On July 23, 2020, the U.S. Commodity Futures Trading Commission (CFTC) adopted a final rule that clarifies the cross-border application of the swap dealer (SD) and major swap participant (MSP) registration thresholds and compliance requirements applicable to non-U.S.-domiciled SDs and MSPs (Final Cross-Border Swap Rule).1 The Final Cross-Border Swap Rule also establishes a process for requesting comparability determinations for substituted compliance from the CFTC and defines key terms for the purpose of applying the Commodity Exchange Act’s (CEA) swaps provisions to cross-border transactions. The Final Cross-Border Swap Rule supersedes the CFTC’s 2013 cross-border guidance (2013 Cross-Border Guidance)2and several of the CFTC no-action letters and dispositions3 on the extraterritorial application of the CEA’s swaps regulations and represents another important step by the CFTC in implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).4
In 2010, Congress passed the Dodd-Frank Act in response to the 2008 financial crisis and gave the CFTC broad authority to regulate the swaps market. With respect to the cross-border application of the provisions of the CEA relating to swaps, the Dodd-Frank Act added new CEA section 2(i) to clarify that such provisions, and the CFTC’s rules and regulations issued thereunder, “shall not apply to activities outside the United States unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce of the United States, or (2) contravene such rules or regulations as the [CFTC] may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of [the CEA] that was enacted by the [Dodd-Frank Act].5
Following the passage of the Dodd-Frank Act, the CFTC proposed or adopted multiple rules, interpretations, and pieces of regulatory guidance addressing the cross-border application of the CEA provisions relating to swaps.6The guidance includes the CFTC’s 2013 Cross-Border Guidance, in which the CFTC set forth its interpretation of the “direct and significant” prong of CEA section 2(i) and established a general framework for the cross-border application of many substantive Dodd-Frank Act requirements and a process for making substituted compliance determinations.7 Although nonbinding, the CFTC’s 2013 Cross-Border Guidance was the sole roadmap for compliance for derivatives markets participants inside of, and particularly outside of, the United States.
The CFTC has acknowledged that the regulatory guidance to date on the cross-border application of the swap provisions under the CEA, including the 2013 Cross-Border Guidance, has “left much to be desired by both our market participants and our regulatory colleagues overseas.”8 At the same time, the 2013 Cross-Border Guidance set an international standard which withstood the test of time and legal challenges in the U.S. court system, and market participants already have spent millions of dollars on compliance with the 2013 Cross-Border Guidance.9 At the same time, the 2013 Cross-Border Guidance set an international standard which withstood the test of time and legal challenges in the U.S. court system, and market participants already have spent millions of dollars on compliance with the 2013 Cross-Border Guidance.10
Nevertheless, CFTC Chairman Heath P. Tarbert and his colleagues adopted the Final Cross-Border Swap Rule to provide perceived “critically needed regulatory certainty to the global swaps markets” and to “properly balance protection of our national interests with appropriate deference to international counterparts.” 11
2. Key takeaways
- The Final Cross-Border Swap Rule largely leaves the overall structure of the 2013 Cross-Border Guidance intact, with several very important changes. The CFTC:
- Narrowed the definition of “U.S. Person” to make it closer to the SEC’s standard and CFTC’s 2016 Cross-Border Margin Rule;
- Narrowed the definition of “Guaranty” and also brought it closer to CFTC’s 2016 Cross-Border Margin Rule;
- Replaced the functional concept of “Conduit Affiliate” with a broader term of “Significant Risk Subsidiary” and partially included the concept in the term Guaranty;
- Clarified the treatment of non-U.S. branches of U.S. banks;
- Established a process for CFTC in making substituted compliance and comparability determinations for foreign-based SDs and MSPs;
- Clarified (but carved out) what transactions qualify as arrange, negotiate, and execute (ANE) transactions by U.S. personnel of non-U.S. SDs;
- Simplified the calculation methodology for non-U.S. persons for monitoring the de minimis threshold to SD registration; and
- Reorganized swap compliance requirements by type of entity from entity-level requirements (ELRs) and transaction-level requirements (TLRs) to Category A, B, and C requirements, and left certain requirements (such as reporting, clearing, capital, trade execution requirements) as “Unaddressed Requirements.”
3. Key definitions
The Final Cross-Border Swap Rule provides new or revised definitions for certain key terms.12 The key terms include definitions for “U.S. Person,” “Non-U.S. Person,” “Guaranty” and “Guaranteed Entity,” “Significant Risk Subsidiary,” “Foreign Branch,” and “Foreign-Based Swap and Foreign Counterparty.” This paper discusses the definitions of certain key terms below in relation to the portion of the Final Cross-Broder Swap Rule to which they relate.
4. Cross-border application of SD and MSP registration thresholds
The Final Cross-Border Swap Rule identifies which cross-border swaps or swap positions a person must consider when determining whether they need to register with the CFTC as an SD or MSP.
CEA section 1a(49) defines “swap dealer” as any person who: (1) holds themself out as a dealer in swaps, (2) makes a market in swaps,13 (3) regularly enters into swaps with counterparties as an ordinary course of business for their own account, or (4) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in swaps. A person will not be deemed to be an SD as a result of their swap dealing activity involving counterparties unless during the preceding 12 months, the aggregate gross notional amount of the swaps connected with those dealing activities exceeded the “de minimis” threshold.14 CEA section 1a(33) defines the term “major swap participant” to include persons who are not SDs but who nevertheless pose a high degree of risk to the U.S. financial system by virtue of the “substantial” nature of their swap positions.” 15
In determining whether a person engages in a de minimis quantity of swap dealing, the Final Cross-Border Swap Rule states that a “U.S. person” must include all of their swap dealing transactions in their de minimis threshold calculation without exception.16 However, whether a non-U.S. person needs to include a swap in their de minimis threshold calculation depends on the non-U.S. person’s status, the status of their counterparty, and, in some cases, the jurisdiction in which the non-U.S. person is domiciled and regulated.17 Specifically, the Final Cross-Border Swap Rule states:
- A person who is a “Guaranteed Entity”18 or a “Significant Risk Subsidiary”19 must count all of their swaps dealing toward the de minimis threshold; 20
- An “Other Non-U.S. Person” must count swaps dealing with a U.S. person toward their de minimis threshold calculation, except for swaps conducted through a foreign branch of a registered U.S. SD or the swaps executed anonymously on an exchange;21 and
- Subject to certain exceptions, an Other Non-U.S. Person must count dealing swaps toward their de minimis threshold calculation if the counterparty to such swaps is a Guaranteed Entity.22
- The Final Cross-Border Swap Rule’s approach for the cross-border application of the MSP thresholds is similar to the approach described above for the SD threshold. 23
5. ANE transactions
The Final Cross-Border Swap Rule states that swaps between non-U.S. persons that are arranged, negotiated, and executed by U.S. personnel (referred to as ANE Transactions) will not be considered a relevant factor for purposes of applying the Final Rule Cross-Border Swap Rule24. In connection with the adoption of this position, the CFTC formally withdrew Staff Advisory No. 13-69 in connection with the adoption of the Final Cross-Border Swap Rule. Staff Advisory No. 13-69 had provided that a non-U.S. SD would generally be required to comply with certain “Transaction-Level Requirements” or “TLRs” (as that term and concept is discussed more fully below) when entering into ANE Transactions (i.e., the “elevator rule”).