On December 10, 2013, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission promulgated the final rule implementing the prohibitions and limitations imposed on banking entities by Section 13 of the Bank Holding Company Act of 1956, known as the “Volcker Rule.” Click here for a general overview of the Volcker Rule.
Since the first published proposal in 2011, we have tracked initiatives and developments regarding a possible European financial tax that would apply to derivatives, among other types of financial transactions.[1] Despite the publication of a European Commission (“EC”) directive in February 2013 that would apply to eleven participating member-states, the scope and implementation of a financial transaction tax continues to be fiercely debated. Among other things, the proposed directive would, after an initial “transitional” period, impose a tax rate of at least 0.01% of the notional amount on derivative transactions.
On November 21, 2013, PricewaterhouseCoopers LLC released a study—commissioned by 27 trade groups in the financial industry—that, based on existing literature surrounding a financial transaction tax, questioned the benefits of such a tax and highlighted its potential to negatively impact financial markets, as well as economic growth.[2] With respect to the derivatives market, the study noted that the EC’s impact assessment estimated that a financial transaction tax would reduce trading volumes by between 70% and 90%.[3] The study further noted that certain commentators have predicted that the tax could have a substantial (or, for some product types, profound) impact on the bid-offer spreads of derivative transactions.[4]
Most recently, it has been reported that the participating member-states have been discussing the implementation of a more narrow and modest tax, including one with more robust exemptions. However, a revised proposal has not yet been published.
[1] See “Financial Transaction Tax Developments” posted on August 26, 2013; “Financial Transaction Tax Developments” posted on June 11, 2013; “Financial Transaction Tax” posted on February 15, 2012; and “Europe Proposes Financial Transaction Tax” posted on October 15, 2011.
[2] PricewaterhouseCoopers LLC, Financial transaction tax: the impacts and arguments, November 21, 2013 (available at: https://www.pwc.fr/fr/assets/files/pdf/2013/11/pwc_ftt_litterature_review.pdf).
[3] Id. at 24.
[4] Id.
On December 20, 2013, the Commodity Futures Trading Commission (“CFTC”) approved substituted compliance in the European Union and five other jurisdictions for a range of “entity-level” and “transaction-level” requirements of Dodd-Frank.[1] Pursuant to a substituted compliance determination, certain swap counterparties generally may comply with the requirements of a jurisdiction (e.g., those of the European Market Infrastructure Regulation in Europe) in lieu of comparable Dodd-Frank requirements. READ MORE
On January 3, 2014, the Commodity Futures Trading Commission (“CFTC”) issued a no-action letter further delaying until September 15, 2014 the effectiveness of a November 14, 2013 advisory regarding the applicability of certain Dodd-Frank requirements to activities that occur in the United States (the “Advisory”).[1] A previous no-action letter, issued on November 26, 2013, had delayed the effectiveness of the Advisory until January 14, 2014.[2]
The Advisory generally provides that a non-U.S. swap dealer registered with the CFTC must comply with “transaction-level” requirements[3] of Dodd-Frank when entering into a swap with a non-U.S. person if the swap is “arranged, negotiated, or executed by personnel or agents” of the non-U.S. swap dealer located in the United States.[4]
In conjunction with the issuance of this latest no-action letter, the CFTC also issued a notice of request for public comment on all aspects of the Advisory.[5]
[1] CFTC Letter No. 14-01, Re: Extension of No-Action Relief: Transaction-Level Requirements for Non-U.S. Swap Dealers (January 3, 2014); CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (November 14, 2013).
[2] CFTC Letter No. 13-71, Re: No-Action Relief: Certain Transaction-Level Requirements for Non-U.S. Swap Dealers (November 26, 2013).
[3] The “transaction-level” requirements include: (i) required clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) mandatory 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. These requirements are separated into “Category A” and “Category B” requirements, the latter of which includes solely external business conduct standards.
[4] See CFTC Staff Advisory No. 13-69, Applicability of Transaction-Level Requirements to Activity in the United States (November 14, 2013).
[5] Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States (available at: https://www.cftc.gov/PressRoom/PressReleases/pr6818-14).
On December 5, 2013, the Internal Revenue Service issued final regulations and proposed regulations under section 871(m), which address withholding on certain equity-linked notional principal contracts and other financial instruments. These regulations are targeted at derivatives referencing U.S. stocks in which non-U.S. persons receive a “dividend equivalent” while arguably avoiding U.S. withholding tax but will impact many common corporate transactions, including merger and acquisition transactions and equity based compensation arrangements. Click here to read more about this recent development.
