> The CFTC has issued long-awaited final guidance on the extraterritorial application of the Dodd-Frank Act s Title VII.

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1 July 26, 2013 CFTC Issues Final Extraterritoriality Guidance Respecting Title VII of the Dodd-Frank Act and Provides Time-Limited Exemptive Relief to Certain Non-U.S. Market Participants Key Takeaways: > The CFTC has issued long-awaited final guidance on the extraterritorial application of the Dodd-Frank Act s Title VII. > The CFTC also approved an exemptive order (replacing the prior order which expired on July 12, 2013) intended to phase in compliance with the final guidance for non-u.s. persons, the non-u.s. branches of U.S. banks and cross-border transactions. > U.S. person includes, among other things, entities organized or with their principal place of business in the United States (along with their non-u.s. branches) and collective investment vehicles that are majority owned by U.S. persons, but excludes non-u.s. affiliates of U.S. persons. > For purposes of swap dealer registration, non-u.s. persons need only consider their dealing swaps with U.S. persons and their guaranteed affiliates, and may omit, among other things, swaps with non-u.s. branches of U.S. banks. > For the major swap participant thresholds, a non-u.s. person would count only swaps with U.S. persons and their guaranteed affiliates, and swaps between a third party non-u.s. person and a third party U.S. person in which such potential registrant guarantees the obligations of the third party non-u.s. person. Contents Introduction... 2 What is a U.S. person under the Final Guidance?3 Which non-u.s. persons must register as SDs under the Final Guidance?... 7 Which non-u.s. persons must register as MSPs under the Final Guidance? Which Title VII requirements apply to non- U.S. persons and crossborder transactions under the Final Guidance? What does the Exemptive Order do? How does the Final Guidance differ from the SEC ET Proposal? Conclusion > Non-U.S. CFTC-registered swap dealers and major swap participants must comply with Title VII s entity-level requirements, but may, in certain circumstances (and with CFTC approval of the substituted regime) use substituted compliance to instead abide by local law requirements. > The final guidance spells out when Title VII s transaction-level requirements apply to cross-border transactions and when substituted compliance with local laws would be permitted. 1

2 Introduction On July 12, 2013, the Commodity Futures Trading Commission (the CFTC ) voted 3-1 to adopt long-awaited final guidance (the Final Guidance ) 1 concerning the extraterritorial application of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ). 2 While the CFTC had previously addressed cross-border issues arising under Title VII in a piecemeal fashion through exemptive orders and no-action letters, the Final Guidance provides a comprehensive framework for application of Title VII s requirements to non-u.s. swap market participants and cross-border transactions. The Final Guidance is broadly consistent with the CFTC s proposed extraterritorial guidance (the Proposed Guidance ), 3 though it reflects a number of noteworthy changes. The CFTC also approved an exemptive order (the Exemptive Order ) 4 on July 12, 2013 that provides a phase-in period for the Final Guidance for certain non- U.S. market participants and transactions executed abroad. 5 The CFTC staff also issued a series of no-action letters related to cross-border issues on July 11, The Securities and Exchange Commission (the SEC ) issued a proposal (the SEC ET Proposal ) concerning the extraterritorial reach of Title VII with respect to security-based swaps on May 1, 2013, 7 but it has not yet been finalized. The SEC ET Proposal differs significantly from the Final Guidance, and it remains to Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg (July 26, 2013), available at Pub. L , 124 Stat.1376 (2010). Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act, 77 Fed. Reg (July 12, 2012), available at On December 21, 2012, the CFTC issued further proposed guidance (the Further Proposed Guidance ) which would have amended certain aspects of the Proposed Guidance. See Further Proposed Guidance Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 909 (Jan. 7, 2013), available at Exemptive Order Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg (July 22, 2013), available at On July 11, 2013, CFTC chairman Gary Gensler had announced that he and European Commissioner for the Internal Market Michel Barnier had agreed to a path forward on the regulation of cross-border derivative transactions that would place a strong emphasis on the use of substituted compliance. The CFTC s press release concerning Gensler s announcement is available at See CFTC Staff Letter No (July 11, 2013) (permitting LCH.Cleanet SA to clear certain index credit default swaps for U.S. clearing members without registering as a derivatives clearing organization, and permitting those clearing members to fulfill their mandatory clearing obligations by clearing through LCH); CFTC Staff Letter No (July 11, 2013) (granting similar relief with respect to index credit default swap and interest rate swap clearing by Eurex Clearing AG); CFTC Staff Letter No (July 11, 2013) (permitting foreign boards of trade to list swap contracts for direct access by U.S. market participants, subject to certain conditions). Copies of the letters may be obtained at Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, 78 Fed. Reg (May 23, 2013), available at 2

