1. What is the White Paper?
The White Paper sets forth the Chairman’s views regarding the CFTC’s current “flawed approach” to the cross-border application of its swaps rules and recommends a number of changes. Although he wrote the White Paper in his official capacity and received input from CFTC commissioners and staff, Chairman Christopher Giancarlo indicated that the views expressed do not necessarily reflect the views of the CFTC or its staff.
The White Paper addresses various previous positions taken by the CFTC and its staff in connection with the cross-border application of the CFTC’s swaps rules adopted pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act. In particular, the White Paper addresses the adverse consequences of
- the 2013 CFTC cross-border guidance (CFTC Cross-Border Guidance)2
- the 2013 CFTC staff guidance regarding swaps trading platforms located outside the United States that permit access by U.S. persons (Staff SEF Guidance)3
- the 2013 CFTC staff advisory regarding swap transactions by non-U.S. counterparties that are “arranged, negotiated, or executed” by personnel or agents located in the United States (Staff ANE Transaction Advisory)4
- the 2016 CFTC cross-border rule proposal (CFTC Cross-Border Rule Proposal)5
Chairman Giancarlo recently characterized the proposals in the White Paper as representing a “sea-change in approach. ... The core of it is deference to overseas regulation ....”6
The White Paper sets forth two general observations, which it refers to as “foundations,” and a series of specific “principles.” The White Paper then addresses, and makes recommendations in respect of, five distinct elements of the CFTC’s swaps rules as currently applied on a cross-border basis.
2. What are the two “foundations” on which the White Paper’s recommendations rest?
The two foundations are:
- CFTC’s limited statutory jurisdiction. The Commodity Exchange Act (CEA) “provides, in relevant part, that the CFTC’s swaps authority ‘shall not apply’ to activities outside the United States unless those activities ‘have a direct and significant connection with activities in, or effect on, commerce of the United States.’ ”7 Thus, when Congress amended the CEA to give the CFTC regulatory jurisdiction over swaps, Congress did not intend for the CFTC to apply its swaps rules extraterritorially as broadly as it has.
- Swaps markets’ institutional nature. The swaps market is an institutional market, and investor protection concerns are thus of less importance that they are in, for example, the futures markets.
3. What are the “principles” from which the White Paper’s recommendations follow?
The principles set forth in the White Paper may be summarized as follows:
- Distinguishing between systemic risk and market integrity. When deciding how to apply swaps rules in a cross-border context, the CFTC should distinguish between swaps requirements that are intended to mitigate systemic risk and those intended to address market issues (e.g., trading and professional practices). Broad application of the first group of requirements — which includes requirements related to clearing, margining, dealer capital and recordkeeping and regulatory reporting — is appropriate given the CFTC’s statutory jurisdiction. The second group of requirements — which includes trade reporting, a variety of trade execution requirements and practices and certain business practice and oversight requirements — should be applied on a more limited cross-border basis. The White Paper observes that broad applicability of U.S. requirements related to market issues may have been “possibly justifiable” when the CFTC Cross-Border Guidance was published, but because other countries have adopted their own swaps reforms in the interim, the CFTC Cross-Border Guidance is now “out of step with the world’s major swaps trading regimes.”8
- Systemic risk: balancing comparability and comity. The CFTC should pursue multilateral solutions with non-U.S. regulators with respect to swaps requirements that are intended to address systemic risk. Those requirements should nonetheless apply to U.S. firms on an “entity basis.” Related substituted compliance findings should be based on a relatively strict degree of comparability between U.S. and non-U.S. requirements, though the CFTC should nonetheless “operate on the basis of comity, not uniformity, with non-U.S. regulators that oversee comparable regulatory regimes.”9
- Market integrity: providing greater flexibility. For requirements intended to address market integrity issues, the CFTC should expect non-U.S. regulators to defer to U.S. markets, but it should demonstrate flexibility when it considers relief with respect to trading in non-U.S. markets.
- Ending the bifurcation of swaps markets for U.S. persons. The global swap markets should not be divided (as they are) between markets that exclude participants that are U.S. persons and those that do not.
