European Commission Supports SEC Proposed Cross-Border Derivative Regulations

In a letter to the SEC, the European Commission generally supported the SEC’s proposed cross-border derivatives regulations, especially praising the Commission’s use of substituted compliance for firms and exemptive relief for market infrastructure. The European Commission is encouraged by the holistic approach that the SEC proposes to take when assessing a foreign regime with a view to awarding substituted compliance. The Commission supports the consideration of regulatory outcomes as the standard for permitting substituted compliance, as well as the consideration of particular market practices and characteristics in individual jurisdictions.

This flexible approach recognizes the differing approaches that regulators and legislators may take to achieving the same regulatory objectives in the derivatives markets. The European Commission did suggest, however, that the review of a foreign regime should be conducted in cooperation solely with the relevant foreign regulators or legislators, as opposed to firms. In particular, the initiation of the review should be left to the relevant foreign regulator or legislator in order to avoid duplication or confusion.

The European Commission is also supportive of a definition of a US person that is territorial in scope, which does not capture entities incorporated in foreign jurisdictions. Within this meaning, the proposed definition of a US person is primarily territorial in nature. But there is one notable exception, in the form of the inclusion of any partnership, corporation, trust, or other legal person having its principal place of business in the United States.

While recognizing that the purported capture of firms incorporated outside of the US but operating principally within the US is designed to ensure the non-evasion of obligations by firms that essentially conduct their core business within the US but that are notionally incorporated in non-regulated jurisdictions, the European Commission urged the SEC to clarify the type of businesses that it intends to capture through this notion, either within the operative text of its rules or through accompanying guidance.

The Commission suggested that the SEC may wish to consider adding criteria to establish whether a non-US entity meets the definition of US person in this respect, such as quantitative thresholds such as a percentage of business conducted in the US and whether the seat of incorporation of the firm is a non-regulated jurisdiction. Indeed, the Commission feels that it is essential that further clarity be provided on this aspect of the definition in order to enable firms to establish whether they or their counterparties would be classified as US persons by the SEC.

The Commission observed that the notion of transactions conducted within the US runs throughout the proposal and is a trigger point for the application of US rules transacted with or between non-US firms. The result is that transactions involving non-US firms may be caught by SEC rules by virtue of being deemed to be concluded on US territory, although either one or both of the legal counterparties to the transaction  may be non-US persons. The proposal would require non-U.S firms to comply with U.S. rules on reporting and trade execution in two instances: 1) when a transaction executed by a non-US firm with a US firm where the non-US firm transacts via a US branch but where the non- US firm is the legal counterparty to the transaction; and 2) a transaction executed between two non-US firms through US branches but where the non- US firms are the legal counterparties to the transaction.

The European Commission asked the SEC not to apply its rules in the case where the legal counterparty to a transaction deemed to be conducted in the US is a non-US firm since no US firms are exposed to counterparty credit risk under such transactions and in particular where those non-US firms are subject to comparable rules in its domestic jurisdiction.