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New U.S. Reporting Requirements on Cross-border Holdings of Long-term Securities

Friday, October 14, 2011

Contributed by Anastasia T. Rockas, Skadden, Arps, Slate, Meagher & Flom LLP

On June 27, 2011, the Department of the Treasury (Treasury) announced the approval of Treasury International Capital Form SLT (Form SLT)1 and accompanying instructions2 by the Office of Management and Budget.3 Form SLT is a reaction to the recent global financial crisis, which heightened awareness of the importance of collecting economic and financial data on cross-border transactions. The Treasury currently collects monthly and annual data on holdings of short-term securities, as well as monthly data on purchases and sales of long-term securities. It uses this data to estimate aggregate monthly holdings of long-term securities. The Treasury, however, has concluded that these estimates are costly and inaccurate. Consequently, the Treasury created Form SLT to ensure more timely and accurate measurement of cross-border holdings of long-term securities. The Treasury expects data from Form SLT reports to improve the preparation of the U.S. balance of payments accounts and the U.S. international investment position, as well as the formulation of U.S. international financial and monetary policies. The first reporting date was September 30, 2011, and the first report will be due on October 24, 2011. The determination of whether and what to report will prove burdensome for many potential reporters, in part because the scope of the report is quite broad. This article provides an overview of the reporting requirements under Form SLT.

Reporters

U.S.-resident custodians,4 which include U.S.-resident central securities depositories,5 U.S.-resident issuers,6 and U.S.-resident end-investors,7 must report if they have consolidated reportable securities with a total fair value equal to or greater than $1 billion on the last business day of a reporting period for that period and for each remaining period in that calendar year. The requirement to report for each remaining period in a calendar year will continue even if the total fair value of reportable securities subsequently drops below $1 billion. A reporter should include securities held for its own account and securities held for clients. A reporter must include reportable securities for all U.S.-resident subsidiaries and affiliates,8 as well as reportable securities for all U.S.-resident investment companies, trusts and other legal entities created by the reporter. The $1 billion reporting threshold only includes gross long positions, and short positions should not be netted. Reporters also should not reduce the value of their reportable securities by debt used to purchase those securities. Unfunded commitments to invest do not count towards the reporting threshold. Reporters must value their reportable securities in accordance with the fair value definition under Accounting Standards Codification 820. A U.S.-resident custodian should report fair value to the extent that it is available as part of the services it provides to its customers, even if the price available is for a date prior to the last business day of the reporting month. Investment managers should provide valuations to any U.S.-resident custodians that report on their behalf. If a reporter cannot provide fair values for positions in funds, it must submit an alternative valuation methodology for approval by the Federal Reserve Bank of New York. However, a reporter who receives permission to use an alternative valuation methodology will still have to submit a "back-test" that compares the value provided by the alternative methodology to the actual value. A reporter who is required to submit Form SLT may have reporting obligations in respect of certain other Treasury Forms, including: TIC Form B, TIC Form C, TIC Form D, TIC Form S, TIC Form SHL, TIC Form SHLA, TIC Form SHC, TIC Form SHCA, and the Treasury Foreign Currency Forms, none of which are discussed here.

— U.S.-resident Custodians

U.S.-resident custodians will be required to report in Part A all U.S. securities that they hold in custody, or manage the safekeeping of, for the account of foreign residents (including their own foreign branches, subsidiaries, and affiliates) and all foreign securities they hold in custody, or manage the safekeeping of, for the account of U.S. residents (including securities held for their own accounts). If a reporter is a U.S.-resident custodian and is also a U.S.-resident issuer or end-investor, the reporter will need to complete both Part A and Part B. A U.S.-resident entity that serves as custodian of foreign securities in which it is also the end-investor or issuer should report such securities in Part B. A U.S.-resident custodian will be required to report securities that it holds, even if the securities are transferred to a foreign sub-custodian. A U.S.-resident sub-custodian will only be required to report securities if it knows the identities of the actual owners of the securities. U.S.-resident central securities depositories will be required to report in Part A all U.S. securities they hold in custody, or manage the safekeeping of, directly on behalf of foreign residents with which they have established direct relationships, including foreign-resident brokers, dealers, exchanges, and central depositories.

— U.S.-resident Issuers

U.S.-resident issuers will be required to report in Part B all securities issued by the U.S.-resident parts of their organization directly to foreign residents, including: (1) registered securities that are owned by foreign residents, but only those securities for which neither a U.S.-resident custodian nor a U.S.-resident central depository is used (transfer or paying agents should be able to provide the U.S.-resident issuer this information); (2) book-entry securities that are held at a foreign-resident central securities depository; (3) bearer securities (which U.S-resident issuers should consider to be owned by foreign residents); and (4) shares or other units or other equity interests issued directly to or placed with foreign residents (e.g., a U.S.-based master fund issues shares to foreign feeder funds; limited partners' interests in limited partnerships). The determination of whether an issuer's securities are held by a U.S.-resident custodian depends on the party with whom the issuer has a contractual relationship. If an issuer has a contract or agreement with a U.S.-resident custodian, then the issuer does not need to report any securities that are held by that custodian, regardless of whether the U.S.-resident custodian transfers the securities to a foreign-resident custodian. In the case of complex relationships with international entities serving as custodian, the determination of who should be reporting will not always be clear.

