2020-16489
Federal Register, Volume 85 Issue 178 (Monday, September 14, 2020)
[Federal Register Volume 85, Number 178 (Monday, September 14, 2020)]
[Rules and Regulations]
[Pages 56924-57016]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16489]
[[Page 56923]]
Vol. 85
Monday,
No. 178
September 14, 2020
Part III
Commodity Futures Trading Commission
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17 CFR Part 23
Cross-Border Application of the Registration Thresholds and Certain
Requirements Applicable to Swap Dealers and Major Swap Participants;
Final Rule
Federal Register / Vol. 85 , No. 178 / Monday, September 14, 2020 /
Rules and Regulations
[[Page 56924]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 23
RIN 3038-AE84
Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is adopting a final rule (``Final Rule'') addressing the
cross-border application of certain swap provisions of the Commodity
Exchange Act (``CEA or ``Act''), as added by Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank
Act''). The Final Rule addresses the cross-border application of the
registration thresholds and certain requirements applicable to swap
dealers (``SDs'') and major swap participants (``MSPs''), and
establishes a formal process for requesting comparability
determinations for such requirements from the Commission. The Final
Rule adopts a risk-based approach that, consistent with the applicable
section of the CEA, and with due consideration of international comity
principles and the Commission's interest in focusing its authority on
potential significant risks to the U.S. financial system, advances the
goals of the Dodd-Frank Act's swap reforms, while fostering greater
liquidity and competitive markets, promoting enhanced regulatory
cooperation, and improving the global harmonization of swap regulation.
DATES: The Final Rule is effective November 13, 2020. Specific
compliance dates are set forth in the Final Rule.
FOR FURTHER INFORMATION CONTACT: Joshua Sterling, Director, (202) 418-
6056, [email protected]; Frank Fisanich, Chief Counsel, (202) 418-
5949, [email protected]; Amanda Olear, Deputy Director, (202) 418-
5283, [email protected]; Rajal Patel, Associate Director, 202-418-5261,
[email protected]; Lauren Bennett, Special Counsel, 202-418-5290,
[email protected]; Jacob Chachkin, Special Counsel, (202) 418-5496,
[email protected]; or Owen Kopon, Special Counsel, [email protected],
202-418-5360, Division of Swap Dealer and Intermediary Oversight
(``DSIO''), Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Statutory Authority and Prior Commission Action
B. Proposed Rule and Brief Summary of Comments Received
C. Global Regulatory and Market Structure
D. Interpretation of CEA Section 2(i)
1. Proposed Rule and Discussion of Comments
2. Final Interpretation
E. Final Rule
II. Key Definitions
A. Reliance on Representations--Generally
B. U.S. Person, Non-U.S. Person, and United States
1. Generally
2. Prongs
3. Principal Place of Business
4. Exception for International Financial Institutions
5. Reliance on Prior Representations
6. Other
C. Guarantee
1. Proposed Rule
2. Summary of Comments
3. Final Rule
D. Significant Risk Subsidiary, Significant Subsidiary,
Subsidiary, Parent Entity, and U.S. GAAP
1. Proposed Rule
2. Summary of Comments
3. Final Rule and Commission Response
E. Foreign Branch and Swap Conducted Through a Foreign Branch
1. Proposed Rule
2. Summary of Comments
3. Final Rule and Commission Response
F. Swap Entity, U.S. Swap Entity, and Non-U.S. Swap Entity
G. U.S. Branch
H. Swap Conducted Through a U.S. Branch
1. Proposed Rule
2. Summary of Comments
3. Final Rule--Swap Booked in a U.S. Branch
I. Foreign-Based Swap and Foreign Counterparty
1. Proposed Rule
2. Summary of Comments
3. Final Rule
III. Cross-Border Application of the Swap Dealer Registration
Threshold
A. U.S. Persons
B. Non-U.S. Persons
1. Swaps by a Significant Risk Subsidiary
2. Swaps With a U.S. Person
3. Guaranteed Swaps
C. Aggregation Requirement
D. Certain Exchange-Traded and Cleared Swaps
IV. Cross-Border Application of the Major Swap Participant
Registration Tests
A. U.S. Persons
B. Non-U.S. Persons
1. Swaps by a Significant Risk Subsidiary
2. Swap Positions With a U.S. Person
3. Guaranteed Swap Positions
C. Attribution Requirement
D. Certain Exchange-Traded and Cleared Swaps
V. ANE Transactions
A. Background and Proposed Approach
B. Summary of Comments
C. Commission Determination
VI. Exceptions From Group B and Group C Requirements, Substituted
Compliance for Group A and Group B Requirements, and Comparability
Determinations
A. Classification and Application of Certain Regulatory
Requirements--Group A, Group B, and Group C Requirements
1. Group A Requirements
2. Group B Requirements
3. Group C Requirements
B. Exceptions From Group B and Group C Requirements
1. Proposed Exceptions, Generally
2. Exchange-Traded Exception
3. Foreign Swap Group C Exception
4. Limited Foreign Branch Group B Exception
5. Non-U.S. Swap Entity Group B Exception
C. Substituted Compliance
1. Proposed Rule
2. Summary of Comments
3. Final Rule
D. Comparability Determinations
1. Standard of Review
2. Supervision of Swap Entities Relying on Substituted
Compliance
3. Effect on Existing Comparability Determinations
4. Eligibility Requirements
5. Submission Requirements
VII. Recordkeeping
VIII. Other Comments
IX. Compliance Dates and Transition Issues
A. Summary of Comments
B. Commission Determination
X. Related Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Cost-Benefit Considerations
1. Benefits
2. Assessment Costs
3. Cross-Border Application of the SD Registration Threshold
4. Cross-Border Application of the MSP Registration Thresholds
5. Monitoring Costs
6. Registration Costs
7. Programmatic Costs
8. Exceptions From Group B and Group C Requirements,
Availability of Substituted Compliance, and Comparability
Determinations
9. Recordkeeping
10. Alternatives Considered
11. Section 15(a) Factors
D. Antitrust Laws
XI. Preamble Summary Tables
A. Table A--Cross-Border Application of the SD De Minimis
Threshold
B. Table B--Cross-Border Application of the MSP Threshold
C. Table C--Cross-Border Application of the Group B Requirements
in Consideration of Related Exceptions and Substituted Compliance
D. Table D--Cross-Border Application of the Group C Requirements
in Consideration of Related Exceptions
[[Page 56925]]
I. Background
A. Statutory Authority and Prior Commission Action
In 2010, the Dodd-Frank Act \1\ amended the CEA \2\ to, among other
things, establish a new regulatory framework for swaps. Added in the
wake of the 2008 financial crisis, the Dodd-Frank Act was enacted to
reduce systemic risk, increase transparency, and promote market
integrity within the financial system. Given the global nature of the
swap market, the Dodd-Frank Act amended the CEA by adding section 2(i)
to provide that the swap provisions of the CEA enacted by Title VII of
the Dodd-Frank Act (``Title VII''), including any rule prescribed or
regulation promulgated under the CEA, shall not apply to activities
outside the United States (``U.S.'') unless those activities have a
direct and significant connection with activities in, or effect on,
commerce of the United States, or they contravene Commission rules or
regulations as are necessary or appropriate to prevent evasion of the
swap provisions of the CEA enacted under Title VII.\3\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 1 et seq.
\3\ 7 U.S.C. 2(i).
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In May 2012, the CFTC and Securities and Exchange Commission
(``SEC'') jointly issued an adopting release that, among other things,
further defined and provided registration thresholds for SDs and MSPs
in Sec. 1.3 of the CFTC's regulations (``Entities Rule'').\4\
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\4\ See 17 CFR 1.3; ``Swap dealer'' and ``Major swap
participant''; Further Definition of ``Swap Dealer,'' ``Security-
Based Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-
Based Swap Participant'' and ``Eligible Contract Participant,'' 77
FR 30596 (May 23, 2012). Commission regulations referred to herein
are found at 17 CFR chapter I.
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In July 2013, the Commission published interpretive guidance and a
policy statement regarding the cross-border application of certain swap
provisions of the CEA (``Guidance'').\5\ The Guidance included the
Commission's interpretation of the ``direct and significant'' prong of
section 2(i) of the CEA.\6\ In addition, the Guidance established a
general, non-binding framework for the cross-border application of many
substantive Dodd-Frank Act requirements, including registration and
business conduct requirements for SDs and MSPs, as well as a process
for making substituted compliance determinations. Given the complex and
dynamic nature of the global swap market, the Guidance was intended to
be a flexible and efficient way to provide the Commission's views on
cross-border issues raised by market participants, allowing the
Commission to adapt in response to changes in the global regulatory and
market landscape.\7\ The Commission accordingly stated that it would
review and modify its cross-border policies as the global swap market
continued to evolve and consider codifying the cross-border application
of the Dodd-Frank Act swap provisions in future rulemakings, as
appropriate.\8\ At the time that it adopted the Guidance, the
Commission was tasked with regulating a market that grew to a global
scale without any meaningful regulation in the United States or
overseas, and the United States was the first member country of the
Group of 20 (``G20'') to adopt most of the swap reforms agreed to at
the G20 Pittsburgh Summit in 2009.\9\ Developing a regulatory framework
to fit that market necessarily requires adapting and responding to
changes in the global market, including developments resulting from
requirements imposed on market participants under the Dodd-Frank Act
and the Commission's implementing regulations in the U.S., as well as
those that have been imposed by non-U.S. regulatory authorities since
the Guidance was issued.
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\5\ See Interpretive Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26,
2013).
\6\ Id. at 45297-45301. The Commission is now restating this
interpretation, as discussed in section I.D.2 infra.
\7\ Id. at 45297 n.39.
\8\ See id.
\9\ See G20 Leaders' Statement: The Pittsburgh Summit, A
Framework for Strong, Sustainable, and Balanced Growth (Sep. 24-25,
2009), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
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On November 14, 2013, DSIO issued a staff advisory (``ANE Staff
Advisory'') stating that a non-U.S. SD that regularly uses personnel or
agents located in the United States to arrange, negotiate, or execute a
swap with a non-U.S. person (``ANE Transactions'') would generally be
required to comply with ``Transaction-Level Requirements,'' as the term
was used in the Guidance (discussed in section V.A).\10\ On November
26, 2013, Commission staff issued certain no-action relief to non-U.S.
SDs registered with the Commission from these requirements in
connection with ANE Transactions (``ANE No-Action Relief'').\11\ In
January 2014, the Commission published a request for comment on all
aspects of the ANE Staff Advisory (``ANE Request for Comment'').\12\
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\10\ See CFTC Staff Advisory No. 13-69, Applicability of
Transaction-Level Requirements to Activity in the United States
(Nov. 14, 2013), available at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf. All Commission staff
letters are available at https://www.cftc.gov/LawRegulation/CFTCStaffLetters/index.htm.
\11\ CFTC Staff Letter No. 13-71, No-Action Relief: Certain
Transaction-Level Requirements for Non-U.S. Swap Dealers (Nov. 26,
2013), available at https://www.cftc.gov/csl/13-71/download.
Commission staff subsequently extended this relief in CFTC Letter
Nos. 14-01, 14-74, 14-140, 15-48, 16-64, and 17-36.
\12\ Request for Comment on Application of Commission
Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S.
Counterparties Involving Personnel or Agents of the Non-U.S. Swap
Dealers Located in the United States, 79 FR 1347, 1348-49 (Jan. 8,
2014).
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In May 2016, the Commission issued a final rule on the cross-border
application of the Commission's margin requirements for uncleared swaps
(``Cross-Border Margin Rule'').\13\ Among other things, the Cross-
Border Margin Rule addressed the availability of substituted compliance
by outlining the circumstances under which certain SDs and MSPs could
satisfy the Commission's margin requirements for uncleared swaps by
complying with comparable foreign margin requirements. The Cross-Border
Margin Rule also established a framework by which the Commission
assesses whether a foreign jurisdiction's margin requirements are
comparable.
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\13\ Margin Requirements for Uncleared Swaps for Swap Dealers
and Major Swap Participants--Cross-Border Application of the Margin
Requirements, 81 FR 34818 (May 31, 2016).
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In October 2016, the Commission proposed regulations regarding the
cross-border application of certain requirements under the Dodd-Frank
Act regulatory framework for SDs and MSPs (``2016 Proposal'').\14\ The
2016 Proposal incorporated various aspects of the Cross-Border Margin
Rule and addressed when U.S. and non-U.S. persons, such as foreign
consolidated subsidiaries (``FCSs'') and non-U.S. persons whose swap
obligations are guaranteed by a U.S. person, would be required to
include swaps or swap positions in their SD or MSP registration
threshold calculations, respectively.\15\ The 2016 Proposal also
addressed the extent to which SDs and MSPs would be required to comply
with the Commission's business conduct standards governing their
conduct with swap counterparties (``external business conduct
standards'') in cross-border
[[Page 56926]]
transactions.\16\ In addition, the 2016 Proposal addressed ANE
Transactions, including the types of activities that would constitute
arranging, negotiating, and executing within the context of the 2016
Proposal, the treatment of such transactions with respect to the SD
registration threshold, and the application of external business
conduct standards with respect to such transactions.\17\
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\14\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to Swap Dealers and
Major Swap Participants, 81 FR 71946 (proposed Oct. 18, 2016).
\15\ Id. at 71947. As noted above, the SD and MSP registration
thresholds are codified in the definitions of those terms at 17 CFR
1.3.
\16\ Id. The Commission's external business conduct standards
are codified in 17 CFR part 23, subpart H (17 CFR 23.400 through
23.451).
\17\ 2016 Proposal, 81 FR at 71947.
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B. Proposed Rule and Brief Summary of Comments Received
In January 2020, the Commission published a notice of proposed
rulemaking (``Proposed Rule''), which proposed to: (1) Address the
cross-border application of the registration thresholds and certain
requirements applicable to SDs and MSPs; and (2) establish a formal
process for requesting comparability determinations for such
requirements from the Commission.\18\ In the Proposed Rule, the
Commission also withdrew the 2016 Proposal, stating that the Proposed
Rule reflected the Commission's current views on the matters addressed
in the 2016 Proposal, which had evolved since the 2016 Proposal as a
result of market and regulatory developments in the swap markets and in
the interest of international comity.\19\ The Commission requested
comments generally on all aspects of the Proposed Rule and on many
specific questions.
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\18\ Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants, 85 FR 952 (proposed Jan. 8, 2020).
\19\ Id. at 954.
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The Commission received 18 relevant comment letters.\20\ Though AFR
and IATP did not support the Commission adopting the Proposed Rule in
its entirety, most commenters were supportive of the Proposed Rule,
generally, or supportive of specific elements of the Proposed Rule.
However, many of these commenters suggested modifications to portions
of the Proposed Rule, which are discussed in the relevant sections
discussing the Final Rule below. In addition, several commenters
requested Commission action beyond the scope of the Proposed Rule.\21\
Further, IIB/SIFMA requested that the Commission re-visit in the Final
Rule the applicability of the Commission's cross-border uncleared swap
margin requirements that were addressed in the Cross-Border Margin
Rule. The Commission addressed those requirements in the Cross-Border
Margin Rule, did not propose modifying them in the Proposed Rule, and
therefore is not making any changes to the Cross-Border Margin Rule in
this Final Rule.
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\20\ The Commission received comments from Alternative
Investment Management Association (``AIMA''); Americans for
Financial Reform Education Fund (``AFR''); Associated Foreign
Exchange, Inc. & GPS Capital Markets, Inc. (``AFEX/GPS''); Chris
Barnard (``Barnard''); Better Markets, Inc. (``Better Markets'');
BGC Partners & Tradition America Holdings, Inc. (``BGC/Tradition'');
Chatham Financial (``Chatham''); Citadel (``Citadel''); Commercial
Energy Working Group (``Working Group''); Credit Suisse (``CS'');
Futures Industry Association (``FIA''); Japan Financial Markets
Council & International Bankers Association of Japan (``JFMC/
IBAJ''); Institute for Agriculture and Trade Policy (``IATP'');
Institute of International Bankers & Securities Industry and
Financial Markets Association (``IIB/SIFMA''); International Swaps
and Derivatives Association (``ISDA''); Japanese Bankers Association
(``JBA''); Japan Securities Clearing Corporation (``JSCC''); and
State Street Corporation (``State Street''). The Commission also
received letters from PT Arba Sinar Jaya, Robert Ware (UIUC), and
William Harrington that were not relevant to the Proposed Rule. All
comments on the Proposed Rule are available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3067.
\21\ See infra section VIII for a discussion of these comments.
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C. Global Regulatory and Market Structure
As noted in the Proposed Rule, the regulatory landscape is far
different now than it was when the Dodd-Frank Act was enacted in
2010.\22\ When the CFTC published the Guidance in 2013, very few
jurisdictions had made significant progress in implementing the global
swap reforms to which the G20 leaders agreed at the Pittsburgh G20
Summit. Today, however, as a result of the cumulative implementation
efforts by regulators throughout the world, significant progress has
been made in the world's primary swap trading jurisdictions to
implement the G20 commitments.\23\ Since the enactment of the Dodd-
Frank Act, regulators in a number of large developed markets have
adopted regulatory regimes that are designed to mitigate systemic risks
associated with a global swap market. These regimes include central
clearing requirements, margin requirements for non-centrally cleared
derivatives, and other risk mitigation requirements.\24\
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\22\ Proposed Rule, 85 FR at 954-955.
\23\ See, e.g., Financial Stability Board (``FSB''), OTC
Derivatives Market Reforms: 2019 Progress Report on Implementation
(Oct. 15, 2019) (``2019 FSB Progress Report''), available at https://www.fsb.org/wp-content/uploads/P151019.pdf; FSB, Implementation and
Effects of the G20 Financial Regulatory Reforms: Fourth Annual
Report (Nov. 28, 2018), available at http://www.fsb.org/wp-content/uploads/P281118-1.pdf.
\24\ For example, at the end of September 2019, 16 FSB member
jurisdictions had comprehensive swap margin requirements in force.
See 2019 FSB Progress Report, at 2.
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Many swaps involve at least one counterparty that is located in the
United States or another jurisdiction that has adopted comprehensive
swap regulations.\25\ Conflicting and duplicative requirements between
U.S. and foreign regimes can contribute to potential market
inefficiencies and regulatory arbitrage, as well as competitive
disparities that undermine the relative positions of U.S. SDs and their
counterparties. This may result in market fragmentation, which can lead
to significant inefficiencies that result in additional costs to end-
users and other market participants. Market fragmentation can also
reduce the capacity of financial firms to serve both domestic and
international customers.\26\ The Final Rule supports a cross-border
framework that promotes the integrity, resilience, and vibrancy of the
swap market while furthering the important policy goals of the Dodd-
Frank Act. In that regard, it is important to consider how market
practices have evolved since the publication of the Guidance. As
certain market participants may have conformed their practices to the
Guidance, the Final Rule will ideally cause limited additional costs
and burdens for these market participants, while supporting the
continued operation of markets that are much more comprehensively
regulated than they were before the Dodd-Frank Act and the actions of
governments worldwide taken in response to the Pittsburgh G20 Summit.
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\25\ See, e.g., 2019 FSB Progress Report; Bank of International
Settlements (``BIS''), Triennial Central Bank Survey of Foreign
Exchange and Over-the-counter Derivatives Markets in 2019 (Sep. 16,
2019), available at https://www.bis.org/statistics/rpfx19.htm.
\26\ See, e.g., Institute of International Finance, Addressing
Market Fragmentation: The Need for Enhanced Global Regulatory
Cooperation (Jan. 2019), available at https://www.iif.com/Portals/0/Files/IIF%20FSB%20Fragmentation%20Report.pdf.
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The approach described below is informed by the Commission's
understanding of current market practices of global financial
institutions under the Guidance. For business and regulatory reasons, a
financial group that is active in the swap market often operates in
multiple market centers around the world and carries out swap activity
with geographically-diverse counterparties using a number of different
operational structures.\27\
[[Page 56927]]
Financial groups often prefer to operate their swap dealing businesses
and manage their swap portfolios in the jurisdiction where the swaps
and the underlying assets have the deepest and most liquid markets. In
operating their swap dealing businesses in these market centers,
financial groups seek to take advantage of expertise in products traded
in those centers and obtain access to greater liquidity. These
arrangements permit them to price products more efficiently and compete
more effectively in the global swap market, including in jurisdictions
different from the market center in which the swap is traded.
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\27\ See BIS, Committee on the Global Financial System, No. 46,
The macrofinancial implications of alternative configurations for
access to central counterparties in OTC derivatives markets, at 1
(Nov. 2011), available at http://www.bis.org/publ/cgfs46.pdf
(stating that ``[t]he configuration of access must take account of
the globalised nature of the market, in which a significant
proportion of OTC derivatives trading is undertaken across
borders'').
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In this sense, a global financial enterprise effectively operates
as a single business, with a highly integrated network of business
lines and services conducted through various branches or affiliated
legal entities that are under the control of the parent entity.\28\
Branches and affiliates in a global financial enterprise are highly
interdependent, with separate entities in the group providing financial
or credit support to each other, such as in the form of a guarantee or
the ability to transfer risk through inter-affiliate trades or other
offsetting transactions. Even in the absence of an explicit arrangement
or guarantee, a parent entity may, for reputational or other reasons,
choose to assume the risk incurred by its affiliates located overseas.
Swaps are also traded by an entity in one jurisdiction, but booked and
risk-managed by an affiliate in another jurisdiction. The Final Rule
recognizes that these and similar arrangements among global financial
enterprises create channels through which swap-related risks can have a
direct and significant connection with activities in, or effect on,
commerce of the United States.
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\28\ The largest U.S. banks have thousands of affiliated global
entities, as shown in data from the National Information Center
(``NIC''), a repository of financial data and institutional
characteristics of banks and other institutions for which the
Federal Reserve Board has a supervisory, regulatory, or research
interest. See NIC, available at https://www.ffiec.gov/npw.
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D. Interpretation of CEA Section 2(i)
1. Proposed Rule and Discussion of Comments
The Proposed Rule set forth the Commission's interpretation of CEA
section 2(i), which mirrored the approach that the Commission took in
the Guidance.
Several commenters provided their views on the Commission's
interpretation of CEA section 2(i). Better Markets agreed with the
Commission's description of the Commission's authority to regulate
swaps activities outside of the United States, recognizing that CEA
section 2(i)'s mandatory exclusion of only certain, limited non-U.S.
activities (i.e., those that do not have a direct and significant
connection with activities in, or effect on, U.S. commerce) evidences
clear congressional intent to preserve jurisdiction with respect to
others. Better Markets stated its belief that this reflects an intent
to ensure U.S. law broadly applies to non-U.S. activities having
requisite U.S. connections or effects. Better Markets argued, however,
that the Commission does not have the discretion to determine whether
and when to apply U.S. regulatory requirements based on vague
principles of international comity, stating that the Commission has not
cited a legally valid basis for its repeated reliance on international
comity, where it simultaneously acknowledges direct and significant
risks to the U.S. financial system.
BGC/Tradition supported the Commission's analysis related to CEA
section 2(i) and what constitutes ``direct and significant.''
Specifically, BGC/Tradition agreed that the appropriate approach is
``to apply the swap provisions of the CEA to activities outside the
United States that have either: (1) A direct and significant effect on
U.S. commerce; or, in the alternative, (2) a direct and significant
connection with activities in U.S. commerce, and through such
connection present the type of risks to the U.S. financial system and
markets that Title VII directed the Commission to address.''
IIB/SIFMA discussed the Commission's interpretation of ``direct''
in CEA section 2(i) and argued that the Commission should have followed
Supreme Court precedent interpreting the ``direct effect'' test found
in the Foreign Sovereign Immunities Act of 1976, which the Court has
interpreted to be satisfied only by conduct abroad that has ``an
immediate consequence'' in the United States.\29\ IIB/SIFMA argued that
a case cited by the Commission as a factor in its interpretation, the
Seventh Circuit en banc decision in Minn-Chem, Inc. v. Agrium, Inc.,
was based on considerations that are relevant to the Foreign Trade
Antitrust Improvements Act of 1982 (``FTAIA''),\30\--but not section
2(i)--namely that (a) because the FTAIA includes the word
``foreseeable'' along with ``direct,'' the word ``direct'' should be
interpreted as part of an integrated phrase that includes
``foreseeable'' effects, and (b) the FTAIA already addresses foreign
conduct that has an immediate consequence in the United States through
its separate provision for import commerce.\31\ But, IIB/SIFMA argued,
CEA section 2(i) does not include the word ``foreseeable,'' nor does it
include any other provisions addressing foreign conduct that have an
immediate consequence within the United States, so the Minn-Chem
Court's reasoning does not support the Commission's decision to
discount the Supreme Court's interpretation of the word ``direct'' in
Weltover.
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\29\ See Republic of Argentina v. Weltover, 504 U.S. 607, 618
(1992).
\30\ 15 U.S.C. 6a.
\31\ See Minn-Chem, Inc. v. Agrium, Inc., 683 F.3d 845, 857 (7th
Cir. 2012).
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IATP argued that the Commission did not provide a sufficient
``international comity'' argument to justify deviating from the plain
meaning of ``direct,'' nor a sufficient argument to rely on FTAIA case
law to interpret ``direct.'' IATP stated its belief that the
Commission's reliance on cross-border anti-trust trade law to interpret
its statutory authority under CEA section 2(i) is an inconsistent and
unreliable foundation for a rule that proposes no measures to prevent
or discipline SDs' unreasonable restraint of trade. IATP recommended
that the Commission abandon its ``restatement'' of its CEA section 2(i)
authority and rely on a plain reading of CEA section 2(i).
In response to Better Markets' contention that the Commission does
not have the discretion to determine whether and when to apply U.S.
regulatory requirements based on principles of international comity
where it simultaneously acknowledges direct and significant risks to
the U.S. financial system, the Commission has followed the Restatement
of Foreign Relations law in striving to minimize conflicts with the
laws of other jurisdictions while seeking, pursuant to CEA section
2(i), to apply the swaps requirements of Title VII to activities
outside the United States that have a direct and significant connection
with activities in, or effect on, U.S. commerce. The Commission has
determined that the rule appropriately accounts for these competing
interests, ensuring that the Commission can discharge its
responsibilities to protect the U.S. markets, market participants, and
financial system, consistent with international comity, as set forth in
the Restatement.
With respect to IIB/SIFMA's contention that the Commission erred in
its interpretation of the meaning of ``direct'' in CEA section 2(i),
IIB/SIFMA incorrectly asserted that the
[[Page 56928]]
Commission relied on the Seventh Circuit en banc decision in Minn-Chem,
Inc. v. Agrium, Inc. Rather, the Commission was clear that its
interpretation of CEA section 2(i) is not reliant on the reasoning of
any individual judicial decision, but instead is drawn from a holistic
understanding of both the statutory text and legal analysis applied by
courts to analogous statutes and circumstances, specifically noting
that the Commission's interpretation of CEA section 2(i) is not solely
dependent on one's view of the Seventh Circuit's Minn-Chem
decision,\32\ but informed by its overall understanding of the relevant
legal principles.
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\32\ See Proposed Rule, 85 FR at 956.
---------------------------------------------------------------------------
Finally, the Commission disagrees with IATP's advice that the
Commission should abandon its interpretation of CEA section 2(i) and
proceed with a ``plain reading'' of the statute. The Commission
believes that IATP's assertion that the extraterritorial provisions of
FTAIA and the case law construing such provisions are not relevant to
CEA section 2(i) because the rule is not concerned with the regulation
of anti-competitive behavior misconstrues the use that the Commission's
interpretation has made of the Federal case law construing the meaning
of the word ``direct'' in CEA section 2(i).\33\
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\33\ See infra notes 41-51, and accompanying text.
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2. Final Interpretation
In light of the foregoing, the Commission is restating its
interpretation of section 2(i) of the CEA with its adoption of the
Final Rule in substantially the same form as appeared in the Proposed
Rule.
CEA section 2(i) provides that the swap provisions of Title VII
shall not apply to activities outside the United States unless those
activities--
Have a direct and significant connection with activities
in, or effect on, commerce of the United States; or
Contravene such rules or regulations as the Commission may
prescribe or promulgate as are necessary or appropriate to prevent the
evasion of any provision of the CEA that was enacted by the Dodd-Frank
Act.
The Commission believes that section 2(i) provides it express
authority over swap activities outside the United States when certain
conditions are met, but it does not require the Commission to extend
its reach to the outer bounds of that authorization. Rather, in
exercising its authority with respect to swap activities outside the
United States, the Commission will be guided by international comity
principles and will focus its authority on potential significant risks
to the U.S. financial system.
(i) Statutory Analysis
In interpreting the phrase ``direct and significant,'' the
Commission has examined the plain language of the statutory provision,
similar language in other statutes with cross-border application, and
the legislative history of section 2(i).
The statutory language in CEA section 2(i) is structured similarly
to the statutory language in the FTAIA,\34\ which provides the standard
for the cross-border application of the Sherman Antitrust Act
(``Sherman Act'').\35\ The FTAIA, like CEA section 2(i), excludes
certain non-U.S. commercial transactions from the reach of U.S. law.
Specifically, the FTAIA provides that the antitrust provisions of the
Sherman Act shall not apply to anti-competitive conduct involving trade
or commerce with foreign nations.\36\ However, like paragraph (1) of
CEA section 2(i), the FTAIA also creates exceptions to the general
exclusionary rule and thus brings back within antitrust coverage any
conduct that: (1) Has a direct, substantial, and reasonably foreseeable
effect on U.S. commerce; \37\ and (2) such effect gives rise to a
Sherman Act claim.\38\ In F. Hoffman-LaRoche, Ltd. v. Empagran S.A.,
the U.S. Supreme Court stated that ``this technical language initially
lays down a general rule placing all (nonimport) activity involving
foreign commerce outside the Sherman Act's reach. It then brings such
conduct back within the Sherman Act's reach provided that the conduct
both (1) sufficiently affects American commerce, i.e., it has a
`direct, substantial, and reasonably foreseeable effect' on American
domestic, import, or (certain) export commerce, and (2) has an effect
of a kind that antitrust law considers harmful, i.e., the `effect' must
`giv[e] rise to a [Sherman Act] claim.' '' \39\
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\34\ 15 U.S.C. 6a.
\35\ 15 U.S.C. 1-7.
\36\ 15 U.S.C. 6a.
\37\ 15 U.S.C. 6a(1).
\38\ 15 U.S.C. 6a(2).
\39\ 542 U.S. 155, 162 (2004) (emphasis in original).
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It is appropriate, therefore, to read section 2(i) of the CEA as a
clear expression of congressional intent that the swap provisions of
Title VII of the Dodd-Frank Act apply to activities beyond the borders
of the United States when certain circumstances are present.\40\ These
circumstances include, pursuant to paragraph (1) of section 2(i), when
activities outside the United States meet the statutory test of having
a ``direct and significant connection with activities in, or effect
on,'' U.S. commerce.
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\40\ SIFMA v. CFTC, 67 F.Supp.3d 373, 425-26 (D.D.C. 2014)
(``The plain text of this provision `clearly expresse[s]' Congress's
`affirmative intention' to give extraterritorial effect to Title
VII's statutory requirements, as well as to the Title VII rules or
regulations prescribed by the CFTC, whenever the provision's
jurisdictional nexus is satisfied.''). See also Prime Int'l Trading,
Ltd. v. BP P.L.C., 937 F.3d 94, 103 (2d Cir. 2019) (stating that
``Section 2(i) contains, on its face, a `clear statement,' Morrison,
561 U.S. at 265, 130 S.Ct. 2869, of extraterritorial application''
and describing it as ``an enumerated extraterritorial command'').
---------------------------------------------------------------------------
An examination of the language in the FTAIA, however, does not
provide an unambiguous roadmap for the Commission in interpreting
section 2(i) of the CEA because there are both similarities, and a
number of significant differences, between the language in CEA section
2(i) and the language in the FTAIA. Further, the Supreme Court has not
provided definitive guidance as to the meaning of the direct,
substantial, and reasonably foreseeable test in the FTAIA, and the
lower courts have interpreted the individual terms in the FTAIA
differently.
Although a number of courts have interpreted the various terms in
the FTAIA, only the term ``direct'' appears in both CEA section 2(i)
and the FTAIA.\41\ Relying upon the Supreme Court's definition of the
term ``direct'' in the Foreign Sovereign Immunities Act (``FSIA''),\42\
the U.S. Court of Appeals for the Ninth Circuit construed the term
``direct'' in the FTAIA as requiring a ``relationship of logical
causation,'' \43\ such that ``an effect is `direct' if it follows as an
immediate consequence of the defendant's activity.'' \44\ However, in
an en banc decision, Minn-Chem, Inc. v. Agrium, Inc., the U.S. Court of
Appeals for the Seventh Circuit held that ``the Ninth Circuit jumped
too quickly on the assumption that the FSIA and the FTAIA use the word
`direct' in the same way.'' \45\ After examining the text of the FTAIA
as well as its history and
[[Page 56929]]
purpose, the Seventh Circuit found persuasive the ``other school of
thought [that] has been articulated by the Department of Justice's
Antitrust Division, which takes the position that, for FTAIA purposes,
the term `direct' means only `a reasonably proximate causal nexus.' ''
\46\ The Seventh Circuit rejected interpretations of the term
``direct'' that included any requirement that the consequences be
foreseeable, substantial, or immediate.\47\ In 2014, the U.S. Court of
Appeals for the Second Circuit followed the reasoning of the Seventh
Circuit in the Minn-Chem decision.\48\ That said, the Commission would
like to make clear that its interpretation of CEA section 2(i) is not
reliant on the reasoning of any individual judicial decision, but
instead is drawn from a holistic understanding of both the statutory
text and legal analysis applied by courts to analogous statutes and
circumstances. In short, as the discussion below will illustrate, the
Commission's interpretation of section 2(i) is not solely dependent on
one's view of the Seventh Circuit's Minn-Chem decision, but informed by
its overall understanding of the relevant legal principles.
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\41\ Guidance, 78 FR at 45299.
\42\ See 28 U.S.C. 1605(a)(2).
\43\ United States v. LSL Biotechnologies, 379 F.3d 672, 693
(9th Cir. 2004). ``As a threshold matter, many courts have debated
whether the FTAIA established a new jurisdictional standard or
merely codified the standard applied in [United States v. Aluminum
Co. of Am., 148 F.2d 416 (2d Cir. 1945)] and its progeny. Several
courts have raised this question without answering it. The Supreme
Court did as much in [Harford Fire Ins. Co. v. California, 509 U.S.
764 (1993)].'' Id. at 678.
\44\ Id. at 692-93, quoting Republic of Argentina v. Weltover,
Inc., 504 U.S. 607, 618 (1992) (providing that, pursuant to the
FSIA, 28 U.S.C. 1605(a)(2), immunity does not extend to commercial
conduct outside the United States that ``causes a direct effect in
the United States'').
\45\ Minn-Chem, Inc. v. Agrium, Inc., 683 F.3d 845, 857 (7th
Cir. 2012) (en banc).
\46\ Id.
\47\ Id. at 856-57.
\48\ Lotes Co., Ltd. v. Hon Hai Precision Industry Co., 753 F.3d
395, 406-08 (2d Cir. 2014).
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Other terms in the FTAIA differ from the terms used in section 2(i)
of the CEA. First, the FTAIA test explicitly requires that the effect
on U.S. commerce be a ``reasonably foreseeable'' result of the
conduct,\49\ whereas section 2(i) of the CEA, by contrast, does not
provide that the effect on U.S. commerce must be foreseeable. Second,
whereas the FTAIA solely relies on the ``effects'' on U.S. commerce to
determine cross-border application of the Sherman Act, section 2(i) of
the CEA refers to both ``effect'' and ``connection.'' ``The FTAIA says
that the Sherman Act applies to foreign `conduct' with a certain kind
of harmful domestic effect.'' \50\ Section 2(i), by contrast, applies
more broadly--not only to particular instances of conduct that have an
effect on U.S. commerce, but also to activities that have a direct and
significant ``connection with activities in'' U.S. commerce. Unlike the
FTAIA, section 2(i) applies the swap provisions of the CEA to
activities outside the United States that have the requisite connection
with activities in U.S. commerce, regardless of whether a ``harmful
domestic effect'' has occurred.
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\49\ See, e.g., Animal Sciences Products. v. China Minmetals
Corp., 654 F.3d 462, 471 (3d Cir. 2011) (``[T]he FTAIA's `reasonably
foreseeable' language imposes an objective standard: the requisite
`direct' and `substantial' effect must have been `foreseeable' to an
objectively reasonable person.'').
\50\ Hoffman-LaRoche, 452 U.S. at 173.
---------------------------------------------------------------------------
As the foregoing textual analysis of the relevant statutory
language indicates, section 2(i) differs from its analogue in the
antitrust laws. Congress delineated the cross-border scope of the
Sherman Act in section 6a of the FTAIA as applying to conduct that has
a ``direct,'' ``substantial,'' and ``reasonably foreseeable''
``effect'' on U.S. commerce. In section 2(i), on the other hand,
Congress did not include a requirement that the effects or connections
of the activities outside the United States be ``reasonably
foreseeable'' for the Dodd-Frank Act swap provisions to apply. Further,
Congress included language in section 2(i) to apply the Dodd-Frank Act
swap provisions in circumstances in which there is a direct and
significant connection with activities in U.S. commerce, regardless of
whether there is an effect on U.S. commerce. The different words that
Congress used in paragraph (1) of section 2(i), as compared to its
closest statutory analogue in section 6a of the FTAIA, inform the
Commission in construing the boundaries of its cross-border authority
over swap activities under the CEA.\51\ Accordingly, the Commission
believes it is appropriate to interpret section 2(i) such that it
applies to activities outside the United States in circumstances in
addition to those that would be reached under the FTAIA standard.
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\51\ The provision that ultimately became section 722(d) of the
Dodd-Frank Act was added during consideration of the legislation in
the House of Representatives. See 155 Cong. Rec. H14685 (Dec. 10,
2009). The version of what became Title VII that was reported by the
House Agriculture Committee and the House Financial Services
Committee did not include any provision addressing cross-border
application. See 155 Cong. Rec. H14549 (Dec. 10, 2009). The
Commission finds it significant that, in adding the cross-border
provision before final passage, the House did so in terms that, as
discussed in text, were different from, and broader than, the terms
used in the analogous provision of the FTAIA.
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One of the principal rationales for the Dodd-Frank Act was the need
for a comprehensive scheme of systemic risk regulation. More
particularly, a primary purpose of Title VII of the Dodd-Frank Act is
to address risk to the U.S. financial system created by
interconnections in the swap market.\52\ Title VII of the Dodd-Frank
Act gave the Commission new and broad authority to regulate the swap
market to address and mitigate risks arising from swap activities that
could adversely affect the resiliency of the financial system in the
future.
---------------------------------------------------------------------------
\52\ Cf. 156 Cong. Rec. S5818 (July 14, 2010) (statement of Sen.
Lincoln) (``In 2008, our Nation's economy was on the brink of
collapse. America was being held captive by a financial system that
was so interconnected, so large, and so irresponsible that our
economy and our way of life were about to be destroyed.''),
available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-14/pdf/CREC-2010-07-14.pdf; 156 Cong. Rec. S5888 (July 15, 2010) (statement of
Sen. Shaheen) (``We need to put in place reforms to stop Wall Street
firms from growing so big and so interconnected that they can
threaten our entire economy.''), available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf; 156 Cong.
Rec. S5905 (July 15, 2010) (statement of Sen. Stabenow) (``For too
long the over-the-counter derivatives market has been unregulated,
transferring risk between firms and creating a web of fragility in a
system where entities became too interconnected to fail.''),
available at http://www.gpo.gov/fdsys/pkg/CREC-2010-07-15/pdf/CREC-2010-07-15-senate.pdf.
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In global markets, the source of such risk is not confined to
activities within U.S. borders. Due to the interconnectedness between
firms, traders, and markets in the U.S. and abroad, a firm's failure,
or trading losses overseas, can quickly spill over to the United States
and affect activities in U.S. commerce and the stability of the U.S.
financial system. Accordingly, Congress explicitly provided for cross-
border application of Title VII to activities outside the United States
that pose risks to the U.S. financial system.\53\ Therefore, the
Commission construes section 2(i) to apply the swap provisions of the
CEA to activities outside the United States that have either: (1) A
direct and significant effect on U.S. commerce; or, in the alternative,
(2) a direct and significant connection with activities in U.S.
commerce, and through such connection present the
[[Page 56930]]
type of risks to the U.S. financial system and markets that Title VII
directed the Commission to address. The Commission interprets section
2(i) in a manner consistent with the overall goal of the Dodd-Frank Act
to reduce risks to the resiliency and integrity of the U.S. financial
system arising from swap market activities.\54\ Consistent with this
interpretation, the Commission interprets the term ``direct'' in
section 2(i) to require a reasonably proximate causal nexus, and not to
require foreseeability, substantiality, or immediacy.
---------------------------------------------------------------------------
\53\ The legislative history of the Dodd-Frank Act shows that in
the fall of 2009, neither the Over-the-Counter Derivatives Markets
Act of 2009, H.R. 3795, 111th Cong. (1st Sess. 2009), reported by
the Financial Services Committee chaired by Rep. Barney Frank, nor
the Derivatives Markets Transparency and Accountability Act of 2009,
H.R. 977, 111th Cong. (1st Sess. 2009), reported by the Agriculture
Committee chaired by Rep. Collin Peterson, included a general
territoriality limitation that would have restricted Commission
regulation of transactions between two foreign persons located
outside of the United States. During the House Financial Services
Committee markup on October 14, 2009, Rep. Spencer Bachus offered an
amendment that would have restricted the jurisdiction of the
Commission over swaps between non-U.S. resident persons transacted
without the use of the mails or any other means or instrumentality
of interstate commerce. Chairman Frank opposed the amendment, noting
that there may well be cases where non-U.S. residents are engaging
in transactions that have an effect on the United States and that
are insufficiently regulated internationally and that he would not
want to prevent U.S. regulators from stepping in. Chairman Frank
expressed his commitment to work with Rep. Bachus going forward, and
Rep. Bachus withdrew the amendment. See H. Fin. Serv. Comm. Mark Up
on Discussion Draft of the Over-the-Counter Derivatives Markets Act
of 2009, 111th Cong., 1st Sess. (Oct. 14, 2009) (statements of Rep.
Bachus and Rep. Frank), available at http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=231922.
\54\ The Commission also notes that the Supreme Court has
indicated that the FTAIA may be interpreted more broadly when the
government is seeking to protect the public from anticompetitive
conduct than when a private plaintiff brings suit. See Hoffman-
LaRoche, 452 U.S. at 170 (``A Government plaintiff, unlike a private
plaintiff, must seek to obtain the relief necessary to protect the
public from further anticompetitive conduct and to redress
anticompetitive harm. And a Government plaintiff has legal authority
broad enough to allow it to carry out its mission.'').
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Further, the Commission does not interpret section 2(i) to require
a transaction-by-transaction determination that a specific swap outside
the United States has a direct and significant connection with
activities in, or effect on, commerce of the United States to apply the
swap provisions of the CEA to such transaction. Rather, it is the
connection of swap activities, viewed as a class or in the aggregate,
to activities in commerce of the United States that must be assessed to
determine whether application of the CEA swap provisions is
warranted.\55\
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\55\ The Commission believes this interpretation is supported by
Congress's use of the plural term ``activities'' in CEA section
2(i), rather than the singular term ``activity.'' The Commission
believes it is reasonable to interpret the use of the plural term
``activities'' in section 2(i) to require not that each particular
activity have the requisite connection with U.S. commerce, but
rather that such activities in the aggregate, or a class of
activity, have the requisite nexus with U.S. commerce. This
interpretation is consistent with the overall objectives of Title
VII, as described above. Further, the Commission believes that a
swap-by-swap approach to jurisdiction would be ``too complex to
prove workable.'' See Hoffman-LaRoche, 542 U.S. at 168.
---------------------------------------------------------------------------
Similar interpretations of other federal statutes regulating
interstate commerce support the Commission's interpretation here. For
example, the Supreme Court has long supported a similar ``aggregate
effects'' approach when analyzing the reach of U.S. authority under the
Commerce Clause.\56\ The Court phrased the holding in the seminal
``aggregate effects'' decision, Wickard v. Filburn,\57\ in this way:
``[The farmer's] decision, when considered in the aggregate along with
similar decisions of others, would have had a substantial effect on the
interstate market for wheat.'' \58\ In another relevant decision,
Gonzales v. Raich,\59\ the Court adopted similar reasoning to uphold
the application of the Controlled Substances Act \60\ to prohibit the
intrastate use of medical marijuana for medicinal purposes. In Raich,
the Court held that Congress could regulate purely intrastate activity
if the failure to do so would ``leave a gaping hole'' in the federal
regulatory structure. These cases support the Commission's cross-border
authority over swap activities that as a class, or in the aggregate,
have a direct and significant connection with activities in, or effect
on, U.S. commerce--whether or not an individual swap may satisfy the
statutory standard.\61\
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\56\ Nat'l Fed'n of Indep. Bus. v. Sebelius, 567 U.S. 519
(2012).
\57\ 317 U.S. 111 (1942).
\58\ 567 U.S. at 552-53. At issue in Wickard was the regulation
of a farmer's production and use of wheat even though the wheat was
``not intended in any part for commerce but wholly for consumption
on the farm.'' 317 U.S. at 118. The Supreme Court upheld the
application of the regulation, stating that although the farmer's
``own contribution to the demand for wheat may be trivial by
itself,'' the federal regulation could be applied when his
contribution ``taken together with that of many others similarly
situated, is far from trivial.'' Id. at 128-29. The Court also
stated it had ``no doubt that Congress may properly have considered
that wheat consumed on the farm where grown, if wholly outside the
scheme of regulation, would have a substantial effect in defeating
and obstructing its purpose . . ..'' Id.
\59\ 545 U.S. 1 (2005).
\60\ 21 U.S.C. 801 et seq.
\61\ In Sebelius, the Court stated in dicta, ``Where the class
of activities is regulated, and that class is within the reach of
federal power, the courts have no power to excise, as trivial,
individual instances of the class.'' 567 U.S. at 551 (quoting Perez
v. United States, 402 U.S. 146, 154 (1971)). See also Taylor v.
U.S.136 S. Ct. 2074, 2079 (2016) (``[A]ctivities . . . that
``substantially affect'' commerce . . . may be regulated so long as
they substantially affect interstate commerce in the aggregate, even
if their individual impact on interstate commerce is minimal.'')
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(ii) Principles of International Comity
Principles of international comity counsel the government in one
country to act reasonably in exercising its jurisdiction with respect
to activity that takes place in another country. Statutes should be
construed to ``avoid unreasonable interference with the sovereign
authority of other nations.'' \62\ This rule of construction ``reflects
customary principles of international law'' and ``helps the potentially
conflicting laws of different nations work together in harmony--a
harmony particularly needed in today's highly interdependent commercial
world.'' \63\
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\62\ Hoffman-LaRoche, 542 U.S. at 164.
\63\ Id. at 165.
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The Restatement (Third) of Foreign Relations Law of the United
States,\64\ together with the Restatement (Fourth) of Foreign Relations
Law of the United States \65\ (collectively, the ``Restatement''),
states that a country has jurisdiction to prescribe law with respect to
``conduct outside its territory that has or is intended to have
substantial effect within its territory.'' \66\ The Restatement also
counsels that even where a country has a basis for extraterritorial
jurisdiction, it should not prescribe law with respect to a person or
activity in another country when the exercise of such jurisdiction is
unreasonable.\67\
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\64\ Restatement (Third) section 402 cmt. d (1987).
\65\ Julian Ku, American Law Institute Approves First Portions
of Restatement on Foreign Relations Law (Fourth), OpinioJuris.com,
May 22, 2017, http://opiniojuris.org/2017/05/22/american-law-institute-approves-first-portions-of-restatement-on-foreign-relations-law-fourth/; Jennifer Morinigo, U.S. Foreign Relations
Law, Jurisdiction Approved, ALI Adviser, May 22, 2017, http://www.thealiadviser.org/us-foreign-relations-law/jurisdiction-approved/; Restatement (Fourth) of Foreign Relations Law Intro.
(Westlaw 2018) (explaining that ``this is only a partial revision''
of the Third Restatement).
\66\ Restatement (Fourth) section 409 (Westlaw 2018).
\67\ Restatement (Fourth) section 405 cmt. a (Westlaw 2018); see
id. at section 407 Reporters' Note 3 (``Reasonableness, in the sense
of showing a genuine connection, is an important touchstone for
determining whether an exercise of jurisdiction is permissible under
international law.'').
---------------------------------------------------------------------------
As a general matter, the Fourth Restatement indicates that the
concept of reasonableness as it relates to foreign relations law is ``a
principle of statutory interpretation'' that ``operates in conjunction
with other principles of statutory interpretation.'' \68\ More
specifically, the Fourth Restatement characterizes the inquiry into the
reasonableness of exercising extraterritorial jurisdiction as an
examination into whether ``a genuine connection exists between the
state seeking to regulate and the persons, property, or conduct being
regulated.'' \69\ The Restatement explicitly indicates that the
``genuine connection'' between the state and the person, property, or
conduct to be regulated can derive from the effects of the particular
conduct or activities in question.\70\
---------------------------------------------------------------------------
\68\ Id. at section 405 cmt. a.
\69\ Id. at section 407 cmt. a; see id. at section 407
Reporters' Note 3.
\70\ Id. at section 407.
---------------------------------------------------------------------------
Consistent with the Restatement, the Commission has carefully
considered, among other things, the level of the foreign jurisdiction's
supervisory interests over the subject activity and the extent to which
the activity takes place within the foreign territory. In doing so, the
Commission has strived to
[[Page 56931]]
minimize conflicts with the laws of other jurisdictions while seeking,
pursuant to section 2(i), to apply the swaps requirements of Title VII
to activities outside the United States that have a direct and
significant connection with activities in, or effect on, U.S. commerce.
The Commission believes the Final Rule appropriately accounts for
these competing interests, ensuring that the Commission can discharge
its responsibilities to protect the U.S. markets, market participants,
and financial system, consistent with international comity, as set
forth in the Restatement. Of particular relevance is the Commission's
approach to substituted compliance in the Final Rule, which mitigates
burdens associated with potentially conflicting foreign laws and
regulations in light of the supervisory interests of foreign regulators
in entities domiciled and operating in their own jurisdictions.
E. Final Rule
The Final Rule identifies which cross-border swaps or swap
positions a person will need to consider when determining whether it
needs to register with the Commission as an SD or MSP, as well as
related classifications of swap market participants and swaps (e.g.,
U.S. person, foreign branch, swap conducted through a foreign
branch).\71\ Further, the Commission is adopting several tailored
exceptions from, and a substituted compliance process for, certain
regulations applicable to registered SDs and MSPs. The Final Rule also
creates a framework for comparability determinations for such
regulations that emphasizes a holistic, outcomes-based approach that is
grounded in principles of international comity. Finally, the Final Rule
requires SDs and MSPs to create a record of their compliance with the
Final Rule and to retain such records in accordance with Sec.
23.203.\72\ The Final Rule supersedes the Commission's policy views as
set forth in the Guidance with respect to its interpretation and
application of section 2(i) of the CEA and the swap provisions
addressed in the Final Rule.\73\
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\71\ There were no MSPs registered with the Commission as of the
date of the Final Rule.
\72\ See Final Sec. 23.23(h)(1).
\73\ See infra section V for a discussion of certain swap
provisions not addressed in the Final Rule.
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Some commenters provided their views on the Proposed Rule
generally. AFR and IATP both argued that, in sum, the Proposed Rule
would fatally weaken the implementation of Title VII of the Dodd-Frank
Act and its application to CFTC-regulated derivatives markets, and
urged the Commission to step back from the course outlined in the
Proposed Rule and restore elements of the Guidance and the 2016
Proposal that, they maintained, offered better oversight of derivatives
markets. The Commission has considered these comments but believes that
the Final Rule generally reflects the approach outlined by the
Commission in the Guidance, and has determined that it takes account of
conflicts with the laws of other jurisdictions when applying the swaps
requirements of Title VII to activities outside the United States that
have a direct and significant connection with activities in, or effect
on, U.S. commerce, permitting the Commission to discharge its
responsibilities to protect the U.S. markets, market participants, and
financial system, consistent with international comity.
More specifically, the Final Rule takes into account the
Commission's experience implementing the Dodd-Frank Act reforms,
including its experience with the Guidance and the Cross-Border Margin
Rule, comments submitted in connection with the ANE Request for Comment
and the Proposed Rule, as well as discussions that the Commission and
its staff have had with market participants,\74\ other domestic \75\
and foreign regulators, and other interested parties. It is essential
that a cross-border framework recognize the global nature of the swap
market and the supervisory interests of foreign regulators with respect
to entities and transactions covered by the Commission's swap regime.
In determining the extent to which the Dodd-Frank Act swap provisions
addressed by the Final Rule apply to activities outside the United
States, the Commission has strived to protect U.S. interests as
contemplated by Congress in Title VII, and minimize conflicts with the
laws of other jurisdictions. The Commission has carefully considered,
among other things, the level of a home jurisdiction's supervisory
interests over the subject activity and the extent to which the
activity takes place within the home country's territory.\76\ At the
same time, the Commission has also considered the potential for cross-
border activities to have a significant connection with activities in,
or effect on, commerce of the United States, as well as the global,
highly integrated nature of today's swap markets.
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\74\ Summaries of such discussions with market participants are
included in the relevant public comment file, available on the
Commission's website at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3067.
\75\ The Commission has consulted with the Securities and
Exchange Commission (``SEC'') and prudential regulators regarding
the Final Rule, as required by section 712(a)(1) of the Dodd-Frank
Act for the purposes of assuring regulatory consistency and
comparability, to the extent possible. Dodd-Frank Act, section
712(a)(1); 15 U.S.C. 8302(a)(1). SEC staff was consulted to increase
understanding of each other's regulatory approaches and to harmonize
the cross-border approaches of the two agencies to the extent
possible, consistent with their respective statutory mandates. As
noted in the Entities Rule, the CFTC and SEC intended to address the
cross-border application of Title VII in separate releases. See
Entities Rule, 77 FR at 30628 n.407.
\76\ The terms ``home jurisdiction'' or ``home country'' are
used interchangeably in this release and refer to the jurisdiction
in which the person or entity is established, including the European
Union.
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To fulfill the purposes of the Dodd-Frank Act swap reforms, the
Commission's supervisory oversight cannot be confined to activities
strictly within the territory of the United States. Rather, the
Commission will exercise its supervisory authority outside the United
States in order to reduce risk to the resiliency and integrity of the
U.S. financial system.\77\ The Commission will also strive to show
deference to non-U.S. regulation when such regulation achieves
comparable outcomes to mitigate unnecessary conflict with effective
non-U.S. regulatory frameworks and limits fragmentation of the global
marketplace.
---------------------------------------------------------------------------
\77\ See supra section I.D.
---------------------------------------------------------------------------
The Commission has also sought to target those classes of entities
whose activities--due to the nature of their relationship with a U.S.
person or U.S. commerce--most clearly present the risks addressed by
the Dodd-Frank Act provisions, and related regulations covered by the
Final Rule. The Final Rule is designed to limit opportunities for
regulatory arbitrage by applying the registration thresholds in a
consistent manner to differing organizational structures that serve
similar economic functions or have similar economic effects. At the
same time, the Commission is mindful of the effect of its choices on
market efficiency and competition, as well as the importance of
international comity when exercising the Commission's authority. The
Commission believes that the Final Rule reflects a measured approach
that advances the goals underlying SD and MSP regulation, consistent
with the Commission's statutory authority, while mitigating market
distortions and inefficiencies, and avoiding fragmentation.
II. Key Definitions
The Commission is adopting definitions for certain terms for the
purpose of applying the Dodd-Frank Act swap provisions addressed by the
Final Rule to cross-border transactions. Certain of these definitions
are relevant
[[Page 56932]]
in assessing whether a person's activities have the requisite ``direct
and significant'' connection with activities in, or effect on, U.S.
commerce within the meaning of CEA section 2(i). Specifically, the
definitions are relevant in determining whether certain swaps or swap
positions need to be counted toward a person's SD or MSP threshold and
in addressing the cross-border application of certain Dodd-Frank Act
requirements (as discussed below in sections III through VII).
A. Reliance on Representations--Generally
The Commission acknowledges that the information necessary for a
swap counterparty to accurately assess whether its counterparty or a
specific swap meets one or more of the definitions discussed below may
be unavailable, or available only through overly burdensome due
diligence. For this reason, the Commission believes that a market
participant should generally be permitted to reasonably rely on written
counterparty representations in each of these respects.\78\ Therefore,
the Commission proposed that a person may rely on a written
representation from its counterparty that the counterparty does or does
not satisfy the criteria for one or more of the definitions below,
unless such person knows or has reason to know that the representation
is not accurate.\79\ AFEX/GPS supported the proposed written
representation language and noted that it would facilitate compliance
with the rules.
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\78\ Proposed Rule, 85 FR at 958-59; Cross-Border Margin Rule,
81 FR at 34827; Guidance, 78 FR at 45315.
\79\ Proposed Sec. 23.23(a); Proposed Rule, 85 FR at 958-59,
1002.
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The Commission is adopting the ``reliance on representations''
language as proposed.\80\ For the purposes of this rule, a person would
have reason to know the representation is not accurate if a reasonable
person should know, under all of the facts of which the person is
aware, that it is not accurate. This language is consistent with: (1)
The reliance standard articulated in the Commission's external business
conduct rules; \81\ (2) the Commission's approach in the Cross-Border
Margin Rule; \82\ and (3) the reliance standard articulated in the
``U.S. person'' and ``transaction conducted through a foreign branch''
definitions adopted by the SEC in its rule addressing the regulation of
cross-border securities-based swap activities (``SEC Cross-Border
Rule'').\83\ A number of commenters also specifically addressed
reliance on representations obtained under the Cross-Border Margin Rule
or the Guidance for the ``U.S. person'' and ``Guarantee'' definitions.
These comments are addressed below in sections II.B.5 and II.C.
---------------------------------------------------------------------------
\80\ Final Sec. 23.23(a).
\81\ See 17 CFR 23.402(d).
\82\ See Cross-Border Margin Rule, 81 FR at 34827.
\83\ See 17 CFR 240.3a71-3(a)(3)(ii) & (4)(iv); Application of
``Security-Based Swap Dealer'' and ``Major Security-Based Swap
Participant'' Definitions to Cross-Border Security-Based Swap
Activities; Republication, 79 FR 47278, 47313 (Aug. 12, 2014).
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B. U.S. Person, Non-U.S. Person, and United States
1. Generally
(i) Proposed Rule
As discussed in more detail below, the Commission proposed defining
``U.S. person'' consistent with the definition of ``U.S. person'' in
the SEC Cross-Border Rule.\84\ The proposed definition of ``U.S.
person'' was also consistent with the Commission's statutory mandate
under the CEA, and in this regard was largely consistent with the
definition of ``U.S. person'' in the Cross-Border Margin Rule.\85\
Specifically, the Commission proposed to define ``U.S. person'' as:
---------------------------------------------------------------------------
\84\ Proposed Sec. 23.23(a)(22); Proposed Rule, 85 FR at 959-
63, 1003. See 17 CFR 240.3a71-3(a)(4); SEC Cross-Border Rule, 79 FR
at 47303-13.
\85\ See 17 CFR 23.160(a)(10); Cross-Border Margin Rule, 81 FR
at 34821-24.
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(1) A natural person resident in the United States;
(2) A partnership, corporation, trust, investment vehicle, or other
legal person organized, incorporated, or established under the laws of
the United States or having its principal place of business in the
United States;
(3) An account (whether discretionary or non-discretionary) of a
U.S. person; or
(4) An estate of a decedent who was a resident of the United States
at the time of death.\86\
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\86\ Proposed Sec. 23.23(a)(22)(i); Proposed Rule, 85 FR at
959-63, 1003.
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As noted in the Cross-Border Margin Rule,\87\ and consistent with
the SEC \88\ definition of ``U.S. person,'' proposed Sec.
23.23(a)(22)(ii) provided that the principal place of business means
the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the activities
of the legal person. Consistent with the SEC, the Commission noted that
the principal place of business for a collective investment vehicle
(``CIV'') would be in the United States if the senior personnel
responsible for the implementation of the CIV's investment strategy are
located in the United States, depending on the facts and circumstances
that are relevant to determining the center of direction, control, and
coordination of the CIV.\89\
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\87\ Cross-Border Margin Rule, 81 FR at 34823.
\88\ 17 CFR 240.3a71-3(a)(4)(ii).
\89\ Proposed Sec. 23.23(a)(22)(ii); Proposed Rule, 85 FR at
960, 1003.
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Additionally, in consideration of the discretionary and appropriate
exercise of international comity-based doctrines, proposed Sec.
23.23(a)(22)(iii) stated that the term ``U.S. person'' would not
include certain international financial institutions.\90\ Specifically,
consistent with the SEC's definition,\91\ the term U.S. person would
not include the International Monetary Fund, the International Bank for
Reconstruction and Development, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the United
Nations, and their agencies and pension plans, and any other similar
international organizations, their agencies, and pension plans.
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\90\ Proposed Sec. 23.23(a)(22)(iii); Proposed Rule, 85 FR at
961-62, 1003.
\91\ 17 CFR 240.3a71-3(a)(4)(iii).
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Further, to provide certainty to market participants, proposed
Sec. 23.23(a)(22)(iv) permitted reliance, until December 31, 2025, on
any U.S. person-related representations that were obtained to comply
with the Cross-Border Margin Rule.\92\
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\92\ Proposed Sec. 23.23(a)(22)(iv); Proposed Rule, 85 FR at
962, 1003.
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(ii) Summary of Comments
In general, AIMA, AFEX/GPS, Barnard, Chatham, CS, IIB/SIFMA, JFMC/
IBAJ, JBA, JSCC, and State Street supported the proposed ``U.S.
person'' definition, while IATP generally opposed the proposed
definition. Additional comments and suggestions are discussed below.
AIMA, Barnard,\93\ Chatham, CS, IIB/SIFMA, JFMC/IBAJ, JSCC, and
State Street generally supported the Commission's view that aligning
with the SEC's definition of ``U.S. person'' provided consistency to
market participants, noting that the harmonized definition would: (1)
Provide a consistent approach from operational and compliance
perspectives; (2) help avoid undue regulatory complexity for purposes
of firms' swaps and security-based swaps businesses; and/or (3)
simplify market practice and reduce complexity. AFEX/GPS, Chatham, CS,
JFMC/IBAJ, JSCC, and State Street generally stated that the simpler and
[[Page 56933]]
streamlined prongs in the proposed ``U.S. person'' definition allowed
for more straightforward application of the definition as compared to
the Guidance. Chatham also noted that the proposed definition of ``U.S.
person'' establishes a significant nexus to the United States.
---------------------------------------------------------------------------
\93\ However, as noted below, Barnard expressed concern
regarding other proposed definitions and treatments.
---------------------------------------------------------------------------
FIA recommended that the Commission explicitly state that the scope
of the proposed definition of a ``U.S. person'' would not extend to
provisions of the CEA governing futures commission merchants (``FCMs'')
with respect to both: (1) Exchange-traded futures, whether executed on
a designated contract market or a foreign board of trade; and (2)
cleared swaps.
IATP suggested restoring the ``U.S. person'' definition from the
Guidance and 2016 Proposal. IATP argued that the SEC definition applies
to the relatively small universe of security-based swaps, and
therefore, the Commission should adopt the ``U.S. person'' and other
definitions from the 2016 Proposal for the much larger universe of
physical and financial commodity swaps the Commission is authorized to
regulate. IATP also asserted that adopting the SEC definition for
harmonization purposes was not necessary because SDs and MSPs should
have the personnel and information technology resources to comply
effectively with reporting and recordkeeping of swaps and security-
based swaps. Further, any reduced efficiency would be compensated for
by having the ``U.S. person'' definition apply not only to enumerated
entities but to a non-exhaustive listing that anticipates the creation
of new legal entities engaged in swaps activities.
(iii) Final Rule
As discussed in more detail below, the Commission is adopting the
``U.S. person'' definition as proposed, with certain
clarifications.\94\ In response to IATP, the Commission continues to be
of the view that harmonization of the ``U.S. person'' definition with
the SEC is the appropriate approach given that it is straightforward to
apply compared to the Guidance definition, and will capture
substantially the same types of entities as the ``U.S. person''
definition in the Cross-Border Margin Rule.\95\ In addition,
harmonizing with the definition in the SEC Cross-Border Rule is not
only consistent with section 2(i) of the CEA,\96\ but is also expected
to reduce undue compliance costs for market participants. Therefore, as
noted by several commenters, the definition will reduce complexity for
entities that are participants in the swaps and security-based swaps
markets and may register both as SDs with the Commission and as
security-based swap dealers with the SEC. The Commission is also of the
view that the ``U.S. person'' definition in the Cross-Border Margin
Rule largely encompasses the same universe of persons as the definition
used in the SEC Cross-Border Rule and the Final Rule.\97\
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\94\ Final Sec. 23.23(a)(23). Note that due to renumbering, the
paragraph references for the definitions in Sec. 23.23(a) of the
Final Rule vary from the paragraph references in the Proposed Rule.
\95\ See Proposed Rule, 85 FR at 959.
\96\ Harmonizing the Commission's definition of ``U.S. person''
with the definition in the SEC Cross-Border Rule also is consistent
with the dictate in section 712(a)(7) of the Dodd-Frank Act that the
CFTC and SEC ``treat functionally or economically similar'' SDs,
MSPs, security-based swap dealers, and major security-based swap
participants ``in a similar manner.'' Dodd-Frank Act, section
712(a)(7)(A); 15 U.S.C. 8307(a)(7)(A). See Proposed Rule, 85 FR at
959.
\97\ See Cross-Border Margin Rule, 81 FR at 34824. The Final
Rule defines ``U.S. person'' in a manner that is substantially
similar to the definition used by the SEC in the context of cross-
border regulation of security-based swaps. Proposed Rule, 85 FR at
959.
---------------------------------------------------------------------------
In response to FIA, pursuant to Sec. 23.23(a), ``U.S. person''
only has the meaning in the definition for the purposes of Sec. 23.23.
However, to be clear that the definition of ``U.S. person'' is only
applicable for purposes of the Final Rule, the rule now includes the
word ``solely'' and reads ``Solely for purposes of this section . . .
.''
Generally, the Commission believes that the definition offers a
clear, objective basis for determining which individuals or entities
should be identified as U.S. persons for purposes of the swap
requirements addressed by the Final Rule. Specifically, the various
prongs, as discussed in more detail below, are intended to identify
persons whose activities have a significant nexus to the United States
by virtue of their organization or domicile in the United States.\98\
---------------------------------------------------------------------------
\98\ Proposed Rule, 85 FR at 959.
---------------------------------------------------------------------------
Additionally, the Commission is adopting as proposed the
definitions for ``non-U.S. person,'' ``United States,'' and ``U.S.''
The term ``non-U.S. person'' means any person that is not a U.S.
person.\99\ Further, the Final Rule defines ``United States'' and
``U.S.'' as the United States of America, its territories and
possessions, any State of the United States, and the District of
Columbia.\100\ The Commission did not receive any comments regarding
these definitions.
---------------------------------------------------------------------------
\99\ Final Sec. 23.23(a)(10).
\100\ Final Sec. 23.23(a)(20).
---------------------------------------------------------------------------
2. Prongs
As the Commission noted in the Proposed Rule, paragraph (i) of the
``U.S. person'' definition identifies certain persons as a ``U.S.
person'' by virtue of their domicile or organization within the United
States.\101\ The Commission has traditionally looked to where legal
entities are organized or incorporated (or in the case of natural
persons, where they reside) to determine whether they are U.S.
persons.\102\ In the Commission's view, these persons--by virtue of
their decision to organize or locate in the United States and because
they are likely to have significant financial and legal relationships
in the United States--are appropriately included within the definition
of ``U.S. person.'' \103\
---------------------------------------------------------------------------
\101\ Proposed Rule, 85 FR at 959.
\102\ Cross-Border Margin Rule, 81 FR at 34823; Proposed Rule,
85 FR at 959. See also 17 CFR 4.7(a)(1)(iv) (defining ``Non-United
States person'' for purposes of part 4 of the Commission regulations
relating to commodity pool operators (``CPOs'')).
\103\ Proposed Rule, 85 FR at 959.
---------------------------------------------------------------------------
(i) Sec. 23.23(a)(23)(i)(A) and (B)
Paragraphs (i)(A) and (B) of the ``U.S. person'' definition
generally incorporate a ``territorial'' concept of a U.S. person.\104\
That is, these are natural persons and legal entities that are
physically located or incorporated within U.S. territory, and thus are
subject to the Commission's jurisdiction. Further, the Commission
generally considers swap activities where such persons are
counterparties, as a class and in the aggregate, as satisfying the
``direct and significant'' test under CEA section 2(i). Consistent with
the ``U.S. person'' definition in the Cross-Border Margin Rule \105\
and the SEC Cross-Border Rule,\106\ the definition encompasses both
foreign and domestic branches of an entity. As discussed below, a
branch does not have a legal identity apart from its principal
entity.\107\
---------------------------------------------------------------------------
\104\ Id.
\105\ See 17 CFR 23.160(a)(10)(iii) (U.S. person includes a
corporation, partnership, limited liability company, business or
other trust, association, joint-stock company, fund or any form of
entity similar to any of the foregoing (other than an entity
described in paragraph (a)(10)(iv) or (v) of this section) (a legal
entity), in each case that is organized or incorporated under the
laws of the United States or that has its principal place of
business in the United States, including any branch of such legal
entity) (emphasis added).
\106\ See SEC Cross-Border Rule, 79 FR at 47308 (``[T]he final
definition determines a legal person's status at the entity level
and thus applies to the entire legal person, including any foreign
operations that are part of the U.S. legal person. Consistent with
this approach, a foreign branch, agency, or office of a U.S. person
is treated as part of a U.S. person, as it lacks the legal
independence to be considered a non-U.S. person for purposes of
Title VII even if its head office is physically located within the
United States.'').
\107\ See Proposed Rule, 85 FR at 959.
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[[Page 56934]]
The first prong of the proposed definition stated that a natural
person resident in the United States would be considered a U.S. person.
No comments were received regarding the first prong of the ``U.S.
person'' definition and the Commission is adopting it as proposed.\108\
---------------------------------------------------------------------------
\108\ Final Sec. 23.23(a)(23)(i)(A).
---------------------------------------------------------------------------
The second prong of the proposed definition stated that a
partnership, corporation, trust, investment vehicle, or other legal
person organized, incorporated, or established under the laws of the
United States or having its principal place of business in the United
States would be considered a U.S. person. In the Proposed Rule, the
Commission stated that the second prong of the definition would subsume
the pension fund and trust prongs of the ``U.S. person'' definition in
the Cross-Border Margin Rule.\109\ No comments were received regarding
this aspect of the Proposed Rule and the Commission is adopting it as
proposed.\110\
---------------------------------------------------------------------------
\109\ Proposed Rule, 85 FR at 959-60. See 17 CFR
23.160(a)(10)(iv) and (v).
\110\ Final Sec. 23.23(a)(23)(i)(B).
---------------------------------------------------------------------------
Specifically, the Commission is of the view that, as adopted, Sec.
23.23(a)(23)(i)(B) includes in the definition of the term ``U.S.
person'' pension plans for the employees, officers, or principals of a
legal entity described in Sec. 23.23(a)(23)(i)(B), which is a separate
prong in the Cross-Border Margin Rule.\111\ Although the SEC Cross-
Border Rule directly addresses pension funds only in the context of
international financial institutions, discussed below, the Commission
believes it is important to clarify that pension funds in other
contexts could meet the requirements of Sec. 23.23(a)(23)(i)(B).\112\
---------------------------------------------------------------------------
\111\ See 17 CFR 23.160(a)(10)(iv).
\112\ Proposed Rule, 85 FR at 959.
---------------------------------------------------------------------------
Additionally, Sec. 23.23(a)(23)(i)(B) subsumes the trust prong of
the ``U.S. person'' definition in the Cross-Border Margin Rule.\113\
With respect to trusts addressed in Sec. 23.23(a)(23)(i)(B), the
Commission expects that its approach is consistent with the manner in
which trusts are treated for other purposes under the law. The
Commission has considered that each trust is governed by the laws of a
particular jurisdiction, which may depend on steps taken when the trust
was created or other circumstances surrounding the trust. The
Commission believes that if a trust is governed by U.S. law (i.e., the
law of a state or other jurisdiction in the United States), then it is
generally reasonable to treat the trust as a U.S. person for purposes
of the Final Rule. Another relevant element in this regard is whether a
court within the United States is able to exercise primary supervision
over the administration of the trust. The Commission expects that this
aspect of the definition generally aligns the treatment of the trust
for purposes of the Final Rule with how the trust is treated for other
legal purposes. For example, the Commission expects that if a person
could bring suit against the trustee for breach of fiduciary duty in a
U.S. court (and, as noted above, the trust is governed by U.S. law),
then treating the trust as a U.S. person is generally consistent with
its treatment for other purposes.\114\
---------------------------------------------------------------------------
\113\ See 17 CFR 23.160(a)(10)(v).
\114\ Proposed Rule, 85 FR at 959-60.
---------------------------------------------------------------------------
(ii) Sec. 23.23(a)(23)(i)(D)
Under the fourth prong of the proposed definition, an estate of a
decedent who was a resident of the United States at the time of death
would be included in the definition of ``U.S. person.'' No comments
were received regarding this aspect of the Proposed Rule and the
Commission is adopting it as proposed.\115\ With respect to Sec.
23.23(a)(23)(i)(D), the Commission believes that the swaps of a
decedent's estate should generally be treated the same as the swaps
entered into by the decedent during their life.\116\ If the decedent
was a party to any swaps at the time of death, then those swaps should
generally continue to be treated in the same way after the decedent's
death, at which time the swaps would most likely pass to the decedent's
estate. Also, the Commission expects that this prong will be
predictable and straightforward to apply for natural persons planning
for how their swaps will be treated after death, for executors and
administrators of estates, and for the swap counterparties to natural
persons and estates.
---------------------------------------------------------------------------
\115\ Final Sec. 23.23(a)(23)(i)(D).
\116\ Proposed Rule, 85 FR at 960.
---------------------------------------------------------------------------
(iii) Sec. 23.23(a)(23)(i)(C)
The third prong of the definition, the ``account'' prong, was
proposed to ensure that persons described in prongs (A), (B), and (D)
of the definition would be treated as U.S. persons even if they use
discretionary or non-discretionary accounts to enter into swaps,
irrespective of whether the person at which the account is held or
maintained is a U.S. person.\117\ Consistent with the Cross-Border
Margin Rule, the Commission stated that this prong would apply for
individual or joint accounts.\118\ IIB/SIFMA recommended that,
consistent with the SEC, the Commission clarify that under the
``account'' prong of the definition, an account's U.S. person status
should depend on whether any U.S.-person owner of the account actually
incurs obligations under the swap in question.
---------------------------------------------------------------------------
\117\ Id.
\118\ Id. See 17 CFR 23.160(a)(10)(vii).
---------------------------------------------------------------------------
The Commission is adopting this aspect of the U.S. person
definition as proposed, with a clarification.\119\ In response to the
IIB/SIFMA comment, the Commission is clarifying that an account's U.S.
person status depends on whether any U.S. person owner of the account
actually incurs obligations under the swap in question. Consistent with
the SEC Cross-Border Rule, where an account is owned by both U.S.
persons and non-U.S. persons, the U.S.-person status of the account, as
a general matter, turns on whether any U.S.-person owner of the account
incurs obligations under the swap.\120\ Neither the status of the
fiduciary or other person managing the account, nor the discretionary
or non-discretionary nature of the account, nor the status of the
person at which the account is held or maintained, are relevant in
determining the account's U.S.-person status.
---------------------------------------------------------------------------
\119\ Final Sec. 23.23(a)(23)(i)(C).
\120\ See SEC Cross-Border Rule, 79 FR at 47312.
---------------------------------------------------------------------------
(iv) Exclusion of Unlimited U.S. Responsibility Prong
Unlike the Cross-Border Margin Rule, the proposed definition of
``U.S. person'' did not include certain legal entities that are owned
by one or more U.S. person(s) and for which such person(s) bear
unlimited responsibility for the obligations and liabilities of the
legal entity (``unlimited U.S. responsibility'' prong).\121\ The
Commission invited comment on whether it should include an unlimited
U.S. responsibility prong in the definition of ``U.S. person,'' and if
not, whether it should revise its interpretation of ``guarantee'' in a
manner consistent with the SEC such that persons that would have been
considered U.S. persons pursuant to an unlimited U.S. responsibility
prong would instead be considered entities with guarantees from a U.S.
person.\122\
---------------------------------------------------------------------------
\121\ Proposed Rule, 85 FR at 961. See 17 CFR 23.160(a)(10)(vi);
Cross-Border Margin Rule, 81 FR at 34823-34824. See also Guidance,
78 FR at 45312-13 (discussing the unlimited U.S. responsibility
prong for purposes of the Guidance).
