The staff of the Commodity Futures Trading Commission (CFTC) recently issued an advisory and a guidance letter, each of which addresses cross-border aspects of the CFTC’s swaps regulation that were not expressly addressed in the cross-border guidance and policy statement adopted by the CFTC several months ago. The advisory addresses transaction-level requirements applicable to transactions negotiated or executed by personnel or agents of non-U.S. swap dealers located in the United States; the guidance letter addresses the application of swap execution facility registration requirements to certain non-U.S. multilateral swap trading platforms. Although this Sidley Update does not address the litigation recently commenced by three industry trade associations to challenge the CFTC’s cross-border guidance and policy statement generally, we note that the complaint filed by the associations cites the advisory and the guidance letter in connection with the challenge.1
CFTC Staff Advisory No. 13-69, dated November 14, 2013 (the Advisory), addresses the application of transaction-level requirements to swaps between a non-U.S. CFTC-registered swap dealer (whether or not the dealer is an affiliate of a U.S. person) and a non-U.S. person where the swap is arranged, negotiated or executed by personnel or agents of the non-U.S. swap dealer located in the United States. In subsequent CFTC No-Action Letter No. 13-71 (the No-Action Letter), the CFTC staff indicated that it would not recommend the CFTC take enforcement action against a non-U.S. CFTC-registered swap dealer for failure to comply with transaction-level requirements in these circumstances until January 14, 2014 (subject to certain exceptions for transactions between two swap dealers).
A CFTC staff guidance letter dated November 15, 2013 (the Guidance Letter) addresses the application of swap execution facility (SEF) registration requirements to multilateral swap trading platforms located outside the United States that are operating in the United States or that provide U.S. persons or other persons located in the United States (including personnel and agents of non-U.S. persons located in the United States) the ability to trade or execute swaps either directly or indirectly (through an intermediary) on the platform.
Taken together, the Advisory and Guidance Letter extend the express reach of the CFTC’s final cross-border guidance and policy statement, adopted in July 2013, regarding the cross-border applicability of swaps regulation under Dodd-Frank’s Title VII (the Cross-Border Guidance).2 The staff’s attention to the location of personnel and agents adds a new dimension to the interpretations previously articulated in the Cross-Border Guidance. The central premise of the Cross-Border Guidance is that Dodd-Frank swap regulation should apply to swap activities that could have a direct effect on the U.S. economy, without regard to where those activities occur. The focus is on the participation of “U.S. persons” (as defined and interpreted by the CFTC) in swap transactions because the financial exposure of U.S. persons would most directly impact U.S. commerce and markets. The Cross-Border Guidance was silent as to extraterritorial jurisdiction over trading platforms, and this silence has been a source of uncertainty.
Most importantly, the CFTC staff’s action bears on:
- whether certain swap transactions that may be thought beyond the reach of Title VII – particularly those involving non-U.S. registered swap dealers and non-U.S. counterparties – will effectively become subject to mandatory clearing requirements upon expiration of the relief provided in the No-Action Letter; and
- whether certain non-U.S. multilateral swap trading platforms that may be thought beyond the reach of Title VII – particularly those permitting trading by non-U.S. persons (including non-U.S. registered swap dealers) but which involve U.S.-based agents (potentially including investment managers and brokers) and those with operations in the United States – are currently subject to SEF registration requirements.3
This Sidley Update addresses the Advisory and the Guidance Letter in turn. It also notes that the CFTC now appears to be taking a territorial approach to regulating swap activity, similar to the approach taken by the Securities and Exchange Commission (SEC) in its May cross-border proposal for regulating security-based swaps activity.
On November 14, 2013, the Division of Swap Dealer and Intermediary Oversight (DSIO) issued the Advisory.4 In the Advisory, the DSIO expressed its view that “Transaction-Level Requirements” generally apply when a non-U.S. CFTC-registered swap dealer enters into a swap with another non-U.S. person if personnel or agents of the non-U.S. registered swap dealer who are located in the United States are regularly used to arrange, negotiate, or execute a swap with non-U.S. persons. Transaction-Level Requirements include, among other requirements,5 mandated centralized clearing of certain swaps.
The Cross-Border Guidance generally indicates that a non-U.S. CFTC-registered swap dealer entering into a swap with another non-U.S. person would not be subject to Transaction-Level Requirements provided its non-U.S. counterparty is not a guaranteed affiliate or affiliate conduit of a U.S. person (and, even in the latter cases, the Cross-Border Guidance provided that substituted compliance would be available).6 By contrast, footnote 513 of the Cross-Border Guidance (Footnote 513) addresses how transactions involving a U.S. branch of a non-U.S. registered swap dealer should be treated. Specifically, Footnote 513 indicates that a “U.S. branch of a non-U.S. swap dealer . . . would be subject to Transaction-Level requirements without substituted compliance available.” In the Advisory, the DSIO expresses its view, without discussing the position previously articulated in Footnote 513, that Transaction-Level Requirements apply to a non-U.S. swap dealer in circumstances beyond those that the CFTC originally articulated in Footnote 513. The Advisory is premised on the CFTC staff’s view that as a U.S. regulator such as the CFTC has a strong supervisory interest in swap dealing activities that occur within the United States, regardless of the status of the counterparties.
