[Federal Register Volume 78, Number 100 (Thursday, May 23, 2013)]
[Proposed Rules]
[Pages 30968-31281]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-10835]
[[Page 30967]]
Vol. 78
Thursday,
No. 100
May 23, 2013
Part II
Securities and Exchange Commission
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17 CFR Parts 240, 242, and 249
Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation
SBSR and Certain Rules and Forms Relating to the Registration of
Security-Based Swap Dealers and Major Security-Based Swap Participants;
Proposed Rule
Federal Register / Vol. 78 , No. 100 / Thursday, May 23, 2013 /
Proposed Rules
[[Page 30968]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240, 242, and 249
[Release No. 34-69490; File Nos. S7-02-13; S7-34-10; S7-40-11]
RIN 3235-AL25
Cross-Border Security-Based Swap Activities; Re-Proposal of
Regulation SBSR and Certain Rules and Forms Relating to the
Registration of Security-Based Swap Dealers and Major Security-Based
Swap Participants
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rules; proposed interpretations.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is publishing for public comment proposed rules and
interpretive guidance to address the application of the provisions of
the Securities Exchange Act of 1934, as amended (``Exchange Act''),
that were added by Subtitle B of Title VII of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (``Dodd-Frank Act''), to
cross-border security-based swap activities. Our proposed rules and
interpretive guidance address the application of Subtitle B of Title
VII of the Dodd-Frank Act with respect to each of the major
registration categories covered by Title VII relating to market
intermediaries, participants, and infrastructures for security-based
swaps, and certain transaction-related requirements under Title VII in
connection with reporting and dissemination, clearing, and trade
execution for security-based swaps. In this connection, we are re-
proposing Regulation SBSR and certain rules and forms relating to the
registration of security-based swap dealers and major security-based
swap participants. The proposal also contains a proposed rule providing
an exception from the aggregation requirement, in the context of the
security-based swap dealer definition, for affiliated groups with a
registered security-based swap dealer. Moreover, the proposal addresses
the sharing of information and preservation of confidentiality with
respect to data collected and maintained by SDRs. In addition, the
Commission is proposing rules and interpretive guidance addressing the
policy and procedural framework under which the Commission would
consider permitting compliance with comparable regulatory requirements
in a foreign jurisdiction to substitute for compliance with
requirements of the Exchange Act, and the rules and regulations
thereunder, relating to security-based swaps (i.e., ``substituted
compliance''). Finally, the Commission is setting forth our view of the
scope of our authority, with respect to enforcement proceedings, under
Section 929P of the Dodd-Frank Act.
DATES: Submit comments on or before August 21, 2013.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
Send an email to [email protected]. Please include
File Number S7-02-13, and File Numbers S7-34-10 (Regulation SBSR) and/
or S7-40-11 (registration of security-based swap dealers and major
security-based swap participants), as applicable, on the subject line;
or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number S7-02-13, and File
Numbers S7-34-10 (Regulation SBSR) and/or S7-40-11 (registration of
security-based swap dealers and major security-based swap
participants), as applicable. This file number should be included on
the subject line if email is used. To help us process and review your
comments more efficiently, please use only one method. The Commission
will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments also are available for Web
site viewing and printing in the Commission's Public Reference Room,
100 F Street NE., Washington, DC 20549, on official business days
between the hours of 10:00 a.m. and 3:00 p.m. All comments received
will be posted without change; we do not edit personal identifying
information from submissions. You should submit only information that
you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Matthew A. Daigler, Senior Special
Counsel, at 202-551-5578, Wenchi Hu, Senior Special Counsel, at 202-
551-6268, Richard E. Grant, Special Counsel, at 202-551-5914, or
Richard Gabbert, Special Counsel, at 202-551-7814, Office of
Derivatives Policy, Division of Trading and Markets, regarding
security-based swap dealers and major security-based swap participants;
Jeffrey Mooney, Assistant Director, Matthew Landon, Senior Special
Counsel, or Stephanie Park, Special Counsel, Office of Clearance and
Settlement, Division of Trading and Markets, at 202-551-5710, regarding
security-based swap clearing agencies, security-based swap data
repositories, and the security-based swap clearing requirement; David
Michehl, Senior Counsel, Office of Market Supervision, Division of
Trading and Markets, at 202-551-5627, regarding security-based swap
reporting; Leah Mesfin, Special Counsel, at 202-551-5655, or Michael P.
Bradley, Special Counsel, at 202-551-5594, Office of Market
Supervision, Division of Trading and Markets, regarding the trade
execution requirement and swap execution facilities; Securities and
Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is proposing new rules and
interpretive guidance under the Exchange Act relating to the
application of Subtitle B of Title VII of the Dodd-Frank Act to cross-
border activities and re-proposing Regulation SBSR and certain rules
and forms relating to the registration of security-based swap dealers
and major security-based swap participants.
The Commission is proposing the following rules under the Exchange
Act: Rule 0-13 (Substituted Compliance Request Procedure); Rule 3a67-10
(Foreign Major Security-Based Swap Participants); Rule 3a71-3 (Cross-
Border Security-Based Swap Dealing Activity); Rule 3a71-4 (Exception
from Aggregation for Affiliated Groups with Registered Security-Based
Swap Dealers); Rule 3a71-5 (Substituted Compliance for Foreign
Security-Based Swap Dealers); Rule 3Ca-3 (Application of the Mandatory
Clearing Requirement to Cross-Border Security-Based Swap Transactions);
Rule 3Ch-1 (Application of the Mandatory Trade Execution Requirement to
Cross-Border Security-Based Swap Transactions); Rule 3Ch-2 (Substituted
Compliance for Mandatory Trade Execution); Rule 13n-4(d) (Exemption
from the Indemnification Requirement); Rule 13n-12 (Exemption from
Requirements Governing Security-Based Swap Data Repositories for
Certain Non-U.S. Persons); Rule 18a-4(e) (Segregation Requirements for
Foreign Security-Based Swap Dealers); and Rule 18a-4(f) (Segregation
Requirements for Foreign Major
[[Page 30969]]
Security-Based Swap Participants). The Commission also is re-proposing
the following rules and forms: 17 CFR 242.900-242.911 (Regulation SBSR)
(RIN 3235-AK80) and 17 CFR 249.1600 (Form SBSE), 249.1600a (Form SBSE-
A), and 249.1600b (Form SBSE-BD) (RIN 3235-AL05).
Table of Contents
I. Background
A. The Dodd-Frank Wall Street Reform and Consumer Protection Act
B. Overview of the Cross-Border Proposal
C. Consultation and Coordination
D. Substituted Compliance
E. Conclusion
II. Overview of the Security-Based Swap Market and the Legal and
Policy Principles Guiding the Commission's Approach to the
Application of Title VII to Cross-Border Activities
A. Overview of the Security-Based Swap Market
1. Global Nature of the Security-Based Swap Market
2. Dealing Structures
(a) U.S. Bank Dealer
(b) U.S. Non-Bank Dealer
(c) Foreign Subsidiary Guaranteed by a U.S. Person
(d) Foreign-Based Dealer
i. Direct Dealing
ii. Intermediation in the United States
3. Clearing Practices
4. Reporting Practices
5. Trade Execution Practices
6. Broad Economic Considerations of Cross-Border Security-Based
Swaps
(a) Major Economic Considerations
(b) Global Nature and Interconnectedness of the Security-Based
Swap Market
(c) Central Clearing
(d) Security-Based Swap Data Reporting
B. Scope of Title VII's Application to Cross-Border Security-
Based Swap Activity
1. Commenters' Views
2. Scope of Application of Title VII in the Cross-Border Context
(a) Overview and General Approach
(b) Territorial Approach to Application of Title VII Security-
Based Swap Dealer Registration Requirements
(c) Application of Other Title VII Requirements to Registered
Entities
(d) Application of Title VII Regulatory Requirements to
Transactions of Foreign Entities Receiving Guarantees From U.S.
Persons
(e) Regulations Necessary or Appropriate To Prevent Evasion of
Title VII
C. Principles Guiding Proposed Approach to Applying Title VII in
the Cross-Border Context
D. Conclusion
III. Security-Based Swap Dealers
A. Introduction
B. Registration Requirement
1. Introduction
2. Background Discussion Regarding the Registration of Foreign
Brokers and Dealers
3. Comment Summary
(a) Market Participants
(b) Foreign Regulators
4. Application of the De Minimis Exception to Cross-Border
Security-Based Swap Dealing Activity
(a) Meaning of the Term ``Person'' in the Security-Based Swap
Dealer Definition
(b) Proposed Rule
5. Proposed Definition of ``U.S. Person''
(a) Introduction
(b) Discussion
i. Natural Persons
ii. Corporations, Organizations, Trusts, and Other Legal Persons
iii. Accounts of U.S. Persons
iv. International Organizations
(c) Conclusion
6. Proposed Definition of ``Transaction Conducted Within the
United States''
7. Proposed Treatment of Transactions With Foreign Branches of
U.S. Banks
8. Proposed Rule Regarding Aggregation of Affiliate Positions
9. Treatment of Inter-Affiliate and Guaranteed Transactions
10. Comparison With Definition of ``U.S. Person'' in Regulation
S
C. Regulation of Security-Based Swap Dealers in Title VII
1. Introduction
2. Comment Summary
3. Title VII Requirements Applicable to Security-Based Swap
Dealers
(a) Transaction-Level Requirements
i. External Business Conduct Standards
ii. Segregation of Assets
(b) Entity-Level Requirements
i. Capital
ii. Margin
iii. Risk Management
iv. Recordkeeping and Reporting
v. Internal System and Controls
vi. Diligent Supervision
vii. Conflicts of Interest
viii. Chief Compliance Officer
ix. Inspection and Examination
x. Licensing Requirements and Statutory Disqualification
4. Application of Certain Transaction-Level Requirements
(a) Proposed Rule
(b) Discussion
i. External Business Conduct Standards
a. Foreign Security-Based Swap Dealers
b. U.S. Security-Based Swap Dealers
ii. Segregation Requirements
a. Foreign Security-Based Swap Dealers
b. Non-Cleared Security-Based Swaps
c. Cleared Security-Based Swaps
d. Disclosure
5. Application of Entity-Level Rules
(a) Introduction
(b) Proposed Approach
D. Intermediation
1. Introduction
2. Comment Summary
3. Discussion
E. Registration Application Re-Proposal
1. Introduction
2. Discussion
IV. Major Security-Based Swap Participants
A. Introduction
B. Comment Summary
C. Proposed Approach
1. In General
2. Guarantees
(a) Guarantees Provided by U.S. Persons to Non-U.S. Persons
(b) Guarantees Provided by Non-U.S. Persons to U.S. Persons and
Guarantees Provided by Non-U.S. Persons to Non-U.S. Persons
(c) Limited Circumstances Where Attribution of Guaranteed
Security-Based Swap Positions Does Not Apply
(d) Operational Compliance
3. Foreign Public Sector Financial Institutions (FPSFIs)
D. Title VII Requirements Applicable to Major Security-Based
Swap Participants
1. Transaction-Level Requirements Related to Customer Protection
(a) Overview
(b) Proposed Rules
2. Entity-Level Requirements
3. Substituted Compliance
V. Security-Based Swap Clearing Agencies
A. Introduction
B. Proposed Title VII Approach
1. Clearing Agency Registration
(a) Clearing Agencies Acting as CCPs
(b) Proposed Interpretive Guidance
2. Exemption From Registration Under Section 17A(k)
3. Application of Alternative Standards to Certain Registrants
VI. Security-Based Swap Data Repositories
A. Introduction
B. Application of the SDR Requirements in the Cross-Border
Context
1. Introduction
2. Comment Summary
3. Proposed Approach
(a) U.S. Persons Performing SDR Functions Are Required To
Register With the Commission
(b) Interpretive Guidance and Exemption for Non-U.S. Persons
That Perform the Functions of an SDR Within the United States
C. Relevant Authorities' Access to Security-Based Swap
Information and the Indemnification Requirement
1. Information Sharing Under Sections 21 and 24 of the Exchange
Act
2. Comment Summary
3. Proposed Guidance and Exemptive Relief
(a) Notification Requirement
(b) Determination of Appropriate Regulators
(c) Option for Exemptive Relief From the Indemnification
Requirement
i. Impact of the Indemnification Requirement
ii. Proposed Rule 13n-4(d): Indemnification Exemption
VII. Security-Based Swap Execution Facilities
A. Introduction
B. Registration of Foreign Security-Based Swap Markets
C. Registration Exemption for Foreign Security-Based Swap
Markets
VIII. Regulation SBSR--Regulatory Reporting and Public Dissemination
of Security-Based Swap Information
A. Background
B. Modifications to the Definition of ``U.S. Person''
C. Additional Modifications to Scope of Regulation SBSR
1. Revisions to Proposed Rule 908(a)
2. Revisions to Proposed Rule 908(b)
[[Page 30970]]
D. Modifications to ``Reporting Party'' Rules and Assigning Duty
To Report
E. Other Technical and Conforming Changes
F. Cross-Border Inter-Affiliate Transactions
G. Foreign Privacy Laws versus Duty To Report Counterparty ID
H. Foreign Public Sector Financial Institutions
I. Summary and Additional Request for Comment
IX. Mandatory Security-Based Swap Clearing Requirement
A. Introduction
B. Summary of Comments
C. Application of Title VII Mandatory Clearing Requirements to
Cross-Border Transactions
1. Statutory Framework
2. Proposed Rule
3. Discussion
(a) Security-Based Swap Transactions Involving U.S. Persons or
Non-U.S. Persons Receiving Guarantees From U.S. Persons
i. Proposed Rule
ii. Proposed Exception for Certain Transactions Involving
Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons
(b) Transactions Conducted Within the United States
i. Proposed Rule
ii. Proposed Exception for Transactions Conducted Within the
United States by Certain Non-U.S. Persons
X. Mandatory Security-Based Swap Trade Execution Requirement
A. Introduction
B. Application of the Mandatory Trade Execution Requirement to
Cross-Border Transactions
1. Statutory Framework
2. Proposed Rule
3. Discussion
(a) Security-Based Swap Transactions Involving U.S. Persons or
Non-U.S. Persons Receiving Guarantees From U.S. Persons
i. Proposed Rule
ii. Proposed Exception for Certain Transactions Involving
Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons
(b) Transactions Conducted Within the United States
i. Proposed Rule
ii. Proposed Exception for Transactions Conducted Within the
United States by Certain Non-U.S. Persons
XI. Substituted Compliance
A. Introduction
B. Process for Making Substituted Compliance Requests
C. Security-Based Swap Dealer Requirements
1. Proposed Rule--Commission Substituted Compliance
Determinations
2. Discussion
D. Regulatory Reporting and Public Dissemination
1. General
2. Security-Based Swaps Eligible and Not Eligible for
Substituted Compliance
3. Requests for Substituted Compliance
4. Findings Necessary for Substituted Compliance
5. Modification or Withdrawal of Substituted Compliance Order
6. Regulatory Reporting and Public Dissemination Considered
Together in the Commission's Analysis of Substituted Compliance
E. Clearing Requirement
F. Trade Execution Requirement
XII. Antifraud Authority
XIII. General Request for Comment
A. General Comments
B. Consistency With CFTC's Cross-Border Approach
XIV. Paperwork Reduction Act
A. Introduction
B. Re-Proposal of Form SBSE, Form SBSE-A, and Form SBSE-BD
1. Summary of Collection of Information
2. Proposed Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
(a) Paperwork Burden Associated With Filing Application Forms
(b) Paperwork Burden Associated With Amending Schedule F
(c) Paperwork Burden Associated With Amending Application Forms
5. Request for Comment on Paperwork Burden Estimates
C. Disclosures by Certain Foreign Security-Based Swap Dealers
and Major Security-Based Swap Participants
1. Summary of Collection of Information
2. Proposed Use of Information
3. Respondents
4. Total Initial and Annual Reporting Burdens
5. Request for Comment on Paperwork Burden Estimates
D. Reliance on Counterparty Representations Regarding Activity
Within the United States
1. Summary of Collection of Information
2. Proposed Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
5. Request for Comment on Paperwork Burden Estimates
E. Requests for Cross-Border Substituted Compliance
Determinations
1. Summary of Collection of Information
2. Proposed Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
(a) Proposed Rule 3a71-5
(b) Re-Proposed Rule 242.908(c)(2)(ii) of Regulation SBSR
(c) Proposed Rule 3Ch-2(c)
F. Reporting and Dissemination of Security-Based Swap
Information
1. Background on the Re-Proposed Rules
2. Modifications to ``Reporting Party'' Rules
(a) Summary of Collection of Information
(b) Proposed Use of Information
(c) Respondents
(d) Total Initial and Annual Reporting and Recordkeeping Burdens
i. Baseline Burdens
ii. Re-Proposed Burdens
iii. Summary of Re-Proposed Burdens
iv. Recordkeeping Requirements
(e) Collection of Information Is Mandatory
(f) Confidentiality
3. Rules 902, 905, 906, 907, and 909
(a) Rule 902
(b) Rule 905
(c) Rule 906
(d) Rule 907
(e) Rule 909
i. Impact of Re-Proposed Rules 902, 905, 906, 907, and 909 on
the Commission's PRA Analysis
4. Rules 900, 903, 908, 910, and 911
(a) Modification of the Definition of ``U.S. Person''
(b) Rule 903
(c) Re-Proposed Rules 908(a) and 908(b)
(d) Rule 910
(e) Rule 911
G. Request for Comments by the Commission and Director of OMB
XV. Economic Analysis
A. Introduction
B. Economic Baseline
1. Overview
2. Current Security-Based Swap Market
(a) Security-Based Swap Market Participants
(b) Levels of Security-Based Swap Trading Activity
(c) Market Participant Domiciles
(d) Level of Current Cross-Border Activity in Single-Name CDS
(e) Levels of Security-Based Swap Clearing
C. Analysis of Potential Effects on Efficiency, Competition, and
Capital Formation
1. Introduction
2. Competition
(a) Security-Based Swap Dealers
(b) Security-Based Swap Market Infrastructure Requirements
i. Registration of Clearing Agencies, SDRs and SB SEFs
ii. Application of Mandatory Clearing, Public Dissemination,
Regulatory Reporting, and Trade Execution Requirements in the Cross-
Border Context
3. Efficiency
4. Capital Formation
D. Economic Analysis of Proposed Rules Regarding ``Security-
Based Swap Dealers'' and ``Major Security-Based Swap Participants''
1. Programmatic Costs and Benefits
(a) Registration of Security-Based Swap Dealers and Major
Security-Based Swap Participants
(b) Security-Based Swap Dealers--De Minimis Exception
(c) Major Security-Based Swap Participants--``Substantial
Position'' and ``Substantial Counterparty Exposure'' Thresholds
2. Assessment Costs
(a) Security-Based Swap Dealers--De Minimis Exception
(b) Major Security-Based Swap Participants--``Substantial
Position'' and ``Substantial Counterparty Exposure'' Thresholds
3. Alternatives Considered
(a) De Minimis Exception
i. Alternatives to the Proposed Definition of U.S. Person
ii. Alternatives to the Proposed Rule Regarding Application of
the De Minimis Exception
[[Page 30971]]
a. Calculation of U.S. Persons' Transactions for De Minimis
Exception
b. Calculation of Non-U.S. Persons' Transactions for De Minimis
Exception (Including Transactions Conducted Within the United
States)
iii. Aggregation of Affiliate Dealing Activity
(b) Major Security-Based Swap Participants
E. Economic Analysis of the Proposed Application of the Entity-
Level and Transaction-Level Requirements to Security-Based Swap
Dealers and Major Security-Based Swap Participants
1. Entity-Level Requirements
2. Transaction-Level Requirements
(a) Proposed Rule 3a71-3(c)--Application of Customer Protection
Requirements
i. Programmatic Benefits and Costs
ii. Assessment Costs
iii. Alternatives
(b) Proposed Rule 18a-4(e)--Application of Segregation
Requirements
i. Programmatic Benefits and Costs
a. Pre-Dodd Frank Segregation Practice
b. Benefits of the Segregation Requirements
c. Costs of the Segregation Requirements
d. Costs and Benefits of Proposed Rules 18a-4(e)(1) and (2)
Regarding Application of Segregation Requirements to Foreign
Security-Based Swap Dealers
e. Costs and Benefits of Proposed Rule 18a-4(e)(3) Regarding
Disclosures
ii. Assessment Costs
F. Economic Analysis of Application of Rules Governing Security-
Based Swap Clearing in Cross-Border Context
1. Programmatic Benefits and Costs Associated With the Clearing
Agency Registration
(a) Proposed Interpretive Guidance Regarding Clearing Agency
Registration
(b) Proposed Exemption of Foreign Clearing Agency From
Registration
(c) Programmatic Effects of Alternative Standards
2. Programmatic Benefits and Costs Associated With the Mandatory
Clearing Requirement of Section 3C(a)(1) of the Exchange Act
(a) Programmatic Effects of the Mandatory Clearing Requirement
(b) Programmatic Benefits and Costs of the Mandatory Clearing
Requirement
3. Programmatic Benefits and Costs of Proposed Rule 3Ca-3
(a) Programmatic Effect of Proposed Rule 3Ca-3
(b) Programmatic Benefits and Costs of Proposed Rule 3Ca-3
(c) Alternatives
(d) Assessment Costs
G. The Economic Analysis of Application of Rules Governing
Security-Based Swap Trading in the Cross-Border Context
1. Programmatic Benefits and Costs of the Proposed Application
of the Registration Requirements of Section 3D of the Exchange Act
to Foreign Security-Based Swap Markets
(a) Programmatic Benefits
(b) Programmatic Costs
(c) Alternatives
2. Programmatic Benefits and Costs of the Potential Availability
of Exemptive Relief to Foreign Security-Based Swap Markets
(a) Programmatic Benefits
(b) Programmatic Costs
(c) Alternatives
(d) Assessment Costs
3. Programmatic Benefits and Costs Associated With the Mandatory
Trade Execution Requirement of Section 3C(h) of the Exchange Act
(a) Programmatic Effect of the Statutory Mandatory Trade
Execution Requirement
(b) Programmatic Benefits of the Statutory Mandatory Trade
Execution Requirement
(c) Programmatic Costs of the Statutory Mandatory Trade
Execution Requirement
4. Programmatic Benefits and Costs of Proposed Rule 3Ch-1
Regarding Application of the Mandatory Trade Execution Requirement
in Cross-Border Context
(a) Programmatic Effect of Proposed Rule 3Ch-1
(b) Programmatic Benefits and Costs of Proposed Rule 3Ch-1
H. Application of Rules Governing Security-Based Swap Data
Repositories in Cross-Border Context
1. Benefits and Costs Associated With Application of the SDR
Requirements in the Cross-Border Context
(a) Benefits of Proposed Approach to SDR Requirements
i. Programmatic Benefits of Proposed Guidance Regarding
Registration
ii. Programmatic Benefits of the SDR Exemption
(b) Costs of Proposed Approach to SDR Requirements
i. Programmatic Costs of the Commission's Proposed Approach
ii. Assessment Costs
(c) Alternative to Proposed Approach
2. Relevant Authorities' Access to Security-Based Swap
Information and the Indemnification Requirement
(a) Benefits and Costs of Relevant Authorities' Access to
Security-Based Swap Data Under the Dodd-Frank Act
i. Benefits of Relevant Authorities' Access to Security-Based
Swap Data
ii. Costs of Relevant Authorities' Access to Security-Based Swap
Data
(b) Benefits and Costs of Proposed Guidance and Exemptive Rule
i. Notification Requirement
ii. Determination of Appropriate Regulators
iii. Exemptive Relief From the Indemnification Requirement
(c) Alternatives to Proposed Guidance and Exemptive Relief
i. Notification Requirement
ii. Determination of Appropriate Regulators
iii. Exemptive Relief From the Indemnification Requirement
3. Economic Analysis of the Re-Proposal of Regulation SBSR
(a) Modifications to ``Reporting Party'' Rules and
Jurisdictional Reach of Regulation SBSR--Re-Proposed Rules 901(a)
and 908(a)
i. Initial Proposal
a. Programmatic Benefits of Initial Proposal
b. Programmatic Costs of Initial Proposal
ii. Re-Proposal
a. Programmatic Benefits
b. Programmatic Costs
(b) Proposed Modification of the Definition of ``U.S. Person''
(c) Revisions to Proposed Rule 908(b)
i. Initial Proposal
ii. Re-Proposal
a. Programmatic Benefits
b. Programmatic Costs
(d) Other Technical Revisions in Re-Proposed Regulation SBSR
(e) Aggregate Total Quantifiable Costs
I. Economic Analysis of Substituted Compliance
1. Programmatic Benefits and Costs
2. Alternatives
3. Assessment Costs
J. General Request for Comments
XVI. Consideration of Impact on the Economy
XVII. Regulatory Flexibility Act Certification
Statutory Basis and Text of Proposed Rules
Appendix A: Application of Subtitle B of Title VII in the Cross-
Border Context
Table I--Registered U.S. Security-Based Swap Dealers
Table II--Registered Non-U.S. Security-Based Swap Dealer with
U.S. Guarantee
Table III--Unregistered Non-U.S. Dealer (or Market Participant)
With U.S. Guarantee
Table IV--Registered Non-U.S. Security-Based Swap Dealer Without
U.S. Guarantee
Table V--Unregistered Non-U.S. Dealer (or Market Participant)
Without U.S. Guarantee
Appendix B: Registration of Security-Based Swap Dealers
Appendix C: Re-Proposal of Registration Forms
Appendix D: List of Commenters
I. Background
The global nature of the security-based swap market highlights the
critical importance of addressing the application of the Title VII of
the Dodd-Frank Act \1\ (``Title VII'') to cross-border activities.\2\
The Commission has received numerous inquiries and comments from market
participants, foreign regulators, and other interested parties
concerning how Title VII and the Commission's implementing regulations
thereunder will apply to the cross-border activities of U.S. and non-
U.S. market participants. To respond to these inquiries and comments,
the Commission is providing our preliminary views on the application of
Title VII to cross-border security-based swap activities \3\ and non-
U.S. persons
[[Page 30972]]
that act in capacities regulated under the Dodd-Frank Act in the
proposed rules and interpretations discussed below.
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\1\ The Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010).
\2\ Unless otherwise indicated, references to Title VII of the
Dodd-Frank Act in this release are to Subtitle B of Title VII.
\3\ Generally, in this release, the application of Title VII to
``cross-border activities'' refers to the application of Title VII
to a security-based swap transaction involving (i) A U.S. person and
a non-U.S. person, (ii) two non-U.S. persons where one or both are
located within the United States, or (iii) two non-U.S. persons
conducting a security-based swap transaction that otherwise occurs
in relevant part within the United States, including by negotiating
the terms of the security-based swap transaction within the United
States or where performance of one or both counterparties under the
security-based swap is guaranteed by a U.S. person.
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A. The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act was enacted, among other reasons, to promote the
financial stability of the United States by improving accountability
and transparency in the financial system.\4\ The 2008 financial crisis
highlighted significant issues in the over-the-counter (``OTC'')
derivatives markets, which have experienced dramatic growth in recent
years \5\ and are capable of affecting significant sectors of the U.S.
economy.\6\ Title VII of the Dodd-Frank Act provides for a
comprehensive new regulatory framework for swaps and security-based
swaps, including by: (i) Providing for the registration and
comprehensive regulation of swap dealers, security-based swap dealers,
major swap participants, and major security-based swap participants;
(ii) imposing clearing and trade execution requirements on swaps and
security-based swaps, subject to certain exceptions; (iii) creating
recordkeeping and real-time reporting regimes and public dissemination;
and (iv) enhancing the rulemaking and enforcement authorities of the
Commission and the Commodity Futures Trading Commission (``CFTC'').\7\
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\4\ The Dodd-Frank Act was enacted ``[t]o promote the financial
stability of the United States by improving accountability and
transparency in the financial system, to end `too big to fail', to
protect the American taxpayer by ending bailouts, to protect
consumers from abusive financial services practices, and for other
purposes.'' Public Law 111-203, Preamble.
\5\ From their beginnings in the early 1980s, the notional value
of these markets grew to approximately $650 trillion globally by the
end of 2011. See Bank for International Settlements, Statistical
Release: OTC Derivatives Statistics at End-December 2011 (May 2012)
at 1, available at: http://www.bis.org/publ/otc_hy1205.pdf.
\6\ See Section II.A.6(b), infra.
\7\ See Public Law 111-203 sections 701-774.
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Specifically, the Dodd-Frank Act provides that the CFTC will
regulate ``swaps,'' the Commission will regulate ``security-based
swaps,'' \8\ and both the CFTC and the Commission (together, the
``Commissions'') will regulate ``mixed swaps.'' \9\ Title VII also
amends the Exchange Act to include many specific provisions governing
security-based swaps that could apply to cross-border security-based
swap transactions and to non-U.S. persons who act in capacities
regulated under the Dodd-Frank Act.\10\ These provisions primarily
relate to Commission oversight of security-based swap dealers,\11\
major security-based
[[Page 30973]]
swap participants,\12\ security-based swap data repositories
(``SDRs''),\13\ security-based swap clearing agencies,\14\ security-
based swap execution facilities (``SB SEFs''),\15\ and mandatory
security-based swap reporting and dissemination,\16\ clearing,\17\ and
trade execution.\18\
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\8\ The definition of ``security'' in both the Exchange Act and
the Securities Act of 1933 (``Securities Act''), 15 U.S.C. 77a et
seq., was amended by the Dodd-Frank Act to include security-based
swaps. Public Law 111-203, Section 761(a)(2) (inserting ``security-
based swap'' after ``security future'' in Section 3(a)(10) of the
Exchange Act, 15 U.S.C. 78c(a)(10)) and Section 768(a)(1) (inserting
``security-based swap'' after ``security future'' in Section 2(a)(1)
of the Securities Act, 15 U.S.C. 77b(a)(1)). The revision of the
Exchange Act's definition of ``security'' raises, among other
things, issues related to the definition of ``broker'' in Section
3(a)(4) of the Exchange Act, 15 U.S.C. 78c(a)(4), the definition of
``dealer'' in Section 3(a)(5) of the Exchange Act, 15 U.S.C.
78c(a)(5), the exchange registration requirements in Sections 5 and
6 of the Exchange Act, 15 U.S.C. 78e and 78f, respectively, and the
requirement in Section 12 of the Exchange Act that securities be
registered before a transaction is effected on a national securities
exchange. See 15 U.S.C. 78l(a). The Securities Act requires that any
offer and sale of a security must either be registered under the
Securities Act (see Section 5 of the Securities Act, 15 U.S.C. 77e)
or made pursuant to an exemption from registration (see, e.g.,
Sections 3 and 4 of the Securities Act, 15 U.S.C. 77c and 77d,
respectively). In addition, the Securities Act requires that any
offer to sell, offer to buy or purchase or sell a security-based
swap to any person who is not an eligible contract participant
(``ECP'') must be registered under the Securities Act. See Section
5(e) of the Securities Act, 15 U.S.C. 77e(e). Because of the
statutory language of Section 5(e), exemptions from this requirement
in Sections 3 and 4 of the Securities Act are not available. This
release does not address the requirements under Section 5 of the
Securities Act.
The Commission adopted interim final rules that provide
exemptions from certain provisions of the Securities Act, the
Exchange Act, and the Trust Indenture Act of 1939 (``Trust Indenture
Act''), 15 U.S.C. 77aaa et seq., for those security-based swaps that
prior to July 16, 2011 were ``security-based swap agreements'' and
are defined as ``securities'' under the Securities Act and the
Exchange Act as of July 16, 2011 due solely to the provisions of
Title VII of the Dodd-Frank Act. See Exemptions for Security-Based
Swaps, Securities Act Release No. 9231 (July 1, 2011), 76 FR 40605
(July 11, 2011); see also Extension of Exemptions for Security-Based
Swaps, Securities Act Release No. 9383 (Jan. 29, 2013), 78 FR 7654
(Feb. 4, 2013). The Commission also issued temporary exemptions
under the Exchange Act regarding certain issues raised by the
inclusion of security-based swaps in the definition of ``security.''
See Order Extending Temporary Exemptions Under the Securities
Exchange Act of 1934 in Connection With the Revision of the
Definition of ``Security'' To Encompass Security-Based Swaps, and
Request for Comment, Exchange Act Release No. 68864 (Feb. 7, 2013),
78 FR 10218 (Feb. 13, 2013); see also Order Granting Temporary
Exemptions Under the Securities Exchange Act of 1934 in Connection
With the Pending Revision of the Definition of ``Security'' To
Encompass Security-Based Swaps, and Request for Comment, Exchange
Act Release No. 64795 (July 1, 2011) 76 FR 39927 (July 7, 2011).
\9\ In addition, the Dodd-Frank Act adds to the Commodity
Exchange Act (``CEA'') and Exchange Act definitions of the terms
``swap dealer,'' ``security-based swap dealer,'' ``major swap
participant,'' and ``major security-based swap participant,'' and
amends the CEA definition of the term ``eligible contract
participant.'' These terms are defined in Sections 721 and 761 of
the Dodd-Frank Act and, with respect to the term ``eligible contract
participant,'' in Section 1a(18) of the CEA, 7 U.S.C. 1a(18), as
redesignated and amended by Section 721 of the Dodd-Frank Act.
Section 712(d)(1) of the Dodd-Frank Act provides that the CFTC and
the Commission, in consultation with the Board of Governors of the
Federal Reserve System, shall jointly further define the terms
``swap,'' ``security-based swap,'' ``swap dealer,'' ``security-based
swap dealer,'' ``major swap participant,'' ``major security-based
swap participant,'' ``eligible contract participant,'' and
``security-based swap agreement.'' Further, Section 721(c) of the
Dodd-Frank Act requires the CFTC to adopt a rule to further define
the terms ``swap,'' ``swap dealer,'' ``major swap participant,'' and
``eligible contract participant,'' and Section 761(b)(3) of the
Dodd-Frank Act permits the Commission to adopt a rule to further
define the terms ``security-based swap,'' ``security-based swap
dealer,'' ``major security-based swap participant,'' and ``eligible
contract participant,'' with regard to security-based swaps, for the
purpose of including transactions and entities that have been
structured to evade Title VII or the amendments made by Title VII.
The Commission and the CFTC jointly adopted rules and
interpretive guidance further defining the terms ``swap,''
``security-based swap,'' and ``security-based swap agreement,'' and
regulations regarding mixed swaps. See Further Definition of
``Swap,'' ``Security-Based Swap,'' and ``Security-Based Swap
Agreement''; Mixed Swaps; Security-Based Swap Agreement
Recordkeeping, Exchange Act Release No. 67453 (July 18, 2012), 77 FR
48208 (Aug. 13, 2012) (``Product Definitions Adopting Release'').
The Commission and the CFTC also jointly adopted rules further
defining the terms ``swap dealer,'' ``security-based swap dealer,''
``major swap participant,'' ``major security-based swap
participant,'' and ``eligible contract participant.'' See Further
Definition of ``Swap Dealer,'' ``Security-Based Swap Dealer,''
``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' Exchange Act
Release No. 66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012)
(``Intermediary Definitions Adopting Release'').
\10\ The provisions of the Exchange Act relating to security-
based swaps that were enacted by Title VII also are referred to
herein as ``Title VII requirements'' or ``requirements in Title
VII.''
\11\ See Section 764(a) of the Dodd-Frank Act. The Commission,
jointly with the CFTC, adopted rules further defining the term
``security-based swap dealer.'' See Intermediary Definitions
Adopting Release, 77 FR 30596.
The Commission has proposed rules regarding the registration and
substantive requirements for security-based swap dealers and major
security-based swap participants. See Proposed Rules Governing
Capital, Margin, and Segregation Requirements for Security-Based
Swap Dealers and Major Security-Based Swap Participants and Capital
Requirements for Broker-Dealers, Exchange Act Release No. 68071
(Oct. 18, 2012) 77 FR 70214 (Nov. 23, 2012) (``Capital, Margin, and
Segregation Proposing Release''); Registration of Security-Based
Swap Dealers and Major Security-Based Swap Participants, Exchange
Act Release No. 65543 (Oct. 12, 2011) (RIN 3235-AL05), 76 FR 65784
(Oct. 24, 2011) (``Registration Proposing Release''); Business
Conduct Standards for Security-Based Swap Dealers and Major
Security-Based Swap Participants, Exchange Act Release No. 64766
(June 29, 2011), 76 FR 42396 (July 18, 2011) (``External Business
Conduct Standards Proposing Release''); and Trade Acknowledgment and
Verification of Security-Based Swap Transactions, Exchange Act
Release No. 63727 (Jan. 14, 2011), 76 FR 3859 (Jan. 21, 2011)
(``Trade Acknowledgment Proposing Release''). The Commission has not
yet proposed rules governing the recordkeeping, reporting, and
notification requirements for security-based swap dealers and major
security-based swap dealers pursuant to Section 15F(f) of the
Exchange Act, 15 U.S.C. 78o-10(f), as added by Section 764(a) of the
Dodd-Frank Act.
\12\ See Section 764(a) of the Dodd-Frank Act. The Commission,
jointly with the CFTC, adopted rules further defining the term
``major security-based swap participant.'' See Intermediary
Definitions Adopting Release, 77 FR 30596. In a number of releases,
the Commission also has proposed rules regarding the registration
and substantive requirements for major security-based swap
participants. See note 11, supra.
\13\ See Section 763(i) of the Dodd-Frank Act. The Commission
has proposed rules regarding the registration and regulation of
SDRs. See Security-Based Swap Data Repository Registration, Duties,
and Core Principles, Exchange Act Release No. 63347 (Nov. 19, 2010),
75 FR 77306 (Dec. 10, 2010), corrected at 75 FR 79320 (Dec. 20,
2010) and 76 FR 2287 (Jan. 13, 2011) (``SDR Proposing Release'').
\14\ See Section 763(b) of the Dodd-Frank Act. The Commission
adopted rules regarding the standards for risk management practices
and operations of registered clearing agencies, including security-
based swap clearing agencies. See Clearing Agency Standards,
Exchange Act Release No. 68080 (Oct. 22, 2012), 77 FR 66220 (Nov. 2,
2012) (``Clearing Agency Standards Adopting Release'').
\15\ See Section 763(c) of the Dodd-Frank Act. The Commission
has proposed rules regarding the registration and regulation of SB
SEFs. See Registration and Regulation of Security-Based Swap
Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011),
76 FR 10948 (Feb. 29, 2011) (``SB SEF Proposing Release'').
\16\ See Sections 763 and 766 of the Dodd-Frank Act. The
Commission has proposed rules on trade reporting, data elements, and
real-time public reporting for security-based swaps. See Regulation
SBSR--Reporting and Dissemination of Security-Based Swap
Information, Exchange Act Release No. 63346 (Nov. 19, 2010) (RIN
3235-AK80), 75 FR 75208 (Dec. 2, 2010) (``Regulation SBSR Proposing
Release'').
\17\ See Section 763(b) of the Dodd-Frank Act. The Commission
has proposed or adopted rules relating to the end-user clearing
exception and the process for submitting for review of security-
based swaps for mandatory clearing. See Process for Submissions for
Review of Security-Based Swaps for Mandatory Clearing and Notice
Filing Requirements for Clearing Agencies; Technical Amendments to
Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory
Organizations, Exchange Act Release No. 67286 (June 28, 2012), 77 FR
41602 (July 13, 2012) (``Clearing Procedures Adopting Release'');
End-User Exception to Mandatory Clearing of Security-Based Swaps
(Corrected), Exchange Act Release No. 63556 (Dec. 15, 2010), 75 FR
79992 (Dec. 21, 2010) (``End-User Exception Proposing Release'').
\18\ See Section 763(b) of the Dodd-Frank Act.
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B. Overview of the Cross-Border Proposal
With limited exceptions, the Commission has not proposed specific
provisions of rules or forms or provided guidance regarding the
application of Title VII to cross-border activities.\19\ Rather than
addressing these issues in a piecemeal fashion through the various
substantive rulemaking proposals implementing Title VII, the Commission
instead is addressing the application of Title VII to cross-border
activities holistically in a single proposing release.\20\ This
approach provides market participants, foreign regulators, and other
interested parties with an opportunity to consider, as an integrated
whole, the Commission's proposed approach to the application of Title
VII to cross-border security-based swap activities and non-U.S. persons
that act in capacities regulated under the Dodd-Frank Act.\21\
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\19\ The Commission has proposed a rule addressing the
application of the security-based swap trade reporting requirement
to cross-border transactions and to non-U.S. persons. See Regulation
SBSR Proposing Release, 75 FR 75239-40, as discussed in Section
VIII, infra. The Commission also has proposed rules imposing special
requirements on ``nonresident security-based swap dealers,''
``nonresident major security-based swap participants,'' ``non-
resident swap data repositories,'' and ``non-resident SB SEFs.'' See
Registration Proposing Release, 76 FR 65799-801, as discussed in
Section III.E, infra; SDR Proposing Release, 75 FR 77310, as
discussed in Section VI, infra; and SB SEF Proposing Release, 76 FR
11000-3, as discussed in Section VII, infra.
\20\ Tables reflecting the Commission's proposed approach as it
would apply to security-based swap transactions between different
types of entities are included in this release as Appendix A. Each
table focuses on a specific type of security-based swap dealing
entity or market participant and sets out the Title VII requirements
that would apply to such person under different transaction
scenarios.
\21\ Cf. CFTC Proposed Interpretive Guidance and Policy
Statement, Cross-Border Application of Certain Swaps Provisions of
the Commodity Exchange Act, 77 FR 41214 (July 12, 2012) (``CFTC
Cross-Border Proposal''); Exemptive Order Regarding Compliance with
Certain Swap Regulations, 77 FR 41110 (July 12, 2012) (``CFTC
Proposed Cross-Border Exemptive Order''); Final Exemptive Order
Regarding Compliance with Certain Swap Regulations, 78 FR 858 (Jan.
7, 2013) (``Final CFTC Cross-Border Exemptive Order''); Further
Proposed Guidance Regarding Compliance With Certain Swap
Regulations, 78 FR 909 (Jan. 7, 2013) (``CFTC Further Proposed
Guidance''). In Section XIII.B below, we solicit general comment on
the differences between our proposed approach and the CFTC's
proposed approach.
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After providing an overview of the security-based swap market, the
Commission's preliminary views on the scope of application of Title VII
to cross-border security-based swap activity, and the legal and policy
principles guiding the Commission's approach to the application of
Title VII to cross-border activities in Section II, we set forth our
proposed approach in the subsequent sections of the release.
In Sections III and IV, we propose rules and interpretive guidance
regarding the registration and regulation of security-based swap
dealers and major security-based swap participants, including the
treatment of foreign branches of U.S. banks and the provision of
guarantees in the cross-border context. In connection with this, we are
re-proposing the following rules and forms: 17 CFR 249.1600 (Form
SBSE), 249.1600a (Form SBSE-A), and 249.1600b (Form SBSE-BD).\22\
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\22\ See Registration Proposing Release, 76 FR 65784, as
discussed in Section III.E, infra.
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In Sections V-VII, we propose rules and interpretive guidance
regarding the registration of security-based swap clearing agencies,
SDRs, and SB SEFs, as well as discuss generally under what
circumstances the Commission would consider granting exemptions from
registration for these infrastructures. To facilitate relevant
authorities' access to security-based swap data collected and
maintained by Commission-registered SDRs, the Commission also is
proposing interpretive guidance to specify how SDRs may comply with the
notification requirement in the Exchange Act and specifying how the
Commission proposes to determine whether a relevant authority is
appropriate for purposes of receiving security-based swap data from an
SDR.\23\ In addition, the Commission is proposing a tailored exemption
from the indemnification requirement in the Exchange Act.\24\
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\23\ See Section VI.C, infra.
\24\ Id.
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In Sections VIII-X, we propose rules and interpretive guidance
regarding the application of Title VII to cross-border activities with
respect to certain transactional requirements in connection with
reporting and dissemination, clearing, and trade execution for
security-based swaps. As discussed further below, these requirements
apply to persons independent of their registration status. In
connection with this, we are re-proposing the following rules: 17 CFR
242.900-242.911 (Regulation SBSR).\25\
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\25\ See Regulation SBSR Proposing Release, 75 FR 75208, as
discussed in Section VIII, infra.
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In Section XI, we set forth a proposed policy and procedural
framework under which we would consider permitting compliance with
comparable regulatory requirements in a foreign jurisdiction to
substitute for compliance with certain requirements of the Exchange
Act, and the rules and regulations thereunder, relating to security-
based swaps (i.e., ``substituted compliance'').\26\ Generally speaking,
the Commission is proposing a policy and procedural framework that
would allow for the possibility of substituted compliance in
recognition of
[[Page 30974]]
the potential, in a market as global as the security-based swap market,
for market participants who engage in cross-border security-based swap
activity to be subject to conflicting or duplicative compliance
obligations.\27\ In addition, the Commission is proposing a rule that
would set forth procedures for requesting a substituted compliance
determination.
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\26\ See Section XI, infra. As discussed in Section XI, in
permitting substituted compliance, the Commission might use
different procedural approaches depending on the different
substantive requirements that are the subject of the substituted
compliance determinations. See also note 27, infra.
\27\ Separately, in Sections V-VII below, the Commission also
discusses generally when we would consider exempting non-resident
security-based swap clearing agencies and SB SEFs that are subject
to comparable, comprehensive supervision and regulation in their
home countries, and certain SDRs that are non-U.S. persons, from
certain obligations under the Exchange Act, including the
requirement to register.
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In Section XII, the Commission sets forth our view of the scope of
our authority, with respect to enforcement proceedings, under Section
929P of the Dodd-Frank Act.\28\ Section XIII sets forth a general
request for comment, including request for comment on the consistency
of our proposed approach with the CFTC's proposed approach to applying
the provisions of the CEA that were enacted by Title VII in the cross-
border context.
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\28\ The rules, forms, and interpretive guidance proposed herein
and discussed in Sections II-XI below relate solely to the
applicability of the registration (and the attendant substantive
regulation) and reporting and dissemination, clearing, and trade
execution requirements in Title VII, and are not intended to limit
or address the cross-border reach or extraterritorial application of
the antifraud or other provisions of the federal securities laws.
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Finally, in Section XIV, the Commission addresses the Paperwork
Reduction Act, and Section XV provides an economic analysis of the
proposed approach, including a discussion of the associated costs and
benefits of the proposals discussed in Sections III-XI, as well as a
discussion of issues related to efficiency, competition, and capital
formation.
Because this release is directly related to security-based swap
data reporting and dissemination, clearing, and trade execution, as
well as the regulation of various persons required to register as a
result of amendments made to the Exchange Act by Title VII, we
anticipate that some of the rules, forms, and interpretive guidance
proposed herein, and comments received thereon, will be addressed in
the adopting releases relating to the impacted substantive rules. In
some areas, we may decide to address comments received on the proposals
contained in this release by adopting rules in a separate
rulemaking.\29\
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\29\ The Commission is not addressing in this release issues
relating to compliance dates of final rules adopted pursuant to
amendments made to the Exchange Act by Title VII. Compliance issues,
including compliance dates, will be addressed in connection with the
various Title VII final rules. See Statement of General Policy on
the Sequencing of the Compliance Dates for Final Rules Applicable to
Security-Based Swaps Adopted Pursuant to the Securities Exchange Act
of 1934 and the Dodd-Frank Wall Street Reform and Consumer
Protection Act, Exchange Act Release No. 67177 (June 11, 2012), 77
FR 35625 (June 14, 2012) (``Implementation Policy Statement''). See
also Reopening of Comment Periods for Certain Rulemaking Releases
and Policy Statement Applicable to Security-Based Swaps Proposed
Pursuant to the Securities Exchange Act of 1934 and the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Exchange Act Release
No. 34-69491 (May 1, 2013).
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C. Consultation and Coordination
As discussed more fully below, a number of market participants,
foreign regulators, and other interested parties have already provided
their views on the application of Title VII to cross-border activities
through both written comment letters to the Commission and/or the CFTC
and meetings with Commissioners and Commission staff.\30\ The
Commission has taken the commenters' views expressed thus far into
consideration in developing these proposed rules, forms, and
interpretive guidance.\31\ In addition, in developing this proposal,
the Commission has, in compliance with Sections 712(a)(2)\32\ and
752(a)\33\ of the Dodd-Frank Act, consulted and coordinated with the
CFTC, the prudential regulators,\34\ and foreign regulatory
authorities.
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\30\ The views expressed in comment letters and meetings are
collectively referred to as the views of ``commenters.'' See
Appendix D for a list of commenters referred to in this release and
the location of their comment letters on the Commission's (or the
CFTC's) Web site.
\31\ In addition, the Commission and the CFTC held a joint
public roundtable regarding the application of Title VII to cross-
border activities. See Joint Public Roundtable on International
Issues Relating to the Implementation of Title VII of the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Exchange Act Release
No. 64939 (July 21, 2011), 76 FR 44507 (July 26, 2011).
\32\ Section 712(a)(2) of the Dodd-Frank Act states, in part,
that ``the Securities and Exchange Commission shall consult and
coordinate to the extent possible with the Commodity Futures Trading
Commission and the prudential regulators for the purposes of
assuring regulatory consistency and comparability, to the extent
possible.''
\33\ Section 752(a) of the Dodd-Frank Act states, in part, that
``[i]n order to promote effective and consistent global regulation
of swaps and security-based swaps, the Commodity Futures Trading
Commission, the Securities and Exchange Commission, and the
prudential regulators (as that term is defined in Section 1a(39) of
the Commodity Exchange Act), as appropriate, shall consult and
coordinate with foreign regulatory authorities on the establishment
of consistent international standards with respect to the regulation
(including fees) of swaps.''
\34\ The term ``prudential regulator'' is defined in Section
1a(39) of the CEA, 7 U.S.C. 1a(39), and that definition is
incorporated by reference in Section 3(a)(74) of the Exchange Act,
15 U.S.C. 78c(a)(74). Pursuant to the definition, the Board of
Governors of the Federal Reserve System (``Federal Reserve Board''),
the Office of the Comptroller of the Currency, the Federal Deposit
Insurance Corporation, the Farm Credit Administration, or the
Federal Housing Finance Agency (collectively, the ``prudential
regulators'') is the ``prudential regulator'' of a security-based
swap dealer if the entity is directly supervised by that agency.
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Efforts to regulate the swaps market are underway not only in the
United States but also abroad. In 2009, leaders of the Group of 20
(``G20'')--whose membership includes the United States, 18 other
countries, and the European Union (``EU'')--called for global
improvements in the functioning, transparency, and regulatory oversight
of OTC derivatives markets. Specifically, the G20 leaders declared
that:
[a]ll standardised OTC derivative contracts should be traded on
exchanges or electronic trading platforms, where appropriate, and
cleared through central counterparties by end-2012 at the latest.
OTC derivative contracts should be reported to trade repositories.
Non-centrally cleared contracts should be subject to higher capital
requirements. We ask the [Financial Stability Board] and its
relevant members to assess regularly implementation and whether it
is sufficient to improve transparency in the derivatives markets,
mitigate systemic risk and protect against market abuse.\35\
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\35\ G20 Meeting, Pittsburgh, United States, September 25, 2009,
available at: http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
In subsequent summits, the G20 leaders have reiterated their commitment
to OTC derivatives regulatory reform.\36\ The Commission has
participated in numerous bilateral and multilateral discussions with
foreign regulatory authorities addressing the regulation of OTC
derivatives.\37\ Through these
[[Page 30975]]
discussions and our participation in various international task forces
and working groups,\38\ we have gathered information about foreign
regulatory reform efforts and have discussed the possibility of
conflicts and gaps, as well as inconsistencies and duplications,
between U.S. and foreign regulatory regimes. We have taken these
discussions into consideration in developing these proposed rules,
forms, and interpretations.
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\36\ For example, on June 18-19, 2012, the leaders of the G20
convened in Los Cabos, Mexico, and reaffirmed their commitments with
respect to the regulation of the OTC derivatives markets. See the
G20 Leaders Declaration (June 2012), para. 39, available at: http://www.g20.org/documents/.
\37\ Senior representatives of OTC derivatives market regulators
from G20 jurisdictions have met on a number of occasions to discuss
international coordination of OTC derivatives regulations. See,
e.g., Joint Press Statement of Leaders on Operating Principles and
Areas of Exploration in the Regulation of the Cross-Border OTC
Derivatives Market (Dec. 4, 2012), available at: http://www.sec.gov/news/press/2012/2012-251.htm; Joint Statement on Regulation of OTC
Derivatives Markets (May 7, 2012), available at: http://www.sec.gov/news/press/2012/2012-85.htm; and Joint Statement on Regulation of
OTC Derivatives Markets (Dec. 9, 2011), available at: http://www.sec.gov/news/press/2011/2011-260.htm . See also Financial
Stability Board (``FSB''), OTC Derivatives Market Reforms, Fifth
Progress Report on Implementation (April 15, 2013) (``FSB Progress
Report April 2013''), at 47, available at: http://www.financialstabilityboard.org/publications/r_130415.pdf (noting
that SEC staff has regularly consulted its counterparts in other
jurisdictions to discuss and compare approaches to the application
of Title VII of the Dodd-Frank Act in cross-border contexts); FSB
Progress Report April 2013 at 5 and 45-46 (discussing meetings of
the group of market regulators ``to identify and explore ways to
address issues and uncertainties in the application of rules in a
cross-border context, including options to address identified
conflicts, inconsistencies, and duplication.'').
\38\ The Commission participates in the FSB's Working Group on
OTC Derivatives Regulation (``ODWG''), both on its own behalf and as
the representative of the International Organization of Securities
Commissions (``IOSCO''), which is co-chair of the ODWG. The
Commission also serves as one of the co-chairs of the IOSCO Task
Force on OTC Derivatives Regulation.
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In addition, the Commission and the CFTC have conducted staff
studies to assess developments in OTC derivatives regulation abroad. As
directed by Congress in Section 719(c) of the Dodd-Frank Act, on
January 31, 2012, the Commission and the CFTC jointly submitted to
Congress a ``Joint Report on International Swap Regulation'' (``Swap
Report'').\39\ The Swap Report discussed swap and security-based swap
regulation and clearinghouse regulation in the Americas, Asia, and the
European Union, and identified similarities and differences in
jurisdictions' approaches to areas of regulation, as well as other
areas of regulation that could be harmonized. The Swap Report also
identified major clearinghouses, clearing members, and regulators in
each geographic area and described the major contracts (including
clearing volumes and notional values), methods for clearing swaps, and
the systems used for setting margin in each geographic area.\40\
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\39\ See CFTC and SEC, Joint Report on International Swap
Regulation (Jan. 31, 2012), available at: http://www.sec.gov/news/studies/2012/sec-cftc-intlswapreg.pdf.
\40\ In addition, Commission and CFTC staff submitted a joint
study to Congress on the feasibility of requiring the derivatives
industry to adopt standardized computer-readable algorithmic
descriptions which may be used to describe complex and standardized
financial derivatives. See Joint Study on the Feasibility of
Mandating Algorithmic Descriptions for Derivatives: A Study by the
Staff of the Securities and Exchange Commission and the Commodity
Futures Trading Commission as Required by Section 719(c) of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (Apr. 7,
2011), available at: http://www.sec.gov/news/studies/2011/719b-study.pdf. In preparing this report, Commission and CFTC staff
coordinated extensively with international financial institutions
and foreign regulators.
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D. Substituted Compliance
As noted above, we recognize the potential, in a market as global
as the security-based swap market, that market participants who engage
in cross-border security-based swap activity may be subject to
conflicting or duplicative compliance obligations. To address this
possibility, we are proposing a ``substituted compliance'' framework
under which we would consider permitting compliance with requirements
in a foreign\41\ regulatory system to substitute for compliance with
certain requirements of the Exchange Act relating to security-based
swaps, provided that the corresponding requirements in the foreign
regulatory system are comparable to the relevant provisions of the
Exchange Act.\42\ The availability of substituted compliance should
reduce the likelihood that market participants would be subject to
potentially conflicting or duplicative sets of rules.
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\41\ In this release, the term ``foreign'' is used
interchangeably with the term ``non-U.S.'' See, e.g., note 372,
infra (discussing the definition of ``foreign security-based swap
dealer'').
\42\ See Section XI, infra.
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As discussed more fully below, the Commission would perform
comparability analysis and make substituted compliance determinations
with respect to four separate categories of requirements.\43\ If, for
example, a foreign regulatory system achieves comparable regulatory
outcomes in three out of the four categories, then the Commission would
permit substituted compliance with respect to those three categories of
comparable requirements, but not for the one, non-comparable category
for which comparable regulatory outcomes are not achieved. In other
words, we are not proposing an ``all-or-nothing'' approach. In
addition, in making comparability determinations within each category
of requirements, the Commission is proposing to take a holistic
approach; that is, we would ultimately focus on regulatory outcomes
rather than a rule-by-rule comparison. Substituted compliance therefore
should accept differences between regulatory regimes when those
differences nevertheless accomplish comparable regulatory outcomes.
---------------------------------------------------------------------------
\43\ Specifically, the Commission is proposing to make
substituted compliance determinations with respect to the following
categories of requirements: (i) Requirements applicable to
registered security-based swap dealers in Section 15F of the
Exchange Act and the rules and regulations thereunder; (ii)
requirements relating to regulatory reporting and public
dissemination of security-based swaps; (iii) requirements relating
to clearing for security-based swaps; and (iv) requirements relating
to trade execution for security-based swaps. See Section XI, infra.
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E. Conclusion
In proposing these rules, forms, and interpretations, the
Commission is mindful that the security-based swap market is global in
nature and developed prior to the enactment of the Dodd-Frank Act.\44\
There are challenges involved in imposing a comprehensive regulatory
regime on existing markets, particularly ones that have not been
subject to the particular regulation that the Dodd-Frank Act provides.
Any rules and interpretive guidance we adopt governing the application
of Title VII to cross-border activities could significantly affect the
global security-based swap market. As discussed further below, to the
extent practicable and consistent with our statutory mandate,\45\ the
Commission has proposed these rules and interpretations with the intent
to achieve the regulatory benefits intended by the Dodd-Frank Act and
to facilitate a well-functioning global security-based swap market,
including by taking into account the impact these proposed rules and
interpretations will have on counterparty protection, transparency,
systemic risk, liquidity, efficiency, and competition in the market. In
addition, the Commission is mindful of the fact that the application of
Title VII to cross-border activities raises issues of potential
conflict or overlap with foreign regulatory regimes. Furthermore, the
Commission is attentive to the fact that a number of registrants may be
registered with both us and the CFTC.\46\
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\44\ See Section II, infra.
\45\ See Section II.C, infra (discussing the principles guiding
proposed approach to applying Title VII in the cross-border
context).
\46\ All references in this release to an entity that is
``registered'' indicate an entity that is registered with the
Commission, unless otherwise indicated.
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The rules and interpretations proposed today represent the
Commission's preliminary views regarding the application of Title VII
to cross-border security-based swap activities and to non-U.S. persons
who act in capacities regulated under the Dodd-Frank Act. We note that
these proposed rules and interpretations are tailored to the unique
circumstances of the security-based swap market, and as such would not
necessarily be appropriate to apply to the Commission's regulation of
traditional securities markets. We also recognize that there are a
number of possible alternative approaches to applying Title VII in the
cross-border context. Accordingly, the Commission invites public
comment regarding all aspects of
[[Page 30976]]
the proposed approach, including each proposed rule and interpretation
contained herein, and potential alternative approaches. In particular,
data and comment from market participants and other interested parties
with respect to the likely effect of each proposed rule and
interpretation regarding application of a specific Title VII
requirement, and the effect of such proposed application in the
aggregate, will be particularly useful to the Commission in evaluating
possible modifications to the proposal and understanding the
consequences of the substantive rules that have not yet been adopted
under Title VII.
II. Overview of the Security-Based Swap Market and the Legal and Policy
Principles Guiding the Commission's Approach to the Application of
Title VII to Cross-Border Activities
In this section, the Commission provides a general overview of the
security-based swap market that informs our proposed implementation of
Title VII, including a description of the various dealing structures
used by U.S.-based and foreign-based entities to conduct their
security-based swap businesses, and existing clearing, reporting, and
trade execution practices. We also discuss the Commission's preliminary
views on the scope of application of Title VII and the principles
guiding our proposed approach to applying Title VII in the cross-border
context.
A. Overview of the Security-Based Swap Market
1. Global Nature of the Security-Based Swap Market
The security-based swap market is a global market.\47\ Security-
based swap business currently takes place across national borders, with
agreements negotiated and executed between counterparties often in
different jurisdictions (and at times booked and risk-managed in still
other jurisdictions).\48\
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\47\ See, e.g., IIB Letter at 1 (noting the ``truly global
nature of the OTC derivatives market''); Cleary Letter IV at 2
(noting that swaps and security-based swaps trade in a ``unique
global market''); Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter II at 2 (noting the ``global nature of the derivatives
business''); see also Bank of International Settlements (``BIS''),
Committee on the Global Financial System, No. 46, The macro
financial implications of alternative configurations for access to
central counterparties in OTC derivatives markets (Nov. 2011) at 1,
available at: http://www.bis.org/publ/cgfs46.pdf (referring to the
``globalized nature of the market, in which a significant proportion
of OTC derivatives trading is undertaken across borders'').
\48\ See, e.g., SIFMA Letter I at 2.
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The global nature of the security-based swap market is evidenced by
the data available to the Commission.\49\ Based on market data in the
Depository Trust and Clearing Corporation's Trade Information Warehouse
(``DTCC-TIW''),\50\ viewed from the perspective of the domiciles of the
counterparties booking credit default swap (``CDS'') transactions,
approximately 49% of U.S. single-name CDS transactions in 2011 were
cross-border transactions between a U.S.-domiciled \51\ counterparty
and a foreign-domiciled counterparty \52\ and an additional 44% of such
CDS transactions were between two foreign-domiciled counterparties.\53\
Thus, approximately 7% of the U.S. single-name CDS transactions in 2011
were between two U.S.-domiciled counterparties.\54\ These statistics
indicate that cross-border transactions are the norm, not the
exception, in the security-based swap market.\55\ Accordingly, the
question of how the Commission is implementing Title VII with respect
to security-based swaps will, to a large extent, be affected by how the
Commission applies Title VII to the cross-border transactions that are
the majority of security-based swaps.
---------------------------------------------------------------------------
\49\ See Section XV.B, infra (discussing in detail the global
nature of the security-based swap market).
\50\ The information was made available to the Commission in
accordance with the agreement between DTCC-TIW and the OTC
Derivatives Regulatory Forum (``ODRF'').
\51\ The domicile classifications in DTCC-TIW are based on the
market participants' own reporting and may not have been verified.
Prior to enactment of the Dodd-Frank Act, funds and accounts did not
formally report their domicile to DTCC-TIW because there was no
systematic requirement to do so. After enactment of the Dodd-Frank
Act, the DTCC-TIW has collected the registered office location of
the account or fund. This information is self-reported on a
voluntary basis. It is possible that some market participants may
misclassify their domicile status because the databases in DTCC-TIW
do not assign a unique legal entity identifier to each separate
entity. Notwithstanding this limitation, we believe that the cross-
border and foreign activity presented in the analysis by the
Commission's Division of Risk, Strategy, and Financial Innovation
demonstrates the nature of the CDS market. See Section XV.B.2.c,
infra.
\52\ DTCC-TIW classified a foreign branch or foreign subsidiary
of a U.S. domiciled entity as foreign-domiciled. Therefore, CDS
transactions with a foreign-domiciled counterparty include CDS
transactions with a foreign branch or foreign subsidiary of a U.S.-
domiciled entity as counterparty.
\53\ Put another way, in 2011, a vast majority (approximately
93%) of U.S. single-name CDS transactions directly involved at least
one foreign-domiciled counterparty. This observation is based on the
data compiled by the Commission's Division of Risk, Strategy, and
Financial Innovation on single-name CDS transactions with U.S.
reference entities from the DTCC-TIW between January 1, 2011, and
December 31, 2011. See Section XV.B.2.d, infra.
\54\ Id.
\55\ We note, however, that, in addition to classifying
transactions between a U.S. counterparty and a foreign branch of a
U.S. bank as a cross-border transaction (see note 51, supra), these
statistics characterize as cross-border transactions those in which
all or substantially all of the activity takes place in the United
States and all or much of the risk of the transactions ultimately is
borne by U.S. persons.
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2. Dealing Structures
Dealers use a variety of business models and legal structures to
conduct security-based swap dealing business \56\ with counterparties
in jurisdictions all around the world.\57\ Commenters have indicated
that both U.S.-based and foreign-based entities use certain dealing
structures for a variety of legal, tax, strategic, and business reasons
that often pre-date the enactment of the Dodd-Frank Act.\58\ Among the
reasons cited for the variety of dealing structures is the desire of
counterparties to reduce risk and enhance credit protection based on
the particular characteristics of each entity's business.\59\
---------------------------------------------------------------------------
\56\ As used in this release, ``security-based swap dealing,''
``security-based swap dealing activity,'' ``dealing activity,'' and
related concepts have the meaning described in the Intermediary
Definitions Adopting Release, 77 FR 30596, unless otherwise
indicated in this release.
\57\ See, e.g., Cleary Letter IV at 5; Davis Polk Letter I at 2-
3; IIB Letter at 7.
\58\ See, e.g., Cleary Letter at 3.
\59\ See, e.g., SIFMA Letter at 2.
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In this subsection, we describe certain dealing structures that
U.S.-based entities and foreign-based entities in the security-based
swap market might use. In each of these dealing structures, because the
booking entity is the counterparty to the security-based swap
transaction resulting from the dealing activity (i.e., the principal)
and bears the ongoing risk of performance on the transaction, we view
the booking entity, and not the intermediary that acts as an agent on
behalf of the booking entity to originate the transaction, as the
dealing entity.\60\
---------------------------------------------------------------------------
\60\ See Intermediary Definitions Adopting Release, 77 FR 30617
n.264 (``A sales force, however, is not a prerequisite to a person
being a security-based swap dealer. For example, a person that
enters into security-based swaps in a dealing capacity can fall
within the dealer definition even if it uses an affiliated entity to
market and/or negotiate those security-based swaps (e.g., the person
is a booking entity).''). See also Section III.D, infra.
---------------------------------------------------------------------------
(a) U.S. Bank Dealer
A U.S. bank holding company may use a U.S. subsidiary that is a
banking entity to deal directly with U.S. and foreign counterparties.
Such U.S. bank dealer may use a sales force in its U.S. home office to
originate security-based swap transactions in the United States and use
separate sales force in foreign branches to originate security-based
swap transactions with counterparties in foreign local markets.\61\ The
resulting security-based swap transactions may be
[[Page 30977]]
booked in the home office of the U.S. bank or in a foreign branch of
the bank.\62\
---------------------------------------------------------------------------
\61\ See Sullivan & Cromwell Letter at 2.
\62\ See id. at 3-4.
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(b) U.S. Non-bank Dealer
A U.S.-based holding company may use a non-bank subsidiary to
conduct security-based swap dealing activity in the U.S. market and
foreign local markets. The U.S. non-bank dealer may act as principal to
originate and book transactions in the United States and use a sales
force in the foreign local markets (e.g., salespersons employed by its
foreign affiliate) as agent to originate transactions on its behalf,
and then centrally book the resulting transactions in the U.S. non-bank
dealer. In some situations, such as where the holding company has rated
debt, but the U.S. non-bank dealer does not, the U.S. non-bank dealer's
performance under security-based swaps may be supported by a parental
guarantee provided by the holding company.\63\ The guarantee would
typically give counterparties to the U.S. non-bank dealer direct
recourse to the holding company for obligations owed by such non-bank
dealer under the security-based swaps as though the guarantor had
entered into the transactions directly with the counterparties.\64\
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\63\ See Cleary Letter IV at 10 (discussing a U.S. holding
company providing a guarantee of performance on the obligations of
its foreign swap dealing subsidiary).
\64\ See Intermediary Definitions Adopting Release, 77 FR 30689.
See also Product Definitions Adopting Release, 77 FR 48227 (stating
that the Commission would consider issues involving cross-border
guarantees of security-based swaps in a separate release addressing
the application of Title VII in the cross-border context).
---------------------------------------------------------------------------
(c) Foreign Subsidiary Guaranteed by a U.S. Person
A U.S.-based holding company also may conduct dealing activity in
both U.S. markets and foreign markets out of a foreign subsidiary.\65\
The foreign subsidiary may use a sales force in the United States
(e.g., salespersons employed by its U.S. affiliate) to originate
security-based swap transactions with counterparties in the U.S.
markets, or may directly solicit, negotiate, and execute security-based
swap transactions with counterparties in the U.S. markets from outside
the United States, and centrally book the resulting transactions
itself. The foreign subsidiary also may conduct security-based swap
dealing activity in various foreign markets using local salespersons as
agent to originate and centrally book the resulting security-based swap
transactions itself. In some situations, such as where the U.S.-based
holding company has rated debt, but the foreign subsidiary does not,
the foreign subsidiary's performance under security-based swaps may be
supported by a parental guarantee provided by the holding company.\66\
Such guarantee would typically give its counterparty direct recourse to
the U.S. parent acting as guarantor for obligations owed by such
foreign subsidiary under the security-based swaps. As a result, a
guarantee provided by a U.S. person of another person's obligations
owed under a security-based swap transaction poses the same degree of
risk to the United States as the risk posed by a transaction entered
into directly by such U.S. person.
---------------------------------------------------------------------------
\65\ See, e.g., Sullivan & Cromwell Letter, at 3-4 (stating that
Bank of America Corporation, Citigroup Inc. and JPMorgan Chase & Co.
conduct swap activities overseas through subsidiaries of the bank
holding company, Edge Corporation subsidiaries of their U.S. banks
and non-U.S. branches of the bank); Cleary Letter IV at 10-11.
\66\ See Cleary Letter IV at 10 (discussing a U.S. holding
company providing a guarantee of performance on the obligations of
its foreign swap dealing subsidiary).
---------------------------------------------------------------------------
In circumstances where a foreign non-bank subsidiary of a U.S.
holding company has sufficient credit-worthiness and does not rely on a
U.S. parental guarantee to support its creditworthiness, the risk of
the security-based swaps entered into by the foreign subsidiary of a
U.S.-based holding company resides in the foreign subsidiary outside
the United States.
(d) Foreign-Based Dealer
i. Direct Dealing
Foreign-based entities also may use a number of business models and
legal structures to conduct global security-based swap dealing activity
in both the U.S. and foreign markets. Like U.S. dealers, foreign
dealers may deal directly with U.S. counterparties and non-U.S.
counterparties without using any agents in the local market to
intermediate and book the resulting transactions in the foreign
entities themselves.\67\
---------------------------------------------------------------------------
\67\ See Cleary Letter VI at 3, 13 (discussing direct dealing by
a foreign dealer from abroad); IIB Letter at 7.
---------------------------------------------------------------------------
ii. Intermediation in the United States
Foreign dealers also may use local personnel with knowledge of and
expertise on the local markets to intermediate security-based swap
transactions in each local market, for instance, using salespersons in
the United States to originate security-based swaps in the U.S. market,
and either book the resulting transactions in an entity based in the
United States (such as a U.S. affiliate) or centrally book the
resulting transactions in a foreign central booking affiliate.\68\
---------------------------------------------------------------------------
\68\ See Cleary Letter IV at 4, 21 (discussing the use of U.S.
affiliate to intermediate) and IIB Letter at 7.
---------------------------------------------------------------------------
Intermediation activity within the United States on behalf of
foreign entities may occur in two principal legal structures.
First, foreign dealers that are banking entities may conduct
dealing activity with U.S. counterparties out of their U.S. branches.
In this structure, a foreign banking entity may originate and book
transactions in its U.S. branch, or the U.S. branch may originate
transactions that are booked in the foreign home office.\69\
---------------------------------------------------------------------------
\69\ See IIB Letter at 8.
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Second, both bank and non-bank foreign dealers may conduct dealing
activity out of their U.S. subsidiaries. The U.S. subsidiaries may act
as principal to originate and book security-based swaps in the United
States and enter into inter-affiliate back-to-back transactions with
the foreign central booking entity (usually the foreign parent) for
purposes of centralized booking and centralized risk management.\70\
The U.S. subsidiary also may act as agent to originate security-based
swaps in the United States on behalf of the foreign entity and the
resulting transactions would be booked in a centralized foreign booking
entity, usually the foreign parent. In some situations, such as where
the foreign-based entity has rated debt, but the U.S. subsidiary does
not, the U.S.-based subsidiary's performance under security-based swaps
that it enters into as principal may be supported by a parental
guarantee provided by the foreign-based entity.\71\
---------------------------------------------------------------------------
\70\ See Cleary Letter IV at 10 (discussing inter-affiliate
transactions).
\71\ See id. (discussing a non-U.S. holding company providing a
guarantee on the obligations of its U.S. swap dealing subsidiary).
---------------------------------------------------------------------------
The transactions originated by the U.S. branch of a foreign bank or
a U.S. subsidiary of a foreign bank or non-bank entity may not be
limited to those with U.S. counterparties in the U.S. security-based
swap market. Foreign bank or non-bank entities may utilize their U.S.
branches or U.S. subsidiaries to conduct dealing activity with, for
instance, non-U.S. counterparties located in various jurisdictions
within the same region or same time zones, such as Canada or Latin
America, and centrally book the resulting transactions in the home
offices of the foreign entities themselves. For example, a Canadian
counterparty might enter into a security-based swap with a non-U.S.-
based dealer that solicits and negotiates the transaction out of a U.S
subsidiary
[[Page 30978]]
acting as agent but books the transaction itself outside the United
States.
3. Clearing Practices
Prior to the enactment of the Dodd-Frank Act, there was no
provision in the Exchange Act or any other laws in the United States
for the mandatory clearing of OTC derivatives. Although initiatives
related to central clearing had been considered before 2008, the 2008
financial crisis brought a new focus on CDS as a source of systemic
risk and contributed to a more general recognition that central
clearing parties (``CCPs'') could play a role in helping to manage
bilateral counterparty credit risk in OTC CDS.\72\
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\72\ The President's Working Group on Financial Markets made the
central clearing of OTC derivatives a top policy objective in 2008.
See Policy Objectives for the OTC Derivatives Market (Nov. 14,
2008), available at: http://www.treasury.gov/resource-center/fin-mkts/Documents/policyobjectives.pdf; see also Policy Statement on
Financial Market Developments (Mar. 13, 2008), available at: http://www.law.du.edu/images/uploads/presidents-working-group.pdf; and
Progress Update on March Policy Statement on Financial Market
Developments (Oct. 2008), available at: http://www.treasury.gov/resource-center/fin-mkts/Documents/q4progress%20update.pdf.
---------------------------------------------------------------------------
In November 2008, the Commission, in consultation and coordination
with the Federal Reserve Board and the CFTC, took steps to help
facilitate the prompt development of CCPs for OTC derivatives.\73\
Specifically, the Commission authorized the clearing of OTC security-
based swaps by permitting certain clearing agencies to clear CDS on a
temporary conditional basis.\74\ As the Commission and other regulatory
agencies monitored the activities of those clearing agencies, a
significant volume of interdealer OTC CDS transactions and a smaller
volume of dealer-to-non-dealer OTC CDS transactions were centrally
cleared on a voluntary basis.\75\ The level of voluntary clearing in
swaps and security-based swaps has steadily increased since that time.
Although the volume of interdealer CDS cleared to date is quite
large,\76\ many security-based swap transactions are still ineligible
for central clearing, and many transactions in security-based swaps
eligible for clearing at a CCP continue to settle bilaterally.
---------------------------------------------------------------------------
\73\ On November 14, 2008, the Commission executed a Memorandum
of Understanding with the Board and the CFTC that established a
framework for consultation and information sharing on issues related
to central counterparties for the OTC derivatives market. See http://www.sec.gov/news/press/2008/2008-269.htm.
\74\ The Commission authorized five entities to clear CDS. See
CDS clearing by ICE Clear Europe Limited, Exchange Act Release Nos.
60372 (July 23, 2009), 74 FR 37748 (July 29, 2009) and 61973 (Apr.
23, 2010), 75 FR 22656 (Apr. 29, 2010); CDS clearing by Eurex
Clearing AG, Exchange Act Release Nos. 60373 (July 23, 2009), 74 FR
37740 (July 29, 2009) and 61975 (Apr. 23, 2010), 75 FR 22641 (Apr.
29, 2010); CDS clearing by Chicago Mercantile Exchange Inc.,
Exchange Act Release Nos. 59578 (Mar. 13, 2009), 74 FR 11781 (Mar.
19, 2009), 61164 (Dec. 14, 2009), 74 FR 67258 (Dec. 18, 2009) and
61803 (Mar. 30, 2010), 75 FR 17181 (Apr. 5, 2010); CDS clearing by
ICE Clear Credit LLC (formerly ICE Trust US LLC), Exchange Act
Release Nos. 59527 (Mar. 6, 2009), 74 FR 10791 (Mar. 12, 2009),
61119 (Dec. 4, 2009), 74 FR 65554 (Dec. 10, 2009) and 61662 (Mar. 5,
2010), 75 FR 11589 (Mar. 11, 2010); Temporary CDS clearing by LIFFE
A&M and LCH.Clearnet Ltd., Exchange Act Release No. 59164 (Dec. 24,
2008), 74 FR 139 (Jan. 2, 2009) (``CDS Clearing Exemption Orders'').
\75\ Voluntary CCP clearing grew out of a series of meetings
beginning in September 2005 hosted by the Federal Reserve Bank of
New York with major market participants and their domestic and
international supervisors for the purpose of discussing problems in
the processing of CDS, and related risk management and control
issues. See http://www.ny.frb.org/newsevents/news/markets/2005/an050915.html. In June 2008 the attendees agreed to an agenda for
improvement in the derivatives market infrastructure that included
``developing a central counterparty for credit default swaps that,
with a robust risk management regime, can help reduce systemic
risk.'' See http://www.ny.frb.org/newsevents/news/markets/2008/ma080609.html; see also https://www.theice.com/marketdata/reports/ReportCenter.shtml.
\76\ As of April 19, 2012, ICE Clear Credit had cleared
approximately $15.6 trillion notional amount of CDS contracts based
on indices of securities and approximately $1.5 trillion notional
amount of CDS contracts based on individual reference entities or
securities. As of April 19, 2012, ICE Clear Europe had cleared
approximately [euro]7.2 trillion notional amount of CDS contracts
based on indices of securities and approximately [euro]1.2 trillion
notional amount of CDS contracts based on individual reference
entities or securities. See Clearing Agency Standards Adopting
Release, 77 FR 66236 n.184 (citing https://www.theice.com/marketdata/reports/ReportCenter.shtml).
---------------------------------------------------------------------------
Voluntary clearing of security-based swaps in the United States is
currently limited to CDS products. Central clearing of security-based
swaps began in March 2009 for index CDS products, in December 2009 for
single-name corporate CDS products, and in November 2011 for single-
name sovereign CDS products. At present, there is no central clearing
in the United States for security-based swaps that are not CDS
products, such as those based on equity securities. The level of
clearing activity appears to have steadily increased as more CDS have
become eligible to be cleared.\77\
---------------------------------------------------------------------------
\77\ See Section XV.B.2(e), infra.
---------------------------------------------------------------------------
4. Reporting Practices
The OTC derivatives markets have historically been largely
opaque.\78\ With respect to CDS, for example, the Government
Accountability Office found in 2009 that ``comprehensive and consistent
data on the overall market have not been readily available,'' that
``authoritative information about the actual size of the CDS market is
generally not available,'' and that regulators currently are unable
``to monitor activities across the market.'' \79\ The reporting of
comprehensive OTC derivative transaction data to trade repositories is
intended to address the lack of transparency in this market, and as
such it was one of the G20 regulatory reform commitments previously
discussed.\80\
---------------------------------------------------------------------------
\78\ See FSB, Implementing OTC Derivatives Market Reforms (Oct.
25, 2010) (``FSB October 2010 Report''), at 11, available at: http://www.financialstabilityboard.org/publications/r_101025.pdf.
\79\ Government Accountability Office, ``Systemic Risk:
Regulatory Oversight and Recent Initiatives to Address Risk Posed by
Credit Default Swaps,'' GAO-09-397T (Mar. 2009), at 2, 5, 27,
available at: http://www.gao.gov/new.items/d09397t.pdf.
\80\ See note 35 and accompanying text, supra. See also SDR
Proposing Release, 75 FR 77307 (``Under the Dodd-Frank Act, SDRs are
intended to play a key role in enhancing transparency in the
[security-based swap] market by retaining complete records of
[security-based swap] transactions, maintaining the integrity of
those records, and providing effective access to those records to
relevant authorities and the public in line with their respective
information needs. The enhanced transparency provided by an SDR is
important to help regulators and others monitor the build-up and
concentration of risk exposures in the [security-based swap] market.
Without an SDR, data on [security-based swap] transactions is
dispersed and not readily available to regulators and others.'').
---------------------------------------------------------------------------
The first trade repositories were established in the mid-2000s.\81\
The development of trade repositories for different asset classes
accelerated following the 2009 G20 commitment in this area, and as
legislative and regulatory requirements began to be put in place. As of
the end of the first quarter of 2013, fourteen FSB member jurisdictions
had legislation in place either requiring reporting of OTC derivatives
contracts or authorizing regulators to implement such regulations.\82\
In addition, as of the date of publication of the FSB Progress Report
April 2013, eighteen trade repositories were either registered or in
the process of becoming registered and twelve were operational,
meaning, typically, that they were at least accepting transaction
reports from more than one asset class.\83\
---------------------------------------------------------------------------
\81\ See Committee on Payment and Settlement Systems (``CPSS'')
and Technical Committee of IOSCO, Report on OTC Derivatives Data
Reporting and Aggregation Requirements (Jan. 2012), at 5, available
at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD366.pdf (``CPSS-
IOSCO Data Report'').
