REPORT
Futures & Derivatives Law
The Journal on the Law of Investment & Risk Management Products
ARTICLE REPRINT
February 2014
n
Volume 34
n
Guarantees, Conduits
and Confusion Under
the CFTC’s Cross-Border
Guidance
BY WILLIAM SHIRLEY
William Shirley is counsel in the New York office of Sidley Austin LLP. His practice encompasses a wide range
of legal matters related to the financial services industry, particularly those associated with Dodd-Frank and
other regulatory initiatives that followed in the wake of the financial crisis.
“The best is the enemy of the good.”1
“If you want to make omelettes, you
have to break some eggs.”2
“Haste makes waste.”3
In adopting its cross-border guidance for
Dodd-Frank swap regulation, the CFTC created a regulatory maze when it conceived
interpretations applicable to non-US swap
counterparties that benefit from US guarantees or act as “conduits” for US affiliates.
The CFTC’s guidance on this subject not only
created distinctions that arguably are overlyfine, but introduced textual twists and turns
and analytic inconsistencies and dead ends
that make practical application difficult.
The swap activity that is the subject of
Dodd-Frank’s Title VII and the CFTC’s guidance is, by its nature, complex. In the face
of the complexities of the market, the CFTC
pursued a very detailed interpretive design
rather than making simpler principle-based
distinctions supplemented by precise and delimited rules. Unfortunately, the combination
of a self-imposed deadline (creating haste), an
interpretive rather than rules-based approach
(eschewing rigor), and an expansive reach
(compensating for concerns about market
unknowns) resulted in a document that is inconsistent and confusing. This is particularly
true in the context of guarantees and conduit
arrangements.
This article does not intend to address all
the issues associated with the treatment of
guarantees and conduits under the guidance;
and the article does not address the administrative law claims made in a recent lawsuit
challenging the guidance as a whole.4 Instead,
it examines three related subjects under the
guidance, one demonstrating the undue fineness of the lines that the CFTC drew, one
demonstrating the kind of broad interpretive uncertainty that the CFTC introduced,
and one apparently demonstrating simple
error. In doing so, it hopes both to provide
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Futures & Derivatives Law Report CONTINUED FROM PAGE 1
analytical guidance for the present and to encourage regulatory endeavors that are better conceived
in the future.
As noted in the article’s concluding remarks, the
challenges and problems described below could
have been avoided if the CFTC, instead of engaging in a rushed interpretive effort, had taken
a more deliberate, and deliberative, rules-based
approach to regulating cross-border swap activity. Had it done so, the CFTC would have likely
faced criticism for moving more slowly than many
may have wished. Thus the article assumes that the
CFTC’s cross-border effort was guided by something like the first quotation above. What is clear
is that the second quotation is at least as apt, given
the difficulties and uncertainties that the guidance
created. Unknown for now, and perhaps never to
be known, is whether the third quotation is in fact
most apt because a more deliberate and considered
approach would have served regulatory purposes
even more effectively.
Background
Title VII (Title VII) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010
(Dodd-Frank) governs swap transactions.5 The
CFTC’s extraterritorial jurisdiction under DoddFrank is set out in Section 2(i) of the Commodity
Exchange Act (CEA) (as added by Dodd-Frank Section 722(d)). As a statutory matter, this jurisdiction
is addressed in the negative:
Swap rules shall not apply to “activities
outside the US unless those activities have
a direct and significant connection with
activities in, or effect on, commerce of the
United States.”6
In its cross-border guidance (the “Guidance”),7
the CFTC elaborated on its jurisdiction, addressing
it in the affirmative and indicating that it reaches:
“activities outside the United States that
have either: (1) A direct and significant
effect on U.S. commerce; or, in the alternative, (2) a direct and significant connection with activities in U.S. commerce, and
through such connection present the type
of risks to the U.S. financial system and
© 2014 THOMSON REUTERS
February 2014 n Volume 34 n Issue 2
markets that Title VII directed the [CFTC]
to address.”8
As to guarantees and conduit arrangements in
particular, the CFTC stated:
“[T]he [CFTC] believes that all of the swap
dealing activities of a non-U.S. person that
is an affiliate of a U.S. person and that is
guaranteed by a U.S. person (a ‘guaranteed
affiliate’), or that is an ‘affiliate conduit’ of
a U.S. person, have the requisite statutory
nexus and potential to impact the U.S. financial system.”9
Overview
In this context, the CFTC created challenges in
the following three areas (among others that are beyond the scope of this article):
1. Although the CFTC made a point of distinguishing “guaranteed affiliates” and “affiliate
conduits” (on the one hand) from US persons
(on the other), it proceeded to weave the treatment of the two concepts into the Guidance in
a varied and complicated way, sometimes mimicking the treatment of US persons and sometimes not.
• In addition, although the two categories—”guaranteed affiliates” and “affiliate conduits”—are themselves treated as
equivalents for most purposes, they are
not treated as equivalents for all.
2. Although the concept of “guaranteed affiliate”
is the predominant means by which the Guidance addresses guarantees provided by US persons, the Guidance, in one important and distinct context, addresses guarantees provided by
US persons differently.
• The predominant approach (tied to concept of “guaranteed affiliates”) is principally relevant for various swap dealer
(SD) and major swap participant (MSP)
threshold calculations.
• By contrast, an alternative approach to
guarantees is relevant to the applicability
of certain transaction-level requirements
in the case of non-US SDs and MSPs
transacting with non-US persons who
are guaranteed by US persons.11
• For purposes of the predominant “guaranteed affiliate” approach, a very broad
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February 2014 n Volume 34 n Issue 2
definition of guarantee applies, but there
is a limiting requirement that the guarantee be provided by an affiliate.
• For the alternative approach, by contrast, something narrower is apparently
intended with respect to what constitutes a “guarantee” (and it appears to
relate to guarantee beneficiaries having
“recourse” directly against guarantors).
However, there is no requirement that
the guarantee be provided by an affiliate.
• Thus, in the discussion below a distinction is drawn between the presence of a
“guaranteed affiliate,” on the one hand,
and the presence of a “US guarantee,” on
the other.
3. The CFTC defined the compound term “guaranteed or conduit affiliate” separately from the
composite terms “guaranteed affiliates” and
“affiliate conduits.” The compound term’s use
strongly indicates that it is synonymous with a
combination of the composite terms—i.e., that
“guaranteed or conduit affiliate” means the
same thing as “guaranteed affiliate” or “affiliate conduit.” However, the compound term is
expressly defined more broadly: it covers any
non-US person with swaps that are guaranteed
by a US person, whether or not the non-US person is an affiliate of the US guarantor.
Taking these observations as three starting
points, the discussion below teases out, in three
separate sections, some of the related consequences
and concerns.
1. As to the relative treatment of guaranteed affiliates and affiliate conduits, a Q&A in tabular
form is presented in Section 1.
• Guaranteed affiliates and affiliate conduits are
both, by definition, non-US persons that are affiliated with US persons.
• The table asks questions about a
hypothetical non-US person that is
affiliated with a US person, and then
answers each of the questions in the
alternative depending on whether
the non-US affiliate is assumed to
be a guaranteed affiliate or, alternatively, an affiliate conduit.
2. Section 2 describes the respective treatment
of guaranteed affiliates and other non-US persons that that are guaranteed with recourse
by a US person.
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Futures & Derivatives Law Report
3. As to the term “guaranteed or conduit affiliate,”
Section 3 elaborates the disconnect between the
technical definition given to this phrase, on the
one hand, and the use and apparent intended
meaning of the phrase, on the other. (For purposes of the Sections 1 and 2, the article assumes that, in fact, the apparent use is correct
and the technical definition is overbroad and in
need of technical correction.)
• Section 3 also suggests how the CFTC’s
Guidance changes if this assumption is
wrong.
