Financial Law Blog

Updates on Banking Law, Investment Management Law, Securities Law, Commodities/Derivatives Law

Category: Commodities/Derivatives Law

CFTC settles enforcement action against VTB for inter-affiliate futures executed as block trades on an exchange

The CFTC on Monday settled enforcement action against VTB for inter-affiliate futures executed as block trades on an exchange. VTB entered into forex futures with a subsidiary (VTB Capital) via block trades on the CME. The subsidiary (a U.K. bank) then offset this currency exposure via the OTC cross-currency swap market. In other words, VTB purchased forex exposure through a subsidiary booking entity. As the CFTC found, this was done because the booking entity was able to receive more favorable pricing than the parent. The CFTC found that the block trade in this transaction constituted a fictitious sale violative of Section 4c(a) of the Commodity Exchange Act.

Institutions always book derivative transactions to whichever affiliate is most advantageous. Regardless of which affiliate entity needs the exposure or hedge, the derivative will still be booked through the booking entity. The exposure will then be offloaded to the affiliate that needed it (via a mirrored inter-affiliate transaction). This is normal practice for large institutions. For example, the CFTC’s recent final rule regarding cross-border application of margin requirements as well as the swaps push-out provision for banks in Dodd-Frank (which was subsequently repealed in substance) are examples of the CFTC and Congress grappling with this practice in other contexts. In some contexts, the CFTC and Staff recognize this practice as sufficiently worthwhile as to remove regulatory barriers to it — for example, in the CFTC’s clearing requirement exemption for inter-affiliate swaps and in the Staff’s no-action letters for centralized treasury affiliates (Letter 13-22 was amended by Letter 14-144).

In 2014 the CFTC settled enforcement action against RBC for taking futures positions opposite its subsidiaries via block trades on the OneChicago exchange. The consent order found that those transactions were “designed, in part, to profit from stock loan businesses, to fund one subsidiary, to optimize capital for another subsidiary, and to achieve certain tax benefits.” Since the fictitious sale doctrine has a long history of being applied to trades made for a tax benefit, one might have thought tax benefit was driving the RBC enforcement action. After the VTB settlement, however, it appears that the CFTC may view all inter-affiliate block trades on an exchange as fictitious sales.

CFTC proposes allowing Luxembourg, UK, Irish, and Canadian GAAP in annual reports by CPOs

CPOs are required to provide an annual report to pool participants and the NFA. The report can be either in accordance with GAAP or, subject to certain conditions, IFRS. CFTC Staff, however, have been providing one-off relief to CPOs following accounting conventions of other jurisdictions. The CFTC recently proposed amending its regulations to allow CPOs to report in accordance with U.K. GAAP, New Irish GAAP, Luxembourg GAAP, and Canadian GAAP, subject to certain conditions. If the changes are adopted, CPOs with pools in foreign jurisdictions would not need to request individualized no-action relief should they wish to prepare pool financial statements in accordance with these accounting conventions.

CFTC proposes removing clearing requirement from registration exemption for foreign entities

The CFTC proposed revisions to Regulation 3.10 yesterday which would remove the clearing requirement from the registration exemption for foreign entities.

Regulation 3.10(c) allows foreign entities touching “commodity interest” transactions to not register with the CFTC as CPOs, CTAs, FCMs and IBs so long as they meet certain conditions. For example, with respect to such transactions, the foreign entity must act only on behalf of persons located outside the U.S. The foreign entity would still be subject to all the substantive rules relating to the transactions, but not those rules which relate only to CFTC registrants.

The CFTC proposed doing away with the requirement that foreign entities clear their commodity interest transactions through a registered FCM. Although prior no-action relief from CFTC Staff allowed foreign entities to rely on the exemption without clearing through FCMs, a change by the Commission in the regulation itself would provide more certainty and permanence to foreign entities intending to rely on the exemption.

Additional reporting lines for Chief Compliance Officers of FCMs, SDs and MSPs are possible according to CFTC Staff guidance

CFTC Staff issued guidance yesterday confirming that additional reporting lines for Chief Compliance Officers are possible.

Regulation 3.3 applies to FCMs and swaps registrant entities. It requires the Chief Compliance Officer of a registrant to report directly to its CEO or Board. The intention of this requirement is to assure the CCO’s independence from the business unit.

Larger institutions, which may have layers of management at the parent level above the registrant, sought assurance that their CCOs could have additional reporting lines outside of the registrant. The Staff noted possibilities such as the registrant’s CCO reporting to a global CCO of the parent company or to another senior officer responsible for multiple of the parent’s lines of business. Each of these arrangements is not foreclosed, noted the Staff, but whether they comply with the rule will depend on “all relevant facts and circumstances.”

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