Introduction

Following CFTC approval, a new regulation addressing the cross-border application of swap dealer (SD) and major swap participant (MSP) registration thresholds and other requirements, and establishing a formal process for substituted compliance and comparability determinations for such requirements from the CFTC (the "Final Rule") came into effect November 13, 2020.1 The Final Rule supersedes the CFTC's 2013 cross-border guidance with respect to these issues and generally follows the CFTC's January 2020 proposal. Compliance with the Final Rule will be required in September 2021.

The Final Rule addresses, in part, a number of longstanding criticisms of the CFTC's prior guidance, simplifies some aspects of the analysis of cross-border issues and conforms the CFTC's approach more closely with that of the SEC. Notably, as discussed below, the amendments adopt a new definition of U.S. person that eliminates certain look-through requirements for collective investment vehicles.

Background

In 2010, the Dodd-Frank Act amended the Commodity Exchange Act (CEA) to provide a new regulatory regime for swaps. The amendments included section 2(i) which provided that the swap provisions of the CEA do not apply to activities outside the U.S. unless they (i) "have a direct and significant connection with activities in, or effect on, commerce of the United States;" or (2) contravene Commission rules or regulations enacted to prevent evasion of the swap provisions enacted under the Dodd-Frank Act. The CFTC published interpretive guidance and certain rules to address these requirements.

Specifically, in July 2013, the CFTC published an interpretative guidance and policy statement regarding the cross-border application of certain swap provisions2 which provided a general framework for the cross-border application of many Dodd-Frank Act requirements, including registration and business conduct requirements for SDs and MSPs (the "2013 Guidance"). Market participants have criticized the 2013 Guidance, and challenged it in court, as procedurally flawed (on the grounds that it should have been adopted as a formal rule) and on substantive grounds, including an overly expansive definition of U.S. person.

In November 2013, CFTC staff issued an advisory generally requiring non-U.S. SDs using personnel or agents in the U.S. to arrange, negotiate or execute (ANE) swap transactions with non-U.S. persons to comply with certain "transaction-level requirements" (the "ANE Staff Advisory").3 In the face of significant concerns expressed by market participants, the Commission has since issued successive no-action letters effectively suspending the staff advisory, and in January 2014, requested further comment on all aspects of the staff advisory.4

In May 2016, the Commission released a final rule on the cross-border application of the margin requirements for uncleared swaps ("Cross-Border Margin Rule"), which set out the circumstances under which substituted compliance would be available to certain SDs and MSPs and established a framework to assess the comparability of a foreign jurisdiction's margin requirements.5

In January 2020, the CFTC proposed a new rule to address cross-border application of registration thresholds and certain requirements applicable to SDs and MSPs, and to establish a formal process for requesting comparability determinations.6

The Final Rule is consistent in many respects with the overall approach set out in the 2013 Guidance, with certain modifications reflecting concerns raised by market participants, the Commission's experience implementing the Dodd-Frank Act and the Cross-Border Margin Rule as well as comments on the proposals and discussions with market participants. 

The Final Rule also provides an updated set of defined terms which are considered particularly relevant to the determination of whether a person's activities have a "direct and significant" connection with activities in, or effect on, U.S. commerce as described in CEA section 2(1) and would therefore be subject to CFTC regulation. A person may rely on a written representation from its counterparty that the counterparty does or does not satisfy the criteria for one or more of the definitions below, unless such person knows or has reason to know that the representation is not accurate.

Cross-Border Application of the Swap Dealer De Minimis Registration Threshold

The CEA and existing CFTC regulations require entities engaged in swap dealing to register as swap dealers unless the aggregate gross notional amount of their swaps do not exceed the applicable de minimis threshold (generally $8 billion, with a lower threshold for transactions with special entities) in the preceding 12 months. The Final Rule generally codifies the 2013 Guidance's approach to the cross-border application of these requirements, but with a new definition of U.S. person and certain other changes.

New Definition of U.S. Person

U.S. person is defined as any person that is: 

  • A natural person resident in the United States; 
  • A partnership, corporation, trust, investment vehicle or other legal person organized, incorporated or established under the laws of the United States or having its principal place of business in the United States; 
  • An account (whether discretionary or non-discretionary) of a U.S. person; or 
  • An estate of a decedent who was a resident of the United States at the time of death. 

Principal place of business refers to the location from which the officers, partners or managers of the legal person primarily direct, control and coordinate the activities of the legal person. With respect to an externally managed investment vehicle, this location is the office from which the manager of the vehicle primarily directs, controls and coordinates the investment activities of the vehicle. Certain multilateral development banks and similar international organizations are excluded from the definition of U.S. person.

