Cross-Border Application of the Registration Thresholds and Certain Requirements Applicable to Swap Dealers and Major Swap Participants
| Published date | 08 January 2020 |
| Citation | 85 FR 952 |
| Record Number | 2019-28075 |
| Section | Proposed rules |
| Court | Commodity Futures Trading Commission |
Federal Register, Volume 85 Issue 5 (Wednesday, January 8, 2020)
[Federal Register Volume 85, Number 5 (Wednesday, January 8, 2020)]
[Proposed Rules]
[Pages 952-1016]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-28075]
[[Page 951]]
Vol. 85
Wednesday,
No. 5
January 8, 2020
Part IICommodity Futures Trading Commission-----------------------------------------------------------------------17 CFR Part 23Cross-Border Application of the Registration Thresholds and Certain
Requirements Applicable to Swap Dealers and Major Swap Participants;
Proposed Rule
Federal Register / Vol. 85 , No. 5 / Wednesday, January 8, 2020 /
Proposed Rules
[[Page 952]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AE84
Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is publishing for public comment a proposed rule (``Proposed
Rule'') addressing the cross-border application of certain swap
provisions of the Commodity Exchange Act (``CEA or ``Act''), as added
by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act''). Specifically, the Proposed Rule
addresses the cross-border application of the registration thresholds
and certain requirements applicable to swap dealers (``SDs'') and major
swap participants (``MSPs''), and establishes a formal process for
requesting comparability determinations for such requirements from the
Commission. The Commission is proposing a risk-based approach that,
consistent with section 2(i) of the CEA, and with due consideration of
international comity principles and the Commission's interest in
focusing its authority on potential significant risks to the U.S.
financial system, would advance the goals of the Dodd-Frank Act's swap
reform, while fostering greater liquidity and competitive markets,
promoting enhanced regulatory cooperation, and advancing the global
harmonization of swap regulation.
DATES: Comments must be received on or before March 9, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AE84, by any
of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish for the Commission to
consider information that is exempt from disclosure under the Freedom
of Information Act (``FOIA''),\1\ a petition for confidential treatment
of the exempt information may be submitted according to the procedures
set forth in Sec. 145.9 of the Commission's regulations.\2\
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\1\ 5 U.S.C. 552.
\2\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR chapter I.
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of
your submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
FOIA.
FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, (202) 418-
6056, [email protected]; Frank Fisanich, Chief Counsel, (202) 418-
5949, [email protected]; Amanda Olear, Associate Director, (202) 418-
5283, [email protected]; Rajal Patel, Associate Director, 202-418-5261,
[email protected]; Lauren Bennett, Special Counsel, 202-418-5290,
[email protected]; Jacob Chachkin, Special Counsel, (202) 418-5496,
[email protected]; Pamela Geraghty, Special Counsel, 202-418-5634,
[email protected]; or Owen Kopon, Special Counsel, [email protected],
202-418-5360, Division of Swap Dealer and Intermediary Oversight
(``DSIO''), Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Statutory Authority and Prior Commission Action
B. Global Regulatory and Market Structure
C. Interpretation of CEA Section 2(i)
1. Statutory Analysis
2. Principles of International Comity
D. Proposed Rule
II. Key Definitions
A. U.S. Person, Non-U.S. Person, and United States
B. Guarantee
C. Significant Risk Subsidiary, Significant Subsidiary,
Subsidiary, Parent Entity, and U.S. GAAP
1. Non-U.S. Persons With U.S. Parent Entities
2. Preliminary Definitions
3. Significant Risk Subsidiaries
4. Exclusions From the Definition of SRS
D. Foreign Branch and Swap Conducted Through a Foreign Branch
E. Swap Entity, U.S. Swap Entity, and Non-U.S. Swap Entity
F. U.S. Branch and Swap Conducted Through a U.S. Branch
G. Foreign-Based Swap and Foreign Counterparty
H. Request for Comment
III. Cross-Border Application of the Swap Dealer Registration
Threshold
A. U.S. Persons
B. Non-U.S. Persons
1. Swaps by a Significant Risk Subsidiary
2. Swaps With a U.S. Person
3. Swaps Subject to a Guarantee
C. Aggregation Requirement
D. Certain Exchange-Traded and Cleared Swaps
E. Request for Comment
IV. Cross-Border Application of the Major Swap Participant
Registration Tests
A. U.S. Persons
B. Non-U.S. Persons
1. Swaps by a Significant Risk Subsidiary
2. Swap Positions With a U.S. Person
3. Swap Positions Subject to a Guarantee
C. Attribution Requirement
D. Certain Exchange-Traded and Cleared Swaps
E. Request for Comment
V. ANE Transactions
A. Background and Proposed Approach
B. Request for Comment
VI. Proposed Exceptions From Group B and Group C Requirements,
Substituted Compliance for Group A and Group B Requirements, and
Comparability Determinations
A. Classification and Application of Certain Regulatory
Requirements--Group A, Group B, and Group C Requirements
1. Group A Requirements
2. Group B Requirements
3. Group C Requirements
4. Request for Comment
B. Proposed Exceptions
1. Exchange-Traded Exception
2. Foreign Swap Group C Exception
3. Non-U.S. Swap Entity Group B Exception
4. Foreign Branch Group B Exception
5. Request for Comment
C. Substituted Compliance
1. Proposed Substituted Compliance Framework for the Group A
Requirements
2. Proposed Substituted Compliance Framework for the Group B
Requirements
3. Request for Comment
D. Comparability Determinations
1. Standard of Review
[[Page 953]]
2. Eligibility Requirements
3. Submission Requirements
4. Request for Comment
VII. Recordkeeping
VIII. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Assessment Costs
2. Cross-Border Application of the SD Registration Threshold
3. Cross-Border Application of the MSP Registration Thresholds
4. Monitoring Costs
5. Registration Costs
6. Programmatic Costs
7. Proposed Exceptions From Group B and Group C Requirements,
Availability of Substituted Compliance, and Comparability
Determinations
8. Recordkeeping
9. Section 15(a) Factors
10. Request for Comment
D. Antitrust Considerations
IX. Preamble Summary Tables
A. Table A--Cross-Border Application of the SD De Minimis
Threshold
B. Table B--Cross-Border Application of the MSP Threshold
C. Table C--Cross-Border Application of the Group B Requirements
in Consideration of Related Exceptions and Substituted Compliance
D. Table D--Cross-Border Application of the Group C Requirements
in Consideration of Related Exceptions
I. Background
A. Statutory Authority and Prior Commission Action
In 2010, the Dodd-Frank Act \3\ amended the CEA \4\ to, among other
things, establish a new regulatory framework for swaps. Added in the
wake of the 2008 financial crisis, the Dodd-Frank Act was enacted to
reduce systemic risk, increase transparency, and promote market
integrity within the financial system. Given the global nature of the
swap market, the Dodd-Frank Act amended the CEA by adding section 2(i)
to provide that the swap provisions of the CEA enacted by Title VII of
the Dodd-Frank Act (``Title VII''), including any rule prescribed or
regulation promulgated under the CEA, shall not apply to activities
outside the United States (``U.S.'') unless those activities have a
direct and significant connection with activities in, or effect on,
commerce of the United States, or they contravene Commission rules or
regulations as are necessary or appropriate to prevent evasion of the
swap provisions of the CEA enacted under Title VII.\5\
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\3\ Public Law 111-203, 124 Stat. 1376 (2010).
\4\ 7 U.S.C. 1 et seq.
\5\ 7 U.S.C. 2(i).
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In May 2012, the CFTC and Securities and Exchange Commission
(``SEC'') jointly issued an adopting release that, among other things,
further defined and provided registration thresholds for SDs and MSPs
in Sec. 1.3 of the CFTC's regulations (``Entities Rule'').\6\
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\6\ See 17 CFR 1.3, ``Swap dealer'' and ``Major swap
participant''; 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).
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In July 2013, the Commission published interpretive guidance and a
policy statement regarding the cross-border application of certain swap
provisions of the CEA (``Guidance'').\7\ The Guidance included the
Commission's interpretation of the ``direct and significant'' prong of
section 2(i) of the CEA.\8\ In addition, the Guidance established a
general, non-binding framework for the cross-border application of many
substantive Dodd-Frank Act requirements, including registration and
business conduct requirements for SDs and MSPs, as well as a process
for making substituted compliance determinations. Given the complex and
dynamic nature of the global swap market, the Guidance was intended as
a flexible and efficient way to provide the Commission's views on
cross-border issues raised by market participants, allowing the
Commission to adapt in response to changes in the global regulatory and
market landscape.\9\ The Commission accordingly stated that it would
review and modify its cross-border policies as the global swap market
continued to evolve and consider codifying the cross-border application
of the Dodd-Frank Act swap provisions in future rulemakings, as
appropriate.\10\ The Commission notes that, at the time that the
Guidance was adopted, it was tasked with regulating a market that grew
to a global scale without any meaningful regulation in the United
States or overseas, and that the United States was the first of the G20
member countries to adopt most of the swap reforms agreed to at the G20
Pittsburgh Summit in 2009.\11\ Developing a regulatory framework to fit
that market necessarily requires adapting and responding to changes in
the global market, including developments resulting from requirements
imposed on market participants under the Dodd-Frank Act and the
Commission's implementing regulations in the U.S., as well as those
that have been imposed by non-U.S. regulatory authorities since the
Guidance was issued.
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\7\ See Interpretive Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26,
2013).
\8\ Id. at 45297-301. The Commission is now restating this
interpretation, as discussed in section I.C below.
\9\ Id. at 45297 n.39.
\10\ See id.
\11\ See G20 Leaders' Statement: The Pittsburgh Summit, A
Framework for Strong, Sustainable, and Balanced Growth (Sep. 24-25,
2009), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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On November 14, 2013, DSIO issued a staff advisory (``ANE Staff
Advisory'') stating that a non-U.S. SD that regularly uses personnel or
agents located in the United States to arrange, negotiate, or execute a
swap with a non-U.S. person (``ANE Transactions'') would generally be
required to comply with ``Transaction-Level Requirements,'' as the term
was used in the Guidance (discussed in section VI.A).\12\ On November
26, 2013, Commission staff issued certain no-action relief to non-U.S.
SDs registered with the Commission from these requirements in
connection with ANE Transactions (``ANE No-Action Relief'').\13\ In
January 2014, the Commission published a request for comment on all
aspects of the ANE Staff Advisory (``ANE Request for Comment'').\14\
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\12\ See CFTC Staff Advisory No. 13-69, Applicability of
Transaction-Level Requirements to Activity in the United States
(Nov. 14, 2013), available at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
\13\ CFTC Staff Letter No. 13-71, No-Action Relief: Certain
Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 26,
2013), available at https://www.cftc.gov/csl/13-71/download.
Commission staff subsequently extended this relief in CFTC Letter
Nos. 14-01, 14-74, 14-140, 15-48, 16-64, and 17-36. All Commission
staff letters are available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/index.htm.
\14\ Request for Comment on Application of Commission
Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S.
Counterparties Involving Personnel or Agents of the Non-U.S. Swap
Dealers Located in the United States, 79 FR 1347, 1348-49 (Jan. 8,
2014).
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In May 2016, the Commission issued a final rule on the cross-border
application of the Commission's margin requirements for uncleared swaps
(``Cross-Border Margin Rule'').\15\ Among other things, the Cross-
Border Margin Rule addressed the availability of substituted compliance
by outlining the circumstances under which certain SDs and MSPs could
satisfy the Commission's margin requirements for uncleared swaps by
complying with comparable foreign margin requirements. The Cross-Border
Margin Rule also established a framework by which the Commission would
assess whether a foreign jurisdiction's margin requirements are
comparable.
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\15\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818 (May 31, 2016).
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[[Page 954]]
In October 2016, the Commission proposed regulations regarding the
cross-border application of certain requirements under the Dodd-Frank
Act regulatory framework for SDs and MSPs (``2016 Proposal'').\16\ The
2016 Proposal incorporated various aspects of the Cross-Border Margin
Rule and addressed when U.S. and non-U.S. persons, such as foreign
consolidated subsidiaries (``FCSs'') and non-U.S. persons whose swap
obligations are guaranteed by a U.S. person, would be required to
include swaps or swap positions in their SD or MSP registration
threshold calculations, respectively.\17\ The 2016 Proposal also
addressed the extent to which SDs and MSPs would be required to comply
with the Commission's business conduct standards governing their
conduct with swap counterparties (``external business conduct
standards'') in cross-border transactions.\18\ In addition, the 2016
Proposal addressed ANE Transactions, including the types of activities
that would constitute arranging, negotiating, and executing within the
context of the 2016 Proposal, the treatment of such transactions with
respect to the SD registration threshold, and the application of
external business conduct standards with respect to such
transactions.\19\
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\16\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to Swap Dealers and
Major Swap Participants, 81 FR 71946 (proposed Oct. 18, 2016).
\17\ Id. at 71947. As noted above, the SD and MSP registration
thresholds are codified in the definitions of those terms at 17 CFR
1.3.
\18\ Id. The Commission's external business conduct standards
are codified in 17 CFR part 23, subpart H (17 CFR 23.400 through
23.451).
\19\ Id.
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The Commission is today withdrawing the 2016 Proposal. The Proposed
Rule reflects the Commission's current views on the matters addressed
in the 2016 Proposal, which have evolved since the 2016 Proposal as a
result of market and regulatory developments in the swap markets and in
the interest of international comity, as discussed in this release.
B. Global Regulatory and Market Structure
The regulatory landscape is far different now than it was when the
Dodd-Frank Act was enacted. Even when the CFTC published the Guidance
in 2013, very few jurisdictions had made significant progress in
implementing the global swap reforms to which the G20 leaders agreed at
the Pittsburgh G20 Summit. Today, however, as a result of the
cumulative implementation efforts by regulators throughout the world,
significant progress has been made by regulators in the world's primary
swap trading jurisdictions to implement the G20 commitments.\20\ Since
the enactment of the Dodd-Frank Act, regulators in a number of large
developed markets have adopted regulatory regimes that are designed to
mitigate systemic risks associated with a global swap market.
Regulators have adopted rules regarding matters including central
clearing, margin requirements for non-centrally cleared derivatives,
and other risk mitigation requirements.\21\
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\20\ See, e.g., Financial Stability Board (``FSB''), OTC
Derivatives Market Reforms: 2019 Progress Report on Implementation
(Oct. 15, 2019) (``2019 FSB Progress Report''), available at https://www.fsb.org/wp-content/uploads/P151019.pdf; and FSB, Implementation
and Effects of the G20 Financial Regulatory Reforms: Fourth Annual
Report (Nov. 28, 2018), available at http://www.fsb.org/wp-content/uploads/P281118-1.pdf.
\21\ For example, at the end of September 2019, 16 FSB member
jurisdictions had comprehensive swap margin requirements in force.
See 2019 FSB Progress Report, at 2.
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Many swaps involve at least one counterparty that is located in the
United States or another jurisdiction that has adopted comprehensive
swap regulations.\22\ However, conflicting and duplicative requirements
between U.S. and foreign regimes can contribute to potential market
inefficiencies and regulatory arbitrage, as well as competitive
disparities that undermine the relative positions of U.S. SDs and their
counterparties. This may result in market fragmentation, which can lead
to significant inefficiencies that result in additional costs to end-
users. Market fragmentation can reduce the capacity of financial firms
to serve both domestic and international customers.\23\ The Proposed
Rule has been designed to support a cross-border framework that
promotes the integrity, resilience, and vibrancy of the swap market
while furthering the important policy goals of the Dodd-Frank Act. In
that regard, giving due regard to how market practices have evolved
since the publication of the Guidance is an important consideration. As
certain market participants may have adjusted their practices to take
the Guidance into account, the Proposed Rule, if adopted, should cause
limited additional costs and burdens for these market participants if
it is adopted, while supporting the continued operation of markets that
are much more comprehensively regulated than they were before the Dodd-
Frank Act and the actions of governments worldwide taken in response to
the Pittsburgh G20 Summit.
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\22\ See, e.g., 2019 FSB Progress Report; and Bank of
International Settlements (``BIS''), Triennial Central Bank Survey
of Foreign Exchange and Over-the-counter Derivatives Markets in 2019
(Sep. 16, 2019), available at https://www.bis.org/statistics/rpfx19.htm.
\23\ See, e.g., Institute of International Finance, Addressing
Market Fragmentation: The Need for Enhanced Global Regulatory
Cooperation (Jan. 2019), available at https://www.iif.com/Portals/0/Files/IIF%20FSB%20Fragmentation%20Report.pdf.
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The approach described below is informed by the Commission's
understanding of current market practices of global financial
institutions under the Guidance. Driven by business and regulatory
reasons, a financial group that is active in the swap market often
operates in multiple market centers around the world and carries out
swap activity with geographically-diverse counterparties using a number
of different operational structures.\24\ From discussions with market
participants, the Commission understands that financial groups
typically prefer to operate their swap dealing businesses and manage
swap portfolios in the jurisdiction where the swaps and the underlying
assets have the deepest and most liquid markets. In operating their
swap dealing businesses in these market centers, financial groups seek
to take advantage of expertise in products traded in those centers and
obtain access to greater liquidity. These arrangements permit them to
price products more efficiently and compete more effectively in the
global swap market, including in jurisdictions different from the
market center in which the swap is traded.
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\24\ See BIS, Committee on the Global Financial System, No. 46,
The macrofinancial implications of alternative configurations for
access to central counterparties in OTC derivatives markets, at 1
(Nov. 2011), available at http://www.bis.org/publ/cgfs46.pdf
(stating that ``[t]he configuration of access must take account of
the globalised nature of the market, in which a significant
proportion of OTC derivatives trading is undertaken across
borders'').
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In this sense, a global financial enterprise effectively operates
as a single business, with a highly integrated network of business
lines and services conducted through various branches or affiliated
legal entities that are under the control of the parent entity.\25\
Branches and affiliates in a global financial enterprise are highly
interdependent, with separate entities in the group providing financial
or credit support to each other, such as in the form of a guarantee or
the ability to transfer risk
[[Page 955]]
through inter-affiliate trades or other offsetting transactions. Even
in the absence of an explicit arrangement or guarantee, a parent entity
may, for reputational or other reasons, choose to assume the risk
incurred by its affiliates, branches, or offices located overseas.
Swaps are also traded by an entity in one jurisdiction, but booked and
risk-managed by an affiliate in another jurisdiction. The Proposed Rule
recognizes that these and similar arrangements among global financial
enterprises create channels through which swap-related risks can have a
direct and significant connection with activities in, or effect on,
commerce of the United States.
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\25\ The largest U.S. banks have thousands of affiliated global
entities, as shown in data from the National Information Center
(``NIC''), a repository of financial data and institutional
characteristics of banks and other institutions for which the
Federal Reserve Board has a supervisory, regulatory, or research
interest. See NIC, available at https://www.ffiec.gov/npw.
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C. Interpretation of CEA Section 2(i)
The Commission's interpretation of CEA section 2(i) in this release
mirrors the approach that the Commission took in the Guidance. However,
in light of the passage of time since the publication of the Guidance,
the Commission is restating its interpretation of section 2(i) of the
CEA with the Proposed Rule.
CEA section 2(i) provides that the swap 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.
The Commission believes that section 2(i) provides it 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 and will focus its authority on potential significant risks
to the U.S. financial system.
1. 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 CEA section 2(i) is structured similarly
to the statutory language in the Foreign Trade Antitrust Improvements
Act of 1982 (``FTAIA''),\26\ which provides the standard for the cross-
border application of the Sherman Antitrust Act (``Sherman Act'').\27\
The FTAIA, like CEA section 2(i), excludes certain non-U.S. commercial
transactions from the reach of U.S. law. Specifically, the FTAIA
provides that the antitrust provisions of the Sherman Act shall not
apply to anti-competitive conduct involving trade or commerce with
foreign nations.\28\ 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; \29\ and (2) such effect gives rise to a Sherman Act
claim.\30\ In F. Hoffman-LaRoche, Ltd. v. Empagran S.A., the U.S.
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.' '' \31\
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\26\ 15 U.S.C. 6a.
\27\ 15 U.S.C. 1-7.
\28\ 15 U.S.C. 6a.
\29\ 15 U.S.C. 6a(1).
\30\ 15 U.S.C. 6a(2).
\31\ 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 swap provisions of
Title VII of the Dodd-Frank Act apply to activities beyond the borders
of the United States when certain circumstances are present.\32\ 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.
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\32\ SIFMA v. CFTC, 67 F.Supp.3d 373, 425-26 (D.D.C. 2014)
(``The plain text of this provision `clearly expresse[s]' Congress's
`affirmative intention' to give extraterritorial effect to Title
VII's statutory requirements, as well as to the Title VII rules or
regulations prescribed by the CFTC, whenever the provision's
jurisdictional nexus is satisfied.''). See also Prime Int'l Trading,
Ltd. v. BP P.L.C., 937 F.3d 94, 103 (2d Cir. 2019) (stating that
``Section 2(i) contains, on its face, a `clear statement,' Morrison,
561 U.S. at 265, 130 S.Ct. 2869, of extraterritorial application''
and describing it as ``an enumerated extraterritorial command'').
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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 because 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 FTAIA, only the term ``direct'' appears in both CEA section 2(i)
and the FTAIA.\33\ Relying upon the Supreme Court's definition of the
term ``direct'' in the Foreign Sovereign Immunities Act (``FSIA''),\34\
the U.S. Court of Appeals for the Ninth Circuit construed the term
``direct'' in the FTAIA as requiring a ``relationship of logical
causation,'' \35\ such that ``an effect is `direct' if it follows as an
immediate consequence of the defendant's activity.'' \36\ However, in
an en banc decision, Minn-Chem, Inc. v. Agrium, Inc., 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.'' \37\ 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.' '' \38\ The Seventh Circuit
rejected interpretations of the term ``direct'' that included any
requirement that the consequences be foreseeable, substantial, or
immediate.\39\ In 2014, the
[[Page 956]]
U.S. Court of Appeals for the Second Circuit followed the reasoning of
the Seventh Circuit in the Minn-Chem decision.\40\ That said, the
Commission would like to make clear that its interpretation of CEA
section 2(i) is not reliant on the reasoning of any individual judicial
decision, but instead is drawn from a holistic understanding of both
the statutory text and legal analysis applied by courts to analogous
statutes and circumstances. In short, as the discussion below will
illustrate, the Commission's interpretation of section 2(i) is not
solely dependent on one's view of the Seventh Circuit's Minn-Chem
decision, but informed by its overall understanding of the relevant
legal principles.
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\33\ Guidance, 78 FR at 45299.
\34\ See 28 U.S.C. 1605(a)(2).
\35\ 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.
\36\ 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'').
\37\ Minn-Chem, Inc. v. Agrium, Inc., 683 F.3d 845, 857 (7th
Cir. 2012) (en banc).
\38\ Id.
\39\ Id. at 856-57.
\40\ Lotes Co., Ltd. v. Hon Hai Precision Industry Co., 753 F.3d
395, 406-08 (2d Cir. 2014).
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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,\41\ whereas 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.'' \42\ 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 swap 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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\41\ 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.'').
\42\ Hoffman-LaRoche, 452 U.S. at 173.
---------------------------------------------------------------------------
As the foregoing textual analysis of the relevant statutory
language indicates, section 2(i) differs 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 Act swap provisions to apply. Further,
Congress included language in section 2(i) to apply the Dodd-Frank Act
swap 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.\43\ 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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\43\ 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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One of the principal rationales for the Dodd-Frank Act was the need
for a comprehensive scheme of systemic risk regulation. 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 swap market.\44\ Title VII of the Dodd-Frank
Act gave the Commission new and broad authority to regulate the swap
market to seek to address and mitigate risks arising from swap
activities that could adversely affect the resiliency of the financial
system in the future.
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\44\ 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 explicitly provided for cross-
border application of Title VII to activities outside the United States
that pose risks to the U.S. financial system.\45\ Therefore, the
Commission construes section 2(i) to apply the swap 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 resiliency and integrity of the U.S. financial
system arising from swap market activities.\46\ Consistent with this
[[Page 957]]
overall interpretation, the Commission interprets the term ``direct''
in section 2(i) to require a reasonably proximate causal nexus, and not
to require foreseeability, substantiality, or immediacy.
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\45\ 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.
\46\ 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.'').
---------------------------------------------------------------------------
Further, the Commission does not read section 2(i) 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 to apply the
swap provisions of the CEA to such transaction. 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 swap provisions is
warranted.\47\
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\47\ 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.
---------------------------------------------------------------------------
This conclusion is bolstered by similar interpretations of other
federal statutes regulating interstate commerce. For example, the
Supreme Court has long supported a similar ``aggregate effects''
approach when analyzing the reach of U.S. authority under the Commerce
Clause.\48\ For example, the Court phrased the holding in the seminal
``aggregate effects'' decision, Wickard v. Filburn,\49\ 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.'' \50\ In another relevant decision,
Gonzales v Raich,\51\ the Court adopted similar reasoning to uphold the
application of the Controlled Substance Act \52\ 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.\53\
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\48\ Nat'l Fed'n of Indep. Bus. v. Sebelius, 567 U.S. 519
(2012).
\49\ 317 U.S. 111 (1942).
\50\ 567 U.S. at 552-53. 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.
\51\ 545 U.S. 1 (2005).
\52\ 21 U.S.C. 801 et seq.
\53\ In Sebelius, the Court stated in dicta, ``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.'' 567 U.S. at 551 (quoting Perez
v. United States, 402 U.S. 146, 154 (1971)). See also Taylor v.
U.S.136 S. Ct. 2074, 2079 (2016) (``[A]ctivities . . . that
``substantially affect'' commerce . . . may be regulated so long as
they substantially affect interstate commerce in the aggregate, even
if their individual impact on interstate commerce is minimal.'')
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2. Principles of International Comity
Principles of international comity counsel the government in one
country to act reasonably in exercising its jurisdiction with respect
to activity that takes place in another country. Statutes should be
construed to ``avoid unreasonable interference with the sovereign
authority of other nations.'' \54\ 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.'' \55\
---------------------------------------------------------------------------
\54\ Hoffman-LaRoche, 542 U.S. at 164.
\55\ Id. at 165.
---------------------------------------------------------------------------
The Restatement (Third) of Foreign Relations Law of the United
States,\56\ together with the Restatement (Fourth) of Foreign Relations
Law of the United States \57\ (collectively, the ``Restatement''),
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.'' \58\ The Restatement also
provides that even where a country has a basis for extraterritorial
jurisdiction, it should not prescribe law with respect to a person or
activity in another country when the exercise of such jurisdiction is
unreasonable.\59\
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\56\ Restatement (Third) section 402 cmt. d (1987).
\57\ Julian Ku, American Law Institute Approves First Portions
of Restatement on Foreign Relations Law (Fourth), OpinioJuris.com,
May 22, 2017, http://opiniojuris.org/2017/05/22/american-law-institute-approves-first-portions-of-restatement-on-foreign-relations-law-fourth/; Jennifer Morinigo, U.S. Foreign Relations
Law, Jurisdiction Approved, ALI Adviser, May 22, 2017, http://www.thealiadviser.org/us-foreign-relations-law/jurisdiction-approved/; Restatement (Fourth) of Foreign Relations Law Intro.
(Westlaw 2018) (explaining that ``this is only a partial revision''
of the Third Restatement).
\58\ Restatement (Fourth) section 409 (Westlaw 2018).
\59\ Restatement (Fourth) section 405 cmt. a (Westlaw 2018); see
id. at section 407 Reporters' Note 3 (``Reasonableness, in the sense
of showing a genuine connection, is an important touchstone for
determining whether an exercise of jurisdiction is permissible under
international law.'').
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As a general matter, the Fourth Restatement has indicated that the
concept of reasonableness as it relates to foreign relations law is ``a
principle of statutory interpretation'' that ``operates in conjunction
with other principles of statutory interpretation.'' \60\ More
specifically, the Fourth Restatement characterizes the inquiry into the
reasonableness of exercising extraterritorial jurisdiction as an
examination into whether ``a genuine connection exists between the
state seeking to regulate and the persons, property, or conduct being
regulated.'' \61\ The Restatement explicitly indicates that the
``genuine connection'' between the state and the person, property, or
conduct to be regulated can derive from the effects of the particular
conduct or activities in question.\62\
---------------------------------------------------------------------------
\60\ Id. at section 405 cmt. a.
\61\ Id. at section 407 cmt. a; see id. at section 407
Reporters' Note 3.
\62\ Id. at section 407.
---------------------------------------------------------------------------
Consistent with the Restatement, the Commission has carefully
considered, among other things, the level of the foreign jurisdiction's
supervisory interests over the subject activity and the extent to which
the activity takes place within the foreign territory. In doing so, the
Commission has strived to minimize conflicts with the laws of other
jurisdictions while seeking, pursuant to section 2(i), to apply the
swaps requirements of Title VII to activities outside the United States
that have a direct and significant connection with activities in, or
effect on, U.S. commerce.
The Commission believes the Proposed Rule strikes an appropriate
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,
[[Page 958]]
consistent with international comity, as set forth in the Restatement.
Of particular relevance is the Commission's approach to substituted
compliance in the Proposed Rule, which would mitigate burdens
associated with potentially conflicting foreign laws and regulations in
light of the supervisory interests of foreign regulators in entities
domiciled and operating in their own jurisdictions.
D. Proposed Rule
The Proposed Rule addresses which cross-border swaps or swap
positions a person would need to consider when determining whether it
needs to register with the Commission as an SD or MSP, as well as
related classifications of swap market participants and swaps (e.g.,
U.S. person, foreign branch, swap conducted through a foreign
branch).\63\ Further, the Commission is proposing exceptions from, and
a substituted compliance process for, certain regulations applicable to
registered SDs and MSPs. The Proposed Rule also would create a
framework for comparability determinations for such regulations that
emphasizes a holistic, outcomes-based approach that is grounded in
principles of international comity. Finally, the Proposed Rule would
require SDs and MSPs to create a record of their compliance with the
Proposed Rule and to retain such records in accordance with Sec.
23.203.\64\ If adopted, the Proposed Rule would supersede the
Commission's policy views with respect to its interpretation of section
2(i) of the CEA and the covered swap provisions, as set forth in the
Guidance.\65\ The Proposed Rule would not supersede the Commission's
policy views as stated in the Guidance or elsewhere with respect to any
other matters.
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\63\ There were no MSPs registered with the Commission as of the
date of the Proposed Rule.
\64\ See Proposed Sec. 23.23(h).
\65\ The Commission notes that, if adopted, the Proposed Rule
would also cause the Commission's Title VII requirements addressed
in section VI of this release to become ``Addressed Transaction-
Level Requirements'' under the terms of CFTC Staff Letter No. 17-36,
Extension of No-Action Relief: Transaction-Level Requirements for
Non-U.S. Swap Dealers (July 25, 2017), available at https://www.cftc.gov/csl/17-36/download, such that relief for such
requirements would no longer be available under that letter. The
treatment of the Commission's other Title VII Requirements under the
letter would not be affected by the finalization of the Proposed
Rule.
---------------------------------------------------------------------------
The Proposed Rule takes into account the Commission's experience
implementing the Dodd-Frank Act reforms, including its experience with
the Guidance and the Cross-Border Margin Rule, comments submitted in
connection with the ANE Request for Comment, as well as discussions
that the Commission and its staff have had with market participants,
other domestic \66\ and foreign regulators, and other interested
parties. It is essential that a cross-border framework recognize the
global nature of the swap market and the supervisory interests of
foreign regulators with respect to entities and transactions covered by
the Commission's swap regime.\67\ In determining the extent to which
the Dodd-Frank Act swap provisions addressed by the Proposed Rule would
apply to activities outside the United States, the Commission has
strived to protect U.S. interests as contemplated 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 a
home jurisdiction's supervisory interests over the subject activity and
the extent to which the activity takes place within the home country's
territory.\68\ At the same time, the Commission has also considered the
potential for cross-border activities to have a significant connection
with activities in, or effect on, commerce of the United States, as
well as the global, highly integrated nature of today's swap markets.
To fulfill the purposes of the Dodd-Frank Act swap reform, the
Commission's supervisory oversight cannot be confined to activities
strictly within the territory of the United States. In exercising its
supervisory oversight outside the United States, however, the
Commission will do so only as necessary to address risk to the
resiliency and integrity of the U.S. financial system.\69\ The
Commission will also strive to show deference to non-U.S. regulation
when such regulation achieves comparable outcomes to mitigate
unnecessary conflict with effective non-U.S. regulatory frameworks and
limit fragmentation of the global marketplace.
---------------------------------------------------------------------------
\66\ The Commission notes that it has consulted with the
Securities and Exchange Commission (``SEC'') and prudential
regulators regarding the Proposed Rule, as required by section
712(a)(1) of the Dodd-Frank Act for the purposes of assuring
regulatory consistency and comparability, to the extent possible.
Dodd-Frank Act, Public Law 111-203, section 712(a)(1); 15 U.S.C.
8302(a)(1). SEC staff was consulted to increase understanding of
each other's regulatory approaches and to harmonize the cross-border
approaches of the two agencies to the extent possible, consistent
with their respective statutory mandates. As noted in the Entities
Rule, the CFTC and SEC intended to address the cross-border
application of Title VII in separate releases. See Entities Rule, 77
FR at 30628 n.407.
\67\ As discussed above, in developing the Proposed Rule, the
Commission is guided by principles of international comity, which
counsels due regard for the important interests of foreign
sovereigns. See Restatement.
\68\ The terms ``home jurisdiction'' or ``home country'' are
used interchangeably in this release and refer to the jurisdiction
in which the person or entity is established, including the European
Union.
\69\ See supra section I.C.
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The Commission has also sought to target those classes of entities
whose activities--due to the nature of their relationship with a U.S.
person or U.S. commerce--most clearly present the risks addressed by
the Dodd-Frank Act provisions, and related regulations covered by the
Proposed Rule. The Proposed Rule is designed to limit opportunities for
regulatory arbitrage by applying the registration thresholds in a
consistent manner to differing organizational structures that serve
similar economic functions or have similar economic effects. At the
same time, the Commission is mindful of the impact of its choices on
market efficiency and competition, as well as the importance of
international comity when exercising the Commission's authority. The
Commission believes that the Proposed Rule reflects a measured approach
that advances the goals underlying SD and MSP regulation, consistent
with the Commission's statutory authority, while mitigating market
distortions and inefficiencies, and avoiding fragmentation.
II. Key Definitions
The Commission is proposing to define certain terms for the purpose
of applying the Dodd-Frank Act swap provisions addressed by the
Proposed Rule to cross-border transactions. If adopted, certain of
these definitions would be relevant in assessing whether a person's
activities have the requisite ``direct and significant'' connection
with activities in, or effect on, U.S. commerce within the meaning of
CEA section 2(i). Specifically, the definitions would be relevant in
determining whether certain swaps or swap positions would need to be
counted toward a person's SD or MSP threshold and in addressing the
cross-border application of certain Dodd-Frank Act requirements (as
discussed below in sections III through VI).
The Commission acknowledges that the information necessary for a
swap counterparty to accurately assess whether its counterparty or a
specific swap meet one or more of the definitions discussed below may
be unavailable, or available only through overly burdensome due
diligence. For this reason, the Commission believes that a market
participant should generally be permitted to reasonably rely on written
counterparty representations in each of these
[[Page 959]]
respects.\70\ Therefore, proposed Sec. 23.23(a) states that a person
may rely on a written representation from its counterparty that the
counterparty does or does not satisfy the criteria for one or more of
the definitions below, unless such person knows or has reason to know
that the representation is not accurate. For the purposes of this rule
a person would have reason to know the representation is not accurate
if a reasonable person should know, under all of the facts of which the
person is aware, that it is not accurate. The Commission notes that
this is consistent with: (1) The reliance standard articulated in the
Commission's external business conduct rules; \71\ (2) the Commission's
approach in the Cross-Border Margin Rule; \72\ and (3) the reliance
standard articulated in the ``U.S. person'' and ``transaction conducted
through a foreign branch'' definitions adopted by the SEC in its rule
addressing the regulation of cross-border securities-based swap
activities (``SEC Cross-Border Rule'').\73\
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\70\ See Cross-Border Margin Rule, 81 FR at 34827; Guidance, 78
FR at 45315.
\71\ See 17 CFR 23.402(d).
\72\ See Cross-Border Margin Rule, 81 FR at 34827.
\73\ See 17 CFR 240.3a71-3(a)(3)(ii) & (4)(iv); Application of
``Security-Based Swap Dealer'' and ``Major Security-Based Swap
Participant'' Definitions to Cross-Border Security-Based Swap
Activities; Republication, 79 FR 47278, 47313 (Aug. 12, 2014).
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A. U.S. Person, Non-U.S. Person, and United States
Under the Proposed Rule, a ``U.S. person'' would be defined as set
forth below, consistent with the definition of ``U.S. person'' adopted
by the SEC in the context of its regulations regarding cross-border
securities-based swap activities.\74\ The Commission believes that such
harmonization is appropriate, given that some firms may register both
as SDs with the Commission and as security-based swap dealers with the
SEC. The proposed definition of ``U.S. person'' also is consistent with
the Commission's statutory mandate under the CEA, and in this regard is
largely consistent with the definition of ``U.S. person'' in the Cross-
Border Margin Rule: \75\
---------------------------------------------------------------------------
\74\ See 17 CFR 240.3a71-3(a)(4). See also SEC Cross-Border
Rule, 79 FR at 47303-13.
\75\ See 17 CFR 23.160(a)(10). See also Cross-Border Margin
Rule, 81 FR at 34821-24.
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(1) A natural person resident in the United States; \76\
---------------------------------------------------------------------------
\76\ Proposed Sec. 23.23(a)(22)(i)(1).
---------------------------------------------------------------------------
(2) A partnership, corporation, trust, investment vehicle, or other
legal person organized, incorporated, or established under the laws of
the United States or having its principal place of business in the
United States; \77\
---------------------------------------------------------------------------
\77\ Proposed Sec. 23.23(a)(22)(i)(2).
---------------------------------------------------------------------------
(3) An account (whether discretionary or non-discretionary) of a
U.S. person; \78\ or
---------------------------------------------------------------------------
\78\ Proposed Sec. 23.23(a)(22)(i)(3).
---------------------------------------------------------------------------
(4) An estate of a decedent who was a resident of the United States
at the time of death.\79\
---------------------------------------------------------------------------
\79\ Proposed Sec. 23.23(a)(22)(i)(4).
---------------------------------------------------------------------------
The Commission believes that this definition offers a clear,
objective basis for determining which individuals or entities should be
identified as U.S. persons for purposes of the swap requirements
addressed by the Proposed Rule. Specifically, the various prongs, as
discussed in more detail below, are intended to identify persons whose
activities have a significant nexus to the United States by virtue of
their organization or domicile in the United States. In addition,
harmonizing with the definition in the SEC Cross-Border Rule is not
only consistent with section 2(i) of the CEA,\80\ but is expected to
reduce undue compliance costs for market participants. As discussed
below, the Commission is also of the view that the ``U.S. person''
definition in the Cross-Border Margin Rule would largely encompass the
same universe of persons as the definition used in the SEC Cross-Border
Rule and the Proposed Rule.\81\
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\80\ Harmonizing the Commission's definition of ``U.S. person''
with the definition in the SEC Cross-Border Rule also is consistent
with the dictate in section 712(a)(7) of the Dodd-Frank Act that the
CFTC and SEC ``treat functionally or economically similar'' SDs,
MSPs, security-based swap dealers, and major security-based swap
participants ``in a similar manner.'' Dodd Frank Act, Public Law
111-203, section 712(a)(7)(A); 15 U.S.C. 8307(a)(7)(A).
\81\ See Cross-Border Margin Rule, 81 FR at 34824 (``The
Commission notes that, as discussed in the proposed rule, the Final
Rule defines `U.S. person' in a manner that is substantially similar
to the definition used by the SEC in the context of cross-border
regulation of security-based swaps.'') As noted below, the
Commission also requests comment on whether it should instead adopt
the ``U.S. person'' definition in the Cross-Border Margin Rule.
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Proposed Sec. 23.23(a)(22)(i) identifies certain persons as a
``U.S. person'' by virtue of their domicile or organization within the
United States. The Commission has traditionally looked to where a legal
entity is organized or incorporated (or in the case of a natural
person, where he or she resides) to determine whether it is a U.S.
person.\82\ In the Commission's view, these persons--by virtue of their
decision to organize or locate in the United States and because they
are likely to have significant financial and legal relationships in the
United States--are appropriately included within the definition of
``U.S. person.''
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\82\ See id. at 34823. See also 17 CFR 4.7(a)(1)(iv) (defining
``Non-United States person'' for purposes of part 4 of the
Commission regulations relating to commodity pool operators).
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More specifically, proposed Sec. Sec. 23.23(a)(22)(i)(1) and (2)
generally incorporate a ``territorial'' concept of a U.S. person. That
is, these are natural persons and legal entities that are physically
located or incorporated within U.S. territory, and thus are subject to
the Commission's jurisdiction. Further, the Commission would generally
consider swap activities where such persons are counterparties, as a
class and in the aggregate, as satisfying the ``direct and
significant'' test under CEA section 2(i). Consistent with the ``U.S.
person'' definition in the Cross-Border Margin Rule \83\ and the SEC
Cross-Border Rule,\84\ the definition encompasses both foreign and
domestic branches of an entity. As discussed below, a branch does not
have a legal identity apart from its principal entity.
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\83\ See 17 CFR 23.160(a)(10)(iii) (U.S. person includes a
corporation, partnership, limited liability company, business or
other trust, association, joint-stock company, fund or any form of
entity similar to any of the foregoing (other than an entity
described in paragraph (a)(10)(iv) or (v) of this section) (a legal
entity), in each case that is organized or incorporated under the
laws of the United States or that has its principal place of
business in the United States, including any branch of such legal
entity) (emphasis added).
\84\ See SEC Cross-Border Rule, 79 FR at 47308 (``[T]he final
definition determines a legal person's status at the entity level
and thus applies to the entire legal person, including any foreign
operations that are part of the U.S. legal person. Consistent with
this approach, a foreign branch, agency, or office of a U.S. person
is treated as part of a U.S. person, as it lacks the legal
independence to be considered a non-U.S. person for purposes of
Title VII even if its head office is physically located within the
United States.'').
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In addition, the Commission is of the view that proposed Sec.
23.23(a)(22)(i)(2) subsumes the pension fund prong of the ``U.S.
person'' definition in the Cross-Border Margin Rule.\85\ Specifically,
Sec. 23.23(a)(22)(i)(2) would also include in the definition of the
term ``U.S. person'' pension plans for the employees, officers, or
principals of a legal entity described in Sec. 23.23(a)(22)(i)(2).
Although the SEC Cross-Border Rule directly addresses pension funds
only in the context of international financial institutions, discussed
below, the Commission believes it is important to clarify that pension
funds in other contexts could meet the requirements of proposed Sec.
23.23(a)(22)(i)(2).
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\85\ See 17 CFR 23.160(a)(10)(iv).
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Finally, the Commission is of the view that proposed Sec.
23.23(a)(22)(i)(2) subsumes the trust prong of the ``U.S. person''
definition in the Cross-Border
[[Page 960]]
Margin Rule.\86\ With respect to trusts addressed in proposed Sec.
23.23(a)(22)(i)(2), the Commission expects that its approach would be
consistent with the manner in which trusts are treated for other
purposes under the 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 Proposed Rule. Another
relevant element in this regard would be whether a court within the
United States is able to exercise primary supervision over the
administration of the trust. The Commission expects that this aspect of
the definition would generally align the treatment of the trust for
purposes of the Proposed Rule 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 consistent
with its treatment for other purposes.
---------------------------------------------------------------------------
\86\ See 17 CFR 23.160(a)(10)(v).
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As noted in the Cross-Border Margin Rule,\87\ and consistent with
the SEC \88\ definition of ``U.S. person,'' proposed Sec.
23.23(a)(22)(ii) provides that the principal place of business means
the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the activities
of the legal person. With the exception of externally managed entities,
as discussed below, the Commission is of the view that for most
entities, the location of these officers, partners, or managers
generally would correspond to the location of the person's headquarters
or main office. However, the Commission believes that a definition that
focuses exclusively on whether a legal person is organized,
incorporated, or established in the United States could encourage some
entities to move their place of incorporation to a non-U.S.
jurisdiction to avoid complying with the relevant Dodd-Frank Act
requirements, while maintaining their principal place of business--and
therefore, risks arising from their swap transactions--in the United
States. Moreover, a ``U.S. person'' definition that does not include a
``principal place of business'' element could result in certain
entities falling outside the scope of the relevant Dodd-Frank Act-
related requirements, even though the nature of their legal and
financial relationships in the United States is, as a general matter,
indistinguishable from that of entities incorporated, organized, or
established in the United States. Therefore, the Commission is of the
view that it is appropriate to treat such entities as U.S. persons for
purposes of the Proposed Rule.\89\
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\87\ Cross-Border Margin Rule, 81 FR at 34823.
\88\ 17 CFR 240.3a71-3(a)(4)(ii).
\89\ See SEC Cross-Border Rule, 79 FR at 47309.
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However, determining the principal place of business of a
collective investment vehicle (``CIV''), such as an investment fund or
commodity pool, may require consideration of additional factors beyond
those applicable to operating companies. The Commission is of the view
that with respect to an externally managed investment vehicle, this
location is the office from which the manager of the vehicle primarily
directs, controls, and coordinates the investment activities of the
vehicle.\90\ This interpretation is consistent with the Supreme Court's
decision in Hertz Corp. v. Friend, which described a corporation's
principal place of business, for purposes of diversity jurisdiction, as
the ``place where the corporation's high level officers direct,
control, and coordinate the corporation's activities.'' \91\ In the
case of a CIV, the senior personnel that direct, control, and
coordinate a CIV's activities are generally not the named directors or
officers of the CIV, but rather persons employed by the CIV's
investment advisor or promoter, or in the case of a commodity pool, its
commodity pool operator. Therefore, consistent with the SEC Cross-
Border Rule,\92\ when a primary manager is responsible for directing,
controlling, and coordinating the overall activity of a CIV, the CIV's
principal place of business under the proposed rule would be the
location from which the manager carries out those responsibilities.
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\90\ Proposed Sec. 23.23(a)(22)(ii).
\91\ See 559 U.S. 77, 80 (2010); Cross-Border Margin Rule, 81 FR
at 34823.
\92\ See SEC Cross-Border Rule, 79 FR at 47310-11.
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The Commission notes that under the Cross-Border Margin Rule,\93\
the Commission would generally consider the principal place of business
of a CIV to be in the United States if the senior personnel responsible
for either: (1) The formation and promotion of the CIV; or (2) the
implementation of the CIV'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 CIV. Although the second prong of that discussion
is consistent with the approach discussed above, the Commission does
not believe that activities such as formation of the CIV, absent an
ongoing role by the person performing those activities in directing,
controlling, and coordinating the investment activities of the CIV,
generally will be as indicative of activities, financial and legal
relationships, and risks within the United States of the type that
Title VII is intended to address as the location of a CIV manager.
---------------------------------------------------------------------------
\93\ See Cross-Border Margin Rule, 81 FR at 34823. This is also
generally consistent with the views expressed in the Guidance. See
Guidance, 78 FR at 45309-12.
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With respect to proposed Sec. 23.23(a)(22)(i)(4), the Commission
believes that the swaps of a decedent's estate should generally be
treated the same as the swaps entered into by the decedent during their
life.\94\ 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, at which time the swaps would most
likely pass to the decedent's estate. Also, the Commission expects that
this prong will be predictable and straightforward 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.
---------------------------------------------------------------------------
\94\ The Commission expects that relatively few estates would
enter into swaps, and those that do would likely do so for hedging
purposes.
---------------------------------------------------------------------------
Proposed Sec. 23.23(a)(22)(i)(3) is intended to ensure that
persons described in prongs (1), (2), and (4) of the definition would
be treated as U.S. persons even if they use discretionary or non-
discretionary accounts to enter into swaps, irrespective of whether the
person at which the account is held or maintained is a U.S. person.
Consistent with the Cross-Border Margin Rule, the Commission is of the
view that this prong would apply for individual or joint accounts.\95\
---------------------------------------------------------------------------
\95\ See 17 CFR 23.160(a)(10)(vii).
