CFTC Issues No-Action Relief to Fannie Mae and Freddie Mac (CFTC Letter 14-111)
Commentary by Bob Zwirb
The CFTC Division of Swap Dealer and Intermediary Oversight issued a no-action letter providing relief to Fannie Mae and Freddie Mac from registration and regulation as commodity pool operators ("CPOs") pursuant to CFTC Rule 4.13(a)(3).
According to the letter, the CFTC granted Fannie Mae and Freddie Mac no-action relief with respect to CPO activities in connection with its operation of a mortgage credit risk sharing initiative. The letter outlines four "prongs" an entity must meet in order to rely on the exemption, which include:
- interests in the pool are exempt from registration under the Securities Act of 1933, and such interests are offered and sold without marketing to the public in the United States;
- the pool at all times meets a de minimis test pursuant to which either the margins, premiums and required minimum security deposit for retail forex transactions does not exceed 5% of the liquidation value of the pool's assets after giving effect to unrealized profits or losses or the aggregate net notional value of the pool's commodity positions, determined at the time the most recent position was established, does not exceed 100 percent of the liquidation value of the pool's portfolio, after taking into account unrealized profits and unrealized losses;
- the pool operator reasonably believes at the time of investment that each investor in the pool meets one of certain enumerated tests relating to the financial sophistication of the investor (e.g., accredited investor or qualified eligible purchaser); and
- participations in the pool are not marketed as or in a vehicle for trading in the commodity futures or commodity options markets.
See: CFTC Letter 14-111.
Commentary
The relief granted here illustrates the incongruity of applying the label "commodity pool" to the risk-sharing structure at issue. The special purpose vehicle ("SPV") described in the letter was set up to allow mortgage credit risk to be shifted from Fannie Mae and Freddie Mac to private investors, not for the purpose of allowing investors to invest in CEA-regulated instruments. But for the presence of a swap, which is used as a conduit to transfer that risk, the CEA and the CFTC would not be relevant.
The problem is that the test that the CFTC applies to determine whether an entity is a commodity pool does not lend itself well to securitization vehicles. No matter, the CFTC, proclaiming that even one swap is enough to trigger the CPO registration requirement, insists that such vehicles are commodity pools notwithstanding that they are clearly not operated for the purpose of trading swaps. Given that the institutional and highly sophisticated investors here will make their investment decision by evaluating the pool of mortgage loans, not the swap (as the CFTC acknowledges, investors will consider the swap terms "only as a means of understanding how the SPV structure will pass any losses on the underlying assets from the GSEs to those investors"), it seems strained to apply the CFTC's commodity pool rules to vehicles structured for such investors. Nevertheless, to avoid that absurdity, the CFTC is periodically called upon to craft highly complex relief not only for SPVs, but for other financial vehicles that were never contemplated as constituting commodity pools, such as REITs, as it has done here. A better approach would be to define the term "commodity pool" in a less ambitiously encompassing manner.