\82\ FSB Progress Report April 2013 at 19.
\83\ Id. at 20-21, 63-65. Ten trade repositories were offering
trade reporting on interest rate derivatives transactions; eight
were offering trade reporting on commodity derivative transactions;
seven were offering trade reporting on equity derivatives
transactions; eight were offering trade reporting on foreign
exchange derivative transactions; and seven were offering trade
reporting on credit derivatives.
---------------------------------------------------------------------------
Prior to the Dodd-Frank Act, global trade repositories had been
established for credit, interest rate, and equity
[[Page 30979]]
derivatives.\84\ In addition, in June 2010, the OTC Derivatives
Regulators' Forum (``ODRF'') \85\ developed indicative guidance for
Warehouse Trust \86\ aiming to identify data that authorities would
expect to request from Warehouse Trust to carry out their mandates.\87\
---------------------------------------------------------------------------
\84\ Pursuant to initiatives led by the OTC Derivatives
Supervisors Group (``ODSG''), in 2009 the largest OTC derivatives
dealers at the global level committed to reporting all of their CDS
trades to a trade repository. At that time, a trade repository for
credit derivatives was already in existence and used by the
industry. To promote the development of trade repositories for all
interest rate and equity derivatives, in 2008 and 2009 ISDA sought
proposals for the creation of central trade repositories for these
asset classes. Two entities were selected to provide trade
repository functions for these asset classes. See FSB October 2010
Report at 44. The ODSG originated in 2005, when the Federal Reserve
Bank of New York (``New York Federal Reserve'') hosted a meeting
with representatives of major OTC derivatives market participants
and their domestic and international supervisors, including the
Commission, in order to address the emerging risks of inadequate
infrastructure for the rapidly growing market in credit derivatives.
The ODSG is chaired by the New York Federal Reserve.
\85\ The ODRF, formed in January 2009, brings together
representatives from central banks, prudential supervisors, and
securities and market regulators to discuss issues of common
interest, regarding OTC derivatives central counterparties and trade
repositories. The ODRF's scope and focus include information
sharing/needs and oversight co-ordination and co-operation.
\86\ The Warehouse Trust Company LLC (``Warehouse Trust'') today
provides certain post-trade processing services to DTCC-TIW. DTCC-
TIW provides a centralized electronic trade database for OTC credit
derivatives contracts.
\87\ See FSB October 2010 Report at 63. Building on this work,
CPSS and IOSCO have published a consultation paper setting forth
more comprehensive guidance regarding trade repositories more
broadly. The paper provides guidance to authorities that supervise
trade repositories; regulators, supervisors, resolution authorities,
central banks, and other public-sector authorities (collectively,
``authorities'') that request OTC derivative data from trade
repositories; and trade repositories. This guidance concerns the
types of data to which authorities will typically require access and
possible approaches to addressing potential constraints and concerns
that may prevent effective access to such data. See CPSS and IOSCO,
Consultative Report on Authorities' Access to Trade Repository Data
(April 2013), available at: http://iosco.org/library/pubdocs/pdf/IOSCOPD408.pdf?v=1.
---------------------------------------------------------------------------
Public availability of trade repository data varies globally and
has changed significantly over time. For example, since October 2008,
on a weekly basis, DTCC has published aggregated data via its Web
site.\88\ More generally, in a recent FSB survey, all trade
repositories that responded stated that they provide or intend to
provide, transaction data on OTC derivatives to the public. In some
cases and for some products, trading information is provided on a real-
time basis. Some trade repositories publicly disclose only aggregated,
end-of-day information.\89\
---------------------------------------------------------------------------
\88\ See CPSS-IOSCO Data Report at 45-46.
\89\ See OTC Derivatives Market Reforms, Fourth Progress Report
on Implementation (Oct. 31, 2012) at 5, available at: http://www.financialstabilityboard.org/publications/r_121031a.pdf.
---------------------------------------------------------------------------
5. Trade Execution Practices
Unlike the markets for cash equity securities and listed options,
the market for security-based swaps currently is characterized
generally by bilateral negotiation directly between two counterparties
in the OTC market and is largely decentralized; many instruments are
individually negotiated and often customized; and many security-based
swaps are not centrally cleared.\90\ The historical one-to-one nature
of trade negotiation in security-based swaps has fostered various types
of trading venues and execution practices, ranging among the following:
---------------------------------------------------------------------------
\90\ See SB SEF Proposing Release, 76 FR 10951.
---------------------------------------------------------------------------
Bilateral Negotiations
``Bilateral negotiation'' refers to the execution practice whereby
one party uses the telephone, email or other means of communication to
directly contact a potential counterparty to negotiate and execute a
security-based swap. In bilateral negotiation and execution, only the
two parties to the transaction are aware of the terms of the
negotiation and the final terms of the agreement.\91\
---------------------------------------------------------------------------
\91\ See id.
---------------------------------------------------------------------------
Single-Dealer RFQ Platforms
A single-dealer request for quote (``RFQ'') platform refers to an
electronic trading platform where a dealer may post indicative quotes
for security-based swaps in various asset classes that the dealer is
willing to trade. Only the dealer's approved customers have access to
the platform. When a customer wishes to transact in a security-based
swap, the customer requests an executable quote, the dealer provides
one, and if the customer accepts the dealer's quote, the transaction is
executed electronically. This type of platform generally provides
indicative quotes on a pricing screen, but only from one dealer to its
customers.\92\
---------------------------------------------------------------------------
\92\ See id. at 10951.
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Multi-Dealer RFQ Platforms
A multi-dealer RFQ electronic trading platform refers to a multi-
dealer RFQ system whereby a requester can send an RFQ to solicit quotes
on a certain security-based swap from multiple dealers at the same
time. After the RFQ is submitted, the recipients have a prescribed
amount of time in which to respond to the RFQ with a quote. Responses
to the RFQ are firm. The requestor then has the opportunity to review
the responses and accept the best quote. A multi-dealer RFQ platform
provides a certain amount of pricing information, depending on its
characteristics.\93\
---------------------------------------------------------------------------
\93\ For example, to the extent that a RFQ platform sets limits
on the number of dealers to whom a customer may send an RFQ, the
customer's pre-trade transparency is restricted to that number of
quotes it receives in response to its RFQ. See SB SEF Proposing
Release, 76 FR 10952.
---------------------------------------------------------------------------
Central Limit Order Books
A central limit order book system or similar system refers to a
trading system in which firm bids and offers are posted for all
participants to see, with the identity of the parties withheld until a
transaction occurs. Bids and offers are then matched based on price-
time priority or other established parameters and trades are executed
accordingly. The quotes on a limit order book system are firm. In
general, a limit order book system provides greater pricing information
than the three platforms described above because all participants can
view bids and offers before placing their bids and offers.\94\
Currently, limit order books for the trading of security-based swaps in
the United States are utilized by inter-dealer brokers for dealer-to-
dealer transactions.
---------------------------------------------------------------------------
\94\ See id.
---------------------------------------------------------------------------
Brokerage Trading
``Brokerage trading'' refers to an execution practice used by
brokers to execute security-based swaps on behalf of customers, often
in larger sized transactions. In such a system, a broker receives a
request from a customer (which may be a dealer) who seeks to execute a
specific type of security-based swap. The broker then interacts with
other customers (which may also be dealers) to fill the request and
execute the transaction. This model often is used by dealers that seek
to transact with other dealers through the use of an interdealer broker
as an intermediary. In this model, participants may or may not be able
to see bids and offers of other participants.\95\
---------------------------------------------------------------------------
\95\ See id.
---------------------------------------------------------------------------
These various trading venues and execution practices provide
different degrees of pre-trade pricing information and different levels
of access. The Commission currently does not have sufficient
information with respect to the volume of security-based swap
transactions executed across these different trading venues and
execution practices to evaluate the individual impact of such venues
and practices on
[[Page 30980]]
pricing information available in the security-based swap market.
6. Broad Economic Considerations of Cross-Border Security-Based Swaps
\96\
---------------------------------------------------------------------------
\96\ See Section XV, infra (providing more detailed commentary
on the economic effects of the proposed rules, including supporting
citations).
---------------------------------------------------------------------------
Our primary economic considerations for promulgating rules and
interpretations regarding the application of Title VII to cross-border
activities include the potential risks of security-based swaps to the
U.S. financial system \97\ that could affect financial stability, the
level of transparency and counterparty protection in the security-based
swap market, the costs to market participants, and the impact of such
rules and interpretations on liquidity, efficiency, and competition in
the market. Unlike most other securities transactions, a security-based
swap gives rise to ongoing obligations between transaction
counterparties during the life of the transaction. This means that each
counterparty to the transaction undertakes the obligation to perform
the security-based swap in accordance with its terms and bears the
counterparty credit risk and market risk until the transaction is
terminated.\98\ The cross-border rules ultimately adopted by the
Commission could materially impact the economic effects of the final
Title VII regulatory requirements.
---------------------------------------------------------------------------
\97\ The Commission generally understands the ``U.S. financial
system'' to include the U.S. banking system and the U.S. financial
markets, including the U.S. security-based swap market, the
traditional securities markets (e.g., the debt and equity markets),
and the markets for other financial activities (e.g., lending).
\98\ See Intermediary Definitions Adopting Release, 77 FR 30616-
17 (noting that ``the completion of a purchase or sale transaction''
in the secondary equity or debt markets ``can be expected to
terminate the mutual obligations of the parties,'' unlike security-
based swap transactions, which often give rise to ``an ongoing
obligation to exchange cash flows over the life of the agreement'').
---------------------------------------------------------------------------
(a) Major Economic Considerations
In determining how Title VII requirements should apply to persons
and transactions in the cross-border context, the Commission is aware
of the potentially significant trade-offs inherent in our policy
decisions. For example, it is possible that counterparties excluded
from the Title VII regulatory framework would not, among other things,
receive the same level of counterparty protection or impartial access
to trading venues and information as those included in the Title VII
regulatory framework. However, it is also possible that market
participants excluded from the Title VII regulatory framework would
face lower regulatory burdens and lower compliance costs associated
with their security-based swap activity. Further, it is possible that
these trade-offs could alter the incentives for individuals to
participate in the security-based swap market, which may impact the
overall market, affecting its liquidity, as well as its efficiency and
the competitive dynamics among participants. In addition, we also
recognize that regulators in other jurisdictions are currently engaged
in implementing their own regulatory reforms of the OTC derivatives
markets and that our proposed application of Title VII to cross-border
activities may affect the policy decisions of these other regulators as
they seek to address potential conflicts or duplication in the
regulatory requirements that apply to market participants under their
authority. In proposing our rules and interpretations in this release,
the Commission has considered the benefits of the Title VII regulatory
framework, including counterparty protection and access to information,
as well as the costs of compliance, taking into account the potential
impact of the rules and interpretations on liquidity, efficiency, and
competition in the security-based swap market.
Moreover, the costs and benefits of various Title VII substantive
requirements may not be the same for each individual market
participant, depending on the role it plays, the market function it
performs, and the activity it engages in in the security-based swap
market. For example, Title VII requirements for security-based swap
dealers and major security-based swap participants may impose
significant costs on persons falling within the definitions of
security-based swap dealer and major security-based swap participant
that are not borne by other market participants. The costs of these
requirements may provide economic incentive for some market
participants falling within the definitions of security-based swap
dealer and major security-based swap participant to restructure their
security-based swap business to operate wholly outside of the Title VII
regulatory framework, exiting the security-based swap market in the
United States and not transacting with U.S. persons. Conversely,
certain Title VII requirements may promote financial stability and
increase market participants' confidence in entering into security-
based swap transactions.
(b) Global Nature and Interconnectedness of the Security-Based Swap
Market
In considering the proposed approach to the application of the
Title VII requirements, the Commission has been informed by the
analysis of current market activity described in this release,\99\
including the extent of cross-border trading activity in the security-
based swap market.\100\ The security-based swap transactions between
U.S.- and non-U.S. domiciled market participants provide conduits of
risk into the U.S. financial system, which could affect the safety and
soundness of the U.S. financial system. Similarly, such transactions
also provide conduits for liquidity into the U.S. financial system. As
a consequence, changes to incentives or costs that result from the
application of U.S. regulatory requirements may have effects on the
liquidity of the global market, as well as its efficiency and
competitive dynamics.
---------------------------------------------------------------------------
\99\ See Section II.A, supra, and Section XV.B.2, infra.
\100\ For example, review of the DTCC-TIW single-name CDS
transactions executed in 2011 reveals that approximately 49% of the
U.S. single-name CDS transactions were between one U.S.-domiciled
counterparty and one foreign-domiciled counterparty, and 44% of such
transactions were between two foreign-domiciled counterparties. See
Section II.A.1, supra, and Section XV.B.2(d), infra.
---------------------------------------------------------------------------
With respect to conduits of risk, one area of particular concern in
the current security-based swap market is the risks that arise when a
large market participant becomes financially distressed, including the
potential for sequential counterparty failure. A default by one or more
security-based swap dealers or major security-based swap participants
could produce spillovers or contagion by reducing the willingness and/
or ability of market participants to extend credit to each other, and
thus could substantially reduce liquidity and valuations for particular
types of financial instruments.\101\
---------------------------------------------------------------------------
\101\ See, e.g., Markus K. Brunnermeier and Lasse Heje Pedersen,
``Market Liquidity and Funding Liquidity,'' Rev. Financ. Stud.
(2009); Denis Gromb and Dimitri Vayanos, ``A Model of Financial
Market Liquidity,'' Journal of the European Economic Association
(2010).
---------------------------------------------------------------------------
The experience of American International Group, Inc. (``AIG''), a
Delaware corporation based in New York, and its subsidiary, AIG
Financial Products Corp. (``AIG FP''), a Delaware corporation based in
Connecticut, during and after the 2008 financial crisis both
illustrates spillovers and contagion arising from security-based swap
transactions and demonstrates how cross-border transactions could
contribute to the destabilization of the
[[Page 30981]]
U.S. financial system if the security-based swap market were not
adequately regulated.\102\ AIG FP sold extensive amounts of credit
protection in the form of CDS in the years leading up to the
crisis,\103\ largely on the strength of AIG's AAA rating; AIG FP's
obligations were guaranteed by its parent AIG.\104\ AIG FP's CDS
business reflected the global nature of the security-based swap market
because, although both AIG and AIG FP were headquartered in the United
States, much of AIG FP's CDS business was run out of its London
office,\105\ and AIG FP sold credit protection to counterparties both
within the United States and around the world.\106\
---------------------------------------------------------------------------
\102\ More generally, the Lehman Brothers Holding Inc.
bankruptcy offers an example of how risk can spread across
affiliated entities of multinational financial institutions. See
Lehman Brothers International (Europe) in Administration, Joint
Administrators' Progress Report for the Period 15 September 2008 to
14 March 2009 (Apr. 14, 2009), available at: http://www.pwc.co.uk/assets/pdf/lbie-progress-report-140409.pdf (``The global nature of
the Lehman business with highly integrated, trading and non-trading
relationships across the group led to a complex series of inter-
company positions being outstanding at the date of Administration.
There are over 300 debtor and creditor balances between LBIE and its
affiliates representing $10.5B of receivables and $11.0B of payables
as at 15 September 2008.'').
\103\ In 2007, AIG FP's CDS portfolio reached a peak of $527
billion. Congressional Oversight Panel, June Oversight Report, ``The
AIG Rescue, Its Impact on Markets, and the Government's Exit
Strategy,'' June 2010, at 23, available at: http://www.gpo.gov/fdsys/pkg/CPRT-111JPRT56698/pdf/CPRT-111JPRT56698.pdf (``AIG
Report'').
\104\ See Intermediary Definitions Adopting Release, 77 FR 30689
n.1133 (``AIGFP's obligations were guaranteed by its highly-rated
parent company . . . an arrangement that facilitated easy money via
much lower interest rates from the public markets, but ultimately
made it difficult to isolate AIGFP from its parent, with disastrous
consequences'') (quoting AIG Report at 20).
\105\ See AIG Report at 18.
\106\ See Office of the Special Inspector General for the
Troubled Asset Relief Program, Factors Affecting Efforts to Limit
Payments to AIG Counterparties, at 20 (Nov. 17, 2009) (listing AIG
FP's CDS counterparties, including a variety of U.S. and foreign
financial institutions), available at: http://www.sigtarp.gov/Audit%20Reports/Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties.pdf.
---------------------------------------------------------------------------
As the subprime mortgage market in the United States collapsed, the
ongoing obligations borne by AIG FP and, through its guarantees, its
parent AIG, arising from AIG FP's CDS transactions produced losses that
threatened to overwhelm both AIG FP and AIG. The Federal Reserve Bank
of New York established a credit facility to prevent AIG from
collapsing. These funds were later supplemented by financial support
from the U.S. Treasury and the Federal Reserve, resulting in over $180
billion in financial assistance.\107\
---------------------------------------------------------------------------
\107\ See AIG Report at 2.
---------------------------------------------------------------------------
As we discuss in more detail below, security-based swap market
regulators need to take into account the spillover and contagion effect
of security-based swap risk to avoid overburdening the financial
system. One way to mitigate the spillover effect of a firm failure is
to impose capital standards that take into account the security-based
swap risk the firm undertakes while allowing flexibility in how it
conducts security-based swap business.\108\ At the same time, the
Commission is mindful that the application of Title VII prudential
requirements such as capital and margin impose costs on market
participants that could provide economic incentives to restructure or
separate their security-based swap activity according to geographical
or jurisdictional regions, or to engage in less security-based swap
activity, which may reduce the liquidity or efficiency of the overall
market.\109\
---------------------------------------------------------------------------
\108\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70218.
\109\ See id. at 70303-06.
---------------------------------------------------------------------------
There are circumstances where risk generated by security-based
swaps may reside in the United States while conduits of such risk
(e.g., security-based swap transactions or persons engaged in security-
based swap transactions) could take place or reside outside the United
States or outside the scope of application of the Title VII
requirements. In these instances, the Commission has considered the
nature of the risk, the magnitude of the risk, and the existence of
other financial regulations, such as regulation of systemically
important financial institutions in Title I and Title II of the Dodd-
Frank Act and banking regulations.
The Commission is mindful that the same interconnectedness in the
security-based swap market that may provide conduits for risk also may
mean that changes to incentives or costs caused by the application of
U.S. regulatory requirements may have effects on the liquidity of the
global market, as well as its efficiency and competitive dynamics. As
described below in Section XV.C, there are a myriad of paths for
liquidity as well as risk to move throughout the financial system in
this interconnected market. In addition, differences in regulatory
requirements between the United States and non-U.S. jurisdictions may
also impact markets by changing the competitive dynamics currently at
play in the interconnected global market. For example, as articulated
in Section XV.C, some potential responses by market participants to the
proposed rules and interpretations in this release may result in
lessened competition in the security-based swap market within the
United States. Among other considerations, some entities may determine
that the compliance costs arising from the requirements of Title VII
warrant exiting the security-based swap market in the United States and
not transacting with U.S. persons. These exits could result in higher
spreads and affect the ability and willingness of end users to engage
in security-based swaps.
(c) Central Clearing
Many of the bilateral counterparty credit risks associated with
security-based swaps can be mitigated by central clearing. Central
clearing of security-based swaps provides a mechanism for market
participants to engage in security-based swap activity without having
to assess the creditworthiness of each counterparty. Clearing of
security-based swaps shifts the counterparty risk from individual
counterparties to CCPs whose members collectively share the default
risk of all members.\110\ Central clearing also requires consistent
application of mark-to-market pricing and margin requirements, which
standardizes the settling of payment or collateral delivery resulting
from market movements and minimizes the risk of clearing member
defaults.\111\
---------------------------------------------------------------------------
\110\ See, e.g., Darrell Duffie and Haoxiang Zhu, ``Does a
Central Clearing Counterparty Reduce Counterparty Risk?'' Stanford
University, Working Paper (2010), available at: http://
www.stanford.edu/~duffie/DuffieZhu.pdf; Nout Wellink, ``Mitigating
systemic risk in OTC derivatives markets,'' Banque de France,
Financial Stability Review, No. 14--Derivatives--Financial
innovation and stability (July 2010), available at: http://www.banque-france.fr/fileadmin/user_upload/banque_de_france/publications/Revue_de_la_stabilite_financiere/etude15_rsf_1007.pdf.
\111\ See Christopher Culp, ``OTC-Cleared Derivative: Benefits,
Costs, and Implications of the Dodd-Frank Wall Street Reform and
Consumer Protection Act,'' Journal of Applied Finance No. 2 (2010),
available at: http://www.rmcsinc.com/articles/OTCCleared.pdf.
---------------------------------------------------------------------------
However, central clearing may also pose risk to financial systems.
Because a CCP necessarily concentrates a large number of otherwise
bilateral contracts into a single location, a CCP could itself become
systemically important.\112\
[[Page 30982]]
While a loss by any single member in excess of its margin posted with
the CCP is likely to be absorbed by the CCP's risk capital structure,
correlated losses among many members, such as those which occurred
among many asset classes during the 2008 financial crisis, could
diminish the effectiveness of the risk mutualization structure of a
CCP. Its failure could create financial instability through its members
if the members, as residual obligors to the default related losses are
unable to absorb the resulting financial impact. Such an outcome could
lead to failure among CCP member counterparties, particularly when
obligations are sizable, which may be the case if the members are
themselves systemically important.
---------------------------------------------------------------------------
\112\ The Financial Stability Oversight Council (``FSOC'') can
designate a CCP as systemically important under Section 804 of the
Dodd-Frank Act. See, e.g., Craig Pirrong, ``Mutualization of Default
Risk, Fungibility, and Moral Hazard: The Economics of Default Risk
Sharing in Cleared and Bilateral Markets,'' University of Houston,
Working Paper (2010), available at: http://business.nd.edu/uploadedFiles/Academic_Centers/Study_of_Financial_Regulation/pdf_and_documents/clearing_moral_hazard_1.pdf (``[c]learing of
OTC derivatives has been touted as an essential component of reforms
designed to prevent a repeat of the financial crisis. A back-to-
basics analysis of the economics of clearing suggests that such
claims are overstated, and that traditional OTC mechanisms may be
more efficient for some instruments and some counterparties.'').
---------------------------------------------------------------------------
Certain aspects of Title VII are intended to reduce the risk of CCP
failure by promoting sound risk management practices among registered
clearing agencies, while also providing open access to market
participants.\113\ Sound risk management practices are important among
both domestic and foreign CCPs, given the global nature of CCP
membership.\114\ When a CCP in the United States has significant number
of foreign members, the CCP and its U.S.-domiciled members would be
exposed to the foreign members. Similarly, when U.S.-domiciled entities
are members of foreign domiciled CCPs, U.S. exposure to a foreign
institution is created that may be systemically important.
---------------------------------------------------------------------------
\113\ See, e.g., Clearing Agency Standards Adopting Release, 77
FR 66220.
\114\ Based on the analysis of the member positions at ICE Clear
Credit in the United States by the staff in the Division of Risk,
Strategy and Financial Innovation, approximately half of the
positions at ICE Clear Credit in the United States are held by
foreign-domiciled dealing entities. See Section XV.B.2(e), infra.
---------------------------------------------------------------------------
(d) Security-Based Swap Data Reporting
Certain Title VII requirements are designed to increase market
transparency for regulators and among security-based swap market
participants. Requirements of regulatory reporting are designed to
provide regulators with a broad view of the market and help monitor
pockets of risk that might not otherwise be observed by market
participants with an incomplete view of the market. Separately,
requirements of post-trade reporting of prices in real-time are
intended to promote price discovery and lower the trading costs by
lessening the information advantage afforded certain OTC market
participants with the largest order flow. Allowing all market
participants access to more information about transactions' prices and
sizes should create a more level playing field and may promote the
efficiency of exchange or SEF trading of security-based swaps. In
particular, as in other security markets, quoted bids and offers should
form and adjust according to the reporting of executed trades. At the
same time, however, we recognize that increased post-trade transparency
also could impact the liquidity of, and competition in, the security-
based swap market.\115\ For example, market participants may be less
willing to provide liquidity for large, potentially market-moving
trades if the implementation of the Title VII public dissemination
requirements reveals private information about future hedging and
inventory needs.
---------------------------------------------------------------------------
\115\ See Section XV.C, infra (discussing the effects of our
proposed cross-border approach on competition, efficiency, and
capital formation).
---------------------------------------------------------------------------
The increased transparency caused by the Title VII reporting
requirements could be diminished if consistent reporting requirements
are not applied to transactions across various jurisdictions and
information regarding security-based swaps taking place in the global
market is not shared among jurisdictions. For instance, the aggregate
exposures created by a particular security-based swap or class of
security-based swaps may only be partially observed if security-based
swap transactions span multiple jurisdictions. As a result any single
regulator may not have a complete view of the security-based swap risks
and may underestimate such risks. Separately, if some regulatory
regimes do not require, or provide for less informative, post-trade
reporting rules, then certain transactions may gravitate to these
jurisdictions so that market participants can escape reporting their
transaction prices. In both instances the increased transparency
contemplated by the Title VII reporting requirements may be diluted.
B. Scope of Title VII's Application to Cross-Border Security-Based Swap
Activity
Congress has given the Commission authority in Title VII to
implement a security-based swap regulatory framework. In the statutory
definitions and registration requirements for market intermediaries and
participants (i.e., security-based swap dealers and major security-
based swap participants) and security-based swap infrastructures (i.e.,
SDRs, security-based swap clearing agencies, and SB SEFs), Congress has
identified the types of security-based swap activity that triggers
Title VII registration and regulatory requirements relevant to such
persons or the application of Title VII transaction-level requirements.
We recognize that applying Title VII to persons and transactions
that fall within the statutory definitions or requirements may subject
some persons based outside the United States, or some transactions
arising from activity that occurs in part inside and in part outside
the United States, to the various provisions of Title VII. At the same
time, however, the global nature of the security-based swap market and
the characteristics of the risk associated with security-based swap
activity suggest that applying Title VII only to the conduct of persons
located within the United States or to security-based swap activity
occurring entirely within the United States would exclude from
regulation a significant proportion of security-based swap activity
that occurs in part inside and in part outside the United States.\116\
Our proposed approach is intended to strike a reasonable balance in
light of the authority provided by Congress, the structure of the
security-based swap market, and the transfer of risk within that
market. Accordingly, among other things, our proposed approach does not
impose Title VII requirements on persons whose relevant security-based
swap activity occurs entirely outside the United States and thus likely
does not raise the types of concerns in the U.S. financial system that
would warrant application of Title VII.
---------------------------------------------------------------------------
\116\ See Section II.A, supra. We preliminarily believe that
many of the circumstances of concern also would create the
opportunity for evasion of the Dodd-Frank Act's regulatory regime.
See, e.g., note 558, infra.
---------------------------------------------------------------------------
Commenters have raised concerns about the application of Title VII
to security-based swap activity in the cross-border context and
specifically about the possibility that the Commission may apply our
security-based swap regulations to ``extraterritorial'' conduct. In
this subsection, we discuss commenters' views regarding the
applicability of Title VII to cross-border security-based swap
activity, explain our proposed approach to determining whether the
relevant security-based swap activity takes place, in whole or in part,
within the United States, and interpret what it means for a person to
``transact a business in security-based swaps without the jurisdiction
of the United States'' as set forth in Section 30(c) of the Exchange
Act (``Section 30(c)'').\117\ In subsequent sections of the release, we
discuss in more detail our proposed
[[Page 30983]]
application of Title VII to cross-border security-based swap activity.
---------------------------------------------------------------------------
\117\ 15 U.S.C. 78dd(c).
---------------------------------------------------------------------------
1. Commenters' Views
Commenters generally expressed the view that Section 30(c)
restricts the Commission's authority to apply Title VII to
``extraterritorial'' conduct and thus, that the Commission follow a
territorial approach in applying Title VII to cross-border security-
based swap activity. One commenter interpreted Section 30(c) as
prescribing a strictly territorial approach to the application of Title
VII, arguing that this section codifies the territorial approach that
we have historically taken in our existing securities regulations.\118\
Several commenters argued that a narrow interpretation of the
``extraterritorial'' reach of Title VII was consistent with both
Commission precedent\119\ and the Supreme Court's decision in Morrison
v. National Australia Bank.\120\
---------------------------------------------------------------------------
\118\ See Cleary Letter IV at 33-36; see also SIFMA Letter I at
5, 22; Sullivan & Cromwell Letter at 6 (suggesting that Section
30(c) permits ``extraterritorial'' application of Title VII only to
prevent ``efforts to evade'' statutory requirements).
\119\ See, e.g., Sullivan & Cromwell Letter at 11 (stating that
the Commission has ``plainly stated that it uses a territorial
approach in applying the broker-dealer requirements to international
operations'').
\120\ 130 S.Ct. 2869 (2010). See, e.g., Jones Day Letter at 7-8
(suggesting that the jurisdictional limits of Dodd-Frank Act
Sections 722 and 772 be interpreted narrowly in a manner consistent
with the Morrison decision); Cleary Letter IV at 33-6 (arguing
against an extraterritorial application of Title VII); SIFMA Letter
I at 5-6; ISDA Letter I at 11.
---------------------------------------------------------------------------
Based on this interpretation of Section 30(c), commenters generally
argued that Title VII does not give the Commission authority to
regulate entities that transact a business in security-based swaps
outside the United States.\121\ Some commenters suggested that non-U.S.
entities (including affiliates of U.S. persons) that conduct business
entirely with counterparties outside the United States should not be
required to register as swap or security-based swap dealers or comply
with Title VII.\122\ Some of these commenters also urged the Commission
not to subject foreign branches and affiliates of U.S. banks to Title
VII registration requirements to the extent that they transact solely
with foreign persons.\123\ Some commenters urged that, even within a
single entity, only those branches, departments, or divisions that
engage in business within the United States should be required to
register.\124\
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\121\ See, e.g., Jones Day Letter at 7-8; Cleary Letter IV at
33-6; Sullivan & Cromwell Letter at 10-11; SIFMA Letter I at 5-6;
ISDA Letter I at 11.
\122\ See SIFMA Letter I at 4; see also ISDA Letter I at 11
(recommending that designation as a dealer should not be triggered
by transactions entered into with foreign affiliates or branches of
a U.S. bank or with foreign entities whose obligations are
guaranteed by a U.S. person, or by legacy positions with U.S.
counterparties); Davis Polk Letter II at 5-6 (stating that a foreign
entity engaged in swaps exclusively with foreign counterparties is
```without the jurisdiction of the United States'''). Similarly, one
commenter recommended that transactions between two foreign entities
should be excluded from calculations of substantial position for
purposes of the major participant definition. Canadian MAVs Letter
at 7-8.
\123\ See, e.g., Sullivan & Cromwell Letter at 7 (stating that a
territorial interpretation of Section 30(c) prevented the Commission
from imposing Title VII requirements on the U.S. banks' ``Non-U.S.
Operations,'' defined to include both foreign affiliates or
subsidiaries and foreign branches of these banks).
\124\ See, e.g., Cleary Letter IV at 12; see also id. at 26
(arguing that a non-U.S. branch or affiliate of a U.S. entity should
not be required to register as a dealer by virtue of its
transactions with a non-U.S. person counterparty); ISDA Letter I at
11 (stating that a ``branch, division or office of an entity should
be able to be designated as a Dealer without subjecting the whole
entity to regulation'').
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Commenters generally took the view that Section 30(c) does not
permit the Commission to apply Title VII to transactions occurring
outside the United States. Accordingly, commenters suggested that
Section 30(c) restricts the Commission's ability to apply Title VII
requirements to the foreign business of entities that are required to
register with the Commission.\125\ For example, one commenter
interpreted Section 30(c) to prohibit application of Title VII to any
of a person's ``activity'' or ``business'' outside the United States,
even if that person otherwise transacts a business in security-based
swaps within the jurisdiction of the United States.\126\
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\125\ See Cleary Letter IV at 11; see also SIFMA Letter I at 14
(suggesting that Section 30(c) ``provide[s] strong support'' for not
applying Title VII to transactions between a registered foreign swap
dealer and non-U.S. persons); ISDA Letter I at 11 (recommending that
no Title VII requirements should apply to transactions between a
non-U.S. entity registered as a dealer and its non-U.S. person
counterparties).
\126\ See Cleary Letter IV at 12.
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Similarly, some commenters suggested that Section 30(c) prohibits
the application of Title VII to transactions involving the foreign
affiliates of U.S. persons, on the basis that such transactions occur
``without the jurisdiction of the United States'' when no U.S. person
is a counterparty to the trade.\127\ One commenter explained that,
because such transactions involve parties outside the United States and
occur outside the United States, they are ``removed from the stream of
U.S. commerce.'' \128\
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\127\ See SIFMA Letter I at 5-6; see also ISDA Letter I at 11
(suggesting that dealer-related requirements of Title VII should not
apply to business with non-U.S. person counterparties, including
foreign affiliates and branches of U.S. persons).
\128\ See Sullivan & Cromwell Letter at 9.
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Commenters also generally recommended a narrower interpretation of
the language in Section 30(c) permitting the application of Title VII
regulations to persons transacting a business in security-based swaps
without the jurisdiction of the United States to the extent that they
are doing so in contravention of rules the Commission has prescribed as
``necessary or appropriate to prevent the evasion of any provision of
[the Exchange Act that was added by the Dodd-Frank Act].'' Under this
view, Section 30(c) permits ``extraterritorial'' application of Title
VII only to entities that have themselves engaged in willful or
intentional evasion.\129\ These commenters argued that the longstanding
use of foreign branches and affiliates by security-based swap market
entities demonstrates that these types of business structures are not
evasive and, therefore, do not fall within the exception to the limits
on the applicability of Title VII as set forth in Section 30(c).\130\
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\129\ See, e.g., id. at 9-10 (suggesting that
``extraterritorial'' application of Title VII requires an ``intent
to evade'' Title VII).
\130\ See Cleary Letter IV at 7.
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2. Scope of Application of Title VII in the Cross-Border Context
(a) Overview and General Approach
Section 772(b) of the Dodd-Frank Act amends Section 30 of the
Exchange Act to provide that ``[n]o provision of [Title VII] . . .
shall apply to any person insofar as such person transacts a business
in security-based swaps without the jurisdiction of the United
States,'' unless that business is transacted in contravention of rules
prescribed to prevent evasion of Title VII.\131\ In so amending Section
30 of the Exchange Act, Congress directly appropriated nearly identical
language defining the scope of the Exchange Act's application that
appears in subsection (b) of Section 30 of the Exchange Act,\132\
indicating that Congress intended the territorial application of Title
VII to entities and transactions in the security-based swap market to
follow similar principles to those applicable to the
[[Page 30984]]
securities market under the Exchange Act.\133\
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\131\ See Section 30(c) of the Exchange Act, 15 U.S.C. 78dd(c),
added by Section 772(b) of the Dodd-Frank Act.
\132\ Section 30(b) of the Exchange Act, 15 U.S.C. 78dd(b),
provides that the Exchange Act and related rules ``shall not apply
to any person insofar as he transacts a business in securities
without the jurisdiction of the United States,'' unless that
business is transacted in contravention of rules prescribed as
necessary or appropriate to prevent evasion of the Exchange Act.
\133\ See, e.g., Commodity Futures Trading Comm'n v. Schor, 478
U.S. 833, 846 (1986) (holding that ``when Congress revisits a
statute giving rise to a longstanding administrative interpretation
without pertinent change, the `congressional failure to revise or
repeal the agency's interpretation is persuasive evidence that the
interpretation is the one intended by Congress''').
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In light of this similar language, commenters have urged us to
follow a territorial approach in applying Title VII to cross-border
security-based swap activity.\134\ We preliminarily agree that a
territorial approach, if properly tailored to the characteristics of
the security-based swap market, should help ensure that our regulatory
framework focuses on security-based swap activity that is most likely
to raise the concerns that Congress intended to address in Title VII,
including the effects of security-based swap activity on the financial
stability of the United States, on the transparency of the U.S.
financial system, and on the protection of counterparties.
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\134\ See, e.g., Cleary Letter IV at 33-37.
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We differ from commenters, however, in our understanding of what a
territorial approach means in the context of a global security-based
swap market. As noted above, some commenters suggested that the
security-based swap activity of foreign branches and affiliates of U.S.
persons with non-U.S. persons occurs outside the United States and has
only an indirect connection with the United States and that, therefore,
subjecting transactions resulting from that activity to Title VII would
involve extraterritorial application of the statute.\135\ Although we
recognize that some of the security-based swap activity involving these
foreign branches and affiliates occur outside the United States, we
believe that a properly tailored territorial approach should look to
both the full range of activities described in the statutory text as
well as to the concerns that Congress intended Title VII to address in
determining whether the relevant activity, considered in its entirety,
occurs at least in part within the United States.\136\
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\135\ See, e.g., Cleary Letter IV at 35; ISDA Letter I at 11;
SIFMA Letter I at 5-6; Sullivan & Cromwell Letter at 11-13.
\136\ See Morrison, 130 S. Ct. at 2884 (looking to the ``focus''
of the relevant statutory provision in determining whether the
statute was being applied to domestic conduct).
---------------------------------------------------------------------------
As noted above, security-based swap transactions differ from most
traditional securities transactions in that they give rise to an
ongoing obligation between the counterparties to the trade: the
counterparties bear the risks that result from those transactions for
the duration of the transactions.\137\ The Dodd-Frank Act was enacted,
in part, to address the risks to the financial stability of the United
States posed by entities bearing such risks, and a territorial approach
to the application of Title VII should be consistent with achieving
these statutory purposes. A territorial approach to the application of
Title VII that excluded from the application of Title VII any activity
conducted by the foreign operations of a U.S. person where they do
business only with non-U.S. counterparties located outside the United
States would likely fail to achieve the financial stability goals of
Title VII, as such an approach would not account for the security-based
swap risks that may be borne by entities located within the United
States whose foreign operations solicit, negotiate, or execute
transactions outside the United States. In addition, it is not clear
that a different territorial approach that focused solely on the
location of the entity bearing the risk (and disregarded whether
certain relevant activity, including execution of the transaction,
occurred within the United States) would adequately address the Dodd-
Frank Act's concern with promoting transparency in the U.S. financial
system and protecting counterparties, concerns that are likely to be
raised by the solicitation, negotiation, or execution within the United
States, even if the risk arising from those security-based swaps
transactions is borne by entities outside the United States. For
example, some transactions characterized by commenters as occurring
outside the United States, even with non-U.S. persons, are entered into
by persons located within the United States and would appear to raise
the same types of risk concerns as transactions occurring wholly within
the United States.
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\137\ See Section II.A, infra.
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Similarly, the Commission preliminarily believes that a territorial
approach should be informed by the text of the statutory provision that
imposes the registration or other regulatory requirement.\138\ Some
commenters suggested, for instance, that a territorial approach would
necessarily exclude certain foreign operations of U.S. persons from
registration as security-based swap dealers so long as they did not
enter into security-based swap transactions with counterparties located
within the United States.\139\ However, in this instance, these
commenters did not show how their suggested approach relates to the
statutory definition of security-based swap dealer or to the rules and
interpretation adopted by the Commission and the CFTC to further define
``security-based swap dealer'' in the Intermediary Definitions Adopting
Release, including our discussion of conduct that is indicative of
dealing activity.\140\ In our preliminary view, we should identify the
activity that the statutory provision regulates before reaching a
determination of whether relevant activity is occurring within the
United States.\141\ Only after we identify the activity that the
statutory provision regulates would we then be able to determine
whether the conduct at issue involves activity that the statutory
provision regulates and whether this conduct occurs within the United
States. To the extent that conduct involving activity that the
statutory provision regulates occurs within the United States,
application of Title VII to that conduct would be consistent with a
territorial approach.
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\138\ See Morrison, 130 S. Ct. at 2884 (performing a textual
analysis of Section 10(b) of the Exchange Act to determine what
conduct was relevant in determining whether the statute was being
applied to domestic conduct).
\139\ See, e.g., Sullivan & Cromwell Letter at 11.
\140\ See note 135, supra; see also Intermediary Definitions
Adopting Release, 77 FR 30616-19.
\141\ See Morrison, 130 S. Ct. at 2884.
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(b) Territorial Approach to Application of Title VII Security-Based
Swap Dealer Registration Requirements
We discuss our application of this approach with respect to each of
the major Title VII registration categories and requirements in
connection with reporting, public dissemination, clearing, and trade
execution for security-based swaps in further detail in the sections
below,\142\ but for sake of illustration, we provide a brief overview
of our territorial approach as it applies to the security-based swap
dealer definition.
---------------------------------------------------------------------------
\142\ See Sections III-VII, infra (discussing each major
registration category), and Sections VIII-IX.A, infra (discussing
certain requirements in connection with reporting and dissemination,
clearing, and trade execution for security-based swaps).
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Section 3(a)(71) of the Exchange Act \143\ defines security-based
swap dealer as a person that engages in any of the following types of
activity:
---------------------------------------------------------------------------
\143\ 15 U.S.C. 78c(a)(71).
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(i) Holding oneself out as a dealer in security-based swaps,
(ii) making a market in security-based swaps,
(iii) regularly entering into security-based swaps with
counterparties as an ordinary course of business for one's own account,
(iv) engaging in any activity causing oneself to be commonly known
in the
[[Page 30985]]
trade as a dealer in security-based swaps.\144\
---------------------------------------------------------------------------
\144\ Section 3(a)(71)(A) of the Exchange Act, 15 U.S.C.
78c(a)(71)(A).
---------------------------------------------------------------------------
We have further interpreted this definition by jointly adopting
interpretive guidance with the CFTC that identifies the types of
activity that is relevant in determining whether a person is a
security-based swap dealer.\145\ In this interpretive guidance, we have
identified indicia of security-based swap dealing activity to include
the following activities:
\145\ See Intermediary Definitions Adopting Release, 77 FR
30617-18.
---------------------------------------------------------------------------
Providing liquidity to market professionals or other
persons in connection with security-based swaps,
seeking to profit by providing liquidity in connection
with security-based swaps,
providing advice in connection with security-based swaps
or structuring security-based swaps,
having a regular clientele and actively soliciting
clients,
using inter-dealer brokers, and
acting as a market maker on an organized security-based
swap exchange or trading system.\146\
---------------------------------------------------------------------------
\146\ Id.
---------------------------------------------------------------------------
As the foregoing list of relevant activities illustrates, both the
statutory text and our interpretation of that text include within the
security-based swap dealer definition a range of activities. The broad
scope of activities listed above identifies various characteristics of
dealing activity. Given the risks associated with dealing activity that
the dealer definition and associated regulatory framework in Title VII
are intended to address, we preliminarily believe that a territorial
approach consistent with these statutory purposes should consider
whether the entity performs any of these indicia of dealing activity
within the United States (even if some of these indicia also arise in
activity conducted outside the United States). This type of analysis
appears to us more consistent with the statutory text and with the
Supreme Court's approach to statutory analysis in its decision in
Morrison than an approach that excludes from jurisdiction certain
foreign operations of U.S. persons transacting with foreign
counterparties. We also believe that our proposed approach would better
help ensure that our regulatory framework achieves the various purposes
of security-based swap dealer regulation under Title VII, while
avoiding application of security-based swap dealer registration to
persons whose dealing activity is unlikely to raise the types of
dealer-specific risks that Title VII dealer registration was intended
to address because it occurs entirely outside the United States.\147\
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\147\ Under our proposed approach to the application of the de
minimis threshold in the cross-border context, non-U.S. persons that
engage in dealing activity with U.S. persons or otherwise within the
United States at levels below the de minimis threshold generally
would also not be required to register as security-based swap
dealers. Such entities are engaged in dealing activity within the
United States, and their dealing activity within the United States
may raise certain concerns addressed by Title VII. However, we
preliminarily believe that, to the extent that this dealing activity
remains at levels below the de minimis threshold, they should be
treated similarly to a U.S. person that engages in dealing activity
at levels below the de minimis threshold. See Section III.B.4,
infra. Like U.S. entities engaged in dealing activity, they may be
required to register under the aggregation requirements the
Commission and the CFTC adopted in the Intermediary Definitions
Adopting Release. See Intermediary Definitions Adopting Release, 77
FR 30631; 17 CFR 240.3a71-2(a)(1). Under the aggregation
requirements we propose below, even entities with security-based
swap dealing activity at levels below the de minimis threshold may
be required to register if the total security-based swap dealing
activity of affiliates under common control (excluding the activity
of any registered affiliates that have independent operations)
exceeds the de minimis threshold. See Section III.B.8, infra.
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Under our proposed territorial approach to the security-based swap
dealer definition, as explained further below, we would require persons
resident or organized in the United States, or with their principal
place of business in the United States, to count all of their dealing
transactions toward their de minimis threshold, including transactions
that arise from dealing activity that occurs in part outside the United
States (for example, because it is negotiated and executed through that
person's foreign branch or office).\148\
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\148\ See Section III.B.4, infra.
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An interpretation of Section 30(c) that advances the view that
security-based swap activity conducted by a U.S. person through a
foreign branch constitutes activity ``without the jurisdiction of the
United States'' or that a transaction arising from such activity
constitutes ``transacting a business in security-based swaps without
the jurisdiction of the United States'' for purposes of Section 30(c)
may not fully account for the statutory definition of ``security-based
swap dealer,'' the purposes of Title VII, or the global nature of the
security-based swap market. It does not account for the entire range of
activities performed by entities active in the security-based swap
market, including security-based swap dealers, and the relevance of
such activities to the statutory definitions and requirements, given
the purposes of Title VII, and it would leave unaddressed significant
levels of activity that poses precisely the sorts of risks that Title
VII was intended to address.
In our preliminary view, to the extent that a U.S. person engages
in dealing activity through a foreign operation that is part of the
U.S. legal person (such as a foreign branch or office), relevant
activity for purposes of the security-based swap dealer definition
occurs, at least in part, within the United States because we believe
it is the U.S. entity as a whole, and not just the foreign branch or
office, that is holding itself out as a dealer and making a market in
security-based swaps. Moreover, it is necessarily the U.S. person as a
whole that is seeking to profit by providing liquidity and engaging in
market-making in security-based swaps, and it is the financial
resources of the entire entity that enable it to provide liquidity and
engage in market-making in connection with security-based swaps. Its
dealing counterparties will look to the entire U.S. person, and not
just the foreign branch or office, for performance on the transaction.
The entire U.S. person assumes, and stands behind, the obligations
arising from the resulting agreement. For these reasons, to the extent
that a dealer resides or is organized, or has its principal place of
business, within the United States, we believe that it cannot hold
itself out as a security-based swap dealer, even through a foreign
branch, as anything other than a single person, given that it generally
could not operate as a dealer absent the financial and other resources
of the entire U.S. person. Its dealing activity with all of its
counterparties, including dealing activity conducted through its
foreign branch or office, is best characterized as occurring, at least
in part, within the United States and should therefore be counted
toward the entity's de minimis threshold.
More generally, we preliminarily believe that transactions that
create ongoing obligations that are borne by a U.S. person are properly
described as directly occurring within the United States, particularly
given Title VII's focus on, among other things, addressing risks to the
financial stability of the United States.\149\ Indeed, the history of
AIG FP confirms that such transactions of U.S. persons can pose risks
to the U.S. financial system even if they are conducted through foreign
operations. The nature of such risks, and their role in the financial
crisis and in the enactment of Title VII, suggest that the statutory
framework established
[[Page 30986]]
by Congress and the objectives of Title VII may require a broader
analysis than excluding transactions involving U.S. persons from the
application of Title VII solely because they are conducted through
operations outside the United States, while others by the same U.S.
persons occur within the United States.\150\
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\149\ As we discuss below, such activity would include providing
guarantees for a foreign entity's security-based swap transactions.
See Section II.B.2(d), infra.
\150\ However, for reasons explained below, the Commission is
not proposing to subject the foreign operations of U.S. persons to
certain of the requirements in Title VII. See, e.g., Sections
III.B.7, III.B.9, VIII.C, IX.C.3(a), and X.B.3(a), infra.
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However, we preliminarily believe that non-U.S. persons engaged in
dealing activity would be required to count toward their de minimis
thresholds only transactions arising from their dealing activity with
U.S. persons \151\ or dealing activity otherwise conducted within the
United States. In addition, to the extent that a non-U.S. person
engages in security-based swap dealing activity within the United
States, we preliminarily believe that such dealing activity should be
counted toward the non-U.S. person's de minimis threshold regardless of
whether its counterparties are U.S. persons.\152\ This view is
consistent with the fact that such security-based swap activity raises
the types of concerns that the Dodd-Frank Act was intended to address.
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\151\ However, for reasons explained below, the Commission is
not proposing to require non-U.S. persons to include transactions
with the foreign branches of U.S. banks in their de minimis
calculations. See Section III.B.7, infra.
\152\ See Intermediary Definitions Adopting Release, 77 FR
30617-18.
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We preliminarily believe that a non-U.S. person not engaged in any
security-based swap activity within the United States (or engaged only
at levels below the de minimis threshold) is unlikely to pose the types
of concerns within the U.S. financial system that Title VII dealer
regulation was intended to address.\153\ Thus, under our proposed
approach, a non-U.S. person that engages in dealing activity entirely
outside the United States (i.e., does not enter into transactions with
a U.S. person or otherwise conduct any part of its dealing activity
within the United States) would not be required to register as a
security-based swap dealer.\154\
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\153\ Proposed Rule 3a71-3(b) under the Exchange Act, as
discussed in Section III.B.4, infra. Of course, the transactions of
an entity engaged in security-based swap dealing activity within the
United States at levels below the de minimis threshold or in
security-based swap activity within the United States that is not
dealing activity may be subject to other Title VII requirements, as
discussed below, or other provisions of the federal securities laws.
\154\ This proposed approach to the application of Title VII
security-based swap dealer registration requirements is not intended
to limit or address the cross-border reach or extraterritorial
application of the antifraud or other provisions of the federal
securities laws.
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(c) Application of Other Title VII Requirements to Registered Entities
We are proposing to apply the Title VII requirements associated
with registration (including, among others, capital and margin
requirements and external business conduct requirements \155\) to the
activities of registered entities to the extent we have determined that
doing so advances the purposes of Title VII.\156\ Although some
commenters suggested that a territorial approach would prohibit the
Commission from applying Title VII to the foreign security-based swap
activities of even registered entities, such an interpretation of the
application of Title VII to registered entities is difficult to
reconcile with the statutory language describing the requirements
applicable to registered security-based swap dealers, with the text of
Section 30(c),\157\ or with the purposes of Title VII and the nature of
risks in the security-based swap market as described above. We have
long taken the view that an entity that has registered with the
Commission subjects itself to the entire regulatory system governing
such registered entities.\158\
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\155\ See Section 15F of the Exchange Act, 15 U.S.C. 78o-10.
\156\ See, e.g., Sections III.C.3 and 4, infra (discussing
requirements applicable to security-based swap dealers).
\157\ Section 30(c) prohibits the application of the Exchange
Act only with respect to those persons that ``transact[] a business
in security-based swaps without the jurisdiction of the United
States.'' Because only security-based swap entities that transact a
business in security-based swaps within the United States would be
required to register under the approach proposed in this release,
registered entities are not persons that ``transact[] a business in
security-based swaps without the jurisdiction of the United
States.''
\158\ See Registration Requirements for Foreign Broker-Dealers,
Exchange Act Release No. 27017 (July 11, 1989), 54 FR 30013, 30016-
17 (July 18, 1989) (``Rule 15a-6 Adopting Release'') (noting that a
foreign registrant is subject to the regulatory system applicable to
such entities); Revision of Form BD, Exchange Act Release No. 25285
(Jan. 22, 1988) (``It is the Commission's view that a broker-dealer
submits to the Commission's jurisdiction when it registers with the
Commission.''); In re International Paper and Power Co., 4 SEC 873,
876 (1939) (registration with the Commission makes registrant
``subject to the complete jurisdiction of the Commission''). See
also Exemption of Certain Foreign Brokers or Dealers, Exchange Act
Release No. 58047 (June 27, 2008), 73 FR 39182 (July 8, 2008)
(``Proposed Amendments to Rule 15a-6''), at 39182 (describing
registration requirements as applying to the entire foreign entity);
In re Ira William Scott, 53 SEC 862, 866 (1998) (holding that
investment adviser that registers with the Commission has
``submitted himself to [the Commission's] jurisdiction pursuant to
the Advisers Act''). Cf. In re United Corp., 232 F.2d 601, 606
(1956) (stating that, upon registration as a holding company, an
entity comes within ``the jurisdiction of the Commission and [is]
subject to all requirements applicable to a registered holding
company'').
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(d) Application of Title VII Regulatory Requirements to Transactions of
Foreign Entities Receiving Guarantees From U.S. Persons
We also are proposing to apply certain Title VII transaction-level
requirements (e.g., mandatory clearing, reporting and dissemination,
and mandatory trade execution of security-based swaps) to certain
transactions involving one or more non-U.S. persons whose performance
under the security-based swaps is guaranteed by a U.S. person. We
discuss the statutory basis for applying specific Title VII
requirements to such transactions in the relevant substantive
discussions below.\159\ In this subsection, we briefly explain why we
believe that a territorial approach that is consistent with the
purposes and text of the Dodd-Frank Act supports the application of
Title VII to such transactions.
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\159\ See Sections VIII-XI, infra.
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In a security-based swap transaction between two non-U.S. persons
where the performance of at least one side of the transaction is
guaranteed by a U.S. person, the guarantee gives the guaranteed
entity's counterparty direct recourse to the U.S. person for
performance of obligations owed by the guaranteed entity under the
security-based swap,\160\ and the U.S. guarantor exposes itself to the
security-based swap risk as if it were a direct counterparty to the
security-based swap through the security-based swap activity engaged in
by the guaranteed entity. As a result, the guarantee creates risk to
the U.S. financial system and counterparties (including U.S.
guarantors) to the same degree as if the transaction were entered into
directly by a U.S. person. In addition, in many cases, the counterparty
would not enter into the transaction (or would not do so on the same
terms) with the guaranteed entity, and the guaranteed entity would not
be able to engage in any security-based swaps, absent the presence of
the guarantee. Given that the guarantee is
[[Page 30987]]
provided by a U.S. person and poses risks to the U.S. financial system,
and considering the reliance by both the guaranteed entity and its
counterparty on the creditworthiness of the guarantor in the course of
engaging in security-based swap transactions and for the duration of
the security-based swap, we preliminarily believe that a transaction
entered into by a non-U.S. person whose performance under the security-
based swap is guaranteed by a U.S. person is within the United States
by virtue of the involvement of the U.S. guarantor in the security-
based swap. Therefore, we preliminarily believe that subjecting such
transactions to Title VII is consistent with our territorial approach.
---------------------------------------------------------------------------
\160\ In discussing the application of the major participant
tests to guaranteed positions in the Intermediary Definitions
Adopting Release, the Commission and the CFTC noted that an entity's
security-based swap positions are attributed to a parent, other
affiliate, or guarantor for purposes of the major participant
analysis to the extent that the counterparties to those positions
have recourse to that parent, other affiliate, or guarantor in
connection with the position. Positions are not attributed in the
absence of recourse. See Intermediary Definitions Adopting Release,
77 FR 30689. As a result, the term ``guarantee'' as used in this
release refers to a contractual agreement pursuant to which one
party to a security-based swap transaction has recourse to its
counterparty's parent, other affiliate, or guarantor with respect to
the counterparty's obligations owed under the transaction.
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(e) Regulations Necessary or Appropriate to Prevent Evasion of Title
VII
As noted above, several commenters expressed the view that Section
30(c) of the Exchange Act restricts the Commission's authority to apply
amendments made to the Exchange Act by Title VII to
``extraterritorial'' conduct. Section 30(c) provides the Commission
with the express authority to prescribe rules and regulations for
persons that transact a business in security-based swaps without the
jurisdiction of the United States to the extent the Commission
determines that doing so is necessary or appropriate to prevent
evasion. Some commenters have expressed the view that this authority
extends to ``extraterritorial'' activity only when such activity is
intended to evade Title VII or to conceal a domestic violation of Title
VII, suggesting that Section 30(c) prohibits application of Title VII
to transactions by foreign affiliates or operations established for a
legitimate business purpose, as the existence of such a purpose is
evidence that the conduct is not intended to be evasive.\161\
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\161\ See, e.g., Cleary Letter IV at 5-6, 7, 18; Sullivan &
Cromwell Letter at 6-7.
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While recognizing the concerns expressed by commenters, the
Commission preliminarily believes that Section 30(c) does not require
the Commission to find actual evasion in order to invoke our authority
to reach activity ``without the jurisdiction of the United States.''
Section 30(c) also does not require that every particular application
of Title VII to security-based swap activity ``without the jurisdiction
of the United States'' address only business that is transacted in a
way that evades Title VII. Section 30(c) authorizes the Commission to
apply Title VII to persons transacting a business ``without the
jurisdiction of the United States'' if they violate rules that the
Commission has prescribed as ``necessary or appropriate to prevent the
evasion of any provision'' of Title VII. The focus of this provision is
not whether such rules impose Title VII requirements only on entities
engaged in evasive activity but whether the rules are generally
``necessary or appropriate'' to prevent evasion of Title VII. In other
words, Section 30(c) permits the Commission to impose prophylactic
rules intended to prevent possible evasion, even if they affect both
evasive and non-evasive conduct. Thus, under our preliminary proposed
interpretation of Section 30(c), the statute permits us to prescribe
such rules to conduct without the jurisdiction of the United States,
even if those rules would also apply to a market participant that has
been transacting business through a pre-existing market structure such
as a foreign branch or guaranteed foreign affiliate established for
valid business purposes, provided the proposed rule or interpretation
is designed to prevent possible evasive conduct.\162\
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\162\ We preliminarily believe that the proposed rules or
interpretations set forth in this release are not being applied to
persons who are ``transact[ing] a business in security-based swaps
without the jurisdiction of the United States,'' within the meaning
of Section 30(c). See Section II.B.2(a), supra. However, as noted
below, the Commission also preliminarily believes that the proposed
rules or interpretations are necessary or appropriate to help
prevent the evasion of the provisions of the Exchange Act that were
added by the Dodd-Frank Act and prophylactically will help ensure
that the particular purposes of the Dodd-Frank Act addressed by the
rule or interpretation are not undermined. See, e.g., note 558,
infra.
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C. Principles Guiding Proposed Approach to Applying Title VII in the
Cross-Border Context
In considering how to apply Title VII in the cross-border context,
the Commission has been mindful of the global nature of the security-
based swap market and the types of risks created by security-based swap
activity to the U.S. financial system and market participants, as well
as the needs of a well-functioning security-based swap market.\163\ We
also have been guided by the purpose of the Dodd-Frank Act \164\ and
the applicable requirements of the Exchange Act, including the
following:
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\163\ See Sections II.A.1-II.A.3, supra.
\164\ See note 4, supra.
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Risk to the U.S. Financial System--The Dodd-Frank Act was
intended to promote, among other things, the financial stability of the
United States by limiting/mitigating risks to the financial
system.\165\
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\165\ See id.
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Transparency--The Dodd-Frank Act was intended to promote
transparency in the U.S. financial system.\166\
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\166\ See id.
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Counterparty Protection--The Dodd-Frank Act adds
provisions to the Exchange Act relating to counterparty protection,
particularly with respect to ``special entities.'' \167\
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\167\ See Section 15F(h) of the Exchange Act, as added by
Section 764(a) of the Dodd-Frank Act, in particular.
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Economic Impacts--The Exchange Act requires the Commission
to consider the impact of our rulemakings on efficiency, competition,
and capital formation.\168\
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\168\ Specifically, Section 3(f) of the Exchange Act provides:
``Whenever pursuant to this title the Commission is engaged in
rulemaking, . . .; required to consider or determine whether an
action is necessary or appropriate in the public interest, the
Commission shall also consider, in addition to the protection of
investors, whether the action will promote efficiency, competition,
and capital formation.'' Section 23(a)(2) of the Exchange Act also
provides: ``The Commission . . ., in making rules and regulations
pursuant to any provisions of this title, shall consider among other
matters the impact any such rule or regulation would have on
competition. The Commission . . . shall not adopt any such rule or
regulation which would impose a burden on competition not necessary
or appropriate in furtherance of the purposes of [the Exchange
Act].''
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Harmonization with Other U.S. Regulators--In connection
with implementation of Title VII, the Dodd Frank Act requires the
Commission to consult and coordinate with the CFTC and prudential
regulators to ensure ``regulatory consistency and comparability, to the
extent possible.'' \169\
---------------------------------------------------------------------------
\169\ See Section 712(a)(2) of the Dodd-Frank Act.
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Consistent International Standards--To promote effective
and consistent global regulation of swaps and security-based swaps, the
Dodd-Frank Act requires the Commission and the CFTC to consult and
coordinate with foreign regulatory authorities on the ``establishment
of consistent international standards'' with respect to the regulation
of swaps and security-based swaps.\170\ In this regard, the Commission
recognizes that regulators in other jurisdictions are currently engaged
in implementing their own regulatory reforms of the OTC derivatives
markets and that our proposed application of Title VII to cross-border
activities may affect the policy decisions of these other regulators as
they seek to address potential conflicts or duplication in the
regulatory requirements that apply to
[[Page 30988]]
market participants under their authority.\171\
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\170\ See Section 752(a) of the Dodd-Frank Act. In this regard,
some commenters have encouraged the Commission to consider
international comity when applying Title VII in the cross-border
context. See note 225, infra.
\171\ For example, subjecting non-U.S. persons to Title VII may
prompt a foreign jurisdiction to respond by subjecting U.S. persons
to the foreign jurisdiction's regulatory regime. However,
substituted compliance of the type proposed in this release or other
mechanisms may address potential conflicts or duplication arising
from overlapping regulatory requirements.
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Anti-Evasion--The Dodd-Frank Act amends the Exchange Act
to provide the Commission with authority to prescribe rules and
regulations as necessary or appropriate to prevent the evasion of any
provision of the Exchange Act that was added by the Dodd-Frank
Act.\172\
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\172\ See Section 30(c) of the Exchange Act, 15 U.S.C. 78dd(c),
as discussed in Section II.B, supra.
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At times these principles reinforce one another; at other times
they compete with each other. For instance, attempts to regulate risk
posed to the United States may, depending on what is proposed, make it
more costly for U.S.-based firms to conduct security-based swap
business, particularly in foreign markets, compared to foreign firms,
or could make foreign firms less willing to deal with U.S. persons. On
the other hand, attempts to provide U.S. persons greater access to
foreign security-based swap markets may, depending on what is proposed,
fail to appropriately address the risk posed to the United States from
transactions conducted outside the United States or create
opportunities for market participants to evade the application of Title
VII, particularly until such time as global initiatives to regulate the
derivatives markets are fully enacted and implemented.
Balancing these sometimes competing principles is complicated by
the fact that Title VII imposes a new regulatory regime on a
marketplace that already exists as a functioning, global market. Title
VII establishes reforms that will have implications for entities that
compete internationally in the global security-based swap market. As we
have formulated our proposal, we have generally sought, in accordance
with the statutory factors described above, to avoid creating
opportunities for regulatory arbitrage or evasion or the potential for
duplicative or conflicting regulations. We also have considered the
needs for a well-functioning security-based swap market and for
avoiding disruption that may reduce liquidity, competition, efficiency,
transparency, or stability in the security-based swap market.
D. Conclusion
Consistent with the principles and requirements outlined above, we
are proposing to structure our implementation of Title VII around an
approach that focuses on identifying market participants whose presence
or activity within the United States or activity involving market
participants within the United States may give rise to the types of
risk to the U.S. financial system and counterparties that Title VII
seeks to address, as described more fully below in the subsequent
sections of the release.
Request for Comment
The Commission requests comment on all aspects of the discussion
and analysis above, including the following:
Is our understanding of the global nature of the security-
based swap market accurate? If not, why not? Please elaborate.
Is our understanding of the dealing structures used by
U.S. and non-U.S. persons accurate? If not, why not? Are there other
dealing structures used by market participants? If so, please
elaborate.
Is our understanding of clearing, reporting, and trade
execution practices accurate? If not, why not? Please elaborate.
As discussed above in Section II.B.1, some commenters
recommend a narrower approach to the cross-border application of Title
VII than this proposal sets forth. We request further comment on these
and any other potential alternative approaches to determining the
extent to which Title VII should be applied to cross-border
transactions, non-U.S. persons, and registered entities.
III. Security-Based Swap Dealers
A. Introduction
Among the market participants subject to regulation under Title VII
as a result of their security-based swap activities are security-based
swap dealers.\173\ As discussed above, a ``security-based swap dealer''
generally is defined as any person that (i) Holds itself out as a
dealer in security-based swaps; (ii) makes a market in security-based
swaps; (iii) regularly enters into security-based swaps with
counterparties as an ordinary course of business for its own account;
or (iv) engages in any activity causing the person to be commonly known
in the trade as a dealer or market maker in security-based swaps.\174\
The Commission, jointly with the CFTC, issued final rules and
interpretive guidance to further define the term security-based swap
dealer,\175\ including rules implementing the de minimis
exception.\176\ As part of these final rules and interpretive guidance,
the Commission stated that the relevant statutory provisions suggest
that, rather than focusing solely on the risk these entities pose to
the financial markets, we should interpret the ``security-based swap
dealer definition in a way that identifies those persons for which
regulation is warranted either: (i) [D]ue to the nature of their
interactions with counterparties; or (ii) to promote market stability
and transparency, in light of the role those persons occupy within the
security-based swap markets.'' \177\ Security-based swap dealers are
subject to a comprehensive regulatory regime under Title VII. The
statutory provisions added to the Exchange Act by Title VII are
intended to provide for financial responsibility associated with
security-based swap dealers' activities (e.g., the ability to satisfy
obligations and the protection of counterparties' funds and assets),
and other counterparty protections, as well as market stability and
transparency.\178\
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\173\ See Section 764(a) of the Dodd-Frank Act, codified as
Section 15F of the Exchange Act, 15 U.S.C. 78o-10. See also Section
IV, infra (discussing major security-based swap participants).
\174\ See Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71), as added by Section 761(a) of the Dodd-Frank Act; see
also Section II.B.2(b), supra.
\175\ See Intermediary Definitions Adopting Release, 77 FR
30596; 17 CFR 240.3a71-1.
\176\ Section 3(a)(71)(D) of the Exchange Act, 15 U.S.C.
78c(a)(71)(D), provides that ``[t]he Commission shall exempt from
designation as a security-based swap dealer an entity that engages
in a de minimis quantity of security-based swap dealing in
connection with transactions with or on behalf of its customers. The
Commission shall promulgate regulations to establish factors with
respect to the making of this determination to exempt.'' This
provision is implemented in Rule 3a71-2 under the Exchange Act (17
CFR 240.3a71-2), as discussed in the Intermediary Definitions
Adopting Release, 77 FR 30626-43.
\177\ Intermediary Definitions Adopting Release, 77 FR 30617.
\178\ See Intermediary Definitions Adopting Release, 77 FR
30608; see also Section III.C.1, infra (discussing substantive
requirements applicable to security-based swap dealers).
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By its terms, application of the security-based swap dealer
definition set forth in Section 3(a)(71) of the Exchange Act \179\ does
not depend on whether a security-based swap dealer or its counterparty
is a U.S. person.\180\ Rather, the security-based swap dealer
definition encompasses persons engaged in security-based swap dealing
activities without regard to the geographic location or legal residence
of either the dealing person or such person's counterparties. The
Commission did not provide guidance on the application of the security-
based swap dealer definition to non-U.S. persons or to U.S. persons
that conduct dealing activities
[[Page 30989]]
in the cross-border context in either our proposed or final rules.\181\
As discussed above \182\ and as further discussed below, market
participants, foreign regulators, and other interested parties have
raised concerns regarding, among other things, the application of Title
VII to non-U.S. persons that engage in security-based swap dealing
activity and U.S. persons who conduct dealing activities ``outside the
United States.'' \183\
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\179\ 15 U.S.C. 78c(a)(71).
\180\ See Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71); 17 CFR 240.3a71-1.
\181\ See Intermediary Definitions Adopting Release, 77 FR
30596; Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' Exchange Act
Release No. 63452 (Dec. 7, 2010), 75 FR 80174 (Dec. 21, 2010)
(``Intermediary Definitions Proposing Release'').
\182\ See Section II.B, supra.
\183\ See Section III.B.3, infra.
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The rules and interpretations described below represent the
Commission's proposed approach to applying the security-based swap
dealer definition to non-U.S. persons and to U.S. persons who conduct
dealing activities in the cross-border context in light of the
principles discussed above.\184\ Our proposal reflects a particular
balancing of these principles, informed by, among other things, the
particular nature of the security-based swap market,\185\ the structure
of security-based swap dealing activity,\186\ and our experience in
applying the federal securities laws in the cross-border context in the
past.\187\ We recognize that other approaches are possible to achieve
the goals of the Dodd-Frank Act, in whole or in part. Accordingly, we
invite comment regarding all aspects of the proposal described below,
and each proposed rule and interpretation contained therein, including
potential alternative approaches. Data and comment from market
participants and other interested parties regarding the likely effect
of each proposed rule and interpretation and potential alternative
approaches will be particularly useful to the Commission in evaluating
possible modifications to the proposal.
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\184\ See Section II.C, supra.
\185\ See Section II.A, supra.
\186\ See Section II.A.2, supra.
\187\ See Section III.B.2, infra.
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B. Registration Requirement
1. Introduction
In the Intermediary Definitions Adopting Release, which was adopted
jointly with the CFTC, the Commission set forth a de minimis threshold
of security-based swap dealing that takes into account the notional
amount of security-based swap positions connected with a person's
security-based swap dealing activity over the prior 12 months.\188\
When a person engages in security-based swap dealing in connection with
transactions above that threshold, such person meets the definition of
a security-based swap dealer under Section 3(a)(71) of the Exchange
Act,\189\ and the rules and regulations thereunder,\190\ and is
required to register as a security-based swap dealer with the
Commission pursuant to Section 15F(a)(1) of the Exchange Act.\191\
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\188\ See Intermediary Definitions Adopting Release, 77 FR
30626-43. The de minimis threshold was adopted by the Commission in
the Intermediary Definitions Adopting Release to implement a
statutory exclusion from the security-based swap dealer definition
found in Section 3(a)(71)(D) of the Exchange Act. See note 176,
supra. The de minimis threshold is defined in terms of a notional
amount of security-based swap positions connected with dealing
activity in which a person engages over the course of the
immediately preceding 12 months. An entity engaged in security-based
swap dealing activity in connection with security-based swap
transactions with or on behalf of its customers below the de minimis
threshold amount is exempt from designation as a security-based swap
dealer. See Intermediary Definitions Adopting Release, 77 FR 30626.
\189\ 15 U.S.C. 78c(3)(a)(71).
\190\ 17 CFR 240.3a71-1 and 240.3a71-2.
\191\ Section 15F(a)(1) of the Exchange Act provides that ``[i]t
shall be unlawful for any person to act as a security-based swap
dealer unless the person is registered as a security-based swap
dealer with the Commission.'' 15 U.S.C. 78o-10(a)(1). A person that
engages in security-based swap dealing activity in connection with
transactions with or on behalf of customers in excess of the de
minimis threshold falls within the security-based swap dealer
definition, and such person must register as a security-based swap
dealer pursuant to Section 15F(a)(1). By contrast, persons that fall
within the statutory definitions of a broker and dealer in Sections
3(a)(4) and (5) of the Exchange Act, 15 U.S.C. 78c(a)(4) and (a)(5),
are required to register with the Commission only if they make use
of the ``mails or any means or instrumentality of interstate
commerce to effect any transactions in, or to induce or attempt to
induce the purchase or sale of, any security. . . . '' Section
15(a)(1) of the Exchange Act, 15 U.S.C. 78o(a)(1).
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The de minimis exception in Section 3(a)(71) of the Exchange Act is
silent on its application to the cross-border security-based swap
dealing activity of U.S. persons and non-U.S. persons, and the
Commission did not address this issue in the Intermediary Definitions
Adopting Release.\192\ Without additional Commission guidance, it would
be unclear how persons would be required to calculate the notional
amount of their security-based swaps for purposes of the de minimis
exception based on their global book of security-based swap dealing
activity. In addition, as discussed below, commenters have raised
questions regarding how the de minimis threshold should be applied in
the cross-border context, expressing concern that, among other things,
if a non-U.S. person were required to register as a security-based swap
dealer with the Commission because its security-based swap dealing
activity exceeded the de minimis threshold, it might be subject to
duplicative and potentially conflicting requirements by the Commission
and a foreign jurisdiction.\193\
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\192\ See Intermediary Definitions Adopting Release, 77 FR 30628
n.407 (indicating that the Commission and the CFTC intended to
address the application of the Title VII dealer regime to non-U.S.
persons in separate releases).
\193\ See Section III.B.2, infra.
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Under the Commission's proposal, as described more fully in the
following subsections of this release, a non-U.S. person \194\ would be
required to register as a security-based swap dealer with the
Commission pursuant to Section 15F(a)(1) of the Exchange Act \195\ if
the notional amount of security-based swap positions connected with its
security-based swap dealing activity \196\ with U.S. persons (other
than with foreign branches of U.S. banks) \197\ or otherwise conducted
within the United States \198\ exceeds the de minimis threshold in the
security-based swap dealer definition.\199\ Thus, a non-U.S. person
with a global security-based swap dealing business, but whose positions
connected with its security-based swap dealing activity with U.S
persons (other than with foreign branches of U.S. banks) or otherwise
conducted within the United States fall below the de minimis threshold,
would not be required to register with the Commission as a security-
based swap dealer.\200\ A U.S. person, by contrast, would be required
to count all of its security-based swap transactions (including
transactions conducted
[[Page 30990]]
through a foreign branch),\201\ conducted in a dealing capacity, toward
the de minimis threshold to determine whether it would be required to
register as a security-based swap dealer with the Commission pursuant
to Section 15F(a)(1) of the Exchange Act.\202\
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\194\ Proposed Rule 3a71-3(a)(7) under the Exchange Act
(defining ``U.S. person''), as discussed in Section III.B.5, infra.
\195\ 15 U.S.C. 78o-10(a)(1).
\196\ See note 188, supra.
\197\ Proposed Rule 3a71-3(a)(1) under the Exchange Act
(defining ``foreign branch''), as discussed in Section III.B.7,
infra.
\198\ Proposed Rule 3a71-3(a)(5) under the Exchange Act
(defining ``transaction conducted within the United States''), as
discussed in Section III.B.6, infra. This provision would capture
dealing activity undertaken by non-U.S. persons that are physically
located within the United States, such as through a U.S. branch of a
foreign bank, or through an agent, such as non-U.S. person's U.S.
subsidiary or an unaffiliated third party acting on the non-U.S.
person's behalf. As discussed elsewhere in the release, foreign
security-based swap dealers utilize these organizational models as
part of their global security-based swap dealing businesses. See
Section II.A.2, supra (discussing dealing structures), and Section
III.D, infra (discussing intermediation).
\199\ Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act.
\200\ But see Section III.B.9, infra (discussing the aggregation
of affiliate positions).
\201\ Proposed Rule 3a71-3(a)(4) under the Exchange Act
(defining ``transaction conducted through a foreign branch''), as
discussed in Section III.C.4, infra.
\202\ Proposed Rule 3a71-3(b)(1)(i) under the Exchange Act.
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As further discussed below, however, we are not proposing to
require a non-U.S. person engaged in security-based swap dealing
activity to count a transaction with a non-U.S. person conducted
outside the United States toward its de minimis threshold, even if its
performance (or the performance of its counterparty) on the security-
based swap is guaranteed by a U.S. person.\203\ In addition, in
conformity with the position that the Commissions took in the
Intermediary Definitions Adopting Release,\204\ we are not proposing to
require cross-border security-based swap transactions between majority-
owned affiliates to be considered when determining whether a person is
a security-based swap dealer.\205\
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\203\ See Section III.B.8, infra. However, such U.S. guarantor
may become a major security-based swap participant by virtue of the
guarantee it extends on the performance of the obligations under the
transaction. See Section IV.C.2, infra. In addition, a security-
based swap entered into by a non-U.S. person whose performance under
such security-based swap is guaranteed by a U.S. person would be
required to be reported and, in certain cases, publicly
disseminated, under re-proposed Regulation SBSR. See Section VIII.C,
infra. Such security-based swap also may be subject to the clearing
and trade execution requirements in Title VII. See Sections IX and
X, infra.
\204\ See Intermediary Definitions Adopting Release, 77 FR
30624-25.
\205\ See Section III.B.8, infra.
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In the following subsections, we first briefly discuss the
Commission's approach to the registration of foreign brokers and
dealers, as background, and the views of commenters on the application
of Title VII to cross-border activities, particularly as such views
relate to security-based swap dealing activity. Then we propose a rule
regarding the application of the de minimis exception to cross-border
security-based swap dealing activity.\206\ In order to give further
definition to this proposed rule, we are proposing rules defining a
number of relevant terms, including ``U.S. person'' \207\ and
``transaction conducted within the United States.''\208\ We also are
proposing a rule excluding from a non-U.S. person's de minimis
calculation security-based swap transactions entered into, in a dealing
capacity, with a foreign branch of a U.S. bank.\209\ In addition, we
are proposing a rule providing an exception from the aggregation
requirement, in the context of the security-based swap dealer
definition, for affiliated groups with a registered security-based swap
dealer.\210\ Finally, we are proposing interpretive guidance regarding
and requesting comment on the treatment of inter-affiliate and
guaranteed transactions in the cross-border context for purposes of the
de minimis threshold.\211\
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\206\ Proposed Rule 3a71-3(b) under the Exchange Act, as
discussed in Section III.B.4, infra.
\207\ Proposed Rule 3a71-3(a)(7) under the Exchange Act, as
discussed in Section III.B.5, infra. The proposed definition of U.S.
person is used not only in the proposed rule regarding the
application of the de minimis threshold in the cross-border context,
but also in proposed rules discussed in subsequent sections of the
release.
\208\ Proposed Rule 3a71-3(a)(5) under the Exchange Act, as
discussed in Section III.B.6, infra. Like the proposed definition of
U.S. person, the definition of ``transaction conducted within the
United States'' is used not only in the proposed rule regarding the
application of the de minimis threshold in the cross-border context,
but also in proposed rules discussed in subsequent sections of the
release. In general, under the Commission's proposal, transactions
conducted within the United States, as defined in the proposed rule,
would trigger certain transaction-level requirements in Title VII.
See Sections VIII-X, infra.
\209\ Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act; see
also proposed Rule 3a71-3(a)(1) under the Exchange Act (defining
``foreign branch''), as discussed in Section III.B.7, infra.
\210\ Proposed Rule 3a71-4 under the Exchange Act, as discussed
in Section III.B.8, infra.
\211\ See Section III.B.8, infra.
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2. Background Discussion Regarding the Registration of Foreign Brokers
and Dealers
Under the Commission's traditional approach to the registration of
brokers and dealers under the Exchange Act, registration and other
requirements generally are triggered by a broker or dealer physically
operating in the United States, even if such activities are directed
only to non-U.S. persons outside the United States.\212\ The
Commission's territorial approach also generally requires broker-dealer
registration by foreign brokers or dealers that, from outside the
United States, induce or attempt to induce securities transactions by
persons within the United States.\213\ By contrast, the Commission has
not required foreign entities to register as broker-dealers if they
conduct their ``sales activities'' entirely outside the United
States.\214\
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\212\ See Rule 15a-6 Adopting Release, 54 FR 30016-17 (``As a
policy matter, the Commission now uses a territorial approach in
applying the broker-dealer registration requirements to the
international operations of broker-dealers. Under this approach, all
broker-dealers physically operating within the United States that
effect, induce, or attempt to induce any securities transactions
would be required to register as broker-dealers with the Commission,
even if these activities were directed only to foreign investors
outside the United States.''); see also Proposed Amendments to Rule
15a-6, 73 FR 39182 (``Under this [territorial] approach, broker-
dealers located outside the United States that induce or attempt to
induce securities transactions with persons in the United States are
required to register with the Commission, unless an exemption
applies'').
\213\ See Rule 15a-6 Adopting Release, 54 FR 30016 (``[E]ven if
section 30(b) [of the Exchange Act] were read to incorporate a
territorial approach, the Commission does not believe that section
30(b) would exempt from broker-dealer registration the activities
suggested by the commenters. In particular, directed selling efforts
to U.S. investors in the United States hardly could be considered
activities not traversing the U.S. territorial limits. A broker-
dealer operating outside the physical boundaries of the United
States, but using the U.S. mails, wires, or telephone lines to trade
securities with U.S. persons located in this country, would not be,
in the words of section 30(b), `transact[ing] a business in
securities without the jurisdiction of the United States.' '').
\214\ See Rule 15a-6 Adopting Release, 54 FR 30016 (citing
Exchange Act Release No. 25801, 53 FR 23646 n.9, and accompanying
text).
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In addition to our territorial approach to registration of broker-
dealers under the Exchange Act, the Commission traditionally has taken
an ``entity'' approach to the application of regulation to registered
broker-dealers.\215\ Pursuant to this approach, we have not limited the
application of the Exchange Act, and rules and regulations thereunder,
solely to the transactions of such entities that result in the
registration requirement. Instead, we have taken the position that a
registered broker-dealer is generally subject to registration and
consequent substantive requirements with respect to all of its
securities activity, including the activity of its branches and
offices, regardless of whether the activity occurs in the United States
or with U.S. persons.\216\ For instance, under this approach, if a
foreign broker-dealer is required to register with the Commission as a
result of conducting securities activity through a branch in the United
States, the registration requirements and the regulatory system
governing U.S. broker-dealers, including capital, margin, and
recordkeeping requirements, would apply to the entire foreign broker-
dealer entity, including its head office, not just the U.S.
branch.\217\ By contrast, the Commission
[[Page 30991]]
traditionally has not extended our regulatory oversight of broker-
dealers to the activities of their corporate parents, subsidiaries, or
other affiliates.\218\
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\215\ See Rule 15a-6 Adopting Release, 54 FR 30017 (``Also, the
Commission uses an entity approach with respect to registered
broker-dealers''); see also Proposed Amendments to Rule 15a-6, 73 FR
39182 (``Because this territorial approach applies on an entity
level, not a branch level, if a foreign broker-dealer establishes a
branch in the United States, broker-dealer registration requirements
would extend to the entire foreign broker-dealer entity.'').
