DCOs subject to Alternative Compliance Regime Proposed Rule
The first proposed rule (the Alternative Compliance Regime Proposed Rule) proposes to create an optional alternative compliance regime for foreign clearing organizations.1 Under this alternative compliance regime, the CFTC would permit certain non-U.S. DCOs that do not pose a substantial risk to the U.S. financial system to register with the CFTC and comply with the legal requirements of their home jurisdictions instead of the corresponding DCO core principles (DCO Core Principles)2 set forth in the Commodity Exchange Act of 1936 (“CEA”).3
In order to use the alternative regime under the Alternative Compliance Regime Proposed Rule, the CFTC would have to determine that compliance with the foreign clearing organization’s home country regulatory regime constitutes compliance with the DCO Core Principles and enter into a memorandum of understanding (“MOU”) with the home country regulator, if it has not already done so. To the extent that the foreign clearing organization’s home country regulatory regime lacks legal requirements that are not primarily related to risk as required by certain DCO Core Principles, the CFTC would have the discretion to grant registration subject to any additional conditions imposed by the CFTC. Non-U.S. DCOs that utilize the alternative compliance regime would still be required to comply with CFTC’s requirements regarding the protection of customer funds and swaps data reporting.
This alternative compliance regime will be similar to CFTC’s foreign board of trade (FBOT) regime that allows direct trading access by U.S. persons on non-U.S. platforms located outside of the United States that have been deemed by the CFTC to be regulated by their local regulators in a manner substantially comparable to CFTC regulations. Notably, the CFTC’s Form FBOT already includes Supplement S-1, which certifies that the foreign DCO that clears for the FBOT is regulated in a comparable manner to U.S.-regulated DCOs.
Similarly, the second proposed rule approved by the CFTC in July (the Exempt DCOs Supplemental Rule)4 exempts from futures commission merchant (FCM) registration foreign brokers that the CFTC deems are regulated in a comparable manner to U.S. FCMs. If the relief with respect to DCOs set forth in the Exempt DCOs Supplemental Rule becomes law, it will be easier for many non-U.S. DCOs to offer their services to U.S. customers and market their clearing services in the United States. Further, the CFTC believes that adopting this rule will be a gesture of goodwill on the part of the CFTC and might encourage EU regulators to extend similar relief to U.S. DCOs.
Exempt DCOs Supplemental Rule
The Exempt DCOs Supplemental Rule supplements a rule initially proposed by the CFTC in August 2018 (that is, the Initial Exempt DCOs Proposed Rule)5 that would codify exemptions from registering as a DCO for the clearing of proprietary swaps for U.S. persons and FCMs. Under the Exempt DCOs Supplemental Rule, the CFTC would allow exempt DCOs to clear swaps entered into by U.S. eligible contract participants (ECPs) through foreign clearing members that are not registered with the CFTC as FCMs. Only foreign clearing organizations that do not pose “substantial risk to the U.S. financial system” would be eligible for the exemption. Pursuant to the Exempt DCOs Supplemental Rule, the CFTC would also permit non-U.S. intermediaries that are not registered as FCMs to accept funds from U.S. ECPs to margin swaps cleared at an exempt DCO.
Due to the uncertainty regarding the protection of U.S. customer funds in the event of insolvency of the FCM, the Exempt DCOs Supplemental Rule does not permit exempt DCOs to accept U.S. customer trades through an FCM either directly or indirectly through a foreign clearing member of the exempt DCO. The CFTC continues to consider the protection of U.S. customer funds in the event of insolvency of the FCM and has requested public comment to assist in evaluating this issue. Furthermore, the Exempt DCOs Supplemental Rule also explains that an intermediary that clears swaps for U.S. persons at an exempt DCO would be prohibited from registering as an FCM, and an exempt DCO must provide written disclosures regarding the status of the customer funds under the non-U.S. customer protection regime.
