2016-18854
Federal Register, Volume 81 Issue 158 (Tuesday, August 16, 2016)
[Federal Register Volume 81, Number 158 (Tuesday, August 16, 2016)]
[Rules and Regulations]
[Pages 54478-54498]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-18854]
[[Page 54478]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 3, 23, 37, 43, 45, 46, and 170
RIN 3038-AE27
Final Response to District Court Remand Order in Securities
Industry and Financial Markets Association, et al. v. United States
Commodity Futures Trading Commission
AGENCY: Commodity Futures Trading Commission.
ACTION: Final response to district court remand order.
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SUMMARY: This release is the Commodity Futures Trading Commission's
(``Commission'' or ``CFTC'') final response to the order of the United
States District Court for the District of Columbia in Securities
Industry and Financial Markets Association, et al. v. United States
Commodity Futures Trading Commission, (``SIFMA v. CFTC''), remanding
eight swaps-related rulemakings to the Commission to resolve what the
court held to be inadequacies in the Commission's consideration of
costs and benefits, or its explanation of its consideration of costs
and benefits, in those rulemakings. In this release the Commission
addresses cost-benefit issues raised and suggestions for rule changes
made in comments submitted in response to the Commission's Initial
Response to the remand order.
DATES: August 16, 2016.
FOR FURTHER INFORMATION CONTACT: Martin B. White, Assistant General
Counsel, Office of the General Counsel, (202) 418-5129,
[email protected]; Frank Fisanich, Chief Counsel, Division of Swap Dealer
and Intermediary Oversight, (202) 418-5949, [email protected]; Philip
Raimondi, Attorney Advisor, Division of Market Oversight, (202) 418-
5717, [email protected]; Michael A. Penick, Economist, Office of the
Chief Economist, (202) 418-5279, [email protected]; Megan Wallace,
Senior Special Counsel, Office of International Affairs, (202) 418-
5150, [email protected]; Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Overview and Scope
This release is the Commission's final response to the order of the
United States District Court for the District of Columbia in SIFMA v.
CFTC 1 remanding eight swaps-related rulemakings to the
Commission. It addresses issues raised by public comments submitted in
response to a previous Federal Register release setting forth the
Commission's initial response to the remand order.\2\
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\1\ No. 13-1916 (PLF), 67 F. Supp. 3d. 373 (D.D.C. Sept. 16,
2014).
\2\ Initial Response to District Court Remand Order in
Securities Industry and Financial Markets Association, et al. v.
United States Commodity Futures Trading Commission, 80 FR 12555
(Mar. 10, 2015) (``Initial Response'').
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The present release is organized as follows. Part II describes the
SIFMA litigation, the district court order, and the Commission's
Initial Response. Part III discusses the Commission's general approach
to extraterritorial costs and benefits in this release and potential
methods for addressing extraterritorial cost-benefit issues. Part IV
supplements the consideration of costs and benefits in the preambles to
the original rulemakings and in the Initial Response by describing and
evaluating the cost-benefit issues raised in the comments. Section IV.A
discusses certain issues related to the costs of the extraterritorial
application of the remanded rules. Section IV.B discusses certain
issues related to the benefits of the extraterritorial application of
the remanded rules. Section IV.C discusses the Commission's efforts to
mitigate costs of the extraterritorial application of the Commission's
rules, including the Commission's substituted compliance program and
other actions. Section IV.D discusses consideration of substantive rule
changes outside the scope of the remand order that may affect cross-
border costs and benefits. Section IV.E discusses commenters' concerns
about ``market fragmentation,'' primarily in the context of the Swap
Execution Facility (``SEF'') Registration Rule. Section IV.F discusses
cost-benefit issues related to the use of a test for the application of
transaction-level Dodd-Frank rules to non-U.S. swap dealers based on
dealing activities physically located in the United States as described
in a November 2013 Division of Swap Dealer and Intermediary Oversight
staff advisory. It also discusses cost-benefit issues related to a test
for the application of the SEF Registration Rule based on the provision
of swap execution services to traders located in the United States as
described in a Division of Market Oversight guidance document, also
issued in November 2013. Section IV.G discusses certain additional
cost-benefit issues specific to particular rules. Part V discusses
commenters' recommendations for changes in the substance of the
remanded rules and evaluates whether these changes are justified in
light of the international cost-benefit considerations addressed in
Part IV and other relevant considerations. Finally, Part VI concludes
that, taking into account the facts and analysis in the original
rulemaking preambles as well as the additional consideration of costs
and benefits in the Initial Response and this release, the remanded
rules are legally sound, and the Commission will not propose changes in
the context of the SIFMA v. CFTC remand order.
The Commission emphasizes that the purpose of the discussion of
costs and benefits in Part IV and of potential rule changes in Parts V
and VI is to respond to the mandate of the SIFMA remand order and to
evaluate the present legal sufficiency of the remanded rulemaking
proceedings. The discussion and conclusions in this release should not
be interpreted to mean that the Commission will not consider other
actions with respect to the rules, including substantive amendments,
looking forward. To the contrary, the Commission will amend the rules
in the future when amendment is in the public interest, whether in
response to new information, experience, or the evolution of the
markets and the international legal landscape.
II. Background \3\
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\3\ For a more detailed description of the background of this
release, see Initial Response, 80 FR at 12556-58.
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A. The District Court Litigation and Decision
On December 4, 2013, three trade associations sued the Commission
in the United States District Court for the District of Columbia,
challenging the Commission's Interpretive Guidance and Policy Statement
Regarding Compliance with Certain Swap Regulations \4\ (``Cross-Border
Guidance'' or ``Guidance'') as well as the extraterritorial application
of fourteen of the rules promulgated by the Commission to implement the
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection
Act \5\ regarding swaps.\6\
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\4\ 78 FR 45292 (July 26, 2013).
\5\ Public Law 111-203, 124 Stat. 1376 (2010).
\6\ See SIFMA, 67 F. Supp. 3d at 384. The plaintiffs were the
Securities Industry and Financial Markets Association, the
International Swaps and Derivatives Association, and the Institute
of International Bankers. Id. See also id. at 437-38.
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The fourteen challenged rules were promulgated by the Commission in
twelve rulemakings.\7\ On September 16,
[[Page 54479]]
2014, the court issued a decision, granting summary judgment to the
Commission on most issues but remanding without vacatur ten rules,
promulgated in eight rulemakings.\8\ The court held that the preambles
for these rules did not adequately address the costs and benefits of
the extraterritorial application of the rules pursuant to section 2(i)
of the Commodity Exchange Act (``section 2(i)'').\9\ Specifically, the
court held that the Commission needed to address whether and to what
extent the costs and benefits as to overseas activity may differ from
those related to the domestic application of the rules.\10\
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\7\ See id. at 437-38. Three of the fourteen challenged rules,
informally identified by the court as the ``Daily Trading Records,''
``Risk Management,'' and ``Chief Compliance Officer'' Rules, were
promulgated as part of a single rulemaking. Id.
\8\ SIFMA, 67 F. Supp. 3d 373. For a more complete description
of the decision, see the Commission's Initial Response, 80 FR 12555.
\9\ SIFMA, 67 F. Supp. 3d at 430-33.
\10\ Id. at 434-35.
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The eight remanded rulemakings are:
Real-Time Public Reporting of Swap Transactions Data \11\ (``Real-
Time Reporting Rule'');
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\11\ 77 FR 1182 (Jan. 9, 2012).
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Swap Data Recordkeeping and Reporting Requirements \12\ (``SDR
Reporting Rule'');
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\12\ 77 FR 2136 (Jan. 13, 2012).
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Registration of Swap Dealers and Major Swap Participants \13\
(``Swap Entity Registration Rule'');
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\13\ 77 FR 2613 (Jan. 19, 2012).
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Swap Dealer and Major Swap Participant Recordkeeping, Reporting,
and Duties Rule; 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
\14\ (``Daily Trading Records,'' ``Risk Management,'' and ``Chief
Compliance Officer'' Rules);
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\14\ 77 FR 20128 (Apr. 3, 2012).
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Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant,'' and ``Eligible Contract Participant'' \15\ (``Swap
Entity Definition Rule'');
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\15\ 77 FR 30596 (May 23, 2012).
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Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment
and Transition Swaps \16\ (``Historical SDR Reporting Rule'');
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\16\ 77 FR 35200 (June 12, 2012).
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Confirmation, Portfolio Reconciliation, Portfolio Compression, and
Swap Trading Relationship Documentation Requirements for Swap Dealers
and Major Swap Participants \17\ (``Portfolio Reconciliation Rule'');
and
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\17\ 77 FR 55904 (Sept. 11, 2012).
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Core Principles and Other Requirements for Swap Execution
Facilities \18\ (``SEF Registration Rule'').
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\18\ 78 FR 33476 (June 4, 2013).
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B. The District Court's Rulings on Consideration of Costs and Benefits
The district court remanded the eight rulemakings ``for further
proceedings consistent with the Opinion issued this same day.'' \19\ As
the Commission explained in its Initial Response to the remand order,
the court's opinion included a number of holdings and observations that
provide guidance as to the actions the Commission must take on remand.
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\19\ SIFMA, 67 F. Supp. 3d at 437.
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1. The court held that, because Congress made the determination
that the swaps rules apply overseas to the extent specified in section
2(i), the CEA provision on consideration of costs and benefits, section
15(a), does not require the Commission to consider whether it is
necessary or desirable for particular rules to apply to overseas
activities as specified in section 2(i).\20\ Indeed, the court
explained, the Commission cannot, based on a consideration of costs and
benefits, second-guess Congress's decision that swaps rules apply to
certain overseas activities.\21\ As a result, the court stated that
``the only issues necessarily before the CFTC on remand would be the
substance of the Title VII rules, not the scope of those Rules'
extraterritorial applications under 7 U.S.C. 2(i).'' \22\
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\20\ Id. at 431.
\21\ Id. at 432; see also id. at 434-35 & n.35.
\22\ Id. at 434-35.
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2. At the same time, the court held that, in considering costs and
benefits of the substantive regulatory choices it makes when
promulgating a swaps rule, the Commission is required to take into
consideration the fact that the rule, by statute, will apply to certain
overseas activity.\23\ Thus, the Commission's consideration of costs
and benefits of the application of the rule must encompass both foreign
and domestic business activities.\24\ The court held that the
Commission failed to meet this requirement because, the court stated,
in the cost-benefit discussions for the rules at issue, the Commission
did not state explicitly whether the identified costs and benefits
regarding overseas activities are the same as, or differ from, those
pertinent to domestic activities.\25\
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\23\ Id. at 431-32.
\24\ Id.
\25\ Id.
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3. The court held that the Commission has discretion either to
consider costs and benefits of the international application of swaps
rules separately from domestic application or to evaluate them
together, ``so long as the cost-benefit analysis makes clear that the
CFTC reasonably considered both.'' \26\ The district court found that,
at the time the rules at issue in the litigation were promulgated,
foreign swaps regulations were still under development so that costs of
possible duplicative regulation were hypothetical and did not have to
be considered.\27\ The court noted that this fact raised the
possibility that the costs and benefits of the rules' extraterritorial
applications ``were essentially identical to those of the Rules'
domestic applications'' so that the Commission ``functionally
considered the extraterritorial costs and benefits'' of the rules ``by
considering the Rules' domestic costs and benefits.'' \28\ However, the
court concluded that it did not need to address that possibility
because the cost-benefit discussions in the rule preambles gave ``no
indication'' that this was so.\29\ The court further noted that foreign
swaps regulations passed since the promulgation of the rules at issue
in the litigation ``may now raise issues of duplicative regulatory
burdens,'' but that ``the CFTC may well conclude that its policy of
substituted compliance largely negates these costs.'' \30\
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\26\ Id. at 433.
\27\ Id.
\28\ Id.
\29\ Id.
\30\ Id. at 435.
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4. Finally, the court noted that ``[p]laintiffs raise no complaints
regarding the CFTC's evaluation of the general, often unquantifiable,
benefits and costs of the domestic application of the Title VII
Rules.'' \31\ As a result, the court held, ``[o]n remand, the CFTC
would only need to make explicit which of those benefits and costs
similarly apply to the Rules' extraterritorial applications.'' \32\
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\31\ Id.
\32\ Id.
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C. The Commission's Initial Response to the Remand Order
On March 10, 2015, the Commission published its Initial Response to
the district court remand order. In that release, the Commission
described the district court litigation and order and took two
substantive actions.
First, the Commission supplemented the discussion of costs and
benefits in the preambles of the remanded rulemakings by stating that
it:
hereby clarifies that it considered costs and benefits based on the
understanding that the swaps market functions internationally, with
many transactions involving U.S. firms
[[Page 54480]]
taking place across international boundaries; with leading industry
members typically conducting operations both within and outside the
United States; and with industry members commonly following
substantially similar business practices wherever located. The
Commission considered all evidence in the record, and in the absence
of evidence indicating differences in costs and benefits between
foreign and domestic swaps activities, the Commission did not find
occasion to characterize explicitly the identified costs and
benefits as foreign or domestic. Thus, where the Commission did not
specifically refer to matters of location, its discussion of costs
and benefits referred to the effects of its rules on all business
activity subject to its regulations, whether by virtue of the
activity's physical location in the United States or by virtue of
the activity's connection with or effect on U.S. commerce under
section 2(i). In the language of the district court, the Commission
``functionally considered the extraterritorial costs and benefits,''
and this was because the evidence in the record did not suggest that
differences existed, with certain limited exceptions that the
Commission addressed.\33\
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\33\ 80 FR at 12558 (internal citation omitted).
Second, to further inform its consideration of costs and benefits
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on remand, the Commission solicited comments on four questions:
1. Are there any benefits or costs that the Commission
identified in any of the rule preambles that do not apply, or apply
to a different extent, to the relevant rule's extraterritorial
applications?
2. Are there any costs or benefits that are unique to one or
more of the rules' extraterritorial applications? If so, please
specify how.
3. Put another way, are the types of costs and benefits that
arise from the extraterritorial application of any of the rules
different from those that arise from the domestic application? If
so, how and to what extent?
4. If significant differences exist in the costs and benefits of
the extraterritorial and domestic application of one or more of the
rules, what are the implications of those differences for the
substantive requirements of the rule or rules? \34\
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\34\ Id.
The Commission requested that commenters focus on information and
analysis specifically relevant to the inquiry required by the remand
order, and supply relevant data to support their comments.\35\
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\35\ Id.
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The Initial Response stated that, following review of the comments,
the Commission would publish a further response to the district court
remand order, which would include any necessary supplementation of the
Commission's consideration of costs and benefits for the remanded
rules. The Commission also stated that it would consider whether to
amend any of the remanded rules based on information developed in this
process.\36\
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\36\ Id. at 12555.
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D. Comments in Response to the Commission's Initial Response
The Commission received four comments in response to its Initial
Response to the remand order: A five-page comment jointly filed by the
International Swaps and Derivatives Association and the Securities
Industry and Financial Markets Association (``ISDA-SIFMA''); a three-
page comment filed by the Japanese Bankers Association (``JBA''); a
two-page comment filed by UBS Securities LLC (``UBS''); and a twenty-
one page comment filed by the Institute of International Bankers
(``IIB'').\37\ The substance of the comments is discussed in detail in
the remainder of this release.
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\37\ The IIB comment also had a thirteen-page appendix
consisting of a comment letter previously filed in response to
another Commission request for comments, but covering largely
similar subject matter to the primary IIB comment. Comment letters
are available on the Commission's Web site at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1564.
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Briefly, ISDA-SIFMA cautioned against an overly narrow conception
of the burdens of overseas application of Commission rules, stating
that, in addition to costs such as registration fees and expenses to
construct and administer compliance systems, foreign entities would
incur additional costs of ``engag[ing] with an unfamiliar, non-domestic
regulator and face uncertainty regarding the ramifications of being
subject to a new regime.'' \38\ The comment stated that ``internal
conflicts and customer resistance frequently may follow.'' \39\ ISDA-
SIFMA further stated that these costs and uncertainties function as
barriers to engagement in U.S. markets, potentially resulting in market
fragmentation and decreased liquidity available to U.S. persons.\40\
ISDA-SIFMA stated that these costs must be weighed against what ISDA-
SIFMA described as ``attenuated or minimal benefits'' from Commission
rules where ``foreign regulations . . . meet the objectives outlined by
the G-20 jurisdictions.'' \41\
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\38\ ISDA-SIFMA at 2. ISDA-SIFMA stated that ``[s]imple
redeployment of the Commission's apparently domestic previous cost-
benefit analysis'' would not yield new information or distill
lessons from experience to date with the Commission's rules and
would ``miss a valuable opportunity to contribute to the global
discussion regarding resolution of cross-border issues.'' Id.
