CFTC Proposes Revised "US Person" Definition and Clarification on Important Cross-Border Swaps Rules | Practical Law

CFTC Proposes Revised "US Person" Definition and Clarification on Important Cross-Border Swaps Rules | Practical Law

The CFTC approved a proposed rule that would redefine certain key cross-border swap terms, including "US Person," and provide clarification on other important Dodd-Frank cross-border swaps rules, such as counting cross-border swaps toward swap dealer thresholds and application of CFTC swaps rules to swaps arranged, negotiated, or executed (ANE) in the US.

CFTC Proposes Revised "US Person" Definition and Clarification on Important Cross-Border Swaps Rules

by Practical Law Finance
Published on 20 Oct 2016 • USA (National/Federal)
The CFTC approved a proposed rule that would redefine certain key cross-border swap terms, including "US Person," and provide clarification on other important Dodd-Frank cross-border swaps rules, such as counting cross-border swaps toward swap dealer thresholds and application of CFTC swaps rules to swaps arranged, negotiated, or executed (ANE) in the US.
On October 11, 2016, the CFTC issued a proposed rule that would redefine certain key cross-border swap terms, including "US Person," and provide clarification on other important Dodd-Frank cross-border swaps rules, such as counting cross-border swaps toward swap dealer thresholds and application of CFTC swaps rules to swaps arranged, negotiated, or executed (ANE) in the US.
Specifically, the proposed rule would:
The proposed rule is intended to:
Comments on the proposed rule are due by December 19, 2016. Comments may be submitted by mail or electronically here.
The CFTC also issued a fact sheet on the proposed rule.
For details on the CFTC Cross-Border Guidance and Cross-Border ANE Staff Advisory, see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules.

Revised Definitions

The proposed rule would revise the definitions of the terms "US Person" and "Foreign Consolidated Subsidiary" for purposes of the application of CFTC Dodd-Frank swaps rules.

"Foreign Consolidated Subsidiary" Definition

The proposed rule would revise the definition of the term "Foreign Consolidated Subsidiary" (FCS) to align with the definition included in the cross-border margin rules. Under the proposed rules, an FCS would be a non-US person that is consolidated for accounting purposes with a US ultimate parent entity in accordance with US Generally Accepted Accounting Principles (US GAAP).
Under this definition, an FCS would be required to include swaps in its SD/MSP notional threshold calculation in the same way a US Person must. The CFTC is looking to close a loophole under which a US financial group could avoid SD/MSP registration, and Dodd-Frank rules, by using an unregistered non-US entity to conduct swap activities. This could capture additional parties within the SD definition, resulting in new registrants.
Because these activities could have a direct impact on the FCS's US parent entity and therefore the US financial system, the CFTC ought to capture the transactions of these entities, subjecting them to its SD/MSP regulatory regime (see Cross-Border Application of the SD and MSP Registration Thresholds).
As noted, the CFTC already closed this loophole with respect to margin rules for certain uncleared swaps (see Legal Update, CFTC Adopts Final Rule on Cross-Border Application of Uncleared Swaps Margin Rules and Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: CFTC Rules on Cross-Border Application of Margin Rules for Uncleared Swaps).

"US Person" Definition

The "US Person" definition would be revised to align with the definition in the cross-border margin rules (see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: CFTC Definition of "US Person"). The definition would include legal entities for which one or more US Persons have unlimited responsibility for the entity's obligations and liabilities, including foreign branches of US Persons.
The proposed definition of "US Person" is also generally consistent with the interpretation set out in the Cross-Border Guidance, except that, unlike the Cross-Border Guidance definition but similar to the definition in the cross-border margin rules, the proposed definition of "US Person" does not include the "US majority owned funds" prong (see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: CFTC Definition of "US Person"). Thus, the proposed definition does not include the following:
  • A commodity pool that is majority-owned by one or more US Persons.
  • A pooled account that is majority-owned by one or more US Persons.
  • An investment fund that is majority-owned by one or more US Persons.
  • A collective investment vehicle that is majority-owned by one or more US Persons.
  • A catchall provision.
  • An international financial institution, which includes "international financial institutions," as defined by the International Monetary Fund (22 USC 262r(c)(2)) and multilateral development banks. This exclusion of international financial institutions is similar to the exclusion in the "US Person" definition found in the SEC's cross-border security-based swaps rules (see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: SEC "US Person" Definition).

