CFTC Grants Relief for Credit Risk Transfer Vehicles Under CPO Exemption
Commentary by Mark Highman
The CFTC’s Market Participants Division ("MPD") will not recommend enforcement against operators of certain special purpose vehicles ("SPVs") used in bank Credit Risk Transfer ("CRT") transactions for failing to register as Commodity Pool Operators ("CPOs").
In a no-action letter, the MPD explained that CRT transactions allow banks to transfer the credit risk of assets, such as loans and mortgages, to sophisticated institutional investors to obtain prudential regulatory capital relief from Federal Reserve, FDIC, and OCC requirements. To facilitate these transactions, a bank-sponsored SPV issues credit-linked notes to investors and enters into a single credit default swap ("CDS") with the bank; the note proceeds are held in cash or highly liquid collateral, and investors absorb losses if credit events occur in the bank’s reference asset pool.
The MPD acknowledged that holding a CDS could make the SPV a "commodity pool," raising potential CPO registration issues, and that required disclosures about the CDS might appear inconsistent with Rule 4.13(a)(3) ("Exemption from registration as a commodity pool operator") marketing limits. The MPD agreed with the requesting party, which argued that these disclosures are unavoidable, as the CDS is essential to the structure. The Division agreed that the SPV’s purpose is solely to transfer credit risk for regulatory capital relief—not to trade swaps for profit—and therefore stated it would not recommend enforcement if the operator relies on Rule 4.13(a)(3), provided the structure remains confined to its credit risk transfer purpose.
The no-action relief is subject to several operational and structural conditions, including: (i) the CRT must solely hedge the bank’s credit exposure for capital relief, with the SPV limited to the single CDS used for that purpose; (ii) the operator must satisfy all remaining requirements of Rule 4.13(a)(3), including notice filing, investor sophistication, and commodity-interest limits; and (iii) note proceeds must be invested only in cash or highly liquid Rule 1.25 ("Investment of customer funds") assets; and (iv) the SPV must remain bankruptcy-remote with appropriate governance, separateness, creditor waivers, and disclosures that the CPO is unregistered and relying on the no-action relief.
Commentary
In 2014, the CFTC issued CFTC Letter 14-111 permitting Fannie Mae and Fredie Mac to rely on CFTC Rule 4.13(a)(3), the de minimis exemption from CPO registration, in connection with credit risk transfer ("CRT") structures that transferred mortgage credit risk from Fannie Mae and Freddie Mac to institutional investors via an SPV. CFTC Letter 25-37 provides similar relief to regulated financial institutions in connection with qualifying CRT structures that transfer financial exposures held on balance sheets to institutional investors via an SPV. The letter thereby enables bank entities to obtain capital relief under applicable bank regulation without registering as a CPO.