Source: https://www.federalregister.gov/documents/2013/12/27/2013-30977/comparability-determination-for-japan-certain-transaction-level-requirements
Timestamp: 2017-08-17 09:06:39
Document Index: 369208381

Matched Legal Cases: ['§\u200923', '§\u200923', 'art 43', 'art 43', '§\u200950', '§\u200950', '§\u200923', '§\u200923', '§\u200950', '§\u200950', '§\u200923', '§\u200923', '§\u200923', '§\u200923', '§\u200923', '§\u20091', '§\u200923', '§\u200923', '§\u200923', '§\u200923', '§\u200923', '§\u200923', '§\u20096', '§\u20096', '§\u200923']

Federal Register :: Comparability Determination for Japan: Certain Transaction-Level Requirements
CFTC-2013-0115
A. Swap Trading Relationship Documentation (§ 23.504)
B. Daily Trading Records (§ 23.202)
https://www.federalregister.gov/d/2013-30977 https://www.federalregister.gov/d/2013-30977
On July 26, 2013, the Commission published in the Federal Register its “Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations” (“Guidance”).[1] In the Guidance, the Commission set forth its interpretation of the manner in which it believes that section 2(i) of the Commodity Exchange Act (“CEA”) applies Title VII's swap provisions to activities outside the U.S. and informed the public of some of the policies that it expects to follow, generally speaking, in applying Title VII and certain Commission regulations in contexts covered by section 2(i). Among other matters, the Guidance generally described the policy and procedural framework under which the Commission would consider a substituted compliance program with respect to Commission regulations applicable to entities located outside the U.S. Specifically, the Commission addressed a recognition program where compliance with a comparable regulatory requirement of a foreign jurisdiction would serve as a reasonable substitute for compliance with the attendant requirements of the CEA and the Commission's regulations promulgated thereunder.
In addition to the Guidance, on July 22, 2013, the Commission issued the Exemptive Order Regarding Compliance with Certain Swap Regulations (the “Exemptive Order”).[2] Among other things, the Exemptive Order provided time for the Commission to consider substituted compliance with respect to six jurisdictions where non-U.S. SDs are currently organized. In this regard, the Exemptive Order generally provided non-U.S. SDs and MSPs (and foreign branches of U.S. SDs and MSPs) in the six jurisdictions with conditional relief from certain requirements of Commission regulations (those referred to as “Transaction-Level Requirements” in the Guidance) until the earlier of December 21, 2013, or 30 days following the issuance of a substituted compliance determination.[3] However, the Commission provided only transitional relief from the real-time public reporting requirements under part 43 of the Commission's regulations until Start Printed Page 78891September 30, 2013, stating that “it would not be in the public interest to further delay reporting under part 43 . . . .” [4] Similarly, the Commission provided transitional relief only until October 10, 2013, from the clearing and swap processing requirements (as described in the Guidance), stating that, “[b]ecause SDs and MSPs have been committed to clearing their [credit default swaps] and interest rate swaps for many years, and indeed have been voluntarily clearing for many years, any further delay of the Commission's clearing requirement is unwarranted.” [5] The Commission did not make any comparability determination with respect to clearing and swap processing prior to October 10, 2013, or real-time public reporting prior to September 30, 2013.
On September 20, 2013, BTMU submitted a request that the Commission determine that laws and regulations applicable in Japan provide a sufficient basis for an affirmative finding of comparability with respect to certain Transaction-Level Requirements, including the Business Conduct Requirements.[6] (BTMU is referred to herein as the “applicant”). On December 16, 2013, the application was further supplemented with corrections and additional materials. The following is the Commission's analysis and determination regarding the Business Conduct Requirements, as detailed below.
With respect to clearing and swap processing, this notice does not address § 50.2 (Treatment of swaps subject to a clearing requirement), § 50.4 (Classes of swaps required to be cleared), § 23.506 (Swap processing and clearing), or § 23.610 (Clearing member acceptance for clearing).
