Judge Grants Amici Motion for Leave to File Brief in Support of CFTC; CFTC Submits Notice of Supplemental Authority in SIFMA v. CFTC Cross-Border Guidance Case

Posted on June 18, 2014 by Steven Lofchie

In a development in the lawsuit brought by SIFMA, ISDA and the Institution of International Bankers (“Associations”) against the CFTC’s Cross-Border Guidance, the U.S. Circuit Court of Appeals for the District of Columbia (“Court”) granted the motion for leave to file the amicus brief in support of the CFTC that was submitted by Congressional Democrats in March 2014. Additionally, the CFTC submitted a notice of supplementary authority to “bring to the Court’s attention” the June 4, 2014 decision of the U.S. Court of Appeals for the Second Circuit (the “Second Circuit”) in Lotes Co., Ltd. v. Hon Hai Precision Industry Co., Ltd. (“Lotes“).

According to the CFTC, the Second Circuit considered the text of the Foreign Trade Antitrust Improvement Act (“FTAIA”) Section 6a, which “parallels CEA Section 2(i).” The FTAIA states that “Sections 1 to 7 of this title shall not apply to conduct involving trade or commerce (other than import trade or commerce) with foreign nations” unless such conduct has a direct, substantial and reasonably foreseeable effect on trade or commerce that is not trade or commerce with foreign nations.

The CFTC argued that the Second Circuit in Lotes read the FTAIA in the same way that the CFTC now reads CEA Section 2(i), in the sense that both describe the conduct to which the swaps provisions apply. According to the CFTC, the Associations overlooked the words “not” and “unless,” and Section 2(i) only limits and does not establish the cross-border reach of the swaps provisions.

Furthermore, the CFTC explained, while the Associations contended that the CFTC’s consideration of the meaning of the word “direct” in its Cross-Border Guidance was mistakenly reliant on the Seventh Circuit’s interpretation of “direct” in Minn-Chem, Inc. v. Agrium, Inc., the CFTC pointed out that the Second Circuit in Lotes also chose to follow Minn-Chem.

Lofchie Comment: The notion that the CEA should be interpreted by referencing an obscure provision of the antitrust laws, which (i) no one in Congress or at any regulator was aware of at the time Dodd-Frank was adopted, (ii) in terms of language, has a few words in common with the CEA, but is far from identical and (iii) is totally unrelated in policy and history, should not pass the (keep a) straight-face test. Is there a single instance historically of a provision of U.S. financial regulatory statutes being drafted or interpreted by reference to the Foreign Trade Antitrust Improvement Act? Is the CFTC arguing that Congress was looking to the FTAIA when it drafted Dodd-Frank (and that, having the FTAIA in mind, it decided to use somewhat different language)?

See: CFTC Notice of Supplemental Authority.

Rep. Waters Writes Letter to CFTC Urging Investigation into U.S. Banks’ Overseas Moves

Posted on June 17, 2014 by Steven Lofchie

Representative Maxine Waters (D-CA) wrote a letter to CFTC Chairman Timothy Massad, urging the CFTC to “thoroughly investigate” recent reports that large U.S. banks are attempting to avoid U.S. swap regulations by changing the swaps agreements of their foreign affiliates to remove explicit references to any guarantee by the U.S. bank.

According to Rep. Waters, swaps transactions of foreign guaranteed affiliates transfer risk back to the United States to the same degree as if the transaction were entered directly by the U.S. bank, regardless of the form of the guarantee.

Therefore, Rep. Waters requested that the CFTC investigate any removal of U.S. guarantees, “focusing on the substance, rather than form, of the arrangements between the U.S. banks and their foreign affiliates.” In particular, she requested the CFTC consider the presence of other non-traditional guarantees and arrangements that, viewed at the entity-level, support the creditworthiness of foreign affiliates.

Lofchie Comment: It is perfectly appropriate for U.S. regulators to discourage U.S. banks from the restructuring of credit arrangements in form, and not substance. It is reasonable to expect that the Dodd-Frank regulations, and the general regulatory climate, will motivate a significant amount of financial business to move in substance, and not merely in form, outside of the United States. U.S. regulators could arguably discourage U.S. financial institutions from doing business outside of the United States, but that would likely result in the loss of business to non-U.S.competitors.

See: Representative Waters’ Letter.

