United States: U.S. Commodity Futures Trading Commission Issues No-Action

Keywords: insurance-linked securities, CFTC, CPO, ILS

On December 18, 2014, the U.S. Commodity Futures Trading Commission (CFTC) issued a no-action letter (CFTC Letter 14-152) providing relief from commodity pool operator (CPO) registration for operators of certain insurance-linked securities (ILS) issuers. As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) and CFTC regulations promulgated there-under, there had been some uncertainty as to whether an ILS issuer could fall within the newly-expanded definition of "commodity pool" to the extent that the underlying risk transfer contract could be considered a "swap." The CFTC no-action letter was issued in response to a Securities Industry and Financial Markets Association (SIFMA) request that was formally made in August 2014 after many months of discussions with the staff of the CFTC.


The Commodity Exchange Act (CEA) defines a "commodity pool" as "any investment trust, syndicate or similar form of enterprise operated for the purpose of trading in commodity interests" and defines a "commodity pool operator" as a person "engaged in a business that is of the nature of a commodity pool ... and who, in connection therewith, solicits, accepts, or receives from others, funds, securities, or property, either directly or through capital contributions, the sale of stock or other forms of securities, or otherwise, for the purpose of trading in commodity interests." In the context of a typical ILS transaction, the operator would likely be the insurance manager or the administrator. Absent an exemption, a CPO must register with the CFTC and comply with other CPO obligations under applicable regulations.

The Dodd-Frank Act expanded the definition of "commodity interests" to include swaps, and as a result risk transfer contracts structured as swaps in ILS transactions became subject to regulation as commodity interests, and ILS issuers potentially became subject to regulation as commodity pools. Section 1a(47) of the CEA defines a "swap," among other things and subject to various exclusions, as an agreement "that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, non-occurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence." This broad definition of swaps potentially covers insurance contracts. The CFTC has acknowledged that the legislative history of the Dodd-Frank Act does not reveal any Congressional intent to have "traditional insurance contracts" included in the expanded "swap" definition. In 2012, the CFTC promulgated a non-exclusive safe harbor exemption for insurance contracts that meet certain conditions.1 If a particular risk transfer contract does not qualify for the safe harbor, a careful analysis based upon facts and circumstances would need to be undertaken to determine if the contract is at risk of being characterized as a "swap" and, likewise, a "commodity interest."

To the extent that a risk transfer contract between the ILS issuer and the cedent could be considered a "swap," the ILS issuer may fall within the definition of "commodity pool," and, absent an exemption, the operator of the ILS issuer would be required to register as a CPO.

The CFTC's recent no-action relief allows operators of ILS issuers that have risk transfer contracts that are "swaps" to rely on CFTC Regulation 4.13(a)(3) for an exemption from CPO registration, subject to certain enumerated conditions.

Requirements for Exemption

In order to qualify for the exemption, Regulations 4.13(a)(3)(i), (ii), and (iii) must be satisfied, namely that:

  • Interests in the 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;
  • The pool at all times meets a de minimis test pursuant to which either (x) the margins, premiums and required minimum security deposit for retail forex transactions does not exceed 5% of the liquidation value of the pool's assets after giving effect to unrealized profits or losses; or (y) the aggregate net notional value of the pool's commodity positions, determined at the time the most recent position was established, does not exceed 100% of the liquidation value of the pool's portfolio, after taking into account unrealized profits and unrealized losses; and
  • The operator of the ILS issuer reasonably 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).

In addition, as set forth in the CFTC's no-action letter, the ILS issuer must be operated such that:

  • There is no active or discretionary management of assets and liabilities (i.e., the collateral and the risk transfer contract);
  • The collateral held by the ILS issuer must be in the form of:
    • Cash;
    • Puttable debt issued by the International Bank for Reconstruction and Development (IBRD), the European Bank for Reconstruction and Development (EBRD), or Kreditanstalt fur Wiederaufbau (KfW);
    • Any U.S. or EU 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;
    • Other assets that are "highly liquid" as defined by CFTC Regulation 1.25(b)(1) (i.e., convertible into cash within one business day without material discount in value); or
    • Any other eligible collateral approved by the CFTC;
  • The collateral held by the ILS issuer must either have a maturity date that is on or before the termination date of the underlying risk transfer contract or be convertible to cash upon demand by the ILS issuer;
  • The ILS issuer must maintain practices to monitor the collateral regularly (up to weekly, depending on availability of pricing sources) and report any shortfall of such collateral under 100% of the reinsurance limit to the CFTC, the cedent, and the ILS holders;
  • The payment obligations of the ILS issuer to the cedent and the ILS holders must be secured by eligible collateral (as described above), and the security interest of the ILS holders must be subordinate to that of the cedent;
  • The ILS issuer must maintain the collateral so that it is available to be distributed in the form of cash or in kind to the cedent at the time a payment becomes due under the underlying risk transfer contract; and
  • The ILS issuer must be subject to arrangements that protect the collateral in the event of insolvency of the ILS issuer, including restricting the business activities of the ILS issuer, restricting incurrence of additional debt, restricting mergers or asset sales, maintaining an independent board of directors, maintaining a separate corporate identity from the cedent, and obtaining no petition covenants from ILS holders.