However, in making this observation, ISDA-SIFMA stated that ``it is
not our purpose in this letter to express a view on what further
actions are necessary in order to satisfy the `reasonable
consideration' and related requirements of the remand order.'' Id.
at 2 n.4.
\39\ Id. at 2.
\40\ Id.
\41\ Id. The reference to G-20 objectives is to the 2009
commitment by the G-20 group of major industrial nations to
implement regulations for the over-the-counter derivatives market,
including requirements for clearing, trading on exchanges or
electronic trading platforms, and reporting of information on
derivatives contracts to trade repositories. See Leaders' Statement,
The Pittsburgh Summit (Sept. 24-25, 2009) at 20, https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf. Of the ten rules
remanded in SIFMA, three fall within the specific scope of the 2009
G-20 commitment--the SEF Registration Rule and the SDR and
Historical SDR Reporting Rules. Other rules contribute to the
broader G-20 objective of reducing risk to the financial system from
the use of derivatives.
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As evidence of market fragmentation, ISDA-SIFMA referred to ISDA
research indicating a reduced percentage of transactions by European
swap dealers with U.S. swap dealers in the market for euro denominated
interest rate swaps following the implementation of the SEF
Registration Rule.\42\ ISDA-SIFMA made suggestions for specific
substantive changes in two remanded rules. In the Swap Entity
Definition Rule, it recommended greater use of safe harbors to reduce
uncertainty for businesses hedging financial risk in applying the de
minimis exception for determining swap dealer status.\43\ In the SDR
Reporting Rule, it recommended that the Commission ``re-examine'' the
requirement of Commission rule 45.2(h) that swap counterparties who are
not Commission registrants make their books and records available to
the Commission and other U.S. authorities.\44\
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\42\ ISDA-SIFMA at 3.
\43\ Id.
\44\ Id.
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ISDA-SIFMA also urged the Commission to undertake greater
harmonization with foreign jurisdictions. In connection with the SEF
Registration Rule, ISDA-SIFMA stated that there was a ``stark
contrast'' between what it described as ``very rigid execution
methods'' under the Commission's rule and ``greater flexibility'' under
the rules that the European Union plans to implement, and urged the
Commission to ``re-examine its approach.'' \45\ ISDA-SIFMA also
supported greater international harmonization in the area of swap data
reporting.\46\ ISDA-SIFMA further stated that significant costs would
be incurred if the Commission implemented the test for the application
of certain Commission rules based on swap dealing activities within the
United States by non-U.S. swap dealers set forth in the Division of
Swap Dealer and
[[Page 54481]]
Intermediary Oversight Advisory, Applicability of Transaction-Level
Requirements to Activity in the United States (CFTC Staff Advisory No.
13-69, Nov. 14, 2013) (``DSIO Advisory'').\47\ Finally, with respect to
the use of substituted compliance as a means for addressing issues of
duplicative regulation, ISDA-SIFMA stated that ``broad, holistic''
substituted compliance ``can be of substantial help.'' \48\
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\45\ Id.
\46\ Id.
\47\ Id. at 4. ISDA-SIFMA called this a ``personnel-based
test.'' Id.
\48\ Id.
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JBA stated that banks are faced with legal and consulting fees to
comply with Dodd-Frank rules and that remaining areas of ambiguity
cause them to manage their business in a conservative manner.\49\ Banks
have also incurred costs to comply with regulatory requirements that
differ across jurisdictions, including where comparability is not
established.\50\ With respect to foreign banks registered as swap
dealers, JBA stated that the Commission's initial cost-benefit analysis
did not take into consideration the fact that entity-level requirements
apply to all of a bank's swaps business even though, for a non-U.S.
bank, transactions with U.S. persons account for only 10% of that
business.\51\ JBA further stated that foreign banks not registered as
swap dealers have avoided transacting with U.S. financial institutions
to avoid U.S. regulation, inconveniencing their customers and
increasing risks and costs for maintaining market liquidity.\52\ JBA
also stated that customers have avoided transacting with subsidiaries
of foreign banks incorporated in the U.S. in order to avoid U.S.
regulation, resulting in costs to book transactions with these
customers with non-U.S. entities to maintain business
relationships.\53\ JBA identified the reporting of swap data to trade
repositories as one area where banks have been subject to differing
requirements in multiple jurisdictions, resulting in increased
compliance costs.\54\ JBA therefore recommended that the swap data
reporting process should be established ``through an industry-wide
initiative.'' \55\ JBA identified the swaps push-out rule as a second
area of particular concern.\56\ However, this statutory provision \57\
was not part of the SIFMA litigation or remand order.
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\49\ JBA at 1.
\50\ Id.
\51\ Id. at 1-2.
\52\ Id. at 2.
\53\ Id.
\54\ Id. at 2-3.
\55\ Id. at 3.
\56\ Id.
\57\ The phrase ``swaps push-out rule'' is commonly used to
refer to 15 U.S.C. 8305, which, broadly speaking and with certain
exclusions, prohibits advances from a Federal Reserve credit
facility or discount window to assist swap dealers and certain
similar entities.
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UBS focused on the benefits of the SEF Registration Rule in
promoting a level playing field for market participants, facilitating
access to liquidity providers, and making the workflow from execution
to clearing as robust and efficient as possible.\58\ UBS stated that
application of the rule to all activities under the Commission's
jurisdiction pursuant to section 2(i) helps to ensure that the core
principles and benefits of the rule ``remain relevant as the global
swaps market continues to evolve.'' \59\ UBS also urged the Commission
to work with foreign regulators to maximize harmonization, avoid
regulatory arbitrage, and establish substituted compliance regimes that
address duplicative regulatory burdens, while also maintaining
consistency with the principles of the Dodd-Frank Act and Commission
regulations in the SEF area.\60\
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\58\ UBS at 1.
\59\ Id.
\60\ Id.
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IIB dealt primarily with cost-benefit issues that would arise from
implementation of the test based on swap dealing activities physically
located in the United States articulated in the DSIO Advisory.\61\ IIB
focused on swaps between a non-U.S. swap dealer and its non-U.S.
counterparties that--under the test set forth in the Advisory--would be
subject to transaction-level Dodd-Frank rules if the relevant swaps are
arranged, negotiated, or executed by personnel or agents of the non-
U.S. swap dealer located in the United States, but not otherwise.
According to IIB, in such transactions, the costs of U.S. rules would
be greater and benefits lower than in other transactions to which Dodd-
Frank rules apply. IIB stated that, in order to avoid U.S. regulation,
foreign swap dealers would forgo using staff located in the United
States in transactions with foreign counterparties even in
circumstances where employing U.S. personnel would be advantageous, for
example because a trader located in the United States is more familiar
with a particular market.\62\ IIB also stated that such a test could
result in covered transactions being subject to duplicative and
possibly contradictory regulation by multiple jurisdictions and in
costs to establish systems to keep track of which swaps are handled by
personnel or agents located in the United States.\63\ IIB further
stated that benefits would be doubtful in transactions made subject to
Commission rules by such a test because the resulting swaps would be
between two foreign entities and thus, according to IIB, pose little
threat to the U.S. financial system.\64\ IIB also discussed cost-
benefit implications of a test based on physical presence in the United
States in the context of several particular Dodd-Frank rules,
including, but not limited to, some of the rules subject to the SIFMA
remand order.\65\ IIB urged the Commission either to not implement such
a test or to implement a version considerably narrower than the one
described in the DSIO Advisory.\66\ IIB also was critical of a
different standard based on services provided within the United States
by non-U.S. persons, set forth in a Division of Market Oversight
guidance document. Under this standard, the SEF Registration Rule
applies to foreign-based entities that provide swap execution services
to traders located in the United States, even if the traders execute
swaps for non-U.S. persons.\67\
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\61\ IIB called this a ``U.S. personnel test.'' IIB at 4.
\62\ IIB at 5.
\63\ Id. at 6-8.
\64\ Id. at 6.
\65\ Id. at 9-16. IIB's points regarding particular remanded
rules are described in section IV.F, below.
\66\ Id. at 17-19.
\67\ Id. at 13-14.
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In addition to discussing the application of Commission rules to
non-U.S. firms based on activities within the United States, IIB stated
that, in the area of swap data reporting, duplicative requirements
create costs that could be avoided if the Commission could obtain
information from foreign regulators and trade repositories.\68\ IIB
stated that it supported Commission efforts to address legal and other
obstacles to cross-border information sharing.\69\ Pending completion
of these international efforts, IIB recommended that the Commission
formalize existing no-action relief relating to the extraterritorial
application of the SDR and Historical SDR Reporting Rules.\70\ IIB made
no recommendations for specific changes in the substantive requirements
of the remanded rules.
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\68\ Id. at 20.
\69\ Id.
\70\ Id.
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[[Page 54482]]
III. General Approach to Costs and Benefits of Extraterritorial
Application of Remanded Rules and Methods for Addressing Cost-Benefit
Issues Raised by Commenters
Under the SIFMA decision, the ultimate mandate to the Commission on
remand, following consideration of the extraterritorial costs and
benefits of the remanded rules, is to determine whether such
consideration requires any changes to be made in the ``substantive
transaction- and entity-level requirements'' of the remanded rules and,
if not, to give a reasoned explanation why not.\71\ The Commission
observes, consistent with the court's analysis, that Congress's
decision to apply the swaps rules extraterritorially may have
implications for the costs and benefits of the substance of those
rules. This possibility is inherent in cross-border regulation because
different sovereigns will make different substantive choices in
implementing swaps-market reforms, and will do so at different paces,
which raises the prospect of regulatory arbitrage and/or overlapping or
inconsistent rulemaking.
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\71\ 67 F. Supp. 3d at 435.
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Although it is likely impossible to fully eliminate those
difficulties, there are three general means by which the Commission and
other regulators can reduce them. First, the regulator may promulgate
rules and pursue policies specifically addressing the geographic reach
of its regulations. For the Commission, any such cross-border rules and
policies must be within the framework for the extraterritorial
application of swaps rules set forth in section 2(i) and must take into
account the policies of the relevant Dodd-Frank provisions as well as
international harmonization and comity. Second, the regulator may alter
the substance of its rules to conform them to those of foreign
jurisdictions or to otherwise address the special issues inherent in
cross-border regulation. Finally, the regulator may offer substituted
compliance or similar relief in situations where a foreign regulation
achieves results that are comparable to its own rules. At the
Commission, similar relief may also come at the staff level in the form
of no-action letters to address problems that may be more transient in
nature, require faster action, or otherwise be better suited to staff
action. These three categories of regulatory action may be used
individually or in concert.
As to the first of these methods--rules or policies specifically
addressing the geographical scope of regulations--the Commission in
2013 issued the Cross-Border Guidance to announce what it judged to be
a desirable balance between Dodd-Frank's financial reform policies and
international cooperation, consistent with the language of section
2(i). The Commission acknowledged, however, that swaps markets are
dynamic and would continue to evolve, necessitating an adaptable
approach.\72\ In that vein, the Commission stated that it would
consider addressing some of the subjects discussed in the Guidance by
rulemaking in the future.\73\ That remains the Commission's position.
As markets evolve and the Commission receives more information, it will
consider the possibility of adopting rules concerning the cross-border
application of its swaps regulations.\74\ Consideration of such rules
is, however, outside the scope of the remand order.\75\
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\72\ Cross-Border Guidance, 78 FR at 45297.
\73\ Id. at 45297 n.39.
\74\ For example, in conjunction with its rule on Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 636 (Jan. 6, 2016), the Commission has adopted
an accompanying rule specifically addressing cross-border
application. 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).
\75\ SIFMA v. CFTC, 67 F. Supp. 3d at 435; see also id. at 434-
35 (distinguishing between ``substance'' of rules and ``scope'' of
their extraterritorial application under section 2(i)).
---------------------------------------------------------------------------
The second tool for addressing cross-border issues, tailoring
substantive rule requirements, is the subject of this release, pursuant
to the district court mandate. Although tailoring substantive rule
requirements is a possible tool by which to avoid certain issues of
regulatory arbitrage and inconsistent regulation, this approach has
significant limitations. Chief among these is that the Commission does
not have unlimited flexibility to alter rules or lower its standards,
consistent with its statutory mandate. Even where the statute permits
flexibility, relaxing a particular substantive requirement to address a
cross-border issue may be undesirable from a public-policy standpoint
when other relevant factors are also considered. This is particularly
true since changes in the substance of rules affect domestic as well as
extraterritorial transactions and entities.
A further concern with relaxation of substantive rule requirements
as a tool to address issues of regulatory arbitrage and costs of
regulation by multiple jurisdictions is that it could contribute to a
``race to the bottom'' dynamic if engaged in unilaterally rather than
as an outcome of internationally coordinated rule harmonization
efforts. This point is complicated by the fact, discussed in more
detail below, that foreign jurisdictions do not yet have regulations in
place, or fully in place, in important areas covered by the remanded
rules. A final consideration in connection with the present remand is
that, at the time of its original rulemakings, the Commission consulted
with foreign regulators, reviewed comments concerning overseas
application of rules, and took these sources of information into
account in framing the substance of rules even where the accompanying
cost-benefit discussion did not explicitly distinguish between domestic
and extraterritorial rule applications.\76\
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\76\ For example, in the Portfolio Reconciliation Rule, the
Commission, at the request of commenters, modified the proposed
confirmation deadlines to take into account swaps executed in
different time zones. 77 FR at 55923. See also, e.g., Real-Time
Reporting Rule, 77 FR at 1189-90; SDR Reporting Rule, 77 FR at 2137-
38, 2151, 2160-62, 2165, 2167.
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Notwithstanding these concerns, the Commission recognizes that
incremental changes to harmonize its substantive rules with those of
foreign jurisdictions, or otherwise to address issues specific to
extraterritorial application, might be desirable under certain
circumstances. However, perhaps because of the difficulties described
in the previous paragraph, commenters made only a small number of
recommendations for specific changes in the substantive requirements of
the remanded rules. As explained in Part V, below, the available record
does not justify adoption of these proposed changes in the context of
the present remand, taking into account both considerations unique to
the extraterritorial application of the relevant rules, and
considerations common to their domestic and extraterritorial
application. Commenters also urged the Commission to continue or expand
its engagement in international harmonization efforts for certain
rules. The Commission agrees, as discussed in more detail below.
However, as also explained below, these efforts have not reached the
point today where they can serve as the basis for specific rule
changes.
At this time, the Commission is focused, in large part, on the
third tool--cooperative international efforts including, but not
limited to, substituted compliance and similar relief at the staff
level. As outlined in the Cross-Border Guidance, the Commission's
substituted compliance program is designed to avoid potential conflicts
and duplication between U.S. regulations and foreign law, consistent
with principles of international comity,
[[Page 54483]]
but only in instances where the laws and regulations of the foreign
jurisdiction are comparable and as comprehensive as a corresponding
category of U.S. laws and regulations, thus avoiding the risk of a race
to the bottom and ensuring that the Commission's public policy goals,
established by Congress, are met.\77\ As foreign regulators continue to
make progress in implementing swaps-market reforms, incentives for
regulatory arbitrage will diminish, and substituted compliance can be
expanded to reduce duplicative or otherwise unnecessary regulatory
burdens.\78\
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\77\ 78 FR at 45340.
\78\ See below at section IV.C.
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IV. Evaluation of International Cost-Benefit Considerations Raised in
Comments
A. Commenters' General Observations on Costs of Extraterritorial
Application of Rules
ISDA-SIFMA identifies a number of general respects in which
compliance with Commission rules may be more difficult for foreign
market participants than domestic ones:
When foreign market participants are subject to Commission
rules, they must engage with an unfamiliar, non-domestic regulator
and face uncertainty regarding the ramifications of being subject to
a new regime. A full-bore legal investigation (which may leave
unresolved issues) and substantial management attention are
prerequisites in any responsible entity becoming subject to a
foreign regulator. The addition of specially trained staff is a
common adjunct. Internal conflicts and customer resistance
frequently may follow. It is unsurprising that non-U.S. market
participants simply may be unwilling to take on this burden.\79\
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\79\ ISDA-SIFMA at 2.
ISDA-SIFMA thus suggests that foreign swaps entities may find it
more costly to comply with Commission regulations than domestic
entities because foreign entities will be less familiar with U.S. laws
and institutions and will need to invest resources in learning about
them. Along the same lines, the JBA comments that ``banks are faced
with increasing costs for legal fees and external consulting fees in
their efforts to accurately interpret and comply with [Dodd-Frank
rules].'' \80\ JBA also points out that banks have incurred costs to
comply with multiple jurisdictions' regulations where the timing of
implementation or requirements may differ, and that foreign swap
dealers need to incur costs to comply with entity-level rules that
apply to a firm's overall operations even though only a relatively
small portion of the dealer's swaps may be with U.S.
counterparties.\81\
---------------------------------------------------------------------------
\80\ JBA at 1.
