The Dodd-Frank Act requires certain entities that engage in swap activities to register with the Commodity Futures Trading Commission (CFTC) as swap dealers or major swap participants. Pursuant to the Dodd-Frank Act, the CFTC has issued rules that provide exemptions to registration for entities whose aggregate swap dealing activity falls below certain thresholds. On October 11, 2016, the CFTC proposed rules that aim to address the cross-border reach of the Dodd-Frank Act with respect to such thresholds as well as swap transactions that are arranged, negotiated or executed using personnel located in the U.S. but involving only non-U.S. counterparties (ANE transactions). Once finalized, the proposed rules will supersede corresponding provisions of the non-binding cross-border framework that was articulated in CFTC guidance issued in July 2013. The CFTC is accepting public comments on the proposed rules through December 19, 2016 and is expected to finalize the rules during the course of next year. The rules will be of particular interest to financial entities that are involved in cross-border swap activity, including hedge funds.
This will be the CFTC's second substantive rulemaking relating to cross-border application of the Dodd-Frank Act, following the release of the final cross-border rule on margin requirements in May 2016. In embarking on a formal administrative rulemaking process, the CFTC is aiming to create a comprehensive doctrine that will serve as a base for future cross-border rules, such as those addressing the inter-jurisdictional application of Dodd-Frank transaction-level requirements, including rules relating to trading and clearing mandates and trade data reporting.
Definitions of "U.S. person" and "Foreign Consolidated Subsidiary"
As a starting point, the CFTC has proposed a comprehensive definition of "U.S. person" that is consistent with the definition set forth in the cross-border margin rule. The definition would include legal entities organized or incorporated under the laws of the U .S. or having their principal place of business in the U.S., including any branches of such entities. Legal entities owned by a U.S. person in which such U.S. person bears unlimited responsibility for the obligations and liabilities of the entity, including any branch of such entity, are also covered by the definition. International financial institutions are excluded from the definition.
This definition is in some ways narrower than the corresponding definition of the 2013 guidance, which also applied to commodity pools, pooled accounts, investment funds and other investment vehicles that are majority owned by one or more U.S. persons. Another aspect of the proposed definition, however, is broader than the 2013 guidance, in that the "unlimited responsibility" test in the 2013 guidance would have only applied where the U.S. person directly or indirectly owned a majority of the entity that is otherwise a non-U.S. person. The proposed definition does not have a majority-ownership test.
The CFTC proposes to apply certain aspects of the Dodd-Frank Act to swap activities involving a "Foreign Consolidated Subsidiary", which is defined to mean a non-U.S. person having an ultimate U.S. person parent with a controlling financial interest, in accordance with U.S. GAAP, such that the U.S. ultimate parent entity includes the non-U.S. person's operating results, financial positions and statement of cash flows in the U.S. ultimate parent entity's consolidated
financial statements, in accordance with U.S. GAAP. "Foreign Consolidated Subsidiary" will be a concept separate from that of "U.S. person", and these two types of entities may be treated differently in the context of different Dodd-Frank swap provisions. The CFTC intends for these definitions to be relevant not only with respect to the rulemaking areas addressed within the proposed rule but also for purposes of subsequent Dodd-Frank cross-border rulemakings, unless the specific rule or context provides for a different meaning.
