Conditional, time-limited no-action relief to an entity for not counting certain loan-related swaps towards its swap dealer de minimis threshold (under paragraph (4) of the “swap dealer” definition in Regulation 1.3).

Summary: Conditional, time-limited no-action relief to an entity for not counting certain loan-related swaps towards its swap dealer de minimis threshold (under paragraph (4) of the “swap dealer” definition in Regulation 1.3).

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5000

Division of Swap Dealer and

Intermediary Oversight

Matthew Kulkin

Director

CFTC Letter No. 18-20

No-Action

August 28, 2018

Division of Swap Dealer and Intermediary Oversight

Re:

No-Action Relief for Excluding Certain Loan-Related Swaps from Counting toward

the Swap Dealer Registration De Minimis Threshold

Ladies and Gentlemen:

This letter is issued by the Division of Swap Dealer and Intermediary Oversight (“DSIO”

or the “Division”) of the Commodity Futures Trading Commission (“Commission” or “CFTC”)

in response to a request from “X”, on behalf of itself and its insured depository institution

(“IDI”) subsidiaries “Y” (and together with their affiliates, “Z”).1 “Z” requests conditional time-

limited no-action relief from counting certain swaps toward the swap dealer de minimis

threshold of any “Z” entity.

Regulatory Background

Pursuant to the requirements of section 1a(49) of the Commodity Exchange Act

(“CEA”), CFTC regulation 1.3 further defines certain terms, including the term “swap dealer”

(the “Swap Dealer Definition”). Paragraph (4) of the Swap Dealer Definition excepts from

registration as a swap dealer a person that meets certain requirements

r de minimis

threshold of any “Z” entity.

Regulatory Background

Pursuant to the requirements of section 1a(49) of the Commodity Exchange Act

(“CEA”), CFTC regulation 1.3 further defines certain terms, including the term “swap dealer”

(the “Swap Dealer Definition”). Paragraph (4) of the Swap Dealer Definition excepts from

registration as a swap dealer a person that meets certain requirements. Generally, a person shall

not be deemed to be a swap dealer if its swap dealing activity – together with the swap dealing

activity of any other entity controlling, controlled by, or under common control with the person –

over the preceding 12-month period does not exceed an aggregate gross notional amount

threshold of $3 billion, subject to a phase-in threshold of $8 billion that is currently in effect (the

“De Minimis Threshold”).2 Additionally, paragraph (4)(iv) of the Swap Dealer Definition

1 Letter from “Z” dated August 23, 2018.

2 See 17 CFR 1.3, Swap dealer, ¶ 4; Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major

Swap Participant,” “Major Security-Based Swap Participant,” “and “Eligible Contract Participant,” 77 FR 30596

(May 23, 2012). Further, there is a de minimis threshold of $25 million for swaps with counterparties that are

special entities.

“X”

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states that a swap dealer must be registered for 12 months before it can apply to withdraw its

swap dealer registration if it intends to continue to engage in swap dealing activity.3

Further, pursuant to the requirements of CEA section 1a(49)(A),4 paragraph (5) of the

Swap Dealer Definition provides that, in calculating whether an IDI has exceeded the De

Minimis Threshold, the IDI may exclude certain swaps entered into with a customer in

connection with originating a loan with that customer, subject to several conditions (the “IDI

Exclusion”).5 In addition to other conditions, to qualify for the IDI Exclusion, the swap must be

entered into no later than 180 day

Dealer Definition provides that, in calculating whether an IDI has exceeded the De

Minimis Threshold, the IDI may exclude certain swaps entered into with a customer in

connection with originating a loan with that customer, subject to several conditions (the “IDI

Exclusion”).5 In addition to other conditions, to qualify for the IDI Exclusion, the swap must be

entered into no later than 180 days after the date of execution of the applicable loan agreement or

transfer of principal to the customer (“180 Day Requirement”).6 As the Commission has stated,

the IDI Exclusion facilitates swap dealing in connection with other client services and may

encourage more IDIs to participate in the swap market, advancing the policy objectives of the De

Minimis Threshold. Greater availability of loan-related swaps may also improve the ability for

customers to hedge their loan-related exposure.7

Summary of Request for Relief

Based on the request for relief and other communications with “Z” and its counsel, we

understand the relevant facts to be as follows. “X” is a

, which,

, offers retail and commercial banking products and services to individuals, small

businesses, middle-market companies, large corporations and institutions. “Z’s” commercial

banking segment offers various financial products and solutions, such as

3 17 CFR 1.3, Swap dealer, ¶ (4)(iv).

