ADDRESSING OVERLAPS BETWEEN EMIR AND CFTC OTC DERIVATIVES REGULATION
http://www.aima.org/download.cfm/docid/64772F11-F066-414B-974E5CC984BEAE42
ADDRESSING OVERLAPS BETWEEN EMIR AND CFTCÂ OTC DERIVATIVES REGULATION1
24 MAY 2013
The Alternative Investment Management Association
2 supports efforts to promote central clearing of over-the-counter (“OTC“) derivatives and reduce systemic risk.3
The implementation of mandatory central clearing is well underway in the US and Japan and we expect that by the middle of 2014, it will be in place in Europe as well.
We appreciate the difficult task that regulators in each jurisdiction have in completing their separate OTC derivatives regulations in a prompt and thorough manner, while also ensuring that those regulations are, to the extent possible, consistent with regulations being finalized and implemented by other regulatory authorities. In particular, we strongly support the efforts of US and EU regulators to ensure an internationally coordinated approach to derivatives market reform that would provide consistent regulation, reflect the global nature of the markets, promote competition and encourage innovation.
Our concern is that, despite these efforts, the risk remains that OTC derivatives transactions could be subject to unnecessarily duplicative – or even conflicting – requirements as a result of the extraterritorial application of rules under the European Market Infrastructure Regulation
4 (“EMIR“) and Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act5 (“Dodd-Frank“). As a result, to assist the European Securities and Markets Authority (“ESMA“), the European Commission and the US Commodity Futures Trading Commission (“CFTC
“), we are providing our views on key rulemaking areas under EMIR and Dodd-Frank where further mitigation of conflicts would be helpful to ensure the continued robustness of the derivatives markets.
AIMAÂ recognizes the scale and importance of the task of implementing the regulatory reform of the derivatives market, which formally commenced with the G20Â level agreement reached at the 2009 G20Â Summit. As national and regional regulatory authorities finalize the laws and regulations that will deliver the G20Â reform package, they will face significant decisions about how to regulate a fundamentally global market. These decisions are expected to be made very shortly. In the US and Europe, the CFTC, the US Securities and Exchange Commission (”
SEC
“) and the European Commission, respectively, will determine the scope of their derivatives regulatory regime with respect to cross-border transactions. These decisions will have a significant impact on the global derivatives market.
Although this paper focuses on EMIR and CFTC rulemaking adopted under Dodd-Frank, AIMA recognizes efforts are well underway between European and US regulators and other global regulators such as Australia, Brazil, Hong Kong, Japan, Ontario, Quebec, Singapore and Switzerland (to name but a few) to address corresponding OTC derivatives regulation which requires further international coordination. In this regard, AIMA believes that the basic principles expounded by this paper have relevance to all global regulators and is, therefore, potentially relevant for a broader audience.
Â
ADDRESSING OVERLAPS BETWEEN EMIR AND CFTCÂ OTC DERIVATIVES REGULATION1
24 MAY 2013
The Alternative Investment Management Association
2 supports efforts to promote central clearing of over-the-counter (“OTC“) derivatives and reduce systemic risk.3
The implementation of mandatory central clearing is well underway in the US and Japan and we expect that by the middle of 2014, it will be in place in Europe as well.
We appreciate the difficult task that regulators in each jurisdiction have in completing their separate OTC derivatives regulations in a prompt and thorough manner, while also ensuring that those regulations are, to the extent possible, consistent with regulations being finalized and implemented by other regulatory authorities. In particular, we strongly support the efforts of US and EU regulators to ensure an internationally coordinated approach to derivatives market reform that would provide consistent regulation, reflect the global nature of the markets, promote competition and encourage innovation.
Our concern is that, despite these efforts, the risk remains that OTC derivatives transactions could be subject to unnecessarily duplicative – or even conflicting – requirements as a result of the extraterritorial application of rules under the European Market Infrastructure Regulation
4 (“EMIR“) and Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act5 (“Dodd-Frank“). As a result, to assist the European Securities and Markets Authority (“ESMA“), the European Commission and the US Commodity Futures Trading Commission (“CFTC
“), we are providing our views on key rulemaking areas under EMIR and Dodd-Frank where further mitigation of conflicts would be helpful to ensure the continued robustness of the derivatives markets.
