CFTC Approves Exemptive Order on Cross-Border Application of the Swaps Provisions of Dodd-Frank

On December 21, 2012, the Commodity Futures Trading Commission (“CFTC”) approved a final exemptive order (the “Order”) providing time-limited relief from the cross-border application of certain swaps provisions of Title VII of the Dodd-Frank Act and CFTC regulations.  The Order provides an interim definition of “U.S. person,” and also clarifies several outstanding calculation issues for non-U.S. persons assessing their status as a swap dealer (“SD”) or major swap participant (“MSP”) under the CFTC’s de minimis and MSP threshold tests.  Additionally, the Order permits registered non-U.S. persons to delay compliance with certain entity-level requirements adopted under Dodd-Frank, and provides relief from certain transaction-level requirements to both registered non-U.S. persons and the foreign branches of U.S.-based SDs and MSPs.[1]  The Order, which is effective immediately, will expire on July 12, 2013.

I. U.S. Person

The Order provides market participants with a new, interim definition of “U.S. person” for use during the effective period of the Order.  Note that this new  December 21 definition differs from both the one set forth in the CFTC’s proposed cross-border interpretive guidance, published in July, CFTC No-Action Letter 12-22, issued on October 12.

For purposes of this Order, an entity is a “U.S. person” if it is any of the following:

(i) A natural person who is a resident of the United States;

(ii) A corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of enterprise similar to any of the foregoing, in each case that is (A) organized or incorporated under the laws of a state or other jurisdiction in the United States or (B) effective as of April 1, 2013 for all such entities other than funds or collective investment vehicles, having its principal place of business in the United States;

(iii) A pension plan for the employees, officers or principals of a legal entity described in (ii) above, unless the pension plan is primarily for foreign employees of such entity;

(iv) An estate of a decedent who was a resident of the United States at the time of death, or a trust governed by the laws of a state or other jurisdiction in the United States if a court within the United States is able to exercise primary supervision over the administration of the trust; or

(v) An individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in (i) through (iv) above.

Any entity not described in (i) to (v) above will be considered a non-U.S. person.

II. De Minimis and MSP Threshold Calculations

For the duration of the Order, a non-U.S. person will not have to aggregate, under either the de minimis test or the MSP threshold tests, the following:

(i) Any swap where the counterparty is not a U.S. person; and

(ii) Any swap where the counterparty is a foreign branch of a U.S. person that is registered as an SD, or represents that it intends to register as an SD by March 31, 2013.

Note that these exclusions will apply regardless of whether the non-U.S. person’s obligations under the swap are guaranteed by a U.S. person.

The Order also provides that a non-U.S. person will not have to aggregate, under the de minimis test, any swaps to which it is not a party because the swap is entered into by an affiliated central booking entity.

III. Aggregation under the De Minimis Calculation for Affiliates under Common Control

The Order provides that a non-U.S. person may exclude, in its de minimis calculation, any swaps entered into by its U.S. affiliates.  Non-U.S. persons will also be able to exclude any non-U.S. facing swaps entered into by non-U.S. affiliates.

Additionally, and only in the case of a non-U.S. person already affiliated with a registered SD, such non-U.S. person will be able to exclude from its de minimis calculation the swaps of any non-U.S. affiliate that is either (i) currently engaged in swap dealing activities with U.S. persons, or (ii) registered as an SD.

IV. Non-U.S. SDs and MSPs

Non-U.S. SDs and MSPs will not have to comply with entity-level requirements until the Order expires, except that:

(i) Non-U.S. SDs and MSPs must comply with applicable swap data repository (“SDR”) reporting and large trader reporting (“LTR”) requirements for all swaps with U.S. counterparties; and

(ii) Non-U.S. SDs and MSPs that are part of an affiliated group in which the ultimate parent entity is a U.S. SD or MSP, U.S. bank, U.S. financial holding company or U.S. bank holding company must comply with SDR reporting and LTR requirements for swaps with non-U.S. counterparties.

Non-U.S. SDs and MSPs will not have to comply with transaction-level requirements when facing a non-U.S. counterparty, except as required by such registrants’ local jurisdictions, provided that such registrants comply with transaction-level requirements when facing U.S. counterparties.