ISDA Publishes Study on Central Clearing in Equity Derivatives Market

Posted on June 12, 2014 by Steven Lofchie

ISDA published a study titled “Central Clearing in Equity Derivatives Market,” which outlines the composition of the equity derivatives market and the extent of central clearing today. The study examines the criteria that should be assessed when determining whether a clearing mandate applies in the European Union. The study also considers whether the liquidity of the underlying reference share, which was proposed by European Securities and Markets Authority (“ESMA”) as a possible method of defining a class of product, is appropriate for clearing mandate determinations.

According to ISDA, the March 18, 2014 approval of Sweden’s Nasdaq OMX, which is the first central counterparty under European Markets Infrastructure Regulation (“EMIR”), focused attention on how a clearing determination will be applied across the EU. ISDA and its members stated that the criteria used to determine a clearing obligation, as proposed in an ESMA discussion paper on July 12, 2013, must be carefully considered.

See: ISDA Study on Central Clearing in the Equity Derivatives Market.

MFA Paper Outlines Problems with Dual Citizenship (Double Regulation) of Funds

Posted on June 4, 2014 by Steven Lofchie

The Managed Funds Association (“MFA”) finalized a discussion paper on Article 13(3) of EMIR. The paper explains what the MFA considers to be the key issue regarding the European Commission’s adoption of an implementing act on equivalence with respect to the United States.

The MFA stated that certain alternative investment funds (“AIFs”) which are legally incorporated outside the United States, but are either managed by a U.S.-based manager or majority-owned by U.S. persons, are thus considered “U.S. persons” subject to CFTC derivatives rules. If the European regulators do not regard AIFs as being “established” in the United States for the purposes of Article 13, however, then AIFs and their EU counterparts will need to comply with both the CFTC rules and EMIR.

Lofchie Comment: The best result would be if European and U.S. regulators would allow such funds (those that have contacts with both the United States and Europe) to decide whether they prefer to be treated as American or European. Since both regulators overregulate the swaps business and private funds, they should allow private funds to pick their poison.

See: MFA Discussion Paper; MFA Press Release.

CFTC Chairman Wetjen Discusses CFTC Dodd-Frank Implementation Efforts

Posted on May 30, 2014 by Steven Lofchie

At the D.C. Bar, Acting CFTC Chairman Mark Wetjen spoke about the CFTC’s efforts to implement Dodd-Frank and other upcoming priorities.

Mr. Wetjen stated that the most important focus for the CFTC in the past six months has been overseeing the CFTC swap-trading mandate. He explained that the CFTC has taken steps to ensure that swaps executed as packaged transactions are treated appropriately as the marketplace moves toward greater use of swap execution facilities. Mr. Wetjen stated that it is important to “remain true to congressional intent to maximize transparency where appropriate, but work to ensure an orderly transition to what remains an historic market-structure shift for swaps.”

With regard to cross-border rules, Mr. Wetjen said, it is important to balance the interests of each foreign regime and customer protection, adding that he expects to see international coordination in the coming weeks concerning non-U.S. clearinghouses and swap trading platforms.

See: Chair Wetjen’s Remarks.

CFTC Reopens Comment Periods for Position Limits for Derivatives and for Aggregation of Positions (Fed. Reg.)

Posted on May 30, 2014 by Steven Lofchie

The CFTC’s proposal to reopen the comment periods for the Position Limits for Derivatives Proposal and for the Aggregation Proposal was published in the Federal Register.

The CFTC reopened the comment periods for an additional three weeks to request that market participants comment on:

hedges of a physical commodity by a commercial enterprise, including gross hedging, cross-commodity hedging, anticipatory hedging and the process for obtaining a non-enumerated exemption;
the setting of spot-month limits in physical-delivery and cash-settled contracts and a conditional spot-month limit exemption;
the setting of non-spot limits for wheat contracts;
the aggregation exemption for certain ownership interests of greater than 50 percent in an owned entity; and
aggregation based on substantially identical trading strategies.

Comments are due by July 3, 2014.

See: 79 FR 30762.

FIA President and CEO Lukken Discusses Global Trends at Shanghai Derivatives Market Forum

Posted on May 30, 2014 by Steven Lofchie

At the Shanghai Derivatives Market Forum, Futures Industry Association (“FIA”) President and CEO Walt Lukken delivered the keynote address in which he discussed global trends in derivatives markets.

In his speech, Mr. Lukken highlighted the opportunities and challenges presented by the transition from over-the-counter trading to exchanges and clearinghouses. He stressed the value in the exchange and clearinghouse model for price discovery and risk management, but urged international regulators to be mindful of the potential problem that could result from concentrating risk in clearinghouses.

See: President Lukken’s Speech.

