On July 13, 2013, the Commodity Futures Trading Commission finalized its guidance concerning the cross-border application of the swaps regulations implemented pursuant to Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The CFTC interprets Title VII to mandate regulation of swaps activities outside of the United States when such activities either have a direct and significant effect on U.S. commerce, or a direct and significant connection with U.S. commercial activities which present risks to the U.S. financial system and markets.
Core to the CFTC's interpretation of the scope of its regulatory authority is the definition of U.S. Person. The CFTC claims jurisdiction over the swap activities of U.S. Persons, regardless of whether U.S. Persons are located inside or outside of the United States. The CFTC defines "U.S. Person" to include natural persons residents of the United States, and their estates when deceased; legal entities organized in, or having their principal place of business in, the United States, and their pension plans; trusts governed by U.S. or state law when a court within the United States has primary supervision over the administration of the trust; collective investment vehicles which are majority-owned by U.S. Persons; any legal entity that is majority-owned by U.S. Persons in which such U.S. Persons have unlimited responsibility for the obligations and liabilities of the legal entity; and any investment account where the beneficial owner is a U.S. Person. A foreign branch of a U.S. Person is considered to be an extension of the U.S. Person and therefore would be treated as a U.S. Person.
Not surprisingly, the CFTC intends to assert and apply its regulatory powers over U.S. Persons, wherever located in the world. A U.S. Person based in the United Kingdom will be required to register with the CFTC as a swap dealer if its overall swap dealing activities, including transactions with non-U.S. Persons, exceed the applicable de minimis threshold. Similarly, a U.S. Person based in the United Kingdom will be required to register with the CFTC as a major swap participant if its overall positions in swaps, including its positions with non-U.S. Persons, exceed the specified thresholds for major swap participants. Similar treatment will be accorded to non-U.S. Persons which are affiliates of U.S. Persons, when the U.S. Persons guarantee the swap obligations of the affiliated non-U.S. Persons or when the affiliates act as conduits for the transmission of swaps risks to the U.S. Persons.
The CFTC also expects non-U.S. Persons to register as swaps dealers or major swap participants, under limited circumstances. As a general rule, a non-U.S. Person will be required to register with the CFTC if its swap dealing activities with U.S. Persons and their guaranteed or conduit affiliates exceed the applicable de minimis threshold. Similarly, a non-U.S. Person will be required to register with the CFTC as a major swap participant if its swaps positions with U.S.Persons and their guaranteed or conduit affiliates exceed the specified thresholds.
The CFTC endorses the concept of "substituted compliance" for non-U.S. Persons who are registered as swap dealers or major swap participants. The CFTC will defer the enforcement against non-U.S. Persons of some, but not all, of the compliance requirements imposed upon registered swap dealers or major swap participants upon its determination that such non-U.S. Persons are adequately regulated by non-U.S. regulators in their own jurisdictions. Among the compliance items which the CFTC will refrain from enforcing are capital adequacy, chief compliance officer, risk management and most swap data recordkeeping. However, the CFTC is not willing to apply the doctrine of "substituted compliance" to other compliance requirements such as required clearing and swap processing, trade execution, real-time public reporting, trade confirmation and external business conduct standards.
Non-U.S. Persons which are not registered as swap dealers or major swap participants may also be required to comply with various aspects of the CFTC compliance regime, principally: required clearing, trade execution, reporting and record-keeping requirements. The CFTC opines that when both counterparties to a swap are non-registered, and one is a U.S. Person, both will be required to comply with applicable requirements. The process of "substituted compliance" will not be available. By contrast, when both non-registered counterparties are non-U.S. Persons, the CFTC will generally not enforce applicable compliance requirements.
Under the terms of an exemptive order issued by the CFTC concurrently with its final guidance, the CFTC provided affected cross-border market participants with relief from many of the compliance requirements for periods generally ranging from 75 days after publication of the guidance to year end 2013. Market participants should take advantage of these grace periods to determine the applicability of specific compliance requirements and to establish the requisite systems to implement compliance.
On July 11, 2013, the CFTC and the European Commission announced an accord with respect to the reconciliation and harmonization of their separate efforts to regulate the swaps market. Recognizing their shared concerns, the agencies resolved to work together to coordinate comparable compliance requirements for market participants. Any resulting need for modification of the CFTC's compliance regime will be implemented by no-action letter.
Practical steps for non-U.S. market participants to take in connection with their ongoing swaps activities:
- Determine whether you or accounts which you manage are U.S. Persons under the CFTC's expansive definition.
- Verify whether your counterparty in any swap transaction is a U.S. Person.
- Determine whether you are a swap dealer as defined by U.S. law, and if so, whether your swap dealing activities exceed the de minimis threshold applicable to you.
- Verify whether your swap dealer, even if not a U.S. Person, is registered with the CFTC.
- Determine whether you are, or are not, a "major swap participant" under the U.S. definition, by calculating the position threshold requirements applicable to you.
- Ascertain whether your counterparty to a swap transaction is a registered major swap participant, even if the counterparty is not a U.S. Person.
- Take account of developments in the regulatory framework of your own jurisdictions which may conflict with CFTC regulations.
The foregoing comments on the CFTC's final guidance cite fundamental issues, without detailing the numerous exceptions, clarifications and applications made by the CFTC. Any of the foregoing recommended determinations should be made with reference to the complete CFTC guidance, rather than with respect to this summary of major points.