Subject to specific conditions, the Division of Swap Dealer and Intermediary Oversight granted the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association no-action relief, such that eithe...

Summary: Subject to specific conditions, the Division of Swap Dealer and Intermediary Oversight granted the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association no-action relief, such that either entity may be exempt from registration as a commodity pool operator pursuant to Regulation 4.13(a)(3) with respect to its operation of a mortgage credit risk sharing initiative described therein.

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5977

Facsimile: (202) 418-5407

gbarnett@cftc.gov

Division of Swap Dealer and

Intermediary Oversight

Gary Barnett

Director

CFTC Letter No. 14-111

No-Action

August 25, 2014

Division of Swap Dealer and Intermediary Oversight

Ellen Marks

Latham & Watkins LLP

233 South Wacker Drive, Suite 5800

Chicago, IL 60606

Joylyn Abrams

Office of General Counsel

Federal Housing Finance Agency

400 7th Street, S.W.

Washington, D.C. 20024

RE:

Request for No-Action Relief from Commodity Pool Operator Registration for the

Federal National Mortgage Association and the Federal Home Loan Mortgage

Corporation

Dear Ms. Marks and Ms. Abrams:

This letter is in response to your correspondence, dated July 29, 2013, Supplemental

Statement, dated November 20, 2013, and multiple telephone conferences (the

“Correspondence”) with staff of the Division of Swap Dealer and Intermediary Oversight

(“Division”) of the Commodity Futures Trading Commission (“Commission”). In the

Correspondence, the Federal Housing Finance Agency (“FHFA”), in its roles as regulator and

conservator of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home

Loan Mortgage Corporation (“Freddie Mac”), requests no-action relief on behalf of Fannie Mae

and Freddie Mac from registration and regulation as commodity pool operators (“CPOs”)

ommission (“Commission”). In the

Correspondence, the Federal Housing Finance Agency (“FHFA”), in its roles as regulator and

conservator of the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home

Loan Mortgage Corporation (“Freddie Mac”), requests no-action relief on behalf of Fannie Mae

and Freddie Mac from registration and regulation as commodity pool operators (“CPOs”). The

no-action relief is requested in connection with a proposed risk-sharing initiative that would

transfer mortgage credit risk from Fannie Mae and Freddie Mac to voluntary sophisticated

institutional investors.

Background

The Correspondence received by the Division made the following representations

regarding the operation, structure, and regulation of Fannie Mae and Freddie Mac. Relief from

CPO registration is requested for Fannie Mae and Freddie Mac, both of which are government-

sponsored enterprises (“GSEs”) “chartered by Congress with a public mission to stabilize the

nation’s residential mortgage markets and expand opportunities for home ownership and

affordable rental housing.”1 In furtherance of that mission, Fannie Mae and Freddie Mac

1 Letter from Ellen Marks on behalf of Fannie Mae and Freddie Mac, at 2 (Jul. 29, 2013) (“Relief Request”).

Ms. Marks and Ms. Abrams

Page 2

purchase residential mortgages and mortgage-related securities and then securitize them into

mortgage-backed securities (“MBS”) that can be sold to investors, who include, among others,

lenders, pension funds, insurance companies, securities dealers, and commercial and central

banks

f of Fannie Mae and Freddie Mac, at 2 (Jul. 29, 2013) (“Relief Request”).

Ms. Marks and Ms. Abrams

Page 2

purchase residential mortgages and mortgage-related securities and then securitize them into

mortgage-backed securities (“MBS”) that can be sold to investors, who include, among others,

lenders, pension funds, insurance companies, securities dealers, and commercial and central

banks. Both Fannie Mae and Freddie Mac guarantee payments of principal and interest on the

MBS they issue, and thus each GSE bears the risk that the underlying mortgages it guarantees

will not be repaid (“mortgage credit risk”).2 More generally, Fannie Mae and Freddie Mac carry

out their statutory missions only through activities authorized by and consistent with the Federal

Housing Enterprises Financial Safety and Soundness Act of 19923 and their respective

congressional charters.

