The CFTC published the final version of its document entitled “Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations” (the “Guidance”), providing the CFTC’s official interpretation of how the swaps provisions of the Commodity Exchange Act (the “CEA”) and related CFTC regulations apply in the cross-border context. The Guidance is derived from Section 2(i) of the CEA, which provides that the swaps provisions of the CEA and related CFTC regulations may apply to cross-border activities when such activities have a “direct and significant connection with activities in, or effect on, commerce of the United States.”
The Guidance is not technically a rule or regulation. The Guidance explains that, while a rule would “state with precision when particular requirements do and do not apply to particular situations,” the Guidance is merely a “statement of the [CFTC’s] general policy regarding cross-border swap activities and allows for flexibility in application to various situations.” A footnote indicates that the Guidance is “intended to provide an efficient and flexible vehicle to communicate the [CFTC’s] current views on how the Dodd-Frank swap requirements would apply on a cross-border basis,” while indicating that the CFTC may consider adopting formal rules on certain aspects of the Guidance in the future.
The Guidance covers a number of topics, including the definition of the term “U.S. person,” swap dealer and major swap participant registration requirements applicable to non-U.S. persons, the categorization of swap regulations as “Entry-Level Requirements” or “Transaction-Level Requirements,” and how the various requirements apply to swaps between various categories of U.S. persons and non-U.S. persons.
“U.S. Person” Definition
The Guidance defines “U.S. person” as one of the following: (i) any natural person who is a resident of the United States, (ii) an estate of a decedent who was a resident of the United States at the time of death, (iii) any corporation, partnership, limited liability company, fund, or similar legal entity that is organized or incorporated under the laws of a state or other jurisdiction of the United States or has its principal place of business in the United States, (iv) a pension plan for the employees, officers, or principals of such a legal entity, (v) any trust governed by the laws of a state or other jurisdiction in the United States, (vi) any commodity pool, investment fund, or other collective investment vehicle that is majority-owned by one or more U.S. persons, except those that are not offered to U.S. persons, (vii) any legal entity that is directly or indirectly majority-owned by one or more U.S. persons in which such person bears unlimited responsibility for the obligations and limitations of the legal entity, and (viii) any individual account or joint discretionary account where the beneficial owner is a U.S. person.
The Guidance also states that the term “U.S. person” generally includes a foreign branch of a U.S. person, because branches are considered “a part, or an extension” of the U.S. person.
The definition of “U.S. person” begins with a statement explaining that the CFTC will interpret the term “generally to include, but not be limited to” the above categories. The Guidance explains that although the CFTC’s “policy generally is to limit its interpretation of” the term “U.S. person,” the CFTC intends to maintain the flexibility to apply the term in currently unforeseen circumstances. The Guidance states that such determinations will be based on a facts-and-circumstances test that may include, for example, the strength of the connections between the person’s swap activities and U.S. commerce, the extent to which they are conducted in the United States, and the extent to which another jurisdiction may be a more appropriate source of regulation to the particular parties or matter.
Swap Dealer and Major Swap Participant Registration Requirements
The definition of “swap dealer” includes a de minimis threshold such that an entity whose swap dealing activity is less than the threshold is not required to register as a swap dealer. The definition of “major swap participant” also includes certain thresholds below which registration is not required. The Guidance clarifies which swaps should or should not be included for those threshold determinations in the cross-border context.
For purposes of the swap dealer definition, the general rule is that both U.S. persons and non-U.S. persons must generally aggregate all the relevant swap dealing activity of all of its U.S. and non-U.S. affiliates under common control, excluding the swap dealing activity of an affiliate (whether a U.S. person or a non-U.S. person) that is a registered swap dealer. All swap dealing activity of a U.S. person and a non-U.S. affiliate guaranteed by a U.S. person must be counted, regardless of its counterparty. For non-U.S. persons that are not guaranteed by a U.S. person, all dealing activity with counterparties who are U.S. persons (excluding foreign branches of U.S. swap dealers) must be counted, as must all dealing activities with affiliates guaranteed by a U.S. person, subject to certain exceptions. In addition, in the case of non-U.S. affiliates that are not guaranteed by a U.S. person, any swap entered into anonymously on a registered designated contract market, swap execution facility, or foreign board of trade, and cleared may be excluded.