\216\ As noted above, this is consistent with the approach we
have taken in other contexts under the federal securities laws. See
note 158, supra.
\217\ See Rule 15a-6 Adopting Release, 54 FR 30017.
\218\ See id. (``If the foreign broker-dealer establishes an
affiliate in the United States, however, only the affiliate must be
registered as a broker-dealer; the foreign broker-dealer parent
would not be required to register.''); see also Proposed Amendments
to Rule 15a-6, 73 FR 39182. As discussed in Section III.B.89, infra,
this is consistent with the approach that the Commission is
proposing to take in the context of security-based swap dealer
registration.
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The Commission's approach to registration and regulation of foreign
broker-dealers thus extends Commission oversight to the global
activities of non-U.S.-based securities market intermediaries that are
registered broker-dealers because of their securities activities with
U.S. persons or that physically operate within the United States.\219\
In recognition of the internationalization of securities markets,
however, the Commission has used available exemptive authority to
tailor rules and regulations to the specific circumstances of foreign
markets and market participants. For example, we used our exemptive
authority under Section 15(a)(2) of the Exchange Act to adopt Rule 15a-
6 under the Exchange Act (``Rule 15a-6''),\220\ which provides limited
exemptions from registration to foreign brokers or dealers engaging in
securities transactions, or offering to engage in securities
transactions, within the United States or with U.S. persons, subject to
certain conditions.\221\
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\219\ See Rule 15a-6 Adopting Release, 54 FR 30017.
\220\ 17 CFR 240.15a-6.
\221\ See Rule 15a-6 Adopting Release, 54 FR 30013. As discussed
below, some commenters have suggested that the Commission use an
approach that would be modeled after the approach the Commission has
applied to foreign broker-dealers in Rule 15a-6 to address issues
related to cross-border security-based swap transactions and foreign
security-based swap dealers.
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3. Comment Summary
(a) Market Participants
As noted above, various commenters expressed concerns about the
``extraterritorial'' application of Title VII, and many of these
commenters expressed particular concerns about the possible
extraterritorial application of security-based swap dealer regulation
and registration requirements.\222\ In addition to concerns described
above regarding the application of Title VII to cross-border security-
based swap activity,\223\ commenters noted that the derivatives
industry functions in a global market and that new regulations pose the
potential to disrupt this market if they do not take into account the
nature of the industry and the appropriate extraterritorial reach of
the regulations.\224\ A consistent theme in many of these comment
letters was the importance of taking into account the principles of
international comity in limiting the extraterritorial reach of the
proposed rules, including entering into coordination agreements with
our foreign regulatory counterparts on the jurisdictional reach of U.S.
and foreign derivatives rules.\225\
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\222\ See e.g., ACP/AMF Letter, BaFin Letter, Cleary Letter IV,
Davis Polk Letter I, Davis Polk Letter II, IIB Letter, ISDA Letter
I, Japanese Banks Letter, JFSA Letter I, Newedge Letter, Rabobank
Letter, Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter I, SIFMA
Letter, Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter II,
Sullivan & Cromwell Letter, and TCX Letter.
\223\ See Section II.B, supra.
\224\ See Section II.B, supra; see also ISDA Letter I at 17
(urging that the new regulations be implemented so as to not distort
the current global derivatives market that functions ``within a
relatively level international playing field,'' and noting that to
address concerns related to competition and conflicts between
various regulators and regulations ``[i]t is imperative that U.S.
and non-U.S. regulators must coordinate requirements to avoid
unintended impediments to, and fragmentation of, the derivatives
markets'').
\225\ See, e.g., Davis Polk Letter II at 12 (recommending that
in implementing Title VII regulations, ``the Commissions and the
Federal Reserve should also give effect to the general
jurisdictional limits specified in Sections 722 and 772 of the Dodd-
Frank Act in a manner that is consistent with the principle of
international comity evident in the statute and general legal
principles governing statutory construction pertaining to
extraterritorial and international matters''); Soci[eacute]t[eacute]
G[eacute]n[eacute]rale Letter I at 8, 11 (recommending U.S. and
foreign counterparts to work toward a memorandum of understanding on
the jurisdictional reach of U.S. and EU derivatives rules and
warning that without cooperation between the U.S. and foreign
regulators the result could be ``regulatory retaliation'' whereby
``the [s]waps market could devolve into regulatory chaos, thereby
increasing systemic risk''); Newedge Letter at 10-12 (expressing
concern that requiring foreign firms to register as swaps dealers or
major swap participants in the U.S. ``could result in foreign
regulators taking retaliatory action against U.S. firms engaging in
swap activities with non-U.S. persons domiciled within their
physical borders'' and that any regulation of foreign firms not
physically present in the United States that are already subject to
foreign regulations is unnecessary and would violate principles of
international comity).
---------------------------------------------------------------------------
For example, a number of commenters recommended that the Commission
take a territorial approach in determining when a person engaging in
security-based swap dealing activity would be required to register with
the Commission as a security-based swap dealer, generally recommending
registration of an entity for its security-based swaps dealing activity
from within the United States or with regard to its dealings with U.S.
counterparties.\226\ Several commenters further suggested that a non-
U.S. person's de minimis amount of swap activities with U.S. persons
should not trigger security-based swap dealer registration.\227\ Some
commenters expressed the view that the Commission's cross-border
framework should seek to avoid imposing duplicative regulation and
unnecessary cost on entities that are already regulated in a foreign
jurisdiction.\228\ Some commenters have suggested that the Commission
use an approach that would be modeled after the approach the Commission
has applied to foreign broker-dealers in Rule 15a-6 to address issues
related to cross-border security-
[[Page 30992]]
based swap transactions and foreign security-based swap dealers.\229\
---------------------------------------------------------------------------
\226\ See, e.g., Sullivan & Cromwell Letter at 11 (``The SEC
has, in the past, plainly stated that it uses a territorial approach
in applying broker-dealer registration requirements to international
operations. Only those broker-dealers who induce, or attempt to
induce, securities transactions with persons in the United States
would be required to register.''); MFA Letter II at 15-16
(commenting that the proposed security-based swap dealer and major
security-based swap participant rules do not appear to encompass
trading outside of the U.S. between non-U.S. entities or non-U.S.
affiliates of U.S. entities, and adding that the rules also should
not capture the non-U.S. affiliates of U.S. investment managers that
advise offshore funds, or non-U.S.-domiciled funds that have U.S.
investment managers but trade in swaps referencing non-U.S.
securities or on a non-U.S. market, considering that foreign
regulators will have jurisdiction over the non-U.S. activities of
U.S. entities); IIB Letter at 9 (urging the Commission to adopt an
interpretation that a ``reference to a U.S. underlier or reference
entity in a swap conducted outside the U.S. [is not] a sufficient
connection to the U.S. to subject either counterparty to U.S. Swap
Dealer registration requirements''); Newedge Letter at 2 (suggesting
that foreign entities engaging in swaps transactions ``with US
persons should not be required to register as swaps dealers or major
swaps participants in the US to the extent they are not physically
located in the US and are subject to a comparable regulatory
regime'').
\227\ See, e.g., Sullivan & Cromwell Letter at 2, 8
(acknowledging that a foreign entity's swaps transactions with U.S.
persons in excess of the de minimis amount, ``if otherwise covered
by the definitions, [should] be required to register'' as a swaps
entity, but suggesting that swaps activities with U.S. persons
within ``any de minimis amount authorized by the final rules and in
transactions with their U.S. affiliates for purposes of risk
management'' should not trigger swaps entity registration); TCX
Letter at 6 (``We are concerned that, should TCX become subject to
swap dealer registration notwithstanding the arguments presented
above, the de minimis exception as proposed in the [Intermediary
Definitions Proposing Release] has been drafted too narrowly to be
of any practical use to TCXIM or to any other similarly-situated
offshore entity with limited US swaps business. In particular, we
urge the Commission to clarify that an offshore entity's swaps with
US counterparties, excluding non-US subsidiaries of US entities,
must be counted when determining if the de minimis exemption is
available.'').
\228\ See, e.g., IIB Letter at 7 (suggesting that the
``Commissions should establish a framework for cross-border swap
activities that preserves and leverages the strengths of existing
market practices and home country supervision and regulation'' and
``avoid a framework that is duplicative, inefficient (for
supervisors and market participants) and would result in unrealistic
extraterritorial supervisory responsibilities for the Commissions
and potential fragmentation of the derivatives markets'').
\229\ See, e.g., Davis Polk Letter I at 11 n.17 (``This model is
similar to the mode of operation permitted by Rule 15a-6 under the
Securities Exchange Act of 1934, pursuant to which foreign broker-
dealers interface with U.S. customers under arrangements with
affiliated or non-affiliated broker-dealers without themselves
registering as broker-dealers in the U.S.''); Cleary Letter IV at 22
(``Accordingly, as one alternative, we suggest that the Commissions
adopt an approach that is modeled on the Commissions' existing
regimes, permitting non-U.S. swap dealers to transact with U.S.
persons without registering in the U.S. if those transactions are
intermediated by a U.S.-registered swap dealer. This would be
consistent with the approach adopted by the SEC under Rule 15a-6 and
prior interpretative precedents with respect to non-U.S. securities
dealers.'').
---------------------------------------------------------------------------
For purposes of analyzing the appropriate definition of U.S. person
in the security-based swap dealer context, several commenters suggested
that the Commission look to rules adopted under the Securities Act and
adopt a definition of U.S. person based on Regulation S under the
Securities Act (``Regulation S'').\230\ Some commenters stated the view
that under Regulation S, only affiliates or branches located within the
United States would be considered U.S. persons.\231\ Some commenters
argued that a foreign affiliate of a U.S. person and non-U.S. branches
of a U.S. bank should be treated as non-U.S. persons and, depending on
their dealing activity, not be required to register as security-based
swap dealers because such entities may not have direct and significant
connection with, or effect on, U.S. commerce.\232\ One commenter
further argued that a non-U.S. affiliate of a U.S. person, in its
insolvency, is subject to separate resolution from its parent, and thus
should be treated as a non-U.S. entity.\233\
---------------------------------------------------------------------------
\230\ See 17 CFR 230.901(k). See, e.g., Cleary Letter IV at 2,
6-9; Davis Polk Letter I at note 6.
\231\ See, e.g., Cleary Letter IV at 7 (stating that
``Regulation S does not include as a `U.S. person' the non-U.S.
branch or affiliate of a U.S. or non-U.S. person; only affiliates or
branches located in the U.S. are covered''); SIFMA Letter at 5
(stating that (``It is noteworthy that the Regulation S definition
of U.S. person does not include non-U.S. affiliates of U.S. persons
or non-U.S. branches of a U.S. bank. . . .'').
\232\ See, e.g., Sullivan & Cromwell Letter at 2-3, 6-9 (arguing
against the extraterritorial application to foreign affiliates of a
U.S. person, stating that when a foreign entity's ``counterparty to
a transaction is a non-U.S. affiliate of a U.S. person,'' the
transactions are ``removed from the U.S. stream of commerce. As a
result, there is no `direct' effect on U.S. commerce and it is
highly unlikely that the transactions would have any significant
effect on U.S. commerce''); ISDA Letter I at 11 (stating that ``Non-
U.S. entities (including non-U.S. affiliates and branches of U.S.
banks) should not be required to register as Dealers where they are
conducting business with non-U.S. counterparties.'').
\233\ See Cleary Letter IV at 7 (``The non-U.S. affiliate of a
U.S. person is, in its own insolvency or that of its parent,
typically subject to separate resolution from its parent and other
affiliates'').
---------------------------------------------------------------------------
Several commenters stated that a foreign branch or office of a U.S.
person also should be treated as a non-U.S. person, despite the fact
that, as a few commenters acknowledged, foreign branches of U.S. banks
are not separate legal entities from their U.S. head office and
typically are not separately capitalized, although in some cases they
may be subject to certain local capital or reserve maintenance
requirements.\234\ Several commenters suggested that broker-dealer
registration, not security-based swap dealer registration, may be more
appropriate for a U.S. branch, agency, or affiliate that acts as an
agent of a non-U.S. person for security-based swaps transactions.\235\
---------------------------------------------------------------------------
\234\ See, e.g., Cleary Letter IV at 7 (arguing that
``[a]lthough bank branches are not usually separately capitalized,''
they should not be considered U.S. persons because their operations
are subject to separate local licensing, examination, and books and
records requirements); SIFMA Letter I at 15 n.37 (``We acknowledge
that Title VII capital requirements cannot be applied at the branch-
level and, therefore, must be applied at the bank level.'');
Sullivan & Cromwell Letter at 16 (remarking that ``foreign branches
have long been allowed to engage in a wider range of activities than
are their U.S. head offices and have benefitted from the presumption
against applying U.S. law extraterritorially'' despite the fact that
``foreign branches of U.S. banks are not corporate entities separate
and apart from their bank parents'').
\235\ See, e.g., IIB Letter at 10 (suggesting that a U.S.-based
person who acts as an agent for a non-U.S. person in soliciting or
negotiating security-based swap transactions with counterparties
located outside of the U.S. should register as a broker-dealer);
Rabobank Letter at 3 (recommending that U.S. affiliates who help to
arrange swaps transactions with U.S. persons should ``register as
futures commissions merchants or introducing brokers, broker-
dealers, or swap dealers depending upon their respective roles in
soliciting transactions, receiving customer margin, performing
delegated compliance functions, effecting transactions as an agent
on exchanges and swap execution facilities and in OTC markets, or
clearing customer transactions''); cf. Newedge Letter at 1-2
(asserting that broker-dealers and foreign entities subject to
comparable regulations who ``engage principally in customer
[security-based] swap facilitation activities'' should not be
subject to security-based swap dealer and major security-based swaps
participant registration requirements because they already are
``subject to stringent rules relating to capital, risk, margin and
other requirements by virtue of their registration status''; and
alternatively, suggesting that registrants who ``execute swaps
solely in response to customer orders and that hedge each such
transactions individually . . . should be exempt since, among other
things, their trading poses little or no risk to themselves, their
customers or the markets generally.'').
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Several commenters acknowledged concerns that persons may seek to
book transactions through non-U.S. branches or subsidiaries in an
effort to evade the requirements of Title VII.\236\ These commenters,
however, urged that the Commissions not seek to address the potential
for evasion through an overbroad definition of a security-based swap
dealer, noting that there are legitimate business reasons for
conducting security-based swap transactions with non-U.S. persons
through non-U.S. operations.\237\
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\236\ See, e.g., Sullivan & Cromwell Letter at 10 (``We
understand the concerns that the Commission may have that persons
would seek to book transactions through non-U.S. branches or
subsidiaries in order to evade the requirements of the CEA or
Exchange Act.'').
\237\ See, e.g., Sullivan & Cromwell Letter at 9-10 (expressing
understanding for the Commissions' evasion concerns, but noting that
U.S. companies have legitimate business reasons for establishing
their non-U.S. operations, including requirements in some foreign
jurisdictions that only local banks and local branches of foreign
banks may engage in swap activities); Cleary Letter IV at 5-7
(noting legitimate business reasons for establishing non-U.S.
operations abroad, and stating that the Commissions ``should not
adopt an extraterritorial regulatory framework premised on the
assumption that activities conducted outside the U.S. will be
undertaken for the purpose of evasion'').
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(b) Foreign Regulators
Foreign regulators have reached out to the Commission through
correspondence and bilateral and multilateral discussions to better
understand the approach being considered by the Commission, to express
concern about the potential impact of potential approaches on their
markets, and to seek regulatory coordination.\238\ One of the principal
concerns of foreign regulators is that the Commission would require
foreign entities to register with the Commission and subject them to
regulatory requirements that are duplicative of, or potentially
conflict with, the requirements imposed by their home country or host
country.\239\ In their view, the Commission's application of Title VII
requirements to foreign entities in jurisdictions that commit to
developing or have developed similar OTC derivatives regulations would
fail to acknowledge, under general principles of international comity,
the effectiveness, suitability, and scope of foreign regulatory regimes
and place undue regulatory burdens on foreign
[[Page 30993]]
entities that conduct security-based swap business with U.S.
persons.\240\
---------------------------------------------------------------------------
\238\ See, e.g., BaFIN Letter at 1-2 (``Close cooperation of our
respective authorities, accompanied by a Memorandum of
Understanding, might help to establish an adequate regulatory
environment for the swap activities of US and German entities and to
provide the confidence that the respective national legislation is
adequately recognized and complied with.'').
\239\ See, e.g., JFSA Letter I at 1-2 (requesting that Japanese
financial institutions be exempted from ``Swap Dealer'' and ``Major
Swap Participant'' registration under the Dodd-Frank Act); BaFIN
Letter at 1 (``The obligations for foreign banks should be
proportionate and take into account equivalent requirements in their
home jurisdiction.''). See also ECB Letter at 2 (expressing concern
about the ``possible inconsistency between US and EU legislation
with respect to differing rules on exempting public international
institutions . . . from the clearing and reporting obligation.'').
\240\ See Asian-Pacific Regulators Letter at 4.
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Such concerns from foreign regulators include comments that U.S.
regulators should not ask financial institutions domiciled in their
jurisdictions to register as security-based swap dealers because this
would create undesirable redundancies for those financial institutions
that are already regulated in the foreign jurisdiction.\241\ Certain
foreign regulators also argued that the Commission should not regulate
foreign subsidiaries of U.S. security-based swap dealers because these
entities would already be regulated by a foreign regulator.\242\ Some
foreign regulators expressed the expectation that the Commission would
limit the registration of foreign banks as security-based swap dealers
to operations conducting activities with U.S. counterparties or clients
and would not apply the registration and regulation requirements to
foreign banks as a whole.\243\
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\241\ See, e.g., JFSA Letter I at 1 (``If these institutions
were also to be regulated under US DFA framework, this will create
an undesirable and redundant effect on these Japanese
institutions.'').
\242\ See, e.g., ACP/AMF Letter at 1-32 (``[W]e strongly support
. . . a mutual recognition regime built around an adequate and
balanced symmetrical system taking into account the home and the
host country regulatory regimes. Thus . . . we expect that [the
registration of non-resident entities] will be limited to activities
in relation with US counterparties and/or clients and will not
involve similar obligations to the financial organizations as a
whole. The obligations for non-resident entities should indeed be
proportionate and take into [account] equivalent requirements in
their home jurisdiction.'').
\243\ See, e.g., BaFIN Letter at 1 (``Without questioning the
registration of foreign banks, I suppose that such registration will
be limited to activities in relation with US counterparties and/or
clients and will not involve similar obligations to foreign banks as
a whole'').
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4. Application of the De Minimis Exception to Cross-Border Security-
Based Swap Dealing Activity
The Commission recognizes the concerns raised by commenters
regarding the potential for imposing inconsistent or conflicting
requirements on security-based swap dealers with global operations, as
well as their desire that the Commission take into account the
principles of international comity when applying Title VII to cross-
border dealing activity. After considering the goals of the Dodd-Frank
Act and the scope of the provisions of Title VII covering security-
based swap dealers, in light of the global nature of the security-based
swap market, the various structures of dealing operations, and the
views of commenters, the Commission is proposing an approach to the
application of the Title VII registration requirement to cross-border
security-based swap dealing activity that focuses on whether dealing
conduct occurs with U.S. persons or otherwise occurs within the United
States.
Specifically, as explained below, the Commission is proposing to
require a non-U.S. person engaged in security-based swap dealing
activity to register with the Commission as a security-based swap
dealer pursuant to Section 15F(a)(1) of the Exchange Act \244\ if the
notional amount of security-based swap transactions connected with its
dealing activity with U.S. persons (other than with foreign branches of
U.S. banks) \245\ or otherwise conducted within the United States \246\
exceeds the de minimis threshold in the security-based swap dealer
definition.\247\ A U.S. person engaged in security-based swap dealing
activity would be required to count all security-based swap
transactions connected with its dealing activity toward the de minimis
threshold, including transactions conducted through a foreign
branch.\248\
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\244\ 15 U.S.C. 78o-10(a)(1).
\245\ Proposed Rule 3a71-3(a)(7) under the Exchange Act
(defining ``U.S. person''), as discussed in Section III.B.5, infra;
proposed Rule 3a71-3(a)(1) under the Exchange Act (defining
``foreign branch''), as discussed in Section III.B.7, infra.
\246\ Proposed Rule 3a71-3(a)(5) under the Exchange Act
(defining ``transaction conducted within the United States''), as
discussed in Section III.B.6, infra.
\247\ Proposed Rule 3a71-3(b) under the Exchange Act; see also
17 CFR 240.3a71-2.
\248\ See id.
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(a) Meaning of the Term ``Person'' in the Security-Based Swap Dealer
Definition
As a preliminary matter, we note that, as the Commission discussed
in the Intermediary Definitions Adopting Release, the term ``person''
as used in the security-based swap dealer definition should be
interpreted to refer to a particular legal person.\249\ Accordingly, a
trading desk, department, office, branch, or other discrete business
unit that is not a separately organized legal person would not be
viewed as a security-based swap dealer (regardless of where located);
rather, the legal person of which it is a part would be the security-
based swap dealer.\250\ Similarly, the term ``person'' in the
Commission's rules implementing the de minimis exception should be
interpreted to refer to a particular legal person.\251\
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\249\ See Intermediary Definitions Adopting Release, 77 FR
30624. Section 3(a)(9) of the Exchange Act defines ``person'' as ``a
natural person, company, government, or political subdivision,
agency, or instrumentality of a government.'' 15 U.S.C. 78c(a)(9);
see also proposed Rule 3a71-3(a)(7) under the Exchange Act (defining
``U.S. person''), as discussed in Section III.B.5, infra.
\250\ This approach is consistent with the Commission's
discussion in the Intermediary Definitions Adopting Release
regarding the entity-level designation of security-based swap
dealers. 77 FR 30624. It also generally is consistent with the
Commission's traditional entity approach to the registration of
broker-dealers, as discussed in Section III.B.2, supra.
\251\ See 17 CFR 240.3a71-2; proposed Rule 3a71-3(b) under the
Exchange Act.
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Thus, the security-based swap dealer definition would apply to the
particular legal person performing the dealing activity, even if that
person's dealing activity is limited to a trading desk or discrete
business unit.\252\ The presumption is that a person who falls within
the security-based swap dealer definition is a dealer with regard to
all of its security-based swap activities.\253\ As a result, a legal
person with a branch, agency, or office that is engaged in dealing
activity in connection with transactions above the de minimis threshold
would be required to register as a security-based swap dealer, even if
the legal person's dealing activity were limited to such branch,
agency, or office. By contrast, each affiliate of a security-based swap
dealer would need to separately consider whether it falls within the de
minimis exception if that affiliate engages in security-based swap
dealing activity.\254\
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\252\ Within an affiliated group of companies, only those legal
persons that engage in dealing activities will be designated as
dealers; that designation will not be imputed to other non-dealer
affiliates or to the group as a whole. A single affiliate group may
have multiple swap or security-based swap dealers. See Intermediary
Definitions Adopting Release, 77 FR 30624-25. But see Section
III.B.8, infra (discussing aggregation).
\253\ The definition of security-based swap dealer provides that
a person may be designated as a security-based swap dealer for a
single type or class or category of security-based swaps or
activity, and not others. See Section 3(a)(71)(B) of the Exchange
Act, 15 U.S.C. 78c(71)(B); 17 CFR 240.3a71-1(c) (``A person that is
a security-based swap dealer in general shall be deemed to be a
security-based swap dealer with respect to each security-based swap
it enters into, regardless of the type, class, or category of the
security-based swap or the person's activities in connection with
the security-based swap, unless the Commission limits the person's
designation as a security-based swap dealer to specified types,
classes, or categories of security-based swaps or specified
activities of the person in connection with security-based
swaps.''). See note 588, infra.
Although the Commission is not proposing to designate non-U.S.
persons as security-based swap dealers in a limited capacity, the
Commission's proposed approach would limit the application of
certain transaction-level requirements to the ``U.S. Business'' of
foreign security-based swap dealers. See Section III.C.4, infra.
\254\ See Section III.B.8, infra (discussing inter-affiliate
transactions), and Section III.B.8, infra (discussing aggregation).
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(b) Proposed Rule
We are proposing a rule identifying the types of security-based
swap transactions that should be included in
[[Page 30994]]
a person's calculation of the notional amount of security-based swap
transactions connected with dealing activity for purposes of
determining whether the de minimis exception excludes that dealer from
the security-based swap dealer definition.\255\ The proposed rule
confirms that all of a U.S. person's security-based swap transactions
conducted in a dealing capacity would count toward its de minimis
threshold, wherever those transactions are solicited, negotiated,
executed, or booked.\256\ Although we recognize that some commenters
have suggested that the Commission should not require U.S. persons to
include positions connected with dealing activity conducted through
foreign branches in calculating the amount of their dealing
activity,\257\ we are not proposing to adopt this approach. The
security-based swap dealing activity of a foreign branch is activity of
the U.S. legal person regardless of the role played by the foreign
branch or the location of the security-based swap dealing activity. We
believe that any dealing activity undertaken by a U.S. person occurs at
least in part within the United States and therefore warrants
application of Title VII, regardless of where particular dealing
activity in connection with the transactions is conducted.\258\ The
security-based swap dealing activity of a U.S. person creates risk to
the U.S. person and to the U.S. financial system, because the risk of
such transactions ultimately is borne by the U.S. person, even if the
transactions in connection with that dealing activity are conducted in
part outside the United States, and because the U.S. person is part of
the U.S. financial system.\259\ To achieve the purposes of Title VII,
including the reduction of systemic risk, we preliminarily believe that
U.S. persons that engage in security-based swap dealing activity
through foreign branches should be subject to the regulatory framework
for dealers established by Congress in Title VII, even if they deal
exclusively with non-U.S. persons.
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\255\ Proposed Rule 3a71-3(b) under the Exchange Act. Appendix B
to this release contains a table that identifies whether a potential
security-based swap dealer would be required to count a transaction
with a specific type of counterparty toward its de minimis
threshold. The table in Appendix B is only a summary of the rules
and interpretations proposed in this release that is provided for
ease of reference; it does not supersede, and should be read in
conjunction with, the proposed rules and interpretations.
\256\ Proposed Rule 3a71-3(b)(1)(i) under the Exchange Act. As
noted above, as used in this release, ``security-based swap
dealing,'' ``security-based swap dealing activity,'' ``dealing
activity,'' and related concepts have the meanings described in the
Intermediary Definitions Adopting Release, 77 FR 30596, unless
otherwise indicated in this release. Such dealing activity is
normally carried out through interactions with counterparties or
potential counterparties, which includes solicitation, negotiation,
or execution of a security-based swap.
\257\ See, e.g., Sullivan and Cromwell Letter, at 9-11.
\258\ See notes 231 and 234, supra. As noted in Section II.A.3
above, the security-based swap transactions of U.S. persons,
wherever entered into, give rise to ongoing obligations that may
affect the financial stability of the United States and thus present
the type of risk that Title VII was intended to address.
\259\ These risk concerns may be greater for uncleared security-
based swap than for cleared security-based swaps where the U.S.
person would not retain the credit risk of its counterparty;
however, cleared security-based swaps still represent an importation
of risk into the U.S. financial system when entered into by U.S.
persons because in the context of cleared security-based swaps, the
U.S. persons would be exposed to the credit, financial, and
operational risks of the clearing agency.
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By contrast, a non-U.S. person would be required to consider only
the security-based swap transactions connected with its dealing
activity with U.S. persons (other than foreign branches of U.S. banks)
\260\ or otherwise conducted within the United States \261\ for
purposes of the de minimis exception.\262\ Under this proposed
approach, a non-U.S. person would be required to calculate its
security-based swap position for purposes of the de minimis threshold
by adding together the notional amount of transactions connected with
dealing activity with U.S. persons (other than foreign branches of U.S.
banks) \263\ or otherwise conducted within the United States.\264\ As a
result, a foreign entity with a global security-based swap dealing
business, but whose transactions connected with its dealing activity
with U.S. persons (other than foreign branches of U.S. banks) or
otherwise conducted within the United States fall under the de minimis
threshold, would not fall within the security-based swap dealer
definition and, therefore, would not be required to register as a
security-based swap dealer.\265\
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\260\ Proposed Rule 3a71-3(a)(7) under the Exchange Act
(defining ``U.S. person''), as discussed in Section III.B.5;
proposed Rule 3a71-3(a)(1) under the Exchange Act (defining
``foreign branch''), as discussed in Section III.B.7, infra.
\261\ Proposed Rule 3a71-3(a)(5) under the Exchange Act
(defining ``transaction conducted within the United States''), as
discussed in Section III.B.6, infra. Proposed Rule 3a71-3(a)(9)
under the Exchange Act defines ``United States'' as ``the United
States of America, its territories and possessions, any States of
the United States, and the District of Columbia.'' The proposed
definition of ``United States'' is consistent with the definition of
that term in other contexts in the federal securities laws. See,
e.g., 17 CFR 230.902(l); 17 CFR 240.15a-6(b)(6).
\262\ Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act.
\263\ See Section III.B.7, infra (discussing the exception from
the de minimis threshold for transactions by foreign dealers with
foreign branches of U.S. banks).
\264\ Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act. For
purposes of the de minimis threshold, the U.S. person-status of a
non-U.S. person's counterparty would be relevant only at the time of
a transaction that arises out of the non-U.S. person's dealing
activity. Any change in a counterparty's U.S. person status after
the transaction is executed would not affect that transaction's
treatment for purposes of the de minimis exception, though it would
affect the treatment of any subsequent dealing transactions with
that counterparty. See also Product Definitions Adopting Release, 77
FR 48286 (``If the material terms of a Title VII instrument are
amended or modified during its life based on an exercise of
discretion and not through predetermined criteria or a predetermined
self-executing formula, the Commissions view the amended or modified
Title VII instrument as a new Title VII instrument'').
\265\ See 17 CFR 240.3a71-2(a). The Commission notes that, to
the extent that a non-U.S. person does not conduct dealing activity
within the United States or with U.S. persons (or to the extent that
the volume of positions connected with such dealing activity does
not exceed the de minimis threshold discussed below), it would not
be required to register with the Commission as a security-based swap
dealer under Section 15F(a)(1) of the Exchange Act regardless of the
volume of non-dealing security-based swap transactions it has within
the United States or with U.S. persons. See Intermediary Definitions
Adopting Release, 77 FR 30631. Such an entity still would be subject
to the major security-based swap participant thresholds with respect
to its non-dealing security-based swap transactions. However, once a
non-U.S. person's transactions with U.S. persons (other than foreign
branches of U.S. banks) or otherwise conducted within the United
States involve dealing activity that exceeds the de minimis
threshold, that person would be required to register as a security-
based swap dealer and would be subject to the statutory requirements
applicable to security-based swap dealers for all of its security-
based swap transactions. See Intermediary Definitions Adopting
Release, 77 FR 30645.
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This approach to the de minimis exception for non-U.S. persons
engaged in cross-border dealing activity preliminarily appears to us to
focus appropriately on a non-U.S. person's security-based swap dealing
activity in the United States. In addition, this proposed approach,
when combined with our broader approach to the registration and
regulation of foreign security-based swap dealers, appears to us to
appropriately focus our oversight on those non-U.S. persons engaged in
security-based swap dealing activities that most directly impact the
U.S. security-based swap market and U.S. financial system and that,
therefore, warrant the application of the provisions of Title VII
covering security-based swap dealers.\266\
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\266\ The Commission understands that entities such as foreign
central banks, international financial institutions, multilateral
development banks, and sovereign wealth funds (``SWFs'') (together,
``foreign public sector financial institutions'' or ``FPSFIs'')
rarely enter into security-based swap transactions in a dealing
capacity. As such, we believe that the proposed approach outlined in
this release would sufficiently address the dealer registration
concerns of these entities. The Commission is soliciting comment on
whether our proposal sufficiently addresses the concerns of FPSFIs
and whether our understanding of the security-based swap activity of
such entities is accurate. See also Section III.B.5(b)iv, infra
(discussing international organizations).
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[[Page 30995]]
The Commission is not proposing, as some commenters have suggested,
an approach modeled on Rule 15a-6(a)(3), which would permit non-U.S.
persons to conduct security-based swap dealing activity with U.S.
persons without registering with the Commission if such dealing
activity were intermediated by a registered security-based swap
dealer.\267\ The Commission preliminarily believes that such an
approach would not address the risk to the U.S. financial system by
dealing activity of non-U.S. persons within the United States or with
U.S. persons. As a dealer, the non-U.S. person would be the party to
the security-based swap transaction and, therefore, the party that
bears the financial risk of such transaction and whose financial
integrity is of primary concern to the Commission. This concern is
heightened by the fact, noted above, that, unlike most other securities
transactions, security-based swap transactions give rise to ongoing
obligations between the transaction counterparties.\268\ Under the
alternative suggested, the important financial responsibility
requirements that Title VII imposes on security-based swap dealers
would not apply to the non-U.S. person with respect to that
transaction. Instead, the intermediating registered security-based swap
dealer would be subject to the financial responsibility rules with
respect to the transaction, but since it would not be a party to, and
would not bear the financial risk of, the security-based swap
transaction, it would not bear the ongoing financial risk of such
transaction. As a result, the financial responsibility requirements
imposed on the intermediating dealer would not address the dealing risk
posed by the non-U.S. person in this context.\269\
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\267\ See note 229, supra.
\268\ See Section II.A.3, supra.
\269\ The Commission also is not proposing a dealer-to-dealer
exception modeled on Rule 15a-6(a)(4)(i) (providing that a foreign
broker or dealer shall be exempt from the registration requirements
of Section 15(a)(l) or 15B(a)(l) of the Exchange Act to the extent
that the foreign broker or dealer effects transactions in securities
with or for, or induces or attempts to induce the purchase or sale
of any security by ``[a] registered broker or dealer, whether the
registered broker or dealer is acting as principal for its own
account or as agent for others, or a bank acting in a broker or
dealer capacity as permitted by U.S. law'').
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Request for Comment
The Commission requests comment on all aspects of the proposed rule
regarding the application of the de minimis exception to U.S. persons
and non-U.S. persons, including the following:
Should the proposed rule limit the de minimis test to the
notional amount of a U.S. person's positions connected with its dealing
activity involving transactions with other U.S. persons or otherwise
conducted within the United States? For example, should the proposed
rule be altered to provide that U.S. banks would not include the
notional amount of transactions connected with the dealing activity of
their foreign branches in the de minimis calculation, rather than
counting these transactions against the de minimis threshold as
required under the proposed approach? Why or why not?
Should the proposed rule require non-U.S. persons to count
transactions with the foreign branches of U.S. banks towards their de
minimis calculations? Why or why not?
Should the proposed rule follow an approach modeled on
Rule 15a-6(a)(3), which would permit non-U.S. persons to conduct
security-based swap dealing activity within the United States without
registering with the Commission if those transactions were
intermediated by a registered U.S. security-based swap dealer? If so,
what compliance obligations, if any, should the unregistered non-U.S.
person be subject to? What obligations should the U.S. security-based
swap dealer be subject to with respect to such intermediated
transactions, particularly with respect to capital, margin, and
segregation requirements? How would this approach deal with risk
concerns, especially with any security-based swaps not subject to
clearing?
Should the proposed rule follow an approach modeled on
Rule 15a-6(a)(4)(i), which would permit non-U.S. persons to conduct
security-based swap dealing activity within the United States without
registering with the Commission if those transactions were with a
registered U.S. security-based swap dealer? If so, what conditions, if
any, should the Commission impose on such an exception?
Should non-U.S. persons acting in a dealing capacity be
required to count transactions entered into with registered security-
based swap dealers toward their de minimis threshold? Why or why not?
If non-U.S. persons are not required to count security-based swap
transactions, conducted in a dealing capacity, with registered
security-based swap dealers, should U.S. persons be required to count
security-based swap transactions, conducted in a dealing capacity, with
registered security-based swap dealers? If not, why not? If so, why?
The CFTC has proposed an interpretation that would require
a non-U.S. person to consider the aggregate notional value of its swap
dealing transactions (or any swap dealing transactions of its
affiliates under common control) where the non-U.S. person's
obligations are guaranteed by a U.S. person.\270\ Should the proposed
rule require a non-U.S. person whose security-based swap transactions
are guaranteed by a U.S. person to count all of its security-based swap
dealing transactions that are guaranteed by a U.S. person toward the de
minimis threshold, even if they are not entered into with U.S. persons
or otherwise conducted within the United States?
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\270\ See CFTC Cross-Border Proposal, 77 FR 41221.
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Should the proposed rule require counting against the de
minimis threshold the notional amount of a non-U.S. person's
transactions entered into in its dealing capacity within the United
States or with a U.S. person? Should a non-U.S. person be required
instead to aggregate the total worldwide notional amount of its
security-based swap transactions entered into in a dealing capacity,
regardless of the geographic location of the dealing activity or the
counterparty's status as a U.S. person if it engages in any dealing
transactions with U.S. persons? Why or why not?
What circumstances, if any, would justify requiring a non-
U.S. person to register with the Commission if its dealing activity
arising from its transactions with non-U.S. persons outside the United
States would exceed the de minimis threshold if it had been conducted
within the United States or with U.S. persons but the non-U.S. person
enters into transactions within the United States or with U.S. persons
solely in a non-dealing capacity?
What circumstances would justify following a different
territorial approach that would treat transactions connected with the
dealing activity conducted by a U.S. person through its foreign
locations with non-U.S. persons as outside the United States and not
required to be counted against such U.S. person's de minimis threshold?
Does the Commission's proposed approach adequately address
the concerns of FPSFIs? Is our understanding of the security-based swap
activity of FPSFIs accurate? If not, please explain.
What would be the market impact of the proposed approach
to apply the de minimis exception in the cross-border context? How
would the proposed application of the de minimis
[[Page 30996]]
exception to U.S. persons and non-U.S. persons affect the
competitiveness of U.S. entities in the global marketplace (both in the
United States as well as in foreign jurisdictions)? Would the proposed
approach place any market participants at a competitive disadvantage or
advantage? If so, please explain. Would the proposed approach be a more
general burden on competition? If so, please explain. What other
measures should the Commission consider to implement the de minimis
exception? What would be the market impacts and competitiveness effects
of alternatives to the proposed approach discussed in this release?
5. Proposed Definition of ``U.S. Person''
Introduction
The proposed rule defining ``U.S. person'' would identify a
person's status as a U.S. person for purposes of applying the
calculation for the de minimis exception in the cross-border
context.\271\ The proposed definition of U.S. person generally follows
an approach to defining U.S. person similar to that used by the
Commission in other contexts.\272\ Specifically, the proposed rule
would define U.S. person to mean any of the following:
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\271\ Proposed Rule 3a71-3(a)(7) under the Exchange Act. The
definition of ``U.S. person'' also is used in other proposed rules
and interpretive guidance discussed below. See Sections IV-XI,
infra.
\272\ See, e.g., Regulation S Adopting Release, 55 FR 18308
(``The Regulation adopted today is based on a territorial approach
to Section 5 of the Securities Act.''). Although the proposed rule
generally follows the same approach as Regulation S, the Commission
preliminarily believes that it is necessary to depart from
Regulation S in certain respects. See Section III.B.10, infra
(comparing the proposed definition of ``U.S.'' person with the
definition of ``U.S. person'' in Regulation S). Notably, neither the
Exchange Act nor Rule 15a-6 contains a definition of U.S. person.
The proposed definition of U.S. person is similar to the
definition of U.S. person that the CFTC staff provided its October
12, 2012 no-action letter. See Time-Limited No-Action Relief: Swaps
Only With Certain Persons to be Included in Calculation of Aggregate
Gross Notional Amount for Purposes of Swap Dealer De Minimis
Exception and Calculation of Whether a Person is a Major Swap
Participant (Oct. 12, 2012), available at: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-22.pdf; see also
Final CFTC Cross-Border Exemptive Order, 78 FR 862 (indicating that
for purposes of its temporary conditional relief the CFTC is taking
a similar approach to the U.S. person definition as that set forth
in the October 12, 2012 no-action letter).
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Any natural person resident in the United States;
Any partnership, corporation, trust, or other legal person
organized or incorporated under the laws of the United States \273\ or
having its principal place of business in the United States; or
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\273\ Proposed Rule 3a71-3(a)(9) under the Exchange Act defines
``United States'' as ``the United States of America, its territories
and possessions, any States of the United States, and the District
of Columbia.''
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Any account (whether discretionary or non-discretionary)
of a U.S. person.\274\
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\274\ Proposed Rule 3a71-3(a)(7)(i) under the Exchange Act.
The proposed rule also would provide that the term ``U.S. person''
would not include the following international organizations: The
International Monetary Fund (``IMF''), the International Bank for
Reconstruction and Development, the Inter-American Development Bank,
the Asian Development Bank, the African Development Bank, the United
Nations, and their agencies and pension plans, and any other similar
international organizations, their agencies and pension plans.\275\
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\275\ Proposed Rule 3a71-3(a)(7)(ii) under the Exchange Act.
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We preliminarily believe that the proposed definition of U.S.
person would achieve three objectives necessary to effective
application of Title VII in the cross-border context. First, it would
identify those types of individuals or entities that, by virtue of
their location within the United States or their legal or other
relationship with the United States, are likely to impact the U.S.
market even if they transact with security-based swap dealers that are
not U.S. persons.\276\ Second, it would identify those types of
individuals or entities that, by virtue of their location within the
United States or their legal or other relationship with the United
States, are part of the U.S. security-based swap market and should
receive the protections of Title VII. Third, it would permit us to
identify dealing entities that most likely would be active in the U.S.
security-based swap market and whose dealing activity most likely would
pose a risk to the U.S. financial system by virtue of their
counterparties' resident or domicile status.
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\276\ As noted in Section II.A.3 above, the security-based swap
transactions of U.S. persons give rise to ongoing liability that is
borne by a person located within the United States and thus are
likely to pose the types of financial stability risks to U.S.
financial system that Title VII was intended to address. The
security-based swap activity of U.S. persons occurs, at least in
part, within the United States.
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Because of the nature of the risks posed by security-based swaps,
which are borne by the entire corporate entity even if the transaction
is entered into by a specific trading desk, office, or branch of such
entity, consistent with the Commission's approach to the meaning of
``person'' in the security-based swap dealer definition, as discussed
above, we are proposing to define the term ``U.S. person'' to include
the entire entity, including its branches and offices that may be
located in a foreign jurisdiction.\277\ Thus, under this approach, the
term ``U.S. person'' would be interpreted to include any foreign
trading desk, office, or branch of an entity that is organized under
U.S. law or whose principal place of business is located in the United
States.\278\
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\277\ See Section III.B.4(a), supra.
\278\ Id.
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(b) Discussion
i. Natural Persons
Under the proposed rule, any natural person resident in the United
States would be a U.S. person, regardless of that individual's
citizenship status.\279\ Individuals resident abroad, on the other
hand, would not be treated as U.S. persons, even if they possess U.S.
citizenship.\280\ We preliminarily believe that natural persons
residing within the United States who engage in security-based swap
transactions may raise the types of concerns intended to be addressed
by Title VII, including those related to transparency and customer
protection.\281\ We also note that this approach is generally
consistent with the approach we have taken in prior rulemakings
relating to the cross-border application of certain similar regulatory
requirements.\282\ Moreover, any risk to such person arising from its
security-based swap activity may manifest itself most directly within
the United States, where a significant portion of its commercial and
legal relationships exist because that is where its residency is
(unlike a U.S. citizen resident abroad).
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\279\ Proposed Rule 3a71-3(a)(7)(i)(A) under the Exchange Act.
\280\ This proposed approach to treating natural persons as U.S.
persons based on residency, rather than citizenship, differs from
the proposed approach to legal entities, such as partnerships and
corporations, discussed below.
\281\ See note 4, supra.
\282\ See Rule 15a-6 Adopting Release, 54 FR 30017 (providing
that foreign broker-dealers soliciting U.S. investors abroad
generally would not be subject to registration requirements with the
Commission).
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ii. Corporations, Organizations, Trusts, and Other Legal Persons
Under the proposed rule, any partnership, corporation, trust, or
other legal person organized or incorporated under the laws of the
United States \283\ or having as its principal place of business in the
United States would be a U.S. person.\284\ We have previously looked to
an entity's place of
[[Page 30997]]
organization or incorporation to determine whether it is a U.S. person
in adopting rules under the federal securities laws,\285\ and we
preliminarily believe that it is also appropriate to do so in the
context of Title VII. We preliminarily believe that the decision of a
corporation, trustee, or other entity to organize under the laws of the
United States indicates a degree of involvement in the U.S. economy or
legal system that warrants ensuring that its security-based swap
activity is subject to the requirements of Title VII.\286\
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\283\ Proposed Rule 3a71-3(a)(9) under the Exchange Act
(defining ``United States'').
\284\ Proposed Rule 3a71-3(a)(7)(i)(B) under the Exchange Act.
\285\ See Regulation S Adopting Release, 55 FR 18316.
\286\ Under this prong of the proposed rule, ``special
entities,'' as defined in Section 15F(h)(2)(C) of the Exchange Act,
would be U.S. persons because they are legal persons organized under
the laws of the United States. Section 15F(h)(2)(C) of the Exchange
Act defines the term ``special entity'' as ``(i) a Federal agency;
(ii) a State, State agency, city, county, municipality, or other
political subdivision of a State; (iii) any employee benefit plan,
as defined in Section 3 of the Employee Retirement Income Security
Act of 1974, 29 U.S.C. 1002; (iv) any governmental plan, as defined
in Section 3 of the Employee Retirement Income Security Act of 1974,
29 U.S.C. 1002; or (v) any endowment, including an endowment that is
an organization described in Section 501(c)(3) of the Internal
Revenue Code of 1986.'' 15 U.S.C. 78o-10(h)(2)(C).
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Similarly, we believe that the proposed definition should ensure
that Title VII applies to entities that are organized or incorporated
in a jurisdiction outside the United States if they have their
principal place of business in the United States.\287\ Any risk to such
entities arising from their security-based swap activity is likely to
manifest itself most directly within the United States, where a
significant portion of their commercial and legal relationships would
be likely to exist. Moreover, focusing exclusively on whether an entity
is organized or incorporated in the United States could encourage some
entities that are currently organized or incorporated in the United
States to incorporate in a non-U.S. jurisdiction to avoid the costs of
complying with Title VII while maintaining their principal place of
business--and thus in all likelihood, the risks arising from their
security-based swap transactions--within the United States. To prevent
this possibility, we are proposing to define ``U.S. person'' to include
entities that are organized or incorporated abroad but have their
principal place of business within the United States.\288\
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\287\ For example, a business may be incorporated under the laws
of a foreign jurisdiction but nonetheless have its business
operations, including its home office, in the United States.
\288\ As discussed in Section III.B.6 below, the Commission also
is proposing to require non-U.S. persons that conduct security-based
swap transactions within the United States, in a dealing capacity,
to count such transactions toward their de minimis threshold. In
addition, the Commission is proposing to subject security-based swap
transactions that are conducted within the United States to certain
transaction-level requirements in Title VII in connection with
reporting and dissemination, clearing, and trade execution. See
Sections VIII-X, infra.
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An entity's status as a U.S. person under the proposed rule would
be determined at the legal entity-level and thus apply to the entire
legal entity, including any foreign operations that are part of the
U.S. legal entity.\289\ Consistent with this entity-level approach, a
foreign branch, agency, or office of a U.S. person would be treated as
a U.S. person under the proposed definition.\290\ As the Commission
noted in proposing Regulation SBSR, ``[b]ecause a branch or office has
no separate legal existence under corporate law, the branch or office
would be an integral part of the U.S. person itself.'' \291\ In other
words, because a branch or office is merely an extension of the head
office, not a separately incorporated or organized legal entity, we
preliminarily believe that it lacks the legal independence to be
considered a non-U.S. person for purposes of Title VII if its head
office is a U.S. person. We preliminarily believe a wholesale exclusion
from the requirements of Title VII for a foreign branch, agency, or
office of a U.S. person is not warranted with respect to its security-
based swap transactions because the legal obligations and economic
risks associated with the transactions directly affect a U.S. person,
of which the branch, agency, or office is merely a part.
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\289\ In principle, Regulation S looks to the location of the
branch rather than the jurisdiction in which the entity is organized
or incorporated in determining whether the branch is a U.S. person.
See 17 CFR 230.902(k)(1)(v) and (2)(v). Thus, under Regulation S,
the foreign branch of a U.S. bank is not treated as a U.S. person
while the U.S. branch of a foreign bank is treated as a U.S. person.
Under subsection (a)(7)(ii) of proposed Rule 3a71-3 under the
Exchange Act, the foreign branch of a U.S. bank would be treated as
part of a U.S. person. See Section III.B.10, infra (discussing the
proposed definition of ``U.S. person'' with the definition of ``U.S.
person'' in Regulation S).
\290\ Proposed Rule 3a71-3(a)(7) under the Exchange Act.
\291\ See Regulation SBSR Proposing Release, 75 FR 75240 (``The
Commission intends for this proposed definition [of U.S. person] to
include branches and offices of U.S. persons''). The Commission is
re-proposing Regulation SBSR in this release, including its
definition of U.S. person. See Section VIII, infra.
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Under the proposed definition, the status of an entity as a U.S.
person would have no bearing on whether separately incorporated or
organized legal entities in its affiliated corporate group are U.S.
persons. Accordingly, a foreign subsidiary of a U.S. person would not
be a U.S. person by virtue of its relationship with its U.S. parent.
Similarly, a foreign entity with a U.S. subsidiary would not be a U.S.
person simply by virtue of its relationship with its U.S.
subsidiary.\292\ The Commission preliminarily believes that it is
appropriate to treat each affiliate separately because of the distinct
legal status of each of the affiliates.\293\
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\292\ See Section III.B.8, infra.
\293\ But see Section III.B.8, infra (discussing the aggregation
of affiliate positions for purposes of the de minimis calculation).
---------------------------------------------------------------------------
iii. Accounts of U.S. Persons
Consistent with the proposed definition's focus on the location of
the person bearing the actual risk arising from the security-based swap
transaction, the proposed definition of U.S. person would include any
accounts (whether discretionary or not) of U.S. persons.\294\ Such
accounts would be U.S. persons regardless of whether the entity at
which the account is held or maintained is a U.S. person. Conversely,
accounts of non-U.S. persons would not be U.S. persons solely because
they are held by a U.S. financial institution or other entity that is
itself a U.S. person.\295\ In our view, the purposes of Title VII
require that its provisions apply to the person that actually bears the
risks arising from the security-based swap transaction.\296\ For this
reason, we preliminarily believe that the status of accounts, wherever
located, should turn on whether any owner of the account is itself a
U.S. person,\297\ and not on the status of the fiduciary or other
person managing the account, the discretionary or non-discretionary
nature of the
[[Page 30998]]
account, or the status of the entity at which the account is held or
maintained.\298\ Thus any account of a U.S. person would be a U.S.
person for purposes of Title VII.
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\294\ Proposed Rule 3a71-3(a)(7)(i)(C) under the Exchange Act.
\295\ An account of a non-U.S. person and, therefore, not a
``U.S. person'' under proposed Rule 3a71-3(a)(7) under the Exchange
Act, may nevertheless engage in ``transactions conducted within the
United States,'' as defined in proposed Rule 3a71-3(a)(5) under the
Exchange Act. For example, if a non-U.S. person executes a security-
based swap from an office located in the United States that
security-based swap would be a ``transaction conducted within the
United States'' even though neither party would be a ``U.S.
person.'' Similarly, if a non-U.S. person solicits a counterparty
within the United States to enter into a security-based swap
transaction, that transaction would be a ``transaction conducted
within the United States,'' regardless of whether both
counterparties were non-U.S. persons. See Section III.B.6, infra.
\296\ The same approach would apply to an account of a
partnership, corporation, trust, or other legal person (e.g., a fund
or a special-purpose investment vehicle) to enter into a security-
based swap. If the partnership, corporation, trust, or other legal
person were a U.S. person, the account would be a U.S. person.
\297\ For purposes of this definition, the term ``account''
includes both discretionary accounts and non-discretionary accounts.
See proposed Rule 3a71-3(a)(7)(i)(C) under the Exchange Act.
\298\ This proposed approach is consistent with the treatment of
managed accounts in the context of the major security-based swap
participant definition, whereby the swap or security-based swap
positions in client accounts managed by asset managers or investment
advisers are not attributed to such entities for purposes of the
major participant definitions, but rather are attributed to the
beneficial owners of such positions based on where the risk
associated with those positions ultimately lies. See Intermediary
Definitions Adopting Release, 77 FR 30690.
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iv. International Organizations
In addition to identifying the persons that fall within the U.S.
person definition, the proposed rule also provides a list of specific
international organizations that do not fall within such
definition.\299\ This list includes ``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, and their agencies and pension
plans, and any other similar international organizations, their
agencies and pension plans.'' \300\ Although these organizations may
have headquarters in the United States, the Commission preliminarily
believes that most of their membership and financial activity are
outside the United States. Thus, based on the nature of these entities
as international organizations the Commission is proposing not to treat
them as U.S. persons for purposes of Title VII.\301\
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\299\ Proposed Rule 3a71-3(a)(7)(ii) under the Exchange Act.
\300\ Id.
\301\ Regulation S also specifies that these international
organizations are not considered U.S. persons, but Regulation S also
considers affiliates of such organizations to be non-U.S. persons.
See 17 CFR 230.902(k)(2)(vi). The Commission is soliciting comment
on whether affiliates of such organizations should be treated as
non-U.S. persons under proposed Rule 3a71-3(a)(7) under the Exchange
Act. Currently, under the proposed rule, an affiliate of one of
these international organizations would have to separately consider
its U.S. person-status.
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(c) Conclusion
In short, by following a territorial approach, the Commission
preliminarily believes that the proposed definition of U.S. person
describes the types of individuals and entities residing, organized, or
conducting business within the United States, and the types of accounts
that should be designated as U.S. persons for purposes of the proposed
rule regarding application of the de minimis exception to security-
based swap dealers.\302\
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\302\ As discussed below, the proposed definition is used in
other proposed rules and interpretive guidance in the release. See
Sections IV-XI, infra.
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Request for Comment
The Commission requests comment on all aspects of the proposed
definition of ``U.S. person,'' including the following:
Does the proposed definition of ``U.S. person''
appropriately address the concerns of security-based swap dealer
regulation under Title VII?
Does the proposed definition appropriately identify all
individuals or entities that should be designated as U.S. persons? Is
the proposed definition too narrow or too broad? Why? Do the proposed
criteria for determining whether an entity is a U.S. person effectively
describe the types of counterparties that are relevant to identifying
the transactions a security-based swap dealer must count when
calculating its de minimis threshold for purposes of determining
whether it is required to register as a security-based swap dealer and
comply with the requirements of Title VII? Does the proposed definition
appropriately identify the types of entities that should be entitled to
the protections afforded to counterparties of security-based swap
dealers under Title VII?
Does the proposed definition appropriately treat natural
persons residing in the United States as U.S. persons? Should certain
categories of persons residing in the United States be excluded from
the definition of U.S. person? Should certain categories of persons
(such as U.S. citizens or permanent residents) residing abroad be
included in the definition of U.S. person? Please explain why excluding
or including particular categories of natural persons would be
consistent with and further the objectives of dealer regulation under
Title VII.
Is the proposed approach to the U.S. person status of
natural persons based on residency, rather than citizenship,
appropriate? In particular, is the proposed approach to natural
persons, which differs from the proposed approach to legal entities,
such as partnerships and corporations, appropriate in light of the fact
that, as the Commission understands, natural persons rarely enter into
security-based swaps?
Does incorporation or organization under the laws of the
United States appropriately define the types of entities (both for-
profit and non-profit) that should be treated as U.S. persons under
Title VII? Is it appropriate to define an entity as a U.S. person if it
has its principal place of business in the United States, even if it is
incorporated or organized under the laws of a foreign jurisdiction? Why
or why not?
Does the proposed rule adequately address the risk of
evasion or avoidance of Title VII requirements? Are there entities
incorporated or organized under foreign law that should be defined as a
U.S. person under the proposed rule that are not currently so defined?
For example, should an entity incorporated or organized under foreign
law but whose security-based swap transactions are guaranteed by a U.S.
person be defined as a U.S. person? Why or why not? Should a foreign
entity that conducts security-based swap dealing activity predominantly
with U.S. persons or within the United States be defined as a U.S.
person? If so, why?
Is it appropriate to determine the U.S. person status of a
corporation or organization on an entity-wide basis? Why or why not?
Should foreign branches, offices, or agencies of U.S. persons be U.S.
persons? Why or why not? What distinguishes transactions mediated or
entered into by a foreign branch of a U.S. bank from transactions
entered into by the head office of such U.S. bank for purposes of Title
VII regulation?
What, if any, competitive concerns would be raised by
defining foreign branches, offices, or agencies of U.S. persons as non-
U.S. persons? Please explain the mechanism of any competitive effects.
For example, would particular business structures become unworkable
under this approach and what would be the relevant impact? If so,
please explain possible alternatives and their relative
competitiveness.
Should the proposed rule include within the definition of
U.S. person foreign affiliates of U.S. persons? Should other factors be
taken into account in determining the status of such affiliated
entities, such as, for example, whether performance on the security-
based swap obligations of the foreign entity is guaranteed by a U.S.
affiliate? Should a foreign entity with performance on its security-
based swap obligations guaranteed by a U.S. affiliate, where such
foreign entity's security-based swap dealing activity is conducted
predominantly or exclusively with non-U.S. persons, be included within
the definition of U.S. person? Why or why not?
Should a foreign branch of a U.S. parent, including a
foreign branch of a U.S. bank, be included in the definition of ``U.S.
person'' for all purposes under Title VII? Why or why not?
[[Page 30999]]
Should a majority-owned subsidiary of a U.S. parent,
regardless of whether the subsidiary has financial guarantees from the
U.S. parent, be included in the definition of ``U.S. person'' for
purposes of Title VII? Why or why not?
Should an account of one U.S. person and one or more non-
U.S. persons be treated as a U.S. person? Should the Commission instead
establish a de minimis threshold amount or otherwise allows some U.S.
person ownership without triggering U.S. person status for the account?
If so, how?
The CFTC has proposed a definition of U.S. person that
would include a legal entity that is directly or indirectly majority-
owned by one or more U.S. persons and in which such person(s) bears
unlimited responsibility for the obligations and liabilities of the
legal entity (other than a limited liability company or limited
liability partnership where partners have limited liability).\303\
Should the Commission adopt a similar approach? If so, why? How should
majority ownership be determined? Is majority ownership the appropriate
test? If not, should some other percentage test be used (e.g., 25% or
some other measure of control)? Are there operational or other
difficulties in implementing such an approach?
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\303\ See CFTC Further Proposed Guidance, 78 FR 912.
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Should entities, whatever their place of domicile, that
guarantee the performance of U.S. person counterparties to security-
based swaps themselves be deemed U.S. persons? Why or why not? How
would treating such indirect counterparties to security-based swaps as
U.S. persons affect the application of Title VII rules?
Is the proposed definition's focus on the status of the
person bearing the actual risk in the transaction (e.g., looking at the
status of the account owner rather than the person with authority to
direct the investment decisions) appropriate in determining whether the
person is a U.S. person?
The CFTC has proposed a definition of U.S. person that
would include any pension plan for the employees, officers or
principals of a legal entity with its principal place of business
inside the United States. Should the Commission adopt a similar
approach? If so, what categories of entities would or would not be U.S.
persons when compared to the Commission's proposed approach? How is
including or excluding such entities, as applicable, from the
definition of U.S. person consistent with and in furtherance of the
objectives of Title VII?
Does the proposed rule appropriately address the treatment
of certain international organizations with respect to the definition
of U.S. person? Should any or all of the organizations specifically
identified in the proposed rule be treated as U.S. persons? If so, why?
Are there other similarly situated international organizations that
should also be explicitly excluded from the U.S. person definition?
Should the affiliates of international organizations be treated as non-
U.S. persons, even if organized under U.S. law? If so, why? If not, why
not?
Should the proposed definition expressly exclude from the
definition of U.S. person any other entity or category of entities? If
so, which ones and why?
The CFTC has proposed a definition of U.S. person that
would include any commodity pool, pooled account, or collective
investment vehicle (whether or not it is organized or incorporated in
the United States) of which a majority ownership is held, directly or
indirectly, by a U.S. person. Should the Commission adopt a similar
definition that includes any investment fund, commodity pool, pooled
account, or collective investment vehicle of which a majority ownership
is held by one or more U.S. persons, even if such entity is not
incorporated or organized under the laws of the United States, or does
not have its principal place of business in the United States? If so,
why and how should majority ownership be determined? Is majority
ownership the appropriate test? If not, should some other percentage
test be used (e.g., 25% or some other measure of control)? Are there
operational or other difficulties in implementing such an approach?
The CFTC has proposed a definition of U.S. person that
would include any commodity pool, pooled account, or collective
investment vehicle the operator of which would be required to register
as a commodity pool operator under the CEA.\304\ Should the Commission
adopt a similar definition that includes any investment fund, commodity
pool, pooled account, or collective investment vehicle the operator of
which would be required to register as a commodity pool operator under
the CEA or an investment adviser under the Investment Advisers Act of
1940 (``Investment Advisers Act'')? If so, why?
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\304\ See CFTC Cross-Border Proposal, 77 FR 41218.
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Should the definition of U.S. person specifically address
the status of estates, which is specifically addressed in Regulation S?
\305\ If so, please explain the types of security-based swap
transaction such entities typically engage in and describe any problems
created by the proposed definition of U.S. person relative to the goals
of Title VII.
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\305\ See Section III.B.10, infra (discussing the definition of
``U.S. person'' in Regulation S).
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The CFTC has proposed a definition of U.S. person that
would include any estate or trust, the income of which is subject to
U.S. income tax regardless of source. Should the Commission adopt a
similar approach? If so, why?
Should the Commission define the term ``principal place of
business'' for purposes of the proposed definition of ``U.S. person''?
If so, should the Commission define ``principal place of business'' as
the location of the personnel who direct, control, or coordinate the
security-based swap activities of the entity? \306\ If no, how should
the Commission define it?
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\306\ This focus would be generally consistent with the focus of
the definition of ``principal office and place of business'' in the
Investment Advisers Act, where it is defined as ``the executive
office of the investment adviser from which the officers, partners,
or managers of the investment adviser direct, control, and
coordinate the activities of the investment adviser.'' 17 CFR
275.222-1(b).
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6. Proposed Definition of ``Transaction Conducted Within the United
States''
We are proposing a definition of ``transaction conducted within the
United States'' to identify security-based swap transactions that
involve activities in the United States that the Commission
preliminarily believes would warrant requiring a non-U.S. person to
count such transactions toward its de minimis threshold in the
security-based swap dealer definition.\307\ Under the proposed rule,
``transaction conducted within the United States'' would be defined to
mean any ``security-based swap transaction that is solicited,
negotiated, executed, or booked within the United States, by or on
behalf of either counterparty to the transaction, regardless of the
location, domicile, or residence status of either counterparty
[[Page 31000]]
to the transaction.'' \308\ It would not, however, include a
transaction conducted through a foreign branch of a U.S. bank, for
reasons discussed below.\309\
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\307\ Proposed Rule 3a71-3(a)(5) under the Exchange Act. The
proposed definition of ``transaction conducted within the United
States'' also is used in other places in the release in the context
of our proposed application of Title VII requirements in the cross-
border context. See Sections VIII-X, infra. The proposed definition
of ``transaction conducted within the United States,'' and related
discussion in this release, is not intended to apply outside of the
scope of the proposals set forth in this release, unless otherwise
indicated. Accordingly, it thus does not affect other rights or
obligations of parties under the Exchange Act or the federal
securities laws generally.
\308\ Proposed Rule 3a71-3(a)(5)(i) under the Exchange Act. The
use of the term ``counterparty'' in the proposed rule is intended to
refer to the direct counterparty to the security-based swap
transaction, not a party that provides a guarantee on the
performance of the direct counterparty to the transaction. See
Section VIII.A, infra (distinguishing between direct and indirect
counterparties).
\309\ Proposed Rule 3a71-3(a)(4)(ii) under the Exchange Act. See
proposed Rule 3a71-3(a)(4) under the Exchange Act (defining
``transaction conducted through a foreign branch''), as discussed in
Section III.B.7, infra.
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As noted above, dealing activity is normally carried out through
interactions with counterparties or potential counterparties that
include solicitation, negotiation, execution, or booking of a security-
based swap.\310\ Engaging in any of these activities within the United
States, as part of dealing activity, would involve a level of
involvement in a security-based swap transaction that the Commission
believes should require such transaction to count toward a potential
security-based swap dealer's de minimis threshold. The proposed rule,
therefore, is designed to identify for market participants the key
aspects of a security-based swap transaction that the Commission
believes should trigger security-based swap dealer registration
requirements.
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\310\ See Section II.B.2(b), supra. More generally,
solicitation, negotiation, execution, and booking are activities
that represent key stages in a potential or completed security-based
swap transaction. As discussed below, transactions conducted within
the United States, regardless of whether in a dealing or non-dealing
capacity, would generally be subject to requirements relating to
reporting and dissemination, clearing, and trade execution. See
Sections VIII-X, infra.
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By contrast, we are not proposing to include either submitting a
transaction for clearing in the United States or reporting a
transaction to an SDR in the United States as activity that would cause
a transaction to be conducted within the United States under the
proposed rule, nor are we proposing to treat activities related to
collateral management (e.g., exchange of margin payments) that may
occur in the United States or involve U.S. banks or custodians as
activity conducted within the United States for these purposes. We
recognize that submission of a transaction for clearing to a CCP
located in the United States poses risk to the U.S. financial system,
and collateral management plays a vital role in an entity's financial
responsibility program and risk management. However, we preliminarily
believe that none of these activities, by themselves, involves
activities conducted between a potential dealer and its counterparty
that may be characterized as dealing activity, although clearing and
collateral management services may be offered in conjunction with
dealing activity.
Under the rule adopted by the Commission, jointly with the CFTC, a
potential security-based swap dealer is required to consider the
security-based swap positions ``connected with'' the dealing activity
in which the potential dealer--or any other entity controlling,
controlled by or under common control with the potential dealer--
engages over the course of the immediately preceding 12 months (or
following the effective date of final rules implementing Section
3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68), if that period is
less than 12 months).\311\ By incorporating the definition of a
``transaction conducted within the United States'' into the proposed
rule applying the de minimis exception in the cross-border
context,\312\ the Commission is proposing that non-U.S. persons engaged
in cross-border dealing activity include in their de minimis
calculations any security-based swap transaction that is connected with
\313\ an entity's dealing activity with another non-U.S. person if a
U.S. branch or office of either counterparty, or an associated person
\314\ of either counterparty--including any affiliate and any
associated person of any affiliate, or a third party agent, located
within the United States--is directly involved in the transaction.
Thus, a non-U.S. person engaged in security-based swap dealing activity
would be required to count toward its de minimis threshold any dealing
transaction entered into with another non-U.S. person that was
conducted in the United States, whether the transaction falls within
the ``conducted within the United States'' definition through such non-
U.S. person's own activity (or that of an agent within the United
States), or that of its non-U.S. person counterparty (or such
counterparty's agent).\315\ Similarly, if any transaction connected
with a non-U.S. person's dealing activity is executed within the United
States, the non-U.S. person would be required to count that transaction
toward its de minimis threshold.\316\
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\311\ See 17 CFR 240.3a71-2(a)(1).
\312\ See proposed Rule 3a71-3(b) under the Exchange Act.
\313\ The de minimis exception threshold is computed based on
the notional amount of an entity's security-based swap positions,
connected with its dealing activity, not transactions that are
merely solicited. See Intermediary Definitions Adopting Release, 77
FR 30630.
\314\ See Section 3(a)(70) of the Exchange Act, 15 U.S.C.
78c(a)(70) (defining ``person associated with a security-based swap
dealer or major security-based swap participant''); see also note
472, infra.
\315\ See Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act.
\316\ See id.
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We recognize that many of a non-U.S. person's transactions
conducted within the United States that arise out of its dealing
activity may also be transactions with U.S. persons, and thus would
already be counted for purposes of the de minimis threshold. However,
requiring non-U.S. persons to include in their de minimis calculations
only transactions with U.S. person counterparties would enable such
persons to engage in significant amounts of security-based swap dealing
activity within the United States without Commission oversight as a
security-based swap dealer, so long as the dealing activity were
limited to non-U.S. persons.\317\ This would be the case if the
potential dealer operated out of a branch, office, or affiliate, or
utilized a third-party agent acting on its behalf within the United
States, or merely directed its dealing activity to non-U.S. persons
that themselves operate out of the United States, either through
branches, office, or affiliates, or by utilizing third party
agents.\318\ The Commission preliminarily does not believe that this
would be consistent with the purposes of the Dodd-Frank Act, which is
intended, in part, to promote accountability and transparency in the
U.S. security-based swap market.\319\
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\317\ Depending on the nature of the activity and the person
located in the United States engaging in the activity, such person
may need to register with the Commission as a broker-dealer under
Section 15(a)(1) of the Exchange Act, 15 U.S.C. 78o(a)(1).
\318\ The Commission is not distinguishing, for purposes of the
proposed rule, whether a potential dealer or its counterparty is
operating out of a branch, an office, an affiliate, or utilizes a
third-party agent to act on its behalf. We are, however, soliciting
comment on whether there is a basis for drawing distinctions in this
area and look forward to receiving commenters' views.
\319\ See note 97, supra.
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First, we preliminarily believe that when a non-U.S. person engages
in dealing activity with another non-U.S. person from within the United
States either through an agent, branch, or office, or otherwise engages
in security-based swap dealing activity within the United States (such
as by soliciting persons within the United States from outside the
United States), the solicitation, negotiation, or execution activity
that occurs within the United States constitutes dealing activity that
is described by the security-based swap dealer definition.\320\ This is
the case even where such transaction is
[[Page 31001]]
ultimately booked by the two non-U.S. entities outside the United
States. Second, most market participants, including non-U.S. persons,
entering into a security-based swap transaction with a security-based
swap dealer, particularly through personnel located in the United
States, could reasonably expect to be entitled to the customer
protections of Title VII because of Title VII's role in setting the
standards for the U.S. security-based swap market and the market
participant's decision to engage in a transaction within that
market.\321\ Given the Commission's responsibility in Title VII to
regulate the U.S. security-based swap market, as well as reasonable
market expectations and the risk of creating confusion among market
participants,\322\ we preliminarily do not believe that it is
appropriate to diverge from our traditional approach to the regulation
of broker-dealers by establishing a regulatory regime for the security-
based swap market that would allow non-U.S. persons to engage in
unregulated dealing activity within the United States, either when it
acts through U.S. branches, office, or agents or it solicits,
negotiates, or executes transactions with non-U.S. persons that
themselves are operating out of the United States.
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\320\ See Section II.B.2(b), supra.
\321\ The Commission previously has noted the role that the
location of the dealer plays in setting expectations regarding the
legal protections available in transactions with that dealer. See
Rule 15a-6 Adopting Release, 54 FR 30017 (noting that a U.S. citizen
residing abroad who seeks out transactions with foreign broker-
dealers would not generally expect U.S. securities laws to apply to
the transaction); Regulation S Adopting Release, 55 FR 18310 (noting
the expectation that a buyer outside the United States who purchases
securities offered outside the United States is aware that ``the
transaction is not subject to registration under the Securities
Act''). See also Cleary Letter IV at 17 (``As both Commissions have
consistently recognized in the past, the non-U.S. counterparty in .
. . transactions [with a non-U.S. branch or affiliate of a U.S.
person] conducted abroad have no expectation of protection under
U.S. law''); Davis Polk Letter II at 20 (``Finally, the non-U.S.
counterparty would not reasonably expect the swap [with a foreign
bank swap dealer] to be subject to Title VII's requirements'').
\322\ See Rui Albequerque and Neng Wang, ``Agency Conflicts,
Investment and Asset Pricing,'' Journal of Finance, Vol. 63, No. 1
(2008) (discussing the effect of customer protection on prices) and
Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and
Robert Vishny, ``Investor Protection and Corporate Valuation,''
Journal of Finance, Vol. 57, No. 3 (2002) (discussing the effect of
customer protection on prices).
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Moreover, suppose non-U.S. persons were not required to register
when engaging in security-based swap dealing activity within the United
States with other non-U.S. persons. Non-U.S. persons seeking to
negotiate security-based swap transactions using personnel in the
United States may choose to enter into security-based swap transactions
with such unregistered non-U.S. persons rather than with a U.S. person
to avoid the application of Title VII. In this way, customers may
choose to forego the protections of Title VII in order to achieve
potential cost savings. This could limit the access of U.S. persons
engaged in dealing activity within the United States to non-U.S.
persons, as well as more generally limiting the ability of U.S. persons
to access liquidity in the security-based swap market. Accordingly, the
Commission is proposing that a non-U.S. person would be required to
count its security-based swap transactions conducted within the United
States (as well as its transactions with U.S. persons) that arise out
of its dealing activity to determine whether the notional amount of its
dealing transactions exceeds the de minimis threshold. This would have
the effect of subjecting both non-U.S. persons engaged in dealing
activity within the United States and U.S. persons engaged in dealing
activity within the United States to the same set of rules, thus
providing their counterparties the same set of protections.
Finally, although the proposed rule reflects the importance of
ensuring that neither non-U.S. person counterparty is engaged in the
relevant activities within the United States for purposes of this
definition, we also recognize the operational difficulties that could
arise in investigating the activities of a counterparty to ensure
compliance with the rule. As a result, we are preliminarily proposing
to allow parties to rely on a representation received from a
counterparty indicating that a given transaction ``is not solicited,
negotiated, executed, or booked within the United States by or on
behalf of such counterparty.'' \323\ A party may rely on such a
representation by its counterparty unless the party knows that the
representation is not accurate.\324\ The Commission preliminarily
believes that this would address whatever operational difficulties
parties may have in determining whether or not their counterparty is
conducting a transaction within the United States.
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\323\ Proposed Rule 3a71-3(a)(5)(iii) under the Exchange Act.
\324\ Id. Cf. Exemptions for Advisers to Venture Capital Funds,
Private Fund Advisers With Less Than $150 Million in Assets Under
Management, and Foreign Private Advisers, Advisers Act Release No.
3222 (June 22, 2011), 76 FR 39646, 39676 (July 6, 2011) (``if an
adviser reasonably believes that an investor is not `in the United
States,' the adviser may treat the investor as not being `in the
United States'''). We are proposing to use a knowledge standard
rather than a reasonable belief standard with respect to
transactions conducted within the United States between non-U.S.
person counterparties due to the fact that this definition applies
to both counterparties to a transaction, thus each counterparty has
an incentive to ensure the accuracy of its representation. In
addition, the proposed ``actual knowledge'' standard and related
discussion in this release are not intended to apply outside the
scope of the proposals set forth in this release. Accordingly, it
does not affect the standard for reliance on representations with
respect to other rights or obligations of persons under the Exchange
Act or the federal securities law generally.
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Request for Comment
The Commission requests comment on all aspects of the proposed rule
regarding registration by non-U.S persons who engage in dealing
activity within the United States, including the following:
Should non-U.S. persons be required to register by virtue
of engaging in security-based swap dealing activity within the United
States, even if none of this dealing activity is directed to, or
otherwise involves, U.S. persons? Why or why not?
Does the proposed approach appropriately impose the dealer
registration requirement on non-U.S. persons based on their dealing
activities conducted within the United States? Should a non-U.S. person
be required to register as a security-based swap dealer if it enters
into, or offers to enter into, security-based swap transactions that
are transactions conducted within the United States if such non-U.S.
person's dealing activity is limited to its foreign business? What
about if the non-U.S. person engages in non-U.S. dealing activity, but
also enters into transactions with U.S. persons in a non-dealing
capacity?
What, if any, market-transparency or counterparty-
protection issues would be likely to arise if non-U.S. persons were not
required to register if they engaged in dealing activity solely with
non-U.S. persons from within the United States?
What, if any, competition issues would be likely to arise
if non-U.S. persons were not required to register if they engaged in
dealing activity solely with non-U.S. persons from within the United
States?
Is the proposed approach toward determining whether
dealing activity is conducted within the United States appropriate?
Does the proposed rule identify appropriate factors in determining
whether a transaction has been conducted within the United States? If
not, what factors should be modified, removed, or added?
Is the proposed identification of activities appropriate
in the context of determining whether a security-based swap is a
transaction conducted within
[[Page 31002]]
the United States? If not, which activities should the Commission
consider as key evidence of a transaction that is conducted within the
United States?
Is direct participation by a branch, agency, office, or
associated person, including any affiliate and any associated person of
any affiliate, within the United States an appropriate element for
identifying whether a security-based swap transaction is a transaction
conducted within the United States? Are there functions routinely
performed by these entities that should not trigger a registration
requirement, even if performed within the United States?
Is the direct participation of a third-party agent an
appropriate element for identifying whether a security-based swap
transaction is a transaction conducted within the United States? If
not, why not?
From an operational perspective, what, if any, changes to
policies and procedures would be required to identify transactions
conducted within the United States under the proposed approach? What
changes would be required, for example, to monitor circumstances that
would prevent a party from relying on representations?
Does the proposed rule appropriately identify the range of
security-based swap activities (i.e., solicitation, negotiation,
execution, and booking) that should be considered in determining
whether dealing activity is conducted within the United States? If not,
what activities should be excluded or included? Why?
Should a transaction entered into by a non-U.S. person in
its capacity as a dealer be treated as dealing activity conducted
within the United States if it is executed on an SB SEF, submitted to
an SDR, or cleared by a security-based swap clearing agency physically
located within the United States, even if no other activity related to
the transaction were conducted within the United States?
Should the Commission allow parties to rely on
representations from their counterparties regarding compliance with the
definition of ``transaction conducted within the United States''? Are
there alternatives to relying on representations to ensure compliance?
Should parties be required to exercise reasonable standards of care and
due diligence?
Is the standard used for the proposed ability to rely on a
representation appropriate? Should another standard of knowledge be
used? If so, what standard would be more appropriate for this purpose?
The CFTC has proposed an interpretation that does not
consider whether swap dealing activity is conducted inside or outside
the United States when determining whether the de minimis threshold is
met.\325\ Should the Commission adopt this approach? If yes, please
address the effect of both approaches on customer protection, market
transparency, competition, and capital formation in the U.S. security-
based swap market.
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\325\ See CFTC Cross-Border Proposal, 77 FR 41219-20.
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What would be the market impact of the proposed approach
to determining whether dealing activity occurred within the United
States? How would the proposed approach affect the competitiveness of
U.S. entities in the global marketplace (both in the United States as
well as in foreign jurisdictions)? Would the proposed approach place
any market participants at a competitive disadvantage or advantage? If
so, please explain. Would the proposed approach be a more general
burden on competition? If so, please explain. What other measures
should the Commission consider to implement the proposed approach? What
would be the market impacts and competitiveness effects of alternatives
to the proposed approach discussed in this release?
7. Proposed Treatment of Transactions With Foreign Branches of U.S.
Banks
As noted above, under the proposed rule, a non-U.S. person would
not be required to count toward the de minimis threshold in the
security-based swap dealer definition its transactions with the foreign
branch of a U.S. bank.\326\ For purposes of this proposed approach, and
as described more fully below, ``foreign branch'' would be defined as
any branch of a U.S. bank if:
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\326\ Proposed Rule 3a71-3(b)(1)(ii) under the Exchange Act.
Section 716 of the Dodd-Frank Act (commonly known as the ``Push-Out
Rule'') prohibits the provision of certain types of ``Federal
assistance'' to certain swap and security-based swap dealers and
major swap and security-based swap participants referred to as
``swaps entities,'' subject to certain exceptions. In addition,
Section 619 of the Dodd-Frank Act (commonly referred to as the
``Volcker Rule'') adds a new Section 13 to the Bank Holding Company
Act of 1956 (``BHC Act'') (to be codified at 12 U.S.C. 1851) that
generally prohibits any banking entity from engaging in proprietary
trading or from acquiring or retaining an ownership interest in,
sponsoring, or having certain relationships with a hedge fund or
private equity fund (``covered fund''), subject to certain
exemptions. See Prohibitions and Restrictions on Proprietary Trading
and Certain Interests in, and Relationships With, Hedge Funds and
Private Equity Funds, Exchange Act Release No. 66057 (Oct. 12,
2011), 76 FR 68846 (Nov. 7, 2011). Both the Push-Out Rule and the
Volcker Rule will potentially limit the ability of U.S. banks to
conduct security-based swap activity.
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The branch is located outside the United States;
The branch operates for valid business reasons;
and
The branch is engaged in the business of banking and is
subject to substantive banking regulation in the jurisdiction where
located.\327\
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\327\ Proposed Rule 3a-71-3(a)(1) under the Exchange Act. We are
not proposing to include ``agencies'' within the definition of
``foreign branch'' as such term is used in connection with our
treatment of transactions with foreign branches of U.S. banks. We
recognize that Regulation S groups agencies and branches together in
defining the term U.S. person. See 17 CFR 230.902(k)(1)(v), (2)(v).
However, as discussed in Section III.B.10 below, although certain
aspects of Regulation S may be useful in the context of security-
based swaps, Title VII and Regulation S are tailored to serve
different objectives. In particular, the common treatment of
agencies and branches under Regulation S does not compel us to
similarly group agencies and branches for purposes of our treatment
of transactions with foreign branches of U.S. banks given the fact
that the term ``agency'' does not have any operative meaning with
respect to the foreign operations of U.S. banks.
