CFTC Grants No Action Relief to Commodity Pool Operators with Respect to Certain Insurance-Linked Securitization Vehicles

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CFTC GRANTS NO-ACTION RELIEF TO COMMODITY POOL
OPERATORS WITH RESPECT TO CERTAIN INSURANCE-LINKED
SECURITIZATION VEHICLES
Daphne G. Frydman, Brian Barrett, and Raymond A. Ramirez
February 3, 2015
Toward the end of 2014, the staff of the Commodity Futures Trading Commission’s (“CFTC”) Division of Swap Dealer
and Intermediary Oversight (“DSIO”) issued two letters affecting insurance-linked securitization vehicles: CFTC Letter
No. 14-145[1] and CFTC Letter No. 14-152.[2]
Both CFTC Letters 14-152 and 14-145, which are summarized below, afford relief from certain Commodity Pool Operator
(“CPO”) compliance obligations. Although Letter 14-145 preceded Letter 14-152, the summary begins with Letter 14-152
because Letter 14-145 is a no-action letter that was issued to a specific (and anonymous) market participant and cannot
be relied on by other market participants. In contrast, Letter 14-152 was addressed to the Securities Industry and Financial
Markets Association (“SIFMA”) and affords industry-wide relief from CPO registration to certain entities that engage in
insurance-linked securities transactions.
CFTC Letter 14-152
Letter 14-152, which was issued on December 18, 2014, permits certain entities that engage in insurance linked securities
(“ILS”) transactions to avail themselves of the exemption from CPO registration afforded by CFTC Rule 4.13(a)(3), so long
as certain conditions, described below, are met.[3] The relief afforded by Letter 14-152 is not self-executing and must be
claimed with the National Futures Association (“NFA”), as is generally the case with regard to the CFTC Rule 4.13(a)(3)
exemption. The relief afforded by Letter 14-152 is not time limited and, therefore, so long as such relief is not amended
or revoked, it can be relied on indefinitely.
Rule 4.13(a)(3) and Why Relief is Necessary
Under the Commodity Exchange Act (“CEA”), as interpreted by the CFTC, any collective investment vehicle that engages
in even one commodity interest transaction (i.e., a futures, option or swap) could be a “commodity pool.”[4] The operator
of a commodity pool is required to register as a “commodity pool operator” with the CFTC, unless it is eligible for an
exemption from CPO registration or an exclusion from CPO status. To the extent that an entity is eligible for an
exemption from CPO registration or an exclusion from CPO status, such entity is not required to satisfy the compliance
obligations applicable to CPOs.
An ILS issuer is a vehicle of pooled assets through which investors (i.e., bondholders) obtain exposure to specified
trigger events. The mechanism by which this is accomplished is the risk transfer contract between the ILS issuer and the
Protection Buyer. To the extent that such risk transfer contract could be considered a swap, then the ILS issuer would be
a commodity pool, and the ILS issuer’s operator could be required to register as a CPO.[5]
There are numerous exclusions and exemptions from CPO status and CPO registration, respectively. Among them is
CFTC Rule 4.13(a)(3). Rule 4.13(a)(3) exempts persons from registration if four criteria are met:
1. Interests in the relevant commodity pool are exempt from registration under the Securities Act of 1933, and such
interests are offered and sold without marketing to the public in the United States;
2. The commodity pool must at all times meet a de minimis commodity interest trading activity threshold. Namely,
either (a) the margins, premiums and required minimum security deposit for retail forex transactions cannot
exceed five percent of the liquidation value of the commodity pool’s assets after giving effect to unrealized profits
or losses, or (b) the aggregate net notional value of the commodity pool’s commodity interest positions, determined
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at the time the most recent position was established, cannot not exceed 100 percent of the liquidation value of
the commodity pool’s portfolio, after taking into account unrealized profits and unrealized losses;
3. The operator of the commodity pool believes, at the time of investment, that each investor in the pool meets
one of certain enumerated tests relating to the financial sophistication of the investor (e.g., accredited investor
or qualified eligible person); and
4. Participations in the commodity pool are not marketed as or in a vehicle for trading in commodity interests.[6]
SIFMA, in its representations to the CFTC staff, indicated that ILS transactions typically satisfy the first three of Rule
4.13(a)(3)’s four criteria for relief:
- According to Letter 14-152, ILS issuers offer their bonds in private placements and such bonds are exempt from
registration under the Securities Act of 1933, and the bonds are not offered or sold through marketing to the
public in the United States. Thus, such ILS transactions meet Rule 4.13(a)(3)’s first condition for relief.