The regulator and conservator of Fannie Mae and Freddie Mac, the FHFA was created by

the Housing and Economic Recovery Act of 2008,4 and is charged with providing effective

supervision, regulation, and housing mission oversight of the GSEs as well as the Federal Home

Loan Banks. The FHFA, a member of the Financial Stability Oversight Council, oversees the

operations of Fannie Mae and Freddie Mac and through FHFA statutory authority, regulations,

guidance, and orders, has the responsibility to ensure that they are operated in a safe and sound

manner that is consistent with the public interest. This responsibility includes monitoring the

GSEs’ capital and internal controls and assessing their exposure to various types of risk,

including mortgage credit risk

f Fannie Mae and Freddie Mac and through FHFA statutory authority, regulations,

guidance, and orders, has the responsibility to ensure that they are operated in a safe and sound

manner that is consistent with the public interest. This responsibility includes monitoring the

GSEs’ capital and internal controls and assessing their exposure to various types of risk,

including mortgage credit risk. The FHFA also has the responsibility to regularly examine the

GSEs’ financial conditions and management practices, presenting and publishing the results of

said examinations in an annual report to Congress.5

You state in the Correspondence that “establishing a path for shifting mortgage credit risk

from [Fannie Mae and Freddie Mac] (and, thereby, [U.S.] taxpayers) to private investors is a

central goal of the FHFA.”6 Specifically, you are asking the Division for no-action relief for the

transaction structure described below that is designed to shift mortgage credit risk from Fannie

Mae and Freddie Mac to private investors through special purpose vehicles (“SPVs”). The SPVs

themselves will be established in the form of an LLC, corporation, or trust, and will be operated

by a third-party administrator or trustee, though the corresponding GSE will generally pay for

costs related to the transaction and retain an ownership interest in the SPV.7 In the

Correspondence, you describe the “basic structure of the risk sharing initiative” as follows:8

 Each GSE designates a reference pool of loans and provides investors with a

comprehensive offering memorandum, including detailed loan-level data about

the underlying loans.

2 Relief Request, at 2-3.

3 12 U.S.C. § 4501 et seq.

4 Pub. L. 110-289, 122 Stat. 2654 (enacted Jul. 30, 2008).

5 Relief Request, at 2-3.

6 Id. at 3.

7 Letter from Ellen Marks on behalf of Fannie Mae and Freddie Mac, at 1 (Nov. 20, 2013) (“Supplemental

Statement”).

8 See Relief Request, at 3-4.

oan-level data about

the underlying loans.

2 Relief Request, at 2-3.

3 12 U.S.C. § 4501 et seq.

4 Pub. L. 110-289, 122 Stat. 2654 (enacted Jul. 30, 2008).

5 Relief Request, at 2-3.

6 Id. at 3.

7 Letter from Ellen Marks on behalf of Fannie Mae and Freddie Mac, at 1 (Nov. 20, 2013) (“Supplemental

Statement”).

8 See Relief Request, at 3-4.

Ms. Marks and Ms. Abrams

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 Investors purchase fixed-income notes issued by the SPV. Potential purchasers

are limited to sophisticated institutional investors.

 The SPV enters into a credit default swap agreement with the related GSE

concurrently with the issuance of notes, by which the GSE agrees to pay a credit

premium to the SPV and the SPV agrees to make payments to the GSE with

respect to specified credit events9 affecting loans in the reference pool. The swap

agreement remains in place for the entire term of the related issuance and the SPV

will enter into no additional swaps.

 When a credit event occurs, the SPV will make a payment to the GSE according

to a fixed loss severity table that is based on historical loan performance data,10 or

on another basis as specified in the offering documents for the SPV. Any such

payment to the Requesting Entity by the SPV will result in a corresponding

reduction in the principal balance of the notes issued by the SPV.

 Loans exit the reference pool when they are paid in full or when a credit event

occurs with respect thereto. No new loans are added to the reference pool at any

time.

 The cash proceeds from the sale of the notes are invested in cash equivalents/high

quality short-term liquid assets. The assets will collateralize the SPV’s

obligations to make payments of principal to noteholders and payments in respect

of credit events to the GSE

paid in full or when a credit event

occurs with respect thereto. No new loans are added to the reference pool at any

time.

