CFTC Issues Proposed Rule on Cross-Border Margin
The CFTC voted unanimously to propose a rule that would apply the CFTC's margin requirements for uncleared swaps in the context of cross-border transactions.
On June 29, 2015, the CFTC voted to publish proposed rules regarding the cross-border application of its margin requirements for uncleared swaps (the "CFTC Cross-Border Proposal" or "Proposal"). The CFTC Cross-Border Proposal follows the CFTC's proposal for margin requirements for uncleared swaps ("Margin Proposal"),[1] which was published in October 2014 and included an advance notice for proposed rulemaking as to the cross-border application of the margin requirements. (A Cadwalader memorandum summarizing the Margin Proposal is available here.)
The CFTC called the Proposal a "hybrid" of the entity and transaction-level approaches outlined in the Margin Proposal and indicated that the approach of the Proposal is intended to be "closely aligned" with that which was taken by the prudential regulators in their margin proposal. (A Cadwalader memorandum summarizing the prudential regulators' proposal is available here.)
Entity Divisions
Regulated Entities. As summarized in the table below, in determining whether the CFTC margin requirements would apply to a swap, the Proposal essentially divides regulated entities into four categories: (i) U.S. swap dealers; (ii) non-U.S. swap dealers guaranteed by U.S. persons ("U.S.-Guaranteed SDs"); (iii) non-U.S. swap dealers that are consolidated subsidiaries of a U.S. "ultimate parent entity" ("FCEs"); and (iv) non-U.S. swap dealers that are neither (ii) nor (iii) ("Fully Non-U.S. SD").[2] The Proposal also would limit the exclusions available to transactions "executed through or by" the U.S. branch of a non-U.S. Swap dealer.
"U.S. Person" Definition. The CFTC did not rely on the definition of "U.S. person" in its cross-border guidance; instead, the Proposal includes a definition of "U.S. person" that starts with the guidance but makes the following notable changes: (i) the "majority ownership" prong that was applicable to pooled investment vehicles has been removed and (ii) the CFTC codified its view that a branch (foreign or not) of a U.S. entity is also a "U.S. person."
"Guarantee" Definition. The CFTC proposed a formal definition of "Guarantee" that would apply when determining one's status under the margin requirements. The definition, which is substantially similar to that which is used by the SEC in its cross-border security-based swaps rules (see SEA Rule 3a71-3(b)(1)(B)), looks to whether an entity has "rights of recourse"; i.e., "a conditional or unconditional legally enforceable right to receive or otherwise collect . . . payments" from a U.S. person in connection with the relevant swap.
Substituted Compliance Process
The Proposal provides that comparability determinations may be requested by either (i) swap dealers eligible for substituted compliance or (ii) foreign regulatory authorities with jurisdiction over swap dealers eligible for substituted compliance. The Proposal then provides that the CFTC will issue such a determination if it determines that "some or all" of the relevant jurisdiction's requirements are comparable, and that in making such a determination, the CFTC will consider five enumerated factors. One of the factors indicates that the CFTC will take an "outcomes-based" approach to substituted compliance, and will focus on whether the foreign jurisdiction's margin requirements "achieve comparable outcomes" to the CFTC margin requirements.
