The proposed US person definitions under the Commodity Futures Trading Commission's ("CFTC") cross-border swap rules are expected to pose a high level of compliance burden to market participants in Asia, a senior official said.
As expected, CFTC's proposed definitions of US persons set out in a consultation paper released in October have elicited a strong response. Ryozo Himino, chair of International Organisation of Securities Commissions' ("IOSCO") Asia-Pacific Regional Committee, in a letter sent to CFTC on 19 December, expressed a number of concerns on behalf of market participants about CFTC's cross-border swap rule. The International Swaps and Derivatives Association ("ISDA") also gave strong views on the same topic in a commentary on 7 December.
"This is as widely expected because the new US person definitions are not creating a level playing field. The Asian clients of US banks operating in Asia will be subject to the cross-border provisions of the Dodd-Frank Act," said Kishore Ramakrishnan, director at PwC in Hong Kong.
The committee's letter addressed two main concerns: the cross-border application of the registration thresholds and the external business conduct rules on swap dealers and major swap participants when trading with non-US entities.
Most strikingly, the committee questioned the limited benefits of CFTC's expanded extra-territorial rule and the unusually high costs to which non-US persons transacting with US persons will be subject.
In the letter, Himino pointed out that CFTC's proposed rule would subject regional financial groups in Asia to "disproportionate burden" because of having to implement infrastructure for counting and monitoring the de minimis threshold for swap dealer registration. He said although certain non-US firms in Asia are likely to exceed the registration threshold, a far greater number of financial institutions in the region will likely remain below the threshold, but the latter will need to continuously monitor their trading amount with US related entities.
"Unlike global financial institutions, the resources of regional financial group[s] in [the] Asia-Pacific region can be limited … They [regional financial groups in Asia] will have difficulty in concurrently complying with two sets of regulations, ie, local regulations as well as CFTC-related regulations," Himino said.
Duplicative Regulatory Burden on Asian Market Participants
Himino offered further insights with figures provided by market participants and regulators in Asia. For instance, an estimate of initial legal costs for non-US swap dealer registration could be more than $1 million per entity, and this is aside from continuing compliance costs.
A few dozen non-US financial groups in some jurisdictions in the Asia-Pacific region are now likely to exceed the swap dealer registration threshold of $8 billion under the proposed calculation. The CFTC's aggregation rule was likely to contribute to some financial groups in Asia falling within the scope of swap dealer registration, Himino said.
"The possible reduction of the de minimis threshold to $3 billion on 31 December 2018 will exacerbate the duplicative regulatory burden to this region further," he said.
ISDA is similarly concerned. It said in its commentary that CFTC's decision to apply its requirements to non-US affiliates that were not guaranteed by a US parent but were consolidated on its balance sheet for accounting purposes to meet CFTC threshold registration and external business conduct requirements when trading with non-US entities, would expose non-US trades to "duplicative and potentially inconsistent" requirements.
The lack of a substituted compliance decision would mean that trades conducted between a foreign consolidated subsidiary ("FCS") and a non-US entity would need to comply with both US regulations and the host regulator's requirements simultaneously, ISDA said.
Non-US Persons in Asia Unlikely to Have a Significant Impact on US Economy
Himino also pointed out that other non-US persons in Asia are unlikely to have a direct and significant impact on the US economy, and this is evident from a number of non-US financial institutions that enter into a hedge transaction with a subsidiary of US persons or FCS in Asia solely to reduce the risks in their core banking business. Such non-US financial institutions do not even have a presence in the United States.
"For the above reasons, requiring other non-US persons to register as new non-US swap dealers does not appear to provide significant added benefit or comfort. This is especially the case for non-US persons who deal with branches of US persons or FCS in their home jurisdictions," he said.
ISDA offered similar argument in its commentary. It said the US Congress was very specific about applying the Dodd-Frank regulation only to activities that have a "direct and significant effect" on the commerce of the United States.
"We don't think a trade between a non-US, non-guaranteed FCS and a non-US entity meets that criterion. At any rate, the non-US affiliate would be regulated by local foreign-country regulators, and either is or soon will be subject to similar regular requirements to Dodd-Frank, as per commitments made by the Group of 20 in 2009," ISDA said.
OTC Derivatives Reforms will not Expose Further Risks to US Financial System
The IOSCO Asia Pacific regional committee also highlighted that the progress of over-the-counter derivatives reforms, including mandatory clearing and margin requirements for non-centrally cleared trades, should pose minimum risk to the US economy. It therefore suggested that transactions that are centrally cleared, subject to margin requirements, and those on trading venues which qualify for non-action relief, should be excluded from the scope of threshold calculations.
Uncertainties Posed by New US Person Definitions
The letter from IOSCO also pointed out the uncertainties posed by the new US person definitions which failed to address new requirements on transactions by FCS as well as arrange, negotiate and execute ("ANE") transactions.
"We are concerned that such uncertainties may hinder market activities. We understand that the proposed definitions of FCS and ANE transactions would apply not only for the purposes of the proposed rule but also for future cross-border rulemakings," Himino said.
The committee asked the CFTC to provide information on full requirements, implementation timelines and possible exemptions before the proposed US person definitions were adopted.
Outcome-Based Substituted Compliance
The IOSCO Asia Pacific committee also pointed out the need for a clear outcome-based substituted compliance framework, and said sufficient time should be given for conducting substituted compliance determination for jurisdictions in Asia.
"Timing for substituted compliance coming into effect is critical. Substituted compliance should be effective before the proposed rule takes effect, not after. Otherwise, market participants would be subject to duplicative and overlapping sets of requirements in their local jurisdiction and under the CFTC rules," the letter said.
The committee said if substituted compliance is not able to come into effect before the proposed rule takes effect, no action relief will be required until substituted compliance can be put in place to reduce the compliance burden.