V. Foreign Branches of U.S. Registrants

The Order reiterates the CFTC’s view, first set out in the proposed guidance, that the foreign branch of a U.S. SD or MSP is a “U.S. person.”  Nevertheless, under the Order, foreign branches of registered U.S. persons will not have to comply with transaction-level requirements when facing a non-U.S. counterparty, except as required by the local jurisdictions of such branches.

Additionally, while a swap between two foreign branches of U.S. registrants would be considered a swap between two U.S. persons, the Order also provides temporary relief from compliance with transaction-level requirements for such swaps, except as required by the local jurisdictions of the branches.  For purposes of this relief with respect to a swap between foreign branches of U.S. registrants, a swap is with the foreign branch when (i) the personnel negotiating and agreeing to the terms of the swap are located in the jurisdiction of the foreign branch; (ii) the documentation of the swap specifies that the counterparty or “office” for the U.S. person is the foreign branch and (iii) the swap is entered into by the foreign branch in its normal course of business.

VI. Additional Comment Period

The Commission is seeking additional public comment on the definition of “U.S. person” and issues relating to affiliate aggregation under the SD de minimis calculation.  The comment period for these issues will be open for 30 days after the Order is published in the Federal Register.


[1] Entity-level requirements refer to the requirements set forth in CFTC regulations 1.31, 3.3, 23.201, 23.203, 23.600, 23.601, 23.602, 23.603, 23.605, 23.606, 23.607, 23.608 and 23.609 and parts 20, 45 and 46. Transaction-level requirements refer to the requirements set forth in CEA section 2(h)(8) and CFTC regulations 23.202, 23.400 to 23.451, 23.501, 23.502, 23.503, 23.504(a), 23.504(b)(2), (b)(3) and (b)(4), 23.505(b)(1), 23.506 and 23.610 and part 43.

[2] 77 Fed. Reg. 41214 (July 12, 2012).

Lofchie Comment:  Firms are required to register as swap dealers on December 31.  This means that the business day by which a registration must be absolutely completed and filed is December 28th as the next two days are on the weekend.  The CFTC issued this order, defining who must register as a swap dealer, sometime on December 21st.  The 22nd and the 23rd were on the weekend; for much of the country, the 24th is a holiday and for all of the country, the 25th is a holiday.  This means that the CFTC is giving firms two full business days (the 26th and the 27th) to determine whether they are required to register or how the registration requirements will apply to them.  I also add that on these two business days, many people will be on vacation and computer systems may be in a year-end slowdown mode.  Further, this “relief” (and it is relief) will require coordination with overseas offices, who may have different holiday or vacation schedules, leave aside the time zone differences.  On top of that, one aspect of the relief requires firms to obtain a representation from counterparties, which again will be logistically difficult to obtain given the timing and the holiday schedule. 

On top of that, we are all dealing with a torrent of no-action letters, some helpful, some useless because of all the conditions attached to reliance, and virtually all of them quite complicated.

It goes without saying that the impacts of swap dealer registrations are tremendous, both for firms that are required to register and for firms that are saved from registration.  The competitive impacts of this order are large; i.e., firms that are not required to register (primarily non-U.S. firms) will likely have a competitive advantage over firms that are required to register assuming, as I fear, that non-U.S. counterparties prefer to stand clear of the ongoing regulatory uncertainty. 

Accordingly, the better course for the CFTC would have been to simply postpone the registration date for all firms.  I think that the CFTC is making a mistake by proceeding in this manner, granting more partial/conditional/last minute relief, rather than simply electing to put its rules fully on hold until they can be coordinated with the rules of the SEC and other global regulators.  This is particularly the case given that that the CFTC’s rules, even its adopted rules, are in a state of flux.  Witness the remarkable number of no-action letters and interpretations that the agency has issued in just over two months.

See: Final Exemptive Order Regarding Compliance with Certain Swap Regulations – Further Proposed Guidance.
See also: Chairman Gensler’s Statement of Support; Commissioner O’Malia’s Concurring Statement; Commissioner Sommers Dissenting Statement; Commissioner Chilton on Global Regulatory Harmonization.
Related statement: SIFMA Statement on CFTC Delay of Cross-Border Rules.