 The cash proceeds from the sale of the notes are invested in cash equivalents/high

quality short-term liquid assets. The assets will collateralize the SPV’s

obligations to make payments of principal to noteholders and payments in respect

of credit events to the GSE. Specifically, you have stated that each asset would

have a maturity date no later than 60 days from its date of purchase, and that the

assets would be limited to the following categories of investments (“Permitted

Investments”):

1. Obligations issued or fully guaranteed by the U.S. government or a U.S.

government agency or instrumentality.

2. General obligations of any State.

3. Demand or time deposits, federal funds or bankers’ acceptances of federal

or state depository institutions or trust companies subject to supervision by

federal or state banking authorities, provided the short-term deposits

and/or long-term obligations or deposits of the depository institution or

trust company are rated in the highest rating category by each applicable

nationally recognized statistical rating organization (“NRSRO”).

4. Repurchase obligations with terms of 30 days or less involving any

security described in #1 above and entered into with a depository

institution or trust company (as principal) described in #3 above.

9 “Specified credit events include loans that become 180-days delinquent and loans less than 180-days delinquent

that are resolved via short sales or deeds-in-lieu of foreclosure.” Relief Request, at 3.

10 “The loss percentages in the fixed severity table are structured to increase along with the percentage of the

cumulative balance of the reference pool that has experienced a credit event.” Id.

pecified credit events include loans that become 180-days delinquent and loans less than 180-days delinquent

that are resolved via short sales or deeds-in-lieu of foreclosure.” Relief Request, at 3.

10 “The loss percentages in the fixed severity table are structured to increase along with the percentage of the

cumulative balance of the reference pool that has experienced a credit event.” Id.

Ms. Marks and Ms. Abrams

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5. Commercial paper (i) issued by a qualifying commercial paper conduit (as

defined under the Volcker Rule regulations) and (ii) that has a rating in the

highest rating category by at least two NRSROs.

6. Money market funds rated in one of two highest categories for long-term

unsecured debt or in the highest category for short-term obligations by

each applicable NRSRO.

 Investors receive a rate of return, which is paid (i) from the credit premium

advanced by the related GSE under the swap agreement and (ii) from investment

earnings on the collateral to the extent available. Principal on the notes (as may

be reduced due to payments made by the SPV to the GSE in respect of credit

events and the corresponding exit of the related loans from the reference pool) is

returned as the reference pool amortizes, subject to specified bond performance

triggers, using proceeds of the collateral.

 Investors will in no event receive more than the stated maximum rate of return

and the ultimate repayment of principal.

 Investors will have access to historical data on a substantial portion of the related

GSE’s loan portfolio. The initial transaction will be structured to return full

principal and interest to investors if credit events do not exceed assumed levels.11

The Correspondence further explains that the fixed-income notes to be offered will be

high-yield debt securities offered and sold only to sophisticated investors pursuant to Rule

144A12 and Regulation S13 promulgated by the Securities and Exchange Commission

tial transaction will be structured to return full

principal and interest to investors if credit events do not exceed assumed levels.11

The Correspondence further explains that the fixed-income notes to be offered will be

high-yield debt securities offered and sold only to sophisticated investors pursuant to Rule

144A12 and Regulation S13 promulgated by the Securities and Exchange Commission. The

Correspondence describes investor disclosures as “robust,” and “focus[ing] primarily on the fact

that the notes are debt securities with a stated rate of return that create exposure to the credit risk

of a pool of reference loans.”14 Though the disclosures will not describe the SPVs as vehicles for

trading in swaps or other commodity interests, the disclosures will discuss the fact that the risk

transfer structure is dependent upon a swap transaction, as well as the material risks and

characteristics of the swap.

Fannie Mae and Freddie Mac will also provide monthly reports on behalf of each SPV

that will disclose payments made and received under the swap between the GSE and the SPV,

payments made to investors, updated loan-level data with respect to the reference pool, the

occurrence of any credit events with respect to the reference pool, the effect of those credit

events on the SPV and the noteholders, and the current balance of the collateral at the end of the

relevant month. Though the Correspondence generally talks about a single SPV structure,

through discussions with Division staff, you have indicated that Fannie Mae and Freddie Mac

anticipate eventually having multiple SPVs and corresponding note issuances. For each

additional note issuance, there will be a single reference pool of mortgages for the life of the

11 Id. at 4-5; see also Supplemental Statement at 1.

12 17 CFR 230.144A.

13 17 CFR 230.901-230.905.