On December 4, 2013, the Securities Industry and Financial Markets Association, the International Swaps and Derivatives Association, Inc., and the Institute of International Bankers filed a lawsuit challenging the CFTC’s final cross-border guidance issued in July of 2013 (the “Guidance”).[1] The amended complaint[2] primarily argues that, in issuing the Guidance, the CFTC issued “a sweeping, international compliance directive that it characterized as mere ‘guidance,’”[3] instead of promulgating an actual rule governing the extraterritorial reach of the rules under Title VII of the Dodd-Frank Act that complied with the requirements of the Administrative Procedure Act (“APA”) and the Commodity Exchange Act (“CEA”), such as cost-benefit analysis.[4] Put simply, the plaintiffs argue that the CFTC “purposefully circumvented the congressionally-required procedures for CFTC rulemaking.”[5] Despite its purported status as mere non-binding guidance, the amended complaint notes that the CFTC has repeatedly made clear that the Guidance is intended to bind the CFTC staff and the public in the manner of a rule.[6] The amended complaint further argues that, in promulgating many Title VII rules (such as the clearing requirement rule and the swap data repository reporting rule), despite public comments, the CFTC failed to address how those rules would apply extraterritorially and failed to consider the costs and benefits of the application of the rules to foreign entities and entities engaged in cross-border transactions.[7]
Use of the “end-user exception” to the Dodd-Frank clearing requirements for swaps subject to a clearing determination by the Commodity Futures Trading Commission (“CFTC”) requires that the end-user, among other things, not be a “financial entity” under the Commodity Exchange Act (“CEA”).[1] The definition of “financial entity” encompasses, among other persons, commodity pools.[2] In turn, the CEA defines a “commodity pool” as “any investment trust, syndicate, or similar form of enterprise operated for the purpose of trading in commodity interests[.]”[3] The Dodd-Frank Act expanded the scope of such “commodity interests” to include “swaps,”[4] which has broadened the term significantly. Moreover, the CFTC has long interpreted the requirement that an enterprise be operated “for the purpose” of trading in commodity interests quite broadly, such that almost any trading in swaps or other commodity interests could bring an entity within the definition of a commodity pool.[5] Recently the CFTC stated, “any swaps activities undertaken by a [commodity pool operator] would result in that entity being required to register because there would be no de minimis exclusion for such activity. As a result, one swap contract would be enough to trigger the registration requirement.”[6] Additionally, the CFTC recently noted that “it is the staff’s position that wholly owned subsidiaries of commodity pools trading in derivatives are themselves commodity pools.”[7] Therefore, taken together, these provisions and guidance suggest that an entity that is a wholly owned subsidiary of a commodity pool and enters into a swap may itself constitute a “commodity pool” and, therefore, would not be eligible to use the end-user exception to the clearing requirement. READ MORE
The cross-border application of Title VII of the Dodd-Frank Act has been a vexing question for regulators. A major factor determining the ultimate reach of such swap regulation is the definition of “U.S. person” for purposes of the regulators’ guidance and other pronouncements regarding cross-border regulation.
On January 7, 2013, the CFTC published in the Federal Register a final order [1] (the “January Order”), which set forth a temporary “U.S. person” definition and provided temporary relief from certain provisions of the Dodd-Frank Act relating to swaps. The January Order expired on July 12, 2013, but on that same day the CFTC approved a new exemptive order [2] (the “July Order”) providing “temporary conditional relief effective upon the expiration of the January Order in order to facilitate transition to the Dodd-Frank Swaps regime.” [3] Although the July Order states that, “the Commission does not believe that an extension of the January Order is necessary or appropriate,” [4] the July Order in effect simply extends many provisions of the January Order until 75 days after the publication in the Federal Register of the related final guidance [5] (the “Final Guidance”), which the CFTC also approved on July 12, 2013. The Final Guidance was published in the Federal Register on July 26, 2013, making the extension date October 9, 2013.