In formulating specific recommendations based on the principles above (which are discussed below), the White Paper distinguishes between jurisdictions that have implemented swaps reforms that the CFTC determines are comparable (Comparable Jurisdictions) to the CFTC’s swaps regime and those that have not. The White Paper notes that only 5 percent of global swaps activity takes place in jurisdictions that have not implemented the G20 reforms.10
4. What does the White Paper recommend with respect to non-U.S. swaps central counterparties (CCPs)?
With respect to U.S. and EU regulation of CCPs that operate on a cross-border basis, the White Paper describes, and largely expresses support for, the status quo. However, the White Paper indicates that the status quo is at risk as the result of a recent EU legislative proposal.
The White Paper first describes both the means by which the CFTC has permitted non-U.S. CCPs to operate in the United States and the means by which EU regulators have reciprocated with respect to U.S. CCPs operating in the European Union (EU). In Chairman Giancarlo’s view, those reciprocal arrangements are
an acknowledgement of common deference between the CFTC and the EC with respect to the regulation and supervision of CCPs. While CFTC and EU rules are not identical, the regimes are equivalent on an outcomes-basis. Under the EC’s equivalence determination for the CFTC, U.S. [CCPs] can offer clearing services to EU market participants by adhering to U.S. law and satisfying the [EU] Equivalence Conditions.11
However, the White Paper then describes a recent EU legislative proposal and states that the proposal
as written would require at least some currently-recognized U.S. [CCPs] to have rules that are fully consistent with all of [the applicable EU regulation] — not just the three provisions that make up [the current] Equivalence Conditions. This requirement disregards the [existing arrangements].... Moreover, ... under the Proposal, at least some recognized U.S. [CCPs] would be required to follow EU law even for the clearing of domestic U.S. contracts, including listed futures, and for the clearing of U.S. customers.12
In Chairman Giancarlo’s view, that outcome, if realized, would impermissibly impinge on the CFTC’s “statutory responsibility to decide what is appropriate regulation for relevant U.S. markets and market participants, just as other non-U.S. regulators should be expected to act as rule makers for their jurisdictions.”13
Accordingly, the White Paper recommends that the status quo be maintained in large part, and it urges the European Commission (EC) to “honor its commitments under [the current arrangements] and ensure that the application of EU law with respect to U.S. CCPs is limited to the boundaries of the EU.”14
In one important respect, however, the White Paper suggests a further limitation on the CFTC’s regulation of certain EU and other non-U.S. CCPs. It proposes that the CFTC exempt CCPs in Comparable Jurisdictions from U.S. registration requirements if it determines that those CCPs do not pose substantial risk that is specific to the U.S. financial system as a whole, even if such CCPs clear swaps for U.S. persons. In such cases, the non-U.S. CCPs “would be permitted to provide clearing services to U.S. customers indirectly through non-U.S. clearing members, without the non-U.S. CCP or its non-U.S. clearing members having to register as a DCO or FCM, respectively.”15
In contrast, non-U.S. CCPs that the CFTC determines to be systemically important would (despite being located in in Comparable Jurisdictions) continue to be “regulated and supervised as they are today with the CFTC’s regulatory and supervisory activity focus concentrated on the CCP’s U.S.-facing clearing while recognizing the supervisory primacy of the home country regulator.”16
5. What does the White Paper recommend with respect to non-U.S trading venues?
The White Paper criticizes the Staff SEF Guidance, which addressed multilateral swaps trading platforms located outside the United States. As described in the White Paper, the Staff SEF Guidance generally required registration as a swap execution facility (SEF) for any non-U.S. multilateral trading platform that
provides U.S. persons or persons located in the United States, including personnel and agents of non-U.S. persons located in the United States (U.S.-located persons), with the ability to trade or execute swaps on, or pursuant to, the rules of the platform, either directly or indirectly through an intermediary.17
The White Paper is critical of the Staff SEF Guidance in large part because global swaps markets have fragmented because non-U.S. trading venues have denied access to U.S. firms.
