Non-US Person Swap Trading Gets Pass

Non-US companies concerned about getting inadvertently sucked into the Dodd-Frank Act’s vortex of requirements may soon be able to breathe a sigh of relief in light of a proposal approved unanimously by US regulators last week.

The Commodity Futures Trading Commission (CFTC) published a proposal October 11, 2016 to modify the definition of a “US person,” clarifying the extent to which certain Dodd-Frank provisions apply to non-US-based corporations. The proposed rule confirms that multinational corporations (MNCs) and financial counterparties that are not US persons are generally exempt from potentially cumbersome rules.

“A benefit to the proposal is that if you are a non-US person corporate and you’re trading with a non-US swap dealer, then the proposed rule confirms that the corporate is exempted from having to comply with the external business conduct standards unless the transaction is negotiated or executed in the United States,” said Christopher Bender, a director of regulatory advisory on Chatham Financial’s Global Regulatory Solutions team. But if the transaction is arranged, negotiated or executed (ANE) in the US, then certain external business conduct requirements would still apply.

Mr. Bender explained that swap dealers are subject to external business conduct rules that govern their dealings with counterparties, including prohibiting certain abusive practices, requiring disclosures of material information, and ensuring swap dealers undertake certain know-your-customer procedures. Eliminating those standards would streamline a lot of the initial due diligence required before a corporate can enter into a trade.

“So it will make it easier for non-US persons trading with non-US banks,” he said.

In addition, the proposed rule should eliminate uncertainty around when Dodd-Frank requirements apply. Many global banks are headquartered outside the US but have operations in the country—think Deutsche Bank, one of the biggest swap counterparties, as well banking behemoths such as Barclays, BNP and Australia’s Macquarie Group. Many of them have large trading desks located in the US, especially in the New York area, that house staff with significant swap-market expertise that might be important to execute certain transactions.

In 2013, Mr. Bender said, the CFTC issued guidance saying non-US corporates executing swaps through a non-US dealer that regularly used an employee located in a US branch or office to arrange, negotiate or execute swaps would have to comply with “transaction-level requirements.” Transaction-level requirements include clearing, margin and external business conduct standards.

However, the CFTC’s guidance on what actions would classify a transaction as ANE in the US was ambiguous and led to a lot of uncertainty in the marketplace about whether Dodd-Frank’s transaction-level requirements would apply.

The proposed rule both clarifies what constitutes ANE and the implications of when ANE applies. The basic distinction between what qualifies as ANE and what does not, Mr. Bender said, is whether the activities are normally associated with sales and trading or whether the activities are considered internal, back-office activities: sales and trading-type activities constitute ANE, whereas internal, back-office don’t.

In the event that a non-US dealer uses US personnel to arrange, negotiate or execute a transaction with a non-US person corporate, then certain of the external business conduct rules will still apply to a transaction—specifically, the rules prohibiting fraud, manipulation and other abusive practice and the fair dealing. If the ANE provision does not apply, then a transaction between a non-US dealer and a non-US person corporate would not be required to comply with the external business conduct rules.

“This proposed rule will help to eliminate some of the legal uncertainty surrounding the ANE provision and should help to facilitate the pre-trade documentation process for certain corporates before they can trade,” Mr. Bender said.

While the proposed rule generally provides needed clarification for non-US person corporates, US multinational corporations may reach a different conclusion. The proposal includes a concept called a foreign consolidated subsidiary, which is essentially a foreign subsidiary of a US parent that appears on the US parent’s consolidated financial statements. The proposal requires that a bank include swaps with foreign consolidated subsidiaries in the bank’s calculation of whether it exceeds the dealing activity required to register as a swap dealer.

Mr. Bender says that, “foreign consolidated subsidiaries could face a situation where banks seeking to remain below the registration threshold refuse to trade with a foreign consolidated subsidiary, especially with the swap dealer registration thresholds scheduled to drop from $8 billion to $3 billion at the end of 2018.” He anticipates that industry groups will oppose this element of the Proposed Rule during the comment period.

The proposal should be published in the Federal Register shortly, after which there will be a 60-day comment period.