On October 11, the Commodity Futures Trading Commission (“CFTC’”) issued proposed rules and interpretations (the “Proposed Rule”) addressing the cross-border application of certain swap provisions of the Commodity Exchange Act. Generally speaking, the Proposed Rule aims to: (1) codify certain aspects of the CFTC’s earlier guidance on the cross-border aspects of its swaps regulations (the “Cross-Border Guidance”), (2) amend the list of swaps that would cause a non-U.S. person to be required to register as a swap dealer (“SD”) or major swap participant (“MSP”) (largely but not solely by incorporating the concept of a “Foreign Consolidated Subsidiary”), and (3) apply certain limited external business conduct standards to non-U.S. SDs and MSPs that use U.S. personnel to arrange, negotiate, or execute (“ANE”) their swaps.
As of the date of this post, the Proposed Rule has yet to be published in the Federal Register, but comments will be due 60 days after publication in the Federal Register.
Key elements of the Proposed Rule
Definition of “U.S. person” and “Foreign Consolidated Subsidiary”
The Proposed Rule would codify definitions of the terms “U.S. person” and “Foreign Consolidated Affiliate” that would be generally applicable to the CFTC’s swap regulations. The Cross-Border Guidance used the term “U.S. person,” but this was not codified in the CFTC’s regulations because it was merely guidance. The CFTC’s margin regulations also use the terms “U.S. person” and “Foreign Consolidated Affiliate,” but they are limited in context to those regulations.
Definition of “U.S. person”
The CFTC proposed to define a “U.S. person” as:
- A natural person who is a resident of the United States;
- An estate of a decedent who was a resident of the United States at the time of death;
- A corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of entity similar to any of the foregoing (other than an entity described in clauses (iv) or (v) below ) (“legal entity”), in each case that is organized or incorporated under the laws of the United States or that has its principal place of business in the United States, including any branch of the legal entity;
- A pension plan for the employees, officers or principals of a legal entity described in paragraph clause (iii) above, unless the pension plan is primarily for foreign employees of such entity;
- A 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;
- A 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 owned by one or more persons described in clauses (i) through (v) above, and for which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity, including any branch of the legal entity; or
- An 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 clauses (i) through (vi) above.
This proposed definition differs in certain ways from the definition used in the Cross-Border Guidance, but is consistent with the definition found in the CFTC’s margin regulations. For example, unlike the definition of a U.S. person in the Cross-Border Guidance, the proposed definition does not include a commodity pool, pooled account, investment fund or other collective investment vehicle that is majority-owned by one or more U.S. persons.
The CFTC stated that if this proposed definition is adopted, it will have relevance not only for the Proposed Rule but for subsequent rulemakings addressing the cross-border application of other substantive Dodd-Frank Act requirements.
Definition of “Foreign Consolidated Subsidiary”
The Proposed Rule also introduces the concept of a “Foreign Consolidated Subsidiary” (“FCS”) into the CFTC’s general swaps regulations, which we believe will attract (potentially significant) comments. An FCS is (generally speaking) a non-U.S. person whose financial statements are consolidated with those of a U.S. ultimate parent (“U.S. ultimate parent entity”) under U.S. generally accepted accounting principles. It does not matter if the liabilities of the non-U.S. person are not guaranteed by the U.S. ultimate parent entity.
Amendments to cross-border SD and MSP registration standards
The CFTC previously specified the level of swap dealing activity that would cause a person to be designated as a SD (the “de minimis threshold”), and clarified in the Cross-Border Guidance that certain swaps entered into by non-U.S. persons for swap dealing purposes would not count toward the de minimis threshold. The Proposed Rule would amend this aspect of the Cross-Border Guidance in certain ways, most notably by introducing the concept of an FCS into the determination.
In summary, in computing the de minimis threshold calculation:
- A U.S. person would include all of its swap dealing transactions.
- A non-U.S. person would include all swap dealing transactions with respect to which its obligations under the relevant swap are guaranteed by a U.S. person (a “U.S. Guaranteed Entity”).
- An FCS would include all of its swap dealing transactions.
- A non-U.S. person that is neither an FCS nor a U.S. Guaranteed Entity (an “Other Non-U.S. Person”) would include all of its swap dealing transactions with counterparties that are:
- U.S. persons
- U.S. Guaranteed Entities or
unless the swap is executed anonymously on a registered swap execution facility (“SEF”), designated contract market (“DCM”), or foreign board of trade (“FBOT”) and, in the case of an FBOT-executed swap, cleared. It would not, however, include any of its swap dealing transactions with Other Non-U.S. Persons, even if they constitute ANE transactions.
