[Federal Register: March 21, 2003 (Volume 68, Number 55)]
[Notices]
[Page 13903-13906]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21mr03-45]
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COMMODITY FUTURES TRADING COMMISSION
In the Matter of Washington Mutual, Inc. and Its Various
Subsidiaries Request for Relief
AGENCY: Commodity Futures Trading Commission.
ACTION: Order.
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SUMMARY: In response to a request for relief from Washington Mutual,
Inc. and its various subsidiaries (collectively, "Washington
Mutual"), the Commodity Futures Trading Commission ("Commission"),
pursuant to section 1a(12)(C) of the Commodity Exchange Act ("Act"),
is issuing an order that provides that, subject to certain conditions,
Single Asset Development Borrowers ("SADBs") that have a natural
person, who is an eligible contract participant ("ECP"), acting as a
guarantor for the SADBs" over-the-counter ("OTC") derivatives
transactions, are "eligible contract participants" as that term is
defined in section 1a(12) of the Act. Accordingly, subject to certain
conditions as set forth in the Commission's order, an SADB acting for
its own account, whose obligations are guaranteed by a natural person
who is an ECP, is permitted to enter into certain OTC derivatives
transactions pursuant to section 2(c), 2(d)(1) and 2(g) of the Act.
DATES: This order is effective March 21, 2003.
[[Page 13904]]
FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Deputy Director or
Peter B. Sanchez, Attorney Advisor, Compliance and Registration
Section, Division of Clearing and Intermediary Oversight, Commodity
Futures Trading Commission, Three Lafayette Center, 1155 21st Street,
NW., Washington, DC 20581. Telephone: 202-418-5439 and 202-418-5236,
respectively. E-mail: [email protected] and [email protected],
respectively.
SUPPLEMENTARY INFORMATION:
I. Statutory Background
Section 1a(12) of the Act, as amended by the Commodity Futures
Modernization Act of 2000 ("CFMA"), Pub. L. 106-554, which was signed
into law on December 21, 2000, defines the term ECP by listing those
entities and individuals considered to be ECPs.\1\ Natural persons who
meet certain financial criteria are explicitly included in the ECP
definition to the extent that such persons transact in their individual
capacity. The section 1(a)(12) definition of ECP also includes certain
entities whose obligations are guaranteed by an ECP. Natural persons
are not among the permissible guarantors enumerated in section
1a(12).\2\
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\1\ Included generally in section 1a(12) as ECPs are financial
institutions; insurance companies and investment companies subject
to regulation; commodity pools and employee benefit plans subject to
regulation and asset requirements; other entities subject to asset
requirements or whose obligations are guaranteed by an ECP that
meets a net worth requirement; governmental entities; brokers,
dealers, and futures commission merchants ("FCMs") subject to
regulation and organized as other than natural persons or
proprietorships; brokers, dealers, and FCMs subject to regulation
and organized as natural persons or proprietorships subject to total
asset requirements or whose obligations are guaranteed by an ECP
that meets a net worth requirement; floor brokers or floor traders
subject to regulation in connection with transactions that take
place on or through the facilities of a registered entity or an
exempt board of trade; individuals subject to total asset
requirements; an investment adviser or commodity trading advisor
acting as an investment manager or fiduciary for another ECP, and
any other person that the Commission deems eligible in light of the
financial or other qualifications of the person.
\2\ Non-natural persons are permitted to act as guarantors for
an entity that would not otherwise be an ECP. Section 1a(12)(A)(v)
defines an ECP as, among other things, a "corporation, partnership,
proprietorship, organization, trust, or other entity" that (1) has
a net worth exceeding $1 million and that enters into agreements,
contracts or transactions in connection with the conduct of the
entity's business or to manage the risk associated with an asset or
liability that is owned or incurred; or (2) that has total assets
exceeding $10 million, the obligations of which are guaranteed or
otherwise supported by an entity described in 1(a)(12)(A)(i)
(financial institutions), (ii) (certain insurance companies), (iii)
(certain investment companies), (iv) (certain commodity pools), or
(vii) (government entities).
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In addition to specifying certain persons as ECPs, the Act gives
the Commission discretion to expand the ECP category. Specifically,
section 1a(12)(C) provides that the list of entities defined as ECPs
shall include "any other person that the Commission determines to be
eligible in light of the financial or other qualifications of the
person." Although the Washington Mutual letter was framed as a request
for a no-action letter, the Commission has determined, pursuant to
section 1a(12)(C) of the Act, to issue an order, subject to conditions,
that certain entities that have a natural person ECP as a guarantor are
ECPs.
