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CFTC Closes Door to Evasion of U.S. Margin Requirements by U.S. Affiliates Operating Overseas

The U.S. Commodity Futures Trading Commission (CFTC) has issued a final rule that applies to the Commission's margin requirements for uncleared swaps in the context of cross-border transactions. It would limit the ability of banks and other traders to move swaps business abroad to avoid U.S. trading requirements.

The final rule, first proposed in June 2015 (see Daily GPIJune 29, 2015) and published in January, was approved by a 2-1 vote Tuesday morning. It will become effective 60 days after publication in the Federal Register.

"The risks our margin rule seeks to prevent do not only originate in the United States," said CFTC Chairman Timothy Massad. "The interconnected nature of the global swaps market means that risks created across the globe have the potential to flow back into the United States. We recognize that having a global swaps market is beneficial to all users. Therefore, one of the most important objectives we already accomplished was to ensure our margin rule is substantially similar to comparable international rules. Harmonization is critical to creating a sound international framework for regulation.

"We also recognize that not all jurisdictions will adopt strong margin rules. And even where rules are substantially harmonized, there will still be some differences. Because cross-border transactions are commonplace, we must clarify which rules apply in different situations. Today, the Commission has acted to provide that clarification."

The dissenting vote on the final rule came from Commissioner J. Christopher Giancarlo, who called the rule "overly complex, unduly narrow and operationally impractical."

The rule "establishes a complicated matrix of potential cross-border counterparties under which substituted compliance is either not permitted, is partially permitted, or is fully permitted, depending upon the category in which the particular transaction fits," he said, and initiates an "element-by-element" analysis by CFTC "of CFTC and foreign margin rules under which a transaction may be subject to a patchwork of U.S. and foreign regulation," instead of assessments of a foreign authority's margin regime as a whole.

"Unfortunately, this complicated rule will make it harder for U.S. financial institutions to compete globally and serve American businesses," Giancarlo said.

The final rule generally requires covered swap entities (CSE) to comply with the CFTC's margin requirements for all uncleared swaps in cross-border transactions, with a limited exclusion for certain non-U.S. CSEs. The exclusion is not available to non-U.S. CSEs that are consolidated with a U.S. parent (foreign consolidated subsidiaries). In certain circumstances, the rule would allow CSEs to comply with comparable margin requirements in foreign jurisdictions as an alternative means of complying with the CFTC's rule to the extent that the foreign jurisdiction's requirements are comparable to CFTC's.

U.S. CSEs and non-U.S. CSEs whose obligations under the relevant swap are guaranteed by a U.S. person are permitted to post initial margin for uncleared swaps with certain non-U.S. counterparties pursuant to comparable rules in the foreign jurisdiction, for example, and non-U.S. CSEs that are not U.S. Guaranteed CSEs, including foreign consolidated subsidiaries, are eligible for substituted compliance with respect to all of CFTC's margin requirements, except for swaps with U.S. CSEs and U.S. Guaranteed CSEs.

The final rule includes special provisions to accommodate swap activities in jurisdictions that do not have a legal framework to support custodial arrangements or that do not have netting arrangements that comply with the CFTC's margin rule. And the rule establishes a process for requesting comparability determinations, including eligibility and submission requirements, as well as the standard of review the CFTC would apply in assessing the comparability of a foreign jurisdiction's margin requirements.

CSEs are Commission-registered swap dealers and major swap participants that are not subject to the margin requirements of other prudential regulators, such as the Federal Reserve Board, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp.

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