The CFTC on Monday settled enforcement action against VTB for inter-affiliate futures executed as block trades on an exchange. VTB entered into forex futures with a subsidiary (VTB Capital) via block trades on the CME. The subsidiary (a U.K. bank) then offset this currency exposure via the OTC cross-currency swap market. In other words, VTB purchased forex exposure through a subsidiary booking entity. As the CFTC found, this was done because the booking entity was able to receive more favorable pricing than the parent. The CFTC found that the block trade in this transaction constituted a fictitious sale violative of Section 4c(a) of the Commodity Exchange Act.
Institutions always book derivative transactions to whichever affiliate is most advantageous. Regardless of which affiliate entity needs the exposure or hedge, the derivative will still be booked through the booking entity. The exposure will then be offloaded to the affiliate that needed it (via a mirrored inter-affiliate transaction). This is normal practice for large institutions. For example, the CFTC’s recent final rule regarding cross-border application of margin requirements as well as the swaps push-out provision for banks in Dodd-Frank (which was subsequently repealed in substance) are examples of the CFTC and Congress grappling with this practice in other contexts. In some contexts, the CFTC and Staff recognize this practice as sufficiently worthwhile as to remove regulatory barriers to it — for example, in the CFTC’s clearing requirement exemption for inter-affiliate swaps and in the Staff’s no-action letters for centralized treasury affiliates (Letter 13-22 was amended by Letter 14-144).
In 2014 the CFTC settled enforcement action against RBC for taking futures positions opposite its subsidiaries via block trades on the OneChicago exchange. The consent order found that those transactions were “designed, in part, to profit from stock loan businesses, to fund one subsidiary, to optimize capital for another subsidiary, and to achieve certain tax benefits.” Since the fictitious sale doctrine has a long history of being applied to trades made for a tax benefit, one might have thought tax benefit was driving the RBC enforcement action. After the VTB settlement, however, it appears that the CFTC may view all inter-affiliate block trades on an exchange as fictitious sales.