Federal Register, Volume 78 Issue 144 (Friday, July 26, 2013)[Federal Register Volume 78, Number 144 (Friday, July 26, 2013)]
[Rules and Regulations]
[Pages 45291-45374]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-17958]
[[Page 45291]]
Vol. 78
Friday,
No. 144
July 26, 2013
Part II
Commodity Futures Trading Commission
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17 CFR Chapter I
Interpretive Guidance and Policy Statement Regarding Compliance With
Certain Swap Regulations; Rule
Federal Register / Vol. 78, No. 144 / Friday, July 26, 2013 / Rules
and Regulations
[[Page 45292]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Chapter I
RIN 3038-AD85
Interpretive Guidance and Policy Statement Regarding Compliance
With Certain Swap Regulations
AGENCY: Commodity Futures Trading Commission.
ACTION: Interpretive Guidance and Policy Statement.
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SUMMARY: On July 12, 2012, the Commodity Futures Trading Commission
(``Commission'' or ``CFTC'') published for public comment its proposed
interpretive guidance and policy statement (``Proposed Guidance'')
regarding the cross-border application of the swaps provisions of the
Commodity Exchange Act (``CEA''), as added by Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act'' or ``Dodd-Frank''). On December 21, 2012, the Commission also
proposed further guidance on certain aspects of the Proposed Guidance
(``Further Proposed Guidance'').
The Commission has determined to finalize the Proposed Guidance
with certain modifications and clarifications to address public
comments. The Commission's Interpretive Guidance and Policy Statement
(``Guidance'') addresses the scope of the term ``U.S. person,'' the
general framework for swap dealer and major swap participant
registration determinations (including the aggregation requirement
applicable to the de minimis calculation with respect to swap dealers),
the treatment of swaps involving certain foreign branches of U.S.
banks, the treatment of swaps involving a non-U.S. counterparty
guaranteed by a U.S. person or ``affiliate conduit,'' and the
categorization of the Dodd-Frank swaps provisions as ``Entity-Level
Requirements'' or ``Transaction-Level Requirements.''
DATES: Effective Date: This Guidance will become effective July 26,
2013.
FOR FURTHER INFORMATION CONTACT: Gary Barnett, Director, Division of
Swap Dealer and Intermediary Oversight, (202) 418-5977,
[email protected]; Sarah E. Josephson, Director, Office of
International Affairs, (202) 418-5684, [email protected]; Mark
Fajfar, Assistant General Counsel, Office of General Counsel, (202)
418-6636, [email protected]; Laura B. Badian, Counsel, Office of General
Counsel, (202) 418-5969, [email protected]; Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. The Dodd-Frank Wall Street Reform and Consumer Protection Act
B. The Proposed Guidance and Further Proposed Guidance
II. Scope of This Guidance
III. Interpretation of Section 2(i)
A. Comments
B. Statutory Analysis
C. Principles of International Comity
IV. Guidance
A. Interpretation of the Term ``U.S. Person''
1. Proposed Interpretation
2. Comments
a. Phase-In Interpretation
b. Comments on Particular Prongs of the Proposed Interpretation
of the Term ``U.S. Person''
c. Commenters' Proposed Alternatives
d. Due Diligence
e. Non-U.S. Person That Is Affiliated, Guaranteed, or Controlled
by U.S. Person
f. Foreign Branch of U.S. Person
g. Regulation S
h. Other Clarifications
3. Commission Guidance
a. Due Diligence
b. Foreign Branch of U.S. Person
c. Regulation S
d. Other Clarifications
4. Summary
B. Registration
1. Proposed Guidance
2. Comments
3. Commission Guidance
a. Registration Thresholds for U.S. Persons and Non-U.S.
Persons, Including Those Guaranteed by U.S. Persons
b. Aggregation
c. Exclusion of Certain Swaps by Non-U.S. Persons From the Swap
Dealer De Minimis Threshold
d. Exclusion of Certain Swaps by Non-U.S. Persons From the MSP
Calculation
e. Exclusion of Certain Swaps Executed Anonymously on a SEF,
DCM, or Foreign Board of Trade (``FBOT'') and Cleared
f. MSP-Parent Guarantees
4. Summary
C. Interpretation of the Term ``Foreign Branch;'' When a Swap
Should Be Considered To Be With the Foreign Branch of a U.S. Person
That Is a Swap Dealer or MSP
1. Interpretation of the Term ``Foreign Branch'' and Treatment
of Foreign Branches
2. Comments
3. Commission Guidance
a. Scope of the Term ``Foreign Branch''
b. Commission Consideration of Whether a Swap Is With a Foreign
Branch of a U.S. Bank
D. Description of the Entity-Level and Transaction-Level
Requirements
1. Description of the Entity-Level Requirements
a. First Category of Entity-Level Requirements
i. Capital Adequacy
ii. Chief Compliance Officer
iii. Risk Management
iv. Swap Data Recordkeeping (Except Certain Aspects of Swap Data
Recordkeeping Relating to Complaints and Sales Materials)
b. Second Category of Entity-Level Requirements
i. SDR Reporting
ii. Swap Data Recordkeeping Relating to Complaints and Marketing
and Sales Materials
iii. Physical Commodity Large Swaps Trader Reporting (Large
Trader Reporting)
2. Description of the Transaction-Level Requirements
a. Category A: Risk Mitigation and Transparency
i. Required Clearing and Swap Processing
ii. Margin and Segregation Requirements for Uncleared Swaps
iii. Trade Execution
iv. Swap Trading Relationship Documentation
v. Portfolio Reconciliation and Compression
vi. Real-Time Public Reporting
vii. Trade Confirmation
viii. Daily Trading Records
b. Category B: External Business Conduct Standards
E. Categorization of Entity-Level and Transaction-Level
Requirements
1. Categorization Under the Proposed Guidance
2. Comments
a. Reporting and Trade-Execution Requirements
b. Swap Trading Relationship Documentation, Portfolio
Reconciliation and Compression, Daily Trading Records and External
Business Conduct Standards
c. Internal Conflicts of Interest Requirement
d. Position Limits and Anti-Manipulation Rules
3. Commission Guidance
a. Entity-Level Requirements
i. The First Category--Capital Adequacy, Chief Compliance
Officer, Risk Management, and Swap Data Recordkeeping (Except for
Certain Recordkeeping Requirements)
ii. The Second Category--SDR Reporting, Certain Swap Data
Recordkeeping Requirements and Large Trader Reporting
b. Transaction-Level Requirements
i. The Category A Transaction-Level Requirements
ii. The Category B Transaction-Level Requirements (External
Business Conduct Standards)
F. Substituted Compliance
1. Proposed Guidance
2. Comments
3. Overview of the Substituted Compliance Regime
4. Process for Comparability Determinations
5. Conflicts Arising Under Privacy and Blocking Laws
6. Clearing
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a. Clearing Venues
b. Foreign End-Users
G. Application of the Entity-Level and Transaction-Level
Requirements To Swap Dealers and MSPs
1. Comments
2. Commission Guidance
3. Application of the Entity-Level Requirements To Swap Dealers
and MSPs the Commission's policy on
a. To U.S. Swap Dealers and MSPs
b. To Non-U.S. Swap Dealers and MSPs
4. Application of the ``Category A'' Transaction-Level
Requirements To Swap Dealers and MSPs
a. Swaps With U.S. Swap Dealers and MSPs
b. Swaps With Non-U.S. Swap Dealers and Non-U.S. MSPs
c. Swaps With a Non-U.S. Person Guaranteed by a U.S. Person
i. Proposed Guidance
ii. Comments
iii. Commission Guidance
d. Swaps With a Non-U.S. Person That Is an Affiliate Conduit
i. Proposed Guidance
ii. Comments
iii. Commission Guidance
5. Application of the ``Category B'' Transaction-Level
Requirements To Swap Dealers and MSPs
a. Swaps With U.S. Swap Dealers and U.S. MSPs
b. Swaps With Foreign Branches of a U.S. Bank That Is a Swap
Dealer or MSP
c. Swaps With Non-U.S. Swap Dealers and Non-U.S. MSPs
H. Application of the CEA's Swap Provisions and Commission
Regulations to Market Participants That Are Not Registered as a Swap
Dealer or MSP
1. Swaps Between Non-Registrants Where One or More of the Non-
Registrants Is a U.S. Person
2. Swaps between Non-Registrants That Are Both Non-U.S. Persons
a. Large Trader Reporting
b. Swaps Where Each of the Counterparties Is Either a Guaranteed
or Conduit Affiliate
c. Swaps Where Neither or Only One of the Parties Is a
Guaranteed or Conduit Affiliate
V. Appendix A--The Entity-Level Requirements
A. First Category of Entity-Level Requirements
1. Capital Adequacy
2. Chief Compliance Officer
3. Risk Management
i. Swap Data Recordkeeping (Except Certain Aspects of Swap Data
Recordkeeping Relating to Complaints and Sales Materials)
B. Second Category of Entity-Level Requirements
1. SDR Reporting
2. Swap Data Recordkeeping Relating to Complaints and Marketing
and Sales Materials
3. Physical Commodity Large Swaps Trader Reporting (Large Trader
Reporting)
VI. Appendix B--The Transaction-Level Requirements
A. Category A: Risk Mitigation and Transparency
1. Required Clearing and Swap Processing
2. Margin and Segregation Requirements for Uncleared Swaps
3. Trade Execution
4. Swap Trading Relationship Documentation
5. Portfolio Reconciliation and Compression
6. Real-Time Public Reporting
7. Trade Confirmation
8. Daily Trading Records
B. Category B: External Business Conduct Standards
VII. Appendix C--Application of the Entity-Level Requirements to
Swap Dealers and MSPs*
VIII. Appendix D--Application of the Category A Transaction-Level
Requirements to Swap Dealers and MSPs*
IX. Appendix E--Application of the Category B Transaction-Level
Requirements to Swap Dealers and MSPs*
X. Appendix F--Application of Certain Entity-Level and Transaction-
Level Requirements to Non-Swap Dealer/Non-MSP Market Participants*
I. Introduction
A. The Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, President Obama signed the Dodd-Frank Act,\1\
Title VII of which amended the CEA to establish a new regulatory
framework for swaps. The legislation was enacted to reduce systemic
risk (including risk to the U.S. financial system created by
interconnections in the swaps market), increase transparency, and
promote market integrity within the financial system by, among other
things: (1) Providing for the registration and comprehensive regulation
of swap dealers \2\ and major swap participants (each, an ``MSP''); (2)
imposing clearing and trade execution requirements on standardized
derivatives products; (3) creating rigorous recordkeeping and data
reporting regimes with respect to swaps, including real-time public
reporting; and (4) enhancing the Commission's rulemaking and
enforcement authorities over all registered entities, intermediaries,
and swap counterparties subject to the Commission's oversight.
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\1\ Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.
\2\ For purposes of this Guidance, the term ``swap dealer''
means any swap dealer registered with the Commission. Similarly, the
term ``MSP'' means any MSP registered with the Commission.
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Section 722(d) of the Dodd-Frank Act amended the CEA by adding
section 2(i),\3\ which provides that the swaps provisions of the CEA
(including any CEA rules or regulations) apply to cross-border
activities when certain conditions are met, namely, when such
activities have a ``direct and significant connection with activities
in, or effect on, commerce of the United States'' or when they
contravene Commission rules or regulations as are necessary or
appropriate to prevent evasion of the swaps provisions of the CEA
enacted under Title VII of the Dodd-Frank Act.\4\
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\3\ 7 U.S.C. 2(i).
\4\ Id. Section 2(i) of the CEA states that the provisions of
the Act relating to swaps that were enacted by the Wall Street
Transparency and Accountability Act of 2010 (including any rule
prescribed or regulation promulgated under that Act), shall not
apply to activities outside the United States unless those
activities have a direct and significant connection with activities
in, or effect on, commerce of the United States; or contravene such
rules or regulations as the Commission may prescribe or promulgate
as are necessary or appropriate to prevent the evasion of any
provision of this Act that was enacted by the Wall Street
Transparency and Accountability Act of 2010.
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The potential for cross-border activities to have a substantial
impact on the U.S. financial system was apparent in the fall of 2008,
when a series of large financial institutional failures threatened to
freeze foreign and domestic credit markets. In September 2008, for
example, U.S.-regulated insurance company American International Group
(``AIG'') nearly failed as a result of risk incurred by the London swap
trading operations of its subsidiary AIG Financial Products
(``AIGFP'').\5\ Enormous losses on credit default swaps entered into by
AIGFP and guaranteed by AIG led to a credit downgrade for AIG,
triggering massive collateral calls and an acute liquidity crisis for
both entities. AIG only avoided default through more than $112.5
[[Page 45294]]
billion in support from the Federal Reserve Bank of New York and nearly
$70 billion from the U.S. Department of the Treasury and the Federal
Reserve.
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\5\ See, e.g., Congressional Oversight Panel, June Oversight
Report, The AIG Rescue, Its Impact on Markets, and the Government's
Exit Strategy, (Jun. 10, 2010), available at http://www.gpo.gov/fdsys/pkg/CPRT-111JPRT56698/pdf/CPRT-111JPRT56698.pdf (``AIG
Report''); Office of the Special Inspector General for the Troubled
Asset Relief Program, Factors Affecting Efforts to Limit Payments to
AIG Counterparties (Nov. 17, 2009), available at http://www.sigtarp.gov/Audit%20Reports/Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf. AIGFP was a Delaware
corporation based in Connecticut that was an active participant in
the credit default swap (``CDS'') market in the years leading up to
the crisis. See id. at 23. AIGFP's CDS activities benefited from
credit support provided by another Delaware corporation, American
International Group, Inc., AIGFP's highly-rated parent company.
Although both AIG and AIGFP were incorporated and headquartered in
the U.S., much of AIGFP's CDS business was conducted through its
London office and involved non-U.S. counterparties and credit
exposures. Id. at 18. See also Office of the Special Inspector
General for the Troubled Asset Relief Program, Factors Affecting
Efforts to Limit Payments to AIG Counterparties, at 20 (Nov. 17,
2009) (listing AIGFP's CDS counterparties, including a variety of
U.S. and foreign financial institutions), available at: http://www.sigtarp.gov/Audit%20Reports/Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf.
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A global, complex, and highly integrated business model also played
a role in, and complicated, the bankruptcy of former U.S.-based
multinational corporation Lehman Brothers Holding Inc. (``LBHI'') in
September 2008. In addition to guaranteeing certain swaps for its
subsidiary Lehman Brothers International Europe (``LBIE''), estimated
at nearly 130,000 OTC derivatives contracts at the time LBIE was placed
into administration on September 15, 2008, LBHI and its global
affiliates relied on each other for many of their financial and
operational services, including treasury and depository functions,
custodial arrangements, trading facilitation, and information
management.\6\ The complexity of the financial and operational
relationships of LBHI and its domestic and international affiliates,
including with respect to risk associated with swaps, provides an
example of how risks can be transferred across multinational affiliated
entities, in some cases in non-transparent ways that make it difficult
for market participants and regulators to fully assess those risks.
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\6\ ``The global nature of the Lehman business with highly
integrated, trading and non-trading relationships across the group
led to a complex series of inter-company positions being outstanding
at the date of Administration. There are over 300 debtor and
creditor balances between LBIE and its affiliates representing
$10.5B of receivables and $11.0B of payables as of September 15
2008.'' See Lehman Brothers International (Europe) in
Administration, Joint Administrators' Progress Report for the Period
15 September 2008 to 14 March 2009 (Apr. 14, 2009) (``Lehman
Brothers Progress Report''), available at http://www.pwc.co.uk/en_uk/uk/assets/pdf/lbie-progress-report-140409.pdf.
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Even in the absence of an explicit business arrangement or
guarantee, U.S. companies may for reputational or other reasons choose,
or feel compelled, to assume the cost of risks incurred by foreign
affiliates. In 2007, U.S.-based global investment firm Bear Stearns
decided to extend loans secured by assets of uncertain value to two
Cayman Islands-based hedge funds it sponsored after they suffered
substantial losses due to their investments in subprime mortgages, even
though Bear Stearns was not legally obligated to support those
funds.\7\ Shortly thereafter, the funds, filed for bankruptcy
protection.\8\
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\7\ See In re Bear Sterns High-Grade Structured Credit
Strategies Master Funds, Ltd., 374 B.R. 122 (Bankr. S.D.N.Y. 2007),
available at http://www.nysb.uscourts.gov/opinions/brl/158971_25_opinion.pdf.
\8\ See id.
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Although the Dodd-Frank Act was enacted in the wake of the 2008
financial crisis, the impact of cross-border activities on the health
and stability of U.S. companies and financial markets is not new. A
decade before the AIG and Lehman collapses, a Cayman Islands hedge fund
managed by Connecticut-based Long-Term Capital Management L.P.
(``LTCM'') nearly failed.\9\ The hedge fund had a swap book of more
than $1 trillion notional and only $4 billion in capital. The hedge
fund avoided collapse only after the Federal Reserve Bank of New York
intervened and supervised a financial rescue and reorganization by
creditors of the fund.\10\ While the fund was a Cayman Island
partnership, its default would have caused significant market
disruption in the United States.\11\
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\9\ See The President's Working Group on Financial Markets,
Hedge Funds, Leverage, and the Lessons of Long-Term Capital
Management (April 1999), available at http://www.treasury.gov/resource-center/fin-mkts/Documents/hedgfund.pdf.
\10\ See id. at 13.
\11\ See id. at 17.
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More recently, J.P. Morgan Chase & Co. (``J.P. Morgan''), the
largest U.S. bank, disclosed a multi-billion dollar trading loss
stemming in part from positions in a credit-related swap portfolio
managed through its London Chief Investment Office.\12\ The
relationship between the New York and London offices of J.P. Morgan
that were involved in the credit swaps that were the source of this
loss demonstrates the close integration among the various branches,
agencies, offices, subsidiaries and affiliates of U.S. financial
institutions, which may be located both inside and outside the United
States. Despite their geographic expanse, the branches, agencies,
offices, subsidiaries and affiliates of large U.S. financial
institutions in many cases effectively operate as a single
business.\13\
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\12\ See Sen. Permanent Subcomm. on Investigations, 113th Cong.,
Majority and Minority Staff Report, JPMorgan Chase Whale Trades: A
Case History of Derivatives Risks and Abuses (March 15, 2013),
available at http://www.levin.senate.gov/download/?id=bfb5cd04-41dc-4e2d-a5e1-ab2b81abfaa8-2560k. See also Dodd-Frank Statement (``[A]ny
suggestion that U.S. financial entities learned enough from AIG's
devastating misjudgments are [sic] undercut by the multi-billion
dollar loss incurred by a bank generally considered to be among the
most careful--J.P.Morgan Chase--in its London derivative
trading.'').
\13\ See Letter from Sen. Carl Levin, Chairman of the Permanent
Subcommittee on Investigations at 4 (Apr. 23, 2013) (``Letter from
Sen. Levin''), available at http://www.levin.senate.gov/download/levin_comment_letter_cftc_042313. See also Cross-Border
Application of Certain Swaps Provisions of the Commodity Exchange
Act, 77 FR 41214, 41216 (Jul. 12, 2012) (``Proposed Guidance'').
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Efforts to regulate the swaps market in the wake of the 2008
financial crisis are underway not only in the United States, but also
abroad. In 2009, leaders of the Group of 20 (``G20'')--whose membership
includes the European Union (``EU''), the United States, and 18 other
countries--agreed that: (i) OTC derivatives contracts should be
reported to trade repositories; (ii) all standardized OTC derivatives
contracts should be cleared through central counterparties and traded
on exchanges or electronic trading platforms, where appropriate, by the
end of 2012; and (iii) non-centrally cleared contracts should be
subject to higher capital requirements. In line with the G20
commitment, much progress has been made to coordinate and harmonize
international reform efforts, but the pace of reform varies among
jurisdictions and disparities in regulations remain due to differences
in cultures, legal and political traditions, and financial systems.\14\
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\14\ Legislatures and regulators in a number of foreign
jurisdictions are undertaking significant regulatory reforms over
the swaps market and its participants. See CFTC and SEC, Joint
Report on International Swap Regulation Required by Section 719(c)
of the Dodd-Frank Wall Street Reform and Consumer Protection Act at
13 (Jan. 31, 2012), available at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/dfstudy_isr_013112.pdf.
For example, the European Commission released a public
consultation on revising the Markets in Financial Instruments
Directive (``MiFID'') in December 2010. See ``European Commission
Public Consultation: Review of the Markets in Financial Instruments
Directive'' (Dec. 8, 2010), available at http://ec.europa.eu/internal_market/consultations/docs/2010/mifid/consultation_paper_en.pdf.
In October 2011, the European Commission released two public
consultations, one to revise MiFID and the other for creating a new
regulation entitled the Markets in Financial Instruments Regulation
(``MiFIR''). See European Commission, Proposal for a Directive of
the European Parliament and of the Council on markets in financial
instruments repealing Directive 2004/39/EC of the European
Parliament and of the Council, COM (2011) 656 final (Oct. 20, 2011),
available at http://ec.europa.eu/internal_market/securities/docs/isd/mifid/COM_2011_656_en.pdf; European Commission, Proposal for
a Regulation of the European Parliament and of the Council on
markets in financial instruments and amending regulation [EMIR] on
OTC derivatives, central counterparties and trade repositories, COM
(2011) 652 final (Oct. 20, 2011), available at http://ec.europa.eu/internal_market/securities/docs/isd/mifid/COM_2011_652_en.pdf.
As of March 15, 2013, the majority of the regulatory technical
standards (i.e., rulemakings) of the European Market Infrastructure
Regulation (``EMIR'') entered into force. The EMIR and the related
regulatory technical standards generally regard requirements for
clearinghouses, clearing, data repositories, regulatory reporting,
and uncleared OTC transactions. Certain technical standards under
EMIR have yet to be developed and completed. These standards regard
margin and capital for uncleared transactions and contracts that
have a ``direct, substantial and foreseeable effect within the
[European] Union.'' See EMIR Article 11(14)(e).
The Japanese legislature passed the Amendment to the Financial
Instruments and Exchange Act (``FIEA'') in May 2010. See Japan
Financial Services Agency, Outline of the bill for amendment of the
Financial Instruments and Exchange Act (May 2010), available at
http://www.fsa.go.jp/en/refer/diet/174/01.pdf.
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The failures of Lehman Brothers and the Bear Stearns hedge funds,
and the near failures of LTCM's hedge fund and AIG (which required
intervention by the government and Federal Reserve), and their
collateral effects on the broader economy and U.S. commerce,\15\
provide examples of how risks that a large financial institution takes
abroad in swap transactions or otherwise can result in or contribute to
substantial losses to U.S. persons and threaten the financial stability
of the entire U.S. financial system. These failures and near failures
revealed the vulnerability of the U.S. financial system and economy to
systemic risk resulting from, among other things, poor risk management
practices of certain financial firms, the lack of supervisory oversight
for certain financial institutions as a whole, and the overall
interconnectedness of the global swap business.\16\ These failures and
near failures demonstrate the need for and potential implications of
cross-border swaps regulation.
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\15\ On October 3, 2008, President Bush signed the Emergency
Economic Stabilization Act of 2008, which was principally designed
to allow the U.S. Treasury and other government agencies to take
action to restore liquidity and stability to the U.S. financial
system (e.g., the Troubled Asset Relief Program--also known as
TARP--under which the U.S. Treasury was authorized to purchase up to
$700 billion of troubled assets that weighed down the balance sheets
of U.S. financial institutions). See Public Law 110-343, 122 Stat.
3765 (2008).
\16\ See Financial Crisis Inquiry Commission, The Financial
Crisis Inquiry Report: Final Report of the National Commission on
the Causes of the Financial and Economic Crisis in the United States
at xvi-xxvii (Jan. 21, 2011), available at http://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
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B. The Proposed Guidance and Further Proposed Guidance
To address the scope of the cross-border application of the Dodd-
Frank Act, the Commission published the Proposed Guidance on July 12,
2012, setting forth its proposed interpretation of the manner in which
it intends that section 2(i) of the CEA would apply Title VII's swaps
provisions to cross-border activities.\17\ In view of the complex legal
and policy issues involved, the Commission published the Proposed
Guidance to solicit comments from all interested persons and to further
inform the Commission's deliberations. Specifically, the Proposed
Guidance addressed the general manner in which the Commission proposed
to consider: (1) When a non-U.S. person's swap dealing activities would
justify registration as a ``swap dealer,'' \18\ as further defined in a
joint release adopted by the Commission and the Securities and Exchange
Commission (``SEC''); \19\ (2) when a non-U.S. person's swaps positions
would justify registration as a ``major swap participant,'' \20\ as
further defined in the Final Entities Rules; and (3) how foreign
branches, agencies, affiliates, and subsidiaries of U.S. swap dealers
generally should be treated. The Proposed Guidance also generally
described the policy and procedural framework under which the
Commission would consider compliance with a comparable and
comprehensive regulatory requirement of a foreign jurisdiction as a
reasonable substitute for compliance with the attendant requirements of
the CEA. Last, the Proposed Guidance set forth the manner in which the
Commission proposed to interpret section 2(i) of the CEA as it would
generally apply to clearing, trading, and certain reporting
requirements under the Dodd-Frank Act with respect to swaps between
counterparties that are not swap dealers or MSPs.
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\17\ See Proposed Guidance, 77 FR 41214. Simultaneously with
publication of the Proposed Guidance, the Commission published a
proposed exemptive order providing time-limited relief from certain
cross-border applications of the swaps provisions of Title VII and
the Commission's regulations. See Proposed Exemptive Order Regarding
Compliance with Certain Swap Regulations, 77 FR 41110 (July 12,
2012) (``Proposed Order''). The Commission approved a final
exemptive order on December 21, 2012, which reflected certain
modifications and clarifications to the Proposed Order to address
public comments. See Final Exemptive Order Regarding Compliance with
Certain Swap Regulations, 78 FR 858 (Jan. 7, 2013) (``January
Order'').
\18\ See 7 U.S.C. 1a(49) (defining the term ``swap dealer'').
\19\ See Further Definition of `Swap Dealer,' `Security-Based
Swap Dealer,' `Major Swap Participant,' `Major Security-Based Swap
Participant' and `Eligible Contract Participant,' 77 FR 30596 (May
23, 2012) (``Final Entities Rules'').
\20\ See 7 U.S.C. 1a(33) (defining the term ``major swap
participant'').
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The public comment period on the Proposed Guidance ended on August
27, 2012. The Commission received approximately 290 comment letters on
the Proposed Guidance from a variety of interested parties, including
major U.S. and non-U.S. banks and financial institutions that conduct
global swap business, trade associations, clearing organizations, law
firms (representing international banks and dealers), public interest
organizations, and foreign regulators.\21\
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\21\ The Commission also received approximately 26 comment
letters on the Proposed Order. Because the Proposed Guidance and
Proposed Order were substantially interrelated, many commenters
submitted a single comment letter addressing both proposals. The
comment letters submitted in response to the Proposed Order and
Proposed Guidance may be found on the Commission's Web site at
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1234.
Approximately 200 individuals submitted substantially identical
letters to the effect that oversight of the $700 trillion global
derivatives market is the key to meaningful reform. The letters
state that because the market is inherently global, risks can be
transferred around the world with the touch of a button. Further,
according to these letters, loopholes in the Proposed Guidance could
allow foreign affiliates of Wall Street banks to escape regulation.
Lastly, the letters request that the Proposed Guidance be
strengthened to ensure that the Dodd-Frank derivatives protections
will directly apply to the full global activities of all important
participants in the U.S. derivatives markets.
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The Further Proposed Guidance, issued on December 21, 2012,\22\
reflected the Commission's determination that further consideration of
public comments regarding the Commission's proposed interpretation of
the term ``U.S. person,'' and its proposed guidance regarding
aggregation for purposes of swap dealer registration, would be helpful
to the Commission in issuing final interpretive guidance. In order to
facilitate the Commission's further consideration of these issues, in
the Further Proposed Guidance the Commission sought public comment on:
(1) An alternative interpretation of the aggregation requirement for
swap dealer registration in Commission regulation 1.3(ggg)(4); \23\ (2)
an alternative ``prong'' of the proposed interpretation of the term
``U.S. person'' in the Proposed Guidance which relates to U.S. owners
that are responsible for the liabilities of a non-U.S. entity; and (3)
a separate alternative prong of the proposed interpretation of the term
``U.S. person'' which relates to commodity pools and funds with
majority-U.S. ownership.
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\22\ See Further Proposed Guidance Regarding Compliance With
Certain Swap Regulations, 78 FR 909, 913 (Jan. 7, 2013) (``Further
Proposed Guidance'').
\23\ 17 CFR 1.3(ggg)(4). The Commission's regulations are
codified at 17 CFR Ch. I.
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The public comment period on the Further Proposed Guidance ended on
February 6, 2013. The Commission received approximately 24 comment
letters on the Further Proposed Guidance from interested parties
including major U.S. and non-U.S. banks and financial institutions,
trade associations, law firms (representing international banks and
dealers), public interest organizations, and foreign regulators.\24\
With respect to both the Proposed Guidance and the Further Proposed
Guidance and throughout the process of considering this Guidance,
[[Page 45296]]
the Commission (and Commission's staff) held numerous meetings and
discussions with various market participants, domestic bank regulators,
and other interested parties.\25\
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\24\ The comment letters submitted in response to the Further
Proposed Guidance are available on the Commission's Web site at
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1315.
\25\ The records of these meetings and communications are
available on the Commission's Web site at http://www.cftc.gov/LawRegulation/DoddFrankAct/Rulemakings/Cross-BorderApplicationofSwapsProvisions/index.htm.
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Further, the Commission's staff closely consulted with the staff of
the SEC in an effort to increase understanding of each other's
regulatory approaches and to harmonize the cross-border approaches of
the two agencies to the greatest extent possible, consistent with their
respective statutory mandates.\26\ The Commission is cognizant of the
value of harmonization by the Commission and the SEC of their cross-
border policies to the fullest extent possible. The staffs of the
Commission and the SEC have participated in numerous meetings to work
jointly toward this objective. The Commission expects that this
consultative process will continue as each agency works towards
implementing its respective cross-border policy.
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\26\ Sections 722 and 772 of the Dodd-Frank Act establish the
scope of the Commission's and SEC's jurisdiction over cross-border
swaps and security-based swaps, respectively. CEA section 2(i),
which was added by section 722 of the Dodd-Frank Act, is discussed
above. Section 30(c) of the Securities Exchange Act of 1934
(``Exchange Act''), which was added by section 772 of the Dodd-Frank
Act, provides that the swaps provisions of the Exchange Act added by
Title VII do not apply ``to any person insofar as such person
transacts a business in security-based swaps without the
jurisdiction of the United States, unless such person transacts such
business in contravention of such rules and regulations as the [SEC]
may prescribe as necessary or appropriate to prevent the evasion of
any provision [added by Title VII of the Dodd-Frank Act] . . . ''
See 15 U.S.C. 78dd(c).
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The SEC recently published for public comment proposed rules and
interpretive guidance to address the application of the provisions of
the Exchange Act, added by Subtitle B of Title VII of the Dodd-Frank
Act, that relate to cross-border security-based swap activities.\27\
The Commission has considered the SEC's cross-border proposal and has
taken it into account in the process of considering this Guidance. The
SEC's proposal acknowledges the statutory provisions and regulatory
precedents that are relevant to security-based swaps by virtue of the
fact that security-based swaps are securities.\28\ For example, the
SEC's proposed rules regarding registration of security-based swap
dealers build from the SEC's traditional approach to the registration
of brokers and dealers under the Exchange Act.\29\ The SEC's proposal
also notes the SEC's belief that Congress intended the territorial
application of Title VII to entities and transactions in the security-
based swaps market to follow similar principles to those applicable to
the securities market under the Exchange Act.\30\ The Commission
believes that one factor in harmonization of the two agencies'
approaches is that Congress did not express a similar intent that the
application of Title VII to entities and transactions in the swaps
market should follow principles that preceded the Dodd-Frank Act, but
rather mandated a new regulatory regime for swaps.\31\
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\27\ See Cross-Border Security-Based Swap Activities; Re-
Proposal of Regulation SBSR and Certain Rules and Forms Relating to
the Registration of Security-Based Swap Dealers and Major Security-
Based Swap Participants, 78 FR 30968 (May 23, 2013) (``SEC Cross-
Border Proposal'').
\28\ The SEC Cross-Border Proposal notes that the definition of
``security'' in the Exchange Act includes security-based swaps,
which raises issues related to the statutory definitions of
``broker'' and ``dealer,'' the statutory exchange registration
requirement, and other statutory requirements related to securities.
Id. at 30972.
\29\ Id. at 30990.
\30\ Id. at 30983-84.
\31\ One commenter expressed the view that the SEC's proposed
rule is entirely inapplicable to the CFTC's statutory mandate to
regulate the risks from cross border derivatives trading and related
activities. This commenter stated that the SEC was given very
limited statutory authority in the Dodd-Frank Act related solely to
anti-evasion, in contrast to the Commission, which was given the
same anti-evasion authority plus an affirmative statutory mandate to
regulate cross-border derivative activities that ``have a direct an
significant connection with activities in, or effect on, commerce of
the United States.'' This commenter further stated that a broader
statutory mandate makes sense because the Commission ``has decades
of expertise and jurisdiction for virtually the entire derivatives
markets,'' whereas the SEC has ``jurisdiction for no more than 3.5
percent of those markets.'' See Better Markets Inc. (``Better
Markets'') (Jun. 24, 2013) at 2.
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The Commission also recognizes the critical role of international
cooperation and coordination in the regulation of derivatives in the
highly interconnected global market, where risks are transmitted across
national borders and market participants operate in multiple
jurisdictions. Close cooperative relationships and coordination with
other jurisdictions take on even greater importance given that, prior
to the recent reforms, the swaps market has largely operated without
regulatory oversight, and given that many jurisdictions are in
differing stages of implementing their regulatory reform. To this end,
the Commission's staff has actively engaged in discussions with their
foreign counterparts in an effort to better understand and develop a
more harmonized cross-border regulatory framework. The Commission
expects that these discussions will continue as it implements the
cross-border interpretive guidance and as other jurisdictions develop
their own regulatory approaches to derivatives.\32\
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\32\ This is one aspect of the Commission's on-going bilateral
and multilateral efforts to promote international coordination of
regulatory reform. The Commission's staff is engaged in
consultations with Europe, Japan, Hong Kong, Singapore, Switzerland,
Canada, Australia, Brazil, and Mexico on derivatives reform. In
addition, the Commission's staff is participating in several
standard-setting initiatives, co-chairs the IOSCO Task Force on OTC
Derivatives, and has created an informal working group of
derivatives regulators to discuss implementation of derivatives
reform. See also Joint Press Statement of Leaders on Operating
Principles and Areas of Exploration in the Regulation of the Cross-
border OTC Derivatives Market, published as CFTC Press Release 6439-
12, Dec. 4, 2012, available at http://www.cftc.gov/PressRoom/PressReleases/pr6439-12; OTC Derivatives Regulators Group Report to
the G-20 Meeting of Finance Ministers and Central Bank Governors of
18-19 April 2013, linked to CFTC Press Release ODRG Report to G-20,
Apr. 16, 2013, available at http://www.cftc.gov/PressRoom/PressReleases/odrg_reporttog20release.
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In general, many of the financial institutions and law firms
(representing financial institutions) that commented on the Proposed
Guidance and Further Proposed Guidance stated that the Commission's
proposed interpretation of the extraterritorial application of Title
VII of the Dodd-Frank Act was overly broad and unnecessarily complex
and unclear.\33\ Among the issues they raised were concerns relating to
the interpretation of the term ``U.S. person,'' aggregation for
purposes of swap dealer registration, lack of parity in the treatment
of foreign branches and affiliates of U.S. persons, the approach to
guaranteed non-U.S. affiliates and non-U.S. affiliate ``conduits,'' and
the ``comparability'' assessment for purposes of substituted
compliance. The commenters also urged the Commission to allow
sufficient time after the publication of the final interpretive
guidance for market participants to understand and implement any new
policies of the Commission, before the Commission begins to apply such
policies.
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\33\ See, e.g., Securities Industry and Financial Markets
Association (``SIFMA'') (Aug. 27, 2012); Institute of International
Bankers (``IIB'') (Aug. 27, 2012); Sullivan & Cromwell, on behalf of
Bank of America Corp., Citi, and J.P. Morgan (``Sullivan &
Cromwell'') (Aug. 13, 2012); Bank of America Merrill Lynch, Barclays
Capital, and PNB Paribas et al., submitted by Cleary Gottlieb Steen
& Hamilton LLP (``Cleary'') (Aug. 16, 2012).
---------------------------------------------------------------------------
Other commenters disagreed that the Commission's proposed
interpretation of its extraterritorial authority was overly broad,
instead arguing that the Commission had not gone far enough.\34\
[[Page 45297]]
For example, AFR stated that the Proposed Guidance ``takes some real
positive steps in affirming CFTC jurisdiction over a variety of cross-
border transactions,'' but ``falls well short of closing potential
cross-border loopholes.'' \35\ Senator Levin wrote that although
``members of the financial industry have filed comment letters urging
the CFTC to weaken its proposals . . . American families and businesses
deserve strong protections against the risks posed by derivatives
trading, including from cross-border swaps, and . . . the Proposed
Guidance should be strengthened rather than weakened.'' \36\
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\34\ See, e.g., Americans for Financial Reform, submitted by
Marcus Stanley (``AFR'') (Aug. 27, 2012); Better Markets (Aug. 16,
2012); Michael Greenberger, Francis King Cary School of Law,
University of Maryland (``Greenberger'') (Aug. 13, 2012).
\35\ AFR (Aug. 27, 2012) at 2.
\36\ Letter from Sen. Levin at 3.
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II. Scope of This Guidance
After carefully reviewing and considering the comments on the
Proposed Guidance and the Further Proposed Guidance, the Commission has
determined to finalize the Proposed Guidance. This Guidance sets forth
the general policy of the Commission in interpreting how section 2(i)
of the CEA provides for the application of the swaps provisions of the
CEA and Commission regulations to cross-border activities when such
activities have a ``direct and significant connection with activities
in, or effect on, commerce of the United States'' or when they
contravene Commission rulemaking.\37\ Unlike a binding rule adopted by
the Commission, which would state with precision when particular
requirements do and do not apply to particular situations, this
Guidance is a statement of the Commission's general policy regarding
cross-border swap activities \38\ and allows for flexibility in
application to various situations, including consideration of all
relevant facts and circumstances that are not explicitly discussed in
the guidance. The Commission believes that the statement of its policy
in this Guidance will assist market participants in understanding how
the Commission intends that the registration and certain other
substantive requirements of the Dodd-Frank Act generally would apply to
their cross-border activities.\39\
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\37\ See 7 U.S.C. 2(i).
\38\ The Commission notes that part 23 of its regulations
defines ``swaps activities'' to mean, ``with respect to a
[registered swap dealer or MSP], such registrant's activities
related to swaps and any product used to hedge such swaps,
including, but not limited to, futures, options, other swaps or
security-based swaps, debt or equity securities, foreign currency,
physical commodities, and other derivatives.'' See 17 CFR 23.200(j);
23.600(a)(7).
\39\ In this regard, the Commission notes that it would consider
codifying certain aspects of the Guidance in future rulemakings, as
appropriate; but at this time, this guidance is intended to provide
an efficient and flexible vehicle to communicate the agency's
current views on how the Dodd-Frank swap requirements would apply on
a cross-border basis.
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This release is intended to inform the public of the Commission's
views on how it ordinarily expects to apply existing law and
regulations in the cross-border context. In determining the application
of the CEA and Commission regulations to particular entities and
transactions in cross-border contexts, the Commission will apply the
relevant statutory provisions, including CEA section 2(i), and
regulations to the particular facts and circumstances. Accordingly, the
public has the ability to present facts and circumstances that would
inform the application of the substantive policy positions set forth in
this release.
The Commission understands the complex and dynamic nature of the
global swap market and the need to take an adaptable approach to cross-
border issues, particularly as it continues to work closely with
foreign regulators to address potential conflicts with respect to each
country's respective regulatory regime. Although the Commission is
issuing the Guidance at this time, the Commission will continue to
follow developments as foreign regulatory regimes and the global swaps
market continue to evolve. In this regard, the Commission will
periodically review this Guidance in light of future developments.
This release is organized into four main sections. Section III sets
forth the Commission's interpretation of CEA section 2(i) and the
general manner in which it intends to apply the swaps provisions of the
Dodd-Frank Act to activities outside the United States. Section IV
addresses the public comments and Commission Guidance on: (A) The
Commission's interpretation of the term ``U.S. person''; (B) swap
dealer and MSP registration; (C) the scope of the term ``foreign
branch'' of a U.S. bank and consideration of when a swap should be
considered to be with the foreign branch of a U.S. bank; (D) a
description of the entity-level requirements and transaction-level
requirements under Title VII and the Commission's related regulations
(``Entity-Level Requirements'' and ``Transaction-Level Requirements,''
respectively); (E) the categorization of Title VII swaps provisions
(and Commission regulations) as either Entity-Level or Transaction-
Level Requirements; (F) substituted compliance, including an overview
of the principles guiding substituted compliance determinations for
Entity-Level and Transaction-Level Requirements, a general description
of the process for comparability determinations, and a discussion of
conflicts arising under foreign privacy and blocking laws; (G)
application of the Entity-Level Requirements and ``Category A'' and
``Category B'' Transaction-Level Requirements to swap dealers and MSPs;
and (H) application of the CEA's swaps provisions and Commission
regulations where both parties to a swap are neither swap dealers nor
MSPs.\40\
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\40\ Certain provisions of Title VII apply regardless of whether
a swap dealer or MSP is a counterparty to the swap. These provisions
include the clearing requirement (7 U.S.C. 2(h)(1)), the trade
execution requirement (2(h)(8)), reporting to SDRs (2(a)(13)(G)),
and real-time public reporting (2(a)(13)).
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In addition, this Guidance includes the following Appendices, which
should be read in conjunction with (and are qualified by) the remainder
of the Guidance: (1) Appendix A--The Entity-Level Requirements; (2)
Appendix B--The Transaction-Level Requirements: (3) Appendix C--
Application of the Entity-Level Requirements; (4) Appendix D--
Application of the Category A Transaction-Level Requirements to Swap
Dealers and MSPs; (5) Appendix E--Application of the Category B
Transaction-Level Requirements to Swap Dealers and MSPs; and (6)
Appendix F--Application of Certain Entity-Level and Transaction-Level
Requirements to Non-Swap Dealer/Non-MSP Market Participants.
III. Interpretation of Section 2(i)
CEA section 2(i) provides that the swaps provisions of Title VII
shall not apply to activities outside the United States unless those
activities--
Have a direct and significant connection with activities
in, or effect on, commerce of the United States; or
contravene such rules or regulations as the Commission may
prescribe or promulgate as are necessary or appropriate to prevent the
evasion of any provision of [the CEA] that was enacted by the [Dodd-
Frank Act].
In the Proposed Guidance, the Commission noted that section 2(i)
provides the Commission express authority over swap activities outside
the United States when certain conditions are met, but it does not
require the Commission to extend its reach to the outer bounds of that
authorization. Rather, in exercising its authority with respect to swap
activities outside the United States, the Commission will be guided by
international comity principles.
[[Page 45298]]
A. Comments
Some commenters addressing the interpretation of section 2(i) in
the Proposed Guidance stated that the activities of the non-U.S.
branches and subsidiaries of U.S. persons outside the United States
with respect to swaps with non-U.S. persons should not be subject to
Dodd-Frank requirements. Sullivan & Cromwell asserted that the non-U.S.
branches and subsidiaries generally do not enter into swaps with U.S.
persons and therefore the jurisdictional nexus with the United States
that would justify application of the Dodd-Frank Act is absent.\41\
Sullivan & Cromwell stated that there are legitimate business reasons
for U.S. persons to establish non-U.S. branches and subsidiaries, so
doing so should not be interpreted to mean that the U.S. person is
using the branch to evade application of the Dodd-Frank Act.\42\
Sullivan & Cromwell argued that the Dodd-Frank Act's application
outside the United States should be narrowly construed because it
includes only specific exceptions to the judicial precedent that U.S.
laws should be interpreted to apply outside the United States only when
such application is clearly expressed in the law.\43\ Similarly, SIFMA
argued that the Commission's proposal asserted a broad jurisdictional
scope that is inconsistent with the congressional intent expressed in
section 2(i) of the CEA.\44\
---------------------------------------------------------------------------
\41\ Sullivan & Cromwell (Aug. 13, 2012) at 6-7.
\42\ Id. at 8.
\43\ Id. at 9.
\44\ SIFMA (Aug. 27, 2012) at 2.
---------------------------------------------------------------------------
Sullivan & Cromwell cited past instances where the Commission has
not applied its regulations to firms that deal solely with foreign
customers and do not conduct business in or from the United States or
to the non-U.S. subsidiaries of entities registered with the
Commission.\45\ Sullivan & Cromwell and SIFMA stated that the
application of Dodd-Frank requirements to non-U.S. swap activities
would be contrary to principles of international comity and cooperation
with foreign regulators, would lead to less efficient use of regulatory
resources, and would subject the affected entities to potentially
conflicting regulations and increased costs of compliance.\46\ SIFMA
asserted that the jurisdictional scope in the Commission's proposal is
not necessary to prevent evasive activity, because the Commission
already has broad authority to address evasion.\47\ Sullivan & Cromwell
and SIFMA also argued that imposing the Dodd-Frank requirements on non-
U.S. branches and subsidiaries of U.S. persons would put those entities
at a disadvantage compared to competitors in foreign jurisdictions,
while other federal laws and banking regulations (such as the Edge Act
\48\) indicate that Congress wishes to promote such entities' ability
to compete in foreign jurisdictions.\49\
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\45\ Sullivan & Cromwell (Aug. 13, 2012) at 10.
\46\ Id. at 11; SIFMA (Aug. 27, 2012) at 3 and A55.
\47\ SIFMA (Aug. 27, 2012) at 3.
\48\ 12 U.S.C. 611-31.
\49\ Id.; Sullivan & Cromwell (Aug. 13, 2012) at 12-14.
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By contrast, Senator Levin stated that the J.P. Morgan ``whale
trades'' provide an example of how major U.S. financial institutions
have integrated their U.S. and non-U.S. swap activities, and therefore
supports the application of the swaps provisions of Title VII and
Commission regulations to the non-U.S. offices of U.S. financial
institutions.\50\ He explained that a Senate investigation found that
J.P. Morgan personnel in London executed the ``whale trades'' using
money from the U.S. bank's excess deposits, and while traders in London
conducted the trades, the trades were attributed to a U.S. affiliate of
J.P. Morgan through back-to-back arrangements between the London branch
and New York branch.\51\ He also stated the whale trades were entered
into with counterparties including major U.S. banks and J.P. Morgan's
own investment bank.\52\ Senator Levin concluded that because of the
integration of U.S. and non-U.S. offices and affiliates of U.S.
financial institutions, it is critical that the non-U.S. offices and
affiliates of U.S. financial institutions follow the same Dodd-Frank
requirements as are applicable to the U.S. financial institutions.\53\
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\50\ Letter from Sen. Levin at 4.
\51\ Id.
\52\ Id.
\53\ Id. at 7. See also Dodd-Frank Statement (``An exemption for
foreign derivatives activity by the [ ] affiliates of American
institutions is a free pass no matter where that activity is
located.'').
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B. Statutory Analysis
In interpreting the phrase ``direct and significant,'' the
Commission has examined the plain language of the statutory provision,
similar language in other statutes with cross-border application, and
the legislative history of section 2(i).
The statutory language in new CEA section 2(i) is structured
similarly to the statutory language in the Foreign Trade Antitrust
Improvements Act of 1982 (the ``FTAIA''),\54\ which provides the
standard for the cross-border application of the Sherman Antitrust
Act.\55\ The FTAIA, like CEA section 2(i), excludes certain non-U.S.
commercial transactions from the reach of U.S. law. It provides that
the antitrust provisions of the Sherman Act ``shall not apply to [anti-
competitive] conduct involving trade or commerce . . . with foreign
nations.'' \56\ However, like paragraph (1) of CEA section 2(i), the
FTAIA also creates exceptions to the general exclusionary rule and thus
brings back within antitrust coverage any conduct that: (1) has a
``direct, substantial, and reasonably foreseeable effect'' on U.S.
commerce; \57\ and (2) ``such effect gives rise to a [Sherman Act]
claim.'' \58\ In F. Hoffman-LaRoche, Ltd. v. Empagran S.A., the Supreme
Court stated that ``this technical language initially lays down a
general rule placing all (nonimport) activity involving foreign
commerce outside the Sherman Act's reach. It then brings such conduct
back within the Sherman Act's reach provided that the conduct both (1)
sufficiently affects American commerce, i.e., it has a `direct,
substantial, and reasonably foreseeable effect' on American domestic,
import, or (certain) export commerce, and (2) has an effect of a kind
that antitrust law considers harmful, i.e., the `effect' must `giv[e]
rise to a [Sherman Act] claim.' '' \59\
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\54\ 15 U.S.C. 6a.
\55\ 15 U.S.C. 1-7.
\56\ 15 U.S.C. 6a.
\57\ 6a(1).
\58\ 6a(2).
\59\ 542 U.S. 155, 162 (2004) (emphasis in original).
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It is appropriate, therefore, to read section 2(i) of the CEA as a
clear expression of congressional intent that the swaps provisions of
Title VII of the Dodd-Frank Act apply to activities beyond the borders
of the United States when certain circumstances are present. These
circumstances include, pursuant to paragraph (1) of section 2(i), when
activities outside the United States meet the statutory test of having
a ``direct and significant connection with activities in, or effect
on,'' U.S. commerce.
An examination of the language in the FTAIA, however, does not
provide an unambiguous roadmap for the Commission in interpreting
section 2(i) of the CEA. There are both similarities, and a number of
significant differences, between the language in CEA section 2(i) and
the language in the FTAIA. Further, the Supreme Court has not provided
definitive guidance as to the meaning of the ``direct, substantial, and
reasonably foreseeable'' test in the FTAIA, and the lower courts have
interpreted the individual terms in the FTAIA differently.
Although a number of courts have interpreted the various terms in
the
[[Page 45299]]
FTAIA, only the term ``direct'' appears in both CEA section 2(i) and
the FTAIA. Relying upon the Supreme Court's definition of the term
``direct'' in the Foreign Sovereign Immunities Act (``FSIA''),\60\ the
U.S. Court of Appeals for the Ninth Circuit construed the term
``direct'' in the FTAIA as requiring a ``relationship of logical
causation,'' \61\ such that ``an effect is `direct' if it follows as an
immediate consequence of the defendant's activity.'' \62\ However, in
an en banc decision, the U.S. Court of Appeals for the Seventh Circuit
held that ``the Ninth Circuit jumped too quickly on the assumption that
the FSIA and the FTAIA use the word `direct' in the same way.'' \63\
After examining the text of the FTAIA as well as its history and
purpose, the Seventh Circuit found persuasive the ``other school of
thought [that] has been articulated by the Department of Justice's
Antitrust Division, which takes the position that, for FTAIA purposes,
the term `direct' means only `a reasonably proximate causal nexus.' ''
\64\ The Seventh Circuit rejected interpretations of the term
``direct'' that included any requirement that the consequences be
foreseeable, substantial, or immediate.\65\
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\60\ See 28 U.S.C. 1605(a)(2).
\61\ United States v. LSL Biotechnologies, 379 F.3d 672, 693
(9th Cir. 2004). ``As a threshold matter, many courts have debated
whether the FTAIA established a new jurisdictional standard or
merely codified the standard applied in [United States v. Aluminum
Co. of Am., 148 F.2d 416 (2d Cir. 1945)] and its progeny. Several
courts have raised this question without answering it. The Supreme
Court did as much in [Harford Fire Ins. Co. v. California, 509 U.S.
764 (1993)].'' Id. at 678.
\62\ Id. at 692-3, quoting Republic of Argentina v. Weltover,
Inc., 504 U.S. 607, 618 (1992) (providing that, pursuant to the
FSIA, 28 U.S.C. 1605(a)(2), immunity does not extend to commercial
conduct outside the United States that ``causes a direct effect in
the United States'').
\63\ Minn-Chem, Inc. v. Agrium, Inc., 683 F.3d 845, 857 (7th
Cir. 2012) (en banc).
\64\ Id.
\65\ Id. at 856-57.
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Other terms in the FTAIA differ from the terms used in section 2(i)
of the CEA. First, the FTAIA test explicitly requires that the effect
on U.S. commerce be a ``reasonably foreseeable'' result of the
conduct.\66\ Section 2(i) of the CEA, by contrast, does not provide
that the effect on U.S. commerce must be foreseeable. Second, whereas
the FTAIA solely relies on the ``effects'' on U.S. commerce to
determine cross-border application of the Sherman Act, section 2(i) of
the CEA refers to both ``effect'' and ``connection.'' ``The FTAIA says
that the Sherman Act applies to foreign `conduct' with a certain kind
of harmful domestic effect.'' \67\ Section 2(i), by contrast, applies
more broadly--not only to particular instances of conduct that have an
effect on U.S. commerce, but also to activities that have a direct and
significant ``connection with activities in'' U.S. commerce. Unlike the
FTAIA, section 2(i) applies the swaps provisions of the CEA to
activities outside the United States that have the requisite connection
with activities in U.S. commerce, regardless of whether a ``harmful
domestic effect'' has occurred.
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\66\ See, e.g., Animal Sciences Products. v. China Minmetals
Corp., 654 F.3d 462, 471 (3d Cir. 2011) (``[T]he FTAIA's `reasonably
foreseeable' language imposes an objective standard: the requisite
`direct' and `substantial' effect must have been `foreseeable' to an
objectively reasonable person.'').
\67\ Hoffman-LaRoche, 452 U.S. at 173.
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As the foregoing textual analysis indicates, Congress crafted
section 2(i) differently from its analogue in the antitrust laws.
Congress delineated the cross-border scope of the Sherman Act in
section 6a of the FTAIA as applying to conduct that has a ``direct''
and ``substantial'' and ``reasonably foreseeable'' ``effect'' on U.S.
commerce. In section 2(i), on the other hand, Congress did not include
a requirement that the effects or connections of the activities outside
the United States be ``reasonably foreseeable'' for the Dodd-Frank
swaps provisions to apply. Further, Congress included language in
section 2(i) to apply the Dodd-Frank swaps provisions in circumstances
in which there is a direct and significant connection with activities
in U.S. commerce, regardless of whether there is an effect on U.S.
commerce. The different words that Congress used in paragraph (1) of
section 2(i), as compared to its closest statutory analogue in section
6a of the FTAIA, inform the Commission in construing the boundaries of
its cross-border authority over swap activities under the CEA.\68\
Accordingly, the Commission believes it is appropriate to interpret
section 2(i) such that it applies to activities outside the United
States in circumstances in addition to those that would be reached
under the FTAIA standard.
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\68\ The provision that ultimately became section 722(d) of the
Dodd-Frank Act was added during consideration of the legislation in
the House of Representatives. See 155 Cong. Rec. H14685 (Dec. 10,
2009). The version of what became Title VII that was reported by the
House Agriculture Committee and the House Financial Services
Committee did not include any provision addressing cross-border
application. See 155 Cong. Rec. H14549 (Dec. 10, 2009). The
Commission finds it significant that, in adding the cross-border
provision before final passage, the House did so in terms that, as
discussed in text, were different from, and broader than, the terms
used in the analogous provision of the FTAIA.
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As further described in the Proposed Guidance, one of the principal
rationales for the enactment of the Dodd-Frank derivatives reforms was
the need for a comprehensive scheme of regulation to prevent systemic
risk in the U.S. financial system.\69\ More particularly, a primary
purpose of Title VII of the Dodd-Frank Act is to address risk to the
U.S. financial system created by interconnections in the swaps
market.\70\ Title VII of the Dodd-Frank Act gave the Commission new and
broad authority to regulate the swaps market to address and mitigate
risks arising from swap activities that in the future could cause a
financial crisis.
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\69\ See Proposed Guidance, 77 FR at 41215-41216.
\70\ Cf. 156 Cong. Rec. S5818 (July 14, 2010) (statement of Sen.
Lincoln) (``In 2008, our Nation's economy was on the brink of
collapse. America was being held captive by a financial system that
was so interconnected, so large, and so irresponsible that our
economy and our way of life were about to be destroyed.''),
available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-14/pdf/CREC-2010-07-14.pdf; 156 Cong. Rec. S5888 (July 15, 2010) (statement of
Sen. Shaheen) (``We need to put in place reforms to stop Wall Street
firms from growing so big and so interconnected that they can
threaten our entire economy.''), available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf; 156 Cong.
Rec. S5905 (July 15, 2010) (statement of Sen. Stabenow) (``For too
long the over-the-counter derivatives market has been unregulated,
transferring risk between firms and creating a web of fragility in a
system where entities became too interconnected to fail.''),
available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf.
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In global markets, the source of such risk is not confined to
activities within U.S. borders. Due to the interconnectedness between
firms, traders, and markets in the U.S. and abroad, a firm's failure,
or trading losses overseas, can quickly spill over to the United States
and affect activities in U.S. commerce and the stability of the U.S.
financial system. Accordingly, Congress did not limit the application
of the Dodd-Frank Act to activities within the United States. Rather,
in recognition of the global nature of the swaps market, and the fact
that risks to the U.S. financial system may arise from activities
outside the United States, as well as from activities within the United
States, Congress explicitly provided for cross-border application of
Title VII to activities outside the United States that pose risks to
the U.S. financial system.\71\
[[Page 45300]]
Therefore, upon consideration of the statutory language, as well as the
prophylactic purpose of the CEA and the amendments made to it by Title
VII, the Commission construes section 2(i) to apply the swaps
provisions of the CEA to activities outside the United States that have
either: (1) A direct and significant effect on U.S. commerce; or, in
the alternative, (2) a direct and significant connection with
activities in U.S. commerce, and through such connection present the
type of risks to the U.S. financial system and markets that Title VII
directed the Commission to address. The Commission interprets section
2(i) in a manner consistent with the overall goals of the Dodd-Frank
Act to reduce risks to the U.S. financial system and avoid future
financial crises.\72\
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\71\ The legislative history of the Dodd-Frank Act shows that in
the fall of 2009, neither the Over-the-Counter Derivatives Markets
Act of 2009, H.R. 3795, 111th Cong. (1st Sess. 2009), reported by
the Financial Services Committee chaired by Rep. Barney Frank, nor
the Derivatives Markets Transparency and Accountability Act of 2009,
H.R. 977, 111th Cong. (1st Sess. 2009), reported by the Agriculture
Committee chaired by Rep. Collin Peterson, included a general
territoriality limitation that would have restricted Commission
regulation of transactions between two foreign persons located
outside of the United States. During the House Financial Services
Committee markup on October 14, 2009, Rep. Spencer Bachus offered an
amendment that would have restricted the jurisdiction of the
Commission over swaps between non-U.S. resident persons transacted
without the use of the mails or any other means or instrumentality
of interstate commerce. Chairman Frank opposed the amendment, noting
that there may well be cases where non-U.S. residents are engaging
in transactions that have an effect on the United States and that
are insufficiently regulated internationally and that he would not
want to prevent U.S. regulators from stepping in. Chairman Frank
expressed his commitment to work with Rep. Bachus going forward, and
Rep. Bachus withdrew the amendment. See H. Fin. Serv. Comm. Mark Up
on Discussion Draft of the Over-the-Counter Derivatives Markets Act
of 2009, 111th Cong., 1st Sess. (Oct. 14, 2009) (statements of Rep.
Bachus and Rep. Frank), available at http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=231922.
\72\ The Commission also notes that the Supreme Court has
indicated that the FTAIA may be interpreted more broadly when the
government is seeking to protect the public from anticompetitive
conduct than when a private plaintiff brings suit. See Hoffman-
LaRoche, 452 U.S. at 170 (``A Government plaintiff, unlike a private
plaintiff, must seek to obtain the relief necessary to protect the
public from further anticompetitive conduct and to redress
anticompetitive harm. And a Government plaintiff has legal authority
broad enough to allow it to carry out its mission.'').
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Consistent with this overall interpretation, the Commission
believes that the term ``direct'' in CEA section 2(i) should be
interpreted in a manner consistent with the position of the Department
of Justice Antitrust Division with respect to the meaning of the same
term in the FTAIA, and as recently adopted by the Seventh Circuit.\73\
The Commission therefore interprets the term ``direct'' in section 2(i)
so as to require ``a reasonably proximate causal nexus'' and not to
require foreseeability, substantiality, or immediacy.\74\
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\73\ See note 63 and accompanying text, supra.
\74\ The Seventh Circuit's rationale for rejecting the Ninth
Circuit's interpretation applies with at least equal, if not
greater, force to the interpretation of the word ``direct'' in
section 2(i) of the CEA. As discussed in note 68 and the
accompanying text, supra, Congress expressly declined to import the
FTAIA standards of substantiality, immediacy, or foreseeability into
section 2(i). The Commission believes that the terms included in
section 2(i) that are the same as the terms in the FTAIA should be
interpreted in a manner consistent with Congress's determination to
not import other, different standards from the FTAIA into section
2(i). Where Congress has included in a new statute one term but not
another from an existing statute, it is reasonable to conclude that
Congress did not want the other existing standards included in the
new statute.
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Consistent with the purpose of Title VII to protect the U.S.
financial system against the build-up of systemic risks, the Commission
does not read section 2(i) so as to require a transaction-by-
transaction determination that a specific swap outside the United
States has a ``direct and significant connection with activities in, or
effect on, commerce of the United States'' in order to apply the swaps
provisions of the CEA to such transactions. Rather, it is the
connection of swap activities, viewed as a class or in the aggregate,
to activities in commerce of the United States that must be assessed to
determine whether application of the CEA swaps provisions is
warranted.\75\
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\75\ The Commission believes this interpretation is supported by
Congress's use of the plural term ``activities'' in CEA section
2(i), rather than the singular term ``activity.'' The Commission
believes it is reasonable to interpret the use of the plural term
``activities'' in section 2(i) to require not that each particular
activity have the requisite connection with U.S. commerce, but
rather that such activities in the aggregate, or a class of
activity, have the requisite nexus with U.S. commerce. This
interpretation is consistent with the overall objectives of Title
VII, as described above. Further, the Commission believes that a
swap-by-swap approach to jurisdiction would be ``too complex to
prove workable.'' See Hoffman-LaRoche, 542 U.S. at 168.
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This conclusion is bolstered by similar interpretations of other
federal statutes regulating interstate commerce. Recently, the Supreme
Court reaffirmed a similar ``aggregate effects'' approach in Nat'l
Fed'n of Indep. Bus. v. Sebelius.\76\ In that case, the Court phrased
the holding in the seminal ``aggregate effects'' decision, Wickard v.
Filburn,\77\ in this way: ``[The farmer's] decision, when considered in
the aggregate along with similar decisions of others, would have had a
substantial effect on the interstate market for wheat.'' \78\ In
another recent case, Gonzales v Raich,\79\ the Court adopted similar
reasoning to uphold the application of the Controlled Substance Act
\80\ to prohibit the intrastate use of medical marijuana for medicinal
purposes. In Raich, the Court held that Congress could regulate purely
intrastate activity if the failure to do so would ``leave a gaping
hole'' in the federal regulatory structure. These cases support the
Commission's cross-border authority over swap activities that as a
class, or in the aggregate, have a direct and significant connection
with activities in, or effect on, U.S. commerce--whether or not an
individual swap may satisfy the statutory standard.\81\
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\76\ 132 S. Ct. 2566 (2012).
\77\ 317 U.S. 111 (1942).
\78\ 132 S. Ct. 2566, 2588 (2012). At issue in Wickard was the
regulation of a farmer's production and use of wheat even though the
wheat was ``not intended in any part for commerce but wholly for
consumption on the farm.'' 317 U.S. at 118. The Supreme Court upheld
the application of the regulation, stating that although the
farmer's ``own contribution to the demand for wheat may be trivial
by itself,'' the federal regulation could be applied when his
contribution ``taken together with that of many others similarly
situated, is far from trivial.'' Id. at 128-29. The Court also
stated it had ``no doubt that Congress may properly have considered
that wheat consumed on the farm where grown, if wholly outside the
scheme of regulation, would have a substantial effect in defeating
and obstructing its purpose . . . .'' Id.
\79\ 545 U.S. 1 (2005).
\80\ 21 U.S.C. 801 et seq.
\81\ In Sebelius, the Court stated, ``Where the class of
activities is regulated, and that class is within the reach of
federal power, the courts have no power to excise, as trivial,
individual instances of the class.'' 132 S. Ct. at 2587 (quoting
Perez v. United States, 402 U.S. 146, 154 (1971).
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C. Principles of International Comity
The case law in the antitrust area also teaches the importance of
recognizing the laws and interests of other countries in applying an
ambiguous federal statute across borders; in such circumstances,
principles of international comity counsel courts and agencies to act
reasonably in exercising jurisdiction with respect to activity that
takes place elsewhere. In Hoffman-LaRoche, an antitrust class action
lawsuit alleging an international price-fixing conspiracy by foreign
and domestic vitamin manufacturers and distributors, the Supreme Court
held that ambiguous statutes should be construed to ``avoid
unreasonable interference with the sovereign authority of other
nations.'' \82\ The Court explained that this rule of construction
``reflects customary principles of international law'' and ``helps the
potentially conflicting laws of different nations work together in
harmony--a harmony particularly needed in today's highly interdependent
commercial world.'' \83\
---------------------------------------------------------------------------
\82\ 542 U.S. at 164.
\83\ Id. at 165.
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In determining whether the exercise of jurisdiction by one nation
over activities in another nation would be reasonable, the courts and
agencies are guided by the Restatement (Third) of Foreign Relations Law
of the United States (the ``Restatement''). Drawing upon traditional
principles of international law, the Restatement provides bases of
jurisdiction to prescribe law, as well as limitations on the exercise
of jurisdiction. In addition
[[Page 45301]]
to recognizing territoriality and nationality as bases for
jurisdiction, the Restatement expressly provides that a country has
jurisdiction to prescribe law with respect to ``conduct outside its
territory that has or is intended to have substantial effect within its
territory.'' \84\
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\84\ See Restatement sec. 402(1)(c). A comment to the
Restatement also identifies jurisdiction with respect to activity
outside the country, but having or intended to have substantial
effect within the country's territory, as an aspect of jurisdiction
based on territoriality. See Restatement sec. 402 cmt. d.
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The Restatement also provides that even where a country has a basis
for jurisdiction, it should not prescribe law with respect to a person
or activity in another country when the exercise of such jurisdiction
is unreasonable.\85\ The reasonableness of such an exercise of
jurisdiction, in turn, is to be determined by evaluating all relevant
factors, including certain specifically enumerated factors where
appropriate:
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\85\ Restatement sec. 403(1).
(a) the link of the activity to the territory of the regulating
state, i.e., the extent to which the activity takes place within the
territory, or has substantial, direct, and foreseeable effect upon
or in the territory;
(b) the connections, such as nationality, residence, or economic
activity, between the regulating state and the persons principally
responsible for the activity to be regulated, or between that state
and those whom the regulation is designed to protect;
(c) the character of the activity to be regulated, the
importance of regulation to the regulating state, the extent to
which other states regulate such activities, and the degree to which
the desirability of such regulation is generally accepted;
(d) the existence of justified expectations that might be
protected or hurt by the regulation;
(e) the importance of the regulation to the international
political, legal, or economic system;
(f) the extent to which the regulation is consistent with the
traditions of the international system;
(g) the extent to which another state may have an interest in
regulating the activity; and
(h) the likelihood of conflict with regulation by another
state.\86\
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\86\ Restatement sec. 403(2).
Notably, the Restatement does not preclude concurrent regulation by
multiple jurisdictions. However, where concurrent jurisdiction by two
or more jurisdictions creates conflict, the Restatement recommends that
each country evaluate both its interests in exercising jurisdiction and
those of the other jurisdiction, and where possible, to consult with
each other.\87\
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\87\ With regard to conflicting exercises of jurisdiction,
section 403(3) of the Restatement states:
(3) When it would not be unreasonable for each of the two states
to exercise jurisdiction over a person or activity, but the
prescriptions by the two states are in conflict, each state has an
obligation to evaluate its own as well as the other state's interest
in exercising jurisdiction, in light of all the relevant factors,
including those set out in Subsection (2), a state should defer to
the other state if that state's interest is clearly greater.
Comment e. to section 403 of the Restatement states:
Conflicting exercises of jurisdiction. Subsection (3) applies
when an exercise of jurisdiction by each of two states is not
unreasonable, but their regulations conflict. In that case, each
state is required to evaluate both its interests in exercising
jurisdiction and those of the other state. When possible, the two
states should consult with each other. If one state has a clearly
greater interest, the other should defer, by abandoning its
regulation or interpreting or modifying it so as to eliminate the
conflict. When neither state has a clearly stronger interest, states
often attempt to eliminate the conflict so as to reduce
international friction and avoid putting those who are the object of
the regulations in a difficult situation. Subsection (3) is
addressed primarily to the political departments of government, but
it may be relevant also in judicial proceedings.
Subsection (3) applies only when one state requires what another
prohibits, or where compliance with the regulations of two states
exercising jurisdiction consistently with this section is otherwise
impossible. It does not apply where a person subject to regulation
by two states can comply with the laws of both; for example, where
one state requires keeping accounts on a cash basis, the other on an
accrual basis. It does not apply merely because one state has a
strong policy to permit or encourage an activity which another state
prohibits, or one state exempts from regulation an activity which
another regulates. Those situations are governed by Subsection (2),
but do not constitute conflict within Subsection (3).
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Consistent with the Restatement, in determining the extent to which
the Dodd-Frank swaps provisions apply to activities abroad, the
Commission has strived to protect U.S. interests as determined by
Congress in Title VII, and minimize conflicts with the laws of other
jurisdictions. The Commission has carefully considered, among other
things, the level of the home jurisdiction's supervisory interests over
the subject activity and the extent to which the activity takes place
within the foreign territory.\88\ At the same time, the Commission has
also considered the potential for cross-border activities to have
substantial connection to or impact on the U.S. financial system and
the global, highly integrated nature of today's swap business; to
fulfill the purposes of the Dodd-Frank swaps reform, the Commission's
supervisory oversight cannot be confined to activities strictly within
the territory of the United States.
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\88\ For purposes of this Guidance, the terms ``home
jurisdiction'' or ``home country'' are used interchangeably and
refer to the jurisdiction in which the person or entity is
established, including the European Union.
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The Commission believes that the Guidance strikes the proper
balance between these competing factors to ensure that the Commission
can discharge its responsibilities to protect the U.S. markets, market
participants, and financial system, consistent with the traditions of
the international system and comity principles, as set forth in the
Restatement. Of particular relevance is the Commission's approach to
substituted compliance, which would be expected to mitigate any burden
associated with potentially conflicting foreign regulations and would
generally be appropriate in light of the supervisory interests of
foreign regulators in entities domiciled and operating in its
jurisdiction.\89\
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\89\ As discussed in section IV.F, infra, the Commission's
recognition of substituted compliance would be based on an
evaluation of whether the requirements of the foreign jurisdiction
are comparable and comprehensive compared to the applicable
requirement(s) under the CEA and Commission regulations, based on a
consideration of all relevant factors, including among other things:
(i) the comprehensiveness of the foreign regulator's supervisory
compliance program, and (ii) the authority of such foreign regulator
to support and enforce its oversight of the registrant's branch or
agency with regard to such activities to which substituted
compliance applies.
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In addition, recognizing that close cooperation and coordination
with other jurisdictions is vital to the regulation of derivatives in
the highly interconnected global market, the Commission's staff expects
to remain actively engaged in discussions with foreign regulators as
the Commission implements the cross-border interpretive guidance and as
other jurisdictions develop their own regulatory requirements for
derivatives. The Commission recognizes that conflicts of law may exist
and is ready to address those issues as they may arise. In that regard,
where a real conflict of laws exists, the Commission strongly
encourages regulators and registrants to consult directly with its
staff.
IV. Guidance
A. Interpretation of the Term ``U.S. Person''
1. Proposed Interpretation
Under the Proposed Guidance, the term ``U.S. person'' identifies
those persons who, under the Commission's interpretation, could be
expected to satisfy the jurisdictional nexus under section 2(i) of the
CEA based on their swap activities either individually or in the
aggregate.\90\ As proposed, the Commission's interpretation of the term
``U.S. person'' would generally encompass: (1) persons (or classes of
persons) located within the United
[[Page 45302]]
States; and (2) persons that may be domiciled or operate outside the
United States but whose swap activities nonetheless have a ``direct and
significant connection with activities in, or effect on, commerce of
the United States'' within the meaning of CEA section 2(i).
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\90\ See Proposed Guidance, 77 FR at 41218. The discussion of
the term ``U.S. person'' in this Guidance is limited to the
relevance of this term for purposes of the Commission regulations
promulgated under Title VII. The Commission does not intend that
this discussion would apply to other uses of the term ``person'' in
the CEA.