II. The Washington Mutual Letter
A. Introduction
By letter to the Division of Clearing and Intermediary Oversight
("Division"), Washington Mutual submitted a request for a no-action
letter pursuant to Commission rule 140.99.\3\ Specifically, Washington
Mutual, acting on behalf of itself and unnamed SADBs who wish to enter
into OTC transactions with Washington Mutual, requested a no-action
letter pursuant to rule 140.99 stating that the Division would not
recommend enforcement action if SADBs, when guaranteed by a natural
person who is an ECP, entered into certain OTC transactions.
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\3\ The request was presented by a letter dated October 22,
2002, to the Director of Division of Trading and Markets from Jacob
Scholl, counsel for Washington Mutual. As of July 1, 2002, a
reorganization of the Commission became effective. The Division of
Clearing and Intermediary Oversight is the successor to the Division
of Trading and Markets.
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SADBs are entities that develop a single piece of commercial real
estate. Because SADB clients typically borrow amounts nearly equal to
the value of the real estate to be developed, they usually have a low
net worth (less than $1 million). Washington Mutual acts as a lender to
several SADBs.
Washington Mutual wishes to engage in OTC derivatives transactions
with these SADBs in order to allow the SADBs to hedge their operating
risks from interest rates, or foreign currencies, but the SADBs do not
qualify as ECPs because they do not possess $10 million in total assets
or $1 million in net worth as required by section 1a(12)(A)(v) of the
CEA. Natural persons who are ECPs with over $10 million in assets are
willing to act as guarantors of SADBs for the OTC transactions, but
absent a finding that the ECP definition should be expanded to include
entities with natural-person ECPs as guarantors, an SADB with a
natural-person ECP as a guarantor will not qualify as an ECP. This
presents a matter of first impression for the Commission.
Washington Mutual represents that the permissible OTC transactions
would be limited to trading in OTC derivatives that are necessary for
the SADB to hedge the risk that the SADB is exposed to, or reasonably
likely to be exposed to, as a result of the SADB's operations. The
trading in the OTC derivatives will be limited to transactions that
constitute hedging transactions.
Washington Mutual further proposed that such transactions would be
subject to additional conditions and restrictions detailed in the
petition and described below.
B. Public Interest Considerations
In its letter, Washington Mutual stated that it is good public
policy for the Commission to permit SADBs to have natural persons
acting as guarantors.
First, Washington Mutual stated that failure to grant the requested
relief would limit the opportunity of SADBs to manage their business
risk.
Second, Washington Mutual stated that failure to grant the
requested relief would yield the unusual result that the guarantor, as
an individual, would be permitted to enter into derivative
transactions, but that an entity which is fully guaranteed by the same
individual may not.
Moreover, a natural person could form a single shareholder
corporation or single member limited liability company and be eligible
to engage in the same kind of contracts directly, as an ECP, or
indirectly as a guarantor. Forming a corporation or LLC that qualifies
as an ECP, however, would tie up a great deal of the natural person's
assets.
Third, the CEA permits commodity pools with assets of over $5
million that are operated by commodity pool operators ("CPOs")
subject to regulation under the Act (or a similarly situated foreign
person) to act as guarantors. Conceivably, a collection of several
investors, each of whom need not have enough assets to qualify as an
ECP, could form a commodity pool and invest in the same type of
derivatives directly, acting as an ECP, or indirectly as a guarantor.
Because the bank and an individual can engage in derivative
transactions among themselves, permiting the individual to guarantee a
third party for the same type of transaction should not be
objectionable--particularly if the derivatives transactions are limited
solely to hedging transactions.
III. Conclusion
After consideration of the Washington Mutual letter, the Commission
has determined that SADBs, subject to
[[Page 13905]]
certain conditions, are eligible to be ECPs as that term is defined in
section 1a(12) of the Act. Under the terms of this order, the SADBs
would meet the financial qualifications of an ECP by having a financial
guarantee for the OTC transactions from a natural person who is an ECP
and by satisfying certain minimum financial requirements.
Accordingly, the Commission has determined to issue an order,
pursuant to section 1a(12)(C) of the Act, subject to certain
conditions, that SADBs as described herein with a natural person who is
an ECP acting as guarantor qualify as ECPs. The order permits the SADBs
to enter into OTC transactions pursuant to section 2(c), 2(d)(1) and
2(g) of the Act.
IV. Cost Benefit Analysis
Section 15 of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation or order under the Act. By its
terms, section 15 does not require the Commission to quantify the costs
and benefits of its action or to determine whether the benefits of the
action outweigh its costs. Rather, section 15 simply requires the
Commission to "consider the costs and benefits" of the subject rule
or order.