3 be seen whether the SEC s and the CFTC s differing approaches will be harmonized. This note summarizes what we consider to be the core aspects of the Final Guidance and the Exemptive Order. What is a U.S. person under the Final Guidance? The Final Guidance defines U.S. person as follows: What is a U.S. Person? 1. Any natural person who is a resident of the United States ( Prong 1 ) 2. Any estate of a decedent who was a resident of the Untied States at the time of death ( Prong 2 ) 3. Any corporation, partnership or other business entity (other than a pension plan or trust as described in Prongs 4 or 5 below, respectively) that is organized under U.S. law or which has its principal place of business 8 in the United States ( Prong 3 ) 4. Any pension plan for the employees, officers or principals of a business entity described in Prong 3 above, unless the plan is primarily for the foreign employees of such an entity ( Prong 4 ) 5. Any trust governed by U.S. law if a court within the United States is able to exercise primary supervision over the trust s administration ( Prong 5 ) 6. Any commodity pool, pooled account, investment fund or other collective investment vehicle (collectively, CIVs ) not described in Prong 3 that is majority-owned by one or more persons described in Prongs 1 5 above, 9 except such CIVs that are publicly offered only to non-u.s. persons and not offered to U.S. persons ( Prong 6 ) 7. Any legal entity that is directly or indirectly majority-owned by one or more U.S. persons described in Prongs 1 5 above and in which such U.S. persons bear unlimited responsibility for the obligations and liabilities of the legal entity owners of which are responsible for the entity s liabilities 10 ( Prong 7 ) 8 The CFTC provided extensive guidance on how to determine a business s principal place of business. Relying on the Supreme Court s 2010 decision in Hertz Corp. v. Friend, the CFTC indicated that the principal place of business should normally be where the corporation maintains its headquarters provided that the headquarters is the actual center of direction, control and coordination, i.e., the nerve center, and not simply an office where the corporation holds its board meetings. Final Guidance, 78 Fed. Reg. at (quoting Friend, 559 U.S. 77, 80 (2010)). 9 See infra notes This is likely intended to capture entities having similar characteristics to general partnerships. The CFTC emphasized that this prong of the definition is not meant to capture as a U.S. person an entity organized outside of the United States the swap activity of which is guaranteed by a U.S. person. Final Guidance, 78 Fed. Reg. at Such guaranteed affiliates are the subject of special treatment in many circumstances, however, as described below. 3

4 What is a U.S. Person? 8. Any individual or joint account, whether discretionary or not, where at least one beneficial owner is a U.S. person as described in Prongs 1 7 above ( Prong 8 ) This definition differs in some respects from that contained in the Proposed Guidance and the Further Proposed Guidance. For instance, the Final Guidance removes the definitional prong that would have included as U.S. persons CIVs the operators of which are required to register with the CFTC as a commodity pool operator. Diligence requirements with respect to determining counterparty s status as a U.S. person Commenters had raised concerns regarding diligence requirements to confirm a swap counterparty is not a U.S. person. The CFTC addressed these concerns by specifying that a market participant may generally reasonably rely on a counterparty s written representation that it is not a U.S. person. 11 The CFTC cautioned, however, that such reliance would not be considered reasonable if the market participant was aware of red flags or other information indicating that the representation is inaccurate. 12 Which CIVs are U.S. persons under the Final Guidance? The Final Guidance addresses both CIVs caught by Prong 3 and when a CIV caught by Prong 6 must look through its investors to determine whether its indirect owners are U.S. persons. An offshore CIV may be a U.S. person if the CIV s senior personnel are U.S. persons even if none of its investors are U.S. persons. The CFTC specified that the relevant senior personnel are not generally the CIV s named officers or board members 13 but rather those key personnel who direct, control and coordinate key functions of the CIV such as (1) formation and promotion of the CIV or (2) implementation of the CIV s investment strategy. 14 Nevertheless, the CFTC also indicated a CIV would not be a U.S. person solely because has a U.S. asset manager and that a CIV s status as a U.S. or non-u.s. person is to be determined through a facts and circumstances analysis. The CFTC provided some helpful examples: > an offshore CIV formed and advised by a U.S. asset manager would be a U.S. person regardless of whether it had U.S. investors; 11 Id. at Id. at n Such individuals could be the relevant personnel if they are the equivalent of high level officers of an operating company because they direct, control and coordinate key functions of the CIV. Id. at Id. at