ANE transactions In the preamble to the proposed rule, the CFTC has stated that arranging, negotiating or executing swaps are activities that fall within the scope of the definition of "swap dealer." Accordingly, pursuant to the proposed rule, using personnel or agents located in the U.S. to arrange, negotiate or execute swap dealing transactions causes those transactions to fall within the scope of the Dodd-Frank Act. The CFTC has explained in the proposed rule that the terms "arrange" and "negotiate" are meant to encompass market-facing activity typically associated with sales and trading, in contrast to back-office operations such as swap processing, provision of research information to sales and trading personnel located outside the U.S. and preparation and negotiation of underlying swap documentation, including master agreements. The term "executed" is meant to refer to the market-facing act of becoming bound to the terms of a swap transaction under applicable law. The proposed rule provides some guidance as to the scope and limits of ANE transactions subject to the Dodd-Frank Act. Accordingly, if personnel located in the U.S. direct other personnel to arrange, negotiate or execute the transaction for or on behalf of the entity, then such transaction would be within the scope of the Dodd-Frank Act. However, the use of personnel assigned to a non-U.S. location that are only incidentally present in the U.S., as well as the use of U.S.-based attorneys in negotiating the terms of the transaction, would not by themselves render a transaction subject to Dodd-Frank. Swap transactions involving algorithmic trading or automatic electronic execution could be viewed as ANE transactions if personnel located in the U.S. specify trading strategy or techniques. The CFTC's rules on what constitutes an ANE transaction may require financial institutions that seek to keep swap dealing activity with non-U.S. counterparties outside the scope of the DoddFrank Act to establish operational and technical frameworks to restrict the involvement of U.S. personnel in such transactions. The CFTC may choose to further narrow or broaden the doctrine after review of comment letters. In particular, the CFTC has asked commenters to weigh in on how it may determine that U.S. personnel are directing algorithmic trading systems within the scope of the ANE doctrine.
Swap dealer registration thresholds in the cross-border context
Pursuant to current CFTC regulations, entities whose aggregate swap dealing activities (including activities of affiliates under common control) are below the so-called de minimis threshold are exempt from the requirement to register as swap dealers. In other words, an entity will not be considered a swap dealer unless, during the preceding 12 months, its aggregate gross notional amount of swap positions connected with swap dealing activities exceeds the threshold, which is set at $8 billion until December 31, 2018, at which time it will automatically decrease to $3 billion absent further action by the CFTC. Certain swaps, such as those entered into by insured depositary institutions in connection with originating loans to customers as well as swaps intended to hedge physical positions, are not required to be included in the de minimis threshold calculations. The proposed rule addresses the extent to which cross-border swaps must be included in these calculations.
The determination of which swaps to include in the de minimis calculations depends on the jurisdictional status of the potential swap dealer. If the potential swap dealer is a U.S. person, it will need to include all of its swap dealing transactions in the calculations, along with all swap dealing activities of its foreign branches and operations.
The proposed rule will be most relevant to non-U.S. persons that are interested in determining whether their swap dealing activity crosses the de minimis threshold. A non-U.S. person that is not a Foreign Consolidated Subsidiary would be required to include all swap dealing transactions with respect to which it is guaranteed by a U.S. person. If the potential swap dealer is a Foreign Consolidated Subsidiary, the proposed rule will require it to include all of its swap dealing transactions. For those non-U.S. persons that are not Foreign Consolidated Subsidiaries and whose swaps are not guaranteed by a U.S. person, the proposed rule will require the inclusion of dealing activities with U.S. persons, with non-U.S. persons guaranteed by U.S. persons and with Foreign Consolidated Subsidiaries. Such entities, however, will not be required to count swap transactions executed anonymously on a trading facility and cleared with a central clearinghouse. Swap transactions with another non-U.S. person that is not a Foreign Consolidated Subsidiary and whose swaps are not guaranteed by a U.S. person will not need to be included, even if those transactions are arranged, negotiated or executed by personnel located in the U.S. The absence or presence of a U.S.-person guarantee is to be determined on a swap-by-swap basis, such that a non-U.S. person may be considered to be guaranteed by a U.S. person (and therefore have its dealing swaps included in the de minimis calculations) with respect to one swap but not another.1
1 With respect to non-U.S. persons, this proposed framework is somewhat different from the parallel SEC rule on the cross-border application of security-based swap dealer de minimis registration thresholds. The SEC rule prov ides that U.S. persons and conduit affiliates of U.S. persons must count all their securitybased swap dealing activities. Furthermore, under the SEC rule, a potential non-U.S. security-based swap dealer that is not a conduit affiliate of a U.S. person must count (a) all dealing transactions with U.S. persons other than certain transactions with the foreign branches of registered security -based swap dealers and (b) all security-based dealing swaps for which its counterparty has recourse against a U.S. person. The SEC rule does not require an ex amination of whether the non -U.S. person's financial results are consolidated in a U.S. person's financial statements.
