[Federal Register Volume 68, Number 55 (Friday, March 21, 2003)]
[Notices]
[Pages 13903-13906]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-6774]


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COMMODITY FUTURES TRADING COMMISSION


In the Matter of Washington Mutual, Inc. and Its Various 
Subsidiaries Request for Relief

AGENCY: Commodity Futures Trading Commission.

ACTION: Order.

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SUMMARY: In response to a request for relief from Washington Mutual, 
Inc. and its various subsidiaries (collectively, ``Washington 
Mutual''), the Commodity Futures Trading Commission (``Commission''), 
pursuant to section 1a(12)(C) of the Commodity Exchange Act (``Act''), 
is issuing an order that provides that, subject to certain conditions, 
Single Asset Development Borrowers (``SADBs'') that have a natural 
person, who is an eligible contract participant (``ECP''), acting as a 
guarantor for the SADBs'' over-the-counter (``OTC'') derivatives 
transactions, are ``eligible contract participants'' as that term is 
defined in section 1a(12) of the Act. Accordingly, subject to certain 
conditions as set forth in the Commission's order, an SADB acting for 
its own account, whose obligations are guaranteed by a natural person 
who is an ECP, is permitted to enter into certain OTC derivatives 
transactions pursuant to section 2(c), 2(d)(1) and 2(g) of the Act.

DATES: This order is effective March 21, 2003.

[[Page 13904]]


FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Deputy Director or 
Peter B. Sanchez, Attorney Advisor, Compliance and Registration 
Section, Division of Clearing and Intermediary Oversight, Commodity 
Futures Trading Commission, Three Lafayette Center, 1155 21st Street, 
NW., Washington, DC 20581. Telephone: 202-418-5439 and 202-418-5236, 
respectively. E-mail: [email protected] and [email protected], 
respectively.

SUPPLEMENTARY INFORMATION:

I. Statutory Background

    Section 1a(12) of the Act, as amended by the Commodity Futures 
Modernization Act of 2000 (``CFMA''), Pub. L. 106-554, which was signed 
into law on December 21, 2000, defines the term ECP by listing those 
entities and individuals considered to be ECPs.\1\ Natural persons who 
meet certain financial criteria are explicitly included in the ECP 
definition to the extent that such persons transact in their individual 
capacity. The section 1(a)(12) definition of ECP also includes certain 
entities whose obligations are guaranteed by an ECP. Natural persons 
are not among the permissible guarantors enumerated in section 
1a(12).\2\
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    \1\ Included generally in section 1a(12) as ECPs are financial 
institutions; insurance companies and investment companies subject 
to regulation; commodity pools and employee benefit plans subject to 
regulation and asset requirements; other entities subject to asset 
requirements or whose obligations are guaranteed by an ECP that 
meets a net worth requirement; governmental entities; brokers, 
dealers, and futures commission merchants (``FCMs'') subject to 
regulation and organized as other than natural persons or 
proprietorships; brokers, dealers, and FCMs subject to regulation 
and organized as natural persons or proprietorships subject to total 
asset requirements or whose obligations are guaranteed by an ECP 
that meets a net worth requirement; floor brokers or floor traders 
subject to regulation in connection with transactions that take 
place on or through the facilities of a registered entity or an 
exempt board of trade; individuals subject to total asset 
requirements; an investment adviser or commodity trading advisor 
acting as an investment manager or fiduciary for another ECP, and 
any other person that the Commission deems eligible in light of the 
financial or other qualifications of the person.
    \2\ Non-natural persons are permitted to act as guarantors for 
an entity that would not otherwise be an ECP. Section 1a(12)(A)(v) 
defines an ECP as, among other things, a ``corporation, partnership, 
proprietorship, organization, trust, or other entity'' that (1) has 
a net worth exceeding $1 million and that enters into agreements, 
contracts or transactions in connection with the conduct of the 
entity's business or to manage the risk associated with an asset or 
liability that is owned or incurred; or (2) that has total assets 
exceeding $10 million, the obligations of which are guaranteed or 
otherwise supported by an entity described in 1(a)(12)(A)(i) 
(financial institutions), (ii) (certain insurance companies), (iii) 
(certain investment companies), (iv) (certain commodity pools), or 
(vii) (government entities).
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    In addition to specifying certain persons as ECPs, the Act gives 
the Commission discretion to expand the ECP category. Specifically, 
section 1a(12)(C) provides that the list of entities defined as ECPs 
shall include ``any other person that the Commission determines to be 
eligible in light of the financial or other qualifications of the 
person.'' Although the Washington Mutual letter was framed as a request 
for a no-action letter, the Commission has determined, pursuant to 
section 1a(12)(C) of the Act, to issue an order, subject to conditions, 
that certain entities that have a natural person ECP as a guarantor are 
ECPs.

