CFTC Enacts Interpretive Guidance and Passes Exemptive Order regarding Cross Border Swaps Transactions

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Published Date : July 16, 2013

As of July 12, 2013, the Commodity Futures Trading Commission issued an Interpretive Guidance and Policy Statement ("Final Guidance") and Exemptive Order ("July 12 Exemptive Order") containing important provisions related to:

  1. the definition of US person;
  2. the Swap Dealer de minimis calculation (individually and in aggregate);
  3. entity and transaction level rules; and
  4. the availability of substituted compliance by certain non-US persons otherwise required to follow CFTC rules.

These measures were approved by the CFTC by a 3-1 vote (with Commissioner O'Malia dissenting) on July 12 following the announcement of an accord on cross border swaps transactions between the CFTC and the European Commission on the prior day (see "News Developments: Peace is at Hand -- EC and CFTC Announce Cross Border Accord" on this website ). On July 11, the CFTC also issued a number of relevant no actions letters to effectuate certain aspects of the accord.

Relief from registration as a designated contract market or swap execution facility, or as a designated clearing organization, seems likely for qualifying foreign boards of trade ("FBOTs") and non-US multilateral trading facilities ("MTFs"), and possible for qualifying non-US central counterparty ("CCP") clearing houses, respectively.

US Persons
Under the Final Guidance, US persons encompass persons whose activities – either individually or in the aggregate have a direct and significant connection with activities in or affect on US commerce. The definition includes persons who are not only incorporated in the US but also those who have their center of direction, control and coordination of business activities in the US. Foreign branches of US persons are also US persons generally.

The definition of US person includes collective investment vehicles – including hedge funds – that are directly or indirectly majority owned by US persons or who have their principal place of business in the US. When considering this, apply a facts and circumstances test, looking principally at the location of a fund's investment managers, fund sponsors, and promoters, and a fund's sales and trading desks.

In an important footnote (fn 204) that hedge funds must study, the CFTC suggests that where so-called "feeder funds" (that have a US nexus) trade through overseas master funds (that typically are the counterparty to swaps), the master fund could be deemed a US person.

However, the CFTC is giving a break to non-US individuals, institutions, pension plans and operating companies that retain asset management firms in the US to provide a host of asset management and other investment related services.  If these entities are not otherwise within the definition of US person, they will not come within the definition solely because they retain an asset management firm in the US.

Moreover, in determining whether a counterparty is a US person, the CFTC will permit parties to swaps reasonably to rely on a counterparty's written representation. It appears, however, that at least perfunctory due diligence – and maybe more – should be conducted to ensure that reliance is reasonable under the particular facts and circumstances.

Market participants are not required to apply this new definition of US person until 75 days after the Final Guidance is published in the Federal Register, and may rely on existing relief until then.

De Minimis Calculation and Aggregation

Why is the definition of US person relevant?

(1) A US person; (2) a non-US person guaranteed by a US person; or (3) a so-called conduit affiliate of a US person will have to register (or has registered) as a swap dealer if its swap dealing activities over the prior 12 months exceed USD 8 Billion gross notional value of swap dealing transactions or whatever the de minimis threshold is at the time – whether the transactions are with US or non-US persons.

(Conduit affiliates are non-US persons that effectively transfer the risks of swaps back to a US person. In the Final Guidance, the CFTC provides a number of indicia to help assess whether an entity is a conduit affiliate, including (among other factors) whether the non-U.S. person is a majority-owned affiliate of a U.S. person or the non-U.S. person is controlling, controlled by or under common control with the U.S. persons (for the full list of indicia, see fn 258). The term "conduit affiliate" generally will not include swap dealers or their affiliates.)

However, for purposes of calculating the de minimis threshold, a non-US person that is not a guaranteed or conduit affiliate of a US person only is required to count its swap transactions with:

  1. US persons (other than with registered Swap Dealers or non-US branches of such entities) and
  2. certain guaranteed affiliates of US person.

In assessing their obligation to register as Swap Dealers:

  1. US and non-US group companies must aggregate the gross notional amount of all swap dealing activity of their affiliated companies (except for other registered swap dealers), and
  2. then have to register:

(a) each entity that exceeds the de minimis threshold itself, or
(b) at least one entity if the overall group exceeds the de minimis threshold.