\81\ Id. at 1-2.
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With respect to these general points about costs of
extraterritorial application of Commission rules, the Commission notes:
1. The commenters do not appear to dispute the basic point made in
the Commission's Initial Response that ``the swaps market functions
internationally, with many transactions involving U.S. firms taking
place across international boundaries; with leading industry members
typically conducting operations both within and outside the United
States; and with industry members commonly following substantially
similar business practices wherever located.'' \82\ By the same token,
ISDA-SIFMA's and JBA's general observations on costs are not
inconsistent with the conclusion that the types of costs and benefits
identified in the original preambles to the remanded rule characterize
the extraterritorial, as well as the domestic, application of the
rules. The Commission agrees, however, that entities doing business
internationally likely would face additional costs resulting from the
need to comply with swaps regulations in more than one jurisdiction.
The more jurisdictions in which the market participant does business,
the greater the costs that predictably will result. This is inherent in
cross-border regulation, both as required of the Commission by Congress
and by foreign regulators.
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\82\ 80 FR at 12558. Similarly, while the comments set forth
various ways in which, according to the commenters, foreign and
domestic costs may differ, they do not take issue with the
Commission's statement in the Initial Response that, in the original
Federal Register releases for the rules at issue, ``where the
Commission did not specifically refer to matters of location, its
discussion of costs and benefits referred to the effects of its
rules on all business activity subject to its regulations, whether
by virtue of the activity's physical location in the United States
or by virtue of the activity's connection with or effect on U.S.
commerce under section 2(i).'' Id.
---------------------------------------------------------------------------
2. ISDA-SIFMA and JBA state that, in at least some instances,
foreign firms will find it more costly to comply with CFTC Dodd-Frank
rules than domestic firms will. However, for purposes of considering
costs and benefits on remand, a number of factors significantly limit
the weight that can be given to their general observations on costs.
a. With certain limited exceptions, discussed below,\83\ ISDA-SIFMA
and JBA provide no quantitative information on, or estimates of, the
differential foreign and domestic cost effects they assert. Moreover,
even in qualitative terms they provide little in the way of specific
analysis or examples of how the cost mechanisms they mention work in
practice.\84\ This makes it difficult to evaluate how significant any
differences in foreign and domestic costs are relative to the
similarities resulting from the overall international nature of the
swaps markets; and to assess the attendant implications with respect to
the substance of the remanded rules.
---------------------------------------------------------------------------
\83\ See section IV.E below.
\84\ IIB provides somewhat more detail in its discussion of
issues raised by the DSIO Advisory. See section IV.F. below.
---------------------------------------------------------------------------
b. The costs identified by ISDA-SIFMA and JBA are, to a
considerable extent, not unique to the foreign applications of the
remanded rules. Both comments emphasize the cost of learning about, and
establishing compliance programs for, a novel regulatory scheme.
However, the Dodd-Frank swaps regime, and the Commission's implementing
rules, were novel for domestic as well as foreign firms since swaps in
the United States were largely unregulated before Dodd-Frank. Moreover,
firms located in the United States also must learn about foreign swaps
regulations if they wish to do business overseas. The discussion by
ISDA-SIFMA and JBA does not clearly distinguish the special costs of
foreign firms complying with novel U.S. regulations from the costs to
all firms of complying with any novel regulations. ISDA-SIFMA also does
not adequately take into consideration that some costs of complying
with U.S. rules may have been higher simply because the United States
moved more quickly than foreign jurisdictions to implement derivatives
regulations in response to the financial crisis; and foreign
jurisdictions still do not have regulations fully in place.
c. The discussion of general costs in ISDA-SIFMA and JBA, to a
large extent, does not distinguish between costs attributable to the
remanded rules and costs attributable to the underlying statute. As
noted, one of the major cost drivers described in these comments is the
cost of learning about, and establishing compliance programs for, U.S.
law. However, in virtually all areas covered by the remanded rules, the
Dodd-Frank statute either specifically required the CFTC to promulgate
some form of rule or directly imposed regulatory requirements.\85\ And,
as held
[[Page 54484]]
by the court in SIFMA, the rules were made applicable to foreign
activity by CEA section 2(i), not the Commission's rulemaking. As a
result, at least part of the cost of figuring out and applying U.S. law
discussed in these comments is attributable to the statutory scheme and
not to the specific terms of the rules promulgated by the Commission.
---------------------------------------------------------------------------
\85\ For example, reporting of swaps to swap data repositories
is required by CEA section 2(a)(13)(G), 7 U.S.C. 2(a)(13)(G); the
Swap Entity Registration Rule is required by CEA sections 4s(a) and
4s(b), 7 U.S.C. 6s(a) and 6s(b); the Daily Trading Records Rule is
required by CEA section 4s(g), 7 U.S.C. 6s(g); the Real-Time
Reporting Rule is required by CEA section 2(a)(13)(C), 7 U.S.C.
2(a)(13)(C); and requirements for risk management and chief
compliance officers are imposed by CEA sections 4s(j)(2) and 4s(k),
7 U.S.C. 6s(j)(2) and 6s(k).
---------------------------------------------------------------------------
d. The regulatory requirements imposed by the remanded rules fall
largely on sophisticated financial firms active in international
markets. It is unlikely that such firms would have significantly more
difficulty than similar U.S. firms in applying U.S. law.
Foreign firms made subject to the rules by section 2(i) are likely
to have significant experience in international markets, including in
particular the U.S. market, since that provision only applies to firms
whose transactions have a significant connection with or effect on U.S.
commerce. Among such firms, the Swap Entity Registration,\86\ Daily
Trading Records, Risk Management, Chief Compliance Officer,\87\ Swap
Entity Definition,\88\ and Portfolio Reconciliation \89\ Rules
primarily impose requirements on swap dealers. A foreign business that
meets the legal criteria to be classified as a swap dealer is likely to
be a major international financial firm, for a number of reasons.
Broadly speaking, the statutory swap dealer definition encompasses
firms that are in the business of making available swaps to other
persons, to meet the business needs of those persons, as opposed to
firms that merely use swaps to hedge their own business risks or for
their own investment purposes.\90\ Firms engaged in this line of
business are likely to be sophisticated financial entities. Indeed, the
Commission's rule further defining a swap dealer includes a ``de
minimis'' exception under which an entity dealing in swaps is not
considered to be a swap dealer unless its volume of dealing activity
exceeds a specified notional dollar amount, currently $8 billion, with
certain limited exceptions.\91\
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\86\ 77 FR 2613.
\87\ 77 FR 20128.
\88\ 77 FR 30596.
\89\ 77 FR 55904.
\90\ See, e.g., the interpretive guidance on the definition of
swap dealer in the preamble to the Swap Entity Definition Rule, 77
FR at 30607-16.
\91\ 17 CFR 1.3(ggg)(4). Under the terms of the regulation, the
amount will change to $3 billion at the end of 2017 unless the
Commission takes action to the contrary. The Commission is currently
evaluating what the de minimis amount should be after this date.
See, e.g., Swap Dealer De Minimis Exception Preliminary Report, A
Report by Staff of the U.S. Commodity Futures Trading Commission
Pursuant to Regulation 1.3(ggg) (Nov. 18, 2015).
---------------------------------------------------------------------------
Pursuant to section 2(i), a foreign firm that otherwise meets the
definition of a swap dealer would not be considered a swap dealer for
purposes of Dodd-Frank swaps regulations unless its dealing activity
has a direct and significant connection with activities in or effect on
U.S. commerce. The Cross-Border Guidance describes current Commission
policy for applying this limitation. Generally speaking, a non-U.S.
firm engaged in swap dealing is only treated as a swap dealer if it is
a guaranteed or conduit affiliate of a U.S. firm, or if its dealing
activity with a connection to or effect on U.S. markets--including
trades with U.S. persons and trades with non-U.S. firms that are
guaranteed or conduit affiliates of U.S. persons--exceeds the de
minimis amount, which, as noted, is currently $8 billion.\92\ Non-U.S.
firms that meet these criteria are likely not only to be sophisticated
financial firms, but also to have a significant presence in
international markets and at least some familiarity with U.S. law,
including Dodd-Frank and the CEA, and capacity for implementing
compliance programs based on it. While the Guidance is non-binding, the
scope of section 2(i) itself means that foreign entities subject to the
swap dealer definition will generally be sophisticated international
companies.
---------------------------------------------------------------------------
\92\ Cross-Border Guidance, 78 FR at 45318-20. An exception is
non-U.S. firms that are themselves guaranteed or conduit affiliates
of U.S. firms. For these firms, all of their swap dealing activity
counts toward the de minimis threshold. Id. at 45318-19.
---------------------------------------------------------------------------
Consistent with this conclusion, of the firms currently registered
as swap dealers with the Commission, almost all that are not U.S.
companies are either foreign affiliates of U.S. companies,
international banking companies, or affiliates of other major
international companies.\93\ Similarly, in the preamble to the Swap
Entity Registration Rule, the Commission noted that many of the
foreign-based commenters on the rule had experience navigating U.S. law
in connection with lines of business such as banking or insurance,
although it acknowledged that there might potentially be higher costs
for any swap dealers that may lack familiarity with U.S. law.\94\
---------------------------------------------------------------------------
\93\ See Dodd-Frank Act, Provisionally Registered Swap Dealers,
CFTC.gov, http://www.cftc.gov/ LawRegulation/DoddFrankAct/
registerswapdealer.
\94\ 77 FR at 2625.
---------------------------------------------------------------------------
The remanded reporting rules--the Real-Time Reporting, SDR
Reporting, and Historical SDR Reporting Rules--also impose duties
largely on sophisticated parties. For transactions executed on or
subject to the rules of designated contract markets \95\ (``DCMs'') or
SEFs, reporting duties generally fall on the relevant DCM or SEF. In
other swap transactions, the reporting duty generally falls on a swap
dealer, assuming at least one of the parties is a dealer.\96\ For
cleared swaps, certain reporting duties are handled by derivatives
clearing organizations, another category of sophisticated entity.\97\
The Commission's understanding is that transactions that are not traded
on or pursuant to the rules of a DCM or SEF and that do not involve a
dealer, account for only a relatively small portion of the market.
---------------------------------------------------------------------------
\95\ Broadly speaking, ``designated contract market'' is the
term used in the CEA for a traditional futures exchange or a similar
exchange used for swap trading.
\96\ 17 CFR 43.3(a)(3)(i)-(iii).
\97\ See, e.g., 17 CFR 45.4(b); Amendments to Swap Data
Recordkeeping and Reporting Requirements for Cleared Swaps, 80 FR
52544 (Aug. 31, 2015).
---------------------------------------------------------------------------
3. The Commission and its staff have taken a variety of actions
that mitigate, though they do not eliminate, differential costs of
compliance for foreign and domestic swaps business, most importantly,
though not only, through the program of substituted compliance. These
mitigation actions are described in section IV.C, below.
B. General Observations by Commenters on Benefits of Extraterritorial
Application of Remanded Rules
ISDA-SIFMA stated that net benefits of the extraterritorial
application of Commission rules are likely to be reduced where foreign
regulations accomplish similar results; they refer to ``attenuated or
minimal benefits'' from ``overlayering Commission regulations onto
foreign regulations that meet the objectives outlined by the G-20
jurisdictions.'' \98\ Other commenters also refer to the existence of
overlapping regulations in some areas such as reporting.\99\ The
Commission agrees that the existence of similar foreign regulations can
potentially reduce the incremental benefits of Commission rules for
entities or transactions covered by those regulations. However, there
are a number of factors that limit the weight that can be given to
commenters' observations on this point in the context of the present
remand.
---------------------------------------------------------------------------
\98\ ISDA-SIFMA at 2.
\99\ JBA at 2-3, IIB at 19-20.
---------------------------------------------------------------------------
1. ISDA-SIFMA and other commenters give little or no information as
to what foreign regulations are currently in effect that they believe
address the subject areas of the remanded Commission rules, in
particular foreign regulations that are not at this time subject to
substituted
[[Page 54485]]
compliance. Several of the remanded rules cover subjects where non-U.S.
regulation is not yet final. One example is the SEF Registration Rule.
In the European Union (``EU''), the leading swaps market outside the
United States, new regulations for ``multilateral trading facilities''
and ``organized trading facilities''--EU terms for certain types of
facilities that execute swaps--are being put in place pursuant to EU
Directive 2014/65, markets in financial instruments directive, commonly
known as ``MiFID II,'' and Regulation No. 600/2014, markets in
financial instruments regulation, commonly known as ``MiFIR,'' both of
which were adopted in 2014.\100\ However, the EU still needs to approve
draft Regulatory Technical Standards put forth by the European
Securities and Markets Authority implementing MiFID II and MiFIR.\101\
For some requirements, individual European states and competent
authorities will need to take action to put requirements in force.\102\
As a result, these EU requirements are not currently expected to go
into effect until January 3, 2018.\103\ Other foreign jurisdictions
also generally do not have current regulations in operation for swaps
trading facilities analogous to SEFs.\104\
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\100\ See, e.g., Directive 2014/65/EU of the European Parliament
and of the Council of 15 May 2014 on markets in financial
instruments and amending Directive 2002/92/EC and Directive 2011/61/
EU, 2014 O.J. (L 173) 349; Regulation (EU) No. 600/2014 of the
European Parliament and of the Council of 15 May 2014 on markets in
financial instruments and amending regulation (EU) No. 648/2012,
2014 O.J. (L 173) 84.
\101\ Council of the EU Press Release 255/16, Markets in
financial instruments: Council confirms agreement on one-year delay
(May 18, 2016).
\102\ Id.
\103\ Id.
\104\ See Financial Stability Board, OTC Derivatives Market
Reforms, Tenth Progress Report on Implementation, at 12-13, 17 Table
F (Nov. 4, 2015), http://www.fsb.org/wp-content/uploads/OTC-Derivatives-10th-Progress-Report.pdf.
---------------------------------------------------------------------------
Another example is the Real-Time Reporting Rule. European
regulations that will require the post-trade publication of swap
transaction information are being implemented within the MiFID II/MiFIR
framework and therefore are not yet operational.\105\ At present, with
very limited exceptions, other non-U.S. jurisdictions also do not yet
provide for public reporting of swap transaction information similar to
that provided by the Real-Time Reporting Rule.\106\
---------------------------------------------------------------------------
\105\ See International Organization of Securities Commissions
(``IOSCO''), Post-Trade Transparency in the Credit Default Swaps
Market, Final Report, at 6 (Aug. 2015), http://www.iosco.org/library/pubdocs/pdf/IOSCOPD499.pdf.
\106\ See id. Financial Stability Board, Thematic Review on OTC
Derivatives Trade Reporting, Peer Review Report, at 51 Table 12
(Nov. 4, 2015) (``FSB Trade Reporting Review''), http://www.fsb.org/wp-content/uploads/Peer-review-on-trade-reporting.pdf.
---------------------------------------------------------------------------
The Commission will also need to monitor the effect of the recent
vote by the United Kingdom to leave the European Union on the timing
and other aspects of the implementation of foreign regulation in the
areas of the remanded rules, particularly given the importance of
London as a financial center.
2. Even where foreign jurisdictions have in place regulations
broadly similar to U.S. regulations, there can be important benefits to
having U.S. rules apply to foreign swaps activity that has a
significant connection with or effect on U.S. markets. Among the
remanded rules, one example is the Swap Entity Registration Rule, which
sets forth the paperwork and related requirements for a swap dealer to
register with the Commission.\107\ As explained in the cost-benefit
discussion in the rule preamble, the major benefit of this rule is that
it ``will enable the Commission to increase market integrity and
protect market participants and the public by identifying the universe
of [swap dealers] and [major swap participants] subject to heightened
regulatory requirements and oversight in connection with their swaps
activities.'' \108\ In other words, the rule provides the Commission
with basic identifying and other information to enable it to monitor
the activities of swap dealers and major swap participants--whether
foreign or domestic--with a significant connection with or effect on
the U.S. market, thereby facilitating regulatory actions that may be
required. Foreign licensure requirements do not provide the same
benefit of directly and systematically providing the Commission
information to enable it to identify and monitor foreign participants
in U.S. markets.
---------------------------------------------------------------------------
\107\ 77 FR at 2614. The underlying requirement to register
derives from the statute. See CEA section 4s(a), 7 U.S.C. 6s(a).