For purposes of the major swap participant definition, a non-U.S. person must include any swap position between it and a U.S. person, any swap position between it and a non-U.S. person that is an affiliate of a U.S. person and guaranteed by a U.S. person, and any swap position between another person and a U.S. person or guaranteed affiliate where the potential major swap participant guarantees the obligations of the other person.
Entry-Level Requirements and Transaction-Level Requirements
The Guidance divides the CEA’s swap provisions and related CFTC regulations into “Entity-Level Requirements” and “Transaction-Level Requirements” and divides each group into two further categories. The manner in which different regulations will apply to different types of entities, discussed in more detail below, depends on its category.
Entity-Level Requirements are generally those that pertain to the entity as a whole. They include, among others, requirements pertaining to capital adequacy, chief compliance officer, risk management, and record-keeping. Entity-Level Requirements also include swap data repository reporting and physical commodity large swaps trader reporting. Although the Guidance indicates that “a number of commenters” argued that these reporting requirements should be categorized as Transaction-Level and not Entity-Level, the CFTC concluded that these regulations relate to overall market transparency and the CFTC’s ongoing market surveillance responsibilities, and are therefore properly classified as Entity-Level.
The Entity-Level Requirements are further divided into “First Category” and “Second Category.” Most Entity-Level Requirements are in the First Category, except that the regulations concerning swap data repository reporting and physical commodity large swaps trader reporting, as well as certain parts of the record-keeping requirements, are in the Second Category.
As the name implies, Transaction-Level Requirements generally apply on a transaction-by-transaction basis. They include regulations pertaining to clearing, segregation and margin for uncleared swaps, mandatory trade execution, swap trading relationship documentation, portfolio reconciliation and compression, real-time public reporting, trade confirmation, daily trading records, and external business conduct standards.
Like the Entity-Level Requirements, Transaction-Level Requirements are also divided into two categories. The external business conduct standards are in “Category B,” while all the other Transaction-Level Requirements are in “Category A.”
The categories are relevant in determining how the various regulations apply to certain cross-border swap transactions. This is discussed in more detail below.
The Guidance contemplates a “substituted compliance” mechanism in which the CFTC will, upon request of a market participant or foreign regulator, consider whether the provisions of a foreign regulatory regime offer comparable (not necessarily identical) protections to those of the CEA and CFTC. The CFTC will evaluate foreign regulatory regimes separately in 13 different regulatory categories. The CFTC will then issue a comparability determination giving its findings with respect to a particular jurisdiction. Once this has been done, the determination will apply for all entities or transactions in that jurisdiction, except that the CFTC will re-evaluate the initial determination within four years and consider making changes as it deems appropriate.
In the event that the CFTC determines that the requirements of a particular regulatory regime are comparable to and as comprehensive as those of the CEA and CFTC regulations in a particular category, a person based in that jurisdiction may comply with the applicable regulations of its home jurisdiction in lieu of CEA and CFTC requirements in that category, to the extent that substituted compliance is available. As discussed below, this depends on whether the person is a swap dealer or major swap participant, the nature of the counterparty, and the category of the regulation in question.
Notwithstanding the availability of substituted compliance, the CFTC retains its examination and enforcement authority over all registered swap dealers and major swap participants.
Finally, the Guidance includes an acknowledgment by the CFTC that its regulations, particularly regarding reporting, may violate privacy and similar laws of other jurisdictions. The Guidance indicates that the CFTC “may consider reasonable alternatives” to reconcile the competing interests, and invites regulators and market participants to consult with the CFTC when appropriate.
Application of Entry-Level Requirements and Transaction-Level Requirements
Whether or not a given person must comply with a particular CEA provision and its related CFTC regulations depends, in part, on whether the person is a U.S. person or non-U.S. person, whether it is a swap dealer or major swap participant, the nature of the relevant swap counterparty, and whether the requirement in question is an Entity-Level Requirement (and whether it is in the First Category or Second Category) or whether the requirement is a Transaction-Level Requirement (and whether it is Category A or Category B).