CFTC Issues Time-Limited, No-Action Relief for Compo Equity Total Return Swaps

Office of the General Counsel (“OGC”) issued a no-action letter providing time-limited relief from requirements arising from the CFTC-SEC joint interpretation that compo equity total return swaps are mixed swaps, subject to regulation by both the CFTC and the SEC.  The no-action letter provides that OGC will not recommend that the CFTC commence action against any person in connection with any failure of such person to comply with the CFTC Rules (other than those relating to anti-fraud and anti-manipulation authority) to the extent such failure arises solely because such person treats a compo equity total return swap solely as a security-based swap (subject only to SEC Rules) and not as a mixed swap (subject as well to the CFTC Rules).

The no-action relief is subject to the following conditions:

(i) market participants are required to act reasonably and in good faith in progressing to full compliance with CFTC rules applicable to mixed swaps with respect to compo equity total return swaps by July 1, 2013;
(ii) affected persons are also required to come into full compliance as the technical and operational issues preventing timely compliance have been resolved, even if such resolution occurs prior to July 1, 2013; and
(iii) during the pendency of the no-action period, and prior to reporting compo equity total return swap transaction data records to a swap data repository, affected persons must retain records with respect to all covered transactions and make such records available to the CFTC.

Lofchie Comment:  Under the SEC/CFTC Rules, a so-called “compo” swap is treated as being subject to both the CFTC and the SEC Rules, whereas a “quanto” swap is treated as only being subject to the SEC Rules.  As a starting matter, I will say that this classification seems illogical to me.  If it were necessary to treat one of these swaps as subject to regulation by both regulators, I would have reversed the treatment myself.   But I think this intellectual dispute only illustrates how absurd the whole scheme of dual regulation is: is it really necessary to have two regulators govern an equity swap that has a non-leveraged currency conversion element?  The regulators can blame the absurdity on Dodd-Frank (which I find easy enough to criticize), but if the CFTC has authority to issue a six-month no-action letter, there seems no reason that the CFTC could not issue a no-action letter of infinite duration and solve the double regulation problem.

Turning back to the substance of the letter, I observe, as I have commented in the past, that the CFTC just seems unwilling to issue no-action letters that come without conditions.  After all, what does it mean to say that the no-action relief is subject to firms’ “good faith in progressing”?  Does that mean that the CFTC could retroactively declare a quanto swap illegal because a firm had not made sufficient progress in hitting a July deadline (and who is to say that the July deadline will not be further delayed)?  Similarly, what does it mean to say that the deadline extends to July 1, but firms must come into compliance earlier if they can?  The regulatory philosophy of the CFTC seems at times to be that every single rule, or exemption from a rule, must be subject to a “facts and circumstances” analysis that makes it impossible for regulated persons to know when the rules apply and when they do not.

See: CFTC Letter 12-64 PDF Image: Mixed swaps, Section 1a(47)(D) of the Commodity Exchange Act; No-Action.

CFTC Issues No-Action Relief for Certain U.S. Banks Wholly Owned by Non-U.S. SDs, for Purposes of De Minimis Exemption

The CFTC’s Division of Swap Dealer and Intermediary Oversight (”DSIO”) issued a no-action letter that provides relief for certain U.S. banks that are wholly owned by non-U.S. banks that are themself CFTC-registered swap dealers.  The no-action letter allows a U.S. bank that is wholly owned by such a foreign entity to ignore the swap dealing activities of its foreign affiliates, or the U.S. branches of such affiliates, when determining whether such U.S. bank satisfies the de minimis exception to the swap dealer definition and registration requirements.

Conditions:  The letter is subject to VERY extensive conditions, which are PARTIALLY set out below:

  1. The U.S. bank must be nationally chartered.
  2. Although the U.S. bank must be ultimately wholly owned by a foreign entity, it must have an intermediate U.S. corporate owner that (i)  is an FHC and (ii) files financial statements with the SEC. 
  3. The U.S. bank and its foreign affiliates must serve “different aspects” of the U.S. swaps market, although customer overlap is permitted.  
  4. The U.S. bank cannot rely on its foreign affiliates for “operational servicing.”