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We preliminarily believe that these factors are appropriate for
determining which entities fall within the definition of a foreign
branch for purposes of this proposed approach due to their focus on the
physical location of the branch and the nature of the branch's business
and regulation in a foreign jurisdiction. Requiring the branch to be
located outside the United States is consistent with the goal of the
proposed rule, which is to identify security-based swap activity that
is not conducted within the United States. Requiring the branch to be
operated for valid business purposes and to be engaged in the business
of banking and subject to substantive banking regulation in a foreign
jurisdiction is intended to help ensure that U.S. banks are not able to
take advantage of the proposed rule by setting up offshore operations
to evade the application of Title VII.
In order for a transaction to be a ``transaction conducted through
a foreign branch,'' and therefore excluded from a non-U.S. person's de
minimis threshold calculation,\328\ the foreign branch must be the
named counterparty to the transaction \329\ and the transaction must
not be solicited, negotiated, or executed by a person within the United
States on behalf of the foreign branch or its counterparty.\330\ To the
extent that the transaction is conducted within the
[[Page 31003]]
United States, as described in the immediately preceding section
(whether on behalf of the U.S. bank to which the branch belongs or of
the foreign counterparty), the non-U.S. person would be required to
count such transaction arising out of its dealing activity toward its
de minimis threshold for purposes of determining whether it is required
to register as a security-based swap dealer.\331\
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\328\ Proposed Rules 3a71-3(b)(1)(ii) and (2)(ii) under the
Exchange Act.
\329\ Proposed Rule 3a71-3(a)(4)(i)(A) under the Exchange Act.
\330\ Proposed Rule 3a71-3(a)(4)(i)(B) under the Exchange Act.
\331\ See Section III.B.6, supra.
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We believe that counting transactions with a foreign branch toward
the de minimis threshold would be consistent with the view that a
foreign branch of a U.S. bank is part of a U.S. person within the
proposed definition.\332\ We also recognize that such transactions pose
risk to the U.S. financial system. At the same time, however, we
believe that imposing registration requirements on non-U.S. persons
solely by virtue of their transactions with foreign branches of U.S.
banks could limit the access of U.S. banks to non-U.S. counterparties
when they conduct their foreign security-based swap dealing activity
through foreign branches because non-U.S. persons may not be willing to
enter into transactions with them in order to avoid being required to
register as a security-based swap dealer.\333\ We have preliminary
concluded that not requiring such transactions to be counted toward the
foreign counterparty's de minimis threshold for purposes of the
security-based swap dealer registration requirement would minimize this
disparate treatment while ensuring that transactions involving foreign
branches of U.S. banks remain subject to certain Title VII requirements
(as described below).\334\
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\332\ See Section III.B.5, supra.
\333\ See, e.g., Sullivan and Cromwell Letter at 14 (``The
jurisdictional scope of the swaps entity definitions is critical to
the ability of U.S. banking organizations to maintain their
competitive position in foreign marketplaces. Imposing the
regulatory regime of Title VII on their Non-U.S. Operations would
place them at a disadvantage to their foreign bank competitors
because the Non-U.S. Operations would be subject to an additional
regulatory regime which their foreign competitors would not.'');
Cleary IV at 7 (``Subjecting such non-U.S. branches and affiliates
to U.S. requirements could effectively preclude them from, or
significantly increase the cost of, managing their risk in the local
financial markets, since local financial institutions may be
required to comply with Dodd-Frank to provide those services'').
\334\ See Section III.C, infra. Provided the transaction is not
a transaction conducted within the United States under proposed Rule
3a71-3(a)(5) under the Exchange Act, the Commission also is not
proposing to require non-U.S. persons to count transactions with a
non-U.S. person toward their de minimis threshold even if the non-
U.S. person's performance on the security-based swap is guaranteed
by a U.S. person. See Section III.B.9, infra.
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Finally, although the proposed rule reflects the importance of
ensuring that neither counterparty is operating from within the United
States for purposes of conducting a transaction through a foreign
branch, we also recognize the operational difficulties that could arise
in investigating the activities of a counterparty to ensure compliance
with the rule. As a result, we are proposing to allow parties to rely
on a representation received from a counterparty indicating that ``no
person within the United States is directly involved in soliciting,
negotiating, executing, or booking'' a given transaction on behalf of
the counterparty.\335\ A party may rely on such a representation by its
counterparty unless the party knows that the representation is not
accurate. The Commission preliminarily believes that this would address
whatever operational difficulties parties may have in determining
whether or not their counterparty is conducting a transaction conducted
through a foreign branch.
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\335\ Proposed Rule 3a71-3(a)(4)(ii) under the Exchange Act; see
also Section III.B.6, supra.
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Request for Comment
The Commission requests comment on all aspects of the proposed
treatment of transactions with foreign branches of U.S. persons for
purposes of the de minimis exception, including the following:
Would the proposed approach reduce the effectiveness of
customer protections or any other provisions of Title VII? If so, how
should these concerns be balanced against the competitiveness concerns
identified as part of the rationale behind the proposed approach?
Does the proposed approach appropriately address the
potential for disparate competitive impacts related to the application
of the de minimis exception to dealers operating out of foreign
branches? If not, how might the Commission more effectively address
these concerns?
Does the proposed approach provide an advantage to U.S.
banks engaging in security-based swap dealing activity through foreign
branches? Are there competitiveness concerns raised by this approach
for entities (either banks or nonbanks) that do not utilize the branch
model? Are there competitiveness concerns for non-U.S. persons,
including non-U.S. persons whose performance under security-based swaps
is guaranteed by a U.S. person? If so, what are they?
Should the Commission allow parties to rely on
representations from their counterparties regarding compliance with the
definition of ``transaction conducted through a foreign branch''?
Should the Commission separately allow parties to rely on
representations from their counterparties regarding status under the
``foreign branch'' definition?
Is the standard used for the proposed ability to rely on a
representation appropriate? Should another standard of knowledge be
used? If so, what standard would be more appropriate for this purpose?
Should the definition of a ``foreign branch'' be broadened
to include ``agencies'' of U.S. banks in addition to branches? If so,
what rationale justifies the inclusion of agencies? In particular, what
are the similarities (or differences) in the legal status and
regulatory treatment of the foreign branches and foreign agencies of
U.S. banks that would warrant similar treatment? How do foreign
agencies of U.S. banks differ from foreign offices of U.S. persons that
are not banks?
How might the proposed approach to the foreign branches of
U.S. banks be impacted by the Volcker Rule and the Push-Out Rule? How
might security-based swap dealers alter their business practices in
response to the Volcker Rule and the Push-Out Rule? Should the proposed
approach to the foreign branches of U.S. banks be altered to account
for these changes to business practice?
What would be the market impact of the proposed treatment
of transactions with foreign branches of U.S. banks? How would the
proposed approach affect the competitiveness of U.S. entities in the
global marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach? What would be
the market impacts and competitiveness effects of alternatives to the
proposed approach discussed in this release?
8. Proposed Rule Regarding Aggregation of Affiliate Positions
One key issue related to our proposed approach to the de minimis
exception, both in the cross-border context and domestically, is the
aggregation of transactions connected with the dealing activity of an
affiliate. In the Intermediary Definitions Adopting Release, the
Commission and the CFTC
[[Page 31004]]
jointly stated that the notional thresholds in the de minimis exception
encompass swap and security-based swap dealing positions entered into
by an affiliate controlling, controlled by, or under common control
with the person at issue.\336\ The Commission and the CFTC further
noted that for these purposes, control would be interpreted to mean the
possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person, whether through
the ownership of voting securities, by contract or otherwise.\337\ This
aggregation of affiliate positions was deemed necessary to prevent
persons from avoiding dealer regulation by dividing up dealing activity
in excess of the notional thresholds among multiple affiliates.\338\
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\336\ See Intermediary Definitions Adopting Release, 77 FR
30631; 17 CFR 240.3a71-2(a)(1).
\337\ See Intermediary Definitions Adopting Release, 77 FR 30631
n.437.
\338\ See Intermediary Definitions Adopting Release, 77 FR
30631.
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The Commission is proposing a rule that would describe how this
aggregation requirement would apply to U.S. persons and non-U.S.
persons engaged in cross-border security-based swap dealing activity,
as well as to U.S. persons engaged in purely domestic
transactions.\339\ As set forth in the Intermediary Definitions
Adopting Release, the affiliate aggregation principle requires that a
person aggregate the entire security-based swap dealing activity of any
of its affiliates, without distinguishing whether the dealing positions
are entered into by U.S. person affiliates or non-U.S. person
affiliates, and without distinguishing whether the dealing positions
are entered into with U.S. persons or non-U.S. persons.\340\ The
proposed rule takes an approach that generally is consistent with the
affiliate aggregation interpretive guidance jointly adopted by the
Commission and the CFTC to require a person to aggregate all of the
security-based swap dealing positions entered into by its U.S. person
affiliates,\341\ except that it excludes from such aggregation the
positions of an affiliate that is a registered security-based swap
dealer, under certain conditions.\342\ The proposed rule also provides
that such aggregation must include any security-based swap transactions
of such person's non-U.S. person affiliates that would be required to
be counted by such affiliates toward their respective de minimis
thresholds in accordance with the proposed approach described above
(i.e., a non-U.S. person affiliate would be required to calculate its
security-based swap transactions connected with dealing activity
conducted with U.S. persons (other than foreign branches of U.S. banks)
or otherwise conducted within the United States).\343\
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\339\ Proposed Rule 3a71-4 under the Exchange Act.
\340\ See Intermediary Definitions Adopting Release, 77 FR 30631
n.438 (explaining that the Commission intended to address the
application of the aggregation principle to non-U.S. persons in a
separate release); 17 CFR 240.3a71-2(a)(1).
\341\ Proposed Rule 3a71-3(b)(2)(i) under the Exchange Act. The
proposed rule also clarifies that only a person directly engaged in
dealing activity that is required to be counted toward such person's
de minimis threshold would be required to aggregate the dealing
activity of its affiliates.
\342\ Proposed Rule 3a71-4 under the Exchange Act.
\343\ See Section III.B.4(b), supra; see also proposed Rule
3a71-3(b)(2)(ii) under the Exchange Act.
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The proposed rule similarly provides that the affiliate aggregation
principle also would apply to non-U.S. persons that engage in
transactions in a dealing capacity with U.S. persons (other than
foreign branches of U.S. banks) or otherwise within the United States.
In determining whether its dealing activity exceeds the de minimis
threshold, a non-U.S. person must aggregate the amount of its own
transactions connected with its dealing activity with U.S. persons
(other than foreign branches) or otherwise conducted within the United
States with the amount of any security-based swap transactions
connected with the dealing activity conducted by its affiliates,
whether U.S. persons or non-U.S. persons, that such affiliates would be
required to count toward their respective de minimis thresholds in
accordance with the proposed approach described above \344\ (other than
the transactions of affiliates that are registered security-based swap
dealers).\345\ Transactions of affiliates that are themselves non-U.S.
persons with other non-U.S. persons (or foreign branches of U.S. banks)
outside the United States would not need to be aggregated for purposes
of the de minimis exception.\346\
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\344\ See Section III.B.4(b), supra. A U.S. person affiliate
would be required to calculate all of its security-based swap
transactions connected with its dealing activity and a non-U.S.-
person affiliate would be required to calculate its security-based
swap transactions connected with its dealing activity with U.S.
persons (other than foreign branches of U.S. banks) or otherwise
conducted within the United States.
\345\ Proposed Rules 3a71-3(b)(2)(i) and (ii) and proposed Rule
3a71-4 under the Exchange Act.
\346\ Id.
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Thus, the Commission's proposal would require aggregation of the
amount of dealing transactions of all affiliates, both U.S. persons and
non-U.S. persons, other than registered security-based swap dealers. We
believe that the Commission's proposed approach implements the de
minimis exception in a manner that is consistent with the Dodd-Frank
Act's focus on the U.S. security-based swap market.\347\ The proposed
approach reflects the fact that all of a U.S. affiliate's security-
based swap dealing transactions impact the U.S. financial system,
regardless of whether such entity's counterparties are located in the
United States or abroad. The same is not true of non-U.S. affiliates,
however, because the security-based swap transactions entered into by a
non-U.S. affiliate with other non-U.S. persons outside the United
States would not impact the U.S. financial system to the same extent as
transactions with U.S. persons. Thus, because the statutory focus is on
the U.S. security-based swap market, we preliminarily believe it is
appropriate to distinguish between U.S. and non-U.S. affiliates based
on the disparate impact of their security-based swap dealing
transactions on the U.S. financial system when determining which
dealing transactions should be aggregated for purposes of the de
minimis threshold. This further suggests that we should aggregate the
dealing positions of both U.S. and non-U.S. person affiliates that are
not already registered security-based swap dealers, in accordance with
the rule and guidance described in the following paragraph regarding
aggregation of the positions of registered dealers, with the goal of
capturing all dealing transactions that warrant imposing dealer
registration and regulation\348\ and minimizing the opportunity for a
person to evasively engage in large amounts of dealing activity.\349\
As a result, where the aggregate security-based swap dealing activity
of an affiliated group, calculated as described above, exceeds the de
minimis threshold, then each affiliate within such group that engages
in the security-based swap dealing activity included in such
aggregation calculation would be required to register with the
Commission as a security-based swap dealer, subject to the exception
described below.
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\347\ See Subtitle B of Title VII of the Dodd-Frank Act.
\348\ See note 4, supra.
\349\ See Intermediary Definitions Adopting Release, 77 FR
30631.
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The Commission also is proposing a rule to address the affiliate
aggregation of dealing positions for purposes of the de minimis
threshold where one or more affiliates within a corporate group are
registered with the Commission as
[[Page 31005]]
security-based swap dealers.\350\ Under the proposed approach, a person
calculating the amount of its security-based swap positions for
purposes of the de minimis threshold would not need to include in such
calculation the security-based swap transactions of an affiliate
controlling, controlled by, or under common control with the person if
such affiliate is registered with the Commission as a security-based
swap dealer.\351\ The application of this proposed rule would be
limited to circumstances where a person's security-based swap
activities are operationally independent from those of its registered
security-based swap dealer affiliate. For purposes of this proposed
rule, the security-based swap activities of two affiliates would be
considered operationally independent if the two affiliated persons
maintained separate sales and trading functions, operations (including
separate back offices), and risk management with respect to any
security-based swap dealing activity conducted by either affiliate that
is required to be counted against their respective de minimis
thresholds. If any of these functions were jointly administered by the
two affiliates, or were managed at a central location within the
affiliates' corporate group (e.g., at the entity serving as the central
booking entity) with respect to any security-based swap dealing
activity conducted by either affiliate that is required to be counted
against their respective de minimis thresholds, then an unregistered
person would not be able to exclude the security-based swap dealing
activities of its registered security-based swap dealer affiliate under
the proposed rule.
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\350\ Proposed Rule 3a71-4 under the Exchange Act.
\351\ Id.
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Absent the proposed exclusion of the dealing positions of a
registered security-based swap dealer affiliate in the proposed rule,
any affiliate of a registered security-based swap dealer that engaged
in security-based swap dealing activity with U.S. persons or within the
United States would be required to aggregate the dealing positions of
the registered security-based swap dealer with its own dealing
positions for purposes of the de minimis threshold. Given that a
registered security-based swap dealer would presumably conduct relevant
security-based swap dealing positions in excess of the de minimis
threshold over the course of the immediately preceding 12 months, all
persons affiliated with a registered security-based swap dealer that
engaged in any level of security-based swap dealing activity that is
required to be counted against the de minimis threshold would
necessarily be required to register with the Commission as security-
based swap dealers because of the affiliate aggregation principle. We
preliminarily do not believe that this outcome would be consistent with
the statutory purpose of the de minimis exception, because it would
prevent all affiliates of a registered dealer from taking advantage of
the exception, even those engaged in a minimal amount of dealing
activity relevant to Title VII dealer registration and regulation. We
also do not believe that this scenario raises the concerns about
evasion that underlie the de minimis affiliate aggregation rule jointly
adopted by the Commission and the CFTC in the Intermediary Definitions
Adopting Release, given that this proposed rule would apply only where
a corporate group already included a registered dealer subject to
Commission oversight, and the dealing positions of all commonly
controlled unregistered affiliates in the corporate group would still
be aggregated for purposes of the de minimis threshold.\352\ For these
reasons, we believe that it is appropriate not to include the security-
based swap dealing positions of registered security-based swap dealers
in the de minimis calculations of their commonly controlled affiliates
provided that their security-based swap dealing activities that are
relevant to the de minimis calculation are operationally independent of
the registered security-based swap dealer affiliates.
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\352\ See Intermediary Definitions Adopting Release, 77 FR
30631.
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Request for Comment
The Commission requests comment on all aspects of the proposed rule
regarding the aggregation of affiliate positions, including the
following:
Should the Commission permit affiliated persons to exclude
the security-based swap dealing positions of affiliated registered
security-based swap dealers from their de minimis calculations, as
proposed? Why or why not?
Would permitting affiliated entities to exclude the
security-based swap dealing positions of registered security-based swap
dealers from their de minimis calculations undermine any of the Title
VII protections associated with security-based swap dealer registration
and regulation? If so, please explain. Should the Commission further
explain what ``operationally independent'' means? If so, what should
the Commission consider?
Should the Commission permit affiliated entities to
exclude the security-based swap dealing positions of operationally
independent affiliates from their de minimis calculations, even if such
affiliates are not registered security-based swap dealers?
The CFTC has adopted temporary conditional relief that
would permit a non-U.S. person to exclude from its de minimis
calculation the security-based swap dealing positions of an affiliated
non-U.S. person that is registered as a swap dealer and not guaranteed
by a U.S. person with respect to its swap obligations.\353\ Should the
Commission adopt a similar interpretation to permit a non-U.S. person
(but not a U.S. person) to exclude the dealing positions of its
affiliated registered non-U.S. security-based swap dealer (but not the
dealing positions of its affiliated registered U.S. security-based swap
dealer)? Should the Commission condition such exclusion on the
affiliated registered security-based swap dealer not being guaranteed
by a U.S. person? If so, please describe the likely economic effects of
providing different exclusions from the affiliate aggregation principle
for U.S. and non-U.S. security-based swap dealers and how the
Commission should best address them.
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\353\ See Final CFTC Cross-Border Exemptive Order, 78 FR 868.
---------------------------------------------------------------------------
The CFTC has also proposed an interpretation that would
permit non-U.S. persons engaged in dealing activity with U.S. persons
to aggregate the notional amounts of security-based swap dealing
transactions by their non-U.S. affiliates separately from any dealing
activity performed by their U.S. affiliates.\354\ Should the Commission
adopt a similar approach? If so, please explain how this approach is
consistent with the de minimis threshold and the rationale provided for
the affiliate aggregation principle in the Intermediaries Definitions
Adopting Release. In addition, please describe the likely economic
effects of providing an effectively higher de minimis threshold for
corporate groups that engage in dealing activity with U.S. persons or
within the United States through affiliates located in the United
States and in foreign jurisdictions.
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\354\ See CFTC Cross-Border Proposal, 77 FR 41219-20; see also
Final CFTC Cross-Border Exemptive Order, 78 FR 867-68 (providing
temporary conditional relief from the CFTC's de minimis aggregation
requirements).
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What would be the market impact of the proposed approach
to aggregation of affiliate positions? How would the proposed approach
affect the competitiveness of U.S. entities in the global marketplace
(both in the United
[[Page 31006]]
States as well as in foreign jurisdictions)? Would the proposed
approach place any market participants at a competitive disadvantage or
advantage? If so, please explain. Would the proposed approach be a more
general burden on competition? If so, please explain. What other
measures should the Commission consider to implement the proposed
approach? What would be the market impacts and competitiveness effects
of alternatives to the proposed approach discussed in this release?
9. Treatment of Inter-Affiliate and Guaranteed Transactions
Consistent with the approach taken in the Intermediary Definitions
Adopting Release, the Commission is proposing that cross-border
security-based swap transactions between majority-owned affiliates
would not need to be considered when determining whether a person is a
security-based swap dealer.\355\ Thus, a non-U.S. person engaged in
dealing activity outside the United States would not be required to
register as a security-based swap dealer simply by virtue of entering
into security-based swap transactions with its majority-owned U.S.
affiliate, even if such inter-affiliate security-based swaps were back-
to-back transactions (i.e., the foreign subsidiary was acting as a
``conduit'' for the U.S. person). Similarly, a U.S. person would not be
required to register as a security-based swap dealer as a result of
back-to-back transactions with a non-U.S. person subsidiary that acts
as a conduit for such U.S. person.\356\ Instead, as proposed, there
must be an independent basis for requiring a person to register as a
security-based swap dealer that is unrelated to its inter-affiliate
transactions.\357\
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\355\ See 17 CFR 240.3a71-1(d), as discussed in the Intermediary
Definitions Adopting Release, 77 FR 30624-25. For the purposes of
this rule, which was adopted in the Intermediary Definitions
Adopting Release, counterparties are considered majority-owned
affiliates if one party directly or indirectly owns a majority
interest in the other, or if a third party directly or indirectly
owns a majority interest in both, based on the right to vote or
direct the vote of a majority of a class of voting securities of an
entity, the power to sell or direct the sale of a majority of a
class of voting securities of an entity, or the right to receive
upon dissolution or the contribution of a majority of the capital of
a partnership. See 17 CFR 240.3a71-1(d)(2).
\356\ This approach differs from the treatment of conduit
entities in the CFTC Cross-Border Proposal. Under the CFTC Cross-
Border Proposal, a U.S. entity may be required to register as a swap
dealer as a result of its inter-affiliate swap transactions with an
affiliated foreign dealer if the foreign dealer is acting as a
conduit by transferring swaps to the U.S. entity through back-to-
back transactions. See CFTC Cross-Border Proposal, 77 FR 41222.
\357\ Proposed Rule 3a71-4 under the Exchange Act.
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Furthermore, the Commission is proposing not to require a non-U.S.
person that receives a guarantee from a U.S. person of its performance
on security-based swaps with non-U.S. persons outside the United States
to count its dealing transactions with those non-U.S. persons toward
the de minimis threshold as a U.S. person would be required to do.\358\
We believe that the primary risk related to these transactions is the
risk posed to the United States via the guarantee from a U.S. person,
not the dealing activity occurring between two non-U.S. persons outside
the United States. As a result, we do not believe that the risk posed
by the existence of the U.S. guarantee would be better addressed
through requiring non-U.S. persons receiving such guarantees to
register with the Commission as security-based swap dealers. One way
that the accumulation of risk resulting from security-based swap
positions is addressed in Title VII is through the major security-based
swap participant registration category. We preliminarily believe that
the risk associated with guarantees by U.S. persons of the performance
on security-based swap obligations of non-U.S. persons may be best
addressed through the application of principles of attribution in the
major security-based swap participant definition described in the
Intermediary Definitions Adopting Release.\359\ We preliminarily
believe that use of the major security-based swap participant
definition to address the risks posed to the United States as a result
of guarantees by U.S. persons effectively deals with the specific
regulatory concerns posed by the risks these guarantees present to the
U.S. financial system and is consistent with the regulatory framework
set forth in the Dodd-Frank Act.\360\
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\358\ This approach differs from the treatment of guaranteed
entities in the CFTC Cross-Border Proposal. Under the CFTC Cross-
Border Proposal, a non-U.S. person that receives a guarantee from a
U.S. person would be required to count all of its swap dealing
transactions against the de minimis threshold. See CFTC Cross-Border
Proposal, 77 FR 41221.
\359\ See Intermediary Definitions Adopting Release, 77 FR
30688-89; Section V.C.2(a), infra.
\360\ See, e.g., Section IV, infra; see also Bank Holding
Company Act of 1956 (12 U.S.C. 1841, et seq.); Title I of the Dodd-
Frank Act (concerning regulation of certain nonbank financial
companies and bank holding companies that pose a threat to the
financial stability of the United States).
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The Commission also is proposing not to require a foreign dealer to
count security-based swap transactions with non-U.S. persons that
receive guarantees from U.S. persons toward the de minimis threshold.
The Commission notes that, in many respects, the risk created for U.S.
persons and the U.S. financial system in these transactions is the same
as the risk posed if the U.S. person who provides the guarantee had
entered into transactions directly with non-U.S. persons. The U.S.
guarantor would be held responsible to settle those obligations, thus
maintaining similar liability as though the U.S. person had entered
into security-based swap transactions directly with a non-U.S person.
The Commission preliminarily believes that the risk posed to the U.S.
markets by non-U.S. persons engaged in dealing activity with non-U.S.
persons outside the United States whose performance under security-
based swaps is guaranteed by a U.S. person can be best addressed
through the major security-based swap participant definition and
requirements applicable to major security-based swap participants, as
the risks to the United States appear to arise only from the resulting
positions and not the dealing activity as such.
Finally, as discussed below, the Commission is proposing to subject
a security-based swap transaction between two non-U.S. persons where at
least one of the persons receives a guarantee on the performance of its
obligations from a U.S. person to the regulatory reporting requirement
(but not, in some cases, to real-time public reporting).\361\ If the
proposed approach is adopted, the Commission would gain an
understanding of market developments in this area as a result of the
proposed de minimis exception.
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\361\ See Section VIII, infra. Under proposed Regulation SBSR,
inter-affiliate transactions would be subject to reporting and
dissemination requirements. See id.
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Request for Comment
The Commission requests comment on all aspects of the proposed
treatment of inter-affiliate and guaranteed transactions, including the
following:
Should the Commission revise our proposed approach to
inter-affiliate transactions to require those transactions to be
considered when determining whether a person is a security-based swap
dealer? If so, why?
If the Commission determines not to exclude inter-
affiliate transactions from security-based swap dealing activity in the
cross-border context, how could such a decision be reconciled with the
exclusion for inter-affiliate transactions provided in the Intermediary
Definitions Adopting Release? Should the Commission and the CFTC
jointly reconsider the approach to inter-affiliate transactions
provided in the Intermediary Definitions Adopting Release?
[[Page 31007]]
Should the Commission require the registration of non-U.S.
dealers that receive guarantees on the performance of their security-
based swap obligations from U.S. persons based on their transactions
with non-U.S. persons as well as U.S. persons? Why or why not? Should
the U.S. guarantor be viewed as engaging indirectly in dealing activity
through its affiliate and, therefore, required to register as a
security-based swap dealer if the security-based swap transactions in
connection with its dealing activity exceed the de minimis threshold?
Should there be a concern that the U.S. guarantor is using the non-US
affiliate to evade the requirements of Title VII?
Does the proposed approach to guarantees effectively
address concerns related to the risk posed to the U.S. financial system
resulting from guarantees by U.S. persons of security-based swap
dealing activity by non-U.S. persons?
Are there competitiveness concerns related to the proposed
approach to guarantees with regard to U.S. entities that engage in non-
U.S. security-based swap dealing activity through business models that
do not rely on guarantees of non-U.S. persons, such as those that
operate through foreign branches?
The CFTC has proposed an interpretation that would subject
an entity that operates a ``central booking system'' where swaps are
booked into a single legal entity, to any applicable swap dealer
registration requirement as if it had entered into such swaps directly,
irrespective of whether such entity is a U.S. person or whether the
booking entity is a counterparty to the swap or enters into the swap
indirectly through a back-to-back swap or other arrangement with its
affiliate or subsidiary.\362\ Should the Commission adopt a similar
approach? If so, please describe how such a decision could be
reconciled with the exclusion for inter-affiliate transactions provided
in the Intermediary Definitions Adopting Release.
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\362\ See CFTC Cross-Border Proposal, 77 FR 41221-22.
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What would be the market impact of the proposed approach
to inter-affiliate and guaranteed transactions? How would the
application of the proposed approach affect the competitiveness of U.S.
entities in the global marketplace (both in the United States as well
as in foreign jurisdictions)? Would the proposed approach place any
market participants at a competitive disadvantage or advantage? If so,
please explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach? What would be
the market impacts and competitiveness effects of alternatives to the
proposed approach discussed in this release?
10. Comparison With Definition of ``U.S. Person'' in Regulation S
In proposing an entity-based approach to the definition of a U.S.
person, we have declined to follow the suggestions by some commenters
that we adopt the definition of ``U.S. person'' used in Regulation S,
which among other things expressly excludes from the definition of
``U.S. person'' agencies or branches of U.S. persons located outside
the United States.\363\ Although we recognize that the Regulation S
definition of U.S. person has the advantage of familiarity for many
market participants, Regulation S addresses specific policy concerns
that are different from those addressed by Title VII.\364\
Specifically, the definition of U.S. person in Regulation S was adopted
in the context of providing an ``issuer safe harbor'' from the
registration requirements of Section 5 of the Securities Act, which was
intended ``to ensure that the [unregistered] securities offered
[abroad] come to rest offshore.'' \365\ In that context, providing a
safe harbor based in part on the location of the person, branch, or
office making the investment decision is consistent with the goals of
that regulatory framework, which include protecting the integrity of
the registration requirements applicable to securities publicly offered
in the United States under the Securities Act. The Regulation S
definition of ``U.S. person'' reflects this policy judgment.
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\363\ See, e.g., Cleary Letter IV at 2 (``The Agencies should
adopt a consistent definition of `U.S. person' based on SEC
Regulation S for purposes of analyzing whether a transaction
involving one or more such persons may be subject to the provisions
of Dodd-Frank.''); Davis Polk I at 6 n.6 (``We propose that the term
`U.S. counterparty' be defined in the same way as the term `U.S.
person' in Rule 902(k) of the SEC's Regulation S under the
Securities Act, 17 CFR 230.902(k). This established definition is
familiar to countless financial market professionals. Following the
`U.S. person' definition in Regulation S, rather than creating an
entirely new definition, would avoid confusion and also provide
consistency of application and legal certainty for a financial
institution that offers a security and a swap to the same customer,
which is common.''); SIFMA Letter I at 5 (``To determine whether a
party to a swap is a `U.S. person,' the Commissions should rely on
the existing definition of that term contained in Rule 902(k) of the
SEC's Regulation S. This established, workable definition is
familiar to regulators and market participants alike, and would
provide legal certainty. It is noteworthy that the Regulation S
definition of U.S. person does not include non-U.S. affiliates of
U.S. persons or non-U.S. branches of a U.S. bank and generally
excludes collective investment vehicles established outside the
United States with U.S. investors.'') (footnotes omitted); see also
Section III.B.5(c), supra.
\364\ See 17 CFR 230.901(k); see also Regulation S Adopting
Release, 55 FR 18306.
\365\ Regulation S Adopting Release, 55 FR 18307.
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We preliminarily believe that the definition of U.S. person in
Title VII should encompass, for example, not only a person that has its
place of residence or legal organization within the United States, but
also its principal place of business within the United States, as the
security-based swap activities of such entities are likely to manifest
themselves most directly within the United States, where the majority
of their commercial, legal, and financial relationships would be likely
to exist because that is where their business principally occurs.\366\
---------------------------------------------------------------------------
\366\ See proposed Rule 3a71-3(a)(7)(i)(B) under the Exchange
Act; Section III.B.5(b)ii, supra.
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Similarly, we preliminarily believe that the definition of U.S.
person in Title VII should include accounts of a U.S. person,
regardless of whether the account is a discretionary account or is held
by a dealer or other person that is not resident in the United States,
because the U.S. person bears the direct risk of transactions in the
account, regardless of where the investment decision is made.\367\
Moreover, we are proposing that an entity's U.S.-person status would
apply to the entity as a whole, since the risks related to the concerns
of Title VII are borne by the entire entity and not just by the
specific business unit (or branch or office) engaged in security-based
swap activity.\368\ With its exclusions for certain foreign branches
and agencies of U.S. persons from the definition of ``U.S. person,''
Regulation S would not address the entity-wide nature of the risks that
Title VII seeks to address.\369\
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\367\ See proposed Rule 3a71-3(a)(7)(i)(C) under the Exchange
Act; Section III.B.5(b)iii, supra.
\368\ See Section III.B.5(a), supra.
\369\ Under Regulation S, the foreign branch of a U.S. bank is
not treated as a U.S. person while the U.S. branch of a foreign bank
is treated as a U.S. person. By contrast, under proposed Rule 3a71-
3(a)(7)(i)(B) under the Exchange Act, the foreign branch of a U.S.
bank would be treated as part of a U.S. person while the U.S. branch
of a foreign bank would be treated as a non-U.S. person.
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The Commission preliminarily believes that adopting the definition
of ``U.S. person'' in Regulation S without significant modifications
would not achieve the goals of Title VII. As discussed above, we are
instead proposing a definition of U.S. person that focuses primarily on
the location of the person bearing the direct risk of the transaction.
Regulation S, with its focus on the person making the investment
decision (rather than the person actually
[[Page 31008]]
bearing the risk), would not necessarily capture the entity that
actually bears the risks arising from security-based swap transactions
that Title VII seeks to address.\370\
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\370\ Rather than creating a U.S. person definition specifically
tailored to Title VII, the Commission could have proposed a modified
version of Regulation S. However, significantly modifying the
definition of ``U.S. person'' in Regulation S to accommodate the
objectives of Title VII would largely eliminate the benefits
associated with adopting a consistent and well-established
regulatory standard.
---------------------------------------------------------------------------
In light of the specific objectives of Title VII, the Commission
preliminarily believes that a definition of U.S. person specifically
tailored to the regulatory objectives it is meant to serve, as
described above, is appropriate.\371\
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\371\ See Section III.B.3(b)(4), infra. The Commission notes
that it took a different approach to the definition of U.S. person
and activity in the United States in connection with the
Commission's exemption from registration for foreign private
advisers. See Exemptions for Advisers to Venture Capital Funds,
Private Fund Advisers With Less Than $150 Million in Assets Under
Management, and Foreign Private Advisers, Advisers Act Release No
3222, 76 FR 39646 (July 6, 2011) (the ``Foreign Private Adviser
Exemption''). The Foreign Private Adviser Exemption defines certain
terms in the statutory definition of ``foreign private adviser''
(added by Section 402 of the Dodd-Frank Act and codified at section
202(a)(30) of the Investment Advisers Act) by incorporating the
definition of a ``U.S. person'' and ``United States'' under
Regulation S. As discussed in this subsection, the Commission
preliminarily believes that it would be inappropriate to follow the
approach in Regulation S in its entirety with respect to the cross-
border regulation of security-based swaps, although it may be
appropriate in the context of the Foreign Private Adviser Exemption
given the similar policy objectives with Regulation S.
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Request for Comment
The Commission requests comment on all aspects of the proposed
definition of U.S. person, including the following:
Should the Commission adopt the definition of U.S. person
in Regulation S? If so, how should the Commission reconcile the
objectives of Title VII with the objectives that Regulation S is meant
to serve?
Should the Commission include all U.S. citizens in the
definition of U.S. person, regardless of a person's residence or
domicile?
Should the Commission include within the definition of
U.S. person entities and accounts where the discretion to enter into
security-based swaps resides with a U.S. person? To what extent would
this approach produce a result that differs from the current approach
reflected in the proposed rule and the definitions of ``security-based
swap dealer'' and ``major security-based swap participant''?
C. Regulation of Security-Based Swap Dealers in Title VII
I. Introduction
To help address the potential effects of registration, and
attendant regulatory requirements, on foreign security-based swap
dealers \372\ with global security-based swap businesses and U.S.
security-based swap dealers \373\ that engage in security-based swap
dealing activity through foreign branches that also may be subject to
registration or regulation in foreign jurisdictions, the Commission is
proposing not to apply the external business conduct standards and
segregation requirements in Title VII to the Foreign Business \374\ of
such registered foreign security-based swap dealers and registered U.S.
security-based swap dealers that engage in dealing activity through
foreign branches with non-U.S. persons and foreign branches of U.S.
banks.\375\ In addition, while we are not proposing a rule to limit the
application of entity-level requirements in Title VII to foreign
security-based swap dealers, we are proposing to establish a policy and
procedural framework under which the Commission would permit
substituted compliance in some circumstances by registered foreign
security-based swap dealers with certain Title VII requirements
specifically applicable to security-based swap dealers.\376\
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\372\ Proposed Rule 3a71-3(a)(8) under the Exchange Act defines
``U.S. security-based swap dealer'' as a security-based swap dealer,
as defined in Section 3(a)(71) of the Exchange Act, 15 U.S.C.
78c(a)(71), and the rules and regulations thereunder, that is a U.S.
person, as defined in proposed Rule 3a71-3(a)(7) under the Exchange
Act. Proposed Rule 3a71-3(a)(3) under the Exchange Act defines
``foreign security-based swap dealer'' as a security-based swap
dealer, as defined in Section 3(a)(71) of the Exchange Act, and the
rules and regulations thereunder, that is not a U.S. security-based
swap dealer.
\373\ See note 372, supra.
\374\ As discussed below, proposed Rule 3a71-3(a)(2) under the
Exchange Act defines ``Foreign Business'' as meaning the security-
based swap transactions of foreign security-based swap dealers and
U.S. security-based swap dealers ``other than the U.S. Business of
such entities.'' ``U.S. Business'' is defined in proposed Rule 3a71-
3(a)(6) under the Exchange Act, with respect to a foreign security-
based swap dealer, as (i) any transaction entered into, or offered
to be entered into, by or on behalf of such foreign security-based
swap dealer, with a U.S. person (other than with a foreign branch);
or (ii) any transaction conducted within the United States; and,
with respect to a U.S. security-based swap dealer, as any
transaction by or on behalf of such U.S. security-based swap dealer,
wherever entered into or offered to be entered into, other than a
transaction conducted through a foreign branch, as defined in
proposed Rule 3a71-3(a)(4), with a non-U.S. person or another
foreign branch. See Section III.C.4, infra.
\375\ Proposed Rule 3a71-3(b) under the Exchange Act.
\376\ Proposed Rule 3a71-5 under the Exchange Act, as discussed
in Section XI, infra.
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In the following sections, we discuss the views of commenters,
describe the transaction-level and entity-level requirements
specifically applicable to security-based swap dealers in Title VII,
and discuss the proposed application of transaction-level and entity-
level requirements to registered security-based swap dealers in the
cross-border context.
2. Comment Summary
Various foreign dealers expressed their views about the application
of the Dodd-Frank Act requirements to their derivatives businesses. A
number of them expressed concern that if the Commission applies
security-based swap dealer regulations, not only to entities conducting
business from within the United States, but also to foreign-domiciled
entities, it could effectively prevent foreign dealers from, among
other things, managing their global security-based swap business out of
a centralized booking entity (i.e., the entity that acts as principal--
the named counterparty--to a security-based swap transaction), which
they maintain has many advantages for foreign dealers and their
clients, including more efficient counterparty netting, greater
transparency, greater financial counterparty financial strength, and
operational efficiencies.\377\ One commenter cautioned that if the
regulations lead foreign dealers to create ``fragmented booking
structures'' to avoid duplicative and conflicting regulatory regimes,
it could harm U.S. consumers through increased transaction costs with
foreign dealers.\378\
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\377\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter I at 3 (``Overall, the advantages of carrying out Swap
transactions in and with a foreign bank with a consolidated booking
structure help control risk significantly . . . . We believe it
would be sensible for the Commissions to craft regulations that do
not discourage foreign banks such as SG from registering as Swap
Dealers.''); Davis Polk Letter I at 2, 5 (``We believe operating and
managing a global swaps business out of a single booking entity
presents many advantages from the perspective of foreign banks,
customers and supervisors.'').
\378\ See ISDA Letter I at 10 (warning that ``U.S.
counterparties will . . . face increased costs and decreased
liquidity if U.S. regulation forces non-U.S. SDs to create
fragmented booking structures to avoid duplicative and conflicting
regulatory regimes'').
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Many commenters suggested that to preserve a registration framework
that would allow foreign dealers to continue to book their global
security-based swap business out of a central non-U.S. entity, the
Commission should use our limited designation authority under the Dodd-
Frank Act's swap dealer definition to designate and regulate only
specific activities and particular branches or agencies of foreign
banks that transact
[[Page 31009]]
with U.S. customers, without subjecting the whole entity or its other
branches to regulation.\379\
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\379\ See, e.g., IIB Letter at 11 (pointing out that Section
3(a)(71) of the Exchange Act, as amended by the Dodd-Frank Act,
provides for limited designation as a security-based swap dealer
``for a single type or single class . . . of activities, and not for
other types, classes, of . . . activities,'' and recommending that
the Commissions designate as a Swap Dealer only the particular U.S.
or non-U.S. branch or agency of the foreign bank involved in the
execution of swaps with U.S. customers''); Rabobank Letter at 2
(recommending that to preserve ``the benefits of the centralized
booking model, a non-U.S. branch of a foreign bank should register
as a swap dealer solely with respect to its swap dealing activities
with U.S. persons. Under this scenario, Title VII's transaction-
level rules would apply only to the non-U.S. branch's swap dealing
activities with U.S. persons and would not apply to its other
activities or to the swap activities of other parts of the foreign
bank'').
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In addition, various commenters suggested a variety of operational
models through which foreign dealers could operate in the U.S.
security-based swap market, generally premising the proposed
registration and regulatory regime on the notion that home country
supervision should apply to entity-level regulations (e.g., capital,
risk management, and conflicts of interest), while Title VII
transaction-level regulations should apply only to security-based swaps
involving a U.S. counterparty.\380\ A number of commenters emphasized
that transaction-level requirements should not apply to security-based
swaps entered into between foreign counterparties.\381\ Other
commenters remarked that if the Commission regulates both the U.S.-
facing business (i.e., transactions with U.S. persons) and the foreign-
facing business (i.e., transactions with non-U.S. persons) of U.S.
security-based swap dealers, but only the U.S.-facing business of
foreign security-based swap dealers, then U.S. firms would be at a
competitive disadvantage vis-[agrave]-vis their foreign counterparts
with respect to transactions with foreign counterparties.\382\
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\380\ See, e.g., Davis Polk Letter II at 4-20 (recommending
reliance on comprehensive home country requirements such as capital,
margin, conflicts of interest, risk management, and limited
recordkeeping requirements for entity-level regulations if certain
standards are met, and recommending the application of Title VII
transaction-level rules to a swap dealer's swap dealing activities
with U.S. persons).
\381\ See, e.g., Sullivan & Cromwell Letter at 14-15 (asserting
that subjecting foreign entities to transaction-level requirements
on foreign transactions would likely lead to a competitive
disadvantage, because other foreign ``banking organizations that are
not so burdened by such dual and potentially conflicting
requirements would be able to provide a wider range of services . .
., which may cause customers to migrate away from'' those foreign
operations, which would limit their ability to manage, transfer, and
reduce systemic risk).
\382\ See, e.g., SIFMA Letter I at 11 (remarking that ``U.S.
swap dealers also may be at a competitive disadvantage relative to
non-U.S. entities if U.S. swap dealers must comply with U.S. rules
when dealing with a non-U.S. counterparty in a jurisdiction that
does not have similar rules, for example, if the foreign rules do
not mandate margin requirements for non-cleared swaps'').
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Several commenters further expressed concern that a requirement for
foreign persons to register with the Commission as security-based swap
dealers could be particularly problematic in the case of capital
requirements, where foreign security-based swap dealers already would
be subject to their home country's prudential requirements. These
commenters favored deferring to foreign regulators the regulation and
supervision of entity-level requirements when a foreign security-based
swap dealer is subject to comprehensive and comparable home country
regulation.\383\ One commenter recommended a comparability standard
whereby the Federal Reserve and the Commission determine comparability
even when a home country regulator does not require margin for non-
cleared security-based swaps, if the home country's capital regime
takes into account functionally equivalent capital charges.\384\
Several commenters recommended that, for monitoring purposes, U.S.
regulators could rely on information-sharing arrangements with home
regulators regarding foreign swap transactions and activities.\385\ A
few commenters argued that U.S. regulators should not have examination
authority over foreign swap transactions and activities located outside
the United States, and suggested that the Commissions obtain any
necessary information about U.S. swap transactions and activities from
U.S. affiliates of the foreign security-based swap dealer.\386\
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\383\ See, e.g., Financial Services Roundtable Letter at 25
(suggesting that the Commissions should defer to foreign prudential
regulators with regard to entity-level requirements such as capital
and margin, when they are deemed consistent with U.S. standards);
Davis Polk Letter I at 3-4 (emphasizing the importance of relying on
home country regulation for entity-level rules such as capital,
margin, conflicts of interest, risk management, and limited
recordkeeping requirements).
\384\ See Davis Polk Letter II at 13-15 (recommending a
comparability standard that ``focuses on the similarities in
regulatory objectives as opposed to identity of technical rules,''
whereby the Federal Reserve, as the prudential regulator, could
determine comparability even when a home country regulator does not
require margin for non-cleared swaps, if ``the capital regime in
such home country is determined to take account appropriately of
unmargined or undermargined swaps by imposing additional capital
charges'').
\385\ See, e.g., Davis Polk Letter I at 9 (stating that
``[w]here information is required from the foreign bank swap dealer,
U.S. regulators should seek to rely upon regulatory examinations by
home country regulators, and information sharing arrangements'').
\386\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter I at 12 (recommending that a foreign dealer based outside the
U.S. with no U.S. nexus ``should be `ring-fenced' and outside the
scope of the Commissions' examination and regulatory authority,''
but allowing for a limited examination of a foreign bank's U.S.
facing business concerning its clearing, trade execution, and
capital rules, through its U.S. domiciled agent who ``would
facilitate this examination by making all necessary information
available directly to the Commissions'').
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3. Title VII Requirements Applicable to Security-Based Swap Dealers
Certain Title VII requirements specifically applicable to security-
based swap dealers apply at a transaction level, that is, to security-
based swap transactions with specific counterparties. Examples of
transaction-level requirements in Title VII principally include
requirements relating to external business conduct standards such as
the requirement that a security-based swap dealer or major security-
based swap participant verify that any counterparty meets the
eligibility standards for an eligible contract participant \387\ and
requirements relating to segregation of assets held as collateral in
security-based swap transactions.\388\ Other requirements apply to
security-based swap dealers at an entity level, that is, to the dealing
entity as a whole. Examples of entity-level requirements include, among
others, requirements relating to capital,\389\ risk management
procedures,\390\ recordkeeping and reporting,\391\ supervision,\392\
and designation of a chief compliance officer.\393\ Some requirements
can be considered both entity-level and transaction-level requirements.
For instance, the margin requirement in Section 15F(e) of the Exchange
Act can be considered both an entity-level requirement because margin
affects the financial soundness of an entity and a transaction-level
requirement because margin calculation is based on particular
transactions (i.e., an entity
[[Page 31010]]
calculates margin based on the market value of specific transactions or
on a portfolio basis).\394\
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\387\ See, e.g., Section 15F(h)(3)(A) of the Exchange Act, 15
U.S.C. 78o-10(h)(3)(A). See generally Section 15F(h) (discussing
external business conduct standards). However, requirements under
Section 15F(h)(1), which address fraud, supervision and adherence to
position limits, apply at the entity level.
\388\ See Section 3E of the Exchange Act, 15 U.S.C. 78c-5.
\389\ See Section 15F(e) of the Exchange Act, 15 U.S.C. 78o-
10(e).
\390\ See Section 15F(j)(2) of the Exchange Act, 15 U.S.C. 78o-
10(j)(2).
\391\ See Section 15F(k) of the Exchange Act, 15 U.S.C. 78o-
10(k).
\392\ See Section 15F(h)(1)(B) of the Exchange Act, 15 U.S.C.
78o-10(h)(1)(B).
\393\ See Section 15F(k) of the Exchange Act, 15 U.S.C. 78o-
10(k).
\394\ See Section 15F(e) of the Exchange Act, 15 U.S.C. 78o-
10(e). To take another example, the requirement that security-based
swap dealers implement conflict-of-interest systems and procedures
relating to security-based swaps in Section 15F(j)(5) of the
Exchange Act, 15 U.S.C. 78o-10(j)(5), is transactional in the sense
that potential conflicts of interest relate to particular security-
based swap transactions. At the same time, however, it also is an
entity-level requirement because implementing such systems and
procedures would require, among other things, a security-based swap
dealer to establish structural and institutional safeguards to wall
off the activities of persons within the firm relating to research
or analysis of the price or market for any security-based swap. See
External Business Conduct Standards Proposing Release, 76 FR 42420.
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Below, we describe in more detail various transaction-level and
entity-level requirements in Title VII applicable to security-based
swap dealers.\395\
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\395\ For purposes of this discussion, we are addressing only
requirements applicable to security-based swap dealers in Sections
3E and 15F of the Exchange Act, 15 U.S.C. 78c-5 and 78o-10, and the
rules and regulations thereunder. Title VII requirements relating to
regulatory reporting and public dissemination, clearing, and trade
execution are discussed in Sections VIII-X below.
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(a) Transaction-Level Requirements
In general, transaction-level requirements primarily focus on
protecting counterparties by requiring security-based swap dealers to,
among other things, provide certain disclosures to counterparties,
adhere to certain standards of business conduct, and segregate customer
funds, securities, and other assets. The following briefly describes
the most significant transaction-level requirements applicable to
security-based swap dealers in Title VII.
i. External Business Conduct Standards
Section 15F(h) of the Exchange Act requires the Commission to adopt
rules specifying external business conduct standards for security-based
swap dealers in their dealings with counterparties,\396\ including
counterparties that are ``special entities.'' \397\ Congress granted
the Commission broad authority to promulgate business conduct
requirements, as the Commission determines to be appropriate in the
public interest, for the protection of investors or otherwise in
furtherance of the purposes of the Exchange Act.\398\
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\396\ Section 15F(h)(6) of the Exchange Act, 15 U.S.C. 78o-
10(h)(6), directs the Commission to prescribe rules governing
external business conduct standards for security-based swap dealers.
Section 15F(h) of the Exchange Act, 15 U.S.C. 78o-10(h), also
generally authorizes and requires the Commission to adopt rules for
major security-based swap participants. See Section IV, infra.
\397\ Section 15F(h)(2)(C) of the Exchange Act, 15 U.S.C. 78o-
10(h)(2)(C). See note 286, supra.
\398\ See Section 15F(h)(3)(D) of the Exchange Act, 15 U.S.C.
78o-10(h)(3)(D) (``[b]usiness conduct requirements adopted by the
Commission shall establish such other standards and requirements as
the Commission may determine are appropriate in the public interest,
for the protection of investors, or otherwise in furtherance of the
purposes of this Act''). See also Section 15F(h)(1)(D) of the
Exchange Act (requiring that security-based swap dealers to comply
as well with ``such business conduct standards . . . as may be
prescribed by the Commission by rule or regulation that relate to .
. . such other matters as the Commission determines to be
appropriate'').
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These standards, as described in Section 15F(h)(3) of the Exchange
Act, must require security-based swap dealers to: (i) Verify that a
counterparty meets the eligibility standards for an ECP; (ii) disclose
to the counterparty material information about the security-based swap,
including material risks and characteristics of the security-based
swap, and material incentives and conflicts of interest of the
security-based swap dealer in connection with the security-based swap;
and (iii) provide the counterparty with information concerning the
daily mark for the security-based swap. Section 15F(h)(3) also directs
the Commission to establish a duty for security-based swap dealers to
communicate information in a fair and balanced manner based on
principles of fair dealing and good faith.
In addition, Section 15F(h)(4) of the Exchange Act requires that a
security-based swap dealer that ``acts as an advisor to a special
entity'' must act in the ``best interests'' of the special entity and
undertake ``reasonable efforts to obtain such information as is
necessary to make a reasonable determination'' that a recommended
security-based swap is in the best interests of the special
entity.\399\ Section 15F(h)(5) requires that security-based swap
dealers that enter into, or offer to enter into, security-based swaps
with a special entity comply with any duty established by the
Commission that requires a security-based swap dealer to have a
``reasonable basis'' for believing that a special entity has an
``independent representative'' that meets certain criteria and
undertakes a duty to act in the ``best interests'' of the special
entity.
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\399\ See External Business Conduct Standards Proposing Release,
76 FR 42423-25.
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The Commission has proposed Rules 15Fh-1 through 15Fh-6 under the
Exchange Act to implement the business conduct requirements described
above.\400\ In addition to external business conduct standards
expressly addressed by Title VII, the Commission has proposed certain
other business conduct requirements for security-based swap dealers
that the Commission preliminarily believed would further the principles
that underlie the Dodd-Frank Act. These rules would, among other
things, impose certain ``know your counterparty'' and suitability
obligations on security-based swap dealers, as well as restrict
security-based swap dealers from engaging in certain ``pay to play''
activities.\401\
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\400\ See External Business Conduct Standards Proposing Release,
76 FR 42396.
\401\ See External Business Conduct Standards Proposing Release,
76 FR 42399-400; proposed Rules 15Fh-3(e) (``know your
counterparty''), 15Fh-3(f) (``suitability''), and 15Fh-6 (``pay to
play'') under the Exchange Act.
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ii. Segregation of Assets
Segregation requirements are designed to identify and protect
customer property held by a security-based swap dealer as collateral in
order to facilitate the prompt return of the property to customers or
counterparties in a liquidation proceeding of such security-based swap
dealer.\402\ Segregation not only protects counterparties who are
customers of a security-based swap dealer but also facilitates orderly
liquidation of a security-based swap dealer and minimizes the
disruption to and impact on the U.S. security-based swap market and the
U.S. financial system overall caused by insolvency and liquidation of a
security-based swap dealer.
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\402\ Proposed Rule 18a-4 under the Exchange Act, as discussed
in Section II.C. of the Capital, Margin, and Segregation Proposing
Release, 77 FR 70274.
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Section 3E of the Exchange Act provides the Commission with
rulemaking authority to prescribe segregation requirements for
securities-based swap dealers that receive assets from, for, or on
behalf of a counterparty to margin, guarantee, or secure a security-
based swap transaction.\403\ Section 3E(c) provides the Commission with
rulemaking authority to prescribe how any margin received by a
security-based swap dealer with respect to cleared security-based swap
transactions may be maintained, accounted for, treated and dealt with
by the security-based swap dealer.\404\ In addition, Section 3E(g)
extended the customer protections of the U.S. Bankruptcy Code to
counterparties of a security-based swap dealer with respect to cleared
security-based swaps, and with respect to non-cleared security-based
swaps, if there is a customer protection requirement under Section
15(c)(3) or a segregation requirement
[[Page 31011]]
prescribed by the Commission.\405\ The Commission has proposed Rule
18a-4 under the Exchange Act to establish segregation requirements for
security-based swap dealers with respect to both cleared and non-
cleared security-based swap transactions.\406\ The provisions of
proposed Rule 18a-4 were modeled on the broker-dealer customer
protection rule and take into account the characteristics of security-
based swaps.\407\
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\403\ See Section 3E of the Exchange Act, 15 U.S.C. 78c-5.
\404\ See Section 3E(c)(2) of the Exchange Act, 15 U.S.C. 78c-
5(c)(2).
\405\ See Section 3E(g) of the Exchange Act, 15 U.S.C. 78c-5(g);
Capital, Margin, and Segregation Proposing Release, 77 FR 70275.
\406\ Proposed Rule 18a-4 under the Exchange Act, as discussed
in the Capital, Margin, and Segregation Proposing Release, 77 FR
70274-88.
\407\ 17 CFR 240.15c3-3. See Capital, Margin, and Segregation
Proposing Release, 77 FR 70276.
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(b) Entity-Level Requirements
Entity-level requirements in Title VII primarily address concerns
relating to the security-based swap dealer as a whole, with a
particular focus on safety and soundness of the entity to reduce
systemic risk in the U.S. financial system.\408\ The most significant
entity-level requirements, as discussed below, are capital and margin
requirements. Certain other entity-level requirements relate to the
capital and margin requirements because, at their core, they relate to
how the firm identifies and manages its risk exposure arising from its
activities (e.g., risk management requirements). Given their functions,
these entity-level requirements would be applied under our proposal on
a firm-wide basis to address risks to the security-based swap dealer as
a whole.
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\408\ For example, Section 15F(e)(3) of the Exchange Act
provides that the requirements relating to capital and margin
imposed by the Commission pursuant to Section 15F(e)(2) shall help
ensure the safety and soundness of the security-based swap dealer
and be appropriate for the risk associated with the non-cleared
security-based swaps held as a security-based swap dealer in order
``[t]o offset the greater risk to the security-based swap dealer . .
. and the financial system arising from the use of security-based
swaps that are not cleared.''
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i. Capital
The Commission is required to establish minimum requirements
relating to capital for security-based swap dealers for which there is
not a prudential regulator (``nonbank security-based swap
dealers'').\409\ The prudential regulators are required to establish
requirements relating to capital for bank security-based swap
dealers.\410\ Some security-based swap dealers may also be registered
as swap dealers with the CFTC. The CFTC is required to establish
capital requirements for nonbank swap dealers.\411\ The prudential
regulators are required to establish capital requirements for bank swap
dealers.\412\
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\409\ See Section 15F(e)(1)(B) of the Exchange Act, 15 U.S.C.
78o-10(e)(1)(B); note 34, supra (discussing the term ``prudential
regulator'').
\410\ See Section 15F(e)(1)(A) of the Exchange Act, 15 U.S.C.
78o-10(e)(1)(A); see also Prudential Regulators Proposed Rule,
Margin and Capital Requirements for Covered Swap Entities, 76 FR
27564 (May 11, 2011) (``Prudential Regulator Margin and Capital
Proposal'').
\411\ See Section 4s(e)(1)(B) of the CEA, 7 U.S.C. 6s(e)(1)(B),
as added by Section 731 of the Dodd-Frank Act; see also CFTC
Proposed Rule, Capital Requirements of Swap Dealers and Major Swap
Participants, 76 FR 27802 (May 12, 2011) (``CFTC Capital
Proposal'').
\412\ See Section 4s(e)(1)(A) of the CEA, 7 U.S.C. 6s(e)(1)(A);
see also Prudential Regulator Margin and Capital Proposal, 76 FR
27564.
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The objective of the Commission's proposed capital rule for
security-based swap dealers is the same as the Commission's capital
rule for broker-dealers; specifically, to ensure that the entity
maintains at all times sufficient liquid assets to (i) promptly satisfy
its liabilities--the claims of customers, creditors, and other
security-based swap dealers, and (ii) provide a cushion of liquid
assets in excess of liabilities to cover potential market, credit, and
other risks.\413\
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\413\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70218 (``[T]he capital and other financial responsibility
requirements for broker-dealers generally provide a reasonable
template for crafting the corresponding requirements for nonbank
[security-based swap dealers]. For example, among other
considerations, the objectives of capital standards for both types
of entities are similar.'').
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As noted above, the Commission's proposed capital rules focus on
the liquid assets of a nonbank security-based swap dealer available to
satisfy its liabilities or cover its risks in a liquidation scenario.
This focus on liquid assets would distinguish the Commission's capital
rules applicable to security-based swap dealers from those applicable
to banks, which generally include a more permissive list of assets that
may be taken into account for purposes of capital calculations.\414\
The difference in approach between the capital rules applicable to
nonbank dealers and bank dealers is supported by certain operational,
policy, and legal differences between nonbank security-based swap
dealers and bank security-based swap dealers.\415\ Notably, existing
capital standards for banks and broker-dealers reflect, in part,
differences in their funding models and access to certain types of
financial support, and we expect that those same differences also will
exist between bank security-based swap dealers and nonbank security-
based swap dealers. For example, banks obtain funding through customer
deposits and can generally obtain liquidity through the Federal
Reserve's discount window to meet their obligations,\416\ whereas
broker-dealers and nonbank security-based swap dealers cannot.\417\
Thus all of a nonbank entity's counterparty obligations must be met
through the nonbank entity's own liquid assets. For these reasons, the
Commission's proposed capital standard for nonbank security-based swap
dealers is a net liquid assets test modeled on the broker-dealer
capital standard in Rule 15c3-1 under the Exchange Act.\418\
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\414\ See, e.g., Basel Committee on Banking Supervision
(``BCBS''), Basel III: International framework for liquidity risk
measurement, standards and monitoring for banks (Dec. 2010) (``Basel
III''), available at: http://www.bis.org/publ/bcbs188.pdf.
\415\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70218. In this release, the Commission discussed the operational,
policy, and legal differences between banks and nonbank entities for
distinguishing the Commission's capital rules from those applicable
to bank security-based swap dealers.
\416\ Depository institutions that maintain transaction accounts
or non-personal time deposits subject to reserve requirements are
eligible to borrow funds from the Federal Reserve's discount window,
such as commercial banks, thrift institutions, and U.S. branches and
agencies of foreign banks. See Regulation D, 12 CFR part 204.
\417\ Under the segregation requirements in Rule 15c3-3 under
the Exchange Act and proposed Rule 18a-4 under the Exchange Act,
broker-dealers and security-based swap dealers are not permitted to
rehypothecate customer assets to finance their business activity.
Thus, they cannot use customer assets as a source of funding,
whereas banks are in the business of investing customer deposits
(subject to banking regulations).
\418\ Id.
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ii. Margin
Margin may be viewed as an entity-level requirement given its
effect on the financial soundness of an entity, as well as a
transaction-level requirement due to the fact that margin is calculated
based on particular transactions and positions. Although margin is
calculated based on individual transactions, the cumulative effect of
collecting margin from counterparties is to protect an entity from the
default of its counterparties. Given the emphasis placed on the
financial soundness of security-based swap dealers in Title VII,\419\
we believe that margin should be treated as an entity-level requirement
for purposes of implementing Title VII in the cross-border context.
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\419\ See, e.g., Section 15F(e)(3)(A)(i) of the Exchange Act, 15
U.S.C. 78o-10(e)(3)(A)(i) (stating that Title VII's capital and
margin requirements are intended to ``help ensure the safety and
soundness of the security-based swap dealer or major security-based
swap participant''). In setting capital and margin requirements for
security-based swap dealers and major security-based swap
participants, the Commission's goal is to help ensure the safety and
soundness of these entities because of their connection to the U.S.
financial system.
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We recognize that this approach differs from the approach to margin
[[Page 31012]]
proposed by the CFTC in its cross-border guidance, which focused on the
transaction-by-transaction nature of margin and thus treated it as a
transaction-level requirement.\420\ However, we preliminarily believe
that treating margin as an entity-level requirement is consistent with
the role margin plays as part of an integrated program of financial
responsibility requirements, along with the capital standards and
segregation requirements, that are intended to enhance the financial
integrity of security-based swap dealers.\421\ The margin requirements
proposed by the Commission are intended to work in tandem with the
capital requirements to strengthen the financial system by reducing the
potential for default to an acceptable level and limiting the amount of
leverage that can be employed by security-based swap dealers and other
market participants.\422\ For example, the capital requirements
proposed by the Commission take into account whether a security-based
swap is cleared or non-cleared, the amount of margin collateral imposed
by registered clearing agencies with respect to cleared security-based
swaps, and the circumstances where non-cleared security-based swaps are
excepted from the margin collection requirements imposed by the
Commission, and would impose a capital charge in certain cases for
uncollateralized or insufficiently collateralized exposures arising
from cleared or non-cleared security-based swaps in order to account
for the counterparty default risk that is not adequately addressed by
margin collateral.\423\ We preliminarily do not believe that margin
would effectively fulfill its purpose as part of a comprehensive
financial responsibility program for non-bank security-based swap
dealers if the Commission were to treat margin solely as a transaction-
level requirement.
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\420\ See CFTC Cross-Border Proposal, 77 FR 41226.
\421\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70303 and 70259.
\422\ See id. at 70304.
\423\ See id. at 70245-46.
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The division of regulatory responsibilities related to margin
requirements in Title VII mirrors that of the capital requirements
discussed above. As with capital, the Commission is required to
establish minimum requirements relating to initial and variation margin
on all security-based swaps that are not cleared by a registered
clearing agency for nonbank security-based swap dealers.\424\ The
prudential regulators are required to establish requirements relating
to margin for bank security-based swap dealers.\425\ Security-based
swap dealers that are also registered as swap dealers with the CFTC
also would be subject to CFTC requirements for nonbank swap dealers
with respect to initial and variation margin requirements on all swaps
that are not cleared by a registered derivatives clearing
organization.\426\
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\424\ See Sections 15F(e)(1)(B) and (2)(B) of the Exchange Act,
15 U.S.C. 78o-10(e)(1)(B) and (2)(B).
\425\ See Section 15F(e)(1)(A) of the Exchange Act, 15 U.S.C.
78o-10(e)(1)(A); see also Prudential Regulator Margin and Capital
Proposal, 76 FR 27564.
\426\ See Section 4s(e)(1)(B) of the CEA, 7 U.S.C. 6s(e)(1)(B),
as added by Section 731 of the Dodd-Frank Act; see also CFTC
Proposed Rule, Margin Requirements for Uncleared Swaps for Swap
Dealers and Major Swap Participants, 76 FR 23732 (Apr. 28, 2011)
(``CFTC Margin Proposal''). The CFTC also has adopted segregation
requirements for cleared swaps and proposed segregation requirements
for non-cleared swaps. See Protection of Cleared Swaps Customer
Contracts and Collateral; Conforming Amendments to the Commodity
Broker Bankruptcy Provisions, 77 FR 6336 (Feb. 7, 2012) (``CFTC
Segregation for Cleared Swaps Final Release''); Protection of
Collateral of Counterparties to Uncleared Swaps; Treatment of
Securities in a Portfolio Margining Account in a Commodity Broker
Bankruptcy, 75 FR 75432 (Dec. 3, 2010) (``CFTC Segregation for
Uncleared Swaps Proposing Release'').
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The objective of the margin requirements for security-based swap
dealers is to offset the greater risk to the security-based swap dealer
and the financial system arising from the use of security-based swaps
that are not cleared.\427\ Margin serves as a buffer in the event a
counterparty fails to meet an obligation to the security-based swap
dealer and the security-based swap dealer must liquidate the assets
posted by the counterparty to satisfy the obligation.\428\ More
generally, under Title VII, the Commission is specifically required to
set both capital and margin requirements for nonbank security-based
swap dealers that (i) help ensure the safety and soundness of the
nonbank security-based swap dealer and (ii) are appropriate for the
risk associated with the non-cleared swaps held as a security-based
swap dealer.\429\
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\427\ See Section 15F(e)(3)(A) of the Exchange Act, 15 U.S.C.
78o-10(e)(3)(A).
\428\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70259.
\429\ See Sections 15F(e)(3)(A)(i) and (ii) of the Exchange Act,
15 U.S.C. 78o-10(e)(3)(A)(i) and (ii).
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Pursuant to Section 15F(e) of the Exchange Act, the Commission has
proposed Rule 18a-3 to establish margin requirements for nonbank
security-based swap dealers with respect to non-cleared security-based
swaps.\430\ Proposed Rule 18a-3 is based on the margin rules applicable
to broker-dealers.\431\ The goal of modeling proposed Rule 18a-3 on the
broker-dealer margin rules is to promote consistency with existing
rules and to facilitate the portfolio margining of security-based swaps
with other types of securities.\432\ Proposed Rule 18a-3 is intended to
form part of an integrated program of financial responsibility
requirements, along with the proposed capital and segregation
standards.\433\
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\430\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70257-74.
\431\ See id. at 70259. Broker-dealers are subject to margin
requirements in Regulation T promulgated by the Federal Reserve (12
CFR 220.1-220.132), in rules promulgated by the self-regulatory
organizations (``SROs'') (see, e.g., Rules 4210-4240 of the
Financial Industry Regulatory Authority (``FINRA'')), and with
respect to security futures, in rules jointly promulgated by the
Commission and the CFTC (17 CFR 242.400-242.406).
\432\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70259.
\433\ Id.
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The Commission preliminarily believes that it is necessary to treat
margin as an entity-level requirement applicable to all of a dealer's
security-based swap transactions in order to effectively address the
Dodd-Frank Act requirements for setting margin. We preliminarily
believe that treating margin solely as a transaction-level requirement,
and applying margin requirements differently to a security-based swap
dealer's U.S. Business and Foreign Business,\434\ would not adequately
further the goals of using margin to ensure the safety and soundness of
security-based swap dealers because it could result in security-based
swap dealers with global businesses collecting significantly less
collateral than would otherwise be required to the extent that they are
not required by local law to collect margin from their counterparties.
Further, separately applying margin in this way would force those
counterparties entering into transactions that constitute the U.S.
Business of a dealer to bear a greater burden in ensuring the safety
and soundness of such dealer than counterparties that are part of the
dealer's Foreign Business.\435\ We thus preliminarily believe that it
is
[[Page 31013]]
appropriate to treat margin as an entity-level requirement applicable
to the security-based swap transactions of registered security-based
swap dealers regardless of the location of their counterparties. As
noted below, the Commission is soliciting comment on this approach.
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\434\ See proposed Rule 3a71-3(a)(2) under the Exchange Act
(defining ``Foreign Business'').
\435\ Although we do not believe that it is appropriate to
distinguish between the geographic locations of counterparties when
applying the margin requirement, we recognize that it may be
appropriate, in certain circumstances, to distinguish between types
of counterparties in applying margin based on such factors as the
risk they pose to dealers and the policy goal of promoting liquidity
in dealers. See Capital, Margin, and Segregation Proposing Release,
77 FR 70265-68 (proposing to exclude both transactions with
commercial end users and those with other dealers from certain
margin requirements applicable to security-based swap dealers).
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iii. Risk Management
Registered security-based swap dealers are required to establish
robust and professional risk management systems adequate for managing
their day-to-day business.\436\ The Commission has proposed that
nonbank security-based swap dealers would be required to comply with
existing Rule 15c3-4 under the Exchange Act.\437\ This rule, originally
adopted for OTC derivative dealers, requires firms subject to its
provisions to establish, document, and maintain a comprehensive system
of internal risk management controls to assist in managing the risks
associated with its business activities, including market, credit,
leverage, liquidity, legal, and operational risks.\438\ These various
risks arise from both the U.S. Business and Foreign Business of a
global security-based swap dealer. A risk management system limited in
scope to cover only one type of business, or limited to certain
security-based swap transactions, would not effectively control the
risks undertaken by a security-based swap dealer because the risks
stemming from business outside the scope of such risk management system
could still negatively impact the dealer. As a result, we preliminarily
believe that it is necessary to treat risk management requirements as
entity-level requirements in order to place risk controls over the
entire security-based swap business, thus effectively addressing the
Dodd-Frank Act requirements for managing risk within security-based
swap dealers.
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\436\ See Section 15F(j)(2) of the Exchange Act, 15 U.S.C. 78o-
10(j)(2).
\437\ See proposed new paragraph (a)(10)(ii) of Rule 15c3-1
under the Exchange Act (17 CFR 240.15c3-1); paragraph (g) of
proposed new Rule 18a-1 under the Exchange Act. See also 17 CFR
240.15c3-4; Capital, Margin, and Segregation Proposing Release, 77
FR 70250-51. The Commission has not proposed rules relating to risk
management for bank security-based swap dealers.
\438\ See OTC Derivatives Dealers, Exchange Act Release No.
40594 (Oct. 23, 1998), 63 FR 59362 (Nov. 3, 1998).
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Rule 15c3-4 identifies a number of qualitative factors that would
need to be a part of the risk management controls of a nonbank
security-based swap dealer. For example, a nonbank security-based swap
dealer would need to have a risk control unit that reports directly to
senior management and is independent from business trading units, and
it would be required to separate duties between personnel responsible
for entering into a transaction and those responsible for recording the
transaction in the books and records of the firm.\439\ In addition, the
Commission is authorized to adopt rules governing documentation
standards of security-based swap dealers for timely and accurate
confirmation, processing, netting, documentation, and valuation of
security-based swaps.\440\ Pursuant to this authority, the Commission
has proposed rules regarding trade acknowledgement and verification
related to security-based swap transactions.\441\
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\439\ See 17 CFR 240.15c3-4(c), as discussed in the Capital,
Margin, and Segregation Proposing Release, 77 FR 70250.
\440\ See Section 15F(i) of the Exchange Act, 15 U.S.C. 78o-
10(i).
\441\ See Trade Acknowledgement Proposing Release, 76 FR 3859.
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iv. Recordkeeping and Reporting
Registered nonbank security-based swap dealers are required to keep
books and records in such form and manner and for such period as may be
prescribed by the Commission by rule or regulation; registered bank
security-based swap dealers are required to keep books and records of
all activities related to their ``business as a security-based swap
dealer'' in such form and manner and for such period as may be
prescribed by the Commission.\442\ Registered security-based swap
dealers also are required to make such reports as are required by the
Commission regarding the transactions and positions, and financial
condition of the registrant.\443\
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\442\ See Sections 15F(f)(1)(B)(i) and (ii) of the Exchange Act,
15 U.S.C. 78o-10(f)(1)(B)(i) and (ii).
\443\ See Section 15F(f)(1)(A) of the Exchange Act, 15 U.S.C.
78o-10(f)(1)(A).
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In addition, security-based swap dealers are required to maintain
daily trading records of the security-based swaps they enter into.\444\
Security-based swap dealers also are required to disclose to the
Commission and the prudential regulators information concerning: (i)
Terms and conditions of their security-based swaps; (ii) security-based
swap trading operations, mechanisms, and practices; (iii) financial
integrity protections relating to security-based swaps; and (iv) other
information relevant to their trading in security-based swaps.\445\
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\444\ See Section 15F(g) of the Exchange Act, 15 U.S.C. 78o-
10(g).
\445\ See Section 15F(j)(3) of the Exchange Act, 15 U.S.C. 78o-
10(j)(3).
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Each of these types of records is an important part of the
Commission's oversight of our registrants because it provides the
Commission with vital information regarding such entities. If the
Commission's information were limited in scope to cover only one type
of business, or limited to only certain security-based swap activities,
the Commission would not be able to effectively regulate our registered
security-based swap dealers because it would not have a full picture of
the business of such registrants. As a result, we preliminarily believe
that it is necessary to treat recordkeeping and reporting as entity-
level requirements in order to provide the Commission with the
information necessary to regulate registered security-based swap
dealers and thus effectively address the Dodd-Frank Act requirements
for maintaining books and records.
The Commission has not yet proposed rules regarding the
recordkeeping and reporting requirements under Section 15F of the
Exchange Act and solicits comment regarding the application of
recordkeeping and reporting requirements in the cross-border context.
v. Internal System and Controls
Security-based swap dealers are required to establish and enforce
systems and procedures to obtain any information that is necessary to
perform any of the functions that are required under Section 15F(j) of
the Exchange Act \446\ and to provide this information to the
Commission, or the responsible prudential regulator, upon request.\447\
The Commission has proposed a rule that would require a registered
security-based swap dealer to establish policies and procedures that
are reasonably designed to comply with its responsibilities under
Section 15F(j) of the Exchange Act.\448\
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\446\ 15 U.S.C. 78o-10(j). These functions include monitoring of
applicable position limits under Section 15F(j)(1) of the Exchange
Act, 15 U.S.C. 78o-10(j)(1); establishment of risk management
procedures under Section 15F(j)(2) of the Exchange Act, 15 U.S.C.
78o-10(j)(2); disclosure of general information to the Commission
and prudential regulators under Section 15F(j)(3) of the Exchange
Act, 15 U.S.C. 78o-10(j)(3); establishment of policies and
procedures to avoid conflicts of interest under Section 15F(j)(5) of
the Exchange Act, 15 U.S.C. 78o-10(j)(5); and avoidance of any
actions that result in an unreasonable restraint of trade or place
any material anticompetitive burden on trading or clearing under
Section 15F(j)(6) of the Exchange Act, 15 U.S.C. 78o-10(j)(6).
\447\ See Section 15F(j)(4) of the Exchange Act, 15 U.S.C. 78o-
10(j)(4).
\448\ See proposed Rule 15Fh-3(h)(2)(iv) under the Exchange Act,
as discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42420.
---------------------------------------------------------------------------
Many of the functions required under Section 15F(j) of the Exchange
Act are
[[Page 31014]]
entity-level in nature (e.g., risk management procedures \449\ and
conflicts of interest \450\). As a result, we preliminarily believe
that the requirement to establish and enforce systems and procedures to
obtain any information that is necessary to perform these functions
cannot be effectively implemented unless it also is treated as an
entity-level requirement, or else it would not cover the full scope of
the requirements under Section 15F(j) of the Exchange Act to which it
applies.
---------------------------------------------------------------------------
\449\ See Section III.C.3(b)iii, supra.
\450\ See Section III.C.3(b)vii, infra.
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vi. Diligent Supervision
The Commission is authorized under the Dodd-Frank Act to adopt
rules requiring diligent supervision of the business of security-based
swap dealers.\451\ The Commission has proposed a rule that would
establish supervisory obligations and that would incorporate principles
from Section 15(b) of the Exchange Act and existing SRO rules.\452\
Among other things, under proposed Rule 15Fh-3(h), a security-based
swap dealer would be required to establish, maintain, and enforce a
system to supervise, and would be required to supervise diligently, its
business and its associated persons, with a view to preventing
violations of applicable federal securities laws, and the rules and
regulations thereunder, relating to its business as a security-based
swap dealer.\453\ The rule proposed by the Commission also would
establish certain minimum requirements relating to the supervisory
systems that are prescriptive in nature, that is, they would impose
specific obligations on security-based swap dealers.\454\
---------------------------------------------------------------------------
\451\ See Section 15F(h)(1)(B) of the Exchange Act, 15 U.S.C.
78o-10(h)(1)(B).
\452\ Proposed Rule 15Fh-3(h) under the Exchange Act, as
discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42419-21.
\453\ Proposed Rule 15Fh-3(h)(1) under the Exchange Act, as
discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42419-21.
\454\ Proposed Rule 15Fh-3(h)(2) under the Exchange Act, as
discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42419-21.
---------------------------------------------------------------------------
As previously noted, the purpose of diligent supervision
requirements is to prevent violations of applicable federal securities
laws, and the rules and regulations thereunder, relating to an entity's
business as a security-based swap dealer. An entity's business as a
security-based swap dealer is not limited to either its Foreign
Business or its U.S. Business, but rather is comprised of its entire
global security-based swap dealing activity. As a result, we
preliminarily believe that it is necessary to treat diligent
supervision as an entity-level requirement applicable to all of a
dealer's security-based swap transactions in order to effectively
address the Dodd-Frank Act requirements for diligent supervision. We
believe that treating diligent supervision solely as a transaction-
level requirement, and applying supervisory requirements differently to
a security-based swap dealer's U.S. Business and Foreign Business,
would not further the Dodd-Frank Act goal of establishing effective
supervisory systems for security-based swap dealers.
vii. Conflicts of Interest
Section 15F(j)(5) of the Exchange Act requires security-based swap
dealers to implement conflict-of-interest systems and procedures. Such
policies and procedures must establish structural and institutional
safeguards to ensure that the activities of any person within the firm
relating to research or analysis of the price or market for any
security-based swap, or acting in the role of providing clearing
activities, or making determinations as to accepting clearing customers
are separated by appropriate informational partitions within the firm
from the review, pressure, or oversight of persons whose involvement in
pricing, trading, or clearing activities might potentially bias their
judgment or supervision, and contravene the core principles of open
access and the business conduct standards addressed in Title VII.\455\
The Commission has proposed a rule that would require a security-based
swap dealer to establish policies and procedures that are reasonably
designed to comply with its responsibilities under Section
15F(j)(5).\456\
---------------------------------------------------------------------------
\455\ See Section 15F(j)(5) of the Exchange Act, 15 U.S.C. 78o-
10(j)(5), as discussed in the External Business Conduct Standards
Proposing Release, 76 FR 42420.
\456\ Proposed Rule 15Fh-3(h)(2)(iv) under the Exchange Act, as
discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42420.
---------------------------------------------------------------------------
The Commission preliminarily believes that it is necessary to treat
conflicts of interest as an entity-level requirement applicable to all
of a dealer's security-based swap transactions in order to effectively
address the Dodd-Frank Act requirements for setting systems and
procedures to prevent conflicts of interest from biasing the judgment
or supervision of security-based swap dealers. We believe that treating
conflicts of interest solely as a transaction-level requirement, and
applying the required structural and institutional safeguards
differently to a security-based swap dealer's U.S. Business and Foreign
Business, would not further the goals of preventing conflicts of
interest from influencing the security-based swap dealing activities of
registered security-based swap dealers because such safeguards would
only be in place for a portion of a security-based swap dealer's
activities.
viii. Chief Compliance Officer
Registered security-based swap dealers are required to designate a
chief compliance officer who reports directly to the board of directors
or to the senior officer of the security-based swap dealer.\457\ The
chief compliance officer's responsibilities include reviewing and
ensuring compliance of the security-based swap dealer with applicable
requirements in the Exchange Act and the rules and regulations
thereunder, resolution of conflicts of interest, administration of
business conduct policies and procedures, and establishment of
procedures for the remediation of noncompliance issues.\458\ The chief
compliance officer also is required to prepare and sign a report that
contains a description of the security-based swap dealer's compliance
with applicable requirements in the Exchange Act, and the rules and
regulations thereunder, and each of the security-based swap dealer's
policies and procedures.\459\ The Commission has proposed a rule to
implement these statutory requirements relating to the designation and
functions of a chief compliance officer.\460\
---------------------------------------------------------------------------
\457\ See Section 15F(k) of the Exchange Act, 15 U.S.C. 78o-
10(k).
\458\ See Section 15F(k)(2) of the Exchange Act, 15 U.S.C. 78o-
10(k)(2).
\459\ See Section 15F(k)(3) of the Exchange Act, 15 U.S.C. 78o-
10(k)(3).
\460\ Proposed Rule 15Fk-1 under the Exchange Act, as discussed
in the External Business Conduct Standards Proposing Release, 76 FR
42435-38.