The Guidance goes into significant detail about the applicability of various categories of rules to various combinations of swap counterparties, including foreign branches of U.S. banks, U.S. persons that are swap dealers or major swap participants soliciting and negotiating a swap through a foreign subsidiary or affiliate, and non-U.S. persons guaranteed by or an affiliate conduit of a U.S. person. In addition, certain exceptions and qualifications apply with respect to particular regulations. Provided below is a summary of only some of the more important provisions of the Guidance. Particular care should be taken to carefully review the Guidance for applicability of different regulations to different combinations of swap counterparties.
Swap Dealers and Major Swap Participants—Entity-Level Requirements. Swap dealers and major swap participants that are not U.S. persons must generally comply with all of the Entity-Level Requirements. Substituted compliance is generally available to swap dealers and major swap participants for all First Category Entity-Level Requirements, regardless of counterparty. However, substituted compliance will be generally permitted for Second Category Entity-Level Requirements only where the counterparty is a non-U.S. person. That is, where the counterparty is a U.S. person, the swap dealer or major swap participant will be required to follow the CEA and CFTC regulations in the Second Category.
In addition, substituted compliance will be available for reporting requirements only if the CFTC is given direct access to all to the reported swap data stored at a foreign trade repository.
Swap Dealers and Major Swap Participants—Transaction-Level Requirements. Swap dealers and major swap participants that are not U.S. persons must generally comply with all Category A Transaction-Level Requirements for swaps in which the counterparty is a U.S. person, a foreign branch of a U.S. bank that is a swap dealer or major swap participant, or a non-U.S. person that is guaranteed by a U.S. person. Substituted compliance will generally not be available when the counterparty is a U.S. person, but will generally be permitted when the counterparty is a foreign branch or a non-U.S. person guaranteed by a U.S. person.
Category B Transaction-Level Requirements apply to swap dealers and major swap participants that are not U.S. persons, in each case with respect to swaps with U.S. persons. Substituted compliance is not permitted. Category B Transaction-Level Requirements do not apply to swaps between non-U.S. persons that are swap dealers or major swap participants, on the one hand, and non-U.S. persons or foreign branches of U.S. banks that are swap dealers or major swap participants, on the other.
End-Users. Several of the regulations discussed above are not applicable to persons that are not swap dealers or major swap participants (“end-users”), regardless of whether such end-users are U.S. persons or non-U.S. persons. For example, neither the chief compliance officer rules nor the external business conduct standards apply to end-users. Therefore, when discussing end-users in the cross-border context, it is only necessary to consider the regulations generally binding on end-users, which the Guidance refers to as “Non-Registrant Requirements.” These generally include rules pertaining to clearing, trade execution, record-keeping, and reporting. The distinction between Entity-Level Requirements and Transactions-Level Requirements is not relevant in the context of end-users.
In a swap between two end-users in which one or both of the counterparties is a U.S. person, the parties to the swap are generally required to comply with the Non-Registrant Requirements. Substituted compliance is not permitted. However, with respect to the clearing requirement and its related exceptions and exemptions, the Guidance confirms previous statements indicating that the CFTC will review the clearing mandates of foreign jurisdictions, including their determinations with respect to the clearing of each class of swap for which the CFTC has issued a clearing determination, and will “exercise broad discretion” in determining whether the two regimes are comparable.
With respect to swaps between two non-U.S. persons, neither of which is a swap dealer or major swap participant nor guaranteed by a U.S. person, most Non-Registrant Requirements would generally not apply. However, the Guidance states that the CFTC’s “policy” is that any non-U.S. clearing member that holds sufficiently large positions in swaps directly or indirectly linked to specified U.S.-listed physical commodity futures markets should be required to report all reportable provisions to the CFTC under the large trader reporting rules included in Part 20 of the CFTC’s regulations.