---------------------------------------------------------------------------
Unlike the Cross-Border Margin Rule, the proposed definition of
``U.S. person'' would not include certain legal entities that are owned
by one or more U.S. person(s) and for which such person(s) bear
unlimited responsibility for the obligations and liabilities of the
legal entity (``unlimited U.S. responsibility prong'').\96\ This prong
was
[[Page 961]]
designed to capture persons that could give rise to risk to the U.S.
financial system in the same manner as with non-U.S. persons whose swap
transactions are subject to explicit financial support arrangements
from U.S. persons. Rather than including this prong in its ``U.S.
person'' definition, the SEC took the view that when a non-U.S.
person's counterparty has recourse to a U.S. person for the performance
of the non-U.S. person's obligations under a security-based swap by
virtue of the U.S. person's unlimited responsibility for the non-U.S.
person, the non-U.S. person would be required to include the security-
based swap in its security-based swap dealer (if it is a dealing
security-based swap) and major security-based swap participant
threshold calculations as a guarantee.\97\ However, as discussed in the
Cross-Border Margin Rule, the Commission does not view the unlimited
U.S. responsibility prong as equivalent to a U.S. guarantee because 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.\98\
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\96\ See 17 CFR 23.160(a)(10)(vi); Cross-Border Margin Rule, 81
FR at 34823-24. The Guidance included a similar concept in the
definition of the term ``U.S. person.'' However, the definition
contained in the Guidance would generally characterize a legal
entity as a U.S. person if the entity were ``directly or indirectly
majority-owned'' by one or more persons falling within the term
``U.S. person'' and such U.S. person(s) bears unlimited
responsibility for the obligations and liabilities of the legal
entity. See Guidance, 78 FR at 45312-13 (discussing the unlimited
U.S. responsibility prong for purposes of the Guidance).
\97\ See SEC Cross-Border Rule, 79 FR at 47308 n.255, 47316-17.
\98\ See Cross-Border Margin Rule, 81 FR at 34823 n.60.
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The Commission is declining at this time to revisit its
interpretation of ``guarantee,'' discussed below, and is not including
an ``unlimited U.S. responsibility prong'' in the ``U.S. person''
definition in the Proposed Rule. The Commission is of the view that the
corporate structure that this prong is designed to capture is not one
that is commonly in use in the marketplace. As noted below, the
Commission requests comments on whether this understanding is correct,
and if not, whether the Commission should add this prong to the
proposed ``U.S. person'' definition or reassess its proposed
interpretation of a ``guarantee.'' In addition, the Commission notes
that the treatment of the unlimited U.S. liability prong in the
Proposed Rule would not impact an entity's obligations with respect to
the Cross-Border Margin Rule. To the extent that entities are
considered U.S. persons for purposes of the Cross-Border Margin Rule as
a result of the unlimited U.S. liability prong, the Commission believes
that the different purpose of the registration-related rules justifies
this potentially different treatment.
The proposed ``U.S. person'' definition is generally consistent
with the ``U.S. person'' interpretation set forth in the Guidance, with
certain exceptions.\99\ As noted above,\100\ the Cross-Border Margin
Rule and the Guidance incorporated a version of the unlimited U.S.
responsibility prong in the U.S. person definition. In addition,
consistent with the definition of ``U.S. person'' in the Cross-Border
Margin Rule \101\ and the SEC Cross-Border Rule,\102\ the proposed
definition does not include a commodity pool, pooled account,
investment fund, or other CIV that is majority-owned by one or more
U.S. persons.\103\ Similar to the SEC, the Commission is of the view
that including majority-owned CIVs within the definition of ``U.S.
person'' for the purposes of the Proposed Rule would be likely to cause
more CIVs to incur additional programmatic costs associated with the
relevant Title VII requirements and ongoing assessments, while not
significantly increasing programmatic benefits given that the
composition of a CIV's beneficial owners is not likely to have
significant bearing on the degree of risk that the CIV's swap activity
poses to the U.S. financial system.\104\ Although many of these CIVs
have U.S. participants that could be adversely impacted in the event of
a counterparty default, systemic risk concerns are mitigated to the
extent these collective investment vehicles would be subject to margin
requirements in foreign jurisdictions. In addition, the exposure of
participants to losses in CIVs is typically limited to their investment
amount, and it is unlikely that a participant in a CIV would make
counterparties whole in the event of a default.\105\ Further, the
Commission continues to believe that identifying and tracking a CIV's
beneficial ownership may pose a significant challenge in certain
circumstances (e.g., fund-of-funds or master-feeder structures).\106\
Therefore, although the U.S. participants in such CIVs may be adversely
impacted in the event of a counterparty default, the Commission
believes that, on balance, the majority-ownership test should not be
included in the proposed definition of U.S. person. Note that a CIV
fitting within the majority U.S. ownership prong may also be a U.S.
person within the scope of Sec. 23.23(a)(22)(i)(2) of the Proposed
Rule (entities organized or having a principal place of business in the
United States). As the Commission clarified in the Cross-Border Margin
Rule, whether a pool, fund, or other CIV is publicly offered only to
non-U.S. persons and not offered to U.S. persons would not be relevant
in determining whether it falls within the scope of the proposed U.S.
person definition.\107\
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\99\ See Guidance, 78 FR at 45308-17 (setting forth the
interpretation of ``U.S. person'' for purposes of the Guidance).
\100\ See supra note 96.
\101\ See Cross-Border Margin Rule, 81 FR at 34824.
\102\ See SEC Cross-Border Rule, 79 FR at 47311, 47337.
\103\ See Guidance, 78 FR at 45313-14 (discussing the U.S.
majority-ownership prong for purposes of the Guidance and
interpreting ``majority-owned'' in this context to mean the
beneficial ownership of more than 50 percent of the equity or voting
interests in the collective investment vehicle).
\104\ See SEC Cross-Border Rule, 79 FR at 47337.
\105\ See id. at 47311.
\106\ See Cross-Border Margin Rule, 81 FR at 34824.
\107\ See id. at 81 FR at 34824 n.62.
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Unlike the non-exhaustive ``U.S. person'' definition provided in
the Guidance, the proposed definition of ``U.S. person'' is limited to
persons enumerated in the rule, consistent with the Cross-Border Margin
Rule and the SEC Cross-Border Rule.\108\ The Commission believes that
the proposed prongs discussed above would capture those persons with
sufficient jurisdictional nexus to the financial system and commerce in
the United States that they should be categorized as ``U.S. persons''
pursuant to the Proposed Rule.
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\108\ See Cross-Border Margin Rule, 81 FR at 34824; Guidance, 78
FR at 45316 (discussing the inclusion of the prefatory phrase
``include, but not be limited to'' in the interpretation of ``U.S.
person'' in the Guidance).
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Further, in consideration of the discretionary and appropriate
exercise of international comity-based doctrines, proposed Sec.
23.23(a)(22)(iii) states that the term ``U.S. person'' would not
include international financial institutions, as defined below.
Specifically, consistent with the SEC's definition,\109\ the term U.S.
person would not include the International Monetary Fund, the
International Bank for Reconstruction and Development, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the United Nations, and their agencies and pension
plans, and any other similar international organizations, their
agencies, and pension plans. The Commission believes that although
foreign entities are not necessarily immune from U.S. jurisdiction for
commercial activities undertaken with
[[Page 962]]
U.S. counterparties or in U.S. markets, the sovereign or international
status of such international financial institutions that themselves
participate in the swap markets in a commercial manner is relevant in
determining whether such entities should be treated as U.S. persons,
regardless of whether any of the prongs of the proposed definition
would apply.\110\ There is nothing in the text or history of the swap-
related provisions of Title VII to suggest that Congress intended to
deviate from the traditions of the international system by including
such international financial institutions within the definitions of the
term ``U.S. person.'' \111\
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\109\ 17 CFR 240.3a71-3(a)(4)(iii).
\110\ See, e.g., Entities Rule, 77 FR at 30692-93 (discussing
the application of the ``swap dealer'' and ``major swap
participant'' definitions to foreign governments, foreign central
banks, and international financial institutions). The Commission
also notes that a similar approach was taken in the Guidance.
Guidance, 78 FR at 45353 n.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. . . . 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 [Entities Rule].'').
\111\ To the contrary, section 752(a) of the Dodd-Frank Act
requires the CFTC to consult and coordinate with other regulators on
the establishment of consistent international standards with respect
to the regulation (including fees) of swaps and swap entities.
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Consistent with the Entities Rule and the Guidance, the Commission
is of the view that the term ``international financial institutions''
includes the ``international financial institutions'' that are defined
in 22 U.S.C. 262r(c)(2) and institutions defined as ``multilateral
development banks'' in the European Union's regulation on ``OTC
derivatives, central counterparties and trade repositories.'' \112\
Reference to 22 U.S.C. 262r(c)(2) and the European Union definition is
consistent with Commission precedent in the Entities Rule.\113\ The
Commission continues to believe that both of those definitions identify
many of the entities for which discretionary and appropriate exercise
of international comity-based doctrines is appropriate with respect to
the ``U.S. person'' definition.\114\ The Commission is of the view that
this prong would also include institutions identified in CFTC Staff
Letters 17-34 \115\ and 18-13.\116\ In CFTC Staff Letter 17-34,
Commission staff provided relief from CFTC margin requirements to swaps
between SDs and the European Stability Mechanism (``ESM''),\117\ and in
CFTC Staff Letter 18-13, Commission staff identified the North American
Development Bank (``NADB'') as an additional entity that should be
considered an international financial institution for purposes of
applying the SD and MSP definitions.\118\ Interpreting the definition
to include the two entities identified in CFTC Staff Letters 17-34 and
18-13 is consistent with the discretionary and appropriate exercise of
international comity because the status of both entities is similar to
that of the other international financial institutions identified in
the Entities Rule. Consistent with the SEC definition of ``U.S.
person,'' the Proposed Rule lists specific international financial
institutions but also provides a catch-all for ``any other similar
international organizations, their agencies, and pension plans.'' The
Commission believes that the catch-all provision would extend to any of
the specific entities discussed above that are not explicitly listed in
the Proposed Rule.
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\112\ Regulation (EU) No 648/2012 of the European Parliament and
of the Council on OTC Derivative Transactions, Central
Counterparties and Trade Repositories, Article 1(5(a)) (July 4,
2012), available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32012R0648. Article 1(5(a)) references Section 4.2 of
Part 1 of Annex VI to Directive 2006/48/EC, available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32006L0048.
\113\ Entities Rule, 77 FR at 30692, n.1180. Additionally, the
Commission notes that the Guidance referenced the Entities Rule's
interpretation as well. Guidance, 78 FR at 45353 n.531.
\114\ The definitions overlap but together include the
following: The International Monetary Fund, International Bank for
Reconstruction and Development, European Bank for Reconstruction and
Development, International Development Association, International
Finance Corporation, Multilateral Investment Guarantee Agency,
African Development Bank, African Development Fund, Asian
Development Bank, Inter-American Development Bank, Bank for Economic
Cooperation and Development in the Middle East and North Africa,
Inter-American Investment Corporation, Council of Europe Development
Bank, Nordic Investment Bank, Caribbean Development Bank, European
Investment Bank and European Investment Fund. Note that the
International Bank for Reconstruction and Development, the
International Development Association, the International Finance
Corporation, and the Multilateral Investment Guarantee Agency are
parts of the World Bank Group.
\115\ See CFTC Staff Letter No. 17-34, Commission Regulations
23.150-159, 161: No-Action Position with Respect to Uncleared Swaps
with the European Stability Mechanism (Jul, 24, 2017), available at
https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/17-34.pdf. See also CFTC Staff
Letter No. 19-22, Commission Regulations 23.150-159, 23.161: Revised
No-Action Position with Respect to Uncleared Swaps with the European
Stability Mechanism (Oct. 16, 2019), available at https://www.cftc.gov/csl/19-22/download.
\116\ See CFTC Staff Letter No. 18-13, No-Action Position:
Relief for Certain Non-U.S. Persons from Including Swaps with
International Financial Institutions in Determining Swap Dealer and
Major Swap Participant Status (May 16, 2018), available at https://www.cftc.gov/sites/default/files/csl/pdfs/18/18-13.pdf.
\117\ See CFTC Staff Letter No. 17-34. In addition, in October
2019, the Commission approved a proposal to exclude ESM from the
definition of ``financial end user'' in Sec. 23.151, which, if
adopted, would have the effect of excluding swaps between certain
SDs and ESM from the Commission's uncleared swap margin
requirements. See Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 84 FR 56392 (Oct. 22, 2019).
\118\ See CFTC Staff Letter 18-13. See also CFTC Staff Letter
17-59 (Nov. 17, 2017) (providing no-action relief to NADB from the
swap clearing requirement of section 2(h)(1) of the CEA), available
at https://www.cftc.gov/idc/groups/public/%40lrlettergeneral/documents/letter/17-59.pdf.
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As described above, the Commission is of the view that the proposed
``U.S. person'' definition is largely similar to the definition in the
Cross-Border Margin Rule. Specifically, the Commission believes that
any person designated as a ``U.S. person'' under the Proposed Rule
would also be designated as such under the Cross-Border Margin Rule.
Therefore, the Commission believes any inconsistencies do not raise
significant concerns regarding the practical application of the ``U.S.
person'' definitions. Further, the Commission believes that having a
definition that is harmonized with the SEC allows for more efficient
application of the definitions by market participants, including
entities that may engage in dealing activity with respect to both swaps
and security-based swaps. Therefore, the Commission may also consider
amending the ``U.S. person'' definition in the Cross-Border Margin Rule
in the future. However, to provide certainty to market participants,
proposed Sec. 23.23(a)(22)(iv) would permit reliance, until December
31, 2025, on any U.S. person-related representations that were obtained
to comply with the Cross-Border Margin Rule. This time-limited relief
is appropriate so that market participants do not have to immediately
obtain new representations from their counterparties. The Commission
also believes that any person designated as a ``U.S. person'' under the
Proposed Rule would also be a ``U.S. person'' under the Guidance
definition, since the Proposed Rule's definition is narrower in scope.
Therefore, the Commission is of the view that market participants would
also be able to rely on representations previously obtained using the
``U.S. person'' definition in the Guidance.
The term ``non-U.S. person'' would be defined to mean any person
that is not a U.S. person.\119\ Further, the Proposed Rule would define
``United States'' and ``U.S.'' as the United States of America,
[[Page 963]]
its territories and possessions, any State of the United States, and
the District of Columbia.\120\
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\119\ Proposed Sec. 23.23(a)(9).
\120\ Proposed Sec. 23.23(a)(19).
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B. Guarantee
Under the Proposed Rule, consistent with the Cross-Border Margin
Rule,\121\ a ``guarantee'' would mean an arrangement, pursuant to which
one party to a swap has rights of recourse against a guarantor, with
respect to its counterparty's obligations under the swap.\122\ For
these purposes, a party to a swap has rights of recourse against a
guarantor if the party has a conditional or unconditional legally
enforceable right to receive or otherwise collect, in whole or in part,
payments from the guarantor with respect to its counterparty's
obligations under the swap. Also, the term ``guarantee'' would
encompass any arrangement pursuant to which the guarantor itself has a
conditional or unconditional legally enforceable right to receive or
otherwise collect, in whole or in part, payments from any other
guarantor with respect to the counterparty's obligations under the
swap.
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\121\ See 17 CFR 23.160(a)(2). However, in contrast with the
Cross-Border Margin Rule, the application of the proposed definition
of ``guarantee'' would not be limited to uncleared swaps.
\122\ Proposed Sec. 23.23(a)(8).
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Consistent with the Cross-Border Margin Rule, the proposed term
``guarantee'' would apply regardless of whether such right of recourse
is conditioned upon the non-U.S. person's insolvency or failure to meet
its obligations under the relevant swap, and regardless of whether the
counterparty seeking to enforce the guarantee is required to make a
demand for payment or performance from the non-U.S. person before
proceeding against the U.S. guarantor.\123\ The terms of the guarantee
need not necessarily be included within the swap documentation or even
otherwise reduced to writing (so long as legally enforceable rights are
created under the laws of the relevant jurisdiction), provided that a
swap counterparty has a conditional or unconditional legally
enforceable right, in whole or in part, to receive payments from, or
otherwise collect from, the U.S. person in connection with the non-U.S.
person's obligations under the swap. For purposes of the Proposed Rule,
the Commission would generally consider swap activities involving
guarantees from U.S. persons to satisfy the ``direct and significant''
test under CEA section 2(i).
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\123\ See 17 CFR 23.160(a)(2); Cross-Border Margin Rule, 81 FR
at 34825.
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The proposed term ``guarantee'' would also encompass any
arrangement pursuant to which the counterparty to the swap has rights
of recourse, regardless of the form of the arrangement, against at
least one U.S. person (either individually, jointly, and/or severally
with others) for the non-U.S. person's obligations under the swap.\124\
This addresses concerns that swaps could be structured such that they
would not have to count toward a non-U.S. person's de minimis threshold
calculation. For example, consider a swap between two non-U.S. persons
(``Party A'' and ``Party B''), where Party B's obligations to Party A
under the swap are guaranteed by a non-U.S. affiliate (``Party C''),
and where Party C's obligations under the guarantee are further
guaranteed by a U.S. parent entity (``Parent D''). The proposed
definition of ``guarantee'' would deem a guarantee to exist between
Party B and Parent D with respect to Party B's obligations under the
swap with Party A.\125\
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\124\ See Cross-Border Margin Rule, 81 FR at 34825.
\125\ See id. This example is included for illustrative purposes
only and is not intended to cover all examples of swaps that could
be affected by the Proposed Rule, if adopted.
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Further, the Commission's proposed definition of guarantee would
not be affected by whether the U.S. guarantor is an affiliate of the
non-U.S. person because, in each case, regardless of affiliation, the
swap counterparty has a conditional or unconditional legally
enforceable right, in whole or in part, to receive payments from, or
otherwise collect from, the U.S. person in connection with the non-U.S.
person's obligations.
The Commission also notes that the proposed ``guarantee''
definition would not apply when a non-U.S. person has a right to be
compensated by a U.S. person with respect to the non-U.S. person's own
obligations under the swap. For example, consider a swap between two
non-U.S. persons (``Party E'' and ``Party F''), where Party E enters
into a back-to-back swap with a U.S. person (``Party G''), or enters
into an agreement with Party G to be compensated for any payments made
by Party E under the swap in return for passing along any payments
received. In such an arrangement, a guarantee would not exist because
Party F would not have a right to collect payments from Party G with
respect to Party E's obligations under the swap (assuming no other
agreements exist).
As with the Cross-Border Margin Rule, the definition of
``guarantee'' in the Proposed Rule is narrower in scope than the one
used in the Guidance.\126\ Under the Guidance, the Commission advised
that it 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. The Commission stated that it believed
that it was necessary to interpret the term ``guarantee'' to include
the different financial arrangements and structures that transfer risk
directly back to the United States.\127\ The Commission is aware that
many other types of financial arrangements or support, other than a
guarantee as defined in the Proposed Rule, may be provided by a U.S.
person to a non-U.S. person (e.g., keepwells and liquidity puts,
certain types of indemnity agreements, master trust agreements,
liability or loss transfer or sharing agreements). The Commission
understands that these other financial arrangements or support transfer
risk directly back to the U.S. financial system, with possible
significant adverse effects, in a manner similar to a guarantee with a
direct recourse to a U.S. person. However, the Commission believes that
a narrower definition of guarantee than that in the Guidance would
achieve a more workable framework for non-U.S. persons, particularly
because this definition of ``guarantee'' would be consistent with the
Cross-Border Margin Rule, and therefore would not require a separate
independent assessment, without undermining the protection of U.S.
persons and the U.S. financial system. The Commission recognizes that
the proposed definition of ``guarantee'' could, if adopted, lead to
certain entities counting fewer swaps towards their de minimis
threshold as compared to the definition in the Guidance. However, the
Commission believes that concerns arising from fewer swaps being
counted could be mitigated to the extent such non-U.S. person meets the
definition of a ``significant risk subsidiary,'' and thus, as discussed
below, would potentially still need to count certain swaps or swap
positions toward its SD or MSP registration threshold. In this way,
non-U.S. persons receiving support from a U.S. person and representing
some measure of material risk to the U.S. financial system would be
captured. The Commission thus believes that the Proposed Rule would
achieve the dual goals of protecting the U.S. markets
[[Page 964]]
while promoting a workable cross-border framework.
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\126\ See id. at 34824.
\127\ Guidance, 78 FR at 45320.
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For discussion purposes in this release, a non-U.S. person would be
considered a ``Guaranteed Entity'' with respect to swaps that are
guaranteed by a U.S. person. A non-U.S. person may be a Guaranteed
Entity with respect to swaps with certain counterparties because the
non-U.S. person's swaps with those counterparties are guaranteed, but
would not be a Guaranteed Entity with respect to swaps with other
counterparties if the non-U.S. person's swaps with the other
counterparties are not guaranteed by a U.S. person. In other words,
depending on the nature of the trading relationship, a single entity
could be a Guaranteed Entity with respect to some of its swaps, but not
others. This release uses the term ``Other Non-U.S. Person'' to refer
to a non-U.S. person that is neither a Guaranteed Entity nor a
significant risk subsidiary. Depending on an entity's corporate
structure and financial relationships, a single entity could be both,
for example, a Guaranteed Entity and an Other Non-U.S. Person.
C. Significant Risk Subsidiary, Significant Subsidiary, Subsidiary,
Parent Entity, and U.S. GAAP
In the Proposed Rule, the Commission is proposing a new category of
person termed a significant risk subsidiary (``SRS''). A non-U.S.
person would be considered an SRS if: (1) The non-U.S. person is a
``significant subsidiary'' of an ``ultimate U.S. parent entity,'' as
those terms are proposed to be defined; (2) the ``ultimate U.S. parent
entity'' has more than $50 billion in global consolidated assets, as
determined in accordance with U.S. GAAP at the end of the most recently
completed fiscal year; and (3) the non-U.S. person is not subject to
either: (a) Consolidated supervision and regulation by the Board of
Governors of the Federal Reserve System (``Federal Reserve Board'') as
a subsidiary of a U.S. bank holding company (``BHC''); or (b) capital
standards and oversight by the non-U.S. person's home country regulator
that are consistent with the Basel Committee on Banking Supervision's
``International Regulatory Framework for Banks'' (``Basel III'') and
margin requirements for uncleared swaps in a jurisdiction for which the
Commission has issued a comparability determination (``CFTC Margin
Determination'') with respect to uncleared swap margin
requirements.\128\ If an entity is determined to be an SRS, the
Commission proposes to apply certain regulations, including the SD and
MSP registration threshold calculations, to the entity in the same
manner as a U.S. person.
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\128\ Proposed Sec. 23.23(a)(11)-(14) and (18).
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1. Non-U.S. Persons With U.S. Parent Entities
In addition to the U.S. persons described above in section II.A,
the Commission understands that U.S. persons may organize the
operations of their businesses through the use of one or more
subsidiaries that are organized and operated outside the United States.
Through consolidation, non-U.S. subsidiaries of U.S. persons may permit
U.S. persons to accrue risk through the swap activities of their non-
U.S. subsidiaries that, in aggregate, may have a significant effect on
the U.S. financial system. Therefore, the Commission believes that
consolidated non-U.S. subsidiaries of U.S. persons may appropriately be
subject to Commission regulation due to their direct and significant
relationship to their U.S. parent entities. Thus, the Commission
believes that consolidated non-U.S. subsidiaries of U.S. parent
entities present a greater supervisory interest to the CFTC, relative
to Other Non-U.S. Persons. Moreover, because U.S. persons have
regulatory obligations under the CEA that Other Non-U.S. Persons may
not have, the Commission also believes that consolidated non-U.S.
subsidiaries of U.S. parent entities present a greater supervisory
interest to the CFTC relative to Other Non-U.S. Persons due to the
Commission's interest in preventing the evasion of obligations under
the CEA.
Pursuant to the consolidation requirements of U.S. GAAP, the
financial statements of a U.S. parent entity reflect the financial
position and results of operations of that parent entity, together with
the network of branches and subsidiaries in which the U.S. parent
entity has a controlling interest, including non-U.S. subsidiaries,
which is an indication of connection and potential risk to the U.S.
parent entity. Consolidation under U.S. GAAP is predicated on the
financial control of the reporting entity. Therefore, an entity within
a financial group that is consolidated with its parent entity for
accounting purposes in accordance with U.S. GAAP is subject to the
financial control of that parent entity. By virtue of consolidation
then, a non-U.S. subsidiary's swap activity creates direct risk to the
U.S. parent. That is, as a result of consolidation and financial
control, the financial position, operating results, and statement of
cash flows of a non-U.S. subsidiary are included in the financial
statements of its U.S. parent and therefore affect the financial
condition, risk profile, and market value of the parent. Because of
that relationship, risks taken by a non-U.S. subsidiary can have a
direct effect on the U.S. parent entity. Furthermore, a non-U.S.
subsidiary's counterparties may generally look to both the subsidiary
and its U.S. parent for fulfillment of the subsidiary's obligations
under a swap, even without any explicit guarantee. In many cases, the
Commission believes that counterparties would not enter into the
transaction with the subsidiary (or would not do so on the same terms),
and the subsidiary would not be able to engage in a swap business,
absent this close relationship with a parent entity. In addition, the
Commission notes that a non-U.S. subsidiary may enter into offsetting
swaps or other arrangements with its U.S. parent entity or other
affiliate(s) to transfer the risks and benefits of swaps with non-U.S.
persons to its U.S. affiliates, which could also lead to risk for the
U.S. parent entity. Because such swap activities may have a direct
impact on the financial position, risk profile, and market value of a
U.S. parent entity, they can lead to spill-over effects on the U.S.
financial system.
However, the Commission preliminarily believes the principles of
international comity counsel against applying its swap regulations to
all non-U.S. subsidiaries of U.S. parent entities. Rather, the
Commission believes that it is consistent with such principles to apply
a risk-based approach to determining which of such entities should be
required to comply with the Commission's swap requirements. The
Commission believes that its approach in the Proposed Rule makes that
determination in a manner that accounts for the risk that non-U.S.
subsidiaries may pose to the U.S. financial system and the ability of
large global entities to efficiently operate outside the United States.
The Commission's risk-based approach is embodied in the proposed
definition of an SRS. SRSs are entities whose obligations under swaps
may not be guaranteed by U.S. persons, but which nonetheless raise
particular supervisory concerns in the United States due to the
possible negative impact on their ultimate U.S. parent entities and
thus the U.S. financial system.
2. Preliminary Definitions
For purposes of the SRS definition, the term ``subsidiary'' would
mean a subsidiary of a specified person that is an affiliate controlled
by such person directly, or indirectly through one or
[[Page 965]]
more intermediaries.\129\ For purposes of this definition, an affiliate
of, or a person affiliated with, a specific person would be a person
that directly, or indirectly through one or more intermediaries,
controls, or is controlled by, or is under common control with, the
person specified. The term ``control,'' including controlling,
controlled by, and under common control with, would 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 shares, by contract, or otherwise.\130\ These
proposed definitions of subsidiary and control are substantially
similar to the definitions found in SEC regulation S-X. Further, under
the Proposed Rule, the term ``parent entity'' would mean any entity in
a consolidated group that has one or more subsidiaries in which the
entity has a controlling interest, in accordance with U.S. GAAP.\131\
U.S. GAAP is defined in the Proposed Rule as U.S. generally accepted
accounting principles.\132\
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\129\ Proposed Sec. 23.23(a)(14).
\130\ Proposed Sec. 23.23(a)(1).
\131\ Proposed Sec. 23.23(a)(11).
\132\ Proposed Sec. 23.23(a)(21).
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Notably, a U.S. parent entity for purposes of the definition of SRS
need not be a non-U.S. subsidiary's ultimate parent entity. The SRS
definition would encompass U.S. parent entities that may be
intermediate entities in a consolidated corporate family with an
ultimate parent entity located outside the U.S. To differentiate
between multiple possible U.S. parent entities, the Proposed Rule
defines an ``ultimate U.S. parent entity'' for purposes of the
significant subsidiary test. A non-U.S. person's ``ultimate U.S. parent
entity'' would be the U.S. parent entity that is not a subsidiary of
any other U.S. parent entity.\133\ Risk of a non-U.S. subsidiary that
flows to its U.S. parent entity may not flow back out of the U.S. to a
non-U.S. ultimate or intermediate parent entity. Because the risk may
ultimately stop in the United States, it is appropriate for the
Commission to base its SRS definition on whether a non-U.S. person has
any U.S. parent entity, subject to certain risk-based thresholds.
---------------------------------------------------------------------------
\133\ Proposed Sec. 23.23(a)(18).
---------------------------------------------------------------------------
3. Significant Risk Subsidiaries
In addition to the definitions discussed above, whether an entity
would be considered an SRS depends on the size of its ultimate U.S.
parent entity, the significance of the subsidiary to its ultimate U.S.
parent entity, and the regulatory oversight of its ultimate U.S. parent
entity or the regulatory oversight of the non-U.S. subsidiary in the
jurisdiction in which it is regulated.
Under the Proposed Rule, the ultimate U.S. parent entity must
exceed a $50 billion consolidated asset threshold. The Commission is
proposing the $50 billion threshold in order to balance the
Commission's interest in adequately overseeing those non-U.S. persons
that may have a significant impact on their ultimate U.S. parent entity
and, by extension, the U.S. financial system, with its interest in
avoiding unnecessary burdens on those non-U.S. persons that would not
have such an impact. The $50 billion threshold has been used in other
contexts as a measure of large, complex institutions that may have
systemic impacts on the U.S. financial system. For example, the
Financial Stability Oversight Council (``FSOC'') initially used a $50
billion total consolidated assets quantitative test as one threshold to
apply to nonbank financial entities when assessing risks to U.S.
financial stability.\134\ The Commission preliminarily believes that
the $50 billion threshold provides an appropriate measure to limit the
burden of the SRS definition to only those entities whose ultimate U.S.
parent entity may pose a systemic risk to the U.S. financial system.
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\134\ See Authority to Require Supervision and Regulation of
Certain Nonbank Financial Companies, Financial Stability Oversight
Council, 77 FR 21637, 21643, 21661 (Apr. 2012). FSOC recently voted
to remove the existing stage 1 quantitative metrics that included,
among other metrics, the $50 billion threshold, because the metrics
generated confusion among firms and members of the public and
because they were not compatible with FSOC's new activities based
approach to addressing risk to financial stability. See Authority to
Require Supervision and Regulation of certain Nonbank Financial
Companies (Dec. 4, 2019), available at https://home.treasury.gov/system/files/261/Interpretive-Guidance-on-Nonbank-Financial-Company-Determinations.pdf. However, the Commission preliminarily believes
that the $50 billion total consolidated threshold remains an
appropriate and workable measure to identify those ultimate U.S.
parent entities that may have a significant impact on the U.S.
financial system.
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In addition, before a non-U.S. subsidiary of an ultimate U.S.
parent entity that meets the $50 billion consolidated asset threshold
would be an SRS, the subsidiary would need to constitute a significant
part of its ultimate U.S. parent entity. This concept of a
``significant subsidiary'' borrows from the SEC's definition of
``significant subsidiary'' in Regulation S-X, as well as the Federal
Reserve Board in its financial statement filing requirements for
foreign subsidiaries of U.S. banking organizations.\135\ The Commission
believes it is appropriate to focus on only those subsidiaries that are
significant to their ultimate U.S. parent entities, in order to capture
those subsidiaries that have a significant impact on their large
ultimate U.S. parent entities. In order to provide certainty to market
participants as to what constitutes a significant subsidiary, the
Proposed Rule includes a set of quantitative significance tests.
Although not identical, the Commission notes that the SEC includes
similar revenue and asset significance tests in its definition of
significant subsidiary in Regulation S-X.\136\ The Commission believes
that, in this case, in order to determine whether a subsidiary meets
such significance, it is appropriate to measure the significance of a
subsidiary's equity capital, revenue, and assets relative to its
ultimate U.S. parent entity.
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\135\ See e.g., Instructions for Preparation of Financial
Statements of Foreign Subsidiaries of U.S. Banking Organizations FR
2314 and FR 2314S, at GEN-2 (Sept. 2016), available at https://
www.federalreserve.gov/reportforms/forms/FR_2314_
FR_2314S20190331_i.pdf (``FR 2314 and FR 2314S Instructions'')
(identifying equity capital significance test applicable to
subsidiaries). See also SEC rule 210.1-02(w), 17 CFR 210.1-02(w)
(identifying asset and income significance tests applicable in
definition of significant subsidiaries).
\136\ 17 CFR 210.1-02(w)(1)-(3) (setting out a ten percent
significance threshold with respect to total assets and income).
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Under the Proposed Rule, the term ``significant subsidiary'' would
mean a subsidiary, including its subsidiaries, where: (1) The three
year rolling average of the subsidiary's equity capital is equal to or
greater than five percent of the three year rolling average of its
ultimate U.S. parent entity's consolidated equity capital, as
determined in accordance with U.S. GAAP at the end of the most recently
completed fiscal year (the ``equity capital significance test''); (2)
the three year rolling average of the subsidiary's revenue is equal to
or greater than ten percent of the three year rolling average of its
ultimate U.S. parent entity's consolidated revenue, as determined in
accordance with U.S. GAAP at the end of the most recently completed
fiscal year (the ``revenue significance test''); or (3) the three year
rolling average of the subsidiary's assets are equal to or greater than
ten percent of the three year rolling average of its ultimate U.S.
parent entity's consolidated assets, as determined in accordance with
U.S. GAAP at the end of the most recently completed fiscal year (the
``asset significance test''). For the proposed equity capital
significance test, equity capital would include perpetual
[[Page 966]]
preferred stock, common stock, capital surplus, retained earnings,
accumulated other comprehensive income and other equity capital
components and should be calculated in accordance with U.S. GAAP.
The Proposed Rule would cause an entity to be a significant
subsidiary only if it passes at least one of these significance tests.
The Commission preliminarily believes that the equity capital test is
an appropriate measure of a subsidiary's significance to its ultimate
U.S. parent entity and notes its use in the context of financial
statement reporting of foreign subsidiaries.\137\ The Commission also
preliminarily believes that if a subsidiary constitutes more than ten
percent of its ultimate U.S. parent entity's assets or revenue, it is
of significant importance to its ultimate U.S. parent entity such that
swap activity by the subsidiary may have a material impact on its
ultimate U.S. parent entity and, consequently, the U.S. financial
system. The Commission is proposing to use a three year rolling average
throughout its proposed significance tests in order to mitigate the
potential for an entity to frequently change from being deemed a
significant subsidiary and not being deemed a significant subsidiary
based on fluctuations in its share of equity capital, revenue, or
assets of its ultimate U.S. parent entity. The Commission preliminarily
believes that if a subsidiary satisfies any one of the three
significance tests proposed here, then it is of sufficient significance
to its ultimate U.S. parent entity, which under proposed Sec.
23.23(a)(12) has consolidated assets of more than $50 billion, to
warrant the application of requirements addressed by the Proposed Rule
if such subsidiary otherwise meets the definition of SRS.
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\137\ FR 2314 and FR 2314S Instructions, at Gen-2.
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4. Exclusions From the Definition of SRS
As indicated above, under the Proposed Rule, a non-U.S. person
would not be an SRS to the extent the entity is subject to prudential
regulation as a subsidiary of a U.S. BHC or is subject to comparable
capital and margin standards. An entity that meets either of those two
exceptions, in the Commission's preliminary view, would be subject to a
level of regulatory oversight that is sufficiently comparable to the
Dodd-Frank Act swap regime with respect to prudential oversight. Non-
U.S. subsidiaries that are part of BHCs are already subject to
consolidated supervision and regulation by the Federal Reserve
Board,\138\ including with respect to capital and risk management
requirements, and therefore their swap activity poses less risk to the
financial position and risk profile of the ultimate U.S. parent entity,
and thus less risk to the U.S. financial system than the swap activity
of a non-U.S. subsidiary of an ultimate U.S. parent entity that is a
not a BHC. In this case, the Commission preliminarily believes
deference to the foreign regulatory regime would be appropriate because
the swap activity is occurring within an organization that is under the
umbrella of U.S. prudential regulation with certain regulatory
protections already in place.\139\
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\138\ See e.g., Board of Governors of the Federal Reserve
System, Bank Holding Company Supervision Manual, section 2100.0.1
Foreign Operations of U.S. Banking Organizations, available at
https://www.federalreserve.gov/publications/files/bhc.pdf (``The
Federal Reserve has broad discretionary powers to regulate the
foreign activities of member banks and bank holding companies (BHCs)
so that, in financing U.S. trade and investments abroad, these U.S.
banking organizations can be competitive with institutions of the
host country without compromising the safety and soundness of their
U.S. operations.''); FR 2314 and FR 2314S Instructions, at GEN 2.
\139\ Proposed Sec. 23.23(a)(12)(i).
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Similarly, in the case of entities that are subject to capital
standards and oversight by their home country regulators that are
consistent with Basel III and subject to a CFTC Margin Determination,
the Commission preliminarily believes that it is appropriate for the
Commission to defer to the home country regulator.\140\ For purposes of
determining whether proposed Sec. 23.23(a)(12)(ii) would apply, the
Commission intends for persons to independently assess whether they
reside in a jurisdiction that has capital standards that are consistent
with Basel III.\141\ In such cases where entities are subject to
capital standards and oversight by their home country regulators that
are consistent with Basel III and subject to a CFTC Margin
Determination, the Commission preliminarily believes that the potential
risk that the entity might pose to the U.S. financial system would be
adequately addressed through these capital and margin requirements.
Further, such an approach is consistent with the Commission's desire to
show deference to non-U.S. regulators whose requirements are comparable
to the CFTC's requirements. For margin purposes, the Commission has
issued a number of determinations that entities can look to in order to
determine if they satisfy this aspect of the exception.\142\ For
capital standards and oversight consistent with Basel III, entities
should look to whether the BIS has determined the jurisdiction is in
compliance as of the relevant Basel Committee on Banking Supervision
deadline set forth in its most recent progress report.\143\ The
Commission preliminarily believes that it is appropriate to except
these entities from the definition of SRS, in large part, because the
swaps entered into by such entities are already subject to significant
regulation, either by the Federal Reserve Board or by the entity's home
country.
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\140\ Proposed Sec. 23.23(a)(12)(ii).
\141\ Discussion regarding the Basel framework is available at
https://www.bis.org/bcbs/basel3.htm.
\142\ See Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 63376 (Sep. 15, 2016); Comparability
Determination for the European Union: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 82 FR
48394 (Oct. 13, 2017) (``Margin Comparability Determination for the
European Union''); Amendment to Comparability Determination for
Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 84 FR 12074 (Apr. 1, 2019); and
Comparability Determination for Australia: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 84 FR
12908 (Apr. 3, 2019). Further, on April 5, 2019, DSIO and the
Division of Market Oversight issued a letter jointly to provide
time-limited no-action relief in connection with, among other
things, the Margin Comparability Determination for the European
Union, in order to account for the anticipated withdrawal of the
United Kingdom from the European Union. See CFTC Staff Letter 19-08,
No-Action Relief in Connection With Certain Previously Granted
Commission Determinations and Exemptions, in Order to Account for
the Anticipated Withdrawal of the United Kingdom From the European
Union (Apr. 5, 2019), available at https://www.cftc.gov/csl/19-08/download.
\143\ The most current report was issued in October 2019. Basel
Committee on Banking Supervision, Seventeenth progress report on
adoption of the Basel regulatory framework (October 2019), available
at https://www.bis.org/bcbs/publ/d478.pdf. Current and historical
reports are available at https://www.bis.org/bcbs/implementation/rcap_reports.htm?m=3%7C14%7C656%7C59.
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As noted above, if a non-U.S. subsidiary of an ultimate U.S. parent
entity does not fall into either of the exceptions in proposed
Sec. Sec. 23.23(a)(12)(i)-(ii), the Proposed Rule would classify the
subsidiary as a SRS only if its ultimate U.S. parent entity has more
than $50 billion in global consolidated assets and if the subsidiary
meets the definition of a significant subsidiary, set forth in proposed
Sec. 23.23(a)(13).
The Commission is requesting comment below on the proposed
definitions discussed in this section.
D. Foreign Branch and Swap Conducted Through a Foreign Branch
Under the Proposed Rule, the term ``foreign branch'' would mean an
office of a U.S. person that is a bank that: (1)
[[Page 967]]
Is located outside the United States; (2) operates for valid business
reasons; (3) 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;
and (4) is engaged in the business of banking or finance and is subject
to substantive regulation in banking or financing in the jurisdiction
where it is located.\144\
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\144\ Proposed Sec. 23.23(a)(2).
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The Commission believes that the factors listed in the proposed
definition are appropriate for determining when an entity would be
considered a foreign branch for purposes of the Proposed Rule.\145\ The
requirement that the foreign branch be located outside of the United
States is consistent with the stated goal of identifying certain swap
activity that is not conducted within the United States. The
requirements that the foreign branch maintain accounts independent of
the U.S. entity, operate for valid business reasons, and be engaged in
the business of banking or finance and be subject to substantive
banking or financing regulation in its non-U.S. jurisdiction are also
intended to prevent evasion of the Dodd-Frank Act requirements.\146\ In
particular, these requirements address the concern that an entity would
set up operations outside the United States in a jurisdiction without
substantive banking or financial regulation to evade Dodd-Frank Act
requirements and CFTC regulations.\147\ The Commission notes that this
proposed definition incorporates concepts from the Federal Reserve
Board's Regulation K,\148\ the FDIC International Banking
Regulation,\149\ and the Office of the Comptroller of the Currency's
``foreign branch'' definition.\150\
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\145\ As discussed below in sections III.B.2 and IV.B.2, the
Proposed Rule would not require an Other Non-U.S. Person to count
toward its de minimis threshold calculations swaps conducted through
a foreign branch of a registered U.S. SD.
\146\ The Commission notes that national banks operating foreign
branches are required under section 25 of the Federal Reserve Act
(``FRA'') 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. 12 U.S.C. 604. The FRA is
codified at 12 U.S.C. 221 et seq.
\147\ As discussed below, the Commission is concerned that the
material terms of a swap would be negotiated or agreed to by
employees of the U.S. bank that are located in the United States and
then be routed to a foreign branch so that the swap would be treated
as a swap with the foreign branch for purposes of the SD and MSP
registration thresholds or for purposes of certain regulatory
requirements applicable to registered SDs or MSPs.
\148\ Regulation K is a regulation issued by the Board of
Governors of the Federal Reserve (``Federal Reserve Board'') under
the authority of the FRA; 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. 12 CFR part
211. Under Regulation K, 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.'' 12 CFR 211.2(k).
\149\ 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.
\150\ 12 CFR 28.2 (defining ``foreign branch'' as an office of a
national bank (other than a representative office) that is located
outside the United States at which banking or financing business is
conducted).
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The proposed definition of ``foreign branch'' is also consistent
with the SEC's approach, which, for purposes of security-based swap
dealer regulation, defined foreign branch as any branch of a U.S. bank
that: (1) Is located outside the United States; (2) operates for valid
business reasons; and (3) is engaged in the business of banking and is
subject to substantive banking regulation in the jurisdiction where
located.\151\ The Commission's intention is to ensure that the
definition provides sufficient clarity as to what constitutes a
``foreign branch''--specifically, an office outside of the U.S. that
has independent accounts from the home office and other branches--while
striving for greater regulatory harmony with the SEC.\152\
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\151\ See 17 CFR 240.3a71-3(a)(2).
\152\ The Commission also notes that the factors listed in the
Proposed Rule are similar to the approach described in the Guidance,
which stated that the foreign branch of a U.S. swap entity is an
entity that is: (1) Subject to Regulation K or the FDIC
International Banking Regulation, or otherwise designated as a
``foreign branch'' by the U.S. bank's primary regulator; (2)
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; and (3) subject to substantive regulation in banking or
financing in the jurisdiction where it is located. See Guidance, 78
FR at 45329.
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The Commission notes that a foreign branch would not include an
affiliate of a U.S. bank that is incorporated or organized as a
separate legal entity.\153\ For similar reasons, the Commission
declines in the Proposed Rule to recognize foreign branches of U.S.
persons separately from their U.S. principal for purposes of
registration.\154\ That is, if the foreign branch engages in swap
activity in excess of the relevant SD or MSP registration thresholds,
as discussed further below, the U.S. person would be required to
register, and the registration would encompass the foreign branch.
However, upon consideration of principles of international comity and
the factors set forth in the Restatement, rather than broadly excluding
foreign branches from the U.S. person definition, the Commission is
proposing to calibrate the requirements for counting certain swaps
entered into through a foreign branch, as described in sections III.B.2
and IV.B.2, and proposing to calibrate the requirements otherwise
applicable to foreign branches of a registered U.S. SD, as discussed in
section VI. Among the benefits, as discussed below, would be to enable
foreign branches of U.S. banks to have greater access to foreign
markets.
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\153\ This is similar to the approach described in the Guidance.
See Guidance, 78 FR at 45328-29.
\154\ This is similar to the approach described in the Guidance.
See id. at 45315, 45328-29.
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Under the Proposed Rule, the term ``swap conducted through a
foreign branch'' would mean a swap entered into by a foreign branch
where: (1) The foreign branch or another foreign branch is the office
through which the U.S. person makes and receives payments and
deliveries under the swap pursuant to a master netting or similar
trading agreement, and the documentation of the swap specifies that the
office for the U.S. person is such foreign branch; (2) the swap is
entered into by such foreign branch in its normal course of business;
and (3) the swap is reflected in the local accounts of the foreign
branch.\155\
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\155\ Proposed Sec. 23.23(a)(16).
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The Commission believes that this definition identifies the type of
swap activity for which the foreign branch performs key dealing
functions outside the United States. Because a foreign branch of a U.S.
bank is not a separate legal entity, the first prong of the definition
clarifies that the foreign branch must be the office of the U.S. bank
through which payments and deliveries under the swap must be made. This
approach is consistent with the standard 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.\156\
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\156\ The ISDA Master Agreement defines ``office'' as a branch
or office of a party, which may be such party's head or home office.
See 2002 ISDA Master Agreement, available at https://www.isda.org/book/2002-isda-master-agreement-english/library.
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[[Page 968]]
The second prong of the definition (whether the swap is entered
into by such foreign branch in the normal course of business) is
intended as an anti-evasion measure to prevent a U.S. bank from simply
routing swaps for booking in a foreign branch so that the swap would be
treated as a swap conducted through a foreign branch for purposes of
the SD and MSP registration thresholds or for purposes of certain
regulatory requirements applicable to registered SDs or MSPs. To
satisfy this prong, it must be the normal course of business for
employees located in the branch (or another foreign branch of the U.S.
bank) to enter into the type of swap in question. The Commission
preliminarily believes that this requirement would not prevent
personnel of the U.S. bank located in the U.S. from participating in
the negotiation or execution of the swap so long the swaps that are
booked in the foreign branch are primarily entered into by personnel
located in the branch (or another foreign branch of the U.S. bank).
With respect to the third prong, the Commission believes that where
a swap is with the foreign branch of a U.S. bank, it generally would be
reflected in the foreign branch's accounts.\157\
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\157\ This proposed definition is generally consistent with the
definition under the Guidance. See Guidance, 78 FR at 45330.
However, the Commission notes that the proposed definition of
``foreign branch'' does not include the requirement that 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, be located in such foreign branch or in another
foreign branch of the U.S. bank. The Commission is of the view that,
as discussed above, the second prong of the proposed definition
addresses this issue.
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E. Swap Entity, U.S. Swap Entity, and Non-U.S. Swap Entity
Under the Proposed Rule, the term ``swap entity'' would mean a
person that is registered with the Commission as a SD or MSP pursuant
to the CEA.\158\ In addition, the Commission is proposing to define
``U.S. swap entity'' as a swap entity that is a U.S. person,\159\ and
``non-U.S. swap entity'' as a swap entity that is not a U.S swap
entity.\160\
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\158\ Proposed Sec. 23.23(a)(15).
\159\ Proposed Sec. 23.23(a)(23).
\160\ Proposed Sec. 23.23(a)(10).
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F. U.S. Branch and Swap Conducted Through a U.S. Branch
Under the Proposed Rule, the term ``U.S. branch'' would mean a
branch or agency of a non-U.S. banking organization where such branch
or agency: (1) Is located in the United States; (2) maintains accounts
independently of the home office and other U.S. branches, with the
profit or loss accrued at each branch determined as a separate item for
each U.S. branch; and (3) engages in the business of banking and is
subject to substantive banking regulation in the state or district
where located.\161\ The term ``swap conducted through a U.S. branch''
would mean a swap entered into by a U.S. branch where: (1) The U.S.
branch is the office through which the non-U.S. person makes and
receives payments and deliveries under the swap pursuant to a master
netting or similar trading agreement, and the documentation of the swap
specifies that the office for the non-U.S. person is such U.S. branch;
or (2) the swap is reflected in the local accounts of the U.S.
branch.\162\
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\161\ Proposed Sec. 23.23(a)(20).
\162\ Proposed Sec. 23.23(a)(17).