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Specifically, as set forth in the Proposed Guidance, the
Commission's interpretation of the term ``U.S. person'' would generally
include, but not be limited to:
(i) any natural person who is a resident of the United States;
(ii) any corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or
any form of enterprise similar to any of the foregoing, in each case
that is either (A) organized or incorporated under the laws of the
United States or having its principal place of business in the
United States (legal entity) or (B) in which the direct or indirect
owners thereof are responsible for the liabilities of such entity
and one or more of such owners is a U.S. person;
(iii) any individual account (discretionary or not) where the
beneficial owner is a U.S. person;
(iv) any commodity pool, pooled account, or collective
investment vehicle (whether or not it is organized or incorporated
in the United States) of which a majority ownership is held,
directly or indirectly, by a U.S. person(s);
(v) any commodity pool, pooled account, or collective investment
vehicle the operator of which would be required to register as a
commodity pool operator under the CEA;
(vi) a pension plan for the employees, officers or principals of
a legal entity with its principal place of business inside the
United States; and
(vii) an estate or trust, the income of which is subject to U.S.
income tax regardless of source.
Under the proposed interpretation, a ``U.S. person'' would include
a foreign branch of a U.S. person; on the other hand, a non-U.S.
affiliate guaranteed by a U.S. person would not be within the
Commission's interpretation of the term ``U.S. person.''
The Further Proposed Guidance included alternatives for two
``prongs'' of the proposed interpretation of the term ``U.S. person''
in the Proposed Guidance: prong (ii)(B), which relates to U.S. owners
that are responsible for the liabilities of a non-U.S. entity; and
prong (iv), which relates to commodity pools and funds with majority-
U.S. ownership.
The alternative version of prong (ii)(B) in the Further Proposed
Guidance would limit its scope to a non-U.S. legal entity that is
directly or indirectly majority-owned by one or more natural persons or
legal entities that meet prong (i) or (ii) of the interpretation, in
which such U.S. person(s) bears unlimited responsibility for the
obligations and liabilities of the legal entity. This alternative prong
(ii)(B) would generally not include an entity that is a corporation,
limited liability company or limited liability partnership where
shareholders, members or partners have limited liability. Further, the
Commission stated in the Further Proposed Guidance that the majority-
ownership criterion would be intended to avoid capturing those legal
entities that have negligible U.S. ownership interests. Unlimited
liability corporations where U.S. persons have majority ownership and
where such U.S. persons have unlimited liability for the obligations
and liabilities of the entity generally would be covered under this
alternative to prong (ii)(B).
The alternative prong (ii)(B) in the Further Proposed Guidance was
as follows:
(ii) A corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or
any form of enterprise similar to any of the foregoing, in each case
that is either (A) organized or incorporated under the laws of a
state or other jurisdiction in the United States or having its
principal place of business in the United States or (B) directly or
indirectly majority-owned by one or more persons described in prong
(i) or (ii)(A) and in which such person(s) bears unlimited
responsibility for the obligations and liabilities of the legal
entity (other than a limited liability company or limited liability
partnership where partners have limited liability);
The Further Proposed Guidance explained that this alternative
proposed prong would generally treat an entity as a U.S. person if one
or more of its U.S. majority owners has unlimited responsibility for
losses of, or nonperformance by, the entity. This prong would reflect
that when the structure of an entity is such that the U.S. direct or
indirect owners are ultimately liable for the entity's obligations and
liabilities, the connection to activities in, or effect on, U.S.
commerce would be expected to satisfy the requisite jurisdictional
nexus. This ``look-through'' requirement also would serve to discourage
persons from creating such indirect ownership structures for the
purpose of engaging in activities outside of the Dodd-Frank regulatory
regime. Under the Further Proposed Guidance, this alternative proposed
prong generally would not render a legal entity organized or domiciled
in a foreign jurisdiction a ``U.S. person'' simply because the entity's
swaps obligations are guaranteed by a U.S. person.
With respect to prong (iv) of the interpretation of the term ``U.S.
person'' in the Proposed Guidance, the Further Proposed Guidance set
forth an alternative under which any commodity pool, pooled account,
investment fund or other collective investment vehicle generally would
be within the interpretation of the term ``U.S. person'' if it is
(directly or indirectly) majority-owned by one or more natural persons
or legal entities that meet prong (i) or (ii) of the interpretation of
the term ``U.S. person.'' The Further Proposed Guidance explained that
for purposes of this alternative prong (iv), the Commission would
interpret ``majority-owned'' to mean the beneficial ownership of 50
percent or more of the equity or voting interests in the collective
investment vehicle. Similar to the alternative prong (ii)(B) discussed
above, the Commission generally would not interpret the collective
investment vehicle's place of organization or incorporation to be
determinative of its status as a U.S. person. The Further Proposed
Guidance clarified that under alternative prong (iv), the Commission
would interpret the term ``U.S. person'' to include a pool, fund, or
other collective investment vehicle that is publicly traded only if it
is offered, directly or indirectly, to U.S. persons.
The alternative prong (iv) in the Further Proposed Guidance was as
follows:
(iv) A commodity pool, pooled account, investment fund, or other
collective investment vehicle that is not described in prong (ii)
and that is directly or indirectly majority-owned by one or more
persons described in prong (i) or (ii), except any commodity pool,
pooled account, investment fund, or other collective investment
vehicle that is publicly-traded but not offered, directly or
indirectly, to U.S. persons;
The Further Proposed Guidance explained that this alternative
proposed prong (iv) is intended to capture collective investment
vehicles that are created for the purpose of pooling assets from U.S.
investors and channeling these assets to trade or invest in line with
the objectives of the U.S. investors, regardless of the place of the
vehicle's organization or incorporation. These collective investment
vehicles may serve as a means to achieve the investment objectives of
their beneficial owners, rather than being separate, active operating
businesses. As such, the beneficial owners would be directly exposed to
the risks created by the swaps that their collective investment
vehicles enter into.
[[Page 45303]]
2. Comments
In general, commenters stated that the proposed ``U.S. person''
interpretation presented significant interpretive issues and
implementation challenges.\91\ The commenters contended that it would
be difficult to determine U.S. person status because of the breadth of
the proposed interpretation, potential ambiguities it contains, and the
collection of information its application may require. The commenters,
therefore, urged the Commission to consider how the proposed
interpretation could be stated in a simpler and more easily applied
manner.\92\ While a number of commenters stated that the Commission's
construction of the term ``U.S. person'' in the Proposed Guidance was
overbroad,\93\ several commenters on the Further Proposed Guidance
advocated for a broader reading of the term than any of those proposed
by the Commission.\94\
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\91\ See SIFMA (Aug. 27, 2012) at 5; Societe Generale
(``SocGen'') (Aug. 8, 2012) at 4; IIB (Aug. 27, 2012) at 4-14;
Deutsche Bank AG (``Deutsche Bank'') (Aug. 27, 2012) at 1-4; Goldman
Sachs ``(Goldman'') (Aug. 27, 2012) at 3; The Hong Kong Association
of Banks (``Hong Kong Banks'') (Aug. 27, 2012) at 3-4; Australian
Bankers' Association Inc. (``Australian Bankers'') (Aug. 27, 2012)
at 4.
\92\ SIFMA (August 27, 2012) at A10.
\93\ See, e.g., European Commission (Aug. 24, 2012) at 1-2; Hong
Kong Banks (Aug. 27, 2012) at 4; J.P. Morgan (Aug. 13, 2012) at 9.
\94\ See Better Markets (Feb. 15, 2013) at 4-8; Michael
Greenberger and Brandy Bruyere, University of Maryland, and AFR
(``Greenberger/AFR'') (Feb. 6, 2013) at 3 (stating that none of the
definitions of U.S. person proposed by the CFTC are sufficient to
protect U.S. taxpayers from the risks of foreign subsidiaries and
affiliates of U.S. financial institutions). See also Letter from
Sen. Levin at 7-8.
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a. Phase-in Interpretation
A number of commenters requested that the Commission adopt an
interim interpretation of ``U.S. person'' that would allow firms to
rely on their existing systems and classifications and avoid the need
to develop systems to follow a temporary interpretation of the term
``U.S. person'' that may change in the near future.\95\ IIB explained
that applying any interpretation of ``U.S. person'' that departs from
status based on residence or jurisdiction of organization, and in some
cases principal place of business, will require sufficient time to
implement relevant documentation conventions and diligence
procedures.\96\ IIB, therefore, requested that the Commission implement
a phased-in approach to the ``U.S. person'' interpretation that would
encompass, in general, (1) a natural person who is a U.S. resident and
(2) a corporate entity that is organized or incorporated under the laws
of the United States or has its place of business in the United
States.\97\
---------------------------------------------------------------------------
\95\ See, e.g., Cleary (Aug. 16, 2012) at 6; SIFMA (Aug. 27,
2012) at A8-9; IIB (Aug. 9, 2012) at 4; Deutsche Bank (Aug. 13,
2012) at 2; State Street Corporation (``State Street'') (Aug. 27,
2012) at 2; Goldman (Aug. 27, 2012) at 3.
\96\ See IIB (Aug. 9, 2012) at 4.
\97\ For purposes of IIB's definition, a foreign branch of a
U.S. swap dealer would be considered a non-U.S. person. IIB added
that it believes that the Commission should adopt a final definition
of ``U.S. person'' that is consistent with its proposed interim
definition. Id.
---------------------------------------------------------------------------
SIFMA also urged the Commission to phase in the ``U.S. person''
interpretation, citing the implementation difficulties identified by
IIB. Specifically, SIFMA recommended that the Commission allow market
participants to apply an interim interpretation of ``U.S. person''
until 90 days after the final interpretation of ``U.S. person'' is
published.\98\ SIFMA stated that the interim interpretation--which was
identical to IIB's interim interpretation--should identify ``core''
U.S. persons and would allow its members to phase in compliance with
the Dodd-Frank requirements without building new systems that might
have to be changed when the Commission states a final interpretation of
the term.\99\
---------------------------------------------------------------------------
\98\ See SIFMA (Aug. 25, 2012) at A8.
\99\ Id. at A8.
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b. Comments on Particular Prongs of the Proposed Interpretation of the
Term ``U.S. Person''
Commenters' concerns were primarily (though not exclusively)
directed to three prongs of the proposed ``U.S. person''
interpretation: prong (ii)(B) relating to U.S. owners that are
responsible for the liabilities of a non-U.S. company; prong (iv)
relating to commodity pools and funds with majority-U.S. ownership; and
prong (v) relating to registered commodity pool operators. Below, the
Commission describes the main comments to all the prongs of the
proposed interpretation of ``U.S. person'' in greater detail.
Commenters generally did not comment on prong (i).
With respect to prong (ii)(A), the Investment Industry Association
of Canada (IIAC) stated that the Commission should look to the location
of a legal entity's management (or the majority of its directors and
executive officers), instead of the location of organization.\100\ Two
commenters stated that the ``principal place of business'' element of
the interpretation was ambiguous and difficult to administer and thus
recommended that it be removed.\101\
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\100\ See IIAC (Aug. 27, 2012) at 3-5.
\101\ See Lloyds Banking Group (``Lloyds'') (Aug. 24, 2012) at
3; Managed Fund Association and Alternative Investment Management
Association (``MFA/AIMA'') (Aug. 28, 2012) at 6.
---------------------------------------------------------------------------
On the other hand, Senator Levin supported an inclusive
interpretation of the term ``U.S. person'' that would encompass foreign
offices and affiliates of U.S. financial institutions and corporations,
because requiring a case-by-case analysis of whether they should be
subject to the Dodd-Frank Act would be complicated, burdensome, and
susceptible to gamesmanship.\102\ He also suggested that, since it
appears that typically foreign affiliates and subsidiaries operate not
as independent actors but are closely integrated with their parent
corporations, obtaining from them the financial backing needed for
their derivative trades, the Commission's interpretation should presume
that a foreign affiliate engaged in swap activity is an extension of
the parent corporation, unless the parent can demonstrate that the
foreign affiliate should be treated as independent.\103\ Senator Levin
also stated that the Commission's interpretation should include as a
U.S. person any foreign affiliate under common control with a U.S.
person, based on factors such as common management, funding, systems,
and financial reporting.\104\
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\102\ See Letter from Sen. Levin at 7-8.
\103\ Id. (stating that it ``makes little economic sense, given
the insubstantial reality of many foreign affiliates and
subsidiaries in the financial industry'' to ``view a foreign
affiliate or subsidiary as a non-U.S. person even if it were fully
integrated with its U.S. parent, operated as a wholly owned shell
operation with no offices or employees of its own, and functioned in
the same way as a branch or agency office'').
\104\ Id. at 8.
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With respect to prong (ii)(B) of the interpretation, which
addresses situations where the direct or indirect owners of an entity
are responsible for its liabilities, several commenters stated that the
phrase ``responsible for the liabilities'' was vague. For example, the
Committee on Capital Markets Regulation (``Capital Markets'') stated
that the phrase ``responsible for the liabilities'' was open to
interpretation and requested that the Commission provide more details
regarding its interpretation of this phrase.\105\ SIFMA sought
clarification on whether the Commission intended to capture
partnerships where the partners have unlimited liability.\106\ The
International Swaps and Derivatives Association Inc. (``ISDA'') stated
that it was not clear whether the concept includes
[[Page 45304]]
guarantees, sureties, simple risk of loss of equity, or other type of
exposure.\107\ Deutsche Bank further noted that the language in prong
(ii)(B) could be read to include an entity guaranteed by a U.S. person,
which appears at odds with possibly varying policies elsewhere in the
Proposed Guidance for entities guaranteed by U.S. persons.\108\
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\105\ See Capital Markets (Aug. 24, 2012) at 5.
\106\ See SIFMA (Aug. 27, 2012) at A13 and A19.
\107\ See ISDA (Aug. 27, 2012) at 9; MFA/AIMA (Aug. 28, 2012) at
6.
\108\ See Deutsche Bank (Aug. 27, 2012) at 3. See also Peabody
Energy Corporation (``Peabody'')(Aug. 28, 2012) at 2-3 (``By
contrast, a foreign affiliate or subsidiary of a U.S. person would
be considered a non-U.S. person, even where such an affiliate or
subsidiary has certain or all of swap-related obligations guaranteed
by the U.S. person.'') (citing Proposed Guidance, 77 FR at 41218);
SIFMA (Aug. 27, 2012) at A2 (stating that the Commission should
clarify that prong (ii)(B) of the interpretation is not meant to
capture an entity merely because it is guaranteed by a U.S. person).
---------------------------------------------------------------------------
Commenters also expressed concerns about the lack of a minimum
U.S.-ownership threshold. For example, Sumitomo Mitsui Trust Bank Ltd.
(``Sumitomo'') stated that there should be a minimum level of ownership
of the entity in question by one or more U.S. persons for this prong to
apply, and suggested that the majority ownership threshold used in
prong (iv) apply here as well.\109\ ISDA emphasized a different point,
stating that without clear thresholds, a non-U.S. business would be
within the Commission's interpretation of the term ``U.S. person'' by
virtue of even negligible ownership interests by U.S. persons.\110\ The
Financial Services Roundtable (``FSR'') stated that prong (ii) is
overbroad because it would cover even minority-U.S. owned institutions
based only on a pro-rata (or less) parent liability guarantee.\111\
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\109\ See Sumitomo (Aug. 24, 2012) at 2.
\110\ See ISDA (Aug. 10, 2012) at 8 (recommending that
regardless of the nature of the ``responsibilities for the
liabilities,'' only direct owners of apparent non-U.S. persons
should be considered, and that the Commission adopt a presumptive
control threshold of 25% direct ownership for distinguishing between
control persons and owners that need not be considered in assessing
the status of an entity as a U.S. person).
\111\ See FSR (Aug. 27, 2012) at 3.
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Capital Markets raised a concern that whether a conclusion that the
direct or indirect owners of a U.S. legal entity are ``responsible for
the liabilities'' of such entity requires knowledge of each
counterparty's legal and ownership structure.\112\ FSR stated that
interpretation of prong (ii)(B) would depend on a reevaluation of most,
if not all, counterparty relationships in order to determine what type
of liability guarantees exist between an entity and its parent.\113\
Both Capital Markets and FSR stated that firms do not currently have
any reasonable means to obtain information necessary to assess this
element of the interpretation, particularly within the short time frame
prior to the registration date.
---------------------------------------------------------------------------
\112\ See Capital Markets (Aug. 24, 2012) at 5.
\113\ See FSR (Aug. 27, 2012) at 3.
---------------------------------------------------------------------------
One commenter supported finalization of the alternative prong
(ii)(B) in the Further Proposed Guidance, with minor clarifying
changes. The Commercial Energy Working Group (``CEWG'') stated that the
words ``all of'' should be added to clarify that this prong would
generally apply when U.S. persons that are majority owners bear
``unlimited responsibility for all of the obligations and liabilities
of the legal entity . . .'' \114\ The CEWG also stated that the
Guidance should reaffirm that a guarantee of a non-U.S. person by a
U.S. person, in and of itself, generally would not invoke U.S. person
status.\115\ Other commenters that supported the principles of the
alternative prong (ii)(B) thought that the interpretation of ``U.S.
person'' in this regard should be restructured. The Investment Company
Institute (``ICI'') stated that the Commission should clarify that
collective investment vehicles would not fall within the alternative
prong (ii)(B) because the investors' liabilities are limited to the
amount of their investment.\116\ Thus, ICI stated that it believes the
alternative prong (ii)(B) would be superfluous with respect to
collective investment vehicles because the alternative prong (iv) in
the Further Proposed Guidance would address these entities if they are
majority-owned by U.S. persons.\117\ MFA/AIMA, on the other hand,
supported the combination of majority ownership and unlimited liability
elements in the alternative prong (ii)(B) and recommended that
collective investment vehicles be considered under that prong.\118\
---------------------------------------------------------------------------
\114\ See CEWG, submitted by Sutherland Asbill & Brennan LLP
(Feb. 25, 2013) at 5.
\115\ Id.
\116\ See ICI (Feb. 6, 2013) at 3.
\117\ See id. at 2. See also IIB (Feb 6, 2013) at 10-11
(collective investment vehicles should be excluded from prong (ii)
and addressed only in prong (iv)).
\118\ See MFA/AIMA (Feb. 6, 2013) at 7-8. Thus under MFA/AIMA's
approach, the status of collective investment vehicles would be
determined by reference to only the tests in alternative prong
(ii)(B).
---------------------------------------------------------------------------
Other commenters stated that the Commission should clarify that the
language at the end of the proposed alternative prong (ii)(B), which
refers to limited liability companies and limited liability
partnerships, would generally also apply to other types of entities
where owners have limited liability but where the entities have
different names in foreign legal jurisdictions.\119\ MFA/AIMA and SIFMA
AMG stated that the Commission should clarify how frequently an entity
should consider (e.g., annually) whether U.S. persons are its direct or
indirect majority owners, and provide for a transition period after an
entity falls within this prong of the interpretation for the first
time.\120\
---------------------------------------------------------------------------
\119\ Id. at 10-11; Asociaci[oacute]n Bancaria y de Entidades
Financieras de Colombia (``Colombian Bankers'') (Feb. 6, 2013) at 1-
2; IIB (Feb. 6, 2013) at 10; ISDA (Feb. 6, 2013) at 5-6.
\120\ See MFA/AIMA (Feb. 6, 2013) at 12; SIFMA/AMG (Feb. 14,
2013) at 6. ISDA stated that the Commission should clarify how the
prong would apply to an entity where some but not all of the owners
have unlimited responsibility. In this case, the Commission should
clarify whether the U.S. owners with majority ownership of the
entity also each must bear unlimited responsibility for the entity's
obligations and liabilities or, rather, whether it suffices that a
single U.S. owner has unlimited responsibility once U.S. majority
ownership is established. See ISDA (Feb. 6, 2013) at 5-7.
---------------------------------------------------------------------------
Other commenters were critical of the alternative prong (ii)(B).
Greenberger/AFR and Better Markets stated that this proposed prong is
too narrow, because it appears to require that U.S. persons be both the
majority owners of an entity and bear unlimited responsibility for the
entity's obligations and liabilities, in order for the entity to be
within the Commission's interpretation of the term ``U.S. person''
based solely on ownership by U.S. persons.\121\ Greenberger/AFR pointed
out that a U.S. person could be the majority owner of an entity
organized outside the United States, and be responsible for 99% of the
entity's obligations, yet the entity would not fall within the
Commission's interpretation under the proposed prong.\122\
---------------------------------------------------------------------------
\121\ See Greenberger/AFR (Feb. 6, 2013) at 7; Better Markets
(Feb. 15, 2013) at 7-8.
\122\ See Greenberger/AFR (Feb. 6, 2013) at 7.
---------------------------------------------------------------------------
Other commenters suggested that the alternative prong (ii)(B) is
too broad, recommending that the ownership element be limited to when a
majority of the direct owners of an entity are U.S. persons, because
considering the indirect ownership of an entity will be unworkable for
many entities.\123\ ISDA also stated that the concept of ``unlimited
responsibility'' is too amorphous to be a basis for the Commission's
interpretation, because it could turn on fact-sensitive and
[[Page 45305]]
uncertain legal judgments under doctrines such as ``veil-piercing'' or
``alter ego'' entities.\124\ Moreover, ISDA asserted that the
Commission has not justified the treatment of unlimited liability
entities in the proposed alternative prong (ii)(B) by demonstrating how
such entities are more susceptible to being used to evade Dodd-Frank
regulations or otherwise raise the concerns addressed by the
Commission's regulations.\125\
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\123\ See MFA/AIMA (Feb. 6, 2013) at 7; SIFMA, The Clearing
House, Association LLC (``The Clearing House''), and FSR (``SIFMA/
CH/FSR'') (Feb. 6, 2013) at 2, A8-9; ISDA (Feb. 6, 2013) at 5. IIB
and SIFMA/AMG made similar comments and questioned whether extending
this prong to entities where a majority of indirect owners are U.S.
persons would be consistent with the ``direct and significant
connection'' language in CEA section 2(i). See IIB (Feb. 6, 2013) at
10; SIFMA/AMG (Feb. 14, 2013) at 3-4.
\124\ See ISDA (Feb. 6, 2013) at 6. ISDA also stated that the
Commission should make clear that the reference to ``unlimited
responsibility'' does not include responsibility arising out of
separate contractual arrangements or extraordinary circumstances,
such as conduct by owners that results in veil piercing or limited
partner participation in management of a partnership. See id. SIFMA/
CH/FSR made similar points and stated that this prong is not
necessary because market participants have not used unlimited
liability entities to avoid Dodd-Frank regulations. See SIFMA/CH/FSR
(Feb. 6, 2013) at A12.
\125\ See ISDA (Feb. 6, 2013) at 6.
---------------------------------------------------------------------------
Commenters were also critical of the element of the alternative
prong (ii)(B) that would treat a collective investment vehicle as a
U.S. person if its principal place of business is in the United States.
They stated that application of this element would be very unclear and
difficult on an operational level.\126\ Commenters also stated that a
collective investment vehicle should be treated as a U.S. person if it
is organized in the U.S., not if its manager or operator is in the
U.S.\127\
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\126\ Id. at 6-7; SIFMA/CH/FSR (Feb. 6, 2013) at A1, A5-6, B5;
IIB (Feb. 6, 2013) at 7-8, 10.
\127\ See MFA/AIMA (Feb. 6, 2013) at 8-9; SIFMA/AMG (Feb. 6,
2013) at A7-8. The Japanese Bankers Association made similar
comments and stated that the Commission should clarify whether the
location of the principal place of business of a subsidiary that is
controlled by its parent is the location of the subsidiary's
headquarters or the parent's headquarters. Japanese Bankers
Association (Feb. 6, 2013) at 7.
---------------------------------------------------------------------------
Peabody Energy Corporation (``Peabody'') and SIFMA/AMG stated the
Commission should adopt the interpretation of U.S. person in the
January Order, which does not include all the elements of the proposed
alternative prong (ii)(B).\128\
---------------------------------------------------------------------------
\128\ See Peabody (Feb. 5, 2013) at 1-2; SIFMA/AMG (Feb. 6,
2013) at 1-3.
---------------------------------------------------------------------------
Commenters generally did not comment on prong (iii) of the proposed
interpretation of the term ``U.S. person.''
With respect to prong (iv) relating to majority direct- or
indirect-owned commodity pools, pooled accounts, or collective
investment vehicles, several commenters stated that this prong was
unworkable because the proposed interpretation would require
potentially unascertainable information.\129\ According to SIFMA,
reliance on representations would be the only practical way to consider
the status of counterparties as U.S. persons under this prong since
other types of information, such as the direct and indirect ownership
of any commodity pool, pooled account or collective investment vehicle
with which a market participant transacts, may be unavailable, non-
public or otherwise sensitive.\130\ Moreover, a fund would be required
to monitor its level of U.S. ownership on an on-going basis, and this
prong could result in frequent changes in the fund's U.S. person
status.\131\ The Clearing House argued that the interpretation should
not look through direct investors to indirect investors, unless there
is evidence of evasion.\132\ Other commenters questioned whether the
proposed interpretation of ``U.S. person'' for commodity pools, pooled
accounts, and collective investment vehicles meets the ``direct and
significant'' jurisdictional nexus applicable to the Commission's
application of Title VII to transactions with such persons.\133\
---------------------------------------------------------------------------
\129\ See, e.g., ISDA (Aug. 10, 2012) at 8; SIFMA (Aug. 27,
2012) at A17; Credit Suisse (Aug. 27, 2012) at 3-4; The Clearing
House Association LLC (``The Clearing House'') (Aug. 27, 2012) at
12-13; Cleary (Aug. 16, 2012) at 7; IIB (Aug. 27, 2012) at 6-7.
\130\ See SIFMA (Aug. 27, 2012) at A17-18. See also IIB (Aug.
27, 2012) at 7 (arguing that since pools cannot ascertain or control
the status of their indirect investors, the reference to indirect
ownership should be removed).
\131\ SIFMA (Aug. 27, 2012) at A17.
\132\ See The Clearing House (Aug. 13, 2012) at 15 n. 20.
\133\ See, e.g., SIFMA/AMG (Aug. 27, 2012) at 2-3; MFA/AIMA
(Aug. 28, 2012) at 4-5; ICI (Aug. 23, 2012) at 4.
---------------------------------------------------------------------------
Cleary urged that the Commission not adopt an interpretation of
``U.S. person'' based on the composition of fund ownership, at least
prior to finalizing the interpretation.\134\ As it explained, even if
the Commission's interpretation would allow for reasonable reliance on
counterparty representations, fund counterparties would not be able to
provide any representation except with respect to funds formed after
the finalization of the interpretation for which the fund's
subscription materials could have been modified to capture the relevant
information.\135\ If the Commission nevertheless decided to adopt an
interpretation based on investor composition, Cleary argued against
including a fund in the interpretation on the basis of indirect
ownership at any level less than a majority-ownership.\136\
---------------------------------------------------------------------------
\134\ See Cleary (Aug. 16, 2012) at 6-7.
\135\ Id.
\136\ Id. IIB also noted that fund sponsors/operators verify
investor status through subscription materials provided at the time
of initial investment. Therefore, they request that any test based
on fund ownership apply only to funds formed after the effective
date of the final ``U.S. person'' interpretation. IIB also agreed
that majority ownership is the minimum threshold under which a
foreign fund should be included in the interpretation of the term
``U.S. person.'' See IIB (Aug. 27, 2012) at 6-7.
---------------------------------------------------------------------------
Consideration of majority-ownership is particularly problematic
with respect to funds that are publicly traded, according to several
commenters.\137\ For example, ICI explained that U.S. persons typically
purchase shares in non-U.S. funds through intermediaries, and that such
shares are registered and held in nominee/street name accounts.\138\ In
such cases, the fund manager/operator would not have information
regarding the underlying investors.\139\ SIFMA recommended that
publicly offered and listed commodity pools organized in foreign
jurisdictions be excluded from the interpretation.\140\ Credit Suisse
stated that a fund should not be considered a U.S person to the extent
that it is organized outside the United States and is subject to
foreign regulation that is comparable to U.S. law. To the extent the
fund is not so regulated, then the fund would be within the U.S. person
interpretation only where it is organized under the laws of the United
States or marketed to U.S. residents.\141\
---------------------------------------------------------------------------
\137\ See, e.g., SIFMA (Aug. 27, 2012) at A20; ICI (Aug. 23,
2012) at 3-7; MFA/AIMA (Aug. 28, 2012) at 4; Credit Suisse (Aug. 27,
2012) at 3-4.
\138\ See ICI (Aug. 23, 2012) at 3.
\139\ ICI also noted that certain jurisdictions may prohibit
disclosure by intermediaries of beneficial owner information. Id.
\140\ See SIFMA (Aug. 27, 2012) at A19-20.
\141\ See Credit Suisse (Aug, 27, 2012) at 3-4.
---------------------------------------------------------------------------
One commenter strongly supported the alternative prong (iv) in the
Further Proposed Guidance. Citadel stated that since the Dodd-Frank
clearing and reporting requirements will mitigate systemic risk,
increase transparency and promote competition, the U.S. person
interpretation should encompass offshore collective investment vehicles
that have a sufficient U.S. nexus.\142\ If it did not, then a core,
active portion of the swaps market would fall outside the scope of the
transaction level requirements, including clearing, which would
undermine central objectives of Dodd-Frank, create opportunities for
regulatory arbitrage, and risk fragmenting the swaps markets.\143\
---------------------------------------------------------------------------
\142\ See Citadel (Feb. 6, 2013) at 1.
\143\ See id.
---------------------------------------------------------------------------
Other commenters argued that the entities that would be covered by
the alternative prong (iv) should not be covered by the interpretation
of ``U.S. person,'' which should cover only entities that are directly
majority-owned by U.S. persons. For example, SIFMA/
[[Page 45306]]
CH/FSR stated that consideration of indirect ownership could require
ongoing monitoring of ownership, which is burdensome or even
impossible, and would not necessarily reflect a sufficient
jurisdictional nexus to the United States.\144\ SIFMA/CH/FSR also
stated that if consideration of majority ownership is included in the
interpretation, it should reflect an objective statement of the
ownership level that the Commission would consider relevant to U.S.-
person status, so as to exclude entities that are owned by U.S. persons
only to a de minimis extent and allow an annual consideration of
ownership.\145\ MFA/AIMA and the Investment Adviser Association
(``IAA'') also provided reasons that there is not a sufficient
jurisdictional nexus with the United States to include in the
Commission's interpretation of the term ``U.S. person'' collective
investment vehicles that are indirectly majority-owned by U.S.
persons.\146\
---------------------------------------------------------------------------
\144\ See SIFMA/CH/FSR (Feb. 6, 2013) at A8-9. See also IIB
(Feb. 6, 2013) at 11 (systems to track indirect ownership would be
difficult and expensive to implement).
\145\ See SIFMA/CH/FSR (Feb. 6, 2013) at A8-9. ISDA stated that
the lack of an objective policy regarding the interpretation of
majority ownership would lead to arbitrary or indeterminate results
for many collective investment vehicles due to their varied capital
structures (citing, for example, structured finance vehicles, which
merit further analysis due not only to their complex capital
structures but also to practical difficulties in monitoring
ownership of their securities), and the practical consequences of
the alternative interpretations can be considered only following a
more concrete proposal offered for public comment. See ISDA (Feb. 6,
2013) at 6-7.
\146\ MFA/AIMA stated that since interactions between collective
investment vehicles and registered swap dealers are expected to be
covered by Dodd-Frank requirements or comparable foreign
regulations, the inclusion of collective investment vehicles as
``U.S. persons'' is less important to achieve regulatory coverage.
See MFA/AIMA (Feb. 6, 2013) at 7-8. MFA/AIMA also disputed whether
the pooling of assets in a collective investment vehicle is a
fundamental difference that denotes a greater U.S. nexus than the
pooling of assets by corporations or other financial entities, and
therefore it is problematic that alternative prong (iv) is more
onerous (in MFA/AIMA's view) for non-U.S collective investment
vehicles than alternative prong (ii) is for corporate or other
financial entities. See id. IAA stated that it is inappropriate to
define an entity as a U.S. person based on characteristics of
investors in the entity rather than the characteristics of the
entity itself. See IAA (Feb. 6, 2013) at 4.
---------------------------------------------------------------------------
Some commenters stated that whether a collective investment vehicle
would be included in the interpretation of U.S. person should depend on
whether the fund or other collective investment vehicle is being
offered to U.S. persons, arguing that the interpretation should cover
collective investment vehicles that are targeted to the U.S. market or
to U.S. investors by focusing on activities within the control of the
vehicle's manager.\147\
---------------------------------------------------------------------------
\147\ See Invesco Advisers Inc. (``Invesco'') (Feb. 6, 2013) at
11 (manager of collective investment vehicle determines whether to
make offering in the United States; subsequent purchases by non-U.S.
persons who have relocated to the U.S. should not alone constitute
offering in the U.S.); IIB (Feb. 6, 2013) at 11. Invesco, ICI and
IAA each stated that the language at the end of alternative prong
(iv) (if it is adopted) should be interpreted to cover collective
investment vehicles that are ``publicly-offered'' only to non-U.S.
persons, even if the vehicles are not publicly-traded. See Invesco
(Feb. 6, 2013) at 2; ICI (Feb. 6, 2013) at 3; IAA (Feb. 6, 2013) at
4. See also ICI (Jul. 5, 2013) at 3 n. 9 (``There is an important
distinction between publicly-traded funds and publicly-offered
funds: publicly-offered funds are those that are broadly available
to retail investors; publicly-traded funds are simply a subset of
publicly-offered funds that trade on exchanges or other secondary
markets. Excluding from the U.S. person definition only publicly-
traded funds would capture only a subset of non-U.S. regulated
funds. We note that, by contrast, hedge funds are neither publicly
offered nor publicly traded and, unlike non-U.S. retail funds, are
not subject to substantive government regulation and oversight
similar in scope to that provided by the U.S. Investment Company
Act.'').
ICI and IAA stated that the Commission should interpret whether
an offer is made to U.S. persons in accordance with precedents under
the SEC's Regulation S. See ICI (Feb. 6, 2013) at 4-5 n. 14; IAA
(Feb. 6, 2013) at 4. ISDA stated that the Commission's
interpretation should specifically exclude any collective investment
vehicle that offers its securities in accordance with local law and
customary documentation practices in a local market, as well as
offerings conducted in accordance with the Regulation S. See ISDA
(Feb. 6, 2013) at 7.
---------------------------------------------------------------------------
Commenters also stated that regardless of the policy adopted in
this regard, in the consideration of whether an entity is a U.S.
person, only information that is available to third parties or other
parties should be considered relevant, and the Commission's policy
should contemplate that market participants would rely on a
representation of U.S. person status. Also, the Commission's policy
should clarify how it would apply during the transition period
immediately after expiration of the January Order.\148\
---------------------------------------------------------------------------
\148\ See SIFMA/AMG (Feb. 14, 2013) at 4 n. 8; IIB (Feb. 6,
2013) at 7; ISDA (Feb. 6, 2013) at 7; Japanese Bankers Association
(Feb. 6, 2013) at 5.
---------------------------------------------------------------------------
Addressing prong (v) relating to registered commodity pool
operators, many commenters stated that the Commission should not adopt
an interpretation that looks to the registration status of a fund's
operator, because this interpretation could capture a non-U.S. fund
that does not itself trigger registration as a commodity pool operator
and has a minimal U.S. nexus.\149\ A number of commenters urged the
Commission not to adopt an interpretation that looks to the nationality
of the fund's manager/operator since this would place U.S.-based
investment managers at a competitive disadvantage, without addressing
the Commission's regulatory objectives.\150\ IIB generally agreed with
these commenters and stated that the commodity pool operator
registration prong would be over-inclusive because, under the
Commission's current rules, an operator of a foreign pool may be
required to register as a commodity pool operator with less than 50
percent U.S. ownership; at the same time, the prong also would be
under-inclusive because it would not cover funds whose operators are
eligible for relief from commodity pool operator registration.
---------------------------------------------------------------------------
\149\ See, e.g., SIFMA (Aug. 27, 2012) at A21; ICI (Aug. 23,
2012) at 3-7; IIB (Aug. 9, 2012) at 3; MFA/AIMA (Aug. 28, 2012) at
4-5; IIAC (Aug. 27, 2012) at 4, 5. As IIB explained, even a fund
that lacks a sufficient U.S. connection can be considered a U.S.
person where its commodity pool operator is required to register.
IIB (Aug. 9, 2012) at 3. Under Commission regulation 3.10, the
operator of a non-U.S. fund with even one U.S.-based owner is
required to register as a commodity pool operator.
\150\ See SIFMA (Aug. 27, 2012) at A13; ICI (Aug, 23, 2012) at
4; Cleary (Aug. 16, 2012) at 7; The Clearing House (Aug. 27, 2012)
at 13-14.
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ICI recommended that the Commission, instead, interpret the term
``U.S. person'' to include a commodity pool, pooled account, or
collective investment vehicle that is ``offered publicly, directly or
indirectly'' by the manager/sponsor to U.S. persons.\151\ As ICI
explained, this alternative approach would base a fund's U.S. person
status on more workable considerations, and not on changes in investor
status that are beyond the control of a fund or its manager/operator.
In the consideration of whether a fund is making a public offering to
U.S. persons, ICI recommended that the Commission look to SEC
Regulation S.\152\
---------------------------------------------------------------------------
\151\ See ICI (Aug. 23, 2012) at 5-6.
\152\ Id. at 6-7. Regulation S is codified at 17 CFR 230.901
through 230.905.
---------------------------------------------------------------------------
IIAC recommended that prong (vi) relating to pension plans be
modified so that pension plans designed exclusively for foreign
employees of a U.S.-based entity are not within the interpretation of
the term ``U.S. person.'' Further, IIAC urged the Commission to clarify
that U.S. investment advisers or other fiduciaries not be considered to
be within the interpretation of the term ``U.S. person'' when they are
acting on behalf of non-U.S. accounts.\153\
---------------------------------------------------------------------------
\153\ IIAC (Aug. 27, 2012) at 4.
---------------------------------------------------------------------------
IIB stated that prong (vii) relating to an estate or trust should
be replaced, explaining that market participants do not typically
identify an estate's or trust's regulatory status on the basis of its
tax status. Instead, it recommended that the Commission's
interpretation look to the status of the executor, administrator, or
trustee. Specifically,
[[Page 45307]]
IIB recommended that the Commission's interpretation of the term ``U.S.
person'' include an estate or trust that is organized in the United
States ``unless (A) an executor, administrator or trustee that is not a
U.S. person has sole or shared investment discretion with respect to
the assets of the trust or estate, (B) in the case of an estate, the
estate is governed by foreign law and (C) in the case of a trust, no
beneficiary of the trust (and no settlor if the trust is revocable) is
a U.S. person . . . .'' \154\
---------------------------------------------------------------------------
\154\ IIB (Aug. 27, 2012) at 14.
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c. Commenters' Proposed Alternatives
A number of commenters provided substantially different alternative
interpretations of the term ``U.S. person.'' \155\ Most notably, the
commenters' alternatives would not encompass persons by virtue of
``indirect'' U.S. ownership. For example, SIFMA's proposed ``U.S.
person'' interpretation would include only those commodity pools or
collective investment vehicles that are organized or incorporated under
U.S. law or are (1) directly majority owned by ``U.S. persons'' or, in
the case of ownership by a pool, a pool that is organized in the United
States and (2) not publicly offered.\156\ IIB submitted an alternative
``U.S. person'' interpretation that generally tracked SIFMA's proposed
interpretation.\157\
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\155\ See, e.g., SIFMA (Aug. 27, 2012); IIB (Aug. 27, 2012); The
Clearing House (Aug. 27, 2012).
\156\ See SIFMA (Aug. 27, 2012) at A10-11.
\157\ See IIB (Aug. 27, 2012) at 13-14.
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d. Due Diligence
Many commenters stated that the Commission's policy in this regard
should contemplate that a firm would reasonably rely on counterparty
representations regarding their U.S. person status.\158\ For example,
SIFMA stated that the Commission's policy should be consistent with a
determination by the swap counterparty itself of its U.S.-person
status, but in the alternative, SIFMA recommended that the Commission's
policy contemplate reasonable reliance on counterparty
representations.\159\ According to these commenters, counterparty
representations are the only practical means of determining
counterparty status as firms do not currently collect the information
necessary to evaluate counterparty status under the proposed
interpretation. The commenters also were concerned that certain prongs
of the proposed interpretation (e.g., ``look-through'' obligations
associated with the ``direct and indirect ownership'' criterion in
prong (iv)) would render it difficult, if not impossible, for market
participants to directly consider whether their counterparties would be
within the Commission's interpretation of the term ``U.S. person.''
SIFMA and Cleary further pointed out that the Commission has accepted
reasonable reliance on counterparty representations in the context of
the external business conduct standards.\160\
---------------------------------------------------------------------------
\158\ See, e.g., SIFMA (Aug. 27, 2012) at A16-17; Deutsche Bank
(Aug. 27, 2012) at 4; Capital Markets (Aug. 24, 2012) at 5; SIFMA/
AMG (Aug. 27, 2012) at 4-5.
\159\ SIFMA (Aug. 27, 2012) at A16-18.
\160\ SIFMA/AMG (Aug. 27, 2012) at 4-5; Cleary (Aug. 16. 2012)
at 6.
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e. Non-U.S. Person That Is Affiliated, Guaranteed, or Controlled by
U.S. Person
Viewed as a whole, the proposed interpretation of the term ``U.S.
person,'' would generally not include a non-U.S. affiliate of a U.S.
person, even if all of such affiliate's swaps are guaranteed by the
U.S. person.\161\ The Commission, nevertheless, raised a concern
regarding risks associated with a U.S. person providing a guarantee to
its non-U.S. affiliates and requested comments on whether the term
``U.S. person'' should, in fact, be interpreted to generally include a
non-U.S. affiliate guaranteed by a U.S. person.\162\ In addition, the
Commission sought comments on whether the term ``U.S. person'' also
should be interpreted to generally include any non-U.S. persons
controlled by or under common control with a U.S. person.\163\
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\161\ See Proposed Guidance, 77 FR at 41218. For purposes of
this Guidance, the Commission generally interprets the term
``affiliates'' to include an entity's parent entity and
subsidiaries, if any, unless stated otherwise.
\162\ Id.
\163\ Id.
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Responding to the Commission's request for comments on this issue,
many commenters stated that Title VII requires the Commission to
interpret the term ``U.S. person'' to include foreign affiliates of
U.S. persons, and U.S. affiliates of foreign persons, in order to
protect U.S. taxpayers from the risks posed by the global swaps
market.\164\ Senator Levin urged that ``[a]t a minimum, it is essential
that [the Guidance] . . . include as a U.S. person any foreign
affiliate or subsidiary under common control with a U.S. person.''
\165\ He also agreed with statements in the Proposed Guidance that non-
U.S. affiliates guaranteed by U.S. persons effectively transfer the
risks of their swaps to the U.S. guarantor, and therefore the
guaranteed non-U.S. affiliates should be subject to U.S.
safeguards.\166\ Public Citizen stated that not interpreting the term
``U.S. person'' to include a foreign affiliate of a U.S. person ``hides
the rabbit in the hat'' for Title VII purposes.\167\ It argued that
Congress intended financial entities that are controlled by U.S.
financial institutions or that could adversely impact the U.S. economy
to be regulated as U.S. persons under Title VII in order to fully
protect American taxpayers from the threat of ``future financial
bailouts.''
---------------------------------------------------------------------------
\164\ See Public Citizen's Congress Watch (``Public Citizen'')
(Aug. 14, 2012) at 9-10; IATP (Aug. 27, 2012) at 4; Better Markets
(Aug. 27, 2012) at 6.
\165\ See Letter from Sen. Levin at 8.
\166\ See id. (citing Proposed Guidance, 77 FR at 41218).
\167\ Public Citizen (Aug. 14, 2012) at 3.
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Greenberger also expressed support for including foreign swap
entities controlled by U.S. parents in the interpretation of the term
``U.S. person.'' In his view, the Commission's distinction between
guaranteed and non-guaranteed foreign subsidiaries is arbitrary, as the
absence of a U.S. guarantee does not insulate the U.S. parent from risk
exposure.\168\ Other commenters argued that the Commission's
interpretation of the term ``U.S. person'' should include foreign
affiliates whose swaps are guaranteed by a U.S. person.\169\
---------------------------------------------------------------------------
\168\ Greenberger (Aug. 27, 2012) at 6-7.
\169\ See Better Markets (Aug. 27, 2012) at 6-7; Public Citizen
(Aug. 14, 2012) at 3.
---------------------------------------------------------------------------
Other commenters objected to including a non-U.S. entity in the
interpretation of the term ``U.S. person'' solely on the basis of
affiliation with a U.S. person or having its swaps guaranteed by a U.S.
person. Sullivan & Cromwell argued that foreign operations of a U.S.-
based bank do not have a ``direct and significant connection with
activities in, or effect on,'' U.S. commerce based solely on
affiliation with or guarantee by a U.S. parent bank.\170\ It stated
that overseas operations usually have a non-U.S. orientation (i.e.,
transactions with non-U.S. counterparties for non-U.S. business
purposes), and thus the connection to U.S. commerce is indirect and,
further, transactions with non-U.S. counterparties will not have a
significant effect on U.S. commerce. Other commenters raised similar
concerns about the lack of jurisdictional nexus. For example, The
Clearing House stated that the Commission must conclude that the risk
to the U.S. entity is ``significant'' before designating a non-U.S.
guaranteed entity a ``U.S. person,'' and further stated that a non-U.S.
entity that is subject to local capital
[[Page 45308]]
rules or swap dealer registration should be excluded from the
interpretation of ``U.S. person.'' \171\ SIFMA, addressing the control
issue, objected to including a non-U.S. person that is controlled by,
or under common control with, such person in the interpretation of the
term ``U.S. person'' since such control is insufficient to satisfy the
jurisdictional nexus required by section 2(i).\172\
---------------------------------------------------------------------------
\170\ See Sullivan & Cromwell (Aug. 13, 2012) at A2-3. See also
Hong Kong Banks (Aug. 27, 2012) at 4.
\171\ See The Clearing House (Aug. 27, 2012) at 17.
\172\ See SIFMA (Aug. 27. 2012) at A20. See also Australian
Bankers (Aug. 27, 2012) at 4 (stating that the control concept
should not be relevant in the definition of ``U.S. person,'' and
while common control may potentially indicate common risk, the
Commission's focus on the ultimate location of the risk is a more
relevant to the interpretation of the term ``U.S. person.'').
---------------------------------------------------------------------------
Japanese Bankers Association did not agree that these situations
effect a risk transfer to the U.S. person, arguing that the risk would
ultimately be incurred by the non-U.S. person and not by the U.S.
guarantor; thus, it believed that the term ``U.S. person'' should not
be interpreted to include a non-U.S. person guaranteed by a U.S.
person.\173\ The Coalition for Derivatives End-Users (``End-Users
Coalition'') expressed concerns about competitive implications, stating
that imputing U.S. status to a non-U.S. person guaranteed by a U.S.
person may disadvantage the non-U.S. affiliates of U.S. end-users,
since those non-U.S. affiliates may need to be guaranteed to enter into
swaps with non-U.S. counterparties.\174\
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\173\ See Japanese Bankers Association (Aug. 27. 2012) at 8.
\174\ See End-Users Coalition (Aug. 27, 2012) at 3 (urging the
Commission to exclude a foreign affiliate of a U.S. end-user,
guaranteed by that end-user, from its interpretation).
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f. Foreign Branch of U.S. Person
In the Proposed Guidance, the Commission stated that a foreign
branch of a U.S. swap dealer should be included in the Commission's
interpretation of the term ``U.S. person'' because it is a part, or an
extension, of a U.S. person.\175\ Several commenters agreed with the
Commission's interpretation.\176\ Senator Levin asserted that the ``JP
Morgan whale trades provide strong factual support for an inclusive
definition of U.S. person, in particular when it comes to the foreign
branch or agency of a U.S. corporation.''\177\ Other commenters
recommended that a foreign branch of a U.S. swap dealer be excluded
from the interpretation. Sullivan & Cromwell argued that a foreign
branch should not be included in the interpretation solely on the basis
that it is a part of a U.S. bank.\178\ Citi recommended that the
Commission's policy should be that a foreign branch of a U.S. swap
dealer is generally considered a non-U.S. person, so long as the branch
remains subject to Entity-Level Requirements and obtains substituted
compliance for Transaction-Level Requirements for transactions with
non-U.S. persons.\179\ In Citi's view, this would address comments by
the foreign branch's non-U.S. clients that they would have to register
as swap dealers or MSPs, while assuring that such non-U.S. clients'
swaps with the foreign branch would generally be covered by the
Transaction-Level Requirements or substituted compliance.
---------------------------------------------------------------------------
\175\ See Proposed Guidance, 77 FR at 41218.
\176\ See, e.g., Public Citizen (Aug. 27, 2012) at 5;
Greenberger (Aug. 27, 2012) at 3; Better Markets (Aug. 27, 2012) at
2, 6-7.
\177\ See Letter from Sen. Levin at 7.
\178\ See Sullivan & Cromwell (Aug. 13, 2012) at A6-7.
\179\ See Citi (Aug. 27, 2012) at 2-4 (stating that foreign
branches of U.S.-based swap dealers should not be considered ``U.S.
persons,'' but should still be subject to the Commission's Entity-
Level and Transactional-Level Requirements). See also State Street
(Aug. 27, 2012) at 3; IIB (Aug. 27, 2012) at 8.
---------------------------------------------------------------------------
g. Regulation S
Some commenters believed that the Commission's policy should
explicitly adopt the SEC's Regulation S definition of a ``U.S.
person.'' MFA/AIMA stated that Regulation S eliminates problems and
inconsistencies in the Commission's proposed interpretation.\180\ J.P.
Morgan stated that Regulation S would facilitate compliance by non-U.S.
market participants since they are familiar with the SEC's
approach.\181\ On the other hand, the Institute for Agriculture and
Trade Policy (``IATP'') argued against incorporating the Regulation S
definition, stating that it predates the prominence of the swaps
market.\182\
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\180\ See MFA/AIMA (Aug. 28, 2012) at 8-9.
\181\ See J.P. Morgan (Aug. 13, 2012) at 9.
\182\ See IATP (Aug. 27, 2012) at 4.
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h. Other Clarifications
A number of commenters voiced concerns regarding potential
expansion of the Commission's interpretation of the term ``U.S.
person,'' which they thought could result from the prefatory phrase
``includes, but is not limited to,'' and requested that the Commission
affirmatively state that non-U.S. persons are any persons that would
not be covered by the interpretation of the term ``U.S. person.'' \183\
A non-exhaustive ``U.S. person'' interpretation, they contended, would
create unnecessary uncertainty.
---------------------------------------------------------------------------
\183\ See SIFMA (Aug. 27, 2012) at A15; IIB (Aug. 27, 2012) at
11-12; EC (Aug. 24, 2012) at 1-2; Australian Bankers (Aug. 27, 2012)
at 4.
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A number of commenters further stated that the interpretation of
the term ``U.S. person'' should be applied only for purposes of the
registration and regulation of swap dealers and MSPs.\184\ The Futures
Industry Association (``FIA'') argued that the interpretation of the
term ``U.S. person'' should not extend to those provisions of the CEA
governing the activities of futures commission merchants (``FCMs'')
with respect to either exchange-traded futures (whether executed on a
designated contract market or a foreign board of trade) or cleared
swaps.\185\ SIFMA similarly requested that the Commission clarify that
the final interpretation of the term ``U.S. person'' does not override
existing market practice as it relates to futures or FCMs, including
with respect to clearing.\186\ SIFMA also requested that the Commission
clarify that the final interpretation of the term ``U.S. person'' for
cross-border swaps regulation is the single interpretation for all
Dodd-Frank swaps regulation purposes.\187\ Finally, SIFMA requested
that supranational organizations, such as the World Bank and
International Monetary Fund (and their affiliates) be excluded from the
interpretation.\188\
---------------------------------------------------------------------------
\184\ See, e.g., The Futures and Options Association Ltd.
(``FOA'') (Aug. 13, 2012) at 10-11; SIFMA (Aug. 27, 2012); IIB (Aug.
27, 2012); EC (Aug. 24, 2012).
\185\ See FIA (Aug. 27, 2012) at 2-3.
\186\ See SIFMA (Aug. 27, 2012) at A14-15.
\187\ Id.
\188\ Id. at A21.
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3. Commission Guidance
The Commission has carefully reviewed and considered the comments
received and is finalizing a policy that will generally set forth an
interpretation of the term ``U.S. person,'' as used in this Guidance,
with certain modifications to the proposed definition as described
below. As explained in the Proposed Guidance, the term ``U.S. person,''
as used in the context of CEA section 2(i), generally encompasses those
persons whose activities--either individually or in the aggregate--have
the requisite ``direct and significant'' connection with activities in,
or effect on, U.S. commerce within the meaning of section 2(i).\189\
The various prongs of
[[Page 45309]]
the Commission's interpretation are intended to identify persons for
which, in practice, the connection or effects required by section 2(i)
are likely to exist and thereby inform the public of circumstances in
which the Commission expects that the swaps provisions of the CEA and
the Commission's regulations would apply pursuant to the statute. In
this respect, the Commission will consider not only a person's legal
form and its domicile (or location of operation), but also the economic
reality of a particular structure or arrangement, along with all other
relevant facts and circumstances, in order to identify those persons
whose activities meet the ``direct and significant'' jurisdictional
nexus. Below, the Commission discusses each prong of its proposed
interpretation of the term ``U.S. person.''
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\189\ For purposes of this Guidance, the Commission interprets
the term ``U.S. person'' by reference to the extent to which swap
activities or transactions involving one or more such persons have
the relevant jurisdictional nexus. For example, this interpretation
would help determine whether non-U.S. persons engaging in swap
dealing transactions with ``U.S. persons'' in excess of the de
minimis level would be required to register and be regulated as a
swap dealer. In addition, for the same reasons, the term ``U.S.
person'' can be helpful in determining the level of U.S. interest
for purposes of analyzing and applying principles of international
comity when considering the extent to which U.S. transaction-level
requirements should apply to swap transactions.
---------------------------------------------------------------------------
First, the Commission will include in its consideration the
elements in prongs (i) and (ii)(A), as proposed, renumbered as prongs
(i) and (iii).\190\ These prongs of the ``U.S. person'' interpretation
generally incorporate a ``territorial'' concept of a U.S. person.\191\
That is, these are natural persons and legal entities that are
physically located or incorporated within U.S. territory and,
consequently, the Commission would generally consider swap activities
involving such persons to satisfy the ``direct and significant'' test
under section 2(i).\192\ The Commission clarifies that it expects that
prong (iii) would encompass legal entities that engage in non-profit
activities, as well as U.S. state, county and local governments and
their agencies and instrumentalities. Under prong (iii), the Commission
would generally interpret the term ``U.S. person'' to include also a
legal entity that is not incorporated in the United States if it has
its ``principal place of business'' in the United States. The
Commission intends that this interpretation would generally include
those entities that are organized outside the United States but have
the center of direction, control, and coordination of their business
activities in the United States.
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\190\ For clarity, the Commission has reordered the prongs of
its interpretation of the term ``U.S. person.''
\191\ For purposes of this Guidance, the Commission would
interpret the term ``United States'' to include the United States,
its states, the District of Columbia, Puerto Rico, the U.S. Virgin
Islands, and any other territories or possessions of the United
States government, or enclave of the United States government, its
agencies or instrumentalities.
\192\ In this respect, the Commission declines to adopt a
commenter's recommendation that IRS regulations should be relevant
in considering whether a person is included in the interpretation of
the term ``U.S. person.'' The Commission believes that adopting the
IRS's approach in the Commission's policy would be inappropriate;
rather, consistent with CEA section 2(i), the Commission's
interpretation of the term ``U.S. person'' focuses on persons whose
swap activities meet the ``direct and significant'' nexus.
---------------------------------------------------------------------------
The concept of an operating company having a principal place of
business has been addressed by the Supreme Court. In a recent case, the
Supreme Court described a corporation's principal place of business as
the ``place where the corporation's high level officers direct,
control, and coordinate the corporation's activities.'' \193\ The
Supreme Court explained that ```principal place of business' is best
read as referring to the place where a corporation's officers direct,
control, and coordinate the corporation's activities. It is the place
that Courts of Appeals have called the corporation's `nerve center.'
And in practice it should normally be the place where the corporation
maintains its headquarters--provided that the headquarters is the
actual center of direction, control and coordination, i.e., the `nerve
center,' and not simply an office where the corporation holds its board
meetings.'' \194\ The Commission notes that commenters on the Proposed
Guidance and Further Proposed Guidance generally did not object to the
inclusion in the interpretation of the term ``U.S. person'' of an
entity that has its principal place of business in the United States.
---------------------------------------------------------------------------
\193\ See Hertz Corp. v. Friend, 559 U.S. 77, 80 (2010)
(determining a corporation's principal place of business for
purposes of diversity jurisdiction).
\194\ Id. at 92-93.
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The Commission is of the view that the application of the principal
place of business concept to a collective investment vehicle may
require consideration of additional factors beyond those applicable to
operating companies. A collective investment vehicle is an entity or
group of related entities created for the purpose of pooling assets of
one or more investors and channeling these assets to trade or invest to
achieve the investment objectives of the investor(s), rather than being
a separate, active operating business.\195\ In this context, the
determination of where the collective investment vehicle's ``high level
officers direct, control, and coordinate the [vehicle's] activities''--
to apply the Hertz decision noted above--can involve several different
factors.\196\
---------------------------------------------------------------------------
\195\ See Further Proposed Guidance, 78 FR at 913.
\196\ As mentioned in the Introduction, Long-Term Capital
Portfolio LP, a Cayman Islands hedge fund advised by LTCM, collapsed
in 1998, leading a number of creditors to provide LTCM substantial
financial assistance under the supervision of the Federal Reserve
Bank of New York. High level officers at LTCM's offices in
Greenwich, Connecticut, directed, controlled and coordinated the
activities of Long-Term Capital Portfolio LP. This hedge fund, with
approximately $4 billion in capital and a balance sheet of just over
$100 billion had a swap book in excess of $1 trillion notional.
Federal Reserve Chairman Alan Greenspan testified that ``[h]ad the
failure of LTCM triggered the seizing up of markets, substantial
damage could have been inflicted on many market participants,
including some not directly involved with the firm, and could have
potentially impaired the economies of many nations, including our
own.'' Systemic Risks to the Global Economy and Banking System from
Hedge Fund Operations: Hearing Before the House Banking and Fin.
Services Comm., 105th Cong., 2nd sess. (Oct. 1, 1998) (statement of
Alan Greenspan, Chairman, Federal Reserve), available at 1998 WL
694498.
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The Commission is aware that the formation and structure of
collective investment vehicles involve a great deal of variability,
including with regard to the formation of the legal entities that will
hold the relevant assets and enter into transactions (including swaps)
in order to achieve the investors' objectives. Legal, regulatory, tax
and accounting considerations may all play a role in determining how
the collective investment vehicle is structured and the jurisdictions
in which the legal entities will be incorporated.\197\ Many legal
jurisdictions around the world have promulgated specialized regimes for
the formation of collective investment vehicles, which offer various
legal, regulatory, tax and accounting efficiencies.\198\
---------------------------------------------------------------------------
\197\ This discussion regarding the location of a collective
investment vehicle's principal place of business is solely for
purposes of applying Commission swaps regulations promulgated under
Title VII. The Commission does not intend to address here the
interpretation of ``principal place of business'' for any other
purpose.
\198\ See Gerald T. Lins, et al., Hedge Funds and Other Private
Funds: Regulation and Compliance Sec. 9:1 (Thomson Reuters 2012-
2013 ed. 2012).
---------------------------------------------------------------------------
In view of these circumstances, the Commission believes that for a
collective investment vehicle, the locations where the relevant legal
entities have registered offices, hold board meetings or maintain books
and records are generally not relevant in determining the principal
place of business of the collective investment vehicle. Instead, as
stated in the Hertz case cited above, the determination should
generally depend on the location of the ``actual center of direction,
control and coordination,'' i.e., the ``nerve center,'' of the
collective investment vehicle.
Hertz focuses on the place where the ``high level officers direct,
control, and coordinate'' the entity's activities.\199\ In this regard,
the Commission believes that the focus should not necessarily be
[[Page 45310]]
on the persons who are named as directors or officers of the legal
entities that comprise the collective investment vehicle.\200\ As noted
above, these legal entities are merely the legal structure through
which the investment objectives of the collective investment vehicle
are implemented. Rather, the analysis should focus on the persons who
are the equivalent for the collective investment vehicle to the ``high
level officers'' of an operating company because they direct, control
and coordinate key functions of the vehicle, such as formation of the
vehicle or its trading and investment.
---------------------------------------------------------------------------
\199\ See note 193 and accompanying text, supra.
\200\ In many cases, the entities that comprise the collective
investment vehicle may not have ``high level officers'' as
contemplated by Hertz, and the directors of the entities may be
individuals who are affiliated with a firm that is the legal counsel
or administrator of the collective investment vehicle and who may
serve as directors for many different vehicles. See Lins, supra note
198, at Sec. 9:4.
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The ``high level officers [who] direct, control and coordinate''
the collective investment vehicle may be those senior personnel who
implement the investment and trading strategy of the collective
investment vehicle and manage its risks, and the location where they
conduct the activities necessary to implement the investment strategies
of the vehicle may be its center of direction, control and
coordination. In this regard, the Commission notes that the achievement
of the investment objectives of a collective investment vehicle
typically depends upon investment performance and risk management.
Investors in a collective investment vehicle seek to maximize the
return on their investment while remaining within their particular
tolerance for risk. Thus, the key personnel relevant to this aspect of
the analysis are those senior personnel responsible for implementing
the vehicle's investment strategy and its risk management. Depending on
the vehicle's investment strategy, these senior personnel could be
those responsible for investment selections, risk management decisions,
portfolio management, or trade execution.\201\
---------------------------------------------------------------------------
\201\ The Commission understands that the collective investment
vehicle may obtain the services of the relevant personnel through a
variety of arrangements, including contracting with an asset manager
that employs the personnel, contracting with other employers, or
retaining the personnel as independent contractors. Thus, in this
analysis, the Commission would generally expect to consider the
location of the personnel who undertake the relevant activities,
regardless of their particular employment arrangements.
---------------------------------------------------------------------------
The achievement of a collective investment vehicle's investment
objectives may be closely linked to its formation. Decisions made in
the structuring and formation of the collective investment vehicle may
have a significant effect on the performance of the vehicle. Thus, for
purposes of identifying the vehicle's principal place of business, the
Commission may also consider the location of the senior personnel who
direct, control and coordinate the formation of the vehicle (i.e., the
promoters).\202\ The location of the promoters of the collective
investment vehicle is relevant, particularly where the vehicle has a
specialized structure or where the promoters of the vehicle continue to
be integral to the ongoing success of the fund, including by retaining
overall control of the vehicle. The location where the promoters of the
collective investment vehicle act to form the vehicle and bring it to
commercial life is relevant in determining the center of direction,
control and coordination of the vehicle, and those promoters may be the
``high level officers'' of the vehicle referred to in Hertz.\203\
---------------------------------------------------------------------------
\202\ The promoters who form a collective investment vehicle may
be integral to the ongoing success of the collective investment
vehicle. In fact, the importance of the role played by the promoters
of a legal entity has long been recognized. See generally 1A
Fletcher Cyc. Corp. Sec. 189. For example, in Old Dominion Copper
Mining & Smelting Co. v. Bigelow, the court drew upon English law in
describing the promoters as follows:
In a comprehensive sense promoter includes those who undertake
to form a corporation and to procure for it the rights,
instrumentalities and capital by which it is to carry out the
purposes set forth in its charter, and to establish it as fully able
to do its business. Their work may begin long before the
organization of the corporation, in seeking the opening for a
venture and projecting a plan for its development, and it may
continue after the incorporation by attracting the investment of
capital in its securities and providing it with the commercial
breath of life.
203 Mass. 159, 177 (1909), aff'd, 225 U.S. 111 (1912).
Modern law continues to refer to the responsibility of promoters
of legal entities. See, e.g., SEC Form D, instructions to Item 3
(requiring information regarding the ``promoters'' of a securities
issuer). See also In Re Charles Schwab Corp. Sec. Litig., 2010 WL
1261705 (N.D. Cal. Mar. 30, 2010) (discussing responsibility of
``fund managers and promoters'' to operate a collective investment
vehicle in accordance with its formation documents).
The Commission generally does not intend that when the promoters
of a collective investment vehicle serve an administrative, purely
ministerial function of handling the flow of funds from investors
into the vehicle, the location of these personnel would be relevant
in this context.
\203\ The Commission is aware that the boards of directors (or
equivalent corporate bodies) of the legal entities that comprise a
collective investment vehicle typically have the authority to
appoint or remove the legal entity's investment manager,
administrator, and auditor, and to approve major transactions
involving the legal entity and the legal entity's audited financial
statements. But since these functions are not key to the actual
implementation of the investment objectives of the collective
investment vehicle, and noting that Hertz focuses on the ``high
level officers'' of the entity rather than its directors, the
Commission would generally not view the boards of directors of the
legal entities to be key personnel for the collective investment
vehicle.
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Accordingly, the Commission will generally consider the principal
place of business of a collective investment vehicle to be in the
United States if the senior personnel responsible for either (1) the
formation and promotion of the collective investment vehicle or (2) the
implementation of the vehicle's investment strategy are located in the
United States, depending on the facts and circumstances that are
relevant to determining the center of direction, control and
coordination of the vehicle.
Since the Commission recognizes that the structures of collective
investment vehicles vary greatly, the Commission believes it is useful
to provide examples to illustrate how the Commission's approach could
apply to a consideration of whether the ``principal place of business''
of a collective investment vehicle is in the United States in
particular hypothetical situations. However, because of variations in
the structure of collective investment vehicles as well as the factors
that are relevant to the consideration of whether a collective
investment vehicle has its principal place of business in the United
States under this Guidance, these examples are for illustrative
purposes only. In addition, these examples are not intended to be
exclusive or to preclude a determination that any particular collective
investment vehicle has its principal place of business in the United
States.
Example 1. An asset management firm located in the United States
establishes a collective investment vehicle outside the United
States (``Fund A'').\204\ Typically, the formation of the collective
investment vehicle by the personnel of the asset management firm
involves the selection of firms to be the administrator, prime
broker, custodian and placement agent for the
[[Page 45311]]
collective investment vehicle.\205\ The legal entities comprising
the collective investment vehicle enter into agreements retaining
the asset management firm as investment manager. Personnel of the
asset management firm who are located in the United States will be
responsible for implementing Fund A's investment and trading
strategy and its risk management. Based on the above facts, the
Commission would be inclined to view the principal place of business
of Fund A as being in the United States,\206\ and therefore each of
the legal entities that comprise Fund A would be within the
interpretation of the term ``U.S. person.''
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\204\ The collective investment vehicle could be a hedge fund, a
private equity fund, or other type of investment fund. The
Commission is aware that the asset management firm may use any of a
variety of structures to form the collective investment vehicle,
which may involve one or more legal entities. In a common hedge fund
structure, the asset management firm forms a legal entity outside
the United States which holds the collective investment vehicle's
assets and is the legal counterparty in its investment transactions,
including swaps (a ``master fund''). If this structure is used, then
typically the equity of the master fund is held by several ``feeder
funds,'' each of which is a separate legal entity formed by the
asset management firm with characteristics that are important to a
different type of investor. Each investor in the collective
investment vehicle obtains an equity interest in one of the feeder
funds and thereby holds an indirect interest in the master fund. The
Commission intends that this Example 1 would encompass, but not be
limited to, a collective investment vehicle using a master/feeder
structure such as this.
\205\ The collective investment vehicle's administrator
generally handles day-to-day administrative activities, such as
operating the vehicle's bank account, issuing payment instructions,
providing net asset calculations, calculating fees, receiving and
processing subscriptions, preparing accounts, maintaining the
shareholder register, arranging payments of redemption proceeds,
coordinating communications with shareholders, and overseeing anti-
money laundering compliance. See id. at Sec. 9:6. The prime broker
facilitates the execution of the vehicle's investment transactions,
including swaps. The custodian is responsible for holding the
vehicle's assets. The placement agent markets and sells shares to
investors.
The Commission generally considers all of these functions,
although important to the collective investment vehicle, to be
ministerial functions that are generally not relevant to the
determination of the location of a collective investment vehicle's
principal place of business. Thus, even if all of these firms and
all the personnel performing these functions were outside the United
States, the Commission would nonetheless be inclined to view the
principal place of business of Fund A as within the United States.
Additional elements that could be relevant to the determination
include the location of the collective investment vehicle's primary
assets, and the location of the collective investment vehicle's
counterparties. However, the Commission believes that the location
of these additional elements outside the United States should
generally not preclude an interpretation that the collective
investment vehicle's principal place of business is in the United
States.
\206\ The Commission notes that elements of Example 1 are
similar to the facts of a recent court case involving a similar
issue--the location of a collective investment vehicle's ``center of
main interest'' for purposes of bankruptcy law. See Bear Stearns,
note 7 and accompanying text, supra. In Bear Stearns, the collective
investment vehicle's ``center of main interest'' was found to be in
the United States even though its registered office was in the
Cayman Islands, because it had no employees or managers in the
Cayman Islands, and its investment manager was located in New York.
Id., 374 B.R. at 129-30. The court further observed that the
administrator that ran the back-office operations was in the United
States, the collective investment vehicle's books and records were
in the United States before the foreign proceedings began, and all
of its liquid assets were located in the United States. Id. at 130.
In addition, investor registries were maintained in Ireland;
accounts receivables were located throughout Europe and the United
States; and counterparties to master repurchase and swap agreements
were based both inside and outside the United States--but none were
claimed to be in the Cayman Islands. Id.
The Commission believes that Bear Stearns aligns with its view
that the principal place of business of a collective investment
vehicle should not be determined based on where it is organized or
has its registered office, but rather should be based on an analysis
of the relevant facts and circumstances. However, the Commission
notes that under bankruptcy law various factors, particularly
factors relating to the debtor's assets and creditors, may be
relevant to the determination of where a debtor has its ``center of
main interest'' for purposes of determining whether a U.S.
bankruptcy court has jurisdiction over the matter. See, e.g., In re
SPhinX, Ltd., 351 B.R. 103 (Bankr. S.D.N.Y. 2006) (including various
factors in the determination of center of main interest, including
the location of the debtor's primary assets and the location of the
majority of the debtor's creditors). The Commission believes that
the factors that are relevant in such bankruptcy jurisdictional
cases differ from those that are relevant to the consideration of
whether a collective investment vehicle has its principal place of
business in the United States for purposes of this Guidance.
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Example 2. An asset management firm located outside the United
States establishes a collective investment vehicle located outside
the United States (``Fund B''). Personnel of the asset management
firm who are located outside the United States will be responsible
for implementing Fund B's investment and trading strategy and its
risk management. However, personnel in two offices of the asset
management firm--one of which is located outside the United States
and the other of which is located in the United States--will be
involved in managing Fund B's investment portfolio. Although the
personnel in the U.S. office may act autonomously on a day-to-day
basis, they will be under the direction of senior personnel in the
non-U.S. office regarding how they are implementing the investment
objectives of Fund B. In terms of the asset management firm's
internal organization, the personnel in the U.S. office report to
the personnel in the non-U.S. office, who also generally hold higher
positions within the firm. Because the personnel located inside the
United States merely facilitate the implementation of the investment
objectives of Fund B, for which senior personnel outside the United
States are responsible, the Commission would be inclined to view the
principal place of business of Fund B as not being in the United
States.\207\ As a result, assuming that Fund B is not majority-owned
by U.S. persons (as discussed further below), Fund B would not be
within the interpretation of the term ``U.S. person,'' and none of
the legal entities that comprise Fund B would be U.S. persons
(unless the legal entity was actually incorporated or organized in
the United States).
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\207\ The Commission expects that in this example, this result
would be the same if the asset management firm entered into a
subadvisory agreement with an independent firm that employed the
personnel in the U.S. office described in this example. That is,
regardless of whether the U.S. personnel are employed by the asset
management firm or a third party employer, the relevant issue is
whether the personnel who fulfill the key functions relating to its
formation or the achievement of its investment objectives are
located in, or outside of, the United States.
