In late July 2020, the Commodity Futures Trading Commission (the CFTC or the Commission) approved a final rule (the Rule) on the cross-border application of certain swap provisions under the Commodity Exchange Act (CEA). In addition, the Rule: outlined certain registration thresholds and certain requirements applicable to Swap Dealers (SDs) and Major Swap Participants (MSPs), established a formal process for requesting comparability determinations for applicable requirements; and defined key terms to apply the CEA’s swaps provisions to cross-border transactions.
In superseding the CFTC’s previous cross-border guidance from 2013, the Rule applies a risk-based approach with the goals of enhancing liquidity and market competition, harmonizing global swaps requirements and giving considerable deference to the CFTC’s foreign peer regulators. Notably, the Rule removes certain situations that previously triggered CFTC regulation, including trades booked overseas by foreign affiliates of U.S. parent entities and trades between non-US counterparties even if they are touched by U.S.-based employees (see ANE section, below).
The Rule outlines the cross-border application of registration requirements, including:
Adopting a formal definition of ‘US Person’ in lieu of an interpretive approach under the prior CFTC guidance. The term is now harmonized with SEC Security-Based Swap definitions of US Person.
Requiring a ‘US Person’ to include all of its SD transactions in its de minimis threshold calculations.
Requiring that any person that is a ‘significant risk subsidiary’ (a new concept) or ‘guaranteed entity’ to count all of its swap dealing activities toward the de minimis threshold.
Requiring ‘Other Non-U.S. Persons’ to count all their swap dealing activities with a US Person toward its de minimis threshold, except for those swaps that were conducted through a foreign branch of a registered US SD.
Significantly, the Rule no longer applies previous CFTC rule interpretations for certain swap requirements, which are “arranged, negotiated or executed” (ANE) by employees of non-US SDs in the US, which involve a non-US Person. This new Rule, therefore, is different from the SEC’s recent cross-border rules for Security-Based Swaps (SBS) and effectively treats all foreign swaps between a Non-US SD and a Non-US Person equally, regardless of whether the swap is an ANE transaction.
Cross-border application of the CFTC’s business conduct standards are organized into requirements for Groups B and C (discussed below). The remaining transaction-level requirements will be addressed in future CFTC rule-making, according to the Commission. The requirements include: capital adequacy, uncleared swap margin and real-time public reporting, capital adequacy, clearing and swap processing and mandatory trade execution.
Significantly, the Rule creates several groups of swap requirements which are used to determine the availability of exceptions to those requirements (or to outline substituted compliance for those requirements).
Group A: covers regulations related to the chief compliance officer (CCO), risk management, recordkeeping and anti-trust provisions.
Group B: covers requirements for swap trading relationship documentation, portfolio reconciliation/compression, trade confirms and daily trading records.
Group C: covers external business conduct standards and segregation of assets used for collateral for uncleared swaps.
The Rule outlines four main exceptions involving the above Groups:
1. Certain anonymous exchange-traded/cleared foreign-based swaps are now eligible for an exception from certain Groups B and C requirements.
2. Certain foreign-based swaps received a narrow exception from some Group C requirements concerning transactions with foreign counterparties, so long as that counterparty is neither a foreign branch nor a guaranteed entity.
3. Certain foreign-based swaps of foreign branches of U.S. SD entities received an exception for swaps with certain foreign counterparties.
4. Foreign-based swaps of certain non-U.S. SD entities received an exemption from Group B concerning certain foreign counterparties.
Additionally, the Rule defines a framework for assessing substituted compliance. Most notably, the Rule permits non-US SD entities to meet any Group A requirements at the enterprise level by complying with the similar standards of a foreign jurisdiction. Similarly, non-US SD entities can meet the requirements of Group B for any swap booked in a US branch with a foreign counterparty by meeting applicable standards of the foreign jurisdiction. At the time of this brief, no substituted compliance was made available for the requirements of Group C.
Firms should begin to assess the impact of these final rules on their foreign swaps activities, including the effect on de minimis threshold exposure and compliance personnel/processes. Firms that have dedicated significant expense complying with U.S. requirements may be able to rely on the requirements of their home jurisdiction, as the CFTC has indicated an intent to respect the law of foreign jurisdictions while focusing on threats to the U.S. financial system. As a result, financial institutions with multiple foreign SD entities are likely the largest benefactors of the Rule, as the likelihood of triggering CFTC requirements when they trade with non-U.S. counterparties is substantially diminished.