On July 11, 2013, the Commodity Futures Trading Commission and the European Commission announced a high-level joint understanding (referred to in the announcement as the “Path Forward”) regarding the approach to the cross-border regulation of over-the-counter derivatives . The announcement comes one day before the CFTC is scheduled to hold a highly-anticipated open meeting to consider its final cross-border guidance and associated phase-in for compliance. The full text of the announcement can be found here.
To address market participants’ concerns that cross-border transactions in derivatives could result in duplicative, conflicting or inconsistent regulatory burdens, and to reduce the incentive to engage in regulatory arbitrage, the CFTC and the EC have generally agreed that the applicable regulators should, where appropriate, defer to the regulatory requirements in another jurisdiction when it is “justified” by the quality of the regime in that jurisdiction. At the same time, the CFTC and the EC are focused on ensuring that their coordinated cross-border approach to regulating derivatives does not permit overseas guaranteed affiliates and branches of US and European Union persons to operate outside of their collective regulatory regimes.
While the announcement is light on details, it does contain certain statements that are noteworthy.
- The announcement indicates that in the case of a non-US swap dealer (SD) that is not affiliated with or guaranteed by a US person, such non-US SD will only be subject to the CFTC’s transaction-level requirements (e.g., clearing and trade execution, margining, external business conduct standards, swap trading relationship documentation, portfolio reconciliation and compression and trade confirmation) in transactions with US persons and guaranteed affiliates of US persons.
- In respect of market participants that are subject to the requirements of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act or European Market Infrastructure Regulation (EMIR), the announcement indicates that the CFTC is expected to issue a no-action letter that where a swap is subject to joint jurisdiction under the US and EU risk mitigation rules (e.g., certain business conduct standards such as confirmation, portfolio reconciliation, portfolio compression, valuation and dispute resolution), compliance under EMIR will achieve compliance with the relevant CFTC rules. The CFTC implemented that pronouncement by issuing Letter 13-45 on July 11, 2013. The announcement also indicates that non-US branches of US SDs may be able to comply with certain CFTC rules through substituted compliance by complying with the equivalent requirements of its home jurisdiction so long as certain conditions are met. This concept of “substituted compliance” was contained in the CFTC’s proposed guidance regarding the cross-border application of certain swap provisions published on July 12, 2012 in situations involving certain non-US persons registered with the CFTC transacting with certain other non-US persons.
- The announcement provides that the definition of US person “should” include offshore hedge funds and collective investment vehicles that are either majority-owned by US persons or that have their principal place of business in the US. Such an approach would be a departure from the CFTC’s latest version of the definition of US person offered in the Final Exemptive Order Regarding Compliance with Certain Swap Regulations issued in January of this year and which expires tomorrow which specifically excluded offshore funds and collective investment vehicles from the definition of US person even if they have their principal place of business in the US.
- In respect of mandatory clearing, the announcement provides that the CFTC and the EC have agreed upon a “stricter-rule-applies” approach for certain cross-border transactions such that where exemptions from clearing would apply in one jurisdiction but not another, such transactions would need to be cleared.
The announcement is intended to be a statement of understanding between the CFTC and the EC and therefore does not specifically address some of the more controversial issues raised by cross-border regulation. For instance, the announcement does not address how non-US affiliates of US SDs or non-US SDs that are guaranteed by US persons will be treated under the CFTC’s final cross-border guidance and the larger cross-border regulatory approach of the CFTC and the EC. We expect more clarity surrounding the cross-border regulation of derivatives following tomorrow’s CFTC open meeting and we anticipate providing a more in-depth review of the cross-border application of derivatives regulation in the near future.