5 > an offshore CIV that is sponsored and advised by a non-u.s. asset manager with both U.S. and non-u.s. offices would not be a U.S. person if the U.S. personnel of the asset manager report (and are subordinate) to the non-u.s. office s personnel; and > an offshore CIV established by a U.S. financial firm which issued multiple classes of investment securities and which was advised by both U.S. and non-u.s. asset managers would be a U.S. person if the financial firm retained contractual control of the CIV s investment strategies and the financial firm could reallocate the CIV s assets among the various asset managers. 15 The Proposed Guidance would have required a CIV to determine whether it had any indirect U.S. investors by looking through any entities that invested in the CIV to determine if the investor was itself owned by U.S. persons. 16 This would have tainted fund of fund structures in the event that any investor up and down the chain was a U.S. person. In response to comments pointing out the practical difficulty of conducting such diligence on a regular basis, the CFTC removed the reference to direct or indirect U.S. person investors. 17 The CFTC indicated that it would instead expect a CIV to determine (1) whether any of its direct investors were U.S. persons under Prongs 1 5 above and (2) look through to the beneficial owners of any legal entity investing in the CIV that is controlled by or under common control with the [CIV]. 18 Investments by unaffiliated legal entities would not be subject to a look through. 19 Only if a majority of the CIV s direct and indirect investors determined in this manner were U.S. persons and the CIV is offered to U.S. persons, would the CIV be considered a U.S. person under Prong 6 above. 20 Are non-u.s. branches of U.S. banks U.S. persons under the Final Guidance? Consistent with the Proposed Guidance, the Final Guidance provides that the non-u.s. branch of a U.S. bank is part of the U.S. bank, and thus a U.S. person. 21 The CFTC emphasized throughout the Final Guidance that it considers transacting with the non-u.s. branch of a U.S. bank to be the same as transacting with the U.S. home office, though the Final Guidance provides a number of exceptions from Title VII requirements for such non-u.s. branches. 22 The CFTC also stated that the registration by a U.S. bank as a swap dealer ( SD ) or major swap participant ( MSP ) would include its non-u.s. branches Id. at Proposed Guidance, 77 Fed. Reg. at Final Guidance, 78 Fed. Reg. at Id. at Id. 20 The CFTC will not treat an entity as a U.S. person solely because it is controlled by or under common control with a U.S. person. Id. at n Id. at E.g., id. at , Id. at

6 The CFTC did not address whether the U.S. branch of a non-u.s. bank would be considered a U.S. person, though by implication, it is reasonable to infer that the U.S. branch would be considered part of the non-u.s. person. The Final Guidance also provides important color concerning when a swap is with the non-u.s. branch of a U.S. bank rather than with the U.S. bank s home office. In order for such a swap to be with the non-u.s. branch, the CFTC specified that: > the employees negotiating and agreeing to the terms of the swap (unless executed electronically, in which case the relevant employees are those managing its execution) are physically located in a non-u.s. branch rather than in the bank s U.S. office; > the non-u.s. branch (or another non-u.s. branch) is the office through which the U.S. bank receives payments and deliveries under the swap, and the swap s documentation specifies the U.S. bank s office as the non-u.s. branch; > the swap is entered into by the non-u.s. branch in its normal course of business; > the swap is treated as a swap of the non-u.s. branch for tax purposes; and > the swap is reflected in the local accounts of the non-u.s. branch. 24 Are non-u.s. affiliates of U.S. entities U.S. persons under the Final Guidance? The Final Guidance follows the Proposed Guidance by treating entities organized outside of the United States that would not otherwise be U.S. persons as non- U.S. persons even if they are affiliated with a U.S. person or the subsidiary of a U.S. parent company. 25 Thus, even if a non-u.s. entity is the beneficiary of a guarantee from its U.S. affiliate (such an entity, a Guaranteed Affiliate ), it would not ipso facto be considered a U.S. person, 26 but it would be required to include its swap dealing activities with both U.S. and non-u.s. persons in its de minimis threshold calculation. 27 As discussed in more detail below, however, Guaranteed Affiliates are subject to certain additional requirements under the Final Guidance. 28 The CFTC also identified a number of Title VII requirements that would be applicable to a non-u.s. entity used by a U.S. affiliate as a conduit for swap trading outside of the United States (such an entity, a Conduit Affiliate ). The 24 Id. at Id. at The CFTC noted that it does not intend that Prong 7 of the U.S. person definition would cover legal entities organized or domiciled in a foreign jurisdiction but whose swaps obligations are guaranteed by a U.S. person. Id. at Id. at See discussion below. 6

7 CFTC noted that U.S. persons may utilize Conduit Affiliates to (i) enter into swaps with U.S. persons and then enter into offsetting swaps with third-parties, or (ii) enter into swaps with third-parties as an agent for a U.S. person. In determining whether a non-u.s. entity is a Conduit Affiliate subject to various Title VII requirements, the CFTC indicated that it would consider the following factors: > whether the non-u.s. entity is majority-owned, directly or indirectly, by a U.S. person; > whether the non-u.s. entity controls, is controlled by, or is under common control with, directly or indirectly, the U.S. person; > whether the financial results of the non-u.s. entity are included in the consolidated financial statements of the U.S. person; and > whether the non-u.s. person, in the regular course of business, engages in swaps with non-u.s. third parties for the purpose of hedging or mitigating risks faced by, or to take positions on behalf of, its U.S. affiliates, and enters into offsetting swaps or other arrangements with its U.S. affiliates in order to transfer the risks and benefits of such swaps with third parties to its U.S. affiliates. The Final Guidance explicitly states that the non-u.s. affiliates of an SD would not be considered Conduit Affiliates. 29 Which non-u.s. persons must register as SDs under the Final Guidance? Analysis for whether a U.S. person, or a Guaranteed or Conduit Affiliate must register as an SD Analysis for whether a non-u.s. persons that is NOT a Guaranteed or Conduit Affiliate must register as an SD Ask the following questions: 30 > Do you hold yourself out as a dealer in swaps? > Do you hold yourself out to U.S. persons and/or Guaranteed Affiliates as a dealer in swaps? Id. at In answering these questions and in conducting the de minimis calculation discussed below, exclude (i) swaps activities not part of a regular business, (ii) swaps entered into by an insured depository institution with a customer in connection with originating a loan to that customer, (iii) swaps between majority-owned affiliates, (iv) swaps entered into by a cooperative with its members, (v) swaps entered into for hedging physical positions and (vi) certain swaps entered into by registered floor traders. 31 The Final Guidance does not contain a discussion of how a non-u.s. person should determine whether its activities are part of a regular business of swap dealing as the Proposed Guidance did. Proposed Guidance, 77 Fed. Reg. at Under a joint CFTC-SEC rule defining certain Title VII entity terms like swap dealer and major swap participant (the Entities Rule ), an entity must assess whether its swap activities are considered swap dealing (the Swap Dealing Assessment ) and need only determine whether it exceeds the de mininis thresholds if it is dealing. Further Definition of Swap Dealer, Security-Based Swap Dealer, Major Swap 7

