U.S. Banking and Capital Markets Developments for Canadian Issuers

U.S. Banking and Capital Markets Developments for Canadian Issuers July 29, 2014, 11:45AM – 3:00PM Speakers: James Schwartz, Jerry Marlatt and Oliver ...
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U.S. Banking and Capital Markets Developments for Canadian Issuers July 29, 2014, 11:45AM – 3:00PM Speakers: James Schwartz, Jerry Marlatt and Oliver Ireland

1. Presentation: Key Developments for Canadian Banks in U.S. Bank Regulation – Oliver Ireland 2. Presentation: Canadian Banks and the U.S. Capital Markets: Opportunities and Issues – Jerry Marlatt 3. Presentation: Current Issues in Implementing Dodd-Frank Title VII – James Schwartz




July 29, 2014 Oliver Ireland Jerry Marlatt James Schwartz

©2014 Morrison & Foerster LLP | All Rights Reserved | mofo.com

U.S. Banking and Capital Markets Developments for Canadian Issuers

July 29, 2014 Oliver Ireland

©2014 Morrison & Foerster LLP | All Rights Reserved | mofo.com

Key Developments for Canadian Banks in U.S. Bank Regulation

Volcker Rule for FBOs


Caveat • This presentation is for informational purposes only and does not constitute legal advice or create an attorneyclient relationship • Please consult your own attorney for legal advice on the issues discussed in this presentation • Because of the generality of this presentation, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations • This outline may constitute attorney advertising.


Changes from Proposals/Effective Dates • Final Rule defers action on single-counterparty credit limits and early remediation standards • Foreign nonbank financial institutions not covered and to be evaluated by Board on a case-by-case basis • Decreases liquidity buffer for U.S. branches and agencies of FBO from 30 days to 14 days • Extends initial compliance date for Covered FBOs from July 1, 2015 to July 1, 2016

Confidential/Subject to Attorney Client Privilege


Changes from Proposals/Effective Dates • Other changes applicable to IHCs • Raises the threshold for requiring a Covered FBO to form an IHC • Defers application of the leverage capital requirements and stress test requirements to IHCs until January 1, 2018 and October 1, 2017, respectively • Transition period to form an IHC extended (discussed below) • Requires IHC implementation plan to be submitted by January 1, 2015 (quid pro quo for extension)

Confidential/Subject to Attorney Client Privilege


Background • Proposed in December 2012 under DFA Sections 165,166 and 167 • Section 165: Enhanced supervision and prudential standards for systemically important banks and nonbank financial companies • Section 166: Early remediation requirements for systemically important banks and nonbank financial companies • Section 167: Intermediate holding company requirement for systemically important nonbank financial companies

• FBO provisions modeled on DFA Section 165/166 rules proposed in December 2011 for domestic bank holding companies

Confidential/Subject to Attorney Client Privilege


Other Topics • Deferred Rulemaking • Single-Counterparty Credit Limits • Early Remediation Standards

• Enhanced Prudential Standards for Non-Bank Financial Companies • To be addressed on a case-by-case basis

Confidential/Subject to Attorney Client Privilege


Volcker Rule for Foreign Banking Organizations • The Volcker Rule is the popular name for Section 619 of the DoddFrank Act, enacted in July 2010 • Codified as Section 13 of the Bank Holding Company Act

• The statute prohibits (with exceptions) banking entities from: • Engaging in proprietary trading; and • Sponsoring, or acquiring or retaining an interest in, private equity and hedge funds.


Conformance Period • The Volcker Rule took effect by statute on July 21, 2012 • Provides for a two-year conformance period, ending July 21, 2014 • Conformance period recently extended by one year by Federal Reserve to July 21, 2015

• Each banking entity is expected to make good faith efforts to conform by end of conformance period • • • •

Develop plan for disposition or restructuring of existing prohibited investments New capital commitments likely prohibited Honoring capital calls under existing commitments Holding on to CDOs and CLOs awaiting guidance

• Banking entities expected to terminate/divest stand-alone proprietary trading operations promptly


Conformance Period • Two one-year extensions possible, upon application • Further extension of up to five years available, upon application, for continued investment/activity with respect to an “illiquid fund” • To qualify for “illiquid fund” extension, must demonstrate that retention of interest necessary to fulfill a contractual commitment in effect on May 1, 2010 • Condition not met if a “regulatory-out” allows sale or redemption of interest • Banking entity required to make reasonable best efforts to get consent for sale or redemption, and to have that consent denied

• No expansion of impermissible activities or investments during the conformance period with expectation of extensions


What the Volcker Rule Covers • Banking entities include • US banks and thrifts • Bank and thrift holding companies • Foreign banking organizations (FBOs) that operate a branch/agency or commercial lending company in the US • Affiliates of these entities (US and foreign) • Banking entities do not include • A covered fund (unless it is a banking entity included in one of the first three categories above) • A portfolio company held by a financial holding company under the merchant banking or insurance company authority or held by a SBIC (unless it is a banking entity included in one of the first three categories above) 12

Prohibition on Proprietary Trading • A banking entity may not trade a financial instrument as principal for its own trading account • Financial Instrument • A security (or option on a security) • A derivative (or option on a derivative) • A contract of sale of a commodity future (or an option on same)

• Not a financial instrument • Loans • Certain commodities • Foreign exchange or currency


Prohibition on Proprietary Trading • Trading Account • Purpose test: trading for short-term resale (presumed if held for fewer than 60 days) or for benefitting from short-term price movements, short-term arbitrage profits, etc. • Market Risk Capital Rule test: if a US bank or thrift or US bank or thrift holding company is subject to the US banking agencies’ market risk capital rules, a trading account includes an account used to trade in financial instruments that are both market risk capital rule covered positions and trading positions • Status test: if the banking entity is a securities dealer, swap dealer or securities-based swap dealer, all trades that would require them to be licensed as such are deemed to be in a trading account


Proprietary Trading Exclusions • • • • • • • • • •

Repos or reverse repos Trades arising under certain securities lending or borrowing arrangements Trades for liquidity management pursuant to a plan Trades by a derivatives clearing organization* and clearing agency** in connection with their clearing and settlement activities Trades in connection with “excluded clearing activities” Trades to satisfy an existing delivery obligation Trades to satisfy a judicial, administrative, arbitration or similar proceeding Trades where the banking entity is acting solely as agent, broker or custodian Trades through a deferred compensation or pension plan Trades made in the ordinary course of collecting a debt previously contracted (DPC exclusion)

*Registered under § 5b of the Commodity Exchange Act, or exempt from registration pursuant to CFTC regulations, or a foreign derivatives organization permitted to clear for a foreign board of trade registered pursuant to CFTC regulations **Securities Exchange Act of 1934, § 3(a)(23). 15

Permitted Proprietary Trading • The following trading activity as principal is permitted: • Trading in US government/agency securities • Trading in US municipal securities • But trading in derivatives in these two categories of securities does not come within this exemption • For such derivatives consider market making or risk-mitigating hedging exemptions discussed below

• Trading on behalf of a customer in a fiduciary capacity or as riskless principal • Trading by a banking entity that is a regulated insurance company (foreign or domestic)


Permitted Proprietary Trading • Foreign Government Obligations • Trading by a foreign subsidiary of a US banking entity that is a foreign bank or regulated securities dealer in the debt of the foreign government in the country in which the foreign subsidiary is organized • A foreign banking entity or affiliate (including a US affiliate) may trade in obligations issued or guaranteed by a foreign sovereign (or any agency or political subdivision) or a multinational central bank of which the foreign sovereign is a part if: • The banking entity is not controlled by a top-tier US banking entity and is not a US bank or thrift • The obligations are issued or guaranteed by the foreign banking entity’s home country sovereign (or agency or political subdivision) or a multinational central bank of which such foreign sovereign is a part • Trading in obligations of multilateral development banks not within these exemptions

• NB: An FBO can trade any foreign debt if it complies with the SOTUS exemption. 17

Permitted Proprietary Trading • Also permitted are • Certain risk-mitigating hedging activities • Certain market-making activities • Certain underwriting activities

• Overall conditions to these permitted activities • The banking entity must maintain an internal compliance program • The compensation arrangements of personnel involved in these activities must not be designed to reward proprietary trading • The banking entity must be appropriately registered or licensed, or not subject to registration or licensing, to engage in market making or underwriting • This is highly complex area See our Client Alert: http://www.mofo.com/files/Uploads/Images/131227-Volcker-Rule-Capital-MarketsOfferings.pdf


Permitted Trading for FBOs • Proprietary trading by a foreign banking entity is permitted to the extent conducted solely outside the United States subject to the following conditions (“SOTUS” exemption) • May not be a US banking entity or controlled by a US banking entity • If an FBO, must be a qualifying foreign banking organization (QFBO) • If not an FBO, must be organized outside the US and have a majority of its business outside the US • The FBO or its affiliate (including relevant personnel who arrange, negotiate or execute the trades, but not those who settle or clear) must be located outside the US • Trading decisions must be made outside the US • Trades (and related hedging) must be booked and accounted for outside the US by a non-US entity • No financing of trade by a US branch/agency or US affiliate of the FBO


Further Conditions for FBO Exemption • Trades may not be with or through a US entity except: • Trades with the foreign operations of US entity as long as no personnel of that entity who are involved in arranging, negotiating or executing the trade are in the US • Trades with an unaffiliated intermediary acting as principal (if the trade is promptly cleared and settled through a clearing agency or organization acting as a central counterparty) • Trades with an unaffiliated intermediary acting as agent if conducted anonymously on an exchange and promptly cleared and settled through a clearing agency or organization acting as a central counterparty


Deal Flow Under Rule 15a-6 • Under SEC Rule 15a-6, foreign broker-dealers and foreign banks acting as principal or agent can solicit securities transactions with US institutional investors if the transactions are effected through a US registered broker-dealer, often a US affiliate. However, such trades as principal by an FBO and/or its foreign affiliates through its US registered broker-dealer affiliate would constitute proprietary trading • Trades by an FBO or its offshore affiliates as agent for its customers are not considered proprietary trading and thus can continue to be effected through a US registered broker-dealer affiliate


Effect on Rule 144A Transactions • Purchase by FBO or its affiliate of securities for resale in a Rule 144A transaction are prohibited as proprietary trading unless (i) within the SOTUS exemption or (ii) the exemption for permissible underwriting activities (discussed on the next slide) • The SOTUS exemption will not be available if resale as principal is directly to US QIBs (because SOTUS exemption requires trade with an unaffiliated intermediary for prompt clearance and settlement through a clearing agency or organization acting as a central counterparty) • Participation in a global (non-US) tranche should satisfy SOTUS exemption as long as the FBO/affiliate does not participate in the US tranche • For US tranche, consider restructuring transaction as private placement to QIBs by issuer, with FBO/affiliate acting as agent 22

Effect on Rule 144A Transactions • Underwriting exemption may be available for Rule 144A transactions, but only if the trading desk underwriting position is related to a “distribution” of securities for which the bank is an underwriter • Distribution: registered under the Securities Act of 1933, or otherwise characterized as different from ordinary trading by virtue of selling efforts • Amount and type of securities in the underwriting position cannot exceed the reasonably expected near term demands of clients, customers, counterparties, etc. • The trading desk must use reasonable efforts to reduce the position within a reasonable time • To rely on the underwriting exemption, banking entity is required to have a compliance program and must comply with other requirements, including compensation that does not incentivize proprietary trading • May constitute underwriting in the US under Regulation K See our Client Alert: http://www.mofo.com/files/Uploads/Images/140109-Volcker-Rule-Prohibition.pdf


Prudential Backstops • Trading in reliance on the SOTUS or any other exemption is not permissible if • The trading involves or results in a material conflict of interest between the banking entity and its clients, customers or counterparties unless (i) the banking entity makes clear and timely disclosure of the conflict or (ii) uses information barriers, such physical separation of personnel or functions, that address the conflict; • The trading would result in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy; or • The trading poses a safety and soundness threat to the institution or a threat to US financial stability


Covered Funds Prohibition • A banking entity, as principal, may not directly or indirectly acquire or retain an ownership interest in, or sponsor, a covered fund • The prohibition on acquiring/retaining an ownership interest does not apply if: • The banking entity acts solely as agent, broker or custodian for the account of or on behalf of a customer and does not have its own ownership interest • The banking entity’s ownership interest is held/controlled by it as trustee in connection with a deferred compensation or similar plan; • The ownership interest is acquired and held in the ordinary course of collecting a debt; or • The banking entity holds the interest as trustee or in a similar capacity solely for a customer that is not itself a covered fund 25

Sponsorship • A banking entity may not sponsor a covered fund, subject to certain exceptions • Sponsorship means: • To serve as a general partner, managing member, trustee or commodity pool operator (CPO) of a covered fund • To select or control selection of a majority of directors, trustees or management of a covered fund • To share with the covered fund the same name or a variation of the name


Ownership Interests • A banking entity may not acquire/retain an ownership interest in a covered fund, subject to certain exceptions • Ownership interest means any equity, partnership or “other similar interest”

• “Other similar interest” is broadly defined to include • Right to participate in the selection/removal of general partner, or managing member, director, investment manager or adviser (but not including typical creditor’s rights in the event of a default or acceleration) • Right to receive a share of income, gains or profits or, after other interests redeemed or paid, the underlying assets (e.g., the “residual” in a securitization) • Right to receives income on a pass-through basis, or rate of return determined by reference to the performance of the underlying asset • Any synthetic right to receive, or be allocated, any of the foregoing • Does not include “restricted profit interest” (carried interest)

• Ownership interest may include an interest in a covered fund not considered an ownership or equity interest in other contexts


Ownership Interests in CLOs and CDOs • Ownership interests in securitization vehicles • Many collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs) provide rights to a “controlling class” of senior debt security holders to participate in the designation of investment managers or advisers • As a result, holders of even the most senior, highly rated debt securities may be considered to hold ownership interests • If the securitization vehicle is a covered fund, a debt holder may inadvertently be covered by the Volcker Rule • CDOs holding trust preferred securities (TruPS) issued by certain issuers have been recently specially exempted • The exemption is narrow • Review of this issue is at the “top of the list” for the Agencies See our Client Alert: http://www.mofo.com/files/Uploads/Images/131226-Volcker-Rule-Impact.pdf


What is a Covered Fund? • Statute prohibits investment in/sponsorship of private equity and hedge funds (not defined) • Under the Final Rule, a covered fund includes an issuer that would be an “investment company” under the Investment Company Act of 1940 (1940 Act) but for Sections 3(c)(1) or 3(c)(7) • Section 3(c)(1) exempts from the definition of “investment company” funds whose securities are sold privately to less than 100 purchasers • Section 3(c)(7) exempts from the definition of “investment company” funds whose securities are sold privately only to “qualified purchasers”

• These two exemptions are the principal ones relied upon by private equity and hedge funds, but many other investment companies rely on these exemptions • Concept imported from Title IV of the Dodd Frank Act, requiring registration of investments advisers to private funds


Commodity Pools • Certain commodity pools are covered funds • A commodity pool is a covered pool when the CPO has claimed an exemption under Rule 4.7 under the Commodity Exchange Act (CEA) • The CPO is registered in connection with the operation of a pool that limits investors to qualified eligible persons (QEPs) • “Exempt” commodity pools are covered funds because they have characteristics similar to those of hedge funds or private equity funds • They are restricted to investors that meet heightened qualification standards


Foreign Covered Funds • Certain foreign funds are covered funds • For a banking entity that is, or is controlled by, a US banking entity (which would include a US branch/agency of a foreign bank), a covered fund includes a foreign fund with the following characteristics • The fund is organized outside the US; • The fund’s interests are offered and sold only to non-US persons; and • The fund is sponsored by the US banking entity (or an affiliate).