The rules for MSPs will be similar but not identical.

Entity and Transaction Level Requirements

Finally, the CFTC divides all entity level requirements into two types:

  1. Category 1, mainly those related to capital adequacy, chief compliance officer, risk management, swap data record keeping (except for certain aspects pertaining to complaints and sales materials), and
  2. Category 2, mainly those pertaining to swap data repository reporting, and those aspects of swap data record keeping related to complaints and sales materials, and large trader reporting.

The CFTC similarly divides transaction level requirements into

  1. Category A – mainly those pertaining to mandatory clearing and swap processing, margining and segregation for uncleared swaps, mandatory trade execution, swap trading relationship documentation, portfolio reconciliation and compression, real-time reporting; trade confirmation; and daily trading records, and
  2. Category B, external business conduct standards.

Substituted Compliance

In general, US swap dealers and MSPs must comply with all entity level requirements without substituted compliance available. Non-US swaps dealers and MSPs must also comply with all entity level requirements but substituted compliance could be available for certain requirements in the Category 1 entity level requirements. Substituted compliance could be available for Category 2 entity level requirements but only where the counterparty is a-non-US person. This will increase the US large trader reporting obligations of non-US swaps dealers and MSPs dealing with non-US persons.

Likewise US swap dealers and MSPs must generally comply will all Category A transaction level requirements but a foreign branch of a US bank could be eligible for substituted compliance with respect to Category A transaction level requirements for swaps with certain counterparties. Non-US swap dealers and MSPs also must generally comply with all Category A transaction level requirements, but could generally be eligible for substituted compliance for swaps with certain counterparties.

Where a swap is with a US swap dealer or US MSP, the CFTC will require the swap to be subject to Category B transaction level requirements in full regardless of whether the counterparty is a US or non-US person. If the swap involves a non-US swap dealer or MSP, Category B transaction level requirements will apply only if the counterparty is a US person.

Appendices C through E of the Final Guidance provide helpful summaries in detail of which and when the entity and transaction level requirements apply to US and non-US swap dealers and MSPs.

In general, the CFTC will permit substituted compliance (where available) – while retaining its examination and enforcement authority – after determining that the relevant jurisdiction's relevant entity level and transaction level requirements are comparable and as comprehensive as those of the CFTC, applying an outcomes-based approach on each of the 13 categories of requirements. Identical requirements are not necessary. It is possible that substituted compliance might be available for only some but not all categories of requirements in a particular jurisdiction.

Applications for a determination may be made by a foreign regulator, individual non-US entity or group of entities; a US bank that is a SD or MSP on behalf of its foreign branches, or a trade association or other group on behalf of similarly situated entities. Once a determination is made for an entity, it will be apply to all entities and be subject to periodic re-evaluation by the CFTC.

Non-US entitles potentially eligible to benefit from substituted compliance in Australia, Canada, the EU, HK, Japan or Switzerland do not have to comply with the relevant Entity and Transaction level rules until the earlier of December 21, 2013 or 30 days following the issuance of a substituted compliance determination.

Swaps Trading Venues and CCPs

It also appears that FBOTs and MTFs  that might otherwise have had to qualify as a designated contract market or swap execution facility under CFTC rules, are likely to be approved for direct access by US persons for swaps trading without registration, provided such entities already are permitted to offer futures and options to US persons on a direct access basis. It appears that equivalent recognition for qualified non-USA CCPs may also be available, freeing them up from registering with the CFTC as designated clearing organizations ("DCO"), once a distinction regarding initial margin coverage between the US and Europe is resolved.

Already two non-US CCPs (LCH.Clearnet SA and Eurex Clearing AG) were granted no action relief to clear certain swaps for US persons without being registered as DCO for the same time period regarding substituted compliance referenced above. The CFTC also granted no action relief to 16 FBOTs to extend their authority to list for trading by direct access by US persons contracts in swaps, in addition to previously approved futures and options.

For more information, see:

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of July 16, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.

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