In the US, the Dodd-Frank Act’s goal of ultimately requiring central clearing of swaps has slowly started to shape the regulatory landscape as we head into the fourth quarter of 2012. Felix Shipkevich, principal Shipkevich PLLC reviews the CFTC rules regarding cross-border applications of the swaps provisions and the extraterritorial implications of these measures. Comments from a DerivSource podcast.
The Commodity Futures Trading Commission (CFTC) has yet to publish any final rules regarding extraterritorial applications. The July 2012 CFTC guidance: Section 722(d) of the Dodd Frank Act states that: activities outside the US shall not apply to the Act unless those activities: (a) have a direct and significant connection with activities in, or effect on, commerce of the US; or (2) contravene such rules or regulations as the CFTC may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of the Commodity Exchange Act.
On June 29th the CFTC issued proposed interpretative guidance regarding the extraterritorial reach of the Dodd-Frank Act. Under the CFTC proposed guidance non-US swap dealers and major swap participants would need to apply Dodd-Frank transaction level rules, including clearing obligations when trading with any US counterparty other than foreign branches of US persons. However, non-US swap entities can apply equivalent home market rules when trading with non-US counterparties whose swap obligations are guaranteed by a US entity, as well as trades with non-US affiliate conduits of a US firm. No requirements exist when a non-US swaps dealer or major swap participant trades with a non-US counterparty not guaranteed by a US person.
A non-US person and a non- US financial institution guaranteed by US institutions could still potentially fall under the requirements of the Dodd Frank legislation, particularly if they are guaranteed by a US-based swap dealer. For these non-US financial firms substituted compliance may apply.
Foreign branches of US dealers would be able to apply substituted compliance when trading with non-US persons regardless of whether its obligations are guaranteed by a US person. Substituted compliance would only apply to transactions between two non-US persons; trades involving counterparties will always be subject to Dodd-Frank even if another jurisdictions regulations also apply. Regardless of the location of the transaction a swap executed with a US person will require clearing under the Dodd-Frank legislation. The CFTC decisions involving substituted compliance would apply to firms rather than jurisdictions.
Over the past few months some foreign regulators have been quite vocal, in particular European regulators who have criticized the proposed guidance published by the CFTC. On initial inspection the guidelines seem in line with the CFTC traditional approach of relying on equivalent requirements from foreign regulators.
The phrase ‘principal place of business’ is worrisome for many foreign institutions as it may capture many overseas firms, which have significant operations in the US. Commodity pool operators with overseas funds could technically be defined as a US person even though their own national regulators would classify them differently. It is still unclear at this point which regulations they would have to adhere to.
The contradiction in the definition of a US person is another area of concern. The CFTC classifies a corporation, partnership or LLC as a US person if the direct or indirect owners are responsible for the liabilities of that entity and one or more of the beneficiaries are a US person. Under the guidance, foreign affiliates or subsidiaries of a US person are exempt even if a US person guarantees the swap obligations.
An important issue to clarify is how the extraterritorial guidance will work with the registration regulations. The CFTC is using a twelve-month look back rule in which an entity must use twelve months historical data to determine registration. If the look back rule is applied foreign entities could be identified as a US person even if it decided to cease swap activities. Some firms may, however, temporarily register with the CFTC to prevent regulatory repercussions.
