# Cross-Border Application of the Registration Thresholds and External Business Conduct Standards Applicable to Swap Dealers and Major Swap Participants > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2016-24905 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** October 18, 2016 - **Citation:** 81 FR 71946 ## Text COMMODITY FUTURES TRADING COMMISSION 17 CFR Parts 1 and 23 RIN 3038-AE54 Cross-Border Application of the Registration Thresholds and External Business Conduct Standards Applicable to Swap Dealers and Major Swap Participants AGENCY: Commodity Futures Trading Commission. ACTION: Proposed rule; interpretations. SUMMARY: The Commodity Futures Trading Commission (“Commission” or “CFTC”) is publishing for public comment proposed rules and interpretations (“Proposed Rule”) addressing the cross-border application of certain swap provisions of the Commodity Exchange Act (“CEA”). Specifically, the proposed rule defines key terms for purposes of applying the CEA's swap provisions to cross-border transactions and addresses the cross-border application of the registration thresholds and external business conduct standards for swap dealers and major swap participants, including the extent to which they would apply to swap transactions that are arranged, negotiated, or executed using personnel located in the United States. DATES: Comments must be received on or before December 19, 2016. ADDRESSES: You may submit comments, identified by RIN number 3038-AE54, by any of the following methods: • CFTC Web site: http://comments.cftc.gov. Follow the instructions for submitting comments through the Comments Online process on the Web site. • Mail: Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. • Hand Delivery/Courier: Same as Mail, above. • Federal eRulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. Please submit your comments using only one method. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to http://www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act (“FOIA”), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the CFTC's regulations, 17 CFR 145.9. The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse or remove any or all of a submission from http://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the notice will be retained in the public comment file and will be considered as required under all applicable laws, and may be accessible under the FOIA. FOR FURTHER INFORMATION CONTACT: Paul Schlichting, Assistant General Counsel, (202) 418-5884, pschlichting@cftc.gov; Laura B. Badian, Assistant General Counsel, (202) 418-5969, lbadian@cftc.gov; or Elise Bruntel, Counsel, (202) 418-5577, ebruntel@cftc.gov; Office of the General Counsel, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. SUPPLEMENTARY INFORMATION: Table of Contents I. Background A. Scope of Rulemaking B. Current Market Structure II. Definitions A. U.S. Person B. Foreign Consolidated Subsidiary (“FCS”) III. ANE Transactions A. Background B. Commission's Views Regarding ANE Transactions C. Proposed Interpretation Regarding the Scope of ANE Transactions IV. Cross-Border Application of the Swap Dealer Registration Threshold A. U.S. Persons and U.S. Guaranteed Entities B. Foreign Consolidated Subsidiaries C. Other Non-U.S. Persons 1. U.S. Counterparties That Are U.S. Persons or U.S. Guaranteed Entities 2. Counterparties That Are FCSs 3. Other Non-U.S. Counterparties 4. Swaps Executed Anonymously on a SEF, DCM, or FBOT and Cleared D. Aggregation Requirement E. Summary V. Cross-Border Application of the Major Swap Participant Registration Thresholds A. U.S. Persons, U.S. Guaranteed Entities, and Foreign Consolidated Subsidiaries B. Other Non-U.S. Persons C. Attribution Requirement D. Summary VI. Cross-Border Application of the External Business Conduct Standards for Swap Dealers and Major Swap Participants VII. Related Matters A. Regulatory Flexibility Act B. Paperwork Reduction Act C. Cost-Benefit Considerations 1. Assessment Costs 2. Cross-Border Application of the Swap Dealer Registration Threshold a. U.S. Persons and U.S. Guaranteed Entities b. Foreign Consolidated Subsidiaries c. Other Non-U.S. Persons 3. Cross-Border Application of the Major Swap Participant Registration Thresholds 4. Monitoring Costs 5. Registration Costs 6. Programmatic Costs 7. Cross-Border Application of External Business Conduct Requirements 8. Section 15(a) Factors a. Protection of Market Participants and the Public b. Efficiency, Competitiveness, and Financial Integrity of the Markets c. Price Discovery d. Sound Risk Management Practices e. Other Public Interest Considerations 9. Appendix to Cost-Benefit Considerations VIII. Preamble Summary Tables Table A—Cross-Border Application of the Swap Dealer De Minimis Threshold Table B—Cross-Border Application of the Major Swap Participant Registration Thresholds Table C—Cross Border Application of the External Business Conduct Standards I. Background A. Scope of Rulemaking In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Dodd-Frank”) 1 amended the Commodity Exchange Act (“CEA”) 2 to establish a new regulatory framework for swaps. Added in the wake of the 2008 financial crisis, which highlighted the potential for cross-border swap activities to have a substantial impact on the U.S. financial system, the new swap provisions expressly apply to activities that have a direct and significant connection with activities in, or effect on, U.S. commerce or that contravene Commission rules or regulations necessary or appropriate to prevent evasion. 3 1 Public Law 111-203, 124 Stat. 1376 (2010). 2 7 U.S.C. 1 et seq. 3 See 7 U.S.C. 2(i). Section 2(i) of the CEA states that the provisions of that chapter relating to swaps that were enacted by the Wall Street Transparency and Accountability Act of 2010 (including any rule prescribed or regulation promulgated under that Act) shall not apply to activities outside the United States unless those activities (1) have a direct and significant connection with activities in, or effect on, commerce of the United States; or (2) contravene such rules or regulations as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of that chapter that was enacted by the Wall Street Transparency and Accountability Act of 2010. In response to requests from market participants, the Commission published a policy statement and interpretive guidance regarding the cross-border application of the swap provisions of the CEA. 4 The Guidance offered an interpretation of the term “U.S. person” and a general, non-binding framework for the cross-border application of many substantive Dodd-Frank requirements, including requirements for swap dealers (“SDs”) and major swap participants (“MSPs”) (collectively, “SD/MSPs”). Given the complex and dynamic nature of the global swap market, the Guidance was intended as a flexible and efficient way to provide the Commission's views on cross-border issues raised by commenters, allowing the Commission to adapt in response to changes in the global regulatory and market landscape. 5 The Commission accordingly stated that it would review and modify its cross-border policies as the global swaps market continues to evolve and consider codifying the cross-border application of Dodd-Frank swap provisions in future rulemakings, as appropriate. 6 4 See Interpretive Guidance and Policy Statement Regarding Compliance With Certain Swap Regulations, 78 FR 45292 (Jul. 26, 2013) (“Guidance”). 5 Id. at 45297, n.39. 6 See id. The Commission notes that at the time that the Guidance was adopted, it was tasked with regulating a market that grew to a global scale without any meaningful regulation. Developing a regulatory framework to fit that market is necessarily an iterative process, one that requires adapting and responding to rapid and continual changes in the market. Therefore, the Commission expects that this proposed rulemaking will be followed by additional rulemakings affecting the cross-border application of the Commission's swap regulations. In this release, the Commission is proposing to codify a central element of the Dodd-Frank regulatory framework for SDs and MSPs, incorporating various aspects of the Commission's recent cross-border rulemaking regarding the margin requirement, 7 including the definitions of “U.S. person” and “guarantee” and the concept of a Foreign Consolidated Subsidiary (“FCS”). Specifically, the Proposed Rule addresses when U.S. and non-U.S. persons, including FCSs and those whose swap obligations are guaranteed by a U.S. person, would be required to include their cross-border swap dealing transactions or swap positions in their SD or MSP registration threshold calculations, respectively, 8 and the extent to which SD/MSPs would be required to comply with the Commission's business conduct standards governing their conduct with swap counterparties (“external business conduct standards”) in cross-border transactions. 9 7 See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants—Cross-Border Application of the Margin Requirements, 81 FR 34818 (May 31, 2016) (“Cross-Border Margin Rule”). 8 See proposed rule § 1.3(ggg)(7) and 1.3(nnn). The SD and MSP registration thresholds are codified at 17 CFR 1.3(ggg)(4) and 1.3(hhh) through (mmm), respectively. 9 See proposed rule § 23.452. The Commission's external business conduct standards are codified in 17 CFR part 23, subpart H (17 CFR 23.400 through 23.451). The Proposed Rule also addresses issues related to a Commission request for comment on a 2013 staff advisory, which discussed the staff's view of the application of certain Dodd-Frank swap provisions to non-U.S. SDs if they use personnel located in the United States. 10 Specifically, the Proposed Rule addresses situations in which swap transactions are arranged, negotiated, or executed using personnel located in the United States (“ANE transactions”), including the types of activities that would fall within the scope of ANE transactions and the extent to which the SD registration threshold and external business conduct standards apply to ANE transactions. 10 See Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States, 79 FR 1347 (Jan. 8, 2014) (“Request for Comment”); CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (Nov. 14, 2013) (“Staff Advisory”), available at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-69.pdf. As stated therein, the Staff Advisory represented the views of the Division of Swap Dealer and Intermediary Oversight (“DSIO”) only, and not necessarily those of the Commission or any other office or division thereof. Id. at 2. As part of the proposed rule, the Commission is also proposing to define the key terms of “U.S. person” and “Foreign Consolidated Subsidiary” for broad cross-border application in a manner consistent with how the terms were defined in the Cross-Border Margin Rule. 11 If adopted, the Commission intends that these definitions would be relevant not only within the context of the proposed rule, but for purposes of any subsequent rulemakings specifically addressing the cross-border application of other substantive Dodd-Frank requirements, unless the context or a specific rule or regulation otherwise requires. The Commission believes that applying a single definition for these terms throughout the Commission's cross-border framework going forward would benefit market participants by eliminating complexity associated with the use of different definitions for different Dodd-Frank rules. 11 See proposed rule § 1.3(aaaaa); Cross-Border Margin Rule, 81 FR 34818; 17 CFR 23.160(a). The Proposed Rule does not address the cross-border application of any substantive Dodd-Frank requirements beyond the SD/MSP registration thresholds and external business conduct standards. The Commission expects to address the cross-border application of other Dodd-Frank requirements, including the availability of substituted compliance, in subsequent rulemakings. B. Current Market Structure In determining how the Commission's SD/MSP registration thresholds should apply to market participants in cross-border transactions and the extent to which the Dodd-Frank swap requirements should apply to ANE transactions, the Commission was informed by its understanding of the current market practices of global financial institutions. Financial groups that are active in the swap market typically operate in multiple market centers 12 and carry out swap activity with counterparties around the world using a number of different operational structures. A financial group's business model, including its booking practices and how it carries out market-facing activities, reflects a range of business and regulatory considerations, which are weighed differently by, and have different effects on, each group. 12 Data from swap data repositories (“SDR data”) indicate that the global swap market has several market centers, including New York, London, and Tokyo. Despite its geographic expanse, a global financial group effectively operates as a single business, with a highly integrated network of business lines and services conducted through various branches or affiliated legal entities that are under the control of the parent entity. While each branch or affiliate may serve a unique purpose, they are highly interdependent and inextricably linked, with affiliated entities within the corporate group providing financial or credit support for each other, such as in the form of a guarantee or the ability to transfer risk through inter-affiliate trades. 13 13 Even in the absence of an explicit arrangement or guarantee, the parent entity may, for reputational or other reasons, choose or be compelled to assume the risk incurred by its affiliates, branches, or offices located overseas. A financial group may reflect all of its swaps in the financial statements of one entity (the “booking entity”), realizing netting and operational benefits, a practice referred to as “central booking.” In this case, the booking entity retains all the risk associated with each swap, creating one swap portfolio. Alternatively, a financial group may book swaps in several different affiliates depending on the jurisdiction where the counterparty is located or, alternatively, where the financial group manages a particular type of risk or product. In the latter case, the swaps will be reflected in the financial statements of different affiliates. The risks related to the swaps, however, may not remain in the entity in which the swap is booked. Using arrangements such as inter-affiliate transactions or assignments, the risks related to a swap may be transferred to different entities within an affiliated group while the entity at which the swap is booked remains unchanged. 