The US and EU are currently introducing comprehensive new measures to regulate over-the-counter derivatives. Both the US and EU measures have some degree of extraterritorial application. In the absence of agreement between the US and EU regulators, extraterritoriality has the potential to cause intractable and irreconcilable conflicts for the derivatives industry. This note sets out some of the situations in which extraterritoriality is likely to result in such conflicts.
Introduction
On 21 July 2010, The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") was enacted in the USA. Title VII of Dodd-Frank sets out a comprehensive reform of the over-the-counter ("OTC") derivatives market. Shortly afterwards, on 15 September 2010, the European Commission published a proposal for a new regulation on OTC derivatives, known as the European Market Infrastructure Regulation ("EMIR") and various further drafts have subsequently been published.1 Both Dodd-Frank and EMIR seek to implement the commitments made by G20 leaders for the standardisation and clearing of all OTC derivatives contracts by the end of 2012. Certain provisions of Dodd- Frank took effect on 16 July 2011,2 although most provisions will be effective once the required rules have been made by federal regulators. EMIR currently has no timeframe for enactment, although the European Commission has committed to meet the G20 timeframe. Unlike in the US, many aspects of OTC derivatives trading, advice and dealing are already regulated in Europe, so this measure focuses on clearing. Certain EU reforms in relation to OTC derivatives, including an exchange trading requirement for standardised OTC derivatives, will be implemented though a set of amendments to the Markets in Financial Instruments Directive (Directive 2004/39/EC, "MiFID"), generally referred to as MiFID II.3
Both Dodd-Frank and EMIR are likely to have some extraterritorial effect. The provisions of Title VII of Dodd-Frank (including rules and regulations made under it) relating to CFTC-governed swaps will not apply to activities outside the United States unless those activities either (a) have a direct and significant connection with activities in, or effect on, commerce in the United States; or (b) contravene CFTC rules intended to prevent evasion of US requirements.4 Similarly, the provisions of Title VII (including any rules and regulations made under it) relating to SEC-governed security-based swaps will not apply to such swaps entered into outside the US, unless this contravenes SEC rules intended to prevent the evasion of US requirements.5 It is currently unclear how EMIR will apply to foreign branches of EU-incorporated entities and EU branches of non-EU entities. Dodd-Frank and EMIR both impose a framework of clearing and reporting requirements on certain OTC derivatives transactions. Significant differences between the two regimes exist, however, particularly in relation to the application of the clearing requirement to non-financial institutions, margin and collateral rules, registration requirements for clearing houses, exchange trading and reporting requirements. Compliance with both sets of requirements is therefore a concern, although it is hoped that regulators on both sides of the Atlantic will continue to consider the need for global harmonisation. It is expected that the CFTC and SEC will provide some further guidance as to the extraterritorial application of US requirements, although the details and timing are uncertain. Legislators have also expressed concern about extraterritorial implications (and the possibility of disadvantaging US institutions (and their non-US subsidiaries) as compared to their non-US counterparts).6 In the meantime, this note is intended to alert our clients to practical issues that may arise from overlapping US and EU regulatory jurisdiction.
Footnotes
1 This note discusses current versions of rule proposals under Dodd-Frank and the European Council's compromise text of the EMIR proposal. The final, definitive versions of the Dodd-Frank rules and EMIR, which will affect how the regimes eventually operate, are likely to differ from the versions discussed in this note.
2 Pending further rulemaking, the CFTC has granted temporary exemptive relief for the majority of those Title VII provisions that were scheduled to do so through the Effective Date for Swap Regulation [Final Order], 76 Fed. Reg. 42508 (19 July 2011).
3 The MiFID II proposals have been set out by the Commission in a Public Consultation (European Commission, Public Consultation, Review of the Markets in Financial Instruments Directive (MiFID), 8 December 2010). A legislative proposal is expected to be published in October 2011.
4 Dodd-Frank, section 722(d).
5 Dodd-Frank, section 772(c).
6 See, e.g. Letter, dated 4 October 2011, from Sen. Johnson and Rep. Frank to the chairmen of the CFTC, SEC, Federal Reserve and FDIC.
7 See e.g. International Banking Act 1978, section 1(b).
8 For example, the extraterritorial application of US sanctions against Cuba so that any entity, wherever organised, that is owned or controlled by a US person is subject to such sanctions led to the EU adopting Regulation 2271/96 prohibiting EU entities from complying with certain extraterritorial US laws. No such measures exist in the financial regulatory sector, though this is possible in the future.
9 Under Dodd-Frank, section 722(c) and (d).
10 Under the CFTC Rules this would be at the option of the counterparty.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