\122\ Proposed Rule, 85 FR at 969.
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Chatham and IIB/SIFMA agreed that the Commission should not include
an unlimited U.S. responsibility prong in the ``U.S. Person''
definition, noting that
[[Page 56935]]
the persons that would be captured under the prong are corporate
structures that are not commonly in use in the marketplace (e.g.,
unlimited liability corporations, general partnerships, and sole
proprietorships). IIB/SIFMA added that to the extent a firm uses this
structure, the Commission can sufficiently address the resulting risks
to the United States by treating the firm as having a guarantee from a
U.S. person, as the SEC does.
The Commission is adopting as proposed a definition of ``U.S.
person'' that does not include an unlimited U.S. responsibility prong.
Although this corporate structure may exist in some limited form, the
Commission does not believe that justifies the cost of classification
as a ``U.S. person.'' This prong was designed to capture persons that
could give rise to risk to the U.S. financial system in the same manner
as with non-U.S. persons whose swap transactions are subject to
explicit financial support arrangements from U.S. persons.\123\ Rather
than including this prong in its ``U.S. person'' definition, the SEC
took the view that when a non-U.S. person's counterparty has recourse
to a U.S. person for the performance of the non-U.S. person's
obligations under a security-based swap by virtue of the U.S. person's
unlimited responsibility for the non-U.S. person, the non-U.S. person
would be required to include the security-based swap in its security-
based swap dealer (if it is a dealing security-based swap) and major
security-based swap participant threshold calculations as a
guarantee.\124\ Therefore, as discussed below with respect to the
definition of ``guarantee,'' the Commission is clarifying that legal
entities that are owned by one or more U.S. person(s) and for which
such person(s) bear unlimited responsibility for the obligations and
liabilities will be considered as having a guarantee from a U.S.
person, similar to the approach in the SEC Cross-Border Rule. The
CFTC's anti-evasion rules address concerns that persons may structure
transactions to avoid classification as a U.S. person.\125\
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\123\ Id. at 960-961.
\124\ SEC Cross-Border Rule, 79 FR at 47308 n.255, 47316-47317.
\125\ See 17 CFR 1.6.
---------------------------------------------------------------------------
The treatment of the unlimited U.S. liability prong in the Final
Rule does not affect an entity's obligations with respect to the Cross-
Border Margin Rule. To the extent that entities are considered U.S.
persons for purposes of the Cross-Border Margin Rule as a result of the
unlimited U.S. liability prong, the Commission believes that the
different purpose of the registration-related rules justifies this
potentially different treatment.\126\
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\126\ Proposed Rule, 85 FR at 961.
---------------------------------------------------------------------------
(v) Exclusion of Collective Investment Vehicle Prong
Consistent with the definition of ``U.S. person'' in the Cross-
Border Margin Rule and the SEC Cross-Border Rule, the proposed
definition did not include a commodity pool, pooled account, investment
fund, or other CIV that is majority-owned by one or more U.S.
persons.\127\ This prong was included in the Guidance definition. The
Commission invited comment on whether it is appropriate that commodity
pools, pooled accounts, investment funds, or other CIVs that are
majority-owned by U.S. persons would not be included in the proposed
definition of ``U.S. person.'' \128\
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\127\ Id. See Cross-Border Margin Rule, 81 FR at 34824; SEC
Cross-Border Rule, 79 FR at 47311, 47337.
\128\ Proposed Rule, 85 FR at 969.
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AIMA, Chatham, IIB/SIFMA, JFMC/IBAJ,\129\ JBA, and State Street
supported not including this prong in the ``U.S. person'' definition.
They generally noted that there are practical difficulties in tracking
the beneficial ownership in CIVs, and therefore, including a CIV prong
would increase the complexity of the ``U.S. person'' definition. AIMA
stated that this could necessitate conservative assumptions being made
to avoid the risk of breaching regulatory requirements that depend on
the status of investors in the vehicle. JBA noted that non-U.S. persons
may choose not to enter into transactions with CIVs in which U.S.
persons are involved to avoid the practical burdens of identifying and
tracking the beneficial ownership of funds in real-time and the
excessive cost arising from the registration threshold calculations.
JFMC/IBAJ elaborated that ownership composition can change throughout
the life of the vehicle due to redemptions and additional investments.
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\129\ JFMC/IBAJ also requested that conforming amendments be
made to the ``U.S. person'' definition under the Cross-Border Margin
Rule. However, this comment is outside of the scope of the Final
Rule.
---------------------------------------------------------------------------
AIMA, Chatham, and State Street also noted that there are limited
benefits to including a requirement to ``look-through'' non-U.S. CIVs
to identify and track U.S. beneficial owners of such vehicles. AIMA
stated that it is reasonable to assume that the potential investment
losses to which U.S. investors in CIVs are exposed are limited to their
initial capital investment. Chatham stated that the composition of a
CIV's beneficial owners is not likely to have a significant bearing on
the degree of risk that the CIV's swap activity poses to the U.S.
financial system, noting that CIVs organized or having a principal
place of business in the U.S. would be under the Commission's
authority, and majority-owned CIVs may be subject to margin
requirements in foreign jurisdictions.
AIMA added that the definition of ``U.S. person'' in the Guidance
is problematic for certain funds managed by investment managers because
they are subject to European rules on clearing, margining, and risk
mitigation.
After consideration of the comments, and consistent with the
definition of ``U.S. person'' in the Cross-Border Margin Rule and the
SEC Cross-Border Rule, the Commission is adopting as proposed a ``U.S.
person'' definition that does not include a commodity pool, pooled
account, investment fund, or other CIV that is majority-owned by one or
more U.S. persons.\130\ Similar to the SEC, the Commission is of the
view that including majority-owned CIVs within the definition of ``U.S.
person'' for the purposes of the Final Rule would likely cause more
CIVs to incur additional programmatic costs associated with the
relevant Title VII requirements and ongoing assessments, while not
significantly increasing programmatic benefits given that the
composition of a CIV's beneficial owners is not likely to have
significant bearing on the degree of risk that the CIV's swap activity
poses to the U.S. financial system.\131\ Although many of these CIVs
have U.S. participants that could be adversely affected in the event of
a counterparty default, systemic risk concerns are mitigated to the
extent these CIVs are subject to margin requirements in foreign
jurisdictions. In addition, the exposure of participants to losses in
CIVs is typically limited to their investment amount, and it is
unlikely that a participant in a CIV would make counterparties whole in
the event of a default.\132\ Further, the Commission continues to
believe that identifying and tracking a CIV's beneficial ownership may
pose a significant challenge, particularly in certain circumstances
such as fund-of-funds or master-feeder structures.\133\ Therefore,
although the U.S. participants in such CIVs may be adversely affected
in the event of a counterparty default, the Commission has determined
that the majority-
[[Page 56936]]
ownership test should not be included in the definition of ``U.S.
person.''
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\130\ See Cross-Border Margin Rule, 81 FR at 34824; SEC Cross-
Border Rule, 79 FR at 47311, 47337.
\131\ Proposed Rule, 85 FR at 961. See SEC Cross-Border Rule, 79
FR at 47337.
\132\ Proposed Rule, 85 FR at 961; SEC Cross-Border Rule, 79 FR
at 47311.
\133\ See Cross-Border Margin Rule, 81 FR at 34824.
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A CIV fitting within the majority U.S. ownership prong may also be
a U.S. person within the scope of Sec. 23.23(a)(23)(i)(B) of the Final
Rule (entities organized or having a principal place of business in the
United States). As the Commission clarified in the Cross-Border Margin
Rule, whether a pool, fund, or other CIV is publicly offered only to
non-U.S. persons and not offered to U.S. persons is not relevant in
determining whether it falls within the scope of the ``U.S. person''
definition.\134\
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\134\ Id. at 34824 n.62.
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(vi) Exclusion of Catch-All Prong
Unlike the non-exhaustive ``U.S. person'' definition provided in
the Guidance,\135\ the Commission proposed that the definition of
``U.S. person'' be limited to persons enumerated in the rule,
consistent with the Cross-Border Margin Rule and the SEC Cross-Border
Rule.\136\ The Commission invited comment on whether the ``U.S.
person'' definition should include a catch-all provision.\137\
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\135\ See Guidance, 78 FR at 45316.
\136\ Proposed Rule, 85 FR at 961. See 17 CFR 23.160(a)(10); 17
CFR 240.3a71-3(a)(4); Cross-Border Margin Rule, 81 FR at 34824.
\137\ Proposed Rule, 85 FR at 969.
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AFEX/GPS, Chatham, IIB/SIFMA, and JBA supported elimination of the
``include, but not limited to'' language from the Guidance. AFEX/GPS
stated that this approach should help facilitate compliance with
Commission rules. Chatham stated that the catch-all prong works against
the core purposes of the cross-border rules, to enhance regulatory
cooperation and transparency. IIB/SIFMA stated that market participants
have lacked any practical way to delineate the scope of that catch-all
phrase, leading to legal uncertainty. JBA stated that the provision is
difficult to interpret and leads to uncertainty, and potentially
reduced transactions by market participants, leading to increased
bifurcation in the market.
The Commission is adopting this aspect of the ``U.S. person''
definition as proposed.\138\ Unlike the non-exhaustive ``U.S. person''
definition provided in the Guidance, the definition of ``U.S. person''
is limited to persons enumerated in the rule, consistent with the
Cross-Border Margin Rule and the SEC Cross-Border Rule.\139\ The
Commission believes that the prongs adopted in the Final Rule capture
those persons with sufficient jurisdictional nexus to the U.S.
financial system and commerce in the United States that they should be
categorized as ``U.S. persons.'' \140\
---------------------------------------------------------------------------
\138\ Id. at 961.
\139\ See 17 CFR 23.160(a)(10); 17 CFR 240.3a71-3(a)(4); Cross-
Border Margin Rule, 81 FR at 34824; Guidance, 78 FR at 45316
(discussing the inclusion of the prefatory phrase ``include, but not
be limited to'' in the interpretation of ``U.S. person'' in the
Guidance).
\140\ Proposed Rule, 85 FR at 961.
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3. Principal Place of Business
The Commission proposed to define ``principal place of business''
as the location from which the officers, partners, or managers of the
legal person primarily direct, control, and coordinate the activities
of the legal person, consistent with the SEC definition of ``U.S.
person.'' \141\ Additionally, with respect to a CIV, the Proposed Rule
stated that this location is the office from which the manager of the
CIV primarily directs, controls, and coordinates the investment
activities of the CIV, and noted that activities such as formation of
the CIV, absent an ongoing role by the person performing those
activities in directing, controlling, and coordinating the investment
activities of the CIV, generally would not be as indicative of
activities, financial and legal relationships, and risks within the
United States of the type that Title VII is intended to address as the
location of a CIV manager.\142\ The Commission invited comment on
whether, when determining the principal place of business for a CIV,
the Commission should consider including as a factor whether the senior
personnel responsible for the formation and promotion of the CIV are
located in the United States, similar to the approach in the Cross-
Border Margin Rule.\143\
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\141\ Proposed Sec. 23.23(a)(22)(ii); Proposed Rule, 85 FR at
960, 1003. See 17 CFR 240.3a71-3(a)(4)(ii).
\142\ Proposed Rule, 85 FR at 960.
\143\ Id. at 969.
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AIMA supported the proposed definition of ``principal place of
business'' and stated that there are more relevant indicia of U.S.
nexus than the activities of forming and promoting a CIV, such as the
location of staff who control the investment activities of the CIV.
Similarly, IIB/SIFMA supported adopting the SEC's ``principal place of
business'' test for CIVs because it better captures business reality by
focusing more on investment strategy rather than the location of
promoters who do not have an ongoing responsibility for the vehicle.
The Commission is adopting the ``principal place of business''
aspect of the ``U.S. person'' definition as proposed.\144\ As noted in
the Cross-Border Margin Rule,\145\ and consistent with the SEC
definition of ``U.S. person,'' \146\ Sec. 23.23(a)(23)(ii) provides
that the principal place of business means the location from which the
officers, partners, or managers of the legal person primarily direct,
control, and coordinate the activities of the legal person. With the
exception of externally managed entities, as discussed below, the
Commission is of the view that for most entities, the location of these
officers, partners, or managers generally corresponds to the location
of the person's headquarters or main office. However, the Commission
believes that a definition that focuses exclusively on whether a legal
person is organized, incorporated, or established in the United States
could encourage some entities to move their place of incorporation to a
non-U.S. jurisdiction to avoid complying with the relevant Dodd-Frank
Act requirements, while maintaining their principal place of business--
and therefore, risks arising from their swap transactions--in the
United States. Moreover, a ``U.S. person'' definition that does not
include a ``principal place of business'' element could result in
certain entities falling outside the scope of the relevant Dodd-Frank
Act-related requirements, even though the nature of their legal and
financial relationships in the United States is, as a general matter,
indistinguishable from that of entities incorporated, organized, or
established in the United States. Therefore, the Commission is of the
view that it is appropriate to treat such entities as U.S. persons for
purposes of the Final Rule.\147\
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\144\ Final Sec. 23.23(a)(23)(ii).
\145\ Cross-Border Margin Rule, 81 FR at 34823.
\146\ 17 CFR 240.3a71-3(a)(4)(ii).
\147\ See Proposed Rule, 85 FR at 960; SEC Cross-Border Rule, 79
FR at 47309.
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However, determining the principal place of business of a CIV, such
as an investment fund or commodity pool, may require consideration of
additional factors beyond those applicable to operating companies.\148\
The Commission interprets that, for an externally managed investment
vehicle, this location is the office from which the manager of the
vehicle primarily directs, controls, and coordinates the investment
activities of the vehicle.\149\ This interpretation is consistent with
the Supreme Court's decision in Hertz Corp. v. Friend, which described
a corporation's principal place of business, for purposes of diversity
jurisdiction, as the ``place where the corporation's high level
officers direct, control, and coordinate the
[[Page 56937]]
corporation's activities.'' \150\ In the case of a CIV, the senior
personnel that direct, control, and coordinate a CIV's activities are
generally not the named directors or officers of the CIV, but rather
persons employed by the CIV's investment advisor or promoter, or in the
case of a commodity pool, its CPO. Therefore, consistent with the SEC
Cross-Border Rule,\151\ when a primary manager is responsible for
directing, controlling, and coordinating the overall activity of a CIV,
the CIV's principal place of business under the Final Rule is the
location from which the manager carries out those responsibilities.
---------------------------------------------------------------------------
\148\ Proposed Rule, 85 FR at 960.
\149\ Final Sec. 23.23(a)(23)(ii).
\150\ 559 U.S. 77, 80 (2010). See Proposed Rule, 85 FR at 960;
Cross-Border Margin Rule, 81 FR at 34823.
\151\ See SEC Cross-Border Rule, 79 FR at 47310-47311.
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Under the Cross-Border Margin Rule,\152\ the Commission generally
considers the principal place of business of a CIV to be in the United
States if the senior personnel responsible for either: (1) The
formation and promotion of the CIV; or (2) the implementation of the
CIV's investment strategy are located in the United States, depending
on the facts and circumstances that are relevant to determining the
center of direction, control, and coordination of the CIV. Although the
second prong is consistent with the approach discussed above, the
Commission does not believe that activities such as formation of the
CIV, absent an ongoing role by the person performing those activities
in directing, controlling, and coordinating the investment activities
of the CIV, generally will be as indicative of activities, financial
and legal relationships, and risks within the United States of the type
that Title VII is intended to address as the location of a CIV
manager.\153\ The Commission may also consider amending the ``U.S.
person'' definition in the Cross-Border Margin Rule in the future.
---------------------------------------------------------------------------
\152\ Cross-Border Margin Rule, 81 FR at 34823.
\153\ Proposed Rule, 85 FR at 960.
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4. Exception for International Financial Institutions
The Commission proposed that, in consideration of the discretionary
and appropriate exercise of international comity-based doctrines, the
term ``U.S. person'' would not include certain multilateral and other
international financial institutions.\154\
---------------------------------------------------------------------------
\154\ Proposed Sec. 23.23(a)(22)(iii); Proposed Rule, 85 FR at
961-962, 1003.
---------------------------------------------------------------------------
IIB/SIFMA supported the proposed exception for certain
international financial institutions, noting that the Commission has
routinely recognized the special status afforded these institutions
under the traditions of the international system by effectively
treating them as non-U.S. persons for most purposes, and it is
therefore appropriate for the Commission to codify this treatment
through this exception. IIB/SIFMA also stated that the catch-all for
``similar international organizations'' appropriately addresses the
international comity considerations that underlie this exception.
The Commission is adopting this aspect of the ``U.S. person''
definition as proposed, with a technical modification as discussed
below.\155\ Consistent with the SEC's definition,\156\ the term ``U.S.
person'' does not include the International Monetary Fund, the
International Bank for Reconstruction and Development, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the United Nations, and their agencies and pension
plans, and any other similar international organizations, and their
agencies and pension plans. The Commission believes that although such
foreign entities are not necessarily immune from U.S. jurisdiction for
commercial activities undertaken with U.S. counterparties or in U.S.
markets, the sovereign or international status of such international
financial institutions that themselves participate in the swap markets
in a commercial manner is relevant in determining whether such entities
should be treated as U.S. persons, regardless of whether any of the
prongs of the definition apply.\157\ There is nothing in the text or
history of the swap-related provisions of Title VII to suggest that
Congress intended to deviate from the traditions of the international
system by including such international financial institutions within
the definitions of the term ``U.S. person.''
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\155\ Final Sec. 23.23(a)(23)(iii).
\156\ See 17 CFR 240.3a71-3(a)(4)(iii).
\157\ Proposed Rule, 85 FR at 961-962. See, e.g., Entities Rule,
77 FR at 30692-30693 (discussing the application of the ``swap
dealer'' and ``major swap participant'' definitions to foreign
governments, foreign central banks, and international financial
institutions). See also Guidance, 78 FR at 45353 n.531.
---------------------------------------------------------------------------
Consistent with the Entities Rule and the Guidance, the Commission
interprets the term ``international financial institutions'' to include
the ``international financial institutions'' that are defined in 22
U.S.C. 262r(c)(2) and institutions defined as ``multilateral
development banks'' in the European Union's regulation on ``OTC
derivatives, central counterparties and trade repositories.'' \158\
Reference to 22 U.S.C. 262r(c)(2) and the European Union definition is
consistent with Commission precedent in the Entities Rule.\159\ Both of
those definitions identify many of the entities for which discretionary
and appropriate exercise of international comity-based doctrines is
appropriate with respect to the ``U.S. person'' definition.\160\ This
prong also includes institutions identified in CFTC Staff Letters 17-34
\161\ and 18-13.\162\ In CFTC Staff Letter 17-34, Commission staff
provided relief from CFTC margin requirements to swaps between SDs and
the European Stability Mechanism (``ESM''),\163\ and in CFTC Staff
Letter
[[Page 56938]]
18-13, Commission staff identified the North American Development Bank
(``NADB'') as an additional entity that should be considered an
international financial institution for purposes of applying the SD and
MSP definitions.\164\ Interpreting the definition to include the two
entities identified in CFTC Staff Letters 17-34 and 18-13 is consistent
with the discretionary and appropriate exercise of international comity
because the status of both entities is similar to that of the other
international financial institutions identified in the Entities Rule.
Consistent with the SEC definition of ``U.S. person,'' the Final Rule
lists specific international financial institutions but also provides a
catch-all for ``any other similar international organizations, and
their agencies and pension plans.'' As a technical edit, the Commission
notes that the catch-all for international financial institutions in
the Final Rule now includes ``and'' in the clause ``and their agencies
and pension plans.'' The catch-all provision extends to any of the
entities discussed above that are not explicitly listed in the Final
Rule.\165\
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\158\ Regulation (EU) No 648/2012 of the European Parliament and
of the Council on OTC Derivative Transactions, Central
Counterparties and Trade Repositories, Article 1(5(a)) (July 4,
2012), available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32012R0648. Article 1(5(a)) references Section 4.2 of
Part 1 of Annex VI to Directive 2006/48/EC, available at https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32006L0048.
\159\ Entities Rule, 77 FR at 30692 n.1180. The Guidance
referenced the Entities Rule's interpretation as well. Guidance, 78
FR at 45353 n.531.
\160\ The definitions overlap but together include the
following: The International Monetary Fund, International Bank for
Reconstruction and Development, European Bank for Reconstruction and
Development, International Development Association, International
Finance Corporation, Multilateral Investment Guarantee Agency,
African Development Bank, African Development Fund, Asian
Development Bank, Inter-American Development Bank, Bank for Economic
Cooperation and Development in the Middle East and North Africa,
Inter-American Investment Corporation, Council of Europe Development
Bank, Nordic Investment Bank, Caribbean Development Bank, European
Investment Bank and European Investment Fund. Note that the
International Bank for Reconstruction and Development, the
International Development Association, the International Finance
Corporation, and the Multilateral Investment Guarantee Agency are
parts of the World Bank Group.
\161\ See CFTC Staff Letter No. 17-34, Commission Regulations
23.150-159, 161: No-Action Position with Respect to Uncleared Swaps
with the European Stability Mechanism (Jul, 24, 2017), available at
https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/17-34.pdf. See also CFTC Staff
Letter No. 19-22, Commission Regulations 23.150-159, 23.161: Revised
No-Action Position with Respect to Uncleared Swaps with the European
Stability Mechanism (Oct. 16, 2019), available at https://www.cftc.gov/csl/19-22/download.
\162\ See CFTC Staff Letter No. 18-13, No-Action Position:
Relief for Certain Non-U.S. Persons from Including Swaps with
International Financial Institutions in Determining Swap Dealer and
Major Swap Participant Status (May 16, 2018), available at https://www.cftc.gov/sites/default/files/csl/pdfs/18/18-13.pdf.
\163\ See CFTC Staff Letter No. 17-34. In addition, in May 2020,
the Commission adopted an amendment to Sec. 23.151 to exclude ESM
from the definition of ``financial end user,'' which will have the
effect of excluding swaps between certain SDs and ESM from the
Commission's uncleared swap margin requirements. See Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 85 FR 27674 (May 11, 2020).
\164\ See CFTC Staff Letter 18-13. See also CFTC Staff Letter
17-59 (Nov. 17, 2017) (providing no-action relief to NADB from the
swap clearing requirement of section 2(h)(1) of the CEA), available
at https://www.cftc.gov/idc/groups/public/%40lrlettergeneral/documents/letter/17-59.pdf.
\165\ Proposed Rule, 85 FR at 962.
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5. Reliance on Prior Representations
As noted above in section II.A, the Final Rule states that a person
may rely on a written representation from its counterparty that the
counterparty does or does not satisfy the criteria for one or more of
the definitions, unless such person knows or has reason to know that
the representation is not accurate.\166\
---------------------------------------------------------------------------
\166\ Final Sec. 23.23(a).
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Further, with respect to the ``U.S. person'' definition, to provide
certainty to market participants, the Commission proposed to permit
reliance, until December 31, 2025, on any U.S. person-related
representations that were obtained to comply with the Cross-Border
Margin Rule.\167\ The Commission also stated that any person designated
as a ``U.S. person'' under the Proposed Rule would also be a ``U.S.
person'' under the Guidance, and therefore, market participants would
also be able to rely on representations previously obtained under the
``U.S. person'' definition in the Guidance.\168\
---------------------------------------------------------------------------
\167\ Proposed Sec. 23.23(a)(22)(iv); Proposed Rule, 85 FR at
962, 1003.
\168\ Proposed Rule, 85 FR at 962.
---------------------------------------------------------------------------
IIB/SIFMA and State Street recommended that the reliance on U.S.
person representations made with respect to the Cross-Border Margin
Rule should be permitted on a permanent basis. State Street asserted
that permanent relief raises no new policy considerations, eliminates a
``cliff effect'' in 2025, and eliminates the potential need for market
participants to seek Commission extension of the 2025 deadline should
circumstances arise where seeking new representations is impractical or
unduly burdensome. Additionally, IIB/SIFMA, ISDA, JFMC/IBAJ, and State
Street stated that reliance should explicitly be permitted with respect
to representations made pursuant to the Guidance. JFMC/IBAJ stated that
this would be appropriate given the compliance burdens associated with
obtaining representations. State Street noted that the Commission would
increase clarity and market efficiency by explicitly providing for
Guidance-related representations in final rule text.
In response to these comments, the Commission notes that it
proposed temporary reliance on prior representations in the Proposed
Rule because it assumed that SDs and MSPs somewhat routinely amend swap
trading relationship documentation and thus updated representations
based on the proposed U.S. person definition could be obtained in the
course of these routine amendments. Permitting temporary reliance to
facilitate this method of updating representations is less burdensome
and more cost efficient than requiring all affected SDs and MSPs to
update representations within a relatively brief compliance period. The
Commission has determined that permanent reliance on representations
obtained under the Guidance or the Cross-Border Margin Rule would be
contrary to good recordkeeping practices, particularly for dormant
relationships, which require updated representations within a set time
period. Additionally, there are a variety of circumstances that
routinely lead SDs and MSPs to amend counterparty trading relationship
documentation, such as address changes, payment detail updates, ISDA
definition changes, and LIBOR amendments.
To relieve concerns that the December 31, 2025 deadline is
burdensome, the Commission is adopting an approximately seven year time
limit, until December 31, 2027, for reliance on ``U.S. person''
representations made pursuant to the Cross-Border Margin Rule, instead
of the five year limit that was proposed.\169\ Thus, for those
counterparties for whom a person has already obtained U.S. person-
related representations under the Cross-Border Margin Rule, U.S.
person-related representations under the Final Rule will only be
required from those counterparties with whom swaps are entered after
December 31, 2027. Nevertheless, best practice is to obtain updated
representations as soon as practicable.
---------------------------------------------------------------------------
\169\ Final Sec. 23.23(a)(23)(iv).
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In addition, the Commission has adjusted the rule text of Sec.
23.23(a)(23)(iv) to clarify that reliance is only permitted for
representations obtained prior to the effective date of the Final
Rule.\170\ Persons should not be permitted to rely on representations
obtained pursuant to the Cross-Border Margin Rule after the effective
date of the Final Rule when such persons could have also obtained
representations pursuant to the Final Rule contemporaneously therewith.
---------------------------------------------------------------------------
\170\ Final Sec. 23.23(a)(23)(iv)(A).
---------------------------------------------------------------------------
The Commission reiterates that it believes that any person
designated as a ``U.S. person'' under the Final Rule is also a ``U.S.
person'' under the Guidance definition, as the Final Rule's definition
is narrower in scope. Therefore, the Commission is of the view that
market participants may also rely on representations previously
obtained using the ``U.S. person'' definition in the Guidance.\171\ A
representation obtained under the Guidance should not be relied on
permanently, and new representations should be obtained as soon as
practicable, but in the Commission's view it would not be appropriate
to rely on representations under the Guidance after the December 31,
2027 deadline for similar representations made under the Cross-Border
Margin Rule. Thus, for those counterparties for whom a person has
already obtained U.S. person-related representations under the
Guidance, U.S. person-related representations under the Final Rule will
only be required from those counterparties with whom swaps are entered
after December 31, 2027.
---------------------------------------------------------------------------
\171\ Proposed Rule, 85 FR at 962.
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In response to commenters, the Commission has determined to add
rule text permitting reliance on representations obtained under the
Guidance.\172\ The Commission understands that while the Guidance is
non-binding, many market participants have chosen to develop policies
and practices that take into account the views expressed therein,
including expending time and resources to classify counterparties in
accordance with the interpretation of the term ``U.S. person''
[[Page 56939]]
as set forth in the Guidance. Adding rule text permitting reliance on
representations obtained under the Guidance recognizes, and should
reduce, the practical burdens of compliance with the Final Rule by
enhancing regulatory certainty.
---------------------------------------------------------------------------
\172\ Final Sec. 23.23(a)(23)(iv)(B).
---------------------------------------------------------------------------
Finally, the rule text of Sec. 23.23(a)(23)(iv)(B) clarifies that
reliance is only permitted for representations obtained prior to the
effective date of the Final Rule. As with U.S. person-related
representations obtained pursuant to the Cross-Border Margin Rule,
persons should not be permitted to rely on representations obtained
pursuant to the Guidance after the effective date of the Final Rule
when such persons could have also obtained representations pursuant to
the Final Rule contemporaneously therewith.
6. Other
The Commission considers the following comments in connection with
the proposed ``U.S. person'' definition beyond the scope of this
rulemaking and is not addressing them in the Final Rule. However, the
Commission takes these comments under advisement for any relevant
future Commission action.
AIMA encouraged the CFTC to use the proposed ``U.S. person''
definition universally across all Title VII requirements and the CEA,
including in part 4 for CPOs, commodity pools, and commodity trading
advisors (``CTAs''). CS encouraged further harmonization of the ``U.S.
person'' definition, to the extent possible, within the context of SD
activity, including the CFTC's capital and margin rules. IIB/SIFMA
recommended making conforming changes to the ``U.S. person'' definition
under the Cross-Border Margin Rule to avoid the confusion that will
arise from using different definitions of the same term in a single,
comprehensive regulatory regime. Finally, JFMC/IBAJ and JSCC requested
that the Commission specify that the ``U.S. person'' definition would
also apply to, and supersede, the definition referenced in the CFTC's
Orders of Exemption from Registration granted to the Japan Securities
Clearing Corporation.\173\
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\173\ See Amended Order of Exemption from Registration issued
for JSCC (May 15, 2017), available at https://www.cftc.gov/idc/groups/public/@otherif/documents/ifdocs/jsccdcoexemptamdorder5-15-17.pdf.
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C. Guarantee
1. Proposed Rule
The Commission proposed defining ``guarantee'' as an arrangement,
pursuant to which one party to a swap has rights of recourse against a
guarantor, with respect to its counterparty's obligations under the
swap.\174\ For these purposes, a party to a swap would have rights of
recourse against a guarantor if the party has a conditional or
unconditional legally enforceable right to receive or otherwise
collect, in whole or in part, payments from the guarantor with respect
to its counterparty's obligations under the swap. Also, the term
``guarantee'' would encompass any arrangement pursuant to which the
guarantor itself has a conditional or unconditional legally enforceable
right to receive or otherwise collect, in whole or in part, payments
from any other guarantor with respect to the counterparty's obligations
under the swap.
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\174\ Proposed Sec. 23.23(a)(8); Proposed Rule, 85 FR at 963-
64, 1002-03.
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2. Summary of Comments
In general, AFEX/GPS, Chatham, IIB/SIFMA, and JFMC/IBAJ supported
the proposed ``guarantee'' definition, while AFR, Barnard, and Better
Markets opposed the proposed definition.
AFEX/GPS, Chatham, and JFMC/IBAJ supported the consistency of the
proposed definition with the definition in the Cross-Border Margin
Rule. JFMC/IBAJ also supported the consistency with the SEC Cross-
Border Rule. AFEX/GPS and Chatham noted that the consistency would make
the definition more workable.
AFEX/GPS stated that using the broad and vague definition of
guarantee in the Guidance, which includes consideration of ``facts and
circumstances'' and a non-exclusive list of examples, would not be
appropriate, while the proposed definition would be objective and
should facilitate compliance without sacrificing concerns about
systemic risk flowing back to the United States. Chatham stated that
the proposed definition would provide greater legal certainty around
what is considered to be a guarantee and focuses the Commission's
authority on potential significant risks to the U.S. financial system.
IIB/SIFMA noted that the proposed definition would promote legal
certainty by establishing a clearer test for when a non-U.S. person is
considered to have financial support from a U.S. person, eliminating
coverage of certain risk-shifting arrangements (e.g., keepwells and
liquidity puts) that do not provide a non-U.S. person's counterparty
with recourse against a U.S. guarantor. IIB/SIFMA added that to the
extent a firm uses the unlimited U.S. responsibility structure
(discussed in section II.B.2.iv above), the Commission could
sufficiently address the resulting risks to the United States by
treating the firm as having a guarantee from a U.S. person, as the SEC
does, rather than considering such an entity a U.S. person. JFMC/IBAJ
stated that the definition under the Guidance introduced compliance
challenges to market participants globally, including difficulties in
confirming or obtaining representations from counterparties regarding
whether certain arrangements, particularly purely internal arrangements
within a counterparty's corporate group, constituted a ``guarantee.''
JFMC/IBAJ also supported the clarification that a non-U.S. person would
be considered a ``guaranteed entity,'' as described below, only with
respect to swaps that are guaranteed by a U.S. person.
ISDA, IIB/SIFMA, JFMC/IBAJ, and State Street also recommended that
the Commission permit reliance on guarantee-related representations
received pursuant to the Cross-Border Margin Rule and Guidance,
analogous to the Proposed Rule and related comments with respect to the
``U.S. person'' definition, discussed above. IIB/SIFMA and State Street
stated that such reliance should not be time limited.
AFR asserted that the narrower definition of guarantee, as compared
to the Guidance, would permit numerous informal or even formal forms of
guarantees between U.S. parent corporations and their subsidiaries to
escape the definition. Barnard stated that the narrower definition
would allow significant risk to be transferred back to the U.S.
financial system over time. Barnard noted that economic implications
are just as important as legal considerations, as confirmed and
intended by CEA section 2(i)(1). Similarly, Better Markets recommended
that the Commission revise its proposed definition of ``guarantee'' to
include all forms of U.S. financial support used to facilitate dealing
through non-U.S. affiliates because financial arrangements posing
potential risks to U.S. persons and the U.S. financial system include
more than solely contractual guarantees contained in swap trading
relationship documentation between non-U.S. counterparties.
Better Markets added that a narrower definition of ``guarantee''
would elevate form over substance and have possible significant adverse
effects on the U.S. financial system. Better Markets did not agree that
a definition posing possible significant adverse effects on the U.S.
financial system nevertheless should be adopted, merely because the
proposed ``guarantee'' definition mirrors the definition in the Cross-
Border Margin
[[Page 56940]]
Rule and therefore would not demand ``a separate independent
assessment.'' Better Markets asserted that it is neither a valid
statutory purpose nor a benefit that outweighs, or even reasonably
approximates, its costs. Better Markets added that CEA section 5(b) and
related provisions make clear that the CFTC's core statutory policy
objectives are to protect the safety and soundness of SDs, prevent
disruptions to the integrity of derivatives markets, ensure the
financial integrity of swaps transactions and the avoidance of systemic
risk, and preserve the stability of the U.S. financial system.
Better Markets also stated that the CFTC's use of the margin-
related ``guarantee'' definition is not appropriate. Its view was that
margin requirements on uncleared swaps are market and credit risk
mitigants that are imposed on specific portfolios of derivatives with
specific counterparties, while the proposed definition would address
broader systemic risk reduction and other policy objectives, including
statutory concerns about the evasion of U.S. law through legal entity
booking strategies. Further, Better Markets asserted that the narrower
definition would increase risks to U.S. persons, because the definition
would result in fewer swaps transactions being treated as
``guaranteed,'' opening a loophole for dealing conducted through
unregistered affiliates of U.S. banks that nevertheless benefit from
direct U.S. financial support.
3. Final Rule
After carefully considering the comments received, the Commission
is adopting the definition of ``guarantee'' as proposed, with certain
modifications and clarifications as discussed below.\175\
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\175\ Final Sec. 23.23(a)(9).
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Consistent with the Cross-Border Margin Rule, the term
``guarantee'' applies regardless of whether the right of recourse is
conditioned upon the non-U.S. person's insolvency or failure to meet
its obligations under the relevant swap, and regardless of whether the
counterparty seeking to enforce the guarantee is required to make a
demand for payment or performance from the non-U.S. person before
proceeding against the U.S. guarantor.\176\ The terms of the guarantee
need not necessarily be included within the swap documentation or even
otherwise reduced to writing, provided that, under the laws of the
relevant jurisdiction, a swap counterparty has a conditional or
unconditional legally enforceable right, in whole or in part, to
receive payments from, or otherwise collect from, the U.S. person in
connection with the non-U.S. person's obligations under the swap. For
purposes of the Final Rule, the Commission generally considers swap
activities involving guarantees from U.S. persons to satisfy the
``direct and significant'' test under CEA section 2(i).\177\
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\176\ Proposed Rule, 85 FR at 963-64. See 17 CFR 23.160(a)(2);
Cross-Border Margin Rule, 81 FR at 34825.
\177\ Proposed Rule, 85 FR at 963.
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However, in contrast to the Cross-Border Margin Rule and the
Proposed Rule, but consistent with the recommendation by IIB/SIFMA, the
Commission is interpreting ``guarantee'' in a manner similar to the
SEC, specifically with respect to the unlimited U.S. responsibility
prong. Similar to the SEC, when a non-U.S. person's counterparty has
recourse to a U.S. person for the performance of the non-U.S. person's
obligations under a swap by virtue of the U.S. person's unlimited
responsibility for the non-U.S. person, such an arrangement is
considered a guarantee, and as discussed in sections III.B.3.i and
IV.B.3.i below, the non-U.S. person is required to include the swap in
its SD and MSP threshold calculations, respectively.\178\ As noted
above, the Commission is not including the unlimited U.S.
responsibility prong in the ``U.S. person'' definition, but interprets
such relationships as guarantees to ensure they are appropriately
covered by the Final Rule.
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\178\ See SEC Cross-Border Rule, 79 FR at 47316-47317, 47344.
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The term ``guarantee'' also encompasses any arrangement pursuant to
which the counterparty to the swap has rights of recourse, regardless
of the form of the arrangement, against at least one U.S. person
(either individually, jointly, and/or severally with others) for the
non-U.S. person's obligations under the swap. This addresses concerns
that swaps could be structured such that they would not count toward a
non-U.S. person's threshold calculations. For example, consider a swap
between two non-U.S. persons (``Party A'' and ``Party B''), where Party
B's obligations to Party A under the swap are guaranteed by a non-U.S.
affiliate (``Party C''), and where Party C's obligations under the
guarantee are further guaranteed by a U.S. parent entity (``Parent
D''). The definition of ``guarantee'' deems a guarantee to exist
between Party B and Parent D with respect to Party B's obligations
under the swap with Party A.\179\
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\179\ Proposed Rule, 85 FR at 963. See Cross-Border Margin Rule,
81 FR at 34825.
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The Commission's definition of guarantee is not affected by whether
the U.S. guarantor is an affiliate of the non-U.S. person because,
regardless of affiliation, the swap counterparty has a conditional or
unconditional legally enforceable right, in whole or in part, to
receive payments from, or otherwise collect from, the U.S. person in
connection with the non-U.S. person's obligations.
Also, the ``guarantee'' definition does not apply when a non-U.S.
person has a right to be compensated by a U.S. person with respect to
the non-U.S. person's own obligations under the swap. For example,
consider a swap between two non-U.S. persons (``Party E'' and ``Party
F''), where Party E enters into a back-to-back swap with a U.S. person
(``Party G''), or enters into an agreement with Party G to be
compensated for any payments made by Party E under the swap in return
for passing along any payments received. In such an arrangement, a
guarantee does not exist because Party F does not have a right to
collect payments from Party G with respect to Party E's obligations
under the swap (assuming no other agreements exist).\180\
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\180\ Proposed Rule, 85 FR at 963. See Cross-Border Margin Rule,
81 FR at 34825.
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As with the Cross-Border Margin Rule, the definition of
``guarantee'' in the Final Rule is narrower in scope than the one used
in the Guidance.\181\ Under the Guidance, the Commission advised that
it would interpret the term ``guarantee'' generally to include not only
traditional guarantees of payment or performance of the related swaps,
but also other formal arrangements that, in view of all the facts and
circumstances, support the non-U.S. person's ability to pay or perform
its swap obligations. The Commission stated that it believed that it
was necessary to interpret the term ``guarantee'' to include the
different financial arrangements and structures that transfer risk
directly back to the United States.\182\ The Commission is aware that
many other types of financial arrangements or support, other than a
guarantee as defined in the Final Rule, may be provided by a U.S.
person to a non-U.S. person (e.g., keepwells and liquidity puts,
certain types of indemnity agreements, master trust agreements,
liability or loss transfer or sharing agreements). The Commission
understands that these other financial arrangements or support transfer
risk directly back to the U.S. financial system, with possible adverse
effects, in a manner similar to a guarantee with a
[[Page 56941]]
direct recourse to a U.S. person. However, the Commission has
determined that a narrower definition of guarantee than that in the
Guidance achieves a more workable framework for non-U.S. persons,
particularly because the Final Rule's definition of ``guarantee'' is
consistent with the Cross-Border Margin Rule, and therefore does not
require a separate independent assessment, without undermining the
protection of U.S. persons and the U.S. financial system. The
Commission is sympathetic to comments regarding, and is independently
aware of, the difficulty in confirming or obtaining representations
from counterparties regarding whether certain arrangements,
particularly purely internal arrangements within a counterparty's
corporate group, constitute a ``guarantee.'' However, such difficulty
does not extend to classifying as guarantees arrangements that provide
a non-U.S. person's counterparty with recourse to a U.S. person for the
performance of the non-U.S. person's obligations under a swap.
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\181\ See Cross-Border Margin Rule, 81 FR at 34824.
\182\ Guidance, 78 FR at 45320.
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A broad definition of guarantee, as recommended by AFR, Barnard,
and Better Markets, would make it difficult for certain entities to
determine whether their counterparty is guaranteed or not. General
consistency with the Cross-Border Margin Rule definition means no
additional burden for market participants. Additionally, though the
definition of ``guarantee'' in the Guidance was broader, having a
specific standard in a rule is preferable to an open-ended
interpretation. The Commission recognizes that the definition of
``guarantee'' could lead to certain entities counting fewer swaps
towards their SD or MSP thresholds or qualify additional counterparties
for exceptions to certain regulatory requirements as compared to the
definition in the Guidance. However, such concerns could be mitigated
to the extent such non-U.S. persons meet the definition of a
``significant risk subsidiary,'' and thus, as discussed below, are
required to count certain swaps or swap positions toward their SD or
MSP registration thresholds. In this way, non-U.S. persons receiving
support from a U.S. person and representing a significant risk to the
U.S. financial system are captured by the Final Rule. Accordingly, the
Final Rule achieves the dual goals of protecting the U.S. markets and
promoting a workable cross-border framework.
In response to comments, the Commission is adopting language in the
``guarantee'' definition that is parallel to the language for ``U.S.
persons,'' allowing persons to rely on counterparty representations
with respect to a counterparty's ``guarantee'' status obtained pursuant
to the Cross-Border Margin Rule. As discussed above, permitting
temporary reliance to facilitate this method of updating
representations is less burdensome and more cost efficient than
requiring all affected SDs to update representations within a
relatively brief compliance period. However, permanent reliance on
representations obtained under the Guidance or the Cross-Border Margin
Rule would be inconsistent with good recordkeeping practices,
particularly for dormant relationships, thus, the Commission has
determined to require an updated representation within a set time
period. The Commission is thus adopting an approximately seven year
time limit, until December 31, 2027, on counterparty representations
with respect to a counterparty's ``guarantee'' status obtained pursuant
to the Cross-Border Margin Rule, the same as is permitted for reliance
on the ``U.S. person'' representations. Thus, for those counterparties
for whom a person has already obtained guarantee-related
representations under the Cross-Border Margin Rule, guarantee-related
representations under the Final Rule will only be required from those
counterparties with whom swaps are entered after December 31, 2027.
Nevertheless, best practice is to obtain updated representations as
soon as practicable.
In addition, the Commission has adjusted the rule text of Sec.
23.23(a)(9) to clarify that reliance is only permitted for
representations obtained prior to the effective date of the Final
Rule.\183\ Persons should not be permitted to rely on representations
obtained pursuant to the Cross-Border Margin Rule after the effective
date of the Final Rule when such persons could have also obtained
representations pursuant to the Final Rule contemporaneously therewith.
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\183\ Final Sec. 23.23(a)(9)(i).
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The Commission believes that any ``guarantee'' related
representation received under the Guidance definition would also apply
under the Final Rule, as the Final Rule's definition is generally
narrower in scope. Therefore, the Commission is of the view that market
participants may also rely on representations previously obtained using
the ``guarantee'' definition in the Guidance.\184\ Nevertheless, a
representation obtained under the Guidance should not be relied on
permanently and should be obtained as soon as practicable, but in the
Commission's view it would not be appropriate to rely on
representations under the Guidance after the December 31, 2027 deadline
for similar representations made under the Cross-Border Margin Rule.
Thus, for those counterparties for whom a person has already obtained
guarantee-related representations under the Guidance, guarantee-related
representations under the Final Rule will only be required from those
counterparties with whom swaps are entered after December 31, 2027.
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\184\ An SD or MSP may not rely on a representation obtained for
purposes of the Guidance that a counterparty's swaps are not
guaranteed by a U.S. person if the SD or MSP has classified the
counterparty as a U.S. person under the unlimited U.S.
responsibility prong of the U.S. person definition in the Guidance.
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In response to commenters, the Commission has determined to add
rule text permitting reliance on representations obtained under the
Guidance.\185\ The Commission understands that while the Guidance is
non-binding, many market participants have chosen to develop policies
and practices that take into account the views expressed therein,
including expending time and resources to classify counterparties in
accordance with the interpretation of the term ``guarantee'' as set
forth in the Guidance. Adding rule text permitting reliance on
representations obtained under the Guidance recognizes, and should
reduce, the practical burdens of compliance with the Final Rule by
enhancing regulatory certainty.
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\185\ Final Sec. 23.23(a)(9)(ii).
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Finally, the rule text of Sec. 23.23(a)(9)(ii) clarifies that
reliance is only permitted for representations obtained prior to the
effective date of the Final Rule. As with guarantee-related
representations obtained pursuant to the Cross-Border Margin Rule,
persons should not be permitted to rely on representations obtained
pursuant to the Guidance after the effective date of the Final Rule
when such persons could have also obtained representations pursuant to
the Final Rule contemporaneously therewith.
For ease of understanding, the discussion in this release uses the
term ``Guaranteed Entity'' to refer to a non-U.S. person whose swaps
are guaranteed by a U.S. person, but only with respect to the swaps
that are so guaranteed. Thus, a non-U.S. person may be a Guaranteed
Entity with respect to its swaps with certain counterparties because
the non-U.S. person's swaps with those counterparties are guaranteed,
but would not be a Guaranteed Entity with respect to its
[[Page 56942]]
swaps with other counterparties if the non-U.S. person's swaps with the
other counterparties are not guaranteed by a U.S. person. In other
words, depending on the nature of the trading relationship, a single
entity could be a Guaranteed Entity with respect to some of its swaps,
but not others.
Additionally, this release uses the term ``Other Non-U.S. Person''
to refer to a non-U.S. person that is neither a Guaranteed Entity nor a
significant risk subsidiary (as defined below).\186\ Depending on an
entity's corporate structure and financial relationships, a single
entity could be both a Guaranteed Entity and a significant risk
subsidiary and, as noted above, it may be a Guaranteed Entity for
certain of its swaps and an Other Non-U.S. Person for others.
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\186\ Note that an Other Non-U.S. Person can include a
registered SD or MSP.
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D. Significant Risk Subsidiary, Significant Subsidiary, Subsidiary,
Parent Entity, and U.S. GAAP
1. Proposed Rule
The Commission proposed a new category of entity termed a
significant risk subsidiary (``SRS''). Under the Proposed Rule, a non-
U.S. person would be considered an SRS if: (1) The non-U.S. person is a
``significant subsidiary'' of an ``ultimate U.S. parent entity,'' as
those terms were proposed to be defined; (2) the ``ultimate U.S. parent
entity'' has more than $50 billion in global consolidated assets, as
determined in accordance with U.S. generally accepted accounting
principles (``GAAP'') at the end of the most recently completed fiscal
year; and (3) the non-U.S. person is not subject to either: (a)
Consolidated supervision and regulation by the Board of Governors of
the Federal Reserve System (``Federal Reserve Board'') as a subsidiary
of a U.S. bank holding company (``BHC''); or (b) capital standards and
oversight by the non-U.S. person's home country regulator that are
consistent with the Basel Committee on Banking Supervision's
``International Regulatory Framework for Banks'' (``Basel III'') and
margin requirements for uncleared swaps in a jurisdiction for which the
Commission has issued a comparability determination (``CFTC Margin
Determination'') with respect to uncleared swap margin
requirements.\187\ If an entity is determined to be an SRS, the
Commission proposed to apply certain regulations to the entity in the
same manner as a U.S. person in some instances, for example in the
application of the SD and MSP registration threshold calculations, and
in the same manner as a Guaranteed Entity in other instances, for
example in the application of group B and C requirements.
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\187\ Proposed Rule, 85 FR at 964-968.
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With respect to conduit affiliates, the Guidance included a
discussion of factors that would be taken into account when determining
whether an entity was a conduit affiliate of a U.S. person. The
Proposed Rule stated that this concept was not being included in the
proposed regulations because the concerns posed by a conduit affiliate
were intended to be addressed through the proposed definition and
regulation of SRSs.
2. Summary of Comments
In the Proposed Rule, the Commission asked whether it should use
the concept of a conduit affiliate, as was done in the Guidance, in
order to harmonize with the SEC.\188\ AEFX/GPS, Chatham, JFMC/IBAJ, and
IIB/SIFMA all stated that they prefer the SRS entity definition to the
use of the conduit affiliate concept from the Guidance. AFEX/GPS,
Chatham, and IIB/SIFMA stated that the objective criteria in the SRS
definition are preferable to the conduit affiliate concept in the
Guidance, which is more difficult to apply. JFMC/IBAJ and IIB/SIFMA
also commented that the SRS definition is an improvement over the FCS
concept previously proposed in the 2016 Proposal because the SRS
definition excludes those subsidiaries that are not significant to
their parent entities. Better Markets stated that the proposed SRS
definition does not address the avoidance and evasion risks addressed
by the conduit affiliate concept in the Guidance. IATP suggested that
the previously proposed FCS concept be retained in place of the SRS
definition. JBA stated that market participants have already assessed,
under the Guidance, whether their activities are subject to the swap
rules based on the attributes of their counterparties and requiring
them to re-assess will create significant burdens on market
participants. ISDA suggested that with respect to SRSs, entities should
be permitted to rely on counterparty representations pertaining to
conduit affiliates as described in the Guidance.
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\188\ Proposed Rule, 85 FR at 969-970.
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CS and IIB/SIFMA stated that the exclusion for subsidiaries of BHCs
in the SRS definition should be expanded to include those entities that
are subsidiaries of intermediate holding companies (``IHCs''). These
commenters noted that IHCs are subject to prudential regulation,
including Basel III capital requirements, stress testing, liquidity,
and risk management requirements.
JFMC/IBAJ and IIB/SIFMA suggested that accounting consolidation
does not create a sufficient jurisdictional nexus to the United States
because there is no requirement that the U.S. entity be directly liable
for the foreign subsidiary's swaps. These commenters stated that if the
SRS definition is nevertheless retained then the proposed significance
tests should also be retained. IIB/SIFMA and the Working Group stated
that the definition of ultimate U.S. parent entity should be limited to
those groups of entities where the top-tier ultimate parent company is
a U.S. person.
With respect to the exception in Sec. 23.23(a)(13)(i) for
subsidiaries of BHCs, AFR and Better Markets stated that the Commission
should eliminate this exception because deference to the prudential
regulators in this way is not justified. AFR noted the failure of
prudential supervision of banks to adequately address derivatives
markets risks prior to the 2008 financial crisis. IATP, AFR, and
Barnard stated that the broad exemptions would exclude almost all
foreign subsidiaries of U.S. companies and be a significant reduction
in the application of the Commission's swap regulations. Better Markets
stated that the Commission does not have the discretion to determine
whether and when to apply U.S. regulatory requirements based on
principles of international comity when there is a direct and
significant risk to U.S. BHCs and the U.S. financial system.
Better Markets suggested that if the SRS definition is retained
then there should be two additional significance tests added to those
in Sec. 23.23(a)(14). This commenter proposed that if an entity were
to meet a risk transfer test, measuring the notional amount of swaps
that are back-to-backed with U.S. entities, or a risk acceptance test,
measuring the trading activity of the subsidiary over a three month
time period, then the entity would be considered a significant
subsidiary.
The Working Group suggested that the proposed SRS definition should
be modified to limit the applicability to only those entities that
qualify as financial entities because the systemic risk associated with
non-financial entities is mitigated because their activities primarily
take place outside of the financial system. The Working Group agreed
with the Commission's proposal to exclude from the SRS definition those
entities that are subject to oversight by the non-U.S. person's home
country regulator and capital
[[Page 56943]]
standards consistent with Basel III. However, the commenter added that
to the extent a regulator has exempted a particular type of entity from
capital requirements otherwise consistent with Basel III, the CFTC
should defer to such exemption and consider such entity as subject to
comparable capital requirements.
3. Final Rule and Commission Response
The Commission is adopting the SRS definition as proposed, with two
modifications as discussed below. First, the Final Rule adds IHCs to
the exclusion in Sec. 23.23(a)(13)(i) for those companies that are
subject to consolidated supervision and regulation by the Federal
Reserve Board. Second, with respect to the carve-out in Sec.
23.23(a)(13)(ii), the Final Rule makes a clarifying revision to the
margin requirements aspect of that provision.
(i) Non-U.S. Persons With U.S. Parent Entities
As discussed in the Proposed Rule, in addition to the U.S. persons
described above in section II.B, the Commission understands that U.S.
persons may organize the operations of their businesses through the use
of one or more subsidiaries that are organized and operated outside the
United States.\189\ Through consolidation, non-U.S. subsidiaries of
U.S. persons may permit U.S. persons to accrue risk through the swap
activities of their non-U.S. subsidiaries. This risk, in the aggregate,
may have a significant effect on the U.S. financial system. Therefore,
the Commission may subject consolidated non-U.S. subsidiaries of U.S.
persons to Commission regulation due to their direct and significant
relationship to their U.S. parent entities. Further, consolidated non-
U.S. subsidiaries of U.S. parent entities present a greater supervisory
interest to the CFTC, relative to Other Non-U.S. Persons.\190\
Moreover, because U.S. persons have regulatory obligations under the
CEA that Other Non-U.S. Persons may not have, consolidated non-U.S.
subsidiaries of U.S. parent entities present a greater supervisory
interest to the CFTC relative to Other Non-U.S. Persons due to the
Commission's interest in preventing the evasion of obligations under
the CEA.
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\189\ Proposed Rule, 85 FR at 964.
\190\ This release uses the term ``Other Non-U.S. Person'' to
refer to a non-U.S. person that is neither a Guaranteed Entity nor
an SRS.
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Pursuant to the consolidation requirements of U.S. GAAP, the
financial statements of a U.S. parent entity reflect the financial
position and results of operations of that parent entity, together with
the network of branches and subsidiaries in which the U.S. parent
entity has a controlling interest, including non-U.S. subsidiaries,
which is an indication of connection and potential risk to the U.S.
parent entity. Consolidation under U.S. GAAP is predicated on the
financial control of the reporting entity. Therefore, an entity within
a financial group that is consolidated with its parent entity for
accounting purposes in accordance with U.S. GAAP is subject to the
financial control of that parent entity. By virtue of consolidation
then, a non-U.S. subsidiary's swap activity creates direct risk to the
U.S. parent.\191\ That is, as a result of consolidation and financial
control, the financial position, operating results, and statement of
cash flows of a non-U.S. subsidiary are included in the financial
statements of its U.S. parent and therefore affect the financial
condition, risk profile, and market value of the parent. Because of
that relationship, risks taken by a non-U.S. subsidiary can have a
direct effect on the U.S. parent entity. Furthermore, a non-U.S.
subsidiary's counterparties may generally look to both the subsidiary
and its U.S. parent for fulfillment of the subsidiary's obligations
under a swap, even without any explicit guarantee. In many cases,
counterparties would not enter into the transaction with the subsidiary
(or would not do so on the same terms), and the subsidiary would not be
able to engage in a swap business, absent this close relationship with
a parent entity. In addition, a non-U.S. subsidiary may enter into
offsetting swaps or other arrangements with its U.S. parent entity or
other affiliate(s) to transfer the risks and benefits of swaps with
non-U.S. persons to its U.S. affiliates, which could also lead to risk
for the U.S. parent entity. Because such swap activities may have a
direct effect on the financial position, risk profile, and market value
of a U.S. parent entity, they can lead to spill-over effects on the
U.S. financial system.
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\191\ Proposed Rule, 85 FR at 964.
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IIB/SIFMA and JFMC/IBAJ stated that there is no legal basis to
apply swap regulations based on accounting consolidation. The
Commission continues to believe, as it stated in its Cross-Border
Margin Rule, by virtue of an entity having its financial statements
consolidated with those of its U.S. ultimate parent, the financial
position, operating results, and statement of cash flows of the entity
are included in the financial statements of its U.S. ultimate parent
entity and therefore affect the financial position, risk profile, and
market value of the U.S. ultimate parent. Because of the entity's
direct relationship with, and the possible negative effect of its swap
activities on, its U.S. ultimate parent entity and the U.S. financial
system, the entity raises greater supervisory concern in the United
States relative to other non-U.S. swap entities.\192\ Accordingly, it
is appropriate to apply certain swap regulations to certain entities
that have financial statements consolidated with U.S. parent entities.
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\192\ See Cross-Border Margin Rule, 81 FR at 34827.
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However, the principles of international comity militate against
applying the Commission's swap regulations to all non-U.S. subsidiaries
of U.S. parent entities. Rather, it is consistent with such principles
to apply a risk-based approach to determining which of such entities
should be required to comply with the Commission's swap requirements.
The Commission's approach in the Final Rule, as discussed further below
with respect to the exclusion for subsidiaries of BHCs and IHCs, makes
that determination in a manner that accounts for the risk that non-U.S.
subsidiaries may pose to the U.S. financial system and the ability of
large global entities to operate efficiently outside the United States.
The Commission's risk-based approach is embodied in the definition of
an SRS, which, as discussed above, captures entities whose obligations
under swaps may not be guaranteed by U.S. persons, but nonetheless
raise particular supervisory concerns in the United States due to the
possible negative effect on their ultimate U.S. parent entities and
thus the U.S. financial system.
(ii) Preliminary Definitions
For purposes of the SRS definition, the term ``subsidiary'' means
an affiliate of a person controlled by such person directly, or
indirectly through one or more intermediaries.\193\ The definition of
``subsidiary'' has been revised in the Final Rule for clarity. For
purposes of this definition, an affiliate of, or a person affiliated
with, a specific person is a person that directly, or indirectly
through one or more intermediaries, controls, or is controlled by, or
is under common control with, the person specified.\194\ In the Final
Rule, the definition of ``affiliate'' has been moved out of the
definition of ``subsidiary'' and into its own definition for added
clarity, since the term ``affiliate'' is relevant for other provisions
of the Final Rule, as
[[Page 56944]]
discussed in this release. The term ``control,'' including controlling,
controlled by, and under common control with, means the possession,
direct or indirect, of the power to direct or cause the direction of
the management and policies of a person, whether through the ownership
of voting shares, by contract, or otherwise.\195\ The definition of
``control'' is also relevant to other provisions of the Final Rule, as
discussed in this release. The definitions of subsidiary, affiliate,
and control are substantially similar to the definitions found in SEC
Regulation S-X.\196\ Further, under the Final Rule, the term ``parent
entity'' means any entity in a consolidated group that has one or more
subsidiaries in which the entity has a controlling interest, in
accordance with U.S. GAAP.\197\ U.S. GAAP is defined in the Final Rule
as U.S. generally accepted accounting principles.\198\
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\193\ Final Sec. 23.23(a)(15).
\194\ Final Sec. 23.23(a)(1).
\195\ Final Sec. 23.23(a)(2).
\196\ See 17 CFR 210.1-02. Regulation S-X generally covers the
form and content requirements for financial statements.
\197\ Final Sec. 23.23(a)(12).
\198\ Final Sec. 23.23(a)(22).
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Notably, a U.S. parent entity for purposes of the definition of SRS
need not be a non-U.S. subsidiary's ultimate parent entity. The SRS
definition encompasses U.S. parent entities that may be intermediate
entities in a consolidated corporate family with an ultimate parent
entity located outside the U.S. To differentiate between multiple
possible U.S. parent entities, the Final Rule defines an ``ultimate
U.S. parent entity'' for purposes of the significant subsidiary test. A
non-U.S. person's ``ultimate U.S. parent entity'' is the U.S. parent
entity that is not a subsidiary of any other U.S. parent entity.\199\
Risk of a non-U.S. subsidiary that flows to its U.S. parent entity may
not flow back out of the U.S. to a non-U.S. ultimate or intermediate
parent entity. Because the risk may ultimately stop in the United
States, the Commission is basing the SRS definition on whether a non-
U.S. person has any U.S. parent entity, subject to certain risk-based
thresholds.
---------------------------------------------------------------------------
\199\ Final Sec. 23.23(a)(19).
---------------------------------------------------------------------------
IIB/SIFMA and the Working Group stated that the SRS definition
should be limited to subsidiaries that have a ``top-tier'' U.S. person
parent entity, rather than including subsidiaries that have a U.S.
parent entity that may not be the ultimate parent entity. The
Commission is including subsidiaries that have non-``top-tier'' U.S.
parent entities because the risk that the subsidiary poses may be
consolidated in the United States. The Final Rule treats all
subsidiaries of U.S. parent entities equally, regardless of where the
U.S. parent entity sits in the corporate structure.
(iii) Significant Risk Subsidiaries
In addition to the definitions discussed above, whether an entity
is an SRS depends on the size of its ultimate U.S. parent entity, the
significance of the subsidiary to its ultimate U.S. parent entity, and
the regulatory oversight of its ultimate U.S. parent entity or the
regulatory oversight of the non-U.S. subsidiary in the jurisdiction in
which it is regulated.
Under the Final Rule, the ultimate U.S. parent entity must exceed a
$50 billion consolidated asset threshold.\200\ The Commission is
adopting the $50 billion threshold after considering both the
Commission's interest in adequately overseeing those non-U.S. persons
that may have a significant effect on their ultimate U.S. parent
entity--and, by extension--the U.S. financial system, and also its
interest in avoiding unnecessary burdens on those non-U.S. persons that
would not have such an effect.\201\ The $50 billion threshold limits
the burden of the SRS definition to only those entities whose ultimate
U.S. parent entity may pose a systemic risk to the U.S. financial
system.
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\200\ Final Sec. 23.23(a)(13).
\201\ Proposed Rule, 85 FR at 965.
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In addition, before a non-U.S. subsidiary of an ultimate U.S.
parent entity that meets the $50 billion consolidated asset threshold
is an SRS, the subsidiary needs to constitute a significant part of its
ultimate U.S. parent entity. This concept of a ``significant
subsidiary'' borrows from the SEC's definition of ``significant
subsidiary'' in Regulation S-X, as well as the Federal Reserve Board in
its financial statement filing requirements for foreign subsidiaries of
U.S. banking organizations.\202\ The Commission is focusing on only
those subsidiaries that are significant to their ultimate U.S. parent
entities, in order to capture those subsidiaries that have a
significant effect on their large ultimate U.S. parent entities. To
provide certainty to market participants as to what constitutes a
significant subsidiary, the Final Rule includes a set of quantitative
significance tests. Although not identical, the SEC includes similar
revenue and asset significance tests in its definition of significant
subsidiary in Regulation S-X.\203\ In this case, in order to determine
whether a subsidiary meets such significance, the Final Rule measures
the significance of a subsidiary's equity capital, revenue, and assets
relative to its ultimate U.S. parent entity.
---------------------------------------------------------------------------
\202\ See e.g., Instructions for Preparation of Financial
Statements of Foreign Subsidiaries of U.S. Banking Organizations FR
2314 and FR 2314S, at GEN-2 (Sept. 2016), available at https://
www.federalreserve.gov/reportforms/forms/FR_2314_
FR_2314S20190331_i.pdf (``FR 2314 and FR 2314S Instructions'')
(identifying equity capital significance test applicable to
subsidiaries). See also SEC rule 210.1-02(w), 17 CFR 210.1-02(w)
(identifying asset and income significance tests applicable in
definition of significant subsidiaries).
\203\ 17 CFR 210.1-02(w)(1)-(3) (setting out a ten percent
significance threshold with respect to total assets and income).
---------------------------------------------------------------------------
Under the Final Rule, the term ``significant subsidiary'' means a
subsidiary, including its own subsidiaries, where: (1) The three year
rolling average of the subsidiary's equity capital is equal to or
greater than five percent of the three year rolling average of its
ultimate U.S. parent entity's consolidated equity capital, as
determined in accordance with U.S. GAAP at the end of the most recently
completed fiscal year (the ``equity capital significance test''); (2)
the three year rolling average of the subsidiary's revenue is equal to
or greater than ten percent of the three year rolling average of its
ultimate U.S. parent entity's consolidated revenue, as determined in
accordance with U.S. GAAP at the end of the most recently completed
fiscal year (the ``revenue significance test''); or (3) the three year
rolling average of the subsidiary's assets is equal to or greater than
ten percent of the three year rolling average of its ultimate U.S.
parent entity's consolidated assets, as determined in accordance with
U.S. GAAP at the end of the most recently completed fiscal year (the
``asset significance test'').\204\ For the equity capital significance
test, equity capital includes perpetual preferred stock, common stock,
capital surplus, retained earnings, accumulated other comprehensive
income, and other equity capital components and is calculated in
accordance with U.S. GAAP.
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\204\ Final Sec. 23.23(a)(14).
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The Final Rule results in an entity being a significant subsidiary
only if it passes at least one of these significance tests. The equity
capital test is used to measure a subsidiary's significance to its
ultimate U.S. parent entity and is used in the context of financial
statement reporting of foreign subsidiaries.\205\ If a subsidiary
constitutes more than ten percent of its ultimate U.S. parent entity's
assets or revenues, it is of significant importance to its ultimate
U.S. parent entity such that swap activity by the subsidiary may
[[Page 56945]]
have a material effect on its ultimate U.S. parent entity and,
consequently, the U.S. financial system. The Commission is using a
three year rolling average throughout its significance tests in order
to mitigate the potential for frequent changes in an entity's SRS
status based on fluctuations in its share of equity capital, revenue,
or assets of its ultimate U.S. parent entity. If a subsidiary satisfies
any one of the three significance tests, then it is of sufficient
significance to its ultimate U.S. parent entity, which under Sec.
23.23(a)(13) has consolidated assets of more than $50 billion, to
warrant the application of requirements addressed by the Final Rule if
such subsidiary otherwise meets the definition of SRS.
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\205\ See FR 2314 and FR 2314S Instructions, at Gen-2.
---------------------------------------------------------------------------
As noted above, Better Markets suggested that the Commission add
two activity-based tests to the proposed significant subsidiary
definition: A risk transfer test and a risk acceptance test. The
Commission declines to include these two tests because they do not
consider the risk to the broader financial system of the entities that
are potentially captured by the Final Rule. Better Markets' proposed
tests are activity-based, rather than risk-based, whereas the
Commission has determined to apply swap requirements to foreign
entities using a risk-based test. Better Markets' proposed tests would
set thresholds above which an entity would be deemed to be significant
subsidiaries, however these tests do not provide any measure that is
relative to the parent entity. Such notional-based thresholds may be a
measure of activity, but they are not a measure of risk that a
subsidiary poses to a parent entity.\206\ The significance tests
adopted here to identify SRSs include those entities that meet the
commenters' proposed tests to the extent those entities pose what the
Commission considers a significant risk to the financial system.
---------------------------------------------------------------------------
\206\ The Commission also has noted in the past that such
notional amount-based thresholds are not measures of the exposure or
risk of particular swap positions. See Entities Rule, 77 FR at
30630.
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(iv) Exclusions From the Definition of SRS
As indicated above, under the Final Rule, a non-U.S. person will
not be an SRS to the extent the entity is subject to prudential
regulation as a subsidiary of a U.S. BHC or IHC, or is subject to
comparable capital and margin standards.\207\ An entity that meets
either of those two exceptions, in the Commission's view, is subject to
a level of regulatory oversight that is sufficiently comparable to the
Dodd-Frank Act swap regime with respect to prudential oversight. Non-
U.S. subsidiaries that are part of BHCs are already subject to
consolidated supervision and regulation by the Federal Reserve
Board,\208\ including with respect to capital and risk management
requirements, and therefore their swap activity poses less risk to the
financial position and risk profile of the ultimate U.S. parent entity,
and thus less risk to the U.S. financial system than the swap activity
of a non-U.S. subsidiary of an ultimate U.S. parent entity that is not
a BHC.\209\ In this case, deference to the foreign regulatory regime is
appropriate because the swap activity is occurring within an
organization that is under the umbrella of U.S. prudential regulation
with certain regulatory protections already in place.
---------------------------------------------------------------------------
\207\ Final Sec. 23.23(a)(13)(i)-(ii).
\208\ See e.g., Board of Governors of the Federal Reserve
System, Bank Holding Company Supervision Manual, section 2100.0.1
Foreign Operations of U.S. Banking Organizations, available at
https://www.federalreserve.gov/publications/files/bhc.pdf (``The
Federal Reserve has broad discretionary powers to regulate the
foreign activities of member banks and [BHCs] so that, in financing
U.S. trade and investments abroad, these U.S. banking organizations
can be competitive with institutions of the host country without
compromising the safety and soundness of their U.S. operations.'');
FR 2314 and FR 2314S Instructions, at GEN 2.
\209\ Proposed Rule, 85 FR at 966.
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The exclusion from the SRS definition for subsidiaries of IHCs is
being added to the Final Rule in response to comments. IHCs are subject
to prudential standards of the Federal Reserve Board that are similar
to those that apply to BHCs. In general, IHCs and BHCs of similar size
are subject to similar liquidity, risk management, stress testing, and
credit limit standards.\210\ Therefore, for the same risk-based reasons
that the Commission proposed to exclude subsidiaries of BHCs from the
definition of SRS,\211\ the Commission is expanding the SRS exclusion
to include subsidiaries of both BHCs and IHCs in Sec. 23.23(a)(13)(i).
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\210\ See e.g., Prudential Standards for Large Bank Holding
Companies, Savings and Loan Holding Companies, and Foreign Banking
Organizations, 84 FR 59032 (Nov. 2019).
\211\ Proposed Rule, 85 FR at 966.
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In response to comments from AFR and Better Markets that the
Commission should not defer to the prudential regulators with respect
to the regulation of derivative market activity of BHCs and those
entities subject to the required non-U.S. capital and margin regimes,
under the Guidance, absent a guarantee, the Commission had generally
not expected these entities to count their swaps or swap positions with
non-US persons towards the SD or MSP thresholds or, if registered as
swap entities, comply with Transaction-Level Requirements (discussed in
section VI below) when transacting with non-U.S. persons that were not
guaranteed by a U.S. person nor acting as conduit affiliates. Thus, the
deference to U.S. and non-U.S. prudential regulators in the Final Rule
maintains the status quo of the last seven years rather than
representing a relinquishment of existing regulatory oversight by the
Commission. Moreover, the SRS definition does not defer to prudential
regulators to regulate derivatives market activity, which is carried on
by the foreign subsidiary, but rather defers to the role of prudential
regulation in the consolidated oversight of prudential risk in
evaluating the extent to which the Commission should expand its
oversight of non-U.S. entities that are not guaranteed by a U.S. person
beyond the Guidance. For the reasons noted above, the Commission has
determined not to apply the Final Rule on the basis of accounting
consolidation alone, but rather, in exercising its oversight of non-
U.S. entities, has taken a risk-based approach to determining which
foreign subsidiaries present a significant risk to their ultimate U.S.
parent and thus to the U.S. financial system. The Commission thus has
determined that because the risk presented by foreign subsidiaries that
are consolidated with a BHC or IHC, or are subject to the specified
prudential regulation in their local jurisdiction, is already being
adequately monitored, such foreign subsidiaries should not also be
subject to the Commission's oversight.
With respect to the BHC exception, Better Markets suggested that
the Commission does not have the legal discretion to defer to
prudential regulators because of the requirements in CEA section 2(i).
As the Commission stated in the Proposed Rule, CEA section 2(i) does
not require the Commission to extend its reach to the outer bounds of
the authorization provided in CEA section 2(i).\212\ In determining how
to exercise its authority, the Commission stated that it will be guided
by principles of international comity and will focus its authority on
potential significant risks to the U.S. financial system. The
Commission noted that the Restatement also provides that even where a
country has a basis for extraterritorial jurisdiction, it should not
prescribe law with respect to a person or activity in another country
when the exercise of
[[Page 56946]]
such jurisdiction is unreasonable.\213\ In the context of the SRS
definition, the risk-based approach to limiting the application of the
Commission's requirements extraterritorially focuses its requirements
on those entities that pose significant risk to the U.S. financial
system, as discussed above.
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\212\ Id. at 955.
\213\ Id. at 957.
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Similarly, in the case of entities that are subject to capital
standards and oversight by their home country regulators that are
consistent with Basel III and subject to a CFTC Margin Determination,
the Commission will defer to the home country regulator.\214\ In cases
where entities are subject to capital standards and oversight by home
country regulators that are consistent with Basel III and subject to a
CFTC Margin Determination, the potential risk that the entity might
pose to the U.S. financial system is adequately addressed through these
home country capital and margin requirements. Further, such an approach
is consistent with the Commission's historical commitment to show
deference to non-U.S. regulators whose requirements are comparable to
the CFTC's requirements. To make clear that the CFTC Margin
Determination must be a positive determination of comparability, the
provision in Sec. 23.23(a)(13)(ii) has been modified to read ``and
margin requirements for uncleared swaps in a jurisdiction that the
Commission has found comparable pursuant to a published comparability
determination with respect to uncleared swap margin requirements.'' For
margin purposes, the Commission has issued a number of determinations
that entities can look to in order to determine if they satisfy this
aspect of the exception.\215\ For capital standards and oversight
consistent with Basel III, entities should look to whether the BIS has
determined the jurisdiction is in compliance as of the relevant Basel
Committee on Banking Supervision deadline set forth in its most recent
progress report.\216\ The Commission is excluding these entities from
the definition of SRS, in large part, because the swaps entered into by
such entities are already subject to significant regulation, either by
the Federal Reserve Board or by the entity's home country.
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\214\ Final Sec. 23.23(a)(13)(ii).
\215\ See Comparability Determination for Japan: Margin
Requirements for Uncleared Swaps for Swap Dealers and Major Swap
Participants, 81 FR 63376 (Sep. 15, 2016); Comparability
Determination for the European Union: Margin Requirements for
Uncleared Swaps for Swap Dealers and Major Swap Participants, 82 FR
48394 (Oct. 13, 2017) (``Margin Comparability Determination for the
European Union''); Amendment to Comparability Determination for
Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and
Major Swap Participants, 84 FR 12074 (Apr. 1, 2019); Comparability
Determination for Australia: Margin Requirements for Uncleared Swaps
for Swap Dealers and Major Swap Participants, 84 FR 12908 (Apr. 3,
2019). Further, on April 5, 2019, DSIO and the Division of Market
Oversight (``DMO'') issued a letter jointly to provide time-limited
no-action relief in connection with, among other things, the Margin
Comparability Determination for the European Union, in order to
account for the anticipated withdrawal of the United Kingdom from
the European Union. See CFTC Staff Letter 19-08, No-Action Relief in
Connection With Certain Previously Granted Commission Determinations
and Exemptions, in Order to Account for the Anticipated Withdrawal
of the United Kingdom From the European Union (Apr. 5, 2019),
available at https://www.cftc.gov/csl/19-08/download.
\216\ The most current report was issued in July 2020. Basel
Committee on Banking Supervision, Eighteenth progress report on
adoption of the Basel regulatory framework (July 2020), available at
https://www.bis.org/bcbs/publ/d506.pdf. Current and historical
reports are available at https://www.bis.org/bcbs/implementation/rcap_reports.htm?m=3%7C14%7C656%7C59.
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The Working Group suggested that where a jurisdiction has capital
and margin requirements consistent with Basel III requirements, but
certain entities located in that jurisdiction are exempted from those
requirements, such entities should nonetheless be considered as subject
to sufficient capital and margin requirements for the purpose of the
proposed SRS exclusion. The Commission is declining to adopt this
suggestion here, but it may warrant further consideration in the
future. It is not clear whether a foreign jurisdiction's exemption from
capital and margin requirements would be based on a risk assessment of
the exempted entities, whether such exemptions are granted on a case-
by-case basis or provided to entire classes or categories, or whether
such exemptions are based on deference to some other form of prudential
regulation. Under the Final Rule, where an entity is exempt from a
country's capital and margin requirements, such an entity will not be
considered to be subject to sufficient capital and margin requirements
for the purpose of the SRS exclusion. As noted above, if a non-U.S.
subsidiary of an ultimate U.S. parent entity does not fall into either
of the exceptions in Sec. 23.23(a)(13)(i) through (ii), the Final Rule
classifies the subsidiary as a SRS only if its ultimate U.S. parent
entity has more than $50 billion in global consolidated assets and if
the subsidiary meets the definition of a significant subsidiary, set
forth in Sec. 23.23(a)(14).