14 14 The extent to which swap risk may be transferred without changing the booking entity may depend on relevant accounting rules, legal requirements, and other factors. Swap activities may also be carried out through branches located in separate jurisdictions rather than, or in addition to, affiliates that are domiciled in separate jurisdictions. Regardless of a financial group's booking practices, it typically engages in sales or trading functions in one or more market centers. Performing sales and trading functions in global market centers provides the financial group with access to counterparties in that jurisdiction. The financial group's presence in a particular market center also enables the group to more effectively engage in swaps in that locale on behalf of affiliates in other jurisdictions that are servicing counterparties in those jurisdictions. 15 15 From discussions with market participants, the Commission understands that financial groups typically prefer to operate their swap businesses and manage swap portfolios in the jurisdiction where the swap and the underlying asset have the deepest and most liquid markets. In operating their swap dealing businesses in these market centers, financial groups seek to take advantage of expertise in products traded in those centers and obtain access to greater liquidity, permitting them to more efficiently price such products or otherwise compete more effectively in the global swap market, including in jurisdictions different from the market center in which the swap is traded. In this highly-integrated corporate structure, where financial groups engage in swap dealing activity with counterparties located in multiple jurisdictions, it is not uncommon for a swap to be traded through an affiliate in one jurisdiction (the “market-facing affiliate”) and booked and risk-managed in another (the “booking affiliate”). In such cases, a particular affiliate may become the market-facing affiliate because its trading desk has expertise in relevant products or because it has an established client network in the relevant jurisdiction or market hub. 16 However, although each affiliate carries out a distinct function in a given swap transaction, together they operate as an integrated dealing business. 16 The market-facing affiliate may in turn employ either its own personnel or the personnel of another affiliate or unaffiliated agent. Market-facing entities may use unaffiliated agents in order to conduct swap dealing activity anonymously or to provide clients with access to market hubs where they do not have their own operations. Large U.S. financial services firms emphasize the importance of operating globally through a unified structure. For example, Goldman Sachs explains that one of its core businesses “serves our clients who come to the firm to buy and sell financial products, raise funding and manage risk. We do this by acting as a market maker and offering market expertise on a global basis . . . . Through our global sales force, we maintain relationships with our clients, receiving orders and distributing investment research, trading ideas, market information and analysis. As a market maker, we provide prices to clients globally across thousands of products in all major asset classes and markets . . . . Much of this connectivity between the firm and its clients is maintained on technology platforms and operates globally wherever and whenever markets are open for trading.” 17 Morgan Stanley explains that it provides financial services to clients globally, primarily through subsidiaries incorporated in the U.S., Europe and Asia, and it “trades, invests and makes markets globally in listed swaps and futures and OTC cleared and uncleared swaps, forwards, options and other derivatives . . . .” 18 Citigroup, one of the largest U.S. bank holding companies, describes its global presence as “trading desks in over 30 countries and market access in 70 countries.” 19 Citigroup also states that it manages its risk exposures from its activities across all these countries via its “Centralized Risk Desk.” 20 17 See The Goldman Sachs Group, Inc. 2013 Annual Report on Form 10-K at 3 (describing Institutional Client Services business, which includes swaps and other derivatives trading), available at http://www.goldmansachs.com/investor-relations/financials/archived/10k/docs/2013-10-k.pdf. 18 See Morgan Stanley 2013 Annual Report on Form 10-K at 3, available at https://www.morganstanley.com/about-us-ir/shareholder/10k2013/10k2013.pdf. 19 See Global Equities, Citigroup, discussion of equities product line (accessed Sept. 29, 2016), available at http://www.citibank.com/icg/global_markets/product_solutions/global_equities/index.jsp. While this description is in the context of equities trading and not necessarily swaps, it illustrates the integrated nature of the global operations of these firms and their affiliates and subsidiaries in different countries. 20 See id. In sum, the current swap market is global in scale and characterized by a high level of interconnectedness among market participants, with transactions negotiated, executed, and arranged between counterparties in different jurisdictions, (and booked and managed in still other jurisdictions). These market realities suggest that a cross-border framework that focuses only on the domicile of the market participant or location of counterparty risk would fail to effectively advance the policy objectives of the Dodd-Frank swap reforms, which were aimed at increasing market transparency and counterparty protections and mitigating the risk of financial contagion in the swap market. 21 At the same time, the Commission is also mindful that its policy choices should aim to enhance market efficiency and competition and the overall functioning of the global swap market. Accordingly, as described in detail below, in developing the Proposed Rule the Commission has strived to implement a cross-border framework that would achieve the important goals of the Dodd-Frank Act while mitigating any unnecessary burdens and avoiding disruption to market practices to the extent possible. 21 Nor would such a framework be consistent with CEA section 2(i), which provides that Dodd-Frank's swap provisions and the Commission's regulations thereunder apply to cross-border transactions under certain circumstances. See Secs. Indus. & Fin. Mkts. Ass'n v. CFTC, 67 F. Supp. 3d 373, 425-26 & n.35 (D.D.C. 2014). II. Definitions The Commission is proposing to define the key terms of “U.S. person” and “Foreign Consolidated Subsidiary” for purposes of applying the Dodd-Frank swaps provisions to cross-border transactions. Whether a market participant is a U.S. person or a Foreign Consolidated Subsidiary would, for instance, affect how the SD/MSP registration thresholds apply under the proposed rule. 22 If adopted, these definitions would also be relevant for purposes of any subsequent rulemakings specifically addressing the cross-border application of other substantive Dodd-Frank requirements, unless the context or a specific rule or regulation otherwise requires. 22 Consistent with the reliance standard articulated in the Commission's external business conduct rules, see 17 CFR 23.402(d), market participants would be allowed to reasonably rely on counterparty representations with respect to each of these definitions unless they have information that would cause a reasonable person to question the accuracy of the representation. A. U.S. Person Under the Proposed Rule, a “U.S. person” would be defined as follows: • Any natural person who is a resident of the United States (proposed § 1.3(aaaaa)(5)(i)); • Any estate of a decedent who was a resident of the United States at the time of death (proposed § 1.3(aaaaa)(5)(ii)); • Any corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of entity similar to any of the foregoing (other than an entity described in proposed paragraph (aaaaa)(5)(iv) or (v) of § 1.3) (“legal entity”), in each case that is organized or incorporated under the laws of the United States or that has its principal place of business in the United States, including any branch of the legal entity 23 (proposed § 1.3(aaaaa)(5)(iii)); 23 The Commission notes that the reference in proposed § 1.3(aaaaa)(5)(iii) and (vi) (indicating that legal entities would include any branch of the legal entity) is intended to make clear that the definition includes both foreign and U.S. branches of an entity. The Commission further notes that a branch does not have a legal identity apart from its principal entity. The proposed language is not intended to introduce any additional criteria for determining an entity's U.S. person status. • Any pension plan for the employees, officers or principals of a legal entity described in proposed paragraph (aaaaa)(5)(iii) of § 1.3, unless the pension plan is primarily for foreign employees of such entity (proposed § 1.3(aaaaa)(5)(iv)); • Any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust (proposed § 1.3(aaaaa)(5)(v)); • Any legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners of the entity have limited liability) that is owned by one or more persons described in proposed paragraphs (aaaaa)(5)(i) through (v) of § 1.3 who bear(s) unlimited responsibility for the obligations and liabilities of the legal entity, including any branch of the legal entity (proposed § 1.3(aaaaa)(5)(vi)); and • Any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in proposed paragraphs (aaaaa)(5)(i) through (vi) of § 1.3 (proposed § 1.3(aaaaa)(5)(vii)). 24 24 See proposed rule § 1.3(aaaaa)(5). See also proposed rule § 1.3(aaaaa)(2) (defining “non-U.S. person” as any person that is not a U.S. person); 17 CFR 23.160(a)(10) (defining U.S. person for purposes of the Cross-Border Margin Rule). The Commission notes that an affiliate or a subsidiary of a U.S. person that is organized or incorporated in a non-U.S. jurisdiction would not be deemed a U.S. person solely by virtue of its affiliation with a U.S. person. As used herein, the term “U.S. counterparty” refers to a swap counterparty that is a “U.S. person” under the Proposed Rule. In line with commenter requests, this definition mirrors the definition of “U.S. person” recently adopted in the context of the Cross-Border Margin Rule. 25 As stated therein, the Commission believes that this definition offers a clear, objective basis for determining which individuals or entities should be identified as U.S. persons and that harmonizing with the definition in the Cross-Border Margin Rule is not only appropriate, but will reduce compliance costs for market participants in the long run. 25 See 17 CFR 23.160(a)(10). See also Cross-Border Margin Rule, 81 FR at 34823-24. Unless expressly stated otherwise herein, the description of the U.S. person definition in the Cross-Border Margin Rule, including the Commission's interpretation of the principal place of business test regarding funds, would also apply in the context of the Proposed Rule. The proposed U.S. person definition is generally consistent with the U.S. person interpretation set forth in the Guidance, with certain exceptions. 26 Notably, the proposed definition does not include a commodity pool, pooled account, investment fund, or other collective investment vehicle that is majority-owned by one or more U.S. persons (“U.S. majority-owned fund prong”). 27 The Commission understands that identifying and tracking a fund's beneficial ownership may pose a significant challenge in certain circumstances. Although the U.S. owners of such funds may be adversely impacted in the event of a counterparty default, the Commission believes that, on balance, the majority-ownership test should not be included in the definition of U.S. person. 28 In the interest of providing legal certainty, the proposed definition also does not include a catchall provision, thereby limiting the definition of “U.S. person” to persons enumerated in the rule. 29 26 See Guidance, 78 FR at 45308-17 (setting forth the interpretation of “U.S. person” for purposes of the Guidance). 27 See id. at 45313-14 (discussing the U.S. majority-ownership prong for purposes of the Guidance). The Guidance interpreted “majority-owned” in this context to mean the beneficial ownership of more than 50 percent of the equity or voting interests in the collective investment vehicle. See id. at 45314. 28 Note that a fund fitting within the majority U.S. ownership prong may also be a U.S. person within the scope of paragraph (iii) of the Proposed Rule (entities organized or having a principal place of business in the United States). As the Commission clarified in the Cross-Border Margin Rule, whether a pool, fund or other collective investment vehicle is publicly offered only to non-U.S. persons and not offered to U.S. persons would not be relevant in determining whether it falls within the scope of the proposed U.S. person definition. See Cross-Border Margin Rule, 81 FR at 34824 n.62. 29 See Guidance, 78 FR at 45316 (discussing the inclusion of the prefatory phrase “include, but not be limited to” in the interpretation of “U.S. person” in the Guidance). Finally, consistent with the Cross-Border Margin Rule, paragraph (vi) of the proposed U.S. person definition includes legal entities where one or more U.S. person owner(s) bear unlimited responsibility for the obligations and liabilities of the legal entity (“unlimited U.S. responsibility prong”). This paragraph represents a modified version of a similar concept from the Guidance, which interpreted “U.S. person” to include a legal entity “directly or indirectly majority-owned” by one or more U.S. person(s) that bear unlimited responsibility for the legal entity's liabilities and obligations. 30 Upon further consideration, the Commission believes that the amount of equity the U.S. owner(s) have in this legal entity would not be relevant because the U.S. person owner(s), by definition, serve as a financial backstop for all of the legal entity's obligations and liabilities regardless of whether they are majority or minority owners. 31 30 See id. at 45312-13 (discussing the unlimited U.S. responsibility prong for purposes of the Guidance). 