Dodd-Frank Act: Title VII - Reaching out on swaps

Author: | Published: 1 Jul 2013
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Annette L Nazareth and E Ashley Harris of Davis Polk & Wardwell examine the extraterritorial reach of the swaps provisions of Title VII of the US Dodd-Frank Act

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) established, for the first time, a comprehensive US regulatory regime for swaps and security-based swaps (referred to collectively in this article as swaps) providing for (i) the registration and regulation of swap dealers and major swap participants; (ii) central clearing and trade execution for standardised swaps; (iii) recordkeeping and reporting for all swaps; and (iv) regulation of swap data repositories, clearing houses and swap execution platforms. The majority of the Title VII provisions require implementing regulations to be issued by the Commodity Futures Trading Commission (CFTC) (for swaps) or the Securities and Exchange Commission (SEC) (for security-based swaps), or both. As such, the precise effect of Title VII, and in particular, its extraterritorial application, are being developed by the US regulators.

Title VII extraterritoriality provisions

The extraterritorial reach of Title VII and the CFTC's and SEC's implementing rules are limited by Sections 722 and 772 of the Dodd-Frank Act. Section 722 applies to the CFTC and provides that the provisions of the Commodity Exchange Act relating to swaps that were enacted by Title VII "shall not apply to activities outside the United States unless those activities … have a direct and significant connection with activities in, or effect on, commerce of the United States [or] contravene [CFTC anti-evasion rules]." Section 772 applies to the SEC and provides that "[n]o provision" of the Securities Exchange Act of 1934 relating to security-based swaps "shall apply to any person insofar as such person transacts a business in security-based swaps without the jurisdiction of the United States, unless such person transacts such business in contravention of [SEC anti-evasion rules]." The generality of Sections 722 and 772 provides the CFTC and SEC with significant regulatory discretion to interpret these provisions and define the cross-border application of Title VII.

The regulators' general approach

"The CFTC’s proposed guidance calls for a sweeping extraterritorial application of the swaps provisions"

Since the swap market developed as a global, interconnected market without regard to geographic boundaries, the CFTC and SEC each plan to address the cross-border issues by adopting a holistic set of rules or guidance regarding the extraterritorial application of Title VII. While the SEC has not yet released its proposal, the CFTC issued proposed guidance in June 2012 (Cross-Border Application of Certain Swaps Provisions of the Commodity Exchange Act, 77 Fed. Reg. 134 (July 12 2012)), which outlines how the CFTC intends to exercise its jurisdiction under Title VII. While many of the CFTC's swaps-related regulations have become effective before the final cross-border guidance has been adopted, the SEC has stated that its cross-border rules for security-based swap activities will be proposed before final rules with cross-border implications, such as security-based swap dealer registration and related regulations, are adopted (Statement of General Policy on the Sequencing of the Compliance Dates for Final Rules Applicable to Security-Based Swaps Adopted Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, 77 Fed. Reg. 35625 (June 14 2012)). On May 1, 2013, the SEC released proposed rules governing cross-border activities in security-based swaps. Because the proposed rules had not been released at the time this article was written, this article focuses only on the CFTC's cross-border regulatory approach.

CFTC proposed guidance

The CFTC's proposed guidance calls for a sweeping extraterritorial application of the swaps provisions of Title VII. Specifically, it would require certain non-US entities to register with the CFTC as swap dealers and comply with swap dealer regulations and would impose the CFTC's regulations on any swap involving a US person and certain other swaps with a sufficient US nexus. (Given the small number of major swap participant registrants, this article discusses the application of Title VII to swap dealers only; the CFTC's proposed cross-border regime for swap dealers and major swap participants is generally the same.) Furthermore, the CFTC would permit "substituted compliance" with foreign regulations, but only on a very limited basis. Pursuant to substituted compliance, a swap dealer will be permitted to comply with a comparable home country regulatory provision in lieu of the US regulatory requirement.