4 7 U.S.C. 1a(49)(A).

5 See 17 CFR 1.3, Swap dealer, ¶ 5.

6 17 CFR 1.3, Swap dealer, ¶ 5(i)(a)

ng products and services to individuals, small

businesses, middle-market companies, large corporations and institutions. “Z’s” commercial

banking segment offers various financial products and solutions, such as

3 17 CFR 1.3, Swap dealer, ¶ (4)(iv).

4 7 U.S.C. 1a(49)(A).

5 See 17 CFR 1.3, Swap dealer, ¶ 5.

6 17 CFR 1.3, Swap dealer, ¶ 5(i)(a). The IDI Exclusion also requires that: (1) the notional item underlying the

swap (rate, asset, liability) be tied to the financial terms of the loan or be required as a condition of the loan to hedge

potential risks due to changes in commodity price; (2) the duration of the swap not extend beyond the loan

termination date; (3) the IDI be the source of a minimum of 10 percent of the principal loan amount or the source of

a principal amount greater than the notional amount of swaps entered into by the IDI in connection with the loan

with the customer; (4) the aggregate gross notional amount of swaps entered into in connection with the loan not

exceed the outstanding principal amount; (5) if not accepted for clearing, the swap be reported as required by other

CEA provisions; (6) the transaction not be a sham transaction, regardless of whether the transaction is intended to

qualify for the IDI Exclusion; and (7) the loan not be a synthetic loan, including, a loan credit default swap or a loan

total return swap.

7 See De Minimis Exception to the Swap Dealer Definition, 83 FR 27444, 27459 (June 12, 2018). The Commission

recently proposed a rule amendment that includes specific factors that may be evaluated by an IDI when assessing if

a swap entered into with a customer in connection with a loan must be counted toward the de minimis threshold of

the IDI. Among other things, the proposal would permit an IDI to exclude from counting swaps entered into with a

customer in connection with a loan to that customer in circumstances where the swap is entered into more than 180

days after execution of the loan

IDI when assessing if

a swap entered into with a customer in connection with a loan must be counted toward the de minimis threshold of

the IDI. Among other things, the proposal would permit an IDI to exclude from counting swaps entered into with a

customer in connection with a loan to that customer in circumstances where the swap is entered into more than 180

days after execution of the loan. See 83 FR at 27459.

“X”

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. It serves various

industries, including . Neither “Y”, nor

any other “Z” entity, is currently registered with the CFTC as a swap dealer.

An important client segment for “Z” is small and medium-sized commercial entities. “Z”

is a strategic and financial advisor for these clients, many of which rely on “Z” to help manage

their overall capital and risk mitigation needs. In a loan origination, “Y” is typically the sole or

primary lender to these clients, and if these clients want to hedge their risks in connection with a

loan using swaps, they will typically turn to “Y” to provide the swap because the clients have

existing credit arrangements and terms with “Z” and do not have established trading

relationships with larger swap dealing banks. According to “Z”, the ancillary swap dealing

services it provides to these clients help them hedge risks associated with loans in a timely and

cost-effective manner.

“Z” represents that until the fall of 2017, “Y” has been able to serve the hedging needs of

its loan clients while staying well below the De Minimis Threshold, in large part by relying on

the IDI Exclusion

er swap dealing banks. According to “Z”, the ancillary swap dealing

services it provides to these clients help them hedge risks associated with loans in a timely and

cost-effective manner.

“Z” represents that until the fall of 2017, “Y” has been able to serve the hedging needs of

its loan clients while staying well below the De Minimis Threshold, in large part by relying on

the IDI Exclusion. Since about , however, due in significant part to changes in

the interest rate environment, “Y” has been experiencing a spike in the demand for interest rate

swaps from its existing loan clients that want to hedge risk by entering into floating to fixed

interest rate swaps. However, if the loan agreement was executed or the transfer of principal

occurred more than 180 days prior to entering into the swap, the swap would not qualify for the

IDI Exclusion and would need to be counted towards “Z’s” De Minimis Threshold.