With respect to the Working Group comment that the SRS definition
should not apply to non-financial entities, the Commission has
determined to apply the SRS definition to those non-financial entities
that satisfy the risk-based tests contained in the definition. Those
entities are not subject to prudential regulation and are, by
definition, significant subsidiaries of large U.S. parent entities that
may pose a risk to the U.S. financial system, and therefore the
Commission believes that such entities should not be excluded from the
SRS definition. Accordingly, the Commission is not adding an exception
for non-financial entities to the SRS definition. However, Other Non-
U.S. Person counterparties to SRSs are not required to include such
swaps in either their SD or MSP registration threshold calculations, as
discussed below. The Commission has also determined for the Final Rule
that non-U.S. swap entities that are neither SRSs nor Guaranteed
Entities are not required to comply with the group B and group C
requirements (as defined in section VI.A.2 and VI.A.3 below) when
entering into foreign-based swaps with certain foreign counterparties,
including SRSs that are neither swap entities nor Guaranteed Entities
(``SRS End Users'').\217\ This application of the Final Rule should
assuage the commenter's concerns about the effect SRS status will have
on the swap trading relationships of a non-financial entity that is an
SRS but does not engage in swap dealing or meet the definition of MSP.
---------------------------------------------------------------------------
\217\ See infra section VI.B.
---------------------------------------------------------------------------
In response to Better Markets' comment that the SRS definition does
not address evasion and avoidance concerns that are addressed by the
conduit affiliate concept, the Commission believes that the SRS
definition adequately addresses those concerns within a risk-based
framework. The Commission believes that to the extent an off-shore
entity is entering into transactions with non-U.S. entities and
subsequently back-to-backing those transactions to a U.S. entity, it is
appropriate to subject such an entity to certain of the Commission's
swap requirements if that entity meets the definition of an SRS and is
consequently a significant subsidiary of a U.S. parent entity that is
significant to the U.S. financial system. This approach is a risk-based
assessment rather than merely a structural or activity-based
assessment. Without this risk-based approach, the SD de minimis
threshold, which is a strictly activity-based test (i.e., a test based
on the aggregate gross notional amount of dealing activity), becomes
the de facto risk test of when an entity would be subject to the
Commission's swap requirements as an SD. The Commission continues to
believe that the risk-based SRS test is better-suited to make such a
determination.
[[Page 56947]]
(v) Counterparty Status and Representations
The Commission acknowledges comments that the implementation of the
SRS definition may require entities to reevaluate the status of their
counterparties. The Commission understands that SDs may have to re-
document whether their counterparties are SRS entities and that this
could require, for example, a new industry protocol, which may be an
additional burden resulting from the adoption of this rule. The
potential burden of this re-assessment of counterparties is considered
in the cost-benefit considerations section of this adopting release.
Regarding the ISDA comment that the Commission should permit swap
entities to rely on representations obtained under the Guidance with
respect to the status of counterparties as conduit affiliates, the
Commission responds that the representations made by counterparties
with respect to the conduit affiliate concept in the Guidance are not
applicable to the SRS definition. Because the definition of an SRS is
new and substantially differs from the conduit affiliate concept, such
conduit affiliate representations do not capture all counterparties
that may be SRSs and may capture entities that fall within the conduit
affiliate concept but are excluded from the definition of SRS.
E. Foreign Branch and Swap Conducted Through a Foreign Branch
1. Proposed Rule
The Commission proposed that the term ``foreign branch'' would mean
an office of a U.S. person that is a bank that: (1) Is located outside
the United States; (2) operates for valid business reasons; (3)
maintains accounts independently of the home office and of the accounts
of other foreign branches, with the profit or loss accrued at each
branch determined as a separate item for each foreign branch; and (4)
is engaged in the business of banking or finance and is subject to
substantive regulation in banking or financing in the jurisdiction
where it is located.\218\
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\218\ Proposed Sec. 23.23(a)(2). See Proposed Rule, 85 FR at
966-968.
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The Commission also proposed that the term ``swap conducted through
a foreign branch'' would mean a swap entered into by a foreign branch
where: (1) The foreign branch or another foreign branch is the office
through which the U.S. person makes and receives payments and
deliveries under the swap pursuant to a master netting or similar
trading agreement, and the documentation of the swap specifies that the
office for the U.S. person is such foreign branch; (2) the swap is
entered into by such foreign branch in its normal course of business;
and (3) the swap is reflected in the local accounts of the foreign
branch.\219\ In the Proposed Rule, the Commission stated that the
second prong of the definition (whether the swap is entered into by
such foreign branch in the normal course of business) is intended as an
anti-evasion measure to prevent a U.S. bank from simply routing swaps
for booking in a foreign branch so that the swap would be treated as a
swap conducted through a foreign branch for purposes of the SD and MSP
registration thresholds or for purposes of certain regulatory
requirements applicable to registered SDs or MSPs. To satisfy this
prong, the Commission proposed that it must be the normal course of
business for employees located in the branch (or another foreign branch
of the U.S. bank) to enter into the type of swap in question. The
Commission stated that this requirement would not prevent personnel of
the U.S. bank located in the U.S. from participating in the negotiation
or execution of the swap so long as the swaps that are booked in the
foreign branch are primarily entered into by personnel located in the
branch (or another foreign branch of the U.S. bank).\220\
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\219\ Proposed Sec. 23.23(a)(16). See Proposed Rule, 85 FR at
966-968.
\220\ See Proposed Rule, 85 FR at 968.
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2. Summary of Comments
While IIB/SIFMA and JFMC/IBAJ supported the proposed definition of
``foreign branch,'' noting that it was consistent with the definition
given to the term in the Guidance, Better Markets recommended that the
definition include a requirement that the foreign branch be operated
pursuant to U.S. banking laws and regulations and in compliance with
applicable restrictions. Better Markets stated that the addition of
this prong adds no additional burden and ensures a foreign branch
cannot be established outside of the considered restrictions and
substantive requirements of U.S. law.
With respect to the proposed definition of a ``swap conducted
through a foreign branch,'' Better Markets recommended that the
Commission require that the swap be arranged, negotiated, and executed
on behalf of the foreign branch solely by persons located outside the
United States, rather than permit personnel of the U.S. bank located in
the U.S. to participate in the negotiation or execution of a swap so
long as the swaps that are booked in the foreign branch are primarily
entered into by personnel located in the branch (or another foreign
branch of the U.S. bank). Better Markets believes that this formulation
defers too significantly to the foreign branches themselves to decide
whether the ``primarily'' restriction has been met, and, instead
recommends that the Commission adopt a foreign branch booking
restriction that harmonizes with the SEC's approach. Better Markets
argues that such restriction is necessary because foreign branches
remain part of the U.S. person in the most critical, risk-related
respects.
IIB/SIFMA and JFMC/IBAJ, on the other hand, supported the proposed
definition, noting that a requirement that the personnel agreeing to a
swap be located in the foreign branch is not necessary because the
location of a U.S. bank's employees in connection with a particular
swap does not determine whether that swap presents risks to the United
States. IIB/SIFMA further argued that because foreign branches of a
U.S. bank are generally subject to foreign rules when transacting with
non-U.S. counterparties regardless of whether the bank's U.S. personnel
are involved, applying additional U.S. rules to swaps with non-U.S.
counterparties based on the involvement of U.S. personnel causes market
distortions by discouraging non-U.S. counterparties from interacting
with U.S. personnel. IIB/SIFMA stated further that since 2013 many U.S.
banks have had to rearrange their front office coverage of non-U.S.
counterparties in order to address this concern and adoption of the
proposed definition would help to reverse this damaging trend.
3. Final Rule and Commission Response
Having considered the foregoing comments, the Commission has
determined to adopt the definitions of ``foreign branch'' and ``swap
conducted through a foreign branch'' as proposed.\221\ Regarding Better
Markets' recommendation that a fifth prong be added to the definition
of ``foreign branch'' to more closely align the definition with the
definitions used by the prudential regulators, as noted below, the
definition of ``foreign branch'' proposed by the Commission is
consistent with the definitions of ``foreign branch'' in the
regulations of the Federal Reserve Board, the Office of the Comptroller
of the Currency
[[Page 56948]]
(``OCC''), and the Federal Deposit Insurance Corporation
(``FDIC'').\222\
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\221\ Final Sec. 23.23(a)(2) and (16).
\222\ See infra notes 226- 228, and accompanying text.
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Regarding Better Markets' comment that a foreign branch should be
treated as a U.S. person unless the employees negotiating and agreeing
to the terms of the swap are exclusively located in a foreign branch,
the Commission responds that such a prescriptive limitation is not
required to prevent evasion of the Commission's swap requirements
through booking strategies. By requiring swaps to be entered into by a
foreign branch in its normal course of business, primarily by personnel
located in the foreign branch, the definition proposed by the
Commission provides a workable standard of review that will permit the
Commission to detect evasive booking strategies while not discouraging
non-U.S. counterparties from interacting with U.S. personnel.
The Commission is adopting the factors listed in the proposed
definition of ``foreign branch'' for determining when an entity is
considered a foreign branch for purposes of the Final Rule.\223\ The
requirement that the foreign branch be located outside of the United
States is consistent with the stated goal of identifying certain swap
activity that is not conducted within the United States. The
requirements that the foreign branch maintain accounts independent of
the U.S. entity,\224\ operate for valid business reasons, and be
engaged in the business of banking or finance and be subject to
substantive banking or financing regulation in its non-U.S.
jurisdiction will prevent an entity from setting up shell operations
outside the United States in a jurisdiction without substantive banking
or financial regulation in order to evade Dodd-Frank Act requirements
and CFTC regulations.\225\ This definition incorporates concepts from
the Federal Reserve Board's Regulation K,\226\ the FDIC's international
banking regulation,\227\ and the OCC's ``foreign branch''
definition.\228\
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\223\ As discussed in sections III.B.2 and IV.B.2, infra, the
Final Rule does not require an Other Non-U.S. Person to count toward
its SD and MSP threshold calculations swaps conducted through a
foreign branch of a registered U.S. SD.
\224\ The Commission notes that national banks operating foreign
branches are required under section 25 of the Federal Reserve Act
(``FRA'') to conduct the accounts of each foreign branch
independently of the accounts of other foreign branches established
by it and of its home office, and are required at the end of each
fiscal period to transfer to their general ledgers the profit or
loss accrued at each branch as a separate item. 12 U.S.C. 604. The
FRA is codified at 12 U.S.C. 221 et seq.
\225\ As discussed below, the Commission is concerned that the
material terms of a swap would be negotiated or agreed to by
employees of the U.S. bank that are located in the United States and
then be routed to a foreign branch so that the swap would be treated
as a swap with the foreign branch for purposes of the SD and MSP
registration thresholds or for purposes of certain regulatory
requirements applicable to registered SDs or MSPs.
\226\ Regulation K is a regulation issued by the Federal Reserve
Board under the authority of the FRA; the Bank Holding Company Act
of 1956 (``BHC Act'') (12 U.S.C. 1841 et seq.); and the
International Banking Act of 1978 (``IBA'') (12 U.S.C. 3101 et
seq.). Regulation K sets forth rules governing the international and
foreign activities of U.S. banking organizations, including
procedures for establishing foreign branches to engage in
international banking. 12 CFR part 211. Under Regulation K, a
``foreign branch'' is defined as ``an office of an organization
(other than a representative office) that is located outside the
country in which the organization is legally established and at
which a banking or financing business is conducted.'' 12 CFR
211.2(k).
\227\ 12 CFR part 347 is a regulation issued by the FDIC under
the authority of the Federal Deposit Insurance Act (12 U.S.C.
1828(d)(2)), which sets forth rules governing the operation of
foreign branches of insured state nonmember banks. Under 12 CFR
347.102(j), a ``foreign branch'' is defined as an office or place of
business located outside the United States, its territories, Puerto
Rico, Guam, American Samoa, the Trust Territory of the Pacific
Islands, or the Virgin Islands, at which banking operations are
conducted, but does not include a representative office.
\228\ 12 CFR 28.2 (defining ``foreign branch'' as an office of a
national bank (other than a representative office) that is located
outside the United States at which banking or financing business is
conducted).
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The definition of ``foreign branch'' in the Final Rule is also
consistent with the SEC's approach, which, for purposes of security-
based swap dealer regulation, defines a foreign branch as any branch of
a U.S. bank that: (1) Is located outside the United States; (2)
operates for valid business reasons; and (3) is engaged in the business
of banking and is subject to substantive banking regulation in the
jurisdiction where located.\229\ The Commission's intention is to
ensure that the definition provides sufficient clarity as to what
constitutes a ``foreign branch''--specifically, an office outside of
the U.S. that has independent accounts from the home office and other
branches--while striving for greater regulatory harmony with the SEC.
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\229\ See 17 CFR 240.3a71-3(a)(2).
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A foreign branch does not include an affiliate of a U.S. bank that
is incorporated or organized as a separate legal entity.\230\ For
similar reasons, the Commission declines in the Final Rule to recognize
foreign branches of U.S. persons separately from their U.S. principal
for purposes of registration.\231\ That is, if the foreign branch
engages in swap activity in excess of the relevant SD or MSP
registration thresholds, as discussed further below, the U.S. person
would be required to register, and the registration would encompass the
foreign branch. However, upon consideration of principles of
international comity and the factors set forth in the Restatement,
rather than broadly excluding foreign branches from the ``U.S. person''
definition, the Commission is calibrating the requirements for counting
certain swaps entered into through a foreign branch, as described in
sections III.B.2 and IV.B.2, and calibrating the requirements otherwise
applicable to foreign branches of a registered U.S. SD, as discussed in
section VI. One of the benefits, as discussed below, will be to enable
foreign branches of U.S. banks to have greater access to foreign
markets.
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\230\ This is similar to the approach described in the Guidance.
See Guidance, 78 FR at 45328-45329.
\231\ This is similar to the approach described in the Guidance.
See id. at 45315, 45328-45329.
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The definition of ``swap conducted through a foreign branch''
identifies the type of swap activity for which the foreign branch
performs key dealing functions outside the United States. Because a
foreign branch of a U.S. bank is not a separate legal entity, the first
prong of the definition clarifies that the foreign branch must be the
office of the U.S. bank through which payments and deliveries under the
swap are made. This approach is consistent with the standard ISDA
Master Agreement, which requires that each party specify an ``office''
for each swap, which is generally where a party ``books'' a swap and/or
the office through which the party makes and receives payments and
deliveries.\232\
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\232\ The ISDA Master Agreement defines ``office'' as a branch
or office of a party, which may be such party's head or home office.
See 2002 ISDA Master Agreement, available at https://www.isda.org/book/2002-isda-master-agreement-english/library.
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The second prong of the definition (whether the swap is entered
into by such foreign branch in the normal course of business) is
intended as an anti-evasion measure to prevent a U.S. bank from simply
routing swaps for booking in a foreign branch so that the swap would be
treated as a swap conducted through a foreign branch for purposes of
the SD and MSP registration thresholds or for purposes of certain
regulatory requirements applicable to registered SDs or MSPs. To
satisfy this prong, it must be the normal course of business for
employees located in the branch (or another foreign branch of the U.S.
bank) to enter into the type of swap in question. This requirement
should not prevent personnel of the U.S. bank located in the U.S. from
participating in the negotiation or execution of the swap so long as
the swaps that are booked in the foreign branch are primarily entered
into by personnel located in the branch (or another foreign branch of
the U.S. bank). As noted above, the Commission
[[Page 56949]]
believes this is a workable standard of review that will permit the
Commission to detect evasive booking strategies by examining the types
of swaps booked in the foreign branch and determining whether any type
of swap is primarily entered into by personnel located in the United
States.
With respect to the third prong, where a swap is with the foreign
branch of a U.S. bank, it generally would be reflected in the foreign
branch's accounts.
F. Swap Entity, U.S. Swap Entity, and Non-U.S. Swap Entity
The Commission proposed that the term ``swap entity'' would mean a
person that is registered with the Commission as a SD or MSP pursuant
to the CEA.\233\ In addition, the Commission proposed to define ``U.S.
swap entity'' as a swap entity that is a U.S. person, and ``non-U.S.
swap entity'' as a swap entity that is not a U.S swap entity.\234\
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\233\ See Proposed Sec. 23.23(a)(15); Proposed Rule, 85 FR at
968, 1003.
\234\ See Proposed Sec. 23.23(a)(10) and (23); Proposed Rule,
85 FR at 968, 1003.
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The Commission did not receive any comments on these proposed
definitions, and is adopting them as proposed.\235\
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\235\ Final Sec. 23.23(a)(11), (18), and (24).
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G. U.S. Branch
The Commission proposed that the term ``U.S. branch'' would mean a
branch or agency of a non-U.S. banking organization where such branch
or agency: (1) Is located in the United States; (2) maintains accounts
independently of the home office and other U.S. branches, with the
profit or loss accrued at each branch determined as a separate item for
each U.S. branch; and (3) engages in the business of banking and is
subject to substantive banking regulation in the state or district
where located.\236\
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\236\ See Proposed Sec. 23.23(a)(20); Proposed Rule, 85 FR at
968, 1003.
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The only comment the Commission received on this definition was
from JFMC/IBAJ, stating that they generally supported the proposed new
definition, as they believe it provides a clear and objective standard
and provides market participants with legal certainty. Thus, the
Commission is adopting the definition of ``U.S. branch'' as
proposed.\237\
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\237\ Final Sec. 23.23(a)(21).
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H. Swap Conducted Through a U.S. Branch
1. Proposed Rule
The Commission proposed that the term ``swap conducted through a
U.S. branch'' would mean a swap entered into by a U.S. branch where:
(1) The U.S. branch is the office through which the non-U.S. person
makes and receives payments and deliveries under the swap pursuant to a
master netting or similar trading agreement, and the documentation of
the swap specifies that the office for the non-U.S. person is such U.S.
branch; or (2) the swap is reflected in the local accounts of the U.S.
branch.\238\
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\238\ See Proposed Sec. 23.23(a)(17); Proposed Rule, 85 FR at
968, 1003.
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2. Summary of Comments
The same as for the definition of ``U.S. branch'' above, JFMC/IBAJ
generally supported the proposed definition of ``swap conducted through
a U.S. branch,'' as they believe it provides a clear and objective
standard and provides market participants with legal certainty.
However, JFMC/IBAJ, CS, and IIB/SIFMA asked the Commission to conform
the definition to the definition of ``swap conducted through a foreign
branch'' by (1) including a ``normal course of business'' prong, and
(2) applying the definition conjunctively rather than disjunctively.
JFMC/IBAJ stated that they see no policy rationale or countervailing
policy benefit of these inconsistencies. CS agreed, stating that, as a
matter of policy, it encourages the CFTC to provide consistent
flexibility for U.S. branches and foreign branches. IIB/SIFMA stated
that, in accordance with principles of international comity, the
Commission should instead take a balanced and symmetric approach to
recognizing when home versus host country regulators have an interest
in applying their rules and that the Proposed Rule offers no
justification for this asymmetric approach. ISDA also requested that
the Commission apply the definition conjunctively, stating that only
when a swap is booked at a particular entity can it be considered a
swap transaction that is attributed to such an entity.
3. Final Rule--Swap Booked in a U.S. Branch
After carefully considering the comments, the Commission is
adopting the definition with certain modifications reflected in the
rule text in this release.\239\ The Commission is removing the first
prong of the definition such that the only relevant factor is whether
the swap is reflected in the local accounts of the U.S. branch, meaning
swaps for which the U.S. branch holds the risks and rewards, with the
swap being accounted for as an obligation of the branch on the balance
sheet of the U.S. branch under applicable accounting standards \240\
and under regulatory reporting requirements \241\ (i.e., the swap is
``booked'' in the U.S. branch). This standard captures activity of non-
U.S. banking organizations taking place in their U.S. branches that
should be treated as taking place in the United States to prevent
evasion of CFTC rules by such organizations. As discussed in the
Proposed Rule, in the case of the swap activities of the U.S. branches
of non-U.S. banking organizations, the Commission has determined that
the location of personnel involved in arranging, negotiating, and
execution activities will not be relevant for application of the Final
Rule.\242\ For this reason, the Commission had intended in the Proposed
Rule only to reach swaps that are booked in the United States under the
definition of ``swap conducted through a U.S. branch.''
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\239\ Final Sec. 23.23(a)(16).
\240\ Or would be accounted for on its balance sheet under
applicable accounting standards if the U.S. branch were a separate
legal entity.
\241\ For example, the swap is included in the non-U.S. person's
Report of Assets and Liabilities of U.S. Branches and Agencies of
Foreign Banks published by the Federal Financial Institution
Examinations Council (FFIEC 002).
\242\ See infra section V; Proposed Rule, 85 FR at 978.
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The Commission now understands that a U.S. branch may be listed as
the office through which a non-U.S. person makes and receives
deliveries under a swap or as the office identified in the master,
netting, or similar trading agreement without the swap being booked in
a U.S. branch. Commenters explained, for example, that the U.S. branch
is often listed for payments and deliveries for swaps denominated in
U.S. Dollars even where the risk/benefit of the swap resides outside
the United States.
Further, to emphasize that booking is the focus of the definition,
the Commission is changing the term from ``swap conducted through a
U.S. branch'' to ``swap booked in a U.S. branch'' (and, accordingly,
revising the definitions of ``foreign-based swap'' and ``foreign
counterparty'' below to reflect this change in terminology).
In response to comments objecting to the differences in the
proposed definitions of ``swap conducted through a foreign branch'' and
``swap conducted through a U.S. branch,'' the Commission
[[Page 56950]]
is retaining these differences because, as a general matter, U.S. swap
entities should be subject to all of the Commission's Title VII
requirements set forth in the Final Rule. Because classifying a swap as
a ``swap conducted through a foreign branch'' makes a U.S. swap entity
eligible for certain exceptions from these requirements and substituted
compliance for the swap under the Final Rule, merely booking a swap in
the foreign branch is not sufficient for a U.S. swap entity to qualify
for these exceptions and substituted compliance. Rather, the U.S. swap
entity is required also to show that the swap is a transaction of a
type that is endemic to the foreign market (i.e., that it is a type of
transaction entered into by personnel in the foreign branch in the
normal course of the business of the branch, rather than a transaction
more normally entered into in a different location and merely booked in
the foreign branch to evade CFTC regulatory requirements). Hence, as
discussed above, the Commission is including a ``normal course of
business'' prong in the definition of ``a swap conducted through a
foreign branch'' and requiring that all three prongs of the definition
be satisfied.
As noted in the Proposed Rule and consistent with the Commission's
approach to foreign branches, a U.S. branch of a non-U.S. banking
organization does not include a U.S. affiliate of the organization that
is incorporated or organized as a separate legal entity. Also
consistent with this approach, the Commission declines in the Final
Rule to recognize U.S. branches of non-U.S. banking organization
separately from their non-U.S. principal for purposes of registration.
I. Foreign-Based Swap and Foreign Counterparty
1. Proposed Rule
The Commission proposed that the term ``foreign-based swap'' would
mean: (1) A swap by a non-U.S. swap entity, except for a swap conducted
through a U.S. branch; or (2) a swap conducted through a foreign
branch.\243\ Further, the term ``foreign counterparty'' would mean: (1)
A non-U.S. person, except with respect to a swap conducted through a
U.S. branch of that non-U.S. person; or (2) a foreign branch where it
enters into a swap in a manner that satisfies the definition of a swap
conducted through a foreign branch.\244\ Under the Proposed Rule,
together with the proposed defined terms ``foreign branch,'' ``swap
conducted through a foreign branch,'' ``U.S. branch,'' and ``swap
conducted through a U.S. branch,'' these terms were to be used to
determine which swaps would be foreign swaps of non-U.S. swap entities
and foreign branches of U.S. swap entities, for which certain relief
from Commission requirements would be available under the Proposed
Rule, and which swaps would be treated as domestic swaps not eligible
for such relief.
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\243\ See Proposed Sec. 23.23(a)(4); Proposed Rule, 85 FR at
968-969, 1002.
\244\ Id.
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2. Summary of Comments
AIMA was supportive of the definition of ``foreign counterparty''
and, in particular, its application to CIVs. However, JFMC/IBAJ
requested that the Commission expand the definition of ``foreign-based
swap'' and ``foreign counterparty'' under the proposed exceptions from
the group B and C requirements (described in sections VI.A.2 and VI.A.3
below) to cover swaps conducted through the U.S. branch of a non-U.S.
swap entity. JFMC/IBAJ stated that these are swap trades between two
non-U.S. persons and thus should be governed by the home country
regulation of the non-U.S. persons according to principles of
international comity, and that there is no material importation of risk
to the U.S. financial system and hence a lack of sufficient
jurisdictional nexus for purposes of CEA section 2(i). JBA similarly
requested that, generally, swap requirements not apply to U.S. branches
in a different manner than the related non-U.S person.
3. Final Rule
After carefully considering the comments, the Commission is
adopting the definitions of ``foreign-based swap'' and ``foreign
counterparty'' as proposed, with a minor technical modification
included in the rule text in this release.\245\ Specifically, to
reflect that the term ``swap conducted through a U.S. branch'' is being
replaced with the term ``swap booked in a U.S. branch,'' each of the
definitions of ``foreign-based swap'' and ``foreign counterparty'' is
being revised to replace the term ``swap conducted through a U.S.
branch'' with the term ``swap booked in a U.S. branch.''
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\245\ Final Sec. 23.23(a)(4) and (5).
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When a swap is booked in a U.S. branch of a non-U.S. swap entity,
that swap is part of the U.S. swap market, and, accordingly, the group
B and group C requirements (described in sections VI.A.2 and VI.A.3
below) should generally apply.\246\ Therefore, the Commission has
determined to carve out a swap booked in a U.S. branch from the
definitions of ``foreign-based swap'' and ``foreign counterparty.''
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\246\ The Commission notes that swap activities of the U.S.
branches of non-U.S. banking organizations take place inside the
United States and, thus, section 2(i)'s applicability (i.e., to
activities ``outside the U.S.'') is not implicated. Nevertheless, as
discussed in sections VI.B and VI.C, infra, the Commission has
determined under the Final Rule to provide certain exceptions from
application of the group C requirements and the availability of
substituted compliance for the group B requirements for certain
swaps booked in the U.S. branches of non-U.S. swap entities.
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As discussed in the Proposed Rule, the Commission is using the
terms ``foreign-based swap'' and ``foreign counterparty'' to identify
the types of swaps that are eligible for certain relief, consistent
with section 2(i) of the CEA, in order that swaps that demonstrate
sufficient indicia of being domestic generally remain subject to the
Commission's requirements under the Final Rule, notwithstanding that
the swap is entered into by a non-U.S. swap entity or a foreign branch
of a U.S. swap entity. Otherwise, an entity or branch might simply be
established outside of the United States to evade Dodd-Frank Act
requirements and CFTC regulations.
As the Commission has previously stated, it has a strong
supervisory interest in regulating swap activities that occur in the
United States.\247\ However, consistent with section 2(i) of the CEA,
foreign swaps of non-U.S. swap entities and foreign branches of U.S.
swap entities should be eligible for relief from certain of the
Commission's requirements. Accordingly, certain exceptions from the
group B and group C requirements and portions of the Commission's
substituted compliance regime (discussed below in sections VI.B and
VI.C), are designed to apply only to certain foreign swaps of non-U.S.
swap entities and foreign branches of U.S. swap entities that the
Commission believes should be treated as occurring outside the United
States. Specifically, these provisions are applicable only to a swap by
a non-U.S. swap entity--except for a swap booked in a U.S. branch--and
a swap conducted through a foreign branch such that it satisfies the
definition of a ``foreign-based swap'' above. They are generally not
applicable to swaps of non-U.S. swap entities that are booked in a U.S.
branch of that swap entity, and swaps of foreign branches of U.S. swap
entities where the foreign branch does not enter into the swaps in a
manner that satisfies the definition of a swap conducted through a
foreign branch, because the
[[Page 56951]]
entrance into a swap by a U.S. swap entity (through its foreign branch)
or a U.S. branch of a non-U.S. swap entity under these circumstances,
demonstrates sufficient indicia of being a domestic swap to be treated
as such for purposes of the Final Rule. Similarly, in certain cases,
the availability of an exception or substituted compliance for a swap
depends on whether the counterparty to such a swap qualifies as a
``foreign counterparty'' under the Final Rule. The Commission is
establishing this requirement to ensure that foreign-based swaps of
swap entities in which their counterparties demonstrate sufficient
indicia of being domestic and, thus, trigger the Commission's
supervisory interest in domestic swaps, remain subject to the
Commission requirements under the Final Rule.
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\247\ See Guidance, 78 FR at 45350, n.513.
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The Commission's approach in the Final Rule to limit certain relief
for U.S. branches of non-U.S. swap entities is parallel to the
Commission's approach in the Final Rule to provide certain exceptions
from Commission requirements or substituted compliance for certain
transactions of foreign branches of U.S. swap entities to take into
account the supervisory interest of local regulators, as discussed
below in section VI.
III. Cross-Border Application of the Swap Dealer Registration Threshold
CEA section 1a(49) defines the term ``swap dealer'' to include any
person that: (1) Holds itself out as a dealer in swaps; (2) makes a
market in swaps; (3) regularly enters into swaps with counterparties as
an ordinary course of business for its own account; or (4) engages in
any activity causing the person to be commonly known in the trade as a
dealer or market maker in swaps (collectively referred to as ``swap
dealing,'' ``swap dealing activity,'' or ``dealing activity'').\248\
The statute also requires the Commission to promulgate regulations to
establish factors with respect to the making of a determination to
exempt from designation as an SD an entity engaged in a de minimis
quantity of swap dealing.\249\
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\248\ 7 U.S.C. 1a(49)(A). In general, a person that satisfies
any one of these prongs is deemed to be engaged in swap dealing
activity.
\249\ 7 U.S.C. 1a(49)(D).
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In accordance with CEA section 1a(49), the Commission issued the
Entities Rule,\250\ which, among other things, further defined the term
``swap dealer'' and excluded from designation as an SD any entity that
engages in a de minimis quantity of swap dealing with or on behalf of
its customers.\251\ Specifically, the definition of ``swap dealer'' in
Sec. 1.3 provides that a person shall not be deemed to be an SD as a
result of its swap dealing activity involving counterparties unless,
during the preceding 12 months, the aggregate gross notional amount of
the swaps connected with those dealing activities exceeds the de
minimis threshold.\252\ Paragraph (4) of that definition further
requires that, in determining whether its swap dealing activity exceeds
the de minimis threshold, a person must include the aggregate gross
notional amount of the swaps connected with the dealing activities of
its affiliates under common control.\253\ For purposes of the
Commission's interpretation of the aggregation requirement in the
cross-border context as set forth in this release, the Commission
construes ``affiliates under common control'' by reference to the
Entities Rule, which defined control as the possession, direct or
indirect, of the power to direct or cause the direction of the
management and policies of a person, whether through the ownership of
voting securities, by contract, or otherwise.\254\ Accordingly, any
reference in the Commission's aggregation interpretation to
``affiliates under common control'' with a person includes affiliates
that are controlling, controlled by, or under common control with such
person.
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\250\ Entities Rule, 77 FR 30596.
\251\ 17 CFR 1.3, Swap dealer, paragraph (4); Entities Rule, 77
FR 30596.
\252\ 17 CFR 1.3, Swap dealer, paragraph (4)(i)(A). The de
minimis threshold is set at $8 billion, except with regard to swaps
with special entities for which the threshold is $25 million. See
id., paragraphs (4)(i)(A)-(B). See generally De Minimis Exception to
the Swap Dealer Definition, 83 FR 56666 (Nov. 13, 2018).
\253\ 17 CFR 1.3, Swap dealer, paragraph (4)(i)(A).
\254\ See Entities Rule, 77 FR at 30631 n.437.
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The Commission is now adopting rules to address how the de minimis
threshold should apply to the cross-border swap dealing transactions of
U.S. and non-U.S. persons. Specifically, the Final Rule identifies when
a potential SD's cross-border dealing activities should be included in
its de minimis threshold calculation and when they may properly be
excluded. As discussed below, whether a potential SD includes a
particular swap in its de minimis threshold calculation depends on how
the entity and its counterparty are classified (e.g., U.S. person, SRS,
etc.) and, in some cases, the jurisdiction in which a non-U.S. person
is regulated.
A. U.S. Persons
The Commission is adopting, as proposed and consistent with the
Guidance, the requirement that a U.S. person include all of its swap
dealing transactions in its de minimis threshold calculation without
exception.\255\ The Commission did not receive comments regarding this
requirement. As discussed in section II.B above, the term ``U.S.
person'' encompasses a person that, by virtue of being domiciled,
organized, or having its principal place of business in the United
States, raises the concerns intended to be addressed by the Dodd-Frank
Act, regardless of the U.S. person status of its counterparty. In
addition, a person's status as a U.S. person is determined at the
entity level and, thus, a U.S. person includes the swap dealing
activity of operations that are part of the same legal person,
including those of its foreign branches. Therefore, a U.S. person
includes in its SD de minimis threshold calculation dealing swaps
entered into by a foreign branch of the U.S. person.\256\
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\255\ Final Sec. 23.23(b)(1). See Proposed Rule, 85 FR at 970-
971, 1004; Guidance, 78 FR at 45326.
\256\ Proposed Rule, 85 FR at 970-971. This approach mirrors the
SEC's approach in its cross-border rule. See 17 CFR 240.3a71-
3(b)(1)(i); SEC Cross-Border Rule, 79 FR at 47302, 47371.
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B. Non-U.S. Persons
Under the Final Rule, as discussed in more detail below, whether a
non-U.S. person needs to include a swap in its de minimis threshold
calculation depends on the non-U.S. person's status, the status of its
counterparty, and, in some cases, the jurisdiction in which the non-
U.S. person is regulated. Specifically, the Final Rule requires a
person that is a Guaranteed Entity or an SRS to count all of its
dealing swaps towards the de minimis threshold.\257\ In addition, an
Other Non-U.S. Person is required to count dealing swaps with a U.S.
person toward its de minimis threshold calculation, except for swaps
conducted through a foreign branch of a registered U.S. SD.\258\
Further, subject to certain exceptions, the Final Rule requires an
[[Page 56952]]
Other Non-U.S. Person to count dealing swaps toward its de minimis
threshold calculation if the counterparty to such swaps is a Guaranteed
Entity.
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\257\ As discussed in section II.C, supra, for purposes of this
release and ease of reading, a non-U.S. person whose obligations
under a swap are subject to a guarantee by a U.S. person is being
referred to as a ``Guaranteed Entity.'' A non-U.S. person may be a
Guaranteed Entity with respect to certain swaps and not others
(including, e.g., where the non-U.S. person is guaranteed only with
respect to its swaps with certain counterparties). Thus, a non-U.S.
person could be a Guaranteed Entity or an Other Non-U.S. Person,
depending on the specific swap.
\258\ As stated, ``swap conducted through a foreign branch''
means a swap entered into by a foreign branch where: (1) The foreign
branch or another foreign branch is the office through which the
U.S. person makes and receives payments and deliveries under the
swap pursuant to a master netting or similar trading agreement, and
the documentation of the swap specifies that the office for the U.S.
person is such foreign branch; (2) the swap is entered into by such
foreign branch in its normal course of business; and (3) the swap is
reflected in the local accounts of the foreign branch.
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1. Swaps by a Significant Risk Subsidiary
The Commission proposed to require an SRS to include all of its
dealing swaps in its de minimis threshold calculation without
exception.\259\
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\259\ Proposed Sec. 23.23(b)(1); Proposed Rule, 85 FR at 971,
1004.
---------------------------------------------------------------------------
IIB/SIFMA stated that, generally, the Commission should not require
a non-U.S. person, whether or not it is an SRS or other FCS, to include
dealing swaps with a non-U.S. person in its SD de minimis threshold
calculation when the risk of such swaps is transferred to an
affiliated, registered U.S. SD. In such a situation, IIB/SIFMA asserted
that there is no significant potential for risk to the United States or
evasion of the Dodd-Frank Act because the Commission already can
exercise appropriate regulatory oversight through direct regulation of
the registered SD, which is subject to Dodd-Frank Act provisions such
as risk management requirements and Commission or prudential regulator
margin and capital requirements. IIB/SIFMA argued that this
consideration underlies the Commission's decision to exclude affiliates
of a registered SD from the ``conduit affiliate'' definition in the
Guidance, as well as the similar approach taken by the SEC in its
implementation of the Dodd-Frank Act.
After considering this comment, the Commission is adopting this
requirement as proposed.\260\ As discussed in section II.D above, the
SRS test identifies a person that, by virtue of being a significant
subsidiary of a U.S. person, and not being subject to prudential
supervision as a subsidiary of a BHC or IHC, or subject to comparable
capital and margin rules, raises the concerns intended to be addressed
by the Dodd-Frank Act requirements addressed by the Final Rule,
regardless of the status of its counterparty as a U.S. person or non-
U.S. person. The Commission believes that treating an SRS differently
from a U.S. person could create a substantial regulatory loophole,
incentivizing U.S. persons to conduct their dealing business with non-
U.S. persons through SRSs to avoid application of the Dodd-Frank Act SD
requirements. Allowing swaps entered into by SRSs, which have the
potential to affect the ultimate U.S. parent entity and U.S. commerce,
to be treated differently depending on how the parties structure their
transactions could undermine the effectiveness of the Dodd-Frank Act
swaps provisions and related Commission regulations addressed by the
Final Rule. Applying the same standard to similar transactions helps to
limit those incentives and regulatory implications. Because the SRS
definition is a risk-based test, the Commission has determined not to
include a carve-out for back-to-back swaps to SDs, as was provided in
the Guidance for conduit affiliates. Additionally, the SRS definition,
as adopted in the Final Rule, already includes a carve-out for
affiliates of BHCs and IHCs. This approach allows for streamlined
application of the rule, and the comment letters have not identified
specific downsides to this approach.\261\
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\260\ Final Sec. 23.23(b)(1).
\261\ See Proposed Rule, 85 FR at 971.
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In addition, a person's status as an SRS is determined at the
entity level and, thus, an SRS is required to include in its SD de
minimis threshold calculation the dealing swaps of its operations that
are part of the same legal person, including those of its
branches.\262\
---------------------------------------------------------------------------
\262\ Id.
---------------------------------------------------------------------------
The Proposed Rule also provided that an Other Non-U.S. Person would
not be required to count a dealing swap with an SRS toward its de
minimis threshold calculation, unless the SRS was also a Guaranteed
Entity (and no exception applied).\263\ JFMC/IBAJ supported this
approach, while JBA asserted that an Other Non-U.S. Person should not
have to count a swap entered into with a non-U.S. person in any
circumstance. As noted above, an SRS is required to count all of its
dealing swaps. However, the Commission continues to believe that where
an Other Non-U.S. Person is entering into a dealing swap with an SRS,
requiring the Other Non-U.S. Person to count the swap towards its de
minimis threshold could cause the Other Non-U.S. Person to stop
engaging in swap activities with SRSs. Though an SRS is required to
count all of its dealing swaps, for the reasons stated above, the
Commission believes that it is important to ensure that SRSs,
particularly ones that are a commercial or non-financial entity that do
not engage in swap dealing activities, continue to have access to swap
liquidity from Other Non-U.S. Persons for hedging or other non-dealing
purposes.
---------------------------------------------------------------------------
\263\ Id.
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2. Swaps With a U.S. Person
Consistent with the Guidance, the Commission proposed to require a
non-U.S. person to count all dealing swaps with a counterparty that is
a U.S. person toward its de minimis threshold calculation, except for
swaps with a counterparty that is a foreign branch of a registered U.S.
SD if such swaps meet the definition of being ``conducted through a
foreign branch'' of such registered SD.\264\
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\264\ Proposed Sec. 23.23(b)(2)(i); Proposed Rule, 85 FR at
971-972, 1004. See Guidance, 78 FR at 45323-45324.
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IIB/SIFMA, JFMC/IBAJ, and JBA supported allowing an Other Non-U.S.
Person to exclude swap dealing transactions conducted through a foreign
branch of a registered SD counterparty. IIB/SIFMA agreed that the
Commission's regulatory interest in these swaps is not sufficient to
warrant a competitive disadvantage for foreign branches of U.S. SDs,
especially considering that other Dodd-Frank Act requirements, such as
margin, mitigate the risk of these swaps to the U.S. SD. Additionally,
IIB/SIFMA stated that the exclusion helps prevent market fragmentation
by enabling Other Non-U.S. Persons to access liquidity provided by U.S.
SDs through their foreign branches. On the other hand, AFR asserted
that the Proposed Rule would allow branches of U.S. persons, which are
actually formally and legally part of the parent U.S. organization, to
effectively act as non-U.S. persons.
After considering the comments, the Commission is adopting this
aspect of the cross-border application of the SD registration threshold
as proposed.\265\ As discussed in section II.B, the term ``U.S.
person'' encompasses persons that inherently raise the concerns
intended to be addressed by the Dodd-Frank Act regardless of the U.S.
person status of their counterparty. In the event of a default or
insolvency of a non-U.S. SD, the SD's U.S. counterparties could be
adversely affected. A credit event, including funding and liquidity
problems, downgrades, default, or insolvency at a non-U.S. SD could
therefore have a direct and significant adverse effect on its U.S.
counterparties, which could in turn create the risk of disruptions to
the U.S. financial system.\266\
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\265\ Final Sec. 23.23(b)(2)(i).
\266\ Proposed Rule, 85 FR at 971-972.
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Allowing a non-U.S. person to exclude swaps conducted through a
foreign branch of a registered SD counterparty from its de minimis
threshold calculation is consistent with the Guidance.\267\ In response
to AFR's comment that the Proposed Rule allows foreign branches of U.S.
persons to effectively act as non-U.S. persons, the
[[Page 56953]]
Commission continues to believe that its regulatory interest in these
swaps is not sufficient to warrant creating a potential competitive
disadvantage for foreign branches of U.S. SDs with respect to their
foreign entity competitors by requiring non-U.S. persons to count
trades with them toward their de minimis threshold calculations. In
this regard, a swap conducted through a foreign branch of a registered
SD triggers certain Dodd-Frank Act transactional requirements (or
comparable requirements), particularly margin requirements, and thus,
such swap activity is not conducted fully outside the Dodd-Frank Act
regime. Moreover, in addition to certain Dodd-Frank Act requirements
that apply to such swaps, other foreign regulatory requirements may
also apply similar transactional requirements to the transactions.\268\
Accordingly, the Commission believes that it is appropriate and
consistent with section 2(i) of the CEA to allow non-U.S. persons to
exclude from their de minimis calculation any swap dealing transactions
conducted through a foreign branch of a registered SD counterparty.
However, this exception does not apply to Guaranteed Entities
(discussed below) or SRSs (discussed above), who have to count all of
their dealing swaps.
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\267\ Id. See Guidance, 78 FR at 45323-45324.
\268\ As noted in section I.C, supra, significant and
substantial progress has been made in the world's primary swaps
trading jurisdictions to implement the G20 swaps reform commitments.
---------------------------------------------------------------------------
The Commission also requested comment on whether it would be
appropriate to require a U.S. branch to include in its SD de minimis
threshold calculation all of its swap dealing transactions, as if they
were swaps entered into by a U.S. person, and whether it would be
appropriate to require an Other Non-U.S. Person to include in its SD de
minimis threshold calculation dealing swaps conducted through a U.S.
branch of its counterparty.\269\ IIB/SIFMA supported not requiring a
U.S. branch of a non-U.S. banking organization to include all of its
swap dealing transactions in its SD de minimis threshold calculation as
if they were swaps entered into by a U.S. person or to require an Other
Non-U.S. Person to include in its SD de minimis threshold calculation
dealing swaps conducted through such a branch of its counterparty. IIB/
SIFMA stated that swaps between a U.S. branch and an Other Non-U.S.
Person do not present risks to the United States that would justify
applying the Commission's SD requirements. JBA also stated that Other
Non-U.S. Persons should not have to count swaps conducted through a
U.S. branch of a counterparty since such an approach may lead to Other
Non-U.S. Persons decreasing activity with U.S. branches.
---------------------------------------------------------------------------
\269\ Proposed Rule, 85 FR at 973. See discussion of the
modification of the definition of a ``swap conducted through a U.S.
branch'' to be a ``swap booked in a U.S. branch'' in section II.H.3,
supra.
---------------------------------------------------------------------------
Having considered the foregoing comments, in this Final Rule, the
Commission is not requiring a U.S. branch of an Other Non-U.S. Person
to count all of its swap dealing transactions in its SD threshold
calculation, as if they were swaps entered into by a U.S. person.
Rather, a U.S. branch is required to count swaps pursuant to the
requirements for Other Non-U.S. Persons (e.g., count swaps with U.S.
persons, Guaranteed Entities subject to certain exceptions, etc.).
Additionally, an Other Non-U.S. Person is not required to include in
its SD de minimis threshold calculation dealing swaps booked in a U.S.
branch of a counterparty, unless that swap has to be counted pursuant
to other requirements of this Final Rule.
3. Guaranteed Swaps
(i) Swaps Entered Into by a Guaranteed Entity
In an approach that is generally consistent with the Guidance, the
Commission proposed to require a non-U.S. person to include in its de
minimis threshold calculation swap dealing transactions where its
obligations under the swaps are guaranteed by a U.S. person.\270\ No
comments were received regarding this aspect of the Proposed Rule.
---------------------------------------------------------------------------
\270\ Proposed Sec. 23.23(b)(2)(ii); Proposed Rule, 85 FR at
972, 1004. The Guidance stated that where a non-U.S. affiliate of a
U.S. person has its swap dealing obligations with non-U.S. persons
guaranteed by a U.S. person, the guaranteed affiliate generally
would be required to count those swap dealing transactions with non-
U.S. persons (in addition to its swap dealing transactions with U.S.
persons) for purposes of determining whether the affiliate exceeds a
de minimis amount of swap dealing activity and must register as an
SD. Guidance, 78 FR at 45312-45313. As discussed above, the Final
Rule does not require that the guarantor be an affiliate of the
guaranteed person for that person to be a Guaranteed Entity.
---------------------------------------------------------------------------
The Commission is adopting this requirement as proposed,\271\
because the swap obligations of a Guaranteed Entity are identical, in
relevant aspects, to a swap entered into directly by a U.S. person. As
a result of the guarantee, the U.S. guarantor generally bears risk
arising out of the swap as if it had entered into the swap directly.
The U.S. guarantor's financial resources in turn enable the Guaranteed
Entity to engage in dealing activity, because the Guaranteed Entity's
counterparties will look to both the Guaranteed Entity and its U.S.
guarantor to ensure performance of the swap. Absent the guarantee from
the U.S. person, a counterparty may choose not to enter into the swap
or may not do so on the same terms. In this way, the Guaranteed Entity
and the U.S. guarantor effectively act together to engage in the
dealing activity.\272\
---------------------------------------------------------------------------
\271\ Final Sec. 23.23(b)(2)(ii).
\272\ Proposed Rule, 85 FR at 972. This view is consistent with
the SEC's approach in its cross-border rule. See SEC Cross-Border
Rule, 79 FR at 47289.
---------------------------------------------------------------------------
Further, treating a Guaranteed Entity differently from a U.S.
person could create a substantial regulatory loophole, incentivizing
U.S. persons to conduct their dealing business with non-U.S. persons
through non-U.S. affiliates, with a U.S. guarantee, to avoid
application of the Dodd-Frank Act SD requirements. Allowing
transactions that have a similar economic reality with respect to U.S.
commerce to be treated differently depending on how the parties
structure their transactions could undermine the effectiveness of the
Dodd-Frank Act swap provisions and related Commission regulations
addressed by the Final Rule. Applying the same standard to similar
transactions helps to limit those incentives and regulatory
implications.\273\
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\273\ Proposed Rule, 85 FR at 972.
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(ii) Swaps Entered Into With a Guaranteed Entity
The Commission also proposed to require a non-U.S. person to count
dealing swaps with a Guaranteed Entity in its SD de minimis threshold
calculation, except when: (1) The Guaranteed Entity is registered as an
SD; or (2) the Guaranteed Entity's swaps are subject to a guarantee by
a U.S. person that is a non-financial entity.\274\ The Commission also
invited comment on whether it should the follow the SEC's approach,
which does not require a non-U.S. person that is not guaranteed by a
U.S. person to count dealing swaps with a Guaranteed Entity.\275\
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\274\ Proposed Sec. 23.23(b)(2)(iii); Proposed Rule, 85 FR at
973, 1004.
\275\ Proposed Rule, 85 FR at 974. The SEC noted that ``concerns
regarding the risk posed to the United States by such security-based
swaps, and regarding the potential use of such guaranteed affiliates
to evade the Dodd-Frank Act . . . are addressed by the requirement
that guaranteed affiliates count their own dealing activity against
the de minimis thresholds when the counterparty has recourse to a
U.S. person.'' SEC Cross-Border Rule, 79 FR at 47322.
---------------------------------------------------------------------------
IIB/SIFMA, ISDA, JFMC/IBAJ, and JBA recommended that the Commission
further conform this provision with the Guidance by expanding the
exceptions to also cover a Guaranteed Entity that engages in de minimis
swap dealing activity and is affiliated with a
[[Page 56954]]
registered SD. IIB/SIFMA and ISDA noted that the Commission's
regulatory concerns are addressed because the Guaranteed Entity would
already be required to count the swap towards its de minimis threshold.
IIB/SIFMA, ISDA, and JFMC/IBAJ noted that absent this exception, Other
Non-U.S. Persons may choose not to trade with Guaranteed Entities,
leading to increased market fragmentation or competitive disadvantages.
JFMC/IBAJ also stated that there has been no material change in the
swaps market since issuance of the Guidance warranting removing this
exception. JBA commented that Other Non-U.S. Persons should not have to
count swaps where the non-U.S. counterparty transfers risks to an
affiliated U.S. SD because of the burdens associated with such an
approach, and the limited risks arising from transactions between two
non-U.S. persons. JBA also recommended that the CFTC follow the SEC
approach and not require a non-U.S. person to count a swap with a
Guaranteed Entity because it is burdensome to assess whether a
guarantee exists.
Consistent with the Guidance, the Commission is adopting, as
proposed, the requirement that a non-U.S. person must count dealing
swaps with a Guaranteed Entity in its SD de minimis threshold
calculation, except when: (1) The Guaranteed Entity is registered as an
SD; or (2) the Guaranteed Entity's swaps are subject to a guarantee by
a U.S. person that is a non-financial entity.\276\ Additionally, after
carefully considering the comments, and to maintain consistency with
the Guidance, the Commission is also adopting an exception that allows
a non-U.S. person to exclude from its de minimis calculation swaps
entered into with a Guaranteed Entity that is itself below the de
minimis threshold and is affiliated with a registered SD.\277\
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\276\ Final Sec. 23.23(b)(2)(iii)(A) and (B). See Guidance, 78
FR at 45324.
\277\ Final Sec. 23.23(b)(2)(iii)(C). See Guidance, 78 FR at
45324.
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The guarantee of a swap is an integral part of the swap and, as
discussed above, counterparties may not be willing to enter into a swap
with a Guaranteed Entity in the absence of the guarantee. The
Commission recognizes that, given the highly integrated corporate
structures of global financial enterprises described above, financial
groups may elect to conduct their swap dealing activity in a number of
different ways, including through a U.S. person or through a non-U.S.
affiliate that benefits from a guarantee from a U.S. person. Therefore,
in order to avoid creating a regulatory loophole, swaps of a non-U.S.
person with a Guaranteed Entity should receive the same treatment as
swaps with a U.S. person. The exceptions are intended to address those
situations where the risk of the swap between the non-U.S. person and
the Guaranteed Entity is otherwise managed under the Dodd-Frank Act
swap regime or is primarily outside the U.S. financial industry.\278\
JBA supported the SEC's approach, which, as noted, does not require a
non-U.S. person that is not a conduit affiliate or guaranteed by a U.S.
person to count dealing swaps with any guaranteed entity toward its de
minimis threshold in any case.\279\ Given the broader global scope of
the swaps market regulated under the Commission's swap regime versus
the relatively more limited U.S.-focused scope of the security-based
swap market regulated under the SEC's security-based swap regime, the
Commission has determined to treat swaps with Guaranteed Entities
differently.
---------------------------------------------------------------------------
\278\ Proposed Rule, 85 FR at 972.
\279\ SEC Cross-Border Rule, 79 FR at 47322.
---------------------------------------------------------------------------
Where an Other Non-U.S. Person enters into swap dealing
transactions with a Guaranteed Entity that is a registered SD, the
Commission will permit the non-U.S. person not to count its dealing
transactions with the Guaranteed Entity against the non-U.S. person's
de minimis threshold for two principal reasons. First, requiring the
non-U.S. person to count such swaps may incentivize them to not engage
in dealing activity with Guaranteed Entities, thereby contributing to
market fragmentation and competitive disadvantages for entities wishing
to access foreign markets. Second, one counterparty to the swap is a
registered SD, and therefore is subject to comprehensive swap
regulation under the oversight of the Commission.\280\
---------------------------------------------------------------------------
\280\ Proposed Rule, 85 FR at 972.
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In addition, an Other Non-U.S. Person need not include in its de
minimis threshold calculation its swap dealing transactions with a
Guaranteed Entity where the Guaranteed Entity is guaranteed by a non-
financial entity. In these circumstances, systemic risk to U.S.
financial markets is mitigated because the U.S. guarantor is a non-
financial entity whose primary business activities are not related to
financial products and such activities primarily occur outside the U.S.
financial sector.\281\ For purposes of the Final Rule, the Commission
interprets ``non-financial entity'' to mean a counterparty that is not
an SD, an MSP, or a financial end-user (as defined in the SD and MSP
margin rule in Sec. 23.151).\282\
---------------------------------------------------------------------------
\281\ Moreover, the SRS definition includes those non-financial
U.S. parent entities that meet the risk-based thresholds set out in
section II.D, supra.
\282\ Proposed Rule, 85 FR at 972.
---------------------------------------------------------------------------
Lastly, as discussed, the Commission requested comment on whether
it should expand the exception to not require a non-U.S. person that is
not a Guaranteed Entity to count dealing swaps with a Guaranteed
Entity, consistent with the SEC. IIB/SIFMA, ISDA, JFMC/IBAJ, and JBA
requested a narrower version of this exception, noting that the
Guidance allowed a non-U.S. person to exclude from its de minimis
calculation swaps entered into with a Guaranteed Entity that is itself
below the de minimis threshold and is affiliated with a registered SD.
The Guidance reflected the Commission's view that when the aggregate
level of swap dealing by a non-U.S. person that is not a guaranteed
affiliate, considering both swaps with U.S. persons and swaps with
unregistered guaranteed affiliates, exceeds the de minimis level of
swap dealing, the non-U.S. person's swap dealing transactions have the
requisite direct and significant connection with activities in, or
effect on, commerce of the United States.\283\ The Commission believes,
however, that where the counterparty to a swap is a Guaranteed Entity
and is not a registered SD, the Commission's regulatory concerns, such
as systemic risk to U.S. financial markets, are addressed because the
Guaranteed Entity engages in a level of swap dealing below the de
minimis threshold and is part of an affiliated group with an SD.\284\
Risk to the Guaranteed Entity should be mitigated by the SD's risk
management program, which under Commission rules must take account of
risks posed by affiliates and must be integrated into risk management
at the consolidated entity level.\285\ Including this exception also
addresses concern that its elimination would discourage Other Non-U.S.
Persons from entering into swaps with Guaranteed Entities, creating
competitive disadvantages.
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\283\ Guidance, 78 FR at 45324.
\284\ Id.
\285\ 17 CFR 23.600(c)(1)(ii).
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C. Aggregation Requirement
Paragraph (4) of the SD definition in Sec. 1.3 requires that, in
determining whether its swap dealing transactions exceed the de minimis
threshold, a person must include the aggregate notional amount of any
swap dealing transactions entered into by its affiliates
[[Page 56955]]
under common control.\286\ Consistent with CEA section 2(i), the
Commission interprets this aggregation requirement in a manner that
applies the same aggregation principles to all affiliates in a
corporate group, whether they are U.S. or non-U.S. persons.
---------------------------------------------------------------------------
\286\ 17 CFR 1.3, Swap dealer, paragraph (4).
---------------------------------------------------------------------------
Accordingly, consistent with the Guidance, the Commission proposed
to require a potential SD, whether a U.S. or non-U.S. person, to
aggregate all swaps connected with its dealing activity with those of
persons controlling, controlled by, or under common control with the
potential SD to the extent that these affiliated persons are themselves
required to include those swaps in their own de minimis threshold
calculations, unless the affiliated person is itself a registered
SD.\287\
---------------------------------------------------------------------------
\287\ Proposed Rule, 85 FR at 972-973; Guidance, 78 FR at 45323.
---------------------------------------------------------------------------
Better Markets supported the proposed aggregation requirement
because it would prevent structuring to avoid or evade the de minimis
threshold. As discussed above in connection with the definition of
``significant risk subsidiary,'' AFR stated that it would be simple for
large international banks and other significant actors to conduct
dealing through foreign subsidiaries that need not be counted toward de
minimis thresholds at the subsidiary level. AFR claimed that the
aggregation provision is negated by the fact that affiliates which are
not SRSs would not have to count non-guaranteed swaps with other non-
U.S., non-SRS persons toward their own de minimis calculations. In this
way, it argued that the weakness of the other definitions in the
Proposed Rule affects the calculation of the de minimis registration
thresholds.
Having considered these comments, the Commission is adopting this
interpretation of the cross-border application of the SD registration
threshold as proposed, and consistent with the Guidance.\288\ Stated in
general terms, the Commission's approach allows both U.S. persons and
non-U.S. persons in an affiliated group to engage in swap dealing
activity up to the de minimis threshold. When the affiliated group
meets the de minimis threshold in the aggregate, one or more
affiliate(s) (a U.S. affiliate or a non-U.S. affiliate) have to
register as an SD so that the relevant swap dealing activity of the
unregistered affiliates remains below the threshold. The Commission
recognizes the borderless nature of swap dealing activities, in which a
dealer may conduct swap dealing business through its various affiliates
in different jurisdictions, and believes that its approach addresses
the concern that an affiliated group of U.S. and non-U.S. persons
engaged in swap dealing transactions with a significant connection to
the United States may not be required to register solely because such
swap dealing activities are divided among affiliates that all
individually fall below the de minimis threshold. The Commission's
approach ensures that the aggregate gross notional amount of applicable
swap dealing transactions of all such unregistered U.S. and non-U.S.
affiliates does not exceed the de minimis level.\289\
---------------------------------------------------------------------------
\288\ Proposed Rule, 85 FR at 972-973; Guidance, 78 FR at 45323.
\289\ Proposed Rule, 85 FR at 972-973.
---------------------------------------------------------------------------
In response to AFR's comment, pursuant to the status quo under the
aggregation policy set forth in the Guidance, foreign subsidiaries of
U.S. persons (that are not ``conduit affiliates'' as described in the
Guidance) have not counted non-guaranteed swaps with other non-U.S.
persons toward their de minimis calculations and U.S. person parent
entities have therefore not aggregated such swaps with their own or
their affiliates' de minimis calculations. Thus, the new SRS category
expands the swaps included by the aggregation requirement rather than
``negating the aggregation provision'' as claimed by AFR.
D. Certain Exchange-Traded and Cleared Swaps
The Commission proposed, in an approach that is generally
consistent with the Guidance, to allow an Other Non-U.S. Person to
exclude from its de minimis threshold calculation any swap that it
anonymously enters into on a designated contract market (``DCM''), a
swap execution facility (``SEF'') that is registered with the
Commission or exempted by the Commission from SEF registration pursuant
to section 5h(g) of the CEA, or a foreign board of trade (``FBOT'')
that is registered with the Commission pursuant to part 48 of its
regulations,\290\ if such swap is also cleared through a registered or
exempt derivatives clearing organization (``DCO'').\291\
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\290\ The Commission considers the exception described herein
also to apply with respect to an FBOT that provides direct access to
its order entry and trade matching system from within the U.S.
pursuant to no-action relief issued by Commission staff.
\291\ Proposed Sec. 23.23(d); Proposed Rule, 85 FR at 973,
1004. See Guidance, 78 FR at 45325.
---------------------------------------------------------------------------
IIB/SIFMA recommended that this exception be expanded to cover
swaps executed anonymously by an Other Non-U.S. Person on a non-U.S.
trading venue and cleared by a non-U.S. clearing organization,
regardless of whether the trading venue and clearing organization are
registered or exempt from registration with the Commission. IIB/SIFMA
stated that: (1) With such trades, the Other Non-U.S. Person cannot
determine whether the swaps would count towards the SD de minimis
threshold; (2) even if the Other Non-U.S. Person was registered as an
SD, the swaps generally would not be subject to the Commission's
external business conduct rules; and (3) a non-U.S. clearing
organization becomes the counterparty to the Other Non-U.S. Person, and
therefore the swaps do not present risk to the U.S. that would justify
application of the Commission's risk mitigation rules. IIB/SIFMA stated
that if the Other Non-U.S. Person's original counterparty was a U.S.
person, the Commission's SEF and DCO registration requirements would
independently require the trading venue and clearing organization to
register with the Commission or obtain an exemption from registration
and, therefore, it is not necessary for the Commission to limit this
exception in a manner that would indirectly expand the SEF and DCO
registration requirements to non-U.S. trading venues and clearing
organizations with Other Non-U.S. Person participants.
Similarly, JFMC/IBAJ generally supported the exception, but also
requested that the Commission not require the clearing organization or
trading venue to be registered or exempt from registration with the
CFTC because, in their view, the same policy rationale of exempting
cleared swaps executed anonymously on a SEF or DCM applies to swaps
executed on non-U.S. trading venues or clearing organizations operating
without a CFTC registration or exemption. JFMC/IBAJ also recommended
that the scope be expanded to include cleared swaps executed
bilaterally outside a trading venue. JBA generally supported the
proposal but also recommended that the exclusion be available for all
cleared swaps, regardless of whether they are anonymously entered into
on a DCM, registered or exempt SEF, or an FBOT, because risk to the
U.S. would be limited after the swap is cleared. JSCC recommended that
a non-U.S. person should be able to exclude swaps entered into with a
U.S. person from the de minimis threshold calculation, if the swap is
cleared with a registered DCO or exempt DCO because any non-U.S.
person-related risk arising from the
[[Page 56956]]
swap will be replaced and instead managed by the DCO.
Better Markets stated that the exception must be amended to limit
the exclusion to DCO-cleared, anonymously SEF or DCM-executed swaps in
which neither counterparty is subsequently disclosed through the
practice of post-trade name give-up. Additionally, Better Markets
objected to the expansion of the exchange-trading exclusion for any
swaps anonymously executed or cleared through an exempted intermediary.
Having considered these comments, the Commission is adopting this
exception as proposed.\292\ When a non-U.S. person enters into a swap
that is executed anonymously on a registered or exempt SEF, DCM, or
registered FBOT, the Commission recognizes that the non-U.S. person
does not have the necessary information about its counterparty to
determine whether the swap should be included in its SD de minimis
threshold calculation. The Commission therefore has determined that in
this case the swap should be excluded altogether due to these practical
difficulties.\293\ However, the exception is limited to Other Non-U.S.
Persons since, as discussed, Guaranteed Entities and SRSs have to count
all of their dealing swaps towards the threshold, so the practical
obstacles that would challenge Other Non-U.S. Persons are not relevant
for Guaranteed Entities and SRSs.
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\292\ Final Sec. 23.23(d).
\293\ See Proposed Rule, 85 FR at 973. Additionally, as the
Commission has clarified in the past, when a non-U.S. person clears
a swap through a registered or exempt DCO, such non-U.S. person
would not have to include the resulting swap (i.e., the novated
swap) in its de minimis threshold calculation. See, e.g., 2016
Proposal, 81 FR at 71957 n.88. A swap that is submitted for clearing
is extinguished upon novation and replaced by new swap(s) that
result from novation. See 17 CFR 39.12(b)(6). See also Derivatives
Clearing Organization General Provisions and Core Principles, 76 FR
69334, 69361 (Nov. 8, 2011). Where a swap is created by virtue of
novation, such swap does not implicate swap dealing, and therefore
it would not be appropriate to include such swaps in determining
whether a non-U.S. person should register as an SD.
---------------------------------------------------------------------------
The Final Rule expands the exception as it appeared in the Guidance
to include SEFs and DCOs that are exempt from registration under the
CEA, and also states that SRSs do not qualify for this exception. The
CEA provides that the Commission may grant an exemption from
registration if it finds that a foreign SEF or DCO is subject to
comparable, comprehensive supervision and regulation by the appropriate
governmental authorities in the SEF or DCO's home country.\294\ The
Commission believes that the policy rationale for providing relief to
swaps anonymously executed on a SEF, DCM, or FBOT and then cleared also
extends to swaps executed on a foreign SEF and/or cleared through a
foreign DCO that has been granted an exemption from registration. As
noted, the foreign SEF or DCO is subject to comprehensive regulation
that is comparable to that applicable to registered SEFs and DCOs.
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\294\ See CEA sections 5h(g) for the SEF exemption provision and
5b(h) for the DCO exemption provision.
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The Commission has determined not to expand at this time the
exception to allow an Other Non-U.S. Person to exclude swaps executed
anonymously on an exchange and which are subsequently cleared,
regardless of whether the exchange and clearing organization are
registered or exempt from registration with the Commission. Commenters
argued that if the Other Non-U.S. Person's original counterparty was a
U.S. person, the Commission's SEF and DCO registration requirements
would independently require the trading venue and clearing organization
to register with the Commission or obtain an exemption from
registration. While guidance from DMO has suggested that this might be
the case with respect to SEFs and DCMs,\295\ the Commission has not
taken a formal position on whether registration of a SEF or DCM is
required where a U.S. person participates on the trading facility, and
has stated that it will do so in the future.\296\ The Commission may
consider expanding the exception pending other amendments to the SEF/
DCO regulations and registration requirements.
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\295\ Division of Market Oversight Guidance on Application of
Certain Commission Regulations to Swap Execution Facilities, at 2
n.8 (Nov. 15, 2013) (``[DMO] expects that a multilateral swaps
trading platform located outside the United States that provides
U.S. persons . . . with the ability to trade or execute swaps on or
pursuant to the rules of the platform, either directly or indirectly
through an intermediary, will register as a SEF or DCM.'').
\296\ See Swap Execution Facilities and Trade Execution
Requirement, 83 FR 61946, 61961 n.106 (``[T]he Commission learned
that many foreign multilateral swaps trading facilities prohibited
U.S. persons and U.S-located persons from accessing their facilities
due to the uncertainty that the guidance created with respect to SEF
registration. The Commission understands that these prohibitions
reflect concerns that U.S. persons and U.S.-located persons
accessing their facilities would trigger the SEF registration
requirement. . . . [T]he Commission expects to address the
application of CEA section 2(i) to foreign multilateral swaps
trading facilities, including foreign swaps broking entities, in the
future.'').
---------------------------------------------------------------------------
In response to comments that anonymity should not be required, the
Commission proposed this exception (and included it in the Guidance)
because when a trade is entered into anonymously on an exchange, the
non-U.S. person would not have the necessary information about its
counterparty to determine whether the swap should be included in its de
minimis threshold calculation.\297\ Therefore, these practical
difficulties justify the exclusion of the swap altogether. However, if
the identity of the counterparty is known to be a U.S. person, then the
Other Non-U.S. Person should be seen to be participating in the U.S.
swap market. Thus, the Commission has determined that such a non-U.S.
person should count such swaps towards its de minimis threshold as
otherwise required. Where the U.S. person status of a counterparty is
known to the non-U.S. person, the Commission sees no reason to treat a
cleared swap differently in the cross-border context than such swap is
treated in the domestic U.S. context where cleared swaps entered into
in a dealing capacity, whether executed anonymously or otherwise, count
toward the SD de minimis threshold.
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\297\ Proposed Rule, 85 FR at 973; Guidance, 78 FR 45325.
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IV. Cross-Border Application of the Major Swap Participant Registration
Tests
CEA section 1a(33) defines the term ``major swap participant'' to
include persons that are not SDs but that nevertheless pose a high
degree of risk to the U.S. financial system by virtue of the
``substantial'' nature of their swap positions.\298\ In accordance with
the Dodd-Frank Act and CEA section 1a(33)(B), the Commission adopted
rules further defining ``major swap participant'' and providing that a
person shall not be deemed an MSP unless its swap positions exceed one
of several thresholds.\299\ The thresholds were designed to take into
account default-related credit risk, the risk of multiple market
participants failing close in time, and the risk posed by a market
participant's swap positions on an aggregate level.\300\ The Commission
also adopted interpretive guidance stating
[[Page 56957]]
that, for purposes of the MSP analysis, an entity's swap positions are
attributable to a parent, other affiliate, or guarantor to the extent
that the counterparty has recourse to the parent, other affiliate, or
guarantor and the parent or guarantor is not subject to capital
regulation by the Commission, SEC, or a prudential regulator
(``attribution requirement'').\301\
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\298\ 7 U.S.C. 1a(33)(A) (defining ``major swap participant'' to
mean any person that is not an SD and either: (1) Maintains a
substantial position in swaps for any of the major swap categories,
subject to certain exclusions; (2) whose outstanding swaps create
substantial counterparty exposure that could have serious effects on
the U.S. financial system; or (3) is a highly leveraged financial
entity that is not subject to prudential capital requirements and
that maintains a substantial position in swaps for any of the major
swap categories).
\299\ 17 CFR 1.3, Major swap participant, paragraph (1). See
generally Entities Rule, 77 FR 30596.
\300\ Entities Rule, 77 FR at 30666 (discussing the guiding
principles behind the Commission's definition of ``substantial
position'' in 17 CFR 1.3); id. at 30683 (noting that the
Commission's definition of ``substantial counterparty exposure'' in
17 CFR 1.3 is founded on similar principles as its definition of
``substantial position'').
\301\ Id. at 30689.
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The Commission is now adopting rules to address the cross-border
application of the MSP thresholds to the swap positions of U.S. and
non-U.S. persons.\302\ Applying CEA section 2(i) and principles of
international comity, the Final Rule identifies when a potential MSP's
cross-border swap positions apply toward the MSP thresholds and when
they may be properly excluded. As discussed below, whether a potential
MSP includes a particular swap in its MSP threshold calculations
depends on how the entity and its counterparty are classified (e.g.,
U.S. person, SRS, etc.) and, in some cases, the jurisdiction in which a
non-U.S. person is regulated.\303\ The Final Rule's approach for the
cross-border application of the MSP thresholds is similar to the
approach described above for the SD threshold.
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\302\ Final Sec. 23.23(c).
\303\ As indicated above, for purposes of the Final Rule, an
``Other Non-U.S. Person'' refers to a non-U.S. person that is
neither a Guaranteed Entity nor an SRS.
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A. U.S. Persons
The Commission is adopting, as proposed, the requirement that a
U.S. person include all of its swap positions in its MSP registration
threshold calculations without exception.\304\ The Commission did not
receive comments regarding this requirement. As discussed in the
context of the Final Rule's approach to applying the SD de minimis
registration threshold, by virtue of it being domiciled or organized in
the United States, or the inherent nature of its connection to the
United States, all of a U.S. person's activities have a significant
nexus to U.S. markets, giving the Commission a particularly strong
regulatory interest in its swap activities.\305\ Accordingly, the
Commission believes that all of a U.S. person's swap positions,
regardless of where they occur or the U.S. person status of the
counterparty, should apply toward the MSP thresholds.
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\304\ Final Sec. 23.23(c)(1); Proposed Rule, 85 FR at 974,
1004.
\305\ See supra section III.A; Proposed Rule, 85 FR at 974.
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B. Non-U.S. Persons
Under the Final Rule, as discussed in more detail below, whether a
non-U.S. person includes a swap position in its MSP threshold
calculations depends on its status, the status of its counterparty, or
the characteristics of the swap. Specifically, the Final Rule requires
a person that is a Guaranteed Entity or an SRS to count all of its swap
positions. In addition, an Other Non-U.S. Person is required to count
all swap positions with a U.S. person, except for swaps conducted
through a foreign branch of a registered U.S. SD. Subject to an
exception, the Final Rule also requires an Other Non-U.S. Person to
count all swap positions if the counterparty to such swaps is a
Guaranteed Entity.\306\
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\306\ As discussed in sections II.C and III.B, supra, for
purposes of this release and ease of reading, such a non-U.S. person
whose obligations under the swaps are subject to a guarantee by a
U.S. person is being referred to as a ``Guaranteed Entity.''
Depending on the characteristics of the swap, a non-U.S. person may
be a Guaranteed Entity with respect to swaps with certain
counterparties, but not be deemed a Guaranteed Entity with respect
to swaps with other counterparties.
---------------------------------------------------------------------------
1. Swaps by a Significant Risk Subsidiary
The Commission proposed to require an SRS to include all of its
swap positions in its MSP threshold calculations.\307\
---------------------------------------------------------------------------
\307\ Proposed Sec. 23.23(c)(1); Proposed Rule, 85 FR at 974-
975, 1004.
---------------------------------------------------------------------------
IIB/SIFMA recommended that the Commission not adopt the proposal,
asserting that absent a guarantee or other form of direct risk transfer
to a U.S. person, a foreign subsidiary does not present sufficiently
``direct'' risk to the United States to justify extraterritorial
application of the MSP registration requirement under section 2(i).
IIB/SIFMA stated that permitting foreign subsidiaries to transact in
swaps without registering as MSPs also would not create a substantial
regulatory loophole, as there is no evidence of sufficiently
substantial non-dealing swap activity occurring in foreign subsidiaries
at present when SRSs are not subject to MSP registration (just as there
are no U.S. persons currently registered as MSPs).
After considering the comment, the Commission is adopting this
aspect of the cross-border application of the MSP registration
thresholds as proposed.\308\ As noted in section II.D, the term SRS
encompasses a person that, by virtue of being a significant subsidiary
of a U.S. person, and not being subject to prudential supervision as a
subsidiary of a BHC or IHC or subject to comparable capital and margin
rules, raises the concerns intended to be addressed by the Dodd-Frank
Act requirements addressed by the Final Rule, regardless of the U.S.
person status of its counterparty. Further, the Commission believes
that treating an SRS differently from a U.S. person could create a
substantial regulatory loophole by incentivizing U.S. persons to
conduct their swap business with non-U.S. persons through SRSs to avoid
application of the Dodd-Frank Act MSP requirements. Allowing swaps
entered into by SRSs, which have the potential to affect the ultimate
U.S. parent entity and U.S. commerce, to be treated differently
depending on how the parties structure their transactions could
undermine the effectiveness of the Dodd-Frank Act swap provisions and
related Commission regulations addressed by the Final Rule. Applying
the same standard to similar swap positions helps to limit those
incentives and regulatory implications.\309\ Additionally, the SRS
definition already includes a carve-out for affiliates of U.S. BHCs and
IHCs. This approach allows for streamlined application of the rule, and
the comment letters have not identified specific problems caused by
applying the same standard to similar swap positions.
---------------------------------------------------------------------------
\308\ Final Sec. 23.23(c)(1).
\309\ Proposed Rule, 85 FR at 974-975.
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In addition, a person's status as an SRS is determined at the
entity level and, thus, an SRS is required to include in its MSP
threshold calculations the swap positions of its operations that are
part of the same legal person, including those of its branches.\310\
---------------------------------------------------------------------------
\310\ Id.
---------------------------------------------------------------------------
For added clarity, the Commission also notes that an Other Non-U.S.
Person is not be required to include swap positions entered into with
an SRS in its MSP threshold calculations, unless the SRS is also a
Guaranteed Entity and no other exception applies.
2. Swap Positions With a U.S. Person
The Commission proposed to require an Other Non-U.S. Person to
count toward its MSP registration thresholds swap positions where the
counterparty is a U.S. person, other than swaps with a foreign branch
of a registered U.S. SD if such swaps are conducted through a foreign
branch of such registered SD.\311\
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\311\ Proposed Sec. 23.23(c)(2)(i); Proposed Rule, 85 FR at
975, 1004.
---------------------------------------------------------------------------
IIB/SIFMA supported this approach, stating that it is consistent
with the Guidance, except that it does not require that swaps with a
foreign branch of a registered SD be subject to daily variation margin
in order to be excluded from an Other Non-U.S. Person's MSP
[[Page 56958]]
registration thresholds. IIB/SIFMA noted that this was appropriate
because the Dodd-Frank Act's margin requirements independently impose
variation margin requirements on SDs where appropriate. Further, they
stated that the change removes the complexity of non-U.S. persons
having to determine their own ``financial entity'' status in order to
evaluate whether variation margin was required now that the uncleared
swap margin rules use a slightly different ``financial end user''
definition.
After considering this comment, the Commission is adopting this
aspect of the cross-border application of the MSP registration
thresholds as proposed.\312\ Generally, a potential MSP must include in
its MSP threshold calculations any swap position with a U.S. person. As
discussed above, the term ``U.S. person'' encompasses persons that
inherently raise the concerns intended to be addressed by the Dodd-
Frank Act, regardless of the U.S. person status of their counterparty.