With respect to the aggregation requirement, a potential swap dealer must include the aggregate notional value of swap dealing transactions entered into by all affiliates under common control, regardless of whether such affiliates are U.S. persons or non-U.S. persons, with the exception of those affiliates that are themselves registered swap dealers. In other words, when the affiliated group meets the de minimis threshold in the aggregate, one or more affiliates must register as a swap dealer such that the aggregate jurisdictional swap dealing activity of the unregistered affiliates returns to a number below the threshold.
Table A Summary of when to include cross-border swaps in swap dealer de minimis calculations
To use this table, first determine the jurisdictional status of the potential swap dealer in the left column. The resulting row lists the categories of counterparties for which dealing swaps with the potential swap dealer must be included in the potential swap dealer's de minimis threshold calc ulations.
Counterparty U.S. person
Potential swap dealer U.S. person Non- Guaranteed by a U.S. U.S. person and/or Foreign person Consolidated
Include Include Include
Foreign Consolidated Other Subsidiary and/or
swap guaranteed by a U.S. person
Anonymous (executed on
a trading facility and
Cross-border application of Dodd-Frank external business conduct standards
Regulations issued pursuant to the Dodd-Frank Act require registered swap dealers to comply with certain external business conduct standards when dealing with swap counterparties, including verifying eligibility to trade, disclosing material swap information, providing daily mid-market marks for uncleared trades and determining the suitability of a particular transaction when making swap recommendations. The CFTC now proposes to define the situations in which these standards would apply in the context of cross-border transactions. Pursuant to the proposed rule, swap dealers that are U.S. persons will be required to comply with applicable external business conduct standards regardless of the jurisdictional status of their counterparties, except with respect to transactions conducted through a foreign branch. Substituted compliance with a comparable foreign regulatory regime will not be allowed.
Foreign branches of U.S. swap dealers along with non-U.S. swap dealers (including Foreign Consolidated Subsidiaries and non-U.S. persons guaranteed by U.S. persons) will be required to comply with all applicable external business conduct standards with respect to transactions with U.S. persons, other than foreign branches of U.S. swap dealers, with no substituted compliance available. However, such entities would not be required to comply with applicable external business conduct standards with respect to transactions with foreign branches of U .S. swap dealers and non-U.S. persons (including Foreign Consolidated Subsidiaries and non-U.S. persons guaranteed by U.S. persons). Pursuant to a narrow exception, however, foreign branches of U.S. swap dealers and non-U.S. swap dealers that use personnel located in the U.S.
to arrange, negotiate or execute such transactions would be subject to anti-fraud and fair dealing rules without the possibility of substituted compliance.
Table B Summary of cross-border application of external business conduct standards
To use this table, first determine the jurisdictional status of the swap dealer in the left column. The resulting rows list the categories of entities for whom the swap relationship with the swap dealer would be subject to Dodd-Frank ex ternal business conduct standards.
Not a foreign Foreign branch of
branch of a U.S. a U.S. swap dealer
swap dealer or or major swap
Swap dealer status
major swap participant
U.S. Not a foreign branch
person Foreign branch
Do not apply1 Do not apply1
Do not apply1 Do not apply1
1 Any swap dealer, regardless of jurisdictional status, using personnel located in the U .S. to arrange,
negotiate or execute a swap (regardless of whether the swap is ultimately entered into) is subject to CFTC
regulations relating to fair dealing in communications and prohibitions on fraud, manipulation and other
abusiv e practices.
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