1. Synopsis
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”).
6. Exceptions, substituted compliance, and comparability determinations
The Dodd-Frank Act and the CFTC’s regulations establish a broad range of requirements applicable to SDs and MSPs, including requirements regarding risk management and internal and external business conduct (the 2013 Cross-Border Guidance referred to these as entity-level requirements (ELRs) and transaction level requirements (TLRs)). If a person is required to register as an SD or MSP, then generally such person is subject to these regulations with respect to their swap activities. The Final Cross-Border Swap Rule has reorganized classifications of ELRs and TLRs and now provides certain exceptions from, and a substituted compliance process for, certain regulations applicable to registered SDs and MSPs. It also left certain ELRs and TLRs unaddressed (Unaddressed Requirements).
(a) Classification of requirements
Instead of the concepts of ELR and TLR, the Final Cross-Border Swap Rule classifies the relevant CFTC regulations as “Group A,” “Group B,” and “Group C” requirements for purposes of determining the availability of certain exceptions from, or substituted compliance for, such regulations.
The Group A requirements include regulations related to chief compliance officers, risk management, swap data record keeping, and antitrust considerations set forth in 17 C.F.R. sections 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, 23.607, and 23.609. 27
The Group B requirements include regulations related to swap trading relationship documentation, portfolio reconciliation and compression, trade confirmations, and daily trading records set forth in 17 C.F.R. sections 23.202, 23.501, 23.502, 23.503, and 23.504. 28
The Group C requirements include the CFTC’s external business conduct rules set forth in 17 C.F.R. section 23.400–451.418 and certain rules regarding the segregation of assets held as collateral in uncleared swap transactions set forth in 17 C.F.R. part 23, subpart L. 29
(b) Group A and B exceptions
In connection with classifying the relevant CFTC regulations into groups of requirements, the Final Cross-Border Swap Rule adopts several exceptions for such classifications of regulations. Specifically, the Final Cross-Border Swap Rule provides: (1) an exception from certain Group B and Group C requirements for certain anonymous, exchange-traded, and cleared foreign-based swaps;30 (2) an exception from the Group C requirements for certain foreign-based swaps with foreign counterparties;31 (3) an exception from the Group B requirements for certain foreign-based swaps of foreign branches of U.S. swap entities with certain foreign counterparties, subject to certain limitations; 32 and (4) an exception from the Group B requirements for the foreign-based swaps of certain non-U.S. swap entities with certain foreign counterparties. 33
7. Comparability determinations
After the adoption of the 2013 Cross-Border Guidance, the CFTC had issued several comparability determinations.34 The Final Cross-Border Swap Rule builds on the foundation established by the 2013 Cross-Border Guidance and provides a framework for substituted compliance with respect to the Group A and Group B requirements. A non-U.S. swap entity may avail itself of substituted compliance (subject to the terms of the relevant comparability determination) for Group A requirements on an entity-wide basis by complying with the applicable standards of a foreign jurisdiction. 35
Subject to the terms of the relevant comparability determination, the Final Cross-Border Swap Rule also allows a non-U.S. swap entity or foreign branch of a U.S. swap entity to satisfy any applicable Group B requirement for a foreign-based swap with a foreign counterparty by complying with the applicable standards of a foreign jurisdiction.36
Finally, the Final Cross-Border Swap Rule allows a non-U.S. swap entity, subject to the terms of the relevant comparability determination, to satisfy any applicable Group B requirement for any swap booked in a U.S. branch with a foreign counterparty that is neither a foreign branch nor a Guaranteed Entity by complying with the applicable standards of a foreign jurisdiction.37 However, no substituted compliance is available for Group C requirements.
The Final Cross-Border Swap Rule also implements a process pursuant to which the CFTC will conduct comparability determinations regarding a foreign jurisdiction’s regulation of swap entities. The process includes a standard of review designed to allow the CFTC to holistically consider all relevant elements of a foreign jurisdiction’s regulatory regime and issue a comparability determination based on its determination that some or all of the relevant foreign jurisdiction’s standards would result in outcomes comparable to those of the CFTC’s corresponding requirements or group of requirements.
Under this process, the CFTC may consider any factor it deems appropriate in assessing comparability, including: (1) the scope and objectives of the relevant foreign jurisdiction’s regulatory standards; (2) whether, despite differences, a foreign jurisdiction’s regulatory standards achieve comparable regulatory outcomes to the CFTC’s corresponding requirements; (3) the ability of the relevant regulatory authority or authorities to supervise and enforce compliance with the relevant foreign jurisdiction’s regulatory standards; and (4) whether the relevant foreign jurisdiction’s regulatory authorities have entered into a memorandum of understanding or similar cooperative arrangement with the CFTC regarding the oversight of swap entities. 38
8. Recordkeeping and effective date
The Final Cross-Border Swap Rule requires SDs and MSPs to create a record of their compliance with the Final Cross-Border Swap Rule and to retain such records in accordance with CFTC Regulation section 23.203.39 The effective date of the Final Cross Border Swap Rule is 60 days after publication of the Final Cross-Border Swap Rule in the Federal Register.40 Given that the Final Cross-Border Swap Rule was published on September 14, 2020, it is effective as of November 13, 2020.
