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CFTC ups the bar on cross-border confusion

CFTC Commissioners voted unanimously yesterday to propose a modified rule that would apply margin requirements for uncleared swaps in the context of cross-border transactions. The new proposal is in response to the recent practice of US banks “de-guaranteeing” their overseas affiliates, an attempt to place these entities beyond the CFTC’s legislative reach. The proposal extends the Agency’s definition of “guarantee” to include non-guaranteed non-US dealers whose accounts are consolidated with a US parent. In this case, the rule would only apply to trades, or portions thereof, between the non-US affiliate and a US dealer, or the non-US affiliate and another non-US affiliate. A trade between the non-US affiliate and a “truly foreign” counterparty would benefit from substituted compliance with that relevant jurisdiction’s swap margin rules. This opens the unpalatable prospect of a single package trade being subject to multiple jurisdictions and margin rule-sets. The fog is further thickened by the proposal’s stipulation that substituted compliance would only apply when the non-US affiliate is posting collateral to its truly foreign counterparty; when receiving collateral the CFTC rules would apply by default. The CFTC press release has the following helpful summary:

  • U.S. covered swap entities would be required to comply with the Commission’s margin rules for all uncleared swaps but would be eligible for substituted compliance with respect to margin that they post (but not that they collect) for swaps with certain non-U.S. counterparties.
  • Uncleared swaps of non-U.S. covered swap entities whose obligations under the relevant swap are guaranteed by a U.S. person would be treated the same as uncleared swaps of U.S. covered swap entities.
  • Uncleared swaps of non-U.S. covered swap entities whose obligations under the relevant swap are not guaranteed by a U.S. person would be eligible for substituted compliance unless the counterparty to the swap is a U.S. covered swap entity or a non-U.S. covered swap entity whose obligations under the swap are guaranteed by a U.S. person.
  • Uncleared swaps between a non-U.S. covered swap entity and a non-U.S. counterparty would be excluded from the margin rules, if neither party’s obligations under the relevant swap are guaranteed by a U.S. person and neither party is a U.S. branch of a non-U.S. covered swap entity nor consolidated in the financial statements of a U.S. person.

The proposal also seeks an attempted re-definition of “US person” as “individuals or entities whose activities have a significant nexus to the US market by virtue of their organization or domicile in the US or the depth of their connection to the US market, even if domiciled or organized outside the US. The proposed rule would not include the US majority-ownership prong that was included in the guidance (50% US person ownership of a fund or other collective investment vehicle)”. Although potentially wider than the “direct and significant effect on US commerce” enshrined in Section 2(i) CEA, this proposed definition is a significant climbdown from the territorial overreach of the Gensler-era CFTC. Commissioner Wetjen’s qualified statement of support for the proposal indicates that 22 non-US entities would be affected by the new rule, most of which are affiliates of the five largest US banks. Commissioner Giancarlo’s statement of “support” for the proposal refers to it as “a highly complicated labyrinth”, concluding that “I support issuing the proposed rule only so that the public may provide thorough analysis and thoughtful comment. My vote to issue the proposal for public comment should not signal, however, my agreement with it.” In a conference call following the press release, Chairman Massad called the proposal “one of the most important rules for regulation of the over-the-counter swaps market under Dodd-Frank Wall Street Reform and Consumer Protection Act”. The public has 60 days to comment on the proposal, Chairman Massad said he expected a final version would be issued “in a few months”.

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