Annette Nazareth, Davis Polk & Wardwell
The CFTC's proposed guidance covers three main areas: (i) the swaps activities that would require non-US entities to register with the CFTC as swap dealers; (ii) how the CFTC's regulations would apply to non-US registrants and their swaps; and (iii) the extent to which the CFTC's regulations would apply to swaps involving two end users, at least one of which is a non-US person. End users are participants in the swaps market that are neither swap dealers nor major swap participants, as defined in the CFTC's regulations. Central to the cross-border application of Title VII under the proposed guidance is the presence of a US person counterparty; swaps with US persons trigger swap dealer registration requirements and the application of CFTC regulations. Therefore, the definition of US person is critical for determining the extraterritorial reach of Title VII. The proposed guidance sets out an expansive definition of US person, which includes: (i) any natural person who is a resident of the United States; (ii) any corporation that is organised or has its principal place of business in the United States, or in which the direct or indirect owners thereof are responsible for the liabilities of such entity and one or more of such owners is a US person; (iii) any individual account where the beneficial owner is a US person; (iv) any commodity pool, pooled account or collective investment vehicle (whether or not it is organised or incorporated in the United States) of which a majority ownership or equity interest is held, directly or indirectly, by a US person; (v) 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 Commodity Exchange Act; (vi) any pension plan for the employees, officers or principals of a legal entity with its principal place of business inside the United States; and (vii) any estate or trust, the income of which is subject to US income tax regardless of its source. Non-US branches of US persons also would be US persons.

Swap dealer registration and regulation

A key aspect of Title VII is the requirement that certain entities register with the CFTC as swap dealers and with the SEC as security-based swap dealers. Under the CFTC's and SEC's joint rules defining swap dealer and security-based swap dealer, an entity is a swap dealer and therefore required to register as such if its swap dealing activities, in aggregation with those of its affiliates under common control, exceed the specified de minimis level (see Further Definition of "Swap Dealer," "Security-Based Swap Dealer," "Major Swap Participant," "Major Security-Based Swap Participant" and "Eligible Contract Participant," 77 Fed. Reg. 30596, May 23 2012). The current de minimis level is set at $8 billion over a 12-month period for swaps and for security-based swaps that are credit default swaps, and $400 million for other security-based swaps. The threshold for swap dealing with so-called special entities (for example pension funds and certain governmental entities) is $25 million over a 12-month period. "Swap dealing" is defined to mean: (i) holding oneself out as a dealer in swaps; (ii) making a market in swaps; (iii) regularly entering into swaps with counterparties as an ordinary course of business for one's own account; or (iv) engaging in activity causing oneself to be commonly known in the trade as a dealer or market maker in swaps.

"Once registered, an entity becomes subject to the full scope of CFTC jurisdiction and regulation"

To determine whether a non-US entity must register with the CFTC as a swap dealer, the proposed guidance provides that such non-US entity would need to count all swap dealing transactions between US persons and any of its non-US affiliates under common control, as well as any swap dealing transactions of any of its non-US affiliates under common control where the obligations of such non-US affiliates are guaranteed by US persons. A non-US entity need not include swap dealing with non-US branches of registered US swap dealers or the swap dealing transactions of its US affiliates.

Once registered with the CFTC, an entity becomes subject to the full scope of CFTC jurisdiction and regulation. The proposed guidance divides the swaps regulations into two categories: entity-level requirements, which apply to a swap dealer as a whole (such as capital, chief compliance officer, internal business conduct, swap data repository reporting and recordkeeping requirements); and transaction-level requirements, which apply to the individual swap (such as clearing, margin for uncleared swaps, real-time reporting, trade execution, trade documentation and external business conduct).

Although entity-level requirements would apply to all registered swap dealers (whether US or non-US), the proposed guidance generally would permit a non-US swap dealer to apply to use substituted compliance for such requirements with applicable foreign regulations.

For transaction-level requirements, the CFTC would impose its transaction-level requirements on a non-US swap dealer's swaps with any US person, any non-US persons whose swap obligations are guaranteed by a US person and any "non-US conduit affiliate", which is defined as an entity that is majority-owned, directly or indirectly, by a US person, that enters into swaps with one or more other US affiliates or subsidiaries of the US person and the financials of which are included in the consolidated financials of the US person. A non-US swap dealer would be permitted to apply to use substituted compliance for transaction-level requirements with respect to swaps between itself and non-US persons guaranteed by US persons and non-US affiliate conduits. The CFTC's transaction-level requirements would not apply to swaps between a non-US swap dealer and any other non-US persons.