In contrast, the White Paper cites favorably a subsequent 2017 agreement between the CFTC and the EC regarding an alternative regulatory approach to swaps trading venues. In accordance with that agreement, (i) the CFTC exempted from SEF registration requirements certain “multilateral trading facilities” and certain “organised trading facilities” regulated under applicable EU regulations law, and (ii) the EU made equivalence findings with respect to certain CFTC-registered trading venues.
The White Paper then proposes that the CFTC exempt from SEF registration requirements all non-U.S. trading venues that are regulated in Comparable Jurisdictions. That exemption would apply to all swap transactions, not only those subject to the CFTC’s trading mandate. As a consequence, U.S. firms would have access to those non-U.S. trading venues.
6. What does the White Paper recommend with respect to non-U.S. swap dealers?
The principal swap dealer registration issue addressed by the White Paper concerns the treatment of non-U.S. swap dealers that are consolidated with ultimate U.S. parent entities but do not trade with a U.S. parent guarantee. Many such “foreign consolidated subsidiaries” (or FCSs) came under scrutiny a few years ago when they gave up U.S. parent guarantees in a manner that permitted them, under the Cross-Border Guidance, to avoid certain CFTC requirements (because, once they were “de-guaranteed,” they were not required to count all of their dealing transactions against the de minimis threshold for swap dealer registration requirements). In 2016, the CFTC proposed a rule change to address those “de-guaranteed” FCSs; the CFTC Cross-Border Rule Proposal would result in requirements that have not been imposed under the Cross-Border Guidance.
The White Paper criticizes the CFTC Cross-Border Rule Proposal and endorses the status quo with regard to FCSs:
While it is right to limit regulatory evasion, there are better means to address the potential risk that might flow to the United States due to de-guaranteeing. It is an overreach to require FCS that engage in swap dealing activity wholly outside the United States to register with the CFTC, based on the theory that they pose a hypothetical risk to the U.S. financial system due to an accounting connection.18
The White Paper reasons:
The ... approach proposed by the CFTC in 2016 of trying to regulate non-U.S. persons whose swap dealing activity occurs solely outside the United States is not only unnecessary to address systemic risk, it does not respect non-U.S. regulators that engage in comparable swap dealing regulatory supervision. ... It is not a good expenditure of the CFTC’s time and resources to attempt to regulate entities whose only connection to the United States is their inclusion on a consolidated financial statement.19
Thus, the White Paper proposes that an FCS that engages in dealing activities wholly outside the United States and is regulated in a Comparable Jurisdiction should not be required to register as a swap dealer with the CFTC.
In contrast, non-U.S. dealer entities that trade with a guarantee from a U.S. person (e.g., are guaranteed by a U.S. holding company parent) would, like U.S. dealer entities, be required to count all of their dealing transactions against the de minimis threshold for swap dealer registration. However, unlike U.S. dealer entities, such guaranteed entities could rely on substituted compliance in Comparable Jurisdictions.
7. What does the White Paper recommend with respect to requirements related to clearing and trade execution?
The White Paper notes that the CFTC’s swap clearing and swap execution requirements are “integrally linked.”20 However, the White Paper proposes that the CFTC apply different standards when it determines whether substituted compliance is available for the requirements. It proposes that difference because the two sets of requirements have different policy objectives:
swaps clearing is focused primarily on managing and mutualizing the accumulation of counterparty credit risk; whereas swaps trade execution is primarily concerned with market integrity and trade practice issues.21
Accordingly, because swap clearing requirements (but not trade execution requirements) focus on systemic risk, “the CFTC should expect a stricter degree of comparability than with respect to comparability determinations for the trade execution.”22
In either case, non-U.S. persons, including both FCS’s and guaranteed entities, should be able to rely on substituted compliance in Comparable Jurisdictions; the only question is the standard the CFTC applies in making its substituted compliance determinations.
8. What does the White Paper recommend with respect to swap transactions between non-U.S. persons that are “arranged, negotiated, or executed” by personnel or agents located in the United States (ANE Transactions)?