8 Analysis for whether a U.S. person, or a Guaranteed or Conduit Affiliate must register as an SD Analysis for whether a non-u.s. persons that is NOT a Guaranteed or Conduit Affiliate must register as an SD > Do you make a market in swaps? > Do you make a market in swaps for U.S. persons and/or Guaranteed Affiliates? > Do you regularly enter into swaps with counterparties as an ordinary course of business for your own account? > Do you engage in any activity that causes you to be commonly known in the trade as a dealer or market maker in swaps? > Do you regularly enter into swaps with counterparties who are U.S. persons and/or Guaranteed Affiliates as an ordinary course of business for your own account? > Do you engage in any activity that causes you to be commonly known in the trade as a dealer or market maker in swaps for U.S. persons and/or Guaranteed Affiliates? If you answered yes to any of the above, count the following types of swaps: > All dealing swaps regardless of whether your counterparty is a U.S. person or a non-u.s. person > All dealing swaps with U.S. persons and Guaranteed Affiliates, except for the following: o Swaps with the non-u.s. branches of registered U.S. SDs o Swaps with Guaranteed Affiliates that are registered as SDs o Swaps with Guaranteed Affiliates that (1) are not registered as SDs but which engage in a less than de minimis amount of dealing Participant, Major Security-Based Swap Participant and Eligible Contract Participant, 77 Fed. Reg (May 23, 2012). Consistent with the Entities Rule, the Proposed Guidance specified that the first step for a non-u.s. person is to determine whether its swap activities with respect to U.S. persons as counterparties qualify as swap dealing activity. Proposed Guidance, 77 Fed. Reg. at The Final Guidance, however, provides no such instruction. However, given that the Entities Rule still requires the Swap Dealing Assessment and the Final Guidance indicates that a non-u.s. person need only consider its dealing swaps in calculating its de minimis thresholds, we believe that the Swap Dealing Assessment component remains relevant for non-u.s. persons and we have thus reflected it in the chart. 8

9 Analysis for whether a U.S. person, or a Guaranteed or Conduit Affiliate must register as an SD Analysis for whether a non-u.s. persons that is NOT a Guaranteed or Conduit Affiliate must register as an SD transactions but which (2) are affiliated with an SD o Swaps with Guaranteed Affiliates where the affiliated is, or is guaranteed by, a nonfinancial entity 32 o Swaps that are executed on a designated contract market (a DCM ), swap execution facility (a SEF ) or foreign board of trade (an FBOT ) and are cleared Aggregate the total notional amount of your counted swaps with the total notional amount of the counted swaps of your affiliates under common control, excluding the notional amount of counted swaps of any U.S. or non-u.s. affiliate that is registered as an SD. 33 If the total notional amount is less than the de minimis thresholds ($8 billion during an initial phase and $3 billion thereafter; always $25 million with respect to special entities ), then you do not need to register as an SD. If the total notional amount exceeds the de minimis thresholds, you must register as a swap dealer. This reflects a number of changes from the Proposed Guidance A financial entity is an SD, MSP, security-based swap dealer, major security-based swap participant, commodity pool, private fund, employee benefit plan, or person predominantly engaged in activities that are in the business of banking, or in activities that are financial in nature, as defined in section 4(k) of the Bank Holding Company Act of U.S.C. 2(h)(7)(C). 33 The Final Guidance specifies that with respect to the aggregation requirement in the SD de minimis analysis, both U.S. and non-u.s. persons may exclude the notional amount of the counted swaps of an affiliate (U.S. or non-u.s.) that is registered as an SD from the de minimis calculation. Final Guidance, 78 Fed. Reg. at Examples of those changes include: (1) requiring non-u.s. persons to consider their swaps with Guaranteed Affiliates (subject to certain exceptions) in calculating whether they ve exceeded the de minimis thresholds, (2) allowing non-u.s. persons to exclude from their affiliate aggregations the notional amount of affiliates that are registered as SDs, (3) mandating that non-u.s. persons aggregate notional amounts of counted swaps across all affiliates rather than (as under the Proposed Guidance) across just non-u.s. affiliates, and (4) the new exception for swaps that are executed on a SEF, DCM or FBOT and cleared. 9

