By: Mark Horwitz | Claire L. Hall
On July 23, 2020, the U.S. Commodity Futures Trading Commission (the CFTC) voted to approve final rules (the Final Rules) regarding the cross-border application of various requirements under the U.S. Commodity Exchange Act (the CEA) applicable to swap dealers (SDs) and major swap participants (MSPs; SDs and MSPs collectively being Swap Entities). The Final Rules supersede the CFTC’s Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations published on July 26, 2013 (the Final Guidance). While the Final Guidance merely reflected the “general policy” of the CFTC in interpreting the cross-border application of the swap provisions of the CEA, the Final Rules have the force of a binding CFTC rule. Accordingly, the Final Rules should provide greater certainty to market participants than the Final Guidance regarding the cross-border application of the swap provisions of the CEA and related CFTC rules and regulations. Israeli companies that trade with US organized swap dealers or swap dealers that book from offices in the US should be aware of these final rules. Below is a summary of the Final Rules with references to changes made from the Final Guidance.
- “U.S. person” definitionThe Final Rules include a definition of “U.S. person” that replaces the corresponding definition in the Final Guidance. The definition in the Final Rules is narrower in scope than the Final Guidance definition such that no person or entity that is not a U.S. person under the Final Guidance will be a U.S. person under the Final Rules. The key changes from the Final Guidance are as follows:
- Collective investment vehicles owned by U.S. persons were included as “U.S. persons” in the Final Guidance but not in the Final Rules.
- The “unlimited U.S. responsibility” prong in the Final Guidance has been eliminated in the Final Rules.Under the Final Guidance, the CFTC indicated that it would consider a majority-owned affiliate to be a U.S. person “where one or more U.S. owners has unlimited responsibility for losses or nonperformance by its majority-owned affiliate.” In its discussion of the Final Rules, the CFTC indicated that while such persons no longer qualify as U.S. persons under the Final Rules, explicit financial support is considered a guarantee.Accordingly, swaps entered into by such a majority-owned affiliate would be considered to be guaranteed by a U.S. person for purposes of the Final Rules.The “unlimited U.S. responsibility” prong also is present in the CFTC’s final cross-border margin rule and that application is unchanged by the Final Rules.
- Commodity pools, investment funds and other collective investment vehicles majority owned by U.S. persons were included as “U.S. persons” in the Final Guidance but not in the Final Rules.
- The definition of U.S. person in the Final Guidance is non-exhaustive.In the Final Guidance, the CFTC indicated that it “will interpret the term ‘U.S. person’ generally to include, but not be limited to” an enumerated list. The Final Rules contain a definitive list of individuals and entities that can be considered U.S. persons, which provides greater certainty and eliminates any “catch-all” considerations.
Market participants currently are able to rely on representations from their counterparty regarding their status as a U.S. person. These representations may be made in a bilateral agreement or by delivery of the Cross-Border Representation Letter published by the International Swaps and Derivatives Association, Inc. (ISDA) on August 19, 2013 (the “Cross-Border Representation Letter”). Notwithstanding the change to the definition of “U.S. person,” the Final Rules permit reliance on Final Guidance U.S. person representations until December 31, 2027 if such representations were obtained prior to effectiveness of Final Rule. Accordingly, to the extent that market participants have obtained such representations from counterparties through the Cross-Border Representation Letter or otherwise, those market participants do not need to refresh those representations to reflect the requirements of the Final Rules until December 31, 2027.
- GuaranteesThe term “guarantee” is expressly defined in in Final Rules as “an arrangement pursuant to which one party to a swap has rights of recourse against a guarantor, with respect to a counterparty’s obligations under the swap.” The CFTC clarified in the Final Rules that a “guarantee” need not be a written instrument as long as the recipient has a legally enforceable right to receive payments from the guarantor in connection with the non-U.S. person’s obligations under a swap. However, the definition in the Final Rules is narrower in scope than the Final Guidance interpretation of a guarantee as the Final Rules do not include financial arrangements such as keepwells, liquidity puts and certain other type of indemnity, liability, loss transfer or sharing agreements. Notwithstanding the modifications to the definition of “guarantee,” the Final Rules permit reliance on Final Guidance guarantee representations until December 31, 2027 if such representations were obtained prior to effectiveness of Final Rules. Accordingly, to the extent that market participants have obtained such representations from counterparties through the Cross-Border Representation Letter or otherwise, those market participants do not need to refresh those representations to reflect the requirements of the Final Rules until December 31, 2027.
