Fundamentals of OTC Derivatives Clearing

The CFTC's Final Cross-Border
As of October 9, 2013
Mary Johannes,
Senior Director and
Head of U.S. Public Policy, ISDA
Joshua Cohn,
Curtis Doty, Counsel
Mayer Brown LLP
Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States;
Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; Mayer Brown JSM, a Hong Kong partnership, and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which
Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.
Extraterritoriality of Dodd-Frank Swaps Provisions
 The Cross-Border Guidance interprets Commodity Exchange
Act § 2(i)
 Swaps provisions of the CEA enacted by Title VII of Dodd-Frank "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 or contravene [CFTC anti-evasion
 A taxonomic approach
 Swap dealer (or MSP) category
 Counterparty category
 Category of requirement - Entity-Level (1st and 2nd); TransactionLevel (A and B)
 Matrices! 78 Fed. Reg. 45292, 45368-70
Counterparty Status
U.S. person
Non-U.S. person that is "guaranteed" by a U.S. person
Non-U.S. person that is an "affiliate conduit" of a U.S.
Non-U.S. person not guaranteed by, or affiliate conduit
of, a U.S. person
Foreign branch of a U.S. bank that is a SD or MSP
"Foreign Branch Characteristics"
Swaps "with a foreign branch"
U.S. branch of a non-U.S. SD or MSP (footnote 513)
Establishing Counterparty Status
Reasonable reliance on a counterparty's written
For representations included in SD's or MSP's
relationship documentation, reliance requires an
agreement from counterparty to timely update for
material changes
ISDA Cross-Border Swaps Representation Letter
ISDA Cross-Border Representation Letter for U.S. Banks
U.S. Person Definition – selected issues
 Eight (8) enumerated prongs, preceded by "generally to include, but not be limited to –"
 A "legal entity" (e.g., corporation, partnership, limited liability company, fund … or any
similar form of enterprise) that (A) is organized or incorporated under US law or (B) has its
principal place of business in the United States.
 Principal place of business – "nerve center"; where the high level officers direct, control
and coordinate the entity's activities
 PPB prong was not applicable to funds and other collective investment vehicles before
October 9, 2013
 For collective investment vehicles -- location of senior personnel responsible for
formation/promotion or implementation of investment strategy, depending on facts
and circumstances.
 "The Commission generally believes that [a non-U.S.] person would not come within
the 'U.S. person' interpretation solely because it retains an asset management firm
located in the United States …." See 78 FR 45312
U.S. Person Definition – selected issues (cont.)
 Any commodity pool, pooled account, investment fund, or other collective investment
vehicle not described in the "legal entity" prong (see previous slide) that is majorityowned by one or more US persons, unless it is publicly offered only to non-U.S. persons
and not offered to U.S. persons
Majority ownership test (See 78 FR 45313)
 Majority-ownership is determined by counting direct beneficial owners and "looking-through" the
beneficial ownership of any entities controlled by or under common control with the collective investment
 May rely on representations of an unrelated investor entity unless the investee vehicle has reason to
believe the investor was formed or is operated principally for the purpose of avoiding looking through to
the ultimate beneficial owners
 Reasonable due diligence, along the lines of the verifications conducted for other regulatory requirements.
"Publicly offered"
 Exception is intended to address comments that ownership verification would be
particularly difficult for publicly offered vehicles
 "Publicly offered" is not defined, but the publicly-offered vehicle "could be a UCITs". 78
FR 45314, fn 224
U.S. Person Definition – selected issues (cont.)
Legal entity (other than LLC, LLP or similar entity where
all of the owners have limited liability) that is directly or
indirectly majority-owned by U.S. persons and in which
such person(s) bear(s) unlimited responsibility for the
obligations and liabilities of the legal entity
Other prongs: natural persons, estates of decedents,
pension plans, trusts, individual or joint accounts
Non-U.S. Persons Guaranteed by a U.S. Person
"Guarantee" – not only traditional guarantees of
payment, but also other formal arrangements that, in
view of all facts and circumstances, support the non-U.S.
person's ability to pay or perform its swap obligations
Compare to "collateral promise" approach that appeared
in final "swap" definition rule
Affiliate conduit
 Majority-owned, directly or indirectly, by a U.S. person
 Controls, is controlled by, or is under common control with
the U.S. person
 In the regular course of business, engages in swaps with nonU.S. third party(ies) for the purpose of hedging or mitigating
risks faced by, or to take positions on behalf of, its U.S.
affiliate(s), and enters into offsetting swaps or other
arrangements with such U.S. affiliate(s) in order to transfer
the risks and benefits of such swaps with third-party(ies) to its
U.S. affiliates
 Financial results of the non-U.S. person are included in the
consolidated financial statements of the U.S. person.
 Other facts and circumstances also may be relevant.
Swap Dealer De Minimis Calculation
• A U.S. person or a guaranteed or conduit affiliate must include all dealing
• A non-U.S. person not guaranteed by, or an affiliate conduit of, a U.S.
person must include all dealing swaps with:
• U.S. persons (other than foreign branches of SDs)
• Counterparties that are guaranteed affiliates of a U.S. person, unless the counterparty
is a SD, a SD affiliate engaged in de minimis dealing, or is guaranteed by a non-financial
• A non-U.S. person not guaranteed by, or an affiliate conduit of, a U.S.
person may exclude swaps entered into anonymously on a DCM, SEF or
FBOT and cleared.
• A person (U.S. or non-U.S.) must aggregate relevant dealing swaps of all
commonly controlled affiliates (U.S. and non-U.S.), except those of any
affiliates that are registered SDs.
