The Commodity Futures Trading Commission (CFTC or Commission)
has proposed guidance on the applicability of its regulations to
cross-border swaps activities. 1 This proposed
guidance will potentially affect all U.S. and many non-U.S. persons
and entities that conduct cross-border swaps transactions. At the
same time, the Commission has proposed delaying compliance with
many of the requirements discussed in the Cross-Border Release.
2
The Commission's proposed guidance expresses its view on: (a)
who is considered a "U.S. Person"; (b) which non-U.S.
firms are required to register as Swap Dealers (SDs) or Major Swap
Participants (MSPs); and (c) which U.S. regulatory requirements
will apply to swaps entered into by various non-U.S. entities. In
addition, the Commission has proposed to rely on regulation by
non-U.S. regulators as a means of complying with certain of the
Commission's requirements. However, market participants should
note that the Commission will not permit such "substituted
compliance" for all of its requirements.
The following discussion answers a number of questions central to
understanding the impact of the Commission's guidance on
various market participants.
I. Registration Issues
To which non-U.S. persons 3 would the DFA's
swaps requirements generally apply?
Non-U.S. persons that act as SDs or MSPs and that exceed the thresholds for SDs or MSPs would be deemed to be engaged in activities that have a "direct and significant" connection with or effect on U.S. commerce and thereby would be subject to the provisions of the Dodd-Frank Act (DFA).4 Accordingly, they would be required to register with the CFTC and be subject to the substantive requirements under Title VII of the DFA that apply to U.S. SDs and MSPs. However, as a matter of international comity, the Commission, as explained in greater detail below, will not apply all U.S. requirements to such entities.
Swap
Dealer Registration
Which non-U.S. entities would have to
register as SDs?
Foreign entities whose obligations are not guaranteed by U.S. persons would have to register if: (a) swap dealing is part of their regular business with respect to U.S. persons as counterparties; and (b) their swap dealing with U.S. counterparties exceeds the de minimis aggregate notional value level ($3 billion, with a phase-in amount of $8 billion) outlined in the Commission's and the Securities and Exchange Commission's (SEC's) joint final rulemaking further defining the terms SD and MSP5 (Entity Definitions Rulemaking). It would not be necessary to determine whether these swaps or activities are located within or outside of the U.S. If a U.S. person is a counterparty, the swaps activities would be deemed not to be outside of the U.S. for purposes of satisfying the de minimis threshold.
Would a non-U.S. SD with only non-U.S. counterparties be required to register?
No. A non-U.S. entity would not be required to apply the de minimis test even if it engages in swaps activities as part of a "regular business" unless such "regular business" is with U.S. person counterparties.
Which transactions would a non-U.S. entity include to determine eligibility for thede minimis exemption from SD registration?
In
determining whether the amount of swap dealing exceeds the de
minimis level for SD registration, entities would have to
include: (a) their swaps and the swaps of their non-U.S. affiliates
(i.e., those under common control with the entity) where a U.S.
person (other than a foreign branch or agency of a U.S. person) is
the counterparty; and (b) their swaps and the swaps of their
non-U.S. affiliates where their obligations (or the obligations of
their non-U.S. affiliates) are guaranteed or otherwise formally
supported by a U.S. person.
On the other hand, a non-U.S. entity could exclude: (a) swaps with
foreign branches of U.S. SDs; (b) swaps with non-U.S. persons as
counterparties (whether or not their obligations are guaranteed by
U.S. persons);6 (c) swaps entered into by its U.S.
affiliates; and (d) swaps the entity enters into with its U.S. or
non-U.S. affiliates as counterparties (i.e., the inter-affiliate
exclusion from the Entity Definitions
Rulemaking).7
Would foreign branches or agencies of U.S. SDs have to register separately?
No. The
CFTC considers foreign branches and agencies of U.S. SDs to be part
of the U.S. parent. The swaps activities of these foreign branches
and agencies would have to be attributed to the U.S. parent, which
would remain responsible for compliance with all applicable
requirements. However, as described below, foreign branches and
agencies of U.S. SDs would still be subject to certain regulatory
requirements in connection with their swaps.
On the other hand, foreign affiliates or subsidiaries of U.S. SDs
would have to register as SDs if they independently meet the
requirements for SD registration ("regular business" and
de minimis threshold). In addition, where a swap
negotiated or arranged by a non-U.S. affiliate or subsidiary is
booked by a U.S. person (whether directly or indirectly), that U.S.
person would also need to register as an SD if it satisfies the
registration criteria.
Major Swap Participant
Registration
Which non-U.S. entities would have to register as
MSPs?
Any non-U.S. person that is not a dealer and that holds swaps positions with U.S. persons as counterparties above the MSP thresholds established in the Entity Definitions Rulemaking would have to register as an MSP.