14 Relief Request, at 5-6.

that Fannie Mae and Freddie Mac

anticipate eventually having multiple SPVs and corresponding note issuances. For each

additional note issuance, there will be a single reference pool of mortgages for the life of the

11 Id. at 4-5; see also Supplemental Statement at 1.

12 17 CFR 230.144A.

13 17 CFR 230.901-230.905.

14 Relief Request, at 5-6.

Ms. Marks and Ms. Abrams

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issuance, a single swap transaction transferring the mortgage credit risk from the GSEs to the

noteholders, and all of the other characteristics described above will continue to apply.

Ms. Marks and Ms. Abrams

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Legal Necessity of No-Action Relief from CPO Registration

Section 1a(10) of the Commodity Exchange Act (“CEA”), added by the Dodd-Frank Act

of 2010, defines a commodity pool as “any investment trust, syndicate or similar form of

enterprise operated for the purpose of trading in commodity interests,”15 and this definition is

identical to its regulatory counterpart, which was proposed and adopted in 1981.16 From the time

of the definition’s initial adoption in 1981, the Commission has declined to constrain the phrase

“operated for the purpose of trading” to the narrowest of possible interpretations. The reasons

that the Commission articulated for rejecting a narrow understanding of the phrase were

grounded in its dual concerns for customer and market protection. The Commission noted in the

Preamble to the 1981 rule that commenters were concerned that the definition was overly

broad.17 One commenter suggested a brightline percentage test as a function of commodity

interests to other portfolio holdings to determine whether a collective investment scheme should

be considered a pool

were

grounded in its dual concerns for customer and market protection. The Commission noted in the

Preamble to the 1981 rule that commenters were concerned that the definition was overly

broad.17 One commenter suggested a brightline percentage test as a function of commodity

interests to other portfolio holdings to determine whether a collective investment scheme should

be considered a pool. The Commission declined to set a specific percentage as a threshold over

which an entity would be considered a commodity pool due to concerns that an entity which

would not exceed the set trading level could still be marketed as a commodity pool to

participants, who should still be afforded the protections under Part 4 of the Commission’s

regulations.18

Several other commenters suggested that the definition should be narrowed to only those

funds whose “principal purpose” was the trading of commodity interests. The Commission

rejected that suggestion because it could “inappropriately exclude from the scope of Part 4 rules

certain persons who are, in fact, operating commodity pools.”19 Thus, the Commission

recognized that there may be entities whose primary business focus may be outside the

commodity interest sphere, yet may still have a significant exposure to those markets, which may

implicate the Commission’s concerns regarding both customer and market protection. The

rejection of the more narrow “principal purpose” language further operated as an additional

indicator of the Commission’s broader understanding of the phrase “operated for the purpose of.”

The Commission recently affirmed and refined this interpretation in the preamble to the

final rule entitled “Commodity Pool Operators and Commodity Trading Advisors: Compliance

Obligations.”20 Explaining its amendments to Commission Regulations 4.5 and 4.13(a)(3) to

15 CEA Section 1a(10), 7 U.S.C. 1a(10).

16 See 17 CFR 4.10(d).

17 46 Fed. Reg. 26004, 26005 (May 8, 1981).

18 Id.

19 Id

this interpretation in the preamble to the

final rule entitled “Commodity Pool Operators and Commodity Trading Advisors: Compliance

Obligations.”20 Explaining its amendments to Commission Regulations 4.5 and 4.13(a)(3) to

15 CEA Section 1a(10), 7 U.S.C. 1a(10).

16 See 17 CFR 4.10(d).

17 46 Fed. Reg. 26004, 26005 (May 8, 1981).

18 Id.

19 Id. at 26006. The Commission’s conclusion that commodity pools are not limited to those funds whose primary

purpose is trading commodity interests is consistent with the Dodd-Frank Act’s recent amendments to the CEA in

Section 4m(3). Section 4m(3) was amended to exempt certain commodity trading advisors (“CTAs”) from

registration provided that their business does not primarily consist of acting as a CTA, and that the CTA does not

serve as a CTA to a commodity pool that is engaged primarily in trading commodity interests. CEA Section 4m(3),

7 U.S.C. 6m(3). By its inclusion of commodity pools that engage primarily in trading commodity interests as a

factor to differentiate between those CTAs required to be registered from those not required to register, this statutory

exemption for CTAs recognizes that there may be entities that are properly considered commodity pools that are not

engaged primarily in trading commodity interests.

