Extra-territoriality has rushed back to the top of the regulatory agenda – thanks to the CFTC. Galen
In November, the Commodity Futures Trading Commission
(CFTC) responded to the widespread confusion amongst
market participants regarding the SEF rules by issuing two
pieces of guidance.
One was regarding the cross-border application of the SEF rules
and the other focused on the requirement for these venues to
provide impartial access. Both pieces of guidance could potentially
have significant and far-reaching consequences for both SEF
operators and users that had not previously been understood.
The cross-border application of the Dodd-Frank Act has proved
to be one of the enduring headaches in implementing the new
regulatory regime and this has proven to be especially true in the
case of trading on SEFs.
Dodging the SEF Rules
The now infamous footnote 88 caught a lot of firms off guard
as it expanded the SEF ‘universe’ by explicitly stating that the
regulators would not be using the clearing mandate to determine
what trades on a SEF, thereby requiring that a broader range of
products be traded on the new platforms.
The Commission notes that it is not tying the registration
requirement in CEA section 5h(a)(1) to the trade execution
requirement in CEA section 2(h)(8), such that only facilities
trading swaps subject to the trade execution requirement would
be required to register as a SEF. Therefore a facility would be
required to register as a SEF if it operates in a manner that meets
the SEF definition even though it only executes or trades swaps
that are not subject to the trade execution mandate.
Once footnote 88 was introduced to the rules and its
importance was understood, some firms began to studiously look
for a way to avoid these rules, and what their lawyers came up
with was footnote 513.
Certain financial institutions had hoped to use this footnote,
found buried in an Agency policy document from June 2013, to
circumnavigate the SEF rules by effectively having a trade put
together in New York and then transferred to non-US affiliates
for the actual execution of the transaction. Thus these institutions
would not be required to register to trade on SEFs.
However, the guidance released by the Division of Swap Dealer
and Intermediary Oversight (DSIO) at the CFTC clearly states that
firms trading in this manner must comply with the SEF rules.
“DSIO believes that persons regularly arranging,
negotiating, or executing swaps for or on behalf of an SD
[swap dealer] are performing core, front office activities of
that SD’s dealing business.
“Thus, DSIO is of the view that a non-US SD (whether an
affiliate or not of a US person) regularly using personnel or
agents located in the US to arrange, negotiate, or execute a swap
with a non-US person generally would be required to comply
with the Transaction-Level Requirements,” according to the
A Matter of Interpretation
The response to this guidance from the market has been
divided. Prior to this clarification some SEFs that don’t have
voice broking operations or the international footprint of the
inter-dealer brokers felt disadvantaged by the use of footnote 513.
“It’s great when the regulators come out and state the rules in
black and white like this, but for some time you’ve had firms
looking at this footnote 513 and thinking that it allows them to
operate differently,” says one SEF operator.
Not all the IDBs tried to avoid the SEF rules in this manner.
Icap took the same interpretation of the rules as the CFTC and
had been voluble in pointing out that, despite private assurances
from the CFTC that this was the correct interpretation, there had
been no direct comment or action from the regulators. Of course,
the government shutdown during the first half of October didn’t
help this issue.
But now that the Commission has closed down this loophole,
what does this mean for market participants?
In the short-term, the impact of this new piece of guidance is
negligible because SEF trading isn’t mandatory yet. But this
could change in February when the Made Available to Trade
(MAT) rules come into force.
The most likely response will be further regionalisation as
markets are divided down regulatory and jurisdictional lines. In
theory, market participants should want to trade on SEFs for the
better prices, wider choices and greater liquidity during tough
times. However, the relative lack of liquidity on the SEF venues
at present, combined with the registration and onboarding
requirements and regulatory uncertainty around the rules are
deterring people from trading there.
With this guidance closing the only loophole that could have
allowed meaningful cross-border interaction between US and non-US persons without the latter having to trade on SEFs, it
could create a sizeable schism within the swaps market.
Eventually, it could be that two distinct markets are created as
those who can stay off SEF do.
Banks Fight Back
Since the guidance was released new reports have surfaced
claiming that a group of banks, under the banners of the
International Swaps and Derivatives Association (ISDA) and the
Securities Industry and Financial Markets Association (SIFMA),
are planning to sue the CFTC for violating the rule-making
procedures of Dodd-Frank.
Allegedly the banks plan to protest that the new guidance is an
overreach by the CFTC, which would give it jurisdiction of
complex international swap deals that involve only an incidental
involvement by a US institution.
