Alert July 10, 2012

CFTC Proposes Interpretive Guidance on Cross-Border Application of Dodd-Frank Swaps Provisions

The CFTC unanimously approved proposed interpretive guidance on the cross-border application of the swaps provisions of the Dodd-Frank Act.  The proposed guidance would interpret Section 2(i) of the Commodity Exchange Act (as amended by the Dodd-Frank Act), which states that the swaps provisions enacted as part of the Dodd-Frank Act shall not apply to activities outside the United States unless those activities have a direct and significant connection with activities in, or effect on, United States commerce. 

The proposed guidance would interpret the term “U.S. person” to include (i) any natural person who is resident in the United States, (ii) any corporation, partnership, or similar entity either (A) organized or incorporated under the laws of the United States or having its principal place of business in the United States, or (B) whose owners are responsible for the liabilities of such entity and one or more of whom is a U.S. person; or (iii) individual accounts, commodity pools, and other vehicles majority owned by U.S. persons or whose operator would be required to register as a commodity pool operator.  The guidance notes that, generally, a foreign branch or agency of a U.S. person would itself meet the definition of “U.S. person,” while a foreign affiliate or subsidiary of a U.S. person would not.  

The proposal would offer guidance regarding swap dealers and major swap participants, noting that the statutory definitions of “swap dealer” and “major swap participant” neither contain geographic limitations nor distinguish between U.S. and non-U.S. swap dealers or major swap participants.  Building on the de minimis thresholds established in the entity definition rules, the guidance proposes that a non-U.S. person whose level of swap dealing with U.S persons as counterparties exceeds the de minimis threshold would be required to register with the CFTC as a swap dealer.  The value of transactions with foreign branches of registered U.S. swap dealers would not be included for purposes of this calculation.  However, the calculation would include the value of any swap dealing transaction between the non-U.S. person or any of its non-U.S. affiliates under common control, on the one hand, and a U.S. person (other than foreign branches of U.S. persons registered as swap dealers), on the other.  It would also include the value of any swap dealing transaction between the non-U.S. person or any of its non-U.S. affiliates under common control where its obligations or the obligations of a non-U.S. affiliate are guaranteed by U.S. persons.  A roughly similar analysis would apply to major swap participants. 

Once registered, non-U.S. swap dealers and non-U.S. major swap participants would become subject to the Dodd-Frank Act provisions applicable to registered swap dealers and major swap participants.  However, the CFTC indicated that it would apply its authority “in a manner consistent with principles of international comity.”  To accomplish this, the proposed guidance would divide the relevant Dodd-Frank Act provisions into two categories:  “entity-level requirements,” which would apply to the firm or entity as a whole, and “transaction-level requirements,” which would apply to an individual swap.  Entity-level requirements would include statutory provisions and CFTC regulations regarding capital adequacy, risk management, chief compliance officers, and various record-keeping and reporting rules, which apply across all of a registrant’s swaps regardless of the counterparty or location of individual swaps.  Transaction-level requirements would include (i) clearing and swap processing, (ii) margining and segregation for uncleared swaps, (iii) trade execution, (iv) swap trading relationship documentation, (v) portfolio reconciliation and compression, (vi) real-time public reporting, (vii) trade confirmation, (viii) daily trading records, and (ix) external business conduct standards.

The proposed guidance would require registered non-U.S. swap dealers and non-U.S. major swap participants to comply with the entity-level requirements, although “substituted compliance,” in which complying with foreign regulations would be deemed to satisfy this requirement, would be permitted in certain circumstances.  The proposed guidance would, however, require non-U.S. swap dealers and non-U.S. major swap participants to comply with the transaction-level requirements for all their swaps with U.S. persons, other than foreign branches of U.S. persons, as counterparties.  Substituted compliance would generally not be permitted for transaction-level requirements. 

Although the CFTC is not required to solicit comments on interpretive guidance, it has chosen to do so here.  Comments are due 45 days after the guidance’s forthcoming publication in the Federal Register.