Which swaps would need to be included in the threshold determination?
Non-U.S. entities would generally have to include their own and their non-U.S. affiliates' swaps positions with U.S. person counterparties as well as swaps between another non-U.S. person and a U.S. person where such entities guarantee the obligations of the non-U.S. person. The non-U.S. entities could exclude those swaps with non-U.S. counterparties, whether or not the counterparties' obligations are guaranteed by a U.S. person. In the case of a guarantee or other formal support of a non-U.S. entity, the U.S. person to which the non-U.S. entity had recourse would be required to count the swap in its MSP determination.
II. Regulatory Requirements for Non-U.S. SDs and
MSPs
What kinds of requirements would apply to non-U.S. SDs and
MSPs that are required to be registered?
The CFTC has divided the DFA swaps-related regulatory requirements into two groups: (a) "Entity-Level" requirements that would apply to the entity as a whole for those entities that are required to be registered; and (b) "Transaction-Level" requirements that would apply to the individual swaps transactions.
Entity-Level
Requirements
What are Entity-Level requirements and who would have to
comply with them?
The
Entity-Level requirements, which would apply to entities
differently based on a number of factors, are: (a) capital
adequacy; (b) chief compliance officer; (c) risk management; (d)
swap data recordkeeping; (e) swap data repository (SDR) reporting;
and (f) physical commodity swaps reporting (Large Trader
Reporting).
The Entity-Level requirements would apply for: (a) foreign branches
or agencies of U.S. SDs; and (b) foreign affiliates of U.S. SDs
when the swaps are booked in the U.S. SD. The Entity-Level
requirements would apply, but substituted compliance would be
available, for: (a) foreign affiliates of U.S. SDs where the
affiliate is the legal counterparty to the swap (i.e., the swap is
not booked in the U.S.), regardless of whether the swap is
guaranteed by a U.S. person; and (b) non-U.S. SDs where the swap is
neither booked in the U.S. nor guaranteed by a U.S. person. The
CFTC proposes, however, that for SDR reporting, substituted
compliance would only be permitted if the Commission is allowed
direct access to the swaps data stored at the applicable foreign
trade repository.
Transaction-Level
Requirements
What are the Transaction-Level
requirements?
The
Transaction-Level requirements, which would apply to entities
differently based on a number of factors, are: (a) clearing and
swap processing; (b) margin (and segregation) for uncleared swap
transactions; (c) mandatory trade execution; (d) swap trading
relationship documentation; (e) portfolio reconciliation and
compression; (f) real-time public reporting; (g) trade
confirmation; (h) daily trading records; and (i) external business
conduct standards.
The Transaction-Level requirements would generally apply to
non-U.S. SDs and MSPs where the counterparty is a U.S.
person.
Substituted compliance would never be permitted if the counterparty
is a U.S. person.
With the exception of the external business conduct standards
(i.e., sales practices standards, discussed below), the
Transaction-Level requirements also would generally apply where the
counterparty is a non-U.S. person guaranteed by a U.S. person (but
see the question below).
With some exceptions, the Transaction-Level requirements would
generally not apply to non-U.S. SDs and MSPs where the counterparty
is a non-U.S. person that is not guaranteed by a U.S. person.
How would the Transaction-Level requirements specifically apply to affiliates, subsidiaries, branches, and agencies of U.S. SDs?
(a)
Non-U.S. SDs that are not affiliates of U.S. SDs. The
Transaction-Level requirements would apply where the swaps are with
a U.S. counterparty or with a non-U.S. counterparty whose
obligations are guaranteed by a U.S. person even if they are
not booked in the U.S. (i.e., the foreign SD is the legal
counterparty and its obligations are not guaranteed by a
U.S. person). Substituted compliance would be permitted.
(b) Foreign affiliates of U.S. SDs. The Transaction-Level
requirements would apply to the swaps entered into by foreign
affiliates of U.S. SDs:
(1)
where the swaps are booked in the U.S. Substituted compliance would
not be permitted, even where the counterparty is a
non-U.S. person;
(2) where the swaps are with a non-U.S. counterparty whose
obligations are guaranteed by a U.S. person even if they are
not booked in the U.S. (i.e., the foreign affiliate is the
legal counterparty and its obligations are not guaranteed
by a U.S. person), in which case substituted compliance would be
permitted; and
(3) where the foreign affiliate acts as a "conduit" for a
U.S. person to execute swaps outside the DFA regime, regardless of
where the swaps are booked. A conduit would be a non-U.S.
counterparty that: (a) is majority-owned, directly or indirectly,
by a U.S. person; (b) regularly enters into swaps with one or more
other U.S. affiliates or subsidiaries of the U.S. person; and (c)
is included in the consolidated financial statements of the U.S.
person. In these instances, substituted compliance would be allowed
for transactions between the affiliate conduit and a non-U.S. SD or
MSP.