10 Which non-u.s. persons must register as MSPs under the Final Guidance? Analysis for whether a U.S. person or a Guaranteed or Conduit Affiliate is required to register as an MSP Analysis for whether a non-u.s. person that is NOT a Guaranteed or Conduit Affiliate is required to register as an MSP If you answer yes to any of the following questions, after deducting the swaps listed below, you must register as an MSP: > Do you have a substantial position in a major swap category, excluding hedging positions? > Do you have substantial counterparty exposure as a result of your swap transactions? > Are you a highly leveraged financial entity with a substantial position in swaps, including hedging positions? > Do you have a substantial position resulting from swap transactions with U.S. persons and Guaranteed Affiliates, and transactions between a U.S. person and another non-u.s. person in which you guarantee the non-u.s. person s performance in a major swap category, excluding hedging positions? > Do you have substantial counterparty exposure as a result of your swap transactions with U.S. persons and Guaranteed Affiliates, and transactions between a U.S. person and another non-u.s. person in which you guarantee the non- U.S. person s performance? > Are you a highly leveraged financial entity with a substantial position in swaps resulting from swap transactions with U.S. persons and Guaranteed Affiliates, and transactions between a U.S. person and another non-u.s. person in which you guarantee the non- U.S. person s performance, including hedging positions? 10

11 Analysis for whether a U.S. person or a Guaranteed or Conduit Affiliate is required to register as an MSP Analysis for whether a non-u.s. person that is NOT a Guaranteed or Conduit Affiliate is required to register as an MSP In conducting the above calculations, exclude the following swaps: > Swaps in which the non-u.s. person s performance is guaranteed by another entity > Swaps in which the non-u.s. person s performance is guaranteed by another entity 35 > If the non-u.s. person is a financial entity, swaps with Guaranteed Affiliates and foreign branches of U.S. SDs which are either (1) cleared or (2) subject to a requirement that the Guaranteed Affiliate or foreign branch collect daily variation margin > If the non-u.s. person is not a financial entity, all swaps with Guaranteed Affiliates and the foreign branches of U.S. SDs The Final Guidance largely follows in the Proposed Guidance s footsteps, with some minor differences. 36 Which Title VII requirements apply to non-u.s. persons and cross-border transactions under the Final Guidance? The Final Guidance also informs us which Title VII requirements apply to non- U.S. persons, whether registered with the CFTC or not, and to cross-border transactions. Like the Proposed Guidance, the Final Guidance divides Title VII s requirements into two categories: those that apply to SDs and MSPs as an entity (the Entity-Level Requirements ) and those that apply to individual 35 The Final Guidance provides that where a counterparty has recourse to another entity, such as a parent guarantor, then the swap should generally be attributed to the guarantor, so if a U.S. person enters into a swap guaranteed by a non-u.s. person, then the swap should generally be attributed to the non-u.s. person guarantor. Id. at The CFTC also explains in the Final Guidance that, in certain circumstances where a non-u.s person guarantees the performance of another non-u.s. person, it may be willing to consider permitting the guaranteed entity to register as an MSP rather than the guarantor. Id. 36 Some of those differences include (1) the treatment of Conduit Affiliates in a manner similar to that applicable to U.S. persons (by requiring them to consider all of their swaps, regardless of whether their counterparty is a U.S. person or not), (2) requiring a non-u.s. person to consider certain swap transactions with Guaranteed Affiliates, and (3) the exclusion from consideration of certain swaps with foreign branches of U.S. SDs. 11

12 transactions (the Transaction-Level Requirements ), which categories themselves are then further subdivided, as discussed in more detail below. 37 What are the Entity-Level Requirements and when do they apply to a non- U.S. registrant? The Final Guidance divides the Entity-Level Requirements into two categories: Category 1 Category 2 > Capital adequacy > Swap data reporting (other than real-time reporting) > Recordkeeping (except for that in Category 2) > Recordkeeping concerning customer complaints and marketing and sales materials ( Category 2 Recordkeeping ) > Risk management > Large trader reporting ( LT Reporting ) > Chief compliance officer Under the Final Guidance, both U.S. and non-u.s. SDs and MSPs ( Non-U.S. SD/MSPs ) must comply with the Category 1 requirements. However, Non-U.S. SD/MSPs would be permitted to utilize substituted compliance in certain circumstances and with CFTC permission, as discussed in more detail below. The Category 2 requirements would also apply to Non-U.S. SD/MSPs, though the availability of substituted compliance depends on the nature of the counterparty to the transaction under which the Category 2 obligation arises. 38 Non-U.S. SDs/MSPs would not be able to utilize substituted compliance with respect to Category 2 requirements arising from swaps with U.S. persons. Further, the Final Guidance makes clear that substituted compliance with respect to LT Reporting obligations would never be permitted. 37 The Final Guidance explicitly notes that it does not speak to the application of CFTC rules establishing position limits for physical commodities or anti-manipulation rules in the cross-border context. Id. at Even though the obligations under the Category 2 requirements all arise in connection with individual swap transactions, the CFTC rejected calls by commenters that they should be included as Transaction-Level Requirements. Id. at