Section 1 thus provides detailed Guidance regarding the CFTC’s complicated approach to guaranteed
affiliates and affiliate conduits; and it then questions the origin of the complication and whether all
the distinctions were worth the trouble and resulting complexity. Section 2 elucidates a curious, but
meaningful, difference in how the CFTC addresses
guarantees provided by US persons for the benefit of
non-US persons in two different regulatory contexts:
calculations associated with SD and MSP thresholds,
on the one hand, and application of transaction-level requirements, on the other; and it then examines
the outcome critically. Section 3 describes and proposes a means of resolving an inconsistency in the
guarantee terminology used in the Guidance; and it
then suggests real issues associated with the lack of
any clarification to date.
In closing, the article offers general remarks regarding the regulatory value of the CFTC’s pushing
ahead in the way that it has, as contrasted with the
greater regulatory value that would have likely been
achieved by a more considered regulatory work
product. It also urges regulation by rule rather than
by interpretation, noting that rule-making imposes
appropriate discipline in regulatory articulation,
while interpretive guidance allows less disciplined
expression of regulatory desire.
1. “Guaranteed Affiliates” and
“Affiliate Conduits”
As noted above, both guaranteed affiliates and
affiliate conduits are, by definition, non-US persons
that are affiliated with a US person.11 The table below answers hypothetical questions about a non-US
person affiliated with a US person, and then answers
each of the questions in two alternative cases: where
the non-US affiliate is assumed to be a guaranteed
affiliate, and where it is assumed to be an affiliate
conduit. Parenthetical page citations in the table re-
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Futures & Derivatives Law Report fer to the Guidance as published in the Federal Register and indicate the authority for each answer.
The implicit question raised by this table is this:
Was it really necessary to make all these detailed
distinctions, both between U.S. persons, on the one
hand, and guaranteed affiliates and affiliate conduits, on the other,28 and then between guaranteed
affiliates and affiliates conduits themselves?29 Here
is one place where, one suspects, a rule-based approach to regulation might have imposed textual
discipline and forced reconsideration and tailoring.
Consider the following.
It would appear that the two definitions—
”guaranteed affiliate” and “affiliate conduit”—
were first conceived for different regulatory
purposes. Look at where the Guidance addresses the contours of each of the two categories at
length: For guaranteed affiliates it is in the context
of SD and MSP registration requirements—where
the question is how non-US persons must count,
and which non-US persons’ transactions must be
counted, when considering numerical thresholds
for SD and MSP registration requirements.30 By
contrast, the Guidance defines the characteristics of
affiliate conduits in a much later discussion related
to circumstances in which Transaction-Level Requirements apply to transactions between non-US
swap dealers and non-US persons. This difference
is also reflected in the CFTC’s initial proposal of its
cross-border interpretations and guidance, where
neither term appears per se, though the concept
of conduit arrangements does; however, conduits
are discussed in the original proposal only in the
context of Transaction-Level Requirements; there
is no mention of conduits in the original proposal’s
discussion of SD or MSP registrations.31
Stepping back from it for a moment—and not
taking it as a given that the two categories would
end up being combined across the Guidance as
they were—the separate elaboration of the concepts makes sense. On the one hand, guarantees
transmit systemic risk; this is the lesson of AIG,
cited extensively in the Guidance as a reason for
developing a broadened approach to guaranteed
transactions when determining which non-US dealing entities are required to register as SDs with the
CFTC.32 On the other hand, US persons, when they
transact with the dealer community, should have
the protections of Transaction-Level Requirements
(or protections substantially similar)33 even when
they transact with the dealer community through
non-US affiliate conduits.
To reinforce this point, look at questions 3 and
4 in the table above. Here, exceptionally, the two
© 2014 THOMSON REUTERS
February 2014 n Volume 34 n Issue 2
categories do not travel together. When the question
is how a non-U.S. swap dealing entity is required
to count swaps against its own de minimis dealing
threshold, it must count those with guaranteed affiliates, but not those with affiliate conduits. There is
no explanation offered for the distinction here. Just
a simple declarative sentence.34 But, as noted above,
the structure of the Guidance suggests the reason:
the different treatment may have arisen because, despite final appearances, the two categories were not
conceived together, and the concept of the affiliate
conduit was not originally intended to operate outside the context of Transaction-Level Requirements.
But the two categories, having been developed
separately, were then (with the exception noted)
joined together. The Guidance joins them first in the
context of its discussion of SD registration. It goes
on at length at this point in describing guarantees
and guaranteed affiliates; however, when it comes
to affiliate conduits, it serves up a summary footnote that points to the broader discussion of the affiliate conduit found category later in the Guidance
(as noted, in the section of the Guidance addressing
Transaction-Level Requirements).
This might have been nothing more than a curiosity—after all, who really cares exactly where definitions sit in a document like this? But the problem is
that the concepts, having likely been elaborated for
different regulatory purposes and joined only subsequently (at the hip for just about all purposes),35
were never really integrated. Section 2 of this article
explains an aspect of this failure of integration, one
that apparently has practical consequences.
2. “Guaranteed Affiliates” vs. Other
Non-US Persons Guaranteed by
US Persons
As amply demonstrated by the table above, the
CFTC focuses significant attention on guaranteed
affiliates in the context of its interpretation of threshold calculations for SD and MSP purposes. To summarize the most important elements, the status of a
non-US person as a guaranteed affiliate is relevant:
• where that non-US person must determine
whether to count all of its swap transactions
(as a guaranteed affiliate or an affiliate conduit,
like a US person, must) or only those with certain US-related counterparties (as other non-US
persons are permitted), and
• where an entity, which has determined that it
does not need to count all of its swap transactions (i.e., a non-US person that is neither
7
February 2014 n Volume 34 n Issue 2
a guaranteed affiliate nor a conduit affiliate),
determines which US-related counterparties to
count (i.e., US persons, guaranteed affiliates
and affiliated conduits).
But in a different context, related to TransactionLevel Requirements, the CFTC’s discourse on guarantees morphs: the concept of “guaranteed affiliate”
disappears, and in its stead the Guidance presents
a different approach to guarantees provided by US
persons. To be specific: When determining whether
Transaction Level Requirements, Category A36 apply when non-US SD/MSPs deal with non-US persons, the relevant question becomes not whether
the non-US person is a “guaranteed affiliate,” but
whether a guarantee is written by, and provides the
non-US SD/MSP recourse against, a US person—irrespective of affiliation. The phrase “guaranteed affiliate” literally disappears from the text.
The regulatory trigger for the alternative “US
guarantee approach” (as it will be called for this discussion) is different in two ways from the “guaranteed affiliate” approach:37
• The kinds of guarantees that are a prerequisite
for the US guarantee approach, while broadly
prescribed, appear nonetheless to be fewer than
the kinds prescribed for the guaranteed affiliate
approach.
•
Any transaction with a non-US person benefiting from a prescribed US guarantee is covered
by the US guarantee approach, while the guaranteed affiliate approach requires that the nonUS person not only to be guaranteed by, but
also to be affiliated with, a US person.
These distinctions are explored below. But at
the outset this aspect of the Guidance should be
seen in the light of the discussion above in Section
1. There it was argued that the concept of an affiliate conduit was likely developed for one regulatory purpose—the extension of Transaction-Level
Requirements—but then imported into a different
regulatory context—the determination of which
non-US persons must register as SDs or MSPs. Here
we have a related, but more troublesome phenomenon: a concept—the presence of a US guarantee—
is cited as jurisdictionally relevant in two different
contexts, but the concept is in fact elaborated differently in the two places. While an affiliate conduit
remains conceptually the same in the two relevant
contexts discussed in Section 1—i.e., the trigger for
two different regulatory consequences is the same—
here, where the Guidance addresses guarantees, the
regulatory trigger changes: not all guarantees are
the same, and differences depend on the regulato-
8
Futures & Derivatives Law Report
ry requirement at issue. It is almost as though the
CFTC’s left hand (staff personnel drafting the SD
and MSP registration section of the document) did
not know what its right hand (staff personnel working on the Transaction-Level Requirement section)
was doing—and vice versa.