End user regulation

While the majority of Title VII requirements apply to swap dealers and their activities, all market participants, including end users, are subject to central clearing, trade execution, recordkeeping and reporting requirements. The proposed guidance provides that where both counterparties are non-US end users, Title VII requirements generally would not apply. Although a swap with a US counterparty would trigger application of Title VII, the CFTC would permit substituted compliance with respect to the requirement to report to a swap data repository, provided the CFTC has direct access to the swap data stored at that repository.

Substituted compliance

As noted above, substituted compliance would be permitted in limited cases. Under the proposed guidance, an individual firm, a group of firms from the same jurisdiction or a non-US regulatory authority could submit an application to use substituted compliance with respect to a non-US supervisory regime. The CFTC would then assess the non-US jurisdiction's laws and regulations on a rule-by-rule basis to determine whether they are comparable to the Commodity Exchange Act and the CFTC's regulations. The proposed guidance also contemplates that the CFTC would establish supervisory memoranda of understanding or other arrangements with relevant non-US supervisors that provide for information sharing and cooperation in the context of supervising swap dealers.


The proposed guidance was widely criticised for overreaching the extraterritorial limits prescribed by Section 722 and resulted in 293 comment letters from the industry, non-US supervisory authorities and US lawmakers. Commenters argued for a narrower, simpler definition of a US person, a more tailored application of CFTC rules abroad and an approach to substituted compliance that is more consistent with principles of international comity. In particular, commenters argued that the proposed broad extraterritorial application of Title VII, combined with the CFTC's narrow approach to substituted compliance, would unnecessarily subject each non-US jurisdiction's swaps law to CFTC evaluation and result in duplicative but not necessarily consistent regulatory requirements. Instead, commenters advocated for a principles-based, holistic inquiry into the relative comparability of foreign regimes.

The current non-US swap dealer regime

In light of the December 31 2012 swap dealer registration deadline with the CFTC and the absence of final cross-border guidance, on December 21 2012 the CFTC issued a temporary exemptive order (Final Exemptive Order Regarding Compliance With Certain Swap Regulations, 78 Fed. Reg. 858 (January 7 2013)) for non-US swap dealers that is intended to mitigate the extraterritorial impact of Title VII for such entities.

"Swap dealers and security-based swap dealers must comply with existing capital standards applicable to them"

The order provides that non-US swap dealers must register with the CFTC if their swap dealing activities with US persons (other than a non-US branch of a US person that is registered as a swap dealer or represents that it intends, by March 31 2013, to register as a swap dealer), combined with those of certain of their non-US affiliates, exceed the de minimis level. As a result, by January 1 2013, 29 non-US swap dealers were among the 66 swap dealers that had provisionally registered with the CFTC. The order permits CFTC-registered dealers to delay compliance with certain Title VII requirements until the order expires on July 12 2013. In particular, non-US swap dealers, as well as non-US branches of US swap dealers, need only comply with the transaction-level requirements of their local jurisdictions with respect to swaps with non-US counterparties and non-US branches of US swap dealers during the pendency of the order, provided that those swap dealers comply with all requirements of the Commodity Exchange Act with respect to their swaps with US persons. The order also permits non-US swap dealers to delay compliance with entity-level requirements, subject to certain exceptions for swap data repository and large trader reporting.

Proposed application of capital and margin requirements to non-US banks

Because the CFTC and SEC do not have jurisdiction to establish capital and margin requirements for swap dealers and security-based swap dealers for which the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration or the Federal Housing Finance Agency (collectively known as the prudential regulators) is the prudential regulator, the prudential regulators will jointly establish the extraterritorial application of the capital and margin for entities subject to their prudential regulation. The prudential regulators' proposed capital rules provide that swap dealers and security-based swap dealers must comply with existing capital standards applicable to them: in the case of foreign banks whose home country has adopted capital standards consistent with the Basel capital accord, this means their home country capital standards (Margin and Capital Requirements for Covered Swap Entities, 76 Fed. Reg. 27564 (May 11 2011)). Their proposed margin requirements would have broad extraterritorial application and would apply to all swaps involving a swap dealer or security-based swap dealer, unless (i) the swap dealer or security-based swap dealer is not a company organised under the laws of the United States or any state, not a branch or office of a company organised under the laws of the United States or any state and not controlled by a company that is organised under the laws of the United States or any state; and (ii) the counterparty is not, and its obligations under the swap are not guaranteed by an affiliate that is, an entity organised in the United States, a branch of a US entity or a US resident.