|
Type of Swap Dealer |
Margin Requirements |
|
U.S. Swap Dealers and U.S.-Guaranteed SDs |
Subject to all CFTC requirements, except where substituted compliance may apply with respect to the posting of initial margin to a non-U.S. person. |
|
Fully Non-U.S. SDs |
Requirements do not apply to transactions with non-U.S. persons (other than FCEs, U.S. branches of Fully Non-U.S. swap dealers and entities guaranteed by U.S. persons) if the transaction is not executed by or through a U.S. branch of the Fully Non-U.S. SD (the "Exclusion"). Substituted compliance generally is available if the counterparty is not a U.S. swap dealer or a U.S.-Guaranteed SD (i.e., including with respect to U.S. persons generally). As to transactions with U.S. swap dealers and U.S.-Guaranteed SDs, substituted compliance is available solely for initial margin collection if the counterparty is a U.S. swap dealer or a U.S.-Guaranteed SD. |
|
FCEs and U.S. branches of Fully Non-U.S. SDs |
Same as above, except that the Exclusion is not available (i.e., margin requirements (CFTC or sub. comp.) apply even when trading with fully non-U.S. counterparties). |
[1] The CFTC margin requirements for uncleared swaps would apply only to those swap dealers that do not have a "prudential regulator," as that term is defined in Commodity Exchange Act § 1a(39) (i.e., the CFTC generally has jurisdiction in this regard over non-bank swap dealers).
[2] The margin rules would apply equally to "major swap participants," but for ease of reference, we refer only to swap dealers here.
See: Fact Sheet; Proposed Rule; Chair Massad's Statement; Commissioner Wetjen's Statement; Concurring Statement by Commissioner Bowen; Commissioner Giancarlo's Statement.
See also: CWT Memo: Summary of Prudential Regulators' Re-Proposed Margin Rules (September 4, 2014); CWT Memo: CFTC Votes to Re-Propose Margin Requirements for Uncleared Swaps (September 18, 2014); CWT Memo: SEC Proposes Title VII Regulatory Framework for Non-US Dealers Transacting in the United States (April 30, 2015).
Related news: ESAs Publish Second Consultation Paper on Margin Requirements for Non-Centrally Cleared Derivatives (with Patel Comment) (June 10, 2015); CFTC Chair Massad Discusses CFTC Rulemaking in an International Context (with Lofchie Comment) (June 9, 2015); SIFMA and Other Associations Submit Letter to Multiple Regulators Regarding the Posting of Margin for Swaps between Affiliates (June 2, 2015).
Commentary
As in so many other cases of derivatives rulemaking across the globe in the past few years, the CFTC Proposal will result in market participants being required to make new status determinations as to themselves and to obtain additional information from their counterparties. The new definitions of "FCE," "U.S. person" and "Guarantee" all may require new data collection efforts. On the other hand, market participants should benefit from the fact that the CFTC is going through a rule-making process for these definitions instead of relying on the cross-border guidance.
As Commissioner J. Christopher Giancarlo mentions in his statement, the Proposal's treatment of U.S. branches of Fully Non-U.S. SDs is curious. In proposing to apply the margin requirements to such entities, the CFTC was not specific as to what it meant for a transaction to be executed "by or through" a U.S. branch. This is even more curious given (1) the controversy surrounding CFTC staff advisory 13-69 (regarding swaps "arranged, negotiated, or executed" in the United States) and (2) the fact that only a few months ago, the SEC devoted several pages in the Federal Register to addressing a substantially similar concept for security-based swap dealers. (A Cadwalader memorandum summarizing the SEC proposal is available here.)
Generally, the statements of Commissioners Mark Wetjen and Christopher Giancarlo are well worth reading in light of some of the issues in the Proposal that merit consideration and should be open to further consideration based on input gathered through the notice-and-comment process.
Of particular interest is the fact Commissioner Wetjen focuses on the macro-level policy implications of the CFTC's choice to take a more "entity-level" approach to the application of its margin requirements. He expresses concern that (1) multiple margin requirements could apply to a single transaction and (2) differences between the prudential regulators' approaches and the CFTC's could incentivize greater swaps activity in FCEs (versus their U.S. bank affiliates) looking to "exploit the relative dearth of resources available to the [CFTC] for supervising and enforcing compliance."
Commissioner Giancarlo's commentary addresses a number of substantive points in the Proposal, including (1) questions as to the CFTC's approach to substituted compliance, (2) the U.S. branch "through or by" treatment noted above, and (3) what the change in approach to cross-border issues will mean for the status of the CFTC cross-border guidance going forward.