CFTC Exempts Certain Wholly-Owned Securitization SPVs from Mandatory Clearing

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On May 4, 2015, the Division of Clearing and Risk of the Commodity Futures Trading Commission (the “CFTC”) issued a no-action letter (the “Letter”)[1] clarifying that securitization special purpose vehicles (“SPVs”) that are wholly-owned by, and consolidated with, a “captive finance company” are eligible for the “end-user exception” in connection with clearing determinations issued by the CFTC under Section 2(h) of the Commodity Exchange Act, as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“CEA”).  The auto securitization industry, including Ford Motor Credit Company LLC, has been particularly focused on the interpretive relief provided by the Letter.[2]

In a typical auto securitization, a captive finance company sells a pool of receivables (including from auto leases) to an SPV, which then sells debt securities to investors.  In some cases, swaps may be employed to manage interest rate exposure between fixed rate receivables and floating rate obligations to investors.  In December 2012, the CFTC made its first clearing determination, which required that certain classes of interest rate swaps and credit default swaps must be cleared by a central clearing counterparty registered with the CFTC.[3]

However, under Section 2(h)(7)(A) of the CEA, an entity may elect not to clear a swap that is subject to a mandatory clearing requirement by the CFTC if that entity: (i) is not a “financial entity”; (ii) uses the swap to hedge or mitigate commercial risk; and (iii) reports certain information to the CFTC (either directly or through a registered “swap data repository”).  Captive finance companies are explicitly excluded from the definition of “financial entity.”[4]  To qualify as a captive finance company, an entity must satisfy a test that, inter alia, requires that the entity’s “primary business” is to provide financing.[5]  A traditional captive finance company makes loans to auto customers, and so, would satisfy this requirement.  However, securitization SPVs of captive finance companies—which are the actual swap counterparties—are only indirectly involved in the financing of these loans, although they facilitate the loans.  The adopting release implementing the end-user exception did not directly address this prong of the captive finance company test.[6]

The Letter clarifies that it is appropriate to consider the business of such an SPV to be part of the business of the related captive finance company, because: (i) the SPV is wholly-owned by the captive finance company; (ii) the SPV’s financial statements are consolidated with those of the captive finance company; and (iii) the SPV’s sole activity is facilitating financing undertaken by the captive finance company.[7]  Therefore, a qualifying SPV may elect to use the end-user exception to a clearing determination in the same way as its parent captive finance company.

[1] CFTC Letter No. 15-27 (May 4, 2015) (available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-27.pdf).

[2] The Letter was in response to requests for clarification made by the automobile industry, including a letter from Ford Credit, dated November 24, 2014, and a letter from a group of nine automotive captive finance companies, dated December 3, 2014.  See Letter at fn 1.

[3] Clearing Requirement Determination Under Section 2(h) of the CEA, 77 Fed. Reg. 74,284 (Dec. 12, 2012).

[4] See CEA Section 2(h)(7)(C)(iii).

[5] The other requirements are that: (i) the entity uses derivatives for the purposes of hedging underlying commercial risks related to interest rate and foreign currency exposures; (ii) 90% or more of which arise from financing that facilitates the purchase or lease of products; and (ii) 90% or more of which are manufactured by the parent company or another subsidiary of the parent company.  See id.  These requirements were not addressed by the Letter.

[6] See End-User Exception to the Clearing Requirement for Swaps, 77 Fed. Reg. 42,560, 42,564 (July 9, 2012).

[7] Letter at 4.  The CFTC further supported its position by noting that the third prong of the captive finance company test, which establishes a minimum percentage of business that must arise from financing that facilitates the purchase or lease of products, is to be assessed “on a consolidated basis” across the company, its parent company, and other affiliates of the parent company.  Id. at 3-4.  The CFTC also highlighted an exchange between certain U.S. senators in the legislative history suggesting that a wholly-owned subsidiary of a captive finance company should be able to use the end-user exception.  Id. at 4.