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Example 3. A financial firm located in the United States
establishes a collective investment vehicle outside the United
States (``Fund C''). The collective investment vehicle includes a
single legal entity organized outside the United States, the assets
of which are segregated into several separate classes.\208\ The U.S.
financial firm arranges with several unaffiliated investment
management firms to manage the assets in the various classes; an
investment management firm affiliated with the U.S. financial firm
may also manage the assets in one or more of the classes. Some of
these investment management firms are located in, and others
outside, the United States. Under the terms of the contracts between
Fund C, the U.S. financial firm and these investment management
firms, Fund C has delegated responsibility for the overall control
of its investment strategies to the U.S. financial firm that
established Fund C, and the U.S. financial firm will have rights to
reallocate Fund C's assets among the investment management firms for
various reasons, including the U.S. financial firm's discretion
regarding Fund C's investment strategies. Based on the above facts,
the Commission would be inclined to view the principal place of
business of Fund C as being in the United States, even though some
of the investment managers involved in implementing Fund C's
investment and trading strategy are located outside the United
States. Therefore, Fund C (including each of the legal entities that
comprise Fund C) would be within the interpretation of the term
``U.S. person.'' \209\
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\208\ Legal entities that may be formed with separate classes
are known in various jurisdictions as segregated portfolio
companies, protected cell companies or segregated accounts
companies. A collective investment vehicle with a structure such as
this is typically referred to as a ``hedge fund platform'' or an
``umbrella'' or ``multi-series'' hedge fund.
\209\ The Commission expects that the result would generally be
the same where the assets of Fund C are not segregated into separate
classes.
The Commission recognizes that the structures of collective
investment vehicles are complex and varied, and it does not intend to
establish bright line tests for when the principal place of business of
a collective investment vehicle would or would not be within the United
States. Rather, the Commission's examples above are intended to
illustrate the considerations that would be relevant to whether a
collective investment vehicle's principal place of business is in the
United States, within the framework of reviewing all the relevant facts
and circumstances.\210\
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\210\ The Commission believes that Commission regulation 140.99,
which provides for persons to request that the staff of the
Commission provide written advice or guidance, would be an
appropriate mechanism for a collective investment vehicle to seek
guidance as to whether the principal place of business of the
vehicle is in the United States for purposes of applying the
Commission swaps regulations promulgated under Title VII.
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The Commission also understands that non-U.S. individuals,
institutions, pension plans or operating companies may retain asset
management firms in the United States to provide a range of asset
management and other investment-related services. Where the individual,
institution, pension plan or operating company is not within any
[[Page 45312]]
prong of the interpretation of the term ``U.S. person'' described in
this Guidance (including prongs (iii) and (vi) which relate to
collective investment vehicles), then the Commission generally believes
that the person would not come within the ``U.S. person''
interpretation solely because it retains an asset management firm
located in the United States to manage its assets or provide other
financial services.\211\
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\211\ However, this policy (that non-U.S. persons generally do
not become U.S. persons solely by retaining U.S. asset management
firms) would not apply to the legal entities comprising a collective
investment vehicle that is within the interpretation of the term
``U.S. person.'' Rather, those legal entities would be within the
interpretation of the term ``U.S. person'' for other reasons (e.g.,
because the vehicle has its principal place of business in the
United States or a majority of its direct or indirect owners are
U.S. persons)--not solely because they had retained a U.S. asset
management firm.
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Second, the Commission will include in its consideration the
elements in the alternative version of prong (ii)(B) that was described
in the Further Proposed Guidance (and renumbered in the Guidance as
prong (vii)). The relevant elements in the alternative version are
whether a legal entity is directly or indirectly majority-owned by one
or more U.S. persons,\212\ in which one or more of these U.S. person(s)
bears unlimited responsibility for the obligations and liabilities of
such legal entity, and the entity is not a corporation, limited
liability company, limited liability partnership or similar entity
where shareholders, members or partners have limited liability.
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\212\ In this context, the term ``U.S. person'' refers to those
natural persons or legal entities that meet prong (i), (ii), (iii),
(iv), or (v) of the interpretation of ``U.S. person.''
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In response to comments on the Proposed Guidance, the Commission
intends that this prong would cover entities that are directly or
indirectly majority-owned by U.S. person(s), but not those legal
entities that have negligible U.S. ownership interests. In the
Commission's view, where the structure of an entity is such that the
U.S. owners are ultimately liable for the entity's obligations and
liabilities, the connection to activities in, or effect on, U.S.
commerce would generally satisfy section 2(i), irrespective of the fact
that the ownership is indirect. The Commission expects that this
``look-through'' aspect of the interpretation also would serve to
discourage persons from engaging in activities outside of the Dodd-
Frank regulatory regime by creating such indirect ownership structures.
In the Commission's view, where one or more U.S. owners has
unlimited responsibility for losses or nonperformance by its majority-
owned affiliate, there is generally a direct and significant connection
with activities in, or effect on, commerce of the United States within
the meaning of section 2(i). Therefore, for purposes of section 2(i),
the majority-owned entity would appropriately be considered a ``U.S.
person.'' \213\ Unlimited liability corporations where U.S. persons
have direct or indirect majority ownership and any such U.S. persons
have unlimited liability for the obligations and liabilities of the
entity would generally be covered under this prong.\214\ By contrast, a
limited liability corporation or limited liability partnership would
generally not be covered under this prong; the Commission also
clarifies, in response to comments on the Further Proposed Guidance,
that it intends that entities in other jurisdictions that are similar
to limited liability corporations or limited liability partnerships in
that none of the owners of such entities bear unlimited liability for
the entity's obligations and liabilities would generally be excluded
from this prong.
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\213\ When Lehman Brothers collapsed in 2008, it had a complex
web of affiliates. This included LBIE, an unlimited liability
company in London. At that time, it had more than 300 outstanding
creditor and debtor balances with its affiliates amounting to more
than $21 billion in total. What happened to LBIE is directly
relevant to the current discussions about cross-border application
of swaps reforms, as LBIE had more than 130,000 swaps contracts
outstanding when it failed. Many of the Lehman Brothers entities
were guaranteed by the parent, Lehman Brothers Holdings, in the
United States. More than $28 billion in client assets and money were
caught up in the bankruptcy of the UK entity. This uncertainty led,
further, to a run on many other financial institutions when
customers feared for their positions and collateral housed in
overseas affiliates of other U.S. financial institutions. See Lehman
Brothers Progress Report, note 6 and accompanying text, supra.
\214\ Unlimited liability corporations include, solely by way of
example, entities such as an unlimited company formed in the U.K.,
see Brian Stewart, Doing Business in the United Kingdom Sec.
18.02[2][c], or an unlimited liability company formed under the law
of Alberta, British Columbia, or Nova Scotia, see Richard E.
Johnston, Doing Business in Canada Sec. 15.04[5].
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The Commission has considered the comments requesting that the
interpretation include consideration of whether the U.S. person
majority owners have unlimited responsibility for ``all of'' the
obligations and liabilities of the entity in connection with this prong
of the interpretation. The Commission believes that even if there are
some potential obligations and liabilities of the entity that may not
flow to the U.S. persons, the risk of unlimited responsibility for
other obligations and liabilities would generally be a sufficient nexus
to the United States for purposes of section 2(i). Similarly, it would
generally not be necessary for all the U.S. persons who are majority
owners to bear unlimited responsibility (as some commenters suggested).
Rather, if any of the U.S. persons who are direct or indirect majority
owners bears unlimited responsibility for the obligations and
liabilities of the entity, it would generally be covered by this prong
of the interpretation.
In response to requests from commenters on the Proposed Guidance,
the Commission clarifies that it does not intend that prong (vii) would
cover legal entities organized or domiciled in a foreign jurisdiction
but whose swaps obligations are guaranteed by a U.S. person.\215\ To be
clear, the Commission remains concerned, as explained in the Proposed
Guidance, about the risks to a U.S. guarantor that flow from its
guarantee of the swaps obligations of an entity that is organized or
domiciled abroad.\216\ Yet, a guarantee does not necessarily provide
for ``unlimited responsibility for the obligations and liabilities of
the guaranteed entity'' in the same sense that the owner of an
unlimited liability corporation bears such unlimited liability.\217\
The Commission believes, therefore, that its concern regarding the
risks associated with guarantee arrangements can, consistent with CEA
section 2(i) and in the interests of international comity,
appropriately be addressed in a more targeted fashion without broadly
treating such guaranteed entities as U.S. persons at this time.
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\215\ Also, the Commission does not interpret section 2(i) to
require that it treat a non-U.S. person as a ``U.S. person'' solely
because it is controlled by or under common control with a U.S.
person.
\216\ See, e.g., Letter from Sen. Levin at 10 (``If a U.S.-based
parent company provides an implicit or explicit guarantee,
regardless of the form of the guarantee, to a non-U.S. subsidiary or
affiliate, the risk is effectively transferred to the U.S. person.
In such circumstances, the exact form of the guarantee should not
prevent the CFTC from demanding compliance with the CFTC's
derivatives safeguards.'').
\217\ Since a guarantee is treated in law as a contract, a
guarantor may be protected by legal defenses to the enforcement of
the contract. Also, in some circumstances, a guarantee may not be
enforceable with respect to underlying obligations that are
materially altered without the guarantor's consent. See, e.g.,
Debtor-Creditor Law Sec. 44.04 (Theodore Eisenberg ed., Matthew
Bender 2005).
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Thus, for example, as set forth below, where a non-U.S. affiliate
of a U.S. person has its swap dealing obligations with non-U.S.
counterparties guaranteed by a U.S. person,\218\ the guaranteed
affiliate generally would be required to count those swap dealing
transactions with non-U.S. counterparties (in addition to its swap
dealing transactions with U.S. persons) for purposes of
[[Page 45313]]
determining whether the affiliate exceeds a de minimis amount of swap
dealing activity and must register as a swap dealer. The Commission
notes that where a non-U.S. affiliate of a U.S. person has its swap
dealing obligations with non-U.S. counterparties guaranteed by a U.S.
person, the guarantee creates a significant risk transfer into the
United States. In the absence of such guarantees, non-U.S.
counterparties may be unwilling to enter into swaps with such non-U.S.
affiliates. As for the substantive swaps requirements, as discussed
below, Transaction-Level Requirements generally would apply to swaps
between a non-U.S. swap dealer or non-U.S. MSP on the one hand, and a
U.S.-guaranteed affiliate on the other hand, though such swaps may be
subject to substituted compliance, as appropriate. The Commission
generally expects that, in considering international comity and the
factors set forth in the Restatement (e.g., the character of the
activity to be regulated, the existence of justified expectations, the
likelihood of conflicts with regulation by foreign jurisdictions), this
approach would strike a reasonable balance in assuring that the swaps
market is brought under the new regulatory regime as directed by
Congress, consistent with section 2(i) of the CEA.
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\218\ See note 267 and accompanying text, supra, for guidance
regarding the Commission's interpretation of the term ``guarantee.''
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Third, the Commission will include in its interpretation of the
term ``U.S. person'' the elements in prong (iii), (renumbered as prong
(viii)), substantially as proposed. Commenters did not comment on, nor
object to, this prong. The Commission clarifies that it expects that
this prong would encompass a joint account where any one of the
beneficial owners is a U.S. person.
Fourth, the Commission will include in its interpretation of the
term ``U.S. person'' the elements in the alternative prong (iv) that
was described in the Further Proposed Guidance (renumbered in the
Guidance as prong (vi)), with some modifications. The Commission
understands from commenters that the determination by some collective
investment vehicles of whether they are majority-owned by U.S. persons
may pose practical difficulties. In response to these practical
difficulties, the Commission has eliminated the reference to
``indirect'' majority ownership in this prong. As revised, this prong
no longer refers to ``direct or indirect'' majority ownership by U.S.
persons.
Under alternative prong (vi), any commodity pool, pooled account,
investment fund or other collective investment vehicle that is
majority-owned by one or more U.S. person(s) \219\ would be deemed a
U.S. person. For purposes of this prong, majority-owned means the
beneficial ownership of more than 50 percent of the equity or voting
interests in the collective investment vehicle. The Commission expects
that the collective investment vehicle would: (1) Determine whether its
direct beneficial owners are U.S. persons described in prong (i), (ii),
(iii), (iv), or (v) of the term ``U.S. person,'' and (2) ``look-
through'' the beneficial ownership of any other legal entity invested
in the collective investment vehicle that is controlled by or under
common control with the collective investment vehicle in determining
whether the collective vehicle is majority-owned by U.S. persons.
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\219\ The term ``U.S. person,'' as used in this context, refers
to those natural persons or legal entities that meet (i), (ii),
(iii), (iv), or (v) of the interpretation of ``U.S. person.''
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For example, a limited company is formed under the laws of the
Cayman Island as a collective investment vehicle that engages in swap
transactions. It has a single investor, which is an investment company
registered with the Securities and Exchange Commission under the
Investment Company Act of 1940. Shares in the registered investment
company are only owned by United States persons and both the Cayman
Island limited company and the registered investment company are
sponsored by the same investment adviser. The Cayman Island limited
company would be viewed as a ``controlled foreign corporation'' of the
registered investment company. Because the Cayman Island limited
company is controlled by the same investment adviser as the investor
registered investment company, the Cayman Island limited company would
be required to ``look through'' the registered investment company and
would be considered majority owned by U.S. persons. Therefore, under
revised prong (vi), the Cayman Island limited company generally would
be a U.S. person, subject to consideration of all the facts and
circumstances.
As another example, a limited company is formed under the laws of
the Cayman Island by an investment manager as a collective investment
vehicle that engages in swap transactions as part of its investment
strategy (``Master Fund''). It has two investors, which are also
collective investment vehicles that were formed by the same investment
manager for the purpose of investing in the Master Fund. One investor
collective investment vehicle is formed under the laws of the state of
Delaware and the other investor collective investment vehicle is a
limited company formed under the laws of the Cayman Island. Because
Master Fund and the two investor collective investment vehicles are
under common control by the investment manager, the Master Fund is
required to ``look through'' the two investor vehicles to their
beneficial owners to determine whether it is majority owned by U.S.
persons. Whether the Master Fund is a U.S. person will require the
assessment of whether the majority of its equity is held indirectly by
U.S. persons through the two investor vehicles.
However, where a collective investment vehicle is owned in part by
an unrelated investor collective investment vehicle, the collective
investment vehicle need not ``look through'' the unrelated investor
entity, but may reasonably rely upon written, bona fide representations
from the unrelated investor entity regarding whether it is a U.S.
person,\220\ unless the investee collective investment vehicle has
reason to believe that such unrelated investor entity was formed or is
operated principally for the purpose of avoiding looking through to the
ultimate beneficial owners of that entity.\221\ The Commission expects
that the collective investment vehicle would take reasonable ``due
diligence'' steps with respect to its investors in making this
determination, along the lines of the verifications that the collective
investment vehicle may conduct in connection with other regulatory
requirements.\222\
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\220\ The ability of the collective investment vehicle to rely
on the bona fide representation of the unrelated investor entity
does not affect the due diligence that the unrelated investor entity
should conduct in order to make such representation to the
collective investment vehicle.
\221\ The Commission has applied similar anti-evasion standards
in other contexts. See, e.g., 17 CFR 4.7(a)(1)(iv)(D) (providing
that a passive investment vehicle will be considered a non-U.S.
person for purposes of section 4.7 under certain circumstances
provided that the entity was ``not formed principally for the
purpose of facilitating investment by persons who do not qualify as
Non-United States persons in a pool'' whose operator is claiming
relief under that section).
\222\ See the discussion of due diligence below, which the
Commission believes is generally applicable to the ``due diligence''
required by the collective investment vehicle in this context.
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The Commission is also including a minor modification to clarify
that it expects that the interpretation in prong (vi) would apply
irrespective of whether the collective investment vehicle is organized
or incorporated in the United States. Similar to the Commission's
analysis with respect to prong (vii) discussed above, the Commission's
[[Page 45314]]
policy is that the place of a collective investment vehicle's
organization or incorporation would not necessarily be determinative of
its status as a ``U.S. person'' for purposes of CEA section 2(i). As
noted above, collective investment vehicles are created for the purpose
of pooling assets from investors and channeling these assets to trade
or invest in line with the objectives of the investors. In the
Commission's view, these are generally passive investment vehicles that
serve as a means to achieve the investment objectives of their
beneficial owners, rather than being separate, active operating
businesses. As such, the beneficial owners would be directly exposed to
the risks created by the swaps that their collective investment
vehicles enter into.\223\ Therefore, the Commission's policy is that if
U.S. persons beneficially own more than 50 percent of the equity or
voting interests in a collective investment vehicle, then the
collective investment vehicle would ordinarily satisfy the ``direct and
significant'' standard of CEA section 2(i).
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\223\ A collective investment vehicle is an arrangement pursuant
to which funds of one or more investors are pooled together and
invested on behalf of such investors by a manager. Typically,
investors do not have day-to-day control over the management or
operation of the vehicle and are essentially passive, beneficial
owners of the vehicle's assets. Prior to participating in a
collective investment vehicle, an investor enters into an
arrangement with the vehicle which governs the fees collected by the
manager of the vehicle and the investor's payout from the vehicle,
which may include periodic payments. Typically a limited liability
entity such as a corporation, limited partnership or limited
liability company is used as part of the arrangement so that
investor liability is limited to the investor's beneficial interest
in the vehicle's assets.
With respect to a swap between a collective investment vehicle
and a non-U.S. swap dealer, the Commission believes that losses
borne by the vehicle upon a default by the non-U.S. swap dealer are
better seen as losses incurred by the investors in the collective
investment vehicle rather than by the vehicle itself. In contrast
with a collective investment vehicle, when an operating company
enters into a swap with a non-U.S. swap dealer, losses borne by the
operating company upon a default by the non-U.S. swap dealer are
better seen as losses incurred by the operating company and only
indirectly by its shareholders. Therefore, prong (vi) only relates
to collective investment vehicles and does not extend to operating
companies.
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The Commission is also revising its interpretation in prong (vi) to
exclude non-U.S. publicly-offered, as opposed to publicly-traded,
collective investment vehicles. That is, a collective investment
vehicle that is publicly offered to non-U.S. persons, but not offered
to U.S. persons, would generally not be included within the
interpretation of the term U.S. person. This revision is intended to
address comments that publicly-traded funds are only a subset of non-
U.S. regulated collective investment vehicles and that ownership
verification is expected to be particularly difficult for pools, funds,
and other collective investment vehicles that are publicly
offered.\224\
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\224\ The publicly-offered collective investment vehicle could
be a UCITS (Undertakings for Collective Investment in Transferable
Securities). See Directive 2009/65/EC of the European Parliament and
of the Council (Jul. 13, 2009), available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:302:0032:0096:EN:PDF. Under the
Commission's interpretation of section 2(i), a UCITS would not be
included in the term ``U.S. person,'' provided it is not offered,
directly or indirectly, to U.S. persons.
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In addition, a collective investment vehicle that is publicly
offered only to non-U.S. persons and not offered to U.S. persons
generally would not fall within any of the prongs of the interpretation
of the term ``U.S. person.''
Fifth, the Commission will not include in its interpretation of the
term ``U.S. person'' the elements in proposed prong (v), which related
to registered commodity pool operators. The Commission agrees with
commenters that neither the location (nor the nationality), nor the
registration status, of the pool operator would normally, without more,
be determinative of whether the underlying pool(s) should be included
in its interpretation of the term ``U.S. person.'' The Commission has
further considered that, as discussed above, the relevant elements for
a commodity pool or other collective investment vehicle would generally
be whether or not its principal place of business is in the United
States or it is majority owned by U.S. persons. The Commission believes
that proposed prong (v) could be overly broad and have the effect of
capturing commodity pools with minimal participation of U.S. persons
and a minimal U.S. nexus.
Sixth, the Commission will include in its interpretation of the
term ``U.S. person'' the elements in prong (vi) (renumbered as prong
(iv)) relating to pension plans. In response to comments, though, the
Commission is clarifying that it does not intend that its
interpretation encompass pension plans that are primarily for foreign
employees of U.S.-based entities described in prong (iii) of the
interpretation. Also, as noted above in the discussion of collective
investment vehicles, the Commission does not generally expect that a
pension plan which is not a U.S. person would become a U.S. person
simply because some of the individuals or entities that manage the
investments of the pension plan are located or organized in the United
States.
Finally, the Commission will include in its interpretation of the
term ``U.S. person'' the elements in prong (vii) (renumbered as prongs
(ii) and (v)) pertaining to an estate or trust, with certain
modifications to take into account the views of commenters who
addressed this issue, and the legal and practical considerations that
are relevant to the treatment of estates and trusts for purposes of the
Dodd-Frank Act. The Commission agrees with the commenters who stated
that treatment of an estate or trust should generally not depend on
whether the income of the estate or trust is subject to U.S. tax. The
Commission understands that whether income is subject to U.S. tax can
depend on a variety of factors, including the source of the income,
which may not be relevant to whether the Dodd-Frank Act should apply to
swaps entered into by the estate or trust.
After further consideration, the Commission will include in its
interpretation of the term ``U.S. person'' (a) an estate if the
decedent was a U.S. person at the time of death and (b) a trust if it
is governed by the law of a state or other jurisdiction in the United
States and a court within the United States is able to exercise primary
supervision over the administration of the trust. For what it expects
to be the relatively few estates that would use swaps (most likely for
purposes of investment hedging), the Commission believes that the
treatment of such swaps should generally be the same as for swaps
entered into by the decedent during life. If the decedent was a party
to any swaps at the time of death, then those swaps should generally
continue to be treated in the same way after the decedent's death, when
the swaps would most likely pass to the decedent's estate. Also, the
Commission expects that this element of the interpretation will be
predictable and easy to apply for natural persons planning for how
their swaps will be treated after death, for executors and
administrators of estates, and for the swap counterparties to natural
persons and estates.
With respect to trusts, the Commission expects that its approach
would be in line with how trusts are treated for other purposes under
law. The Commission has considered that each trust is governed by the
laws of a particular jurisdiction, which may depend on steps taken when
the trust was created or other circumstances surrounding the trust. The
Commission believes that if a trust is governed by U.S. law (i.e., the
law of a state or other jurisdiction in the United States), then it
would generally be reasonable to treat the trust as a U.S. person for
purposes of the Dodd-Frank Act. Another relevant element in this regard
would be whether a court within the United States is able
[[Page 45315]]
to exercise primary supervision over the administration of the
trust.\225\ The Commission expects that including this element of the
interpretation would generally align the treatment of the trust for
purposes of the Dodd-Frank Act with how the trust is treated for other
legal purposes. For example, the Commission expects that if a person
could bring suit against the trustee for breach of fiduciary duty in a
U.S. court (and, as noted above, the trust is governed by U.S. law),
then treating the trust as a U.S. person would generally be in line
with how it is treated for other purposes.
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\225\ The Commission is aware that one element applied by the
Internal Revenue Service to determine if a trust is a U.S. person
for tax purposes depends on whether a court within the United States
is able to exercise primary supervision over the administration of
the trust. See 26 CFR 301.7701-7(a)(1)(i). The Commission believes
that precedents developed under tax law could be relevant, as
appropriate, in applying this aspect of its interpretation of the
term ``U.S. person.'' However, the Commission does not intend to
formally adopt the Internal Revenue Service test for this purpose.
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The Commission disagrees with commenters that the status of an
estate or trust should be based solely on the status of the executor,
administrator or trustee.\226\ For one thing, this would mean that the
treatment of the estate or trust could change if, for example, the
executor or trustee relocates its offices. The Commission also does not
believe it would be appropriate that the treatment of a trust would
depend solely on the identity of the beneficiaries to the trust
because, among other reasons, the beneficiaries may be described as a
class of persons, rather than particular persons. In the Commission's
view, more important considerations in formulating its policy are
whether the treatment of the estate or trust is predictable and whether
it is in line with how the entity is treated for other purposes. The
Commission would also consider other facts and circumstances related to
the estate or trust that could be relevant to whether the entity should
be within the interpretation of the term ``U.S. person'' in the context
of section 2(i).
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\226\ The Commission does not intend to preclude considerations
relating to the trustee in determining whether the trust is governed
by U.S. law or subject to the jurisdiction of U.S. courts, if any
such considerations are relevant. Rather, the Commission believes
that the status of the trustee would generally not be directly
relevant to determining if a trust should be treated as a U.S.
person.
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a. Due Diligence
As described above, many commenters indicated that the information
necessary to accurately assess the status of their counterparties as
U.S. persons may not be available, or may be available only through
overly burdensome due diligence, particularly where the interpretation
includes a ``look-through'' element that considers ``direct and
indirect'' ownership. For this reason, these commenters requested that
the Commission's policy contemplate reasonable reliance on counterparty
representations as to the relevant elements of the interpretation of
the term ``U.S. person.''
The Commission agrees with the commenters that a party to a swap
should generally be permitted to reasonably rely on its counterparty's
written representation in determining whether the counterparty is
within the Commission's interpretation of the term ``U.S. person.'' In
this context, the Commission's policy is to interpret the
``reasonable'' standard to be satisfied when a party to a swap conducts
reasonable due diligence on its counterparties, with what is reasonable
in a particular situation to depend on the relevant facts and
circumstances. The Commission notes that under the External Business
Conduct Rules, a swap dealer or MSP generally meets its due diligence
obligations if it reasonably relies on counterparty representations,
absent indications to the contrary.\227\ As in the case of the External
Business Rules, the Commission believes that allowing for reasonable
reliance on counterparty representations encourages objectivity and
avoids subjective evaluations, which in turn facilitates a more
consistent and foreseeable determination of whether a person is within
the Commission's interpretation of the term ``U.S. person'' and the
extent to which the Title VII requirements apply to certain cross-
border activities.\228\
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\227\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants with Counterparties, 77 FR 9734 (Feb. 17, 2012)
(``External Business Conduct Rules''). Consistent with the
``reasonable reliance'' standard in the External Business Conduct
Rules, a swap dealer or MSP may rely on the written representations
of a counterparty to satisfy its due diligence requirements.
However, a swap dealer or MSP should not rely on a written
representation if it has information that would cause a reasonable
person to question the accuracy of the representation. In other
words, a swap dealer or MSP should not ignore red flags when relying
on written representations to satisfy its due diligence obligations.
Further, if agreed to by the counterparty, the written
representations may be included in counterparty relationship
documentation. However, a swap dealer or MSP may only rely on such
representations in the counterparty relationship documentation if
the counterparty agrees to timely update any material changes to the
representations. In addition, the Commission expects swap dealers
and MSPs to review the written representations on a periodic basis
to ensure that they remain appropriate for the intended purpose.
\228\ This approach is generally consistent with suggestions
provided by commenters. For example, SIFMA suggested that the
determination of whether a counterparty is a U.S. person should be
made at the inception of the swap transaction based on the most
recent representation from the counterparty, which should be renewed
by the counterparty once per calendar year. See SIFMA (Aug. 27,
2012) at A17.
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b. Foreign Branch of U.S. Person
The Commission is confirming its interpretation, as proposed, that
a foreign branch of a U.S. person is itself a ``U.S. person.'' As the
Commission explained in the Proposed Guidance, a branch does not have a
legal identity separate from that of its principal entity. In this
respect, the Commission notes that branches are neither separately
incorporated nor separately capitalized and, more generally, the rights
and obligations of a branch are the rights and obligations of its
principal entity (and vice versa). Under these circumstances, the
Commission views the activities of a foreign branch as the activities
of the principal entity, and thus a foreign branch of a U.S. person is
a U.S. person.
Accordingly, the Commission declines to recognize foreign branches
of U.S. persons separately from their U.S. principal for purposes of
registration. That is, if the foreign branch were to be a swap dealer
or MSP, as discussed further below, the U.S. person would be required
to register, and the registration would encompass the foreign branch.
Upon consideration of principles of international comity and the
factors set forth in the Restatement, though, the Commission has
calibrated the requirements otherwise applicable to such foreign
branches in respects other than broadly excluding them from the U.S.
person interpretation. For example, as discussed further below, foreign
branches of U.S. persons may comply with Transaction-Level Requirements
through substituted compliance, where appropriate, with respect to
swaps with foreign counterparties, as well as with a foreign branch of
another U.S. person. Further, non-U.S. persons may exclude swaps with
foreign branches of registered swap dealers for purposes of determining
whether they have exceeded the de minimis level of swap dealing
activity under the swap dealer definition.
The types of offices the Commission would consider to be a
``foreign branch'' of a U.S. bank, and the circumstances in which a
swap is with such foreign branch, are discussed further below in
section C below.
[[Page 45316]]
c. Regulation S
The Commission has considered the recommendation by several
commenters that the Commission follow, entirely or to some extent, the
definition of ``U.S. person'' in the SEC's Regulation S.\229\ With
respect to the treatment of foreign branches in particular, Regulation
S excludes from its definition of ``U.S. person'' any agency or branch
of a U.S. person located outside the United States if (1) the agency or
branch operates for valid business reasons; and (2) the agency or
branch is engaged in the business of insurance or banking, and is
subject to substantive insurance or banking regulation in the
jurisdiction where it is located.\230\ As the Commission noted in the
Proposed Guidance, however, Regulation S addresses the level of
activities (i.e., offerings of securities) conducted within the United
States, and related customer protection issues.\231\ As such, the
regulation's territorial approach to determining U.S. person status is,
in the Commission's view, unsuitable for purposes of interpreting
section 2(i), which addresses the connection with activities in and the
risks to U.S. commerce arising from activities outside the United
States.
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\229\ See, e.g., MFA/AIMA (Aug. 28, 2012) at 4, 8-9; IIAC (Aug.
27, 2012) at 3; J.P. Morgan (Aug. 27, 2012) at 3, 8-9; SocGen (Aug.
8, 2012) at 5; ISDA (Aug. 10, 2012) at 9. See also IIB (Aug. 9,
2012) at 3 (noting that the proposed interpretation is more
expansive than other Commission and SEC definitions of ``U.S.
person'' and makes it difficult to assess U.S. person status).
Regulation S is codified at 17 CFR 230.901 through 230.905.
\230\ See 17 CFR 230.902(k)(2)(v).
\231\ See Offshore Offers and Sales, 55 FR 18306 (May 2, 1990).
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Similarly, Regulation S and the Dodd-Frank swaps provisions also
serve fundamentally different regulatory objectives with respect to the
treatment of collective investment vehicles. Under Regulation S, the
SEC will consider certain investment funds and securities issuers that
are organized in foreign jurisdictions, but owned by U.S. investors, to
be U.S. persons unless the U.S. investors are accredited
investors.\232\ The accredited investor condition provides a level of
assurance that U.S. investors are entities that understand the
consequences of investing through a foreign entity and, in effect, may
be deemed to have waived the benefits of the U.S. securities laws. In
contrast, the focus of Title VII is not limited to customer protection.
Whether or not the investors in a collective investment vehicle are
accredited investors, in the Commission's view, is irrelevant; rather,
under section 2(i), the focus is whether the swap activities of a
collective investment vehicle have a direct and significant connection
with activities in, or effect on, U.S. commerce.
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\232\ See 17 CFR 230.902(k)(1)(viii). Also, the exception from
the Regulation S definition of ``U.S. person'' is not available if
any of such accredited investors are natural persons, estates or
trusts. Id.
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The Commission understands that the Regulation S definition of
``U.S. person'' is generally understood and applied by market
participants. However, as the foregoing examples demonstrate, the
Regulation S definition of ``U.S. person'' could fail to capture
persons whose activities, the Commission believes, meet the ``direct
and significant'' jurisdictional test of CEA section 2(i)--and whose
activities present the type of risk that Congress addressed in Title
VII. This potential for underinclusion, together with the fact that the
Commission has addressed commenter concerns by providing further
details and guidance about its interpretation of the term ``U.S.
person,'' which the Commission expects will facilitate a more
consistent understanding of that term among market participants,
provides the basis for not importing the Regulation S definition into
the Commission's interpretation of CEA section 2(i).
d. Other Clarifications
The Commission continues to include the prefatory phrase ``include,
but not be limited to'' in its interpretation of the term ``U.S.
person,'' as it appeared in the Proposed Guidance. While the
Commission's policy generally is to limit its interpretation of this
term, for purposes of this Guidance, to persons encompassed within the
several prongs discussed above, the Commission also expects that there
may be circumstances that are not fully addressed by those prongs, or
other situations where the interpretation discussed above does not
appropriately resolve whether a person should be included in the
interpretation of the term ``U.S. person.'' Thus, the Commission
continues to include the prefatory phrase to indicate that there may be
situations where a person not fully described in the interpretation
above is appropriately treated as a ``U.S. person'' for purposes of
this Guidance in view of the relevant facts and circumstances and a
balancing of the various regulatory interests that may apply. In these
situations, the Commission anticipates that the relevant facts and
circumstances may generally include the strength of the connections
between the person's swap-related activities and U.S. commerce; the
extent to which such activities are conducted in the United States; the
importance to the United States (as compared to other jurisdictions
where the person may be active) of regulating the person's swap-related
activities; the likelihood that including the person within the
interpretation of ``U.S. person'' could lead to regulatory conflicts;
and considerations of international comity.\233\ The Commission
anticipates that it would also likely be helpful to consider how the
person (and in particular its swap activities) is currently regulated,
and whether such regulation encompasses the person's swap activities as
they relate to U.S. commerce.
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\233\ These factors are among those relevant to whether a
country has a basis to assert jurisdiction over an activity under
the Restatement. See generally note 86 and accompanying text, supra.
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Finally, in response to commenters' requests for clarification
regarding the scope of the applicability of the ``U.S. person''
interpretation,\234\ the Commission confirms that its policy is to
apply its interpretation of the term ``U.S. person'' only to swaps
regulations promulgated under Title VII, unless provided otherwise in
any particular regulation. Therefore, for example, the Commission does
not intend that this Guidance address how the term ``person'' or ``U.S.
person'' should be interpreted in connection with any other CEA
provisions or Commission regulations promulgated thereunder.
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\234\ See, e.g., Goldman (Aug. 27, 2010) at 3, FOA (Aug. 13,
2012) at 10-11; SIFMA (Aug. 27, 2012) at A14-15, FIA (Aug. 27, 2012)
at 2-5.
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4. Summary
In summary, for purposes of the application of CEA section 2(i),
the Commission will interpret the term ``U.S. person'' generally to
include, but not be limited to: \235\
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\235\ The Commission believes that Commission regulation 140.99,
which provides for persons to request that the staff of the
Commission provide written advice or guidance, would be an
appropriate mechanism for a person to seek guidance as to whether it
is a U.S. person for purposes of applying the Commission swaps
regulations promulgated under Title VII.
(i) Any natural person who is a resident of the United States;
(ii) any estate of a decedent who was a resident of the United
States at the time of death;
(iii) any corporation, partnership, limited liability company,
business or other trust, association, joint-stock company, fund or
any form of enterprise similar to any of the foregoing (other than
an entity described in prongs (iv) or (v), below) (a ``legal
entity''), in each case that is organized or incorporated under the
laws of a state or other jurisdiction in the United States or having
its principal place of business in the United States;
(iv) any pension plan for the employees, officers or principals
of a legal entity described in prong (iii), unless the pension
[[Page 45317]]
plan is primarily for foreign employees of such entity;
(v) any trust governed by the laws of a state or other
jurisdiction in the United States, if a court within the United
States is able to exercise primary supervision over the
administration of the trust;
(vi) any commodity pool, pooled account, investment fund, or
other collective investment vehicle that is not described in prong
(iii) and that is majority-owned by one or more persons described in
prong (i), (ii), (iii), (iv), or (v), except any commodity pool,
pooled account, investment fund, or other collective investment
vehicle that is publicly offered only to non-U.S. persons and not
offered to U.S. persons;
(vii) any legal entity (other than a limited liability company,
limited liability partnership or similar entity where all of the
owners of the entity have limited liability) that is directly or
indirectly majority-owned by one or more persons described in prong
(i), (ii), (iii), (iv), or (v) and in which such person(s) bears
unlimited responsibility for the obligations and liabilities of the
legal entity; and
(viii) any individual account or joint account (discretionary or
not) where the beneficial owner (or one of the beneficial owners in
the case of a joint account) is a person described in prong (i),
(ii), (iii), (iv), (v), (vi), or (vii).
Under this interpretation, the term ``U.S. person'' generally means
that a foreign branch of a U.S. person would be covered by virtue of
the fact that it is a part, or an extension, of a U.S. person.
For convenience of reference, this Guidance uses the terms ``U.S.
swap dealer'' and ``U.S. MSP'' to refer to swap dealers and MSPs,
respectively, that are within the Commission's interpretation of the
term ``U.S. person'' under this Guidance. The terms ``non-U.S. swap
dealer'' and ``non-U.S. MSP'' refer to swap dealers and MSPs,
respectively, that are not within the Commission's interpretation of
the term ``U.S. person'' under this Guidance; and the term ``non-U.S.
person'' refers to a person that is not within the Commission's
interpretation of the term ``U.S. person'' under this Guidance.
B. Registration
1. Proposed Guidance
Under section 2(i) of the CEA, the Dodd-Frank swaps provisions,
including the swap dealer and MSP registration provisions, do not apply
to activities overseas unless such activities have a ``direct and
significant connection with activities in, or effect on,'' U.S.
commerce. In the Proposed Guidance, the Commission addressed the
general manner in which a person's overseas swap dealing activities or
positions may require registration as a swap dealer or MSP,
respectively. Specifically, under the Proposed Guidance, the Commission
would expect that a non-U.S. person whose swap dealing transactions
with U.S. persons exceed the de minimis threshold would register as a
swap dealer.\236\ Likewise, under the Proposed Guidance, the Commission
would expect that a non-U.S. person who holds swaps positions where one
or more U.S. persons are counterparties above the specified MSP
thresholds would register as an MSP.\237\ As explained in the Proposed
Guidance, the Commission believes that, consistent with section 2(i),
the level of swap dealing or positions that is sufficient to require a
person to register as a swap dealer or MSP when conducted by a person
located in the United States would generally also meet the ``direct and
significant'' nexus when such activities are conducted by a non-U.S.
person with a U.S. person and in some other limited circumstances.
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\236\ See Proposed Guidance, 77 FR at 41218-41219.
\237\ Id.
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In the consideration of whether a non-U.S. person is engaged in
more than a de minimis level of swap dealing, the Proposed Guidance
would generally include the notional value of any swaps between such
non-U.S. person (or any of its non-U.S. affiliates under common
control) and a U.S. person (other than a foreign branch of a registered
swap dealer).\238\ Further, where the potential non-U.S. swap dealer's
obligations are guaranteed by a U.S. person, the Commission would
expect that the non-U.S. person would register with the Commission as a
swap dealer when the aggregate notional value of its swap dealing
activities (along with the swap dealing activities of its non-U.S.
affiliates that are under common control and also guaranteed by a U.S.
person) with U.S. persons and non-U.S. persons exceeds the de minimis
threshold. Additionally, the Proposed Guidance clarified that the
Commission would not expect a non-U.S. person without a guarantee from
a U.S. person to register as a swap dealer if it does not engage in
swap dealing with U.S. persons as part of ``a regular business'' with
U.S. persons, even if the non-U.S. person engages in dealing with non-
U.S. persons.
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\238\ Id. at 41218-20.
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Following a similar rationale, under the Proposed Guidance if a
non-U.S person holds swaps positions above the requisite threshold, the
Commission would expect such non-U.S. person to register as an MSP. In
considering whether a non-U.S. person that is a potential MSP meets the
applicable threshold, under the Proposed Guidance, the non-U.S. person
would have included the notional value of: (1) any swaps entered into
between such non-U.S. person and a U.S. person (provided that if the
non-U.S. person's swaps are guaranteed by a U.S. person, then such
swaps will be attributed to the U.S. guarantor and not the potential
non-U.S. MSP); and (2) any swaps between another non-U.S. person and a
U.S. person if the potential non-U.S. MSP guarantees the obligations of
the other non-U.S. person thereunder.\239\
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\239\ Id. at 41221.
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2. Comments
In general, commenters on the Proposed Guidance did not raise
concerns or objections to the Commission's interpretation that non-U.S.
persons who engage in more than a de minimis level of swap dealing with
U.S. persons should be expected to register as swap dealers.\240\ A
number of commenters argued, however, that a non-U.S. person should not
be expected to register as a swap dealer solely by reason of being
guaranteed by a U.S. person.\241\ SIFMA stated that the ``connection
between a non-U.S. swap dealing entity and its U.S. guarantor creates
too tenuous a nexus to justify registration on the basis of this
relationship alone.'' \242\ As an alternative, SIFMA posited that only
guarantees by a U.S. person for which there is a material likelihood of
payment by the U.S. guarantor should be counted towards the de minimis
calculation. To implement this recommendation, SIFMA suggested that the
Commission establish how to determine whether the likelihood of payment
is remote, such as a comparison of the aggregate contingent liability
of the U.S. person
[[Page 45318]]
guarantor to the net equity of that guarantor.\243\
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\240\ One commenter, Japanese Bankers Association, stated that
the cross-border application of Dodd-Frank is overbroad because it
would capture even hedging transactions made by a non-U.S. swap
dealer with a U.S. swap dealer that is making a market. The
definition of ``dealing activity'' is ambiguous, this commenter
asserted, and might require the non-U.S. swap dealer to register.
See Japanese Bankers Association (Aug. 27, 2012) at 1.
\241\ See, e.g., Goldman (Aug. 27, 2012) at 5; ISDA (Aug. 10,
2012) at 12 (stating that, in the typical case, an intra-group
guarantee allocates risks and activities within the corporate group
and is not a dealing activity of the non-U.S. person); CEWG (Aug.
27, 2012) at 6-7 (stating that the Proposed Guidance should not
include swap guarantees for aggregation purposes because it is
contrary to the Final Entities Rules; jurisdiction should not be
extended to transactions between two non-U.S. persons if the swaps
obligations of one party are guaranteed by a U.S. person because
U.S. jurisdiction in these circumstances is not supported by law or
existing conventions of international jurisdiction).
\242\ SIFMA (Aug. 27, 2012) at A29.
\243\ Id. at A29-30.
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Similarly, Goldman argued that it would be inconsistent with the
Dodd-Frank Act to expect non-U.S. persons to register as swap dealers
solely on the basis of guarantees by a U.S. parent, absent any showing
of a ``direct and significant'' jurisdictional nexus. Goldman
recommended that any concerns regarding potential evasion of the
registration requirement be addressed through the Commission's exercise
of its anti-evasion authority.\244\ ISDA agreed, suggesting that rather
than protecting the U.S. guarantor by encouraging swap dealer
registration of the guaranteed non-U.S. person, a better course is
addressing the question of when (if ever) the U.S. guarantor must
register as a swap dealer.\245\ Australian Bankers stated that the
considerations relevant to whether a non-U.S. person (without a
guarantee from a U.S. affiliate) is expected to register as a swap
dealer should relate to the aggregate notional amount of swap dealing
activities with U.S. persons within a particular asset class.\246\
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\244\ Goldman (Aug 27, 2012) at 5. See also CEWG (Aug. 27, 2012)
6-7 (stating that because there is no legal basis under section 2(i)
for asserting jurisdiction based on a guaranty, the Commission
should amend the Proposed Guidance to clarify that a non-U.S. person
is not subject to Commission regulation, even where a U.S. person
guarantees either counterparty; swap dealing activity outside the
United States that does not involve a U.S. person should not be
subject to the Commission's jurisdiction; guarantees do not alter
the location of activity, nor should they alter a participant's
residency); Hong Kong Banks (Aug. 27, 2012) at 8 (arguing that swaps
between non-U.S. persons should be excluded from the de minimis
determination regardless of whether a counterparty is guaranteed).
\245\ ISDA (Aug. 10, 2012) at 12.
\246\ Australian Bankers (Aug. 27, 2012) at 4.
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IIAC requested that the Commission confirm that a guarantee by a
foreign holding company would not be deemed to be a guarantee by all of
its subsidiaries, including U.S. entities, solely as a result of the
indirect ownership.\247\ J.P. Morgan raised concerns regarding the
scope of the interpretation of the term a ``guarantee.'' Specifically,
it argued that the term ``guarantee'' should not be interpreted to
include keepwells and liquidity puts because these agreements do not
create the same types of third-party rights as traditional guarantees
and may be unenforceable by third parties.\248\ CEWG objected to the
broader interpretation of the term ``guarantee'' in the Proposed
Guidance than under the Final Product Definitions Rules,\249\ stating
that the Commission ``must undertake a more thorough regulatory
analysis with respect to guarantees of swaps obligations.'' \250\
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\247\ IIAC (Aug. 27, 2012) at 6, 8.
\248\ J.P. Morgan (Aug. 27, 2012) at 10.
\249\ See Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping; Final Rule, 77 FR 48208
(Aug. 13, 2012) (``Final Swap Definition'').
\250\ CEWG (Aug. 27, 2012) at 5.
---------------------------------------------------------------------------
On the other hand, Senator Levin stated that guarantees are central
to concerns regarding cross-border swaps, and that any guarantee,
implicit or explicit, by a U.S. parent company to its non-U.S.
affiliates effectively transfers risk to the U.S. parent.\251\
Therefore, Senator Levin stated that the exact form of the guarantee
should not limit compliance with Dodd-Frank requirements, and the list
of relevant guarantee arrangements should be expanded to include
arrangements involving total return swaps, credit default swaps or
customized options that result in the foreign affiliate's activities
creating off balance sheet liabilities for a U.S. person.\252\ Eight
Senators commented that focusing on whether affiliates are explicitly
``guaranteed'' by a U.S. affiliate does not go far enough. They
expressed concern that market pressures cause U.S. parent firms to
stand behind their foreign affiliates even if explicit guarantees are
not in place. The Senators suggested that other factors be considered
to determine whether risk is effectively guaranteed such as:
limitations on permissible transactions between the parent and
affiliate; explicit non-guarantee disclosures to investors, regulators
and counterparties; restrictions on operating under a common name or
sharing employees and officers; and whether comprehensive resolution
protocols exist in the foreign jurisdiction.\253\
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\251\ Letter from Sen. Levin at 10.
\252\ Id. at 11.
\253\ Letter from Senators Blumenthal, Boxer, Feinstein, Harkin,
Levin, Merkley, Shaheen, and Warren (Jul. 3, 2013).
---------------------------------------------------------------------------
AFR stated that the Commission's failure to clarify its
interpretation of when affiliates of a ``U.S. person'' would be treated
as guaranteed, or to capture ``the large grey area'' between explicit
and informal guarantees, among other things, creates opportunities to
escape Dodd-Frank regulations by shifting business overseas.\254\ AFR
stressed that the Commission should clarify in the guidance that it
``intends to follow through on properly implementing these principles
and will not enable a `race to the bottom' in which incentives are
created for derivatives affiliates of global banks . . . to relocate to
areas of lax regulation to take advantage of an inadequate `substituted
compliance' regime.'' \255\
---------------------------------------------------------------------------
\254\ AFR (Aug. 27, 2012) at 4.
\255\ Id. at 4.
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3. Commission Guidance
a. Registration Thresholds for U.S. Persons and Non-U.S. Persons,
Including Those Guaranteed by U.S. Persons
Under the Final Entities Rules, a person is required to register as
a swap dealer if its swap dealing activity activities over the
preceding 12 months exceeds the de minimis threshold of swap dealing.
In addition, Commission regulation 1.3(ggg)(4) requires that a person
include, in determining whether its swap dealing activities exceed the
de minimis threshold, the aggregate notional value of swap dealing
transactions entered by its affiliates under common control.\256\
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\256\ As discussed in greater detail below, in light of the
global nature of the swaps markets, the Commission's policy is to
interpret the aggregation requirement in Commission regulation
1.3(ggg)(4) in a manner that applies the same aggregation principles
to all affiliates in a corporate group, whether they are U.S. or
non-U.S. persons.
---------------------------------------------------------------------------
For purposes of determining whether a U.S. person is required to
register as a swap dealer, a U.S. person should count all of its swap
dealing activity, whether with U.S. or non-U.S. counterparties. This
interpretation reflects that swaps markets are global, and therefore,
in the Commission's view, all of a U.S. person's swap dealing
activities, whether with U.S. persons or non-U.S. persons, have the
requisite jurisdictional nexus and potential to impact the U.S.
financial system. Similarly, the Commission believes that all of the
swap dealing activities of a non-U.S. person that is an affiliate of a
U.S. person and that is guaranteed by a U.S. person (a ``guaranteed
affiliate''),\257\ or that is an ``affiliate conduit'' of a U.S.
person,\258\ have the requisite statutory
[[Page 45319]]
nexus and potential to impact the U.S. financial system. Therefore,
under the Commission's interpretation of 2(i), a guaranteed or conduit
affiliate \259\ should count swap dealing transactions towards the de
minimis threshold for swap dealer registration in the same manner as a
U.S. person. That is, in light of the global nature of the swaps
markets, a guaranteed or conduit affiliate should count all of its swap
dealing transactions, whether with U.S. or non-U.S. counterparties,
towards the de minimis threshold for swap dealer registration.
---------------------------------------------------------------------------
\257\ See note 267 and accompanying text, supra, for guidance
regarding the Commission's interpretation of the term ``guarantee.''
\258\ When a non-U.S. person generally would be considered to be
an affiliate conduit is discussed below in section G. As discussed
below, for the purposes of the Commission's interpretation of CEA
section 2(i), the Commission believes that certain factors are
relevant to considering whether a non-U.S. person is an ``affiliate
conduit.'' Such factors include whether: The non-U.S. person is a
majority-owned affiliate of a U.S. person; the non-U.S. person is
controlling, controlled by or under common control with the U.S.
person; the financial results of the non-U.S. person are included in
the consolidated financial statements of the U.S. person; and the
non-U.S. person, in the regular course of business, engages in swaps
with non-U.S. third-parties for the purpose of hedging or mitigating
risks faced by, or to take positions on behalf of, its U.S.
affiliate(s), and enters into offsetting swaps or other arrangements
with its U.S. affiliate(s) in order to transfer the risks and
benefits of such swaps with third-parties to its U.S. affiliates.
The term ``conduit affiliate'' generally would not include swap
dealers or affiliates thereof.
\259\ This Guidance uses the term ``guaranteed or conduit
affiliate'' to refer to a non-U.S. person whose swap obligations are
guaranteed by a U.S. person or that is an affiliate conduit.
---------------------------------------------------------------------------
However, under the Commission's interpretation of section 2(i), a
more circumscribed registration policy applies to non-U.S. persons that
are not guaranteed or conduit affiliates. In this case, the Commission
believes that the non-U.S. person should count only its swap dealing
transactions with U.S. persons (other than foreign branches of swap
dealers that are registered with the Commission), and with guaranteed
affiliates towards the de minimis thresholds for swap dealer
registration, with three exceptions, which are described below. Non-
U.S. persons that are not guaranteed or conduit affiliates are not
required to count swaps with a conduit affiliate towards the swap
dealer de minimis calculation.
Similarly, for purposes of determining whether a U.S. person is
required to register as an MSP, as the Commission interprets section
2(i), a U.S. person and a guaranteed or conduit affiliate should
include all of swap positions with counterparties, whether they are
U.S. or non-U.S. persons. With respect to whether a non-U.S. person
must calculate whether its swap positions create exposures above the
relevant MSP thresholds, the Commission believes, for policy reasons
and consistent with principles of international comity, that CEA
section 2(i) should not be interpreted to require non-U.S. persons that
are not financial entities to include for MSP calculation purposes
certain swap positions as explained below.
As the Commission explained in the Proposed Guidance, in the event
of a default or insolvency of a non-U.S. swap dealer with more than a
de minimis level of swap dealing with U.S. persons, or a non-U.S. MSP
with more than the threshold level of swaps positions with U.S.
persons, the swap dealer's or MSP's U.S. counterparties could be
adversely affected. Such an event may adversely affect numerous persons
engaged in commerce within the United States, disrupt such commerce,
and increase the risk of a widespread disruption to the financial
system in the United States.
Similar effects on U.S. persons and on the U.S. financial system
may occur in the event of a default or insolvency of certain non-U.S.
person with respect to swap dealing transactions in excess of the de
minimis level, or swaps positions above the MSP threshold, entered into
such non-U.S. persons with other non-U.S. persons whose swaps
obligations are guaranteed by a U.S. person. The Commission interprets
section 2(i) of the CEA to encompass swaps entered into by guaranteed
or conduit affiliates in addition to encompassing swaps entered into by
U.S. persons. In the final rule to further define the term ``swap,''
the Commission found that a guarantee of a swap is a term of that swap
that affects the price or pricing attributes of that swap, and that
when a swap has the benefit of a guarantee, the guarantee is an
integral part of that swap.\260\ The Commission therefore interprets
the term ``swap'' (that is not a security-based swap or mixed swap)
``to include a guarantee of such swap, to the extent that a
counterparty to a swaps position would have recourse to the guarantor
in connection with the position.'' \261\ Because a guarantee of a swap
is an integral part of the swap, and counterparties may not otherwise
be willing to enter into a swap with the guaranteed affiliate, the
affiliate would not have significant swap business if not for the
guarantee. The Commission believes that swap activities outside the
United States that are guaranteed by U.S. persons would generally have
a direct and significant connection with activities in, or effect on,
U.S. commerce in a similar manner as the underlying swap would
generally have a direct and significant connection with activities in,
or effect on, U.S. commerce if the guaranteed counterparty to the
underlying swap were a U.S. person.\262\ Similarly, the Commission
believes that swap activities outside the United States of an affiliate
conduit would generally have a direct and significant connection with
activities in, or effect on, U.S. commerce in a similar manner as would
be the case if the affiliate conduit's U.S. affiliates entered into the
swaps directly.
---------------------------------------------------------------------------
\260\ See Final Swap Definition, 77 FR at 48225-48226. The
Commission explained that when a swap counterparty typically uses a
guarantee as credit support for its swaps obligations, the
guarantor's resources are added to the analysis of the swap because
``the market will not trade with that counterparty at the same
price, on the same terms, or at all without the guarantee.'' Id. The
Commission stated that it viewed a guarantee as, generally, ``a
collateral promise by a guarantor to answer for the debt or
obligation of a counterparty obligor under a swap.'' Id.
\261\ Id. at 48226 n. 187. In response to a comment that
guarantees are contingent obligations that do not necessarily
replicate the economics of the underlying swap, the Commission
stated:
The CFTC is persuaded that when a swap (that is not a security-
based swap or mixed swap) has the benefit of a guarantee, the
guarantee and related guaranteed swap must be analyzed together. The
events surrounding the failure of [AIGFP] highlight how guarantees
can cause major risks to flow to the guarantor. The CFTC finds that
the regulation of swaps and the risk exposures associated with them,
which is an essential concern of the Dodd- Frank Act, would be less
effective if the CFTC did not interpret the term ``swap'' to include
a guarantee of a swap.
Id. at 48226.
\262\ Congress has recognized the significance of guarantees of
swaps obligations with respect to the activities of financial
entities in section 210(c)(16) of the Dodd-Frank Act. There,
Congress specifically addressed guarantees in the context of a Title
II resolution proceeding. Section 210(c)(16) provides that, where a
financial institution is in FDIC receivership, a ``qualified
financial contract'' (or ``QFC,'' which includes swaps) with a
subsidiary of that financial institution that is guaranteed by the
financial institution cannot be terminated by a counterparty facing
that subsidiary pursuant to the QFC based solely on the insolvency
or receivership of the financial institution if certain conditions
are satisfied.
---------------------------------------------------------------------------
Accordingly, under section 2(i), the Commission intends to
interpret section 2(i) as applying the swaps provisions of the CEA to
swaps that are entered into by guaranteed or conduit affiliates in a
manner similar to how section 2(i) would apply if a U.S. person had
entered into the swap (subject to appropriate considerations of
international comity for non-guaranteed, non-U.S. persons facing such
guaranteed or conduit affiliates, as discussed below).
Thus, in the case of a guaranteed or conduit affiliate, the
Commission interprets CEA section 2(i) to provide that the guaranteed
or conduit affiliate is expected to count toward the swap dealer de
minimis threshold all of its swap dealing activities.\263\ Following a
[[Page 45320]]
similar rationale, the Commission interprets CEA section 2(i) to
provide that a guaranteed or conduit affiliate, in calculating whether
the applicable MSP threshold is met, would be expected to include, and
attribute to the U.S. guarantor, the notional value of: (1) All swaps
with U.S. and non-U.S. counterparties, and (2) any swaps between
another non-U.S. person and a U.S. person or guaranteed affiliate, if
the potential non-U.S. MSP guarantees the obligations of the other non-
U.S. person thereunder.
---------------------------------------------------------------------------
\263\ The Commission notes that the SEC Cross-Border Proposal
agrees that ``[i]n a security-based swap transaction between two
non-U.S. persons where the performance of at least one side of the
transaction is guaranteed by a U.S. person, . . . the guarantee
creates risk to the U.S. financial system and counterparties
(including U.S. guarantors) to the same degree as if the transaction
were entered into directly by a U.S. person.'' SEC Cross-Border
Proposal, 78 FR at 30986. However, the SEC does not propose to
address the risk posed by the guarantee through requiring the non-
U.S. guaranteed affiliate to register as a security-based swap
dealer, but rather through the application of principles of
attribution in the major security-based swap participant definition.
See id. at 31006.
The Commission believes that while the SEC's proposed approach
may be appropriate for the securities-based swaps market, it would
not be desirable to follow a similar approach for the swaps markets
within the Commission's jurisdiction. Due to the differing
characteristics of the markets, such as the involvement of a much
larger and more diverse number of commercial companies using swaps
as compared to security-based swaps, the risks that may be
transmitted through the interconnected financial system from the
non-U.S. guaranteed affiliate operating as a swap dealer to the U.S.
swaps market may not be adequately managed by the MSP structure,
which has relatively high exposure thresholds before registration is
required.
---------------------------------------------------------------------------
In the Final Swap Definition, the Commission also acknowledged that
a ``full recourse'' guarantee would have a greater effect on the price
of a swap than a ``limited'' or ``partial recourse'' guarantee, yet
nevertheless determined that the presence of any guarantee with
recourse, no matter how robust, is price forming and an integral part
of a guaranteed swap.\264\ Moreover, as the recent financial crisis has
demonstrated, in a moment of crisis--whether at the firm-level or more
generally, market-wide--it matters little whether the parent guarantees
are capped or otherwise qualified. In the face of solvency concerns,
the parent guarantor will find it necessary to assume the liabilities
of its affiliates.\265\ For these reasons, the Commission declines to
incorporate in the Guidance commenters' suggestions that only certain
types of guarantees (e.g., under which there is a material likelihood
of liability) should be considered for purposes of registration
determinations for non-U.S. persons.
---------------------------------------------------------------------------
\264\ Final Swap Definition, 77 FR at 48226.
\265\ According to one commenter, these concerns may be present
even where a guarantee is implicit, but not explicitly provided:
A recent example of the importance of implicit guarantees is the
collapse of Bear Stearns, which was brought down by the failure of
non-guaranteed hedge fund affiliates. These hedge funds were foreign
affiliates technically not guaranteed by the parent, and the
investment by the parent company in the funds was minimal. However,
the firm was forced to try to save the funds for reputational
reasons and also because a fire sale of subsidiary assets could have
seriously impacted correlated positions held by the parent company.
. . . The example of Bear Stearns is only one among many instances
where parent companies have been forced to rescue failing affiliates
even in the absence of an explicit guarantee.
AFR (Aug. 27, 2012) at 8. See also Letter from Sen. Levin, note
216, supra.
---------------------------------------------------------------------------
Finally, with respect to the Japanese Bankers Association's concern
about potential constraints on their hedging activities, the Commission
contemplates that swaps that are between foreign branches of U.S. swap
dealers and dealing non-U.S. persons generally will be excluded from
the swap dealer registration determination, as further described below.
The Commission believes that under section 2(i) of the CEA, it would
generally be appropriate for non-U.S. market participants, such as
members of the Japanese Bankers Association, to engage in hedging
activities with foreign branches of U.S. swap dealers without being
expected to count such transactions for purposes of the swap dealer
registration determination.
The Commission also is affirming that, for purposes of this
Guidance, the Commission would interpret the term ``guarantee''
generally to include not only traditional guarantees of payment or
performance of the related swaps, but also other formal arrangements
that, in view of all the facts and circumstances, support the non-U.S.
person's ability to pay or perform its swap obligations with respect to
its swaps.\266\ The Commission believes that it is necessary to
interpret the term ``guarantee'' to include the different financial
arrangements and structures that transfer risk directly back to the
United States. In this regard, it is the substance, rather than the
form, of the arrangement that determines whether the arrangement should
be considered a guarantee for purposes of the application of section
2(i).\267\
---------------------------------------------------------------------------
\266\ See Proposed Guidance, 77 FR at 41221 n. 47.
\267\ Thus, for example, while keepwells and liquidity puts,
certain types of indemnity agreements, master trust agreements,
liability or loss transfer or sharing agreements, and any other
explicit financial support arrangements may provide for different
third-party rights and/or address different risks than traditional
guarantees, the Commission does not believe that these differences
would generally be relevant for purposes of section 2(i). Under
these agreements or arrangements, one party commits to provide a
financial backstop or funding against potential losses that may be
incurred by the other party, either from specific contracts or more
generally. In the Commission's view, this is the essence of a
guarantee.
---------------------------------------------------------------------------
b. Aggregation
Commission regulation 1.3(ggg)(4) requires that a person include,
in determining whether its swap dealing activities exceed the de
minimis threshold, the aggregate notional value of swap dealing
transactions entered by its affiliates under common control.\268\
Additionally, under the Proposed Guidance, a non-U.S. person, in
determining whether its swap dealing transactions exceed the de minimis
threshold, would include the aggregate notional value of swap dealing
transactions entered into by its non-U.S. affiliates under common
control but would not include the aggregate notional value of swap
dealing transactions entered into by its U.S. affiliates.
---------------------------------------------------------------------------
\268\ For purposes of this Guidance regarding the application of
Commission regulation 1.3(ggg)(4), the Commission construes the
phrase ``affiliates under common control'' with respect to
affiliates as stated in the Final Entities Rules, which defines
control as ``the possession, direct or indirect, of the power to
direct or cause the direction of the management and policies of a
person, whether through the ownership of voting securities, by
contract or otherwise.'' See Final Entities Rules, 77 FR at 30631 n.
437. Thus, for purposes of this Guidance, a reference to
``affiliates under common control'' with a person includes
affiliates that are controlling, controlled by, or under common
control with such person.
---------------------------------------------------------------------------
Numerous commenters objected to the aggregation interpretation
regarding swap dealer registration in the Proposed Guidance.\269\ IIB
and Cleary, while acknowledging the Commission's evasion concerns,
contended that the aggregation interpretation in the Proposed Guidance
would effectively eliminate the de minimis exemption for any affiliate
of a registered swap dealer.\270\ IIB further stated that the proposed
aggregation interpretation would require a significant amount of
coordination among entities within a corporate group in order to gather
the relevant information and to reconfigure their registration plans.
These difficulties, according to IIB, would be compounded by
uncertainties in the proposed interpretation of the term ``U.S.
person.'' \271\
---------------------------------------------------------------------------
\269\ See, e.g., Cleary (Aug. 16, 2012) at 9-10; IIB (Aug. 27,
2012) at 22-24; FOA (Aug. 13, 2012) at 11-12; ISDA (Aug. 10, 2012)
at 11-12; SocGen (Aug. 8, 2012) at 8; Deutsche Bank (Aug. 27, 2012)
at 4-5, FSR (Aug. 27, 2012) at 4-6.
\270\ Cleary (Aug. 16, 2012) at 9-10; IIB (Aug. 27, 2012) at 22.
\271\ IIB (Aug. 9, 2012) at 6.
---------------------------------------------------------------------------
Cleary argued that the positions of a registered swap dealer should
be excluded from the de minimis calculation by its affiliate and
further added that such aggregation relief should be available to any
U.S. or non-U.S. affiliates of any U.S.- or non-U.S. registered swap
dealer.\272\ FOA recommended that the Commission consider a policy that
would permit non-U.S. persons to not aggregate the swap dealing
activities of their non-U.S. swap dealing affiliates under common
control and to require aggregation only
[[Page 45321]]
where there is evidence that a group of non-U.S. swap dealing
affiliates sufficiently coordinate their swap dealing activities.\273\
ISDA asserted that the proposed asymmetric application of aggregation
(i.e., U.S. affiliates aggregate the entire worldwide group, but non-
U.S. affiliates aggregate only non-U.S. affiliates) would produce
arbitrary results, citing, as an example, a group that has a U.S.
affiliate with $500 million of swaps and a non-U.S. affiliate with $7.6
billion of swaps with non-U.S. persons. In that scenario, the U.S.
affiliate must register; the non-U.S. affiliate is not required to
register.\274\
---------------------------------------------------------------------------
\272\ Cleary (Aug. 16, 2012) at 9-10.
\273\ FOA (Aug. 13, 2012) at 11-12. FOA argued that the Proposed
Guidance would have a disproportionate effect by providing that a
non-U.S. person engaging in a de minimis amount of U.S.-facing swap
dealing activities should register as a swap dealer simply because
its other non-U.S. affiliates under common control, in the
aggregate, exceed the de minimis threshold, even though there is no
coordinated effort. Id.
\274\ ISDA (Aug. 10, 2012) at 12 (noting that if an exclusion
from aggregation for an affiliated swap dealer's swaps were in
place, then the group in the above example could decide which entity
registers and thereby bring the swaps attributable to the other
entity under the threshold).
---------------------------------------------------------------------------
In the Further Proposed Guidance, the Commission proposed an
alternative interpretation of the aggregation requirement in Commission
regulation 1.3(ggg)(4). Under this alternative, a non-U.S. person would
be expected, in the consideration of whether its swap dealing
transactions exceed the de minimis threshold, to include the aggregate
notional value of swap dealing transactions entered into by all its
affiliates under common control (i.e., both non-U.S. affiliates and
U.S. affiliates), but not include the aggregate notional value of swap
dealing transactions of any non-U.S. affiliate under common control
that is registered as a swap dealer.\275\ The Commission noted that the
application of the aggregation requirement in Commission regulation
1.3(ggg)(4) to non-U.S. affiliates of non-U.S. swap dealers may, in
certain circumstances, impose significant burdens on such non-U.S.
affiliates without advancing significant regulatory interests of the
Commission. Because the conduct of swap dealing business through
locally-organized affiliates may in some cases be required in order to
comply with legal requirements or business practices in foreign
jurisdictions, such non-U.S. affiliates may be numerous and it could be
impractical to require all such non-U.S. affiliates to register as swap
dealers. Further, the Commission's interest in registration may be
reduced for a non-U.S. affiliate of a registered non-U.S. swap dealer
where the non-U.S. affiliate (or group of such affiliates) engages in
only a small amount of swap dealing activity with U.S. persons.
---------------------------------------------------------------------------
\275\ Also, under this alternative approach, a non-U.S. person
would not be expected to include the aggregate notional value of
swap dealing transactions of any of its non-U.S. affiliates under
common control where the counterparty to such affiliate is also a
non-U.S. person.
---------------------------------------------------------------------------
On the other hand, the Commission also noted in the Further
Proposed Guidance that, given the borderless nature of swap dealing
activities, a swap dealer may conduct swap dealing activities through
various affiliates in different jurisdictions, which suggests that its
interpretation should take into account the applicable swap dealing
transactions entered by all of a non-U.S. person's affiliates under
common control worldwide. Otherwise, affiliated persons may not
register solely because their swap dealing activities are divided, such
that each affiliate falls below the de minimis level. The Commission
noted its concern that a policy under which such affiliates whose swap
dealing activities individually fall below the de minimis level, but
whose swap dealing activities in the aggregate exceed the de minimis
level, would not register as swap dealers could provide an incentive
for firms to spread their swap dealing activities among several
unregistered affiliates rather than centralize their swap dealing in
registered firms. Such a result would increase systemic risks to U.S.
market participants and impede the Commission's ability to protect U.S.
markets.
Two commenters supported the alternative interpretation of the
aggregation requirement set out in the Further Proposed Guidance.
Greenberger/AFR stated that the aggregation requirement helps to
prevent the spreading of risk, because without aggregation U.S. persons
could avoid registration as swap dealers by routing their swap activity
through non-U.S. affiliates and thereby remain under the de minimis
threshold.\276\ Better Markets supported the alternative interpretation
in the Further Proposed Guidance because it contemplates that non-U.S.
persons would aggregate all swap dealing of all affiliates, including
U.S. affiliates, except where the affiliate is registered as a swap
dealer.\277\
---------------------------------------------------------------------------
\276\ Greenberger/AFR (Feb. 6, 2013) at 8-9.
\277\ Better Markets (Feb. 15, 2013) at 8-9.
---------------------------------------------------------------------------
Other commenters were opposed to the alternative interpretation in
the Further Proposed Guidance. SIFMA/CH/FSR stated that aggregation of
swap dealing activity across affiliates is not appropriate in any
circumstance.\278\ ISDA stated that application of the aggregation
principle to non-U.S. affiliates may impose significant burdens on the
non-U.S. affiliates without advancing significant regulatory interests,
and expanding the scope of aggregation to include swaps of U.S.
affiliates would exacerbate this disproportionality.\279\
---------------------------------------------------------------------------
\278\ SIFMA/CH/FSR (Feb. 6, 2013) at A2-3
\279\ ISDA (Feb. 6, 2013) at 3-4 (relevant affiliates are
unlikely to have systems to monitor U.S. person status of swap
counterparties). See also European Federation of Energy Traders
(``EFET'') (Feb. 6, 2013) at 3-4 (arguing that cost of system to
monitor aggregation would be substantial and relative benefits of
requiring aggregation are small, given that equivalent regulation
already applies, or soon will apply, in non-U.S. jurisdictions).
ISDA, IIB and CEWG all stated that the treatment in the January
Order of grandfathered affiliates (i.e., those affiliates engaged in
swap dealing with U.S. persons on December 21, 2012) should be made
permanent in order to avoid disrupting established transactional
relationships. See ISDA (Feb. 6, 2013) at 3; IIB (Feb. 6, 2013) at
6; CEWG (Feb. 25, 2013) at 2-4.
---------------------------------------------------------------------------
Mitsubishi UFJ Financial Group Inc. (``Mitsubishi UFJ'') asked the
Commission to clarify its interpretation of the term ``control'' in the
context of a non-U.S. joint venture where only one owner controls and
operates, and financially consolidates, the joint venture entity.\280\
Mitsubishi UFJ stated that in this case the joint venture should be
linked for aggregation purposes to the owner that has operational
control, provided that the owner has at least one affiliate that is a
registered swap dealer.\281\
---------------------------------------------------------------------------
\280\ Mitsubishi UFJ (Feb. 1, 2013) at 3-4.
\281\ Id. at 5.
---------------------------------------------------------------------------
In the Further Proposed Guidance, the Commission asked commenters
to address several questions regarding the aggregation provision. In
particular, the Commission asked whether the alternative interpretation
of the aggregation requirement should apply to non-U.S. persons that
are guaranteed by a U.S. person with respect to their swaps obligations
in the same way that it applies to non-U.S. persons that are not so
guaranteed, and if so, should the Commission continue to construe the
term ``guarantee'' for this purpose to mean any collateral promise by a
guarantor to answer for the debt or obligation of an obligor under a
swap and should the term include arrangements such as keepwells and
liquidity puts.
Greenberger/AFR replied to this question affirmatively, stating
that the Commission should establish a rebuttable presumption that
foreign affiliates are guaranteed by the parent company, and require
clear evidence that the market has been explicitly informed that the
parent will not stand behind affiliate liabilities in the event of
[[Page 45322]]
a default or bankruptcy.\282\ To do otherwise, they stated, would
encourage swap activity through non-U.S. affiliates rather than U.S.
persons.\283\
---------------------------------------------------------------------------
\282\ Greenberger/AFR (Feb. 6, 2013) at 5-6.
\283\ Id. at 6.
---------------------------------------------------------------------------
Other commenters stated that the alternative interpretation should
not apply to non-U.S. persons that are guaranteed by a U.S. person in
the same way that it applies to non-U.S. persons that are not so
guaranteed. SIFMA/CH/FSR stated that a guarantee by a U.S. person is
not, in itself, a sufficient nexus for jurisdiction under section 2(i)
of the CEA, since swaps may be guaranteed for a number of reasons that
do not necessarily implicate U.S. jurisdiction.\284\ Thus, there may be
no importation of risk to the United States through the guarantee and,
in any event, concern about importation of risk is appropriately
addressed where the guarantor is a prudentially regulated entity, and
the Commission should rely on its anti-evasion authority to prevent use
of guarantees to evade registration requirements.\285\ ISDA also stated
that a guarantee constitutes an insufficient jurisdictional nexus, and
that it would be consistent with international comity and regulatory
reciprocity to regulate swaps between two non-U.S. persons primarily
under non-U.S. regulation.\286\ Regarding the potential for risk
transfer across borders, ISDA stated that much of the regulation
applicable to swap dealers is not relevant to this concern--external
and internal business conduct rules, for example, cannot assure the
ultimate solvency of a swap dealer, and it is unclear that encouraging
further capitalization of overseas affiliates of a U.S. guarantor,
causing financial resources to be contributed overseas, would advance
the stability of the U.S. financial system.\287\ The Financial Services
Agency, Government of Japan (``Japan FSA'') also thought that a
guarantee from a U.S. person should not, in itself, cause swaps with a
non-U.S. person to be included in the de minimis calculation.\288\
---------------------------------------------------------------------------
\284\ SIFMA/CH/FSR (Feb. 6, 2013) at A4.
\285\ Id.