NOTE: In order to rely on the relief provided in the no-action letter, a bank must file a claim with DSIO.

Lofchie Comment:  I don’t understand why every CFTC no-action letter  must be subject to so many conditions.  Why does it matter whether the relevant U.S. bank is nationally chartered or state chartered?  Why does it matter whether the U.S. bank and the non-U.S. bank serve the same “aspects” of the swaps market (and what does that even mean?)?  All of these conditions inevitably raise difficult legal questions because there is no obvious policy basis for them; e.g., what does it mean to “rely” on an affiliate for “operational services” and what are “core operational capabilities”?  I just don’t understand what policy issues are at stake here that make these conditions necessary to the grant of relief.

See: CFTC Letter 12-61 PDF Image: Commission Regulation 1.3(ggg)(4); No-Action.

SIFMA Submits Comments to the SEC Requesting an Extension of the SEC’s Exemptive Order and Security-Based Swaps Interim Final Rules

SIFMA submitted a comment letter to the SEC requesting an extension of the expiration date of the SEC’s Exchange Act Exemptive Order and security-based swaps (”SBS”) interim final rules until July 17, 2013.  In the letter, SIFMA notes that Dodd-Frank Sections 761 and 768 included SBS in the definition of “security” for purposes of the Exchange Act and Securities Act, and states that key issues and questions regarding the application of the federal securities laws to SBS remain unresolved.  The exemptive order is currently set to expire on February 11, 2013, which SIFMA argues would be premature.  

Lofchie Comment:  The notion of an exemptive order being issued before the last moment seems like a cool idea.  Maybe it would start a trend.

Click here to view letter in full (links externally to SIFMA website).
See also related news item: CFTC Delays Business Conduct and Documentation Rules .

MFA Submits Proposals for the CFTC to Consider with Respect to §4.13(a)(3)

The MFA submitted a comment letter to the CFTC urging it to consider adopting new guidance on the application of CFTC Rule 4.13(a)(3) for funds that invest in other collective investment vehicles, including certain securitization vehicles, ETFs, mortgage REITs, and private funds.  According to the letter, the CFTC did not classify such products as commodity pools at the time when many of these vehicles were created, and at the time when funds invested in them.  The MFA asserts that this new categorization makes the CFTC registration rule changes particularly problematic and potentially very disruptive to strategies of private funds, because “members largely cannot secure contractual arrangements with underlying funds, and generally cannot obtain daily, weekly, or even monthly information on an underlying fund’s commodity interest exposure.”  Recommendations are included within the letter. 

Click here to view letter in full (links externally to MFA website).

Central Banking Journal Highlights The Bretton Woods Transcripts

Central Banking, a quarterly journal for practitioners and observers of central banking, has published an article on The Bretton Woods Transcripts. (Article is here, but it may not be accessible from all computers.) Jacques de Larosière and Steve Hanke, who wrote the preface to the book, repeat some observations they made there. In particular, they stress how effective the conference was at covering the issues before it and how a number of those issues persist today. De Larosière was Managing Director–the top official–of the International Monetary Fund from 1978-1987; he remains active in French financial circles and is currently chairman of Eurofi. Hanke is Professor of Applied Economics at The Johns Hopkins University and Special Counselor at the CFS.

SEC Issues Special Report to Congress on Assigned Credit Ratings for Structured Products

The attached study, conducted by the Staff of the SEC, examines the Exchange Act Section 15E(w) (”Registration of nationally recognized statistical rating organizations”), the credit ratings system and potential alternatives to that system.  The study also discusses existing Exchange Act Rule 17g-5 (”Conflicts of interest”), which is intended to mitigate the issuer-pay conflict with respect to structured finance products.

The report does not make any definitive recommendations, but it does provide an easy-to-read description of the way that ratings are assigned, potential conflicts of interest, and various alternative means by which ratings agencies might function or be regulated.

This report was submitted to Congress pursuant to Dodd-Frank Section 939F.