31 See Cross-Border Margin Rule, 81 FR at 34823-24. In consideration of principles of international comity, the Commission proposes that the term “U.S. person” would not include international financial institutions. Consistent with Commission precedent, 32 the Commission interprets “international financial institutions” to include “international financial institutions” as defined in 22 U.S.C. 262r(c)(2) and institutions defined as “multilateral development banks” in the Proposal for the Regulation of the European Parliament and of the Council on OTC Derivative Transactions, Central Counterparties and Trade Repositories, Council of the European Union Final Compromise Text, Article 1(4a(a)) (March 19, 2012). 33 32 See Guidance, 78 FR at 45353 n.531 (incorporating the interpretation of “international financial institutions” included in Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” 77 FR 30596, 30692 n.1180 (May 23, 2012) (“Entities Rule”)). 33 The two definitions overlap but together include the following: The International Monetary Fund, International Bank for Reconstruction and Development, European Bank for Reconstruction and Development, International Development Association, International Finance Corporation, Multilateral Investment Guarantee Agency, African Development Bank, African Development Fund, Asian Development Bank, Inter-American Development Bank, Bank for Economic Cooperation and Development in the Middle East and North Africa, Inter-American Investment Corporation, Council of Europe Development Bank, Nordic Investment Bank, Caribbean Development Bank, European Investment Bank and European Investment Fund. Note that the International Bank for Reconstruction and Development, the International Finance Corporation and the Multilateral Investment Guarantee Agency are parts of the World Bank Group. The Commission's proposal is generally similar to the position adopted by the SEC, which excluded from its U.S. person definition the International Monetary Fund, the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans. See 17 CFR 240.3a71-3(a)(4)(iii); Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities; Republication, 79 FR 47278, 47306 (Aug. 12, 2014) (“SEC Cross-Border Rule”). Request for Comment. The Commission invites comment on all aspects of the Proposed Rule, including on whether and in what respects the Commission should further harmonize the U.S. person definition in the Proposed Rule to either the interpretation of U.S. person included in the Guidance or the U.S. person definition adopted by the Securities Exchange Commission (“SEC”) in rule 3a71-3(a)(4) under the Securities Exchange Act of 1934 (“Exchange Act”). 34 34 Exchange Act rule 3a71-3(a)(4), 17 CFR 240.3a71-3(a)(4), defines “U.S. person” to mean any natural person resident in the United States; any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States; any account (whether discretionary or non-discretionary) of a U.S. person; or any estate of a decedent who was a resident of the United States at the time of death. Exchange Act rule 3a71-3(a)(4) defines “principal place of business” to mean the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person. It also provides that, with respect to an externally managed investment vehicle, this location is the office from which the manager of the vehicle primarily directs, controls, and coordinates the investment activities of the vehicle. B. Foreign Consolidated Subsidiary (“FCS”) Under the Proposed Rule, the term “Foreign Consolidated Subsidiary” identifies a non-U.S. person that is consolidated for accounting purposes with an ultimate parent entity that is a U.S. person (a “U.S. ultimate parent entity”). Consistent with the Cross-Border Margin Rule, the proposed rule would define “Foreign Consolidated Subsidiary” to mean a non-U.S. person in which an ultimate parent entity that is a U.S. person has a controlling financial interest, in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”), such that the U.S. ultimate parent entity includes the non-U.S. person's operating results, financial position and statement of cash flows in the U.S. ultimate parent entity's consolidated financial statements, in accordance with U.S. GAAP. 35 The proposed rule would define the term “ultimate parent entity” to mean the parent entity in a consolidated group in which none of the other entities in the consolidated group has a controlling interest, in accordance with U.S. GAAP. 36 35 See proposed rule § 1.3(aaaaa)(1). See also 17 CFR 23.160(a)(1) (defining “Foreign Consolidated Subsidiary” for purposes of the Cross-Border Margin Rule). The Cross-Border Margin Rule defined the term “Foreign Consolidated Subsidiary” as limited to SDs and MSPs subject to the Commission's margin requirements (“Covered Swap Entities” or “CSEs”), using the term to distinguish non-U.S. CSEs with a U.S. ultimate parent entity from other non-U.S. CSEs. 81 FR at 34826-27. The proposed FCS definition similarly but more broadly distinguishes any non-U.S. person that is consolidated with a U.S. ultimate parent entity from other non-U.S. persons, regardless of whether it is a CSE. 36 See proposed rule § 1.3(aaaaa)(3). See also 17 CFR 23.160(a)(6) (defining “ultimate parent entity” for purposes of the Cross-Border Margin Rule). The proposed FCS definition offers a clear, bright-line test for identifying non-U.S. persons whose swap activities present a greater supervisory interest relative to other non-U.S. market participants, due to the nature and extent of the FCS's relationship with its U.S. ultimate parent. As described above, the nature of modern finance is such that large financial institutions typically conduct their business operations through a highly integrated network of business lines and services conducted through multinational branches or subsidiaries that are under the control of the ultimate parent entity. Under this structure, U.S. and non-U.S. derivatives trading functions as a single enterprise, using funds, risk management, information systems and trading personnel across the entire consolidated entity in the most efficient manner in effectuating coordinated trading strategies, with the profits and losses from global trading operations aggregated in the consolidated financial statements of the ultimate parent entity. The Commission believes that the FCS definition appropriately encompasses those entities within this consolidated group that are subject to the financial control, and directly impact the financials, of the U.S. ultimate parent entity. First, consolidation under U.S. GAAP is predicated on the financial control of the reporting entity. 37 Therefore, an entity within a financial group that is consolidated with its parent entity for accounting purposes in accordance with U.S. GAAP is subject to the financial control of that parent entity. Second, as the Commission previously stated, by virtue of consolidation with its parent entity's financial statement under U.S. GAAP, an FCS's swap activity creates direct risk to the U.S. parent. 38 That is, as a result of consolidation, the financial position, operating results, and statement of cash flows of an FCS are included in the financial statements of its U.S. ultimate parent and therefore affect the financial condition, risk profile, and market value of the parent. Because of that relationship, risks taken by FCSs can have a direct effect on the U.S. ultimate parent entity. Furthermore, the FCS's counterparties generally look to both the FCS and its U.S. ultimate parent for fulfillment of the FCS's obligations under the swap, even without any explicit guarantee. 39 In many cases, the Commission believes that the counterparty would not enter into the transaction with the subsidiary (or would not do so on the same terms), and the subsidiary would not be able to engage in a swaps business, absent this close relationship with the parent entity. 37 There are two consolidation models. First, entities are subjected to the variable interest entity (`VIE') model. If the VIE model is not applicable, then entities are subjected to the voting interest model. Under the VIE model, a reporting entity has a controlling financial interest in a VIE if it has: (a) The power to direct the activities of the VIE that most significantly affect the VIE's economic performance, and (b) the obligation to absorb losses or the right to receive benefits that could be significant to the VIE. Under the voting interest model, a controlling financial interest generally exists if a reporting entity has a majority voting interest in another entity. In certain circumstances, the power to control may exist when one entity holds less than a majority voting interest ( e.g., because of contractual provisions or agreements with other shareholders). See Financial Accounting Standards Board, Accounting Standards Codification 810, Consolidation . 38 Cross-Border Margin Rule, 88 FR at 34826-27. 39 As Moody's Ratings states in a description of its bank assessment methodology, “most [financial] groups can be expected to support banking entities within their consolidation.” See Moody's Investors Service, Cross-Border Application of the Swap Dealer De Minimis Exception (Sept. 9, 2014) at 66, available at https://www.moodys.com/microsites/gbrm2014/RFC.pdf . Under these circumstances, the Commission believes that it is appropriate to require FCSs to include relevant swaps for the SD/MSP registration calculation like a U.S. person (and U.S. Guaranteed Entity). 40 A failure to treat these entities the same in this context could provide a U.S. financial group with an opportunity to avoid SD or MSP registration by conducting relevant swap activities through unregistered entities. However, as in the Cross-Border Margin Rule, the Commission would not necessarily treat FCSs the same as a U.S. person (or U.S. Guaranteed Entity) in the context of other Dodd-Frank swap provisions. 41 The Commission also recognizes that other affiliates, even though they are not consolidated with the U.S. ultimate parent entity for accounting purposes, could likewise be distinguished from other non-U.S. persons given the nature of their relationship with the U.S. person and the U.S. market. 42 The Commission believes that the consolidation test provides a workable definition that is tailored to focus on those affiliates that present greater supervisory concerns (relative to other non-U.S. persons). 40 The Commission notes that there are some important differences between a U.S. Guaranteed Entity and an FCS. See Cross-Border Margin Rule, 81 FR at 34827 (noting that, in contrast to U.S. Guaranteed CSEs, in the event of an FCS's default, the U.S. ultimate parent entity does not have a legal obligation to fulfill the obligations of the FCS. Rather that decision would depend on the business judgment of its parent). See also supra note 35 (describing the definition of FCS in the context of the Cross-Border Margin Rule). 41 Although the proposed rule is focused on the cross-border application of the registration thresholds and external business conduct standards for SD/MSPs, the Commission expects to address how other substantive Dodd-Frank swap requirements (including the trading and clearing mandates and reporting requirements) would apply to FCSs in cross-border transactions in subsequent rulemakings. In doing so, the Commission will give due consideration to whether, and the extent to which, substituted compliance should be made available to FCSs' swap transactions. 42 In particular, the Commission recognizes that, even absent consolidated financial statements, a U.S. parent entity may, for reputational reasons, determine that they must support their non-U.S. affiliates at times of crisis, with direct risk implications for the U.S. parent and U.S. market. Request for Comment. The Commission seeks comment on all aspects of the Proposed Rule's definition of “Foreign Consolidated Subsidiary” including on whether the proposed FCS definition appropriately captures persons that raise greater supervisory concerns relative to other non-U.S. persons whose swap obligations are not guaranteed by a U.S. person. If not, please explain and provide an alternative(s). III. ANE Transactions A. Background In November 2013, DSIO issued a staff advisory providing that a non-U.S. swap dealer that regularly uses personnel or agents located in the United States to arrange, negotiate, or execute a swap with a non-U.S. person (“Covered Transactions”) would generally be required to comply with the “Transaction-Level Requirements,” as the term was used in the Guidance. 43 In January 2014, the Commission published a request for comment on all aspects of the Staff Advisory, including (1) the scope and meaning of the phrase “regularly arranging, negotiating, or executing” and what characteristics or factors distinguish “core, front-office” activity from other activities; (2) whether the Commission should adopt the Staff Advisory as Commission policy, in whole or in part; and (3) whether substituted compliance should be available for non-U.S. swap dealers with respect to Covered Transactions. 44 43 See supra note 10. See also Guidance, 78 FR at 45333 (providing that the Transaction-Level Requirements include (i) Required clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) mandatory trade execution; (iv) swap trading relationship documentation; (v) portfolio reconciliation and compression; (vi) real-time public reporting; (vii) trade confirmation; (viii) daily trading records; and (ix) external business conduct standards). 44 See Request for Comment, 79 FR at 1348-49. The Commission received seventeen comment letters in response to the Request for Comment. 45 Most commenters challenged the Staff Advisory as inconsistent with CEA section 2(i) 46 or international comity. 47 They emphasized that the risk associated with Covered Transactions lies outside the United States 48 and that non-U.S. swap dealers involve U.S. personnel primarily for the convenience of their global customers. 49 They also characterized the Staff Advisory as impractical or unworkable, describing its key language (“regularly arranging, negotiating, or executing swaps” and “performing core, front-office activities”) as vague, open to broad interpretation, and potentially capturing activities that are merely “incidental” to the swap transaction. 50 They further argued that if the Staff Advisory were adopted as Commission policy, non-U.S. swap dealers would close U.S. branches and relocate personnel to other countries (or otherwise terminate agency contracts with U.S.-based agents) in order to avoid Dodd-Frank swap regulation or having to interpret and apply the Staff Advisory, thereby increasing market fragmentation. 