The mandatory clearing requirement in Japan, which is consistent with the G20 commitments [7] and objectives, was implemented in November 2012, ahead of other G20 jurisdictions. Japan's clearing requirement, at its initial stage, is applied to transactions between large domestic financial institutions registered under the Financial Instruments and Exchange Act, No. 25 of 1948 (“FIEA”), who are members of licensed clearing organizations [8] , for (i) certain credit default swaps (i.e., those referencing iTraxx Japan—an investment-grade index CDS from 50 Japanese firms); and (ii) certain interest rate swaps (i.e., three month or six month Japanese yen LIBOR interest rate swaps). According to Japanese authorities, the scope of entities and products subject to the clearing requirement in Japan will be expanded over the next two years in a phased manner.
While the Commission considers that the legal framework in respect of clearing and swap processing in Japan is comparable to the U.S framework, it also recognizes that there are differences in the scope of entities and products between its clearing requirement under section 2(h)(1)(A) of the CEA and § 50.2 (“the CEA clearing requirement”) and the Japanese FIEA clearing requirement, due to differences in market structures and conditions. Due to such differences, the Commission has not made a comparability determination with respect to §§ 50.2, 50.4, 23.506, or 23.610 at this time. The Commission may address these requests in a separate notice at a later date, taking into account further developments in the U.S. and Japan.
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act [9] (“Dodd-Frank Act” or “Dodd-Frank”), which, in Title VII, established a new regulatory framework for swaps.
Section 722(d) of the Dodd-Frank Act amended the CEA by adding section 2(i), which provides that the swap provisions of the CEA (including any CEA rules or regulations) apply to cross-border activities when certain conditions are met, namely, when such activities have a “direct and significant connection with activities in, or effect on, commerce of the United States” or when they contravene Commission rules or regulations as are necessary or appropriate to prevent evasion of the swap provisions of the CEA enacted under Title VII of the Dodd-Frank Act.[10]
In the three years since its enactment, the Commission has finalized 68 rules and orders to implement Title VII of the Dodd-Frank Act. The finalized rules include those promulgated under section 4s of the CEA, which address registration of SDs and MSPs and other substantive requirements applicable to SDs and MSPs. With few exceptions, the delayed compliance dates for the Commission's regulations implementing such section 4s requirements applicable to SDs and MSPs have passed and new SDs and MSPs are now required to be in full compliance with such regulations upon registration with the Commission.[11] Notably, the requirements under Title VII of the Dodd-Frank Act related to SDs and MSPs by their terms apply to all registered SDs and MSPs, irrespective of where they are located, albeit subject to the limitations of CEA section 2(i).
To provide guidance as to the Commission's views regarding the scope Start Printed Page 78892of the cross-border application of Title VII of the Dodd-Frank Act, the Commission set forth in the Guidance its interpretation of the manner in which it believes that Title VII's swap provisions apply to activities outside the U.S. pursuant to section 2(i) of the CEA. Among other matters, the Guidance generally describes the policy and procedural framework under which the Commission would consider a substituted compliance program with respect to Commission regulations applicable to entities located outside the U.S. Specifically, the Commission established a recognition program where compliance with a comparable regulatory requirement of a foreign jurisdiction would serve as a reasonable substitute for compliance with the attendant requirements of the CEA and the Commission's regulations. With respect to the standards forming the basis for any determination of comparability (“comparability determination” or “comparability finding”), the Commission stated:
In evaluating whether a particular category of foreign regulatory requirement(s) is comparable and comprehensive to the applicable requirement(s) under the CEA and Commission regulations, the Commission will take into consideration all relevant factors, including but not limited to, the comprehensiveness of those requirement(s), the scope and objectives of the relevant regulatory requirement(s), the comprehensiveness of the foreign regulator's supervisory compliance program, as well as the home jurisdiction's authority to support and enforce its oversight of the registrant. In this context, comparable does not necessarily mean identical. Rather, the Commission would evaluate whether the home jurisdiction's regulatory requirement is comparable to and as comprehensive as the corresponding U.S. regulatory requirement(s).[12]
Upon a comparability finding, consistent with CEA section 2(i) and comity principles, the Commission's policy generally is that eligible entities may comply with a substituted compliance regime, subject to any conditions the Commission places on its finding, and subject to the Commission's retention of its examination authority and its enforcement authority.[13]
In this regard, the Commission notes that a comparability determination cannot be premised on whether an SD or MSP must disclose comprehensive information to its regulator in its home jurisdiction, but rather on whether information relevant to the Commission's oversight of an SD or MSP would be directly available to the Commission and any U.S. prudential regulator of the SD or MSP.[14] The Commission's direct access to the books and records required to be maintained by SD or MSP registered with the Commission is a core requirement of the CEA [15] and the Commission's regulations,[16] and is a condition to registration.[17]
As represented to the Commission by the applicant, swap activities in Japan may be governed by the Banking Act of Japan, No. 59 of 1981 (“Banking Act”), covering banks and bank holding companies, and the FIEA, covering, among others, Financial Instrument Business Operators (“FIBOs”) and Registered Financial Institutions (“RFIs”). The Japanese Prime Minister delegated broad authority to implement these laws to the Japanese Financial Services Agency (“JFSA”). Pursuant to this authority, the JFSA has promulgated the Order for Enforcement,[18] Cabinet Office Ordinance,[19] Supervisory Guidelines [20] and Inspection Manuals.[21] The Securities and Exchange Surveillance Commission (“SESC”) is within the JFSA and has promulgated, among other things, the Inspection Manual for FIBOs.