---------------------------------------------------------------------------
As noted above, part of the chief compliance officer's
responsibilities, under the proposed rule, include establishing,
maintaining, and reviewing policies and procedures reasonably designed
to ensure compliance with applicable requirements in the Exchange Act
and the rules and regulations thereunder.\461\ Many of Title VII
requirements, such as those applicable to security-based swap dealers
that are described in this section, apply at the entity level. As a
result, we preliminarily believe that it is necessary to treat the
chief compliance officer as an entity-level requirement applicable to
all of a dealer's security-
[[Page 31015]]
based swap business in order to effectively address the Dodd-Frank Act
requirements for the chief compliance officer. We believe that treating
the chief compliance officer solely as a transaction-level requirement,
and applying the chief compliance officer requirements differently to a
security-based swap dealer's U.S. Business and Foreign Business, would
be unworkable given the chief compliance officer's oversight
responsibilities over entity-level requirements and thus would not
further the goals of establishing the chief compliance officer role for
security-based swap dealers.
---------------------------------------------------------------------------
\461\ See Proposed Rule 15Fk-1(b)(2) under the Exchange Act, as
discussed in the External Business Conduct Standards Proposing
Release, 76 FR 42435-36.
---------------------------------------------------------------------------
ix. Inspection and Examination
Registered bank and nonbank security-based swap dealers are
obligated to keep their books and records required pursuant to
Commission rules and regulations open to inspection and examination by
any representative of the Commission.\462\ The Commission has proposed
a rule that would require, among other things, ``nonresident security-
based swap dealers'' that are required to register with the Commission
to appoint and identify to the Commission an agent in the United States
(other than the Commission or a Commission member, official, or
employee) for service of process.\463\ In addition, the proposed rule
would require that a nonresident security-based swap dealer certify
that the firm can, as a matter of law, provide the Commission with
prompt access to its books and records and can, as a matter of law,
submit to onsite inspection and examination by the Commission.\464\ The
proposed rule also would require that the nonresident security-based
swap dealer provide the Commission with an opinion of counsel
concurring that the firm can, as a matter of law, provide the
Commission with prompt access to its books and records and can, as a
matter of law, submit to onsite inspection and examination by the
Commission.\465\
---------------------------------------------------------------------------
\462\ See Section 15F(f)(1)(C) of the Exchange Act, 15 U.S.C.
78o-10(f)(1)(C). Registered bank security-based swap dealers are
only required to keep the books and records associated with the
activities related to their security-based swap dealing business, as
prescribed by the Commission, and to make these books and records
available for inspection by any representative of the Commission.
See id.
\463\ Proposed Rule 15Fb2-4 under the Exchange Act, as discussed
in the Registration Proposing Release, 76 FR 65799. For a
description of the term ``nonresident security-based swap dealer''
as defined in proposed Rule 15Fb2-4(a) under the Exchange Act,
including how that definition differs from the definition of the
term ``foreign security-based swap dealer'' as proposed in this
release, see note 579 above.
\464\ Proposed Rule 15Fb2-4 under the Exchange Act, as discussed
in the Registration Proposing Release, 76 FR 65800.
\465\ Proposed Rule 15Fb2-4 under the Exchange Act, as discussed
in the Registration Proposing Release, 76 FR 65799-801.
---------------------------------------------------------------------------
In proposing this rule, the Commission stated that it preliminarily
believed that the nonresident security-based swap certification and
supporting opinion of counsel were important to confirm that each
registered nonresident security-based swap dealer has taken the
necessary steps to be in the position to provide the Commission with
prompt access to its books and records and to be subject to inspection
and examination by the Commission.\466\ To effectively fulfill our
regulatory oversight responsibilities with respect to nonresident
security-based swap dealers registered with it, the Commission stated
that it must have access to those entities' records and the ability to
examine them. The Commission recognized, however, that certain foreign
jurisdictions may have laws that complicate the ability of financial
institutions, such as nonresident security-based swap dealers located
in their jurisdictions, to share and/or transfer certain information
including personal financial data of individuals that the financial
institutions come to possess from third persons (e.g., personal data
relating to the identity of market participants or their
customers).\467\ The Commission further stated that the required
certification and opinion of counsel regarding the nonresident
security-based swap dealer's ability to provide prompt access to books
and records and to be subject to inspection and examination would allow
the Commission to better evaluate a nonresident security-based swap
dealer's ability to meet the requirements of registration and ongoing
supervision.\468\
---------------------------------------------------------------------------
\466\ See Registration Proposing Release, 76 FR 65800.
\467\ Id.
\468\ Id.
---------------------------------------------------------------------------
The Commission's inspection and examination authority is vital to
our oversight of registered security-based swap dealers. If the
Commission's inspection and examination were limited in scope to cover
only one type of business, or limited to only certain security-based
swap activities, the Commission would not be able to effectively
regulate our registered security-based swap dealers because it would
not have a full picture of the business of such registrants. As a
result, we preliminarily believe that it is necessary to treat
inspection and examination requirements as entity-level in order to
provide the Commission with the information and access necessary to
regulate registered security-based swap dealers.
x. Licensing Requirements and Statutory Disqualification
The Commission has not proposed any licensing requirements for
associated persons of registered security-based swap dealers, that are
specifically related to their security-based swap dealing activities.
However, the Commission has proposed a rule that would require
security-based swap dealers (and major security-based swap
participants) to certify that no person associated with such entities
who effects or is involved in effecting security-based swaps on their
behalf is subject to statutory disqualification, as defined in Section
3(a)(39) of the Exchange Act.\469\ This proposed rule relates to
paragraph (b)(6) of Section 15F of the Exchange Act,\470\ which
generally prohibits security-based swap dealers (and major security-
based swap participants) from permitting any of their associated
persons \471\\\ who are subject to a ``statutory disqualification'' to
effect or be involved in effecting \472\\\ security-based swaps on
behalf of such entities if the security-based swap dealer (or major
security-based swap participant) knew, or in the exercise of
[[Page 31016]]
reasonable care should have known, of the statutory
disqualification.\473\
---------------------------------------------------------------------------
\469\ 15 U.S.C. 78c(a)(39). See proposed Rule 15Fb6-1 under the
Exchange Act, as discussed in the Registration Proposing Release, 76
FR 65795.
\470\ 15 U.S.C. 78o-10(b)(6).
\471\ Section 3(a)(70) of the Exchange Act, 15 U.S.C.
78c(a)(70), generally defines the term ``person associated with'' a
security-based swap dealer or major security-based swap participant
(``SBS Entity'') to include: (i) any partner, officer, director, or
branch manager of an SBS Entity (or any person occupying a similar
status or performing similar functions); (ii) any person directly or
indirectly controlling, controlled by, or under common control with
an SBS Entity; or (iii) any employee of an SBS Entity. However, it
generally excludes persons whose functions are solely clerical or
ministerial.
\472\ As stated in the Registration Proposing Release, ``[t]he
Commission believes that associated persons `involved in effecting'
security-based swaps would include, but not be limited to, persons
involved in drafting and negotiating master agreements and
confirmations, persons recommending security-based swap transactions
to counterparties, persons on a trading desk actively involved in
effecting security-based swap transactions, persons pricing
security-based swap positions and managing collateral for the
[security-based swap dealer or major security-based swap
participant], and persons assuring that the [security-based swap
dealer's or major security-based swap participant's] security-based
swap business operates in compliance with applicable regulations. In
short, the term would encompass persons engaged in functions
necessary to facilitate the [security-based swap dealer's or major
security-based swap participant's] security-based swap business.''
Registration Proposing Release, 76 FR 65795 n. 56.
\473\ See Registration Proposing Release, 76 FR 65795.
---------------------------------------------------------------------------
The Commission preliminarily believes that it is necessary to treat
requirements related to licensing and statutory disqualification as
entity-level requirements applicable to all of a dealer's security-
based swap business in order to effectively address the Exchange Act's
statutory disqualification provision. We believe that treating
licensing requirements and statutory disqualification solely as
transaction-level requirements, and applying the statutory
disqualification differently to a security-based swap dealer's U.S.
Business and Foreign Business, would not further the goals of
preventing statutorily disqualified persons from effecting security-
based swaps on behalf of registered security-based swap dealers because
such disqualifications would only be in place for a portion of a
security-based swap dealer's activities.
4. Application of Certain Transaction-Level Requirements \474\
---------------------------------------------------------------------------
\474\ For purposes of this discussion, we are addressing only
requirements applicable to security-based swap dealers in Sections
3E and 15F of the Exchange Act, 15 U.S.C. 78c-5 and 78o-10, and the
rules and regulations thereunder. Title VII requirements relating to
reporting and dissemination, clearing, and trade execution are
discussed in Sections VIII-X, infra.
---------------------------------------------------------------------------
(a) Proposed Rule
The Commission is proposing a rule that would provide that a
registered foreign security-based swap dealer and a foreign branch of a
registered U.S. security-based swap dealer, with respect to their
Foreign Business, shall not be subject to the requirements relating to
external business conduct standards described in Section 15F(h) of the
Exchange Act,\475\ and the rules and regulations thereunder, other than
the rules and regulations prescribed by the Commission pursuant to
Section 15F(h)(1)(B).\476\
---------------------------------------------------------------------------
\475\ 15 U.S.C. 78o-10(h).
\476\ Proposed Rule 3a71-3(c) under the Exchange Act. The
approach under the proposed rule does not affect applicability of
the general antifraud provisions of the federal securities laws to
the activity of a foreign security-based swap dealer. See Section
XII, infra.
---------------------------------------------------------------------------
The proposed rule would define ``Foreign Business'' as security-
based swap transactions entered into, or offered to be entered into, by
or on behalf of a foreign security-based swap dealer or a U.S.
security-based swap dealer that do not include its U.S. Business.\477\
The proposed rule would define ``U.S. Business'' as:
---------------------------------------------------------------------------
\477\ Proposed Rule 3a71-3(a)(2) under the Exchange Act.
---------------------------------------------------------------------------
With respect to a foreign security-based swap dealer, (i)
any transaction entered into, or offered to be entered into, by or on
behalf of such foreign security-based swap dealer, with a U.S. person
(other than with a foreign branch), or (ii) any transaction conducted
within the United States; \478\ and
---------------------------------------------------------------------------
\478\ Proposed Rule 3a71-3(a)(6) under the Exchange Act. A
person that meets the security-based swap dealer definition is a
dealer with regard to all of its security-based swap activities, not
just its dealing activities. See Intermediary Definitions Adopting
Release, 77 FR 30645. Accordingly, a foreign security-based swap
dealer's U.S. Business would not be limited only to transactions
arising from its dealing activity, but rather would include all
types of security-based swap activity.
---------------------------------------------------------------------------
With respect to a U.S. security-based swap dealer, any
transaction by or on behalf of such U.S. security-based swap dealer,
wherever entered into or offered to be entered into, other than a
transaction conducted through a foreign branch with a non-U.S. person
or another foreign branch.\479\
---------------------------------------------------------------------------
\479\ Proposed Rule 3a71-3(a)(6) under the Exchange Act.
---------------------------------------------------------------------------
Whether the activity occurred within the United States or with a
U.S. person for purposes of identifying whether security-based swap
transactions are part of a U.S. Business or Foreign Business would turn
on the same factors used to determine whether a foreign security-based
swap dealer is engaging in dealing activity within the United States or
with U.S. persons, as discussed above.\480\ The proposed rule provides
that a U.S. security-based swap dealer would be considered to have
conducted a security-based swap transaction through a foreign branch
if:
---------------------------------------------------------------------------
\480\ See Section III.B.6, supra (discussing the proposed
definition of ``transaction conducted within the United States'').
---------------------------------------------------------------------------
The foreign branch is the counterparty to such security-
based swap transaction; and
No person within the United States is directly involved in
soliciting, negotiating, or executing the security-based swap
transaction on behalf of the foreign branch or its counterparty.\481\
---------------------------------------------------------------------------
\481\ Proposed Rule 3a71-3(a)(4) under the Exchange Act. See
also proposed Rule 3a71-3(a)(5)(ii) under the Exchange Act
(providing that the definition of ``transaction conducted within the
United States'' shall not include a transaction conducted through a
foreign branch).
---------------------------------------------------------------------------
As discussed above,\482\ the proposed rule would define ``foreign
branch'' as any branch of a U.S. bank if:
---------------------------------------------------------------------------
\482\ See Section III.B.7, supra.
---------------------------------------------------------------------------
The branch is located outside the United States;
The branch operates for valid business reasons; and
The branch is engaged in the business of banking and is
subject to substantive banking regulation in the jurisdiction where
located.\483\
---------------------------------------------------------------------------
\483\ Proposed Rule 3a71-3(a)(1) under the Exchange Act.
---------------------------------------------------------------------------
All other requirements in Section 15F of the Exchange Act, and the
rules and regulations thereunder, would apply to both U.S. and foreign
security-based swap dealers registered with the Commission, although
the Commission is proposing to establish a policy and procedural
framework under which it would consider permitting substituted
compliance for foreign security-based swap dealers (but not for U.S.
security-based swap dealers that conduct dealing activity through
foreign branches) under certain circumstances, as discussed below.\484\
---------------------------------------------------------------------------
\484\ See Section XI.C, infra.
---------------------------------------------------------------------------
The Commission also is proposing a rule that would provide that a
foreign security-based swap dealer would not be required to comply with
the segregation requirements set forth in Section 3E of the Exchange
Act, and the rules and regulations thereunder, with respect to
security-based transactions with non-U.S. person counterparties in
certain circumstances.\485\ Specifically, the Commission is proposing a
rule that would provide the following:
---------------------------------------------------------------------------
\485\ Proposed Rule 18a-4(e) under the Exchange Act.
---------------------------------------------------------------------------
With respect to non-cleared security-based swap
transactions:
[cir] A registered foreign security-based swap dealer that is a
registered broker-dealer would be subject to the requirements relating
to segregation of assets held as collateral set forth in Section 3E of
the Exchange Act, and rules and regulations thereunder, with respect to
assets collected from, for, or on behalf of any counterparty to margin
a non-cleared security-based swap transaction.
[cir] a registered foreign security-based swap dealer that is not a
registered broker-dealer would be subject to the requirements relating
to segregation of assets held as collateral set forth in Section 3E of
the Exchange Act, and Rules 18a-4(a)-(d), solely with respect to assets
collected from, for, or on behalf of a counterparty that is a U.S.
person to margin a non-cleared security-based swap transaction. The
special account maintained by a registered foreign security-based swap
dealer that is not a registered broker-dealer in accordance with
proposed Rule 18a-4(c) would be required to be designated for the
exclusive benefit of U.S. person security-based swap customers.\486\
---------------------------------------------------------------------------
\486\ Proposed Rule 18a-4(e)(1) under the Exchange Act.
---------------------------------------------------------------------------
With respect to cleared security-based swap transactions:
[[Page 31017]]
[cir] A registered foreign security-based swap dealer that is not a
foreign bank with a branch or agency in the United States and is a
registered broker-dealer shall be subject to the requirements relating
to segregation of assets held as collateral set forth in Section 3E of
the Exchange Act, and rules and regulations thereunder, with respect to
assets collected from, for, or on behalf of any counterparty to margin
a cleared security-based swap transaction.
[cir] a registered foreign security-based swap dealer that is not a
foreign bank with a branch or agency in the United States and that is
not a registered broker-dealer shall be subject to the requirements
relating to segregation of assets held as collateral set forth in
Section 3E of the Exchange Act, and Rules 18a-4(a)-(d), only if such
registered foreign security-based swap dealer accepts any assets from,
for, or on behalf of a counterparty that is a U.S. person to margin,
guarantee, or secure a cleared security-based swap transaction.\487\
---------------------------------------------------------------------------
\487\ Proposed Rule 18a-4(e)(2)(ii) under the Exchange Act.
---------------------------------------------------------------------------
[cir] a registered foreign security-based swap dealer that is a
foreign bank with a branch or agency in the United States would be
subject to the requirements relating to segregation of assets held as
collateral set forth in Section 3E of the Exchange Act, and Rules 18a-
4(a)-(d),\488\ solely with respect to assets collected from a
counterparty that is a U.S. person to margin a cleared security-based
swap transaction. The special account maintained by a registered
foreign security-based swap dealer that is a foreign bank with a branch
or agency in the United States in accordance with proposed Rule 18a-
4(c) would be required to be designated for the exclusive benefit of
U.S. person security-based swap customers.\489\
---------------------------------------------------------------------------
\488\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70274-88 (proposing Rules 18a-4(a)-(d) under the Exchange Act).
\489\ Proposed Rule 18a-4(e)(2)(i) under the Exchange Act.
---------------------------------------------------------------------------
In addition, a registered foreign security-based swap dealer would
be required to disclose to its counterparty the potential treatment of
the assets segregated by such registered foreign security-based swap
dealer pursuant to Section 3E of the Exchange Act, and rules and
regulations thereunder, in insolvency proceedings under the U.S.
bankruptcy law and applicable foreign insolvency laws.\490\
---------------------------------------------------------------------------
\490\ Proposed Rule 18a-4(e)(3) under the Exchange Act.
---------------------------------------------------------------------------
(b) Discussion
i. External Business Conduct Standards
a. Foreign Security-Based Swap Dealers
The Commission preliminarily believes it is appropriate not to
impose on foreign security-based swap dealers the external business
conduct standards in Section 15F(h) (other than rules and requirements
prescribed by the Commission pursuant to Section 15F(h)(1)(B)) of the
Exchange Act, and the rules and regulations thereunder, described in
the proposed rule,\491\ with respect to their Foreign Business, because
these requirements relate primarily to customer protection. The Dodd-
Frank Act's counterparty protection mandate focuses on the United
States and the U.S. markets.\492\ In addition, we preliminarily believe
that foreign counterparties typically would not expect to receive the
customer protections of Title VII when dealing with a foreign security-
based swap dealer outside the United States. At the same time, our
proposed approach would preserve customer protections for U.S.
counterparties that would expect to benefit from the protection
afforded to them by Title VII of the Dodd-Frank Act.
---------------------------------------------------------------------------
\491\ Proposed Rule 3a71-3(c) under the Exchange Act.
\492\ See note 4, supra.
---------------------------------------------------------------------------
Therefore, the Commission preliminarily believes that requiring
foreign security-based swap dealers to comply with the external
business conduct standards requirement with respect to their security-
based swap transactions conducted outside the United States with non-
U.S. persons (or with foreign branches of U.S. banks) would not advance
this statutory purpose. Although this approach represents a departure
from the entity approach the Commission has traditionally taken in the
regulation of foreign broker-dealers, as discussed above, whereby the
Commission applies our regulations to the entire global business of a
registered broker-dealer, we preliminarily believe this departure is
appropriate in the context of a global security-based swap market in
order to create a regulatory framework that provides effective
protections for counterparties that are U.S. persons while recognizing
the role of foreign regulators in non-U.S. markets.
The Commission also preliminarily believes that this approach
addresses many of the concerns raised by commenters, including foreign
regulators, concerning the potential application of Title VII to
transactions between registered foreign security-based swap dealers and
non-U.S. counterparties. In addition, this approach is consistent with
the reasonable expectations of U.S. person counterparties, who would
expect to receive the protection of external business conduct standards
and conflicts of interest requirements when dealing with a foreign
security-based swap dealer within the United States.\493\
---------------------------------------------------------------------------
\493\ See note 321, supra.
---------------------------------------------------------------------------
The Commission's proposed approach to external business conduct
standards would not except foreign security-based swap dealers from the
rules and requirements prescribed by the Commission pursuant to Section
15F(h)(1)(B) of the Exchange Act with respect to their Foreign
Business.\494\ Section 15F(h)(1)(B) requires security-based swap
dealers to conform with such business conduct standards relating to
diligent supervision as the Commission shall prescribe.\495\ The
Commission preliminarily believes that it is not appropriate to except
foreign security-based swap dealers from compliance with such
requirements. Because registered foreign security-based swap dealers
would be subject to a number of obligations under the federal
securities laws with respect to their security-based swap business, the
Commission preliminarily believes that having systems in place
reasonably designed to ensure diligent supervision would be an
important aspect of their compliance with the federal securities laws.
However, as discussed below, the Commission is proposing to permit
substituted compliance with the diligent supervision requirement in
Section 15F(h)(1)(B), and the rules and regulations thereunder, by
foreign security-based swap dealers.\496\ The Commission preliminarily
believes that foreign security-based swap dealers subject to regulation
in a foreign jurisdiction are very likely to be subject to diligent
supervision requirements and to the extent that such requirements are
comparable to Commission requirements, we would consider permitting
substituted compliance, as discussed below.\497\
---------------------------------------------------------------------------
\494\ Proposed Rule 3a71-3(c) under the Exchange Act.
\495\ 15 U.S.C. 78o-10(h)(1)(B). See Section III.C.3(b)vi, supra
(discussing the diligent supervision requirements).
\496\ See Section XI.C, infra.
\497\ See id.
---------------------------------------------------------------------------
The Commission is proposing to except foreign security-based swap
dealers from complying with the rules and regulations that the
Commission may prescribe pursuant to Section 15F(h)(1)(A) or (C) of the
Exchange
[[Page 31018]]
Act.\498\ Section 15F(h)(1)(A) requires security-based swap dealers to
conform with such business conduct standards relating to fraud,
manipulation, and other abusive practices involving security-based
swaps (including security-based swaps that are offered but not entered
into) as prescribed by the Commission. Section 15F(h)(1)(C) requires
security-based swap dealers to adhere to rules and regulations
prescribed by the Commission with respect to applicable position
limits. The Commission has not engaged in rulemaking pursuant to these
provisions.\499\ If the Commission does propose rules pursuant to these
provisions in the future, the Commission would consider, at that time,
whether it would be appropriate to subject foreign security-based swap
dealers to such requirements with respect to their Foreign Business.
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\498\ 15 U.S.C. 78o-10(h)(1)(A) and (C).
\499\ Although the Commission has not proposed rules under
Section 15F(h)(1)(A) of the Exchange Act, the Commission has
proposed new Rule 9j-1 under the Exchange Act, which is intended to
prevent fraud, manipulation, and deception in connection with the
offer, purchase, or sale of any security-based swap, the exercise of
any right or performance of any obligation under a security-based
swap, or the avoidance of such exercise or performance. See
Prohibition Against Fraud, Manipulation, and Deception in Connection
with Security-Based Swaps, Exchange Act Release No. 63236 (Nov. 3,
2010), 75 FR 68560 (Nov. 8, 2010). The Commission's view of its
antifraud enforcement authority in the cross-border context is
described in further detail in Section XI below.
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b. U.S. Security-Based Swap Dealers
The Commission preliminarily believes it is appropriate not to
subject U.S. security-based swap dealers to the external business
conduct standards in Section 15F(h) (other than Section 15F(h)(1)(B))
of the Exchange Act, and the rules and regulations thereunder, as
specified in the proposed rule, with respect to security-based swap
transactions conducted through their foreign branches outside the
United States with non-U.S. counterparties, because such requirements
relate primarily to customer protection requirements. The Dodd-Frank
Act generally is concerned with the protection of U.S. markets and
participants in those markets.\500\ Therefore, we preliminarily believe
that subjecting U.S. security-based swap dealers to the Title VII
customer protection requirements with respect to their security-based
swap transactions conducted through their foreign branches outside the
United States (even though the transactions may pose risk to the U.S.
financial system) with non-U.S. persons would produce little or no
benefit to U.S. market participants. Although this approach would
represent a departure from the entity approach the Commission has
traditionally taken in the regulation of broker-dealers, whereby the
Commission applies our regulations to the entire global business of a
registered broker-dealer, we preliminarily believe it is appropriate in
the context of a global security-based swap market in order to develop
a national regulatory framework that provides effective protections for
counterparties who are U.S. persons while recognizing the role of
foreign regulators in non-U.S. markets.
---------------------------------------------------------------------------
\500\ See note 4, supra.
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The Commission also preliminarily believes that this approach would
help address the potential application of duplicative and conflicting
regulatory requirements to security-based swap transactions between the
foreign branches of registered U.S. bank security-based swap dealers
and non-U.S. counterparties. In addition, the Commission preliminarily
believes this approach is consistent with the reasonable expectations
of foreign counterparties, who would not necessarily expect to receive
the protections of Title VII when dealing with a foreign branch of a
U.S. bank outside the United States, even if it is registered as a
security-based swap dealer with the Commission.\501\
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\501\ See note 321, supra. The proposed definition of foreign
branch is the same as discussed above. See proposed Rule 3a71-
3(a)(1) under the Exchange Act, as discussed in Section III.B.7,
supra.
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The purpose of the proposed provision defining when a security-
based swap transaction would be considered to have been conducted
through a foreign branch is intended to prevent U.S. security-based
swap dealers from using the proposed rule to evade the application of
Title VII.\502\ Requiring that the foreign branch be the named
counterparty to the security-based swap transaction and that no person
within the United States be directly involved in soliciting,
negotiating, or executing the security-based swap transaction on behalf
of the foreign branch or its counterparty is intended to help ensure
that the security-based swap transaction occurs outside the United
States, even though the Commission recognizes that the risk of the
transaction would ultimately be borne by the U.S. security-based swap
dealer, of which the foreign branch is merely a part.\503\ The U.S.
security-based swap dealer would still be subject to the entity-level
requirements described above intended to address the risk the
transactions pose to the U.S. financial system.
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\502\ Proposed Rule 3a71-3(a)(4) under the Exchange Act.
\503\ Proposed Rule 3a71-3(a)(4)(i) under the Exchange Act.
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ii. Segregation Requirements
The segregation requirements set forth in Section 3E of the
Exchange Act, and rules and regulations thereunder, are closely tied to
U.S. bankruptcy laws.\504\ Subchapter III of Chapter 7, Title 11 of the
United States Code (the ``stockbroker liquidation provisions'') \505\
provides special protections for ``customers'' of stockbrokers. Among
other protections, ``customers'' share ratably with other customers
ahead of virtually all other creditors in the ``customer property''
held by the failed stockbroker.\506\ The Dodd-Frank Act contains
provisions designed to ensure that cash and securities held by a
security-based swap dealer relating to security-based swaps will be
deemed customer property under the stockbroker liquidation
provisions.\507\ In particular, Section 3E(g) of the Exchange Act \508\
provides, among other things, that a security-based swap shall be
considered to be a ``security'' as such term is used in section
101(53A)(B) \509\ and the stockbroker liquidation provisions. Section
3E(g) also provides that an account that holds a security-based swap
shall be considered to be a ``securities account'' as that term is
defined in the stockbroker liquidation provisions.\510\ In addition,
Section 3E(g) provides that the terms ``purchase'' and ``sale'' as
defined in Sections 3(a)(13) and (14) of the Exchange Act,
respectively, shall be applied to the terms ``purchase'' and ``sale''
as used in the stockbroker liquidation
[[Page 31019]]
provisions.\511\ Finally, Section 3E(g) provides that the term
``customer'' as defined in the stockbroker liquidation provisions
excludes any person to the extent the person has a claim based on a
non-cleared security-based swap transaction except to the extent of any
margin delivered to or by the customer with respect to which there is a
customer protection requirement under Section 15(c)(3) of the Exchange
Act or a segregation requirement.\512\
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\504\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70274-78 (discussing the customer protection treatment provided
by proposed Rules 18a-4(a)-(d) in the stockbroker liquidation
provisions in the U.S. Bankruptcy Code).
\505\ See 11 U.S.C. 741-53.
\506\ See 11 U.S.C. 752.
\507\ See Public Law 111-203 section 763(d), adding Section
3E(g) to the Exchange Act, 15 U.S.C. 78c-5(g).
\508\ See 15 U.S.C. 78c-5(g).
\509\ See 11 U.S.C. 101(53A)(B). Section 101(53A) of the U.S.
Bankruptcy Code defines a ``stockbroker'' to mean a person--(A) with
respect to which there is a customer, as defined in section 741,
subchapter III of chapter 7, title 11, United States Code (the
definition section of the stockbroker liquidation provisions); and
(B) that is engaged in the business of effecting transactions in
securities--(i) for the account of others; or (ii) with members of
the general public, from or for such person's own account. See 11
U.S.C. 101(53A).
\510\ See 15 U.S.C. 78c-5(g) and 11 U.S.C. 741. There is not a
definition of ``securities account'' in 11 U.S.C. 741. The term
``securities account'' is used in 11 U.S.C. 741(2) and (4) in
defining the terms ``customer'' and ``customer property.''
\511\ See also 15 U.S.C. 78c-5(g) and 11 U.S.C. 741-753. Section
3(a)(13) of the Exchange Act, as amended by Section 761(a) of the
Dodd-Frank Act, defines the term ``purchase'' to mean, in the case
of security-based swaps, the execution, termination (prior to its
scheduled maturity date), assignment, exchange, or similar transfer
or conveyance of, or extinguishing of rights or obligations under, a
security-based swap, as the context may require. See 15 U.S.C.
3(a)(13). Section 3(a)(14) of the Exchange Act, as amended by
Section 761(a) of the Dodd-Frank Act, defines the term ``sale'' to
mean, in the case of security-based swaps, the execution,
termination (prior to its scheduled maturity date), assignment,
exchange, or similar transfer or conveyance of, or extinguishing of
rights or obligations under, a security-based swap, as the context
may require. See 15 U.S.C. 3(a)(14).
\512\ See 15 U.S.C. 78c-5(g) and 11 U.S.C. 741(2).
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The provisions of Section 3E(g) of the Exchange Act apply the
customer protection elements of the stockbroker liquidation provisions
to cleared security-based swaps, including related collateral, and, if
subject to customer protection requirements under Section 15(c)(3) of
the Exchange Act or a segregation requirement prescribed by the
Commission, to collateral delivered as margin for non-cleared security-
based swaps.\513\ The Commission has proposed Rule 18a-4(a)-(d) to
establish segregation requirements for security-based swap dealers with
respect to cleared and non-cleared security-based swaps pursuant to
Section 3E of the Exchange Act and pursuant to Section 15(c)(3) of the
Exchange Act \514\ with respect to security-based swap dealers that are
broker-dealers.\515\
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\513\ See 15 U.S.C. 78c-5(g) and 11 U.S.C. 741-53.
\514\ 15 U.S.C. 78o(c)(3).
\515\ See proposed Rules 18a-4(a)-(d) under the Exchange Act and
Section 3E of the Exchange Act, 15 U.S.C. 78c-5. See also the
Capital, Margin, and Segregation Proposing Release, 77 FR 70278-88,
for detailed descriptions and discussions of the proposed
segregation requirements for security-based swaps in proposed Rules
18a-4(a), (b), and (c) under the Exchange Act and special provisions
for non-cleared security-based swaps in proposed Rule 18a-4(d) under
the Exchange Act.
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Specifically, proposed Rule 18a-4(b) requires a security-based swap
dealer to promptly obtain and thereafter maintain physical possession
or control of all excess securities collateral carried for the accounts
of security-based swap customers. Such possession or control
requirement is designed to ensure the securities held for the accounts
of security-based swap customers are under the control of the security-
based swap dealer and, therefore, readily available to be returned to
security-based swap customers. Proposed Rule 18a-4(c) requires a
security-based swap dealer to maintain a special account for the
exclusive benefit of security-based swap customers and have on deposit
in that account at all times an amount of cash or qualified securities
determined by computing the net amount of credits owed to
customers.\516\ The objective of the possession or control and special
account requirements in proposed Rule 18a-4 is to facilitate the prompt
return of ``customer property'' to security-based swap customers either
before or during a liquidation proceeding if the firm fails. In the
event of a failure of the security-based swap dealer, customers would
share the ``customer property'' ratably with other customers and ahead
of virtually all other creditors.\517\ In addition, with respect to
non-cleared security-based swaps, proposed Rule 18a-4(d) requires a
security-based swap dealer to provide the notice required under Section
3E(f)(1)(A) of the Exchange Act \518\ to a counterparty in writing
prior to the execution of the first non-cleared security-based swap
transaction with such counterparty. If a counterparty to a non-cleared
security-based swap elects to segregate funds or other property with a
third-party custodian pursuant to Section 3E(f) of the Exchange Act or
elects not to require the omnibus segregation of funds or other
property pursuant to proposed Rule 18a-4(c), the security-based swap
dealer must obtain an agreement from such counterparty to subordinate
all claims against the security-based swap dealer to the claims of
security-based swap customers of such security-based swap dealer.\519\
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\516\ See proposed Rule 18a-4(c) and the related discussion in
the Capital, Margin, and Segregation Proposing Release, 77 FR 70277.
\517\ See the stockbroker liquidation provisions in the U.S.
Bankruptcy Code, 11 U.S.C. 741-53.
\518\ 15 U.S.C. 78c-5(f)(1)(A).
\519\ See proposed Rules 18a-4(d)(1) and (d)(2)(i) and (ii)
under the Exchange Act, as discussed in the Capital, Margin, and
Segregation Proposing Release, 77 FR 70287-88. If a non-cleared
security-based swap counterparty elects to segregate funds or other
property with a third-party custodian, the subordination agreement
would be conditioned on the counterparty's funds and other property
segregated at a third-party custodian not being included in the
bankruptcy estate of the security-based swap dealer. If the election
is not effective in keeping the counterparty's assets bankruptcy
remote, then the counterparty should be treated as a security-based
swap customer with a pro rata priority claim to customer property.
See proposed Rule 18a-4(d)(2)(i) under the Exchange Act. If a non-
cleared security-based swap counterparty elects not to segregate any
assets at all, the security-based swap dealer would need to obtain
an unconditional subordination agreement from the counterparty that
waives segregation altogether. See proposed Rule 18a-4(d)(2)(ii)
under the Exchange Act.
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As proposed in the Capital, Margin and Segregation Proposing
Release, the segregation requirements in proposed Rule 18a-4(a)-(d) do
not distinguish between U.S. security-based swap dealers and foreign
security-based swap dealers or between U.S. person and non-U.S. person
security-based swap counterparties, and do not address application of
the segregation requirements in the cross-border context. The
Commission preliminarily believes that the Dodd-Frank Act's mandate to
promote financial stability, improve accountability, and protect
counterparties focuses territorially on the United States and the U.S.
security-based swap market \520\ and, therefore, is not proposing any
changes with respect to U.S. security-based swap dealers to the
segregation requirements already proposed.\521\ The Commission's
proposed approach to application of segregation requirements to foreign
security-based swap dealers intends to protect U.S. person
counterparties and minimize the impact of a failed security-based swap
dealer on the U.S. financial system generally and the U.S. security-
based swap market in particular.
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\520\ See note 4, supra.
\521\ See proposed Rules 18a-4(a)-(d) under the Exchange Act and
Section 3E of the Exchange Act, 15 U.S.C. 78c-5. See also the
Capital, Margin, and Segregation Proposing Release, 77 FR 70278-88.
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a. Foreign Security-Based Swap Dealers
As stated above, Section 3E(g) extends the customer protection
provided by the stockbroker liquidation provisions of the U.S.
Bankruptcy Code to cleared security-based swaps and non-cleared
security-based swaps in different ways. In addition, a foreign
security-based swap dealer may not be subject to the stockbroker
liquidation provisions if it is a foreign bank with a branch or agency
in the United States.\522\ Such foreign security-based swap dealer's
insolvency and liquidation would be subject to banking
regulations.\523\ On the
[[Page 31020]]
other hand, if a foreign security-based swap dealer is not a foreign
bank with a branch or agency in the United States, it may be subject to
the stockbroker liquidation provisions \524\ in a stockbroker
liquidation proceeding in a U.S. bankruptcy court. Moreover, if a
foreign security-based swap dealer is a registered broker-dealer, it is
a member of the Securities Investor Protection Corporation (``SIPC'')
\525\ and is subject to segregation requirements under Section 15(c)(3)
of the Exchange Act,\526\ and rules and regulations thereunder.\527\
Such a foreign security-based swap dealer would be subject to the
liquidation proceeding under the Securities Investor Protection Act of
1970 (the ``SIPA'').\528\ Therefore, we propose an approach that would
apply the segregation requirements to a foreign security-based swap
dealer depending on whether it holds assets to secure cleared security-
based swap transactions or non-cleared security-based swap transactions
and whether such foreign security-based swap dealer is a registered
broker-dealer, a foreign bank with a branch or agency in the United
States, or neither of the above.\529\
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\522\ See Section 109(b) of the U.S. Bankruptcy Code, 11 U.S.C.
109(b) (providing that a person may be a debtor under chapter 7 of
the U.S. Bankruptcy Code only if such person is not, among other
things, a bank or similar institution which is an insured bank as
defined in Section 3(h) of the Federal Deposit Insurance Act, or a
foreign bank that has a branch or agency (as defined in Section 1(b)
of the International Banking Act of 1978) in the United States).
\523\ See 12 U.S.C. 1821-25. Whereas insured deposit
institutions would be resolved under the Federal Deposit Insurance
Act, uninsured U.S. branches of foreign banks would be resolved
under either relevant state statutes, in the case of uninsured state
branches, or the International Banking Act, in the case of uninsured
federal branches.
\524\ See note 522, supra.
\525\ We recognize that a very limited number of registered
foreign broker-dealers who do not conduct securities business in the
United States and do not hold U.S. person customers' funds are not
members of SIPC.
\526\ 15 U.S.C. 78o(c)(3).
\527\ See Rule 15c3-3 under the Exchange Act, 17 CFR 240.15c3-3.
\528\ See 15 U.S.C. 78aaa et seq.
\529\ We preliminarily believe that the proposed approach with
respect to the segregation requirements set forth in Section 3E of
the Exchange Act, and rules and regulations thereunder, is not being
applied to persons who are ``transact[ing] a business in security-
based swaps without the jurisdiction of the United States,'' within
the meaning of Section 30(c). See Section II.B.2(a), supra. However,
the Commission also preliminary believes that the proposed approach
with respect to the segregation requirements is necessary or
appropriate to help prevent the evasion of the particular provisions
of the Exchange Act that were added by the Dodd-Frank Act that are
being implemented by the proposed approach and prophylactically will
help ensure that the purposes of those provisions of the Dodd-Frank
Act are not undermined. See Section II.B.2(e), supra; see also
Section II.B.2(c), supra.
For example, if the segregation requirements do not apply to the
entire business of a registered foreign security-based swap dealer
that is a registered broker-dealer, or do not apply to assets
received from non-U.S. person customers to secure cleared security-
based swaps by a registered foreign security-based swap dealer that
is not a registered broker-dealer (and is not a foreign bank with a
branch or agency in the United States) if such foreign security-
based swap dealer also receives assets from a U.S. person customer
to secure clear security-based swaps, then U.S. security-based swap
dealers would have an incentive to evade the full application of the
segregation requirements by moving their operations outside the
United States. In this event, these security-based swap dealers
could use the assets collected from the non-U.S. person
counterparties for their own business purposes, and the assets
segregated (i.e., assets posted by U.S. person customers) could be
insufficient to satisfy the combined priority claims of both U.S.
person and non-U.S. person customers, potentially resulting in
losses to U.S. person customers in contravention of the purposes of
the customer protection framework established by the Dodd-Frank Act.
See discussions of application of the segregation requirements to a
foreign security-based swap dealer that is a registered broker-
dealer with respect to non-cleared security-based swaps in Section
III.C.4(b)ii.b.i, application of the segregation requirements to a
foreign security-based swap dealer that is a registered broker-
dealer with respect to cleared security-based swaps in Section
III.C.4(b)ii.c.i, and application of the segregation requirements to
a foreign security-based swap dealer that is not a registered
broker-dealer and is not a foreign bank with a branch or agency in
the United States in Section III.C.4(b)ii.c.ii above.
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We recognize that a foreign security-based swap dealer may not be
subject to the stockbroker liquidation provisions and its insolvency or
liquidation proceeding in the United States may be administered under
SIPA or banking regulations concurrently with other potential
insolvency proceedings outside the United States under applicable
foreign insolvency laws. Therefore, the effectiveness of the
segregation requirements with respect to a foreign security-based swap
dealer in practice may depend on many factors, including the type and
objectives of the insolvency or liquidation proceeding and how the U.S.
Bankruptcy Code, SIPA, banking regulations and applicable foreign
insolvency laws are interpreted by the U.S. bankruptcy court, SIPC,
Federal Deposit Insurance Corporation and relevant foreign authorities.
b. Non-Cleared Security-Based Swaps
i. Foreign Security-Based Swap Dealer That Is a Registered Broker-
Dealer
With respect to non-cleared security-based swaps, the Commission
proposes to apply segregation requirements differently to foreign
security-based swap dealers depending on whether they also are
registered broker-dealers. Specifically, the Commission proposes to
require a foreign security-based swap dealer that is a registered
broker-dealer to segregate margin received from all counterparties to
secure non-cleared security-based swap transactions, in accordance with
Section 3E of the Exchange Act, and rules and regulations
thereunder.\530\
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\530\ See proposed Rule 18a-4(e)(1)(i) under the Exchange Act.
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If a foreign security-based swap dealer is a registered broker-
dealer, it already would: (i) be subject to the customer protection
requirements under Section 15(c)(3) of the Exchange Act,\531\ and rules
and regulations thereunder, including Rule 15c3-3 if it carries
customer securities and cash; (ii) be required to maintain possession
or control of customer securities and maintain cash or qualified
securities in a special reserve account if it carries customer
securities and cash; and (iii) if it is a member of SIPC, be liquidated
in a formal proceeding under the SIPA.\532\ Rule 15c3-3 under Section
15(c)(3) of the Exchange Act provides customer protection and defines
``customer'' broadly to include any person from whom or on whose behalf
a broker or dealer has received or acquired or holds funds or
securities for the account of that person.\533\ Therefore, if a foreign
security-based swap dealer that is a registered broker-dealer receives
collateral from a non-cleared security-based swap counterparty, such
counterparty would be a ``customer'' and is afforded customer
protection with respect to such collateral under Rule 15c3-3. As stated
above, Section 3E(g) extends ``customer'' status to non-cleared
security-based swap counterparties to the extent of any margin
delivered to or by the counterparties with respect to which there is a
customer protection requirement under Section 15(c)(3).\534\ Therefore,
non-cleared security-based swap counterparties of a foreign security-
based swap dealer that is a registered broker-dealer are ``customers''
within the meaning of the stockbroker liquidation provisions.\535\
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\531\ 15 U.S.C. 78o(c)(3).
\532\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70276-77 (discussing the broker-dealer segregation rule--Rule
15c3-3 under the Exchange Act, 17 CFR 240.15c3-3).
\533\ See Rule 15c3-3(a)(1) under the Exchange Act, 17 CFR
240.15c3-3(a)(1).
\534\ See Section 3E(g) of the Exchange Act, 15 U.S.C. 78c-5(g)
(``The term `customer', as defined in section 741 of title 11,
United States Code, excludes any person, to the extent that such
person has a claim based on any . . . non-cleared security-based
swap except to the extent of any margin delivered to or by the
customer with respect to which there is a customer protection
requirement under section 15(c)(3) or a segregation requirement.'').
\535\ A non-cleared security-based swap counterparty may waive
its pro rata priority claim on customer property with other
customers by executing a conditional subordination agreement
pursuant to proposed Rule 18a-4(d)(i) under the Exchange Act to
affirmatively elect individual segregation, or by executing an
unconditional subordination agreement pursuant to proposed Rule 18a-
4(d)(ii) under the Exchange Act to affirmatively waive segregation
altogether.
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As such, if the Commission does not require a foreign security-
based swap dealer that is a registered broker-dealer to segregate all
counterparties' assets posted to secure non-cleared security-based
swaps, in a SIPA liquidation
[[Page 31021]]
proceeding of such foreign security-based swap dealer and broker-
dealer,\536\ the pool of assets segregated pursuant to Rule 15c3-3 and
proposed Rule 18a-4 may be insufficient to satisfy the combined claims
of all customers, resulting in losses to all customers. Therefore, the
Commission proposes to subject a foreign security-based swap dealer
that is a registered broker-dealer to the segregation requirements set
forth in Section 3E of the Exchange Act, and rules and regulations
thereunder, relating to assets received from all counterparties held as
collateral to secure non-cleared security-based swap transactions.
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\536\ In very limited circumstances where a foreign security-
based swap dealer that is a registered broker-dealer is not a SIPC
member, it would potentially be liquidated pursuant to the
stockbroker liquidation provisions in a U.S. bankruptcy court.
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ii. Non-Cleared Security-Based Swaps--Foreign Security-Based Swap
Dealer That is Not a Registered Broker-Dealer
If a foreign security-based swap dealer is not a registered broker-
dealer, its non-cleared security-based swap counterparties would be
``customers'' under the stockbroker liquidation provisions only to the
extent that there is a segregation requirement prescribed by the
Commission.\537\ The Commission proposes to subject such foreign
security-based swap dealer to the segregation requirements set forth in
Section 3E of the Exchange Act, and rules and regulations thereunder,
solely with respect to non-cleared security-based swaps with U.S.
person counterparties.\538\ This approach would provide U.S. person
counterparties ``customer'' status under the stockbroker liquidation
provisions and their assets would be segregated for their exclusive
benefit. Non-U.S. person counterparties would not be ``customers'' and
would not have ``customer'' status with respect to the segregated
assets. As stated above, the Commission preliminarily believes that the
objective of the Dodd-Frank Act is to protect U.S. counterparties and
to minimize disruption to the U.S. financial system caused by a
security-based swap dealer's failure. Therefore, the Commission
preliminarily believes that the proposed approach would achieve the
benefit intended by the segregation requirements set forth in Section
3E of the Exchange Act, and rules and regulations thereunder.
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\537\ See Section 3E(g) of the Exchange Act, 15 U.S.C. 78c-5(g).
\538\ See proposed Rule 18a-4(e)(1)(ii) under the Exchange Act.
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The Commission recognizes that a foreign security-based swap dealer
that is not a broker-dealer but is a foreign bank with a branch or
agency (as defined in Section 1(b) of the International Banking Act of
1978) \539\ in the United States may not be eligible to be liquidated
pursuant to the stockbroker liquidation provisions.\540\ Such foreign
security-based swap dealer's insolvency proceeding in the United States
would be administered under banking regulations.\541\ Nevertheless, the
Commission preliminarily believes that imposing segregation
requirements on such foreign security-based swap dealer when it
receives collateral from U.S. person counterparties would reduce the
likelihood of U.S. person counterparties incurring losses by helping
identify U.S. customers' assets in an insolvency proceeding of such
foreign security-based swap dealer in the United States and would
potentially minimize disruption to the U.S. security-based swap market,
thereby producing potential benefits to the U.S. financial system and
U.S. counterparties that are consistent with the objectives of the
Dodd-Frank Act.
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\539\ See Sections 1(b)(1), (3), and (7) of the International
Banking Act of 1978, 12 U.S.C. 3101(b)(1), (3) and (7), for
definitions of ``agency,'' ``branch,'' and ``foreign bank.''
\540\ See Section 109(b)(3)(B) of the U.S. Bankruptcy Code, 11
U.S.C. 109(b)(3)(B).
\541\ See 12 U.S.C. 1821-25. Whereas insured deposit
institutions would be resolved under the Federal Deposit Insurance
Act, uninsured U.S. branches of foreign banks would be resolved
under either relevant state statutes, in the case of uninsured state
branches, or the International Banking Act, in the case of uninsured
federal branches.
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c. Cleared Security-Based Swaps
In applying the segregation requirements to a foreign security-
based swap dealer with respect to cleared security-based swap
transactions, the Commission also proposes to distinguish among: (1) a
foreign security-based swap dealer that is a registered broker-dealer;
(2) a foreign security-based swap dealer that is not a registered
broker-dealer and is not a foreign bank with a branch or agency in the
United States; and (3) a foreign security-based swap dealer that is a
foreign bank with a branch or agency in the United States. In the
following paragraphs, we will discuss how we propose to apply the
segregation requirements to foreign security-based swap dealers in each
of these categories with respect to assets held by them as collateral
to secure cleared security-based swaps.
i. Foreign Security-Based Swap Dealer That Is a Registered Broker-
Dealer
The proposed rule would apply segregation requirements to a foreign
security-based swap dealer that is a registered broker-dealer with
respect to assets received from all counterparties to secure cleared
security-based swaps.\542\ As stated above, Section 3E(g) of the
Exchange Act extends customer protection under the stockbroker
liquidation provisions to all cleared security-based swap
counterparties and to all non-cleared security-based swap
counterparties, with respect to which there is a customer protection
requirement under Section 15(c)(3) of the Exchange Act.\543\ Therefore,
all security-based swap counterparties of a foreign security-based swap
dealer that is a registered broker-dealer are customers under the
stockbroker liquidation provisions.\544\ In the absence of a Commission
requirement that a foreign security-based swap dealer that is a
registered broker-dealer segregate all cleared security-based swap
counterparties' collateral, if such an entity were liquidated pursuant
to SIPA, the amount of assets segregated could be less than the
combined priority claims of all security-based swap customers,
potentially resulting in losses to customers. Therefore, the Commission
proposes to subject a foreign security-based swap dealer who is a
registered broker-dealer to segregation requirements set forth in
Section 3E of the Exchange Act, and rules and regulations thereunder,
with respect to assets received from all counterparties to secure
cleared security-based swaps.
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\542\ Proposed Rule 18a-4(e)(2)(i) under the Exchange Act.
\543\ See Section III.C.4(b)ii.b, supra.
\544\ A non-cleared security-based swap counterparty would be a
customer of a foreign security-based swap dealer that is a
registered broker-dealer and have a pro rata priority claim to
customer property under the stockbroker liquidation provisions
unless it affirmatively waives segregation altogether by executing
an unconditional subordination agreement pursuant to proposed Rule
18a-4(d)(ii) under the Exchange Act, or elects individual
segregation pursuant to Section 3E(f) of the Exchange Act by
executing a conditional subordination agreement pursuant to proposed
Rule 18a-4(d)(i) under the Exchange Act.
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ii. Foreign Security-Based Swap Dealer That Is Not a Registered Broker-
Dealer and Is Not a Foreign Bank With Branch or Agency in the United
States
If a foreign security-based swap dealer is not a registered broker-
dealer and is not a foreign bank that has a branch or agency (as
defined in Section 1(b) of the International Banking Act of 1978) in
the United States, such foreign security-based swap dealer may be
eligible to be
[[Page 31022]]
a debtor under Chapter 7 of the U.S. Bankruptcy Code and may therefore
be subject to the stockbroker liquidation provisions in the U.S.
Bankruptcy Code.\545\ As stated above, Section 3E(g) of the Exchange
Act provides ``customer'' status to all counterparties to cleared
security-based swaps, making no distinction between U.S. customers or
counterparties and non-U.S. person customers or counterparties.\546\
Therefore, in the case where such foreign security-based swap dealer
receives any assets from, for, or on behalf of a U.S. person customer
to margin, guarantee, or secure security-based swaps, if the Commission
were to apply the segregation requirements only to assets posted by
U.S. person customers but not to assets posted by non-U.S. person
customers, in a stockbroker liquidation proceeding of such foreign
security-based swap dealer, the assets segregated (i.e., assets posted
by U.S. person customers) could be insufficient to satisfy the combined
priority claims of both U.S person and non-U.S. person customers,
potentially resulting in losses to U.S. person customers. As stated
above, the Commission preliminarily believes that Section 3E intends to
provide customer protection to U.S. person counterparties and apply
segregation requirements in a way that would protect the U.S. financial
system and counterparties in the United States. Therefore, the
Commission proposes to apply segregation requirements described in
Section 3E of the Exchange Act, and the rules and regulations
thereunder, to a foreign security-based swap dealer that is not a
registered broker-dealer and is not a foreign bank with a branch or
agency in the United States with respect to assets received from both
U.S. person counterparties and non-U.S. person counterparties if such
foreign security-based swap dealer receives collateral from U.S. person
counterparties to secure security-based swaps.\547\
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\545\ See Section 109(b) of the U.S. Bankruptcy Code, 11 U.S.C.
109(b).
\546\ See 15 U.S.C. 78c-5(g) and 11 U.S.C. 741(2).
\547\ Proposed Rule 18a-4(e)(2)(ii) under the Exchange Act.
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iii. Foreign Security-Based Swap Dealer That is Not a Registered
Broker-Dealer and is a Foreign Bank With Branch or Agency in the United
States
Finally, if a foreign security-based swap dealer is not a
registered broker-dealer and is a foreign bank that has a branch or
agency in the United States, it is not eligible to be a debtor under
Chapter 7 and will therefore not be subject to the stockbroker
liquidation provisions of the U.S. Bankruptcy Code \548\ and its
insolvency proceeding in the United States would be administered under
banking regulations.\549\ Consistent with the objective of protecting
U.S. person counterparties, the Commission is proposing that such
foreign security-based swap dealer shall be subject to the segregation
requirements set forth in Section 3E of the Exchange Act, and the rules
and regulations thereunder, with respect to any assets received from,
for or on behalf of a counterparty who is a U.S. person to margin,
guarantee, or secure a cleared security-based swap, but shall not be
required to segregate assets received from, for or on behalf of all
other counterparties to margin, guarantee, or secure a cleared
security-based swap.\550\ The special account maintained by the foreign
security-based swap dealer shall be designated for the exclusive
benefit of U.S. person security-based swap customers. The Commission
preliminarily believes that imposing segregation requirements on such
foreign security-based swap dealer when it receives collateral from
U.S. person counterparties would reduce the likelihood of U.S. person
counterparties incurring losses by helping identify U.S. customers'
assets in an insolvency proceeding of such foreign security-based swap
dealer in the United States and would potentially minimize disruption
to the U.S. security-based swap market, thereby producing potential
benefits to the U.S. financial system and U.S. counterparties that are
consistent with the objectives of the Dodd-Frank Act. For the same
reason, the Commission preliminarily does not believe that extending
segregation requirements and customer protection to such foreign
security-based swap dealer's transactions with non-U.S. persons would
advance the purposes of the Dodd-Frank Act.
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\548\ See Section 109(b) of the U.S. Bankruptcy Code, 11 U.S.C.
109(b).
\549\ See 12 U.S.C. 1821-25. Whereas insured deposit
institutions would be resolved under the Federal Deposit Insurance
Act, uninsured U.S. branches of foreign banks would be resolved
under either relevant state statutes, in the case of uninsured state
branches, or the International Banking Act, in the case of uninsured
federal branches.
\550\ Proposed Rule 18a-4(e)(2)(iii) under the Exchange Act.
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d. Disclosure
In addition to the proposed rules described above relating to
application of the segregation requirements to foreign security-based
swap dealers, the Commission also is proposing to require foreign
security-based swap dealers to make certain disclosures.\551\ Since the
treatment of the special account under Sections 3E(b) and (g) or
individually segregated assets pursuant to Section 3E(f) of the
Exchange Act in insolvency proceedings of a foreign security-based swap
dealer may vary depending on the status of the foreign security-based
swap dealer and the insolvency proceedings such foreign security-based
swap dealer is subject to, the Commission proposes to require a foreign
security-based swap dealer to disclose to each counterparty that is a
U.S. person, prior to accepting any assets from, for, or on behalf of
such counterparty to margin, guarantee, or secure a security-based
swap, the potential treatment of the assets segregated by such foreign
security-based swap dealer pursuant to Section 3E of the Exchange Act,
and the rules and regulations thereunder, in insolvency proceedings
relating to such foreign security-based swap dealer under U.S.
bankruptcy law and applicable foreign insolvency laws. Pursuant to this
proposed rule, the Commission intends to require that a foreign
security-based swap dealer disclose whether it is subject to the
segregation requirement set forth in Section 3E of the Exchange Act,
and the rules and regulations thereunder, with respect to the assets
collected from the U.S. person counterparty who will receive the
disclosure, whether the foreign security-based swap dealer could be
subject to the stockbroker liquidation provisions in the U.S.
Bankruptcy Code, whether the segregated assets could be afforded
customer property treatment under the U.S. bankruptcy law, and any
other relevant considerations that may affect the treatment of the
assets segregated under Section 3E of the Exchange Act in insolvency
proceedings of a foreign security-based swap dealer.\552\ Since the
proposed rule regarding application of the segregation requirements in
the cross-border context is designed to advance the goals of protecting
U.S. person counterparties, the Commission believes that such
disclosure would enhance U.S. person counterparty protection and the
objectives that segregation requirements intend to achieve in the
context of cross-border security-based swap dealing.
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\551\ Proposed Rule 18a-4(e)(3) under the Exchange Act.
\552\ Proposed Rule 18a-4(e)(3) under the Exchange Act.
---------------------------------------------------------------------------
Request for Comment
The Commission requests comment on all aspects of the proposed rule
regarding the application of transaction-
[[Page 31023]]
level requirements relating to customer protection and segregation,
including the following:
What, if any, are the likely competitive effects, within
the U.S. security-based swap market and among U.S. security-based swap
dealers, of the proposed approach for foreign security-based swap
dealers? Please describe the specific nature of any such effects.
Should a foreign security-based swap dealer automatically
be eligible for the proposed approach by virtue of being a nonresident
entity? Alternatively, should the Commission consider other factors,
such as the share of the foreign security-based swap dealer's business
that constitutes U.S. Business, in determining how to apply
transaction-level requirements?
From an operational perspective, what types of internal
controls would be necessary to identify Foreign Business and U.S.
Business and ensure that the foreign security-based swap dealer
complies with the external business conduct standards with respect to
its U.S. Business? Should U.S. Business be generally defined with
reference to the type of activity that, if performed in a dealing
capacity, triggers the registration requirement?
Does the proposed approach appropriately classify entity-
level and transaction-level requirements? Does it appropriately
identify those transaction-level requirements that relate to the
operation of the security-based swap dealer on an entity level? If not,
please identify those requirements that should be classified
differently and how doing so is consistent with the goals of Title VII.
To what extent would foreign security-based swap dealers
in various jurisdictions be prohibited from complying, under local law,
with the Commission's requirements to provide the Commission with
prompt access to their books and records and to submit to onsite
inspection and examination by the Commission? If there are limitations,
what are they, and under what circumstances would they arise? Are there
other entity-level requirements that foreign security-based swap
dealers would not be permitted to comply with under local law? If so,
what are they?
Should the external business conduct rules apply in
transactions between a registered non-U.S. security-based swap dealer
and foreign branches of a U.S. bank?
Should the external business conduct rules apply in
transactions between a registered non-U.S. security-based swap dealer
and non-U.S. persons with U.S. guarantees in transactions outside the
United States?
Does the proposed application of the business conduct
standards in the cross-border context appropriately implement the
business conduct standards as described in Section 15F(h) of the
Exchange Act?
As described above, the Commission does not, at this time,
propose to apply the business conduct standards in Section 15F(h) of
the Exchange Act, and the rules and regulations thereunder (other than
the rules and regulations relating to diligent supervision prescribed
by the Commission pursuant to Section 15F(h)(1)(B)), to the Foreign
Business of registered security-based swap dealers. Should such
standards apply to the Foreign Business of registered security-based
swap dealers? Would such application of business conduct standards
further the goals of Title VII of the Dodd-Frank Act?
Should the Commission apply rules and regulations pursuant
to Section 15F(h)(1)(A) of the Exchange Act relating to fraud,
manipulation, and other abusive practices involving security-based
swaps (including security-based swaps that are offered but not entered
into) to the Foreign Business of registered foreign security-based swap
dealers?
Should the Commission apply rules and regulations pursuant
to Section 15F(h)(1)(C) of the Exchange Act relating to position limits
to the Foreign Business of foreign security-based swap dealers?
Should the proposed rule relating to conflicts of interest
set forth in Section 15F(j)(5) of the Exchange Act apply to both the
U.S. Business and Foreign Business of security-based swap dealers?
Does the proposed approach appropriately treat the rules
and regulations prescribed by the Commission relating to diligent
supervision pursuant to Section 15F(h)(1)(B) as entity-level
requirements applicable to both the U.S. Business and the Foreign
Business of foreign security-based swap dealers? Why or why not?
Is it appropriate that the proposed rule does not apply
future rules and regulations that the Commission may prescribe pursuant
to Section 15F(h)(1)(A) of the Exchange Act relating to fraud,
manipulation, and other abusive practices involving security-based
swaps (including security-based swaps that are offered but not entered
into) to the Foreign Business of foreign security-based swap dealers?
Why or why not?
Is it appropriate that the proposed rule does not apply
future rules and regulations that the Commission may prescribe pursuant
to Section 15F(h)(1)(C) of the Exchange Act relating to position limits
to the Foreign Business of foreign security-based swap dealers? Why or
why not?
Does the proposed approach appropriately treat the
requirements relating to conflicts of interest set forth in Section
15F(j)(5) of the Exchange Act as entity-level requirements applicable
to both the U.S. Business and Foreign Business of foreign security-
based swap dealers? If not, please identify any requirements that
should not be applied to a foreign security-based swap dealer and
explain how such an approach would be consistent with the goals of
Title VII. Please identify what the costs or operational challenges
would be, if any, for a registered security-based swap dealer to
establish conflict-of-interest systems and procedures that would apply
to its U.S. Business but not its Foreign Business.
Does the proposed approach appropriately implement the
requirements relating to segregation of assets held as collateral in
Section 3E of the Exchange Act, and rules and regulations thereunder,
in light of various statuses of foreign security-based swap dealers?
Should the Commission apply segregation requirements to a
foreign security-based swap dealer that is not subject to the
stockbroker liquidation provisions in the U.S. Bankruptcy Code? If not,
what are the reasons for not applying segregation requirements? If the
segregation requirements do not apply, how would the objective of
customer protection be achieved?
Should the Commission adopt the disclosure requirement
with respect to foreign security-based swap dealers? Why or why not? Is
the proposed disclosure requirement feasible? What would the
difficulties be in complying with the proposed disclosure requirement?
The CFTC has proposed an interpretation that would
effectively treat a non-U.S. person whose obligations are guaranteed by
a U.S. person as a U.S. person for purposes of determining whether a
swap between it and a non-U.S. swap dealer or major swap participant
would be subject to transaction-level requirements as interpreted by
the CFTC to include, without limitation, margin and segregation
requirements, reporting, clearing, and trade execution.\553\ Should the
Commission adopt a similar approach? What would be the effects on
efficiency, competition and capital
[[Page 31024]]
formation in the event that there are overlapping or duplicative
requirements across multiple jurisdictions?
---------------------------------------------------------------------------
\553\ See CFTC Cross-Border Proposal, 77 FR 41228-29.
---------------------------------------------------------------------------
In addition, the CFTC has proposed an interpretation that
includes a description of a ``conduit affiliate'' that includes: (1) a
non-U.S. person that is majority-owned, directly or indirectly, by a
U.S. person where (2) the non-U.S. person regularly enters into swaps
with one or more U.S. affiliates or subsidiaries of the U.S. person,
and (3) the financial statements of the non-U.S. person are included in
the consolidated financial statements of the U.S. person.\554\ Conduit
affiliates would be subject to transaction-level requirements as if
they were U.S. persons. Should the Commission consider a similar
approach?
---------------------------------------------------------------------------
\554\ See id. at 41229.
---------------------------------------------------------------------------
The CFTC's proposed interpretation would subject foreign
branches of U.S.-based bank swap dealers and major swap participants to
the CFTC's entity-level requirements and transaction-level requirements
(other than external business conduct standards for swaps with non-U.S.
persons), provided that foreign branches would be eligible for a
limited exception in emerging markets where foreign regulations are not
comparable.\555\ Should the Commission consider a similar approach? If
so, please explain how such an approach would be consistent with the
goals of Title VII.
---------------------------------------------------------------------------
\555\ See id. at 41230-31.
---------------------------------------------------------------------------
What would be the market impact of the proposed approach
to application of the transaction-level requirements relating to
customer protection and segregation? How would the proposed application
of transaction-level requirements affect the competitiveness of U.S.
entities in the global marketplace (both in the United States as well
as in foreign jurisdictions)? Would the proposed approach place any
market participants at a competitive disadvantage or advantage? If so,
please explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the transaction-level requirements?
What would be the market impacts and competitiveness effects of
alternatives to the proposed approach discussed in this release?
5. Application of Entity-Level Rules
(a) Introduction
As noted above, by their very nature, entity-level requirements
apply to the operation of a security-based swap dealer as a whole. The
Commission recognizes that the capital, margin, and other entity-level
requirements that it adopts could have a substantial impact on
international commerce and the relative competitive position of
intermediaries operating in various, or multiple, jurisdictions. In
particular, if these requirements are substantially more or less
stringent than corresponding requirements, if any, that apply to
intermediaries operating in security-based swap markets outside the
United States, depending on how the rules are written, these
differences could impact the ability of firms based in the United
States to participate in non-U.S. markets, access to U.S. markets by
foreign-based firms, and how and whether international firms make use
of global ``booking entities'' to centralize risks related to security-
based swaps, among other possible impacts. These issues have been the
focus of numerous comments to the Commission and other regulators, as
discussed above, as well as Congressional inquiries and other public
dialogue.
(b) Proposed Approach
The Commission is not proposing to provide specific relief for
foreign security-based swap dealers from Title VII entity-level
requirements, although, as discussed in Section XI below, under a
Commission substituted compliance determination, a foreign security-
based swap dealer would be able to satisfy relevant Title VII entity-
level requirements by substituting compliance with corresponding
requirements under a foreign regulatory system.\556\ The Commission
preliminarily believes that entity-level requirements are core
requirements of the Commission's responsibility to ensure the safety
and soundness of registered security-based swap dealers.\557\ The
Commission preliminarily believes that it would not be consistent with
this mandate to provide a blanket exclusion to foreign security-based
swap dealers from entity-level requirements applicable to such
entities.\558\
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\556\ See Section XI, infra.
\557\ See note 419, supra.
\558\ We preliminarily believe that the proposed approach with
respect to entity-level requirements is not being applied to persons
who are ``transact[ing] a business in security-based swaps without
the jurisdiction of the United States,'' within the meaning of
Section 30(c) of the Exchange Act. See Section II.B.2(a), supra.
However, the Commission also preliminarily believes that the
proposed approach with respect to entity-level requirements is
necessary or appropriate to help prevent the evasion of the
particular provisions of the Exchange Act that were added by the
Dodd-Frank Act that are being implemented by the proposed approach
and prophylactically will help ensure that the purposes of those
provisions of the Dodd-Frank Act are not undermined. See Section
II.B.2(e), supra; see also Section II.B.2(c), supra.
For example, if entity-level requirements do not apply to the
entire business of a registered foreign security-based swap dealer,
then U.S. security-based swap dealers would have an incentive to
evade the full application of the entity-level requirements by
moving their operations outside the United States. In this event,
assuming the scope of the security-based swap dealers dealing
activity remained unchanged, the risk presented by the entity to its
U.S. counterparties and the U.S. financial system would remain
unchanged. If, for instance, Title VII margin requirements did not
apply to the entire entity, these entities could accumulate risk
through their non-U.S. dealing activity and transmit that risk to
U.S. counterparties in contravention of the purposes of the
financial responsibility framework established by the Dodd-Frank
Act. See Section III.C.3(b)ii, supra.
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For example, capital requirements play an essential role in
ensuring the safety and soundness of security-based swap dealers. As
discussed above, the Commission's proposed capital rules for nonbank
security-based swap dealers are modeled on the net liquid assets test
found in the capital requirements applicable to broker-dealers.\559\ We
believe that this capital standard is necessary to ensure the safety
and soundness of nonbank security-based swap dealers, and thus we are
not proposing to exclude foreign nonbank security-based swap dealers
from our capital rules. In addition, we believe that the capital,
margin, and other entity-level requirements proposed and adopted by the
Commission work together to provide a comprehensive regulatory scheme
that is vital for ensuring the safety and soundness of registered
security-based swap dealers, and that the benefits of Title VII's
entity-level requirements are equally important to both foreign and
U.S. dealers registered with the Commission. As a result, we are not
proposing to provide specific relief from individual entity-level
requirements for foreign dealers.
---------------------------------------------------------------------------
\559\ See Section III.C.3(b)i, supra.
---------------------------------------------------------------------------
We do, however, recognize the concerns raised by commenters
regarding the application of entity-level requirements to foreign
security-based swap dealers.\560\ We preliminarily believe that these
concerns are largely addressed through the Commission's overall
proposed approach to substituted compliance in the context of Title
VII, which is discussed in detail in Section XI below. In general, the
Commission is proposing a framework under which it may permit a
registered foreign security-based swap dealer (or class thereof) to
satisfy the capital, margin, and other requirements in Section 15F of
the Exchange Act, and the rules and regulations thereunder, by
[[Page 31025]]
complying with the corresponding requirements established by its
foreign financial regulatory authority,\561\ subject to certain
conditions.\562\ We preliminarily believe that providing foreign
security-based swap dealers with the possibility of substituted
compliance in this way will help address concerns related to
competitiveness and overlapping regulations related to entity-level
requirements, while still ensuring that registered foreign security-
based swap dealers are subject to appropriate regulatory oversight.
---------------------------------------------------------------------------
\560\ See, e.g., Davis Polk Letter II at 4-20; Sullivan &
Cromwell Letter at 14-15.
\561\ Section 3(a)(52) of the Exchange Act, 15 U.S.C.
78c(a)(52), defines ``foreign financial regulatory authority'' as
``any (A) foreign securities authority, (B) other governmental body
or foreign equivalent of a self-regulatory organization empowered by
a foreign government to administer or enforce its laws relating to
the regulation of fiduciaries, trusts, commercial lending,
insurance, trading in contracts of sale of a commodity for future
delivery, or other instruments traded on or subject to the rules of
a contract market, board of trade, or foreign equivalent, or other
financial activities, or (C) membership organization a function of
which is to regulate participation of its members in activities
listed above.'' The term ``foreign securities authority'' is defined
in Section 3(a)(50) of the Exchange Act as ``any foreign government,
or any governmental body or regulatory organization empowered by a
foreign government to administer or enforce its laws as they relate
to securities matters.''
\562\ Proposed Rule 3a71-5 under the Exchange Act. As discussed
in Section II.C.3(b) above, the Commission has authority to
establish capital and margin requirements only for registered
nonbank security-based swap dealers. For treatment of the capital
and margin requirements for foreign bank security-based swap
dealers, see Prudential Regulator Margin and Capital Proposal, 76 FR
27564.
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Request for Comment
The Commission requests comment on all aspects of the proposed
interpretive guidance regarding the proposed provision of substituted
compliance for certain requirements in Section 15F of the Exchange Act
for foreign security-based swap dealers, including the following:
What types of conflicts might a foreign security-based
swap dealer face if subjected to capital requirements in more than one
jurisdiction? In what situations would compliance with more than one
capital requirement be difficult or impossible?
Should the Commission provide specific relief to foreign
security-based swap dealers with respect to entity-level requirements?
If so, please indicate the specific relief that should be provided and
the rationale for providing such relief.
Would the provision of relief from entity-level
requirements undermine the Commission's efforts to set capital
requirements to ensure the safety and soundness of security-based swap
dealers, as required by Section 15F(e)(2)(C) of the Exchange Act? Why
or why not?
Should the Commission treat margin as an entity-level
requirement or a transaction-level requirement? If only a transaction-
level requirement, why?
Should the Commission consider providing relief for
foreign security-based swap dealers from the statutory disqualification
requirement in Section 15F(b)(6) of the Exchange Act with respect to
their transactions with non-U.S. persons? For example, should the
Commission permit associated persons of a foreign security-based swap
dealer that are subject to a statutory disqualification to conduct
security-based swap activity with non-U.S. persons outside the United
States? If so, why?
The CFTC has proposed an interpretation that categorizes
certain entity-level requirements and transaction-level requirements
differently when compared to the Commission's proposed approach.\563\
For example, the CFTC has proposed classifying margin requirements
applicable to uncleared swaps as a transaction-level requirement, where
the Commission has proposed categorizing margin as an entity-level
requirement. Should the Commission adopt portions of the CFTC's
approach to categorization? If so, which requirements should be re-
categorized and why?
---------------------------------------------------------------------------
\563\ See CFTC Cross-Border Proposal, 77 FR 41223-27.
---------------------------------------------------------------------------
What would be the market impact of the proposed approach
to applying entity-level requirements to registered foreign security-
based swap dealers? How would the proposed application of the entity-
level requirements affect the competitiveness of U.S. entities in the
global marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the entity-level requirements? What
would be the market impacts and competitiveness effects of alternatives
to the proposed approach discussed in this release?
D. Intermediation
1. Introduction
Security-based swap dealers currently use a variety of business
models and legal structures to do business with customers in
jurisdictions around the world. For instance, many security-based swap
dealers with global businesses use local personnel to provide security-
based swap services to customers in a particular jurisdiction while
booking transactions originated from multiple jurisdictions in a single
entity (i.e., a centralized booking model). Some security-based swap
dealers also use unique organizational structures to provide local
customers with access to market or product specialists in other
jurisdictions. As discussed below, commenters have indicated that, in
the U.S. market, these scenarios are particularly prevalent in the case
of foreign security-based swap dealers seeking access to U.S. customers
or providing non-U.S. customers with expertise from employees located
in the United States.\564\
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\564\ See, e.g., IIB Letter at 15 (``Perhaps more commonly, a
foreign bank may transact in swaps as a dealer with U.S. customers
through a separate U.S. branch, agency, or affiliate that
intermediates the transactions as agent for the foreign bank. This
is often because, to facilitate strong relationships with U.S.
customers, the personnel who solicit and negotiate with U.S.
customers and commit a foreign bank to swaps are located in the
U.S.'').
---------------------------------------------------------------------------
In the following discussion, we briefly describe comments received
regarding various intermediation models. Throughout this release we use
the term ``intermediation'' generally to refer to origination activity
(e.g., solicitation and negotiation of transactions) in connection with
a security-based swap transaction.
2. Comment Summary
Commenters stated that foreign security-based swap dealers use
different types of business models to service U.S. customers and
provide their global customer base with specialized information, while
at the same time reducing both customer costs and entity risks through
centralized netting and risk management of their global security-based
swap businesses.\565\ In
[[Page 31026]]
support of these perceived benefits, commenters have urged the
Commission not to apply Title VII to cross-border transactions in a way
that would either prohibit or disincentivize the existing security-
based swap dealing business models of foreign security-based swap
dealers.\566\
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\565\ See, e.g., IIB Letter at 6 (``Globally, there are a number
of paradigms under which swap activity is conducted. To achieve the
benefits of reduced risk and increased liquidity and efficiency
associated with netting and margining on a portfolio basis, foreign
banks (like their U.S. domestic counterparts) typically seek to
transact with swap counterparties globally, to the extent feasible,
through a single, highly creditworthy entity. In many cases,
however, the personnel who have relationships with U.S. customers or
who manage the market risk of the foreign bank's swap portfolio are
located regionally, outside the jurisdiction in which the foreign
bank is domiciled. In some cases, entities other than the foreign
bank (such as a U.S. branch, agency, or affiliate) transact with
local customers in order to satisfy unique customer documentation,
insolvency, tax, regulatory, or other considerations.); Davis Polk
Letter I at 2-3 (suggesting that ``operating and managing a global
swaps business out of a single booking entity presents many
advantages from the perspective of foreign banks, customers and
supervisors,'' including reduction in system risk, maximization of
benefits of counterparty netting for customers, and consolidated
supervision); Cleary IV at 3-4 (stating that the represented firms
``conduct their swap dealing businesses through a variety of
structures, based on multiple and in many cases interdependent
legal, strategic and business considerations that pre-date Dodd-
Frank,'' and urging the Commissions to address a number of ``common
cross-border transaction structures'').
\566\ See, e.g., IIB Letter at 6-7 (``[T]he Commissions should
establish a framework for cross-border swap activities that
preserves and leverages the strengths of existing market practices
and home country supervision and regulation.''); Cleary IV at 3-4
(urging the Commissions to give consideration to a number of common
cross-border transaction structures in deciding how to implement
Title VII).
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A number of commenters recommended that a foreign dealer that
engages in security-based swap transactions with U.S. counterparties,
but only through U.S. registered swap or security-based swap dealers,
should not be subject to security-based swap dealer registration.\567\
One commenter stated that in such situations, the Commission should
either not require security-based swap dealer registration of the non-
U.S. security-based swap dealer at all, or require a limited
registration, whereby the non-U.S. security-based swap dealer would be
subject to only capital and related prudential requirements and be
permitted to rely on comparable home country regulation.\568\ In
situations where a foreign security-based swap dealer uses a U.S.
domiciled subsidiary or affiliate as its agent to solicit and negotiate
the terms of security-based swap transactions, several commenters
suggested that the Commission allow for a bifurcated registration and
regulation framework allowing the foreign security-based swap dealer to
comply with Title VII's requirements by registering both the foreign
dealer and its agent in limited capacities and allocating the
compliance responsibilities between the two entities.\569\ Other
commenters remarked that the foreign security-based swap dealer should
remain ultimately responsible for ensuring compliance with all the
applicable Title VII requirements whether or not the regulated
activities were carried out by the foreign security-based swap dealer
or its agent.\570\
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\567\ See, e.g., Financial Services Roundtable Letter at 25
(suggesting that ``entities that would meet the definition of `swap
dealer' based on their non-U.S. activity, but that act in the U.S.
only on an intermediated basis through a regulated U.S. swap dealer,
should not be subject to U.S. regulation''); Davis Polk Letter II at
4, 7 (discussing reasons to exclude dealing activities with U.S.-
registered swap dealers, including because ``a swap between a
foreign dealer and a U.S. registered swap dealer would be already
subject to Title VII by the virtue of the latter's involvement'').
\568\ See Cleary Letter IV at 3-4 (recommending that the
Commission either adopt an approach similar to the broker-dealer
registration regime, ``under which a non-U.S. swap dealer
transacting with U.S. persons . . . intermediated by an affiliated
U.S.-registered swap dealer'' would not have to register as a swap
dealer or a major swap participant, or adopt a limited registration
approach whereby ``the non-U.S. swap dealer would be subject to U.S.
swap dealer registration and regulation solely with respect to the
capital and related prudential requirements relevant to its status
as a swap counterparty, which requirements could be satisfied
through compliance with comparable home country requirements'').
\569\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter I at 4-6 (suggesting a bifurcated registration model allowing
foreign banks to centrally book their U.S. swap and security-based
swap business with a registered ``Foreign Swap Dealer'' who is
responsible for obligations associated with a booking entity (e.g.,
complying with capital requirements), while complying with most of
Title VII's regulations through a U.S. domiciled, registered ``Non-
Booking Swap Dealer''); and Davis Polk Letter II at 4-22 (proposing
two registration scenarios, including one that would require a
foreign bank to register with the Commission solely as a booking
center for security-based swap transactions, while a U.S. affiliate
of a foreign bank would also register with the Commission, and the
foreign bank's obligations under Title VII would be divided between
the two registered entities).
\570\ See, e.g., Cleary Letter IV at 12 (recommending a limited
designation registration whereby ``the branch, department or
division of a registrant involved in the regulated swap activity
should be responsible for compliance with Dodd-Frank's
requirements,'' but allowing for the outsourcing of ``performance
(but not responsibility for due performance) of those requirements
to a U.S. affiliate that is registered as an introducing broker,
futures commission merchant (``FCM'') and/or securities broker-
dealer''); Rabobank Letter at 3 (suggesting that ``the non-U.S.
branch registrant would use one or more U.S. affiliates as agents in
arranging swaps with U.S. persons and would be permitted to delegate
certain compliance functions to its U.S. affiliates, although such
delegation would not relieve the non-U.S. branch registrant of its
ultimate compliance responsibilities'').
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3. Discussion
The Commission is not at this time proposing any specific rules
regarding security-based swap dealing activities undertaken through
intermediation. At the same time, we recognize the importance of
intermediation, particularly with respect to foreign security-based
swap dealers accessing U.S. customers or product specialists located in
the United States. Based on the Commission's experience in the
securities markets, we expect that many foreign security-based swap
dealers will operate within the U.S. market by utilizing their U.S.
affiliates or other U.S. entities as agents \571\ in the United States,
while booking transactions facilitated by such U.S. personnel in a
central booking entity located abroad. We preliminarily believe that
the approach proposed in this release for the cross-border regulation
of security-based swap dealing activity will not impede the use of
these types of intermediation business models by foreign security-based
swap dealers. More specifically, we believe that the Commission's
proposed approach to the application of transaction-level requirements
related to Foreign Business \572\ and proposed framework for
substituted compliance on entity-level requirements \573\ should help
to address commenter concerns that a foreign security-based swap dealer
engaging in Foreign Business would be subject to potentially
duplicative and conflicting transaction-level requirements in a foreign
jurisdiction with respect to its Foreign Business.
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\571\ The Commission previously proposed new Rule 15Fh-2(d),
which would provide that the term ``security-based swap dealer''
would include, where relevant, an ``associated person'' of the
security-based swap dealer. See External Business Conduct Standards
Proposing Release, 76 FR 42402. Section 3(a)(70) of the Exchange
Act, as added by Section 761(a)(6), defines the term ``person
associated with a security-based swap dealer or major security-based
swap participant'' as ``(i) any partner, officer, director, or
branch manager of such security-based swap dealer or major security-
based swap participant (or any person occupying a similar status or
performing similar functions); (ii) any person directly or
indirectly controlling, controlled by, or under common control with
such security-based swap dealer or major security-based swap
participant; or (iii) any employee of such security-based swap
dealer or major security-based swap participant.'' The term does not
include, however, any person associated with a security-based swap
dealer or major security-based swap participant ``whose functions
are solely clerical or ministerial.'' See id.
As the Commission noted, to the extent that a security-based
swap dealer acts through, or by means of, an associated person of
that security-based swap dealer, the associated person must comply
as well with the applicable business conduct standards. See External
Business Conduct Standards Proposing Release, 76 FR 42402-3. In
support of this position, the Commission cited Section 20(b) of the
Exchange Act, which provides that ``[i]t shall be unlawful for any
person, directly or indirectly, to do any act or thing which it
would be unlawful for such person to do under the provisions of this
title or any rule or regulation thereunder through or by means of
any other person.''
\572\ See Section III.C.4, supra.
\573\ See Section III.C.5, supra, and Section XI, infra.