SIFMA AMG Submits Comments Regarding Review of Swap Data Recordkeeping and Reporting Requirements

Posted on May 29, 2014 by Steven Lofchie

The Asset Management Group of SIFMA (“SIFMA AMG”) submitted comments to the CFTC regarding its request for review of CFTC Rules Parts 43, 45, 46 and 49 (the “Swap Reporting Rules”), which collectively set forth requirements for swap data recordkeeping and reporting, as well as swap data repository (“SDR”) operations and data.

SIFMA AMG highlighted its concerns with the Swap Reporting Rules as implemented to date, stating first that, as a basic principle, asset managers should, but do not, have access to swap trade information reported to an SDR by a dealer for clients on whose behalf a manager is acting.

Additionally, SIFMA AMG said, it believes that the CFTC can improve the quality of swap data being reported by establishing uniform standards that would allow the CFTC and other global financial regulators to compare data across multiple SDRs easily. To harmonize the swap data reporting requirements on a cross-border basis, SIFMA AMG also recommended the development of these uniform standards in conjunction with those being implemented in jurisdictions outside the United States.

More specifically, SIFMA AMG requested that the CFTC work with each SDR to ensure the following:

asset managers have the ability, if they so choose, to review SDR-reported trade information for trades executed on behalf of clients, or otherwise process such information in an automated fashion;

client trade information is made available to asset managers in an easily accessible, easy-to-read format, without the client’s trades, including those placed by other managers, being exposed to unauthorized parties;

trade information is not deemed verified merely by the passage of time;

confidential client trade information is not provided to third parties without the asset manager’s or its client’s consent; and

consistent specifications and reporting fields are utilized to harmonize reporting requirements across jurisdictions and ensure the interoperability of such information.

Lofchie Comment: Both the SIFMA AMG letter and the ISDA letter object to the ability of the Swap Data Repositories (“SDRs”) to resell the trade information that is reported to them. There are certainly good reasons why the SDRs should not be able to resell information transactions to which they are a party. However, if the SDRs cannot resell trade information, it raises a question of the business rationale for serving as an SDR. It also raises the question of how best to finance the activity. Acting as an SDR appears to be a governmental function, since there is no apparent way to make money in the role. Query: if resale of trade information were to be prohibited, what is the business rationale for serving as an SDR?

See: SIFMA AMG Comment Letter; ISDA’s Response to the CFTC’s Request for Comment on Part 45 and Related Provisions of the Swap Data Reporting Rules.
Related news: CFTC Publishes Request for Comment on Swap Data Recordkeeping and Reporting Requirements (Fed. Reg.) (March 27, 2014); CFTC Announces It Is Requesting Public Comment on Swap Data Reporting Rules (Pre-Fed. Reg.) (March 20, 2014); CFTC Announces Formation of Interdivisional Working Group to Review Regulatory Reporting (January 22, 2014).

CFTC Announces Three Actions to Clean up Problems with Swaps Regulations

Posted on May 23, 2014 by Steven Lofchie

The CFTC announced three actions to address problems in prior rulemakings: (i) a proposed rule amendment to the swap dealer de minimis provisions that would allow parties to enter into a meaningful volume of swaps with utility special entities before being required to register with the CFTC, (ii) an extension of the comment period on the CFTC’s proposed position limits as applied to commercial market participants, and (iii) the promotion of end-user trading on swap execution facilities (“SEFs”) and designated contract markets (“DCMs”).

Both Acting Chairman Wetjen and Commissioner O’Malia applauded the actions, noting that the proposals mark a significant victory for the end-user community. Commissioner O’Malia stated he is pleased that the CFTC “has chosen to confront the shortcomings in its rules by using the proper process that is consistent with the Administrative Procedures Act.” The three actions are summarized below.

Proposal to Amend Regulations for Entities Entering into Swaps with Utility Special Entities

The proposed rule amendment would adjust the de minimis threshold for determining if an entity that enters into swaps with utility special entities must register as a swap dealer. It would also amend the CFTC’s swap dealer definition to permit a person dealing in “utility operations-related swaps” with “utility special entities” to exclude those swaps in determining whether that person has exceeded the de minimis threshold specific to dealing with special entities. Under the proposal, however, such swaps would be considered to determine whether the general dealing de minimis threshold applies.

Comments on the proposal will be due 30 days after it is published in the Federal Register.