When the CFTC presents its Guidance concerning
the US guarantee approach in the context of Transaction-Level Requirements, the issue of what kinds
of guarantee qualify is squarely raised:
“One commenter requested that the Commission clarify the scope of a ‘guarantee’
that can trigger application of Transaction-Level Requirements in these circumstances. Another objected to the scope of
the term ‘guarantee’ if it were defined to
include not only a guarantee of payment
or performance of swaps obligations, but
also other formal arrangements to support
the ability of a person to perform its obligations (such as liquidity puts and keepwell agreements).”38
What initially follows in this section of the Guidance is not particularly remarkable (given the Guidance’s interpretation of “guaranteed affiliate” in the
earlier section concerning SD and MSP registration):
“Under this Guidance, with respect to swaps
between a non-U.S. swap dealer or non-U.S.
MSP (including an affiliate of a U.S. person)
on the one hand, and a non-U.S. counterparty on the other hand where the non-U.S.
counterparty’s performance is guaranteed
(or otherwise supported by) a U.S. person,
the Commission would generally expect the
parties to the swap to comply with all of
the Category A Transaction-Level Requirements” (emphasis added). 39
Note the absence above of any emphasis on “recourse.” Note, however, how “recourse” then becomes a predominant theme in the CFTC analysis
that follows:
“In response to commenters that requested clarification of the nature of the guarantee of a non-U.S. counterparty by a U.S.
person that will trigger the application of
Transaction-Level Requirements to swaps
with non-U.S. swap dealers or non-U.S.
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report February 2014 n Volume 34 n Issue 2
MSPs, the Commission references the approach set forth in the final rule further
defining the term ‘swap,’ among others.
That is, for this purpose, a guarantee of a
swap is a collateral promise by a guarantor
to answer for the debt or obligation of a
counterparty obligor under a swap. Thus,
to the extent that the non-U.S. swap dealer
or non-U.S. MSP would have recourse to the
U.S. guarantor in connection with its swaps
position, the Commission would generally
expect such non-U.S. swap dealer or MSP
to comply with the Category A TransactionLevel Requirements for such a guaranteed
swap” (emphasis added).40
agreements, master trust agreements, liability or loss transfer or sharing agreements, and any other explicit financial
support arrangements may provide for different third-party rights and/or address different risks than traditional guarantees, the
Commission does not believe that these
differences would generally be relevant
for purposes of section 2(i). Under these
agreements or arrangements, one party
commits to provide a financial backstop or
funding against potential losses that may
be incurred by the other party, either from
specific contracts or more generally. In the
Commission’s view, this is the essence of a
guarantee” (emphasis added).42
“The Commission agrees with commenters
who stated that Transaction-Level Requirements should not apply if a non-U.S. swap
dealer or non-U.S. MSP relies on a written
representation by a non-U.S. counterparty
that its obligations under the swap are
not guaranteed with recourse by a U.S.
person” (emphasis added).41
Note here the reach beyond “traditional guarantees” and (implicitly but clearly) normal contractual
rights of recourse that are the hallmark of a traditional guarantee. The CFTC states very specifically
that “different third-party rights”—presumably different from those conferring direct recourse against
a guarantor—may support a conclusion that a given
financial support arrangement qualifies as a guarantee for purposes of identifying a guaranteed affiliate.
Perhaps most important in this discussion of guaranteed affiliates, the CFTC focused on the fact that financial consequences of many different kinds of credit
support could come back to the United States. In addressing guaranteed affiliates, the CFTC effectively
focused on the systemic risks associated with the US
providers of guarantees and the ability of guaranteed
affiliates to “transfer risk directly back to the United
States” generally.43 By contrast, the CFTC focuses, in
the context of Transaction-Level Requirements, not on
economic risks to the U.S. financial system, but on the
transactional risks borne by the US providers of guarantees in respect of specific transactions and specific
counterparties:
This is to be contrasted with the analogous, but
substantively different, discussion earlier in the
Guidance when the CFTC elaborated the guaranteed affiliate approach. In that context there is no
emphasis on “recourse”:
“The Commission also is affirming that, for
purposes of this Guidance, the Commission would interpret the term ‘guarantee’
generally to include not only traditional
guarantees of payment or performance of
the related swaps, but also other formal
arrangements that, in view of all the facts
and circumstances, support the non-U.S.
person’s ability to pay or perform its swap
obligations with respect to its swaps. The
Commission believes that it is necessary to
interpret the term ‘guarantee’ to include
the different financial arrangements and
structures that transfer risk directly back
to the United States.”
“Thus, for example, while keepwells and
liquidity puts, certain types of indemnity
© 2014 THOMSON REUTERS
“The Transaction-Level Requirements also
serve to protect against risk to the guarantor U.S. person by reducing the likelihood
that its obligations under the guarantee
will be called upon in the first instance”44
(emphasis added).
In the earlier SD/MSP registration context it is
systemic risk that is protected against; there the
CFTC seeks to carry out the Dodd-Frank mandate
of protecting the U.S. financial system; there the
9
February 2014 n Volume 34 n Issue 2
emphasis is on protecting the US financial system
from US guarantors that take on extensive financial
exposure to swaps (like AIG) via SDs and MSPs. In
the latter context, by contrast, it is transactional risk
borne by the US guarantor; there the CFTC seeks
to carry out the Dodd-Frank mandate of protecting
individual market participants; there US guarantors
are to be protected—not protected against. Thus in
this latter case the CFTC places additional emphasis
on recourse, in the absence of which there would be
no transactional risk to a US guarantor. Notably the
latter context also extends the scope of protection to
any US person that provides a guarantee rather than
limiting the scope to US affiliates.
The dichotomy makes some sense in light of the
separate goals targeted by the different elements of
Dodd-Frank’s Title VII: In the case of SD/MSP registration, the focus is on systemic risk presented by
very active swap market participants (SD/MSPs),
and the concern is any kind of economic contagion.
In the case of Transaction-Level Requirements, the
focus is on transactional risk to US persons—here
the US guarantor of a transaction between a guaranteed non-US person and a non-US SD/MSP.
It also appears that the CFTC and SEC’s jointly-adopted final entity rules had a bearing on the CFTC’s
decision to adopt a US guarantee approach (as opposed to its guaranteed affiliate approach) in the
transaction-related context. The CFTC cited the final
entity rules in its Guidance as follows:
“See Final Entities Rules, 77 FR at 30689
(‘‘[A]n entity’s swap or security-based
swaps positions in general would be attributed to a parent, other affiliate or
guarantor for purposes of major participant analysis to the extent that counterparties to those positions would have recourse
to that other entity in connection with the
position. Positions would not be attributed
in the absence of recourse.’)” (emphasis
added).45
It would be hard to square the CFTC’s (and
SEC’s) emphasis on a guarantee being part of the
swap if the guarantee did not provide for recourse—
for example, in the case a keepwell that does not
provide recourse or third-party beneficiary rights to
swap counterparties:
“Further, in the Final Swap Definition, the
Commission found that a guarantee of a
swap is a term of that swap that affects
10
Futures & Derivatives Law Report
the price or pricing attributes of that swap.
The Commission therefore concluded that
when a swap has the benefit of a guarantee, the guarantee is an integral part of
that swap.”46
This is arguably an appropriate analytical conclusion where a swap counterparty has recourse
in respect of a specific swap; in the absence of recourse it is not. Put another way: When a guarantee provides for recourse against the guarantor,
the guarantor is properly viewed as a party to the
transaction at hand, and consequently the guarantor should, if it is a US person, receive the protection of Transaction-Level Requirements; in the
absence of recourse, protections at the transaction
level seem less compelling.
The CFTC sums up regarding Transaction-Level
Requirements:
“Where a U.S. person provides a guarantee
of a non-U.S. counterparty’s swaps obligations for which there is recourse to the
U.S. person, where that guarantee is a
term of the swap and affects the price or
pricing attributes of that swap, and where
the Transaction-Level Requirements serve
to protect and mitigate risk to that U.S. person guarantor, the Commission believes
that such swaps, either individually or in
the aggregate, have a direct and significant connection with activities in, or effect
on, U.S. commerce. . . .