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Similar to how the terms ``foreign branch'' and ``conducted through
a foreign branch'' are used under the Proposed Rule to identify swap
activity of U.S. entities that is taking place outside the United
States and, thus, may be eligible for certain relief from the
Commission's requirements under the Proposed Rule, these definitions
would be used to identify swap activity that the Commission believes
should be considered to take place in the United States and, thus,
remain subject to the Commission's requirements addressed in the
Proposed Rule, as discussed below with respect to the definitions of
``foreign-based swap'' and ``foreign counterparty.'' In particular,
these proposed definitions are intended to address the concern that an
entity would operate outside the United States to evade Dodd-Frank Act
requirements and CFTC regulations for a swap while still benefiting
from the swap taking place in the United States. The Commission
preliminarily believes that the requirements listed in the proposed
definitions are appropriate to identify swaps of a non-U.S. banking
organization operating through a foreign branch in the United States
that should remain subject to Commission requirements addressed in the
Proposed Rule.
Consistent with the Commission's proposed approach to foreign
branches, a U.S. branch of a non-U.S. banking organization would not
include a U.S. affiliate of the organization that is incorporated or
organized as a separate legal entity. Also consistent with this
approach, the Commission declines in the Proposed Rule to recognize
U.S. branches of non-U.S. banking organization separately from their
non-U.S. principal for purposes of registration.
G. Foreign-Based Swap and Foreign Counterparty
Under the Proposed Rule, the term ``foreign-based swap'' would
mean: (1) A swap by a non-U.S. swap entity, except for a swap conducted
through a U.S. branch; or (2) a swap conducted through a foreign
branch.\163\ The term ``foreign counterparty'' would mean: (1) A non-
U.S. person, except with respect to a swap conducted through a U.S.
branch of that non-U.S. person; or (2) a foreign branch where it enters
into a swap in a manner that satisfies the definition of a swap
conducted through a foreign branch.\164\ Together with the proposed
defined terms ``foreign branch,'' ``swap conducted through a foreign
branch,'' ``U.S. branch,'' and ``swap conducted through a U.S. branch''
discussed above, these terms would be used to determine which swaps the
Commission considers to be foreign swaps of non-U.S. swap entities and
foreign branches of U.S. swap entities for which certain relief from
Commission requirements would be available under the Proposed Rule, and
which swaps should be treated as domestic swaps not eligible for such
relief. The Commission is proposing to limit the types of swaps that
are eligible for relief, consistent with section 2(i) of the CEA, to
address its concern that swaps that demonstrate sufficient indicia of
being domestic remain subject to the Commission's requirements
addressed by the Proposed Rule, notwithstanding that the swap is
entered into by a non-U.S. swap entity or a foreign branch of a U.S.
swap entity. Otherwise, the Commission is concerned that an entity or
branch might simply be established outside of the United Stated to
evade Dodd-Frank Act requirements and CFTC regulations.
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\163\ Proposed Sec. 23.23(a)(4).
\164\ Proposed Sec. 23.23(a)(3).
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As the Commission has previously stated, it has a strong
supervisory interest in regulating swap activities that occur in the
United States.\165\ In addition, consistent with section 2(i) of the
CEA, the Commission believes that foreign swaps of non-U.S. swap
entities and foreign branches of U.S. swap entities should be eligible
for relief from certain of the Commission's requirements. Accordingly,
certain portions of the Commission's proposed substituted compliance
regime, as well as its proposed exceptions from certain requirements in
CFTC regulations (each discussed below in section VI), are
[[Page 969]]
designed to be limited to certain foreign swaps of non-U.S. swap
entities and foreign branches of U.S. swap entities that the Commission
believes should be treated as occurring outside the United States.
Specifically, these provisions are applicable only to a swap by a non-
U.S. swap entity, except for a swap conducted through a U.S. branch,
and a swap conducted through a foreign branch such that it would
satisfy the definition of a ``foreign-based swap'' above. They are not
applicable to swaps of non-U.S. swap entities that are conducted
through a U.S. branch of that swap entity, and swaps of foreign
branches of U.S. swap entities where the foreign branch does not enter
into the swaps in a manner that satisfies the definition of a swap
conducted through a foreign branch, because, in the Commission's view,
the entrance into a swap by a U.S. swap entity (through its foreign
branch) or a U.S. branch of a non-U.S. swap entity under these
circumstances, demonstrates sufficient indicia of being a domestic swap
to be treated as such for purposes of the Proposed Rule.\166\
Similarly, in certain cases, the availability of a proposed exception
or substituted compliance for a swap would depend on whether the
counterparty to such a swap qualifies as a ``foreign counterparty''
under the Proposed Rule. The Commission is proposing this requirement
to ensure that foreign-based swaps of swap entities in which their
counterparties demonstrate sufficient indicia of being domestic and,
thus, trigger the Commission's supervisory interest in domestic swaps,
continue to be subject to the Commission requirements addressed in the
Proposed Rule.
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\165\ See Guidance, 78 FR at 45350, n.513.
\166\ The Commission notes that the Guidance took a similar
approach with respect to U.S. branches of non-U.S. SDs or MSPs,
stating that they would be subject to the transaction-level
requirements (discussed in section VI.A below), without substituted
compliance. Id.
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The Commission also notes that its approach in the Proposed Rule
for U.S. branches of non-U.S. swap entities is parallel to the
Commission's approach in the Proposed Rule to provide certain
exceptions from Commission requirements or substituted compliance for
transactions of foreign branches of U.S. swap entities to take into
account the supervisory interest of local regulators, as discussed
below in section VI.
H. Request for Comment
The Commission invites comment on all aspects of the Proposed Rule,
including each of the definitions discussed above, and specifically
requests comments on the following questions. Please explain your
responses and provide alternatives to the relevant portions of the
Proposed Rule, where applicable.
(1) The ``U.S. person'' definition the Commission is proposing here
aligns with the definition of that term adopted by the SEC in the
context of its cross-border swap regulations. Should the Commission
instead adopt the U.S. person definition used in its Cross-Border
Margin Rule? Alternatively, should the Commission instead harmonize the
``U.S. person'' definition in the Proposed Rule to the interpretation
of U.S. person included in the Guidance?
(2) Is it appropriate, as proposed, that commodity pools, pooled
accounts, investment funds, or other CIVs that are majority-owned by
U.S. persons not be included in the proposed definition of ``U.S.
person''? Would a majority of such funds or CIVs be subject to margin
requirements of foreign jurisdictions? Is it accurate to assume that
the exposure of investors to losses in CIVs is generally capped at
their investment amount? Does tracking a CIV's beneficial ownership
pose challenges in certain circumstances?
(3) When determining the principal place of business for a CIV,
should the Commission consider including as a factor whether the senior
personnel responsible for the formation and promotion of the CIV are
located in the United States, similar to the approach in the Cross-
Border Margin Rule? \167\
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\167\ See Cross-Border Margin Rule, 81 FR at 34823.
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(4) Should the Commission include an unlimited U.S. responsibility
prong in the definition of ``U.S. person''? If not, should the
Commission revise its interpretation of ``guarantee'' in a manner
consistent with the SEC to ensure that persons that would otherwise be
considered U.S. persons pursuant to the unlimited U.S. responsibility
prong would nonetheless be considered entities with guarantees from a
U.S. person? Are there any persons that would be captured under the
unlimited U.S. responsibility prong?
(5) Should the ``U.S. person'' definition include a catch-all
provision? What types of entities would be expected to fall under such
a provision?
(6) Should the Commission consider providing an exemption from the
``U.S. person'' definition for pension plans organized in the U.S. that
are primarily for the benefit of the foreign employees of U.S.-based
entities, consistent with the Cross-Border Margin Rule's ``U.S.
person'' definition? \168\
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\168\ See 17 CFR 23.260(a)(10)(iv).
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(7) Should the catch-all provision for international financial
institutions be restricted to organizations in which the U.S.
government is a shareholder?
(8) Does the proposed SRS definition appropriately capture persons
that raise greater supervisory concerns relative to Other Non-U.S.
Persons whose swap obligations are not guaranteed by a U.S. person? If
not, how should the definition be revised? Is $50 billion an
appropriate threshold to determine when an ultimate U.S. parent entity
may have a significant impact on the U.S. financial system?
(9) Should the Commission consider alternative or additional tests
for whether a person would be a significant subsidiary or an SRS? Would
an alternate approach to the use of a three year rolling average
throughout the proposed significance tests more effectively mitigate
the risk of an entity frequently varying between being a significant
subsidiary and not being a significant subsidiary?
(10) Should the exclusion set out in proposed Sec. 23.23(a)(12)(i)
include any entity that is subject to consolidated supervision and
regulation by the Federal Reserve Board rather than being limited to
subsidiaries of BHCs (for example, intermediate holding companies of
foreign banking organizations that are subject to supervision by the
Federal Reserve Board)?
(11) Does the proposed definition of ultimate U.S. parent entity
adequately account for affiliated entity structures with multiple U.S.
parent entities? Are there situations where the proposed ultimate U.S.
parent entity definition would result in more than one ultimate U.S.
person entity being identified?
(12) Are the proposed tests for compliance with Basel III capital
standards and compliance with margin requirements in a comparable
jurisdiction appropriate? What are alternative ways for a person to
confirm it is compliant with Basel III capital standards?
(13) In the interests of harmonizing with the SEC, should the
Commission use the concept of ``conduit affiliate,'' as in 17 CFR
240.3a71-3(a)(1), instead of the concept of SRS? \169\ Or should the
[[Page 970]]
Commission address both conduit affiliates and SRSs in its cross-border
rules?
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\169\ The Commission notes that the Guidance included the
concept of a ``conduit affiliate.'' Although the Commission did not
define the concept of a ``conduit affiliate'' it did identify
certain factors it believed were relevant to the determination of
whether an entity would be considered a conduit affiliate of a U.S.
person. See Guidance, 78 FR at 45359. The Commission, in this
Proposed Rule, is not separately including the concept of a
``conduit affiliate'' because the concerns posed by a conduit
affiliate are intended to be addressed through the proposed
definition and treatment of SRSs.
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(14) Should the definition of ``foreign branch'' include the
requirement that the branch be ``subject to substantive regulation in
banking or financing in the jurisdiction where it is located,'' given
that the definition of ``foreign branch'' under Regulation K does not
contain such a requirement? Similarly, should the definition of ``U.S.
branch'' include the requirement that the branch be ``subject to
substantive banking regulation in the state or district where
located''?
(15) Should the definitions of ``foreign branch'' and ``swap
conducted through a foreign branch'' be further harmonized with the
definition of ``foreign branch'' by the SEC in rule 3a71-3(a)(2) under
the Exchange Act and the definition of ``transaction conducted through
a foreign branch'' by the SEC in rule 3a71-3(a)(3) under the Securities
Exchange Act? \170\ Should the Commission instead use the definitions
of those terms in the Guidance? \171\ The Commission proposes that a
swap will be deemed to be entered into by such foreign branch in the
normal course of business if swaps of the type in question are
primarily, but not exclusively, entered into by personnel located in
the branch (or another foreign branch of the U.S. bank). Should the
Commission instead stipulate that a swap will be considered to be
``entered into by such foreign branch in the normal course of
business'' only if personnel located in the U.S. do not participate in
the negotiation or execution of such swap? Should the Commission
instead take an alternative approach? If so, what should it be?
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\170\ The SEC defined the term ``foreign branch'' in Exchange
Act rule 3a71-3(a)(2), 17 CFR 240.3a71- 3(a)(2), to mean any branch
of a U.S. bank if: (1) The branch is located outside the United
States; (2) the branch operates for valid business reasons; and (3)
the branch is engaged in the business of banking and is subject to
substantive banking regulation in the jurisdiction where located.
The SEC defined the term ``transaction conducted through a foreign
branch'' in Exchange Act rule 3a71-3(a)(3), 17 CFR 240.3a71-3(a)(3),
to mean a security-based swap transaction that is arranged,
negotiated, and executed by a U.S. person through a foreign branch
of such U.S. person if: (1) The foreign branch is the counterparty
to such security-based swap transaction; and (2) the security-based
swap transaction is arranged, negotiated, and executed on behalf of
the foreign branch solely by persons located outside the United
States. See also SEC Cross-Border Rule, 79 FR 47278.
\171\ See Guidance, 78 FR at 45328-31 (discussing that scope of
the term ``foreign branch'' and the Commission's consideration of
whether a swap with a foreign branch of a U.S. bank by a non-U.S.
person should count toward the non-U.S. person's de minimis
threshold calculation).
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(16) Should the definitions of ``foreign branch'' and ``U.S.
branch'' be restricted to entities engaged in the business of banking
and/or finance and subject to substantive regulation in banking and/or
finance? If not, what other types of entities should be considered
branches?
(17) Are the definitions of ``U.S. branch'' and ``swap conducted
through a U.S. branch'' effective to appropriately capture transactions
that should be considered to be domestic rather than foreign, such that
they are ineligible for certain exceptions from the group B and group C
requirements and substituted compliance for the group B requirements
(discussed in section VI below)? If not, what changes should be made to
the definitions?
(18) Are the definitions of ``foreign-based swap,'' ``foreign
branch,'' ``foreign counterparty,'' and ``swap conducted through a
foreign branch'' effective to appropriately capture transactions that
should be considered to be foreign rather than domestic, such that they
are eligible for certain exceptions from the group B and group C
requirements and substituted compliance for the group B requirements
(discussed in section VI below)? If not, what changes should be made to
the definitions?
III. Cross-Border Application of the Swap Dealer Registration Threshold
CEA section 1a(49) defines the term ``swap dealer'' to include any
person that: (1) Holds itself out as a dealer in swaps; (2) makes a
market in swaps; (3) regularly enters into swaps with counterparties as
an ordinary course of business for its own account; or (4) engages in
any activity causing the person to be commonly known in the trade as a
dealer or market maker in swaps (collectively referred to as ``swap
dealing,'' ``swap dealing activity,'' or ``dealing activity'').\172\
The statute also requires the Commission to promulgate regulations to
establish factors with respect to the making of a determination to
exempt from designation as an SD an entity engaged in a de minimis
quantity of swap dealing.\173\
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\172\ 7 U.S.C. 1a(49)(A). In general, a person that satisfies
any one of these prongs is deemed to be engaged in swap dealing
activity.
\173\ 7 U.S.C. 1a(49)(D).
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In accordance with CEA section 1a(49), the Commission issued the
Entities Rule,\174\ which, among other things, further defined the term
``swap dealer'' and excluded from designation as an SD any entity that
engages in a de minimis quantity of swap dealing with or on behalf of
its customers.\175\ Specifically, the definition of ``swap dealer'' in
Sec. 1.3 provides that a person shall not be deemed to be an SD as a
result of its swap dealing activity involving counterparties unless,
during the preceding 12 months, the aggregate gross notional amount of
the swap positions connected with those dealing activities exceeds the
de minimis threshold.\176\ Paragraph (4) of that definition further
requires that, in determining whether its swap dealing activity exceeds
the de minimis threshold, a person must include the aggregate gross
notional value of the swaps connected with the dealing activities of
its affiliates under common control.\177\ For purposes of the Proposed
Rule, the Commission construes ``affiliates under common control'' by
reference to the Entities Rule, which defined 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.\178\
Accordingly, any reference in the Proposed Rule to ``affiliates under
common control'' with a person would include affiliates that are
controlling, controlled by, or under common control with such person.
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\174\ Entities Rule, 77 FR 30596.
\175\ See 17 CFR 1.3, Swap dealer, paragraph (4); Entities Rule,
77 FR 30596.
\176\ See 17 CFR 1.3, Swap dealer, paragraph (4)(i)(A). The de
minimis threshold is set at $8 billion, except with regard to swaps
with special entities for which the threshold is $25 million. See De
Minimis Exception to the Swap Dealer Definition, 83 FR 56666 (Nov.
13, 2018).
\177\ See 17 CFR 1.3, Swap dealer, paragraph (4)(i)(A).
\178\ See Entities Rule, 77 FR at 30631 n.437.
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The Commission is now proposing rules to address how the de minimis
threshold should apply to the cross-border swap dealing transactions of
U.S. and non-U.S. persons. Specifically, the Proposed Rule identifies
when a potential SD's cross-border dealing activities should be
included in its de minimis threshold calculation and when they may
properly be excluded. As discussed below, whether a potential SD would
include a particular swap in its de minimis threshold calculation would
depend on how the entity is classified (e.g., U.S. person, SRS, etc.)
and, in some cases, the jurisdiction in which a non-U.S. person is
regulated.
A. U.S. Persons
Under the Proposed Rule, consistent with the Guidance,\179\ a U.S.
person would include all of its swap dealing transactions in its de
minimis threshold
[[Page 971]]
calculation without exception.\180\ As discussed in section II.A above,
the term ``U.S. person'' would encompass a person that, by virtue of
being domiciled, organized, or having its principal place of business
in the United States, raises the concerns intended to be addressed by
the Dodd-Frank Act, regardless of the U.S. person status of its
counterparty. In addition, a person's status as a U.S. person would be
determined at the entity level and, thus, a U.S. person would include
the swap dealing activity of operations that are part of the same legal
person, including those of its foreign branches. Therefore, a U.S.
person would include in its SD de minimis threshold calculation dealing
swaps entered into by a foreign branch of the U.S. person.\181\
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\179\ See Guidance, 78 FR at 45326.
\180\ Proposed Sec. 23.23(b)(1).
\181\ The Commission notes that this approach mirrors the SEC's
approach in its cross-border rule. See 17 CFR 240.3a71-3(b)(1)(i);
SEC Cross-Border Rule, 79 FR at 47302, 47371.
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B. Non-U.S. Persons
Under the Proposed Rule, whether a non-U.S. person would need to
include a swap in its de minimis threshold calculation would depend on
the non-U.S. person's status, the status of its counterparty, and, in
some cases, the jurisdiction in which the non-U.S. person is regulated.
Specifically, the Proposed Rule would require a person that is a
Guaranteed Entity or an SRS to count all of its dealing swaps towards
the de minimis threshold.\182\ In addition, an Other Non-U.S. Person
would be required to count dealing swaps with a U.S. person toward its
de minimis threshold calculation, except for swaps conducted through a
foreign branch of a registered SD.\183\ Further, subject to certain
exceptions, the Proposed Rule would require an Other Non-U.S. Person to
count dealing swaps toward its de minimis threshold calculation if the
counterparty to such swaps is a Guaranteed Entity.
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\182\ As discussed in section II.B above, for purposes of this
release and ease of reading, a non-U.S. person whose obligations
under the swaps are subject to a guarantee by a U.S. person is being
referred to as a ``Guaranteed Entity.'' A non-U.S. person may be a
Guaranteed Entity with respect to swaps with certain counterparties,
but not be deemed a Guaranteed Entity with respect to swaps with
other counterparties. Also, a non-U.S. person could be a Guaranteed
Entity or an Other Non-U.S. Person, depending on the specific swap.
\183\ This release uses the phrase ``through a foreign branch''
to describe swaps that are entered into by a foreign branch and
which meet the definition of ``swap conducted through a foreign
branch.'' As stated, the Commission is proposing that ``swap
conducted through a foreign branch'' would mean a swap entered into
by a foreign branch where: (1) The foreign branch or another foreign
branch is the office through which the U.S. person makes and
receives payments and deliveries under the swap pursuant to a master
netting or similar trading agreement, and the documentation of the
swap specifies that the office for the U.S. person is such foreign
branch; (2) the swap is entered into by such foreign branch in its
normal course of business; and (3) the swap is reflected in the
local accounts of the foreign branch.
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1. Swaps by a Significant Risk Subsidiary
Under the Proposed Rule, an SRS would include all of its dealing
swaps in its de minimis threshold calculation without exception.\184\
As discussed in section II.C above, the proposed definition of SRS
encompasses a person that, by virtue of being a significant subsidiary
of a U.S. person, and not being subject to prudential supervision as a
subsidiary of a BHC or subject to comparable capital and margin rules,
raises the concerns intended to be addressed by the Dodd-Frank Act
requirements addressed by the Proposed Rule, regardless of the U.S.
person status of its counterparty.
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\184\ Proposed Sec. 23.23(b)(1).
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The Commission believes that treating an SRS differently from a
U.S. person could create a substantial regulatory loophole,
incentivizing U.S. persons to conduct their dealing business with non-
U.S. persons through significant non-U.S. subsidiaries to avoid
application of the Dodd-Frank Act SD requirements. Allowing swaps
entered into by SRSs, which have the potential to impact the ultimate
U.S. parent entity and U.S. commerce, to be treated differently
depending on how the parties structure their transactions could
undermine the effectiveness of the Dodd-Frank Act swaps provisions and
related Commission regulations addressed by the Proposed Rule. Applying
the same standard to similar transactions helps to limit those
incentives and regulatory implications.
However, under the Proposed Rule, an Other Non-U.S. Person would
not be required to count a dealing swap with an SRS toward its de
minimis threshold calculation, unless the SRS was also a Guaranteed
Entity (and no exception applied). As noted above, an SRS would be
required to count all of its dealing swaps. However, where an Other
Non-U.S. Person is entering into a dealing swap with an SRS, requiring
the Other Non-U.S. Person to count the swap towards the de minimis
threshold could cause the Other Non-U.S. Person to stop engaging in
swap activities with the SRS. The Commission believes it is important
to ensure that an SRS, particularly a commercial entity, continues to
have access to swap liquidity from Other Non-U.S. Persons for hedging
or other non-dealing purposes.
In addition, a person's status as an SRS would be determined at the
entity level and, thus, an SRS would include the swap dealing activity
of operations that are part of the same legal person, including those
of its branches. Therefore, an SRS would include in its SD de minimis
threshold calculation dealing swaps entered into by a branch of the
SRS.
2. Swaps With a U.S. Person
The Proposed Rule would require a non-U.S. person to count all
dealing swaps with a counterparty that is a U.S. person toward its de
minimis threshold calculation, except for swaps with a counterparty
that is a foreign branch of a registered U.S. SD and such swap meets
the definition of being ``conducted through a foreign branch'' of such
registered SD.\185\ Generally, the Commission believes that all
potential SDs should include in their de minimis threshold calculations
any swap with a U.S. person. As discussed in section II.A, the proposed
term ``U.S. person'' encompasses persons that inherently raise the
concerns intended to be addressed by the Dodd-Frank Act regardless of
the U.S. person status of their counterparty. In the event of a default
or insolvency of a non-U.S. SD, the SD's U.S. counterparties could be
adversely affected. A credit event, including funding and liquidity
problems, downgrades, default, or insolvency at a non-U.S. SD could
therefore have a direct adverse impact on its U.S. counterparties,
which could in turn create the risk of disruptions to the U.S.
financial system.
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\185\ Proposed Sec. 23.23(b)(2)(i).
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The Proposed Rule's approach in allowing a non-U.S. person to
exclude swaps conducted through a foreign branch of a registered SD
from its de minimis threshold calculation is consistent with the
Guidance.\186\ The Commission's view is that its regulatory interest in
these swaps is not sufficient to warrant creating a potential
competitive disadvantage for foreign branches of U.S. SDs with respect
to their foreign entity competitors by requiring non-U.S. persons to
count trades with them toward their de minimis threshold calculations.
In this regard, the Commission notes that a swap conducted through a
foreign branch of a registered SD would trigger certain Dodd-Frank Act
transactional requirements, particularly margin requirements, and,
thus, such swap activity would not be conducted outside
[[Page 972]]
the Dodd-Frank Act regime. Moreover, in addition to certain Dodd-Frank
Act requirements that would apply to such swaps, other foreign
regulatory requirements may also apply similar transactional
requirements to the transactions.\187\ Accordingly, the Commission
believes that it would be appropriate and consistent with section 2(i)
of the CEA to allow non-U.S. persons to exclude from their de minimis
calculation any swap dealing transactions conducted through a foreign
branch of a registered SD. However, this exception would not apply for
Guaranteed Entities (discussed below) or SRSs (discussed above), who
would have to count all of their dealing swaps.
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\186\ See Guidance, 78 FR at 45323-24.
\187\ As noted above in section I.B, significant and substantial
progress has been made in the world's primary swaps trading
jurisdictions to implement the G20 swaps reform commitments.
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3. Swaps Subject to a Guarantee
In an approach that is generally consistent with the Guidance,\188\
the Proposed Rule would require a non-U.S. person to include in its de
minimis threshold calculation swap dealing transactions where its
obligations under the swaps are subject to a guarantee by a U.S.
person.\189\ The Commission believes that this result is appropriate
because the swap obligations of a Guaranteed Entity are identical, in
relevant aspects, to a swap entered into directly by a U.S. person. As
a result of the guarantee, the U.S. guarantor bears risk arising out of
the swap as if it had entered into the swap directly. The U.S.
guarantor's financial resources in turn enable the Guaranteed Entity to
engage in dealing activity, because the Guaranteed Entity's
counterparties will look to both the Guaranteed Entity and its U.S.
guarantor to ensure performance of the swap. Absent the guarantee from
the U.S. person, a counterparty may choose not to enter into the swap
or may not do so on the same terms. In this way, the Guaranteed Entity
and the U.S. guarantor effectively act together to engage in the
dealing activity.\190\
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\188\ The Guidance stated that where a non-U.S. affiliate of a
U.S. person has its swap dealing obligations with non-U.S. persons
guaranteed by a U.S. person, the guaranteed affiliate generally
would be required to count those swap dealing transactions with non-
U.S. persons (in addition to its swap dealing transactions with U.S.
persons) for purposes of determining whether the affiliate exceeds a
de minimis amount of swap dealing activity and must register as an
SD. Guidance, 78 FR at 45312-13. As discussed above, the Proposed
Rule would not require that the guarantor be an affiliate of the
guaranteed person for that person to be a Guaranteed Entity.
\189\ Proposed Sec. 23.23(b)(2)(ii).
\190\ The Commission notes that this view is consistent with the
SEC's approach in its cross-border rule. See SEC Cross-Border Rule,
79 FR at 47289.
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Further, the Commission believes that treating a Guaranteed Entity
differently from a U.S. person could create a substantial regulatory
loophole, incentivizing U.S. persons to conduct their dealing business
with non-U.S. persons through non-U.S. affiliates, with a U.S.
guarantee, to avoid application of the Dodd-Frank Act SD requirements.
Allowing transactions that have a similar economic reality with respect
to U.S. commerce to be treated differently depending on how the parties
structure their transactions could undermine the effectiveness of the
Dodd-Frank Act swap provisions and related Commission regulations
addressed by the Proposed Rule. Applying the same standard to similar
transactions helps to limit those incentives and regulatory
implications.
The Commission is also proposing that a non-U.S. person must count
dealing swaps with a Guaranteed Entity in its SD de minimis threshold
calculation, except when: (1) The Guaranteed Entity is registered as an
SD; or (2) the Guaranteed Entity's swaps are subject to a guarantee by
a U.S. person that is a non-financial entity.\191\ The guarantee of a
swap is an integral part of the swap and, as discussed above,
counterparties may not be willing to enter into a swap with a
Guaranteed Entity in the absence of the guarantee. The Commission
recognizes that, given the highly integrated corporate structures of
global financial enterprises described above, financial groups may
elect to conduct their swap dealing activity in a number of different
ways, including through a U.S. person or through a non-U.S. affiliate
that benefits from a guarantee from a U.S. person. Therefore, in order
to avoid creating a regulatory loophole, the Commission believes that
swaps of a non-U.S. person with a Guaranteed Entity should receive the
same treatment as swaps with a U.S. person. The two exceptions
discussed above are intended to address those situations where the risk
of the swap between the non-U.S. person and the Guaranteed Entity would
be otherwise managed under the Dodd-Frank Act swap regime or is
primarily outside the U.S. financial sector.\192\
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\191\ Proposed Sec. 23.23(b)(2)(iii).
\192\ In this regard, the Commission notes that the SEC's cross-
border rules do not require a non-U.S. person that is not a conduit
affiliate or guaranteed by a U.S. person to count dealing swaps with
a guaranteed entity toward its de minimis threshold in any case.
Below we solicit comment on whether the CFTC should adopt a similar
approach. See SEC Cross-Border Rule, 79 FR at 47322.
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Where a non-U.S. person (that itself is not a Guaranteed Entity or
an SRS) enters into swap dealing transactions with a Guaranteed Entity
that is a registered SD, the Commission preliminarily believes it is
appropriate to permit the non-U.S. person not to count its dealing
transactions with the Guaranteed Entity against the non-U.S. person's
de minimis threshold for two principal reasons. First, requiring the
non-U.S. person to count such swaps may incentivize them to not engage
in dealing activity with Guaranteed Entities, thereby contributing to
market fragmentation and competitive disadvantages for entities wishing
to access foreign markets. Second, one counterparty to the swap is a
registered SD, and therefore is subject to comprehensive swap
regulation under the oversight of the Commission.
In addition, a non-U.S. person that is not a Guaranteed Entity or
an SRS would not include in its de minimis threshold calculation its
swap dealing transactions with a Guaranteed Entity where the Guaranteed
Entity is guaranteed by a non-financial entity. In these circumstances,
systemic risk to U.S. financial markets is mitigated because the U.S.
guarantor is a non-financial entity whose primary business activities
are not related to financial products and such activities primarily
occur outside the U.S. financial sector.\193\ For purposes of the
Proposed Rule, the Commission interprets ``non-financial entity'' to
mean a counterparty that is not an SD, an MSP, or a financial end-user
(as defined in the SD and MSP margin rule in Sec. 23.151).
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\193\ Moreover, the SRS definition would include those non-
financial U.S. parent entities that meet the risk-based thresholds
set out above in section II.C.
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C. Aggregation Requirement
Paragraph (4) of the SD definition in Sec. 1.3 requires that, in
determining whether its swap dealing transactions exceed the de minimis
threshold, a person must include the aggregate notional value of any
swap dealing transactions entered into by its affiliates under common
control.\194\ Consistent with CEA section 2(i), the Commission
interprets this aggregation requirement 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. Accordingly, under the
Proposed Rule and consistent with the Guidance,\195\ a potential SD,
whether a U.S. or non-U.S. person, would aggregate all swaps connected
with its dealing activity with those of persons controlling, controlled
by, or
[[Page 973]]
under common control with \196\ the potential SD to the extent that
these affiliated persons are themselves required to include those swaps
in their own de minimis threshold calculations, unless the affiliated
person is itself a registered SD. The Commission notes that its
proposed approach 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.
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\194\ 17 CFR 1.3, Swap dealer, paragraph (4).
\195\ See Guidance, 78 FR at 45323.
\196\ The Commission clarifies that for this purpose, the term
``affiliates under common control'' would include parent companies
and subsidiaries.
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Stated in general terms, the Commission's approach 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) (a U.S. affiliate or a non-U.S. affiliate) would have to
register as an SD 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 believes that its approach would
address the concern that an affiliated group of U.S. and non-U.S.
persons engaged in swap dealing transactions with a significant
connection to the United States may not be required to register solely
because such swap dealing activities are divided among affiliates that
all individually fall below the de minimis threshold.
D. Certain Exchange-Traded and Cleared Swaps
The Proposed Rule, in an approach that is generally consistent with
the Guidance, would allow a non-U.S. person that is not a Guaranteed
Entity or SRS to exclude from its de minimis threshold calculation any
swap that it anonymously enters into on a designated contract market
(``DCM''), a swap execution facility (``SEF'') that is registered with
the Commission or exempted by the Commission from SEF registration
pursuant to section 5h(g) of the CEA, or a foreign board of trade
(``FBOT'') that is registered with the Commission pursuant to part 48
of its regulations,\197\ if such swap is also cleared through a
registered or exempt derivatives clearing organization (``DCO'').\198\
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\197\ The Commission would consider the proposed exception
described herein also to apply with respect to an FBOT that provides
direct access to its order entry and trade matching system from
within the U.S. pursuant to no-action relief issued by Commission
staff.
\198\ Proposed Sec. 23.23(d).
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When a non-U.S. person enters into a swap that is executed
anonymously on a registered or exempt SEF, DCM, or registered FBOT, the
Commission recognizes that the non-U.S. person would not have the
necessary information about its counterparty to determine whether the
swap should be included in its de minimis threshold calculation. The
Commission therefore believes that in this case the practical
difficulties make it reasonable for the swap to be excluded
altogether.\199\
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\199\ Additionally, as the Commission has clarified in the past,
when a non-U.S. person clears a swap through a registered or exempt
DCO, such non-U.S. person would not have to include the resulting
swap (i.e., the novated swap) in its de minimis threshold
calculation. See, e.g., 2016 Proposal, 81 FR at 71957 n.88. A swap
that is submitted for clearing is extinguished upon novation and
replaced by new swap(s) that result from novation. See 17 CFR
39.12(b)(6). See also Derivatives Clearing Organization General
Provisions and Core Principles, 76 FR 69334, 69361 (Nov. 8, 2011).
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 an SD.
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The Proposed Rule is consistent with the Guidance but would expand
the exception to include SEFs and DCOs that are exempt from
registration under the CEA, and also states that SRSs do not qualify
for this exception. The CEA provides that the Commission may grant an
exemption from registration if it finds that a foreign SEF or DCO is
subject to comparable, comprehensive supervision and regulation by the
appropriate governmental authorities in the SEF's or DCO's home
country.\200\ The Commission believes that the policy rationale for
providing relief to swaps anonymously executed on a SEF, DCM, or FBOT
and then cleared also extends to swaps executed on a foreign SEF and/or
cleared through a foreign DCO that has been granted an exemption from
registration. As noted, the foreign SEF or DCO would be subject to
comparable and comprehensive regulation, as is the case with U.S.-based
SEFs and DCMs.\201\
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\200\ See CEA sections 5h for the SEF exemption provision and
5b(h) for the DCO exemption provision.
\201\ The Commission recognizes that it recently issued two
proposed rulemakings regarding non-U.S. DCOs. One applied to DCOs
registered with the Commission. Registration With Alternative
Compliance for Non-U.S. Derivatives Clearing Organizations, 84 FR
34819 (proposed July 19, 2019). That proposal, and a second that
applied to exempt DCOs, Exemption From Derivatives Clearing
Organization Registration, 84 FR 35456 (proposed July 23, 2019),
both applied to non-U.S. DCOs that do not pose substantial risk to
the U.S. financial system based on metrics set forth therein. The
Commission may modify this exception for exchange-traded and cleared
swaps as necessary, based on any DCO-related proposed rules that are
adopted by the Commission.
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E. Request for Comment
The Commission invites comment on all aspects of the cross-border
application of the SD registration threshold described in sections
III.A through III.D, and specifically requests comments on the
following questions. Please explain your responses and provide
alternatives to the relevant portions of the Proposed Rule, where
applicable.
(19) Should a non-U.S. person be permitted to exclude from its de
minimis threshold calculation swap dealing transactions conducted
through a foreign branch of a registered SD?
(20) As discussed in section II.F, under the Proposed Rule, the
term ``U.S. branch'' would mean a branch or agency of a non-U.S.
banking organization where such branch or agency: (1) Is located in the
United States; (2) maintains accounts independently of the home office
and other U.S. branches, with the profit or loss accrued at each branch
determined as a separate item for each U.S. branch; and (3) engages in
the business of banking and is subject to substantive banking
regulation in the state or district where located. Given that
definition, would it be appropriate to require a U.S. branch to include
in its SD de minimis threshold calculation all of its swap dealing
transactions, as if they were swaps entered into by a U.S. person?
Would it be appropriate to require an Other Non-U.S. Person to include
in its SD de minimis threshold calculation dealing swaps conducted
through a U.S. branch?
(21) Under the Proposed Rule, an Other Non-U.S. Person would not be
required to include its dealing swaps with an SRS or an Other Non-U.S.
Person in its SD de minimis threshold. The Commission invites comment
as to whether, and in what circumstances, a non-U.S. person should be
required to include dealing swaps with a non-U.S. person in its SD de
minimis threshold calculation if any of the risk of such swaps is
transferred to an affiliated U.S. SD through one or more inter-
affiliate swaps, and as to whether it would be too complex or costly to
monitor and implement such a rule.\202\
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\202\ The Commission notes that the Commission's final margin
rule requires covered swap entities to collect initial margin from
certain affiliates that are not subject to comparable initial margin
collection requirements on their own outward-facing swaps with
financial end-users, which addresses some of the credit risks
associated with the outward-facing swaps. See 17 CFR 23.159; Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 636, 673-74 (Jan. 6, 2016).
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[[Page 974]]
(22) With respect to proposed Sec. 23.23(b)(2)(iii), should the
Commission follow the SEC's approach, which does not require a non-U.S.
person that is not a conduit affiliate nor guaranteed by a U.S. person
to count dealing swaps with a non-U.S. person whose security-based swap
transactions are guaranteed by a U.S. person. The SEC noted that
``concerns regarding the risk posed to the United States by such
security-based swaps, and regarding the potential use of such
guaranteed affiliates to evade the Dodd-Frank Act . . . are addressed
by the requirement that guaranteed affiliates count their own dealing
activity against the de minimis thresholds when the counterparty has
recourse to a U.S. person.'' \203\
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\203\ SEC Cross-Border Rule, 79 FR at 47322.
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IV. Cross-Border Application of the Major Swap Participant Registration
Tests
CEA section 1a(33) defines the term ``major swap participant'' to
include persons that are not SDs but that nevertheless pose a high
degree of risk to the U.S. financial system by virtue of the
``substantial'' nature of their swap positions.\204\ In accordance with
the Dodd-Frank Act and CEA section 1a(33)(B), the Commission adopted
rules further defining ``major swap participant'' and providing that a
person would not be deemed an MSP unless its swap positions exceed one
of several thresholds.\205\ The thresholds were designed to take into
account default-related credit risk, the risk of multiple market
participants failing close in time, and the risk posed by a market
participant's swap positions on an aggregate level.\206\ The Commission
also adopted interpretive guidance stating that, for purposes of the
MSP analysis, an entity's swap positions would be attributable to a
parent, other affiliate, or guarantor to the extent that the
counterparty has recourse to the parent, other affiliate, or guarantor
and the parent or guarantor is not subject to capital regulation by the
Commission, SEC, or a prudential regulator (``attribution
requirement'').\207\
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\204\ See 7 U.S.C. 1a(33)(A) (defining ``major swap
participant'' to mean any person that is not an SD and either (1)
maintains a substantial position in swaps for any of the major swap
categories, subject to certain exclusions; (2) whose outstanding
swaps create substantial counterparty exposure that could have
serious effects on the U.S. financial system; or (3) is a highly
leveraged financial entity that is not subject to prudential capital
requirements and that maintains a substantial position in swaps for
any of the major swap categories. See also 17 CFR 1.3, Major swap
participant, paragraph (1); 156 Cong. Rec. S5907 (daily ed. July 15,
2010) (colloquy between Senators Hagen and Lincoln, discussing how
the goal of the major participant definitions was to ``focus on risk
factors that contributed to the recent financial crisis, such as
excessive leverage, under-collateralization of swap positions, and a
lack of information about the aggregate size of positions'').
\205\ See 17 CFR 1.3, Major swap participant, Substantial
counterparty exposure, Substantial position, Financial entity;
highly leveraged, Hedging or mitigating commercial risk, and
Category of swaps; major swap category. See also Entities Rule, 77
FR 30596.
\206\ See Entities Rule, 77 FR at 30666 (discussing the guiding
principles behind the Commission's definition of ``substantial
position'' in 17 CFR 1.3); id. at 30683 (noting that the
Commission's definition of ``substantial counterparty exposure'' in
17 CFR 1.3 is founded on similar principles as its definition of
``substantial position'').
\207\ Id. at 30689.
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The Commission is now proposing rules to address the cross-border
application of the MSP thresholds to the swap positions of U.S. and
non-U.S. persons.\208\ Applying CEA section 2(i) and principles of
international comity, the Proposed Rule identifies when a potential
MSP's cross-border swap positions would apply toward the MSP thresholds
and when they may be properly excluded. As discussed below, whether a
potential registrant would include a particular swap in its MSP
calculation would depend on whether the potential registrant is a U.S.
person, a Guaranteed Entity, an SRS, or an Other Non-U.S. Person.\209\
The Proposed Rule's approach for the cross-border application of the
MSP thresholds is similar to the approach described above for the SD
threshold.
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\208\ Proposed Sec. 23.23(c).
\209\ As indicated above, for purposes of the Proposed Rule, an
``Other Non-U.S. Person'' refers to a non-U.S. person that is
neither a Guaranteed Entity nor an SRS.
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A. U.S. Persons
Under the Proposed Rule, all of a U.S. person's swap positions
would apply toward the MSP registration thresholds without
exception.\210\ As discussed in the context of the Proposed Rule's
approach to applying the SD de minimis registration threshold, by
virtue of it being domiciled or organized in the United States, or the
inherent nature of its connection to the United States, all of a U.S.
person's activities have a significant nexus to U.S. markets, giving
the Commission a particularly strong regulatory interest in its swap
activities.\211\ Accordingly, the Commission believes that all of a
U.S. person's swap positions, regardless of where they occur or the
U.S. person status of the counterparty, should apply toward the MSP
thresholds.
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\210\ Proposed Sec. 23.23(c)(1).
\211\ See supra section III.A.
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B. Non-U.S. Persons
Under the Proposed Rule, whether a non-U.S. person would include a
swap position in its MSP threshold calculation would depend on its
status, the status of its counterparty, or the characteristics of the
swap. Specifically, the Proposed Rule would require a person that is a
Guaranteed Entity or an SRS to count all of its swap positions. In
addition, an Other Non-U.S. Person would be required to count all swap
positions with a U.S. person, except for swaps conducted through a
foreign branch of a registered SD. Subject to certain exceptions, the
Proposed Rule would also require an Other Non-U.S. Person to count all
swap positions if the counterparty to such swaps is a Guaranteed
Entity.\212\
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\212\ As discussed in sections II.B and III.B above, for
purposes of this release and ease of reading, such a non-U.S. person
whose obligations under the swaps are subject to a guarantee by a
U.S. person is being referred to as a ``Guaranteed Entity.''
Depending on the characteristics of the swap, a non-U.S. person may
be a Guaranteed Entity with respect to swaps with certain
counterparties, but not be deemed a Guaranteed Entity with respect
to swaps with other counterparties.
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1. Swaps by a Significant Risk Subsidiary
Under the Proposed Rule, an SRS would include all of its swap
positions in its MSP threshold calculation.\213\ As discussed in
section II.C above, the proposed term SRS encompasses a person that, by
virtue of being a significant subsidiary of a U.S. person, and not
being subject to prudential supervision as a subsidiary of a BHC or
subject to comparable capital and margin rules, raises the concerns
intended to be addressed by the Dodd-Frank Act requirements addressed
by the Proposed Rule, regardless of the U.S. person status of its
counterparty.
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\213\ Proposed Sec. 23.23(c)(1).
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The Commission believes that treating an SRS differently from a
U.S. person could create a substantial regulatory loophole by
incentivizing U.S. persons to conduct their swap business with non-U.S.
persons through significant non-U.S. subsidiaries to avoid application
of the Dodd-Frank Act MSP requirements. Allowing swaps entered into by
SRSs, which have the potential to impact the ultimate U.S. parent
entity and U.S. commerce, to be treated differently depending on how
the parties structure their transactions could undermine the
effectiveness of the Dodd-Frank Act swap provisions and related
Commission regulations addressed by the Proposed Rule. Applying the
same standard to similar
[[Page 975]]
swap positions helps to limit those incentives and regulatory
implications.
In addition, a person's status as an SRS would be determined at the
entity level and, thus, an SRS would include the swap positions that
are part of the same legal person, including those of its branches.
Therefore, an SRS would include in its MSP threshold calculation swap
positions entered into by a branch of the SRS.
2. Swap Positions With a U.S. Person
Under the Proposed Rule, a non-U.S. person would include all of its
swap positions with U.S. persons, unless the transaction is a swap
conducted through a foreign branch of a registered SD.\214\ Generally,
the Commission believes that a potential MSP should include in its MSP
threshold calculation any swap position with a U.S. person. As
discussed above, the term ``U.S. person'' encompasses persons that
inherently raise the concerns intended to be addressed by the Dodd-
Frank Act, regardless of the U.S. person status of their counterparty.
The default or insolvency of the non-U.S. person would have a direct
adverse effect on a U.S. person and, by virtue of the U.S. person's
significant nexus to the U.S. financial system, potentially could
result in adverse effects or disruption to the U.S. financial system as
a whole, particularly if the non-U.S. person's swap positions are
substantial enough to exceed an MSP registration threshold.
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\214\ Proposed Sec. 23.23(c)(2)(i).
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The Proposed Rule's approach in allowing a non-U.S. person to
exclude swap positions conducted through a foreign branch of a
registered SD is consistent with the approach described in section
III.B.2 for cross-border treatment with respect to SDs. A swap
conducted through a foreign branch of a registered SD would trigger the
Dodd-Frank Act transactional requirements (or comparable requirements)
and therefore mitigate concern that this exclusion could be used to
engage in swap activities outside the Dodd-Frank Act regime.\215\
Accordingly, the Commission believes that it would be appropriate and
consistent with section 2(i) to allow a non-U.S. person, that is not a
Guaranteed Entity or SRS, to exclude from its MSP threshold calculation
any swaps conducted through a foreign branch of a registered SD. The
Commission recognizes that the Guidance provides that such swaps would
need to be cleared or that the documentation of the swaps would have to
require the foreign branch to collect daily variation margin, with no
threshold, on its swaps with such non-U.S. person.\216\ The Proposed
Rule does not include such a requirement given that the foreign branch
of the registered SD would nevertheless be required to post and collect
margin, as required by the SD margin rules. In addition, a non-U.S.
person's swaps conducted through a foreign branch of a registered SD
must be addressed in the SD's risk management program. Such program
must account for, among other things, overall credit exposures to non-
U.S. persons.\217\
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\215\ The Commission believes that the Dodd-Frank Act-related
requirements that the transaction would be subject to as a result of
a registered SD being a counterparty would also mitigate concerns
that the non-U.S. person would not be subject to CFTC capital rules
(when implemented).
\216\ See Guidance, 78 FR at 45324-25.
\217\ See 17 CFR 23.600(c)(4)(ii), requiring registered SDs 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 17 CFR
23.600(c)(1)(i), requiring the senior management and the governing
body of each SD and MSP to review and approve credit risk tolerance
limits for the SD or MSP.
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3. Swap Positions Subject to a Guarantee
The Proposed Rule would require a non-U.S. person to include in its
MSP calculation each swap position with respect to which it is a
Guaranteed Entity.\218\ As explained in the context of the SD de
minimis threshold calculation,\219\ the Commission believes that the
swap positions of a non-U.S. person whose swap obligations are
guaranteed by a U.S. person are identical, in relevant aspects, to
those entered into directly by a U.S. person and thus present similar
risks to the stability of the U.S. financial system or of U.S.
entities. Although the default on that swap may not directly affect the
U.S. guarantor on that swap, the default could affect the Guaranteed
Entity's ability to meet its other obligations, for which the U.S.
guarantor may also be liable. Treating Guaranteed Entities differently
from U.S. persons could also create a substantial regulatory loophole,
allowing transactions that have a similar connection to or impact on
U.S. commerce to be treated differently depending on how the parties
are structured and thereby undermining the effectiveness of the Dodd-
Frank Act swap provisions and related Commission regulations.
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\218\ Proposed Sec. 23.23(c)(2)(ii).
\219\ See supra section III.B.3.
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The Commission is also proposing that a non-U.S. person must count
swap positions with a Guaranteed Entity counterparty, except when the
counterparty is registered as an SD.\220\ The Commission notes that the
guarantee of a swap is an integral part of the swap and that, as
discussed above, counterparties may not be willing to enter into a swap
with a Guaranteed Entity in the absence of the guarantee. The
Commission also recognizes that, given the highly integrated corporate
structures of global financial enterprises, financial groups may elect
to conduct their swap activity in a number of different ways, including
through a U.S. person or through a non-U.S. affiliate that benefits
from a guarantee from a U.S. person. Therefore, in order to avoid
creating a substantial regulatory loophole, the Commission believes
that swaps of a non-U.S. person with a counterparty whose obligations
under the swaps are guaranteed by a U.S. person should receive the same
treatment as swaps with a U.S. person.
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\220\ Proposed Sec. 23.23(c)(2)(iii). The Commission notes that
the proposed MSP provision does not include a provision for swap
positions with non-U.S. persons guaranteed by a non-financial
entity, similar to the carve-out in the proposed SD provision. See
proposed Sec. 23.23(b)(2)(iii)(2).
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However, similar to the discussion regarding SDs in section
III.B.3, where a non-U.S. person (that itself is not a Guaranteed
Entity or an SRS) enters into a swap with a Guaranteed Entity that is a
registered SD, it is appropriate to permit the non-U.S. person not to
count its swap position with the Guaranteed Entity against the non-U.S.
person's MSP thresholds,\221\ because one counterparty to the swap is a
registered SD subject to comprehensive swap regulation and operating
under the oversight of the Commission. For example, the swap position
must be addressed in the SD's risk management program and account for,
among other things, overall credit exposures to non-U.S. persons.\222\
In addition, a non-U.S. person's swaps with a Guaranteed Entity that is
an SD 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.