— U.S.-resident End-investors

U.S.-resident end-investors will be required to report in Part B all investments in foreign securities for their own portfolio or for the portfolios of their U.S.-resident clients, but only those securities that are not held by U.S.-resident custodians. This includes securities that are held-for-trading, available-for-sale, held-for maturity, or which have been invested on behalf of others, such as by managers of mutual funds, insurance companies, and pension funds. If a U.S.-resident end-investor's foreign securities are held by a custodian who does not know the identities of the actual investors, then the end-investor will be required to report these securities. As with U.S.-resident issuers, the determination of whether securities are held by a U.S.-resident custodian depends on the party with whom a U.S.-resident end-investor has a contract or agreement.

Reportable Securities

Reportable securities are long-term securities held for portfolio investment purposes that are either issued by U.S. residents and owned by foreign residents or issued by foreign residents and owned by U.S. residents. Long-term securities have an original maturity of more than one year or no contractual maturity. Residency is generally determined by the country of legal residence (e.g., country of incorporation) of the issuer or beneficial owner of a security, subject to certain exceptions.9 A portfolio investment is any investment that is not a direct investment which is defined as ownership of at least ten percent of the voting securities of an incorporated business or the equivalent interest in an unincorporated business. The Final Instructions clarify that limited partner interests generally are not direct investments and that general partner interests are direct investments. Direct investment transactions and positions include equity interests and certain debt between affiliated entities. Although direct investments are not reportable on Form SLT, a reporter may have a separate obligation to report direct investments to the Bureau of Economic Analysis.

  • Reportable securities include: equities; equity interests in funds; long-term debt securities; and asset-backed securities.
  • Reportable equity interests include: common stock; preferred stock; restricted stock; depositary receipts/shares held by U.S. investors; equity interests in funds and equivalent investment vehicles; limited partnership interests and equity interests in other entities that do not issue shares or stock; and all other equity interests, including privately placed interests and interests in private equity companies and venture capital companies. All equity interests are considered to be long-term securities.
  • Reportable long-term debt securities include: debt, registered and bearer bonds and notes (unstripped and stripped) and bonds with multiple call options; convertible bonds and debt with attached warrants; zero-coupon debt and discount notes; index-linked securities (e.g., property index certificates); asset-backed securities; and floating rate notes, such as perpetual notes, variable rate notes, structured floating rate notes, reverse floating rate notes, collared floating rate notes, step up recovery floating rate notes, and range/corridor/accrual notes.

The following securities are not reportable on Form SLT: short-term securities (maturity of one calendar year or less); bankers' acceptances and trade acceptances; derivative contracts; rights and warrants; loans and loan participation certificates; letters of credit; precious metals; currencies held in a reporter's vaults for foreign residents; bank deposits, including time deposits; short-term and long-term negotiable certificates of deposit; demand deposits; annuities, including variable rate annuities; direct investments; securities taken in as collateral; securities received in repurchase/resale (reverse repurchase) agreements and securities lending agreements; and investments in real estate. For U.S.-issued securities owned by foreign residents, reporters will have to disclose the fair value of reportable securities by type of security, by residence of foreign holder, by type of foreign holder, and by type of U.S. issuer. For foreign-issued securities owned by U.S. residents, reporters will have to disclose the fair value of reportable securities by type of security, by residence of foreign issuer, and by type of U.S. holder.

