The CFTC has adopted a rule governing margin requirements in cross-border transactions. CFTC Rule 23.160 excludes uncleared swap transactions from compliance with CFTC margin requirements if they are entered into between two non-U.S. persons: (1) whose obligations are not guaranteed by a U.S. person; (2) that are not “Foreign Consolidated Subsidiaries” (defined below) of a U.S. person; and (3) that are not acting through or by a U.S. branch.
The term “U.S. person” is generally consistent with the CFTC’s prior definition of a U.S. person in its Cross Border Guidance and includes entities organized or incorporated in the U.S., entities with a principal place of business in the U.S., natural persons residing in the U.S. and accounts beneficially owned by any such persons. However, the Rule does not include the U.S. majority-ownership prong that was included in the Cross Border Guidance (50% U.S. person ownership of a fund or other collective investment vehicle). The CFTC will permit a party to reasonably rely on its counterparty’s written representation in determining whether or not such counterparty is a U.S. person, absent any indications to the contrary.
The term “Foreign Consolidated Subsidiary,” referenced above, captures any swap dealer or major swap participant that is not a U.S. person in which an ultimate parent entity that is a U.S. person has a controlling interest, such that the ultimate parent entity includes the non-U.S. swap dealer or major swap participant’s operating results, financial position and statement of cash flows in its consolidated financial statements.
In regard to swaps that may be guaranteed by a U.S. person, “guarantee” is defined to include an arrangement where a party to an uncleared swap transaction with a non-U.S. counterparty has a legally enforceable right of recourse against at least one U.S. person (irrespective of any affiliation with the counterparty) with respect to the counterparty’s obligations under the uncleared swap transaction. Under the Rule, the terms of the guarantee do not necessarily need to be included in the swap documentation or even reduced to writing (so long as enforceable rights are created under the laws of the relevant jurisdiction), provided that a swap counterparty has a legally enforceable right to receive payments from (or collect from) the U.S. person in connection with the non-U.S. person’s obligations under the swap. To address potential evasion, the term, “guarantee” also includes any arrangement pursuant to which the guarantor itself has the rights of recourse against a third party with respect to the counterparty’s obligations under the swap. The guarantee provision was written to ensure the rules would still apply to affiliates of large U.S. banks who had stopped guaranteeing obligations of their offshore affiliates. As a result of the Rule, the CFTC’s margin requirements will apply to the offshore affiliates even without a formal guarantee.
If substituted compliance is granted by the CFTC with respect to some or all of a foreign jurisdiction’s uncleared margin requirements, then swap dealers and major swap participants will be entitled to comply with the foreign jurisdiction’s uncleared swap margin requirements in order to satisfy the CFTC’s requirements.
The Rule also includes special provisions pertaining to custodial arrangements and netting arrangements that take into account differences in the laws of other jurisdictions. In the case of custodial arrangements, where compliance with the CFTC’s rules governing margin for uncleared swaps is impracticable, Foreign Consolidated Subsidiaries and foreign branches of covered swap entities (“CSEs”) are permitted to engage in swaps with non-U.S. counterparties that are not guaranteed by a U.S. person, without having to comply with: (1) the requirement to post initial margin or (2) the requirements pertaining to initial margin collected by a CSE, subject to a 5% limit that applies separately to each of the broad risk categories (agriculture, credit, energy, equity, foreign exchange/interest rate, metals and others).
For jurisdictions that do not have netting arrangements that meet the CFTC’s margin rules, qualifying CSEs would be permitted to engage in uncleared swaps if they treat swaps under the netting agreement on a gross basis in determining the amount of margin they collect. The CSEs would also be permitted to net those swaps in determining the amount of margin they post, in accordance with the netting provisions of the margin rule.
The Rule will become effective on September 1, 2016, the same day that the CFTC begins implementing its rules governing margin for uncleared swaps. In light of the impending deadline, the CFTC has recommended that parties seeking comparability determinations for purposes of substituted compliance promptly submit their requests.