In a letter to the SEC and CFTC, eight U.S. Senators
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 U.S. trading
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 U.S.
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.
supervision.
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.