The default or insolvency of the non-U.S. person would have a direct
and significant adverse effect on a U.S. person and, by virtue of the
U.S. person's significant nexus to the U.S. financial system,
potentially could result in adverse effects or disruption to the U.S.
financial system as a whole, particularly if the non-U.S. person's swap
positions are substantial enough to exceed an MSP registration
threshold.\313\
---------------------------------------------------------------------------
\312\ Final Sec. 23.23(c)(2)(i).
\313\ Proposed Rule, 85 FR at 975.
---------------------------------------------------------------------------
The Final Rule's approach in allowing a non-U.S. person to exclude
swap positions conducted through a foreign branch of a registered SD
counterparty is consistent with the approach described in section
III.B.2 for cross-border treatment with respect to SDs.\314\ In this
regard, a swap conducted through a foreign branch of a registered SD
triggers certain Dodd-Frank Act transactional requirements (or
comparable requirements), particularly margin requirements, and
therefore mitigates concern that this exclusion could be used to engage
in swap activities outside the Dodd-Frank Act regime.
---------------------------------------------------------------------------
\314\ Id.
---------------------------------------------------------------------------
Accordingly, the Commission has determined that it is appropriate
and consistent with section 2(i) of the CEA to allow a non-U.S. person,
which is not a Guaranteed Entity or SRS, to exclude from its MSP
threshold calculations any swaps conducted through a foreign branch of
a registered SD counterparty. The Commission recognizes that the
Guidance provided that such swaps would need to be cleared or that the
documentation of the swaps would have to require the foreign branch to
collect daily variation margin, with no threshold, on its swaps with
such non-U.S. person.\315\ The Final Rule does not include such a
requirement because the foreign branch of the registered SD is
nevertheless required to post and collect margin, as required by the SD
margin rules. In addition, a non-U.S. person's swaps conducted through
a foreign branch of a registered SD counterparty must be addressed in
the SD's risk management program. Such program must account for, among
other things, overall credit exposures to non-U.S. persons.\316\
---------------------------------------------------------------------------
\315\ Guidance, 78 FR at 45324-45325.
\316\ See 17 CFR 23.600(c)(4)(ii), requiring registered SDs and
MSPs to have credit risk policies and procedures that account for
daily measurement of overall credit exposure to comply with
counterparty credit limits, and monitoring and reporting of
violations of counterparty credit limits performed by personnel that
are independent of the business trading unit. See also 17 CFR
23.600(c)(1)(i), requiring the senior management and the governing
body of each SD and MSP to review and approve credit risk tolerance
limits for the SD or MSP.
---------------------------------------------------------------------------
In response to a request for comment,\317\ IIB/SIFMA supported not
requiring a U.S. branch of a non-U.S. banking organization to include
all of its swap positions in its MSP calculation as if they were swaps
entered into by a U.S. person or to require an Other Non-U.S. Person to
include in its MSP calculation dealing swaps conducted through such a
branch. IIB/SIFMA stated that swaps between a U.S. branch and an Other
Non-U.S. Person do not present risks to the United States that would
justify applying the Commission's MSP requirements. Consistent with the
Proposed Rule, the Commission has determined not to require a U.S.
branch to include swaps with Other Non-U.S. Persons in its MSP
threshold calculations as if they were swaps entered into by a U.S.
person. Similarly, the Final Rule does not require an Other Non-U.S.
Person to include in its MSP calculation dealing swaps booked in a U.S.
branch.
---------------------------------------------------------------------------
\317\ Proposed Rule, 85 FR at 977.
---------------------------------------------------------------------------
3. Guaranteed Swap Positions
(i) Swap Positions Entered Into by a Guaranteed Entity
The Commission proposed to require a non-U.S. person to include in
its MSP calculation each swap position with respect to which it is a
Guaranteed Entity.\318\ No comments were received regarding this aspect
of the Proposed Rule, and the Commission is adopting this aspect of the
cross-border application of the MSP registration thresholds as
proposed.\319\
---------------------------------------------------------------------------
\318\ Proposed Sec. 23.23(c)(2)(ii); Proposed Rule, 85 FR at
975, 1004.
\319\ Final Sec. 23.23(c)(2)(ii).
---------------------------------------------------------------------------
As explained in the context of the SD de minimis threshold
calculation, the Commission believes that the swap positions of a
Guaranteed Entity are identical, in relevant aspects, to those entered
into directly by a U.S. person and thus present similar risks to the
stability of the U.S. financial system or of U.S. entities.\320\ As a
result of the guarantee, the U.S. guarantor generally bears risk
arising out of the swap as if it had entered into the swap directly.
Absent the guarantee from the U.S. person, a counterparty may choose
not to enter into the swap or may not do so on the same terms. Treating
Guaranteed Entities differently from U.S. persons could also create a
substantial regulatory loophole, allowing transactions that have a
similar connection to or effect on U.S. commerce to be treated
differently depending on how the parties are structured and thereby
undermining the effectiveness of the Dodd-Frank Act swap provisions and
related Commission regulations.
---------------------------------------------------------------------------
\320\ See supra section III.B.3.i; Proposed Rule, 85 FR at 975.
---------------------------------------------------------------------------
(ii) Swaps Positions Entered Into With a Guaranteed Entity
The Commission also proposed to require an Other Non-U.S. Person to
count toward its MSP registration thresholds swap positions with a
counterparty that is a Guaranteed Entity, except when the counterparty
is registered as an SD.\321\
---------------------------------------------------------------------------
\321\ Proposed Sec. 23.23(c)(2)(iii); Proposed Rule, 85 FR at
975-976, 1004.
---------------------------------------------------------------------------
IIB/SIFMA supported this approach, stating that it is consistent
with the Guidance, except that it does not require that swaps with a
Guaranteed Entity be subject to daily variation margin in order to be
excluded from an Other Non-U.S. Person's MSP registration thresholds.
IIB/SIFMA noted that this was appropriate because the Dodd-Frank Act's
margin requirements independently impose variation margin requirements
on SDs where appropriate. Further, they stated that the change removes
the complexity of non-U.S. persons having to determine their own
``financial entity'' status in order to evaluate whether variation
margin was required now that the uncleared swap margin rules use a
slightly different ``financial end user'' definition.
The Commission is adopting as proposed the requirement that a non-
U.S. person must count swap positions
[[Page 56959]]
with a Guaranteed Entity counterparty, except when the counterparty is
registered as an SD.\322\ The guarantee of a swap is an integral part
of the swap and, as discussed above, counterparties may not be willing
to enter into a swap with a Guaranteed Entity in the absence of the
guarantee. The Commission also recognizes that, given the highly
integrated corporate structures of global financial enterprises,
financial groups may elect to conduct their swap activity in a number
of different ways, including through a U.S. person or through a non-
U.S. affiliate that benefits from a guarantee from a U.S. person.
Therefore, in order to avoid creating a substantial regulatory
loophole, the Commission has determined that swap positions of a non-
U.S. person with a counterparty whose obligations under the swaps are
guaranteed by a U.S. person must receive the same treatment as swap
positions with a U.S. person.\323\
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\322\ Final Sec. 23.23(c)(2)(iii). The MSP provision does not
include an exception for swap positions with non-U.S. persons
guaranteed by a non-financial entity, or for swap positions with a
Guaranteed Entity where such Guaranteed Entity is itself below the
SD de minimis threshold under paragraph (4)(i) of the ``swap
dealer'' definition in Sec. 1.3 and is affiliated with a registered
SD, similar to the carve-outs in the SD provision. See Final Sec.
23.23(b)(2)(iii)(B) and (C); supra section III.B.3.ii.
\323\ Proposed Rule, 85 FR at 975-976.
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However, similar to the discussion regarding SDs in section
III.B.3.ii, where an Other Non-U.S. Person enters into a swap with a
Guaranteed Entity that is a registered SD, it is appropriate to permit
the non-U.S. person not to count its swap position with the Guaranteed
Entity against the non-U.S. person's MSP thresholds, because one
counterparty to the swap is a registered SD subject to comprehensive
swap regulation and operating under the oversight of the Commission.
For example, the swap position must be addressed in the SD's risk
management program and account for, among other things, overall credit
exposures to non-U.S. persons.\324\ In addition, a non-U.S. person's
swap positions with a Guaranteed Entity that is an SD are included in
exposure calculations and attributed to the U.S. guarantor for purposes
of determining whether the U.S. guarantor's swap exposures are
systemically important on a portfolio basis and therefore require the
protections provided by MSP registration. Therefore, in these
circumstances, the Commission has determined that the non-U.S. person
need not count such a swap position toward its MSP thresholds.\325\
---------------------------------------------------------------------------
\324\ See 17 CFR 23.600(c)(4)(ii). See also 17 CFR
23.600(c)(1)(i).
\325\ Proposed Rule, 85 FR at 975-976.
---------------------------------------------------------------------------
C. Attribution Requirement
In the Entities Rule, the Commission and the SEC provided a joint
interpretation that an entity's swap positions in general are
attributed to a parent, other affiliate, or guarantor for purposes of
the MSP analysis to the extent that the counterparties to those
positions have recourse to the parent, other affiliate, or guarantor in
connection with the position, such that no attribution is required in
the absence of recourse.\326\ Even in the presence of recourse,
however, attribution of a person's swap positions to a parent, other
affiliate, or guarantor is not necessary if the person is already
subject to capital regulation by the Commission or the SEC or is a U.S.
entity regulated as a bank in the United States (and is therefore
subject to capital regulation by a prudential regulator).\327\
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\326\ Entities Rule, 77 FR at 30689.
\327\ Id.
---------------------------------------------------------------------------
The Commission proposed to address the cross-border application of
the attribution requirement in a manner consistent with the Entities
Rule and CEA section 2(i) and generally comparable to the approach
adopted by the SEC.\328\ Specifically, the Commission stated that the
swap positions of an entity, whether a U.S. or non-U.S. person, should
not be attributed to a parent, other affiliate, or guarantor for
purposes of the MSP analysis in the absence of a guarantee. The
Commission stated that even in the presence of a guarantee, attribution
would not be required if the entity that entered into the swap directly
is subject to capital regulation by the Commission or the SEC or is
regulated as a bank in the United States.\329\ Additionally, the
Commission invited comment on whether it should modify its
interpretation with regard to the attribution requirement to provide
that attribution of a person's swap positions to a parent, other
affiliate, or guarantor would not be required if the person is subject
to capital standards that are comparable to and as comprehensive as the
capital regulations and oversight by the Commission, SEC, or a U.S.
prudential regulator.\330\
---------------------------------------------------------------------------
\328\ Proposed Rule, 85 FR at 976. See SEC Cross-Border Rule, 79
FR at 47346-47348.
\329\ Proposed Rule, 85 FR at 976.
\330\ Id. at 977.
---------------------------------------------------------------------------
IIB/SIFMA stated that the Guidance clarified that the exception for
entities subject to capital regulation also includes entities subject
to non-U.S. capital standards that are comparable to, and as
comprehensive as, the capital regulations and oversight by the
Commission, SEC, or a U.S. prudential regulator (i.e., Basel compliant
capital standards and oversight by a G20 prudential supervisor).
Therefore, IIB/SIFMA recommended that the attribution requirement in
the MSP threshold context should exclude entities subject to Basel
compliant capital standards and oversight by a G20 prudential
supervisor, as those entities should pose no higher risk than entities
subject to capital regulation by the Commission, SEC, or a prudential
regulator.
The Commission is adopting the interpretation of the attribution
requirement as discussed in the Proposed Rule, with a clarification.
The Commission has determined that, in addition to entities that are
subject to capital regulation by the Commission, SEC, or U.S.
prudential regulators, the attribution requirement in the MSP threshold
context also excludes entities subject to Basel compliant capital
standards and oversight by a G20 prudential supervisor. As noted by
IIB/SIFMA in response to a request for comment, this approach is
consistent with the Guidance, and is recommended because those entities
pose no higher risk than entities subject to capital regulation by the
Commission, SEC, or a prudential regulator. The Commission has further
determined that the swap positions of an entity that is required to
register as an MSP, or whose MSP registration is pending, are not
subject to the attribution requirement.
Generally, if a guarantee is present, however, and the entity being
guaranteed is not subject to capital regulation (as described above),
whether the attribution requirement applies depends on the U.S. person
status of the person to whom there is recourse under the guarantee
(i.e., the U.S. person status of the guarantor). Specifically, a U.S.
person guarantor attributes to itself any swap position of an entity
subject to a guarantee, whether a U.S. person or a non-U.S. person, for
which the counterparty to the swap has recourse against that U.S.
person guarantor. The Commission finds that when a U.S. person acts as
a guarantor of a swap position, the guarantee creates risk within the
United States of the type that MSP regulation is intended to address,
regardless of the U.S. person status of the entity subject to a
guarantee or its counterparty.\331\
---------------------------------------------------------------------------
\331\ Id. at 976. See Entities Rule, 77 FR at 30689 (attribution
is intended to reflect the risk posed to the U.S. financial system
when a counterparty to a position has recourse against a U.S.
person).
---------------------------------------------------------------------------
A non-U.S. person attributes to itself any swap position of an
entity for which the counterparty to the swap has
[[Page 56960]]
recourse against the non-U.S. person unless all relevant persons (i.e.,
the non-U.S. person guarantor, the entity whose swap positions are
guaranteed, and its counterparty) are non-U.S. persons that are not
Guaranteed Entities.\332\ In this regard, the Commission finds that
when a non-U.S. person provides a guarantee with respect to the swap
position of a particular entity, the economic reality of the swap
position is substantially identical, in relevant respects, to a
position entered into directly by the non-U.S. person.
---------------------------------------------------------------------------
\332\ As noted above, the term Guaranteed Entity is limited to
entities that are guaranteed by a U.S. person.
---------------------------------------------------------------------------
In addition, the Commission believes that entities subject to a
guarantee are able to enter into significantly more swap positions (and
take on significantly more risk) as a result of the guarantee than they
can otherwise, amplifying the risk of the non-U.S. person guarantor's
inability to carry out its obligations under the guarantee. Given the
types of risk that MSP regulation is intended to address, the
Commission has a strong regulatory interest in ensuring that the
attribution requirement applies to non-U.S. persons that provide
guarantees to U.S. persons and Guaranteed Entities. Accordingly, the
Commission has determined that a non-U.S. person must attribute to
itself the swap positions of any entity for which it provides a
guarantee unless it, the entity subject to the guarantee, and its
counterparty are all non-U.S. persons that are not Guaranteed Entities.
D. Certain Exchange-Traded and Cleared Swaps
Consistent with its approach for SDs, the Commission proposed to
allow a non-U.S. person that is not a Guaranteed Entity or an SRS to
exclude from its MSP calculation any swap position that it anonymously
enters into on a DCM, a registered SEF or a SEF exempted from
registration by the Commission pursuant to section 5h(g) of the CEA, or
an FBOT registered with the Commission pursuant to part 48 of its
regulations,\333\ if such swap is also cleared through a registered or
exempt DCO.\334\
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\333\ The Commission considers the exception described herein
also to apply with respect to an FBOT that provides direct access to
its order entry and trade matching system from within the U.S.
pursuant to no-action relief issued by Commission staff.
\334\ Proposed Sec. 23.23(d); Proposed Rule, 85 FR at 976,
1004.
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As discussed in section III.D in connection with the cross-border
application of the SD registration threshold, as compared to the
Proposed Rule, IIB/SIFMA, JFMC/IBAJ, JBA, and JSCC advocated for
expansion of this exception, while Better Markets stated that the
proposed exception should be narrowed.
Consistent with the cross-border application of the SD registration
threshold, the Commission is adopting this exception as proposed.\335\
When a non-U.S. person enters into a swap position that is executed
anonymously on a registered or exempt SEF, DCM, or registered FBOT, the
Commission recognizes that the non-U.S. person does not have the
necessary information about its counterparty to determine whether the
swap position should be included in its MSP calculation. The Commission
has determined that in this case the swap position should be excluded
altogether due to these practical difficulties.\336\ However, the
exception is limited to Other Non-U.S. Persons since, as discussed,
Guaranteed Entities and SRSs have to count all of their swap positions
towards the threshold, so the practical obstacles that would challenge
Other Non-U.S. Persons are not relevant for Guaranteed Entities and
SRSs.
---------------------------------------------------------------------------
\335\ Final Sec. 23.23(d).
\336\ See Proposed Rule, 85 FR at 976.
---------------------------------------------------------------------------
The Final Rule expands the exception as it appeared in the Guidance
to include SEFs and DCOs that are exempt from registration under the
CEA, and also states that SRSs do not qualify for this exception. The
CEA provides that the Commission may grant an exemption from
registration if it finds that a foreign SEF or DCO is subject to
comparable, comprehensive supervision and regulation by the appropriate
governmental authorities in the SEF or DCO's home country.\337\ The
policy rationale for providing relief to swap positions anonymously
executed on a SEF, DCM, or FBOT and then cleared also extends to swaps
executed on a foreign SEF and/or cleared through a foreign DCO that has
been granted an exemption from registration. As noted, the foreign SEF
or DCO is subject to comprehensive regulation that is comparable to
that applicable to registered SEFs and DCOs.
---------------------------------------------------------------------------
\337\ See CEA sections 5h(g) for the SEF exemption provision and
5b(h) for the DCO exemption provision.
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The Commission is not at this time expanding the exception to allow
an Other Non-U.S. Person to exclude swap positions executed anonymously
on an exchange and which are subsequently cleared, regardless of
whether the exchange and clearing organization are registered or exempt
from registration with the Commission. Commenters argued that if the
Other Non-U.S. Person's original counterparty was a U.S. person, the
Commission's SEF and DCO registration requirements would independently
require the trading venue and clearing organization to register with
the Commission or obtain an exemption from registration. While guidance
from DMO has suggested that this might be the case with respect to SEFs
and DCMs,\338\ the Commission has not taken a formal position on
whether registration of a SEF or DCM is required where a U.S. person
participates on the trading facility, and has stated that it will do so
in the future.\339\ The Commission may consider expanding the exception
pending other amendments to the SEF/DCO regulations.
---------------------------------------------------------------------------
\338\ Division of Market Oversight Guidance on Application of
Certain Commission Regulations to Swap Execution Facilities, at 2
n.8 (Nov. 15, 2013) (``[DMO] expects that a multilateral swaps
trading platform located outside the United States that provides
U.S. persons . . . with the ability to trade or execute swaps on or
pursuant to the rules of the platform, either directly or indirectly
through an intermediary, will register as a SEF or DCM.'').
\339\ See Swap Execution Facilities and Trade Execution
Requirement, 83 FR 61946, 61961 n.106 (``[T]he Commission learned
that many foreign multilateral swaps trading facilities prohibited
U.S. persons and U.S-located persons from accessing their facilities
due to the uncertainty that the guidance created with respect to SEF
registration. The Commission understands that these prohibitions
reflect concerns that U.S. persons and U.S.-located persons
accessing their facilities would trigger the SEF registration
requirement. . . . [T]he Commission expects to address the
application of CEA section 2(i) to foreign multilateral swaps
trading facilities, including foreign swaps broking entities, in the
future.'').
---------------------------------------------------------------------------
In response to comments that anonymity should not be required, the
Commission proposed this exception (and included it in the Guidance)
because when a trade is entered into anonymously on an exchange, the
non-U.S. person would not have the necessary information about its
counterparty to determine whether the swap position should be included
in its MSP calculation.\340\ Therefore, these practical difficulties
justify exclusion of the swap position altogether. However, if the
identity of the counterparty is known to be a U.S. person, then the
Other Non-U.S. Person should be seen to be participating in the U.S.
swap market. Thus, the Commission has determined that such a non-U.S.
person should count such swap positions towards its MSP calculation as
otherwise required. As stated above, where the U.S. person status of a
counterparty is known to the non-U.S. person, the Commission sees no
reason to treat a cleared swap differently in the cross-border context
than such swap
[[Page 56961]]
position is treated in the domestic U.S. context.
---------------------------------------------------------------------------
\340\ Proposed Rule, 85 FR at 976; Guidance, 78 FR 45325.
---------------------------------------------------------------------------
V. ANE Transactions
A. Background and Proposed Approach
The ANE Staff Advisory provided that a non-U.S. SD would generally
be required to comply with Transaction-Level Requirements (as that term
was used in the Guidance) when entering into ANE Transactions.\341\
---------------------------------------------------------------------------
\341\ See ANE Staff Advisory. The ANE Staff Advisory represented
the views of DSIO only, and not necessarily those of the Commission
or any other office or division thereof. As discussed in section
VI.A, infra, the Transaction-Level Requirements are: (1) Required
clearing and swap processing; (2) margining (and segregation) for
uncleared swaps; (3) mandatory trade execution; (4) swap trading
relationship documentation; (5) portfolio reconciliation and
compression; (6) real-time public reporting; (7) trade confirmation;
(8) daily trading records; and (9) external business conduct
standards.
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In the Proposed Rule the Commission stated that, based on the
Commission's consideration of its experience under the Guidance, the
comments it had received pursuant to the ANE Request for Comment,\342\
respect for international comity, and the Commission's desire to focus
its authority on potential significant risks to the U.S. financial
system, the Commission had determined that ANE Transactions will not be
considered a relevant factor for purposes of applying the Proposed
Rule.\343\ Therefore, under the Proposed Rule, all foreign-based swaps
entered into between a non-U.S. swap entity and a non-U.S. person would
be treated the same regardless of whether the swap is an ANE
Transaction. The Commission further noted that, to the extent the
Proposed Rule is finalized, this treatment would effectively supersede
the ANE Staff Advisory with respect to the application of the group B
and C requirements (discussed in sections VI.A.2 and VI.A.3 below) to
ANE Transactions.
---------------------------------------------------------------------------
\342\ In the January 2014 ANE Request for Comment, the
Commission requested comments on all aspects of the ANE Staff
Advisory, including: (1) The scope and meaning of the phrase
``regularly arranging, negotiating, or executing'' and what
characteristics or factors distinguish ``core, front-office''
activity from other activities; and (2) whether the Commission
should adopt the ANE Staff Advisory as Commission policy, in whole
or in part.
\343\ See Proposed Rule, 85 FR at 977-979.
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With respect to its experience, the Commission noted that the ANE
No-Action Relief, which went into effect immediately after issuance of
the ANE Staff Advisory, generally relieved non-U.S. swap entities from
the obligation to comply with most Transaction-Level Requirements when
entering into swaps with most non-U.S. persons.\344\ The Commission
also noted that in the intervening period, the Commission had not found
a negative effect on either its ability to effectively oversee non-U.S.
swap entities, or the integrity and transparency of U.S. derivatives
markets.
---------------------------------------------------------------------------
\344\ Specifically, non-U.S. persons that are neither guaranteed
nor conduit affiliates, as described in the Guidance.
---------------------------------------------------------------------------
Noting its interest in international comity, the Commission
observed that ANE Transactions involve swaps between non-U.S. persons,
and thus the Commission considered whether the U.S. aspect of ANE
Transactions should override its general view that such transactions
should qualify for the same relief provided under the Proposed Rule
(and the Guidance) for swaps between certain non-U.S. persons (e.g., an
exception from compliance with Transaction-Level Requirements under the
Guidance and group B and C requirements under the Proposed Rule, as
discussed below). The Commission expressly recognized that a person
that, in connection with its dealing activity, engages in market-facing
activity using personnel located in the United States is conducting a
substantial aspect of its dealing business in the United States. But,
because the transactions involve two non-U.S. persons, and the
financial risk of the transactions lies outside the United States, the
Commission considered the extent to which the underlying regulatory
objectives of the Dodd-Frank Act would be advanced in light of other
policy considerations, including undue market distortions and
international comity, when making a determination of the extent to
which the Dodd-Frank Act swap requirements would apply to ANE
Transactions.
The Commission noted that the consequences of not applying the
Dodd-Frank Act swap requirements would be mitigated in two respects.
First, persons engaging in any aspect of swap transactions within the
U.S. remain subject to the CEA and Commission regulations prohibiting
the employment, or attempted employment, of manipulative, fraudulent,
or deceptive devices, such as section 6(c)(1) of the CEA,\345\ and
Sec. 180.1.\346\ The Commission thus would retain anti-fraud and anti-
manipulation authority, and would continue to monitor the trading
practices of non-U.S. persons that occur within the territory of the
United States in order to enforce a high standard of customer
protection and market integrity. Even where a swap is entered into by
two non-U.S. persons, the United States has a significant interest in
deterring fraudulent or manipulative conduct occurring within its
borders and cannot be a haven for such activity.
---------------------------------------------------------------------------
\345\ 7 U.S.C. 9(1).
\346\ 17 CFR 180.1.
---------------------------------------------------------------------------
Second, with respect to more specific regulation of swap dealing in
accordance with the Commission's swap regime, the Commission noted
that, in most cases, non-U.S. persons entering into ANE Transactions
would be subject to regulation and oversight in their home
jurisdictions similar to the Commission's Transaction-Level
Requirements as most of the major swap trading centers have implemented
similar risk mitigation requirements.\347\
---------------------------------------------------------------------------
\347\ See 2019 FSB Progress Report, Table M.
---------------------------------------------------------------------------
With respect to market distortion, the Commission gave weight to
comments submitted in response to the ANE Request for Comment, who
argued that application of Transaction-Level Requirements to ANE
Transactions would cause non-U.S. SDs to relocate personnel to other
countries (or otherwise terminate agency contracts with U.S.-based
agents) in order to avoid Dodd-Frank Act swap regulation or to have to
interpret and apply what the commenters considered a challenging ANE
analysis, thereby potentially increasing market fragmentation.\348\
---------------------------------------------------------------------------
\348\ Proposed Rule, 85 FR at 977.
---------------------------------------------------------------------------
The Commission also gave weight to the regulatory interests of the
home jurisdictions of non-U.S. persons engaged in ANE Transactions.
Because the risk of the resulting swaps lies in those home countries
and not the U.S. financial system, the Commission recognized that, with
the exception of enforcing the prohibition on fraudulent or
manipulative conduct taking place in the United States, non-U.S.
regulators will have a greater incentive to regulate the swap dealing
activities of such non-U.S. persons--such as, for example, with respect
to business conduct standards with counterparties, appropriate
documentation, and recordkeeping. In these circumstances, where the
risk lies outside the U.S. financial system, the Commission recognized
the greater supervisory interest of the authorities in the home
jurisdictions of the non-U.S. persons. The Commission also noted that
no major swap regulatory jurisdiction applies its regulatory regime to
U.S. entities engaging in ANE Transactions within its territory.
In light of the foregoing, the Commission determined that the
mitigating effect of the anti-fraud and anti-manipulation authority
retained by
[[Page 56962]]
the Commission and the prevalence of applicable regulatory requirements
similar to the Commission's own, the likelihood of market fragmentation
and disruption, the Commission's respect for the regulatory interests
of the foreign jurisdictions where the actual financial risks of ANE
Transactions primarily lie in accordance with the principles of
international comity, and the awareness that application of its swap
requirements in the ANE context would make the Commission an outlier
among the major swap regulatory jurisdictions, outweighed the
Commission's regulatory interest in applying its swap requirements to
ANE Transactions differently than such were otherwise proposed to be
applied to swaps between Other Non-U.S. Persons. The Commission invited
comment on all aspects of the proposed treatment of ANE Transactions.
B. Summary of Comments
Neither Better Markets nor AFR supported the Commission's
determination to disregard ANE Transactions and commented that the
Commission should not permit U.S.-located personnel to arrange,
negotiate, or execute swaps on behalf of the non-U.S. affiliates of
U.S. BHCs (and others) without being subject to the full panoply of
U.S. regulations. Better Markets stated its belief that any such policy
facilitates avoidance, if not evasion, and regulatory arbitrage. Better
Markets specifically disputed the Commission's contention in the
Proposed Rule that ``the financial risk of the [ANE] transactions
[only] lie outside of the United States,'' which Better Markets
contends is demonstrably untrue and conflicts with the Commission's own
views elsewhere in the Proposed Rule, presumably referring to the
proposed treatment of swaps of non-U.S. persons with Guaranteed
Entities and SRSs, which are also non-U.S. persons that the Commission
nevertheless proposed generally would be subject to certain Dodd-Frank
Act requirements.\349\
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\349\ As discussed below, the Final Rule excepts certain
transactions with ``SRS End-Users'' from the Group B requirements,
excepts certain transactions with Guaranteed Entities and SRSs from
the Group C requirements, and provides a limited exception from the
Group B requirements for transactions entered into by Guaranteed
Entities and SRSs that are swap entities with certain non-U.S.
persons. See infra sections VI.B.3 and VI.B.5.
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On the other hand, AIMA, Chatham Financial, CS, IIB/SIFMA, ISDA,
and JFMC/IBAJ supported the Commission's decision in the Proposed Rule
to only apply anti-fraud and anti-manipulation rules to ANE
Transactions, agreeing in various respects with the Commission's
analysis that:
1. ANE Transactions do not present direct financial risk to the
United States;
2. The Commission's anti-fraud and anti-manipulation rules that
would remain applicable would mitigate potential concerns associated
with any potential misconduct occurring in connection with ANE
Transactions and any other conduct subject to the jurisdiction of the
CEA;
3. Most ANE Transactions are expected to be subject to foreign
regulatory requirements similar to the Commission's own, unlike at the
time of the adoption of the Guidance; and
4. Applying the Commission's rules to ANE Transactions would likely
result in disruptive and unnecessary market fragmentation as
transactions ordinarily arranged, negotiated, or executed by U.S.
personnel would shift to non-U.S. locations, resulting in decreased
Commission oversight.
Commenting on specific aspects of the Commission's proposed
treatment of ANE Transactions, AIMA encouraged the CFTC to adopt the
SEC's approach and require counting of ANE Transactions toward the SD
registration threshold and to apply reporting requirements to ensure
that a baseline level of transparency is maintained.
IIB/SIFMA recognized that the Proposed Rule's approach to ANE
Transactions would deviate from that taken by the SEC, but argued that
this deviation is justified. They argued that the relationship of the
security-based swap market to the cash securities markets, and
Congress's decision to define security-based swaps as ``securities,''
presents some justification for the SEC to apply a test for use of U.S.
jurisdictional means to conduct security-based swap business that is
similar to the test that applies in connection with existing, pre-Dodd-
Frank Act securities broker-dealer regulation, while no similar
justification applies in connection with swaps regulation by the
Commission, as the swaps market generally trades independently of the
U.S. futures market, and Congress did not define swaps to be a type of
futures contract.
IIB/SIFMA, CS, JFMC/IBAJ, and ISDA also commented on the continuing
viability of the ANE Staff Advisory. These commenters stated that,
currently, ANE Transactions are subject to the ANE Staff Advisory and
related ANE No-Action Relief, noting that, if adopted, the Proposed
Rule would supersede the ANE Staff Advisory, but only with respect to
those requirements covered by the Proposed Rule. These commenters noted
that certain other Commission requirements--mandatory clearing,
mandatory trade execution, and real-time public reporting--would remain
subject to the ANE Staff Advisory and related ANE No-Action Relief,
pending further Commission action. To achieve a coherent, Commission-
driven ANE Transaction policy, these commenters all requested that the
Commission immediately direct staff to withdraw the ANE Staff Advisory
(which, in their view, would render the ANE No-Action Relief moot).
ISDA noted that the ANE No-Action Relief was issued two weeks after
the ANE Staff Advisory and that market participants have operated under
this relief for almost seven years. ISDA argued that, during this time,
to ISDA's knowledge, there have been no regulatory concerns associated
with these transactions that would warrant a change in course. Thus,
should the Commission decide to switch gears and apply clearing,
trading, and real-time reporting requirements to ANE Transactions,
market participants would incur significant compliance costs without
commensurate benefit to the Commission's regulatory oversight.
Although Citadel agreed that the Commission should apply its
jurisdiction over ANE Transactions in a targeted manner, taking into
account principles of international comity, as well as its supervisory
interests and statutory objectives, Citadel argued that because the
Commission's relevant statutory objectives include not only mitigating
systemic risk, but also increasing transparency, competition, and
market integrity, the Commission should, at a minimum, apply regulatory
and public reporting requirements to ANE Transactions. AIMA also
encouraged the Commission to apply reporting requirements to ensure
that a baseline level of transparency is maintained. Citadel stated
that application of reporting requirements to these transactions would
enable the Commission to better monitor for disruptive trading
practices and provide the necessary data regarding overall market
trading activity to allow the Commission to evaluate market trends and
accurately assess the effect of other reforms implemented in the swaps
market.
Stating that ANE Transactions could account for a material portion
of total swap dealing activity in the United States, Citadel claimed
that market transparency in EUR interest rate swaps for U.S. investors
has been greatly reduced based on data showing that, following issuance
of the ANE No-Action Relief, interdealer trading activity in EUR
interest rate swaps
[[Page 56963]]
began to be booked almost exclusively to non-U.S. entities, a fact
pattern that Citadel believes is ``consistent with (although not direct
proof of) swap dealers strategically choosing the location of the desk
executing a particular trade in order to avoid trading in a more
transparent and competitive setting.'' Citadel further noted that
applying regulatory and public reporting requirements to ANE
Transactions would be consistent with the SEC's approach.
C. Commission Determination
Having considered the comments received, the Commission's
consideration of its experience under the Guidance, respect for
international comity, and the Commission's desire to focus its
authority on potential significant risks to the U.S. financial system,
the Commission has determined that, consistent with its rationale
expressed in the Proposed Rule summarized above, ANE Transactions will
not be considered a relevant factor for purposes of applying the Final
Rule.
Regarding the many comments and suggestions received regarding
whether the Commission should withdraw the ANE Staff Advisory and
related ANE No-Action Relief and extend its proposed treatment of ANE
Transactions to requirements in addition to the group B and group C
requirements, in 2014, subsequent to the publication of the ANE Staff
Advisory, the Commission, citing the complex legal and policy issues
raised by the statements in the ANE Staff Advisory, requested comments
on whether the Transaction-Level Requirements should apply to swap
transactions between certain non-U.S. SDs and non-U.S. counterparties
that are ``arranged, negotiated, or executed'' by the SDs' personnel or
agents located in the United States.\350\ The Commission did not
follow-up on the request for comment. In this rulemaking, the
Commission is addressing the issue with respect to the group B and
group C requirements; the Commission intends to address the issue with
respect to the remaining Transaction-Level Requirements (the
``Unaddressed TLRs'') in connection with future cross-border
rulemakings relating to such requirements. Until such time, the
Commission will not consider, as a matter of policy, a non-U.S. swap
entity's use of their personnel or agents located in the United States
to ``arrange, negotiate, or execute'' swap transactions with non-U.S.
counterparties for purposes of determining whether Unaddressed TLRs
apply to such transactions. As part of any such rulemaking, the
Commission expects to first engage in fact-finding to determine the
extent to which ANE Transactions raise policy concerns that are not
otherwise addressed by the CEA or Commission regulations. In this
connection, DSIO is withdrawing the ANE Staff Advisory and, together
with the Division of Clearing and Risk and DMO, is withdrawing the ANE
No-Action Relief and granting certain non-U.S. SDs no-action relief
with respect to the applicability of the Unaddressed TLRs to their
transactions with non-U.S. counterparties that are arranged,
negotiated, or executed in the United States.
---------------------------------------------------------------------------
\350\ See ANE Request for Comment, supra note 12.
---------------------------------------------------------------------------
The Commission will take AIMA and Citadel's comments regarding the
advisability of applying the Commission's regulatory and real-time
reporting requirements to ANE Transactions under advisement when
considering the cross-border application of those requirements in a
future rulemaking.
With respect to AFR and Better Markets' contentions that the
Commission should not permit derivatives dealers located within the
U.S. to engage in transactions using U.S. personnel on U.S. soil
without being subject to U.S. law, the Proposed Rule clearly stated
that the Commission recognized that a person that, in connection with
its dealing activity, engages in market-facing activity using personnel
located in the United States is conducting a substantial aspect of its
dealing business in the United States and is subject to U.S. law. But,
because the transactions involve two non-U.S. persons, and the
financial risk of the transactions lies primarily outside the United
States, the Commission also recognized that it must consider the extent
to which the underlying regulatory objectives of the Dodd-Frank Act
would be advanced in light of other policy considerations, including
undue market distortions and international comity, when making a
determination of the extent to which the Dodd-Frank Act swap
requirements should apply to ANE Transactions.
With respect to AIMA's comment encouraging the CFTC to adopt the
SEC's approach with respect to ANE Transactions by requiring counting
of ANE Transactions toward the SD registration threshold, the
Commission sees little value in requiring counting of ANE Transactions
when, if such counting resulted in SD registration, such ANE
Transactions would not be subject to most of the SD requirements. ANE
Transactions by definition are swaps between non-U.S. persons, the risk
of which lies primarily outside of the U.S., and which, in accordance
with the Commission's determination above and the regulatory exceptions
discussed immediately below, are generally excepted from the group B
and C requirements.
VI. Exceptions From Group B and Group C Requirements, Substituted
Compliance for Group A and Group B Requirements, and Comparability
Determinations
As discussed in the Proposed Rule, Title VII of the Dodd-Frank Act
and Commission regulations thereunder establish a broad range of
requirements applicable to SDs and MSPs, including requirements
regarding risk management and internal and external business
conduct.\351\ These requirements are designed to reduce systemic risk,
increase counterparty protections, and increase market efficiency,
orderliness, and transparency.\352\ Consistent with the Guidance,\353\
SDs and MSPs (whether or not U.S. persons) are subject to all of the
Commission regulations described below by virtue of their status as
Commission registrants. Put differently, the Commission's view is that
if an entity is required to register as an SD or MSP under the
Commission's interpretation of section 2(i) of the CEA, then such
entity should be subject to these regulations with respect to all of
its swap activities. As explained further below, such an approach is
necessary because of the important role that the SD and MSP
requirements play in the proper operation of a registrant.
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\351\ See Proposed Rule, 85 FR at 979-980.
\352\ See, e.g., Entities Rule, 77 FR at 30629, 30703.
\353\ See Guidance, 78 FR at 45342. The Commission notes that
while the Guidance states that all swap entities (wherever located)
are subject to all of the CFTC's Title VII requirements, the
Guidance went on to describe how and when the Commission would
expect swap entities to comply with specific requirements and when
substituted compliance would be available under its non-binding
framework.
---------------------------------------------------------------------------
However, consistent with section 2(i) of the CEA, in the interest
of international comity, and for other reasons discussed in this
release, the Commission is providing exceptions from, and a substituted
compliance process for, certain regulations applicable to registered
SDs and MSPs, as appropriate.\354\ Further, the Final
[[Page 56964]]
Rule creates a framework for comparability determinations that
emphasizes a holistic, outcomes-based approach that is grounded in
principles of international comity.
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\354\ As noted in the Proposed Rule, the Commission intends to
separately address the cross-border application of Title VII
requirements not addressed in the Final Rule (e.g., capital
adequacy, clearing and swap processing, mandatory trade execution,
swap data repository reporting, large trader reporting, and real-
time public reporting) (hereinafter, the ``Unaddressed
Requirements''). In that regard, the Commission notes that it
adopted capital adequacy and related financial reporting
requirements for SDs and MSPs at its open meeting on July 22, 2020.
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A. Classification and Application of Certain Regulatory Requirements--
Group A, Group B, and Group C Requirements
As discussed in the Proposed Rule, the Guidance applied a
bifurcated approach to the classification of certain regulatory
requirements applicable to SDs and MSPs, based on whether the
requirement applies to the firm as a whole (``Entity-Level
Requirement'' or ``ELR'') or to the individual swap or trading
relationship (``Transaction-Level Requirement'' or ``TLR'').\355\
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\355\ See, e.g., Guidance, 78 FR at 45331.
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The Guidance categorized the following regulatory requirements as
ELRs: (1) Capital adequacy; (2) chief compliance officer (``CCO''); (3)
risk management; (4) swap data recordkeeping; (5) swap data repository
(``SDR'') reporting; and (6) large trader reporting.\356\ The Guidance
further divided ELRs into two subcategories.\357\ The first category of
ELRs includes: (1) Capital adequacy; (2) CCO; (3) risk management; and
(4) certain swap data recordkeeping requirements \358\ (``First
Category ELRs'').\359\ The second category of ELRs includes: (1) SDR
reporting; (2) certain aspects of swap data recordkeeping relating to
complaints and marketing and sales materials under Sec. 23.201(b)(3)
and (4); and (3) large trader reporting (``Second Category
ELRs'').\360\
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\356\ See, e.g., id.
\357\ See, e.g., id.
\358\ Swap data recordkeeping under 17 CFR 23.201 and 23.203
(except certain aspects of swap data recordkeeping relating to
complaints and sales materials).
\359\ See, e.g., Guidance, 78 FR at 45331.
\360\ See, e.g., id.
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The Guidance categorized the following regulatory requirements as
TLRs: (1) Required clearing and swap processing; (2) margin (and
segregation) for uncleared swaps; (3) mandatory trade execution; (4)
swap trading relationship documentation; (5) portfolio reconciliation
and compression; (6) real-time public reporting; (7) trade
confirmation; (8) daily trading records; and (9) external business
conduct standards.\361\ As with the ELRs, the Guidance similarly
subdivided TLRs into two subcategories.\362\ The Commission determined
that all TLRs, other than external business conduct standards, address
risk mitigation and market transparency.\363\ Accordingly, under the
Guidance, all TLRs except external business conduct standards are
classified as ``Category A TLRs,'' whereas external business conduct
standards are classified as ``Category B TLRs.'' \364\ Under the
Guidance, generally, whether a specific Commission requirement applies
to a swap entity and a swap and whether substituted compliance is
available depends on the classification of the requirement as an ELR or
TLR and the sub-classification of each and the type of swap entity and,
in certain cases, the counterparty to a specific swap.\365\
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\361\ See, e.g., id. at 45333.
\362\ See, e.g., id.
\363\ See, e.g., id.
\364\ See, e.g., id.
\365\ See, e.g., id. at 45337-45338.
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To avoid confusion that may have arisen from using the ELR/TLR
classification in the Proposed Rule, given that the Proposed Rule did
not address the same set of Commission regulations as the Guidance, the
Commission proposed to classify certain of its regulations as group A,
group B, and group C requirements for purposes of determining the
availability of certain exceptions from, and/or substituted compliance
for, such regulations. The Commission requested comment on the group A,
group B, and group C requirement classifications and on whether any
modifications should be made to the set of requirements in such
groups.\366\
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\366\ Proposed Rule, 85 FR at 982.
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The Commission received several comments on its proposed use of the
group A, group B, and group C requirements classifications. IIB/SIFMA
and JFMC/IBAJ generally supported the Proposed Rule's classification of
swap entity requirements. However, IIB/SIFMA requested that the
Commission expand and clarify such categorization in certain respects
(discussed in the relevant sections below) to align the cross-border
application of the Commission's requirements with the policy objectives
for those requirements. AIMA stated its belief that any swap involving
a non-U.S. person (even where its counterparty is a U.S. person) should
also be able to use substituted compliance and encouraged the CFTC to
review the group B and group C requirements with this approach in mind,
but did not provide any specific recommended changes to those
classifications. IATP stated that it was not clear which set of
regulations were covered by the Proposed Rule that are not covered by
the Guidance and that, without a comparative summary of the different
set of regulations covered by each, there is no grounds to judge
readily why the Commission proposed to abandon the readily understood
``entity level'' and ``transaction level'' requirement classifications
to compare for granting substituted compliance to foreign regulatory
regimes.
After considering the comments, the Commission continues to believe
that classifying certain of its regulations as group A, group B, and
group C requirements is appropriate and helpful for purposes of
determining the availability of certain exceptions from, and/or
substituted compliance for, such regulations.\367\ The proposed and
final group A, group B, and group C requirements are discussed below.
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\367\ With respect to AIMA's comment, the Commission notes that
the Proposed Rule provided a summary of all of the requirements
addressed by the Guidance and which requirements were addressed in
the Proposed Rule.
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1. Group A Requirements
(i) Proposed Rule
The Commission proposed that the group A requirements would
include: (1) CCO; (2) risk management; (3) swap data recordkeeping; and
(4) antitrust considerations. Specifically, under the Proposed Rule,
the group A requirements consisted of the requirements set forth in
Sec. Sec. 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605,
23.606, 23.607, and 23.609.\368\ As discussed in the Proposed Rule, the
Commission believes that the group A requirements would be impractical
to apply only to specific transactions or counterparty relationships
and are most effective when applied consistently across the entire
enterprise, noting that they ensure that swap entities implement and
maintain a comprehensive and robust system of internal controls to
ensure the financial integrity of the firm, and, in turn, the
protection of the financial system. Further, the Commission noted that,
together with other Commission requirements, the proposed group A
requirements constitute an important line of defense against financial,
operational, and compliance risks that could lead to a firm's default;
and, further, that requiring swap entities to rigorously monitor and
address the risks they incur as part of their day-to-day businesses
lowers the registrants' risk of default--and ultimately protects the
public and the financial system. For this reason, the Commission stated
that it
[[Page 56965]]
has strong supervisory interests in ensuring that swap entities
(whether domestic or foreign) are subject to the group A requirements
or comparably rigorous standards.\369\
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\368\ 17 CFR 3.3, 23.201, 23.203, 23.600, 23.601, 23.602,
23.603, 23.605, 23.606, 23.607, and 23.609.
\369\ See Proposed Rule, 85 FR at 980-981.
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Each of the proposed group A requirements is discussed in more
detail below.
(a) Chief Compliance Officer
Section 4s(k) of the CEA requires that each SD and MSP designate an
individual to serve as its CCO and specifies certain duties of the
CCO.\370\ Pursuant to section 4s(k), the Commission adopted Sec.
3.3,\371\ which requires SDs and MSPs to designate a CCO responsible
for administering the firm's compliance policies and procedures,
reporting directly to the board of directors or a senior officer of the
SD or MSP, as well as preparing and filing with the Commission a
certified annual report discussing the registrant's compliance policies
and activities. The CCO function is an integral element of a firm's
risk management and oversight, as well as the Commission's effort to
foster a strong culture of compliance within SDs and MSPs.
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\370\ 7 U.S.C. 6s(k).
\371\ 17 CFR 3.3. See Swap Dealer and Major Swap Participant
Recordkeeping, Reporting, and Duties Rules; Futures Commission
Merchant and Introducing Broker Conflicts of Interest Rules; Chief
Compliance Officer Rules for Swap Dealers, Major Swap Participants,
and Futures Commission Merchants, 77 FR 20128 (Apr. 3, 2012)
(``Final SD and MSP Recordkeeping, Reporting, and Duties Rule''). In
2018, the Commission adopted amendments to the CCO requirements. See
Chief Compliance Officer Duties and Annual Report Requirements for
Futures Commission Merchants, Swap Dealers, and Major Swap
Participants, 83 FR 43510 (Aug. 27, 2018).
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(b) Risk Management
Section 4s(j) of the CEA requires each SD and MSP to establish
internal policies and procedures designed to, among other things,
address risk management, monitor compliance with position limits,
prevent conflicts of interest, and promote diligent supervision, as
well as maintain business continuity and disaster recovery
programs.\372\ The Commission implemented these provisions in
Sec. Sec. 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606.\373\ The
Commission also adopted Sec. 23.609,\374\ which requires certain risk
management procedures for SDs or MSPs that are clearing members of a
DCO.\375\ Collectively, these requirements help to establish a
comprehensive internal risk management program for SDs and MSPs, which
is critical to effective systemic risk management for the overall swap
market.
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\372\ 7 U.S.C. 6s(j).
\373\ 17 CFR 23.600, 23.601, 23.602, 23.603, 23.605, and 23.606.
See Final SD and MSP Recordkeeping, Reporting, and Duties Rule, 77
FR 20128 (addressing rules related to risk management programs,
monitoring of position limits, diligent supervision, business
continuity and disaster recovery, conflicts of interest policies and
procedures, and general information availability).
\374\ 17 CFR 23.609.
\375\ See Customer Clearing Documentation, Timing of Acceptance
for Clearing, and Clearing Member Risk Management, 77 FR 21278 (Apr.
9, 2012).
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(c) Swap Data Recordkeeping
CEA section 4s(f)(1)(B) requires SDs and MSPs to keep books and
records for all activities related to their swap business.\376\
Sections 4s(g)(1) and (4) require SDs and MSPs to maintain trading
records for each swap and all related records, as well as a complete
audit trail for comprehensive trade reconstructions.\377\ Additionally,
CEA section 4s(f)(1) requires SDs and MSPs to ``make such reports as
are required by the Commission by rule or regulation regarding the
transactions and positions and financial condition of'' the registered
SD or MSP.\378\ Further, CEA section 4s(h) requires SDs and MSPs to
``conform with such business conduct standards . . . as may be
prescribed by the Commission by rule or regulation.'' \379\
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\376\ 7 U.S.C. 6s(f)(1)(B).
\377\ 7 U.S.C. 6s(g)(1) and (4).
\378\ 7 U.S.C. 6s(f)(1).
\379\ 7 U.S.C. 6s(h)(1). See 7 U.S.C. 6s(h)(3).
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Pursuant to these provisions, the Commission promulgated final
rules that set forth certain reporting and recordkeeping requirements
for SDs and MSPs.\380\ Specifically, Sec. Sec. 23.201 and 23.203 \381\
require SDs and MSPs to keep records including complete transaction and
position information for all swap activities (e.g., documentation on
which trade information is originally recorded). In particular, Sec.
23.201 states that each SD and MSP shall keep full, complete, and
systematic records of all activities related to its business as a SD or
MSP.\382\ Such records must include, among other things, a record of
each complaint received by the SD or MSP concerning any partner,
member, officer, employee, or agent,\383\ as well as all marketing and
sales presentations, advertisements, literature, and
communications.\384\ Commission regulation 23.203 \385\ requires, among
other things, that records (other than swap data reported in accordance
with part 45 of the Commission's regulations \386\) be maintained in
accordance with Sec. 1.31.\387\ Commission regulation 1.31 requires
that records relating to swaps be maintained for specific durations,
including that records of swaps be maintained for a minimum of five
years and as much as the life of the swap plus five years, and that
most records be ``readily accessible'' for the entire recordkeeping
period.\388\
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\380\ See Final SD and MSP Recordkeeping, Reporting, and Duties
Rule, 77 FR 20128.
\381\ 17 CFR 23.201 and 203.
\382\ 17 CFR 23.201(b).
\383\ 17 CFR 23.201(b)(3)(i).
\384\ 17 CFR 23.201(b)(4).
\385\ 17 CFR 23.203.
\386\ 17 CFR 45.
\387\ 17 CFR 1.31.
\388\ 17 CFR 1.31(b).
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(d) Antitrust Considerations
Section 4s(j)(6) of the CEA prohibits an SD or MSP from adopting
any process or taking any action that results in any unreasonable
restraint of trade or imposes any material anticompetitive burden on
trading or clearing, unless necessary or appropriate to achieve the
purposes of the CEA.\389\ The Commission promulgated this requirement
in Sec. 23.607(a) \390\ and also adopted Sec. 23.607(b), which
requires SDs and MSPs to adopt policies and procedures to prevent
actions that result in unreasonable restraints of trade or impose any
material anticompetitive burden on trading or clearing.\391\
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\389\ 7 U.S.C. 6s(j)(6).
\390\ 17 CFR 23.607(a).
\391\ 17 CFR 23.607(b).
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(ii) Summary of Comments
JFMC/IBAJ and IIB/SIFMA were supportive of the streamlining of the
Commission's recordkeeping requirements under Sec. 23.201 as group A
requirements (which the Guidance separated into two different
subcategories). JFMC/IBAJ also requested the Commission explicitly
categorize Sec. 1.31 as a group A requirement in furtherance of the
goal of providing legal certainty and streamlining recordkeeping
requirements. IIB/SIFMA requested that the Commission include
Sec. Sec. 1.31 and 45.2 as group A requirements, which they stated
would be consistent with categorizing Sec. 23.203 as a group A
requirement. IIB/SIFMA also was supportive of including the
Commission's antitrust rules (which were not addressed by the Guidance)
as a group A requirement.
(iii) Final Rule
After carefully considering the comments, the Commission is
adopting the proposed group A requirements and adding Sec. 45.2(a) to
the group A requirements to the extent it duplicates Sec. 23.201, as
shown in the rule text in
[[Page 56966]]
this release.\392\ The Commission is making this addition to clarify
that, to the extent the same substantive recordkeeping requirement is
included in both Sec. Sec. 23.201 and 45.2(a),\393\ each is a group A
requirement for which substituted compliance may be available, as
discussed in section VI.C below.\394\
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\392\ Final Sec. 23.23(a)(6).
\393\ Commission regulation 23.201 requires, in relevant part,
that each SD and MSP keep full, complete, and systematic records,
together with all pertinent data and memoranda, of all its swaps
activities and its activities related to its business as a SD or
MSP. Commission regulation 45.2(a) requires, in relevant part, that
each SD and MSP subject to the jurisdiction of the Commission shall
keep full, complete, and systematic records, together with all
pertinent data and memoranda, of all activities relating to the
business of such entity or person with respect to swaps, as
prescribed by the Commission.
\394\ Similarly, the Commission will view any previously issued
comparability determination that allows substituted compliance for
Sec. 23.201 to also allow for substituted compliance with Sec.
45.2(a) to the extent it duplicates Sec. 23.201.
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Regarding the comments to include Sec. 1.31 as a group A
requirement, Sec. 1.31 is a general requirement providing maintenance
and access requirements for many regulatory records, and not only those
required under the group A requirements. Further, to the extent an SD/
MSP receives substituted compliance for a group A requirement, such as
Sec. 23.203, that incorporates Sec. 1.31's recordkeeping requirements
for certain regulatory records, the Commission's view is that Sec.
1.31 would also not apply to such regulatory records. Therefore, the
Commission is declining to include Sec. 1.31 as a group A requirement.
2. Group B Requirements
(i) Proposed Rule
The Commission proposed that the group B requirements would
include: (1) Swap trading relationship documentation; (2) portfolio
reconciliation and compression; (3) trade confirmation; and (4) daily
trading records. Specifically, under the Proposed Rule, the group B
requirements consist of the requirements set forth in Sec. Sec.
23.202, 23.501, 23.502, 23.503, and 23.504.\395\ As discussed in the
Proposed Rule, the group B requirements relate to risk mitigation and
the maintenance of good recordkeeping and business practices.\396\ The
Commission stated that, unlike for the group A requirements, it
believes that the group B requirements can practically be applied on a
bifurcated basis between domestic and foreign transactions or
counterparty relationships and, thus, do not need to be applied
uniformly across an entire enterprise. Therefore, the Commission stated
that it can have greater flexibility with respect to the application of
these requirements to non-U.S. swap entities and foreign branches of
U.S. swap entities.\397\
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\395\ 17 CFR 23.202, 23.501, 23.502, 23.503, and 23.504.
\396\ See, e.g., Int'l Org. of Sec. Comm'ns, Risk Mitigation
Standards for Non-Centrally Cleared OTC Derivatives, IOSCO Doc.
FR01/2015 (Jan. 28, 2015) (``IOSCO Risk Management Standards''),
available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD469.pdf (discussing, among other things, the objectives and
benefits of trading relationship documentation, trade confirmation,
reconciliation, and portfolio compression requirements). In
addition, the group B requirements also provide customer protection
and market transparency benefits.
\397\ See Proposed Rule, 85 FR at 981-982.
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Each of the proposed group B requirements is discussed in more
detail below.
(a) Swap Trading Relationship Documentation
CEA section 4s(i) requires each SD and MSP to conform to Commission
standards for the timely and accurate confirmation, processing,
netting, documentation, and valuation of swaps.\398\ Pursuant to
section 4s(i), the Commission adopted, among other regulations, Sec.
23.504.\399\ Regulation 23.504(a) requires SDs and MSPs to ``establish,
maintain and follow written policies and procedures'' to ensure that
the SD or MSP executes written swap trading relationship documentation,
and Sec. 23.504(c) requires that documentation policies and procedures
be audited periodically by an independent auditor to identify material
weaknesses.\400\ Under Sec. 23.504(b), the swap trading relationship
documentation must include, among other things: (1) All terms governing
the trading relationship between the SD or MSP and its counterparty;
(2) credit support arrangements; (3) investment and re-hypothecation
terms for assets used as margin for uncleared swaps; and (4) custodial
arrangements.\401\ Swap documentation standards facilitate sound risk
management and may promote standardization of documents and
transactions, which are key conditions for central clearing, and lead
to other operational efficiencies, including improved valuation.
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\398\ 7 U.S.C. 6s(i).
\399\ 17 CFR 23.504. See Confirmation, Portfolio Reconciliation,
Portfolio Compression, and Swap Trading Relationship Documentation
Requirements for Swap Dealers and Major Swap Participants, 77 FR
55904 (Sept. 11, 2012) (``Final Confirmation, Risk Mitigation, and
Documentation Rules'').
\400\ 17 CFR 23.504(a)(2) and (c).
\401\ 17 CFR 23.504(b).
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(b) Portfolio Reconciliation and Compression
CEA section 4s(i) directs the Commission to prescribe regulations
for the timely and accurate processing and netting of all swaps entered
into by SDs and MSPs.\402\ Pursuant to CEA section 4s(i), the
Commission adopted Sec. Sec. 23.502 and 23.503,\403\ which require SDs
and MSPs to perform portfolio reconciliation and compression for their
swaps.\404\ Portfolio reconciliation is a post-execution risk
management tool designed to ensure accurate confirmation of a swap's
terms and to identify and resolve any discrepancies between
counterparties regarding the valuation of the swap. Portfolio
compression is a post-trade processing and netting mechanism that is
intended to ensure timely, accurate processing and netting of
swaps.\405\ Further, Sec. 23.503 requires all SDs and MSPs to
establish policies and procedures for terminating fully offsetting
uncleared swaps, when appropriate, and periodically participating in
bilateral and/or multilateral portfolio compression exercises for
uncleared swaps with other SDs or MSPs or through a third party.\406\
The rule also requires policies and procedures for engaging in such
exercises for uncleared swaps with non-SDs and non-MSPs upon
request.\407\
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\402\ 7 U.S.C. 6s(i).
\403\ 17 CFR 23.502 and 503. See Final Confirmation, Risk
Mitigation, and Documentation Rules, 77 FR 55904.
\404\ See 17 CFR 23.502 and 503.
\405\ For example, the reduced transaction count may decrease
operational risk as there are fewer trades to maintain, process, and
settle.
\406\ See 17 CFR 23.503(a).
\407\ 17 CFR 23.503(b).
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(c) Trade Confirmation
Section 4s(i) of the CEA requires that each SD and MSP must comply
with the Commission's regulations prescribing timely and accurate
confirmation of swaps.\408\ The Commission adopted Sec. 23.501,\409\
which requires, among other things, timely and accurate confirmation of
swap transactions (which includes execution, termination, assignment,
novation, exchange, transfer, amendment, conveyance, or extinguishing
of rights or obligations of a swap) among SDs and MSPs by the end of
the first business day following the day of execution.\410\ Timely and
accurate confirmation of swaps--together with portfolio reconciliation
and compression--is an important post-
[[Page 56967]]
trade processing mechanism for reducing risks and improving operational
efficiency.\411\
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\408\ 7 U.S.C. 6s(i).
\409\ 17 CFR 23.501. See Final Confirmation, Risk Mitigation,
and Documentation Rules, 77 FR 55904.
\410\ 17 CFR 23.501(a)(1).
\411\ Additionally, the Commission notes that Sec. 23.504(b)(2)
requires that the swap trading relationship documentation of SDs and
MSPs must include all confirmations of swap transactions. 17 CFR
23.504(b)(2).
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(d) Daily Trading Records
Pursuant to CEA section 4s(g),\412\ the Commission adopted Sec.
23.202,\413\ which requires SDs and MSPs to maintain daily trading
records, including records of trade information related to pre-
execution, execution, and post-execution data that is needed to conduct
a comprehensive and accurate trade reconstruction for each swap. The
regulation also requires that records be kept of cash or forward
transactions used to hedge, mitigate the risk of, or offset any swap
held by the SD or MSP.\414\ Accurate and timely records regarding all
phases of a swap transaction can serve to greatly enhance a firm's
internal supervision, as well as the Commission's ability to detect and
address market or regulatory abuses or evasion.
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\412\ 7 U.S.C. 6s(g).
\413\ 17 CFR 23.202. See Final SD and MSP Recordkeeping,
Reporting, and Duties Rule, 77 FR 20128.
\414\ 17 CFR 23.202(b).
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(ii) Summary of Comments
IIB/SIFMA stated that they support the Commission's proposed
categorization of the group B requirements, but requested that the
Commission recategorize its pre-execution daily trading records
requirements under Sec. 23.202 as group C requirements instead of
group B requirements. IIB/SIFMA asserted that pre-execution information
generally has no nexus to the risk management of the swap entity or to
the Commission's risk mitigation rules and instead relate to a swap
entity's sales practices.
(iii) Final Rule
After carefully considering the comments, the Commission is
adopting the group B requirements as proposed.\415\ With respect to the
request to make pre-execution trading records requirements a group C
requirement, accurate and timely records regarding all phases of a swap
transaction (including pre-execution trading records) can serve to
greatly enhance a firm's internal supervision, as well as the
Commission's ability to detect and address market or regulatory abuses
or evasion. Because these records relate to market integrity (and not
only customer protection), the Commission believes the pre-execution
trading records requirements should continue to be group B requirements
and not be eligible for the exceptions the Final Rule provides from the
group C requirements.
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\415\ Final Sec. 23.23(a)(7).
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3. Group C Requirements
(i) Proposed Rule
Pursuant to CEA section 4s(h),\416\ the Commission adopted external
business conduct rules, which establish certain additional business
conduct standards governing the conduct of SDs and MSPs in dealing with
their swap counterparties.\417\ The Commission proposed that the group
C requirements would consist of these rules, which are set forth in
Sec. Sec. 23.400 through 23.451.\418\ As discussed in the Proposed
Rule, broadly speaking, these rules are designed to enhance
counterparty protections by establishing robust requirements regarding
SDs' and MSPs' conduct with their counterparties. Under these rules,
SDs and MSPs are required to, among other things, conduct due diligence
on their counterparties to verify eligibility to trade (including
eligible contract participant (``ECP'') status), refrain from engaging
in abusive market practices, provide disclosure of material information
about the swap to their counterparties, provide a daily mid-market mark
for uncleared swaps, and, when recommending a swap to a counterparty,
make a determination as to the suitability of the swap for the
counterparty based on reasonable diligence concerning the counterparty.
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\416\ 7 U.S.C. 6s(h).
\417\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants with Counterparties, 77 FR 9734 (Feb. 17, 2012).
\418\ 17 CFR 23.400-23.451.
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As the Commission discussed in the Proposed Rule, the group C
requirements have a more attenuated link to, and are therefore
distinguishable from, systemic and market-oriented protections in the
group A and group B requirements. Additionally, the Commission noted
its belief that the foreign jurisdictions in which non-U.S. persons and
foreign branches of U.S. swap entities are located are likely to have a
significant interest in the type of business conduct standards that
would be applicable to transactions with such non-U.S. persons and
foreign branches within their jurisdiction, and, consistent with
section 2(i) of the CEA and in the interest of international comity, it
is generally appropriate to defer to such jurisdictions in applying, or
not applying, such standards to foreign-based swaps with foreign
counterparties.\419\
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\419\ See Proposed Rule, 85 FR at 982.
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(ii) Summary of Comments
IIB/SIFMA supported the Proposed Rule's categorization of the
Commission's external business conduct standards as group C
requirements because the approach is consistent with the Guidance, and
these requirements focus on counterparty protection. However, IIB/SIFMA
requested that the Commission add its rules for elective initial margin
segregation to the list of group C requirements.\420\ They argued that
these rules found in part 23, subpart L (Sec. Sec. 23.700-23.704)
(``Subpart L''),\421\ like the proposed group C requirements, are
largely focused on customer protection rather than risk mitigation.
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\420\ As noted in the discussion of the group B requirements,
IIB/SIFMA also requested that the Commission recategorize pre-
execution daily trading records rules as group C requirements (not
group B requirements).
\421\ 17 CFR part 23, subpart L.
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(iii) Final Rule
After careful consideration of the comments, the Commission is
adopting the group C requirements as proposed and adding the
requirements of Subpart L as group C requirements, as shown in the rule
text in this release.\422\
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\422\ Final Sec. 23.23(a)(8).
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Section 724(c) of the Dodd-Frank Act amended the CEA to add section
4s(l),\423\ which addresses segregation of initial margin held as
collateral in uncleared swap transactions (i.e., swaps not submitted
for clearing on a DCO). Section 4s(l) was implemented in Subpart L,
which imposes requirements on SDs and MSPs with respect to the
treatment of collateral posted by their counterparties to margin,
guarantee, or secure certain uncleared swaps.\424\ Specifically, Sec.
23.701 requires, except in those circumstances where segregation is
mandatory under the Margin Rules,
[[Page 56968]]
that a SD/MSP provide notice to its counterparty of its right to have
Initial Margin (``IM'') \425\ provided by it to the SD/MSP segregated
in accordance with Sec. Sec. 23.702 and 23.703.\426\ Commission
regulations 23.702 and 23.703 provide requirements for segregation and
investment of IM where the counterparty elects such segregation,\427\
and Sec. 23.704 requires that each SD/MSP report quarterly to each
counterparty that does not choose to require IM segregation that the
back office procedures of the SD/MSP relating to margin and collateral
requirements are in compliance with the agreement of the
counterparties.\428\
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\423\ 7 U.S.C. 6s(l).
\424\ Protection of Collateral of Counterparties to Uncleared
Swaps; Treatment of Securities in a Portfolio Margining Account in a
Commodity Broker Bankruptcy, 78 FR 66621 (Nov. 2013). The Commission
later amended Subpart L in light of the Commission's adoption of
subpart E of part 23 (Capital and Margin Requirements for Swap
Dealers and Major Swap Participants) in January 2016 and the
prudential regulators' adoption of similar rules in November 2015
(together, ``Margin Rules''), which, among other things, established
initial margin requirements applicable to SDs and MSPs. As a result,
Subpart L's segregation requirements apply only when the Margin
Rules' segregation requirements do not. Further, the Commission
understands that counterparties have elected segregation under
Subpart L very rarely. See, e.g., Segregation of Assets Held as
Collateral in Uncleared Swap Transactions, 84 FR 12894 (Apr. 2019).
\425\ ``Initial Margin'' is defined in Sec. 23.700 for purposes
of Subpart L as money, securities, or property posted by a party to
a swap as performance bond to cover potential future exposures
arising from changes in the market value of the position. 17 CFR
23.700.
\426\ 17 CFR 23.701.
\427\ 17 CFR 23.702 and 703.
\428\ 17 CFR 23.704.
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The Commission agrees with IIB/SIFMA that these requirements are
focused on customer protection rather than risk mitigation and are
appropriately included as group C requirements. In this regard, the
Commission notes, specifically, that Subpart L leaves to the discretion
of the counterparty to the SD/MSP whether IM is segregated, rather than
mandating its segregation, and has largely been superseded by the
Margin Rules, which specifically address systemic risk in relation to
margin for uncleared swaps.
B. Exceptions From Group B and Group C Requirements
1. Proposed Exceptions, Generally
(i) Proposed Rule
Consistent with section 2(i) of the CEA, the Commission proposed
four exceptions from certain Commission regulations for foreign-based
swaps in the Proposed Rule.\429\
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\429\ See Proposed Rule, 85 FR at 982-984.
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First, the Commission proposed an exception from certain group B
and C requirements for certain anonymous, exchange-traded, and cleared
foreign-based swaps (``Exchange-Traded Exception'').
Second, the Commission proposed an exception from the group C
requirements for certain foreign-based swaps with foreign
counterparties (``Foreign Swap Group C Exception'').
Third, the Commission proposed an exception from the group B
requirements for certain foreign-based swaps of foreign branches of
U.S. swap entities with certain foreign counterparties, subject to
certain limitations, including a quarterly cap on the amount of such
swaps (``Limited Foreign Branch Group B Exception'').\430\
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\430\ This exception was defined as the ``Foreign Branch Group B
Exception'' in the Proposed Rule. The Commission is adding the word
``Limited'' to the beginning of the defined term, to reflect the
conditions that apply to the use of the exception, including the cap
on its use in a calendar quarter.
---------------------------------------------------------------------------
Fourth, the Commission proposed an exception from the group B
requirements for the foreign-based swaps of certain non-U.S. swap
entities with certain foreign counterparties (``Non-U.S. Swap Entity
Group B Exception'').
While these exceptions each have different eligibility
requirements, a common requirement is that they would be available only
to foreign-based swaps,\431\ as other swaps would be treated as
domestic swaps for purposes of applying the group B and group C
requirements and, therefore, would not be eligible for the above
exceptions. Further, swap entities that avail themselves of these
exceptions for their foreign-based swaps would be required to comply
with the applicable laws of the foreign jurisdiction(s) to which they
are subject, rather than the relevant Commission requirements, for such
swaps; however, notwithstanding these exceptions, swap entities would
remain subject to the CEA and Commission regulations not covered by the
exceptions, including the prohibition on the employment, or attempted
employment, of manipulative and deceptive devices in Sec. 180.1.\432\
The Commission also would expect swap entities to address any
significant risk that may arise as a result of the utilization of one
or more exceptions in their risk management programs required pursuant
to Sec. 23.600.\433\
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\431\ As discussed in section II.I, supra, a foreign-based swap
means: (1) A swap by a non-U.S. swap entity, except for a swap
booked in a U.S. branch; or (2) A swap conducted through a foreign
branch.
\432\ 17 CFR 180.1.
\433\ 17 CFR 23.600.
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The Commission requested comments on whether, in light of the
Commission's supervisory interests, the proposed exceptions were
appropriate or whether they should be broadened or narrowed.\434\
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\434\ Proposed Rule, 85 FR at 984.
---------------------------------------------------------------------------
(ii) Summary of Comments
JFMC/IBAJ generally supported the proposed exceptions to the
application of group B and C requirements under the Proposed Rule,
stating that they believe the exceptions generally strike the right
balance in protecting the integrity, safety, and soundness of the U.S.
financial system while recognizing the principles of international
comity. ISDA stated that it supported the Commission's intent to place
non-U.S. swap entities (that are Other Non-U.S. Persons) and foreign
branches of U.S. swap entities on equal footing with respect to the
cross-border application of certain CFTC requirements, noting that
foreign branches of U.S. swap entities are subject to the laws of the
foreign jurisdictions in which they operate and, thus, imposing U.S.
requirements on these entities results in duplicative regulation--
increasing compliance costs, complexity, and inefficiencies. However,
JFMC/IBAJ, ISDA, and IIB/SIFMA requested that the Commission expand and
clarify the Proposed Rule's exceptions in certain specific respects,
which are discussed in the relevant sections below. AFR asserted that
the Proposed Rule would allow branches of U.S. persons, which are
actually formally and legally part of the parent U.S. organization, to
effectively act as non-U.S. persons.\435\ IATP stated that it only
understands the Exchange-Traded Exception and did not comment on the
other proposed exceptions. Its comment on the proposed Exchange-Traded
Exception is discussed below.
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\435\ The Commission disagrees with this assertion. For example,
under the Proposed Rule, group B requirements apply more broadly to
foreign branches than to non-U.S. persons due to the limited scope
of the Limited Foreign Branch Group B Exception as compared to the
Non-U.S. Swap Entity Group B Exception (each discussed below), and
foreign branches (as a part of a U.S. person) are not eligible for
substituted compliance for the group A requirements.
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2. Exchange-Traded Exception
(i) Proposed Rule
The Commission proposed that, with respect to its foreign-based
swaps, each non-U.S. swap entity and foreign branch of a U.S. swap
entity would be excepted from the group B requirements (other than the
daily trading records requirements in Sec. Sec. 23.202(a) through
23.202(a)(1) \436\) and the group C requirements with respect to any
swap entered into on a DCM, a registered SEF or a SEF exempted from
registration by the Commission pursuant to section 5h(g) of the CEA, or
an FBOT registered with the Commission pursuant to part 48 of its
regulations \437\ where, in each case, the swap is cleared through a
registered DCO or a clearing organization that has been exempted from
registration by the Commission
[[Page 56969]]
pursuant to section 5b(h) of the CEA, and the swap entity does not know
the identity of the counterparty to the swap prior to execution.\438\
---------------------------------------------------------------------------
\436\ 17 CFR 23.202(a) through (a)(1).
\437\ The Commission stated that it would consider the proposed
exception also to apply with respect to an FBOT that provides direct
access to its order entry and trade matching system from within the
U.S. pursuant to no-action relief issued by Commission staff.
\438\ See Proposed Rule, 85 FR at 982-983. This approach is
similar to the Guidance. See Guidance, 78 FR at 45351-45352 and
45360-45361.
---------------------------------------------------------------------------
With respect to the group B trade confirmation requirement, the
Commission noted that where a cleared swap is executed anonymously on a
DCM or SEF (as discussed above), independent requirements that apply to
DCM and SEF transactions pursuant to the Commission's regulations
should ensure that these requirements are met.\439\ And, for a
combination of reasons, including the fact that a registered FBOT is
analogous to a DCM and is expected to be subject to comprehensive
supervision and regulation in its home country,\440\ and the fact that
the swap will be cleared, the Commission believes that the Commission's
trade confirmation requirements should not apply to foreign-based swaps
that meet the requirements of the exception and are traded on
registered FBOTs.
---------------------------------------------------------------------------
\439\ See 17 CFR 23.501(a)(4)(i) and 37.6(b).
\440\ See 17 CFR 48.5(d)(2).
---------------------------------------------------------------------------
Of the remaining group B requirements, the Commission noted that
the portfolio reconciliation and compression and swap trading
relationship documentation requirements would not apply to the cleared
DCM, SEF, or FBOT transactions described above because the Commission
regulations that establish those requirements make clear that they do
not apply to cleared transactions.\441\ For the last group B
requirement--the daily trading records requirement \442\--the
Commission stated that it believes that, as a matter of international
comity and recognizing the supervisory interests of foreign regulators
who may have their own trading records requirements, it is appropriate
to except such foreign-based swaps from certain of the Commission's
daily trading records requirements. However, the Commission stated that
the requirements of Sec. 23.202(a) through (a)(1) should continue to
apply, as all swap entities should be required to maintain, among other
things, sufficient records to conduct a comprehensive and accurate
trade reconstruction for each swap. The Commission noted that, in
particular, for certain pre-execution trade information under Sec.
23.202(a)(1),\443\ the swap entity may be the best, or only, source for
such records, and for this reason, paragraphs (a) through (a)(1) of
Sec. 23.202 are carved out from the group B requirements in the
proposed exception.
---------------------------------------------------------------------------
\441\ See 17 CFR 23.502(d), 23.503(c), 23.504(a)(1)(iii).
\442\ See 17 CFR 23.202.
\443\ See 17 CFR 23.202(a)(1).
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Additionally, the Commission noted that, given that this exception
is predicated on anonymity, many of the group C requirements would be
inapplicable.\444\ Further, because the Commission believes a
registered FBOT is analogous to a DCM for these purposes and is
expected to be subject to comprehensive supervision and regulation in
its home country, and because a SEF that is exempted from registration
by the Commission pursuant to section 5h(g) of the CEA must be subject
to supervision and regulation that is comparable to that to which
Commission-registered SEFs are subject, the Commission also proposed
that these group C requirements would not be applicable where such a
swap is executed anonymously on a registered FBOT, or a SEF that has
been exempted from registration with the Commission pursuant to section
5h(g) of the CEA, and cleared. In the interest of international comity
and because the proposed exception requires that the swap be exchange-
traded and cleared, the Commission proposed that foreign-based swaps
would also be excepted from the remaining group C requirements in these
circumstances. The Commission noted that it expects that the
requirements that the swaps be exchange-traded and cleared will
generally limit swaps that benefit from the exception to standardized
and commonly-traded, foreign-based swaps, for which the Commission
believes application of the remaining group C requirements is not
necessary.
---------------------------------------------------------------------------
\444\ See 17 CFR 23.402(b)-(c), 23.430(e), 23.431(c), 23.450(h),
23.451(b)(2)(iii).
---------------------------------------------------------------------------
(ii) Summary of Comments
IIB/SIFMA requested that the Commission expand the exception to
apply to all anonymous cleared swaps (whether or not the trading venue
and clearing organization are registered or exempt from registration
with the Commission), in light of the risk mitigating effects of
central clearing and the regulatory compliance and market integrity
protections of trading anonymously on a regulated platform. They stated
that it is not necessary for the Commission to limit this exception for
anonymous cleared swaps in a manner that would indirectly expand the
SEF and DCO registration requirements to non-U.S. trading venues and
clearing organizations with non-U.S. swap entity participants. Further,
they asserted that if the counterparty to a swap was a U.S. person, the
Commission's SEF and DCO registration requirements would independently
require the trading venue and clearing organization to register with
the Commission or obtain an exemption from registration. Additionally,
IIB/SIFMA requested the exception be made available to U.S. swap
entities, as well, except for daily trading records rules, arguing that
the interposition of clearing organizations reduces risk to the United
States, thereby obviating the need to apply the risk mitigation rules
(where applicable). They also noted that SEFs provide market
participants with the regulatory compliance protections associated with
centralized trading and that many group C requirements already do not
apply to a swap entity in connection with swaps executed anonymously,
regardless of the U.S. person status of the swap entity.\445\
---------------------------------------------------------------------------
\445\ In addition to noting the exceptions in the regulations
themselves, IIB/SIFMA reference the relief provided by Staff Letter
13-70 for intended to be cleared swaps (``Staff ITBC Letter'').
