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CFTC and EU Reach Accord on Derivatives Regulation; CFTC Issues Cross-border Guidance and Relief
Practical Law Legal Update 9-534-5846 (Approx. 6 pages)
CFTC and EU Reach Accord on Derivatives Regulation; CFTC Issues Cross-border Guidance and Relief
by Practical Law Finance
| Published on 16 Jul 2013 • European Union, USA (National/Federal) |
The CFTC and the European Commission (EC) have agreed to harmonize cross-border derivatives reform, and the CFTC granted temporary relief to non-US firms from compliance with Dodd-Frank rules for swap dealers and major swap participants that were to begin to apply to non-US entities on July 12, 2013. The CFTC also issued guidance on when it will subject non-US entities to its Dodd-Frank swaps rules under its "substituted compliance" rules.
On July 11, 2013, the CFTC and the European Commission (EC) reached a cross-border accord on derivatives regulation, resolving a transatlantic controversy initiated when the CFTC announced the extraterritorial reach of its Dodd-Frank swaps rules in 2012. The CFTC-EC compromise prevented an interruption of cross-border derivative transactions that would have resulted from the CFTC's proposal to:
- Force all swaps involving at least one US counterparty to be cleared in the US.
- Subject certain non-US institutions entering into swaps with US entities to two sets of potentially duplicative, conflicting or inconsistent regulations.
The CFTC also issued:
- On July 26, 2013, a final guidance and policy statement (final guidance) on when it will subject non-US entities to its Dodd-Frank swaps rules under its "substituted compliance" rules, in light of the agreement. This guidance will go into effect shortly, once it is published in the Federal Register. For details on the final guidance, see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules.
- Issued four related no-action letters in connection with the CFTC-EC accord. The CFTC issued No-action Letter 13-43 and No-action Letter 13-44 to two European-based clearing organizations, LCH.Clearnet and Eurex Clearing, to allow them to perform certain clearing services to clearing members that are US persons during the period that their DCO registration is pending. This relief will expire on the earlier of the date on which the CFTC approves the firm's pending application for registration as a DCO, or December 31, 2013.
- An exemptive order effective July 13, 2013, which provides non-US SDs and MSPs with the following temporary relief until October 9, 2013:
- Exclusion of non-US swaps SD/MSP calculations. The exemptive order provides that a non-US person (regardless of whether the non-US person's swaps obligations are guaranteed by a US person) may exclude from its calculation of the aggregate gross notional amount of swaps connected with its swap dealing activity for purposes of determining whether it is an SD under CFTC Regulation 1.3(ggg)(4) or in its calculation of whether it is an MSP under CFTC Regulation 1.3(hhh) (see Practice Note, Is Your Client a Swap Dealer or Major Swap Participant?), any swaps where the counterparty is a non-US person, or any swap where the counterparty is a foreign branch of a US person that is registered as an SD.
- Use of previous definition of "US person." The interim grace period under the final guidance permits firms to use the previous definition of "US person" until October 9, 2013 (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Definition of "US Person").
- Exemption from Dodd-Frank swap clearing requirements for non-US SDs and MSPs. Non-US SDs and non-US MSPs need not comply with effective Dodd-Frank swap clearing requirements under CEA section 2(h)(1), CFTC Regulations Part 50, and CFTC Regulation 23.506.
- Exemption for certain non-US SDs from compliance with transaction-level requirements. Non-US SDs and foreign branches of US SDs outside of the six enumerated jurisdictions (Australia, Canada, the EU, Hong Kong, Japan and Switzerland) entering into swaps with guaranteed affiliates of US persons may comply with any law and regulation of the jurisdiction in which it is established instead of complying with transaction-level requirements (for information on transaction-level requirements, see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Entity-level Requirements and Transaction-level Requirements).For further details on the exemptive order, see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Temporary CFTC Exemptive Relief for Non-US SDs and MSPs.
- On July 31, 2013, a notice regarding expiration of cross-border exemptive relief from Dodd-Frank swap clearing requirements, which clarifies that certain exemptive relief regarding clearing requirements will expire on October 9, 2013, and non-US entities that had previously been exempt under this relief will be required to comply with clearing requirements as of October 10, 2013. On this date certain collective investment vehicles organized outside the US and other entities that qualify as US persons become subject to the Dodd-Frank clearing requirement (see Summary of the Dodd-Frank Act: Swap Clearing and Exchange Trading under Title VII).Under the notice, the following transactions must be submitted for clearing with a registered derivatives clearing organization (DCO), unless other relief is applicable:
- all transactions by foreign branches of US banks that are registered SDs;
- transactions between SDs and MSPs that are not US persons and guaranteed affiliates or affiliate conduits of US persons (established in any jurisdiction outside the US) that are not SDs or MSPs, or with foreign branches of US banks that are registered SDs or MSPs;
- transactions between SDs and MSPs that are not US persons and foreign branches of US banks that are registered SDs of MSPs; and
- transactions between two guaranteed affiliates or affiliate conduits of US persons (established in any jurisdiction outside the US) that are not SDs or MSPs.