13 What are the Transaction-Level Requirements and when do they apply to a cross-border transaction? The Final Guidance also divides the Transaction-Level Requirements into two categories as follows: Category A > Mandatory clearing and swap processing Category B > External business conduct rules > Margining and segregation for uncleared swaps > Trade execution on a SEF or DCM > Swap trading relationship documentation > Portfolio recognition and compression > Real-time public reporting > Trade confirmation > Daily trading records As was the case under the Proposed Guidance, whether the Transaction-Level Requirements or the Non-Registrant Requirements apply depends on the nature of the counterparties, as detailed in the table below. The closer the party s ties to the United States, the more likely that the Transaction-Level Requirements will apply, and the less likely that substituted compliance will be available. 13

14 Which requirements apply to transactions between the following counterparties? U.S. person Foreign branch of a U.S. bank that is an SD/MSP Guaranteed or Conduit Affiliate Non-U.S. person that is not a Guaranteed or Conduit Affiliate U.S. SD or MSP 39 Categories A & B Categories A & B Categories A & B Categories A & B Foreign branch of a U.S. bank that is an SD/MSP Categories A & B Category A (substituted compliance allowed) Category A (substituted compliance allowed) Category A (special substituted compliance allowed 40 ) Non-U.S. SD or MSP Categories A & B 41 (compliance with essentially identical non- U.S. rules allowed 42 ) Category A (substituted compliance allowed) Category A 43 (substituted compliance allowed) None 39 According to a summary appendix to the Final Guidance, where a U.S. SD or MSP solicits or negotiates a swap through a foreign affiliate but books the swap in the U.S. entity, the Category B requirements would not apply unless its counterparty was a U.S. person (other than a foreign branch of a U.S. bank that is an SD/MSP). Id. at However, this carve out is not discussed in the text of the Final Guidance at all. 40 The Final Guidance provides that, with respect to a swap between a foreign branch and a non-u.s. person that is not a Guaranteed or Conduit Affiliate, and which take place in a country other than Australia, Canada, the European Union, Hong Kong, Japan or Switzerland (the Substituted Compliance Applicant Jurisdictions ), the foreign branch may comply with local rules even if the CFTC has made no Substituted Compliance Determination (as defined below) with respect to that jurisdiction provided that (1) the aggregate notional value of all of the swaps of the U.S. SD or MSP s foreign branches outside of the Substituted Compliance Applicant Jurisdictions does not exceed five percent of its total notional amount of swaps and (2) the U.S. SD or MSP maintains records to verify that the first element is true. Id. at The Final Guidance provides that where a swap is executed anonymously on a DCM, SEF or FBOT and then cleared, the counterparties to the swap will be deemed to have satisfied all of the Transaction-Level Requirements. Id. at While substituted compliance is not available for swaps between Non-U.S. SD/MSPs and U.S. persons, the CFTC indicated that a market participant would be deemed in compliance with the relevant Dodd-Frank requirements where it complies with requirements in its home jurisdiction that are essentially identical to the Dodd-Frank requirements. Final Guidance at 232. The essentially identical standard appears to be more exacting than the comparable and comprehensive standard of the substituted compliance regime. In this connection, the CFTC staff has issued a noaction letter finding that certain CFTC and European Union risk mitigation rules are essentially identical. See CFTC Staff Letter No (July 11, 2013). 43 The Final Guidance provides that a Conduit Affiliate may achieve compliance with the Category A requirements by complying with the conditions of the CFTC s rule providing for an exception from clearing for inter-affiliate trades (the Inter-Affiliate Exception ). These conditions are discussed in our client note on the Inter-Affiliate Exception, which is available at 14