\286\ ISDA (Feb. 6, 2013) at 2-3.
\287\ Id. at 3.
\288\ Japan FSA (Feb. 6, 2013) at 2.
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The Commission also asked if non-U.S. persons should not be
expected to include in the de minimis calculation the swap dealing
transactions of their U.S. affiliates under common control, or,
alternatively, should the policy of the Commission contemplate that
they would exclude from the de minimis calculation the swap dealing
transactions of their U.S. affiliates under common control that are
registered as swap dealers.
Responding to this question, Greenberger/AFR stated it is important
in any case to require aggregation across all non-U.S. affiliates of a
global bank, in order to effectively capture transactions spread across
multiple foreign affiliates; otherwise, it would be much easier to
avoid registration as a swap dealer.\289\ They believe that the second
alternative--excluding only the swap dealing transactions of U.S.
affiliates that are registered as swap dealers--is much preferable to
the first, because the first alternative would permit two groups of
affiliates, one within the U.S. and another non-U.S., to both engage in
swap dealing up to the de minimis level, which would create an
incentive to split a swap dealing business between U.S. and non-U.S.
affiliates.\290\ The second alternative would effectively allow a group
of affiliates that individually and collectively fall below the de
minimis threshold to forego registration, which they believed could be
a sensible compromise, so long as aggregation across foreign affiliates
is maintained.\291\
---------------------------------------------------------------------------
\289\ Greenberger/AFR (Feb. 6, 2013) at 9.
\290\ Id.
\291\ Id.
---------------------------------------------------------------------------
Several commenters were opposed to a policy under which non-U.S.
persons would aggregate the swap dealing activities of U.S. affiliates
that are registered swap dealers. CEWG argued that this policy could
lead to registration of non-U.S. persons as swap dealers because of the
activities of their U.S. affiliates, which it asserted would be
contrary to the separation sometimes maintained between U.S. and non-
U.S. affiliates and unsupported by any policy rationale.\292\ ISDA and
SIFMA/CH/FSR were of the view that all persons (both U.S. and non-U.S.)
should be able to exclude from their de minimis calculations the swaps
of any affiliate (whether U.S. or non-U.S.) that is registered with the
Commission as a swap dealer, because swaps by a registered swap dealer
are subject to Dodd-Frank protections and no purpose would be served by
attributing them to affiliated entities in order to impose swap dealer
registration on those affiliates.\293\
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\292\ CEWG (Feb. 25, 2013) at 2-4.
\293\ ISDA (Feb. 6, 2013) at 4; SIFMA/CH/FSR (Feb. 6, 2013) at
B11-12. CEWG and ISDA also both stated that U.S. persons should in
no event be required to aggregate swaps of non-U.S. affiliates with
non-U.S. persons, because such swaps have insufficient nexus to the
United States. CEWG (Feb. 25, 2013) at 2; ISDA (Feb. 6, 2013) at 4.
---------------------------------------------------------------------------
The Mizuho Corporate Bank, Ltd. (``Mizuho'') and Sumitomo submitted
a joint letter arguing that the swap dealing activity of U.S.
affiliates that are registered as swap dealers should be excluded from
aggregation because otherwise the de minimis exception would be
effectively unavailable to non-U.S. based firms that conduct U.S.-
facing swap dealing activity through a U.S. affiliate that is
registered as a swap dealer.\294\ This result, in turn, would
inappropriately disfavor these firms as compared to firms that conduct
the same business through non-U.S. affiliates registered as swap
dealers; the Commission's interpretation should encourage, rather than
disfavor, registration of U.S. affiliates as swap dealers.\295\ IIB
stated that the policy reasons for allowing the exclusion of swap
dealing by non-U.S. affiliates registered as swap dealers also applies
to the dealing activity of U.S affiliates that are registered.\296\
---------------------------------------------------------------------------
\294\ Mizuho/Sumitomo (Feb. 6, 2013) at 3.
\295\ Id. See also Japan FSA (Feb. 6, 2013) at 2 (arguing that
the swap dealing activity of U.S. affiliates that are registered as
swap dealers should be excluded because the affiliates are subject
to supervision by the Commission).
\296\ IIB (Feb. 6, 2013) at 5-6.
---------------------------------------------------------------------------
Other commenters went further, stating that non-U.S. persons should
not be required to aggregate the swap dealing activities of any of
their U.S. affiliates. The Japanese Bankers Association stated U.S.
affiliates should be excluded from the non-U.S. person's calculations
because the U.S. persons are already subject to Dodd-Frank regulation
as warranted by their activities.\297\ EDF Trading stated that non-U.S.
persons that maintain minimal contacts with the United States should
not be required to register as swap dealers due to the activities of
their U.S. affiliates, because such a requirement would be inconsistent
with the jurisdictional limitation in section 2(i) of the CEA; result
in duplicative and potentially inconsistent regulatory requirements of
multiple jurisdictions applying to the same swap activity; and
encourage commercial firms to cease potential swap dealing activity in
the U.S., resulting in reduced U.S. swaps market liquidity and
fragmentation of the global swaps markets.\298\
---------------------------------------------------------------------------
\297\ Japanese Bankers Association (Feb. 6, 2013) at 2-3. See
also Japan FSA (Feb. 6, 2013) at 2 (arguing that all affiliates of
Japanese financial institutions should be excluded from the de
minimis calculation because the affiliates are supervised by Japan
FSA on a consolidated basis).
\298\ EDF Trading (Feb. 6, 2013) at 1-4. See also Brigard &
Urrutia Abogados (Feb. 6, 2013) at 2 (non-U.S. persons should be
allowed to exclude from the de minimis calculation the swap dealing
activities of U.S. affiliates, and of any affiliate (U.S. or non-
U.S.) that is a registered swap dealer).
---------------------------------------------------------------------------
Last, the Commission solicited commenters' views on whether a
person
[[Page 45323]]
engaged in swap dealing activities could take advantage of an
interpretation of the aggregation provision that allows a person to
exclude the swap dealing activities of one or more of its affiliates
under common control. The Commission asked whether, under such an
interpretation, a person could spread its swap dealing activities into
multiple affiliates, each under the de minimis threshold, and therefore
avoid the registration requirement, even though the aggregate level of
swap dealing by the affiliates exceeds the de minimis threshold. In
this regard, the Commission asked if any such interpretation should
include any conditions or limits on the overall amount of swap dealing
engaged in by unregistered persons within an affiliated group.
Greenberger/AFR opined that any approach that did not require
significant aggregation of swap dealing activities across affiliates
would create the danger of risk spreading outlined in the Further
Proposed Guidance.\299\ They stated that financial institutions could
easily remain under the de minimis threshold and thereby avoid
registration by routing swaps through their non-U.S. affiliates.\300\
---------------------------------------------------------------------------
\299\ Greenberger/AFR (Feb. 6, 2013) at 8-9.
\300\ See id. (citing press reports that U.S. banks such as
Morgan Stanley and Goldman Sachs are using foreign entities ``in
seriatim fashion to avoid going over the $ 8 billion test''). Making
a similar point, Better Markets emphasized that market participants
may be expected to implement the lowest-cost structure, considering
all regulatory costs. Better Markets (Feb. 6, 2013) at 15.
---------------------------------------------------------------------------
The Japanese Bankers Association stated that while the approach in
the Further Proposed Guidance could potentially prevent evasion, it
would do so at the cost of requiring multiple non-U.S. affiliates to
register as swap dealers even if the group of affiliates concentrated
its U.S. swap dealing activity in one U.S. entity.\301\ In fact, they
argued, concentrating U.S. swap dealing activity in a U.S. entity
should be encouraged because it facilitates Commission supervision of
that activity.\302\ Further, they stated that to expect non-U.S.
persons to register as swap dealers as a result of dealing activity by
their U.S. affiliates undermines the regulatory independence of
different jurisdictions and international understandings on regulatory
harmonization.\303\ Similarly, EDF Trading stated that expecting
multiple entities within a corporate group to register as swap dealers
would be burdensome and may not advance regulatory interests, and the
alternative in the Further Proposed Guidance would merely increase
economic and regulatory burdens without achieving a significant
reduction in systemic risk, because it would encourage the
concentration of swap dealing activity in non-U.S affiliates.\304\
---------------------------------------------------------------------------
\301\ Japanese Bankers Association (Feb. 6, 2013) at 3.
\302\ Id.
\303\ Id. at 3-4.
\304\ EDF Trading (Feb. 6, 2013) at 5.
---------------------------------------------------------------------------
SIFMA/CH/FSR were of the view that it would be burdensome for
market participants to use multiple affiliates to avoid swap dealer
registration, because moving swap dealing activity between affiliates
requires a significant legal, technological and operational investment,
and fragmenting the activity among affiliates may make it harder for a
multinational institutions to manage risk efficiently.\305\ Along the
same lines, IIB stated that where one entity in a corporate group is
registered as a swap dealer, there are substantial commercial and
credit risk incentives to centralize swap dealing in the registered
entity, because doing so maximizes the potential to net offsetting
transactions, uses capital more efficiently, and is operationally
efficient.\306\ On the other hand, IIB stated that using unregistered
entities for swap dealing would not reduce the fixed costs incurred in
registration and that the unregistered entities in the group would
still be subject to swap costs such as clearing, reporting and trade
execution.\307\
---------------------------------------------------------------------------
\305\ SIFMA/CH/FSR (Feb. 6, 2013) at A3.
\306\ IIB (Feb. 6, 2013) at 3.
\307\ Id.
---------------------------------------------------------------------------
Based on the comments received on the Proposed Guidance and the
Further Proposed Guidance, and its further review of issues related to
the aggregation requirement, the Commission's policy is to interpret
the aggregation requirement in Commission regulation 1.3(ggg)(4) in a
manner that applies the same aggregation principles to all affiliates
in a corporate group, whether they are U.S. or non-U.S. persons.
Further, the Commission will generally apply the aggregation principle
(as articulated in the Final Entities Rules) such that, in considering
whether a person is engaged in more than a de minimis level of swap
dealing, a person (whether U.S. or non-U.S.) should generally include
all relevant dealing swaps of all its U.S. and non-U.S. affiliates
under common control,\308\ except that swaps of an affiliate (either
U.S. or non-U.S.) that is a registered swap dealer are excluded, as
discussed below. The Commission notes that this policy would ensure
that the aggregate notional value of applicable swap dealing
transactions of all such unregistered U.S. and non-U.S. affiliates does
not exceed the de minimis level.
---------------------------------------------------------------------------
\308\ For purposes of this Guidance, the Commission clarifies
that a reference to ``affiliates under common control'' with a
person includes affiliates that are controlling, controlled by, or
under common control with such person. See note 268, supra. Further,
in response to a question from a commenter, the Commission clarifies
that for this purpose, the term ``affiliates under common control''
includes parent companies and subsidiaries, and is not limited to
``sister companies'' at the same organizational level. See David Mu
(Jan. 8, 2013).
---------------------------------------------------------------------------
Stated in general terms, the Commission's interpretation allows
both U.S. persons and non-U.S. persons in an affiliated group to engage
in swap dealing activity up to the de minimis threshold. When the
affiliated group meets the de minimis threshold in the aggregate, one
or more affiliate(s) (inside or outside the United States) would
generally have to register as swap dealer(s) so that the relevant swap
dealing activity of the unregistered affiliates remains below the
threshold.
The Commission recognizes the borderless nature of swap dealing
activities, in which a dealer may conduct swap dealing business through
its various affiliates in different jurisdictions, and the Commission
believes that its policy on aggregation outlined above addresses the
concern that an affiliated group of U.S. and non-U.S. persons with
significant swap dealing transactions with U.S. persons or guaranteed
affiliates may not be required to register solely because such swap
dealing activities are divided between affiliates that each fall below
the de minimis level.
c. Exclusion of Certain Swaps by Non-U.S. Persons From the Swap Dealer
De Minimis Threshold
The Proposed Guidance would generally allow a non-U.S. person to
exclude from its de minimis threshold calculation its swaps with
foreign branches of U.S. swap dealers. This exclusion was intended to
allow non-U.S. persons to continue their inter-dealer swap activities
with foreign branches of U.S. swap dealers without exceeding the de
minimis threshold, thereby triggering a requirement to register as a
swap dealer.
Commenters on the Proposed Guidance, such as Goldman Sachs, argued
that the rationale for this exclusion is equally applicable when non-
U.S. persons that are banks or broker-dealers engage in swap dealing
transactions with U.S. swap dealers that do not conduct overseas
business through foreign branches. Absent a similar interpretation in
these circumstances, the commenters argued, U.S. swap dealers would be
at a
[[Page 45324]]
competitive disadvantage vis-[agrave]-vis foreign branches of U.S. swap
dealers since non-U.S. persons would be incentivized to limit their
dealing activities to foreign branches of U.S. swap dealers.\309\
---------------------------------------------------------------------------
\309\ Goldman (Aug. 27, 2012) at 5-6.
---------------------------------------------------------------------------
The Commission's policy is to generally allow non-U.S. persons that
are not guaranteed or conduit affiliates of U.S. persons not to count
toward their de minimis thresholds their swap dealing transactions with
(i) A foreign branch of a U.S. swap dealer, (ii) a guaranteed affiliate
of a U.S. person that is a swap dealer, and (iii) a guaranteed or
conduit affiliate that is not a swap dealer and itself engages in de
minimis swap dealing activity and which is affiliated with a swap
dealer.\310\ The Commission believes that where the guaranteed
affiliate of a U.S. person is registered as a swap dealer, or where the
foreign branch is included within the swap dealer registration of its
U.S. home office, then it is appropriate to generally permit such non-
U.S. not to count its swap dealing transactions with those entities
against the non-U.S. person's de minimis threshold, because in these
cases one counterparty to the swap is a swap dealer subject to
comprehensive swap regulation and operating under the oversight of the
Commission.
---------------------------------------------------------------------------
\310\ Note that if a non-U.S. person that is not a guaranteed or
conduit affiliate of a U.S. person engages in a swap dealing
transaction with another non-U.S. person that is not a guaranteed
affiliate of a U.S. person (including such non-U.S. person that is a
swap dealer), then such swap dealing transaction does not count
toward the de minimis threshold of the unregistered, swap dealing
party.
---------------------------------------------------------------------------
The Commission understands that commenters are concerned that
foreign entities, in order to avoid swap dealer status, may decrease
their swap dealing business with foreign branches of U.S. registered
swap dealers and guaranteed affiliates that are swap dealers.
Therefore, the Commission's policy, based on its interpretation of
section 2(i) of the CEA, will be that swap dealing transactions with a
foreign branch of a U.S. swap dealer or with guaranteed affiliates that
are swap dealers should generally be excluded from the de minimis
calculations of non-U.S. persons that are not guaranteed or conduit
affiliates.\311\ However, the Commission is not persuaded that similar
concerns arise regarding foreign entities that may engage in swap
dealing business with such persons.\312\
---------------------------------------------------------------------------
\311\ The types of offices the Commission would generally
consider in this regard to be a ``foreign branch'' of a U.S. bank,
and the circumstances in which a swap would generally be treated as
being with such foreign branch, are discussed further in section C,
infra.
\312\ See Goldman (Aug. 27, 2012) at 3-4.
---------------------------------------------------------------------------
With regard to non-U.S. persons that are not guaranteed or conduit
affiliates of U.S. persons, such non-U.S. persons also generally would
not count toward their de minimis thresholds their swap dealing
transactions with a guaranteed affiliate that is not a swap dealer and
itself engages in de minimis swap dealing activity and which is
affiliated with a swap dealer. This interpretation reflects the
Commission's view that when the aggregate level of swap dealing by a
non-U.S. person that is not a guaranteed affiliate, considering both
swaps with U.S. persons and swaps with unregistered guaranteed
affiliates (together with any swap dealing transactions that the non-
U.S. person aggregates for purposes of the de minimis calculation as
described below) exceeds the de minimis level of swap dealing, the non-
U.S. person's swap dealing transactions have the requisite ``direct and
significant connection with activities in, or effect on, commerce of
the United States.'' \313\ The Commission believes, however, that where
the counterparty to a swap is a guaranteed affiliate and is not a
registered swap dealer, the Commission's regulatory concerns are
addressed because the guaranteed affiliate engages in a level of swap
dealing below the de minimis threshold and is part of an affiliated
group with a swap dealer.
---------------------------------------------------------------------------
\313\ In the Proposed Guidance, the Commission asked whether the
place of execution or clearing is relevant to the determination of
whether a non-U.S. person should be required to register as a swap
dealer. The Commission's policy is that a person generally would not
be required to register as a swap dealer if the person's only
connection to the United States is that the person uses a U.S.-
registered swap execution facility (``SEF'')or designated contract
market (``DCM'') in connection with its swap dealing activities.
---------------------------------------------------------------------------
In addition, non-U.S. persons that are not guaranteed or conduit
affiliates of U.S. persons also generally would not count toward their
de minimis thresholds their swap dealing transactions with a guaranteed
affiliate where the guaranteed affiliate is guaranteed by a non-
financial entity.\314\ This exception is appropriate given that the
risks to the U.S. financial markets are mitigated because the U.S.
guarantor is a non-financial entity.
---------------------------------------------------------------------------
\314\ See CEA section 2(h)(7)(C) for a definition of financial
entity.
---------------------------------------------------------------------------
The Commission notes that under its interpretation of section 2(i),
a non-U.S. person that is not a guaranteed or conduit affiliate would
not have to count its swap dealing transactions with other non-U.S.
persons that are not guaranteed affiliates because, in the Commission's
view, such swap dealing activity would not have the requisite ``direct
and significant connection with activities in, or effect on, U.S.
commerce.''
d. Exclusion of Certain Swaps by Non-U.S. Persons From the MSP
Calculation
Related to their discussion of the swap dealer de minimis
threshold, some commenters, such as SIFMA and Citi, stated that a non-
U.S. person should not have to include swaps with foreign branches of
U.S. swap dealers towards the MSP calculation.\315\
---------------------------------------------------------------------------
\315\ See SIFMA (Aug. 27, 2012) at A28-29; Citi (Aug. 27, 2012)
at 2-3.
---------------------------------------------------------------------------
The Commission has considered whether, under section 2(i), the
swaps that a non-U.S. person that is not a guaranteed or conduit
affiliate enters into with a foreign branch of a U.S. swap dealer or a
guaranteed affiliate that is a swap dealer should be excluded from the
calculation of the non-U.S. person's MSP registration threshold. The
Commission notes that its policy regarding such swaps for purposes of
the MSP registration may reasonably be distinguished from its policy
for purposes of the swap dealer registration threshold calculation. As
described in the Final Entities Rules, MSP registration is required for
non-dealers with swaps positions so large as to pose systemic risk.
This is in contrast to swap dealer registration, which is a functional
test focused on the nature of activities conducted by a potential
registrant. Consequently, if all swaps between a non-U.S. person and
foreign branches of U.S. swap dealers or swap dealers that are
guaranteed affiliates were generally excluded under the Commission's
policy with respect to MSP registration, a market participant that
poses systemic risk within the meaning of the MSP definition could
potentially be relieved of the requirement to register as an MSP. The
Commission believes that such an outcome could undermine the MSP
registration scheme. However, the Commission is persuaded that it is
possible to control the potential risk of the non-U.S. person's risk
with foreign branches of U.S. swap dealers and guaranteed affiliates
that are swap dealers under certain limited circumstances and therefore
that limited interpretive relief from the MSP calculation requirement
is appropriate.\316\ Thus, a non-U.S. person that is not a guaranteed
affiliate of a U.S. person and is a financial entity generally does not
have to count toward
[[Page 45325]]
its MSP threshold its exposure under swaps with foreign branches of a
U.S. swap dealer or guaranteed affiliates that are swap dealers;
provided, that the swap is either cleared, or the documentation of the
swap requires the foreign branch or guaranteed affiliate to collect
daily variation margin, with no threshold, on its swaps with such non-
U.S. person. When this condition is met, the Commission believes that
it would generally be appropriate for the non-U.S. person not to count
its exposure under such swaps against its MSP threshold.
---------------------------------------------------------------------------
\316\ The interpretation applies to non-U.S. persons that are
not guaranteed by U.S. persons. Non-U.S. financial entities would be
required to include swaps positions with foreign branches and
guaranteed affiliates of U.S. persons unless they choose to comply
with voluntary margining requirements, discussed below.
---------------------------------------------------------------------------
The Commission notes that a non-U.S. person's swaps positions with
guaranteed affiliates that are swap dealers and foreign branches of
U.S. swap dealers must be addressed in the latter entities' risk
management programs. Such programs must account for, among other
things, overall credit exposures to non-U.S. persons.\317\ Second, the
Commission notes that a non-U.S. person's swaps with a guaranteed
affiliate that is a swap dealer would be included in exposure
calculations and attributed to the U.S. guarantor for purposes of
determining whether the U.S. guarantor's swap exposures are
systemically-important on a portfolio basis and therefore require the
protections provided by MSP registration.\318\
---------------------------------------------------------------------------
\317\ See Commission regulation 23.600(c)(4)(ii), requiring swap
dealers and MSPs to have credit risk policies and procedures that
account for daily measurement of overall credit exposure to comply
with counterparty credit limits, and monitoring and reporting of
violations of counterparty credit limits performed by personnel that
are independent of the business trading unit. See also Commission
regulation 23.600(c)(1)(i), requiring the senior management and the
governing body of each swap dealer and MSP to review and approve
credit risk tolerance limits for the swap dealer or MSP.
\318\ See Final Entities Rules at 30689, stating the
Commission's interpretation that ``an entity's swap . . . positions
in general would be attributed to a parent, other affiliate or
guarantor for purposes of the major participant analysis to the
extent that the counterparties to those position would have recourse
to that other entity in connection with the position.'' The
Commission stated further that ``entities will be regulated as major
participants when they pose a high level of risk in connection with
the swap . . . positions they guarantee.''
---------------------------------------------------------------------------
Finally, a non-U.S. person that is not a guaranteed affiliate and
is not a financial entity \319\ would generally not have to count
toward its MSP thresholds its exposure under swaps with a foreign
branch of a U.S. swap dealer or guaranteed affiliate that is a swap
dealer. This exclusion reflects the Commission's recognition of the
more modest risk to the U.S. financial markets from swaps activities
with non-financial entities organized outside the United States.\320\
Further, the Commission notes that the Basel Committee on Banking
Supervision (``BCBS'') and the International Organization of Securities
Commissions (``IOSCO'') have recently issued a second consultative
document under which, if finalized, would not apply margin requirements
to the non-centrally cleared derivatives of non-financial entities,
given that such transactions are viewed as posing little or no systemic
risk and are exempt from clearing mandates in most jurisdictions.\321\
---------------------------------------------------------------------------
\319\ See CEA section 2(h)(7)(C) for a definition of financial
entity.
\320\ Based on data the Bank for International Settlements
obtained from thirteen reporting countries (Australia, Belgium,
Canada, France, Germany, Italy, Japan, the Netherlands, Spain,
Sweden, Switzerland, the United Kingdom and the United States), at
the end of December 2012, notional amounts outstanding for OTC
foreign exchange derivatives, interest rate derivatives, and credit
default swaps with non-financial customers accounted for an average
of less than 8 percent of the total aggregate amounts outstanding
for these asset classes. See Bank for International Settlements,
Statistical release: OTC derivatives statistics at end-December 2012
(May 2013), available at http://www.bis.org/publ/otc_hy1305.pdf.
\321\ See BCBS IOSCO, Margin Requirements for Non-Centrally
Cleared Derivatives, Second Consultative Document, at 7 (issued for
comment March 15, 2013), available at http://www.bis.org/publ/bcbs242.pdf.
---------------------------------------------------------------------------
e. Exclusion of Certain Swaps Executed Anonymously on a SEF, DCM, or
Foreign Board of Trade (``FBOT'') and Cleared
The Commission believes that when a non-U.S. person that is not a
guaranteed or conduit affiliate enters into swaps anonymously on a
registered DCM, SEF, or FBOT \322\ and such swaps are cleared, the non-
U.S. person would generally not have to count such swaps against its de
minimis threshold. The Commission understands that in these
circumstances, the non-U.S. person would not have any prior information
regarding its counterparty to the swap. Also, as discussed below, the
Commission is interpreting CEA section 2(i) such that, where a swap
between such a non-U.S. person and a U.S. person is executed
anonymously on a registered DCM, SEF, or FBOT and cleared the non-U.S.
person generally will satisfy all of the applicable Category A
Transaction-Level Requirements \323\ that pertain to such a swap
transaction. The Commission believes that the regulatory interest in
including such swaps in the non-U.S. person's de minimis calculation is
outweighed by the practical difficulties involved in determining
whether the non-U.S. person should include the swap in the calculation,
given that the non-U.S. person would have no information regarding its
swap counterparty prior to execution of the swap.
---------------------------------------------------------------------------
\322\ As used herein, a registered FBOT means an FBOT that is
registered with the Commission pursuant to part 48 of the
regulations in order to permit direct access to the FBOT's order
entry and trade matching system from within the U.S. Among others,
16 FBOTs that currently permit direct access for the trading of
futures and option contracts, but not swaps, pursuant to no-action
relief letters issued by Commission staff have submitted complete
applications for registration. In light of the fact that registered
FBOTs can also list swaps for trading by direct access and in view
of the time required to properly assess registration applications
and the interest on the part of certain FBOTs operating pursuant to
the no-action relief in listing swaps for trading by direct access,
the Division of Market Oversight has determined to amend the 16 no-
action letters to permit those FBOTs, subject to certain conditions,
to also list swaps for trading by direct access. Accordingly, all
provisions in this document that apply to registered FBOTs also
apply to the 16 FBOTs permitting trading by direct access pursuant
to the amended no-action relief.
\323\ The Commission notes that while the real-time reporting
requirement will be satisfied for cleared swaps executed anonymously
on a DCM or SEF, absent further affirmative actions by an FBOT, the
requirement will not be satisfied through FBOT execution alone. See
section G, infra.
---------------------------------------------------------------------------
The Commission also believes that when a non-U.S. person that is
not a guaranteed or conduit affiliate clears a swap through a
registered derivatives clearing organization (``DCO''), such non-U.S.
person would generally not have to count the resulting swap (i.e., the
novated swap) against its swap dealer de minimis threshold or MSP
threshold.\324\ Where a swap is created by virtue of novation, such
swap does not implicate swap dealing, and therefore it would not be
appropriate to include such swaps in determining whether a non-U.S.
person should register as a swap dealer.
---------------------------------------------------------------------------
\324\ A swap that is submitted for clearing is extinguished upon
novation and replaced by new swap(s) that result from novation. See
Commission regulation 39.12(b)(6). See also Derivatives Clearing
Organization General Provisions and Core Principles, 76 FR 69334,
69361 (Nov. 8, 2011).
---------------------------------------------------------------------------
f. MSP-Parent Guarantees
While under the Proposed Guidance swaps conducted by a non-U.S.
person, where guaranteed by a U.S. person, would generally be
attributed only to the U.S. person in determining who must register as
an MSP, the Commission did not expressly address a guarantee by a non-
U.S. person of the swaps obligations of its U.S. subsidiary. In SIFMA's
view, the Proposed Guidance created ambiguity as to the treatment of
guarantees between other types of entities (e.g., where a U.S. person
is guaranteed by a non-U.S. person or where a non-U.S. person is
guaranteed by a non-U.S. person).\325\ In
[[Page 45326]]
addition, Cleary noted that the Commission determined in the Final
Entities Rules not to include a parental guarantee of a subsidiary's
swaps in the computation of the parent's outward exposure under the MSP
definition where the subsidiary is subject to capital oversight by the
Commission, SEC, or an appropriate banking regulator. They asked that
the Commission consider extending comparable treatment for parental
guarantees where the non-U.S. subsidiary is subject to Basel-compliant
capital oversight by another G20 prudential supervisor.\326\
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\325\ SIFMA (Aug. 27, 2012) at A32. Along similar lines, IIB
commented that there might be circumstances under which a wholly-
owned subsidiary of a person already registered as a swap dealer
enters into swaps with U.S. persons where its obligations are
guaranteed by the swap dealer. IIB (Aug. 27, 2012) at 25.
\326\ Cleary (Aug. 16, 2012) at 12.
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Under the Commission's interpretation of section 2(i) of the CEA,
the discussion in the Final Entities Rules regarding attribution of
swaps positions of guaranteed persons for purposes of the MSP
definition should generally apply to non-U.S. persons. That is, as
applied to non-U.S. persons, where there is no guarantee or recourse to
another person under the swap, the swap should generally be attributed
to the person who enters into the swap, and there generally would be no
attribution or aggregation of the swaps position with the swaps
positions of the person's affiliates.\327\ On the other hand, where the
counterparty to the swap would have recourse to another person, such as
a parent guarantor, the swap should generally be attributed to the
person to whom there is recourse. Thus, if a U.S. person enters into a
swap guaranteed by a non-U.S. person, the swap should generally be
attributed to the non-U.S. person, and if a non-U.S. person enters into
a swap guaranteed by a U.S. person, the swap should generally be
attributed to the U.S. person.
---------------------------------------------------------------------------
\327\ See Final Entities Rules, 77 FR at 30689.
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However, the Commission is also cognizant that, as a matter of
international comity, regulation of non-U.S. persons can be less
preferable where the same regulatory outcomes can be achieved by
regulating an affiliated U.S. person. So where the swaps of a U.S.
person are guaranteed by a non-U.S. person, the Commission would
consider the possibility that registration of the non-U.S. person would
not be required if the U.S. person registers as an MSP, and there may
be circumstances where registration of the U.S. person would be
preferable. Also, the same considerations of international comity
suggest that regulation of non-U.S. persons should be effected in a
manner that generally does not interfere with non-U.S. regulation.
Thus, the Commission would be willing to consider that the swaps
positions of non-U.S. persons that are guaranteed by other non-U.S.
persons may be attributed to either the non-U.S. guarantor or the
guaranteed non-U.S. person so long as all of the swaps positions that
would trigger MSP registration are subject to the MSP registration and
regulatory requirements. Thus, in IIB's scenario, the non-U.S.-based
bank may consult with the Commission and decide to register itself--or
its subsidiaries--as an MSP. The Commission would generally not expect
both the parent guarantor bank and the guaranteed bank to register as
MSPs. In the Commission's view, the related risk concerns should be
adequately addressed by requiring either the guarantor or the
guaranteed person to register, provided that the swap activities giving
rise to MSP registration are regulated under Dodd-Frank.
As to Cleary's request regarding comparable treatment for certain
parental guarantees, the Commission agrees that, as a matter of policy,
it would generally be appropriate to extend similar treatment to
parental guarantees of a subsidiary that is subject to comparable and
comprehensive capital oversight by a G20 prudential supervisor. In this
respect, the Commission views Basel-compliant capital standards as
sufficiently comparable and comprehensive to capital oversight by the
Commission, SEC, or banking regulator. Thus, where a subsidiary is
subject to Basel-compliant capital standards and oversight by a G20
prudential supervisor, the subsidiary's positions would generally not
be attributed to a parental guarantor in the computation of the
parent's outward exposure under the MSP definition.
4. Summary
The Commission's policy under this Guidance may be summarized as
follows.
The Commission will generally apply the aggregation principle (as
articulated in the Final Entities Rules) such that, in considering
whether a person is engaged in more than a de minimis level of swap
dealing, a person (whether U.S. or non-U.S.) should generally include
all relevant dealing swaps of all its U.S. and non-U.S. affiliates
under common control, except that swaps of an affiliate (either U.S. or
non-U.S.) that is a registered swap dealer are excluded. For this
purpose, consistent with the Commission's policy on counting swap
transactions towards the de minimis threshold for swap dealer
registration detailed above, the dealing swaps of an affiliate under
common control with such person would include:
(i) In the case of a U.S. person or a guaranteed or conduit
affiliate, all its swap dealing transactions; and
(ii) in the case of a non-U.S. person that is not a guaranteed
or conduit affiliate:
a. all dealing swaps with counterparties who are U.S. persons
(other than foreign branches of U.S. swap dealers); and
b. all dealing swaps with guaranteed affiliates except:
i. guaranteed affiliates that are swap dealers;
ii. guaranteed affiliates that are not swap dealers but which
are affiliated with a swap dealer and where the guaranteed affiliate
itself engages in de minimis swap dealing activity;
iii. guaranteed affiliates that are guaranteed by a non-
financial entity.
In addition, a non-U.S. affiliate that is not a guaranteed or
conduit affiliate may exclude any swaps that are entered into
anonymously on a registered DCM, SEF, or FBOT and cleared, as more
fully discussed above.
The Commission's interpretation would allow both U.S. persons and
non-U.S. persons in an affiliated group to engage in unregistered swap
dealing activity up to the de minimis level for the entire group. When
the affiliated group nears the de minimis threshold in the aggregate,
it would have to register a number of affiliates (inside or outside the
United States) as swap dealers sufficient to maintain the relevant
dealing swaps of the unregistered affiliates below the threshold.
In determining whether a non-U.S. person holds swap positions above
the MSP thresholds, the non-U.S. person should consider the aggregate
notional value of:
(i) Any swap position between it and a U.S. person;
(ii) any swap position between it and a guaranteed affiliate
(but its swap positions where its own obligations thereunder are
guaranteed by a U.S. person should be attributed to that U.S. person
and not included in the non-U.S. person's determination); and
(iii) any swap position between another (U.S. or non-U.S.)
person and a U.S. person or guaranteed affiliate, where it
guarantees the obligations of the other person thereunder.
A non-U.S. person that is not a guaranteed affiliate of a U.S.
person and is a financial entity would generally not have to count
toward its MSP thresholds its exposure under swaps with foreign
branches of U.S. swap dealers or guaranteed affiliates that are swap
dealers, provided that the swap is either cleared, or the documentation
of the
[[Page 45327]]
swap requires the foreign branch or guaranteed affiliate to, and the
swap dealer actually does, collect daily variation margin, on its swaps
with the non-U.S. person.
In addition, a non-U.S. person that is not a guaranteed affiliate
and is not a financial entity \328\ would generally not have to count
toward its MSP thresholds its exposure under swaps with a foreign
branch or guaranteed affiliate, in each case that is a swap dealer.
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\328\ See CEA section 2(h)(7)(C) for a definition of financial
entity.
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C. Interpretation of the Term ``Foreign Branch;'' When a Swap Should Be
Considered To Be With the Foreign Branch of a U.S. Person That Is a
Swap Dealer or MSP
1. Interpretation of the Term ``Foreign Branch'' and Treatment of
Foreign Branches
As discussed above, the Commission considers a foreign branch of a
U.S. person to be a part of the U.S. person. Thus, in the Proposed
Guidance, the Commission proposed that the U.S. person would be legally
responsible for complying with all applicable Entity-Level
Requirements. Under this approach, the foreign branch of the U.S.
person would not register separately as a swap dealer. The Commission
believes that this approach is appropriate because a foreign branch of
a U.S. swap dealer is an integral part of a U.S. swap dealer and not a
separate legal entity.
In the Proposed Guidance, the Commission also proposed interpreting
2(i) so that where a swap is with a foreign branch of a U.S.-based swap
dealer, irrespective of whether the counterparty is a U.S. person or
non-U.S. person, the foreign branch would be expected to comply with
most of the Transaction-Level Requirements. The Commission stated that
this proposed approach is appropriate in light of the Commission's
strong supervisory interests in entities that are a part or an
extension of a U.S.-based swap dealer. The Commission also proposed
interpreting 2(i) so that swaps between a foreign branch of a U.S.
person and a non-U.S. person counterparty (irrespective of whether that
non-U.S. person counterparty's obligations under the swap are
guaranteed by a U.S. person or not) would be eligible for substituted
compliance with respect to Category A Transaction-Level Requirements.
As discussed further below, where the counterparty to a swap with a
foreign branch is a non-U.S. person (whether or not swaps such non-U.S.
person is guaranteed or otherwise supported by, or is an affiliate
conduit of, a U.S. person), the Commission continues to be of the view
that the swap should be eligible for substituted compliance with
respect to Category A Transaction-Level Requirements, to the extent
applicable, in light of the supervisory interest of the foreign
jurisdiction in the execution and clearing of trades occurring in that
jurisdiction. As discussed further in section F below, the Commission's
recognition of substituted compliance would be based on an evaluation
of whether the requirements of the home jurisdiction are comparable and
comprehensive to the applicable requirement(s) under the CEA and
Commission regulations based on a consideration of all relevant
factors, including among other things: (i) The comprehensiveness of the
foreign regulator's supervisory compliance program and (ii) the
authority of such foreign regulator to support and enforce its
oversight of the registrant's branch or agency with regard to such
activities to which substituted compliance applies.
In the January Order, the Commission gave exemptive relief from
Transaction-Level Requirements during the pendency of the January Order
for swaps between a foreign branch of a U.S. swap dealer or U.S. MSP
and a non-U.S. counterparty (including a non-U.S. swap dealer or non-
U.S. MSP). Thus, notwithstanding the Commission's view that the foreign
branch of a U.S. swap dealer is a U.S. person, the Commission granted
temporary relief during the pendency of the January Order for swaps
between a foreign branch of a U.S. registrant and a non-U.S. swap
dealer, allowing the non-U.S. swap dealer to treat the foreign branch
as a non-U.S. person.
In the January Order, the Commission also stated that because it
believes a swap between two foreign branches of U.S. registrants is a
swap between two U.S. persons, such swaps are fully subject to the
Transaction-Level Requirements. Nevertheless, during the pendency of
the January Order, the Commission determined it would be appropriate to
permit foreign branches of U.S. registrants to comply only with
transaction-level requirements required in the location of the foreign
branch while the Commission further considered, and worked with
international regulators regarding, the treatment of foreign branches
of U.S. registrants. However, for purposes of this relief, the
Commission stated that for a swap between foreign branches of U.S.
registrants, the swap would be treated as with the foreign branch of a
U.S. person when: (i) The personnel negotiating and agreeing to the
terms of the swap are located in the jurisdiction of such foreign
branch; (ii) the documentation of the swap specifies that the
counterparty or ``office'' for the U.S. person is such foreign branch;
and (iii) the swap is entered into by such foreign branch in its normal
course of business (collectively the ``January Order Criteria''). If
the swap failed to satisfy all three of the January Order Criteria, the
Commission stated that the swap would be treated as a swap of the U.S.
person and not as a swap of the foreign branch of the U.S. person, and
would not be eligible for relief from transaction-level requirements
under the January Order.\329\
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\329\ See the January Order, 78 FR at 873 n. 123.
---------------------------------------------------------------------------
The Commission also stated in the January Order that as part of the
Commission's further consideration of this issue, additional factors
may be relevant to the consideration of whether a swap is with the
foreign branch of a U.S. person. These factors could include, for
example, that:
(i) The foreign branch is the location of employment of the
employees negotiating the swap for the U.S. person or, if the swap
is executed electronically, the employees managing the execution of
the swap;
(ii) the U.S. person treats the swap as a swap of the foreign
branch for tax purposes,
(iii) the foreign branch operates for valid business reasons and
is not only a representative office of the U.S. person; and
(iv) the branch is engaged in the business of banking or
financing and is subject to substantive regulation in the
jurisdiction where it is located (collectively the ``Additional
Factors'').\330\
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\330\ Id. at 873.
The Commission also sought comment from market participants and
other interested parties regarding whether it is appropriate to include
these or other factors in the consideration of when a swap is with the
foreign branch of a U.S. person.
2. Comments
The Commission received several comments on how the Commission
should determine whether a swap is ``with a foreign branch,'' both with
regard to swaps between a foreign branch and a non-U.S. swap dealer and
swaps between two foreign branches of U.S. swap dealers. In addition,
several organizations commented on the term ``foreign branch'' of a
U.S. bank.
Commenters stated that in determining whether a swap between a non-
U.S. swap dealer and a non-U.S. branch of a U.S. bank is bona fide with
the non-U.S. branch, the Commission should look to whether the swap is
booked in the foreign branch (as defined in Regulation K), and that the
four
[[Page 45328]]
additional factors that the Commission stated it was considering are
unnecessary.\331\ These commenters stated that the first Additional
Factor being considered (i.e., that the foreign branch is the location
of employment of the employees negotiating the swap for the U.S. person
or, if the swap is executed electronically, the employees managing the
execution of the swap) should be deleted because employees that
negotiate and agree to the terms of a swap may be located outside of
the non-U.S. branch that books the trade for a variety of valid
reasons.\332\ Similar arguments were made with regard to the first
prong of the January Order Criteria (i.e., that the personnel
negotiating and agreeing to the terms of the swap are located in the
jurisdiction of such foreign branch).\333\ As noted above, State Street
stated that in a global economy, foreign exchange swaps are negotiated
24 hours a day, by parties in various locations. Therefore, the
physical location of employees has little connection to the legal
jurisdiction of the branch in which the swaps are booked. Determination
of the branch in which the swap is booked is influenced by a number of
factors, including the convenience of the swap counterparty and
agreements between counterparties to book swaps to mutually agreeable
and preferred locations. State Street further stated that limiting the
ability to book transactions to a foreign branch would be inappropriate
for U.S. dealers in foreign exchange because foreign exchange
transactions are typically negotiated in large blocks, which combine
the orders of a variety of asset owners, and which can include both
U.S. persons and non-U.S. persons. Once negotiated and executed, these
blocks are allocated to the various asset owners, and booked to the
location preferred by the asset owner or in some cases the dealer's
non-U.S. branch. This allows managers to trade foreign exchange more
efficiently, using a single point of dealer contact, and ensures that
all asset owners on whose behalf they are trading receive the same
price. State Street also stated that the approach outlined in proposal
would place U.S. businesses at a competitive disadvantage, as non-U.S.
owners would be unwilling to do business that would subject them to the
U.S. regulatory requirements.\334\
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\331\ See SIFMA/CH/FSR (Feb. 6, 2013) at B18-20; State Street
(Feb. 6, 2013) at 2-4.
\332\ See, e.g., SIFMA/CH/FSR (Feb. 6, 2013) at B18.
\333\ Id. at B17.
\334\ State Street (Feb. 6, 2013) at 3-4.
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A commenter stated that it does not strongly object to prongs 2, 3
and 4 of the Additional Factors (that the swap is treated as a swap of
the foreign branch for tax purposes, that the branch operates for valid
business reasons and is not only a representative office, and that the
branch is engaged in banking or financing and subject to substantive
local regulation) since they could ``be reasonable indicia of a bona
fide non-U.S. branch of a U.S. swap dealer.'' However, this commenter
stated that each of these prongs may be challenging to properly define
and evaluate.\335\
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\335\ State Street (Feb. 6, 2013) at 2.
---------------------------------------------------------------------------
With respect to the proposed tax prong (prong 2 of the Additional
Factors), other commenters stated that the income from a swap that is
booked in a foreign branch of a U.S. person is subject to taxation in
the local jurisdiction in which the foreign branch is resident, which
demonstrates that such swaps are bona fide with the non-U.S. branch.
The commenters further noted that a foreign tax credit is generally
allowed for income taxes paid locally.\336\
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\336\ See SIFMA/CH/FSR (Feb. 6, 2013) at B18; State Street (Feb.
6, 2013) at 2.
---------------------------------------------------------------------------
With regard to prong 3 of the Additional Factors (that the branch
operates for valid business reasons and is not only a representative
office), as noted earlier, SIFMA/CH/FSR argued that the only criteria
that is relevant in determining whether a swap is bona fide with a
foreign branch of a U.S. swap dealer is whether the swap is booked in
the foreign branch (as reflected in the trade confirm), with the term
``foreign branch'' defined with reference to Regulation K. These
commenters stated that the definition of a foreign branch in Regulation
K makes it clear that a foreign branch of a U.S. bank is not a
``representative office.'' In addition, Regulation K is a comprehensive
regulation of the Federal Reserve Board that ensures that foreign
branches operate for valid reasons.\337\
---------------------------------------------------------------------------
\337\ See SIFMA/CH/FSR (Feb. 6, 2013) at B19.
---------------------------------------------------------------------------
With regard to prong 4 of the Additional Factors (that the branch
is engaged in banking or financing and subject to substantive local
regulation), SIFMA/CH/FSR argue that this prong is unnecessary because,
in addition to being regulated under Regulation K by the Federal
Reserve, foreign branches are also subject to substantive local
regulation and supervision, including licensing requirements and
potentially local derivatives rules that the Commission could find to
constitute substituted compliance. Although these commenters
acknowledged that the nature and scope of these regulations will vary
by jurisdiction, they state that many foreign jurisdictions require the
same level of compliance with local regulations that U.S. regulators
require of U.S. branches of foreign banks with regards to U.S. laws and
regulations. They also stated that requiring foreign branches to show
that they are subject to substantive regulation in their local
jurisdiction so as to determine whether each swap they enter into is
bona fide would be overly burdensome and unnecessary. In their view,
the only relevant factor that the Commission should consider is whether
the swap has been booked into the foreign branch, which the trade
confirm would reflect.\338\
---------------------------------------------------------------------------
\338\ See id. at B19-20.
---------------------------------------------------------------------------
Conversely, one commenter argued that, consistent with clear
evidence from the last crisis that the risks accrued by foreign
branches, guaranteed subsidiaries, and even non-guaranteed subsidiaries
all flow back to the parent entity, foreign branches of U.S. persons
should under no circumstances be subject to weaker regulation than the
parent company. This commenter also argues that there is no substantive
difference between a branch and a subsidiary of a U.S. person in terms
of covering derivatives losses, and that both must be held to the same
high standards as apply to the U.S. person itself. Otherwise, the U.S.
taxpayer will be exposed to the risk of another massive bailout.\339\
In addition, this commenter stated that claims made by industry groups
that foreign branches of U.S. entities should not be classified as U.S.
persons or they will find no foreign counterparties willing to do
business with them are absurd and unsubstantiated, and taken literally,
seem to suggest that the Commission should exempt all overseas swap
activity from the requirements of Title VII of the Dodd-Frank Act,
which would directly violate Congress's clear intent.
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\339\ Better Markets (Feb. 15, 2013) at 2, 4-5.
---------------------------------------------------------------------------
3. Commission Guidance
In preparing the Guidance, the Commission has carefully considered
commenters' concerns and recommendations related to both the
appropriate scope of the term ``foreign branch'' for purposes of this
Guidance and Commission consideration of when a swap should be
considered to be ``with the foreign branch'' of a U.S. bank that is a
swap dealer or MSP.
a. Scope of the Term ``Foreign Branch''
The Commission notes that foreign branches of a U.S. bank are part
of a
[[Page 45329]]
U.S. bank rather than a separate legal entity, and are therefore ``U.S.
persons.'' Nevertheless, as a policy matter, the Commission believes
that CEA section 2(i) should be interpreted so as to exclude swap
dealing transactions with a foreign branch of a U.S. swap dealer from
the de minimis calculations for swap dealer or MSP registration. In
addition, the Commission believes that CEA section 2(i) should be
interpreted so that swaps between a foreign branch of a U.S. swap
dealer or MSP and a non-U.S. person should be eligible for substituted
compliance with regard to Category A Transaction-Level
Requirements.\340\ The Commission believes that CEA section 2(i) should
be interpreted in this manner in order to avoid the potential result
that foreign entities would cease doing swap dealing business with
foreign branches of U.S. registered swap dealers. However, the
Commission notes that interpreting CEA section 2(i) in this manner
creates a distinction between swaps with foreign branches of U.S. banks
and swaps with the U.S. principal bank. Therefore, the Commission also
believes that Commission consideration of both the scope of the term
``foreign branch'' and when a swap is with the foreign branch of a U.S.
bank should be construed under CEA section 2(i) in a manner that does
not create unnecessary distinctions between otherwise similar
activities.
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\340\ As discussed further in section G, under the Commission's
interpretation of 2(i), in the case of a swap with a U.S. swap
dealer or U.S. MSP (including an affiliate of a non-U.S. person, and
including a foreign branch of a U.S. bank that is a swap dealer or
MSP), the parties to the swap generally would not be not eligible
for substituted compliance with one exception--where the swap is
between the foreign branch of a U.S. bank that is a swap dealer or
MSP and a non-U.S. person (regardless of whether the non-U.S. person
is guaranteed or otherwise supported by, or is an affiliate conduit
of, a U.S. person).
---------------------------------------------------------------------------
Therefore, the Commission interprets CEA section 2(i) such that,
for purposes of this Guidance, the Commission will generally consider a
``foreign branch'' of a U.S. swap dealer or U.S. MSP to be any
``foreign branch'' (as defined in the applicable banking regulation) of
a U.S. bank that is: (i) Subject to Regulation K \341\ or the FDIC
International Banking Regulation,\342\ or otherwise designated as a
``foreign branch'' by the U.S. bank's primary regulator, (ii) maintains
accounts independently of the home office and of the accounts of other
foreign branches with the profit or loss accrued at each branch
determined as a separate item for each foreign branch,\343\ and (iii)
subject to substantive regulation in banking or financing in the
jurisdiction where it is located (the ``Foreign Branch
Characteristics''). However, in addition to the foregoing Foreign
Branch Characteristics, the Commission will consider other relevant
facts and circumstances in considering whether a foreign office of a
U.S. bank is a ``foreign branch'' of a U.S. bank for purposes of this
Guidance.
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\341\ Regulation K is a regulation issued by the Board of
Governors of the Federal Reserve (``Federal Reserve Board'') under
the authority of the Federal Reserve Act (``FRA'') (12 U.S.C. 221 et
seq.); the Bank Holding Company Act of 1956 (``BHC Act'') (12 U.S.C.
1841 et seq.) and the International Banking Act of 1978 (``IBA'')
(12 U.S.C. 3101 et seq.). Regulation K sets forth rules governing
the international and foreign activities of U.S. banking
organizations, including procedures for establishing foreign
branches to engage in international banking.
Under Regulation K, 12 CFR part 211, a ``foreign branch'' is
defined as ``an office of an organization (other than a
representative office) that is located outside the country in which
the organization is legally established and at which a banking or
financing business is conducted.'' See 17 CFR 211.2(k).
\342\ 12 CFR part 347 is a regulation issued by the Federal
Deposit Insurance Corporation under the authority of the Federal
Deposit Insurance Act (12 U.S.C. 1828(d)(2)), which sets forth rules
governing the operation of foreign branches of insured state
nonmember banks (``FDIC International Banking Regulation''). Under
12 CFR 347.102(j), a ``foreign branch'' is defined as ``an office or
place of business located outside the United States, its
territories, Puerto Rico, Guam, American Samoa, the Trust Territory
of the Pacific Islands, or the Virgin Islands, at which banking
operations are conducted, but does not include a representative
office.''
\343\ The Commission notes that national banks operating foreign
branches are required under section 25 of the Federal Reserve Act,
12 U.S.C. 604a, to conduct the accounts of each foreign branch
independently of the accounts of other foreign branches established
by it and of its home office, and are required at the end of each
fiscal period to transfer to its general ledger the profit or loss
accrued at each branch as a separate item.
---------------------------------------------------------------------------
Further, for purposes of this Guidance, the Commission interprets
CEA section 2(i) so that generally a foreign branch of a U.S. bank
could include an office of a foreign bank that satisfies the foregoing
Foreign Branch Characteristics. However, a foreign branch of a U.S.
bank would generally not include an affiliate of a U.S. bank that is
incorporated or organized as a separate legal entity.
In considering the scope of the term ``foreign branch,'' the
Commission agrees with commenters that stated that Regulation K of the
Federal Reserve Board's regulations provides a useful reference because
Regulation K provides a comprehensive regime for regulation of foreign
branches that ensures that foreign branches of U.S. banks operate for
valid reasons and are not ``representative offices.'' Similarly, the
Commission believes that the FDIC International Banking Regulation
provides a useful reference for U.S. banks that have foreign branches
which are subject to FDIC jurisdiction.\344\
---------------------------------------------------------------------------
\344\ See notes 341 and 342 above and accompanying text for
additional information regarding the definition of a ``foreign
branch'' in Regulation K and the FDIC International Banking
Regulation.
---------------------------------------------------------------------------
In addition, regardless of a foreign branch of a U.S. bank is
subject to Regulation K or the FDIC International Banking Regulation or
is otherwise designated as a ``foreign branch'' by the U.S. bank's
primary regulator, the Commission believes that CEA section 2(i) should
be interpreted so that, for purposes of this Guidance, a foreign branch
of a U.S. bank should generally also be subject to substantive
regulation in banking or financing in the jurisdiction where it is
located. Finally, the Commission believes that in order for a foreign
office of a U.S. bank to be viewed as a ``foreign branch'' for purposes
of this Guidance, another factor should generally be present--the
foreign branch should maintain its accounts independently of the home
office and of the accounts of other foreign branches, and at the end of
each fiscal period the U.S. bank should transfer to its general ledger
the profit or loss accrued at each branch as a separate item.\345\
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\345\ The Commission notes that section 25 of the Federal
Reserve Act, 12 U.S.C. 604a, states that national banking
associations with $1 million or more in capital and surplus may file
an application with the Board of Governors of the Federal Reserve
System for permission to exercise certain powers, including
establishment of foreign branches. In addition, section 25(9)
requires that every national banking association operating foreign
branches conduct the accounts of each foreign branch independently
of the accounts of other foreign branches established by it and of
its home office, and at the end of each fiscal period transfer to
its general ledger the profit or loss accrued at each branch as a
separate item.
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b. Commission Consideration of Whether a Swap Is With a Foreign Branch
of a U.S. Bank
With regard to Commission consideration of whether a swap by a U.S.
bank through a foreign office should be considered to be ``with a
foreign branch'' of the U.S. person for purposes of the de minimis
calculations for swap dealer and MSP registration \346\ or application
of the Transaction-Level Requirements \347\ under this Guidance, the
Commission has carefully considered the comments submitted on this
question.
---------------------------------------------------------------------------
\346\ See section B, supra.
\347\ See section G, infra.
---------------------------------------------------------------------------
SIFMA/CH/FSR stated that the only criteria that is relevant in
determining whether a swap is bona fide with a foreign branch of a U.S.
swap dealer is whether the swap is booked in the foreign branch (as
reflected in the trade confirmation), with the term ``foreign branch''
defined with reference to Regulation K. However, the
[[Page 45330]]
Commission's view is that the trade confirmation generally is not
relevant for purposes of determining whether to treat a swap as being
with a foreign branch of a U.S. bank rather than with the U.S.
principal bank. In reality, because the foreign branch of a U.S. bank
is not a separate legal entity, the U.S. principal bank would generally
be the party that is ultimately responsible for a swap with its foreign
branch. The Commission's view is that a foreign branch of a U.S. bank
should be considered a ``U.S. person'' under this Guidance because it
is a part of the U.S. bank. Moreover, Better Markets has argued that
foreign branches of U.S. banks as well as foreign subsidiaries and
affiliates should be treated exactly the same as U.S. persons in all
respects under this Guidance.
However, in light of principles of international comity and giving
consideration to comments that state that foreign branches of U.S.
banks will be at a competitive disadvantage if foreign branches of U.S.
banks are not treated the same as non-U.S. persons, the Commission
believes that in considering whether a swap should be considered as
being with the foreign branch of a U.S. bank under this Guidance, all
of the facts and circumstances are relevant. In particular, the
Commission's view is that if all of the following factors are present,
generally the swap should be considered to be with the foreign branch
of a U.S. bank for purposes of this Guidance:
(i) The employees negotiating and agreeing to the terms of the
swap (or, if the swap is executed electronically, managing the
execution of the swap), other than employees with functions that are
solely clerical or ministerial, are located in such foreign branch
or in another foreign branch of the U.S. bank;
(ii) the foreign branch or another foreign branch is the office
through which the U.S. bank makes and receives payments and
deliveries under the swap on behalf of the foreign branch pursuant
to a master netting or similar trading agreement, and the
documentation of the swap specifies that the office for the U.S.
bank is such foreign branch;
(iii) the swap is entered into by such foreign branch in its
normal course of business;
(iv) the swap is treated as a swap of the foreign branch for tax
purposes; and
(v) the swap is reflected in the local accounts of the foreign
branch.
However, if material terms of the swap are negotiated or agreed to
by employees of the U.S. bank located in the United States, the
Commission believes that generally the swap should be considered to be
with the U.S. principal bank, rather than its foreign branch, for
purposes of this Guidance.
The Commission also believes that the factors enumerated above
would be relevant both to an analysis of whether a swap should be
considered to be between a foreign branch of a U.S. bank and a non-U.S.
swap dealer and an analysis of whether a swap should be considered to
be between two foreign branches of U.S. banks. The Commission discusses
each of the enumerated factors in more detail below.
The first of the five factors enumerated above is similar to prong
1 of the Additional Factors (whether the employees negotiating the swap
for the U.S. person are located in the foreign branch, or if the swap
is executed electronically, the employees managing the execution of the
swap); however, the first factor above considers whether the employees
negotiating and agreeing to the terms of the swap are located in any
foreign branch of the U.S. bank. This modification addresses the
objection of commenters that stated that employees that negotiate and
agree to swaps are often located outside the foreign branch for bona
fide reasons.\348\ However, to the extent that material terms of the
swap are negotiated or agreed by employees of the U.S. bank located in
the United States, the Commission believes that generally the swap
should be considered to be with the U.S. principal bank for purposes of
this Guidance.
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\348\ See, e.g., SIFMA/CH/FSR (Feb. 6, 2013) at B18; State
Street (Feb. 6, 2013) at 2-4.
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The second factor above is similar to prong (ii) of the January
Order Criteria (that the documentation of the swap specifies that the
counterparty or ``office'' for the U.S. person is such foreign branch).
However, because a foreign branch of a U.S. bank is not a separate
legal entity, the Commission believes that the U.S. principal bank
generally should be considered to be the counterparty for purposes of
this Guidance irrespective of whether the foreign branch is named as
the counterparty in the swap documentation. Therefore, the Commission
has modified the second factor, consistent with its other
interpretations of section 2(i), so that it makes no reference to the
foreign branch as counterparty. Rather, the second factor above relates
to whether the foreign branch or another foreign branch is the office
through which the U.S. bank makes and receives payments and deliveries
under the swap on behalf of the foreign branch pursuant to a master
netting or similar trading agreement, and whether the documentation of
the swap specifies that the office for the U.S. bank is such foreign
branch. This modification is consistent with the ISDA Master Agreement,
which requires that each party specify an ``office'' for each swap,
which is where a party ``books'' a swap and/or the office through which
the party makes and receives payments and deliveries.
The third factor above (whether the swap is entered into by such
foreign branch in its normal course of business) is the same as prong
(iii) in the January Order Criteria discussed above. The Commission is
concerned about the material terms of a swap being negotiated or agreed
by employees of the U.S. bank that are located in the United States and
then routed to a foreign branch in order for the swap to be treated as
a swap with the foreign branch for purposes of the de minimis
calculations for swap dealer and MSP registration or application of the
Transaction-Level Requirements under this Guidance.
The fourth factor above (whether the swap is treated as a swap of
the foreign branch for tax purposes) is the same as prong 2 of the
Additional Factors. The Commission notes that State Street stated that
it does not strongly object to prongs 2, 3 and 4 of the Additional
Factors (that the swap is treated as a swap of the foreign branch for
tax purposes, that the branch operates for valid business reasons and
is not only a representative office, and that the branch is engaged in
banking or financing and subject to substantive local regulation) since
they could ``be reasonable indicia of a bona fide non-U.S. branch of a
U.S. swap dealer.'' However, State Street stated that each of these
prongs may be challenging to properly define and evaluate.\349\ Other
commenters stated that the income from a swap that is booked in a
foreign branch of a U.S. person is subject to taxation in the local
jurisdiction in which the foreign branch is resident, which
demonstrates that such swaps are bona fide with the non-U.S.
branch.\350\ The Commission notes that the fourth factor above only
refers to whether the tax treatment of the swap is consistent with the
swap being treated as a swap of the foreign branch for tax purposes.
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\349\ See State Street (Feb. 6, 2013) at 2.
\350\ See, e.g., SIFMA/CH/FSR (Feb. 6, 2013) at B18.
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The fifth factor above focuses on whether the swap is reflected in
the accounts of the foreign branch. The Commission believes that where
a swap is bona fide with the foreign branch of a U.S. bank, it
generally would be
[[Page 45331]]
reflected in the foreign branch's accounts.
D. Description of the Entity-Level and Transaction-Level Requirements
Title VII of the Dodd-Frank Act establishes a comprehensive new
regulatory framework for swap dealers and MSPs that Congress enacted
with the goal of reducing systemic risk and enhancing market
transparency. Under this framework, a swap dealer or MSP must, among
other things, comport with certain standards (and regulations as the
Commission may promulgate) governing risk management, internal and
external business conduct, and reporting. Further, swap dealers and
MSPs are required to comply with all of the requirements applicable to
swap dealers and MSPs for all their swaps, not just the swaps that make
them a swap dealer or MSP.
Even before the Commission published the Proposed Guidance, a
number of commenters recommended that the Commission, in interpreting
the cross-border applicability of the Dodd-Frank Act swaps provisions,
should distinguish between requirements that apply at an entity level
(i.e., to the firm as a whole) as compared to those that apply at a
transactional level (i.e., to the individual swap transaction or
trading relationship).\351\ These commenters argued that requirements
that relate to the core operations of a firm and should be applied to
the entity as a whole would include the capital and related prudential
requirements and recordkeeping, as well as certain risk mitigation
requirements (e.g., information barriers and the designation of a chief
compliance officer). The commenters stated that other requirements,
such as margin, should apply on transaction-by-transaction basis and
only to swaps with U.S. counterparties.
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\351\ See, e.g., SIFMA (Feb. 3, 2011); ISDA (Jan. 24, 2011);
Cleary (Sept. 20, 2011); Barclays Bank PLC, BNP Paribas S.A.,
Deutsche Bank AG, Royal Bank of Canada, The Royal Bank of Scotland
Group PLC, Societe Generale, and UBS AG (Jan. 11, 2011); Barclays
Bank PLC, BNP Paribas S.A., Credit Suisse AG, Deutsche Bank AG,
HSBC, Nomura Securities International, Inc., Rabobank Nederland,
Royal Bank of Canada, The Royal Bank of Scotland Group PLC, Societe
Generale, The Toronto-Dominion Bank, and UBS AG (Feb. 17, 2011).
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Commenters on the Proposed Guidance generally supported the
division of Dodd-Frank's swaps provisions (and Commission regulations
thereunder) into Entity-Level and Transaction-Level Requirements.\352\
Certain of these commenters, however, made specific recommendations for
reclassification of some of these Requirements, which are discussed in
section E below.
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\352\ See, e.g., SocGen (Aug. 8, 2012) at 6; IIB (Aug. 27, 2012)
at 2; Clearing House (Aug. 27, 2012) at 22.
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The Commission agrees with the commenters that the various Dodd-
Frank Act swaps provisions applicable to swap dealers and MSPs can be
conceptually separated into Entity-Level Requirements, which apply to a
swap dealer or MSP firm as a whole, and Transaction-Level Requirements,
which apply on a transaction-by-transaction basis. Descriptions of each
of the Entity-Level Requirements under this Guidance are set out
immediately below, followed by descriptions of the Transaction-Level
Requirements. Additional information related to the categorization of
Entity-Level and Transaction-Level Requirements is discussed in section
E.
1. Description of the Entity-Level Requirements
The Entity-Level Requirements under Title VII of the Dodd-Frank Act
and the Commission's regulations promulgated thereunder relate to: (i)
Capital adequacy; (ii) chief compliance officer; (iii) risk management;
(iv) swap data recordkeeping; (v) swap data repository reporting (``SDR
Reporting''); and (vi) physical commodity large swaps trader reporting
(``Large Trader Reporting''). The Entity-Level Requirements apply to
registered swap dealers and MSPs across all their swaps without
distinctions as to the counterparty or the location of the swap
(although under this Guidance in some circumstances the availability of
substituted compliance may vary based on whether the counterparty is a
U.S. person or a non-U.S. person).
The Entity-Level Requirements are split into two categories. The
first category of Entity-Level Requirements includes capital adequacy,
chief compliance officer, risk management, and swap data recordkeeping
under Commission regulations 23.201 and 23.203 (except certain aspects
of swap data recordkeeping relating to complaints and sales materials)
(``First Category''). The second category of Entity-Level Requirements
includes SDR Reporting, certain aspects of swap data recordkeeping
relating to complaints and marketing and sales materials under
Commission regulations 23.201(b)(3) and 23.201(b)(4) and Large Trader
Reporting (``Second Category'').
Each of the Entity-Level Requirements is discussed in the
subsections that follow.
a. First Category of Entity-Level Requirements
i. Capital Adequacy
Section 4s(e)(2)(B) of the CEA specifically directs the Commission
to set capital requirements for swap dealers and MSPs that are not
subject to the capital requirements of U.S. prudential regulators
(hereinafter referred to as ``non-bank swap dealers or MSPs'').\353\
With respect to the use of swaps that are not cleared, these
requirements must: ``(1) [h]elp ensure the safety and soundness of the
swap dealer or major swap participant; and (2) [be] appropriate for the
risk associated with the non-cleared swaps held as a swap dealer or
major swap participant.'' \354\ Pursuant to section 4s(e)(3), the
Commission proposed regulations, which would require non-bank swap
dealers and MSPs to hold a minimum level of adjusted net capital (i.e.,
``regulatory capital'') based on whether the non-bank swap dealer or
MSP is: (i) Also a FCM; (ii) not an FCM, but is a non-bank subsidiary
of a bank holding company; or (iii) neither an FCM nor a non-bank
subsidiary of a bank holding company.\355\ The primary
[[Page 45332]]
purpose of the capital requirement is to reduce the likelihood and cost
of a swap dealer's or MSP's default by requiring a financial cushion
that can absorb losses in the event of the firm's default.
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\353\ See 7 U.S.C. 6s(e)(2)(B). Section 4s(e) of the CEA
explicitly requires the adoption of rules establishing capital and
margin requirements for swap dealers and MSPs, and applies a
bifurcated approach that requires each swap dealer and MSP for which
there is a U.S. prudential regulator to meet the capital and margin
requirements established by the applicable prudential regulator, and
each swap dealer and MSP for which there is no prudential regulator
to comply with the Commission's capital and margin regulations. See
7 U.S.C. 6s(e). Further, systemically important financial
institutions (``SIFIs'') that are not FCMs would be exempt from the
Commission's capital requirements, and would comply instead with
Federal Reserve Board requirements applicable to SIFIs, while
nonbank (and non-FCM) subsidiaries of U.S. bank holding companies
would calculate their Commission capital requirement using the same
methodology specified in Federal Reserve Board regulations
applicable to the bank holding company, as if the subsidiary itself
were a bank holding company. The term ``prudential regulator'' is
defined in CEA section 1a(39) as the Board of Governors of the
Federal Reserve System, the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation, the Farm Credit
Administration, and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39). In addition, in the proposed capital regulations for swap
dealers and MSPs, the Commission solicited comment regarding whether
it would be appropriate to permit swap dealers and MSPs to use
internal models for computing market risk and counterparty credit
risk charges for capital purposes if such models had been approved
by a foreign regulatory authority and were subject to periodic
assessment by such foreign regulatory authority. See Capital
Requirements of Swap Dealers and Major Swap Participants, 76 FR
27802 (May 12, 2011) (``Proposed Capital Requirements'').
\354\ See 7 U.S.C. 6s(e)(3)(A).
\355\ See 7 U.S.C. 6s(e). See also Proposed Capital
Requirements, 76 FR at 27817 (``The Commission's capital proposal
for [swap dealers] and MSPs includes a minimum dollar level of $20
million. A non-bank [swap dealer] or MSP that is part of a U.S. bank
holding company would be required to maintain a minimum of $20
million of Tier 1 capital as measured under the capital rules of the
Federal Reserve Board. [A swap dealer] or MSP that also is
registered as an FCM would be required to maintain a minimum of $20
million of adjusted net capital as defined under [proposed] section
1.17. In addition, [a swap dealer] or MSP that is not part of a U.S.
bank holding company or registered as an FCM would be required to
maintain a minimum of $20 million of tangible net equity, plus the
amount of the [swap dealer's] or MSP's market risk exposure and OTC
counterparty credit risk exposure.'').
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ii. Chief Compliance Officer
Section 4s(k) requires that each swap dealer and MSP designate an
individual to serve as its chief compliance officer (``CCO'') and
specifies certain duties of the CCO.\356\ Pursuant to section 4s(k),
the Commission adopted regulation 3.3, which requires swap dealers and
MSPs to designate a CCO who would be responsible for administering the
firm's compliance policies and procedures, reporting directly to the
board of directors or a senior officer of the swap dealer or MSP, as
well as preparing and filing with the Commission a certified report of
compliance with the CEA. The chief compliance function is an integral
element of a firm's risk management and oversight and the Commission's
effort to foster a strong culture of compliance within swap dealers and
MSPs.
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\356\ See 7 U.S.C. 6s(k).
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iii. Risk Management
Section 4s(j) of the CEA requires each swap dealer and MSP to
establish internal policies and procedures designed to, among other
things, address risk management, monitor compliance with position
limits, prevent conflicts of interest, and promote diligent
supervision, as well as maintain business continuity and disaster
recovery programs.\357\ The Commission adopted implementing regulations
23.600, 23.601, 23.602, 23.603, 23.605, and 23.606).\358\ The
Commission also adopted regulation 23.609, which requires certain risk
management procedures for swap dealers or MSPs that are clearing
members of a DCO.\359\ Collectively, these requirements help to
establish a robust and comprehensive internal risk management program
for swap dealers and MSPs, which is critical to effective systemic risk
management for the overall swaps market.
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\357\ 7 U.S.C. 6s(j).
\358\ Swap Dealer and Major Swap Participant Recordkeeping,
Reporting, and Duties Rules; Futures Commission Merchant and
Introducing Broker Conflicts of Interest Rules; and Chief Compliance
Officer Rules for Swap Dealers, Major Swap Participants, and Futures
Commission Merchants, 77 FR 20128 (Apr. 3, 2012) (``Final Swap
Dealer and MSP Recordkeeping Rule'') (relating to risk management
program, monitoring of position limits, business continuity and
disaster recovery, conflicts of interest policies and procedures,
and general information availability, respectively).
\359\ Customer Clearing Documentation, Timing of Acceptance for
Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr. 9,
2012) (``Final Customer Documentation Rules''). Also, swap dealers
must comply with Commission regulation 23.608, which prohibits swap
dealers providing clearing services to customers from entering into
agreements that would: (i) disclose the identity of a customer's
original executing counterparty; (ii) limit the number of
counterparties a customer may trade with; (iii) impose counterparty-
based position limits; (iv) impair a customer's access to execution
of a trade on terms that have a reasonable relationship to the best
terms available; or (v) prevent compliance with specified time
frames for acceptance of trades into clearing.
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iv. Swap Data Recordkeeping (Except Certain Aspects of Swap Data
Recordkeeping Relating to Complaints and Sales Materials)
CEA section 4s(f)(1)(B) requires swap dealers and MSPs to keep
books and records for all activities related to their business.\360\
Sections 4s(g)(1) and (4) require swap dealers and MSPs to maintain
trading records for each swap and all related records, as well as a
complete audit trail for comprehensive trade reconstructions.\361\
Pursuant to these provisions, the Commission adopted regulations
23.201and 23.203, which require swap dealers and MSPs to keep records
including complete transaction and position information for all swap
activities, including documentation on which trade information is
originally recorded. Pursuant to Commission regulation 23.203, records
of swaps must be maintained for the duration of the swap plus 5 years,
and voice recordings for 1 year, and records must be ``readily
accessible'' for the first 2 years of the 5 year retention period. Swap
dealers and MSPs also must comply with Parts 43, 45 and 46 of the
Commission's regulations, which, respectively, address the data
recordkeeping and reporting requirements for all swaps subject to the
Commission's jurisdiction, including swaps entered into before the date
of enactment of the Dodd-Frank Act (``pre-enactment swaps'') and swaps
entered into on or after the date of enactment of the Dodd-Frank Act
but prior to the compliance date of the swap data reporting rules
(``transition swaps'').\362\
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\360\ 7 U.S.C. 6s(f)(1)(B).
\361\ 7 U.S.C. 6s(g)(1).
\362\ See 17 CFR part 46; Swap Data Recordkeeping and Reporting
Requirements: Pre-Enactment and Transition Swaps, 76 FR 22833 (Apr.
25, 2011) (``Proposed Data Rules'').
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b. Second Category of Entity-Level Requirements
i. SDR Reporting
CEA section 2(a)(13)(G) requires all swaps, whether cleared or
uncleared, to be reported to a registered SDR.\363\ CEA section 21
requires SDRs to collect and maintain data related to swaps as
prescribed by the Commission, and to make such data electronically
available to particular regulators under specified conditions related
to confidentiality.\364\ Part 45 of the Commission's regulations (and
Appendix 1 thereto) sets forth the specific swap data that must be
reported to a registered SDR, along with attendant recordkeeping
requirements; and part 46 addresses recordkeeping and reporting
requirements for pre-enactment and transition swaps (``historical
swaps''). The fundamental goal of part 45 of the Commission's
regulations is to ensure that complete data concerning all swaps
subject to the Commission's jurisdiction is maintained in SDRs where it
will be available to the Commission and other financial regulators for
fulfillment of their various regulatory mandates, including systemic
risk mitigation, market monitoring and market abuse prevention. Part 46
supports similar goals with respect to pre-enactment and transition
swaps and ensures that data needed by regulators concerning
``historical'' swaps is available to regulators through SDRs. Among
other things, data reported to SDRs will enhance the Commission's
understanding of concentrations of risks within the market, as well as
promote a more effective monitoring of risk profiles of market
participants in the swaps market. The Commission also believes that
there are benefits that will accrue to swap dealers and MSPs as a
result of the timely reporting of comprehensive swap transaction data
and consistent data standards for recordkeeping, among other things.
