UNCLEARED SWAPS MAKE MORE SENSE FOR ASSET-BACKEDS FROM AUTO MAKERS

Manufacturers that fund customer lending via the securitization market just got a break from the Commodity Futures Trading Commission.

The CFTC clarified that swaps used to hedge risks in asset-backed securities sponsored by so-called captive finance companies do not need to be listed on a derivative clearing organization, in most cases.

This will help auto and equipment makers, among others, avoid the headaches and potentially higher costs of clearing swaps in these transactions. The CFTC was responding to concerns raised by the financing arm of Ford Motor Co..

Swaps are agreements to exchange one set of cash flows for another. A cleared swap is required to post margin — basically additional cash; uncleared swaps are not, at least not yet.

“They won’t have to post margin, unless a counterparty requires it,” said Even Koster, partner at Hogan Lovells.

He added that clearing a swap also restricts the kinds of collateral you can post as margin.

Other kinds of flexibility matter as well. Securitization swaps tend to be bespoke and would have trouble fitting into the more standardized formats required by clearing. 

The contract in an uncleared swap is “tailored to your own needs,” said Steven Quinlivan, a partner at Stinson Leonard Street. In cleared swaps, “the parameters are clearly defined.”

Swaps are commonly used in securitization to protect against interest rate mismatch. A deal that pays a fixed rate of interest but is backed by floating rate loans, for instance, would have one. This can raise the credit quality to deal to a point where it is palatable to target investors. The same goes for a security denominated in a different currency than the underlying collateral.

The CFTC’s clarification came as a letter to Ford Motor Credit Company, which had requested that a securitization vehicle that is fully owned by, and consolidated with, an entity known as a “captive finance company” enjoy the same swap-clearing exemptions as captive finance companies themselves.

The CFTC agreed.

Basically, said Evans, the CFTC now sees swaps as consolidated with these companies. 

As defined by the regulator, a captive finance company is a firm whose primary business is to provide financing, 90% of which must facilitate the purchase or lease of products, of which, in turn, 90% must be made by the parent company or related company. In addition, the swap, or derivative, in question must be used to hedge risks linked to interest-rate and currencies.

In an online post, law firm Chapman & Cutler said prior to the letter there had been uncertainty whether a securitization vehicles main business is to provide financing, and hence could be considered a captive finance company.

A spokeswoman for Ford did not respond to requests for comment.

In web post, the CFTC said it had received the same request from other manufacturers such as American Honda Finance Corporation, Ford Motor Credit Company, General Motors Financial Company, Mercedes-Benz Financial Services, Mitsubishi Motors Credit of America, Nissan Motor Acceptance Corporation, Toyota Financial Services, and VW Credit Inc. as well as equipment maker CNH Industrial Capital.

The CFTC’s clarification “has potential applicability to any manufacturer that has a captive finance company,” Quinlivan said. 

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