Notably, the Advisory would apply not only where a non-U.S. CFTC-registered swap dealer is entering into a trade through its U.S. branch (as addressed in Footnote 513), but also where it regularly uses personnel or agents located in the U.S. to arrange, negotiate, or executeswaps. The Advisory does not, however, provide any guidance as to the meaning of “arrange, negotiate, or execute” or, for that matter, to the meaning of “regularly.” Presumably some level of activity will fall short of these standards and some level will clearly meet them, and even after careful consideration, uncertainty will remain, as will the prospect of 20/20 hindsight. In addition, although the Advisory did not specifically address the role played by U.S.-based interdealer brokers, consideration must be given to how they may continue to operate on behalf of certain non-U.S. CFTC-registered swap dealers.
Because substituted compliance will be unavailable in circumstances where the Advisory applies, a non-U.S. CFTC-registered swap dealer may have to satisfy Title VII requirements in addition to any applicable requirements of its home jurisdiction. This may result in duplicative or inconsistent regulatory obligations.
In the subsequent No-Action Letter,7 the CFTC staff indicated that until January 14, 2014, it would not recommend that the CFTC take enforcement action against a non-U.S. swap dealer (whether or not an affiliate of a U.S. person) for failure to comply with Transaction-Level Requirements addressed by the Advisory (except that multilateral portfolio compression requirements and swap trading relationship requirements apply for transactions between non-US swap dealers).
As noted above, the most immediate concern for market participants is whether a category of swap transactions previously thought to be beyond the jurisdiction of the CFTC’s mandatory clearing mandate (that is, swaps between non-U.S. persons and non-U.S. swap dealers with U.S.-located desks or agents) will be subject to the mandate given the view expressed by the DSIO in the Advisory. The issues will compound when one or more categories of swaps become subject to mandatory execution on a SEF or designated contract market (DCM).8
The Guidance Letter
On November 15, 2013, a different division of the CFTC’s staff, the Division of Market Oversight (DMO), issued the Guidance Letter, which is addressed generally to SEFs and applicants for SEF registration.9 Although not limited to this subject, the Guidance Letter sets out the DMO’s expectations regarding when non-U.S. multilateral swaps trading platforms (Non-U.S. Platforms) are required to register as a SEF or DCM.
CFTC rules require a person operating a facility that offers a trading system or platform in which more than one market participant has the ability to execute or trade swaps with more than one other market participant to register as either a SEF or DCM.10 The Guidance Letter explains that the DMO expects a multilateral swaps trading platform that is a U.S. person (no surprise there) or is located or operating in the United States will register as a SEF or DCM. The Guidance Letter also expresses the DMO's expectation that Non-U.S. Platforms providing U.S. persons or persons located in the United States (including personnel and agents of non-U.S. persons located in the United States) (U.S.-Located Persons) with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary, will register as a SEF or DCM. In assessing when registration is mandated, the Guidance Letter identifies the following two factors as relevant (noting that there may be other relevant factors): (1) whether the Non-U.S. Platform directly solicits or markets its services to U.S. persons or U.S.-Located Persons; or (2) whether a significant portion of the market participants that the Non-U.S. Platform permits to effect transactions are U.S. persons or U.S.-Located Persons. For these purposes, market participant means a person that directly or indirectly effects transactions, including persons with trading privileges on the platform and persons whose trades are intermediated.
Although the Guidance Letter sets out these (non-exclusive) factors for purposes of addressing the requirement to register, the DMO seemingly sets the bar much lower when it expresses its expectation about registration: it appears that if a Non-U.S. Platform merely “provides . . . the ability to trade or execute swaps” to U.S. persons or U.S.-Located Persons, then the staff expects the Non-U.S. Platform to register. Accordingly, Non-U.S. Platforms that have not registered as a SEF or DCM11 will need to re-assess any extent to which they provide U.S. persons, or non-U.S. persons acting through U.S.-Located Persons, with the ability to enter into swaps (whether directly or indirectly).
