The United States District Court for the District of Columbia issued an opinion on September 16, 2014, available here, largely rejecting challenges to the Commodity Futures Trading Commission’s (“CFTC”) Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (“Cross-Border Guidance”) which the CFTC issued on July 26, 2013 (available here). The Cross-Border Guidance outlines the CFTC’s intentions with respect to the extraterritorial application of several substantive rules under the Dodd-Frank Act, including real-time reporting, reporting to swap data repositories, daily trading records, portfolio reconciliation and documentation, definitions of swap dealer and major swap participant, swap entity registration, risk management, chief compliance officer, swap execution facility registration, large trader reporting, straight-through processing and clearing determination rules. Generally, the CFTC announced that it will apply its Dodd-Frank regulations to swaps involving certain entities owned or controlled by U.S. persons, and to swaps involving entities guaranteed by U.S. affiliates as well as entities that act as a conduit for their U.S. affiliates by hedging the risks of those affiliates.
The plaintiffs, the Securities Industry and Financial Markets Association (“SIFMA”), the International Swaps and Derivatives Association (“ISDA”) and the Institute of International Bankers (“IIB”), asked the court to vacate the Cross-Border Guidance as well as the substantive rules listed above to the extent the CFTC seeks to apply those rules outside of the United States.
The court rejected the direct challenge to the Cross-Border Guidance, holding that the guidance does not “purport to carry the force of law” and is, therefore, not a “final agency action” subject to judicial review under the Administrative Procedure Act. The plaintiffs argued that the CFTC is not authorized to apply its Dodd-Frank regulations outside of the United States without first adopting regulations, but the court held that section 2(i) of the Dodd-Frank Act expressly authorizes extraterritorial application of the CFTC’s swap regulations where there is a nexus between the swap and the United States, regardless of whether the CFTC exercises that authority through a formal rulemaking or proceeds on a case-by-case basis. According to the court, because the Cross-Border Guidance is not a rulemaking, it “is binding on neither the CFTC nor swaps market participants.” Nevertheless, the court noted, if entities engaging in potentially regulated swaps act contrary to the CFTC’s policy guidance, they may be required to defend themselves from administrative action by the agency under the CFTC’s general extraterritorial authority granted under the Dodd-Frank Act.
The court did hold that the CFTC failed to conduct the necessary cost/benefit analysis of several of the substantive rules, specifically real-time reporting, reporting to swap data repositories, daily trading records, portfolio reconciliation and documentation, definitions of swap dealer and major swap participant, swap entity registration, risk management, chief compliance officer, and swap execution facility registration, and remanded to the agency to supply the missing analysis. Importantly, the court did not vacate those rules, instead holding that the CFTC will likely be able to justify their extraterritorial application and vacating the rules would be unduly disruptive to the CFTC’s regulation of swap markets.
Entities entering into swaps outside the United States that nevertheless have some connection to the U.S., such as a guarantee provided by a U.S. person to one of the swap parties or a back-to-back swap involving a U.S. affiliate, will be faced with the decision of whether to comply with the CFTC’s Cross-Border Guidance, even though the agency has not provided binding rules as to when those requirements apply. The District Court’s decision indicates that the CFTC likely will not face a high hurdle in justifying extending its regulations to non-U.S. swaps with a connection to the U.S., and that a cautious swap participant will treat the Cross-Border Guidance as a strong indication of the way the CFTC will apply its regulations in a specific case.