US Financial Regulators Balk at Examining Complex Finance

Written by Bill Harrington

February 8, 2018

The main US regulator for complex finance — the US Commodity Futures Trading Commission (CFTC) — intentionally got many basic features of a complex type of derivative contract exceptionally wrong in its recent No-Action Letter from late October of last year on margin requirements for swaps used by “special purpose vehicles.”

The numerous misrepresentations that underlie the CFTC’s decision not to take action on these complex, undercapitalized swaps raise serious concerns regarding the CFTC’s mission, competency, and trustworthiness. The same goes for other US financial regulators such as the US Department of the Treasury (US Treasury), the US Securities and Exchange Commission (SEC), and the National Futures Association.

Last week, on February 2, I wrote CFTC Secretary Christopher Kirkpatrick to express my concerns about “31 Misrepresentations in CFTC Letter No. 17-52.” I also copied key staff at US Treasury, the SEC, the European Securities and Markets Authority, the Bank of England, as well as six leading swap proponents, including the large student loan company Navient, the Structured Finance Industry Group, and four nationally recognized statistical rating organizations (NRSROs) DBRS, Fitch Ratings, Moody’s Investors Service, and S&P. My full letter with supporting appendices is available on

The defective regulatory actions by the CFTC, SEC and US Treasury jeopardize the sustainability of financing tools for building and protecting infrastructure. According to a report by S&P Global Ratings (S&P) of 10 October 2017, these kinds of special purpose vehicles make wide-ranging investments in “project finance transactions, catastrophe bonds, gas pre-pay financings, stand-alone tax-exempt single- and multifamily housing bonds, equipment trust certificates, municipal pools, and industrial development bonds.”

The US sorely needs these types of financial vehicles to work optimally in order to support investment in the most effective infrastructure projects. Financing tools that failed in the past, such as undercapitalized asset-backed securities (ABS) and other structured finance, won’t do the job. Yet, this is exactly the type of failed financing that the CFTC misrepresented in its letter and that the US Treasury promotes as critical to boosting growth in its recent report on “A Financial System That Creates Economic Opportunities” (Treasury Blueprint).

In fact, the Treasury Blueprint advocates that the US Congress invest the CFTC and the SEC with the discretion to make a whole lot more, intentionally wrong decisions in the future. The main post-crisis reform of complicated finance — the Dodd-Frank Act Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) — purposely withheld this discretion from the CFTC and SEC in key areas such as the regulation of complicated derivative products. The Dodd-Frank Act also tasked the SEC with increased oversight of NRSROs. The Treasury now wants to “fix” this Dodd-Frank Act fix.

The type of complicated derivative product that the CFTC intentionally got all wrong — an “ABS flip clause swap” — started and fueled the financial crisis. Moreover, ABS flip clause swaps remain embedded in many student loan ABS deals, as I described in a Croatan Institute “Views” column on 18 January.

While posted my letter to the CFTC of 2 February within a day, no one from the CFTC or the other 10 entities that I copied had even acknowledged receipt of the letter as of the time of this writing.

As an analyst who has assessed ABS flip clause swaps since 1999, I have publicly identified similar mistakes in a previous CFTC decision contained in CFTC Letter No. 15-21 of 31 March 2015. My letter of 2 February describes these earlier errors, which I had raised with key CFTC staff in an email of 7 April 2015, a letter of 15 May 2015, and a teleconference on 28 May 2015.

These earlier communications with the CFTC enable me to state with authority that the 31 misrepresentations that my letter itemizes are intentional mistakes that ultimately, to use the CFTC’s own language, “render this no-action position void.”

Unfortunately for us, the private sector cannot do its job of funding sustainable infrastructure while the CFTC coddles the users of failed financing techniques, the SEC coddles the NRSROs that publish flawed ratings and methodologies, and the US Treasury coddles the CFTC and SEC by advocating for more of the same.

Bill Harrington is a senior fellow at Croatan Institute. He can be reached at