The re-assessment may pose challenges to Non-U.S. Platforms that limit trading to Non-U.S. persons but do not restrict access for non-U.S. persons (including non-U.S. registered swap dealers) that use U.S.-Located Persons in executing trades. Examples of circumstances and issues that may bear consideration include when U.S.-based investment advisors or investment managers trade on behalf of non-U.S. persons through a Non-U.S. Platform, and when so, whether the involvement of the U.S.-based investment advisor or investment manager triggers the registration requirement for the SEF or DCM. A similar concern may arise where U.S.-based swap brokers are involved in platform-based transactions on behalf of non-U.S. registered swap dealers. This would seem to be inconsistent with the care that the CFTC itself took in the Cross-Border Guidance to avoid disadvantaging U.S. investment advisory firms when it framed its U.S. person definition.12
The Territorial Approach and the SEC’s Proposed Cross-Border Rules and Interpretation
Both the Advisory and the Guidance Letter specify circumstances, not identified in the Cross-Border Guidance, in which Title VII swap requirements may be applicable notwithstanding that a transaction is between two non-U.S. counterparties. Both take a “territorial” approach to transactional activity that was seemingly rejected in the Cross-Border Guidance, but apparently is being embraced in the Advisory and Guidance Letter. The SEC, unlike the CFTC, proposed an express territorial approach to the regulation of security-based swaps that are “conducted within the United States.”
In the case of clearing, the position set out in the Advisory is similar to the SEC’s proposed rule. The SEC proposes to impose mandatory clearing on any security-based swap that is a “transaction conducted within the United States” subject to certain exceptions (one of which, as noted below, is relevant here). The SEC’s definition of a “transaction conducted within the United States” reflects a broad territorial approach applied to transactional activity, not dissimilar to the territorial approach reflected in the Advisory. Here are the principal passages from the CFTC staff Advisory and the SEC proposal regarding territorial reach:
- CFTC Staff Advisory: “regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person”
- SEC Proposal: “a . . . transaction that is solicited, negotiated, executed, or booked within the United States, by or on behalf of either counterparty to the transaction, regardless of the location, domicile, or residence status of either counterparty to the transaction”13
The SEC went on to propose an exception to mandated clearing where a transaction conducted in the United States is between two non-U.S. persons, but the exception would not be available if either party were a non-U.S. registered security-based swap dealer.14Similarly, the Advisory is restricted by its affirmative terms to non-U.S. registered swap dealers, leaving the implication (at least for now) that a swap transaction between two non-U.S. persons may be executed by U.S.-based personnel or agents on behalf of either or both parties without the transaction becoming subject to Transaction-Level Requirements (including mandatory clearing) as long as neither non-U.S. party is a registered swap dealer.
This comparison would seem to reflect a partial convergence of the SEC’s territorial approach to transactional jurisdiction and the CFTC’s (or at least its staff’s) approach. A similar convergence seems to be reflected in the Guidance Letter in the context of SEF registration requirements. While the SEC addressed the question of when a non-U.S. platform would be required to register as a security-based swap execution facility (SB SEF), the CFTC’s Cross-Border Guidance did not. That CFTC’s staff has now taken steps to fill the void. As with the standards for mandatory clearing, the standards for SEF and SB SEF registration, in the context of cross-border application, are similar (though more important differences seem to exist here than in the context of mandatory clearing).15
Although significant overlap exists between the standard enunciated by the CFTC staff in the Guidance Letter and the interpretation proposed by the SEC, one of the principal differences is whether indirect access (as contrasted to direct access) to a platform is relevant. While it does not appear to be relevant in the view of the CFTC’s staff, in the case of the SEC, it may be.16 It seems clear that, in the first instance, the SEC proposes to interpret its jurisdiction in a way that would leave U.S.-based agents (such as investment advisors) the ability to seek swap execution outside the United States (via a non-US intermediary) without implicating SB SEF registration requirements for any non-U.S. swap execution platform that may be involved. The CFTC staff’s position – in respect of the CFTC’s jurisdiction over U.S.-Located Persons that have even an indirect ability to execute swaps through an intermediary – appears more expansive.
In the Cross-Border Guidance the CFTC adopted an express jurisdictional interpretation in Footnote 513 that described the U.S.-based activity of a non-U.S. registered swap dealer that would trigger application of Transaction-Level Requirements. In the Advisory, the staff extended that interpretation (or at least made express what, at most, might have been implied). In the Cross-Border Guidance, the CFTC did not address, in any substantive way, its jurisdictional reach in respect of overseas swap trading platforms, leaving something of a regulatory void. In the Guidance Letter, the staff has begun to fill that void. These actions surprised not only market participants but also overseas regulators.17
We would finally note that, given the approach taken by the CFTC’s staff, there remains the possibility of further advisories or guidance that may enumerate additional circumstances in which Title VII requirements apply, or perhaps clarify where the staff believes jurisdiction exists beyond that previously articulated by the CFTC. Accordingly, continued monitoring of CFTC staff actions by international derivatives market participants is warranted.