II. The Washington Mutual Letter

A. Introduction

    By letter to the Division of Clearing and Intermediary Oversight 
(``Division''), Washington Mutual submitted a request for a no-action 
letter pursuant to Commission rule 140.99.\3\ Specifically, Washington 
Mutual, acting on behalf of itself and unnamed SADBs who wish to enter 
into OTC transactions with Washington Mutual, requested a no-action 
letter pursuant to rule 140.99 stating that the Division would not 
recommend enforcement action if SADBs, when guaranteed by a natural 
person who is an ECP, entered into certain OTC transactions.
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    \3\ The request was presented by a letter dated October 22, 
2002, to the Director of Division of Trading and Markets from Jacob 
Scholl, counsel for Washington Mutual. As of July 1, 2002, a 
reorganization of the Commission became effective. The Division of 
Clearing and Intermediary Oversight is the successor to the Division 
of Trading and Markets.
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    SADBs are entities that develop a single piece of commercial real 
estate. Because SADB clients typically borrow amounts nearly equal to 
the value of the real estate to be developed, they usually have a low 
net worth (less than $1 million). Washington Mutual acts as a lender to 
several SADBs.
    Washington Mutual wishes to engage in OTC derivatives transactions 
with these SADBs in order to allow the SADBs to hedge their operating 
risks from interest rates, or foreign currencies, but the SADBs do not 
qualify as ECPs because they do not possess $10 million in total assets 
or $1 million in net worth as required by section 1a(12)(A)(v) of the 
CEA. Natural persons who are ECPs with over $10 million in assets are 
willing to act as guarantors of SADBs for the OTC transactions, but 
absent a finding that the ECP definition should be expanded to include 
entities with natural-person ECPs as guarantors, an SADB with a 
natural-person ECP as a guarantor will not qualify as an ECP. This 
presents a matter of first impression for the Commission.
    Washington Mutual represents that the permissible OTC transactions 
would be limited to trading in OTC derivatives that are necessary for 
the SADB to hedge the risk that the SADB is exposed to, or reasonably 
likely to be exposed to, as a result of the SADB's operations. The 
trading in the OTC derivatives will be limited to transactions that 
constitute hedging transactions.
    Washington Mutual further proposed that such transactions would be 
subject to additional conditions and restrictions detailed in the 
petition and described below.

B. Public Interest Considerations

    In its letter, Washington Mutual stated that it is good public 
policy for the Commission to permit SADBs to have natural persons 
acting as guarantors.
    First, Washington Mutual stated that failure to grant the requested 
relief would limit the opportunity of SADBs to manage their business 
risk.
    Second, Washington Mutual stated that failure to grant the 
requested relief would yield the unusual result that the guarantor, as 
an individual, would be permitted to enter into derivative 
transactions, but that an entity which is fully guaranteed by the same 
individual may not.
    Moreover, a natural person could form a single shareholder 
corporation or single member limited liability company and be eligible 
to engage in the same kind of contracts directly, as an ECP, or 
indirectly as a guarantor. Forming a corporation or LLC that qualifies 
as an ECP, however, would tie up a great deal of the natural person's 
assets.
    Third, the CEA permits commodity pools with assets of over $5 
million that are operated by commodity pool operators (``CPOs'') 
subject to regulation under the Act (or a similarly situated foreign 
person) to act as guarantors. Conceivably, a collection of several 
investors, each of whom need not have enough assets to qualify as an 
ECP, could form a commodity pool and invest in the same type of 
derivatives directly, acting as an ECP, or indirectly as a guarantor.
    Because the bank and an individual can engage in derivative 
transactions among themselves, permiting the individual to guarantee a 
third party for the same type of transaction should not be 
objectionable--particularly if the derivatives transactions are limited 
solely to hedging transactions.

III. Conclusion

    After consideration of the Washington Mutual letter, the Commission 
has determined that SADBs, subject to

[[Page 13905]]

certain conditions, are eligible to be ECPs as that term is defined in 
section 1a(12) of the Act. Under the terms of this order, the SADBs 
would meet the financial qualifications of an ECP by having a financial 
guarantee for the OTC transactions from a natural person who is an ECP 
and by satisfying certain minimum financial requirements.
    Accordingly, the Commission has determined to issue an order, 
pursuant to section 1a(12)(C) of the Act, subject to certain 
conditions, that SADBs as described herein with a natural person who is 
an ECP acting as guarantor qualify as ECPs. The order permits the SADBs 
to enter into OTC transactions pursuant to section 2(c), 2(d)(1) and 
2(g) of the Act.