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While the foreign security-based swap dealer would remain
responsible for ensuring that all relevant Title VII requirements
applicable to a given security-based swap transaction are fulfilled,
the dealer and its agent(s) may choose to allocate the specific
responsibilities such as taking responsibility that all U.S. external
[[Page 31027]]
business conduct requirements are complied with, margin is collected
and segregated, and required trading records are maintained and
available, to be undertaken by each entity depending on the
intermediation model it adopts.\574\
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\574\ The agent, in these circumstances, would need to consider
whether it separately would need to register as a security-based
swap dealer (if, for example, the agent acted as principal in a
security-based swap with the counterparty, and then entered into a
back-to-back transaction with the booking entity), a broker (e.g.,
by soliciting or negotiating the terms of security-based swap
transactions), or other regulated entity. Further, the allocation of
functions between a foreign security-based swap dealer and a U.S.
agent would not affect the aggregation calculation for determining
whether the foreign security-based swap dealer exceeded the de
minimis threshold. See Section III.B.3(c), supra.
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Further, although a foreign security-based swap dealer could use an
entity that is not a security-based swap dealer to act as its agent,
the foreign security-based swap dealer would nonetheless be responsible
for ensuring compliance with all the requirements applicable to
security-based swap dealers under Title VII (and the federal securities
laws) whether or not the regulated activities were carried out by the
foreign security-based swap dealer or its non-security-based swap
dealer agent.\575\
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\575\ See note 574, supra.
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Request for Comment
The Commission requests comment on all aspects of the proposed
approach to intermediation. In addition, the Commission requests
comment in response to the following questions:
Should the Commission revise our proposed approach to
address directly the concerns of entities using the intermediation
model to access the U.S. market? If so, what type of approach should
the Commission use to address these concerns consistent with the
protection of counterparties' interests and the purposes of Title VII?
Should the Commission adopt a model on intermediation
similar to the approach laid out in Rule 15a-6(a)(3) (17 CFR 240.15a-
6(a)(3)) governing foreign broker-dealers, which would permit non-U.S.
persons to conduct security-based swap dealing activity within the
United States without registering with the Commission if those
transactions were intermediated by a registered U.S. security-based
swap dealer? If so, how would it work in the security-based swap
context, and how would it address Title VII policy concerns?
What would be the market impact of the proposed approach
to intermediation? How would the application of the proposed approach
to intermediation affect the competitiveness of U.S. entities in the
global marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach to
intermediation? What would be the market impacts and competitiveness
effects of alternatives to the proposed approach discussed in this
release?
E. Registration Application Re-Proposal
1. Introduction
As discussed in Section XI.C below, the Commission is proposing a
rule that would create a framework under which the Commission would
consider permitting a foreign security-based swap dealer, where
appropriate, to rely on a substituted compliance determination by the
Commission with respect to certain of the requirements in Section 15F
of the Exchange Act and the rules and regulations thereunder.\576\ In
discussing the application of this proposed framework below, the
Commission indicated that certain entity-level requirements under
Section 15F of the Exchange Act may be candidates for substituted
compliance determinations.\577\
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\576\ Proposed Rule 3a71-3(c) under the Exchange Act.
\577\ See Section III.C.5, supra.
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The Commission preliminarily believes that the most appropriate
time for a foreign security-based swap dealer to notify the Commission
of its intention to avail itself of an existing substituted compliance
determination \578\ would be at the time the foreign security-based
swap dealer files an application to register with the Commission as a
security-based swap dealer.\579\ As part of its application, the
foreign security-based swap dealer would already be providing the
Commission with detailed information in support of its application. The
intent of a foreign security-based swap dealer to avail itself of a
previously granted substituted compliance determination would be
relevant to the Commission's review of such application because it
would impact how the Commission will conduct oversight of the security-
based swap dealer. In addition, if a security-based swap dealer
determines, after it registered with the Commission, that it intends to
rely on a substituted compliance determination, proposed Rule 15Fb2-3
would require that it promptly update its application.\580\
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\578\ The Commission is proposing to establish a separate
process whereby foreign security-based swap dealers may request that
the Commission make a substituted compliance determination with
respect to a particular foreign jurisdiction. See Section XI, infra.
\579\ The Commission's Registration Proposing Release does not
use the term ``foreign security-based swap dealer,'' but rather
references a ``nonresident security-based swap dealer.'' Proposed
Rule 15Fb2-4(a) under the Exchange Act defines the term
``nonresident security-based swap dealer'' as a security-based swap
dealer that is incorporated or organized any place that is not in
the United States or that has its principal place of business in any
place not in the United States. See Registration Proposing Release,
76 FR 65799-801.
The definition of ``nonresident security-based swap dealer'' in
proposed Rule 15Fb2-4(a) is similar to, but potentially broader
than, the definition of ``foreign security-based swap dealer'' in
proposed Rule 3a71-3(a)(3) under the Exchange Act because it uses
``or'' instead of ``and'' in the definition. As a result, proposed
Rule 15Fb2-4(a) would treat a U.S. corporation as a nonresident
person if its principal place of business were outside the United
States, whereas proposed Rule 3a71-3(a)(3) would not treat such an
entity as a U.S. security-based swap dealer and, therefore, it would
not be able to avail itself of substituted compliance determinations
applicable to foreign security-based swap dealers.
The Commission preliminarily believes that defining the term
``foreign security-based swap dealer'' more narrowly for purposes of
the proposals in this release is appropriate because proposed Rule
15Fb2-4(a) uses the term ``nonresident security-based swap dealer''
only for determining whether a nonresident security-based dealer
would be required to appoint an agent for service of process in the
United States and provide assurance that the Commission would have
prompt access to books and records in the foreign jurisdiction. In
proposed Rule 3a71-3(a)(3), by contrast, the definition of ``foreign
security-based swap dealer'' would be used to determine who would be
eligible to take advantage of the proposed substituted compliance
framework, as well as how customer protection and segregation
requirements would be applied. The Commission does not believe that
it is appropriate to treat an entity as a foreign security-based
swap dealer for these purposes if its principal place of business
were outside the United States but it were incorporated in the
United States, because of its connection to the U.S. security-based
swap market. Nonetheless, the Commission would still want the
assurances required of a ``nonresident security-based swap dealer''
described above, even if the dealer is incorporated in the United
States but has a principal place of business outside the United
States.
\580\ See Registration Proposing Release, 76 FR 65822.
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Accordingly, the Commission preliminarily believes it is
appropriate to require foreign security-based swap dealers to provide
additional information in their applications for registration as
security-based swap dealers, as described below.
The Commission previously proposed Form SBSE, Form SBSE-A, and Form
SBSE-BD for the purpose of registering security-based swap dealers and
major security-based swap participants.\581\ All of these forms are
generally based on Form BD, which is the consolidated form used by
broker-dealers to register
[[Page 31028]]
with the Commission, states, and SROs.\582\ Forms SBSE-A and SBSE-BD
are shorter forms that have been modified to provide a more streamlined
application process for entities that are registered or registering
with the CFTC or registered or registering with the Commission as a
broker-dealer.\583\ Each of these forms is designed to be used to
gather information concerning a registrant's business operations to
facilitate the Commission's initial registration decisions, as well as
ongoing examination and monitoring of registration.'' \584\ While the
Commission received four comments on the Registration Proposing
Release, only one specifically expressed views on the Forms SBSE, SBSE-
A, and SBSE-BD.\585\
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\581\ See id. at 65784.
\582\ See id. at 65802.
\583\ See id. at 65804-5.
\584\ See id. at 65802.
\585\ See SIFMA Letter II. SIFMA indicated that it appreciated
``the Commission's attempts to minimize registration burdens by
aligning its proposed registration requirements for SBSDs and MSBSPs
with those the CFTC is proposing for swap dealers and major swap
participants as well as by creating a streamlined registration
process for entities already registered with the Commission or the
CFTC,'' and was ``generally pleased that the Commission elected to
make its existing broker-dealer registration forms the basis for its
proposed registration requirements for SBSDs and MSBSPs'' because
``[m]arket participants are familiar with these requirements and
may, in some cases, be registering broker-dealers as SBSDs.''
However, SIFMA did object to ``several of the required disclosures
on proposed Form SBSE,'' which are substantially similar to
disclosures required on Form BD, which it claimed would ``impose
significant burdens on registrants.''
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2. Discussion
To address the Commission's proposed rule regarding substituted
compliance, the Commission is re-proposing Forms SBSE, SBSE-A, and
SBSE-BD to add two questions to Form SBSE and Form SBSE-A, add one
question to all three Forms, and to modify Schedule F to all the Forms.
In addition, we are proposing one new instruction to the Forms, which
is unrelated to substituted compliance, to clarify that if an
application is not filed properly or completely, it may be delayed or
rejected.\586\ Key differences from the originally proposed forms are
discussed more fully below. The Commission is not proposing to modify
or eliminate any of the other Forms, or any of the rules, proposed in
the Registration Proposing Release.
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\586\ See Instruction B.1.b. on Forms SBSE, SBSE-A, and SBSE-BD.
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Re-proposed Forms SBSE and SBSE-A would include two new questions,
question 3 (which has three parts) and question 6.\587\ The new
question 3.A. would ask whether an applicant is a foreign security-
based swap dealer that intends to work with the Commission and its
primary regulator to have the Commission determine whether the
requirements of its primary regulator's regulatory system are
comparable to the Commission's, or avail itself of a substituted
compliance determination previously granted by the Commission with
respect to the requirements of Section 15F of the Exchange Act and the
rules and regulations thereunder. If the applicant responds in the
affirmative to either part of the question, new question 3.B. would
require that the applicant identify the foreign financial regulatory
authority that serves as the applicant's primary regulator and for
which the Commission has made, or may make, a substituted compliance
determination. If the applicant indicates that it is relying on a
previously granted substituted compliance determination, new question
3.C. would require the applicant to describe how it satisfies any
conditions the Commission may have placed on the use of such
substituted compliance determination. New question 3 would elicit basic
information from an applicant to inform the Commission with respect to
its intent to rely upon a substituted compliance determination.
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\587\ The Commission is not proposing to add these questions to
the Form SBSE-BD, because that form is only applicable to entities
that are already registered as broker-dealers. These firms would not
be eligible to rely on a substituted compliance determination
because the substituted compliance determination only is with
respect to the requirements in Section 15F of the Exchange Act, not
the requirements in the Exchange Act to which registered broker-
dealers are subject.
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New question 6 would ask whether the applicant is a U.S. branch of
a non-resident entity. If the applicant responds in the affirmative,
the applicant would need to identify the non-resident entity and its
location. This question would provide the Commission with information
regarding whether the firm would be subject to the rules of the foreign
regulator or the rules of one of the U.S. banking regulators, which
would, in turn, elicit which rules may be applicable to the entity's
U.S. security-based swap business.
Re-proposed Forms SBSE and SBSE-A would also include new question
17, which would be identified as new question 15 in re-proposed Form
SBSE-BD. This new question would ask if the applicant is registered
with or subject to the jurisdiction of a foreign financial regulatory
authority. If the applicant answered this question in the affirmative,
it would be directed to provide additional information on Schedule F as
discussed below. This question would apply to all applicants, not just
foreign security-based swap applicants, and would provide the
Commission with information regarding other regulatory schemes that may
be applicable to an applicant.
The proposed revisions to Schedule F would divide Schedule F into
two sections. Section I would include the full text of the originally
proposed Schedule F. Section II would elicit additional information
regarding foreign regulators with which the applicant may be registered
or that otherwise have jurisdiction over the applicant.
The Commission preliminarily believes that modifying Forms SBSE,
SBSE-A, and SBSE-BD (including the changes to Schedule F), as described
above, would be appropriate because it would provide foreign security-
based swap dealers with a convenient and cost-effective way of
informing the Commission of their intention to rely on or seek a
substituted compliance determination, as discussed above. In addition,
we believe these modifications to our original proposal would provide
the Commission with additional information necessary to make a
determination as to whether it is appropriate to grant or institute
proceedings to deny registration to a person applying to become a non-
resident security-based swap dealer.
Request for Comment
The Commission requests comment on all aspects of the proposed
modifications and additions to proposed Forms SBSE, SBSE-A and SBSE-BD
(including the proposed changes to Schedule F). The Commission also
specifically requests comment on the following:
Please explain whether Form SBSE and Form SBSE-A are the
appropriate places to identify whether an entity is intending to rely
on a substituted compliance determination. If not, please explain why
and what other method of notifying the Commission might be appropriate
as well as when such notification to the Commission should be required
to be made.
Please explain whether Forms SBSE, SBSE-A, and SBSE-BD
(and Schedule F) are the appropriate places to identify whether an
entity is subject to oversight by a foreign regulator, and if so, which
regulators. If so, why? If not, why not?
Should any additional questions be added to Form SBSE to
elicit information related to a registrant's reliance on a substituted
compliance determination?
Should any additional questions be added to Form SBSE-A to
elicit information related to a registrant's
[[Page 31029]]
reliance on a substituted compliance determination?
Should Form SBSE-BD also be modified to include any of the
additional questions the Commission is proposing to include in re-
proposed Form SBSE or Form SBSE-A? If so, which questions and why?
The Commission previously indicated in the Intermediary
Definitions Adopting Release that it would consider applications for
limited purpose designations from the major security-based swap
participant and security-based swap dealer definitions under Rules
3a67-1(b) and 3a71-1(c) under the Exchange Act, respectively,\588\ and
requested comment on this topic in the Registration Proposing
Release.\589\ Since that time, we have adopted and proposed, both
jointly with the CFTC and individually, various rules that further
clarify the regulations that will be applicable to security-based swap
dealers,\590\ and today we propose a substituted compliance framework
to potentially address the concerns of foreign security-based swap
dealers. Given these developments, are there any situations addressed
by previous comments where limited registration designation would no
longer be appropriate? Are there any situations, addressed by previous
comments or otherwise, where a limited registration designation may be
appropriate for security-based swap dealers? If so, in what situations
would a limited registration designation be warranted, and how should
the registration forms be amended to facilitate such limited
registration? If not, why not?
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\588\ As we noted in the Intermediary Definitions Adopting
Release, 77 FR 30643-46 and 30696-97, the Commission will consider
limited designation applications on an individual basis through
analysis of the unique circumstances of each applicant, given that
the types of entities that engage in security-based swap
transactions are diverse and their organization and activities are
varied. Any particular limited designation application will be
analyzed in light of the unique circumstances presented by the
applicant, and must demonstrate full compliance with the
requirements that apply to the type, class, or category of security-
based swap, or the activities involving security-based swaps, that
fall within the security-based swap dealer or major security-based
swap participant designation. A key challenge that any applicant for
a limited purpose designation will face is the need to demonstrate
that the applicant can comply with the statutory and regulatory
requirements applicable to security-based swap dealers or major
security-based swap participants while subject to a limited
designation. Regardless of the type of limited designation being
requested, the Commission will not designate a person as a security-
based swap dealer or major security-based swap participant in a
limited capacity unless it can demonstrate that it can fully comply
with the applicable requirements.
\589\ See Registration Proposing Release, 76 FR 65795. The
Commission received one comment on this topic, from SIFMA (see note
585, supra). SIFMA indicated that it ``SIFMA strongly believes that
the Commission should allow for limited SBSD or MSBSP registration
along a number of dimensions.'' For instance, SIFMA suggested that
the Commission allow entities to separately register individual
trading desks, allow an entity to register as an SBSD in one class
or type of security-based swap but not another (e.g., ``an entity
that acts as a dealer in single-name credit default swaps but not
total return swaps on single securities should be able to register
as an SBSD in the former but not the latter''), and ``allow entities
to register as an SBSD or MSBSP for their activities with U.S.
persons, keeping activities with non-U.S. persons outside the scope
of registration and related regulation.''
\590\ See, e.g., the Product Definitions Adopting Release, 77 FR
48208, and the Capital, Margin, and Segregation Proposing Release,
77 FR 70214.
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IV. Major Security-Based Swap Participants
A. Introduction
Title VII defines a new type of entity regulated by the Commission,
the ``major security-based swap participant.'' \591\ The statutory
definition of major security-based swap participant encompasses persons
whose security-based swap activities do not cause them to be dealers,
but nonetheless could pose a high degree of risk to the U.S. financial
system generally.\592\ This term was further defined in the
Intermediary Definitions Adopting Release, focusing on the potential
market impact and risks associated with a person's security-based swap
positions.\593\ In this respect, the major security-based swap
participant definition differs from the security-based swap dealer
definition, which generally focuses on a person's activities and how it
holds itself out to the market. The amount or significance of those
activities is relevant only in the context of the de minimis
exception.\594\ As a result, we believe that the cross-border issues
that are raised by the definition of major security-based swap
participant differ from those raised by the definition of security-
based swap dealer. The application of the major security-based swap
participant definition to cross-border activities was not addressed in
the Intermediary Definitions Adopting Release.\595\
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\591\ See Section 3(a)(67) of Exchange Act, 15 U.S.C.
78c(a)(67), as added by Section 761(a) of the Dodd-Frank Act.
\592\ As discussed in the Intermediary Definitions Adopting
Release, the tests of the major security-based swap participant
definition use terms--particularly ``systemically important,''
``significantly impact the financial system'' or ``create
substantial counterparty exposure''--that denote a focus on entities
that pose a high degree of risk through their security-based swap
activities. See Intermediary Definitions Adopting Release, 77 FR
30661 n.761. In addition, the link between the major participant
definitions and risk was highlighted during the congressional debate
on the statute. See 156 Cong. Rec. S5907 (daily ed. July 15, 2010).
\593\ See Intermediary Definitions Adopting Release, 77 FR
30661. Under Rule 3a67-1 under the Exchange Act, 17 CFR 240.3a67-1,
a major security-based swap participant is any entity that maintains
security-based swap positions exceeding one of the following three
thresholds: (1) $1 billion current uncollateralized exposure or $2
billion combined current uncollateralized exposure and potential
future exposure in a major category of security-based swaps
(excluding certain hedging positions); (2) $2 billion current
uncollateralized exposure or $4 billion combined current
uncollateralized exposure and potential future exposure in all
security-based swaps; or (3) highly leveraged financial entities
with $1 billion current uncollateralized exposure or $2 billion
combined current uncollateralized exposure and potential future
exposure in a major category of security-based swaps. See
Intermediary Definitions Adopting Release, 77 FR 30751-54.
\594\ See Intermediary Definitions Adopting Release, 77 FR
30661.
\595\ The Commission indicated that the cross-border application
of the major security-based swap participant definition would be
addressed in a separate release. See Intermediary Definitions
Adopting Release, 77 FR 30692 n.1181.
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B. Comment Summary
A variety of commenters provided their views on the application of
the major security-based swap participant definition and its related
thresholds in the cross-border context, generally suggesting that the
major participant tests focus on the systemic risk that an entity's
swap transactions poses to the U.S. market.\596\ Commenters further
suggested that major security-based swap participant threshold
calculations should exclude security-based swap transactions that do
not involve a U.S. counterparty.\597\ Several FPSFIs further
[[Page 31030]]
requested specific exclusions from the major security-based swap
participant definition, suggesting that as a matter of comity, swap
transactions involving foreign central banks as a counterparty,\598\
international financial institutions, and/or foreign SWFs should be
excluded from the major participant definitions.\599\
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\596\ See, e.g., Financial Services Roundtable Letter at 25
(stating that ``non-US entities should not be subject to regulation
as major participants unless their activities in US markets exceed
the relevant thresholds, even if their aggregate global activity
would exceed those thresholds'' and warning that ``the regulatory
burden is sufficiently high that such entities may choose to exit
the US markets, or deny US market participants access to non-US
markets, rather than submit to regulation''); APG Asset Management
Letter at 4 (recommending that the thresholds be amended to exclude
from the computations the outward credit exposures of the computing
party to non-U.S. persons, and supporting the CFTC's statement in
its proposed registration release that the major participant
analysis should be focused on an entity's activities with U.S.
counterparties or using U.S. mails or instrumentalities); and AIMA
Letter at 4-5 (suggesting that in the case of managed funds, only
U.S. funds or funds otherwise regulated in the U.S. should be
subject to potential major participant designation).
\597\ See, e.g., Jones Day Letter at 7-8 (recommending that
``[f]oreign swap transactions not involving a U.S. counterparty,
i.e., between two foreign counterparties[,] are more appropriately
the province of the supervisory authorities in the relevant non-U.S.
jurisdiction and should, therefore, be excluded from calculations of
substantial swap positions''); Milbank Tweed Letter at 3 (``Clearly,
the thresholds should not be applied to a non-U.S. participant's
transactions with all of its counterparties. Equally, all
transactions with U.S. counterparties can reasonably be included. To
take account of transactions with non-U.S. counterparties that might
meet the `direct and significant connection' standard, we suggest
the Commissions consider including only those transactions by a
potential non-U.S. major swap participant that are with non-U.S.
registered swap dealers or non-U.S. registered major swap
participants.'').
\598\ For this purpose, we consider the Bank for International
Settlements, in which the Federal Reserve and foreign central banks
are members, to be a foreign central bank. See http://www.bis.org/about/orggov.htm.
\599\ See, e.g., Norges Bank Letter at 4-5 (recommending
exemptions for foreign governments and their agencies); KfW letter
at 8 (FPSFIs); World Bank Group Letter II at 1-2 (multilateral
development institutions); China Investment Letter at 2 (SWFs); and
GIC Letter at 2, 5-6 (SWFs).
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Certain entities managed or controlled by foreign governments also
have asked for exemptions or exclusions from Commission registration or
the Dodd-Frank Act's substantive requirements. For example, SWFs
commented that they believe SWFs should be excluded from the definition
of major security-based swap participant and thus the related
regulatory obligations.\600\ These entities argued that the Commission
should not subject SWFs to registration requirements based on
principles of international comity and cooperation and noted that SWFs
are typically subject to comparable home country supervision that would
render SEC regulation largely duplicative. They also argued that
excluding SWFs from the major security-based swap participant
definition would not increase systemic risks given that SWFs make long-
term investments across diverse asset classes, use swaps or security-
based swaps to hedge portfolio risks rather than generate returns, and
are more likely to ensure that risk management measures are in place
because of SWFs' heightened concerns regarding reputational risk.\601\
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\600\ See China Investment Letter at 2-4 (further explaining
that exempting SWFs from the definition of MSBSP would not result in
reduced transparency, given that the SWF would still have to comply
with a number of other Dodd-Frank Act requirements) and GIC Letter
at 2, 5-6.
\601\ See China Investment Letter at 3-4 and GIC Letter at 3.
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Another entity, which operates with an explicit government
guarantee of its swap and security-based swap obligations, argued that
it should be excluded from the major participant definition due to its
lack of risk to the market resulting from this government support.\602\
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\602\ See KfW Letter at 8.
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C. Proposed Approach
In light of the comments received on the application of the major
security-based swap participant definition in the cross-border context
and the principles discussed above,\603\ the Commission is proposing a
rule and interpretive guidance regarding the application of the major
security-based swap participant definition to cross-border activities.
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\603\ See Section II.C, supra.
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1. In General
The Commission is proposing a rule under which a U.S. person would
consider all security-based swap transactions entered into by it, while
a non-U.S. person would consider only transactions entered into with
U.S. persons,\604\ when determining whether the person falls within the
major security-based swap participant definition.\605\ Under this
proposed approach, a non-U.S. person would calculate its security-based
swap positions under the three prongs of the major security-based swap
participant definition \606\ based solely on its transactions with U.S.
persons (including foreign branches of U.S. banks). All security-based
swap transactions by a non-U.S. person with other non-U.S. person
counterparties, regardless of whether they are conducted within the
United States or whether the non-U.S. person counterparties are
guaranteed by a U.S. person, would be excluded from the major security-
based swap participant analysis.
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\604\ Proposed Rule 3a67-10(a)(2) under the Exchange Act
(defining the term ``U.S. person'' by cross-reference to the
definition of U.S. person in proposed Rule 3a71-3(a)(7) under the
Exchange Act, as discussed in Section III.B.5, supra).
\605\ Proposed Rule 3a67-10(c) under the Exchange Act.
\606\ See Rule 3a67-1 under the Exchange Act, 17 CFR 240.3a67-1;
see also note 593, supra.
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The proposed rule would use the same definition of ``U.S. person''
as proposed in the context of foreign security-based swap dealer
registration.\607\ As previously discussed, this definition generally
follows a territorial approach to defining U.S. person.\608\ The
proposed approach to the U.S. person definition is intended to identify
individuals or legal persons that, by virtue of their location within
the United States or their legal or other relationship with the United
States, are likely to impact the U.S. financial market and the U.S.
financial system.\609\ Therefore, we preliminarily believe that
requiring a non-U.S. person to take into account its security-based
swap positions with U.S. persons, as proposed to be defined, for
purposes of the major security-based swap participant definition would
provide an appropriate indication of the degree of default risk posed
by such non-U.S. person's security-based swap positions to the U.S.
financial system, which we view as the focus of the major security-
based swap participant definition.\610\ Consistent with the rules
further defining the definition of major security-based swap
participant adopted in the Intermediary Definitions Adopting Release,
such risk to the U.S. financial system would be measured by calculating
such non-U.S. person's aggregate outward exposures \611\ to U.S.
persons (that is, what such non-U.S. person owes, or potentially could
owe, on its security-based swaps with U.S. persons).\612\ If such non-
U.S. person's aggregate outward exposures to U.S. persons exceed one of
the thresholds set forth in the rules further defining ``major
security-based swap
[[Page 31031]]
participant,'' \613\ the non-U.S. person would be required to register
as a major security-based swap participant.
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\607\ Proposed Rule 3a67-10(a)(2) under the Exchange Act; see
also proposed Rule 3a71-3(a)(7) under the Exchange Act, as discussed
in Section III.B.5, supra.
\608\ See Section III.B.5, supra, (discussing the definition of
``U.S. person'').
\609\ Id.
\610\ See Section 3(a)(67) of Exchange Act, 15 U.S.C.
78c(a)(67). In particular, one of the thresholds of the statutory
definition of major security-based swap participant focuses on the
serious adverse effects on the financial stability of the U.S.
banking system or financial markets as a result of substantial
counterparty exposure created by a person's security-based swap
positions. See Section 3(a)(67)(A)(ii)(II) of the Exchange Act, 15
U.S.C. 78c(a)(67)(A)(ii)(II). In addition, Section 3(a)(67)(B) of
the Exchange Act requires the Commission to define the term
``substantial position'' in Sections 3(a)(67)(A)(ii)(I) and (III) of
the Exchange Act at the threshold that the Commission determines to
be prudent for the effective monitoring, management, and oversight
of entities that are systemically important or can significantly
impact the financial system of the United States. See Section
3(a)(67)(B) of the Exchange Act, 15 U.S.C. 78c(a)(67)(B).
\611\ See Intermediary Definitions Adopting Release, 77 FR
30666-71; Rules 3a67-3(b) and (c) under the Exchange Act, 17 CFR
240.3a67-3(b) and (c).
\612\ The determination of whether a security-based swap
transaction must be included in a non-U.S. person's major security-
based swap participant calculation is based on the U.S. person
status of the non-U.S. person's counterparty to such transaction,
regardless of whether the counterparty is a security-based swap
dealer, end user, CCP, or other market participant. For example,
where a non-U.S. person enters into a security-based swap
transaction with a security-based swap dealer, and that transaction
is submitted for clearing and novated from the dealer to a CCP, the
non-U.S. person would look to the U.S. person status of the CCP that
became its counterparty as a result of such novation when
determining whether the transaction must be included in such non-
U.S. person's major security-based swap participant calculation.
\613\ See Rule 3a67-3 and Rule 3a67-5 under the Exchange Act, 17
CFR 240.3a67-3 and 17 CFR 240.3a67-5 (defining ``substantial
position'' and ``substantial counterparty exposure'').
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Given the focus of the major security-based swap participant
definition on the degree of risk to the U.S. financial system,\614\ the
Commission preliminarily believes that the location in which security-
based swap transactions are conducted is not relevant to the
calculation of a person's security-based swap positions for purposes of
determining such person's status as a major security-based swap
participant. Such an approach would differ from the approach we are
proposing with respect to the security-based swap dealer definition,
where we would count transactions connected with security-based swap
dealing activity conducted within the United States toward a potential
security-based swap dealer's de minimis threshold even if the
transactions were with non-U.S. persons.\615\ This difference in
approach is driven by the different focuses of the statutory
definitions of the terms security-based swap dealer and major security-
based swap participant. While the statutory major security-based swap
participant definition is focused specifically on risk,\616\ the
statutory security-based swap dealer definition is focused on, in
addition to risk, the nature of the activities undertaken by an entity,
its interactions with counterparties, and its role within the security-
based swap market.\617\ These different statutory emphases lead us to
treat major security-based swap participants differently from security-
based swap dealers with respect to whether activities conducted within
the United States should be counted toward their respective thresholds.
---------------------------------------------------------------------------
\614\ See note 610, supra.
\615\ See Section III.B.6, supra.
\616\ See note 610, supra.
\617\ See note 177 and accompanying text, supra.
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In addition, as stated above, the U.S. person definition applies to
the entire entity, including its branches and offices that may be
located in a foreign jurisdiction.\618\ Therefore, under the proposed
approach, a non-U.S. person would need to include its security-based
swap transactions with foreign branches of U.S. banks when calculating
its security-based swap positions for purposes of the major security-
based swap participant definition.
---------------------------------------------------------------------------
\618\ See Section III.B.5, supra.
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Some commenters on the CFTC Cross-Border Proposal have suggested
that a non-U.S. person should be allowed to exclude swap transactions
with foreign branches of U.S. banks for purposes of determining whether
it is a major swap participant because otherwise non-U.S. persons would
have a strong incentive to limit or even stop trading with U.S. banks
that operate outside the United States via foreign branches.\619\ We
are mindful of these concerns. However, because foreign branches are
not separate legal persons,\620\ the Commission believes that the
potential losses that a U.S. bank would suffer due to a non-U.S. person
counterparty's default, and the potential impact on the U.S. banking
system and the U.S. financial system generally, would not differ
depending on whether the non-U.S. person counterparty entered into the
security-based swap with the home office of the U.S. bank or with a
foreign branch of the U.S. bank. Therefore, the Commission
preliminarily believes that it is appropriate to require a non-U.S.
person to include its security-based swap transactions with foreign
branches of U.S. banks for purposes of determining its major security-
based swap participant status.
---------------------------------------------------------------------------
\619\ See, e.g., Citigroup Letter at 3.
\620\ See Section III.B.5, supra.
---------------------------------------------------------------------------
By contrast, the Commission preliminarily believes that a non-U.S.
person (the ``potential non-U.S. person major security-based swap
participant'') does not need to include its security-based swap
transactions with non-U.S. person counterparties in determining whether
it is a major security-based swap participant. As stated above, the
focus of the major security-based swap participant definition is on the
degree of risk posed by a person's security-based swap positions to the
U.S. financial system.\621\ In the case of transactions with non-U.S.
person counterparties, the risk that a potential non-U.S. person major
security-based swap participant will not pay what it owes (or
potentially could owe) under its security-based swaps to its non-U.S.
counterparties is not transmitted directly and fully to the U.S.
financial system in the way that such risk would be transmitted if the
potential non-U.S. person major security-based swap participant engaged
in security-based swap transactions with U.S. person counterparties.
Instead, the non-U.S. person counterparties bear the direct and full
risk of loss.\622\ We recognize that there may be indirect spillover
effects related to the security-based swap positions arising from the
activity conducted by a potential non-U.S. person major security-based
swap participant and a non-U.S. person counterparty (e.g., a U.S.
person that has an ownership interest in such a non-U.S. person
counterparty would potentially face losses on the value of its
investment in such a non-U.S. person counterparty due to failure of the
potential non-U.S. person major security-based swap participant), but
the Commission preliminarily believes that the major security-based
swap participant tests do not need to address the potential indirect
spillover risk to the U.S. financial system from foreign investments by
U.S. persons in non-U.S. persons, or other non-security-based swap
activities by U.S. persons with non-U.S. persons.\623\
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\621\ See note 610, supra.
\622\ This is the case even if the non-U.S. person
counterparties' obligations under the security-based swaps with the
potential non-U.S. person major security-based swap participant are
guaranteed by a U.S. person. As discussed in more detail below, the
Commission proposes to address the risk posed by a non-U.S. person's
security-based swap positions guaranteed by a U.S. person to the
U.S. financial system through its treatment of guarantees for
purposes of the major security-based swap participant definition.
See Section IV.C.2(a), infra.
\623\ The Commission preliminarily believes that such risk is
more appropriately addressed under Titles I and II of the Dodd-Frank
Act.
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The Commission recognizes that this proposed approach results in
different treatment of U.S. and non-U.S. persons under the major
security-based swap participant definition (i.e., a non-U.S. person
would consider its security-based swap transactions with only U.S.
persons, while a U.S. person would consider all of its security-based
swap transactions). However, the Commission preliminarily believes that
this approach is appropriate in light of the focus in the major
security-based swap participant definition on the U.S. financial
system. More specifically, the need for separate analysis of U.S. and
non-U.S. entities results from the fact that all of a U.S. person's
security-based swap transactions are part of and create risk to the
U.S. financial system, regardless of whether such entity's
counterparties are U.S. persons or non-U.S. persons. The same is not
true of non-U.S. persons, however, because the security-based swap
transactions entered into by a non-U.S. person with other non-U.S.
persons are not fundamentally part of the U.S. financial system, while
such non-U.S. person's security-based swap transactions with U.S.
persons would directly impact the U.S. financial system. Thus, we
preliminarily believe that the statutory major security-based swap
participant definition's focus on the U.S. financial system, justifies
treating U.S. and non-U.S. persons differently for purposes of the
major participant analysis based on
[[Page 31032]]
the disparate impacts of their security-based swap transactions on the
U.S. financial system.
We recognize that a non-U.S. person's transactions with other non-
U.S. person counterparties could still have an impact on the U.S.
financial system, including where those transactions threatened the
financial integrity of a non-U.S. person counterparty and such person
had significant security-based swap positions with U.S. persons.
However, the amount of risk the non-U.S. person poses to the U.S.
financial system would most directly stem from the size of its direct
positions with U.S. persons. As a result, the Commission preliminarily
believes it is appropriate to limit the international application of
the major security-based swap participant definition to a non-U.S.
person's security-based swaps entered into with U.S. persons.
2. Guarantees
The application of the major security-based swap participant
definition to security-based swap positions guaranteed by a parent,
other affiliate, or guarantor raises unique issues in the cross-border
context. These issues were not addressed in the Intermediary
Definitions Adopting Release.\624\
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\624\ In the Intermediary Definitions Adopting Release, the
Commissions stated they intended to address guarantees provided to
non-U.S. entities, and guarantees by non-U.S. holding companies, in
separate releases. See Intermediary Definitions Adopting Release, 77
FR 30689 n.1134. In this release, we are not altering the
interpretive approach with respect to the attribution of guarantees
that was adopted by the Commissions in the Intermediary Definitions
Adopting Release, but rather we are proposing an interpretive
approach that would apply the principles adopted in the Intermediary
Definitions Adopting Release in the cross-border context.
---------------------------------------------------------------------------
As a general principle, the Commission and the CFTC did note in the
Intermediary Definitions Adopting Release that an entity's security-
based swap positions are attributed to a parent, other affiliate, or
guarantor for purposes of the major participant analysis to the extent
that the counterparties to those positions have recourse to that
parent, other affiliate, or guarantor in connection with the
position.\625\ Positions are not attributed in the absence of
recourse.\626\ The Commission and the CFTC further stated that
attribution of these positions for purposes of the major participant
definitions is intended to reflect the risk focus of the major
participant definitions by providing that entities will be regulated as
major participants when they pose a high level of risk in connection
with the swap and security-based swap positions they guarantee.
---------------------------------------------------------------------------
\625\ See Intermediary Definitions Adopting Release, 77 FR
30689, and the accompanying note 1132 on that page.
\626\ See id. As indicated in note 160 above, the term
``guarantee'' as used in this release refers to a contractual
agreement pursuant to which one party to a security-based swap
transaction has recourse to its counterparty's parent, other
affiliate, or guarantor with respect to the counterparty's
obligations owed under the transaction.
---------------------------------------------------------------------------
The application of these general principles in the cross-border
context is discussed below, including the attribution of guaranteed
security-based swap positions to U.S. persons and non-U.S. persons,
respectively, when they provide guarantees on performance of the
security-based swap obligations of other persons, the limited
circumstances where attribution of guaranteed security-based swap
positions is not required, and operational compliance.
(a) Guarantees Provided by U.S. Persons to Non-U.S. Persons
One cross-border issue that arises from the general approach to
guarantees set forth in the Intermediary Definitions Adopting Release
is how the attribution of guarantees for purposes of the major
security-based swap participant definition would apply to a guarantee
provided by a U.S. person for performance on the obligations of a non-
U.S. person, such as a U.S. holding company providing a guarantee on
the obligations of a foreign subsidiary. As noted in the Intermediary
Definitions Adopting Release, the attribution of guaranteed positions
for purposes of the major participant definitions is intended to
reflect the risk that a guarantor might pose to, and the systemic
impact of such risk may impose on, the U.S. financial system as a
result of the guarantees that it provides.\627\ The Commission
preliminarily believes that these risk concerns are the same when U.S.
persons act as guarantors for foreign persons regardless of whether the
underlying security-based swap transactions that they guarantee are
entered into with U.S. persons or non-U.S. persons, given that the risk
borne by the U.S. person guarantor would not be impacted by the status
of the guaranteed non-U.S. person's counterparty as either a U.S.
person or non-U.S. person. As a result, the Commission is proposing
that, other than in the limited circumstances described below,\628\ all
security-based swaps entered into by a non-U.S. person and guaranteed
by a U.S. person be attributed to such U.S. person guarantor for
purposes of determining such U.S. person guarantor's major security-
based swap participant status, regardless of whether the underlying
transaction was entered into with a U.S. person counterparty or non-
U.S. person counterparty.\629\
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\627\ See id.
\628\ See Section IV.C.2(c), infra (discussing the limited
circumstances where attribution of guaranteed security-based swap
positions to the guarantor would not apply).
\629\ In all circumstances where a U.S. person guarantor is
required to attribute to itself all security-based swap transactions
entered into by the guaranteed non-U.S. person, the guaranteed non-
U.S. person would still be required to consider those security-based
swap transactions that it enters into with U.S. person
counterparties for purposes of determining whether it is a major
security-based swap participant pursuant to the proposed Rule 3a67-
10(c)(2) under the Exchange Act. See Section IV.C.1, supra
(discussing proposed Rule 3a67-10(c) under the Exchange Act). Once
the guaranteed non-U.S. person becomes a major security-based swap
participant and registers with the Commission, the U.S. guarantor
would no longer be required to attribute to itself the security-
based swap positions entered into by the guaranteed non-U.S. person.
See Intermediary Definitions Adopting Release, 77 FR 30689. This
same result would also occur where a guaranteed non-U.S. person
becomes subject to capital regulation by the Commission or the CFTC
(e.g., a registered major swap participant, swap dealer, security-
based swap dealer, futures commission merchant, or broker-dealer).
See id.
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(b) Guarantees Provided by Non-U.S. Persons to U.S. Persons and
Guarantees Provided by Non-U.S. Persons to Non-U.S. Persons
Another cross-border issue related to the Commission's approach to
the attribution of guarantees is how guarantees provided by non-U.S.
persons are treated for purposes of the major security-based swap
participant definition. As previously noted, the statutory major
security-based swap participant definition's focus on the accumulation
of security-based swap risk by non-U.S. persons is primarily centered
on the impact such risk could have on the U.S. financial system.\630\
Where a non-U.S. person provides a guarantee on performance of the
security-based swap obligations of a U.S. person (e.g., a non-U.S.
holding company providing a guarantee on performance of the obligations
owed by its U.S. subsidiary under security-based swaps entered into by
the U.S. subsidiary), the counterparties of such U.S. person would be
taking the credit risk of the non-U.S. person guarantor as well as the
U.S. person. If the non-U.S. person guarantor defaults, the full amount
of risk accumulated under the guaranteed U.S. person's security-based
swap positions would impact the U.S. financial system. As a result,
subject to the limited circumstances described in the Intermediary
Definitions Adopting Release,\631\ a non-U.S. person providing
[[Page 31033]]
a guarantee on performance of the security-based swap obligations of a
U.S. person would attribute to itself all of the U.S. person's
security-based swap positions that are guaranteed by the non-U.S.
person guarantor for purposes of determining the non-U.S. person
guarantor's major security-based swap participant status.\632\
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\630\ See note 610, supra.
\631\ See Intermediary Definitions Adopting Release, 77 FR 30730
(discussing the limited circumstances where attribution of
guaranteed security-based swap positions of a U.S. person to the
guarantor would not apply).
\632\ See note 629, supra.
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By contrast, where a non-U.S. person provides a guarantee on
performance of the security-based swap obligations of another non-U.S.
person (e.g., a non-U.S. holding company providing a guarantee on
performance of the obligations owed by its non-U.S. subsidiary under
security-based swaps entered into by the non-U.S. subsidiary), the
ultimate counterparty credit risk associated with the transaction would
generally reside outside of the United States with the non-U.S.
guarantor. In this scenario, the potential impact on the U.S. financial
system would be limited to transactions entered into by the guaranteed
non-U.S. person with U.S. person counterparties. Therefore, the
Commission preliminarily believes that, other than in the limited
circumstances described below,\633\ where a non-U.S. person guarantees
performance on the security-based swap transactions of another non-U.S.
person, the non-U.S. guarantor need only attribute to itself such
guaranteed security-based swap transactions entered into with U.S.
person counterparties for purposes of determining its major security-
based swap participant status.\634\
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\633\ See Section IV.C.2(c), infra (discussing the limited
circumstances where attribution of guaranteed security-based swap
positions of a non-U.S. person to the guarantor would not apply).
\634\ Where a non-U.S. person guarantor is required to attribute
to itself the security-based swap positions entered into by a non-
U.S. person that are guaranteed by the first non-U.S. person, the
guaranteed non-U.S. person also would be required to consider all
security-based swap transactions entered into by itself with U.S.
person counterparties for purposes of determining its major
security-based swap participant status in accordance with proposed
Rule 3a67-10(c)(2) under the Exchange Act. See Section IV.C.1, supra
(discussing proposed Rule 3a67-10(c) under the Exchange Act). Once
the guaranteed non-U.S. person becomes a major security-based swap
participant and registers with the Commission, the non-U.S.
guarantor would no longer be required to attribute to itself the
security-based swap positions entered into by the guaranteed non-
U.S. person. See Intermediary Definitions Adopting Release, 77 FR
30689.
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(c) Limited Circumstances Where Attribution of Guaranteed Security-
Based Swap Positions Does Not Apply
In addition to setting forth general principles regarding the
attribution of guaranteed swap or security-based swap positions to the
guarantor for the major participant definitions, the Intermediary
Definitions Adopting Release also provided interpretive guidance
related to the limited circumstances under which attribution of
guaranteed swap or security-based swap positions is not required.\635\
Specifically, it stated that even in the presence of a guarantee, it is
not necessary to attribute a person's swap or security-based swap
positions to a parent or other guarantor if the person already is
subject to capital regulation by the Commission or the CFTC (i.e., swap
dealers, security-based swap dealers, major swap participants, major
security-based swap participants, FCMs, and broker-dealers) or if the
person is a U.S. entity regulated as a bank in the United States.\636\
In providing this interpretive guidance, the Commission and the CFTC
explained that the positions of those regulated entities already will
be subject to capital and other requirements, making it unnecessary to
separately address, via major participant regulations, the risks
associated with guarantees of those positions of a regulated
entity.\637\
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\635\ See Intermediary Definitions Adopting Release, 77 FR
30689.
\636\ Id. This interpretive guidance applies to both U.S.
persons and non-U.S. persons that are subject to registration and
regulation in the enumerated categories.
\637\ See Intermediary Definitions Adopting Release, 77 FR
30689.
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The Intermediary Definitions Adopting Release did not address the
application of the interpretive guidance regarding attribution of
guaranteed positions where a guarantee is provided to support a non-
U.S. person's performance on the obligations under security-based swaps
in the cross-border context. The Commission preliminarily believes that
the interpretation jointly adopted by the Commission and the CFTC in
the Intermediary Definitions Adopting Release regarding security-based
swap positions of a person subject to capital regulation by the CFTC or
the Commission should equally apply to a non-U.S. person whose
security-based swap positions are guaranteed by another person.
Therefore, the Commission is proposing to interpret that it is not
necessary to attribute a non-U.S. person's security-based swap
positions to a parent or other guarantor if such non-U.S. person
already is subject to capital regulation by the Commission or the CFTC
(i.e., swap dealers, security-based swap dealers, major swap
participants, major security-based swap participants, FCMs and broker-
dealers).
In addition, in the cross-border context and with respect to a non-
U.S. person, if such non-U.S. person is not subject to capital
regulation by the Commission or the CFTC, consistent with the rationale
for the approach to attribution of security-based swap positions of a
person that is a U.S. entity regulated as a bank in the United States,
it would not be necessary to attribute such non-U.S. person's security-
based swap positions to its guarantor if such non-U.S. person is
subject to capital standards that are consistent with the capital
standards such non-U.S. person would have been subject to if such non-
U.S. person were a bank subject to the prudential regulators' capital
regulation. Therefore, the Commission preliminarily believes that it is
not necessary to attribute such non-U.S. person's security-based swap
positions to its guarantor for purposes of determining the guarantor's
major security-based swap participant status, if such non-U.S. person
is subject to capital standards adopted by its home country supervisor
that are consistent in all respects with the Capital Accord of the
Basel Committee on Banking Supervision (the ``Basel Accord'').\638\
This proposed approach also is consistent with the capital standards
proposed by the prudential regulators for a foreign bank that is a swap
dealer, major swap participant, security-based swap dealer or major
security-based swap participant, which require such foreign bank to
comply with regulatory capital rules already made applicable to such
foreign bank as part of the existing prudential regulatory regime.\639\
The Commission preliminarily believes that security-based swap
positions of a non-U.S. person subject to foreign regulatory capital
requirements consistent with the Basel Accord would be subject to risk-
based capital requirements that take into account the unique risks
(including the
[[Page 31034]]
credit risk, market risk, and other risks) arising from security-based
swap transactions, in such a way as to make it unnecessary to
separately address, via major security-based swap participant
regulation, the risks associated with guarantees of those security-
based swap positions.
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\638\ This is consistent with the capital standards of the
prudential regulators with respect to foreign banks that are bank
holding companies subject to the Federal Reserve Board of Governors'
supervision. See Sec. 225.2(r)(3) of the Regulation Y (``For
purposes of determining whether a foreign banking organization
qualifies under paragraph (r)(1) of this section: (A) A foreign
banking organization whose home country supervisor . . . has adopted
capital standards consistent in all respects with the Capital Accord
of the Basle Committee on Banking Supervision (Basle Accord) may
calculate its capital ratios under the home country standard . .
.''), 12 CFR 225.2(r)(3).
\639\ See Prudential Regulator Margin and Capital Proposal, 76
FR 27582 (``The proposed rule generally requires a covered swap
entity to comply with regulatory capital rules already made
applicable to that covered swap entity as part of its prudential
regulatory regime. . . . In the case of a foreign bank or the U.S.
branch or agency of a foreign bank, the capital rules that are made
applicable to such covered entity pursuant to Sec. 225.2(r)(3) of
the Board's Regulation Y, 12 CFR 225.2(r)(3) . . .'').
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(d) Operational Compliance
Finally, the Commission believes that it is necessary to provide
interpretive guidance regarding operational compliance and the special
issues that may result from the attribution of security-based swap
positions to a parent or guarantor. As the Commission and the CFTC
noted in the Intermediary Definitions Adopting Release, these include
issues regarding the application of the transaction-focused
requirements applicable to registered major participants (e.g., certain
requirements related to trading records and transaction confirmations),
given that the entity that is the direct counterparty to the swap or
security-based swap may be better positioned to comply with those
requirements.\640\ In the Intermediary Definitions Adopting Release,
the Commission and the CFTC stated that ``an entity that becomes a
major participant by virtue of swaps or security-based swaps directly
entered into by others must be responsible for compliance with all
applicable major participant requirements with respect to those swaps
or security-based swaps (and must be liable for failures to comply),
but may delegate operational compliance with transaction-focused
requirements to entities that directly are party to the transactions.
The entity that is the major participant, however, cannot delegate
compliance duties with the entity-level requirements applicable to
major participants (e.g., requirements related to registration and
capital).'' \641\
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\640\ Intermediary Definitions Adopting Release, 77 FR 30689.
\641\ Id.
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The Commission preliminarily believes that the same approach should
apply in the cross-border context when the guarantor and the guaranteed
person are located in different jurisdictions (e.g., U.S. holding
companies that act as guarantors of the security-based swap obligations
of their non-U.S. dealing subsidiaries). In each case, the major
security-based swap participant may delegate compliance duties for
transaction-focused requirements to the entities that are
counterparties to the transactions, but the major security-based swap
participant would remain responsible for ensuring that the Title VII
requirements applicable to such transactions are fulfilled. However,
major security-based swap participants must comply with all relevant
entity-level requirements themselves that are not transaction-focused,
such as registration and capital. Entity-level requirements that have a
transaction focus, such as margin, may be delegated to the guaranteed
entities that directly are party to the transactions. However, the
major security-based swap participants would remain responsible for
ensuring compliance with these requirements.
3. Foreign Public Sector Financial Institutions (FPSFIs)
The proposed approach to the cross-border application of the major
security-based swap participant definition described above provides a
general framework for applying the definition to non-U.S. persons. That
framework does not separately address questions raised by commenters
regarding how the major security-based swap participant definition
applies to FPSFIs. Specifically, some commenters requested explicit
exclusions from the major security-based swap participant definition
for these types of entities.\642\
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\642\ See note 599, supra.
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We note that FPSFIs encompass a wide range of institutions and
organizations, ranging from divisions of foreign central banks, to
international financial institutions established under treaties, to
multilateral development banks formed, owned, and controlled by
sovereign members, to sovereign wealth funds and other investment
corporations owned by foreign governments. Some FPSFIs' obligations are
guaranteed or backed by foreign governments; others may not be. The
purposes and activities of these institutions and organizations vary.
For example, some FPSFIs (such as the Bank for International
Settlements) provide banking services to foreign central banks who are
their members. Some FPSFIs provide credits and grants to promote
economic development in developing countries (e.g., multilateral
development banks) or distribute funds of regional recovery programs to
promote regional economies (e.g., KfW for the European Recovery
Program). Other FPSFIs conduct investment activities around the world
and their exclusive customers are the foreign governments to which they
are linked. Depending on their purposes and activities, FPSFIs may
engage in different types of swaps or security-based swaps to various
degrees, although the Commission is not aware of data reflecting the
nature and amount of such transactions across the FPSFI population. One
commenter stated that it enters into swaps to manage interest rates and
foreign exchange risks but does not use swaps to generate returns.\643\
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\643\ See China Investment Letter at 3-4. Cf. World Bank Letter
II states that ``not all multilateral development banks use
derivatives in their development operations, or do so only on a
limited basis.'' See World Bank Letter II at 1 n.1.
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Several commenters requested that FPSFIs be excluded from the major
security-based swap participant definition. They provided various
reasons and basis to support their requests. Some FPSFIs commented that
they are subject to exceptionally high risk controls and have extremely
strong capital bases and therefore pose no risk to systemic
stability.\644\ Others argued that they already are subject to
comparable or comprehensive substantive regulation of their respective
governments in their home countries and therefore, subjecting them to
the major security-based swap participant regulation would create
regulatory duplication or conflicts.\645\ One FPSFI argued that it only
conducts swap activities with dealers, which would be regulated under
Title VII, and therefore it is not necessary to subject it to
duplicative regulation and supervision.\646\ Another FPSFI, which
operates with an explicit government guarantee of its swap and
security-based swap obligations, argued that it should be excluded from
the major participant definition due to its lack of risk to the market
resulting from this government support.\647\ Intergovernmental
organizations, such as multilateral development banks, argued that
multilateral development institutions are never subject to national
regulations and their privileges and immunities should be fully
respected.\648\
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\644\ See BIS Letter II at 3 and World Bank Letter I at 7.
\645\ See GIC Letter at 3-4 and KfW Letter at 3 and 8.
\646\ See China Investment Letter at 3-4.
\647\ See KfW Letter at 8.
\648\ See World Bank Letter II at 2-3.
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After considering the concerns of these commenters, we recognize
that FPSFIs raise unique and complex issues because of the diversity of
the special purposes they are serving, their differing governance
structures and sources of financial strength, and their supranational,
intergovernmental, or sovereign nature. The Commission also recognizes
that we have received relatively little information from commenters
regarding the types, levels, and natures of security-based swap
activity that FPSFIs regularly engage in (although some information has
been
[[Page 31035]]
received regarding their swap transactions) and that, consequently, the
Commission has comparatively little basis on which to understand their
roles in the security-based swap markets and, as appropriate, exclude
them from the major security-based swap participant definition.
Therefore, we are not proposing to specifically address the treatment
of FPSFIs at this time. Instead, we are soliciting comment to help
determine the basis on which it may be appropriate to exclude FPSFIs
from the proposed rule regarding application of the major security-
based swap participant definition to non-U.S. persons. In particular,
we invite public comment regarding the types, levels, and nature of the
security-based swap activity that various types of FPSFIs may engage in
on a regular basis, the roles of FPSFIs in the security-based swap
market, the mitigating factors and reasons that FPSFIs may not pose
systemic risk as a result of their security-based swap activity, and
whether it would be more appropriate for the Commission to address
FPSFI concerns on an individual basis. We also request considerations,
information, and data regarding potential definitions of a FPSFI for
purposes of the major security-based swap definition. Responses that
are supported by empirical data and analysis are encouraged in
assisting the Commission in considering whether excluding FPSFIs from
the definition of the major security-based swap participant is
warranted.
D. Title VII Requirements Applicable to Major Security-Based Swap
Participants
1. Transaction-Level Requirements Related to Customer Protection
(a) Overview
As previously noted, the Dodd-Frank Act is generally concerned with
the protection of the U.S. financial system and counterparties in the
U.S. security-based swap market.\649\ This general principle is
particularly relevant to the customer protection, including
segregation, requirements in Title VII, which are focused on the
protection of the counterparties or customers of security-based swap
dealers. As a result, the Commission preliminarily believes that it is
not necessary to the objective of Title VII to subject foreign major
security-based swap participants to certain of the customer protection
requirements in Title VII with respect to their transactions with non-
U.S. persons. Accordingly, the Commission is proposing rules that would
identify specific transaction-level requirements that would not apply
to foreign major security-based swap participants with respect to their
transactions with non-U.S. persons.
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\649\ See note 4, supra.
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(b) Proposed Rules
The proposed rules would provide that foreign major security-based
swap participants would not be subject, solely with respect to their
transactions with non-U.S. persons, to certain of the transaction-level
requirements that apply to major security-based swap participants.\650\
Specifically, under the proposed rules registered foreign major
security-based swap participants would not have to comply with business
conduct standards as described in Section 15F(h) of the Exchange Act,
and the rules and regulations thereunder, other than the rules and
regulations prescribed by the Commission relating to diligent
supervision pursuant to Section 15F(h)(1)(B) \651\ and the rules and
regulations thereunder, with respect to their transactions with non-
U.S. persons.\652\ In addition, under the proposed rules, registered
foreign major security-based swap participants that are not registered
broker-dealers would not have to comply with requirements related to
the segregation of assets held as collateral in Section 3E of the
Exchange Act and the rules and regulations thereunder with respect to
their transactions with non-U.S. persons.\653\
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\650\ Proposed Rule 3a67-10(b) and proposed Rule 18a-4(f) under
the Exchange Act.
\651\ 15 U.S.C. 78o-10(h)(1)(B).
\652\ See Section III.C.3(a)(i), supra. As discussed previously,
Section 15F(h)(1)(B) requires security-based swap dealers to conform
with such business conduct standards relating to diligent
supervision as the Commission shall prescribe.
\653\ See proposed Rule 18a-4(f) under the Exchange Act.
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Our rationale for this proposed approach to the application of
transaction-level requirements for foreign major security-based swap
participants is substantially the same as that discussed previously in
the context of foreign security-based swap dealers.\654\ This rationale
includes our belief that applying these customer protections and
segregation requirements to security-based swap transactions with non-
U.S. persons outside the United States would not advance the objectives
of Title VII to protect the U.S. financial system or U.S.
counterparties. At the same time, this approach would preserve customer
protections for U.S. person counterparties who would expect to benefit
from the protections afforded by Title VII.
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\654\ See generally Section III.C.4(b), supra. In addition, all
``nonresident major security-based swap participants,'' as defined
in proposed Rule 15Fb2-4(a) under the Exchange Act, would be
required: (1) To appoint and identify to the Commission an agent in
the United States (other than the Commission or a Commission member,
official or employee) for service of process; (2) to certify that
the firm can, as a matter of law, provide the Commission with prompt
access to its books and records and can, as a matter of law, submit
to onsite inspection and examination by the Commission; and (3) to
provide the Commission with an opinion of counsel concurring that
the firm can, as a matter of law, provide the Commission with prompt
access to its books and records and can, as a matter of law, submit
to onsite inspection and examination by the Commission. See proposed
Rule 15Fb2-4(b) under the Exchange Act, as discussed in the
Registration Proposing Release, 76 FR 65799-801.
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(2) Entity-Level Requirements
Entity-level requirements in Title VII primarily address concerns
relating to the major security-based swap participant as a whole, with
a particular focus on safety and soundness of the entity to reduce
systemic risk in the U.S. financial system. The most significant
entity-level requirements are capital and margin requirements. Because
these requirements address the financial, operational, and business
integrity of the entity engaged in security-based swap activity, the
Commission preliminarily believes that a registered foreign major
security-based swap participant should be required to adhere to these
standards. As noted above, other requirements that the Commission
believes should apply at the entity, rather than the transactional,
level include, but are not limited to, risk management procedures,
books and records requirements, conflicts of interest systems and
procedures, and designation of a chief compliance officer.\655\ These
entity-level requirements ensure the safety and soundness of the entire
registrant and are thus distinguishable from the transaction-level
requirements discussed above, which apply to transactions with
individual counterparties and thus may be applied differently based on
the U.S. person status of a counterparty.
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\655\ See Section III.C.3(b), supra.
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3. Substituted Compliance
The Commission is not proposing, at this time, to establish a
policy and procedural framework under which we would consider
permitting compliance by a foreign major security-based swap
participant with comparable regulatory requirements in a foreign
jurisdiction to substitute for compliance with requirements of the
Exchange Act, and the rules and regulations thereunder, applicable to
major security-based swap
[[Page 31036]]
participants, as it is proposing to do for foreign security-based swap
dealers.\656\
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\656\ See Section XI.C, infra.
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Unlike foreign security-based swap dealers whose primary businesses
are in securities, security-based swaps, swaps, banking and other
financial and investment banking activities, the non-U.S. persons that
may need to register as nonbank major security-based swap participants
may engage in a diverse range of business activities different from,
and broader than, the activities conducted by broker-dealers or
security-based swap dealers (otherwise they may be required to register
as a security-based swap dealer and/or broker-dealer) or the activities
conducted by banks. For example, as stated in the Capital, Margin and
Segregation Proposing Release, persons that may need to register as
nonbank major security-based swap participants may engage in commercial
activities that require them to have substantial fixed assets to
support manufacturing and/or result in them having significant assets
comprised of unsecured receivables.\657\ Therefore, it is not clear
what types of entity-level regulatory oversight, if any, especially
with respect to capital and margin, a foreign major security-based swap
participant would be subject to in the foreign regulatory system.
---------------------------------------------------------------------------
\657\ See Capital, Margin, and Segregation Proposing Release, 77
FR 70315.
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Accordingly, in light of the limited information currently
available to us regarding what types of foreign entities may become
major security-base swap participants, if any, and the foreign
regulation of such entities, we are not, at this time, proposing to
extend the proposed policy and procedural framework for substituted
compliance to foreign major-security-based swap participants.
Nevertheless, we will continue to consider the appropriateness of
permitting substituted compliance for major security-based swap
participants in light of comments received on this proposal and market
developments more generally and will consider what further steps to
take, if any, at adoption. In this regard, we request considerations,
information, and data regarding potential foreign major security-based
swap participants. Responses that are supported by empirical data and
analysis are encouraged in assisting the Commission in considering
whether permitting substituted compliance by foreign major security-
based swap participants would be warranted.
Request for Comment
The proposed rules and interpretations regarding the application of
the major security-based swap participant definition and transaction-
level and entity-level requirements to registered major security-based
swap participants discussed above represent the Commission's
preliminary views. The Commission seeks comment on the proposed rules
and interpretations in all aspects. Interested persons are encouraged
to provide supporting data and analysis and, when appropriate, suggest
modifications to proposed rule text and interpretations. Responses that
are supported by data and analysis provide great assistance to the
Commission in considering the practicality and effectiveness of the
proposed application as well as considering the benefits and costs of
proposed requirements. In addition, the Commission seeks comment on the
following specific questions:
Should the major security-based swap participant
definition focus only on a non-U.S. person's security-based swap
transactions entered into with U.S. persons, or should the major
security-based swap participant definition incorporate some or all of a
non-U.S. person's other security-based swap transactions? Which
transactions? For example, should a non-U.S. person include security-
based swap transactions with non-U.S. person counterparties guaranteed
by U.S. persons in such non-U.S. person's major security-based swap
participant calculation? Why or why not?
Should the proposed approach toward determining whether a
non-U.S. person should count its security-based swap transactions that
are cleared through CCPs be adopted? Why or why not? Should the
Commission adopt a different approach to the treatment of security-
based swap transactions cleared through CCPs for purposes of the cross-
border application of the major security-based swap participant test?
If so, how should cleared transactions be treated for purposes of the
cross-border application of the major security-based swap participant
test?
Should a non-U.S. person be permitted to exclude its
security-based swap transactions entered into with foreign branches of
U.S. banks from the calculation for purposes of determining whether it
is a major security-based swap participant? Why? If a non-U.S. person's
security-based swaps with foreign branches of U.S. banks are not
required to be considered in determining such non-U.S. person's major
security-based swap participant status, how should the risk (in terms
of outward exposures) that such non-U.S. person poses to U.S. banks be
addressed?
Should the Commission permit a non-U.S. person to exclude
from its major security-based swap participant calculations its
security-based swap positions arising from transactions with the
foreign branches of U.S. banks if such non-U.S. person is subject to
capital standards adopted by its home country supervisor that are
consistent in all respect with the Basel Accord? Are there other
conditions or standards the Commission should consider that a non-U.S.
person may satisfy or comply with that should allow a non-U.S. person
to exclude its security-based swap positions arising from transactions
with foreign branches of U.S. banks from its major security-based swap
participant calculation?
Are there competitiveness concerns related to the proposed
different treatment of U.S. persons and non-U.S. persons for purposes
of calculating their status under the major security-based swap
participant definition? If so, what are these concerns, and how should
they be addressed?
Should the proposed approach towards the attribution of
security-based swap positions guaranteed by U.S. persons and non-U.S.
persons be altered? What justifications would support an alternate
approach?
Should the Commission adopt the proposed approach to the
attribution of guaranteed security-based swap positions whereby the
positions of guaranteed entities subject to capital standards adopted
by its home country supervisor that are consistent in all respects with
the Basel Accord would not need to be attributed? Is Basel Accord
capital standard an appropriate standard for determining whether it is
not necessary to attribute guaranteed security-based swap positions to
a guarantor, or should another standard be used? Is this proposed
standard clear, or is additional guidance necessary? In addition to the
proposed capital standard, should the Commission's approach to the
attribution of guaranteed security-based swap positions also include a
requirement that the guaranteed entities be subject to effective
capital oversight by its home country supervisor as determined by the
Commission in order not to attribute the guaranteed security-based swap
positions to the guarantor?
Are there FPSFIs that would fall within the definition of
major security-based swap participant based on the proposed rules and
interpretive guidance? If so, should the Commission
[[Page 31037]]
provide relief to such FPSFIs? If so, what type of relief, what types
of entities should be eligible for such relief, and what factors would
justify such relief? Would it be more appropriate for the Commission to
address these concerns on an individual basis?
Should the Commission adopt the proposed approach to the
application of certain customer protection requirements and segregation
requirements to foreign major security-based swap participants with
respect to their transactions with non-U.S. persons? If so, are there
other transaction-level requirements that should be included within
this proposed approach?
Should substituted compliance be provided to foreign major
security-based swap participants with respect to entity-level
requirements? Transaction-level requirements? If so, how should the
Commission make such a determination? In particular, what standard
should be used for determining whether existing regulation merits a
substituted compliance determination?
What would be the market impact of the proposed approach
to major security-based swap participants? How would the application of
the proposed approach affect the competitiveness of U.S. entities in
the global marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach to major
security-based swap participants? What would be the market impacts and
competitiveness effects of alternatives to the proposed approach
discussed in this release?
V. Security-Based Swap Clearing Agencies
A. Introduction
Title VII of the Dodd-Frank Act adds a number of provisions to the
Exchange Act relating to the registration and regulation of clearing
agencies that provide clearance and settlement services for security-
based swaps.\658\ Such provisions augment the Commission's existing
authority to register and regulate clearing agencies in Section 17A of
the Exchange Act.\659\ In particular, Section 17A(g) of the Exchange
Act, as added by Section 763(b) of the Dodd-Frank Act, requires
clearing agencies that use interstate commerce to perform the functions
of a clearing agency with respect to security-based swaps to register
with the Commission.\660\ Section 17A(k) of the Exchange Act, as added
by Section 763(b) of the Dodd-Frank Act, provides the Commission with
authority to exempt a security-based swap clearing agency from
registration if the Commission determines that the clearing agency is
subject to comparable, comprehensive supervision and regulation by the
CFTC or the appropriate government authorities in the home country of
the clearing agency.\661\ The Dodd-Frank Act also added provisions to
Section 17A of the Exchange Act relating to voluntary clearing agency
registration and the establishment of clearing agency standards.\662\
Finally, Section 17A(j) requires the Commission to adopt rules
governing persons that are registered as clearing agencies for
security-based swaps.\663\
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\658\ See Section 763(b) of the Dodd-Frank Act.
\659\ See 15 U.S.C 78q-1 and 17 CFR 240.17Ab2-1.
\660\ 15 U.S.C. 78q-1(g). Note that Section 929W of the Dodd-
Frank Act added another subsection (g) to Section 17A of the
Exchange Act. The subsection (g) added by Section 763(b) of the
Dodd-Frank Act is the focus of the discussion in this section.
\661\ 15 U.S.C. 78q-1(k). The exemptive authority contained in
Section 17A(k) of the Exchange Act only pertains to clearing
agencies that would be required to register under Section 17A of the
Exchange Act for the clearing of security-based swaps. It does not
alter the Commission's existing exemptive authority found in Section
17A(b)(1) and Section 36 of the Exchange Act.
\662\ Section 17A(h) of the Exchange Act, as added by Section
763(b) of the Dodd-Frank Act, permits a person, in certain cases, to
voluntarily register as a clearing agency with the Commission. 15
U.S.C. 78q-1(h). Section 17A(i) of the Exchange Act, as added by
Section 763(b) of the Dodd-Frank Act, requires security-based swap
clearing agencies to comply with standards established by the
Commission. 15 U.S.C. 78q-1(i).
\663\ 15 U.S.C. 78q-1(j).
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Because of the global nature of the security-based swap market, the
Commission recognizes that there may be some uncertainty regarding when
a foreign security-based swap clearing agency \664\ that provides
central counterparty (``CCP'') services \665\ for security-based swaps
would be required to register with the Commission as a clearing agency.
Accordingly, we are proposing interpretive guidance regarding the
application of the registration requirement in Section 17A(g) of the
Exchange Act for security-based swap clearing agencies that act as
CCPs.\666\ We also address our exemptive authority under Section 17A(k)
to exempt a foreign security-based swap clearing agency from the
registration requirement in Section 17A(g).\667\ In addition, we
discuss the potential application of alternative standards to certain
foreign clearing agency registrants.
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\664\ In using the terms ``foreign'' and ``non-resident'' in
connection with a security-based swap clearing agency, the
Commission means a security-based swap clearing agency that is not a
U.S. person, as that term is defined in proposed Rule 3a71-3(a)(7)
under the Exchange Act, as discussed in Section III.B.5, supra. In
this regard, the Commission notes that legal persons that have their
principal place of business in the United States would be considered
``U.S. persons'' under the proposed definition regardless of their
place of incorporation or organization. See proposed Rule 3a71-
3(a)(7)(i)(B) under the Exchange Act.
\665\ As discussed more fully below, generally speaking, a CCP
is an entity that interposes itself between the counterparties to a
securities transaction. See 17 CFR 240.17Ad-22(a)(1).
\666\ In this section, the Commission is proposing interpretive
guidance only regarding the registration requirement in Section
17A(g) of the Exchange Act as it applies to clearing agencies that
provide CCP services. The Commission is not addressing the
registration requirement in Section 17A(b) of the Exchange Act,
which was unchanged by the Dodd-Frank Act. The Commission also is
not addressing the registration of clearing agencies that provide
other types of services for security-based swaps and other
securities. Elsewhere, the Commission has provided a temporary
exemption from the clearing agency registration requirements to
clearing agencies that provide non-CCP types of clearance and
settlement services for security-based swaps. See Order Pursuant to
Section 36 of the Securities Exchange Act of 1934 Granting Temporary
Exemptions from Clearing Agency Registration Requirements under
Section 17A(b) of the Exchange Act for Entities Providing Certain
Clearing Services for Security-Based Swaps, Exchange Act Release No.
64796 (July 1, 2011). Accordingly, the Commission expects to address
clearing agencies that provide non-CCP services in a future release.
\667\ The Commission also has adopted final rules to exempt
transactions by CCPs in security-based swaps from all provisions of
the Securities Act, other than the anti-fraud provisions in Section
17(a), as well as from Exchange Act registration requirements and
provisions of the Trust Indenture Act. See Exemptions for Security-
Based Swaps issued by Certain Clearing Agencies, Securities Act
Release No. 9308 (Mar. 30, 2012), 77 FR 20536 (Apr. 5, 2012). The
exemption is conditioned on the CCP being registered or exempt from
registration with the Commission, on the determination that the
security-based swap is required to be cleared or that the CCP is
permitted to clear it pursuant to its rules, that the security-based
swap is sold only to an ECP, and that certain information be made
available to a counterparty or to the public.
---------------------------------------------------------------------------
The proposed interpretation discussed below represents the
Commission's preliminary views regarding the application of the
registration requirement in Section 17A(g) for security-based swap
clearing agencies acting as CCPs in the cross-border context. Our
proposal reflects a balancing of the principles described above,
including, in particular, the goal of the Dodd-Frank Act to address the
risk to the U.S. financial system.\668\ We
[[Page 31038]]
recognize, however, that the proposed interpretation represents one of
a number of possible alternative approaches in applying Title VII in
the cross-border context. Accordingly, the Commission invites comment
regarding all aspects of the proposal discussed below, including
potential alternative approaches. Responses that are supported by data
and analysis provide great assistance to the Commission in considering
the practicality and effectiveness of the proposed application as well
as considering the benefits and costs of proposed requirements.
---------------------------------------------------------------------------
\668\ See Section II.C, supra. In addition, as noted above, to
promote effective and consistent global regulation of swaps and
security-based swaps, the Dodd-Frank Act requires the Commission and
the CFTC to consult and coordinate with foreign regulatory
authorities on the ``establishment of consistent international
standards'' with respect to the regulation of swaps and security-
based swaps. Public Law 111-203 section 752(a).
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B. Proposed Title VII Approach
1. Clearing Agency Registration
Section 17A(g) of the Exchange Act, entitled ``Registration
Requirement,'' provides that ``[i]t shall be unlawful for a clearing
agency, unless registered with the Commission, directly or indirectly
to make use of the mails or any means or instrumentality of interstate
commerce to perform the functions of a clearing agency with respect to
a security-based swap.'' \669\ The Commission preliminarily believes
that Title VII was intended to apply to clearing agencies that perform
clearing agency functions within the United States, regardless of their
principal place of business or their place of incorporation or
organization.\670\ For reasons discussed below, the proposed
interpretive guidance would provide that a security-based swap clearing
agency performs the functions of a CCP within the United States if it
has a U.S. person as a member.
---------------------------------------------------------------------------
\669\ 15 U.S.C. 78q-1(g).
\670\ See Section II.B, supra.
---------------------------------------------------------------------------
(a) Clearing Agencies Acting as CCPs
Clearing agencies are broadly defined under the Exchange Act and
undertake a variety of functions.\671\ One such function is to act as a
CCP,\672\ which is an entity that interposes itself between the
counterparties to a securities transaction. For example, when a
security-based swap contract between two counterparties that are
members of a CCP is executed and submitted for clearing, it is
typically replaced by two new contracts--separate contracts between the
CCP and each of the two original counterparties. At that point, the
original counterparties are no longer counterparties to each other.
Instead, each acquires the CCP as its counterparty, and the CCP assumes
the counterparty credit risk of each of the original counterparties
that are members of the CCP. Structured and operated appropriately,
CCPs may improve the management of counterparty risk and may provide
additional benefits such as multilateral netting of trades.\673\
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\671\ Section 3(a)(23)(A) of the Exchange defines the term
``clearing agency'' to mean any person who: (i) acts as an
intermediary in making payments or deliveries or both in connection
with transactions in securities; (ii) provides facilities for
comparison of data respecting the terms of settlement of securities
transactions, to reduce the number of settlements of securities
transactions, or for the allocation of securities settlement
responsibilities; (iii) acts as a custodian of securities in
connection with a system for the central handling of securities
whereby all securities of a particular class or series of any issuer
deposited within the system are treated as fungible and may be
transferred, loaned, or pledged by bookkeeping entry, without
physical delivery of securities certificates (such as a securities
depository); or (iv) otherwise permits or facilitates the settlement
of securities transactions or the hypothecation or lending of
securities without physical delivery of securities certificates
(such as a securities depository). 15 U.S.C. 78c(a)(23)(A).
\672\ See Clearing Agency Standards Adopting Release, 77 FR
66221 n.17 (``[a]n entity that acts as a CCP for securities
transactions is a clearing agency as defined in the Exchange Act and
is required to register with the Commission'').
\673\ See id.
---------------------------------------------------------------------------
Although technology and risk management practices frequently change
and vary from CCP to CCP, the following are some of the functions
performed by the subset of clearing agencies that are CCPs: \674\
---------------------------------------------------------------------------
\674\ The Commission does not believe that the opening and
maintenance of bank accounts or investment accounts in the United
States by a CCP that are not directly accessible by members of a
security-based swap clearing agency constitutes the performance of
functions of a CCP for these purposes. See, e.g., Exchange Act
Release No. 39643 (Feb. 11, 1998), 63 FR 8232, 8234 (Feb. 18, 1998)
(discussing a foreign unregistered clearing agency's use of a U.S.
depository, which did not in and of itself trigger the registration
requirement). In addition, the Commission does not believe that the
use of U.S.-based persons to perform services on behalf of a CCP in
the ordinary course of business that do not involve clearing agency
functions (e.g., financial guaranties, banking services, or payroll
operations) constitutes the performance of functions of a clearing
agency.
---------------------------------------------------------------------------
The extinguishing of a security-based swap contract
between two counterparties and the associated novation of it with two
new contracts between the CCP and each of the two original
counterparties;
The assumption of counterparty credit risk of members of
the CCP through the novated security-based swap contracts;
The calculation and collection of initial and variation
margin during the life of the security-based swap contract;
The determination of settlement obligations under a
security-based swap contract;
The determination of a default under a security-based swap
contract;
The collection of funds from members for contributions to
a clearing fund;
The implementation of a loss-sharing arrangement among
members to respond to a member insolvency or default; and
The multilateral netting of trades.\675\
---------------------------------------------------------------------------
\675\ See, e.g., CDS Clearing Exemption Orders, note 74, supra.
---------------------------------------------------------------------------
In performing these functions, CCPs help facilitate over-the-
counter trading, and trading on exchanges and other platforms, through
the assumption of counterparty risk by the CCP from the original
counterparties. During times of market stress, a CCP would mitigate the
potential for a market participant's failure to be transmitted to other
market participants, and would increase transparency of the risks borne
by its members, as well as confidence of the market participants in the
performance of their transactions.\676\
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\676\ See Report of the Senate Committee on Banking, Housing,
and Urban Affairs regarding The Restoring American Financial
Stability Act of 2010, S. Rep. No. 111-176 at 31 (stating that by
``mandating the use of central clearinghouses, institutions would
become much less interconnected, mitigating risk and increasing
transparency.''). At the same time, concentrating risk from several
counterparties into a CCP could actually introduce risks through the
prospect of moral hazard, such as if the costs of imprudent
decisions by one clearing member were shifted to other clearing
members or to the general public through bail-out of a CCP. See,
e.g., Craig Pirrong, ``Mutualization of Default Risk, Fungibility,
and Moral Hazard: The Economics of Default Risk Sharing in Cleared
and Bilateral Markets,'' University of Houston, Working Paper
(2010), available at: http://business.nd.edu/uploadedFiles/Academic_Centers/Study_of_Financial_Regulation/pdf_and_documents/clearing_moral_hazard_1.pdf. Such cost-shifting
mechanisms might induce members to take on more risk than they
otherwise would in a bilateral setting.
---------------------------------------------------------------------------
Furthermore, the agreements among members and between members and a
CCP play a key role in the CCP's performance of the functions of a
clearing agency. The Exchange Act permits clearing agencies to deny
membership if a person does not meet a clearing agency's financial
responsibility, operational capacity, experience and competence
standards.\677\ In a scenario where risk is mutualized under loss-
sharing arrangements, the strength of the CCP hinges upon the strength
of its members. The legal arrangements between a CCP and its members
are of significant importance to the operational resilience of the CCP
itself.
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\677\ See, e.g., 15 U.S.C. 78q-1(b)(4); see also 17 CFR
240.17Ad-22(d)(2) (requiring registered clearing agencies to
establish, implement, maintain, and enforce written policies and
procedures reasonably designed to require participants to meet
certain operational capacity standards).
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[[Page 31039]]
(b) Proposed Interpretive Guidance
The Commission is proposing interpretive guidance that a security-
based swap clearing agency performing the functions of a CCP within the
United States would be required to register pursuant to Section 17A(g)
of the Exchange Act.\678\ In our preliminary view, a foreign security-
based swap clearing agency that provides CCP services, as described
above, to a member that is a U.S. person for security-based swaps would
be performing the functions of a CCP within the United States and,
therefore, would be required to register pursuant to Section 17A(g) of
the Exchange Act. The Commission preliminarily believes that such an
approach is consistent with the Dodd-Frank Act's goal of reducing
systemic risk in the U.S. financial system.\679\ Foreign security-based
swap clearing agencies that provide CCP services to U.S. members could
pose a risk to the United States due to the risk mutualization among
members of these clearing agencies.\680\ Further, the more complete
information about relationships between security-based swap market
participants that registration would provide to regulators and the
marketplace may help reduce the risk of crises.\681\ Accordingly, to
address the risk to the U.S. financial system posed by foreign
security-based swap clearing agencies with U.S. members, the Commission
preliminarily is proposing to require foreign security-based swap
clearing agencies that provide CCP services to U.S. members to register
pursuant to Section 17A(g) of the Exchange Act.
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\678\ 15 U.S.C. 78q-1.
\679\ See note 4, supra.
\680\ See, e.g., Clearing Agency Standards Adopting Release, 77
FR 66267 (stating that ``[a]ll clearing agencies that act as CCPs in
the United States collect contributions from their members to
guaranty funds or clearing funds for the mutualization of losses
under extreme but plausible market scenarios'').
\681\ See note 676, supra.
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The Commission anticipates, however, that some U.S. persons may
choose to clear transactions at a foreign security-based swap clearing
agency on an indirect basis through a correspondent clearing
arrangement with a non-U.S. member of the clearing agency.\682\ We
preliminarily do not believe that such a correspondent clearing
arrangement of a U.S. person with a non-U.S. person member alone would
cause the foreign security-based swap clearing agency to be required to
register with the Commission because the clearing agency's business is
conducted directly with its member firms, which in this example would
be located outside of the United States. Correspondent clearing
arrangements do not pose the same type of direct risk to the U.S.
financial system that foreign security-based swap clearing agencies
with U.S. members pose because customers, unlike clearing agency
members, do not take mutual responsibility for the obligations of the
clearing agency.\683\
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\682\ Traditionally, the Commission has required registration
(or an exemption from registration) as a clearing agency if a
foreign clearing agency provides services for U.S. securities
directly to U.S. persons. The Commission has not viewed
intermediated access by U.S. persons to a foreign clearing agency's
services (for example, through a foreign broker) as sufficiently
direct to trigger registration requirements. See Proposed Amendments
to Rule 15a-6, 73 FR 39198 (summarizing the Commission's position
taken in past exemptive orders).
\683\ As noted above, the interpretation proposed here applies
solely to the registration requirement in Section 17A(g) of the
Exchange Act with respect to clearing agencies that provide CCP
services for security-based swaps; it does not change the
Commission's interpretation of Section 17A(b) of the Exchange Act.
See note 666, supra.
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2. Exemption from Registration under Section 17A(k)
Section 17A(k) of the Exchange Act, as added by Section 763(b) of
the Dodd-Frank Act, provides that the Commission may grant a
conditional or unconditional exemption from clearing agency
registration for the clearing of security-based swaps if the Commission
determines that the clearing agency is subject to comparable,
comprehensive supervision and regulation by the CFTC or the appropriate
government authorities in the home country of the clearing agency.\684\
---------------------------------------------------------------------------
\684\ 15 U.S.C. 78q-1(k).
---------------------------------------------------------------------------
The Commission preliminarily believes that it may be appropriate to
consider an exemption as an alternative to registration in
circumstances where the clearing agency is subject to comparable,
comprehensive supervision and regulation by appropriate government
authorities in the home country of the clearing agency, and the nature
of the clearing agency's activities and performance of functions within
the United States suggest that registration is not necessary to achieve
the Commission's regulatory objectives. Exemptions that are carefully
targeted could help to improve clearing agency supervision overall by
allowing the Commission to devote resources most efficiently where U.S.
interests are more directly implicated, while reducing duplication of
efforts in areas where its interests are aligned with those of other
regulators. Section 17A(k) further provides that any such exemption may
be subject to appropriate conditions that may include, but are not
limited to, requiring the clearing agency to be available for
inspection by the Commission and to make available all information
requested by the Commission.\685\
---------------------------------------------------------------------------
\685\ Id.