---------------------------------------------------------------------------
ISDA was supportive of the proposed exception, but requested that
it be extended to cover: (1) All relevant group B and C requirements;
and (2) U.S. and non-U.S. entities' transactions that are SEF- (or
exempt SEF-) executed and cleared at a DCO, exempt DCO, or
clearinghouse subject to CFTC no-action relief, regardless of whether
they are anonymously executed. ISDA noted that one of the regulatory
benefits of SEF trading is that market participants receive the
necessary regulatory compliance protections associated with centralized
trading, and that, as self-regulatory organizations, SEFs (and exempt
SEFs) are expected to keep daily trading records and audit trails of
each transaction executed on their platforms, so it makes sense to
allow counterparties not to comply with group B requirements when
executing trades on SEFs (or exempt SEFs), and restricting this
exemption to a particular method of execution on a SEF does not serve
any regulatory purpose. Moreover, ISDA argued that imposing CFTC
external business conduct standards to centrally-executed and cleared
trades also creates redundancies, as counterparties that trade on SEFs
(or exempt SEFs) receive necessary disclosures as part of the
onboarding process and regulatory required pre-trade credit checks
ensure that counterparties have sufficient credit to execute
transactions.
IATP stated that the biggest exception, in terms of the notional
amount of swaps and the number of group B and C requirements that would
be exempted
[[Page 56970]]
from compliance, is the Exchange-Traded Exception, and that this
exception would comport generally with G20 reform objectives to
centrally clear swaps and trade them anonymously (preferably post-trade
as well as pre-trade) on regulated exchanges. However, IATP objected to
the granting of the exception for foreign SEFs and clearing
organizations that have not qualified for registration with the
Commission, but have been granted exemptions from registration,
presumably in the interest of international comity, noting that if the
Exchange-Traded Exception results in disapplication of Commission
requirements to customized foreign affiliate swaps traded and cleared
on exempted entities, the risks to U.S. ultimate parents could be most
unexpected.
(iii) Final Rule
After carefully considering the comments, the Commission is
adopting the exception as proposed.\446\
---------------------------------------------------------------------------
\446\ Final Sec. 23.23(e)(1)(i). The Commission notes that the
addition of the Subpart L requirements to the group C requirements
under the Final Rule will not substantively expand the Exchange-
Traded Exception as the Subpart L requirements do not apply to swaps
cleared by a DCO. Also, as stated in the Proposed Rule, the
Commission considers the exception also to apply with respect to an
FBOT that provides direct access to its order entry and trade
matching system from within the U.S. pursuant to no-action relief
issued by Commission staff.
---------------------------------------------------------------------------
Regarding requests to expand the exception to include all anonymous
foreign-based swaps entered into on an exchange and which are
subsequently cleared, regardless of whether the exchange and clearing
organization are registered or exempt from registration with the
Commission, or to include swaps that are cleared on a DCO that has
received staff no-action relief from registration requirements, the
Commission is declining to expand the exception. As noted in the
Proposed Rule, the exception is based, in part, on the swaps eligible
for it being subject to independent requirements that apply to
transactions on a DCM or registered SEF pursuant to Commission
regulations or, with respect to exempt SEFs and registered FBOTs, to
comprehensive supervision and regulation in their home countries.
Similarly, the Commission believes that limiting the exception to DCOs
that are registered or exempt provides assurance that the DCOs clearing
swaps eligible for the exception will be subject to comprehensive
supervision and regulation. Further, as explained above, the Commission
does not find persuasive IIB/SIFMA's argument that if the counterparty
to a foreign-based swap is a U.S. person, other Commission rules
require that the trade be executed on a registered or exempt SEF and
cleared through a registered or exempt DCO.\447\ The Commission will
consider expanding the exception pending other amendments to the SEF/
DCO regulations.
---------------------------------------------------------------------------
\447\ See supra sections III.D and IV.D.
---------------------------------------------------------------------------
Regarding the request not to require that eligible foreign-based
swaps be anonymous, the Commission declines to expand the exception in
this manner. The other exceptions in the Final Rule provide relief
where appropriate for foreign-based swaps where the counterparty is
known, and this limited exception, as in the Guidance, is only meant to
provide relief from certain of the group B and group C requirements
where the counterparty is unknown and, thus, it would be impractical to
comply with such requirements.
Regarding the request to allow U.S. swap entities (other than their
foreign branches) to utilize the exception, the Commission declines to
expand the exception in this manner. The Commission is of the view,
consistent with the Guidance, that where a U.S. swap entity (other than
its foreign branch) enters into a swap, that swap is part of the U.S.
swap market. And, accordingly, the group B and group C requirements
should generally apply fully to such swap entity. \448\ In addition,
the Commission is generally of the view that the Final Rule is not the
appropriate place to make changes to the regulation of the U.S. swap
market. Expanding the exception to cover swaps in the U.S. swaps market
would require amendments to the underlying group B and group C
requirements that apply to all covered swaps rather than creating a
limited exception to them for certain foreign swaps. However, as
comments were supportive of extending the exception to U.S. swap
entities, the Commission will continue to analyze this issue and take
these comments into consideration when next considering changes to the
group B and group C requirements.
---------------------------------------------------------------------------
\448\ The Commission notes that, as referenced by IIB/SIFMA and
subject to certain specified conditions, the Staff ITBC Letter
provides relief to all swap entities from certain of the group B and
group C requirements for intended to be cleared swaps.
---------------------------------------------------------------------------
With respect to the request to include pre-execution trading
records (i.e., by revising the exception to apply to all group B
requirements), the Commission declines to expand the exception in this
manner. Excluding pre-execution trading records requirements is
consistent with the Guidance and, as noted in the Proposed Rule, these
requirements should continue to apply, as all swap entities should be
required to maintain, among other things, sufficient records to conduct
a comprehensive and accurate trade reconstruction for each swap, and
the swap entity may be the best, or only, source for pre-execution
trading records.
3. Foreign Swap Group C Exception
(i) Proposed Rule
The Commission proposed that each non-U.S. swap entity and foreign
branch of a U.S. swap entity would be excepted from the group C
requirements with respect to its foreign-based swaps with a foreign
counterparty.\449\ The Commission noted that such swaps would not
include as a party a U.S. person (other than a foreign branch where the
swap is conducted through such foreign branch) or be conducted through
a U.S. branch,\450\ and, given that the group C requirements are
intended to promote counterparty protections in the context of local
market sales practices, foreign regulators may have a relatively
stronger supervisory interest than the Commission in regulating such
swaps in relation to the group C requirements. Accordingly, the
Commission stated that it believed applying the group C requirements to
these transactions may not be warranted.
---------------------------------------------------------------------------
\449\ See Proposed Rule, 85 FR at 983-984. This approach is
similar to the Guidance. See Guidance, 78 FR at 45360-45361. As used
herein, the term swap includes transactions in swaps as well as
swaps that are offered but not entered into, as applicable.
\450\ See discussion of the modification of the definition of a
``swap conducted through a U.S. branch'' to be a ``swap booked in a
U.S. branch'' in section II.H.3, supra.
---------------------------------------------------------------------------
The Commission noted that, just as the Commission has a strong
supervisory interest in regulating and enforcing the group C
requirements associated with swaps taking place in the United States,
foreign regulators would have a similar interest in overseeing sales
practices for swaps occurring within their jurisdictions. Further,
given the scope of section 2(i) of the CEA with respect to the
Commission's regulation of swap activities outside the United States,
the Commission stated that it believes imposing its group C
requirements on a foreign-based swap between a non-U.S. swap entity or
foreign branch of a U.S. swap entity, on one hand, and a foreign
counterparty, on the other, is generally not necessary to advance the
customer protection goals of the Dodd-Frank Act embodied in the group C
requirements.
[[Page 56971]]
By contrast, the Commission stated that whenever a swap involves at
least one party that is a U.S. person (other than a foreign branch
where the swap is conducted through such foreign branch) or is a swap
conducted through a U.S. branch, the Commission believes it has a
strong supervisory interest in regulating and enforcing the group C
requirements, as a major purpose of Title VII is to control the
potential harm to U.S. markets that can arise from risks that are
magnified or transferred between parties via swaps. Therefore, the
Commission concluded that exercise of U.S. jurisdiction with respect to
the group C requirements over such swaps is reasonable because of the
strong U.S. interest in minimizing the potential risks that may flow to
the U.S. economy as a result of such swaps.\451\
---------------------------------------------------------------------------
\451\ See supra section I.D.2.
---------------------------------------------------------------------------
(ii) Summary of Comments
ISDA stated that it fully agrees with the Commission that there is
no policy benefit in subjecting non-U.S. market participants to the
CFTC's extensive customer protection regime,\452\ and therefore,
believes that these rules should be left within the remit of home
country regulators. Further, ISDA stated that it agrees that foreign
branch ANE Transactions should not be subject to group C
Requirements.\453\ IIB/SIFMA also supported the proposed exception.
However, ISDA and IIB/SIFMA requested specific changes to the
underlying group C requirements, including that certain of the group C
requirements apply only on an ``opt-in'' basis.
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\452\ As explained more fully below, the Commission notes that
it did not make such a statement in the Proposed Rule.
\453\ As explained more fully below, this statement does not
wholly comport with the Commission's position as set forth in the
Proposed Rule.
---------------------------------------------------------------------------
Specifically, ISDA stated that non-U.S. persons should be allowed
to opt-in to receiving external business conduct disclosures from U.S.
persons. Under ISDA's proposed alternative, unless a non-U.S. client
chooses to ``opt-in'' into the full spectrum of the CFTC requirements,
U.S swap entities and U.S. branches of non-U.S. swap entities would
only have the obligation to provide disclosures related to: (1)
Prohibition on fraud, manipulation, and other abusive practices; (2)
verification of ECP status; (3) material risks, excluding requirements
to provide daily mark and scenario analysis; (4) fair dealing
communications; and (5) brief descriptions of other external business
conduct disclosures, including the option to opt-in to receiving such
disclosures.
IIB/SIFMA similarly requested that, to better balance counterparty
protection interests against the market fragmentation that results when
swap entities ask their non-U.S. counterparties to enter into
documentation designed to satisfy U.S. legal requirements, the
Commission refine how the group C requirements apply to all swaps
entered into by U.S. swap entities and U.S. branches of non-U.S. swap
entities when they transact with non-U.S. counterparties, including
swaps entered into by U.S. swap entities in the United States. IIB/
SIFMA argued that, because the business conduct requirements are
designed to provide customer protection rather than to mitigate risk to
the United States, the Commission has a limited regulatory interest in
mandating full application of its customer protection requirements to
all swap transactions between swap entities and their non-U.S.
counterparties. Further, IIB/SIFMA asserted that, in other contexts,
the Commission has recognized that non-U.S persons do not generally
implicate U.S. investor protection concerns (e.g., in its CPO and CTA
rules). They proposed that only the following requirements would apply
to a U.S. swap entity (including its U.S. branches or when it otherwise
trades in the United States) or U.S. branch of a non-U.S. swap entity
when it trades with a non-U.S. counterparty unless otherwise opted into
by a non-U.S. person counterparty: (1) The prohibition on fraud,
manipulation, and other abusive practices (but not additional
confidentiality requirements under Sec. 23.410(c)); (2) verification
of ECP status (although in their view such verification should not
require a written representation regarding a specific prong of the ECP
definition, as it does for U.S. persons); (3) disclosure of material
risks (but not scenario analysis under Sec. 23.431(b)), material
characteristics and economic terms, and material conflicts of interest
and incentives (but not pre-trade mid-market marks under Sec.
23.431(a)(3)(i)), without requiring the counterparty to agree in
writing to the manner of disclosure as under Sec. 23.402(e) and (f);
(4) fair and balanced communications; and (5) a one-time notification
prior to entering into a new trading relationship with a non-U.S.
counterparty that the non-U.S. counterparty may opt in to the
additional customer protections provided by the remaining external
business conduct rules along with a summary description of those rules.
Further, IIB/SIFMA requested that the Commission clarify that non-U.S.
persons are not ``Special Entities'' (as defined in CEA section
4s(h)(2)(C) and Sec. 23.401(c)), considering that Congress was not
seeking to protect foreign pension plans and endowments.
(iii) Final Rule--Foreign Swap Group C Exception and U.S. Branch Group
C Exception
After carefully considering the comments, the Commission is
adopting the exception as proposed.\454\ The Commission recognizes
that, although the exception is being adopted as proposed, the scope of
the exception is being expanded because the Subpart L requirements have
been added to the group C requirements under the Final Rule. For the
reasons discussed in section VI.A.3, the Commission believes that the
Subpart L requirements are appropriately classified as group C
requirements and, thus, the expansion of the exception in this manner
is appropriate.
---------------------------------------------------------------------------
\454\ Final Sec. 23.23(e)(1)(ii).
---------------------------------------------------------------------------
In addition, based on the comments received, the Commission is
adopting an additional exception from the group C requirements for
certain swaps of U.S. branches of non-U.S. swap entities (``U.S. Branch
Group C Exception''), as shown in the rule text in this release.\455\
Specifically, under the U.S. Branch Group C Exception, a non-U.S. swap
entity is excepted from the group C requirements with respect to any
swap booked in a U.S. branch with a foreign counterparty that is
neither a foreign branch nor a Guaranteed Entity. The Commission is
adopting this exception because, although the swaps benefiting from the
exception are part of the U.S. swap market, the Commission believes
that foreign regulators have a stronger interest in such swaps with
respect to the group C requirements--which relate to counterparty
protection rather than risk mitigation--because they are between a non-
U.S. swap entity (by definition, a non-U.S. person) and certain foreign
counterparties that have a limited nexus to the United States (i.e.,
non-U.S. persons, including SRSs that are not Guaranteed Entities). The
Commission is not providing this exception to swaps booked in a U.S.
branch of a non-U.S. swap entity with a foreign branch of a U.S. swap
entity, Guaranteed Entity, or U.S. branch counterparty (where, for the
U.S. branch, the swap is booked in the U.S. branch of the
counterparty). A foreign branch (which is, by definition, a part of
U.S. person), a Guaranteed Entity, and a U.S. branch counterparty have
a closer nexus to the United States, and,
[[Page 56972]]
thus, the Commission believes that the group C requirements should
continue to apply to swaps with such counterparties.
---------------------------------------------------------------------------
\455\ Final Sec. 23.23(e)(2).
---------------------------------------------------------------------------
Regarding the requests to change the application of some or all of
the group C requirements to swaps entered into by U.S. swap entities
and U.S. branches of non-U.S. swap entities when they transact with
non-U.S. counterparties such that certain of the requirements would
apply only where non-US counterparties ``opt-in'' to such treatment,
the Commission is of the view that where a U.S. swap entity (other than
its foreign branch) enters into a swap or where a swap is booked in a
U.S. branch of a non-U.S. swap entity, those swaps are part of the U.S.
swap market, and, accordingly, other than as provided in the U.S.
Branch Group C Exception, the group C requirements should generally
apply fully to such swap entities, regardless of the U.S. person status
of its counterparty.
In response to IIB/SIFMA's comment that adopting their requested
change is in line with the Commission's recognition in the CPO/CTA
context that non-U.S persons do not generally implicate U.S. investor
protection concerns, the Commission has never stated that U.S.-based
CPOs/CTAs do not need to register or comply with the Commission's
applicable rules. Rather, under Sec. 3.10(c)(3), a foreign person is
not required to register as a CPO/CTA (or comply with most Commission
regulations) in connection with commodity interest transactions on
behalf of persons located outside the United States that are submitted
for clearing through a registered futures commission merchant.
Moreover, a CPO/CTA advising a customer on the investment of their
funds or managing such investment is in a fundamentally different
position than a swap entity that is acting as a counterparty under a
swap. In addition, as noted above, the Commission is of the view that,
generally, the Final Rule is not the appropriate place to make changes
to the regulation of the U.S. swap market. Making the group C
requirements an ``opt-in'' regime would require changing the underlying
group C requirements that apply to all covered swaps rather than
creating a limited exception to them for certain foreign swaps.
On the request of IIB/SIFMA that the Commission ``clarify'' that
non-U.S. persons are not Special Entities because ``Congress was not
seeking to protect foreign pension plans and endowments,'' the
Commission received similar comments when it adopted the definition of
``Special Entity'' in its final rule on external business conduct
standards for swap entities and addressed them in that rulemaking.\456\
First, the Commission, in interpreting the CEA, refined the definition
of ``Special Entity'' to remove, among other things, certain foreign
employee benefit plans from the scope of the definition.\457\ Second,
the Commission expressly addressed foreign endowments potentially being
classified as Special Entities, saying that because ``the statute does
not distinguish between foreign and domestic counterparties in Section
4s(h) . . . the Commission has determined that prong (v) of Section
4s(h)(2)(C) and Sec. 23.401(c)(5) [the endowment prongs of the
definitions] will apply to any endowment, whether foreign or
domestic.'' \458\ Therefore, the Commission is declining to provide the
clarification that IIB/SIFMA requested.
---------------------------------------------------------------------------
\456\ Business Conduct Standards for Swap Dealers and Major Swap
Participants With Counterparties, 77 FR 9733, 9774-75 (Feb. 2012).
\457\ Id. at 9776.
\458\ Id.
---------------------------------------------------------------------------
Regarding ISDA's statement that it fully agrees with the Commission
that there is no policy benefit in subjecting non-U.S. market
participants to the CFTC's extensive customer protection regime and,
therefore, believes that these rules should be left within the remit of
home country regulators, this statement does not wholly comport with
the Commission's position as set forth in the Proposed Rule. Rather,
the Commission proposed that only certain foreign-based swaps meeting
the eligibility criteria for the exception would be excepted from the
group C requirements. ISDA also stated that it agrees that foreign
branch ANE Transactions should not be subject to group C Requirements.
The Commission notes that this would only be true to the extent the
swap is conducted through the relevant foreign branch or branches,
which would require, among other things, that the swap be entered into
by each relevant foreign branch in its normal course of business. To
satisfy this prong, it must be the normal course of business for
employees located in the branch (or another foreign branch of the U.S.
bank) to enter into the type of swap in question. Under the Final Rule
(and as proposed), where the swap is primarily entered into by
personnel not located in a foreign branch of the U.S. bank, this
requirement would not be satisfied.
4. Limited Foreign Branch Group B Exception
(i) Proposed Rule
The Commission proposed that each foreign branch of a U.S. swap
entity would be excepted from the group B requirements with respect to
any foreign-based swap with a foreign counterparty that is an Other
Non-U.S. Person, subject to certain limitations.\459\ Specifically,
under the Proposed Rule: (1) The exception would not be available with
respect to any group B requirement for which substituted compliance
(discussed in section VI.C below) is available for the relevant swap;
and (2) in any calendar quarter, the aggregate gross notional amount of
swaps conducted by a swap entity in reliance on the exception may not
exceed five percent of the aggregate gross notional amount of all its
swaps in that calendar quarter.
---------------------------------------------------------------------------
\459\ See Proposed Rule, 85 FR at 984. This is similar to a
limited exception for transactions by foreign branches in certain
specified jurisdictions in the Guidance. See Guidance, 78 FR at
45351.
---------------------------------------------------------------------------
As discussed in the Proposed Rule, the Commission proposed the
Limited Foreign Branch Group B Exception to allow the foreign branches
of U.S. swap entities to continue to access swap markets for which
substituted compliance may not be available under limited
circumstances.\460\ The Commission stated that it believes the Limited
Foreign Branch Group B Exception is appropriate because U.S. swap
entities' activities through foreign branches in these markets, though
not significant in volume in many cases, may nevertheless be an
integral element of a U.S. swap entity's global business. Additionally,
although not the Commission's main purpose, the Commission noted that
it endeavors to preserve liquidity in the emerging markets in which it
expects this exception to be utilized, which may further encourage the
global use and development of swap markets. Further, because of the
proposed five percent cap on the use of the exception, the Commission
stated that it preliminarily believed that the swap activity that would
be excepted from the group B requirements would not raise significant
supervisory concerns.
---------------------------------------------------------------------------
\460\ As noted above, under the Proposed Rule, where substituted
compliance is available for a particular group B requirement and
swap, the exception would not be available.
---------------------------------------------------------------------------
(ii) Summary of Comments
IIB/SIFMA generally supported this exception, but requested that
the Commission clarify that: (1) The exception applies on a swap-by-
swap,
[[Page 56973]]
requirement-by-requirement basis; (2) that it is optional for a U.S.
swap entity to rely on the exception for any given swap; and (3) that
the five percent notional amount cap would only cover transactions
entered into ``in reliance on'' the exception, not all swaps eligible
for the exception. In a subsequent discussion with Commission staff,
IIB/SIFMA further clarified their request that the exception should
apply on a ``requirement-by-requirement basis'' to mean that the
exception should have a separate five percent gross notional amount cap
applicable to each requirement, rather than a single five percent gross
notional amount cap where any swap that relied on the exception for any
group B requirement would count towards the cap. State Street also
supported the proposed exception; however, it requested that the
Commission provide further guidance on the calculation of the notional
amount cap.
IIB/SIFMA also asked that, consistent with its other requests, the
exception be available when a foreign branch transacts with an SRS that
is not a swap entity or with a U.S. branch of a foreign bank. With
respect to such an entity, IIB/SIFMA noted that the group B
requirements indirectly regulate the end user (i.e., non-swap entity)
counterparties of swap entities by requiring them to execute
documentation and engage in portfolio reconciliation and compression
exercises, when they trade with swap entities subject to the
requirements. IIB/SIFMA asserted that many more end users will qualify
as SRSs than swap entities under the proposed definition because,
unlike swap entities, commercial and non-financial end users generally
will not qualify for the exclusions from the SRS definition and that,
as a result, significant foreign subsidiaries of large U.S.
multinational companies would find themselves subject to group B
requirements when they trade with non-U.S. swap entities. IIB/SIFMA
noted that the indirect application of the group B requirements would
pose particular problems for significant subsidiaries doing business in
emerging market jurisdictions that have not yet adopted comparable
rules to the group B requirements because swap entities' operations in
those jurisdictions might not be set up to apply the group B
requirements to trading with those subsidiaries, and that this could
cause those subsidiaries to lose access to key interest or currency
hedging products and face increased hedging and risk management costs
relative to their foreign competitors. IIB/SIFMA also stated that
subjecting an SRS that is not a swap entity to group B requirements
would impose undue costs on non-U.S. swap entities, noting that because
the SRS test depends on a non-U.S. counterparty's internal
organizational structure and financial metrics, it generally would not
be possible for a swap entity to determine whether its non-U.S.
counterparty is an SRS without obtaining an affirmative representation
and, because it would be difficult for a swap entity categorically to
rule out any class of non-U.S. counterparties from being an SRS, swap
entities would be forced to obtain relevant representations from nearly
their entire global client bases.
Further, IIB/SIFMA noted that any credit or legal risks arising
from swaps conducted in reliance on the exception should already be
addressed through existing provisions of Sec. 23.600 and, accordingly,
they assume the Proposed Rule was not meant to imply some additional
risk management program requirement in connection with reliance on the
exception.
JBA asked that the Commission review the Proposed Rule from the
perspective of ensuring symmetric application of requirements between
U.S. swap entities and non-U.S. swap entities. Specifically, JBA
requested that an exception consistent with the Limited Foreign Branch
Group B Exception should be applicable to the non-U.S. swap entities
even when their counterparty is a foreign branch of a U.S. person. As
an example, JBA stated that when the Seoul branch of a U.S. bank that
is registered as an SD enters into a swap with the Tokyo headquarters
of a Japanese bank that is registered as an SD, the U.S. bank SD may
rely on the Limited Foreign Branch Group B Exception, whereas the
Japanese bank SD may not rely on an exception from the group B
requirements.
ISDA stated that it agrees that foreign branch ANE Transactions
should not be subject to group B requirements where substituted
compliance is available.\461\
---------------------------------------------------------------------------
\461\ As discussed more fully below, this statement is not an
accurate description of the Proposed Rule.
---------------------------------------------------------------------------
(iii) Final Rule
After carefully considering the comments, the Commission is
adopting the exception with certain modifications, as shown in the rule
text in this release.\462\ Specifically, the Commission is: (1)
Adjusting the exception such that it is not available for swaps between
swap entities; (2) broadening the exception to apply to foreign-based
swaps with an SRS End User; and (3) making some minor technical changes
to the text of the Final Rule.
---------------------------------------------------------------------------
\462\ Final Sec. 23.23(e)(4).
---------------------------------------------------------------------------
The Commission believes that a swap between the foreign branch of a
U.S. swap entity and a non-U.S. swap entity should generally be subject
to the group B requirements. Where both parties to a swap are swap
entities, the rationale for the Limited Foreign Branch Group B
Exception is not present. As discussed in the Proposed Rule and the
Guidance, as well as above, the exception is designed to allow the
foreign branches of U.S. swap entities to continue to access swap
markets for which substituted compliance may not be available under
limited circumstances (a) because U.S. swap entities' activities
through foreign branches in these markets, though not significant in
volume in many cases, may nevertheless be an integral element of a U.S.
swap entity's global business, and (b) to preserve liquidity in the
emerging markets in which it expects this exception to be utilized.
Where both parties to a swap are registered swap entities, the
Commission sees no impediment to compliance with the group B
requirements.
With respect to SRS End Users, the Commission acknowledges that
applying the group B requirements to a swap entity's swaps indirectly
affects their counterparties, including SRS End User counterparties, by
requiring them to execute documentation (e.g., compliant swap trading
relationship documentation), and engage in portfolio reconciliation and
compression exercises as a condition to entering into swaps with swap
entity counterparties. As noted by IIB/SIFMA, requiring compliance with
these obligations may cause counterparties, including SRS End Users, to
face increased costs relative to their competitors not affected by the
application of the group B requirements (e.g., for legal fees or as a
result of costs being passed on to them by their swap entity
counterparties), and/or to potentially lose access to key interest or
currency hedging products. Also, the Commission recognizes that, as
IIB/SIFMA notes, because the SRS test depends on a non-U.S.
counterparty's internal organizational structure and financial metrics
and it would be difficult to rule out any category of non-U.S.
counterparties as being an SRS, the proposed application of group B
requirements to all SRSs may cause swap entities to obtain SRS
representations from nearly their entire non-U.S. client bases,
potentially increasing costs for all of these clients.
[[Page 56974]]
Taking this into account and the Commission's belief that it is
important to ensure that an SRS, particularly a commercial or non-
financial entity, continues to have access to swap liquidity for
hedging or other non-dealing purposes, the Commission is expanding the
exception only to SRS End Users (and not to SRSs that are swap entities
(``SRS Swap Entities'') or Guaranteed Entities). The Commission
believes that an SRS End User does not pose as significant a risk to
the United States as an SRS Swap Entity or a Guaranteed Entity, because
an SRS End User: (1) Has a less direct connection to the United States
than a Guaranteed Entity; and (2) has been involved, at most, in only a
de minimis amount of swap dealing activity, or has swap positions below
the MSP thresholds, such that it is not required to register as an SD
or MSP, respectively. In addition, because the SRS category was first
considered in the Proposed Rule, unlike for Guaranteed Entities, there
is no precedent in the Guidance to apply the group B requirements to
all SRSs as originally proposed. Moreover, treating SRSs End Users and
Guaranteed Entities differently under the exception is consistent with
the differences in swap counting requirements under the Final
Rule.\463\ For example, an Other Non-U.S. Person is generally not
required to count a dealing swap with an SRS toward its de minimis
threshold calculation for SD registration, whereas an Other Non-U.S.
Person is (absent certain exceptions) generally required to count its
dealing swaps with a Guaranteed Entity.
---------------------------------------------------------------------------
\463\ See discussion of counting requirements of swaps with SRSs
in sections III.B.1 and IV.B.1, supra.
---------------------------------------------------------------------------
In addition, in response to commenters requesting further guidance
on the application of the exception, the Commission is clarifying that
the five percent gross notional amount cap applies only to swaps
entered into in reliance on the exception. This does not include
situations where a foreign branch of a U.S. swap entity complies with
all of the group B requirements, either directly or through substituted
compliance, with respect to a swap that is eligible for the exception.
In such situation, though the swap is eligible for the exception for
the requirements not addressed by substituted compliance, it does not
count toward the five percent gross notional amount cap for swaps
entered into in reliance on the exception because compliance with the
applicable group B requirements was achieved. On the other hand, where
a foreign branch relies on the exception with respect to any group B
requirement for a swap, the notional amount of that swap counts toward
the five percent gross notional amount cap for the relevant calendar
quarter. The Commission is declining to expand the five percent cap as
requested by IIB/SIFMA such that there would be a separate five percent
gross notional amount cap for each group B requirement, because it
believes such an exception would potentially allow a much greater
percentage of swaps by notional amount to be eligible for the
exception, and it would be difficult for a swap entity to track and for
the Commission and the National Futures Association (``NFA'') to
monitor compliance with such a standard. Accordingly, the five percent
cap applies on a swap-by-swap basis, but does not apply on a
requirement-by-requirement basis such that a foreign branch may rely on
the exception for greater than five percent of its swaps by gross
notional amount in any calendar quarter.
Regarding the request to expand the exception to make it available
to swaps of a foreign branch with U.S. branches of foreign banks, the
Commission does not believe that such an expansion is appropriate. As
noted above, the exception is designed to allow the foreign branches of
U.S. swap entities to continue to access swap markets for which
substituted compliance may not be available under limited
circumstances. It is not designed to allow foreign branches to transact
with U.S. branches of non-U.S. banking organizations without complying
with the group B requirements. A foreign branch of a U.S. bank is a
U.S. person, and, as noted above, the Commission is of the view that
where a swap is booked in a U.S. branch, that swap is part of the U.S.
swap market. Accordingly, the Commission retains a supervisory interest
in swaps between a foreign branch and a U.S. branch such that the group
B requirements should generally apply to such swaps.
Regarding ISDA's statement that it agrees that foreign branch ANE
Transactions should not be subject to group B requirements where
substituted compliance is available, the Commission notes that this
statement is not accurate as the Limited Foreign Branch Group B
Exception does not apply where substituted compliance is available.
Also, as discussed above, even where substituted compliance is not
available, this statement would only be true to the extent the swap is
conducted through the relevant foreign branch or branches, which would
require, among other things, that the swap be entered into by each
relevant foreign branch in its normal course of business. To satisfy
this prong, it must be the normal course of business for employees
located in the branch (or another foreign branch of the U.S. bank) to
enter into the type of swap in question. Under the Final Rule (and as
proposed), where the swap is primarily entered into by personnel not
located in a foreign branch of the U.S. bank, this requirement would
not be satisfied.
Further, in line with IIB/SIFMA's comment, the Commission confirms
that its stated expectation that swap entities will address any
significant risk that may arise as a result of the utilization of one
or more exceptions in their risk management programs required pursuant
to Sec. 23.600 is not meant to imply an additional risk management
program requirement, but rather to remind swap entities of their
obligations under Sec. 23.600.
5. Non-U.S. Swap Entity Group B Exception
(i) Proposed Rule
The Commission also proposed that each non-U.S. swap entity that is
an Other Non-U.S. Person would be excepted from the group B
requirements with respect to any foreign-based swap with a foreign
counterparty that is also an Other Non-U.S. Person.\464\ The Commission
stated that, in these circumstances, where no party to the foreign-
based swap is a U.S. person, a Guaranteed Entity, or an SRS, and, the
particular swap is not conducted through a U.S. branch \465\ of a
party, notwithstanding that one or both parties to such swap may be a
swap entity, the Commission believes that foreign regulators may have a
relatively stronger supervisory interest in regulating such swaps with
respect to the subject matter covered by the group B requirements, and
that, in the interest of international comity, applying the group B
requirements to these foreign-based swaps is not warranted.
---------------------------------------------------------------------------
\464\ See Proposed Rule, 85 FR at 984. This approach is similar
to the Guidance; however, the Commission notes that the Proposed
Rule limited the non-U.S. swap entities eligible for this exception
to those that are Other Non-U.S. Persons, and the Guidance did not
contain a similar limitation. See Guidance, 78 FR at 45352-45353.
\465\ See discussion of the modification of the definition of a
``swap conducted through a U.S. branch'' to be a ``swap booked in a
U.S. branch'' in section II.H.3, supra.
---------------------------------------------------------------------------
The Commission noted that, generally, it would expect that swap
entities that rely on this exception are subject to risk mitigation
standards in the foreign jurisdictions in which they reside similar to
those included in the group B requirements, as most
[[Page 56975]]
jurisdictions surveyed by the FSB in respect of their swaps trading
have implemented such standards.\466\
---------------------------------------------------------------------------
\466\ See 2019 FSB Progress Report, Table M.
---------------------------------------------------------------------------
(ii) Summary of Comments
IIB/SIFMA agreed with the Commission that foreign regulators have a
stronger supervisory interest in these swaps than the Commission in
regards to the risk mitigation matters covered by the group B
requirements, but recommended that the Commission expand the proposed
exception by: (1) Applying the exception to swaps with an SRS that is
not a swap entity, so as to avoid inappropriately burdening the foreign
subsidiaries of U.S. multinational corporations and their
counterparties (as discussed in section VI.B.4 above); (2) conforming
the treatment of a non-U.S. swap entity that either is an SRS Swap
Entity or benefits from a U.S. guarantee for the relevant swap
(``Guaranteed Swap Entity'') to the Guidance \467\ (or, at a minimum,
adopting an exception for de minimis trading by these entities in
jurisdictions not eligible for substituted compliance similar to the
Limited Foreign Branch Group B Exception where, for SRS Swap Entities,
the five percent notional amount cap would apply at the level of the
ultimate U.S. parent entity), so as to minimize the competitive
disadvantages faced by such swap entities and their counterparties when
they are subject to U.S. rules extraterritorially; and (3) permitting a
U.S. branch to rely on the exception when it trades with a non-U.S.
person that is neither a Guaranteed Entity nor another U.S. branch,
which, in their view, would appropriately recognize that such swaps do
not present risks to the United States, are generally unnecessary due
to home country regulation, and align the scope of the exception to be
consistent with analogous EU rules.
---------------------------------------------------------------------------
\467\ The Commission notes that SRSs were not contemplated by
the Guidance, so the Commission assumes that the comment requested
that the Commission conform the treatment of SRSs to conduit
affiliates under the Guidance.
---------------------------------------------------------------------------
JFMC/IBAJ similarly requested that the Commission exclude
transactions between a Guaranteed Swap Entity or an SRS Swap Entity and
an Other Non-U.S. Person from the application of group B requirements,
stating that these requirements would not apply to such transactions
under the Guidance and they see no justification for the change in
Commission policy. They argued that the expanded extraterritorial
application will indirectly impose regulatory compliance burdens on
Japanese market participants, most of which are Other Non-U.S. Persons,
when trading swaps with Guaranteed Swap Entities, especially where a
Guaranteed Swap Entity cannot rely on substituted compliance with local
Japanese regulations to satisfy group B requirements, and that Japanese
market participants will likely refrain from trading swaps with a
Guaranteed Swap Entity to avoid the indirect imposition of the
Commission's swaps regulations and the costs associated therewith. They
noted that this may diminish the ability of U.S.-headquartered firms to
compete or access liquidity in the Japanese swaps market, which could
result in fragmented global swaps markets comprised of small and
disconnected liquidity pools, leading to exacerbation of systemic risk.
ISDA requested that, in line with the Proposed Rule's intent to
give deference to home country regulators where there are applicable
foreign regulatory requirements, the Commission not apply the proposed
group B requirements to transactions between: (1) U.S. branches of non-
U.S. swap entities and Other Non-U.S. Persons; and (2) Guaranteed
Entities and Other Non-U.S. Persons, supporting the position and
rationale of IIB/SIFMA on this topic. ISDA noted that the Commission
has set a precedent for taking this approach by providing an exemption
in the Guidance to Guaranteed Entities from compliance with group B
requirements when transacting with Other Non-U.S. Persons.\468\
---------------------------------------------------------------------------
\468\ The Commission assumes that ISDA was referring to non-U.S.
Persons that are not a guaranteed or conduit affiliate of a U.S.
Person (each as defined or described in the Guidance), as the term
``Other Non-U.S. Person'' is not used in the Guidance.
---------------------------------------------------------------------------
(iii) Final Rule--Non-U.S. Swap Entity Group B Exception and Limited
Swap Entity SRS/Guaranteed Entity Group B Exception
After carefully considering the comments, the Commission is
adopting the Non-U.S. Swap Entity Group B Exception with certain
modifications, as shown in the rule text in this release.\469\
Specifically, for the same reasons that the Commission is expanding the
Limited Foreign Branch Group B Exception to include swaps with SRS End
Users,\470\ the Commission is also expanding the Non-U.S. Swap Entity
Group B Exception to include swaps with SRS End Users.
---------------------------------------------------------------------------
\469\ Final Sec. 23.23(e)(3).
\470\ See supra section VI.B.4.iii.
---------------------------------------------------------------------------
In addition, based on the comments received, the Commission is
adopting an additional limited exception from the group B requirements
similar to the Limited Foreign Branch Group B Exception in the Final
Rule (discussed above), for trading by an SRS Swap Entity or a
Guaranteed Swap Entity, on the one hand, and certain non-U.S. persons,
on the other (``Limited Swap Entity SRS/Guaranteed Entity Group B
Exception''), as shown in the rule text in this release.\471\ As
commenters noted, under the Guidance, a Guaranteed Swap Entity or a
non-U.S. swap entity that was a conduit affiliate would not have been
expected to comply with the group B requirements when transacting with
a non-U.S. person that was not a conduit or guaranteed affiliate, so
the Proposed Rule deviated from the Guidance and would have
disadvantaged SRS Swap Entities and Guaranteed Swap Entities relative
to foreign branches of U.S. swap entities in the application of the
group B requirements. Thus, the Commission believes a limited exception
is warranted because, as a policy matter, it has determined that
Guaranteed Swap Entities and SRS Swap Entities (who, by definition, are
non-U.S. persons) should not be subject to stricter application of the
group B requirements than foreign branches of U.S swap entities (who
are U.S. persons). Under the Limited Swap Entity SRS/Guaranteed Entity
Group B Exception, each Guaranteed Swap Entity and SRS Swap Entity is
excepted from the group B requirements, with respect to any foreign-
based swap with a foreign counterparty (other than a foreign branch)
that is neither a swap entity \472\ nor a Guaranteed Entity, subject to
certain conditions. Specifically, (1) the exception is not available
with respect to any group B requirement if the requirement as
applicable to the swap is eligible for substituted compliance pursuant
to a comparability determination issued by the Commission prior to the
execution of the swap (discussed in sections VI.C and VI.D below); and
(2) in any calendar quarter, the aggregate gross notional amount of
swaps conducted by an SRS Swap Entity or a Guaranteed Swap Entity in
reliance on this exception aggregated with the gross notional amount of
swaps conducted by all affiliated SRS Swap Entities and Guaranteed Swap
Entities in reliance on
[[Page 56976]]
this exception does not exceed five percent of the aggregate gross
notional amount of all swaps entered into by the SRS Swap Entity or a
Guaranteed Swap Entity and all affiliated swap entities.\473\
---------------------------------------------------------------------------
\471\ Final Sec. 23.23(e)(5). As noted above, the Commission,
generally, expects that swap entities that rely on this exception
are subject to risk mitigation standards in the foreign
jurisdictions in which they reside similar to those included in the
group B requirements, as most jurisdictions surveyed by the FSB in
respect of their swaps trading have implemented such standards. See
2019 FSB Progress Report, Table M.
\472\ As discussed above, the Commission is also excluding swaps
with a swap entity counterparty from the Limited Foreign Branch
Group B Exception.
\473\ Final Sec. 23.23(e)(5)(i) and (ii). As described above
for the Limited Foreign Branch Group B Exception, a swap entered
into by a SRS Swap Entity or Guaranteed Swap Entity will only count
toward the gross notional amount cap where it is entered into in
reliance on the Limited Swap Entity SRS/Guaranteed Entity Group B
Exception.
---------------------------------------------------------------------------
With respect to the request to dis-apply fully the group B
requirements to swaps between an SRS Swap Entity or Guaranteed Swap
Entity, on the one hand, and an Other Non-U.S. Person on the other, the
Commission believes that the group B requirements should generally
continue to apply to these swaps, as these requirements relate to risk
mitigation, and SRS Swap Entities and Guaranteed Swap Entities may pose
significant risk to the United States. Other than the Limited Foreign
Branch Group B Exception, this matches the treatment of swaps between a
foreign branch of a U.S. swap entity and an Other Non-U.S. Person under
the Proposed Rule. Therefore, it is the Commission's view that
providing the Limited Swap Entity SRS/Guaranteed Entity Group B
Exception (discussed above) to put these entities on a substantially
similar footing as such foreign branches under the group B requirements
under the Final Rule is the better approach.
Regarding the requests to expand the exception to include
transactions between U.S. branches and certain non-U.S. persons, the
Commission declines such an expansion. As noted above, the Commission
believes that where a swap is booked in a U.S. branch of a non-U.S.
swap entity, that swap is part of the U.S. swap market, and,
accordingly, the group B requirements should generally apply.
C. Substituted Compliance
As discussed in the Proposed Rule, substituted compliance is a
fundamental component of the Commission's cross-border framework.\474\
It is intended to promote the benefits of integrated global markets by
reducing the degree to which market participants will be subject to
duplicative regulations. Substituted compliance also fosters
international harmonization by encouraging U.S. and foreign regulators
to adopt consistent and comparable regulatory regimes that can result
in deference to each other's regime. Substituted compliance, therefore,
also is consistent with the directive of Congress in the Dodd-Frank Act
that the Commission ``coordinate with foreign regulatory authorities on
the establishment of consistent international standards with respect to
the regulation'' of swaps and swap entities.\475\ When properly
calibrated, substituted compliance promotes open, transparent, and
competitive markets without compromising market integrity. On the other
hand, if construed too broadly, substituted compliance could defer
important regulatory interests to foreign regulators that have not
implemented comparably robust regulatory frameworks.
---------------------------------------------------------------------------
\474\ For example, in addition to the Guidance, the Commission
has provided substituted compliance with respect to foreign futures
and options transactions (see, e.g., Foreign Futures and Options
Transactions, 67 FR 30785 (May 8, 2002); Foreign Futures and Options
Transactions, 71 FR 6759 (Feb. 9, 2006)); and margin for uncleared
swaps (see Cross-Border Margin Rule, 81 FR 34818).
\475\ See Dodd-Frank Act, section 752(a); 15 U.S.C. 8325.
---------------------------------------------------------------------------
The Commission has determined that, in order to achieve the
important policy goals of the Dodd-Frank Act, U.S. swap entities
(excluding their foreign branches) must be fully subject to the Dodd-
Frank Act requirements addressed by the Final Rule, without regard to
whether their counterparty is a U.S. or non-U.S. person. Given that
such firms are U.S. persons conducting their business within the United
States, their activities inherently have a direct and significant
connection with activities in, or effect on, U.S. commerce. However,
the Commission recognizes that, in certain circumstances, non-U.S. swap
entities' and foreign branches' swaps with non-U.S. persons have a more
attenuated nexus to U.S. commerce. Further, the Commission acknowledges
that foreign jurisdictions also have a supervisory interest in such
swaps. The Commission therefore believes that substituted compliance is
appropriate for non-U.S. swap entities and foreign branches of U.S.
swap entities in certain circumstances.
In light of the interconnectedness of the global swap market and
consistent with CEA section 2(i) and principles of international
comity, the Commission is implementing a substituted compliance regime
with respect to the group A and group B requirements that builds upon
the Commission's prior substituted compliance framework and aims to
promote diverse markets without compromising the central tenets of the
Dodd-Frank Act. As discussed below, the Final Rule outlines the
circumstances in which a non-U.S. swap entity or foreign branch of a
U.S. swap entity is permitted to comply with the group A and/or group B
requirements by complying with comparable standards in its home
jurisdiction.
1. Proposed Rule
The Commission proposed to permit a non-U.S. swap entity to avail
itself of substituted compliance with respect to the group A
requirements on an entity-wide basis.\476\ The Commission also proposed
to permit a non-U.S. swap entity or a foreign branch of a U.S. swap
entity to avail itself of substituted compliance with respect to the
group B requirements for its foreign-based swaps with foreign
counterparties.\477\ The Commission did not propose to permit
substituted compliance for the group C requirements, where broader
exceptions for swaps with foreign counterparties would be available.
---------------------------------------------------------------------------
\476\ See Proposed Sec. 23.23(f)(1); Proposed Rule, 85 FR at
985.
\477\ See Proposed Sec. 23.23(f)(2); Proposed Rule, 85 FR at
985.
---------------------------------------------------------------------------
2. Summary of Comments
Chatham, JFMC/IBAJ, and BGC/Tradition generally supported the
Proposed Rule's approach to substituted compliance, stating that it is
consistent with the principles of international comity. The Commission
also received two comments requesting that the Commission expand the
proposed scope of substituted compliance. Specifically, AIMA stated
that the Commission should expand the availability of substituted
compliance by making it available to cross-border transactions as far
as possible, including any swap involving a non-U.S. person, even swaps
with U.S. persons. AIMA stated that the Commission's supervisory
interest in the swap activities of U.S. persons should not prelude the
availability of substituted compliance for U.S. persons. AIMA also
supported a universal, entity-wide approach to substituted compliance,
whereby substituted compliance would be fully available for cross-
border transactions.
In addition, IIB/SIFMA stated that the Commission should expand the
availability of substituted compliance for the group B requirements to:
(1) All swaps entered into by a non-U.S. swap entity or foreign branch,
including swaps with U.S. persons; and (2) swaps conducted through a
U.S. branch.\478\ IIB/SIFMA further requested that the Commission make
substituted compliance available for the group C requirements where
such requirements apply. IIB/SIFMA noted that the SEC permits
substituted compliance for U.S.-facing transactions with respect to its
external business conduct standards.
---------------------------------------------------------------------------
\478\ See discussion of the modification of the definition of a
``swap conducted through a U.S. branch'' to be a ``swap booked in a
U.S. branch'' in section II.H.3, supra.
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[[Page 56977]]
3. Final Rule
After carefully considering the comments, the Commission is
adopting the scope of substituted compliance largely as proposed. The
Commission continues to believe that the group A requirements, which
relate to compliance programs, risk management, and swap data
recordkeeping, cannot be effectively applied on a fragmented
jurisdictional basis. Accordingly, it is not practical to limit
substituted compliance for the group A requirements to only those
transactions involving non-U.S. persons. Therefore, in furtherance of
international comity, the Final Rule permits a non-U.S. swap entity,
subject to the terms of the relevant comparability determination, to
satisfy any applicable group A requirement on an entity-wide basis by
complying with the applicable standards of a foreign jurisdiction.\479\
---------------------------------------------------------------------------
\479\ Final Sec. 23.23(f)(1).
---------------------------------------------------------------------------
Unlike the group A requirements, the group B requirements, which
relate to counterparty relationship documentation, portfolio
reconciliation and compression, trade confirmation, and daily trading
records, are more closely tied to local market conventions and can be
effectively implemented on a transaction-by-transaction or relationship
basis. As noted above, the Commission believes that Congress intended
for the Dodd-Frank Act to apply fully to U.S. persons (other than their
foreign branches) with no substituted compliance available; therefore,
an expansion of substituted compliance for the group B requirements for
U.S. persons is not appropriate. However, in light of the comments
received, the Commission has reconsidered the availability of
substituted compliance for U.S. branches of non-U.S. swap entities. In
the Proposed Rule, the Commission treated a swap conducted through a
U.S. branch \480\ in the same manner as a swap of a U.S. swap entity
for the purposes of substituted compliance. The Commission
acknowledges, however, that a swap booked in a U.S. branch of a non-
U.S. swap entity with a foreign counterparty that is neither a foreign
branch nor a Guaranteed Entity has a comparatively smaller nexus to
U.S. commerce than a swap booked in a U.S. branch with a U.S. person,
Guaranteed Entity, or another U.S. branch.
---------------------------------------------------------------------------
\480\ See discussion of the modification of the definition of a
``swap conducted through a U.S. branch'' to be a ``swap booked in a
U.S. branch'' in section II.H.3, supra.
---------------------------------------------------------------------------
Accordingly, subject to the terms of the relevant comparability
determination, the Final Rule permits a non-U.S. swap entity or foreign
branch of a U.S. swap entity to avail itself of substituted compliance
for the group B requirements in certain circumstances, depending on the
nature of its counterparty. Specifically, given the Commission's
interest in promoting international comity and market liquidity, the
Final Rule allows a non-U.S. swap entity or foreign branch of a U.S.
swap entity, subject to the terms of the relevant comparability
determination, to satisfy any applicable group B requirement for a
foreign-based swap with a foreign counterparty by complying with the
applicable standards of a foreign jurisdiction.\481\ Further, the Final
Rule allows a non-U.S. swap entity, subject to the terms of the
relevant comparability determination, to satisfy any applicable group B
requirement for any swap booked in a U.S. branch with a foreign
counterparty that is neither a foreign branch nor a Guaranteed Entity
by complying with the applicable standards of a foreign
jurisdiction.\482\
---------------------------------------------------------------------------
\481\ Final Sec. 23.23(f)(2). Thus, substituted compliance is
not available for a swap booked in the U.S. branch of a non-U.S.
swap entity entered into with a foreign branch of a U.S. swap
entity.
\482\ Final Sec. 23.23(f)(3).
---------------------------------------------------------------------------
The Commission is also modifying the text of Sec. 23.23(f)(1) and
(2) as shown in the rule text in this release (and including rule text
in Sec. 23.23(f)(3)) to clarify that substituted compliance is only
available to a non-U.S swap entity or foreign branch of a U.S. swap
entity to the extent permitted by, and subject to any conditions
specified in, a comparability determination, and only where it complies
with the standards of a foreign jurisdiction applicable to it, as
opposed to other foreign standards to which it is not subject.\483\
---------------------------------------------------------------------------
\483\ Final Sec. 23.23(f)(1) through (3).
---------------------------------------------------------------------------
With respect to the group C requirements, the Commission reiterates
its longstanding position that it has a strong supervisory interest in
ensuring that the counterparty protections of the group C requirements
generally apply to swaps with U.S. persons with no substituted
compliance available.
D. Comparability Determinations
The Commission is also implementing a process pursuant to which it
will, in connection with certain requirements addressed by the Final
Rule, conduct comparability determinations regarding a foreign
jurisdiction's regulation of swap entities. This approach builds upon
the Commission's prior substituted compliance regime and aims to
promote international comity and market liquidity without compromising
the Commission's interests in reducing systemic risk, increasing market
transparency, enhancing market integrity, and promoting counterparty
protections. Specifically, the Final Rule outlines procedures for
initiating comparability determinations, including eligibility and
submission requirements, with respect to certain requirements addressed
by the Final Rule. The Final Rule also establishes a standard of review
that the Commission will apply to such comparability determinations
that emphasizes a holistic, outcomes-based approach. The Final Rule
does not affect the effectiveness of any existing Commission
comparability determinations that were issued consistent with the
Guidance, which will remain effective pursuant to their terms.\484\ The
Commission may, however, reevaluate prior comparability determinations
in due course pursuant to the terms of the Final Rule.
---------------------------------------------------------------------------
\484\ See, e.g., Comparability Determination for Australia:
Certain Entity-Level Requirements, 78 FR 78864 (Dec. 27, 2013);
Comparability Determination for Canada: Certain Entity-Level
Requirements, 78 FR 78839 (Dec. 27, 2013); Comparability
Determination for the European Union: Certain Entity-Level
Requirements, 78 FR 78923 (Dec. 27, 2013); Comparability
Determination for Hong Kong: Certain Entity-Level Requirements, 78
FR 78852 (Dec. 27, 2013); Comparability Determination for Japan:
Certain Entity-Level Requirements, 78 FR 78910 (Dec. 27, 2013);
Comparability Determination for Switzerland: Certain Entity-Level
Requirements, 78 FR 78899 (Dec. 27, 2013); Comparability
Determination for the European Union: Certain Transaction-Level
Requirements, 78 FR 78878 (Dec. 27, 2013); Comparability
Determination for Japan: Certain Transaction-Level Requirements, 78
FR 78890 (Dec. 27, 2013).
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As discussed above, the Final Rule permits a non-U.S. swap entity
or foreign branch of a U.S. swap entity to comply with a foreign
jurisdiction's swap standards in lieu of the Commission's corresponding
requirements in certain cases, provided that the Commission determines
that such foreign standards are comparable to the Commission's
requirements. All swap entities, regardless of whether they rely on
such a comparability determination, will remain subject to the
Commission's examination and enforcement authority.\485\ Accordingly,
if a swap entity fails to comply with a foreign jurisdiction's relevant
standards, or the terms of the applicable comparability determination,
the Commission may initiate an action for a violation of the
Commission's corresponding requirements.
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\485\ Final Sec. 23.23(g)(5). The Commission notes that NFA has
certain delegated authority with respect to SDs and MSPs.
Additionally, all registered SDs and MSPs are required to be members
of the NFA and are subject to examination by the NFA.
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[[Page 56978]]
1. Standard of Review
(i) Proposed Rule
The Commission proposed a flexible outcomes-based approach that
emphasized comparable regulatory outcomes over identical regulatory
approaches. Specifically, the Commission proposed a standard of review
that was designed to allow the Commission to consider all relevant
elements of a foreign jurisdiction's regulatory regime, thereby
permitting the Commission to tailor its assessment to a broad range of
foreign regulatory approaches.\486\ Accordingly, pursuant to the
Proposed Rule, a foreign jurisdiction's regulatory regime did not need
to be identical to the relevant Commission requirements, so long as
both regulatory frameworks are comparable in terms of holistic outcome.
The Proposed Rule permitted the Commission to consider any factor it
deems appropriate when assessing comparability.\487\
---------------------------------------------------------------------------
\486\ See Proposed Sec. 23.23(g)(4); Proposed Rule, 85 FR at
986-987.
\487\ Id.
---------------------------------------------------------------------------
(ii) Summary of Comments
The Commission received five comments that generally supported the
proposed standard of review. However, of those commenters, JFMC/IBAJ
and ISDA stated that the Commission should not consider whether a
foreign jurisdiction has issued a reciprocal comparability
determination in its assessment.
Further, the Commission received four comments opposing the
proposed standard of review. Specifically, AFR, Better Markets,
Citadel, and IATP stated that the proposed standard provides the
Commission with overly-broad discretion that undermines objectivity in
the assessment process. Citadel contended that the proposed standard
may harm U.S. investors as a result of an overall reduction in market
transparency and liquidity if trading activity is permitted to migrate
to less transparent jurisdictions as a result of inaccurate
comparability determinations.
IATP stated that the Commission should not base comparability on a
foreign jurisdiction's supervisory guidelines or voluntary standards.
IATP stated that if a foreign jurisdiction lacks a standard that
compares to a Commission requirement, the Commission should issue a
more limited comparability determination until such time as the foreign
jurisdiction has published a standard that would result in a regulatory
outcome comparable to the Commission's requirements. IATP also stated
that regulatory deference to jurisdictions whose rules the Commission
finds to produce regulatory outcomes comparable to those of the
Commission must not be vague, unconditional, nor of indefinite
duration. IATP noted that during market events or credit events, or in
the event of swaps trading data anomalies, the Commission must retain
the means to verify that the foreign affiliate swaps trading of U.S.
parents does not result in losses that the U.S. parent must guarantee,
either as a matter of law or a matter of market practice.
Citadel also recommended that the Commission provide an opportunity
for public comment prior to finalizing a comparability determination to
ensure that all relevant costs and benefits are considered.
(iii) Final Rule
After carefully considering the comments, the Commission is
adopting the standard of review as proposed, with certain modifications
as shown in the rule text in this release.\488\ Specifically, the
Commission is making some technical changes to the standard of review
to clarify, as stated in the Proposed Rule \489\ and discussed below,
that the Commission may issue a comparability determination based on
its determination that some or all of the relevant foreign
jurisdiction's standards would result in outcomes comparable to those
of the Commission's corresponding requirements or group of
requirements.\490\
---------------------------------------------------------------------------
\488\ Sec. 23.23(g)(4).
\489\ See Proposed Rule, 85 FR at 986.
\490\ Id.
---------------------------------------------------------------------------
The Commission believes that this standard of review appropriately
reflects a flexible, outcomes-based approach that emphasizes comparable
regulatory outcomes over identical regulatory approaches. Accordingly,
pursuant to the Final Rule, the Commission may consider any factor it
deems appropriate in assessing comparability, which may include: (1)
The scope and objectives of the relevant foreign jurisdiction's
regulatory standards; (2) whether, despite differences, a foreign
jurisdiction's regulatory standards achieve comparable regulatory
outcomes to the Commission's corresponding requirements; (3) the
ability of the relevant regulatory authority or authorities to
supervise and enforce compliance with the relevant foreign
jurisdiction's regulatory standards; and (4) whether the relevant
foreign jurisdiction's regulatory authorities have entered into a
memorandum of understanding or similar cooperative arrangement with the
Commission regarding the oversight of swap entities.\491\ In assessing
comparability, the Commission need not find that a foreign jurisdiction
has a comparable regulatory standard that corresponds to each group A
or group B requirement. Rather, the Commission may find a foreign
jurisdiction's standards comparable if, viewed holistically, the
foreign jurisdiction's standards achieve a regulatory outcome that
adequately serves the same regulatory purpose as the group A or group B
requirements as a whole.
---------------------------------------------------------------------------
\491\ Final Sec. 23.23(g)(4).
---------------------------------------------------------------------------
Further, given that some foreign jurisdictions may implement
prudential supervisory guidelines in the regulation of swaps, the Final
Rule allows the Commission to base comparability on a foreign
jurisdiction's regulatory standards, rather than regulatory
requirements. The Guidance similarly provided that the Commission has
broad discretion to consider ``all relevant factors'' in assessing
comparability, in addition to a non-exhaustive list of elements of
comparability.\492\ However, this standard of review is broader than
the Guidance in that it explicitly allows the Commission to consider a
foreign jurisdiction's regulatory standards (as opposed to regulatory
requirements) comparable to the CEA and Commission regulations, as
experience has demonstrated that such standards are often implemented
in a similar manner as the Commission's swaps regime.
---------------------------------------------------------------------------
\492\ Guidance, 78 FR at 45353.
---------------------------------------------------------------------------
Although, when assessed against the relevant Commission
requirements, the Commission may find comparability with respect to
some, but not all, of a foreign jurisdiction's regulatory standards, it
may also make a holistic finding of comparability that considers the
broader context of a foreign jurisdiction's related regulatory
standards. Accordingly, a comparability determination need not contain
a standalone assessment of comparability for each relevant regulatory
requirement, so long as it clearly indicates the scope of regulatory
requirements that are covered by the determination. Further, the
Commission may impose any terms and conditions on a comparability
determination that it deems appropriate.\493\
---------------------------------------------------------------------------
\493\ Final Sec. 23.23(g)(6).
---------------------------------------------------------------------------
The Final Rule adopts many of the Commission's existing practices
with respect to comparability determinations, and does not reflect a
significant change in policy. Accordingly, the phrasing of
[[Page 56979]]
the standard of review is primarily intended to clarify, rather than
change, the standard of review articulated in the Guidance. Reciprocity
is only one of many non-determinative factors that the Commission may
consider when assessing comparability. However, absence of a reciprocal
comparability determination would not preclude a finding of
comparability on the part of the Commission. Further, the Commission
may, at its own discretion, seek public comment on any comparability
determination issued pursuant to the Final Rule.
2. Supervision of Swap Entities Relying on Substituted Compliance
The Commission proposed to retain its examination and enforcement
authority with respect to all swap entities relying on substituted
compliance.\494\ Accordingly, if a swap entity failed to comply with a
foreign jurisdiction's relevant standards, or the terms of an
applicable comparability determination, the Commission could initiate
an action for a violation of the Commission's corresponding
requirements.
---------------------------------------------------------------------------
\494\ See Proposed Sec. 23.23(g)(5); Proposed Rule, 85 FR at
986. The Commission notes that it similarly retained its examination
and enforcement authority in comparability determinations that were
issued pursuant to the Guidance.
---------------------------------------------------------------------------
IIB/SIFMA requested that the Commission state that it and NFA would
not independently examine for or otherwise assess whether a swap entity
is complying with foreign standards, but would instead look to the
relevant foreign regulatory authority to conduct such examinations or
assessments. IIB/SIFMA contended that the Commission and NFA lack the
subject-matter expertise to interpret and apply foreign laws.
After carefully considering IIB/SIFMA's comment, the Commission is
adopting this aspect of the rule as proposed.\495\ In considering IIB/
SIFMA's comment, and the broader issue of the Commission's supervision
of non-U.S. swap entities, the Commission notes the various
manifestations of international comity, deference, and supervisory
cooperation presently taking place in the examination practices of the
Commission and NFA. As a preliminary matter, the Commission's and NFA's
examinations of non-U.S. swap entities occur with appropriate notice
and consultation with the relevant foreign authority in the foreign
jurisdiction that has primary oversight of the non-U.S swap entity. The
Commission continues to be open to further ways to cooperate with such
authorities in the supervision of non-U.S. swap entities.
---------------------------------------------------------------------------
\495\ Final Sec. 23.23(g)(5).
---------------------------------------------------------------------------
Moreover, the Commission generally relies upon the relevant foreign
regulator's oversight of a non-U.S. swap entity in relation to the
application of a foreign jurisdiction's standards where a non-U.S. swap
entity complies with such standards pursuant to a comparability
determination issued by the Commission. To briefly recount these
instances, a foreign swap entity may demonstrate compliance with a
Commission requirement in group A through substituted compliance (i.e.,
complying with comparable standards in its home jurisdiction that the
Commission has determined to be comparable), regardless of whether the
transactions involve a U.S. person.\496\ Given the Commission's
interest in promoting international comity and market liquidity, the
Final Rule allows a non-U.S. swap entity (unless booking a transaction
in a U.S. branch or Guaranteed Entity), or a U.S. swap entity
transacting through a foreign branch, to avail itself of substituted
compliance with respect to the group B requirements for swaps with
foreign counterparties. Further, the Final Rule allows a non-U.S. swap
entity, subject to the terms of the relevant comparability
determination, to satisfy any applicable group B requirement for any
swap booked in a U.S. branch with a foreign counterparty that is
neither a foreign branch nor a Guaranteed Entity by complying with an
applicable corresponding standard of a foreign jurisdiction. With
regard to the group C requirements, the Commission considers that it is
generally appropriate to defer to foreign jurisdictions and thus
provides an exception from application of the business conduct
standards to foreign-based swaps with foreign counterparties. The
Commission has also noted above certain exceptions from the group B
requirements in the Final Rule for certain foreign-based swaps; non-
U.S. swap entities that avail themselves of these exceptions for their
eligible swaps would only be required to comply with the applicable
laws of the foreign jurisdiction(s) to which they are subject, rather
than the relevant Commission requirements, for such swaps.
---------------------------------------------------------------------------
\496\ Moreover, to the extent a foreign swap entity receives
substituted compliance for a group A requirement that incorporates
Sec. 1.31's recordkeeping requirements for certain regulatory
records, Sec. 1.31 would also not apply to such regulatory records.
---------------------------------------------------------------------------
With regard to exams of non-U.S. swap entities and access to their
books and records by the Commission and NFA, the general focus is on
assessing compliance with any of the Commission's group A requirements
for which substituted compliance is not found, group B requirements for
transactions involving a U.S. person, and group C requirements as to
transactions where the counterparty customer is in the U.S. Both the
Commission and NFA retain examination and enforcement authority over
swap entities to assess compliance with any Commission requirements in
appropriate circumstances.\497\
---------------------------------------------------------------------------
\497\ A non-U.S. swap entity remains subject to the Commission's
anti-fraud and anti-manipulation authority, which may entail access
to books and records covering transactions and/or activities not
involving a U.S. person.
---------------------------------------------------------------------------
3. Effect on Existing Comparability Determinations
In the Proposed Rule, the Commission stated that this rulemaking
would not have any impact on the effectiveness of existing Commission
comparability determinations that were issued consistent with the
Guidance, which would remain effective pursuant to their terms.\498\
Three commenters requested that the Commission revisit prior
comparability determinations in light of this rulemaking. Specifically,
ISDA stated that the Commission should recalibrate existing
comparability determinations with the aim of issuing holistic,
outcomes-based substituted compliance and clarify in the meantime that
existing determinations would continue to be valid under the
Commission's new cross-border framework. Further, IIB/SIFMA and JFMC/
IBAJ requested that the Commission amend its previously-issued
comparability determinations for Australia, Canada, the EU, Hong Kong,
Japan, and Switzerland to include Sec. 23.607 (antitrust
requirements), which the Commission is adding to the scope of the group
A requirements. The Commission has carefully considered these comments
and is adopting this aspect of the rule as proposed. The Commission
will consider applications to amend existing comparability
determinations in due course. However, the Commission will view any
previously issued comparability determination that allows for
substituted compliance for Sec. 23.201 to also allow for substituted
compliance with Sec. 45.2(a) to the extent it duplicates Sec. 23.201.
---------------------------------------------------------------------------
\498\ See Proposed Rule, 85 FR at 986.
---------------------------------------------------------------------------
4. Eligibility Requirements
The Proposed Rule outlined eligibility requirements to allow a
comparability determination to be initiated by the Commission itself or
certain outside
[[Page 56980]]
parties, including: (1) Swap entities that are eligible for substituted
compliance; (2) trade associations whose members are such swap
entities; or (3) foreign regulatory authorities that have direct
supervisory authority over such swap entities and are responsible for
administering the relevant swap standards in the foreign
jurisdiction.\499\ The Commission did not receive any comments
regarding eligibility, and is therefore adopting this aspect of the
rule as proposed.\500\
---------------------------------------------------------------------------
\499\ Proposed Sec. 23.23(g)(2); Proposed Rule, 85 FR at 987.
\500\ Final Sec. 23.23(g)(2).
---------------------------------------------------------------------------
5. Submission Requirements
The Proposed Rule also outlined submission requirements in
connection with a comparability determination with respect to some or
all of the group A and group B requirements. Specifically, the Proposed
Rule stated that applicants would be required to furnish certain
information to the Commission that provides a comprehensive
understanding of the foreign jurisdiction's relevant swap standards,
including how they might differ from the corresponding requirements in
the CEA and Commission regulations.\501\ Further, the Proposed Rule
stated that applicants would be expected to provide an explanation as
to how any such differences may nonetheless achieve comparable outcomes
to the Commission's attendant regulatory requirements.\502\ The
Commission did not receive any comments regarding submission
requirements, and is therefore adopting this aspect of the rule
substantially as proposed and shown in the rule text in this
release.\503\ Specifically, to provide the Commission additional
information to use in making its comparability determinations, the
Commission is revising Sec. 23.23(g)(3)(ii) to require that the
submission address how the relevant foreign jurisdiction's standards
address the elements or goals of the Commission's corresponding
requirements or group of requirements.\504\
---------------------------------------------------------------------------
\501\ Proposed Sec. 23.23(g)(3); Proposed Rule, 85 FR at 987.
\502\ Proposed Sec. 23.23(g)(3)(iii); Proposed Rule, 85 FR at
987.
\503\ Final Sec. 23.23(g)(3).
\504\ Final Sec. 23.23(g)(3)(ii).
---------------------------------------------------------------------------
VII. Recordkeeping
The Commission proposed to require a SD or MSP to create a record
of its compliance with all provisions of the Proposed Rule, and retain
those records in accordance with Sec. 23.203.\505\ The Commission
received no comments on this provision. The Commission is therefore
adopting this provision as proposed.\506\ The Commission reiterates
that registrants' records are a fundamental element of an entity's
compliance program, as well as the Commission's oversight function.
Accordingly, such records should be sufficiently detailed to allow
compliance officers and regulators to assess compliance with the Final
Rule.
---------------------------------------------------------------------------
\505\ Proposed Sec. 23.23(h); Proposed Rule, 85 FR at 987.
\506\ Final Sec. 23.23(h)(1).
---------------------------------------------------------------------------
VIII. Other Comments
The Commission received several comments that it considers beyond
the scope of this rulemaking.
BGC/Tradition, IIB/SIFMA, and ISDA requested that the Commission
include certain of the Unaddressed Requirements as group A
requirements, group B requirements, and group C requirements.
ISDA requested that the Commission take a number of actions
regarding the cross-border application of regulatory reporting
requirements prior to finalizing the Proposed Rule. These included
codifying an SDR reporting obligation no-action letter (CFTC Staff
Letter 17-64),\507\ providing substituted compliance for SDR reporting
obligations for certain transactions, eliminating the Commission's
large trader reporting requirements with respect to certain cross-
border transactions, and revisiting the group C requirements in their
entirety.
---------------------------------------------------------------------------
\507\ CS also requested codification of CFTC Staff Letter 17-64.
---------------------------------------------------------------------------
State Street recommended that the Commission address fragmentation
of global non-deliverable forward liquidity pools created by Commission
rulemaking and guidance in future Commission rulemaking.
JBA requested guidance on how swap requirements will apply to a
non-U.S. person that is not a swap entity similar to Appendix F of the
Guidance.
BGC/Tradition requested that the Commission confirm that non-U.S.
introducing brokers (``IBs'') engaged in soliciting or accepting swap
orders from customers, including U.S. person SDs, may comply with the
applicable rules in the relevant non-U.S. jurisdictions without
duplicative regulatory liability under the CEA and Commission
regulations. BGC/Tradition requests that the CFTC provide guidance on
how these foreign operations may avail themselves of relief through
substituted compliance or another form of mutual recognition.
As noted above, these comments are beyond the scope of this
rulemaking. Although not addressed in this rulemaking, the Commission
appreciates the information provided by commenters and will take the
requests and suggestions under advisement in the context of any
relevant future Commission action.
IX. Compliance Dates and Transition Issues
A. Summary of Comments
IIB/SIFMA commented that, if adopted, the Proposed Rule would bring
significant changes to portions of the Commission's cross-border
framework and thus, the Commission should consider making the following
clarifications and conforming changes to ensure an orderly transition
process:
1. The Commission should clarify that any no-action relief or
guidance that applies to the requirements not addressed in the Proposed
Rule will remain effective, and that any no-action letter or guidance
not specifically revoked by the Proposed Rule remains in effect.
2. If the Commission plans to amend or revoke any applicable
letters, guidance, or other relief not specifically addressed in the
Proposed Rule, the Commission should only do so following adequate
notice and opportunity for comment.
3. The Commission should grandfather transactions entered into
prior to the compliance date of any final cross-border rules adopted by
the Commission.
4. The Commission should continue the codification exercise
reflected by the Proposed Rule further by codifying the cross-border
application of the Unaddressed Requirements.
5. The Commission should delay the compliance date for the changes
set forth in the Proposed Rule until it has codified the cross-border
application of the swap-related requirements not covered by the
Proposed Rule. Until that time, market participants could continue to
follow the Guidance.
JBA requested that the Commission clarify as soon as possible the
cross-border treatment of other requirements not addressed in the
Proposed Rule, and consider harmonizing the timing of application of
all requirements such that they are applied simultaneously.
B. Commission Determination
As requested by IIB/SIFMA, the Commission hereby clarifies that any
no-action relief or guidance that applies to the Unaddressed
Requirements will remain effective, and that any no-action
[[Page 56981]]
letter or guidance not specifically revoked remains in effect.\508\
---------------------------------------------------------------------------
\508\ As noted in section V, supra, the ANE Staff Advisory and
related ANE No-Action Relief has been withdrawn contemporaneously
with promulgation of the Final Rule, while Commission staff has
provided new no-action relief concerning the Unaddressed TLRs in the
context of ANE Transactions.
---------------------------------------------------------------------------
Regarding the scope of application of the Final Rule, as requested
by commenters the Commission has provided in the Final Rule that it
will only apply to swaps entered into on or after the specified
compliance date.
The effective date of the Final Rule will be the date that is 60
days after publication of the Final Rule in the Federal Register.
The Commission has provided under paragraph (h) of the Final Rule
that the exceptions provided in paragraph (e) of the Final Rule will be
effective upon the effective date of the rule, provided that SDs and
MSPs comply with the recordkeeping requirements set forth in paragraph
(h)(1) of the Final Rule.
Otherwise, affected market participants must comply with Sec.
23.23 on or before September 14, 2021. Given the similarity of the
Final Rule to the Guidance with which market participants have been
familiar since 2013, the Commission believes that a compliance period
of one year is adequate for market participants to come into
compliance, especially given that the Final Rule permits reliance on
representations received from counterparties pursuant to the Cross-
Border Margin Rule and the Guidance for many aspects of the Final Rule.
X. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires that agencies
consider whether the regulations they propose will have a significant
economic impact on a substantial number of small entities.\509\ In the
Proposed Rule, the Commission certified that the Proposed Rule would
not have a significant economic impact on a substantial number of small
entities. The Commission received no comments with respect to the RFA.
---------------------------------------------------------------------------
\509\ See 5 U.S.C. 601 et seq.
---------------------------------------------------------------------------
The Commission previously established definitions of ``small
entities'' to be used in evaluating the impact of its regulations on
small entities in accordance with the RFA.\510\ The Final Rule
addresses when U.S. persons and non-U.S. persons are required to
include their cross-border swap dealing transactions or swap positions
in their SD or MSP registration threshold calculations,
respectively,\511\ and the extent to which SDs or MSPs are required to
comply with certain of the Commission's regulations in connection with
their cross-border swap transactions or swap positions.\512\
---------------------------------------------------------------------------
\510\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (Apr. 30, 1982) (finding that DCMs, FCMs, CPOs, and
large traders are not small entities for RFA purposes).
\511\ Final Sec. 23.23(b) through (d).
\512\ Final Sec. 23.23(e) through (g).
---------------------------------------------------------------------------
The Commission previously determined that SDs and MSPs are not
small entities for purposes of the RFA.\513\ The Commission believes,
based on its information about the swap market and its market
participants, that: (1) The types of entities that may engage in more
than a de minimis amount of swap dealing activity such that they would
be required to register as an SD--which generally would be large
financial institutions or other large entities--would not be ``small
entities'' for purposes of the RFA, and (2) the types of entities that
may have swap positions such that they would be required to register as
an MSP would not be ``small entities'' for purposes of the RFA. Thus,
to the extent such entities are large financial institutions or other
large entities that would be required to register as SDs or MSPs with
the Commission by virtue of their cross-border swap dealing
transactions and swap positions, they would not be considered small
entities.\514\
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\513\ See Entities Rule, 77 FR at 30701; Registration of Swap
Dealers and Major Swap Participants, 77 FR 2613, 2620 (Jan. 19,
2012) (noting that like FCMs, SDs will be subject to minimum capital
requirements, and are expected to be comprised of large firms, and
that MSPs should not be considered to be small entities for
essentially the same reasons that it previously had determined large
traders not to be small entities).
\514\ The SBA's Small Business Size Regulations, codified at 13
CFR 121.201, identifies (through North American Industry
Classification System codes) a small business size standard of $38.5
million or less in annual receipts for Sector 52, Subsector 523--
Securities, Commodity Contracts, and Other Financial Investments and
Related Activities. Entities that are affected by the Final Rule are
generally large financial institutions or other large entities that
are required to include their cross-border dealing transactions or
swap positions toward the SD and MSP registration thresholds,
respectively, as specified in the Final Rule.
---------------------------------------------------------------------------
To the extent that there are any affected small entities under the
Final Rule, they would need to assess how they are classified under the
Final Rule (i.e., U.S. person, SRS, Guaranteed Entity, and Other Non-
U.S. Person) and monitor their swap activities in order to determine
whether they are required to register as an SD or MSP under the Final
Rule. The Commission believes that, with the adoption of the Final
Rule, market participants will only incur incremental costs, which are
expected to be small, in modifying their existing systems and policies
and procedures resulting from changes to the status quo made by the
Final Rule.\515\
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\515\ The Final Rule addresses the cross-border application of
the registration and certain other regulations. The Final Rule does
not change such regulations.
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Accordingly, for the foregoing reasons, the Commission finds that
there will not be a substantial number of small entities impacted by
the Final Rule. Therefore, the Chairman, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b) that the Final Rule will
not have a significant economic impact on a substantial number of small
entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \516\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA. The Final Rule provides for the
cross-border application of the SD and MSP registration thresholds and
the group A, group B, and group C requirements.
