In a letter to the SEC and CFTC, eight
urged the Commissions not to allow a U.S.-based financial firm to escape
U.S.-mandated swaps oversight simply because its swaps trading is conducted
through an offshore affiliate or branch. If the current SEC and CFTC proposals
are adopted, warned the senators, U.S. financial firms could easily
arrange their affairs to produce that outcome. The letter, which was addressed
to CFTC Chair Gary Gensler and SEC Chair Mary Jo White, was signed by Senators
Jeff Merkley (D-OR), Carl Levin (D-MI), Tom Harkin (D-IA), Elizabeth Warren
(D-MA), Jeanne Shaheen (D-NH), Barbara Boxer (D-CA), Richard Blumenthal (D-CT),
and Dianne Feinstein (D-CA).
If the current proposals are adopted, they noted, foreign firms doing business with the foreign affiliate of a U.S.-based derivatives dealer would likely opt to forego an express guarantee from the U.S.-based entity in return for more favorable pricing and the ability to avoid
regulations and any attendant costs. If those arrangements were to become
widespread, feared the senators, Title VII of Dodd-Frank would be rendered
inapplicable to that derivatives trading activity, at the same time placing
U.S,. businesses at a competitive disadvantage to their foreign counterparts.
Some proposals also appear to allow swaps between U.S. guaranteed foreign affiliates
and some non-U.S. persons to be outside U.S.-mandated oversight, including the
doctrine of substituted compliance. The senators emphasized that this would be
unacceptable for the same reasons. Regulating conduits to capture these risks
is important, said the senators, but is ultimately insufficient.
The CFTC proposed guidance on cross-border derivatives regulation introduced the concept of substituted compliance under which the CFTC would defer to comparable and comprehensive foreign regulations. The CFTC proposes to permit a non-U.S. swap dealer or non-U.S. major swap participant, once registered with the Commission, to comply with a substituted compliance regime under certain circumstances. Substituted compliance means that a non-U.S. swap dealer or non-U.S. major swap participant is permitted to conduct business by complying with its home regulations, without additional requirements under the Commodity Exchange Act.
The senators reminded the SEC and CFTC that they have a statutory obligation to ensure that the liabilities of unregulated, risky foreign swaps trading truly cannot flow back to the
To achieve that goal, it is important to understand the contexts in which these
issues of liability would likely arise. For example, the liabilities of an
offshore affiliate may come back to the U.S.-based entity if a foreign court,
following foreign law, were to determine that the U.S.-based entity is liable.
It could also happen under U.S.
law, if a U.S.
court were to elect to pierce the corporate veil, and find that the U.S.-based
entity is liable for the actions of its affiliate.
The senators explained that another way the liabilities may come back to the U.S.-based entity is if the U.S.-based entity is placed under market pressure into effectively guaranteeing the liabilities of an offshore affiliate. Protecting the firm’s reputation and customer base has proven to be a powerful motivator when a
U.S. parent has been asked to stand
behind its affiliates.
This pressure to absorb liabilities of an offshore affiliate may be particularly acute if the U.S.-based entity and the foreign entity share a common name or valued customers or counterparties; if the entities have a business reliance on one another for an essential business or service; if the entities share employees or executives; or if the counterparties to the foreign entity believe that the U.S.-based entity is likely to bail out the liabilities of the foreign entity or press it to do so
The senators urged the SEC and CFTC to revise their proposals to apply
U.S. oversight and
regulation to offshore affiliates and branches of U.S.-based firms whose
liabilities could flow back to the United States. They allowed that in
appropriate limited circumstances the doctrine of substituted compliance may
stand in for direct U.S.
While the presence of an explicit guarantee of those liabilities would be a critical and dispositive factor in that analysis, they noted, it is not the only relevant factor. Other factors that should be used to determine whether that risk is effectively guaranteed by the U.S. entity include whether there are limitations on the types of transactions that may occur between the U.S.-based and related foreign-based entity, including prohibitions on guarantees, indemnification agreements, liquidity puts, or any other transactions that may pass liability or losses to the U.S.-based entity, and CEO certification from both the U.S.-based entity and foreign entity regarding compliance with the restrictions.
In addition, another factor is whether there are specific disclosures by the U.S.-based entity to its investors and regulators that it is not guaranteeing or otherwise indemnifying the liabilities of the foreign entity; and yet another would be whether there are specific disclosures by the foreign entity to its counterparties that it is not guaranteed or indemnified by any other entity within the corporate family.
Another factor would the presence of any restrictions precluding the related foreign entity from operating under a common name with the U.S.-based entity, sharing common employees, executives, or directors, or sharing a common set of customers or counterparties. Other factors in the mix would be any limits on the dollar amounts of the foreign entity’s trading; and comprehensive resolution protocols for the foreign entity in the jurisdiction in which it is domiciled, which may include a memorandum of understanding regarding cooperation between the relevant resolution authority and the FDIC.