AIMAÂ recognizes the scale and importance of the task of implementing the regulatory reform of the derivatives market, which formally commenced with the G20Â level agreement reached at the 2009 G20Â Summit. As national and regional regulatory authorities finalize the laws and regulations that will deliver the G20Â reform package, they will face significant decisions about how to regulate a fundamentally global market. These decisions are expected to be made very shortly. In the US and Europe, the CFTC, the US Securities and Exchange Commission (”
SEC
“) and the European Commission, respectively, will determine the scope of their derivatives regulatory regime with respect to cross-border transactions. These decisions will have a significant impact on the global derivatives market.
Although this paper focuses on EMIR and CFTC rulemaking adopted under Dodd-Frank, AIMA recognizes efforts are well underway between European and US regulators and other global regulators such as Australia, Brazil, Hong Kong, Japan, Ontario, Quebec, Singapore and Switzerland (to name but a few) to address corresponding OTC derivatives regulation which requires further international coordination. In this regard, AIMA believes that the basic principles expounded by this paper have relevance to all global regulators and is, therefore, potentially relevant for a broader audience.
Â
INTRODUCTION
Both EMIR and Dodd-Frank apply extraterritorially by virtue of provisions in each that seek to impose certain requirements on entities located, or on transactions executed, overseas. The extraterritorial application of EMIR is part of the regulation, although there are provisions in EMIR intended to allow the relevant regulatory authorities to eliminate conflicts or duplication with the requirements of another jurisdiction by treating compliance with the requirements of that jurisdiction as amounting to compliance with the EMIR requirements, a concept referred to as “equivalence”. Similar provisions exist under Dodd-Frank, referred to under the CFTC’s proposed interpretative guidance on the cross-border application of the Dodd-Frank swap requirements
6
as “substituted compliance”.
6
Cross Border Application of Certain Swaps Provisions of the Commodity Exchange Act, 77 Fed. Reg. 41214 (12 July 2012) (“CFTC Cross Border Guidance
“).
Given the global nature of the derivatives market and the potential overlapping extraterritorial reach of EMIR and Dodd-Frank, there is potential for conflict and overlap between certain ESMA and CFTC regulations adopted under EMIR and Dodd-Frank, notwithstanding the shared objectives of promoting central clearing, increasing transparency and overall financial stability. In particular, some conflicts may prevent counterparties from complying with either regime or result in avoidable increased compliance costs in complying with both regimes. Substituted compliance/equivalence when approached and implemented pragmatically, will go a long way in ensuring the continued operation of the global derivatives market.
Substituted compliance/equivalence may mitigate some of the risks of conflict and overlap, especially for requirements that are in direct conflict and make compliance impossible, such as separate requirements to trade or clear a swap in two different jurisdictions. However, it is less clear how substituted compliance will address the potential for divergent requirements in other areas, such as segregation of collateral for cleared and uncleared swaps, collateral eligibility and business conduct requirements. Accordingly, there is need for greater coordination between the domestic approaches of key free-market jurisdictions to these other areas.