Therefore, in these
[[Page 976]]
circumstances, the Commission believes it is not necessary for the non-
U.S. person to count such a swap position toward its MSP thresholds.
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\221\ Proposed Sec. 23.23(c)(2)(iii).
\222\ See 17 CFR 23.600(c)(4)(ii), requiring SDs 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 17 CFR
23.600(c)(1)(i), requiring the senior management and the governing
body of each SD and MSP to review and approve credit risk tolerance
limits for the SD or MSP.
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C. Attribution Requirement
In the Entities Rule, the Commission and the SEC provided a joint
interpretation that an entity's swap positions in general would be
attributed to a parent, other affiliate, or guarantor for purposes of
the MSP analysis to the extent that the counterparties to those
positions have recourse to the parent, other affiliate, or guarantor in
connection with the position, such that no attribution would be
required in the absence of recourse.\223\ Even in the presence of
recourse, however, the Commissions stated that attribution of a
person's swap positions to a parent, other affiliate, or guarantor
would not be necessary if the person is already subject to capital
regulation by the Commission or the SEC or is a U.S. entity regulated
as a bank in the United States (and is therefore subject to capital
regulation by a prudential regulator).\224\
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\223\ See Entities Rule, 77 FR at 30689 (Stating 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
positions 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.'').
\224\ Id.
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The Commission is proposing to address the cross-border application
of the attribution requirement in a manner consistent with the Entities
Rule and CEA section 2(i) and generally comparable to the approach
adopted by the SEC.\225\ Specifically, the Commission believes that the
swap positions of an entity, whether a U.S. or non-U.S. person, should
not be attributed to a parent, other affiliate, or guarantor for
purposes of the MSP analysis in the absence of a guarantee. Even in the
presence of a guarantee, attribution would not be required if the
entity that entered into the swap directly is subject to capital
regulation by the Commission or the SEC or is regulated as a bank in
the United States.\226\
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\225\ See SEC Cross-Border Rule, 79 FR at 47346-48.
\226\ The Commission further clarifies that the swap positions
of an entity that is required to register as an MSP, or whose MSP
registration is pending, would not be subject to the attribution
requirement.
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If a guarantee is present, however, and the entity being guaranteed
is not subject to capital regulation (as described above), whether the
attribution requirement would apply would depend on the U.S. person
status of the person to whom there is recourse under the guarantee
(i.e., the U.S. person status of the guarantor). Specifically, a U.S.
person guarantor would attribute to itself any swap position of an
entity subject to a guarantee, whether a U.S. person or a non-U.S.
person, for which the counterparty to the swap has recourse against
that U.S. person guarantor. The Commission believes that when a U.S.
person acts as a guarantor of a swap position, the guarantee creates
risk within the United States of the type that MSP regulation is
intended to address, regardless of the U.S. person status of the entity
subject to a guarantee or its counterparty.\227\
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\227\ See Entities Rule, 77 FR at 30689 (attribution is intended
to reflect the risk posed to the U.S. financial system when a
counterparty to a position has recourse against a U.S. person).
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A non-U.S. person would attribute to itself any swap position of an
entity for which the counterparty to the swap has recourse against the
non-U.S. person unless all relevant persons (i.e., the non-U.S. person
guarantor, the entity whose swap positions are guaranteed, and its
counterparty) are non-U.S. persons that are not Guaranteed Entities. In
this regard, the Commission believes that when a non-U.S. person
provides a guarantee with respect to the swap position of a particular
entity, the economic reality of the swap position is substantially
identical, in relevant respects, to a position entered into directly by
the non-U.S. person.
In addition, the Commission believes that entities subject to a
guarantee would be able to enter into significantly more swap positions
(and take on significantly more risk) as a result of the guarantee than
they would otherwise, amplifying the risk of the non-U.S. person
guarantor's inability to carry out its obligations under the guarantee.
Given the types of risk that MSP regulation is intended to address, the
Commission has a strong regulatory interest in ensuring that the
attribution requirement applies to non-U.S. persons that provide
guarantees to U.S. persons and Guaranteed Entities. Accordingly, the
Commission preliminarily believes that a non-U.S. person should be
required to attribute to itself the swap positions of any entity for
which it provides a guarantee unless it, the entity subject to the
guarantee, and its counterparty are all non-U.S. persons that are not
Guaranteed Entities.
D. Certain Exchange-Traded and Cleared Swaps
The Proposed Rule, consistent with its approach for SDs discussed
above in section III.D, would allow a non-U.S. person that is not a
Guaranteed Entity or an SRS to exclude from its MSP calculation any
swap position that it anonymously enters into on a DCM, a registered
SEF or a SEF exempted from registration by the Commission pursuant to
section 5h(g) of the CEA, or an FBOT registered with the Commission
pursuant to part 48 of its regulations,\228\ if such swap is also
cleared through a registered or exempt DCO.\229\
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\228\ The Commission would consider the proposed exception
described herein also to apply with respect to an FBOT that provides
direct access to its order entry and trade matching system from
within the U.S. pursuant to no-action relief issued by Commission
staff.
\229\ Proposed Sec. 23.23(d).
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When a non-U.S. person enters into a swap position that is executed
anonymously on a registered or exempt SEF, DCM, or registered FBOT, the
Commission recognizes that the non-U.S. person would not have the
necessary information about its counterparty to determine whether the
swap position should be included in its MSP calculation. The Commission
therefore believes that in this case the practical difficulties make it
reasonable for the swap position to be excluded altogether.
The Proposed Rule is consistent with the Guidance, but would expand
the exception to include SEFs and DCOs that are exempt from
registration under the CEA, and also states that SRSs may not qualify
for this exception. The CEA provides that the Commission may grant an
exemption from registration if it finds that a foreign SEF or DCO is
subject to comparable, comprehensive supervision and regulation by the
appropriate governmental authorities in the SEF or DCO's home
country.\230\
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\230\ See CEA sections 5h for the SEF exemption provision and
5b(h) for the DCO exemption provision. As discussed, supra note 201,
the Commission recognizes that it recently issued proposed
rulemakings regarding non-U.S. DCOs, and may modify this exception
for exchange-traded and cleared swaps as necessary, based on any
DCO-related proposed rules that are adopted by the Commission.
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E. Request for Comment
The Commission invites comment on all aspects of the proposed
cross-border application of the MSP registration threshold calculation
described in sections IV.A through IV.D, and specifically requests
comments on the following questions. Please explain your responses and
provide alternatives to
[[Page 977]]
the relevant portions of the Proposed Rule, where applicable.
(23) Should the Commission modify its interpretation with regard to
the attribution requirement to provide that attribution of a person's
swap positions to a parent, other affiliate, or guarantor would not be
required if the person is subject to capital standards that are
comparable to and as comprehensive as the capital regulations and
oversight by the Commission, SEC, or a U.S. prudential regulator? If
so, should the home country capital standards be deemed comparable and
comprehensive if they are consistent in all respects with Basel III?
(24) Would it be appropriate to require a U.S. branch to include in
its MSP threshold calculation all of its swap positions, as if they
were swap positions of a U.S. person? Would it be appropriate to
require an Other Non-U.S. Person to include in its MSP de minimis
threshold calculation swaps conducted through a U.S. branch?
V. ANE Transactions
A. Background and Proposed Approach
The ANE Staff Advisory provided that a non-U.S. SD would generally
be required to comply with transaction-level requirements for SDs for
ANE Transactions.\231\ In the January 2014 ANE Request for Comment, the
Commission requested comments on all aspects of the ANE Staff Advisory,
including: (1) The scope and meaning of the phrase ``regularly
arranging, negotiating, or executing'' and what characteristics or
factors distinguish ``core, front-office'' activity from other
activities; and (2) whether the Commission should adopt the ANE Staff
Advisory as Commission policy, in whole or in part.\232\
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\231\ See ANE Staff Advisory. The ANE Staff Advisory represented
the views of DSIO only, and not necessarily those of the Commission
or any other office or division thereof. See also Guidance, 78 FR at
45333 (providing that the transaction-level requirements include:
(1) Required clearing and swap processing; (2) margining (and
segregation) for uncleared swaps; (3) mandatory 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).
\232\ See ANE Request for Comment, 79 FR at 1348-49.
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The Commission received seventeen comment letters in response to
the ANE Request for Comment.\233\ Most commenters emphasized that the
risk associated with ANE Transactions lies outside the United States
\234\ and that non-U.S. SDs involve U.S. personnel primarily for the
convenience of their global customers.\235\ They also characterized the
ANE Staff Advisory as impractical or unworkable, describing its key
language (``regularly arranging, negotiating, or executing swaps'' and
``performing core, front-office activities'') as vague, open to broad
interpretation, and potentially capturing activities that are merely
incidental to the swap transaction.\236\ They further argued that if
the ANE Staff Advisory were adopted as Commission policy, non-U.S. SDs
would close U.S. branches and relocate personnel to other countries (or
otherwise terminate agency contracts with U.S.-based agents) in order
to avoid Dodd-Frank Act swap regulation or having to interpret and
apply the ANE Staff Advisory, thereby increasing market
fragmentation.\237\ Two commenters addressed concerns regarding
international comity and inconsistent, conflicting, or duplicative
regimes, with one arguing that ``it is of paramount importance to
prevent the duplication of applicable rules to derivative transactions,
in particular when the transactions have a strong local nature or only
remote links with other jurisdictions, in order to support an efficient
derivatives market[;]'' \238\ and the other saying that ``[r]ules
should therefore include the possibility to defer to those of the host
regulator in most cases.'' \239\
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\233\ Comments were submitted by the following entities:
American Bankers Association Securities Association (``ABASA'')
(Mar. 10, 2014); Americans for Financial Reform (``AFR'') (Mar. 10,
2014); Barclays Bank PLC (``Barclays'') (Mar. 10, 2014); Chris R.
Barnard (Mar. 8, 2014); Better Markets Inc. (``Better Markets'')
(Mar. 10, 2014); Coalition for Derivatives End-Users (``Coalition'')
(Mar. 10, 2014); Commercial Energy Working Group (Mar. 10, 2014);
European Commission (Mar. 10, 2014); European Securities and Markets
Authority (``ESMA'') (Mar. 13, 2014); Institute for Agriculture and
Trade Policy (``IATP'') (Mar. 10, 2014); Institute of International
Bankers (``IIB'') (Mar. 10, 2014); International Swaps and
Derivatives Association, Inc. (``ISDA'') (Mar. 7, 2014); Investment
Adviser Association (``IAA'') (Mar. 10, 2014); Japan Financial
Markets Council (``JFMC'') (Mar. 4, 2014); Japanese Bankers
Association (``JBA'') (Mar. 7, 2014); Securities Industry and
Financial Markets Association, Futures Industry Association, and
Financial Services Roundtable (``SIFMA/FIA/FSR'') (Mar. 10, 2014);
Soci[eacute]t[eacute] G[eacute]n[eacute]rale (``SG'') (Mar. 10,
2014). The associated comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1452&ctl00_ctl00_cphContentMain_MainContent_gvCommentListChangePage=1_50. Although the comment file includes records
of 22 comments, five were either duplicate submissions or not
responsive to the ANE Request for Comment.
\234\ See, e.g., Barclays at 3 n.11; IIB at 4-5; ISDA at 6-7;
SIFMA/FIA/FSR at 2, A-9-A-10; SG at 2 (adopting the ANE Staff
Advisory would extend the Commission's regulations ``to swaps whose
risk lies totally offshore'' and that do not pose a high risk to the
U.S. financial system).
\235\ See, e.g., Coalition at 2 (non-U.S. SDs use U.S. personnel
to arrange, negotiate, or execute swaps because they have particular
subject matter expertise for or due to the location of their clients
across time zone); European Commission at 1; IIB at 7-8 n.18; IAA at
2; ISDA at 4; JFMC at 2-3; SIFMA/FIA/FSR at A-4; SG at 3 (a non-U.S.
SD may use salespersons in the United States if the ANE Transaction
is linked to a USD instrument).
\236\ See, e.g., Barclays at 4-5; European Commission at 3
(whether negotiation of a master agreement by U.S. middle office
staff would trigger application of the ANE Staff Advisory is
unclear); IAA at 5 (``[T]he terms `arranging' and `negotiating' are
overly broad and may encompass activities that are incidental to a
swap transaction,'' such as providing market or pricing
information); SIFMA/FIA/FSR at A-12 (arranging and negotiating
trading relationships and legal documentation are ``middle- and
back-office operations'' and should not be included); SG at 7-8
(``regularly'' is an arbitrary concept that cannot be made workable,
and programming trading systems to interpret ``arranging,
negotiating, or executing'' on a trade-by-trade basis would not be
feasible).
\237\ See, e.g., ABASA at 2 (adopting the ANE Staff Advisory
would ``impose unnecessary compliance burdens on swaps market
participants, encourage them to re-locate jobs and activities
outside the United States to accommodate non-U.S. client demands,
and fragment market liquidity''); Coalition at 3 (emphasizing the
impact on non-U.S. affiliates of U.S. end users, such as increased
hedging costs and reduced access to registered counterparties); IIB
at 7-8; ISDA at 4; JFMC at 3; SG at 8-9. See also IAA at 3
(expressing concern that non-U.S. clients may avoid hiring U.S.
asset managers to avoid application of the ANE Staff Advisory).
\238\ See ESMA at 1.
\239\ See European Commission at 1.
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A few commenters, however, supported the ANE Staff Advisory.\240\
They argued that the Commission has jurisdiction over swap activities
occurring in the United States \241\ and expressed concern that the
Commission's failure to assert such jurisdiction would create a
substantial loophole, allowing U.S. financial firms to operate in the
United States without Dodd-Frank Act oversight by merely routing swaps
through a non-U.S. affiliate.\242\ They further argued that arranging,
negotiating, or executing swaps are functions normally performed by
brokers, traders, and salespersons
[[Page 978]]
and are economically central to the business of swap dealing.\243\
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\240\ See AFR; Better Markets; IATP.
\241\ See AFR at 2 (CEA section 2(i) clearly sets the statutory
jurisdiction of CFTC rules to include all activities conducted
inside the United States); Better Markets at 3 (the ANE Staff
Advisory ``represents the only reasonable interpretation of
Congress's mandate to regulate swaps transactions with a `direct and
significant connection with activities in, or effect on, commerce of
the United States'''); IATP at 1 (``It should be self-evident that
the swap activities in the United States of non-U.S. persons fall
under the Commission's jurisdiction.'').
\242\ See AFR at 3 (failure to adopt the ANE Staff Advisory
``could mean that U.S. firms operating in the U.S. would face
different rules for the same transactions as compared to competitor
firms also operating in the very same market and location, perhaps
literally next door, who had arranged to route transactions through
a nominally foreign subsidiary''); Better Markets at 3 (allowing
registered SDs to book transactions overseas but otherwise handle
the swap inside the United States would ``create a gaping
loophole,'' resulting in ``keystroke off-shoring of the bookings,
but otherwise the on-shoring of the core activities associated with
the transaction'').
\243\ See AFR at 2-3, 5; Better Markets at 5 (brokers,
structurers, traders, and salesmen ``collectively comprise the
general understanding of the core front office'').
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In addition to consideration of the foregoing comments, the
Commission also considered a report the U.S. Treasury Department issued
in October 2017, which expressed the view that the SEC and the CFTC
should ``reconsider the implications'' of applying the Dodd-Frank Act
requirements to certain transactions ``merely on the basis that U.S.-
located personnel arrange, negotiate, or execute the swap, especially
for entities in comparably regulated jurisdictions.'' \244\
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\244\ See U.S. Department of Treasury, A Financial System That
Creates Economic Opportunities: Capital Markets, at 133-36 (Oct.
2017), available at https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.
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Based on the Commission's consideration of its experience under the
Guidance, the comments it has received, respect for international
comity, and the Commission's desire to focus its authority on potential
significant risks to the U.S. financial system, the Commission has
determined that ANE Transactions will not be considered a relevant
factor for purposes of applying the Proposed Rule. Accordingly, under
the Proposed Rule, all foreign-based swaps entered into between a non-
U.S. swap entity and a non-U.S. person are treated the same regardless
of whether the swap is an ANE Transaction. To the extent the Proposed
Rule is finalized, this treatment would effectively supersede the ANE
Staff Advisory with respect to the application of the group B and C
requirements (discussed below) to ANE Transactions.
With respect to its experience, the Commission notes that the ANE
No-Action Relief, which went into effect immediately after issuance of
the ANE Staff Advisory, generally relieved non-U.S. swap entities from
the obligation to comply with most transaction-level requirements when
entering into swaps with most non-U.S. persons.\245\ In the intervening
period, the Commission has not found a negative impact on either its
ability to effectively oversee non-US swap entities, nor the integrity
and transparency of U.S. derivatives markets.
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\245\ Specifically, non-U.S. persons that are neither guaranteed
nor conduit affiliates, as described in the Guidance.
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In the interest of international comity, under the Proposed Rule,
as under the Guidance, swaps between certain non-U.S. persons would
qualify for an exception from application of certain CFTC
requirements.\246\ ANE Transactions also involve swaps between non-U.S.
persons, and thus the Commission has considered whether the U.S. aspect
of ANE Transactions should override its general view that such
transactions should qualify for the same relief. A person that, in
connection with its dealing activity, engages in market-facing activity
using personnel located in the United States is conducting a
substantial aspect of its dealing business in the United States. But,
because the transactions involve two non-U.S. persons, and the
financial risk of the transactions lies outside the United States, the
Commission considers the extent to which the underlying regulatory
objectives of the Dodd-Frank Act would be advanced in light of other
policy considerations, including undue market distortions and
international comity, when making the determination as to whether the
Dodd-Frank Act swap requirements should apply to ANE Transactions.
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\246\ Consisting of transaction-level requirements under the
Guidance and group B and C requirements under the Proposed Rule, as
discussed below.
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As a preliminary matter, the Commission notes that the consequences
of disapplication of the Dodd-Frank Act swap requirements would be
mitigated in two respects. First, persons engaging in any aspect of
swap transactions within the U.S. remain subject to the CEA and
Commission regulations prohibiting the employment, or attempted
employment, of manipulative, fraudulent, or deceptive devices, such as
section 6(c)(1) of the CEA,\247\ and Commission regulation 180.1.\248\
The Commission thus would retain anti-fraud and anti-manipulation
authority, and would continue to monitor the trading practices of non-
U.S. persons that occur within the territory of the United States in
order to enforce a high standard of customer protection and market
integrity. Even where a swap is entered into by two non-U.S. persons,
the United States has a significant interest in deterring fraudulent or
manipulative conduct occurring within its borders and cannot be a haven
for such activity.
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\247\ 7 U.S.C. 9(1).
\248\ 17 CFR 180.1.
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Second, with respect to more specific regulation of swap dealing in
accordance with the Commission's swap regime, the Commission notes
that, in most cases, non-U.S. persons entering into ANE Transactions
would be subject to regulation and oversight in their home
jurisdictions similar to the Commission's transaction-level
requirements as most of the major swap trading centers have implemented
similar risk mitigation requirements.\249\
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\249\ See 2019 FSB Progress Report, Table M.
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With respect to market distortion, the Commission gives weight to
commenters that argued that application of transaction-level
requirements to ANE Transactions would cause non-U.S. SDs to relocate
personnel to other countries (or otherwise terminate agency contracts
with U.S.-based agents) in order to avoid Dodd-Frank Act swap
regulation or having to interpret and apply what the commenters
considered a challenging ANE analysis, thereby potentially increasing
market fragmentation.\250\
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\250\ See, e.g., ABASA at 2 (adopting the ANE Staff Advisory
would ``impose unnecessary compliance burdens on swaps market
participants, encourage them to re-locate jobs and activities
outside the United States to accommodate non-U.S. client demands,
and fragment market liquidity''); Coalition at 3 (emphasizing the
impact on non-U.S. affiliates of U.S. end users, such as increased
hedging costs and reduced access to registered counterparties); IIB
at 7-8; ISDA at 4; JFMC at 3; SG at 8-9. See also IAA at 3
(expressing concern that non-U.S. clients may avoid hiring U.S.
asset managers to avoid application of the ANE Staff Advisory).
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The Commission also gives weight to the regulatory interests of the
home jurisdictions of non-U.S. persons engaged in ANE Transactions.
Because the risk of the resulting swaps lies in those home countries
and not the U.S. financial system, the Commission recognizes that, with
the exception of enforcing the prohibition on fraudulent or
manipulative conduct taking place in the United States, non-U.S.
regulators will have a greater incentive to regulate the swap dealing
activities of such non-U.S. persons--such as, for example, with respect
to business conduct standards with counterparties, appropriate
documentation, and recordkeeping. In these circumstances, where the
risk lies outside the U.S. financial system, the Commission recognizes
the greater supervisory interest of the authorities in the home
jurisdictions of the non-U.S. persons. The Commission is also not aware
of any major swap regulatory jurisdiction that applies its regulatory
regime to U.S. entities engaging in ANE Transactions within its
territory.
In sum, the Commission has determined that the mitigating effect of
the anti-fraud and anti-manipulation authority retained by the
Commission and the prevalence of applicable regulatory requirements
similar to the Commission's own, the likelihood of disruptive
avoidance, the Commission's respect for the regulatory interests of the
foreign jurisdictions where the actual
[[Page 979]]
financial risks of ANE Transactions lie in accordance with the
principles of international comity, and the awareness that application
of its swap requirements in the ANE context would make the Commission
an outlier among the major swap regulatory jurisdictions, outweighs the
Commission's regulatory interest in applying its swap requirements to
ANE Transactions differently than such are otherwise proposed to be
applied to swaps between Other Non-U.S. Persons.
B. Request for Comment
The Commission invites comment on all aspects of the proposed
treatment of ANE Transactions described in section V, and specifically
requests comments on the following questions. Please explain your
responses and provide alternatives to the Proposed Rule, where
applicable.
(25) Should the Commission apply certain transaction-level
requirements (e.g., Sec. 23.433 (fair dealing)) to SDs and MSPs with
respect to ANE Transactions, or are the existing anti-fraud and anti-
manipulation powers under the CEA and Commission regulations adequate
safeguards to address any wrongdoing arising from ANE Transactions.
(26) Should the Commission consider adopting a territorial approach
similar to the SEC, where non-US counterparties engaging in ANE
Transactions would count such transactions towards their de minimis
thresholds and be subject to certain transaction-level
requirements,\251\ rather than the proposed comity-based approach of
excluding ANE Transactions from the Proposed Rule?
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\251\ See Security-Based Swap Transactions Connected with a Non-
U.S. Person's Dealing Activity That Are Arranged, Negotiated, or
Executed by Personnel Located in a U.S. Branch or Office or
Security-Based Swap Dealer De Minimis Exception, 81 FR 8598 (Feb.
19, 2016); Proposed Rule Amendments and Guidance Addressing Cross-
Border Application of Certain Security-Based Swap Requirements, 84
FR 24206 (May 24, 2019).
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VI. Proposed Exceptions From Group B and Group C Requirements,
Substituted Compliance for Group A and Group B Requirements, and
Comparability Determinations
Title VII of the Dodd-Frank Act and Commission regulations
thereunder establish a broad range of requirements applicable to SDs
and MSPs, including requirements regarding risk management and internal
and external business conduct. These requirements are designed to
reduce systemic risk, increase counterparty protections, and increase
market efficiency, orderliness, and transparency.\252\ Consistent with
the Guidance,\253\ SDs and MSPs (whether or not U.S. persons) are
subject to all of the Commission regulations described below by virtue
of their status as Commission registrants. Put differently, the
Commission's view is that if an entity is required to register as an SD
or MSP under the Commission's interpretation of section 2(i) of the
CEA, then such entity should be subject to these regulations with
respect to all of its swap activities. As explained further below, such
an approach is necessary because of the important role that the SD and
MSP requirements play in the proper operation of a registrant.
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\252\ See, e.g., Entities Rule, 77 FR at 30629, 30703.
\253\ See Guidance, 78 FR at 45342. The Commission notes that
while the Guidance states that all swap entities (wherever located)
are subject to all of the CFTC's Title VII requirements, the
Guidance went on to describe how and when the Commission would
expect swap entities to comply with specific requirements and when
substituted compliance would be available under its non-binding
framework.
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However, consistent with section 2(i) of the CEA, in the interest
of international comity, and for other reasons discussed in this
release, the Commission is proposing exceptions from, and a substituted
compliance process for, certain regulations applicable to registered
SDs and MSPs, as appropriate.\254\ Further, the Proposed Rule would
create a framework for comparability determinations that emphasizes a
holistic, outcomes-based approach that is grounded in principles of
international comity.
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\254\ The Commission intends to separately address the cross-
border application of the Title VII requirements addressed in the
Guidance that are not discussed in this release (e.g., capital
adequacy, clearing and swap processing, mandatory trade execution,
swap data repository reporting, large trader reporting, and real-
time public reporting). With respect to capital adequacy
requirements for SDs and MSPs, the Commission notes that it has
proposed but not yet adopted final regulations. See the Commission's
proposed capital adequacy regulations in Capital Requirements of
Swap Dealers and Major Swap Participants, 84 FR 69664 (proposed Dec.
19, 2019); Capital Requirements of Swap Dealers and Major Swap
Participants, 81 FR 91252 (proposed Dec. 16, 2016); and Capital
Requirements of Swap Dealers and Major Swap Participants, 76 FR
27802 (proposed May 12, 2011).
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A. Classification and Application of Certain Regulatory Requirements--
Group A, Group B, and Group C Requirements
The Guidance applied a bifurcated approach to the classification of
certain regulatory requirements applicable to SDs and MSPs, based on
whether the requirement applies to the firm as a whole (``Entity-Level
Requirement'' or ``ELR'') or to the individual swap or trading
relationship (``Transaction-Level Requirement'' or ``TLR'').\255\
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\255\ See, e.g., Guidance, 78 FR at 45331.
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The Guidance categorized the following regulatory requirements as
ELRs: (1) Capital adequacy; (2) chief compliance officer; (3) risk
management; (4) swap data recordkeeping; (5) swap data repository
(``SDR'') reporting; and (6) large trader reporting.\256\ The Guidance
further divided ELRs into two subcategories.\257\ The first category of
ELRs includes: (1) Capital adequacy; (2) chief compliance officer; (3)
risk management; and (4) certain swap data recordkeeping requirements
\258\ (``First Category ELRs'').\259\ The second category of ELRs
includes: (1) SDR reporting; (2) certain aspects of swap data
recordkeeping relating to complaints and marketing and sales materials
under Sec. Sec. 23.201(b)(3) and 23.201(b)(4); and (3) large trader
reporting (``Second Category ELRs'').\260\
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\256\ See, e.g., id.
\257\ See, e.g., id.
\258\ Swap data recordkeeping under 17 CFR 23.201 and 23.203
(except certain aspects of swap data recordkeeping relating to
complaints and sales materials).
\259\ See, e.g., Guidance, 78 FR at 45331.
\260\ See, e.g., id.
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The Guidance categorized the following regulatory requirements as
TLRs: (1) Required clearing and swap processing; (2) margin (and
segregation) for uncleared swaps; (3) mandatory 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.\261\ As with the ELRs, the Guidance similarly
subdivided TLRs into two subcategories.\262\ The Commission determined
that all TLRs, other than external business conduct standards, address
risk mitigation and market transparency.\263\ Accordingly, under the
Guidance, all TLRs except external business conduct standards are
classified as ``Category A TLRs,'' whereas external business conduct
standards are classified as ``Category B TLRs.'' \264\ Under the
Guidance, generally, whether a specific Commission requirement applies
to a swap entity and a swap and whether substituted compliance is
available depends on the classification of the requirement as an ELR or
TLR and the sub-classification of each and the type
[[Page 980]]
of swap entity and, in certain cases, the counterparty to a specific
swap.\265\
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\261\ See, e.g., id. at 45333.
\262\ See, e.g., id.
\263\ See, e.g., id.
\264\ See, e.g., id.
\265\ See, e.g., id. at 45337-38.
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To avoid confusion that may arise from using the ELR/TLR
classification in the Proposed Rule, given that the Proposed Rule does
not address the same set of Commission regulations as the Guidance, the
Commission is proposing to classify certain of its regulations as group
A, group B, and group C requirements for purposes of determining the
availability of certain exceptions from, and/or substituted compliance
for, such regulations. A description of each of the group A
requirements, group B requirements, and group C requirements is below.
1. Group A Requirements
The group A requirements include: (1) Chief compliance officer; (2)
risk management; (3) swap data recordkeeping; and (4) antitrust
considerations. Specifically, the group A requirements consist of the
requirements set forth in Sec. Sec. 3.3, 23.201, 23.203, 23.600,
23.601, 23.602, 23.603, 23.605, 23.606, 23.607, and 23.609,\266\ each
discussed below. The Commission believes that these requirements would
be impractical to apply only to specific transactions or counterparty
relationships, and are most effective when applied consistently across
the entire enterprise. They ensure that swap entities 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. Together with other Commission
requirements, they constitute an important line of defense against
financial, operational, and compliance risks that could lead to a
firm's default. Requiring swap entities to rigorously monitor and
address the risks they incur as part of their day-to-day businesses
lowers the registrants' risk of default--and ultimately protects the
public and the financial system. For this reason, the Commission has
strong supervisory interests in ensuring that swap entities (whether
domestic or foreign) are subject to the group A requirements or
comparably rigorous standards.
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\266\ 17 CFR 3.3, 23.201, 23.203, 23.600, 23.601, 23.602,
23.603, 23.605, 23.606, 23.607, and 23.609.
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(i) Chief Compliance Officer
Section 4s(k) of the CEA requires that each SD and MSP designate an
individual to serve as its chief compliance officer (``CCO'') and
specifies certain duties of the CCO.\267\ Pursuant to section 4s(k),
the Commission adopted Sec. 3.3,\268\ which requires SDs and MSPs to
designate a CCO responsible for administering the firm's compliance
policies and procedures, reporting directly to the board of directors
or a senior officer of the SD or MSP, as well as preparing and filing
with the Commission a certified annual report discussing the
registrant's compliance policies and activities. The CCO 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 SDs
and MSPs.
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\267\ 7 U.S.C. 6s(k).
\268\ 17 CFR 3.3. See 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 SD and MSP Recordkeeping, Reporting, and Duties
Rule''). In 2018, the Commission adopted amendments to the CCO
requirements. See Chief Compliance Officer Duties and Annual Report
Requirements for Futures Commission Merchants, Swap Dealers, and
Major Swap Participants, 83 FR 43510 (Aug. 27, 2018).
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(ii) Risk Management
Section 4s(j) of the CEA requires each SD 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.\269\ The Commission implemented these provisions in
Sec. Sec. 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606.\270\ The
Commission also adopted Sec. 23.609,\271\ which requires certain risk
management procedures for SDs or MSPs that are clearing members of a
DCO.\272\ Collectively, these requirements help to establish a
comprehensive internal risk management program for SDs and MSPs, which
is critical to effective systemic risk management for the overall swap
market.
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\269\ 7 U.S.C. 6s(j).
\270\ 17 CFR 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606.
See Final SD and MSP Recordkeeping, Reporting, and Duties Rule, 77
FR 20128 (addressing rules related to risk management programs,
monitoring of position limits, diligent supervision, business
continuity and disaster recovery, conflicts of interest policies and
procedures, and general information availability).
\271\ 17 CFR 23.609.
\272\ See Customer Clearing Documentation, Timing of Acceptance
for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr.
9, 2012).
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(iii) Swap Data Recordkeeping
CEA section 4s(f)(1)(B) requires SDs and MSPs to keep books and
records for all activities related to their swap business.\273\
Sections 4s(g)(1) and (4) require SDs and MSPs to maintain trading
records for each swap and all related records, as well as a complete
audit trail for comprehensive trade reconstructions.\274\ Additionally,
CEA section 4s(f)(1) requires SDs 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
SD or MSP.\275\ Further, CEA section 4s(h) requires SDs and MSPs to
``conform with such business conduct standards . . . as may be
prescribed by the Commission by rule or regulation.'' \276\
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\273\ 7 U.S.C. 6s(f)(1)(B).
\274\ 7 U.S.C. 6s(g)(1) and (4).
\275\ 7 U.S.C. 6s(f)(1).
\276\ 7 U.S.C. 6s(h)(1). See 7 U.S.C. 6s(h)(3).
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Pursuant to these provisions, the Commission promulgated final
rules that set forth certain reporting and recordkeeping for SDs and
MSPs.\277\ Specifically, Sec. Sec. 23.201 and 23.203 \278\ require SDs
and MSPs to keep records including complete transaction and position
information for all swap activities, including documentation on which
trade information is originally recorded. In particular, Sec. 23.201
states that each SD and MSP shall keep full, complete, and systematic
records of all activities related to its business as a SD or MSP.\279\
Such records must include, among other things, a record of each
complaint received by the SD or MSP concerning any partner, member,
officer, employee, or agent,\280\ as well as all marketing and sales
presentations, advertisements, literature, and communications.\281\
Commission regulation 23.203 \282\ requires, among other things, that
records (other than swap data reported in accordance with part 45 of
the Commission's regulations) \283\ be maintained in accordance with
Sec. 1.31.\284\ Commission regulation 1.31 requires that records
relating to swaps be maintained for specific durations, including that
records of swaps be maintained for a minimum of five years and as much
as the life of the swap plus five years, and that most records be
``readily accessible'' for the entire record keeping period.\285\
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\277\ See Final SD and MSP Recordkeeping, Reporting, and Duties
Rule, 77 FR 20128.
\278\ 17 CFR 23.201 and 203.
\279\ 17 CFR 23.201(b).
\280\ 17 CFR 23.201(b)(3)(i).
\281\ 17 CFR 23.201(b)(4).
\282\ 17 CFR 23.203.
\283\ 17 CFR 45.
\284\ 17 CFR 1.31.
\285\ 17 CFR 1.31(b).
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[[Page 981]]
(iv) Antitrust Considerations
Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting
any process or taking any action that results in any unreasonable
restraint of trade or imposes any material anticompetitive burden on
trading or clearing, unless necessary or appropriate to achieve the
purposes of the CEA.\286\ The Commission promulgated this requirement
in Sec. 23.607(a) \287\ and also adopted Sec. 23.607(b), which
requires SDs and MSPs to adopt policies and procedures to prevent
actions that result in unreasonable restraints of trade or impose any
material anticompetitive burden on trading or clearing.\288\
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\286\ 7 U.S.C. 6s(j)(6).
\287\ 17 CFR 23.607(a).
\288\ 17 CFR 23.607(b).
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2. Group B Requirements
The group B requirements include: (1) Swap trading relationship
documentation; (2) portfolio reconciliation and compression; (3) trade
confirmation; and (4) daily trading records. Specifically, the group B
requirements consist of the requirements set forth in Sec. Sec.
23.202, 23.501, 23.502, 23.503, and 23.504,\289\ each discussed below.
The group B requirements relate to risk mitigation and the maintenance
of good recordkeeping and business practices.\290\ Unlike the group A
requirements, the Commission believes that the group B requirements can
practically be applied on a bifurcated basis between domestic and
foreign transactions or counterparty relationships and, thus, do not
need to be applied uniformly across an entire enterprise. This allows
the Commission to have greater flexibility with respect to the
application of these requirements to non-U.S. swap entities and foreign
branches of U.S. swap entities.
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\289\ 17 CFR 23.202, 23.501, 23.502, 23.503, and 23.504.
\290\ See, e.g., Int'l Org. of Sec. Comm'ns, Risk Mitigation
Standards for Non-Centrally Cleared OTC Derivatives, IOSCO Doc.
FR01/2015 (Jan. 28, 2015) (``IOSCO Risk Management Standards''),
available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD469.pdf (discussing, among other things, the objectives and
benefits of trading relationship documentation, trade confirmation,
reconciliation, and portfolio compression requirements). In
addition, the group B requirements also provide customer protection
and market transparency benefits.
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(i) Swap Trading Relationship Documentation
CEA section 4s(i) requires each SD and MSP to conform to Commission
standards for the timely and accurate confirmation, processing,
netting, documentation, and valuation of swaps.\291\ Pursuant to
section 4s(i), the Commission adopted, among other regulations, Sec.
23.504.\292\ Regulation 23.504(a) requires SDs and MSPs to ``establish,
maintain and follow written policies and procedures'' to ensure that
the SD or MSP executes written swap trading relationship documentation,
and Sec. 23.504(c) requires that documentation policies and procedures
be audited periodically by an independent auditor to identify material
weaknesses.\293\ Under Sec. 23.504(b), the swap trading relationship
documentation must include, among other things: (1) All terms governing
the trading relationship between the SD or MSP and its counterparty;
(2) credit support arrangements; (3) investment and re-hypothecation
terms for assets used as margin for uncleared swaps; and (4) custodial
arrangements.\294\ 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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\291\ 7 U.S.C. 6s(i).
\292\ 17 CFR 23.504. See 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, Risk Mitigation, and
Documentation Rules'').
\293\ 17 CFR 23.504(a)(2) and (c).
\294\ 17 CFR 23.504(b).
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(ii) 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 SDs and MSPs.\295\ Pursuant to CEA section 4s(i), the
Commission adopted Sec. Sec. 23.502 and 23.503,\296\ which require SDs
and MSPs to perform portfolio reconciliation and compression,
respectively, for their swaps.\297\ Portfolio reconciliation is a post-
execution risk management tool designed 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.\298\ Further, Sec. 23.503 requires all SDs 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 SDs or MSPs or through a third party.\299\
The rule also requires policies and procedures for engaging in such
exercises for uncleared swaps with non-SDs and non-MSPs upon
request.\300\
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\295\ 7 U.S.C. 6s(i).
\296\ 17 CFR 23.502 and 503. See Final Confirmation, Risk
Mitigation, and Documentation Rules, 77 FR 55904.
\297\ See 17 CFR 23.502 and 503.
\298\ For example, the reduced transaction count may decrease
operational risk as there are fewer trades to maintain, process, and
settle.
\299\ See 17 CFR 23.503(a).
\300\ 17 CFR 23.503(b).
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(iii) Trade Confirmation
Section 4s(i) of the CEA requires that each SD and MSP must comply
with the Commission's regulations prescribing timely and accurate
confirmation of swaps.\301\ The Commission adopted Sec. 23.501,\302\
which requires, among other things, 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 SDs and MSPs by the end of
the first business day following the day of execution.\303\ 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.\304\
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\301\ 7 U.S.C. 6s(i).
\302\ 17 CFR 23.501. See Final Confirmation, Risk Mitigation,
and Documentation Rules, 77 FR 55904.
\303\ 17 CFR 23.501(a)(1).
\304\ Additionally, the Commission notes that Sec. 23.504(b)(2)
requires that the swap trading relationship documentation of SDs and
MSPs must include all confirmations of swap transactions. 17 CFR
23.504(b)(2).
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(iv) Daily Trading Records
Pursuant to CEA section 4s(g),\305\ the Commission adopted Sec.
23.202,\306\ which requires SDs 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
regulation 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 SD or MSP.\307\ Accurate and timely records regarding all
phases of a swap transaction can serve to greatly enhance a firm's
internal supervision, as well as
[[Page 982]]
the Commission's ability to detect and address market or regulatory
abuses or evasion.
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\305\ 7 U.S.C. 6s(g).
\306\ 17 CFR 23.202. See Final SD and MSP Recordkeeping,
Reporting, and Duties Rule, 77 FR 20128.
\307\ 17 CFR 23.202(b).
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3. Group C Requirements
Pursuant to CEA section 4s(h),\308\ the Commission adopted external
business conduct rules, which establish certain additional business
conduct standards governing the conduct of SDs and MSPs in dealing with
their swap counterparties.\309\ The group C requirements are set forth
in Sec. Sec. 23.400-451.\310\ Broadly speaking, these rules are
designed to enhance counterparty protections by establishing robust
requirements regarding SDs' and MSPs' conduct with their
counterparties. Under these rules, SDs and MSPs are required to, among
other things, 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.
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\308\ 7 U.S.C. 6s(h).
\309\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants with Counterparties, 77 FR 9734 (Feb. 17, 2012).
\310\ 17 CFR 23.400-451.
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In the Commission's view, the group C requirements focus on
customer protection and have a more attenuated link to, and are
therefore distinguishable from, systemic and market-oriented
protections in the group A and group B requirements. Additionally, as
discussed below, the Commission believes that the foreign jurisdictions
in which non-U.S. persons and foreign branches of U.S. swap entities
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 and foreign branches within their
jurisdiction, and, consistent with section 2(i) of the CEA and in the
interest of international comity, it is generally appropriate to defer
to such jurisdictions in applying, or not applying, such standards to
foreign-based swaps with foreign counterparties.
4. Request for Comment
The Commission invites comment on all aspects of the Proposed Rule,
including the classifications of Title VII requirements discussed
above, and specifically requests comments on the following questions.
Please explain your responses and provide alternatives to the relevant
portions of the Proposed Rule, where applicable.
(27) On the classification of group A, group B, and group C
requirements, should the Commission use these classifications, revert
to the ELR and TLR classifications used in the Guidance, or otherwise
classify the relevant Title VII requirements?
(28) To the extent that you agree with the Commission's proposed
use of the group A, group B, and group C requirements classification,
should any of the requirements be re-classified or removed from such
groups? Should requirements not included of any of the groups be added
to any of them? If so, which requirements?
B. Proposed Exceptions
Consistent with section 2(i) of the CEA, the Commission is
proposing four exceptions from certain Commission regulations for
foreign-based swaps in the Proposed Rule.
First, the Commission is proposing an exception from certain group
B and C requirements for certain anonymous, exchange-traded, and
cleared foreign-based swaps (``Exchange-Traded Exception'').
Second, the Commission is proposing an exception from the group C
requirements for certain foreign-based swaps with foreign
counterparties (``Foreign Swap Group C Exception'').
Third, the Commission is proposing an exception from the group B
requirements for the foreign-based swaps of certain non-U.S. swap
entities with certain foreign counterparties (``Non-U.S. Swap Entity
Group B Exception'').
Fourth, the Commission is proposing an exception from the group B
requirements for certain foreign-based swaps of foreign branches of
U.S. swap entities with certain foreign counterparties, subject to
certain limitations, including a quarterly cap on the amount of such
swaps (``Foreign Branch Group B Exception'').
While these exceptions each have different eligibility requirements
discussed below, a common requirement is that they would be available
only to foreign-based swaps. As discussed in section II.G above, under
the Proposed Rule, a foreign-based swap would mean: (1) A swap by a
non-U.S. swap entity, except for a swap conducted through a U.S.
branch; or (2) a swap conducted through a foreign branch. Under the
Proposed Rule, swaps that do not meet these requirements would be
treated as domestic swaps for purposes of applying the group B and
group C requirements and, therefore, would not be eligible for the
above exceptions.
Pursuant to the Proposed Rule, swap entities that avail themselves
of these exceptions for their foreign-based swaps would only be
required to comply with the applicable laws of the foreign
jurisdiction(s) to which they are subject, rather than the relevant
Commission requirements, for such swaps. However, the Commission notes
that, notwithstanding these exceptions, swap entities would remain
subject to the CEA and Commission regulations not covered by the
exceptions, including the prohibition on the employment, or attempted
employment, of manipulative and deceptive devices in Sec. 180.1 of the
Commission's regulations.\311\ In addition, the Commission would expect
swap entities to address any significant risk that may arise as a
result of the utilization of one or more exceptions in their risk
management programs required pursuant to Sec. 23.600.\312\
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\311\ 17 CFR 180.1.
\312\ 17 CFR 23.600.
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1. Exchange-Traded Exception
The Commission is proposing that, with respect to its foreign-based
swaps, each non-U.S. swap entity and foreign branch of a U.S. swap
entity would be excepted from the group B requirements (other than the
daily trading records requirements in Sec. Sec. 23.202(a) through
23.202(a)(1)) \313\ and the group C requirements with respect to any
swap entered into on a DCM, a registered SEF or a SEF exempted from
registration by the Commission pursuant to section 5h(g) of the CEA, or
an FBOT registered with the Commission pursuant to part 48 of its
regulations \314\ where, in each case, the swap is cleared through a
registered DCO or a clearing organization that has been exempted from
registration by the Commission pursuant to section 5b(h) of the CEA,
and the swap entity does not know the identity of the counterparty to
the swap prior to execution.\315\
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\313\ 17 CFR 23.202(a) through (a)(1).
\314\ The Commission would consider the proposed exception
described herein also to apply with respect to an FBOT that provides
direct access to its order entry and trade matching system from
within the U.S. pursuant to no-action relief issued by Commission
staff.
\315\ Proposed Sec. 23.23(e)(1)(i). This approach is similar to
the Guidance. See Guidance, 78 FR at 45351-52 and 45360-61. As
discussed in the Guidance and below, the Commission recognizes that
certain of the group B requirements and group C requirements are not
applicable to swaps meeting the requirements of the exception in any
event. However, the Commission nonetheless wishes to expressly
provide that the swaps described in the exception are excepted from
all of the group B and group C requirements, other than Sec. Sec.
23.302(a) through (a)(1) as discussed below. As discussed, supra
note 201, the Commission recognizes that it recently issued proposed
rulemakings regarding non-U.S. DCOs, and may modify this exception
for exchange-traded and cleared swaps as necessary, based on any
DCO-related proposed rules that are adopted by the Commission.
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[[Page 983]]
With respect to the group B trade confirmation requirement, the
Commission notes that where a cleared swap is executed anonymously on a
DCM or SEF (as discussed above), independent requirements that apply to
DCM and SEF transactions pursuant to the Commission's regulations
should ensure that these requirements are met.\316\ And, for a
combination of reasons, including the fact that a registered FBOT is
analogous to a DCM and is expected to be subject to comprehensive
supervision and regulation in its home country,\317\ and the fact that
the swap will be cleared, the Commission believes that the Commission's
trade confirmation requirements should not apply to foreign-based swaps
that meet the requirements of the exception and are traded on
registered FBOTs.
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\316\ See 17 CFR 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.''); and
37.6(b) (``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 . . .'').
\317\ Pursuant to 17 CFR 48.5(d)(2), in reviewing the
registration application of an FBOT, the Commission will consider
whether the FBOT and its clearing organization are subject to
comprehensive supervision and regulation by the appropriate
governmental authorities in their home country or countries that is
comparable to the comprehensive supervision and regulation to which
DCMs and DCOs are respectively subject under the Act, Commission
regulations, and other applicable United States laws and
regulations.
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Of the remaining group B requirements, the portfolio reconciliation
and compression and swap trading relationship documentation
requirements would not apply to cleared DCM, SEF, or FBOT transactions
described above because the Commission regulations that establish those
requirements make clear that they do not apply to cleared
transactions.\318\ For the last group B requirement--the daily trading
records requirement \319\--the Commission believes that, as a matter of
international comity and recognizing the supervisory interests of
foreign regulators who may have their own trading records requirements,
it is appropriate to except such foreign-based swaps from certain of
the Commission's daily trading records requirements. However, the
Commission believes that the requirements of Sec. Sec. 23.202(a)
through (a)(1) should continue to apply, as it believes that all swap
entities should be required to maintain, among other things, sufficient
records to conduct a comprehensive and accurate trade reconstruction
for each swap. The Commission notes that, in particular, for certain
pre-execution trade information under Sec. 23.202(a)(1),\320\ the swap
entity may be the best, or only, source for such records. For this
reason, paragraphs (a) through (a)(1) of Sec. 23.202 are carved out
from the group B requirements in the proposed exception.
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\318\ See 17 CFR 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.''); and
23.504(a)(1)(iii) (``The requirements of this section [swap trading
relationship documentation] shall not apply to . . . [s]waps cleared
by a derivatives clearing organization.'').
\319\ See 17 CFR 23.202.
\320\ See 17 CFR 23.202(a)(1).
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Additionally, given that this exception is predicated on anonymity,
many of the group C requirements would be inapplicable.\321\ In the
interest of international comity and because the proposed exception
requires that the swap be exchange-traded and cleared, the Commission
is proposing that foreign-based swaps also be excepted from the
remaining group C requirements in these circumstances. The Commission
expects that the requirements that the swaps be exchange-traded and
cleared will generally limit swaps that benefit from the exception to
standardized and commonly-traded, foreign-based swaps, for which the
Commission believes application of the remaining group C requirements
is not necessary.