- Significant risk subsidiaryA “significant risk subsidiary” (SRS) is a new category of market participant that the CFTC added in the Final Rule. The SRS replaces the concept of a “conduit affiliate” (also referred to as “affiliate conduit”) in the Final Guidance. The Final Rules define an SRS as “any non-U.S. significant subsidiary of a U.S. parent entity where the ultimate U.S. parent entity has more than $50 billion in global consolidated assets, as determined in accordance with U.S. GAAP at the end of the most recently completed fiscal year,” but not including prudentially regulated subsidiaries of bank holding companies or entities subject to Basel capital standards and oversight and subject to comparable uncleared swaps margin rules. “Significant subsidiary” is defined in the Final Rules similarly to the same term in U.S. Securities Exchange Commission Regulation S-X, although the Final Rules contains a three year rolling average test determined in accordance with U.S. generally accepted accounting principles Specifically a “significant subsidiary” under the Final Rules must meet one of the following three conditions:
- three-year rolling average GAAP equity capital of at least 5 percent of that of the ultimate U.S. parent as of the end of the most recent fiscal year
- three-year rolling average GAAP total revenue of at least 10 percent of that of the ultimate U.S. parent as of the end of the most recent fiscal year or
- three-year rolling average GAAP total assets of at least 10 percent of that of the ultimate U.S. parent as of the end of the most recent fiscal year.
“Subsidiary” is defined in Final Rules as “an affiliate of a person controlled by such person directly or indirectly or through one or more intermediaries.”
Since SRS is a new kind of market participant, representations and other disclosures regarding SRS status and type do not appear in any ISDA protocols or standard representation letters published as of the date of this alert. Swap participants likely will be requested to make these representations and/or disclosures as a condition to future swap trading following effectiveness of the Final Rule.
- Foreign branch/swap conducted through a foreign branchThe Final Rules include the new defined terms “foreign branch” and “swap conducted through a foreign branch.” These terms are used in determining when certain swap related requirements are applicable to Swap Entities that are U.S. persons that transact from outside the United States. A “foreign branch” is defined as “any office of a U.S. bank that: (i) is located outside the United States; (ii) operates for valid business reasons; (iii) maintains accounts independently of the home office and the accounts of other foreign branches, with the profit and loss accrued at each branch determined as a separate item for each foreign branch; and (iv) is engaged in the business of banking and is subject to substantive regulation in banking or financing in the jurisdiction where it is located.” A “foreign branch” is a branch office and not a separate legal entity. A “swap conducted though a foreign branch” occurs if (i) payments and deliveries are made and received through the branch and the related documentation specifies that branch as such office; (ii) the foreign branch enters into the swap in its normal course of business (ie, not for evasion); and (iii) the swap is reflected in the local accounts of the foreign branch. 
- U.S. branch/swap booked through a U.S. branchThe Final Rules include the new defined terms “U.S. branch” and “swap booked through a U.S. branch.” These terms are used in determining when certain swap related requirements are applicable to Swap Entities that are non-U.S. persons that transact from the United States. A “U.S. branch” is a branch or agency of a non-U.S. banking organization that (i) is located in the United States; (ii) maintains accounts independently of the home office with profit and loss determined separately for each U.S. branch; and (iii) engages in the business of banking and is subject to substantive banking regulation in the state or district where located. A “swap booked through a U.S. branch” occurs if it is entered into by the U.S. branch and is reflected in the local accounts of the U.S. branch. The test for a swap by a U.S. entity being conducted through a foreign branch is higher than the test for a swap by a non-U.S. entity being booked through a U.S. branch. The former contains an anti-evasion requirement and requires payments or deliveries to be made to and from the branch outside the U.S. The latter only requires booking in the U.S.
