Tensions between buy- and sell-side firms in Asia are tipped to rise in the coming months, as swap dealers, such as prime brokers, will soon be obliged to determine whether their clients are US persons under incoming rules.
According to a provision added to Dodd-Frank rules by the US Commodity Futures Trading Commission (CFTC) in mid-July, a non-US hedge fund will be considered a US person if the majority of its investor base comprises either permanent US residents or institutions incorporated in America.
Several jurisdictions have successfully applied to have portions of the rules delayed until December 21 from the original deadline of October 9. They are Australia, Hong Kong and Japan in Asia Pacific, and Canada, the European Union and Switzerland outside the region.
Yet non-US swap dealers are still struggling to deal with the wave of regulation that will soon be imposed by the CFTC, as the responsibility ultimately lies with them to determine whether their clients – covering investment entities of all types – are US persons under the rules.
It’s an ominous task, given that the definition varies between regulatory bodies. The US Securities and Exchange Commission defines a US person according to where a fund manager is based, whereas the CFTC focuses on where most of the firm’s investors are located.
The two regulators’ definitions of securities also vary – for instance, the SEC has jurisdiction over swaps on individual securities such as stocks and bonds, while the CFTC has oversight on commodity swaps.
This can create jurisdictional headaches for sell-side firms. In fact, many are simply categorising buy-side firms as US persons, which can be frustrating for these clients, says Karl Egbert, a Hong Kong-based partner at law firm Dechert.
“Swap dealers are kind of taking a ‘shoot first, ask questions later’ approach because they face all of the regulatory risk,” he notes. “Rather than sitting down and looking at the application of the swaps rules on a case-by-case basis, the first impulse is to send out documentation and say to the buy-side ‘sign these documents or we can’t trade with you’.”
But firms such as hedge funds, institutional investors and mutual fund managers want more guidance on these complex regulatory issues, says Egbert.
“If you’re on the buy-side and figuring out what you are supposed to do, chances are you’re not going to get as much guidance from the sell-side, because their incentive is just to ask whether you are a US person or not,” he says. “We might start hearing [of a] little bit of tension between the buy-side and sell-side [in the next few weeks].”
Egbert is advising on several disputes in this area, and urges both sides to work together more. “[The] best approach is a little more guidance and more counselling about what these different obligations mean,” he says.
However, one prime broking executive at an international bank believes this tension is slightly exaggerated. “Considering the huge workload that this change in the US person definition has caused, I think the industry and brokers did a reasonably good job,” he says. “Going through your entire client lists to determine who is a US person is obviously not an easy task, but the process was handled pretty well.”