\108\ Swap Entity Registration Rule, 77 FR at 2623.
---------------------------------------------------------------------------
Other important examples are the SDR and Historical SDR Reporting
Rules. Among the primary benefits of these rules is to provide the
Commission and other U.S. regulators with information on swaps trades
to enable them to monitor and analyze the market.\109\ This benefit is
relevant to swaps outside the United States made subject to reporting
by section 2(i), since such swaps are likely to have significant
effects on or connections to the U.S. financial system. While the EU
and some other major swaps jurisdictions have rules in place requiring
reporting of swaps transactions to ``trade repositories,'' U.S.
regulators currently do not have ready access to this data for a
variety of legal and practical reasons.\110\ While efforts are underway
to address these issues, at present reporting to foreign trade
repositories does not provide the same benefits for U.S. markets as the
Commission's SDR and Historical SDR Reporting Rules.\111\
---------------------------------------------------------------------------
\109\ See, e.g., discussion of benefits of SDR Reporting Rule in
rule preamble, 77 FR at 2176, 2179, 2181.
\110\ See FSB Trade Reporting Review at 27-28.
\111\ See id. at 29-30 (recommendation that all jurisdictions
should have a legal framework in place to permit access to data in
trade repositories by foreign regulatory authorities by June 2018).
---------------------------------------------------------------------------
3. In circumstances where foreign and U.S. regulations address
similar concerns, there may be economies in compliance activity that
partially compensate for the effects of regulatory overlap. For
example, investments by a firm in information and compliance systems to
comply with foreign legal requirements in areas such as reporting and
risk management are likely to be useful for--and thus reduce the
incremental cost of--complying with similar U.S. requirements even if
the rules differ in detail.
4. Through substituted compliance and other actions, the Commission
has allowed businesses to rely on foreign law in circumstances where it
can be shown that that law achieves benefits similar to the
Commission's requirements. The Commission expects to make additional
use of substituted compliance or other forms of recognition of similar
foreign regulation as appropriate in the future, including when other
foreign rules take effect. Substituted compliance and related actions
are discussed in detail in section IV.C, below.
C. Substituted Compliance and Other Commission Actions To Mitigate
Costs of Application of Remanded Rules Outside the United States
The Commission has taken a variety of actions to modify the
overseas application of the remanded rules in circumstances where other
jurisdictions have similar regulations in place. These actions may not
eliminate the costs associated with duplicative regulation, but they
substantially mitigate them, and therefore reduce any justification for
substantive rule changes to address extraterritorial concerns.
The most important of the Commission's actions to address problems
of duplicative regulation is substituted compliance. A framework for
substituted compliance was set forth in the Commission's Cross-Border
[[Page 54486]]
Guidance.\112\ Notably, since the Guidance is a non-binding policy
statement, the Commission is not precluded from employing substituted
compliance in circumstances, or on terms, not specified in the Guidance
if there are good reasons for doing so.\113\
---------------------------------------------------------------------------
\112\ 78 FR at 45342ff.
\113\ For example, in the recently promulgated rule on the
cross-border application of the Commission's rule on margin
requirements for uncleared swaps, the Commission established
standards as to when substituted compliance would be available with
respect to that rule that are somewhat different from the standards
set forth in the Cross-Border Guidance. See 81 FR at 34829-30.
---------------------------------------------------------------------------
Substituted compliance is relevant to entities that are subject to
the Commission's rules pursuant to section 2(i), but also are subject
to the swaps laws of a foreign jurisdiction. Examples given in the
Guidance include non-U.S. firms required under section 2(i) to register
with the Commission as swap dealers and foreign branches and foreign-
located guaranteed and conduit affiliates of U.S. swap dealers.\114\
Substituted compliance means that the Commission will permit the entity
to comply with the law of the relevant foreign jurisdiction in lieu of
compliance with one or more of the Commission's regulatory
requirements.\115\ As a condition for substituted compliance, the
Commission must find that the foreign jurisdiction's requirements, in a
particular subject area, are comparable to and as comprehensive as, the
Commission's requirements.\116\ The foreign jurisdiction's requirements
need not be identical, however, so long as they achieve similar
outcomes.\117\ Under the program described in the Guidance, the
availability of substituted compliance may vary depending on the type
of regulations or transactions at issue. For example, for certain
regulations, called ``transaction-level requirements'' in the Guidance,
substituted compliance is available to foreign swap dealers that are
affiliates of U.S. firms in transactions with foreign counterparties,
but not in transactions with counterparties who are U.S. persons, in
light of the greater U.S. interest in the latter.\118\
---------------------------------------------------------------------------
\114\ 78 FR at 45342.
\115\ Id.
\116\ Id.
\117\ Id. at 45342-43.
\118\ Id. at 45350-61.
---------------------------------------------------------------------------
Procedurally, persons interested in substituted compliance must
apply to the Commission for a comparability determination. Applicants
must identify the Commission requirements for which they seek
substituted compliance and provide information about the foreign law
that they believe is comparable.\119\ Applicants can include regulated
firms, foreign regulators, and trade associations or similar
groups.\120\ However, a resulting comparability determination will
apply to all entities or transactions in the relevant jurisdiction, not
just to particular applicants.\121\ In addition to the formal
application, comparability determinations typically also involve
consultation by the Commission with foreign regulators and may involve
follow-up memoranda of understanding providing for information sharing
and other forms of cooperation between regulators.\122\ These elements
of the process allow the Commission to reduce burdens without
sacrificing its regulatory interests as defined by the CEA and Dodd-
Frank.
---------------------------------------------------------------------------
\119\ Id. at 45344.
\120\ Id.
\121\ Id.
\122\ Id.
---------------------------------------------------------------------------
In December 2013, the Commission announced comparability
determinations--making substitute compliance possible--with respect to
six foreign jurisdictions: Australia, Canada, the European Union, Hong
Kong, Japan, and Switzerland in certain rulemaking areas. All of these
jurisdictions were found to have laws comparable to two of the remanded
rules, the Chief Compliance Officer and Risk Management Rules.\123\ The
EU and Japan were found to have laws comparable to the Daily Trading
Records Rule.\124\ The EU was also found to have laws comparable to
most, and Japan to have laws comparable to some, provisions of the
Portfolio Reconciliation Rule.\125\ The comparability determinations
incorporated a number of exceptions, typically to ensure that the
Commission or other U.S. authorities obtain information on foreign
registrants.\126\
---------------------------------------------------------------------------
\123\ 17 CFR 3.3, 23.600-23.606; see Comparability Determination
for Australia: Certain Entity-Level Requirements, 78 FR 78864,
78868-75 (Dec. 27, 2013); Comparability Determination for Canada:
Certain Entity-Level Requirements, 78 FR 78839, 78842-49 (Dec. 27,
2013); Comparability Determination for the European Union: Certain
Entity-Level Requirements, 78 FR 78923, 78927-35 (Dec. 27, 2013);
Comparability Determination for Hong Kong: Certain Entity-Level
Requirements, 78 FR 78852, 78855-62 (Dec. 27, 2013); Comparability
Determination for Japan: Certain Entity-Level Requirements, 78 FR
78910, 78914-21 (Dec. 27, 2013); Comparability Determination for
Switzerland: Certain Entity-Level Requirements, 78 FR 78899, 78902-
08 (Dec. 27, 2013).
\124\ 17 CFR 23.202; see Comparability Determination for the
European Union: Certain Entity-Level Requirements, 78 FR 78878,
78887-88 (Dec. 27, 2013); Comparability Determination for Japan:
Certain Transaction-Level Requirements, 78 FR 78890, 78896-97 (Dec.
27, 2013).
\125\ 17 CFR 23.501-23.506; see 78 FR at 78883-87; 78 FR at
78894-95.
\126\ For example the comparability determinations for the Risk
Management and Chief Compliance Officer Rules required covered
entities to make reports to the Commission, although these reports
could be the same as the equivalent reports provided to the relevant
foreign regulators.
---------------------------------------------------------------------------
Nothing in the Commission's policies for substituted compliance
precludes additional comparability determinations, beyond those made in
2013, as the international legal landscape for swaps evolves. The
Commission recently made a comparability determination for certain
European rules for central counterparties, the EU equivalent of what
U.S. law calls derivatives clearing organizations.\127\ While this is a
subject area outside the SIFMA litigation, the Commission remains open
to further substituted compliance for the remanded rules, upon an
adequate showing of comparability.
---------------------------------------------------------------------------
\127\ Comparability Determination for the European Union: Dually
Registered Derivatives Clearing Organizations and Central
Counterparties, 81 FR 15260 (Mar. 22, 2016).
---------------------------------------------------------------------------
Comparability determinations have been supplemented by other
actions to mitigate costs of the extraterritorial application of the
remanded rules and accommodate foreign regulation. For example, in the
Cross-Border Guidance, the Commission set forth a policy that, with
certain exceptions, foreign swap dealers generally would not be
required to comply with transaction-level requirements in connection
with their swaps with foreign counterparties independently of the
substituted compliance program.\128\ Another major example is the use
of staff no-action letters. These have been used particularly in areas
where the law is unsettled, either because of the continuing evolution
of foreign law, efforts to harmonize regulation across jurisdictions,
or, in some instances, possible changes in the Commission's own rules.
Staff no-action relief has typically been for limited periods of time,
with extensions granted as appropriate.
---------------------------------------------------------------------------
\128\ 78 FR at 45369. In connection with the cross-border
application of the margin rule for uncleared swaps, which postdates
the present litigation, the Commission has established certain
exclusions by rule. See 81 FR at 34850-51 (Table A).
---------------------------------------------------------------------------
One example is no-action relief in the area of the SDR and
Historical SDR Reporting Rules. With certain exceptions, the
Commission's Division of Market Oversight has granted no-action relief
with respect to these rules for swap dealers and major swap
participants established under the laws of Australia, Canada, the
European
[[Page 54487]]
Union, Japan, or Switzerland.\129\ This relief was issued after the
Commission received requests for comparability determinations for trade
repository reporting rules in these jurisdictions.\130\ The primary
exceptions to the relief are for entities that are part of an
affiliated group with a U.S. parent and for transactions with
counterparties who are U.S. persons or guaranteed or conduit affiliates
of U.S. persons.\131\ These exceptions reflect the stronger U.S.
supervisory and oversight interest in such entities and
transactions.\132\
---------------------------------------------------------------------------
\129\ CFTC Letter No. 15-61 (extending no-action relief provided
in CFTC Letter No. 13-75 and extended under CFTC Letter No. 14-141).
\130\ See id. at 2; CFTC Letter No. 13-75 at 1-2. In response to
a request from ISDA, this relief was extended in late 2015 until the
earlier of (a) 30 days after the issuance of a relevant
comparability determination or (b) December 1, 2016. CFTC Letter No.
15-61 at 2.
\131\ CFTC Letter No. 15-61 at 2. There are also exceptions for
certain recordkeeping requirements. Id.
\132\ See CFTC Letter No. 13-75 at 2.
---------------------------------------------------------------------------
For certain other jurisdictions, the Division of Market Oversight,
in response to an ISDA request, has granted no-action relief in
connection with requirements in the SDR and Historical SDR Reporting
Rules to report identifying information regarding swap counterparties
in certain circumstances where doing so would conflict with foreign
privacy laws or other legal requirements.\133\ The most recent no-
action letter on this subject extends relief through March 1,
2017.\134\
---------------------------------------------------------------------------
\133\ See, e.g., CFTC Letter Nos. 16-03, 13-41; see also IIB at
20 (supporting Commission's efforts to dispel conflicts with foreign
privacy laws through no-action relief, data standardization, and
memoranda of understanding).
\134\ CFTC Letter No. 16-03 at 4-5.
---------------------------------------------------------------------------
In connection with the SEF Registration Rule, in 2014 the Division
of Market Oversight and Division of Swap Dealer and Intermediary
Oversight issued a letter stating that no-action relief from that rule
would be available to multilateral trading facilities in EU member
states upon certification that they were subject to regulatory
requirements of their home governments similar to those of the SEF
Registration Rule in specified ways.\135\ The letter also stated that
certain no-action relief would be available to persons trading on these
facilities to reflect the fact that the facilities would be carrying
out functions like those of U.S. SEFs.\136\ This includes partial
relief from two of the remanded rules, SDR Reporting and Real-Time
Reporting, since the EU trading facility, like a SEF, would be
reporting the swap data in question.\137\ To date, no European trading
facilities have submitted the required certification to obtain this no-
action relief.
---------------------------------------------------------------------------
\135\ See CFTC Letter No. 14-46. This letter superseded an
earlier no-action letter on the same subject, CFTC Letter No. 14-16.
\136\ CFTC Letter No. 14-46.
\137\ Id.
---------------------------------------------------------------------------
The Division of Market Oversight and the Division of Swap Dealer
and Intermediary Oversight have also issued a letter announcing the
availability of similar no-action relief for certain Australian
licensed financial markets.\138\ An Australian trading facility has
advised the Division of Market Oversight that it intends to make the
certification required by the enabling letter.\139\ In the interim, the
Division has issued a series of no-action letters granting the facility
time-limited no-action relief from the SEF Registration Rule, subject
to certain conditions.\140\ This relief currently extends until
September 15, 2016.\141\
---------------------------------------------------------------------------
\138\ CFTC Letter No. 14-117, updated by CFTC Letter No. 15-29.
\139\ See CFTC Letter No. 16-52.
\140\ Id.
\141\ Id.
---------------------------------------------------------------------------
Further, in response to industry requests, the Commission staff has
issued no-action relief to address a variety of issues related to the
implementation of some of the remanded rules that do not specifically
involve cross-border issues, but that may provide relief to foreign as
well as domestic businesses subject to the rules.\142\ In addition, the
Commission is codifying some existing no-action relief via
rulemaking.\143\
---------------------------------------------------------------------------
\142\ See, e.g., CFTC Letter Nos. 15-60, 15-38.
\143\ The Commission has recently done this for registration
requirements involving foreign nationals. Alternative to
Fingerprinting Requirement for Foreign Natural Persons, 81 FR 18743
(Apr. 1, 2016). See also, Definitions of ``Portfolio
Reconciliation'' and ``Material Terms'' for Purposes of Swap
Portfolio Reconciliation, 81 FR 27309 (May 6, 2016).
---------------------------------------------------------------------------
D. Commission Consideration of Substantive Rule Changes Outside the
Context of the Remand Order
Another factor weighing against adopting substantive rule changes
in the immediate context of the SIFMA remand is that the Commission
currently is involved in a number of ongoing international efforts that
may in the future result in the Commission considering substantive rule
changes and may thereby lead to further mitigation of costs of
extraterritorial application of the remanded rules. These include
discussions with foreign regulators at a variety of levels of
formality. For example, in the SEF area, the Commission has worked with
European counterparts to understand similarities and differences in our
rules.
In the area of swap data reporting, the Commission staff is
actively involved in international efforts to develop guidance
regarding data elements used for reporting in different
jurisdictions.\144\ While the primary purpose of this effort is to make
reported information more valuable to regulators, better
standardization of data elements may also reduce compliance costs for
entities operating under the laws of multiple jurisdictions and help
facilitate the use of substituted compliance for reporting requirements
in the future. In another example of ongoing developments involving
swaps data reporting, in December 2015 Congress amended the Dodd-Frank
provision regarding swaps data repositories to remove an
indemnification requirement that has proven to be an obstacle to the
sharing of data internationally.\145\ The Commission staff is
considering recommendations to the Commission for amendments to
Commission rules to address this statutory change. As with data
standards, improved sharing of information among regulators potentially
could support the future use of substituted compliance in the swap data
reporting area.
---------------------------------------------------------------------------
\144\ See, e.g., Committee on Payments and Market
Infrastructures and Board of the International Organization of
Securities Commissions, Consultative report, Harmonisation of key
OTC derivatives data elements (other than UTI and UPI)--first batch
(Sept. 2015). The Commission co-chairs an international working
group in this area. Id. at Annex 2.
\145\ See, e.g., FAST Act Includes Dodd-Frank Swap Fix on Global
Transparency, Practical Law (Dec. 15, 2015), http://us.practicallaw.com/w-001-0649?q=&qp=&qo=&qe=.