• Such a covered foreign fund would not include a foreign fund that, if organized or offered in the US, would not rely on Section 3(c)(1) or 3(c)(7) for an exemption from the definition of an “investment company.”


Foreign Fund Exclusion • The Proposed Rule included as a covered fund any fund organized/offered solely outside the US to non-US persons that would have been a covered fund if organized/offered in the US—a “foreign equivalent fund” • The narrowed definition in the Final Rule of a foreign covered fund implies that a foreign equivalent fund is not a covered fund for purposes of sponsorship/ investment by a foreign banking entity (not controlled by a US banking entity) • Same fund could be a covered foreign fund for a US banking entity but not for a foreign banking entity

• Investment in or sponsorship of a foreign equivalent fund by a foreign banking entity not controlled by a US banking entity should not be subject to requirements applicable to covered funds (e.g., prudential backstops, compliance program) • Certain US connections with sponsorship or investment activity may make the exclusion unavailable • If foreign fund not a covered fund, could be a “banking entity” if controlled by an FBO 32

Foreign Fund Exemption • The Volcker Rule contains a specific exemption for a foreign fund. The exemption corresponds to the SOTUS exemption for proprietary trading. To qualify for the foreign fund exemption, the investor/sponsor • may not be a US banking entity or controlled by a US banking entity • if an FBO, must be a QFBO • if not an FBO, must be organized outside the US and have a majority of its business outside the US • must make investment/sponsorship decisions outside the US through an entity located and organized outside the US—i.e., decision-making personnel must be outside the US • back office and administrative functions can be in the US • investment advice can be given from the US • US-based entity can offer and sell the fund interests—but only to non-US persons


Foreign Fund Exemption • Additional conditions for foreign fund exemption • Fund interests may be offered and sold only in an offering that does not target US Persons (basically, compliant with SEC Regulation S, with appropriate disclosures) • Secondary trades • Multi-tier funds • Parallel funds

• Fund investment/sponsorship (including any related hedging) cannot be booked or accounted for in a US entity (including in any US branch/agency) • No financing of any fund investment/sponsorship may be provided by a US affiliate (including any US branch/agency) • Conditions applicable to covered funds apply (e.g., prudential backstops and compliance program) See http://www.mofo.com/files/Uploads/Images/131211-Volcker-Rule.pdf


Investments by Foreign Funds • No restrictions under Volcker Rule on a foreign excluded fund or foreign exempt fund investing in US portfolio companies or US securities • An foreign banking entity would need to determine whether the investment in the foreign fund was otherwise permissible under the Bank Holding Company Act


What is Not a Covered Fund? • Companies that do not meet the general definition of an “investment company” • For example, a fund may not be an investment company if it is not engaged or proposes to engage in the business of investing in securities that have a value exceeding 40% of the value of the company’s total assets (excluding cash and government securities)

• Funds that rely on an exception other than those found in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act • These could include funds invested primarily, for example, in real estate instead of securities. • See our Volcker Rule “User’s Guide”: http://www.mofo.com/files/Uploads/Images/131223-A-UsersGuide-to-The-Volcker-Rule.pdf


Foreign Public Funds • A foreign public fund is not a covered fund if • The fund is organized outside the US • The fund is authorized to offer and sell its interests to retail investors in the fund’s home jurisdiction (no investor suitability qualification) • The fund sells its interests through one or more public offerings predominantly outside the US (85% or more to non-US Persons) • If a US banking entity sponsors the fund, the interests must be sold predominantly to persons other than the sponsoring banking entity, its affiliates and their employees and directors

• Foreign funds that do not meet the specific conditions of this exclusion may not be covered funds for other reasons • They may qualify for the foreign fund exclusion (discussed above) or they may not rely on Section 3(c)(1) or Section 3(c)(7) of the 1940 Act • Foreign public funds may also qualify for the foreign fund exemption 37

Loan Securitization Vehicles • Loan securitization vehicles are not covered funds • Loan securitization issuers may meet the definition of a covered fund if they rely on Section 3(c)(1) or Section 3(c)(7) of the 1940 Act • But the Volcker Rule was not intended to limit the ability of banking entities to sell or securitize loans • Thus, the definition of a “covered fund” explicitly excludes issuers of collateralized obligations secured by loans (e.g., mortgage loans, auto loans, student loans and credit card receivables), including commercial paper conduits backed by loans • However, there are detailed requirements for this exclusion, and securitization vehicles with assets that include securities or derivatives may not qualify for the exclusion and therefore are covered funds • The treatment of securitization vehicles is complex See our Client Alert: http://www.mofo.com/files/Uploads/Images/131226-Volcker-Rule-Impact.pdf


Qualifying Covered Bonds • The definition of “covered funds” explicitly excludes an entity owning /holding a pool of loans or other assets that would qualify for a loan securitization for the benefit of holders of “covered bonds”: • “Covered bonds” are defined as • Debt obligations issued by an FBO, guaranteed by an entity owning/holding a pool of loans as described above, or • Debt obligations of an entity owning/holding a pool of loans described above, provided that the debt obligations are guaranteed by an FBO, and the entity is a wholly-owned subsidiary of the FBO


Other Exclusions • The following entities are also excluded from the definition of “covered funds”: • • • • • • • • • •

Wholly owned subsidiaries Joint ventures Acquisition vehicles Registered investment companies (including seeding vehicles) and business development companies Foreign pension or retirement funds Insurance company separate accounts Bank-owned life insurance company separate accounts SBICs and certain permissible public welfare and similar funds Entities used by the FDIC to dispose of assets as receiver/conservator Others that the federal agencies choose to exclude


Permitted Fund Activities and Investments • Customer funds • A banking entity may acquire ownership interests in and/or sponsor a covered fund, as a means of offering investment opportunities to its existing or future customers • This customer fund activity must be in connection with the banking entity’s trust, fiduciary or investment management services for customers pursuant to a written plan • Detailed conditions apply • Among other things, the banking entity: • cannot guarantee performance of customer funds • cannot share the same name as a customer fund • must make clear and conspicuous specified disclosures in writing to prospective investors


Permitted Fund Activities and Investments • Asset-backed securities • A banking entity may acquire ownership interests in an issuing entity of assetbacked securities* that is a covered fund, but only in connection with the banking entity’s organization and offering of the covered fund’s ownership interests, subject, generally, to the same conditions that apply to customer funds • This exemption does not permit a banking entity to invest, as a passive investor, in ownership interests in securitization vehicles that are covered funds

• Underwriting and market-making activities • A banking entity may acquire an ownership interest in a covered fund in connection with the banking entity’s underwriting or market making of the covered fund’s ownership interests, as long as those activities conform to the Volcker Rule’s requirements for permissible underwriting and market making-related activities *See Securities and Exchange Act of 1934, §3(a)(79)


Investment Limitations • Per-fund limits • A banking entity’s and its affiliates’ investment in covered funds, as a general rule, cannot exceed 3% of the value of, or the number of ownership interests in, the covered fund • During a seeding period of up to one year, the investment may exceed the 3% limit while unaffiliated investors are actively solicited

• Special rules apply for calculating the per-fund investment limits for ownership interests held in • asset-backed securities issuers in connection with a banking entity’s organization and offering of that entity’s ownership interests and • covered funds whose ownership interests are underwritten by a banking entity or in which a banking entity makes a market


Investment Limitations • Aggregate investment limits • The aggregate value of all ownership interests in such permitted covered fund investments cannot exceed 3% of the banking entity’s Tier 1 capital

• Capital deduction • A US banking entity (but not an FBO) is required to deduct from Tier 1 capital its investment in such funds • The Volcker Rule treatment does not correspond to Basel III risk weights and deductions for fund investments • The Agencies intend to review the interaction between the Volcker Rule and Basel III and propose steps to reconcile them


“Super 23A” and 23B Restrictions • No banking entity that (i) advises or sponsors a covered fund, (ii) organizes and offers a customer fund or an issuer of ABS, or (iii) holds an ownership interest in an ABS issuer, and no affiliate of any of these, may enter into any of the following transactions with the fund* • A loan or extension of credit to the fund (including repos) • The purchase of securities issued by the fund (except for permitted ownership interests) • The purchase of assets from the fund • The issuance of guarantees, acceptances or letters of credit on behalf of the fund • Securities borrowing or lending or derivative transactions that result in the banking entity having a credit exposure to the fund *Section 23A also prohibits the acceptance of securities issued by an affiliate as collateral for a loan, but as such a transaction would not be with the covered fund, it is not subject to Super 23A


“Super 23A” and 23B Restrictions • These restrictions are called “Super 23A” because, unlike Section 23A itself, which allows affiliated transactions within limits, these prohibitions are absolute • However, the following transactions are permitted • Acquisitions of ownership interests in a covered fund to the extent permitted elsewhere in the Final Rule • Subject to certain conditions, prime brokerage transactions (transactions that would be subject to Super 23A but are provided in connection with custody, clearance and settlement, securities borrowing and lending, trade execution, etc.) with a covered fund in which a covered fund that is managed, sponsored or advised by the banking entity or its affiliates has taken an ownership interest (a “second-tier fund”)

• The “market terms” requirement of Section 23B of the Federal Reserve Act also applies, as if the banking entity were a bank and the fund it sponsors or advises, its affiliate


Other Permitted Fund Investments/Activities • Risk-mitigating hedging activities • Sponsorship of, and investment in, covered funds engaged in permitted riskmitigating hedging activities, subject to extensive conditions, including a specific internal compliance program

• Insurance companies • Investment and sponsorship by regulated foreign and domestic insurance companies of any covered funds, if conducted in compliance with applicable insurance investment laws


Prudential Backstops • No permitted fund investments and activities are permissible if • The investment/activity involves or results in a material conflict of interest between the banking entity and its clients, customers or counterparties, unless • The banking entity makes clear and timely disclosure of the conflict, or • The banking entity uses information barriers, such as physical separation of personnel or functions, that address the conflict

• The investment/activity results in a material exposure by the banking entity to a high-risk asset or a high-risk trading strategy • The investment/activity poses a safety and soundness threat to the institution or a threat to US financial stability


Other Regulations Not Pre-empted • None of the activities or investments permitted under the Volcker Rule pre-empt other applicable investment or activity limitations that apply to banking entities and their affiliates • A banking entity must evaluate any such investment/activity under both the Volcker Rule and other regulations of the Board of Governors of the Federal Reserve applicable to investments and activities by banking entities and their affiliates • For example, an FBO may be able to hold 10% of a US real estate fund under the Volcker Rule • However, the FBO may not be able to invest in more than 4.9% of the ownership interests of such a fund under other applicable provisions of the Bank Holding Company Act and Regulation K


Compliance Programs • Applies to all banking entities (including FBOs) engaged in permitted proprietary trading or permitted covered fund investment/activity • If an FBO and its affiliates are not engaged in proprietary trading (other than trading in US government obligations) or covered fund investment/activity, they are not required to establish a Volcker-Rule specific compliance program • However, they will need to determine whether they are engaging in such activities.

• Banking entities with such activities/investments that have total worldwide consolidated assets of $10 billion or less need only refer to the requirements of the Volcker Rule in their compliance policies and procedures and make “adjustments as appropriate given the activities, size, scope and complexity of the [banking entity].”


Six-point Compliance Program • All other banking entities engaged in such activity must implement a compliance program that meets the following six criteria • Written policies and procedures reasonably designed to document, describe, monitor and limit proprietary trading activities, and activities and investments with respect to covered fund activities, to ensure compliance with the Rule • A system of internal controls reasonably designed to monitor compliance with the Volcker Rule, and to prevent the occurrence of activities or investments that are prohibited by the Rule • A management framework that delineates responsibility and accountability for compliance with the Volcker Rule and includes management review of trading limits, strategies, etc. • Independent testing and audit of the effectiveness of the compliance program • Training for trading personnel and managers, as well as other “appropriate” personnel, to appropriately implement and enforce the compliance program • Records sufficient to demonstrate compliance with the Volcker Rule.