15 The Final Guidance reflects some changes from the Proposed Guidance. 44 Which Title VII requirements apply to transactions between nonregistrants? The Final Guidance provides that certain Category 2 Entity-Level Requirements and certain Category A Transaction-Level Requirements will apply to transactions between non-u.s. persons that are not registered as SDs or MSPs in some cases. These requirements include clearing, trade execution, real-time public reporting, LT Reporting, swap data reporting and swap data recordkeeping (collectively, the Non-Registrant Requirements ). The application of the Non- Registrant Requirements also varies based upon the counterparties: Which requirements apply to transactions between the following unregistered counterparties? U.S. person Guaranteed or Conduit Affiliate Non-U.S. person that is not a Guaranteed or Conduit Affiliate U.S. person 45 Non-Registrant Requirements Non-Registrant Requirements Non-Registrant Requirements Guaranteed or Conduit Affiliate Non-Registrant Requirements Non-Registrant Requirements (substituted compliance allowed) None (except LT Reporting) Non-U.S. person that is not a Guaranteed or Conduit Affiliate Non-Registrant Requirements None (except LT Reporting) None (except LT Reporting) In the Final Guidance, the CFTC stated that it expects unregistered, non-u.s. person counterparties transacting with each other to comply with its LT Reporting rules, which require the reporting of large positions in physical commodities. There are no doubt non-u.s. financial institutions that will transact in derivatives exclusively (or nearly exclusively) with other non-u.s. persons, and under the Final Guidance, they would be required to report counterparties positions in physical commodities under certain circumstances. It is unclear how the CFTC 44 Among those changes are (1) the treatment of Conduit Affiliates as similar to Guaranteed Affiliates, (2) the explicit treatment of transactions between two foreign branches of a U.S. bank that is an SD or MSP, and (3) an exemption from the Transaction-Level Requirements for swaps between Non- U.S. SD/MSPs and U.S. persons that are executed on a DCM, SEF or FBOT and then cleared. 45 The CFTC stated its view that where a swap is executed between two non-registrants on a DCM or SEF and cleared through a DCO, the only requirements by which the counterparties to the swap would be required to abide would be the Large-Trader Reporting, swap data reporting and swap data recordkeeping. Final Guidance, 78 Fed. Reg. at

16 would obtain jurisdiction over such a non-u.s. financial institution to enforce compliance, nor is it clear how a transaction entirely with non-u.s. entities that are not registered with a U.S. regulator could be considered to pose a threat to U.S. financial stability. How does substituted compliance work? As discussed above, Non-U.S. SD/MSPs and counterparties to certain transactions executed outside of the Untied States may comply with local or home-country rules with respect to certain requirements under the CFTC s substituted compliance regime. In making determinations ( Substituted Compliance Determinations ) about the permissibility of substituted compliance, the CFTC indicated that it will assess a foreign country s regime to determine whether it is comparable to and as comprehensive as the U.S. regime under the Dodd-Frank Act, but will not require that the foreign jurisdiction have identical requirements. The CFTC also stated that it would make Substituted Compliance Determinations with respect to individual Entity-Level and Transaction-Level Requirements rather than making them on the basis of a foreign regime as a whole. Determinations made at the request of one party will be applicable to all market participants in that jurisdiction. The CFTC stated that, even if it does issue a Substituted Compliance Determination, it will retain examination and enforcement authority over market participants that utilize that substituted compliance. The CFTC indicated that it has received or expects to receive materials seeking Substituted Compliance Determinations with respect to the six Substituted Compliance Applicant Jurisdictions. 46 The CFTC indicated that substituted compliance with respect to the swap data reporting and real-time reporting requirements would only be allowed if the CFTC had direct access to all of the reported swap data elements stored in a foreign data repository. 47 Since many foreign countries laws could prohibit the sharing of trade data with the CFTC in certain circumstances, this issue could prove problematic. The CFTC indicated that it continues to work on a bilateral and multilateral basis with foreign regulators to address these issues and that it may, under certain circumstances, consider alternatives that both allow the CFTC to fulfill its oversight duties and comply with foreign law. 48 What does the Exemptive Order do? The Exemptive Order permits a phase-in period for the Final Guidance with respect to certain Title VII requirements for non-u.s. persons and cross-border transactions. The Exemptive Order extends and in some ways modifies relief previously granted by the CFTC in an order published in the Federal Register in 46 As discussed above, the Substituted Compliance Applicant Jurisdictions are Australia, the European Union, Japan, Switzerland, Canada and Hong Kong. 47 Id. at Id. 16

17 January (the January Order ), which expired on July 12, things, until October 9, 2013, 50 the Exemptive Order: Among other > extends the January Order s transitional definition of U.S. person ; > permits non-u.s. persons to continue excluding swaps with U.S. persons and the foreign branches of U.S. persons when calculating whether they have exceeded SD de minimis levels or MSP registration thresholds; and > allows non-u.s. persons to apply the January Order s aggregation principles in calculating whether they are in excess of the SD de minimis thresholds. The Exemptive Order also grants relief with respect to certain Entity-Level and Transaction-Level Requirements for market participants and foreign branches of U.S. registrants, as described below: Exemption Non-U.S. SD/MSPs in the Substituted Compliance Applicant Jurisdictions may comply with home country rules with respect to Entity- Level Requirements for which substituted compliance is allowed under the Final Guidance 51 Non-U.S. SD/MSPs in the Substituted Compliance Applicant Jurisdictions may comply with home country rules with respect to Transaction-Level Requirements for which substituted compliance is allowed under the Final Guidance 52 Non-U.S. SD/MSPs outside of the Substituted Compliance Applicant Jurisdictions may comply with home country rules with respect to Phase-In Date Earlier of December 21, 2013 or 30 days after the issuance of a Substituted Compliance Determination Earlier of December 21, 2013 or 30 days after the issuance of a Substituted Compliance Determination October 9, Final Exemptive Order Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 858 (Jan. 7, 2013). 50 This relief is available until 75 days after the Final Guidance is published in the Federal Register. Since the Final Guidance was published on July 26, 2013, this relief will expire on October 9, The Exemptive Order also grants relief from the swap data reporting requirements to non-u.s. SDs and non-u.s. MSPs established in a Substituted Compliance Applicant Jurisdiction that are not part of a corporate group the ultimate parent of which is a U.S. SD, U.S. MSP, U.S. bank, or U.S. bank or financial holding company with respect to swaps counterparty to non-u.s. persons provided certain conditions are met. 52 Swaps with Guaranteed Affiliates are subject to the clearing, trade execution and real-time reporting requirements under the Exemptive Order. However, Non-U.S. SD/MSPs in the Substituted Compliance Applicant Jurisdictions may, in transactions with Guaranteed Affiliates, abide by local rules concerning real-time reporting until September 30, Non-U.S. SD/MSPs that were not required to clear transactions with Guaranteed Affiliates under the January Order will not be required to clear until October 9,