The new definition is intended to capture substantially the same types of entities as the "U.S. person" definition in the 2013 Guidance. Prong (B) is intended to incorporate the pension prong and trust prong of the definition in the 2013 Guidance such that pension plans for the employees, officers or principals of a legal entity described in prong (B) and trusts governed by U.S. law would both be covered by prong (B). Unlike under the 2013 Guidance, the definition of U.S. person does not include certain legal entities that are owned by one or more U.S. person(s) and for which such person(s) bear unlimited responsibility for the obligations and liabilities of the legal entity. Legal entities that are owned by one or more U.S. person(s) and for which such person(s) bear unlimited responsibility for the obligations and liabilities will instead be considered as having a guarantee from a U.S. person. Also unlike the 2013 Guidance, the definition does not include a commodity pool, pooled account, investment fund or other collective investment vehicle (CIV) that is majority-owned by one or more U.S. persons (unless it otherwise falls within the scope of prong (B)). Finally, unlike the non-exhaustive definition provided in the 2013 Guidance, the final U.S. person definition is limited to persons enumerated in the rule.

Swap Dealing Threshold Calculation

The Final Rule, consistent with the 2013 Guidance, requires that U.S. Persons include all of their swap dealing transactions (whether with U.S. Persons or non-U.S. Persons) in their threshold calculations without exception. A U.S. Person would also include any swap dealing transactions made by foreign branches of that U.S. Person.

The Final Rule defines "foreign branch," as "any office of a U.S. bank that: (i) is located outside the United States; (ii) operates for valid business reasons; (iii) maintains accounts independently of the home office and the accounts of other foreign branches, with the profit and loss accrued at each branch determined as a separate item for each foreign branch and (iv) is engaged in the business of banking and is subject to substantive regulation in banking or financing in the jurisdiction where it is located." It is considered a branch office and not a separate legal entity.

Whether a non-U.S. person is required to include its swap transactions in its de minimis threshold calculations will depend on its status and the status of its counterparty, and the jurisdiction in which it is regulated.

  • The Final Rule establishes a new category of market participant, called a "Significant Risk Subsidiary" (SRS) which replaces the "conduit affiliate" concept. An SRS is defined as a non-U.S. significant subsidiary of a U.S. parent entity, which parent entity has more than $50 billion in global consolidated assets at the end of the most recently completed fiscal year pursuant to U.S. GAAP. Prudentially regulated subsidiaries of bank holding companies and subsidiaries subject to Basel capital rules and oversight and comparable uncleared swaps margin rules are excluded from the definition. "Significant subsidiary" is defined similarly to the same term in U.S. Securities Exchange Commission Regulation S-X and must meet one of the following conditions based on a three-year rolling average as of the end of the most recent fiscal year in accordance with U.S. GAAP: (i) equity capital of at least five percent of the U.S. parent; (ii) total revenue of at least ten percent of the U.S. parent; or (iii) total assets of at least ten percent of the U.S. parent.
  • The Final Rule requires an SRS to count all transactions (with U.S. Persons and non-U.S. Persons) towards its threshold calculations (effectively treating it in the same manner as a U.S. person). 
  • In addition, swaps of a non-U.S. Person that are guaranteed by a U.S. Person must be counted toward the non-U.S. Person's threshold (whether they are with U.S. Persons or non-U.S. Persons). 
  • However, for a non-U.S. Person that is not an SRS and is not guaranteed by a U.S. Person, only the following swaps would be counted:
    • swaps with a U.S. Person (other than swaps with a foreign branch of a registered swap dealer); and
    • swaps with a counterparty that is guaranteed by a U.S. Person, unless the counterparty is a swap dealer, the guarantee is by a non-financial entity or the counterparty is a de minimis swap dealer and is affiliated with a registered swap dealer. 

Cross-Border Application of the Major Swap Participant Registration Tests 

Under existing CFTC rules, entities with swap positions exceeding certain thresholds must register as MSPs. The Final Rule requires both a U.S. Person and an SRS to count all swaps they enter into towards this threshold. With respect to a non-U.S. person that is not an SRS, the following swaps must be counted toward the threshold: (i) swaps with a U.S. person, other than swaps conducted through a foreign branch of a registered SD; (ii) swaps where its obligations under the swaps are guaranteed by a U.S. person; and (iii) swaps with a non-U.S. person whose obligations under the swaps are guaranteed by a U.S. person, except when the counterparty is a registered SD.

ANE Transactions 

Based on comments received, considerations of international comity in light of regulation in other jurisdictions and the desire to focus on other risks it deems more significant, the CFTC has decided ANE transactions will not be subject to additional requirements, or treated as transactions involving a U.S. Person, for purposes of the Final Rule. This is consistent with the proposed rule, where the CFTC determined that ANE transactions do not present direct financial risk to the United States, and that most ANE transactions are expected to be subject to foreign regulatory requirements. Additionally, the CFTC believes that imposing requirements on ANE transactions would likely result in market fragmentation, and transactions ordinarily entered into by U.S. persons would shift to non-U.S. persons, decreasing the CFTC's oversight. As such, the CFTC also withdrew the ANE Staff Advisory and related no-action relief.

