear that Congress intended for the statute to evolve through interpretation as the markets and the technologies that underpin them evolve.
But while this embedded flexibility within the Congressional mandate has potential benefits, the CFTC may not escape challenge as it charges forward in new directions. In a few emerging areas, most notably crypto and climate issues, the CFTC is exploring possible avenues for expanding its oversight. In these areas, the CFTC will need to consider whether the CEA is clear enough to support those efforts or face potential challenge under the new major questions doctrine.
Climate and crypto
With respect to climate issues, the CFTC has dabbled in carbon markets regulation for years and, indeed, several exchanges under its oversight have listed futures and options that are rooted in efforts to reduce emissions and encourage the transition to renewable energy. However, a bold initiative to tackle climate issues proactively may lack the clear footing in Congressional authority that the Supreme Court now requires.
A similar picture is emerging in the crypto space. The rapidly developing markets are seeking oversight and legitimacy and many in the crypto markets have sought regulation by the CFTC. The CEA is clear that exclusive jurisdiction over futures lies with the CFTC, so crypto futures have been on solid jurisdictional ground since the first contracts were listed in 2017. But it is less clear whether the CEA supports the CFTC as a primary regulator of cash trading of crypto, even if those markets voluntarily ask for CFTC regulation.
With several market regulators jockeying for jurisdiction over this new asset class, and with several proposals for a new legal framework now pending in Congress, any rulemakings undertaken by the CFTC may be complicated by the new attention on the major questions doctrine. If the EPA had trouble with a rulemaking on energy plans across generation types, the CFTC, born of the agricultural markets and still subject to the oversight of the agriculture committees of Congress, may find it hard to find solid ground on which to build rulemaking for comprehensive regulation of a new digital asset class.
This does not mean, however, that the CFTC has no authority at all in this area. Given the various levels of details across CEA provisions, some actions in the digital currency space will be easier to substantiate than others. For example, those portions of the CEA that show clear Congressional intent and directions, such as the spoofing provisions from the Dodd-Frank Act, are quite specific. Industry members therefore should not expect that CFTC enforcement actions against spoofing in the crypto futures markets to be highly susceptible to challenge on the grounds of the Major Questions Doctrine. By contrast, the CFTC may be more vulnerable to challenge if it attempts to create a new regulatory scheme for operators of a crypto asset cash market.
Changes to the rulemaking process
There are clearly many unanswered questions in the wake of the landmark EPA ruling and the future implications for the derivatives markets. That said, we can make some reasonable assumptions about how the regulatory process itself will change as a result of the major questions doctrine.
- First, there will likely be an extra step of analysis when writing rules to determine whether any new proposals are clearly articulated by Congress as within the agency's authority.
- Second, even if an agency concludes it has authority to move forward, affected industries and interest groups will undertake their own analyses of the clarity of Congressional authority. Regulated entities may make this question of authority a threshold question in any public comments or third-party analyses of rules.
- Third, if industry concerns of potential overreach are not clearly addressed, we may see greater willingness among affected parties to challenge agency rulemakings in court.
Much of the coverage around the West Virginia v. EPA case has, understandably, explored the impact of the ruling on climate policy and fossil fuel use. However, this Supreme Court decision has real implications for FIA members and the global cleared derivatives markets because it may change the US regulatory process altogether. Here is a link to the full Supreme Court opinion on West Virginia v. EPA, for those who are interested. Admittedly it will not be a page-turner for most people – but for those of us who take derivatives law seriously, it is the must-read document of the year.
Allison Lurton is FIA's Chief Legal Officer & General Counsel, and has worked for the association since 2013. She previously served as Senior Counsel at the CFTC.
