The Commodity Futures Trading Commissions (CFTC)
proposed swap rules under
Title VII of the Dodd-Frank Act could result in a shut-out
of US persons in Asias over-the-counter (OTC) derivatives
Counsel are alarmed by the rule's broad extraterritorial
reach and its strict interpretation of substituted compliance.
Non-US regulators have also expressed concerns about non-US
persons being subject to CFTC registration and compliance with
two sets of regulations that may overlap or conflict.
Although the CFTC has proposed a substituted compliance
provision, its requirements are not in line with market
structures throughout Asia, which are generally less active and
have less liquidity than that of the US.
Robert Chu, partner in Sullivan & Cromwells
Melbourne office, said that this period will present
opportunities for sophisticated, well-informed and well-advised
players, but others will be mired in layers of mind-boggling
US persons and extraterritorial
The definition of US persons in the CFTCs proposed
rules is broader than that of similar laws and regulations,
such as the definition included in the SECs Regulation S
and the proposed Volcker rule.
Theodore Paradise, head of Davis Polk & Wardwells
Tokyo office, said that one significant difference is that its
definition of US person includes a collective investment
vehicle of which majority ownership is held directly or
indirectly by US persons. Moreover, the definition includes an
individual account, whether discretionary or not, where the
beneficiary is a US person.
Foreign affiliates or agencies of US-based swap dealers such
as a branch of an American bank in a foreign country falls
under the US person definition. In contrast, a subsidiary or
affiliate of an American bank in a foreign country would be a
non-US person, even if all swaps were guaranteed by a US
But it will be difficult to identify US persons under such
broad guidelines, resulting in compliance issues.
Requiring non-US person swap dealers or major swap
participants to register if they meet de minimis
thresholds makes it difficult to do business with US persons.
Chu said that it is a daunting prospect for non-US persons
unfamiliar with the US regulatory regime to comply. It
may not be simple to determine whether they are subject to the
requirements, whether on registration, on execution and
clearing or on capital and margin, he added.
In a joint comment letter by the Australian Securities and
Investments Commission (ASIC), Reserve Bank of Australian
(RBA), Hong Kong Monetary Authority (HKMA), the Securities and
Futures Commission (SFC) and the Monetary Authority of
Singapore (MAS), the regulatory bodies warned that non-US swap
dealers may be unable to continue dealing with US customers in
the OTC derivatives market to avoid legal risk.
Sources warn that the rules could result in regulatory
overlap, duplication, confusion and fragmentation.
Several jurisdictions have already noted that compliance
with the CFTCs rules would violate local law. A comment
letter submitted by the Korea Federation of Banks noted that
Korean financial institutions would be in violation of
Koreas Real Name Act if they submitted trade data to US
regulators without specific customer consent.
Why substituted compliance isnt a
Although the CFTC has introduced substituted compliance to
account for different rules across different jurisdictions,
counsel largely believe it may create more problems than
Francis Edwards, partner at Clifford Chance, said that there
is a general dissatisfaction with substituted compliance
because each entity must apply separately. It seems to
entail a line-by-line review of the laws in each jurisdiction,
and entities could be subject to some or all of Dodd Frank
anyway, he said.
Substituted compliance would only apply to transactions
between two non-US persons: trades involving US counterparties
will always be subject to Dodd-Frank, even if another
jurisdictions regulations also apply.
CFTC decisions involving substituted compliance would apply
to firms rather than jurisdictions. The European
Commissions comment letter condemned the firm-by-firm
approach, commenting that it lead to different and even
discriminatory treatment between firms and jurisdictions.
But most Asian jurisdictions OTC derivatives markets
are not prepared for substituted compliance. Edwards said that
there is a different market structure in Asia: the OTC
derivatives market is not as big and less liquid.
The joint letter by Australian, Hong Kong and Singapore
regulators highlighted local market liquidity as an issue, and
questioned whether the OTC derivatives markets are large enough
to implement mandatory trading on exchanges or electronic
Implementation of the CFTCs rules
Another issue stemming from broad-based, extraterritorial
rules is their implementation. Chu noted that regulators have
been facing resource constraints and have found their
rulemaking responsibility under Dodd-Frank challenging.
The CFTC in particular has been resource-constrained in
the rulemaking endeavor and theyre not out of the woods
yet, he commented.
Under the CFTCs proposed rules, non-US swap dealers
with US customers and major swap participants (MSPs) are
required to register with the CFTC: the registration deadline
was 12 October,
but may have been pushed to January. Registered non-US swap
dealers and MSPs will be required to comply with swap data
reporting and physical commodity swaps reporting
Though the deadline has been extended, Edwards commented
that a lot of Asian banks may not be able to get up to speed
that quickly to assess whether they need to register. He said
that if theres no resolution of these issues, Asian banks
may find themselves in a position where they have to cease
trading certain products until they can ensure compliance with
But the rules are still in flux. Chu warned that completion
of the rulemaking process is still a long way off. Although
final rules and interpretations have been adopted with respect
to certain definitions and products, additional layers of
regulatory guidance are still in the works.