Scope of Arranged, Negotiated, or Executed (ANE) Rules

In September 2014, the CFTC's controversial Staff Advisory 13-69 (ANE Staff Advisory) was challenged and upheld in federal court (see Legal Update, CFTC Cross-border Swaps Rules Upheld in Court). With that judicial stamp of approval, the CFTC is now codifying and clarifying the ANE Staff Advisory and related rules for purposes of determining:
  • Whether persons engaged in ANE transactions are required to comply with certain provisions of the Dodd-Frank Act, including certain business conduct rules and the application of the SD registration threshold.
  • Whether persons engaged in ANE transactions would be required to comply with applicable provisions of the proposed rule.
Under the proposed rules (like the ANE Staff Advisory), a non-US SD or MSP using US personnel to arrange, negotiate, or execute its swap transactions falls within the scope of the Dodd-Frank Act and related CFTC rules, including business conduct rules and the application of the SD registration threshold. In making a determination of whether a particular Dodd-Frank swap requirement would apply to an ANE transaction, the final rule states that the CFTC would also consider whether underlying regulatory objectives would be furthered by subjecting ANE transactions to that particular Dodd-Frank swap requirement.
ANE swaps are subject to Dodd-Frank swaps rules including internal and external business conduct rules for SDs and MSPs (see The Dodd-Frank Act: Requirements for Swap Dealers and MSPs Checklist).
The proposed rule focuses on whether a person is arranging, negotiating, or executing a swap within the scope of the CFTC's "swap dealer" definition under the Commodity Exchange Act (CEA) and CFTC regulations (7 USC 1a(49) and 17 CFR 1.3(ggg)), regardless of whether the primary risks of the transaction reside within or outside of the US.
The application of the rule turns on whether the US or non-US person is engaging US personnel in market-facing activity, as opposed to internal, ministerial, or clerical tasks performed by personnel not involved in the actual swap. As such, the terms "arrange" and "negotiate" would not include activities such as:
  • Swap processing.
  • Preparation of the underlying swap documentation, including negotiation of a master agreement (such as an ISDA Master Agreement) and related documentation.
  • Provision of research information to sales and trading personnel in the US.
US personnel engaging in sales and trading activities, even if the personnel is not formally designated as sales persons or traders, would fall within the scope of "arranging" or "negotiating."
The CFTC explains that "arranging," "negotiating," and "executing" swaps are, again, functions that fall specifically within the definition of the term "swap dealer," so the CFTC relies on that definition to determine whether certain activities are considered ANE.
The CFTC cites the following examples as being activities that would qualify a person as an SD, under CFTC and SEC definitions, and thus would also qualify as market-facing activity for purposes of the scope of "arranging" and "negotiating" a transaction:
  • Advising a counterparty on how to use swaps or structuring swaps on behalf of a counterparty.
  • Actively advertising or soliciting clients in connection with swaps.
  • Acting in a market-making capacity and helping to set prices offered in the market.
(77 FR 30596, at 30608). For more information on the definition of "swap dealer," see Practice Note, Swap Dealer and MSP Threshold Calculations.
The CFTC further clarifies that the application of the proposed rule would include incidental swap activity that falls within the scope of an ANE transaction and would not be limited to swaps "regularly" arranged, negotiated, or executed using US personnel.

