SEC Adopts Cross-Border Rules

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On June 25, the Securities and Exchange Commission (“SEC”) adopted a final rule and interpretive guidance[1] (the “Final Rule”) to address the application of certain provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to cross-border security-based swap activities. Generally, the Final Rule does not, itself, impose obligations on market participants, but, rather, is definitional and may determine the cross-border scope of the SEC’s eventual implementation of certain security-based swaps requirements under Dodd-Frank. Certain significant provisions of the Final Rule are discussed below.

First, the Final Rule includes a definition of “U.S. person” that will be critical to identifying when security-based swaps requirements will apply to cross-border transactions. This definition includes the following:

  • any natural person resident in the United States;
  • any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States;
  • any account (whether discretionary or non-discretionary) of a U.S. person; or
  • any estate of a decedent who was a resident of the United States at the time of death.

A person’s “principal place of business” is defined to mean “the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person.”[2] The Final Rule also provides that, with respect to an externally managed investment vehicle, this location “is the office from which the manager of the vehicle primarily directs, controls, and coordinates the investment activities of the vehicle.”[3] Additionally, a non-U.S. branch of a U.S. bank generally is considered a U.S. person, while a U.S. branch of a non-U.S. bank is considered a non-U.S. person. Foreign central banks and certain supranational organizations and their agencies are excluded from the U.S. person definition.

The Final Rule’s “U.S. person” definition is generally similar to that set forth under the CFTC’s cross-border guidance,[4] but with certain differences. For example, the SEC definition does not include, as a separate test, U.S. person status of a collective investment vehicle solely by virtue of being majority-owned by one more U.S. persons.

The Final Rule also addresses the de minimis exemption from registration as a “security-based swap dealer.” Pursuant to the de minimis exemption, an entity generally need not register as a security-based swap dealer if its dealing activities over the preceding 12 months do not exceed any of the following thresholds: (i) $3 billion in notional of credit default security-based swaps (subject to a phase-in level of $8 billion); (ii) $150 million in notional of other types of security-based swaps (subject to a phase-in level of $400 million in notional); and (iii) $25 million in notional in any type of security-based swap entered into with “special entities.”[5] Pursuant to the Final Rule, a non-U.S. person (the “calculating counterparty”) that is not a conduit affiliate[6] generally must count security-based swap transactions entered into with the following persons towards the de minimis threshold from registration as a security-based swap dealer:

  • U.S. persons (other than foreign branches of a U.S. registered swap dealers); and
  • non-U.S. persons if such non-U.S. persons have rights of recourse in connection with security-based swaps against U.S. persons that are affiliates of the calculating counterparty.

However, a U.S. person must count all security-based swaps entered into with both U.S. and non-U.S. persons, including those conducted through a foreign branch of a U.S. person. The SEC intends to determine at a later date whether a non-U.S. person must count toward the de minimis threshold security-based swaps entered into with another non-U.S. person solely because transactions are “conducted” within the United States.

In addition, the Final Rule provides a process by which market participants and foreign regulators may apply to the SEC for a “substituted compliance” determination. Similar to “substituted compliance” determinations in the CFTC context,[7] eventually market participants may be able to comply with the requirements of a relevant foreign jurisdiction, such as the European Market Infrastructure Regulation (EMIR), in lieu of the comparable security-based swaps requirements under Dodd-Frank if a “substituted compliance” determination is made by the SEC.

[1] Application of ‘‘Security-Based Swap Dealer’’ and ‘‘Major Security-Based Swap Participant’’ Definitions to Cross-Border Security-Based Swap Activities, 79 Fed. Reg. 47,278 (August 12, 2014) (“Final Rule”).

[2] Id. at 47,371.

[3] Id.

[4] Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45,292 (July 26, 2013). See “U.S. Person” Definitions Under the Final Exemptive Order and the Final Guidance, Application to Certain Foreign Branches, and Determination for Collective Investment Vehicles.

[5] 17 C.F.R. § 240.3a71–2. “Special entities” are defined to include employee benefit plans subject to the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), endowments and state and local governmental entities. See 15 U.S.C. 78o–10(h)(2)(C).

[6] Conduit affiliate means “a person, other than a U.S. person, that: (A) [i]s directly or indirectly majority-owned by one or more U.S. persons; and (B) [i]n the regular course of business enters into security-based swaps with one or more other non-U.S. persons, or with foreign branches of U.S. banks that are registered as security-based swap dealers, for the purpose of hedging or mitigating risks faced by, or otherwise taking positions on behalf of, one or more U.S. persons (other than U.S. persons that are registered as security-based swap dealers or major security-based swap participants) who are controlling, controlled by, or under common control with the person, and enters into offsetting security-based swaps or other arrangements with such U.S. persons to transfer risks and benefits of those security-based swaps.” Final Rule at 47,370.

[7] See, e.g., Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45,292, 45,340-46 (July 26, 2013). See also CFTC Substituted Compliance Determinations and No-Action Letters.