(c)
Exception: Foreign affiliates of U.S. SDs acting as agent. In cases
in which the subsidiary or affiliate acts only as a disclosed agent
and does not otherwise meet the definition of an SD, the
Transaction-Level requirements would not apply to the affiliate,
provided that the agency relationship is adequately documented and
the principal is primarily responsible for the actions of the
affiliate.
(d) Foreign branches and agencies of a U.S. SD. The
Transaction-Level requirements would apply to foreign branches and
agencies of U.S. SDs. Substituted compliance would be permitted
where the counterparty is a non-U.S. person, whether or not the
non-U.S. person is guaranteed by a U.S. person. In addition, in
limited circumstances and subject to certain conditions, and in the
absence of a comparable foreign regulatory regime, compliance might
be allowed with local transaction-level requirements. For instance,
foreign branches of U.S. SDs in emerging markets, without a
comparable regulatory framework, would be able to participate in
those markets if the aggregate notional value of the swaps of all
of the branches in each market did not exceed 5% of the aggregate
notional value of all of the swaps of the U.S. SD.
To which transactions would the external business conduct standards apply?
The
external business conduct standards would apply to the swaps
entered into by the following entities, but only if they are with
U.S. person counterparties: (a) foreign branches or agencies of
U.S. SDs; (b) foreign affiliates of U.S. SDs, where the swaps are
booked in the U.S. SD; (c) foreign affiliates of U.S. SDs where the
affiliate is the legal counterparty (regardless of whether the
swaps are guaranteed by a U.S. person); and (d) non-U.S. SDs where
the swaps are neither booked in nor guaranteed by a U.S.
person.
The Commission would not require that non-U.S. SDs or MSPs meet
external business conduct standards for transactions with non-U.S.
persons even if performance is guaranteed by a U.S. person.
Substituted compliance would not be permitted for those non-U.S.
entities required to comply with external business conduct
requirements.
III. Regulatory Requirements for Market
Participants
Which regulatory requirements would apply when neither
party is an SD or MSP?
Many of the Commodity Exchange Act's (CEA) requirements, namely, clearing, trade execution, real-time public reporting, Large Trader Reporting, SDR reporting, and recordkeeping, would apply to swaps market participants that are not SDs or MSPs if one or both counterparties to a swap is a U.S. person (and not an SD or MSP). Moreover, substituted compliance would not be permitted, except for SDR reporting and swap data recordkeeping, if substituted compliance would provide the Commission access to the swap data for these transactions.
IV. Determining Whether Substituted Compliance Would
be Permitted
Assuming substituted compliance would be permitted as
described above, when would non-U.S. entities be able to rely on
their compliance with the regulatory authority of their home
country to satisfy Commission requirements?
According to the Cross-Border Release, in instances in which substituted compliance would be permitted, the CFTC would allow non-U.S. entities that can demonstrate that their home regimes are "comparable" to the provisions of the CEA and Commission regulation to substitute their compliance with their home regulatory regime for compliance with the Entity-Level and/or Transaction-Level requirements. In order to receive approval for substituted compliance, entities would have to apply to the Commission as described below.
How would the CFTC determine if a non-U.S. entity could use substituted compliance in areas where it is permissible?
The Commission intends to review the foreign regulatory regime's laws and determine if they are comparable (not necessarily identical) by taking the following factors into account: (a) the scope and objectives of the relevant regulatory requirement(s); (b) the comprehensiveness of those requirement(s); (c) the comprehensiveness of the foreign regulator's supervisory compliance program; and (d) the foreign regulator's authority to support and enforce its oversight of the non-U.S. SD or MSP applicant.
V. Compliance Dates
When is the compliance date for these requirements?
Under
the Proposed Exemptive Order, compliance will be delayed for most
of the Entity-Level and Transaction-Level requirements discussed in
the Releases. However, the Releases would not affect the effective
date or compliance date of any specific DFA rulemaking by the
CFTC.
For U.S. SDs and MSPs, compliance with most of the Entity-Level and
Transaction-Level requirements will be delayed from the effective
date until January 1, 2013. However, as proposed, the relief would
not extend to SDR reporting and Large Trader Reporting
requirements. Nor would it postpone the date by which U.S. SDs and
MSPs would be expected to apply to register.
For non-U.S. SDs and MSPs, compliance with all the relevant
requirements (except for SDR reporting and Large Trader Reporting
of swaps with U.S. counterparties) will be delayed for 12 months
from the date of publication of the Proposed Exemptive Order, as
long as the conditions described below are satisfied.
May non-U.S. SDs or MSPs delay compliance with applicable Entity-Level requirements?
Yes.