Enhanced Compliance Programs • Enhanced minimum standards for compliance programs are required of banking entities that • as of the previous calendar year-end, had total consolidated assets of $50 billion or more or, in the case of an FBO, had total US assets of $50 billion or more; • Engage in permitted proprietary trading and have a minimum level of trading assets and liabilities that trigger the reporting requirements described on the next slide; or • Otherwise are required to meet such enhanced standards by the applicable US regulatory agencies


Reporting and Recordkeeping Requirements • An FBO is subject to specific reporting and recordkeeping requirements if • it is engaged in permitted proprietary trading activity and • the average gross sum of the FBO’s trading assets and liabilities of its combined US operations (excluding trading assets and liabilities involving US government or agency obligations) over the previous four quarters is greater than or equal to • $50 billion between June 30, 2014 and April 29, 2016 • $25 billion between April 30, 3016 and December 30, 2016 • $10 billion beginning on December 31, 2016


Prudential Standards for FBOs

Confidential/Subject to Attorney Client Privilege


Prudential Regulations for Foreign Banks • • • • • • • •

Coverage Intermediate Holding Companies Capital Risk Management Liquidity Stress Testing Debt-to-Equity Limits Issues and Response Strategies

Confidential/Subject to Attorney Client Privilege


Some Helpful Definitions • Board – Federal Reserve Board • FBO – Foreign banking organization as defined in the Board’s Regulation K • IHC – U.S. intermediate holding company • BHCA –U.S. Bank Holding Company Act • BHC – Bank holding company as defined under the BHCA • DFA – Dodd-Frank Wall Street Reform and Consumer Protection Act • DPC subsidiaries – Subsidiaries of a U.S. branch/agency formed to hold assets acquired in the ordinary course for debt previously contracted (“DPC”)

Confidential/Subject to Attorney Client Privilege


Quantitative Thresholds • Covered FBO – FBO with $50BB+ of consolidated worldwide assets • $10BB FBO – FBO with consolidated worldwide assets of between $10BB and $50BB • Combined U.S. Assets – the sum of the consolidated assets of each toptier U.S. subsidiary of the FBO (excluding any BHCA section 2(h)(2) company) and the total assets of each U.S. branch and agency of the FBO • U.S. Non-branch Assets - the sum of the consolidated assets of the toptier U.S. subsidiaries of the FBO (excluding any BHCA section 2(h)(2) company and DPC branch subsidiary) • Combined U.S. Operations – the U.S. branches and agencies of an FBO and (i) if the FBO has an IHC, the IHC and its subsidiaries; or (ii) if the FBO does not have an IHC, the direct and indirect U.S. subsidiaries of the FBO (excluding any section 2(h)(2) company, if applicable)

Confidential/Subject to Attorney Client Privilege


Background • Lessons learned: location of capital and liquidity critical in times of stress • Capital and liquidity trapped in home country: Lehman and Icelandic banks • Potential for ring-fencing of assets by home/host country in a crisis

• Resolution regimes nationally based: no effective cross-border resolution scheme • Doubts raised as to whether U.S. as host supervisor can rely on FBO as source of strength for U.S. operations • Concern as to whether home-country governments will backstop foreign operations of their important banks in a crisis • Some FBOs may have constraints placed on their ability to support their foreign operations in a crisis

Confidential/Subject to Attorney Client Privilege


Coverage • General Coverage • All Covered FBOs • $10BB FBOs are subject to stress testing and, if publicly traded, risk committee requirements • Tiered applicability based on size and footprint of U.S. operations

Confidential/Subject to Attorney Client Privilege


Summary of Tiered Applicability Size


Subpart of Final Rule

$10BB FBOs

Company-run stress tests

Subpart L

$10BB FBOs that are publicly traded

Risk committee

Subpart M

Covered FBO with less than $50BB of Combined U.S. Assets

Risk-based and leverage capital Risk committee Liquidity Capital stress testing

Subpart N

Debt-to-equity limits (upon grave threat determination)

Subpart U

Risk-based and leverage capital Risk management framework Risk committee and U.S. chief risk officer Liquidity risk-management, stress-testing and buffers Capital stress testing

Subpart O

U.S. IHC requirement (if U.S. Non-branch Assets of $50BB+)

Subpart O Subpart E (IHC Supervisory Stress Test) Subpart F (IHC Company-Run Stress Test)

Debt-to-equity limits (upon grave threat determination)

Subpart U

Covered FBO with $50BB+ of Combined U.S. Assets

Confidential/Subject to Attorney Client Privilege


IHCs • IHC not required under DFA section 165 but established as an additional prudential standard • Board may establish any appropriate additional prudential standard for covered companies • Purpose of IHC is to prevent or mitigate risks to U.S. financial stability • IHC requirement intended to increase the resiliency of the U.S. operations of large FBOs • Also provides for a single focus for risk management of operations of U.S. Non-branch Assets • Provides “single point of entry” for resolution of operations of U.S. Nonbranch Assets

Confidential/Subject to Attorney Client Privilege


IHCs • A Covered FBO with $50BB+ of U.S. Non-branch Assets must consolidate those assets under an IHC • The IHC requirement applies even if the Covered FBO does not operate a bank or thrift in the U.S. – subjects such operations to capital and other BHC-type requirements even though not a BHC • IHC not required to serve as source of strength for subsidiaries that are not depository institutions • U.S. Non-branch Assets are measured for this purpose based on four prior quarters’ Form FR Y7-Q financial data • Must provide notice to the Board within 30 days of establishing or designating an IHC

Confidential/Subject to Attorney Client Privilege


IHCs • IHC Compliance dates • FBOs that meet the threshold on July 1, 2015 must form an IHC and transfer their U.S. BHC and bank subsidiaries and substantially all of their other U.S. nonbank subsidiary business to the IHC by July 1, 2016. Full compliance must be achieved by July 1, 2017 • FBOs that meet the threshold after July 1, 2015 must comply by the first day of the ninth quarter following the date on which it meets the threshold • FBOs meeting the threshold as of June 30, 2014 must submit an implementation plan by January 1, 2015 • Timeline for transfer of subsidiaries to IHC • List of subsidiaries to be held or excluded from IHC • Planned capital actions that will allow IHC capital compliance • 3 years of pro forma quarterly financials • How IHC will comply with risk management and liquidity stress testing requirements Confidential/Subject to Attorney Client Privilege


IHCs • Structure and Regulation of the IHC • IHCs must be organized under U.S. law • All U.S. banking and nonbanking operations must be held under the IHC, except • U.S. branches and agencies of the FBO • BHCA section 2(h)(2) companies owned by the FBO • DPC branch subsidiaries

• Controlled merchant banking portfolio companies and/or insurance companies must be held under the IHC – even though not integral to U.S. operations • IHCs must have a full-functioning board of directors or managers • Use of BHCA “control” definition could create uncertainties for companies owned at 10 – 24.99% level

Confidential/Subject to Attorney Client Privilege


IHCs • Structure and Regulation of the IHC (cont.) • IHCs subject to supervision and regulation comparable to U.S. BHCs, including enhanced prudential standards • Enhanced prudential standards apply to the consolidated operations of the IHC, including foreign subsidiaries of the IHC • Until the IHC becomes subject to the new parallel requirements applicable to IHCs (date varies based on the type of requirement), U.S. BHCs with $50BB+ of consolidated assets controlled by an FBO are subject to enhanced prudential standards applicable to U.S. BHCs beginning on January 1, 2015

Confidential/Subject to Attorney Client Privilege


IHCs • Alternative Organizational Structures • Home country law may prohibit FBO from owning U.S. subsidiaries through a single U.S. IHC • Other circumstances may warrant exceptions based on the FBO’s activities, scope of operations, structure or similar considerations, e.g. • an FBO controls multiple lower-tier FBOs that have separate U.S. operations • an FBO cannot transfer its ownership interest in a U.S. subsidiary to an IHC or otherwise restructure its investment (passivity commitment or supervisory agreement may be required) • Alternative structures require application to Board • “Virtual” U.S. IHC not permitted • Board voices concerns about centralized risk management • Exercise of resolution authority through holding company model

Confidential/Subject to Attorney Client Privilege


Capital • Requirements for Covered FBOs: • Beginning July 1, 2016, a Covered FBO must certify and demonstrate compliance with capital adequacy standards at the consolidated level consistent with the Basel Committee capital framework (including Basel III as phased in) • Specific reports on applicable Basel capital ratios (including leverage ratio) to be included in FR Y-7Q

• Must provide reports relating to their compliance with the Basel capital adequacy standards (Board will propose these rules separately as an amendment to the FR Y-7Q) • FBO public disclosures must be consistent with the Basel Capital Framework • Failure to meet capital adequacy standards may result in Board restrictions on U.S. activities or business operations Confidential/Subject to Attorney Client Privilege


Capital • IHCs • IHCs are subject to U.S. risk-based capital and leverage requirements to the same extent as U.S. BHCs (even if they are not BHCs) • Must comply with leverage capital requirements by January 1, 2018 • Includes base 4% leverage ratio and, for IHCs with total consolidated assets of $250BB+ or foreign exposures of $10BB+, 3% supplementary leverage ratio • Not required to implement advanced internal models based approach to determine capital (even if a BHC) • Until the IHC becomes subject to the new parallel requirements applicable to U.S. BHCs, each subsidiary BHC and bank subsidiary of an FBO currently subject to leverage capital requirements must continue to comply

• IHCs must comply with Board capital plan rule to the same extent as a covered U.S. BHC (first plan would be due in January 2017) • Must comply with risk-based capital and capital plan requirements by July 1, 2016 Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with less than $50BB of Combined U.S. Assets • Annual Basel Committee-consistent internal liquidity stress test with results reported to the Board • Failure to comply with this requirement obliges the Covered FBO to limit the net aggregate amount owed by the FBO parent office and non-U.S. affiliates to its Combined U.S. Operations to 25% or less of the Combined U.S. Operations’ third-party liabilities on a daily basis

Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with $50BB+ of Combined U.S. Assets • U.S. risk committee must: • Approve the liquidity risk tolerance for the Combined U.S. Operations at least annually • Review information provided by senior management of the Combined U.S. Operations at least semi-annually to determine compliance with liquidity risk tolerance • Approve the contingency funding plan for Combined U.S. Operations at least annually or upon revision • Conduct a liquidity risk review of significant business lines and products of the Combined U.S. Operations at least annually

Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with $50BB+ of Combined U.S. Assets • U.S. chief risk officer must: • Review liquidity risk management strategies, policies and procedures for Combined U.S. Operations • Review information provided by senior management of U.S. operations to determine compliance with liquidity risk tolerance • Report to the U.S. and enterprise-wide risk committee on U.S. operations’ liquidity risk profile at least semi-annually (and establish procedures governing the content of such reports) • Approve new products and business lines based on liquidity risk • At least quarterly: • Review cash flow projections for Combined U.S. Operations • Establish and determine compliance with liquidity risk limits • And upon material revision, approve liquidity stress testing practices, methodologies and assumptions • Review liquidity stress testing results • Approve liquidity buffer Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with $50BB+ of Combined U.S. Assets • Establish and maintain a liquidity risk management review function independent of the management responsible for funding • Regular (no less than annual) review of adequacy and effectiveness of liquidity risk management processes within Combined U.S. Operations and compliance with law • Report liquidity risk management issues to U.S. risk committee and enterprise-wide risk committee

• Produce comprehensive cash flow projections • Establish and maintain a contingency funding plan • Monitor sources of liquidity risk and establish liquidity risk limits consistent with liquidity risk tolerance • Establish and maintain procedures for collateral, legal entity, and intraday liquidity risk monitoring

Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with $50BB+ of Combined U.S. Assets • Conduct monthly (or more frequently as the Board may require) liquidity stress tests that are reported to the Board • Separate testing of branch/agency network and IHC • Stress testing must also be conducted for the Combined U.S. Operations • Policies, procedures and controls for liquidity stress testing are required

• FBO parent of IHC is required to make available to the Board in a timely manner the results of home-country liquidity stress testing and the establishment of any liquidity buffers

Confidential/Subject to Attorney Client Privilege


Liquidity: Covered FBOs with $50BB+ of Combined U.S. Assets • IHC must maintain in U.S. liquidity buffer of unencumbered “highly liquid assets” equal to external and internal “net stressed cash flow need” over a 30-day horizon • Liquidity buffer for IHC comprised of cash may not be held in an account at a U.S. branch/agency or other affiliate that is not controlled by the IHC

• U.S. branch/agency network must maintain in U.S. 14day liquidity buffer (change from proposal) • Liquidity buffer for U.S. branch/agency network comprised of cash may not be held in an account at the IHC or other affiliate

Confidential/Subject to Attorney Client Privilege


Risk Management • $10BB FBOs that are publicly traded and Covered FBOs with less than $50BB of Combined U.S. Assets • The FBO must certify annually to the Board that it maintains a risk committee that oversees the risk management policies (formerly “practices”) of its Combined U.S. Operations, with at least one member with risk management experience (formerly “expertise”) • The risk committee may be a committee of the FBO’s global board of directors or supervisory board • The certification requirement would first apply on the later of July 1, 2016 or the first day of the ninth quarter following the date on which it meets the threshold • Certification to be filed concurrently with FR Y-7 • Noncompliance with risk management requirements may result in Board-imposed limits on activities or business operations Confidential/Subject to Attorney Client Privilege


Risk Management • Covered FBOs with $50BB+ of Combined U.S. Assets • FBO must also maintain a risk committee with at least one member with risk management experience, and at least one “independent” member • An FBO conducting operations through U.S. branches/agencies may place its risk committee at the FBO’s global board of directors or supervisory board, or at the IHC if applicable • An FBO that operates in the U.S. solely through an IHC must place its U.S. risk committee at the IHC

• Risk committee must meet at least quarterly and fully document and maintain records, including risk-management decisions • Risk committee’s responsibilities include the liquidity riskmanagement responsibilities

Confidential/Subject to Attorney Client Privilege


Risk Management • Covered FBOs with $50BB+ of Combined U.S. Assets (cont.) • U.S. risk committee would have a number of specific responsibilities, including the obligation to: • Approve and periodically review risk management policies of Combined U.S. Operations or IHC • Oversee the risk-management framework that is commensurate with the structure, risk profile, complexity, and size of Combined U.S. Operations or IHC

• An FBO generally may rely on its parent company’s enterprisewide risk management policies for its U.S. operations • IHC must have its own risk committee to oversee the risk function of the IHC (but may also fulfill the responsibilities of the U.S. risk committee of the Combined U.S. Operations) Confidential/Subject to Attorney Client Privilege


Risk Management • Covered FBOs with $50BB+ of Combined U.S. Assets (cont.) • The FBO or its IHC must appoint a U.S. chief risk officer, who must: • Have risk management experience (formerly “expertise”) • Be independently compensated • Be employed by and located in the U.S. branch/agency, IHC, or another U.S. subsidiary • Report directly and regularly provide information to the U.S. risk committee and global risk officer • Undertake liquidity risk-management responsibilities

Confidential/Subject to Attorney Client Privilege


Risk Management • Covered FBOs with $50BB+ of Combined U.S. Assets (cont.) • The U.S. chief risk officer must oversee: • Measurement, aggregation, and monitoring of risks of U.S. combined operations • Implementation of and compliance with the policies and procedures for reporting risks and risk-management deficiencies • Management, monitoring and testing of risks and risk controls

• Noncompliance with risk management requirements may result in Board-imposed limits on activities or business operations

Confidential/Subject to Attorney Client Privilege


Stress Testing • $10BB FBOs and Covered FBOs with less than $50BB of Combined U.S. Assets • Must be subject to a consolidated home country stress-testing regime that includes either (i) an annual supervisory stress test, or (ii) a supervisor-reviewed annual internal stress test • The home country regime also must include requirements for governance and controls of the stress testing regime • The FBO must conduct and pass the home country stress test • These requirements also apply to foreign savings and loan holding companies of $10BB+ in assets (DFA requirement) • Separate information/reporting requirements of the sort applicable to Covered FBOs with $50BB+ of Combined U.S. Assets (discussed below) would not apply

Confidential/Subject to Attorney Client Privilege


Stress Testing • $10BB FBOs and Covered FBOs with less than $50BB of Combined U.S. Assets (cont.) • Failure to comply with these requirements would trigger: • An asset maintenance requirement for the FBO’s U.S. branch/agency network of “eligible assets” equal to 105% of third-party liabilities • An annual stress test requirement of its U.S. subsidiaries. This test could be conducted separately or as part of an enterprisewide stress test

