SEC Final Rule: Application of Security-Based Swap Entity Definitions to Cross-Border Activities
|FINAL RULE: Approved June 24, 2014|
|Final Rule Posted||Effective Date||Final Rule - Non-U.S. Persons|
|July 9, 2014||September 8, 2014||February 10, 2016|
On June 24, 2014, the SEC approved a final set of rules and guidance on cross-border activities for security-based swaps, including:
- An explanation of when a cross-border transaction needs to be counted toward the requirement to register as a security-based swap dealer or major security-based swap participant (SB-SD/MSP, including transactions guaranteed by a U.S. person and transactions by a “conduit affiliate” (a foreign affiliate of a U.S. person that could be used to evade the requirements of Title VII of the Dodd-Frank Act).
- Procedures for foreign regulators or market participants to apply for substituted compliance, which would permit market participants to comply with U.S. requirements by complying with foreign requirements.
- An anti-fraud rule that addresses the scope of the Commission’s cross border anti-fraud enforcement authority, clarifying that the authority applies where the fraud occurs or is felt within the U.S.
Among the provisions of Title VII of the Dodd-Frank Act is a requirement that swaps reforms 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.” The SEC is tasked with developing a framework for oversight of security-based swaps, and to adapt the SEC regulations to include such oversight.
The concern is that swap trading by foreign affiliates of large financial entities pose a systemic risk to the U.S., and thus should be under commission jurisdiction. The proposed rule includes many questions for discussion with market participants regarding the structure of cross-border jurisdiction.
On May 1, 2013, the SEC approved a proposed rulemaking and a request for comment regarding cross-border application of security-based swaps rules related to the Dodd-Frank Act. The rule appeared in the Federal Register on May 23, 2013, and the deadline for public comment was August 21, 2013. Comments can be found HERE. A final rule and guidance on applying swap entity definitions were approved by the SEC on June 24, 2014. The rule appeared in the Federal Register on July 8, 2014 (with a correction posted August 12), and its effective date is September 8, 2014.
Summary of the Final Rule - Swap Dealers
Transactions Included in the Dealer Calculation
The final rules specify which cross-border dealing transactions count toward the dealer thresholds set by the CFTC/SEC Joint Final Rule on Swap Entity Definitions, April 2012. Specifically:
- U.S. persons are required to count their security-based swap dealing transactions toward the thresholds, including dealing transactions conducted through their foreign branches.
- For non-U.S. persons are required to count dealing transactions with counterparties that are U.S. persons, including foreign branches of U.S. banks (unless the foreign branch is a branch of a registered security-based swap dealer); dealing transactions with any counterparty that has rights of recourse against a U.S. affiliate of the non-U.S. person in connection with the non-U.S. person’s obligation under the security-based swap; and all dealing activity if a non-U.S. person acts as a “conduit affiliate.”
Definition of a U.S. Person
- Any natural person who resides in the U.S.
- Any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the U.S. or having its principal place of business in the U.S.
- Any discretionary or non-discretionary account of a U.S. person.
- Any estate of a decedent who was a resident of the United States at the time of death.
A "principal place of business" means the location from which the officers, partners, or managers of the legal person primarily direct, control and coordinate the activities of the legal person.
Consistent with rules adopted by the SEC jointly with the CFTC regarding the Title VII definitions of dealer and major participant – foreign branches of U.S. banks and U.S. branches of foreign banks are not separate legal persons for purposes of Title VII and have the same U.S.-person status as the bank’s home office.
A “conduit affiliate” is a non-U.S. affiliate of a U.S. person that enters into security-based swaps with non-U.S. persons or with certain foreign branches of a U.S. bank on behalf of its U.S. affiliates (other than U.S. affiliates that are registered as security-based swap dealers or major security-based swap participants) and enters into offsetting transactions with its U.S. affiliates to transfer the risks and benefits of those security-based swaps.
Cleared Anonymous Transactionsprovide an exclusion from non-U.S. persons having to count a transaction against the thresholds if the transaction is entered into anonymously and is cleared.
Activity between Two Non-U.S. Persons:
The final rules do not include an element of the proposal that would have required dealing activity between two non-U.S. persons to be counted for purposes of the dealer definition if the security-based swap transaction was conducted within the United States. Given the complex and important issues raised by that proposed requirement, the SEC expects to solicit additional comment regarding when a transaction between two non-U.S. persons should be included in the relevant dealer thresholds because one or both counterparties are engaged in security-based swap activity within the U.S.
Summary of the Final Rule - Major Swap Participants
Under the final rules, U.S. persons are required to count all of their security-based swap positions when determining whether they are major participants.
Non-U.S. persons are required to count the following positions against the major participant thresholds:
- Positions with U.S. persons, including foreign branches of U.S. banks (unless the foreign branch is a branch of a registered security-based swap dealer).
- Positions with a counterparty that has rights of recourse against a U.S. affiliate of the non-U.S. person in connection with the non-U.S. person’s obligation under the security-based swap.
- All positions if a non-U.S. person acts as a “conduit affiliate.”
Attribution of Guaranteed Positions
A guarantee on a security-based swap allows a counterparty to demand that the person providing the guarantee perform the obligations of the guaranteed entity under the security-based swap. In 2012, the SEC and the CFTC jointly adopted interpretive guidance generally requiring persons to include in their calculations of the major security-based swap threshold any positions resulting from transactions that they guarantee. Under the proposed approach, guaranteed positions would be attributed as follows:
- A non-U.S. person that guarantees performance of the security-based swap obligations of a U.S. person would attribute to itself all of the U.S. person’s security-based swap positions that it guarantees.
- A non-U.S. person that guarantees performance on the security-based swap transactions of another non-U.S. person would attribute to itself only the guaranteed security-based swap positions arising from transactions with U.S. person counterparties.
- A U.S. person that guarantees performance of the security-based swap obligations of a non-U.S. person would attribute to itself all of that non-U.S. person’s security-based swap positions that it guarantees, regardless of whether the non-U.S. person’s positions arise from transactions with a U.S. person counterparty or a non-U.S. person counterparty.
- However, a guarantor would not be required to attribute to itself any guaranteed positions entered into by a non-U.S. person that is subject to Basel capital standards.
Related Document: Final Rule as Sent to the Federal Register