Section 723(a)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 2(e) of the Commodity Exchange Act, or CEA to provide that “it shall be unlawful for any person, other than an [eligible contract participant, or ECP], to enter into a swap unless the swap is entered into on, or subject to the rules of, a board of trade designated as a contract market under section 5.” On May 23, 2012, the Commodity Futures Trading Commission published jointly with the Securities and Exchange Commission (“SEC,” and together with the CFTC, “Commissions”) final rules further defining the term “eligible contract participant” and providing interpretations regarding ECP definitional issues.
In response to various requests for further clarifications and relief with respect to the application of section 2(e) in various circumstances, the CFTC Office of General Counsel, or OGC, has provided the following interpretations:
- swap guarantors generally must be ECPs;
- a non-ECP generally may not be jointly and severally liable for swap obligations; and
- cash proceeds from a loan may be included within the calculation of total assets.
In addition, OGC has provided no-action relief, subject to certain condition with respect to the application of CEA sections 2(e) and 13(a) to:
- certain ECP guarantee arrangements;
- “anticipatory ECPs”; and
- certain determinations regarding “amounts invested on a discretionary basis” under CEA section 1a(18)(A)(xi).
Swap Guarantee Arrangements
OGC will not recommend that the Commission commence an enforcement action against a guarantor (“Guarantor”) guaranteeing the swap obligations of a third party that is not an ECP (such third party, a “Guaranteed Swap Counterparty”) for violating CEA sections 2(e) or 13(a), or against a Guaranteed Swap Counterparty, for violating section 2(e) of the CEA, or against the beneficiary of the swap guarantee (“Beneficiary”) for violating CEA section 13(a), if:
- the Guarantor is:
- a corporation, partnership, proprietorship, organization, trust, or other entity that has a net worth exceeding $1 million; or
- an indirect proprietorship that consists of an individual or, if permitted by applicable state law individuals, with:
- a net worth (in the aggregate across all indirect co-proprietors, where applicable state law permits proprietorships comprised of more than one individual) exceeding $1 million; or
- amounts invested on a discretionary basis, the aggregate of which is in excess of $5 million (in the aggregate across all indirect co-proprietors, where applicable state law permits proprietorships comprised of more than one individual); and
- all of the following conditions applicable to a particular Guarantor and/or Guaranteed Swap Counterparty, respectively, are satisfied:
- the Guaranteed Swap Counterparty enters into the swaps solely to manage the floating interest rate risk associated with a loan received, or reasonably likely to be received, by the Guaranteed Swap Counterparty in the conduct of its business;
- in the case of all Guarantors other than a proprietorship Guarantor, the Guarantor is an owner of the Guaranteed Swap Counterparty and plays an active role in operating the business of such Guaranteed Swap Counterparty (other than performing solely clerical, secretarial or administrative functions);
- in the case of a proprietorship Guarantor, if applicable state law contemplates proprietorships with more than one proprietor, the Guarantor and the Guaranteed Swap Counterparty are co-proprietors;
- the Guarantor computes its net worth or amounts invested on a discretionary basis in accordance with generally accepted accounting principles (“GAAP”), consistently applied (provided that the value of real property can be determined using fair market value (“FMV”));
- the Guaranteed Swap Counterparty enters into the guaranteed swaps only as a principal; and
- the Beneficiary verifies that the Guarantor and Guaranteed Swap Counterparty satisfy the conditions of the no action position set forth herein.
OGC will not recommend that the Commission commence an enforcement action against a (1) Guaranteed Swap Counterparty or other non-ECP swap counterparty for violating CEA section 2(e), (2) Guaranteed Swap Counterparty’s Guarantor for violating CEA sections 2(e) or 13(a), or (3) a Beneficiary or other swap counterparty to a non-ECP swap counterparty for violating CEA section 13(a), in connection with a swap entered into other than on or subject to the rules of a DCM prior to the borrower receiving the proceeds of a related loan in an amount sufficient for the Guaranteed Swap Counterparty or other non-ECP swap counterparty to achieve ECP status under CEA section 1a(18)(A)(v)(I), if:
- the swap for which ECP status is necessary is intended to manage the Guaranteed Swap Counterparty’s or other non-ECP swap counterparty’s floating interest rate risk on the loan;
- in the case of a swap entered into by a Guaranteed Swap Counterparty or other non-ECP swap counterparty to manage its floating interest rate risk on a loan that would, if disbursed, cause the Guaranteed Swap Counterparty or other non-ECP swap counterparty to qualify as an ECP under CEA section 1a(18)(A)(v)(I) but that has not yet closed, the Guaranteed Swap Counterparty or other non-ECP swap counterparty has received a bona fide loan commitment for such loan;
- in the case of a construction loan or other loan disbursed in stages, the lender intends at the time of making the loan, or the related loan commitment to fund the entirety of the loan, subject only to the satisfaction of commercially reasonable closing conditions and/or the failure to occur, after loan disbursements have commenced, of any events set forth in the loan or swap documentation that would excuse the lender’s obligation to continue funding the loan (such as, for example, the borrower’s failure to make a payment), provided that such events are not designed to permit the lender to fail to fund the loan while leaving the swap in place; and
- the loan is funded in an amount causing the Guaranteed Swap Counterparty or other non-ECP swap counterparty to qualify as an ECP under CEA section 1a(18)(A)(v)(I), unless it is not funded in such amount as a result of a failure to satisfy a commercially reasonable condition to closing the loan set forth in the bona fide loan commitment or an event set forth in the loan or swap documentation that would excuse the lender’s obligation to continue funding the loan (such as, for example, the borrower’s failure to make a payment)
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Contact Steve Quinlivan for more information.
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