Extraterritorial application to CFTC requirements to
SDs and MSPs
 In determining how Title VII will apply extraterritorially under the July 2013
Interpretive Guidance and Policy Statement, the CFTC has divided substantive
swaps regulations conceptually into (i) "Entity-Level Requirements" and (ii)
"Transaction-Level Requirements."
 Entity-Level Requirements
 First Category: capital adequacy; chief compliance officer; risk management; swap
data recordkeeping (other than complaints and marketing/sales materials)
 Second Category: SDR reporting; recordkeeping for complaints and
marketing/sales materials; "large trader" reporting of physical commodity swaps
 Transaction-Level Requirements
 Category A: clearing and swap processing; margining and segregation for
uncleared swaps; trade execution; swap trading relationship documentation;
portfolio reconciliation and compression; real-time public reporting; trade
confirmation; daily trading records
 Category B: external business conduct standards
Appendix D – Application of the Category A Transaction-Level Requirements to Swap Dealers and
(Category A includes (1) Clearing and swap processing; (2) Margining and segregation for uncleared swaps; (3)
Trade Execution; (4) Swap trading relationship documentation; (5) Portfolio reconciliation and compression; (6)
Real-time public reporting; (7) Trade confirmation; and (8) Daily trading records).
U.S. Person
(other than
Foreign Branch
of U.S. Bank
that is a Swap
Dealer or MSP)
Foreign Branch
of U.S. Bank
that is a Swap
Dealer or MSP
Guaranteed by,
or Affiliate
Conduit1 of, a
U.S. Person
Non-U.S. Person Not
Guaranteed by, and Not
an Affiliate Conduit1 of,
a U.S. Person
Foreign Branch of U.S. Apply
Bank that is a Swap
Dealer or MSP
Non-U.S. Swap
Dealer or MSP
(including an affiliate
of a U.S. person)
Compliance 3
U.S. Swap Dealer or
MSP (including an
affiliate of a non-U.S.
Substituted Compliance2
Do Not Apply
*The Appendices to the Guidance should be read in conjunction with the rest of the Guidance.
Appendix F – Application of Certain Entity-Level and Transaction-Level Requirements to
Non-Swap Dealer/Non-MSP Market Participants*
(The relevant Dodd-Frank requirements are those relating to: clearing, trade execution, real-time public
reporting, Large Trader Reporting, SDR Reporting and swap data recordkeeping).
U.S. Person
(including an affiliate
of non-U.S. person)
Non-U.S. Person
Guaranteed by, or
Affiliate Conduit1
of, a U.S. Person
Non-U.S. Person Not
Guaranteed by, or Affiliate
Conduit1 of, by U.S. Person
U.S. Person
(including an affiliate
of non-U.S. person)
Non-U.S. Person
Guaranteed by, or
Affiliate Conduit1 of,
a U.S. person
Compliance2 3 4
Do Not Apply4
Non-U.S. Person Not
Guaranteed by, or
Affiliate Conduit1 of,
U.S. Person
Do Not Apply4
Do Not Apply4
*The Appendices to the Guidance should be read in conjunction with the rest of the Guidance.
Substituted Compliance
Per Guidance: in the case of certain parties and certain
rules compliance with another country's rules may satisfy
CFTC in lieu of its own
Parties – CFTC classifications
Rules – Entity-Level (1st and 2nd)
Substituted Compliance (cont.)
"May" – matrices at 78 FR 45368-70
Comparability analysis standard: comparable and
Broad MOU required
Generic determinations
5% Exception – Transaction-level requirements
Noted areas of concern:
Data repository direct access
Privacy laws
Clearing and trading venue recognition
Substituted Compliance (cont.)
"Essentially identical" – another standard or "one-off"
6 jurisdictions have submitted to CFTC: EU, Australia, Canada,
Hong Kong, Japan, Switzerland ("Six Jurisdictions")
 special timing applies to these jurisdictions
Exemptive Order
CFTC solicited comments
75 days → Oct. 9: prior definition of U.S. person holds
Other 75-day changes?
Exemptive Order (cont.)
Six Jurisdictions
Earlier of Dec. 21 or 30 days after substituted compliance
Non-U.S. SDs/MSPs – entity-level requirements for which
substituted compliance is possible
special reporting obligations
Non-U.S. SDs/MSPs and Foreign Branches of U.S. –
transaction-level requirements for which substituted
compliance is possible
But not clearing, trade execution or some Part 43 obligations
Common Path Forward
European Commission and CFTC – July 11, 2013
Acknowledged risks of conflicts of law and legal
uncertainty in international markets
Common Path Forward (cont.)
"[J]urisdictions and regulators should be able to defer to
each other when it is justified by the quality of their
respective regulation and enforcement regimes."
CFTC deems EU and US rules for risk mitigation of
bilateral uncleared swaps essentially identical and will
issue no-action relief. The EU concept of "equivalence" is
to be applicable.
Common Path Forward (cont.)
CFTC will extend "foreign board of trade" no-action relief
to swap contracts to facilitate the trade-execution
requirement and may offer no-action relief to certain
EU-regulated multilateral trading facilities.
EC, ESMA and CFTC to work together on STP, margin for
uncleared swaps mandatory clearing, and reporting to
trade repositories.
Common goal of assuring that overseas guaranteed
subsidiaries and branches are covered.
Common Path Forward (cont.)
With respect to CCPs, initial margin is viewed as the only
key material difference.
Common Path Forward (cont.)
CFTC No-Action Letters:
13-45 – "Identicality" relief for certain EMIR risk mitigation rules
13-44 – Eurex clearing temporary registration relief
13-43 – LCH parallel
13-46 – Amends foreign board of trade direct access no-action
Europe – 2015?
Substituted compliance – but are substitutes available?
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