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\321\ See 17 CFR 23.402(b)-(c) (requiring SDs and MSPs to obtain
and retain certain information only about each counterparty ``whose
identity is known to the SD or MSP prior to the execution of the
transaction''); 23.430(e) (not requiring SDs and MSPs to verify
counterparty eligibility when a transaction is entered on a DCM or
SEF and the SD 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 SD or
MSP does not know the identity of the counterparty prior to
execution); 23.450(h) (not requiring SDs 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 SD or MSP does not know
the identity of the Special Entity prior to execution); and
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 SD or MSP does not
know the identity of the Special Entity prior to execution). Because
the Commission believes a registered FBOT is analogous to a DCM for
these purposes and is expected to be subject to comprehensive
supervision and regulation in its home country, and because a SEF
that is exempted from registration by the Commission pursuant to
section 5h(g) of the CEA must be subject to supervision and
regulation that is comparable to that to which Commission-registered
SEFs are subject, the Commission is also proposing that these group
C requirements would not be applicable where such a swap is executed
anonymously on a registered FBOT, or a SEF that has been exempted
from registration with the Commission pursuant to section 5h(g) of
the CEA, and cleared.
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2. Foreign Swap Group C Exception
The Commission is also proposing that each non-U.S. swap entity and
foreign branch of a U.S. swap entity would be excepted from the group C
requirements with respect to its foreign-based swaps with a foreign
counterparty.\322\ Such swaps would not include as a party a U.S.
person (other than a foreign branch where the swap is conducted through
such foreign branch) or be conducted through a U.S. branch. Given that
the group C requirements are intended to promote counterparty
protections in the context of local market sales practices, the
Commission recognizes that foreign regulators may have a relatively
stronger supervisory interest in regulating such swaps in relation to
the group C requirements. Accordingly, the Commission believes that
applying the group C requirements to these transactions may not be
warranted.\323\
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\322\ Proposed Sec. 23.23(e)(1)(ii) This approach is similar to
the Guidance. See Guidance, 78 FR at 45360-61. As discussed in
section II.G, under the Proposed Rule, a foreign counterparty would
mean: (1) A non-U.S. person, except with respect to a swap conducted
through a U.S. branch of that non-U.S. person; or (2) a foreign
branch where it enters into a swap in a manner that satisfies the
definition of a swap conducted through a foreign branch.
As used herein, the term swap includes transactions in swaps as
well as swaps that are offered but not entered into, as applicable.
\323\ The Commission expressed a similar view in the Guidance.
See Guidance, 78 FR at 45360-61.
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The Commission notes that, just as the Commission has a strong
supervisory interest in regulating and enforcing the group C
requirements associated with swaps taking place in the United States,
foreign regulators would have a similar interest in overseeing sales
practices for swaps occurring within their jurisdictions. Further,
given the scope of section 2(i) of the CEA with respect to the
Commission's regulation of swap activities outside the United States,
the Commission believes that imposing its group C requirements on a
foreign-based swap between a non-U.S. swap entity or foreign branch of
a U.S. swap entity, on
[[Page 984]]
one hand, and a foreign counterparty, on the other, is generally not
necessary to advance the customer protection goals of the Dodd-Frank
Act embodied in the group C requirements.
On the other hand, whenever a swap involves at least one party that
is a U.S. person (other than a foreign branch where the swap is
conducted through such foreign branch) or is a swap that is conducted
through a U.S. branch, the Commission believes it has a strong
supervisory interest in regulating and enforcing the group C
requirements. 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. Exercise of U.S. jurisdiction
with respect to the group C requirements over such swaps 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.\324\
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\324\ See supra section I.C.2.
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3. Non-U.S. Swap Entity Group B Exception
The Commission is also proposing that each non-U.S. swap entity
that is an Other Non-U.S. Person would be excepted from the group B
requirements with respect to any foreign-based swap with a foreign
counterparty that is also an Other Non-U.S. Person.\325\ In these
circumstances, where no party to the foreign-based swap is a U.S.
person, guaranteed by a U.S. person, or an SRS, and, the particular
swap is a foreign-based swap, notwithstanding that one or both parties
to such swap may be a swap entity, the Commission believes that foreign
regulators may have a relatively stronger supervisory interest in
regulating such swaps with respect to the subject matter covered by the
group B requirements, and that, in the interest of international
comity, applying the group B requirements to these foreign-based swaps
is not warranted.\326\
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\325\ Proposed Sec. 23.23(e)(2). This approach is similar to
the Guidance; however, the Commission notes that the Proposed Rule
limits the non-U.S. swap entities eligible for this exception to
those that are Other Non-U.S. Persons, and the Guidance did not
contain a similar limitation. See Guidance, 78 FR at 45352-53.
\326\ The Commission notes that, generally, it would expect swap
entities that rely on this exception to be subject to risk
mitigation standards in the foreign jurisdictions in which they
reside similar to those included in the Group B Requirements, as
most jurisdictions surveyed by the FSB in respect of their swaps
trading have implemented such standards. See 2019 FSB Progress
Report, Table M.
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4. Foreign Branch Group B Exception
The Commission is also proposing that each foreign branch of a U.S.
swap entity would be excepted from the group B requirements, with
respect to any foreign-based swap with a foreign counterparty that is
an Other Non-U.S. Person, subject to certain limitations.\327\
Specifically, (1) the exception would not be available with respect to
any group B requirement for which substituted compliance (discussed in
section VI.C below) is available for the relevant swap; and (2) in any
calendar quarter, the aggregate gross notional amount of swaps
conducted by a swap entity in reliance on the exception may not exceed
five percent of the aggregate gross notional amount of all its swaps in
that calendar quarter.\328\
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\327\ Proposed Sec. 23.23(e)(3). This is similar to a limited
exception for transactions by foreign branches in certain specified
jurisdictions in the Guidance. See Guidance, 78 FR at 45351.
\328\ Proposed Sec. 23.23(e)(3)(i) and (ii). For example, if a
swap entity were to enter into $10 billion in aggregate gross
notional of swaps in a calendar quarter, no more than $500 million
in aggregate gross notional of such swaps would be eligible for the
Foreign Branch Group B Exception.
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The Commission is proposing the Foreign Branch Group B Exception to
allow the foreign branches of U.S. swap entities to continue to access
swap markets for which substituted compliance may not be available
under limited circumstances.\329\ The Commission believes the Foreign
Branch Group B Exception is appropriate because U.S. swap entities'
activities through foreign branches in these markets, though not
significant in volume in many cases, may nevertheless be an integral
element of a U.S. swap entity's global business. Additionally, although
not the Commission's main purpose, the Commission endeavors to preserve
liquidity in the emerging markets in which it expects this exception to
be utilized, which may further encourage the global use and development
of swap markets. Further, because of the proposed five percent cap on
the use of the exception, the Commission preliminarily believes that
the swap activity that would be excepted from the group B requirements
would not raise significant supervisory concerns.
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\329\ As noted above, where substituted compliance is available
for a particular group B requirement and swap, the proposed
exception would not be available. Proposed Sec. 23.23(e)(3)(i).
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5. Request for Comment
The Commission invites comment on all aspects of the Proposed Rule,
including each of the proposed exceptions discussed above, and
specifically requests comments on the following questions. Please
explain your responses and provide alternatives to the relevant
portions of the Proposed Rule, where applicable.
(29) In light of the Commission's supervisory interests, are the
proposed exceptions appropriate? Should they be broadened or narrowed?
For example, should the Exchange-Traded Exception be available to swaps
other than foreign-based swaps? Should U.S. swap entities (other than
their foreign branches) be eligible for any of the exceptions and under
what circumstances? Should there be further limitations on the types of
exchanges on which swaps eligible for the Exchange-Traded Exception may
occur? With respect to foreign-based swaps with foreign branches,
should the Foreign Swap Group C Exception be limited to swaps with
foreign branches of a swap entity? Should the Non-U.S. Swap Entity
Group B Exception and/or Foreign Branch Group B Exception be expanded
to apply to foreign-based swaps with foreign counterparties that are
foreign branches and/or to SRSs that are commercial entities? Should
the Commission increase, decrease, or otherwise change the cap under
the Foreign Branch Group B Exception?
(30) With respect to the Non-U.S. Swap Entity Group B Exception,
the Commission considered as an alternative allowing for substituted
compliance for swaps that would be eligible for the exception. Would
allowing for substituted compliance in these circumstances be a better
approach than providing the Non-U.S. Swap Entity Group B Exception?
C. Substituted Compliance
Substituted compliance is a fundamental component of the
Commission's cross-border framework.\330\ It is intended to promote the
benefits of integrated global markets by reducing the degree to which
market participants will be subject to duplicative regulations.
Substituted compliance also fosters international harmonization by
encouraging U.S. and foreign regulators to seek to adopt consistent and
comparable regulatory regimes that can result in deference to each
other's regime.\331\ When properly
[[Page 985]]
calibrated, substituted compliance promotes open, transparent, and
competitive markets without compromising market integrity. On the other
hand, when construed too broadly, substituted compliance could defer
important regulatory interests to foreign regulators that have not
implemented comparably robust regulatory frameworks.
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\330\ For example, in addition to the Guidance, the Commission
has provided substituted compliance with respect to foreign futures
and options transactions (see, e.g., Foreign Futures and Options
Transactions, 67 FR 30785 (May 8, 2002); Foreign Futures and Options
Transactions, 71 FR 6759 (Feb. 9, 2006)) and margin for uncleared
swaps (see Cross-Border Margin Rule, 81 FR 34818).
\331\ Substituted compliance, therefore, also is consistent with
the directive of Congress in the Dodd-Frank Act that the Commission
``coordinate with foreign regulatory authorities on the
establishment of consistent international standards with respect to
the regulation'' of swaps and swap entities. See Dodd-Frank Act,
Public Law 111-203 section 752(a); 15 U.S.C. 8325.
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The Commission believes that in order to achieve the important
policy goals of the Dodd-Frank Act, all U.S. swap entities must be
fully subject to the Dodd-Frank Act requirements addressed by the
Proposed Rule, without regard to whether their counterparty is a U.S.
or non-U.S. person.\332\ Given that such firms conduct their business
within the United States, their activities inherently have a direct and
significant connection with activities in, or effect on, U.S. commerce.
However, the Commission recognizes that, in certain circumstances, non-
U.S. swap entities' activities with non-U.S. persons may have a more
attenuated nexus to U.S. commerce. Further, the Commission acknowledges
that foreign jurisdictions also have a supervisory interest in such
activity. The Commission therefore believes that substituted compliance
may be appropriate for non-U.S. swap entities and foreign branches of
U.S. swap entities in certain circumstances.
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\332\ As further explained below, the Commission is proposing
limited substituted compliance for swaps conducted through a foreign
branch with foreign counterparties.
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In light of the interconnectedness of the global swap market and
consistent with CEA section 2(i) and international comity, the
Commission is proposing a substituted compliance regime with respect to
the group A and group B requirements that builds upon the Commission's
current substituted compliance framework and aims to promote diverse
markets without compromising the central tenets of the Dodd-Frank Act.
As discussed below, the Proposed Rule outlines the circumstances in
which a non-U.S. swap entity or foreign branch of a U.S. swap entity
would be permitted to comply with the group A and/or group B
requirements by complying with comparable standards in its home
jurisdiction.
1. Proposed Substituted Compliance Framework for the Group A
Requirements
The group A requirements, which relate to compliance programs, risk
management, and swap data recordkeeping, are generally implemented on a
firm-wide basis in order to effectively address enterprise risk.
Accordingly, it is not practical to limit substituted compliance for
the group A requirements to only those transactions involving non-U.S.
persons. Further, the Commission recognizes that foreign regulators
maintain the primary relationships with, and may have the strongest
supervisory interests over, non-U.S. swap entities. Therefore, given
that the group A requirements cannot be effectively applied on a
fragmented jurisdictional basis, and in furtherance of international
comity, the Commission is proposing to permit a non-U.S. swap entity to
avail itself of substituted compliance with respect to the group A
requirements where the non-U.S swap entity is subject to comparable
regulation in its home jurisdiction.\333\
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\333\ Proposed Sec. 23.23(f)(1). This approach is consistent
with the Guidance. See Guidance, 78 FR at 45338.
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2. Proposed Substituted Compliance Framework for the Group B
Requirements
Unlike the group A requirements, the group B requirements, which
relate to counterparty relationship documentation, portfolio
reconciliation and compression, trade confirmation, and daily trading
records, are more closely tied to local market conventions and can be
effectively implemented on a transaction-by-transaction or relationship
basis. It is therefore practicable to allow substituted compliance for
group B requirements for transactions with non-U.S. persons. The
Commission also recognizes that foreign regulators may have strong
supervisory interests in transactions that take place in their
jurisdiction. Accordingly, the Commission is proposing to permit a non-
U.S. swap entity or foreign branch of a U.S. swap entity to avail
itself of substituted compliance for the group B requirements in
certain circumstances, depending on the nature of its counterparty.
As discussed above, the Commission believes that swaps involving
U.S. persons are one of the types of swaps that have a direct and
significant connection with activities in, or effect on, U.S. commerce.
Accordingly, the Proposed Rule would generally not permit substituted
compliance for the group B requirements for swaps where one of the
counterparties is a U.S. person.\334\ However, the Commission
recognizes that substituted compliance may be appropriate in certain
circumstances for foreign branches of U.S. swap entities. Although
foreign branches are fully integrated within U.S. persons, they
generally enter into foreign-based swaps. In such cases, the Commission
believes it may not be appropriate to impose strict adherence to the
Commission's group B requirements, which are tailored to U.S. market
practices. The Commission acknowledges that requiring foreign branches
of U.S. swap entities to comply with U.S.-based requirements in non-
U.S. markets may place them at a competitive disadvantage.
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\334\ As further explained below, the Commission is proposing a
limited exception for swaps conducted through a foreign branch with
foreign counterparties.
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Given that group B requirements can be effectively applied on a
transaction-by-transaction basis, and the Commission's interest in
promoting international comity and market liquidity, the Commission is
proposing to allow a non-U.S. swap entity (unless transacting though a
U.S. branch), or a U.S. swap entity transacting through a foreign
branch, to avail itself of substituted compliance with respect to the
group B requirements for swaps with foreign counterparties.\335\
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\335\ Proposed Sec. 23.23(f)(2). This approach is consistent
with the Guidance. The Commission is proposing to limit the
availability of substituted compliance to swaps conducted through a
foreign branch of a U.S. swap entity as an anti-evasion measure to
prevent U.S. swap entities from simply booking trades in a foreign
branch to avoid the group B requirements.
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3. Request for Comment
The Commission invites comment on all aspects of the Proposed Rule,
including its proposed approach to substituted compliance for the group
A and group B requirements, and specifically requests comments on the
following questions. Please explain your responses and provide
alternatives to the relevant portions of the Proposed Rule, where
applicable.
(31) Should the Commission continue to treat group A requirements
differently than group B requirements for purposes of substituted
compliance? Should the Commission adopt a universal entity-wide or
transaction-by-transaction approach?
(32) Should the Commission expand or narrow the availability of
substituted compliance for swaps involving U.S. persons?
(33) Is it practicable for non-U.S. swap entities to utilize
substituted compliance for transactions with non-U.S. persons? \336\
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\336\ The Commission notes that while the Guidance stated that
all swap entities (wherever located) are subject to all of the
CFTC's Title VII requirements, the Guidance went on to describe how
and when the Commission would expect swap entities to comply with
specific ELRs and TLRs, and when substituted compliance would be
available.
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[[Page 986]]
(34) Given that the Guidance did not apply the group B requirements
to swaps between certain non-U.S. persons, should the Commission
consider a phase-in period for the application of the group B
requirements for swaps between SDs that are Guaranteed Entities or SRSs
with counterparties that are Other Non-U.S. Persons where substituted
compliance is not currently available?
(35) To what extent do foreign branches of U.S. swap entities enter
into swaps with U.S. persons or affiliates of U.S. persons?
(36) Should the Commission treat foreign branches differently than
the rest of the U.S. swap entity for purposes of substituted
compliance?
(37) How did/does the approach to substituted compliance in the
Guidance positively and negatively impact market practices? Please
provide any data in support of your comment.
D. Comparability Determinations
The Commission is proposing to implement a process pursuant to
which it would, in connection with certain requirements addressed by
the Proposed Rule, conduct comparability determinations regarding a
foreign jurisdiction's regulation of swap entities. The proposed
approach builds upon the Commission's existing substituted compliance
regime and aims to promote international comity and market liquidity
without compromising the Commission's interests in reducing systemic
risk, increasing market transparency, enhancing market integrity, and
promoting counterparty protections. Specifically, the Proposed Rule
outlines procedures for initiating comparability determinations,
including eligibility and submission requirements, with respect to
certain requirements addressed by the Proposed Rule. The Proposed Rule
would establish a standard of review that the Commission would apply to
such comparability determinations that emphasizes a holistic, outcomes-
based approach. The Proposed Rule, if adopted, is not intended to have
any impact on the effectiveness of any existing Commission
comparability determinations that were issued consistent with the
Guidance, which would remain effective pursuant to their terms.\337\
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\337\ See, e.g., Comparability Determination for Australia:
Certain Entity-Level Requirements, 78 FR 78864 (Dec. 27, 2013);
Comparability Determination for Canada: Certain Entity-Level
Requirements, 78 FR 78839 (Dec. 27, 2013); Comparability
Determination for the European Union: Certain Entity-Level
Requirements, 78 FR 78923 (Dec. 27, 2013); Comparability
Determination for Hong Kong: Certain Entity-Level Requirements, 78
FR 78852 (Dec. 27, 2013); Comparability Determination for Japan:
Certain Entity-Level Requirements, 78 FR 78910 (Dec. 27, 2013);
Comparability Determination for Switzerland: Certain Entity-Level
Requirements, 78 FR 78899 (Dec. 27, 2013); Comparability
Determination for the European Union: Certain Transaction-Level
Requirements, 78 FR 78878 (Dec. 27, 2013); and Comparability
Determination for Japan: Certain Transaction-Level Requirements, 78
FR 78890 (Dec. 27, 2013).
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As discussed above, the Commission is proposing to permit a non-
U.S. swap entity or foreign branch of a U.S. swap entity to comply with
a foreign jurisdiction's swap standards in lieu of the Commission's
corresponding requirements in certain cases, provided that the
Commission determines that such foreign standards are comparable to the
Commission's requirements. All swap entities, regardless of whether
they rely on such a comparability determination, would remain subject
to the Commission's examination and enforcement authority.\338\
Accordingly, if a swap entity fails to comply with a foreign
jurisdiction's relevant standards, or the terms of the applicable
comparability determination, the Commission could initiate an action
for a violation of the Commission's corresponding requirements.
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\338\ Proposed Sec. 23.23(g)(5). The Commission notes that the
National Futures Association (``NFA'') has certain delegated
authority with respect to SDs and MSPs. Additionally, all registered
SDs and MSPs are required to be members of the NFA and are subject
to examination by the NFA.
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1. Standard of Review
The Commission is proposing to establish a standard of review
pursuant to which the Commission would determine whether a foreign
jurisdiction's regulatory standards are comparable to the group A and
group B requirements. The Commission is proposing a flexible outcomes-
based approach that emphasizes comparable regulatory outcomes over
identical regulatory approaches.\339\ The Commission has published
numerous comparability determinations consistent with the Guidance and
pursuant to the Cross-Border Margin Rule.\340\ In doing so, the
Commission has developed a deeper understanding of the nuances in
comparing foreign jurisdictions' regulatory approaches with that of the
Commission. Specifically, the Commission has identified several
circumstances in which a foreign jurisdiction may achieve comparable
regulatory outcomes to those of the CFTC, notwithstanding certain
differences in regulatory or supervisory structures. For example, in
certain jurisdictions, the Commission has found comparability with
respect to certain Commission requirements based on a combination of
robust prudential supervision coupled with supervisory guidelines to
achieve comparable regulatory outcomes as the Commission
requirements.\341\ Therefore, the Commission believes it is necessary
to adopt a flexible approach to substituted compliance that would
enable it to address a broad range of regulatory approaches.
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\339\ This is similar to the Commission's approach in the
Guidance (see Guidance, 78 FR at 45342-43) and the Cross-Border
Margin Rule (see Cross-Border Margin Rule, 81 FR at 34846).
\340\ See e.g., supra notes 142 and 337.
\341\ See, e.g., Comparability Determination for Canada: Certain
Entity-Level Requirements, 78 FR 78839 (Dec. 27, 2013); Amendment to
Comparability Determination for Japan: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 84 FR
12074 (Apr. 1, 2019).
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While the Commission has historically taken a similar outcomes-
based approach to comparability determinations, the Proposed Rule would
allow the Commission to take an even more holistic view of a foreign
jurisdiction's regulatory regime. Specifically, the Proposed Rule would
allow the Commission to consider all relevant elements of a foreign
jurisdiction's regulatory regime, thereby allowing the Commission to
tailor its assessment to a broad range of foreign regulatory
approaches.\342\ Accordingly, pursuant to the Proposed Rule, a foreign
jurisdiction's regulatory regime would not need to be identical to the
relevant Commission requirements, so long as both regulatory frameworks
are comparable in terms of holistic outcome. Under the Proposed Rule,
in assessing comparability, the Commission may consider any factor it
deems appropriate, which may include: (1) The scope and objectives of
the relevant foreign jurisdiction's regulatory standards; (2) whether,
despite differences, a foreign jurisdiction's regulatory standards
achieve comparable regulatory outcomes to the Commission's
corresponding requirements; (3) the ability of the relevant regulatory
authority or authorities to supervise and enforce compliance with the
relevant foreign jurisdiction's regulatory standards; and (4) whether
the relevant foreign
[[Page 987]]
jurisdiction's regulatory authorities have entered into a memorandum of
understanding or similar cooperative arrangement with the Commission
regarding the oversight of swap entities.\343\ The Proposed Rule would
also enable the Commission to consider other relevant factors,
including whether a foreign regulatory authority has issued a
reciprocal comparability determination with respect to the Commission's
corresponding regulatory requirements. Further, given that some foreign
jurisdictions may implement prudential supervisory guidelines in the
regulation of swaps, the Proposed Rule would allow the Commission to
base comparability on a foreign jurisdiction's regulatory standards,
rather than regulatory requirements.
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\342\ Under the Proposed Rule, the Commission would consider all
relevant elements of a foreign jurisdiction's regulatory regime;
however, the fact that a foreign regulatory regime may not address
one of more of such elements would not preclude a finding of
comparability by the Commission. Also, in making a comparability
determination, the Commission would have the flexibility to weigh
more heavily elements it deems to be more critical than others and
less heavily those that it deems to be less critical.
\343\ Proposed Sec. 23.23(g)(4).
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Although, when assessed against the relevant Commission
requirements, the Commission may find comparability with respect to
some, but not all, of a foreign jurisdiction's regulatory standards, it
may also make a holistic finding of comparability that considers the
broader context of a foreign jurisdiction's related regulatory
standards. Accordingly, under the Proposed Rule, a comparability
determination need not contain a standalone assessment of comparability
for each relevant regulatory requirement, so long as it clearly
indicates the scope of regulatory requirements that are covered by the
determination. Further, the Commission may impose any terms and
conditions on a comparability determination that it deems
appropriate.\344\
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\344\ Proposed Sec. 23.23(g)(6).
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2. Eligibility Requirements
Under the Proposed Rule, the Commission could undertake a
comparability determination on its own initiative in furtherance of
international comity.\345\ In such cases, the Commission expects that
it would nonetheless engage with the relevant foreign regulator and/or
regulated entities to develop a fulsome understanding of the relevant
foreign regulatory regime. Alternatively, certain outside parties would
also be eligible to request a comparability determination from the
Commission with respect to some or all of the group A and group B
requirements. Under the Proposed Rule, a comparability determination
could be requested by: (1) Swap entities that are eligible for
substituted compliance; (2) trade associations whose members are such
swap entities; or (3) foreign regulatory authorities that have direct
supervisory authority over such swap entities and are responsible for
administering the relevant swap standards in the foreign
jurisdiction.\346\
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\345\ Proposed Sec. 23.23(g)(1).
\346\ Proposed Sec. 23.23(g)(2).
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3. Submission Requirements
In connection with a comparability determination with respect to
some or all of the group A and group B requirements, applicants would
be required to furnish certain information to the Commission that
provides a comprehensive understanding of the foreign jurisdiction's
relevant swap standards, including how they might differ from the
corresponding requirements in the CEA and Commission regulations.\347\
Further, applicants would be expected to provide an explanation as to
how any such differences may nonetheless achieve comparable outcomes to
the Commission's attendant regulatory requirements.\348\
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\347\ Proposed Sec. 23.23(g)(3).
\348\ Proposed Sec. 23.23(g)(3)(iii).
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4. Request for Comment
The Commission invites comment on all aspects of the Proposed Rule,
including its proposed approach to comparability determinations, and
specifically requests comments on the following questions. Please
explain your responses and provide alternatives to the relevant
portions of the Proposed Rule, where applicable.
(38) Please provide comments regarding the Commission's proposal
regarding its standard of review for comparability determinations.
Should the Commission limit the factors it may consider when issuing a
comparability determination?
(39) Should comparability determinations contain an element-by-
element assessment of comparability?
(40) How should the Commission address inconsistencies or conflicts
between U.S. and non-U.S. regulatory standards?
(41) How have the Commission's approaches to comparability
determinations in the Guidance and the Cross-Border Margin rule
positively and negatively impacted market practices? Please provide any
data in support of your comment.
VII. Recordkeeping
Under the Proposed Rule, a SD or MSP would be required to create a
record of its compliance with all provisions of the Proposed Rule, and
retain those records in accordance with Sec. 23.203.\349\ Registrants'
records are a fundamental element of an entity's compliance program, as
well as the Commission's oversight function. Accordingly, such records
should be sufficiently detailed to allow compliance officers and
regulators to assess compliance with the Proposed Rule.
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\349\ Proposed Sec. 23.23(h).
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VIII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\350\ The
Commission previously established definitions of ``small entities'' to
be used in evaluating the impact of its regulations on small entities
in accordance with the RFA.\351\ The Proposed Rule addresses when U.S.
persons and non-U.S. persons would be required to include their cross-
border swap dealing transactions or swap positions in their SD or MSP
registration threshold calculations, respectively,\352\ and the extent
to which SDs or MSPs would be required to comply with certain of the
Commission's regulations in connection with their cross-border swap
transactions or swap positions.\353\
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\350\ See 5 U.S.C. 601 et seq.
\351\ See 47 FR 18618 (Apr. 30, 1982) (finding that DCMs, FCMs,
commodity pool operators and large traders are not small entities
for RFA purposes).
\352\ Proposed Sec. 23.23(b)-(d).
\353\ Proposed Sec. 23.23(e).
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The Commission previously determined that SDs and MSPs are not
small entities for purposes of the RFA.\354\ The Commission believes,
based on its information about the swap market and its market
participants, that: (1) The types of entities that may engage in more
than a de minimis amount of swap dealing activity such that they would
be required to register as an SD--which generally would be large
financial institutions or other large entities--would not be ``small
entities'' for purposes of the RFA, and (2) the types of entities that
may have swap positions such that they would be required to register as
an MSP would not be ``small entities'' for purposes of the RFA. Thus,
to the extent such entities are large financial institutions or other
large entities that would be required to register as SDs or MSPs with
the Commission by virtue of their cross-
[[Page 988]]
border swap dealing transactions and swap positions, they would not be
considered small entities.\355\
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\354\ See Entities Rule, 77 FR at 30701; Registration of Swap
Dealers and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19,
2012) (noting that like FCMs, SDs will be subject to minimum capital
requirements, and are expected to be comprised of large firms, and
that MSPs should not be considered to be small entities for
essentially the same reasons that it previously had determined large
traders not to be small entities).
\355\ The SBA's Small Business Size Regulations, codified at 13
CFR 121.201, identifies (through North American Industry
Classification System codes) a small business size standard of $38.5
million or less in annual receipts for Sector 52, Subsector 523--
Securities, Commodity Contracts, and Other Financial Investments and
Related Activities. Entities that would be affected by the Proposed
Rule are generally large financial institutions or other large
entities that would be required to include their cross-border
dealing transactions or swap positions toward the SD and MSP
registration thresholds, respectively, as specified in the Proposed
Rule.
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To the extent that there are any affected small entities under the
Proposed Rule, they would need to assess how they are classified under
the Proposed Rule (i.e., U.S. person, SRS, Guaranteed Entity, and Other
Non-U.S. Person) and monitor their swap activities in order to
determine whether they are required to register as an SD under the
Proposed Rule. The Commission believes that, if the Proposed Rule is
adopted, market participants would only incur incremental costs, which
are expected to be small, in modifying their existing systems and
policies and procedures resulting from changes to the status quo made
by the Proposed Rule.\356\
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\356\ The Proposed Rule addresses the cross-border application
of the registration and certain other regulations. The Proposed Rule
would not change such regulations.
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Accordingly, for the foregoing reasons, the Commission finds that
there will not be a substantial number of small entities impacted by
the Proposed Rule. Therefore, the Chairman, on behalf of the
Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed regulations will not have a significant economic impact on a
substantial number of small entities. The Commission invites comment on
the impact of the Proposed Rule on small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \357\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA. The Proposed Rule provides for the
cross-border application of the SD and MSP registration thresholds and
the group A, group B, and group C requirements.
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\357\ 44 U.S.C. 3501 et seq.
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Proposed Sec. Sec. 23.23(b) and (c), which address the cross-
border application of the SD and MSP registration thresholds,
respectively, potentially could lead to non-U.S. persons that are
currently not registered as SDs or MSPs to exceed the relevant
registration thresholds, therefore requiring the non-U.S. persons to
register as SDs or MSPs. However, the Commission preliminarily believes
that, if adopted, the Proposed Rule will not result in any new
registered SDs or MSPs or the deregistration of registered SDs,\358\
and therefore, it does not believe an amendment to any existing
collection of information is necessary as a result of proposed
Sec. Sec. 23.23(b) and (c). Specifically, the Commission does not
believe the Proposed Rule, if adopted, would change the number of
respondents under the existing collection of information,
``Registration of Swap Dealers and Major Swap Participants,'' Office of
Management and Budget (``OMB'') Control No. 3038-0072.
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\358\ There are not currently any registered MSPs.
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Similarly, proposed Sec. 23.23(h) contains collection of
information requirements within the meaning of the PRA as it would
require that swap entities create a record of their compliance with
Sec. 23.23 and retain records in accordance with Sec. 23.203;
however, the Commission believes that records suitable to demonstrate
compliance are already required to be created and maintained under the
collections related to the Commission's swap entity registration, group
B, and group C requirements. Specifically, existing collections of
information, ``Confirmation, Portfolio Reconciliation, and Portfolio
Compression Requirements for Swap Dealers and Major Swap
Participants,'' OMB Control No. 3038-0068; ``Registration of Swap
Dealers and Major Swap Participants,'' OMB Control No. 3038-0072;
``Swap Dealer and Major Swap Participant Conflicts of Interest and
Business Conduct Standards with Counterparties,'' OMB Control No. 3038-
0079; ``Confirmation, Portfolio Reconciliation, Portfolio Compression,
and Swap Trading Relationship Documentation Requirements for Swap
Dealers and Major Swap Participants,'' OMB Control No. 3038-0083;
``Reporting, Recordkeeping, and Daily Trading Records Requirements for
Swap Dealers and Major Participants,'' OMB Control No. 3038-0087; and
``Confirmation, Portfolio Reconciliation, Portfolio Compression, and
Swap Trading Relationship Documentation Requirements for Swap Dealers
and Major Swap Participants,'' OMB Control No. 3038-0088 relate to
these requirements.\359\ Accordingly, the Commission is not submitting
to OMB an information collection request to create a new information
collection in relation to proposed Sec. 23.23(h).
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\359\ To the extent a swap entity avails itself of an exception
from a group B or group C requirement under the Proposed Rule and,
thus, is no longer required to comply with the relevant group B and/
or group C requirements and related paperwork burdens, the
Commission expects the paperwork burden related to that exception
would be less than that of the corresponding requirement(s).
However, in an effort to be conservative, because the Commission
does not know how many swap entities will choose to avail themselves
of the exceptions and for how many foreign-based swaps, the
Commission is not changing the burden of its related collections to
reflect the availability of such exceptions.
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Proposed Sec. 23.23(g) would result in collection of information
requirements within the meaning of the PRA, as discussed below. The
Proposed Rule contains collections of information for which the
Commission has not previously received control numbers from the Office
of Management and Budget (``OMB''). If adopted, responses to this
collection of information would be required to obtain or retain
benefits. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The Commission has submitted to OMB
an information collection request to create a new information
collection under OMB control number 3038-0072 (Registration of Swap
Dealers and Major Swap Participants) for the collections contained in
the Proposed Rule.
As discussed in section VI.C above, the Commission is proposing to
permit a non-U.S. swap entity or foreign branch of a U.S. swap entity
to comply with a foreign jurisdiction's swap standards in lieu of the
Commission's corresponding group A and group B requirements in certain
cases, provided that the Commission determines that such foreign
standards are comparable to the Commission's requirements. Proposed
Sec. 23.23(g) would implement a process pursuant to which the
Commission would conduct these comparability determinations, including
outlining procedures for initiating such determinations. As discussed
in section VI.D above, a comparability determination could be requested
by swap entities that are eligible for substituted compliance, their
trade associations, and foreign regulatory authorities meeting certain
requirements.\360\ Applicants seeking a comparability determination
would be required to furnish certain information to the Commission that
provides a comprehensive explanation of the foreign jurisdiction's
relevant swap standards, including how they might
[[Page 989]]
differ from the corresponding requirements in the CEA and Commission
regulations and how, notwithstanding such differences, the foreign
jurisdiction's swap standards achieve comparable outcomes to those of
the Commission.\361\ The information collection would be necessary for
the Commission to consider whether the foreign jurisdiction's relevant
swap standards are comparable to the Commission's requirements.
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\360\ Proposed Sec. 23.23(g)(2).
\361\ Proposed Sec. 23.23(g)(3).
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Though under the Proposed Rule many entities would be eligible to
request a comparability determination,\362\ the Commission expects to
receive far fewer requests because once a comparability determination
is made for a jurisdiction it would apply for all entities or
transactions in that jurisdiction to the extent provided in the
Commission's determination. Further, the Commission has already issued
comparability determinations under the Guidance for certain of the
Commission's requirements for Australia, Canada, the European Union,
Hong Kong, Japan, and Switzerland,\363\ and the effectiveness of those
determinations would not be affected by the Proposed Rule.
Nevertheless, in an effort to be conservative in its estimate for
purposes of the PRA, the Commission estimates that, if the Proposed
Rule is adopted, it will receive a request for a comparability
determination in relation to five (5) jurisdictions per year. Further,
based on the Commission's experience in issuing comparability
determinations, the Commission estimates that each request would impose
an average of 40 burden hours, for an aggregate estimated hour burden
of 200 hours. Accordingly, the proposed changes would result in an
increase to the current burden estimates of OMB control number 3038-
0072 by 5 in the number of submissions and 200 burden hours.
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\362\ Currently, there are approximately 107 swap entities
provisionally registered with the Commission, many of which may be
eligible to apply for a comparability determination as a non-U.S.
swap entity or a foreign branch. Additionally, a trade association,
whose members include swap entities, and certain foreign regulators
may also apply for a comparability determination.
\363\ See supra note 142 and 337.
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The frequency of responses and total new burden associated with OMB
control number 3038-0072, in the aggregate, reflecting the new burden
associated with all the amendments proposed by the rulemaking and
current burden not affected by this rulemaking,\364\ is as follows:
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\364\ The numbers below reflect the current burden for two
separate information collections that are not affected by this
rulemaking.
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Estimated annual number of respondents: 770.
Estimated aggregate annual burden hours per respondent: 1.13 hours.
Estimated aggregate annual burden hours for all respondents: 872.
Frequency of responses: As needed.
Information Collection Comments. The Commission invites the public
and other Federal agencies to comment on any aspect of the proposed
information collection requirements discussed above, including, without
limitation, the Commission's discussion of the estimated burden of the
collection of information requirements in Sec. 23.23(h). Pursuant to
44 U.S.C. 3506(c)(2)(B), the Commission solicits comments in order to:
(1) Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have practical
utility; (2) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information; (3) determine whether
there are ways to enhance the quality, utility, and clarity of the
information to be collected; and (4) minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566, or by email at
[email protected]. Please provide the Commission with a copy
of submitted comments so that all comments can be summarized and
addressed in the final rule preamble. Refer to the ADDRESSES section of
this notice for comment submission instructions to the Commission. A
copy of the supporting statements for the collection of information
discussed above may be obtained by visiting RegInfo.gov. OMB is
required to make a decision concerning the collection of information
between 30 and 60 days after publication of this document in the
Federal Register. Therefore, a comment is best assured of having its
full effect if OMB receives it within 30 days of publication.
C. Cost-Benefit Considerations
As detailed above, the Commission is proposing rules that would
define certain key terms for purposes of certain Dodd-Frank Act swap
provisions and address the cross-border application of the SD and MSP
registration thresholds and the Commission's group A, group B, and
group C requirements.
The baseline against which the costs and benefits of the Proposed
Rule are considered is, in principle, current law: In other words,
applicable Dodd-Frank Act swap provisions in the CEA and regulations
promulgated by the Commission to date, as made applicable to cross-
border transactions by Congress in CEA section 2(i), in the absence of
a Commission rule establishing more precisely the application of that
provision in particular situations. However, in practice, use of this
baseline poses important challenges, for a number of reasons.
First, there are intrinsic difficulties in sorting out costs and
benefits of the Proposed Rule from costs and benefits intrinsic to the
application of Dodd-Frank Act requirements to cross-border transactions
directly pursuant to section 2(i), given that statute sets forth
general principles for the cross-border application of Dodd-Frank Act
swap requirements but does not attempt to address particular business
situations in detail.
Second, the Guidance established a general, non-binding framework
for the cross-border application of many substantive Dodd-Frank Act
requirements. In doing so, the Guidance considered, among other
factors, the regulatory objectives of the Dodd-Frank Act and principles
of international comity. As is apparent from the text of the Proposed
Rule and the discussion in this preamble, the Proposed Rule is in
certain respects consistent with the Guidance. The Commission
understands that, while the Guidance is non-binding, many market
participants have developed policies and practices that take into
account the views expressed therein. At the same time, some market
participants may currently apply CEA section 2(i), the regulatory
objectives of the Dodd-Frank Act, and principles of international
comity in ways that vary from the Guidance, for example because of
circumstances not contemplated by the general, non-binding framework in
the Guidance.
Third, in addition to the Guidance, the Commission has issued
comparability determinations finding that certain provisions of the
laws and regulations of other jurisdictions are comparable in outcome
to certain requirements under the CEA and regulations thereunder.\365\
In general,
[[Page 990]]
under these determinations, a market participant that complies with the
specified provisions of the other jurisdiction would also be deemed to
be in compliance with Commission regulations, subject to certain
conditions.\366\
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\365\ See supra notes 142 and 337.
\366\ See id.
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Fourth, the Commission staff has issued several interpretive and
no-action letters that are relevant to cross-border issues.\367\ As
with the Guidance, the Commission recognizes that many market
participants have relied on these staff letters in framing their
business practices.
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\367\ See, e.g., CFTC Letter No. 13-64, No-Action Relief:
Certain Swaps by Non-U.S. Persons that are Not Guaranteed or Conduit
Affiliates of a U.S. Person Not to be Considered in Calculating
Aggregate Gross Notional Amount for Purposes of Swap Dealer De
Minimis Exception (Oct. 17, 2013), available at https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-64.pdf; ANE Staff Advisory; ANE No-Action Relief; and CFTC Staff
Letter No. 18-13.
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Fifth, as noted above, the international regulatory landscape is
far different now than it was when the Dodd-Frank Act was enacted in
2010.\368\ Even in 2013, when the CFTC published the Guidance, very few
jurisdictions had made significant progress in implementing the global
swap reforms that were agreed to by the G20 leaders at the Pittsburgh
G20 Summit. Today, however, as a result of cumulative implementation
efforts by regulators throughout the world, significant and substantial
progress has been made in the world's primary swap trading
jurisdictions to implement the G20 commitments. For these reasons, the
actual costs and benefits of the Proposed Rule that would be
experienced by a particular market participant may vary depending on
the jurisdictions in which the market participant is active and when
the market participant took steps to comply with various legal
requirements.
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\368\ See supra section I.B.
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Because of these complicating factors, as well as limitations on
available information, the Commission believes that a direct comparison
of the costs and benefits of the Proposed Rule with those of a
hypothetical cross-border regime based directly on section 2(i)--while
theoretically the ideal approach--is infeasible in practice. As a
further complication, the Commission recognizes that the Proposed
Rule's costs and benefits would exist, regardless of whether a market
participant: (1) First realized some of those costs and benefits when
it conformed its business practices to provisions of the Guidance or
Commission staff action that would now become binding legal
requirements under the Proposed Rule; (2) does so now for the first
time; or (3) did so in stages as international requirements evolved.
In light of these considerations, the Commission will consider
costs and benefits by focusing primarily on two types of information
and analysis.
First, the Commission will compare the Proposed Rule with current
business practice, on the understanding that many market participants
are now conducting business taking into account the Guidance,
applicable CFTC staff letters, and existing comparability
determinations. This approach will, for example, compare expected costs
and benefits of conducting business under the Proposed Rule with those
of conducting business in conformance with analogous provisions of the
Guidance. In effect, this inquiry will examine new costs and benefits
that would result from the Proposed Rule for market participants that
are currently following the relevant Dodd-Frank Act swap provisions and
regulations thereunder, the Guidance, the comparability determinations,
and applicable staff letters. This is referred to as ``Baseline A.''
Second, to the extent feasible, the Commission will consider
relevant information on costs and benefits that industry has incurred
to date in complying with the Dodd-Frank Act in cross-border
transactions of the type that would be affected by the Proposed Rule.
In light of the overlap in the subjects addressed by the Guidance and
the Proposed Rule, this will include consideration of costs and
benefits that have been generated where market participants have chosen
to conform their business practices to the Guidance in areas relevant
to the Proposed Rule. This second form of inquiry is, to some extent,
over inclusive in that it is likely to capture some costs and benefits
that flow directly from Congress's enactment of section 2(i) of the CEA
or that otherwise are not strictly attributable to the Proposed Rule.
However, since a theoretically perfect baseline for consideration of
costs and benefits does not appear feasible, this second form of
inquiry will help ensure that costs and benefits of the Proposed Rules
are considered as fully as possible. This is referred to as ``Baseline
B.''
The Commission invites comments regarding all aspects of the
baselines applied in this consideration of costs and benefits. In
particular, the Commission would like commenters to address any
variances or different circumstances they have experienced that affect
the baseline for those commenters. Please be as specific as possible
and include quantitative information where available.
The costs associated with the key elements of the Commission's
proposed cross-border approach to the SD and MSP registration
thresholds--requiring market participants to classify themselves as
U.S. persons, Guaranteed Entities, or SRSs \369\ and to apply the rules
accordingly--fall into a few categories. Market participants would
incur costs determining which category of market participant they and
their counterparties fall into (``assessment costs''), tracking their
swap activities or positions to determine whether they should be
included in their registration threshold calculations (``monitoring
costs''), and, to the degree that their activities or positions exceed
the relevant threshold, registering with the Commission as an SD or MSP
(``registration costs'').
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\369\ Proposed Sec. 23.23(a).
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Entities required to register as SDs or MSPs as a result of the
Proposed Rule would also incur costs associated with complying with the
relevant Dodd-Frank Act requirements applicable to registrants, such as
the capital (when promulgated), margin, and business conduct
requirements (``programmatic costs'').\370\ While only new registrants
would be assuming these programmatic costs for the first time, the
obligations of entities that are already registered as SDs may also
change in the future as an indirect consequence of the Proposed Rule.
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\370\ The Commission's discussion of programmatic costs and
registration costs does not address MSPs. No entities are currently
registered as MSPs, and the Commission does not expect that this
status quo would change as a result of the Proposed Rule being
adopted given the general similarities between the Proposed Rule's
approach to the MSP registration threshold calculations and the
Guidance.
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In developing the Proposed Rule, the Commission took into account
the potential for creating or accentuating competitive disparities
between market participants, which could contribute to market
deficiencies, including market fragmentation or decreased liquidity, as
more fully discussed below. Notably, competitive disparities may arise
between U.S.-based financial groups and non-U.S. based financial groups
as a result of differences in how the SD and MSP registration
thresholds apply to the various classifications of market participants.
For instance, an SRS must count all dealing swaps toward its SD de
minimis calculation. Therefore, SRSs would be more likely to trigger
the SD registration threshold relative to Other Non-U.S. Persons, and
may therefore be at a competitive disadvantage compared
[[Page 991]]
to Other Non-U.S. Persons when trading with non-U.S. persons, as non-
U.S. persons may prefer to trade with non-registrants in order to avoid
application of the Dodd-Frank Act swap regime.\371\ On the other hand,
the Commission notes that certain counterparties may prefer to enter
into swaps with SDs and MSPs that are subject to the robust
requirements of the Dodd-Frank Act.
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\371\ Dodd-Frank Act swap requirements may impose significant
direct costs on participants falling within the SD or MSP
definitions that are not borne by other market participants,
including costs related to capital and margin requirements and
business conduct requirements. To the extent that foreign
jurisdictions adopt comparable requirements, these costs would be
mitigated.
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Other factors also create inherent challenges associated with
attempting to assess costs and benefits of the Proposed Rule. To avoid
the prospect of being regulated as an SD or MSP, or otherwise falling
within the Dodd-Frank Act swap regime, some market participants may
restructure their businesses or take other steps (e.g., limiting their
counterparties to Other Non-U.S. Persons) to avoid exceeding the
relevant registration thresholds. The degree of comparability between
the approaches adopted by the Commission and foreign jurisdictions and
the potential availability of substituted compliance, whereby a market
participant may comply with certain Dodd-Frank Act SD or MSP
requirements by complying with a comparable requirement of a foreign
financial regulator, may also affect the competitive impact of the
Proposed Rule. The Commission expects that such impacts would be
mitigated as the Commission continues to work with foreign and domestic
regulators to achieve international harmonization and cooperation.
In the sections that follow, the Commission discusses the costs and
benefits associated with the Proposed Rule.\372\ Section 1 begins by
addressing the assessment costs associated with the Proposed Rule,
which derive in part from the defined terms used in the Proposed Rule
(e.g., the proposed definitions of ``U.S. person,'' ``significant risk
subsidiary,'' and ``guarantee''). Sections 2 and 3 consider the costs
and benefits associated with the Proposed Rule's determinations
regarding how each classification of market participants apply to the
SD and MSP registration thresholds, respectively. Sections 4, 5, and 6
address the monitoring, registration, and programmatic costs associated
with the proposed cross-border approach to the SD (and, as appropriate,
MSP) registration thresholds, respectively. Section 7 addresses the
costs and benefits associated with the Proposed Rule's exceptions from,
and available substituted compliance for, the group A, group B, and
group C requirements, as well as comparability determinations. Section
8 addresses the costs associated with the Proposed Rule's recordkeeping
requirements. Section 9 discusses the factors established in section
15(a) of the CEA.
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\372\ The Commission endeavors to assess the expected costs and
benefits of proposed rules in quantitative terms where possible.
Where estimation or quantification is not feasible, the Commission
provides its discussion in qualitative terms. Given a general lack
of relevant data, the Commission's analysis in the Proposed Rule is
generally provided in qualitative terms.
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The Commission invites comment regarding the nature and extent of
any costs and benefits that could result from adoption of the Proposed
Rule and, to the extent they can be quantified, monetary and other
estimates thereof.
1. Assessment Costs
As discussed above, in applying the proposed cross-border approach
to the SD and MSP registration thresholds, market participants would be
required to first classify themselves as a U.S. person, an SRS, a
Guaranteed Entity, or an Other Non-U.S. Person.
With respect to Baseline A, the Commission expects that the costs
to affected market participants of assessing which classification they
fall into would generally be small and incremental. In most cases, the
Commission believes an entity will have performed an initial
determination or assessment of its status under either the Cross-Border
Margin Rule (which uses substantially similar definitions of ``U.S.
person'' and ``guarantee'') or the Guidance (which interprets ``U.S.
person'' in a manner that is similar but not identical to the proposed
definition of ``U.S. person''). Additionally, the Proposed Rule would
allow market participants to rely on representations from their
counterparties with regard to their classifications.\373\ However, the
Commission acknowledges that swap entities would have to modify their
existing operations to accommodate the new concept of an SRS.
Specifically, market participants would need to determine whether they
or their counterparties qualify as SRSs. Further, in order to rely on
certain exclusions outlined in the Proposed Rule, swap entities would
need to obtain annual representations regarding a counterparty's status
as an SRS.