- Moreover, ILS issuers can, and according to SIFMA will, comply with Rule 4.13(a)(3)’s de minimis threshold.
- Last, ILS transactions are typically only sold to sophisticated institutional investors meeting the qualified eligible
purchaser standard, in compliance with Rule 4.13(a)(3)’s third condition for relief.
However, because the risk transfer contract is the mechanism by which bondholders obtain exposure to insurance-linked
risk, according to the CFTC, it is difficult to argue that ILS transactions are not the primary source of investment gains
and losses to the bondholders. Therefore, ILS transactions, whose underlying risk transfer agreement is a swap, could,
according to the CFTC, “involve the marketing of ILS Issuers and their Bonds as vehicles for investing interests in violation
of the fourth prong of Regulation 4.13(a)(3).”
According to Letter 14-152, ILS transactions are typically offered via an offering circular that includes a risk analysis report,
prepared by an independent company, that uses models widely employed by insurers and reinsurers in their own risk
evaluations. The risk analysis forms much of the basis on which bonds are evaluated, rated and priced. Following numerous
representations from SIFMA, the CFTC staff deemed it appropriate to characterize (1) the marketing efforts associated
with ILS transactions as focused on the analysis and statistical modeling of insurance risks to and for which the Protection
Buyer is actually exposed, and (2) the risk transfer contract as merely a conduit to transmit the insurance-related risks of
the Protection Buyer through the ILS issuer to the bondholders.
Relief Granted
Based on SIFMA’s representations and the CFTC staff’s conclusions resulting therefrom, Letter 14-152 permits ILS issuers
to avail themselves of the CFTC Rule 4.13(a)(3) exemption provided that they meet the following requirements:
1. The operator of the ILS issuer meets the first three conditions for exemption of CFTC Rule 4.13(a)(3).
2. The operator of the ILS issuer files a notice of eligibility for exemption from CPO registration with the NFA in
accordance with the requirements of CFTC Rule 4.13(b) (which also requires an annual reaffirmation of the
exemption).
3. The ILS issuer is operated in the following manner:
- There is no active management of assets and liabilities over the lifetime of the ILS issuer.
- The collateral (Eligible Collateral) held by the ILS issuer must at all times:
A. Be in the form of cash or cash-equivalent, “highly-liquid” assets, i.e., assets that can be converted into
cash within one business day without a material discount in value, limited to:
i. Puttable debt issued by the International Bank for Reconstruction and Development, the European
Bank for Reconstruction and Development, or the Kreditanstalt für Wiederaufbau;
ii. Any U.S. or European Union-regulated money market fund that invests solely in debt issued by the
U.S. Treasury or U.S. sponsored agencies, or repurchase and reverse repurchase agreements
collateralized by debt issued by the U.S. Treasury or U.S. sponsored agencies;
iii. Other assets that are “highly liquid” under CFTC Rule 1.25; or
iv. Any other CFTC- or DSIO-approved collateral; and

B. Either have a maturity date that falls on or before the termination date of the risk transfer contract
entered into by the ILS issuer, or be convertible to cash upon demand by the ILS issuer.
4. Upon becoming aware that the value of collateral held by the ILS issuer is less than the notional amount of the
relevant risk transfer contract, the ILS issuer (a) shall promptly notify the DSIO of the same in writing, and copies
of such notice must be provided to the Protection Buyer and the bondholders pursuant to the notice procedures
in the applicable transaction documentation, and (b) shall neither issue any additional bonds nor enter into any
commodity interest transactions for so long as such deficiency exists.
5. The payment obligations of the ILS issuer to the Protection Buyer and to the bondholders must be secured by
Eligible Collateral, and the security arrangements must provide that obligations to the Protection Buyer under
the relevant risk transfer contract will be satisfied from the Eligible Collateral prior to any proceeds of the Eligible
Collateral being used to repay principal to the bondholders.
