On 12 July 2013, the U.S. Commodity Futures Trading Commission (“CFTC”) issued Final interpretive Guidance Regarding Compliance With Certain Swap Regulations (the “Final Guidance”) and an Exemptive Order Regarding Compliance With Certain Swap Regulations (the “Exemptive Order”).
This has been one of the most controversial rule makings to date, with Republican Commissioner Scott O’Malia expressly dissenting against both initiatives on the basis that they:
- fail to articulate a valid statutory foundation for its overbroad scope and inconsistently apply the statute to different activities;
- cross the line between interpretive guidance and rulemaking; and
- give insufficient consideration to international law and comity.
Nevertheless, the Guidance was approved three votes to one and became effective from 13 July 2013. The Exemptive Order was also approved at the same time and provides a 75 day transitional period before the Final Guidance becomes effective on 9 October 2013.
The Final Guidance, amongst other things, amends the definition of “U.S. Person” solely with respect to the Commodity Exchange Act’s swap provisions and CFTC swap regulations. This does not, however, extend to whether an asset manager needs to register with the CFTC. This article is limited to the new definition of U.S. Person and does not consider other elements of the Final Guidance.
New definition of U.S. Person:
Pursuant to the Final Guidance, a U.S. Person is defined as:
i.any natural person who is a resident of the U.S.;
ii. any estate of a decedent who was a resident of the U.S. 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 U.S. or having its principal place of business in the U.S.;
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 U.S., if a court within the U.S. 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 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).
The Final Guidance omits a prong from the proposed guidance which would have captured as a U.S. Person any commodity pool operated by a person subject to CFTC registration as a Commodity Pool Operator. The absence of this prong from the Final Guidance reduces the scope of the definition substantially.
The CFTC has clarified that it will generally consider the “Principal Place of Business” of an investment vehicle (under prong (iii)) to be the place where the key personnel are located, where business decisions are made and from where the investment vehicle is operated. The location of the investment vehicle’s Board of Directors (the “Board”) is not a relevant consideration as the Board will not have the function of actually implementing the investment objectives of the investment vehicle(s), and therefore the members of the Board are not viewed as key personnel.
Asset managers managing investment vehicles caught by the new definition of U.S. Person that enter into a swap with a non-U.S. counterparty (including a non-U.S. Swap Dealer (“SD”) subject to a later CFTC compliance date) will be required, unless agreed otherwise, to undertake the swap reporting and record keeping requirements. For swaps entered into with a SD or a Major Swap Participant (“MSP”) that is deemed to be a U.S. Person, the SD or MSP will be required to report the swap. Swaps between two non-U.S. Persons are not caught. Therefore, swap dealers will likely reach out to their counterparties to obtain representations as to the counterparties’ U.S. Person status. In addition, the counterparties may be required to complete the ISDA Dodd-Frank Protocols so that the swap dealers can incorporate certain provisions into the trading documentation.
The CFTC confirmed that foreign branches of U.S. Persons (such as banks) are U.S. Persons on the basis that they are not separately incorporated, capitalized, and the rights and obligations of the branch are the same as those of the parent. An affiliate or subsidiary of a U.S. Person will not solely by virtue of its relationship be a U.S. Person, even if its swaps obligations are guaranteed by its parent or an affiliate.
Key steps that should be undertaken by all asset managers:
i. Determine if any investment vehicles are caught by the new U.S. Person definition;
ii. Determine if the funds enter into swaps subject to clearing;
iii. Certify to each investment vehicle’s counterparties whether the investment vehicle is a U.S. Person;
iv. Speak with investment vehicle’s counterparties and determine if the counterparty is a U.S. Person and, if not, obtain a ‘Non-US Person’ representation from the counterparty;
v. Determine who is going to report the swap transaction where applicable; and
vi. Start negotiating with each investment vehicle’s counterparties the relevant trading documentation to permit clearing (if applicable).
Asset managers also should revisit any exemptions they rely upon; for example, asset managers relying upon an exemption under Section 4m(1) of the Commodity Exchange Act from having to register as a Commodity Trading Adviser on the basis that the asset manager has provided commodity trading advice to less than 15 U.S. Persons over the last 12 months.
The CFTC’s Final Guidance and the Exemptive Order can be accessed by clicking here.
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