The novel approach set forth in the Exempt DCOs Supplemental Rule raised significant concerns within the CFTC, with both Commissioner Dan Berkovitz and Commissioner Rostin Behnam voting against such Supplemental Rule.6 Commissioner Dawn Stump also expressed concerns about the inability of registered FCMs to provide services to U.S. persons and requested public comment on this aspect of the proposed rule.7
Amendments to Part 30 of CFTC regulations
Under the CEA, any entity that provides brokerage services with respect to futures or swaps must register as an FCM.8 However, the CFTC allows certain brokers located outside of the United States that only provide brokerage services outside of the United States to be exempted from the registration as an FCM, provided that such broker’s local regulatory regime is comparable to that in the United States.9 If the CFTC makes this comparability determination, it issues the section 30.10 order to a local regulator or a local self-regulatory organization, and foreign brokers in good standing become exempted from CEA’s FCM registration requirements. Notably, section 30.10 of the CFTC regulations did not include provisions for revoking this determination.
The Alternative Compliance Regime Proposed Rule and the Exempt DCOs Supplemental Rule were preceded by CFTC rule amendment proposal on July 5, 2019, pursuant to which the CFTC proposed to amend 17 C.F.R. section 30.10 to specifically provide that the CFTC may terminate the section 30.10 exemptive relief: (1) where the CFTC determines that there has been a material change or omission in the facts and circumstances pursuant to which relief was granted that demonstrates that the standards forming the basis for granting such relief are no longer met; (2) where the CFTC determines that the continued exemptive relief would be contrary to the public interest or inconsistent with the purposes of the section 30.10 exemption; and (3) should the CFTC determine that the information-sharing arrangements no longer adequately support exemptive relief. As an example, under the July 5 proposed rule, in considering whether exemptive relief continues to be warranted, the CFTC could take into account a lack of comity relating to the execution or clearing of any commodity interest subject to the CFTC’s exclusive jurisdiction.
This rule amendment is intended to send a message to foreign regulators that the CFTC is scrutinizing comparability of U.S. and foreign regulatory regimes and is prepared to reassess its previous determinations for those jurisdictions that no longer meet comparability standards.
Conclusion
CFTC Chairman J. Christopher Giancarlo has noted that the approaches set forth in the Alternative Compliance Regime Proposed Rule and the Exempt DCOs Supplemental Rule are part of the “carrot and a stick” negotiation tactic that the CFTC adopted in resolving the recent dispute with the European Securities and Markets Authority (“ESMA”) over recognition of EU DCOs in the United States and vice versa subsequent to Brexit.10
The strategy is intended to provide the CFTC with tools to revoke EU broker exemptions under previous orders if the EU refuses to exempt U.S. DCOs in a similar manner. The CFTC would likely consider such a refusal as proof that the EU regulatory regime is no longer comparable with that in the United States.
- Registration With Alternative Compliance for Non-U.S. Derivatives Clearing Organizations, 84 FR 34819, CFTC Proposed Rule (July 19, 2019).
- The CFTC proposed a two-part test to determine whether a non-U.S. DCO poses substantial risk to the U.S. financial system that focuses on the amount of initial margin required at the DCO.
- The Commodity Exchange Act, as amended, 7 U.S.C. section 1 et seq.
- Exemption From Derivatives Clearing Organization Registration, 84 FR 35456, CFTC Proposed Rule (July 23, 2019).
- Exemption From Derivatives Clearing Organization Registration, 83 FR 39923, CFTC Proposed Rule (Aug. 13, 2018).
- See Dissenting Statement of Commissioner Rostin Behnam on the Exemption from Derivatives Clearing Organization Registration; Notice of Supplemental Proposal (July 11, 2019), available at www.cftc.gov; Dissenting Statement of Commissioner Dan M. Berkovitz on the Supplemental Proposal for Exemption from Derivatives Clearing Organization Registration (July 11, 2019), available at www.cftc.gov.
- See Statement of Commissioner Dawn D. Stump for the CFTC Open Meeting (July 11, 2019), available at www.cftc.gov.
- CEA section 1a(28).
- CFTC Regulation 17 C.F.R. section 30.10.
- See Remarks of Chairman J. Christopher Giancarlo at FIA Expo Chicago, Illinois (Oct. 17, 2018), (“Be assured that the CFTC has a range of options, short of further legislative action, that it can execute unilaterally in response to an extraterritorial overreach by a non-U.S. authority. They include revisiting the CFTC’s Part 30 regime to withdraw existing exemptions in particular overseas jurisdictions. They also include delaying or withholding CFTC staff relief for non-U.S. entities from such jurisdictions.”), available at www.cftc.gov.
Client Alert 2019-207