6. The Eligible Collateral shall be maintained by the ILS issuer so that it is available to be distributed in the form of
cash or in kind to the Protection Buyer at the time a payment becomes due under the risk transfer contract.
7. The Eligible Collateral held by the ILS issuer shall be subject to arrangements that protect the Protection Buyer in
the event that the ILS issuer becomes subject to an insolvency proceeding. This condition will be satisfied if the
ILS issuer satisfies the following criteria:
- The powers of the ILS issuer shall be limited so that the ILS issuer may not engage in business or activity other
than as necessary or appropriate for serving as an ILS vehicle;
- The ILS issuer can be restricted from incurring additional debt, except as may be necessary or appropriate for
entering into additional ILS offerings in the case of a multi-user issuer, in which case the obligation to repay
such additional debt shall be secured solely by additional Eligible Collateral obtained in connection with such
additional ILS offering;
- The ILS issuer shall be restricted from entering into any additional commodity interest transactions beyond the
swap transaction necessary for the ILS offering, except that in the case of a multi-use ILS issuer, the ILS issuer
may enter into additional swaps to the extent it is necessary or appropriate in order to enter into additional
ILS offerings;
- The ILS issuer shall be governed by a board of directors (or other similar body) comprised of individuals
independent of the Protection Buyer;
- Corporate formalities shall be observed between the ILS issuer, on the one hand, and the Protection Buyer
and affiliates of the Protection Buyer;
- As a condition to any agreement imposing obligations on the ILS issuer, the interest holders, the Protection
Buyer and any potential creditors of the ILS issuer shall be required to waive any right to file an involuntary
bankruptcy petition for the ILS issuer or otherwise initiate a solvency, liquidation, dissolution, or other action
having a substantially similar effect with respect to the ILS issuer; and
- The ILS issuer shall be prohibited from filing a voluntary petition for bankruptcy and from engaging in a
merger, asset sale, consolidation, liquidation, dissolution, or other action having a substantially similar effect.
CFTC Letter 14-145
Letter 14-145, which was issued on November 12, 2014, relieves an anonymous registered CPO, “A,” from having to
satisfy the CPO financial statement delivery requirements under CFTC Rule 4.22 and the disclosure requirements of CFTC
Rule 4.24(s), in each case with respect to an ILS issuer.[7] Because Letter 14-145 is a no-action letter that is addressed to
a specific market participant, it cannot be relied on by market participants generally. However, it is nevertheless useful
because it provides insight into the CFTC staff’s view of ILS transactions within the context of the CPO regulatory regime.
Background
As described in Letter 14-145, the ILS issuer in question entered into a risk transfer agreement to transfer excess
mortality life insurance risk from an insurance company, C, and certain of its affiliates (the Protection Buyer), to investors
in insurance- linked notes issued by the ILS issuer and pursuant to which the Protection Buyer agreed to make quarterly
payments to the ILS issuer in exchange for the ILS issuer’s commitment to make payments to the Protection Buyer upon
the occurrence of certain excess mortality events. The quarterly payments made by the Protection Buyer, together with

investment returns on collateral held by the ILS issuer resulting from the sale of the insurance-linked notes, fund the
interest payments to the holders of the ILS issuer’s insurance-linked notes. Such returns were generated from investment
in a pool of “high-quality instruments,” including “AAA” rated bonds and U.S. Treasury-only money market funds.
Relief Granted from CFTC Rules 4.22 and 4.24(s)
CFTC Rule 4.22
CFTC Rule 4.22 requires a registered CPO to distribute periodic account statements and annual reports to each pool
participant and to submit copies of such statements and reports to the NFA.[8] The purpose of CFTC Rule 4.22 is to
ensure that commodity pool participants receive accurate, fair and timely information on the overall trading performance
and financial condition of the pool.