The timing of substituted compliance or equivalence determinations will be critical. If relevant regulations come into effect before the European Commission or CFTCÂ make their respective determinations, market participants will be forced to expend significant resources to comply with both sets of rules (assuming such compliance is possible) during the interim period or, what would be even worse, start splitting their derivatives activities in order to avoid regulatory breaches due to conflicts of laws. 4
1. THE EXTRATERRITORIALITY OF EMIR REQUIREMENTS
1.1 Under EMIR, certain OTC derivative contracts, as determined by ESMA, must be cleared through CCPs. OTC derivative contracts subject to this mandatory clearing obligation must be concluded between: (i) two financial counterparties
7; (ii) a financial counterparty and a non-financial counterparty8 exceeding the clearing threshold; (iii) two non-financial counterparties exceeding the clearing threshold; (iv) a financial counterparty or a non-financial counterparty exceeding the clearing threshold and an entity established in a third country that would be subject to the clearing obligation if established in the European Union; or (v) two entities established in one or more third countries that would be subject to the clearing obligation if they were established in the European Union, provided that the contract has a direct, substantial and foreseeable effect in the European Union or where such an obligation is necessary or appropriate to prevent the evasion of any provisions of EMIR.9
ESMAÂ has not yet issued the technical standards specifying the contracts that have a direct, substantial and foreseeable effect within the EU or the cases where it is necessary or appropriate to prevent the evasion of any provision of EMIR. The reach of the clearing obligation is, therefore, unclear at this stage, although ESMA has stressed the need to forestall any attempts at regulatory arbitrage or circumvention of EMIR requirements.
7 ‘Financial counterparties’ are entities listed under Article 2(8) of EMIR and include investment firms and credit institutions authorised under applicable EU legislation.
8 ‘Non-financial counterparties’ are undertakings established in the Union, other than financial counterparties and CCPs (EMIR, Article 2(9)).
9 EMIR, Article 4(1)(a)(v).
10 EMIR, Article 13.
11
Apart from EMIR, additional requirements in relation to OTC derivatives contracts, including an exchange trading requirement for standardised OTC derivatives, will be implemented through amendments to the Markets in Financial Instruments Directive11
, generally referred to as MiFIDÂ II, and a new regulation on markets in financial instruments, generally referred to as MiFIR.
12
Dodd-Frank, section 722(d); Commodity Exchange Act Section 2(i). Similarly, the requirements relating to security-based swaps regulated by the SEC will apply to security-based swaps entered into outside the US where these contravene SEC rules intended to prevent the evasion of US requirements. Recently, the SEC issued proposed rules on the “Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants” (“SEC Proposed Rules
“), in which the SEC’s sets forth its proposal for addressing the extraterritorial application of the security-based swap requirements in light of discussions with international regulators and public comment on the CFTC Cross Border Guidance.
13 In the CFTCÂ Cross Border Guidance, the CFTCÂ included a broad definition of ‘US person’ that would include: (i) any commodity pool, pooled account or collective investment vehicle (whether or not it is organized or incorporated in the United States) of which a majority ownership is held, directly or indirectly, by a U.S. person(s); any (ii) any commodity pool, pooled account or collective investment vehicle the operator of which would be required to register as a commodity pool operator under the CEA.
1.2 A provision of EMIR intended to avoid duplicative or conflicting rules, to some extent, mitigates the impact of the potentially broad scope of the clearing and reporting obligations. Where one party to the transaction is established outside the EU and is subject to a regime declared “equivalent” to EMIR, the parties will be deemed to comply with the EMIR clearing and reporting obligations if they satisfy such requirements in the “equivalent” jurisdiction.
10 This deemed equivalence is conditional upon the European Commission adopting an implementing act on the equivalence of the non-EU regime. To date, the European Commission has not adopted any such implementing acts.
11
2. THE EXTRATERRITORIALITYÂ OF CFTC RULES
2.1 Section 722(d) of Dodd-Frank, which amends Section 2 of the Commodity Exchange Act (”
CEA“), provides the CFTCÂ with express authority over swap activities outside the United States where such activities either: (a) have a direct and significant connection with activities in, or effect on, commerce in the US; or (b) contravene CFTC rules intended to prevent evasion of US requirements.
12
2.2 On 29 June 2012, the CFTC issued the CFTC Cross Border Guidance. Under the CFTC’s proposed approach, where a non-US institution engages in derivatives transactions with a “US person”
13
(or, in certain cases, 5
non-US persons guaranteed by US persons) those institutions and/or transactions would be subject to registration with the CFTCÂ and related regulatory requirements, although, in some cases, the CFTCÂ would permit “substituted compliance” with the institution’s home country requirements in lieu of compliance with its rules. The CFTC Cross Border Guidance has been the subject of substantial comment and concern from non-US institutions and governments.