---------------------------------------------------------------------------
The Commission believes that harmonization through substantive rule
changes is best considered first in consultation with foreign
counterparts, rather than unilaterally and reactively. Indeed, section
752 of Dodd-Frank directs the Commission to ``consult and coordinate
with foreign regulatory authorities on the establishment of consistent
international standards with respect to the regulation (including fees)
of swaps.'' \146\ This ensures that rule changes are more likely to
result in harmonized regulation rather than a race to the bottom or
rules that do not function efficiently in combination. Where such
progress has not yet produced agreement or relief, it does not affect
the present costs and benefits of the extraterritorial application of
the remanded rules. But the existence of these efforts is a factor
weighing against making immediate changes in the rules in the context
of the SIFMA v. CFTC remand.
---------------------------------------------------------------------------
\146\ Public Law 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
[[Page 54488]]
E. Market Fragmentation and Related Issues
ISDA-SIFMA and JBA state that, in addition to imposing direct costs
on foreign businesses, the extraterritorial application of the remanded
rules may induce such businesses to reduce their participation in the
U.S. market to avoid U.S. regulation. For example, ISDA-SIFMA observes:
These costs and uncertainties [of foreign entities' compliance
with U.S. rules] function as barriers to entry and to continued
engagement in U.S. markets, potentially resulting in market
fragmentation and decreased liquidity available to U.S. persons as
foreign market participants change their business practices so as
not to subject themselves to Commission regulation.\147\
---------------------------------------------------------------------------
\147\ ISDA-SIFMA at 2. See also JBA at 2. IIB also discusses
market withdrawal issues, but primarily in the context of
application of the DSIO Advisory and Division of Market Oversight
guidance document relating to legal standards for the application of
Commission rules based on the provision of swap-related services by
non-U.S. persons within the United States. IIB's concerns in this
area are discussed below in section IV.F.
This is an important issue worthy of the Commission's sustained
attention. The possibility that compliance costs may induce some
businesses--whether domestic or foreign--to reduce their swaps
activities was recognized at the time of the original rulemakings and
was discussed in the cost-benefit section of the preamble to the Swap
Entity Definition Rule, albeit without specifically distinguishing
between domestic and cross-border activity.\148\ It is plausible that
foreign firms are more likely to reduce their swaps activities in U.S.
markets in response to U.S. regulation since U.S. markets may be less
important to foreign firms, at least for some firms and some categories
of swaps. However, it is difficult to evaluate the magnitude of any
such effects since, with the important but limited exception of ISDA
data on the SEF Registration Rule discussed immediately below,
commenters generally did not provide quantitative information on the
subject.
---------------------------------------------------------------------------
\148\ See 77 FR at 30703 & n.1272, 30705.
---------------------------------------------------------------------------
Nevertheless, it is reasonable to believe that if an individual
firm judges that costs of complying with U.S. rules exceed the costs of
reducing its participation in or withdrawing from U.S. markets, it may
choose to avoid U.S. markets, at least temporarily. Accordingly, it is
important to consider, as ISDA-SIFMA has raised, whether and to what
extent rule-induced avoidance of U.S. markets will have a significant
effect on the liquidity and the overall operation of those markets.
ISDA-SIFMA discusses two ISDA research notes which provide relevant
quantitative information on this issue for one of the remanded rules,
the SEF Registration Rule.\149\
---------------------------------------------------------------------------
\149\ ISDA-SIFMA at 3 & n.6 (citing ISDA Research Note, Cross-
Border Fragmentation of Global OTC Derivatives: An Empirical
Analysis (Jan. 2014), https://www2.isda.org/attachment/NjIzNw==/Cross%20Border%20Fragmentation%20-%20An%20Empirical%20Analysis.pdf;
and ISDA Research Note, Revisiting Cross-Border Fragmentation of
Global OTC Derivatives: Mid-Year 2014 Update (July 2014), https://www2.isda.org/attachment/NjY0NQ==/Fragmentation%20study%20FINAL.pdf).
---------------------------------------------------------------------------
The research notes studied transactions between U.S. and European
swap dealers before and after the compliance date of the rule in
October 2013. They studied transactions involving two categories of
cleared swaps, euro-denominated interest rate swaps (``euro IRS'') and
U.S. dollar-denominated interest rate swaps (``dollar IRS'').\150\ For
euro IRS, the notes found that, before the compliance date of the SEF
Registration Rule, the average volume of transactions between European
and U.S. dealers was approximately 29% of the total volume of euro IRS.
This figure fell to 9% in October 2013 and 6% in May 2014.\151\
---------------------------------------------------------------------------
\150\ ISDA Research Note, Cross-Border Fragmentation of Global
OTC Derivatives: An Empirical Analysis (Jan. 2014), and ISDA
Research Note, Revisiting Cross-Border Fragmentation of Global OTC
Derivatives: Mid-Year 2014 Update (July 2014).
\151\ ISDA-SIFMA at 3.
---------------------------------------------------------------------------
The ISDA figures on euro IRS volume provide evidence of a reduction
in European involvement in the U.S. interdealer market following the
compliance date of the SEF Registration Rule, but do not measure
liquidity or market quality. The ISDA evidence raises concerns about
market fragmentation and justifies further inquiry, including inquiry
into possible effects of market fragmentation on liquidity. However,
the ISDA data does not require immediate changes in the SEF
Registration Rule in the context of the SIFMA v. CFTC remand, for a
number of reasons.
1. There is a significant possibility that the ISDA data reflect a
temporary transition period rather than the permanent effects of the
SEF Registration Rule. As discussed above, the European Union, in MiFID
II and MiFIR, has determined to put in place a regulatory framework for
swap trading facilities that aims at many of the same objectives as the
Dodd-Frank regime for SEFs.\152\ As also discussed above, these
regulations are planned to take effect in 2018. As a result, to the
extent that the reduced participation in the U.S. market reported by
ISDA is driven by differences in U.S. and European regulation of
trading facilities, those differences can be expected to narrow in the
next few years. For the same reason, the results reported by ISDA may
not reflect European dealers' response to the specific substantive
requirements of the SEF Registration Rule but, rather, a preference to
trade in a market where more robust regulation of trading platforms has
yet been put into effect. It is also possible that, as the European
Union regime is implemented, the Commission may consider substituted
compliance or similar actions that might affect choice of
counterparties by European dealers.\153\
---------------------------------------------------------------------------
\152\ See, e.g., MiFIR, supra note 100, at 2-3 (recital 8).
\153\ See, e.g., CEA section 5h(g), 7 U.S.C. 7b-3(g)
(authorizing conditional or unconditional exemptions from SEF
registration for SEFs subject to comparable, comprehensive
supervision and regulation by governmental authorities in the home
country of the facility). For comparison, in the area of clearing,
the Commission has granted conditional exemptions from U.S.
registration to a number of foreign-regulated derivatives clearing
organizations under the authority of CEA section 5b(h), 7 U.S.C. 7a-
1(h). See, e.g., Order of Exemption from Registration, In the Matter
of the Petition of Japan Securities Clearing Corporation for
Exemption from Registration as a Derivatives Clearing Organization
(CFTC Oct. 26, 2015), available on the Commission's Web site at
http://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/jsccdcoexemptorder10-26-15.pdf.
---------------------------------------------------------------------------
2. It is not clear how far the results reported by ISDA for euro
IRS generalize. According to the more recent of the research notes
cited by ISDA-SIFMA, in the interdealer market for dollar IRS, the
portion of the market involving transactions between European and U.S.
swap dealers declined to some extent for several months after the SEF
Registration Rule took effect, but then returned to more-or-less pre-
rule levels.\154\ The note suggests that the difference between the
results for euro IRS and dollar IRS ``may be because the market for US
IRS is US-centric, whereas the market for euro IRS has a more global
character and is thus more prone to fragmentation.'' \155\ The market
for euro IRS is large enough that even results confined to this market
are still important for Commission policymaking, but the differences in
the results reported by ISDA for different IRS markets affected by the
same SEF Registration Rule are a reason for caution in drawing
conclusions with respect to the specifics of the rule.\156\
---------------------------------------------------------------------------
\154\ ISDA Research Note, Revisiting Cross-Border Fragmentation
of Global OTC Derivatives: Mid-Year 2014 Update at 8.
\155\ Id.
\156\ It may also be noted that, in the euro IRS market, U.S.
swap dealers continued to do most of their trading with European
swap dealers after the implementation of the SEF Registration Rule,
notwithstanding the apparent shift away from the U.S. market by the
European firms. According to the more recent of the research notes,
U.S. swap dealers did 66% of the volume of their euro IRS trades
with European swap dealers in 2013, and still did 61% of the volume
of these trades with European swap dealers in the first part of
2014. Id. at 5.
---------------------------------------------------------------------------
[[Page 54489]]
3. To the extent that the results reported by ISDA are attributable
to regulation, they may be partly attributable to regulatory
requirements that are not subject to the SIFMA remand, including
statutory requirements. As the more recent of the ISDA research notes
points out, initial ``made available to trade'' determinations occurred
in early 2014, triggering a requirement under U.S. law that the types
of swaps studied by ISDA be traded on SEFs or DCMs. According to the
research note, this could have contributed to the European swap dealer
behavior reported by ISDA.\157\ However, the requirement that certain
swaps be traded on either SEFs or DCMs is not imposed by the remanded
SEF Registration Rule. It arises primarily from the combined effect of
the mandatory clearing requirement under CEA section 2(h)(1); \158\ the
Commission's Clearing Determination Rule,\159\ which was part of the
SIFMA lawsuit, but was not remanded; and the statutory requirement that
swap transactions subject to mandatory clearing be traded on a SEF or
DCM if a SEF or DCM makes the swap available to trade.\160\ This adds a
further complication in drawing conclusions from the ISDA data for
purposes of the remand order.
---------------------------------------------------------------------------
\157\ Id. at 1, 4-5.
\158\ 7 U.S.C. 2(h)(1).
\159\ 17 CFR part 50.
\160\ See CEA section 2(h)(8), 7 U.S.C. 2(h)(8).
---------------------------------------------------------------------------
4. The criteria for identifying dealers as European and U.S. in the
ISDA research notes is not completely clear, but appear to be based, at
least in part, on country of incorporation.\161\ However, some swap
dealers incorporated in Europe are subsidiaries or affiliates of U.S.
companies while some swap dealers incorporated in the United States are
subsidiaries or affiliates of European companies.\162\ As a result, it
is likely that some of the swaps business that shifted away from U.S.
dealers as reported in the ISDA notes moved to swap dealers
incorporated in Europe that have corporate relationships with U.S. swap
dealers. The economic effect of such a shift may depend on the nature
of the business relationship between the affiliated dealers--for
example whether their swaps activities are managed in a unified manner
or how risks and obligations are transferred among the affiliates.
These issues are not explored in the research notes.
---------------------------------------------------------------------------
\161\ See ISDA Research Note, Revisiting Cross-Border
Fragmentation of Global OTC Derivatives: Mid-Year 2014 Update at 4
n.5.
\162\ See Dodd-Frank Act, Provisionally Registered Swap Dealers,
CFTC.gov, http://www.cftc.gov/ LawRegulation/DoddFrankAct/
registerswapdealer (list of registered swap dealers).
---------------------------------------------------------------------------
5. Even apart from scheduled changes in European law, enhanced
regulation of multilateral swap trading platforms, such as SEFs, is
still relatively new and the industry is likely to continue to
evolve.\163\ There is also ongoing research into the effects of SEF
regulation, including the market fragmentation issue raised by ISDA-
SIFMA.\164\ As a result, a better understanding of the issue and its
implications is likely to be available in the reasonably near future
compared with the present record.
---------------------------------------------------------------------------
\163\ See, e.g., Chris Barnes, Is an All-to-All SEF Market About
to Arrive? Clarus Financial Technology (Sept. 8, 2015), https://www.clarusft.com/is-an-all-to-all-sef-market-about-to-arrive/.
\164\ See, e.g., Evangelos Benos, Richard Payne & Michalis
Vasios, Centralized trading, transparency and interest rate swap
market liquidity: evidence from the implementation of the Dodd-Frank
Act, Staff Working Paper No. 580 (Jan. 2016), http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp580.pdf; ISDA Research Note, Cross-Border Fragmentation of Global
Interest Rate Derivatives: The New Normal? First Half 2015 Update
(Oct. 2015), http://www2.isda.org/attachment/Nzk2NA==/Market%20fragmentation%20Oct15%20FINAL.pdf. Because these sources
postdate the comment period on the Commission's Initial Response,
the Commission is not relying on their findings. They are cited as
evidence that relevant research is ongoing.
---------------------------------------------------------------------------
6. The evidence of market fragmentation cited by ISDA-SIFMA needs
to be considered against the background of the expected benefits to the
functioning of the swap market provided by the requirements of the SEF
Registration Rule. These benefits were discussed in detail in the
preamble to the rule.\165\ They include, among others, increased pre-
trade transparency (availability of information about prices and
quantities at which traders are prepared to transact), potentially
making the market more efficient by facilitating the ability of
participants to identify potential counterparties.\166\ The
requirements of the rule are also calculated to put market participants
on a more even footing, reducing the effects of informational
asymmetries or other forms of market power, and potentially making the
swaps market less concentrated and more competitive.\167\ All of this
can potentially increase market liquidity.\168\ The research notes
cited by ISDA-SIFMA raise significant issues but provide little, if
any, information on how the functioning of U.S. swaps markets has been
affected, so far, by any reduced participation on the part of European
swap dealers. For example, they do not provide comparative information
on bid-ask spreads or other indicators of market efficiency.
---------------------------------------------------------------------------
\165\ See 78 FR at 33553-56, 33564-81.
\166\ Id. at 33564-65.
\167\ Id. at 33564.
\168\ See id. at 33554-55.
---------------------------------------------------------------------------
Notwithstanding these considerations, the research cited by ISDA-
SIFMA raises important issues that justify further inquiry. But, for
the reasons stated, it does not require immediate changes to the SEF
Registration Rule in the context of the SIFMA remand.
F. Issues Relating to Application of Commission Rules to Foreign Firms
Based on Swaps Activities Within the United States
1. Background
The IIB comment focused on the cost-benefit implications for the
remanded rules if the Commission employs a test based on swaps-related
activities physically located within the United States for determining,
in certain circumstances, whether U.S. swaps rules apply to
transactions between two non-U.S. firms. ISDA-SIFMA addressed the
implications of such a test more briefly, making points similar to
those of IIB. As noted previously, the idea of a test based on physical
presence of activities in the United States in connection with rules
for swap dealers was articulated in the November 2013 DSIO Advisory;
while a test based on trading by persons inside the United States on
multilateral platforms located outside the country was articulated in
the Division of Market Oversight Guidance on Application of Certain
Commission Regulations to Swap Execution Facilities (November 15, 2013)
(``DMO Guidance''). Before addressing the issues raised by IIB and
ISDA-SIFMA, some background will be given as context.
The DSIO Advisory dealt with certain issues involving the
application of transaction-level requirements to non-U.S. swap dealers,
i.e., foreign firms that do sufficient U.S.-related swap dealing that
they are required to register with the Commission as swap dealers. In
the Cross-Border Guidance, the Commission stated that its policy for
applying Commission rules to such dealers in accordance with section
2(i) of the CEA would make use of a distinction between what it
described as entity-level requirements and transaction-level
requirements.\169\ As the names imply, an entity-level requirement is a
rule
[[Page 54490]]
requirement that is recognized by the Commission as applying to a firm
as a whole, while a transaction-level requirement is a requirement that
is recognized by the Commission as applying at the level of the
individual transaction.\170\ Among the remanded rules, the Real-Time
Reporting, Daily Trading Records, and Portfolio Reconciliation Rules
are characterized as transaction-level rules in the Guidance.\171\
According to the policy announced in the Cross-Border Guidance,
transaction-level requirements would generally be expected to apply to
swaps between a non-U.S. swap dealer and U.S. counterparty, but they
would not generally be expected to apply, with certain exceptions, to
swaps between a non-U.S. swap dealer and a non-U.S. counterparty.\172\
The general exceptions are for transactions with certain non-U.S.
counterparties with a particularly close connection to the U.S. market,
specifically guaranteed and conduit affiliates of U.S. firms.\173\
---------------------------------------------------------------------------
\169\ 78 FR at 45331.
\170\ Id.
\171\ Id. at 45333.
\172\ Id. at 45350-53.
\173\ Id. at 45353-59.
---------------------------------------------------------------------------
The DSIO Advisory addresses situations where a non-U.S. swap dealer
has personnel located within the United States that regularly engage in
certain forms of swap dealing activity. The advisory expressed the view
that a non-U.S. dealer who is ``regularly using personnel or agents
located in the U.S. to arrange, negotiate, or execute a swap with a
non-U.S. person generally would be required to comply with the
Transaction-Level Requirements'' with respect to such swaps, even
though a non-U.S. swap dealer generally is not required to comply with
transaction-level requirements for swaps with another non-U.S.
counterparty.\174\ In support of this position, the advisory stated
that, in the view of DSIO, ``the Commission has a strong supervisory
interest in swap dealing activities that occur within the United
States, regardless of the status of the counterparties.'' \175\ The
advisory stated that it reflected the views of DSIO only, and did not
necessarily represent the position of the Commission or any other
office or division of the Commission.\176\
---------------------------------------------------------------------------
\174\ DSIO Advisory at 2.