20 77 Fed. Reg. 11252 (Feb. 24, 2012).

Ms. Marks and Ms. Abrams

Page 7

include swaps in the trading thresholds, the Commission stated, “any swaps activities undertaken

by a CPO would result in that entity being required to register because there would be no de

minimis exclusion for such activity. As a result, one swap contract would be enough to trigger

the registration requirement.”21 This statement is the Commission’s most recent guidance with

respect to the relationship between an entity’s swaps activity and the requirement that its

operator register with the Commission as a CPO

hat entity being required to register because there would be no de

minimis exclusion for such activity. As a result, one swap contract would be enough to trigger

the registration requirement.”21 This statement is the Commission’s most recent guidance with

respect to the relationship between an entity’s swaps activity and the requirement that its

operator register with the Commission as a CPO.

The Correspondence states that the risk transfer structures will involve the establishment

of an SPV that will hold an interest in a swap creating synthetic exposure to the risk of mortgage

loans held or securitized by Fannie Mae and Freddie Mac. Therefore, the SPVs fall within the

definition of “commodity pool” set forth in Section 1a(10) of the CEA.22 That interpretation is

consistent with the historical interpretation of the commodity pool definition. Notwithstanding

the fact that the SPV(s) to be established in the manner described above is a commodity pool, the

Correspondence requests that the Division grant no-action relief to Fannie Mae and Freddie Mac

from CPO registration.

Legal Analysis

The Division agrees that the SPV structure used to transfer the GSEs’ mortgage credit

risk to investors is properly considered a commodity pool and, absent relief from the Division,

the GSEs operating the SPV(s) would be required to register as CPOs. The Correspondence,

however, requests no-action relief from registration, provided that the GSEs and their SPV

structure substantially meet the conditions required for a CPO to be exempt from registration

under Regulation 4.13(a)(3). Based on the foregoing representations and the legal analysis and

conditions below, the Division will not recommend that the Commission take an enforcement

action against Fannie Mae or Freddie Mac operating the SPV structure described above for

failure to register as a CPO

tructure substantially meet the conditions required for a CPO to be exempt from registration

under Regulation 4.13(a)(3). Based on the foregoing representations and the legal analysis and

conditions below, the Division will not recommend that the Commission take an enforcement

action against Fannie Mae or Freddie Mac operating the SPV structure described above for

failure to register as a CPO.

Regulation 4.13(a)(3)23 contains four prongs an entity must meet in order to rely on the

exemption:

 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;24

21 Id. at 11258.

22 Relief Request, at 6.

23 17 CFR 4.13(a)(3).

24 The Division notes that the Correspondence also requests relief from this general prohibition on marketing to the

public, pursuant to the recent adoption by the Securities and Exchange Commission of rules relaxing its prohibitions

on general solicitation in connection with Rule 144A and Regulation D offerings, as required by the JOBS Act of

2012. See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule

144A Offerings, 78 Fed. Reg. 44771 (July 24, 2013). The Division is not inclined to grant relief from the

prohibition on marketing to the public in Regulation 4.13(a)(3)(i) at this time because Commission staff is still

reviewing this rulemaking and determining what, if any, impact it may have on Commission regulations, and it is

anticipated that this request will be addressed in forthcoming Division and/or Commission action.

(July 24, 2013). The Division is not inclined to grant relief from the

prohibition on marketing to the public in Regulation 4.13(a)(3)(i) at this time because Commission staff is still

reviewing this rulemaking and determining what, if any, impact it may have on Commission regulations, and it is

anticipated that this request will be addressed in forthcoming Division and/or Commission action.

Ms. Marks and Ms. Abrams

Page 8

 The pool at all times meets a de minimis test pursuant to which either (x) 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 (y) the aggregate net notional value

of the pool’s commodity positions,25 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.