Such benefits include more robust risk monitoring and management
capabilities for swap dealers and MSPs, which in turn will improve the
monitoring of their current swaps market positions.
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\363\ 7 U.S.C. 2(a)(13)(G).
\364\ 7 U.S.C. 24a.
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[[Page 45333]]
ii. Swap Data Recordkeeping Relating to Complaints and Marketing and
Sales Materials
CEA section 4s(f)(1) requires swap dealers and MSPs to ``make such
reports as are required by the Commission by rule or regulation
regarding the transactions and positions and financial condition of the
registered swap dealer or MSP.'' \365\ Additionally, CEA section 4s(h)
requires swap dealers and MSPs to ``conform with such business conduct
standards . . . as may be prescribed by the Commission by rule or
regulation.'' \366\ Pursuant to these provisions, the Commission
promulgated final rules that set forth certain reporting and
recordkeeping for swap dealers and MSPs.\367\ Commission Regulation
23.201 states that ``[e]ach swap dealer and major swap participant
shall keep full, complete, and systematic records of all activities
related to its business as a swap dealer or major swap participant.''
Such records must include, among other things, ``[a] record of each
complaint received by the swap dealer or major swap participant
concerning any partner, member, officer, employee, or agent,'' \368\ as
well as ``[a]ll marketing and sales presentations, advertisements,
literature, and communications.'' \369\
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\365\ 7 U.S.C. 6s(f)(1).
\366\ 7 U.S.C. 6s(h)(1); see 7 U.S.C. 6s(h)(3).
\367\ Final Swap Dealer and MSP Recordkeeping Rule, 77 FR 20128.
\368\ 17 CFR 23.201(b)(3)(i).
\369\ 17 CFR 23.201(b)(4).
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iii. Physical Commodity Large Swaps Trader Reporting (Large Trader
Reporting)
CEA section 4t authorizes the Commission to establish a large
trader reporting system for significant price discovery swaps (of which
the economically equivalent swaps subject to part 20 of the
Commission's regulations are a subset).\370\ Pursuant thereto, the
Commission adopted its Large Trader Reporting rules (part 20 of the
Commission's regulations), which require routine reports from swap
dealers, among other entities, that hold significant positions in swaps
that are linked, directly or indirectly, to a prescribed list of U.S.-
listed physical commodity futures contracts.\371\ Additionally, Large
Trader Reporting requires that swap dealers, among other entities,
comply with certain recordkeeping obligations.
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\370\ 7 U.S.C. 6t.
\371\ Large Trader Reporting for Physical Commodity Swaps, 76 FR
43851 (July 22, 2011). The rules require routine position reporting
by clearing organizations, as well as clearing members and swap
dealers with reportable positions in the covered physical commodity
swaps. The rules also establish recordkeeping requirements for
clearing organizations, clearing members and swap dealers, as well
as traders with positions in the covered physical commodity swaps
that exceed a prescribed threshold. In general, the rules apply to
swaps that are linked, directly or indirectly, to either the price
of any of the 46 U.S. listed physical commodity futures contracts
the Commission enumerates (Covered Futures Contracts) or the price
of the physical commodity at the delivery location of any of the
Covered Futures Contracts.
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2. Description of the Transaction-Level Requirements
The Transaction-Level Requirements include: (i) Required clearing
and swap processing; (ii) margining (and segregation) for uncleared
swaps; (iii) mandatory trade execution; (iv) swap trading relationship
documentation; (v) portfolio reconciliation and compression; (vi) real-
time public reporting; (vii) trade confirmation; (viii) daily trading
records; and (ix) external business conduct standards.
The Transaction-Level Requirements--with the exception of external
business conduct standards--relate to both risk mitigation and market
transparency. Certain of these requirements, such as clearing and
margining, serve to lower a firm's risk of failure. In that respect,
these Transaction-Level Requirements could be classified as Entity-
Level Requirements. Other Transaction-Level Requirements--such as trade
confirmation, swap trading relationship documentation, and portfolio
reconciliation and compression--also serve important risk mitigation
functions, but are less closely connected to risk mitigation of the
firm as a whole and thus are more appropriately applied on a
transaction-by-transaction basis. Likewise, the requirements related to
trade execution, trade confirmation, daily trading records, and real-
time public reporting have a closer nexus to the transparency goals of
the Dodd-Frank Act, as opposed to addressing the risk of a firm's
failure.
As a result, whether a particular requirement of Title VII should
apply on a transaction-by-transaction basis in the context of cross-
border activity for purposes of section 2(i) of the CEA requires the
Commission to exercise some degree of judgment. Nevertheless, in the
interest of comity principles, the Commission believes that the
Transaction-Level Requirements may be applied on a transaction-by-
transaction basis. The Transaction-Level Requirements are split into
two categories. All of the Transaction-Level Requirements except
external business conduct standards are in Category A. The external
business conduct standards are in Category B.
Each of the Transaction-Level Requirements is discussed below.
a. Category A: Risk Mitigation and Transparency
i. Required Clearing and Swap Processing
Section 2(h)(1) of the CEA requires a swap to be submitted for
clearing to a DCO if the Commission has determined that the swap is
required to be cleared, unless one of the parties to the swap is
eligible for an exception from the clearing requirement and elects not
to clear the swap.\372\ Clearing via a DCO mitigates the counterparty
credit risk between swap dealers or MSPs and their counterparties.
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\372\ 7 U.S.C. 2(h)(1), (7).
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Commission regulations implementing the first designations of swaps
for required clearing were published in the Federal Register on
December 13, 2012.\373\ Under Commission regulation 50.2, all persons
executing a swap that is included in a class of swaps identified under
Commission regulation 50.4 must submit such swap to an eligible DCO for
clearing as soon as technologically practicable after execution, but in
any event by the end of the day of execution.
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\373\ Clearing Requirement Determination Under Section 2(h) of
the CEA, 77 FR 74284 (Dec. 13, 2012) (``Clearing Requirement
Determination'').
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Regulation 50.4 establishes required clearing for certain classes
of swaps. Currently, those classes include, for credit default swaps:
Specified series of untranched North American CDX indices and European
iTraxx indices; and for interest rate swaps: Fixed-to-floating swaps,
basis swaps, forward rate agreements referencing U.S. Dollar, Euro,
Sterling, and Yen, and overnight index swaps referencing U.S. Dollar,
Euro, and Sterling. Each of the six classes is further defined in
Commission regulation 50.4. Swaps that have the specifications
identified in the regulation are required to be cleared and must be
cleared pursuant to the rules of any eligible DCO \374\ unless an
exception or exemption specified in the CEA or the Commission's
regulations applies.
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\374\ A DCO's eligibility to clear swaps that are required to be
cleared pursuant to section 2(h)(1)(A) of the CEA and part 50 of the
Commission's regulations is governed by regulation 39.5(a), relating
to DCO eligibility.
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Generally, if a swap is subject to CEA section 2(h)(1)(A) and part
50 of the Commission's regulations, it must be cleared through an
eligible DCO, unless: (i) One of the counterparties is eligible for and
elects the end-user exception
[[Page 45334]]
under Commission regulation 50.50; \375\ or (ii) both counterparties
are eligible for and elect an inter-affiliate exemption under
Commission regulation 50.52.\376\ To elect either the End-User
Exception or the Inter-Affiliate Exemption, the electing party or
parties and the swap must meet certain requirements set forth in the
regulations.
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\375\ See End-User Exception to the Clearing Requirement for
Swaps, 77 FR 42560 (July 19, 2012) (``End-User Exception'').
\376\ The Commission has adopted an exemption from required
clearing for swaps between certain affiliated entities. Exemption
for Swaps Between Certain Affiliated Entities, 78 FR 21750 (Apr. 11,
2013) (``Inter-Affiliate Exemption'').
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Closely connected with the clearing requirement are the following
swap processing requirements: (i) Commission regulation 23.506, which
requires swap dealers and MSPs to submit swaps promptly for clearing;
and (ii) Commission regulations 23.610 and 39.12, which establish
certain standards for swap processing by DCOs and/or swap dealers and
MSPs that are clearing members of a DCO.\377\ Together, required
clearing and swap processing requirements promote safety and soundness
of swap dealers and MSPs, and mitigate the credit risk posed by
bilateral swaps between swap dealers or MSPs and their
counterparties.\378\
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\377\ 17 CFR 23.506 and 23.610. See also Final Customer
Documentation Rules, 77 FR 21278.
\378\ See section H regarding the application of required
clearing rules to market participants that are not registered as
swap dealers or MSPs, including the circumstances under which the
parties to such swaps would be eligible for substituted compliance.
---------------------------------------------------------------------------
ii. Margin and Segregation Requirements For Uncleared Swaps
Section 4s(e) of the CEA requires the Commission to set margin
requirements for swap dealers and MSPs that trade in swaps that are not
cleared.\379\ The margin requirements ensure that outstanding current
and potential future risk exposures between swap dealers and their
counterparties are collateralized, thereby reducing the possibility
that swap dealers or MSPs take on excessive risks without having
adequate financial backing to fulfill their obligations under the
uncleared swap. In addition, with respect to swaps that are not
submitted for clearing, section 4s(l) requires that a swap dealer or
MSP notify the counterparty of its right to request that funds provided
as margin be segregated, and upon such request, to segregate the funds
with a third-party custodian for the benefit of the counterparty. In
this way, the segregation requirement enhances the protections offered
through margining uncleared swaps and thereby provides additional
financial protection to counterparties. The Commission is working with
foreign and domestic regulators to develop and finalize appropriate
regulations for margin and segregation requirements.
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\379\ See 7 U.S.C. 6s(e). See also Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 FR
23732, 23733-23740 (Apr. 28, 2011) (``Proposed Margin
Requirements''). Section 4s(e) explicitly requires the adoption of
rules establishing margin requirements for swap dealers and MSPs,
and applies a bifurcated approach that requires each swap dealer and
MSP for which there is a prudential regulator to meet the margin
requirements established by the applicable prudential regulator, and
each swap dealer and MSP for which there is no prudential regulator
to comply with the Commission's margin regulations. In contrast, the
segregation requirements in section 4s(1) do not use a bifurcated
approach--that is, all swap dealers and MSPs are subject to the
Commission's regulations regarding notice and third party custodians
for margin collected for uncleared swaps.
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iii. Trade Execution
Integrally linked to the clearing requirement is the trade
execution requirement, which is intended to bring the trading of swaps
that are required to be cleared and are made available to trade onto
regulated exchanges or execution facilities. Specifically, section
2(h)(8) of the CEA provides that unless a clearing exception applies
and is elected, a swap that is subject to a clearing requirement must
be executed on a DCM or SEF, unless no such DCM or SEF makes the swap
available to trade.\380\ Commission regulations implementing the
process for a DCM or SEF to make a swap available to trade were
published in the Federal Register on June 4, 2013.\381\ Under
Commission regulations 37.10 and 38.12, respectively, a SEF or DCM may
submit a determination for Commission review that a mandatorily cleared
swap is available to trade based on enumerated factors. By requiring
the trades of mandatorily cleared swaps that are made available to
trade to be executed on an exchange or an execution facility--each with
its attendant pre- and post-trade transparency and safeguards to ensure
market integrity--the trade execution requirement furthers the
statutory goals of financial stability, market efficiency, and enhanced
transparency.
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\380\ See 7 U.S.C. 2(h)(8).
\381\ See Process for a Designated Contract Market or Swap
Execution Facility To Make a Swap Available to Trade, Swap
Transaction Compliance and Implementation Schedule, and Trade
Execution Requirement Under the Commodity Exchange Act, 78 FR 33606
(Jun. 4, 2013).
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iv. Swap Trading Relationship Documentation
CEA section 4s(i) requires each swap dealer and MSP to conform to
Commission standards for the timely and accurate confirmation,
processing, netting, documentation and valuation of swaps. Pursuant
thereto, Commission regulation 23.504(a) requires swap dealers and MSPs
to ``establish, maintain and enforce written policies and procedures''
to ensure that the swap dealer or MSP executes written swap trading
relationship documentation.\382\ Under Commission regulation 23.504(b),
the swap trading relationship documentation must include, among other
things: All terms governing the trading relationship between the swap
dealer or MSP and its counterparty; credit support arrangements;
investment and re-hypothecation terms for assets used as margin for
uncleared swaps; and custodial arrangements.\383\ Further, the swap
trading relationship documentation requirement applies to all swaps
with registered swap dealers and MSPs. In addition, Commission
regulation 23.505 requires swap dealers and MSPs to document certain
information in connection with swaps for which exceptions from required
clearing are elected.\384\ Swap documentation standards facilitate
sound risk management and may promote standardization of documents and
transactions, which are key conditions for central clearing, and lead
to other operational efficiencies, including improved valuation.
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\382\ See also Confirmation, Portfolio Reconciliation, Portfolio
Compression, and Swap Trading Relationship Documentation
Requirements for Swap Dealers and Major Swap Participants; 77 FR
55904 (Sept. 11, 2012) (``Final Confirmation Rules'').
\383\ The requirement under section 4s(i) relating to trade
confirmations is a Transaction-Level Requirement. Accordingly,
Commission regulation 23.504(b)(2) requires a swap dealer's and
MSP's swap trading relationship documentation to include all
confirmations of swaps, will apply on a transaction-by-transaction
basis.
\384\ See also Final Confirmation Rules, 77 FR 55964.
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v. Portfolio Reconciliation and Compression
CEA section 4s(i) directs the Commission to prescribe regulations
for the timely and accurate processing and netting of all swaps entered
into by swap dealers and MSPs. Pursuant to CEA section 4s(i), the
Commission adopted regulations (23.502 and 23.503), which require swap
dealers and MSPs to perform portfolio reconciliation and compression,
respectively, for all swaps.\385\ Portfolio reconciliation is a
[[Page 45335]]
post-execution risk management tool to ensure accurate confirmation of
a swap's terms and to identify and resolve any discrepancies between
counterparties regarding the valuation of the swap. Portfolio
compression is a post-trade processing and netting mechanism that is
intended to ensure timely, accurate processing and netting of
swaps.\386\ Regulation 23.503 requires all swap dealers and MSPs to
establish policies and procedures for terminating fully offsetting
uncleared swaps, when appropriate, and periodically participating in
bilateral and/or multilateral portfolio compression exercises for
uncleared swaps with other swap dealers or MSPs or conducted by a third
party.\387\ The rule also requires policies and procedures for engaging
in such exercises for uncleared swaps with non-swap dealers and non-
MSPs upon request. Further, participation in multilateral portfolio
compression exercises is mandatory for dealer-to-dealer trades.
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\385\ See id.
\386\ For example, the reduced transaction count may decrease
operational risk as there are fewer trades to maintain, process, and
settle.
\387\ See Confirmation, Portfolio Reconciliation, and Portfolio
Compression Requirements for Swap Dealers and Major Swap
Participants, 75 FR 81519 (Dec. 28, 2010) (``Confirmation NPRM'').
---------------------------------------------------------------------------
vi. Real-Time Public Reporting
Section 2(a)(13) of the CEA directs the Commission to promulgate
rules providing for the public availability of swap transaction and
pricing data on a real-time basis.\388\ In accordance with this
mandate, the Commission promulgated part 43, which provides that all
``publicly reportable swap transactions'' must be reported and publicly
disseminated, and which establishes the method, manner, timing and
particular transaction and pricing data that must be reported by
parties to a swap transaction.\389\ Additionally, the Commission
adopted regulation 23.205, which directs swap dealers and MSPs to
undertake such reporting and to have the electronic systems and
procedures necessary to transmit electronically all information and
data required to be reported in accordance with part 43.\390\ The real-
time dissemination of swap transaction and pricing data supports the
fairness and efficiency of markets and increases transparency, which in
turn improves price discovery and decreases risk (e.g., liquidity
risk).\391\
---------------------------------------------------------------------------
\388\ See 7 U.S.C. 2(a)(13). See also Real-Time Public Reporting
of Swap Transaction Data, 77 FR 1182, 1183 (Jan. 9, 2012) (``Final
Real-Time Reporting Rule'').
\389\ Part 43 defines a ``publicly reportable swap transaction''
as (i) any swap that is an arm's-length transaction between two
parties that results in a corresponding change in the market risk
position between the two parties; or (ii) any termination,
assignment, novation, exchange, transfer, amendment, conveyance, or
extinguishing of rights or obligations of a swap that changes the
pricing of a swap. See Final Real-Time Reporting Rule, 77 FR 1182.
\390\ Final Swap Dealer and MSP Recordkeeping Rule, 77 FR at
20205.
\391\ See Final Real-Time Reporting Rule, 77 FR at 1183.
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vii. Trade Confirmation
Section 4s(i) of the CEA \392\ requires that each swap dealer and
MSP must comply with the Commission's regulations prescribing timely
and accurate confirmation of swaps. The Commission has adopted
regulation 23.501, which requires, among other things, a timely and
accurate confirmation of swap transactions (which includes execution,
termination, assignment, novation, exchange, transfer, amendment,
conveyance, or extinguishing of rights or obligations of a swap) among
swap dealers and MSPs by the end of the first business day following
the day of execution.\393\ Timely and accurate confirmation of swaps--
together with portfolio reconciliation and compression--are important
post-trade processing mechanisms for reducing risks and improving
operational efficiency.\394\
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\392\ 7 U.S.C. 6s(i).
\393\ See also Final Confirmation Rules, 77 FR 55904.
\394\ In addition, the Commission notes that regulation
23.504(b)(2) requires that the swap trading relationship
documentation of swap dealers and MSPs must include all
confirmations of swap transactions.
---------------------------------------------------------------------------
viii. Daily Trading Records
Pursuant to CEA section 4s(g), the Commission adopted regulation
23.202, which requires swap dealers and MSPs to maintain daily trading
records, including records of trade information related to pre-
execution, execution, and post-execution data that is needed to conduct
a comprehensive and accurate trade reconstruction for each swap. The
final rule also requires that records be kept of cash or forward
transactions used to hedge, mitigate the risk of, or offset any swap
held by the swap dealer or MSP.\395\ Accurate and timely recordkeeping
regarding all phases of a swap transaction can serve to greatly enhance
a firm's internal supervision, as well as the Commission's ability to
detect and address market or regulatory abuses or evasion.
---------------------------------------------------------------------------
\395\ See Final Swap Dealer and MSP Recordkeeping Rule, 77 FR
20128.
---------------------------------------------------------------------------
b. Category B: External Business Conduct Standards
Pursuant to CEA section 4s(h), the Commission has adopted external
business conduct rules, which establish business conduct standards
governing the conduct of swap dealers and MSPs in dealing with their
counterparties in entering into swaps.\396\ Broadly speaking, these
rules are designed to enhance counterparty protection by significantly
expanding the obligations of swap dealers and MSPs towards their
counterparties. Under these rules, swap dealers and MSPs will be
required, among other things, to conduct due diligence on their
counterparties to verify eligibility to trade, provide disclosure of
material information about the swap to their counterparties, provide a
daily mid-market mark for uncleared swaps and, when recommending a swap
to a counterparty, make a determination as to the suitability of the
swap for the counterparty based on reasonable diligence concerning the
counterparty.
---------------------------------------------------------------------------
\396\ See 7 U.S.C. 6s(h). See also External Business Conduct
Rules, 77 FR at 9822-9829.
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E. Categorization of Entity-Level and Transaction-Level Requirements
As noted above, even before the Commission published the Proposed
Guidance, a number of commenters recommended that the Commission, in
interpreting the cross-border applicability of the Dodd-Frank Act swaps
provisions, should distinguish between requirements that apply at an
entity level (i.e., to the firm as a whole) as compared to those that
apply at a transactional level (i.e., to the individual swap
transaction or trading relationship).\397\ The Commission agrees with
such commenters, and generally expects that it may apply its policies
differently depending on the category (Entity-Level or Transaction-
Level) or sub-category (First or Second Category of Entity-Level
Requirements or Category A or B of the Transaction-Level Requirements)
into which such requirement falls, subject to its further consideration
of all of the relevant facts and circumstances.
---------------------------------------------------------------------------
\397\ See note 351, supra.
---------------------------------------------------------------------------
After giving further consideration to the categorization in the
Proposed Guidance, including comments received in this area, this
Guidance makes a few minor modifications to the proposed categorization
of Entity-Level and Transaction-Level Requirements, as described below.
1. Categorization Under the Proposed Guidance
The Proposed Guidance separated the Entity-Level Requirements into
two subcategories. The first included capital adequacy, chief
compliance officer, risk management, and swap data
[[Page 45336]]
recordkeeping, all of which relate to risks to a firm as a whole. The
second proposed subcategory included SDR Reporting and Large Trader
Reporting, which relate directly to the Commission's market oversight.
The Proposed Guidance separated the Transaction-Level Requirements
into two subcategories, ``Category A'' and ``Category B.'' The
``Category A'' Transaction-Level Requirements relate to risk mitigation
and transparency: (1) Clearing and swap processing; (2) margining and
segregation for uncleared swaps; (3) trade execution; (4) swap trading
relationship documentation; (5) portfolio reconciliation and
compression; (6) real-time public reporting; (7) trade confirmation;
and (8) daily trading records.
The ``Category B'' Transaction-Level Requirements--the external
business conduct standards--are those requirements that may not be
necessary to apply to swaps between non-U.S. persons taking place
outside the United States. With respect to these swaps, the Commission
believes that foreign regulators may have a relatively stronger
supervisory interest in regulating sales practices concerns than the
Commission.
2. Comments
Commenters generally supported the division of Dodd-Frank's swaps
provisions (and Commission regulations thereunder) into Entity-Level
and Transaction-Level Requirements.\398\ Certain of these commenters,
however, made specific recommendations for reclassification of some of
these Requirements.
---------------------------------------------------------------------------
\398\ See, e.g., SocGen (Aug. 8, 2012) at 6; IIB (Aug. 27, 2012)
at 2; Clearing House (Aug. 27, 2012) at 22.
---------------------------------------------------------------------------
a. Reporting and Trade-Execution Requirements
With regard to reporting and trade-execution requirements, a number
of commenters argued that all forms of swaps reporting, including SDR
Reporting and Large Trader Reporting, should be treated as Transaction-
Level Requirements and thereby could be eligible for substituted
compliance for certain transactions with non-U.S. counterparties.\399\
In their view, SDR Reporting--like real-time public reporting--is
implemented on a swap-by-swap basis and more closely linked to market
transparency than risk mitigation. Credit Suisse noted that the
Commission's bifurcated approach to SDR Reporting and real-time public
reporting creates unnecessary complications. It argued that both sets
of reporting requirements should apply to a non-U.S. swap dealer only
when dealing with U.S. persons (excluding foreign branches of U.S. swap
dealers).\400\
---------------------------------------------------------------------------
\399\ See, e.g., SIFMA (Aug. 27, 2012) at A4, A34, A35; Credit
Suisse (Aug. 27, 2012) at 10; Association for Financial Markets in
Europe (AFME) (Aug. 24, 2012) at 8-9.
\400\ Credit Suisse (Aug. 27, 2012) at 10.
---------------------------------------------------------------------------
ISDA believed that real-time public reporting and trade execution
should be treated like the external business conduct rules. It argued
that these rules relate to pre-trade price discovery and market
structure and client protections.\401\ Similarly, J.P. Morgan commented
that the real-time public reporting and trade execution requirements
should not apply to transactions between non-U.S. swap dealers or non-
U.S. MSPs and non-U.S. counterparties, arguing that these requirements
do not reduce market risk but rather promote price competition.\402\
IIB stated that the Commission should treat mandatory trade execution,
real-time public reporting and daily trading records as ``Category B''
Transaction-Level Requirements, since these requirements are intended
to give customers enhanced access to the best pricing and affect not
only individual counterparties but the overall market.\403\
---------------------------------------------------------------------------
\401\ ISDA (Aug. 27, 2012) at 11. Similarly, Australian Bankers
stated that the real-time public reporting and trade execution
requirements should be treated in the same manner as the external
business conduct standards and have no application to transactions
involving a non-U.S. swap dealer and its non-U.S. counterparties.
Australian Bankers (Aug. 27, 2012) at 5. See also SIFMA (Aug. 27,
2012) at A37 (stating that real-time public reporting should be
treated in the same way as external business conduct standards and,
in particular, should not apply to non-U.S. swap entities or non-
U.S. branches for transactions with non-U.S. persons).
\402\ See also The Clearing House (Aug. 27, 2012) at 22 (stating
that no pre- or post-trade transparency rules or conflict of
interest rules should apply to transactions with non-U.S.
counterparties. These rules should be treated similarly to the
external business conduct rules--excluded from the Transaction-Level
and Entity-Level categories, and not applied at all to transactions
between a non-U.S. entity (including a non-U.S. branch of a U.S.
entity) and its non-U.S. counterparty, regardless of whether that
counterparty is guaranteed by, or a conduit for, a U.S. person).
\403\ IIB (Aug. 27, 2012) at 17, 32-33. IIB further stated that
application of these pre- and post-trade requirements to swaps
between non-U.S. persons outside the United States would raise
``serious, unprecedented'' concerns relating to the sovereignty of
foreign markets. IIB (Aug. 27, 2012) at 34.
---------------------------------------------------------------------------
On the other hand, Senator Levin stated that reporting and trade
execution requirements should be applied broadly to all swaps of non-
U.S. swap dealers and non-U.S. MSPs that are affiliates of U.S.
financial institutions, so as to provide transparency regarding their
swap activities and to protect the U.S. financial system.\404\ He
stated that standard trade execution helps to ensure that complex swaps
are properly booked, and reporting discourages ``below-the-radar''
transactions involving complex swaps.\405\
---------------------------------------------------------------------------
\404\ Letter from Sen. Levin at 11-12.
\405\ Id.
---------------------------------------------------------------------------
b. Swap Trading Relationship Documentation, Portfolio Reconciliation
and Compression, Daily Trading Records and External Business Conduct
Standards
Sumitomo stated that certain Transaction-Level Requirements,
including swap trading relationship documentation, portfolio
reconciliation and compression, daily trading records, and external
business conduct standards, should instead be classified as Entity-
Level Requirements. It contended that these are not logically linked to
particular transactions and would be required to be conducted on a
daily basis per counterparty.\406\ IATP stated that portfolio
compression and reconciliation requirements are critical to a firm's
central risk mitigation functions and therefore should be classified as
Entity-Level Requirements. This commenter also argued that margin,
segregation and other requirements for swaps that are so designated by
non-U.S. affiliates of U.S. persons as to be unclearable should be
regulated under the Entity-Level Requirements.\407\
---------------------------------------------------------------------------
\406\ Sumitomo (Aug. 24, 2012) at 3.
\407\ IATP (Aug. 27, 2012) at 7.
---------------------------------------------------------------------------
Similarly, Senator Levin stated that clearing, margin and portfolio
reconciliation and compression requirements and external business
conduct standards should be applied to all swaps of non-U.S. swap
dealers and non-U.S. MSPs that are affiliates of U.S. financial
institutions.\408\ In the Senator's view, margin requirements are
critical safeguards against rapidly increasing losses, portfolio
reconciliation and compression procedures help to maintain an accurate
understanding of the size and nature of a firm's swaps positions, and
external business conduct standards encourage integrity in the swaps
markets.\409\ Societe Generale also stated that rules relating to
confirmation processing and portfolio reconciliation and compression
should be categorized as Entity-Level Requirements, explaining that
these all relate to the functioning of a swap dealer's ``back office''
operations and are tied to its trading systems. As a result,
implementing confirmation rules, for
[[Page 45337]]
example, for swaps with U.S. persons only is ``extremely difficult from
a technological standpoint.'' \410\
---------------------------------------------------------------------------
\408\ Letter from Sen. Levin at 11-12.
\409\ Id.
\410\ SocGen (Aug. 8, 2012) at 6 (stating that banks with a
centralized booking model will face technological difficulties in
applying confirmation processing and portfolio reconciliation and
compression rules only with respect to U.S. persons, and that a
requirement to apply these rules to all customers (even non-U.S.
persons) is inconsistent with international comity). See also
Australian Bankers (Aug. 27, 2012) at 5 (stating that portfolio
reconciliation and compression requirements should be categorized as
Entity-Level Requirements, as they are critical to risk mitigation
and back-office functions).
---------------------------------------------------------------------------
IIB recommended that the daily trading records requirements
(Commission regulation 23.202) be categorized as a Category B
Transaction-Level Requirement. It reasoned that this rule is most
relevant when a non-U.S. swap dealer or non-U.S. MSP is trading with a
U.S. person to whom it owes U.S. sales practice obligations and for
whom the Commission's interest in addressing market abuses is highest.
It also noted that the obligation to make and retain records of pre-
execution oral conversations, a principal element of the rule, is most
likely to give rise to conflicts with foreign privacy laws.\411\
---------------------------------------------------------------------------
\411\ IIB (Aug. 27, 2012) at 32-33.
---------------------------------------------------------------------------
c. Internal Conflicts of Interest Requirement
IIB noted that the internal conflicts of interest requirement
(Commission regulation 23.605) is categorized as an Entity-Level
Requirement in the Proposed Guidance. It stated that internal research
conflicts of interest procedures are intended to promote the integrity
of research reports to customers, and that internal clearing conflicts
of interest procedures are intended to promote client access to better
pricing on execution and clearing. As a result, IIB views the
Commission's interest in applying these requirements to non-U.S.
clients as minimal and recommends that the internal conflicts of
interest requirement be categorized as a new ``Category B'' Entity-
Level Requirement.\412\
---------------------------------------------------------------------------
\412\ IIB (Aug. 27, 2012) at 32. This would render internal
conflicts of interest requirements applicable only in connection
with personnel of its research department or clearing unit preparing
research reports for use with, or providing clearing services to,
respectively, U.S. persons.
---------------------------------------------------------------------------
d. Position Limits and Anti-Manipulation Rules
SIFMA stated that position limits and anti-manipulation rules,
which were not addressed in the Proposed Guidance, should be
categorized as Transaction-Level Requirements and, therefore, be
eligible for relief in some circumstances. They argued that these rules
have a close nexus to market transparency, as opposed to risk
mitigation of a firm's failure.\413\
---------------------------------------------------------------------------
\413\ SIFMA (Aug. 27, 2012) at A35-36.
---------------------------------------------------------------------------
3. Commission Guidance
In general, the Commission would apply the Dodd-Frank provisions
differently depending on the category (Entity-Level or Transaction-
Level) or sub-category (First or Second Category of Entity-Level
Requirements or Category A or B of the Transaction-Level Requirements)
into which such requirement falls. Therefore, the Commission has
carefully reviewed comments on the classification of the Entity-Level
Requirements and Transaction-Level Requirements, as well as comments
regarding whether and how Entity-Level and Transaction-Level
Requirements should apply to swaps between various types of
counterparties, and under what circumstances the Commission's policy
should contemplate that various swaps should generally be eligible for
substituted compliance, or provide that certain of the Commission's
requirements would generally not apply.
After careful consideration, the Commission would generally treat
swaps requirements as Entity-Level Requirements and Transaction-Level
Requirements largely in accordance with the Proposed Guidance, with
certain minor modifications described below.
a. Entity-Level Requirements
Consistent with CEA section 2(i), the Commission would treat the
following requirements as Entity-Level Requirements, as proposed:
Capital adequacy, chief compliance officer, risk management, swap data
recordkeeping, SDR Reporting, and Large Trader Reporting.
At the core of a robust internal risk controls system is the firm's
capital--and particularly, how the firm identifies and manages its risk
exposure arising from its portfolio of activities.\414\ Equally
foundational to the financial integrity of a firm is an effective
internal risk management process, which must be comprehensive in scope
and reliant on timely and accurate data regarding its swap activities.
To be effective, such a system must have a strong and independent
compliance function. These internal controls-related requirements--
namely, the requirements related to chief compliance officer, risk
management, swap data recordkeeping--are designed to serve that end.
Given their functions, the Commission's policy is that these
requirements should be applied on a firm-wide basis to effectively
address risks to the swap dealer or MSP as a whole, and should be
classified as Entity-Level Requirements.
---------------------------------------------------------------------------
\414\ By way of illustration, consistent with the purpose of the
capital requirement, which is intended to reduce the likelihood and
cost of a swap dealer's default by requiring a financial cushion, a
swap dealer's or MSP's capital requirements would be set on the
basis of its overall portfolio of assets and liabilities.
---------------------------------------------------------------------------
SDR Reporting and Large Trader Reporting relate more closely to
market transparency and to the Commission's market surveillance
program. Among other things, data reported to SDRs will enhance the
Commission's understanding of concentrations of risks within the
market, as well as promote a more effective monitoring of risk profiles
of market participants in the swaps market. Large Trader Reporting,
along with an analogous reporting system for futures contracts, is
essential to the Commission's ability to conduct effective surveillance
of markets in U.S. physical commodity futures and economically
equivalent swaps. Given the functions of these reporting requirements,
the Commission's view is that each requirement generally should be
applied across swaps, irrespective of the counterparty or the location
of the swap, in order to ensure that the Commission has a comprehensive
and accurate picture of market activities. Otherwise, the intended
value of these requirements would be significantly compromised, if not
undermined. Therefore, the Commission's policy is to generally treat
SDR Reporting and Large Trader Reporting as Entity-Level Requirements.
The Commission did not address in the Proposed Guidance whether
position limits and anti-manipulation provisions should fall in the
Entity-Level or Transaction-Level Requirements category. It is the
Commission's view that these provisions relate more to market
integrity, as opposed to the financial integrity of a firm, and it is
essential that they apply regardless of the counterparty's status (U.S.
person or not) in order to fully achieve the underlying purpose of
these respective provisions. Accordingly, these requirements are
outside the scope of this Guidance. However, the monitoring of position
limits under Commission regulation 23.601 is included in the Entity-
Level Requirements under this Guidance.
After considering the input of market participants and others
through the comment process, and giving further consideration to how
the language in CEA section 2(i) should be interpreted for purposes of
applying the Entity-
[[Page 45338]]
Level Requirements and permitting substituted compliance, the
Commission's policy is to treat the Entity-Level Requirements in
subcategories largely as proposed.
As explained above, Entity-Level Requirements ensure that
registered swap dealers and MSPs implement and maintain a comprehensive
and robust system of internal controls to ensure the financial
integrity of the firm, and in turn, the protection of the financial
system. In this respect, the Commission has strong supervisory
interests in applying the same rigorous standards, or comparable and
comprehensive standards, to non-U.S. swap dealers and non-U.S. MSPs
whose swap activities or positions are substantial enough to require
registration under the CEA. Requiring such swap dealers and MSPs to
rigorously monitor and address the risks they incur as part of their
day-to-day businesses would lower the registrants' risk of default--and
ultimately protect the public and the financial system.
Therefore, the Commission contemplates that non-U.S. swap dealers
and non-U.S. MSPs will comply with all of the First Category of Entity-
Level Requirements. In addition, consistent with principles of
international comity, substituted compliance may be available for these
Entity-Level Requirements in certain circumstances, as explained
further below. In contrast, with regard to Entity-Level Requirements in
the Second Category, substituted compliance should generally be
available only where the counterparty is a non-U.S. person.\415\
---------------------------------------------------------------------------
\415\ In addition, as noted in section G below, reflecting its
interpretation of CEA section 2(i), the Commission generally
contemplates that U.S. swap dealers and MSPs would comply in full
with the Entity-Level Requirements (regardless of whether the
Entity-Level Requirements are classified as being in the First
Category or Second Category), without substituted compliance
available. This interpretation also applies to swaps with U.S. swap
dealers or U.S. MSPs that are affiliates of non-U.S. persons.
---------------------------------------------------------------------------
i. The First Category--Capital Adequacy, Chief Compliance Officer, Risk
Management, and Swap Data Recordkeeping (Except for Certain
Recordkeeping Requirements)
The Commission's policy generally is to treat the requirements
related to capital adequacy, chief compliance officer, risk management,
and swap data recordkeeping (except swap data recordkeeping relating to
complaints and marketing and sales materials under Commission
regulations 23.201(b)(3) and 23.201(b)(4), respectively) in the First
Category. These requirements address and manage risks that arise from a
firm's operation as a swap dealer or MSP. Collectively, they constitute
a firm's first line of defense against financial, operational, and
compliance risks that could lead to a firm's default.
The First Category is identical to the first subcategory proposed
by the Commission in the Proposed Guidance, except that the
Commission's policy is to treat swap data recordkeeping under part 43
and part 46 of the Commission's regulations and swap data recordkeeping
related to complaints and marketing and sales materials under
Commission regulations 23.201(b)(3) and 23.201(b)(4) as part of the
``Second Category'' of Entity-Level Requirements. As noted above, for
Entity-Level Requirements in the First Category, substituted compliance
generally would be available for a non-U.S. swap dealer or non-U.S. MSP
(including one that is an affiliate of a U.S. person) regardless of
whether the counterparty is a U.S. person or a non-U.S. person.\416\ In
contrast, for Entity-Level Requirements in the Second Category,
substituted compliance generally would be available for a non-U.S. swap
dealer or MSP only where the counterparty is a non-U.S. person.
---------------------------------------------------------------------------
\416\ As explained in section G below, the Commission's policy
is that where a swap dealer or MSP is a U.S. person, all of the
entity-level requirements would generally apply in full (without
substituted compliance available), regardless of the type of
counterparty.
---------------------------------------------------------------------------
ii. The Second Category--SDR Reporting, Certain Swap Data Recordkeeping
Requirements and Large Trader Reporting
The Commission's policy retains SDR Reporting in the Second
Category, as proposed. SDR Reporting furthers the goals of the Dodd-
Frank Act to reduce systemic risk, increase transparency and promote
market integrity. Specifically, data reported to SDRs under the SDR
Reporting rules provide the Commission with information necessary to
better understand and monitor concentrations of risk, as well as risk
profiles of individual market participants for cleared and uncleared
swaps.
The Commission believes that retaining SDR Reporting in the Second
Category would be appropriate. Consistent with section 2(i), the
Commission's policy is that U.S. swap dealers or MSPs (including those
that are affiliates of a non-U.S. person) generally should comply in
full with all of the Entity-Level Requirements, including SDR
Reporting. Further, non-U.S. swap dealers and non-U.S. MSPs (including
those that are affiliates of a U.S. person), generally should comply
with SDR Reporting, and substituted compliance should be available (to
the extent applicable) only where the swap counterparty is a non-U.S.
person, provided that the Commission has direct access (including
electronic access) to the relevant swap data that is stored at the
foreign trade repository.\417\
---------------------------------------------------------------------------
\417\ See section G, infra, for additional information on the
application of the Entity-Level Requirements.
---------------------------------------------------------------------------
The Commission contemplates treating swap data recordkeeping
related to complaints and marketing and sales materials under
Commission regulations 23.201(b)(3) and 23.201(b)(4) as part of the
``Second Category'' because, in the Commission's view, non-U.S. swap
dealers and non-U.S. MSPs (including those that are affiliates of a
U.S. person) generally should comply with SDR Reporting. Further,
substituted compliance should be available for non-U.S. swap dealers or
MSPs, to the extent applicable, only where the swap counterparty is a
non-U.S. person.
Large Trader Reporting furthers the goals of the Dodd-Frank Act to
reduce systemic risk, increase transparency and promote market
integrity. Large Trader Reporting, in conjunction with the Commission's
large trader reporting system for futures contracts, is essential to
the Commission's ability to conduct effective surveillance of markets
in U.S. physical commodity futures and economically equivalent swaps.
Given the regulatory function of Large Trader Reporting, the
Commission's policy is to apply these requirements to non-U.S. persons
whose trading falls within its scope to the same extent as U.S.
persons. Accordingly, as discussed further in section G below, the
Commission would not recognize substituted compliance in place of
compliance with Large Trader Reporting.
b. Transaction-Level Requirements
As previously noted, whether a particular Dodd-Frank Act
requirement should apply on a transaction-by-transaction basis in the
context of cross-border activity for purposes of section 2(i) of the
CEA requires the exercise of some degree of judgment. Nevertheless,
bearing in mind principles of international comity, the Commission
anticipates that, in general, the Transaction-Level Requirements may be
applied on a transaction-by-transaction basis.
The Commission's policy contemplates treating as Transaction-Level
Requirements all of the requirements that the Commission proposed to
include. Thus, the
[[Page 45339]]
Transaction-Level Requirements are: (1) Required clearing and swap
processing; (2) margining and segregation for uncleared swaps; (3)
trade execution; (4) swap trading relationship documentation; (5)
portfolio reconciliation and compression; (6) real-time public
reporting; (7) trade confirmation; (8) daily trading records; and (9)
external business conduct standards.
The Commission contemplates treating the Transaction-Level
Requirements in two subcategories, designated as Category A and
Category B, largely as proposed. Generally, these categories reflect
how the Commission generally contemplates applying various Transaction-
Level Requirements to various types of counterparties, and in guiding
the consideration of when substituted compliance will be available
under this Guidance.\418\
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\418\ Substituted compliance is discussed in section F, infra.
The application of the Category A Transaction-Level Requirements and
eligibility for substituted compliance is discussed in section
IV.G.4. The application of the Category B Transaction-Level
Requirements is discussed in section IV.G.5. The application of
certain CEA provisions and certain Entity and Transaction-Level
Requirements to non-registrants is discussed in section IV.H.
---------------------------------------------------------------------------
i. The Category A Transaction-Level Requirements
The ``Category A'' Transaction-Level Requirements relate to risk
mitigation and transparency, and included the first eight Transaction-
Level requirements referenced above.
The Commission does not believe it would be appropriate to treat,
as suggested by commenters, swap trading relationship documentation,
portfolio reconciliation and compression, daily trading records and
external business conduct standards as Entity-Level Requirements. The
Commission recognizes that firms may find a certain degree of
operational efficiency in applying these requirements on a firm-wide
basis. On the other hand, the Commission expects that treatment of
these as Transaction-Level Requirements should allow for greater
flexibility in terms of whether and how Dodd-Frank requirements apply.
For example, under the Proposed Guidance, the Commission would not
interpret section 2(i) generally to apply the Dodd-Frank's clearing
requirement to a swap between a non-U.S. swap dealer and a non-U.S.
counterparty. In the Commission's judgment, allowing swap trading
relationship documentation, portfolio reconciliation and compression
and external business conduct standards to be applied on a transaction
basis would not undermine the underlying regulatory objectives and,
yet, will give due recognition to the home jurisdiction's supervisory
interest. Consistent with this rationale, the Commission would treat
margin, segregation, and related requirements as Transaction-Level
Requirements.
The Commission also is retaining the trade execution requirement,
as proposed, in Category A. The trade execution requirement is intended
to bring the trading of mandatorily cleared swaps that are made
available to trade onto regulated exchanges or execution facilities. By
requiring the trades of mandatorily cleared swaps that are made
available to trade to be executed on an exchange or an execution
facility--each with its attendant pre- and post-trade transparency and
safeguards to ensure market integrity--the trade execution requirement
furthers the statutory goals of promoting financial stability, market
efficiency and enhanced transparency.
The Commission's policy will treat real-time public reporting as a
Transaction-Level Requirement. However, for the reasons discussed
below, the Commission clarifies that it does not intend that its policy
would preclude a market participant from applying real-time public
reporting with respect to swap transactions that are not necessarily
subject to this Transaction-Level Requirement if doing so would be more
efficient for the market participant.
Part 43 of the Commission's regulations and part 45 of the
Commission's regulations, respectively, prescribe the data fields that
are to be included in real-time public reporting and SDR Reporting
reports with respect to a reportable swap transaction.\419\
---------------------------------------------------------------------------
\419\ See generally Final Real-Time Reporting Rule, 77 FR at
1250-1266; Swap Data Recordkeeping and Reporting Requirements, 77 FR
2136, 2210-2224 (Jan. 13, 2012) (``Final Data Rules''). Part 43
applies to reports of swap transaction and pricing data to a
registered SDR, in order that the SDR can publicly disseminate such
data pursuant to part 43 and Appendix A to part 43 as soon as
technologically practicable after execution of the publicly
reportable swap. Final Real-Time Reporting Rule, 77 FR 1249. Under
part 45, counterparties report creation data for the swap--including
all primary economic terms (``PET'') data and confirmation data--as
well as continuation data also as soon as technologically
practicable. See Final Data Rules, 77 FR at 2149-2151, 2199-2202.
---------------------------------------------------------------------------
The Commission understands from commenters that in certain
circumstances, reporting part 43 and part 45 data for the same swap
transaction in separate reports (``two stream reporting'') could
accommodate market participants that have a transactional structure
and/or systems that are designed or suited to send separate
submissions.\420\ However, the Commission also recognizes that in other
circumstances, permitting market participants to include part 43 and
part 45 data for the same swap transaction in a single report (``single
stream reporting'') could optimize efficiency.\421\
---------------------------------------------------------------------------
\420\ See Final Real-Time Reporting Rule, 77 FR 1237 (Jan. 9,
2012) (noting that `` . . . coordination is expected to reduce costs
by allowing reporting parties, SEFs and DCMs to send one set of data
to an SDR for the purpose of satisfying the requirements of both
rules.''); id. at 1210 (noting that '' . . . although reporting
parties may use the same data stream for reporting regulatory data
and real-time data, Commission regulation 43.4(d)(2) clarifies the
intent of the Proposing Release: The reporting requirements for
SEFs, DCMs and reporting parties for real-time public reporting
purposes are separate from the requirement to report to an SDR for
regulatory reporting purposes.'').
\421\ Final Data Rules, 77 FR 2150, 2182. If SDR Reporting and
real-time public reporting do not both apply to a swap transaction,
market participants that have connected to registered SDRs and
employed single stream reporting infrastructure and systems may be
required to change such systems to bifurcate the part 43 and part 45
data sets, which are generated and transmitted in a single report.
The Commission understands that such bifurcation could occur due to
the manner with which Transaction-Level and Entity-Level
requirements apply to the particular swap transaction.
---------------------------------------------------------------------------
The Commission anticipated that reporting parties might elect to
use one data reporting stream for both SDR Reporting and real-time
public reporting under part 45 and part 43 respectively, to reduce
costs and optimize efficiency, and many market participants have chosen
to build and integrate single stream reporting systems.\422\ The
Commission is aware that, as commenters have stated, categorizing SDR
Reporting under part 45 as an Entity-Level requirement and real-time
public reporting under part 43 as a Transaction-Level requirement
could, in certain circumstances, negate the benefits of single stream
reporting, and could present challenges to market participants who have
built single stream reporting infrastructure.
---------------------------------------------------------------------------
\422\ Real-Time Public Reporting of Swap Transaction Data, 77 FR
1217. See also Final Data Rules, 77 FR at 2182.
---------------------------------------------------------------------------
In view of these concerns, the Commission would, in general, treat
real-time public reporting as a Transaction-Level Requirement. However,
the Commission does not intend that its policy would preclude a market
participant from applying real-time public reporting with respect to
swap transactions that are not necessarily subject to this Transaction-
Level Requirement if, for example, this would allow the market
participant to realize efficiency gains from single stream reporting or
otherwise as discussed above.
[[Page 45340]]
ii. The Category B Transaction-Level Requirements (External Business
Conduct Standards)
As proposed, the Commission's policy will treat external business
conduct standards as a ``Category B'' Transaction-Level Requirement for
purposes of the general application of this Transaction-Level
Requirement to various categories of swap counterparties.\423\ External
business conduct standards are oriented toward customer-protection.
Among other obligations, the external business conduct rules generally
require registrants to conduct due diligence on their counterparties to
verify eligibility to trade (including eligible contract participant
status), refrain from engaging in abusive market practices, provide
disclosure of material information about the swap to their
counterparties, provide a daily mid-market mark for uncleared swaps
and, when recommending a swap to a counterparty, make a determination
as to the suitability of the swap for the counterparty based on
reasonable diligence concerning the counterparty. In the Commission's
view, such rules have an attenuated link to, and are distinguishable
from, market-oriented protections such as the trade execution mandate.
Additionally, the Commission believes that the foreign jurisdictions in
which non-U.S. persons are located are likely to have a significant
interest in the type of business conduct standards that would be
applicable to transactions with such non-U.S. persons within their
jurisdiction. Because the Commission believes that foreign regulators
may have a relatively stronger supervisory interest in regulating sales
practices concerns related to swaps between non-U.S. persons taking
place outside the United States than the Commission, the Commission
believes that generally it is appropriate that the business conducts
standards of the home jurisdiction, rather than those established by
the Commission, apply to such transactions between non-U.S. persons.
---------------------------------------------------------------------------
\423\ The application of the Category B Transaction-Level
Requirements to swap dealers and MSPs is discussed in section
IV.G.5.
---------------------------------------------------------------------------
After reviewing the comments on internal conflicts of interest
procedures, the Commission has given consideration to whether to treat
internal conflicts of interest rules relating to clearing under
Commission regulation 23.605 under Category B of the Transaction-Level
Requirements. The Commission considered the view of commenters that
stated that this particular requirement is generally more akin to the
external business conduct standards and, as such, can reasonably be
expected to be narrowly targeted to apply only with respect to U.S.
clients, without undermining the regulatory benefits associated with
the rule. However, because the Commission believes that internal
conflicts of interest related to clearing should be applied on a firm-
wide basis, the Commission's policy is that this requirement generally
should be treated as an Entity-Level Requirement as proposed.
The Commission also has considered whether internal conflicts of
interest procedures relating to research should be treated as Entity-
Level Requirements as proposed. These informational and supervisory
firewalls are designed to ensure that research reports are free from
undue influence by the firm's trading personnel. As a practical matter,
it is generally difficult, if not impossible, to establish and maintain
such safeguards on a transaction or client basis. Because the
Commission believes that these firewalls, in order to achieve their
regulatory purpose, should be applied on a firm-wide basis, the
Commission's policy is that internal conflicts of interest procedures
relating to research generally should be treated as Entity-Level
Requirements.
F. Substituted Compliance
1. Proposed Guidance
In the Proposed Guidance, the Commission stated that a cross-border
policy that allows for flexibility in the application of the CEA while
ensuring the high level of regulation contemplated by the Dodd-Frank
Act and avoiding potential conflicts between U.S. regulations and
foreign law is consistent with principles of international comity. To
that end, the Commission set forth a general framework for substituted
compliance. Under this ``substituted compliance'' regime, the
Commission may determine that certain laws and regulations of a foreign
jurisdiction are comparable to and as comprehensive as a corresponding
category of U.S. laws and regulations. If the Commission makes such a
determination, then an entity or transaction in that foreign
jurisdiction that is subject to the category of U.S. laws and
regulations for which comparability is determined will be deemed to be
in compliance therewith if that entity or transaction complies with the
corresponding foreign laws and regulations.
2. Comments
Several commenters urged the Commission to use a principles-based
approach and to review the legal regime as a whole, rather than
evaluate comparability on an issue-by-issue basis.\424\ A commenter
supported the Commission's view that comparable does not mean
identical, and urged the Commission to place an emphasis on shared
principles and mutual recognition.\425\
---------------------------------------------------------------------------
\424\ See, e.g., SIFMA, (Aug. 27, 2012) at 3, A46; State Street
(Aug. 27, 2012) at 3; Global Financial Markets Association
(``GFMA'') (Aug. 27, 2012) at 2; Association for Financial Markets
in Europe (``AFME'') (Aug. 27, 2012) at 2; J.P. Morgan (Aug. 13,
2012) at 5; Australian Bankers (Aug. 27, 2012) at 2; Japanese
Bankers Association (Aug. 27, 2012) at 3; Comissao de Valores
Mobiliarios (``CVM'') (Aug. 27, 2012) at 2.
\425\ See, e.g., FSR (Aug. 27, 2012) at 6-7.
---------------------------------------------------------------------------
Some commenters stated that foreign jurisdiction laws and
regulations are unlikely to be identical to those in the United States
and that they thus support the Commission's proposed ``outcomes based
approach'' to evaluating whether foreign regulatory requirements meet
Dodd-Frank normative objectives.\426\ One of these commenters stated
that in some cases foreign regulators would be faced with several
challenges, noting that in ``light touch'' or principle-based
regulatory jurisdictions, commodity derivatives data collection and
surveillance is weak or even non-existent, as is concomitant
enforcement.\427\
---------------------------------------------------------------------------
\426\ See IATP (Aug. 27, 2012) at 11-12; IIAC (Aug. 27, 2012) at
2, 9-11.
\427\ See IATP (Aug. 27, 2012) at 11-12.
---------------------------------------------------------------------------
Commenters stressed the need to avoid imposing duplicative or
conflicting regulatory requirements which could result in unnecessary
costs.\428\ Commenters urged the Commission to engage in a dialogue
with other regulators \429\ and to build on work done at the
international level.\430\
---------------------------------------------------------------------------
\428\ See, e.g., ICI (Aug. 23, 2012) at 7-11; Capital Markets
(Aug. 24, 2012) at 5-6.
\429\ See Deutsche Bank, Aug. 27, 2012 at 5-6; Lloyds (Aug. 24,
2012) at 2.
\430\ See Australian Securities and Investments Commission; Hong
Kong Monetary Authority; Monetary Authority of Singapore; Reserve
Bank of Australia; Securities and Futures Commission, Hong Kong
(Aug. 27, 2012) at 3-4.
---------------------------------------------------------------------------
Some commenters expressed the view that substituted compliance
should not require Commission approval if the applicable foreign
regulator promulgates applicable regulations in accordance with G20
commitments, or that a presumption that foreign rules are comparable
should apply if the rules are consistent with G20 principles.\431\ Some
commenters urged the Commission to take what they described as an
[[Page 45341]]
``equivalence approach'' similar to EMIR in the European Union,\432\ by
making substituted compliance determinations based on recognition of
``equivalent'' jurisdictions and not of individual firms.\433\ The
European Commission stated that EU firms dealing with U.S.
counterparties would always be subject to the Dodd-Frank Act, while
U.S. firms dealing with EU counterparties could not be subject to EU
rules if the EU decides to grant equivalence to the United States. The
European Commission stated that it is difficult to understand why
comparable foreign legislation in the EU should not be sufficient.\434\
---------------------------------------------------------------------------
\431\ See CEWG (Aug. 27, 2012) at 7; CVM (Aug. 27, 2012) at 2;
ICI (Aug. 23, 2012) at 9; IIB (Aug. 27, 2012) at 38-39; Hong Kong
Banks (Aug. 27, 2012) at 2, 10, 14, 15; Korea Federation of Banks
(``Korea Banks'') (Aug. 27, 2012) at 2-3; The Clearing House (Aug.
27, 2012) at 3-4, 31-35.
\432\ See Australian Securities and Investments Commission; Hong
Kong Monetary Authority; Monetary Authority of Singapore; Reserve
Bank of Australia; Securities and Futures Commission, Hong Kong
(Aug. 27, 2012) at 2-3.
\433\ See Deutsche Bank (Aug. 27, 2012) at 6.
\434\ See European Commission (Aug. 24, 2012) at 4.
---------------------------------------------------------------------------
Commenters, including foreign regulators, requested that the
Commission more clearly outline the circumstances under which a
particular foreign jurisdiction would be acceptable for substituted
compliance purposes.\435\ Commenters stressed the need for
comparability determinations to be transparent.\436\ One commenter
stated that comparability determinations should allow for notice and
comment.\437\ Another commenter stated that there should be a procedure
for appeals, that memoranda of understanding (``MOUs'') should form the
framework for comparability determinations, and that the Commission
should develop a process for periodic review of comparability
determinations.\438\
---------------------------------------------------------------------------
\435\ See, e.g., Financial Services Authority (United Kingdom)
(Aug. 24, 2012) at 3.
\436\ See IIB (Aug. 27, 2012) at 40; American Bankers
Association, (Aug. 27, 2012) at 2; IATP (Aug. 27, 2012) at 11.
\437\ See American Bankers Association (Aug. 27, 2012) at 2.
\438\ See IATP (Aug. 27, 2012) at 11-13.
---------------------------------------------------------------------------
Some commenters found the Commission's proposed approach to
substituted compliance too narrow or limiting. The European Securities
and Markets Authority (``ESMA'') stated that when equivalence or
substituted compliance is granted for an entire jurisdiction,
registration should not be a prerequisite before substituted compliance
can apply. ESMA also stated that the Commission's approach is quite
limited because it is applied not uniformly but ``chapter by chapter,''
which ESMA represents contradicts what they described as EMIR's
concepts of equivalence and mutual recognition.\439\ Japan FSA and Bank
of Japan expressed concern that the scope of application of substituted
compliance is too narrow and requested that it be extended to avoid
overlap or conflict with foreign regulations.\440\ Other commenters
stated that the approach being taken toward substituted compliance was
narrow and not in accordance with comity.\441\ However, another
commenter stated that substituted compliance procedures are an inferior
option to direct compliance with Commission regulations. This commenter
stated that the Commission does not violate principles of international
comity by extending the cross-border application to cover how ``U.S.
persons'' operate in foreign jurisdictions, particularly when those
jurisdictions lack the laws and/or regulatory capacity to prevent
damage to the U.S. economy resulting from counterparty defaults
originating in foreign affiliate swaps.\442\
---------------------------------------------------------------------------
\439\ See ESMA (Aug. 27, 2012) at 3-4.
\440\ See Japan FSA and Bank of Japan (Aug. 13, 2012) at 2-3.
\441\ See SIFMA (Aug. 27, 2012) at 3, A46; Futures Industry
Association (FIA), (Aug. 27, 2012) at 5-7.
\442\ See IATP (Aug. 27, 2012) at 2-3.
---------------------------------------------------------------------------
Another commenter stated that substituted compliance should be
expanded to a broader category of swap transactions, specifically, to
the trade execution requirement.\443\
---------------------------------------------------------------------------
\443\ See Tradeweb Markets LLC (Aug. 27, 2012) at 4.
---------------------------------------------------------------------------
Some commenters urged the Commission to clarify which law is
``substituted'' for U.S. law and allow swap entities to determine which
jurisdictions' laws apply where it could be more than one.\444\
---------------------------------------------------------------------------
\444\ See SIFMA (Aug. 27, 2012) at A48; Deutsche Bank (Aug. 27,
2012) at 6.
---------------------------------------------------------------------------
Some commenters expressed concern regarding the timing of reform in
other jurisdictions, urging the Commission to delay substituted
compliance implementation or provide a grace period for these
jurisdictions.\445\
---------------------------------------------------------------------------
\445\ See, e.g., CFA Institute (Aug. 27, 2012) at 3; Financial
Services Authority (United Kingdom) (Aug. 24, 2012) at 3; Barclays
(Aug. 27, 2012) at 2; ICAP Group (Aug. 27, 2012) at 2; IIB (Aug. 27,
2012) at 39.
---------------------------------------------------------------------------
Some commenters urged the Commission not to allow substituted
compliance or to use it only sparingly, pointing out the risks of
substituted compliance by the Commission. For example, one commenter
contended that substituted compliance fails to ensure rigorous
regulation of derivatives markets and so should not be allowed for
foreign subsidiaries of U.S. parents as these subsidiaries pose a
severe risk to the U.S. economy.\446\ This commenter also stated that
substituted compliance should only be used in ``rare circumstances''
and only after such rules in foreign jurisdictions have come into
existence,\447\ stating that the Commission ``cannot, through its use
of comity, consider other countries' interests to the total derogation
of Congress's intent to protect U.S. taxpayers.'' \448\ Citizen and
taxpayer groups contended that substituted compliance should not be
permitted when the swap transaction is with a U.S. counterparty,\449\
including subsidiaries of a U.S. person.\450\
---------------------------------------------------------------------------
\446\ See Greenberger (Aug. 27, 2012) at 20-24.
\447\ See Greenberger (Aug. 27, 2012) at 3, 19, 22-23.
\448\ See Greenberger (Aug. 27, 2012) at 19.
\449\ See Public Citizen (Aug. 27, 2012) at 13, 16, 19.
\450\ See Better Markets (Aug. 27, 2012) at 10.
---------------------------------------------------------------------------
Commenters also urged that, to the extent substituted compliance is
permitted, a rigorous approach be applied, including examining the
history of enforcement in a foreign jurisdiction, the ability to revoke
substituted compliance where necessary, the ability of the public to
comment on substituted compliance applications, periodic review of the
application of substituted compliance and a requirement that the
applicant immediately inform the Commission of any material changes in
its jurisdiction.\451\
---------------------------------------------------------------------------
\451\ See, e.g., Better Markets (Aug. 27, 2012) at 10-11; Public
Citizen (Aug. 27, 2012) at 13, 16, 19.
---------------------------------------------------------------------------
With regard to SDR Reporting, some commenters disagreed with the
Commission that a foreign trade repository must allow Commission access
to information to be considered comparable, arguing that comparability
should be based solely on the foreign jurisdiction's regulatory
regime,\452\ or that access is unnecessary where swaps are between non-
U.S. counterparties.\453\ In contrast, another commenter stated that
open access to foreign swap data repositories is necessary to ensure
that foreign surveillance of transaction-level swaps data flow
requirements is comparable and comprehensive.\454\
---------------------------------------------------------------------------
\452\ See Deutsche Bank (Aug. 27, 2012) at 6.
\453\ See Japanese Bankers Association (Aug. 27, 2012) at 10.
\454\ See IATP (Aug. 27, 2012) at 6-7.
---------------------------------------------------------------------------
International regulators have continued to express commitment to
the Pittsburgh G20 reforms of OTC derivatives regulation, including a
commitment to harmonize cross-border regulations and allow for
substituted compliance or equivalence arrangements when appropriate.
However, no international consensus has emerged regarding the
implementation of such reforms or the
[[Page 45342]]
circumstances under which substituted compliance should be permitted.
In an April 18, 2013 letter to Treasury Secretary Lew, nine
international financial regulators expressed concern about
fragmentation in the OTC derivatives market as a result of lack of
regulatory coordination, noting that ``[a]n approach in which
jurisdictions require that their own domestic regulatory rules be
applied to their firms' derivatives transactions taking place in
broadly equivalent regulatory regimes abroad is not sustainable.''
\455\ The letter expressed concern that such an approach would lead the
global derivatives market to ``recede into localized and less efficient
structures, impairing the ability of business across the globe to
manage risk.'' The letter also suggested, among other things, that
cross-border rules be adopted that would not result in duplicative or
conflicting requirements through substituted compliance or equivalence
arrangements, and that a reasonable transition period and measures be
provided to foreign entities to ensure a smooth transition.\456\
---------------------------------------------------------------------------
\455\ See letter to Treasury Secretary Lew regarding cross-
border OTC derivatives regulation from Deputy Prime Minister Taro
Aso, Minister of State for Finance Services, Government of Japan;
Commissioner Michel Barnier, Commissioner for Internal Markets and
Services, European Commission; Minister Pravin Gordhan, Minister of
Finance, Government of South Africa; Minister Guido Mantega,
Ministry of Finance, Government of Brazil; Minister Pierre
Moscovici, Ministry of Finance, Government of France; Chancellor
George Osborne, Chancellor of the Exchequer, Government of the
United Kingdom; Minister Wolfgang Sch[auml]uble, Ministry of
Finance, Government of Germany; Minister Anton Siluanov, Minister of
Finance, Government of Russia; and Minister Eveline Widmer-Schlumpf,
Finance Minister, Government of Switzerland (``Nine International
Regulators'') (Apr. 18, 2013). See also letter to Treasury Secretary
Lew from Sens. Kirsten E. Gillibrand, Thomas R. Carper, Kay R.
Hagan, Heidi Heitkamp, Michael F. Bennet, and Charles E. Schumer
(June 26, 2013) (advocating domestic and international harmonization
of derivatives regulation).
\456\ Id.
---------------------------------------------------------------------------
A group of 25 organizations from numerous nations responded by
asserting that the letter to Treasury Secretary Lew ``appears to place
a higher priority on preventing `fragmentation' in global financial
markets than on effective management of global financial risks.'' \457\
Emphasizing that the global financial crisis of 2008-2009 caused ``mass
unemployment, home foreclosures, and cutbacks in key public services,''
these organizations argued that ``[s]ince G-20 nations have not yet met
their 2009 Pittsburgh commitment to put in place effective derivatives
regulation by the close of 2012, the first priority should be to
complete this crucial element of financial oversight.'' \458\ Although
these organizations recognized the challenge of effectively regulating
the global financial markets, they asserted that ``the path to
addressing these challenges does not lie in further delays that prevent
any nation from acting until every jurisdiction globally has agreed on
a similar approach.'' \459\ Instead, these organizations urged the
international community ``to coordinate around a shared high level of
financial oversight, and in the meantime to support the efforts of
individual nations to ensure that the scope of their financial
regulation properly captures all transactions, wherever conducted, that
affect the safety and stability of each national financial system.''
\460\
---------------------------------------------------------------------------
\457\ See letter to Nine International Regulators from ActionAid
International; AFL-CIO (American Federation of Labor And Congress of
Industrial Organizations); Americans for Financial Reform; Berne
Declaration; Center of Concern; The Centre for Research on
Multinational Corporations (SOMO); Centre national de
coop[eacute]ration au d[eacute]veloppement, CNCD-11.11.11; CGIL--
Italian General Confederation of Labour; Consumer Federation of
America; Global Progressive Forum; IBON International; The
International Institute for Monetary Transformation; Institute for
Agriculture and Trade Policy (IATP); Institute for Policy Studies,
Global Economy Project; Jubilee Debt Campaign, UK; Kairos Europe
(Brussels); Missionary Oblates--USP (Washington, DC); Oxfam; Red
Latinoamericana sobre Deuda, Desarrollo y Derechos--LATINDADD; Stamp
Out Poverty; Tax Justice Network; UBUNTU Forum; War on Want; WEED
(World Economy, Ecology, and Development); and World Development
Movement (Jul. 1, 2013).
\458\ Id.
\459\ Id.
\460\ Id.
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3. Overview of the Substituted Compliance Regime
Once registered, a non-U.S. swap dealer or non-U.S. MSP would
become subject to all of the substantive requirements under Title VII
of the Dodd-Frank Act that apply to registered swap dealers or MSPs. In
other words, the requirements under Title VII of the Dodd-Frank Act
related to swap dealers and MSPs apply to all registered swap dealers
and MSPs, irrespective of where they are based.
Consistent with CEA section 2(i) and comity principles, the
Commission's policy generally is that eligible entities may comply with
a substituted compliance regime under certain circumstances, subject,
however, to the Commission's retention of its examination authority
\461\ and its enforcement authority. To the extent that the substituted
compliance regime applies, the Commission generally would permit a non-
U.S. swap dealer or MSP, U.S. bank that is a swap dealer or MSP with
respect to its foreign branches,\462\ or non-U.S. non-registrant that
is a guaranteed or conduit affiliate, as applicable, to substitute
compliance with the requirements of the relevant home jurisdiction's
law and regulations (or in the case of foreign branches of a bank, the
foreign location of the branch) in lieu of compliance with the
attendant Entity-Level Requirements and/or Transaction-Level
Requirements under the CEA and Commission regulations, provided that
the Commission finds that such home jurisdiction's requirements (or in
the case of foreign branches of a bank, the foreign location of the
branch) are comparable with and as comprehensive as the corollary
area(s) of regulatory obligations encompassed by the Entity- and
Transaction-Level Requirements. Significantly, the Commission will rely
upon an outcomes-based approach to determine whether these requirements
achieve the same regulatory objectives of the Dodd-Frank Act. An
outcomes-based approach in this context means that the Commission is
likely to review the requirements of a foreign jurisdiction for rules
that are comparable to and as comprehensive as the requirements of the
Dodd-Frank Act, but it will not require that the foreign jurisdiction
have identical requirements to those
[[Page 45343]]
established under the Dodd-Frank Act. This approach builds on the
Commission's longstanding policy of recognizing comparable regulatory
regimes based on international coordination and comity principles with
respect to cross-border activities involving futures (and options on
futures).\463\ The Commission anticipates that its approach also will
require close consultation, cooperation, and coordination among the
Commission and relevant foreign regulators regarding ongoing compliance
efforts. To date, the Commission notes that it has engaged in many
multilateral and bilateral consultations and efforts to coordinate on
the substance of OTC derivatives reform efforts.
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\461\ Under Commission regulations 23.203 and 23.606, all
records required by the CEA and the Commission's regulations to be
maintained by a registered swap dealer or MSP shall be maintained in
accordance with Commission regulation 1.31 and shall be open for
inspection by representatives of the Commission, the United States
Department of Justice, or any applicable prudential regulator.
In the January Order, the Commission noted that an applicant for
registration as a swap dealer or MSP must file a Form 7-R with the
National Futures Association and that Form 7-R was being modified at
that time to address existing blocking, privacy or secrecy laws of
foreign jurisdictions that applied to the books and records of swap
dealers and MSPs acting in those jurisdictions. See 78 FR at 871-872
n. 107. The modifications to Form 7-R were a temporary measure
intended to allow swap dealers and MSPs to apply for registration in
a timely manner in recognition of the existence of the blocking,
privacy, and secrecy laws. The Commission clarifies that the change
to Form 7-R impacts the registration application only and does not
modify the Commission's authority under the CEA and its regulations
to access records held by registered swap dealers and MSPs.
Commission access to a registrant's books and records is a
fundamental regulatory tool necessary to properly monitor and
examine each registrant's compliance with the CEA and the
regulations adopted pursuant thereto. The Commission has maintained
an ongoing dialogue on a bilateral and multilateral basis with
foreign regulators and with registrants to address books and records
access issues and may consider appropriate measures where requested
to do so.
\462\ The types of offices which the Commission would consider
to be a ``foreign branch'' of a U.S. bank, and the circumstances in
which a swap is with such foreign branch, are discussed further in
section IV.C.3, supra.
\463\ For example, under part 30 of the Commission's
regulations, if the Commission determines that compliance with the
foreign regulatory regime would offer comparable protection to U.S.
customers transacting in foreign futures and options and there is an
appropriate information-sharing arrangement between the home
supervisor and the Commission, the Commission has permitted foreign
brokers to comply with their home regulations (in lieu of the
applicable Commission regulations), subject to appropriate
conditions. See, e.g., Foreign Futures and Options Transactions, 67
FR 30785 (May 8, 2002); Foreign Futures and Options Transactions, 71
FR 6759 (Feb. 9, 2009).
Upon promulgating part 30, the Commission stated that it
``intends to monitor closely the application of this regulatory
scheme for the offer and sale of foreign futures and foreign options
in the U.S. and to make adjustments in these rules, as necessary,
based, in part, on it experience in administering the exemptive
procedure [i.e., 30.10 relief] as well as other requests for
interpretations of the provisions herein.'' Foreign Futures and
Foreign Options Transactions, 52 FR 28980, 28993 (Aug. 5, 1987). For
example, the Commission has expanded part 30 to allow 30.10-exempt
foreign brokers to act as introducing brokers for the purpose of
executing linked U.S. transactions on behalf of U.S. customers under
certain circumstances. The Commission also promulgated regulation
30.12 to allow unlicensed ``local'' brokers located outside the
United States to execute trades through the customer omnibus account
of an FCM or 30.10 exempt foreign broker, again under certain
circumstances. The Commission expects that the substituted
compliance process contemplated by this Guidance may similarly
evolve.
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In part, because many foreign jurisdictions have been implementing
OTC derivatives reforms in an incremental manner, the Commission's
comparability determinations may be made on a requirement-by-
requirement basis, rather than on the basis of the foreign regime as a
whole. For example, many jurisdictions have moved more quickly to
implement reporting to trade repositories, and so the Commission may
focus first on comparability with those requirements. In addition, in
making its comparability determinations, the Commission may include
conditions that take into account timing and other issues related to
coordinating the implementation of reform efforts across jurisdictions.
A non-U.S. swap dealer or non-U.S. MSP, a U.S. bank that is a swap
dealer or MSP with respect to its foreign branches, or non-U.S. non-
registrant that is a guaranteed or conduit affiliate, to the extent
applicable under this Guidance, may comply with regulations in its home
jurisdiction (or in the case of foreign branches of a bank, the foreign
location of the branch) to the extent that the Commission determines
that these requirements are comparable to, and as comprehensive as, the
corollary areas of the CEA and Commission regulations.\464\ As noted
above, however, the home jurisdiction's requirements do not have to be
identical to the Dodd-Frank Act requirements. Moreover, the Commission
notes, however, that entities relying on substituted compliance may be
required to comply with certain of the Dodd-Frank Act requirements
where comparable and comprehensive regulation in their home
jurisdiction (or in the case of foreign branches of a bank, the foreign
locations of the branches) are determined to be lacking.\465\
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\464\ As stated in note 88, for purposes of this Guidance, the
terms ``home jurisdiction'' or ``home country'' are used
interchangeably and refer to the jurisdiction in which the person or
entity is established, including the European Union. Further, the
Commission clarifies that where a non-U.S. swap dealer (or non-U.S.