Cross-border coordination

"Three years after enactment of Dodd-Frank, Title VII remains in an inchoate stage"

Section 752 of the Dodd-Frank Act explicitly requires the CFTC and SEC to "consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards" with respect to the regulation of swaps. Accordingly, the extraterritorial application of Title VII is also influenced by the cross-border dialogue among the CFTC, SEC and non-US regulatory authorities. On December 4 2012, the SEC and CFTC released a public statement regarding certain understandings agreed upon with non-US regulatory authorities regarding the cross-border regulation of swaps. The Joint Press Statement of Leaders on Operating Principles and Areas of Exploration in the Regulation of the Cross-Border OTC Derivatives Market (December 4 2012) is available at

In particular, the SEC and CFTC agreed with the non-US regulatory authorities to: (i) consult with one another before adopting final mandatory clearing determinations; (ii) attempt to ensure that the relevant supervisory authorities enter into supervisory cooperation and enforcement agreements; (iii) adopt a reasonable, limited transition period to facilitate the implementation of such cross-border regulatory requirements in appropriate circumstances and in consultation with other jurisdictions; (iv) further consider the concepts of recognition, substituted compliance, registration categories and exemptions, including continued consultation in a timely manner about their respective processes for determining when they will use recognition, substituted compliance, registration categories or exemptions and the conditions that they will require to be met for such treatment; and (v) remain active in various work streams, such as those of the International Organisation of Securities Commissions, related to swaps.

Not over yet

Three years after enactment of the Dodd-Frank Act, the extraterritorial application of Title VII remains in an inchoate stage. While non-US market participants that enter into swaps with US person counterparties will be required to comply with at least some aspects of Title VII, the precise application of Title VII abroad and the balance of home and host country regulations as applied to cross-border swaps and non-US entities remain to be determined.

About the author

Annette L. Nazareth
Partner, Davis Polk & Wardwell

Washington D.C, US
T +1 202-962-7075

Annette L. Nazareth is a partner in the financial institutions group of Davis Polk & Wardwell in the Washington DC office. She advises clients across a broad range of complex regulatory matters and transactions.

Nazareth was a key financial services policymaker for more than a decade. She joined the SEC Staff in 1998 as a senior counsel to Chairman Arthur Levitt. She then served as director of the Division of Market Regulation (now the Division of Trading and Markets) from 1999 to 2005. In 2005, she was appointed an SEC Commissioner. Nazareth also served as the Commission's representative on the Financial Stability Forum from 1999 to 2008. Since leaving the SEC in January 2008, she has served as rapporteur for the Group of Thirty's report, 'The Structure of Financial Supervision: Approaches and Challenges in a Global Marketplace' and as project director for their report, 'Enhancing Financial Stability and Resilience: Macroprudential Policy, Tools and Systems for the Future'.

Nazareth received her JD from Columbia Law School in 1981 and an AB, magna cum laude, from Brown University in 1978.

About the author

E. Ashley Harris
Associate, Davis Polk & Wardwell

New York, US
T: +1 212-450-4780

E. Ashley Harris is an associate in the financial institutions group of Davis Polk & Wardwell in the New York office. Harris works on a wide range of bank regulatory matters, bank M&A and capital markets transactions, and securities regulatory matters. She also advises financial institutions on the implementation and impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, with particular focus on the Volcker Rule, enhanced prudential regulation, resolution planning and derivatives regulation.

Harris received her JD, magna cum laude, from Harvard Law School in 2008 and an AB, magna cum laude, from Brown University in 2005.


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