CFTC’s swap dealer rule for compliance chiefs: many questions in first “annual reports”

October 1, 2014

By Henry Engler, Compliance Complete

NEW YORK, Oct. 1, 2014 (Thomson Reuters Accelus) – New rules governing swap dealers and the requirements for dedicated chief compliance officers are now more than a year in effect, and a new review of the so-called “annual reports” that dealers must submit to the Commodities Futures Trading Commission suggest there are still lingering questions over the roles and responsibilities of CCOs, particularly for non-U.S. dealers.

The review, published by the law firm Wilmer Hale , found that as of May 31, 2014, 105 entities were provisionally registered as swap dealers, and therefore subject to the CFTC’s CCO rule, which came into force in December 2012. The study noted that of the total population, 53 were located in the United States, with the rest in other jurisdictions, including the European Union, Canada, Australia, Hong Kong, Japan, Mexico, Singapore, and Switzerland. 

The annual report that dealers must provide the commission cover a wide range of compliance issues. They include evidence of trading that would raise conflicts of interest and events that are deemed as non-compliant with rules governing swap trading. The CCO must in effect attest to the CFTC that the firm is compliant through written communication – the “annual report.”

However, for non-U.S. dealers, the rules are somewhat more flexible. In December 2013, the CFTC issued several “comparability determinations” in accordance with the policies and procedures set forth in the CFTC’s Interpretive Guidance and Policy Statement regarding the cross-border application of the swap provisions of the Dodd-Frank Act and the Commission’s regulations.

“The comparability determinations permit non-U.S. swap dealers to comply with most of the CCO requirements of their home jurisdictions — including the annual reporting requirements of their home jurisdictions — rather than the requirements under the CCO Rule (i.e., “substituted compliance”),” the review said.

In essence, both U.S. and non-U.S. swap dealers require that CCOs be “actively engaged in all aspects of swap dealer compliance, be provided with both the authority and resources to facilitate effective compliance, and have direct and meaningful access to the swap dealer’s governing body.”

In reviewing the swap dealer submissions of policies and procedures – so-called “Section 4s” – the CFTC and the National Futures Association (NFA)– the self-regulatory association charged with implementing swap dealer registration requirements and overseeing swap dealer compliance with Commission regulations — have found numerous requests for more detail, particularly regarding the procedures swap dealers are or will be using to implement their policies.

“In conducting their reviews, the CFTC and NFA have also recognized the complexities involved in the new swap dealer regulatory regime and have indicated a willingness to work with swap dealers to refine and improve their Section 4s submissions. NFA on-site examinations of U.S. swap dealers were scheduled to begin in the summer of 2014,” the review added.

Issues requiring more clarity

The following are issues on which firms sought greater clarity from the CFTC:

  • What is material noncompliance? – The annual report must identify material noncompliance issues, a term the CFTC has declined to define. Thus, the CCO must use his or her judgment to determine when a noncompliance issue is material and must be reported. It remains to be seen how much flexibility the CFTC will allow in making the determination of materiality.
  • Conflicts of interest resolution – Similarly, the CCO is responsible, in consultation with the board of directors or senior officer, for “resolving any conflicts of interest that may arise” and for taking reasonable steps to ensure compliance with CFTC regulations. The CCO’s authority in these areas is not precisely defined. The commission has explicitly declined to adopt the “existing precedent for compliance models in the financial services industry,” but has not provided specific guidance on alternative models.
  • CCO dual roles – It also may be challenging for a CCO with a dual role (e.g., an individual who is both CCO and general counsel), which is permitted by the CCO Rule, to manage all aspects of both roles, some of which may potentially be in conflict. As the CFTC and NFA review Section 4s submissions and CCO annual reports over the next two years, the regulators may provide additional guidance on some of the less clear interpretive and/or implementation issues.
  • Non-U.S. swap dealers – The CFTC’s comparability determinations provide: (a) that a covered swap dealer may follow only its home jurisdiction rules with respect to preparation and form of the annual report, and (b) that this report be certified by the swap dealer’s CCO or CEO and submitted timely to the Commission. However, the different requirements and practices outside the U.S. have raised a number of issues for non-U.S. swap dealers regarding how to comply with the substituted compliance determinations.

Concerns have ranged from issues of scope to issues of format and timing. For example, there has been significant uncertainty as to the degree to which non-U.S. swap dealers should read the Commission’s comparability determinations literally and rely fully on substituted compliance — whether they should provide to the Commission precisely in form and substance that which they are required to produce in their home jurisdiction.

The review notes that the CFTC and NFA have both responded to these issues by asking for more detail, particularly in terms of processes within firms.

“We would expect, at least for the coming year, to see an iterative process between the regulators and swap dealers as they work through the appropriate level of detail and the various interpretive and implementation issues, many of which will likely only be identified after a complete review of the Section 4s submissions and the CCO annual reports and on-site examinations by NFA,” the review concluded.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus. Compliance Complete provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Accelus compliance news on Twitter: @GRC_Accelus)

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