Under the "Common Path Forward," the CFTC and EC have each generally agreed to defer to the regulatory requirements of the other jurisdiction in situations where it is "justified," while attempting to ensure that the coordinated cross-border approach to derivatives regulation does not allow for certain affiliates or branches of US or EU persons to engage in regulatory arbitrage between the US and EU derivatives regulatory regimes.
Under the final guidance, the CFTC permits substituted compliance for entity-level requirements applicable in the EU that are comparable to, and as comprehensive as, those applicable in the US (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Entity-level Requirements and Transaction-level Requirements). The CFTC has made separate substituted compliance determinations on 13 categories of requirements (five entity-level and eight transaction-level requirements). For more information on substituted compliance, see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: "Substituted Compliance" with Foreign Regulations Sufficient in Certain Circumstances.
The final guidance allows non-US banks and other major swaps traders to wait to comply with certain Dodd-Frank provisions until the CFTC determines:
- If the analogous rules to which they are subject are comparable to the US rules.
- Whether to permit these entities to comply with "home country" rules rather than the US rules.
If the CFTC does not make a determination of comparability of home-country rules by December 21, 2013, entities that would otherwise qualify as SDs or MSPs due to their US swaps activity would be required to begin to comply with US derivatives regulations.
Under the cross-border accord and the guidance, generally:
- A non-US SD that is not affiliated with or guaranteed by a US person will only be subject to the CFTC's transaction-level requirements in transactions with US persons and guaranteed affiliates of US persons. For details on which requirements are transaction-level requirements, see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Entity-level Requirements and Transaction-level Requirements.
- For bilateral uncleared swaps, the CFTC plans to issue no-action relief for certain transaction-level requirements. Market participants will be allowed to determine their own choice of rules.
- For trade execution requirements, the CFTC plans to permit foreign boards of trade (FBOTs), non-US derivatives exchanges, which are operating under a "direct access" no-action relief letter, to also list swap contracts for trading by direct access to avoid market and liquidity disruption.
- The CFTC plans to clarify that where a swap is executed on an anonymous and cleared basis on a registered designated contract market (DCM), swaps execution facility (SEF) or FBOT, the counterparties will be deemed to have met their transaction-level requirements, including the CFTC's Dodd-Frank trade-execution requirement. On July 11, 2013, the CFTC issued No-action letter 13-46, which amends previous no-action letters to permit identified members or other participants located in the US to list swap contracts for trading by direct access, subject to certain conditions.
- In the event that the CFTC's Dodd-Frank trade execution requirement is triggered before March 15, 2014, the CFTC will extend appropriate relief to certain EU-regulated multilateral trading facilities (MTFs) that have multinational trading schemes, a sufficient level of pre- and post-trade price transparency, non-discriminatory access by market participants and an appropriate level of oversight.
- The EC, European Maritime Safety Agency (EMSA) and the CFTC acknowledge that they have many identical processes for mandatory clearing obligations and regulating intra-group swaps and derivatives trades, and will continue to work together to harmonize international rules on margins for uncleared swaps.
- The EC, EMSA and CFTC agree that they will continue to resolve remaining issues such as consistent data fields in swap data reporting rules, access to data and other issues related to privacy, blocking and secrecy laws.
- Both CFTC rules and European Market Infrastructure Regulation (EMIR) rules regarding derivatives clearing organizations (DCOs) and derivatives clearinghouses central counterparties (CCPs) are based on international minimum standards with CCP initial margin coverage as the only key material difference between them. The CFTC and EU will work together to reduce any regulatory arbitrage opportunities and ensure that DCOs and CCPs that have not yet been recognized or registered will be permitted to continue their business operations.
- The CFTC and EU acknowledge that they have essentially identical rules in the areas of risk mitigation for the largest counterparty swap market participants. On July 11, 2013, the CFTC issued No-action Letter 13-45 specifying that where a swap is subject to joint jurisdiction under the US (Section 4s of the CEA) and EU risk mitigation rules (Article 11 of EMIR), compliance under EMIR will achieve compliance under the relevant CFTC rules.
- The definition of "US person" should include offshore hedge funds and collective investment vehicles that are either majority-owned by US persons or that have their principal place of business in the US. This is a significant change from the definition of "US person" detailed in the Final Exemptive Order Regarding Compliance with Certain Swap Regulations which was issued in January 2013 and expired on July 12, 2013. This definition specifically excluded offshore funds and collective investment vehicles even if they had their principal place of business in the US (see Practice Note, The Dodd-Frank Act: Cross-border Application of Swaps Rules: Definition of "US Person").