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\373\ The Commission believes that these assessment costs for
the most part have already been incurred by potential SDs and MSPs
as a result of adopting policies and procedures under the Guidance
and Cross-Border Margin Rule (which had similar classifications),
both of which permitted counterparty representations. See Guidance,
78 FR at 45315; Cross-Border Margin Rule, 81 FR at 34827.
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With respect to Baseline B, wherein only certain market
participants would have previously determined their status under the
similar, but not identical, Cross-Border Margin Rule (and not the
Guidance), the Commission believes that their assessment costs would
nonetheless be small as a result of the Proposed Rule's reliance on
clear, objective definitions of the terms ``U.S. person,''
``substantial risk subsidiary,'' and ``guarantee.'' Further, with
respect to the determination of whether a market participant falls
within the ``significant risk subsidiary'' definition,\374\ the
Commission believes that assessment costs would be small as the
definition relies, in part, on a familiar consolidation test already
used by affected market participants in preparing their financial
statements under U.S. GAAP. Further, the Commission notes that only
those market participants with an ultimate U.S. parent entity that has
more than $50 billion in global consolidated assets and that do not
fall into one of the exceptions in proposed Sec. 23.23(a)(12)(i) or
(ii) would need to consider if they are an SRS.
---------------------------------------------------------------------------
\374\ The ``substantial risk subsidiary'' definition is
discussed further in section II.C.
---------------------------------------------------------------------------
Additionally, the Proposed Rule relies on the definition of
``guarantee'' provided in the Cross-Border Margin Rule, which is
limited to arrangements in which one party to a swap has rights of
recourse against a guarantor with respect to its counterparty's
obligations under the swap.\375\ Although non-U.S. persons would need
to know whether they are Guaranteed Entities with respect to the
relevant swap on a swap-by-swap basis for purposes of the SD and MSP
registration calculations, the Commission believes that this
information would already be known by non-U.S. persons.\376\
Accordingly, with respect to both baselines, the Commission believes
that the costs associated with assessing whether an entity or its
counterparty is a Guaranteed Entity would be small and incremental.
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\375\ See supra section II.B.
\376\ Because a guarantee has a significant effect on pricing
terms and on recourse in the event of a counterparty default, the
Commission believes that the guarantee would already be in existence
and that a non-U.S. person therefore would have knowledge of its
existence before entering into a swap.
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[[Page 992]]
2. Cross-Border Application of the SD Registration Threshold
(i) U.S. Persons, Guaranteed Entities, and SRSs
Under the Proposed Rule, a U.S. person would include all of its
swap dealing transactions in its de minimis calculation, without
exception.\377\ As discussed above, that would include any swap dealing
transactions conducted through a U.S. person's foreign branch, as such
swaps are directly attributed to, and therefore impact, the U.S.
person. Given that this requirement mirrors the Guidance in this
respect, the Commission believes that the Proposed Rule would have a
minimal impact on the status quo with regard to the number of
registered or potential U.S. SDs, as measured against Baseline A.\378\
With respect to Baseline B, all U.S. persons would have included all of
their transactions in its de minimis calculation, even absent the
Guidance, pursuant to paragraph (4) of the SD definition.\379\ However,
the Commission acknowledges that, absent the Guidance, some U.S.
persons may not have interpreted CEA section 2(i) to require them to
include swap dealing transactions conducted through their foreign
branches in their de minimis calculation. Accordingly, with respect to
Baseline B, the Commission expects that some U.S. persons may incur
some incremental costs as a result of having to count swaps conducted
through their foreign branches.
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\377\ Proposed Sec. 23.23(b)(1).
\378\ The Commission is not estimating the number of new U.S.
SDs, as the methodology for including swaps in a U.S. person's SD
registration calculation does not diverge from the approach included
in the Guidance (i.e., a U.S. person must include all of its swap
dealing transactions in its de minimis threshold calculation).
Further, the Commission does not expect a change in the number of
SDs would result from the Proposed Rule's definition of U.S. person
and therefore assumes that no additional entities would register as
U.S. SDs, and no existing SD registrants would deregister as a
result of the Proposed Rule, if adopted.
\379\ See 17 CFR 1.3, Swap dealer, paragraph (4).
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The Proposed Rule would also require Guaranteed Entities to include
all of their dealing transactions in their de minimis threshold
calculation without exception.\380\ This approach, which recognizes
that a Guaranteed Entity's swap dealing transactions may have the same
potential to impact the U.S. financial system as a U.S. person's
dealing transactions, closely parallels the approach taken in the
Guidance with respect to the treatment of the swaps of ``guaranteed
affiliates.'' \381\ Given that the Proposed Rule would establish a more
limited definition of ``guarantee'' as compared to the Guidance, and a
similar definition of guarantee as compared to the Cross-Border Margin
Rule, the Commission does not expect that the Proposed Rule would cause
more Guaranteed Entities to register with the Commission. Accordingly,
the Commission believes that, in this respect, any increase in costs
associated with the Proposed Rule, with respect to Baselines A and B,
would be small.
---------------------------------------------------------------------------
\380\ Proposed Sec. 23.23(b)(2)(ii).
\381\ While the Proposed Rule and the Guidance treat swaps
involving Guaranteed Entities in a similar manner, they have
different definitions of the term ``guarantee.'' Under the Guidance,
a ``guaranteed affiliate'' would generally include all swap dealing
activities in its de minimis threshold calculation without
exception. The Guidance interpreted ``guarantee'' to generally
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.'' See Guidance, 78 FR at 45320. In contrast, the term
``guarantee'' in the Proposed Rule has the same meaning as defined
in Sec. 23.160(a)(2) (cross-border application of the Commission's
margin requirements for uncleared swaps), except that application of
the proposed definition of ``guarantee'' would not be limited to
uncleared swaps. See supra section II.B.
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Under the Proposed Rule, an SRS would include all swap dealing
transactions in its de minimis threshold calculation.\382\ Given that
the concept of an SRS was not included in the Guidance or the Cross-
Border Margin Rule, the Commission believes that this aspect of the
Proposed Rule would have a similar impact on market participants when
measured against Baseline A and Baseline B. Under the Guidance, an SRS
would likely have been categorized as either a conduit affiliate (which
would have been required to count all dealing swaps towards its de
minimis threshold calculation) or an Other Non-U.S. Person (which would
have been required to count only a subset of its dealing swaps towards
its de minimis threshold calculation). Accordingly, under the Proposed
Rule, there may be some SRSs that would have to count more swaps
towards their de minimis threshold calculation than would have been
required under the Guidance.
---------------------------------------------------------------------------
\382\ Proposed Sec. 23.23(b)(1).
---------------------------------------------------------------------------
However, as noted in sections II.C and III.B, the Commission
believes that it would be appropriate to distinguish SRSs from Other
Non-U.S. Persons in determining the cross-border application of the SD
de minimis threshold to such entities. As discussed above, SRS, as a
class of entities, presents a greater supervisory interest to the CFTC
relative to an Other Non-U.S. Person, due to the nature and extent of
the their relationships with their ultimate U.S. parent entities. Of
the 60 non-U.S. SDs that were provisionally registered with the
Commission as of December 2019, the Commission believes that few, if
any, would be classified as SRSs pursuant to the Proposed Rule. With
respect to Baseline A, the Commission notes that any potential SRSs
would have likely classified themselves as conduit affiliates or Other
Non-U.S. Persons pursuant to the Guidance. Accordingly, some may incur
incremental costs associated with assessing and implementing the
additional counting requirements for SRSs. With respect to Baseline B,
the Commission believes that most potential SRSs would have interpreted
section 2(i) to require them to count their dealing swaps with U.S.
persons, but acknowledges that some may not have interpreted section
2(i) so as to require them to count swaps with non-U.S. persons toward
their de minimis calculation. Accordingly, such non-U.S. persons would
incur the incremental costs of associated with the additional SRS
counting requirements contained in the Proposed Rule. The Commission
believes that the proposed SRS de minimis calculation requirements
would prevent regulatory arbitrage by ensuring that certain entities do
not simply book swaps through a non-U.S. affiliate to avoid CFTC
registration. Accordingly, the Commission believes that such provisions
would benefit the swap market by ensuring that the Dodd-Frank Act swap
provisions addressed by the Proposed Rule are applied specifically to
entities whose activities, in the aggregate, have a direct and
significant connection to, and impact on, U.S. commerce.
(ii) Other Non-U.S. Persons
Under the Proposed Rule, non-U.S. persons that are neither
Guaranteed Entities nor SRSs would be required to include in their de
minimis threshold calculations swap dealing activities with U.S.
persons (other than swaps conducted through a foreign branch of a
registered SD) and certain swaps with Guaranteed Entities.\383\ The
Proposed Rule would not, however, require Other Non-U.S. Persons to
include swap dealing transactions with SRSs or Other Non-U.S. Persons.
Additionally, Other Non-U.S. Persons would not be required to include
in their de minimis calculation any transaction that is executed
anonymously on a DCM, registered or exempt SEF, or registered FBOT, and
cleared.
---------------------------------------------------------------------------
\383\ Proposed Sec. 23.23(b)(2).
---------------------------------------------------------------------------
The Commission believes that requiring all non-U.S. persons to
[[Page 993]]
include their swap dealing transactions with U.S. persons in their de
minimis calculations is necessary to advance the goals of the Dodd-
Frank Act SD registration regime, which focuses on U.S. market
participants and the U.S. market. As discussed above, the Commission
believes it is appropriate to allow Other Non-U.S. Persons to exclude
swaps conducted through a foreign branch of a registered SD because,
generally, such swaps would be subject to Dodd-Frank Act transactional
requirements and, therefore, would not evade the Dodd-Frank Act regime.
Given that these requirements are consistent with the Guidance in
most respects, the Commission believes that the Proposed Rule would
have a negligible impact on Other Non-U.S. Persons, as measured against
Baseline A. With respect to Baseline B, the Commission believes that
most non-U.S. persons would have interpreted CEA section 2(i) to
require them to count their dealing swaps with U.S. persons, but
acknowledges that some non-U.S. persons may not have interpreted 2(i)
so as to require them to count such swaps with non-U.S. persons toward
their de minimis calculation. Accordingly, such non-U.S. persons would
incur the incremental costs associated with the counting requirements
for Other Non-U.S. Persons contained in the Proposed Rule.
The Commission recognizes that the Proposed Rule's cross-border
approach to the de minimis threshold calculation could contribute to
competitive disparities arising between U.S.-based financial groups and
non-U.S. based financial groups. Potential SDs that are U.S. persons,
SRSs, or Guaranteed Entities would be required to include all of their
swap dealing transactions in their de minimis threshold calculations.
In contrast, Other Non-U.S. Persons would be permitted to exclude
certain dealing transactions from their de minimis calculations. As a
result, Guaranteed Entities and SRSs may be at a competitive
disadvantage, as more of their swap activity would apply toward the de
minimis threshold (and thereby trigger SD registration) relative to
Other Non-U.S. Persons.\384\ While the Commission does not believe that
any additional Other Non-U.S. Persons would be required to register as
a SD under the Proposed Rule, the Commission acknowledges that to the
extent that one does, its non-U.S. person counterparties (clients and
dealers) may possibly cease transacting with it in order to operate
outside the Dodd-Frank Act swap regime.\385\ Additionally, unregistered
non-U.S. dealers may be able to offer swaps on more favorable terms to
non-U.S. persons than their registered competitors because they are not
required to incur the costs associated with CFTC registration.\386\ As
noted above, however, the Commission believes that these competitive
disparities would be mitigated to the extent that foreign jurisdictions
impose comparable requirements. Given that the Commission has found
many foreign jurisdictions comparable with respect to various aspects
of the Dodd-Frank Act swap requirements, the Commission believes that
such competitive disparities would be negligible.\387\ Further, as
discussed below, the Commission is proposing to adopt a flexible
standard of review for comparability determinations relating to the
group B and group C requirements that would be issued pursuant to the
Proposed Rule, which would serve to further mitigate any competitive
disparities arising out of disparate regulatory regimes. Finally, the
Commission reiterates its belief that the cross-border approach to the
SD registration threshold taken in the Proposed Rule is appropriately
tailored to further the policy objectives of the Dodd-Frank Act while
mitigating unnecessary burdens and disruption to market practices to
the extent possible.
---------------------------------------------------------------------------
\384\ On the other hand, as noted above, the Commission
acknowledges that some market participants may prefer to enter into
swaps with counterparties that are subject to the swaps provisions
adopted pursuant to the Dodd-Frank Act. Further, Guaranteed Entities
and SRSs may enjoy other competitive advantages due to the support
of their guarantor or ultimate U.S. parent entity.
\385\ Additionally, some unregistered dealers may opt to
withdraw from the market, thereby contracting the number of dealers
competing in the swaps market, which may have an adverse effect on
competition and liquidity.
\386\ These non-U.S. dealers also may be able to offer swaps on
more favorable terms to U.S. persons, giving them a competitive
advantage over U.S. competitors with respect to U.S. counterparties.
\387\ See supra notes 142 and 337.
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3. Cross-Border Application of the MSP Registration Thresholds
(i) U.S. Persons, Guaranteed Entities, and SRSs
The Proposed Rule's approach to the cross-border application of the
MSP registration threshold closely mirrors the proposed approach for
the SD registration threshold. Under the Proposed Rule, a U.S. person
would include all of its swap positions in its MSP threshold, without
exception.\388\ As discussed above, that would include any swap
conducted through a U.S. person's foreign branch, as such swaps are
directly attributed to, and therefore impact, the U.S. person. Given
that this requirement is consistent with the Guidance in this respect,
the Commission believes that the Proposed Rule would have a minimal
impact on the status quo with regard to the number of potential U.S
MSPs, as measured against Baseline A. With respect to Baseline B, all
of a U.S. person's swap positions would apply toward the MSP threshold
calculation, even absent the Guidance, pursuant to paragraph (6) of the
MSP definition.\389\ However, the Commission acknowledges that, absent
the Guidance, some U.S. persons may not have interpreted CEA section
2(i) to require them to include swaps conducted through their foreign
branches in their MSP threshold calculation. Accordingly, with respect
to Baseline B, the Commission expects that some U.S. persons may incur
incremental costs as a result of having to count swaps conducted
through their foreign branches.
---------------------------------------------------------------------------
\388\ Proposed Sec. 23.23(c)(1).
\389\ 17 CFR 1.3, Major swap participant, paragraph (6).
---------------------------------------------------------------------------
The Proposed Rule would also require Guaranteed Entities to include
all of their swap positions in their MSP threshold calculation without
exception.\390\ This approach, which recognizes that such swap
transactions may have the same potential to impact the U.S. financial
system as a U.S. person's swap positions, closely parallels the
approach taken in the Guidance with respect to ``conduit affiliates''
and ``guaranteed affiliates.'' \391\ The Commission believes that few,
if any, additional MSPs would qualify as Guaranteed Entities pursuant
to the Proposed Rule, as compared to Baseline A. Accordingly, the
Commission believes that, in this respect, any increase in costs
associated with the Proposed Rule would be small.
---------------------------------------------------------------------------
\390\ Proposed Sec. 23.23(c)(2)(ii).
\391\ See Guidance, 78 FR at 45319-20.
---------------------------------------------------------------------------
Under the Proposed Rule, an SRS would also include all of its swap
positions in its MSP threshold calculation.\392\ Under the Guidance, an
SRS would likely have been categorized as either a conduit affiliate
(which would have been required to count all its swap positions towards
its MSP threshold calculation) or an Other Non-U.S. Person (which would
have been required to count only a subset of its swap positions towards
its MSP threshold calculation). Unlike an Other Non-U.S. Person, SRSs
would additionally be required to include in
[[Page 994]]
their de minimis calculation any transaction that is executed
anonymously on a DCM, registered or exempt SEF, or registered FBOT, and
cleared.
---------------------------------------------------------------------------
\392\ Proposed Sec. 23.23(c)(1).
---------------------------------------------------------------------------
As noted in sections II.C and IV.B, the Commission believes that it
would be appropriate to distinguish SRSs from Other Non-U.S. Persons in
determining the cross-border application of the MSP threshold to such
entities, as well as with respect to the Dodd-Frank Act swap provisions
addressed by the Proposed Rule more generally. As discussed above,
SRSs, as a class of entities, present a greater supervisory interest to
the CFTC relative to Other Non-U.S. Persons, due to the nature and
extent of the their relationships with their ultimate U.S. parent
entities. Therefore, the Commission believes that it is appropriate to
require SRSs to include more of their swap positions in their MSP
threshold calculation than Other Non-U.S. Persons would. Additionally,
allowing an SRS to exclude all of its non-U.S. swap positions from its
calculation could incentivize U.S. financial groups to book their non-
U.S. positions into a non-U.S. subsidiary to avoid MSP registration
requirements. Given that this requirement was not included in the
Guidance or the Cross-Border Margin Rule, the Commission believes that
this aspect of the Proposed Rule would have a similar impact on market
participants when measured against Baseline A and Baseline B. The
Commission notes that there are no MSPs registered with the Commission,
and expects that few entities would be required to undertake an
assessment to determine whether they would qualify as an MSP under the
Proposed Rule. Any such entities would likely have classified
themselves as Other Non-U.S. Persons pursuant to the Guidance.
Accordingly, they may incur incremental costs associated with assessing
and implementing the additional counting requirements for SRSs. With
respect to Baseline B, the Commission believes that most potential SRSs
would have interpreted CEA section 2(i) to require them to count their
swap positions with U.S. persons, but acknowledges that some may not
have interpreted CEA section 2(i) so as to require them to count swap
positions with non-U.S. persons toward their MSP threshold calculation.
Accordingly, such SRSs would incur the incremental costs associated
with the additional SRS counting requirements contained in the Proposed
Rule. The Commission believes that these proposed SRS calculation
requirements would mitigate regulatory arbitrage by ensuring that U.S.
entities do not simply book swaps through an SRS affiliate to avoid
CFTC registration. Accordingly, the Commission believes that such
provisions would benefit the swap market by ensuring that the Dodd-
Frank Act swap requirements that are addressed by the Proposed Rule are
applied to entities whose activities have a direct and significant
connection to, and impact on, the U.S. markets.
(ii) Other Non-U.S. Persons
Under the Proposed Rule, Other Non-U.S. Persons would be required
to include in their MSP calculations swap positions with U.S. persons
(other than swaps conducted through a foreign branch of a registered
SD) and certain swaps with Guaranteed Entities.\393\ The Proposed Rule
would not, however, require Other Non-U.S. Persons to include swap
positions with SRSs or Other Non-U.S. Persons. Additionally, Other Non-
U.S. Persons would not be required to include in their MSP threshold
calculation any transaction that is executed anonymously on a DCM, a
registered or exempt SEF, or registered FBOT, and cleared.\394\
---------------------------------------------------------------------------
\393\ Proposed Sec. 23.23(c)(2).
\394\ Proposed Sec. 23.23(d).
---------------------------------------------------------------------------
Given that these requirements are consistent with the Guidance in
most respects, the Commission believes that the Proposed Rule would
have a minimal impact on Other Non-U.S. Persons, as measured against
Baseline A. With respect to Baseline B, the Commission believes that
most non-U.S. persons would have interpreted CEA section 2(i) to
require them to count their swap positions with U.S. persons, but
acknowledges that some non-U.S. persons may not have interpreted CEA
section 2(i) so as to require them to count swaps with non-U.S. persons
toward their MSP threshold calculation. Accordingly, such non-U.S.
persons would incur the incremental costs of associated with the
counting requirements for Other Non-U.S. Persons contained in the
Proposed Rule.
The Commission recognizes that the Proposed Rule's cross-border
approach to the MSP threshold calculation could contribute to
competitive disparities arising between U.S.-based financial groups and
non-U.S. based financial groups. Potential MSPs that are U.S. persons,
SRSs, or Guaranteed Entities would be required to include all of their
swap positions. In contrast, Other Non-U.S. Persons would be permitted
to exclude certain swap positions from their MSP threshold
calculations. As a result, SRSs and Guaranteed Entities may be at a
competitive disadvantage, as more of their swap activity would apply
toward the MSP calculation and trigger MSP registration relative to
Other Non-U.S. Persons. While the Commission does not believe that any
additional Other Non-U.S. Persons would be required to register as an
MSP under the Proposed Rule, the Commission acknowledges that to the
extent that a currently unregistered non-U.S. person would be required
to register as an MSP under the Proposed Rule, its non-U.S. persons may
possibly cease transacting with it in order to operate outside the
Dodd-Frank Act swap regime.\395\ Additionally, unregistered non-U.S.
persons may be able to enter into swaps on more favorable terms to non-
U.S. persons than their registered competitors because they are not
required to incur the costs associated with CFTC registration.\396\ As
noted above, however, the Commission believes that these competitive
disparities would be mitigated to the extent that foreign jurisdictions
impose comparable requirements. Further, the Commission reiterates its
belief that the cross-border approach to the MSP registration threshold
taken in the Proposed Rule aims to further the policy objectives of the
Dodd-Frank Act while mitigating unnecessary burdens and disruption to
market practices to the extent possible.
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\395\ Additionally, some unregistered swap market participants
may opt to withdraw from the market, thereby contracting the number
of competitors in the swaps market, which may have an effect on
competition and liquidity.
\396\ These non-U.S. market participants also may be able to
offer swaps on more favorable terms to U.S. persons, giving them a
competitive advantage over U.S. competitors with respect to U.S.
counterparties.
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4. Monitoring Costs
Under the Proposed Rule, market participants would need to continue
to monitor their swap activities in order to determine whether they
are, or continue to be, required to register as an SD or MSP. With
respect to Baseline A, the Commission believes that market participants
have developed policies and practices consistent with the cross-border
approach to the SD and MSP registration thresholds expressed in the
Guidance. Therefore the Commission believes that market participants
would only incur incremental costs in modifying their existing systems
and policies and procedures in response to the Proposed Rule (e.g.,
determining which swap activities or positions would be required to be
included in the registration threshold calculations).\397\
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\397\ Although the cross-border approach to the MSP registration
threshold calculation in the Proposed Rule is not identical to the
approach included in the Guidance (see supra section IV.B.2), the
Commission believes that any resulting increase in monitoring costs
resulting from the Proposed Rule being adopted would be incremental
and de minimis.
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[[Page 995]]
For example, the Commission notes that SRSs may have adopted
policies and practices in line with the Guidance's approach to non-U.S.
persons that are not guaranteed or conduit affiliates and therefore may
only be currently counting (or be provisionally registered by virtue
of) their swap dealing transactions with U.S. persons, other than
foreign branches of U.S. SDs. Although an SRS would be required under
the Proposed Rule to include all dealing swaps in its de minimis
calculation, the Commission believes that any increase in monitoring
costs for SRSs would be negligible, both initially and on an ongoing
basis, because they already have systems that track swap dealing
transactions with certain counterparties in place, which includes an
assessment of their counterparties' status.\398\ The Commission expects
that any adjustments made to these systems in response to the Proposed
Rule would be minor.
---------------------------------------------------------------------------
\398\ See supra section VIII.C.1, for a discussion of assessment
costs.
---------------------------------------------------------------------------
With respect to Baseline B, the Commission believes that, absent
the Guidance, most market participants would have interpreted CEA
section 2(i) to require them, at a minimum, to monitor their swap
activities with U.S. persons to determine whether they are, or continue
to be, required to register as an SD or MSP. Therefore, the Commission
believes that certain market participants may incur incremental costs
in modifying their existing systems and policies and procedures in
response to the Proposed Rule to monitor their swap activity with non-
U.S. persons.
5. Registration Costs
With respect to Baseline A, the Commission believes that few, if
any, additional non-U.S. persons would be required to register as a SD
pursuant to the Proposed Rule. With respect to Baseline B, the
Commission acknowledges that, absent the Guidance, some non-U.S.
persons may not have interpreted CEA section 2(i) so as to require them
to register with the Commission. Accordingly, a subset of such entities
may be required to register with the Commission pursuant to the
Proposed Rule, if adopted.
The Commission acknowledges that if a market participant were
required to register, it may incur registration costs. The Commission
previously estimated registration costs in its rulemaking on
registration of SDs; \399\ however, the costs that may be incurred
should be mitigated to the extent that these new SDs are affiliated
with an existing SD, as most of these costs have already been realized
by the consolidated group. While the Commission cannot anticipate the
extent to which any potential new registrants would be affiliated with
existing SDs, it notes that most current registrants are part of a
consolidated group. The Commission has not included any discussion of
registration costs for MSPs because it believes that few, if any,
market participants would be required to register as an MSP under the
Proposed Rule, as noted above.
---------------------------------------------------------------------------
\399\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR at 2623-25.
---------------------------------------------------------------------------
6. Programmatic Costs
With respect to Baseline A, as noted above, the Commission believes
that few, if any, additional non-U.S. persons would be required to
register as a SD under the Proposed Rule. With respect to Baseline B,
the Commission acknowledges that, absent the Guidance, some non-U.S.
persons may not have interpreted CEA section 2(i) so as to require them
to register with the Commission. Accordingly, a subset of such entities
may be required to register with the Commission pursuant to the
Proposed Rule, if adopted.
To the extent that the Proposed Rule acts as a ``gating'' rule by
affecting which entities engaged in cross-border swap activities must
comply with the SD requirements, the Proposed Rule, if adopted, could
result in increased costs for particular entities that otherwise would
not register as an SD and comply with the swap provisions.\400\
---------------------------------------------------------------------------
\400\ As noted above, the Commission believes that, if the
Proposed Rule is adopted, few (if any) market participants would be
required to register as an MSP under the Proposed Rule, and
therefore it has not included a separate discussion of programmatic
costs for registered MSPs in this section.
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7. Proposed Exceptions From Group B and Group C Requirements,
Availability of Substituted Compliance, and Comparability
Determinations
As discussed in section VI above, the Commission, consistent with
section 2(i) of the CEA, is proposing exceptions from, and substituted
compliance for, certain group A, group B, and group C requirements
applicable to swap entities, as well as the creation of a framework for
comparability determinations.
(i) Exceptions
Specifically, as discussed above in section VI, the Proposed Rule
includes: (1) The Exchange-Traded Exception from certain group B and
group C requirements for certain anonymously executed, exchange-traded,
and cleared foreign-based swaps; (2) the Foreign Swap Group C Exception
for certain foreign-based swaps with foreign counterparties; (3) the
Non-U.S. Swap Entity Group B Exception for foreign-based swaps of
certain non-U.S. swap entities with certain foreign counterparties; and
(4) the Foreign Branch Group B Exception for certain foreign-based
swaps of foreign branches of U.S. swap entities with certain foreign
counterparties.\401\
---------------------------------------------------------------------------
\401\ As discussed above, these exceptions are similar to ones
provided in the Guidance.
---------------------------------------------------------------------------
Under the Proposed Rule, U.S. swap entities (other than their
foreign branches) would not be excepted from, or eligible for
substituted compliance for, the Commission's group A, group B, and
group C requirements. This reflects the Commission's view that these
requirements should apply fully to registered SDs and MSPs that are
U.S. persons because their swap activities are particularly likely to
affect the integrity of the swap market in the United States and raise
concerns about the protection of participants in those markets. With
respect to both baselines, the Commission does not expect that this
would impose any additional costs on market participants given that the
Commission's relevant business conduct requirements already apply to
U.S. SDs and MSPs pursuant to existing Commission regulations.
Pursuant to the Exchange-Traded Exception, non-U.S. swap entities
and foreign branches of non-U.S. swap entities would generally be
excluded from the group B and group C requirements with respect to
their foreign-based swaps that are anonymously executed, exchange-
traded, and cleared.
Further, pursuant to the Foreign Swap Group C Exception, non-U.S.
swap entities and foreign branches of U.S. swap entities would be
excluded from the group C requirements with respect to their foreign-
based swaps with foreign counterparties.
In addition, pursuant to the Non-U.S. Swap Entity Group B
Exception, non-U.S. swap entities that are neither SRSs nor Guaranteed
Entities would be excepted from the group B requirements with respect
to any foreign-based swap with foreign counterparties that are neither
SRSs nor Guaranteed Entities.
[[Page 996]]
Finally, pursuant to the Foreign Branch Group B Exception, foreign
branches of U.S. swap entities would be excepted from the group B
requirements, with respect to any foreign-based swap with a foreign
counterparty that is an Other Non-U.S. Person, subject to certain
limitations. Specifically, the exception would not be available with
respect to any group B requirement for which substituted compliance is
available for the relevant swap, and in any calendar quarter, the
aggregate gross notional amount of swaps conducted by a U.S. swap
entity in reliance on the exception may not exceed five percent of the
aggregate gross notional amount of all its swaps.
The Commission acknowledges that the group B requirements may apply
more broadly to swaps between non-U.S. persons than as contemplated in
the Guidance. Specifically, the Proposed Rule would require swap
entities that are either Guaranteed Entities or SRSs to comply with the
group B requirements for swaps with Other Non-U.S. Persons, whereas the
Guidance stated that all non-U.S. swap entities (other than their U.S.
branches) were excluded from the group B requirements with respect to
swaps with a non-U.S. person that is not a guaranteed or conduit
affiliate. However, the Commission believes that the proposed
exceptions, coupled with the availability of substituted compliance,
would help to alleviate any additional burdens that may arise from such
application. Notwithstanding the availability of these exceptions and
substituted compliance, the Commission acknowledges that some non-U.S.
swap entities may incur costs to the extent that a comparability
determination has not yet been issued for certain jurisdictions.
Further, the Commission expects that swap entities that avail
themselves of the proposed exceptions would be able to reduce their
costs of compliance with respect to the excepted requirements (which,
to the extent they are similar to requirements in the jurisdiction in
which they are based, may be potentially duplicative or conflicting).
The Commission notes that swap entities are not required to take any
additional action to avail themselves of these exceptions (e.g.,
notification to the Commission) that would cause them to incur
additional costs. The Commission recognizes that the exceptions (and
the inherent cost savings) may give certain swap entities a competitive
advantage with respect to swaps that meet the requirements of the
exception.\402\ The Commission nonetheless believes that it is
appropriate to tailor the application of the group B and group C
requirements in the cross-border context, consistent with section 2(i)
of the CEA and international comity principles, so as to except these
foreign-based swaps from the relevant requirements. In doing so, the
Commission is aiming to reduce market fragmentation which may result by
applying certain duplicative swap requirements in non-U.S. markets,
which are often subject to robust foreign regulation. The Commission
notes that the proposed exceptions are similar to those provided in the
Guidance. Therefore, the Commission does not expect such exceptions
would have a significant impact on the costs of, and benefits to, swap
entities.
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\402\ The degree of competitive disparity will depend on the
degree of disparity between the Commission's requirements and that
of the relevant foreign jurisdiction.
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(ii) Substituted Compliance
As described in section VI.C, the extent to which substituted
compliance is available under the Proposed Rule would depend on the
classification of the swap entity or branch and, in certain cases the
counterparty, to a particular swap. The Commission recognizes that the
decision to offer any substituted compliance carries certain trade-
offs. Given the global and highly-interconnected nature of the swap
market, where risk is not bound by national borders, market
participants are likely to be subject to the regulatory interest of
more than one jurisdiction. Allowing compliance with foreign swap
requirements as an alternative to compliance with the Commission's
requirements can therefore reduce the application of duplicative or
conflicting requirements, resulting in lower compliance costs and
potentially facilitating a more efficient regulatory framework over
time as regulatory regimes compete to have swap transactions occur in
their respective jurisdictions. Substituted compliance also helps
preserve the benefits of an integrated, global swap market by fostering
and advancing efforts among U.S. and foreign regulators to collaborate
in establishing robust regulatory standards. If not properly
implemented, however, the Commission's swap regime could lose some of
its effectiveness. Accordingly, the ultimate costs and benefits of
substituted compliance are affected by the standard under which it is
granted and the extent to which it is applied. The Commission was
mindful of this dynamic in structuring a proposed substituted
compliance regime for the group A and group B requirements and believes
the Proposed Rule strikes an appropriate balance, enhancing market
efficiency and fostering global coordination of these requirements
while ensuring that swap entities (wherever located) are subject to
comparable regulation.
The Commission also understands that by not offering substituted
compliance equally to all swap entities, the Proposed Rule, if adopted,
could lead to certain competitive disparities between swap entities.
For example, to the extent that a non-U.S. swap entity can rely on
substituted compliance that is not available to a U.S. swap entity, it
may enjoy certain cost advantages (e.g., avoiding the costs of
potentially duplicative or inconsistent regulation). The non-U.S. swap
entity may then be able to pass on these cost savings to their
counterparties in the form of better pricing or some other benefit.
U.S. swap entities, on the other hand, could, depending on the extent
to which foreign swap requirements apply, be subject to both U.S. and
foreign requirements, and therefore be at a competitive disadvantage.
Counterparties may also be incentivized to transact with swap entities
that are offered substituted compliance in order to avoid being subject
to duplicative or conflicting swap requirements, which could lead to
increased market deficiencies.\403\
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\403\ The Commission recognizes that its proposed framework, if
adopted, may impose certain initial operational costs, as in certain
cases swap entities will be required to determine the status of
their counterparties in order to determine the extent to which
substituted compliance is available.
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Nevertheless, the Commission does not believe it is appropriate to
make substituted compliance broadly available to all swap entities. As
discussed above, the Commission has a strong supervisory interest in
the swap activity of all swap entities, including non-U.S. swap
entities, by virtue of their registration with the Commission. Further,
U.S. swap entities are particularly key swap market participants and
their safety and soundness is critical to a well-functioning U.S. swap
market and the stability of the U.S. financial system. The Commission
believes that losses arising from the default of a U.S. entity are more
likely to be borne by other U.S. entities (including parent companies);
therefore a U.S. entity's risk to the U.S. financial system is more
acute than that of a similarly situated non-U.S. entity. Accordingly,
in light of the Commission's supervisory interest in the activities of
U.S. persons and its statutory obligation to ensure the safety and
soundness of swap entities and the
[[Page 997]]
U.S. swap market, the Commission believes that it is generally not
appropriate for substituted compliance to be available to U.S. swap
entities for purposes of the Proposed Rule. With respect to non-U.S.
swap entities, however, the Commission believes that, in the interest
of international comity, making substituted compliance broadly
available for the requirements discussed in the Proposed Rule is
appropriate.
(iii) Comparability Determinations
As noted in section VI.D above, under the Proposed Rule, a
comparability determination may be requested by: (1) Eligible swap
entities; (2) trade associations whose members are eligible swap
entities; or (3) foreign regulatory authorities that have direct
supervisory authority over eligible swap entities and are responsible
for administering the relevant foreign jurisdiction's swap
requirements.\404\ Once a comparability determination is made for a
jurisdiction, it applies for all entities or transactions in that
jurisdiction to the extent provided in the determination, as approved
by the Commission.\405\ Accordingly, given that the Proposed Rule would
have no impact on any existing comparability determinations, swap
entities could continue to rely on such determinations with no impact
on the costs or benefits of such reliance. To the extent that an entity
wishes to request a new comparability determination pursuant to the
Proposed Rule, it would incur costs associated with the preparation and
filing of submission requests. However, the Commission anticipates that
a person would not elect to incur the costs of submitting a request for
a comparability determination unless such costs were exceeded by the
cost savings associated with substituted compliance.
---------------------------------------------------------------------------
\404\ Proposed Sec. 23.23(g)(2).
\405\ Proposed Sec. 23.23(f).
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The Proposed Rule includes a standard of review that allows for a
holistic, outcomes-based approach that enables the Commission to
consider any factor it deems relevant in assessing comparability.
Further, in determining whether a foreign regulatory requirement is
comparable to a corresponding Commission requirement, the Proposed Rule
would allow the Commission to consider the broader context of a foreign
jurisdiction's related regulatory requirements. Allowing for a
comparability determination to be made based on comparable outcomes and
objectives, notwithstanding potential differences in foreign
jurisdictions' relevant standards, helps to ensure that substituted
compliance is made available to the fullest extent possible. While the
Commission recognizes that, to the extent that a foreign swap regime is
not deemed comparable in all respects, swap entities eligible for
substituted compliance may incur costs from being required to comply
with more than one set of specified swap requirements, the Commission
believes that this approach is preferable to an all-or-nothing
approach, in which market participants may be forced to comply with
both regimes in their entirety.
8. Recordkeeping
The Proposed Rule would also require swap entities to create and
retain records of their compliance with the Proposed Rule. Given that
swap entities are already subject to robust recordkeeping requirements,
the Commission believes that, if the Proposed Rule is adopted, swap
entities would only incur incremental costs, which are expected to be
minor, in modifying their existing systems and policies and procedures
resulting from changes to the status quo made by the Proposed Rule.
9. Section 15(a) Factors
Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders. Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The Commission considers the costs and benefits
resulting from its discretionary determinations with respect to the
section 15(a) factors.
(i) Protection of Market Participants and the Public
The Commission believes the Proposed Rule would support protection
of market participants and the public. By focusing on and capturing
swap dealing transactions and swap positions involving U.S. persons,
SRSs, and Guaranteed Entities, the Proposed Rule's approach to the
cross-border application of the SD and MSP registration threshold
calculations would work to ensure that, consistent with CEA section
2(i) and the policy objectives of the Dodd-Frank Act, significant
participants in the U.S. market are subject to these requirements. The
proposed cross-border approach to the group A, group B, and group C
requirements similarly ensures that these requirements would apply to
swap activities that are particularly likely to affect the integrity of
and raise concerns about the protection of participants in the U.S.
market while, consistent with principles of international comity,
recognizing the supervisory interests of the relevant foreign
jurisdictions in applying their own requirements to transactions
involving non-U.S. swap entities and foreign branches of U.S. swap
entities with non-U.S. persons and foreign branches of U.S. swap
entities.
(ii) Efficiency, Competitiveness, and Financial Integrity of the
Markets
To the extent that the Proposed Rule leads additional entities to
register as SDs or MSPs, the Commission believes that the Proposed Rule
could enhance the financial integrity of the markets by bringing
significant U.S. swap market participants under Commission oversight,
which may reduce market disruptions and foster confidence and
transparency in the U.S. market. The Commission recognizes that, if
adopted, the Proposed Rule's cross-border approach to the SD and MSP
registration thresholds may create competitive disparities among market
participants, based on the degree of their connection to the United
States, that could contribute to market deficiencies, including market
fragmentation and decreased liquidity, as certain market participants
may reduce their exposure to the U.S. market. As a result of reduced
liquidity, counterparties may pay higher prices, in terms of bid-ask
spreads. Such competitive effects and market deficiencies may, however,
be mitigated by global efforts to harmonize approaches to swap
regulation and by the large inter-dealer market, which may link the
fragmented markets and enhance liquidity in the overall market. The
Commission believes that the Proposed Rule's approach is necessary and
appropriately tailored to ensure that the purposes of the Dodd-Frank
Act swap regime and its registration requirements are advanced while
still establishing a workable approach that recognizes foreign
regulatory interests and reduces competitive disparities and market
deficiencies to the degree possible. The Commission further believes
that the Proposed Rule's cross-border approach to the group A, group B,
and group C requirements would promote the financial integrity of the
markets by fostering transparency and
[[Page 998]]
confidence in the major participants in the U.S. swap markets.
(iii) Price Discovery
The Commission recognizes that, if adopted, the Proposed Rule's
approach to the cross-border application of the SD and MSP registration
thresholds and group A, group B, and group C requirements could also
have an effect on liquidity, which may in turn influence price
discovery. As liquidity in the swap market is lessened and fewer
dealers compete against one another, bid-ask spreads (cost of swap and
cost to hedge) may widen and the ability to observe an accurate price
of a swap may be hindered. However, as noted above, these negative
effects would be mitigated as jurisdictions harmonize their swap
initiatives and global financial institutions continue to manage their
swap books (i.e., moving risk with little or no cost, across an
institution to market centers, where there is the greatest liquidity).
The Commission does not believe that, if adopted, the Proposed Rule's
approach to the group A, group B, and group C requirements, however,
will have a noticeable impact on price discovery.
(iv) Sound Risk Management Practices
The Commission believes that, if adopted, the Proposed Rule's
approach could promote the development of sound risk management
practices by ensuring that significant participants in the U.S. market
are subject to Commission oversight (via registration), including in
particular important counterparty disclosure and recordkeeping
requirements that will encourage policies and practices that promote
fair dealing while discouraging abusive practices in U.S. markets. On
the other hand, to the extent that a registered SD or MSP relies on the
exceptions proposed in this release, and is located in a jurisdiction
that does not have comparable swap requirements, the Proposed Rule
could lead to weaker risk management practices for such entities.
(v) Other Public Interest Considerations
The Commission believes that the Proposed Rule is consistent with
the principles of international comity.
10. Request for Comment
The Commission invites comment on all aspects of the costs and
benefits associated with the Proposed Rule, and specifically requests
comments on the following questions. Please explain your responses.
(42) Would additional market participants be required to register
as SDs (compared to the status quo) as a result of the Proposed Rule
being adopted? If so, please provide an estimate for the number of such
market participants. Please include an explanation for the basis of the
estimate, and associated costs and benefits of the Proposed Rule's
provisions for SDs (including potential SDs).
(43) Would any market participants be required to register as an
MSP as a result of the Proposed Rule being adopted? If so, please
provide an estimate for the number of such market participants. Please
include an explanation for the basis of the estimate, and associated
costs and benefits of the Proposed Rule's provisions for potential
MSPs.
(44) The Proposed Rule would not provide relief to swap entities
that are SRSs or Guaranteed Entities from the group B requirements for
transactions facing Other Non-U.S. Persons. Thus, under the Proposed
Rule, SRSs and Guaranteed Entities would generally be required to
comply with the group B requirements for all of their swaps, rely on
existing substituted compliance determinations, or seek additional
substituted compliance determinations. Please provide an estimate for
the number of swap entities that would be likely to incur compliance
costs as a result of this aspect of the Proposed Rule, as well as an
estimate of the associated costs and benefits of such provision. To
what extent would the proposed availability of substituted compliance
in such instances affect these costs and benefits?
(45) The Commission invites information regarding whether and the
extent to which specific foreign requirement(s) may affect the costs
and benefits of the Proposed Rule, including information identifying
the relevant foreign requirement(s) and any monetary or other
quantitative estimates of the potential magnitude of those costs and
benefits.
(46) Would the proposed recordkeeping provision cause registrants
to incur more than a minor incremental cost to implement? If so, please
provide an estimate for such costs. Please include an explanation for
the basis of the estimate, and associated costs and benefits of the
Proposed Rule's recordkeeping provisions.
D. Antitrust Considerations
Section 15(b) of the CEA \406\ requires the Commission to ``take
into consideration the public interest to be protected by the antitrust
laws and endeavor to take the least anticompetitive means of achieving
the objectives of [the CEA], as well as the policies and purposes of
[the CEA], in issuing any order or adopting any Commission rule or
regulation (including any exemption under section 4(c) or 4c(b), or in
requiring or approving any bylaw, rule, or regulation of a contract
market or registered futures association established pursuant to
section 17 of [the CEA].''
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\406\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requests comment on whether the Proposed Rule implicates any other
specific public interest to be protected by the antitrust laws.
The Commission has considered the Proposed Rule to determine
whether it is anticompetitive and has preliminarily identified no
anticompetitive effects. The Commission requests comment on whether the
Proposed Rule is anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has preliminarily determined that the
Proposed Rule is not anticompetitive and has no anticompetitive
effects, the Commission has not identified any less anticompetitive
means of achieving the purposes of the CEA. The Commission requests
comment on whether there are less anticompetitive means of achieving
the relevant purposes of the CEA that would otherwise be served by
adopting the Proposed Rule.
IX. Preamble Summary Tables
A. Table A--Cross-Border Application of the SD De Minimis Threshold
Table A should be read in conjunction with the text of the Proposed
Rule.
[[Page 999]]
[GRAPHIC] [TIFF OMITTED] TP08JA20.007
B. Table B--Cross-Border Application of the MSP Threshold
Table B should be read in conjunction with the text of the Proposed
Rule.
[[Page 1000]]
[GRAPHIC] [TIFF OMITTED] TP08JA20.008
C. Table C--Cross-Border Application of the Group B Requirements in
Consideration of Related Exceptions and Substituted Compliance
Table C \407\ should be read in conjunction with the text of the
Proposed Rule.
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\407\ As discussed in section VI.A.2, the group B requirements
are set forth in Sec. Sec. 23.202, 23.501, 23.502, 23.503, and
23.504 and relate to (1) swap trading relationship documentation;
(2) portfolio reconciliation and compression; (3) trade
confirmation; and (4) daily trading records. Proposed exceptions
from the group B requirements are discussed in section VI.B.1, 3,
and 4. Proposed substituted compliance for the group B requirements
is discussed in section VI.C.2.
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[[Page 1001]]
[GRAPHIC] [TIFF OMITTED] TP08JA20.009
D. Table D--Cross-Border Application of the Group C Requirements in
Consideration of Related Exceptions
Table D \408\ should be read in conjunction with the text of the
Proposed Rule.
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\408\ As discussed in section VI.A.3, the group C requirements
are set forth in Sec. Sec. 23.400-451 and relate to certain
business conduct standards governing the conduct of SDs and MSPs in
dealing with their swap counterparties. Proposed exceptions from the
group C requirements are discussed in section VI.B.1 and 2.
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[[Page 1002]]
[GRAPHIC] [TIFF OMITTED] TP08JA20.010
List of Subjects in 17 CFR Part 23
Business conduct standards, Counterparties, Cross-border,
Definitions, De minimis exception, Major swap participants, Swaps, Swap
Dealers.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 23 as follows:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Public Law 111-203, 124 Stat. 1641 (2010).
0
2. Add Sec. 23.23 to read as follows:
Sec. 23.23 Cross-border application.
(a) Definitions. For purposes of this section the terms below have
the following meanings. A person may rely on a written representation
from its counterparty that the counterparty does or does not satisfy
the criteria for one or more of the definitions below, unless such
person knows or has reason to know that the representation is not
accurate; for the purposes of this rule a person would have reason to
know the representation is not accurate if a reasonable person should
know, under all of the facts of which the person is aware, that it is
not accurate.
(1) Control including the terms controlling, controlled by, and
under common control with, means 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 shares,
by contract, or otherwise.
(2) Foreign branch means any office of a U.S. bank that:
(i) Is located outside the United States;
(ii) Operates for valid business reasons;
(iii) 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;
and
(iv) Is engaged in the business of banking and is subject to
substantive regulation in banking or financing in the jurisdiction
where it is located.
(3) Foreign counterparty means:
(i) A non-U.S. person, except with respect to a swap conducted
through a U.S. branch of that non-U.S. person; or
(ii) A foreign branch where it enters into a swap in a manner that
satisfies the definition of a swap conducted through a foreign branch.
(4) Foreign-based swap means:
(i) A swap by a non-U.S. swap entity, except for a swap conducted
through a U.S. branch; or
(ii) A swap conducted through a foreign branch.
(5) Group A requirements mean the requirements set forth in
Sec. Sec. 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605,
23.606, 23.607, and 23.609 of this chapter.
(6) Group B requirements mean the requirements set forth in
Sec. Sec. 23.202 and 23.501-504.
(7) Group C requirements mean the requirements set forth in
Sec. Sec. 23.400-451.
(8) Guarantee means an arrangement pursuant to which one party to a
swap has rights of recourse against a
[[Page 1003]]
guarantor, with respect to its counterparty's obligations under the
swap. For these purposes, a party to a swap has rights of recourse
against a guarantor if the party has a conditional or unconditional
legally enforceable right to receive or otherwise collect, in whole or
in part, payments from the guarantor with respect to its counterparty's
obligations under the swap. In addition, in the case of any arrangement
pursuant to which the guarantor has a conditional or unconditional
legally enforceable right to receive or otherwise collect, in whole or
in part, payments from any other guarantor with respect to the
counterparty's obligations under the swap, such arrangement will be
deemed a guarantee of the counterparty's obligations under the swap by
the other guarantor.
(9) Non-U.S. person means any person that is not a U.S. person.
(10) Non-U.S. swap entity means a swap entity that is not a U.S.
swap entity.
(11) Parent entity means any entity in a consolidated group that
has one or more subsidiaries in which the entity has a controlling
interest, as determined in accordance with U.S. GAAP.
(12) Significant risk subsidiary means any non-U.S. significant
subsidiary of an ultimate U.S. parent entity where the ultimate U.S.
parent entity has more than $50 billion in global consolidated assets,
as determined in accordance with U.S. GAAP at the end of the most
recently completed fiscal year, but excluding non-U.S. subsidiaries
that are:
(i) Subject to consolidated supervision and regulation by the Board
of Governors of the Federal Reserve System as a subsidiary of a U.S.
bank holding company; or
(ii) Subject to capital standards and oversight by the subsidiary's
home country supervisor that are consistent with the Basel Committee on
Banking Supervision's ``International Regulatory Framework for Banks''
and subject to margin requirements for uncleared swaps in a
jurisdiction for which the Commission has issued a comparability
determination.