2.3 Although the CFTC has not finalized the CFTC Cross Border Guidance, on 21 December 2012, the CFTC issued a temporary exemptive order addressing the extraterritorial application of certain swaps requirements, which is effective until 12 July 2013 (the ”
Cross Border Exemptive Order“).14 Among other matters, the Cross Border Exemptive Order: (i) instructs market participants for the purposes of the Cross Border Exemptive Order, to apply a temporary, more narrow definition of “US person” as compared to the proposed definition in the CFTC Cross Border Guidance15; (ii) clarifies certain aspects of the de minimis exception from swap dealer (“SD“) and major swap participant (“MSP“) registration as it applies to non-US persons; (iii) delays implementation of “Entity-Level Requirements”16 for registered non-US SDs and MSPs; and (iv) allows non-US dealers and non-US branches of US dealers to comply with transaction-level requirements of the local jurisdiction for trades with non-US persons instead of CFTC “Transaction-Level Requirements”17
. In adopting this temporary relief, the CFTCÂ indicated that it is continuing to review cross-border implementation issues, including through discussions with other regulators, and expects to provide further guidance in the future. Nonetheless, significant questions remain, including the treatment of funds and similar entities as US persons and the application of CFTC rules to such entities or the transactions into which they enter.
14
Final Exemptive Order Regarding Compliance with Certain Swap Regulations; Further Proposed Guidance, 78 Fed. Reg. 858 (7 January 2013).
15
For example, the narrower “US person” definition in the Cross Border Exemptive Order did not include several categories that were in the “US person” definition in the CFTC Cross Border Guidance, including: (i) collective investment vehicles organised outside the US that are majority owned by US persons, (ii) collective investment vehicles with a registered commodity pool operator, and (iii) legal entities organized in the US in which one or more of the direct or indirect owners that are responsible for the liabilities of such entity is a US person.
16
Entity-Level Requirements relate to: (i) capital adequacy; (ii) chief compliance officer; (iii) risk management; (iv) swap data recordkeeping; (v) swap data reporting; and (vi) physical commodity swaps reporting (i.e.
, large swap trader reporting). The Entity-Level Requirements generally apply to registered SDs and MSPs, across all their swap transactions, without distinctions as to the counterparty or the location of the swap.
17
Transaction-Level Requirements relate to: (i) clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) trade execution; (iv) swap trading relationship documentation; (v) portfolio reconciliation and compression; (vi) real-time public reporting; (vii) trade confirmation; (viii) daily trading records; and (ix) external business conduct standards.
3. POTENTIAL FOR REGULATORY CONFLICT OR OVERLAP
3.1 Given that the OTC derivatives market is global in nature, there is an inherent challenge for individual authorities when it comes to defining the reach of their rules. Accordingly, there is a clear risk that parties or a transaction may be subject to conflicting or overlapping rules and thus, may be legally or practically prohibited from trading or otherwise complying with the relevant requirements (e.g., conflicting clearing obligations). Conflict or overlap may lead to market fragmentation and could disrupt the global nature of the derivatives market.
3.2 Article 13 of EMIR addressing duplicative or conflicting rules and the CFTC’s proposal for “substituted compliance” are helpful, but the US and EU regulators still need to take formal steps to avoid market fragmentation before the duplicative or conflicting requirements come into effect. Below are examples where the extraterritorial impact of US and EU regulations could lead to practical compliance issues (for further areas of overlap and conflict between EMIR and the CFTC rules, please see the Annex to this paper):
(a) Clearing Obligation: We encourage continued dialogue between CFTC and European Commission when making determinations as to which derivatives products will be subject to mandatory 6
clearing.
18
However, potential remains for regulatory conflict for transactions between EU entities and US entities that are subject to mandatory clearing under both regimes. For example, counterparties may trade in a swap that is subject to the CFTC’s mandatory clearing regime as well as the clearing obligation in the EU.