Reporting Issues for Investment Advisers

U.S.-resident investment advisers may be required to report as custodians, issuers, and end-investors, depending on the fund structures they use and the securities they hold. A U.S.-resident investment adviser will have to report as a custodian if U.S. securities owned by foreign-resident clients or foreign securities owned by U.S.-resident clients are held with a custodian in an omnibus account in the adviser's name. A U.S.-resident investment adviser who establishes a U.S. master fund that issues interests to a foreign feeder fund or directly to foreign residents will have to report these fund interests as an issuer. Further, a U.S.-resident investment adviser who creates a foreign-based master fund that issues interests to a U.S.-based feeder fund will have to report these interests as foreign-issued securities held by a U.S.-resident end-investor. If a U.S.-resident investment adviser manages foreign securities for an unaffiliated U.S. client who is a natural person, the investment adviser should report these securities on behalf of its client as an end-investor. But if it is not clear whether a U.S.-resident investment manager or a U.S.-resident end-investor should report, such as if a U.S.-resident investment manager manages foreign securities for an unaffiliated U.S.-resident end-investor who is not a natural person, the Treasury has said in FAQs that the investment adviser or the end-investor should contact the Federal Reserve Bank of New York to determine who should report. A U.S.-resident investment adviser also will be required to disclose its U.S. funds' investments in foreign-issued securities as an end-investor. In all of the examples above, a U.S.-resident investment adviser will not have to report any securities that are held by a U.S.-resident custodian who knows the identities of the investors in the securities. A foreign-resident investment adviser who sets up a foreign-based master fund and a U.S.-based feeder fund will have to report any interests of the foreign-based master fund issued to the U.S.-based feeder fund as foreign-issued securities held by a U.S.-resident end-investor. Similarly, a foreign-resident investment adviser who sets up a U.S.-based master fund and a foreign-based feeder fund will be required to report any interests of the U.S.-based master fund that are issued to the foreign-based feeder fund. As with U.S.-resident investment advisers, a foreign-resident investment adviser will not have to report any securities that are held by a U.S.-resident custodian who knows the identities of the actual investors in the securities.

Consolidation Rules

For purposes of Form SLT, U.S.-resident entities are required to report for all of their subsidiaries, including their international banking facilities, except for foreign-resident offices and subsidiaries, in accordance with U.S. GAAP. They also are required to report for U.S.-resident affiliates and entities created, sponsored, or managed by the reporting entity that are not consolidated under U.S. GAAP. This includes: trusts; funds/commingled accounts; special purpose vehicles, special purpose entities, and variable interest entities; venture capital companies; and private equity companies. The top U.S. entity should report on behalf of all U.S.-resident entities within its organization. U.S.-resident investment advisers and managers should file one consolidated report of the holdings and issuances of all U.S.-resident entities that they advise or manage, unless unaffiliated U.S.-resident custodians hold the securities. A U.S.-resident entity should not consolidate pension funds for its employees or foundations or endowments set-up, sponsored, or funded by the entity. Such pension funds, foundations, or endowments should report separately if they meet the reporting threshold. If a U.S.-resident entity has set up pension funds for its employees or charitable foundations and it believes that these entities would meet the reporting criteria for Form SLT, the entity is obligated to notify these funds or foundations of their potential reporting responsibilities. At seminars on new Form SLT, the Federal Reserve Bank of New York has encouraged potential reporters to contact its personnel to discuss which entity in its organization structure should report.

Confidentiality

The Treasury, the Board of Governors of the Federal Reserve System, and the Federal Reserve Banks acting as fiscal agents of the Treasury will maintain the confidentiality of all information reported on Form SLT. Information may be given to other Federal agencies, as authorized by applicable law. Data from individual respondents will not be published or otherwise publicly disclosed. However, aggregate data from reports may be published or otherwise publicly disclosed in a manner that will not reveal the amounts reported by any individual respondent. Data from Form SLT reports will be used by the Board of Governors of the Federal Reserve, the Treasury, the U.S. Department of Commerce, the International Monetary Fund, private sector analysts, and academic researchers.

Timing and Submission of Reports

The requirements of Form SLT became effective as of September 30, 2011. In 2011, reporters will be required to submit quarterly data for September 30 and December 31 reporting dates. Beginning with the January 31, 2012 reporting date, reporters will have to submit reports monthly. Data on Form SLT must be reported as of the last business day of the reporting month and must be submitted no later than the twenty-third calendar day of the following month. Reporters that are banks, depository institutions, bank holding companies, or financial holding companies should file their reports with the Federal Reserve Bank of the District in which they are located, unless otherwise instructed by their District Federal Reserve Bank. All other reporters should file their reports with the Federal Reserve Bank of New York. Reporters will be able to submit their Form SLT reports electronically using the Federal Reserve's Internet Electronic Submission System. Reporters who must submit their forms to the Federal Reserve Bank of New York also may mail their reports directly to the Federal Reserve Bank of New York.

Penalties for Non-compliance

Failure to report can result in a civil penalty of not less than $2,500 and not more than $25,000. Willful failure to report can result in criminal prosecution and upon conviction a fine of not more than $10,000, and, if an individual, imprisonment for not more than one year, or both. Any officer, director, employee, or agent of any corporation who knowingly participates in such violation may, upon conviction, be punished by a like fine, imprisonment, or both. Anastasia T. Rockas is a partner in Skadden, Arps, Slate, Meagher & Flom LLP's Investment Management group, focusing her practice on private investment funds and private equity investments. Ms. Rockas' private investment fund practice comprises representing sponsors and investors in forming and investing in domestic and offshore funds. Ms. Rockas would like to acknowledge the assistance of Matthew B. Collin, an associate in Skadden's Investment Management group, with the preparation of this article.

Disclaimer
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
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