The GSEs state that the notes of the SPV will be sold pursuant to Rule 144A and

Regulation S, making them exempt from Securities Act registration and, because the Division is

not at this time considering relief from the general marketing prohibition pursuant to the JOBS

Act, the notes will be sold without marketing to the public in the United States. Additionally, the

notes will only be sold to sophisticated institutional investors that meet the accredited investor or

qualified eligible purchaser standards

m Securities Act registration and, because the Division is

not at this time considering relief from the general marketing prohibition pursuant to the JOBS

Act, the notes will be sold without marketing to the public in the United States. Additionally, the

notes will only be sold to sophisticated institutional investors that meet the accredited investor or

qualified eligible purchaser standards.

The GSEs further describe the proposed transaction, stating that:

[t]he swap will be the vehicle through which the default and delinquency

performance of the underlying mortgage loans (above certain levels) will

be allocated to the fund, but the mortgage loans themselves (and not the

swap) will be the primary source of potential losses. Aside from the

agreed rate of return under the swap and any gains relating to the

permitted investments in cash equivalents/high-quality short-term liquid

assets, the fund will not have the opportunity for gains. We believe the

allocation of losses through the swap is distinguishable from the

circumstances in which futures, options and swaps transactions are entered

into for the purpose of achieving trading profit. … Investors will make an

investment decision by evaluating the pool of mortgage loans and will

consider the swap terms only as a means of understanding how payments

are received by and how the performance of the underlying mortgages is

allocated to the fund.26

25 If the stated notional amount of a swap is leveraged in any way or otherwise enhanced by the structure of the swap

or the arrangement in which it is issued, the threshold calculation would be required to be based on the effective

notional amount of the swap rather than on the stated notional amount.

26 Relief Request, at 7.

to the fund.26

25 If the stated notional amount of a swap is leveraged in any way or otherwise enhanced by the structure of the swap

or the arrangement in which it is issued, the threshold calculation would be required to be based on the effective

notional amount of the swap rather than on the stated notional amount.

26 Relief Request, at 7.

Ms. Marks and Ms. Abrams

Page 9

The GSEs further represent that the notional amount of the swap between a GSE and the

corresponding SPV will not exceed the amount of collateral raised from the sale of the notes and

invested in the Permitted Investments by the vehicle. One of the de minimis tests in Regulation

4.13(a)(3) requires that the notional value of the commodity interest position, in this case a credit

default swap, not exceed the liquidation value27 of the pool’s, in this instance the SPV’s,

portfolio. Due to the importance of the SPV’s collateral in the cash flows from the SPV to the

GSEs and to the noteholders, the list of Permitted Investments is restricted to short-term assets

with typically high liquidity and very limited market value risk, making them easily convertible

to cash when credit payments to GSEs or note payments to investors are necessary. The

Division believes that the continual investment of the collateral in short-term assets with

typically high liquidity and very limited market risk is integral to the representation by FHFA

that the notional value of the swap will not exceed the value of the collateral.

As represented by the GSEs, when a specified credit event occurs requiring payment to

the GSE, the SPV will liquidate enough of its collateral to provide the required credit coverage to

the GSE, thereby reducing the funds available to repay the noteholders

market risk is integral to the representation by FHFA

that the notional value of the swap will not exceed the value of the collateral.

As represented by the GSEs, when a specified credit event occurs requiring payment to

the GSE, the SPV will liquidate enough of its collateral to provide the required credit coverage to

the GSE, thereby reducing the funds available to repay the noteholders. Because the notional

value of the swap will be reduced when defaulting mortgages exit the pool, and the assets held

by the SPV will be liquidated to pay credit coverage to the GSE, thereby reducing the collateral

as well, the GSEs state that the notional value of the swap should not exceed the liquidation

value of the SPV’s assets – in fact, the liquidation value of the SPV’s assets will consistently be

greater than or equal to the notional value of the swap.

