As part of the Dodd-Frank financial reforms, the U.S. Commodity Futures Trading Commission (“CFTC”) increased its oversight of “swaps”. One change stemming from Dodd-Frank is that a “swap”, as defined in the Commodity Exchange Act and CFTC regulations, is now a “commodity interest”. The CFTC regulates collective investment vehicles that invest in commodity interests, which it calls “commodity pools”. This can include SPVs which are not incorporated in the U.S..
The CFTC regulates the person with managerial or operational control over the commodity pool which is referred to as the commodity pool operator (“CPO”). Determining precisely which person should serve as the CPO in any given structure requires an analysis beyond the scope of this blog post but where there is a commodity pool, there must be a CPO. CPOs can be subject to onerous regulatory requirements. Determining whether or not an entity is a commodity pool and then whether its operator needs to register as a CPO requires some careful analysis and, to make the issue more interesting, the rules have undergone significant changes recently.
Participants in the structured finance markets outside the US have been raising queries as to whether SPVs which are party to swaps could be treated as commodity pools and, as a result, the relevant CPO would be required to register with the CFTC and what the consequences of that would be. Where possible, the best outcome for the parties structuring a securitisation is for the SPV not to be classed as a commodity pool.
In very high level terms, the CFTC has indicated in no-action letters that it would not consider a securitisation SPV to be a commodity pool and would not require its operator to register as a CPO if:
- the SPV is limited to passively owning or holding financial assets; and
- the SPV’s use of swaps is limited to hedging interest rate risk, hedging foreign exchange risk or providing credit enhancement and not using swaps to create investment exposure.
By way of example, an SPV which purchases a pool of residential mortgage loans, issues notes, and enters into interest rate and cross currency swaps would not be a commodity pool because it would passively hold financial assets and would not use swaps to create investment exposure. This would be true whether or not the SPV held U.S. mortgage loans, issued notes to U.S. persons or entered into swaps with a U.S. bank.
The picture is somewhat different where the structure in question is a synthetic securitisation or credit linked note and the main asset backing the notes is a swap. If an SPV uses a swap to create investment exposure, then the SPV could be a commodity pool, and unless an exemption exists, the CFTC would require the SPV’s operator to register as a CPO.
The CFTC has jurisdiction over CPOs making use of “any means or instrumentality” of U.S. interstate commerce, such as having a U.S. investor, or entering into swaps with a U.S. counterparty. Indeed, past CFTC guidance has indicated that the CFTC would not find that CPO registration is required where:
1. the commodity pool activities of the SPV will be confined to areas outside the U.S.;
2. no participant in the SPV is a U.S. resident or citizen; and
3. no funds or other capital may be committed to the SPV from U.S. sources.
CFTC rules also provide exemptions from CPO registration, under certain other circumstances. Under CFTC Rule 3.10(c)(3), an SPV located outside of the U.S. will be exempt from registering as a CPO if all of it swaps and derivatives in the U.S. are cleared and, when the SPV enters each position, it has no U.S. Person investors.
CFTC Rule 4.13(a)(3) provides an exemption from CPO registration for de minimis swap use. To qualify for the de minimis exemption:
1. At all times (but determined when the SPV entered its most recent position), either
a. the aggregate initial margin or premiums of the SPV’s swaps and other derivatives does not exceed 5% of the liquidation value of the SPV’s portfolio; or
b. the aggregate net notional value of the SPV’s swaps and other derivatives does not exceed 100% of the liquidation value of the SPV’s portfolio;
2. at the time of investment, the SPV reasonably believes that each investor fits one of an enumerated list of persons (including “Non U.S. Persons” and “accredited investors”); and
3. interests in the SPV are exempt from registration under the Securities Act of 1933 and they are not marketed to the public in the U.S.; and
4. the SPV is not marketed as a vehicle to participate in the commodity futures or options markets.
The CFTC indicated that operators of SPVs formed prior to 12 October 2012 will not be required to register as CPOs. For SPVs formed after 12 October 2012, the CFTC will not take action against SPV operators for failure to register as a CPO until 31 March 2013.
For more information on U.S. derivatives regulation, please visit our sister blog The Swap Report.
This article has been published for information purposes only and should not be relied upon as legal advice under any circumstances.