9. Reporting requirements
The 2013 Cross-Border Guidance applied a bifurcated approach to regulatory requirements applicable to SDs and MSPs: ELRs that apply to the entity itself and the TLRs that apply to each individual transaction. ELRs included, among other things, swap data repository reporting under part 45 of CFTC regulations and large trader reporting (second category ELRs). TLR included, among other things, real-time public reporting under part 43 of CFTC regulations (Category A TLRs). As noted above, ELR and TLR categories were reorganized into Group A, B, and C requirements.
However, the Final Cross-Border Swap Rule does not address reporting matters (real-time public reporting under part 43, swap date repository reporting under part 45 (and CFTC Staff Letter 17-64), and large trader reporting) and specifically reserved addressing these regulatory requirements for a later time. These requirements are classified as “Unaddressed Requirements.” 41
Further, with respect to ANE transactions, the Final Cross-Border Swap Rule states that it will address the Unaddressed Requirements at a later time and that “[u]ntil such time, the [CFTC] will not consider, as a matter of policy, a non-U.S. swap entity’s use of their personnel or agents located in the United States to ‘arrange, negotiate, or execute’ swap transactions with non-U.S. counterparties for purposes of determining whether Unaddressed TLRs apply to such transactions.” 42
10. Conclusions
The Final Cross-Border Swap Rule in many significant ways gives more deference to local regulators where potential SDs and MSPs are located. By narrowing the definitions and by redesignating compliance categories, the Final Cross-Border Swap Rule provides the much needed certainty to cross-border swaps transactions.
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- Peter Y. Malyshev is a partner in the Washington, D.C., office of Reed Smith; Christine T. Parker is a partner in the New York office of Reed Smith; and Joseph M. Motto is a senior associate in the Pittsburgh office of Reed Smith. The authors thank Ilene Froom, a partner in the New York office of Reed Smith, and Trevor Levine, a senior associate in the New York office of Reed Smith, for their contributions.
- See Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants 85 Fed. Reg. 56924 (Sept. 14, 2020), available at govinfo.gov. The Final Cross-Border Swap Rule is effective as of November 13, 2020.
- See Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45292 (July 26, 2013), available at cftc.gov.
- See infra note 7.
- See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111–203 (July 21, 2010).
- See 7 U.S.C. section 2(i).
- See generally “Swap dealer” and “Major swap participant,” Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant,” and “Eligible Contract Participant” (May 23, 2012) (defining and providing registration thresholds for SDs and MSPs in section 1.3 of the CFTC’s regulations); CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (Nov. 14, 2013) (finding that a non-U.S. SD that regularly uses personnel or agents located in the United States to arrange, negotiate, or execute a swap with a non-U.S. person would generally be required to comply with “transaction-level requirements,” as such term was used in the guidance);CFTC Staff Letter No. 13-71, No-Action Relief: Certain Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 26, 2013) (providing certain no-action relief to non-U.S. SDs registered with the CFTC from certain requirements in connection with non-U.S. persons); Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants – Cross-Border Application of the Margin Requirements (May 31, 2016) (addressing, among other things, the availability of substituted compliance by outlining the circumstances under which certain SDs and MSPs could satisfy the CFTC’s margin requirements for uncleared swaps by complying with comparable foreign margin requirements) CFTC 2016 Cross-Border Margin Rule; Cross-Border Application of the Registration Thresholds and External Business Conduct Standards Applicable to Swap Dealers and Major Swap Participants (Oct. 18, 2016) (proposing rules for the cross-border application of certain requirements under the Dodd-Frank Act regulatory framework for SDs and MSPs).
- See 2013 Cross-Border Guidance. The SEC has adopted rule amendments to address the cross-border application of certain security-based swap requirements under the Securities Exchange Act of 1934 that were added by the Dodd-Frank Act. See Cross-Border Application of Certain Security-Based Swap Requirements (Dec. 18, 2019), available at sec.gov.
- See Statement of Chairman Heath P. Tarbert in Support of Final Cross-Border Swap Rule (July 23, 2020), available at cftc.gov.
