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SEC Adopts Cross-border Security-based Swaps Rules
Practical Law Legal Update 3-572-8107 (Approx. 6 pages)
SEC Adopts Cross-border Security-based Swaps Rules
by Practical Law Finance
| Published on 02 Jul 2014 • USA (National/Federal) |
On June 25, 2014, the SEC adopted the first of a series of rules and guidance on the application of Dodd-Frank swaps rules to cross-border security-based swaps (SBS).
On June 25, 2014, the SEC adopted the first of a series of final rules and guidance on the application of Dodd-Frank swaps rules to cross-border security-based swaps (SBS). These rules, among other things, provide:
- An explanation of when a cross-border SBS transaction must be counted towards the de minimis thresholds requiring registration with the SEC as either a security-based swap dealer (SBSD) or major security-based swap participant (MSBSP). SBS that are guaranteed by US persons or that are entered into with conduit affiliates of US persons count toward these thresholds.
- Procedural rules regarding applications for substituted compliance (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Rules Eligible for Foreign Substituted Compliance: Security-based Swaps).
- An antifraud rule that addresses the scope of the SEC's cross-border antifraud authority and clarifies that the authority applies in circumstances where the fraud occurs or is felt in the US.
The scope of the rules, which is viewed by some as limited, could allow banks to continue a trend in which they shift their swaps into non-US units not explicitly guaranteed by a US affiliate in order to evade US swaps rules. The SEC has therefore also announced is commitment to work with other regulators to actively monitor the process of banks "de-guaranteeing" their foreign affiliates.
The final rules become effective 60 days after they are published in the Federal Register.
"US Person" Definition
In developing the final rules, the SEC took into account the related elements of the CFTC cross-border guidance and aimed to minimize disturbances for market participants who would otherwise have to comply with two sets of rules. Under the SEC rules, the definition of a US person is very similar to the definition in the CFTC cross-border guidance (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Revised Definition of "US Person") and include:
- Any natural person who resides in the US.
- Any discretionary or non-discretionary account of a US person.
- Any estate of a decedent who was a resident of the United States at the time of death.
- Any partnership, corporation, trust, investment vehicle, or other legal person that either:
- is organized, incorporated, or established under the laws of the US; or
- has its principal place of business in the US.
A principal place of business is defined 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. The definition provides that with respect to an externally managed investment vehicle, this location is the office from which the manager of the investment vehicle primarily directs, controls, and coordinates the investment activities of the investment vehicle. Consistent with rules adopted by the SEC jointly with the CFTC regarding final Title VII definitions of "swap dealer," "security-based swap dealer," "major swap participant" and "major security-based swap participant," foreign branches of US banks and US branches of foreign banks are not separate legal persons for purposes of Title VII and have the same US person status as the bank's home office.
Counting Cross-border SBS Toward SBSD and MSBSP Minimum Thresholds
The rules delineate which cross-border SBS must be counted toward notional calculations which could require a party to register as an SBSD under Section 15F of the Exchange Act. Under rules adopted jointly by the CFTC and the SEC in 2012, non-US entities must register as swap dealers or SBSDs, as applicable, if their notional trading activity exceeds certain de minimis notional thresholds over a 12-month period.
These rules rely on a final definition of "US person" that was adopted as part of the final rules. For details on this definition, see "US Person" Definition.
The final rules require that US persons are required to count all SBS toward these thresholds to identify whether they are an SBSD, including transactions conducted through their foreign branches. Non-US persons are required to count the following in considering whether they meet the SBSD threshold:
- Market-making (referred to as "dealing") SBS transactions with counterparties that are US persons, including foreign branches of US banks (unless the foreign branch is a branch of a registered SBSD).
- Dealing SBS transactions with any counterparty that has rights of recourse against a US affiliate of the non-US person in connection with the non-US person's obligation under the SBS.
- Any dealing SBS activity entered into with a non-US person acting as a conduit affiliate of a US person. The final rules define a "conduit affiliate" as a non-US affiliate of a US person that enters into SBS with non-US persons or with certain foreign branches of a US bank on behalf of its US affiliates that are not registered as SBSDs or MSBSPs, and enters into offsetting transactions with its US affiliates to transfer the risks and benefits of the SBS to such US affiliates.
For details on these, see Practice Note, US Derivatives Regulation: Swap Dealer and MSP Threshold Calculations.
The final SBS cross-border rules also provide clarification regarding which cross-border SBS must be counted in determining whether a party must register with the SEC as a MSBSP under Section 15F of the Exchange Act. Under rules adopted jointly by the CFTC and the SEC in 2012, a non-US entity must register as a MSBSP if its SBS trading activity:
- Exceeds a "substantial position," for which there are certain tests.
- Exceeds a substantial counterparty exposure threshold.
US persons are required to count all SBS positions when determining whether they are MSBSPs. Non-US persons are required to count the following positions in determining whether they are MSBSPs:
- Positions with US-person counterparties, including foreign branches of US banks (unless the foreign branch is a branch of a registered SBSD).
- Positions with non-US-person counterparties that have rights of recourse against a US affiliate of the non-US person counterparty in connection with the non-US person's obligation under the SBS.
- Positions with a non-US person acting as a conduit affiliate of a US person.
Generally, all positions that a US person guarantees must be included in the MSBSP calculation.
Under the final rules, guaranteed cross-border SBS positions are attributed as follows:
- A non-US person that provides a recourse guarantee of the SBS obligations of a US person counts all of the US person's SBS positions that it guarantees.
- A non-US person that provides a recourse guarantee of the SBS obligations of another non-US person counts only the guaranteed positions under SBS transactions with US-person counterparties.
- A US person that provides a recourse guarantee of the SBS obligations of a non-US person counts all of the non-US person's SBS positions that it guarantees.
- A guarantor is not required to count any guaranteed SBS positions of a non-US person if the non-US person is subject to:
- Basel capital standards;
- capital regulations by the SEC or CFTC; or
- US banking regulations.
Applications for SBS Substituted Compliance
The final rules also address the procedures for submitting requests for substituted compliance, including:
- A request for substituted compliance may be submitted either by a party that potentially would comply with requirements under the Exchange Act through substituted compliance or by a relevant foreign financial regulatory authority.
- Applications must include any supporting documentation necessary to make the application complete, including:
- information regarding applicable requirements established by the foreign financial regulatory authority; and
- methods used by the foreign financial regulatory authority to monitor compliance with the rules.
The SEC expects to address further details regarding the availability of substituted compliance as part of future cross-border SBS rulemaking.
Extraterritorial Reach of SEC SBS Antifraud Rules
The final rules also address the scope of the SEC's cross-border antifraud civil enforcement authority and clarifies that the SEC's SBS antifraud authority extends to conduct:
- Within the US that constitutes significant steps in furtherance of an antifraud violation even if the securities transactions occurs outside the US and involves only foreign investors.
- Occurring outside the US that has a foreseeable substantial effect within the US.