Pursuant to Article 29 of the FIEA, any person that engages in trade activities that constitute “Financial Instruments Business”—which, among other things, includes over-the-counter transactions in derivatives (“OTC derivatives”) or intermediary, brokerage (excluding brokerage for clearing of securities) or agency services therefor [22] —must register under the FIEA as a FIBO. Banks that conduct specified activities in the course of trade, including OTC derivatives, must register under the FIEA as RFIs pursuant to Article 33-2 of the FIEA. Banks registered as RFIs are required to comply with relevant laws and regulations for FIBOs regarding specified activities. Failure to comply with any relevant laws and regulations, Supervisory Guidelines or Inspection Manuals would subject the applicant to potential sanctions or corrective measures.
The applicant is a licensed bank in Japan that is also registered as an RFI under the supervision of the JFSA. In addition, the applicant is a member of several self-regulatory organizations, including the Japanese Securities Start Printed Page 78893Dealers Association (“JSDA”). The JSDA is a “Financial Instruments Firms Association” authorized under FIEA by the Prime Minister of Japan.[23]
The Commission's comparability analysis will be based on a comparison of specific foreign requirements against the specific related CEA provisions and Commission regulations as categorized and described in the Guidance. As explained in the Guidance, within the framework of CEA section 2(i) and principles of international comity, the Commission may make a comparability determination on a requirement-by-requirement basis, rather than on the basis of the foreign regime as a whole.[24] In making its comparability determinations, the Commission may include conditions that take into account timing and other issues related to coordinating the implementation of reform efforts across jurisdictions.[25]
The home jurisdiction's authority to support and enforce its oversight of the registrant.[26]
In making a comparability determination, the Commission takes an “outcome-based” approach. An “outcome-based” approach means that when evaluating whether a foreign jurisdiction's regulatory requirements are comparable to, and as comprehensive as, the corollary areas of the CEA and Commission regulations, the Commission ultimately focuses on regulatory outcomes (i.e., the home jurisdiction's requirements do not have to be identical).[27] This approach recognizes that foreign regulatory systems differ and their approaches vary and may differ from how the Commission chose to address an issue, but that the foreign jurisdiction's regulatory requirements nonetheless achieve the regulatory outcome sought to be achieved by a certain provision of the CEA or Commission regulation.
In doing its comparability analysis the Commission may determine that no comparability determination can be made [28] and that the non-U.S. SD or non-U.S. MSP, U.S. bank that is a SD or MSP with respect to its foreign branches, or non-registrant, to the extent applicable under the Guidance, may be required to comply with the CEA and Commission regulations.