18 Please also see the position taken by the OTC Derivatives Regulators Group as addressed in its Report to the G-20 Meeting of Finance Ministers and Central Bank of Governors of 18-19 April 2013 for further support in this area.
19 EMIR, Article 9.
20 Commission Implementing Regulation (EU) No 1247/2012 of 19 December 2012, Annex
21 17 C.F.R. Part 49.16.
22
Ibid
It will be problematic for market participants and clearing houses to comply with the clearing obligations under both the CFTC’s rules and ESMA’s technical standards. Many clearing houses will seek to dually-register and obtain all relevant authorisations and recognitions in the US and EU to mitigate these issues. In theory, such dual registration may permit market participants to satisfy a clearing obligation in both jurisdictions. Yet, even where a clearing house is a CFTC-registered derivatives clearing organisation (”
DCO“) and authorized or recognized as a central counterparty (“CCP
“) under EMIR, the differing requirements on margin and segregation (as set out in the Annex), as well as different rules for intermediaries and the method of access to the DCOs/CCPs, will raise significant legal and operational issues that could prove difficult to overcome.
With limited exceptions, the CFTCÂ has not proposed to allow substituted compliance with respect to the clearing obligation in a transaction between a USÂ person and an EU counterparty. Even under EMIR – which would allow an “equivalence” determination in that context – it is not clear whether the European Commission will make any “equivalence” determinations, either affirmatively or negatively, in time for the commencement of the clearing obligation. These issues are compounded by a lack of clarity over the precise scope of many of the requirements for equivalence.
(b) Reporting Obligation: Unless US swap data repositories (”
SDRs“) and EU trade repositories (“TRs“) become dual registered, it may not be possible to comply with both the EMIR and CFTC reporting rules in respect of a transaction between a US counterparty and an EU counterparty without making two separate reports. Reporting requirements in more than one jurisdiction are likely to apply if the counterparties to the trade are located in different jurisdictions or if a foreign branch is used.19 The reporting fields under CFTC rules and ESMA technical standards are different and use different terminology for the same fields.20
The more extensive EU reporting requirements, particularly in relation to margin posted for OTC derivatives, may mean that CFTC-compliant reporting may not be regarded as “equivalent” for EMIR purposes. As above for clearing, it is not clear whether ESMA will make any “equivalence” determinations for TRs, either affirmatively or in time for the commencement of reporting obligations. Contrary to the position for clearing, to our knowledge no European repository is dual regulated in the US, or vice versa.
In addition to duplicative reporting, the confidential treatment of the reported information may not be consistent. The CFTCÂ requires SDRs to establish policies and procedures to protect the confidentiality of the data it maintains.
21 SDRs also cannot require, as a condition to accepting swap data, the waiver of a counterparty’s privacy rights.22
Under EMIR, TRs’ internal policies must prevent any use of information for commercial use, for illegitimate purposes or that amount to disclosure of confidential information. Furthermore, with respect to real-time reporting, the CEA explicitly directs the CFTC to require that real-time public reporting of transactions by SDRs occur in a manner that does not disclose a party’s business transactions and market positions. To that end, the CFTC is requiring SDRs to apply an appropriate time delay, rounding convention and 7
notional cap
23 prior to the public dissemination of the swap transaction and pricing data.24
There is a concern that duplicative reporting of trades increases the risk of the misuse or leakage of confidential information.
23
In order to protect the counterparties’ identities, business transactions and market positions, the CFTC is requiring that the rounded notional or principal amount that is publicly disseminated for a publicly reportable swap transaction be capped in a manner that adjusts in accordance with the appropriate minimum block size that corresponds to such transaction. For example, the cap for interest rate swaps with a tenor greater than zero up to and including two years will be USD 250 million.
24 17 C.F.R. Part 43.4.
25 17 C.F.R. Part 22.2.
26 17 C.F.R. Part 39.13.