Confidential/Subject to Attorney Client Privilege


Stress Testing • Covered FBOs with $50BB+ of Combined U.S. Assets • FBOs having a U.S. branch/agency must be subject to a consolidated home country stress-testing regime that includes either (i) an annual supervisory stress test, or (ii) or a supervisorreviewed annual internal stress test • Home country regime also must include requirements for governance and controls of the stress testing regime • FBO must conduct and pass the home country stress test • FBO must report summary information about its stress-testing activities and results by January 5 of each year

Confidential/Subject to Attorney Client Privilege


Stress Testing • Covered FBOs with $50BB+ of Combined U.S. Assets (cont.) • U.S. branch/agency networks in a net “due from” position to their foreign parent/affiliates have additional reporting requirements, determined on a case-by-case basis and accounting for the size, complexity, and business activities of the FBO and its U.S. operations • Additional information required by January 5 of each year • Confidentiality of information would be determined in accordance with existing Board and FOIA requirements

Confidential/Subject to Attorney Client Privilege


Stress Testing • Covered FBOs with $50BB+ of Combined U.S. Assets (cont.) • Consequences of failure to comply: • An asset maintenance requirement • U.S. branch/agency network would have to hold “eligible assets” equal to 108% of third party liabilities

• Annual stress test requirement for U.S. subsidiaries (to the extent that an FBO has not established an IHC) • The Board would have the authority to impose liquidity buffers or intragroup funding restrictions on noncompliant FBOs

Confidential/Subject to Attorney Client Privilege


Stress Testing • IHCs • IHCs are subject to the annual supervisory and semi-annual company-run stress testing requirements applicable to similarlysized U.S. BHCs • Must comply by October 1, 2017

• Requirements for U.S. subsidiaries of IHCs: • Until the IHC becomes subject to the new parallel requirements applicable to IHCs, each subsidiary BHC and insured depository institution of an FBO currently subject to stress test requirements must continue to comply through September 30, 2017

Confidential/Subject to Attorney Client Privilege


Debt-to-Equity Limits • Covered FBOs: • A conditional debt-to-equity limit of not more than 15-to-1, upon a determination by the U.S. Financial Stability Oversight Council that a Covered FBO poses a “grave threat” to U.S. financial stability, and that the debt-to-equity limit is necessary to mitigate that risk • The limits would be applied to any IHC and any U.S. subsidiary (other than a section 2(h)(2) company or DPC branch subsidiary) that is not part of an IHC structure • In addition, the FBO’s U.S. branch/agency network would be subject to a daily 108% asset maintenance requirement

Confidential/Subject to Attorney Client Privilege


Issues and Response Strategies • The economic and regulatory costs of the Final Rule could be substantial in some cases, and will need to be carefully assessed by affected FBOs (which will essentially include any FBOs with U.S. banking operations) • That being said, the impact of the Final Rule on FBOs will be widely disparate, depending on the nature and footprint of an FBO’s U.S. operations

• Possible Strategic Responses • Reduce size of U.S. operations, especially capital-intensive operations • Move certain U.S. operations into the U.S. branch/agency network • Board discusses this possibility and will be monitoring

Confidential/Subject to Attorney Client Privilege


Issues and Response Strategies • Possible FBO response strategies: • Review nature and scope of U.S. operations and their role in, and consistency with, the enterprise’s strategic planning efforts and outcomes • Quantify economic and regulatory costs of the compliance with standards for various thresholds (i.e. total consolidated assets, Combined U.S. Assets, and U.S. Non-branch Assets) • Assess impact of the Final Rule on enterprise profitability • Critically consider adjustments to U.S. operations based on the foregoing reviews • If applicable, consider potential alternative organizational structures in lieu of establishing a single IHC

Confidential/Subject to Attorney Client Privilege


Deferred Topics • Single-counterparty Credit Limits • The Board is continuing to develop single-counterparty credit limits required under DFA Section 165 based on the results of a quantitative impact study conducted last summer and the Basel Committee’s initiative to develop a regulatory framework governing large credit exposures that would apply to all global banks

• Early Remediation Requirements (DFA Section 166) • The Board is continuing to review comments on early remediation requirements and is integrating the remediation levels with the Basel III capital rules adopted in July 2013

• Prudential Requirements for Systemically Important Nonbank Financial Companies (DFA Section 167) • Unlike the proposal’s one-size-fits-all approach for nonbank financial companies, the Final Rule provides that the Board will apply enhanced prudential standards on a case-by-case basis

Confidential/Subject to Attorney Client Privilege


The Consumer Financial Protection Bureau

Confidential/Subject to Attorney Client Privilege


Overview of CFPB Authority • Rulemaking • Enumerated Consumer Laws • UDAAP • Covered Persons and Service Providers

• Enforcement • Enumerated Consumer Laws • UDAAP • Covered Persons, Service Providers, aiders/abettors

• Supervision • Certain Covered Persons and Service Providers

Confidential/Subject to Attorney Client Privilege


Covered Person • Offers consumer financial services to consumers • • • • •

Extending credit, brokering loans, Taking deposits, issuing stored value cards, Check cashing, Providing financial advisory services or credit counseling, Bill pay, P2P, mobile wallet

This is MoFo.


Covered Person • Offers or provides to businesses, in connection with consumer financial services: • Servicing loans, • Real estate settlement services, • But not the “business of insurance” or appraisals • The term “Business of Insurance” means “the writing of insurance or the reinsuring of risks by an insurer” • Analyzing, collecting, maintaining credit report information • Debt collection

This is MoFo.


Service Provider • Provides a material service to a covered person in connection with the offering or provision by such covered person of a consumer financial product or service, • Including a person that— • participates in designing, operating, or maintaining the consumer financial product or service; or • processes transactions relating to the consumer financial product or service

This is MoFo.


Exclusions from CFPB Authority • • • • •

Securities Firms; firms regulated by CFTC; employee benefit plans Charities Accountants, tax preparers, attorneys Regulated by Farm Credit Administration Merchants/Retailers • Excluded from enforcement, supervision, and UDAAP rules • But only to the extent merchant is offering retail sales finance, and only if merchant assigns retail paper

• Motor Vehicle Dealers (includes autos, boats, RVs) • But only if dealer does not assign retail paper • Also excluded from all CFPB rulemaking (not just UDAAP)

• Real Estate Brokerage, Manufactured Home Retailers

This is MoFo.


Excluded Persons: Insurance • The CFPB shall have no authority to “exercise any power to enforce” the CFPA with respect to a person regulated by a State insurance regulator • The term “person regulated by a State insurance regulator” means any person that is • engaged in the “business of insurance” and • subject to regulation by any State insurance regulator, but • only to the extent that such person acts in such capacity

• But • Only to the extent “acting in the capacity of a regulated person,” and • Not if engaged in the offering of a consumer financial product or service, or • Otherwise subject to any enumerated consumer law

• May be a Service Provider (12 USC 5517(n))

This is MoFo.


McCarran Ferguson Act • McCarran Ferguson Act, 15 U.S.C. §1012 (1945) • “The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business” • “No Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance”

• What is the “Business of Insurance”? 3-part test: • Does the activity have the effect of transferring or spreading a policyholder's risk? • Is the activity an integral part of the policy relationship between the insurer and the insured? • Is the practice limited to entities within the insurance industry? • Union Labor Life Insurance Co. v. Pireno, 458 U.S. 119 (1982).


Enumerated Consumer Laws • Credit: • ECOA; TILA; FCBA

• Mortgage and Real Estate: • AMTPA; HOPA; HOEPA; RESPA & ILSFDA; MAP Rule, MARS Rule; HMDA; SAFE Act

• Deposit: • EFTA; TISA

• FCRA & FACT Act; FDCPA; GLBA Privacy • What is not included: • FHA, CRA, data security, data disposal, red flags

This is MoFo.


Federal Consumer Financial Law • Enumerated Consumer Laws, PLUS • Consumer Financial Protection Act of 2010 (CFPA) • • • • • •

Unfair, deceptive and abusive acts and practices (UDAAP) Recordkeeping Access to books and records, cooperation with exams Registration Bonding Background checks

This is MoFo.


UDAAP “It shall be unlawful for any covered person or service provider … to engage in any unfair, deceptive, or abusive act or practice.” CFPA § 1036, 12 USC § 5536


Unfairness • The “act … causes or is likely to cause substantial injury to consumers • “Which is not reasonably avoidable by consumers themselves and • “Not outweighed by countervailing benefits to consumers or to competition.”

This is MoFo.


Deception FTC Deception Policy Statement (1983) • “[A] representation, omission or practice that is likely to mislead the consumer;” • “[F]rom the perspective of a consumer acting reasonably in the circumstances;” and • “The representation, omission, or practice must be a ‘material’ one.” • “The basic question is whether the act or practice is likely to affect the consumer's conduct or decision with regard to a product or service.”


Abusiveness • Materially interferes with the ability of a consumer to understand the terms or conditions of the product or service, or • Takes unreasonable advantage of: • A lack of consumer understanding of material risks, costs, or conditions; • The inability of the consumer to protect his or her own interests in selecting or using product or service; or • The reasonable reliance by the consumer on the Covered Person to act in the consumer’s interests


What Might be Abusive? • Products or transactions where you win when the consumer fails • Products that are only profitable when the consumer defaults or breaches and is assessed penalties or additional fees • Offering a product that the consumer is not likely to be able to afford

• Loan flipping • Refinancing on less beneficial terms or with no “net benefit” to the consumer

• Lending without regard to ability to repay • Making it difficult to reduce or eliminate indebtedness • Prepayment penalties or balloon payments


CFPB Rulemaking • Enumerated Consumer Laws • All persons who are subject to the laws • For example, “creditors” under ECOA & TILA, or “furnishers” and “consumer reporting agencies” under FCRA • Except motor vehicle dealers (FTC and Federal Reserve Board maintain separate set of rules)

• Federal Consumer Financial Law (ECL + CFPA) • Only Covered Persons and Service Providers

This is MoFo.


CFPB Enforcement • May enforce Enumerated Consumer Laws against all persons who are subject to the laws • Shares enforcement with FTC and states • CFPB and FTC have negotiated an MOU • Except banks with < $10 bn in assets and excluded persons

• Against Covered Persons and Service Providers: • May enforce CFPA – UDAAP, recordkeeping, etc. • May enforce FTC Trade Regulation Rules and TSR

• Aiding/Abetting • May take enforcement action against any person who aids or abets UDAAP violations by Covered Persons and Service Providers


CFPB Enforcement • Administrative or Federal Court • Injunctive relief • Civil money penalties of up to • $5,000 per day per violation if law violated, even if unintentional • $25,000 per day per violation if reckless • $1,000,000 per day violation if knowing

• Enforcement actions to date center on: • UDAAP in foreclosure relief, debt settlement, debt collection, credit cards, marketing and sale of ancillary products


CFPB Supervision • CFPB may conduct examinations of certain Covered Persons and Service Providers to • assess compliance with Federal Consumer Financial Law, • collect data, and • assess risks to consumers and markets

This is MoFo.


Who is Subject to Supervision? • Large banks (> $10 billion in assets) • Mortgage Lenders & Brokers; Student & Payday Lenders • Covered Persons that are “Larger Participants” of consumer financial services markets • Consumer reporting participants > $7 million in annual revenue • Debt collection participants > $10 million in annual revenue • Student loan servicers > 1 million accounts

• Covered Persons that present special risks to consumers • CFPB must designate by rule or order

• Service Providers to any of the above

This is MoFo.


July 29, 2014 Jerry Marlatt

© 2013 Morrison & Foerster LLP All Rights Reserved | mofo.com

Canadian Banks and the U.S. Capital Markets: Opportunities and Issues

Topics for Presentation • Rule 144A offerings • Section 3(a)(2) offerings • Covered bond offerings • Registration process for registered offerings

Foreign Bank Debt Financing Activities • Types of bank debt issuances • • • • • • •

Senior unsecured debt Senior secured debt (including covered bonds) Subordinated debt Structured debt (e.g., equity-linked and commodity-linked notes) Hybrid debt / preferred stock Contingent capital (“coco”) debt Deposit liabilities

• Issuing entities • • • •

Home offices US bank subsidiaries US branches Other affiliated entities (e.g., financing SPVs)

Financial Products Offered by Foreign Banks

• In recent months, Canadian and other non-U.S. banks have been active issuing: • Structured products • Covered bonds • Currently little 144A US-Dollar denominated issuance • SEC-registered in reliance on SEC no-action letter guidance • Contingent capital instruments • Deutsche Bank multi-currency • UBS Reg S USD CoCo • Credit Agricole Reg S multi-currency • UBS 3(a)(2) offering • Barclays registered offering

Rule 144A Offering Alternative

Why Are Rule 144A Offerings Attractive to Non-U.S. Banks?

• Rule 144A provides a clear safe harbor for offerings to institutional investors.

• Does not require extensive ongoing registration or disclosure requirements. • Issuances may have liquidity in the Rule 144A market.

Rule 144A Overview • Rule 144A provides a non-exclusive safe harbor from the registration requirements of Section 5 of the 1933 Act for resales of restricted securities to “qualified institutional buyers” (QIBs). • The rule recognizes that not all investors are in need of the protections of the prospectus requirements of the 1933 Act. • The rule applies to offers made by persons other than the issuer of the securities (i.e., “resales”). • The rule applies to securities that are not listed on a U.S. securities exchange or quoted on an automated inter-dealer quotation system. • A reseller may rely on any applicable exemption from the registration requirements of the 1933 Act in connection with the resale of restricted securities (such as Reg S or Rule 144).

Types of 144A Offerings • 144A offering for an issuer that is not registered in the U.S. – usually a standalone • 144A continuous offering program • Used for repeat offerings, often by financial institution and insurance company issuers, to institutional investors. • Often used for structured products and for covered bonds sold to QIBs.

How are 144A Offerings Structured? • The issuer initially sells restricted securities to investment bank(s) in a Section 4(a)(2). • The investment bank reoffers and immediately resells the securities to QIBs under Rule 144A. • Often combined with a Regulation S offering.

Rule 144A Offering Memorandum • May contain similar information to a full “S-1/F-1” prospectus, or may be much shorter. • If the issuer is a public company, it may incorporate by reference the issuer’s filings from its home country. • Scope of disclosure (whether included or incorporated by reference) may be comparable to a public offering, as the initial underwriters/purchasers expect “10b-5” representations from the issuer, and legal opinions from counsel. • Due diligence by counsel will often be similar to that performed in a public offering. • For a non-U.S. offering, with a Rule 144A “tranche,” there may be a U.S. “Rule 144A wrapper” attached to the nonU.S. offering document.

