In a letter to the SEC and CFTC, the Securities Industry and Financial Markets Association urged the Commissions to carefully consider comity and the extraterritorial application of the derivatives provisions in Title VII of Dodd-Frank when adopting swap dealer regulations for a global marketplace. In SIFMA’s view, registration requirements for non-U.S. entities should be based solely on whether the activity by a non-U.S. entity is with a U.S. person. To determine whether a party to a swap is a U.S. person, said SIFMA, the Commissions should rely on the existing definition of that term contained in Rule 902(k) of the SEC’s Regulation S, which is familiar to regulators and market participants alike and would thus provide legal certainty.
SIFMA noted that a single swap may be negotiated and executed between counterparties located in two different countries, booked in a third country and risk-managed in a fourth country, thereby triggering swaps regulation in multiple jurisdictions simultaneously. Moreover, many participants use a central booking entity to efficiently manage risks arising from swaps that they execute around the world through their subsidiaries and branches. Thus, an effective approach to U.S. swaps regulation must accommodate the global risk management and efficient operational structures currently in place.
SIFMA asked the SEC and CFTC to, in their Title VII rules, avoid disrupting these international arrangements except where necessary to achieve an explicit legislative purpose. U.S. regulators should also give effect to the principles of international comity by refraining from unnecessarily regulating conduct outside national borders while appropriately allocating supervision of cross-border swaps activities in a way that protects U.S. markets and counterparties and avoids duplicative and inconsistent regulations. SIFMA believes that a non-U.S. firm, including a non-U.S. affiliate or branch of a U.S. firm, should not be required to register as a swap dealer and comply with Title VII’s swap dealer regulations if it conducts swaps transactions solely outside of the United States with non-U.S. persons.
In SIFMA’s view, Title VII’s swap dealer requirements can be conceptually divided into requirements that apply on an entity-level, such as capital requirements, and requirements that apply on a transactional basis, such as mandatory clearing and business conduct requirements. SIFMA asked the Commissions to examine the entity-level regulations applicable to a swap dealer and consider where it would be appropriate to rely on a non-U.S. swap dealer’s home country entity-level regulation, for example when such regulation yields comparable results to U.S. regulation.
In addition, U.S. regulators should examine the transaction-based regulations applicable to a swap dealer and consider whether such regulations should apply to swap dealers when a non-U.S. person is involved. They should be sensitive to situations in which their transaction-based rules may conflict with foreign transaction-based rules applicable to non-U.S. persons. SIFMA also urged the Commissions to permit multiple operating and risk-management models, including intermediary models, in which a non-U.S. swap dealer and its U.S. affiliate are responsible for fulfilling different responsibilities under Title VII, and inter-affiliate structures in which Title VII’s transaction-based regulations would not apply to transactions between affiliates entered into for risk hedging purposes.
SIFMA assured that the approach it is suggesting would not require the SEC and CFTC to exempt entities from Title VII regulations. The legal authority to implement the approach involves reliance on the jurisdiction provisions in Sections 722 and 772 to limit Title VII’s requirements to U.S. transactions instead of granting exemptions from such requirements and the broad authority of the Commissions under Section 712(d) of Dodd-Frank to define “swap dealer” and adopt such other rules regarding the definition of swap dealer as they deem necessary. SIFMA also noted the statutory mandate in Section 752 to coordinate and consult with foreign authorities on the regulation of swaps and swap dealers, as well as the authority of the Commissions in Sections 721 and 761 to designate an entity as a swap dealer with respect to certain activities and to limit the application of Title VII regulation to such activities.
At the same time, SIFMA acknowledged that U.S. regulators have jurisdiction over cross-border swaps activities where at least one counterparty to the swap is a U.S. person, where an entity registers as a swap dealer, and where swap-dealing activities are conducted from within the United States. However, the SEC and CFTC should use discretion and limit the exercise of this jurisdiction with respect to cross-border swaps transactions where doing so would meet the policy objectives of Dodd-Frank and would preserve international comity.
SIFMA believes that its recommendations for defining a US person are consistent both with both Dodd-Frank and the US Supreme Court’s recent Morrison decision. Section 722 (CFTC) and Section 772 (SEC) of Dodd-Frank limit the Commissions’ jurisdiction to the United States, subject to specific exceptions for anti-evasion regulations and, in the case of Section 722 only, to offshore activities with a “direct and significant” U.S. nexus.
Looking at the Supreme Court’s reasoning in Morrison, SIFMA presumed Sections 722 and 772 to be primarily concerned with domestic conditions and that their extraterritorial scope would be narrowly construed. In Morrison, noted SIFMA, the Supreme Court discussed the meaning of Section 30(b) of the Exchange Act, a jurisdictional provision substantively identical to Section 30(c) of the Exchange Act, as inserted by Section 772 of Dodd-Frank.
The Supreme Court stated that the exclusive focus on domestic purchases and sales is strongly confirmed by § 30(a) and (b) and under both provisions it is the foreign location of the transaction that establishes or reflects the presumption of the Act's inapplicability, absent SEC anti-evasion regulations. According to SIFMA, this statement suggests that absent the anti-evasion exception, Section 30(b) of the Exchange Act does not provide the SEC with jurisdiction over foreign transactions. Thus, continuing to reason by analogy, SIFMA concluded that a swap where neither counterparty is a U.S. person would clearly be a foreign transaction outside the scope of Section 30(c) of the Exchange Act.
Specifically, a transaction between two foreign entities that are affiliates of U.S. persons should be “without the jurisdiction of the United States” (for purposes of Section 772 regulating security-based swaps) or “outside the United States” (for purposes of Section 722 regulating swaps. The mere fact that a U.S. entity directly or indirectly controls or is under common control with a foreign-incorporated entity generally is considered to be too tangential to constitute a sufficient U.S. nexus. Similarly, the exception in Section 722 for activities outside the United States that have a direct and significant effect on US commerce does not warrant defining “U.S. person” to include foreign affiliates of U.S. persons because the affect on U.S. commerce will be tenuous in the context of the global economy.
SIFMA further opined that a foreign affiliate’s swap transactions and dealings with other foreign entities should not generally trigger the Commissions’ anti-evasion authority under Sections 722 and 772. Many U.S. companies have affiliates that are incorporated or organized outside the United States and conduct swaps activities overseas for legitimate business reasons, such as the need to build local relationships with customers. These well-established foreign affiliates of U.S. firms are clearly not seeking to evade Dodd-Frank.