October 15, 2012 CFTC Relief and Guidance as the “Swap” Definition Takes Effect CFTC Issues Interpretive and No-Action Letters, and Responds to Questions Providing Guidance as the Definition of “Swap” Takes Effect SUMMARY The Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”, collectively with the SEC, “Commissions”)1 adopted rules further defining key terms under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) including “swap dealer”, “major swap participant”, “security-based swap dealer”, “major security-based swap participant” and “eligible contract participant” (the “Entity Definitions”), and subsequently adopted rules further defining additional key terms under Title VII of Dodd-Frank (“Title VII”) including “swap”, “security-based swap” and “mixed swap” (the “Product Definitions”).2 The Product Definitions generally took effect on October 12, 2012, triggering a number of regulatory obligations under Title VII, except that for purposes of certain relief from SEC requirements, the effective date of the definition of “security-based swap” will be February 11, 2013.3 On October 10-12, the CFTC issued an unprecedented 13 interpretive and no-action letters as well as three sets of responses to questions previously submitted by industry participants. The letters and other guidance provide clarifications and relief in a number of areas, including: Clarification as to the timing of certain restrictions relating to swap customer collateral. Temporary no-action relief applicable to transactions that may be exempt under pending proposals to exempt certain transactions in electricity markets and certain transactions involving not-for-profit electric cooperatives. Interpretive relief for certain real estate investment trusts (“REITs”) and securitization vehicles from meeting the definition of “commodity pool” under Section 1a(10) of the Commodity Exchange Act (“CEA”). New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com Temporary no-action relief from registration requirements for persons required to register as a introducing broker (“IB”), CPO, CTA, floor broker (“FB”), floor trader (“FT”), or an associated person of an FCM, IB, CPO or CTA, solely by virtue of involvement with swaps and/or certain CME/ICE Contracts. Temporary no-action relief relating to certain swap transactions in exempt and agricultural commodities, including with respect to transactions cleared through CME Group (“CME”) and Intercontinental Exchange (“ICE”) that are being transitioned to a futures model. Interpretive guidance and no-action relief relating to the restriction against a person that is not an eligible contract participant (“ECP”) from entering into a swap unless the swap is entered into on, or subject to the rules of, a designated contract market (“DCM”). Temporary no-action relief that effectively raises the de minimis threshold under the definition of “swap dealer” from $25 million to $800 million with respect to certain swap dealing transactions conducted with special entities that are utilities. Interpretive relief for calculating whether a registered investment company meets certain thresholds for being exempt from CPO registration requirements under Section 4.5 of the CEA. Temporary no-action relief from swap dealer (“SD”), major swap participant (“MSP”), commodity pool operator (“CPO”), and commodity trading advisor (“CTA”) registration requirements on account of foreign exchange forward and foreign exchange swap transactions. Temporary no-action relief for transactions between non-U.S. counterparties for purposes of SD/MSP calculations. Responses to questions relating to the definitions of “swap dealer” and “major swap participant”. Responses to questions relating to the timing of reporting obligations and the reporting of cleared swaps. A more detailed, but still summary, analysis of these issuances is provided below.4 RELIEF REGARDING TIMING OF SWAP COLLATERAL SEGREGATION On October 10, 2012, the CFTC issued temporary no-action relief (“Letter 12-10”) until November 8, 2012 with respect to the statutory requirement for the segregation of cleared swaps collateral held at a derivatives clearing organization. Dodd-Frank amended the CEA to require the segregation of customer collateral held by a derivatives clearing organization (“DCO”) and a futures commission merchant (“FCM”) on behalf of customers (such collateral, “Customer Swaps Collateral”) from collateral posted with respect to proprietary accounts of the FCM. In addition, an FCM and a DCO that receives Customer Swaps Collateral with respect to cleared swap positions must treat such Customer Swaps Collateral as belonging to the relevant customer and cannot use that Customer Swaps