The starting point in the Commission's analysis is a consideration of the regulatory objectives of the foreign jurisdiction's regulation of swaps and swap market participants. As stated in the Guidance, jurisdictions may not have swap specific regulations in some areas, and instead have regulatory or supervisory regimes that achieve comparable and comprehensive regulation to the Dodd-Frank Act requirements, but on a more general, entity-wide, or prudential, basis.[29] In addition, portions of a foreign regulatory regime may have similar regulatory objectives, but the means by which these objectives are achieved with respect to swap market activities may not be clearly defined, or may not expressly include specific regulatory elements that the Commission concludes are critical to achieving the regulatory objectives or outcomes required under the CEA and the Commission's regulations. In these circumstances, the Commission will work with the regulators and registrants in these jurisdictions to consider alternative approaches that may result in a determination that substituted compliance applies.[30]
Finally, the Commission generally will rely on an applicant's description of the laws and regulations of the foreign jurisdiction in making its comparability determination. The Commission considers an application to be a representation by the applicant that the laws and regulations submitted are in full force and effect, that the description of such laws and regulations is accurate and complete, and that, unless otherwise noted, the scope of such laws and regulations encompasses the swaps activities [31] of SDs and MSPs [32] in the relevant jurisdictions.[33] Further, as stated in the Guidance, the Commission expects that an applicant would notify the Commission of any Start Printed Page 78894material changes to information submitted in support of a comparability determination (including, but not limited to, changes in the relevant supervisory or regulatory regime) as, depending on the nature of the change, the Commission's comparability determination may no longer be valid.[34]
The Guidance provided a detailed discussion of the Commission's policy regarding the availability of substituted compliance [35] for the Business Conduct Requirements.
In the Guidance, the Commission stated that, in connection with a determination that substituted compliance is appropriate, it would expect to enter into an appropriate memorandum of understanding (“MOU”) or similar arrangement [36] with the relevant foreign regulator(s). Although existing arrangements would indicate a foreign regulator's ability to cooperate and share information, “going forward, the Commission and relevant foreign supervisor(s) would need to establish supervisory MOUs or other arrangements that provide for information sharing and cooperation in the context of supervising SDs and MSPs.”[37]
Accordingly, the Commission is negotiating such a supervisory arrangement with each applicable foreign regulator of an SD or MSP. The Commission expects that the arrangement will establish expectations for ongoing cooperation, address direct access to information,[38] provide for notification upon the occurrence of specified events, memorialize understandings related to on-site visits,[39] and include protections related to the use and confidentiality of non-public information shared pursuant to the arrangement.
Commission Requirement: Section 4s(i) of the CEA requires each SD and MSP to conform to Commission standards for the timely and accurate confirmation, processing, netting, documentation, and valuation of swaps.[40] Pursuant to this requirement, the Commission adopted § 23.504.
Pursuant to § 23.504(a), SDs and MSPs must have policies and procedures reasonably designed to ensure that the SD or MSP enters into swap trading relationship documentation with each counterparty prior to executing any swap with such counterparty. Such requirement does not apply to cleared swaps.
Pursuant to § 23.504(b), SDs and MSPs must, at a minimum, document terms relating to:
Transfer of rights/obligations;Start Printed Page 78895
Generally identical in intent to § 23.504(b)(2), (3), and (4), the Japanese confirmation and valuation documentation requirements are designed to reduce the legal, operational, counterparty credit, and market risk that can arise from undocumented transactions or terms, reducing the risk of collateral and legal disputes, and exposure of counterparties to significant counterparty credit risk.
Moreover, generally identical in intent to § 23.504(a)(2), (b)(1), (c), and (d), the Japanese standards require that SDs and MSPs establish policies and procedures, including audit procedures, approved in writing by senior management of the SD or MSP, reasonably designed to ensure that they have entered into swap trading relationship documentation in compliance with appropriate standards with each counterparty prior to or contemporaneously with entering into a swap transaction with such counterparty.
The foregoing comparability determination does not extend to the requirement that such documentation include notice of the status of the counterparty under the orderly liquidation procedures of Title II of the Dodd-Frank Act, and the effect of clearing on swaps executed bilaterally.[41]
Daily trading records must be maintained in a form and manner identifiable and searchable by transaction and counterparty, and records of swaps must be maintained for the duration of the swap plus five years, and voice recordings for one year. Records must be “readily accessible” for the first two years of the five year retention period (consistent with § 1.31).