\175\ Id.
\176\ Id.
---------------------------------------------------------------------------
Shortly after the DSIO Advisory was issued, the Division of Swap
Dealer and Intermediary Oversight, the Division of Market Oversight,
and the Division of Clearing and Risk issued temporary no-action relief
with respect to activity within the scope of that described in the DSIO
Advisory regarding transaction-level requirements.\177\ This relief has
since been extended, most recently until the earlier of September 30,
2016, or the effective date of any Commission action with respect to
the issues raised by the DSIO Advisory.\178\ In January of 2014, the
Commission published a notice in the Federal Register seeking public
comment on the DSIO Advisory.\179\ Comments on the DSIO Advisory remain
under review and the Commission, to date, has not sought to enforce its
rules against a foreign entity based solely on the type of swap dealing
activity discussed in the advisory.
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\177\ CFTC Letter No. 13-71.
\178\ CFTC Letter No. 15-48.
\179\ 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).
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The DMO Guidance addressed a variety of issues regarding
application of the SEF Registration Rule. As relevant here, the DMO
Guidance addressed circumstances in which a multilateral swaps trading
platform located outside the United States provides U.S. persons or
persons located in the United States--including personnel or agents of
non-U.S. persons--with the ability to trade or execute swaps on or
pursuant to the rules of the platform, whether directly or through
intermediaries.\180\ The DMO Guidance expressed the view that provision
of the ability to trade or execute swaps to U.S. located-persons,
including personnel or agents of non-U.S. persons, ``may create the
requisite connection under CEA section 2(i) for purposes of the SEF/DCM
registration requirement.'' \181\ As a result, the Division of Market
Oversight ``expects that a multilateral swaps trading platform located
outside the United States'' that provides U.S. located persons,
including personnel or agents of non-U.S. firms, with the ability to
trade or execute swaps pursuant to the rules of the platform ``will
register as a SEF or DCM.'' \182\ The DMO Guidance indicated that in
determining whether a particular foreign trading platform needed to
register as a SEF, it would take into consideration whether the
platform directly solicits or markets its services to U.S.-located
persons and whether a significant portion of its business involved
U.S.-located persons.\183\ The DMO Guidance stated that it represents
the views of the Division of Market Oversight only and does not
represent the views of the Commission or any other office or division
of the Commission.\184\
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\180\ DMO Guidance at 2.
\181\ Id.
\182\ Id. at 2.
\183\ Id. at 2 n.8.
\184\ Id. at 5.
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2. Comments on Cost-Benefit Implications of DSIO Advisory
a. Points Made by Commenters
IIB identifies a number of general costs--not specific to
particular rules--from applying a test based on presence in the United
States to transactions between non-U.S. swap dealers and non-U.S.
counterparties. The major cost, according to IIB, is that such a test
would create incentives to avoid using personnel located in the United
States in such transactions in order to avoid being subject to U.S.
transaction-level rules.\185\ While the transactions could still occur,
IIB states that parties would lose certain advantages that may be
associated with the use of personnel located in the United States. In
particular, IIB states that personnel with the greatest expertise in
some markets, such as U.S. dollar denominated interest rate swaps, are
typically located in the United States.\186\ Relatedly, presence in the
United States may provide traders with better access to information on
U.S. markets.\187\ In addition, U.S.-located personnel can have
advantages for time zone reasons.\188\ IIB also states that some
advantages of centralized risk management may be lost if functions
previously handled by personnel located in the United States are split,
with U.S. personnel retaining the functions for transactions with U.S.
counterparties and personnel outside the U.S. handling those same
functions for other transactions to avoid the effects of a U.S.
presence test.\189\
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\185\ IIB at 5-6; see also ISDA-SIFMA at 4.
\186\ IIB at 5 & n.12.
\187\ Id. at 5.
\188\ Id.
\189\ Id. at 5-6.
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IIB also states that, since such a test applies to transactions
between non-U.S. firms, it exposes them to the cost of dealing with
duplicative and possibly contradictory foreign regulation.\190\ IIB
also notes that there will be costs associated with keeping track of
which swaps with non-U.S. counterparties are arranged, negotiated, or
executed by personnel located in the United States and incorporating
that information into compliance systems.\191\ IIB further observes
that, even if most of these costs fall on non-U.S. swap dealers who
maintain offices in the United States, some will fall on non-U.S.
[[Page 54491]]
counterparties who deal with these swap dealers.\192\
---------------------------------------------------------------------------
\190\ Id. at 6-7.
\191\ Id. at 8.
\192\ Id. at 8-9.
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IIB also characterizes the benefits of applying a test based on
physical presence in the United States to transaction-level
requirements as doubtful. IIB states that transactions made subject to
U.S. regulation by such a test do not give rise to risks to the U.S.
financial system because they do not involve a counterparty that is a
U.S. person or a guaranteed or conduit affiliate of a U.S. person.\193\
IIB further asserts that this test does not offer competitive parity
benefits. IIB states that, even if the Commission believes that,
without a physical presence test, there is an unlevel playing field
between U.S. and non-U.S. swap dealers employing U.S.-located front-
office personnel, such concerns are outweighed by the applicability of
foreign regulation to those non-U.S. swap dealers and by new
competitive disparities such a test would create between U.S. and non-
U.S. personnel.\194\ Finally, IIB states that any benefits from
application of rules pursuant to a physical presence test would be
``largely illusory'' to the extent that non-U.S. entities structure
transactions to fall outside the test.\195\
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\193\ Id. at 6. As explained above, under the policies for
applying section 2(i) announced in the Cross-Border Guidance,
transactions between a non-U.S. swap dealer and a counterparty that
is a U.S. person or guaranteed or conduit affiliate are subject to
transaction-level requirements independently of the location of the
swap dealer's personnel.
\194\ IIB at 6.
\195\ Id.
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IIB also discusses certain implications of the application of such
a test to particular rules, including the three transaction-level rules
that are part of the SIFMA remand.\196\ IIB notes that the Portfolio
Reconciliation Rule and the Daily Trading Records Rule are intended to
mitigate risks to the U.S. financial system.\197\ IIB states that the
risks those rules are intended to address are not borne by the
personnel who arrange, negotiate, or execute swaps, but rather by the
parties to the swap.\198\ In transactions made subject to these rules
solely based on the physical presence of dealing activity in the United
States, neither counterparty is a U.S. person or a guaranteed or
conduit affiliate of a U.S. person so, according to IIB, the risks do
not flow back to the U.S. financial system and the purposes of the
rules are not served or only served in an attenuated way.\199\
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\196\ Much of IIB's discussion of specific rules concerns
external business conduct and entity-level rules that are outside
the remand and therefore are not addressed here. See, e.g., IIB at
14-16, 19-20.
\197\ IIB at 9.
\198\ Id.
\199\ Id. at 9 & n.27.
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With respect to the Real-Time Reporting Rule, IIB appears to
acknowledge that this rule, as a general matter, may generate useful
market information since it states that non-U.S. counterparties ``can
effectively free ride and obtain the benefits of the CEA's real-time
public reporting requirements by accessing publicly available price
data and taking that data into account when negotiating its swaps.''
\200\ However, IIB asserts that these same non-U.S. counterparties have
a financial incentive to avoid engaging in transactions that are
subject to this rule, and will therefore have an incentive to avoid
transactions involving U.S. personnel if a physical presence test
applies. In particular, according to IIB, swap dealers may provide
worse pricing in transactions subject to real-time reporting. This is
so, according to IIB, because swap dealers must allow for the
possibility that they will be unable to hedge the transaction before
the terms of the underlying transaction are disclosed pursuant to the
Real-Time Reporting Rule, and may face worse market terms for their
hedge transactions as a result of the disclosure.\201\ IIB does not,
however, provide data indicating how often this phenomenon is likely to
occur or comparing bid-ask spreads in transactions subject to the Real-
Time Reporting Rule with those in similar transactions not covered by
the rule. IIB also states that application of a physical presence test
to the Real-Time Reporting Rule may be costly to implement because
current systems used by non-U.S. swap dealers to identity which of
their swaps must be reported under the rule do not track information on
the location of front-office personnel involved in arranging,
negotiating, or executing the swap.\202\ IIB does not provide
quantitative cost estimates, however.
---------------------------------------------------------------------------
\200\ Id. at 12.
\201\ Id.
\202\ Id.
---------------------------------------------------------------------------
b. Commission Response
The Commission agrees with IIB and ISDA-SIFMA that the test
articulated in the DSIO Advisory raises significant issues that need to
be considered by the Commission. However, their comments are
overwhelmingly presented as a criticism of the test itself, not as a
basis for substantive rule changes. The SIFMA v. CFTC remand order does
not cover this issue, because the test relates to the geographical
scope of application of certain Commission rules and not to their
substance.\203\ Accordingly, the Commission will not pass judgment on
it in the context of this release. Rather, as noted above, the
Commission has separately solicited, and is considering, comments on
the DSIO Advisory; and, in the interim, the Commission's regulatory
divisions have granted staff no-action relief.
---------------------------------------------------------------------------
\203\ See SIFMA, 67 F. Supp. 3d at 434-35.
---------------------------------------------------------------------------
For purposes of the remand, the Commission will address a narrower
issue: do the possible cost-benefit implications of a physical presence
test sufficiently alter the evaluation of the costs and benefits of the
three remanded transaction-level rules to require the Commission to
make changes in the substance of those rules at the present time. The
Commission concludes that they do not, for a number of reasons:
1. The cost-benefit implications of the test articulated in the
DSIO Advisory for the three remanded transaction-level rules are
currently uncertain because the Commission is still considering public
comments and it is uncertain at this time whether the Commission will
apply the test. As a result of no-action relief, the test has not, to
date, been applied or, therefore, affected the costs and benefits of
the remanded rules. As a result, even if the test potentially might
affect costs and benefits in a manner that is distinct from the mere
fact of extraterritorial regulation, it is not appropriate at this time
to fashion substantive rule changes to account for it.
2. The test articulated in the DSIO Advisory affects a somewhat
limited segment of the market--only swap transactions that a non-U.S.
swap dealer enters into with non-U.S. counterparties that are not
guaranteed or conduit affiliates of U.S. persons and that are arranged,
negotiated, or executed using personnel or agents of the non-U.S. swap
dealer that are located in the United States. This limits the
implications of the test for the overall costs and benefits of the
remanded rules even if the points made by the commenters are important
for purposes of the costs and benefits of the rules as applied to
transactions within the scope of such a test. In addition, this fact
makes it likely that the best way to address issues raised with respect
to the test will involve assessing the test itself rather than making
rule changes that would affect numerous transactions outside its scope.
Consistent with this conclusion, the IIB comment makes recommendations
with regard to application of the test itself, but makes no
recommendations for across-the-board changes in the substance of the
[[Page 54492]]
three remanded transaction-level rules.\204\ Similarly, ISDA-SIFMA
identifies costs that it states would be caused by implementation of
the test, but does not make recommendations for changes to the
substance of the remanded transaction-level rules as a way of
addressing those costs.\205\
---------------------------------------------------------------------------
\204\ See IIB at 16-19.
\205\ ISDA-SIFMA at 4.
---------------------------------------------------------------------------
3. Even assuming that a test based on dealing activities by non-
U.S. firms physically present in the United States were to be
implemented for transaction-level rules, there are a number of
considerations that limit, though they do not eliminate, the weight
that can be given to some of the points made by commenters with respect
to the implications of such a test for costs and benefits.
(a) IIB and ISDA-SIFMA do not provide quantitative information or
estimates of the effects they project.\206\ The fact that staff no-
action relief was promptly put in place presumably affected the ability
to obtain quantitative information on the effects of the test in the
DSIO Advisory, but the absence of quantitative information, or even
estimates, makes it difficult to assess how important the effects
described by the commenters would be in practice.
---------------------------------------------------------------------------
\206\ The ISDA research notes on market fragmentation do not
relate to the test in the DSIO Advisory since they involve
transactions between European and U.S. swap dealers, while the DSIO
Advisory primarily relates to transactions between two non-U.S.
firms.
---------------------------------------------------------------------------
(b) Convergence between foreign and U.S. regulation may reduce
incentives to avoid U.S. regulation and therefore to avoid making use
of U.S. personnel or agents to avoid such regulation. For example, as
described above, the EU currently is planning to implement public
reporting of swaps transactions broadly similar to the Real-Time
Reporting Rule in 2018.
(c) The discussion of the implications of a physical presence test
for the Real-Time Reporting Rule in the IIB comment asserts that swap
dealers will tend to offer worse pricing to counterparties in
transactions subject to the Real-Time Reporting Rule because reporting
may expose dealers to worse prices in their hedging transactions.\207\
However, this possibility was recognized in the original rulemaking and
provisions were built into the rule to minimize the chance that the
otherwise anonymous public reporting of trades would provide the market
with information that would enable traders to identify planned, but
not-yet-executed, hedge trades by dealers and take advantage of that
information. These provisions include time delays for reporting of
large transactions \208\ and reporting of rounded or ``capped''
notional amounts rather than the actual notional amount for block
trades and certain other large transactions.\209\ The cost-benefit
discussion in the preamble to the rule concluded that time delays
``will counter the possibility for front-running large block trades
before they can be adequately hedged.'' \210\ The IIB comment does not
address the consideration of this issue in the original rulemaking and
in a subsequent rulemaking that amended the anonymity-protecting
provisions.\211\
---------------------------------------------------------------------------
\207\ IIB at 12.
\208\ See 17 CFR 43.5.
\209\ See 17 CFR 43.4(h).
\210\ Real-Time Reporting Rule, 77 FR at 1239.
\211\ See Procedures to Establish Appropriate Minimum Block
Sizes for Large Notional Off-Facility Swaps and Block Trades, 78 FR
32866, 32928-31 (May 31, 2013) (discussing costs and benefits of
amendments to anonymity protection provisions of Real-Time Reporting
Rule).
---------------------------------------------------------------------------
3. Comments on Application of SEF Registration Rule to Non-U.S. Trading
Platforms Based on Provision of Services Within the United States
a. Points Made in Comments
IIB discusses cost-benefit issues arising from the application of a
test based on provision of services within the United States to the SEF
Registration Rule pursuant to the interpretation of section 2(i) in the
DMO Guidance.\212\ As described above, according to this
interpretation, a non-U.S. swaps trading platform would be subject to
the SEF Registration Rule even if the platform provides swap execution
services solely to non-U.S. persons, if it provides personnel or agents
of those persons with the ability to make trades from locations within
the United States. According to IIB, this has a number of negative
effects. IIB states that some non-U.S. multilateral trading platforms
have refused access to U.S.-located personnel of foreign firms in order
to avoid the costs of having to register as SEFs.\213\ According to
IIB, this encourages U.S. personnel of non-U.S. entities to trade swaps
bilaterally, over-the-counter, contrary to the Commission's overall
transparency objectives.\214\ IIB does not, however, provide
information on how often these phenomena may have occurred or give
examples. IIB also does not discuss whether U.S. SEFs or other non-U.S.
multilateral trading platforms may sometimes be able to provide
substitute services if a particular non-U.S. multilateral trading
platform refuses access. IIB also notes that the test in the DMO
Guidance extends to trades executed through an intermediary and states
that the benefits of SEF registration are highly attenuated in
transactions where U.S. personnel of non-U.S. firms trade on a non-U.S.
multilateral trading facility through an intermediary because the
intermediary will be regulated by the Commission and this will provide
significant customer and market integrity protections.\215\
---------------------------------------------------------------------------
\212\ IIB at 13-14.
\213\ Id. at 13.
\214\ Id.
\215\ Id. at 14.
---------------------------------------------------------------------------
b. Commission Response
As with the DSIO Advisory, the issues raised by IIB with respect to
the DMO Guidance relate to the geographic scope of the SEF Registration
Rule as opposed to substantive rule requirements that may carry unique
cross-border costs. Consistent with this, IIB recommends changes in the
geographic approach taken in the DMO Guidance and does not recommend
changes in the SEF Registration Rule itself. Moreover, to the extent
that there are cost implications of the type identified by IIB, they
relate to a limited subset of the market--transactions between non-U.S.
firms that the firms would prefer to have executed on a non-U.S.
trading platform with at least one firm using a U.S.-based trader. For
these reasons, the Commission concludes that the issues raised by IIB
with respect to the DMO Guidance do not warrant changes in the
substantive provisions of the SEF Registration Rule and are beyond the
scope of the remand.