- Foreign based swap/foreign counterparty/non-U.S. Swap Entity/U.S. Swap EntityThe Final Rules include the new defined terms “foreign-based swap,” “foreign counterparty,” “non-U.S. swap entity” and “U.S. swap entity.” These terms are used in determining which swaps entered into by non-U.S. Swap Entities with non-U.S. persons are outside the scope of CFTC regulation for purposes of the CFTC regulations covered by the Final Rules. A “foreign-based swap” is a swap by (i) a non-U.S. swap entity that is not a swap booked in a U.S. branch; or (ii) a swap conducted through a foreign branch. A “foreign counterparty” is (i) a non-U.S. person, except with respect to a swap booked in a U.S. branch of that non-U.S. person; or (ii) a foreign branch where it enters into the swap conducted through a foreign branch. A “non-U.S. swap entity” is a Swap Entity that is not a U.S. swap entity. A “U.S. swap entity” is a Swap Entity that is a U.S. person.
- Application of de minimis SD and MSP thresholdsThe CEA and the rules and related CFTC rules and regulations require any entity engaged in swap dealing activity to register as a swap dealer unless the aggregate gross notional amount of its swaps do not exceed the $8 billion de minimis threshold over the preceding 12 months. In addition, the CEA and the related CFTC rules and regulations require any entity whose swap positions exceed specified thresholds register as an MSP. The Final Rules address what swaps are counted toward the $8 billion SD de minimis threshold and the MSP threshold. Under the Final Rules, where the potential SD or MSP is a U.S. person, all swaps are counted toward the threshold. Where the potential SD or MSP is a non-U.S. person, the counterparty’s categorization will determine whether swaps are excluded from the relevant calculation.
- ANE transactionsOn November 14, 2013, the CFTC’s Division of Swap Dealer and Intermediary Oversight (DSIO” issued a staff advisory (the ANE Staff Advisory) that a non-U.S. SD that regularly uses personnel or agents located in the United States to arrange, negotiate, or execute a swap with a non-U.S. person (ANE Transactions) generally is subject to “Transaction-Level Requirements” under the Final Guidance. As more fully described below, the Final Rules remove the concept of “Transaction-Level Requirements” entirely from the cross-border analysis and explicitly exempt ANE Transactions from “group B” and “group C” requirements. The CFTC further indicated in its discussion of the Final Rules that the DSIO is withdrawing the ANE Staff Advisory. Certain transaction-level requirements, such as swap data reporting, are purposely not addressed in the Final Rules. In its discussion of the Final Rules, the CFTC indicated that it intends to consider the application of ANE Transactions to the unaddressed Transaction-Level Requirements in future rulemakings.
- Group A, B and C requirementsIn the Final Guidance the CFTC categorized its regulatory requirements as either “transaction level” or “entity level.” Those categories were each sub-divided into two further categories. The Final Rules recategorize the regulatory requirements into three groups – A, B, and C – although the requirements remain largely the same. The requirements apply to all Swap Entities unless an exemption or substituted compliance is available.
Group A requirements apply to all SDs on an entity-wide basis and are not dependent on the swap counterparty being a U.S. person. Group A requirements comprise the following:
(i) chief compliance officer; (ii) risk management, (monitoring compliance with position limits, conflicts of interest, diligent supervision, business continuity and disaster recovery programs, information availability); (iii) swap data recordkeeping, and (iv) antitrust considerations. Substituted compliance is available for all group A requirements: the Final Rules permit a non-U.S. Swap Entity to avail itself of substituted compliance with respect to any group A requirement if such entity is subject to comparable regulation in its home jurisdiction.
Group B requirements essentially track the transaction level requirements in the Final Guidance related to risk mitigation and recordkeeping, namely: (i) swap trading relationship documentation; (ii) portfolio reconciliation; (iii) trade confirmation; and (iv) daily trading records. A number of exemptions apply to the group B and group C requirements as set forth below.
The group C requirements address business conduct standards (such as counterparty due diligence and disclosure of material information) and segregation of initial margin. Group B and C requirements apply to all Swap Entities unless one or more of the following exceptions apply.
- Exchange traded exception (for group B and C). This exception applies with respect to certain anonymously cleared, exchange-traded, and cleared foreign-based swaps entered into by a non-U.S. Swap Entity or a foreign branch of a U.S. Swap Entity.
- Foreign Counterparties (group C only). This exception applies to any foreign-based swap entered into by a non-U.S. Swap Entity or a foreign branch of a U.S. Swap Entity with a foreign counterparty.
