CFTC Issues Further Guidance on Application of Its Rules to SEFs (with Lofchie Comment)

The CFTC Division of Market Oversight ("DMO") has issued further staff "guidance" as to swap execution facilities ("SEFs"). The Guidance addresses six areas, including:

• SEF/DCM registration requirements, which apply to multilateral swaps trading platforms located both in and outside the U.S. under CFTC Rule 37.3 ("Requirements and Procedures for Registration") if the SEF is used for executions by either (i) non-U.S. persons located within the United States or (ii) U.S. persons through agents;
• consent by clearing members to the jurisdiction of a SEF pursuant to CFTC Rule 37.700 ("Core Principle 7-Financial Integrity of Transactions"), which requires that SEFs "establish and enforce rules and procedures for ensuring the financial integrity of swaps entered on or through the facilities of the SEF, including the clearance and settlement of the swaps pursuant to Section 2(h)(1)" of the CEA;
• a SEF's use of proprietary data or personal information collected by the SEF from its market participants. The Guidance states that it is inconsistent with CFTC Rule 37.7 ("Prohibited Use of Data Collected for Regulatory Purposes") for a SEF participation agreement or rulebook to contain a requirement that, in order to access the SEF, an eligible contract participant must consent to the SEF's using data it collects from the ECP, including market data, propriety data, and personal data for business or marketing purposes;
• clarification that a trade guarantee from a clearing member is required to satisfy CFTC Rule 37.700, but that an additional guarantee from a SEF member is not required;
• a SEF's definition of "emergency" situations must be consistent with the definition in CFTC Rule 40.1(h) ("Definitions") and not broader than such definition; and
• SEF reporting obligations, particularly the obligation that, when a SEF reports swap data, it must also report the legal entity identifier of the SEF.

Lofchie Comment: This "guidance" appears to represent a fairly remarkable extension of the CFTC's jurisdiction, albeit subject to the usual questions as to whether (i) the CFTC is stretching its assertion of jurisdiction in Section 2(i) beyond what Congress intended, (ii) the CFTC is acting in violation of the Administrative Procedures Act and (iii) the standards laid down in the guidance are clear.In the first instance, the "guidance" states that the "[Market Oversight] Division [of the CFTC] expects that a multilateral swaps trading platform located outside the United States that provides U.S. persons or persons located in the U.S. (including personnel and agents of non-U.S. persons located in the United States) . . . with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary, will register as a SEF or DCM." A footnote to this language indicates that the CFTC would consider various factors in determining whether a non-U.S. SEF would have to register, although the conditions in the footnote are entirely ambiguous and include phrases such as "a significant [but undefined] portion" and "generally include, but not be limited to." In short, a SEF that does not exclude all trading by U.S. persons, or by non-U.S. persons who are present in the United States, is subject to CFTC registration. Further, according to the guidance, once a SEF registers, every clearing member of the SEF must be subject to the jurisdiction of the SEF, which has the effect of giving the CFTC indirect jurisdiction over the clearing member. In summary, the CFTC assert that it may have jurisdiction over SEFs everywhere in the world (even where no U.S. person can trade directly on the SEF) and over every clearing member of every such SEF.As to the three questions we mentioned above: (i) it seems very doubtful that activity on a foreign exchange in which US persons participate through agents is the type of activity that Congress intended the CFTC to regulate and the CFTC's authority to do so would seem certain to be challenged by non-US governments; (ii) if this is a rule, there should be cmpiance with the Administrative Procedures Act; and (iii) the standard for when a non-U.S. exchange must register is entirely unclear. As to the latter point, the text of the guidance would seem to indicate that one bad transaction could require registration, while the footnote indicate that guidance would "generally" not be required unless a "significant" portion of transactions involved the U.S., but the key terms are undefined. This guidance is likely to have significant market consequences as non-U.S. SEFs exclude U.S. participation to avoid CFTC registration and to draw international resistance from the CFTC's global regulatory colleagues.

See: CFTC DMO Staff Guidance. Related news: CFTC Issues Staff "Guidance" on Impartial Access to SEFs (with Lofchie Comment) (November 14, 2013); Triple International Financial Law Review Articles on SEFs (October 24, 2013); CFTC Issues Time-Limited No-Action Letter for FCMs and SEFs (13-62) (with Lofchie Comment) (October 1, 2013); CFTC Issues Time-Limited No-Action Letter Relief for Temporarily Registered SEFs and Designated Contract Markets from the One-Business-Day Product Review Period Requirement (13-60) (October 1, 2013); CFTC's DMO Issues Time-Limited No-Action Relief for Temporarily Registered SEFs (with Lofchie Comment) (September 30, 2013); Two CFTC No-Action Letters (13-55 and 13-56) on Swap Data Reporting (with Lofchie Comment) (September 30, 2013); CFTC's DMO Provides Time-Limited No-Action Relief to SEFs and Market Participants (with Lofchie Comment) (September 27, 2013); CFTC Issues Staff Guidance on Swaps Straight-Through Processing (with Delta Strategy Group Summary) (September 27, 2013).