51 45 See American Bankers Association Securities Association (“ABASA”) (Mar. 10, 2014); Americans for Financial Reform (“AFR”) (Mar. 10, 2014); Barclays Bank PLC (“Barclays”) (Mar. 10, 2014); Chris R. Barnard (“Barnard”) (Mar. 8, 2014); Better Markets Inc. (“Better Markets”) (Mar. 10, 2014); Coalition for Derivatives End-Users (“Coalition”) (Mar. 10, 2014); Commercial Energy Working Group (“CEWG”) (Mar. 10, 2014); European Commission (Mar. 10, 2014); European Securities and Markets Authority (“ESMA”) (Mar. 13, 2014); Institute for Agriculture and Trade Policy (“IATP”) (Mar. 10, 2014); Institute of International Bankers (“IIB”) (Mar. 10, 2014); International Swaps and Derivatives Association, Inc. (“ISDA”) (Mar. 7, 2014); Investment Adviser Association (“IAA”) (Mar. 10, 2014); Japanese Bankers Association (“JBA”) (Mar. 7, 2014); Japan Financial Markets Council (“JFMC”) (Mar. 4, 2014); Securities Industry and Financial Markets Association, Futures Industry Association, and Financial Services Roundtable (“SIFMA/FIA/FSR”) (Mar. 10, 2014); Société Générale (“SG”) (Mar. 10, 2014). The associated comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1452&ctl00_ctl00_cphContentMain_MainContent_gvCommentListChangePage=1_50 . Although the comment file includes records of 22 comments, five were either duplicate submissions or not responsive to the Request for Comment. 46 See, e.g., IAA at 2 n.4; IIB at 4-5 (transactions between two non-U.S. persons present no risk to the U.S. financial system and therefore do not have a “direct and significant” nexus to U.S. commerce); ISDA at 3-4, 10-13 (challenging the Commission's interpretation of “direct and significant”); JFMC at 3; SIFMA/FIA/FSR at A-2-A-3 (section 2(i) should be interpreted in light of the Dodd-Frank goal of mitigating risk); SG at 8. Accord European Commission (the Staff Advisory does not clearly articulate how the standard it sets out is consistent with section 2(i)). 47 See, e.g., European Commission at 2 (the unavailability of substituted compliance would seem to depart from the G20 commitment to defer to foreign regulators when appropriate); IIB at 5-6; ISDA at 8-9; IAA at 4 (failure to grant substituted compliance reflects a lack of coordination with foreign regulators, leading to a less efficient use of regulatory resources and the potential for duplicative or conflicting regulations); JFMC at 3; SIFMA/FIA/FSR at A-13. 48 See, e.g., Barclays at 3 n.11; IIB at 4-5; ISDA at 6-7; SIFMA/FIA/FSR at 2, A-9-A-10; SG at 2 (adopting the Staff Advisory would extend the Commission's regulations “to swaps whose risk lies totally offshore” and that do not pose a high risk to the U.S. financial system). 49 See, e.g., Coalition at 2 (non-U.S. SDs use U.S. personnel to arrange, negotiate, or execute swaps because they have particular subject matter expertise for or due to the location of their clients across time zone); European Commission at 1; IIB at 7-8 n.18; IAA at 2; ISDA at 4; JFMC at 2-3; SIFMA/FIA/FSR at A-4; SG at 3 (a non-U.S. SD may use salespersons in the United States if the Covered Transaction is linked to a USD instrument). 50 See, e.g., Barclays at 4-5; European Commission at 3 (whether negotiation of a Master Agreement by U.S. middle office staff would trigger application of the Staff Advisory is unclear); IAA at 5 (“[T]he terms `arranging' and `negotiating' are overly broad and may encompass activities that are incidental to a swap transaction,” such as providing market or pricing information); SIFMA/FIA/FSR at A-12 (arranging and negotiating trading relationships and legal documentation are “middle- and back-office operations” and should not be included); SG at 7-8 (“regularly” is an arbitrary concept that cannot be made workable, and programming trading systems to interpret “arranging, negotiating, or executing” on a trade-by-trade basis would not be feasible). 51 See, e.g., ABASA at 2 (adopting the Staff Advisory would “impose unnecessary compliance burdens on swap market participants, encourage them to re-locate jobs and activities outside the United States to accommodate non-U.S. client demands, and fragment market liquidity”); Coalition at 3 (emphasizing the impact on non-U.S. affiliates of U.S. end users, such as increased hedging costs and reduced access to registered counterparties); IIB at 7-8; ISDA at 4; JFMC at 3; SG at 8-9. See also IAA at 3 (expressing concern that non-U.S. clients may avoid hiring U.S. asset managers to avoid application of the Staff Advisory). A few commenters, however, supported the Staff Advisory. 52 They argued that the Commission has jurisdiction over swap activities occurring inside the United States 53 and expressed concern that the Commission's failure to assert such jurisdiction would create a substantial loophole, allowing U.S. financial firms to operate in the United States without Dodd-Frank oversight by merely routing swaps through a non-U.S. affiliate. 54 They further argued that arranging, negotiating, or executing swaps are functions normally performed by brokers, traders, and salesperson and are “economically central to the business of swap dealing.” 55 They added the focus on the “regular” use of personnel located in the United States to perform such core dealing activities would exclude “entirely incidental” interactions with U.S. personnel from triggering Dodd-Frank oversight. 56 52 See AFR; Better Markets; IATP. 53 See AFR at 2 (CEA section 2(i) clearly sets the statutory jurisdiction of CFTC rules to include all activities conducted inside the United States); Better Markets at 3 (the Staff Advisory “represents the only reasonable interpretation of Congress's mandate to regulate swaps transactions with a `direct and significant connection with activities in, or effect on, commerce of the United States'”); IATP at 1 (“It should be self-evident that the swaps activities in the United States of non-U.S. persons fall under the Commission's jurisdiction.”). 54 See AFR at 3 (failure to adopt the Staff Advisory “could mean that U.S. firms operating in the U.S. would face different rules for the same transactions as compared to competitor firms also operating in the very same market and location, perhaps literally next door, who had arranged to route transactions through a nominally foreign subsidiary”); Better Markets at 3 (allowing registered swap dealers to book transactions overseas but otherwise handle the swap inside the United States would “create a gaping loophole,” resulting in “keystroke off-shoring of the bookings, but otherwise the on-shoring of the core activities associated with the transaction”). 55 See AFR at 2-3, 5; Better Markets at 5 (brokers, structurers, traders, and salesmen “collectively comprise the general understanding of the core front office”). 56 See AFR at 2-3, 5 (terms “`arranging, negotiating, or executing' would appear to exclude purely clerical and incidental functions such as notating or recording the sale of a swap for consolidated risk management or bookkeeping purposes”). See also id. at 5 (definition of “regularly” should be tied to an expectation that U.S. personnel are available on request to arrange, negotiate, and execute swaps). Commenters that disagreed with the Staff Advisory nevertheless offered a few suggestions for its modification, should the Commission determine to adopt it, including offering substituted compliance for Covered Transactions 57 or otherwise limiting the scope of applicable requirements. 58 Certain commenters, for instance, recommended that the applicable requirements be limited to pre-trade disclosure requirements ( e.g., disclosure of material information), arguing that applying relationship-wide external business conduct rules would require wholesale amendments to relationship documentations even where the specific communication is not material to the overall trading relationship. 59 57 See, e.g., Coalition at 5; ESMA at 1; IAA at 3-4; ISDA at 9-10; SIFMA/FIA/FSR at A-13, SG at 6-7. 58 See, e.g., Barclays at 3 n.11 (transaction-level requirements focused on risk mitigation, market integrity, or transparency should not apply to Covered Transactions); Barnard at 2 (transaction-level requirements should not apply to Covered Transactions with non-U.S. counterparties that are not guaranteed or conduit affiliates); IIB at 9-10. 59 See, e.g., Barclays at 3 (“Applying the pre-trade disclosure requirements promotes the Commission's interests in regulating activities of U.S. based personnel or agents of Commission registered entities and in protecting counterparties. Such concerns may be raised by the activities of such individuals even if the risk arising from those swaps transactions is borne by entities outside the United States.”); IIB at 10-12 (“Non-U.S. counterparties may reasonably expect the protection of the sales practice rules applicable in the jurisdiction of the personnel responsible for committing the non-U.S. swap dealer to the swap.”); SIFMA/FIA/FSR at A-10-A-12 (“[O]nly direct communications by personnel located in the United States with counterparties that commit the SD to the execution of the transaction should trigger application of the requirements under the Staff Advisory.” (Emphasis omitted)). B. Commission's Views Regarding ANE Transactions After considering the views of commenters on the Staff Advisory in response to the Commission's Request for Comment, the Commission is setting forth its views on whether persons engaged in ANE transactions or transactions arising from this activity fall within the scope of the Dodd-Frank Act. The Commission's analysis is guided by the definition of “swap dealer” under the CEA and Commission regulations. Under both the CEA and Commission regulations, whether a person is a “swap dealer” is a functional test that focuses on whether the person engages in particular types of activities involving swaps. 60 In general, the swap dealer definition encompasses persons that engage in any of the following types of activity: (1) Holding oneself out as a dealer in swaps; (2) making a market in swaps; (3) regularly entering into swaps with counterparties as an ordinary course of business for one's own account; or (4) engaging in any activity causing oneself to be commonly known in the trade as a dealer or market maker in swaps. 61 Commission regulations further define the term to include specific activities indicative of acting as a swap dealer, such as (1) providing liquidity by accommodating demand for or facilitating interest in the swap, holding oneself out as willing to enter into swaps, or being known in the industry as being available to accommodate demand for swaps; (2) advising a counterparty as to how to use swaps to meet the counterparty's hedging goals, or structuring swaps on behalf of a counterparty; (3) having a regular clientele and actively advertising or soliciting clients in connection with swaps; (4) acting in a market maker capacity on an organized exchange or trading system for swaps, and (5) helping to set the prices offered in the market rather than taking those prices, although the fact that a person regularly takes the market price for its swaps does not foreclose the possibility that the person may be a swap dealer. 62 Neither the statutory definition of “swap dealer” nor the Commission's further definition of that term turns solely on risk to the U.S. financial system. Consistent with the focus of the “swap dealer” definition on a person's activity, the Commission does not believe that the location of counterparty credit risk associated with a dealing swap—which, as discussed above, is easily and often frequently moved across the globe—should be determinative of whether a person's dealing activity falls within the scope of the Dodd-Frank Act or whether the Commission has a regulatory interest in the dealing activity. The appropriate inquiry also considers whether a non-U.S. person is engaged in the United States in any of the indicia of dealing activity set forth in the definition of “swap dealer.” 60 See 7 U.S.C. 1a(49); 17 CFR 1.3(ggg); Entities Rule, 77 FR at 30598. 61 See Entities Rule, 77 FR at 30597; 7 U.S.C. 1a(49)(A); 17 CFR 1.3(ggg)(1). 62 See Entities Rule, 77 FR at 30608. In the Commission's view, and as further explained below, arranging, negotiating, or executing swaps are functions that fall within the scope of the “swap dealer” definition. That the counterparty risks may reside primarily outside the United States is not determinative. To the extent that a person uses personnel located in the United States (whether its own personnel or personnel of an agent) to arrange, negotiate, or execute its swap dealing transactions, the Commission believes that such person is conducting a substantial aspect of its swap dealing activity within the United States and therefore, falls within the scope of the Dodd-Frank Act. The Commission further believes that to the extent that ANE transactions raise regulatory concerns of the type that the Dodd-Frank Act is intended to address, applying specific Dodd-Frank swap requirements to ANE transactions may be appropriate. In establishing a comprehensive regulatory regime for swaps under the Dodd-Frank Act, Congress intended to advance several fundamental policy objectives, including reducing risk, increasing market transparency and promoting market integrity within the financial system. A person that, in connection with its dealing activity, engages in market-facing activity using personnel located in the United States is conducting a substantial aspect of its dealing business in the United States. 63 Even if the financial risks are borne by entities residing outside the United States, this activity indicates a level of involvement, and intention to participate, in the U.S. swap market that may raise concerns regarding customer protection, market transparency and financial contagion intended to be addressed by the Dodd-Frank Act. Accordingly, it would undermine the policy objectives of the Dodd-Frank Act to deem persons that, in connection with their dealing activity, engage in ANE transactions or transactions arising from this activity to fall entirely outside the scope of the Dodd-Frank Act solely because the transactions involve two non-U.S. counterparties. 