Documentation for a Rule 144A Offering • Offering Memorandum/Private Placement Memorandum • A purchase agreement between the issuer and the initial purchasers/underwriter(s) • Similar to an underwriting agreement in terms of representations, covenants, closing conditions and indemnities.

• Issuing and Paying Agency Agreement • Legal opinions • Comfort letters

How Are Rule 144A Offerings Conducted? • Often similar to a registered offering. • “Road show” with a preliminary offering memorandum. • Confirmation of orders with the final offering memorandum. • The offering memorandum may be delivered electronically. • The purchase agreement is executed at pricing, together with the delivery of a comfort letter. • Closing on a “T+3” basis, or as otherwise agreed with the investors. • Publicity: generally limited to a Rule 135c compliant press release – limited information about the offering. However, the new “general solicitation” rules enable broader announcements.

Conditions for Rule 144A Offering • Reoffers or resales only to a QIB, or to an offeree or purchaser that the reseller reasonably believes is a QIB. • Reseller must take steps to ensure that the buyer is aware that the reseller may rely on Rule 144A in connection with such resale. • The securities reoffered or resold (a) when issued were not of the same class as securities listed on a U.S. national securities exchange or quoted on a U.S. automated inter-dealer quotation system and (b) are not securities of an open-end investment company, UIT, etc. • For an issuer that is not an Exchange Act reporting company or exempt from reporting pursuant to Rule 12g3-2(b), the holder and a prospective buyer designated by the holder must have the right to obtain from the issuer, upon the holder’s request, certain reasonably current information.

What Is a QIB? • An entity that is an “accredited investor” acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests at least $100 million in securities of unaffiliated issuers ($10 million for a broker-dealer). • Banks and savings and loan associations with a net worth of at least $25 million. • A broker-dealer acting as a riskless principal for an identified QIB. • To qualify, the QIB must commit to the broker dealer that the QIB will simultaneously purchase the securities from the broker-dealer.

• A QIB can be formed solely for purpose of conducting a Rule 144A transaction. • Contrast: “qualified purchaser” definition under the 1940 Act.

How Can a Reseller Ascertain a Person Is a QIB? A reseller may rely on the following (as long as the information is no more than 16 months old): • the purchaser’s most recent publicly available annual financial statements; • information filed with the SEC or another government agency or self-regulatory organization; • information in a recognized securities manual, such as Moody’s or S&P; • certification by the purchaser’s chief financial or other executive officer specifying the amount of securities owned and invested as of the end of the purchaser’s most recent fiscal year; and • a QIB questionnaire. The SEC acknowledges that the reseller may use other information to establish a reasonable belief of eligibility.

How Will Reseller Make the Buyer Aware That Security Is a Rule 144A Security? • By legending the security • By including an appropriate statement in the offering document • By obtaining an agreement that the purchaser understands that the securities must be reoffered and resold pursuant to an exemption or registration under the 1933 Act • By obtaining a restricted CUSIP number

Current Information Requirements • For securities of a non-public company, the holder and a prospective purchaser designated by the holder have the right to obtain from the issuer, upon request, the following information: • A brief statement of the nature of the business of the issuer, and its products and services; and • The issuer's most recent balance sheet and profit and loss and retained earnings statements, and similar financial statements for such part of the two preceding fiscal years as the issuer has been in operation. • The financial statements should be audited, to the extent reasonably available.

• The information must be “reasonably current.”

Rule 159: “Time of Sale Information” • Although Rule 159 is not expressly applicable to Rule 144A offerings, many investment banks apply the same treatment, in order to help reduce the risk of liability. • Use of term sheets and offering memoranda supplements, to ensure that all material information is conveyed to investors at the time of pricing. • Counsel is typically expected to opine as to the “disclosure package,” as in the case of a public offering.

NY2 632073

Section 3(a)(2) Offerings

Section 3(a)(2) and Offerings by Banks • Section 3(a)(2) of the Securities Act exempts from registration under the Securities Act any security issued or guaranteed by a bank. • Basis: banks are highly regulated, and provide adequate disclosure to investors about their finances in the absence of federal securities registration requirements. Banks are also subject to various capital requirements that may increase the likelihood that holders of their debt securities will receive timely payments of principal and interest.

What Is a “Bank”? • Under Section 3(a)(2), the institution must meet both of the following requirements: • it must be a national bank or any institution supervised by a state banking commission or similar authority; and • its business must be substantially confined to banking.

• Examples of entities that do not qualify: • • • •

Bank holding companies Finance companies Investment banks Foreign banks

• Regulated U.S. branches and agencies of foreign banks may qualify

Guarantees • Another basis for qualification as a bank: securities guaranteed by a bank. • Not limited to a guaranty in a legal sense, but also includes arrangements in which the bank agrees to ensure the payment of a security. • The guaranty or assurance of payment, however has to cover the entire obligation; it cannot be a partial guarantee or promise of payment. • Again, guarantees by foreign banks (other than those of an eligible U.S. branch or agency) would not qualify for this exception. • The guarantee is a legal requirement to qualify for the exemption; investors will not be looking to the US branch for payment/credit. Investors will look to the home office.

Non-U.S. Banks/U.S. Offices • U.S. branches/agencies of foreign banks are conditionally entitled to rely on the Section 3(a)(2) exemption. • 1986: the SEC takes the position that a foreign branch/agency will be deemed to be a “national bank” or a “banking institution organized under the laws of any state” if “the nature and extent of federal and/or state regulation and supervision of that particular branch or agency is substantially equivalent to that applicable to federal or state chartered domestic banks doing business in the same jurisdiction.” • As a result, U.S. branches/agencies of foreign banks are frequent issuers or guarantors of debt securities in the U.S. Most issuances or guarantees occur through the NY branches of these banks.

Non-U.S. Banks/U.S. Offices (cont’d) Examples of Issuing Entities: • U.S. branch as direct issuer: UBS, CS, NAB, CBA and ANZ • U.S. branch as guarantor, headquarters as issuer: BNP, Rabo, SocGen, Svenska • U.S. branch as guarantor, SPV/Cayman branch as issuer: Fortis, BNP • More banks are using a guarantee structure to allow greater flexibility for use of proceeds

Which Regulator? • Most U.S. branches have elected the N.Y. State Banking Commissioner as their primary regulator with their secondary regulator the Federal Reserve. • Some U.S. branches have opted for the Office of the Comptroller of the Currency (“OCC”) as their primary regulator.

OCC Registration/Disclosure • National banks or federally licensed U.S. branches/agencies of foreign banks regulated by the Office of the Comptroller of the Currency (the “OCC”) are subject to OCC securities offering (Part 16) regulations. • Part 16 of OCC regulations provides that these banks or banking offices may not offer and sell their securities until a registration statement has been filed and declared effective with the OCC, unless an exemption applies. • An OCC registration statement is generally comparable in scope and detail to an SEC registration statement; as a result, most bank issuers prefer to rely upon an exemption from the OCC’s registration requirements. Section 16.5 provides a list of exemptions, which includes: • Regulation D offerings (note the applicability of new amended rules, as discussed in the earlier session today) • Rule 144A offerings

Part 16.6 of the OCC Regulations • 12 CFR 16.6 provides a separate partial exemption for offerings of “non-convertible debt” to accredited investors in denominations of $250,000 or more. • National banks with foreign parents that have shares traded in the US may be able to rely upon this exemption by furnishing the foreign private issuer reports (Forms 20-F, 6-K) filed by foreign issuers. • Alternatively, Federal branches/agencies may rely on this exemption by furnishing to the OCC parent bank information which is required under Exchange Act Rule 12g3-2(b), and to purchasers the information required under Securities Act Rule 144A(d)(4)(i).

Denominations • The 3(a)(2) exemption does not require specific minimum denominations in order to obtain the exemption. • State-chartered banks may issue in smaller denominations ($1,000 denominations are common). • However, for a variety of reasons, denominations may at times be significantly higher than in retail transactions: • Offerings targeted to institutional investors. • Complex securities. • Relationship to 16.6’s requirement of $250,000 minimum denominations.

Deposits Versus Other Liabilities • Foreign banks may elect to issue debt instruments in the form of deposit liabilities as opposed to “pure” debt: • Yankee CDs (US$-denominated deposit liabilities of a foreign bank or its US branch). • Other types of deposits (e.g., structured deposits).

• What are the legal differences between deposit liabilities and other debt issuances? • In the case of foreign banks, less than meets the eye. • Foreign banking organization (“FBO”) deposit liabilities are not insured and generally are issued in large denominations (minimum $100,000 and usually higher). • For capital equivalency/asset segregation purposes, deposits and nondeposit liabilities generally are treated in the same manner.

Certificates of Deposit • FDIC insured branches may issue CDs that benefit from FDIC insurance. • “Yankee CDs” - typically do not have the benefit of FDIC insurance, but designed to have the preferences for deposits that apply under applicable banking laws. • Are they securities? Answer depends upon terms of instrument and marketing. • However, even if they are securities, an exemption from SEC registration (and OCC registration) can typically be found. • Typically offered in large denominations, in transactions that are privately negotiated with sophisticated investors. • Consider appropriate level of disclosures about the issuer, the instrument, and the relevant risk factors.

FINRA Requirements • Even though securities offerings under Section 3(a)(2) are exempt from registration under the Securities Act, public securities offerings conducted by banks must be filed with the Financial Industry Regulatory Authority (“FINRA”) for review under Rule 5110(b)(9), unless an exemption is available. • Transactions under Section 3(a)(2) must also be reported through FINRA’s Trade Reporting and Compliance Engine (“TRACE”). TRACE eligibility provides greater transparency for investors. Currently, Rule 144A securities are not TRACE reported, but rules have been adopted to require them to be so reported.

Blue Sky Regulation • Securities issued under Section 3(a)(2) are considered “covered securities” under Section 18 of the Securities Act. • As a result, blue sky filings are not needed in any state in which the securities are offered.

Exchange Act Reporting • Section 12(i) of the Exchange Act provides that the administration and enforcement of Exchange Act Sections 12, 13, 14(a), 14(c), 14(d), 14(f), and 16 is vested in the OCC with respect to national banks, the Federal Reserve Board as to member banks of the Federal Reserve System, the FDIC as to all other insured banks, and the OTS as to savings associations. • As a result, a bank that otherwise would be subject to Exchange Act periodic reporting requirements would submit its reports to the appropriate banking agency, and not to the SEC.

Exchange Act Reporting (cont’d) • Foreign banks are not Section 3(a)(2) “banks” and therefore are not subject to Exchange Act Section 12(i), but to the extent they otherwise are required to register under the Exchange Act as issuers, or submit reports as foreign private issuers, they would register and file their reports with the SEC. • U.S. branches/agencies of foreign banks would not be subject to Exchange Act Section 12(i) requirements solely by virtue of their issuance of debt securities.

Section 3(a)(2) Offering Documentation • The offering documentation for bank notes is similar to that of a registered offering. • Base offering document, which may be an “offering memorandum” or an “offering circular” (instead of a “prospectus”). • The base document is supplemented for a particular offering by one or more “pricing supplements” and/or “product supplements.” • These offering documents may be supplemented by additional offering materials, including term sheets and brochures.

Comparison of Section 3(a)(2) to Rule 144A Section 3(a)(2)

Rule 144A

Required issuer:

Need a US state or federal licensed bank as issuer or as guarantor

No specific issuer or guarantor is required

Exemption from the Securities Act:

Section 3(a)(2)

Section 4(a)(2) / Rule 144A

FINRA Filing Requirement (Corporate Financing Rule)

Subject to filing requirement and payment of filing fee

Not subject to FINRA filing

Blue Sky:

Generally exempt from blue sky regulation

Generally exempt from blue sky regulation

Listing on an exchange:

May be listed if issued in compliance with Part 16.6



No; considered “public” and therefore eligible for bond indices, TRACE reporting


Comparison of Section 3(a)(2) to Rule 144A (cont’d) Section 3(a)(2)

Rule 144A

Required governmental approvals:

Banks licensed by the OCC are subject to the Part 16.6 limitations, unless an exemption is available.

Generally none.

Permitted Offerees:

All investors, which means that there is a broader market. However, banks licensed by the OCC are subject to the Part 16.6 limitations, unless an exemption is available. Generally, sales to “accredited investors.”

Only to QIBs. No retail.

Minimum denominations:

All denominations. However, banks licensed by the OCC are subject to minimum denomination requirement.

No minimum denominations requirement.

Role of Manager/Underwriter:

Either agented or principal basis.

Must purchase as principal.

1940 Act:

“Banks” not considered investment companies. Foreign banks will want to review 1940 Act guidance.

Non-bank issuer should consider whether there is a 1940 Act issue.


Through DTC, Euroclear/Clearstream.

Through DTC, Euroclear/Clearstream

Industry Guide 3 • Provides guidelines for statistical disclosures by foreign banks and bank holding companies in SEC filings. • Market practice to also meet guidelines for unregistered offerings. • Statistical disclosures can be included in the registration statement itself or incorporated by reference from the FPI’s annual report or quarterly/period reports to shareholders. • Generally, the data provided must be for each of the last three or five fiscal years, plus any interim period if necessary to keep the information from being misleading. • Available at http://www.sec.gov/about/forms/industryguides.pdf.

Industry Guide 3 (cont’d) • Guidelines require detailed disclosures regarding a foreign bank’s: • • • • • • • • • • • •

assets, liabilities and equity accounts, interest rates and interest spreads, investment portfolio, loan portfolio, loan maturities, loan sensitivity to changes in interest rates, problem loans, loan concentrations, loan loss experience, other earning assets, deposits, and return on equity and assets.

Industry Guide 3 (cont’d) • Disclosure requirements are applicable to the extent the requested information is available. • Since an FPI is required to disclose in the registration statement all material information necessary to make what is disclosed not misleading, the disclosures may in certain circumstances go beyond the requirements of Industry Guide 3. • However, the SEC has permitted deviations from the guidelines if more meaningful disclosure with respect to a particular issue would be provided as a result. • If the required information is unavailable or cannot be gathered without undue burden or expense to the FPI, the situation should be brought to the attention of the SEC in the early stages of the registration process.

Covered Bond Offerings

What Are Covered Bonds? • Senior debt of a regulated financial entity • Secured by a pool of financial assets • Mortgage loans – residential and commercial • Public sector obligations • Ship loans • Protected from acceleration in the event of issuer insolvency • By statute or legal structure • Collateral is isolated from insolvency estate of the issuer • Collateral pays bonds as scheduled through maturity • • • • •

A dynamic collateral pool – refreshed every month Typically bullet maturity, fixed rate bonds Repayment liabilities remain on the balance sheet of the originator Most countries have statutes enabling covered bond. Very strong implicit government support in many jurisdictions

Foreign Bank Issuances • Foreign banks issuing into the U.S. market have been relying on their domestic covered bond framework and have been using cover pool assets that are foreign (not in the U.S.). • Issuances into the U.S. have been structured as program issuances (or syndicated takedowns) conducted on an exempt basis, that means that the foreign issuer is relying on exemptions from the U.S. securities laws requiring registration of public offerings of securities. • To date, RBC, BNS, and BMO have registered covered bonds with the SEC. It is expected that other foreign issuers will follow suit. • As a result, offerings generally have been targeted at U.S. institutional investors and generally conducted in reliance on Rule 144A.

