Securities Regulation Daily Wrap Up, DERIVATIVES—CFTC Grants Swap Dealers No-Action Relief on External Business Conduct Standards Re: Prime Brokerage Arrangements, (May 1, 2013)

By Lene Powell, J.D.

The CFTC Division of Swap Dealer and Intermediary Oversight (DSIO) issued a time-limited no-action letter providing swap dealers with relief from certain External Business Conduct Standards rules in the context of prime brokerage arrangements.

Under Section 4s(h) of the Commodity Exchange Act (CEA), the Commission published final business conduct rules for swap dealers (SDs) and major swap participants (MSPs) as subpart H of part 23.5. The compliance date for a number of the provisions of the External Business Conduct Standards was subsequently postponed until May 1, 2013.

Prime brokerage arrangements. With respect to compliance with the External Business Conduct Standards in transactions entered into through a prime brokerage arrangement, the Commission stated in the adopting release that SDs and MSPs were permitted to arrange with third parties, such as the counterparty’s prime broker, a method of providing disclosure or verifying that a Special Entity has an independent representative. However, the SD or MSP remained responsible for compliance with the rules.

Exempt FX transactions. Although the Secretary of the Treasury determined that foreign exchange (FX) swaps and forwards should not be regulated as swaps under the CEA, Section 1a(47)(E)(iv) provides that, notwithstanding the Secretary’s determination, SDs and MSPs that are parties to an FX swap or forward must conform to the business conduct standards contained in Section 4s(h). Thus, SDs and MSPs must comply with the External Business Conduct Standards with respect to Exempt FX Transactions, including those for which the compliance date is May 1, 2013.

Request for relief. To facilitate compliance with the External Business Conduct Standards in the context of prime brokerage arrangements, market participants proposed that SDs be permitted to allocate responsibility between two SDs for compliance with certain obligations to counterparties under the External Business Conduct Standards. In addition, relief was requested for SDs acting as prime brokers from compliance with certain External Business Conduct Standards altogether when an executing dealer is not required to be registered with the Commission as a SD.

No-action position. DSIO will not recommend that the Commission bring an enforcement action against a SD for failure to comply with the obligations of the SD under Commission Regulations §§ 23.402(b)-(f) (Know your counterparty, True name and owner, Reasonable reliance on representations, Manner of disclosure and Disclosures in a standard format, respectively), 23.430 (Verification of counterparty eligibility), 23.431 (Disclosures of material information), 23.432(b) (Clearing disclosures for swaps not required to be cleared—right to clearing), 23.434 (Recommendations to counterparties—institutional suitability), 23.440 (Requirements for swap dealers acting as advisors to Special Entities), 23.450 (Requirements for swap dealers and major swap participants acting as counterparties to Special Entities), and 23.451 (Political contributions by certain swap dealers) with respect to a Covered Transaction with a counterparty executed under a prime brokerage arrangement to the extent any such obligations have been allocated to another SD and such other SD has accepted such allocation, subject to a number of conditions.

Additionally, DSIO will not recommend that the Commission bring an enforcement action against a SD for failure to comply with the obligations of the SD under Commission Regulations §§ 23.431(a)(3)(i) or 23.431(b) with respect to an Exempt FX Transaction with a counterparty executed under a prime brokerage arrangement, subject to conditions.

To allow time for SDs to complete new documentation and provide certain notices to qualify for relief, DSIO will not recommend that the Commission commence an enforcement action against a SD for failure to comply with any apportionable business conduct obligations, as defined in the letter, with respect to Covered Transactions until May 15, 2013, provided that such Covered Transactions are conducted under prime brokerage arrangements of such SD in existence on the date of the letter. The relief does not apply to Covered Transactions with any counterparty not executed under a prime brokerage arrangement in existence on April 30, 2013.

The relief in the letter is time-limited and will end at 12:01 eastern time on the later of the effective date or the compliance date of any final rule or final order providing relief from the Prime Brokerage External Business Conduct Standards as they relate to Covered Transactions executed under prime brokerage arrangements, as described in the letter.

RegulatoryActivity: Derivatives