On July 26, 2013, the Commodity Futures Trading Commission (CFTC) published Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (Guidance). The purpose of the Guidance is to help derivative market participants determine when the CFTC will assert jurisdiction over swap transactions that have a non-U.S. element. ISDA has prepared two status representation letters designed to permit counterparties to provide representations to each other. The deadline for providing counterparties with the appropriate representation letter is October 9, 2013.
The steps that need to be taken by October 9, 2013 are necessitated by a provision within Title VII of The Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which states that U.S. derivatives reform under Dodd-Frank applies to any activity outside of the U.S. that has a "direct and significant" connection with, or effect on, U.S. commerce. Completion of the ISDA representation letters is designed to assist counterparties, including non-U.S. Persons, in understanding their respective obligations under Dodd-Frank.
CROSS-BORDER SWAPS REPRESENTATION LETTER
The primary purpose of this representation letter is to determine whether your counterparty is a "U.S. Person", as defined by the CFTC. The Guidance lists the following categories of U.S. Persons:
- any natural person who is a resident of the United States;
- any estate of a decedent who was a resident of the United States at the time of death;
- any corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of enterprise similar to any of the foregoing (other than an entity described in prongs (iv) or (v) below) (a legal entity), in each case that is organized or incorporated under the laws of a state or other jurisdiction in the United States or having its principal place of business in the United States;
- any pension plan for the employees, officers or principals of a legal entity described in prong (iii), unless the pension plan is primarily for foreign employees of such entity;
- any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust;
- any commodity pool, pooled account, investment fund, or other collective investment vehicle that is not described in prong (iii) and that is majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v), except any commodity pool, pooled account, investment fund, or other collective investment vehicle that is publicly offered only to non-U.S. persons and not offered to U.S. persons;
- any legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners of the entity have limited liability) that is directly or indirectly majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v) and in which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity; and
- any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in prong (i), (ii), (iii), (iv), (v), (vi), or (vii).
The Guidance specifically provides that a foreign branch of a U.S. Person will fall within the definition of U.S. Person by virtue of the fact that it is a part, or an extension, of the U.S. Person.
The CFTC also states that while it is the CFTC's policy generally to limit the interpretation of the term U.S. Person to persons that fit within the above definition, there will be circumstances that are not fully addressed by the definition. Unfortunately, even with the Guidance it is difficult to determine whether certain entities are U.S. Persons. This is particularly the case with Canadian investment funds that have U.S. sub-advisors.
If you represent to your counterparty that you are not a U.S. Person, then you are required to also represent whether you are an "affiliate conduit". The Guidance sets out the following four factors to help determine whether or not a non-U.S. Person is an affiliate conduit:
- the non-U.S. Person is a majority-owned affiliate of a U.S. Person;
- the non-U.S. Person is controlling, controlled by or under common control with the U.S. Person;
- the financial results of the non-U.S. Person are included in the consolidated financial statements of the U.S. Person; and
- the non-U.S. Person, in the regular course of business, engages in swaps with non-U.S. third-party(ies) for the purpose of hedging or mitigating risks faced by, or to take positions on behalf of, its U.S. affiliate(s) and enters into offsetting swaps or other arrangements with its U.S. affiliate(s) in order to transfer the risks and benefits of such swaps with third-party(ies) to is U.S. affiliates.
In the view of the CFTC, given the relationship between the U.S. Person and the affiliate conduit, the U.S. Person is directly exposed to the risks from and incurred by the conduit. The CFTC is also concerned that a U.S. swap dealer or major swap participant might try to use affiliate conduits to conduct swaps outside of the Dodd-Frank regulatory regime.
In addition to the affiliate conduit representation, a non-U.S. Person is also required to provide certain representations to its counterparty about certain guarantees that may support the obligations of that non-U.S. Person under the swap transactions.
CROSS-BORDER SWAPS REPRESENTATION LETTER FOR U.S. BANKS
In addition to the above representation letter, ISDA also published a representation letter that allows a U.S. bank to provide its counterparties with status representations in order to determine (i) whether a transaction is deemed to have been entered into with a non-U.S. bank of that U.S. bank under the Guidance and (ii) whether the bank satisfies requirements for a safe habour to comply with local law of the branch instead of the CRTC's transaction-level requirements.
Both of these representation letters are available on ISDA's website here and may be completed through ISDA Amend, which facilities the bilateral delivery of these status letters.
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.