“In the Final Swap Definition, the Commission acknowledged that a ‘full recourse’
guarantee would have a greater effect
on the price of a swap than a ‘limited’ or
‘partial recourse’ guarantee, yet nevertheless determined that the presence of any
guarantee with recourse, no matter how
robust, is price forming and an integral
part of a guaranteed swap. The Commission
similarly believes that the presence of any
guarantee with recourse by a U.S. person of
the swaps obligations of a non-U.S. counterparty to a swap with a non-U.S. swap
dealer or non-U.S. MSP suffices to justify
the application of Transaction-Level Requirements that swap. Therefore, as noted
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report above, to the extent that a non-U.S. swap
dealer or non-U.S. MSP would have recourse to the U.S. guarantor in connection
with its swaps position, the Commission
would generally expect such non-U.S. swap
dealer or MSP to comply with the Category
A Transaction-Level Requirements for such
a guaranteed swap” (emphasis added).47
Note that normal rules of statutory (and regulatory) construction would require one to give
meaning to the repeated use of the word “recourse” in this context. As noted above, “guarantee” is very broadly defined early in the Guidance
in the context of SD and MSP registration considerations associated with guaranteed affiliates, but
the word “guarantee” is then repeatedly qualified
in the portion of the Guidance addressing Transaction-Level Requirements as those requirements
apply to non-US person SD/MSPs dealing with
non-US persons. This strongly suggests a limiting
of the regulatory trigger. The counter-argument
would be that the repeated use of “recourse” is
a device of description or emphasis—but if this is
the case, it would appear that the original definition was not as broad as it seemed.48
Note also that having elaborated the concept of
“guaranteed affiliate” earlier, the Guidance fails to
use the phrase anywhere in this discussion of Transaction-Level Requirements.49 Something different
must have been intended.
A last note before moving on: To confuse matters further, the Guidance provides, in its concluding substantive section,50 a final twist and
turn. This section addresses the application of
“Non-Registrant Requirements,” which apply
in certain circumstances when neither counterparty to a swap is an SD or MSP. Some of the
Non-Registrant Requirements are TransactionLevel Requirements (clearing, trade execution,
real-time public reporting), and some are EntityLevel Requirements (swap data repository (SDR)
reporting and swap data recordkeeping).51 Where
each counterparty to a swap transaction is a nonUS person (and neither is an SD or MSP), NonRegistrant Requirements apply if each counterparty is either a guaranteed affiliate or an affiliate
conduit.52 In other words, in a context that is
analogous to the Transaction-Level Requirement
context described in this Section 2 (but not the
same since Non-Registrant Requirements comprise only a limited number of Transaction-Level
Requirements, together with certain Entity-Level
© 2014 THOMSON REUTERS
February 2014 n Volume 34 n Issue 2
Requirements), the Guidance reverts to the “guaranteed affiliate” approach and away from the “US
guarantee” approach.
Perhaps the CFTC and its staff would contend
that the distinctions drawn above—between the
“guaranteed affiliate” approach applicable in the
context of SD and MSP registration requirements
and in the context of Non-Registrant Requirements,
and the “US guarantee” approach applicable in the
context of Transaction-Level Requirements as applied to non-US SDs—were not intended. Or perhaps they would contend that the two approaches,
despite the very different phraseology, are in fact the
same. In any case, given the textual differences, and
the lack of explicit clarification to date, it is hard to
know what exactly they intended, and equally hard
to render confident legal advice.53
3. “Guaranteed or Conduit Affiliate”
The Guidance defines different terms related to
guaranteed affiliates in an inconsistent manner. The
Guidance uses not only the defined term “guaranteed affiliate,” but also the compound term “guaranteed or conduit affiliate.” This compound term
is defined in a footnote in the Guidance (Footnote
259) as follows:
“a non-U.S. person whose swap obligations are guaranteed by a U.S. person or
that is an affiliate conduit.”54
Note that there is no requirement, in the portion
of the definition concerning guarantees, that the
guaranteed non-US person be an affiliate of a US
person. The term is defined this way despite its commonsense meaning, a meaning driven by the manner in which the words “guaranteed” and conduit”
each grammatically modifies the word “affiliate” in
the phrase “guaranteed or conduit affiliate.”
Thus, with the commonsense meaning pointing
in one direction—i.e., the U.S. guarantor needs to
be an affiliate—and the technical definition pointing in a different direction—i.e., there being no need
for any such affiliation—one looks to usage and
context: almost every use of the compound term in
the Guidance is consistent with the first direction,
where the term would be read as a simple amalgam
of “guaranteed affiliate” or “affiliate conduit.”
Guaranteed affiliate is defined without ambiguity
as follows:
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February 2014 n Volume 34 n Issue 2
“a non-U.S. person that is an affiliate of a
U.S. person and that is guaranteed by a U.S.
person” (emphasis added).55
ed something different, it used a different verbal
formulation. This was the case in the circumstances
discussed in Section 2 above:
The first use of the compound term (“guaranteed or conduit affiliate”) and the two related terms
(“guaranteed affiliates” and “affiliate conduits”)
demonstrates the disconnect between definitions
and usage, and supports an interpretation of the
compound term as having been intended to serve
as a shorthand amalgam of the separate terms (and
thus perhaps erroneously defined in Footnote 259):
“Conversely, where a non-U.S. swap dealer
or non-U.S. MSP enters into a swap with a
non-U.S. counterparty that does not have a
guarantee as so described from a U.S. person
and is not an affiliate conduit, the Commission’s view is that the Transaction-Level
Requirements should not apply” (emphasis
added).58
“[T]he Commission believes that all of
the swap dealing activities of a non-U.S.
person that is an affiliate of a U.S. person
and that is guaranteed by a U.S. person
(a ‘guaranteed affiliate’), or that is an ‘affiliate conduit’ of a U.S. person, have the
requisite statutory nexus and potential to
impact the U.S. financial system. Therefore,
under the Commission’s interpretation of
2(i), a guaranteed or conduit affiliate should
count swap dealing transactions towards
the de minimis threshold for swap dealer
registration in the same manner as a U.S.
person” (emphasis added).56
This usage and likely intention is re-emphasized a
few paragraphs later:
“Because a guarantee of a swap is an integral part of the swap, and counterparties may not otherwise be willing to enter
into a swap with the guaranteed affiliate,
the affiliate would not have significant
swap business if not for the guarantee….
Accordingly, under section 2(i), the Commission intends to interpret section 2(i) as
applying the swaps provisions of the CEA
to swaps that are entered into by guaranteed or conduit affiliates in a manner similar to how section 2(i) would apply if a U.S.
person had entered into the swap (subject
to appropriate considerations of international comity for non-guaranteed, non-U.S.
persons facing such guaranteed or conduit
affiliates, as discussed below)” (emphasis
added).57
Also supporting this interpretation of the compound term is the fact that where the CFTC intend-
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Futures & Derivatives Law Report
It would appear that the reason that the CFTC
chose not to use the phrase “guaranteed or conduit
affiliate” here is because it did not intend to limit the
guarantees at issue—i.e., those that bear on whether
a non-US SD/MSP is subject certain TransactionLevel Requirements when dealing with a non-US
person—to those supporting non-US persons that
are affiliates of US persons.59 The reason for this
difference of approach to guarantees is discussed
in Section 2 above; the point here concerns how to
interpret the compound term given the definitional
inconsistency introduced in Footnote 259.
A further inconsistency is now worth mentioning, though it may favor interpreting the compound
term in a manner consistent with the terms of its
broader technical definition (at the expense of earlier usage and apparent intention): in remarks prefatory to the detailed discussion of Transaction-Level
Requirements (described in Section 2 above), the
CFTC wrote:
“[F]or the reasons discussed in the next
two sections, where a swap is between a
non-U.S. swap dealer or non-U.S. MSP, on
the one hand, and a non-U.S. person that
is a guaranteed or conduit affiliate, on the
other, under the Commission’s interpretation of 2(i), the Commission would generally expect the parties to comply with
the Category A Transaction-Level Requirements. However, where a swap is between
a non-U.S. swap dealer or non-U.S. MSP
(including an affiliate of a U.S. person), on
the one hand, and a non-U.S. person that is
not a guaranteed or conduit affiliate, on the
other, under the Commission’s interpretation of 2(i), the Commission would not
expect the parties to the swap to comply
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report with the Category A Transaction-Level Requirements” (emphasis added).60
This seems straight forward,61 until one reads
the first of the “next two sections” that are cited.