18 Exemption Transaction-Level Requirements for which substituted compliance is allowed under the Final Guidance Non-U.S. branches of U.S. SDs and MSPs located in the Substituted Compliance Applicant Jurisdictions may comply with those jurisdictions rules with respect to Transaction- Level Requirements for which substituted compliance is allowed under the Final Guidance 53 with the exception of those related to the real-time reporting, clearing and trade execution requirements, which phase-in October 9, 2013 Non-U.S. branches of U.S. SDs and MSPs outside of the Substituted Compliance Applicant Jurisdictions may comply with those jurisdictions rules with respect to Transaction- Level Requirements for which substituted compliance is allowed under the Final Guidance Transactions between two Guaranteed Affiliates are subject to home country rules with respect to Transaction-Level Requirements for which substituted compliance is allowed under the Final Guidance Phase-In Date Earlier of December 21, 2013 or 30 days after the issuance of a Substituted Compliance Determination October 9, 2013 October 9, 2013 How does the Final Guidance differ from the SEC ET Proposal? Although the CFTC announced an accord with E.U. regulators on certain crossborder derivatives issues it has yet to achieve harmony with its sister regulator, the SEC. The Final Guidance will only govern transactions that are considered swaps under Title VII. Security-based swap transactions will be subject to whatever guidance and regulations are eventually adopted by the SEC. 54 Mixed swaps are subject to both agencies jurisdiction, and will thus be governed by both sets of guidance. 53 As was the case with Non-U.S. SD/MSPs, there is a carve-out for swaps with Guaranteed Affiliates in respect of the clearing, trade execution and real-time reporting requirements. Non-U.S. branches that were not required to clear transactions with Guaranteed Affiliates under the January Order need not do so until October 9, Non-U.S. branches in the Substituted Compliance Applicant Jurisdictions may also comply with local rules with respect to real-time reporting until September 30, For a discussion of the differences between swaps and security-based swaps, please see our note: 18

19 The Final Guidance s approach differs significantly in some respects from that taken in the SEC ET Proposal. For instance, the SEC has proposed a threeprong definition of U.S. person that is significantly less complicated than that of the Final Guidance. The SEC ET Proposal also tends to focus more on the location where derivative transactions are negotiated than does the Final Guidance in determining whether substantive Dodd-Frank Act requirements apply and whether a particular transaction counts for determining registration requirements. Perhaps most notably, the SEC ET Proposal is arguably more comprehensive and would implement cross-border rules through both guidance and formal regulations while the CFTC has opted for only providing guidance that, at least in the CFTC s eyes, need not pass muster under a cost-benefit analysis. The potential disharmony between the CFTC s and the SEC s approaches is of real concern. Two separate regimes are likely to beget different compliance and operations systems, which could raise market participants costs significantly. CFTC commissioners and staff have indicated that they have consulted extensively with their counterparts at the SEC, but it remains to be seen whether that consultation results in the sort of regulatory unity that would aid the markets and reduce costs. Conclusion The CFTC has provided market participants, both within the United States and abroad, long-awaited guidance in understanding how Title VII will impact their operations and transactions. While the CFTC had been acting in fits and starts to address extraterritoriality, the Final Guidance offers a fairly comprehensive blueprint for how non-u.s. entities may conduct swap transactions without running afoul of the Dodd-Frank Act. Many non-u.s. market participants will also be pleased with the CFTC s efforts to reach accord with the European Union on substituted compliance. The Final Guidance does leave some questions unanswered. Specifically, it remains to be seen how strict the CFTC will be in making Substituted Compliance Determinations. It is also unclear how the CFTC will resolve the tension between its need to access data reported to foreign trade repositories with other nations privacy laws. Lastly, the Final Guidance contains a number of ambiguities and points that would be advanced by further clarification. We think it is likely that further guidance from either the CFTC or its staff will be forthcoming in the months and years ahead to address these issues. 19

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