27 EMIR, Article 46(1).
(c) Segregation and Portability of Cleared Swap Customer Collateral: Under EMIR, CCPs have to offer the choice between omnibus segregation and individual client segregation in separate accounts for cleared swaps. In addition, CCPs must take all reasonable steps to ensure that they have legal powers to liquidate the proprietary positions of the defaulting clearing member and to transfer or liquidate the positions of the defaulting clearing member’s clients.
In contrast, under CFTC rules, the Legal Segregation with Operational Commingling (”
LSOC“) model is the only option for cleared swaps, which provides that futures commission merchants (“FCMs“) and DCOs must track separately each customer’s positions and the collateral allocated to those positions, although they may operationally maintain customer collateral in an omnibus account.25
The FCM and DCO would further be prohibited from using margin collateral allocated to one customer’s positions to satisfy the liabilities related to another customer’s positions. By requiring separate accounting of each customer’s collateral and daily reconciliation, LSOC is intended to facilitate the porting of customer positions and related margin from an insolvent FCM to a solvent FCM.
The structures that would satisfy the EMIR requirement for individual segregation appear to exceed the requirements of LSOC in that asset-by-asset accounting will be needed for customers, not just the protection of the value of a customer’s interest in the pool of customer collateral. In addition, because the EMIR and CFTC segregation options differ, in the event of a clearing member’s default, customers would have different rights and abilities to transfer their positions and collateral. As a result, it is unclear whether ESMA will determine that the LSOC approach is equivalent for US clearing houses wishing to have access to European markets, or whether the European requirements would apply in the context of the insolvency of a US clearing member of a European clearing house.
(d) Eligible Collateral for Cleared Transactions: For both cleared and uncleared swaps, it is possible that eligible collateral requirements will differ
. With respect to cleared swaps, the CFTC’s rules mandate a DCO to limit the type of assets it accepts as initial margin to those which have minimal credit, market and liquidity risks.26 Although no assets are specifically identified, the rule prohibits DCOs from accepting letters of credit as initial margin for cleared swaps, whereas under EMIR, initial margin may include letters of credit or bank guarantees for non-financial counterparties.27
It may, in theory, be possible for counterparties to comply with the more stringent requirements where a transaction is subject to duplicative regulation, however, this is likely to be difficult operationally. Even if CCPs and clearing members are allowed to comply separately with EMIR or Dodd-Frank requirements for particular transactions, that may require them to hold separate accounts for Dodd-Frank-compliant transactions and for EMIR-compliant transactions. The need for such multiple accounts will increase the operational burden and may have the effect of increasing collateral requirements overall. That in turn may have the effect of non-US entities being reluctant to enter into transactions with, or clear for, US entities, or vice versa. 8
(e) Margin Requirements for Uncleared Swaps: Under the CFTC’s proposed margin rules, uncleared swaps are subject to margin requirements at least as stringent as are applicable to cleared swaps. Specifically, SDs and MSPs must exchange both initial and variation margin on uncleared swaps where their counterparty is also an SD or MSP. The CFTC also proposes to require financial end-users to post both initial and variation margin to their SD/MSP counterparty, however, the CFTC does not require the SD/MSP to post any collateral to the financial end-user (although the SD/MSP could agree to do so).
28 In contrast, in the EU, the European Supervisory Authorities have yet to propose specific technical standards relating to margin requirements for uncleared swaps, despite the adoption of technical standards for risk mitigation techniques for uncleared swaps.29
As a result, the possibility remains that these requirements ultimately will be inconsistent and lead to substantial differences in costs of trading uncleared swaps in the EU as compared to the US. We note that some of these issues are expected to be considered in the Basel Committee on Banking Supervision/International Organization of Securities Commissions’ consultation on margin requirements for uncleared swaps.
28 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 76 Fed. Reg. 23732 (28 April 2011).
29 Commission Delegated Regulation (EU) No 149/2013 of 19 December 2012 supplementing Regulation (EU) No 648/2012 (EMIR).
30 See CFTC Cross Border Guidance
at 41232.
31
Ibid.
at 41233.
