CFTC Issues Prime Broker No-action Relief from Business Conduct Rules | Practical Law

CFTC Issues Prime Broker No-action Relief from Business Conduct Rules | Practical Law

On April 30, 2013, the CFTC issued no-action relief for swap dealers (SDs) from certain final Dodd-Frank external business conduct standards (EBCS) when entering into swaps and certain foreign exchange (FX) transactions in a prime brokerage capacity.

CFTC Issues Prime Broker No-action Relief from Business Conduct Rules

Practical Law Legal Update 4-527-2649 (Approx. 5 pages)

CFTC Issues Prime Broker No-action Relief from Business Conduct Rules

by PLC Finance
Published on 06 May 2013 • USA (National/Federal)
On April 30, 2013, the CFTC issued no-action relief for swap dealers (SDs) from certain final Dodd-Frank external business conduct standards (EBCS) when entering into swaps and certain foreign exchange (FX) transactions in a prime brokerage capacity.
On April 30, 2013, the CFTC issued No-action Letter 13-11 (Letter 13-11), providing no-action relief to swap dealers (SDs) entering into swaps and certain foreign exchange (FX) transactions with their customers in a prime brokerage (PB) capacity from compliance with certain Dodd-Frank external business conduct standards (EBCS) applicable to SDs (see Practice Note, Swap Dealers and MSPs: Final Dodd-Frank External Business Conduct (EBC) Rules), which became effective May 1, 2013. PBs, which are almost always SDs, often rely on other institutions to act as executing dealers (EDs) to execute certain individual PB transactions with their PB customers, which are then transferred to the PB. Because many of the EBCS involve pre-trade obligations, it is often not practicable for the PB to fulfill all of its obligations as an SD under the EBCS with respect to a particular PB transaction. The no-action relief therefore:
  • Permits an SD engaging in a PB transaction (a PBSD) to allocate certain EBCS responsibilities to an ED that is also an SD.
  • Exempts the PBSD from certain obligations under the EBCS where the ED is not an SD.
The CFTC has granted relief to PBSDs from the following EBCS when entering into "Covered Transactions" under a PB arrangement, provided an ED that is an SD has accepted the allocation by the PBSD of the PBSD's allocated EBCS responsibilities:
  • Section 23.402(b)-(f) (know your counterparty, true name and owner, reasonable reliance on representations, manner of disclosure and disclosures in a standard format).
  • Section 23.430 (verification of counterparty eligibility).
  • Section 23.431 (disclosures of material information).
  • Section 23.432(b) (clearing disclosures for swaps not required to be cleared).
  • Section 23.434 (recommendations to counterparties of institutional suitability).
  • Section 23.440 (requirements for SDs acting as advisors to Special Entities).
  • Section 23.450 (requirements for SDs and MSPs acting as counterparties to Special Entities).
  • Section 23.451 (political contributions by certain SDs).
Covered Transactions include:
This relief is subject to various conditions enumerated on pages seven through nine of the letter, including:
  • The PB and the counterparty must enter into a Covered Transaction where all material terms and conditions are substantially identical to those that the counterparty and ED committed to.
  • The PB and the ED must enter into a Covered Transaction with substantially equal but opposite terms and conditions to the Covered Transaction between the PB and the counterparty.
  • All apportionable business conduct obligations are allocated between the two SDs.
  • Proper notice of allocation of business conduct allocation has been given in writing and includes an agreement by each SD that:
    • it will be fully responsible for each apportionable business conduct obligation that has been allocated to it;
    • it will not be responsible for compliance with the business conduct obligations that were allocated solely to the other SD; and
    • each SD will remain responsible for fulfilling its allocated business conduct obligations until they expire or terminate, and its counterparty or a duly authorized representative will provide notice of any expiration or termination of the allocation of the apportionable business conduct obligation no later than 30 days prior to the expiration or termination.
Additionally, the CFTC has provided no-action relief from EBCS Sections 23.431(a)(3)(i) (requiring the disclosure of the transaction's per-trade mid-market mark) and 23.431(b) (requiring that the SD provide its counterparty with a scenario analysis if requested) for Exempt FX Transactions executed under a PB arrangement where the PB is an SD but the ED is not an SD. This relief is subject to the following conditions:
  • The PB is an SD and the ED is not an SD.
  • The PBSD notifies the counterparty prior to entering into the Exempt FX Transaction that it will not perform the obligations exempted under Letter 13-11 for qualifying transactions.
The CFTC recognizes that the conditions to this no-action relief may require the drafting of new documentation and therefore provides a two-week phase-in period until May 15, 2013. During the phase- in period, the CFTC will not enforce action against any SD for failure to comply with any apportionable EBCS obligations mentioned in Letter 13-11 with respect to Covered Transactions provided that they are conducted under PB arrangements of the SD that were in existence as of April 30, 2013. This no-action relief is intended to be time-limited and will expire on the later of either:
  • The effective date of any final rule or order providing relief from the EBCS relating to Covered Transactions executed under PB arrangements as described in Letter 13-11.
  • The compliance date of any final rule or order providing relief from the EBCS relating to Covered Transactions executed under PB arrangements as described in Letter 13-11.
Under a typical PB arrangement, a customer may seek quotes for a transaction from among a group of approved EDs and, provided the transaction terms fall within certain pre-agreed parameters, the transaction is then essentially transferred to the PB under what is known as a "give up" (which functions as a novation). The PB then stands opposite the customer in the transaction. This is done to enable the customer to obtain best pricing on its transactions and to access markets in which its PB may not offer certain products or competitive pricing.