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In a speech today at the 2012 FINRA Annual Conference, CFTC Chairman Gary Gensler provided a preview of the CFTC's much anticipated guidance regarding cross-border application of Title VII of the Dodd-Frank Act. According to Chairman Gensler, the proposed cross-border guidance, which is expected sometime in June, will address how Title VII's registration, transaction-level and entity-level requirements for swap dealers and major swap participants (collectively, "Swaps Entities") would apply to non-U.S. Swaps Entities, including those non-U.S. Swaps Entities that are affiliated with U.S. financial institutions. Chairman Gensler's five-point summary of the key elements of the forthcoming guidance is provided below, followed by our views of potential implications and open issues associated with each key element.
1. "First, when a foreign entity transacts in more than a de minimis level of U.S. facing swap dealing activity, the entity would register under the CFTC's recently completed swap dealer registration rules."
Potential Implications and Open Issues. The first "key element" suggests that, in determining whether a non-U.S. entity must register as a swap dealer, the CFTC would focus on the entity's "U.S. facing swap dealing activity" and whether such activity cross "a de minimis level." In stating that the approach applies to a "foreign entity," Chairman Gensler appears to imply that it would not be available to a U.S. entity. It is unclear whether the reference to "a de minimis level" refers to the way in which non-U.S. facing swap dealing activity is counted for purposes of the general de minimis exemption from the definition of swap dealer, or whether the CFTC plans a separate de minimis threshold for "U.S. facing swap dealing activity."
2. "Second, the release will address what it means to be a U.S. facing transaction. I believe this must include transactions not only with persons or entities operating in the United States, but also with their overseas branches. In the midst of a default or a crisis, there is no satisfactory way to really separate the risk of a bank and its branches. Likewise, I believe this must include transactions with overseas affiliates that are guaranteed by a U.S. entity, as well as the overseas affiliates operating as conduits for a U.S. entity's swap activity."
Potential Implications and Open Issues. The second "key element" implies that "U.S. facing transaction" will include, at a minimum: (i) transactions with non-U.S. branches of "entities operating in the United States;" (ii) transactions with overseas affiliates that are guaranteed by a U.S. entity; and (iii) overseas affiliates operating as conduits for a U.S. entity's swap activity. As a result, it appears that a swap with a non-U.S. branch of a U.S. bank will be treated as a "U.S. facing transaction." While it is unclear what "entities operating in the United States" means in this context, it may signal an approach to cross-border application that is not based solely on an entity's place of incorporation or organization. Also unclear is whether "operating as conduits for a U.S. entity's swap activity" is intended to be an anti-evasion category or an attempt to more generally regulate non-U.S. swap booking entities with which U.S. swap dealers enter into back-to-back transactions.
3. "Third, based on input the Commission has received from market participants, the staff recommendations will include a tiered approach for requirements for overseas swap dealers. Some requirements would be considered entity-level, such as for capital, risk management and recordkeeping. Some requirements would be considered transaction-level, such as clearing, margin, real-time public reporting, trade execution and sales practices."
Potential Implications and Open Issues. The third "key element" addresses how Title VII's substantive requirements will apply to non-U.S. Swaps Entities and distinguishes between entity-level and transaction-level requirements. This entity-level/transaction-level conceptual paradigm for the cross-border application of Title VII was advocated in a number of industry comment letters.
4. "Fourth, such entity-level requirements would apply to all registered swap dealers, but in certain circumstances, overseas swap dealers could comply with these requirements through substituted compliance."
Potential Implications and Open Issues. Chairman Gensler explained elsewhere in his speech that "substituted compliance" refers to "reliance on comparable and comprehensive foreign regulatory regimes." This fourth "key element" suggests that the CFTC may defer on certain entity-level requirements to foreign regulation, but implies that U.S. swap dealers would not benefit from such "substituted compliance." It remains to be seen how the CFTC will evaluate the comparability or comprehensiveness of foreign regulatory regimes.
5. "Fifth, such transaction-level requirements would apply to all U.S. facing transactions, but for certain transactions between an overseas swap dealer (including a foreign swap dealer that is an affiliate of a U.S. person) and counterparties not guaranteed by or operating as conduits for U.S. entities, Dodd-Frank may not apply. For example, this would be the case for a transaction between a foreign swap dealer and a foreign insurance company not guaranteed by a U.S. person."
Potential Implications and Open Issues. The fifth "key element" implies that U.S. Swaps Entities will be subject to transaction-level requirements with respect to all swap activities, regardless of whether the counterparty is a U.S. person. However, a non-U.S. swap dealer, including one that is affiliated with a U.S. financial institution, may benefit from a limited exclusion for transactions between the non-U.S. swap dealer and non-U.S. counterparties that are not "guaranteed by or operating as conduits for U.S. entities." An open issue is how the CFTC will define "U.S. person."
While Chairman Gensler's remarks shed light on the CFTC's current thinking, it also raises important issues and questions that may only be made clear in the forthcoming cross-border guidance itself.
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