(13) Significant subsidiary means a subsidiary, including its
subsidiaries, which meets any of the following conditions:
(i) The three year rolling average of the subsidiary's equity
capital is equal to or greater than five percent of the three year
rolling average of the ultimate U.S. parent entity's consolidated
equity capital, as determined in accordance with U.S. GAAP as of the
end of the most recently completed fiscal year;
(ii) The three year rolling average of the subsidiary's total
revenue is equal to or greater than ten percent of the three year
rolling average of the ultimate U.S. parent entity's total consolidated
revenue, as determined in accordance with U.S. GAAP as of the end of
the most recently completed fiscal year; or
(iii) The three year rolling average of the subsidiary's total
assets is equal to or greater than ten percent of the three year
rolling average of the ultimate U.S. parent entity's total consolidated
assets, as determined in accordance with U.S. GAAP as of the end of the
most recently completed fiscal year.
(14) Subsidiary means a subsidiary of a specified person that is an
affiliate controlled by such person directly, or indirectly through one
or more intermediaries. For purposes of this definition, an affiliate
of, or a person affiliated with, a specific person is a person that
directly, or indirectly through one or more intermediaries, controls,
or is controlled by, or is under common control with, the person
specified.
(15) Swap entity means a person that is registered with the
Commission as a swap dealer or major swap participant pursuant to the
Act.
(16) Swap conducted through a foreign branch means a swap entered
into by a foreign branch where:
(i) The foreign branch or another foreign branch is the office
through which the U.S. person makes and receives payments and
deliveries under the swap pursuant to a master netting or similar
trading agreement, and the documentation of the swap specifies that the
office for the U.S. person is such foreign branch;
(ii) The swap is entered into by such foreign branch in its normal
course of business; and
(iii) The swap is reflected in the local accounts of the foreign
branch.
(17) Swap conducted through a U.S. branch means a swap entered into
by a U.S. branch where:
(i) The U.S. branch is the office through which the non-U.S. person
makes and receives payments and deliveries under the swap pursuant to a
master netting or similar trading agreement, and the documentation of
the swap specifies that the office for the non-U.S. person is such U.S.
branch; or
(ii) The swap is reflected in the local accounts of the U.S.
branch.
(18) Ultimate U.S. parent entity means the U.S. parent entity that
is not a subsidiary of any other U.S. parent entity.
(19) United States and U.S. means the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.
(20) U.S. branch means a branch or agency of a non-U.S. banking
organization where such branch or agency:
(i) Is located in the United States;
(ii) Maintains accounts independently of the home office and other
U.S. branches, with the profit or loss accrued at each branch
determined as a separate item for each U.S. branch; and
(iii) Engages in the business of banking and is subject to
substantive banking regulation in the state or district where located.
(21) U.S. GAAP means U.S. generally accepted accounting principles.
(22) U.S. person: (i) Except as provided in paragraph (a)(22)(iii)
of this section, U.S. person means any person that is:
(A) A natural person resident in the United States;
(B) A partnership, corporation, trust, investment vehicle, or other
legal person organized, incorporated, or established under the laws of
the United States or having its principal place of business in the
United States;
(C) An account (whether discretionary or non-discretionary) of a
U.S. person; or
(D) An estate of a decedent who was a resident of the United States
at the time of death.
(ii) For purposes of this section, principal place of business
means the location from which the officers, partners, or managers of
the legal person primarily direct, control, and coordinate the
activities of the legal person. With respect to an externally managed
investment vehicle, this location is the office from which the manager
of the vehicle primarily directs, controls, and coordinates the
investment activities of the vehicle.
(iii) The term U.S. person does not include the International
Monetary Fund, the International Bank for Reconstruction and
Development, the Inter-American Development Bank, the Asian Development
Bank, the African Development Bank, the United Nations, and their
agencies and pension plans, and any other similar international
organizations, their agencies and pension plans.
(iv) Notwithstanding paragraph (a)(22)(i) of this section, until
December 31, 2025, a person may continue to classify counterparties as
U.S. persons based on representations that were previously made
pursuant to the ``U.S. person'' definition in Sec. 23.160(a)(10).
(23) U.S. swap entity means a swap entity that is a U.S. person.
[[Page 1004]]
(b) Cross-border application of de minimis registration threshold
calculation. For purposes of determining whether an entity engages in
more than a de minimis quantity of swap dealing activity under
paragraph (4)(i) of the swap dealer definition in Sec. 1.3 of this
chapter, a person shall include the following swaps (subject to
paragraph (6) of the swap dealer definition in Sec. 1.3 of this
chapter):
(1) If such person is a U.S. person or a significant risk
subsidiary, all swaps connected with the dealing activity in which such
person engages.
(2) If such person is a non-U.S. person (other than a significant
risk subsidiary), all of the following swaps connected with the dealing
activity in which such person engages:
(i) Swaps with a counterparty that is a U.S. person, other than
swaps conducted through a foreign branch of a registered swap dealer.
(ii) Swaps where the obligations of such person under the swaps are
subject to a guarantee by a U.S. person.
(iii) Swaps with a counterparty that is a non-U.S. person where the
counterparty's obligations under the swaps are subject to a guarantee
by a U.S. person, except when:
(A) The counterparty is registered as a swap dealer; or
(B) The counterparty's swaps are subject to a guarantee by a U.S.
person that is a non-financial entity.
(c) Application of major swap participant tests in the cross-border
context. For purposes of determining a person's status as a major swap
participant, as defined in Sec. 1.3 of this chapter, a person shall
include the following swap positions:
(1) If such person is a U.S. person or a significant risk
subsidiary, all swap positions that are entered into by the person.
(2) If such person is a non-U.S. person (other than a significant
risk subsidiary), all of the following swap positions of such person:
(i) Swap positions where the counterparty is a U.S. person, other
than swaps conducted through a foreign branch of a registered swap
dealer.
(ii) Swap positions where the obligations of such person under the
swaps are subject to a guarantee by a U.S. person.
(iii) Swap positions with a counterparty that is a non-U.S. person
where the counterparty's obligations under the swaps are subject to a
guarantee by a U.S. person, except when the counterparty is registered
as a swap dealer.
(d) Notwithstanding any other provision of Sec. 23.23, for
purposes of determining whether a non-U.S. person (other than a
significant risk subsidiary or a non-U.S. person whose performance
under the swap is subject to a guarantee by a U.S. person) engages in
more than a de minimis quantity of swap dealing activity under
paragraph (4)(i) of the swap dealer definition in Sec. 1.3 of this
chapter or for determining the non-U.S. person's status as a major swap
participant as defined in Sec. 1.3 of this chapter, such non-U.S.
person does not need to count any swaps or swap positions, as
applicable, that are entered into by such non-U.S. person on a
designated contract market, a registered swap execution facility or a
swap execution facility exempted from registration by the Commission
pursuant to section 5h(g) of the Act, or a registered foreign board of
trade, and cleared through a registered derivatives clearing
organization or a clearing organization that has been exempted from
registration by the Commission pursuant to section 5b(h) of the Act,
where the non-U.S. person does not know the identity of the
counterparty to the swap prior to execution.
(e) Exceptions from certain swap requirements for certain foreign-
based swaps. (1) With respect to its foreign-based swaps, each non-U.S.
swap entity and foreign branch of a U.S. swap entity shall be excepted
from:
(i) The group B requirements (other than Sec. Sec. 23.202(a)
through 23.202(a)(1)) and the group C requirements with respect to any
swap (i) entered into on a designated contract market, a registered
swap execution facility or a swap execution facility exempted from
registration by the Commission pursuant to section 5h(g) of the Act, or
a registered foreign board of trade; (ii) cleared through a registered
derivatives clearing organization or a clearing organization that has
been exempted from registration by the Commission pursuant to section
5b(h) of the Act; and (iii) where the swap entity does not know the
identity of the counterparty to the swap prior to execution; and
(ii) The group C requirements with respect to any swap with a
foreign counterparty.
(2) With respect to its foreign-based swaps, each non-U.S. swap
entity that is neither a significant risk subsidiary nor a person whose
performance under the swap is subject to a guarantee by a U.S. person
shall be excepted from the group B requirements with respect to any
swap with a foreign counterparty (other than a foreign branch) that is
neither a significant risk subsidiary nor a person whose performance
under the swap is subject to a guarantee by a U.S. person.
(3) With respect to its foreign-based swaps, each foreign branch of
a U.S. swap entity shall be excepted from the group B requirements with
respect to any swap with a foreign counterparty (other than a foreign
branch) that is neither a significant risk subsidiary nor a person
whose performance under the swap is subject to a guarantee by a U.S.
person, provided that:
(i) This exception shall not be available with respect to any group
B requirement for a swap that is eligible for substituted compliance
for such group B requirement pursuant to a comparability determination
issued by the Commission prior to the execution of the swap; and
(ii) In any calendar quarter, the aggregate gross notional amount
of swaps conducted by a swap entity in reliance on this exception shall
not exceed five percent of the aggregate gross notional amount of all
its swaps.
(f) Substituted Compliance. (1) A non-U.S. swap entity may satisfy
any applicable group A requirement by complying with the corresponding
requirement of a foreign jurisdiction for which the Commission has
issued a comparability determination under paragraph (g) of this
section; and
(2) With respect to its foreign-based swaps, a non-U.S. swap entity
or foreign branch of a U.S. swap entity may satisfy any applicable
group B requirement for a swap with a foreign counterparty by complying
with the corresponding requirement of a foreign jurisdiction for which
the Commission has issued a comparability determination under paragraph
(g) of this section.
(g) Comparability determinations. (1) The Commission may issue
comparability determinations under this section on its own initiative.
(2) Eligibility requirements. The following persons may, either
individually or collectively, request a comparability determination
with respect to some or all of the group A requirements and group B
requirements:
(i) A swap entity that is eligible, in whole or in part, for
substituted compliance under this section or a trade association or
other similar group on behalf of its members who are such swap
entities; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more swap entities subject to the group A
requirements and/or group B requirements and that is responsible for
administering the relevant foreign jurisdiction's swap standards.
(3) Submission requirements. Persons requesting a comparability
determination pursuant to this section
[[Page 1005]]
shall electronically provide the Commission:
(i) A description of the objectives of the relevant foreign
jurisdiction's standards and the products and entities subject to such
standards;
(ii) A description of how the relevant foreign jurisdiction's
standards address, at minimum, each element of the Commission's
corresponding requirements. Such description should identify the
specific legal and regulatory provisions that correspond to each
element and, if necessary, whether the relevant foreign jurisdiction's
standards do not address a particular element;
(iii) A description of the differences between the relevant foreign
jurisdiction's standards and the Commission's corresponding
requirements, and an explanation regarding how such differing
approaches achieve comparable outcomes;
(iv) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's standards. Such description
should discuss the powers of the foreign regulatory authority or
authorities to supervise, investigate, and discipline entities for
compliance with the standards and the ongoing efforts of the regulatory
authority or authorities to detect and deter violations of, and ensure
compliance with, the standards;
(v) Copies of the foreign jurisdiction's relevant standards
(including an English translation of any foreign language document);
and
(vi) Any other information and documentation that the Commission
deems appropriate.
(4) Standard of review. The Commission may issue a comparability
determination pursuant to this section to the extent that it determines
that some or all of the relevant foreign jurisdiction's standards are
comparable to the Commission's corresponding requirements, after taking
into account such factors as the Commission determines are appropriate,
which may include:
(i) The scope and objectives of the relevant foreign jurisdiction's
standards;
(ii) Whether the relevant foreign jurisdiction's standards achieve
comparable outcomes to the Commission's corresponding requirements;
(iii) The ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's standards; and
(iv) Whether the relevant regulatory authority or authorities has
entered into a memorandum of understanding or other arrangement with
the Commission addressing information sharing, oversight, examination,
and supervision of swap entities relying on such comparability
determination.
(5) Reliance. Any swap entity that, in accordance with a
comparability determination issued under this section, complies with a
foreign jurisdiction's standards, would be deemed to be in compliance
with the Commission's corresponding requirements. Accordingly, if a
swap entity has failed to comply with the foreign jurisdiction's
standards or a comparability determination, the Commission may initiate
an action for a violation of the Commission's corresponding
requirements. All swap entities, regardless of whether they rely on a
comparability determination, remain subject to the Commission's
examination and enforcement authority.
(6) Discretion and Conditions. The Commission may issue or decline
to issue comparability determinations under this section in its sole
discretion. In issuing such a comparability determination, the
Commission may impose any terms and conditions it deems appropriate.
(7) Modifications. The Commission reserves the right to further
condition, modify, suspend, terminate or otherwise restrict a
comparability determination issued under this section in the
Commission's discretion.
(8) Delegation of authority. The Commission hereby delegates to the
Director of the Division of Swap Dealer and Intermediary Oversight, or
such other employee or employees as the Director may designate from
time to time, the authority to request information and/or documentation
in connection with the Commission's issuance of a comparability
determination under this section.
(h) Records. Swap dealers and major swap participants shall create
a record of their compliance with this section and shall retain records
in accordance with Sec. 23.203 of this chapter.
* * * * *
Issued in Washington, DC, on December 20, 2019, by the
Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Cross-Border Application of the Registration Thresholds
and Certain Requirements Applicable to Swap Dealers and Major Swap
Participants--Commission Voting Summary and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative.
Appendix 2--Supporting Statement of Chairman Heath Tarbert
I am pleased to support the Commission's proposed rule on the
cross-border application of registration thresholds and certain
requirements for swap dealers and major swap participants. It is
critical that the CFTC finalize a sensible cross-border registration
rule in 2020, as we approach the 10-year anniversary of the Dodd-
Frank Act.
Need for Rule-Based Finality
Since 2013, market participants have been relying on cross-
border ``interpretive guidance,'' \1\ which was published outside
the standard rulemaking process under the Administrative Procedure
Act (APA).\2\ Although this policy statement has had a sweeping
impact on participants in the global swaps market, it is technically
not enforceable. Market participants largely follow the 2013
Guidance, but they are not legally required to do so.\3\ Over the
intervening years, a patchwork of staff advisories and no-action
letters has supplemented the 2013 Guidance. With almost seven years
of experience, it is high time for the Commission to bring finality
to the issues the 2013 Guidance and its progeny address.
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\1\ Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013) (``2013 Guidance''), http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2013-17958a.pdf.
\2\ 5 U.S.C. 551 et seq.
\3\ As then Commissioner Scott O'Malia pointed out regarding the
2013 Guidance: ``Legally binding regulations that impose new
obligations on affected parties--`legislative rules'--must conform
to the APA.'' Appendix 3--Dissenting Statement of Commissioner Scott
D. O'Malia, 2013 Guidance at 45372 (citing 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)).
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We call this a ``cross-border'' proposal, and in certain
respects it is. For example, the proposed rule addresses when non-
U.S. persons must count dealing swaps with U.S. persons, including
foreign branches of American banks, toward the de minimis threshold
in our swap dealer definition. More fundamentally, however, the
proposed rule answers a basic question: What swap dealing activity
outside the United States should trigger CFTC registration and other
requirements?
[[Page 1006]]
Congressional Mandate
To answer this question, we must turn to section 2(i) of the
Commodity Exchange Act (``CEA''), a provision Congress added in
Title VII of the Dodd-Frank Act.\4\ Section 2(i) provides that the
CEA does not apply to swaps activities outside the United States
except in two circumstances: (1) Where activities have a ``direct
and significant connection with activities in, or effect on,
commerce of the United States'' or (2) where they run afoul of the
Commission's rules or regulations that prevent evasion of Title
VII.\5\ Section 2(i) evidences Congress's clear intent for the U.S.
swaps regulatory regime to stop at the water's edge, except where
foreign activities either are closely and meaningfully related to
U.S. markets or are vehicles to evade our laws and regulations.
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\4\ 7 U.S.C. 2(i).
\5\ Id.
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I believe the proposed rule before us today is a levelheaded
approach to the exterritorial application of our swap dealer
registration regime and related requirements. The proposed rule
would fully implement the congressional mandate in section 2(i). At
the same time, it acknowledges the important role played by the
CFTC's domestic and international counterparts in regulating what is
a global swaps market. In short, the proposal employs neither a
full-throated ``intergalactic commerce clause'' \6\ nor an
isolationist mentality. It is thoughtful and balanced.
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\6\ See Commissioner Jill E. Sommers, Statement of Concurrence:
(1) Cross-Border Application of Certain Swaps Provisions of the
Commodity Exchange Act, Proposed Interpretive Guidance and Policy
Statement; (2) Notice of Proposed Exemptive Order and Request for
Comment Regarding Compliance with Certain Swap Regulations (June 29,
2012), available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/sommersstatement062912 (noting that ``staff had
been guided by what could only be called the `Intergalactic Commerce
Clause' of the United States Constitution, in that every single swap
a U.S. person enters into, no matter what the swap or where it was
transacted, was stated to have a direct and significant connection
with activities in, or effect on, commerce of the United States'').
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Guiding Principles for Regulating Foreign Activities
For my part, I am guided by three additional principles in
considering the extent to which the CFTC should make full use of its
extraterritorial powers.
(1) Protect the National Interest
An important role of the CFTC is to protect and advance the
interests of the United States. In this instance, Congress provided
the CFTC with explicit extraterritorial power to safeguard the U.S.
financial system where swaps activities are concerned. We need to
think continually about the potential outcome for American
taxpayers. We cannot have a regulatory framework that incentivizes
further bailouts of large financial institutions. We therefore need
to ensure that risk created outside the United States does not flow
back into our country.
But it is not just any risk outside the United States that we
must guard against. Congress made that clear in section 2(i). We
must not regulate swaps activities in far flung lands simply to
prevent every risk that might have a nexus to the United States.
That would be a markedly poor use of American taxpayers' dollars. It
would also divert the CFTC from channeling our resources where they
matter the most: To our own markets and participants. The proposal
therefore focuses on instances when material risks from abroad are
most likely to come back to the United States and where no one but
the CFTC is responsible for those risks.
Hence, guarantees of offshore swaps by U.S. parent companies are
counted toward our registration requirements because that risk is
effectively underwritten and borne in the United States. The same is
true with the concept of a ``significant risk subsidiary'' (SRS). An
SRS is a large non-U.S. subsidiary of a large U.S. company that
deals in swaps outside the United States but (1) is not subject to
comparable capital and margin requirements in its home country, and
(2) is not a subsidiary of a holding company subject to consolidated
supervision by an American regulator, namely the Federal Reserve
Board. As a consequence, our cross-border rule would require an SRS
to register as a swap dealer or major swap participant with the CFTC
if the SRS exceeds the same registration thresholds as a U.S. firm
operating within the United States. The national interest demands
it.\7\
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\7\ The SRS concept has been designed to address a potential
situation where a U.S. entity establishes an offshore subsidiary to
conduct its swap dealing business without an explicit guarantee on
the swaps in order to avoid the Dodd-Frank Act. For example, the
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.
See, e.g., Congressional Oversight Panel, June Oversight Report, The
AIG Rescue, Its Impact on Markets, and the Government's Exit
Strategy (June 10, 2010), available at: http://www.gpo.gov/fdsys/pkg/CPRT-111JPRT56698/pdf/CPRT-111JPRT56698.pdf. If the Commission
did not regulate SRS, an AIG-type entity could establish a non-U.S.
affiliate to conduct its swaps dealing business, and, so long as it
did not explicitly guarantee the swaps, it would avoid application
of the Dodd-Frank Act and bring risk created offshore back into the
United States without appropriate regulatory safeguards.
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(2) Follow Kant's Categorical Imperative
Rarely does the name of Immanuel Kant, the famous 18th century
German philosopher, come up when talking about financial
regulation.\8\ One of the lasting contributions Kant made to Western
thought was his concept of the ``categorical imperative.'' In
deducing the laws of ethical behavior, i.e., how people should treat
one another, he came up with a simple test: We should act according
to the maxim that we wish all other rational people to follow, as if
it were a universal law.\9\ Kant's categorical imperative is also a
good foundation for considering cross-border rulemaking here at the
CFTC.
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\8\ Yet even at first glance, derivatives regulation and Kant's
philosophy share some strikingly common attributes. Title 17 of the
Code of Federal Regulation (CFR) and The Critique of Pure Reason
(Kritik der reinen Vernunft) (1781) are impenetrable to all but a
handful of subject matter experts. And scholars spend decades
writing and thinking about them, often coming up with more questions
than answers.
\9\ ``Act only according to that maxim whereby you can, at the
same time, will that it should become a universal law.'' Immanuel
Kant, Grounding for the Metaphysics of Morals (1785) [1993],
translated by James W. Ellington (3rd ed.).
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What I take from it is that we should adopt a regulatory regime
that we would like all other jurisdictions to follow as if it were a
universal law. How does this work? Let me start by explaining how it
does not work. If we impose our regulations on non-U.S. persons
whenever they have a remote nexus to the United States, then we
should be willing for all other jurisdictions to do the same. The
end result would be absurdity, with everyone trying to regulate
everyone else. And the duplicative and overlapping regulations would
inevitably lead to fragmentation in the global swaps market--itself
a potential source of systemic risk.\10\ Instead, we should adopt a
framework that applies CFTC regulations outside the United States
only when it addresses one or more important risks to our country.
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\10\ See FSB Report on Market Fragmentation (June 4, 2019),
available at: https://www.fsb.org/wp-content/uploads/P040619-2.pdf.
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Furthermore, we should afford comity to other regulators who
have adopted comparable regulations, just as we expect them to do
for us. This is especially important when we evaluate whether
foreign subsidiaries of U.S. parents could pose a significant risk
to our financial system. The categorical imperative leads us to an
unavoidable result: We should not impose our regulations on the non-
U.S. activities of non-U.S. companies in those jurisdictions that
have comparable capital and margin requirements to our own.\11\ By
the same token, when U.S. subsidiaries of foreign companies operate
within our borders, we expect them to follow our laws and
regulations and not apply rules from their home country.
---------------------------------------------------------------------------
\11\ See, e.g., Comments of the European Commission in respect
of CFTC Staff Advisory No. 13-69 regarding the applicability of
certain CFTC regulations to the activity in the United States of
swap dealers and major swap participants established in
jurisdictions other than the United States (Mar. 10, 2014),
available at: https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59781&SearchText= (``In order to ensure that
cross-border activity is not inhibited by the application of
inconsistent, conflicting or duplicative rules, regulators must work
together to provide for the application of one set of comparable
rules, where our rules achieve the same outcomes. Rules should
therefore include the possibility to defer to those of the host
regulator in most cases.'').
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Charity, it is often said, begins at home. The categorical
imperative further compels us to avoid duplicating the work of other
American regulators. If a foreign subsidiary of a U.S. financial
institution is subject to consolidated regulation and supervision by
the Federal Reserve Board, then we should rely on our domestic
counterparts to do their jobs when it is a question of dealing
activity outside the United States. The Federal Reserve Board has
extensive regulatory and supervisory tools to ensure a financial
[[Page 1007]]
holding company is prudent in its risk taking at home and
abroad.\12\ The CFTC does not have similar experience, and therefore
should focus on regulating dealing activity within the United States
or with U.S. persons.
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\12\ For example, the Federal Reserve Board requires all foreign
branches and subsidiaries ``to ensure that their operations conform
to high standards of banking and financial prudence.'' 12 CFR
211.13(a)(1). Furthermore, they are subject to examinations on
compliance. See Bank Holding Company Supervision Manual, Section
3550.0.9 (``The procedures involved in examining foreign
subsidiaries of domestic bank holding companies are generally the
same as those used in examining domestic subsidiaries engaged in
similar activities.'').
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(3) Pursue SEC Harmonization Where Appropriate
In the jurisdictional fight over swaps, Congress split the baby
between the CFTC and the SEC in Title VII of the Dodd-Frank Act.\13\
The SEC got jurisdiction over security-based swaps, and we got
jurisdiction over all other swaps--the vast majority of the current
market.\14\ Congress also required both Commissions to consult and
coordinate our respective regulatory approaches, and required us to
treat economically similar entities or products in a similar
manner.\15\ Simple enough, right? Wrong.
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\13\ This was unfortunately nothing new. On a number of
occasions prior to the Dodd-Frank Act, the CFTC and SEC fought over
jurisdiction of certain derivative products. See, e.g., In Board of
Trade of the City Of Chicago v. Securities and Exchange Commission,
677 F. 2d 1137 (7th Cir. 1982) (finding that the SEC lacked the
authority to approve CBOE to trade options on mortgage-backed
securities because the options fell within the CFTC's exclusive
jurisdiction).
\14\ The swaps market is significantly larger than the security-
based swaps market. Aggregating across all major asset classes in
the global derivatives market, dominated by interest rates and FX,
the ratio exceeds 95% swaps to 5% security-based swaps by notional
amount outstanding. This ratio holds even with relatively
conservative assumptions like assigning all equity swaps (a small
asset class) to the security-based swaps category. See Bank for
International Settlements, OTC derivatives outstanding (Updated 8
December 2019), available at: https://www.bis.org/statistics/derstats.htm.
\15\ See Section 712(a)(7) of the Dodd-Frank Act.
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The CFTC and the SEC could not even agree on a basic concept
that is not even particular to financial regulation: Who is a ``U.S.
person.'' In what can only be described as a bizarre series of
events, the CFTC and the SEC adopted different definitions of ``U.S.
person'' in our respective cross-border regimes. I find it surreal
that two federal agencies that regulate similar products pursuant to
the same title of the same statute--with an explicit mandate to
``consult and coordinate'' with each other--have not agreed until
today on how to define ``U.S. person.'' This failure to coordinate
has increased operational and compliance costs for market
participants.\16\ And that is why I am pleased that our proposal
uses the same definition of U.S. person that is in the SEC's cross-
border rulemaking.
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\16\ See, e.g., Futures Industry Association Letter re:
Harmonization of SEC and CFTC Regulatory Frameworks (Nov. 29, 2018),
available at: https://fia.org/articles/fia-offers-recommendations-cftc-and-sec-harmonization.
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To be sure, as my colleagues have said on several occasions, we
should not harmonize with the SEC merely for the sake of
harmonization.\17\ I agree that we should harmonize only if it is
sensible. In the first instance, we must determine whether Congress
has explicitly asked us to do something different or implicitly did
so by giving us a different statutory mandate. It also requires us
to consider whether differences in our respective products or
markets warrant a divergent approach. Just as the proposed rule
takes steps toward harmonization, it also diverges where
appropriate.
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\17\ See, e.g., Dissenting Statement of Commissioner Dan M.
Berkovitz, Rulemaking to Provide Exemptive Relief for Family Office
CPOs: Customer Protection Should be More Important than Relief for
Billionaires (Nov. 25, 2019), available at: https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement112519 (``The
Commission eliminates the notice requirement largely on the basis
that this will harmonize the Commission's regulations with those of
the SEC. Harmonization for harmonization's sake is not a rational
basis for agency action.'').
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The prime example is the approach we have taken with respect to
``ANE Transactions.'' \18\ ANE Transactions are swap (or security-
based swap) transactions between two non-U.S. persons that are
``arranged, negotiated, or executed'' by their personnel or agents
located in the United States, but booked to entities outside
America. While some or all of the front-end sales activity takes
place in the United States, the financial risk of the transactions
resides overseas.
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\18\ See SEC, Proposed Rule Amendments and Guidance Addressing
Cross-Border Application of Certain Security-Based Swap
Requirements, 84 FR 24206 (May 24, 2019), available at: https://www.govinfo.gov/content/pkg/FR-2019-05-24/pdf/2019-10016.pdf.
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Here, key differences in the markets for swaps and security-
based swaps are dispositive. The swaps market is far more global
than the security-based swaps market is. While commodities such as
gold and oil are traded throughout the world, equity and debt
securities trade predominantly in the jurisdictions where they were
issued. For this reason, security-based swaps are inextricably tied
to the underlying security, and vice versa. This is particularly the
case with a single-name credit default swap. The arranging,
negotiating, or execution of this kind of security-based swap is
typically done in the United States because the underlying reference
entity is a U.S. company. Because security-based swaps can affect
the price and liquidity of the underlying security, the SEC has a
legitimate interest in requiring these transactions to be reported.
By contrast, because commodities are traded throughout the world,
there is less need for the CFTC to apply its swaps rules to ANE
Transactions.\19\
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\19\ Under the proposal, persons engaging in any aspect of swap
transactions within the United States remain subject to the CEA and
Commission regulations prohibiting the employment, or attempted
employment, of manipulative, fraudulent, or deceptive devices, such
as section 6(c)(1) of the CEA (7 U.S.C. 9(1)) and Commission
regulation 180.1 (17 CFR 180.1). The Commission thus would retain
anti-fraud and anti-manipulation authority, and would continue to
monitor the trading practices of non-U.S. persons that occur within
the territory of the United States in order to enforce a high
standard of customer protection and market integrity. Even where a
swap is entered into by two non-U.S. persons, we have a significant
interest in deterring fraudulent or manipulative conduct occurring
within our borders, and we cannot let our country be a haven for
such activity.
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In addition, as noted above, Congress directed the CFTC to
regulate foreign swaps activities outside the United States that
have a ``direct and significant'' connection to our financial
system. Congress did not give a similar mandate to the SEC. As a
result of its different mandate, the SEC has not crafted its cross-
border rule to extend to an SRS engaged in swap dealing activity
offshore that may pose a systemic risk to our financial system. Our
proposed rule does, aiming to protect American taxpayers from
another Enron conducting its swaps activities through a major
foreign subsidiary.\20\
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\20\ The SEC's cross-border rule would, however, appear to
extend to a foreign-to-foreign transaction not involving the
arranging, negotiation, or execution of the trade in the United
States if the transaction involved an SEC-registered broker-dealer.
---------------------------------------------------------------------------
Conclusion
In sum, the proposed rule before us today represents a critical
step toward finalizing the regulations Congress asked of us nearly a
decade ago. I believe our proposal is also a sensible and principled
approach to addressing when foreign transactions should fall within
the CFTC's swaps registration and related requirements.
Perhaps President Eisenhower said it best: ``The world must
learn to work together, or finally it will not work at all.'' \21\
My sincere hope is that our domestic and international counterparts
will view this proposal as a concrete step toward working together
to provide sound regulation to the global swaps market.
---------------------------------------------------------------------------
\21\ Transcript of President Dwight D. Eisenhower's Farewell
Address (1961), available at: https://www.ourdocuments.gov/doc.php;?flash=true&doc=90&page=transcript.
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Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I am very pleased to support today's proposed rule, which, in my
view, delineates important boundaries of the Commission's regulation
of swaps activity conducted abroad, which would codify elements of
the Commission's 2013 interpretive guidance,\1\ and make important
adjustments with the benefit of six years' additional experience in
swaps market oversight.
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\1\ Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292 (July 26,
2013).
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Direct AND Significant
As I have said before, the foundational principle underlying any
CFTC regulation of cross-border swaps activity, and the prism
through which all extraterritorial reach by the CFTC must be viewed,
is the statutory directive from Congress that the agency may only
regulate those activities outside the United States that ``have a
direct and
[[Page 1008]]
significant connection with activities in, or effect on commerce of,
the United States.'' \2\ Congress deliberately placed a clear and
strong limitation on the CFTC's extraterritorial reach, recognizing
the need for international comity and deference in a global swaps
market.
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\2\ Sec. 2(i) of the Commodity Exchange Act (CEA).
---------------------------------------------------------------------------
I believe the proposal strikes a strong balance in interpreting
Section 2(i) of the CEA. The proposal before us would interpret this
provision in ways that both provide important safeguards to the U.S.
financial markets, and avoid duplicative regulation or
disadvantaging U.S. commercial and financial institutions acting in
foreign markets.
Registration
The proposal would require a foreign institution dealing in
swaps to count the notional value of the swaps it executes towards
the CFTC's recently finalized $8 billion registration threshold \3\
only in certain, enumerated circumstances that clearly concern U.S.
institutions and implicate risk to the U.S. financial system when
that risk is not otherwise addressed by the Commission or by the
banking regulators.\4\ I would like to highlight a few of these
circumstances.
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\3\ CFTC regulation 1.3 (definition of swap dealer, paragraph
(4)), promulgated by De Minimis Exception to the SD Definition, 83
FR 56666 (Nov. 13, 2018) (final rule).
\4\ Proposed CFTC regulation 23.23(b).
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First, a foreign swap dealing firm would generally be required
to count swaps executed opposite a ``U.S. person.'' \5\ I believe
the proposed definition of U.S. person \6\ is an improvement upon
the one included in the 2013 guidance.\7\ The proposed definition of
U.S. person is also consistent with the one published by the SEC in
connection with that agency's oversight over security-based SDs and
MSPs.\8\ Only in Washington could two financial regulators have
different definitions of a U.S. Person. Such a harmonized
definition, if finalized, will facilitate compliance with the CFTC's
and SEC's swaps regulations by dually registered entities. The
proposed definition is largely similar to the definition of U.S.
person issued by the Commission in 2016 in connection with the rule
for cross-border applicability of the margin requirements for
uncleared swaps,\9\ and more streamlined than the one included with
the Commission's 2013 cross-border guidance, for example in the
context of investment funds. This will make it easier for market
participants readily to determine their status. One element of the
definition that I would like to highlight, an element that is
consistent with the SEC's rule, is that an investment fund would be
considered a U.S. person if the fund's primary manager is located in
the U.S.\10\ (proposed 23.23(a)(22)(ii)).
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\5\ Proposed 23.23(b)(1).
\6\ Proposed 23.23(a)(22).
\7\ Interpretive Guidance, 45,316-317.
\8\ Securities and Exchange Act rule 3a71-3(a)(3)(ii) & (4)(iv),
promulgated by Application of ``Security-Based Swap Dealer'' and
``Major Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities, 79 FR 47278, 47313 (Aug. 12,
2014).
\9\ CFTC regulation 23.160(a)(10), promulgated by Margin
Requirements for Uncleared Swaps for SDs and MSPs--Cross-Border
Application of the Margin Requirements, 81 FR 34818 (May 31, 2016).
\10\ Proposed 23.23(a)(22)(ii).
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In addition to counting swaps opposite a U.S. person, a foreign
firm would also be required to count swaps executed opposite a non-
U.S. entity, if that firm's obligations under the swap are
``guaranteed'' by a U.S. person, or if the counterparty's
obligations are U.S.-guaranteed.\11\ Here too, the proposal provides
a simpler, more targeted definition of guarantee \12\ than the one
published in the 2013 guidance,\13\ and the definition is consistent
with the one included in the Commission's cross-border rule for
uncleared swap margining.\14\ The definition would include an
arrangement under which a party to a swap has rights of recourse
against a guarantor, including traditional guarantees of payment or
performance, but it would not include other financial arrangements
or structures such as ``keepwells and liquidity puts'' or master
trust agreements.
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\11\ Proposed 23.23(b)(2)(ii) and (iii).
\12\ Proposed 23.23(a)(8).
\13\ Interpretive Guidance, 45,318-20.
\14\ 23.160(a)(2).
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Notably, if a non-U.S. firm's obligations to a swap are
guaranteed by a non-financial U.S. entity (meaning a U.S. commercial
end-user), then that swap would be excluded from the foreign
dealer's tally towards possible CFTC registration.\15\ Commercial
end-users typically enter into swaps for hedging purposes, and their
swaps generally pose less risk to the financial system than swaps by
financial institutions. The fact that a foreign dealer would not be
required to count a swap with a U.S.-guaranteed commercial end-user
towards the dealer's possible CFTC registration may give foreign
subsidiaries of U.S. commercial firms a greater choice of swap
dealers. This flexibility is consistent with Congress' decision not
to apply to commercial end-users either the requirement that certain
swaps be cleared at a derivatives clearing organization (DCO)
(``swap clearing requirement'') or that uncleared swaps be subject
to margin requirements.\16\
---------------------------------------------------------------------------
\15\ Proposed 23.23(b)(2)(iii)(2).
\16\ Secs. 2(h)(1) and 4s(e) of the CEA, implemented by parts 50
and 23 subpart E of the Commission's regulations.
---------------------------------------------------------------------------
I would also like to highlight that the proposal properly does
not require a foreign dealer to count towards the CFTC's
registration threshold a swap opposite a foreign branch of a U.S.
institution already registered with the CFTC as an SD.\17\ While a
U.S. SD of course stands behind a swap executed by its foreign
branch, I believe it makes sense for the Commission not to require a
foreign dealer to count that swap towards the foreign dealer's tally
for possible CFTC registration because the CFTC is already
overseeing the U.S. firm, and its swaps, due to the U.S. firm's SD
registration.
---------------------------------------------------------------------------
\17\ Proposed 23.23(b)(2)(i).
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FCS--Not ``Significant'' on Accounting Consolidation Alone
Today's proposal makes an important, and appropriate,
distinction from the Commission's 2016 proposal on the cross-border
application of the SD registration threshold and SD business conduct
standards.\18\ That proposal would have required thousands of non-
U.S. firms to count all of their dealing swaps, with U.S. and non-
U.S. counterparties alike, towards possible CFTC SD registration.
For instance, the 2016 proposed rule would have required every
foreign subsidiary of a U.S. firm that, for accounting purposes,
consolidates its financial statements into its parent, (referred to
as a ``foreign consolidated subsidiary'') to count all of its
swaps.\19\ While an accounting link between a foreign subsidiary and
its U.S. parent may have satisfied the ``direct'' connection to U.S.
activities under CEA 2(i), an accounting link alone is meaningless
in terms of the 2(i) ``significant'' connection to commerce of the
U.S.
---------------------------------------------------------------------------
\18\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to SDs and MSPs, 81
FR 71946 (Oct. 18, 2016) (proposed rule).
\19\ 2016 proposed regulations 1.3(ggg)(7) and 1.3(aaaaa).
---------------------------------------------------------------------------
By contrast, today's proposal creates a sensible
``significance'' test for a foreign subsidiary of a U.S. firm
through the classification of a ``significant risk subsidiary,''
which would be required to count every dealing swap towards possible
CFTC SD registration.\20\ The proposed significant risk subsidiary
class targets only a foreign entity that may present major risk to a
large U.S. institution and appropriately scopes out the limits of
Section 2(i) of the CEA.\21\ Moreover, a significant risk subsidiary
does not include an entity already subject to supervision either by
the Federal Reserve Board or by a foreign banking regulator
operating under Basel standards in a jurisdiction that the
Commission determined has instituted a margining regime for
uncleared swaps that is comparable to the Commission's framework for
margining uncleared swaps.\22\ This construct makes sense. The
Federal Reserve already reviews swaps activity by foreign
subsidiaries of bank holding companies.\23\ Additionally, the CFTC
[[Page 1009]]
has already found multiple jurisdictions' uncleared margin regimes
comparable to ours. In order to eliminate duplicative regulation,
and for the sake of international comity and respect for foreign
jurisdictions' sovereignty, it is prudent for the Commission to rely
on other authorities, either the Federal Reserve or its counterparts
in comparable jurisdictions, to supervise the swaps entered into by
non-U.S. subsidiaries of the banks they supervise on a consolidated
basis.
---------------------------------------------------------------------------
\20\ Proposed 23.23(a)(12) and 23.23(b)(1).
\21\ In order to be a significant risk subsidiary, the U.S.
parent must have at least $50 billion in global consolidated assets,
and the subsidiary must exceed one of three thresholds (measured
according to a percentage of capital, revenue, or assets) as
compared to its parent (proposed 23.23(a)(12)-(13)). The proposed
definition of ``significant subsidiary'' is consistent with the
definition of this term included in SEC Regulation S-X (17 CFR
210.1-01(w)).
\22\ Proposed 23.23(a)(12)(i)-(ii). To date, the Commission has
determined Australia, the E.U., and Japan to have issued margining
regimes for uncleared swaps comparable to the Commission's (82 FR
48394 (Oct. 18, 2017 (E.U.); 84 FR 12908 (Apr. 3, 2019) (Australia);
and 84 FR 12074 (Apr. 1, 2019) (Japan)).
\23\ Federal Reserve Board, Bank Holding Co. Supervision Manual,
sec. 2100.0.1 Foreign Operations of U.S. Banking Organizations,
available at, https://www.federalreserve.gov/publications/files/bhc.pdf.
---------------------------------------------------------------------------
By limiting the number of foreign firms registered with the CFTC
as SDs, I believe the Commission, together with the National Futures
Association (NFA), will best apply the agency's limited resources to
the non-U.S. entities outside of the Federal Reserve's purview,
especially given that there are already over 100 registered SDs
organized in more than 10 countries.\24\
---------------------------------------------------------------------------
\24\ List of SDs available on the CFTC's website at, https://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.html.
---------------------------------------------------------------------------
Business Conduct Requirements
In addition to setting boundaries in the area of non-U.S. firms
counting swaps towards possible CFTC registration, today's proposal
would build on the 2013 guidance by providing certainty regarding
when a non-U.S. firm, which is registered with the CFTC as an SD,
must comply with the Commission's SD standards. Again, importantly
and appropriately out of respect for foreign jurisdictions, the
proposal would exempt swaps executed with certain counterparties
located abroad and make available compliance with local rules that
the CFTC has determined comparable to its own (``substituted
compliance'').\25\ The proposed rule also sets forth exemptions and
substituted compliance for foreign branches of U.S. financial
institutions registered as SDs with the CFTC.\26\ As in 2013, the
Commission believes that certain of the Commission's SD rules, or
comparable foreign rules, should apply to every registered SD,
including one organized in a foreign jurisdiction, with respect to
all of the dealer's swaps, namely requirements concerning: A Chief
Compliance Officer; a risk management program, including special
rules for when the SD is a member of a DCO; addressing conflicts of
interest and antitrust considerations; recordkeeping; disclosing
information to the CFTC and banking regulators; and position limits
monitoring (collectively, the ``Group A requirements'').\27\ I note
that substituted compliance is currently available for particular
Group A requirements for SDs established in, and operating out of,
Australia, Canada, the E.U., Hong Kong, Japan, and Switzerland.\28\
With regard to other SD requirements, namely daily trading
records, confirmations, documentation, and portfolio reconciliation
and compression (collectively, the ``Group B requirements''),\29\
today's proposal reasonably exempts foreign firms registered with
the Commission as SDs, as well as foreign branches of U.S.
registered as SDs, from these requirements for swaps with certain
counterparties located outside of the U.S., including those non-U.S.
counterparties whose swap obligations are not guaranteed by a U.S.
person and those foreign counterparties not covered by the proposed
definition of significant risk subsidiary.\30\ As with the 2013
guidance, substituted compliance is also available.\31\ Finally,
under today's proposal, both a non-U.S. firm registered with the
Commission as an SD, and the foreign branch of a U.S. firm
registered as an SD, would only be required to comply with a set of
business conduct requirements, those addressing how registered SDs
transact with certain counterparties (collectively, the ``Group C
requirements''),\32\ for swaps with U.S. counterparties, but not
with non-U.S. counterparties.\33\
---------------------------------------------------------------------------
\25\ Proposed 23.23(e)-(f).
\26\ Id.
\27\ CFTC regulations 3.3, 23.201, 23.203, 23.600-607, and
23.609 (referred to by the Proposal as the ``Group A requirements''
(proposed 23.23(a)(5) and 23.23(e)-(f)). ``Entity-level''
comparability determinations, available at, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\28\ ``Entity-level'' comparability determinations, available
at, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\29\ CFTC regulations 23.202 and 501-504 (referred to by the
Proposal as the ``Group B requirements (proposed 23.23(a)(6)).
\30\ Proposed 23.23(e)(2).
\31\ Proposed 23.23(f)(2). Currently, substituted compliance for
certain Group B requirements is available for SDs organized in the
E.U. and in Japan. These comparability determinations are available
at, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm.
\32\ CFTC regulations 23.400-451 (referred to by the proposal as
the Group C requirements (proposed 23.23.(a)(7)).
\33\ Proposed 23.23(e)(1)(ii).
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``ANE''--Eliminating the ``Elevator Test''
Today's proposal makes an important distinction from how the
Commission's Division of Swap Dealer and Intermediary Oversight
(DSIO) addressed compliance with ``transaction-level requirements''
(referred to in today's proposal as Groups B and C requirements) in
2013. A November 2013 DSIO Advisory \34\ suggested that a foreign
CFTC-registered SD must comply with CFTC transaction-level
requirements even in connection with a swap opposite another non-
U.S. person if the SD used personnel located in the U.S. to
``arrange,'' ``negotiate'' or ``execute'' (ANE) the swap. Such a
broad, vague, and burdensome application caused such widespread
confusion and international condemnation that it was, within 13 days
of publishing, placed under no-action relief.\35\ That no-action
relief exists to this day, having been renewed six times.\36\
---------------------------------------------------------------------------
\34\ CFTC Staff Advisory 13-69 (Nov. 14, 2013).
\35\ CFTC Letter 13-71 (Nov. 26, 2013).
\36\ CFTC Letters 14-01, 14-74, 14-140, 15-48, 16-64, and 17-36.
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Prudently, today's proposal eliminates the ANE standard. I
believe the Commission should only consider applying its
transaction-level requirements to a foreign registered SD when a
swap is executed opposite a U.S. counterparty.\37\ The fact that the
foreign SD may be using U.S. personnel to support the transaction
does not implicate how the swap should be executed with a foreign
counterparty. Under the limited extra-territorial jurisdiction
Congress gave to the CFTC in overseeing the swaps market, it is
appropriate that the Commission refrains from requiring foreign
firms to comply with the CFTC's SD transaction-level requirements,
or comparable foreign requirements, for swaps where both
counterparties are outside of the United States and there is no U.S.
nexus.
---------------------------------------------------------------------------
\37\ I note that the proposal also appropriately applies the
Group B requirements to a swap involving a non-U.S. person that is
either U.S.-guaranteed or a significant risk subsidiary (proposed
23.23.(e)(2)).
---------------------------------------------------------------------------
Enhancing Substituted Compliance
I am pleased that today's proposal codifies a process under
which the Commission will issue future substituted compliance
determinations.\38\ Substituted compliance is the lynchpin of a
global swaps market. Said differently, the absence of regulatory
deference has been the fracturing sound we hear as the global swaps
market fragments. The 11 substituted compliance determinations the
Commission has issued to date for registered SDs, concerning
business conduct and uncleared swap margining rules, highlight the
progress other jurisdictions have made in issuing swaps rules. While
not identical, those rulesets largely address the same topics and
guard against the same risks. I hope that the Commission will soon
be in a position to issue additional comparability determinations,
particularly for Group B requirements. Whereas Group A substituted
compliance determinations have been issued for six jurisdictions
(Australia, Canada, the E.U., Hong Kong, Japan, and Switzerland),
Group B substituted compliance determinations have been issued for
only two jurisdictions (the E.U. and Japan).
---------------------------------------------------------------------------
\38\ Proposed 23.23(f).
---------------------------------------------------------------------------
In conclusion, I am pleased that the Commission is making
meaningful progress in providing legal certainty to the market with
regard to complying with the Dodd-Frank swaps regulations on a
cross-border basis. I hope that the Commission will soon propose
other cross-border regulations regarding other areas of the CFTC's
swap regulations, including the swap clearing requirement, the trade
execution requirement,\39\ and the swaps reporting requirement.\40\
---------------------------------------------------------------------------
\39\ Sec. 2(h)(8) of the CEA, implemented by CFTC part 37.
\40\ Secs. 2(a)(13) and 21 of the CEA, implemented by CFTC parts
43 and 45.
---------------------------------------------------------------------------
I would like to thank the staff of DSIO for their efforts on
this proposal, as well as a personal thank you to Matt Daigler from
the Chairman's office, who worked tirelessly on this proposal and
its unpublished predecessor and has held countless conversations
with me and my staff on this issue over the past year.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
Introduction
I respectfully dissent from the Commodity Futures Trading
Commission's (the ``Commission'' or ``CFTC'') notice of proposed
rulemaking addressing the cross-border application of the
registration
[[Page 1010]]
thresholds and certain requirements applicable to swap dealers
(``SDs'') and major swap participants (``MSPs'') (the ``Proposal'').
I support the Commission's effort to make good on its commitment to
periodically review its approach to evaluating the circumstances
under which the swaps provisions of Title VII of the Dodd-Frank Act
\1\ ought to apply to swap dealing and related activities outside
the United States.\2\ Indeed, the Guidance currently in place and
Section 2(i) of the Commodity Exchange Act (the ``Act'' or ``CEA'')
itself provide the Commission the flexibility to evaluate its
approach on a case-by-case basis, affording interested and affected
parties the opportunity to present facts and circumstances that
would inform the Commission's application of the relevant
substantive Title VII provisions in each circumstance.\3\ Today, the
Commission, without adequate explanation of its action,
consideration of alternatives, or deference to the wisdom of the
United States District Court for the District of Columbia on the
matter, is proposing to discard both the existing Guidance and the
use of agency guidance and non-binding policy statements altogether
in addressing the cross-border reach of its authority in favor of
hard and fast rules. I simply do not believe the Commission has made
a strong enough case for wholesale abandonment of guidance at this
point in the evolution of our global swaps markets, and in light of
current events that are already impacting market participants and
their view of the future global swaps landscape. As well, I have
serious questions and concerns as to what the Commission may give up
should the Proposal be codified in its current form.
