Australian financial institutions who had hoped the US Commodities Futures Trading Commission (CFTC) was going to clearly limit the application of the swap provisions of the US Dodd-Frank legislation have been disappointed.
Instead, they are likely to find that the draft guidance on the “Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act” provided by the CFTC is unclear, inconsistent and at times contradictory. In this Alert, we give a background to some of the concerns Australians might have with the latest chapter in global regulation of our domestic financial services sector.
What is the draft guidance about?
The draft guidance is about when the derivatives parts of the Dodd-Frank legislation apply outside of the United States. The legislation itself was not clear on this and this has been a significant concern for Australian financial institutions. At the moment, this a key concern because it is necessary to register with the CFTC very soon if they do apply.
The draft guidance tries to clarify:
- whether all swaps or only swaps with “US persons” are included in determining whether you must register with the CFTC;
- the Dodd-Frank Act requirements that apply to all swaps and those that only apply to swaps with “US persons”; and
- when obligations under the Dodd-Frank Act can be satisfied through “substituted compliance” with Australian laws.
Is the draft guidance clear enough for Australians?
The current draft of the guidance is not likely to provide the clarity that Australian financial institutions would have hoped for. Examples of concerns which Australians are likely to identify are:
- some of the obligations under the Dodd-Frank Act will apply to swaps that have no US connection;
- the guidance is unclear and at times contradictory - for example, it states both that the Transaction-Level Requirements will apply to swaps with foreign branches and also that they will not;
- the US centric exclusions from what is a “swap” and therefore caught by Dodd-Frank have not been translated into a global context. For example, there is an exclusion for transactions with the US government, a Federal Reserve Bank or a federal agency but there is no exclusion for transactions with other national governments or central banks; and
- substituted compliance will not be available for most requirements unless the Australian Government introduces legislation that is “comparable” to the Dodd-Frank Act and in any event substituted compliance is not allowed in relation to all obligations.
What does that mean?
The lack of clarity will have a significant impact on the cost of compliance to Australian financial institutions. For example, Australian financial institutions will still be required to have procedures in place to obtain the consent of all swap counterparties to report information to the CFTC and to report that information to the CFTC.
The CFTC has confirmed that they do not expect the final guidance in relation to the cross-border application of the Dodd-Frank Act will be issued before Australian financial institutions are required to register. This places Australian financial institutions in the difficult position of either trying to guess what form the final guidance will take or disregarding it entirely in deciding whether to register and what to include in the compliance plan which must be submitted with any application for exemptive relief to delay compliance with substantive rules.
What does the guidance say?
Swaps to be included in determining whether you must register with the CFTC
To be required to register as a swap dealer an Australian financial institution (and any non-US affiliates under common control) whose swap dealings are not guaranteed by a US person must engage in more than a de minimis level of swap dealings with “US persons. In this context a “US person” does not include foreign branches of registered US swap dealers and the transactions of US affiliates are to be excluded.
To be required to register as a major swap participant, an Australian financial institution must hold swap positions with US persons above the specified thresholds. If any of the Australian financial institution’s swap positions are guaranteed by a US person, those positions do not need to be included in the threshold calculation, however, any swaps between a US-person and non-US person where the Australian financial institutions has guaranteed the obligations of the non-US person must be included.
Swaps that the Dodd-Frank Act requirements apply to
Even though only swaps with “US persons” are relevant in determining whether registration is required the guidance proposes that swaps with non-US persons will still be regulated under the Dodd-Frank Act.
The “entity level requirements” applying to swap dealers or major swap participants (including capital adequacy requirements and swap data reporting and record keeping) apply to all swaps not just swaps with US persons – although non-US swap dealers and major swap participants may be able to rely on delayed compliance with some of these obligations until July 2013.
The “transaction level requirements” applying to swap dealers or major swap participants (including clearing, margining and trade execution obligations) and the requirements that apply to persons other than a swap dealer or major swap participant (including clearing, trade execution, record keeping and reporting) will only apply to swaps with “US persons”. However, some of these requirements will also apply where the counterparty of a non-US swap dealer or major swap participant is a non-US person guaranteed by a US person.
It is not clear whether the transaction level requirements will apply to swaps with foreign branches of US persons as there are a number of inconsistent statements in the guidelines.
The CFTC is proposing to allow swap dealers and major swap participants to comply with the “entity level requirements” through “substituted compliance” with Australian laws if the CFTC determines that such laws are comparable to the requirements under the Dodd-Frank Act.
Compliance through “substituted compliance” will not be permitted in relation to “transaction level requirements” with US persons and the requirements that apply to persons other than a swap dealer or major swap participant where one of the counterparties is a US person.
From a practical perspective, substituted compliance will not be relevant to Australian financial institutions for all obligations unless the Australian Government introduces legislation that is “comparable” to the Dodd-Frank Act. This may not be fully effective before the exemptive relief provided to Australian financial institutions expires in July 2013.
Where to next?
Australian financial institutions must decide whether to register with the CFTC and/or the SEC and whether to seek exemptive relief to delay compliance with substantive rules until July 2013. If a decision to register is made, consideration should be given to how compliance can be achieved even if exemptive relief is provided as it may take a significant period to implement appropriate procedures (for example, obtaining consent from all existing swap counterparties to the disclosure of information).