Collateral to margin or secure its own swap positions or any other customer’s cleared swap positions. In February of 2012, the CFTC adopted rules implementing these statutory requirements and imposing a legally segregated, operationally commingled model (“LSOC”).5 The compliance date for the LSOC rules is November 8, 2012. Letter 12-10 clarifies that the statutory requirements as to segregation of Customer Swaps Collateral do not apply until November 8, 2012.6 It should be noted that the CFTC did not provide no- action relief from the requirement that cleared swaps be treated as “commodity contracts” under the U.S. bankruptcy code.7 -2- CFTC Relief and Guidance as the “Swap” Definition Takes Effect October 15, 2012 RELIEF FOR RTO/ISO TRANSACTIONS On October 11, 2012, the CFTC issued no-action relief (“Letter 12-11”)8 relating to its August 28, 2012 proposed order to exempt certain transactions involving independent system operators and regional transmission organizations (the “Proposed ISO-RTO Order”)9 from the provision of the CEA and the CFTC Regulations thereunder other than provisions relating to the CFTC’s general anti-fraud, anti- manipulation and enforcement authority. The Proposed ISO-RTO Order would exempt “Financial Transmission Rights”, “Energy Transactions”, “Forward Capacity Transactions”, and “Reserve or Regulations Transactions” (as defined in the Proposed ISO-RTO Order) with certain independent system operators or regional transmission organizations. Letter 12-11 provides no-action relief whereby it will exempt these transactions on the terms set forth in the Proposed ISO-RTO Order. This relief will expire on the earlier of March 31, 2013 or the effective date of any CFTC final action with respect to the Proposed ISO-RTO Order. RELIEF FOR COOP TRANSACTIONS On October 11, 2012, the CFTC issued no-action relief (“Letter 12-12”)10 relating to its August 23, 2012 proposed order to exempt certain transactions involving not-for-profit electric utilities (the “Proposed Coop Order”)11 from provisions of the CEA and CFTC Regulations thereunder other than provisions relating to the CFTC’s general anti-fraud, anti-manipulation and enforcement authority. The Proposed Coop Order was in response to an industry petition (the “Coop Petition”), and would exempt an “Electric Operations- Related Transaction” (as defined in the Coop Petition) solely between “NFP Electric Entities” (as defined in the Coop Petition) from the provision of the CEA (excepting the CFTC’s general anti-fraud, anti- manipulation and enforcement provisions). Letter 12-12 grants no-action relief whereby it will exempt Electric Operations Related Transactions between NFP Electric Entities on the terms set forth in the Coop Petition. This relief will expire on the earlier of March 31, 2013 or the effective date of any final CFTC action taken with respect to the Proposed Coop Order. RELIEF FOR REAL ESTATE INVESTMENT TRUSTS FROM COMMODITY POOL STATUS On October 11, 2012, the CFTC issued Interpretive Letter 12-13 (“Letter 12-13”) defining the term “commodity pool” to exclude certain real estate investment trusts (“REITs”).12 In response to a request for interpretive guidance stating that equity REITs are operating companies that hold income-producing real estate and engage in real estate management activities and are not within the statutory definition of a “commodity pool,” Letter 12-13 provides that a REIT meeting the following criteria would not meet the definition of “commodity pool” as that term is used under Section 1a(10) of the CEA and Section 4.10(d) of the CFTC’s Regulations: -3- CFTC Relief and Guidance as the “Swap” Definition Takes Effect October 15, 2012 The REIT primarily derives its income from the ownership and management of real estate and uses derivatives for the limited purpose of “migitat[ing] their exposure to changes in interest rates or fluctuations in currency”; The REIT is operated so as to comply with all of the requirements of a REIT election under the Internal Revenue Code, including 26 U.S.C. § 856(c)(2) and 26 U.S.C. § 856(c)(3);13 and The REIT has identified itself as an equity REIT in Item G of its last U.S. income tax return on Form 1120-REIT and continues to qualify as such, or, if the REIT has not yet filed its first tax filing with the Internal Revenue Service, the REIT has stated its intention to do so to its participants and effectuates its stated intention. Taken together, the Letter 12-14 (as defined below) and Letter 12-13 provide further guidance regarding the distinction the CFTC has made between operating companies, which may engage in commodity interest transactions, but are not considered to be “commodity pools,” and true