On August 28, 2018, the Division of Swap Dealer and Intermediary Oversight (DSIO) of the Commodity Futures Trading Commission (CFTC) released a staff no-action letter allowing an anonymous individual financial institution temporary relief from some of the limiting criteria in the insured depository institution exclusion (IDI Exclusion) from swap dealer registration. The IDI Exclusion allows lender banks to enter into swap transactions with borrowers in order to hedge the borrower’s loan-related exposures, without the lender bank needing to count the swap transaction toward its swap dealer registration requirement. The August 28 no-action letter would allow the requesting financial institution to exclude from its registration requirement loan-related swaps with certain smaller customers, up to a specified notional limit, even if the swap was not executed within the IDI Exclusion’s window of 180 days from the making of the loan. The DSIO staff elected to grant the relief based on the representation from the requesting financial institution that the changing interest rate environment was leading to a temporary spike in clients with legacy loans (outside of the 180-day window) who wanted to hedge their interest rate exposure and that those smaller clients may not be able to meet their risk management needs elsewhere absent temporary relief to the requesting entity.
While this no-action relief was directed to an individual requesting entity and not to all market participants relying on the IDI Exclusion, it represents an important potential opportunity for other banks who may have had to limit their swap activities, and therefore the service they are able to provide to their customers, in order to comply with the IDI Exclusion’s requirements. We encourage financial institutions relying on the IDI Exclusion to consider whether they have had to forego swap activity with clients to remain within the IDI Exclusion’s requirements, and if so, whether obtaining similar relief would create additional opportunities to better serve their clients’ hedging needs.
One of the core requirements of the U.S. derivatives regulatory regime under Title VII of the Dodd-Frank Act is registration – and significant regulation – of entities that engage in swap dealing activity that exceeds a specified de minimis threshold. However, embedded within the statutory definition of “swap dealer” is the IDI Exclusion, providing that an insured depository institution is not considered to be a swap dealer in connection with swaps it enters into with customers in connection with originating loans to those customers. While many large financial institutions have become provisionally registered as swap dealers, most small lenders who engage in limited customer-facing swap activity have not registered, in reliance on the IDI Exclusion (and in some cases, the de minimis threshold). Through its rulemaking, the CFTC has created criteria that must be met in order for this swap activity to not be counted toward a lender’s registration requirement, including that the swap must be entered into within 180 days of the loan.
This requirement limits the ability of the lender to service clients who may desire to hedge interest rate or other exposures in connection with an existing loan due to changing market or internal circumstances. Often these clients may not have the practical ability to enter into their desired risk management derivatives elsewhere because they lack trading relationships with the large swap dealer firms, or otherwise lack the credit or ability to pledge collateral to secure swap obligations with a party other than their original lender.
The August 28 no-action letter was granted by the DSIO staff based on several representations of the requesting entity, including that the changing interest rate market was leading to a temporary spike in customer demand for interest rate derivatives rather than a permanent need for relief. It also included a representation that many of the clients would not have the ability to execute the requested transactions with swap dealers due to the reasons stated above, and therefore allowed the letter to rely on the policy justification of making sure the derivatives markets are open to end users who utilize them to manage risks related to their business. Based on those representations, the DSIO staff granted temporary no-action relief allowing the requesting institution to exclude swaps entered into prior to December 31, 2018, that meet the following criteria:
- are entered into with existing loan clients of the financial institution;
- are with clients who have annual revenues of under $750 million; and
- which would, absent the 180-day window requirement, satisfy the elements of the IDI Exclusion.
As noted above, the no-action letter was directed to an individual requesting firm, and was based on the specific representations made by that firm. However, the issuance of the letter brings up some important points relevant to the broader market of firms relying on the IDI Exclusion.
While this relief was issued to an individual institution, it is based primarily on market, rather than individual, circumstances and therefore may form the basis of similar requests for relief from other market participants who may also face the inability to serve clients’ hedging needs in the current interest rate environment within the limitations of the IDI Exclusion.
The issuance of this letter indicates some level of flexibility at the CFTC in the interpretation of the IDI Exclusion, as well as reinforces a policy goal at the CFTC to limit the ways that regulation restricts the ability for smaller institutions to serve the legitimate risk management needs of end users of derivatives. We encourage firms to consider whether there are specific ways in which the current derivatives regulation has limited their ability to serve the needs of end users, particularly smaller non-financial end users, and whether there may be avenues for targeted Title VII regulatory relief to allow those firms to better serve clients’ needs.