Lofchie Comment:  The proposals for restructuring the way in which the rating agencies determine to rate any particular product include proposals that would result in the government playing a far greater role in the decision as to which rating agency might rate any particular product.  Although I can see the formal logic of an impartial goverment-directed process, I would be extremely nervous as to the thought of the government playing such a large role in determining the direction of capital, particularly given the scale of government “investment” in private industry and finance, as well as the government’s subsidization of certain industries.  One can easily imagine political “inquiries” into why certain issuers are being upgraded or downgraded.

Click here to view study in full (links externally to SEC website).

Price Momentum ETFs Obtain SEC Order and No-Action Letter

The SEC issued an Exemptive Order to ETFs that seeks to track the performance of a particular underlying index (“Index”), which for each ETF is composed of shares of exchange-traded products (“ETPs”) (primarily other ETFs, but also some exchange-traded commodity pools).  Using a methodology developed by the index provider as to the ETFs, each Index is intended to provide exposure to the price momentum of certain equity markets and U.S. fixed income markets by reflecting the combination of weightings of the ETPs that underlie each Index that would have provided the highest six-month historical return, subject to constraints on maximum and minimum weights and volatility controls.  The Index is rebalanced monthly, but may also be rebalanced as frequently as daily if the daily volatility control is triggered. Each ETF intends to operate as an “ETF of ETFs” by seeking to track the performance of its underlying Index in investing at least 80% of its assets in the ETPs that comprise each Index.  Except for the fact that the funds will operate as ETFs of ETFs, the funds will operate in a manner identical to the products that comprise each Index.

The SEC staff also issued a no-action letter as to Exchange Act Rule 10b-17 and Rules 101 and 102 of Regulation M in connection with secondary market transactions and the creation or redemption of shares issued by the ETFs.

Click here to view Order in full (links externally to SEC website).
See also: Request of ALPS ETF Trust for Exemptive, Interpretive or No-Action Relief from Rule 10b-I7 and Rules 101 and 102 of Regulation M promulgated under the Securities Exchange Act of 1934 for Index-Based ETF of ETFs.

CFTC Delays Business Conduct and Documentation Rules

The CFTC approved interim final rules delaying the compliance dates for certain business conduct and documentation requirements applicable to swap dealers and major swap participants.  Additionally, the CFTC voted 5-0 to approve the interim final rules, which will become effective immediately upon publication in the Federal Register.  The CFTC also indicated that it will consider any comments received during a 30-day period following publication of the interim final rules and may revise the rules based on comments received.

The rulemaking comes in response to requests from a variety of market participants for additional time to achieve compliance with rules that have significant documentation components.  The rulemaking provides limited additional time to establish compliant documentation in light of the fact that only a small percentage of affected parties have agreed to update relevant documentation despite significant outreach efforts.

For Part 23 rules adopted as part of the CFTC external business conduct rulemaking, as well two other Part 23 rules (listed below), the compliance date has been delayed to May 1, 2013.  The formerly phased compliance dates for Part 23 rules relating to required portfolio reconciliations and swap trading relationship documentation have been delayed to July 1, 2013.

A list follows of the regulations for which compliance dates were delayed, as well as a list of regulations that were adopted as part of the relevant rulemakings but for which compliance dates were not delayed.

Business Conduct Requirements

Compliance dates for the CFTC external business conduct requirements, which were published at 77 Fed. Reg. 9734 (February 17, 2012), have been extended as follows:
 Extended to May 1, 2013:
• Rule 23.402: “know your counterparty” requirements; true name and owner information; requirements for reliance on representations; manner of disclosure standards;
• Rule 23.410(c): confidential treatment of counterparty information;
• Rule 23.430: verification of eligible contract participant and special entity status;
• Rules 23.431(a)-(c): material risk and information disclosures, including pre-trade marks;
• Rule 23.432: clearing disclosures;
• Rule 23.434(a)(2): counterparty-specific suitability requirements;
• Rule 23.440: requirements for swap dealers acting as advisors to special entities;

• Rule 23.450: requirements for trading with special entities.
No extension provided:
• Rule 23.410(a)-(b): anti-fraud;
• Rule 23.431(d)(1): requirement to provide notice that valuations for cleared swaps are available from the relevant DCO;
• Rule 23.431(d)(2): requirement to provide daily marks for uncleared swaps;
• Rule 23.434(a)(1): general product suitability requirements;
• Rule 23.451: restrictions on political contributions.