MSP), or a non-U.S. non-registrant that is a guaranteed or conduit
affiliate, transacts outside the home jurisdiction, substituted
compliance is available and they may comply with the comparable and
comprehensive requirements of the home jurisdiction, provided that
they comply with such requirements in that other jurisdiction.
\465\ The Commission recognizes that substantial progress has
been made in other jurisdictions towards implementing OTC
derivatives reform. For example, EMIR requires financial
counterparties, including hedge funds, to clear OTC derivatives
contracts subject to the clearing obligation through a central
counterparty registered or recognized in accordance with EMIR. EMIR
also requires such entities to comply with EMIR's risk mitigation
techniques for uncleared OTC derivatives contracts; risk mitigation
techniques include, confirmation, portfolio reconciliation,
compression, valuation and dispute resolution. Lastly, EMIR requires
financial counterparties to report all derivatives contracts to a
trade repository registered or recognized in accordance with EMIR.
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In evaluating whether a particular category of foreign regulatory
requirement(s) is comparable and comprehensive to the applicable
requirement(s) under the CEA and Commission regulations, the Commission
will take into consideration all relevant factors, including but not
limited to, the comprehensiveness of those requirement(s), the scope
and objectives of the relevant regulatory requirement(s), the
comprehensiveness of the foreign regulator's supervisory compliance
program, as well as the home jurisdiction's authority to support and
enforce its oversight of the registrant. In this context, comparable
does not necessarily mean identical. Rather, the Commission would
evaluate whether the home jurisdiction's regulatory requirement is
comparable to and as comprehensive as the corresponding U.S. regulatory
requirement(s).
In response to comments requesting greater clarity with respect to
the substituted compliance determinations, the Commission notes that a
comparability analysis would begin with a consideration of the
regulatory objectives of a foreign jurisdiction's regulation of swaps
and swaps market participants. In this regard, the Commission will
first look to foreign regulator's swap-specific regulations. The
Commission recognizes, however, that jurisdictions may not have swap-
specific regulations in some areas, and instead may have regulatory or
supervisory regimes that achieve comparable and comprehensive
regulatory objectives as the Dodd-Frank Act requirements, but on a more
general, entity-wide, or prudential, basis.\466\ In addition, portions
of a foreign regulatory regime may have similar regulatory objectives,
but the means by which these objectives are achieved with respect to
swaps market activities may not be clearly defined, or may not
expressly include specific regulatory elements that the Commission
concludes are critical to achieving the regulatory objectives or
outcomes required under the CEA and the Commission's regulations. In
these circumstances, the Commission anticipates that, as part of its
broader efforts to consult and coordinate with foreign jurisdictions,
it will work with the regulators and registrants in these jurisdictions
to consider alternative approaches that may result in a determination
that substituted compliance applies.\467\
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\466\ The Commission notes that, of the 35 provisionally
registered non-U.S. swap dealers as of July 12, 2013, all but one of
them are banking entities that are subject to prudential supervision
by banking supervisors in their home jurisdictions or affiliates of
such banks. By comparison, 19 of the provisionally registered U.S.
swap dealers and MSPs are not regulated by a prudential supervisor
or the SEC.
\467\ The Commission notes that such alternatives are available
for both Entity- and Transaction-Level Requirements, but are more
likely appropriate for Entity-Level Requirements.
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The approaches used will vary depending on the circumstances
relevant to each jurisdiction. One example would include coordinating
with the foreign regulators in developing appropriate regulatory
[[Page 45344]]
changes or new regulations, particularly where changes or new
regulations already are being considered or proposed by the foreign
regulators or legislative bodies. As another example, the Commission
may, after consultation with the appropriate regulators and market
participants, include in its substituted compliance determination a
description of the means by which certain swaps market participants can
achieve substituted compliance within the construct of the foreign
regulatory regime. The identification of the means by which substituted
compliance is achieved would be designed to address the regulatory
objectives and outcomes of the relevant Dodd-Frank Act requirements in
a manner that does not conflict with a foreign regulatory regime and
reduces the likelihood of inconsistent regulatory obligations. For
example, the Commission may specify that swap dealers and MSPs in the
jurisdiction undertake certain recordkeeping and documentation for swap
activities that otherwise is only addressed by the foreign regulatory
regime with respect to financial activities generally. In addition, the
substituted compliance determination may include provisions for summary
compliance and risk reporting to the Commission to allow the Commission
to monitor whether the regulatory outcomes are being achieved. By using
these approaches, in the interest of comity, the Commission would seek
to achieve its regulatory objectives with respect to the Commission's
registrants that are operating in foreign jurisdictions in a manner
that works in harmony with the regulatory interests of those
jurisdictions.\468\
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\468\ The Commission anticipates that non-U.S. swap dealers and
MSPs may require additional time after a Substituted Compliance
Determination in order to phase in compliance with the relevant
requirements of the jurisdiction in which the non-US swap dealer or
MSP is established. The Commission and its staff intend to address
the need for any further transitional relief at the time that the
subject Substituted Compliance Determination is made.
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4. Process for Comparability Determinations
Any comparability analysis will be based on a comparison of
specific foreign requirements against specific related CEA provisions
and Commission regulations in 13 categories of regulatory obligations
and will consider the factors described above. After receiving a
submission from an applicant, the resulting comparability determination
would be made by the Commission with regard to each of the 13
categories of regulatory obligations, as appropriate. More
specifically, the Commission could determine that a particular set of
foreign laws and regulations provides a sufficient basis for an
affirmative finding of comparability with respect to a relevant area of
regulatory obligations. Where no comparability determination can be
made,\469\ the non-U.S. swap dealer or non-U.S. MSP, U.S. bank that is
a swap dealer or MSP with respect to its foreign branches, or non-
registrant, to the extent applicable under this Guidance, may be
required to comply with the applicable Entity- or Transactional-Level
requirements under the CEA and Commission regulations.
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\469\ A finding of comparability may not be possible for a
number of reasons, including the fact that the foreign jurisdiction
has not yet implemented or finalized particular requirements.
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Anyone who is eligible for substituted compliance may apply, either
individually or collectively, as may foreign regulators. Persons who
may request a comparability determination include: (i) Foreign
regulators, (ii) an individual non-U.S. entity, or group of non-U.S.
entities; (iii) a U.S. bank that is a swap dealer or MSP with respect
to its foreign branches; \470\ or (iv) a trade association, or other
group, on behalf of similarly-situated entities. Persons requesting a
comparability determination may want to coordinate their application
with other market participants and their home regulators to simplify
and streamline the process. Once a comparability determination is made
for a jurisdiction, it will apply for all entities or transactions in
that jurisdiction to the extent provided in the determination, as
approved by the Commission.
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\470\ As previously noted, where the counterparty to a swap with
a foreign branch is a non-U.S. person (whether or not such non-U.S.
person is guaranteed or otherwise supported by, or is an affiliate
conduit of, a U.S. person), the Commission continues to be of the
view that compliance with comparable and comprehensive requirements
in the foreign jurisdiction should be permitted in light of the
supervisory interest of the foreign jurisdiction in the swaps
transacted in that jurisdiction, together with the fact that foreign
branches of U.S. swap dealers or U.S. MSPs are subject generally to
direct or indirect oversight by U.S. regulators because they are
part of a U.S. person. As discussed further in section IV.F.3,
supra, the Commission's recognition of substituted compliance would
be based on an evaluation of whether the requirements of the home
jurisdiction are comparable and comprehensive to the applicable
requirement(s) under the CEA and Commission regulations based on a
consideration of all relevant factors, including among other things:
(i) The comprehensiveness of the foreign regulator's supervisory
compliance program and (ii) the authority of such foreign regulator
to support and enforce its oversight of the registrant's branch or
agency with regard to such activities to which substituted
compliance applies.
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Generally, the Commission would expect that the applicant, at a
minimum, state with specificity the factual and legal basis for
requesting that the Commission find that a particular set of foreign
laws and regulations is comparable to, and as comprehensive as,
particular Dodd-Frank Act requirements as described above; include with
specificity all applicable legislation, rules, and policies; and
provide an assessment whether the objectives of the two regulatory
regimes are comparable and comprehensive.\471\ If the applicant is a
registered swap dealer or MSP, it also would generally be helpful to
understand the capacity in which the applicant is licensed with the
applicant's regulator(s) in its home country and whether the applicant
is in good standing.
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\471\ The Commission may, as it deems appropriate and necessary,
conduct an on-site examination of the applicant, as well as consult
with the applicant's home regulator regarding the status of the
applicant. For certain matters, the Commission may request an
opinion of counsel.
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The Commission expects that the comparability analysis process
would, in most cases, involve consultation with the regulators in each
jurisdiction for which a substituted compliance application has been
submitted so that the Commission may better analyze the compliance
regime of a jurisdiction. Consultations are particularly important in
the near future because many jurisdictions are in the process of
finalizing and implementing their derivatives reforms incrementally and
the Commission's comparability determinations may need to take into
account the timing of regulatory reforms that have been proposed or
finalized, but not yet implemented.
Further, the Commission expects that, in connection with a
determination that substituted compliance is appropriate, it would
enter into an appropriate MOU or similar arrangement between the
Commission and the relevant foreign regulator(s). Existing information-
sharing and/or enforcement arrangements would be indicative of a
foreign supervisor's ability to share information and otherwise work
with the Commission. However, going forward, the Commission and
relevant foreign supervisor(s) would need to establish supervisory MOUs
or other arrangements that provide for information sharing and
cooperation in the context of supervising swap dealers and MSPs. The
Commission contemplates that such a supervisory MOU would establish the
type of coordination activities that would continue on an ongoing basis
between the Commission and the foreign supervisor(s), including topics
such as procedures for confirming continuing oversight activities,
access to
[[Page 45345]]
information,\472\ on-site visits, and notification procedures in
certain situations.\473\
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\472\ As previously noted, the Commission observes that under
section 4s(j)(3) and (4) of the CEA and Commission regulation
23.606, a registered swap dealer or MSP must make all records
required to be maintained in accordance with Commission regulation
1.31 available to the Commission promptly upon request to
representatives of the Commission. The Commission reserves this
right to access records held by registered swap dealers and MSPs,
including those that are non-U.S. persons who may comply with the
Dodd-Frank recordkeeping requirement through substituted compliance.
See also 7 U.S.C. 6s(f); 17 CFR 23.203.
\473\ In this regard, the Commission has started working with
foreign regulators to prepare for such arrangements.
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The Commission expects that an applicant would notify the
Commission of any material changes to information submitted in support
of a comparability determination (including, but not limited to,
changes in the relevant supervisory or regulatory regime) as the
Commission's comparability determination may no longer be valid.
Within four years of issuing any Substituted Compliance
Determination, the Commission will reevaluate its initial determination
to ascertain whether any changes should be made to its finding and
shall reissue the relevant Commission action, conditionally or
unconditionally, as it deems appropriate.
SDR Reporting and real-time public reporting would generally be
eligible for substituted compliance, as outlined above, but only if the
Commission has direct access to all of the reported swap data elements
that are stored in a foreign trade repository. The Commission intends
that direct access would generally include, at a minimum, real time,
direct electronic access to the data and the absence of any legal
impediments to the Commission's access to the data. Due to the
technical nature of this inquiry, a comparability evaluation for SDR
Reporting and real-time public reporting would generally entail a
detailed comparison and technical analysis. The Commission notes that
while direct access to swap data is a threshold matter to be addressed
in a comparability evaluation, a more particularized analysis would
generally be necessary to determine whether the data stored in a
foreign trade repository provides for effective Commission use, in
furtherance of the regulatory purposes of the Dodd-Frank Act.
Comparability determinations for SDR Reporting and real-time public
reporting would generally take into account whether the Commission may
effectively access and use data stored in foreign trade repositories,
both in isolation and when compared to and aggregated with swap data
from other foreign trade repositories, as well as registered SDRs. At a
minimum, effective use would generally require that the data elements
stored in foreign trade repositories are sufficient to permit
comparison and aggregation, and that all transactions with comparable
required data elements, otherwise required to be reported to a
registered SDR, are available in the foreign trade repository.
5. Conflicts Arising Under Privacy and Blocking Laws
Potential and actual conflicts between the Commission's regulations
and the privacy and blocking laws of some non-U.S. jurisdictions may,
in certain circumstances, limit or prohibit the disclosure of data that
is required to be reported under the Dodd-Frank Act and implementing
regulations.\474\ For example, the Commission's part 45 and part 46
swap data reporting rules establish swap data recordkeeping and SDR
reporting requirements applicable to reporting counterparties. Among
other requirements, these rules prescribe certain reporting data fields
for all swaps subject to the Commission's jurisdiction, including the
identity of each counterparty to a swap. The privacy laws of some non-
U.S. jurisdictions may, however, restrict or prohibit the disclosure by
a reporting party or registrant of a non-reporting party's identity. In
some jurisdictions, this privacy restriction may be overcome if the
counterparty consents to the disclosure. In others, the restriction may
take the form of a blocking statute which acts as an absolute
prohibition to the disclosure of information, creating a direct
conflict with the requirements of the Dodd-Frank Act.
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\474\ Section 727 of the Dodd Frank Act added to the CEA new
section 2(a)(13)(G), which requires all swaps, whether cleared or
uncleared, to be reported to registered SDRs. Section 21 of the CEA,
added by section 728 of the Dodd Frank Act, directs the Commission
to prescribe standards that specify the data elements for each swap
that shall be collected and maintained by each registered SDR. Part
45 of the Commission's regulations establishes swap data
recordkeeping and SDR reporting requirements; part 46 establishes
similar requirements for pre-enactment and transition swaps
(collectively, ``historical swaps'').
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The Commission recognizes that, notwithstanding the importance of
swap data to its mandate under the Dodd-Frank Act, its regulations may
be in conflict with the blocking, privacy, and/or secrecy laws of other
jurisdictions. The Commission is mindful of the challenges presented by
such circumstances and continues to work on a bilateral and
multilateral basis with foreign regulators to address these issues.
Where appropriate, the Commission may consider reasonable alternatives
that allow the Commission to fulfill its mandate while respecting the
regulatory interests of other jurisdictions. In that regard, where a
real conflict of laws exists, the Commission strongly encourages
regulators and registrants to consult directly with its staff.
6. Clearing
a. Clearing Venues
With respect to acceptable clearing venues, the Commission notes
that section 2(h)(1) of the CEA provides that swaps subject to the
clearing requirement must be submitted for clearing to a registered DCO
or a DCO that is exempt from registration under the CEA.\475\
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\475\ As noted above, EMIR requires financial counterparties,
including hedge funds, to clear OTC derivatives contracts subject to
the clearing obligation through a CCP registered or recognized in
accordance with EMIR.
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The Commission has previously recognized the role of foreign-based
clearing organizations, including in the context of FBOTs.
Specifically, in the final rules pertaining to Registration of Foreign
Boards of Trade, the Commission required that an FBOT, in order to be
registered, clear through a clearing organization that either is
registered with the Commission as a DCO or observes the Principles for
Financial Market Infrastructures (``PFMIs'').\476\ Other relevant
requirements in the FBOT final rules include, among other things, that
the clearing organization be in good regulatory standing in its home
country.
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\476\ Registration of Foreign Boards of Trade, 76 FR 80674,
80681-80682 (Dec. 23, 2011) (the PFMIs are the successor standards
to the Recommendations for Central Counterparties (``RCCPs''), which
were issued jointly by the Committee on Payment and Settlement
Systems (``CPSS'') and the Technical Committee of IOSCO).
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In addition, in the final rules adopting the Inter-Affiliate
Exemption, the Commission permitted eligible affiliated counterparties
that are located in certain jurisdictions to satisfy a condition to
electing the exemption (requiring counterparties to clear their swaps
with third-parties) by clearing the swap through a registered DCO or a
clearing organization that is subject to supervision by appropriate
government authorities in the clearing organization's home country and
that has been assessed to be in compliance with the PFMIs.\477\
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\477\ Inter-Affiliate Exemption, 78 FR at 21784 (adopting 17 CFR
50.52(b)(4)(i)(E)).
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[[Page 45346]]
More recently, in the final rulemaking adopting Core Principles and
Other Requirements for Swap Execution Facilities, the Commission noted
that under section 5b(h) of the CEA it has discretionary authority to
exempt DCOs, conditionally or unconditionally, from the applicable DCO
registration requirements.\478\ Thus, the Commission has discretion to
exempt from registration DCOs that, at a minimum, are subject to
comparable and comprehensive supervision by another regulator. The
Commission further noted that it had not yet exercised its
discretionary authority to exempt DCOs from registration. The
Commission explained that, notwithstanding that there were no exempt
DCOs at that time, certain swaps executed on a SEF could be cleared at
an exempt DCO, if and when the Commission determined to exercise its
authority to exempt DCOs from applicable registration requirements, at
which time the Commission would likely address, among other things, the
conditions and limitations applicable to clearing swaps for customers
subject to section 4d(f) of the CEA.\479\
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\478\ Specifically, section 5b(h) of the CEA provides that
``[t]he Commission may exempt, conditionally or unconditionally, a
derivatives clearing organization from registration under this
section for the clearing of swaps if the Commission determines that
the [DCO] is subject to comparable, comprehensive supervision and
regulation by the Securities and Exchange Commission or the
appropriate government authorities in the home country of the
organization.'' 7 U.S.C. 7a-1(h). See also Core Principles and Other
Requirements for Swap Execution Facilities, 78 FR 33476, 33591 (Jun.
4, 2013) (adopting 17 CFR 37.701) (``Part 37 SEF Regulations'').
\479\ Id. at 33534.
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The conditions that may have to be met for a clearing organization
to be eligible to qualify as an exempt DCO could include, among other
things: (i) The Commission having entered into an appropriate
memorandum of understanding or similar arrangement with the relevant
foreign supervisor in the clearing organization's home country and (ii)
the clearing organization having been assessed to be in compliance with
the PFMIs.\480\ The use of the PFMIs, an international standard that is
substantially similar to the requirements for registered DCOs under
part 39 of the Commission's regulations, would be consistent with the
Commission's determination in the context of FBOTs.\481\
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\480\ The PFMIs were developed with significant input and public
comment from market participants, and benefited from broad
participation of market regulators and prudential supervisors from
multiple nations. The PFMIs were approved by both IOSCO's Technical
Committee and the CPSS and published in April 2012.
\481\ The Commission recognizes that certain DCOs registered
with the Commission also may be authorized, licensed, or recognized
by a foreign authority. The Commission continues to work on a
bilateral basis with such non-US authorities with respect to issues
of central counterparty supervision. The Commission also
participates in multilateral discussions with its foreign
counterparts through a number of international groups.
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The Commission notes that its exemptive authority under CEA section
5b(h) is entirely discretionary. Accordingly, the Commission is not
compelled to exempt any clearing organization from the DCO registration
requirements, even upon a finding that a facility is ``subject to
comparable, comprehensive supervision and regulation'' by another
regulator.
b. Foreign End-Users
One of the conditions of the Inter-Affiliate Exemption, known as
the ``treatment of outward-facing swaps'' condition, generally requires
the clearing of swaps between affiliated counterparties and their
unaffiliated counterparties.\482\ Pursuant to Commission regulation
50.52(b)(4)(i)(C), eligible affiliate counterparties \483\ can satisfy
the treatment of outward-facing swaps condition by complying with the
requirements of an exception or exemption under section 2(h)(7) of the
CEA or part 50 of the Commission's regulations. Pursuant to section
2(h)(7) of the CEA, also known as the end-user exception, a
counterparty to a swap that is subject to the clearing requirement
\484\ may elect not to clear the swap provided that such counterparty
meets the conditions of section 2(h)(7)(A)(i)-(iii) of the CEA and the
attendant regulations.\485\
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\482\ See Clearing Exemption for Swaps Between Certain
Affiliated Entities, 78 FR 21749; Commission regulation
50.52(b)(4)(i).
\483\ As such term is defined in Commission regulation 50.52(a).
\484\ See Clearing Requirement Determination, 77 FR 74284.
\485\ See End-User Exception to the Clearing Requirement for
Swaps, 77 FR 42560.
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For the purposes of the Inter-Affiliate Exemption, consistent with
section 2(i), the Commission will permit a non-U.S. person eligible
affiliate counterparty to satisfy Commission regulation
50.52(b)(4)(i)(C) for swaps entered into with an unaffiliated non-US
person that is not otherwise subject to the CEA (``Foreign End-User''),
under certain circumstances. The Foreign End-User may elect the end-
user exception as if the provisions of sections 2(h)(7)(A)(i) and (ii)
of the CEA apply to the Foreign End-User and the Foreign End-User
elects not to clear the swap.\486\
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\486\ If the Foreign End-User is an issuer of securities under,
or required to file reports pursuant to, the Securities Exchange Act
of 1934 (``SEC Filer''), then the Foreign End-User must obtain the
approval to enter into uncleared swaps from an appropriate committee
of the SEC Filer's board of directors (or governing body). See
section 2(j) of the CEA. The Commission considers a counterparty
controlled by an SEC Filer to be an SEC Filer itself for the
purposes of the end-user exception. See 77 FR 42570.
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Accordingly, a Foreign End-User may elect not to clear a swap if
(1) the Foreign End-User and non-US person eligible affiliate
counterparty are not located in a foreign jurisdiction in which the
Commission has determined that a comparable and comprehensive clearing
requirement exists and that the exceptions and/or exemptions thereto
are comparable and comprehensive; \487\ (2) the Foreign End-User is not
a financial entity as provided in section 2(h)(7)(A)(i) of the CEA; and
(3) the Foreign End-User enters into the swap to hedge or mitigate
commercial risk as provided in section 2(h)(7)(A)(ii) of the CEA.\488\
In the interests of international comity, the Commission will not
require the Foreign End-User to satisfy the provisions of section
2(h)(7)(A)(iii) of the CEA which require the end-user to notify the
Commission how it generally meets its financial obligations associated
with entering into non-cleared swaps.\489\
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\487\ In these situations, the counterparties should comply with
laws of the foreign jurisdiction. See Commission regulations
50.52(b)(4)(i)(B) and (D).
\488\ Foreign End-Users may look to Commission regulation
50.50(c) in order to determine whether a swap hedges or mitigates
commercial risk.
\489\ This guidance is only applicable to Commission regulation
50.52(b)(4)(i)(C); all other persons electing the End-User Exception
must comply with the requirements of section 2(h)(7) of the CEA and
Commission regulation 50.50.
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G. Application of the Entity-Level and Transaction-Level Requirements
to Swap Dealers and MSPs
This section sets forth the Commission's policy on application of
the Entity-Level and Transaction-Level Requirements to swap dealers and
MSPs, including when swaps generally would be eligible for substituted
compliance.
1. Comments
As noted in section E above, commenters generally supported the
division of Dodd-Frank's swaps provisions (and Commission regulations
thereunder) into Entity-Level and Transaction-Level Requirements for
purposes of this Guidance. Certain of these commenters, however, made
specific recommendations for
[[Page 45347]]
reclassification of some of these requirements.\490\
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\490\ See section E, supra.
---------------------------------------------------------------------------
In addition, some commenters addressed perceived disparities in the
application of Transaction-Level Requirements to U.S. swap dealers,
stating that transactions between U.S. swap dealers and non-U.S.
counterparties should be eligible for substituted compliance for
Transaction-Level Requirements so as to avoid putting U.S. swap dealers
at a competitive disadvantage.\491\
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\491\ See SIFMA (Aug. 27, 2012) at A36. See also State Street
(Aug. 27, 2012) at 2; IIB (Aug. 27, 2012) at 27-28; The Clearing
House (Aug. 27, 2012) at 4, 27.
---------------------------------------------------------------------------
Other commenters supported the Commission's proposed application of
the Transaction-Level Requirements to the transactions of U.S. persons
with non-U.S. persons.\492\ One commenter stated that the Transaction-
Level Requirements should apply to transactions by registered swap
dealers and MSPs with U.S. persons.\493\
---------------------------------------------------------------------------
\492\ See Public Citizen (Aug. 27, 2012) at 13 (arguing that
substituted compliance should not be permitted when the swap
involves a U.S. counterparty and that Transaction-Level Requirements
should be required for counterparties that are non-U.S. persons).
See also IATP (Aug. 27, 2012) at 7-8 (recommending that Transaction-
Level Requirements apply to transactions between non-U.S. swap
dealers or MSPs and a U.S. person who is not a swap dealer or MSP).
\493\ See IIAC (Aug. 27, 2012) at 8.
---------------------------------------------------------------------------
Several commenters objected to the applicability of certain
Transaction-Level Requirements to transactions between two non-U.S.
parties.\494\ One commenter stated that Transaction-Level Requirements
should never apply to swaps between counterparties that are both non-
U.S. persons.\495\
---------------------------------------------------------------------------
\494\ See, e.g., Clearing House (Aug. 27, 2012) at 22-24
(arguing that pre- and post-trade transparency rules should not
apply to interactions with non-U.S. customers); SIFMA (Aug. 27,
2012) at A37 (stating that real-time public reporting requirements
would be inappropriate for swaps involving only non-U.S.
counterparties).
\495\ See Australian Bankers (Aug. 27, 2012) at 5, A8.
---------------------------------------------------------------------------
With respect to external business conduct standards, one commenter
stated that these standards should not apply to swaps between U.S. swap
entities and non-U.S. persons because the Commission's supervisory
interest in these transactions are less implicated when the
counterparty is a non-U.S. person.\496\ Other commenters also stated
that the external business conduct standards should not apply to
transactions between two non-U.S. persons.\497\
---------------------------------------------------------------------------
\496\ See SIFMA (Aug. 27, 2012) at A38.
\497\ See Australian Bankers (Aug. 27, 2012) at 4, A10. See also
IIAC (Aug. 27, 2012) at 8 (agreeing that external business conduct
standards should not apply to swaps between non-U.S. swap dealers
and MSPs and non-U.S. counterparties (whether or not guaranteed by a
U.S. person)).
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2. Commission Guidance
The Commission has carefully considered the comments on Entity-
Level and Transaction-Level Requirements. With regard to U.S. swap
dealers and U.S. MSPs, the Commission's policy is that they generally
would be expected to comply in full with all of the Entity-Level
Requirements and Transaction-Level Requirements, without substituted
compliance available. The Commission's policy would apply regardless of
whether the counterparty to the swap is a U.S. person or non-U.S.
person. This is consistent with the Commission's traditional approach
to registered FCMs, wherein a person, once registered as an FCM, is
subject to the full panoply of regulations applicable to such
registrants, without distinctions based on whether the counterparties
are U.S. or non-U.S. counterparties.
Further, the Commission believes that its cross-border policy and
interpretation with respect to U.S. swap dealers and MSPs must be
informed by the purposes of the Dodd-Frank Act. As discussed earlier,
the Dodd-Frank Act was enacted to reduce systemic risk, increase
transparency, and promote market integrity within the financial system
by, among other things, providing for the comprehensive regulation of
swap dealers and MSPs. In doing so, Congress understood the highly
integrated nature of the global swaps business, with regard to both
individual firms and the market at large, and that risk to U.S. firms
and in turn, U.S. financial markets may arise anywhere in the world.
In view of the policy goals underlying the Dodd-Frank Act swaps
reforms, the Commission's view is that U.S. swap dealers and MSPs
should be fully subject to the robust oversight contemplated by the
Dodd-Frank Act, without regard to whether their counterparty is a U.S.
or non-U.S person. These firms are conducting their swap dealing
business within the territory of the United States. That some of their
business may be directed to foreign clients does not diminish the
Commission's obligation to ensure that swaps between U.S. swap dealers
and MSPs and their counterparties are subject to Dodd-Frank's financial
safeguards and transparency requirements, to the fullest extent.
Therefore, in the Commission's view, substituted compliance is
incompatible with the Commission's ability to effectively discharge its
statutory responsibilities.
For substantially the same reasons, the Commission believes that
full U.S. regulation of U.S. swap dealers and MSPs, even when they
transact swaps with non-U.S. counterparties, is a reasonable exercise
of U.S. jurisdiction under the principles of foreign relations law.
Among the factors supporting this exercise of U.S. jurisdiction are the
links between the U.S. swap dealers and MSPs and their swap activities
to U.S. commerce, and the generally accepted importance of regulating
the activities of these entities both to the United States and the
international financial system.\498\ In addition, having an agency of
the U.S. government serve as the primary regulator of U.S. entities is
generally consistent with normal expectations and with traditions of
the international system.\499\ To the extent that other countries have
an interest in regulating transactions with their nationals, the
Commission notes that the U.S. regulatory scheme for swap dealers and
MSPs does not preclude other countries from imposing their regulations
if they consider it necessary for transactions affecting their
interests.\500\ As discussed below, the Commission will work with other
regulators to avoid, and resolve where necessary, direct conflicts, as
well as to reduce unnecessary burdens. The Commission observes that
very few conflicts between the foreign regimes and Dodd-Frank Act
requirements have been identified as part of many multilateral and
bilateral consultations between staff of the CFTC and their foreign
counterparts. For these purposes, conflict means that actions required
for compliance under one jurisdiction's law are prohibited under the
other jurisdiction's law, or compliance with the regulations of both
jurisdictions is otherwise impossible.
---------------------------------------------------------------------------
\498\ See Restatement secs. 403(2)(a)-(c), 403(2)(e).
\499\ See Restatement secs. 403(2)(d), 403(2)(f).
\500\ See Restatement sec. 403(2)(g).
---------------------------------------------------------------------------
With regard to non-U.S. swap dealers or MSPs (including those that
are affiliates of a U.S. person), the Commission's policy is that these
firms should be subject to all of the Entity-Level Requirements, but
under certain circumstances substituted compliance should be available
(except with regard to Large Trader Reporting). The Commission's policy
with regard to the application of Transaction-Level Requirements to
non-U.S. swap dealers or MSPs, and the availability of substituted
compliance, depends in part on the type of counterparty to the swap
transaction.
The foreign branch of a U.S. bank that is a swap dealer or MSP is
expected to
[[Page 45348]]
comply in full with the Entity-Level Requirements, without substituted
compliance available, because it is not a separate legal entity.\501\
In some circumstances the Commission's policy is that a foreign branch
of a U.S. swap dealer or MSP would be expected to comply in full with
Category A Transaction-Level Requirements where its counterparty is a
U.S. person. However, as further explained below, substituted
compliance would generally be available to a foreign branch of a U.S.
bank with regard to Category A Transaction-Level Requirements where the
counterparty to a swap transaction is a non-U.S. person or a foreign
branch of a U.S. bank that is a swap dealer or MSP. In addition, the
Commission's policy with regard to the application of the Category B
Transaction-Level Requirements is explained below.
---------------------------------------------------------------------------
\501\ The types of offices the Commission would consider to be a
``foreign branch'' of a U.S. bank, and the circumstances in which a
swap is with such foreign branch, are discussed further in section
C, supra.
---------------------------------------------------------------------------
Below, the Commission describes its policies regarding how Entity-
Level and Transaction-Level Requirements should apply to both U.S. and
non-U.S. swap dealers and MSPs, and to foreign branches of a U.S. banks
that are swap dealers and MSPs, as well as the circumstances under
which substituted compliance would be available.
3. Application of the Entity-Level Requirements to Swap Dealers and
MSPs
In this section, the Commission discusses its policy regarding the
application of the Entity-Level Requirements to swap dealers and MSPs
in cross-border transactions under its interpretation of 2(i), as well
as the circumstances under which such swaps would be eligible for
substituted compliance.
Section a discusses the Commission's view on the application of
Entity-Level Requirements to swaps with U.S. swap dealers and U.S.
MSPs, including subsidiaries and affiliates of non-U.S. persons, and
foreign branches of U.S. swap dealers or U.S. MSPs, under CEA section
2(i).
Section b discusses the Commission's view on the application of
Entity-Level Requirements to swaps with non-U.S. swaps dealers and
MSPs, including subsidiaries and affiliates of U.S. persons.
The Commission's policy on application of the Entity-Level
Requirements to swap dealers and MSPs, as well as substituted
compliance, is discussed below and summarized in Appendix C to this
Guidance, which should be read in conjunction with the rest of the
Guidance.
a. To U.S. Swap Dealers and MSPs
As explained above, U.S. swap dealers and U.S. MSPs generally would
be expected to comply in full with all of the Entity-Level
Requirements, without substituted compliance available. The
Commission's policy generally would apply regardless of whether the
counterparty to the swap is a U.S. person or non-U.S. person.
Because under this Guidance the term ``U.S. person'' includes
corporations, partnerships, limited liability companies, and other
legal entities (as discussed above), the foregoing interpretation also
applies to affiliates of non-U.S. persons that are U.S. swap dealers or
U.S. MSPs. It also applies to U.S. banks that are swap dealers or MSPs
when the swap is with their foreign branch. In this case, because a
foreign branch of a U.S. bank is an integral part of the U.S. principal
entity and has no separate legal existence, and the U.S. principal bank
is the entity that registers as a swap dealer or MSP, under the
Commission's interpretation of CEA section 2(i), the U.S. bank
(principal entity) would be the party ultimately responsible for
compliance with the Entity-Level Requirements for the entire legal
entity.
b. To Non-U.S. Swap Dealers and MSPs
Consistent with CEA section 2(i), the Commission would expect non-
U.S. swap dealers and non-U.S. MSPs to comply with all of the Entity-
Level Requirements. This policy also applies to foreign affiliates of a
U.S. person that are independently required to register as swap dealers
or MSPs and to comply with applicable Dodd-Frank Act requirements.
However, in considering whether substituted compliance is available
to a non-U.S. swap dealer or MSP with respect to particular Entity-
Level Requirements, the Commission would consider it relevant whether
the Entity-Level Requirement is classified in the First Category or
Second Category (and with respect to the Second Category, whether the
counterparty is a U.S. person).
The Commission recognizes that non-U.S swap dealers or MSPs are
likely to have their principal swap business in their home
jurisdiction, and in consideration of international comity principles,
is interpreting CEA section 2(i) such that such non-U.S swap dealers or
MSPs generally would be eligible for substituted compliance with regard
to Entity-Level Requirements in the First Category (i.e., capital
adequacy, chief compliance officer, risk management, and swap data
recordkeeping, except certain aspects of swap data recordkeeping
relating to complaints and marketing and sales materials \502\).\503\
---------------------------------------------------------------------------
\502\ See 17 CFR 23.201(b)(3), (4).
\503\ As noted in the Proposed Guidance, the Commission
anticipates that non-U.S. swap dealers and non-U.S. MSPs will likely
have their principal swap business in their home jurisdiction. In
these circumstances, the Commission notes that the home regulator
would have a primary relationship to the swap dealer or MSP, which,
coupled with the firm-wide focus of the Entity-Level Requirements,
supports generally making the non-U.S. registrant eligible for
substituted compliance. Therefore, consistent with the Proposed
Guidance, the Commission believes that it is appropriate to make
non-U.S. swap dealers and MSPs eligible for substituted compliance
with respect to Entity-Level Requirements in the First Category
where the non-U.S. swap dealers or non-U.S. MSPs are subject to
comparable regulation in their home jurisdiction.
---------------------------------------------------------------------------
With respect to Entity-Level Requirements in the First Category, as
noted by commenters on the Proposed Guidance, an affiliate of a U.S.
swap dealer that is guaranteed by such U.S. swap dealer (or guaranteed
by a U.S.-based parent or other affiliate of such swap dealer) may
under certain circumstances be required to register as a swap dealer
based on its swap dealing activity solely with non-U.S. persons,
including those non-U.S. persons that are neither guaranteed affiliates
or affiliate conduits of U.S. persons. Commenters have represented that
some corporate groups may be required to register many of these
guaranteed affiliates as swap dealers, even though such affiliates
provide swap dealing services only to non-U.S. markets, and that many
of such guaranteed affiliates exist only because the law of the local
jurisdiction requires that a subsidiary be incorporated in the
jurisdiction in order to enter into swaps with counterparties located
in such jurisdiction. The Commission recognizes that certain structural
conditions required to comply with the regulatory obligations of swap
dealers may be burdensome for a corporate group with many of these
guaranteed affiliates due to the requirement that such obligations be
complied with at the individual entity level (e.g., Commission
regulations Sec. Sec. 3.3 (Chief compliance officer), 23.600 (Risk
Management Program for swap dealers and major swap participants),
23.601 (Monitoring of position limits), 23.602 (Diligent supervision),
23.603 (Business continuity and disaster recovery), and 23.606 (General
information: Availability for disclosure and inspection)).
[[Page 45349]]
Specifically, the Commission notes that Commission regulations
Sec. Sec. 3.3 (Chief compliance officer), 23.600 (Risk Management
Program for swap dealers and major swap participants), 23.601
(Monitoring of position limits), 23.602 (Diligent supervision), 23.603
(Business continuity and disaster recovery), and 23.606 (General
information: Availability for disclosure and inspection) mandate that
each swap dealer in a corporate group under common control individually
establish policies, procedures, governance structures, reporting lines,
operational units, and systems specified in the rules. Thus, the
Commission would consider relief, subject to appropriate conditions and
restrictions to be determined, that would permit guaranteed affiliates
in a corporate group under common control that do not enter into swaps
with U.S. persons to comply with such regulations by establishing
consolidated policies, procedures, governance structures, reporting
lines, operational units, and systems, thereby increasing operational
efficiencies and lessening the economic burden on these groups with
respect to their guaranteed affiliates that do not directly face U.S.
persons when engaging in swaps activities.\504\ The Commission notes,
however, that any such relief would require a consolidated program to
manage the risks of the included guaranteed affiliates on an
individual, rather than a net, basis.
---------------------------------------------------------------------------
\504\ ``Swaps activities'' are defined in Commission regulation
23.600(a)(7).
---------------------------------------------------------------------------
The Commission encourages interested parties to contact the
Director of the Division of Swap Dealer and Intermediary Oversight to
discuss the necessary conditions and restrictions of appropriate
relief.
The Commission clarifies that, in the interest of international
comity and for the purpose of permitting efficiencies in compliance
programs, it would remain open to considering (or directing its staff
to consider) relief, subject to appropriate conditions and restrictions
to be determined, that would permit guaranteed affiliates in a
corporate group under common control (that do not enter into swaps with
U.S. persons or U.S. guaranteed affiliates or affiliate conduits of
U.S. persons) to comply with certain of such regulations on a
consolidated or group basis. The Commission notes, however, that any
such relief would require a consolidated program to manage the risks of
the included guaranteed affiliates on an individual, rather than a net,
basis.
With respect to one of the Entity-Level Requirements in the Second
Category, SDR Reporting (i.e., SDR Reporting and swap data
recordkeeping related to complaints and marketing and sales
materials),\505\ the Commission interprets CEA section 2(i) such that
swap dealers or MSPs that are not U.S. persons generally would be
eligible for substituted compliance only with respect to swaps where
the counterparty is a non-U.S. person that is not a guaranteed or
conduit affiliate.
---------------------------------------------------------------------------
\505\ See 17 CFR 23.201(b)(3), (4).
---------------------------------------------------------------------------
With respect to the other Entity-Level Requirement in the Second
Category (i.e., swap data recordkeeping related to complaints and
marketing and sales materials),\506\ the Commission interprets CEA
section 2(i) such that swap dealers or MSPs that are not U.S. persons
generally would be eligible for substituted compliance only with
respect to swaps where the counterparty is a non-U.S. person. However,
as explained below, with respect to Large Trader Reporting, the
Commission's policy would not recognize substituted compliance in place
of compliance with Large Trader Reporting.
---------------------------------------------------------------------------
\506\ See id.
---------------------------------------------------------------------------
Specifically, with respect to SDR Reporting, the Commission
interprets CEA section 2(i) such that substituted compliance may be
available to non-U.S. swap dealers and non-U.S. MSPs (whether or not
such swap dealers or MSPs are affiliates of or are guaranteed by U.S.
persons) for swaps with non-U.S. counterparties, provided that the
Commission has direct access (including electronic access) to the
relevant swap data that is stored at the foreign trade repository. The
Commission believes that this ensures that the Commission will have
access to information that is critical to its oversight of these
entities even where substituted compliance with regard to SDR Reporting
would be applicable under this Guidance.\507\ However, the Commission
interprets section 2(i) as applied to these requirements such that
substituted compliance generally would not be available for non-U.S.
swap dealers and non-U.S. MSPs (whether or not such swap dealers or
MSPs are guaranteed by U.S. persons) with respect to swaps with U.S.
counterparties. The Commission believes that in general, application of
these requirements, without eligibility for substituted compliance, is
appropriate given its strong supervisory interest in a swap between a
registered swap dealer or MSP and a U.S. counterparty.
---------------------------------------------------------------------------
\507\ As the Commission noted in the Proposed Guidance, data
reported to SDRs is critical to ensure that the Commission has a
comprehensive and accurate picture of swap dealers and MSPs that are
its registrants, including the gross and net counterparty exposures
of swaps of all swap dealers and MSPs, to the greatest extent
possible. Therefore, the Commission's view is that non-U.S. swap
dealers and non-U.S. MSPs generally should be expected to report all
of their swaps to a registered SDR. At the same time, the Commission
recognized the interests of foreign jurisdictions with respect to
swaps between a non-U.S. swap dealer or non-U.S. MSP with a non-U.S.
counterparty. Therefore, the Commission would interpret section 2(i)
so that swaps between non-U.S. swap dealers or MSPs with non-U.S.
counterparties generally are eligible for substituted compliance
with regard to SDR Reporting, but only if the Commission has direct
access to all of the reported swap data elements that are stored at
a foreign trade repository.
---------------------------------------------------------------------------
However, with regard to the SDR reporting requirements, for the
future, the Commission has agreed to continue to work collaboratively
and to consider any unforeseen implementation effects that might arise
in the application of our respective rules. The Commission will
continue discussions with other international partners with a view to
establishing a more generalized system that would allow, on the basis
of these countries' implementation of the G-20 commitments, an
extension of the treatment the EU and the CFTC will grant to each
other.
With regard to certain aspects of swap data recordkeeping that
relate to complaints and marketing and sales materials, the Commission
interprets CEA section 2(i) such that non-U.S. swap dealers or non-U.S.
MSPs generally would be eligible for substituted compliance with
respect to swaps with non-U.S. counterparties.\508\
---------------------------------------------------------------------------
\508\ In the Proposed Guidance, the Commission included all of
the swap data recordkeeping requirements of regulations 23.201 and
23.203 in the proposed first subcategory of Entity-Level
Requirements. 77 FR at 41225. In this Guidance, swap data
recordkeeping related to complaints and marketing and sales
materials under regulations 23.201(b)(3) and 23.201(b)(4),
respectively, are being moved from the First Category to the Second
Category because the Commission does not believe that substituted
compliance generally should be available for requirements relating
to complaints and marketing and sales materials where the
counterparty is a U.S. person. This policy pertains equally to swaps
with foreign affiliates of a U.S. person that are required to
independently register as swap dealers and to comply with applicable
Entity-Level Requirements.
---------------------------------------------------------------------------
To the extent that swap data reported to a foreign trade repository
would include data regarding the physical commodity swaps covered by
Large Trader Reporting, the Commission--even if provided with direct
access to such data--would still likely be required to convert it to
``futures equivalent'' positional data in order to render it comparable
to the data obtained through Large Trader Reporting, which contemplates
conversion by the entity required to
[[Page 45350]]
report data to the Commission.\509\ Given that Large Trader Reporting
is intended to enable the Commission, in a prompt and efficient manner,
to identify significant traders in the covered physical commodity swaps
and to collect data on their trading activity in order to reconstruct
market events, the time and resources expended by the Commission in
conversion could significantly impede its market surveillance efforts.
---------------------------------------------------------------------------
\509\ Large Trader Reporting provides the Commission with data
regarding large positions in swaps that are linked, directly or
indirectly, to a discrete list of U.S.-listed physical commodity
futures contracts, in order to enable the Commission to implement
and conduct effective surveillance of these economically equivalent
swaps and futures. To facilitate surveillance efforts and the
monitoring of trading across the swaps and futures markets, swaps
positions must be converted to equivalent positions of the related
U.S. futures contract (``futures equivalents'') for reporting
purposes; reportable thresholds are also defined in terms of
``futures equivalents.''
---------------------------------------------------------------------------
The Commission notes further that its interpretation of CEA section
2(i) to permit substituted compliance with comparable and comprehensive
regimes in certain circumstances recognizes the interests of foreign
jurisdictions with respect to swaps between non-U.S. persons. Large
Trader Reporting, however, reflects a very specific interest of the
Commission in conducting effective surveillance of markets in swaps
that have been determined to be economically equivalent to certain
U.S.-listed physical commodity futures contracts. In light of this
specific Commission interest--which is reflected in the particularized
scope and methodology of Large Trader Reporting--and in light of the
anticipated impediments to obtaining directly comparable positional
data through any foreign swap data reporting regime, the Commission's
policy would not recognize substituted compliance in place of
compliance with Large Trader Reporting.
4. Application of the ``Category A'' Transaction-Level Requirements to
Swap Dealers and MSPs
This section discusses the Commission's guidance on the application
of the Category A Transaction Level Requirements to the parties to a
swap where one of the parties is a registered swap dealer or MSP,\510\
including when substituted compliance may be available to various types
of counterparties.
---------------------------------------------------------------------------
\510\ Some of the Transaction-Level and Entity-Level
Requirements also are applicable to market participants that are not
swap dealers or MSPs, which are referred to herein as non-
registrants. See section H, infra, for a discussion of the
Commission's interpretation of how these requirements would apply to
non-registrants under CEA section 2(i).
---------------------------------------------------------------------------
As noted above, the Category A Transaction Level Requirements
include: (1) Required clearing and swap processing; (2) margining and
segregation requirements for uncleared swaps; (3) trade execution; (4);
swap trading relationship documentation; (5) portfolio reconciliation
and compression; (6) real-time public reporting; (7) trade
confirmation; and (8) daily trading records.\511\
---------------------------------------------------------------------------
\511\ The categorization of Transaction-Level Requirements into
Categories A and B is discussed in section E, supra. See Appendix B
for a descriptive list of the Category A and Category B requirements
and Appendix D for a table summarizing the application of the
Category A Transaction-Level Requirements to Swap Dealers and MSPs.
---------------------------------------------------------------------------
The Commission's policy on application of the Category A
Transaction-Level Requirements is summarized in Appendix D to this
Guidance, which should be read in conjunction with the rest of the
Guidance.
a. Swaps With U.S. Swap Dealers and MSPs
As explained above, where one of the counterparties to a swap is a
U.S. swap dealer or U.S. MSP, under the Commission's interpretation of
CEA section 2(i), the Commission would generally expect the parties to
the swap to comply with Category A Transaction-Level Requirements with
respect to the transaction, without regard to whether the other
counterparty to the swap is a U.S. person or a non-U.S. person.
Because the Commission interprets section 2(i) so that the term
``U.S. person'' would include any legal entity organized or
incorporated under the laws of the United States or having its
principal place of business in the United States, this interpretation
also would apply where one of the parties to the swap is a U.S. swap
dealer or U.S. MSP that is an affiliate of a non-U.S. person.\512\ In
addition, because the Commission considers a foreign branch of a U.S.
person to be a part of the U.S. person, the foregoing interpretation
also applies to swaps with foreign branches of a U.S. bank that is a
swap dealer or MSP (although in some circumstances substituted
compliance may be available as explained below).
---------------------------------------------------------------------------
\512\ See the Proposed Guidance, 77 FR 1218.
---------------------------------------------------------------------------
Further, as explained above, with regard to substituted compliance,
where one of the counterparties to a swap is a U.S. swap dealer or U.S.
MSP (including those that are affiliates of a non-U.S. person), other
than a foreign branch of a U.S. bank that is a swap dealer or MSP, the
Commission's policy is that substituted compliance generally would not
be available for the Category A Transaction-Level Requirements, without
regard to whether the other counterparty is a U.S. person or a non-U.S.
person. The Commission has a strong supervisory interest in ensuring
that the Category A Transaction-Level Requirements apply to swaps with
a U.S. swap dealer or MSP.\513\
---------------------------------------------------------------------------
\513\ Consistent with the foregoing rationale, the Commission
takes the view that a U.S. branch of a non-U.S. swap dealer or MSP
would be subject to Transaction-Level requirements, without
substituted compliance available. As discussed above, a branch does
not have a separate legal identity apart from its principal entity.
Therefore, the Commission considers a U.S. branch of a non-U.S. swap
dealer or non-U.S. MSP to be a non-U.S. person (just as the
Commission considers a foreign branch of a U.S. person to be a U.S.
person). Nevertheless, the Commission also recognizes its strong
supervisory interest in regulating the dealing activities that occur
with the United States, irrespective of the counterparty (just as
the Commission allows for substituted compliance for foreign
branches in certain instances to take into account the strong
supervisory interest of local regulators).
---------------------------------------------------------------------------
Similarly, under the Commission's interpretation of 2(i), where a
swap is between a foreign branch of a U.S. bank that is a swap dealer
or MSP, on the one hand, and a U.S. person on the other, the
Commission's policy is that substituted compliance generally would not
be available with respect to the Category A Transaction-Level
Requirements. In this case, the Commission also has a strong
supervisory interest in ensuring that the Category A Transaction-Level
Requirements fully apply to the transaction because it views the swap
transaction as being between two U.S. persons. The Commission believes
that this approach is appropriate in light of the Commission's strong
supervisory interests in entities that are part or an extension of a
U.S. swap dealer or U.S. MSP.
However, where a swap is between two foreign branches of U.S. banks
that are both swap dealers or MSPs, the Commission believes that the
interests of foreign regulators in applying their transaction-level
requirements to a swap taking place in their jurisdiction, together
with the fact that foreign branches of U.S. swap dealers or U.S. MSPs
are subject generally to direct or indirect oversight by U.S.
regulators, weigh in favor of allowing substituted compliance with
comparable and comprehensive foreign regulatory requirements (to the
extent applicable).
In addition, where a swap is between the foreign branch of a U.S.
bank that is a swap dealer or MSP, on the one hand, and a non-U.S.
person on the other
[[Page 45351]]
(regardless of whether the non-U.S. person is a guaranteed or conduit
affiliate), as a policy matter, the Commission believes that
substituted compliance should be available (if otherwise applicable).
In this case, even though the Commission considers the foreign branch
of a U.S. person to be a U.S. person, the Commission believes that the
interests of foreign regulators in applying their transaction-level
requirements to a swap taking place in their jurisdiction, together
with the fact that foreign branches of U.S. swap dealers or U.S. MSPs
are subject generally to direct or indirect oversight by U.S.
regulators because they are part of a U.S. person, may weigh in favor
of allowing substituted compliance with comparable and comprehensive
foreign regulatory requirements (to the extent applicable) where the
counterparty to the foreign branch is a non-U.S. person.
In a modification to the Proposed Guidance, where a swap between
the foreign branch of a U.S. swap dealer or U.S. MSP and a non-U.S.
person (that is not a guaranteed or conduit affiliate) takes place in a
foreign jurisdiction other than Australia, Canada, the European Union,
Hong Kong, Japan, or Switzerland,\514\ the Commission's policy is to
interpret CEA section 2(i) so that counterparties may comply with the
transaction-level requirements applicable to entities domiciled or
doing business in the foreign jurisdiction where the foreign branch is
located, rather than the Transaction-Level Requirements that would
otherwise be applicable, if two elements are present. First, the
aggregate notional value (expressed in U.S. dollars and measured on a
quarterly basis) of the swaps of all U.S. swap dealer's foreign
branches in foreign jurisdictions other than Australia, Canada, the
European Union, Hong Kong, Japan, or Switzerland does not exceed five
percent of the aggregate notional value (expressed in U.S. dollars and
measured on a quarterly basis) of all of the swaps of the U.S. swap
dealer. Second, the U.S. person maintains records with supporting
information to verify that the first element is present, as well as to
identify, define, and address any significant risk that may arise from
the non-application of the Transaction-Level Requirements. The
Commission believes this policy is appropriate because U.S. swap
dealers' dealing activities through branches or agencies in
jurisdictions other than the six jurisdictions referenced above, though
not significant in many cases, may be nevertheless an integral element
of their global business. The Commission notes that this exception is
not available in the six jurisdictions referenced above because the
Commission has received, or expects to receive in the near term, a
request for substituted compliance determinations for transactions in
these jurisdictions.
---------------------------------------------------------------------------
\514\ Market participants or regulators in all of these
jurisdictions have submitted requests for Substituted Compliance
Determinations.
---------------------------------------------------------------------------
Although the foreign branch of a U.S. registrant would not register
separately as a swap dealer or MSP, the Commission interprets 2(i) in a
manner that would permit the U.S. registrant to task its foreign branch
to fulfill its regulatory obligations with respect to the Category A
Transaction-Level Requirements. The Commission would generally consider
compliance by the foreign branch to constitute compliance with these
Transaction-Level Requirements. However, under the Commission's
interpretation of 2(i), the U.S. person (principal entity) would remain
responsible for compliance with the Category A Transaction-Level
Requirements.
b. Swaps With Non-U.S. Swap Dealers and Non-U.S. MSPs
Under the Commission's interpretation of CEA section 2(i), where a
swap is between a non-U.S. swap dealer or non-U.S. MSP (including an
affiliate of a U.S. person), on the one hand, and a U.S. person (other
than a foreign branch of a U.S. swap dealer or MSP), on the other, the
Commission would generally expect the parties to comply with Category A
Transaction-Level Requirements with respect to the transaction.\515\
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\515\ Under the Commission's futures regulatory regime, any
person located outside the U.S. that seeks to serve as an
intermediary to U.S. persons trading on a U.S. designated contract
market or in foreign futures and option contracts is required to
register in the appropriate category and comply with related
regulations, absent the availability of an exemption from
registration (e.g., relief pursuant to Commission regulation 30.10
in the foreign futures and option context).'' See, e.g., Commission
regulation 30.4.
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The Commission notes, however, that where a swap is executed
anonymously between any non-U.S. person, whether a swap dealer or an
MSP, and a U.S. person (other than a foreign branch of a U.S. swap
dealer or MSP) on a registered DCM or SEF and cleared, the non-U.S.
person will generally be considered to have satisfied each of the eight
Category A Transaction-Level Requirements that apply to such a swap
transaction as a consequence of being so executed on a DCM or SEF.
Thus, neither the non-U.S. person (nor its U.S. person counterparty)
will need to take any further steps to comply with the Category A
Transaction-Level Requirements in connection with such a
transaction.\516\
---------------------------------------------------------------------------
\516\ However, non-U.S. swap dealers and MSPs must satisfy the
daily trading record requirement found in Commission regulation
23.202(a)(1).
---------------------------------------------------------------------------
In making this determination, the Commission observes that where a
cleared swap transaction is executed anonymously on a registered DCM or
SEF, certain independent requirements that apply to DCM and SEF
transactions generally, pursuant to the CEA or the Commission's
regulations, will ensure that four of the eight Category A Transaction-
Level Requirements will be met for such transactions--required clearing
and swap processing,\517\ trade execution,\518\ real-time public
reporting,\519\ and trade confirmation.\520\
---------------------------------------------------------------------------
\517\ Pursuant to Commission regulations 37.702 and 38.601, each
SEF and DCM must coordinate with each DCO to which it submits
transactions for clearing in the development of rules and procedures
to facilitate prompt and efficient transaction processing to meet
the requirements of Commission regulation 39.12(b)(7). Commission
regulation 39.12(b)(7)(ii) requires a DCO to accept or reject swaps
executed on a SEF or DCM for clearing ``as quickly after execution
as would be technologically practicable if fully automated systems
were used.'' See also 17 CFR 23.506(a); 39.12(b)(7)(iii); Final
Customer Documentation Rules, 77 FR at 21306-21310. As stated in the
Final Customer Documentation Rules, these rules, taken as a whole,
``require SEFs, DCMs, swap dealers, MSPs, and DCOs to coordinate in
order to facilitate real time acceptance or rejection of trades for
clearing.'' Id. at 21296.
\518\ CEA section 2(h)(8)(A) provides that transactions in swaps
subject to the trade execution mandate must be executed on a
registered DCM or SEF, or a SEF that has been exempted from
registration. The Commission clarifies that the trading mandate
under CEA section 2(h)(8)(A) is satisfied by trading on a registered
DCM or SEF or a SEF that has been exempted from registration.
\519\ Parties that execute a swap transaction on a DCM or SEF
meet their real-time public reporting obligations by operation of a
set of Commission regulations that essentially delegate the
obligations to the DCM or SEF on which the transaction was executed,
and the SDR to which the DCM or SEF reports the transaction.
Specifically, Commission regulation 43.3(a)(2) provides that a party
to a publicly reportable swap transaction satisfies its real-time
reporting obligations by executing a publicly reportable swap
transaction on or pursuant to the rules of a registered SEF or DCM.
In turn, Commission regulation 43.3(b)(1) requires a SEF or DCM to
transmit swap transaction and pricing data to a registered SDR, as
soon as technically practicable after the publicly reportable swap
transaction has been executed on or pursuant to the rules of such
trading platform or facility. Finally, Commission regulation
43.3(b)(2) requires a registered SDR to ensure that swap transaction
and pricing data is publicly disseminated, as soon as
technologically practicable after such data is received from a
registered SEF or DCM.
\520\ See Commission regulation 23.501(a)(4)(i) (``Any swap
transaction executed on a swap execution facility or designated
contract market shall be deemed to satisfy the requirements of this
section, provided that the rules of the swap execution facility or
designated contract market establish that confirmation of all terms
of the transactions shall take place at the same time as
execution''); 37.6(b); Part 37 SEF Regulations, 78 FR at 33585 (``A
swap execution facility shall provide each counterparty to a
transaction that is entered on or pursuant to the rules of the swap
execution facility with a written record of all of the terms of the
transaction which shall legally supersede any previous agreement and
serve as confirmation of the transaction. The confirmation of all
terms shall take place at the same time as execution . . . '').
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[[Page 45352]]
For a combination of reasons, the Commission also believes that the
four remaining Transaction-Level Requirements do not, or should not,
apply to cleared, anonymous DCM or SEF transactions. So, for instance,
the fact that the DCM or SEF swap transaction will be cleared, obviates
the need for margining or segregation requirements applicable to
uncleared swaps. Two other Category A Transaction-Level Requirements--
swap trading relationship documentation and portfolio reconciliation
and compression--would not apply because the Commission regulations
that establish those requirements make clear that they do not apply to
cleared DCM or SEF transaction.\521\ The last requirement--the daily
trading records requirement \522\--would only be applicable to the non-
U.S. swap dealer and only with regard to pre-trade execution swaps.
However, because the non-U.S. swap dealer will have no information
about its counterparty where the swap is executed anonymously, the
Commission is of the view that, as a matter of international comity,
CEA section 2(i) should not be interpreted to apply all of the daily
trading records requirements to such a swap.\523\
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\521\ See 17 CFR 23.504(a)(1) (``The requirements of this
section [swap trading relationship documentation] shall not apply to
. . . swaps executed on a board of trade designated as a contract
market under section 5 of the Act or to swaps executed anonymously
on a swap execution facility under section 5h of the Act, provided
that such swaps are cleared by a derivatives clearing organization .
. .''); 23.502(d) (``Nothing in this section [portfolio
reconciliation] shall apply to a swap that is cleared by a
derivatives clearing organization''); 23.503(c) (``Nothing in this
section [portfolio compression] shall apply to a swap that is
cleared by a derivatives clearing organization.'').
\522\ See 17 CFR 23.202.
\523\ The Commission is of the view that CEA section 2(i) should
not be interpreted to apply the daily trading records requirements,
with the exception of those found in Commission regulation
23.202(a)(1).
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In addition, the Commission is interpreting CEA section 2(i) such
that, where a swap between a non-U.S. person, regardless of its swap
dealer or MSP status, and a U.S. person is executed anonymously on an
FBOT registered with the Commission pursuant to part 48 and cleared the
non-U.S. person will generally be considered to have satisfied the
Category A Transaction-Level Requirements that pertain to such a swap
transaction. Some of the requirements will be satisfied by requirements
levied by regulation on the FBOT and some will be satisfied because a
registered FBOT is analogous to a DCM and is subject to comprehensive
supervision and regulation in its home country that is comparable to
that exercised over a DCM by the Commission. Thus, neither the non-U.S.
person (nor its U.S. person counterparty) will need to take any further
steps to satisfy the applicable Category A Transaction-Level
Requirements in connection with such a transaction.\524\
---------------------------------------------------------------------------
\524\ However, a non-U.S. swap dealer or non-U.S. MSP must
satisfy the daily trading record requirement found in Commission
regulation 23.202(a)(1).
---------------------------------------------------------------------------
In making this determination, the Commission observes that where a
cleared swap transaction is executed anonymously on a registered FBOT,
the FBOT, similar to a DCM, based on certain independent requirements
that apply to DCM transactions generally pursuant to the CEA or the
Commission's regulations, will ensure that two of the eight Category A
Transaction-Level Requirements will be satisfied for such transactions:
Required clearing and swap processing \525\ and trade execution.\526\
The Commission notes that while the real-time reporting requirement
will be satisfied for cleared swaps executed anonymously on a DCM by
operation of the Commission's real-time reporting regulations, absent
further affirmative actions by an FBOT, the real-time public reporting
requirements will not be satisfied through FBOT execution alone.\527\
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\525\ As discussed above, pursuant to Commission regulation
48.7(c)(1)(ii), all contracts, including swaps, made available in
the U.S. by a registered FBOT must be cleared. The clearing
organization must be either a DCO or must observe international
clearing standards: The RCCP or the successor standards, PFMI.
\526\ See discussion of clearing at section IV.F.6, supra. The
Commission clarifies that the trading mandate under CEA section
2(h)(8)(A) is satisfied by trading on a registered FBOT.
\527\ Pursuant to Commission regulation 48.8(a)(9), the
registered FBOT must ensure that all transaction data relating to
each swap transaction, including price and volume, are reported as
soon as technologically practicable after execution of the swap
transaction to a SDR that is either registered with the Commission
or has an information sharing arrangement with the Commission. While
Commission regulation 43(b)(2) requires that an SDR ensure that swap
transaction and pricing data is publicly disseminated as soon as
technologically practicable after such data is received from a
registered SEF, DCM or reporting party, it does not specifically
require public dissemination of swap transaction and pricing data
from the FBOT. Therefore, in order for the FBOT to ensure that the
real-time public reporting requirement is satisfied, the FBOT must
either report the data to the public itself or enter into an
arrangement with the SDR to which the data are reported pursuant to
which the SDR agrees to publicly disseminate the data as soon as
technologically practicable.
---------------------------------------------------------------------------
For a combination of reasons, including the fact that the swap will
be cleared, the Commission also is of the view that the remaining
Transaction-Level Requirements do not apply to such transactions
executed on a registered FBOT. For instance, the fact that the swap
will be cleared, as required by regulation 48.7(c)(1)(ii), renders
inapplicable the margining or segregation requirements for uncleared
swaps. As the Commission observed above with respect to swaps executed
anonymously on DCMs, certain of the other Category A Transaction-Level
Requirements would not apply to the swap. Consistent with this
determination, three of the other Category A Transaction-Level
Requirements--swap trading relationship documentation, portfolio
reconciliation and compression and trade confirmation--would not apply
to the swap executed on a registered FBOT because the underlying
Commission regulations themselves do not apply those requirements to
cleared DCM or SEF transactions. The last requirement--the daily
trading records requirement--would only be applicable to the non-U.S.
swap dealer and only with regard to pre-trade execution swaps. However,
because the non-U.S. swap dealer will have no information about its
counterparty where the swap is executed anonymously on a registered
FBOT, the Commission is of the view that, as a matter of international
comity, CEA section 2(i) should be interpreted such that certain of the
daily trading records requirements also would not apply to the
swap.\528\
---------------------------------------------------------------------------
\528\ The Commission is of the view that CEA section 2(i) should
not be interpreted to apply the daily trading records requirements,
with the exception of those found in Commission regulation
23.202(a)(1).
---------------------------------------------------------------------------
In addition, for the reasons discussed in the next two sections,
where a swap is between a non-U.S. swap dealer or non-U.S. MSP, on the
one hand, and a non-U.S. person that is a guaranteed or conduit
affiliate, on the other, under the Commission's interpretation of 2(i),
the Commission would generally expect the parties to comply with the
Category A Transaction-Level Requirements.\529\
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\529\ Where one of the parties to the swap is a conduit
affiliate, the Commission would generally expect the parties to the
swap only to comply with (to the extent that the Inter-Affiliate
Exemption is elected), the conditions of the Inter-Affiliate
Exemption, including the treatment of outward-facing swaps condition
in Commission regulation 50.52(b)(4)(i). In addition, the part 43
real-time reporting requirements must be satisfied.
---------------------------------------------------------------------------
However, where a swap is between a non-U.S. swap dealer or non-U.S.
MSP (including an affiliate of a U.S. person), on the one hand, and a
non-U.S. person
[[Page 45353]]
that is not a guaranteed or conduit affiliate, on the other, under the
Commission's interpretation of 2(i), the Commission would not expect
the parties to the swap to comply with the Category A Transaction-Level
Requirements.\530\ In this case, the Commission believes that generally
there may be a relatively greater supervisory interest on the part of
foreign regulators with respect to transactions between two
counterparties that are non-U.S. persons so that application of the
Category A Transaction-Level Requirements may not be warranted.\531\
---------------------------------------------------------------------------
\530\ Thus, for example, a swap between a registered non-U.S.
swap dealer and a German person would not be subject to Category A
Transaction-Level Requirements.
\531\ Where the counterparty to a non-U.S. swap dealer or non-
U.S. MSP is an international financial institution such as the World
Bank, the Commission also generally would not expect the parties to
the swap to comply with the Category A Transaction-Level
Requirements, even if the principal place of business of the
international financial institution were located in the United
States.
For this purpose, the Commission would consider the
international financial institutions to be the institutions listed
as such in the Final Entities Rules, 77 FR at 30692 n. 1180, which
include the International Monetary Fund, International Bank for
Reconstruction and Development, International Development
Association, International Finance Corporation, Multilateral
Investment Guarantee Agency, the Inter-American Development Bank,
and the Inter-American Investment Corporation. Even though some or
all of these international financial institutions may have their
principal place of business in the United States, the Commission
would generally not consider the application of the Category A
Transaction-Level Requirements to be warranted, for the reasons of
the traditions of the international system discussed in the Final
Entities Rules.
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With regard to substituted compliance, where a swap is between a
non-U.S. swap dealer or non-U.S. MSP (including an affiliate of a U.S.
person), on the one hand, and a U.S. person (other than a foreign
branch of a U.S. bank swap dealer or U.S. MSP), on the other, the
Commission's policy is that substituted compliance would generally not
be available for the Category A Transaction-Level Requirements. The
Commission believes that this approach is appropriate in this case
because the Commission has a strong interest in ensuring that the swap
fully complies with the Category A Transaction Level Requirements,
without substituted compliance. A number of related reasons support
this conclusion. As discussed above, a major purpose of Title VII is to
control the potential harm to U.S. markets that can arise from risks
that are magnified or transferred between parties via swaps. As also
discussed above, swaps between U.S. persons and non-U.S. persons
inherently raise the possibility of such risk magnification and
transfer. The Category A Transaction Level Requirements are designed to
constrain such risk magnification and transfer. The United States thus
has a strong interest in applying the Dodd-Frank Act requirements,
rather than substitute requirements adopted by non-U.S. authorities, to
swaps with U.S. persons. Exercise of U.S. jurisdiction with respect to
the Category A Transaction Level Requirements over swaps between U.S.
persons and non-U.S. persons is a reasonable exercise of jurisdiction
because of the strong U.S. interest in minimizing the potential risks
that may flow to the U.S. economy as a result of such swaps.\532\
---------------------------------------------------------------------------
\532\ See Restatement secs. 403(2)(a) (effect on territory of
regulating state), 403(2)(c) (importance of regulated activity to
the regulating state); 403 cmt. b (weight to be given to
reasonableness factors depends on circumstances).
---------------------------------------------------------------------------
Even though substituted compliance is not available with respect to
swaps between a non-U.S. swap dealer or non-U.S. MSP, on the one hand,
and a U.S. person (other than a foreign branch of a U.S. bank swap
dealer or U.S. MSP), on the other, a market participant would be deemed
in compliance with the relevant Dodd-Frank requirements where it
complies with requirements in its home jurisdiction that are
essentially identical to the Dodd-Frank requirements. Whether the home
jurisdiction's requirements are essentially identical to the corollary
Dodd-Frank requirements would be evaluated on a provision-by-provision
basis. The Commission intends that a finding of essentially identical
generally would be made through Commission action but in appropriate
cases could be made through staff no-action.
Based on the foregoing principles, the Commission staff issued a
no-action letter related to risk mitigation.\533\ The Commission staff
found that the Commission and the EU have essentially identical rules
in important areas of risk mitigation for the largest counterparty swap
market participants. Specifically, the Commission staff determined that
under the European Market Infrastructure Regulation (EMIR), the EU has
adopted risk mitigation rules that are essentially identical to certain
provisions of the Commission's business conduct standards for swap
dealers and major swap participants. In areas such as confirmation,
portfolio reconciliation, portfolio compression, valuation, and dispute
resolution, the Commission staff found that the respective regimes are
essentially identical. The Commission staff determined that where a
swap/OTC derivative is subject to concurrent jurisdiction under US and
EU risk mitigation rules, compliance under EMIR will achieve compliance
with the relevant Commission rules because they are essentially
identical.\534\
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\533\ See No-Action Relief for Registered Swap Dealers and Major
Swap Participants from Certain Requirements under Subpart I of Part
23 of Commission Regulations in Connection with Uncleared Swaps
Subject to Risk Mitigation Techniques under EMIR, CFTC Letter No.
13-45 (Jul. 11, 2013) (``Risk Mitigation Letter'').
\534\ The Risk Mitigation Letter provides an example of when
requirements in a foreign jurisdiction would be essentially
identical to Dodd-Frank requirements. See id.
---------------------------------------------------------------------------
However, where the swap is between a non-U.S. swap dealer or non-
U.S. MSP (including an affiliate of a U.S. person) and a foreign branch
of a U.S. bank that is a swap dealer or MSP, as a policy matter, the
Commission believes that substituted compliance should be available for
the Category A Transaction-Level Requirements, to the extent
applicable. Under substituted compliance, a counterparty can choose to
follow a foreign jurisdiction's rules even though those rules are not
essentially identical, provided that the regime is comparable and
comprehensive. The Commission believes that international comity
principles support taking this more flexible approach where the
transaction, although it involves a U.S. person, takes place in a
foreign jurisdiction.
In addition, where a swap is between a non-U.S. swap dealer or non-
U.S. MSP (including an affiliate of a U.S. person), on the one hand,
and a non-U.S. person that is a guaranteed or conduit affiliate, on the
other, substituted compliance may be available to satisfy the Category
A Transaction Level Requirements, to the extent applicable, as
discussed in the next two sections.
c. Swaps With a Non-U.S. Person Guaranteed by a U.S. Person
i. Proposed Guidance
In the Proposed Guidance, with respect to swaps between a non-U.S.
swap dealer or non-U.S. MSP, on the one hand, and a non-U.S.
counterparty on the other hand, the Commission proposed to interpret
CEA section 2(i) such that a non-U.S. swap dealer or non-U.S. MSP would
be expected to comply with the Category A Transaction-Level
Requirements for swaps where the non-U.S. counterparty's performance is
guaranteed, or otherwise supported by, a U.S. person.\535\ In
consideration of international comity principles, the Commission
further proposed to interpret CEA section 2(i) so as to
[[Page 45354]]
permit substituted compliance for these Transaction-Level Requirements.
---------------------------------------------------------------------------
\535\ See Proposed Guidance, 77 FR 41288.
---------------------------------------------------------------------------
The Commission explained that it proposed to interpret section 2(i)
in this manner because, where a non-U.S. counterparty's swaps
obligations are guaranteed by a U.S. person, the risk of non-
performance by the counterparty rests with the U.S. person that is the
guarantor of performance or payment. If the non-U.S. person defaults on
its obligations under the swaps, then the U.S. person guarantor will be
held responsible (or would bear the cost) to settle those obligations.
In circumstances in which a U.S. person ultimately bears the risk of
non-performance of a counterparty to a swap with a non-U.S. swap dealer
or non-U.S. MSP, the Commission noted its strong regulatory interest in
performance by both parties to the swap, and hence proposed to apply
these Transaction-Level Requirements.\536\
---------------------------------------------------------------------------
\536\ See id.
---------------------------------------------------------------------------
ii. Comments
Some commenters concurred in the Commission's emphasis on a
guarantee by a U.S. person as an interpretive guidepost. IATP, for
example, stated that ``the U.S. person's guarantee is a crucial
criterion for the Commission's determination of whether a non-U.S.
person would be subject to compliance with Dodd-Frank or whether
substituted compliance would be appropriate.'' \537\ Similarly, AFR, in
commenting on the Proposed Order, expressed concern about U.S. taxpayer
exposure to ``foreign affiliates of U.S. banks whose liabilities are
guaranteed (implicitly or explicitly) by the parent company.'' \538\
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\537\ See IATP (Aug. 27, 2012) at 3-4.
