CFTC Finalizes Guidance On Cross-Border Application Of Dodd-Frank Swap Provisions

The Commodity Futures Trading Commission ("CFTC" or "Commission") has issued its much anticipated final guidance on the cross-border application of the swaps provisions of the Commodity Exchange Act ("CEA"), as added by Title VII of the Dodd-Frank Act ("Final Guidance").1 The Final Guidance will be of interest to all persons who conduct cross-border swaps transactions, and will have far-reaching effects for many.

The Final Guidance contains the Commission's statements of the manner in which it intends to interpret when swap-related activities have a "direct and significant connection with activities in, or effect on, commerce of the United States," or when they "contravene such [Commission] rules or regulations . . . as are necessary or appropriate to prevent evasion of the swaps provisions of [the CEA] that was enacted by the [Dodd-Frank Act]."2 The Final Guidance thus addresses: (1) who qualifies as a U.S. person; (2) how multi-national organizations should calculate the de minimis threshold for swap dealer registration; (3) what regulatory requirements will apply to particular entities conducting business transnationally; and (4) the ability to substitute compliance with certain foreign regulatory schemes for CFTC regulation.

The Final Guidance became effective on July 26, 2013, the date of publication in the Federal Register. However, in a companion release, the CFTC also issued an exemptive order delaying compliance with several of the requirements in the Final Guidance ("Exemptive Order").3 Compliance with the "U.S. person" interpretation and the final interpretation relating to calculation of the swap dealer registration threshold will not be expected until 75 days after July 26, 2013. Until such time, market participants may continue to rely on the Commission's January Order.

This alert addresses many of the significant issues discussed in the Final Guidance.4

1. INTERPRETATION OF "U.S. PERSON"

   For purposes of the Final Guidance, a "U.S. person" is a person whose swap activities could be expected to satisfy the jurisdictional nexus with the United States, either individually or in the aggregate.5 U.S. persons generally include individuals or entities located within the United States as well as individuals or entities outside of the United States whose swap activities nonetheless have a direct and significant connection with the United States. The Commission's interpretation contains eight separate categories or prongs, which include natural persons and legal entities physically located, organized, or with their principal place of business in the United States, as well as accounts of which a U.S. person is a beneficial owner; certain pension plans, trusts, and collective investment vehicles; and unlimited liability legal entities that are directly or indirectly owned by a U.S. person.6

   As discussed below, the Commission modified certain aspects of its proposed "U.S. person" interpretation,7 including those relating to legal entities and collective investment vehicles that are majority-owned by a U.S. person, estates and trusts, pension plans, joint accounts, and commodity pool operators. The Commission retained the prefatory language "to include, but not be limited to" in its interpretation of "U.S. person," emphasizing that it will take a facts and circumstances approach to identifying those persons whose activities meet the "direct and significant" jurisdictional nexus, and not limiting its determination to a person's legal form and its domicile or location of operation. Accordingly, there may be situations where a person that does not fit into any of the enumerated prongs may nonetheless be treated as a U.S. person.

   A party to a swap will be allowed reasonably to rely on the representation of its counterparty as to its status as a U.S. person. The reasonableness of the reliance will depend on the relevant facts and circumstances.

   Resident of the United States—Prongs (i) and (ii)

   Leaving its proposed interpretation largely unchanged, the Commission will construe an individual to be a resident of the U.S. if he or she is physically located in the U.S. or one of its territories. The Final Guidance adds that the estate of a person who was a resident of the U.S. at the time of his or her death is also a U.S. person. The Proposed Guidance had instead looked to whether the estate was subject to U.S. income tax, regardless of the source.

   Legal Entities Organized or With Their Principal Place of Business in the U.S.—Prong (iii)

   The Commission finalized the first part of the "legal entity" prong largely as proposed, i.e., any legal entity organized or incorporated in the U.S. or having its principal place of business in the U.S. is a U.S. person.8 The interpretation generally includes those entities that are organized outside of the U.S. but have their "nerve center," that is the "center of direction, control, and coordination of their business activities," in the U.S.9

   Additional factors are relevant to the determination of principal place of business of a collective investment vehicle, however.10 The Commission will generally focus on the location of the "high level officers" who direct, control, and coordinate the key functions of the vehicle such as its formation and trading and investment strategies.

   Legal Entities Majority Owned by a U.S. Person—Prong (vii)

   The Initial Proposed Guidance would have considered a legal entity of which a U.S. person is a direct or indirect owner and is responsible for the entity's liabilities to be a U.S. person. The Further Proposed Guidance significantly moderated this approach by proposing as an alternative that only those legal entities for which a U.S. person (a) is a majority owner and (b) has unlimited responsibility for the entity's liabilities should be considered a U.S. person. The Final Guidance adopts the alternative approach laid out in the Further Proposed Guidance.

   In order to be a U.S. person under the Final Guidance, the majority owner U.S. person(s) need not bear responsibility for all of the entity's liabilities nor do all majority owner U.S. persons need to bear unlimited responsibility.

   Collective Investment Vehicles Majority Owned by a U.S. Person—Prong (vi)

   The Commission also significantly changed its initial proposed approach to which collective investment vehicles would be considered U.S. persons. Previously, the Commission advised that a collective investment vehicle would be considered a U.S. person if it was owned either directly or indirectly by a U.S. person, irrespective of where it was organized or to whom it was offered. The Further Proposed Guidance added a majority ownership qualification and also provided that a publicly traded collective investment vehicle not offered to U.S. persons would not be a U.S. person. Because of the difficulties involved in verifying ownership of publicly offered collective investment funds, the Final Guidance expands the exclusion of public funds to incorporate all publicly offered funds that are not offered to U.S. persons.

   In addition, the Final Guidance removes the "directly or indirectly" qualifier and provides that a collective investment vehicle that is majority-owned by one or more U.S. persons, regardless of where organized, will be considered a U.S. person. The Commission expects the collective investment vehicle both to determine whether its direct beneficial owners are U.S. persons and to "look through" the beneficial ownership of any other legal entity invested in the collective investment vehicle that is controlled by or under common control with the collective investment vehicle.

   Commodity Pool Operators—Elimination of Proposed Prong (v)

   The Final Guidance does not include as a U.S. person all operators of commodity pools or other collective investment vehicles that would be required to register as a commodity pool operator under the CEA, as had been...