On October 11, the Division of Swap Dealer and Intermediary Oversight (the "Division") published two interpretative letters in relation to the regulation of commodity pool operators. The first letter, addressed to the National Association of Real Estate Investment Trusts ("NAREIT"), discussed whether "equity" REITS are within the statutory definition of commodity pools (the "REIT Letter"). The second letter (the "Securitization Letter"), addressed to both the Securities Industry and Financial Markets Association ("SIFMA") and the American Securitization Forum ("ASF") concerned whether the operators of securitization vehicles are required to register as commodity pool operators or commodity trading advisors.

The REIT Letter

In September 2012, NAREIT requested that the Division interpret the definition of commodity pool in Section 1a(10) of the Commodity Exchange Act (the "CEA") to exclude certain REITs. The letter addressed only "equity" REITS and not "mortgage" REITS. In response to that request, the REIT Letter provides that REITs that primarily derive their income from the ownership and management of real estate and that use derivatives for the limited purpose of mitigating exposure to changes in interest rates or currency fluctuations are outside the scope of the commodity pool definition as long as the following criteria are met:

  • The REIT primarily derives its income from the ownership and management of real estate and uses derivatives for the limited purpose of mitigating their exposure to changes in interest rates or fluctuations in currency.
  • The REIT is operated so as to comply with all the requirements of a REIT election under the Internal Revenue Code.
  • The REIT has identified itself as an equity REIT in Item G of its last US income tax return on Form 1120-REIT and continues to qualify as such or, if the REIT has not yet filed its first tax filing with the Internal Revenue Service, the REIT has stated its intention to do so to its participants and effectuates its stated intention.

For the purposes of the REIT Letter, the Division refers to equity REITs as real estate investment trusts that hold income-producing real estate and engage in real estate management activities, including leasing and maintaining real estate, providing a variety of tenant services, and developing and redeveloping real estate.

The Securitization Letter

The Securitization Letter is a response to communications from ASF and SIFMA from August and October of 2012 seeking interpretation from the Division that operators of vehicles that issue asset-backed securities are not commodity pool operators or that, in the alternative, no action would be taken against such operators for failure to register with the CFTC as a commodity pool operator.

The Division declined to provide the requested interpretation, reasoning that it is required to determine whether a pooled investment vehicle is a commodity pool using a facts-and-circumstances approach. However, the Division agreed with SIFMA and ASF that certain securitization vehicles should not be included with the definition of commodity pool and that the operator thereof should not be included within the definition of commodity pool operator if the following criteria are met:

  • The issuer of the asset-backed securities or mortgage-backed securities is operated consistent with the conditions set forth in Regulation AB, or Rule 3a-7, whether or not the issuer's security offerings are in fact regulated pursuant to either regulation, such that the issuer, pool assets and issued securities satisfy the requirements of either regulation.
  • The entity's activities are limited to passively owning or holding a pool of receivables or other financial assets, which may be either fixed or revolving, that by their terms convert to cash within a finite time period plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to security holders.
  • The entity's use of derivatives is limited to the uses of derivatives permitted under the terms of Regulation AB, which include credit enhancement and the use of derivatives such as interest rate and currency swap agreements, to alter the payment characteristics of the cash flows from the issuing entity.
  • The issuer makes payments to securities holders only from cash flow generated by its pool assets and other permitted rights and assets, and not from or otherwise based upon changes in the value of the entity's assets.
  • The issuer is not permitted to acquire additional assets or dispose of assets for the primary purpose of realizing gain or minimizing loss due to changes in market value of the vehicle's assets.

Securitization vehicles that satisfy the above criteria do not fall within the definition of commodity pool under Section 1a(10) of the CEA and are not included in Regulation 4.10(d). Therefore, the operators of such vehicles will not be required to register as a commodity pool operator. In light of the above criteria, it is unlikely that synthetic CLOs, market value CLOs and any securitization vehicle that is permitted to actively trade in and out of assets will be covered by the interpretative guidance set forth in the Securitization Letter.

In addition to the Securitization Letter, on October 12, 2012, the Division published numerous no-action letters, one of which addressed entities that would, on October 12, 2012, be a commodity pool operator ("CPO") or commodity trading advisor ("CTA") solely because of such entity's swaps activity. Absent no-action relief or other exemption, such entities would have been required to register as a CPO or CTA on October 12, 2012. The no-action letter provides temporary relief from enforcement action, subject to compliance with certain conditions set forth in the letter, to persons who were not previously required to register as a CPO or CTA—such persons now have until December 31, 2012 to register or file for an applicable exemption.

Derivatives Insight