\538\ See AFR (Aug. 14, 2012) at 1-2.
---------------------------------------------------------------------------
Other commenters, by contrast, stated that: (1) The Transaction-
Level Requirements should never apply to swaps between counterparties
that are both non-U.S. persons; \539\ (2) the Commission should exclude
the swap dealing transactions of a non-U.S. person where the
counterparties to the swaps are, themselves, non-U.S. persons,
irrespective of whether such counterparties' obligations are guaranteed
by the U.S. person; \540\ and (3) section 2(i) does not provide a legal
basis for jurisdiction over a swap between non-U.S. persons based on a
guaranty by a U.S. person because guarantees ``do not alter the
location of activity.'' \541\ In a similar vein, IIB stated that the
Commission's proposed treatment of guarantees based on its concern that
the U.S. guarantor is exposed to risks incurred by one of its non-U.S.
affiliates, ``is unduly broad.'' \542\
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\539\ See Australian Bankers (Aug. 27, 2012) at A8.
\540\ See Sumitomo (Aug. 24, 2012) at 3. Sumitomo added that, at
a minimum, the Commission should exclude swaps obligations in excess
of a capped guaranty. Id.
\541\ See CEWG (Aug. 27, 2012) at 6-7.
\542\ See IIB (Aug. 27, 2012) at 14-15.
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IIB explained that guarantees are a very common way for U.S.
multinational corporations (both financial and non-financial) to
provide credit support for their non-U.S. subsidiaries. According to
IIB, parent credit support enables these subsidiaries to hedge their
risks cost-effectively in the markets in which they operate, thereby
reducing the cost of risk management and therefore the costs of
operations.\543\ Citi noted that ordinary course parent support
commitments, general payment guarantees and capital maintenance
commitments are often necessary to enter foreign banking markets. It
added that U.S. multinationals also guarantee obligations of local
subsidiaries so that their subsidiaries can effectively hedge risks in
local markets.\544\
---------------------------------------------------------------------------
\543\ Id. at 15-16.
\544\ See Citi (Aug. 27, 2012) at 4-9.
---------------------------------------------------------------------------
IIB argued that these arrangements ``are in stark contrast to
circumstances where an unregulated foreign `shell' affiliate is used
for purposes of entering into significant swap dealing activity outside
the scope of Dodd-Frank and systematically transferring the market and
credit risks arising from the activity to a U.S. affiliate.'' \545\
Accordingly, IIB maintained that application of Transaction-Level
Requirements where a non-U.S. counterparty to a non-U.S. swap dealer or
non-U.S. MSP is guaranteed by a U.S. person is unnecessary because the
Commission already has adopted an anti-evasion rule to address such
schemes.\546\
---------------------------------------------------------------------------
\545\ See IIB (Aug. 27, 2012) at 20.
\546\ Id. See also Sullivan & Cromwell (Aug. 13, 2012) at 7
(``the counterparty should be considered a non-U.S. person for
purposes of the regulatory requirements, provided that the
transactions are not being conducted by the non-U.S. persons as an
evasion''); The Clearing House (Aug. 27, 2012) at 17 (stating that
``[a]ny guaranteed entity of a U.S. Person should only include
`shell' entities that have transferred substantially all of their
market and credit risk to a U.S. Person (excluding non-financial
entities) or any entities created to evade U.S. swaps rules.'');
Citi (Aug. 27, 2012) at 4-9 (``. . . Title VII should not apply to
non-U.S. subsidiaries on the basis of guarantees . . . where such
subsidiaries are bona fide companies.'').
---------------------------------------------------------------------------
Commenters stated that in many instances, the Commission's concerns
about a guarantee by a U.S. person can be addressed as a safety and
soundness matter by the Federal Reserve Board when it supervises both
the guarantor and its subsidiaries; further, where the U.S. providing a
guarantee is itself a swap dealer or MSP, it also will be subject to
Title VII requirements.\547\ In a related vein, the Commission was
urged to adopt an exception from its proposed treatment of a non-U.S.
counterparty with a guarantee from a U.S. person if either: (1) The
counterparty is subject to U.S. capital requirements or comparable
foreign (i.e., Basel-compliant) capital requirements; or (2) the
guarantor is a U.S. bank holding company.\548\
---------------------------------------------------------------------------
\547\ See Sullivan & Cromwell (Aug. 13, 2012) at 15.
\548\ See IIB (Aug. 27, 2012) at 17-18.
---------------------------------------------------------------------------
IIB also stated that the Commission should tie the application of
Title VII requirements to the cross-border activities of U.S.-
guaranteed foreign subsidiaries to the significance of the risk to the
United States arising from the underlying guaranteed activity--that is,
where the existence of a guarantee gives rise to direct and significant
risks to the United States.\549\ Otherwise, IIB stated, ``the level of
risk to the United States is too contingent, remote or low to justify
application of U.S. regulation in the face of strong and more direct
non-U.S. regulatory interests.'' \550\ Under such an approach, IIB
stated, the Commission should adopt an exception from its proposed
treatment of a non-U.S. counterparty with a guarantee from a U.S.
person if the non-U.S. counterparty is not a financial entity and is
entering into the transaction for hedging or risk mitigation
purposes.\551\ More particularly, IIB posited, if the level of the non-
U.S. counterparty's swap activity is insubstantial in relation to its
net equity, or if the aggregate potential liability of the U.S.
guarantor with respect to the non-U.S. counterparty's swap activity is
insubstantial in relation to the net equity of the guarantor, then the
risk to the United States will not be significant and Transaction-Level
Requirements should not be applied.\552\
---------------------------------------------------------------------------
\549\ Id. at 15-16, 18-19.
\550\ Id. at 4.
\551\ Id. at 16-17.
\552\ Id. at 15-16.
---------------------------------------------------------------------------
Many of the comments on this topic stated that the Commission's
proposal in this regard would result in adverse competitive
consequences.\553\ Others,
[[Page 45355]]
though, objected that Transaction-Level Requirements should not apply
to entities guaranteed by U.S. persons because non-U.S. counterparties
will likely be unwilling to agree to the legal documents necessary to
comply with those requirements.\554\ And others stated that the
proposed interpretation will not achieve the objective of mitigating
counterparties' exposure to the credit risks of swap dealers because
the U.S. guarantor's exposure in this scenario is to the credit risk of
the guaranteed non-U.S. counterparty, not to the non-U.S. swap dealer
that is transacting with that guaranteed non-U.S. counterparty.\555\
---------------------------------------------------------------------------
\553\ See End Users Coalition (Aug. 27, 2012) at 3 (Commission's
proposal may disadvantage non-U.S. affiliates of U.S. end-users
whose non-U.S. counterparties may require guarantees to do
business); Citi (Aug. 27, 2012) at 4-9 (applying Transaction-Level
Rules in these circumstances would place U.S. multinationals at a
severe competitive disadvantage relative to foreign-based
corporations, as their subsidiaries abroad would have to either
forgo parent support or comply with different transaction-level
rules than those of the local market); IIB (Aug. 27, 2012) at 18
(non-U.S. persons that register as swap dealers due to their trading
with U.S. persons would be disadvantaged vis-[agrave]-vis non-U.S.
firms that do not have a U.S. swap dealing business because only the
former would be obligated to comply with the Transaction-Level
Requirements for swaps with U.S.-guaranteed counterparties);
Sullivan & Cromwell (Aug. 13, 2012) at 6 (Title VII should not apply
to the non-U.S. operations and activities of an entity simply
because it has a U.S. parent that provides a guarantee because this
would impose duplicative regulation and unnecessary costs on non-
U.S. operations that are already subject to local foreign rules and
regulations).
\554\ See Hong Kong Banks (Aug. 27, 2012) at 4-5.
\555\ See, e.g., ISDA (Aug. 10, 2012) at 10.
---------------------------------------------------------------------------
Citi commented that if Transaction-Level Requirements were to be
applied to swaps of non-U.S. persons whose obligations were guaranteed
by a U.S. person, then U.S.-based firms may be forced to remove parent
support from their overseas subsidiaries in order to remain
competitive. It argued that this would cause significant additional
capital, resources, and personnel to be moved abroad so that these non-
U.S. subsidiaries could manage swap risk on a stand-alone basis which,
it averred, would fragment and harm the safety and soundness of U.S.-
based firms, U.S. swaps markets, and the U.S. economy.\556\
Accordingly, it urged the Commission to further study the issue of
guarantees before finalizing its cross-border guidance.\557\
---------------------------------------------------------------------------
\556\ See Citi (Aug. 27, 2012) at 4-9.
\557\ Id. See also CEWG (Aug. 27, 2012) at 4-5 (recommending
that the Commission ``undertake a more thorough regulatory analysis
with respect to guarantees of swaps obligations'').
---------------------------------------------------------------------------
One commenter requested that the Commission clarify the scope of a
``guarantee'' that can trigger application of Transaction-Level
Requirements in these circumstances.\558\ Another objected to the scope
of the term ``guarantee'' if it were defined to include not only a
guarantee of payment or performance of swaps obligations, but also
other formal arrangements to support the ability of a person to perform
its obligations (such as liquidity puts and keepwell agreements).\559\
---------------------------------------------------------------------------
\558\ See Hong Kong Banks at 4-5.
\559\ See CEWG (Aug. 27, 2012) at 4-5.
---------------------------------------------------------------------------
iii. Commission Guidance
Under this Guidance, with respect to swaps between a non-U.S. swap
dealer or non-U.S. MSP (including an affiliate of a U.S. person) on the
one hand, and a non-U.S. counterparty on the other hand where the non-
U.S. counterparty's performance is guaranteed (or otherwise supported
by) a U.S. person, the Commission would generally expect the parties to
the swap to comply with all of the Category A Transaction-Level
Requirements. The Commission believes that this policy is warranted in
light of the significant regulatory interest in managing and reducing
the risks to U.S. firms, markets and commerce from such transactions.
Further, this policy is based on the Commission's view that the failure
to apply Category A Transaction-Level Requirements to such swaps could
leave a significant gap in the regulation of risks presented by swap
activities undertaken by U.S. firms. However, as proposed, the
Commission's policy contemplates that substituted compliance (to the
extent applicable) could satisfy the Category A Transaction-Level
Requirements that otherwise might apply to such swaps, as further
discussed below.
In response to commenters that requested clarification of the
nature of the guarantee of a non-U.S. counterparty by a U.S. person
that will trigger the application of Transaction-Level Requirements to
swaps with non-U.S. swap dealers or non-U.S. MSPs, the Commission
references the approach set forth in the final rule further defining
the term ``swap,'' among others.\560\ That is, for this purpose, a
guarantee of a swap is a collateral promise by a guarantor to answer
for the debt or obligation of a counterparty obligor under a swap.\561\
Thus, to the extent that the non-U.S. swap dealer or non-U.S. MSP would
have recourse to the U.S. guarantor in connection with its swaps
position, the Commission would generally expect such non-U.S. swap
dealer or MSP to comply with the Category A Transaction-Level
Requirements for such a guaranteed swap (although substituted
compliance may satisfy compliance with such requirements to the extent
it is applicable, as discussed above). This interpretation also is
consistent with the interpretation related to the MSP definition that
the Commission set forth in the Final Entities Rules.\562\
---------------------------------------------------------------------------
\560\ See Final Swap Definition, 77 FR at 48225-48227. The
interpretation herein applies only to a swap that is not a security-
based swap or a mixed swap.
\561\ Id. at 48226 n.186.
\562\ See Final Entities Rules, 77 FR at 30689 (``[A]n entity's
swap or security-based swaps positions in general would be
attributed to a parent, other affiliate or guarantor for purposes of
major participant analysis to the extent that counterparties to
those positions would have recourse to that other entity in
connection with the position. Positions would not be attributed in
the absence of recourse.'').
---------------------------------------------------------------------------
Conversely, where a non-U.S. swap dealer or non-U.S. MSP enters
into a swap with a non-U.S. counterparty that does not have a guarantee
as so described from a U.S. person and is not an affiliate conduit, the
Commission's view is that the Transaction-Level Requirements should not
apply.\563\ Considerations relevant to application of the Transaction-
Level Requirements also relate to persons guaranteeing swaps
obligations. As noted in the proposal, the Transaction-Level
Requirements with respect to required clearing and swap processing,
margin (and segregation), and portfolio reconciliation and compression
can serve to significantly mitigate risks to the swap dealer's
counterparties, and by extension, the risk to the U.S. person
guaranteeing the non-U.S. counterparty's obligations under the swap.
Other Transaction-Level Requirements--trade confirmation, swap trading
relationship documentation, and daily trading records--protect the
counterparties to the swap, and thus also protect a U.S. person that
guarantees a non-U.S. counterparty's obligations under the swap, by
ensuring that swaps are properly documented and recorded.
---------------------------------------------------------------------------
\563\ The Commission agrees with commenters who stated that
Transaction-Level Requirements should not apply if a non-U.S. swap
dealer or non-U.S. MSP relies on a written representation by a non-
U.S. counterparty that its obligations under the swap are not
guaranteed with recourse by a U.S. person. Such an approach is
consistent with Commission practice in other contexts such as the
external business conduct rules.
---------------------------------------------------------------------------
In the Commission's view, because Congress directed that the trade
execution requirement apply to swaps that are subject to the clearing
requirement and made available to trade, it is appropriate for the
trade execution requirement to apply to those cross-border swaps that
are subject to the clearing mandate and are made available to trade.
The Commission believes that both requirements--the clearing mandate
and trade execution requirement--are of fundamental importance to the
management and reduction of risks posed by swap activities of market
participants. Requiring swaps to be traded on a regulated exchange or
execution facility provides market participants with
[[Page 45356]]
greater pre- and post-trade transparency. Real-time public reporting
improves price discovery by requiring that swap and pricing data be
made publicly available. Taken together, the trade execution and real-
time public reporting Transaction-Level Requirements provide important
information to market participants and regulators with resulting
efficiency in the marketplace. This, in turn, facilitates risk
management which benefits swap counterparties and also serves to reduce
the likelihood that a U.S. guarantor will be called upon to satisfy a
non-U.S. counterparty's swaps obligations.\564\
---------------------------------------------------------------------------
\564\ Accordingly, the Commission disagrees with commenters who
objected to the proposed interpretation on the ground that it would
not advance the goal of mitigating the risk of credit exposure of
the guarantor U.S. person to the non-U.S. swap dealer or non-U.S.
MSP. The Transaction-Level Requirements also serve to protect
against risk to the guarantor U.S. person by reducing the likelihood
that its obligations under the guarantee will be called upon in the
first instance.
---------------------------------------------------------------------------
Further, in the Final Swap Definition, the Commission found that a
guarantee of a swap is a term of that swap that affects the price or
pricing attributes of that swap. The Commission therefore concluded
that when a swap has the benefit of a guarantee, the guarantee is an
integral part of that swap. The Commission explained that typically
when a swap counterparty uses a guarantee as credit support for its
swaps obligations, the guarantor's resources are added to the analysis
of the swap because ``the market will not trade with that counterparty
at the same price, on the same terms, or at all without the
guarantee.'' \565\
---------------------------------------------------------------------------
\565\ See Final Swap Definition, 77 FR 48225-48226.
---------------------------------------------------------------------------
For all the foregoing reasons, the Commission disagrees with
commenters that asserted that it should not, or lacks the legal
authority to, interpret CEA section 2(i) as to apply to swaps where one
counterparty is a non-U.S. swap dealer or a non-U.S. MSP and the other
counterparty is a non-U.S. person whose obligations under the swap are
guaranteed by a U.S. person. Where a U.S. person provides a guarantee
of a non-U.S. counterparty's swaps obligations for which there is
recourse to the U.S. person, where that guarantee is a term of the swap
and affects the price or pricing attributes of that swap, and where the
Transaction-Level Requirements serve to protect and mitigate risk to
that U.S. person guarantor, the Commission believes that such swaps,
either individually or in the aggregate, have a direct and significant
connection with activities in, or effect on, U.S. commerce.
The application of Dodd-Frank Act requirements to swaps of non-U.S.
persons whose swaps obligations are guaranteed by U.S. persons is also
consistent with foreign relations law. As noted in the discussion above
regarding the application of these requirements to swaps of U.S.
persons with non-U.S. persons, a major purpose of Title VII is to
control the potential harm to U.S. markets that can arise from risks
that are magnified or transferred between parties via swaps. Similarly,
a guarantee--which is an integral part of a swap--can lead to the
transfer of risk from the guaranteed non-U.S. person to the U.S.
guarantor. Because Category A Transaction Level Requirements are
designed to mitigate such risk transfer, the Commission believes there
is a strong interest in applying the Dodd-Frank Act requirements to
swaps of non-U.S. persons that are guaranteed by U.S. persons.\566\
However, the Commission also understands the countervailing interest of
home country regulators in such swaps, and therefore believes that
substituted compliance should generally be available in this context.
---------------------------------------------------------------------------
\566\ See generally note 532 and related discussion, supra.
---------------------------------------------------------------------------
The Commission also disagrees with commenters that suggested that
its interpretation on this score should apply only to certain
guaranteed swaps (e.g., not to swaps by non-financial entities entered
into for hedging or risk mitigation purposes), or only to in certain
circumstances (e.g., where the guaranteed non-U.S. counterparty's swap
activity is a certain percentage of its net equity or the aggregate
potential liability of the U.S. guarantor with respect to the non-U.S.
counterparty's swaps obligations is a certain percentage of the
guarantor's net equity), or only to a certain extent (e.g., to swaps
obligations in excess of a capped guarantee). In the Final Swap
Definition, the Commission acknowledged that a ``full recourse''
guarantee would have a greater effect on the price of a swap than a
``limited'' or ``partial recourse'' guarantee, yet nevertheless
determined that the presence of any guarantee with recourse, no matter
how robust, is price forming and an integral part of a guaranteed
swap.\567\
---------------------------------------------------------------------------
\567\ Id. at 48226.
---------------------------------------------------------------------------
The Commission similarly believes that the presence of any
guarantee with recourse by a U.S. person of the swaps obligations of a
non-U.S. counterparty to a swap with a non-U.S. swap dealer or non-U.S.
MSP suffices to justify the application of Transaction-Level
Requirements that swap. Therefore, as noted above, to the extent that a
non-U.S. swap dealer or non-U.S. MSP would have recourse to the U.S.
guarantor in connection with its swaps position, the Commission would
generally expect such non-U.S. swap dealer or MSP to comply with the
Category A Transaction-Level Requirements for such a guaranteed swap
(although substituted compliance may satisfy compliance with such
requirements to the extent it is applicable). Although the Commission
believes all relevant facts and circumstances should be analyzed, as a
general matter the Commission is of the view that the purpose for which
the non-U.S. counterparty is entering into the swap, or the net equity
of the non-U.S. counterparty or the guarantor, or the extent of the
guarantee, would generally not warrant a different conclusion.
Finally, the Commission disagrees with commenters that urged it to
limit its interpretation in this regard to cases of evasion, or to
exclude from the scope of its interpretation those swaps in which the
non-U.S. counterparty is subject to appropriate capital requirements or
the guarantor is a U.S. bank holding company. The events surrounding
the collapse of AIGFP highlight how guarantees can cause major risks to
flow to the guarantor. ``AIGFP's obligations were guaranteed by its
highly rated parent company . . . an arrangement that facilitated easy
money via much lower interest rates from the public markets, but
ultimately made it difficult to isolate AIGFP from its parent, with
disastrous consequences.'' \568\
---------------------------------------------------------------------------
\568\ AIG Report, supra note 5, at 20.
---------------------------------------------------------------------------
The Commission's view is that the protections and mitigation of
risk exposures afforded by the Category A Transaction-Level
Requirements would be rendered far less effective if in the case of
swaps where one counterparty is a non-U.S. swap dealer or a non-U.S.
MSP and the other counterparty is a non-U.S. person guaranteed by a
U.S. person such requirements only apply when such swaps are part of a
scheme to evade the Dodd-Frank Act. Further, while capital requirements
are an important element of the Title VII regime to reduce systemic
risk,\569\ the
[[Page 45357]]
comprehensive regulatory structure established by the Dodd-Frank Act
goes beyond such requirements. The CEA, as amended by the Dodd-Frank
Act, also requires the imposition of the Transaction-Level Requirements
\570\ except to the extent that section 2(i) limits their application
to cross-border transactions or activities. Therefore, the Commission
believes that, rather than excluding the swaps at issue from the scope
of the Title VII regulatory regime, with the corresponding increase in
risk to U.S. persons and to the U.S. financial system, in most cases
compliance with the Category A Transaction-Level Requirements is
appropriate where non-U.S. swap dealers and non-U.S. MSPs that enter
into swaps with non-U.S. counterparties guaranteed by a U.S. person.
Further, the Commission does not believe that a different
interpretation should be taken solely because applicable capital
requirements are satisfied.\571\
---------------------------------------------------------------------------
\569\ CEA section 4s(e)(1) provides that each registered swap
dealer and MSP for which there is a prudential regulator shall meet
such minimum capital requirements as the applicable prudential
regulator shall prescribe, but that each registered swap dealer and
MSP for which there is not a prudential regulator shall meet such
minimum capital requirements as the Commission shall prescribe.
\570\ See Appendix B for information regarding the Transaction-
Level Requirements and the provisions of the CEA which they
implement.
\571\ In the Final Entities Rules, the Commission stated that it
does ``not believe that it is necessary to attribute a person's swap
or security-based swaps positions to a parent or other guarantor if
the person is already subject to capital regulation by the CFTC or
SEC (i.e., swap dealers, security-based swap dealers, MSPs, major
security-based swap participants, FCMs and broker-dealers) or if the
person is a U.S. entity regulated as a bank in the United States.
Positions of those regulated entities already will be subject to
capital and other requirements, making it unnecessary to separately
address, via major participant regulations, the risks associated
with guarantees of those positions.'' See Final Entities Rules, 77
FR at 30689. The Commission continued, ``As a result of this
interpretation, holding companies will not be deemed to be major
swap participants as a result of guarantees to certain U.S. entities
that are already subject to capital regulation.'' Id. at 30689 n.
1134. Subsequently, in the Final Swap Definition, the Commission
stated that ``[a]s a result of interpreting the term `swap' (that is
not a security-based swap or mixed swap) to include a guarantee of
such swap, to the extent that a counterparty to a swaps position
would have recourse to the guarantor in connection with the
position, and based on the reasoning set forth [in the Final
Entities Rules] in connection with major swap participants, the CFTC
will not deem holding companies to be swap dealers as a result of
guarantees to certain U.S. entities that are already subject to
capital regulation.'' See Final Swap Definition, 77 FR at 48266
n.188. The Commission's conclusion that capital compliance and
prudential regulation, in certain circumstances, can obviate the
need for registration as a swap dealer or MSP does not bear upon,
and is not inconsistent with, the Commission's interpretation herein
that notwithstanding capital compliance and prudential regulation,
Transaction-Level Requirements may be applied where a non-U.S. swap
dealer or non-U.S. MSP enters into a swap with a non-U.S.
counterparty whose obligations under that swap are guaranteed, with
recourse, by a U.S. person.
---------------------------------------------------------------------------
In addition, the Commission believes that this Guidance, which
contemplates a system of substituted compliance in accordance with
principles of international harmonization, may allow non-U.S. swap
dealers and non-U.S. MSPs to comply, in appropriate circumstances, with
their home-country requirements when transacting with non-U.S.
counterparties whose swaps obligations are guaranteed with recourse by
U.S. persons. The Commission believes that the substituted compliance
regime contemplated by the Guidance will facilitate equivalent
regulatory treatment of equivalent swaps without undermining the swaps
reforms enacted by Congress in Title VII.
d. Swaps With a Non-U.S. Person That is an Affiliate Conduit
i. Proposed Guidance
The Commission proposed to interpret CEA section 2(i) such that the
Category A Transaction-Level Requirements would apply to a swap if at
least one of the parties to the swap is an ``affiliate conduit.'' Under
the Proposed Guidance, an affiliate conduit exists when: (1) A non-U.S.
person that is majority-owned, directly or indirectly, by a U.S.
person; (2) the non-U.S. person regularly enters into swaps with one or
more of its U.S. affiliates of its U.S. person owner; and (3) the
financial results of such non-U.S. person are included in the
consolidated financial statements of its U.S. person owner.\572\ The
Commission explained that it believed the proposed application of
Transaction-Level Requirements was necessary because, ``given the
nature of the relationship between the conduit and the U.S. person, the
U.S. person is directly exposed to risks from and incurred by'' the
affiliate conduit.\573\ The Commission further indicated that it was
concerned that a U.S. swap dealer or U.S. MSP would utilize affiliate
conduits to conduct swaps outside the Dodd-Frank regulatory regime.
---------------------------------------------------------------------------
\572\ See Proposed Guidance, 77 FR at 41229.
\573\ Id.
---------------------------------------------------------------------------
ii. Comments
The commenters who addressed the Commission's proposed approach to
affiliate conduits expressed concerns about what they felt was an
overly broad scope of the term ``affiliate conduit.'' Several of these
commenters stated that the non-U.S. affiliate conduit concept should be
omitted from the Guidance.\574\ SIFMA stated that the term ``regular''
is too vague in that ``it does not account for the purpose of the
inter-affiliate swap, the relative amount of the conduit's risk
transferred, the nature of the transferred risk, or whether some or all
of the risk is transferred.''\575\ SIFMA also commented that activities
of a non-U.S. affiliate conduit do not satisfy the requisite nexus to
the United States under section 2(i) to justify different treatment
from other non-U.S. counterparties. Further, SIFMA stated that where
substituted compliance is unavailable, a non-U.S. swap dealer
transacting with an affiliate conduit is subject to applicable
Transaction-Level Requirements, which could cause non-U.S. swap dealers
to cease doing business with non-U.S. affiliate conduits.\576\ As an
alternative, SIFMA recommended that the proposed affiliate conduit
provision that the conduit ``regularly enter into swaps'' should be
replaced with a provision that the conduit ``regularly enter[ ] into
swaps with one or more other U.S. affiliates of the U.S. person for the
purpose of transferring to that U.S. person all risk of swap
activity.''
---------------------------------------------------------------------------
\574\ SIFMA (Aug. 27, 2012) at A22-23; IIB at (Aug. 27, 2012) at
20-21; Hong Kong Banks (Aug. 27, 2012) at 13.
\575\ SIFMA (Aug. 27, 2012) at A23. See also IIAC (stating that
the Commission should clarify the meaning of ``regularly enters into
swaps with . . . affiliates'' and circumstances under which the
Commission would interpret the financials of a non-U.S. counterparty
to be combined with the financial statements of the U.S. person for
purposes of applying Transaction-Level Requirements to transactions
by U.S. persons that might be using conduits to avoid such
requirements) (Aug. 27, 2012) at 8.
\576\ SIFMA (Aug. 27, 2012) at A22.
---------------------------------------------------------------------------
Other commenters raised similar objections concerning the scope of
the affiliate conduit provision. Goldman stated that the proposed
description of an affiliate conduit was so broad that ``an entity could
be rendered a conduit by executing even a single trade despite the fact
that the entity otherwise would be eligible for substituted compliance,
or would not fall within Title VII's jurisdiction at all.'' \577\ Such
a broad definition, in Goldman's view, will result in competitive
disparities for foreign affiliates of U.S.-based swap dealers and may
even cover non-financial entities attempting to hedge risk.\578\ SIFMA
added that the concept
[[Page 45358]]
of indirect majority ownership is imprecise and its application to non-
U.S. affiliate conduits is unclear.\579\ Hong Kong Banks believed that
the conduit proposal is unnecessary since its activities would be
captured in the registration process.\580\ Peabody stated that the
application of Transaction-Level Requirements to affiliate conduits
seemingly contradicts the Proposed Guidance's treatment of foreign
affiliates as non-U.S. persons.\581\ If the affiliate conduit concept
remains in the Guidance, SIFMA requested that the Commission clarify
whether or not swap dealers may rely on a counterparty's
representations as to its non-U.S.-affiliate's conduit status.\582\
---------------------------------------------------------------------------
\577\ Goldman (Aug. 27, 2012) at 6. See also Japanese Bankers
Association (Aug. 27, 2012) at 11 (stating that it is difficult to
determine under the Proposed Guidance when a counterparty is a
conduit for a U.S. person, and that the conduit provisions should
not be implemented).
\578\ Goldman (Aug. 27, 2012) at 6. See also Peabody (Aug. 27.
2012) at 3 (stating that applying the Dodd-Frank requirements to
swaps entered into or booked by affiliates of commercial end-users
outside the United States to hedge or mitigate commercial risks of
activities outside the United States will create an overlapping (and
potentially inconsistent) tangle of international laws that will
increase costs and potential liabilities associated with such swaps,
and materially undermine their utility and risk mitigation benefits;
stating further that foreign entities wishing to avoid becoming
subject to Dodd-Frank requirements will decline to enter into swaps
with such affiliates, thereby decreasing market liquidity,
increasing market risk competition, imposing higher commercial
costs, and resulting in higher prices for customers and downstream
consumers, and would put U.S. business at a competitive disadvantage
in global markets).
\579\ SIFMA (Aug. 27, 2012) at A24.
\580\ Hong Kong Banks (Aug. 27, 2012) at 13.
\581\ Peabody (Aug. 28, 2012) at 2-3.
\582\ SIFMA (Aug. 27, 2012) at A24. SIFMA stated that the
determination of whether a counterparty to a swap is a non-U.S.
affiliate conduit should be made at the inception of the swap based
on the most recent updated representation from the counterparty,
which should be renewed by the counterparty once per calendar year.
Id. at A25.
---------------------------------------------------------------------------
IIB stated that the Commission should withdraw its proposal on
affiliate conduits and instead, where there is clear circumvention,
rely on its existing anti-evasion authority.\583\ It added that the
Commission's proposal for the ``conduit'' treatment of a foreign entity
that ``regularly'' engages in back-to-back swaps with a U.S. affiliate
is unjustifiably broad. IIB also stated that the proposed standard is
inconsistent with statutory standards for the extraterritorial
application of Title VII, and that there is no basis to conclude that
inter-affiliate swaps create direct and significant risk to the United
States simply because they occur ``regularly.'' \584\
---------------------------------------------------------------------------
\583\ IIB (Aug. 27, 2012) at 20-21.
\584\ Id. at 19.
---------------------------------------------------------------------------
iii. Commission Guidance
In the Proposed Guidance, the Commission explained that it believed
the proposed application of Transaction-Level Requirements was
necessary because, ``given the nature of the relationship between the
conduit and the U.S. person, the U.S. person is directly exposed to
risks from and incurred by'' the affiliate conduit.\585\ The Commission
further indicated that it was concerned that a U.S. swap dealer or U.S.
MSP would utilize affiliate conduits to conduct swaps outside the Dodd-
Frank regulatory regime.
---------------------------------------------------------------------------
\585\ See Proposed Guidance, 77 FR at 41229.
---------------------------------------------------------------------------
For purposes of this policy statement, the Commission is clarifying
that an affiliate conduit encompasses those entities that function as a
conduit or vehicle for U.S. persons conducting swaps transactions with
third-party counterparties. In response to comments received, the
Commission is identifying some of the factors that the Commission
believes are relevant to determining whether a non-U.S. person is an
``affiliate conduit'' of a U.S. person. As explained in greater detail
below, modifications to the Proposed Guidance with regard to the term
``affiliate conduit'' are intended to respond to commenters' concerns
about a lack of clarity on the scope of the term affiliate conduit and
to better identify those non-U.S. affiliates whose swap activities,
either individually or in the aggregate, have a direct and significant
connection with activities in, or effect on, U.S. commerce as a result
of their relationship with their U.S. affiliates. Specifically, the
Commission is modifying the factors that might be relevant to the
consideration of whether a non-U.S. affiliate of a U.S. person is an
affiliate conduit by: (1) clarifying the meaning of ``regularly enters
into swaps,'' and in particular, the activities of a non-U.S.
counterparty that renders it an affiliate conduit; and (2) adding the
concept of ``control.''
As the Commission understands, it is common for large global
companies to centralize their hedging or risk-management activities in
one or more affiliates (informally referred to as a ``treasury
conduit'' or ``conduit''). Under this structure, the conduit may enter
into swaps with its affiliates and then enter into offsetting swaps
with third-parties. In other cases, the conduit may enter into swaps
with third-parties as agent for its affiliates. In either case, the
conduit functions as a vehicle by which various affiliates engage in
swaps with third-parties (i.e., the market). This paradigm promotes
operational efficiency and prudent risk management by enabling a
company to manage its risks on a consolidated basis at a group
level.\586\ Accordingly, based on comments, rather than considering
whether a non-U.S. person ``regularly enters into swaps'' with one or
more of its U.S. affiliates of its U.S. person owner, the Commission
will generally consider whether the non-U.S. person, in the regular
course of business, engages in swaps with non-U.S. third-parties for
the purpose of hedging or mitigating risks faced by, or to take
positions on behalf of, its U.S. affiliates, and enters into offsetting
swaps or other arrangements with its U.S. affiliates in order to
transfer the risks and benefits of such swaps with third-parties to its
U.S. affiliates.
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\586\ One market participant described the functions of such a
conduit and its relationship with respect to other affiliates within
the corporate group in the following manner:
Many business enterprises, including [Prudential Financial Inc.,
or ``PFI''], elect to operate in a manner that assigns specific
functions to related and commonly-controlled affiliates. With regard
to swap transactions, it has long been our practice, as an
enterprise-type company with separate legal entities that are
commonly owned by PFI to use one affiliate, Prudential Global
Funding LLC (``PGF''), to directly face the market as a ``conduit''
to hedge the net commercial and financial risk of the various
operating affiliates within PFI. Under this practice, only PGF
(i.e., the conduit) is required to trade with external market
participants, while the internal affiliates within PFI trade
directly with the PGF. The use of PGF as the single conduit for the
various operating affiliates within PFI diminishes the demands on
PFI's financial liquidity, operational assets and management
resources, as affiliates within PFI avoid having to establish
independent relationships and unique infrastructure to face the
market. Moreover, use of PGF as a conduit within PFI permits the
netting of our affiliates' trades (e.g., one affiliate is hedging
floating rates while another is hedging fixed rates). This
effectively reduces the overall risk of PFI and our affiliates, and
allows us to manage fewer outstanding positions with external market
participants.
The Prudential Insurance Company of America (Feb. 17, 2011) at
2.
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The Commission recognizes the significant benefits associated with
a corporate group's use of a single entity to conduct the group's
market-facing swap business. The Commission also believes, though, that
in this situation the risks resulting from swaps of the entity that
faces the market as a conduit on behalf of its affiliates in fact
reside with those affiliates; that is, while the swaps are entered into
by the conduit, through back-to-back swaps or other arrangements the
conduit passes the risks and benefits of those swaps to its
affiliates.\587\ Where the conduit is located outside the United
States, but is owned and controlled by a U.S. person, the Commission
believes that to recognize the economic reality of the situation, the
conduit's swaps should be attributed to the U.S. affiliate(s). The fact
that the conduit is located outside the United States does not alter
the economic reality that its swaps are undertaken for the benefit of,
and at the economic risk of, the U.S. affiliate(s), and more broadly,
for the corporate group that is owned and controlled by a U.S. person.
Under these circumstances, the Commission believes that the swap
activities of the non-U.S. conduit may meet the ``direct and
[[Page 45359]]
significant'' jurisdictional nexus within the meaning of CEA section
2(i).\588\
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\587\ See The Prudential Insurance Company of America (Feb. 17,
2011); Kraft Foods (``Kraft'') (Feb. 11, 2011).
\588\ In this respect, it is irrelevant whether the risk is
wholly or partly transferred back to the U.S. affiliate(s); the
jurisdictional nexus is met by reason of the trading relationship
between the conduit and the affiliated U.S. persons.
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Further, in order to facilitate a consistent application of the
term affiliate conduit and to mitigate any undue burden or complexity
for market participants in assessing affiliate conduit status, the
Commission clarifies that its policy contemplates that a market
participant may reasonably rely on counterparty representations as to
its non-U.S. affiliate conduit status.\589\
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\589\ This is consistent with the Commission's approach to the
determination of whether a counterparty is a ``U.S. person.'' See
section IV.A, supra.
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Finally, the Commission notes in response to commenters that an
affiliate conduit would not necessarily be guaranteed by its parent. As
one market participant explained, ``centralized hedging centers are
generally evaluated as wholly-owned subsidiaries of the corporate group
that do not require additional credit support, such as a parent
guaranty or collateral.'' \590\ Therefore, the Commission believes that
it is reasonable and appropriate to interpret CEA section 2(i) in a
manner that recognizes an affiliate conduit as a separate category of
counterparty whose swaps with non-U.S. persons may be subject to
certain Transaction-Level Requirements. Specifically, where one of the
parties to the swap is a conduit affiliate, the Commission would
generally expect the parties to the swap only to comply with (to the
extent that the Inter-Affiliate Exemption is elected), the conditions
of the Inter-Affiliate Exemption, including the treatment of outward-
facing swaps condition in Commission regulation 50.52(b)(4)(i). In
addition, the part 43 real-time reporting requirements must be
satisfied.
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\590\ See Kraft (Feb. 11, 2011) at 3.
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In summary, for the purposes of the Commission's interpretation of
CEA section 2(i), the Commission believes that certain factors are
relevant to considering whether a non-U.S. person is an ``affiliate
conduit.'' Such factors include whether:
(i) the non-U.S. person is a majority-owned affiliate \591\ of a
U.S. person;
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\591\ Commission regulation 1.3(ggg)(6)(i) defines ``majority-
owned affiliates'' as follows:
[C]ounterparties to a swap are majority-owned affiliates if one
counterparty directly or indirectly owns a majority interest in the
other, or if a third party directly or indirectly owns a majority
interest in both counterparties to the swap, where `majority
interest' is the right to vote or direct the vote of a majority of a
class of voting securities of an entity, the power to sell or direct
the sale of a majority of a class of voting securities of an entity,
or the right to receive upon dissolution or the contribution of a
majority of the capital of a partnership.
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(ii) the non-U.S. person is controlling, controlled by or under
common control \592\ with the U.S. person;
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\592\ Commission regulation 1.3(ggg)(4)(i) refers to an ``entity
controlling, controlled by or under common control with the
person.'' Final Entities Rules elaborated on this provision,
stating:
For these purposes, we interpret control to mean the possession,
direct or indirect, of the power to direct or cause the direction of
the management and policies of a person, whether through the
ownership of voting securities, by contract or otherwise. This is
consistent with the definition of ``control'' and ``affiliate'' in
connection with Exchange Act rules regarding registration
statements. See Exchange Act rule 12b-2. . . .
77 FR 30631 n. 437, and
[I]f a parent entity controls two subsidiaries which both engage
in activities that would cause the subsidiaries to be covered by the
dealer definitions, then each subsidiary must aggregate the swaps or
security-based swaps that result from both subsidiaries' dealing
activities in determining if either subsidiary qualifies for the de
minimis exception.
Id. at n. 438.
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(iii) the financial results of the non-U.S. person are included
in the consolidated financial statements of the U.S. person; and
(iv) the non-U.S. person, in the regular course of business,
engages in swaps with non-U.S. third-party(ies) for the purpose of
hedging or mitigating risks faced by, or to take positions on behalf
of, its U.S. affiliate(s), and enters into offsetting swaps or other
arrangements with its U.S. affiliate(s) in order to transfer the
risks and benefits of such swaps with third-party(ies) to its U.S.
affiliates.
Other facts and circumstances also may be relevant. The Commission does
not intend that the term ``conduit affiliate'' would include affiliates
of swap dealers.
5. Application of the ``Category B'' Transaction-Level Requirements to
Swap Dealers and MSPs
This section discusses the Commission's policy on the application
of the Category B Transaction-Level Requirements to swaps in which at
least one of the parties to the swap is a registered swap dealer or
MSP. As noted earlier, the Category B Transaction Level Requirements
pertain to external business conduct standards which the Commission
adopted pursuant to CEA section 4s(b) as a Category B Transaction-Level
Requirement.\593\
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\593\ The categorization of Transaction-Level Requirements into
Categories A and B is discussed in section E, supra. See Appendix B
for a descriptive list of the Category A and Category B requirements
and Appendix D for a table summarizing the application of the
Category A Transaction-Level Requirements to Swap Dealers and MSPs.
The Appendices to this Guidance should be read in conjunction with
this section and the rest of the Guidance.
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Consistent with the Proposed Guidance, the Commission will
generally interpret CEA section 2(i) so that the Category B
Transaction-Level Requirements (i.e., the external business conduct
standards) either do or do not apply to the swap, based on the
counterparties to the swap, as explained below. Under this
interpretation, substituted compliance is generally not expected to be
applicable with regard to the Category B Transaction-Level Requirements
under this Guidance.\594\
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\594\ See Appendix E to this Guidance for a summary of these
requirements and the discussion in section D, supra.
---------------------------------------------------------------------------
In considering whether Category B Transaction-Level Requirements
are applicable, the Commission would generally consider whether the
swap is with a:
(i) U.S. swap dealer or U.S. MSP (including affiliates of non-
U.S. persons);
(ii) foreign branch of a U.S. bank that is a swap dealer or MSP;
or
(iii) non-U.S. swap dealer or non-U.S. MSP (including an
affiliate of a U.S. person).
Specifically, as explained more below, where a swap is with a U.S.
swap dealer or U.S. MSP, the parties to the swap generally should be
subject to the Category B Transaction-Level Requirements in full,
regardless of whether the other counterparty to the swap is a U.S.
person or a non-U.S. person. However, in the case of a foreign branch
of a U.S. bank that is a swap dealer or MSP, or a non-U.S. swap dealer
or non-U.S. MSP, the parties to the swap should generally only be
subject to the Category B Transaction-Level Requirements when the
counterparty to the swap is a U.S. person (other than a foreign branch
of a U.S. bank that is a swap dealer or MSP). Conversely, under the
Commission's interpretation of 2(i), where a swap is between a non-U.S.
swap dealer or non-U.S. MSP (including an affiliate of a U.S. person)
and a non-U.S. counterparty (regardless of whether the non-U.S.
counterparty is a guaranteed or conduit affiliate), the parties to the
swap would not be expected to comply with the Category B Transaction-
Level Requirements. The reasons for the Commission's policies are
discussed below.
The application of the Category B Transaction-Level Requirements is
summarized in Appendix E to this Guidance, which should be read in
conjunction with the rest of this Guidance.
a. Swaps With U.S. Swap Dealers and U.S. MSPs
As explained above, where a swap is with a U.S. swap dealer or U.S.
MSP (including an affiliate of a non-U.S. person), the Commission's
policy is that the parties to the swap should be subject
[[Page 45360]]
to the Category B Transaction-Level Requirements in full, regardless of
whether the counterparty is a U.S. person or a non-U.S. person, without
substituted compliance available.
b. Swaps With Foreign Branches of a U.S. Bank That Is a Swap Dealer or
MSP
In the case of a swap with a foreign branch of a U.S. bank that is
a swap dealer or MSP, the Commission's policy is that the Category B
Transaction-Level Requirements should apply only if the counterparty to
the swap is a U.S. person (other than a foreign branch of a U.S. bank
that is a swap dealer or MSP).\595\
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\595\ For the reasons discussed in note 531, supra, where the
counterparty to the swap is an international financial institution,
the Commission also generally would not expect the parties to the
swap to comply with the Category B Transaction-Level Requirements,
even if the principal place of business of the international
financial institution were located in the United States.
---------------------------------------------------------------------------
The Commission believes that where a swap is between a foreign
branch of a U.S. bank that is a swap dealer or MSP \596\ and a U.S.
person (other than a foreign branch of a U.S. bank that is a swap
dealer or MSP), the swap has a direct and significant connection with
activities in, or effect on, U.S. commerce. Because of the significant
risks to U.S. persons and the financial system presented by such swap
activities, under the Commission's interpretation of CEA section 2(i),
generally the parties to the swap should comply with the Category B
Transaction Level Requirements. Whenever a swap involves at least one
counterparty that is a U.S. person, the Commission believes it has a
strong supervisory interest in regulating and enforcing Transaction-
Level Requirements, including external business conduct standards. In
this case, the Commission believes the transaction should be viewed as
being between two U.S. persons. For these reasons, the Commission's
policy under section 2(i) is that substituted compliance would not be
available.\597\
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\596\ See section C, supra, regarding the definition of a
foreign branch and the determination of when a swap transaction is
with a foreign branch for purposes of this Guidance.
\597\ In this case, although the foreign branch would not
register separately as a swap dealer, the Commission interprets 2(i)
in a manner that would permit the U.S. person to task its foreign
branch to fulfill its regulatory obligations with respect to the
Category B Transaction-Level Requirements. The Commission would
consider compliance by the foreign branch or agency to constitute
compliance with these Transaction-Level Requirements. However, under
the Commission's interpretation of 2(i), the U.S. person (principal
entity) would remain responsible for compliance with the Category B
Transaction-Level Requirements.
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However, where the swap is between a foreign branch of a U.S. bank
that is a swap dealer or MSP, on the one hand, and a non-U.S. person on
the other (whether or not such non-U.S. person is a guaranteed or
conduit affiliate), the Commission believes that the interests of the
foreign jurisdiction in applying its own transaction-level requirements
to the swap are sufficiently strong that the Category B Transaction-
Level Requirements generally should not apply under section 2(i). In
this case, even though the Commission considers a foreign branch of a
U.S. bank that is a swap dealer or MSP to be a U.S. person, the
Commission believes that because the counterparty is a non-U.S. person
and the swap takes place outside the United States, foreign regulators
may have a relatively stronger supervisory interest in regulating and
enforcing sales practices related to the swap. Therefore, in light of
international comity principles, the Commission believes that
application of the Category B Transaction-Level Requirements may not be
warranted in this case. Therefore, under the Commission's
interpretation of section 2(i), the parties to the swap generally would
not be expected to comply with the Category B Transaction-Level
Requirements.
The Commission believes that, in the context of the Category B
Transaction-Level Requirements, the same reasoning also should apply to
a swap between two foreign branches of U.S. banks that are each swap
dealers or MSPs. Just as the Commission would have a strong supervisory
interest in regulating and enforcing sales practices associated with
activities taking place within the United States, the foreign
regulators would have a similar claim to overseeing sales practices
occurring within their jurisdiction.
Accordingly, the Commission interprets CEA section 2(i) so that
where a swap is between the foreign branch of a U.S. bank that is a
swap dealer or MSP, on the one hand, and either a non-U.S. person or a
foreign branch of a U.S. bank that is a swap dealer or MSP, on the
other, the parties to the swap generally would not be expected to
comply with the Category B Transaction-Level Requirements.
c. Swaps With Non-U.S. Swap Dealers and Non-U.S. MSPs
Under the Commission's interpretation of 2(i), where a swap is
between a non-U.S. swap dealer or non-U.S. MSP (including an affiliate
of a U.S. person), on the one hand, and a U.S. person, on the other,
the parties to the swap generally would be expected to comply with the
Category B Transaction-Level Requirements.\598\ In the Commission's
view, in this case, the swap should be subject to the provisions of
Title VII of the Dodd-Frank Act and Commission implementing
regulations, including the Category B Transaction-Level Requirements.
Because of the significant risks to U.S. persons and the financial
system presented by swap activities outside the United States where one
of the counterparties to the swap is a U.S. person (whether inside or
outside the United States), the Commission believes that a U.S.
person's swap activities with a non-U.S. counterparty has the requisite
direct and significant connection with activities in, or effect on,
U.S. commerce under CEA section 2(i) to apply the Category B
Transaction-Level Requirements to the transaction.
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\598\ As noted above, for the reasons discussed in note 531,
where the counterparty to the swap is an international financial
institution, the Commission also generally would not expect the
parties to the swap to comply with the Category B Transaction-Level
Requirements, even if the principal place of business of the
international financial institution were located in the United
States.
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The Commission observes that, where a swap between a non-U.S. swap
dealer and a U.S. person is executed anonymously on a registered DCM or
SEF and cleared by a registered DCO,\599\ the Category B Transaction-
Level Requirements would not be applicable.\600\
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\599\ As discussed in greater detail above, the Commission notes
that there are no exempt DCOs at this time. If and when the
Commission determines to exercise its authority to exempt DCOs from
applicable registration requirements, the Commission would likely
address, among other things, the conditions and limitations
applicable to clearing swaps for customers subject to section 4d(f)
of the CEA.
\600\ See 17 CFR 23.402(b)-(c) (requiring swap dealers and MSPs
to obtain and retain certain information only about each
counterparty ``whose identity is known to the swap dealer or MSP
prior to the execution of the transaction''); 23.430(e) (not
requiring swap dealers and MSPs to verify counterparty eligibility
when a transaction is entered on a DCM or SEF and the swap dealer or
MSP does not know the identity of the counterparty prior to
execution); 23.431(c) (not requiring disclosure of material
information about a swap if initiated on a DCM or SEF and the swap
dealer or MSP does not know the identity of the counterparty prior
to execution); 23.450(h) (not requiring swap dealers and MSPs to
have a reasonable basis to believe that a Special Entity has a
qualified, independent representative if the transaction with the
Special Entity is initiated on a DCM or SEF and the swap dealer or
MSP does not know the identity of the Special Entity prior to
execution); 23.451(b)(2)(iii) (disapplying the prohibition on
entering into swaps with a governmental Special Entity within two
years after any contribution to an official of such governmental
Special Entity if the swap is initiated on a DCM or SEF and the swap
dealer or MSP does not know the identity of the Special Entity prior
to execution).
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Because a registered FBOT is analogous to a DCM, the Commission is
of the view that the requirements
[[Page 45361]]
likewise would not be applicable where such a swap is executed
anonymously on a registered FBOT and cleared.
Conversely, under the Commission's interpretation of 2(i), where a
swap is between a non-U.S. swap dealer or non-U.S. MSP (including an
affiliate of a U.S. person) and a non-U.S. counterparty (regardless of
whether the non-U.S. counterparty is a guaranteed or conduit
affiliate), the parties to the swap would not be expected to comply
with the Category B Transaction-Level Requirements. The Commission
believes that regulators may have a relatively stronger supervisory
interest in regulating the Category B Transaction-Level Requirements
related to swaps between non-U.S. persons taking place outside the
United States than the Commission, and that therefore applying the
Category B Transaction-Level Requirements to these transactions may not
be warranted. The Commission notes that just as the Commission would
have a strong supervisory interest in regulating and enforcing the
Category B Transaction-Level Requirements associated with activities
taking place in the United States, foreign regulators would have a
similar claim to overseeing sales practices for swaps occurring within
their jurisdiction.
For the reasons stated in section b above, under the Commission's
interpretation of section 2(i), where a swap is between a non-U.S. swap
dealer or non-U.S. MSP (including an affiliate of a U.S. person), on
the one hand, and the foreign branch of a U.S. bank that is a swap
dealer or MSP, on the other, the parties to the swap generally would
not be expected to comply with the Category B Transaction-Level
Requirements.
As noted previously, under the 2(i) interpretations, substituted
compliance is generally not expected to be applicable to the Category B
Transaction-Level Requirements under this Guidance.\601\
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\601\ See Appendix E to this Guidance for a summary of these
requirements and the discussion in section E, supra.
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H. Application of the CEA's Swap Provisions and Commission Regulations
to Market Participants That Are Not Registered as a Swap Dealer or MSP
This section sets forth the Commission's general policy on
application of the CEA's swaps provisions and Commission regulations to
swap counterparties that are not registered as swap dealers or MSPs
(``non-registrants''), including the circumstances under which the
counterparties would be eligible for substituted compliance.
Several of the CEA's swaps provisions and Commission regulations--
namely, those relating to required clearing, trade execution, real-time
public reporting, Large Trader Reporting, SDR Reporting, and swap data
recordkeeping (collectively, the ``Non-Registrant Requirements'')
\602\--also apply to persons or counterparties other than a swap dealer
or MSP. In this section, the Commission sets forth the Commission's
policy on application of these Non-Registrant Requirements to cross-
border swaps in which neither counterparty is a swap dealer or MSP
(i.e., all other market participants including ``financial entities,''
as defined in CEA section 2(h)(7)(C)).\603\
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\602\ See section IV.D, supra. Part 45 of the Commission's
regulations requires swap counterparties that are not swap dealers
or MSPs to keep ``full, complete and systematic records, together
with all pertinent data and memoranda'' with respect to each swap to
which they are a counterparty. See 17 C.F. R. 45.2. Such records
must include those demonstrating that they are entitled, with
respect to any swap, to make use of the clearing exception in CEA
section 2(h)(7). Swap counterparties that are not swap dealers or
MSPs must also comply with the Commission's regulations in part 46,
which address the reporting of data relating to pre-enactment swaps
and data relating to transition swaps.
\603\ Nothing in this Guidance should be construed to address
the ability of a foreign board of trade to offer swaps to U.S.
persons pursuant to part 48 of the Commission's regulations.
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Section 1 discusses the Commission's policy under CEA section 2(i)
with regard to the application of the Non-Registrant Requirements to
cross-border swaps between two non-registrants where one (or both) of
the counterparties to the swap is a U.S. person. Substituted compliance
is not applicable where one (or both) swap counterparties is a U.S.
person.
Section 2 discusses the Commission's policy under CEA section 2(i)
with regard to the application of the Non-Registrant Requirements to
cross-border swaps between two non-registrants where both
counterparties to the swap are non-U.S. persons. The eligibility of
various counterparties to such swaps for substituted compliance is also
addressed in section 2.
The application of the specified Dodd-Frank provisions and
Commission regulations specified below to swaps between counterparties
that are neither swap dealers nor MSPs is summarized in Appendix F to
this Guidance, which should be read in conjunction with the rest of
this Guidance.
1. Swaps Between Non-Registrants Where One or More of the Non-
Registrants is a U.S. Person
As noted in the Proposed Guidance, to manage risks in a global
economy, U.S. persons may need to, and frequently do, transact swaps
with both U.S. and non-U.S. counterparties. The swap activities of U.S.
persons, particularly those with global operations, frequently occur
outside of U.S. borders.
With regard to cross-border swaps between two non-registrants where
one (or both) of the counterparties to the swap is a U.S. person
(including an affiliate of a non-U.S. person), the Commission's
interprets CEA 2(i) such that the parties to the swap generally would
be expected to comply with the Non-Registrant Requirements. As the
Commission noted in the Proposed Guidance, the risks to U.S. persons
and the U.S. financial system do not depend on the location of the swap
activities of U.S. persons.\604\ Where one or both of the
counterparties to a swap between two non-registrants is a U.S. person,
the Commission believes that the U.S. persons' swap activities (whether
inside or outside the United States)--due their presence in the U.S.
and relationship to U.S. commerce--have a direct and significant
connection with activities in, or effect on, U.S. commerce. Therefore,
the Commission's policy is that where a swap transaction is between
non-registrants, and one or more of the counterparties is a U.S.
person, generally the parties to the swap will be expected to comply in
full with the Non-Registrant Requirements.\605\ In addition, where one
or more of the counterparties to a swap between non-registrants is a
U.S. person, the Commission's policy generally is that
[[Page 45362]]
substituted compliance is not available, for the reasons discussed
below.
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\604\ See Proposed Guidance, 77 FR 41234 n. 138. Further, in the
Proposed Guidance, the Commission stated that it believes that
section 2(i) does not require a transaction-by-transaction
determination that a particular swap outside the United States has a
direct and significant connection with activities in, or effect on,
commerce of the United States in order to apply the swaps provisions
of the CEA to such transactions; rather, it is the aggregate of such
activities and the aggregate connection of such activities with
activities in the U.S. or effect on U.S. commerce that warrants
application of the CEA swaps provisions to all such activities. See
Hoffmann-La Roche, 542 U.S. at 168 (responding that respondents'
recommendation that the court should take account of comity
considerations on a case by case basis is ``too complex to prove
workable'').
\605\ For the reasons discussed in note 531, supra, one or more
of the counterparties to a swap between non-registrants is an
international financial institution, the Commission generally would
not expect the parties to the swap to comply with the Non-Registrant
Requirements, even if the principal place of business of the
international financial institution were located in the United
States.
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As noted in section D above, the Dodd-Frank Act's required clearing
and swap processing requirements protect counterparties from the
counterparty credit risk of their original counterparties, which in
turn, protects against the accumulation of systemic risk because of the
risk mitigation benefits offered by central clearing. Similarly, the
trade execution and real-time public reporting requirements serve to
promote both pre- and post-trade transparency which, in turn, enhance
price discovery and decrease risk. Together, these requirements serve
an essential role in protecting U.S. market participants and the
general market against financial losses. The Commission cannot fully
and responsibly fulfill its charge to protect the U.S. markets and
market participants through a substituted compliance regime where one
counterparty is a U.S. person. Accordingly, the Commission's policy is
to expect full compliance with the Non-Registrant Requirements relating
to required clearing, trade execution, and real-time public reporting
with regard to any swaps between non-registrants where one or both of
the counterparties is a U.S. person. For substantially the same
reasons, application of U.S. requirements in these transactions is a
reasonable exercise of U.S. jurisdiction under principles of foreign
relations law.\606\
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\606\ See Restatement Sec. Sec. 403(2)(a)-(c).
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Large Trader Reporting provides the Commission with data regarding
large positions in swaps with a direct or indirect linkage to specified
U.S.-listed physical commodity futures contracts, in order to enable
the Commission to implement and conduct effective surveillance of these
economically equivalent swaps and futures. To facilitate the monitoring
of trading across the swaps and futures markets, swaps positions must
be converted to futures equivalents for reporting purposes; reportable
thresholds are also defined in terms of futures equivalents. As
discussed in further detail in section G above, in light of the very
specific interest of the Commission in conducting effective
surveillance of markets in swaps that have been determined to be
economically equivalent to U.S. listed physical commodity futures
contracts, and given the anticipated impediments to obtaining directly
comparable positional data through any foreign swap data reporting
regime, the Commission's policy is to construe CEA section 2(i) in a
manner that would not recognize substituted compliance in lieu of
compliance with Large Trader Reporting.
As noted in section E, data reported under the SDR Reporting rules
provide the Commission with information necessary to better understand
and monitor concentrations of risk, as well as risk profiles of
individual market participants. Swap data recordkeeping is an important
component of an effective internal risk management process. Therefore,
the Commission's policy is that generally both SDR Reporting and swap
data recordkeeping should apply in full where one of the counterparties
to a swap between two non-registrants (non-swap dealers or non-MSPs) is
a U.S. person.
As noted above, the clearing of swaps through a DCO mitigates
counterparty credit risk and collateralizes the credit exposures posed
by swaps. Section 2(h)(1) of the CEA requires a swap to be submitted
for clearing to a registered DCO or a DCO that is exempt from
registration under the CEA, if the Commission has determined that the
swap is required to be cleared.\607\ The Commission has adopted a
clearing requirement determination pursuant to the CEA and rules under
part 50 of the Commission's regulations such that certain classes of
swaps are required to be cleared, unless counterparties to the swap
qualify for an exception or exemption from clearing under the CEA or
part 50 of the Commission's regulations.\608\ In the final rules
adopting the Inter-Affiliate Exemption, the Commission stated that a
U.S. person that enters into any swap that is required to be cleared is
subject to the clearing requirements of the CEA and part 50 of the
Commission's regulations.\609\ Accordingly, in the context of this
Guidance, the Commission's policy is that the clearing requirement
under section 2(h)(1) and part 50 of the Commission's regulations
applies in full to a swap where at least one of the counterparties to
the swap is a U.S. person, without substituted compliance available.
But substituted compliance may be available with respect to the
clearing requirement for swaps between, on the one hand, a U.S. swap
dealer or U.S. MSP acting through its foreign branch or a non-U.S.
person that is a guaranteed or conduit affiliate, and on the other
hand, a non-U.S. swap dealer, non-U.S. MSP or other non-U.S. person.
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\607\ The Commission notes that under CEA section 5b(h), the
Commission has discretionary authority to exempt DCOs, conditionally
or unconditionally, from the applicable DCO registration
requirements. Specifically, section 5b(h) of the Act provides that
``[t]he Commission may exempt, conditionally or unconditionally, a
derivatives clearing organization from registration under this
section for the clearing of swaps if the Commission determines that
the [DCO] is subject to comparable, comprehensive supervision and
regulation by the Securities and Exchange Commission or the
appropriate government authorities in the home country of the
organization.'' Thus, the Commission has discretion to exempt from
registration DCOs that, at a minimum, are subject to comparable and
comprehensive supervision by another regulator. The Commission
further notes that it has not yet exercised its discretionary
authority to exempt DCOs from registration, and that until such time
as the Commission determines to exercise such authority, swaps
subject to the clearing requirement must be submitted to registered
DCOs for clearing.
\608\ In addition to the End-User Exception under CEA section
2(h)(7), which is codified in Commission regulation 50.50, as noted
above, the Commission has adopted an exemption from required
clearing for swaps between certain affiliated entities, codified at
Commission regulation 50.52. See Inter-Affiliate Exemption, 78 FR
21750.
\609\ Id. at 21765 (requiring, among other conditions, that
eligible affiliate counterparties electing the exemption from
clearing for the inter-affiliate swap must clear their swaps with
unaffiliated counterparties, and permitting eligible affiliate
counterparties located in foreign jurisdictions to clear such swaps
pursuant to their applicable foreign jurisdictions' clearing regime,
if the Commission determines that such regime is comparable and
comprehensive to the U.S. clearing mandate).
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With respect to the clearing requirement, the Commission has
previously addressed both the scope and process of a comparability
determination, which also would apply to the extent that substituted
compliance is applicable under this Guidance.\610\
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\610\ In particular, in the Inter-Affiliate Exemption, the
Commission permitted eligible affiliate counterparties located
outside of the U.S. to comply with a condition of the exemption to
clear their swaps with unaffiliated counterparties (not located in
the U.S.), to the extent such swaps are subject to the clearing
requirement under section 2(h)(1) of the CEA, by complying with the
requirements of a foreign jurisdiction's clearing mandate, including
any exception or exemption granted under the foreign clearing
mandate, provided that the Commission determines that: (i) such
foreign jurisdiction's clearing mandate is comparable and
comprehensive, but not necessarily identical, to the clearing
requirement established under the CEA and part 50 of the
Commission's regulations, and (ii) the exception or exemption is
determined to be comparable to an exception or exemption provided
under the CEA or part 50 of the Commission's regulations. See 17 CFR
50.52(b)(4)(i).
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As for the process for determining comparability of a foreign
jurisdiction's clearing mandate, the Commission has also previously
stated that it will review the comparability and comprehensiveness of a
foreign jurisdiction's clearing mandate by reviewing: (i) The foreign
jurisdiction's laws and regulations with respect to its mandatory
clearing regime (i.e., jurisdiction-specific review) and (ii) the
foreign jurisdiction's clearing determinations with respect to each
class of swaps for which the
[[Page 45363]]
Commission has issued a clearing determination under Commission
regulation 50.4 (i.e., product-specific review).\611\ In determining
whether an exemption or exception under a comparable foreign mandate is
comparable to an exception or exemption under the CEA or part 50, the
Commission anticipates that it would review, for comparability
purposes, the foreign jurisdiction's laws and regulations with respect
to its mandatory clearing regime, as well as the relevant exception or
exemption, and would exercise broad discretion to determine whether the
requirements and objectives of such exemption are consistent with those
under the comparable foreign clearing regime.
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\611\ The Commission further explained that comparability will
not require a regime identical to the clearing framework established
under the CEA and the Commission regulations. Rather, the Commission
anticipates that it will make jurisdiction-specific comparability
determinations by comparing the regulatory requirements of a foreign
jurisdiction's clearing regime with the requirements and objectives
of the Dodd-Frank Act. The Commission further noted that it
anticipates that the product-specific comparability determination
will necessarily be made on the basis of whether the applicable swap
is included in a class of swaps covered under Commission regulation
50.4.
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The Commission is also of the view that where a swap is executed
anonymously on a registered DCM or SEF between two non-registrants and
cleared by a registered DCO, and one (or both) of the counterparties to
the swap is a U.S. person, neither party to the swap should be required
to comply with the Non-Registrant Requirements that otherwise apply to
the swap, with the exception of Large Trader Reporting,\612\ SDR
Reporting, and swap data recordkeeping.\613\ The Commission notes that
in this case, the DCM or SEF will fulfill the required clearing, trade
execution,\614\ and real-time public reporting requirements that apply
to the swap.
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\612\ The Commission's part 20 regulations set forth large
trader reporting rules for physical commodity swaps. See 76 FF 43851
(Jul. 22, 2011). Part 20 requires routine swaps position reports
from clearing organizations, clearing members and swap dealers, and
establishes certain non-routine reporting requirements for large
swaps traders. Among other things, part 20 requires that a reporting
entity, as defined in Commission regulation 20.1, disclose the
identity of the counterparty in respect of which positional
information is being reported in large swap trader reports and
associated filings. See 76 FR. 43851 at 43863-4 n.11.
\613\ The Dodd-Frank Act added to the CEA provisions requiring
the retention and reporting of data related to swap transactions.
Section 727 of the Dodd-Frank Act added section 2(a)(13)(g), which
requires that all swaps, whether cleared or uncleared, be reported
to an SDR. Section 728 of the Dodd-Frank Act added section 21(b),
which directs the Commission to prescribe standards for swap data
recordkeeping and reporting. Section 723 of the Dodd-Frank Act added
section 2(h)(5), which addresses the reporting of swap data for
swaps executed before the enactment of the Dodd-Frank Act and swaps
executed on or after the date of its enactment. The Commission's
swap data reporting and recordkeeping requirements are found in part
45, which establishes swap data recordkeeping and SDR reporting
requirements; and part 46, which establishes swap data recordkeeping
and SDR reporting requirements for pre-enactment and transition
swaps (collectively, ``historical swaps''). See 77 FR 2136 (Jan. 13,
2012) (part 45); 77 FR 35200 (June 12, 2012) (part 46). Under both
part 45 and part 46 (collectively, the ``swap data reporting
rules'') reporting parties have swap data reporting obligations. The
swap data reporting rules further prescribe certain data fields that
must be included in swap data reporting. See Appendix 1 to part 45;
Appendix 1 to part 46. For all swaps subject to the Commission's
jurisdiction, each counterparty must be identified by means of a
single legal entity identifier (``LEI'') in all swap data reporting
pursuant to parts 45 and 46. A reporting counterparty, as defined in
Commission regulations 45.1 and 46.1, respectively, has obligations
that include providing certain data to the SDR relating to the
primary economic terms (``PET'') of the swap, including the LEI of
the non-reporting counterparty.
\614\ The Commission clarifies that the trading mandate under
CEA section 2(h)(8)(A) is satisfied by trading on a registered DCM
or SEF or a SEF that is exempt from registration.
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Further, the Commission is of the view that where a swap is
executed anonymously between two non-registrants on a registered FBOT
and cleared and one (or both) of the counterparties to the swap is a
U.S. person, neither party to the swap (as is the case when the swap is
executed anonymously on a DCM) should be required to comply with the
Non-Registrant Requirements that otherwise apply to the swap, with the
exception of Large Trader Reporting, SDR Reporting and swap data
recordkeeping. The Commission notes that in this case, the registered
FBOT, as would the DCM, will fulfill the required clearing and trade
execution requirements \615\ that apply to the swap but not, without
further action, the real-time public reporting requirements.
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\615\ The Commission clarifies that the trading mandate under
CEA section 2(h)(8)(A) is satisfied by trading on a registered FBOT.
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The Commission expects that derivatives markets and regulatory
regimes will continue to evolve in the future. In order to ensure a
level playing field, promote participation in transparent markets, and
promote market efficiency, the Commission will, through staff no action
letters, extend appropriate time-limited transitional relief to certain
European Union-regulated multilateral trading facilities (MTFs), in the
event that the Commission's trade execution requirement is triggered
before March 15, 2014. Such relief would be available through March
15th for MTFs that have multilateral trading schemes, a sufficient
level of pre- and post-trade price transparency, non-discriminatory
access by market participants, and an appropriate level of oversight.
In addition, the Commission will consult with the European Commission
in giving consideration to extending regulatory relief to European
Union-regulated trading platforms that are subject to requirements that
achieve regulatory outcomes that are comparable to those achieved by
the requirements for SEFs. Both parties will assess progress in January
2014.
2. Swaps Between Non-Registrants That Are Both Non-U.S. Persons
As noted above, where a swap is between two non-U.S. persons and
neither counterparty is required to register as a swap dealer or MSP,
the Commission proposed interpreting CEA section 2(i) so as not to
apply the Non-Registrant Requirements,\616\ with the exception of Large
Trader Reporting.\617\
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\616\ See the Proposed Guidance, 77 FR 41234-41235.
\617\ See id. at 41234 n. 139, 41235.
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Section a discusses the Commission's policy on application of Large
Trader Reporting to swaps between two non-registrants that are not U.S.
persons. Section b discusses the application of the other Non-
Registrant Requirements to swaps between two non-registrants that are
not U.S. persons, where each of the counterparties to the swap is a
guaranteed or conduit affiliate, and the availability of substituted
compliance for the parties to such swaps. Section c discusses the
Commission's policy on application of the Non-Registrant Requirements
other than Large Trader Reporting to swaps between non-registrants that
are not U.S. persons where neither or only one of the counterparties is
a guaranteed or conduit affiliate.
a. Large Trader Reporting
Large Trader Reporting requires routine positional reports from
clearing members in addition to clearing organizations and swap
dealers. As is the case with swap dealers, routine reports are required
from clearing members to the extent that they hold significant
positions in the swaps subject to Large Trader Reporting--swaps that
are directly or indirectly linked to specified U.S.-listed physical
commodity futures contracts. Routine reporting provides essential
visibility into the trading activity of large market participants,
which enables the Commission to conduct effective surveillance of
markets in swaps and futures that have been determined to be
economically equivalent. Given the
[[Page 45364]]
linkage of the swaps covered by Large Trader Reporting to U.S. futures
markets, the Commission believes that any non-U.S. clearing member that
holds positions in such swaps that are significant enough to trigger
routine reporting obligations is engaged in activities that have a
direct and significant connection with activities in, or effect on,
commerce of the United States. Consistent with the Proposed Guidance,
the Commission's policy, in light of its interpretation of CEA section
2(i), is that any such non-U.S. clearing member should report all
reportable positions to the Commission.\618\
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\618\ To the extent that they transact in the physical commodity
swaps covered by the Commission's Large Trader Reporting rules, non-
U.S. clearing members also should maintain the records required by
such rules.
---------------------------------------------------------------------------
Large Trader Reporting also establishes recordkeeping requirements
for traders with significant positions in the covered physical
commodity swaps. Given the vital role that Large Trader Reporting plays
in ensuring that the Commission has access to comprehensive data
regarding trading activity in swaps linked to U.S. futures, the
Commission's policy, in light of its interpretation of CEA section
2(i), is that non-U.S. persons with positions that meet the prescribed
recordkeeping thresholds should comply with the prescribed
recordkeeping requirements. The Commission notes that traders, which
are not swap dealers or clearing members with routine Large Trader
Reporting obligations, may generally keep books and records regarding
their transactions in the covered physical commodity swaps and produce
them for inspection by the Commission in the record retention format
that such traders have developed in the normal course of their business
operations.
b. Swaps Where Each of The Counterparties Is Either a Guaranteed or
Conduit Affiliate
In contrast to the Proposed Guidance, where a swap is between two
non-registrants that are not U.S. persons, and each of the
counterparties to the swap is a guaranteed or conduit affiliate,\619\
the parties to the swap generally should be expected to comply with the
Non-Registrant Requirements with respect to the transaction. However,
where at least one of the parties to the swap is an ``affiliate
conduit,'' the Commission would generally expect the parties to the
swap only to comply with (to the extent that the Inter-Affiliate
Exemption is elected), the conditions of the Inter-Affiliate Exemption,
including the treatment of outward-facing swaps condition in Commission
regulation 50.52(b)(4)(i). In addition, the part 43 real-time reporting
requirements must be satisfied.
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\619\ As noted above, this Guidance uses the term ``guaranteed
or conduit affiliate'' to refer to a non-U.S. person that is
guaranteed by a U.S. person or that is an affiliate conduit.
---------------------------------------------------------------------------
The Commission has not interpreted CEA section 2(i) so as to
include a guaranteed or conduit affiliate in the interpretation of the
term ``U.S. person'' solely because of the guarantee or affiliation.
Where each of the counterparties to the swap are non-registrants that
are guaranteed or conduit affiliates, the Commission believes that the
risks to U.S. persons and to the U.S. financial system sufficiently
increase so that the additional measure of applying the Non-Registrant
Requirements to the swap is warranted (but with substituted compliance
available, to the extent applicable).\620\ The Commission notes that in
the case of guarantees by U.S. persons, if there is a default by the
non-U.S. person, the U.S. guarantor generally would be held responsible
to settle the obligations. In the case of affiliate conduits, a non-
U.S. affiliate could effectively operate as a conduit for the U.S.
person, and could be used to execute swaps with counterparties in
foreign jurisdictions, outside the Dodd-Frank Act regulatory regime.
