The applicability of the Dodd-Frank Act’s provisions on OTC derivatives to cross-border transactions is being debated even as swap execution facilities, along with clearing and reporting obligations, swing into operation.
The Commodity Futures Trading Commission has issued guidance which says that “substituted compliance” should be available, or transaction-level requirements should not apply, with respect to swaps between a non-U.S. swap dealer and a non-U.S. person where the activities of the non-U.S. swap dealer take place outside the United States.
The key issue revolves around what is meant by “activities.” The CFTC is of the view that persons regularly arranging, negotiating, or executing swaps for or on behalf of a swap dealer are performing core, front-office activities of that dealer’s business. Thus, a non-U.S. swap dealer (whether an affiliate or not of a U.S. person) regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person generally would be required to comply with the transaction-level requirements.
“You need to know which jurisdiction a trade falls in,” said Satya Pemmaraju, CEO of Droit Financial Technology, a provider of compliance software and services. “The CFTC has defined a category of U.S. person. If I’m trading with Barclays plc, which is not a U.S. person or RBC, which is not a U.S. person, the CFTC doesn’t cover that, unless the trader or salesperson is in the U.S. Then you have to ask if this trade comes under the clearing or SEF mandate? If so, has it been listed by a SEF? Has it been made available to trade? Which clearing platforms can clear this trade?”
The CFTC guidance said that “For the avoidance of doubt, the Division’s view would also apply to a swap between a non-U.S. person and a non-U.S. swap dealer booked in a non-U.S. branch of the swap dealer, if the dealer is using personnel or agents located in the U.S. to arrange, negotiate, or execute the swap.
“If you take the fact pattern where a non-U.S. swap dealer is effectively trading outside the United States, say in London, with a client who is also based in London, but maybe there is sales coverage being provided from the United States, in those circumstances the risk associated with that transaction is risk residing in the London entity where it is traded and booked,” said Chris Allen, head of regulatory policy at Barclays plc, at a meeting of the CFTC Global Markets Advisory Committee earlier this month. “ Looked at from that perspective, it’s difficult to see why in those circumstances, U.S. transaction-level rules should apply to that transaction at all, and to the extent they might, why you couldn’t cross-substitute compliance.”
Allen continued, “There are practical ramifications to the absence of substituted compliance in the context of other sets of regulations applicable to that entity and transaction in London, which may be difficult to reconcile with the obligations being imposed by the CFTC.”