On October 11, 2016, the Commodity Futures Trading Commission (CFTC) proposed new rules governing cross-border swap transactions (Proposed Rules). The Proposed Rules would supersede the CFTC’s July 2013 Interpretive Guidance (2013 Guidance) and apply to future CFTC cross-border rule makings. The Proposed Rules define the terms, “U.S. person” and “Foreign Consolidated Subsidiary”, clarify certain swap dealer de minimis calculations, and simplify the application of the CFTC’s external business conduct (EBC) standards. The Proposed Rules also address how the swap dealer de minimis calculations and EBC standards would apply to swap arranged, negotiated, or executed using personnel located in the U.S.
The definition of “U.S. Person” is largely consistent with the definition set forth in the 2013 Guidance. However, the Proposed Rules’ definition of U.S. person doesn’t include a commodity pool, pooled account, investment fund, or other collective investment vehicle that is majority-owned by one or more U.S. persons. In addition, the Proposed Rules don’t include the catchall provision found in the 2013 Guidance. These exclusions provide much needed legal certainty by limiting the definition of ‘‘U.S. person’’ to those persons enumerated in the Proposed Rules. The Proposed Rules also define “Foreign Consolidated Subsidiary” (FCS) as a non-U.S. person consolidated for accounting purposes with an ultimate parent entity that is a U.S. person, which is typically somewhat easier for firms to apply in practice given it leverages understood and widely applied accounting methods. The FCS definition is key to applying the Proposed Rules’ swap dealer de minimis calculations.
Swap Dealer De Minimis Calculations
The Proposed Rules may simplify swap dealer de minimis calculations, but could potentially result in additional swaps counting toward the registration threshold. The 2013 Guidance counted swap dealing by conduit affiliates and guaranteed affiliates toward the threshold, but it didn’t count dealing activity by FCSs. After the CFTC issued its 2013 Guidance, some U.S. financial institutions removed their guarantees of non-U.S. affiliates, but such non-U.S. affiliates were still consolidated for accounting purposes with the U.S. institution’s ultimate parent. The Proposed Rules would require an FCS to count all swap dealing transactions. U.S. persons will continue to count swap dealing activity toward the registration threshold. Non-U.S. persons would count dealing activity with FCSs, U.S. persons and guaranteed affiliates of U.S. persons, unless the swap is traded anonymously on a registered exchange and cleared.
External Business Conduct Standards
The Proposed Rules should clarify the application of the CFTC’s EBC standards. Under the Proposed Rules, U.S. swap dealers must continue to comply with the EBC standards, as would non-U.S. swap dealers facing U.S. persons. However, non-U.S. swap dealers and foreign branches of U.S. swap dealers would not be subject to EBC standards for their swaps with non-U.S. persons and foreign branches of a U.S. swap dealers; except that, foreign branches of any swap dealer (U.S. or non-U.S.) that use personnel located in the U.S. to “arrange, negotiate, or execute” swaps will continue to be subject to CFTC Regulations 23.410 (Prohibition on Fraud, Manipulation) and 23.433 (Fair Dealing), without substituted compliance. The Proposed Rules consider the terms “arrange” and “negotiate” to mean market-facing activity normally associated with sales and trading, and not internal, back-office activities, such as ministerial or clerical tasks, performed by personnel not involved in the actual sale or trading of swaps. The Proposed Rules adopt the same definition of “execute,” the market-facing act of becoming legally and irrevocably bound to the terms of a swap transaction under applicable law, as used in the 2013 Interpretations.
The CFTC expects to address additional cross-border application of other swap requirements in subsequent rulemakings. Additionally, the CFTC may also amend or extend CFTC Letter 16-64, its time-limited no action relief from compliance with certain “Transaction-Level Requirements” associated with swaps arranged, negotiated, or executed in the U.S. Derivations will provide more analysis of the CFTC’s cross-border interpretations, including the potential impact on margin rules, before the European margin regulations come into force in 2017. The CFTC’s fact sheet on the Proposed Rules is available here.