Registered Offerings: Non-U.S. Issuers Offer Securities as “Foreign Private Issuers”

What Is a “Foreign Private Issuer”? • An FPI is any issuer (other than a foreign government) incorporated or organized under the laws of a jurisdiction outside of the U.S., unless more than 50% of the issuer’s outstanding voting securities are held directly or indirectly by residents of the U.S., and any of the following applies: • the majority of the issuer’s executive officers or directors are U.S. citizens or residents; • the majority of the issuer’s assets are located in the U.S.; or • the issuer’s business is principally administered in the U.S.

• An FPI will be subject to the reporting requirements under U.S. federal securities laws if it registers with the SEC the public offer and sale of its securities under the Securities Act. • However, an FPI may also deregister more easily than a domestic issuer.

This is MoFo.


Benefits Available to FPIs • An FPI may exit (or deregister) the U.S. reporting regime more easily than a U.S. issuer. • Quarterly reports: An FPI is not required to file quarterly reports – submits its non-U.S. reports under cover of Form 6K. • Proxies: An FPI is not required to file proxy statements. • Ownership reporting: No Section 16 (“short-swing” profits) reporting. • Governance: An FPI may choose to rely on certain homecountry practices. • XBRL: Temporary XBRL relief was previously granted to FPIs.

Benefits Available to FPIs (cont’d) • Internal controls: Annual internal control reporting, rather than with quarterly reports • Executive compensation: As an FPI, certain of the more onerous executive compensation disclosure requirements are not applicable. • IFRS without GAAP reconciliation • 12g3-2(b) exemption

MJDS • For detailed information, please see our FAQs: http://www.mofo.com/files/Uploads/Images/FAQsMultijurisdictional-Disclosure-System-MJDS.pdf • Designed to enable Canadian issuers to more efficiently effect registered offerings in the U.S., using their Canadian offering documents. • Registration statement consists essentially of a cover page which “wraps” the Canadian prospectus. • Limited SEC review – the SEC will not comment, except under unusual circumstances. • Annual report (Form 40-F) wraps the Canadian annual report. • Eligibility: public float of at least US$75 million. • System is optional.

Updates to MJDS: Rescission of Form F-9 • In December 2012, the SEC rescinded Form F-9. • This form was previously used to register investment grade debt and preferred securities under the MJDS. • MJDS companies who would have been eligible to use Form F-9 may now use Form F-10 or Form F-3. • However, there is an “eligibility gap” between Form F-10 and F-9 where F-9 filers were not required to have a public float of $75 million. • Moreover, removal of Form F-9 references from Form 40-F caused MJDS companies who were eligible to use Form 40-F based on their registration on Form F-9 to be ineligible to use Form 40-F and required them to file on Form 20-F. Form 20F requires disclosure in accordance with SEC standards rather than Canadian disclosure rules.

Updates to MJDS: Rescission of Form F-9 (con’t) • The SEC adopted a temporary grandfather provision that permits registrants who would have been eligible to use Form F-9 as of December 31, 2012 to file on Form F-10 without satisfying the public float or parent guarantee requirement until December 31, 2015. • The SEC also adopted a permanent grandfather clause allowing filers who have filed and sold securities under a Form F-9 before December 31, 2012 to continue to be eligible to use Form 40-F to satisfy their Exchange Act reporting requirements. • Derivative securities (most structured notes) were eligible for issuance on Form F-9. With its rescission, Canadian issuers of these products need to register on Form F-3.

You Have a Form F-3 or Form F…why would you still consider having a private note 10… program? • Avoid strict liability provisions of the securities laws that apply to registered offerings. • Avoid SEC review. • No SEC filing fees. • Potential of reduced regulatory scrutiny. • Structured securities: • Some investors seek confidentiality (no public filing) for the terms of their investment. • Some structured securities are not eligible for the “Morgan Stanley” letter – credit linked notes, linking to individual small cap stocks, etc. • Potential to avoid certain aspects of the SEC 2012 “sweep letter”, which technically, is not applicable to unregistered offerings.

Registration Process

Which Registration Form Should Be Used? • Once an FPI has been subject to the U.S. reporting requirements for at least 12 calendar months, it may use Form F-3 to offer securities publicly in the U.S. • Form F-3 is a short-form registration statement (analogous to Form S-3 for U.S. domestic issuers) and may be used by an FPI if the FPI meets both the form’s registrant requirements and the applicable transaction requirements. • Form F-3 permits an FPI to disclose minimal information in the prospectus included in the Form F-3 by incorporating by reference the more extensive disclosures already filed with the SEC under the Exchange Act, primarily in the FPI’s most recent Annual Report on Form 20-F and its Forms 6-K. • Form F-3’s filed by WKSI’s are automatically effective, without SEC review. • Shelf registration statements on Form F-3 are typically not reviewed.

What Is a WKSI? • A “well-known seasoned issuer” (“WKSI”) is an issuer that has at least $700 million of common equity held by non-affiliates or (b) issued $1 billion of non-convertible securities during the past three years. • Can be a U.S. issuer or a non-U.S. issuer. • Can be a subsidiary of a company that is a WKSI. • Subject to certain disqualifications. • Canadian companies filing under the MJDS system cannot be WKSI’s.

Automatic Shelf Registration Statements • Automatic, immediate effectiveness, without SEC review • Registration of unspecified amounts of specified classes of securities • Presumption of proper form

• Process and consequences of notification by Staff if SEC objects to use of form • Impacts form of underwriting agreement, opinions and other offering documents. • Omission of information from base prospectus

• • • •

Identification of primary or secondary offering Description of securities Names of selling security holders Plan of distribution

• Mechanics for including omitted information

• Limited requirements for post-effective amendments • Pay-as-you-go registration fees as an option

• Unique to automatic shelf registrations • “In whole or in part” • Practical application in MTN programs and other special situations

Ongoing Reporting Obligations and Governance

Ongoing Reporting Obligations • An FPI that has registered securities under Section 12(b) or 12(g) of the Exchange Act or is required to file under Section 15(d) of the Exchange Act (because it has recently completed a registered offering) is obligated to file the following Exchange Act reports with the SEC: • Annual Report on Form 20-F (or Form 40-F, for MJDS issuers) • Reports on Form 6-K

Annual Report on Form 20-F • The information required to be disclosed in an Annual Report on Form 20-F includes, but is not limited to, the following: • • • • • • • • • • •

operating results; liquidity and capital resources; trend information; off-balance sheet arrangements; consolidated financial statements and other financial information; significant business changes; selected financial data; risk factors; history and development of the FPI; business overview; and organizational structure.

Reports on Form 6-K • An FPI must also “furnish” reports on Form 6-K to the SEC from time to time. • Generally, a Form 6-K contains information that is material to an investment decision in the securities of an FPI. • May include press releases, securityholder reports and other materials that an FPI publishes in its home-country in accordance with home-market law or custom, as well as any other information that the FPI may want to make publicly available. • Reports on Form 6-K generally take the place of Quarterly Reports on Form 10-Q (which include financial reports) and Current Reports on Form 8-K (which include disclosure on material events) that U.S. domestic issuers are required to file. • For many of the larger FPIs, the Forms 6-K that are filed with the SEC generally include similar types of information and are filed with the same frequency as Forms 10-Q and 8-K that are filed by U.S. domestic issuers. • The disclosures are prepared in accordance with “home country” practice.

Sarbanes-Oxley Requirements • Section 302 of Sarbanes-Oxley requires certifications by an FPI’s CEO/CFO regarding the effectiveness of the FPI’s disclosure controls and procedures, the completeness and accuracy of the FPI’s reports filed under Section 13(a) and 15(d) of the Exchange Act, and any deficiencies in, and material changes to, the FPI’s internal control over financial reporting. • Section 302 reporting begins once the FPI is an SEC registrant. • These certifications must be included in the FPI’s Form 20-F. • Other reports filed or furnished by the FPI, such as reports on Form 6-K, are not subject to the certification requirements. • Section 404 of Sarbanes-Oxley requires an annual report by both management and external auditors regarding the effectiveness of the company’s internal controls over financial reporting. • Section 404 reporting begins with the second annual filing with the SEC. • FPIs that are “non-accelerated” filers do not have to provide the auditor’s attestation.

Disclosure Controls and Procedures • “Disclosure controls and procedures” are controls and other procedures designed to ensure that the information required to be disclosed in the reports filed under the Exchange Act, on a timely basis, is recorded, processed, summarized and reported. • Disclosure controls and procedures include, but are not limited to, controls and procedures designed to ensure that information required to be disclosed by a company in its Exchange Act reports is appropriately accumulated and communicated to the company’s management, including its principal executive and financial officers, to allow timely decisions regarding required disclosure. • Important to have an “up the chain” process of reporting from lower managers to CEO and CFO.

Disclosure Issues • Foreign issuers are among those most affected by specialized disclosure requirements • Iran disclosures • Conflict minerals • SEC FAQs


Conflict Minerals Disclosure • Section 1502 of the Act requires persons to disclose annually whether any “conflict minerals” that are “necessary to the functionality or production” of a product of the person originated in the Democratic Republic of the Congo or an adjoining country and, if so, to provide a report describing, among other matters, the measures taken to exercise due diligence on the source and chain of custody of those minerals. • This must include an independent private sector audit of the report that is certified by the person filing the report.

• The SEC adopted final rules on August 22, 2012, and the first required filings will be on May 31, 2014. • Litigation challenging the rule has commenced. Upheld by a District Court in July 2013.

Confidential/Subject to Attorney Client Privilege


Resource Extraction Payments • Section 1504 of the Dodd-Frank requires reporting issuers engaged in the commercial development of oil, natural gas, or minerals to disclose, in an annual report, certain payments made to the United States or a foreign government. The SEC must make a compilation of the electronically-provided information available online. • Section 1504 was enacted against a backdrop of international efforts seeking to encourage greater transparency and accountability in countries dependent on the revenues from oil, gas and mining. • The SEC adopted final rules on August 22, 2012. • Litigation challenging the rules has commenced, and a U.S. District Court invalidated the rules in July 2013.

Confidential/Subject to Attorney Client Privilege


Liability Concerns

Securities Liability – Rule 144A and Section 3(a)(2) • Neither Rule 144A offerings or securities offerings of, or guaranteed by, a bank under Section 3(a)(2) are subject to the civil liability provisions under Section 11 and Section 12(a)(2) of the Securities Act. • Rule 144A offerings and offerings under Section 3(a)(2) are subject to Section 10(b) of the Exchange Act and the anti-fraud provisions of Rule 10b-5 of the Exchange Act. • Impact on offering documents, and use of offering circulars to convey material information and risk factors.

Liability Under the Exchange Act • Rule 10b-5 applies to registered and exempt offerings. • Rule 10b-5 of the Exchange Act prohibits: • the use of any device, scheme, or artifice to defraud; • the making of any untrue statement of a material fact or the omission of a material fact necessary to make the statements made not misleading; or • the engaging in any act, practice, or course of business that would operate to deceive any person in connection with the purchase or sale of any securities. • To bring a successful cause of action under Rule 10b-5, the plaintiff must prove: • that there was a misrepresentation or failure to disclose a material fact, • that was made in connection with plaintiffs’ purchase or sale of a security, • that defendants acted with “scienter,” or the intent or knowledge of the violation, • that plaintiffs “relied” on defendants’ misrepresentation or omission, and • that such misrepresentation or omission caused plaintiffs’ damages.

Section 11 Liability – Registered Offerings • Directors and officers of an FPI who sign a registration statement filed in connection with a securities offering are subject to the liability provisions of Section 11 of the Securities Act. • Section 11 of the Securities Act creates civil liability for misstatements or omissions in a registration statement at the time it became effective. • Any person that acquired a security registered under a registration statement, and did not have knowledge of the misstatement or omission at the time of the acquisition of the security, can bring suit against: • every person who signed the registration statement, including the FPI; • every director of the FPI at the time of the filing of the registration statement, whether or not such director signed the registration statement; and • experts who consent to such status, but only with respect to those sections of the registration statement (e.g., auditors).

Section 12 Liability – Registered Offerings • Section 12 of the Securities Act assigns liability to any person who offers or sells a security in violation of Section 5 of the Securities Act (pursuant to Section 12(a)(1)), or by means of a prospectus or oral communication that includes a misstatement or omission of material fact (pursuant to Section 12(a)(2)). • No action under Section 12(a)(1) may be brought more than three years after the bona fide public offering of a security, or, in the case of Section 12(a)(2), more than three years after the actual sale of a security.

July 29, 2014 James Schwartz

©2014 Morrison & Foerster LLP | All Rights Reserved | mofo.com

Current Issues in Implementing Title VII

Overview • Topics include: • Latest CFTC developments, including with respect to the CFTC’s cross-border guidance and prospects for inter-jurisdictional harmonization • Status of CFTC rules vs. SEC rules for security-based swaps • Swap execution facilities and the implementation of the trade execution requirement • Expected rules regarding margin for uncleared swaps

This is MoFo.


Background • September 2009 - G-20 made a commitment to transparency and safety in the market place “All standardized OTC derivatives should be traded on exchanges […] cleared through central counterparties […] OTC derivatives contracts should be reported to trade repositories”

• Aims of Title VII include: • Reducing systemic risk to the financial system posed by the swaps/OTC derivatives market • Increasing transparency of the swaps/OTC derivatives market, for both pre and post execution pricing • Enhancing the integrity of the swaps/OTC derivatives market • Improving the conduct of major market participants

This is MoFo.


Regulatory Responsibility • Title VII has bifurcated the regulatory responsibility between: • CFTC regulating swaps, swap dealers, and major swap participants; and • SEC regulating security-based swaps, security-based swap dealers and major security-based swap participants

This is MoFo.


Swaps vs. Security-Based Swaps • Swaps are subject to the jurisdiction of the CFTC and include interest rate swaps, floors, caps and collars, commodity swaps, crosscurrency swaps, total return swaps on broad-based security indices or two or more loans and credit default swaps on broad-based security indices • Security-based swaps are subject to the jurisdiction of the SEC and include swaps on a single security, loan, or narrow-based securities index • “Narrow based security index” means, among other things, an index with nine or fewer components, or in which a component security comprises more than 30 percent of the index’s weighting • The SEC and CFTC have adopted joint rules for the regulation of mixed swaps, which combine characteristics of both swaps an security-based swaps This is MoFo.