The CFTC has subsequently issued a no-action letter that
allows non-US swap dealers additional time to comply with the
rules explained in the November 14 guidance.
In a statement the Commission says that it has issued this relief
because “concerns were raised by certain Non-US SDs regarding
compliance with the Transaction-Level Requirements, who
represented that, in order to avoid market disruption for their non-
US counterparties, additional time would be necessary to come
These non-US swap dealers now have until January 14th to
comply with the CFTC’s guidance.Although the two pieces of guidance
issued on November 14 are not necessarily
legally binding because they have not been
voted on, the extra-territorial reach by the
US regulators has already been so great that
it is unlikely the courts would reject them
purely on these grounds.
“Regarding the weight of guidance, these interpretations aren’t fully binding, but they do express the
“expert agency’s” view of what the statute means, and courts give
great weight to the expertise of an agency unless the view is
arbitrary (see last year’s position limits case ISDA v CFTC),”
explains Neal Wolkoff, CEO of Wolkoff Consulting Services.
Creating a Level Playing Field
The second piece of guidance issued by the CFTC requires
SEFs to offer impartial access to their trading platforms.
Commenting on this issue, CFTC chairman Gary Gensler has
been keen to stress that impartial access is about allowing market
participants to “compete on a fair and level playing field”,
according to the direction given to the Commission by Congress.
Included in the guidance was that SEFs cannot require their
customers to sign breakage agreements, can’t designate members
exclusively as liquidity takers or makers, can’t require members
to be self-clearing and can’t restrict the number of firms someone
can RFQ out to – all must be an option.
Although Gensler claims, “that guidance really didn’t say that
much more than was already in the law and in the rules”, some
market participants clearly think differently.
A New Model of Market Access
The Wholesale Markets Brokers’ Assocation held its annual
conference on the development of SEFs shortly after the guidance
was released and it was a hot topic of conversation.
“I think that the impartial access guidance that was just
released recently will significantly change the landscape of howthe market operates today in the dealer-to-customer space. Until
now the market has been operating on the assumption that there
could be classes of participants and I think at first glance that it
reads as though these guidelines remove those classes of
participants,” said Sonali Das Theisen, director in credit at
Richard McVey, CEO and chairman of the board at
MarketAxess opined a similar view.
“Is the SEF market compliant with the clarified impartial
access rules from Thursday last week? No,” he said.
McVey added that some SEFs, based on previous interpretations of the rules, had reasonably assumed that a certain
level of permissioning would be appropriate in order to retain the
previous client-to-dealer relationship.
“But I think that the clarifications suggested that, that’s not
really the case and that we’re moving to a very different model in
terms of impartial access,” he concluded.
MarketAxess SEF has since released a statement to clarify that
it is, in fact, compliant with the guidelines, after media reports
It must be remembered that impartial access is not the same
thing as open access to everyone. It was originally thought that
the SEF rules required the venues to provide the former, but not
necessarily the latter. But with the new guidance the CFTC has
removed much of the discretion for SEF operators to decide who
or how people trade on their platforms.
They can still decide whether to offer name give-ups or
anonymous trading and might be able to impose minimum trade sizes, but that is about the limit. This guidance places restrictions
on what the SEFs can include in their rule book, giving more
choice to their users and could potentially eliminate categories
such as dealer-to-dealer or dealer-to-client platforms.
That the Commission is being forced to constantly issue new
pieces of guidance and no-action letters is a sign of the continued
uncertainty in the financial industry regarding the SEF rules. That
the industry is finding obscure footnotes (number 513, no less) to
avoid these requirements shows the level of resistance in some
corners of the market to them.
The guidance regarding impartial access may have caught some
by surprise but in many respects it will only serve to accelerate
the move to an all-to-all model that many have expected the
market to move towards regardless. Firms will have to adjust
their business models, even if that involves a significant re-
structuring of these models.
The cross-border guidance will prove far more problematic to
“Despite what Chairman Gensler says, this is very much still a
grey area. Expect this argument to drag on for some time,” one
former SEC legal counsel tells Profit & Loss.
Issues concering the extraterritorial application of US rules
and substituted compliance will rumble on for some time
longer, but ultimately it will be harder for firms to avoid SEF
trading once the no-action letter expires in January. As such, the
implications of this piece of guidance are likely to extend far
beyond the US borders.