63 As discussed above, the financial group affiliate may use the trading desk of an affiliate that possesses expertise in relevant products or personnel of an affiliate with an established client network in relevant market hubs. The financial group affiliate may also use the personnel of an unaffiliated agent to conduct its swap dealing activity, typically where it is seeking to trade anonymously or to provide clients with access to market hubs where it does not have its own operation. In making a determination as to whether a particular Dodd-Frank swap requirement (including those specifically applicable to swap dealers) should apply to an ANE transaction, the Commission would consider the extent to which the underlying regulatory objectives would be advanced in light of other policy considerations, including the potential for undue market distortions and international comity. As indicated above, the Proposed Rule addresses the application of the SD registration threshold and external business conduct standards to ANE transactions. The Commission intends to address application of other Dodd-Frank swap requirements to ANE transactions in subsequent cross-border rulemakings as necessary and appropriate. C. Proposed Interpretation Regarding the Scope of ANE Transactions For purposes of the proposed rule, the Commission uses the terms “arrange” and “negotiate” to refer to market-facing activity normally associated with sales and trading, as opposed to internal, back-office activities, such as ministerial or clerical tasks, performed by personnel not involved in the actual sale or trading of the relevant swap. 64 Accordingly, the terms would not encompass activities such as swap processing, preparation of the underlying swap documentation (including negotiation of a master agreement and related documentation), or the mere provision of research information to sales and trading personnel located outside the United States. In line with Commission precedent, “executed” would refer to the market-facing act of becoming legally and irrevocably bound to the terms of the transaction under applicable law. 65 64 A swap transaction may be “arranged” by personnel located in the United States regardless of whether the counterparty initiated the transaction or whether the counterparty's business was solicited. 65 Cf. 17 CFR 23.200(e) (defining “execution” to mean an agreement by the parties (whether orally, in writing, electronically, or otherwise) to the terms of a swap that legally binds the parties to such swap terms under applicable law); 23.200(d) (further defining “executed” to mean the completion of the execution process). In applying the proposed rule, the Commission would look to the activities of personnel assigned to (on an ongoing or temporary basis) or regularly working in a U.S. location. 66 Such personnel may be working directly for the dealing entity itself or a third-party that is acting for or on behalf of ( i.e., as an agent of) the dealing entity, including a U.S. affiliate of the dealing entity. The proposed definition would also include the market-facing activity of personnel normally associated with sales and trading even if the personnel are not formally designated as sales persons or traders. As an anti-evasionary measure, a transaction would be viewed as falling within the scope of the Dodd-Frank Act if personnel located in the United States direct other personnel to arrange, negotiate, or execute the transaction for or on behalf of a dealing entity. 66 The Proposed Rule would accordingly not capture the activities of personnel assigned to a non-U.S. location if such personnel are only incidentally present in the United States when they arrange, negotiate, or execute a transaction ( e.g., an employee of a non-U.S. person happens to be traveling within the United States to attend a conference). Nor would the Proposed Rule include a transaction solely on the basis that a U.S.-based attorney is involved in negotiations regarding the terms of the transaction. Swap transactions arranged, negotiated, or executed by personnel located in the United States implicate the Commission's supervisory interests regardless of the reason such U.S. personnel were involved. For example, a swap would not fall outside the scope of the Dodd-Frank Act because a counterparty sought to enter into the swap outside of its jurisdiction's regular trading hours. Additionally, the Commission believes permitting such an exception would only incentivize dealing entities to wait until after hours to enter into a swap, creating the potential for a substantial loophole. Finally, as the SEC noted in its cross-border rulemaking addressing ANE transactions, the Commission would not view a swap as falling outside the scope of the ANE transactions solely as a result of algorithmic trading. 67 That is, a swap transaction involving algorithmic trading could be viewed as having been arranged, negotiated, or executed using personnel located in the United States if such personnel specify the trading strategy or techniques carried out through algorithmic trading or automated electronic execution of swaps. 68 Therefore, performance of such activity by personnel located in the United States may fall within the scope of the Dodd-Frank Act and trigger the application of certain swap requirements thereunder. 67 See Security-Based Swap Transactions Connected With a Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent; Security-Based Swap Dealer De Minimis Exception, 81 FR 8598, 8623 (Feb. 19, 2016) (“SEC ANE Rule”). The Commission would also not view a swap as falling outside the scope of ANE transactions because it resulted from automated electronic execution. 68 The activities or location of personnel responsible solely for coding the algorithm, however, as opposed to specifying the trading strategy or techniques that the algorithm is to follow, would not be relevant. The Commission's proposed approach to the determination of when a swap is an ANE transaction reflects its consideration of the comments received in response to the Request for Comment and is generally aligned with the SEC's approach to this determination in the context of security-based swaps. 69 In response to commenters and in the interest of aligning with the SEC, to the extent that the proposed rule applies to ANE transactions, application of the proposed rule would not be limited to swaps “regularly” arranged, negotiated, or executed using U.S. personnel. Accordingly, a dealing entity may need to establish operational structures to identify swaps for which relevant personnel performing market-facing activity in connection with the transaction are located in the United States. The Commission believes, however, that the proposed rule's focus on personnel assigned to or regularly working in a U.S. location would exclude incidental activity and mitigate the burden of such an analysis, as the Commission expects that market participants have means of identifying personnel involved in market-facing activity, either for regulatory compliance purposes or to facilitate compensation. 70 The Commission further expects that, to the extent that the Proposed Rule applies to ANE transactions, additional burdens on potential SDs could be reduced given that the Commission's proposed approach to determining whether a swap falls within the scope of ANE transactions is substantively identical to the SEC's approach to ANE transactions. 71 69 See supra note 67. 70 Dealing entities may also facilitate their compliance by establishing appropriate policies and procedures, including by requiring dealing activity to be arranged, negotiated, and executed by personnel located outside the United States. 71 One commenter on the SEC's proposed approach, which closely tracked its final rule, observed that it created “a definable standard that will bring clarity to the application of security-based swap requirements to security-based swap dealers, and is appropriate and consistent with the expectations of the parties as to when U.S. security-based swap requirements will apply.” SIFMA/FSR (SEC July 13, 2015) at 2 (stating also that the commenters “strongly believe that the Commission has taken the correct approach in focusing on market-facing activity of sales and trading personnel in defining the `arrange, negotiate, or execute' nexus that subjects security-based swap activity to the Commission's regulations based on location of conduct”). The Commission's treatment of ANE transactions is intended to capture activity that raises a substantial regulatory interest while still promoting a framework that is clear and workable for market participants. By focusing on market-facing activity carried out by personnel located in the United States, the Commission believes its interpretation adequately captures the Commission's inherently strong regulatory interest in dealing activity occurring within its jurisdiction while enabling market participants to apply the definition in a relatively efficient manner. Request for Comment. The Commission invites comment on all aspects of the Proposed Rule, including the following: 1. The Commission invites comment on whether its interpretation of ANE transactions is appropriately tailored to capture activity that raises a substantial regulatory interest and sufficiently clear and workable for market participants. Is the Commission's focus on and discussion of market-facing activity understandable and effective in excluding activities that are merely incidental to the swap transaction? Will the Commission's interpretation pose any operational challenges? Please explain and provide specific recommendations for modifications or clarifications. 2. Under what other circumstances, if any, should the Commission determine that U.S. personnel are directing a system for the algorithmic trading within the scope of its interpretation of ANE transactions? IV. Cross-Border Application of the Swap Dealer Registration Threshold In accordance with CEA section 1a(49)(D), the Commission has exempted from designation as an SD any entity that engages in a de minimis quantity of swap dealing with or on behalf of its customers. 72 Specifically, Commission regulation 1.3(ggg)(4) provides that a person shall not be deemed to be an SD as a result of its swap dealing activity involving counterparties unless, during the preceding 12 months, the aggregate gross notional amount of the swap positions connected with those dealing activities exceeds the de minimis threshold. 73 Commission regulation 1.3(ggg)(4) further requires that, in determining whether its swap dealing activity exceeds the de minimis threshold, a person must include the aggregate notional value of the swap positions connected with the dealing activities of its affiliates under common control (“aggregation requirement”). 74 72 See 7 U.S.C. 1a(49)(D) (directing the Commission to establish a de minimis exception from the SD definition). See also 17 CFR 1.3(ggg)(4); Entities Rule, 77 FR 30596. 73 See 17 CFR 1.3(ggg)(4)(i)(A). The de minimis threshold is currently set at a phase-in level of $8 billion, with an ultimate threshold of $3 billion. Pursuant to Commission regulation 1.3(ggg)(4)(ii), following publication of a staff report on the de minimis exception, the Commission may either terminate the phase-in level, and thereby institute the $3 billion threshold, or propose an alternative threshold through rulemaking. See 17 CFR 1.3(ggg)(4)(ii). Commission staff published for public comment a preliminary report on the de minimis exception in November 2015, with comments due by January 19, 2016. See Swap Dealer De Minimis Exception Preliminary Report (Nov. 18, 2015), available at http://www.cftc.gov/idc/groups/public/@swaps/documents/file/dfreport_sddeminis_1115.pdf. The comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1634. Note that Commission regulation 1.3(ggg)(4) also contains separate de minimis exceptions related to transactions in which the counterparty is a “special entity” or “utility special entity.” See 17 CFR 1.3(ggg)(4)(i)(A)-(B). See also 17 CFR 1.3(ggg)(6) (identifying swaps that are not considered in determining whether a person is a swap dealer). 74 See 17 CFR 1.3(ggg)(4)(i)(A). For purposes of the Proposed Rule, the Commission construes “affiliates under common control” by reference to the Entities Rule, which defined control as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise. See 77 FR at 30631 n.437. Accordingly, any reference in the Proposed Rule to “affiliates under common control” with a person would include affiliates that are controlling, controlled by, or under common control with such person. The Commission is now proposing rules to address how the de minimis threshold should apply to the cross-border swap dealing transactions of U.S. and non-U.S. persons. 75 Specifically, the proposed rule identifies when a potential SD's cross-border dealing activities should be included in its de minimis calculation and when they may properly be excluded. As discussed in the sections below, whether a potential SD would include a particular swap in its de minimis calculation would depend on whether the potential SD is classified as either a U.S. person or a non-U.S. person whose obligations under the relevant swap are guaranteed by a U.S. person (“U.S. Guaranteed Entity”) 76 (section A); a Foreign Consolidated Subsidiary (section B); or a non-U.S. person that is neither an FCS nor a U.S. Guaranteed Entity (“Other Non-U.S. Person”) (section C). Section D addresses the cross-border application of the aggregation requirement. Section E provides an overall summary of the Commission's proposed approach. If adopted, the Proposed Rule would supersede the Guidance with respect to the cross-border application of the SD de minimis threshold. 75 See proposed rule § 1.3(ggg)(7). 76 The preamble of this release uses the term “U.S. Guaranteed Entity” for convenience only. Whether a non-U.S. person would be considered a U.S. Guaranteed Entity would vary on a swap-by-swap basis, such that a non-U.S. person may be considered a U.S. Guaranteed Entity for one swap and not another, depending on whether the non-U.S. person's obligations under the swap are guaranteed by a U.S. person. In developing the proposed cross-border approach to applying the SD and MSP registration thresholds, 77 the Commission attempted to target those entities that—due to the nature of their relationship with a U.S. person or U.S. financial market—most directly implicate the purposes of the Dodd-Frank registration scheme. The proposed rule is also designed to apply the registration thresholds in a consistent manner to differing organizational structures that serve similar economic functions so as to avoid creating substantial regulatory loopholes. At the same time, the Commission is mindful of the impact of its choices on market efficiency and competition, as well as the importance of international comity when exercising the Commission's authority. The Commission believes that the proposed rule reflects a measured approach that advances the goals underlying the SD and MSP registration schemes, consistent with the Commission's statutory authority, while mitigating market distortions and inefficiencies. 