- All potential SDs, whether U.S. or non-U.S. persons, would aggregate their swap dealing transactions with those of persons controlling, controlled by, or under common control with the potential SD to the extent that those affiliates are themselves required to include those swaps in their own de minimis thresholds, unless the affiliated person is a registered SD.
The Proposed Rule therefore adds an extra step to the cross-border analysis for swap dealing activity by requiring FCSs to count all of their swap dealing activity toward the de minimis threshold. However, it also removes parts of the analysis because: (1) it does not require consideration of whether the dealing entity is a “conduit affiliate” and (2) it removes some of the complicated carve-outs included in the Cross-Border Guidance.
The Proposed Rule also contains similar provisions on the cross-border application of the CFTC’s registration thresholds for determining whether an entity must to register as an MSP.
In summary, in computing the MSP threshold calculation:
- A U.S. person would include all of its swap positions.
- A non-U.S. person would include all swap positions with respect to which it is a U.S. Guaranteed Entity.
- An FCS would include all of its swap positions.
- An Other Non-U.S. Person would include all of its swap positions with counterparties that are U.S. persons, U.S. Guaranteed Entities, or FCSs, unless the swap is executed anonymously on a registered SEF, DCM, or FBOT and cleared. It would not, however, include any of its swap positions with Other Non-U.S. counterparties.
For purposes of the MSP threshold, all swap positions that are subject to recourse should also be attributed to a guarantor, whether or not such guarantor is a U.S. person, unless the guarantor, the guaranteed entity, and its counterparty are all Other Non-U.S. Persons.
Arranged, negotiated, or executed: Cross-Border application of the External Business Conduct Standards
In November 2013, staff of the CFTC’s Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued an advisory stating that non-U.S. SDs that regularly use personnel or agents located in the U.S. in the to arrange, negotiate, or execute (“ANE”) swaps with non-U.S. persons would generally be required to comply with the “Transaction-Level Requirements,” as the term was used in the Cross-Border Guidance. DSIO subsequently issued no-action relief from this requirement due to its controversial nature, which is still in place today.
The Proposed Rule would codify the ANE requirement, but would significantly reduce the Transaction-Level Requirements that would apply to ANE swaps. Specifically, under the Proposed Rule, an SD that uses personnel located in the United States to arrange, negotiate, or execute a swap with a non-U.S. person or a foreign branch of an SD or MSP, would be subject to the CFTC’s regulations prohibiting fraud, manipulation and abusive practices, and requiring fair dealing.
Appearing below is a reproduction of a table summarizing the cross-border application of the CFTC’s external business conduct standards.
|U.S. Person||Non-U.S. Person|
|Not a Foreign Branch of an SD/MSP||Foreign Branch of an SD/MSP|
|Not a Foreign Branch||Apply||Apply||Apply|
|Foreign Branch||Apply||Do Not Apply*||Do Not Apply*|
|Non-U.S. Person||Apply||Do Not Apply*||Do Not Apply*|
*If the SD uses U.S. personnel for ANE, limited Transaction-Level requirements apply: subject only to CFTC regulations 23.410 (Prohibition of Fraud, manipulation, and other Abusive Practices) and 23.433 (Fair dealing).
Concerns expressed by Commissioners Bowen and Giancarlo
Although the Proposed Rule was unanimously approved, Commissioners Sharon Bowen and Christopher Giancarlo expressed certain concerns about the Proposed Rule.
Commissioner Bowen stressed the importance to comment on the fact that the proposal does not capture the dealing activity of “conduit affiliates.” Generally speaking, a conduit affiliates means: (i) a non-US affiliate that is consolidated with a U.S. entity where there is no ultimate U.S. parent and (ii) which transfers, through back to back swaps, the risk of swaps it enters into with non-US counterparties to that U.S. person.
Commissioner Bowen also encouraged comments on the terms “Arranged,” “Negotiated,” or “Executed.” According to Bowen, dealing activity that occurs in the U.S. with U.S. personnel from the trading desk of a non-U.S. dealer should be counted toward that non-U.S. dealer’s threshold, even though the transactions are between two non-U.S. counterparties and are booked outside the U.S.
Commissioner Giancarlo urged CFTC staff to extend the DSIO no-action letters in order to provide clarity that the swap requirements will not apply to the ANE transactions until the CFTC addresses the application of other Dodd-Frank swap requirements to those transactions.
Special thanks to Veronica Simonet for her assistance in drafting this post.