---------------------------------------------------------------------------
\1\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203 section 712(d), 124 Stat. 1376, 1644 (2010)
(the ``Dodd-Frank Act'').
\2\ See Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swaps Regulations, 78 FR 45292, 45297 (Jul.
26, 2013) (the ``Guidance'').
\3\ Id.
---------------------------------------------------------------------------
Whereas the Commission understands the scope of our
jurisdictional reach with respect to Title VII, a federal district
court has affirmed that understanding, and we have operated within
such boundaries--aware of the risks and successfully responding in
kind, the Commission is now making a decision based on the most
current thinking that we should retreat under a banner of comity and
focus only on that which can fit on the head of a pin. Oddly enough,
that pin will hold only the giants of the swaps market. Indeed,
where our jurisdiction stands on its own, the ability to exercise
our authority through adjudication \4\ and enforcement has allowed
the Commission to articulate policy fluidly, refining our approach
as circumstances change without the risk of running afoul of our
mandate. Today's Proposal suggests that we can resolve all
complexities in one fell swoop if we alter our lens, abandon our
longstanding and literal interpretation of CEA section 2(i), and
limit ourselves to a purely risk-based approach. I cannot support an
approach that would limit our jurisdiction and consequently
oversight directly in conflict with Congressional intent, and
potentially expose the U.S. to systemic risk.
---------------------------------------------------------------------------
\4\ See 5 U.S.C. 554.
---------------------------------------------------------------------------
Throughout the preamble, the Proposal evinces a clear
understanding that the complexity of swaps markets, transactions,
corporate structures and market participants create channels through
which swaps-related risks warrant our attention by meeting the
jurisdictional nexus described in CEA Section 2(i).\5\ However, in
many instances, we manage to simply acknowledge the obvious risk and
step aside in favor of the easier solution of doing nothing,
assuming that the U.S. prudential regulators will act on our behalf,
or waving the comity banner. The Proposal provides shorthand
rationales for each of its decision points without the support of
data or direct experience as if doing so would reveal the vision's
vulnerabilities. Perhaps most concerning are the Proposal's
contracted definitions of ``U.S. person'' and ``guarantee,'' its
introduction of ``substantial risk subsidiaries,'' and its
determination that ``ANE'' means something akin to ``absolutely
nothing to explain'' regarding our jurisdictional interest--even
when activities are occurring within the territorial United States.
These represent some notable examples where the Proposal undermines
the core protections sought to be addressed by section 2(i), as the
Commission has, until now, understood them to be.
---------------------------------------------------------------------------
\5\ See, e.g., Proposal at I.B., I.C., II.B, II.C., V, and VII.
---------------------------------------------------------------------------
My concerns aside for a moment, I am grateful that within the
four corners of the document, the requests for comment seek to build
consensus and operatively provide the public an option to maintain
the status quo with regard to most aspects of the Guidance--albeit
without sticking with guidance. While this leads me to more
questions as to whether and how the Proposal could go final absent
additional intervening process, I am pleased that there is
recognition that the public and market participants may have lost
their appetite for this brand of rulemaking or perhaps have come to
agree with the D.C. District Court that the Commission's decision to
issue the Guidance benefits market participants.\6\ Further, as the
Commission currently engages with our foreign counterparts regarding
impending regulatory matters related to Brexit, I hope we are
measured in timing and substance on the Proposal.
---------------------------------------------------------------------------
\6\ See SIFMA v. CFTC, 67 F.Supp.3d 373, 426-427, 429 (D.D.C.
2014) (finding the CFTC's choice to address extraterritorial
application of the Title VII Rules incrementally and through the
Guidance reasonable, ``particularly, where, as here, `the agency may
not have had sufficient experience with a particular problem to
warrant rigidifying its tentative judgment into a hard and fast
rule' and `the problem may be so specialized and varying in nature
as to be impossible to capture within the boundaries of a general
rule.' '' (quoting SEC v. Chenery Corp., 332 U.S. 194, 202-203, 67
S.Ct. 1760, 90 L.Ed 1995(1947))).
---------------------------------------------------------------------------
Before I highlight certain aspects of the Proposal, I want to
take a brief moment to acknowledge why--as a general matter--we are
here, and why this particular proposal is so important. Without
rehashing market realties that led to the economic devastation of
2008, it should never be lost on our collective consciousness that a
significant driving force that exacerbated the financial crisis and
great recession, at least within the context of the over-the-counter
derivatives market, was housed overseas. Although much of the risk
completed its journey within the continental U.S., it was conjured
up in foreign jurisdictions.\7\ But, as we all also know too well,
more than 10 years later, despite the products often being
constructed, sold, and traded overseas, the highly complex web of
relationships between holding companies, subsidiaries, affiliates,
and the like, created a perfect storm that brought our financial
markets to a near halt, and the global economy to a shudder. Those
experiences should always serve as the foundation from which we
craft cross-border derivatives policy. Always.
---------------------------------------------------------------------------
\7\ See Guidance, 78 FR at 45293-5; SIFMA v. CFTC, 67 F.Supp.3d
at 387-88 (describing the ``several poster children for the 2008
financial crisis'' that demonstrate the impact that overseas over-
the-counter derivatives swaps trading can have on a U.S. parent
corporation).
---------------------------------------------------------------------------
Cutting to the Chase on Codification
Since 2013, when the Commission announced its first cross-border
approach in flexible guidance as a non-binding policy statement,\8\
the Commission has understood that addressing the complex and
dynamic nature of the global swaps market cannot be described in
black and white, and that even describing it in shades of gray
quickly overwhelms our regulatory sensibilities. Cutting through the
haze with bright line rules for identity, ownership, control, and
attribution to find comfort in comity seems to be our approach in
addressing the nature of risk in the global swaps market. However,
Congress has granted the Commission authority without any attendant
instruction to engage in rulemaking.\9\ Under such circumstances,
the Commission must critically evaluate whether a rule-driven
application of policy amid a global market that is only growing in
size and in its complexity may prove inadequate as we carry out our
mandate and protect our domestic interests. It seems in this
instance that the Commission is barreling toward hard and fast
comprehensive rules without acknowledging the benefits of what we
have today.
---------------------------------------------------------------------------
\8\ See Guidance, 78 FR at 45292.
\9\ SIFMA v. CFTC, 67 F.Supp.3d at 423-25, 427 (finding that
Section 2(i) operates independently and provides the CFTC with the
authority--without implementing regulations--to enforce the Title
VII Rules extraterritorially); See also, Id. at 427 (``Although many
provisions in the Dodd-Frank Act explicitly require implementing
regulations, Section 2(i) does not.'').
---------------------------------------------------------------------------
To be clear, while I support the Commission's efforts to address
problems resulting from its current approach to regulating swaps
activities in the cross-border context, it is not clear to me at
this moment that we have reached a point where codification would
provide immediate benefits to either the Commission or the public.
While the Guidance is complex, it is difficult to say it is any more
complex than the Proposal. The complexity is and will be inherent to
whatever action we take as it,
[[Page 1011]]
``merely reflects the complexity of swaps markets, swaps
transactions, and the corporate structures of the market
participants that the CFTC regulates.'' \10\ It is this type of
complexity that supported the Commission's initial determination to
issue the Guidance, and to my knowledge, such determination has not
hindered the Commission's ability to pursue enforcement actions that
apply Title VII extraterritorially \11\ or to participate in
discourse with and decision-making among our fellow international
financial regulators.
---------------------------------------------------------------------------
\10\ Id. at 419-20 (``Indeed, the complexity of a regulatory
issue is one reason an agency might choose to issue a non-binding
policy statement rather than a rigid `hard and fast rule.' ''
(citing SEC v. Chenery Corp., 332 U.S. 194, 202-203, 67 S.Ct. 1760,
90 L.Ed 1995(1947))).
\11\ See, e.g., SIFMA v. CFTC, 67 F.Supp.3d at 421, (``Indeed,
even after promulgating the Cross-Border Action, the CFTC has relied
solely on its statutory authority in Section 2(i) when bringing
enforcement actions that apply to Title VII Rules
extraterritorially.'').
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CEA Section 2(i) Preservation
As recognized by the D.C. District Court, the Title VII
statutory and regulatory requirements apply extraterritorially
through the independent operation of CEA section 2(i), which the
CFTC is charged with enforcing.\12\ Congress did not direct--and has
not since directed--the Commission to issue rules or even guidance
regarding its intended enforcement policies pursuant to CEA section
2(i). To the extent the CFTC interpreted Section 2(i) in the
Guidance, an interpretation carried forward in the Proposal, such
interpretation is drawn linguistically from the statute; its
interpretation has not substantively changed the regulatory
reach.\13\ Putting aside the anti-evasion prong in CEA section
2(i)(2), it remains that the Commission construes CEA section 2(i)
to apply the swaps provisions of the CEA to activities, viewed in
the class or aggregate, outside the United States that, meet either
of two jurisdictional nexus: (1) A direct and significant effect on
U.S. commerce; or (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.\14\ Accordingly, to
any extent the Commission is moving away from guidance towards
substantive rulemaking, it must preserve that interpretation.
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\12\ SIFMA v. CFTC, supra note 9.
\13\ SIFMA v. CFTC, 67 F.Supp.3d at 424.
\14\ See Proposal at C.1.; Guidance, 78 FR at 45292, 45300; see
also SIFMA v. CFTC, 67 F.Supp.3d at 424-5.
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As I read the Proposal--which purports to reflect the
Commission's current views \15\--I cannot help but notice that our
``risk-based approach'' seems to focus on individual entities that
present a particular category of significant risk--the giants among
global swap market participants-- and ignores smaller pockets of
risk that, in the aggregate, may ultimately raise systemic risk
concerns.\16\ What is lacking is any discussion of how our laser
focus on individual corporate families and their ability to
singularly impact systemic risk to the U.S. financial system
adequately ensures that we are not disregarding the potential for
similar swap dealing activities of groups of market participants,
regardless of individual size, and in the aggregate, present a
similar risk profile, or at the least a risk profile worth
monitoring. Perhaps more troubling, the Proposal is focused largely
on the threshold matter of swap dealer registration requirements.
However, as the Commission has acknowledged, ``Neither the statutory
definition of `swap dealer' nor the Commission's further definition
of that term turns solely on risk to the U.S. financial system.''
\17\ And to that end, ``[T]he Commission does not believe that the
location of counterparty credit risk associated with a dealing
swap--which . . . is easily and often frequently moved across the
globe--should be determinative of whether a person's dealing
activity falls within the scope of the Dodd-Frank Act.'' \18\
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\15\ Proposal at I.A.
\16\ The Commission proposes to limit its supervisory oversight
outside the United States, ``only as necessary to address risk to
the resiliency and integrity of the U.S. financial system.''
Proposal at I.D. (emphasis supplied).
\17\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to Swap Dealers and
Major Swap Participants, 81 FR 71946, 71952 (Oct. 18, 2016) (``2016
Proposal'').
\18\ Id.
---------------------------------------------------------------------------
I also cannot help but notice the Proposal seems to frequently
reference ``comity'' without providing supporting rationales for
deferring to our fellow domestic regulators and foreign counterparts
or for providing per se exemptions. I support working closely with
foreign regulators to address potential conflicts with respect to
each of our respective regulatory regimes, and I believe that our
cross-border approach must absolutely align with principles of
international comity. But, I do not understand how we can reach
regulatory absolutes and conclusions based on comity, absent a
finding that the exercise of our authority under CEA section 2(i)
would be patently unreasonable under international principles. I
believe that substituted compliance is generally the most workable
and respectful solution, and I believe we must engage with our
fellow global regulators to address matters of risk that may impact
each of our jurisdictions regardless of size and nature.
Contraction Justifies Inaction--``U.S. Persons'' and ``Guarantees''
The bulk of the Proposal is dedicated to codifying 23
definitions ``key'' to determining whether certain swaps or swap
positions would need to be counted towards a person's SD or MSP
threshold and in addressing the cross-border application of the
Title VII requirements. While most of the defined terms are familiar
from the Guidance, there are some differences that stand out as more
than a simple exercise in conformity. For example, the preamble of
the Proposal describes the proposed definition of ``U.S. person'' as
``largely consistent with'' and the definition of ``guarantee'' as
``consistent with'' the Commission's Cross-Border Margin Rule.\19\
However, both represent a narrowing in scope from the current
Guidance, and in turn, may potentially retract our authority under
CEA Section 2(i) with respect to swap dealing activities relevant to
swap dealer registration and oversight.
---------------------------------------------------------------------------
\19\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818 (May 31, 2016).
---------------------------------------------------------------------------
With regard to ``U.S. persons,'' the definition harmonizes with
the definition adopted by the Securities and Exchange Commission
(``SEC'') in the context of its regulations regarding cross-border
security-based swap activities, which largely encompasses the same
universe of persons as the Commission's Cross-Border Margin Rule.
However, among other things, the proposed ``U.S. person''
definition, unlike the Cross Border Margin Rule, would not include
certain legal entities that are owned by one or more U.S. person(s)
and for which such person(s) bear unlimited responsibility for the
obligations and liabilities of the legal entity (``unlimited U.S.
responsibility prong'').\20\ In support of its decision, the
Commission puts forth what almost reads as an incomplete syllogism
that fatally fails to address how such relationships may satisfy the
jurisdictional nexus laid out in CEA section 2(i). After noting (1)
that the SEC does not include an unlimited U.S. responsibility prong
because it considers this type of arrangement as a guarantee, and
(2) that when considering the issue in the context of the Cross-
Border Margin rule, the Commission does not view the unlimited U.S.
responsibility prong as equivalent to a U.S. guarantee, the Proposal
states that (3) the Commission is not revisiting its interpretation
of ``guarantee'' and is not including an unlimited U.S.
responsibility prong in the ``U.S. person'' definition because it
``is of the view that the corporate structure that this prong is
designed to capture is not one that is commonly used in the
marketplace.'' \21\
---------------------------------------------------------------------------
\20\ Proposal at II.A.
\21\ Proposal at II.A.
---------------------------------------------------------------------------
To be clear, the Guidance includes an unlimited U.S.
responsibility prong in its interpretation of ``U.S. persons'' for
purposes of applying CEA section 2(i) that is intended to cover
entities that are directly or indirectly owned by U.S. person(s)
such that the U.S. owner(s) are ultimately liable for the entity's
obligations and liabilities.\22\ Among other things, where this
relationship exists, the Commission's stated view is that, ``[W]here
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) . . . '' \23\
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\22\ See Proposal at II.A.; Guidance, 78 FR at 45312-13.
\23\ Guidance, 78 FR at 45312.
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While I am not arguing that the Commission cannot change its
views regarding the necessity for including a U.S. responsibility
prong in a proposed ``U.S. person'' definition, I do believe that if
we do
[[Page 1012]]
so, we must articulate a rationale relevant to the particular
context at issue and explain why our past reasoning with regard to
the jurisdictional nexus is no longer valid.
More concerning, the proposed ``guarantee'' definition is
narrower in scope than the one used in the Guidance in that it would
not include several different financial arrangements and structures
that transfer risk directly back to the United States such as
keepwells and liquidity puts, certain types of indemnity agreements,
master trust agreements, liability or loss transfer or sharing
agreements, etc.\24\ While in this instance, the Proposal explains
the Commission's rationale for the broader interpretation of
``guarantee'' for purposes of CEA section 2(i) in the Guidance, and
admits that the rationale is still valid, it nevertheless chooses to
ignore the truth of the matter and focus on what is more
``workable'' for non-U.S. persons.\25\ Further concerning, as I will
explain shortly, the Proposal puts forth that while the proposed
``guarantee'' definition could lead to entities counting fewer swaps
towards their de minimis threshold calculation relevant to SD
registration as compared to the Guidance, related concerns could be
mitigated to the extent such non-U.S. person meets the definition of
a ``significant risk subsidiary.'' \26\ In this instance, the
Commission is simply ignoring its responsibilities under CEA section
2(i) to save non-U.S. persons a little extra work, or as the
Proposal might say, ``overly burdensome due diligence.'' \27\
---------------------------------------------------------------------------
\24\ Proposal at II.B; See Guidance 78 FR at 45320, n. 267.
\25\ Id.
\26\ Id.
\27\ Proposal at II.
---------------------------------------------------------------------------
SOS on SRS
The introduction of the ``significant risk subsidiary'' or
``SRS'' is perhaps the most elaborate departure from the
Commission's interpretation of CEA section 2(i) and almost seems to
be an attempt to ensure that no non-U.S. subsidiary of a U.S. parent
entity will ever have to consider its swap dealing activities for
purposes of the relevant SD or MSP registration threshold
calculations. Save for a single footnote reference to a request for
comment and passing references to SRSs likely being classified as
conduits in the explanation of Cost-Benefit Considerations, the
Proposal does not mention anything regarding the Guidance's concept
of a conduit affiliate--despite the fact that the SEC includes the
concept of conduit affiliate in its definitions relevant to cross-
border security-based swap dealing activity.\28\ Rather, instead of
elaborating on whether and how the concept of conduit affiliates
described in the Guidance failed to achieve its purpose, is no
longer relevant, resulted in loss of liquidity, fragmentation,
proved unworkable, etc., or should be deleted from all frame of
reference in favor of harmonizing with the SEC, the Proposal simply
introduces the SRS as a new category of person and walks through an
elaborate analysis that really begins where it ends--an exclusion.
It is a policy decision of the worst ilk because it masquerades as a
solution by diminishing the problem.
---------------------------------------------------------------------------
\28\ See 17 CFR 240.3a71-3(a)(1).
---------------------------------------------------------------------------
SRSs represent a tiny subset of the consolidated non-U.S.
subsidiaries of U.S. parent entities that the Commission believes
are of supervisory interest in light of their clear potential to
permit U.S. persons to accrue risk that, in the aggregate, may have
a significant effect on the U.S. financial system or may otherwise
be used for evasion.\29\ The Proposal's stated rationale for
targeting only a subset of non-U.S. subsidiary relationship focuses
on comity and the application of a risk-based approach acts like a
sieve on CEA section 2(i) such that only the largest entities that
themselves as individual entities may pose risk to the financial
system. An approach that outright acknowledges the potential for
widespread swap activities within the scope of CEA section 2(i),
which could ultimately result in significant risk being transferred
back to U.S. parent entities, only to be met with a bright line
induced shrug by the Commission--is simply untenable.
---------------------------------------------------------------------------
\29\ Proposal at II.C.1.
---------------------------------------------------------------------------
Rather than rehashing the elements of the SRS definition, I will
focus on two aspects that I find most troubling. First is the
requirement that the U.S. parent entity meet a $50 billion
consolidated asset threshold. This threshold is intended to limit
the SRS definition to only those entities whose U.S. parent entity
may pose a systemic risk to the U.S. financial system. Foremost,
given CEA section 2(i)'s focus on activities in the aggregate, a
bright line threshold at the entity level is irrelevant. Not to
mention that if Congress had wanted the Commission to focus its
cross-border authority on systemically significant entities, it
would have used language that was not so embedded in common law \30\
or would have articulated that directive clearly in the Dodd-Frank
Act.\31\
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\30\ See, e.g. Proposal at I.C.1.; Guidance 81 FR at 45298-300;
See SIFMA v. CFTC, 67 F.Supp.3d at 427 (``Congress modeled Section
2(i) on other statutes with extraterritorial reach that operate
without implementing regulations.'' (citations omitted); See Larry
M. Eig, Cong. Research Serv., 97-589, Statutory Interpretation:
General Principles and Recent Trends 20 (2014) (Congress is presumed
to legislate with knowledge of existing common law.'').
\31\ Id. at 16-17 (``where Congress includes particular language
in one section of a statute but omits it in another . . ., it is
generally presumed that Congress acts intentionally and purposely in
the disparate inclusion or exclusion.'' (quoting Atlantic Cleaners &
Dyers, Inc. v. United States, 286 U.S. 427, 433 (1933))).
---------------------------------------------------------------------------
Second, even if a non-U.S. person met one of three tests for
being a significant subsidiary of a U.S. parent with over $50
billion in consolidated assets, it would not be an SRS if it is
either subject to prudential regulation as a subsidiary of a U.S.
bank holding company or subject to comparable capital and margin
standards and oversight by its home country supervisor. While I
believe these exclusions are appropriate in the context of the
policy the Proposal is putting forward in its vision of the SRS, I
am concerned that we are substituting our oversight with that of the
Federal Reserve Board, in one instance, on the grounds that being
subject to consolidated supervision and regulation by the Federal
Reserve Board with respect to capital and risk management
requirements provides appropriate regulatory coverage. While I do
not disagree with respect to risk management that the Federal
Reserve Board provides comparable oversight, finding that
comparability satisfies our regulatory oversight concerns in this
instance may lead us down a slippery slope in which we find
ourselves fighting to maintain our own Congressionally delegated
jurisdiction with respect to swaps activities. This fact is only
further validated-- considering the breadth of the exclusions--by
the high likelihood that a non-U.S. subsidiary of a U.S. parent
entity with over $50 billion in consolidated assets is a financial
entity subject to some form or prudential regulation in its home
jurisdiction. Indeed, the Proposal suggests that of the current
population of 59 SDs, ``few, if any, would be classified as SRSs.''
\32\
---------------------------------------------------------------------------
\32\ Proposal at VII.C.2.i.
---------------------------------------------------------------------------
While the concept of an SRS is interesting to me, the Proposal's
attempt to draw multiple bright lines in a web of interconnectedness
almost ensures that risk will find an alternate route back to the
U.S. with potentially disastrous results. Without a better
understanding of how the SRS proposal would work in practice and
whether it is truly better than the conduit affiliate concept
currently outlined in the Guidance and presumably similar to the
SEC's own approach, it is difficult to get behind a policy that
could most certainly bring risk into the U.S. of the very type CEA
Section 2(i) seeks to address.
ANE--Anyone? Anyone?
The issue of how to address the application of certain
transaction-level requirements with respect to swap transactions
arranged, negotiated, or executed by personnel or agents located in
the United States of non-U.S. SDs (whether affiliates or not of a
U.S person) with non-U.S. counterparties (``ANE Transactions'') is
one aspect of the Commission's cross-border approach that has
continually raised concerns and demands greater certainty. First
articulated in a 2013 Staff Advisory,\33\ the issue boils down to
whether transactional requirements apply to ANE swaps, and if so,
whether substituted compliance may be available. A 2014 Commission
Request for Comment \34\ sought to address the complex legal and
policy issues raised by the 2013 Staff Advisory. It was followed by
the Commission's 2016 Proposal, which among other things, addressed
ANE transactions, including the types of activities that would
constitute arranging, negotiating, and executing within the context
of the 2016 Proposal, and the
[[Page 1013]]
extent to which the SD registration threshold and external business
conduct standards apply with respect to ANE Transactions.\35\
Today's Proposal withdraws the 2016 Proposal on grounds that the
Commission's views have changed and evolved as a result of market
and regulatory developments and ``in the interest of international
comity.'' \36\
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\33\ See CFTC Staff Advisory No. 13-69, Applicability of
Transaction-Level Requirements to Activity in the United States
(Nov. 14, 2013), http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
\34\ See Request for Comment on Application of Commission
Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S.
Counterparties Involving Personnel or Agents of the Non-U.S. Swap
Dealers located in the United States, 79 FR 1347 (Jan. 8, 2014)
(``2014 Request for Comment'').
\35\ See Cross-Border Application of the Registration Thresholds
and External Business Conduct Standards Applicable to Swap Dealers
and Major Swap Participants, 81 FR 71946 (Oct. 18, 2016).
\36\ Proposal at I.A.
---------------------------------------------------------------------------
The proposal sets forth an approach largely based on comments to
the 2014 Request for Comment \37\ and seemingly in response to a
recommendation made in an October 2017 report of the U.S. Treasury
Department that both the CFTC and SEC ``reconsider the implications
of applying their Title VII rules to transactions between non-U.S.
firms or between a non-U.S. firm and a foreign branch or affiliate
of a U.S. firm merely on the basis that U.S. located personnel
arrange, negotiate, or execute the swap, especially for entities in
comparably regulated jurisdictions.'' \38\ The proposed approach is
simply to ignore ANE Transactions within the scope of the Proposal
as irrelevant ``because the transactions involve two non-U.S.
counterparties, and the financial risk of the transactions lies
outside the United States . . .'' \39\ That may be the case in some
circumstances; however, casting an overly broad net on a category of
activities may run the risk of slippage, and I am concerned we have
not given this important element of our cross-border jurisdiction
enough thought to warrant such an expeditious solution.
---------------------------------------------------------------------------
\37\ Indeed, the discussion of the seventeen comments to the
2014 Request for Comment in the 2016 Proposal is nearly identical to
that of the Proposal. See, 2016 Proposal, 81 FR at 71946, 71952-3;
Proposal at V.
\38\ See U.S. Dep't of the Treasury, A Financial System that
Creates Economic Opportunities: Capital Markets 135-136 (Oct. 2017),
https://home.treasury.gov/system/files/136/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.
\39\ Proposal at V.
---------------------------------------------------------------------------
Conclusion
Despite my concerns regarding this Proposal, I look forward to
hearing constructive input from market participants and the public.
I am encouraged by the balanced nature of the requests for comment,
and would like to modestly request that in responding to the
Proposal, commenters indicate whether they believe it is appropriate
and prudent for the Commission to proceed with a rulemaking at this
time, or whether the preference is to adhere to the current
Guidance, or some hybrid of the two.
As with all rulemakings, input the Commission receives through
public comment drives the conversation, and sets us on a course that
balances diverse interests; seeks transparency, resiliency, and
efficiency; and above all else, focuses on protecting U.S. markets,
its participants and most importantly the customers that rely on
this truly global marketplace. One might assume that making
targeted, surgical changes to an existing regulatory framework is
easier than creating a framework. But, in some circumstances, it is
exactly the opposite. Global swaps markets have grown and evolved
around rule sets that were completed and implemented in the very
recent past. As regulators I believe we should caution against any
wholesale rewrite when we find well regulated, transparent, and
generally well running financial markets. But, if we do find
vulnerabilities or inefficiencies in our rules (certainly both old
and new), the process to reconsider should be deliberate, balanced,
and inclusive to ensure the Commission, as a collective body,
understands the gravity of its decisions.
Appendix 5--Dissenting Statement of Commissioner Dan M. Berkovitz
I dissent from today's cross-border swap regulation proposal
(the ``Proposal'') because it would significantly weaken the
Commission's existing regulatory framework that protects the United
States from risky overseas swaps activity. The existing cross-border
framework has worked well over the past six years to protect the
U.S. financial system from risks from cross-border swaps activity,
while simultaneously enabling U.S. banks to compete successfully in
overseas markets.\1\ The Proposal would create multiple loopholes
for U.S. banks to evade the Commission's oversight of their cross-
border activity and pose risks to the U.S. financial system. With a
wink and a nod, U.S. banks could effectively guarantee their
overseas swap dealing affiliates from losses while also enabling
those affiliates to escape regulation as swap dealers. The Proposal
would enable U.S. banks to book their swap trades in unregistered
foreign affiliates that would not be required to report their swaps
in the United States, and would not be subject to our capital,
margin, and risk management requirements.
---------------------------------------------------------------------------
\1\ U.S. banks are the strongest in the world. The Global League
Tables ranking global banks by amount of banking business activity
shows that three or four U.S. banks are in the top five banks in
almost every category, including for banking business in foreign
markets. See GlobalCapital.com, Global League Tables, available at
https://www.globalcapital.com/data/all-league-tables. While we could
not locate a global ranking of banks by swap business,
GlobalCapital.com selected Bank of America Merrill Lynch as
``derivatives house of the year'' and four of the seven other banks
shortlisted for the award were U.S. banks. See Ross Lancaster,
Global Derivatives Awards 2019: the winners, GlobalCapital.com
(Sept. 26, 2019), available at https://www.globalcapital.com/article/b1h9txdc91yw4k/globalcapital-global-derivatives-awards-2019-the-winners. By comparison, in 2006, ``Deutsche Bank dominate[d] in
every region'' in the competition for derivatives house of the year.
See Yassine Bouhara, Global Derivatives House of the Year,
GlobalCapital.com, (Nov. 9, 2006), available at https://www.globalcapital.com/article/k64qjpc6mxwc/global-derivatives-house-of-the-year.
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The Proposal also sends us down a rabbit hole with a complex new
entity designation, ``Significant Risk Subsidiary'' (``SRS''). An
SRS would be a type of overseas swap dealing affiliate that in
theory is subject to greater Commission oversight. The Proposal
admits, however, that there would be ``few, if any,'' entities in
this elusive category.\2\ What is the purpose of creating a
complicated category that does not include a single entity? This is
a Seinfeldian regulation--a regulation about nothing.\3\
---------------------------------------------------------------------------
\2\ See Proposal, section VII.C.2(i).
\3\ See Wikipedia.org, Seinfeld, available at https://en.wikipedia.org/wiki/Seinfeld.
---------------------------------------------------------------------------
The Proposal would transform the Commission from a watchdog
guarding U.S. shores into a timid turtle, reluctant to poke its head
out of its domestic shell. When the next financial crisis arrives,
will foreign governments bail out affiliates of U.S. persons located
in their jurisdictions? Experience has taught us that while finance
may be global, global financial rescues are American. With today's
Proposal, I fear that the U.S. tax payer will once again be called
on to bear the costs. We've been down this de-regulatory road
before, and it ended in disaster for the United States and the
global financial system. Congress enacted the Dodd-Frank Act to
avoid these same mistakes, yet today the Commission is voting out a
proposal that ignores both those lessons and the law.
Why Cross-Border Swaps Must Be Regulated by the CFTC
It seems that every few years, we must remind ourselves of why
regulating cross-border financial transactions, and swaps in
particular, is important to managing systemic risk. If we forget,
the financial system delivers its own destructive reminders.
Examples from recent history prove that foreign financial activity,
usually involving swaps, can lead to massive losses triggering the
need for emergency action by the Department of the Treasury and/or
the Federal Reserve System--sometimes at the expense of the U.S.
taxpayer. As described later in my statement, the Proposal would
undermine the direction in CEA section 2(i) to regulate cross-border
swap activity, and again allow such activity by U.S. financial
institutions to go unobserved and unsupervised.
In 1998, the U.S. hedge fund Long-Term Capital Management L.P.
(``LTCM'') was saved from failure through an extraordinary bailout
by 15 banks. The bailout was brokered by the Federal Reserve Bank of
New York. The near failure of LTCM roiled financial markets. The
financial system could have seized up if LTCM had failed because of
the large and opaque derivatives exposures that many U.S. banks had
with LTCM.\4\ Although LTCM was mostly managed from Connecticut, it
was a Cayman Islands entity with over a dozen affiliates, only $4
billion in capital, and a complex derivatives book with a notional
amount in excess of $1 trillion.\5\
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\4\ See The President's Working Group on Financial Markets,
Hedge Funds, Leverage, and the Lessons of Long-Term Capital
Management (Apr. 1999) available at http://www.treasury.gov/resource-center/fin-mkts/Documents/hedgfund.pdf; see also
International Monetary Fund, World Economic Outlook and
International Capital Markets (Dec. 1998), available at https://www.imf.org/external/pubs/ft/weo/weo1298/pdf/file3.pdf.
\5\ Id.
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In 2007, U.S.-based Bear Stearns provided loans intended to
shore up two Cayman Islands hedge funds sponsored by Bear
[[Page 1014]]
Stearns. Bear Stearns was not legally obligated to back the funds
financially. Those actions were the beginning of a chain of events
that eventually led to the fire sale of Bear Stearns to J.P. Morgan
in March 2008. To entice J.P. Morgan to buy a distressed Bear
Stearns, the Federal Reserve System provided financial support for
the purchase.\6\ This is not to suggest that Bear Stearns failed
solely because of swap activity, but to illustrate how financial
institutions are essentially obligated to support foreign affiliated
entities even when they do not guarantee performance, and how such
support can have serious consequences to the U.S. financial system.
---------------------------------------------------------------------------
\6\ See Reuters, Timeline: A dozen key dates in the demise of
Bear Stearns (Mar. 17, 2008), available at https://www.reuters.com/article/us-bearstearns-chronology/timeline-a-dozen-key-dates-in-the-demise-of-bear-stearns-idUSN1724031920080317.
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Walter Wriston, former chairman and CEO of Citicorp, testified
to Congress regarding the obligation of a parent bank to bail out a
subsidiary, no matter the degree of legal separation: ``It is
inconceivable that any major bank would walk away from any
subsidiary of its holding company. If your name is on the door, all
of your capital funds are going to be behind it in the real world.
Lawyers can say you have separation, but the marketplace is
persuasive, and it would not see it that way.'' \7\
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\7\ See https://en.wikipedia.org/wiki/Walter_Wriston (citing
Financial Institutions Restructuring and Services Act of 1981,
Hearings on S. 1686, S. 1703, S. 1720 and S. 1721, before the Senate
Committee on Banking, Housing, and Urban Affairs, 97th Congress, 1st
Session, Part 11, 589-590) (italics added).
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When Lehman Brothers went bankrupt and triggered the 2008
financial crisis, its London affiliate, Lehman Brothers
International Europe, had a book of nearly 130,000 swaps that took
many years to resolve in bankruptcy.\8\ Soon thereafter, American
International Group would have failed as a result of swaps trading
by the London operations of a subsidiary, AIG Financial Products, if
not for over $180 billion of support from the Federal Reserve System
and the U.S. Department of Treasury. \9\
---------------------------------------------------------------------------
\8\ See Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292, 45294 (July
26, 2013) (``2013 Guidance'').
\9\ Id. at 45293-94.
---------------------------------------------------------------------------
In 2012, on the eve of the swap dealer regulations going into
effect, J.P. Morgan Chase & Co. disclosed multi-billion dollar
losses from credit-related swaps managed through its London chief
investment office. While this loss did not require the Treasury or
the Federal Reserve System to act, it did result in an enforcement
action by the CFTC. The enforcement order detailed how the trading
activity that caused the loss would have been subject to tighter
controls and oversight--and likely would not have happened--if the
activity had been subject to swap dealer regulation by the CFTC.\10\
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\10\ See In re JPMorgan Chase Bank, N.A., CFTC No. 14-01, 2013
WL 6057042, at *6-8 (Oct. 16, 2013), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrenforcementactions/documents/legalpleading/enfjpmorganorder101613.pdf.
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Each of these very substantial financial failures occurred at
least in part because of overseas activity by U.S. financial
institutions. Although the activity occurred away from the United
States, and was not subject to direct U.S. regulatory oversight, the
risks and the costs both came back to the United States.
Foreign derivatives activity is of particular concern because
derivatives are, by their very nature, contracts that can transfer
large amounts of risk between entities and across borders. Congress
recognized this concern when it adopted CEA section 2(i) applying
the swaps provisions of the Dodd-Frank Act to regulate cross-border
swaps activity that has a ``direct and significant connection with
activities in, or effect on, commerce of the United States.''
Notably, this cross-border jurisdiction is both activity-based as
well as effects-based. It is the nature of the activity and its
connection to commerce in the United States--not simply the level of
risk presented--that is the basis for the CFTC's cross-border
jurisdiction. Congress recognized that we cannot always foresee the
risks presented by swap activities. By supposedly focusing on risk,
the Proposal ignores this crucial insight and critical component of
the Commission's cross-border jurisdiction.
But even with respect to activities presenting serious risks to
the United States, the Proposal gets it wrong. The risks incurred by
foreign affiliates are transferred, or otherwise inure, to the U.S.
parent firms in several ways. The traditional method was for the
U.S. parent to guarantee the swap payment obligations of its foreign
affiliates. Swap dealers removed many of those formal, written
guarantees that were executed prior to the financial crisis in 2014
after the 2013 Guidance was issued (more on that later).
Alternatively, using inter-affiliate swaps, a foreign affiliate
typically transfers to its U.S. parent all of the risk it incurs in
a swaps portfolio. While the U.S. parent may not be directly liable
to the counterparties of its foreign affiliate, any losses of the
affiliate are equivalent to losses the parent incurs on its swap
with the affiliate. If the affiliate makes bad bets, the parent pays
for them. Finally, a U.S. parent can be less directly responsible
for its foreign affiliate's swap obligations through capital
contribution arrangements (e.g., keepwell agreements or deed-poll
arrangements), or simply because letting an affiliate fail and
default to numerous foreign entities is untenable as a business
matter. As Walter Wriston noted, as a matter of market survival a
U.S. bank would not allow a wholly-owned affiliate to fail and
default on its swap obligations.
The Commission's regulation of cross-border swap activity should
address all of these risk transfer conduits. At the same time, it
should be flexible enough to allow U.S. banks to compete in global
markets. In my view, the 2013 Guidance and the attendant no action
relief achieved the right balance and is working well. As noted
above, U.S. banks are competing throughout the world. In fact, they
are out-competing their non-U.S. competitors. There is no persuasive
reason to weaken a regulatory standard that is consistent with our
law and that has successfully protected the American people for the
last six years--while simultaneously witnessing the global
preeminence of American banks. The Proposal snatches defeat from the
jaws of victory.
The Proposal would greatly weaken the Commission's ability to
monitor and regulate foreign swap activity by U.S. financial
institutions, putting our financial system at risk once again. Only
ten years after the financial crisis, the Proposal tosses aside hard
lessons learned at the expense of 10% unemployment, millions of
foreclosures, massive bailouts, and lasting damage to the economic
fortunes of tens of millions of our fellow citizens. It does this in
the interest of secondary considerations--harmonization, a
``workable framework'' for regulations, and reducing costs. Whereas
``legal certainty'' was the buzzword to limit the CFTC's
jurisdiction over the swaps market in the 1990s and 2000s, today's
de-regulatory mantra includes ``harmonization,'' ``reducing
fragmentation,'' and ``deference.'' Call it what you like, but the
results are intended to be the same: Preventing the CFTC from
overseeing the swaps activity of major U.S. banks. Creating the
possibility for another taxpayer-funded bailout for overseas swap
activity cannot possibly be the right outcome for the American
people.
What Is Wrong With the Proposal
The Proposal starts on a good note by essentially adopting the
interpretation of CEA section 2(i) contained in the 2013 Guidance.
The Proposal also acknowledges that ``a global financial enterprise
effectively operates as a single business, with a highly integrated
network of business lines and services conducted through various
branches or affiliated legal entities that are under the control of
the parent entity.'' \11\ It then explains that the entities in a
global financial enterprise provide ``financial or credit support to
each other, such as in the form of a guarantee or the ability to
transfer risk through inter-affiliate trades or other offsetting
transactions.'' \12\ The Proposal then uses the basic framework of
the 2013 Guidance and adopts some of its substantive provisions.
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\11\ Proposal, section I.B. (noting that large U.S. banks have
thousands of affiliated entities around the world.)
\12\ Id. The Proposal notes that ``even in the absence of an
explicit arrangement or guarantee, the parent entity may, for
reputational or other reasons, choose or be compelled to assume the
risk incurred by its affiliates, branches, or offices located
overseas.''
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But the Proposal makes a number of changes to key provisions,
all geared toward limiting the application of our regulations. Most
concerning are the narrowing of the definition of ``guarantee'' and
``U.S. persons,'' and codifying full relief for arranging,
negotiating, or executing (``ANE'') swaps in the United States that
are then booked in non-U.S. legal entities. Together, these
provisions in the Proposal create a loophole through which U.S.
financial institutions can undertake substantial swap dealing
activity outside the U.S. swap regulatory regime through
unregistered foreign affiliates and bring the risks they incur back
to the United
[[Page 1015]]
States. In addition, these key provisions allow U.S. persons to
undertake substantial dealing activity inside the United States and
then evade regulation by booking the trades in foreign entities.
Together, these provisions will codify a framework for circumventing
our swap regulations greatly undermining CEA section 2(i) and Title
VII of the Dodd-Frank Act.
I am concerned that codifying this result will encourage U.S.
banks to book much of their swap dealing activity in foreign
affiliates that limit their swap dealing with U.S. persons and
therefore will not have to register as swap dealers. Under the
narrowed definition of ``guarantee'' in the Proposal, the U.S.
parents would be able to provide full financial support to these
unregistered foreign affiliates, just not in the form of an
explicit, direct swap payment guarantee. Furthermore, these changes
will allow two U.S. entities, whether they are, for example, two
global banks or a global bank and a large U.S. corporation,
insurance company or hedge fund, to trade with each other without
subjecting that trade to U.S. oversight so long as the trade is
booked in foreign affiliates. Finally, by largely eliminating the
ANE requirement,\13\ those U.S. firms can use their employees in the
United States for that trading activity and still evade U.S.
regulation if the swaps are booked in foreign affiliates. As
discussed above and acknowledged in the Proposal, the U.S. parents
will still be on the hook because the risks incurred by the foreign
affiliates is transferred back to the U.S. parent through swaps with
the affiliate and/or through other capital support mechanisms.
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\13\ At my request, the preamble to the Proposal was modified to
clarify that our anti-fraud and anti-manipulation regulations never
the less apply to the conduct occurring in the United States.
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This outcome is not merely an issue of whether the foreign
affiliates of U.S. persons need to register as swap dealers. By not
registering, these foreign affiliates will not need to report their
swap activity to CFTC registered swap data repositories. They will
not be subject to our margin, capital, and risk management
requirements. These firms will not be subject to the swap dealing
best practices that our regulations require. CEA section 2(i) will
be undermined.
The three changes in the Proposal are intended to address
unintended effects on previously standard business practices that
helped U.S. banks compete in global markets. A foreign counterparty
that is not headquartered in the United States (a ``true non-U.S.
entity'') may not want to trade with affiliates of U.S. banks, or
with bank employees in the United States, if doing so means the true
non-U.S. entity would need to count those swaps toward its CFTC swap
dealer registration threshold.
Under the 2013 Guidance, guaranteed foreign affiliates of U.S.
banks are deemed U.S. persons for purposes of counting dealing swaps
with U.S. persons. The term ``guarantee'' was defined broadly. Once
it became apparent that true non-U.S. entities did not want to count
those swaps, U.S. banks de-guaranteed their foreign affiliate swap
dealers. The 2016 cross border proposal \14\ tried to adjust the
guidance framework by adding back into the U.S. person definition
foreign consolidated subsidiaries (``FCS'') that are consolidated on
the books of a U.S. parent. However, that would have the effect of
exacerbating the problem for U.S. banks competing for swap business
with true non-U.S. entities. The Proposal discards the FCS concept
and narrows the definition of a ``guarantee'' to solely an explicit
recourse of the counterparty to the U.S. parent for payment on the
swap. The Proposal further narrows the U.S. person definition to
delete full recourse subsidiaries and eliminate conduit affiliates
treatment for the same reasons.
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\14\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to Swap Dealers and
Major Swap Participants, 81 FR 71946 (Oct. 18, 2016).
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I am highly skeptical that the status quo will be maintained if
the ANE no action relief and de-guaranteeing framework are codified.
Large U.S. banks would have incentives to de-register some of their
foreign affiliate swap dealers. They are likely to maintain only one
or two foreign entities that are registered to handle business with
U.S. persons operating in foreign jurisdictions who want to trade
with registered swap dealers. Even if they do not de-register those
swap dealers, swap activity can easily be moved to other
unregistered foreign affiliates that are supported by their U.S.
parents in ways other than an explicit swap payment obligation
guarantee.
There is a potential alternative for addressing the concerns of
true non-U.S. entities without also excluding from oversight all
activity of foreign affiliates of U.S. financial institutions. The
regulations potentially could provide that, with substituted
compliance determinations in place for key swap regulations (e.g.
margin and risk management), true non-U.S. entities can trade with
foreign affiliates of U.S. entities without counting those swaps
toward U.S. swap dealer registration. This could be a reasonable
balance of systemic safety and competitiveness.
At the same time, foreign entities that are wholly owned by U.S.
parents would still be required to count swaps with other wholly-
owned foreign affiliates of other U.S. parents. In this way, U.S.
financial institutions can compete for foreign swap business while
preventing U.S. firms from evading swap regulation by booking swaps
with each other in foreign affiliates.
I invite commenters to address this potential solution.
Seinfeldian Regulation: Significant Risk Subsidiary
The Proposal contains a new regulatory construct called the
``Significant Risk Subsidiary'' (``SRS''). It is a putative
replacement for a broader definition of guarantee and the FCS
alternative. But it appears to be an empty set. The Cost-Benefit
Considerations project that ``few, if any'' entities would fall
within its ambit. It would not accomplish anything.
The SRS is a very complicated construct, with no less than six
tests for determining whether a firm would qualify for regulation as
an SRS. Bizarrely, none of these tests have anything to do with the
amount of the entity's swap activity. The basic threshold is that
the entity be affiliated with a commercial enterprise with at least
$50 billion in capital. Consider this: LTCM had $4 billion in
capital and a derivatives book with a notional amount of about $1
trillion at the time it was bailed out.
Another hurdle excludes any entity regulated by U.S. or foreign
banking regulators. In effect, the entities that do the vast
majority of swap dealing in the world are excluded from the SRS
definition. With so many hurdles for the SRS determination, it
appears that the Proposal has little interest in actually
contributing to the control of systemic risk exposure in the U.S.
financial system. The reasoning goes, if the entity is regulated by
a banking regulator that follows basic Basel capital and supervision
standards, then CFTC regulation is unnecessary.\15\ But Congress
decided in 2010 when it adopted the Dodd-Frank Act that swap dealing
needed to be separately regulated from prudential bank regulation.
The catastrophic cross border financial failures discussed
previously in this statement demonstrate why these additional
protections are necessary. Prudential regulation alone was
insufficient to prevent those failures and risks to the financial
system. Those failures eventually required emergency action by the
Federal Reserve System and/or the Department of the Treasury.
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\15\ ``An entity that meets either of these two exceptions, in
the Commission's preliminary view, would be subject to a level of
regulatory oversight that is sufficiently comparable to the Dodd-
Frank Act swap regime with respect to prudential oversight. . . . In
such cases where entities are subject to capital standards and
oversight by their home country regulators that are consistent with
Basel III and subject to a CFTC Margin Determination, the Commission
preliminarily believes that the potential risk that the entity might
pose to the U.S. financial system would be adequately addressed
through these capital and margin requirements.'' Proposal, at
II.C.4.
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Substituted Compliance Shortcomings
I support the principle of international comity. The CFTC should
continue to recognize the interests of other countries in regulating
swap activity occurring within their borders. The 2013 Guidance has
a flexible, outcomes based substituted compliance review process
based on a finding that the foreign regulated entities are subject
to comparable, comprehensive supervision and regulation.\16\ The
standard of review is effectively the same as the standard
established by Congress in CEA sections 4(b)(1)(A), 5b(h), and 5h(g)
for finding, respectively, foreign boards of trade, swap
[[Page 1016]]
execution facilities, and exempt derivatives clearing organizations
comparable.
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\16\ ``[T]he 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 established under the Dodd-
Frank Act.'' 2013 Guidance, 78 FR 45292, 45342-3.
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The Proposal would apply a lesser standard. It would permit the
Commission to issue a comparability determination if it determines
that ``some or all of the relevant foreign jurisdiction's standards
are comparable.'' The condition that the regulations be
``comprehensive'' is dropped. Furthermore, unlike the 2013 Guidance
and the CEA comparability analysis, which require the Commission to
make a comparability determination or finding based on the standard,
the Proposal says that the Commission can consider any factors it
``determines are appropriate, which may include'' \17\ four factors
listed. This arbitrary, non-standard ``standard'' creates too much
uncertainty and flexibility. The Commission should not defer
regulating U.S. bank affiliates to other regulatory jurisdictions
operating under a lesser standard than the Commission has previously
used in this context or currently uses in other contexts.
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\17\ Proposal, rule text section 23.23(g)(4).
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Conclusion
The Proposal would allow U.S. banks to evade swap regulation by
booking swaps in non-U.S. affiliates. The Proposal would enable U.S.
banks to arrange, negotiate, and execute swaps in New York, but
avoid swap regulation by booking those swaps in their non-U.S.
affiliates. A non-U.S. affiliate of a U.S. bank could enter into
trillions of dollars of swaps with non-U.S. affiliates of other U.S.
entities without registering with the CFTC as a swap dealer. The
U.S. parent bank could provide full financial support for those non-
U.S. affiliates so long as the support does not come in the narrow
form of an explicit swap payments guarantee.
Ultimately, the risk from all of those swaps will still be borne
by the parent bank in the United States. These risks can be very
large. The activities of bank affiliates outside the United States
have a direct and significant connection with activities in, or
effect on, commerce in the United States. In Title VII of the Dodd-
Frank Act, the Congress directed the CFTC to apply its swap
regulations to these activities. Because the Proposal retreats from
these responsibilities, I dissent.
[FR Doc. 2019-28075 Filed 1-7-20; 8:45 am]
BILLING CODE 6351-01-P