77 See section V, infra, for a discussion of the Commission's proposed cross-border approach to applying the MSP registration thresholds. A. U.S. Persons and U.S. Guaranteed Entities Under the Proposed Rule, a U.S. person would include all of its swap dealing transactions in its de minimis threshold calculation without exception. As discussed in section II.A above, the term “U.S. person” encompasses a person who, by virtue of being domiciled or organized in the United States (or in the case of the unlimited U.S. responsibility prong, because U.S. person owner(s) serve as a financial backstop for all of the legal entity's obligations and liabilities), raises the concerns intended to be addressed by the Dodd-Frank Act, regardless of the U.S. person status of its counterparty. Additionally, a person's status as a U.S. person would be determined at the entity level and thus a U.S. person would include the swap dealing activity of foreign branches or operations that are part of the same legal person. The Commission notes that the proposed rule's requirement that a U.S. person include all of its swap dealing transactions in its de minimis calculation is consistent with the Guidance. 78 78 See Guidance, 78 FR at 45326. The proposed rule would also require a non-U.S. person that is not an FCS to include in its de minimis calculation swap dealing transactions with respect to which it is a U.S. Guaranteed Entity. The Commission believes that this result is appropriate because the swap of a non-U.S. person whose swap obligations are guaranteed by a U.S. person is identical, in relevant aspects, to a swap entered into directly by a U.S. person. 79 As a result of the guarantee, the U.S. guarantor bears risk arising out of the swap as if it had entered into the swap directly. The U.S. guarantor's financial resources in turn enable the non-U.S. affiliate to engage in dealing activity, because the affiliate's counterparties will look to both the U.S. Guaranteed Entity and its U.S. guarantor to ensure performance of the swap. Absent the guarantee from the U.S. person, a counterparty may choose not to enter into the swap or may not do so on the same terms. In this way, the U.S. Guaranteed Entity and the U.S. guarantor effectively act together to engage in the dealing activity. 79 For purposes of this proposed rulemaking, “guarantee” has the same meaning as defined in Commission regulation 23.160(a)(2) (cross-border application of the Commission's margin requirements for uncleared swaps), except that application of the proposed definition of “guarantee” would not be limited to uncleared swaps. Under this definition, a “guarantee” would include arrangements, pursuant to which one party to a swap has rights of recourse against a guarantor, with respect to its counterparty's obligations under the swap. For these purposes, a party to a swap has rights of recourse against a guarantor if the party has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from the guarantor with respect to its counterparty's obligations under the swap. This “guarantee” definition also encompasses any arrangement pursuant to which the guarantor itself has a conditional or unconditional legally enforceable right to receive or otherwise collect, in whole or in part, payments from any other guarantor with respect to the counterparty's obligations under the swap. See Cross-Border Margin Rule, 81 FR 34818. Furthermore, treating U.S. Guaranteed Entities differently from U.S. persons could create a substantial regulatory loophole, incentivizing U.S. persons to conduct their dealing business with non-U.S. counterparties through non-U.S. affiliates, with a U.S. guarantee, to avoid application of the Dodd-Frank swap dealer requirements. Allowing transactions that have a similar economic reality with respect to U.S. commerce to be treated differently depending on how the parties structure their transactions could undermine the effectiveness of the Dodd-Frank swap provisions and related Commission regulations. Applying the same standard to similar transactions instead helps to limit those incentives and regulatory implications. B. Foreign Consolidated Subsidiaries Under the proposed rule, a Foreign Consolidated Subsidiary would include all of its swap dealing transactions in its de minimis threshold calculation, without exception. 80 The Commission believes that the swap dealing transactions of an FCS should be treated in the same manner as swap dealing transactions of a U.S. person (and U.S. Guaranteed Entity) for purposes of the de minimis threshold calculation, given the nature of the relationship between the FCS and its U.S. ultimate parent entity. As discussed in section II.B. above, an FCS is under the financial control of its U.S. ultimate parent entity. Further, by virtue of consolidated reporting under U.S. GAAP, the swap activity of an FCS creates a direct risk for the U.S. ultimate parent entity. The Commission is also concerned that offering FCSs disparate treatment compared to U.S. persons could incentivize U.S. entities to conduct swap activities with non-U.S. counterparties through consolidated non-U.S. subsidiaries in order to avoid application of the Dodd-Frank Act SD requirements, creating the potential for a substantial regulatory loophole. 80 To the extent that a non-U.S. person is both an FCS and a U.S. Guaranteed Entity with respect to a particular swap, the non-U.S. person would only be required to include the swap in its SD de minimis calculation once. See proposed rule § 1.3(ggg)(7). C. Other Non-U.S. Persons Under the proposed rule, whether an Other Non-U.S. Person would include a particular swap in its de minimis calculation would depend on the status of the counterparty. Specifically, as further explained below, an Other Non-U.S. Person would be required to include in its de minims threshold calculation its dealing activities with U.S. Persons, U.S. Guaranteed Entities, and FCSs, but not with Other Non-U.S. Persons (“Other Non-U.S. counterparties”). Additionally, Other Non-U.S. Persons would not be required to include in their de minimis threshold calculation any transaction that is executed anonymously on a swap execution facility (“SEF”), designated contract market (“DCM”), or foreign board of trade (“FBOT”) and cleared through a registered or exempt derivatives clearing organization (“DCO”). 1. U.S. Counterparties that are U.S. Persons or U.S. Guaranteed Entities Under the proposed rule, an Other Non-U.S. Person would generally include in its de minimis calculation all swap dealing transactions with U.S. counterparties, subject to the exception for transactions executed anonymously on a SEF, DCM, or FBOT and cleared (discussed in section 4 below). As a general rule, the Commission believes that all potential SDs should include in their de minimis calculations any swap with a U.S. counterparty. 81 As discussed in section II.A. above, the term “U.S. person” encompasses persons that inherently raise the concerns intended to be addressed by the Dodd-Frank Act regardless of the U.S. person status of their counterparty. In the event of a default or insolvency of an Other Non-U.S. SD with more than a de minimis level of swap dealing, the SD's U.S. counterparties could be adversely affected. A credit event, including funding and liquidity problems, downgrades, default or insolvency at an Other Non-U.S. Person SD could therefore have a direct adverse impact on its U.S. counterparties, which could in turn create the risk of disruptions to the U.S. financial system. 81 As discussed above, the definition of “U.S. person” includes any foreign branch. See proposed rule § 1.3(aaaaa)(5)(iii), (vi) (defining “U.S. person” to include “any branch of the legal entity”). The Commission notes that the proposed rule's requirement that an Other Non-U.S. Person include in its de minimis calculation all swap dealing transactions with U.S. person counterparties (subject to the exception for swaps executed anonymously on a SEF, DCM, or FBOT and cleared, discussed in section 4 below) is largely consistent with the Guidance, except with respect to the treatment of swaps with foreign branches of U.S. SDs. Under the Guidance, a non-U.S. person that is not a “guaranteed affiliate” or a “conduit affiliate” (as those terms are interpreted in the Guidance) 82 would generally include in its de minimis threshold calculations all swap transactions with counterparties that are U.S. persons, except transactions with foreign branches of U.S. SDs. 83 This exception was primarily driven by concerns that, absent such an exception, non-U.S. counterparties would avoid transacting with U.S. SDs. 84 82 See Guidance, 78 FR at 45318, n.257-58. The Guidance uses the terms “conduit affiliate” and “affiliate conduit” interchangeably. 83 See id. at 45318-19. 84 See id. at 45324. Upon further consideration, however, the Commission believes that incorporating a similar exception into the proposed rule could create a substantial regulatory loophole. As discussed above, a foreign branch is an integral part of a U.S. person, such that a transaction involving a foreign branch of a U.S. SD poses risk to the U.S. SD itself and, consequently, the U.S. financial system. Allowing Other Non-U.S. Persons to engage in potentially unlimited swap dealing with foreign branches of U.S. SDs without having to register as SDs could therefore result in a substantial amount of dealing activity with U.S. counterparties occurring outside the comprehensive Dodd-Frank swap regime, undermining the effectiveness of the proposed rule. Under the proposed rule, an Other Non-U.S. Person would also include in its de minimis threshold calculation swap dealing transactions with a non-U.S. person that is a U.S. Guaranteed Entity, subject to an exception for transactions executed anonymously on a SEF, DCM, or FBOT and cleared. 85 The Commission notes that the guarantee of a swap is an integral part of the swap and that, as discussed above, counterparties may not be willing to enter into a swap with a U.S. Guaranteed Entity in the absence of the guarantee. The Commission also recognizes that, given the highly-integrated corporate structures of global financial groups described above, financial groups may elect to conduct their swap dealing activity in a number of different ways, including through a U.S. person or through a non-U.S. affiliate that benefits from a recourse guarantee from a U.S. person. Therefore, in order to avoid creating a substantial regulatory loophole, the Commission believes that swaps of an Other Non-U.S. Person with a U.S. Guaranteed Entity should receive the same treatment as swaps with a U.S. person and should therefore be included in the Other Non-U.S. Person's SD de minimis calculation. If Other Non-U.S. Persons were not required to include such transactions in their SD de minimis threshold calculations, they could engage in a significant level of swap dealing activity with U.S. Guaranteed Entities without being required to register as SDs. Treating swaps of Other Non-U.S. Persons with U.S. Guaranteed Entities differently than their swaps with U.S. persons could thereby undermine the effectiveness of the Dodd-Frank swap provisions and related Commission regulations. 85 To the extent that the swap is with a non-U.S. counterparty that is both an FCS and a U.S. Guaranteed Entity with respect to a particular swap, the Other Non-U.S. Person would only be required to include the swap in its SD de minimis calculation once. See proposed rule § 1.3(ggg)(7). 2. Counterparties That Are FCSs Under the proposed rule, an Other Non-U.S. Person would include in its de minimis threshold calculation swap dealing transactions with a non-U.S. person that is an FCS, subject to an exception for transactions executed anonymously on a SEF, DCM, or FBOT and cleared. As discussed above, the default or insolvency of an Other Non-U.S Person could have a direct adverse effect on an FCS, which through the interconnection to its U.S. ultimate parent, could have knock-on effects, potentially leading to disruptions to the U.S. financial system. The Commission believes that such risk would be significant to the extent that the Other Non-U.S. Person's dealing activities with FCSs, U.S. persons and U.S. Guaranteed Entities 86 exceed the de minimis threshold. 86 Id. 3. Other Non-U.S. Counterparties Under the proposed rule, an Other Non-U.S. Person would not include in its de minimis calculation its swap dealing transactions with an Other Non-U.S. Person. This approach reflects the Commission's recognition of foreign jurisdictions' strong supervisory interest in the swap transactions between Other Non-U.S. Persons, both of which are domiciled and operate abroad. Consistent with comity principles, the Commission believes that it would be appropriate to except this class of swap transactions from counting against the de minimis threshold. Further, the proposed rule would not require an Other Non-U.S. Person to include a swap transaction with an Other Non-U.S. Person counterparty in its de minimis threshold calculation even if the swap is arranged, negotiated, or executed by personnel located in the United States. Although, as stated above, a non-U.S. person that engages in ANE transactions is performing dealing activity in the United States, the Commission preliminarily does not believe that requiring Other Non-U.S. Persons to include ANE transactions in their de minimis threshold calculations would be necessary to advance the policy objectives of the Dodd-Frank swap regime when taking the proposed rule in context. In particular, the Commission preliminarily believes that the proposal to require FCSs to include all of their swap dealing transactions in their de minimis threshold calculations would capture a substantial portion of dealing activity engaged in by non-U.S. persons in which the Commission has a strong regulatory interest, such that the level of ANE transactions engaged in by Other Non-U.S. Persons may be comparatively insignificant. Additionally, Other Non-U.S. Persons that engage in ANE transactions could either be registered already by virtue of their swap transactions with U.S. persons or, if the proposed rule is adopted, be required to register as SDs by virtue of their swap transactions with U.S. persons, U.S. Guaranteed Entities or FCSs. 4. Swaps Executed Anonymously on a SEF, DCM, or FBOT and Cleared The Commission believes that when an Other Non-U.S. Person enters into a swap that is executed anonymously on a registered SEF, DCM, or FBOT and the swap is cleared through a registered or exempt DCO, the Other Non-U.S. Person may exclude the swap from its de minimis threshold calculation. 