Exceptions from Group B and Group C Requirements, Substituted Compliance for Group A and Group B Requirements, and Comparability Determinations

The CFTC has established a broad range of requirements applicable to SDs and MSPs. In the interest of international comity, among other reasons, the Final Rule establishes certain exceptions and permits substituted compliance with respect to certain requirements. The approach appears to be intended to provide greater flexibility than the approach taken in the 2013 Guidance. The Final Rule categorizes certain requirements as follows:

  • The group A requirements include: (1) Chief Compliance Officer requirements; (2) risk management requirements; (3) swap data recordkeeping; and (4) antitrust considerations.
  • The group B requirements include: (1) swap trading relationship documentation; (2) portfolio reconciliation and compression; (3) trade confirmation; and (4) daily trading records.
  • The group C requirements include certain business conduct rules. 

The CFTC adopted the following exceptions to group B and group C requirements:

  • an exception from certain group B and C requirements for certain anonymous, exchange-traded and cleared foreign-based swaps entered into by non-U.S. swap entities or foreign branches of U.S. swap entities; 
  • an exception from the group C requirements for non-U.S. swap entities and foreign branches of U.S. swap entities entering into foreign-based swaps with foreign counterparties;
  • an exception from the group B requirements for foreign-based swaps of foreign branches of U.S. swap entities with non-U.S. persons that are neither guaranteed by a U.S. Person nor an SRS (unless they are end users), subject to certain limitations, including a quarterly cap on the amount of such swaps; and
  • an exception from the group B requirements for the foreign-based swaps of non-U.S. swap entities that are neither guaranteed by a U.S. Person nor an SRS with certain non-U.S. persons (other than foreign branches) that are neither guaranteed by a U.S. Person nor an SRS.

A "foreign-based swap" is defined as a swap (i) by a non-U.S. swap entity not conducted through a U.S. branch or (ii) conducted through a foreign branch.

The Final Rule defines "U.S. branch" to mean a branch or agency of a non-U.S. bank entity that (i) is located in the U.S., (ii) maintains separate accounts from the home office with profits and losses determined separately for each U.S. branch and (iii) engages in the banking business and is subject to substantive banking regulation in the state or district where located.

A "swap conducted though a foreign branch" is considered to occur if (i) payments and deliveries occur through the branch and related documentation specifies such branch as the office for the swap, (ii) the foreign branch enters into the swap in its normal course of business and (iii) the foreign branch reflects the swap in its local accounts. 

Substituted Compliance and Comparability Determinations

The Final Rule addresses the circumstances under which substituted compliance is available for the SD and MSP regulatory requirements and the process pursuant to which the CFTC may make comparability determinations relating to substituted compliance. The rule permits a non-U.S. swap entity, subject to any conditions specified in a comparability determination issued by the Commission, to avail itself of substituted compliance with respect to the group A requirements on an entity-wide basis. It also permits a non-U.S. swap entity or foreign branch of a U.S. swap entity, subject to a comparability determination, to avail itself of substituted compliance with respect to the Group B requirements for its foreign-based swaps with foreign counterparties by complying with the applicable requirements of a foreign jurisdiction. The Final Rule does not address substituted compliance with respect to the group C requirements as broader exceptions from those requirements for swaps with foreign counterparties are available, as discussed above.

With respect to a comparability determination, as in the January 2020 proposed rule, a foreign jurisdiction's regulatory regime does not need to be identical to the Commission requirements to be considered comparable, so long as both regulatory frameworks are comparable in terms of holistic outcome. 

Conclusions

The Final Rule marks the completion of rulemaking relating to certain Dodd-Frank Act requirements that have been the focus of the CFTC for the past ten years. The effective date of the Final Rule was November 13, 2020, and the compliance date is September 14, 2021. The exceptions to the Group B and C requirements will be effective upon the effective date for SDs and MSPs that comply with certain recordkeeping requirements. Otherwise, market participants must comply with the Final Rule on or before September 14, 2021.

Footnotes

1 CFTC Release Number 8211-20, CFTC Approves Final Cross-Border Swaps Rule and an Exempt SEF Amendment Order at July 23 Open Meeting (July 23, 2020);  Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants, 85 Fed. Reg. 56924 (Sept. 14, 2020).

2  Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 FR 45292 (July 26, 2013).

3 CFTC Staff Advisory No. 13-69, "Applicability of Transaction-Level Requirements to Activity in the United States" (November 14, 2013).

4 CFTC Staff Letter No. 13-71, "No-Action Relief: Certain Transaction-Level Requirements for Non-U.S. Swap Dealers" (Nov. 26, 2013);  Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States, 79 Fed. Reg. 1347 (Jan. 8, 2014).

5  Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants-Cross-Border Application of the Margin Requirements, 81 Fed. Reg. 34817 (May 31, 2016).

6  Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants, 85 FR 952 (Jan. 8, 2020).

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