32 EMIR, Article 13(3).
4. SUBSTITUTED COMPLIANCE
4.1 As discussed above, substituted compliance or equivalence, in general, refers to the ability of a market participant to comply with the comparable regulations imposed by competent authorities in one jurisdiction in lieu of compliance with another jurisdiction’s rules, where the market participant and/or its transactions would otherwise be subject to both sets of rules. As mentioned herein, the CFTC issued the CFTC Cross Border Guidance, which proposes to permit a non-US SD/MSP to conduct business by complying with its home jurisdiction’s law and regulations, without having to comply with certain requirements under the CEA, provided that, the CFTC finds that such home country rules are comparable to the CFTC’s requirements. The CFTC would make this comparability determination on an individual requirement basis, rather than on the foreign regime as a whole.
30
Hence, the CFTC may permit a non-US SD/MSP to comply with regulations of its home jurisdiction to the extent that the comparability standard is met for certain requirements, but the non-US SD/MSP may also have to comply with certain CFTC rules where comparable home country regulations are deemed to be lacking.
4.2 In making a comparability determination, the CFTC has stated that it will calibrate its approach to reflect the heightened requirements and expectations under Dodd-Frank, and will use an outcomes-based approach to determine whether the home jurisdiction’s requirements are designed to meet the same regulatory objectives of Dodd-Frank. The CFTC will also retain broad discretion to determine that the objectives of any program elements are met, notwithstanding the fact that the foreign requirements may not be identical to the equivalent requirements of the CFTC.31
4.3 In contrast, the European Commission would make an equivalence determination in the EU by looking at the non-EU regime as a whole. Thus, if the European Commission declares that the CFTC regime is equivalent as a whole to EMIR, it would be acceptable for the EU counterparty of a swap with a US counterparty to comply with all relevant US requirements.
32
However, given that the CFTCÂ looks at substituted compliance on an individual requirement basis, the CFTCÂ may find that the US counterparty may clear its swap in the EU but must also still report that swap in the US.
4.4 In our submissions to the CFTC on the CFTC Cross Border Guidance as well as the CFTC’s further proposed guidance on cross-border issues, we recommended that the US authorities should, in tandem with other jurisdictions, defer to the mechanism of jurisdiction-level equivalence for resolving situations of conflict or overlap, rather than using either the requirement-by-requirement form of substituted compliance it 9
has proposed or
ad hoc no-action relief for individual requirements. Substituted compliance should apply to all US swap requirements, including Transaction-Level Requirements. In addition, we would respectfully submit that the CFTCÂ should use broad-based criteria in making any determinations required as part of implementing a substituted compliance framework. Given that the reform of the OTC derivatives market stems from a G20-level agreement, we believe that substituted compliance should be broadly construed, rather than based on one-to-one correspondence of specific requirements.
33
33
Although we have not yet formulated our response to the SEC’s Proposed Rules, we note the approach to substituted compliance appears to be based on a number of high level categories, rather than on a line-by-line comparison and should take appropriate account of comparable regulatory regimes of other countries.
34
“Active funds” are defined as private funds, under the US Investment Company Act of 1940, that are not a third-party subaccount and that execute 200 or more swaps a month based on a monthly average over preceding 12 months. See
17 C.F.R. Part 50.25(a).
4.5 Although even substituted compliance would not completely eliminate differences in EU and US regulatory requirements, mutual agreement amongst authorities in leading financial jurisdictions on substituted compliance would: (i) provide greater certainty for market participants (thereby creating greater stability in the swaps market), (ii) mitigate the potential for regulatory arbitrage, (iii) ensure equal and fair treatment of all market participants, and (iv) reduce potential drains on the CFTC’s resources in having to address conflicts on a case-by-case basis. We, however, acknowledge that given the advances the CFTC has made in its Dodd-Frank rulemaking process (
e.g., mandatory clearing is already in place in the US for SDs, MSPs and active funds,34 and will be in place for all market participants by September 2013, while mandatory clearing is not expected to occur in the EU until 2014), the CFTC would not be able to make its determination regarding substituted compliance until ESMA issues a sufficient number of key technical standards under EMIR. As a result, market participants subject to both the CFTC’s rules and ESMA’s technical standards are likely to face duplicative requirements until the CFTC and the European Commission are able to complete a comparability analysis for the purpose of making a determination as to whether substituted compliance or equivalence is permissible.
