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From Securities Regulation Daily, December 20, 2013

Using substituted compliance, CFTC approves entity-level derivatives requirements for six foreign jurisdictions

By Jim Hamilton, J.D., LL.M.

The CFTC approved a series of broad comparability determinations that would permit substituted compliance with non-U.S. derivatives regulatory regimes as compared to certain swaps provisions of Title VII of the Dodd-Frank Act and the Commission’s regulations. Working with authorities in Australia, Canada, the European Union, Hong Kong, Japan, and Switzerland, the Commission was able to issue comparability determinations for a broad range of entity-level requirements, such as risk management, for these six jurisdictions. In two jurisdictions, the E.U. and Japan, the Commission also approved substituted compliance for some key transaction-level requirements, such as clearing.

The vote was conducted via seriatim, which was approved by CFTC Chair Gary Gensler and Commissioners Bart Chilton and Mark Wetjen. Commissioner Scott O’Malia dissented from the comparability determinations. Chair Gensler noted that the approval by the Commission reflects a collaborative effort with authorities and market participants from each of the six jurisdictions that have registered swap dealers.

Substituted compliance. Substituted compliance describes the circumstances where the Commission’s general policy would be to permit non-U.S. swap dealers or non-U.S. swap participants whose swaps activities might bring them within the scope of CFTC regulations to use compliance with regulations in their home jurisdictions as a substitute for compliance with the relevant Commission regulations. This approach builds on the Commission’s long-standing policy of recognizing comparable regulatory regimes based on international coordination and comity principles with respect to cross-border activities involving futures and options.

The CFTC chair emphasized that the making of substituted compliance determinations is an evolutionary process. Thus, as jurisdictions outside the U.S. continue to strengthen their regulatory regimes, the Commission may determine that additional foreign regulatory requirements are comparable to and as comprehensive as requirements under the Dodd-Frank Act and CFTC regulations.

Entity-level requirements. An important distinction must be made between substituted compliance on entity-level requirements, such as risk management, and on swap-specific transaction-level requirements. The entity-level requirement determinations of comparability for all six foreign jurisdictions, include the areas of having a risk management program, having a chief compliance officer, monitoring of position limits, swap data recordkeeping, diligent supervision, undue influence, and business continuity.

With regard to swap data recordkeeping, except for Japan, the Commission reserved the right to require a swap dealer or major swap participant to provide direct access to or produce the records required to be maintained under the Commodity Exchange Act and CFTC regulations to Commission staff, the staff of an applicable U.S. prudential regulator, or the Department of Justice. With respect to chief compliance officers, the comparability determinations for all six jurisdictions excluded the U.S. requirement that the CEO or CCO of a swap dealer or major swap participant certify that the annual compliance report is accurate and complete.

Path forward and CFTC guidance. The substituted compliance determinations come against the backdrop of an earlier agreement between European Commissioner for the Internal Market Michel Barnier and Chair Gensler on a Path Forward regarding their joint understandings on a package of measures for how to approach cross-border derivatives regulation. As part of the agreement, the CFTC and the European Commission pledged not to seek to apply their respective regulations unreasonably in the other jurisdiction, but to rely on the application and enforcement of the rules by the other jurisdiction.

Subsequent to the agreement, the CFTC issued final guidance to provide greater legal certainty and clarity to U.S. and non-U.S. market participants regarding their obligations under the Commodity Exchange Act with respect to their cross-border swaps activities. The guidance embodies the concept of substituted compliance, under which the CFTC would defer to comparable and comprehensive foreign derivatives regulatory regimes.

The guidance broadly describes the process and the factors that the CFTC would consider in in making a comparability assessment. The CFTC staff emphasized in connection with substituted compliance that comparable and comprehensive does not mean that the CFTC would look for identical regulations abroad. Rather, the Commission would take into account all relevant factors including the scope and objectives of the relevant regulatory requirements and the comprehensiveness of the foreign regulators compliance program when making the assessment. Also, this assessment does not entail a rule-by-rule analysis; instead, the Commission would make this assessment on a category-by-category basis.

Dissent. Commissioner O’Malia said that he could not support the Commission’s comparability determinations because they are based on legally unsound cross-border guidance and are the result of a flawed substituted compliance process.

MainStory: TopStory Derivatives CFTCNews DoddFrankAct InternationalNews Swaps RiskManagement

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