On December 7, 2012, the Division of Swap Dealer and Intermediary Oversight (the "Division") of the Commodity Futures Trading Commission ("CFTC") issued CFTC Letter No. 12-45 ("Letter 12-45"). Letter 12-45 excludes certain types of securitization vehicles from the definition of "commodity pool" and extends no-action relief until March 31, 2013 with respect to operators of nonexcluded securitization vehicles that fail to register as commodity pool operators ("CPOs"). The issue addressed in Letter 12-45 arises from the revised definition of "commodity pool" brought about by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which expanded the definition of "commodity interests" to include "swaps" and therefore ostensibly confers commodity pool status on any fund or similar enterprise that enters into any swap. As a result, operators of such funds or other similar enterprises would either have to register, or claim an exemption from registering, as CPOs, in either case by December 31, 2012.
Letter 12-45 expands the interpretive guidance provided by CFTC Letter No. 12-14 issued by the Division on October 11, 2012 ("Letter 12-14"). In Letter 12-14, the Division determined that securitization vehicles would not be included within the definition of "commodity pool" under the Commodity Exchange Act if they met certain conditions:
- The issuer of the asset-backed securities is operated consistent with the conditions set forth in Securities and Exchange Commission Regulation AB or Rule 3a-7 under the Investment Company Act of 1940, 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 issuer'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 issuer's use of derivatives is limited to the uses of derivatives permitted under the terms of Regulation AB, which include credit enhancements 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.
Noting that the above conditions define a type of passive investment of financial assets that receive only limited types of support from swap transactions, Letter 12-45 restates the conclusion set forth in Letter 12-14: If an issuer does not limit its investments to financial assets that are used to pay the issuer's securities, or if the issuer uses swaps to create synthetic exposure, the issuer will not be able to claim the exclusion afforded by Letter 12-14.
Recognizing the limitations of Letter 12-14, the Division notes in Letter 12-45 that there are a number of transactions that, while not satisfying the operating or trading limitations required by Letter 12-14 as contained in Regulation AB or Rule 3a-7, represent investments that are essentially investments in the financial assets of the vehicle and not in any swaps, consistent with condition 3 above. In particular, Letter 12-45 describes asset-backed commercial paper vehicles, traditional (cash) collateralized debt obligations, and covered bond transactions as examples of vehicles in which swaps are used solely to enhance credit, to swap interest rates or currencies or to create investment exposure, or to effect some combination of the foregoing. The Division recognizes that the use of swaps solely to enhance credit or to swap interest rates or currencies, absent other factors, does not render a vehicle a "commodity pool." In contrast, a vehicle such as a CDO with "synthetic" asset exposure or a repackaging vehicle (for example, an issuer of credit-linked notes) that uses swaps to create investment exposure may, in the view of the Division, be a "commodity pool" although its operator may nevertheless be entitled to claim an exemption from registration as a CPO if the vehicle's usage of such swaps falls within the "de minimis" conditions of CFTC Rule 4.13(a)(3).
In addition to recognizing that certain vehicles are not commodity pools by virtue of their limited swaps usage, in response to industry concerns, Letter 12-45 extends no-action relief for certain securitization vehicles (such as synthetic CDOs or repackaging vehicles that do not satisfy the criteria of Letter 12-14 or Letter 12-45) formed prior to October 12, 2012. The Division notes that it will not recommend that the CFTC take enforcement action against any operator of such securitization vehicle for failing to register as a CPO if the following criteria are met:
- The issuer issued fixed income securities before October 12, 2012 that are backed by and structured to be paid from payments on or proceeds received in respect of, and whose creditworthiness primarily depends upon, cash or synthetic assets owned by the issuer.
- The issuer has not and will not issue new securities on or after October 12, 2012.
- The issuer shall, promptly upon request of the CFTC or any division or office thereof, and in any event within five business days of such request, provide to such requestor an electronic copy of the following: (i) the most recent disclosure document used in connection with the offering of the related securities, (ii) all amendments to the principal documents since issue, (iii) the most recent distribution statement to investors, and (iv) if the issuer's securities were offered relying on Rule 144A under the Securities Act of 1933, a copy of the information that would be provided to prospective investors to satisfy Rule 144A(d)(4); provided that, if the issuer does not provide the information required hereunder, it must demonstrate that it cannot obtain the required documents through reasonable commercial efforts.
Finally, with respect to securitization vehicles not covered by Letter 12-14 or the additional exclusions or no-action relief provided in Letter 12-45, the Division has extended limited no-action relief until March 13, 2013, in order to facilitate continuation of the dialogue between the CFTC and the securitization industry.
The Letter may be accessed here.