US Securities And Exchange Commission Issues Final Rules Regarding The Application Of Security-Based Swap Intermediary Definitions To Cross-Border Security Based Swap Activity

Keywords: SEC, Dodd-Frank Act, cross-border rules, security-based swaps,

The US Securities and Exchange Commission ("SEC") has adopted final rules (the "Cross- Border Rules") regarding the cross-border application of certain security-based swap ("SBS") provisions of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").1

The Cross-Border Rules: (i) define the term "US person" and indicate which SBS transactions a non-US SBS participant should include in its SBS dealer ("SBSD") and major SBS participant ("MSBSP") registration threshold calculations; (ii) establish the procedural rules for market participants and non-US regulators to request that the SEC determine that another jurisdiction's SBS rules are comparable to the SEC's rules and permit market participants in that jurisdiction to rely on that jurisdiction's SBS rules via substituted compliance when acting in the jurisdiction; and (iii) generally define the scope of the SEC and US Department of Justice's ("DOJ") cross-border enforcement authority with respect to the antifraud provisions of the US federal securities laws.

Because it intends to request further public comment, the SEC declined to adopt a rule defining the circumstances under which an SBS between two non-US persons constitutes dealing activity within the United States.2 It also declined to adopt rules defining the cross-border application of the entity-level and transaction-level requirements for SBSDs or requirements specific to clearing, trade execution, regulatory reporting and public disclosure; the SEC intends to address those items in subsequent rulemakings and guidance regarding the relevant substantive requirements.3

The Cross-Border Rules were issued in the form of legally binding regulations, and were styled as such, in contrast to the US Commodity Futures Trading Commission's ("CFTC's") approach of denominating its principles for applying the cross-border provisions of its swaps rules as agency "guidance." Also, while the Cross-Border Rules state, and SEC Commissioners indicated at the time of adoption, that the SEC consulted with the CFTC and sought to minimize differences between the SBS and swaps regulatory regimes, significant differences are evident when comparing the two regimes.4 The SEC, however, did move markedly toward the CFTC position with regard to the treatment of guaranteed affiliates and conduit affiliates. It will be important to monitor and understand, in particular, how dealers subject to both CFTC and SEC jurisdiction adapt over time to the challenge of emerging differences in analogous rules.

Timing. The SEC stated that these rules become effective September 8, 2014, but that compliance generally will not be required until after the SEC adopts related substantive SBS rules (e.g., rules for registration of SBSDs and MSBSPs).5

Definition of "US Person"

US Person. The Cross-Border Rules define a US person as:

a natural person resident in the United States; a 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; an account (whether discretionary or non-discretionary) of a US person; or an estate of a decedent who was a resident of the United States at the time of death.6 The Cross-Border Rules provide that a person may treat a counterparty as a non-US person if the person receives a representation to that effect from the counterparty and does not know or have reason to know that the representation is inaccurate.7 This provision roughly mirrors the CFTC's guidance with respect to reasonable reliance on representations.8

In contrast to the CFTC, the Cross-Border Rules expressly exclude from the definition of a US person the International Monetary Fund, Inter- American Development Bank, and other similar international organizations, their constituent agencies, and their pension plans.9

Like the CFTC, the SEC treats foreign branches and offices of a US person as part of that US person, stating that dealing counterparties will look to the entire US person, and not just its foreign branch, for performance on the transaction.10 That said, foreign branches of US banks receive distinct treatment in certain parts of the Cross-Border Rules. As for US branches of foreign banks, the preamble suggests, but does not make express, that they will be treated as non-US persons.11

The SEC and CFTC definitions of a US person diverge in that the SEC's omits any requirement to "look-through" the ownership structure of a collective investment vehicle or unlimited liability entity and determine the US person status of the owners or investors. The treatment of investment vehicles also differs as a result of the way that each agency has articulated a principal place of business test. The CFTC focuses on where the vehicle is (i) formed and promoted and (ii) where its investment strategy and risk management are implemented.12 The SEC requires that one look to the location of the office from which an investment vehicle's investment adviser primarily directs, controls, and coordinates the vehicle's investment activities to determine the US person status of the vehicle.13 The SEC, however, in line with the CFTC's guidance, indicates that the mere retention of a US person asset manager will not make the investment vehicle a US person.14

SBSD and MSBSP Registration Threshold Calculations

SBSD DeMinimis Calculation for US Persons and Conduit Affiliates. The Cross- Border Rules require US persons and non-US persons who are...