The U.S. Commodity Futures Trading Commission (the “CFTC”) has issued interpretive guidance regarding which Dodd-Frank1 requirements apply to certain non-U.S. swap transactions (the “Cross-Border Rule”).2In order to facilitate parties’ compliance with the Cross Border Rule, the International Swaps and Derivatives Association (“ISDA”) has published the ISDA 2013 DF Agreement for Non-U.S. Transactions (the “Non-U.S. Agreement”) through which parties may elect applicable requirements. On December 4, 2013, ISDA filed a complaint in the U.S. District Court for the District of Columbia challenging the Cross-Border Rule (the “Complaint”).3 This alert provides a brief overview of the Non-U.S. Agreement and the Complaint, and highlights considerations for swaps counterparties in light of the legal uncertainty around the Cross-Border Rule.
Under Dodd-Frank, certain rules and regulations will apply to cross-border swaps if certain conditions are met. Namely, when such transactions have a “direct and significant connection with activities in, or effect on, commerce of the United States” or when they contravene CFTC rules or regulations necessary or appropriate to prevent evasion of the swaps provisions enacted under Dodd-Frank.4
However, only a limited set of such rules and regulations will apply where (a) one party to a transaction is a swap dealer registered with the CFTC that (i) would not be characterized as a “U.S. Person” under the Cross-Border Rule or (ii) is a U.S. bank that transacts through a non-U.S. branch and (b) the other party to the transaction is a non-U.S. person (whether or not the transaction is guaranteed by a U.S. person or by a person acting as an “affiliate conduit”5); some of the “Transaction Level Requirements” specified in the relevant CFTC regulations will not apply and/or will apply in a more limited fashion in contrast to domestic transactions involving only U.S. persons.
Parties falling into these circumstances may wish to use the Non-U.S. Agreement in order to provide for compliance with the more limited set of applicable requirements in lieu of adhering to or entering into broader documentation solutions that may contain unnecessary or inapplicable terms. However, the parties may need additional documentation depending on a variety of considerations, including the specific Dodd-Frank requirements that apply to the situation, the existing documentation between the parties and the local law in their respective jurisdictions.
The applicability of the Cross-Border rule has itself been challenged by ISDA, the Securities Industry and Financial Markets Association (“SIFMA”) and the Institute of International Bankers under a lawsuit filed on December 4, 2013, which renders the legal landscape even more uncertain as it relates to cross-border swaps rules.
II. The Non-U.S. Agreement
The Non-U.S. Agreement is structured as an integrated agreement consisting of a “base” master agreement and two Annexes. Annex I addresses “Entity-Level Requirements” (relating to capital adequacy, risk management, compliance governance, large-trader or physical commodity swaps reporting, swap data recordkeeping and swap data repository reporting). This Annex may be useful whenever one of the parties is a non-U.S. swap dealer or a bank swap dealer operating out of a non-U.S. branch.
Annex II addresses “Category-A Transaction-Level Requirements” (relating to clearing and swap processing; margining and segregation for uncleared swaps; trade execution; swap trading relationship documentation; portfolio reconciliation and compression; real-time public reporting; trade confirmation; and daily trading records). Annex II is for either (i) a non-U.S. swap dealer transacting with a non-U.S. person that is guaranteed by a U.S. person or functions as an “affiliate conduit” thereof or (ii) a U.S. swap dealer that is a bank transacting through a non-U.S. branch with a non-U.S. person (including a non-U.S. person guaranteed by a U.S. person or functioning as an “affiliate conduit” of a U.S. person).
The base agreement contains various terms including notice provisions and basic representations as to the accuracy of information provided in the Annexes as well as terms for the updating of such information. An ISDA Guidance Note6 points out that the Non-U.S. Agreement is not a protocol so there is no standardized adherence process; rather counterparties privately negotiate or execute the bilateral arrangement. Additionally, unlike protocols, the Non-U.S. Agreement does not supplement existing swap agreements between counterparties but generally applies to bilateral trading relationships. Conversely, the Annexes specify transactional scope.7
ISDA notes that the Non-U.S. Agreement does not reproduce representations contained in the Cross-Border Swaps Representation Letters published by ISDA8 regarding the parties’ status under the Cross-Border Rule since the Non-U.S. Agreement assumes the parties have already established their respective statuses; it only contains acknowledgments of the representations.9
ISDA also notes that the Non-U.S. Agreement does not relate to all cross-border rules including those permitting substituted compliance with similar regulatory regimes like the European Market Infrastructure Regulation.10 Therefore, each Non-U.S. Agreement negotiation should be tailored to reflect any alternate rules on which the counterparties are relying for compliance with Dodd-Frank swap regulations and related Commodity Exchange Act11 (the “CEA”) rules.
III. The Complaint
The Complaint states that the CFTC unlawfully circumvented the requirements of the Administrative Procedure Act and CEA by mis-characterizing its regulations as “guidance” rather than binding rules, failing to conduct any legally-required cost-benefit analysis, conducting a flawed rulemaking process, and imposing a series of rules that are contrary to the letter and spirit of international comity, with potential to harm global markets.12
In light of this Complaint, the Cross-Border Rule’s legal application remains murky, and the Non-U.S. Agreement may not necessarily provide needed clarity since it was developed by assuming the Cross-Border Rule’s effectiveness.
All market participants should continue to monitor developments in this area.