---------------------------------------------------------------------------
The Commission is not at this point specifying how such
determinations might be made. The Commission notes that market
structure and clearing agency supervision and regulation vary in other
jurisdictions, and these variances in combination would affect the
Commission's ability to make a determination under Section 17A(k) of
the Exchange Act in a particular case, as well as the conditions that
would be applied to any exemption. In addition to these factors,
differences among individual clearing agencies on matters such as
organizational governance, rules for members, and risk management
procedures would inform individual exemption determinations.
3. Application of Alternative Standards to Certain Registrants
In addition, the Commission may consider, as an alternative to an
exemption from registration, proposing rules that are specific to
foreign-based CCPs that are registered with the Commission under
Section 17A(g). We believe that this approach is contemplated by
Section 17A(i) of the Exchange Act, which permits the Commission to
adopt rules for registered CCPs that clear security-based swaps and
conform our regulatory standards and supervisory practices to reflect
evolving United States and international standards.\686\ This approach
may be particularly appropriate where the Commission determines not to
grant a general exemption from registration under Section 17A(k) of the
Exchange Act, based on consideration of the factors described above,
but where consistency with some regulatory standards suggests that a
targeted regulatory approach may be warranted.
---------------------------------------------------------------------------
\686\ Specifically, Section 17A(i) of the Exchange Act, entitled
``Standards for Clearing Agencies Clearing Security-Based Swap
Transactions'': (i) Requires registered clearing agencies that clear
security-based swaps to comply with such standards that the
Commission may establish by rule; (ii) contemplates that the
Commission may conform such standards or its oversight practices to
reflect evolving United States and international standards; and
(iii) except where the Commission determines otherwise by rule or
regulation, confirms that a clearing agency shall have reasonable
discretion in establishing the manner in which it complies with any
such standards. 15 U.S.C. 78q-1(i).
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[[Page 31040]]
Request for comment
The Commission requests comment on all aspects of the proposed
interpretation, including the following:
Should performing the functions of a CCP for only one U.S.
person member of the CCP warrant requiring a foreign security-based
swap clearing agency to register with the Commission? If not, why not?
Further, are there other kinds of activities in the United States or
outside the United States that would warrant requiring a CCP to be
registered? If so, what are they?
To what extent might the proposed approach create
incentives for foreign CCPs to restrict access to U.S. person members?
Please explain.
Are there any other circumstances where a foreign
security-based swap CCP should be required to register with the
Commission? For example, is there a circumstance where a CCP that has
no U.S. members but clears security-based swaps with a U.S. security as
an underlying security should be required to register with the
Commission as a clearing agency? Similarly, is there a circumstance
where a CCP that has no U.S. members and does not conduct activities
within the United States but that clears security-based swaps for the
U.S. customers of its members should be required to register with the
Commission as a clearing agency? Would the provision of omnibus or
individual segregation of U.S. customer funds affect this analysis? Why
or why not? Should a security-based swap CCP that relies on a financial
guaranty of a U.S. person in allowing a non-U.S. person to become a
member be required to register with the Commission? If not, why not?
How will Commission registration of, exemption from
registration for, or promulgation of alternative standards applicable
to registered foreign security-based swap CCPs affect the central
clearing of security-based swaps? How would it affect the management of
counterparty credit risk? How would it affect systemic risk? What
impact would it have on the continued development of the global
security-based swap market?
What factors should the Commission consider in determining
whether a foreign security-based swap CCP is subject to comparable,
comprehensive supervision and regulation by appropriate government
authorities in the home country of the CCP? What level of similarity
should be required in order for a home country supervision and
regulatory framework to be considered comparable and comprehensive when
compared to that of the United States?
How should the Commission determine the home country of a
CCP for purposes of Section 17A(k) of the Exchange Act? Should it be
the country in which the CCP is incorporated or organized or the
country in which it conducts the principal amount of its clearance and
settlement activities?
What other facts and circumstances should the Commission
review in determining whether an exemption may be granted under
Exchange Act Section 17A(k)? What terms and conditions should be
required in connection with an exemption from registration? For
example, should the Commission consider whether a jurisdiction has
implemented any international standards, such as the CPSS-IOSCO
Principles for Financial Market Infrastructures in its regulatory
framework? \687\ In addition, should the existence of a cooperative
agreement with the home country be a factor?
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\687\ See CPSS-IOSCO, Principles for Financial Market
Infrastructures (Apr. 2012) (``FMI Principles''), available at:
http://www.bis.org/publ/cpss101a.pdf.
---------------------------------------------------------------------------
What would be the market impact of the proposed approach
to the registration of foreign CCPs? How would the application of the
proposed approach affect the competitiveness of U.S. entities in the
global marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach? What would be
the market impacts and competitiveness effects of alternatives to the
proposed approach discussed in this release?
VI. Security-Based Swap Data Repositories
A. Introduction
Under the Dodd-Frank Act, SDRs are intended to play a key role in
enhancing transparency in the security-based swap market by retaining
complete records of security-based swap transactions, maintaining the
integrity of those records, and providing effective access to those
records to relevant authorities and the public consistent with their
respective information needs.\688\ Title VII provides the Commission
with authority to adopt rules governing SDRs.\689\ Using this
authority, the Commission has proposed rules governing the SDR
registration process, duties, and core principles, including duties
related to data maintenance and access by relevant authorities and
those seeking to use the SDR's repository services.\690\
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\688\ See SDR Proposing Release, 75 FR 77307.
\689\ See Section 13(n)(9) of the Exchange Act, 15 U.S.C.
78m(n)(9), as added by Section 763(i) of the Dodd-Frank Act.
\690\ See SDR Proposing Release, 75 FR 77306.
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As noted above, the security-based swap market is global in scope
and transactions often involve counterparties in different
jurisdictions.\691\ The Commission recognizes that, as a result, there
may be uncertainty regarding the application of Section 13(n) of the
Exchange Act \692\ and the rules and regulations thereunder
(collectively, ``SDR Requirements'').\693\ In addition, the Commission
is concerned that an overly broad application of the SDR Requirements
may unnecessarily restrict global regulators' access to, and sharing
of, security-based swap data in various jurisdictions and present
difficulties in enhancing transparency in the global security-based
swap market.\694\ To address these concerns, and as explained more
fully below, the Commission is proposing to limit the application of
the SDR Requirements to certain persons that perform the functions of
an SDR, including proposing a new rule to provide non-U.S. persons
performing the functions of an SDR within the United States with
exemptive relief from the SDR Requirements. In addition, to facilitate
relevant authorities' access to security-based swap data collected and
maintained by Commission-registered SDRs, the Commission is proposing
interpretive guidance to specify how SDRs may comply with the
notification requirement set forth in Section 13(n)(5)(G) of the
Exchange Act \695\ and previously proposed Rule 13n-4(b)(9) thereunder.
The Commission also is specifying how the Commission proposes to
determine whether a relevant authority is appropriate for purposes of
receiving security-based swap data from an SDR. In addition, the
Commission is proposing a new rule to provide SDRs with exemptive
relief from the indemnification requirement
[[Page 31041]]
set forth in Section 13(n)(5)(H)(ii) of the Exchange Act \696\ and
previously proposed Rule 13n-4(b)(10) thereunder.
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\691\ See Section II.A, supra.
\692\ 15 U.S.C. 78m(n)(9), as added by Section 763(i) of the
Dodd-Frank Act.
\693\ See Section 13(n) of the Exchange Act, 15 U.S.C. 78m(n),
as added by Section 763(i) of the Dodd-Frank Act, and proposed Rules
13n-1 to 13n-11 under the Exchange Act.
\694\ Cf. Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter I
at 2 (suggesting that U.S. and EU regulators limit their
jurisdiction to the part of the security-based swap business that
they can most practically regulate, even if they have jurisdiction
over a broader range of that business).
\695\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\696\ 15 U.S.C. 78m(n)(5)(H)(ii), as added by Section 763(i) of
the Dodd-Frank Act.
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In formulating this proposal, the Commission has sought to balance
the policy considerations discussed above \697\ and the particular
concerns related to security-based swap reporting discussed below. The
Commission recognizes that other approaches may exist in achieving the
mandate of the Dodd-Frank Act, in whole or in part. Accordingly, the
Commission invites comment regarding all aspects of the proposal
described below, including potential alternative approaches. Data and
comment from market participants and other interested parties regarding
the likely effect of the Commission's proposed rules and interpretative
guidance as well as potential alternative approaches will be
particularly useful to the Commission in evaluating possible
modifications to the proposal.
---------------------------------------------------------------------------
\697\ See Section II.C, supra (discussing principles guiding the
Commission's proposed approach to applying Title VII in the cross-
border context).
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B. Application of the SDR Requirements in the Cross-Border Context
1. Introduction
Section 3(a)(75) of the Exchange Act defines a ``security-based
swap data repository'' to mean ``any person that collects and maintains
information or records with respect to transactions or positions in, or
the terms and conditions of, security-based swaps entered into by third
parties for the purpose of providing a centralized recordkeeping
facility for security-based swaps.'' \698\ Section 13(n)(1) of the
Exchange Act provides that ``[i]t shall be unlawful for any person,
unless registered with the Commission, directly or indirectly, to make
use of the mails or any means or instrumentality of interstate commerce
to perform the functions of a security-based swap data repository.''
\699\
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\698\ 15 U.S.C. 78c(a)(75), as added by Section 761(a) of the
Dodd-Frank Act.
\699\ 15 U.S.C. 78m(n)(1), as added by Section 763(i) of the
Dodd-Frank Act.
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Although the Commission has previously proposed a rule governing
the registration process for SDRs,\700\ which includes requirements for
``non-resident security-based swap data repositor[ies],'' \701\ the
Commission has not explicitly explained under what circumstances in the
cross-border context would a person performing the functions of an SDR
be required to register with the Commission pursuant to Section
13(n)(1) of the Exchange Act \702\ and previously proposed Rule 13n-1
thereunder, and to comply with the other SDR Requirements.\703\ As
discussed further below, the Commission is proposing interpretative
guidance to discuss such circumstances and a new rule to provide
exemptive relief from the SDR Requirements.
---------------------------------------------------------------------------
\700\ See proposed Rule 13n-1 under the Exchange Act.
\701\ See proposed Rule 13n-1(a)(2) under the Exchange Act,
which defines ``non-resident security-based swap data repository''
(hereinafter ``non-resident SDR'') as ``(i) [i]n the case of an
individual, one who resides in or has his principal place of
business in any place not in the United States; (ii) [i]n the case
of a corporation, one incorporated in or having its principal place
of business in any place not in the United States; or (iii) [i]n the
case of a partnership or other unincorporated organization or
association, one having its principal place of business in any place
not in the United States.'' Proposed Rule 13n-1(g) under the
Exchange Act would require any non-resident SDR applying for
registration with the Commission to certify and provide an opinion
of counsel that it can, as a matter of law, provide the Commission
with prompt access to its books and records and submit to onsite
inspection and examination by the Commission.
\702\ 15 U.S.C. 78m(n)(1), as added by Section 763(i) of the
Dodd-Frank Act.
\703\ In addition to the SDR Requirements, the Commission has
proposed, and is re-proposing in this release, Regulation SBSR,
which, if adopted as re-proposed, would impose certain obligations
on SDRs registered with the Commission. See Section VIII, infra. In
a separate proposal relating to implementation of Section 763(i) of
the Dodd-Frank Act (adding Exchange Act Section 13(n)(5)(E), 15
U.S.C. 78m(n)(5)(E)), the Commission has proposed rules that would
require SDRs registered with the Commission to collect data related
to monitoring the compliance and frequency of end-user clearing
exemption claims. See End-User Exception Proposing Release, 75 FR
79992. Because these proposed rules and regulations, on their face,
apply only to Commission-registered SDRs, the Commission
preliminarily believes that these requirements, if adopted as
proposed, would not apply to unregistered SDRs, including those that
avail themselves of the SDR Exemption, discussed below.
---------------------------------------------------------------------------
2. Comment Summary
The Commission received several comment letters concerning the
registration and regulation of SDRs in the cross-border context. As a
general matter, commenters suggested that the Commission should apply
principles of international comity.\704\
---------------------------------------------------------------------------
\704\ See DTCC Letter III at 3 (urging the Commission, in its
regulation of SDRs, to aim for regulatory comity); Davis Polk Letter
I at 7 (recommending that the Commission work with foreign
authorities to permit SDRs in all major jurisdictions to register
with the appropriate regulators in each jurisdiction); see also
Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter I at 2
(suggesting that the Commission consider international comity and
public policy goals of derivatives regulation to limit its
regulation of swap business); ISDA/SIFMA Letter I at 18 (``The
Commission should consult with foreign regulators before
establishing the extra-territorial scope of the rules promulgated
under Title VII.'').
---------------------------------------------------------------------------
In addition, two commenters expressed concerns about the potential
impact of duplicative registration requirements imposed on SDRs.\705\
Specifically, one of these commenters remarked that the Commission's
previously proposed rules governing SDRs ``would seem to force a non-
resident SDR to be subject to multiple regimes and to the jurisdiction
of several authorities'' and that the SDR Proposing Release made no
``reference to equivalency of regulatory regimes or cooperation with
the authorities of the country of establishment of the non-resident
SDRs.'' \706\ To address this concern, the commenter suggested that the
Commission adopt a regime under which foreign SDRs would be deemed to
comply with the SDR Requirements if the laws and regulations of the
relevant foreign jurisdiction were equivalent to those of the
Commission and an MOU has been entered into between the Commission and
the relevant foreign authority.\707\ The commenter noted that the
recommended ``regime would have the following advantages: (i)
facilitating cooperation among authorities from different
jurisdictions; (ii) ensuring the mutual recognition of [SDRs]; and
(iii) establishing convergent regulatory and supervisory regimes which
is necessary in a global market such as the OTC derivatives one.''
\708\
---------------------------------------------------------------------------
\705\ See Cleary Letter IV at 31; ESMA Letter.
\706\ ESMA Letter at 1.
\707\ See id. at 2.
\708\ Id.
---------------------------------------------------------------------------
Recognizing that some SDRs would function solely outside of the
United States and, therefore, would be regulated by an authority in
another jurisdiction, commenters suggested possible approaches to the
SDR registration regime. One commenter, for example, believed that ``a
non-U.S. SDR should not be subject to U.S. registration so long as it
collects and maintains information from outside the U.S., even if such
information is collected from non-U.S. swap dealer or [major security-
based swap participant] registrants.'' \709\ Another commenter
supported ``cross-registration'' of SDRs, whereby SDRs in all major
jurisdictions may register with the appropriate regulators in each
jurisdiction.\710\
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\709\ See Cleary Letter IV at 31.
\710\ Davis Polk Letter I at 7 (``Cross-registration of SDRs is
not only necessary given the global nature of the swaps market, it
also reduces duplicative data reporting. Cross-registration would
also facilitate the creation of uniform reporting rules and
procedures that would enable easy comparison of transaction data
from different jurisdictions.'').
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3. Proposed Approach
In light of the concerns raised by commenters and the policy
[[Page 31042]]
considerations discussed above,\711\ the Commission is proposing (i)
interpretive guidance regarding the application of the SDR Requirements
to U.S. persons that perform the functions of an SDR; and (ii)
interpretive guidance regarding the application of the SDR Requirements
to non-U.S. persons that perform the functions of an SDR within the
United States and a new rule providing exemptive relief from the SDR
Requirements for such non-U.S. persons, subject to a condition.
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\711\ See Section II.C, supra (discussing principles guiding the
Commission's proposed approach to applying Title VII in the cross-
border context).
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(a) U.S. Persons Performing SDR Functions Are Required to Register With
the Commission
Consistent with the approach taken elsewhere in this release,\712\
the Commission preliminarily believes that any U.S. person \713\ that
performs the functions of an SDR \714\ would be required to register
with the Commission pursuant to Section 13(n)(1) of the Exchange Act
\715\ and previously proposed Rule 13n-1 thereunder. The Commission
preliminarily believes that requiring U.S. persons that perform the
functions of an SDR to register with the Commission and comply with the
SDR Requirements, as well as other requirements applicable to SDRs
registered with the Commission,\716\ is necessary to achieve the policy
objectives of Title VII.\717\ Requiring U.S. persons that perform the
functions of an SDR to be operated in a manner consistent with the
Title VII regulatory framework and subject to the Commission's
oversight, would, among other things, help ensure that relevant
authorities are able to monitor the build-up and concentration of risk
exposure in the security-based swap market, reduce operational risk in
that market, and increase operational efficiency.\718\ As the
Commission noted in the SDR Proposing Release, SDRs themselves are
subject to certain operational risks that may impede the ability of
SDRs to meet these goals,\719\ and the Title VII regulatory framework
is intended to address these risks.
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\712\ See Section V.B, supra, and Section VII.B, infra.
\713\ Under this proposed interpretation, the term ``U.S.
person'' would have the same meaning as set forth in proposed Rule
3a71-3(a)(7) under the Exchange Act, as discussed in Section
III.B.5, supra. As a practical matter, the Commission preliminarily
believes that all non-resident SDRs would likely be non-U.S. persons
given the similar distinguishing factors in the definitions of
``non-resident security-based swap data repository'' and ``non-U.S.
person.''
\714\ Generally speaking, the Commission preliminarily believes
that the ``functions of a security-based swap data repository''
include, at a minimum, the core services or functions that are
embedded in the statutory definition of a ``security-based swap data
repository.'' See Section 3(a)(75) of the Exchange Act, 15 U.S.C.
78c(a)(75), as added by Section 761(a) of the Dodd-Frank Act
(defining ``security-based swap data repository'' to mean ``any
person that collects and maintains information or records with
respect to transactions or positions in, or the terms and conditions
of, security-based swaps entered into by third parties for the
purpose of providing a centralized recordkeeping facility for
security-based swaps'').
\715\ 15 U.S.C. 78m(n)(1), as added by Section 763(i) of the
Dodd-Frank Act.
\716\ See note 703, supra.
\717\ See Section II.C, supra (discussing principles guiding the
Commission's proposed approach to applying Title VII in the cross-
border context).
\718\ See SDR Proposing Release, 75 FR 77307 (``The enhanced
transparency provided by an SDR is important to help regulators and
others monitor the build-up and concentration of risk exposures in
the [security-based swap] market . . . . In addition, SDRs have the
potential to reduce operational risk and enhance operational
efficiency in the [security-based swap] market.'').
\719\ See id. (``The inability of an SDR to protect the accuracy
and integrity of the data that it maintains or the inability of an
SDR to make such data available to regulators, market participants,
and others in a timely manner could have a significant negative
impact on the [security-based swap] market. Failure to maintain
privacy of such data could lead to market abuse and subsequent loss
of liquidity.'').
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(b) Interpretive Guidance and Exemption for Non-U.S. Persons That
Perform the Functions of an SDR Within the United States
In the context of the cross-border reporting of security-based swap
data, the Commission recognizes that some uncertainty may arise
regarding when the SDR Requirements, and other requirements applicable
to SDRs registered with the Commission,\720\ apply to non-U.S. persons
that perform the functions of an SDR. The Commission preliminarily
believes that a non-U.S. person that performs the functions of an SDR
within the United States would be required to register with the
Commission, absent an exemption.\721\
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\720\ See note 703, supra.
\721\ See Section 13(n)(1) of the Exchange Act, 15 U.S.C.
78m(n)(1), as added by Section 763(i) of the Dodd-Frank Act
(requiring persons that, directly or indirectly, make use of the
mails or any means or instrumentality of interstate commerce to
perform the functions of an SDR, to register with the Commission).
The Commission recognizes that some non-U.S. persons that perform
the functions of an SDR may do so entirely outside the United States
and thus are not required to register with the Commission.
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In order to provide legal certainty to market participants and
address concerns raised by commenters, and consistent with the proposed
interpretive guidance discussed above, the Commission is proposing,
pursuant to our authority under Section 36 of the Exchange Act,\722\ an
exemption from the SDR Requirements for non-U.S. persons that perform
the functions of an SDR within the United States, subject to a
condition. Specifically, the Commission is proposing Rule 13n-12 (``SDR
Exemption''), which states as follows: ``A non-U.S. person \723\ that
performs the functions of a security-based swap data repository within
the United States shall be exempt from the registration and other
requirements set forth in Section 13(n) of the [Exchange] Act . . . and
the rules and regulations thereunder, provided that each regulator with
supervisory authority over such non-U.S. person has entered into a
supervisory and enforcement memorandum of understanding (`MOU') or
other arrangement with the Commission that addresses the
confidentiality of data collected and maintained by such non-U.S.
person, access by the Commission to such data, and any other matters
determined by the Commission.'' \724\
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\722\ Section 36 of the Exchange Act authorizes the Commission
to conditionally or unconditionally exempt any person, security, or
transaction, or any class or classes of persons, securities, or
transactions, from certain provisions of the Exchange Act or certain
rules or regulations thereunder, by rule, regulation, or order, to
the extent that such exemption is necessary or appropriate in the
public interest, and is consistent with the protection of investors.
15 U.S.C. 78mm.
\723\ Proposed Rule 13n-12(a)(1) under the Exchange Act defines
``non-U.S. person'' to mean any person that is not a U.S. person.
Proposed Rule 13n-12(a)(2) under the Exchange Act defines ``U.S.
person'' by cross-reference to the definition of ``U.S. person'' in
re-proposed Rule 3a71-3(a)(7) under the Exchange Act, as discussed
in Section III.B.5 above.
\724\ Proposed Rule 13n-12(b) under the Exchange Act.
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The Commission preliminarily believes that a non-U.S. person would
be performing ``the functions of a security-based swap data repository
within the United States'' if, for example, it enters into contracts,
such as user or technical agreements, with a U.S. person to enable the
U.S. person to report security-based swap data to such non-U.S. person.
As another example, a non-U.S. person would be performing ``the
functions of a security-based swap data repository within the United
States'' if it has operations in the United States, such as maintaining
security-based swap data on servers physically located in the United
States, even if its principal place of business is not in the United
States.\725\ Given the constant
[[Page 31043]]
innovation in the market and the fact-specific nature of the
determination, it is not possible to provide here a comprehensive
discussion of every activity that would constitute a non-U.S. person
performing ``the functions of a security-based swap data repository
within the United States.''
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\725\ The Commission notes that if a person performing the
functions of an SDR has operations in the United States to the
extent that such operations constitute a principal place of
business, then the person would fall within the proposed definition
of ``U.S. person.'' As proposed, the term ``U.S. person'' includes a
partnership, corporation, trust, or other legal person having its
principal place of business in the United States. See Section
III.B.5(b)ii, supra. As a result, under the interpretation proposed
in Section VI.B.3(a) above, such person would be required to
register as an SDR with the Commission.
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The Commission preliminarily believes that the SDR Exemption is
necessary or appropriate in the public interest, and consistent with
the protection of investors. Because the reporting requirements of
Title VII and re-proposed Regulation SBSR can be satisfied only if a
security-based swap transaction is reported to an SDR that is
registered with the Commission,\726\ the Commission preliminarily
believes that the primary reason for a person subject to the reporting
requirements of Title VII and re-proposed Regulation SBSR to report a
security-based swap transaction to an SDR that is not registered with
the Commission would likely be to satisfy reporting obligations that it
or its counterparty has under foreign law. Such person would still be
required to fulfill its reporting obligations under Title VII and re-
proposed Regulation SBSR by reporting its security-based swap
transaction to an SDR registered with the Commission, absent other
relief from the Commission,\727\ even if the transaction were also
reported to a non-U.S. person that relies on the SDR Exemption. The
Commission preliminarily believes that this proposed approach to the
SDR Requirements appropriately would balance the Commission's interest
in having access to security-based swap data involving U.S. persons,
while addressing commenters' concerns regarding the potential for
duplicative regulatory requirements \728\ as well as furthering the
goals of the Dodd-Frank Act.
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\726\ The Commission notes that a non-U.S. person that performs
the functions of an SDR may choose to register with the Commission
as an SDR to enable that person to accept data from persons that are
reporting a security-based swap pursuant to the reporting
requirements of Title VII and re-proposed Regulation SBSR. See 15
U.S.C. 78m(m)(1)(G) and 78m-1(a)(1), as added by Sections 763(i) and
766(a) of the Dodd-Frank Act and Section VIII, infra (discussing re-
proposed Regulation SBSR). The Commission may consider also
granting, pursuant to its authority under Section 36 of the Exchange
Act, 15 U.S.C. 78mm, exemptions to such non-U.S. person that
registers with the Commission from certain of the SDR Requirements
on a case-by-case basis. In determining whether to grant such an
exemption, the Commission may consider, among other things, whether
there are overlapping requirements in the Exchange Act and
applicable foreign law.
\727\ See discussion of Regulation SBSR in Section VIII, infra,
and discussion of substituted compliance in Section XI.D, infra.
\728\ See Section VI.B.2, supra (summarizing comment letters
concerning the registration of SDRs in the cross-border context).
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The SDR Exemption would be subject to the condition that each
regulator with supervisory authority over the non-U.S. person that
performs the functions of an SDR within the United States enters into a
supervisory and enforcement MOU or other arrangement with the
Commission, as specified in proposed Rule 13n-12(b) under the Exchange
Act. The Commission anticipates that in determining whether to enter
into such an MOU or other arrangement with a relevant authority, the
Commission would consider whether the relevant authority would keep
data collected and maintained by the non-U.S. person that performs the
functions of an SDR within the United States confidential \729\ and
whether the Commission would have access to data collected and
maintained by such non-U.S. person.\730\ The Commission anticipates
that it would consider other matters, including, for example, whether
the relevant authority agrees to provide the Commission with reciprocal
assistance in securities matters within the Commission's jurisdiction
and whether a supervisory and enforcement MOU or other arrangement
would be in the public interest.\731\ The Commission preliminarily
believes that, in lieu of requiring non-U.S. persons that perform the
functions of an SDR within the United States to register with the
Commission, the condition in the SDR Exemption is appropriate to
address the Commission's interest in having access to security-based
swap data involving U.S. persons and U.S. market participants that is
maintained by non-U.S. persons that perform the functions of an SDR
within the United States and protecting the confidentiality of such
security-based swap data involving U.S. persons and U.S. market
participants.
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\729\ The Commission contemplates that the relevant authority
would keep data collected and maintained by such non-U.S. person
confidential in a manner that is consistent with Section 24 of the
Exchange Act and Rule 24c-1 thereunder. See 15 U.S.C. 78x and 17 CFR
240.24c-1.
\730\ The Commission contemplates that the Commission's access
to data collected and maintained by such non-U.S. person would be in
a manner that is consistent with Section 13(n)(5)(D) of the Exchange
Act and previously proposed Rule 13n-4(b)(5) thereunder. See 15
U.S.C. 78m(n)(5)(D), as added by Section 763(i) of the Dodd-Frank
Act.
\731\ The Commission has previously entered numerous cooperative
agreements with foreign authorities. See Cooperative Arrangements
with Foreign Regulators, available at: http://www.sec.gov/about/offices/oia/oia_cooparrangements.shtml. Based on the Commission's
experience with negotiating MOUs and other agreements with foreign
authorities, the Commission believes that the MOU or agreement
described in proposed Rule 13n-12(b) could, in many cases, be
negotiated in a timely manner based on existing confidentiality and
information sharing agreements so that the exemptive relief provided
under proposed Rule 13n-12(b) would be available before the
registration of an SDR seeking to claim the exemption would be
required.
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Request for comment
The Commission requests comment on all aspects of the Commission's
proposed interpretive guidance and the SDR Exemption, including the
following:
Is the Commission's proposed interpretive guidance and the
SDR Exemption appropriate and sufficiently clear? Why or why not? Do
you agree with the Commission's proposed interpretive guidance and SDR
Exemption? Is it overly broad or narrow? If so, why? Is there a better
alternative?
Under the Commission's proposed interpretive guidance and
SDR Exemption, will SDRs be subject to duplicative regulatory
requirements? If so, will the Commission's proposed interpretive
guidance and SDR Exemption reduce the costs of compliance with
duplicative regulatory requirements? Why or why not?
How may the Commission's proposed interpretive guidance
and SDR Exemption affect the duplicative reporting of security-based
swap data? Would the Commission's ability to exercise oversight of our
registrants be compromised if it did not have the ability to learn and/
or obtain all security-based swap data from non-U.S. persons that
perform the functions of an SDR within the United States that have
chosen not to register with the Commission and that are not subject to
a substituted compliance order? Why or why not?
Are there any circumstances where a U.S. person performing
the functions of an SDR should not be required to register with the
Commission? If so, what are those circumstances?
Should the Commission require all non-U.S. persons that
perform the functions of an SDR within the United States to register
with the Commission? Why or why not?
Non-U.S. persons that perform the functions of an SDR
within the United States may rely on the SDR Exemption. Are there any
circumstances where non-U.S. persons that perform the functions of an
SDR within the United States should be required to register with the
Commission? If so, what are those circumstances? Do any of the
following facts and circumstances, either individually or in
combination, warrant requiring non-U.S. persons that perform
[[Page 31044]]
the functions of an SDR within the United States to register with the
Commission: maintaining security-based swap data pertaining to a U.S.
person or U.S. financial product; facilitating or supporting in the
United States the submission of security-based swap data by U.S.
persons; having any operations within the United States; entering into
contracts, such as user or technical agreements, in order to accept
security-based swap data from U.S. persons? If so, which one(s) and
why? If not, why not? What types of activities and SDR functions
performed within the United States do not warrant requiring a non-U.S.
person that performs the functions of an SDR within the United States
to be registered with the Commission? What if, for example, a non-U.S
person that performs the functions of an SDR within the United States
accepts only data from persons that are ``U.S. persons'' solely because
they are foreign branches of U.S. persons?
Does the proposed definition of ``U.S. person'' or ``non-
U.S. person'' in the SDR Exemption need to be clarified or modified? If
so, which terms and how should they be defined?
Do you agree with the proposed condition in the SDR
Exemption? Why or why not? Should the condition include additional
requirements? If so, what requirements would be appropriate? Are the
Commission's estimates of the time required to establish an MOU
reasonable? Why or why not? Should the condition apply only to certain
non-U.S. persons that perform the functions of an SDR within the United
States? Please explain. Should the condition apply if, for example, the
only connection to the United States by a non-U.S. person that performs
the functions of an SDR within the United States is that it maintains a
back-up server physically located in the United States? Should the
condition apply only to non-U.S. persons that perform the functions of
an SDR within the United States that collect security-based swap data
from a reporting side that includes at least one counterparty that is a
U.S. person?
Do you believe that most, if not all, non-U.S. persons
that perform the functions of an SDR within the United States will
maintain at least some security-based swap data involving U.S. persons
or U.S. market participants? Why or why not?
Is the Commission's reference in the SDR Exemption to a
``non-U.S. person that performs the functions of a security-based swap
data repository'' sufficiently clear? If not, what is a better
alternative? Should the Commission replace, for example, ``non-U.S.
person'' with ``non-resident security-based swap data repository,'' as
defined in previously proposed Rule 13n-1(a)(2) under the Exchange Act,
instead? Why or why not? Are there circumstances that would be covered
by using ``non-U.S. person that performs the functions of a security-
based swap data repository'' in the SDR Exemption rather than using
``non-resident security-based swap data repository that performs the
functions of a security-based swap data repository'' in the SDR
Exemption, and vice versa? If so, what circumstances and does it matter
for practical purposes?
Is the SDR Exemption's reference to ``within the United
States'' sufficiently clear? What are the implications of this
reference in the SDR Exemption?
Are there any other factors that the Commission should
consider in our interpretive guidance or the SDR Exemption, but that
are not addressed above? If so, please explain.
What would be the market impact of proposed approach to
the registration of SDRs? How would the application of proposed
approach affect the competitiveness of U.S. entities in the global
marketplace (both in the United States as well as in foreign
jurisdictions)? Would the proposed approach place any market
participants at a competitive disadvantage or advantage? If so, please
explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the proposed approach? What would be
the market impacts and competitiveness effects of alternatives to the
proposed approach discussed in this release?
C. Relevant Authorities' Access to Security-Based Swap Information and
the Indemnification Requirement
Section 13(n)(5)(G) of the Exchange Act \732\ and previously
proposed Rule 13n-4(b)(9) thereunder provide that an SDR shall on a
confidential basis, pursuant to Section 24 of the Exchange Act, and the
rules and regulations thereunder, upon request, and after notifying the
Commission of the request (``Notification Requirement''), make
available all data obtained by the SDR, including individual
counterparty trade and position data, to each appropriate prudential
regulator, the Financial Stability Oversight Council, the CFTC, the
Department of Justice, the Federal Deposit Insurance Corporation and
any other person that the Commission determines to be appropriate,
including, but not limited to, foreign financial supervisors (including
foreign futures authorities), foreign central banks, and foreign
ministries. Further, Section 13(n)(5)(H) of the Exchange Act \733\ and
previously proposed Rule 13n-4(b)(10) provide that before sharing
information with any entity described in Section 13(n)(5)(G) \734\ or
previously proposed Rule 13n-4(b)(9),\735\ respectively, an SDR must
obtain a written agreement from the entity stating that the entity
shall abide by the confidentiality requirements described in Section 24
of the Exchange Act,\736\ and the rules and regulations thereunder,
relating to the information on security-based swap transactions that is
provided; in addition, the entity shall agree to indemnify the SDR and
the Commission for any expenses arising from litigation relating to the
information provided under Section 24 of the Exchange Act \737\ and the
rules and regulations thereunder (``Indemnification Requirement'').
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\732\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\733\ 15 U.S.C. 78m(n)(5)(H), as added by Section 763(i) of the
Dodd-Frank Act.
\734\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\735\ Proposed Rules 13n-4(b)(9) and (10) essentially repeat the
requirements of Sections 13(n)(5)(G) and (H) of the Exchange Act,
respectively, with the exception of the addition in proposed Rule
13n-4(b)(9) of the Federal Deposit Insurance Corporation to the
relevant authorities specified in Section 13(n)(5)(G) of the
Exchange Act.
\736\ 15 U.S.C. 78x.
\737\ Id.
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The Commission believes that the goals of Sections 13(n)(5)(G) and
13(n)(5)(H) of the Exchange Act \738\ are, among other things, to
obligate SDRs to make available security-based swap information to
relevant authorities and maintain the confidentiality of such
information. More broadly, the goal of the Dodd-Frank Act is, among
other things, to promote the financial stability of the U.S. by
improving accountability and transparency in the financial system.\739\
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\738\ 15 U.S.C. 78m(n)(5)(G) and (H), as added by Section 763(i)
of the Dodd-Frank Act.
\739\ See note 4, supra.
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As discussed further below, the Commission recognizes that the
Indemnification Requirement raises a number of concerns, including,
among other things, the inability of certain relevant authorities to
provide, as a matter of law or practice, an open-ended indemnification
agreement and the possibility of security-based swap data being
fragmented among trade repositories globally if foreign authorities
establish trade repositories
[[Page 31045]]
in their jurisdictions to ensure access to data that they need to
perform their regulatory mandates and legal responsibilities.\740\
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\740\ See Section VI.C.3(c), infra.
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In this section, the Commission will first describe the
alternatives to the Notification Requirement and Indemnification
Requirement that were discussed in the SDR Proposing Release. The
Commission will then summarize the comments received, primarily in
response to the SDR Proposing Release. Finally, the Commission will
discuss our proposed interpretive guidance regarding relevant
authorities' access to security-based swap information and our proposed
exemptive relief from the Indemnification Requirement.
1. Information Sharing Under Sections 21 and 24 of the Exchange Act
In the SDR Proposing Release, the Commission highlighted two
alternative ways for relevant authorities to obtain data maintained by
SDRs directly from the Commission (rather than directly from SDRs)
without providing an indemnification agreement.\741\ Specifically, the
Commission noted that there is existing independent authority in the
Exchange Act for certain domestic and foreign authorities to obtain
data maintained by SDRs directly from the Commission (rather than
directly from SDRs) pursuant to Sections 21(a) and 24(c) of the
Exchange Act \742\ in certain circumstances and without application of
the Indemnification Requirement.\743\
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\741\ See SDR Proposing Release, 75 FR 77319.
\742\ 15 U.S.C. 78u(a) and 15 U.S.C. 78x(c).
\743\ Section 13(n)(5)(H) of the Exchange Act, 15 U.S.C.
78m(n)(5)(H), as added by Section 763(i) of the Dodd-Frank Act. See
SDR Proposing Release, 75 FR 77319. The Indemnification Requirement
does not apply to requests for information made pursuant to Sections
21(a) and 24(c) of the Exchange Act. Further, since relevant
authorities requesting information under these provisions would go
directly to the Commission, the Notification Requirement would also
be inapplicable. Thus, these requirements would not apply to
requests by relevant authorities for security-based swap data when
the Commission is exercising its independent statutory authority to
assist relevant authorities pursuant to Section 21(a) or 24(c) of
the Exchange Act.
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Section 21(a)(2) of the Exchange Act \744\ provides that the
Commission may provide assistance to a foreign securities authority.
The term ``foreign securities authority'' is broadly defined in Section
3(a)(50) of the Exchange Act \745\ to include ``any foreign government,
or any governmental body or regulatory organization empowered by a
foreign government to administer or enforce its laws as they relate to
securities matters.'' The Commission may provide assistance under
Section 21(a)(2) of the Exchange Act \746\ to the foreign securities
authority in connection with an investigation being conducted by the
foreign securities authority to determine whether any person has
violated, is violating, or is about to violate any laws or rules
relating to securities matters that the authority administers or
enforces. Section 21(a)(2) further provides that, as part of this
assistance, the Commission may conduct an investigation to collect
information and evidence pertinent to the foreign securities
authority's request for assistance.\747\ The Commission believes that
Section 21(a)(2) provides the Commission with independent authority to
assist foreign securities authorities in certain circumstances by, for
example, collecting security-based swap data from an SDR and providing
such authorities with the data.
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\744\ 15 U.S.C. 78u(a)(2).
\745\ 15 U.S.C. 78c(a)(50).
\746\ 15 U.S.C. 78u(a)(2).
\747\ Section 21(a)(2) of the Exchange Act requires that, in
considering whether to provide assistance to a foreign securities
authority, the Commission determine whether the requesting authority
has agreed to provide reciprocal assistance in securities matters to
the United States, and whether compliance with the request would
prejudice the public interest of the United States.
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Pursuant to Section 24(c) of the Exchange Act \748\ and Rule 24c-1
thereunder,\749\ the Commission may share nonpublic information \750\
in our possession with, among others, any ``federal, state, local, or
foreign government, or any political subdivision, authority, agency or
instrumentality of such government . . . [or] a foreign financial
regulatory authority.'' \751\ Because the Exchange Act provides the
Commission with the statutory authority to share information in our
possession with other authorities, the Commission is of the view that
if security-based swap transaction data is in our possession, then it
may share this information with other authorities. In this regard, the
Commission notes that the indemnification requirement set forth in
Section 13(n)(5)(H)(ii) of the Exchange Act \752\ does not apply to the
Commission, and would be inapplicable to the Commission's provision of
security-based swap data to relevant authorities pursuant to our
independent authority in Section 24(c) of the Exchange Act.\753\
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\748\ 15 U.S.C. 78x(c).
\749\ 17 CFR 240.24c-1.
\750\ Under Rule 24c-1 under the Exchange Act, the term
``nonpublic information'' means ``records, as defined in Section
24(a) of the [Exchange] Act, and other information in the
Commission's possession, which are not available for public
inspection and copying.'' 17 CFR 240.24c-1.
\751\ Section 3(a)(52) of the Exchange Act defines ``foreign
financial regulatory authority'' to mean ``any (A) foreign
securities authority, (B) other governmental body or foreign
equivalent of a self-regulatory organization empowered by a foreign
government to administer or enforce its laws relating to the
regulation of fiduciaries, trusts, commercial lending, insurance,
trading in contracts of sale of a commodity for future delivery, or
other instruments traded on or subject to the rules of a contract
market, board of trade, or foreign equivalent, or other financial
activities, or (C) membership organization a function of which is to
regulate participation of its members in activities listed above.''
15 U.S.C. 78c(a)(52).
\752\ 15 U.S.C. 78m(n)(5)(H)(ii).
\753\ 15 U.S.C. 78x(c).
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2. Comment Summary
Four commenters submitted comments relating to relevant
authorities' access to security-based swap information, three of which
were in response to the SDR Proposing Release and one of which was in
response to a joint public roundtable regarding the cross-border
application of Title VII held by the Commission and the CFTC on August
1, 2011.\754\ Commenters were generally supportive of relevant
authorities having access to security-based swap data maintained by
SDRs when such access is within the scope of the authorities' mandate,
but these commenters expressed particular concerns relating to the
Indemnification Requirement and relevant authorities' unfettered access
to security-based swap data.
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\754\ See Cleary Letter IV at 30-31; DTCC Letter I at 2 and III
at 22-23; ESMA Letter at 2; MFA Letter I at 3.
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As a general matter, one commenter stated that an SDR should be
able to provide: (i) Enforcement authorities with necessary trading
information; (ii) regulatory agencies with counterparty-specific
information about systemic risk based on trading activity; (iii)
aggregate trade information on market-wide activity and aggregate gross
and net open interest for publication; and (iv) real-time reporting
from SB SEFs and bilateral counterparties and related
dissemination.\755\ The same commenter supported relevant authorities'
access to reports from SDRs that are scheduled on a regular basis or
triggered by certain events, and believed that the Commission's
regulatory model regarding regulatory access should be ``location
agnostic, without preferential access for [a] prudential regulator,
except to perform its prudential duties.'' \756\ The commenter also
believed that ``it is important to preserve [the] spirit of cooperation
and coordination between regulators around the world'' in the context
of ensuring
[[Page 31046]]
global regulators' access to security-based swap data.\757\
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\755\ DTCC Letter IV at 5.
\756\ DTCC Letter III at 12.
\757\ Id. at 12 (discussing the spirit of cooperation and
coordination between regulators in the context of implementation of
guidance provided by the ODRF regarding global regulators' access to
security-based swap data maintained by a trade repository in the
United States).
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Two commenters concurred with the Commission's statements in the
SDR Proposing Release that relevant authorities will likely be unable
to agree to provide SDRs and the Commission with indemnification, as
required by Section 13(n)(5)(H)(ii) of the Exchange Act prior to
receiving security-based swap data maintained by SDRs.\758\ One of
these commenters described the Indemnification Requirement as
contravening the purpose of SDRs by diminishing transparency if
regulators are not allowed to have ready access to information and
thereby jeopardizing market stability.\759\ Specifically, the commenter
believed that the Indemnification Requirement should not apply where
relevant authorities are carrying out their regulatory
responsibilities, in accordance with international agreements and while
maintaining the confidentiality of data provided to them.\760\
Recognizing that the Indemnification Requirement is mandated by the
Dodd-Frank Act, however, the commenter suggested that in order to
ensure consistent application of the requirement and to ``minimize any
disruption to the global repository framework,'' the Commission should
provide model indemnification language for all SDRs to use.\761\
Further, the commenter believed that ``any indemnity should be limited
in scope to minimize the potential reduction in value of registered
SDRs to the regulatory community.'' \762\
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\758\ See DTCC Letter I at 3; Cleary Letter IV at 31; see also
SDR Proposing Release, 75 at 77318-19 (``With respect to the
indemnification provision, the Commission understands that
regulators may be legally prohibited or otherwise restricted from
agreeing to indemnify third parties, including SDRs as well as the
Commission. The indemnification provision could chill requests for
access to data obtained by SDRs, thereby hindering the ability of
others to fulfill their regulatory mandates and
responsibilities.'').
\759\ See DTCC Letter I at 3 (discussing how the Indemnification
Requirement would result in the reduction of information accessible
to regulators on a timely basis and would greatly diminish
regulators' ability to carry out oversight functions).
\760\ DTCC Letter III at 12.
\761\ Id.
\762\ Id.
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In discussing the Indemnification Requirement, another commenter
reiterated the notion that relevant authorities must ensure the
confidentiality of security-based swap data provided to them.\763\ The
commenter believed that the Indemnification Requirement ``undermines
the key principle of trust according to which exchange of information
[among relevant authorities] should occur.'' \764\ Thus, the commenter
recommended that the Commission's rules help streamline the
Indemnification Requirement for an ``efficient exchange of
information.'' \765\
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\763\ ESMA Letter at 2.
\764\ Id.
\765\ Id.
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One commenter voiced concerns about unfettered access to security-
based swap information by regulators, including foreign financial
supervisors, foreign central banks, and foreign ministries, beyond
their regulatory authority and mandate.\766\ This commenter was
concerned that the statutory language incorporated in previously
proposed Rule 13n-4(b)(9), which provides that in addition to the
entities specifically listed in the rule, an SDR could make available
data to ``any other person that the Commission determines to be
appropriate,'' is vague and could result in an SDR providing access to
persons without proper authority.\767\ The commenter suggested that the
Commission adopt an approach similar to the CFTC's proposed Rule
49.17(d),\768\ and that the Commission and the CFTC ``endeavor to adopt
similar procedures to control regulator requests for security-based
swap information.'' \769\
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\766\ MFA Letter I at 3.
\767\ Id. at 4.
\768\ As adopted, CFTC Rule 49.17(d) requires any ``Appropriate
Domestic Regulator'' or ``Appropriate Foreign Regulator'' requesting
access to swap data obtained and maintained by a swap data
repository to first file a request for access with the swap data
repository and certify the statutory authority for such request. The
swap data repository then must promptly notify the CFTC of such
request and the swap data repository subsequently would provide
access to the requested swap data. CFTC Rule 49.17(b)(1) defines
``Appropriate Domestic Regulator'' and CFTC Rule 49.17(b)(2)
provides that ``Appropriate Foreign Regulators'' are those that have
an existing memorandum of understanding with the CFTC or otherwise
as determined through an application process. See CFTC Final Rule,
Swap Data Repositories: Registration Standards, Duties and Core
Principles, 76 FR 54538 (Sept. 1, 2011) (``CFTC SDR Adopting
Release'').
\769\ MFA Letter I at 4.
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3. Proposed Guidance and Exemptive Relief
Consistent with the goals of the Dodd-Frank Act \770\ and the
purposes of SDRs,\771\ and after considering the comments received to
date, the Commission is proposing additional guidance regarding
relevant authorities' access to security-based swap information and
proposing exemptive relief from the Indemnification Requirement. For
the reasons discussed further below, the Commission preliminarily
believes that our proposed guidance and exemption from the
Indemnification Requirement is necessary or appropriate to, among other
things, further the goals of the Dodd-Frank Act and the purposes of
SDRs while preserving the confidentiality of the security-based swap
information maintained by SDRs, as necessary. The Commission also
preliminarily believes that our proposed guidance and exemption will,
as one commenter suggested, help provide for an ``efficient exchange of
information.'' \772\
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\770\ Dodd-Frank Act, Public Law 111-203 at Preamble (goals
include promoting ``the financial stability of the United States by
improving accountability and transparency in the financial
system'').
\771\ See SDR Proposing Release, 75 FR 77307 (stating that
``SDRs are intended to play a key role in enhancing transparency in
the [security-based swap] market by . . . providing effective access
to [security-based swap transaction] records to relevant
authorities. . . .'').
\772\ See ESMA Letter at 2.
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(a) Notification Requirement
Section 13(n)(5)(G) of the Exchange Act requires an SDR, upon
request, to ``make available all data obtained by the SDR, including
individual counterparty trade and position data,'' to certain specified
relevant authorities, as well as ``other persons that the Commission
determines to be appropriate.'' \773\ However, the SDR may make such
data available only ``after notifying the Commission of the request.''
\774\ The Commission preliminarily believes that an SDR can fulfill its
obligation to notify ``the Commission of the request'' under Section
13(n)(5)(G) of the Exchange Act \775\ and previously proposed Rule 13n-
4(b)(9) by notifying the Commission, upon the initial request for
security-based swap data by a relevant authority, of the request for
security-based swap data from the SDR, and maintaining records of the
initial request and all subsequent requests.\776\
[[Page 31047]]
The Commission would consider the notice provided and records
maintained as satisfying the Notification Requirement.\777\ The
Commission preliminarily believes that this approach is an efficient
way for an SDR to satisfy its statutory notification obligation.\778\
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\773\ Section 13(n)(5)(G) of the Exchange Act, 15 U.S.C.
78m(n)(5)(G), as added by Section 763(i) of the Dodd-Frank Act
(specifying each appropriate prudential regulator, the Financial
Stability Oversight Council, the CFTC, and the Department of
Justice); see also proposed Rule 13n-4(b)(9) under the Exchange Act
(adding the Federal Deposit Insurance Corporation).
\774\ Section 13(n)(5)(G) of the Exchange Act, 15 U.S.C.
78m(n)(5)(G), as added by Section 763(i) of the Dodd-Frank Act; see
also proposed Rule 13n-4(b)(9) under the Exchange Act.
\775\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\776\ Pursuant to previously proposed Rule 13n-7(b) under the
Exchange Act, the SDR would be required to maintain records of the
initial request and all subsequent requests, including details of
any on-line access by relevant authorities to security-based swap
data maintained by the SDR, by such relevant authority. See proposed
Rule 13n-7(b) under the Exchange Act (requiring, among other things,
keeping at least one copy of all documents required under the
Exchange Act and records made or received by the SDR in the course
of its business as such for not less than five years, and promptly
furnishing such documents to any representative of the Commission
upon request).
\777\ One commenter stated that ``regulators want direct
electronic access to data in SDRs where that data is needed to
fulfill regulatory responsibilities'' rather than access ``by
request, with notice to another regulatory authority.'' See DTCC
Letter III at 11-12. The Commission preliminarily believes that SDRs
can provide direct electronic access to relevant authorities under
its interpretation. In such a case, the SDR would have to provide
the Commission with actual notification upon the initial time that
the relevant authority accesses the SDR's security-based swap data,
and retain records of any electronic access by the relevant
authority.
\778\ As discussed in the SDR Proposing Release, an SDR must
keep its notifications to the Commission and requests by relevant
authorities confidential. See SDR Proposing Release, 75 FR 77318.
Failure by an SDR to treat such notifications and requests
confidential could render ineffective or could have adverse effects
on the underlying basis for the requests. See id. If, for example, a
regulatory use of the data is improperly disclosed, such disclosure
could possibly signal a pending investigation or enforcement action,
which could have detrimental effects. See id.
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(b) Determination of Appropriate Regulators
Section 13(n)(5)(G) of the Exchange Act requires an SDR, upon
request, to ``make available all data obtained by the [SDR], including
individual counterparty trade and position data,'' to certain specified
relevant authorities, as well as ``each appropriate prudential
regulator'' and ``other persons that the Commission determines to be
appropriate,'' including, but not limited to, foreign financial
supervisors (including foreign futures authorities), foreign central
banks, and foreign ministries.\779\ The Commission contemplates that a
relevant authority will be able to request that the Commission make a
determination that the relevant authority is appropriate for requesting
security-based swap data from an SDR. The Commission preliminarily
believes that it will make such a determination through the issuance of
a Commission order.
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\779\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act. See also proposed Rule 13n-4(b)(9) under the
Exchange Act.
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In making such a determination, the Commission expects that we
would consider a variety of factors, and our order may include, among
other things, conditions on determining that a relevant authority is
appropriate for purposes of receiving security-based swap data directly
from SDRs. The Commission preliminarily believes that such
determination will likely be conditioned on a supervisory and
enforcement MOU or other arrangement between the Commission and the
relevant authority.\780\ Given the necessity of maintaining the
confidentiality of the proprietary and highly sensitive data maintained
by an SDR, such an MOU or arrangement \781\ would be designed to
protect the confidentiality of the security-based swap data provided to
the relevant authority by an SDR.\782\ The Commission anticipates that
in determining whether to enter into such an MOU or other arrangement
with a relevant authority, the Commission may consider whether, among
other things, the relevant authority needs security-based swap
information from an SDR to fulfill its regulatory mandate or legal
responsibilities and the relevant authority agrees to protect the
confidentiality of the security-based swap information provided to it.
The Commission preliminarily believes that this MOU or arrangement
could also satisfy the condition in proposed Rule 13n-4(d)(3) for an
SDR to avail itself of the Indemnification Exemption, which is
discussed below.\783\
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\780\ Similarly, the CFTC requires ``appropriate foreign
regulator[s]'' to have an MOU or similar type of arrangement with
the CFTC or, as determined by the CFTC on a case-by-case basis. CFTC
Rule 49.17(b)(2), 17 CFR 49.17(b)(2).
\781\ This MOU or other arrangement is separate from the written
agreement under Section 13(n)(5)(H)(i) of the Exchange Act and
previously proposed Rule 13n-4(b)(10) thereunder, both of which
require the SDR to receive a written agreement from each relevant
authority pertaining to the confidentiality of the security-based
swap transaction information that is provided by the SDR. The MOU or
other arrangement is between the Commission and the relevant
authority, whereas the written agreement is between the SDR and the
relevant authority.
\782\ The CFTC requires certain foreign regulators ``to provide
sufficient facts and procedures to permit the [CFTC] to analyze
whether the [foreign regulator] employs appropriate confidentiality
procedures and to satisfy itself that the information will be
disclosed only as permitted by Section 8(e) of the [Commodity
Exchange Act].'' CFTC Rule 49.17(b)(2), 17 CFR 49.17(b)(2). The
Commission expects that the relevant authority will need to provide
to the Commission similar information before the Commission will
enter into the MOU or other arrangement.
\783\ See Section VI.C.3(c), infra.
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In addition, the Commission preliminarily believes that in making
the determination, it would be reasonable for the Commission to
consider whether the relevant authority has a legitimate need for
access to the security-based swaps maintained by an SDR in order to
help safeguard such information.\784\ Confirming that the relevant
authority has a legitimate need could reduce the risk of unauthorized
disclosure, misappropriation, or misuse of security-based swap data. In
this regard, the Commission would be furthering the objectives of the
Dodd-Frank Act, which created a number of protections for proprietary
and highly sensitive data, including ``individual counterparty trade
and position data,'' maintained by an SDR.\785\ The Commission,
therefore, preliminarily believes that a reasonable approach for our
determination of an appropriate authority is for the Commission to
consider the scope of the relevant authority's regulatory mandate and
legal responsibilities. The Commission preliminarily believes that our
consideration of these factors will further the Dodd-Frank Act's
objective to safeguard security-based swap data and should address a
commenter's concerns over unfettered access to such proprietary
data.\786\ The Commission also anticipates considering, among other
things, whether the relevant authority agrees to provide the Commission
with reciprocal assistance in securities matters within the
Commission's jurisdiction, and whether such a determination would be in
the public interest. The Commission may take into account any other
factors as the Commission determines are appropriate in making our
determination.
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\784\ See MFA Letter I at 3 (voicing concerns about unfettered
access to security-based swap information by regulators, including
foreign financial supervisors, foreign central banks, and foreign
ministries, beyond their regulatory authority and mandate).
\785\ See Section 13(n)(5)(G) of the Exchange Act, 15 U.S.C.
78m(n)(5)(G), as added by Section 763(i) of the Dodd-Frank Act
(directing SDRs to provide data, including individual counterparty
trade and position data, on a confidential basis only to
circumscribed list of authorities or other persons that the
Commission determines to be appropriate); Section 13(n)(5)(H)(i) of
the Exchange Act, 15 U.S.C. 78m(n)(5)(H)(i), as added by Section
763(i) of the Dodd-Frank Act (requiring that, prior to an SDR
sharing such information, the SDR must receive a written agreement
from each entity stating that the entity shall abide by certain
confidentiality requirements); and Section 13(n)(5)(F) of the
Exchange Act, 15 U.S.C. 78m(n)(5)(F), as added by Section 763(i) of
the Dodd-Frank Act (requiring SDRs to maintain the privacy of any
and all security-based swap transaction information that they
receive from a security-based swap dealer, counterparty, or any
other registered entity).
\786\ See MFA Letter I at 3.
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In addition, the Commission preliminarily believes that it is not
necessary to prescribe by rule--as one commenter suggested \787\--a
specific process such as the one proposed by the
[[Page 31048]]
CFTC \788\ that sets forth criteria for relevant authorities and the
SDR to use in order to facilitate relevant authorities' access to
security-based swap data maintained by the SDR. The Commission
preliminarily believes that our determination of an appropriate
authority, pursuant to the process described above, represents a
reasonable approach to provide appropriate access by relevant
authorities, while at the same time providing safeguards against access
by persons without proper authority.\789\ The Commission also
preliminarily believes that SDRs should have the flexibility to
consider whether to provide relevant authorities with access to
requested security-based swap data.\790\ The Commission preliminarily
believes that a specific rule that delineates a process governing
relevant authorities' access requests, as suggested by the commenter,
would limit the flexibility of SDRs in considering whether to provide
relevant authorities with access to requested security-based swap data.
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\787\ See MFA Letter I at 4 (suggesting that the Commission
adopt an approach similar to the CFTC's proposed Rule 49.17(d)).
\788\ See CFTC Notice of Proposed Rulemaking: Swap Data
Repositories, 75 FR 80898 (Dec. 23, 2010). The CFTC has since
adopted CFTC Rule 49.17(d), 17 CFR 49.17(d), which does not include
several of its proposed requirements, such as requiring relevant
authorities to detail the basis for their requests. See CFTC SDR
Adopting Release, 76 FR 54538.
\789\ See MFA Letter I at 4 (voicing concern that vague standard
could result in an SDR providing access to persons without proper
authority).
\790\ The Commission preliminarily believes that an SDR's
consideration of whether to provide relevant authorities with access
to requested security-based swap data is implicitly subsumed in an
SDR's statutory duty to maintain the privacy of security-based swap
information that it receives. See Section 13(n)(5)(F) of the
Exchange Act, 15 U.S.C. 78m(n)(5)(F), as added by Section 763(i) of
the Dodd-Frank Act; see also proposed Rule 13n-4(b)(8) under the
Exchange Act (requiring SDRs to maintain the privacy of any and all
security-based swap transaction information that the SDR receives
from a security-based swap dealer, counterparty, or certain
registered entity) and proposed Rule 13n-9 under the Exchange Act
(requiring an SDR to protect the privacy of security-based swap
transaction information that the SDR receives by, among other
things, establishing safeguards, policies, and procedures that are
reasonably designed to protect such information and that address,
without limitation, the SDR limiting access to confidential
information, material, nonpublic information, and intellectual
property).
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The Commission contemplates that, in our sole discretion, we would
determine whether to grant or deny a request for a determination that
the relevant authority is appropriate for purposes of requesting
security-based swap data from an SDR.\791\ In addition, the Commission
could revoke our determination at any time.\792\ For example, the
Commission may revoke a determination or request additional information
from a relevant authority to support continuation of the determination
if a relevant authority fails to keep confidential security-based swap
data provided to it by an SDR.
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\791\ The Commission may issue a determination order that is for
a limited time.
\792\ As a general matter, the Commission provides a list of
MOUs and other arrangements on its Web site, which is one way for an
SDR to monitor and determine whether a relevant authority has
entered into an applicable MOU or other arrangement. The MOUs and
other arrangements can be found at the following link: http://www.sec.gov/about/offices/oia/oia_cooparrangements.shtml.
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(c) Option for Exemptive Relief from the Indemnification Requirement
i. Impact of the Indemnification Requirement
As noted above, Section 13(n)(5)(G) of the Exchange Act \793\ and
previously proposed Rule 13n-4(b)(9) thereunder provide that an SDR
shall on a confidential basis, pursuant to Section 24 of the Exchange
Act, and the rules and regulations thereunder, upon request, and after
notifying the Commission of the request, make available all data
obtained by the SDR to each appropriate prudential regulator, the
Financial Stability Oversight Council, the CFTC, the Department of
Justice, the Federal Deposit Insurance Corporation and any other person
that the Commission determines to be appropriate. Section
13(n)(5)(H)(ii) of the Exchange Act requires that before an SDR shares
security-based swap information with a relevant authority requesting
such information from the SDR, the relevant authority must ``agree to
indemnify the security-based swap data repository and the Commission
for any expenses arising from litigation relating to the information
provided under section 24 [of the Exchange Act].'' \794\ Based on the
Commission's understanding that certain relevant authorities may be
unable to agree to indemnify any SDR and the Commission, the Commission
preliminarily believes that the Indemnification Requirement could
significantly frustrate the purpose of Section 13(n)(5)(G) of the
Exchange Act \795\ by preventing SDRs from making available security-
based swap information to relevant authorities.
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\793\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\794\ 15 U.S.C. 78m(n)(5)(H)(ii), as added by Section 763(i) of
the Dodd-Frank Act.
\795\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
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As stated in the SDR Proposing Release, ``under the Dodd-Frank Act,
SDRs are intended to play a key role in enhancing transparency in the
[security-based swap] market by retaining complete records of
[security-based swap] transactions, maintaining the integrity of those
records, and providing effective access to those records to relevant
authorities and the public in line with their respective information
needs.'' \796\ Commenters \797\ as well as relevant authorities,
however, have expressed concerns about how the Indemnification
Requirement would contravene the purposes of the Dodd-Frank Act, and
more specifically, the statutory purposes of SDRs.\798\ The Commission
preliminarily believes that the Indemnification Requirement should not
be applied rigidly so as to frustrate such purposes.
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\796\ SDR Proposing Release, 75 FR 77307.
\797\ See, e.g., Cleary Letter IV at 31 (``[T]he indemnification
requirement could be a significant impediment to effective
regulatory coordination, since non-US regulators may establish
parallel requirements for U.S. regulators to access swap data
reported in their jurisdictions.''); DTCC Letter I at 3 (discussing
how the Indemnification Requirement would result in the reduction of
information accessible to regulators on a timely basis and would
greatly diminish regulators' ability to carry out oversight
functions); ESMA Letter at 2 (noting that the Indemnification
Requirement ``undermines the key principle of trust according to
which exchange of information [among relevant authorities] should
occur'').
\798\ See, e.g., DTCC Letter IV at 5 (noting that SDRs should be
able to provide, among other things, enforcement authorities with
necessary trading information and regulatory agencies with certain
counterparty-specific information). As stated above, the Commission
believes that the goal of Sections 13(n)(5)(G) and 13(n)(5)(H) of
the Exchange Act is, among other things, to obligate SDRs to make
available security-based swap information to relevant authorities,
provided that the confidentiality of the information is preserved.
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Specifically, the Commission recognizes that certain domestic
authorities, including some of those expressly identified in Section
13(n)(5)(G) of the Exchange Act \799\ and the Commission, cannot, as a
matter of law, provide an open-ended indemnification agreement. For
example, the Antideficiency Act prohibits certain U.S. federal agencies
from obligating or expending federal funds in advance or in excess of
an appropriation, apportionment, or certain administrative subdivisions
of those funds (e.g., through an unlimited or unfunded
indemnification).\800\ Similarly, the Commission understands that
foreign authorities may also be prohibited under applicable foreign
laws from satisfying the Indemnification Requirement.\801\ As such, the
Commission agrees with three commenters' views that the Indemnification
Requirement could hinder the ability of relevant authorities
[[Page 31049]]
to fulfill their regulatory mandates and legal responsibilities.\802\
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\799\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
\800\ 31 U.S.C. 1341, 1517(a).
\801\ See Cleary Letter IV at 31; DTCC Letter I at 3; ESMA
Letter at 2.
\802\ See Cleary Letter IV at 31; DTCC Letter I at 3; ESMA
Letter at 2.
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Moreover, the Commission understands from foreign authorities that
their regulatory regimes will require them to have direct access to
data maintained by trade repositories, including SDRs registered with
the Commission, in order to fulfill their regulatory mandates and legal
responsibilities.\803\ Many foreign regulators \804\ and market
participants have indicated, however, that because foreign authorities
cannot, as a matter of law or practice, comply with the Indemnification
Requirement, the practical effect of having an open-ended
indemnification requirement may be the fragmentation of security-based
swap data across multiple SDRs, as foreign authorities establish trade
repositories in their jurisdictions to ensure access to data that they
need to perform their regulatory mandates and legal
responsibilities.\805\ Such fragmentation may lead to duplicative
reporting requirements in multiple jurisdictions, higher reporting
costs for market participants, and less transparency in the security-
based swap market.\806\ In light of these concerns, the Commission
preliminarily believes that an exemption from the Indemnification
Requirement may be necessary or appropriate, as a practical matter, to
minimize fragmentation of security-based swap data that could otherwise
be consolidated and reduce duplicative reporting requirements.\807\
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\803\ For example, in the case of Europe, under European Market
Infrastructure Regulation (``EMIR''), trade repositories established
in third countries that provide services to entities established in
the European Union must apply for recognition by ESMA, which
conditions its approval on, among other things, ``[European] Union
authorities, including ESMA, hav[ing] immediate and continuous
access'' to information in such trade repositories. Regulation No.
648/2012 of the European Parliament and of the Council of 4 July
2012 on OTC derivatives, central counterparties and trade
repositories, 2012 O.J. (L 201) 1, 49.
\804\ See CFTC and SEC, Joint Report on International Swap
Regulation (Jan. 31, 2012) (noting that the indemnification
provisions have ``caused concern among foreign regulators, some of
which have expressed unwillingness to register or recognize [a swap
data repository] unless [they are] able to have direct access to
necessary information'' and that foreign regulators ``are
considering the imposition of a similar requirement that would
restrict the CFTC's and SEC's access to information at [trade
repositories] abroad'').
\805\ See Section XV.H.2(b)iii, infra (discussing the potential
effects of fragmentation of security-based swap data among trade
repositories across multiple jurisdictions).
\806\ See, e.g., Cleary Letter IV at 31 (The Indemnification
Requirement ``could be a significant impediment to effective
regulatory coordination, since non-U.S. regulators may establish
parallel requirements for U.S. regulators to access swap data
reported in their jurisdictions'').
\807\ The Commission preliminarily believes that the
Indemnification Requirement does not apply when an SDR is registered
with the Commission and is also registered or licensed with a
foreign authority and that authority is obtaining security-based
swap information directly from the SDR pursuant to that foreign
authority's regulatory regime.
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ii. Proposed Rule 13n-4(d): Indemnification Exemption
The Commission is proposing, pursuant to our authority under
Section 36 of the Exchange Act,\808\ a tailored exemption from the
Indemnification Requirement. To avoid a result that could significantly
frustrate the purpose of Section 13(n)(5)(G) and the purpose of SDRs,
the Commission preliminarily believes that the Indemnification
Exemption is necessary or appropriate in the public interest, and is
consistent with the protection of investors,\809\ particularly given
that the exemption is narrowly tailored and could be applied in only
limited circumstances.
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\808\ 15 U.S.C. 78mm (providing the Commission with general
exemptive authority * * * ``to the extent that such exemption is
necessary or appropriate in the public interest, and is consistent
with the protection of investors'').
\809\ 15 U.S.C. 78mm.
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Specifically, the Commission is proposing Rule 13n-4(d)
(``Indemnification Exemption''), which states as follows: ``A
registered security-based swap data repository is not required to
comply with the indemnification requirement set forth in Section
13(n)(5)(H)(ii) of the [Exchange] Act and [Rule 13n-4(b)(9) thereunder]
with respect to disclosure of security-based swap information by the
security-based swap data repository if: (1) [a]n entity described in
[Rule 13n-4(b)(9)] requests security-based swap information from the
security-based swap data repository to fulfill a regulatory mandate
and/or legal responsibility of the entity; (2) [t]he request of such
entity pertains to a person or financial product subject to the
jurisdiction, supervision, or oversight of the entity; and (3) [s]uch
entity has entered into a supervisory and enforcement memorandum of
understanding or other arrangement with the Commission that addresses
the confidentiality of the security-based swap information provided and
any other matters as determined by the Commission.''
In proposing the Indemnification Exemption, the Commission is
mindful of the comments received. The Commission intends for the
Indemnification Exemption to--as one commenter suggested--``preserve
[the] spirit of cooperation and coordination between regulators around
the world'' in the context of ensuring global regulators' access to
security-based swap data.\810\ By identifying specific conditions that
are applicable to requests by any relevant authority, the Commission
also intends for the Indemnification Exemption to be--as one commenter
suggested--``location agnostic,'' \811\ whereby relevant authorities
are treated similarly regardless of whether they are domestic
authorities or foreign authorities.\812\ In addition, the
Indemnification Exemption is consistent with one commenter's suggestion
that the Commission should not apply the Indemnification Requirement
where relevant authorities are carrying out their regulatory
responsibilities, in accordance with international agreements and while
maintaining the confidentiality of data provided to them.\813\ In order
for an SDR to share security-based swap information with a relevant
authority without an indemnification agreement, the three proposed
conditions specified in the Indemnification Exemption, as discussed
further below, must be met.
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\810\ See DTCC Letter III at 12 (discussing implementation of
guidance provided by the ODRF regarding global regulators' access to
security-based swap data maintained by a trade repository in the
United States).
\811\ See DTCC Letter III at 12 (suggesting that the
Commission's regulatory model regarding regulatory access should be
``location agnostic'').
\812\ The Commission intends for the Indemnification Exemption
to provide relief for both foreign authorities and domestic
authorities that require access to security-based swap data
maintained by SDRs in order to fulfill a regulatory mandate or legal
responsibility. The Commission preliminarily believes that an SDR
may rely on the Indemnification Exemption in connection with
requests from relevant authorities, including SROs, registered
futures associations, and international financial institutions.
\813\ See DTCC Letter III at 12.
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First, the relevant authority's request for security-based swap
information from an SDR must be for the purpose of fulfilling the
relevant authority's regulatory mandate and/or legal responsibility.
The Commission preliminarily believes that this condition is aligned
with the Dodd-Frank Act's requirements to protect security-based swap
information, including proprietary and highly sensitive data,
maintained by an SDR from unauthorized disclosure, misappropriation, or
misuse of security-based swap information.\814\ In
[[Page 31050]]
particular, the Commission preliminarily believes that this condition
is consistent with an SDR's statutory duty to maintain the privacy of
security-based swap information that it receives.\815\ In complying
with its duty to maintain the privacy of security-based swap
information, an SDR would need to determine when it can or cannot
provide security-based swap information to others. The Commission
preliminarily believes that, for the limited purposes of satisfying the
Indemnification Exemption, it is appropriate for the SDR to include in
its consideration of whether to provide security-based swap information
to relevant authorities whether a relevant authority's specific request
for security-based swap information is indeed within its regulatory
mandate or legal responsibilities before the SDR provides the
information to the relevant authority.\816\ Finally, the Commission
notes that establishing such a condition in the Indemnification
Exemption is consistent with guidelines that one commenter indicated
that it followed on a voluntary basis in providing relevant authorities
with access to security-based swap information.\817\
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\814\ See Section 13(n)(5)(F) of the Exchange Act, 15 U.S.C.
78m(n)(5)(F), as added by Section 763(i) of the Dodd-Frank Act
(requiring SDRs to maintain the privacy of any and all security-
based swap transaction information that they receive from a
security-based swap dealer, counterparty, or any other registered
entity); Section 13(n)(5)(G) of the Exchange Act, 15 U.S.C.
78m(n)(5)(G), as added by Section 763(i) of the Dodd-Frank Act
(directing SDRs to provide data, including individual counterparty
trade and position data, on a confidential basis only to
circumscribed list of authorities or other persons that the
Commission determines to be appropriate); and Section 13(n)(5)(H)(i)
of the Exchange Act, 15 U.S.C. 78m(n)(5)(H)(i), as added by Section
763(i) of the Dodd-Frank Act (requiring that, prior to an SDR
sharing such information, the SDR must receive a written agreement
from each entity stating that the entity shall abide by certain
confidentiality requirements).
\815\ See Section 13(n)(5)(F) of the Exchange Act, 15 U.S.C.
78m(n)(5)(F), as added by Section 763(i) of the Dodd-Frank Act; see
also proposed Rule 13n-4(b)(8) under the Exchange Act (requiring
SDRs to maintain the privacy of any and all security-based swap
transaction information that the SDR receives from a security-based
swap dealer, counterparty, or certain registered entity) and
proposed Rule 13n-9 under the Exchange Act (requiring an SDR to
protect the privacy of security-based swap transaction information
that the SDR receives by, among other things, establishing
safeguards, policies, and procedures that are reasonably designed to
protect such information and that address, without limitation, the
SDR limiting access to confidential information, material, nonpublic
information, and intellectual property).
\816\ The Commission preliminarily believes that in complying
with an SDR's statutory privacy duty, the SDR has the flexibility to
consider whether to provide relevant authorities with access to
requested security-based swap data and will most likely decide that
it is reasonable to consider whether a relevant authority's request
for security-based swap information is within its regulatory mandate
or legal responsibilities before the SDR provides the information.
\817\ See DTCC Letter III at 12 (stating that it ``routinely
provides [swap] transaction data to U.S. regulators (and . . .
routinely provides data related to [swap] transactions in the U.S.
by U.S. persons on European underlyings to European regulators), as
contemplated by the ODRF'' guidelines that provide guidance on
relevant authorities' information needs and level of access to
data); see also DTCC Letter IV at 7-8.
---------------------------------------------------------------------------
Second, the relevant authority's request must pertain to a person
or financial product subject to that authority's jurisdiction,
supervision, or oversight. If, for instance, the relevant authority
requests information on a security-based swap that pertains to a
counterparty or underlier that is subject to the authority's
jurisdiction, supervision, or oversight, then this condition to the
Indemnification Exemption would be satisfied. The Commission
preliminarily believes that the person or financial product need not be
registered or licensed with the authority in order for this condition
to be satisfied. Similar to the first condition of the Indemnification
Exemption, the Commission preliminarily believes that this condition is
aligned with the Dodd-Frank Act's requirements to protect security-
based swap information, including proprietary and highly sensitive
data, maintained by an SDR from unauthorized disclosure,
misappropriation, or misuse of security-based swap information.\818\ In
particular, the Commission preliminarily believes that the second
condition is consistent with an SDR's statutory duty to maintain the
privacy of security-based swap information that it receives.\819\ In
complying with its duty to maintain the privacy of security-based swap
information, an SDR would need to determine when it can or cannot
provide security-based swap information to others. The Commission
preliminarily believes that, for the limited purposes of satisfying the
Indemnification Exemption, it is appropriate for the SDR to include in
its consideration of whether to provide security-based swap information
to relevant authorities whether a relevant authority's specific request
pertains to a person or financial product that is subject to the
authority's jurisdiction, supervision, or oversight. \820\ Finally, the
Commission notes that establishing such a condition in the
Indemnification Exemption is consistent with guidelines that one
commenter indicated that it followed on a voluntary basis in providing
relevant authorities with access to security-based swap
information.\821\
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\818\ See Sections 13(n)(5)(F), (G), and (H)(i) of the Exchange
Act, 15 U.S.C. 78m(n)(5)(F), (G), and (H)(i), as added by Section
763(i) of the Dodd-Frank Act.
\819\ See Section 13(n)(5)(F) of the Exchange Act, 15 U.S.C.
78m(n)(5)(F), as added by Section 763(i) of the Dodd-Frank Act; see
also proposed Rule 13n-4(b)(8) under the Exchange Act (requiring
SDRs to maintain the privacy of any and all security-based swap
transaction information that the SDR receives from a security-based
swap dealer, counterparty, or certain registered entity) and
proposed Rule 13n-9 under the Exchange Act (requiring an SDR to
protect the privacy of security-based swap transaction information
that the SDR receives by, among other things, establishing
safeguards, policies, and procedures that are reasonably designed to
protect such information and that address, without limitation, the
SDR limiting access to confidential information, material, nonpublic
information, and intellectual property).
\820\ The Commission preliminarily believes that in complying
with an SDR's statutory privacy duty, the SDR has the flexibility to
consider whether to provide relevant authorities with access to
requested security-based swap data and will most likely decide that
it is reasonable to consider whether a relevant authority's request
for security-based swap information pertains to a person or
financial product that is subject to the authority's jurisdiction,
supervision, or oversight before the SDR provides the information.
\821\ See DTCC Letter III at 12 (stating that it ``routinely
provides [swap] transaction data to U.S. regulators (and . . .
routinely provides data related to [swap] transactions in the U.S.
by U.S. persons on European underlyings to European regulators), as
contemplated by the ODRF'' guidelines that provide guidance on
relevant authorities' information needs and level of access to
data); see also DTCC Letter IV at 7-8.
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Third, the requesting relevant authority must enter into a
supervisory and enforcement MOU or other arrangement with the
Commission that addresses the confidentiality of the security-based
swap information provided and any other matters as determined by the
Commission.\822\ For those entities not expressly identified in Section
13(n)(5)(G) of the Exchange Act \823\ or the rules thereunder, such an
MOU or other arrangement can be entered into during the Commission's
determination process, as discussed in Section VI.C.3(b) above. On the
other hand, entities expressly identified in Section 13(n)(5)(G) of the
Exchange Act and the rules thereunder, which are not subject to the
Commission's process to determine appropriate regulators, would need to
enter into such an MOU or other arrangement to satisfy this condition
of the Indemnification Exemption. The Commission anticipates that in
determining whether to enter into such a supervisory and enforcement
MOU or other arrangement with a relevant authority, the Commission will
consider whether, among other things, the
[[Page 31051]]
relevant authority needs security-based swap information from an SDR to
fulfill its regulatory mandate or legal responsibilities; the relevant
authority agrees to protect the confidentiality of the security-based
swap information provided to it; the relevant authority agrees to
provide the Commission with reciprocal assistance in securities matters
within the Commission's jurisdiction; and a supervisory and enforcement
MOU or other arrangement would be in the public interest.
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\822\ As a general matter, the Commission provides a list of
MOUs and other arrangements on its Web site, which is one way for an
SDR to monitor and determine whether a relevant authority has
entered into an applicable MOU or other arrangement for purposes of
satisfying the third condition of the Indemnification Exemption. The
MOUs and other arrangements can be found at the following link:
http://www.sec.gov/about/offices/oia/oia_cooparrangements.shtml.
\823\ 15 U.S.C. 78m(n)(5)(G), as added by Section 763(i) of the
Dodd-Frank Act.
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The Commission preliminarily believes that the third condition in
the Indemnification Exemption is--as one commenter suggested--an
effective way to streamline the Indemnification Requirement for an
``efficient exchange of information.'' \824\ The Commission also
preliminarily believes that the third condition in the Indemnification
Exemption is appropriate to help protect the confidentiality of the
security-based swap data provided to relevant authorities, and also to
further the purposes of the Dodd-Frank Act. In this regard, the
Commission preliminarily believes that where a relevant authority
cannot agree to indemnification, a supervisory and enforcement MOU or
other arrangement, which a relevant authority can legally enter into,
may be a reasonable alternative because, similar to an indemnification
agreement, a supervisory and enforcement MOU or other arrangement would
serve as another mechanism to protect the confidentiality of security-
based swap data provided to a relevant authority by committing the
authority to maintain such confidentiality.\825\ In light of the
confidentiality agreement required under Section 13(n)(5)(H)(i) of the
Exchange Act and previously proposed Rule 13n-4(b)(10) \826\ as well as
the importance of maintaining good relations and trust among relevant
authorities, the Commission also preliminarily believes that a relevant
authority will have strong incentives to take reasonable measures and
precautions to comply with its obligation to protect the
confidentiality of the security-based swap information received from an
SDR. In lieu of providing an indemnification agreement, a supervisory
and enforcement MOU or other arrangement would provide an SDR and the
Commission with an additional layer of protection in maintaining the
confidentiality of security-based swap information shared by the
SDR.\827\
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\824\ See ESMA Letter at 2 (recommending an MOU between the
Commission and relevant authorities to address duplicative
regulatory regimes and facilitate cooperation among authorities from
different jurisdictions).
\825\ See 15 U.S.C. 8325(a), as added by Section 752 of the
Dodd-Frank Act (providing that the Commission and foreign regulators
``may agree to such information-sharing arrangements as may be
deemed to be necessary or appropriate in the public interest . . .
.'').
\826\ As stated above, the MOU or other arrangement is separate
from the written agreement under Section 13(n)(5)(H)(i) of the
Exchange Act and previously proposed Rule 13n-4(b)(9) thereunder
stating that the relevant authority shall abide by the
confidentiality requirements described in Section 24 of the Exchange
Act relating to the information on security-based swap transactions
that is provided by the SDR. The MOU or other arrangement is between
the Commission and the relevant authority, whereas the written
agreement is between the SDR and the relevant authority.
\827\ The Commission notes that the MOU or other arrangement
would not constitute a waiver on the part of the Commission or SDR
to pursue legal action against a relevant authority and liability,
if any, will be determined in accordance with applicable law. The
Commission also does not interpret the indemnification as extending
to an SDR's own wrongful acts.
---------------------------------------------------------------------------
For the reasons stated above, the Commission preliminarily believes
that the Indemnification Exemption is a reasonable alternative to the
Indemnification Requirement. The Commission recognizes, however, that a
supervisory and enforcement MOU or other arrangement would not
necessarily provide SDRs that invoke the exemption with the same level
of protection that an indemnification agreement would provide (i.e.,
coverage for any expenses arising from litigation relating to
information provided to a relevant authority) and thus, an SDR may
prefer the benefits of the Indemnification Requirement rather than rely
on the Indemnification Exemption. Therefore, under the Commission's
proposed exemption, an SDR would have the option to require an
indemnification agreement from a relevant authority should the SDR
choose to do so rather than rely on the Indemnification Exemption.
