The CFTC’s newly proposed rules on cross-border transactions address which swap activities affect swap-dealer thresholds and trigger transaction-level swap requirements. These are the latest in a series of CFTC rulemakings, orders and guidance on cross-border issues arising from the Dodd-Frank Act.
CFTC Proposes Rules to Count Cross-Border Swaps for Swap-Dealer Thresholds and Other Requirements
On October 18, 2016, the Commodity Futures Trading Commission (CFTC or Commission) proposed rules (Proposed Rules)1 that would (1) define the terms "U.S. person" and "foreign consolidated subsidiary" (FCS) for purposes of applying the CFTC's transaction-level swap dealer and major swap participant requirements, (2) clarify which cross-border swap activities trigger transaction-level swap requirements, (3) establish cross-border calculation methods for determining whether U.S. and non-U.S. persons meet the swap dealer or major swap participant registration thresholds, and (4) establish when CFTC external business conduct standards apply to cross-border transactions.2 The Proposed Rules are the latest in a series of CFTC rulemakings, orders and guidance on cross-border issues arising from the Dodd-Frank Act.3 The Proposed Rules, if finalized, can be expected to cause entities engaged in cross-border swaps activity to expend additional resources to track cross-border swap positions and determine whether they or their counterparties are subject to the new regulations.
Public comments and responses to specific questions in the Proposed Rules are due on or before December 19, 2016.
US Person Definition
The Proposed Rules define "U.S. person" in a manner substantially similar to definitions in previous cross-border rulemakings:4
-- A natural person who is a U.S. resident;
-- The estate of a decedent who was a U.S. resident at the time of death;
-- A corporation, partnership, limited liability company (LLC), business or other trust, association, joint-stock company, fund or other similar entity that is organized or incorporated in the U.S. or has its principal place of business in the U.S. ("legal entity"), including any branch of the legal entity;
-- A pension plan for the employees, officers or principals of a legal entity, unless the pension plan is primarily for foreign employees of such entity;
-- A trust "governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust;"
-- A legal entity (other than an LLC, limited liability partnership or similar entity where all the owners have limited liability) that is owned by one or more of the above persons and for which those persons bear unlimited responsibility for the entity's obligations and liabilities, including any branch of the legal entity; and
-- An individual account or joint account for which the beneficial owner is one of the above persons.5
Citing the difficulty in identifying and tracking beneficial ownership, the CFTC did not include collective investment vehicles that are majority-owned by U.S. persons in the definition. Accordingly, a collective investment vehicle would not be a U.S. person unless it otherwise meets the U.S. organized/principal place of business or unlimited U.S. responsibility prongs of the definition. Likewise, in the interest of providing legal certainty, the CFTC did not insert a "catch-all" provision in the U.S. person definition.6
Interpretation of Scope of Cross-Border Activities Subject to Transaction-Level Swap Requirements
In November 2013, the CFTC issued a staff advisory stating that non-U.S. swap dealers that regularly use personnel or agents in the U.S. to "arrange, negotiate, or execute" swaps with non-U.S. persons (ANE transactions) would be required to comply with certain "Transaction-Level Requirements."7 Transaction-Level
5See 81 Fed. Reg. at 71,948-71,949, 71,973. 6See id. at 71,949. 7CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements
to Activity in the United States (Nov. 14, 2013); see also Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 45,292 (Jul. 26, 2013). For more information, see our July 31, 2013, client alert.
Requirements are CFTC requirements for transactions with U.S. counterparties related to external business conduct standards, recordkeeping, clearing, reporting and other transactionbased issues.8
After considering comments received in response to the staff advisory, the CFTC now is proposing to interpret the terms "arrange" and "negotiate" to refer to "market-facing activity normally associated with sales and trading" instead of "internal, back-office activities." Accordingly, "ministerial or clerical tasks" performed by individuals who are not involved in trading would not be "arranging" or "negotiating" swaps. Nor would the CFTC consider arranging or negotiating swaps to include swap processing, preparing underlying swap documentation, negotiating master agreements and related documentation, or providing research information to sales and trading personnel abroad.9 The term "executed" would refer to the "market-facing act of becoming legally and irrevocably bound to the terms of the transaction."10
Cross-Border Application of Registration Thresholds for Swap Dealers and Major Swap Participants11
Any entity that engages in a de minimis quantity of swap dealing with or on behalf of its customers is excepted from the definition of a swap dealer.12 Similarly, entities with swap positions falling under certain thresholds are excepted from the definition of a "major swap participant."13 The Proposed Rules identify which cross-border swap transactions would be counted to determine whether a person's swap dealing or swap positions exceed the de minimis thresholds.
Under the proposal, a "Foreign Consolidated Subsidiary" would need to keep count of both U.S. and non-U.S. swap positions for purposes of determining whether the entity is a swap dealer or major swap participant.14 Expressing concern that a foreign subsidiary's risks can affect a domestic parent and, therefore, present a greater supervisory interest than other non-U.S. market participants, the CFTC proposed to define a Foreign Consolidated Subsidiary to be:
[A] non-U.S. person in which an ultimate parent entity that is a U.S. person ... has 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 position and statement of cash flows in the U.S. ultimate parent entity's consolidated financial statements, in accordance with U.S. [GAAP].15
The CFTC also proposed that an entity be required to count swap transactions for which it is a "U.S. Guaranteed Entity" for purposes of determining whether the entity is a swap dealer or major swap participant. The Proposed Rules refer to a U.S. Guaranteed Entity as a non-U.S. person whose obligations under a particular swap are guaranteed by a U.S. person. Whether a non-U.S. person would be considered a U.S. Guaranteed Entity would "vary on a swap-by-swap basis," and a non-U.S. person "may be considered a U.S. Guaranteed Entity for one swap and not another, depending on whether the non-U.S. person's obligations under the swap are guaranteed by a U.S. person."16
The following chart details which swap dealing transactions would be factored into swap dealer de minimis threshold calculations.
The following chart details which swap dealing transactions should be factored into major swap participant de minimis threshold calculations.
Cross-Border Application of External Business Conduct Standards for Swap Dealers and Major Swap Participants
The Proposed Rules also address which entities would be required to comply with the CFTC's external business conduct standards.19 As shown in the following chart, compliance would depend on whether the entity is a U.S. swap dealer, U.S. major swap participant, or branch of a U.S. swap dealer or major swap participant.