A significant question is raised by the fourth prong of Regulation 4.13(a)(3). That prong

requires that investments in the SPV not be marketed as or in a vehicle for trading in the

commodity futures or commodity options markets.28 In the same 2012 final rule amending part 4

of the Commission’s regulations referenced above, the Commission also outlined several factors

to be considered in a facts and circumstances analysis of whether or not an investment vehicle

27 The Division does not believe that the liquidation value of the pool should be reduced by the SPV’s payment

obligations to the noteholders in this instance because the credit default swap and the notes sold by the SPV are

essentially off-setting cash flows. To the extent that the SPV is required to pay coverage to a GSE due to specified

default events in the underlying pool of mortgages, the SPV’s corresponding obligation to pay the principal and

interest owed to the noteholders is equally reduced

obligations to the noteholders in this instance because the credit default swap and the notes sold by the SPV are

essentially off-setting cash flows. To the extent that the SPV is required to pay coverage to a GSE due to specified

default events in the underlying pool of mortgages, the SPV’s corresponding obligation to pay the principal and

interest owed to the noteholders is equally reduced. The notes are not traditional debt in that repayment to the

noteholders by the SPV is subject to the SPV’s payment of losses on the underlying pool of mortgages held and

guaranteed by the GSEs pursuant to the terms of the swap. This is, of course, by design – otherwise, there would be

no actual transfer of the mortgage credit risk from the GSEs to the noteholders. For these reasons, in performing the

test in Regulation 4.13(a)(3), the Division is considering the notional value of the swap versus the liquidation value

of the assets held by the SPV, without reducing their value by the amount owed to its noteholders.

28 As explained above, in 2012, the Commission, upon Division staff recommendations and consistent with the

expansion by the Dodd-Frank Act of the Commission’s jurisdiction to include swap transactions, added swaps to the

transactions considered in the trading threshold calculations contained in Regulation 4.13(a)(3)(ii) by specifically

referencing the term “commodity interest,” which as defined in Regulation 1.3(yy) includes futures, options, and

swaps. In order to consistently interpret the prongs of the exemption in Regulation 4.13(a)(3), Division staff

similarly considers swaps added to the transactions listed in the marketing prong of that exemption, though the

Commission has not yet explicitly amended Regulation 4.13(a)(3)(iv) to also include swaps.

nterest,” which as defined in Regulation 1.3(yy) includes futures, options, and

swaps. In order to consistently interpret the prongs of the exemption in Regulation 4.13(a)(3), Division staff

similarly considers swaps added to the transactions listed in the marketing prong of that exemption, though the

Commission has not yet explicitly amended Regulation 4.13(a)(3)(iv) to also include swaps.

Ms. Marks and Ms. Abrams

Page 10

has been marketed as a vehicle for trading in commodity interests.29 Additionally, the

Commission stated that “no single factor is dispositive.”30

Most of the seven factors are either irrelevant or inapplicable to the risk-sharing structure

the Correspondence describes, with the exception of one: “Whether the futures/options/swap

transactions engaged in by the fund or on behalf of the fund will directly or indirectly be its

primary source of potential gains and losses.”

Because the single swap transaction between either Fannie Mae or Freddie Mac and the

SPV is the mechanism for creating and transmitting the risk exposure in the risk-sharing

structure, it is difficult to argue that the swap is not literally the primary source of investment

gains and losses to investors. However, the Division believes that the factor needs to be

considered in the context of the marketing condition. Thus, the Division is of the view that in the

context of Regulation 4.13(a)(3) where the de minimis exposure is being satisfied, and when the

swap is used as a mere conduit to transmit the risk of the reference assets to the protection

sellers, the Division accepts the GSEs’ representations that the marketing efforts are focused on

the risk of the reference assets rather than the risks and rewards of the swap. The Division

expects, and the GSEs have represented, that appropriate disclosure will be provided to describe

the effect of the swap’s risks and characteristics as such may affect the efficacy of the conduit

between the reference assets and the counterparties

presentations that the marketing efforts are focused on

the risk of the reference assets rather than the risks and rewards of the swap. The Division

expects, and the GSEs have represented, that appropriate disclosure will be provided to describe

the effect of the swap’s risks and characteristics as such may affect the efficacy of the conduit

between the reference assets and the counterparties. In contrast, when a swap creates other

investment exposures for investors, whether through the provision of leverage or the

transmission of other risks, the Division would assume that the swap itself must be marketed as

part of the investment package in violation of the fourth prong.

In light of the foregoing considerations and representations, the Division agrees that

“[i]nvestors will make an investment decision by evaluating the pool of mortgage loans and 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. If the question was whether the

vehicle was a commodity pool, the swap’s role in generating the investment exposure would be

very material. However, here the issue at hand is the extent to which marketing of the swap is

occurring. Importantly, the swap transaction, in this context, serves as the conduit for exposure

to the mortgage credit risk of assets actually held by a counterparty to said swap, and the terms

of the swap will not be a source of investment returns or losses beyond those directly correlated

to the underlying mortgage loans, as there is no leverage embedded in the terms of the swap.