As argued, the provision of periodic account statements and annual reports to the holders of the ILS issuer’s notes, in
accordance with CFTC Rule 4.22, would not provide relevant information to the holders of the ILS issuer’s notes. This is
because the ILS issuer in question has predefined assets and liabilities and its activities largely consist of holding eligible
investments, receiving quarterly payments from the Protection Buyer, and using such investments and payments, as
applicable, to pay its obligations under the risk transfer agreement or to investors in accordance with the terms of the
ILS issuer’s notes. Thus, there is no management of assets and liabilities over the lifetime of the ILS issuer. As a result of
A’s representations concerning the ILS issuer, the staff of the DSIO deemed it appropriate to replace the requirements of
CFTC Rule 4.22 with the disclosures required as conditions for relief, described below, certain of which are already made
by the ILS issuer in an Offering Circular Supplement provided by the ILS issuer to the holders of its notes.
CFTC Rule 4.24(s)
CFTC Rule 4.24 requires a registered CPO to make certain general disclosures, in a disclosure document, to each prospective
participant in a pool that it operates.[9] Among such disclosures are those required by subsection (s) of Rule 4.24, which
relate to the inception of trading of a commodity pool. Specifically, CFTC Rule 4.24(s) requires the disclosure of:
1. the minimum aggregate subscriptions that are necessary for a commodity pool to commence trading;
2. the minimum and maximum aggregate subscriptions that may be contributed to a commodity pool;
3. the maximum period of time that a pool will hold funds prior to the commencement of trading;
4. the disposition of funds received if a commodity pool does not receive the necessary amount to commence
trading, including the period of time within which the disposition will be made; and
5. where a CPO will deposit funds received prior to the commencement of trading by a pool.
The principal purpose of these disclosures is to ensure that commodity pool participants are informed about the material
facts regarding a commodity pool before they commit their funds.
In its request for relief, A argued that CFTC Rule 4.24(s) is not applicable to the ILS issuer in question due to the structure
of ILS transactions. According to A, the information about subscriptions is known ahead of closing and disclosed in the
offering prospectus supplement and pricing settlement, because a predefined principal amount of the notes is to be
issued. In addition, the other disclosures required by CFTC Rule 4.24(s) are irrelevant because the risk transfer agreement
between the ILS issuer and the Protection Buyer is entered into concurrently with the issuance of notes to investors by
the ILS issuer. Based on these representations, the staff of the DSIO deemed it appropriate to afford relief from the Rule
4.24(s) disclosure requirements, subject to the conditions for relief described below.
The Conditions for Relief
The CFTC granted relief to A from the requirements of CFTC Rules 4.22 and 4.24(s) on the following conditions:
1. That A provide the holders of the ILS issuer’s notes with the following information on at least a monthly basis:
- All payments that have been made during the month prior pursuant to the risk transfer agreement, and all
payments that have at least a reasonable possibility of being payable pursuant to the risk transfer agreement.
- Material performance information concerning the assets supporting the ILS issuer’s notes or the obligations
under the risk transfer agreement, including without limitation, any swaps held in the issuer’s portfolio.

2. That A provide the holders of the ILS issuer’s notes with basic, material information concerning all of the
following, to the extent an existing investor has not received such information, at the same time or before the
information required above is first provided:
- The terms and conditions of the risk transfer agreement, including the risks agreed to be borne by the ILS
issuer;
- The structure of the securities and distributions thereon;
- The nature and servicing of the assets supporting the ILS issuer’s notes and the obligations under the risk
transfer agreement including, without limitation, a discussion of any swaps held in the ILS issuer’s portfolio,
including the function of such swaps; and
- The ILS issuer’s counterparties.
3. To prospective holders of the ILS issuer’s notes, A must provide the most recent copy of the information required
to be provided to the existing holders of notes of the ILS issuer that are described immediately above.
4. If A knows or should know that the above information is materially inaccurate or incomplete in any respect, it
must correct the defect and distribute the correction consistent with the CFTC’s rules concerning the correction
of disclosure documents, which are found in CFTC Rule 4.26(c).
5. There is to be no management of assets or liabilities over the lifetime of the ILS issuer.
6. A must calculate net asset value with respect to the ILS issuer in the following manner:
- Fixed income securities rated BB and higher should be treated as debt.
- All other fixed income securities and equity tranches should be treated as equity.
Finally, Letter 14-145 does not excuse A from complying with other applicable requirements under the CEA or CFTC
regulations promulgated thereunder.
APPENDIX A
ILS Transaction Summary
The relief afforded in Letter 14-152 is premised on the following ILS transaction structure, which market participants will
note is consistent with the typical structure used in the market. Thus, Letter 14-152 should have some general applicability.