- Foreign Counterparties but booked in U.S. (group C only). A non-U.S. Swap Entity is exempt from the group C requirements with respect to any swap booked in a U.S. branch with a foreign counterparty that is neither a foreign branch nor a person whose performance under the swap is subject to a guarantee by a U.S. person.
- Foreign branches (group B only). This exception applies to foreign-based swaps entered into by foreign branches of a U.S Swap Entity with a foreign counterparty (other than a foreign branch) that is neither a Swap Entity nor subject to a guarantee from a U.S. Person. The exception is not available for any swap for which substituted compliance is available and the use of the exception is capped so that in any calendar quarter, the aggregate gross notional amount of swaps conducted by a Swap Entity in reliance on the exception may not exceed five percent of the aggregate gross notional amount of all its swaps in that calendar quarter.
- Non-U.S. Swap Entity (group B only).This exception applies to foreign-based swaps between a non-U.S. Swap Entity that is neither an SRS nor subject to a guarantee by a U.S. Person and a foreign counterparty (other than a foreign branch of a U.S Person) that is also neither an SRS nor guaranteed by a U.S. Person.
- Non-U.S. Swap Entity/SRS or Guaranteed Entity (group B only).This exception is available for foreign-based swaps between a non-U.S. Swap Entity that is an SRS or a person whose performance under the swap is subject to a guarantee by a U.S. person with and a foreign counterparty (other than a foreign branch) that is neither a Swap Entity nor a person whose performance under the swap is subject to a guarantee by a U.S. person. However, the exception is not available for any swap for which substituted compliance is available and is subject to a similar five percent cap as the one applied to the “foreign branches” exemption above.
- Substituted compliance and comparability determinations
The Final Rules also allow for substituted compliance with certain requirements and set out the procedure by which the CFTC will conduct comparability determinations regarding a foreign jurisdiction’s regulation of Swap Entities. The approach in the Final Rules builds upon the CFTC’s substituted compliance regime under the Final Guidance. The Final Rules establish a standard of review that the CFTC will apply to comparability determinations that emphasizes a holistic, outcomes-based approach. The Final Rules do not affect the effectiveness of any existing comparability determinations that were issued consistent with the Final Guidance, which will remain effective pursuant to their terms. The CFTC may, however, reevaluate prior comparability determinations in due course pursuant to the terms of the Final Rules.
 Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 45292, 45297 (July 23, 2013).
 Id. at 45312.
 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants – Cross-Border Application of the Margin Requirements, 81 Fed Reg. 34818, 34823-24 (May 31, 2016).
 78 Fed. Reg. at 45316.
 17 CFR 23.23(a)(23)(iv).
 17 CFR 23.23(a)(9).
 17 CFR 23.23(a)(13).
 17 CFR 23.23(a)(14); see also 17 CFR 210.1-02(w).
 17 CFR 23.23(a)(15).
 17 CFR 23.23(a)(3).
 17 CFR 23.23(a)(17).
 17 CFR 23.23(a)(21).
 17 CFR 23.23(a)(16).
 17 CFR 23.23(a)(4).
 17 CFR 23.23(a)(5).
 17 CFR 23.23(a)(11).
 17 CFR 23.23(a)(24).
 See 17 CFR 23.23(b) (SD thresholds) and 17 CFR 23.23(c) (MSP thresholds).
 See 17 CFR 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, 23.607, and 23.609.
 See 17 CFR 23.202, 23.501, 23.502, 23.503, and 23.504
 See 17 CFR 23.400-451
 Applies to all group B requirements except daily trading records requirements
 17 C.F.R 23.23(e)(1)(i).
 17 C.F.R 23.23(e)(1)(ii).
 17 C.F.R 23.23(e)(2).
 17 C.F.R 23.23(e)(4).
 17 C.F.R 23.23(e)(3). In its discussion of the Final Rules, the CFTC stated that where no party to the foreign-based swap is a U.S. person, or guaranteed by a U.S. person, or an SRS, and, the particular swap is not conducted through a U.S. branch of a party, notwithstanding that one or both parties to such swap may be a swap entity, foreign regulators may have a relatively stronger supervisory interest in regulating such swaps with respect to the subject matter covered by the group B requirements, and that, in the interest of international comity, applying the group B requirements to these foreign-based swaps is not warranted
 17 C.F.R 23.23(e)(5).
 See 17 C.F.R 23.23(f).