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\516\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
Commission regulations 23.23(b) and (c), which address the cross-
border application of the SD and MSP registration thresholds,
respectively, potentially could lead to non-U.S. persons that are
currently not registered as SDs or MSPs to exceed the relevant
registration thresholds, therefore requiring the non-U.S. persons to
register as SDs or MSPs. However, the Commission believes that the
Final Rule will not result in any new registered SDs or MSPs or the
deregistration of registered SDs,\517\ and therefore, it does not
believe an amendment to any existing collection of information is
necessary as a result of Sec. 23.23(b) and (c). Specifically, the
Commission does not believe the Final Rule will change the number of
respondents under the existing collection of information,
``Registration of Swap Dealers and Major Swap Participants,'' Office of
Management and Budget (``OMB'') Control No. 3038-0072.
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\517\ There are not currently any registered MSPs.
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Similarly, Sec. 23.23(h)(1) contains collection of information
requirements within the meaning of the PRA as it requires that swap
entities create a record of their compliance with Sec. 23.23 and
retain records in accordance with Sec. 23.203; however, the Commission
believes that records suitable to demonstrate compliance are already
required to be created and maintained under the collections related to
the
[[Page 56982]]
Commission's swap entity registration, and group B and group C
requirements. Specifically, existing collections of information,
``Confirmation, Portfolio Reconciliation, and Portfolio Compression
Requirements for Swap Dealers and Major Swap Participants,'' OMB
Control No. 3038-0068; ``Registration of Swap Dealers and Major Swap
Participants,'' OMB Control No. 3038-0072; ``Swap Dealer and Major Swap
Participant Conflicts of Interest and Business Conduct Standards with
Counterparties,'' OMB Control No. 3038-0079; ``Confirmation, Portfolio
Reconciliation, Portfolio Compression, and Swap Trading Relationship
Documentation Requirements for Swap Dealers and Major Swap
Participants,'' OMB Control No. 3038-0083; ``Reporting, Recordkeeping,
and Daily Trading Records Requirements for Swap Dealers and Major
Participants,'' OMB Control No. 3038-0087; and ``Confirmation,
Portfolio Reconciliation, Portfolio Compression, and Swap Trading
Relationship Documentation Requirements for Swap Dealers and Major Swap
Participants,'' OMB Control No. 3038-0088 relate to these
requirements.\518\ Accordingly, the Commission is not submitting to OMB
an information collection request to create a new information
collection in relation to Sec. 23.23(h)(1).
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\518\ To the extent a swap entity avails itself of an exception
from a group B or group C requirement under the Final Rule and,
thus, is no longer required to comply with the relevant group B and/
or group C requirements and related paperwork burdens, the
Commission expects the paperwork burden related to that exception
would be less than that of the corresponding requirement(s).
However, in an effort to be conservative, because the Commission
does not know how many swap entities will choose to avail themselves
of the exceptions and for how many foreign-based swaps, the
Commission is not changing the burden of its related collections to
reflect the availability of such exceptions.
---------------------------------------------------------------------------
Final Sec. 23.23(g) results in collection of information
requirements within the meaning of the PRA, as discussed below. The
Final Rule contains collections of information for which the Commission
has not previously received control numbers from the OMB. Responses to
this collection of information are required to obtain or retain
benefits. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The Commission has submitted to OMB
an information collection request to create a new information
collection under OMB control number 3038-0072 (Registration of Swap
Dealers and Major Swap Participants) for the collections contained in
the Final Rule.
As discussed in section VI.C above, the Commission is permitting a
non-U.S. swap entity or foreign branch of a U.S. swap entity to comply
with a foreign jurisdiction's swap standards in lieu of the
Commission's corresponding group A and group B requirements in certain
cases, provided that the Commission determines that such foreign
standards are comparable to the Commission's requirements. Commission
regulation 23.23(g) implements a process pursuant to which the
Commission will conduct these comparability determinations, including
outlining procedures for initiating such determinations. As discussed
in section VI.D above, a comparability determination could be requested
by swap entities that are eligible for substituted compliance, their
trade associations, and foreign regulatory authorities meeting certain
requirements.\519\ Applicants seeking a comparability determination are
required to furnish certain information to the Commission that provides
a comprehensive explanation of the foreign jurisdiction's relevant swap
standards, including how they might differ from the corresponding
requirements in the CEA and Commission regulations and how,
notwithstanding such differences, the foreign jurisdiction's swap
standards achieve comparable outcomes to those of the Commission.\520\
The information collection is necessary for the Commission to consider
whether the foreign jurisdiction's relevant swap standards are
comparable to the Commission's requirements.
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\519\ Final Sec. 23.23(g)(2).
\520\ Final Sec. 23.23(g)(3).
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Though under the Final Rule many entities are eligible to request a
comparability determination,\521\ the Commission expects to receive far
fewer requests because once a comparability determination is made for a
jurisdiction it applies for all entities or transactions in that
jurisdiction to the extent provided in the Commission's determination.
Further, the Commission has already issued comparability determinations
under the Guidance for certain of the Commission's requirements for
Australia, Canada, the European Union, Hong Kong, Japan, and
Switzerland,\522\ and the effectiveness of those determinations is not
affected by the Final Rule. Nevertheless, in an effort to be
conservative in its estimate for purposes of the PRA, the Commission
estimates that it will receive a request for a comparability
determination in relation to five (5) jurisdictions per year under the
Final Rule. Further, based on the Commission's experience in issuing
comparability determinations, the Commission estimates that each
request would impose an average of 40 burden hours, for an aggregate
estimated hour burden of 200 hours. Accordingly, the changes are
estimated to result in an increase to the current burden estimates of
OMB control number 3038-0072 by 5 in the number of submissions and 200
burden hours.
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\521\ Currently, there are approximately 108 swap entities
provisionally registered with the Commission, many of which may be
eligible to apply for a comparability determination as a non-U.S.
swap entity or a foreign branch. Additionally, a trade association,
whose members include swap entities, and certain foreign regulators
may also apply for a comparability determination.
\522\ See supra notes 215 and 484.
---------------------------------------------------------------------------
The frequency of responses and total new burden associated with OMB
control number 3038-0072, in the aggregate, reflecting the new burden
associated with all the amendments made by the Final Rule and current
burden not affected by this Final Rule,\523\ is as follows:
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\523\ The numbers below reflect the current burden for two
separate information collections that are not affected by this
rulemaking.
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Estimated annual number of respondents: 770.
Estimated aggregate annual burden hours per respondent: 1.13 hours.
Estimated aggregate annual burden hours for all respondents: 872.
Frequency of responses: As needed.
Information Collection Comments. In the Proposed Rule, the
Commission requested comments on the information collection
requirements discussed above, including, without limitation, on the
Commission's discussion of the estimated burden of the collection of
information requirements in proposed Sec. 23.23(h) (Sec. 23.23(h)(1)
in the Final Rule). The Commission did not receive any such comments.
C. Cost-Benefit Considerations
As detailed above, the Commission is adopting rules that define
certain key terms for purposes of certain Dodd-Frank Act swap
provisions and that address the cross-border application of the SD and
MSP registration thresholds and the Commission's group A, group B, and
group C requirements.
Since issuing the Proposed Rule, the baseline against which the
costs and benefits of the Final Rule are considered is unchanged and
is, in principle, current law: In other words, applicable Dodd-Frank
Act swap provisions in the CEA and regulations promulgated by the
Commission to date, as made applicable to cross-border transactions by
Congress in CEA section 2(i), in the absence of a
[[Page 56983]]
Commission rule establishing more precisely the application of that
provision in particular situations. However, in practice, use of this
baseline poses important challenges, for a number of reasons.
First, there are intrinsic difficulties in sorting out costs and
benefits of the Final Rule from costs and benefits intrinsic to the
application of Dodd-Frank Act requirements to cross-border transactions
directly pursuant to section 2(i), given that the statute sets forth
general principles for the cross-border application of Dodd-Frank Act
swap requirements but does not attempt to address particular business
situations in detail.
Second, the Guidance established a general, non-binding framework
for the cross-border application of many substantive Dodd-Frank Act
requirements. In doing so, the Guidance considered, among other
factors, the regulatory objectives of the Dodd-Frank Act and principles
of international comity. As is apparent from the text of the Final Rule
and the discussion in this preamble, the Final Rule is in certain
respects consistent with the Guidance. The Commission understands that
while the Guidance is non-binding, many market participants have
developed policies and practices that take into account the views
expressed therein. At the same time, some market participants may
currently apply CEA section 2(i), the regulatory objectives of the
Dodd-Frank Act, and principles of international comity in ways that
vary from the Guidance, for example because of circumstances not
contemplated by the general, non-binding framework in the Guidance.
Third, in addition to the Guidance, the Commission has issued
comparability determinations finding that certain provisions of the
laws and regulations of other jurisdictions are comparable in outcome
to certain requirements under the CEA and regulations thereunder.\524\
In general, under these determinations, a market participant that
complies with the specified provisions of the other jurisdiction would
also be deemed to be in compliance with Commission regulations, subject
to certain conditions.\525\
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\524\ See supra notes 215 and 484.
\525\ See id.
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Fourth, the Commission staff has issued several interpretive and
no-action letters that are relevant to cross-border issues.\526\ As
with the Guidance, the Commission recognizes that many market
participants have relied on these staff letters in framing their
business practices.
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\526\ See, e.g., CFTC Letter No. 13-64, No-Action Relief:
Certain Swaps by Non-U.S. Persons that are Not Guaranteed or Conduit
Affiliates of a U.S. Person Not to be Considered in Calculating
Aggregate Gross Notional Amount for Purposes of Swap Dealer De
Minimis Exception (Oct. 17, 2013), available at https://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-64.pdf; ANE Staff Advisory; ANE No-Action Relief; CFTC Staff Letter
No. 18-13.
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Fifth, as noted above, the international regulatory landscape is
far different now than it was when the Dodd-Frank Act was enacted in
2010.\527\ Even in 2013, when the CFTC published the Guidance, very few
jurisdictions had made significant progress in implementing the global
swap reforms that were agreed to by the G20 leaders at the Pittsburgh
G20 Summit. Today, however, as a result of cumulative implementation
efforts by regulators throughout the world, substantial progress has
been made in the world's primary swap trading jurisdictions to
implement the G20 commitments. For these reasons, the actual costs and
benefits of the Final Rule that are experienced by a particular market
participant may vary depending on the jurisdictions in which the market
participant is active and when the market participant took steps to
comply with various legal requirements.
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\527\ See supra section I.C.
---------------------------------------------------------------------------
Because of these complicating factors, as well as limitations on
available information, the Commission believes that a direct comparison
of the costs and benefits of the Final Rule with those of a
hypothetical cross-border regime based directly on section 2(i)--while
theoretically the ideal approach--is infeasible in practice. As a
further complication, the Commission recognizes that the Final Rule's
costs and benefits would exist, regardless of whether a market
participant: (1) First realized some of those costs and benefits when
it conformed its business practices to provisions of the Guidance or
Commission staff action that will be binding legal requirements under
the Final Rule; (2) does so now for the first time; or (3) did so in
stages as international requirements evolved.
In light of these considerations and given that there were no
public comments regarding the baseline outlined in the Proposed Rule,
the Commission has considered costs and benefits by focusing primarily
on two types of information and analysis.
First, the Commission compared the Final Rule with current business
practices, with the understanding that many market participants are now
conducting business taking into account, among other things, the
Guidance, applicable CFTC staff letters, and existing comparability
determinations. This approach, for example, included a comparison of
the expected costs and benefits of conducting business under the Final
Rule with those of conducting business in conformance with analogous
provisions of the Guidance. In effect, this analysis included an
examination of new costs and benefits that will result from the Final
Rule for market participants that are currently following the relevant
Dodd-Frank Act swap provisions and regulations thereunder, the
Guidance, the comparability determinations, the Cross-Border Margin
Rule, and applicable staff letters. This is referred to as ``Baseline
A.''
Second, to the extent feasible, the Commission considered relevant
information on costs and benefits that market participants have
incurred to date in complying with the Dodd-Frank Act in cross-border
transactions of the type that will be affected by the Final Rule,
absent the Guidance. This second form of analysis is, to some extent,
over-inclusive in that it is likely to capture some costs and benefits
that flow directly from Congress's enactment of section 2(i) of the CEA
or that otherwise are not strictly attributable to the Final Rule.
However, since a theoretically perfect baseline for consideration of
costs and benefits does not appear feasible, this second form of
analysis helps ensure that costs and benefits of the Final Rules are
considered as fully as possible. This is referred to as ``Baseline B.''
The Commission requested comments regarding all aspects of the
baselines applied in this consideration of costs and benefits,
including a discussion of any variances or different circumstances
commenters have experienced that affect the baseline for those
commenters. While no commenters questioned the Commission's defined
baseline, the Commission received a few cost-benefit related comments
that are addressed in the relevant sections of this discussion.
The costs associated with the key elements of the Commission's
cross-border approach to the SD and MSP registration thresholds--
requiring market participants to classify themselves as U.S. persons,
Guaranteed Entities, or SRSs \528\ and to apply the rules accordingly--
fall into a few categories. Market participants will incur costs
determining which category of market participant they and their
counterparties fall into (``assessment
[[Page 56984]]
costs''), tracking their swap activities or positions to determine
whether they should be included in their registration threshold
calculations (``monitoring costs''), and, to the degree that their
activities or positions exceed the relevant threshold, registering with
the Commission as an SD or MSP (``registration costs'').
---------------------------------------------------------------------------
\528\ Final Sec. 23.23(a).
---------------------------------------------------------------------------
Entities required to register as SDs or MSPs as a result of the
Final Rule will also incur costs associated with complying with the
relevant Dodd-Frank Act requirements applicable to registrants, such as
the capital, margin, and business conduct requirements (``programmatic
costs'').\529\ While only new registrants will assume these
programmatic costs for the first time, the obligations of entities that
are already registered as SDs may also change in the future as an
indirect consequence of the Final Rule.
---------------------------------------------------------------------------
\529\ The Commission's discussion of programmatic costs and
registration costs does not address MSPs. No entities are currently
registered as MSPs, and the Commission does not expect that this
status quo will change as a result of the Final Rule being adopted
given the general similarities between the Final Rule's approach to
the MSP registration threshold calculations and the Guidance.
---------------------------------------------------------------------------
In developing the Final Rule, the Commission took into account the
potential for creating or accentuating competitive disparities between
market participants, which could contribute to market deficiencies,
including market fragmentation or decreased liquidity, as more fully
discussed below. Notably, competitive disparities may arise between
U.S.-based financial groups and non-U.S. based financial groups as a
result of differences in how the SD and MSP registration thresholds
apply to the various classifications of market participants. For
instance, an SRS must count all dealing swaps toward its SD de minimis
calculation. Therefore, SRSs are more likely to trigger the SD
registration threshold relative to Other Non-U.S. Persons, and may
therefore be at a competitive disadvantage compared to Other Non-U.S.
Persons when trading with non-U.S. persons, as non-U.S. persons may
prefer to trade with non-registrants in order to avoid application of
the Dodd-Frank Act swap regime.\530\ On the other hand, certain
counterparties may prefer to enter into swaps with SDs and MSPs that
are subject to the robust requirements of the Dodd-Frank Act.
---------------------------------------------------------------------------
\530\ Dodd-Frank Act swap requirements may impose significant
direct costs on participants falling within the SD or MSP
definitions that are not borne by other market participants,
including costs related to capital and margin requirements and
business conduct requirements. To the extent that foreign
jurisdictions adopt comparable requirements, these costs would be
mitigated.
---------------------------------------------------------------------------
Other factors also create inherent challenges associated with
attempting to assess costs and benefits of the Final Rule. To avoid the
prospect of being regulated as an SD or MSP, or otherwise falling
within the Dodd-Frank Act swap regime, some market participants may
restructure their businesses or take other steps (e.g., limiting their
counterparties to Other Non-U.S. Persons) to avoid exceeding the
relevant registration thresholds. The degree of comparability between
the approaches adopted by the Commission and foreign jurisdictions and
the potential availability of substituted compliance, whereby a market
participant may comply with certain Dodd-Frank Act SD or MSP
requirements by complying with a comparable requirement of a foreign
financial regulator, may also affect the competitive effect of the
Final Rule. The Commission expects that such effects will be mitigated
as the Commission continues to work with foreign and domestic
regulators to achieve international harmonization and cooperation.
In the sections that follow, the Commission discusses the costs and
benefits associated with the Final Rule.\531\ Section 1 discusses the
main benefits of the Final Rule. Section 2 begins by addressing the
assessment costs associated with the Final Rule, which derive in part
from the defined terms used in the Final Rule (e.g., the definitions of
``U.S. person,'' ``significant risk subsidiary,'' and ``guarantee'').
Sections 3 and 4 consider the costs and benefits associated with the
Final Rule's determinations regarding how each classification of market
participants applies to the SD and MSP registration thresholds,
respectively. Sections 5, 6, and 7 address the monitoring,
registration, and programmatic costs associated with the Final Rule's
cross-border approach to the SD (and, as appropriate, MSP) registration
thresholds, respectively. Section 8 addresses the costs and benefits
associated with the Final Rule's exceptions from, and available
substituted compliance for, the group A, group B, and group C
requirements, as well as comparability determinations. Section 9
addresses the costs associated with the Final Rule's recordkeeping
requirements. Section 10 discusses the factors established in section
15(a) of the CEA.
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\531\ The Commission endeavors to assess the expected costs and
benefits of its rules in quantitative terms where possible. Where
estimation or quantification is not feasible, the Commission
provides its discussion in qualitative terms. Given a general lack
of relevant data, the Commission's analysis in the Final Rule is
generally provided in qualitative terms.
---------------------------------------------------------------------------
1. Benefits
The main benefits of the Final Rule are two-fold: (1) Legal
certainty; and (2) creating and continuing to maintain a harmonized
regulatory framework internationally that shows deference to other
countries' laws and regulations when such laws and regulations achieve
comparable outcomes, a construct known as comity. The clarity of the
Final Rule makes it easier for market participants to comply with the
Commission's regulations, to conduct business in a well-organized,
efficient way, and to re-allocate resources from compliance to other
areas, such as productivity, business development, and innovation.
Congress directed the Commission in the Dodd-Frank Act to
``coordinate with foreign regulatory authorities on the establishment
of consistent international standards with respect to the regulation''
of swaps and SDs and MSPs.\532\ In doing so, the Commission is acting
in the public interest and employing comity as one of the
justifications for the choices the Commission is making in the Final
Rule. For example, the provision of substituted compliance in the Final
Rule allows some market participants to elect a regulatory jurisdiction
that best suits their needs. Accordingly, some market participants may
choose the U.S. as a jurisdiction in which to register and operate to
achieve benefits such as robust SD requirements, third-party custodial
arrangements, transparent exchanges, and bankruptcy regimes that have
strong property rights and tend to lead to assets being recovered
sooner than some other regimes. Therefore, the Commission believes that
substituted compliance may lead to more effective regulation over time
as regulators are incentivized to have their jurisdiction be chosen
over other jurisdictions, and to modify ineffective or inefficient
regulation as needed to adapt to market innovations and other changes
that occur over time. The Commission recognizes, however, that such
provision may present an opportunity for regulatory arbitrage, which
could undermine the fundamental principles of the reduction of systemic
risk and the promotion of market integrity.
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\532\ See Dodd-Frank Act, section 752(a); 15 U.S.C. 8325.
---------------------------------------------------------------------------
2. Assessment Costs
As discussed above, in applying the Final Rule's cross-border
approach to the SD and MSP registration thresholds,
[[Page 56985]]
market participants are required to first classify themselves as a U.S.
person, an SRS, a Guaranteed Entity, or an Other Non-U.S. Person.
With respect to Baseline A, the Commission expects that the costs
to affected market participants of assessing which classification they
fall into will generally be small and incremental. In most cases, the
Commission believes an entity will have performed an initial
determination or assessment of its status under either the Cross-Border
Margin Rule (which uses substantially similar definitions of ``U.S.
person'' and ``guarantee'') or the Guidance (which interprets ``U.S.
person'' in a manner that is similar but not identical to the Final
Rule's definition of ``U.S. person''). Harmonizing the ``U.S. person''
definition in the Final Rule with the definition in the SEC Cross-
Border Rule is also expected to reduce undue compliance costs for
market participants. Additionally, the Final Rule allows market
participants to rely on representations from their counterparties with
regard to their classifications.\533\ However, the Commission
acknowledges that swap entities will have to modify their existing
operations to accommodate the new concept of an SRS. Specifically,
market participants must determine whether they qualify as SRSs.
Further, in order to rely on certain exceptions outlined in the Final
Rule, swap entities must ascertain whether they or their counterparty
qualify as an SRS.
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\533\ The Commission believes that these assessment costs for
the most part have already been incurred by potential SDs and MSPs
as a result of adopting policies and procedures under the Guidance
and Cross-Border Margin Rule (which had similar classifications),
both of which permitted counterparty representations. See Guidance,
78 FR at 45315; Cross-Border Margin Rule, 81 FR at 34827.
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With respect to Baseline B, wherein only certain market
participants have previously determined their status under the similar,
but not identical, Cross-Border Margin Rule (and not the Guidance), the
Commission believes that their assessment costs will nonetheless be
small as a result of the Final Rule's reliance on clear, objective
definitions of the terms ``U.S. person,'' ``significant risk
subsidiary,'' and ``guarantee.'' Further, with respect to the
determination of whether a market participant falls within the
``significant risk subsidiary'' definition,\534\ the Commission
believes that assessment costs are small as the definition relies, in
part, on a familiar consolidation test already used by affected market
participants in preparing their financial statements under U.S. GAAP.
Further, only those market participants with an ultimate U.S. parent
entity that has more than $50 billion in global consolidated assets and
that do not fall into one of the exceptions in Sec. 23.23(a)(13)(i) or
(ii) of the Final Rule must consider if they are an SRS.
---------------------------------------------------------------------------
\534\ The ``substantial risk subsidiary'' definition is
discussed further in section II.D, supra.
---------------------------------------------------------------------------
Additionally, the Final Rule primarily relies on the definition of
``guarantee'' provided in the Cross-Border Margin Rule, which is
limited to arrangements in which one party to a swap has rights of
recourse against a guarantor with respect to its counterparty's
obligations under the swap.\535\ The Final Rule also incorporates the
concept of an entity with unlimited U.S. responsibility into the
guarantee definition; however, the Commission is of the view that the
corporate structure that this prong is designed to capture is not one
that is commonly in use in the marketplace. Therefore, although non-
U.S. persons must determine whether they are Guaranteed Entities with
respect to the relevant swap on a swap-by-swap basis for purposes of
the SD and MSP registration calculations, the Commission believes that
this information is already known by non-U.S. persons.\536\
Accordingly, with respect to both baselines, the Commission believes
that the costs associated with assessing whether an entity or its
counterparty is a Guaranteed Entity is small and incremental.
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\535\ See supra section II.C.
\536\ Because a guarantee has a significant effect on pricing
terms and on recourse in the event of a counterparty default, the
Commission believes that the guarantee would already be in existence
and that a non-U.S. person therefore would have knowledge of its
existence before entering into a swap.
---------------------------------------------------------------------------
Better Markets commented that the proposed definition of
``guarantee,'' which was narrower than that in the Guidance, would
increase systemic risk and hinder other public interest objectives by
possibly excluding certain arrangements that may import risk into the
United States. In the Proposed Rule, the Commission stated that the
alignment of the definitions of ``guarantee'' in this rulemaking and
the Cross-Border Margin Rule would benefit market participants to the
extent that they would not be required to make a separate independent
assessment of a counterparty's guarantee status. Better Markets stated
that this benefit to market participants does not outweigh or
reasonably approximate the potential costs to the underlying policy
objectives of the Dodd-Frank Act, including promoting the safety and
soundness of SDs, preventing disruptions to the derivatives markets,
ensuring the financial integrity of swaps transactions and the
avoidance of systemic risk, and preserving the stability of the U.S.
financial system. The Commission has carefully considered the attendant
costs and benefits of narrowing the definition of ``guarantee'' from
the Guidance, and continues to believe, however, that the alignment of
the ``guarantee'' definitions in this Final Rule and the Cross-Border
Margin Rule serves to reduce costs to market participants without
sacrificing the attendant policy goals of the Dodd-Frank Act. The
Commission will continue to monitor arrangements that were previously
considered guarantees that could shift risk back to the U.S. swap
market, in general, and take appropriate action as warranted in the
future.
3. Cross-Border Application of the SD Registration Threshold
(i) U.S. Persons, Guaranteed Entities, and SRSs
Under the Final Rule, a U.S. person must include all of its swap
dealing transactions in its de minimis calculation, without
exception.\537\ As discussed above, that includes any swap dealing
transactions conducted through a U.S. person's foreign branch, as such
swaps are directly attributed to, and therefore affect, the U.S.
person. Given that this requirement mirrors the Guidance in this
respect, the Commission believes that the Final Rule will have a
negligible effect on the status quo with regard to the number of
registered or potential U.S. SDs, as measured against Baseline A.\538\
With respect to Baseline B, all U.S. persons would have included all of
their transactions in their de minimis calculation, even absent the
Guidance, pursuant to paragraph (4) of the SD definition.\539\ However,
the Commission acknowledges that, absent the Guidance, some U.S.
persons may not have interpreted CEA section 2(i) to require them to
include swap dealing transactions conducted through their foreign
branches in their de minimis calculation. Accordingly, with respect
[[Page 56986]]
to Baseline B, the Commission expects that some U.S. persons may incur
some incremental costs as a result of having to count swaps conducted
through their foreign branches.
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\537\ Final Sec. 23.23(b)(1).
\538\ The Commission is not estimating the number of new U.S.
SDs, as the methodology for including swaps in a U.S. person's SD
registration calculation does not diverge from the approach included
in the Guidance (i.e., a U.S. person must include all of its swap
dealing transactions in its de minimis threshold calculation).
Further, the Commission does not expect a change in the number of
SDs will result from the Final Rule's definition of U.S. person and
therefore assumes that no additional entities will register as U.S.
SDs, and no existing U.S.-SD registrants will deregister as a result
of the Final Rule.
\539\ See 17 CFR 1.3, Swap dealer, paragraph (4).
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The Final Rule also requires Guaranteed Entities to include all of
their swap dealing transactions in their de minimis threshold
calculation without exception.\540\ This approach, which recognizes
that a Guaranteed Entity's swap dealing transactions may have the same
potential to affect the U.S. financial system as a U.S. person's
dealing transactions, closely parallels the approach taken in the
Guidance with respect to the treatment of the swaps of ``guaranteed
affiliates.'' \541\ Given that the Final Rule establishes a more
limited definition of ``guarantee'' as compared to the Guidance, and a
similar definition of guarantee as compared to the Cross-Border Margin
Rule, the Commission does not expect that the Final Rule will cause
more Guaranteed Entities to register with the Commission. Accordingly,
the Commission believes that, in this respect, any increase in costs
associated with the Final Rule, with respect to Baselines A and B, will
be small.
---------------------------------------------------------------------------
\540\ Final Sec. 23.23(b)(2)(ii).
\541\ While the Final Rule and the Guidance treat swaps
involving Guaranteed Entities in a similar manner, they have
different definitions of the term ``guarantee.'' Under the Guidance,
a ``guaranteed affiliate'' would generally include all swap dealing
activities in its de minimis threshold calculation without
exception. The Guidance interpreted ``guarantee'' to generally
include ``not only traditional guarantees of payment or performance
of the related swaps, but also other formal arrangements that, in
view of all the facts and circumstances, support the non-U.S.
person's ability to pay or perform its swap obligations with respect
to its swaps.'' See Guidance, 78 FR at 45320. In contrast, the term
``guarantee'' in the Final Rule has the same meaning as defined in
Sec. 23.160(a)(2) (cross-border application of the Commission's
margin requirements for uncleared swaps), except that application of
the definition of ``guarantee'' in the Final Rule is not limited to
uncleared swaps, and also now incorporates the concept of
``unlimited U.S. responsibility.'' See supra section II.C.
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Under the Final Rule, an SRS must include all swap dealing
transactions in its de minimis threshold calculation.\542\ Given that
the concept of an SRS was not included in the Guidance or the Cross-
Border Margin Rule, the Commission believes that this aspect of the
Final Rule will have a similar effect on market participants when
measured against Baseline A and Baseline B. Under the Guidance, an SRS
would likely have been categorized as either a conduit affiliate (which
would have been required to count all dealing swaps towards its de
minimis threshold calculation) or a non-U.S. person that is neither a
conduit affiliate nor a guaranteed affiliate (which would have been
required to count only a subset of its dealing swaps towards its de
minimis threshold calculation). Accordingly, under the Final Rule,
there may be some SRSs that will have to count more swaps towards their
de minimis threshold calculation than would have been required under
the Guidance.
---------------------------------------------------------------------------
\542\ Final Sec. 23.23(b)(1).
---------------------------------------------------------------------------
However, as noted in sections II.D and III.B.1, the Commission
believes that it is appropriate to distinguish SRSs from Other Non-U.S.
Persons in determining the cross-border application of the SD de
minimis threshold to such entities. As discussed above, SRSs, as a
class of entities, present a greater supervisory interest to the CFTC
relative to Other Non-U.S. Persons, due to the nature and extent of
their relationships with their ultimate U.S. parent entities. Of the 61
non-U.S. SDs that were provisionally registered with the Commission as
of July 2020, the Commission believes that few, if any, will be
classified as SRSs pursuant to the Final Rule. With respect to Baseline
A, any potential SRSs would have likely classified themselves as a
conduit affiliate or a non-U.S. person that is neither a conduit
affiliate nor a guaranteed affiliate pursuant to the Guidance.
Accordingly, some may incur incremental costs associated with assessing
and implementing the additional counting requirements for SRSs. With
respect to Baseline B, the Commission believes that most potential SRSs
would have interpreted section 2(i) so as to require them to count
their dealing swaps with U.S. persons, but acknowledges that some may
not have interpreted section 2(i) so as to require them to count swaps
with non-U.S. persons toward their de minimis calculation. Accordingly,
such non-U.S. persons will incur the incremental costs associated with
the additional SRS counting requirements contained in the Final Rule.
The Commission believes that the SRS de minimis calculation
requirements will prevent regulatory arbitrage by ensuring that certain
entities do not simply book swaps through a non-U.S. affiliate to avoid
CFTC registration. Accordingly, the Commission believes that such
provisions will benefit the swap market by ensuring that the Dodd-Frank
Act swap provisions addressed by the Final Rule are applied
specifically to entities whose activities, in the aggregate, have a
direct and significant connection to, and effect on, U.S. commerce.
(ii) Other Non-U.S. Persons
Under the Final Rule, non-U.S. persons that are neither Guaranteed
Entities nor SRSs are required to include in their de minimis threshold
calculations swap dealing activities with U.S. persons (other than
swaps conducted through a foreign branch of a registered SD) and
certain swaps with Guaranteed Entities.\543\ The Final Rule does not,
however, require Other Non-U.S. Persons to include swap dealing
transactions with: (1) Guaranteed Entities that are SDs; (2) Guaranteed
Entities that are affiliated with an SD and are also below the de
minimis threshold; (3) Guaranteed Entities that are guaranteed by a
non-financial entity; (3) SRSs (other than SRSs that are also
Guaranteed Entities and no other exception applies); or (4) Other Non-
U.S. Persons. Additionally, Other Non-U.S. Persons are not required to
include in their de minimis calculation any transaction that is
executed anonymously on a DCM, registered or exempt SEF, or registered
FBOT, and cleared through a registered or exempt DCO.
---------------------------------------------------------------------------
\543\ Final Sec. 23.23(b)(2).
---------------------------------------------------------------------------
The Commission believes that requiring all non-U.S. persons to
include their swap dealing transactions with U.S. persons in their de
minimis calculations is necessary to advance the goals of the Dodd-
Frank Act SD registration regime, which focuses on U.S. market
participants and the U.S. market. As discussed above, the Commission
believes it is appropriate to allow Other Non-U.S. Persons to exclude
swaps conducted through a foreign branch of a registered SD because,
generally, such swaps would be subject to Dodd-Frank Act transactional
requirements and, therefore, will not evade the Dodd-Frank Act regime.
Given that these requirements are consistent with the Guidance in
most respects, the Commission believes that the Final Rule will have a
negligible effect on Other Non-U.S. Persons, as measured against
Baseline A. With respect to Baseline B, the Commission believes that
most non-U.S. persons would have interpreted CEA section 2(i) to
require them to count their dealing swaps with U.S. persons, but
acknowledges that some non-U.S. persons may not have interpreted 2(i)
so as to require them to count such swaps with non-U.S. persons toward
their de minimis calculation. Accordingly, such non-U.S. persons will
incur the incremental costs associated with the counting requirements
for Other Non-U.S. Persons contained in the Final Rule.
The Commission recognizes that the Final Rule's cross-border
approach to
[[Page 56987]]
the de minimis threshold calculation could contribute to competitive
disparities arising between U.S.-based financial groups and non-U.S.
based financial groups. Potential SDs that are U.S. persons, SRSs, or
Guaranteed Entities will be required to include all of their swap
dealing transactions in their de minimis threshold calculations. In
contrast, Other Non-U.S. Persons will be permitted to exclude certain
dealing transactions from their de minimis calculations. As a result,
Guaranteed Entities and SRSs may be at a competitive disadvantage, as
more of their swap activity will apply toward the de minimis threshold
(and thereby trigger SD registration) relative to Other Non-U.S.
Persons.\544\ While the Commission does not believe that any additional
Other Non-U.S. Persons will be required to register as a SD under the
Final Rule, the Commission acknowledges that to the extent that one
does, its non-U.S. person counterparties (clients and dealers) may
possibly cease transacting with it in order to operate outside the
Dodd-Frank Act swap regime.\545\ Additionally, unregistered non-U.S.
dealers may be able to offer swaps on more favorable terms to non-U.S.
persons than their registered competitors because they are not required
to incur the costs associated with CFTC registration.\546\
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\544\ On the other hand, as noted above, the Commission
acknowledges that some market participants may prefer to enter into
swaps with counterparties that are subject to the swaps provisions
adopted pursuant to the Dodd-Frank Act. Further, Guaranteed Entities
and SRSs may enjoy other competitive advantages due to the support
of their guarantor or ultimate U.S. parent entity.
\545\ Additionally, some unregistered dealers may opt to
withdraw from the market, thereby contracting the number of dealers
competing in the swaps market, which may have an adverse effect on
competition and liquidity.
\546\ These non-U.S. dealers also may be able to offer swaps on
more favorable terms to U.S. persons, giving them a competitive
advantage over U.S. competitors with respect to U.S. counterparties.
---------------------------------------------------------------------------
As noted above, however, the Commission believes that these
competitive disparities will be mitigated to the extent that foreign
jurisdictions impose comparable requirements. Given that the Commission
has found many foreign jurisdictions comparable with respect to various
aspects of the Dodd-Frank Act swap requirements, the Commission
believes that such competitive disparities will be negligible.\547\
Further, as discussed below, the Commission is adopting a flexible
standard of review for comparability determinations relating to the
group A and group B requirements that will be issued pursuant to the
Final Rule, which will serve to further mitigate any competitive
disparities arising out of disparate regulatory regimes. Finally, the
Commission reiterates its belief that the cross-border approach to the
SD registration threshold taken in the Final Rule is appropriately
tailored to further the policy objectives of the Dodd-Frank Act while
mitigating unnecessary burdens and disruption to market practices to
the extent possible.
---------------------------------------------------------------------------
\547\ See supra notes 215 and 484.
---------------------------------------------------------------------------
(iii) Aggregation Requirement
The Final Rule also addresses the cross-border application of the
aggregation requirement in a manner consistent with the Entities Rule
and CEA section 2(i). Specifically, paragraph (4) of the SD definition
in Sec. 1.3 requires that, in determining whether its swap dealing
transactions exceed the de minimis threshold, a person must include the
aggregate notional amount of any swap dealing transactions entered into
by its affiliates under common control. Consistent with CEA section
2(i), the Commission interprets this aggregation requirement in a
manner that applies the same aggregation principles to all affiliates
in a corporate group, whether they are U.S. or non-U.S. persons. In
general, the Commission's approach allows both U.S. persons and non-
U.S. persons in an affiliated group to engage in swap dealing activity
up to the de minimis threshold. When the affiliated group meets the de
minimis threshold in the aggregate, one or more affiliate(s) (a U.S.
affiliate or a non-U.S. affiliate) have to register as an SD so that
the relevant swap dealing activity of the unregistered affiliates
remains below the threshold. The Commission's approach ensures that the
aggregate gross notional amount of applicable swap dealing transactions
of all such unregistered U.S. and non-U.S. affiliates does not exceed
the de minimis level.
Given that this approach is consistent with the Guidance, the
Commission believes that market participants will only incur
incremental costs with respect to Baseline A in modifying their
existing systems and policies and procedures in response to the Final
Rule. Absent the Guidance, the Commission believes that most market
participants would have relied on the interpretation of the aggregation
requirement in the Entities Rule, which is similar to the approach set
forth in the Final Rule. Accordingly, with respect to Baseline B, the
Commission believes that market participants will only incur
incremental costs in modifying their existing systems and policies and
procedures in response to the Final Rule.
4. Cross-Border Application of the MSP Registration Thresholds
(i) U.S. Persons, Guaranteed Entities, and SRSs
The Final Rule's approach to the cross-border application of the
MSP registration thresholds closely mirrors the approach for the SD
registration threshold. Under the Final Rule, a U.S. person must
include all of its swap positions in its MSP thresholds, without
exception.\548\ As discussed above, that includes any swap conducted
through a U.S. person's foreign branch, as such swaps are directly
attributed to, and therefore affect, the U.S. person. Given that this
requirement is consistent with the Guidance in this respect, the
Commission believes that the Final Rule will have a minimal effect on
the status quo with regard to the number of potential U.S. MSPs, as
measured against Baseline A. With respect to Baseline B, all of a U.S.
person's swap positions would apply toward the MSP threshold
calculations, even absent the Guidance, pursuant to paragraph (6) of
the MSP definition.\549\ However, the Commission acknowledges that,
absent the Guidance, some U.S. persons may not have interpreted CEA
section 2(i) to require them to include swaps conducted through their
foreign branches in their MSP threshold calculations. Accordingly, with
respect to Baseline B, the Commission expects that some U.S. persons
may incur incremental costs as a result of having to count swaps
conducted through their foreign branches.
---------------------------------------------------------------------------
\548\ Final Sec. 23.23(c)(1).
\549\ 17 CFR 1.3, Major swap participant, paragraph (6).
---------------------------------------------------------------------------
The Final Rule also requires Guaranteed Entities to include all of
their swap positions in their MSP threshold calculations without
exception.\550\ This approach, which recognizes that such swap
transactions may have the same potential to affect the U.S. financial
system as a U.S. person's swap positions, closely parallels the
approach taken in the Guidance with respect to ``conduit affiliates''
and ``guaranteed affiliates.'' \551\ The Commission believes that few,
if any, additional MSPs will qualify as Guaranteed Entities pursuant to
the Final Rule, as compared to Baseline A. Accordingly, the Commission
believes that, in this
[[Page 56988]]
respect, any increase in costs associated with the Final Rule will be
small.
---------------------------------------------------------------------------
\550\ Final Sec. 23.23(c)(2)(ii).
\551\ See Guidance, 78 FR at 45319-45320.
---------------------------------------------------------------------------
Under the Final Rule, an SRS must also include all of its swap
positions in its MSP threshold calculations.\552\ Under the Guidance,
an SRS would likely have been categorized as either a conduit affiliate
(which would have been required to count all its swap positions towards
its MSP threshold calculations) or a non-U.S. person that is neither a
conduit affiliate nor a guaranteed affiliate (which would have been
required to count only a subset of its swap positions towards its MSP
threshold calculations). Unlike an Other Non-U.S. Person, SRSs will
additionally be required to include in their MSP threshold calculations
any transaction that is executed anonymously on a DCM, registered or
exempt SEF, or registered FBOT, and cleared through a registered or
exempt DCO.
---------------------------------------------------------------------------
\552\ Final Sec. 23.23(c)(1).
---------------------------------------------------------------------------
As noted in sections II.D and IV.B.1, the Commission believes that
it is appropriate to distinguish SRSs from Other Non-U.S. Persons in
determining the cross-border application of the MSP thresholds to such
entities, as well as with respect to the Dodd-Frank Act swap provisions
addressed by the Final Rule more generally. As discussed above, SRSs,
as a class of entities, present a greater supervisory interest to the
CFTC relative to Other Non-U.S. Persons, due to the nature and extent
of the their relationships with their ultimate U.S. parent entities.
Therefore, the Commission believes that it is appropriate to require
SRSs to include more of their swap positions in their MSP threshold
calculations than Other Non-U.S. Persons do. Additionally, allowing an
SRS to exclude all of its non-U.S. swap positions from its calculation
could incentivize U.S. financial groups to book their non-U.S.
positions into a non-U.S. subsidiary to avoid MSP registration
requirements.
Given that this requirement was not included in the Guidance or the
Cross-Border Margin Rule, the Commission believes that this aspect of
the Final Rule will have a similar effect on market participants when
measured against Baseline A and Baseline B. The Commission notes that
there are no MSPs registered with the Commission, and expects that few
entities will be required to undertake an assessment to determine
whether they would qualify as an MSP under the Final Rule. Any such
entities would likely have classified themselves as a non-U.S. person
that is neither a conduit affiliate nor a guaranteed affiliate pursuant
to the Guidance. Accordingly, they may incur incremental costs
associated with assessing and implementing the additional counting
requirements for SRSs. With respect to Baseline B, the Commission
believes that most potential SRSs would have interpreted CEA section
2(i) to require them to count their swap positions with U.S. persons,
but acknowledges that some may not have interpreted CEA section 2(i) so
as to require them to count swap positions with non-U.S. persons toward
their MSP threshold calculations. Accordingly, such SRSs will incur the
incremental costs associated with the additional SRS counting
requirements contained in the Final Rule. The Commission believes that
these SRS calculation requirements will mitigate regulatory arbitrage
by ensuring that U.S. entities do not simply book swaps through an SRS
affiliate to avoid CFTC registration. Accordingly, the Commission
believes that such provisions will benefit the swap market by ensuring
that the Dodd-Frank Act swap requirements that are addressed by the
Final Rule are applied to entities whose activities have a direct and
significant connection to, or effect on, U.S. commerce.
(ii) Other Non-U.S. Persons
Under the Final Rule, Other Non-U.S. Persons are required to
include in their MSP calculations swap positions with U.S. persons
(other than swaps conducted through a foreign branch of a registered
SD) and certain swaps with Guaranteed Entities.\553\ The Final Rule
does not, however, require Other Non-U.S. Persons to include swap
positions with a Guaranteed Entity that is an SD, SRSs (other than SRSs
that are also Guaranteed Entities and no other exception applies), or
Other Non-U.S. Persons. Additionally, Other Non-U.S. Persons will not
be required to include in their MSP threshold calculations any
transaction that is executed anonymously on a DCM, a registered or
exempt SEF, or registered FBOT, and cleared through a registered or
exempt DCO.\554\
---------------------------------------------------------------------------
\553\ Final Sec. 23.23(c)(2).
\554\ Final Sec. 23.23(d).
---------------------------------------------------------------------------
Given that these requirements are consistent with the Guidance in
most respects, the Commission believes that the Final Rule will have a
minimal effect on Other Non-U.S. Persons, as measured against Baseline
A. With respect to Baseline B, the Commission believes that most non-
U.S. persons would have interpreted CEA section 2(i) to require them to
count their swap positions with U.S. persons, but acknowledges that
some non-U.S. persons may not have interpreted CEA section 2(i) so as
to require them to count swaps with non-U.S. persons toward their MSP
threshold calculations. Accordingly, such non-U.S. persons will incur
the incremental costs associated with the counting requirements for
Other Non-U.S. Persons contained in the Final Rule.
The Commission recognizes that the Final Rule's cross-border
approach to the MSP threshold calculations could contribute to
competitive disparities arising between U.S.-based financial groups and
non-U.S. based financial groups. Potential MSPs that are U.S. persons,
SRSs, or Guaranteed Entities will be required to include all of their
swap positions. In contrast, Other Non-U.S. Persons will be permitted
to exclude certain swap positions from their MSP threshold
calculations. As a result, SRSs and Guaranteed Entities may be at a
competitive disadvantage, as more of their swap activity will apply
toward the MSP calculation and trigger MSP registration relative to
Other Non-U.S. Persons. While the Commission does not believe that any
additional Other Non-U.S. Persons will be required to register as MSPs
under the Final Rule, the Commission acknowledges that to the extent
that a currently unregistered non-U.S. person is required to register
as an MSP under the Final Rule, its non-U.S. person counterparties may
possibly cease transacting with it in order to operate outside the
Dodd-Frank Act swap regime.\555\ Additionally, unregistered non-U.S.
persons may be able to enter into swaps on more favorable terms to non-
U.S. persons than their registered competitors because they are not
required to incur the costs associated with CFTC registration.\556\ As
noted above, however, the Commission believes that these competitive
disparities will be mitigated to the extent that foreign jurisdictions
impose comparable requirements. Further, the Commission reiterates its
belief that the cross-border approach to the MSP registration
thresholds taken in the Final Rule aims to further the policy
objectives of the Dodd-Frank Act while mitigating unnecessary burdens
and disruption to market practices to the extent possible.
---------------------------------------------------------------------------
\555\ Additionally, some unregistered swap market participants
may opt to withdraw from the market, thereby contracting the number
of competitors in the swaps market, which may have an effect on
competition and liquidity.
\556\ These non-U.S. market participants also may be able to
offer swaps on more favorable terms to U.S. persons, giving them a
competitive advantage over U.S. competitors with respect to U.S.
counterparties.
---------------------------------------------------------------------------
[[Page 56989]]
(iii) Attribution Requirement
The Final Rule also addresses the cross-border application of the
attribution requirement in a manner consistent with the Entities Rule
and CEA section 2(i) and generally comparable to the approach adopted
by the SEC. Specifically, the swap positions of an entity, whether a
U.S. or non-U.S. person, should not be attributed to a parent, other
affiliate, or guarantor for purposes of the MSP analysis in the absence
of a guarantee. Even in the presence of a guarantee, attribution is not
required if the entity that enters into the swap directly is subject to
capital regulation by the Commission or the SEC, is regulated as a bank
in the United States, or is subject to Basel compliant capital
standards and oversight by a G20 prudential supervisor. The Final Rule
also clarifies that the swap positions of an entity that is required to
register as an MSP, or whose MSP registration is pending, is not
subject to the attribution requirement. Given that this approach is
largely consistent with the Guidance, with certain caveats, the
Commission believes that market participants will only incur
incremental costs with respect to Baseline A in modifying their
existing systems and policies and procedures in response to the Final
Rule. Absent the Guidance, the Commission believes that most market
participants would have relied on the interpretation of the attribution
requirement in the Entities Rule, which is similar to the approach set
forth in the Final Rule. Accordingly, with respect to Baseline B, the
Commission believes that market participants will only incur
incremental costs in modifying their existing systems and policies and
procedures in response to the Final Rule. In addition, the Commission
believes that consistency with the approach in the SEC Cross-Border
Rule will reduce compliance costs for market participants.
5. Monitoring Costs
Under the Final Rule, market participants must continue to monitor
their swap activities in order to determine whether they are, or
continue to be, required to register as an SD or MSP. With respect to
Baseline A, the Commission believes that market participants have
developed policies and practices consistent with the cross-border
approach to the SD and MSP registration thresholds expressed in the
Guidance. Therefore, the Commission believes that market participants
will only incur incremental costs in modifying their existing systems
and policies and procedures in response to the Final Rule (e.g.,
determining which swap activities or positions are required to be
included in the registration threshold calculations).\557\
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\557\ Although the cross-border approach to the MSP registration
threshold calculations in the Final Rule is not identical to the
approach included in the Guidance (see supra section IV.B), the
Commission believes that any resulting increase in monitoring costs
resulting from the adoption of the Final Rule will be incremental
and de minimis.
---------------------------------------------------------------------------
For example, with respect to the SD registration threshold, SRSs
may have adopted policies and practices in line with the Guidance's
approach to non-U.S. persons that are not guaranteed or conduit
affiliates and therefore may only be currently counting (or be
provisionally registered by virtue of) their swap dealing transactions
with U.S. persons, other than foreign branches of U.S. SDs. Although an
SRS will be required under the Final Rule to include all dealing swaps
in its de minimis calculation, the Commission believes that any
increase in monitoring costs for SRSs will be negligible, both
initially and on an ongoing basis, because they already have systems
that track swap dealing transactions with certain counterparties in
place, which includes an assessment of their counterparties'
status.\558\ The Commission expects that any adjustments made to these
systems in response to the Final Rule will be minor.
---------------------------------------------------------------------------
\558\ See supra section X.C.2, for a discussion of assessment
costs.
---------------------------------------------------------------------------
With respect to Baseline B, the Commission believes that, absent
the Guidance, most market participants would have interpreted CEA
section 2(i) to require them, at a minimum, to monitor their swap
activities with U.S. persons to determine whether they are, or continue
to be, required to register as an SD or MSP. Accordingly, such persons
will incur the incremental costs in modifying their existing systems
and policies and procedures in response to the Final Rule to monitor
their swap activity with certain non-U.S. persons. To the extent that
market participants did not interpret CEA section 2(i) in such manner,
they will incur more substantial costs in implementing such monitoring
activities.
6. Registration Costs
With respect to Baseline A, the Commission believes that few, if
any, additional non-U.S. persons will be required to register as an SD
pursuant to the Final Rule. With respect to Baseline B, the Commission
acknowledges that, absent the Guidance, some non-U.S. persons may not
have interpreted CEA section 2(i) so as to require them to register
with the Commission. Accordingly, a subset of such entities could be
required to register with the Commission pursuant to the Final Rule.
The Commission acknowledges that if a market participant is
required to register, it will incur registration costs. The Commission
previously estimated registration costs in its rulemaking on
registration of SDs; \559\ however, the costs that may be incurred
should be mitigated to the extent that any new SDs are affiliated with
an existing SD, as most of these costs have already been realized by
the consolidated group. While the Commission cannot anticipate the
extent to which any potential new registrants will be affiliated with
existing SDs, it notes that most current registrants are part of a
consolidated group. The Commission has not included any discussion of
registration costs for MSPs because it believes that few, if any,
market participants will be required to register as an MSP under the
Final Rule, as noted above.
---------------------------------------------------------------------------
\559\ See Registration of Swap Dealers and Major Swap
Participants, 77 FR at 2623-2625.
---------------------------------------------------------------------------
7. Programmatic Costs
With respect to Baseline A, as noted above, the Commission believes
that few, if any, additional non-U.S. persons will be required to
register as an SD under the Final Rule. With respect to Baseline B, the
Commission acknowledges that, absent the Guidance, some non-U.S.
persons may not have interpreted CEA section 2(i) so as to require them
to register with the Commission. Accordingly, a subset of such entities
could be required to register with the Commission pursuant to the Final
Rule.
To the extent that the Final Rule acts as a ``gating'' rule by
affecting which entities engaged in cross-border swap activities must
comply with the SD requirements, the Final Rule will result in
increased costs for particular entities that otherwise would not
register as an SD and comply with the swap requirements.\560\
---------------------------------------------------------------------------
\560\ As noted above, the Commission believes that few (if any)
market participants will be required to register as an MSP under the
Final Rule, and therefore it has not included a separate discussion
of programmatic costs for registered MSPs in this section.
---------------------------------------------------------------------------
8. Exceptions From Group B and Group C Requirements, Availability of
Substituted Compliance, and Comparability Determinations
As discussed in section VI above, the Commission, consistent with
section 2(i) of the CEA, is adopting exceptions
[[Page 56990]]
from, and substituted compliance for, certain group A, group B, and
group C requirements applicable to swap entities, as well as the
creation of a framework for comparability determinations.
(i) Exceptions
Specifically, as discussed above in section VI, the Final Rule
includes: (1) The Exchange-Traded Exception from certain group B and
group C requirements for certain anonymously executed, exchange-traded,
and cleared foreign-based swaps; (2) the Foreign Swap Group C Exception
for certain foreign-based swaps with foreign counterparties; (3) the
U.S. Branch Group C Exception, for swaps booked in a U.S. branch with
certain foreign counterparties; (4) the Limited Foreign Branch Group B
Exception for certain foreign-based swaps of foreign branches of U.S.
swap entities with certain foreign counterparties; (5) the Non-U.S.
Swap Entity Group B Exception for foreign-based swaps of non-U.S. swap
entities that are Other Non-U.S. Persons with certain foreign
counterparties; and (6) the Limited Swap Entity SRS/Guaranteed Entity
Group B Exception for certain foreign-based swaps of SRS Swap Entities
and Guaranteed Swap Entities with certain foreign counterparties.
Under the Final Rule, U.S. swap entities (other than their foreign
branches) are not excepted from, or eligible for substituted compliance
for, the Commission's group A, group B, and group C requirements. These
requirements apply fully to registered SDs and MSPs that are U.S.
persons because their swap activities are particularly likely to affect
the integrity of the swap market in the United States and raise
concerns about the protection of participants in those markets. With
respect to both baselines, the Commission does not expect that this
will impose any additional costs on market participants given that the
Commission's relevant business conduct requirements already apply to
U.S. SDs and MSPs pursuant to existing Commission regulations.
Pursuant to the Exchange-Traded Exception, non-U.S. swap entities
and foreign branches of non-U.S. swap entities are generally excepted
from most of the group B and group C requirements with respect to their
foreign-based swaps that are executed anonymously on a DCM, a
registered or exempt SEF, or registered FBOT, and cleared through a
registered or exempt DCO.
Further, pursuant to the Foreign Swap Group C Exception, non-U.S.
swap entities and foreign branches of U.S. swap entities are excepted
from the group C requirements with respect to their foreign-based swaps
with foreign counterparties.
Under the U.S. Branch Group C Exception, a non-U.S. swap entity is
excepted from the group C requirements with respect to any swap booked
in a U.S. branch with a foreign counterparty that is neither a foreign
branch nor a Guaranteed Entity.
Pursuant to the Limited Foreign Branch Group B Exception, foreign
branches of U.S. swap entities are excepted from the group B
requirements, with respect to any foreign-based swap with a foreign
counterparty that is an SRS End User or an Other Non-U.S. Person that
is not a swap entity, subject to certain conditions: Specifically, (1)
a group B requirement is not eligible for the exception if the
requirement, as applicable to the swap, is eligible for substituted
compliance pursuant to a comparability determination issued by the
Commission prior to the execution of the swap; and (2) in any calendar
quarter, the aggregate gross notional amount of swaps conducted by a
swap entity in reliance on this exception does not exceed five percent
of the aggregate gross notional amount of all its swaps.
In addition, pursuant to the Non-U.S. Swap Entity Group B
Exception, non-U.S. swap entities that are Other Non-U.S. Persons are
excepted from the group B requirements with respect to any foreign-
based swap with a foreign counterparty that is an SRS End User or Other
Non-U.S. Person.
Finally, pursuant to the Limited Swap Entity SRS/Guaranteed Entity
Group B Exception, each Guaranteed Swap Entity and SRS Swap Entity is
excepted from the group B requirements, with respect to any foreign-
based swap with a foreign counterparty that is an SRS End User or an
Other Non-U.S. Person that is not a swap entity, subject to certain
conditions. Specifically, under the Final Rule: (1) The exception is
not available with respect to any group B requirement if the
requirement as applicable to the swap is eligible for substituted
compliance pursuant to a comparability determination issued by the
Commission prior to the execution of the swap; and (2) in any calendar
quarter, the aggregate gross notional amount of swaps conducted by an
SRS Swap Entity or a Guaranteed Swap Entity in reliance on this
exception aggregated with the gross notional amount of swaps conducted
by all affiliated SRS Swap Entities and Guaranteed Swap Entities in
reliance on this exception does not exceed five percent of the
aggregate gross notional amount of all swaps entered into by the SRS
Swap Entity or a Guaranteed Swap Entity and all affiliated swap
entities.
The Commission acknowledges that the group B requirements may apply
more broadly to swaps between non-U.S. persons than as contemplated in
the Guidance. For example, the Final Rule generally requires non-U.S.
swap entities that are Guaranteed Entities or SRSs to comply with the
group B requirements for swaps with Other Non-U.S. Persons, whereas the
Guidance stated that all non-U.S. swap entities (other than their U.S.
branches) were excluded from the group B requirements with respect to
swaps with a non-U.S. person that is not a guaranteed or conduit
affiliate.\561\ However, the Commission believes that the exceptions
from the group B requirements in the Final Rule, coupled with the
availability of substituted compliance, will help to alleviate any
additional burdens that may arise from such application. Further, the
group C requirements have been expanded to include Subpart L, which
consequently expands the scope of certain of the exceptions from the
group C requirements under the Final Rule. Notwithstanding the
availability of these exceptions and substituted compliance, the
Commission acknowledges that some non-U.S. swap entities may incur
costs to the extent that a comparability determination has not yet been
issued for certain jurisdictions. Further, the Commission expects that
swap entities that avail themselves of the exceptions will be able to
reduce their costs of compliance with respect to the excepted
requirements (which, to the extent they are similar to requirements in
the jurisdiction in which they are based, may be potentially
duplicative or conflicting). Swap entities are not required to take any
additional action to avail themselves of these exceptions (e.g.,
notification to the Commission) that would cause them to incur
additional costs. The Commission recognizes that the exceptions (and
the inherent cost savings) may give certain swap entities a competitive
advantage with respect to swaps that meet the requirements of the
exception.\562\
---------------------------------------------------------------------------
\561\ The group B requirements were categorized as Category A
transaction-level requirements under the Guidance.
\562\ The degree of competitive disparity will depend on the
degree of disparity between the Commission's requirements and that
of the relevant foreign jurisdiction.
---------------------------------------------------------------------------
The Commission nonetheless believes that it is appropriate to
tailor the application of the group B and group C
[[Page 56991]]
requirements in the cross-border context, consistent with section 2(i)
of the CEA and international comity principles, by providing the
exceptions in the Final Rule. In doing so, the Commission is aiming to
reduce market fragmentation which may result by applying certain
duplicative swap requirements in non-U.S. markets, which are often
subject to robust foreign regulation. Other than the U.S. Branch Group
C Exception, the exceptions in the Final Rule are largely similar to
those provided in the Guidance. Therefore, the Commission does not
expect that the exceptions in the Final Rule will, in the aggregate,
have a significant effect on the costs of, and benefits to, swap
entities.
(ii) Substituted Compliance
As described in section VI.C, the extent to which substituted
compliance is available under the Final Rule depends on the
classification of the swap entity or branch and, in certain cases the
counterparty, to a particular swap. The Commission recognizes that the
decision to offer substituted compliance carries certain trade-offs.
Given the global and highly-interconnected nature of the swap market,
where risk is not bound by national borders, market participants are
likely to be subject to the regulatory interest of more than one
jurisdiction. Allowing compliance with foreign swap standards as an
alternative to compliance with the Commission's requirements can
therefore reduce the application of duplicative or conflicting
requirements, resulting in lower compliance costs and potentially
facilitating a more efficient regulatory framework over time.
Substituted compliance also helps preserve the benefits of an
integrated, global swap market by fostering and advancing efforts among
U.S. and foreign regulators to collaborate in establishing robust
regulatory standards. If substituted compliance is not properly
implemented, however, the Commission's swap regime could lose some of
its effectiveness. Accordingly, the ultimate costs and benefits of
substituted compliance are affected by the standard under which it is
granted and the extent to which it is applied. The Commission was
mindful of this dynamic in structuring a substituted compliance regime
for the group A and group B requirements and has determined that the
Final Rule will enhance market efficiency and foster global
coordination of these requirements while ensuring that swap entities
(wherever located) are subject to comparable regulation.
The Commission also understands that by not offering substituted
compliance equally to all swap entities, the Final Rule could lead to
certain competitive disparities between swap entities. For example, to
the extent that a non-U.S. swap entity can rely on substituted
compliance that is not available to a U.S. swap entity, it may enjoy
certain cost advantages (e.g., avoiding the costs of potentially
duplicative or inconsistent regulation). The non-U.S. swap entity may
then be able to pass on these cost savings to its counterparties in the
form of better pricing or some other benefit. U.S. swap entities, on
the other hand, could, depending on the extent to which foreign swap
requirements apply, be subject to both U.S. and foreign requirements,
and therefore be at a competitive disadvantage. Counterparties may also
be incentivized to transact with swap entities that are offered
substituted compliance in order to avoid being subject to duplicative
or conflicting swap requirements, which could lead to increased market
deficiencies.\563\
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\563\ The Commission recognizes that its substituted compliance
framework may impose certain initial operational costs, as in
certain cases swap entities will be required to determine the status
of their counterparties in order to determine the extent to which
substituted compliance is available.
---------------------------------------------------------------------------
Nevertheless, the Commission does not believe it is appropriate to
make substituted compliance broadly available to all swap entities
because it needs to protect market participants and the public. As
discussed above, the Commission has a strong supervisory interest in
the swap activity of all swap entities, including non-U.S. swap
entities, by virtue of their registration with the Commission. Further,
U.S. swap entities are particularly key swap market participants, and
their safety and soundness is critical to a well-functioning U.S. swap
market and the stability of the U.S. financial system. The Commission
believes that losses arising from the default of a U.S. entity are more
likely to be borne by other U.S. entities (including parent companies);
therefore, a U.S. entity's risk to the U.S. financial system is more
acute than that of a similarly situated non-U.S. entity. Accordingly,
in light of the Commission's supervisory interest in the activities of
U.S. persons and its statutory obligation to ensure the safety and
soundness of swap entities and the U.S. swap market, the Commission
believes that it is generally not appropriate for substituted
compliance to be available to U.S. swap entities for purposes of the
Final Rule. With respect to non-U.S. swap entities, however, the
Commission believes that, in the interest of international comity,
making substituted compliance generally available for the requirements
discussed in the Final Rule is appropriate.
IATP stated that the Commission should not make the costs of
complying with, or economic benefits from, substituted compliance a
decision criterion for comparability determinations, and that
participation in U.S. markets is a privilege with consequent costs and
benefits. Such costs and benefits drive the underlying policy of the
substituted compliance regime as discussed in this Final Rule, rather
than the decision-making that accompanies an individual comparability
determination assessment.
(iii) Comparability Determinations
As noted in section VI.D above, under the Final Rule, a
comparability determination may be requested by: (1) Eligible swap
entities; (2) trade associations whose members are eligible swap
entities; or (3) foreign regulatory authorities that have direct
supervisory authority over eligible swap entities and are responsible
for administering the relevant foreign jurisdiction's swap
requirements.\564\ Once a comparability determination is made for a
jurisdiction, it applies for all entities or transactions in that
jurisdiction to the extent provided in the determination, as approved
by the Commission.\565\ Accordingly, given that the Final Rule will
have no effect on any existing comparability determinations, swap
entities may continue to rely on such determinations with no effect on
the costs or benefits of such reliance. To the extent that an entity
wishes to request a new comparability determination pursuant to the
Final Rule, it will incur costs associated with the preparation and
filing of a submission request. However, the Commission anticipates
that a person would not elect to incur the costs of submitting a
request for a comparability determination unless such costs were
exceeded by the cost savings associated with substituted compliance.
---------------------------------------------------------------------------
\564\ Final Sec. 23.23(g)(2).
\565\ Final Sec. 23.23(f).
---------------------------------------------------------------------------
The Final Rule includes a standard of review that allows for a
holistic, outcomes-based approach that enables the Commission to
consider any factor it deems relevant in assessing comparability.
Further, in determining whether a foreign regulatory standard is
comparable to a corresponding Commission requirement, the Final Rule
[[Page 56992]]
allows the Commission to consider the broader context of a foreign
jurisdiction's related regulatory requirements. Allowing for a
comparability determination to be made based on comparable outcomes,
notwithstanding potential differences in foreign jurisdictions'
relevant standards, helps to ensure that substituted compliance is made
available to the fullest extent possible. While the Commission
recognizes that, to the extent that a foreign swap regime is not deemed
comparable in all respects, swap entities eligible for substituted
compliance may incur costs from being required to comply with more than
one set of specified swap requirements, the Commission believes that
this approach is preferable to an all-or-nothing approach, in which
market participants may be forced to comply with both regimes in their
entirety.
9. Recordkeeping
The Final Rule also requires swap entities to create and retain
records of their compliance with the Final Rule.\566\ Given that swap
entities are already subject to robust recordkeeping requirements, the
Commission believes that swap entities will only incur incremental
costs, which are expected to be minor, in modifying their existing
systems and policies and procedures resulting from changes to the
status quo made by the Final Rule.
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\566\ Final Sec. 23.23(h)(1).
---------------------------------------------------------------------------
10. Alternatives Considered
The Commission carefully considered several alternatives to various
provisions of the Final Rule. In determining whether to accept or
reject each alternative, the Commission considered the potential costs
and benefits associated with each alternative.
For example, the Commission considered Better Markets' suggestion
that the Commission add two additional tests to determine whether an
entity is a significant subsidiary. Better Markets proposed that if an
entity were to meet a risk transfer test, measuring the notional amount
of swaps that are back-to-backed with U.S. entities, or a risk
acceptance test, measuring the trading activity of the subsidiary over
a three month time period, then the entity should be considered a
significant subsidiary. The Commission declined to include these two
tests because these activity-based tests do not provide a measure of
risk that a subsidiary poses to a parent entity, and thus would
potentially subject a greater number of entities to certain Commission
regulations without providing a significant reduction in systemic risk.
Similarly, the Commission considered IIB/SIFMA's comment that the
application of the group B requirements to swaps of Guaranteed Swap
Entities and SRS Swap Entities should conform to the Guidance, so as to
reduce the competitive disadvantages faced by such swap entities and
their counterparties when they are subject to U.S. rules
extraterritorially. The Commission declined to adopt this alternative,
citing the fact that the group B requirements relate to risk
mitigation, and SRS Swap Entities and Guaranteed Swap Entities may pose
significant risk to the United States. However, the Commission
acknowledged the potential competitive disadvantages that such
application may pose to Guaranteed Swap Entities and SRS Swap Entities
(as opposed to foreign branches of U.S. swap entities), and therefore
also adopted the Limited Swap Entity SRS/Guaranteed Entity Group B
Exception in an effort to reduce potential burdens to such entities
without sacrificing the important risk mitigation goals associated with
the group B requirements.
On the other hand, the Commission adopted certain alternatives to
elements of the Proposed Rule. For example, CS and IIB/SIFMA stated
that the exclusion for subsidiaries of BHCs in the SRS definition
should be expanded to include those entities that are subsidiaries of
IHCs. These commenters noted that IHCs are subject to prudential
regulation, including Basel III capital requirements, stress testing,
liquidity, and risk management requirements. The Commission determined
that IHCs are subject to prudential standards by the Federal Reserve
Board that are similar to those to which BHCs are subject. In general,
IHCs and BHCs of similar size are subject to similar liquidity, risk
management, stress testing, and credit limit standards. Therefore, for
the same risk-based reasons that the Commission proposed to exclude
subsidiaries of BHCs from the definition of SRS, the Commission is
expanding the SRS exclusion to include subsidiaries of both BHCs and
IHCs in Sec. 23.23(a)(13)(i).
The Commission is also adopting an alternative raised by IIB/SIFMA,
who recommended that the Commission expand the proposed Non-U.S. Swap
Entity Group B Exception and the Limited Foreign Branch Group B
Exception by applying the exceptions to swaps with an SRS that is not a
swap entity, so as to avoid inappropriately burdening the foreign
subsidiaries of U.S. multinational corporations and their
counterparties. In doing so, the Commission acknowledges that applying
the group B requirements to a swap entity's swaps indirectly affects
their counterparties, including SRS End User counterparties, by
requiring them to execute documentation (e.g., compliant swap trading
relationship documentation), and engage in portfolio reconciliation and
compression exercises as a condition to entering into swaps with swap
entity counterparties. Accordingly, mandating compliance with these
obligations may cause counterparties, including SRS End Users, to face
increased costs relative to their competitors not affected by the
application of the group B requirements (e.g., for legal fees or as a
result of costs being passed on to them by their swap entity
counterparties) and/or to potentially lose access to key interest rate
or currency hedging products. Also, because the SRS test depends on a
non-U.S. counterparty's internal organizational structure and financial
metrics and it would be difficult to rule out any category of non-U.S.
counterparties as being an SRS, the proposed application of group B
requirements to all SRSs may cause swap entities to obtain SRS
representations from nearly their entire non-U.S. client bases,
potentially increasing costs for all of these clients.
In light of the importance of ensuring that an SRS, particularly a
commercial or non-financial entity, continues to have access to swap
liquidity for hedging or other non-dealing purposes, the Commission
expanded the exceptions to apply to SRS End Users. The Commission noted
that an SRS End User does not pose as significant a risk to the United
States as an SRS Swap Entity or a Guaranteed Entity, because an SRS End
User: (1) Has a less direct connection to the United States than a
Guaranteed Entity; and (2) has been involved, at most, in only a de
minimis amount of swap dealing activity, or has swap positions below
the MSP thresholds, such that it is not required to register as a SD or
MSP, respectively.
The Commission considered several other alternatives to the Final
Rule, which are discussed in detail throughout this release.\567\ In
each instance, the Commission considered the costs and burdens of the
Final Rule and the regulatory benefits that the Final Rule seeks to
achieve.
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\567\ See supra sections II-VI.
---------------------------------------------------------------------------
11. Section 15(a) Factors
Section 15(a) of the CEA \568\ requires the Commission to consider
the costs and benefits of its actions before
[[Page 56993]]
promulgating a regulation under the CEA or issuing certain orders.
Section 15(a) further specifies that the costs and benefits shall be
evaluated in light of five broad areas of market and public concern:
(1) Protection of market participants and the public; (2) efficiency,
competitiveness, and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) factors.
---------------------------------------------------------------------------
\568\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
(i) Protection of Market Participants and the Public
The Commission believes the Final Rule will support protection of
market participants and the public. By focusing on and capturing swap
dealing transactions and swap positions involving U.S. persons, SRSs,
and Guaranteed Entities, the Final Rule's approach to the cross-border
application of the SD and MSP registration threshold calculations works
to ensure that, consistent with CEA section 2(i) and the policy
objectives of the Dodd-Frank Act, significant participants in the U.S.
market are subject to these requirements. The cross-border approach to
the group A, group B, and group C requirements similarly ensures that
these requirements apply to swap activities that are particularly
likely to affect the integrity of, and raise concerns about, the
protection of participants in the U.S. market while, consistent with
principles of international comity, recognizing the supervisory
interests of the relevant foreign jurisdictions in applying their own
requirements to transactions involving non-U.S. swap entities and
foreign branches of U.S. swap entities with non-U.S. persons and
foreign branches of U.S. swap entities.
(ii) Efficiency, Competitiveness, and Financial Integrity of the
Markets
To the extent that the Final Rule leads additional entities to
register as SDs or MSPs, the Commission believes that the Final Rule
will enhance the financial integrity of the markets by bringing
significant U.S. swap market participants under Commission oversight,
which may reduce market disruptions and foster confidence and
transparency in the U.S. market. The Commission recognizes that the
Final Rule's cross-border approach to the SD and MSP registration
thresholds may create competitive disparities among market
participants, based on the degree of their connection to the United
States, that could contribute to market deficiencies, including market
fragmentation and decreased liquidity, as certain market participants
may reduce their exposure to the U.S. market. As a result of reduced
liquidity, counterparties may pay higher prices, in terms of bid-ask
spreads. Such competitive effects and market deficiencies may, however,
be mitigated by global efforts to harmonize approaches to swap
regulation and by the large inter-dealer market, which may link the
fragmented markets and enhance liquidity in the overall market. The
Commission believes that the Final Rule's approach is necessary and
appropriately tailored to ensure that the purposes of the Dodd-Frank
Act swap regime and its registration requirements are advanced while
still establishing a workable approach that recognizes foreign
regulatory interests and reduces competitive disparities and market
deficiencies to the extent possible. The Commission further believes
that the Final Rule's cross-border approach to the group A, group B,
and group C requirements will promote the financial integrity of the
markets by fostering transparency and confidence in the significant
participants in the U.S. swap markets.
(iii) Price Discovery
The Commission recognizes that the Final Rule's approach to the
cross-border application of the SD and MSP registration thresholds and
group A, group B, and group C requirements could have an effect on
liquidity, which may in turn influence price discovery. As liquidity in
the swap market is lessened and fewer dealers compete against one
another, bid-ask spreads (cost of swap and cost to hedge) may widen and
the ability to observe an accurate price of a swap may be hindered.
However, as noted above, these negative effects will be mitigated as
jurisdictions harmonize their swap regimes and global financial
institutions continue to manage their swap books (i.e., moving risk
with little or no cost, across an institution to market centers, where
there is the greatest liquidity). The Commission does not believe that
the Final Rule's approach to the group A, group B, and group C
requirements will have a noticeable effect on price discovery.
(iv) Sound Risk Management Practices
The Commission believes that the Final Rule's approach could
promote the development of sound risk management practices by ensuring
that significant participants in the U.S. market are subject to
Commission oversight (via registration), including in particular
important counterparty disclosure and recordkeeping requirements that
will encourage policies and practices that promote fair dealing while
discouraging abusive practices in U.S. markets. On the other hand, to
the extent that a registered SD or MSP relies on the exceptions in the
Final Rule, and is located in a jurisdiction that does not have
comparable swap requirements, the Final Rule could lead to weaker risk
management practices for such entities.
(v) Other Public Interest Considerations
The Commission believes that the Final Rule is consistent with
principles of international comity. The Commission has carefully
considered, among other things, the level of foreign jurisdictions'
supervisory interests over the subject activity and the extent to which
the activity takes place within a particular foreign territory. In
doing so, the Commission has strived to minimize conflicts with the
laws of other jurisdictions while seeking, pursuant to section 2(i), to
apply the swaps requirements of the Dodd-Frank Act to activities
outside the United States that have a direct and significant connection
with activities in, or effect on, U.S. commerce.
The Commission believes the Final Rule appropriately accounts for
these competing interests, ensuring that the Commission can discharge
its responsibilities to protect the U.S. markets, market participants,
and financial system, consistent with international comity. Of
particular relevance is the Commission's approach to substituted
compliance in the Final Rule, which mitigates burdens associated with
potentially duplicative foreign laws and regulations in light of the
supervisory interests of foreign regulators in entities domiciled and
operating in their own jurisdictions.
D. Antitrust Laws
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
objectives of the CEA, as well as the policies and purposes of the CEA,
in issuing any order or adopting any Commission rule or regulation
(including any exemption under section 4(c) or 4c(b)), or in requiring
or approving any bylaw, rule, or regulation of a contract market or
registered futures association established pursuant to section 17 of
the CEA.\569\
---------------------------------------------------------------------------
\569\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
[[Page 56994]]
The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
requested and did not receive any comments on whether the Proposed Rule
implicated any other specific public interest to be protected by the
antitrust laws.
The Commission has considered the Final Rule to determine whether
it is anticompetitive and has identified no significant discretionary
anticompetitive effects.\570\ The Commission requested and did not
receive any comments on whether the Proposed Rule was anticompetitive
and, if it was, what the anticompetitive effects are.
---------------------------------------------------------------------------
\570\ The Final Rule is being adopted pursuant to the direction
of Congress in section 2(i) of the CEA, as discussed in section I.D,
that the swap provisions of the CEA enacted by Title VII of the
Dodd-Frank Act, including any rule prescribed or regulation
promulgated under the CEA, shall not apply to activities outside the
United States unless those activities have a direct and significant
connection with activities in, or effect on, commerce of the United
States, or they contravene Commission rules or regulations as are
necessary or appropriate to prevent evasion of the swap provisions
of the CEA enacted under Title VII. As discussed above, the degree
of any competitive disparity will depend on the degree of disparity
between the Commission's requirements and that of the relevant
foreign jurisdiction.
---------------------------------------------------------------------------
Because the Commission has determined that the Final Rule is not
anticompetitive and has no significant discretionary anticompetitive
effects and received no comments on its determination on the Proposed
Rule, the Commission has not identified any less anticompetitive means
of achieving the purposes of the CEA.
XI. Preamble Summary Tables
A. Table A--Cross-Border Application of the SD De Minimis Threshold
Table A should be read in conjunction with the text of the Final
Rule.
BILLING CODE 6351-01-P
[GRAPHIC] [TIFF OMITTED] TR14SE20.000
B. Table B--Cross-Border Application of the MSP Threshold
Table B should be read in conjunction with the text of the Final
Rule.
[[Page 56995]]
[GRAPHIC] [TIFF OMITTED] TR14SE20.001
C. Table C--Cross-Border Application of the Group B Requirements in
Consideration of Related Exceptions and Substituted Compliance
Table C \571\ should be read in conjunction with the text of the
Final Rule.
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\571\ As discussed in section VI.A.2, supra, the group B
requirements are set forth in Sec. Sec. 23.202, 23.501, 23.502,
23.503, and 23.504 and relate to (1) swap trading relationship
documentation; (2) portfolio reconciliation and compression; (3)
trade confirmation; and (4) daily trading records. Exceptions from
the group B requirements are discussed in sections VI.B.2, VI.B.4,
and VI.B.5, supra. Substituted compliance for the group B
requirements is discussed in section VI.C, supra.
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[[Page 56996]]
[GRAPHIC] [TIFF OMITTED] TR14SE20.002
D. Table D--Cross-Border Application of the Group C Requirements in
Consideration of Related Exceptions
Table D \572\ should be read in conjunction with the text of the
Final Rule.
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\572\ As discussed in section VI.A.3, supra, the group C
requirements are set forth in Sec. Sec. 23.400 through 23.451 and
23.700 through 23.704 and relate to certain business conduct
standards governing the conduct of SDs and MSPs in dealing with
their swap counterparties, and the segregation of assets held as
collateral in certain uncleared swaps. Exceptions from the group C
requirements are discussed in sections VI.B.2 and VI.B.3, supra.
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[[Page 56997]]
[GRAPHIC] [TIFF OMITTED] TR14SE20.003
BILLING CODE 6351-01-C
List of Subjects in 17 CFR Part 23
Business conduct standards, Counterparties, Cross-border,
Definitions, De minimis exception, Major swap participants, Swaps, Swap
Dealers.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 23 as follows:
PART 23--SWAP DEALERS AND MAJOR SWAP PARTICIPANTS
0
1. The authority citation for part 23 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6p, 6r, 6s, 6t,
9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21.
Section 23.160 also issued under 7 U.S.C. 2(i); Sec. 721(b),
Public Law 111-203, 124 Stat. 1641 (2010).
0
2. Add Sec. 23.23 to read as follows:
Sec. 23.23 Cross-border application.
(a) Definitions. Solely for purposes of this section the terms
listed in this paragraph (a) have the meanings set forth in paragraphs
(a)(1) through (24) of this section. A person may rely on a written
representation from its counterparty that the counterparty does or does
not satisfy the criteria for one or more of the definitions listed in
paragraphs (a)(1) through (24) of this section, unless such person
knows or has reason to know that the representation is not accurate;
for the purposes of this rule a person would have reason to know the
representation is not accurate if a reasonable person should know,
under all of the facts of which the person is aware, that it is not
accurate.
(1) An affiliate of, or a person affiliated with a specific person,
means a person that directly, or indirectly through one or more
intermediaries, controls, or is controlled by, or is under common
control with, the person specified.
(2) Control including the terms controlling, controlled by, and
under common control with, means the possession, direct or indirect, of
the power to direct or cause the direction of the management and
policies of a person, whether through the ownership of voting shares,
by contract, or otherwise.
(3) Foreign branch means any office of a U.S. bank that:
(i) Is located outside the United States;
(ii) Operates for valid business reasons;
(iii) Maintains accounts independently of the home office and of
the accounts of other foreign branches, with the profit or loss accrued
at each branch determined as a separate item for each foreign branch;
and
(iv) Is engaged in the business of banking and is subject to
substantive regulation in banking or financing in the jurisdiction
where it is located.
(4) Foreign-based swap means:
(i) A swap by a non-U.S. swap entity, except for a swap booked in a
U.S. branch; or
(ii) A swap conducted through a foreign branch.
(5) Foreign counterparty means:
(i) A non-U.S. person, except with respect to a swap booked in a
U.S. branch of that non-U.S. person; or
(ii) A foreign branch where it enters into a swap in a manner that
satisfies the definition of a swap conducted through a foreign branch.
(6) Group A requirements mean the requirements set forth in Sec.
3.3 of this chapter, Sec. Sec. 23.201, 23.203, 23.600, 23.601, 23.602,
23.603, 23.605, 23.606, 23.607, 23.609 and, to the extent it duplicates
Sec. 23.201, Sec. 45.2(a) of this chapter.
[[Page 56998]]
(7) Group B requirements mean the requirements set forth in
Sec. Sec. 23.202 and 23.501 through 23.504.
(8) Group C requirements mean the requirements set forth in
Sec. Sec. 23.400 through 23.451 and 23.700 through 23.704.
(9) Guarantee means an arrangement pursuant to which one party to a
swap has rights of recourse against a guarantor, with respect to its
counterparty's obligations under the swap. For these purposes, a party
to a swap has rights of recourse against a guarantor if the party has a
conditional or unconditional legally enforceable right to receive or
otherwise collect, in whole or in part, payments from the guarantor
with respect to its counterparty's obligations under the swap. In
addition, in the case of any arrangement pursuant to which the
guarantor has a conditional or unconditional legally enforceable right
to receive or otherwise collect, in whole or in part, payments from any
other guarantor with respect to the counterparty's obligations under
the swap, such arrangement will be deemed a guarantee of the
counterparty's obligations under the swap by the other guarantor.
Notwithstanding the foregoing, until December 31, 2027, a person may
continue to classify counterparties based on:
(i) Representations that were made pursuant to the ``guarantee''
definition in Sec. 23.160(a)(2) prior to the effective date of this
section; or
(ii) Representations made pursuant to the interpretation of the
term ``guarantee'' in the Interpretive Guidance and Policy Statement
Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (Jul.
26, 2013), prior to the effective date of this section.
(10) Non-U.S. person means any person that is not a U.S. person.
(11) Non-U.S. swap entity means a swap entity that is not a U.S.
swap entity.
(12) Parent entity means any entity in a consolidated group that
has one or more subsidiaries in which the entity has a controlling
interest, as determined in accordance with U.S. GAAP.
(13) Significant risk subsidiary means any non-U.S. significant
subsidiary of an ultimate U.S. parent entity where the ultimate U.S.
parent entity has more than $50 billion in global consolidated assets,
as determined in accordance with U.S. GAAP at the end of the most
recently completed fiscal year, but excluding non-U.S. subsidiaries
that are:
(i) Subject to consolidated supervision and regulation by the Board
of Governors of the Federal Reserve System as a subsidiary of a U.S.
bank holding company or an intermediate holding company; or
(ii) Subject to capital standards and oversight by the subsidiary's
home country supervisor that are consistent with the Basel Committee on
Banking Supervision's ``International Regulatory Framework for Banks''
and subject to margin requirements for uncleared swaps in a
jurisdiction that the Commission has found comparable pursuant to a
published comparability determination with respect to uncleared swap
margin requirements.
(14) Significant subsidiary means a subsidiary, including its
subsidiaries, which meets any of the following conditions:
(i) The three year rolling average of the subsidiary's equity
capital is equal to or greater than five percent of the three year
rolling average of the ultimate U.S. parent entity's consolidated
equity capital, as determined in accordance with U.S. GAAP as of the
end of the most recently completed fiscal year;
(ii) The three year rolling average of the subsidiary's total
revenue is equal to or greater than ten percent of the three year
rolling average of the ultimate U.S. parent entity's total consolidated
revenue, as determined in accordance with U.S. GAAP as of the end of
the most recently completed fiscal year; or
(iii) The three year rolling average of the subsidiary's total
assets is equal to or greater than ten percent of the three year
rolling average of the ultimate U.S. parent entity's total consolidated
assets, as determined in accordance with U.S. GAAP as of the end of the
most recently completed fiscal year.
(15) Subsidiary means an affiliate of a person controlled by such
person directly, or indirectly through one or more intermediaries.
(16) Swap booked in a U.S. branch means a swap entered into by a
U.S. branch where the swap is reflected in the local accounts of the
U.S. branch.
(17) Swap conducted through a foreign branch means a swap entered
into by a foreign branch where:
(i) The foreign branch or another foreign branch is the office
through which the U.S. person makes and receives payments and
deliveries under the swap pursuant to a master netting or similar
trading agreement, and the documentation of the swap specifies that the
office for the U.S. person is such foreign branch;
(ii) The swap is entered into by such foreign branch in its normal
course of business; and
(iii) The swap is reflected in the local accounts of the foreign
branch.
(18) Swap entity means a person that is registered with the
Commission as a swap dealer or major swap participant pursuant to the
Act.
(19) Ultimate U.S. parent entity means the U.S. parent entity that
is not a subsidiary of any other U.S. parent entity.
(20) United States and U.S. means the United States of America, its
territories and possessions, any State of the United States, and the
District of Columbia.
(21) U.S. branch means a branch or agency of a non-U.S. banking
organization where such branch or agency:
(i) Is located in the United States;
(ii) Maintains accounts independently of the home office and other
U.S. branches, with the profit or loss accrued at each branch
determined as a separate item for each U.S. branch; and
(iii) Engages in the business of banking and is subject to
substantive banking regulation in the state or district where located.
(22) U.S. GAAP means U.S. generally accepted accounting principles.
(23) U.S. person:
(i) Except as provided in paragraph (a)(23)(iii) of this section,
U.S. person means any person that is:
(A) A natural person resident in the United States;
(B) A partnership, corporation, trust, investment vehicle, or other
legal person organized, incorporated, or established under the laws of
the United States or having its principal place of business in the
United States;
(C) An account (whether discretionary or non-discretionary) of a
U.S. person; or
(D) An estate of a decedent who was a resident of the United States
at the time of death.
(ii) For purposes of this section, principal place of business
means the location from which the officers, partners, or managers of
the legal person primarily direct, control, and coordinate the
activities of the legal person. With respect to an externally managed
investment vehicle, this location is the office from which the manager
of the vehicle primarily directs, controls, and coordinates the
investment activities of the vehicle.
(iii) The term U.S. person does not include the International
Monetary Fund, the International Bank for Reconstruction and
Development, the Inter-American Development Bank, the Asian Development
Bank, the African Development Bank, the United Nations, and their
agencies and pension plans, and any other similar international
organizations, and their agencies and pension plans.
[[Page 56999]]
(iv) Notwithstanding paragraph (a)(23)(i) of this section, until
December 31, 2027, a person may continue to classify counterparties as
U.S. persons based on:
(A) Representations made pursuant to the ``U.S. person'' definition
in Sec. 23.160(a)(10) prior to the effective date of this section; or
(B) Representations made pursuant to the interpretation of the term
``U.S. person'' in the Interpretive Guidance and Policy Statement
Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (Jul.
26, 2013), prior to the effective date of this section.
(24) U.S. swap entity means a swap entity that is a U.S. person.
(b) Cross-border application of swap dealer de minimis registration
threshold calculation. For purposes of determining whether an entity
engages in more than a de minimis quantity of swap dealing activity
under paragraph (4)(i) of the swap dealer definition in Sec. 1.3 of
this chapter, a person shall include the following swaps (subject to
paragraph (d) of this section and paragraph (6) of the swap dealer
definition in Sec. 1.3 of this chapter):
(1) If such person is a U.S. person or a significant risk
subsidiary, all swaps connected with the dealing activity in which such
person engages.
(2) If such person is a non-U.S. person (other than a significant
risk subsidiary), all of the following swaps connected with the dealing
activity in which such person engages:
(i) Swaps with a counterparty that is a U.S. person, other than
swaps conducted through a foreign branch of a registered swap dealer.
(ii) Swaps where the obligations of such person under the swaps are
subject to a guarantee by a U.S. person.
(iii) Swaps with a counterparty that is a non-U.S. person where the
counterparty's obligations under the swaps are subject to a guarantee
by a U.S. person, except when:
(A) The counterparty is registered as a swap dealer; or
(B) The counterparty's swaps are subject to a guarantee by a U.S.
person that is a non-financial entity; or
(C) The counterparty is itself below the swap dealer de minimis
threshold under paragraph (4)(i) of the swap dealer definition in Sec.
1.3, and is affiliated with a registered swap dealer.
(c) Cross-border application of major swap participant tests. For
purposes of determining a person's status as a major swap participant,
as defined in Sec. 1.3 of this chapter, a person shall include the
following swap positions (subject to paragraph (d) of this section and
the major swap participant definition in Sec. 1.3 of this chapter):
(1) If such person is a U.S. person or a significant risk
subsidiary, all swap positions that are entered into by the person.
(2) If such person is a non-U.S. person (other than a significant
risk subsidiary), all of the following swap positions of such person:
(i) Swap positions where the counterparty is a U.S. person, other
than swaps conducted through a foreign branch of a registered swap
dealer.
(ii) Swap positions where the obligations of such person under the
swaps are subject to a guarantee by a U.S. person.
(iii) Swap positions with a counterparty that is a non-U.S. person
where the counterparty's obligations under the swaps are subject to a
guarantee by a U.S. person, except when the counterparty is registered
as a swap dealer.
(d) Exception from counting for certain exchange-traded and cleared
swaps. Notwithstanding any other provision of Sec. 23.23, for purposes
of determining whether a non-U.S. person (other than a significant risk
subsidiary or a non-U.S. person whose performance under the swap is
subject to a guarantee by a U.S. person) engages in more than a de
minimis quantity of swap dealing activity under paragraph (4)(i) of the
swap dealer definition in Sec. 1.3 of this chapter or for determining
the non-U.S. person's status as a major swap participant as defined in
Sec. 1.3 of this chapter, such non-U.S. person does not need to count
any swaps or swap positions, as applicable, that are entered into by
such non-U.S. person on a designated contract market, a registered swap
execution facility or a swap execution facility exempted from
registration by the Commission pursuant to section 5h(g) of the Act, or
a registered foreign board of trade, and cleared through a registered
derivatives clearing organization or a clearing organization that has
been exempted from registration by the Commission pursuant to section
5b(h) of the Act, where the non-U.S. person does not know the identity
of the counterparty to the swap prior to execution.
(e) Exceptions from certain swap requirements for certain foreign
swaps. (1) With respect to its foreign-based swaps, each non-U.S. swap
entity and foreign branch of a U.S. swap entity shall be excepted from:
(i) The group B requirements (other than Sec. 23.202(a)
introductory text and (a)(1)) and the group C requirements with respect
to any swap--
(A) Entered into on a designated contract market, a registered swap
execution facility or a swap execution facility exempted from
registration by the Commission pursuant to section 5h(g) of the Act, or
a registered foreign board of trade;
(B) Cleared through a registered derivatives clearing organization
or a clearing organization that has been exempted from registration by
the Commission pursuant to section 5b(h) of the Act; and
(C) Where the swap entity does not know the identity of the
counterparty to the swap prior to execution; and
(ii) The group C requirements with respect to any swap with a
foreign counterparty.
(2) A non-U.S. swap entity shall be excepted from the group C
requirements with respect to any swap booked in a U.S. branch with a
foreign counterparty that is neither a foreign branch nor a person
whose performance under the swap is subject to a guarantee by a U.S.
person.
(3) With respect to its foreign-based swaps, each non-U.S. swap
entity that is neither a significant risk subsidiary nor a person whose
performance under the swap is subject to a guarantee by a U.S. person
shall be excepted from the group B requirements with respect to any
swap with a foreign counterparty (other than a foreign branch) that is
neither--
(i) A significant risk subsidiary that is a swap entity nor
(ii) A person whose performance under the swap is subject to a
guarantee by a U.S. person.
(4) With respect to its foreign-based swaps, each foreign branch of
a U.S. swap entity shall be excepted from the group B requirements with
respect to any swap with a foreign counterparty (other than a foreign
branch) that is neither a swap entity nor a person whose performance
under the swap is subject to a guarantee by a U.S. person, subject to
the following conditions:
(i) A group B requirement is not eligible for the exception if the
requirement, as applicable to the swap, is eligible for substituted
compliance pursuant to a comparability determination issued by the
Commission prior to the execution of the swap; and
(ii) In any calendar quarter, the aggregate gross notional amount
of swaps conducted by a swap entity in reliance on this exception does
not exceed five percent (5%) of the aggregate gross notional amount of
all its swaps.
(5) With respect to its foreign-based swaps, each non-U.S. swap
entity that is a significant risk subsidiary (an ``SRS
[[Page 57000]]
SE'') or a person whose performance under the swap is subject to a
guarantee by a U.S. person (a ``Guaranteed SE'') shall be excepted from
the group B requirements with respect to any swap with a foreign
counterparty (other than a foreign branch) that is neither a swap
entity nor a person whose performance under the swap is subject to a
guarantee by a U.S. person, subject to the following conditions:
(i) A group B requirement is not eligible for the exception if the
requirement, as applicable to the swap, is eligible for substituted
compliance pursuant to a comparability determination issued by the
Commission prior to the execution of the swap; and
(ii) In any calendar quarter, the aggregate gross notional amount
of swaps conducted by an SRS SE or a Guaranteed SE in reliance on this
exception aggregated with the gross notional amount of swaps conducted
by all affiliated SRS SEs and Guaranteed SEs in reliance on this
exception does not exceed five percent (5%) of the aggregate gross
notional amount of all swaps entered into by the SRS SE or Guaranteed
SE and all affiliated swap entities.
(f) Substituted Compliance. (1) A non-U.S. swap entity may satisfy
any applicable group A requirement by complying with the applicable
standards of a foreign jurisdiction to the extent permitted by, and
subject to any conditions specified in, a comparability determination
issued by the Commission under paragraph (g) of this section;
(2) With respect to its foreign-based swaps, a non-U.S. swap entity
or foreign branch of a U.S. swap entity may satisfy any applicable
group B requirement for a swap with a foreign counterparty by complying
with the applicable standards of a foreign jurisdiction to the extent
permitted by, and subject to any conditions specified in, a
comparability determination issued by the Commission under paragraph
(g) of this section; and
(3) A non-U.S. swap entity may satisfy any applicable group B
requirement for any swap booked in a U.S. branch with a foreign
counterparty that is neither a foreign branch nor a person whose
performance under the swap is subject to a guarantee by a U.S. person
by complying with the applicable standards of a foreign jurisdiction to
the extent permitted by, and subject to any conditions specified in, a
comparability determination issued by the Commission under paragraph
(g) of this section.
(g) Comparability determinations. (1) The Commission may issue
comparability determinations under this section on its own initiative.
(2) Eligibility requirements. The following persons may, either
individually or collectively, request a comparability determination
with respect to some or all of the group A requirements and group B
requirements:
(i) A swap entity that is eligible, in whole or in part, for
substituted compliance under this section or a trade association or
other similar group on behalf of its members who are such swap
entities; or
(ii) A foreign regulatory authority that has direct supervisory
authority over one or more swap entities subject to the group A
requirements and/or group B requirements and that is responsible for
administering the relevant foreign jurisdiction's swap standards.
(3) Submission requirements. Persons requesting a comparability
determination pursuant to this section shall electronically provide the
Commission:
(i) A description of the objectives of the relevant foreign
jurisdiction's standards and the products and entities subject to such
standards;
(ii) A description of how the relevant foreign jurisdiction's
standards address, at minimum, the elements or goals of the
Commission's corresponding requirements or group of requirements. Such
description should identify the specific legal and regulatory
provisions that correspond to each element or goal and, if necessary,
whether the relevant foreign jurisdiction's standards do not address a
particular element or goal;
(iii) A description of the differences between the relevant foreign
jurisdiction's standards and the Commission's corresponding
requirements, and an explanation regarding how such differing
approaches achieve comparable outcomes;
(iv) A description of the ability of the relevant foreign
regulatory authority or authorities to supervise and enforce compliance
with the relevant foreign jurisdiction's standards. Such description
should discuss the powers of the foreign regulatory authority or
authorities to supervise, investigate, and discipline entities for
compliance with the standards and the ongoing efforts of the regulatory
authority or authorities to detect and deter violations of, and ensure
compliance with, the standards;
(v) Copies of the foreign jurisdiction's relevant standards
(including an English translation of any foreign language document);
and
(vi) Any other information and documentation that the Commission
deems appropriate.
(4) Standard of review. The Commission may issue a comparability
determination pursuant to this section to the extent that it determines
that some or all of the relevant foreign jurisdiction's standards are
comparable to the Commission's corresponding requirements or group of
requirements, or would result in comparable outcomes as the
Commission's corresponding requirements or group of requirements, after
taking into account such factors as the Commission determines are
appropriate, which may include:
(i) The scope and objectives of the relevant foreign jurisdiction's
standards;
(ii) Whether the relevant foreign jurisdiction's standards achieve
comparable outcomes to the Commission's corresponding requirements;
(iii) The ability of the relevant regulatory authority or
authorities to supervise and enforce compliance with the relevant
foreign jurisdiction's standards; and
(iv) Whether the relevant regulatory authority or authorities has
entered into a memorandum of understanding or other arrangement with
the Commission addressing information sharing, oversight, examination,
and supervision of swap entities relying on such comparability
determination.
(5) Reliance. Any swap entity that, in accordance with a
comparability determination issued under this section, complies with a
foreign jurisdiction's standards, would be deemed to be in compliance
with the Commission's corresponding requirements. Accordingly, if a
swap entity has failed to comply with the foreign jurisdiction's
standards or a comparability determination, the Commission may initiate
an action for a violation of the Commission's corresponding
requirements. All swap entities, regardless of whether they rely on a
comparability determination, remain subject to the Commission's
examination and enforcement authority.
(6) Discretion and Conditions. The Commission may issue or decline
to issue comparability determinations under this section in its sole
discretion. In issuing such a comparability determination, the
Commission may impose any terms and conditions it deems appropriate.
(7) Modifications. The Commission reserves the right to further
condition, modify, suspend, terminate, or otherwise restrict a
comparability determination issued under this section in the
Commission's discretion.
[[Page 57001]]
(8) Delegation of authority. The Commission hereby delegates to the
Director of the Division of Swap Dealer and Intermediary Oversight, or
such other employee or employees as the Director may designate from
time to time, the authority to request information and/or documentation
in connection with the Commission's issuance of a comparability
determination under this section.
(h) Records, scope of application, effective and compliance dates--
(1) Records. Swap dealers and major swap participants shall create a
record of their compliance with this section and shall retain records
in accordance with Sec. 23.203.
(2) Scope of Application. The requirements of this section shall
not apply to swaps executed prior to September 14, 2021.
(3) Effective date and compliance date. (i) This section shall be
effective on the date that is 60 days following its publication in the
Federal Register.
(ii) Provided that swap dealers and major swap participants comply
with the recordkeeping requirements in paragraph (h)(1) of this
section, the exceptions in paragraph (e) of this section are effective
upon the effective date of the rule.
(iii) Swap dealers and major swap participants must comply with the
requirements of this section no later than September 14, 2021.
Issued in Washington, DC, on July 24, 2020, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Cross-Border Application of the Registration Thresholds
and Certain Requirements Applicable to Swap Dealers and Major Swap
Participants--Commission Voting Summary, Chairman's Statement, and
Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz and
Stump voted in the affirmative. Commissioners Behnam and Berkovitz
voted in the negative.
Appendix 2--Supporting Statement of Chairman Heath P. Tarbert
President John Adams once warned: ``Great is the guilt of
unnecessary war.'' \1\ While he was obviously referring to military
conflicts, his admonition applies to conflicts among nations more
generally. Financial regulation has not been exempt from
international discord. And in recent years, the CFTC's own cross-
border guidance on swaps has caused concerns about a regulatory arms
race and the balkanization of global financial markets. Consider the
following entreaties by our overseas allies and regulatory
counterparts:
---------------------------------------------------------------------------
\1\ Letter from John Adams to Abigail Adams, 19 May 1794
[electronic edition]. Adams Family Papers: An Electronic Archive,
Massachusetts Historical Society, http://www.masshist.org/digitaladams/.
---------------------------------------------------------------------------
``At a time of highly fragile economic growth, we believe that
it is critical to avoid taking steps that risk withdrawal from
global financial markets into inevitably less efficient regional or
national markets.''
--Letter from the Finance Ministers of the United Kingdom, France,
Japan, and the European Commission to CFTC Chairman regarding the
CFTC's cross-border guidance (Oct. 17, 2012)
``We believe a failure to address [our] concerns could have
unintended consequences, including increasing market fragmentation
and, potentially, systemic risk in these markets, as well as unduly
increasing the compliance burden on industry and regulators.''
--Letter from the Australian Securities and Investments Commission,
the Hong Kong Monetary Authority, the Monetary Authority of
Singapore, the Reserve Bank of Australia, and the Securities and
Futures Commission of Hong Kong to CFTC Chairman regarding the
CFTC's cross-border guidance (Aug. 27, 2012)
``. . . [U]sing personnel or agents located in the U.S. would
not be a sufficient criterion supporting the duplication of
applicable sets of rules to transactions [between non-U.S. persons,]
and [we] ask you to consider not directly applying rules on this
basis.''
--Letter from Steven Maijoor, Chair, European Securities and Markets
Authority to Acting CFTC Chairman regarding the CFTC staff's ``ANE
Advisory,'' No. 13-69 (Mar. 13, 2014)
I will leave it to others to debate whether the international
discord caused by the CFTC's cross-border guidance \2\ and related
staff advisory \3\ was ``necessary'' at the time it was introduced.
Far more constructive is for us to ask whether it is necessary
today. For me, there is but one conclusion: Because nearly all G20
jurisdictions have adopted similar swaps regulations pursuant to the
Pittsburgh Accords,\4\ it is unnecessary for the CFTC to be the
world's policeman for all swaps.
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\2\ Interpretive Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations, 78 FR 45292 (July 26,
2013) (``2013 Guidance''), http://www.cftc.gov/idc/groups/public/@lrfederalregister/documents/file/2013-17958a.pdf.
\3\ CFTC Staff Advisory No. 13-69 (Nov. 14, 2013), https://www.cftc.gov/node/212831.
\4\ Financial Stability Board, Annual Report on Implementation
and Effects of the G20 Financial Regulatory Reforms 3 (Oct. 16,
2019) (showing that a very large majority of FSB jurisdictions have
implemented the G20 priority reforms for over-the-counter
derivatives).
---------------------------------------------------------------------------
On this basis, I am pleased to support the Commission's final
rule on the cross-border application of registration thresholds and
certain requirements for swap dealers and major swap participants
(``swap entities''). This final rule provides critically needed
regulatory certainty to the global swaps markets. And I believe it
properly balances protection of our national interests with
appropriate deference to international counterparts.
Need for Rule-Based Finality
As noted above, the Commission's 2013 Guidance left much to be
desired by both our market participants and our regulatory
colleagues overseas. The action was taken outside the standard
rulemaking process under the Administrative Procedure Act,\5\ so was
merely ``guidance'' that is not technically enforceable. But because
market participants as a practical matter followed it nonetheless,
it had a sweeping impact on the global swaps markets. Over the
intervening years, a patchwork of staff advisories and no-action
letters has supplemented the 2013 Guidance. With almost seven years
of experience, it is high time for the Commission to bring finality
to the issues the 2013 Guidance and its progeny sought to address.
---------------------------------------------------------------------------
\5\ 5 U.S.C. 551 et seq.
---------------------------------------------------------------------------
Congressional Mandate
We call this final rule a ``cross-border'' rule, and in certain
respects it is. For example, the rule addresses when non-U.S.
persons must count dealing swaps with U.S. persons, including
foreign branches of American banks, toward the de minimis threshold
in our swap dealer definition. More fundamentally, however, the rule
answers a basic question: What swap dealing activity outside the
United States should trigger CFTC registration and other
requirements?
To answer this question, we must turn to section 2(i) of the
Commodity Exchange Act (``CEA''),\6\ a provision Congress added in
Title VII of the Dodd-Frank Act. Section 2(i) provides that the CEA
does not apply to swaps activities outside the United States except
in two circumstances: (1) Where activities have a ``direct and
significant connection with activities in, or effect on, commerce of
the United States'' or (2) where they run afoul of the Commission's
rules or regulations that prevent evasion of Title VII. Section 2(i)
evidences Congress's clear intent for the U.S. swaps regulatory
regime to stop at the water's edge, except where foreign activities
either are closely and meaningfully related to U.S. markets or are
vehicles to evade our laws and regulations.
---------------------------------------------------------------------------
\6\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
I believe the final rule we issue today is a levelheaded
approach to the exterritorial application of our swap dealer
registration regime and related requirements, and it fully
implements the congressional mandate in section 2(i). At the same
time, it acknowledges the important role played by the CFTC's
domestic and international counterparts in regulating parts of the
global swaps markets. In short, the final rule employs neither a
full-throated ``intergalactic commerce clause'' \7\ nor an
isolationist
[[Page 57002]]
mentality. It is thoughtful and balanced, and it will avoid future
unnecessary conflicts among regulators.
---------------------------------------------------------------------------
\7\ Commissioner Jill E. Sommers, Statement of Concurrence: (1)
Cross-Border Application of Certain Swaps Provisions of the
Commodity Exchange Act, Proposed Interpretive Guidance and Policy
Statement; (2) Notice of Proposed Exemptive Order and Request for
Comment Regarding Compliance with Certain Swap Regulations (June 29,
2012), https://www.cftc.gov/PressRoom/SpeechesTestimony/sommersstatement062912 (noting that ``staff had been guided by what
could only be called the `Intergalactic Commerce Clause' of the
United States Constitution, in that every single swap a U.S. person
enters into, no matter what the swap or where it was transacted, was
stated to have a direct and significant connection with activities
in, or effect on, commerce of the United States'').
---------------------------------------------------------------------------
Guiding Principles for Regulating Foreign Activities
As I have stated before,\8\ I am guided by three additional
principles in considering the extent to which the CFTC should make
use of our extraterritorial powers.
---------------------------------------------------------------------------
\8\ Statement of Chairman Heath P. Tarbert in Support of the
Cross-Border Swaps Proposal (Dec. 18, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement121819.
---------------------------------------------------------------------------
1. Protect the National Interest
An important role of the CFTC is to protect and advance the
interests of the United States. In this regard, Congress provided
the CFTC with explicit extraterritorial power to safeguard the U.S.
financial system where swaps activities are concerned.
It is incumbent upon us to guard against risks created outside
the United States flowing back into our country. But our focus
cannot be on all risks. Congress made that clear in section 2(i). It
would be a markedly poor use of American taxpayers' dollars to
regulate swaps activities in far-flung lands simply to prevent every
risk that might have a nexus to the United States. It would also
divert the CFTC from channeling our resources where they matter the
most: To our own markets and participants. The rule therefore
focuses on instances where material risks from abroad are most
likely to come back to the United States and where no one but the
CFTC is responsible for those risks.
Hence, guarantees of offshore swaps by U.S. parent companies are
counted toward our registration requirements because that risk is
effectively underwritten and borne in the United States. The same is
true with the concept of a ``significant risk subsidiary''
(``SRS''). As explained in the rule, an SRS is a large non-U.S.
subsidiary of a large U.S. company that deals in swaps outside the
United States but (1) is not subject to comparable capital and
margin requirements in its home country, and (2) is not a subsidiary
of a holding company subject to consolidated supervision by an
American regulator, namely the Federal Reserve Board. Our final
cross-border rule requires an SRS to register as a swap dealer or
major swap participant with the CFTC if the SRS exceeds the same
registration thresholds as a U.S. firm operating within the United
States. The national interest demands it.\9\
---------------------------------------------------------------------------
\9\ The SRS concept is designed to address a potential situation
where a U.S. entity establishes an offshore subsidiary to conduct
its swap dealing business without an explicit guarantee on the swaps
in order to avoid U.S. regulation. For example, the U.S.-regulated
insurance company American International Group (``AIG'') nearly
failed as a result of risk incurred by the London swap trading
operations of its subsidiary AIG Financial Products. See, e.g.,
Congressional Oversight Panel, June Oversight Report, The AIG
Rescue, Its Impact on Markets, and the Government's Exit Strategy
(June 10, 2010), http://www.gpo.gov/fdsys/pkg/CPRT-111JPRT56698/pdf/CPRT-111JPRT56698.pdf. If the Commission did not regulate SRSs, an
AIG-type entity could establish a non-U.S. affiliate to conduct its
swaps dealing business, and, so long as it did not explicitly
guarantee the swaps, it would avoid application of the Dodd-Frank
Act and bring risk created offshore back into the United States
without appropriate regulatory safeguards.
---------------------------------------------------------------------------
2. Follow Kant's Categorical Imperative
As I said when we proposed this rule, I believe cross-border
rulemaking should follow Kant's ``categorical imperative'': We
should act according to the maxim that we wish all other rational
people to follow, as if it were a universal law.\10\
---------------------------------------------------------------------------
\10\ ``Act only according to that maxim whereby you can, at the
same time, will that it should become a universal law.'' Immanuel
Kant, Grounding for the Metaphysics of Morals (1785) [1993],
translated by James W. Ellington (3rd ed.).
---------------------------------------------------------------------------
What I take from that is that we should ourselves establish a
regulatory regime that we believe should be the global convention.
How would this work? Let me start by explaining how it would not
work. If we impose our regulations on non-U.S. persons whenever they
have a remote nexus to the United States, then we should be willing
for all other jurisdictions to do the same. The end result would be
absurdity, with everyone trying to regulate everyone else. And the
duplicative and overlapping regulations would inevitably lead to
fragmentation in the global swaps markets--itself a potential source
of systemic risk.\11\ Instead, we should adopt a framework that
applies CFTC regulations outside the United States only when it
addresses one or more important risks to our markets.
---------------------------------------------------------------------------
\11\ See Financial Stability Board, Annual Report on
Implementation and Effects of the G20 Financial Regulatory Reforms 3
(Oct. 16, 2019).
---------------------------------------------------------------------------
Furthermore, we should afford comity to other regulators who
have adopted comparable regulations, just as we expect them to do
for us. This is especially important when we evaluate whether
foreign subsidiaries of U.S. parent companies could pose a
significant risk to our financial system. The categorical imperative
leads us to an unavoidable result: We should not impose our
regulations on the non-U.S. activities of non-U.S. companies in
those jurisdictions that have comparable capital and margin
requirements to our own.\12\ By the same token, when U.S.
subsidiaries of foreign companies operate within our borders, we
expect them to follow our laws and regulations and not simply comply
with rules from their home country.
---------------------------------------------------------------------------
\12\ See, e.g., Comments of the European Commission in respect
of CFTC Staff Advisory No. 13-69 regarding the applicability of
certain CFTC regulations to the activity in the United States of
swap dealers and major swap participants established in
jurisdictions other than the United States (Mar. 10, 2014), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59781&SearchText= (``In order to ensure that
cross-border activity is not inhibited by the application of
inconsistent, conflicting or duplicative rules, regulators must work
together to provide for the application of one set of comparable
rules, where our rules achieve the same outcomes. Rules should
therefore include the possibility to defer to those of the host
regulator in most cases.''); FSB Fragmentation Report, supra note
11, at 8 (noting that the G20 ``has agreed that jurisdictions and
regulators should be able to defer to each other when it is
justified by the quality of their respective regulatory and
enforcement regimes, based on similar outcomes in a non-
discriminatory way, paying due respect to home country regulation
regimes'').
---------------------------------------------------------------------------
Charity, it is often said, begins at home. The categorical
imperative further compels us to avoid duplicating the work of other
American regulators. If a foreign subsidiary of a U.S. financial
institution is subject to consolidated regulation and supervision by
the Federal Reserve Board, then we should defer to our domestic
counterparts on questions of dealing activity outside the United
States. The Federal Reserve Board has extensive regulatory and
supervisory tools to ensure a holding company is prudent in its
risk-taking at home and abroad.\13\ The CFTC instead should focus on
regulating dealing activity within the United States or with U.S.
persons.
---------------------------------------------------------------------------
\13\ For example, the Federal Reserve Board requires all foreign
branches and subsidiaries ``to ensure that their operations conform
to high standards of banking and financial prudence.'' 12 CFR
211.13(a)(1). Furthermore, they are subject to examinations on
compliance. See Bank Holding Company Supervision Manual, Section
3550.0.9 (``The procedures involved in examining foreign
subsidiaries of domestic bank holding companies are generally the
same as those used in examining domestic subsidiaries engaged in
similar activities.'').
---------------------------------------------------------------------------
3. Pursue SEC Harmonization Where Appropriate
As I said in connection with our proposal of this rule, I find
it surreal that the SEC and the CFTC, two federal agencies that
regulate similar products pursuant to the same title of the same
statute--with an explicit mandate to ``consult and coordinate'' with
each other--have not agreed until today on how to define ``U.S.
person.'' This failure to coordinate has unnecessarily increased
operational and compliance costs for market participants.\14\ I am
pleased that this final rule uses the same definition of ``U.S.
person'' as the SEC's cross-border rulemaking.
---------------------------------------------------------------------------
\14\ See, e.g., Futures Industry Association Letter re:
Harmonization of SEC and CFTC Regulatory Frameworks (Nov. 29, 2018),
https://fia.org/articles/fia-offers-recommendations-cftc-and-sec-harmonization.
---------------------------------------------------------------------------
To be sure, as my colleagues have said on several occasions, we
should not harmonize with the SEC merely for the sake of
harmonization.\15\ We should do so only if it
[[Page 57003]]
is sensible. In the first instance, we must determine whether
Congress has explicitly asked us to do something different or
implicitly did so by giving us a different statutory mandate. We
must also consider whether differences in our respective products or
markets warrant a divergent approach. Just as today's final rule
takes steps toward harmonization, it also diverges where
appropriate.
---------------------------------------------------------------------------
\15\ See, e.g., Dissenting Statement of Commissioner Dan M.
Berkovitz, Rulemaking to Provide Exemptive Relief for Family Office
CPOs: Customer Protection Should be More Important than Relief for
Billionaires (Nov. 25, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement112519 (``The Commission
eliminates the notice requirement largely on the basis that this
will harmonize the Commission's regulations with those of the SEC.
Harmonization for harmonization's sake is not a rational basis for
agency action.'').
---------------------------------------------------------------------------
The approach we have taken with respect to ``ANE Transactions''
is deliberately different than the SEC's.\16\ ANE Transactions are
swap (or security-based swap) transactions between two non-U.S.
persons that are ``arranged, negotiated, or executed'' by their
personnel or agents located in the United States, but booked to
entities outside America. While some or all of the front-end sales
activity takes place in the United States, the financial risk of the
transactions resides overseas.
---------------------------------------------------------------------------
\16\ See Securities and Exchange Commission, Final Rules and
Guidance on Cross-Border Application of Certain Security-Based Swap
Requirements, 85 FR 6270, 6272 (Feb. 4, 2020) (stating that ``the
[SEC] continues to believe the `arranged, negotiated, or executed'
criteria form an appropriate basis for applying Title VII
requirements in the cross-border context'').
---------------------------------------------------------------------------
Here, key differences in the markets for swaps and security-
based swaps are dispositive. The swaps market is far more global
than the security-based swaps market. While commodities such as gold
and oil are traded throughout the world, equity and debt securities
trade predominantly in the jurisdictions where they were issued. For
this reason, security-based swaps are inextricably tied to the
underlying security, and vice versa. This is particularly the case
with single-name credit default swaps, where the arranging,
negotiating, or execution is typically done in the United States
because the underlying reference entity is a U.S. company. More
generally, security-based swaps can affect the price and liquidity
of the underlying security, so the SEC has a legitimate interest in
regulating transactions in those instruments. By contrast, because
commodities are traded globally, there is less need for the CFTC to
apply its swaps rules to ANE Transactions.\17\
---------------------------------------------------------------------------
\17\ Under the final rule, persons engaging in any aspect of
swap transactions within the United States remain subject to the CEA
provisions and Commission regulations prohibiting the employment, or
attempted employment, of manipulative, fraudulent, or deceptive
devices, such as section 6(c)(1) of the CEA (7 U.S.C. 9(1)) and
Commission regulation 180.1 (17 CFR 180.1). The Commission thus
would retain anti-fraud and anti-manipulation authority, and would
continue to monitor the trading practices of non-U.S. persons that
occur within the territory of the United States in order to enforce
a high standard of customer protection and market integrity. Even
where a swap is entered into by two non-U.S. persons, we have a
significant interest in deterring fraudulent or manipulative conduct
occurring within our borders, and we cannot let our country be a
haven for such activity.
---------------------------------------------------------------------------
Moreover, as noted above, Congress directed the CFTC to regulate
foreign swaps activities outside the United States that have a
``direct and significant'' connection to our financial system.
Congress did not give a similar mandate to the SEC. As a result, the
SEC has not crafted its cross-border rule to extend to an SRS
engaged in security-based swap dealing activity offshore that may
pose a systemic risk to our financial system. Our rule does with
respect to swaps, aiming to protect American taxpayers from another
Enron conducting its swaps activities through a major foreign
subsidiary without CFTC oversight.
The final rule addresses Transaction-Level Requirements
applicable to swap entities (specifically, the Group B and Group C
requirements), but does not cover other Transaction-Level
Requirements, such as the reporting, clearing, and trade execution
requirements. The Commission intends to address these remaining
Transaction-Level Requirements (the ``Unaddressed TLRs'') in
connection with future cross-border rulemakings. Until such time,
the Commission will not consider, as a matter of policy, a non-U.S.
swap entity's use of their personnel or agents located in the United
States to ``arrange, negotiate, or execute'' swap transactions with
non-U.S. counterparties for purposes of determining whether
Unaddressed TLRs apply to such transactions.
In connection with the final rule, DSIO has withdrawn Staff
Advisory No. 13-69,\18\ and, together with the Division of Clearing
and Risk and the Division of Market Oversight, granted certain non-
U.S. swap dealers no-action relief with respect to the applicability
of the Unaddressed TLRs to their transactions with non-U.S.
counterparties that are arranged, negotiated, or executed in the
United States. In Staff Advisory 13-69, the CFTC's staff applied
Transaction-Level Requirements to ANE Transactions, without the
Commission engaging in notice and comment rulemaking to determine
whether such an application is appropriate. Going forward, I fully
expect that the Commission will first conduct fact-finding to
determine the extent to which ANE Transactions raise policy concerns
that are not otherwise addressed by the CEA or our regulations.
---------------------------------------------------------------------------
\18\ CFTC Staff Advisory No. 13-69 (Nov. 14, 2013), https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
---------------------------------------------------------------------------
Refinements to the Proposed Rule
In response to public comment, and consistent with the guiding
principles described above, the final rule includes a number of
refinements from the proposal issued last December. I will leave it
to our extremely knowledgeable staff to outline all the changes in
detail, but I will highlight some of the key refinements here. These
principally concern the treatment of SRSs and U.S. branches of
foreign swap entities.
1. Significant Risk Subsidiaries
As noted, the SRS concept is not intended to reach subsidiaries
of holding companies that are subject to consolidated supervision by
the Federal Reserve Board. The final rule recognizes that
intermediate holding companies of foreign banking organizations
under the Federal Reserve Board's Regulation YY are subject to such
consolidated supervision, and to enhanced capital, liquidity, risk-
management, and stress-testing requirements. Accordingly, foreign
subsidiaries of intermediate holding companies are excluded from the
SRS definition under the final rule.
In addition, the final rule recognizes that certain SRSs may act
as ``customers'' or ``end users'' in the global swaps markets,
engaging in only a de minimis level of swap dealing or no dealing
activity at all. Consistent with the principle of focusing on risk
to the United States, the ``Group B'' category of risk-mitigating
regulatory requirements will not apply to swaps between a non-U.S.
swap entity and an SRS that is simply an end user.\19\ This approach
will help preserve end users' access to liquidity in foreign
markets.
---------------------------------------------------------------------------
\19\ This exception applies only to ``Other Non-U.S. Person''
swap entities, i.e., non-U.S. swap entities that are neither an SRS
nor an entity subject to a U.S. person guarantee (``guaranteed
entity''). A non-U.S. swap entity that is an SRS or guaranteed
entity would need to rely on the limited Group B exception discussed
below.
---------------------------------------------------------------------------
For similar reasons, the final rule also provides a limited
exception from the Group B requirements for a swap entity that is an
SRS or a guaranteed entity--to the extent that swap entity's
counterparty is an SRS end user or an Other Non-U.S. Person that is
not a swap entity. In addition, the final rule clarifies that a non-
U.S. person that is not itself an SRS or a guaranteed entity need
not count swaps with an SRS toward its swap dealer de minimis
threshold, unless that SRS is a guaranteed entity.
I believe these adjustments to the proposed SRS regime will
further serve to channel our regulatory resources, while offering
appropriate deference to our domestic and foreign regulatory
counterparts.
2. U.S. Branches
The final rule also includes two key changes to the treatment of
U.S. branches of foreign swap entities. First, it expands the
availability of substituted compliance for the Group B requirements
to include swaps between such a U.S. branch, on the one hand, and an
SRS or Other Non-U.S. Person, on the other.\20\ And second, it
creates a new exception from the ``Group C'' external business
conduct standards for swaps between U.S. branches and foreign
counterparties (other than guaranteed entities and foreign branches
of U.S. swap entities). These changes recognize that U.S. branches,
though located on U.S. soil, are part of a non-U.S. legal entity.
Accordingly, while such branches should be subject to certain risk-
mitigating regulations, they should not be subject to the full
panoply of requirements applicable to true U.S. persons.
---------------------------------------------------------------------------
\20\ This expansion of substituted compliance does not apply to
swaps between two U.S. branches of non-U.S. swap entities.
---------------------------------------------------------------------------
Conclusion
In sum, the final rule before us today provides a critical
measure of regulatory certainty for the global swaps markets. I
believe the rule is also a sensible and principled approach to
addressing when foreign transactions should fall within the CFTC's
swap entity registration and related requirements.
I have noted before President Eisenhower's observation that
``The world must learn to
[[Page 57004]]
work together, or finally it will not work at all.'' I sincerely
hope our domestic and international counterparts will view today's
action as a positive step toward further cooperation to provide
sound regulation to the global swaps markets.
Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I am very pleased to support today's final rule interpreting
Congress' statutory directive that the Commission may only regulate
those foreign activities that ``have a direct and significant
connection with activities in, or effect on commerce, of the United
States.'' \1\ As I noted when I supported the proposal last
December, Congress deliberately placed a clear and strong limitation
on the CFTC's extraterritorial reach, recognizing the need for
international comity and deference in a global swaps market.\2\
Today's rule provides important safeguards to the US financial
markets in delineating which cross-border swap activity must be
counted towards potential registration with the Commission, and
which transactions should be subject to the CFTC's business conduct
requirements for swap dealers (SDs) and major swap participants
(MSPs). At the same time, the final rule appropriately defers to
foreign regulatory regimes to avoid duplicative regulation and
disadvantaging U.S. institutions acting in foreign markets.
---------------------------------------------------------------------------
\1\ Sec. 2(i) of the Commodity Exchange Act.
\2\ Supporting Statement of Commissioner Brian Quintenz
Regarding Proposed Rule: Cross-Border Application of the
Registration Thresholds and Certain Requirements Applicable to SDs
and MSPs, https://www.cftc.gov/PressRoom/SpeechesTestimony/quintenzstatement121819b.
---------------------------------------------------------------------------
Today's rule achieves the goals for cross-border regulation that
I articulated in a speech before the ISDA Annual Japan Conference in
October of last year.\3\ I stated that each jurisdiction's
recognition of, and deference to, the sovereignty of other
jurisdictions is crucial in avoiding market fragmentation that poses
serious risks to the liquidity and health of the derivatives
markets. This rule properly grants deference to other jurisdictions
by limiting the extent to which non-US counterparties must comply
with significant aspects of the CFTC's regulatory framework for SDs
and MSPs and by providing market participants with the opportunity
to comply with local laws that the Commission has deemed comparable
to the CFTC's regulations (``substituted compliance'').
---------------------------------------------------------------------------
\3\ Remarks of CFTC Commissioner Brian Quintenz at 2019 ISDA
Annual Japan Conference, ``Significant's Significance,'' https://www.cftc.gov/PressRoom/SpeechesTestimony/opaquintenz20.
---------------------------------------------------------------------------
Substituted Compliance
As I noted with respect to the proposal, substituted compliance
is the lynchpin of a global swaps market, and the absence of
regulatory deference has been the fracturing sound we hear when the
global swaps market fragments. The final rule provides a framework
for substituted compliance with respect to two sets of regulations,
``group A'' entity-level requirements, such as conflicts of interest
policies and a risk management program, and ``group B'' transaction-
level requirements, such as daily trading records, confirmation, and
portfolio reconciliation. While the Commission has issued
substituted compliance determinations for entity-level requirements
in six jurisdictions and for transaction-level requirements in two
jurisdictions, they all contain exceptions for particular provisions
of the Commission's regulations, and one of the transaction-level
determinations partially addresses only two of the five regulations
in group B.\4\
---------------------------------------------------------------------------
\4\ The determinations are available at, https://www.cftc.gov/LawRegulation/DoddFrankAct/CDSCP/index.htm. The transaction-level
determination partially addressing only two of the group B
regulations is for Japan, 78 FR 78890 (Dec. 27, 2013).
---------------------------------------------------------------------------
Today's rule provides for a flexible, outcomes-based framework
for future comparability determinations that will assess the goals
of the Commission's regulations against the standards of its foreign
counterparts' regimes, instead of directing the Commission to focus
on a rigid line-by-line or even regulation-by-regulation
comparison.\5\ More specifically, and a primary reason for my
support of this final rule, under this new framework, the Commission
can compare the goals of its regulations to the outcomes of foreign
regulations on an entire group-wide basis, so that the standards of
a foreign regime will be considered holistically compared to the
goals of all the Commission's either group A or group B
requirements.
---------------------------------------------------------------------------
\5\ Regulation 23.23(g).
---------------------------------------------------------------------------
Additionally, this final rule allows the Commission to
proactively assess and issue comparability determinations without
waiting for a request from a jurisdiction. I recognize that several
G-20 jurisdictions have made significant progress in the area of
issuing transaction-level requirements, as evidenced by a recent
report by the Financial Stability Board (FSB).\6\ I hope that the
Commission will soon issue additional substituted compliance
determinations in order that foreign firms registered as SDs with
the Commission, as well as foreign branches of US SDs, can gain the
efficiencies of complying with local laws for many of their
transactions with non-US persons.\7\ Ideally, future determinations
will provide for comprehensive, holistic substituted compliance in a
particular jurisdiction for all transaction-level requirements in
the CFTC's group B.
---------------------------------------------------------------------------
\6\ FSB, OTC Derivatives Market Reforms: 2019 Progress Report on
Implementation (Oct. 15, 2019), Table M, https://www.fsb.org/wp-content/uploads/P151019.pdf.
\7\ The availability of substituted compliance, depending on the
status of the counterparty, is provided for in regulation
23.23(f)(1) with respect to group A regulations and in 23.23(f)(2)
through (3) with respect to group B regulations.
---------------------------------------------------------------------------
ANE
Today's rule properly eliminates the possibility that a non-US
SD be required to follow many of the CFTC's transaction-level
requirements for a swap opposite a non-US counterparty if US-based
personnel of that SD ``arrange, negotiate, or execute'' (ANE) the
swap. This action brings to a close almost seven years of
uncertainty, beginning with the misguided DSIO Advisory of November
2013.\8\ I note that the staff's no-action letter issued this week
suspends enforcement of ANE with respect to transaction-level
requirements not covered by today's rule, specifically in the areas
of real-time reporting of swaps to data repositories and the
clearing and trade execution requirements, pending future Commission
rulemakings that address these rules in a cross-border context. I
expect the Commission will issue such rules in the near future in
order to provide the marketplace with legal certainty in these areas
and formally dispense with the ANE construct, just as it has with
respect to the requirements addressed today. I believe strongly that
ANE has no place with respect to real-time reporting, the clearing
requirement, or the trade execution requirement, just like it has no
place with respect to the business conduct regulations.
---------------------------------------------------------------------------
\8\ CFTC Staff Advisory 13-69 (Nov. 14, 2013).
---------------------------------------------------------------------------
US Guarantees and SRS
Another important element of today's rule is that it only
requires two, clearly defined classes of non-US entities to count
all of their swaps towards the Commission's SD and MSP registration
thresholds, and to generally comply with the Commission's SD and MSP
rules if registered. The first is an entity whose obligations to a
swap are guaranteed by a US person, under a standard consistent with
the Commission's cross-border rule for uncleared swap margin
requirements.\9\ The second is an entity deemed a ``significant risk
subsidiary'' (SRS) of a US firm. It is very important that
subsidiaries of US bank holding companies, including intermediate
subsidiaries, are carved out from the SRS definition. Those firms
are subject to supervision by the Federal Reserve Board, and,
therefore, it does not make sense for the CFTC to deploy its
precious resources to regulating those entities.
---------------------------------------------------------------------------
\9\ Regulation 23.160.
---------------------------------------------------------------------------
Helping US SDs' Foreign Branches Compete
Today's rule properly makes substituted compliance available for
group B requirements to a foreign branch of a US SD similarly to how
substituted compliance is available for many non-US SDs registered
with the Commission. I expect that this will help these branches
compete with local institutions in that they will be subject to the
same rules. For example, the Commission has already granted
substituted compliance to EU regulations with respect to certain
group B regulations.\10\ As a result, both the EU branch of a US
firm registered with the Commission as an SD and an EU firm
registered as an SD could comply with many of the same EU rules for
swaps with a US person or with a non-US person that is either US-
guaranteed or an SRS registered as an SD or MSP (``swap entity
SRS''). Moreover, under the ``limited foreign branch group B
exception,'' the foreign branch of a US firm would be excused from
complying with any group B rules, subject to a 5% notional cap, for
a swap with a non-US person that is neither US guaranteed nor a swap
entity SRS. However, if substituted compliance has been provided in
a jurisdiction, then instead of
[[Page 57005]]
being excused from the group B rules for those swaps, the foreign
branch would have to comply with the local rules. Due to the fact
that neither of the transaction-level determinations granted
comparability for all of the group B requirements, with respect to
those requirements not subject to a substituted compliance
determination, the foreign branch may either comply with CFTC
regulations or count the notional value of the swap towards its 5%
limited group B exception. Clearly, the rules favor the possibility
of substituted compliance, pursuant to which a foreign branch of a
US firm would have no limitation in following local rules. I believe
that group-wide comparability determinations, without any
exceptions, would simplify this situation and make more consistent
the treatment of US dealer's foreign branches and their local
competitors.
---------------------------------------------------------------------------
\10\ 78 FR 78878 (Dec. 27, 2013).
---------------------------------------------------------------------------
In conclusion, I am very pleased to have been a part of the
Commission that accomplished this major milestone in a long road of
issuing final regulations in the area of cross-border swaps
oversight. I would like to thank the staff of the Division of Swap
Dealer and Intermediary Oversight for all of their work in
completing this final rule and to Chairman Tarbert for his
leadership on this important issue.
Appendix 4--Dissenting Statement of Commissioner Rostin Behnam
Introduction and Overview
Today, by approving a final rule addressing the cross-border
application of the registration thresholds and certain requirements
applicable to swap dealers (``SDs'') and major swap participants
(``MSPs'') (the ``Final Rule''), the Commodity Futures Trading
Commission (``CFTC'' or ``Commission'') overlooks Dodd-Frank Act \1\
purposes, Congressional mandates thereunder, an opinion of the DC
District Court,\2\ and multiple comments raising significant
concerns. The Commission instead relies on broad deference that
opens a gaping hole \3\ in the federal regulatory structure. I
cannot support a decision to jettison a cross-border regime that has
not proven unreasonable, inflexible, or ineffective in favor of an
approach that fails to address the most critical concerns that the
Dodd-Frank Act directed the CFTC to address in favor of ``more
workable'' \4\ solutions. As the Final Rule opts to address the
conflicts of economic interest between the regulated and those who
are advantaged by it \5\ by usurping Congressional (and
congressionally delegated) authority to rethink section 2(i) of the
Commodity Exchange Act (``CEA'' or ``Act'') via prescriptive rules,
I must respectfully dissent.
---------------------------------------------------------------------------
\1\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank Act'').
\2\ SIFMA v. CFTC, 67 F.Supp.3d 373 (D.D.C. 2014).
\3\ See generally Gonzales v. Raich, 545 U.S. 1 (2005) (relied
on by the Commission in the Final Rule at 1.D.2.(i) and in the
Interpretive Guidance and Policy Statement Regarding Compliance with
Certain Swaps Regulations, 78 FR 45292, 45300 (Jul. 26, 2013)
(``Guidance'') to support its interpretation of the Commission's
cross-border authority over swap activities that as a class, or in
the aggregate, have a direct and significant connection with
activities in, or effect on, U.S. commerce--whether or not an
individual swap may satisfy the statutory standard.).
\4\ See, e.g., Final Rule at II.C.3.
\5\ See Wickard v. Filburn, 317 U.S. 111, 129 (1942).
---------------------------------------------------------------------------
Almost ten years ago to the day, Congress passed the Dodd-Frank
Wall Street Reform and Consumer Protection Act as a legislative
response to the 2008 financial crisis. Driven by a series of
systemic failures, the crisis laid bare that the essentially
unregulated and unmonitored over-the-counter derivatives or
``swaps'' markets were not the bastions of efficiency, stability,
and resiliency they were thought to be.\6\ Title VII of the Dodd-
Frank Act gave the Commission new and broad authority to regulate
the swaps market to address and mitigate risks arising from swap
activities.\7\
---------------------------------------------------------------------------
\6\ See SIFMA, 67 F.Supp.3d at 385-86 (citing Inv. Co. Inst. v.
CFTC, 891 F.Supp.2d 162, 171, 173 (D.D.C. 2012), aff'd, 720 F.3d 370
(D.C. Cir. 2013)).
\7\ See Guidance, 78 FR at 45299.
---------------------------------------------------------------------------
Although much of the over-the-counter derivatives market's
contributions to the 2008 financial crisis completed their journey
within the continental U.S., the risk originated in foreign
jurisdictions.\8\ Accordingly, Congress provided in CEA section 2(i)
that the provisions of Title VII, as well as any rules or
regulations issued by the CFTC, apply to cross-border activities
when certain conditions are met.\9\
---------------------------------------------------------------------------
\8\ See Guidance, 78 FR at 45293-45295; see also SIFMA, 67
F.Supp.3d at 387-88 (describing the ``several poster children for
the 2008 financial crisis'' that demonstrate the impact that
overseas over-the-counter derivatives swaps trading can have on a
U.S. parent corporation).
\9\ 7 U.S.C. 2(i).
---------------------------------------------------------------------------
The D.C. District Court recognized that ``Section 2(i) operates
independently, without the need for implementing regulations, and
that the CFTC is well within its discretion to proceed by case-by-
case adjudications, rather than rulemaking, when applying Section
2(i)'s jurisdictional nexus.'' \10\ The D.C. District Court also
found that, because the Commission was ``not required to issue any
rules (let alone binding rules) regarding its intended enforcement
policies pursuant to Section 2(i),'' the CFTC's decision to issue
the Guidance as a non-binding policy statement benefits market
participants.\11\ To the extent the CFTC interpreted the meaning of
CEA section 2(i) in its 2013 cross-border Guidance, an
interpretation carried forward in the Final Rule today (and in its
proposal), such interpretation is permissibly drawn linguistically
from the statute and, regardless, cannot substantively change the
legislative reach of section 2(i) or the Title VII regime.\12\ In
this regard, the interpretation reinforces the direct meaning of CEA
section (2)(i)'s grant of authority--without implementing
regulations--to enforce the Title VII rules extraterritorially
whenever activities ``have a direct and significant connection with
activities in, or effect on, commerce of the United States.'' \13\
Putting aside the anti-evasion prong in CEA section 2(i)(2), it
remains that CEA section 2(i) applies the swaps provisions of the
CEA to certain activities, viewed in the class or aggregate, outside
the United States, that meet either of two jurisdictional nexuses:
(1) A direct and significant effect on U.S. commerce; or (2) a
direct and significant connection with activities in U.S. commerce,
and through such connection, present the type of risks to the U.S.
financial system and markets that Title VII directed the Commission
to address.\14\
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\10\ SIFMA, 67 F.Supp.3d at 423-25, 427; (``Although many
provisions in the Dodd-Frank Act explicitly require implementing
regulations, Section 2(i) does not.'').
\11\ Id. at 423 (citation omitted).
\12\ Id. at 424.
\13\ Id. at 426.
\14\ See Proposal at C.1.; Guidance, 78 FR at 45292, 45300; see
also SIFMA, 67 F.Supp.3d at 424-25, 428 n. 31 (finding that Congress
addressed issue of determining which entities and activities are
covered by Title VII regulations, ``For Congress already addressed
this `important' issue by defining the scope of the Title VII Rules'
extraterritorial applications in the statute itself.'').
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The Dodd-Frank Act's derivatives reforms contemplate that an
individual entity's systemic riskiness is a product of the
interrelations among its various activities and risk-management
practices. As a result, the post-crisis reforms target the activity
of derivatives trading as a means to reach those entities that
conduct the trading.\15\ As the Commission has acknowledged,
``Neither the statutory definition of `swap dealer' nor the
Commission's further definition of that term turns solely on risk to
the U.S. financial system.'' \16\ And to that end, ``[T]he
Commission does not believe that the location of counterparty credit
risk associated with a dealing swap--which . . . is easily and often
frequently moved across the globe--should be determinative of
whether a person's dealing activity falls within the scope of the
Dodd-Frank Act.'' \17\ By adopting an overarching risk-based
approach to cross-border regulation today, the Commission
jeopardizes the integrity and soundness of the markets it regulates.
The Final Rule acknowledges that systemic risk may derive from the
activities of entities that do not individually generate the kind of
risk that
[[Page 57006]]
would subject them to systemic risk-based regulation, but then
chooses not to address that very risk. When the CFTC focuses its
regulatory oversight only on individually systemically significant
entities, it unavoidably leaves risky activities unregulated that
due to the interconnectedness of global markets individually, and in
the aggregate, can and likely will negatively impact U.S.
markets.\18\
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\15\ See Jeremy Kress et al., Regulating Entities and
Activities: Complimentary Approaches to Nonbank Systemic Risk, 92 S.
Cal. L. Rev. 1455, 1459-60, 1462 (Sept. 2019).
\16\ Cross-Border Application of the Registration Thresholds and
External Business Conduct Standards Applicable to Swap Dealers and
Major Swap Participants, 81 FR 71946, 71952 (Oct. 18, 2016) (``2016
Proposal''); see also Further Definition of ``Swap Dealer,''
``Security-Based Swap Dealer,'' ``Major Swap Participant,'' ``Major
Security-Based Swap Participant'' and ``Eligible Contract
Participant,'' 77 FR 30596, 30597-98 (May 23, 2012) (``SD Definition
Adopting Release'') (explaining how the Dodd-Frank Act definitions
of ``swap dealer'' and ``security-based swap dealer'' focus on
whether a person engages in particular types of activities involving
swaps or security based swaps); id. at 30757 (In response to
questions as to whether the swap dealer definition should
appropriately be activities-based or relate to how an entity is
classified, Chairman Gensler clarified that, ``The final rule is
consistent with Congressional intent that we take an activities-
based approach.'').
\17\ 2016 Proposal, 81 FR at 71952.
\18\ See Guidance, 78 FR at 45300 (consistent with relevant case
law and the purpose of Title VII to protect the U.S. financial
system from the build-up of systemic risks, under CEA section 2(i),
the Commission must assess the connection of swap activities, viewed
as a class or in the aggregate, to activities in commerce of the
United States to determine whether application of the CEA swaps
provisions is warranted).
---------------------------------------------------------------------------
Moreover, Congress embedded a risk-based approach, appropriate
to the Commission's mandate, within the Dodd-Frank Act's swap dealer
definition by instructing the Commission to exempt from designation
as a dealer a person that ``engages in a de minimis quantity of swap
dealing in connection with transactions with or on behalf of its
customers'' and providing that an insured depository institution is
not to be considered a swap dealer ``to the extent it offers to
enter into a swap with a customer in connection with originating a
loan with that customer.'' \19\ The swap dealer definition further
provides that a person may be designated as a dealer for one or more
types, classes or categories of swaps or activities without being
designated a dealer for other types, classes, or categories of swaps
or activities,\20\ further indicating that the type and level of
risk a particular person's activities present are the guiding factor
in determining whether they may be required to register with the
Commission as an SD and comply with the requirements of Title VII.
The Commission seems to have lost sight of the fact that the
activity of swap dealing itself presents the type of risk addressed
by Title VII.\21\ The Commission's ability to establish a threshold
amount of such activity that warrants direct oversight via
registration does not diminish this underlying trait, which is not
binary, but a measure of the scale of risk. Risk is simply in the
DNA of an SD.
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\19\ See CEA section 1a(49)(C) through (D), 7 U.S.C. 1a(49)(C)
through (D).
\20\ See CEA section 1a(49)(B), 7 U.S.C. 1a(49)(B).
\21\ See Final Rule at II.D.3.(iv) (identifying the SD de
minimis threshold as ``a strictly activity-based test (i.e., a test
based on the aggregate gross notional amount of dealing activity).
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As recognized by the Commission, requiring registration and
compliance with the requirements of the Dodd-Frank Act reduces risk
and enhances operational standards and fair dealing in the swaps
markets.\22\ To the extent the Dodd-Frank Act was enacted to reduce
systemic risk to the financial system, the CFTC's role is to
individually utilize its expertise in addressing risk to the
financial system created by interconnections in the swaps market as
a market conduct regulator through supervisory oversight of SDs and
MSPs,\23\ and to contribute as a voting member in support of the
broader systemic risk oversight carried out by the Financial
Stability Oversight Council (``FSOC'').\24\
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\22\ See SD Definition Adopting Release, 77 FR at 30599.
\23\ See Press Release Number 8033-19, CFTC, CFTC Orders Six
Financial Institutions to Pay Total of More Than $6 Million for
Reporting Failures (Oct. 1, 2019), https://www.cftc.gov/PressRoom/PressReleases/8033-19 (``The Commission's swap-dealer risk
management rules are designed to monitor and regulate the systemic
risk endemic to the swaps marke.t''); see also, Authority to Require
Supervision and Regulation of Certain Nonbank Financial Companies,
84 FR 71740, 71744 (Dec. 30, 2019) (explaining that the activities-
based approach to identifying, assessing, and addressing potential
risks and threats to U.S. financial stability reflects two
priorities, one of which is ``allowing relevant financial regulatory
agencies, which generally possess greater information and expertise
with respect to company, product, and market risks, to address
potential risks, rather than subjecting companies to new regulatory
authorities.'').
\24\ Among other things, the FSOC is authorized to ``issue
recommendations to the primary financial regulatory agencies to
apply new or heightened standards and safeguards.'' Dodd-Frank Act
section 120, 124 Stat. at 1408-1410.
---------------------------------------------------------------------------
Since 2013, when the Commission announced its first cross-border
approach in flexible guidance as a non-binding policy statement,\25\
the Commission has understood that the global scale of the swap
markets and domestic scale of regulation poses significant
challenges for regulators and market participants.\26\ I dissented
from the December 2019 proposal for the Final Rule the Commission
considers today.\27\ Like the Final Rule, the Proposal suggested
that we can resolve all complexities in one fell swoop if we alter
our lens, abandon our longstanding and literal interpretation of CEA
section 2(i), and limit ourselves to the purely risk-based approach
described therein.
---------------------------------------------------------------------------
\25\ See Guidance, 78 FR at 45292.
\26\ See Hannah L. Buxbaum, Transnational Legal Ordering and
Regulatory Conflict: Lessons from the Regulation of Cross Border
Derivatives, 1 U.C. Irvine J. Int'l Transnat'l & Comp. L. 91, 92
(2016).
\27\ See Cross-Border Application of the Registration Thresholds
and Certain Requirements Applicable to Swap Dealers and Major Swap
Participants, 85 FR 952, 1008 (proposed Jan. 8, 2020) (the
``Proposal'').
---------------------------------------------------------------------------
Today's action ignores that, ``It is the essence of regulation
that it lays a restraining hand on the self-interest of the
regulated and that the advantages from the regulation commonly fall
to others.'' \28\ The Final Rule is essentially the Proposal with a
more clearly articulated intention to rethink the Commission's
mandate under the Dodd-Frank Act to seize the status of primary
significant risk regulator--a position the Commission was neither
delegated to assume nor provided the resources to occupy--so as to
limit the application of Title VII. Like the Proposal, the Final
Rule acknowledges the likelihood that the chosen course will result
in increased risks of the kind Title VII directs us to address
flowing into the U.S., or even originating in the U.S. via ANE
activities, and then states a belief that the chosen approach is
either ``adequate'' \29\ or of no moment because our focus on
significant participants in the U.S. market should ensure the
appropriate persons are subject to Commission oversight via
registration, even if, ``to the extent that a registered SD or MSP
relies on the exceptions in the Final Rule, and is located in a
jurisdiction that does not have comparable swap requirements, the
Final Rule could lead to weaker risk management practices for such
entities.''.\30\ This approach boils down to: ad hoc harmonizing
with the Securities and Exchange Commission (``SEC''); de facto
delegating to the U.S. prudential regulators; or deferring to a
foreign jurisdiction under a banner of comity without ever
explaining how the application of the swap dealer de minimis
registration threshold is unreasonable.
---------------------------------------------------------------------------
\28\ Wickard v. Filburn, 317 U.S. 111.
\29\ See, e.g., Final Rule at II.D.3.(iii)-(iv).
\30\ Final Rule at X.C.11.(iv).
---------------------------------------------------------------------------
In various statements throughout the preamble, the Commission
subtly--and not so subtly--promotes its emergent ``desire to focus
its authority on potential significant risks to the U.S. financial
system.'' \31\ In one glaring instance, the Commission responds to a
very clear comment on the weakness of the SRS definition in terms of
addressing evasion and avoidance concerns by eviscerating Congress's
very carefully crafted SD definition, stating, ``[w]ithout this
risk-based approach [SRS], the SD de minimis threshold, which is a
strictly activity-based test (i.e., a test based on the aggregate
gross notional amount of dealing activity), becomes the de facto
risk test of when an entity would be subject to the Commission's
swap requirements as an SD.'' \32\ In the past several years, I have
noted the Commission's eagerness to bypass clear Congressional
intent in order to address longstanding concerns with Dodd-Frank Act
implementation.\33\ Indeed, the Commission has at times made a
concerted effort to avoid targeted amendments in favor of sweeping
changes to the regulation of swap dealers without regard for the
long term consequences of its fickle interpretation of the law and
analysis of risk.\34\ I have grave concerns that the Final Rule's
motive in commandeering the role of systemic risk regulator is to
provide certainty to entities that they will have sufficient paths
in the future to avoid registration with the Commission, and thus
fly under the radar of the FSOC and the entire Title VII regime. As
the DC District Court noted, the Commission cannot second-guess
Congress' decision that Title VII apply extraterritorially.\35\ In
layering its new approach over the CEA section 2(i) analysis, the
Commission does just that.
---------------------------------------------------------------------------
\31\ See Final Rule at V.C.
\32\ See Final Rule at II.D.3.(iv).
\33\ See, e.g., De Minimis Exception to the Swap Dealer
Definition--Swaps Entered into by Insured Depository Institutions in
Connection With Loans to Customers, 84 FR 12450, 12468-12471 (Apr.
1, 2019).
\34\ See, e.g., id.; Segregation of Assets Held as Collateral in
Uncleared Swap Transactions, 84 FR 12894, 12906 (Apr. 3, 2019); De
Minimis Exception to the Swap Dealer Definition, 83 FR 27444
(proposed June 12, 2018).
\35\ SIFMA, 67 F.Supp.3d at 432.
---------------------------------------------------------------------------
My dissent to the Proposal expounded at length on concerns with
the Commission's ``new approach,'' which seeks to improve upon and
clarify the Guidance while reallocating responsibilities in a manner
that
[[Page 57007]]
is ill-conceived given that we are just 10 years past one crisis,
and currently navigating a global pandemic. Accordingly, I will not
reiterate my earlier points, but incorporate by reference my prior
dissent,\36\ which is still on point save for a comment I made on
the ``unlimited U.S. responsibility prong'' to the U.S. person
definition, which has been addressed, and I thank staff for
addressing my concern.\37\ I will, however, take the opportunity
here to focus on how the Commission's approach to the cross-border
application of the SD registration threshold in the Final Rule
amounts to a re-write of the Dodd-Frank Act, as exemplified by the
``significant risk subsidiary'' or ``SRS'' definition.
---------------------------------------------------------------------------
\36\ See 85 FR at 1009-1013.
\37\ Id. at 1011.
---------------------------------------------------------------------------
The Commission Does Not Have a Blank Check
By codifying a purely and defined risk-based approach to its
extraterritorial jurisdiction, exempting from the CFTC's regulatory
oversight all entities but those which individually pose systemic
risk to the U.S. financial system, the CFTC abdicates its
Congressionally-mandated responsibility under CEA section 2(i) to
regulate activities outside of the United States that meet one of
the aforementioned jurisdictional nexuses.\38\ The Final Rule today
defies Congress' clear intent in enacting CEA section 2(i),
improperly elevates comity over adhesion to the CFTC's mandate, and
increases the riskiness of global swap markets.
---------------------------------------------------------------------------
\38\ See 7 U.S.C. 2(i).
---------------------------------------------------------------------------
Congress demonstrated its ability to discern between purely
systemic risk-based and activities-based regulation when it
designated authority to the CFTC. It directed the Commission to
develop a metric to analyze which entities pose enough risk to
require SD registration, creating an exception to the registration
requirement for entities engaged in only a de minimis quantity of
swap dealing.\39\ It is telling that the CEA does not, under section
2(i), direct the CFTC to develop a similar threshold measurement to
evaluate whether foreign entities singularly pose systemic risk to
U.S. commerce. The lack of a comparable exception in CEA section
2(i) indicates that Congress intended to do exactly what the plain
language of CEA section 2(i) suggests--require that the CFTC oversee
activities outside of the U.S. that pose risk to U.S. commerce (not
individual persons or entities). \40\ Furthermore, nothing in the
swap dealer definition or CEA section 2(i) expresses that we should
defer to prudential regulators, whether U.S. or foreign;
prudentially-regulated entities may be required to register as swap
dealers with the CFTC.\41\ If the Congress believed that prudential
regulation could sufficiently mitigate risk to the U.S. financial
system, it would have chosen to delegate this function to the U.S.
prudential regulators. Congress instead chose to enact a
registration requirement in Title VII of the Dodd-Frank Act.
Ultimately, the introduction of the concept of an ``SRS'' and
accompanying exemptions for: (1) Entities with parents that have
less than $50 billion in consolidated assets, and for entities that
are already (2) prudentially regulated or (3) subject to comparable
foreign regulation, is impermissible under CEA section 2(i).
---------------------------------------------------------------------------
\39\ See CEA section 1a(49)(D); 7 U.S.C. 1a(49)(D).
\40\ Silvers v. Sony Pictures Entm't, Inc., 402 F.3d 881, 885
(9th Cir. 2005) (``The doctrine of expressio unius est exclusio
alterius `as applied to statutory interpretation creates a
presumption that when a statute designates certain persons, things,
or manners of operation, all omissions should be understood as
exclusions.''' (quoting Boudette v. Barnette, 923 F.2d 754, 756-57
(9th Cir. 1991)).
\41\ See also CEA section 4s(c), 7 U.S.C. 4s(c) (requiring any
person that is required to register as a swap dealer or major swap
participant to register with the Commission, ``regardless of whether
the person also is a depository institution or is registered with
the Securities and Exchange Commission.'').
---------------------------------------------------------------------------
Whether or not we agree with Congress, the CFTC is not free to
rewrite the statute and enact rules that contravene our mandate.
Agencies may not act like they have a ``blank check'' to proffer
legislative rules outside of their delegated authority; \42\
regulators have to take directives from their governing statute and
not second-guess Congress.\43\ Thus, the CFTC is not free to
disregard its mandate in the pursuit of other objectives--such as
comity, deference, adequacy, workability, or an inexplicable desire
to act solely like a prudential regulator--no matter how laudable
some of those objectives might be.\44\ The Commission today dodges
the responsibility with which it was entrusted in the wake of a
crisis, impermissibly rewriting the Dodd-Frank Act to pass the buck
to prudential regulators and our international counterparts.
---------------------------------------------------------------------------
\42\ Neomi Rao, Address at the Brookings Institution: What's
next for Trump's regulatory agenda: A conversation with OIRA
Administrator Neomi Rao (Jan. 26, 2018), Transcript at 10 (``. .
.agencies should not act as though they have a blank check from
Congress to make law.''), https://www.brookings.edu/wp-content/uploads/2018/01/es_20180126_oira_transcript.pdf.
\43\ See SIFMA, 67 F.Supp.3d at 432 (finding that the CFTC
``could not have second-guessed Congress decision'' that Title VII
rules apply extraterritorially).
\44\ BP W. Coast Prods., LLC v. FERC, 374 F.3d 1263 (DC Cir.
2004) (Congressional mandates to agencies to carry out ``specific
statutory directives define[ing] the relevant functions of [the
agency] in a particular area.'' Such a mandate does not create for
the agency ``a roving commission'' to achieve those or ``any other
laudable goal.'' (quoting Michigan v. EPA, 268 F.3d 1075, 1084 (DC
Cir. 2001)); see also Farmers Union Cent. Exch., Inc. v. FERC, 734
F.2d 1486, 1500 (DCC. 1984) (``Agency decisionmaking, of course,
must be more than `reasoned' in light of the record. It must also be
true to the Congressional mandate from which it derives
authority.'').
---------------------------------------------------------------------------
The CFTC's implementation of the Final Rule's purely risk-based
approach to regulating global swaps is neither allowable under Title
VII, nor is it wise. Our current Chairman, in fulfilling his role as
the CFTC's representative on the FSOC, when supporting guidance
signifying that the FSOC would adopt an activities-based approach to
determining risks to financial stability, stated that an entity-
based approach, ``inevitably leads to a `whack-a-mole' scenario in
which risky activities are transferred out of highly-regulated
entities and into less-regulated ones.'' \45\ Given the
conglomeration of exceptions built into the Final Rule's definitions
of ``guarantee,'' and ``SRS,'' and its determination regarding ``ANE
Transactions,'' it is hard to see how this transfer of risk to less-
regulated entities--which still pose risk in the aggregate to U.S.
markets--will not come to pass, inevitably leaving gaps in the
CFTC's ability to oversee the activities it regulates.
---------------------------------------------------------------------------
\45\ Heath P. Tarbert, Chairman, CFTC, Statement on the New
Activities-Based Approach to Systemic Risk (Dec. 19, 2019), https://www.cftc.gov/PressRoom/SpeechesTestimony/tarbertstatement120619.
---------------------------------------------------------------------------
With respect to our cooperation with foreign counterparts, I
firmly believe that the CFTC should work diligently to coordinate
oversight and elevate principles of international comity as we
develop our cross-border approach--but not when doing so requires us
to abdicate our mandate. To that end, I generally support the Final
Rule's application of substituted compliance even if I do not fully
agree with entity categorizations via the definitions. I also
generally support the CFTC's deference to foreign regulators when it
makes sound comparability determinations. To the extent the Final
Rule grants somewhat indeterminate discretion to the CFTC to depart
from an objective evaluation in making such determinations, as noted
by several commenters,\46\ I will remain vigilant when participating
in such Commission action and be mindful of potential for slippage.
---------------------------------------------------------------------------
\46\ See Proposal at VI.D.1.(ii.).
---------------------------------------------------------------------------
I remain concerned that the Final Rule, like the Proposal, makes
vague references to ``comity'' to justify our resistance to
regulating overseas activities that pose risk to U.S. markets. I
agree that making substituted compliance available to foreign
entities or subsidiaries, via sound comparability determinations, is
appropriately deferential to principles of international comity.
Nevertheless, we should only use comity to justify rulemaking when
there is ambiguity in the governing statute,\47\ or when our
requirements unreasonably interfere with those of our international
counterparts \48\--neither of which is overtly true regarding our
statutory obligation under CEA sections 4s(a) and (c) \49\ to
register SDs and MSPs based on
[[Page 57008]]
their swap activities. Registration is a critical first step in
determining whether a non-U.S. entity is engaged in activities
covered under 2(i), and must not be disregarded for the sake of
comity.
---------------------------------------------------------------------------
\47\ Michael Greenberger, Too Big to Fail--U.S. Banks'
Regulatory Alchemy: Converting an Obscure Agency Footnote into an
``At Will'' Nullification of Dodd-Frank's Regulation of the Multi-
Trillion Dollar Financial Swaps Market, 14 J. Bus. & Tech. L. 197,
367 (2019) (``There is no legal precedent extant that defines
`international comity' as giving authority to a U.S. administrative
agency to weaken unilaterally the otherwise clear Congressional
statutory language or intent that the statute must be applied
extraterritorially.'')
\48\ See Proposal, 85 FR at 957; Final Rule at II.D.3.(iv);
Aaron D. Simowitz, The Extraterritoriality Formalisms, 51 Conn. L.
Rev. 375, 405-6 and n. 205 (2019) (describing the principle of
``prescriptive comity'' in the Restatement (Fourth) of Foreign
Relations Law and recognizing that ``Interference with the sovereign
authority of foreign states may be reasonable if such application
would serve the legitimate interests of the United States.'' (citing
Restatement (Fourth) of Foreign Relations Law Sec. 405 cmt. (Am.
Law. Inst. 2018)).
\49\ CEA section 4s(a), (c), 7 U.S.C. 4s(a), (c).
---------------------------------------------------------------------------
It is also pertinent to note here that by prioritizing comity
and refusing to appropriately retain jurisdiction, at least to some
degree, over transactions that are arranged, negotiated, or executed
in the United States by non-U.S. SDs with non-U.S. counterparties
(``ANE Transactions''), the Commission's abdication of
Congressionally-mandated responsibility extends beyond CEA section
2(i). There is no need to even address whether these transactions
have a ``direct and substantial'' impact on U.S. commerce, because
they occur in the United States and accordingly fall squarely within
the regulatory purview of the CFTC.\50\ Ignoring all ANE
Transactions invites entities to evade U.S. law, even as they avail
themselves of the benefits of U.S. markets by residing in the U.S.
and using U.S. personnel, as they can administratively treat
transactions as booked in a foreign subsidiary based on the
conclusion that any relevant risk has been shipped off. I am
concerned that the CFTC is improperly fixating on comity at the
expense of not only its mandate, but also at the expense of
developing sound regulation that increases transparency,
competition, and market integrity. The Final Rule brushes past
concerns raised by a market participant that exempting ANE
transactions from reporting requirements gives non-U.S. entities an
advantage over U.S. SDs and jeopardizes the intended benefits of the
CFTC's public reporting regime.\51\ I am concerned by the
Commission's response to the comment,\52\ and I struggle to
understand why any U.S. regulator would implement a rule that defies
its statutory mandate, subjects U.S. entities to a competitive
disadvantage relative to its foreign counterparts, and reduces U.S.
investors' transparency into the markets.
---------------------------------------------------------------------------
\50\ See SIFMA, 67 F. Supp. 3d at 426 (''Section 2(i)'s
``technical language initially lays down a general rule placing all
[swap] activity'' occurring outside of the United States beyond
Title VII's reach. But it then expressly brings such swap activities
``back within'' Title VII's purview). ANE Transactions should not be
a part of the initial exemption step required by section 2(i),
because they do not occur outside of the United States.
\51\ See Proposal at V. B.-C.; Citadel, Comment Letter on
Proposed Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants (Mar. 9, 2020), https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=62376.
\52\ See SIFMA, 67 F. Supp. 3d at 429 (An agency ```need not
address every comment, but it must respond in a reasoned manner to
those that raise significant problems.' ''(citing Covad Commc'ns Co.
v. FCC, 450 F.3d 528, 550 (D.C. Cir. 2006) (quoting Reytblatt v.
Nuclear Regulatory Comm'n, 105 F.3d 715, 722 (D.C. Cir. 1997))).
---------------------------------------------------------------------------
SRS: This Is the Way
In my dissent to the Proposal, I identified SRS as the most
elaborate departure from both the Commission's interpretation of CEA
section 2(i) and from our mandate under the Dodd-Frank Act, in its
elimination of a large cross-section of non-U.S. subsidiaries of
U.S. parent entities from having to count their swap dealing
activities toward the relevant SD or MSP registration threshold
calculations.\53\ The SRS replaces the conduit affiliate concept
from the Guidance, which, although broader, served to (1)
appropriately define the universe of entities whose risks related to
swap activities may accrue and have a direct and significant
connection with activities in, or effect on, U.S. commerce, and (2)
harmonize with the SEC's cross-border application of the de minimis
threshold relevant to security-based swap dealing activity.\54\
---------------------------------------------------------------------------
\53\ 85 FR at 1012; see also Dissenting Statement of
Commissioner Dan M. Berkovitz, 85 FR at 1015 (describing the SRS
construct as ``an empty set.'').
\54\ See 17 CFR 240.3a71-3(a)(1).
---------------------------------------------------------------------------
Despite a clear split among Commissioners and commenters, the
Commission has determined to move forward with the SRS, which
creates broad exceptions that could exclude large amounts of the
swap dealing activities by foreign subsidiaries of U.S. entities
from counting towards the SD and MSP registration threshold
calculations and therefore, ultimately exclude them from the
Commission's oversight and application of the swap dealer
regulations. In support of its determination, the Commission
rehashes and repeats the argument that SRS ``embodies'' the
Commission's purely risk-based approach.\55\ If ``this is the way,''
\56\ then I am afraid our new approach may not account--perhaps at
all--for the risk that Congress and the Dodd-Frank Act directed the
Commission to oversee. If Congress had wanted the Commission to
focus its cross-border authority solely on systemically significant
non-bank entities, it would have been explicit, and refrained from
using language in CEA section 2(i) that was so embedded in common
law.\57\
---------------------------------------------------------------------------
\55\ See Final Rule at II.C. 3.(iii) (in declining to
incorporate risk transfer and risk acceptance test into the
``significant subsidiary'' definition, the Commission finds that
such activity-based tests are inconsistent with the Commission's
determination to apply swap requirements to foreign entities using a
risk-based test to isolate entities that the Commission considers to
pose a significant risk to the financial system based solely on
their significance in terms of their balance sheet size relative to
the parent entity).
\56\ ``This is the way'' is identified as a Mandalorian mantra
and cultural meme associated with keeping members of the group on
the same wavelength without any question at all. See Evan Romano,
What `This Is the Way' Explains About the Mandalorians in The
Mandalorian, Men'sHealth (Nov. 22, 2019).
\57\ See, e.g. Proposal at I.C.1.; Guidance 81 FR at 45298-
45300; see SIFMA, 67 F.Supp.3d at 427 (``Congress modeled Section
2(i) on other statutes with extraterritorial reach that operate
without implementing regulations.'' (citations omitted)); see Larry
M. Eig, Cong. Research Serv., 97-589, Statutory Interpretation:
General Principles and Recent Trends 20 (2014) (Congress is presumed
to legislate with knowledge of existing common law.'').
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In excluding subsidiaries of bank holding companies and
intermediate holding companies from the SRS definition, the
Commission defers to the ``role of prudential regulation in the
consolidated oversight of prudential risk,'' again relying on ``the
risk-based approach to determining which foreign subsidiaries
present a significant risk to their ultimate U.S. parent and thus to
the financial system.'' \58\ In presuming that prudential oversight
provides ``sufficient'' comparable oversight to that prescribed by
Title VII, the Commission entirely ignores that history weighs
against such a presumption \59\ and Congress acted accordingly.\60\
Under the Dodd-Frank Act, the CFTC is the ``primary financial
regulatory agency'' for swap dealers.\61\ CEA section 4s(c) \62\
provides that any person that is required to be registered as an SD
or MSP shall register with the CFTC regardless of whether the person
also is a depository institution (i.e., any bank or savings
association) or is registered with the SEC as a security-based swap
dealer. Moreover, to the extent SDs or MSPs have a prudential
regulator, Title VII recognizes that such SDs/MSPs are to comply
with capital and margin requirements established by their respective
prudential regulators.\63\ However, it explicitly does not recognize
prudential regulation as a substitute for SD/MSP regulatory
oversight by the Commission.\64\
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\58\ Notably, the Commission determined to use the $50 billion
threshold for the ultimate parent entity of an SRS because the FSOC
initially used a $50 billion total consolidated assets quantitative
test as one threshold to apply to nonbank financial entities for
purposes of designated nonbank financial companies as ``systemically
important financial institutions'' (``SIFIs''). See Proposal, 85 FR
at 965 n.134. The FSOC recently voted to remove the $50 billion
threshold because, among other things, it was ``not compatible with
the prioritization of an activities-based approach'' to addressing
risks to financial stability. Id.; see also FSOC Interpretive
Guidance, 84 FR at 71742.
\59\ See, e.g., Guidance, 78 FR at 45294; Proposal, 85 FR at
1013-1015.
\60\ Id.
\61\ Dodd-Frank Act, Public Law 111-203 section 2(12)(C)(viii),
124 Stat. 1389.
\62\ CEA section 4s(c), 7 U.S.C. 4s(c).
\63\ CEA section 4s(e)(2)(A), 7 U.S.C. 4s(e)(2)(A)
\64\ See Eig, supra note 57 at 16-17 (``where Congress includes
particular language in one section of a statute but omits it in
another . . . , it is generally presumed that Congress acts
intentionally and purposely in the disparate inclusion or
exclusion.'' (quoting Atlantic Cleaners & Dyers, Inc. v. United
States, 286 U.S. 427, 433 (1933))).
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Again, I believe that our cross-border approach must absolutely
align with principles of international comity and that our rules and
supervisory approach should harmonize and work in tandem with
prudential regulation. However, I do not believe that the SRS
definition is reasonable or consistent with the SD definition or CEA
section 2(i), due to its deference to the role of prudential
regulation in the consolidated oversight of prudential risk to carve
out consideration of swap dealing activities of non-U.S. entities
(that are not guaranteed by a U.S. person) for purposes of SD
registration and Commission oversight.
The Final Rule would suggest that our consideration of the
activities of non-U.S. subsidiaries of U.S. entities is an
``expansion'' of the Commission's oversight.\65\ I disagree. The
post-2010 crisis reforms require intensive oversight of entities
engaged in swaps activities throughout the world. The Commission
must retain in full
[[Page 57009]]
its oversight and regulatory responsibilities over entities whose
activities have a direct and significant connection with activities
in, or effect on, U.S. commerce. To do that effectively, we must be
able to apply the SD definition and de minimis threshold to the web
of interconnections through which risk travels, not simply rely on
bright line balance sheet box checking to wholesale elimination of
non-U.S. subsidiaries from our scope of consideration. As I stated
in my prior dissent, without a more concrete understanding as to
whether SRS is truly superior to the conduit affiliate \66\ concept
currently outlined in the Guidance and presumably similar to the
SEC's own approach, it is difficult to get behind a policy that
would bring risk into the U.S. of the very type CEA Section 2(i)
seeks to address.
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\65\ Final Rule at II. D. 3. (iv).
\66\ See, e.g., 85 FR at 1012 (noting the Proposal's lack of
explaining whether and how the conduit affiliate concept failed to
achieve its purpose, is no longer relevant, resulted in loss of
liquidity or market fragmentation, proved unworkable, etc.).
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Complexity and Burden Should Not Direct the Outcomes
I continue to have reservations regarding the Commission's
determination to discard the Guidance and the use of agency guidance
and non-binding policy statements in favor of prescriptive
rules.\67\ As I noted with regard to the Proposal, while the
Guidance is complex, it is no more complex than this Final Rule.
Complexity is the hallmark of the regulation of cross-border
derivatives, and ``merely reflects the complexity of swaps markets,
swaps transactions, and the corporate structures of the market
participants that the CFTC regulates.'' \68\ I am especially
concerned that the Commission is acting in haste to nail down hard
and fast rules while many pieces in the global regulatory puzzle are
still in flux.
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\67\ Id. at 1010.
\68\ SIFMA, 67 F.Supp.3d at 419-20 (``Indeed, the complexity of
a regulatory issue is one reason an agency might choose to issue a
non-binding policy statement rather than a rigid `hard and fast
rule.' '' (citing SEC v. Chenery Corp., 332 U.S. 194, 202-203
(1947))).
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Commenters refrained from weighing in on the virtues of
retaining the Guidance--or agency guidance generally. The Proposal
garnered just 18 relevant comment letters.\69\ It is difficult to
determine why, but perhaps market participants have followed the
Guidance and utilized their expertise in reviewing the overall
statutory scheme and the straightforward language of CEA section
2(i) to come into compliance with Title VII either directly or via
substituted compliance and have not found it prohibitive to do
so.\70\
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\69\ Comments to the Proposal are available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3067. Of note,
the proposal to the Guidance received approximately 290 comment
letters. Guidance, 78 FR at 45295. The 2016 Proposal received
approximately 29 substantive comment letters, available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=1752.
\70\ Indeed, the DC District Court concluded that the CFTC need
not address every facet of the overall regulatory scheme and can
rely on regulated market participants to reference other controlling
statutes and regulations to address issues left unresolved by a
given Title VII rule. See SIFMA, 67 F. Supp. 3d at 428 n.31.
---------------------------------------------------------------------------
Like the Proposal, the Final Rule prides its alteration of
various definitions such as ``U.S. person'' and ``guarantee,'' the
substitution of SRS for conduit affiliates, and the abandonment of
ANE Transactions, as burden and/or cost reducing (or, ``more
workable''). Unfortunately, I believe the Commission in some
instances has not fully evaluated the true weight of the burdens,
and in other instances, not fully measured those burdens against the
goals of Title VII and the benefits of the overall intent of CEA
section 2(i).
A straightforward example is the Commission's determination to
increase the proposed five-year time limits for reliance on
representations regarding U.S. person and guarantee status to seven
years to appease commenters who asked for perpetual reliance on
previously obtained representations.\71\ There is no indication that
the Commission considered anything but providing market participants
more time, in spite of recognizing that best practice would be to
obtain updated representations as soon as practicable.
---------------------------------------------------------------------------
\71\ See Final Rule at II.B.5. and C.3.
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A more concerning example is the Commission's decision to move
forward with a narrower definition of ``guarantee'' than that
outlined in the Guidance, despite recognizing that it could lead to
entities counting fewer swaps towards their de minimis registration
threshold or ``qualify additional counterparties for exceptions to
certain regulatory requirements as compared to the definition in the
Guidance.'' \72\ The Commission did not address the commenter who
also pointed out that the narrower definition would allow
significant risk to be transferred back to the U.S. financial system
over time noting that, ``economic implications are just as important
as legal considerations, as confirmed and intended by CEA section
2(i)(1).\73\ Instead, the Final Rule offers the possibility that the
SRS definition would capture some non-U.S. persons, returning to the
mantra that in this way we focus on those entities that represent
``material risk to the U.S. financial system,'' through something
``workable.'' \74\
---------------------------------------------------------------------------
\72\ See Final Rule at II.C.2. and 3.
\73\ Id.
\74\ See Final Rule at II.C.3.
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Conclusion
Before I conclude, I would like to take a moment to thank staff
from the Division of Swap Dealer and Intermediary Oversight for
their presentations, tireless work on this rulemaking, and frequent
engagement with my office over the last few weeks leading up to
today's open meeting. Like all of the CFTC's work, today's
discussion would not have been possible without the expertise and
commitment of our dedicated staff.
As the Commission wraps up its scheduled work, before a brief
summer respite, particularly on this 10th anniversary week of the
Dodd-Frank Act, our work yesterday and today, although some may like
to think it, is not the culmination of years of work towards
implementing the Dodd-Frank Act. In fact, the Commission acted
promptly in issuing the cross-border 2013 Guidance, only a few years
after bill passage and in the throes of dozens of other equally
important Title VII rulemakings.
This week's exercise is a retrenchment of sound derivatives
policy that provided the CFTC the tools necessary to monitor swap
markets and protect the U.S. financial system and American
taxpayers, and most importantly was steadfast to clearly articulated
Congressional intent. There is always room for improvement,
tweaking, and evolving--I have said as much, many times since
becoming a Commissioner.
But, unfortunately, during this week that we should be lifting
up the merits of financial reform, especially given the role post-
crisis reforms played in absorbing massive shocks during the worst
of the Covid-19 pandemic just a few months ago, we are turning back
the clock to a previous era that proved to be inadequate to meeting
our core responsibilities.
Appendix 5--Statement of Commissioner Dawn D. Stump Overview
When we met together in person late last year to consider
proposing cross-border rules with respect to registration thresholds
and regulatory requirements applicable to swap dealers and major
swap participants (the ``Proposal''),\1\ I stressed that because we
were proposing to replace the Commission's 2013 cross-border
guidance (the ``Guidance'') \2\ with binding and enforceable rules,
those rules must be clear, sensible, and workable.\3\ In supporting
the Proposal at the time, I concluded that the proposed rules met
those standards. And I have not seen anything in the many thoughtful
comment letters we received that causes me to doubt that conclusion.
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\1\ There are no registered major swap participants at this
time. Accordingly, for convenience, this Statement generally will
refer only to swap dealers, and not to major swap participants.
\2\ Interpretive Guidance and Policy Statement Regarding
Compliance With Certain Swap Regulations, 78 FR 45292 (July 26,
2013).
\3\ Statement of Commissioner Dawn D. Stump Regarding Proposed
Rule: Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants (December 18, 2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement121819.
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The final rules that are before us today, as we meet remotely
several months later, are largely the same as those we proposed. But
based on public input: (1) In several places, we are providing
clarifications requested by market participants; \4\ (2) in a few
places where the proposal deviated from the Guidance, we have been
persuaded that the Guidance got it right, and thus are returning to
the Guidance approach; \5\ and (3) in still
[[Page 57010]]
other places, we are incorporating suggestions made by
commenters.\6\ As a result, the final rules build and improve upon
the foundation laid by the Proposal. They, too, are clear, sensible,
and workable, and I am pleased to support them.
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\4\ E.g., clarification that in addition to entities that are
subject to capital regulation by the CFTC, Securities and Exchange
Commission (``SEC''), or U.S. prudential regulators, the attribution
requirement in connection with the major swap participant
registration threshold also excludes entities subject to Basel-
compliant capital standards and oversight by a G-20 prudential
supervisor.
\5\ E.g., addition of a provision that was in the Guidance, but
not in the Proposal, whereby a non-U.S. person does not have to
count in its de minimis swap dealer registration calculation swaps
entered into with an entity whose swap obligations are guaranteed by
a U.S. person if the guaranteed entity is itself below the de
minimis threshold and is affiliated with a registered swap dealer.
\6\ E.g.: (1) While the Proposal removed the prong of the ``U.S.
person'' definition in the Guidance that included a legal entity
that is majority-owned by one or more U.S. person(s) in which such
person(s) ``bears unlimited responsibility for the obligations and
liabilities'' of the legal entity, the final rules add such a
circumstance to the definition of a ``guarantee;'' and (2) while the
Proposal excepted certain subsidiaries of bank holding companies
from the definition of a ``significant risk subsidiary,'' the final
rules also except certain subsidiaries of intermediate holding
companies in the same circumstances.
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I do not plan to summarize here the changes to the Proposal that
are encompassed within the final rules. To those not steeped in the
minutiae of de minimis swap dealer registration calculations and
entity- and transaction-level requirements under the Guidance,\7\
such a summary can become somewhat mind-numbing. Instead, I would
like to place today's cross-border rulemaking in context, and
explain my support from a broader perspective.
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\7\ The final rules replace the Guidance's classification of
requirements imposed on registered swap dealers under the
Commission's rules as entity- and transaction-level requirements
with a similar (but not identical) classification into group A,
group B, and group C requirements (discussed further below).
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Section 2(i) and Codifying the Guidance
We begin, as we must, with the terms of the statute--Section
2(i) of the Commodity Exchange Act (``CEA''), which was added by the
Dodd-Frank Act.\8\ Given the importance of this topic, please
indulge my reiterating a few points that I made about the Proposal.
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\8\ Public Law 111-203, 124 Stat. 1376 (2010) (``Dodd-Frank'').
---------------------------------------------------------------------------
Section 2(i) limits the international reach of CFTC swap
regulations by affirmatively stating that they ``shall not apply to
activities outside the United States unless those activities . . .
have a direct and significant connection with activities in, or
effect on, commerce of the United States.'' \9\ A common-sense
reading of this section is that there is a limited extraterritorial
reach to the Dodd-Frank swap requirements, and to stretch them
beyond the stated statutory criteria impermissibly infringes upon
the rule sets of other nations.
---------------------------------------------------------------------------
\9\ CEA Section 2(i), 7 U.S.C. 2(i).
---------------------------------------------------------------------------
That is, the plainly stated congressional intent is to start
with US law not applying beyond our borders, and then continue to
the limited conditions where extraterritoriality would be deemed
appropriate. The law does not say that CFTC rules govern derivatives
market activities around the world if there is any linkage or tie to
the United States and should not be interpreted and abused as such.
In adopting rules setting out how we will apply Section 2(i) to
the registration thresholds and regulatory requirements relevant to
the cross-border activities of swap dealers, we are not writing on a
blank canvas. The Guidance has been in place for seven years now,
and although it is non-binding,\10\ market participants (both those
that have registered and those that have had to determine whether
they are required to register) have devoted a tremendous amount of
human and financial resources to conform to its complicated
contours.
---------------------------------------------------------------------------
\10\ SIFMA v. CFTC, 67 F. Supp.3d 373 (D.D.C. 2014).
---------------------------------------------------------------------------
Faced with that reality, although I was not a fan of the
Guidance when it was issued,\11\ I agree that it is appropriate to
codify its basic elements into our rule set rather than start from
scratch. And that is what the final rules before us today will do.
The final rules codify many elements of the Guidance, while updating
a few provisions to reflect current realities and incorporating some
improvements based on our experience during the intervening
years.\12\
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\11\ When the CFTC was considering the Guidance, I shared the
view vividly articulated by then-Commissioner Jill Sommers that the
Guidance, as it had been proposed, reflected ``what could only be
called the `Intergalactic Commerce Clause' of the United States
Constitution . . .'' See Cross-Border Application of Certain Swaps
Provisions of the Commodity Exchange Act, 77 FR 41214, 41239
(proposed July 12, 2012) (Statement of Commissioner Sommers).
\12\ Several commenters asked the Commission to take the
opportunity of this rulemaking to significantly alter the Guidance
approach to the cross-border activities of swap dealers in various
respects. As noted, we have determined to codify, rather than
reconstruct, most of the decisions that underlie the Guidance
(although we have made some adjustments as discussed herein). While
maintaining the status quo under the Guidance may deny affected
market participants results they wish for, it does not require them
to give up what they have had for the past seven years.
---------------------------------------------------------------------------
Much has been made of statements in the Proposal, which are
carried over into today's release, that the focus of the
Commission's analysis under Section 2(i) is on risk to the U.S.
financial system. But this, too, is essentially a codification of
the approach taken in the Guidance. While I do not often quote then-
Chairman Gary Gensler, I note that in his Statement supporting the
adoption of the Guidance, he said:
There's no question to me, at least, that the words of Dodd-
Frank addressed this (i.e., risk importation) when they said that a
direct and significant connection with activities and/or effect on
commerce in the United States covers these risks that may come back
to us.
I want to publicly thank Chairman Barney Frank along with
Spencer Bachus, Frank Lucas, and Collin Peterson, and their staffs
for reaching out to the CFTC and the public to ask how to best
address offshore risks that could wash back to our economy in Dodd-
Frank.\13\
---------------------------------------------------------------------------
\13\ Guidance, 78 FR at 45371 (Statement of Chairman Gary
Gensler).
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Implementing our statutory cross-border mandate through a risk-
based analysis that focuses on the pertinent issue of risk to the US
financial system is a sensible approach, which I endorse.
For those who maintain that the final rules take too narrow a
view of the Commission's extraterritorial reach with respect to swap
dealers, I note the truly remarkable fact that today, with the
Guidance in effect, approximately half of the over 100 swap dealers
currently registered with the CFTC are located outside the United
States.\14\ This percentage has stayed relatively constant since the
CFTC's swap dealer registration regime ``went live'' at the end of
2012. Registered non-US swap dealers are located across the globe--
in North and South America, Europe, Asia, and Australia.
---------------------------------------------------------------------------
\14\ See National Futures Association Membership and Directories
(data as of July 22, 2020), available at https://www.nfa.futures.org/registration-membership/membership-and-directories.html#SDRegistry.
---------------------------------------------------------------------------
In other words, although it is non-binding, the Commission's
Guidance appears to have brought a substantial portion of global
swap dealing activity into the Commission's swap dealer regulatory
regime. And the record before us is devoid of evidence suggesting
that the number of registered non-US swap dealers is seriously over-
or under-inclusive. Given the extent to which the final rules codify
the Guidance, a significant change in that number is unlikely.
Because the final rules essentially codify the Guidance, and
because I support the final rules for the reasons explained herein,
I accept the interpretation of CEA Section 2(i) stated in the
Guidance and the final rules in the limited context of registration
thresholds and regulatory requirements applicable to swap dealers.
To codify the Guidance while revising the foundation on which it was
based would only generate confusion--as opposed to the clarity that
I hope this rulemaking will bring to one aspect of our cross-border
work.
But the analysis of, in Mr. Gensler's words, ``offshore risks
that could wash back to our economy'' may well differ in the context
of other Dodd-Frank requirements. As we proceed with other aspects
of our cross-border work--in areas such as clearing, trade
execution, and reporting--rigorous analysis of the Section 2(i) test
for each rule we adopt is necessary to ensure that the law is
followed both to the letter and in spirit.
Clear, Sensible, and Workable Rules
Transitioning from the interpretation of Section 2(i) to the
rules before us, some have questioned why we are adopting rules in
the first place. While it is true that Section 2(i), unlike other
provisions in Dodd-Frank, does not require the Commission to adopt
implementing rules, I believe it is good government to do so.
Guidance has its place, of course. Given the nascent state of post-
Pittsburgh derivatives reforms in 2013, reliance on guidance made
sense at the time. But I have spoken before of the benefits of
codifying interpretations issued by our staff where appropriate,\15\
and those benefits accrue in equal measure to the codification
[[Page 57011]]
of Commission guidance. Replacing the prior Guidance with rules that
reflect current realities and are based on experience developed
during the past seven years provides certainty to the marketplace
and a shared understanding of the ``rules of the road.''
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\15\ See Statement of Commissioner Dawn D. Stump Regarding
Amending Rule 3.10(c)(3)--Exemption from Registration for Foreign
Persons Acting as Commodity Pool Operators on Behalf of Offshore
Commodity Pools (May 28, 2020) (``Commissioner Stump Part 3
Statement''), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement052820.
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Some may argue that in those few places where the rules of the
road that we are adopting today depart from the Guidance, the
Commission has retreated with respect to the extraterritorial
application of its swap regulatory regime. As I shall discuss,
however, such criticisms fail to take account of other, equally
important, considerations relevant to the exercise of our rulemaking
authority: (1) The aforementioned need for clear, sensible, and
workable rules; and (2) appropriate deference to comparable regimes
of our international regulatory colleagues.
Definition of a ``Guarantee''
For example, the release accompanying the final rules
acknowledges that the definition of a ``guarantee'' that we are
adopting today is narrower than that in the Guidance. The final
rules define a ``guarantee'' as an arrangement in which one party to
a swap has rights of recourse against a guarantor with respect to
its counterparty's obligations under the swap, with ``rights of
recourse'' meaning a legally enforceable right to collect payments
from the guarantor. By contrast, the Guidance interpreted a
``guarantee'' to include not only the foregoing, ``but also other
formal arrangements that, in view of all the facts and
circumstances, support the non-U.S. person's ability to pay or
perform its swap obligations with respect to its swaps.'' \16\
---------------------------------------------------------------------------
\16\ Guidance, 78 FR at 45320 (emphasis added).
---------------------------------------------------------------------------
The concept of a guarantee is important to our cross-border
rules for swap dealers in part because a guarantee of a non-U.S.
person's swap obligations by a US person can require the non-US
person--or its non-US counterparty--to count the swap towards its de
minimis swap dealer registration threshold. But when the
determination of whether an entity must register with the CFTC
depends on whether the entity's or its counterparty's obligations
under a swap are guaranteed by a U.S. person, the meaning of the
term ``guarantee'' cannot be left to a review of ``all the facts and
circumstances.''
A rule in which non-US persons must try to determine, or obtain
representations from non-U.S. counterparties regarding, whether the
CFTC might subsequently conclude that a particular arrangement
satisfies an open-ended definition of a ``guarantee'' is not a
workable rule. By contrast, the definition of a ``guarantee'' in the
final rules, which is based on concepts of legal recourse and a
legally enforceable right to recover, is clear and workable. Some
may downplay the importance of ``workability'' in Commission
rulemakings, but no matter how well-intentioned a rule may be, if it
is not workable, it cannot deliver on its intended purpose.
Significant Risk Subsidiaries
Some commenters objected that the definition of a ``significant
risk subsidiary'' inappropriately substitutes oversight by the Board
of Governors of the Federal Reserve System (the ``FRB''), and/or
foreign regulatory authorities, for the Commission's regulation of
derivatives market activity overseas. A significant risk subsidiary,
or ``SRS,'' is a non-U.S. ``significant subsidiary'' (based on
varioU.S. numerical metrics set out in the final rules) of an
ultimate U.S. parent entity that has more than $50 billion in global
consolidated assets. Excluded from the definition, however, are non-
U.S. subsidiaries that are subject to either: (1) Consolidated
supervision and regulation by the FRB as a subsidiary of a U.S. bank
holding company (``BHC'') or intermediate holding company (``IHC'');
or (2) capital standards and oversight by the subsidiary's home
country supervisor that are consistent with Basel requirements and
subject to margin requirements for uncleared swaps in a jurisdiction
for which the Commission has issued a margin comparability
determination. It is these exclusions that commenters have cited as
a concern.
To this, there are three responses. First, as discussed above,
in exercising the Commission's oversight responsibilities with
respect to an SRS (which, again, is a non-U.S. subsidiary), we look
to the risk that such a subsidiary poses to its ultimate parent in
the United States, and thus to the U.S. financial system. It is not
that we are replacing our oversight responsibilities with those of
the FRB or foreign regulators. Rather, it is that we have determined
that the risk presented by foreign subsidiaries consolidated with a
BHC or IHC, or subject to regulation as specified in the SRS
definition in their home country, is already being adequately
monitored and thus does not warrant an additional layer of
regulation by the CFTC.
Second, we must compare the SRS definition in the final rules to
what it replaces in the Guidance: The ``conduit affiliate.'' The
Guidance did not actually define a conduit affiliate, but rather
described it in terms of certain ``factors.'' The most critical
factor, but unfortunately also the most amorphous, was the last one,
which asked whether ``the non-U.S. person in the regular course of
business, engages in swaps with non-U.S. third-party(ies) for the
purpose of hedging or mitigating risks faced by, or to take
positions on behalf of, its U.S. affiliate(s), and enters into
offsetting swaps or other arrangements with its U.S. affiliate(s) in
order to transfer the risks and benefits of such swaps with third-
party(ies) to its U.S. affiliates.'' \17\
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\17\ Guidance, 78 FR at 45318 n.258 and 45359.
---------------------------------------------------------------------------
As with the definition of a ``guarantee,'' I make no apologies
for supporting the workable definition of an SRS in the final rules,
which is based on objective and observable metrics, as compared to
the ambiguous description of a conduit affiliate set forth in the
Guidance. We owe the global swaps market the certainty that can only
come from clarity in our rules, and the definition of an SRS in the
final rules fits the bill.
Third, the record before us does not afford any basis on which
to conclude that the definition of an SRS in the final rules will
lead to any less robust Commission oversight of the cross-border
swap activities of swap dealers than does the vague description of a
conduit affiliate in the Guidance. We have no evidence that the
number of non-U.S. entities that have waded through the multi-
faceted conduit affiliate description in the Guidance and concluded
that they were a conduit affiliate, but would conclude that they are
not an SRS under the definition in the final rules, is significant--
or even material. If experience going forward proves otherwise, the
Commission can always amend the SRS definition accordingly. But
absent such evidence, hypothetical concerns are an insufficient
basis on which to reject the clear and workable SRS definition in
the final rules.
ANE Transactions, Exceptions to Regulatory Requirements, and
Substituted Compliance
Finally, some may see a retreat from the Guidance in the
Commission's determinations: (1) Not to apply its group A, group B,
or group C requirements \18\ to swaps of a non-U.S. swap dealer with
a non-U.S. counterparty where the non-U.S. swap dealer uses
personnel or agents in the United States to arrange, negotiate, or
execute the swaps (``ANE transactions''); (2) to except certain
foreign-based swaps from the group B and group C requirements; and
(3) to expand the availability of substituted compliance to
encompass group B requirements for swaps between a U.S. branch of a
non-U.S. swap dealer and certain non-U.S. counterparties. I
respectfully disagree.
---------------------------------------------------------------------------
\18\ Under the final rules: (1) Group A requirements for swap
dealers generally relate to the Chief Compliance Officer
requirement, risk management, swap data recordkeeping, and antitrust
considerations; (2) group B requirements for swap dealers generally
relate to swap trading relationship documentation, portfolio
reconciliation and compression, trade confirmation, and daily
trading records; and (3) group C requirements for swap dealers
generally relate to external business conduct rules, including
voluntary initial margin segregation.
---------------------------------------------------------------------------
First, the notion that the CFTC's swap regulatory regime should
apply to ANE transactions was not stated in the Commission's
Guidance; rather, it was stated in a staff Advisory published after
the Guidance was adopted. The Commission has never endorsed that
staff view, and it has never taken effect.\19\ Second, the
exceptions from swap dealer requirements that apply to the swaps of
non-U.S. swap dealers with non-U.S. persons, again, generally codify
[[Page 57012]]
exceptions that were included in the Guidance, too.
---------------------------------------------------------------------------
\19\ Today's release acknowledges that the policy the Commission
is adopting with respect to the applicability of CFTC requirements
to non-U.S. swap dealers' ANE transactions differs from that taken
by the SEC. But as has often been said, harmonization with the SEC,
while an important goal and one that Congress supported in Dodd-
Frank, should not be undertaken simply for harmonization's own sake.
Here, the Commission has determined that, in light of Congress'
decision to define security-based swaps as ``securities'' in Dodd-
Frank, harmonization with the SEC's determination to apply its
existing, pre-Dodd-Frank securities broker-dealer regulation to ANE
transactions in security-based swaps is not appropriate.
---------------------------------------------------------------------------
To be sure, based on input we received in the comments, the
final rules include two exceptions to swap dealer regulatory
requirements that were not included in the Proposal. Yet, to take
one as an example, today's release explains that the ``Limited Swap
Entity SRS/Guaranteed Entity Group B Exception'' is: (1) Tailored to
placing foreign swap dealer subsidiaries of U.S. firms on the same
footing as foreign branches of U.S. swap dealers; (2) consistent
with an exception in the Guidance that was not carried forward in
the Proposal; \20\ and (3) limited in terms of the amount of swaps
that can be entered into in reliance on the exception, and
unavailable if the parties can rely on substituted compliance
instead.
---------------------------------------------------------------------------
\20\ The release explains that under the Guidance, a non-U.S.
person that was guaranteed by a U.S. person or a conduit affiliate
would not have been expected to comply with group B requirements
when transacting with a non-U.S. counterparty that also was not
guaranteed by a U.S. person or a conduit affiliate.
---------------------------------------------------------------------------
But what is critically important for the treatment of ANE
transactions, the exceptions to certain regulatory requirements, and
substituted compliance in the final rules is to keep in mind the
scenario at issue: Although in some instances activity with respect
to the swap may occur in the United States, the swaps involve non-
U.S. swap dealers (or foreign branches of U.S. swap dealers) and a
non-U.S. counterparty (or a foreign branch of a U.S. person) and,
therefore, will also be subject to regulation in another
jurisdiction. Where the regulatory interest of that other
jurisdiction is paramount, the CFTC should appropriately defer, just
as where the Commission's regulatory interest is paramount, we
expect other foreign jurisdictions to defer to our regulation. As I
stated in connection with a recent Open Meeting that also addressed
cross-border issues:
[T]he Commission's historical commitment to appropriate
deference to our international regulatory colleagues (which also is
sometimes referred to as mutual recognition), `is a demonstration of
international comity--an expression of mutual respect for the
important interests of foreign sovereigns.' This deference also
reflects the shared goals of global authorities seeking to achieve
the most effectively regulated markets through coordination rather
than duplication.\21\
---------------------------------------------------------------------------
\21\ See Commissioner Stump Part 3 Statement, n.15, supra
(footnote omitted).
The Commission's historical commitment to mutual recognition is
in keeping with principles of international comity. In reviewing the
comment letters, frankly, there sometimes seems to be a sense that
``international comity'' is simply a buzzword the Commission invokes
to justify what critics believe is an improper easing of its
regulation of cross-border activity. I emphatically reject the
notion that appropriate deference to international regulatory
authorities weakens oversight or protections of our markets, market
participants, or financial system. To the contrary, our reliance on
international comity is deeply rooted in several sources.
First, as discussed in greater detail in the release, the
Restatement (Fourth) of Foreign Relations Law of the United States
counsels that even where a country has a basis for extraterritorial
jurisdiction, it should not prescribe law with respect to a person
or activity in another country when the exercise of such
jurisdiction is unreasonable.\22\ This doctrine of reasonableness is
``a principle of statutory interpretation'' \23\ that has been
recognized in Supreme Court case law.\24\
---------------------------------------------------------------------------
\22\ Restatement (Fourth) section 405 cmt. A (Westlaw 2018).
\23\ Id.
\24\ See F. Hoffman-LaRoche, Ltd. v. Empagran S.A., 542 U.S.
155, 164 (2004) (statutes should be construed to ``avoid
unreasonable interference with the sovereign authority of other
nations.'').
---------------------------------------------------------------------------
Second, Congress in Dodd-Frank specifically directed the
Commission, ``[i]n order to promote effective and consistent global
regulation of swaps,'' to ``consult and coordinate with foreign
regulatory authorities on the establishment of consistent
international standards with respect to the regulation . . . of
swaps [and] swap entities . . .'' \25\ Congress recognized that
global swap markets cannot function absent consistent international
standards.
---------------------------------------------------------------------------
\25\ Dodd-Frank, Section 752(a).
---------------------------------------------------------------------------
Third, as I have previously observed on multiple occasions, when
the G-20 leaders met in Pittsburgh in the midst of the financial
crisis in 2009, they, too, recognized that due to the global nature
of the derivatives markets, designing a workable solution, though
complicated, demands coordinated policies and cooperation.\26\ To do
otherwise would ignore the reality that modern markets are not bound
by jurisdictional borders.
---------------------------------------------------------------------------
\26\ See Leaders' Statement from the 2009 G-20 Summit in
Pittsburgh, Pa. (``G-20 Pittsburgh Leaders' Statement'') at 7 (Sept.
24-25, 2009) (``We are committed to take action at the national and
international level to raise standards together so that our national
authorities implement global standards consistently in a way that
ensures a level playing field and avoids fragmentation of markets,
protectionism, and regulatory arbitrage''), available at https://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
---------------------------------------------------------------------------
And fourth, this Commission historically has been a global
leader in its commitment to applying principles of international
comity, in the form of mutual recognition, in a variety of contexts.
That commitment is reflected in the Commission's Part 30 rules,\27\
which apply to foreign firms ``with respect to the offer and sale of
foreign futures and options to U.S. customers and are designed to
ensure that such products offered and sold in the U.S. are subject
to regulatory safeguards comparable to those applicable to
transactions entered into on designated contract markets.'' \28\ It
also is reflected in our approach (initially through staff no-action
relief, and later through registration after Dodd-Frank) to foreign
boards of trade (``FBOTs'') offering US participants ``direct
access'' to enter trades directly into the FBOT's order entry and
trade matching systems.\29\ And just recently, it was reflected in
the Commission's proposal to amend Rule 3.10(c)(3) to permit non-US
commodity pool operators to claim exemption from CFTC registration
for offshore commodity pools with no US participants on a pool-by-
pool basis.\30\
---------------------------------------------------------------------------
\27\ 17 CFR part 30.
\28\ Foreign Futures and Options Transactions, 85 FR 15359,
15360 (March 18, 2020).
\29\ See Statement of Commissioner Dawn D. Stump Regarding
Foreign Board of Trade Registration Applications of Euronext
Amsterdam, Euronext Paris, and European Energy Exchange (November 5,
2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/stumpstatement110519.
\30\ Exemption From Registration for Certain Foreign Persons
Acting as Commodity Pool Operators of Offshore Commodity Pools, 85
FR 35820 (June 12, 2020); see also Commissioner Stump Part 3
Statement, n.15, supra.
---------------------------------------------------------------------------
When the Commission issued the Guidance in 2013, only a few
derivatives reforms had been adopted in a few other jurisdictions.
How things have changed since then. Many of our fellow regulators in
the world's major financial centers have implemented reforms
governing the conduct of swap dealers commensurate to our own, and
extensive strides have been made (and continue to be made) towards
international harmonization--thereby aligning our regulatory
principles, just as the G-20 envisioned. As a result, most swaps
involving non-U.S. counterparties today are expected to be subject
to foreign regulatory requirements similar to the Commission's own,
unlike at the time the Guidance was adopted.\31\ Further, our
deference to the comprehensive swap regulation of our international
colleagues has been demonstrated by the fact that since the Guidance
was issued, the CFTC has issued 11 comparability determinations
regarding the regulation of swap dealers in the European Union,
Canada, Japan, Australia, Hong Kong, and Switzerland.
---------------------------------------------------------------------------
\31\ As recounted in the release, CEA Section 2(i) has its
origins in an amendment that Rep. Spencer Bachus offered during the
House Financial Services Committee markup on October 14, 2009, that
would have restricted the Commission's jurisdiction over swaps
between non-U.S. resident persons. Chairman Frank opposed the
amendment, noting that there may well be cases where non-U.S.
residents are engaging in transactions that have an effect on the
United States and that are insufficiently regulated internationally
and that he would not want to prevent U.S. regulators from stepping
in. Chairman Frank expressed his commitment to work with Rep. Bachus
going forward, Rep. Bachus withdrew the amendment, and eventually
Section 2(i) was included in Dodd-Frank. See H. Fin. Serv. Comm.
Mark Up on Discussion Draft of the Over-the-Counter Derivatives
Markets Act of 2009, 111th Cong., 1st Sess. (Oct. 14, 2009)
(statements of Rep. Bachus and Rep. Frank). For the reasons
discussed in text, the prospect of swaps between non-U.S.
counterparties being insufficiently regulated internationally is far
less today than it was when the extraterritoriality of the CFTC's
jurisdiction over swaps was being debated.
---------------------------------------------------------------------------
Thus, regulation of global swap markets that imposes overlapping
and duplicative requirements on swap dealers and their cross-border
activities by multiple regulators is inconsistent with: (1)
Principles of statutory interpretation; (2) Congress' direction to
the Commission; (3) the vision of the G-20 Leaders at the Pittsburgh
Summit; and (4) the Commission's own longstanding commitment to
international comity through mutual recognition of foreign
regulatory regimes. In a word: It is not workable.
[[Page 57013]]
Conclusion
In conclusion, I support codifying our prior cross-border
Guidance into enforceable rules. I believe that the final rules
before us today are clear, sensible, and workable, and that they
appropriately apply the Commission's regulations to the cross-border
activities of swap dealers. They improve upon the Guidance based on
our experience in administering the Dodd-Frank swap regulatory
regime over the past several years, and they recognize the current
state of global regulation of globally interconnected derivatives
markets by carrying on this agency's established tradition of mutual
recognition and substituted compliance.
I therefore support the final cross-border rules for swap
dealers before us today. I want to very much thank the staff of the
Division of Swap Dealer and Intermediary Oversight, the General
Counsel's Office, and the Chief Economist's Office for their efforts
in preparing this rulemaking. I am particularly appreciative of the
time that the staff devoted to answering our diverse questions--
always in a thoughtful and comprehensive manner--and reviewing and
addressing the various comments and requests from me and my team.
Appendix 6--Dissenting Statement of Commissioner Dan M. Berkovitz
Introduction
I dissent from today's final cross-border swap rulemaking (the
``Final Rule''). As described by the Chairman, this Final Rule will
``pare[] back our extraterritorial application of our swap dealer
regime.'' \1\ Over the past seven years, the current cross-border
regime has helped protect the U.S. financial system from risky
overseas swap activity. The Commission should not be paring back
these protections for the American financial system, particularly
now, during a global pandemic.
---------------------------------------------------------------------------
\1\ Kadhim Shubber, Financial Times, U.S. regulator investigates
oil fund disclosures (July 15, 2020), available at https://www.ft.com/content/1e689137-2d1f-4393-a18f-fe0da02141cc.
---------------------------------------------------------------------------
The Final Rule will permit U.S. swap dealers to book their swaps
with non-U.S. persons in offshore affiliates, thereby avoiding the
CFTC's swap regulations, even when they conduct those swap
activities from within the United States and the U.S. parent retains
the risks from those swap activities. The structure of the Final
Rule practically invites multinational U.S. banks and hedge funds to
book their swaps in offshore affiliates to avoid our swap dealer
regulations. This will permit risks to flow back into the United
States with none of the intended regulatory protections.
The Commission defends its retreat by citing principles of
international comity and asserting that compliance with the laws of
another jurisdiction in lieu of the CFTC's requirements will be
permitted only when the CFTC finds that the laws of the other
jurisdiction are ``comparable'' to those of the CFTC. The Final
Rule, however, establishes a weak and vague standard for determining
when the swap regulations of another jurisdiction are comparable.
Further, the Final Rule even permits substituted compliance where
the swap activity occurs within the United States--such as for swaps
between a U.S. branch of a non-U.S. swap dealer and another non-U.S.
person, even if those swaps are negotiated and booked in the United
States. The Commission is not permitted to defer to regulators in
other jurisdictions when the swap activity is conducted within the
United States, nor should it do so even if such deference were
permitted.
As I noted in my dissent on the proposed rule, experience has
taught us that while finance may be global, global financial rescues
are American. We should not loosely outsource the protection of the
U.S. financial system and American taxpayers to foreign regulators
that are unaccountable to the American people.
Less Regulation of U.S. Persons Conducting Swap Activities Outside the
U.S.
In the Final Rule, the Commission acknowledges that cross-border
swaps activities can have a ``direct and significant'' connection
with activities in, or effect on, U.S. commerce. The Final Rule,
however, removes several key protections in the 2013 Cross-Border
Guidance (``Guidance'') \2\ that mitigated the risks arising from
such cross-border activities.\3\ The Final Rule narrows the
definition of ``guarantee'' in a legalistic manner, permitting banks
to craft financing arrangements for their overseas swap activities
that bring risks back into the U.S. parent organization without
triggering the application of Dodd-Frank requirements for those
activities. The Final Rule also discards the Guidance's firewalls
that were designed to prevent banks from evading Dodd-Frank
requirements by using foreign affiliates as the front office for
swaps with non-U.S. persons while bringing the risk from those swaps
back to the U.S. home office through back-to-back internal swaps
(``affiliate conduits'').
---------------------------------------------------------------------------
\2\ Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations, 78 FR 45292, 45298-45301
(July 26, 2013).
\3\ The preamble to the final rule observes (Sec. I.C.):
In this sense, a global financial enterprise effectively
operates as a single business, with a highly integrated network of
business lines and services conducted through various branches or
affiliated legal entities that are under the control of the parent
entity. [footnote omitted]. Branches and affiliates in a global
financial enterprise are highly interdependent, with separate
entities in the group providing financial or credit support to each
other, such as in the form of a guarantee or the ability to transfer
risk through inter-affiliate trades or other offsetting
transactions. Even in the absence of an explicit arrangement or
guarantee, a parent entity may, for reputational or other reasons,
choose to assume the risk incurred by its affiliates, branches, or
offices located overseas. Swaps are also traded by an entity in one
jurisdiction, but booked and risk-managed by an affiliate in another
jurisdiction. The Final Rule recognizes that these and similar
arrangements among global financial enterprises create channels
through which swap-related risks can have a direct and significant
connection with activities in, or effect on, commerce of the United
States.
---------------------------------------------------------------------------
The Final Rule creates a new category of entities--the SRS--
supposedly to capture the risks arising from the swap activities of
very large foreign affiliates of U.S. firms. But the Commission
admits that this new category likely will include ``few, if any''
entities.\4\ Most likely, therefore, the SRS construct will provide
no protections to the financial system from the swap activities of
overseas affiliates of U.S. entities that bring risks to their U.S.
parents and to the U.S. financial system. Each of these significant
deficiencies is discussed in greater detail below.
---------------------------------------------------------------------------
\4\ Final Rule release, Sec. X.C.3.
---------------------------------------------------------------------------
Swap activity outside the U.S. guaranteed by a U.S. Person. The
Guidance provided that when a swap of a non-U.S. person is
guaranteed by a U.S. person, then the Dodd-Frank requirements
regarding swap dealer registration and many of the attendant swap
dealer regulations would apply to that non-U.S. person in the same
manner as they would apply to a U.S. person. This is because a swap
conducted by a non-U.S. person guaranteed by a U.S. person poses
essentially the same risks to the U.S. financial system as a swap
conducted by a U.S. person.\5\ The Guidance adopted a functional
rather than literal approach to the term ``guarantee'':
---------------------------------------------------------------------------
\5\ ``The Commission believes that swap activities outside the
U.S. that are guaranteed by U.S. persons would generally have a
direct and significant connection with activities in, or effect on,
U.S. commerce in a similar manner as the underlying swap would
generally have a direct and significant connection with activities
in, and effect on, U.S. commerce if the guaranteed counterparty to
the underlying swap were a U.S. person.'' Cross-Border Guidance, 78
FR at 45319.
---------------------------------------------------------------------------
The Commission also is affirming that, for purposes of this
Guidance, the Commission would interpret the term ``guarantee''
generally to include not only traditional guarantees of payment or
performance of the related swaps, but also other formal arrangements
that, in view of all the facts and circumstances, support the non-
U.S. person's ability to pay or perform its swap obligations with
respect to its swaps. The Commission believes that it is necessary
to interpret the term ``guarantee'' to include the different
financial arrangements and structures that transfer risk directly
back to the United States. In this regard, it is the substance,
rather than the form, of the arrangement that determines whether the
arrangement should be considered a guarantee for purposes of the
application of section 2(i).\6\
---------------------------------------------------------------------------
\6\ Id. at 45320 (footnotes omitted).
---------------------------------------------------------------------------
The Final Rule, however, adopts a narrow, legalistic definition
of guarantee: ``Guarantee means an arrangement pursuant to which one
party to a swap has rights of recourse against a guarantor, with
respect to its counterparty's obligations under the swap.'' \7\ The
Commission recognizes that this definition is ``narrower'' than the
definition in the Guidance, and that this narrower definition could
result in increased risk to the U.S. financial system.\8\ The
Commission further acknowledges that this narrower definition
``could lead to certain entities counting fewer
[[Page 57014]]
swaps towards their de minimis threshold or qualify additional
counterparties for exceptions to certain regulatory requirements as
compared to the definition in the Guidance.'' \9\
---------------------------------------------------------------------------
\7\ Final Rule release, Section 23.23(a)(9).
\8\ The Commission states that arrangements that would meet the
broader definition in the Guidance, but are not within the narrower
scope of the Final Rule, ``transfer risk directly back to the U.S.
financial system, with possible adverse effects, in a manner similar
to a guarantee with direct recourse to a U.S. person.'' Final Rule
release, Sec. II.C.3.
\9\ Id.
---------------------------------------------------------------------------
The Commission asserts, however, that the narrower definition is
``more workable'' because it is consistent with the definition of
guarantee in the Cross-Border Margin Rule, and therefore will not
require an ``independent assessment.'' \10\ The Commission presents
no evidence, however, as to why the current definition, which has
now been in place for seven years, is not ``workable,'' or why
multinational financial institutions that trade hundreds of
billions, and even trillions, of dollars of swaps on a daily basis
are not capable of determining whether their overseas affiliates are
guaranteed by a U.S. person. A global financial institution that
cannot readily determine or represent whether or not the risks from
its overseas swaps are guaranteed by one of its U.S. entities should
not be a global financial institution.
---------------------------------------------------------------------------
\10\ Id.
---------------------------------------------------------------------------
Affiliate conduits. The Guidance also applied the Dodd-Frank
swap dealer registration requirements, and many of the attendant
swap dealer regulations, to the swap activities of ``affiliate
conduits'' \11\ of U.S. persons in the same manner as it applies to
U.S. persons. Under the Guidance, a key factor in determining
whether a non-U.S. person would be considered to be an affiliate
conduit of a U.S. person is whether the non-U.S. person regularly
enters into swaps with non-U.S. counterparties and then enters into
``offsetting swaps or other arrangements with its U.S. affiliate(s)
in order to transfer the risks and benefits of such swaps with third
parties to its U.S. affiliates.'' \12\
---------------------------------------------------------------------------
\11\ The term ``affiliate conduit'' and ``conduit affiliate''
are used interchangeably. See, e.g., Cross-Border Guidance, 78 FR at
45319.
\12\ The Commission explained, ``the Commission believes that
swap activities outside the United States of an affiliate conduit
would generally have a direct and significant connection with
activities in, or effect on, U.S. commerce in a similar manner as
would be the case if the affiliate conduit's U.S. affiliates entered
into the swaps directly.'' Id.
---------------------------------------------------------------------------
The affiliate conduit provisions in the Guidance were designed
to prevent U.S. entities from booking those swaps in their non-U.S.
affiliates to escape the CFTC's Dodd-Frank requirements that would
otherwise apply to the entity's swap activity in the United States.
The risks and benefits of those swaps booked offshore could then be
transferred back to the U.S. with back-to-back internal swaps
between the U.S. parent and its non-U.S. affiliate. Ultimately, risk
from the swap would reside on the books of the U.S. entity. Through
this back-to-back process, the U.S. entity could still conduct the
swap activity, and bear the risk of the swaps, yet would avoid the
application of CFTC requirements that would apply had the swap been
booked directly in the U.S. entity.
The Final Rule does not include any comparable provisions to
prevent the use of affiliate conduits to avoid CFTC regulation. This
is an invitation to abuse and to risk for the U.S. financial system.
Significant risk subsidiary (SRS). The Final Rule adopts a new
construct--the ``significant risk subsidiary''--to supposedly
encompass overseas affiliates of U.S. entities whose swap activities
pose significant risks to the U.S. financial system. An SRS is
defined as any non-U.S. ``significant subsidiary'' of an ultimate
U.S. parent entity where that ultimate parent has more than $50
billion in global consolidated assets. An entity is a ``significant
subsidiary'' if it has a sufficient size relative to its parent,
measured in terms of percentage of either revenue, equity capital,
or total assets.\13\ However, the definition then excludes non-U.S.
subsidiaries that are either (i) prudentially regulated by the
Federal Reserve; or (ii) prudentially regulated by the entity's home
country prudential regulator whose regulations are consistent with
the Basel Committee's capital standards, and subject to comparable
margin requirements for uncleared swaps in its home country. An
entity that survives the gantlet of thresholds and exclusions to be
considered an SRS would then be subject to the same registration
requirements as a U.S. person, and many of the same regulatory
requirements that apply to U.S. swap dealers. That outcome, however,
is very unlikely. The threshold criteria to be a ``significant
subsidiary'' are high, and because entities that meet these high
thresholds are typically affiliated with prudentially-regulated
banks, it is likely they will be excluded from the SRS definition.
It therefore is improbable that any entities will fall into the SRS
category. The Cost-Benefit Considerations in the notice of proposed
rulemaking for the Final Rule concede that ``few, if any'' entities
would fall within its ambit.\14\
---------------------------------------------------------------------------
\13\ The Final Rule release asserts that the criteria for
qualifying as a ``significant subsidiary'' are risk-based. The
relative financial measures of revenue, equity capital, and total
assets, however, are not related to the risks presented by the
subsidiary's swap activity. These criteria have nothing at all to do
with swaps and in no way a measure or reflect the risks posed by the
subsidiary's swap activities.
\14\ ``Of the 61 non-U.S. SDs that were provisionally registered
with the Commission in June 2020, the Commission believes that few,
if any, will be classified as SRSs pursuant to the Final Rule.''
Final Rule release, Sec. X.C.3.
---------------------------------------------------------------------------
Furthermore, the criteria apply to each subsidiary separately.
If an institution has a subsidiary that is approaching the high
thresholds set in the Final Rule, it can incorporate another non-
U.S. subsidiary and conduct swap dealing activity out of that entity
to avoid SRS designation for any of its subsidiaries.
One commenter noted that the qualifications only indirectly
address the significance of the subsidiary and suggested the test be
modified to assess the extent to which swap risk is accepted by a
non-U.S. subsidiary or transferred back to the subsidiary's U.S.
affiliates.\15\ The Commission characterized the suggested test as
an activity-based test and rejected the commenter's proposed fix. On
the other hand, when other commenters noted that subsidiaries that
do not engage in any swap dealing activity would potentially be
captured by the SRS qualifications--because the qualifications have
nothing to do with swaps--the Commission modified the Final Rule
with an activity-based end-user test to exempt those entities from
the SRS category.
---------------------------------------------------------------------------
\15\ Better Markets, Comment Letter, Cross-Border Application of
the Registration Thresholds and Certain Requirements Applicable to
Swap Dealers and Major Swap Participants, at 17 (Mar. 9, 2020);
available at https://comments.cftc.gov/Handlers/PdfHandler.ashx?id=29136.
---------------------------------------------------------------------------
Under the Final Rule, a significant subsidiary that is regulated
by U.S. or foreign banking regulators is excluded from the SRS
category. ``The Commission is excluding these entities from the
definition of SRS, in large part, because the swaps entered into by
such entities are already subject to significant regulation, either
by the Federal Reserve Board or by the entity's home country.'' \16\
---------------------------------------------------------------------------
\16\ Final Rule release, Sec. II.D.3.iv.
---------------------------------------------------------------------------
Here the Commission forgets the lessons of the 2008 financial
crisis and ignores the mandate of Congress. Following the financial
crisis--and as a result of the lessons learned during the crisis--
Congress subjected the swaps markets to both prudential and market
regulation. The Commodity Futures Modernization Act of 2000, which
spectacularly failed to prevent the build-up of catastrophic
systemic risks within the financial system leading to the 2008
financial crisis, was based on the premise that market regulation is
unnecessary to protect against systemic risks for financial entities
that are subject to prudential regulation.\17\ Events taught us,
however, that prudential regulation alone was insufficient to
prevent the build-up of those risks to the financial system.
Following the crisis, Congress mandated both prudential regulation
and market regulation for banks conducting swap activities. The
safeguards and protections to the financial system afforded under
Title VII of the Dodd-Frank Act were to be applied regardless of the
extent of prudential regulation. The prudential regulation in a non-
U.S. jurisdiction of an affiliate of a U.S. swap dealer whose swaps
risks are transferred back into the U.S. is not an adequate
substitute for the protections mandated by Title VII of the Dodd-
Frank Act.
---------------------------------------------------------------------------
\17\ For a more detailed discussion of the financial firm
failures involving cross border activity and related U.S. government
and bail outs, see my dissenting statement to the Proposed Cross-
border swap regulations (Dec. 18, 2019), available at https://www.cftc.gov/PressRoom/SpeechesTestimony/berkovitzstatement121819b.
---------------------------------------------------------------------------
The Commission does not dispute that the Final Rule will allow
affiliates currently subjected to the Guidance provisions regarding
guarantees and affiliate conduits affiliates to operate free of CFTC
swap regulations. The Commission also acknowledges that the
activities of these entities may pose risks to the U.S. financial
system.\18\ Not only will the Final Rule permit
[[Page 57015]]
risks to flow into the U.S., but it will provide an incentive for
U.S. banks to move their swap activities into these foreign
affiliates, where they can conduct the same activities but be free
from the CFTC's regulations.
---------------------------------------------------------------------------
\18\ ``The Commission is aware that many other types of
financial arrangements or support, other than a guarantee as defined
in the Final Rule, may be provided by a U.S. person to a non-U.S.
person (e.g., keepwells and liquidity puts, certain types of
indemnity agreements, master trust agreements, liability or loss
transfer or sharing agreements). The Commission understands that
these other financial arrangements or support transfer risk directly
back to the U.S. financial system, with possible adverse effects, in
a manner similar to a guarantee with a direct recourse to a U.S.
person.'' Final Rule release, Sec.II.C.3. See also Final Rule
release, Sec. II.D.3 (recognition that conduit affiliate structures
may present significant risks to the U.S. financial system but
determination not to apply de minimis registration threshold to a
non-U.S. affiliates that is not an SRS).
---------------------------------------------------------------------------
Less Regulation of Swap Activity in the U.S.
ANE Swaps. In 2013, the CFTC issued a Staff Advisory addressing
the applicability of the ``Transaction-Level Requirements'' to non-
U.S. swap dealers that use persons in the U.S. to facilitate swap
transactions with other non-U.S. persons. The CFTC staff observed
that ``persons regularly arranging, negotiating, or executing swaps
for or on behalf of an SD [swap dealer] are performing core, front-
office activities of that SD's dealing business,'' and declared that
``the Commission has a strong supervisory interest in swap dealing
activities that occur within the United States, regardless of the
status of the counterparties.'' \19\ The CFTC staff advised that a
non-U.S. swap dealer ``regularly using personnel or agents located
in the U.S. to arrange, negotiate, or execute [``ANE''] a swap with
a non-U.S. person generally would be required to comply with the
Transaction-Level Requirements.'' \20\
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\19\ CFTC Staff Advisory 13-69, Division of Swap Dealer and
Intermediary Oversight Advisory, Applicability of Transaction Level
Requirements to Activity in the United States (Nov. 14, 2013),
available at https://www.cftc.gov/csl/13-69/download.
\20\ Id.
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The Staff Advisory prompted an outcry from non-U.S. swap
dealers, including wholly-owned non-U.S. affiliates of U.S.
financial institutions, who objected to the CFTC's imposition of its
clearing, trade execution, reporting, and business conduct standards
on their swaps with other non-U.S. persons. Non-U.S. dealers argued
that the risks from these swap activities resided primarily in the
home country, and warned that they may remove their swap dealing
business from the U.S. if these requirements applied. Shortly
thereafter, the CFTC staff provided no-action relief from the
application of the Staff Advisory,\21\ and the Commission issued a
Request for Comment on whether the Commission should adopt the Staff
Advisory, in whole or in part.\22\
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\21\ CFTC No-Action Letter No. 13-71, Certain Transaction-Level
Requirements for Non-U.S. Swap Dealers (Nov. 26, 2013), available at
https://www.cftc.gov/csl/13-71/download. This no-action relief has
been extended multiple times and will continue in effect until the
Final Rule becomes effective. Concurrent with the issuance of the
Final Rule, the CFTC staff is extending this no-action relief for
transaction-level requirements not addressed by the Final Rule
(which includes requirements relating to clearing, trade-execution,
and real-time public reporting). At the same time, the staff is
withdrawing the 2013 Staff Advisory as it applies to all
transaction-level requirements, including requirements not addressed
in the Final Rule. In conjunction with the Commission's
consideration of the Final Rule, both of these staff actions were
presented to the Commission in a single package under the ``Absent
Objection'' process, with any objections due the day before the
Commission is scheduled to vote on the Final Rule. Although I would
support the extension of this no-action relief for such transactions
not covered by this rulemaking, were it issued separately, I cannot
support, in conjunction with this rulemaking, the withdrawal of the
ANE advisory for transactions not covered by the Final Rule. The
withdrawal of the Staff Advisory for transactions not covered by the
rulemaking is being taken in response to selected comments received
as part of the rulemaking, yet the public was not afforded notice
and opportunity for comment as to the manner in which the Commission
should address transaction-level requirements not within the scope
of the rulemaking. It would have been just as workable for market
participants to provide the no-action relief while maintaining the
Staff Advisory. Accordingly, I have objected to the ``Absent
Objection'' package presented to the Commission that included both
the withdrawal of the Staff Advisory and the extension of no-action
relief for transactions not covered by the Final Rule.
\22\ 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 Final Rule discards the ANE concept entirely. ``ANE
transactions will not be considered a relevant factor for purposes
of applying the Final Rule.'' \23\
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\23\ Final Rule release, Sec. V.C. The Securities and Exchange
Commission (``SEC'') requires a non-U.S. person to include ANE
transactions in determining whether the amount of its swap dealing
activity exceeds the de minimis threshold for registration. Cross-
Border Application of Certain Security-Based Swap Requirements, 85
FR 6270, 6272 (Feb. 4, 2020), available at https://www.federalregister.gov/documents/2020/02/04/2019-27760/cross-border-application-of-certain-security-based-swap-requirements. The
preamble to the Final Rule includes many statements regarding the
importance of ``harmonization'' with the SEC rules. However, on this
issue, which imposes a more stringent result for potential swap
dealers, the Commission has decided not to harmonize with the SEC.
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The ability of non-U.S. persons to use personnel within the
U.S., without limitation, to conduct their swap activities with
other non-U.S. persons without CFTC regulation or oversight could
have a variety of detrimental consequences. Foremost among these is
the possibility, perhaps even likelihood, that U.S. swap dealers
will move the booking of their swaps with non-U.S. persons
(including non-U.S. affiliates of other U.S. firms) into their own
non-U.S. affiliates, while maintaining the U.S. location of the
personnel conducting the swap business, in order to avoid the
application of the Dodd-Frank requirements to those transactions. In
fact, Citadel noted in its comments on the proposed rule that this
may be happening already. Citadel stated that ``market transparency
in EUR interest rate swaps for U.S. investors has been greatly
reduced based on data showing that, following issuance of the ANE
No-Action Relief, interdealer trading activity in EUR interest rate
swaps began to be booked almost exclusively to non-U.S. entities, a
fact pattern that Citadel believes is 'consistent with (although not
direct proof of) swap dealers strategically choosing the location of
the desk executing a particular trade in order to avoid trading in a
more transparent and competitive setting.' '' \24\
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\24\ Final Rule release, Sec. V.C. In support of this assertion,
Citadel cites Evangelos Benos, Richard Payne and Michalis Vasios,
Bank of England Staff Working Paper (No. 580), Centralized trading,
transparency and interest rate swap market liquidity: Evidence from
the implementation of the Dodd-Frank Act (May 2018), available at:
https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2018/centralized-trading-transparency-and-interest-rate-swap-market-liquidity-update. In addition to the language quoted by Citadel,
this study concluded:
Additionally, we find that, for the EUR-denominated swap market,
the bulk of interdealer trading previously executed between U.S. and
non-U.S. trading desks is now largely executed by the non-U.S.
(mostly European) trading desks of the same institutions (i.e. banks
have shifted inter-dealer trading of their EUR swap positions from
their U.S. desks to their European desks). We interpret this as an
indication that swap dealers wish to avoid being captured by the SEF
trading mandate and the associated impartial access requirements.
Migrating the EUR inter-dealer volume off-SEFs enables dealers to
choose who to trade with and (more importantly) who not to trade
with. This might allow them to erect barriers to potential entrants
to the dealing community. Thus this fragmentation of the global
market may be interpreted as dealers trying to retain market power,
where possible. Importantly, we find no evidence that customers in
EUR swap markets try to avoid SEF trading and the improved liquidity
it delivers.
Id. at 31-32.
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If more than one U.S. swap dealer were to employ this strategy,
the result could be that swap activity between two U.S. swap dealers
that currently takes place within the U.S. and is fully subject to
the CFTC's swap regulations might then be booked in two non-U.S.
affiliates outside the United States. So long as the U.S. parents do
not provide explicit guarantees for the swaps of the
subsidiaries,\25\ the trading between these subsidiaries would not
count toward the dealer registration threshold. Furthermore, even if
one of those non-U.S. entities were a registered swap dealer, the
trading would not be subject to any CFTC transaction-level
requirements, even though the risk from those transactions is
ultimately borne by the U.S. parent through consolidated accounting,
and U.S. personnel would be negotiating those transactions.\26\
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\25\ Even in the absence of an explicit guarantee or other
financial support, there is likely an expectation that the U.S.
parent will ensure the subsidiary has sufficient funds to pay its
swap obligations. The U.S. parent has substantial reputation risk if
its subsidiaries start defaulting on their swaps. The expansive
definition of ``guarantee'' in the Guidance is perhaps one reason
that U.S. banks that withdrew the explicit guarantees provided their
affiliates have not yet attempted to withdraw their swap dealer
registration. Further regulatory uncertainty about the viability of
de-registering may have arisen from the cross-border rule proposed
by the Commission in 2016 that would have treated non-U.S.
affiliates that were consolidated subsidiaries of U.S. persons as
U.S. persons.
\26\ This strategy would be less effective if either of the non-
U.S. affiliates were an SRS. However, as described above, it is
likely that ``few, if any,'' non-U.S. affiliates will be captured
within this definition particularly affiliates of prudentially
regulated banks, which are excepted out of the definition
altogether.
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[[Page 57016]]
U.S. banks already conduct a significant amount of inter-bank
business through their non-U.S. affiliates. Data from swap data
repositories shows that U.S. bank swap dealers commonly book swaps
with each other through their respective non-U.S. subsidiaries. For
a recent one-year period, the data shows that a number of U.S. banks
booked more than 10 percent--and in some cases close to 50 percent--
of the reported notional amount of swaps across their entire bank-
to-bank swaps books through non-U.S. subsidiaries. In other words, a
number of U.S. banks are already booking material amounts of swaps
with each other through their non-U.S. wholly-owned consolidated
subsidiaries.
Non-U.S. banks conducting swap activity in the U.S. The Final
Rule reverses the position taken by the Commission in the proposed
rule that would have prevented a U.S. branch of a non-U.S. swap
entity from obtaining substituted compliance for various
transactional requirements for swaps with non-U.S. swap entities
that are booked in the U.S. branch.\27\ The cross-border notice of
proposed rulemaking upon which the Final Rule is based (``2019
Proposal'') would have permitted substituted compliance only for the
foreign-based swaps of a non-U.S. swap entity. Both under the 2019
Proposal and the Final Rule, a swap conducted by a non-U.S. swap
entity through a U.S. branch would not be considered a ``foreign-
based swap.''
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\27\ 2019 Proposal, rule text, Sec. 23.23(e)(3), 85 FR 952,
1004.
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Sensibly, under the 2019 Proposal, substituted compliance would
be available only for foreign-based swaps. As the Commission
explained in the 2019 Proposal, ``[t]he Commission preliminarily
believes that the requirements listed in the proposed definitions
are appropriate to identify swaps of a non-U.S. banking organization
operating through a foreign branch in the United States that should
remain subject to Commission requirements. . . .'' \28\
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\28\ 2019 Proposal, 85 FR 952, 968.
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Although the Commission repeats nearly verbatim the rationale
articulated in the 2019 Proposal for applying CFTC regulations
without substituted compliance to transactions booked in the United
States, conducted in the United States, and within an organization
regulated under the laws of the United States, the Final Rule now
excludes swaps booked in a U.S. branch of a non-U.S. swap entity
from this general principle, and permits it to obtain substituted
compliance for its transactions with non-U.S. persons.\29\
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\29\ The Commission's adoption of the opposite of what was
proposed also presents significant notice and comment issues under
the Administrative Procedure Act. See Environmental Integrity
Project v. EPA, 425 F.3d 992, 998 (``Whatever a ``logical
outgrowth'' of this proposal may include, it certainly does not
include the Agency's decision to repudiate its proposed
interpretation and adopt its inverse.''); Chocolate Mfrs. Ass'n v.
Block, 755 F.2d 1098, 1104 (``An agency, however, does not have
carte blanche to establish a rule contrary to its original proposal
simply because it receives suggestions to alter it during the
comment period.'').
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The Commission has no authority to grant substituted compliance
for transactions occurring within the United States. The ability of
the Commission to consider international comity in determining
whether to apply CFTC regulations or permit substituted compliance
with the laws of a foreign regulator only applies with respect to
activities outside the United States. The Final Rule defines a
``foreign-based swap'' in a manner that does not include swaps
booked in the U.S. branch of a non-U.S. swap entity. The fact that
one of the counterparties to a transaction is owned by a non-U.S.
entity does not transform activity conducted by that entity within
the United States into foreign activity. Thus, the Final Rule not
only retreats from the application of U.S. law to transactions that
are arranged, negotiated, and executed in the United States, it even
retreats from the application of U.S. law to transactions that are
booked in the United States. This is not in accordance with either
Section 2(i) of the Commodity Exchange Act (``CEA''), which limits
the application of the swaps provisions of the CEA only with respect
to activities outside the United States, or with the principles of
international comity, which the Commission recognizes only applies
with respect to activity occurring in another jurisdiction.
Weakening the Standards for Substituted Compliance
I agree with the Commission's interpretation of CEA Section 2(i)
that international comity is an important consideration in
determining the extent to which the CEA and the CFTC's swap
regulations should apply to cross-border swap activity occurring in
another jurisdiction. I have voted for every substituted compliance
determination presented to the Commission during my tenure under the
standards adopted in the Guidance.
The standards established in the Final Rule for substituted
compliance determinations, however, depart significantly from the
current standards. The Final Rule creates a lesser standard that
permits a finding of comparability if the Commission determines that
``some or all of the relevant foreign jurisdiction's standards are
comparable . . . or would result in comparable outcomes . . . .''
\30\ Under the Guidance, however, the Commission must also find that
the regulations of the other jurisdiction are as ``comprehensive''
as the Commission's regulations. Furthermore, the Final Rule permits
the Commission to consider any factors it ``determines are
appropriate, which may include'' \31\ any of four factors listed in
the Final Rule. This ``standard for review'' is not a standard at
all. It permits the Commission to withdraw the cross-border
application of its regulations regardless of the robustness of the
other jurisdiction's regulatory regime, for whatever reasons the
Commission chooses. In the absence of more rigorous, objective
criteria, it will be very difficult for the Commission to deny
requests from other jurisdictions or market participants for
comparability determinations.
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\30\ Final Rule, rule text, section 23.23(g)(4).
\31\ Id.
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Conclusion
The Final Rule is a significant retreat from the robust yet
balanced cross-border framework presented in the Guidance. The
current framework has worked well to both protect the U.S. financial
system from systemic risks arising from swap activities outside the
U.S. and recognize the interests of other nations in regulating
conduct within their own borders. The Final Rule destroys this
balance.
I cannot support this abdication of responsibility to protect
the U.S. financial markets and the American taxpayer.
[FR Doc. 2020-16489 Filed 9-11-20; 8:45 am]
BILLING CODE 6351-01-P