Therefore, the Division does not believe that the presence of this swap should automatically

result in the GSEs and SPV(s) violating the marketing restriction in Regulation 4.13(a)(3)(iv),

consistent with the Commission’s previous statements

nvestment returns or losses beyond those directly correlated

to the underlying mortgage loans, as there is no leverage embedded in the terms of the swap.

Therefore, the Division does not believe that the presence of this swap should automatically

result in the GSEs and SPV(s) violating the marketing restriction in Regulation 4.13(a)(3)(iv),

consistent with the Commission’s previous statements.

Because Fannie Mae and Freddie Mac will have significant involvement in the operation

of the SPV(s), through which they will ensure that the SPV(s) will continuously meet all other

29 Although the factors were enumerated by the Commission in the context of its revisions to Regulation 4.5, the

Division believes that such factors are useful in determining whether a CPO has violated the terms of the marketing

restriction in Regulation 4.13(a)(3)(iv) because the limitations in both regulations are substantially similar in scope

and intent.

30 77 Fed. Reg. at 11259.

Ms. Marks and Ms. Abrams

Page 11

requirements set forth in Regulation 4.13(a)(3) and the representations described in this letter,

and because Fannie Mae and Freddie Mac themselves are subject to comprehensive regulation

by the FHFA, the Division has determined that it will not recommend to the Commission that it

take an enforcement action against either Fannie Mae or Freddie Mac for their failure to register

as CPOs, provided that they and their SPV(s) continue to meet the requirements of the exemption

from CPO registration under Regulation 4.13(a)(3) as well as the conditions below:

1. The collateral, received by the SPV from the sale of notes to investors, will continually

be invested in assets fitting one of the six categories outlined above in this letter, none of

which will have a maturity date beyond 60 days from their date of purchase.

2

to meet the requirements of the exemption

from CPO registration under Regulation 4.13(a)(3) as well as the conditions below:

1. The collateral, received by the SPV from the sale of notes to investors, will continually

be invested in assets fitting one of the six categories outlined above in this letter, none of

which will have a maturity date beyond 60 days from their date of purchase.

2. Any disclosure document circulated by or on behalf of Fannie Mae and Freddie Mac to

potential and actual investors must indicate that they are not registered as CPOs with the

Commission and are subject to the conditions of the no-action relief provided in this

letter.

3. In the event of a bankruptcy proceeding involving the SPV, the exercise of any

contractual right by Fannie Mae or Freddie Mac to cause the termination, liquidation, or

acceleration of or to offset or net termination values, payment amounts, or other transfer

obligations arising under or in connection with the swap agreement shall not be stayed,

avoided, or otherwise limited, under applicable law.

4. The SPV will not engage in any additional commodity interest transactions beyond the

swap transaction discussed herein.

This letter, and the positions taken herein, represent the view of this Division only, and

do not necessarily represent the position or view of the Commission or of any other office or

division of the Commission. The relief issued by this letter does not excuse the affected persons

from compliance with any other applicable requirements contained in the Act or in the

Commission’s regulations issued thereunder. Further, this letter, and the relief contained herein,

is based upon the representations made to the Division. Any different, changed or omitted

material facts or circumstances might render this letter void

issued by this letter does not excuse the affected persons

from compliance with any other applicable requirements contained in the Act or in the

Commission’s regulations issued thereunder. Further, this letter, and the relief contained herein,

is based upon the representations made to the Division. Any different, changed or omitted

material facts or circumstances might render this letter void. In this regard, you must notify the

Division immediately in the event that the operations or activities of Fannie Mae or Freddie Mac

or their SPV(s) change in any material respect from the representations above.

Ms. Marks and Ms. Abrams

Page 12

Should you have any questions, please do not hesitate to contact Amanda Olear,

Associate Director, at 202-418-5283 or aolear@cftc.gov, or Elizabeth Groover, Special Counsel,

at 202-418-5985 or egroover@cftc.gov.

Very truly yours,

Gary Barnett

cc:

Regina Thoele, Compliance

National Futures Association, Chicago