G. Additional Observations Made by Commenters on Costs and Benefits of
Extraterritorial Application of Particular Rules
1. SEF Registration Rule
The UBS comment emphasized the benefits of the SEF Registration
Rule, particularly provisions requiring SEFs to provide impartial
access so that market participants can compete on a level playing field
and to provide straight-through-processing, which is designed to make
the workflow from trade execution to clearing as robust and efficient
as possible.\216\ The comment endorsed the extraterritorial application
of the rule consistent with section 2(i), stating that, ``[i]n light of
the global and flexible nature of swaps execution, failing to apply the
provisions of [the rule] to all activities subject to the Commission's
jurisdiction would risk undermining the importance of the core
principles contained therein as the
[[Page 54493]]
global swaps market continues to evolve.'' \217\ The comment further
stated that, as other jurisdictions proceed with finalizing swap
execution rules, the Commission should attempt to maximize
harmonization while preserving core principles that are critical to a
well-functioning market.\218\
---------------------------------------------------------------------------
\216\ UBS at 1.
\217\ Id.
\218\ Id.
---------------------------------------------------------------------------
The Commission agrees that broad application of the SEF
Registration Rule within its jurisdiction will benefit the market in
terms of transparency, efficiency, and competitiveness. The Commission
also agrees that realization of those benefits may be enhanced by
harmonization with foreign regimes, consistent with the Commission's
own regulatory objectives.
ISDA-SIFMA also recommended harmonization in the SEF area; and
specifically urged the Commission to ``re-examine'' what ISDA-SIFMA
considered to be a ``very rigid'' approach to execution methods in the
SEF Registration Rule in light of what ISDA-SIFMA characterized as
greater flexibility for swap trading platforms in the European Union
under MiFID II.\219\ As described previously, the MiFID II regime is
still in the process of being implemented and is not expected to be in
operation until 2018. The Commission also notes that the SEF
Registration Rule provides for flexibility in execution methods, albeit
not in the precise ways that ISDA and SIFMA have recommended in other
documents.\220\ In particular, the rule requires SEFs to make available
trading via an order book, but also allows trades to be executed on
SEFs using a request for quotes system.\221\ It also allows block
trading for large transactions.\222\ Additional flexibility for SEFs
with respect to block trades has been provided through staff no-action
relief.\223\ The MiFID II standards for pre-trade transparency in
transactions on derivatives trading platforms, in some important
respects, may be more stringent and prescriptive than the Commission's
SEF rules.\224\
---------------------------------------------------------------------------
\219\ ISDA-SIFMA at 3.
\220\ See generally ISDA, Path Forward for Centralized Execution
of Swaps (Apr. 2015), cited in ISDA-SIFMA at 3 n.7.
\221\ 17 CFR 37.9.
\222\ 17 CFR 37.9(a)(2).
\223\ See CFTC Letter No. 15-60.
\224\ See, e.g., MiFIR, supra note 100, at 2-3 (recital 8); Amir
Khwaja, MiFID II and Transparency for Swaps: What You Need to Know,
Clarus Financial Technology (Sept. 29, 2015), https://www.clarusft.com/mifid-ii-and-transparency-for-swaps-what-you-need-to-know/.
---------------------------------------------------------------------------
2. SDR and Historical SDR Reporting Rules
Commenters observed that the current international regime in which,
pursuant to international commitments made following the 2008 financial
crisis, multiple jurisdictions have put in place requirements to report
data on swap transactions to swap data repositories or their foreign
equivalents has increased costs and reduced benefits of reporting. For
example, ISDA-SIFMA stated:
[I]mplementation of trade reporting mandates in different
jurisdictions is producing a disjointed and costly framework of
overlapping reporting obligations, in some cases in conflict with
local laws, with market participants reporting to a multiplicity of
trade repositories on different bases. Despite having access to
tremendous amounts of information, regulators are unable to
consolidate, aggregate and effectively use that information.\225\
---------------------------------------------------------------------------
\225\ ISDA-SIFMA at 3.
JBA and IIB made substantially similar observations.\226\ None of
the commenters provided quantitative data on, or estimates of, the cost
of duplicative reporting. Commenters also did not provide detailed or
specific qualitative information on how the Commission's reporting
rules interact with foreign requirements. With the exception of a
recommended change in Commission rule 45.2(h), discussed below, none of
the commenters recommended specific substantive changes in the SDR or
Historical SDR Reporting Rules. Commenters generally recommended that
the Commission address the current problems with the international
reporting regime through international cooperative means such as
memoranda of understanding with foreign regulators, initiatives to
promote data standardization and remove legal obstacles to cross-border
access to reported information, and international rules to determine
parties responsible for reporting.\227\ IIB also recommended that,
while efforts to resolve international data reporting issues are
ongoing, the Commission keep in place and formalize existing no-action
relief.\228\
---------------------------------------------------------------------------
\226\ JBA at 2-3; IIB at 19-20.
\227\ JBA at 3; IIB at 20.
\228\ IIB at 20.
---------------------------------------------------------------------------
The Commission agrees that improvements in standardization and
sharing of reported swap data across jurisdictions would be beneficial,
and Commission staff is working toward these objectives, as noted in
section IV.D, above. Among other benefits, they might facilitate the
use of substituted compliance or similar arrangements to reduce
duplicative regulation in the swap reporting area. By their nature,
however, improvements in these areas require international cooperative
efforts, as commenters generally recognized. As a result, the issues
with swap data reporting raised by the commenters do not support
unilateral changes in the substance of the SDR or Historical SDR
Reporting Rules in the context of the present remand.
V. Commenters' Recommendations for Changes in Substantive Requirements
of Rules
A. Introduction
As noted above in Part III, under the SIFMA decision, the ultimate
mandate to the Commission on remand, following consideration of any
differences between the extraterritorial and domestic costs and
benefits of the remanded rules, is to determine whether such
consideration requires any changes to be made in the substantive
requirements of the remanded rules and, if not, to give a reasoned
explanation why not.\229\ For this purpose the Commission, as mentioned
above, asked commenters about ``the implications of'' any differences
between extraterritorial and domestic costs and benefits ``for the
substantive requirements'' of the remanded rules.\230\ In addition to
general discussions of cross-border costs and benefits of some of the
remanded rules, addressed in Part IV, above, commenters put forth two
requests for specific changes in particular substantive rule
requirements, which are discussed here. The Commission believes that it
is useful in this context to evaluate the commenters' proposed changes
in light of the fact that the Commission is required to apply to its
own regulatory proposals pursuant to section 15(a) of the Commodity
Exchange Act (``section 15(a)'').\231\ The Commission also incorporates
by reference the discussions in the preceding sections.
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\229\ See 67 F. Supp. 3d at 435.
\230\ Initial Response, 80 FR at 12558.
\231\ Section 15(a)(1), 7 U.S.C. 19(a)(1), requires the
Commission, with certain exceptions, to consider the costs and
benefits of its action before promulgating a regulation or issuing
an order. Section 15(a)(2), 7 U.S.C. 19(a)(2) states that the costs
and benefits of the proposed Commission action shall be evaluated in
light of--(A) considerations of protection of market participants
and the public; (B) consideration of the efficiency,
competitiveness, and financial integrity of futures markets; (C)
considerations of price discovery; (D) considerations of sound risk
management practices; and (E) other public interest considerations.
---------------------------------------------------------------------------
In addition to making recommendations regarding the substance of
some of the remanded rules, the commenters made a number of
recommendations as to how the
[[Page 54494]]
Commission should apply section 2(i) in particular circumstances to
establish the extraterritorial scope of one or more of the rules.\232\
For purposes of its response to the remand order, the Commission will
not attempt to make determinations regarding the merits of commenters'
recommendations for rule changes or other actions defining the
extraterritorial scope, as opposed to the substance, of the rules.
---------------------------------------------------------------------------
\232\ An example is IIB's recommendation that the Commission not
make use of a test based on the physical presence of swap dealing
activity in the United States test in determining what transactions
are subject to transaction-level rules. IIB at 16-19.
---------------------------------------------------------------------------
B. Expanded Use of Safe Harbors in the Swap Entity Definition Rule
1. Commenter Proposal
Based on its observation that foreign entities are likely to have
more difficulty figuring out U.S. law than U.S. firms, ISDA-SIFMA
states that the costs of extraterritorial application of rules could be
mitigated by ``greater clarity around the scope of Commission rules and
greater use of safe harbors.'' \233\ The Commission agrees that use of
safe harbors or other forms of ``bright line'' rules can make it easier
for businesses to determine whether they are in compliance with
regulations. On the other hand, use of bright line rules commonly
involves a trade-off between simplicity of implementation and risks of
either underinclusiveness or overinclusiveness with regard to the
policy objectives of the regulation. As a result, suggestions for
greater use of bright line rules need to be evaluated in specific
contexts.
---------------------------------------------------------------------------
\233\ ISDA-SIFMA at 3.
---------------------------------------------------------------------------
ISDA-SIFMA makes only one specific suggestion for greater use of
safe harbor provisions, in the definition of a swap dealer. The comment
states:
[P]ersons utilizing the de minimis exemption from swap dealer
status may be avoiding transactions with U.S. swap dealers due to
uncertainty regarding whether their swaps hedging their own
financial risks would be considered to be entered into ``in
connection with dealing activity.'' Expansion of the safe harbor now
restricted to physical commodity hedging, so as to encompass a
broader array of hedging transactions, could mitigate this
effect.\234\
---------------------------------------------------------------------------
\234\ Id.
The ISDA-SIFMA recommendation relates to an issue that was
considered by the Commission at the time of the original Swap Entity
Definition rulemaking. As noted above, under the Commission's
regulation defining a swap dealer, a person who enters into swap
transactions is only considered to be a swap dealer if its swap
positions in connection with its dealing activity exceed a specified de
minimis amount, currently $8 billion.\235\ Thus, in order to determine
if it needs to register as a swap dealer, a business that enters into a
large volume of swaps may need to evaluate whether its positions
involve dealing or are for some other purpose. In close cases, this may
involve a judgment taking into account a number of factors.\236\
However, the Commission has specified that some categories of swap
transactions are not considered in determining whether an entity is a
swap dealer. One of these safe harbor categories is swaps used to hedge
market positions in physical commodities.\237\
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\235\ 17 CFR 1.3(ggg)(4)(i)(A).
\236\ See, e.g., 77 FR at 30614-16 (discussing interpretive
issues in application of statutory definition of swap dealer).
\237\ 17 CFR 1.3(ggg)(6)(iii).
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At the time of the original rulemaking, the Commission considered
whether to also create a safe harbor for swaps used to hedge commercial
risks--including financial risks--not associated with physical
commodities.\238\ The Commission stated that hedging generally was not
a form of dealing activity, but determined that a per se safe harbor
for commercial hedging should not be adopted because, in practice, it
is often difficult to distinguish commercial hedging transactions from
dealing transactions without taking into consideration the surrounding
facts and circumstances.\239\ ``[N]o method has yet been developed to
reliably distinguish, through a per se rule between: (i) [s]waps that
are entered into for the purpose of hedging or mitigating commercial
risk; and (ii) swaps that are entered into for the purpose of
accommodating the counterparty's needs or demands or otherwise
constitute swap dealing activity, but which also have a hedging
consequence.'' \240\ By contrast, the Commission had extensive
experience in the futures market with exclusions for hedging risks
associated with physical commodities and therefore concluded that it
could safely make use of a per se rule for swaps used for this
purpose.\241\ The hedging safe harbor was adopted as an interim final
rule and the Commission invited comments, including on whether the safe
harbor should be expanded to include hedging of financial risks.\242\
However, the Commission has not, to date, found reason to modify the
safe harbor as originally promulgated.
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\238\ 77 FR at 30611-13.
\239\ Id.
\240\ Id. at 30613.
\241\ Id. at 30612-13.
\242\ Id. at 30613.
---------------------------------------------------------------------------
The ISDA-SIFMA safe-harbor proposal thus raises issues that go well
beyond ISDA-SIFMA's concern with making U.S. law easier for foreign
firms to figure out. Maintaining the integrity of the line between
hedging and dealing activities is fundamental to a definition of a swap
dealer that is meaningful in practice and thus fundamental to the
effectiveness of the Dodd-Frank regulatory regime for swap dealers,
both foreign and domestic. Unfortunately, the ISDA-SIFMA comment does
not put forward a solution to the problem identified in the original
rulemaking--devising a reliable per se rule for distinguishing between
swaps entered into to hedge commercial risks and swaps that constitute
dealing activity without taking into consideration additional facts and
circumstances.
2. Evaluation in Light of Section 15(a) Factors
a. Protection of Market Participants and the Public
Expanding the hedging safe harbor in the definition of swap dealer
to cover hedging of financial risks poses significant risks of reducing
protection of market participants and the public. As noted above, the
Commission found in the preamble to the Swap Entity Definition Rule
that no reliable per se method has been found for distinguishing
between hedging financial risks using swaps and swap dealing. As a
result, a safe harbor for hedging financial risks could increase the
possibility that some entities engaged in a large volume of swap
dealing would be misclassified and not treated as dealers. This is
particularly true since, in close cases, businesses would have
incentives to label transactions as hedging rather than dealing to take
advantage of the safe harbor. Thus, a safe harbor for hedging financial
risks could result in some entities engaged in large volumes of swap
dealing not being subject to the provisions of Dodd-Frank and
Commission implementing regulations designed to protect market
participants and the public against wrongdoing by swap dealers and
against the risks to the financial system that were associated with
unregulated swap dealing before Dodd-Frank. This includes both some of
the remanded rules and statutory provisions and Commission rules that
are not subject to the remand order but that would not apply to firms
that were no longer classified as swap dealers as
[[Page 54495]]
a result of an expanded safe harbor.\243\ This concern applies to
overseas as well as domestic entities since, given the de minimis
volume element of the swap dealer definition and limits of section
2(i), a safe harbor would only be relevant to foreign entities engaged
in a reasonably large volume of swaps that affect or are connected to
U.S. markets. The ISDA-SIFMA comment does not specify methods for
crafting a safe harbor for hedging financial risks that avoids
misidentification or otherwise give reasons to overturn the
Commission's judgment regarding the workability of a safe harbor in the
preamble to the Swap Entity Definition Rule.
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\243\ Relevant remanded rules include the Swap Entity
Registration, Daily Trading Records, Risk Management, Chief
Compliance Officer, and Portfolio Reconciliation Rules. Examples of
other requirements imposed on swap dealers to protect market
participants and the public include the business conduct standards
set forth at 17 CFR part 23, subpart H.
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b. Efficiency, Competitiveness, and Financial Integrity
A safe harbor for hedging of financial risks poses a significant
risk of reducing efficiency, competitiveness, and financial integrity
because, as already explained, it could result in firms that engage in
large volumes of swap dealing not being subject to Dodd-Frank
provisions and Commission regulations that apply to swap dealers and
that are themselves designed to promote efficiency, competitiveness,
and financial integrity in the business of swap dealing. Examples
include the Daily Trading Records, Risk Management, Chief Compliance
Officer, Portfolio Reconciliation, and Real-Time Reporting Rules, among
others.
c. Price Discovery
The recommended safe harbor appears unlikely to have a significant
effect on price discovery. A safe harbor for swaps used to hedge
financial risks could increase the volume of swaps transactions by some
amount, but in light of the limited circumstances in which it is likely
to make a difference, any change in volume of transactions is unlikely
to affect price discovery. This is particularly true with respect to
the even narrower category of foreign swaps market participants who
might be affected by an expanded safe harbor.
d. Sound Risk Management Practices
The recommended safe harbor could increase the use of swaps to
manage financial risks in some limited circumstances--for example where
a firm's volume of swap transactions is close to the de minimis amount
for classification as a swap dealer, the firm wishes to expand its use
of swaps to hedge financial risks, the costs of regulation as a swap
dealer would outweigh the benefits from expanded use of swaps, and the
nature of the firm's business model creates ambiguity as to whether it
is engaged in hedging or dealing in the absence of a safe harbor. It is
unclear from available information how often this is likely to be the
case. For foreign firms, a safe harbor is unlikely to significantly
increase use of swaps to manage risks because such firms can already
avoid regulation as U.S. swap dealers by entering into swaps beyond the
de minimis amount with non-U.S. counterparties.