In the first instance, the White Paper distinguishes those ANE Transactions that personnel or agents in the United States execute from those that such personnel or agents only arrange and/or negotiate. The former (those executed by personnel or agents in the United States) would always be subject to CFTC SEF execution requirements (despite the fact that ANE Transactions are, by definition, between two non-U.S. persons). The treatment of the latter would depend on the particular circumstances:
- Where the ANE Transaction is arranged and/or negotiated by a “third-party U.S. intermediary located in the United States, such as an [executing broker],” that third party will need to be registered as a SEF.
- Where the ANE Transaction is arranged and/or negotiated by a “U.S.-based agent/employee of a non-U.S. swap dealer located in the United States,” it too will be subject to CFTC jurisdiction. But the White Paper states that if the non-U.S. swap dealer is subject to regulation in a Comparable Jurisdiction, “there may be a basis to defer” to the regulation of that jurisdiction. The White Paper notes that future rule proposals will need to reflect
an approach that both avoids fragmenting the swaps market in the United States and imposing unwarranted costs on market participants. The goal must be, both in non-U.S. markets and in the United States: one unified marketplace, under one set of comparable trading rules and one competent regulator.23
9. What happens next?
Chairman Giancarlo intends to direct the CFTC staff
to put forth new rule proposals to address a range of cross-border issues in swaps reform — from the registration and regulation of swap dealers and major swap participants (MSPs) to the registration of non-U.S. trading venues and clearing organizations. These proposals should be presented to the full Commission for thoughtful input and bipartisan consideration and adoption. The resulting rulemakings would replace the CFTC Cross-Border Guidance and the 2016 Proposed Cross-Border Rules, as well as address certain positions taken in CFTC staff advisories and no-action letters.24
The White Paper does not seek public comment or other input, but any resulting rule-makings would be subject to public notice and comment requirements.
2 Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (July 26, 2013), available at https://www.gpo.gov/fdsys/pkg/FR-2013-07-26/pdf/2013-17958.pdf. See Sidley Update, CFTC Adopts Final Cross-Border Guidance and Exemptive Order; Announces “Path Forward” with EU (July 19, 2013).
3 CFTC Division of Market Oversight, Guidance on Application of Certain Commission Regulations to Swap Execution Facilities (Nov. 15, 2013), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/dmosefguidance111513.pdf.
4 CFTC Staff Advisory 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (Nov. 14, 2013), available at https://www.cftc.gov/sites/default/files/idc/groups/public/@newsroom/documents/file/dmosefguidance111513.pdf.
5 Cross-Border Application of the Registration Thresholds and External Business Conduct Standards Applicable to Swap Dealers and Major Swap Participants, 81 FR 71946 (Oct. 18, 2016), available at https://www.gpo.gov/fdsys/pkg/FR-2016-10-18/pdf/2016-24905.pdf. See Sidley Update, CFTC Proposes Cross-Border Swap Rule, Revisits 2013 Cross-Border Swap Guidance (November 9, 2016), available at https://www.sidley.com/en/insights/newsupdates/2016/11/cftc-proposed-cross-border-swap.
6 Mackenzie Smith, R. Q&A: CFTC’s Giancarlo on the Race to Overhaul Cross-Border Rules, Risk.net (October 4, 2018), available at https://www.risk.net/regulation/6002076/qa-cftcs-giancarlo-on-the-race-to-overhaul-cross-border-rules.
7 White Paper at 20.
8 White Paper at 82.
9 White Paper at 24.
10 Given the limited swaps market activity that occurs in non-Comparable Jurisdictions, this Sidley Update does not address a number of the White Paper’s suggestions with respect to such jurisdictions.
11 White Paper at 40-41.
12 White Paper at 41.
13 White Paper at 28.
14 White Paper at 42.
15 White Paper at 44.
16 White Paper at 45.
17 White Paper at 48-49.
18 White Paper at 66.
19 White Paper at 67-68.
20 White Paper at 75.
21 White Paper at 70.
22 White Paper at 73.
23 White Paper at 81.
24 White Paper at iii.
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