Counting Cross-Border Transactions Toward SD and MSP Registration Thresholds

If adopted, the proposed rule would supersede the Cross-Border Guidance with respect to counting cross-border swap transactions toward the de minimis notional SD and MSP thresholds, and would clarify the following:
  • A US Person or a non-US person whose obligations under the relevant swap are guaranteed by a US Person (US-guaranteed entity) would include all of its swap dealing transactions.
  • A FCS would include all of its swap dealing transactions.
  • A non-US Person that is neither a FCS or US-guaranteed entity ("Other Non-US Person") would not include swap dealing transactions with other non-US persons, even if they constitute ANE transactions, but would include a particular swap if the counterparty is a:
In addition, the proposed rule includes an aggregation requirement for SDs that mirrors the requirement in the Cross-Border Guidance. Under the proposed rule, a potential SD would aggregate all swaps connected with its dealing activity with those of persons controlling, controlled by, or under common control with the potential SD, regardless of whether US or non-US persons, to the extent that these affiliated persons are themselves required to include those swaps in their own de minimis thresholds, unless the affiliated person is itself a registered SD (see Practice Note, The Dodd-Frank Act: Cross-Border Application of Swaps Rules: Cross Border Aggregation Rules for SD and MSP Calculations).
Similarly, for MSPs under the proposed rule, in making its MSP threshold calculations:
  • A US Person or US guaranteed entity would include all of its swap positions.
  • A FCS would include all its swap positions.
  • Other Non-US Persons would include all of their swap positions with counterparties that are US Persons, US-guaranteed entities, or FCS, unless the swap is cleared and executed anonymously on a registered SEF, DCM, or FBOT.
  • Other Non-US Persons would not include any of their swap positions with other non-US counterparties, even if they constitute ANE transactions.
All swap positions for which there is recourse to another entity must be attributed to a guarantor, whether a US Person or a non-US person, unless the guarantor, the guaranteed entity, and its counterparty is an Other Non-US Person.
Under the proposed rule, this attribution requirement is only applicable for MSPs, and does not apply to SDs. SDs are subject to the aggregation requirement, discussed above at Counting Cross-Border Transactions Toward SD and MSP Registration Thresholds, whereas MSPs are not subject to the aggregation requirement.
In addition, the CFTC notes that under the proposed rule, a non-US person would be required to include in its de minimis calculations a swap entered into with a foreign branch of a US SD. On the other hand, under the Cross-Border Guidance, a non-US person that is not a guaranteed affiliate (a non-US affiliate of a US person that is guaranteed by a US person) or a conduit affiliate would not be required to include transactions entered into with foreign branches of US SDs in its threshold calculations.
The CFTC has proposed to include foreign branches of SDs in non-US persons' threshold calculations, which is consistent with its inclusion of foreign branches in the proposed rule's definition of "US Person" (see "US Person" Definition).
For further details on SD and MSP threshold calculations, see US Derivatives Regulation: Swap Dealer and MSP Threshold Calculations.

Cross-Border Application of EBC Standards for SDs and MSPs

Lastly, the proposed rule addresses the extent to which SDs and MSPs would be required to comply with the CFTC EBC rules in cross border transactions. Under the proposed rule:
  • US SDs and MSPs would be required to comply with the EBC rules regardless of the status of the counterparty as a US or non-US person, without substituted compliance.
  • Foreign branches of US SDs and MSPs and non-US SDs and MSPs, including FCS and US-guaranteed entities, would be:
    • required to comply with the EBC rules to the extent that the counterparty is a US person, without substituted compliance; and
    • generally not required to comply with the EBC rules to the extent that the counterparty is a non-US SD or MSP or foreign branch of a US SD or MSP, with the exception that they would be required to comply with CFTC Regulations 23.410, the Prohibition on Fraud, Manipulation, and other Abusive Practices, and 23.433, Fair Dealing, if the non-US SD or MSP or foreign branch of a US SD or MSP is engaged in an ANE transaction, without substituted compliance (see Proposed Definitions and Application of Proposed Rule to ANE Transactions). (17 CFR 23.410, 23.433).
If adopted, the proposed rule would supersede the Cross-Border Guidance with regard to the cross-border application of the EBC rules.
For more information on EBC rules for SDs and MSPs, see Practice Note, the Dodd-Frank Act: External Business Conduct (EBC) Rules for Swap Dealers and MSPs.