Regulatory Objective: Through § 23.202, the Commission seeks to ensure that an SD's or MSP's records include all information necessary to conduct a comprehensive and accurate trade reconstruction for each swap, which necessarily requires the records to be identifiable by transaction and counterparty. Complete and accurate trade reconstruction is critical for both regulatory oversight and investigations of illegal activity pursuant to the Commission's enforcement authority. The Commission believes that a comprehensive and accurate trade reconstruction requires records of pre-execution, execution, and post-execution trade information.
Similarly, IV-5-2(i) of Supervisory Guideline for FIBOs would ensure the availability of information to a regulator promptly upon request. Under this provision, the JFSA assesses whether a designated parent company of a FIBO Start Printed Page 78897ensures group-wide compliance with the relevant laws, regulations and rules of each country in which it does business by establishing an appropriate control environment for legal compliance in accordance with the size of its overseas bases and the characteristics of its business operations.
The JFSA has informed the Commission that, in the process of its oversight and enforcement of the foregoing Japanese standards for FIBOs and RFIs, any SD or MSP would be subject to such standards and required to record pre-execution trade information, communicated by not only telephone but also other forms of communication comparable to those listed in § 23.202(a)(1) and (b)(1).
Commission Determination: The Commission finds that compliance with Japanese standards would enable the relevant competent authority to conduct a comprehensive and accurate trade reconstruction for each swap, which the Commission finds generally meets the regulatory objective of § 23.202.
Based on the foregoing and the representations of the applicant, the Commission hereby determines that the daily trading records requirements of Japan's standards are comparable to and as comprehensive as § 23.202.
As I previously stated in my dissent, the Guidance fails to articulate a valid statutory foundation for its overbroad scope and inconsistently applies the statute to different activities.[2] Section 2(i) of the Commodity Exchange Act (“CEA”) states that the Commission does not have jurisdiction over foreign activities unless “those activities have a direct and significant connection with activities in, or effect on, commerce of the United States . . .” [3] However, the Commission never properly articulated how and when this limiting standard on the Commission's extraterritorial reach is met, which would trigger the application of Title VII of the Dodd-Frank Act[4] and any Commission regulations promulgated thereunder to swap activities that are outside of the United States. Given this statutorily unsound interpretation of the Commission's extraterritorial authority, the Commission often applies CEA section 2(i) inconsistently and arbitrarily to foreign activities.
First, earlier this year, the OTC Derivatives Regulators Group (“ODRG”) agreed to a number of substantive understandings to improve the cross-border implementation of over-the-counter derivatives reforms.[5] The ODRG specifically agreed that a flexible, outcomes-based approach, based on a broad category-by-category basis, should Start Printed Page 78898form the basis of comparability determinations.[6]
11. The compliance dates are summarized on the Compliance Dates page of the Commission's Web site. (http://www.cftc.gov/​LawRegulation/​DoddFrankAct/​ComplianceDates/​index.htm.)
14. Under §§ 23.203 and 23.606, all records required by the CEA and the Commission's regulations to be maintained by a registered SD or MSP shall be maintained in accordance with Commission regulation 1.31 and shall be open for inspection by representatives of the Commission, the United States Department of Justice, or any applicable prudential regulator.
16. See e.g., §§ 23.203(b) and 23.606.
38. Section 4s(j)(3) and (4) of the CEA and Commission regulation 23.606 require a registered SD or MSP to make all records required to be maintained in accordance with Commission regulation 1.31 available promptly upon request to, among others, representatives of the Commission. See also 7 U.S.C. § 6s(f); 17 CFR 23.203. In the Guidance, the Commission states that it “reserves this right to access records held by registered [SDs] and MSPs, including those that are non-U.S. persons who may comply with the Dodd-Frank recordkeeping requirement through substituted compliance.” 78 FR 45345 n. 472; see also id. at 45342 n. 461 (affirming the Commission's authority under the CEA and its regulations to access books and records held by registered SDs and MSPs as “a fundamental regulatory tool necessary to properly monitor and examine each registrant's compliance with the CEA and the regulations adopted pursuant thereto”).
40. See 7 U.S.C. § 6s(i).
41. See § 23.504(b)(5) and (6).