87 The Commission recognizes that, under these circumstances, the Other Non-U.S. Person would not have the necessary information about its counterparty to determine whether the swap should be included in its de minimis threshold calculation. The Commission therefore believes that in this case the practical difficulties make it reasonable for the swap to be excluded altogether. 88 87 The Commission clarifies that an Other Non-U.S. Person would also be able exclude from its de minimis threshold calculation any swap that is executed anonymously on a foreign trading platform that is subject to relief from the requirement to register as a SEF or DCM, provided the swap is cleared through a registered or exempt DCO. 88 The Commission also believes that when an Other Non-U.S. Person clears a swap through a registered or exempt DCO, such Other Non-U.S. Person would not have to include the resulting swap ( i.e., the novated swap) in its de minimis threshold calculation. A swap that is submitted for clearing is extinguished upon novation and replaced by new swap(s) that result from novation. See Commission regulation 39.12(b)(6). See also Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334, 69361 (Nov. 8, 2011). Where a swap is created by virtue of novation, such swap does not implicate swap dealing, and therefore it would not be appropriate to include such swaps in determining whether a non-U.S. person should register as an SD. D. Aggregation Requirement As stated above, Commission regulation 1.3(ggg)(4) requires that, in determining whether its swap dealing transactions exceed the de minimis threshold, a person must include the aggregate notional value of any swap dealing transactions entered into by its affiliates under common control. Consistent with CEA section 2(i), the Commission interprets the aggregation requirement in Commission regulation 1.3(ggg)(4) in a manner that applies the same aggregation principles to all affiliates in a corporate group, whether they are U.S. or non-U.S. persons. Accordingly, under the proposed rule, a potential SD, whether a U.S. or non-U.S. person, would aggregate all swaps connected with its dealing activity with those of persons controlling, controlled by, or under common control with 89 the potential SD to the extent that these affiliated persons are themselves required to include those swaps in their own de minimis thresholds, unless the affiliated person is itself a registered SD. The Commission notes that this interpretation, which mirrors the approach taken in the Guidance, 90 ensures that the aggregate notional value of applicable swap dealing transactions of all such unregistered U.S. and non-U.S. affiliates does not exceed the de minimis level. 89 The Commission clarifies that for this purpose, the term “affiliates under common control” would include parent companies and subsidiaries. 90 See 78 FR at 45323. Stated in general terms, the Commission interprets the aggregation requirement to allow both U.S. persons and non-U.S. persons in an affiliated group to engage in swap dealing activity up to the de minimis threshold. When the affiliated group meets the de minimis threshold in the aggregate, one or more affiliate(s) (a U.S. affiliate or a non-U.S. affiliate) would have to register as an SD so that the relevant swap dealing activity of the unregistered affiliates remains below the threshold. The Commission recognizes the borderless nature of swap dealing activities, in which a dealer may conduct swap dealing business through its various affiliates in different jurisdictions, and believes that this interpretation would address the concern that an affiliated group of U.S. and non-U.S. persons engaged in swap dealing transactions with a significant connection to the United States may not be required to register solely because such swap dealing activities are divided among affiliates that all individually fall below the de minimis threshold. E. Summary In summary, under the proposed rule, in making its de minimis calculation: • A U.S. person would include all of its swap dealing transactions. • A non-U.S. person would include all swap dealing transactions with respect to which it is a U.S. Guaranteed Entity. • A Foreign Consolidated Subsidiary would include all of its swap dealing transactions. • An Other Non-U.S. Person would include all of its swap dealing transactions with counterparties that are U.S. persons, U.S. Guaranteed Entities, or FCSs, unless the swap is executed anonymously on a registered SEF, DCM, or FBOT and cleared. It would not, however, include any of its swap dealing transactions with Other Non-U.S. Persons, even if they constitute ANE transactions. • All potential SDs, whether U.S. or non-U.S. persons, would aggregate their swap dealing transactions with those of persons controlling, controlled by, or under common control with the potential SD to the extent that those affiliates are themselves required to include those swaps in their own de minimis thresholds, unless the affiliated person is a registered SD. Request for Comment. The Commission invites comment on all aspects of Proposed Rule, including the following: 1. The Commission invites comment on the appropriateness, necessity, and potential impact of requiring Other Non-U.S. Persons to include ANE transactions in their de minimis threshold calculations. Should the Commission further harmonize with the SEC by requiring Other Non-U.S. Persons to include ANE transactions in their de minimis threshold calculations? 91 What effect would a determination not to impose such a requirement have on market liquidity and competitiveness? To what degree would U.S. swap dealers be adversely affected? Would a determination not to impose such a requirement create a substantial loophole or otherwise expose the U.S. financial system to unregulated risk? Do ANE transactions conducted by Other Non-U.S. Persons, particularly those not currently registered as SDs by virtue of their transactions with U.S. persons, form a significant segment of the U.S. swap market? The Commission is particularly interested in data or estimates regarding the current level of ANE transactions entered into by Other Non-U.S. Persons, including whether and how many Other Non-U.S. Persons that are not currently registered as SDs would exceed the current de minimis threshold as a result of being required to include ANE transactions in their de minimis threshold calculations. 91 See SEC ANE Rule, 81 FR at 8621. 2. The Commission invites comment on whether and to what extent the Proposed Rule should incorporate certain exceptions for non-U.S. persons that were included in the Guidance. 92 Specifically, should the proposed rule permit Other Non-U.S. Persons to exclude from their de minimis threshold calculations: 92 See 78 FR at 45324 (providing that non-U.S. persons that are not guaranteed or conduit affiliates would generally not count toward their de minimis threshold calculations their swap dealing transactions with (i) a foreign branch of a U.S. swap dealer, (ii) a guaranteed affiliate of a U.S. person that is a swap dealer, and (iii) a guaranteed or conduit affiliate that is not a swap dealer and itself engages in de minimis swap dealing activity and which is affiliated with a swap dealer). a. Swap transactions with foreign branches of U.S. SDs? If so, why and how should the Commission interpret the term “foreign branch of a U.S. swap dealer” ( e.g., consistent with the Guidance, 93 consistent with the SEC's definitions of “foreign branch” and “transaction conducted through a foreign branch” in Exchange Act rules, 94 or an alternative approach)? 93 See id. at 45328-31 (discussing the scope of the term “foreign branch” and Commission's consideration of whether a swap is with a foreign branch of a U.S. bank). 94 The SEC defined the term “foreign branch” in Exchange Act rule 3a71-3(a)(2), 17 CFR 240.3a71-3(a)(2), to mean any branch of a U.S. bank if (i) the branch is located outside the United States; (ii) the branch operates for valid business reasons; and (iii) the branch is engaged in the business of banking and is subject to substantive banking regulation in the jurisdiction where located. The SEC defined the term “transaction conducted through a foreign branch” in Exchange Act rule 3a71-3(a)(3), 17 CFR 240.3a71-3(a)(3), to mean a security-based swap transaction that is arranged, negotiated, and executed by a U.S. person through a foreign branch of such U.S. person if (A) the foreign branch is the counterparty to such security-based swap transaction; and (B) the security-based swap transaction is arranged, negotiated, and executed on behalf of the foreign branch solely by persons located outside the United States. See also SEC Cross-Border Rule, 79 FR 47278. b. Any swap transactions with U.S. Guaranteed Entities? If so, why and under what circumstances? 3. The Commission is concerned that a non-U.S. person that is affiliated with a U.S. SD could act as a conduit or an extension of the affiliated U.S. SD by entering into market-facing swaps in a foreign jurisdiction and then transferring some or all of the risk of such swaps to its affiliated U.S. SD through one or more inter-affiliate swaps. Furthermore, under the Proposed Rule, an Other Non-U.S. Person would not be required to include its market-facing swaps with Other Non-U.S. counterparties in its SD de minimis threshold. The Commission invites comment as to whether Other Non-U.S. Persons should be required to include market-facing swaps with non-U.S. persons in their de minimis threshold calculations if any of the risk of such swaps is transferred to an affiliated U.S. SD through one or more inter-affiliate swaps and as to whether it would be too complex or costly to monitor and implement. 95 If so: 95 The Commission notes that the Commission's final margin rule requires CSEs to collect initial margin from certain affiliates that are not subject to comparable initial margin collection requirements on their own outward-facing swaps with financial end-users, which addresses some of the credit risks associated with the outward-facing swaps. See Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636, 703 (Jan. 6, 2016) (“Final Margin Rule”). a. Should an Other Non-U.S. Person that is consolidated with an affiliated U.S. SD for financial reporting purposes and that transfers some or all of the risk of a swap with an Other Non-U.S. counterparty, directly or indirectly, to its affiliated U.S. SD (an “SD conduit”) be required to count outward-facing swap as to which it acts as a conduit toward its SD or MSP registration threshold? b. Should an Other Non-U.S. Person be considered an SD Conduit only when it “regularly” acts as an SD Conduit, and if so, how would the Commission determine whether it “regularly” acts as an SD Conduit? c. Would it be appropriate to require an SD Conduit to include a market-facing swap in its de minimis threshold calculation in its entirety, for ease of calculation, even if not all of the risk arising out of that swap is transferred to an affiliated U.S. SD through inter-affiliate swaps? Is the Commission's assumption that a formula to calculate the percentage of risk would be too costly and burdensome to implement correct? If not, please propose such a workable formula. Alternatively, should an SD Conduit be required to include all of its swap dealing transactions (and not just those as to which it acts as an SD conduit) in its SD or MSP registration threshold? d. The Commission understands that a non-U.S. person may aggregate all or a group of its market-facing swaps and then transfer all or a portion of the risk of such swaps as one position to the affiliated U.S. SD. In that case, the Commission understands that it would not be burdensome for the non-U.S. person to disaggregate the netted swap, as the non-U.S. person's trading system would aggregate these trades initially, and therefore should be able to perform a disaggregation function. Is the Commission's understanding correct? e. Should the proposed rule be modified to require that Other Non-U.S. Persons include swaps in their SD or MSP registration thresholds if their counterparty is acting as an SD Conduit? f. Should swaps where either one of the counterparties is acting as an SD conduit be subject to other Dodd-Frank requirements (in addition to SD and MSP registration thresholds) in future rulemakings? V. Cross-Border Application of the Major Swap Participant Registration Thresholds CEA section 1a(33) defines “major swap participant” to include persons that are not SDs but that nevertheless pose a high degree of risk to the U.S. financial system by virtue of the “substantial” nature of their swap positions. 96 In accordance with the Dodd-Frank Act and CEA section 1a(33)(B), the Commission adopted rules further defining “major swap participant” and providing that a person would not be deemed an MSP unless its swap positions exceed one of several thresholds. 97 The thresholds were designed to take into account default-related credit risk, the risk of multiple market participants failing close in time, and the risk posed by a market participant's swap positions on an aggregate level. 98 The Commission also adopted interpretive guidance that, for purposes of the MSP analysis, an entity's swap positions would be attributable to a parent, other affiliate, or guarantor to the extent that the counterparty has recourse to the parent, other affiliate, or guarantor and the parent or guarantor is not subject to capital regulation by the Commission, SEC, or a prudential regulator (“attribution requirement”). 99 96 See 7 U.S.C. 1a(33)(A) (defining “major swap participant” to mean any person who is not an SD and either (i) maintains a substantial position in swaps for any of the major swap categories, subject to certain exclusions; (ii) whose outstanding swaps create substantial counterparty exposure that could have serious effects on the U.S. financial system; or (iii) is a highly leveraged financial entity that is not subject to prudential capital requirements and that maintains a substantial position in swaps for any of the major swap categories. See also 17 CFR 1.3(hhh)(1); 156 Cong. Rec. S5907 (daily ed. July 15, 2010) (colloquy between Senators Hagen and Lincoln, discussing how the goal of the major participant definitions was to “focus on risk factors that contributed to the recent financial crisis, such as excessive leverage, under-collateralization of swap positions, and a lack of information about the aggregate size of positions”). 