The recommended safe harbor also has a significant likelihood of
reducing use of sound risk management practices by some firms that
engage in swap dealing. As discussed previously, a safe harbor for
swaps used to hedge financial risks may lead to some firms that engage
in a large volume of swap dealing affecting U.S. markets being
misclassified and not regulated as swap dealers. Many of the Dodd-Frank
provisions and Commission rules applicable to swap dealers are designed
to ensure that swap dealers adopt sound risk management practices,
including, but not limited to, the Daily Trading Records, Risk
Management, Chief Compliance Officer, and Portfolio Reconciliation
Rules.
e. Other Public Interest Considerations
For some firms, an expanded safe harbor could contribute to
efficiency by making it easier to determine whether the firm needs to
comply with regulations applicable to swap dealers. This would be true
primarily, if not only, for firms that engaged in a total volume of
swap transactions that approached or exceeded the de minimis amount and
whose overall business model did not otherwise make clear whether or
not they were engaged in swap dealing. ISDA-SIFMA does not provide
information on the number of firms, either foreign or domestic, likely
to be in this category and the Commission is not aware of other sources
of information on this question. ISDA-SIFMA suggests that ease of
determining whether a firm is within the definition of a swap dealer
would be particularly valuable to foreign firms, on the theory that
such firms have difficulty coping with U.S. law. However, it is unclear
how important this factor would be for firms to which the recommended
safe harbor is most relevant since such firms, for the reasons just
stated, would likely have some level of financial and legal
sophistication, whether domestic firms engaged in substantial swaps
activity or foreign firms engaged in a significant volume of cross-
border swaps affecting or connected to U.S. markets.
Relatedly, the recommended safe harbor might encourage some foreign
counterparties who currently enter into swaps to hedge financial risks
with non-U.S. firms to move some of their business to U.S. swap
dealers. In particular, this might be true for foreign counterparties
whose other business does not make them swap dealers; who engage, or
would potentially engage, in more than the de minimis amount of swaps
with U.S. persons; whose business model currently creates ambiguity as
to whether the swaps in question are a form of dealing in the absence
of a safe harbor; and who do not have other reasons for confining their
swaps business to local, non-U.S., dealers. The available record does
not provide information on the number of firms that would meet all
these criteria or the volume of swaps business that would be involved.
However, given the limited circumstances in which a safe harbor would
have an effect, it appears unlikely, in the absence of information to
the contrary, that the volume of swaps involved would have a major
impact on the overall liquidity of U.S. markets.
Based on its evaluation of these factors, the Commission concludes
that expanding the hedging safe harbor is not warranted on the present
record. This is particularly true in light of (1) the fact that the
suggested expansion of the safe harbor would apply across the board and
not just in circumstances where foreign firms have greater difficulty
than U.S. firms in applying the swap dealer definition; (2) the
importance of maintaining the integrity of the swap dealer definition
to the entire Dodd-Frank regulatory regime; and (3) the conclusion in
the original Swaps Entity Definition rulemaking that there is no
reliable per se test for distinguishing between hedging financial risk
and dealing, and the absence of any showing by the commenters that this
conclusion is incorrect.
C. ``Re-examination'' of Application of Rule 45.2(h) to Non-Registrants
1. Commenter Proposal
ISDA-SIFMA recommends that the Commission ``re-examine the
provisions of Regulation 45.2 that require non-registrants `subject to
the jurisdiction of the Commission' to make books and records available
to the Commission and
[[Page 54496]]
other U.S. authorities.'' \244\ Commission rule 45.2 generally deals
with recordkeeping requirements for registered entities and parties
involved in swaps transactions. Section 45.2(h) requires covered
persons subject to the Commission's jurisdiction, including registrants
such as swap dealers but also swap counterparties not required to
register with the Commission, to make records available on request to
the Commission, the Justice Department, and the Securities and Exchange
Commission; and to U.S. prudential regulators (i.e., bank regulators)
as authorized by the Commission.\245\ The ISDA-SIFMA comment does not
explain specifically how and to what extent costs of compliance for
Sec. 45.2(h) differ for foreign and domestic entities, beyond ISDA-
SIFMA's general assertion, discussed in section IV.A above, that some
foreign firms may have more difficulty coping with U.S. law than U.S.
firms.
---------------------------------------------------------------------------
\244\ ISDA-SIFMA at 3.
\245\ 17 CFR 45.2(h).
---------------------------------------------------------------------------
2. Evaluation in Light of Section 15(a) Factors
a. Protection of Market Participants and the Public
Eliminating or significantly restricting application of Sec.
45.2(h) to non-registrants, including both domestic swaps
counterparties and foreign counterparties sufficiently involved in U.S.
swaps markets to be subject to U.S. regulation pursuant to section
2(i), can be expected to reduce protection of market participants and
the public since prompt and efficient access to records is necessary
for effective regulation of financial activity, both for purposes of
law enforcement and for purposes of market surveillance. This benefit
is limited somewhat by the alternative possibilities of obtaining
information about swap market participants by means such as legal
process or obtaining the assistance of foreign regulators. However,
such alternatives are likely to be slower and less efficient than use
of Sec. 45.2(h). Prompt and efficient access to records is
particularly important in developing situations, for example when there
is reason to believe that fraud or other law violations are ongoing and
that records may be destroyed or assets dissipated or hidden. It is
similarly important when there is reason to believe that insolvency or
other business problems at a firm with a large swaps portfolio may pose
risks to other market participants or the market in general. While it
is not practicable to quantify the benefits of Sec. 45.2(h) in
protecting market participants and the public, there is strong reason
to believe that the benefits are high relative to the costs since the
provision commonly is employed in situations where regulators have a
specific reason to be concerned about a firm's swaps activities or
otherwise have a specific need for information.
b. Efficiency, Competitiveness, and Financial Integrity
Eliminating or significantly restricting application of Sec.
45.2(h) to non-registrants is likely to reduce efficiency,
competitiveness, and financial integrity of relevant markets since it
would make it more difficult to enforce legal requirements designed to
promote these objectives, such as the anti-fraud and anti-market
manipulation provisions of the Commodity Exchange Act.\246\ As noted in
the previous section, it would also make it more difficult for U.S.
authorities to make prompt inquiries when the financial integrity of a
market participant is in question. The Commission does not have data
that would permit it to quantify these effects, however. The Commission
also does not have quantitative information on the costs of Sec.
45.2(h). However, there is reason to believe that overall costs are
relatively modest since this provision does not itself require either
recordkeeping or routine making of reports, but only provision of
access to existing records on request.
---------------------------------------------------------------------------
\246\ CEA sections 4b(a)(2), 6(c), 7 U.S.C. 6b(a)(2), 9.
---------------------------------------------------------------------------
c. Price Discovery
Changes in Sec. 45.2(h) appear unlikely to have any direct impact
on price discovery. Scaling back this requirement could have negative
indirect effects on price discovery since the provision can be used to
investigate violations of provisions designed to promote the price
discovery function of Commission-regulated markets, such as the
prohibition against price manipulation.\247\ The Commission lacks
information that would permit it to quantify any such effects, however.
---------------------------------------------------------------------------
\247\ CEA section 6(c), 7 U.S.C. 9.
---------------------------------------------------------------------------
d. Sound Risk Management Practices
Scaling back Sec. 45.2(h) appears unlikely to have a significant
effect on use of swaps to manage risks since, as noted, this provision
does not require recordkeeping or routine making of reports, but only
requires that records be made available to the CFTC and other
authorities on request.
e. Other Public Interest Considerations
Conceivably, some foreign non-registrant swap counterparties who
would prefer to avoid even a chance of involvement with U.S.
authorities might switch business from foreign swap providers to U.S.
swap dealers if Sec. 45.2(h) did not apply to them. ISDA-SIFMA does
not provide information on how often this would be the case. However,
in the absence of information to the contrary, it appears unlikely that
any such effect would be large enough to have a significant impact on
the overall liquidity of U.S. markets since the foreign firms in
question would still be subject to inspection by their home
authorities; and their records might still become available to U.S.
authorities, albeit less expeditiously, through mechanisms such as
cooperative enforcement arrangements with foreign jurisdictions.
In light of these considerations and the importance of access to
books and records for law enforcement, market surveillance, and other
regulatory purposes, the Commission concludes that ISDA-SIFMA has not
justified an amendment to Sec. 45.2(h) to exclude non-registrants.
D. Process Recommendations
Commenters made a number of recommendations for Commission
engagement in processes that could be expected to lead to substantive
changes in some of the remanded rules. In particular, commenters
generally supported Commission engagement in efforts for international
harmonization of rules in the area of swap data reporting and
regulation of SEFs and their foreign equivalents.\248\ The Commission
agrees that such efforts are important and is participating in them, as
described in section IV.C and IV.D, above. However, they are not at the
point where they can provide the basis for specific rule changes in the
context of the SIFMA remand. Consistent with this, commenters did not
identify specific rule changes based on harmonization efforts to date.
---------------------------------------------------------------------------
\248\ E.g., ISDA-SIFMA at 3; IIB at 20.
---------------------------------------------------------------------------
VI. Conclusion
The comments on the Initial Response identify some respects in
which the costs and benefits of the extraterritorial application of the
remanded rules may differ from the domestic application. However,
taking into account the facts and analysis in the original rulemaking
preambles as well as the additional consideration of costs and benefits
in the Initial Response and this release, the record does not establish
a need to make
[[Page 54497]]
changes in the substantive requirements of the remanded rules as
originally promulgated at the present time and in the context of the
SIFMA remand order.
Issued in Washington, DC, on August 4, 2016, by the Commission.
Christopher J. Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Final Response to District Court Remand Order in
Securities Industry and Financial Markets Association, et al. v. United
States Commodity Futures Trading Commission--Commission Voting Summary,
Chairman's Statement, and Commissioner's Statement
Appendix 1--Commission Voting Summary
On this matter, Chairman Massad and Commissioner Bowen voted in
the affirmative. Commissioner Giancarlo voted in the negative.
Appendix 2--Statement of Chairman Timothy G. Massad
I support the two actions the Commission and staff have taken
today, which address issues related to the cross-border application
of our rules on swaps. I thank the staff for their hard work on
these matters, my fellow Commissioners for their consideration, and
the public for their feedback.
Today, the CFTC has issued a final response to the remand order
of the U.S. District Court for the District of Columbia in
litigation brought by the Securities Industry and Financial Markets
Association and other industry associations against the Commission.
The litigation challenged the extra-territorial application of
several swaps rules and unsuccessfully sought to invalidate the
Commission's 2013 cross-border guidance. Today we have supplemented
our earlier answer to the Court's inquiry regarding the costs and
benefits of the overseas application of those rules.
In addition, Commission staff today has extended for another
year the previously issued no-action relief from certain
transaction-level requirements for transactions between non-U.S.
parties that regularly use personnel or agents located in the U.S.
to ``arrange, negotiate, or execute'' them.
These actions are part of our overall effort to address the
cross-border implications of swap activity, while at the same time
harmonizing derivatives regulation with other jurisdictions as much
as possible. The past several years have been marked by progress in
this regard. In the last year alone, we have accomplished a great
deal in each of the four basic areas of derivatives regulation--
central clearing, oversight of swap dealers, trading and reporting.
Consider the following:
With regard to central clearing, we and the European Commission
agreed upon a common approach regarding requirements for central
clearing counterparties (CCPs), which will permit U.S. and European
CCPs to continue providing clearing services to entities in each
other's jurisdiction. We also granted exempt status to several
foreign clearinghouses. The CFTC is also co-chairing a task force
with international regulators to address resiliency requirements and
engage in recovery planning, while also participating in
international resolution planning for CCPs.
When it comes to the oversight of swap dealers, we harmonized
the substance of rules setting margin requirements for uncleared
swaps, one of the most important parts of our overall regulatory
framework. We also agreed on an international timetable for
implementation. Although the European Commission recently delayed
their implementation for technical reasons, they have made clear
that this delay will be modest. We adopted a cross-border
application of our margin rule, which provides a broad scope of
substituted compliance. And we are currently working with other
jurisdictions on substituted compliance determinations that will
supplement those we have previously made in other areas.
On trading, the CFTC is looking at ways to harmonize our swap
execution facility rules with those of other jurisdictions. For
example, now that the European Securities and Markets Authority has
published its MiFiD II technical standards, we are working with our
European counterparts to look at differences in our respective rules
and make progress toward harmonization. We also recently issued no-
action relief to an Australia-based trading platform.
We are focused on harmonizing data reporting standards as well.
The CFTC co-chairs an international task force that is leading this
effort. CFTC staff is also working with international regulators and
the Office of Financial Research to develop effective means to
identify swaps and swap activity by participant, transaction and
product type throughout the swap lifecycle.
We will continue making progress in all these areas. For
example, this fall I intend to ask the Commission to consider a rule
to begin to address the ``arrange, negotiate, or execute'' issues
raised by the no-action relief that we have extended today.
Our first responsibility is to implement our nation's laws
faithfully, which requires us to address the cross-border
implications of swap activity. A strong global regulatory framework
is the best way to do so, and that is why harmonization is so
important. To focus on the fact that full harmonization has not been
reached, or that progress sometimes occurs in fits and starts, I
believe misses the forest for the trees. Regulations are implemented
by individual nations, or unions of nations, each of which has its
own legal traditions, regulatory philosophies, political processes,
and often, statutory timetables. There will always be differences,
just as there are in every other area of financial regulation. The
more important story is we are making good, steady progress.
Appendix 3--Dissenting Statement of Commissioner J. Christopher
Giancarlo
I respectfully dissent from the Commodity Futures Trading
Commission's (CFTC or Commission) final response in the SIFMA
litigation.
The CFTC appears to have addressed the District Court's inquiry
whether the costs and benefits identified in the remanded
rulemakings apply to swaps activities outside of the United States
(U.S.) and what differences are present in the costs and benefits
between domestic and overseas activities. Nevertheless, it must be
noted that the Commission has repeatedly failed to coordinate
effectively with foreign regulators to ``implement global
standards'' in financial markets as agreed to by the G-20 leaders in
Pittsburgh in 2009.\1\ The lack of harmonization in the
implementation date for margin for uncleared swaps is the latest
example. The result for financial markets has been a complex,
conflicting and costly array of CFTC cross-border regulations.
---------------------------------------------------------------------------
\1\ G-20 Leaders' Statement, The Pittsburgh Summit at 7 (Sept.
24-25, 2009) (G-20 Statement), available at http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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The Commission's uncoordinated approach to regulation of swaps
trading started with its July 2013 Interpretative Guidance and
Policy Statement Regarding Compliance With Certain Swap Regulations
(Interpretative Guidance).\2\ The Interpretative Guidance, which the
District Court found is a non-binding general statement of policy,
basically stated that every single swap a U.S. Person enters into,
no matter where it is transacted, has a direct and significant
connection with activities in, and effect on, commerce of the U.S.
that requires imposing CFTC transaction rules.\3\ This uncoordinated
approach has continued through the CFTC's Cross-Border Application
of Margin Requirements,\4\ in which the Commission unilaterally
imposed a set of preconditions to substituted compliance that is
overly complex, unduly narrow and operationally impractical.\5\
---------------------------------------------------------------------------
\2\ 78 FR 45292 (Jul. 26, 2013).
\3\ Id.
\4\ 81 FR 34818 (May 31, 2016).
\5\ Id. at 34853-54.
---------------------------------------------------------------------------
Unfortunately, the Commission's uncoordinated approach to cross-
border harmonization has allowed foreign regulators to respond in
kind. The CFTC's and European Union's (EU) tortured and repeatedly
delayed central counterparty clearinghouse equivalence process is a
stark example, as is the EU's recent decision to postpone until 2017
new rules setting collateral requirements for uncleared derivatives.
The CFTC must do better to work with foreign regulators to
implement global standards consistently in a way that ensures a
level playing field and avoids market fragmentation, protectionism
and regulatory arbitrage.\6\ As a good start, the CFTC should
replace its Interpretative Guidance with a formal rulemaking that
recognizes outcomes-
[[Page 54498]]
based substituted compliance for competent non-U.S. regulatory
regimes.\7\ Such an approach is practical, provides certainty and is
in keeping with the cooperative spirit of the 2009 G-20 Pittsburgh
Accords.\8\
---------------------------------------------------------------------------
\6\ G-20 Statement, par. 12.
\7\ Keynote Address of CFTC Commissioner J. Christopher
Giancarlo at The Global Forum for Derivatives Markets, 35th Annual
Burgenstock Conference, Geneva, Switzerland, Sept. 24, 2014, http://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlos-1.
\8\ See generally G-20 Statement.
[FR Doc. 2016-18854 Filed 8-15-16; 8:45 am]
BILLING CODE 6351-01-P