At an open meeting, the CFTC adopted a final rule for an exception to the swap dealer de minimis threshold for swaps entered into by insured depository institutions ("IDIs") in connection with loans to customers.

The rule adds a new paragraph (4)(C) to the definition of "swap dealer" in CFTC Regulation 1.3 and would permit IDIs to exclude, from counting towards the $8 billion de minimis dealing threshold (but not the lower "special entity" threshold), swaps that satisfy specified criteria:

  • (1) the swap is entered into with a customer no more than 90 days before execution of the applicable loan or transfer of principal to the customer, unless an executed commitment or forward agreement for the loan is in place;
  • (2) the underlier on the swap "is, or is related to" a financial term of the loan, is permissible under the IDI's loan underwriting criteria, and is commercially appropriate for hedging risks incidental to the borrower's business that may affect the borrower's ability to pay the loan;
  • (3) the duration of the swap does not extend beyond termination of the loan;
  • (4) the IDI is committed to being the source of at least 5% of the maximum principal of the loan, or, if the IDI is less than 5%, the aggregate notional of swaps entered into by the IDI with the customer in connection with the financial terms of the loan cannot exceed the principal of the IDI's loan;
  • (5) a swap is considered "entered into in connection with originating a loan" if the IDI directly transfers the loan, is part of a syndicate of lenders, purchases or receives a participation in the loan, or is (or is intended to be) the source of the funds of the loan; and
  • (6) the loan does not include any "sham" transaction or any "synthetic" loan.

The new rule is to become effective on publication in the Federal Register. The CFTC, however, indicated that the new exception does not apply to swaps entered into before the effective date.

CFTC Chair J. Christopher Giancarlo expressed strong support for the final rule, while also noting that the CFTC Office of the Chief Economist is directed to conduct a study of the new rule three years after implementation, and added that he "take[s] seriously" concerns about potential misuse of the new exception. He also noted the intended limited scope and the fact that the entities that are able to avail themselves of the exception are separately subject to prudential regulation by U.S. banking authorities. CFTC Commissioner Brian Quintenz also supported the final rule, while adding that the amendments are just a few of the number of other changes to the de minimis threshold that should be acted on from the CFTC June 2018 proposal. He also expressed his continuing concern that notional amount may be an inappropriate measure for purposes of the de minimis exception. Commissioner Dawn Stump also voted in favor of the rule.

CFTC Commissioner Rostin Behnam voiced opposition to the final rule, stating that the uncertainties in the IDI de minimis provision "deprive IDIs and their customers" of the legal certainty intended by Congress and may lead to heightened risks for market participants. He said that the CFTC would have been "wise to avoid creating this rambling IDI exemption that will now sit awkwardly beside the IDI Swap Dealing Exclusion" in the CFTC rules.

Commissioner Dan Berkovitz issued a lengthy dissent, contending that the rule had a "transparent purpose . . . to circumvent the will of Congress that 'swap dealer' be defined only through joint rulemakings with the SEC," and that the rule "drives a truck through the de minimis exception to the swap dealer registration rule" by allowing an unlimited quantity of swap dealing by an IDI regarding loans with customers. Further, Mr. Berkovitz contended that the unlimited amount of swap dealer activity permitted under the new exception is not the "de minimis quantity" that Congress intended for the CFTC to permit. He also questioned the process involved in the rulemaking, stating that "[t]he Commission has not provided any analysis or reasoned estimate of the aggregate amount of swap dealing activity that would be excluded under the new IDI De Minimis Provision." Finally, Mr. Berkovitz raised a number of concerns with the language of the rule text itself, noting the ways in which the rule loosens restrictions in the current exception from swap dealing for certain IDIs under the CFTC as potentially creating ways for activities beyond the intended scope to be able to rely on the exception.

Commentary / Nihal Patel

Banks involved in loan origination (including as a syndicate member or through participations) - and particularly banks that are not registered with the CFTC as a "swap dealer" - should closely review the new rules and look to adopt new policies and procedures relating to the entering into of swaps with customers. This is particularly the case given that the new rules will become effective in a short amount of time - they become effective upon publication in the Federal Register.

The new rule, as highlighted by Mr. Berkovitz (though in dissent), presents a material expansion on the possible scope of derivatives activities that can be undertaken by a non-swap dealer bank. Firms that rely on the existing IDI exception will have a much greater amount of leeway in conducting derivatives activities with lending customers. With that said, Mr. Berkovitz's dissent and Mr. Giancarlo's expressed concerns about preventing abuse of the new exception should be kept in mind by firms implementing the exception as part of their business.

As to the procedural concerns raised by Commissioners Behnam and Berkovitz, they may have the right argument on statutory grounds ( note concerns raised in previous commentary). As a practical matter, however, it's hard to see why this issue is one where the SEC could have much to say, given that the relevant products should be entirely within the purview of the CFTC and that the SEC has no comparable exception for security-based swap dealers. Moreover, while not joint rulemaking, SEC Chairman Jay Clayton agreed that it made sense for the CFTC to go solo on this one.

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