97 See 17 CFR 1.3(hhh)-(mmm). See also Dodd Frank Act section 712(d)(1) (directing the Commission and the SEC, in consultation with the Board of Governors of the Federal Reserve System, to jointly further define, among other things, the term “major swap participant”); 7 U.S.C. 1a(33)(B) (directing the Commission to further define “substantial position” at the threshold the Commission deems prudent for the effective monitoring, management, and oversight of entities that are systemically important or can significantly impact the U.S. financial system); Entities Rule, 77 FR 30596. 98 See 77 FR at 30666 (discussing the guiding principles behind the Commission's definition of “substantial position” in 17 CFR 1.3(jjj)); id. at 30683 (noting that the Commission's definition of “substantial counterparty exposure” in 17 CFR 1.3(lll) is founded on similar principles as its definition of “substantial position”). 99 Id. at 30689. The Commission is now proposing rules to address the cross-border application of the MSP thresholds to the swap positions of U.S. and non-U.S. persons. 100 Applying CEA section 2(i) and principles of international comity, the proposed rule identifies when a potential MSP's cross-border swap positions should apply toward the MSP thresholds and when they may be properly excluded. As discussed in the sections below, whether a potential registrant would include a particular swap in its MSP calculations would depend on whether the potential registrant is a U.S. person, a U.S. Guaranteed Entity, 101 or a Foreign Consolidated Subsidiary (section A) or an Other Non-U.S. Person 102 (section B). Section C addresses the cross-border application of the attribution requirement. Section D provides an overall summary of the rule. If adopted, the Proposed Rule would supersede the Commission's Cross-Border Guidance with respect to the cross-border application of the MSP thresholds. 100 See proposed rule § 1.3(nnn). 101 See notes 76 and 79, supra. 102 As indicated above, for purposes of the Proposed Rule, an “Other Non-U.S. Person” refers to a non-U.S. person that is neither an FCS nor a U.S. Guaranteed Entity. See section IV, supra. A. U.S. Persons, U.S. Guaranteed Entities, and Foreign Consolidated Subsidiaries Under the proposed rule, all of a U.S. person's swap positions would apply toward the MSP thresholds without exception. As discussed in the context of the Proposed Rule's approach to applying the SD de minimis registration threshold, by virtue of it being domiciled or organized in the United States, or the inherent nature of its connection to the United States, all of a U.S. person's activities have a significant nexus to U.S. markets, giving the Commission a particularly strong regulatory interest in their swap activities. Accordingly, the Commission believes that all of a U.S. person's swap positions, regardless of where they occur or the U.S. person status of the counterparty, present risk to the stability of the U.S. financial system and U.S. entities, including those that may be systemically important, and thus should apply toward the MSP thresholds. For related reasons, the proposed rule would also require a non-U.S. person that is not an FCS to include in its MSP calculations each swap position with respect to which it is a U.S. Guaranteed Entity. As explained in context of the SD de minimis threshold calculation, the Commission believes that the swap positions of a non-U.S. person whose swap obligations are guaranteed by a U.S. person are identical, in relevant aspects, to those entered into directly by a U.S. person and thus present risks to the stability of the U.S. financial system or of U.S. entities. Treating U.S. Guaranteed Entities differently from U.S. persons could also create a substantial regulatory loophole, allowing transactions that have a similar connection to or impact on U.S. commerce to be treated differently depending on how the parties are structured and thereby undermining the effectiveness of the Dodd-Frank swap provisions and related Commission regulations. The proposed rule would also require an FCS to include all of its swap positions in its MSP calculations. 103 As discussed in the context of applying the SD de minimis threshold, by virtue of its relationship to its U.S. ultimate parent, the risk associated with an FCS's swap positions have a direct impact on the financial position and risk profile of its U.S. parent. Accordingly, should the FCS or its counterparty default on a swap, the financial stability of the U.S. ultimate parent entity would be directly impacted, raising the types of regulatory concerns that MSP registration is intended to address. The Commission is also concerned that offering disparate treatment to FCSs compared to U.S. persons could create a substantial regulatory loophole, incentivizing U.S. financial groups to conduct their swap activities with non-U.S. counterparties through non-U.S. subsidiaries and thereby undermining the effectiveness of the Dodd-Frank swap provisions and related Commission regulations. 103 To the extent that a non-U.S. person is both an FCS and a U.S. Guaranteed Entity with respect to a particular swap, the non-U.S. person would only be required to include the swap position in its MSP calculations once. See proposed rule § 1.3(nnn). B. Other Non-U.S. Persons Under the proposed rule, an Other Non-U.S. Person would include all of its swaps with U.S. persons, U.S. Guaranteed Entities, and Foreign Consolidated Subsidiaries in its MSP calculations, with a limited exception for transactions executed anonymously on a SEF, DCM, or FBOT and cleared. 104 As discussed above, the default or insolvency of the Other Non-U.S. Person would have a direct adverse effect on a U.S. counterparty and, by virtue of the U.S. person's significant nexus to the U.S. financial system, potentially could result in adverse effects or disruption to the U.S. financial system as a whole, particularly if the Other Non-U.S. Person's swap positions are substantial enough to exceed an MSP registration threshold. 104 To the extent that the Other Non-U.S. Person's swap position is with a non-U.S. counterparty that is both an FCS and a U.S. Guaranteed Entity with respect to a particular swap, the Other Non-U.S. Person would only be required to include the swap position in its MSP calculations once. See proposed rule § 1.3(nnn). The default or insolvency of the Other Non-U.S. Person would also present a financial impact to the U.S. financial system where the counterparty is an FCS because its U.S. ultimate parent would be directly impacted. The Other Non-U.S. Person's default could also impact the United States through a U.S. Guaranteed Entity. Although the default on that swap may not directly affect the U.S. guarantor on that swap, the default could affect the U.S. Guaranteed Entity's ability to meet its other obligations, for which the U.S. guarantor may also be liable. The Commission is also concerned that offering Other Non-U.S. Persons disparate treatment with respect to their swap positions with U.S. Guaranteed Entities compared to their swap positions with FCSs could incentivize Other Non-U.S. Persons to favor transacting with U.S. Guaranteed Entities solely in order to avoid application of the Dodd-Frank swap provisions. The Commission therefore has a strong regulatory interest in ensuring that Other Non-U.S. Persons are subject to the Dodd-Frank MSP requirements to the extent that their swap positions with U.S. Guaranteed Entities and FCSs exceed a registration threshold. Accordingly, the Commission believes that requiring Other Non-U.S. Persons to include their swap positions with FCSs and U.S. Guaranteed Entities as well as U.S. persons appropriately captures swap positions that present a risk to the U.S. financial system, ensuring that MSP regulation applies once that risk exceeds the relevant thresholds. However, as discussed in the context of the SD de minimis threshold, where the swap is executed anonymously on a SEF, DCM, or FBOT and cleared, the Commission believes that the practical difficulties involved in determining the status of the potential MSP's counterparty would make it reasonable for the swap position to be excluded altogether. 105 105 See section IV.C.4, supra. Where the counterparty is an Other Non-U.S. Person, however, the proposed rule would not require an Other Non-U.S. Person to include the swap position in its MSP calculations, as the Commission does not believe the swap would present the type of risk to the U.S. financial system that MSP registration is intended to address. 106 Further, the Commission clarifies that under the Proposed Rule, an Other Non- U.S. Person would not be required to include its swap position with an Other Non-U.S. Person counterparty in its MSP calculations solely by reason of such swap being arranged, negotiated, or executed by personnel located in the United States. As stated above, arranging, negotiating, or executing swaps are functions that fall within the scope of the “swap dealer” definition. In contrast, the definition of MSP focuses primarily on credit risk and thus, the Commission does not believe that including ANE transactions in this context would address the regulatory concerns underlying the MSP registration requirement. 106 The Commission notes that the Guidance provided that non-U.S. persons that are not guaranteed affiliates generally could exclude from their MSP threshold calculations swap positions with either a foreign branch of a U.S. SD or a guaranteed affiliate that is an SD if either (i) the potential non-U.S. MSP is a non-financial entity or (ii) the potential non-U.S. MSP is a financial entity and the swap is either cleared or the swap documentation requires the foreign branch or guaranteed affiliate to collect daily variation margin with no threshold. See Guidance, 78 FR at 45324-25. The Commission has determined that a similar exception in the Proposed Rule with regard to the swap positions of Other Non-U.S. Persons would be unnecessary and inappropriate because (1) two of the three prongs of the statutory MSP definition apply regardless of whether the potential MSP is a financial entity, see 7 U.S.C. 1a(33)(A)(i)-(ii), and (2) although subjecting a swap to the clearing or margin requirements may mitigate some of the risk of the swap, the risk is not entirely eliminated, and the mitigation effect of the clearing and margin requirements is taken into account in calculating the relevant MSP thresholds. See 17 CFR 1.3(jjj)(3)(iii) (defining “substantial position” such that the potential future exposure associated with positions that are subject to central clearing by a registered or exempt DCO is equal to 0.1 times the potential future exposure that would otherwise be calculated). Accordingly, the Commission believes that such swaps create the potential for systemic risk within the meaning of the MSP definition and that allowing such exclusion would allow market participants to inappropriately avoid the Dodd-Frank registration and other associated requirements that are designed to mitigate that risk. The Commission further believes that the Proposed Rule has the added benefit of aligning more closely with the SEC in this regard, which should serve to reduce compliance costs associated with MSP registration. C. Attribution Requirement In the Entities Rule, the Commission and the SEC (collectively, “Commissions”) provided a joint interpretation that an entity's swap positions in general would be attributed to a parent, other affiliate, or guarantor for purposes of the MSP analysis to the extent that the counterparties to those positions have recourse to the parent, other affiliate, or guarantor in connection with the position, such that no attribution would be required in the absence of recourse. 107 Even in the presence of recourse, however, the Commissions stated that attribution of a person's swap positions to a parent, other affiliate, or guarantor would not be necessary if the person is already subject to capital regulation by the Commission or the SEC or is a U.S. entity regulated as a bank in the United States (and is therefore subject to capital regulation by a prudential regulator). 108 107 See 77 FR at 30689. 108 Id. (positions of U.S. entities regulated as banks in the United States would be subject to capital and other requirements, making it unnecessary to separately address the risks associated with guarantees of those positions via MSP regulation). See also id. at n.1134 (“As a result of this interpretation, holding companies will not be deemed to be major participants as a result of guarantees to certain U.S. entities that already are subject to capital regulation. The Commissions intend to address guarantees provided to non-U.S. entities, and guarantees by non-U.S. holding companies, in separate releases.”). The Commission is also proposing to address the cross-border application of the attribution requirement in a manner consistent with the Entities Rule and CEA section 2(i) and generally comparable to the approach adopted by the SEC. 109 Specifically, the Commission believes that the swap positions of an entity, whether a U.S. or non-U.S. person, should not be attributed to a parent, other affiliate, or guarantor for purposes of the MSP analysis in the absence of recourse. Even in the presence of recourse, attribution would not be required if the entity that entered into the swap directly is subject to capital regulation by the Commission or the SEC or is regulated as a bank in the United States. 110 109 See SEC Cross-Border Rule, 79 FR at 47346-48. 110 The Commission further clarifies that the swap positions of an entity that is required to register as an MSP, or whose MSP registration is pending, would not be subject to the attribution requirement. If recourse is present, however, and the entity subject to a recourse guarantee (“guaranteed entity”) is not subject to capital regulation (as described above), whether the attribution requirement would apply would depend on the U.S. person status of the person to whom there is recourse ( i.e., the U.S. person status of the guarantor). Specifically, a U.S. person guarantor would attribute to itself any swap position of a guaranteed e [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2016-24905. Public record. Not legal advice.