Back in October we wrote about an issue that had arisen which could affect issuers of catastrophe bonds and insurance-linked securities due to changing regulation in U.S. financial markets. Under the Dodd-Frank Act the definition of a ‘commodity pool’ was being expanded to include any entity which operates to trade in swaps. At the same time the definition of a swap was expanded by the Commodity Futures Trading Commission (CFTC) to better fit with Dodd-Frank.
The end result of these changes to regulation seemed to point towards many issuers of securitizations becoming classified as commodity pools and the concern was that it might include cat bond and ILS issuing entities. This would have put additional responsibilities on issuers, requiring them to have a CFTC registered Commodity Pool Operator (CPO) and Commodity Trading Advisor (CTA) which would have increased the legal and administrative burden of issuing a cat bond or ILS.
At the time, law firm Cadwalader said that unless ILS and cat bond issuers were exempted or specifically not considered as engaging in swap activity then they would likely become classified as commodity pools. Few securitization issuers are expected to get exemption, but one that may succeed is ILS and cat bond issues according to rating agency Moody’s.
In a briefing published today Moody’s says that a new letter from the CFTC where they clarified their position on exemptions from CFTC registration for operators of securitizations. The latest guidance has expanded the group of securitizations which are explicitly excluded from the need to register and Moody’s says this is ‘credit positive’ for the securitization market as a whole. Exemption allows securitization operators to continue managing risk through swaps while relieving them from any additional burden of registration Moody’s says.
ILS and cat bond issuers are not generally actively dealing in or managing risk through swaps anyway, but the previous guidance was not clear on whether they could be exempted from consideration as a commodity pool. The latest CFTC guidance makes this much clearer and Moody’s says that there is a chance that catastrophe bonds and ILS will now be one of a minority of structured products which are able to register for an exemption.
The CFTC has clarified that the original conditions for exemption that they set out in prior communications are not exhaustive and if a securitization keeps investments in the financial assets of the deal and not in swaps it would not be considered a commodity pool. This would seem to fit with an ILS or cat bond where the financial assets are investments which are held as collateral and are generally high-rated. Even in the case of a tri-party repurchase the underlying assets are held as collateral and no use of swaps to manage risk is seen.
Moody’s says that while it is by no means certain that catastrophe bonds and ILS will receive an exemption, the latest guidance would seem to point to them not fitting within the designation as commodity pools.
The deadline for non-exempt securitizations to register has been extended to the 31st March 2013. It’s vital that those involved in cat bond and ILS issuance get in touch with the CFTC and discuss the case for ILS becoming exempt, if indeed you feel that is the best route for the market to take. With a little extra time on your side to get registrations in place we’d advise following up the CFTC sooner rather than later.
You can read the latest letter from the CFTC here.