Notwithstanding the preface, the first of the two
sections (which deals with guarantees, the second
addressing affiliate conduits) completely avoids the
compound term all together (or, for that matter, as
noted in Section 2 above, the term “guaranteed affiliate” standing alone). This section of the Guidance,
which is the source of the second quotation above
(beginning, “Conversely . . . “), demonstrates a direction deliberately away from the compound term.
The Exemptive Order, which the CFTC adopted
at the same time it adopted the Guidance, is also
instructive. Although the broader compound term
is used in the section of the Guidance that indicates that transactions between two guaranteed or
conduit affiliates are subject to the Non-Registrant
Requirements,62 the Exemptive Order, which delayed imposition of this requirement, spoke only of
(more narrowly defined) “guaranteed affiliates.”63
This supports the narrower reading of the compound term.
Subsequently, the CFTC’s staff provided implicit,
though nonetheless relatively clear, guidance on the
subject. In its July 31, 2013 press release, the staff
noted the coming effectiveness of certain requirements. In referencing certain requirements that,
in the Guidance, had been addressed via the compound term, the press release reverted to the component definitions:
“[O]n October 10, 2013, staff anticipates
the following transactions to be submitted
for clearing with a registered derivatives
clearing organization (DCO) . . . (2) transactions by SDs and MSPs that are not U.S.
persons with guaranteed affiliates or affiliate conduits of U.S. persons (established in
any jurisdiction outside the U.S.) that are
not SDs or MSPs . . . , and (3) guaranteed
affiliates or affiliate conduits of U.S. persons
(established in any jurisdiction outside the
U.S.) that are not SDs or MSPs, for transactions with other such entities” (emphasis
added).64
This seems to be clear subsequent textual authority for the proposition that “guaranteed or
conduit affiliate” should be read synonymously
with “guaranteed affiliates” or “affiliate conduits”
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February 2014 n Volume 34 n Issue 2
and, despite the Guidance’s express definition in
Footnote 259, should not be read to include nonUS persons that are not affiliated with a US person.
Finally, there is this from a policy perspective:
As is evident from the discussion above, one relevant context—the question of SD/MSP registration—entails an entity-level perspective, while the
other context—the application of TransactionLevel Requirements to swaps with certain non-US
persons—ties clearly to a transaction-level perspective. Looked at with this in mind, the compound
term makes most sense if it is limited to affiliates
of US persons: it is non-US persons that are affiliated with (and guaranteed by) US persons that
most clearly present the risk addressed by SD/MSP
registration—the risk of broad financial contagion
entering the US by way of an unregistered SD/MSP
transacting with non-US affiliates of US persons.
Where does this leave us? First, it leaves us with
inconsistency. Second it leaves us guessing as to intended meaning. Finally, it leaves at least the author believing that where the compound term is
used, the CFTC in fact meant to limit the meaning
to affiliates of US persons. This is consistent with
its usage in the context of SD/MSP registration,
where US affiliation (in addition to a US guarantee)
seems to make the most sense. The outlier inconsistency, which cannot be reconciled this way, is the
last inconsistency cited immediately above. There,
in the preface to the discussion of Transaction-Level Requirements, the usage of the compound term
simply seems to have been a mistake—it should not
have been used to introduce the referenced (and
operative) “next two sections,” which themselves
avoid using the term. In any case, one way or the
other, the CFTC needs to clarify its meaning. Otherwise these questions will remain open:
• For a non-US person that benefits from the
guarantee of a US person that is not an affiliate of the non-US person:
• Is the non-US person required to count
all of its swaps against its SD and MSP
de minimis thresholds?
• Are other non-US persons required to
count the guaranteed non-US person
against their own SD and MSP de minimis thresholds?
• “No” would seem the correct answer in each case under the Guidance, but this would be inconsistent with a strict reading of the
definition of the compound term
“guaranteed or conduit affiliate” in
Footnote 259.
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February 2014 n Volume 34 n Issue 2
•
For a non-US person that receives from an affiliate a weak keepwell (e.g., one that expressly
excludes recourse by third parties, which is not
unusual):
• Do Transaction-Level Requirements,
Category A apply to swaps between it
and non-US SD/MSPs?
• “No” would seem the right answer
under the operative sections of the
Guidance, but it would be inconsistent with the use of the term “guaranteed or conduit affiliate” in an
earlier prefatory section.
Conclusion
The CFTC is to be commended for its desire to
push the very important agenda of regulatory reform of the US swap market. But it appears that
an undermanned and perhaps over-extended staff
was pressed beyond its ability to create clear and
consistent regulatory text for consideration by the
CFTC’s commissioners. And it appears that the
commissioners, with lesser or greater levels of resistance,65 acquiesced in that state of affairs.
Whether due to:
•
sheer complexity: guaranteed affiliates and
affiliate conduits are treated the same as US
persons for most purposes, but not all—and
guaranteed affiliates and affiliate conduits are
themselves treated the same for most purposes, but not all; or
•
inconsistent approaches to regulatory concepts: guarantees provided by US persons
are handled differently, without explanation,
when the regulatory context is SD and MSP
registration thresholds and when the regulatory context is Transaction-Level Requirements;
or
•
conflicting definitions: “guaranteed or conduit
affiliates,” technically speaking, are not necessarily affiliates of US persons; but yet pretty
clearly they should be;
the problems for the market in interpreting
and applying the Guidance are extensive.
A rules-based approach—and the simple act of
drafting technical self-delimiting rules and the discipline it requires—would have likely pushed the
CFTC and its staff toward a unified approach to
guarantees and guaranteed affiliates, rather than
the disparate and inconsistent interpretive ap-
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Futures & Derivatives Law Report
proach discussion in Section 2 above. A rules-based
approach almost certainly would have flushed out
the technical definitional problem described in Section 3 above, particularly if rules with the definitions had been published in proposed form before
being adopted. Whether a rules-based approach
would have reduced the complexity associated
with guaranteed affiliates and affiliate conduits,
as described in Section 1 above, is another matter: such complexity might have found a regulatory
home even had the CFTC taken a rules-based approach; but at least, had the CFTC proposed rules
embodying the complexity before adopting them,
it would have benefitted from a proper public vetting. As it stands, “guaranteed affiliates” and “affiliate conduits” were, in effect, announced and
adopted in a single stroke, without an opportunity
for public comment.66
This is not to say there is not a reasonably
strong core of new cross border swap regulation
for which the CFTC is to be commended. There
is. And this is not to say that the CFTC’s drive has
not pushed, even lead, regulatory developments
worldwide. It has. But the problem is that the
elements of the Guidance discussed above—like
elements of other new CFTC rules and interpretations that have been rushed to market (literally)—
have caused significant confusion and thus significant expense and inefficiency. If more time had
been taken, if more care had been given, if more
precision in the form of rules-based (rather than
interpretive) regulation had been pursued—if in
fact time for more coordination with other Federal and non-US regulators had been allowed—
the outcome, perhaps two or three years from
now, would have been less disruptive, while every
bit as protective in the long-run. Of course the
CFTC would have needed to balance this benefit
against the risk associated with short-term additional delay in regulation. Perhaps such a delay
would have been politically unpalatable; however,
it seems likely that it would have been economically desirable.
END NOTES
1.
Often attributed to a poem written by Voltaire.
See Wikipedia, “Perfect is the enemy of good”
(quoting Voltaire, La_B%C3%A9gueule” \o
“s:fr:La Bégueule: “Dans ses écrits, un sage Italien/Dit que le mieux est l’ennemi du bien.”),
available at: http://en.wikipedia.org/wiki/Perfect_is_the_enemy_of_good.
2.
Attributed to various. See WikiAnswers, “Who
first said you can’t make an omelet without
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report 3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
breaking a few eggs?”, available at: http://
wiki.answers.com/Q/Who_first_said_you_
can’t_make_an_omelet_without_breaking_a_
few_eggs.
Old English adage popularized in America by
Benjamin Franklin. See Franklin, Benjamin,
PoorRichard’sAlmanack (1753), available at:
http://www.unsv.com/voanews/specialenglish/
scripts/2010/11/07/0040/Poor_Richard’s_Almanack_by_Franklin_Benjamin.pdf.
This article had been largely completed when
three industry trade associations commenced
litigation in federal district court challenging
the guidance. See Complaint, Securities Industry and Financial Markets Association et al. vs.
U.S. Commodity Futures Trading Commission
(December 4, 2013) (Civil Action No. 13-CV1916) (D.D.C.) (http://assets.isda.org/media/
73a60510/00344e8a.pdf/). The article takes no
view on the interesting legal questions raised
in the complaint concerning whether the CFTC
improperly exercised rule-making authority in
adopting the guidance; however, as discussed
further in its concluding remarks, the article
does express the view that, as a matter of policy and best practice, a rules-based approach
would have been preferable to the approach
taken by the CFTC in adopting the guidance.
Public Law 111—203, 124 Stat. 1376 (2010).
Title VII also governs security-based swap transactions subject to the jurisdiction and rulemaking authority of the Securities Exchange
Commission (SEC).
7 U.S.C. 2(i).
Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 45292 (July 26, 2013) (the
Guidance).
Id. at 45300.
Id. at 45318-19.
As discussed below (see infra notes 50-52 and
accompanying text), the predominant approach, tied to the concept of “guaranteed
affiliate,” then reappears for the Guidance’s
treatment of certain requirements applicable
to transactions involving solely non-SD/MSPs.
The latter part of this assertion—regarding affiliation with a US person—is at the heart of
the discussion in Section 3 below. This Section 1
and the following Section 2 assume that when
the Guidance uses the compound term, “guaranteed or conduit affiliate,” it is speaking of
a “guaranteed affiliate” or “affiliate conduit.”
This assumption is explored in detail in Section
3 below.
Defined as “a non-U.S. person that is an affiliate of a U.S. person and that is guaranteed by
a U.S. person.” Guidance at 45318. Where the
non-US person is guaranteed by, but not an af-
© 2014 THOMSON REUTERS
February 2014 n Volume 34 n Issue 2
13.
14.
15.
16.
filiate of, a US person, it would not fall into the
category of “guaranteed affiliate.” However,
such a circumstance remains separately relevant with respect to Transaction-Level Requirements as discussed in Section 2 below.
The CFTC stated that “certain factors are relevant to considering whether a non-U.S. person is an ‘affiliate conduit.’ Such factors include
whether: (i) the non-U.S. person is a majorityowned affiliate of a U.S. person; (ii) the nonU.S. person is controlling, controlled by or under common control with the U.S. person; (iii)
the financial results of the non-U.S. person are
included in the consolidated financial statements of the U.S. person; and (iv) the non-U.S.
person, in the regular course of business, engages in swaps with non-U.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 its U.S.
affiliate(s) in order to transfer the risks and
benefits of such swaps with third-party(ies) to
its U.S. affiliates. Other facts and circumstances
also may be relevant. The Commission does not
intend that the term ‘conduit affiliate’ would
include affiliates of swap dealers.” Id. at 45359.
The SEC takes a different view: It does not require a non-US person that is guaranteed by a
US person to count SB swaps with non-US persons against its own SB swap dealer or MSBSP
thresholds. Nor does it require non-US dealers to
count swaps with non-US persons that are guaranteed (i.e., guaranteed affiliates). Instead, the
US guarantor in such circumstances must count
the SB swaps it guarantees against its own MSBSP threshold. See Cross-Border Security-Based
Swap Activities; Re-Proposal of Regulation SBSR
and Certain Rules and Forms Relating to the
Registration of Security-Based Swap Dealers and
Major Security-Based Swap Participants (May 23,
2013), 78 Fed. Reg. 30968, at 31006 (including
footnote 358), 31030, 31032; see also Guidance
at 45319 n. 263. The SEC’s release is available at:
http://www.gpo.gov/fdsys/pkg/FR-2013-05-23/
pdf/2013-10835.pdf.
The CFTC indicated that additional ad hoc relief would potentially be available in respect
of certain Entity-Level Requirements where the
guaranteed affiliate (i) became subject to SD
registration solely because of swaps with nonUS persons (excluding guaranteed affiliates
and affiliate conduits) and (ii) is a guaranteed
affiliate of a US swap dealer. The relief would
be subject to appropriate conditions and restrictions related to a consolidated program of
risk management. See id. at 45348-49.
The Guidance clearly indicates that a guaranteed affiliate must count, for MSP purposes, all
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February 2014 n Volume 34 n Issue 2
16
swaps that it enters into, whether the counterparty is a US person or a non-US person; it also
makes clear that such swaps are counted by attributing them to the guaranteed affiliate’s US
guarantor. See id at 45319-20 and 45326. However, the Guidance is much less clear when it addresses how the MSP thresholds apply when an
affiliate conduit is counting the swaps.
The Guidance starts by stating clearly that “a . .
. conduit affiliate should include all of swap positions with counterparties, whether they are
U.S. or non-U.S. persons.” Id. at 45319. But then
the Guidance confuses the matter twice. First,
it states: “a . . . conduit affiliate, in calculating
whether the applicable MSP threshold is met,
would be expected to include, and attribute to
the U.S. guarantor, the notional value of: (1)
All swaps with U.S. and non-U.S. counterparties
. . .” (emphasis added). Id. at 45320. But this
makes no sense since there is no US guarantor
to which such swaps may be attributed (otherwise we would have a “guaranteed affiliate”).
Perhaps the CFTC meant “U.S. guarantor or U.S.
affiliate,” but it did not say so. Second, when
the Guidance summarizes the CFTC’s interpretation a few pages later, it drops reference to
affiliate conduits all together: “In determining
whether a non-U.S. person holds swap positions above the MSP thresholds, the non-U.S.
person should consider the aggregate notional
value of: . . . (ii) any swap position between it
and a guaranteed affiliate (but its swap positions where its own obligations thereunder
are guaranteed by a U.S. person should be attributed to that U.S. person and not included
in the non-U.S. person’s determination).” Id.
at 45326. Perhaps the CFTC intended this summary of its MSP interpretation to apply only to
non-US persons that were neither guaranteed
affiliates nor affiliate conduits, but it did not
say so. In fact, given the parenthetical portion
of clause (ii) cited above, it seems clear that the
summary covers at least guaranteed affiliates.
So why is there no reference, in this summary,
to how affiliate conduits should calculate their
holdings against MSP thresholds; and why, as
noted above in this footnote, is there a guarantor attribution rule on page 45320. One might
speculate that this confusion is a casualty of importing, at the last minute, and without having
(or taking) the time to draft carefully, the concept of affiliate conduit into the SD and MSP
registration regime, something that was missing entirely from the originally proposed guidance. See infra notes 30-31 and accompanying
text.
The non-US affiliate (whether a guaranteed affiliate or an affiliate conduit) must also count,
against its own MSP threshold, any swap that it
Futures & Derivatives Law Report
17.
18.
19.
20.
21.
22.
guarantees where the swap is between (i) another [non-US] person that the non-US affiliate
guarantees, and (ii) any US person or guaranteed affiliate (but not a conduit affiliate). Id. at
45320, 45326. (Bracketed phrase is present on
page 45320 but not on page 45326.)
This odd distinction between the treatment of
guaranteed affiliates and affiliate conduits was
not explained by the CFTC, but nonetheless
may have an explanation. See discussion below
following the tabular Q&A (infra notes 30-34
and accompanying text).
The non-US person must also count swaps
it guarantees if the counterparty is a US person or a guaranteed affiliate (but not necessarily an affiliate conduit). See Guidance at
45326. Cf. supra note 16 and accompanying
text. There the question is which swaps must
the hypothetical non-US affiliate (guaranteed
affiliate or affiliate conduit) count toward its
MSP de minimis threshold. Here the question is
the inverse: When must the non-US affiliate be
counted by another non-US person with which
it transacts?
Cf. supra note 17.
In this case, the non-US person’s “swap positions where its own obligations thereunder
are guaranteed by a U.S. person should be attributed to that U.S. person and not included
in the non-U.S. person’s determination.” Guidance at 45326. Note, however, that this limitation, as drafted in the Guidance, is technically
applicable only to clause (ii) in the summary
discussion on page 45326, which covers swaps
between non-US persons and guaranteed affiliates; but it seems relatively likely that the limitation was intended to operate more broadly
(as represented in the table above). See, e.g.
id. at 45317 (noting that in the guidance originally proposed in 2012 a non-US person’s swaps
even with US persons would not be counted
against the non-US person’s MSP threshold if
“the non-U.S. person’s swaps are guaranteed
by a U.S. person, [in which case] such swaps will
be attributed to the U.S. guarantor and not the
potential non-U.S. MSP”); id. at 45326 (stating
that “if a non-U.S. person enters into a swap
guaranteed by a U.S. person, the swap should
generally be attributed to the U.S. person.”).
Arguably this is an example of where the
CFTC’s line-drawing was unduly fine. See id. at
45324 (drawing a distinction between risks arising when non-US persons transact with guaranteed affiliates that are themselves registered
swap dealers depending on whether or not the
non-US person is a financial entity).
Substituted compliance for SDR reporting is
not available with respect to swaps between a
non-US SD/MSP, on the one hand, and a guar-
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report 23.
24.
25.
anteed affiliate or affiliate conduit on the
other. Substituted compliance would remain
available for SDR reporting for non-US SD/MSP
swaps with other non-US persons (subject to
the CFTC having direct access to swap data at
foreign repository). See id. at 45349 and 45368.
Curiously, the Guidance introduces ambiguity
into the analysis by referencing twice, on page
45349 (including in footnote 507), “non-U.S.
counterparties” in connection with noting the
availability of substituted compliance; presumably this phrase was intended as short-hand
for non-U.S. persons that are not guaranteed
affiliates or affiliate conduits. But cf. Guidance
at 45368 (where the phrase “non-U.S. counterparties” is modified by a limitation—”that are
not guaranteed or conduit affiliates”—which
would be redundant and thus not necessary if
the suggested short-hand interpretation were
correct). This is another instance of less than
careful regulatory drafting.
Substituted compliance is never available for
Large Trader Reporting. See id. at 45349.
The Guidance classifies certain regulatory requirements applicable to SDs and MSPs as
“Transaction-Level Requirements.” Transaction-Level Requirements are subdivided into
two categories, with Category A covering (1)
clearing and swap processing requirements;
(2) margining and segregation for uncleared
swaps requirements; (3) trade execution requirements; (4) swap trading relationship
documentation requirements; (5) portfolio
reconciliation and compression requirements;
(6) real-time public reporting requirements;
(7) trade confirmation requirements; and (8)
daily trading records requirements. Category B
consists of the external business conduct standards. See id. at 45338-40.
As noted above and discussed at length below
in Section 2, the requirement that non-US SD/
MSPs, when dealing with a non-US person that
is guaranteed by a US person, comply with
Transaction-Level Requirements, Category A is
not tied to swaps with “guaranteed affiliates”
per se. As discussed in Section 2, this requirement is triggered where the SD/MSP benefits
from a guarantee that provides for recourse
against a US person; the two related terms defined in the Guidance—”guaranteed affiliate”
and “guaranteed or conduit affiliate”—are
not used in the relevant operative sections.
However, for purposes of this part of question
7 in the table, it does not matter whether the
Transaction-Level Requirement, Category A is
triggered by the presence of a “guaranteed affiliate” per se; the only point here is that substituted compliance is available.
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February 2014 n Volume 34 n Issue 2
26.
27.
28.
29.
30.
31.
Each of the following jurisdictions made a
submission to the CFTC seeking a determination that its laws and regulations satisfy the
CFTC’s criteria for one or more substituted
compliance findings: Australia, Canada, the
European Union, Hong Kong, Japan and Switzerland. CFTC determinations were published
on December 20, 2013. See CFTC, Comparability Determinations for Substituted Compliance
Purposes. available at: http://www.cftc.gov/
LawRegulation/DoddFrankAct/CDSCP/index.
htm; see also CFTC, Press Release, CFTC Approves Comparability Determinations for Six
Jurisdictions for Substituted Compliance Purposes (PR 6820-13) (December 20, 2013), available at: http://www.cftc.gov/PressRoom/PressReleases/pr6802-13.
The related relief—for foreign branches of US
SD/MSPs dealing outside the six jurisdictions
with non-US persons other than guaranteed
affiliates and affiliate conduits—did not need
to be extended to registered non-US SD/MSPs
because non-US SD/MSPs are permitted to deal
with such non-US persons without any application of Transaction Level Requirements,
Category A (i.e., no need for substituted compliance, as is required for foreign branches of
US SD/MSPs dealing with non-US persons). This
raises the following question, however: Would
a non-US SD/MSP that benefited from substituted compliance in its home jurisdiction be
able to transact with guaranteed affiliates and
affiliate conduits in, for example, Seoul or Singapore, without complying with Transaction
Level Requirements, Category A? A branch of a
US SD/MSP located in either of those locations
would not be permitted to do so.
See “no” answers to questions 3 and 4 (but cf.
supra note 20, which suggests otherwise for
one of the “no” answers), and “yes” answers
to question 6, in the table. In each of these
instances, the answer for a US person would
have been the opposite of the answer set out
for guaranteed affiliates and affiliate conduits;
otherwise guaranteed affiliates and affiliate
conduits are treated in the same manner as
US persons. Of course, there is an interpretive
question wherever a question mark is noted.
See questions 3 and 4 in the table, where the
answer is different depending on whether the
non-US affiliate in question is a guaranteed affiliate or only an affiliate conduit.
See Guidance at 45318-20.
See Cross-Border Application of Certain Swaps
Provisions of the Commodity Exchange Act, 77
Fed. Reg. 41214 (Jul. 12, 2012) (Proposed Guidance), available at: http://www.gpo.gov/fdsys/
pkg/FR-2012-07-12/pdf/2012-16496.pdf; cf. id.
at 41228-29 (discussing conduits solely in the
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February 2014 n Volume 34 n Issue 2
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
18
context of transaction-level requirements).
Conduit arrangements are not mentioned at
all in the CFTC’s subsequent further proposed
guidance. See Further Proposed Guidance Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 909 (Jan. 7, 2013) (Further
Proposed Guidance), available at: http://www.
gpo.gov/fdsys/pkg/FR-2013-01-07/pdf/201231734.pdf.
See Guidance at 45293 (at n. 5), 45319 (at n.
261) and 45356 (at n. 568).
Interestingly, non-US SDs may avail themselves
of substituted compliance when dealing with
conduit affiliates and guaranteed affiliates,
but not when dealing directly with US persons.
“Non-U.S. persons that are not guaranteed
or conduit affiliates are not required to count
swaps with a conduit affiliate towards the swap
dealer de minimis calculation.” Id. at 45319.
For example, even though conduit arrangements did not figure into the Proposed Guidance’s proposed treatment of SD and MSP
registration requirements (see supra note 31
and accompanying text), they became, as demonstrated by the table above, part and parcel
of the Guidance’s final treatment of these requirements. This change may well relate to the
troubling creation of the defined term “guaranteed or conduit affiliate,” which is the subject of Section 3.
For a list of the requirements, see supra note 24.
In a given circumstance, a non-US person counterparty may be both a guaranteed affiliate
and a US guarantee. In fact, their combined
presence is likely to be the more prevalent circumstance (as guarantees and affiliations often go hand in hand). The principal exception
might entail circumstances where there is relatively weak keepwell given by a parent in respect of a subsidiary, resulting in the presence
of guaranteed affiliate, but not a US guarantee
(as the latter term is used here where the emphasis is on recourse). An alternative exception
might apply where a relatively strong guarantee (with recourse) is given in the absence of
any affiliation, leaving an absence of any guaranteed affiliate notwithstanding the presence
of a US guarantee that triggers TransactionLevel Requirements.
Guidance at 45355.
Id.
Id.
Id. at n. 563.
Id. at 45320 and n. 267. Earlier in this discussion, the Guidance cites the CFTC’s prior determination, in the context of promulgating final
rules related to the definition of “swap,” that
a swap “include[s] a guarantee of such swap, to
the extent that a counterparty to a swaps posi-
Futures & Derivatives Law Report
43.
44.
45.
46.
47.
48.
49.
50.
51.
52.
53.
tion would have recourse to the guarantor in
connection with the position.” Id. at 45319 and
n. 261. See also id. at 45320 and n. 264 (also
citing the earlier determination). But the term
does not figure into the Guidance in an operative manner here as it does in the latter context
regarding Transaction-Level Requirements.
The Guidance cites AIG as its case in point. See
supra note 32 and accompanying text.
Guidance at 45356 at n. 564.
Id. at 45355 at n. 562.
Id. at 45356.
Id.
The exemptive order that CFTC adopted at
the same time that it adopted the Guidance is
also instructive here. Throughout almost the
entirety of the order, the CFTC uses the term
“guaranteed affiliate.” See, e.g., Exemptive Order Regarding Compliance With Certain Swap
Regulations (July 12, 2013) (Exemptive Order),
78 Fed. Reg. 43785 at 43789 n. 45 (“As used
in the Exemptive Order, the term ‘guaranteed
affiliate’ refers to a non-U.S. person that is affiliated with a U.S. person and guaranteed by
a U.S. person.”), available at: http://www.cftc.
gov/ucm/groups/public/@lrfederalregister/documents/file/2013-17467a.pdf.
However, in the portion of the Exemptive Order describing the delay in application of the
Transaction-Level Requirements in question
here, the Exemptive Order (like the Guidance)
shifts lexicon: “As described in the Guidance, a
non-U.S. SD or non-U.S. MSP should generally
comply with the Category A Transaction-Level
Requirements for its swaps with U.S. persons
and with non-U.S. persons that are guaranteed
by, or are affiliate conduits of, a U.S. person . .
. .” (emphasis added). Id. at 43790. As is immediately apparent, had the CFTC meant to limit
the guarantees in question to affiliate situations, the emphasized phrase above would
have been “guaranteed affiliates” rather than
“non-U.S. persons that are guaranteed by . . . a
U.S. person.”
But see discussion below (infra notes 60-61
and accompanying text) regarding remarks in
the Guidance that are prefatory to the section
discussed at length here. It is a mystery why
the CFTC introduced the section concerning
Transaction-Level Requirements by referring
to “guaranteed affiliates,” but then entirely
dropped the phrase from the ensuing discussion.
See Guidance at 45361 et seq.
See id. at 45361.
See id. at 45364.
Cf. infra note 64 and accompanying text (discussing a subsequent CFTC staff press release,
which suggests that the staff doesn’t appreci-
© 2014 THOMSON REUTERS
Futures & Derivatives Law Report 54.
55.
56.
57.
58.
59.
60.
61.
62.
63.
ate these differences, inasmuch as the press
release addresses the application of certain
Category A Transaction-Level Requirements
(mandatory clearing) by reference to “guaranteed affiliates” rather than by reference to
swaps guaranteed with recourse by US guarantors (whether or not the guarantor is an affiliate of the guaranteed counterparty).
Guidance at 45319 at n. 259. See also id. at n.
619 (repeating the definition).
Id. at 45318.
Id. at 45318-19.
Id. at 45319.
Id. at 45355.
An alternative argument is that the CFTC avoided the compound definition in its discussion of
Transaction-Level Requirements because it is
associated with a broader definition of guarantee—one that arguably picks up support arrangements that do not include recourse. See
discussion in Section 2 above.
Guidance at 45352-53.
Indeed, the point is reemphasized a few paragraphs later:
“In addition, where a swap is between a nonU.S. swap dealer or non-U.S. MSP (including an
affiliate of a U.S. person), on the one hand, and
a non-U.S. person that is a guaranteed or conduit affiliate, on the other, substituted compliance may be available to satisfy the Category A
Transaction Level Requirements, to the extent
applicable, as discussed in the next two sections” (emphasis added).
Id. at 45353. But cf. infra note 64.
“[W]here a swap is between two nonregistrants that are not U.S. persons, and each of
the counterparties to the swap is a guaranteed
or conduit affiliate, the parties to the swap
generally should be expected to comply with
the Non-Registrant Requirements with respect
to the transaction” (emphasis added). Id. at
45364. See also supra notes 50-52 and accompanying text.
“For swaps transactions between a guaranteed
affiliate of a U.S. person (established in any jurisdiction outside the United States) that is not
registered as a SD or MSP and another guaranteed affiliate of a U.S. person (established in
any jurisdiction outside the United States) that
is not registered as a SD or MSP, such non-registrants may comply with any law and regulations of the jurisdiction where they are established (and only to the extent required by such
jurisdiction) for the relevant Transaction-Level
Requirement in lieu of complying with any
Transaction-Level Requirement for which substituted compliance would be possible under
the Commission’s Guidance until 75 days after
© 2014 THOMSON REUTERS
February 2014 n Volume 34 n Issue 2
64.
65.
the publication of the Guidance in the Federal
Register.” Exemptive Order at 43795.
CFTC Release PR6657-13 (July 31, 2013), available at: http://www.cftc.gov/PressRoom/PressReleases/pr6657-13. The antecedent for clause
(3) in the press release is the portion of the
Guidance addressing Non-Registrant Requirements. See supra note 62. The antecedent for
clause (2) is trickier: this is the context addressed
in Section 2 above—where the compound term
is in fact used only to introduce the referenced
“next two sections” describing the applicability of Transaction-Level Requirements to swaps
executed by non-US SDs with other non-US persons, but is probably used incorrectly since the
operative section of the Guidance then avoids
reference to any affiliation when it discusses
US guarantees. See supra notes 60-61 and accompanying text. Thus, clause (2) in the press
release muddies these waters even further
than was suggested in Section 2: one has to ask
whether, when the CFTC discusses TransactionLevel Requirements, Category A as applied to
non-US SD/MSPs dealing with non-US persons,
does it mean to capture transactions with nonUS persons that are covered by (i) the technical
definition of the compound term (guarantee
arrangements defined without reference to
recourse, but with no affiliation needed—see
supra notes 60-61 and accompanying text), (ii)
the likely intended meaning of the compound
term (guarantee arrangements defined without reference to recourse, and with affiliation
required—this is supported by the text of the
press release), or (iii) the operative discussion
of the requirements in the Guidance itself
(guarantees providing for recourse, but with
no affiliation required—see Section 2 above)?
Commissioner Wetjen voted in favor of the
Guidance, but at the CFTC’s open meeting,
even he expressed concern about the process of
drafting the final regulatory product. See Transcript, CFTC Open Meeting to Consider CrossBorder Final Guidance and Cross-Border PhaseIn Exemptive Order (July 12, 2013) at 53 (“On
the technical corrections, we talked about this
a little bit. There might be a number of them,
given the short time frame that we’ve had to
have the staff draft all this up, so we look forward to continuing to work with the staff, and
we’ll get those changes based on our review
that reflect the agreement to the staff as quickly as possible.”), available at: http://www.cftc.
gov/ucm/groups/public/@swaps/documents/
dfsubmission/dfsubmission_071213-trans.pdf.
This was echoed in a comment by Chairman
Gensler. See id. at 104 (referring to “technical
corrections, which everybody will see as these
hours proceeded [sic] today, and maybe into
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February 2014 n Volume 34 n Issue 2
the weekend”). Commissioner O’Malia dissented from the CFTC’s adoption of the Guidance,
indicating that the CFTC’s actions were “woefully short” of “good process.” See Guidance,
Appendix 3, Dissenting Statement of Commissioner Scott D. O’Malia (July 12, 2013), 78 Fed.
Reg. 45374.
20
Futures & Derivatives Law Report
66.
Neither the CFTC’s Proposed Guidance in July
2012, nor the Further Proposed Guidance in
December 2012, used these concepts per se or
used similar concepts in the extensive manner
reflected in the Guidance. See Proposed Guidance; Further Proposed Guidance. See also supra note 31 and accompanying text.
© 2014 THOMSON REUTERS