In addition to the foregoing conditions, an operator of an ILS issuer that is seeking to rely on this exemption from CPO registration must file a notice of eligibility with the National Futures Association through its electronic exemption filing system. The notice must provide (i) the name and contact information of the person claiming the exemption and the name of the pool for which it is claiming the exemption and (ii) the section number pursuant to which the operator is filing the notice (in this case, Regulation 4.13(a)(3)) and a representation that the pool will be operated in accordance with the requirements there-under. Such eligibility notice must be reaffirmed annually.

Moreoever, operators of ILS issuers relying on this Exemption must comply with the recordkeeping and reporting requirements set forth in Regulation 4.13, which include (i) keeping books and records prepared in connection with its activities as a pool operator for a period of five years from the date of preparation, (ii) keeping such books and records readily accessible during the first two years of the aforementioned five-year period and making such books available for inspection upon the request of the CFTC, the U.S. Department of Justice, or any other appropriate regulatory agency, and (iii) submitting to special calls as the CFTC may make to demonstrate eligibility for and compliance with the applicable criteria for exemption.

Practical Implications

Most of the foregoing conditions are standard in ILS transactions and, therefore, sweeping changes to ILS structures that use swaps will likely not be required. Of course, the preponderance of ILS transaction structures to date have relied upon risk transfer contracts which are reinsurance contracts, and these structures should not be affected. However, there are a few points to highlight.

The CFTC's no-action letter does not help clarify the definition of a "swap" or in any way change the insurance safe harbor originally promulgated in 2012. For better or worse, an issuer still must rely on the existing guidance for determining whether a particular risk transfer contract is a swap.

The no-action letter should not have an impact on any outstanding catastrophe bond transactions. The exemption provided for in the letter is only available for transactions on a prospective basis. In addition, since the promulgation of the rules relating to swaps under the Dodd-Frank Act, the risk transfer contracts in most catastrophe bond transactions have been structured to either fit within the insurance safe harbor or meet characteristics of traditional insurance contracts. As a result, in many transactions there has not been the need for the operator of the ILS issuer to register as a CPO. For recent transactions where the underlying risk transfer contract was structured as a swap, the operators have complied with the CPO registration requirements.

As noted above, ILS issuers relying on this CPO registration exemption are required to make notice filings with the CFTC (which must be reaffirmed annually) and maintain books and records for a five-year period after the inception of the transaction. The typical catastrophe bond has a risk period of approximately 3 years, and so provisions will need to be made at the inception of the transaction for the administrator to maintain these records for the required period of time, even if the underlying transaction has terminated and the underlying catastrophe bonds are no longer outstanding.

Certain changes will also need to be made to the manner in which the underlying collateral is managed. As described above, the collateral must be monitored regularly, which in certain circumstances may mean that the monitoring needs to be done weekly, in contrast to the current market standard of monthly monitoring.

Furthermore, ILS issuances that invest collateral in investments other than IBRD/EBRD/KfW notes or money market funds with U.S. dollar-denominated underlying investments must ensure that the investments are "highly liquid" and convertible into cash within one business day (or be separately approved by the CFTC).

This new exemption will have the most impact on sponsors seeking to structure ILS transactions using a swap contract as the underlying risk transfer contract as opposed to a reinsurance contract having the characteristics of traditional insurance. Prior to the enactment of the Dodd-Frank Act, sponsors of catastrophe bond transactions who were indifferent as to whether the underlying risk transfer contract was treated as reinsurance (typically certain sponsors outside of the United States) would often structure the risk transfer contract as a swap. This became less common after the adoption of the Dodd-Frank Act due to the need for the operator of the ILS issuer to register as a CPO. Now, in light of the CFTC's no-action relief, swaps may be used in ILS transactions with fairly minimal regulatory burden.


1 For more information regarding the insurance safe harbor, see Mayer Brown's September 6, 2012 memorandum, which can be found at http://www.mayerbrown.com/files/uploads/Documents/PDFs/2012/September/CFTCandSECinsurancevswapsfullarticle.pdf.

Previously published 31 December 2014

Learn more about our Insurance practice.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2015. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions