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.

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 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.

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.

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. 

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. 

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. 

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]

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]

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.

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 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.”   

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]

The concept of a guarantee is important to our cross-border rules for swap dealers in part because a guarantee of a non-US 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 US 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-US 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-US “significant subsidiary” (based on various numerical metrics set out in the final rules) of an ultimate US parent entity that has more than $50 billion in global consolidated assets.  Excluded from the definition, however, are non-US subsidiaries that are subject to either:  1) consolidated supervision and regulation by the FRB as a subsidiary of a US 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-US subsidiary), we look to the risk that such a subsidiary poses to its ultimate parent in the United States, and thus to the US 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]

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-US 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-US swap dealer with a non-US counterparty where the non-US 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 US branch of a non-US swap dealer and certain non-US counterparties.  I respectfully disagree.

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-US swap dealers with non-US persons, again, generally codify exceptions that were included in the Guidance, too. 

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 US firms on the same footing as foreign branches of US 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. 

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-US swap dealers (or foreign branches of US swap dealers) and a non-US counterparty (or a foreign branch of a US 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]

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]    

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.

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. 

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]

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-US 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.

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. 

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 question—always in a thoughtful and comprehensive manner—and reviewing and addressing the various comments and requests from me and my team.