“Z” further represents that the spike in demand for swaps that would not qualify for the

IDI Exclusion is temporary and that such increased demand is expected to abate by the end of

2018. For example, “Z” states that it is already observing that clients are reverting to more

historically normal rates of entering into swaps contemporaneously with a loan. Over the next

four to six months, “Z” anticipates that the temporary spike will place limitations on its ability to

provide ancillary swap dealing services to its loan clients because, absent relief, it has two

options: (1) to remain below the De Minimis Threshold, turn away small and medium-sized

commercial clients that rely on “Z” for swaps to hedge interest rate risk associated with loans if

the swaps do not qualify for the IDI Exclusion; or (2) exceed the De Minimis Threshold and

register as a swap dealer, only to begin the process of deregistering within twelve months after

registration

as two

options: (1) to remain below the De Minimis Threshold, turn away small and medium-sized

commercial clients that rely on “Z” for swaps to hedge interest rate risk associated with loans if

the swaps do not qualify for the IDI Exclusion; or (2) exceed the De Minimis Threshold and

register as a swap dealer, only to begin the process of deregistering within twelve months after

registration.

Regarding the first option, “Z” is concerned that being unable to accommodate the

hedging needs of its existing small and medium-sized commercial clients who expect to be

served by “Z” and, under normal circumstances, would be served by “Z”, would potentially be

detrimental to those clients. As stated, these clients typically do not have established trading

relationships with other swap dealers, and lacking these relationships, “Z” believes those clients

may find it challenging to quickly identify and enter into the necessary agreements with

alternative providers of cost-effective swaps in an environment where speed is important due to

the changing interest rate environment. “Z” notes that this outcome would be inconsistent with

“X”

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the Commission’s policy goal of supporting small and regional banks’ ancillary dealing activities

to meet end-users’ risk mitigation needs.

Alternatively, given its current business as a regional commercial bank, “Z” currently has

no plans to operate any of its entities as a registered swap dealer and states that registration as a

swap dealer would be very costly. Therefore, taking the steps to register as a swap dealer (and

then to deregister soon thereafter) does not make economic sense to “Z”. Additionally, it would

be burdensome and confusing for clients, as they would need to work with “Z” to complete the

various swap dealer onboarding processes, only to be informed soon thereafter that “Z” is no

longer a registered swap dealer

ld be very costly. Therefore, taking the steps to register as a swap dealer (and

then to deregister soon thereafter) does not make economic sense to “Z”. Additionally, it would

be burdensome and confusing for clients, as they would need to work with “Z” to complete the

various swap dealer onboarding processes, only to be informed soon thereafter that “Z” is no

longer a registered swap dealer.

Given these circumstances, “Z” states that requiring registration as a swap dealer would

not further the CFTC’s policy goals associated with swap dealer registration and the IDI

Exclusion, while imposing significant costs on “Z” and its clients. Therefore, “Z” requests

conditional relief from counting certain loan-related swaps toward the De Minimis Threshold of

any “Z” entity,8 so that it can continue to serve the hedging needs of its small and medium-sized

clients while staying below the De Minimis Threshold.

Division No-Action Position

Based on the foregoing and the representations made by “Z”, the Division believes that

granting no-action relief is warranted. Accordingly, the Division will not recommend that the

Commission take an enforcement action against any “Z” entity for not counting towards its De

Minimis Threshold during the period beginning the date of this letter and ending December 31,

2018, swaps that meet the following conditions (the “Excluded IDI Loan-Related Swaps”):

1. The swaps are with existing loan clients of “Y”;

2. Each such client is a small or medium-sized commercial entity, which for purposes of

this relief is an entity with annual revenues of under $750 million; and

3. But for the 180 Day Requirement, the swaps would qualify for the IDI Exclusion.

Further, the aggregate notional amount of the Excluded IDI Loan-Related Swaps that are

not counted toward the De Minimis Threshold by “Z” may not exceed $1.5 billion at any time

during the relief period

ercial entity, which for purposes of

this relief is an entity with annual revenues of under $750 million; and

3. But for the 180 Day Requirement, the swaps would qualify for the IDI Exclusion.

Further, the aggregate notional amount of the Excluded IDI Loan-Related Swaps that are

not counted toward the De Minimis Threshold by “Z” may not exceed $1.5 billion at any time

during the relief period.

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

do not necessarily represent the positions or views of the Commission or of any office or other

division of the Commission. The relief issued by this letter does not excuse persons relying on it

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

8

However, because of the aggregation requirement, “Z” is requesting that the relief

cover all of the entities within the “Z” corporate group.

“X”

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regulations issued thereunder. The relief also does not create or confer any rights for or

obligations on any person or persons subject to compliance with the CEA that bind the

Commission or any of its other offices or divisions. 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 no-action relief void.

Should you have any questions, please do not hesitate to contact Erik Remmler, Deputy

Director, DSIO, at (202) 418-7630 or Rajal Patel, Associate Director, DSIO, at (202) 418-5261.

Very truly yours,

Matthew Kulkin

Director

Division of Swap Dealer and Intermediary Oversight