Significantly, the July Order extends until October 9, 2013 the “U.S. person” definition exactly as it was set forth in the January Order. [6] Upon the expiration of this definition on October 9, 2013, the “U.S. person” definition set forth in the Final Guidance will apply. The Final Guidance provides that the CFTC will interpret the term “U.S. person” generally to include, but not be limited to:
(i) any natural person who is a resident of the United States;
(ii) any estate of a decedent who was a resident of the United States at the time of death;
(iii) any corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of enterprise similar to any of the foregoing (other than an entity described in prongs (iv) or (v), below) (a “legal entity”), in each case that is organized or incorporated under the laws of a state or other jurisdiction in the United States or having its principal place of business in the United States;
(iv) any pension plan for the employees, officers or principals of a legal entity described in prong (iii), unless the pension plan is primarily for foreign employees of such entity;
(v) any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust;
(vi) any commodity pool, pooled account, investment fund, or other collective investment vehicle that is not described in prong (iii) and that is majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v), except any commodity pool, pooled account, investment fund, or other collective investment vehicle that is publicly offered only to non-U.S. persons and not offered to U.S. persons;
(vii) any legal entity (other than a limited liability company, limited liability partnership or similar entity where all of the owners of the entity have limited liability) that is directly or indirectly majority-owned by one or more persons described in prong (i), (ii), (iii), (iv), or (v) and in which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity; and
(viii) any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in prong (i), (ii), (iii), (iv), (v), (vi), or (vii). [7]
The Final Guidance definition is similar to the temporary definition, but broader. For example, the temporary definition does not include an equivalent of prong (vi) above relating to legal entities that are majority-owned by persons that constitute U.S. Persons and which bear unlimited responsibility for the obligations and liabilities of the legal entity. Moreover, the Final Guidance provides explanation on each prong of the foregoing definition and makes some important clarifications.
Once such clarification is that a foreign branch of a U.S. bank registered with the CFTC as a “swap dealer” (an “SD Foreign Branch”) is a “U.S. person” for purposes of the CFTC’s Dodd-Frank regulations. However, generally speaking, the Final Guidance permits “substituted compliance” by an SD Foreign Branch that enters into a swap with a non-U.S. counterparty for one of more Dodd-Frank requirements if the CFTC has made a determination of comparability with respect to those regulatory requirements (a “Substituted Compliance Determination”). Specifically: (i) with respect to “Category A Transaction-Level Requirements,” [8] an SD Foreign Branch may comply with the requirements of the local law and regulations in the foreign location of the branch in lieu of compliance with Dodd-Frank where a Substituted Compliance Determination has been made and (ii) with respect to “Category B Transaction-Level Requirements,” [9] an SD Foreign Branch need not comply with such requirements unless its swap counterparty is a U.S. person (other than another SD Foreign Branch). The CFTC has not yet issued any Substituted Compliance Determinations, although it is currently considering substituted compliance applications submitted by six jurisdictions: Australia, Canada, the European Union, Hong Kong, Japan and Switzerland.
Another important clarification is the application of a “principal place of business” test for purposes of determining whether a collective investment vehicle constitutes a U.S. person (under prong (iii) of the definition). In particular, the Final Guidance states that the determination of the principal place of business for a collective investment vehicle generally should depend on the location of the “actual center of direction, control and coordination,” that is the “nerve center” [10] of the vehicle. The Final Guidance further highlights that “[t]he key personnel relevant to this aspect of the analysis are those senior personnel responsible for implementing the vehicle’s investment strategy and its risk management. Depending on the vehicle’s investment strategy, these senior personnel could be those responsible for investment selections, risk management decisions, portfolio management, or trade execution.” [11] In sum, the Final Guidance provides that a collective investment vehicle’s principal place of business will be the United States “if the senior personnel responsible for either (1) the formation and promotion of the collective investment vehicle or (2) the implementation of the vehicle’s investment strategy are located in the United States, depending on the facts and circumstances that are relevant to determining the center of direction, control and coordination of the vehicle.” [12]
The CFTC has encouraged requests to provide written advice and guidance as to the application of the definition of “U.S. person,” [13] apparently recognizing that ambiguities may remain despite publication of the Final Guidance.
[1] Final Exemptive Order Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 858 (January 7, 2013).
[2] Exemptive Order Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 43,785 (July 22, 2013).
[3] Id. at 43,785.
[4] Id. at 43,786.