ILS transactions allow insurance companies (Protection Buyers) to obtain collateralized protection against insurance-
related risks from the capital markets, pursuant to a risk transfer contract with an ILS issuer, which is a special purpose
vehicle formed by the Protection Buyer.
In an ILS transaction, a Protection Buyer will form an ILS issuer. The Protection Buyer and the ILS issuer subsequently enter
into a risk transfer contract, pursuant to which the ILS issuer agrees to make payments to the Protection Buyer if certain
trigger events occur. The example used in Letter 14-152 is that of an insurance company that has historically had exposure
to California earthquakes. Such an insurance company could create an ILS issuer and contract with such issuer to receive
payments if a California earthquake occurs, and the Protection Buyer must pay claims to earthquake insurance policyholders.
To support its obligations under the risk transfer contract, an ILS issuer sells bonds, notes, certificates or other instruments
(Bonds) in an amount equal to its maximum exposure under the risk transfer contract. Bonds are only sold to persons who
are qualified institutional buyers that, with respect to U.S. persons, are also qualified purchasers.[10] All proceeds of the
Bonds are deposited into a collateral account. Upon the occurrence of a specified trigger event (e.g., an earthquake in
California, in the above example), the ILS issuer pays the contractual payment amount to the Protection Buyer from the
collateral account. Coverage provided by the ILS issuer cannot exceed the collateralized amount. When amounts are
transferred from the collateral account to cover a specified trigger event under a risk transfer contract, the aggregate
principal amount of the Bonds is written down in the amount of such transfer.
As part of the risk transfer contract, the Protection Buyer makes payments to the ILS issuer to cover the ILS issuer’s expenses
and to pay interest to the holders of the Bonds (Bondholders). The Bondholders’ interest rate payments consist of a
portion of the Protection Buyer’s payments plus the earnings on investments of the proceeds from the Bond issuance.
At maturity and upon satisfaction of the risk transfer contract obligations to the Protection Buyer, funds from the collateral
account are used for repayment of the remaining principal balance of the Bonds to the Bondholders.

Notes
[1] http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-145.pdf.
[2] http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-152.pdf.
[3] See Appendix A for a description of the ILS transaction structure for which Letter 14-152 affords relief.
[4] See 77 Fed. Reg. 11,252 (Feb. 24, 2012) at 11,258. See also 7 U.S.C. § 1a(10).
[5] The term “swap” is broadly defined. See Section 1a(47) of the CEA and the joint CFTC and Securities and Exchange
Commission regulations adopted to further define the term, 77 Fed. Reg. 48,207 (Aug. 13, 2012).
[6] See 17 C.F.R. § 4.13(a)(3) (2014).
[7] The directors of the ILS issuer in question delegated their CPO obligations with respect to the ILS issuer to A, and such
delegation satisfied the CPO-delegation requirements outlined in CFTC Letter No. 14-126.
[8] 17 C.F.R. § 4.22 (2014).
[9] 17 C.F.R. § 4.24(s).
[10] Qualified purchasers are “qualified eligible persons” as defined in CFTC Regulation 4.7(a), 17 C.F.R. § 4.7(a) (2014).
About The Authors
Daphne G. Frydman is a partner in Sutherland Asbill Brennan’s Washington D.C. office. She helps companies in the
financial services industry raise capital through a broad range of financing, including life insurance reserve securitizations,
and general corporate finance transactions including senior debt financing, structured finance, convertible notes, and retail
notes. She may be contacted at daphne.frydman@sutherland.com.
Brian Barrett is a partner in Sutherland Asbill Brennan’s New York office. He advises insurers, reinsurers, banks, broker-
dealers, hedge funds, and asset managers on all aspects of structured finance, secured lending, and derivatives. He may be
contacted at brian.barrett@sutherland.com.
Raymond A. Ramirez is an associate at Sutherland Asbill Brennan, where he represents clients in matters related to
derivatives and structured products, and counsels clients on compliance with the Dodd-Frank Act. He may be contacted at
ray.ramirez@sutherland.com.

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CFTC Grants No Action Relief to Commodity Pool Operators with Respect to Certain Insurance-Linked Securitization Vehicles

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