- See, e.g., Securities Industry & Financial Markets Ass’n v. CFTC, 67 F. Supp. 3d 373 (D.C.D.C. 2014). CFTC Commissioner Dan M. Berkovitz dissented from the CFTC’s adoption of the Final Cross-Border Swap Rule, noting that the rule would pare back the extraterritorial application of the CFTC’s swap dealer regime, which, over the past seven years, had helped protect the U.S. financial system from risky overseas swap activity. See Dissenting Statement of Commissioner Dan M. Berkovitz on the Final Rule for Cross-Border Swap Activity of Swap Dealers and Major Swap Participants (July 23, 2020), available at cftc.gov. Commissioner Berkovitz believed that the CFTC “should not be paring back these protections for the American financial system, particularly now, during a global pandemic.” See id.
- See Statement of Chairman Heath P. Tarbert in Support of Final Cross-Border Swap Rule (July 23, 2020), available at cftc.gov.
- See Final Cross-Border Swap Rule, at 56931–56951.
- See 7 U.S.C. section 1a(49)(A).
- See 17 C.F.R. section 1.3, Swap dealer, paragraph (4)(i)(A). The de minimis threshold is $8 billion, except with regard to swaps with special entities for which the threshold is $25 million.
- See 7 U.S.C. section 1a(33)(A). A person is not deemed to be an MSP unless their swap positions exceed one of several thresholds established by the CFTC. See 17 C.F.R. section 1.3, Major swap participant, paragraph (1).
- See Final Cross-Border Swap Rule, at 56951. The Final Cross-Border Swap Rule defines a “U.S. person” as “(A) [a] natural person resident in the United States; (B) [a] partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States; (C) [a]n account (whether discretionary or non-discretionary) of a U.S. person; or (D) [a]n estate of a decedent who was a resident of the United States at the time of death.” See id. at 56998.
- See id. at 56951.
- A “Guaranteed Entity” is a non-U.S. person whose swaps are guaranteed by a U.S. person, with respect to those swaps that are so guaranteed. See id. at 56941.
- A “significant risk subsidiary” is a “any non-U.S. significant subsidiary of an ultimate U.S. parent entity where the ultimate U.S. parent entity has more than $50 billion in global consolidated assets, as determined in accordance with U.S. GAAP at the end of the most recently completed fiscal year,” subject to certain exceptions. See id. at 56998.
- See id. at 56952–56954.
- See id. at 56951, 56952–56954. An “Other Non-US Person” is a non-U.S. person who is neither a Guaranteed Entity nor a Significant Risk Subsidiary. See id. at 56942.
- See id. at 56952–56954. An Other Non-U.S. Person may exclude from their de minimis threshold calculation any swap that they anonymously enter into on a designated contract market, a swap execution facility (SEF) that is registered with the CFTC or exempted by the CFTC from SEF registration pursuant to CEA section 5h(g), or a foreign board of trade that is registered with the CFTC pursuant to part 48 of its regulations, if such swap is also cleared through a registered or exempt derivatives clearing organization. See id. at 56955–56956.
- See id. at 56956–56961.
- See id. at 56963.
- See CFTC Staff Advisory No. 13-69 (Nov. 14, 2013).
- Substituted compliance is the process by which an SD or MSP subject to the rules of a foreign jurisdiction, but whose swap activities bring them within the scope of certain CFTC regulations, may rely on compliance with the rules of the foreign jurisdiction as a substitute for compliance with certain CFTC regulations.
- See Final Cross-Border Swap Rule, at 56964–56966.
- See id. at 56966–56967.
- See id. at 56967–56968.
- See id. at 56968–56970.
- See id. at 56970–56972.
- See id. at 56972–56974.
- See id. at 56974–56976.
- The CFTC’s comparability determinations that would permit substituted compliance with certain non-U.S. regulatory regimes are available on the CFTC’s website at cftc.gov. The CFTC has stated that the Final Cross-Border Swap Rule does not impact the effectiveness of existing comparability determinations, which will remain effective pursuant to their terms. See Final Cross-Border Swap Rule, at 56979. It is expected that additional rulemakings will be adopted by the CFTC addressing comparability determinations.
- See id. at 56976–56977.
- See id.
- See id.
- See id. at 56977–56979.
- See id. at 56980; see also 17 C.F.R. section 23.203.
- See id. at 56981.
- The CFTC proposed extensive revisions to its reporting rules in 2020. These rules were finally adopted by the CFTC on September 17, 2020 (Amendments to the Real-Time Public Reporting Requirements (part 43); Amendments to the Swap Data Recordkeeping and Reporting Requirements (part 45), and Amendments to Commission’s Regulations relating to Certain Swap Data Repository and Data Reporting Requirements (part 49 verification)). See also, Final Cross-Border Swap Rule, at 56964 n. 354.
- See id at 57003.
Client Alert 2020-524