[5] Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45,292 (July 26, 2013). Note that, in addition to its interpretation of “U.S. person,” the Final Guidance covers various other issues in the cross-border context, including swap dealer and major swap participant registration, interpretation of “foreign branch,” application of the Dodd-Frank Title VII requirements to various types of market participants, and substituted compliance.
[6] July Order, supra note 2, at 43,787. The January Order stated that the CFTC “will treat as a ‘U.S. person’ any person identified by the following five criteria”:
(i) A natural person who is a resident of the United States;
(ii) A corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund or any form of enterprise similar to any of the foregoing, in each case that is (A) organized or incorporated under the laws of a state or other jurisdiction in the United States or (B) effective as of April 1, 2013 for all such entities other than funds or collective investment vehicles, having its principal place of business in the United States;
(iii) A pension plan for the employees, officers or principals of a legal entity described in (ii) above, unless the pension plan is primarily for foreign employees of such entity;
(iv) An estate of a decedent who was a resident of the United States at the time of death, or a trust governed by the laws of a state or other jurisdiction in the United States if a court within the United States is able to exercise primary supervision over the administration of the trust; or
(v) An individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in (i) through (iv) above.
[7] Id. at 45,316-17.
[8] “Category A Transaction-Level Requirements” consist of the following Dodd-Frank Act requirements: (1) clearing and swap processing; (2) margin and segregation requirements for uncleared swaps; (3) trade execution; (4) swap trading relationship documentation; (5) portfolio reconciliation and compression; (6) real-time public reporting; (7) trade confirmation; and (8) daily trading records.
[9] “Category B Transaction-Level Requirements” consist of Dodd-Frank requirements regarding external business conduct standards (including those currently being addressed through the August 2012 Dodd-Frank Protocol and similar arrangements).
[10] Id. at 45,309 (citing Hertz Corp. v. Friend, 559 U.S. 77 (2010)).
[11] Id. at 45,310 (footnotes omitted). The Final Guidance elaborates:
The achievement of a collective investment vehicle’s investment objectives may be closely linked to its formation. Decisions made in the structuring and formation of the collective investment vehicle may have a significant effect on the performance of the vehicle. Thus, for purposes of identifying the vehicle’s principal place of business, the Commission may also consider the location of the senior personnel who direct, control and coordinate the formation of the vehicle (i.e., the promoters). The location of the promoters of the collective investment vehicle is relevant, particularly where the vehicle has a specialized structure or where the promoters of the vehicle continue to be integral to the ongoing success of the fund, including by retaining overall control of the vehicle.
Id.
[12] Id.
[13] Specifically, the Final Guidance notes that: “The [CFTC] believes that [CFTC] regulation 140.99, which provides for persons to request that the staff of the [CFTC] provide written advice or guidance, would be an appropriate mechanism for a person to seek guidance as to whether it is a U.S. person for purposes of applying the [CFTC] swaps regulations promulgated under Title VII [of the Dodd-Frank Act].” Final Guidance, supra note 4, at 45,316 n.235.
The governments of Europe continue to consider the application of a financial transaction tax (“FTT”) on bond, equity and derivatives transactions.[1] On February 14, 2013, the European Commission (“EC”) published a directive (the “FTT Directive”) that would apply to eleven member-states through an “enhanced cooperation procedure” approved by the European Parliament on December 12, 2012.[2] Most recently, on July 3, 2013, the European Parliament, which has a consultative role in the process,[3] approved the FTT Directive, subject to several proposed amendments. READ MORE
End-users in the United States traditionally have entered into swaps with counterparties that, following the implementation of the Dodd-Frank Act, registered with the CFTC as “swap dealers.” Pursuant to CFTC regulation 45.8, where one party to a swap is a registered swap dealer, that party (known as the “reporting counterparty”) is the one required to report relevant swap data to a “swap data repository” (“SDR”). The reporting requirements of the Dodd-Frank Act apply to new swaps, as well as swaps existing on or after the enactment of the Dodd-Frank Act but entered into before the required reporting date (known as “historical swaps”). The exact compliance date for reporting historical swap data depends on the type of swap and the type of reporting counterparty; for example, swap dealers were required to report swap data for interest rate swaps by October 12, 2012. However, where neither party is registered as a swap dealer, an end-user that is the sole “U.S. person” to a swap may find itself in the position of being the reporting counterparty.[1] In such a case, the end-user has been granted additional time to comply with the Dodd-Frank reporting requirements. READ MORE