Documentation Requirements

Compliance dates for CFTC swap documentation requirements, which were published at 77 Fed. Reg. 55904 (September 11, 2012), have been extended as follows:
 Extended to May 1, 2013:

• Rule 23.505: end user exception documentation (note: mandatory clearing requirements for end users don’t go into effect until after May 1).
Extended to July 1, 2013:
• Rule 23.502: portfolio reconciliations;

• Rule 23.504: swap trading relationship documentation, including agreements as to valuation methodologies.
No extension provided:
• 23.501: swap confirmation;
• 23.503: portfolio compression.

Effective Date: From the date of publication in the Federal Register.


Lofchie Comment:  That this relief would be granted had been promised more or less in a recent speech by CFTC Commissioner Chilton.  See Related News Story: CFTC Commissioner Chilton Calls for Six-Month Transition Compliance Period.

The CFTC staff has made what is unquestionably a valiant effort to finalize Dodd-Frank rules as quickly as possible.  (I cannot deny the level of effort, notwithstanding my fundamental disagreement with the approach to financial regulation taken by Dodd-Frank and my disagreement with particular rules and with rule particulars.)  That said, it should have long ago become clear, and the most recent CFTC action emphasizes, that the attempt to bring swaps rules online as fast as they could be adopted just did not work. 

I do note it was not only the CFTC that was making a valiant effort.  Much of the financial industry and the various participants in the commodities industries were frantic to meet deadlines that we all understood could not be met under the best of circumstances, and which we hoped and guessed would be partially delayed at the next-to-last minute.  Now that has been largely done, and it would be better if the rules were completely delayed. 

It should now be time for the CFTC to adopt the approach taken by the SEC in its swaps rulemaking: to propose a comprehensive set of rules that can be understood as a whole and commented upon a whole; to confront the questions of international jurisdiction before adopting rules that have international effect; and eventually to adopt a feasible schedule for rule implementation.


View 17 CFR Part 23 (links externally to CFTC website).

Caution on CFTC Requirement on Tape Recording

On December 17, 2012, the Commodity Futures Trading Commission voted to amend Rules 1.31 and 1.35 to require recording of certain oral communications that lead to the execution of a transaction in a “commodity interest” by certain CEA-registered persons.  See News Item:  CFTC Announces Approval of Final Rule on Recordkeeping.

Although recording is being mandated by the CFTC for both these registered entities under Rule 1.31 and 1.35, as well as for swap dealers and major swap participants under Part 23, firms should be aware that the electronic recording of conversations is separately and expressly regulated both by federal law and by the criminal laws of all the states (other than Vermont), and that the failure to comply with these laws can result in substantial civil and criminal penalties.  While an argument could be made that these state recording laws are implicitly preempted by the CEA (at least with respect to swap dealers and major swap participants), this would be a matter of first impression for the courts.  Thus, when implementing recording programs to comply with CFTC regulations, clients should ensure that these recording programs comply with federal and state telephone recording laws.  While federal law and the criminal law of most states require consent of only one party to the recording (such as the employee), twelve states require the consent of both parties to the call, i.e., including the counterparty’s employee.  Which state’s law governs the conversation will depend on the location of the individuals having the conversation.

When one or both parties to the telephone call are located in a “two-party consent” state, exceptional care should be exercised when recording.  It is a common belief that, in these “two-party consent” states, the playing of an “electronic beep” is sufficient to comply with state criminal law.  This is typically not the case.  It is also sometimes believed that consent by the caller’s employer – rather than by the individual employee participating in the call – is in all cases sufficient.  The law in this regard is not uniform or clear.  Conversely, it is clear that the giving of an appropriate prior notice – on both inbound and outbound calls – that the call may be recorded will constitute compliance in every state.  While providing an automated notice on inbound calls is relatively easy and is typically included as part of the initial “hold” music or message, providing notice on outbound calls is far more cumbersome.   Whether notice must be provided on outbound calls will depend on whether the individual being called reasonably has been made aware that call recording is occurring.

In addition to providing notice, in every state, registrants should seek written consent from their employees to ensure compliance with the one-party consent requirements of federal law and most states’ laws.