Definition of “Swap” • CFTC rule-making has given further detail to the definitions • Swaps defined widely: • Exclusions: certain consumer and commercial transactions, spot FX, simple FX swaps or forwards or commodity forwards • Security Based Swaps are swaps on a single security or loan or narrow-based security index and single-issue CDS • Treasury Secretary exempts foreign exchange forwards and swaps from the definition of “swap” for many (but not all) purposes

This is MoFo.


CFTC vs. SEC Rulemaking • CFTC has completed the large majority of its rulemaking under Title VII – today we will review many of its rulemakings • Among the many completed CFTC regulations are rules relating to swap dealer registration, reporting and recordkeeping, mandatory clearing and trade execution • However, the SEC is taking a different approach • It appears that no registration requirements will be imposed until most or all substantive Title VII rulemaking by SEC is complete • SEC’s has finalized relatively few rules, although with the release of certain cross-border rules it now seems to be gaining momentum • The SEC has provided time-limited relief from many Dodd-Frank requirements, and that relief, subject to conditions, has generally been extended to February, 2017 184

Swap Market Fragmentation • The CFTC is out ahead of not only the SEC, but also many (if not all) non-U.S. swaps regulators • The consensus view is that, in the bread-and-butter business of interest rate swaps (especially in USD), liquidity has fragmented between the U.S. and other jurisdictions • This fragmentation results in significant part from the decision of the CFTC to finalize its regulations to implement mandatory clearing and mandatory trading platform execution of swaps before regulators in other jurisdictions, while at the same time placing significant regulatory burdens on market participants in other jurisdictions transacting or facilitating transactions with U.S. parties


Entities Regulated under CFTC Rules • Swap Dealers (SDs) - Includes any person who: • Holds itself out as a swap dealer; • Makes a market in swaps; • Regularly enters into swaps with counterparties as an ordinary course of business for its own account; or • Is commonly known in the trade as a dealer or market maker in swaps

• Major Swap Participants (MSPs) - Includes any person who is not a dealer and: • Maintains a substantial position in swaps, excluding positions held for hedging or mitigating commercial risk; • Has outstanding positions which create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets; or • Is a highly leveraged financial entity that maintains a substantial position in swaps and is not subject to a Federal banking agency’s capital requirements

This is MoFo.


Entities Regulated under CFTC Rules (cont’d) • • • •

Derivatives Clearing Organizations (DCOs) Swap Execution Facilities (SEFs) Swap Data Repositories (SDRs) Notable exemptions: • End users of derivative instruments using the derivative to hedge risk (exempt from clearing and trade execution rules) • CFTC end-user exception is quite limited • the end-user cannot be a financial entity • must use swaps in order to hedge or mitigate commercial risk • reporting requirements • Central banks (exempt from clearing)

This is MoFo.


Extraterritoriality – Statutory Bases • Dodd-Frank’s provisions for extraterritorial jurisdiction differ somewhat with respect to the CFTC and the SEC • CFTC: Under Title VII section 722(d), activities outside the U.S. may be regulated if: • they have a direct and significant connection with activities in, or effect on, commerce of the U.S.; or • they contravene such rules or regulations as may be prescribed under the Act, necessary or appropriate to prevent the evasion of the relevant provisions of the Act • SEC: Under Title VII section 772(c), a person transacting a business in security-based swaps outside the U.S. may be regulated if: • such person transacts such business in contravention of such rules and regulations as the SEC may prescribe as necessary or appropriate to prevent the evasion of the relevant provisions of the Act This is MoFo.


CFTC Extraterritoriality • The scope of Title VII extraterritoriality as interpreted by the CFTC is extremely extensive as per CFTC guidance regarding the definition of U.S. and non-U.S. Persons: • Swap Dealer requirements apply to a non-U.S. entity who has more than de minimis swap dealing activity with U.S. persons (although non-U.S. persons may be able to comply with certain requirements through compliance with home country rules) • Entity-level requirements apply to all swap entities required to register with the CFTC; these include capital adequacy, CCO requirement, risk management and recordkeeping requirements • Transactional requirements will generally apply only to swaps between U.S. persons or between a U.S. person and a non-U.S. person and not necessarily to a swap between a non-U.S. Swap Dealer and a non-U.S. person • Branches of U.S. entities will generally be treated as a U.S. person but branches of U.S. banks that are Swap Dealers may meet transactional requirements for swaps with non-U.S. Persons by compliance with local rules if the CFTC determines comparability

This is MoFo.


CFTC Extraterritoriality (cont’d) • Substituted Compliance: • With respect to many requirements, the CFTC provides it may be possible for foreign entities to comply with their local comparable regulatory requirements • To make a substituted compliance determination, the CFTC must determine that the foreign jurisdiction’s requirements “are comparable with and as comprehensive as the corollary area(s) of regulatory obligations encompassed by” the CFTC’s own rules • The CFTC may consider both swap-specific regulations of the relevant foreign regulator and other provisions that may “achieve comparable and comprehensive regulatory objectives as the Dodd-Frank Act requirements, but on a more general, entity-wide, or prudential, basis” • In certain cases the CFTC may seek to influence the contents of foreign regulations by “coordinating with the foreign regulators in developing appropriate regulatory changes or new regulations, particularly where changes or new regulations already are being considered or proposed by the foreign regulators or legislative bodies”

This is MoFo.


CFTC Extraterritoriality (cont’d) • Path forward: • July 11, 2013 – CFTC and EU Commission published papers – “The European Commission and the CTFC reach a Common Path forward on Derivatives” • Acknowledged simultaneous application of European rules and Title VII could lead to conflicts of law, inconsistences and uncertainty • Set out high level agreement between EU Commission and CFTC as to how to resolve certain issues • There were questions, however, about how effective the high level agreement was

This is MoFo.


CFTC Extraterritoriality (cont’d) • In general, though, there now seems to be improving crossjurisdictional cooperation • At the G20 finance meeting held in February, the G20 committed to cooperate across jurisdictions with a renewed focus on timely and consistent implementation supported by meaningful peer reviews, with a particular attention to OTC derivatives reform • The OTC Derivatives Regulators Group in March prepared a report regarding remaining cross-border implementation issues, and it is expected to prepare a series of further reports this year

This is MoFo.


CFTC Final Guidance Important Points: • The term “U.S. Person” • Registration requirements • Treatment of foreign branches • Entity-Level and Transaction-Level Requirements • Substituted Compliance

This is MoFo.


CFTC Final Guidance (cont’d) • Definition of U.S. Person “generally” includes, but may “not be limited” to: • natural person resident of the United States or an estate thereof; • any corporation, partnership, or other forms of enterprise in each case that is organized or incorporated under the laws of a state or other jurisdiction in the United States or having its principal place of business in the United States; • U.S. pension plans; • any trust governed by the laws of a state or other jurisdiction in the United States • any commodity pool, pooled account, investment fund, or other collective investment vehicle that is majority-owned by U.S. Persons; • any legal entity (other than an entity where all of the owners of the entity have limited liability) that is directly or indirectly majority-owned by specified types of U.S. Persons and in which such U.S. Person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity; and • Certain individual accounts or joint accounts owned by U.S. Person(s)

This is MoFo.


CFTC Final Guidance (cont’d) Key Considerations – U.S. Person • A non-U.S. person does not become a U.S. person by virtue of a guarantee by U.S. affiliate • However, such a non-U.S. affiliate may be a “guaranteed affiliate” or “affiliate conduit” and, for that reason, in certain circumstances, subject to many of the CFTC’s transaction level requirements • Whether a non-U.S. person is a “guaranteed affiliate” or “affiliate conduit” depends on consideration of several factors that focus on the closeness of the relationship between the non-U.S. person and the U.S. affiliate (e.g., ownership, control, concerted action, consolidated financial statements)

This is MoFo.


CFTC Final Guidance (cont’d) Key Considerations – Swap Dealer Registration (Affiliates) • A non-U.S. entity which has more than de minimis swap dealing activity with U.S. persons must register as a swap dealer. When determining whether swap dealing activities exceed the de minimis threshold, a person must include the aggregate notional value of swap dealing transactions by affiliates under common control • The guidance interprets this requirement as applicable to all affiliates in a corporate group regardless of whether they are U.S. or non-U.S. persons • But this does not apply to activities of an affiliate that is already registered as a swap dealer • For U.S. and non-U.S. persons in an affiliated group, this effectively means that if the group exceeds the de minimis threshold then one or more members of the group would have to register as a swap dealer to bring the group’s dealing activity below the de minimis threshold

This is MoFo.


CFTC Final Guidance (cont’d) Key Considerations – Foreign Branches • A foreign branch of a U.S. person is considered a part of the U.S. person • Therefore a foreign branch of a U.S. Person would not register separately from the U.S. person as a U.S. swap dealer • The foreign branch of a U.S. Person is expected to comply with all of the CFTC’s entity-level requirements • For a swap transaction between the foreign branch of a U.S. Person and a non-U.S. person, the swap is eligible for substituted compliance with respect to the “Category A” transaction level requirements • This amounts to all of the transaction-level requirements except for external business conduct standards

This is MoFo.


CFTC Final Guidance (cont’d) • U.S. branches of foreign swap dealers and footnote 513: • In this footnote in its cross-border guidance, the CFTC stated its view that “a US branch of a non-US swap dealer or MSP” is subject to transaction level requirements, without the possibility of substituted compliance • Even though a “branch does not have a separate legal identity” and is therefore part of a non-U.S. Person, the CFTC has a “strong supervisory interest in regulating the dealing activities that occur with the United States, irrespective of the counterparty” • In addition to fn 513, in mid November of last year, the CFTC’s Division of Swap Dealer and Intermediary Oversight issued a “Staff Advisory” regarding swaps “arranged, negotiated or executed, or executed by personnel or agents of the nonUS SD located in the United States” • Under this Advisory, what appears to matter, for purposes of the applicability of transaction level requirements, is not the SD office entering into the swap as a legal matter, but instead, the location of the persons arranging or negotiating the swap

This is MoFo.


CFTC Final Guidance (cont’d) • U.S. branches of foreign swap dealers and footnote 513 (cont’d) • It appeared that, by means of fn 513 and the additional Advisory, the CFTC would require counterparties to a swap to comply with certain transaction level requirements even if both were foreign and enter into a swap through non-U.S. offices, if one entity employed U.S.-based front office personnel or agents in relation to the swap • However, the status of the Advisory is now ambiguous • A CFTC no-action letter, issued subsequent to the advisory, grants relief until December 31, 2014 to non-U.S. swap dealers failing to comply with the Transaction-Level Requirements in relation to swaps with many non-U.S. person • In addition, the CFTC issued a request for comment on “whether the Commission should adopt” the advisory “as Commission policy, in whole or in part” • As a result, the extent of the applicability of the Transaction-Level Requirements remains unsettled in certain circumstances, notably in relation to swaps between a non-U.S. dealer and another non-U.S. Person

This is MoFo.


CFTC Final Guidance (cont’d) • Substituted Compliance determinations to date: • On December 20, 2013, the CFTC announced comparability determinations for various entity-level requirements for Australia, Canada, the EU, HK, Japan and Switzerland • However, with respect to transaction-level requirements, the CFTC’s comparability determinations were limited to a few provisions for Japan and the EU • No substituted compliance determinations yet with respect to mandatory clearing or trade execution

This is MoFo.


Litigation over CFTC Guidance • The CFTC’s cross-border guidance led to the most recent lawsuit by industry groups (SIFMA, ISDA, IIB) challenging the CFTC’s implementation of Title VII • Plaintiffs allege that the CFTC, in adopting and promulgating its cross-border guidance: • Failed to engage in required cost-benefit analysis; • Violated the Administrative Procedures Act by failing to provide interested persons sufficient opportunity to participate in rulemaking, failing to respond adequately to comments, and acting arbitrarily and capriciously with regard to the scope of the entities and transactions covered by its rules; • Adopted a rule applicable to activities outside of the United States without a sufficient connection to the United States

• The complaint also alleges that the CFTC’s SEF registration rule is arbitrary and capricious in regulating entities and activities with an insufficient connection to U.S. commerce This is MoFo.


Litigation over CFTC Guidance • Current status: the parties have made cross-motions for summary judgment and have made numerous recent submissions in support of their motions • Wrangling over, among other things, the plaintiffs’ standing to bring the lawsuit and whether the CFTC’s cross-border guidance should be deemed a rule (with which compliance is mandatory) or a mere interpretive statement

This is MoFo.


SEC Final Cross-Border Rules • The SEC last month released a portion of its final cross-border rules • The rules do not state which substantive regulatory requirements will apply to which security-based swaps or which types of counterparties • Instead, the SEC final rules focus largely on which swaps will count for which types of entities toward the thresholds for registering as a Security-Based Swap Dealer or Major Security-Based Swap Participant • They also contain a procedural rule for the submission of substituted compliance requests to the SEC • Although the rules become will effective 60 days after publication in the Federal Register, the rules applicable to the SBSD and MSBSP definitions and establishing the procedures for submitting substituted compliance requests will not impose requirements on market participants until after relevant substantive rulemakings have been completed (such as a rule setting forth the form and manner of registration for such entities)

This is MoFo.


SEC Final Cross-Border Rules • SEC rules relating to de minimis threshold are broadly similar to CFTC rules • The Securities Exchange Act excepts from designation as “security-based swap dealer” entities that engage in a “de minimis” quantity of security-based swap dealing activity • Under SEC final rules defining (among other things) ‘‘Security-Based Swap Dealer,’’ a person may take advantage of de minimis exception if, in connection with CDS that constitute security-based swaps, the person’s dealing activity over the preceding twelve months does not exceed a gross notional amount of $3 billion, subject to a phase-in level of $8 billion • Lower thresholds apply for other types of SBS ($150 million, subject to a phase-in level of $400 million) • The phase-in levels will remain in place until, following a study, the SEC either terminates the phase-in period or establishes an alternative threshold following rulemaking

This is MoFo.


SEC Final Cross-Border Rules • Highlights of SEC cross-border rules: • Rules regarding transactions that will count toward the de minimis threshold are broadly similar to the CFTC’s rules: • A U.S. Person must count toward the de minimis threshold all security-based swap dealing transactions • Non-U.S. Persons must in many cases count toward the de minimis threshold security-based swap dealing transactions with U.S. Persons (details differ between CFTC and SEC rules)

This is MoFo.