4.6 Consideration of substituted compliance/equivalence should not detract US and EU regulators, to the extent possible, from engaging in on-going discussions and making every effort to address conflicting or duplicative derivatives regulations. There is a critical need for the US and EU regulators to arrive at a consensus on some of the most important requirements, such as eligible collateral, segregation requirements, margin calculation methodologies and business conduct requirements for uncleared swaps.
4.7 We acknowledge that in its role as the agency charged with oversight of the swaps market under Dodd-Frank, the CFTC, like other global policy makers, has a difficult task in ensuring its rulemaking effectively captures swaps activity with a sufficient commercial nexus in its home jurisdiction. We further acknowledge that regulators are required to consider a degree of extraterritorial application in their respective rulemaking as a consequence of the global nature of the swaps market.
4.8 In presenting the key areas of rulemaking susceptible to duplicative or conflicting requirements, we are hopeful that this paper is a useful source of information to global policy makers and thus aids the continued implementation of globally consistent OTC derivatives reform as envisaged at the 2009 G20 Summit. We look forward to continued correspondence with the CFTC on this matter and welcome the opportunity to discuss issues raised in this paper in greater depth.
* * * * * * * * * * * * * * * *
10
| ANNEX: COMPARISON OF REQUIREMENTS UNDER CFTC RULES AND EMIR Requirement
|
CFTC
|
EMIR
|
| Clearing Obligation
|
Any person who is a party to a swap that is within a category of swaps designated by the CFTCÂ for mandatory clearing must centrally clear the swap. The CFTCÂ Cross-Border Guidance would make a transaction between a US person and a non-US person subject to the mandatory clearing requirement.
There is an exception to the clearing requirement where one of the counterparties is not a “financial entity”, it is using the swap to hedge risk, and it notifies the CFTC how it will meet its financial obligations on the swap.
35 There is also an exemption from the clearing requirement for inter-affiliate swaps between majority-owned affiliates that meet certain conditions.
36
A non-financial counterparty to an uncleared swap can require that the swap be cleared.
The CFTCÂ determines the swaps which will be subject to mandatory clearing. The CFTC has initially determined that certain interest rate swaps and index CDS are required to be cleared.
37
Certain FX deliverable swap and forward transactions are exempt from the definition of swap (and thus from the mandatory clearing requirement).
The CFTC has not yet proposed to make other categories of swaps subject to mandatory clearing.
|
The clearing obligation will apply to OTC derivatives contracts that:
(a) are entered into by:
(i) two EU “financial counterparties”;
(ii) an EU “financial counterparty” and an EU “non-financial counterparty” which has exceeded the clearing threshold (to be set out in technical standards) based on its rolling average positions for 30 working days (in which case central clearing of all contracts must begin within 4 months);
(iii) two EU “non-financial counterparties” which have exceeded the clearing threshold;
(iv) an EU financial or non-financial counterparty which has exceeded the clearing threshold and a non-EU entity that would be subject to the clearing obligation were it established in the EU; or
(v) two non-EU entities that would be subject to the clearing obligation if they were established in the EU provided that the transaction has a “direct, substantial and foreseeable effect” within the EU or to prevent evasion; and
(b) are in an instrument declared subject to the clearing obligation (to be set out in technical standards that ESMA has not yet published).
Such contracts must be cleared by a CCP authorized in accordance with EMIR (EU-incorporated CCPs) or recognized under EMIR (non-EU CCPs).
Intragroup transactions are exempt from the clearing requirement.
Counterparties are permitted to comply with the clearing obligation through indirect clearing arrangements with a clearing member of a CCP.
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The EMIR clearing thresholds for non-financial counterparties are based on different notional amounts per asset class. When one threshold is reached, the non-financial counterparty will
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