CFTC’s Derivative Guidelines Befuddle FHFA

The Federal Housing Finance Agency, Fannie Mae and Freddie Mac are stumped over how to escape the growing reach of the Commodity Futures Trading Commission.

Specifically, the operations are scrambling to figure out how they might avoid CFTC regulation for some $400 billion of unguaranteed subordinate bonds and derivative instruments that they have been planning to add to future securitizations of agency mortgages. So far, they haven’t figured out what to do.

The issue is just the latest to emerge from a Dodd-Frank Act provision that defines any type of derivative transaction as a commodity pool, and thus subjects their issuers to regulation by the CFTC. While the agency has recently created temporary exemptions for most types of structured products — and has indicated that it plans to add to that list before making it permanent on Dec. 31 — it apparently has resisted requests for the same treatment for the “risk-sharing” instruments to be issued by Fannie or Freddie.

The impact apparently would be felt chiefly among synthetic portions of those deals, entailing derivatives that would shift exposure to defaults among the underlying loans to private-sector investors. “This commodity-pool thing turned the FHFA upside down,” one source said. “Now they’re stuck at third base and don’t know how to move forward.”

Beyond positioning Fannie and Freddie as commodity-pool operators and saddling them with the compliance and registration procedures required of such vehicles, the CFTC’s planned treatment of the risk-sharing products could dampen demand for the deals. That’s because new limits on banks’ commodity-pool investments under Dodd-Frank’s so-called Volcker Rule would likely prompt them to avoid the instruments.

The FHFA has responded to that threat in part by joining the American Securitization Forum in lobbying the Comptroller of the Currency, FDIC, Federal Reserve and SEC to lift restrictions on banks’ commodity businesses when they finalize the Volcker Rule in early 2013.

The FHFA has been developing its risk-sharing initiative in cooperation with the U.S. Treasury Department as part of a push to bring more private capital into the mortgage-finance industry while reducing the activities of Fannie and Freddie. “This isn’t a piddling little one-off transaction. There’s a ton of sponsorship behind it,” one source said “The synthetic component is clearly an issue and they have to do something to work around it. Exactly what, no one knows yet. But there are a lot of smart people working on it and I wouldn’t say the plan is dead, but indefinitely delayed.”

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