SEC Final Cross-Border Rules • SEC definition of U.S. Person is narrower than CFTC definition in that: • SEC does not include collective investment vehicles that beneficially are majority-owned by U.S. persons • SEC does not include any legal person that is directly or indirectly majority-owned by one or more U.S. persons that bear unlimited responsibility for the obligations and liabilities of such legal person • SEC excludes the International Monetary Fund, the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, their agencies and pension plans, and similar international organizations This is MoFo.


Mandatory Clearing • In general: • Section 2(h)(1)(A) of the CEA makes it unlawful to engage in any swap that the CFTC requires to be cleared, unless it is submitted to a registered clearing organization for clearing or an exception is available • The CFTC subjects classes or types of swaps to mandatory clearing by describing them in a clearing determination. To date, there has been only one final clearing determination • Once a final clearing determination has been issued, the related swap types are subject to mandatory clearing on a phased-in timeline based on type of entity (T+90, T+180, T+270)

This is MoFo.


Mandatory Clearing (cont’d) • A swap or security based swap must be cleared if the CFTC or SEC deems it to be a class of derivative instruments that is subject to mandatory clearing • Classes are defined by the CFTC, but may also be suggested by clearing organisations • In its initial clearing determination, the CFTC required the clearing of broad categories of interest rate swaps and index CDS • Mandatory clearing of standard IRS and CDS products commenced on March 11, 2013 for Category 1 entities, June 10, 2013 for Category 2 entities and September 9, 2013 for end-users (subject to applicable exceptions)

This is MoFo.


Mandatory Clearing (cont’d) • Relationship documentation for cleared swaps includes: • Futures Account Agreement (“FAA”) - governing the relationship between a party to a swap and its futures commission merchant (“FCM”), which is a member of the relevant swaps clearinghouse • Cleared OTC Derivatives Addendum to the FAA - addressing matters particular to cleared swaps in the context of a clearing relationship • Cleared Swaps Execution Agreement

This is MoFo.


Mandatory Clearing (cont’d) • Section 2(h)(7)(A) of the CEA provides an exception to the clearing requirement (the “end-user exception”) • In the adopting release of the CFTC’s final rules addressing the end-user exception, the CFTC announced that it intended to look into a possible additional exception for inter-affiliate swaps • A final rule excepting inter-affiliate trades under specified conditions was adopted in early April 2013

This is MoFo.


Mandatory Clearing/Affiliate Exception • The CFTC released final Rule 50.52 on April 1, 2013 • CFTC has made clear it anticipates that the exemption will be used primarily for trades between affiliated financial entities that are less likely to be able to use the end-user exception • The rule allows the eligible affiliate counterparties to a swap to elect not to clear a swap that would otherwise be subject to mandatory clearing, subject to numerous limitations, including the following: • Only majority-owned affiliates eligible for exemption • Both counterparties would have to elect not to clear the swap • Swap trading relationship documentation required between the parties • Swap must be subject to a centralized risk management program within the group of affiliated entities that is reasonably designed to monitor and manage the risks associated with inter-affiliate swaps

This is MoFo.


SEFs • To promote pre-trade price transparency, the Dodd-Frank Act requires that all swaps that are required to be cleared be executed on a designated contract market (DCM) or a swap execution facility (SEF), unless the swap is not available to trade on any DCM/SEF or another clearing exception applies • Dodd-Frank generally defines a SEF as a trading system or platform that is not a DCM, and in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants (definition excludes single-dealer platforms) • Customers who are not “eligible contract participants” may only enter into swap executed on or subject to the rules of a designated contract market • The CFTC approved final rules for SEFs in May of last year

This is MoFo.


SEFs (cont’d) • CFTC’s core principles and other requirements for SEFs: • require SEFs to comply with a minimum functionality requirement by offering an “Order Book,” an electronic trading facility, trading facility, or trading system or platform in which all market participants have the ability to enter multiple bids and offers, observe or receive bids and offers, and transact on them • distinguish between “Required Transactions,” which are required to be cleared and executed on a SEF or DCM and “Permitted Transactions” not subject to mandatory SEF execution • provide that Required Transactions, other than block trades, must be executed on an Order Book or a Request for Quote (RFQ) system, by which market participants send a request for a quote to buy/sell a particular instrument to at least two (after October 2 2014, three) independent market participants

This is MoFo.


SEFs (cont’d) • CFTC’s “Made Available to Trade” (“MAT”) rule provides that a swap that is subject to mandatory clearing must be executed on a SEF or DCM only if a SEF or DCM has made the swap “available to trade” • After listing, a SEF or DCM may make a MAT determination for a group, category, type or class of swap, and then the MAT determination is provided to the CFTC • A SEF or DCM may make the initial determination that a swap is made available to trade based on any one or more of the following factors: • existence of ready and willing buyers and sellers; • frequency or size of transactions; • trading volume; • number and types of market participants; • bid/ask spread; and • usual number of firm or indicative bids and off • The initial five MAT determinations went into effect starting on February 15 and apply to many USD and EUR interest rate swaps and certain index CDS

This is MoFo.


SEFs (cont’d) • The CFTC, in its release of its core principles and other requirements for SEFs, surprised the market by stating, in a footnote, that if a facility operates in a manner that meets the SEF definition, it is required to register as a SEF, even if it facilitates the execution of only “Permitted Transactions” that are not subject to the trade execution mandate • This means that, unexpectedly, multiple-to-multiple FX platforms, and other platforms on which “Permitted Transactions” are traded, are required to register as SEFs

This is MoFo.


SEFs (cont’d) • Extraterritoriality issue in relation to SEF registration: • In a guidance letter issued last November, the CFTC’s Division of Market Oversight stated its expectation that a multilateral swaps trading platform located outside the United States that provides U.S. persons or persons located in the U.S. (such as agents of non-U.S. persons located in the United States) with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary, will register as a SEF or a DCM • This means that many multilateral swaps trading platforms outside the United States are, based on this guidance, required to register with the CFTC • In response, certain non-U.S. platforms have denied access to U.S. firms and U.S. based traders of non-U.S. firms

This is MoFo.


SEFs (cont’d) • The CFTC has provided no-action letters intended to provide relief to (i) multilateral trading facilities (“MTFs”), the European equivalent of SEFs, overseen by competent European authorities from the CFTC’s SEF registration requirement and (ii) parties executing swap transactions on such qualifying MTFs from the U.S. trade execution requirement • However, the take-up of the CFTC’s relief appears to have been minimal • Many believe that the CFTC’s rules regarding SEFs and extraterritoriality effectively penalize non-U.S. market participants from dealing with the U.S. and have effectively fragmented market liquidity into U.S. and non-U.S. segments for many vanilla products

This is MoFo.


SEFs – Package Transactions • The phase-in of SEF trading has caused issues in relation to so-called “package trades” • These are transactions with multiple inter-dependent component legs, priced based on simultaneous execution of all components, at least one leg of which is “available to trade” and thus subject to the trade execution requirement • Under a CFTC no-action letter for package transactions, a leg of a package transaction that would otherwise be required to be executed on a SEF may not be required to be executed on a SEF if it is part of a package transaction • The relief that remains in effect, and is scheduled to expire in November of this year, relates to package transactions in which the components include at least one swap component that is subject to the CFTC’s trade execution requirement, and at least one swap component • that is under the CFTC’s exclusive jurisdiction and not subject to the CFTC’s clearing requirement, • other than a transaction in U.S. Treasury securities that is not a swap; or • that is a swap over which the CFTC does not have exclusive jurisdiction.

This is MoFo.


Margin – Uncleared Swaps • The CFTC has proposed margin rules for uncleared swaps that apply to SDs/MSPs that are not prudentially regulated (banking agencies have released a proposal for SDs/MSPs subject to prudential regulation) • However, since the time when the CFTC proposed its rules, the Basel Committee on Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”) have issued their final framework for margin requirements, which are expected to be influential in determining the CFTC’s final rules • Timing for release of CFTC final margin rules for uncleared swaps is not clear

This is MoFo.


Margin – Uncleared Swaps (cont’d) • Key BCBS/IOSCO principles include: • Margin requirements for uncleared swaps should promote central clearing by reflecting the higher risk associated with uncleared swaps • All financial firms and systemically important non-financial entities should exchange initial and variation margin • Initial margin should be exchanged by both parties, on a gross, unnetted basis • Initial margin should be rehypothecated only in very narrow circumstances • Variation margin may generally be rehypothecated or otherwise re-used

This is MoFo.


Segregation of initial margin • Title VII gives end-users the right to require that any initial margin they post be segregated and, if it chooses, held by a third-party custodian • CFTC late last year issued regulations pursuant to which, prior to the execution of an uncleared swap, but not more often than annually, a swap dealer must: • Give notice to its counterparty stating the counterparty’s right to require the segregation of initial margin provided by the counterparty; • Identify one or more acceptable custodians that are legal entities independent of the dealer and the counterparty; and • Provide information regarding the price of segregation for each custodian to the extent that the dealer has such information

• Under the rule, segregated initial margin may only be invested in a limited number of instruments

This is MoFo.


Segregation of Margin for Cleared Swaps • For cleared swaps, clearinghouses will drive how much margin will be required • Margin posted in respect of cleared swaps (but not futures contracts) is required to be “legally separate but operationally commingled” (“LSOC”) • Under LSOC, FCMs and DCOs may operationally commingle customer funds, but must maintain legally segregated accounts, and are not permitted to use a non-defaulting customer’s collateral to cover losses resulting from the default of another customer

This is MoFo.


Reporting Obligations • Reporting obligations are now generally in effect, but also subject to possible significant changes • Swaps (whether cleared or not) must be reported to swap data repositories (SDRs) in the U.S. • Details must be reported according to differing timeframes depending on the type of swap and whether it is subject to mandatory clearing • Reported details must include primary economic terms and any variation to the data

This is MoFo.


Reporting Obligations (cont’d) • The obligation to report in respect of an exchange traded swap is the responsibility of the SEF • If the swap is cleared, then the relevant clearing organization must report confirmation data • If the swap is not traded on a SEF, then the obligation to report exists in the following order: • • • •

A SD. If none, then a MSP. If none, then a financial entity. If none, then as decided between the parties.

• Reporting of swaps between a U.S. and non-U.S. Person are generally the responsibility of the U.S. person.

This is MoFo.


Status of Reporting Rules • It is not clear what use the CFTC is making, or is currently capable of making, of the data that is reported • Reports of frustration with the difficulty of making use of reported data • Early this year the CFTC announced the formation of an interdivisional staff working group to review certain swaps transaction data reporting • The working group is expected to formulate and recommend questions for public comment relating to reporting rules and related provisions • Based on the working group’s request for comment, released in March of this year, it appears that it will be primarily Part 45 of the CFTC’s rules that will be subject to possible modification

This is MoFo.


Working Group Request for Comment • Addresses such fundamental issues as • What terms of a swap should be reported • How data reflecting swap life cycle events (assignment, compression, clearing, novation and others) should be represented in SDR data and kept current and accurate • How modifications of swaps should be represented in SDR data • How the swap data reporting rules should address cleared swaps


Working Group Request for Comment (cont’d) • More fundamental issues: • How reporting entities and SDRs can improve data quality and standardization across all data elements and asset classes within an SDR • Whether there are any identifiers in addition to LEIs, UPIs and USIs that the CFTC should consider • Any additional steps that market participants can take to ensure that counterparties have valid LEIs • How the CFTC should enhance Part 45 to facilitate oversight of registered entities (swap dealers and major swap participants) • How Part 45 can better facilitate monitoring and surveillance 227

Re-Proposed Position Limits Rules • CFTC originally proposed position limits in January, 2011 and first finalized them later that year • However, ISDA and SIFMA were successful in lawsuit that they brought to vacate the CFTC’s final rules • Court ruled, on summary judgment, that CFTC had failed to make a required finding that position limits were actually necessary before imposing such limits • As a result, the CFTC re-proposed position limits rules in November 2013 • CFTC re-proposal release contains a “preliminary finding,” spread over 12 pages of the Federal Register, that position limits are necessary to achieve the purpose of the Commodity Exchange Act


Re-Proposed Position Limits Rules • Proposed rule would limit speculative position limits in 28 physical commodity contracts and applies to “economically equivalent” futures, options and swaps based on these physical commodities • The proposed rules include three type of limits: • spot-month position limits – applicable in the period immediately before settlement • single-month position limits – each separate futures trading month • all-months-combined position limits – the sum of all futures trading months


Re-Proposed Position Limits Rules • Revised Definition of Bona Fide Hedging for Exemption Purposes • Purpose must be to offset price risk incidental to commercial cash operations (“Incidental Test”) • Position must be established and liquidated in an orderly manner in accordance with sound commercial practices (“Orderly Trading Requirement”) • Plus additional requirements for particular transaction types (such excluded (financial) commodities and physical commodities)


■ MoFo was named Law Firm of the Year, Americas by Structured Products magazine in 2006, 2007, 2009, 2011, 2012 and 2014 for innovative capital markets, derivatives and structured products work.

■ Chambers Global 2013 ranks MoFo as having leading U.S. derivatives practice and a leading structured finance and derivatives practice globally. Several of our derivatives partners are also ranked by Chambers Global.

■ Legal 500 2014 ranks MoFo’s derivatives practice as a leader in the U.S., as well as in the UK. Legal 500 writes, “Morrison & Foerster LLP provides ‘very high levels of service – response times are minimal even when lawyers are out of the office’ and clients ‘would recommend it to anyone in the derivatives world’.”

■ IFLR1000 2014 ranks MoFo’s derivatives practice as a leading national practice. IFLR1000 says, “Morrison & Foerster is known for its expertise in derivatives and structured products.” IFLR1000 also ranks several of our derivatives attorneys as leaders in their field.

■ mtn-i named us a “Legal Leader” in 2013 for our structured product work. Two of our transactions were honored with separate awards.

Derivatives and Structured Products ■ US News & World Report 2014 ranks us as a Tier 1 national practice in Derivatives and Futures Law. ■ We were named StructuredRetailProducts.com “Best Law Firm in the Americas” in 2012, 2013 and 2014.

■ Chambers USA 2014 ranks MoFo as a leading derivatives practice. Chambers says, "This firm is widely respected for the broad scope of its derivatives expertise, with strength in credit and equity derivatives, and commodity, equity, index, insurance, currency and rate-linked products. The group also wins praise for its familiarity with restructuring and regulatory reform issues.” Several of our derivatives partners are ranked by Chambers USA.

■ Derivatives Week named us 2013 “European Law Firm of the Year”.

■ Best Lawyers in America 2014 names several of our partners as “Best Lawyers” in the field of derivatives.


Contact Details Oliver Ireland Partner Tel: +1 (202) 778-1614 Email: [email protected]

Jerry Marlatt Senior Of Counsel Tel: +1 (212) 468-8024 Email: [email protected]

James Schwartz Of Counsel Tel: +1 (212) 336-4327 Email: [email protected]