Futures Act Provides Certainty for Bank Products

By James Hamilton, J.D., LL.M., Senior Writer Analyst, CCH Federal Securities Law Reporter; Co-Author, CCH Federal Privacy Rules for Financial Institutions and Financial Services Modernization - Gramm-Leach-Bliley Act of 1999 - Law and Explanation; contributing author, CCH FOCUS.

he recently enacted Commodity Futures Modernization Act provides certainty that products offered by banking institutions will not be regulated as futures contracts. Title IV of the Act is the Legal Certainty for Bank Products Act, which is a freestanding provision of law, part of neither the banking nor the commodities statutes. The provision clarifies the jurisdictional line between the regulation of banking products and futures products.

Title IV provides an exclusion for traditional banking products as well as for hybrid products that are predominantly banking in nature. New products offered by banks that were not in existence on December 5, 2000, or are otherwise not excluded from the CEA would fall under a “jump ball” provision of the Act under which the Commodity Futures Trading Commission and the Federal Reserve Board would determine whether a new non-traditional product offered by a bank should be regulated under the banking or futures laws.

Regarding banking products, the language of the bill clarifies what is already the current state of the law. The CFTC does not regulate traditional banking products, such as deposit accounts, certificates of deposit, and loan participations. The language of Title IV is very clear and very tightly worded. It requires that, in order to qualify for the exclusion, a bank must first obtain a certification from its regulator that the identified banking product was commonly offered by that bank before December 5, 2000.

The term “commonly offered’’ means, in effect, that the product was not obscure or offered only briefly. It is not to be construed to mean that the product must be of a type that is appropriate or suitable for any and all users since many common bank products are tailored for specific consumers. Two examples of tailored products are small business loans and low-cost checking accounts for seniors.

The product must have been actively bought, sold, purchased or offered and not just be a customized deal that the bank may have done for a handful of clients. The product cannot be one that was either prohibited by the Commodity Exchange Act or regulated by the CFTC. In other words, according to Senator Tom Harkin, a bank cannot pull a futures product out of regulation by using this provision.

For new products, Title IV allows hybrid products to be excluded from the Commodity Exchange Act only if they pass a “predominance test” indicating they are primarily identified as banking products. While the statute provides a mechanism for resolving disputes about the application of this test, there is no intent that a product that flunks this test be regulated by anyone other than the CFTC.

The predominance test is a self-test. Banks themselves can apply the factors of the predominance test with regard to the development of new products without making prior application to any regulator. The predominance test is intended to replace provisions in the Commodity Exchange Act concerning the application of a predominance test to hybrid instruments.

ADMINISTRATION OF THE PREDOMINANCE TEST

If a bank, having applied the predominance test to a new product, determines that the product is predominantly a banking product not subject to CFTC regulation, and the CFTC later challenges the bank’s conclusion, the CFTC is still prohibited from exercising regulatory authority over the product unless the Commission obtains the concurrence of the Federal Reserve Board. If the Board does not concur in the CFTC’s decision, the Board may submit the controversy for determination by the U.S. Court of Appeals for the District of Columbia. The appeals court must base its decision on whether the product is predominantly a banking product and whether applying the Commodity Exchange Act to it is appropriate in light of the history, purpose and extent of regulation under the federal commodity and banking laws. The court will give no deference to the views of either the CFTC or the Fed.

Congress expects the CFTC to be circumspect in applying the predominance test. For example, it does not necessarily follow that a hybrid instrument not satisfying the predominance test is inevitably a futures contract subject to CFTC regulation. The CFTC must not interpret normal or traditional banking practices and activities, or prudent actions taken by a bank to maintain safety and soundness, to be hybrid instruments that the agency may regulate.

For example, a loan made by a bank is an identified banking product under Section 206(a)(3) of the Gramm-Leach-Bliley Act. Some may argue that a new loan product offered after December 5, 2000, may be interpreted to be covered by the definition of a hybrid product if it has payments indexed to the value of, or provides for the delivery of, one or more commodities. However, there would be little justification for the CFTC to construe the pledging of a commodity as collateral for a loan, or a term providing that a commodity may be offered as part or full satisfaction of a loan, to be representative of a futures contract over which the CFTC may exert jurisdiction.

No such result is contemplated under the legislation. Moreover, the fact that a loan may be renegotiated or sold, or that a loan or other identified banking product may not be held until maturity, is not a violation of the predominance test. These are merely examples of the reasonable interpretations that the CFTC must adhere to when it applies the statutory predominance test.