Section 15(a) further specifies that the costs and benefits of the
proposed rule or order shall be evaluated in light of five broad areas
of market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness, and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
may, in its discretion, give greater weight to any one of the five
enumerated areas of concern and may, in its discretion, determine that,
notwithstanding its costs, a particular rule or order is necessary or
appropriate to protect the public interest or to effectuate any of the
provisions or to accomplish any of the purposes of the Act.
The order is intended to reduce regulatory barriers to permit
SADBs, when acting in a proprietary capacity, with a natural person who
is an ECP as guarantor, to enter into OTC transactions for hedging
purposes. The Commission has considered the costs and benefits of the
order in light of the specific provisions of section 15(a) of the Act.
A. Protection of Market Participants and the Public
The order would permit an SADB to participate in the OTC markets,
subject to a guarantee from a natural person who qualifies as an ECP.
Accordingly, there should be no effect on the Commission's ability to
protect market participants and the public.
B. Efficiency and Competition
The order is not expected to have an effect on efficiency or
competition.
C. Financial Integrity of Futures Markets and Price Discovery
The order should have no effect, from the standpoint of imposing
costs or creating benefits, on the financial integrity of the futures
and options markets.
D. Sound Risk Management Practices
The order should have no effect, from the standpoint of imposing
costs, on the risk management practices of the OTC derivatives, futures
or options industry.
E. Other Public Interest Considerations
The order will have the positive effect of allowing SADBs to hedge
the risks that they may be exposed to as a result of their business
operations.
V. Order
Upon due consideration, and pursuant to its authority under section
1a(12)(C) of the Act to determine that persons other than those
enumerated in the Act are ECPs in light of the financial or other
qualifications of these persons, the Commission hereby determines that
an SADB, whose OTC derivatives obligations are guaranteed by a natural
person who is an ECP, is an eligible contract participant and may enter
into OTC derivatives contracts, agreements or transactions under the
following conditions:
1. The contracts, agreements or transactions must be entered into
pursuant to section 2(c), 2(d)(1) or 2(g) of the Act.
2. Washington Mutual must verify that each natural-person ECP
guarantor to an SADB meets the financial requirements to be an ECP as a
natural person, pursuant to section 1a(12)(A)(xi)(I).
3. The SADB must have obtained a financial guarantee for the
contracts, agreements or transactions from a natural person that meets
the qualifications to be an ECP as such term is currently defined in
section 1(a)(12)(A)(xi)(I) of the Act and as may be amended from time
to time.
4. An SADB may engage in OTC derivatives contracts, agreements or
transactions only to the extent that such OTC derivatives contracts,
agreements or transactions are necessary to hedge the risk associated
with an asset or liability owned or incurred or reasonably likely to be
owned or incurred by an SADB in the conduct of its business.
5. SADBs may only engage in OTC derivatives trades with Washington
Mutual if they have an existing lending relationship with Washington
Mutual and they act in a principal capacity with Washington Mutual.
6. A guarantor must compute its net worth and total assets in
accordance with generally accepted accounting principles consistently
applied.
7. Natural persons acting as guarantors must unconditionally
guarantee the full amount of an SADB's OTC derivatives contracts,
agreements or transactions.
8. Washington Mutual will keep records relating to its OTC
derivative contracts, agreements and transactions with SADBs and their
guarantors under this Order, including documentation demonstrating
compliance with conditions 2, 3, 4, 5 and 7 of this order, the levels
of OTC trading and the number of SADBs and guarantors who participated
in these activities. Such records shall be made available upon the
request of any representative of the Commission, the Department of
Justice, Washington Mutual's banking regulators or any other
governmental entity with jurisdiction over Washington Mutual or the OTC
derivatives transactions in question.
This Order is based upon the representations made and supporting
material provided to the Commission by Washington Mutual. Any material
changes or omissions in the facts and circumstances pursuant to which
this Order is granted might require the Commission to reconsider its
finding that the provisions set forth herein are appropriate. Further,
if experience demonstrates that the continued effectiveness of this
Order would be contrary to the public interest, the Commission may
condition, modify, suspend, terminate or otherwise restrict the
provisions of this Order, as appropriate, on its own motion. This Order
pertains only to OTC derivative transactions that are not contrary to
banking laws and regulations that may otherwise govern Washington
Mutual's conduct.
[[Page 13906]]
Issued in Washington, DC, on March 17, 2003, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-6774 Filed 3-20-03; 8:45 am]
BILLING CODE 6351-01-P