Notice Opening Comment Period to Further Consider Certain Issues Related to Hedging of Physical Commodities

The CFTC reopened the comment periods for the Position Limits Proposal and the Aggregation of Positions Proposal for a three-week period beginning June 12, 2014, and ending July 3, 2014, requesting that market participants comment on:

hedges of a physical commodity by a commercial enterprise, including gross hedging, cross-commodity hedging, anticipatory hedging, and the process for obtaining a non-enumerated exemption;
the setting of spot month limits in physical-delivery and cash-settled contracts and a conditional spot-month limit exemption;
the setting of non-spot limits for wheat contracts;
the aggregation exemption for certain ownership interests of greater than 50 percent in an owned entity; and
aggregation based on substantially identical trading strategies.

The CFTC will also hold a public roundtable on June 19, 2014, to consider certain hedging issues relating to market practices in physical commodity derivatives.

No-Action Relief from Compliance with Certain Requirements under Rule 1.35(a) for Certain Members of DCMs or SEFs

The CFTC Division of Swap Dealer and Intermediary Oversight and Division of Market Oversight issued a no-action letter that provides relief with respect to compliance with certain recordkeeping provisions of Rule 1.35(a) (“Records of Commodity, Interest and Related Cash or Forward Transactions”) to members of DCMs or SEFs that are not registered or required to be registered with the CFTC (“Covered Members”).

The letter provides relief, pending further CFTC action, to Covered Members with respect to complying with the requirements under Rule 1.35(a) to keep electronic text messages and to keep records in a form and manner identifiable and searchable by transaction.

Lofchie Comment: These three actions are significant steps forward in cleaning up rules adopted under the CFTC’s former leadership.

The proposed rule amendment applicable to swaps with utilities will greatly expand the universe of entities with which utilities are able to trade, as utilities will no longer be limited (as a practical matter) to trading with CFTC-registered swap dealers.

The extension of the comment period as to physical commodities is a move to head off the likelihood of litigation that would result if the CFTC re-adopts its prior position limit rules without going through a more significant comment process and/or without performing a meaningful cost-benefit analysis. (Note that the extension of the comment period does not apply to the whole release, but only to those portions that relate to “hedges of a physical commodity by a commercial enterprise”; i.e., not to the use of swaps by financial institutions.)

The third action provides no-action relief (not time-limited!) from certain aspects of the Rule 1.35 recordkeeping requirements for firms that are not otherwise registered with the CFTC. The relief in the letter is not available to CFTC registrations even though the letter notes that it is not clear whether there exists a technology that can fulfill the requirements of the rule that is not “cost-prohibitive.”

These three actions will help clean up problems with the existing rules. A next welcome step would see the CFTC extend this clean up beyond commercial users of swaps to include financial market participants. Lessening the burdens of Rule 1.35 for commercial users may induce more such users to trade on swap execution facilities (“SEFs”); however, they are less likely to find good prices there if Rule 1.35 discourages the use of SEFs by CFTC registrants.

See: CFTC No-Action Letter 14-72; Extension of Comment Period; CFTC Press Release.

CFTC Submits Consolidated Reply in Opposition to Market Participants Motion for Summary Judgment

Posted on May 7, 2014 by Steven Lofchie

In a development to the lawsuit challenging the CFTC’s Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (the “Cross-Border Rule”), the CFTC submitted a consolidated reply in support of its cross-motion for summary judgment and in opposition to the ISDA, SIFMA and the Institute of International Bankers’ (together, the “Associations”) motion for summary judgment.

In its consolidated reply, the CFTC stated that the Associations’ case “rests entirely on the mistaken premise that Congress required the CFTC to determine the cross-border application of Title VII – without ever saying so in any statute.” According to the CFTC, Congress established a system of swaps regulation in Title VII, including a test for determining when it applies abroad, so that market participants cannot avoid reforms by shifting their swaps activities overseas. The CFTC stated that it has carried out its rulemaking duties under Title VII according to Congress’s design, and has properly considered the costs and benefits of its own actions in accordance with the APA, including relevant comments, and has issued a policy statement (“Guidance”) to inform the public of its views on the meaning and likely application of CEA Section 2(i) (“Jurisdiction of Commission; Liability of Principal for Act of Agent; Commodity Futures Trading Commission; Transaction in Interstate Commerce”) to common swaps activities.

In response to the Associations’ claim that the Guidance is really a set of rules that impose cross-border obligations, the CFTC stated that “the agency reasonably exercised its broad discretion” not to codify its policies through a rulemaking process. Thus, the CFTC stated, it is entitled to judgment as a matter of law, and the Court should grant the CFTC’s consolidated motion to dismiss and “should refuse to upend the Dodd-Frank reforms” as the Associations demand.