Compliance by non-U.S. SDs and MSPs with Entity-Level requirements
may be delayed if:
(a) An application to register as an SD or MSP is filed with
the National Futures Association (NFA) by the date such entity is
required to apply for registration; and
(b) Within 60 days of filing the application, the applicant
files a compliance plan addressing how it plans to comply with each
applicable CEA requirement (both Entity-Level and
Transaction-Level) once this relief expires.
When would the application for registration be required?
An application for registration is, for practical purposes, due by the effective date of the joint final rule further defining the term "swap." The Commission voted to issue the final definitional rules (jointly with the SEC) on July 10, 2012. These rules are expected to be effective 60 days after their publication in the Federal Register.
VI. Next Steps
Interested parties will have 45 days from publication in
the Federal Register to comment on the Cross-Border
Release and 30 days from publication to comment on the Proposed
Exemptive Order.
VII. Appendices
For ease of reference, included here are reproductions of charts provided by
the Commission in the Appendices to the Cross-Border Release
describing the application of Entity-Level and Transaction-Level
requirements to the various U.S. and non-U.S. entities.
Footnotes
1. Proposed Interpretive Guidance and Policy Statement on the Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act (Cross-Border Release), RIN 3038-AD57 (scheduled to be published in the Federal Register in July) (June 29, 2012).
2. Exemptive Order Regarding Compliance with
Certain Swap Regulations (Proposed Exemptive Order), RIN 3038-AD85
(scheduled to be published in the Federal Register in
July) (June 29, 2012). The Cross-Border Release and the Proposed
Exemptive Order are together referred to as the
"Releases."
3. In the Releases, a U.S. person is defined as:
(a) A natural person who is a resident of the U.S.; (b) An entity
organized or incorporated in the U.S. or having a principal place
of business in the U.S., which (1) includes a foreign branch or
agency of a U.S. person, but (2) does not include a foreign
affiliate or subsidiary of a U.S. person, even if the affiliate or
subsidiary has some or all of its swap-related obligations
guaranteed by the U.S. person; (c) An entity whose direct or
indirect owners are responsible for its liabilities and one or more
of such owners is a U.S. person; (d) An individual account
(including discretionary accounts) with a U.S. person as a
beneficial owner; (e) A commodity pool, pooled account, collective
investment vehicle (whether or not organized in the U.S.) where
majority ownership or equity interest is held by a U.S. person
or where its operator would be required to register as a
commodity pool operator under the Commodity Exchange Act (CEA); (f)
A pension plan for employees, officers, or principals of a legal
entity with its principal place of business in the U.S.; or (g) An
estate or trust whose income is subject to U.S. income tax,
regardless of source.
4. Section 722(d) of the DFA amended the CEA by
adding Section 2(i), which states that the DFA's provisions
related to swaps and Commission regulations promulgated thereunder
are not applicable to activities outside the U.S. unless those
activities: (a) have a "direct and significant connection with
activities in, or effect on, commerce" of the U.S.; or (b)
"contravene such rules or regulations" that the
Commission enacts to prevent evasion of the CEA.
5. "Further Definition of 'Swap
Dealer,' 'Security-Based Swap Dealer,' 'Major Swap
Participant,' 'Major Security-Based Swap Participant'
and 'Eligible Contract Participant,'" 77 Fed. Reg.
30596 (May 23, 2012). See WilmerHale's alert,
"The SEC and CFTC Issue Joint Rules Further Defining Swap
Dealers and Major Swap Participants," May 4, 2012, available
at:
http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=10138.
6. The Cross-Border Release is not completely
clear as to whether swaps with non-U.S. counterparties involving
guarantees of such parties' obligations by U.S. persons would
need to be counted. The Commission notes that the non-U.S. person
should count swap dealing between it (or its non-U.S. affiliates)
and U.S. persons as well as swap dealing where its or its
affiliates' obligations are guaranteed by U.S. persons
(Cross-Border Release at 27), suggesting that a guarantee by a U.S.
person of a non-U.S. counterparty's obligations would not be
relevant here. This reading is supported by the Commission's
questions, which further suggest that such U.S. person-guaranteed
swaps need not be counted. However, a contrary reading is suggested
by the following: "In the case of an affiliated group of
non-U.S. persons under common control, the Commission believes that
all of the affiliated non-U.S. persons should aggregate the
notional value of their swap dealing transactions with U.S. persons
(and their swap dealing transactions with non-U.S. persons in which
such person's obligations are guaranteed by U.S. persons), in
order to determine, in effect, the level of swap dealing
activities...." (Cross-Border Release at 22). The Commission
will need to clarify this point in its final guidance.
7. See Cross-Border Release, n.43.
8. While the Commission charts refer to foreign affiliates of U.S. persons, the guidance itself in some instances is limited to a discussion of foreign affiliates of U.S. SDs. We would expect that final guidance would clarify any ambiguities.
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.