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\620\ The Commission proposed to interpret section 2(i) so that
the Non-Registrant Requirements would not apply to swaps between two
non-registrants (whether or not one or more counterparties was
guaranteed by a U.S. person), with the exception of Large Trader
Reporting. The Commission noted in the Proposed Guidance that it
intended to review the issue of affiliate conduits. See Proposed
Guidance, 77 FR 1234-41235.
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Therefore, where a swap is between two non-registrants that are
guaranteed or conduit affiliates, the Commission believes that the swap
has a ``direct and significant connection with activities in, or effect
on, commerce of the United States'' within the meaning of CEA section
2(i) so that certain Entity-Level and Transaction-Level Requirements
would apply to the swap counterparties. Consistent with section 2(i),
however, the Commission's policy generally is to make the parties to
the swap eligible for substituted compliance (except with regard to
Large Trader Reporting, and provided that SDR Reporting would be
eligible for substituted compliance only if the Commission has direct
access to all of the reported swap data elements that are stored at a
foreign trade repository).
c. Swaps Where Neither or Only One of the Parties is a Guaranteed or
Conduit Affiliate
With respect to swaps between two non-registrants where neither or
only one party is a guaranteed or conduit affiliate, the Commission's
policy is that the parties to the swap generally should not be expected
to comply with the Non-Registrant Requirements, except as described
below.
As discussed above, where a counterparty to a swap is a guaranteed
or conduit affiliate, the risks to U.S. persons and to the U.S.
financial system increase. In the case of guarantees by U.S. persons,
if there is a default by the non-U.S. person, the U.S. guarantor would
be held responsible to settle the obligations. In the case of affiliate
conduits, a non-U.S. affiliate could effectively operate as a
``conduit'' for the U.S. person, and could be used to execute swaps
with counterparties in foreign jurisdictions, outside the Dodd-Frank
Act regulatory regime. Nevertheless, the Commission also recognizes
that foreign jurisdictions may have an interest in regulating swaps
between two non-registrants where both counterparties to the swap are
non-U.S. persons. Therefore, consistent with international comity
principles, the Commission would generally expect the parties to the
swap only to comply with (to the extent that the Inter-Affiliate
Exemption is elected), the conditions of the Inter-Affiliate Exemption,
including the treatment of outward-facing swaps condition in Commission
regulation 50.52(b)(4)(i), and Large Trader Reporting. The Commission
believes that this policy strikes the right balance between U.S.
interests in regulating such a swap and the interest of foreign
regulators.
V. Appendix A--The Entity-Level Requirements
A. First Category of Entity-Level Requirements
The First Category of Entity-Level Requirements includes capital
adequacy, chief compliance officer, risk management, and swap data
recordkeeping (except certain aspects of swap data recordkeeping
relating to complaints and sales materials).
1. Capital Adequacy
Section 4s(e)(2)(B) of the CEA specifically directs the Commission
to set capital requirements for swap dealers and MSPs that are not
subject to the capital requirements of U.S. prudential regulators
(hereinafter referred to as ``non-bank swap dealers or
[[Page 45365]]
MSPs'').\621\ With respect to the use of swaps that are not cleared,
these requirements must: ``(1) [h]elp ensure the safety and soundness
of the swap dealer or major swap participant; and (2) [be] appropriate
for the risk associated with the non-cleared swaps held as a swap
dealer or major swap participant.'' \622\ Pursuant to section 4s(e)(3),
the Commission proposed regulations, which would require non-bank swap
dealers and MSPs to hold a minimum level of adjusted net capital (i.e.,
``regulatory capital'') based on whether the non-bank swap dealer or
MSP is: (i) also a FCM; (ii) not an FCM, but is a non-bank subsidiary
of a bank holding company; or (iii) neither an FCM nor a non-bank
subsidiary of a bank holding company.\623\ The primary purpose of the
capital requirement is to reduce the likelihood and cost of a swap
dealer's or MSP's default by requiring a financial cushion that can
absorb losses in the event of the firm's default.
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\621\ See 7 U.S.C. 6s(e)(2)(B). Section 4s(e) of the CEA
explicitly requires the adoption of rules establishing capital and
margin requirements for swap dealers and MSPs, and applies a
bifurcated approach that requires each swap dealer and MSP for which
there is a U.S. prudential regulator to meet the capital and margin
requirements established by the applicable prudential regulator, and
each swap dealer and MSP for which there is no prudential regulator
to comply with the Commission's capital and margin regulations. See
7 U.S.C. 6s(e). Further, systemically important financial
institutions (``SIFIs'') that are not FCMs would be exempt from the
Commission's capital requirements, and would comply instead with
Federal Reserve Board requirements applicable to SIFIs, while
nonbank (and non-FCM) subsidiaries of U.S. bank holding companies
would calculate their Commission capital requirement using the same
methodology specified in Federal Reserve Board regulations
applicable to the bank holding company, as if the subsidiary itself
were a bank holding company. The term ``prudential regulator'' is
defined in CEA section 1a(39) as the Board of Governors of the
Federal Reserve System, the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation, the Farm Credit
Administration, and the Federal Housing Finance Agency. See 7 U.S.C.
1a(39). In addition, in the proposed capital regulations for swap
dealers and MSPs, the Commission solicited comment regarding whether
it would be appropriate to permit swap dealers and MSPs to use
internal models for computing market risk and counterparty credit
risk charges for capital purposes if such models had been approved
by a foreign regulatory authority and were subject to periodic
assessment by such foreign regulatory authority. See Proposed
Capital Requirements, 76 FR 27802.
\622\ See 7 U.S.C. 6s(e)(3)(A).
\623\ See 7 U.S.C. 6s(e). See also Proposed Capital
Requirements, 76 FR 27802. ``The Commission's capital proposal for
[swap dealers] and MSPs includes a minimum dollar level of $20
million. A non-bank [swap dealer] or MSP that is part of a U.S. bank
holding company would be required to maintain a minimum of $20
million of Tier 1 capital as measured under the capital rules of the
Federal Reserve Board. [A swap dealer] or MSP that also is
registered as an FCM would be required to maintain a minimum of $20
million of adjusted net capital as defined under [proposed] section
1.17. In addition, an [swap dealer] or MSP that is not part of a
U.S. bank holding company or registered as an FCM would be required
to maintain a minimum of $20 million of tangible net equity, plus
the amount of the [swap dealer's] or MSP's market risk exposure and
OTC counterparty credit risk exposure.'' See id. at 27817.
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2. Chief Compliance Officer
Section 4s(k) requires that each swap dealer and MSP designate an
individual to serve as its chief compliance officer (``CCO'') and
specifies certain duties of the CCO.\624\ Pursuant to section 4s(k),
the Commission adopted regulation 3.3, which requires swap dealers and
MSPs to designate a CCO who would be responsible for administering the
firm's compliance policies and procedures, reporting directly to the
board of directors or a senior officer of the swap dealer or MSP, as
well as preparing and filing with the Commission a certified report of
compliance with the CEA. The chief compliance function is an integral
element of a firm's risk management and oversight and the Commission's
effort to foster a strong culture of compliance within swap dealers and
MSPs.
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\624\ See 7 U.S.C. 6s(k).
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3. Risk Management
Section 4s(j) of the CEA requires each swap dealer and MSP to
establish internal policies and procedures designed to, among other
things, address risk management, monitor compliance with position
limits, prevent conflicts of interest, and promote diligent
supervision, as well as maintain business continuity and disaster
recovery programs.\625\ The Commission adopted implementing regulations
(23.600, 23.601, 23.602, 23.603, 23.605, and 23.606).\626\ The
Commission also adopted regulation 23.609, which requires certain risk
management procedures for swap dealers or MSPs that are clearing
members of a derivatives clearing organization (``DCO'').\627\
Collectively, these requirements help to establish a robust and
comprehensive internal risk management program for swap dealers and
MSPs, which is critical to effective systemic risk management for the
overall swaps market.
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\625\ 7 U.S.C. 6s(j).
\626\ See Final Swap Dealer and MSP Recordkeeping Rule, 77 FR
20128 (relating to risk management program, monitoring of position
limits, business continuity and disaster recovery, conflicts of
interest policies and procedures, and general information
availability, respectively).
\627\ Customer Documentation Rule, 77 FR 21278. Also, swap
dealers must comply with Commission regulation 23.608, which
prohibits swap dealers providing clearing services to customers from
entering into agreements that would: (i) Disclose the identity of a
customer's original executing counterparty; (ii) limit the number of
counterparties a customer may trade with; (iii) impose counterparty-
based position limits; (iv) impair a customer's access to execution
of a trade on terms that have a reasonable relationship to the best
terms available; or (v) prevent compliance with specified time
frames for acceptance of trades into clearing.
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i. Swap Data Recordkeeping (Except Certain Aspects of Swap Data
Recordkeeping Relating to Complaints and Sales Materials)
CEA section 4s(f)(1)(B) requires swap dealers and MSPs to keep
books and records for all activities related to their business.\628\
Sections 4s(g)(1) and (4) require swap dealers and MSPs to maintain
trading records for each swap and all related records, as well as a
complete audit trail for comprehensive trade reconstructions.\629\
Pursuant to these provisions, the Commission adopted regulations
23.201and 23.203, which require swap dealers and MSPs to keep records
including complete transaction and position information for all swap
activities, including documentation on which trade information is
originally recorded. Pursuant to regulation 23.203, records of swaps
must be maintained for the duration of the swap plus 5 years, and voice
recordings for 1 year, and records must be ``readily accessible'' for
the first 2 years of the 5 year retention period. Swap dealers and MSPs
also must comply with Parts 43, 45 and 46 of the Commission's
regulations, which, respectively, address the data recordkeeping and
reporting requirements for all swaps subject to the Commission's
jurisdiction, including swaps entered into before the date of enactment
of the Dodd-Frank Act (``pre-enactment swaps'') and swaps entered into
on or after the date of enactment of the Dodd-Frank Act but prior to
the compliance date of the swap data reporting rules (``transition
swaps'').\630\
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\628\ 7 U.S.C. 6s(f)(1)(B).
\629\ 7 U.S.C. 6s(g)(1).
\630\ 17 CFR part 46; Proposed Data Rules, 76 FR 22833.
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B. Second Category of Entity-Level Requirements
The Second Category of Entity-Level Requirements includes SDR
Reporting, certain aspects of swap data recordkeeping relating to
complaints and marketing and sales materials under Commission
regulations 23.201(b)(3) and 23.201(b)(4) and Large Trader Reporting.
1. SDR Reporting
CEA section 2(a)(13)(G) requires all swaps, whether cleared or
uncleared, to be reported to a registered SDR.\631\ CEA section 21
requires SDRs to collect and maintain data related to swaps as
prescribed by the Commission, and to
[[Page 45366]]
make such data electronically available to particular regulators under
specified conditions related to confidentiality.\632\ Part 45 of the
Commission's regulations (and Appendix 1 thereto) sets forth the
specific swap data that must be reported to a registered SDR, along
with attendant recordkeeping requirements; and part 46 addresses
recordkeeping and reporting requirements for pre-enactment and
transition swaps (``historical swaps''). The fundamental goal of the
part 45 rules is to ensure that complete data concerning all swaps
subject to the Commission's jurisdiction is maintained in SDRs where it
will be available to the Commission and other financial regulators for
fulfillment of their various regulatory mandates, including systemic
risk mitigation, market monitoring and market abuse prevention. Part 46
supports similar goals with respect to pre-enactment and transition
swaps and ensures that data needed by regulators concerning
``historical'' swaps is available to regulators through SDRs. Among
other things, data reported to SDRs will enhance the Commission's
understanding of concentrations of risks within the market, as well as
promote a more effective monitoring of risk profiles of market
participants in the swaps market. The Commission also believes that
there are benefits that will accrue to swap dealers and MSPs as a
result of the timely reporting of comprehensive swap transaction data
and consistent data standards for recordkeeping, among other things.
Such benefits include more robust risk monitoring and management
capabilities for swap dealers and MSPs, which in turn will improve the
monitoring of their current swaps market positions.
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\631\ 7 U.S.C. 2(a)(13)(G).
\632\ 7 U.S.C. 24a.
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2. Swap Data Recordkeeping Relating to Complaints and Marketing and
Sales Materials
CEA section 4s(f)(1) requires swap dealers and MSPs to ``make such
reports as are required by the Commission by rule or regulation
regarding the transactions and positions and financial condition of the
registered swap dealer or major swap participant.'' \633\ Additionally,
CEA section 4s(h) requires swap dealers and MSPs to ``conform with such
business conduct standards . . . as may be prescribed by the Commission
by rule or regulation.'' \634\ Pursuant to those authorities, the
Commission promulgated final rules that set forth certain reporting and
recordkeeping for swap dealers and MSPs.\635\ Commission Regulation
23.201 states that ``[e]ach swap dealer and major swap participant
shall keep full, complete, and systematic records of all activities
related to its business as a swap dealer or major swap participant.''
Such records must include, among other things, ``[a] record of each
complaint received by the swap dealer or major swap participant
concerning any partner, member, officer, employee, or agent,'' \636\ as
well as ``[a]ll marketing and sales presentations, advertisements,
literature, and communications.'' \637\
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\633\ 7 U.S.C. 6s(f)(1).
\634\ 7 U.S.C. 6s(h)(1). See 7 U.S.C. 6s(h)(3).
\635\ Final Swap Dealer and MSP Recordkeeping Rule, 77 FR 20128.
\636\ 17 CFR 23.201(b)(3)(i).
\637\ 17 CFR 23.201(b)(4).
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3. Physical Commodity Large Swaps Trader Reporting (Large Trader
Reporting)
CEA section 4t \638\ authorizes the Commission to establish a large
trader reporting system for significant price discovery swaps (of which
the economically equivalent swaps subject to the Commission's part 20
rules are a subset). Pursuant thereto, the Commission adopted its Large
Trader Reporting rules (part 20 of the Commission regulations), which
require routine reports from swap dealers, among other entities, that
hold significant positions in swaps that are linked, directly or
indirectly, to a prescribed list of U.S.-listed physical commodity
futures contracts.\639\ Additionally, Large Trader Reporting requires
that swap dealers, among other entities, comply with certain
recordkeeping obligations.
---------------------------------------------------------------------------
\638\ 7 U.S.C. 6t.
\639\ Large Trader Reporting for Physical Commodity Swaps, 76 FR
43851. The rules require routine position reporting by clearing
organizations, as well as clearing members and swap dealers with
reportable positions in the covered physical commodity swaps. The
rules also establish recordkeeping requirements for clearing
organizations, clearing members and swap dealers, as well as traders
with positions in the covered physical commodity swaps that exceed a
prescribed threshold. In general, the rules apply to swaps that are
linked, directly or indirectly, to either the price of any of the 46
U.S.-listed physical commodity futures contracts the Commission
enumerates (Covered Futures Contracts) or the price of the physical
commodity at the delivery location of any of the Covered Futures
Contracts.
---------------------------------------------------------------------------
VI. Appendix B--The Transaction-Level Requirements
The Transaction-Level Requirements cover a range of Dodd-Frank
requirements: some of the requirements more directly address financial
protection of swap dealers (or MSPs) and their counterparties; others
address more directly market efficiency and/or price discovery.
Further, some of the Transaction-Level Requirements can be classified
as Entity-Level Requirements and applied on a firm-wide basis across
all swaps or activities. Nevertheless, in the interest of comity
principles, the Commission believes that the Transaction-Level
Requirements may be applied on a transaction-by-transaction basis.
A. Category A: Risk Mitigation and Transparency
1. Required Clearing and Swap Processing
Section 2(h)(1) of the CEA requires a swap to be submitted for
clearing to a DCO if the Commission has determined that the swap is
required to be cleared, unless one of the parties to the swap is
eligible for an exception from the clearing requirement and elects not
to clear the swap.\640\ Clearing via a DCO mitigates the counterparty
credit risk between swap dealers or MSPs and their counterparties.
---------------------------------------------------------------------------
\640\ 7 U.S.C. 2(h)(1), (7).
---------------------------------------------------------------------------
Commission regulations implementing the first designations of swaps
for required clearing were published in the Federal Register on
December 13, 2012.\641\ Under Commission regulation 50.2, all persons
executing a swap that is included in a class of swaps identified under
Commission regulation 50.4 must submit such swap to an eligible
derivatives clearing organization (DCO) for clearing as soon as
technologically practicable after clearing, but in any event by the end
of the day of execution.
---------------------------------------------------------------------------
\641\ 77 FR 72284.
---------------------------------------------------------------------------
Regulation 50.4 establishes required clearing for certain classes
of swaps. Currently, those classes include, for credit default swaps:
Specified series of untranched North American CDX indices and European
iTraxx indices; and for interest rate swaps: Fixed-to-floating swaps,
basis swaps, forward rate agreements referencing U.S. Dollar, Euro,
Sterling, and Yen, and overnight index swaps referencing U.S. Dollar,
Euro, and Sterling. Each of the six classes is further defined in
Commission regulation 50.4. Swaps that have the specifications
identified in the regulation are required to be cleared and must be
cleared pursuant to the rules of any eligible DCO unless an exception
or exemption specified in the CEA or the Commission's regulations
applies.
Generally, if a swap is subject to Section 2(h)(1)(A) of the CEA
and part 50 of the Commission's regulations, it must be cleared through
an eligible DCO, unless: (i) One of the counterparties is eligible for
and elects
[[Page 45367]]
the End-User Exception under Commission regulation 50.50; \642\ or (ii)
both counterparties are eligible for and elect an Inter-Affiliate
Exemption under Commission regulation 50.52. To elect either the end-
user exception or the Inter-Affiliate Exemption, the electing party or
parties and the swap must meet certain requirements set forth in the
regulations.
---------------------------------------------------------------------------
\642\ See End-User Exception to the Clearing Requirement for
Swaps, 77 FR 42560 (Jul. 19, 2012).
---------------------------------------------------------------------------
Closely connected with the clearing requirement are the following
swap processing requirements: (i) Commission regulation 23.506, which
requires swap dealers and MSPs to submit swaps promptly for clearing;
and (ii) Commission regulations 23.610 and 39.12, which establish
certain standards for swap processing by DCOs and/or swap dealers and
MSPs that are clearing members of a DCO.\643\ Together, required
clearing and swap processing requirements promote safety and soundness
of swap dealers and MSPs, and mitigate the credit risk posed by
bilateral swaps between swap dealers or MSPs and their
counterparties.\644\
---------------------------------------------------------------------------
\643\ See Final Customer Documentation Rules, 77 FR 21278.
\644\ See section IV.H, supra, regarding the application of
required clearing rules to market participants that are not
registered as swap dealers or MSPs, including the circumstances
under which the parties to such swaps would be eligible for
substituted compliance.
---------------------------------------------------------------------------
2. Margin and Segregation Requirements for Uncleared Swaps
Section 4s(e) of the CEA requires the Commission to set margin
requirements for swap dealers and MSPs that trade in swaps that are not
cleared.\645\ The margin requirements ensure that outstanding current
and potential future risk exposures between swap dealers and their
counterparties are collateralized, thereby reducing the possibility
that swap dealers or MSPs take on excessive risks without having
adequate financial backing to fulfill their obligations under the
uncleared swap. In addition, with respect to swaps that are not
submitted for clearing, section 4s(l) requires that a swap dealer or
MSP notify the counterparty of its right to request that funds provided
as margin be segregated, and upon such request, to segregate the funds
with a third-party custodian for the benefit of the counterparty. In
this way, the segregation requirement enhances the protections offered
through margining uncleared swaps and thereby provides additional
financial protection to counterparties. The Commission is working with
foreign and domestic regulators to develop and finalize appropriate
regulations for margin and segregation requirements.
---------------------------------------------------------------------------
\645\ See 7 U.S.C. 6s(e). See also Proposed Margin Requirements,
76 FR at 23733-23740. Section 4s(e) explicitly requires the adoption
of rules establishing margin requirements for swap dealers and MSPs,
and applies a bifurcated approach that requires each swap dealer and
MSP for which there is a prudential regulator to meet the margin
requirements established by the applicable prudential regulator, and
each swap dealer and MSP for which there is no prudential regulator
to comply with the Commission's margin regulations. In contrast, the
segregation requirements in section 4s(1) do not use a bifurcated
approach--that is, all swap dealers and MSPs are subject to the
Commission's rule regarding notice and third party custodians for
margin collected for uncleared swaps.
---------------------------------------------------------------------------
3. Trade Execution
Integrally linked to the clearing requirement is the trade
execution requirement, which is intended to bring the trading of
mandatorily cleared swaps that are made available to trade onto
regulated exchanges or execution facilities. Specifically, section
2(h)(8) of the CEA provides that unless a clearing exception applies
and is elected, a swap that is subject to a clearing requirement must
be executed on a DCM or SEF, unless no such DCM or SEF makes the swap
available to trade.\646\ Commission regulations implementing the
process for a DCM or SEF to make a swap available to trade were
published in the Federal Register on June 4, 2013.\647\ Under
Commission regulations 37.10 and 38.12, respectively, a SEF or DCM may
submit a determination for Commission review that a mandatorily cleared
swap is available to trade based on enumerated factors. By requiring
the trades of mandatorily cleared swaps that are made available to
trade to be executed on an exchange or an execution facility--each with
its attendant pre- and post-trade transparency and safeguards to ensure
market integrity--the trade execution requirement furthers the
statutory goals of financial stability, market efficiency, and enhanced
transparency.
---------------------------------------------------------------------------
\646\ See 7 U.S.C. 2(h)(8).
\647\ 78 FR 33606.
---------------------------------------------------------------------------
4. Swap Trading Relationship Documentation
CEA section 4s(i) requires each swap dealer and MSP to conform to
Commission standards for the timely and accurate confirmation,
processing, netting, documentation and valuation of swaps.\648\
Pursuant thereto, Commission regulation 23.504(a) requires swap dealers
and MSPs to ``establish, maintain and enforce written policies and
procedures'' to ensure that the swap dealer or MSP executes written
swap trading relationship documentation.\649\ Under Commission
regulation 23.504, the swap trading relationship documentation must
include, among other things: all terms governing the trading
relationship between the swap dealer or MSP and its counterparty;
credit support arrangements; investment and re-hypothecation terms for
assets used as margin for uncleared swaps; and custodial
arrangements.\650\ Further, the swap trading relationship documentation
requirement applies to all swaps with registered swap dealers and MSPs.
In addition, Commission regulation 23.505 requires swap dealers and
MSPs to document certain information in connection with swaps for which
exceptions from required clearing are elected.\651\ A robust swap
documentation standard may promote standardization of documents and
transactions, which are key conditions for central clearing, and lead
to other operational efficiencies, including improved valuation and
risk management.
---------------------------------------------------------------------------
\648\ See 7 U.S.C. 6s(i).
\649\ See Final Confirmation Rules, 77 FR 55904.
\650\ The requirements under section 4s(i) relating to trade
confirmations is a Transaction-Level Requirement. Accordingly,
Commission regulation 23.504(b)(2) requires a swap dealer's and
MSP's swap trading relationship documentation to include all
confirmations of swaps, will apply on a transaction-by-transaction
basis.
\651\ See Final Confirmation Rules, 77 FR at 55964.
---------------------------------------------------------------------------
5. Portfolio Reconciliation and Compression
CEA section 4s(i) directs the Commission to prescribe regulations
for the timely and accurate processing and netting of all swaps entered
into by swap dealers and MSPs. Pursuant to CEA section 4s(i), the
Commission adopted regulations (23.502 and 23.503), which require swap
dealers and MSPs to perform portfolio reconciliation and compression,
respectively, for all swaps.\652\ Portfolio reconciliation is a post-
execution risk management tool to ensure accurate confirmation of a
swap's terms and to identify and resolve any discrepancies between
counterparties regarding the valuation of the swap. Portfolio
compression is a post-trade processing and netting mechanism that is
intended to ensure timely, accurate processing and netting of
swaps.\653\ Regulation 23.503 requires all swap dealers and MSPs to
participate in bilateral compression exercises and/or multilateral
portfolio compression
[[Page 45368]]
exercises conducted by a third party.\654\ The rule also requires
policies and procedures for engaging in such exercises for uncleared
swaps with non-swap dealers and non-MSPs upon request. Further,
participation in multilateral portfolio compression exercises is
mandatory for dealer-to-dealer trades.
---------------------------------------------------------------------------
\652\ See id.
\653\ For example, the reduced transaction count may decrease
operational risk as there are fewer trades to maintain, process, and
settle.
\654\ See 17 CFR 23.503(c); Confirmation NPRM, 75 FR 81519.
---------------------------------------------------------------------------
6. Real-Time Public Reporting
Section 2(a)(13) of the CEA also directs the Commission to
promulgate rules providing for the public availability of swap
transaction and pricing data on a real-time basis.\655\ In accordance
with this mandate, the Commission promulgated part 43 of its
regulations, which provide that all ``publicly reportable swap
transactions'' must be reported and publicly disseminated, and which
establish the method, manner, timing and particular transaction and
pricing data that must be reported by parties to a swap
transaction.\656\ The real-time dissemination of swap transaction and
pricing data supports the fairness and efficiency of markets and
increases transparency, which in turn improves price discovery and
decreases risk (e.g., liquidity risk).\657\
---------------------------------------------------------------------------
\655\ See 7 U.S.C. 2(a)(13). See also Real-Time Reporting Rule,
77 FR 1183.
\656\ Part 43 defines a ``publicly reportable swap transaction''
as: (i) Any swap that is an arm's-length transaction between two
parties that results in a corresponding change in the market risk
position between the two parties; or (ii) any termination,
assignment, novation, exchange, transfer, amendment, conveyance, or
extinguishing of rights or obligations of a swap that changes the
pricing of a swap. See Real-Time Reporting Rule, 77 FR 1182.
Additionally, the Commission adopted regulation 23.205, which
directs swap dealers and MSPs to undertake such reporting and to
have the electronic systems and procedures necessary to transmit
electronically all information and data required to be reported in
accordance with part 43. See Final Swap Dealer and MSP Recordkeeping
Rule, 77 FR 20205.
\657\ See Real-Time Reporting Rule, 77 FR 1183.
---------------------------------------------------------------------------
7. Trade Confirmation
Section 4s(i) of the CEA \658\ requires that each swap dealer and
MSP must comply with the Commission's regulations prescribing timely
and accurate confirmation of swaps. The Commission has adopted
regulation 23.501, which requires, among other things, a timely and
accurate confirmation of swap transactions (which includes execution,
termination, assignment, novation, exchange, transfer, amendment,
conveyance, or extinguishing of rights or obligations of a swap) among
swap dealers and MSPs by the end of the first business day following
the day of execution.\659\ Timely and accurate confirmation of swaps--
together with portfolio reconciliation and compression--are important
post-trade processing mechanisms for reducing risks and improving
operational efficiency.\660\
---------------------------------------------------------------------------
\658\ 7 U.S.C. 6s(i).
\659\ See Final Confirmation Rules, 77 FR 55904.
\660\ In addition, the Commission notes that regulation
23.504(b)(2) requires that the swap trading relationship
documentation of swap dealers and MSPs must include all
confirmations of swap transactions.
---------------------------------------------------------------------------
8. Daily Trading Records
Pursuant to section CEA 4s(g), the Commission adopted regulation
23.202, which requires swap dealers and MSPs to maintain daily trading
records, including records of trade information related to pre-
execution, execution, and post-execution data that is needed to conduct
a comprehensive and accurate trade reconstruction for each swap. The
final rule also requires that records be kept of cash or forward
transactions used to hedge, mitigate the risk of, or offset any swap
held by the swap dealer or MSP.\661\ Accurate and timely recordkeeping
regarding all phases of a swap transaction can serve to greatly enhance
a firm's internal supervision, as well as the Commission's ability to
detect and address market or regulatory abuses or evasion.
---------------------------------------------------------------------------
\661\ See Final Swap Dealer and MSP Recordkeeping Rule, 77 FR
20128.
---------------------------------------------------------------------------
B. Category B: External Business Conduct Standards
Pursuant to CEA section 4s(h), the Commission has adopted external
business conduct rules, which establish business conduct standards
governing the conduct of swap dealers and MSPs in dealing with their
counterparties in entering into swaps.\662\ Broadly speaking, these
rules are designed to enhance counterparty protection by significantly
expanding the obligations of swap dealers and MSPs towards their
counterparties. Under these rules, swap dealers and MSPs will be
required, among other things, to conduct due diligence on their
counterparties to verify eligibility to trade, provide disclosure of
material information about the swap to their counterparties, provide a
daily mid-market mark for uncleared swaps and, when recommending a swap
to a counterparty, make a determination as to the suitability of the
swap for the counterparty based on reasonable diligence concerning the
counterparty.
---------------------------------------------------------------------------
\662\ See 7 U.S.C. 6s(h). See also External Business Conduct
Rules, 77 FR 9822-9829.
---------------------------------------------------------------------------
VII. Appendix C--Application of the Entity-Level Requirements to Swap
Dealers and MSPs *
------------------------------------------------------------------------
------------------------------------------------------------------------
U.S. Swap Dealer or MSP (including an Apply.
affiliate of a non-U.S. person). Also
applies when acting through a foreign
branch.\1\
Non-U.S. Swap Dealer or MSP (including First Category: \2\ Substituted
an affiliate of a U.S. person).. Compliance.
Second Category: \3\ Apply for
U.S. counterparties;
Substituted Compliance for SDR
reporting with non-U.S.
counterparties that are not
guaranteed or conduit
affiliates; Substituted
compliance (except for Large
Trader Reporting) with non-
U.S. counterparties.\4\
------------------------------------------------------------------------
* The Appendices to the Guidance should be read in conjunction with the
rest of the Guidance.
------------------------------------------------------------------------
\1\ Both Entity-Level and Transaction-Level Requirements are the
ultimate responsibilities of the U.S.-based swap dealer or MSP.
\2\ First Category is capital adequacy, Chief Compliance Officer, risk
management, and swap data recordkeeping (except Commission regulations
23.201(b)(3) and (4)).
\3\ Second Category is SDR Reporting, certain aspects of swap data
recordkeeping relating to complaints and marketing and sales materials
(Commission regulations 23.201(b)(3) and (4)), and Large Trader
Reporting.
\4\ Substituted compliance does not apply to Large Trader Reporting,
i.e., non-U.S. persons that are subject to part 20 would comply with
it in the same way that U.S. persons comply. With respect to the SDR
Reporting requirement, the Commission may make substituted compliance
available only if direct access to swap data stored at a foreign trade
repository is provided to the Commission.
[[Page 45369]]
VIII. Appendix D--Application of the Category A Transaction-Level
Requirements to Swap Dealers and MSPs *
(Category A includes (1) Clearing and swap processing; (2) Margining
and segregation for uncleared swaps; (3) Trade Execution; (4) Swap
trading relationship documentation; (5) Portfolio reconciliation and
compression; (6) Real-time public reporting; (7) Trade confirmation;
and (8) Daily trading records).**
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. Person (other than Non-U.S. Person
Foreign Branch of U.S. Foreign Branch of U.S. Guaranteed by, or Non-U.S. Person Not Guaranteed by, and
Bank that is a Swap Bank that is a Swap Affiliate Conduit \1\ Not an Affiliate Conduit \1\ of, a
Dealer or MSP) Dealer or MSP of, a U.S. Person U.S. Person
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. Swap Dealer or MSP (including Apply.................. Apply.................. Apply................. Apply.
an affiliate of a non-3U.S. person).
Foreign Branch of U.S. Bank that is Apply.................. Substituted Compliance. Substituted Substituted Compliance.\2\
a Swap Dealer or MSP. Compliance.\2\
Non-U.S. Swap Dealer or MSP Apply.................. Substituted Compliance. Substituted Compliance Do Not Apply.
(including an affiliate of a U.S.
person).
--------------------------------------------------------------------------------------------------------------------------------------------------------
* The Appendices to the Guidance should be read in conjunction with the rest of the Guidance.
--------------------------------------------------------------------------------------------------------------------------------------------------------
** Where one of the counterparties is electing the Inter-Affiliate Exemption, the Commission would expect the parties to the swap to comply with the
conditions of the Inter-Affiliate Exemption, including the treatment of outward-facing swaps condition in Commission regulation 50.52(b)(4)(i).
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Factors that are relevant to the consideration of whether a non-U.S. person is an ``affiliate conduit'' include whether: (i) the non-U.S. person is
majority-owned, directly or indirectly, by a U.S. person; (ii) the non-U.S. person controls, is controlled by, or is under common control with the
U.S. person; (iii) the non-U.S. person, in the regular course of business, engages in swaps with non-U.S. third party(ies) for the purpose of hedging
or mitigating risks faced by, or to take positions on behalf of, its U.S. affiliate(s), and enters into offsetting swaps or other arrangements with
such U.S. affiliate(s) in order to transfer the risks and benefits of such swaps with third-party(ies) to its U.S. affiliates; and (iv) the financial
results of the non-U.S. person are included in the consolidated financial statements of the U.S. person. Other facts and circumstances also may be
relevant.
\2\ Under a limited exception, where a swap between the foreign branch of a U.S. swap dealer or U.S. MSP and a non-U.S. person (that is not a guaranteed
or conduit affiliate) takes place in a foreign jurisdiction other than Australia, Canada, the European Union, Hong Kong, Japan, or Switzerland, the
counterparties generally may comply only with the transaction-level requirements in the foreign jurisdiction where the foreign branch is located if
the aggregate notional value of all the swaps of the U.S. swap dealer's foreign branches in such countries does not exceed 5% of the aggregate
notional value of all of the swaps of the U.S. swap dealer, and the U.S. person maintains records with supporting information for the 5% limit and to
identify, define, and address any significant risk that may arise from the non-application of the Transaction-Level Requirements.
Notes:
\1\ The swap trading relationship documentation requirement applies to all transactions with registered swap dealers and MSPs.
\2\ Participation in multilateral portfolio compression exercises is mandatory for dealer to dealer trades.
IX. Appendix E--Application of the Category B Transaction-Level
Requirements to Swap Dealers and MSPs *
(Category B is External Business Conduct Standards).
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. Person (other than Non-U.S. Person
Foreign Branch of U.S. Foreign Branch of U.S. Guaranteed by, or Non-U.S. Person Not Guaranteed by, and
Bank that is a Swap Bank that is a Swap Affiliate Conduit \1\ Not an Affiliate Conduit \1\ of, a U.S.
Dealer or MSP) Dealer or MSP of, a U.S. Person Person
--------------------------------------------------------------------------------------------------------------------------------------------------------
U.S. Swap Dealer or MSP (including Apply.................. Apply.................. Apply................. Apply.
an.
affiliate of a non-U.S. person).....
U.S. Swap Dealer or MSP (when it Apply.................. Do Not Apply........... Do Not Apply.......... Do Not Apply.
solicits and negotiates through a
foreign subsidiary or affiliate).
Foreign Branch of U.S. Bank that is Apply.................. Do Not Apply........... Do Not Apply.......... Do Not Apply.
a Swap Dealer or MSP.
Non-U.S. Swap Dealer or MSP Apply.................. Do Not Apply........... Do Not Apply.......... Do Not Apply.
(including an affiliate of a U.S.
person).
--------------------------------------------------------------------------------------------------------------------------------------------------------
*The Appendices to the Guidance should be read in conjunction with the rest of the Guidance.
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Factors that are relevant to the consideration of whether a non-U.S. person is an ``affiliate conduit'' include whether: (i) the non-U.S. person is
majority-owned, directly or indirectly, by a U.S. person; (ii) the non-U.S. person controls, is controlled by, or is under common control with the
U.S. person; (iii) the non-U.S. person, in the regular course of business, engages in swaps with non-U.S. third party(ies) for the purpose of hedging
or mitigating risks faced by, or to take positions on behalf of, its U.S. affiliate(s), and enters into offsetting swaps or other arrangements with
such U.S. affiliate(s) in order to transfer the risks and benefits of such swaps with third-party(ies) to its U.S. affiliates; and (iv) the financial
results of the non-U.S. person are included in the consolidated financial statements of the U.S. person. Other facts and circumstances also may be
relevant.
[[Page 45370]]
X. Appendix F--Application of Certain Entity-Level and Transaction-
Level Requirements to Non-Swap Dealer/Non-MSP Market Participants*
(The relevant Dodd-Frank requirements are those relating to: clearing,
trade execution, real-time public reporting, Large Trader Reporting,
SDR Reporting and swap data recordkeeping).**
----------------------------------------------------------------------------------------------------------------
Non-U.S. Person Non-U.S. Person Not
U.S. Person (including Guaranteed by, or Guaranteed by, or
an affiliate of non- Affiliate Conduit \1\ Affiliate Conduit \1\
U.S. person) of, a U.S. Person of, by U.S. Person
----------------------------------------------------------------------------------------------------------------
U.S. Person (including an affiliate Apply.................. Apply.................. Apply.
of non-U.S. person).
Non-U.S. Person Guaranteed by, or Apply.................. Substituted Do Not Apply.
Affiliate Conduit \1\ of, a U.S. Compliance.\2\
person.
Non-U.S. Person Not Guaranteed by, or Apply.................. Do Not Apply........... Do Not Apply.
Affiliate Conduit \1\ of, U.S.
Person.
----------------------------------------------------------------------------------------------------------------
* The Appendices to the Guidance should be read in conjunction with the rest of the Guidance.
----------------------------------------------------------------------------------------------------------------
** Where one of the counterparties is electing the Inter-Affiliate Exemption, the Commission would generally
expect the parties to the swap to comply with the conditions of the Inter-Affiliate Exemption, including the
treatment of outward-facing swaps condition in Commission regulation 50.52(b)(4)(i).
----------------------------------------------------------------------------------------------------------------
\1\ Factors that are relevant to the consideration of whether a non-U.S. person is an ``affiliate conduit''
include whether: (i) the non-U.S. person is majority-owned, directly or indirectly, by a U.S. person; (ii) the
non-U.S. person controls, is controlled by, or is under common control with the U.S. person; (iii) the non-
U.S. person, in the regular course of business, engages in swaps with non-U.S. third party(ies) for the
purpose of hedging or mitigating risks faced by, or to take positions on behalf of, its U.S. affiliate(s), and
enters into offsetting swaps or other arrangements with such U.S. affiliate(s) in order to transfer the risks
and benefits of such swaps with third-party(ies) to its U.S. affiliates; and (iv) the financial results of the
non-U.S. person are included in the consolidated financial statements of the U.S. person. Other facts and
circumstances also may be relevant.
\2\ Substituted compliance does not apply to Large Trader Reporting, i.e., non-U.S. persons that are subject to
part 20 would comply with it in the same way that U.S. persons comply. With respect to the SDR Reporting
requirement, the Commission may permit substituted compliance only if direct access to swap data stored at a
foreign trade repository is provided to the Commission.
Issued in Washington, DC, on July 17, 2013, by the Commission.
Melissa D. Jurgens,
Secretary of the Commission.
Appendices to Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations--Commission Voting Summary and
Statements of Commissioners
Note: The following appendices do not constitute a part of the
Interpretive Guidance and Policy Statement itself.
Appendix 1--Commission Voting Summary
On this matter, Chairman Gensler and Commissioners Chilton and
Wetjen voted in the affirmative; Commissioner O'Malia voted in the
negative.
Appendix 2--Statement of Chairman Gary Gensler
I support the Interpretive Guidance and Policy Statement
Regarding Compliance with Certain Swap Regulations (Guidance) and
the related phase-in exemptive order also being adopted today. With
this Commission action another important step has been taken to make
swaps market reform a reality.
This Guidance is being adopted just shy of the third anniversary
of President Obama signing the Dodd-Frank Act, and that law was
historic. It was an historic answer to an historic problem: the near
collapse of the American economy driven, in part, by the unregulated
derivatives marketplace. Congress and the President were clear in
their intention to bring transparency to this marketplace, to lower
risk to the public, and to ensure the regulation of swap dealers and
major swap participants.
In 2008, when both the financial system and the financial
regulatory system failed the public, Americans paid the price
through the crisis with their jobs, their pensions, and their homes.
We lost 8 million jobs in that crisis and thousands of businesses
shuttered. The swaps market was central to the crisis and financial
institutions operating complicated swaps businesses and offshore
entities nearly toppled the economy. Congress responded. Americans
are remarkably resilient--but the public really does expect us to
learn from the lessons of the crisis, and to do everything possible
to prevent this from happening to any of us again.
It's pretty straightforward, I think. Even though we oversee,
here at the CFTC, a complex and sometimes difficult to understand
market (my mom consistently asks me, ``Gary, what are swaps?''), the
questions the American people are looking for us to answer are
simple: Have we lowered risk? Have we brought transparency to these
markets? Have we promoted competition and openness in these markets
so that end users can get the greatest benefit when they seek to
lower their risk and focus on what they do well--which is employing
people, innovating and moving our economy forward? That is why
reform matters.
Five years after the crisis and three years after Dodd-Frank
passed, market participants are coming into compliance with the
common sense reforms that Congress and the President laid out.
Through Dodd-Frank and the rules that this agency has put in place,
no longer will the markets be opaque and dark, and we will have
transparency in the markets. In fact, throughout this year, for the
first time, the public and regulators have benefitted from reporting
to swap data repositories and reporting to the public. And later
this year, starting actually in August, facilities called swap
execution facilities will start so that the public can benefit from
greater openness and competition before the transaction occurs. And
by the end of this year, there are likely to be trade execution
mandates for interest rate and credit derivative index products, as
well.
Central clearing became required for the broader market earlier
this year, with key phase in dates to come this Fall and Winter, as
well. We have 80 swap dealers, and, yes, two major swap
participants, now provisionally registered. As part of the
responsibilities accompanying registration, they're responsible for
sales practice, record keeping and other business conduct
requirements that help lower the risk to the public.
Yesterday, we took another significant step when we and the
European Commission announced a path forward regarding joint
understandings regarding the regulation of cross border derivatives.
I want to publicly thank Commissioner Michel Barnier, his Director
General Jonathan Faull, and their staffs, the staffs at the European
Securities Market Authority, and Steven Maijoor's leadership, for
collaborating throughout the reform process. This was a significant
step forward in harmonizing and giving clarity to the markets as to
when there might be jurisdictional overlaps with regard to this
reform.
Today, we are considering two important actions, the Guidance,
as well as a related
[[Page 45371]]
phase-in exemptive order. And as you probably have heard me say
before, the nature of modern finance is that financial institutions
commonly set up hundreds, even thousands of legal entities around
the globe. In fact, the U.S.'s largest banks each have somewhere
between 2,000 and 3,000 legal entities around the globe. Some of
them have hundreds of legal entities just in the Cayman Islands
alone. We have to remind ourselves that the largest banks and
institutions are global in nature, and when a run starts on any part
of an overseas affiliate or branch of a modern financial
institution, risk comes crashing right back to our shores.
Similarly, if it's an EU financial institution and it has some
guaranteed affiliate in the U.S. or overseas that gets into trouble,
that risk can flow back to their shores. That's why, together both
we and Europe recognize the importance of covering guaranteed
affiliates, whether they're guaranteed affiliates of a U.S. person
or of an EU person.
There's no question to me, at least, that the words of Dodd-
Frank addressed this (i.e., risk importation) when they said that a
direct and significant connection with activities and/or effect on
commerce in the United States covers these risks that may come back
to us.
I want to publicly thank Chairman Barney Frank along with
Spencer Bachus, Frank Lucas, and Collin Peterson, and their staffs
for reaching out to the CFTC and the public to ask how to best
address offshore risks that could wash back to our economy in Dodd-
Frank.
In addition, we should not forget the actual events over the
past several years that remind us of the risks to the U.S. that can
be posed by offshore entities:
AIG nearly brought down the U.S. economy. Lehman Brothers had
3,300 legal entities, including a London affiliate that was
guaranteed here in the U.S., and it had 130,000 outstanding swap
transactions. Citigroup had structured investment vehicles that were
set up in the Cayman Islands, run out of London, and yet were
central to not one, but two bailouts of that institution. Bear
Stearns, in 2007 had two sinking hedge funds that had to be bailed
out by Bear Stearns--and, yes, those hedge funds were organized in
the jurisdiction of the Cayman Islands.
More than a decade earlier, I was working in my position as
Assistant Secretary of the United States Department of the Treasury.
I found myself making a call from Connecticut to then Treasury
Secretary Robert Rubin to report that Long Term Capital Management's
$1.2 trillion swaps book was not only going to go down within a day
or two, but that the business--that we thought was in Connecticut--
was actually incorporated in the Cayman Islands as a PO Box
facility.
Even last year, we had yet another reminder that branches of big
U.S. banks can bring risk back to the US. Even though they were not
the risks as large as I've just related, JPMorgan Chase's Chief
Investment Office's credit default swaps were executed primarily in
the U.K. branch.
Each of these examples demonstrated a direct and significant
connection with activities and/or an effect on commerce in the
United States. Congress knew this painful history when it provided
the cross border provisions of swaps market reform. And as market
participants asked the CFTC to provide interpretive guidance on
Congress's word, I believe that we have had to keep this painful
history in mind. Two and a half years ago, the CFTC started working
on guidance, which was published for notice and comment in June
2012, and for which we sought further input on in December 2012. We
have greatly benefitted from this public input. The Guidance the
Commission will adopt today incorporates the public's input and, I
think, appropriately interprets the cross border provisions of Dodd-
Frank.
There are four areas that I think really are important:
First, the CFTC interprets the cross-border provisions to cover
swaps between non U.S. swap dealers and guaranteed affiliates of
U.S. Persons, as well as swaps between two guaranteed affiliates
that are not swap dealers. The guidance does, as was proposed,
recognize and embrace the concept of substituted compliance where
there are comparable and comprehensive rules abroad. But the history
of AIG, Lehman Brothers, Citigroup and the others, and of guaranteed
affiliates, is a strong lesson that Congress knew when we were
approaching these issues.
Second, the definition of U.S. person in this guidance captures
offshore hedge funds and collective investment vehicles that have
their principal place of business here in the U.S., or that are
majority owned by U.S. persons. Addressing ourselves to guidance,
and yet forgetting the lessons of Long Term Capital Management or
Bear Stearns, is not in my opinion what Congress wanted.
Third, under the guidance, foreign branches, like the JPMorgan's
U.K. branch, of U.S. swap dealers may also comply with Dodd-Frank
through substituted compliance if they are appropriately ring-
fenced--that is, they are truly branches where employees and the
booking and the taxes are actually offshore in the foreign branch.
The Guidance allows, if there are comparable and comprehensive
regimes overseas and supervisory authorities overseas looking at
those branches, that those branches can avail themselves to
substituted compliance in the manner offshore guaranteed affiliates
would.
Lastly, the guidance provides that swap dealers, foreign or
U.S., transacting with U.S. persons (whether they be in New Jersey,
Maryland, Michigan, Arkansas, Iowa--I have to get all the right
states, recognizing where my fellow Commissioners come from)
anywhere in the United States, must comply with Dodd-Frank's swap
market reform. The guidance does provide, though, that U.S. Persons
can meet international people anonymously, and not only on our
exchanges called designated contract markets, but also on the new
swap execution facilities, as well as foreign boards of trade.
International parties trading on those platforms do not have to
worry about whether those swaps might make them a swap dealer, or
whether they need to worry about certain transaction level
requirements. And I think that was important to maintain and promote
the liquidity of these three very important types of platforms--
foreign boards of trade, swap execution facilities, and designated
contract markets.
In conclusion, I will be voting in support of the Guidance and
the related phase-in exemptive order also being adopted today. I'll
say more about the exemptive order in my statement of support for
that document, but I think these are both critical steps for the
Commission and swaps reform. They add to the approximately 56 final
guidance and rules that this Commission has adopted. We're well over
90 percent through the various rule and guidance writing. And the
markets are probably well towards half way implementing these
reforms. I have a deep respect for how much work market participants
are doing to come into compliance.
So now, 3 years after the passage of financial reform, and a
full year after the Commission proposed guidance with regard to the
cross border application of reform, it is time for reforms to
properly apply to and cover those activities that, as identified by
Congress in section 722(d) of the Dodd-Frank Act, have ``a direct
and significant connection with activities in, or effect on,
commerce of the United States.'' With the additional transitional
phase-in period provided by this Order, it is now time for the
public to get the full benefit of the transparency and the measures
to reduce risk included in Dodd Frank reforms.
Appendix 3--Dissenting Statement of Commissioner Scott D. O'Malia
I respectfully dissent from the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') approval of its
interpretive guidance and policy statement (``Guidance'') regarding
the cross-border application of the swaps provisions of the
Commodity Exchange Act (``CEA''), as well as from the Commission's
approval of a related exemptive order (``Exemptive Order'').
When I voted in July 2012 to issue for public comment the
proposed interpretive guidance and policy statement (``Proposed
Guidance''),\1\ I made clear that if I had been asked to vote on the
Proposed Guidance as final, my vote would have been no. I then laid
out my concerns with the Proposed Guidance, all relating to the
Commission's unsound interpretation of section 2(i) of the CEA,\2\
which governs the extraterritorial application of the CEA's swaps
provisions. Regrettably, the Guidance fails to address these
concerns and constitutes a regulatory overreach based on a weak
foundation of thin statutory and legal authority.
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\1\ Cross-Border Application of Certain Swaps Provisions of the
Commodity Exchange Act, 77 FR 41214 (July 12, 2012).
\2\ 7 U.S.C. 1 et seq.
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Like the Proposed Guidance, the Guidance: (1) Fails to
articulate a valid statutory foundation for its overbroad scope and
inconsistently applies the statute to different activities; (2)
crosses the line between interpretive guidance and rulemaking; and
(3) gives insufficient consideration to international law and
comity. These shortcomings are compounded by serious procedural
flaws in the Commission's treatment of international harmonization
and substituted compliance, as well as in its issuance of the
Exemptive Order.
[[Page 45372]]
Lack of Statutory Foundation
Section 2(i) of the CEA \3\ as amended by the Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (the ``Dodd-Frank
Act'') \4\ provides, in part, that the Commission's swap authority
``shall not apply'' to activities outside the United States unless
those activities ``have a direct and significant connection with
activities in, or effect on, commerce of the United States . . . .''
\5\ This provision is clearly a limitation on the Commission's
authority.\6\ It follows that the Commission must properly
articulate how and when the ``direct and significant'' standard is
met in order to apply Commission rules to swap activities that take
place outside of the United States.
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\3\ Sec. 2(i).
\4\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Public Law 111-203, 124 Stat. 1376 (2010).
\5\ Sec. 2(i)(1).
\6\ Stated another way, section 2(i)(1) may be read as the
following: ``[The CEA's swaps provisions enacted by the Dodd-Frank
Act] may apply to activities outside the United States only if those
activities have a direct and significant connection with activities
in, or effect on, commerce of the United States.''
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The Guidance, however, fails to do so. Instead, it treats
section 2(i) as a ready tool to expand authority rather than as a
limitation. The statutory analysis section of the Guidance is
insufficient to support the broad sweep of extraterritorial
activities that the Guidance contemplates would fall under the
Commission's jurisdiction, relying heavily on a comparison to
somewhat similar statutory language whose wholly different context
renders the comparison unpersuasive. The Guidance makes no mention
of statutes that may be more analogous to the CEA, such as the
securities or banking laws.\7\ Because the ``direct and
significant'' standard is never defined, the Guidance's attempts to
link certain requirements imposed on market participants to the
``direct and significant'' standard do not establish the requisite
jurisdictional nexus.\8\
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\7\ For a recent statutory analysis of the extraterritorial
application of the Securities and Exchange Act of 1934, see Morrison
v. Nat'l Australia Bank, 561 U.S. ---- (2010).
\8\ See Appalachian Power Co. v. Envtl. Prot. Agency, 208 F.3d
1015, 1027 (D.C. Cir. 2000) (vacating agency guidance interpreting
statutory language with practical binding effect because it did not
define subparts of the interpreted term and should have been
promulgated as a legislative rule under the APA).
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I would also like to point out that CEA section 2(i) contains a
second clause, which allows for the limited application of the
Commission's swap rules to activities outside the United States when
they violate the Commission's anti-evasion rules.\9\ Pursuant to
this clause, the Commission promulgated section 1.6 under Part 1 of
its regulations.\10\ Rather than relying on section 1.6 to address
its concerns about evasion, the Commission chose simply to reference
the same concerns in justifying its overbroad reach in the Guidance.
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\9\ 7 U.S.C. 2(i)(2) ([The CEA's swaps provisions enacted by the
Dodd-Frank Act] ``shall not apply to activities outside the United
States unless those activities . . . contravene such rules or
regulations as the Commission may prescribe or promulgate as are
necessary or appropriate to prevent the evasion of any provision of
[the CEA enacted by the Dodd-Frank Act]'').
\10\ 17 CFR 1.6.
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With such an unsound foundation for the Commission's
extraterritorial authority under the ``direct and significant''
standard, I am not surprised that the Guidance often applies section
2(i) of the CEA inconsistently and arbitrarily. Examples of
inconsistency abound.
For instance, just as with the Proposed Guidance, the Guidance
does not provide a basis for its reasoning that all Transaction-
Level Requirements described in the Guidance satisfy the ``direct
and significant'' standard under section 2(i). As I stated in my
concurrence to the Proposed Guidance, trade execution and real-time
public reporting requirements, although important for transparency
purposes, do not raise the same systemic risk concerns that clearing
and margining for uncleared swaps do. The Guidance acknowledges this
point, but does not go on to sufficiently explain why they should
be, and are, treated equally. The Guidance also acknowledges that
clearing and margining, because of their implications for systemic
risk, could be classified as Entity-Level Requirements, but it does
not explain why are they are not. The Guidance's failure to give
meaning to the ``direct and significant'' standard in its discussion
of these requirements is glaring.
Inconsistent application can also be seen within a specific
Transaction-Level Requirement, for example reporting to swap data
repositories (``SDRs''). The Guidance allows non-U.S. swap dealers
(``SDs'') and major swap participants (``MSPs'') to utilize
substituted compliance for SDR reporting of their swaps with non-
U.S. counterparties, but it does not allow for substituted
compliance for non-U.S. SD and MSPs' trades with U.S.
counterparties. Again, the Commission fails here to give real
meaning to ``direct and significant'' in order to adequately explain
its reasoning for this distinction. The rationale is even weaker
given the fact that substituted compliance is available for swaps
with non-U.S. counterparties only under the condition that the
Commission has direct access to the relevant data at the foreign
trade repository. In either case, the Commission will have direct
access to the relevant data, whether substituted compliance is
available or not. This raises the question: if the outcome is the
same, why is the distinction made? If it is different, the Guidance
does not explain how or why--despite requiring data at foreign trade
repositories to be essentially the same as data at domestic SDRs,
before the Commission even contemplates substituted compliance for
SDR reporting.
Yet another example of inconsistent application of section 2(i)
involves the requirement of physical commodity large swaps trader
reporting (``Large Trader Reporting''). In contrast to SDR
reporting, the Guidance does not allow substituted compliance for
Large Trader Reporting, even for swaps between a non-U.S. registrant
and a non-U.S. counterparty. The Commission's flimsy rationale is
that Large Trader Reporting involves data conversion to ``futures
equivalent'' units, and that it would cost too much time and
resources for the Commission to conduct this conversion on data that
it could access in a foreign trade repository. Here again, the
``direct and significant'' standard is nowhere to be found.
Moreover, the Commission overstates the burden of the ``futures
equivalent'' conversion and, more generally, the significance of
Large Trader Reporting in its oversight duties, while understating
the availability of data collected through SDR reporting, with its
eligibility for substituted compliance, to achieve the same
regulatory objectives.
Interpretive Guidance Versus Rulemaking
The imposition of requirements on market participants raises
another of my major concerns with the Guidance. I strongly disagree
with the Commission's decision to issue its position on the cross-
border application of its swaps regulations in the form of
``interpretive guidance'' instead of promulgating a legislative rule
under the Administrative Procedure Act (``APA'').\11\
---------------------------------------------------------------------------
\11\ 5 U.S.C. 551 et seq.
---------------------------------------------------------------------------
Simply putting the guise of ``guidance'' on this document does
not change its content or consequences. Where agency action has the
practical effect of binding parties within its scope, it has the
force and effect of law, regardless of the name it is given.\12\
Legally binding regulations that impose new obligations on affected
parties--``legislative rules''--must conform to the APA.\13\ On its
face, the Guidance sets out standards that it contemplates will be
regularly applied by staff to cross-border activities in the swaps
markets. Market participants cannot afford to ignore detailed
regulations imposed upon their activities that may result in
enforcement or other penalizing action.\14\ This point is underlined
by the fact that, as I discuss below, Commission staff no-action
letters have been issued in connection with compliance obligations
that have essentially been imposed by the Guidance.\15\ All of this
leads to the logical conclusion that the Guidance has a practical
binding effect and
[[Page 45373]]
should have been promulgated as a legislative rule under the APA.
---------------------------------------------------------------------------
\12\ See Gen. Elec. Co. v. Envtl. Prot. Agency, 290 F.3d 377,
380 (D.C. Cir. 2002) (finding that a guidance document is final
agency action); Appalachian Power, 208 F.3d at 1020-21.
\13\ See Chrysler Corp. v. Brown, 441 U.S. 281, 302-03 (1979)
(agency rulemaking with the force and effect of law must be
promulgated pursuant to the procedural requirements of the APA).
\14\ ``A document will have practical binding effect before it
is actually applied if the affected private parties are reasonably
led to believe that failure to conform will bring adverse
consequences . . . .'' Gen. Elec., 290 F.3d at 383 (quoting Anthony,
Robert A., Interpretive Rules, Policy Statements, Guidances,
Manuals, and the Like--Should Federal Agencies Use Them to Bind the
Public?, 41 Duke L.J. 1311 (1992)) (vacating an agency's guidance
document that the court found to have practical binding effect and
where procedures under the APA were not followed).
\15\ A no-action letter is issued by a division of the
Commission and states that, for the reasons and under the conditions
described therein, it will not recommend that the Commission
commence an enforcement action against an entity or group of
entities for failure to comply with obligations imposed by the
Commission.
---------------------------------------------------------------------------
There are important policy and legal considerations that weigh
strongly in support of rulemaking in accordance with the APA. Not
only do the safeguards enacted by Congress in the APA ensure fair
notice and public participation, they help to ensure reasoned
decision-making and accountability. In addition, the APA requires
that courts take a ``hard look'' at agency action.\16\
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\16\ The ``arbitrary and capricious'' standard of review of
agency action under the APA is a rationality analysis also known as
the hard-look doctrine:
Under the leading formulation of this doctrine, ``the agency
must examine the relevant data and articulate a satisfactory
explanation for its action including a `rational connection between
the facts found and the choices made.' '' The court ``consider[s]
whether the decision was based on a consideration of the relevant
factors and whether there has been a clear error of judgment.'' In
addition, the agency may not ``entirely fail[ ] to consider an
important aspect of the problem,'' may not ``offer[ ] an explanation
for its decision that runs counter to the evidence before the
agency,'' nor offer an explanation that is ``so implausible that it
could not be ascribed to a difference in view or the product of
agency expertise.'' The agency must also relate the factual findings
and expected effects of the regulation to the purposes or goals the
agency must consider under the statute as well as respond to salient
criticisms of the agency's reasoning.
Stack, Kevin M., Interpreting Regulations, 111 Mich. L. Rev.
355, 378-79 (2012) (internal citations omitted).
---------------------------------------------------------------------------
By issuing ``interpretive guidance'' instead of rulemaking, the
Commission has also avoided analyzing the costs and benefits of its
actions pursuant to section 15(a) of the CEA,\17\ because the CEA
requires the Commission to consider costs and benefits only in
connection with its promulgation of regulations and orders.
Compliance with the Commission's swaps regulations entails
significant costs for market participants. Avoiding cost-benefit
analysis by labeling the document as guidance is unacceptable.
---------------------------------------------------------------------------
\17\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
In my concurrence to the Proposed Guidance, I suggested that the
Commission should at least prepare a report analyzing the costs
attributable to the breadth of the Commission's new authority under
CEA section 2(i). I am disappointed, but not surprised, that the
Commission has not taken up my suggestion.
Insufficient Consideration of Principles of International Comity
Also in my concurrence to the Proposed Guidance, I pointed out
that the Commission's approach gave insufficient consideration to
principles of international comity. The Guidance suffers from the
same shortcoming.
The Commission does describe principles of international comity
in the Guidance, as it did in the Proposed Guidance. However, mere
citation is meaningless if unaccompanied by adherence. With an
interpretation of section 2(i) that essentially views the
Commission's jurisdiction as boundless, roping in all transactions
with U.S. persons regardless of the location or the regulations that
foreign regulators may have in place, the reality is that the
Commission's approach is unilateral and does not give adequate
consideration to comity principles.
These principles are crucial given the global, interconnected
nature of today's swaps markets. Properly considering these
principles--in addition to indicating respect for the international
system and the legitimate interests of other jurisdictions--
strengthens, not weakens, the Commission's ability to effectively
regulate swaps markets.
On the Path Forward to Harmonization, But a Flawed Process
In order to implement principles of international comity and
develop a harmonized global regulatory system that is both effective
and efficient, I have consistently called for meaningful cooperation
with foreign regulators. I initially did so in my concurrence to the
Proposed Guidance, and the necessity of greater collaboration was
subsequently driven home by the number and tone of comment letters
on the Proposed Guidance submitted by foreign regulators.\18\ Then,
when the Commission finalized a cross-border exemptive order last
December with an expiration date of July 12,\19\ in my concurring
statement I again urged the Commission and foreign regulators to
engage in meaningful, substantive discussions.
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\18\ The Commission received comment letters from, among others:
Jonathan Faull, European Commission; Steven Maijoor, European
Securities and Markets Authority; David Lawton and Stephen Bland, UK
Financial Services Authority; Pierre Moscovici, France Ministry of
Economy and Finance, Christian Noyer, Autorite de controle
prudential, and Jacques Delmas-Marsalet, Autorite des marches
financiers; Patrick Raaflaub and Mark Branson, Swiss Financial
Market Supervisory Authority; Masamichi Kono, Japan Financial
Services Agency, and Hideo Hayakawa, Bank of Japan; K.C. Chan,
Financial Services and Treasury Bureau of the Hong Kong Special
Administrative Region; Belinda Gibson, Australian Securities and
Investments Commission, Malcolm Edey, Reserve Bank of Australia,
Arthur Yuen, Hong Kong Monetary Authority, Keith Lui, Hong Kong
Securities and Futures Commission, and Teo Swee Lian, Monetary
Authority of Singapore. These and all public comment letters on the
Proposed Guidance are available at: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1234&ctl00--ctl00--
cphContentMain--MainContent--gvCommentList.
\19\ Final Exemptive Order Regarding Compliance With Certain
Swap Regulations, 78 FR 858 (January 7, 2013). The document was
adopted by the Commission in December 2012 and published in the
Federal Register in January 2013.
---------------------------------------------------------------------------
I am pleased that over the past several months, this engagement
has taken place and progress has been made toward harmonization.
However, we are not where we need to be: many outstanding issues and
questions remain, from data privacy concerns, to the implications of
other jurisdictions still finalizing their regulations, to a lack of
a clear, consistent and transparent framework for substituted
compliance. It would have made sense for these issues to be
addressed in the Guidance--but they are not. The looming July 12
expiration of the December exemptive order and the resulting time
crunch cannot reasonably be cited as the reason for this failure,
because July 12 is an artificial date; it could have been pushed
back in order to reach the right outcome with the right process.
Instead, while we are moving toward a workable outcome on
harmonization, the process by which we are getting there is patently
unacceptable. The most glaring example of this flawed process is
this week's publication of a Commission staff no-action letter
allowing substituted compliance for certain of the Transaction-Level
Requirements.\20\ It boggles the mind to think that a staff letter
issued by a single division, with no input from the Commission,
would be used as the vehicle for addressing such a major issue.\21\
Making matters worse, this no-action letter is outside the scope of
a forthcoming Commission decision regarding the comparability of
European rules. And the relief is not time-limited, thereby creating
an effect similar to a rulemaking. Consequently, this indefinite
exclusion not only preemptively overrides a Commission decision, but
it also seems to provide relief beyond that contemplated by the
Guidance, which calls for a re-evaluation of all substituted
compliance determinations within four years of the initial
determination.
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\20\ No-Action Relief for Registered Swap Dealers and Major Swap
Participants from Certain Requirements under Subpart I of Part 23 of
Commission Regulations in Connection with Uncleared Swaps Subject to
Risk Mitigation Techniques under EMIR, CFTC Letter No. 13-45 (July
11, 2013).
\21\ I have set forth in note 18 some of the comment letters
that the Commission has received from foreign supervisors and
regulators. By allowing substituted compliance to be addressed
through a no-action letter, is the Commission implying that, e.g.,
the Bank of Japan should accede to, e.g., decisions of the CFTC
Division of Swap Dealer and Intermediary Oversight? If so, I find
such implication inappropriate.
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Unfortunately, this is not the first instance in recent times of
staff no-action letters being used to issue Commission policy. Not
only are they an improper tool to get around formal Commission
action, their prolific use is a reflection of the ad-hoc, last-
minute approach that has been far too prevalent lately at the
Commission. I cannot emphasize this enough: the Commission must stop
this approach and get back to issuing policy in a more formal, open
and transparent manner.
Substituted Compliance
In my discussions with fellow regulators abroad and
international regulatory bodies, it is clear that there are varying
degrees of reforms being developed and implemented in respective
jurisdictions: some are comparable to U.S. regulations and some are
less stringent, but there are some that exceed the Commission's own
requirements. I would have preferred the Commission to take the past
year following the release of the Proposed Guidance to engage our
international colleagues and to involve the International
Organization of Securities Commissions (``IOSCO'') in order to
resolve the issue of harmonizing our rules. Under this approach, we
could finalize our guidance upon completion of the international
harmonization process, allowing us to take into account any
shortcomings in that process. Instead, we
[[Page 45374]]
have chosen the reverse order: to impose statutorily weak guidance,
with all its no-action riders and exemptions, with only the promise
of further negotiations with our foreign counterparts.
Given the way the Commission has proceeded up to this point, it
is my hope that the harmonization work lying ahead will be
undertaken in a more transparent manner and not done through the
abused no-action process that lacks any formal Commission process or
oversight. Further, I hope that the process of substituted
compliance will offer the opportunity for other regulatory bodies to
engage directly with the full Commission, so that we can better
understand how our rules and theirs will work and can minimize the
likelihood of regulatory retaliation and inconsistent, duplicative,
or conflicting rules. I believe the Commission has worked too hard
to develop principles and standards that will encourage greater
transparency, open access to clearing and trading and improved
market data to let them go to waste due to a lack of global
regulatory harmonization.
I want to work with other home country regulators to ensure
there is not an opportunity for entities to exploit regulatory
loopholes. The stark reality is that this Commission is not the
global regulatory authority and does not have the resources to
support such a mission. Therefore, our best and most effective
solution is to engage in a fully transparent discussion on
substituted compliance and to do so immediately.
Exemptive Order
In an effort to mitigate the broad reach of the Guidance and
accommodate its last-minute finalization, and in a moment of
humility, the Commission has agreed to delay the application of
certain elements of the Commission's swaps regulations with its
approval of the Exemptive Order. The Exemptive Order provides relief
ranging from 75 days (for application of the expanded U.S. person
definition, for example) to December 21, 2013 (for Entity-Level and
Transaction-Level Requirements for non-U.S. SDs and MSPs in certain
jurisdictions). The Commission is issuing the Exemptive Order
pursuant to section 4(c) of the CEA.\22\
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\22\ Section 4(c) of the CEA grants the Commission the authority
to ``exempt any agreement, contract, or transaction (or class
thereof) that is otherwise subject to subsection (a) (including any
person or class of persons offering, entering into, rendering advice
or rendering other services with respect to, the agreement,
contract, or transaction). . . .'' 7 U.S.C. 6(c). Section 4(a)
applies to ``any person to offer to enter into, to enter into, to
execute, to confirm the execution of, or to conduct any office or
business anywhere in the United States, its territories or
possessions, for the purpose of soliciting, or accepting any order
for, or otherwise dealing in, any transaction in, or in connection
with, a contract for the purchase or sale of a commodity for future
delivery (other than a contract which is made on or subject to the
rules of a board of trade, exchange, or market located outside the
United States, its territories or possessions). . . .'' 7 U.S.C.
6(a).
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Even though the Exemptive Order goes into effect immediately,
the Commission has included a post hoc 30-day comment period. I
support the additional time that the Exemptive Order provides for
market participants to comply with the Commission's last-minute
Guidance, but I cannot support a final order that blatantly ignores
the APA-mandated comment periods for Commission action, especially
when I advocated for a relief package that would have provided for
public comment over a month ago.\23\
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\23\ The Exemptive Order claims, unconvincingly, that it falls
under a good-cause exception to notice-and-comment requirements
provided for by the APA under section 553(b)(B): ``Except when
notice and hearing is required by statute, this subsection does not
apply . . . (B) when the agency for good cause finds (and
incorporates the finding and a brief statement of reasons therefore
in the rules issued) that notice and public procedure thereon are
impracticable, unnecessary, or contrary to the public interest.'' 5
U.S.C. 553(b)(B) (emphasis added). However, section 4(c) of the CEA
clearly provides that the Commission may grant exemptive relief only
by ``rule, regulation, or order after notice and opportunity for
hearing'' (emphasis added). 7 U.S.C. 6(c). The APA further provides
under section 559 that it does not ``limit or repeal additional
requirements imposed by statute or otherwise recognized by law.'' 5
U.S.C. 559. The CEA also grants emergency powers to the Commission
under exigent circumstances. See, e.g., 7 U.S.C. 12a(9). In
addition, courts have narrowly construed the good-cause exception
and placed the burden of proof on the agency. See Tenn. Gas Pipeline
Co. v. Fed. Energy Regulatory Comm'n, 969 F.2d 1141 (D.C. Cir.
1992); Guardian Fed. Sav. & Loan Ass'n v. Fed. Sav. & Loan Ins.
Corp., 589 F.2d 658, 663 (D.C. Cir. 1978).
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Additional Concerns
In addition to the above, the Guidance leaves me concerned in a
number of other areas. I am concerned about whether the definition
of U.S. person contained herein provides the necessary clarity for
market participants, particularly as its enumerated prongs are
explicitly deemed to form a non-exhaustive list. I question whether
the Commission has done enough to harmonize its cross-border
approach with that of the Securities and Exchange Commission (which
is being issued through notice-and-comment rulemaking instead of
interpretive guidance, I should note), in particular with regard to
the definitions of U.S. person and foreign branches. I also am
concerned about whether the Guidance creates an uneven playing field
for U.S. firms, which would be a plainly unacceptable outcome to me.
I am concerned that the Guidance is overlapping, duplicative, and
perhaps even contradictory with other provisions in the Dodd-Frank
Act that mitigate systemic risk and allocate responsibility for
administering its complex and comprehensive regulatory regime to
multiple agencies under Title I, Title II, and even within Title
VII.\24\ In addition, I am concerned that the Guidance practically
ignores the hugely important matter of protecting customer funds,
specifically in connection with bankruptcies, which has critical
cross-border implications as vividly demonstrated by the recent
collapse of MF Global.\25\ Finally, I am concerned about whether in
overreaching to rope in entities into U.S. jurisdiction that would
more appropriately be regulated elsewhere pursuant to an effective
system of substituted compliance, the Guidance will have the
perverse effect of creating more risk to the U.S. system and more
risk to U.S. taxpayers.
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\24\ See, e.g., 7 U.S.C. 6s(d)(2) (``The Commission may not
prescribe rules imposing prudential requirements on swap dealers or
major swap participants for which there is a prudential
regulator.''); 7 U.S.C. 6b-1(b) (``The prudential regulators shall
have exclusive authority to enforce the provisions of section 4s(e)
with respect to swap dealers or major swap participants for which
they are the prudential regulator.'')
\25\ In a recent op-ed article James Giddens, the bankruptcy
trustee for MF Global's U.S.-registered entities, points out that
serious concerns regarding the harmonization, or lack thereof, of
bankruptcy regimes were identified during the resolution of Lehman
Brothers in 2008 (he was then the liquidation trustee for Lehman
Brothers's U.S. broker-dealer), only for similar failings to appear
with MF Global. He urges clearer and more consistent cross-border
rules regarding the protection of customer money in advance of any
future multinational financial company meltdown. Giddens, James, How
to Avoid the Next MF Global Surprise: Change Cross-Border Rules to
Stop Raids on U.S. Customer Accounts, Wall St. J., July 9, 2013.
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Conclusion
For an administrative agency, good government combines good
substance--based on a faithful, appropriate reading of the guiding
statute--and good process. The Guidance falls woefully short on both
counts. Therefore, I respectfully dissent from the decision of the
Commission to approve the Guidance and Exemptive Order for
publication in the Federal Register.
[FR Doc. 2013-17958 Filed 7-25-13; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: July 26, 2013