IV. Cost Benefit Analysis

    Section 15 of the Act, as amended by section 119 of the CFMA, 
requires the Commission to consider the costs and benefits of its 
action before issuing a new regulation or order under the Act. By its 
terms, section 15 does not require the Commission to quantify the costs 
and benefits of its action or to determine whether the benefits of the 
action outweigh its costs. Rather, section 15 simply requires the 
Commission to ``consider the costs and benefits'' of the subject rule 
or order.
    Section 15(a) further specifies that the costs and benefits of the 
proposed rule or order shall be evaluated in light of five broad areas 
of market and public concern: (1) Protection of market participants and 
the public; (2) efficiency, competitiveness, and financial integrity of 
futures markets; (3) price discovery; (4) sound risk management 
practices; and (5) other public interest considerations. The Commission 
may, in its discretion, give greater weight to any one of the five 
enumerated areas of concern and may, in its discretion, determine that, 
notwithstanding its costs, a particular rule or order is necessary or 
appropriate to protect the public interest or to effectuate any of the 
provisions or to accomplish any of the purposes of the Act.
    The order is intended to reduce regulatory barriers to permit 
SADBs, when acting in a proprietary capacity, with a natural person who 
is an ECP as guarantor, to enter into OTC transactions for hedging 
purposes. The Commission has considered the costs and benefits of the 
order in light of the specific provisions of section 15(a) of the Act.

A. Protection of Market Participants and the Public

    The order would permit an SADB to participate in the OTC markets, 
subject to a guarantee from a natural person who qualifies as an ECP. 
Accordingly, there should be no effect on the Commission's ability to 
protect market participants and the public.

B. Efficiency and Competition

    The order is not expected to have an effect on efficiency or 
competition.

C. Financial Integrity of Futures Markets and Price Discovery

    The order should have no effect, from the standpoint of imposing 
costs or creating benefits, on the financial integrity of the futures 
and options markets.

D. Sound Risk Management Practices

    The order should have no effect, from the standpoint of imposing 
costs, on the risk management practices of the OTC derivatives, futures 
or options industry.

E. Other Public Interest Considerations

    The order will have the positive effect of allowing SADBs to hedge 
the risks that they may be exposed to as a result of their business 
operations.

V. Order

    Upon due consideration, and pursuant to its authority under section 
1a(12)(C) of the Act to determine that persons other than those 
enumerated in the Act are ECPs in light of the financial or other 
qualifications of these persons, the Commission hereby determines that 
an SADB, whose OTC derivatives obligations are guaranteed by a natural 
person who is an ECP, is an eligible contract participant and may enter 
into OTC derivatives contracts, agreements or transactions under the 
following conditions:
    1. The contracts, agreements or transactions must be entered into 
pursuant to section 2(c), 2(d)(1) or 2(g) of the Act.
    2. Washington Mutual must verify that each natural-person ECP 
guarantor to an SADB meets the financial requirements to be an ECP as a 
natural person, pursuant to section 1a(12)(A)(xi)(I).
    3. The SADB must have obtained a financial guarantee for the 
contracts, agreements or transactions from a natural person that meets 
the qualifications to be an ECP as such term is currently defined in 
section 1(a)(12)(A)(xi)(I) of the Act and as may be amended from time 
to time.
    4. An SADB may engage in OTC derivatives contracts, agreements or 
transactions only to the extent that such OTC derivatives contracts, 
agreements or transactions are necessary to hedge the risk associated 
with an asset or liability owned or incurred or reasonably likely to be 
owned or incurred by an SADB in the conduct of its business.
    5. SADBs may only engage in OTC derivatives trades with Washington 
Mutual if they have an existing lending relationship with Washington 
Mutual and they act in a principal capacity with Washington Mutual.
    6. A guarantor must compute its net worth and total assets in 
accordance with generally accepted accounting principles consistently 
applied.
    7. Natural persons acting as guarantors must unconditionally 
guarantee the full amount of an SADB's OTC derivatives contracts, 
agreements or transactions.
    8. Washington Mutual will keep records relating to its OTC 
derivative contracts, agreements and transactions with SADBs and their 
guarantors under this Order, including documentation demonstrating 
compliance with conditions 2, 3, 4, 5 and 7 of this order, the levels 
of OTC trading and the number of SADBs and guarantors who participated 
in these activities. Such records shall be made available upon the 
request of any representative of the Commission, the Department of 
Justice, Washington Mutual's banking regulators or any other 
governmental entity with jurisdiction over Washington Mutual or the OTC 
derivatives transactions in question.
    This Order is based upon the representations made and supporting 
material provided to the Commission by Washington Mutual. Any material 
changes or omissions in the facts and circumstances pursuant to which 
this Order is granted might require the Commission to reconsider its 
finding that the provisions set forth herein are appropriate. Further, 
if experience demonstrates that the continued effectiveness of this 
Order would be contrary to the public interest, the Commission may 
condition, modify, suspend, terminate or otherwise restrict the 
provisions of this Order, as appropriate, on its own motion. This Order 
pertains only to OTC derivative transactions that are not contrary to 
banking laws and regulations that may otherwise govern Washington 
Mutual's conduct.


[[Page 13906]]


    Issued in Washington, DC, on March 17, 2003, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 03-6774 Filed 3-20-03; 8:45 am]
BILLING CODE 6351-01-P