The Commission expects that where an SDR seeks to obtain an
indemnification agreement from a relevant authority, the SDR should
negotiate in good faith an indemnification agreement. In this regard,
the Commission agrees with one commenter's view that ``any indemnity
should be limited in scope'' \828\ and expects that an SDR will not
unreasonably hinder the ability of relevant authorities to obtain
security-based swap information from the SDR.\829\ Regarding the same
commenter's suggestion that the Commission provide model
indemnification language,\830\ the Commission does not believe that it
is appropriate to prescribe by rule specific language that an SDR would
be required to use when requesting indemnification from relevant
authorities. Because such language could vary on a case-by-case basis
depending on various factors, such as the laws applicable to the
relevant authority, the Commission preliminarily believes that it is
appropriate to allow for flexibility in negotiation of an
indemnification agreement.
---------------------------------------------------------------------------
\828\ See DTCC Letter III at 12.
\829\ For example, the Commission does not expect that an
indemnification agreement would include a provision requiring a
relevant authority to indemnify the SDR from the SDR's own wrongful
or negligent acts.
\830\ See DTCC Letter III at 12.
---------------------------------------------------------------------------
Request for comment
The Commission requests comment on all aspects of the proposed
guidance, interpretation, and the Indemnification Exemption, including
the following:
Is the Commission's proposed interpretation of the
Notification Requirement appropriate and sufficiently clear? Why or why
not? Is it overly broad or narrow? If so, why? Does the Commission's
proposed interpretation provide the Commission with sufficient
information to fulfill our responsibilities?
Should the Commission require SDRs to provide the
Commission with actual notice of all of requests for security-based
swap data by relevant authorities? Why or why not? If so, what should
such notice include? Why?
What would be the advantage of requiring SDRs to provide
actual notice to the Commission of requests for security-based swap
data by relevant authorities before making the data available to the
relevant authorities?
With regard to the Notification Requirement, should the
Commission adopt a rule that is consistent with the approach taken by
the CFTC in its Rule 49.17(d)(4), 17 CFR 49.17(d)(4), which requires a
swap data repository to promptly notify the CFTC regarding any request
received by an appropriate foreign or domestic regulator to gain access
to the swap data maintained by such swap data repository? Why or why
not?
Should the Commission provide an exemption from the
Notification Requirement similar to the Indemnification Exemption? Why
or why not? For example, should proposed Rule 13n-4(d) be revised to
begin with ``[a] registered security-based swap data repository is not
required to comply with the notification requirements set forth in
Section 13(n)(5)(G) of the Act and paragraph (b)(9) of this section and
the indemnification requirement set forth in Section 13(n)(5)(H)(ii) of
the Act and paragraph (b)(10) of this section . . .''? Why or why not?
[[Page 31052]]
Should the Commission propose a rule with regard to the
application of the Notification Requirement? Why or why not? If so,
what should the rule stipulate?
In determining whether a person is appropriate to obtain
security-based swap data from SDRs, should the Commission establish the
process set forth in this release for persons to request a Commission
determination? Why or why not? Should the Commission make such a
determination by order? Why or why not? Should the Commission delegate
this determination to the staff? Why or why not?
In determining whether a person is appropriate to obtain
security-based swap data from SDRs, should the Commission require a
supervisory and enforcement MOU or other arrangement? Why or why not?
If so, what matters should be addressed in the MOU or other
arrangement? What factors should the Commission take into consideration
when determining whether to enter into an MOU or other arrangement with
the person?
In determining whether a person is appropriate to obtain
security-based swap data from SDRs, does the Commission need to
understand the scope of a relevant authority's regulatory mandate or
legal responsibilities? Why or why not? What other factors should the
Commission take into account in making such a determination?
Should the Commission's process for determining whether a
person is appropriate to obtain security-based swap data from SDRs be
memorialized in a rule? If so, what should the rule stipulate?
Should the Commission require by rule or in our
determination orders that SDRs not provide relevant authorities with
access to security-based swap data beyond their regulatory mandates or
legal responsibilities? Why or why not? Should the Commission adopt a
process such as the one adopted by the CFTC in its Rule 49.17(d), 17
CFR 49.17(d), which requires certain regulators seeking to gain access
to the swap data maintained by a swap data repository to certify that
they are acting within the scope of their jurisdiction?
Are there any reasons why the Commission should determine
a person appropriate to obtain security-based swap data from one or
more SDRs, but not all SDRs? If so, what are they?
Should the Commission, when it determines that a person is
appropriate to obtain security-based swap data from SDRs, include
limitations on such determination? Why or why not? For example, should
the Commission limit the determination to a certain period of time or
to certain individual persons at a relevant authority?
Under what circumstances should the Commission be able to
revoke our determination order? Under what circumstances would it be
appropriate for the Commission to request a relevant authority to
provide additional information in order to maintain such a
determination?
Should the Commission provide additional clarification
with respect to how parties comply with the confidentiality
requirements in Section 24 of the Exchange Act? In what aspect would
clarification be helpful?
Is the Commission's proposed interpretation of the
Indemnification Requirement appropriate and sufficiently clear? Should
the Commission interpret the Indemnification Requirement more broadly
or narrowly? If so, explain.
Should the Commission interpret the Indemnification
Requirement to be limited to the liability that a relevant authority
otherwise would have to an SDR pursuant to the laws applicable to that
relevant authority, such as the Federal Tort Claims Act, which is
applicable to domestic authorities?
Is the Commission's Indemnification Exemption appropriate
and sufficiently clear? If not, what would be a better alternative?
Please also explain the costs and benefits of any alternative,
including how the alternative would be consistent with and further the
goals of Title VII.
Is the Indemnification Exemption overly broad or narrow?
If so, what would be a better alternative? Please also explain the
costs and benefits of any alternative, including how the alternative
would be consistent with and further the goals of Title VII.
Are there ways to narrowly tailor the Indemnification
Exemption further without hindering a relevant authority's ability to
obtain security-based swap data information from SDRs?
Should the SDRs have the option to require a relevant
authority to provide an indemnification agreement even if the three
conditions in the Indemnification Exemption can be satisfied? Why or
why not? Does providing SDRs with such an option raise any
competiveness concerns?
If the Commission were to modify the Indemnification
Exemption so that SDRs do not have the option to require an
indemnification agreement pursuant to Section 13(n)(5)(H)(ii) of the
Exchange Act even if the three conditions in the exemption are
satisfied, would this be appropriate and consistent with the
Indemnification Requirement?
What is the likelihood of an SDR not availing itself of
the Indemnification Exemption even if the three conditions are met? Are
there any measures that the Commission should take to address or
mitigate this scenario? Are there any restrictions that the Commission
should impose on an SDR that requires an indemnification agreement even
if it can avail itself of the Indemnification Exemption?
Should an SDR be required to make and keep records of its
decision to rely on the Indemnification Exemption?
Are the Indemnification Exemption and the Commission's
proposed interpretive guidance sufficient to address the possibility
that SDRs may be registered with ESMA and national regulators at the
European Union (``EU'') member state level will obtain security-based
swap information from ESMA? Are there any regulatory regime or
circumstances that the Commission should take into consideration that
is not addressed by the Indemnification Exemption or the Commission's
interpretive guidance? Please explain.
Will organizations such as FINRA and other self-regulatory
organizations, the National Futures Association, the IMF, and the
International Bank for Reconstruction and Development be able to meet
the three conditions of the Indemnification Exemption? Why or why not?
If not, should the Indemnification Exemption be modified to explicitly
exempt such organizations from the Indemnification Requirement? Why or
why not? If so, which organizations and why?
Does the Indemnification Exemption adequately address the
concerns of relevant authorities with respect to the Indemnification
Requirement? Are there any circumstances that would warrant an
exemption from the Indemnification Requirement, but that would not
satisfy all the conditions in the Indemnification Exemption? If so, how
could the Indemnification Exemption be modified and narrowly tailored
to capture such circumstances so as not to have the effect of
nullifying the Indemnification Requirement?
Is it appropriate to provide SDRs with the flexibility to
determine, on a case-by-case basis, whether a relevant authority that
is requesting security-based swap information is acting within the
scope of its regulatory mandate or legal responsibilities? Why or why
not?
Should the Commission impose any additional requirements
on SDRs to confirm that a relevant authority is requesting security-
based swap
[[Page 31053]]
information for the purpose of fulfilling its regulatory mandate or
legal responsibilities? For example, should the Commission prescribe,
as a condition in the Indemnification Exemption, that the SDR obtain a
written confirmation from the requesting relevant authority that it is
acting within its regulatory mandate or legal responsibilities?
Should the Commission impose any additional requirements
on SDRs to confirm that a relevant authority is requesting security-
based swap information that pertains to a person or financial product
subject to the jurisdiction, supervision, or oversight of the
authority? For example, should the Commission prescribe, as a condition
in the Indemnification Exemption, that the SDR obtain a written
confirmation from the requesting relevant authority that its request
pertains to a person or financial product subject to the jurisdiction,
supervision, or oversight of the authority?
Would an MOU between the Commission and a relevant
authority in lieu of an indemnification agreement provide protection of
security-based swap information shared with the relevant authority
comparable to that of an indemnification agreement? If not, why not?
Should the Commission specify in the Indemnification
Exemption any other matters that may be in a supervisory and
enforcement MOU or other arrangement? If so, what?
On January 25, 2012, the European Commission proposed
reforms to strengthen online privacy rights and to modernize the
principles set forth in the EU's 1995 Data Protection Directive (``EU
Directive'') to protect personal data. Will the EU Directive affect the
ability of SDRs to provide security-based swap data to other relevant
authorities, including the Commission? If so, please explain. Will the
EU Directive affect the ability of the EU and its member countries to
provide reciprocal assistance in securities matters, as contemplated by
the supervisory and enforcement MOU or other arrangement discussed
above? If so, please explain.
Should the Commission impose any additional conditions in
the Indemnification Exemption? If so, what? Are there any conditions in
the Indemnification Exemption that the Commission should not require?
If so, what conditions and why?
For the purpose of satisfying the Indemnification
Exemption, should an SDR be required to maintain policies and
procedures setting forth how to determine (i) whether security-based
swap information being requested is needed to fulfill a regulatory
mandate and/or legal responsibility of the requesting entity, (ii)
whether a relevant authority's requests pertain to a person or
financial product subject to the authority's jurisdiction, supervision,
or oversight, or (iii) whether the requesting relevant authority has
entered into a supervisory and enforcement MOU or other arrangement
with the Commission? To the extent such policies and procedures require
each requesting relevant authority to provide a written representation
with respect to one or more of the conditions in the Indemnification
Exemption, should such written representations be considered sufficient
to satisfy the relevant conditions in the Indemnification Exemption?
Are there better ways that the Commission could address
the Indemnification Requirement besides the Indemnification Exemption
that would be consistent with and further the goals of Title VII?
Please explain the costs and benefits of any alternative.
What is the likely impact of the Indemnification Exemption
on the security-based swap market? Would the Indemnification Exemption
potentially promote or impede the establishment of SDRs?
Is the Commission's proposed interpretation of how the
Indemnification Requirement applies to SDRs dually registered with the
Commission and a foreign regulator appropriate and sufficiently clear?
If not, why not? Should the Commission apply the Indemnification
Requirement when an SDR is registered with the Commission and is also
registered or licensed with a foreign authority and that foreign
authority is obtaining information from the SDR pursuant to its
regulatory regime? Why or why not? Should there be any additional
conditions in such instances? If so, what conditions and why?
Should the Commission provide guidance on what it means
for a ``person or financial product'' to be ``subject to [an]
authority's jurisdiction, supervision, or oversight''? Why or why not?
What would be the market impact of the proposed approach
to providing an exemption from the Indemnification Requirement? How
would the proposed application of the Indemnification Requirement,
including the proposed exemption, affect the competitiveness of U.S.
entities in the global marketplace (both in the United States as well
as in foreign jurisdictions)? Would the proposed approach place any
market participants at a competitive disadvantage or advantage? If so,
please explain. Would the proposed approach be a more general burden on
competition? If so, please explain. What other measures should the
Commission consider to implement the Indemnification Requirement? What
would be the market impacts and competitiveness effects of alternatives
to the proposed approach discussed in this release?
VII. Security-Based Swap Execution Facilities
A. Introduction
As discussed throughout this release, the market for security-based
swaps is global in scope, with transactions in security-based swaps
often involving counterparties in different jurisdictions. The
Commission recognizes that, as a result, there may be uncertainty
regarding the application of our proposed SB SEF registration
requirements for a security-based swap market whose principal place of
business is outside of the United States. The Commission believes,
therefore, that guidance and clarification on the application of our
proposed registration requirements would be useful with respect to
security-based swap markets operating in the cross-border context.
Under the Dodd-Frank Act, new Section 3D(a)(1) of the Exchange Act
provides that ``no person may operate a facility for the trading or
processing of security-based swaps, unless the facility is registered
as a security-based swap execution facility or as a national securities
exchange under this section.'' \831\ In our release proposing rules
governing SB SEFs,\832\ the Commission expressed the view that the
registration requirement of Section 3D(a)(1) would apply only to a
facility that meets the definition of ``security-based swap execution
facility'' in Section 3(a)(77) of the Exchange Act.\833\ The SB SEF
Proposing Release, however, did not explicitly address the
circumstances under which a foreign \834\
[[Page 31054]]
security-based swap market would be required to register with the
Commission under Section 3D of the Exchange Act.\835\ As discussed
below, the Commission herein proposes to interpret when the
registration requirements of Section 3D of the Exchange Act would apply
to a foreign security-based swap market.\836\ The Commission also
discusses below the circumstances under which it may consider granting
an exemption from registration for a foreign security-based swap
market.
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\831\ 15 U.S.C. 78c-4(a)(1).
\832\ See SB SEF Proposing Release, 76 FR 10948. The proposed
rules governing SB SEFs are contained in proposed Regulation SB SEF.
\833\ See SB SEF Proposing Release, 76 FR 10949 n.10. Section
3(a)(77) of the Exchange Act defines ``security-based swap execution
facility'' to mean ``a trading system or platform in which multiple
participants have the ability to execute or trade security-based
swaps by accepting bids and offers made by multiple participants in
the facility or system, through any means of interstate commerce,
including any trading facility, that (A) facilitates the execution
of security-based swaps between persons and (B) is not a national
securities exchange.'' 15 U.S.C. 78c(a)(77).
\834\ In using the terms ``foreign'' and ``non-resident'' in
connection with a security-based swap market, the Commission intends
that these terms refer to a security-based swap market that is not a
U.S. person.
\835\ In the SB SEF Proposing Release, the Commission
contemplated that non-resident persons may apply for registration as
a SB SEF. In this regard, the Commission proposed Rule 801(f) of
Regulation SB SEF, which would require any non-resident person
applying for registration as a SB SEF to certify and provide an
opinion of counsel that it can, as a matter of law, provide the
Commission with prompt access to its books and records and submit to
onsite inspection and examination by representatives of the
Commission. See SB SEF Proposing Release, 76 FR 11001.
\836\ Entities that do not meet the definition of SB SEF may
nonetheless be required to register in another capacity under the
Exchange Act.
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The proposed interpretations described below represent the
Commission's proposed approach to applying the SB SEF registration
requirements to foreign security-based swap markets. We recognize that
other approaches may achieve the goals of the Dodd-Frank Act, in whole
or in part. Accordingly, we invite comment regarding all aspects of the
proposal described below, and each proposed interpretation contained
therein, including potential alternative approaches. Data and comment
from market participants and other interested parties regarding the
likely effect of each proposed interpretation and potential alternative
approaches would be particularly useful to the Commission in evaluating
modifications to the proposals.
B. Registration of Foreign Security-Based Swap Markets
As noted above, in our SB SEF Proposing Release, the Commission
expressed the view that the registration requirement of Section
3D(a)(1) would apply only to a facility that meets the definition of
``security-based swap execution facility'' in Section 3(a)(77) of the
Exchange Act.\837\ A ``security-based swap execution facility'' is
defined as ``a trading system or platform in which multiple
participants have the ability to execute or trade security-based swaps
by accepting bids and offers made by multiple participants in the
facility or system, through any means of interstate commerce, including
any trading facility, that (A) facilitates the execution of security-
based swaps between persons and (B) is not a national securities
exchange.'' \838\
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\837\ See note 833 and accompanying text, supra.
\838\ 15 U.S.C. 78c(a)(77).
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As outlined further below, the Commission preliminarily believes
that, when evaluating whether a foreign security-based swap market
would have to register under Section 3D(a)(1), activities by the
foreign security-based swap market that provide U.S. persons, or non-
U.S. persons located in the United States, the ability to directly
execute or trade security-based swaps on the foreign security-based
swap market or facilitate the execution or trading of security-based
swaps by U.S. persons, or non-U.S. persons located in the United
States, on the foreign security-based swap market should be
considered.\839\ The Commission also preliminarily believes that, if a
foreign security-based swap market takes affirmative actions to induce
the execution or trading of security-based swaps on its market by U.S.
persons, or non-U.S. persons located in the United States, including by
inducing such execution or trading through marketing its services
relating to the ability to execute or trade security-based swaps on its
market to U.S. persons, or non-U.S. persons located in the United
States, or otherwise initiating contact with such persons for the
purpose of inducing such execution or trading, then those activities
could be viewed as facilitating the execution or trading of security-
based swaps on its market and could cause the foreign security-based
swap market to fall within the scope of the registration requirements
of Section 3D of the Exchange Act.
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\839\ See id. Non-U.S. persons located in the United States
could include, for example, U.S. branches of foreign entities.
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The Commission believes that it would be useful to provide some
discussion of the types of activities that it preliminarily believes
would place a foreign security-based swap market within the scope of
Section 3D of the Exchange Act under the Commission's proposed
interpretation. Given the constant innovation of trading mechanisms and
methods, as well as technological and communication developments,
however, it would not be possible to provide a comprehensive, final
discussion of every activity for which a foreign security-based swap
market would be considered to be providing U.S. persons or non-U.S.
persons located in the United States the ability to execute or trade
security-based swaps, or to be facilitating the execution or trading of
security-based swaps, on its market, thereby triggering the requirement
to register as a SB SEF under Section 3D(a)(1).
The Commission preliminarily believes that when a foreign security-
based swap market provides U.S. persons, or non-U.S. persons located in
the United States, with the direct ability to trade or execute
security-based swaps on the foreign security-based swap market by
accepting bids and offers made by one or more participants on the
foreign security-based swap market, then such market would be required
to register as a SB SEF. The Commission notes that a foreign security-
based swap market could grant such direct access to U.S. persons, and
non-U.S. persons located in the United States, through a variety of
means, such as (i) providing proprietary electronic screens, market
terminals, monitors or other devices for trading security-based swaps
on its market; (ii) granting direct electronic access to the foreign
security-based swap market's trading system or network, including by
providing data feeds or codes for use with software operated through
the computer of a U.S. person, or non-U.S. person located in the United
States, or by allowing such persons to access the foreign security-
based swap market through third-party service vendors or public
networks (such as the Internet); or (iii) allowing its members or
participants to provide U.S. persons or non-U.S. persons located in the
United States with direct electronic access to trading in security-
based swaps on the foreign security-based swap market.
The Commission also preliminarily believes that, if a foreign
security-based swap market were to grant membership or participation in
the foreign security-based swap market to U.S. persons, or non-U.S.
persons located in the United States, which would provide such persons
with the ability to directly execute or trade security-based swaps by
accepting bids and offers made by one or more participants on the
foreign security-based swap market, then such market would be required
to register as a SB SEF.
Although the Commission preliminarily believes that the foregoing
activities are the types of activities that would warrant application
of the registration requirement of Section 3D, the Commission
emphasizes that these activities are not intended to be an exclusive or
exhaustive discussion of all the activities that could trigger the
registration requirements of Section 3D by a foreign security-based
swap market. In addition, as trading and
[[Page 31055]]
communication mechanisms and methods evolve, other activities that aim
at providing U.S. persons, or non-U.S. persons located in the United
States, the ability to directly execute or trade security-based swaps
by accepting bids and offers made by multiple participants on a foreign
security-based swap market, or that aim to facilitate the execution or
trading of security-based swaps by U.S. persons or non-U.S. persons
located in the United States on a trading platform or system operated
by a foreign security-based swap market, could cause a foreign
security-based swap market to fall within the ambit of the registration
requirements of Section 3D.\840\
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\840\ In the alternative, the foreign security-based swap market
could elect to apply for registration as a national securities
exchange. See 15 U.S.C. 78f.
---------------------------------------------------------------------------
The Commission anticipates that some U.S. persons or non-U.S.
persons located in the United States may choose to transact on a
foreign security-based swap market on an indirect basis through a non-
U.S. person that is not located in the United States and that is a
member or participant of a foreign security-based swap market. The
Commission preliminarily believes that, to the extent that the U.S.
person, or non-U.S. person located in the United States, initiates the
contact and the foreign security-based swap market does not attempt to
solicit such business, such a transaction would not on its own warrant
requiring the foreign security-based swap market to register under
Section 3D of the Exchange Act.\841\ However, as discussed above, to
the extent that a foreign security-based swap market initiates contacts
with U.S. persons or non-U.S. persons located in the United States to
induce or facilitate the execution or trading of security-based swaps
by such persons on its market, such activity would trigger the
requirement to register under Section 3D.\842\
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\841\ The U.S. person or non-U.S. person located in the United
States may, however, be required to register as a broker under
Section 15(a)(1) of the Exchange Act. See 15 U.S.C. 78o(a)(1).
\842\ For example, if a foreign security-based swap market were
to allow its members or participants to provide U.S. persons, or
non-U.S. persons located in the United States with direct electronic
access to trading in security-based swaps on the foreign security-
based swap market, this access would be considered direct access by
a U.S. person, or a non-U.S. person located in the United States
and, as noted above, would require the foreign security-based swap
market to register.
---------------------------------------------------------------------------
The Commission also anticipates that, given the global nature of
the security-based swap business, a foreign security-based swap market
could, at some point, seek to enter into a business combination with a
registered SB SEF. Under the Commission's proposed interpretation, such
business combination also could trigger the registration requirements
of Section 3D of the Exchange Act for the foreign security-based swap
market, depending on the nature and extent of integration of the
entities' operations and activities. In this regard, the Commission's
experience in recent years with national securities exchanges that have
engaged in cross-border combinations may be illustrative for these
purposes. Several national securities exchanges in recent years have
entered into transactions to combine under common ownership with
certain non-U.S. markets, such as NYSE Group, Inc.'s transaction with
Euronext N.V. to form NYSE Euronext in 2007; \843\ Eurex Frankfurt AG's
acquisition of the International Securities Exchange, LLC in 2007;
\844\ and The Nasdaq Stock Market, Inc.'s transaction with Borse Dubai
Limited to form NASDAQ OMX Group, Inc. in 2008.\845\ In each case, the
U.S. and the foreign markets, under their respective parent companies,
generally have continued to operate as separate legal entities,
maintained separate liquidity pools in their respective jurisdictions
without integrating trading interest among markets under common
ownership, and continued to be regulated subject to their own home
country's requirements. Similarly, a registered SB SEF and a foreign
security-based swap market could come under common ownership but
continue to be separate legal entities, maintain separate liquidity
pools for their security-based swap businesses without integrating
trading interest among affiliated markets, and be separately regulated
in their own home jurisdictions. However, if a registered SB SEF and
foreign security-based swap market were to integrate their security-
based swap trading facilities, for example, by the foreign security-
based swap market providing direct access to the SB SEF's participants,
or by the foreign security-based swap market and the registered SB SEF
integrating their liquidity pools,\846\ under the Commission's proposed
interpretation, such actions would trigger the registration
requirements of Section 3D of the Exchange Act for the foreign
security-based swap market because the market would then be operating a
facility for trading security-based swaps within the United States.
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\843\ See Exchange Act Release No. 55293 (Feb. 14, 2007), 72 FR
8033 (Feb. 22, 2007).
\844\ See Exchange Act Release No. 56955 (Dec. 13, 2007), 72 FR
71979 (Dec. 19, 2007).
\845\ See Exchange Act Release No. 57099 (Jan. 4, 2008), 73 FR
1901 (Jan. 10, 2008).
\846\ An integrated trading pool for security-based swaps would
indicate that there is a unitary market for the security-based
swaps. In such a scenario, persons with direct access to or
membership in the registered SB SEF effectively would have the same
direct access or membership privileges in the foreign security-based
swap market by virtue of their access to the integrated trading
pool, and thus would have the ability to directly execute or trade
security-based swaps on the foreign security-based swap market.
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C. Registration Exemption for Foreign Security-Based Swap Markets
The prior section discusses when a foreign security-based swap
market would be required to register as a SB SEF under Section 3D of
the Exchange Act. The Commission recognizes, however, that the
security-based swap market is global in nature and therefore one or
more foreign security-based swap markets may seek relief from the
Commission to allow some of the activities discussed above that would
trigger the SB SEF registration requirement to continue without the
foreign security-based swap market having to register as a SB SEF under
Section 3D of the Exchange Act.
Following the publication of the SB SEF Proposing Release, the
Commission received comments from the public expressing concerns about
the implications of the proposed rules and the requirements of Section
3D of the Exchange Act for foreign security-based swap markets and the
global markets for security-based swaps generally.\847\ Several
commenters urged the Commission to work with foreign regulators to
develop harmonized rules for the trading of security-based swaps.\848\
Some commenters believed that harmonization or flexibility with regard
to foreign security-based swap markets would help reduce the risk of
regulatory arbitrage.\849\ One commenter stated that such harmonization
would reduce the burdens of duplicative or conflicting requirements
that could be faced by security-based swap markets operating in
multiple jurisdictions.\850\
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\847\ See, e.g., Thomson Letter at 3-4, Blackrock Letter at 12-
13, Bloomberg Letter at 6-7, ISDA/SIFMA II Letter at 2, WMBAA Letter
at 10-11, Cleary Letter III at 4, and Cleary Letter IV at 5, 13.
\848\ See Thomson Letter, BlackRock Letter, ISDA/SIFMA Letter
II, and WMBAA Letter.
\849\ See Thomson Letter, Bloomberg Letter, and WMBAA Letter.
\850\ See Bloomberg Letter.
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Although a number of foreign jurisdictions are in the process of
developing standards for the regulation of security-based swaps and
security-based swap markets, at this time few foreign jurisdictions
have enacted legislation or adopted standards for the regulation of
security-based swap
[[Page 31056]]
markets.\851\ The Commission, however, is in discussions with its
foreign counterparts to explore steps toward harmonizing standards for
such regulation in the future.\852\ In the meantime, the Commission is
considering how best to address commenters' concerns about the risks of
regulatory arbitrage and duplicative regulatory burdens on security-
based swap markets that operate on a cross-border basis, in a manner
consistent with the requirements of the Dodd-Frank Act and the federal
securities laws generally.
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\851\ See FSB Progress Report April 2013 at 1 (``While progress
has been made in moving [OTC derivatives] markets towards
centralized infrastructure, less than half of the FSB member
jurisdictions currently have legislative and regulatory frameworks
in place to implement the G20 commitments and there remains
significant scope for increases in trade reporting, central clearing
and exchange and electronic platform trading in global OTC
derivatives markets.'').
\852\ See Section I.C, supra.
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The Commission preliminarily believes that it may be appropriate to
consider an exemption as an alternative approach to SB SEF registration
depending on the nature or scope of the foreign security-based swap
market's activities in, or the nature or scope of the contacts the
foreign security-based swap market has with, the United States.
Exemptions that are carefully tailored to achieve the objectives of
Section 3D could help to improve security-based swap market supervision
overall by allowing the Commission to focus our resources on areas
where it has a substantial interest, while reducing duplication of
efforts in areas where our interests are aligned with those of other
regulators.
The Commission could exempt from the registration requirements of
Section 3D a foreign security-based swap market that is subject to
comparable, comprehensive supervision and regulation under appropriate
governmental authorities in its home country.\853\ The availability of
such an exemption could serve to reduce any potential duplicative
regulatory burdens faced by security-based swap markets that operate on
a cross-border basis and that otherwise would be required to register
both in the United States and in a non-U.S. jurisdiction.
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\853\ Any such exemption would be issued by order pursuant to
the Commission's authority under Section 36 of the Exchange Act. 15
U.S.C. 78mm.
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Before the Commission would consider issuing an exemption from the
registration requirements of Section 3D for a particular foreign
security-based swap market, the Commission could consider whether the
foreign security-based swap market is subject to comparable,
comprehensive supervision and regulation by the appropriate
governmental authorities in its home country, as compared to the
supervision and regulation of SB SEFs under the Dodd-Frank Act and the
Commission's implementing regulations. This process could include a
review of the foreign jurisdiction's laws, rules, regulatory standards
and practices governing the foreign security-based swap market and
would entail consultation and cooperation with the foreign security-
based swap market's home country governmental authorities.
The Commission expects that any such registration exemption could
be subject to appropriate conditions that could include, but not be
limited to, requiring a foreign security-based swap market to certify
that it would provide the Commission with prompt access to its books
and records, including, for example, data relating to orders, quotes,
and transactions, as well as provide an opinion of counsel that, as a
matter of law, it is able to provide such access. The Commission also
could require, as a condition to receiving an exemption from
registration, that a foreign security-based swap market would appoint
an agent for service of process in the United States who is not an
employee or official of the Commission. These potential conditions
would be consistent with the proposed requirements for non-resident
registered SB SEFs \854\ and would allow the Commission to exercise, as
necessary or appropriate, supervisory oversight of a foreign security-
based swap market that receives an exemption from Section 3D's
registration requirements. The Commission also could require that,
before issuing an exemption from registration, the Commission and the
appropriate financial regulatory authority or authorities in the
foreign security-based swap market's home jurisdiction enter into a MOU
that addresses the oversight and supervision of that market.
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\854\ See SB SEF Proposing Release, 76 FR 11001, proposed Rule
801(f), and proposed Form SB SEF.
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In certain cases, the Commission also could require, as a condition
to granting such an exemption, that a foreign security-based swap
market meet some of the requirements applicable to registered SB SEFs.
Such a condition may be useful where the Commission is unable to make a
determination regarding the broader comparability of the home
jurisdiction's regulation and supervision, but where there is
comparability with respect to some of the requirements applicable to
registered SB SEFs and to a foreign security-based swap market (or
class of security-based swap markets) in its home country. Therefore,
the terms and conditions of any exemption that the Commission may grant
to a foreign security-based swap market (or class of security-based
swap markets) could depend on the degree to which the foreign
jurisdiction's laws, rules, regulatory standards, and practices
governing security-based swaps ``compare'' to those of the United
States.
In considering the above, the Commission may consider any
requirements of the home country that would conflict with the
requirements applicable to SB SEFs under the Dodd-Frank Act. For
example, Section 3D of the Exchange Act seeks to ensure fair and open
access to SB SEFs by requiring that a SB SEF establish and enforce
rules that include means to provide market participants with impartial
access to the market.\855\ The Commission also could consider whether a
home country regulator imposes a regulation or policy limiting fair and
open access to its security-based swap markets.
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\855\ 15 U.S.C. 78c-4(d)(2)(B).
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The Commission notes that security-based swap market structure and
security-based swap market supervision and regulation could vary in
other jurisdictions and could affect the Commission's ability to make a
comparability determination. In addition, such differences in
supervision and regulation would necessitate that each exemption
request be reviewed on a jurisdiction-by-jurisdiction basis by the
Commission. The conditions to any such exemption also would be based on
the differences in the market structure and supervisory regime in the
jurisdiction under consideration in comparison to U.S. oversight of SB
SEFs.
As noted above, few foreign jurisdictions have adopted a
comprehensive framework for the regulation of security-based swap
markets and the Commission has not yet adopted rules governing SB SEFs.
Thus, the Commission believes that it is premature to specify the
precise criteria that the Commission may use for our evaluation and
comparison of the regulatory and supervision programs for foreign
security-based swap markets, should the Commission choose to consider
exempting from registration as a SB SEF a foreign security-based swap
market that becomes subject to regulation in its home country at a
future date. Nonetheless, the Commission believes that it is useful now
to elicit comment from interested
[[Page 31057]]
persons regarding our proposed approach, should it choose to consider
providing such an exemption.
The Commission preliminarily believes that the proposed approach,
which may condition any exemption for a foreign security-based swap
market on the existence of comparable, comprehensive supervision and
regulation under the appropriate financial regulatory authority or
authorities in the foreign security-based swap market's home country,
should provide comparable regulatory oversight and supervision as that
afforded by the Commission's regulation and supervision of SB SEFs. The
standard of ``comparability'' discussed above should allow the
Commission sufficient flexibility to make exemption determinations
based on the similarity of the requirements and practices of the
foreign jurisdiction's regulatory program governing security-based
swaps. In this regard, the Commission preliminarily believes that the
comparability standard could extend not only to the written laws and
rules of the foreign jurisdiction, but also to the jurisdiction's
comprehensive supervision and regulation of its security-based swap
markets, including the jurisdiction's oversight of its markets and
enforcement of its laws and rules. The breadth of the proposed
comparability standard (i.e., to consider actual practices as well as
written laws and rules) could help ensure that the regulatory
protections provided in the foreign jurisdiction's security-based swap
markets are substantially realized by sufficiently vigorous supervision
and enforcement.
Finally, as discussed below,\856\ the Commission proposes to permit
substituted compliance, under certain circumstances, with respect to
the mandatory trade execution requirement in Section 3C(h)(1) of the
Exchange Act, if the Commission finds that a foreign-based security-
based swap market (or class of security-based swap markets) is subject
to comparable, comprehensive supervision and regulation by a foreign
financial regulatory authority in such foreign jurisdiction.\857\ While
the proposed comparability standard for our granting an exemption from
SB SEF registration could be similar to the proposed comparability
standard for a substituted compliance determination with respect to the
mandatory trade execution requirement, which is discussed below, the
factors that the Commission could find relevant to a comparability
determination with respect to SB SEF registration would not necessarily
be the same factors that it would consider when making a comparability
determination with respect to mandatory trade execution. This is
because Section 3D of the Exchange Act is focused on the registration
of SB SEFs and compliance by registered SB SEFs with the 14 enumerated
core principles governing SB SEFs,\858\ whereas Section 3C(h)(1) of the
Exchange Act is focused on the circumstances where execution of a
security-based swap on a SB SEF (or an exchange) is required.\859\
However, the Commission solicits comment on the appropriateness or
feasibility of our proposed approach.
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\856\ See Section XI.F, infra.
\857\ See proposed Rule 3Ch-2 under the Exchange Act.
\858\ See 15 U.S.C. 78c-4.
\859\ See 15 U.S.C. 78c-3(h)(1).
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Request for Comment
The Commission generally requests comment on the discussion
regarding SB SEFs, including the following:
The Commission requests comment on all aspects of our
discussion regarding when a foreign security-based swap market would be
required to register as a SB SEF under Section 3D and on the non-
exhaustive discussion of the types of activities, noted above, that
would trigger registration of the foreign security-based swap market as
a SB SEF. The Commission also requests comment on all aspects of our
proposal to consider requests for an exemption from SB SEF registration
for a foreign security-based swap market under certain circumstances.
The Commission seeks commenters' views on the potential
impact of applying the proposed SB SEF registration requirements to
foreign security-based swap markets that engage in activities that
would require such markets to register as a SB SEF. Are there aspects
of the proposed SB SEF rules and registration requirements that present
issues for foreign security-based swap markets that would be required
to register as a SB SEF? If so, please explain in detail.
The Commission requests commenters' views on whether the
non-exhaustive discussion of the types of activities, noted above,
which would trigger the application of Section 3D registration
requirements to a foreign security-based swap market, is appropriate to
aid foreign security-based swap markets in assessing whether they would
be required to register as a SB SEF. Are there other activities that
foreign security-based swap markets currently engage in that should be
evaluated for consideration as to whether those activities would
trigger Section 3D registration requirements? If so, please describe
those activities in detail. Are there specific items set forth in the
non-exhaustive discussion of the types of activities noted above or any
other specific activities engaged in by foreign security-based swap
markets that should not trigger Section 3D registration requirements?
If so, commenters should describe those activities in detail and
explain their rationale. Does the proposed interpretation regarding the
application of Section 3D and the proposed non-exhaustive discussion of
the types of activities provide sufficient guidance for a foreign
security-based swap market to assess whether it would have to register,
or seek an exemption from registration, as a SB SEF? If not, what kind
of further guidance would be helpful for making that determination?
Does the proposed approach provide sufficient guidance to a foreign
security-based swap market that may seek an exemption? If not, what
kind of further guidance would be helpful?
The Commission seeks comment on the appropriateness of the
proposed interpretation that the registration requirements of Section
3D should be triggered by certain activities directed at ``U.S.
persons, or non-U.S. persons located in the United States.'' Are the
categories of persons captured by this proposed approach too broad? Too
narrow? Please specify and explain. For example, foreign branches would
be included by the proposed approach, such that a foreign security-
based swap market's provision of direct access or participation in its
market to a foreign branch, or activities facilitating execution or
trading of security-based swaps on its market by such a foreign branch,
would trigger the Section 3D registration requirement. Do commenters
agree with this approach? If not, why not? What would be a better
approach? If so, how so?
The Commission requests comment on what would be the
appropriate circumstances under which the Commission should consider
granting an exemption from the registration requirements of Section 3D.
Should the Commission consider granting an exemption from registration
for a foreign security-based swap market when the nature or scope of
its activities in the United States are limited? If so, why? Or should
the Commission also consider granting an exemption for a foreign
security-based swap market when the nature or scope of its activities
in the United States are more extensive? Why or why not? What would be
the advantages and disadvantages of either
[[Page 31058]]
approach? What would be the appropriate criteria for the Commission to
apply when it considers whether to grant an exemption from the
registration requirements of Section 3D? Please specify and explain.
The Commission seeks comment on whether the proposed
standard of comparability is an appropriate standard for the Commission
to determine whether to grant an exemption from Section 3D's
registration requirements for a foreign security-based swap market.
Should a different standard be used? If so, what should be the standard
and why? Should it be stricter or more lenient than the proposed
standard? If it should be stricter or more lenient, in what respects
and in what manner? Why or why not? As proposed, when making a
comparability determination, the Commission would look not just at the
rules of a foreign jurisdiction, but also at the comprehensiveness of
the supervision and regulation by the appropriate governmental
authorities of that jurisdiction. Is the Commission's holistic approach
to making a comparability determination appropriate? Why or why not?
Comment also is requested regarding whether the Commission should put
in place a more detailed standard for granting an exemption, for
example, by providing specific criteria that the Commission would look
to in determining whether there is comparable, comprehensive regulation
and supervision of a foreign security-based swap market by the
appropriate financial regulatory authority or authorities in the home
country. If so, what criteria should the Commission include and why?
Commenters also are requested to explain how the Commission should
develop such criteria in the absence of existing regulations in other
jurisdictions at the present time. Are there specific procedures or
comparability considerations that commenters believe that the
Commission would find useful to incorporate in our proposed exemption
approach at this time? If so, please describe. What would be the
advantages of adopting such measures now? What would be the
disadvantages of adopting such measures now?
The Commission solicits comment on the appropriateness or
feasibility of distinguishing between the comparability determination
for purposes of an exemption from registration as a SB SEF and for
purposes of substituted compliance for the mandatory trade execution
requirement. Should the Commission consider the same factors in making
a comparability determination for mandatory trade execution and a
comparability determination for SB SEF registration? If so, what
factors would be relevant and appropriate to both determinations?
Please describe. What factors, if any, would only be relevant or
appropriate to a comparability determination for SB SEF registration or
a comparability determination for mandatory trade execution,
respectively? Please describe.
The Commission seeks comment on the proposed process for
granting an exemption from Section 3D's registration requirements for a
foreign security-based swap market. Is the process explained in a
sufficiently clear manner? Does the process provide foreign security-
based swap markets with an efficient method for obtaining exemptions?
If not, what aspects of the process would be burdensome for foreign
security-based swap markets? Are there other ways to streamline the
exemption process? Please describe.
What would be the market impact of the proposed approach
to the registration of foreign security-based swap markets? How would
the proposed application of the SB SEF registration requirement affect
the competitiveness of U.S. entities in the global marketplace (both in
the United States as well as in foreign jurisdictions)? Would the
proposed approach place any market participants at a competitive
disadvantage or advantage? If so, please explain. Would the proposed
approach be a more general burden on competition? If so, please
explain. What other measures should the Commission consider to
implement the proposed approach to the registration of foreign
security-based swap markets? What would be the market impacts and
competitiveness effects of alternatives to the proposed approach
discussed in this release?
VIII. Regulation SBSR--Regulatory Reporting and Public Dissemination of
Security-Based Swap Information
A. Background
Section 13A(a)(1) of the Exchange Act \860\ provides that all
security-based swaps that are not accepted for clearing shall be
subject to regulatory reporting. Section 13(m)(1)(G) of the Exchange
Act \861\ provides that each security-based swap (whether cleared or
uncleared) shall be reported to a registered SDR, and Section
13(m)(1)(C) of the Exchange Act \862\ generally provides that
transaction, volume, and pricing data of all security-based swaps shall
be publicly disseminated in real time, except in the case of block
trades.\863\ On November 19, 2010, the Commission proposed Regulation
SBSR to implement these requirements.\864\
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\860\ 15 U.S.C. 78m-1(a)(1).
\861\ 15 U.S.C. 78m(m)(1)(G).
\862\ 15 U.S.C. 78m(m)(1)(C).
\863\ Section 13(m)(1)(E) of the Exchange Act, 15 U.S.C.
78(m)(1)(E), provides that, with respect to cleared security-based
swaps, the rule promulgated by the Commission related to public
dissemination shall contain provisions that ``specify the criteria
for determining what constitutes a large notional security-based
swap transaction (block trade) for particular market and contracts''
and ``specify the appropriate time delay for reporting large
notional security-based swap transactions (block trades) to the
public.''
\864\ See Regulation SBSR Proposing Release, 75 FR 75208.
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Rule 908 of Regulation SBSR as initially proposed was designed to
clarify the application of Regulation SBSR to cross-border security-
based swaps. Proposed Rule 908(a) would require a security-based swap
to be reported and publicly disseminated if the security-based swap:
(i) Has at least one counterparty that is a U.S. person; (ii) was
executed in the United States or through any means of interstate
commerce; or (iii) was cleared through a registered clearing agency
having its principal place of business in the United States. Proposed
Rule 908(b) provided that, notwithstanding any other provision of
Regulation SBSR, no counterparty to a security-based swap would incur
any obligation under Regulation SBSR unless it is: (i) A U.S. person;
(ii) a counterparty to a security-based swap executed in the United
States or through any means of interstate commerce; or (iii) a
counterparty to a security-based swap cleared through a clearing agency
having its principal place of business in the United States. Thus,
under the Commission's initial proposal, a security-based swap--
wherever it is executed or cleared--would be required to be reported
pursuant to Regulation SBSR if at least one counterparty were a U.S.
person. Furthermore, a security-based swap--even if both counterparties
were non-U.S. persons--would be required to be reported if the
security-based swap were executed in the United States or through any
means of interstate commerce, or cleared through a clearing agency
having its principal place of business in the United States.
Rule 901(a)(1), as initially proposed, also provided that, where
only one counterparty to a security-based swap is a U.S. person, the
U.S. person would be the ``reporting party'' (i.e., the party that
incurs the duty to report the security-based swap pursuant to
Regulation SBSR). Rule 901(a)(3), as initially proposed, provided that,
where neither
[[Page 31059]]
counterparty to a security-based swap that must be reported is a U.S.
person, the counterparties must select which of them would be the
reporting party.
To date, the Commission has received 48 comment letters
specifically in response to proposed Regulation SBSR, many of which
raised issues relating to the cross-border aspects of the proposal. The
Commission has received other letters that, while not specifically
referencing proposed Regulation SBSR, raised cross-border issues that
are germane to proposed Regulation SBSR.\865\ In response to these
comments--which are described further herein--and upon further
consideration of issues related to cross-border security-based swap
transactions across all of the various areas of Title VII, the
Commission is proposing various modifications to proposed Regulation
SBSR, particularly Rule 908 thereof, which address cross-border
transactions.
---------------------------------------------------------------------------
\865\ All such letters are cited in Appendix D.
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One significant modification being proposed here would take into
account situations in which a U.S. person, although not a ``direct
counterparty,'' as defined below, to a security-based swap, guarantees
the performance of one of the direct counterparties. As discussed
above,\866\ the Commission is proposing to apply various Title VII
provisions to the security-based swap transactions of non-U.S. persons
that are guaranteed by U.S. persons--including the regulatory reporting
and public dissemination requirements of Regulation SBSR, as discussed
below.\867\ A second significant modification is to propose a
``substituted compliance'' regime. As explained in more detail below,
the Commission is now proposing a framework that would allow certain
Title VII requirements to be satisfied by compliance with the rules of
a foreign jurisdiction rather than the specific requirements under U.S.
rules. Below, the Commission describes the circumstances under which
compliance with the rules of such a foreign jurisdiction could, under
re-proposed Regulation SBSR, be ``substituted'' for compliance with the
specific regulatory reporting and public dissemination requirements of
Regulation SBSR.\868\
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\866\ See Section II.B.2(d), supra.
\867\ See Sections VIII.C and VIII.D, infra.
\868\ See Section XI.D, infra.
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A number of new definitions are being added to re-proposed Rule 900
in light of the changes being proposed.\869\ For example, new paragraph
(g) of Rule 900 would define the term ``counterparty'' to mean ``a
person that is a direct counterparty or indirect counterparty of a
security-based swap.'' A direct counterparty would be ``a person that
enters directly with another person into a contract that constitutes a
security-based swap.'' An indirect counterparty would be ``a person
that guarantees the performance of a direct counterparty to a security-
based swap or that otherwise provides recourse to the other side for
the failure of the direct counterparty to perform any obligation under
the security-based swap.'' Although a guarantor is not a direct
counterparty to the security-based swap, the duties to be performed
under the security-based swap, and thus the risks associated with the
security-based swap, ultimately fall to the guarantor.\870\ Therefore,
the Commission preliminarily believes that it is appropriate to deem a
guarantor to be a counterparty to the security-based swap for purposes
of the regulatory reporting requirements of Title VII and the rules
proposed thereunder. As discussed in detail below, the concept of
``reporting party'' used in Regulation SBSR as initially proposed would
be replaced by the newly proposed term ``reporting side,'' to reflect
the fact that reporting obligations could attach to both direct and
indirect counterparties.\871\
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\869\ In some cases, a definition used in Rule 900 would cross-
reference a term defined elsewhere in the Commission's Title VII
rules. In other cases, a definition might be specific to Regulation
SBSR and not be used elsewhere in the Commission's Title VII rules.
\870\ See Section II.B.2(d), supra.
\871\ Re-proposed Rule 900(ee) would define ``side'' as ``a
direct counterparty and any indirect counterparty that guarantees
the direct counterparty's performance of any obligation under a
security-based swap.'' Re-proposed Rule 900(cc) would define
``reporting side'' as ``the side of a security-based swap having the
duty to report information in accordance with [Regulation SBSR] to a
security-based swap data repository, or if there is no security-
based swap data repository that would receive the information, to
the Commission.''
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The Commission has received and continues to consider comments on
the Regulation SBSR Proposing Release that address areas other than
those relating to cross-border security-based swap activity. In this
release, the Commission is re-proposing only changes relating to cross-
border security-based swap activity, technical and conforming changes
necessitated by these larger revisions, and certain other minor changes
that would help to clarify these re-proposed revisions (such as
numbering each definition in re-proposed Rule 900, so that each defined
term can more readily be identified). Changes to Regulation SBSR in
other areas could, if appropriate, be addressed in a future
release.\872\
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\872\ For example, the Commission in the Regulation SBSR
Proposing Release did not propose how to define a ``block trade.''
As noted in Regulation SBSR Proposing Release, the Commission
intends to do so in a separate proposal. See Regulation SBSR
Proposing Release, 75 FR 75228.
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Regulation SBSR, as re-proposed today, represents the Commission's
preliminary views regarding the application of Title VII's provisions
relating to regulatory reporting and public dissemination of cross-
border security-based swap transactions, and how those provisions would
apply to non-U.S. persons who act in capacities regulated under the
Dodd-Frank Act. The Commission invites comment regarding all aspects of
the approaches taken by the Commission and each provision of re-
proposed Regulation SBSR, including potential alternative approaches.
In particular, data and comment from market participants and other
interested parties regarding the likely effect of each re-proposed rule
regarding application of a specific Title VII requirement, the effect
of such proposed application in the aggregate, and potential
alternative approaches will be particularly useful to the Commission in
evaluating possible modifications to re-proposed Regulation SBSR.
B. Modifications to the Definition of ``U.S. Person''
Rule 900 of re-proposed Regulation SBSR contains a revised
definition of ``U.S. person.'' As initially proposed, ``U.S. person''
was defined as ``a natural person that is a U.S. citizen or U.S.
resident or a legal person that is organized under the corporate laws
of any part of the United States or has its principal place of business
in the United States.'' Two persons who commented specifically on the
Regulation SBSR proposal \873\ argued that ``U.S. person'' as used in
the Commission's Title VII rules should have the same definition as in
Regulation S.\874\
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\873\ See Cleary Letter III at 2, 6-9; Davis Polk Letter I at
note 6 (arguing that using the existing Regulation S definition,
rather than creating a new definition, ``would avoid confusion and
also provide consistency of application'').
\874\ 17 CFR 230.901 to 230.905.
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Proposed Regulation SBSR was the only one of the Commission's
proposals for implementing Title VII to propose to use and define the
term ``U.S. person.'' Because the Commission is now addressing cross-
border issues across multiple Title VII rules, the Commission has given
further thought to the definition of ``U.S. person'' as initially
[[Page 31060]]
proposed in Regulation SBSR. The Commission now believes that using a
single definition of ``U.S. person'' in all Title VII rulemaking would
promote consistency and transparency in understanding and complying
with these various rules. However, as described above,\875\ the
Commission preliminarily believes that the Regulation S definition of
``U.S. person'' is not appropriate for Title VII rules. Proposed Rule
900(pp) would define ``U.S. person'' to have the same meaning as in
proposed Rule 3a71-3(a)(7) under the Exchange Act.\876\
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\875\ See Section III.B.10, supra.
\876\ See Section III.B.5, supra.
---------------------------------------------------------------------------
Under both the proposed and re-proposed definitions of ``U.S.
person,'' a natural person resident in the United States would be a
U.S. person, as would a legal person that is organized or incorporated
under the laws of the United States or having its principal place of
business in the United States. Furthermore, under both definitions, a
foreign branch of a U.S. person would not be recognized as having an
existence separate from the U.S. person.\877\ The proposed rule also
would cover partnerships, trusts, and other legal persons, as set forth
in proposed Rule 3a71-3(a)(7) under the Exchange Act. The re-proposed
definition of ``U.S. person'' also would clarify certain situations
that were not specifically addressed in the initial proposal. For
example, the initially proposed definition of ``U.S. person'' did not
address whether--and, if so, when--an account would be considered a
U.S. person. The re-proposed definition would provide that an account,
whether discretionary or non-discretionary, of a U.S. person would be a
U.S. person.
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\877\ See Regulation SBSR Proposing Release, 75 FR 75240 (``The
Commission intends for this proposed definition [of U.S. person] to
include branches and offices of U.S. persons''). See also Section
III.B.5(b)ii, supra (proposing that an entity's status as a U.S.
person would be determined at the legal-entity level and thus apply
to the entire legal entity, including any foreign operations such as
branches that are part of the U.S. legal entity).
---------------------------------------------------------------------------
New paragraph (q) of re-proposed Rule 900 would define the term
``non-U.S. person'' as a person that is not a U.S. person.
Request for Comment
The Commission requests comment on all aspects of the re-proposed
definition of ``U.S. person'' in Regulation SBSR. In particular:
Should the definition of ``U.S. person'' in Regulation
SBSR be consistent with that proposed for the Commission's other Title
VII rules? Why or why not? If so, what should that definition be and
why? Would having a different definition of ``U.S. person'' in
Regulation SBSR create ambiguity or conflict with other Title VII rules
being issued by the Commission? If not, why not?
C. Additional Modifications to Scope of Regulation SBSR
1. Revisions to Proposed Rule 908(a)
Rule 908(a), as initially proposed, provided that a security-based
swap would be subject to regulatory reporting and public dissemination
under Regulation SBSR if the security-based swap: (i) Has at least one
counterparty that is a U.S. person; (ii) is executed in the United
States or through any means of interstate commerce; or (iii) is cleared
through a registered clearing agency having its principal place of
business in the United States. Thus, Rule 908(a), as originally
proposed, would not impose reporting or public dissemination
requirements in connection with a security-based swap solely because
the obligations of one of the direct counterparties is guaranteed by a
U.S. person. As noted above, the re-proposed definition of ``U.S.
person''--like the initially proposed definition--would not treat a
direct counterparty that is guaranteed by a U.S. person as itself,
solely due to the existence of the guarantee, a U.S. person. However,
as noted below, the Commission is concerned about instances where--
because of a guarantee extended by a U.S. person--the risk of a
transaction resides in the United States, even if the direct
counterparties of the transaction are domiciled outside the United
States. Thus, upon further consideration, the Commission is now
proposing to apply Title VII's regulatory reporting requirements to
security-based swaps having at least one counterparty, whether direct
or indirect, that is a U.S. person.
Guarantees provided by U.S. persons to their foreign affiliates or
other non-U.S. persons could have the effect of concentrating
significant risks within the United States that may rise to the
systemic level. If a U.S. person guarantees the performance of a non-
U.S. person, the financial resources of that U.S. person could be
called upon to satisfy the contract. This activity is capable of posing
risks to the stability of the U.S. financial system. The Commission
preliminarily believes that, if it does not require regulatory
reporting of security-based swaps that are guaranteed by U.S. persons,
in addition to security-based swaps having a U.S. person direct
counterparty, the Commission and other federal financial regulators
would be less likely to detect the build-up of potentially significant
risks within individual institutions or more widespread systemic risks
to the U.S. financial system. The Dodd-Frank Act is intended to promote
the financial stability of the United States by, among other things,
reducing risks to the U.S. financial system by allowing regulators
better access to necessary market data.\878\
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\878\ See, e.g., S. Comm. on Banking, Hous., & Urban Affairs,
The Restoring American Financial Stability Act of 2010, S. Rep. No.
111-176, at 32 (``As a key element of reducing systemic risk and
protecting taxpayers in the future, protections must include
comprehensive regulation and rules for how the OTC derivatives
market operates. Increasing the use of central clearinghouses,
exchanges, appropriate margining, capital requirements, and
reporting will provide safeguards for American taxpayers and the
financial system as a whole'') (emphasis added); note 4, supra.
---------------------------------------------------------------------------
In addition, the Commission is now proposing to require regulatory
reporting of all security-based swaps entered into by non-U.S. person
security-based swap dealers and major security-based swaps
participants, wherever they may be executed.\879\ This is a change from
how the initial proposal applied to a security-based swap executed by a
non-U.S. person security-based swap dealer or major security-based swap
participant. Under the initial proposal, such a security-based swap
would not be required to be reported solely based on an entity's status
as a security-based swap dealer or major security-based swap
participant, unless the security-based swap was executed in the United
States or through any means of interstate commerce, or was cleared by a
clearing agency having its principal place of business in the United
States.
---------------------------------------------------------------------------
\879\ See re-proposed Rule 908(a)(1)(iii) of Regulation SBSR.
---------------------------------------------------------------------------
A non-U.S. person security-based swap dealer or major security-
based swap participant generally would be subject to all rules
applicable to security-based swap dealers or major security-based swaps
participants, regardless of its principal place of business or where it
is organized.\880\ Having access to all of the security-based swap
transactions entered into by a security-based swap dealer or major
security-based swap participant is an important aspect of understanding
its compliance with the applicable Title VII requirements, including
without limitation, compliance with the capital, margin, and other
applicable entity-level and transaction-level requirements. The
Commission notes that Section 15F(f)(1)(a) of the Exchange Act provides
that each registered security-based swap dealer and major
[[Page 31061]]
security-based swap participant shall make such reports as are required
by the Commission, by rule or regulation, regarding the transactions
and financial condition of the registered security-based swap dealer or
major security-based swap participant.\881\ Therefore, the Commission
is now proposing to require that all security-based swaps of all
security-based swap dealers and major security-based swap participants,
regardless of where such security-based swaps are executed or where
these entities have their principal place of business or are organized,
be subject to regulatory reporting to a registered SDR.\882\
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\880\ See Sections III.C and IV.D, supra.
\881\ 15 U.S.C. 78o-8(f)(1)(A). The Commission further notes
that Section 15F(f)(2) of the Exchange Act, 15 U.S.C. 78o-8(f)(2),
requires the Commission to ``adopt rules governing reporting and
recordkeeping for security-based swap dealers and major security-
based swap participants.''
\882\ As discussed below, however, the Commission is proposing
that certain security-based swaps of non-U.S. person security-based
swap dealers and major security-based swap participants would not be
subject to public dissemination. In addition, certain security-based
swaps that would otherwise be subject to regulatory reporting and
public dissemination under Regulation SBSR could qualify for
substituted compliance. See Section XI.D, infra.
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To reflect these changes and to reincorporate other provisions that
are not being substantially revised, the Commission is re-proposing
Rule 908(a) as follows. The rule would be divided into two
subparagraphs, (1) and (2), which would address regulatory reporting
and public dissemination, respectively. Specifically, re-proposed Rule
908(a)(1) would provide that a security-based swap transaction would be
subject to regulatory reporting if:
(i) The security-based swap is a transaction conducted within the
United States;
(ii) There is a direct or indirect counterparty that is a U.S.
person on either side of the transaction;
(iii) There is a direct or indirect counterparty that is a
security-based swap dealer or major security-based swap participant on
either side of the transaction; or
(iv) The security-based swap is cleared through a clearing agency
having its principal place of business in the United States.
Re-proposed Rule 908(a)(1)(i) would preserve the principle from the
original proposal that a security-based swap would be subject to
regulatory reporting if it is executed in the United States.\883\ As
noted above,\884\ the concept of a security-based swap transaction
being solicited, negotiated, executed, or booked in the United States
has been integrated into the new term ``transaction conducted within
the United States,'' which also is being used in other Title VII
proposals of the Commission. Proposed Rule 3a71-3(a)(5) under the
Exchange Act would define ``transaction conducted within the United
States'' as ``a security-based swap transaction that is solicited,
negotiated, executed, or booked within the United States, by or on
behalf of either counterparty to the transaction, regardless of the
location, domicile, or residence status of either counterparty to the
transaction.'' \885\
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\883\ See Rule 908(a)(2) of Regulation SBSR, as originally
proposed.
\884\ See Section III.B.6, supra.
\885\ See note 308, supra (explaining that the word
``counterparty'' as used within this term has the same meaning as
``direct counterparty'' in re-proposed Rule 900(j) of Regulation
SBSR).
---------------------------------------------------------------------------
The Commission received no comments that specifically addressed our
use of the phrase ``through any means of interstate commerce'' in three
places in Regulation SBSR, as initially proposed.\886\ However, upon
further consideration, the Commission is concerned that this language
could unduly require a security-based swap to be reported if it had
only the slightest connection with the United States. Therefore, the
Commission has decided to delete the phrase ``through any means of
interstate commerce'' from re-proposed Regulation SBSR. Instead, the
Commission is proposing to require reporting of a security-based swap
that falls within the definition of ``transaction conducted within the
United States,'' which would describe more precisely the nature of the
activities in the United States that could result in a security-based
swap becoming subject to Regulation SBSR. The Commission generally
believes that security-based swaps that are solicited, negotiated,
executed, or booked within the United States--by or on behalf of either
counterparty to the transaction, and regardless of the location,
domicile, or residence status of either counterparty to the
transaction--generally should be subject to Regulation SBSR.
---------------------------------------------------------------------------
\886\ See Rules 900 (definition of ``participant''), 908(a), and
908(b) of Regulation SBSR, as initially proposed.
---------------------------------------------------------------------------
Re-proposed Rule 908(a)(1)(ii)--which would require regulatory
reporting of any security-based swap if there is a direct or indirect
counterparty that is a U.S. person on either side of the transaction--
embodies the principle in the initial proposal that a security-based
swap, wherever executed, must be reported if it has at least one
counterparty that is a U.S. person. This revised prong, however, also
would apply the reporting requirement to any security-based swap,
wherever executed, that has at least one indirect counterparty \887\
that is a U.S. person, even when no direct counterparty is a U.S.
person. The original proposal, because it did not include guarantors as
counterparties, would not have required regulatory reporting in such
case. As discussed above, the Commission now preliminarily believes
that--to satisfy Congressional intent that security-based swaps be
subject to regulatory reporting, thereby informing the Commission and
other financial regulators of potential systemic risks--any security-
based swap having at least one direct counterparty that is a U.S.
person should be reported. The Commission also preliminarily believes
that, because guarantees extended by U.S. persons create risk to the
U.S. financial system, regulatory reporting of security-based swaps
should extend to any security-based swap transaction in which one or
both direct counterparties is guaranteed by a U.S. person. In the
absence of regulatory reporting of such security-based swaps, the
Commission's ability to detect and analyze potentially significant
sources of risk to the U.S. financial system could be limited.
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\887\ ``Indirect counterparty'' would be defined as ``a
guarantor of a direct counterparty's performance of any obligation
under a security-based swap.'' See re-proposed Rule 900(o) of
Regulation SBSR.
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Re-proposed Rule 908(a)(1)(iii) would, for reasons described above,
require regulatory reporting of any security-based swap executed by a
security-based swap dealer or major security-based swap participant,
regardless of the entity's place of domicile and regardless of the
place of execution.
Re-proposed Rule 908(a)(1)(iv) would preserve the principle from
the original proposal that a security-based swap would be subject to
regulatory reporting if it is cleared through a clearing agency having
its principal place of business in the United States.\888\ As noted in
the Regulation SBSR Proposing Release, the Commission preliminarily
believes that, if a security-based swap is cleared by a clearing agency
having its principal place of business in the United States, U.S.
regulators should have access to information regarding the security-
based swap through a registered SDR.\889\ This approach is premised on
the view that, when a security-based swap is cleared through a clearing
agency, the initial transaction is novated and two new transactions
take its place, with the clearing agency becoming the seller to the
buyer and the buyer to the seller. If the clearing agency is located
within the
[[Page 31062]]
United States, the new transactions necessarily would be executed
within the United States.\890\
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\888\ See Rule 908(a)(3) of Regulation SBSR, as originally
proposed.
\889\ See Regulation SBSR Proposing Release, 75 FR 75240.
\890\ See id. (noting that the concept of being ``executed in
the United States or through any means of interstate commerce''
includes being cleared through a clearing agency having its
principal place of business in the United States).
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While subparagraph (1) of re-proposed Rule 908(a) would address
when a security-based swap would be subject to regulatory reporting,
subparagraph (2) would address when a security-based swap would be
subject to public dissemination. Re-proposed Rule 908(a)(2) would
provide that a security-based swap shall be subject to public
dissemination if:
(i) The security-based swap is a transaction conducted within the
United States;
(ii) There is a direct or indirect counterparty that is a U.S.
person on each side of the transaction;
(iii) At least one direct counterparty is a U.S. person (except in
the case of a transaction conducted through a foreign branch \891\);
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\891\ The term ``foreign branch'' would be defined in re-
proposed Rule 900(n) of Regulation SBSR to cross-reference the
definition in proposed Rule 3a71-3(a)(1) under the Exchange Act. See
Section III.B.7, supra, for a definition of that term.
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(iv) One side includes a U.S. person and the other side includes a
non-U.S. person that is a security-based swap dealer; or
(v) The security-based swap is cleared through a clearing agency
having its principal place of business in the United States.
The Commission notes that Section 13(m)(1)(B) of the Exchange Act
\892\ ``authorize[s] the Commission to make security-based swap
transaction and pricing data available to the public in such form and
at such times as the Commission determines appropriate to enhance price
discovery.'' Re-proposed Rule 908(a)(2) reflects the Commission's
revised preliminary determination regarding an appropriate way to
enhance price discovery in the U.S. market for security-based swaps. As
noted below, since issuing the Regulation SBSR Proposing Release, the
Commission has obtained and analyzed more extensive data regarding the
overlap between the U.S. market and the global market for security-
based swaps.\893\ These data suggest that a vast majority of security-
based swap transactions directly involved at least one non-U.S.
domiciled counterparty.\894\ Furthermore, these transactions frequently
may be conducted with one direct counterparty located in one
jurisdiction with the other direct counterparty located in another
jurisdiction, further suggesting that no easy distinction can be made
between the U.S. market and foreign or global markets. The Commission
is concerned that limiting the application of Title VII's public
dissemination requirement only to transactions that are wholly
conducted within the United States or to transactions where both direct
counterparties are U.S. persons would significantly reduce the
potential benefits of post-trade transparency in the security-based
swap market. The Commission stated in the Regulation SBSR Proposing
Release that, ``[b]y reducing information asymmetries, post-trade
transparency has the potential to lower transaction costs, improve
confidence in the market, encourage participation by a larger number of
market participants, and increase liquidity in the [security-based
swap] market.'' \895\ The Commission also noted that, ``[i]n other
markets, greater post-trade transparency has increased competition
among market participants and reduced transaction costs.'' \896\
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\892\ 15 U.S.C. 78m(m)(1)(B).
\893\ See Section XIV.F.2(d)ii, infra.
\894\ See Section II.A.1, supra.
\895\ Regulation SBSR Proposing Release, 75 FR 75224.
\896\ Id. at 75225 (citing studies of the impact of TRACE (Trade
Reporting and Compliance Engine) on the corporate bond market).
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Re-proposed Rule 908(a)(2) eliminates use of the term `interstate
commerce'' and instead incorporates the new concept of ``transaction
conducted within the United States,'' which is being used throughout
the Commission's proposed Title VII cross-border rules, to help
delineate precisely the types of security-based swap transactions that
would be subject to public dissemination under Regulation SBSR.
Furthermore, re-proposed Rule 908(a)(2) is designed to achieve the goal
of improving the transparency, fairness, and efficiency of the U.S.
security-based swap market, as reflected in Section 13(m)(1)(B) of the
Exchange Act. Re-proposed Rule 908(a)(2) also is designed, as far as
practicable, to minimize competitive disparities that might result
under the proposed public dissemination regime, as well as to minimize
incentives for market participants to structure their operations for
the purpose of evading Regulation SBSR.\897\ Each individual
subparagraph of re-proposed Rule 908(a)(2) is discussed below.
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\897\ We preliminarily believe that the proposed approach with
respect to regulatory reporting and public dissemination is not
being applied to persons who are ``transact[ing] a business in
security-based swaps without the jurisdiction of the United
States,'' within the meaning of Section 30(c). See Sections
II.B.2(a)-II.B.2(d), supra. However, the Commission also
preliminarily believes that the proposed approach with respect to
regulatory reporting and public dissemination is necessary or
appropriate to help prevent the evasion of the particular provisions
of the Exchange Act that were added by the Dodd-Frank Act that are
being implemented by the approach and prophylactically will help
ensure that the purposes those provisions of the Dodd-Frank Act are
not undermined. See Section II.B.2(e), supra; see also Section
II.B.2(d), supra.
For example, if the reporting requirements do not apply to
transactions among non-U.S. persons that receive guarantees from
U.S. persons and foreign branches of U.S. banks, then U.S. persons
would have an incentive to evade the reporting requirements by
conducting transactions with other U.S. persons through guaranteed
foreign affiliates or foreign branches. Altering the form of the
transaction in this manner would allow U.S. persons to continue to
avail themselves of transparency in the U.S. security-based swap
market while themselves evading the requirements intended to enhance
that transparency, even though the substance of the transaction
remains unchanged.
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Re-proposed Rule 908(a)(2)(i), similar to re-proposed Rule
908(a)(1)(i), generally would preserve the principle from the original
proposal that a security-based swap would be subject to public
dissemination if it were executed in the United States.\898\ That
concept has been integrated into the new term ``transaction conducted
within the United States,'' which also is being used in the
Commission's other Title VII proposals.
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\898\ See Rule 908(a)(2) of Regulation SBSR, as originally
proposed. See also Regulation SBSR Proposing Release, 75 FR 75239-
40.
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Re-proposed Rule 908(a)(2)(ii) would provide that a security-based
swap would be subject to public dissemination if there is a direct or
indirect counterparty that is a U.S. person on each side of the
transaction. Under the initial proposal, a security-based swap
involving two non-U.S. person direct counterparties, but where each
direct counterparty is guaranteed by a U.S. person, would not be
required to be publicly disseminated. The Commission now preliminarily
believes that, where U.S. persons have an interest on both sides of the
transaction, even if indirectly, the transaction generally should be
viewed as part of the U.S. security-based swap market and, as such,
should be subject to Title VII's public dissemination requirement.
Moreover, to the extent that U.S. persons might be incented to
structure their trading operations through guaranteed foreign
subsidiaries to avoid public dissemination that otherwise would apply
to trades executed between U.S. person direct counterparties, the
Commission seeks to minimize that incentive by re-proposing Rule
908(a)(2)(ii) to require public dissemination of a security-based swap
transaction if a U.S. person is present on
[[Page 31063]]
each side, whether directly or indirectly.
Re-proposed Rule 908(a)(2)(iii) would provide that a security-based
swap would be subject to public dissemination if at least one direct
counterparty is a U.S. person (except in the case of a transaction
conducted through a foreign branch \899\). This prong generally
reincorporates the original proposal's approach that a security-based
swap executed anywhere in the world and having just one U.S. person
counterparty would be subject to public dissemination. The Commission
generally believes that a security-based swap transaction having even
just one U.S. person direct counterparty generally should be viewed as
part of the U.S. security-based swap market and, as such, should be
subject to Title VII's public dissemination requirement. The Commission
preliminarily believes that the benefits of requiring public
dissemination of all security-based swaps involving at least one U.S.
person direct counterparty would inure to other U.S. persons that
transact in the same or similar instruments.
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\899\ The term ``transaction conducted through a foreign
branch'' would be defined in re-proposed Rule 900(hh) of Regulation
SBSR to cross-reference the definition of that term in proposed Rule
3a71-3(a)(4) under the Exchange Act, as discussed in Section III.B.7
above.
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However, re-proposed Rule 908(a)(2)(iii) would provide a limited
exception to the general rule that any transaction involving a U.S.
person direct counterparty would be subject to public dissemination;
re-proposed Rule 908(a)(2)(iii) would not apply if the transaction is
conducted through a foreign branch.\900\ The Commission is concerned
that, if it did not take this approach, non-U.S. market participants
might avoid entering into security-based swaps with the foreign
branches of U.S. banks so as to avoid their security-based swaps being
publicly disseminated. The Commission notes that registration with the
local regulatory authority to engage in banking business is inherent in
the proposed definition of ``foreign branch.'' This approach would
restrict the proposed exception to public dissemination for
transactions conducted through a foreign branch.\901\ The Commission
further notes that the proposed exclusion for transactions conducted
through a foreign branch is equivalent to the proposed approach for
transactions conducted by foreign affiliates that are guaranteed by a
U.S. person. In the case of a security-based swap transaction executed
outside the United States between a non-U.S. person and either the
guaranteed foreign affiliate or the foreign branch of the U.S. bank,
re-proposed Rule 908(a)(2) would not require public dissemination of
the transaction. Re-proposed Rule 908(a)(2)(iii) would not require
public dissemination if the transaction were conducted through a
foreign branch. Re-proposed Rule 908(a)(2)(ii) would not require public
dissemination if the only U.S. person involved in the transaction were
the U.S. person providing the guarantee.
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\900\ However, a security-based swap having a direct
counterparty that is a foreign branch could be subject to public
dissemination for other reasons--e.g., if the transaction included a
U.S. person on the other side. See re-proposed Rule 908(a)(2)(ii) of
Regulation SBSR.
\901\ Thus, for example, a security-based swap involving a U.S.
person that sends staff to a foreign country to negotiate and
execute the transaction but does not have a recognized foreign
branch in that country would be required to be publicly
disseminated, and would not qualify for the proposed exclusion in
re-proposed Rule 908(a)(2)(iii) for transactions conducted through a
foreign branch.
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Re-proposed Rule 908(a)(2)(iv) would provide that a security-based
swap would be subject to public dissemination if one side includes a
U.S. person and the other side includes a non-U.S. person that is a
security-based swap dealer, as defined in Section 3(a)(71) of the
Exchange Act and the rules and regulations thereunder. The Commission
notes that re-proposed Rule 908(a)(2)(ii) would require public
dissemination of a transaction if both sides include a U.S. person.
Under re-proposed Rule 908(a)(2)(iv), however, public dissemination
would be required when only one side includes a U.S. person, provided
the other side includes a non-U.S. person security-based swap dealer.
The Commission preliminarily believes that both types of transaction
generally should be considered part of the U.S. security-based swap
market and, as such, should be subject to Title VII's public
dissemination requirement. As the Commission has previously stated,
post-trade transparency of security-based swap transactions would
reduce information asymmetries and could have the potential to lower
transaction costs, improve confidence in the market, encourage
participation by a larger number of market participants, and increase
liquidity in the security-based swap market.\902\ Post-trade
transparency of security-based swap transactions also has the potential
to improve valuation models and thereby contribute to more efficient
capital allocation.\903\ The Commission preliminarily believes that not
subjecting transactions between U.S. persons (whether directly or
indirectly) or between a U.S. person and a non-U.S. person security-
based swap dealer to post-trade transparency would undermine these
goals. The fact that both sides of the transaction include a U.S.
person, or that one side includes a U.S. person and the other side
includes a person that conducts enough U.S. business to warrant
requiring it to register with the Commission, suggests that they are
engaging in the types of transactions that might be engaged in by other
U.S. persons or others who are required to register with the
Commission. Furthermore, in the absence of re-proposed Rule
908(a)(2)(iv), a non-U.S. person security-based swap dealer could
encourage foreign affiliates that are guaranteed by a U.S. parent to
transact business with it outside the United States in order to evade
the public dissemination requirement.\904\ If re-proposed Rule
908(a)(2)(iv) applied, all transactions between a security-based swap
dealer (regardless of whether it is a U.S. person) and a U.S. person
(whether as a direct or indirect counterparty), would be required to be
publicly disseminated, regardless of where such transactions are
conducted. Finally, the Commission notes that Section 13(m)(1)(D) of
the Exchange Act gives the Commission authority to require registered
entities--such as security-based swap dealers--regardless of whether or
not they are U.S. persons, to publicly disseminate security-based swap
transaction and pricing data.
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\902\ See Regulation SBSR Proposing Release, 75 FR 75267.
\903\ See id. at 75267-68.
\904\ The Commission notes that re-proposed Rule 908(a)(2)(iii)
of Regulation SBSR would require public dissemination if only one
direct counterparty is a U.S. person, regardless of the status,
nationality, or place of domicile of the other direct counterparty.
Thus, re-proposed Rule 908(a)(2)(iii) already would require public
dissemination in the case of a security-based swap between a non-
U.S. person security-based swap dealer and a U.S. person direct
counterparty. Re-proposed Rule 908(a)(2)(iv) of Regulation SBSR
would, in addition, require public dissemination in the case of a
security-based swap between a non-U.S. person security-based swap
dealer and a U.S. person indirect counterparty.
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However, the Commission notes that re-proposed Rule 908(a)(2) would
not require public dissemination of a security-based swap transacted
outside the United States between two non-U.S. persons that are
security-based swap dealers (assuming that neither side is guaranteed
by a U.S. person). Non-U.S. person security-based swap dealers are
likely to have significant operations in foreign security-based swap
markets. A transaction between two such non-U.S. person security-based
swap dealers conducted outside the United States is less likely than a
transaction conducted within the United States or a transaction
[[Page 31064]]
involving a U.S. person on the other side to affect the U.S. security-
based swap market. Therefore, the Commission is not proposing to
require public dissemination of transactions conducted outside the
United States between two non-U.S. person security-based swap dealers.
Re-proposed Rule 908(a)(2)(v) would preserve the principle from the
original proposal that a security-based swap would be subject to public
dissemination if it is cleared through a clearing agency having its
principal place of business in the United States.\905\ As noted in the
Regulation SBSR Proposing Release, the Commission preliminarily
believes that, if non-U.S. persons determined to clear a security-based
swap transaction through a clearing agency having its principal place
of business in the United States, this suggests that the clearing
agency has made the security-based swap eligible for clearing because
at least some U.S. counterparties might wish to trade the security-
based swap as well.\906\ The Commission preliminarily believes,
therefore, that requiring public dissemination of the security-based
swap transaction would promote price discovery for market participants
in the United States and elsewhere.\907\
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\905\ See Rule 908(a)(3) of Regulation SBSR, as originally
proposed.
\906\ See Regulation SBSR Proposing Release, 75 FR 75240.
\907\ See id.
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A security-based swap transaction would need to meet only one prong
of re-proposed Rule 908(a)(2) to trigger the public dissemination
requirement. For example, assume a security-based swap is solicited,
negotiated, executed, and cleared in London between (A) the London
branch of a U.S. financial institution and (B) a London-based firm
(i.e., a non-U.S. person) that has registered with the Commission as a
security-based swap dealer. Re-proposed Rule 908(a)(2)(i) would not
apply, because the transaction is not conducted within the United
States. Re-proposed Rule 908(a)(2)(v) would not apply, because the
security-based swap is not cleared in the United States. Re-proposed
Rule 908(a)(2)(ii) would not apply, because there is not a direct or
indirect counterparty that is a U.S. person on both sides of the
transaction. Re-proposed Rule 908(a)(2)(iii) would not apply because
neither side includes a direct counterparty that is a U.S. person that
would trigger public dissemination; here, the U.S. person direct
counterparty is acting through a foreign branch, which is carved out of
re-proposed Rule 908(a)(2)(iii). However, this transaction would be
subject to public dissemination under re-proposed Rule 908(a)(2)(iv):
one side includes a U.S. person (in this case, the London branch of the
U.S. bank) and the other side includes a non-U.S. person security-based
swap dealer. The result would be the same if, instead of a London
branch of a U.S. financial institution, one of the direct
counterparties were the London-based affiliate of a U.S. person that
guarantees the performance of the London subsidiary (i.e., the
transaction is between, on one side, a security-based swap dealer and,
on the other side, an indirect counterparty that is a U.S. person).
Request for Comment
The Commission requests comment on all aspects of the re-proposed
Rule 908(a), including the following:
Do you agree with the approach taken in re-proposed Rule
908(a) that a security-based swap should be subject to regulatory
reporting and public dissemination regardless of the nationality or
place of domicile of the counterparties if it is a transaction
conducted in the United States? Why or why not? Do you agree with the
Commission's use of the term ``transaction conducted within the United
States'' in re-proposed Rule 908? Why or why not?
Do you agree with the approach taken in re-proposed Rule
908(a) that a security-based swap cleared through a clearing agency
having its principal place of business in the United States should be
subject to the regulatory reporting and public dissemination
requirements? Why or why not?
Do you agree with the Commission's general approach of
treating guarantors as counterparties for purposes of security-based
swap trade reporting requirements? Why or why not? Do you believe that
a security-based swap should be subject to regulatory reporting solely
because one side includes a guarantor that is a U.S. person? Why or why
not? Would the Commission's ability to exercise prudential and
regulatory oversight of the securities markets be compromised if it did
not have the ability to learn about all security-based swap positions
held by U.S. persons, including guarantors? Why or why not?
Do you believe that a security-based swap should be
subject to regulatory reporting solely because one side includes a
security-based swap dealer or major security-based swap participant,
regardless of the nationality or place of domicile of that entity? Why
or why not? Would the Commission's ability to exercise prudential and
regulatory oversight of entities registered with it be compromised if
it did not have the ability to learn about all security-based swap
positions held by such entities? Why or why not?
In general, do you agree with how re-proposed Rule 908(a)
would apply to security-based swaps entered into by non-U.S. person
security-based swap dealers and major security-based swap participants?
Why or why not?
Do you agree with the requirement, in re-proposed Rule
908(a)(2)(ii), that a security-based swap should be subject to public
dissemination if there is a direct or indirect counterparty that is a
U.S. person on each side of the transaction? Why or why not? What would
be the benefits of requiring public dissemination in this scenario?
What would be the costs? Please be specific.
Do you agree with the requirement, in re-proposed Rule
908(a)(2)(iii), that a security-based swap should be subject to public
dissemination if at least one direct counterparty is a U.S. person,
even if the transaction is not conducted within the United States? Why
or why not? What would be the benefits of requiring public
dissemination in this scenario? What would be the costs? Please be
specific. Do you agree with the exception to this general rule for
transactions conducted through a foreign branch of a U.S. person? Why
or why not? Should the exception be limited to foreign branches? Why or
why not? Are there any alternatives that the Commission should
consider? If so, what are they?
Do you agree with the requirement, in re-proposed Rule
908(a)(2)(iv), that would provide that a security-based swap, even if
not a transaction conducted within the United States, would be subject
to public dissemination if one side includes a U.S. person and the
other side includes a non-U.S. person security-based swap dealer? Why
or why not? What would be the benefits of requiring public
dissemination in this scenario? What would be the costs? Please be
specific.
Should the Commission require public dissemination of
security-based swaps cleared by any clearing agency registered with the
Commission, even if its principal place of business is outside the
United States? Why or why not?
In general, do you agree the distinctions drawn in the
scenarios set forth in re-proposed Rule 908(a) regarding which
security-based swaps would be subject to the regulatory reporting and
public dissemination? Why or why not?
[[Page 31065]]
2. Revisions to Proposed Rule 908(b)
In the initial proposal, the Commission explained when duties would
be imposed on non-U.S. person counterparties of security-based swaps
when some connection to the United States might be present. Rule
908(b), as initially proposed, provided that no duties would be imposed
on a counterparty unless one of the following conditions were true:
The counterparty is a U.S. person;
The security-based swap is executed in the United States
or through any means of interstate commerce; or
The security-based swap is cleared through a clearing
agency having its principal place of business in the United States.
Under the initial proposal, if none of these conditions were true, a
foreign counterparty ``would not become a `participant' of an SDR and
would not become subject to proposed Regulation SBSR'' \908\--even if
the security-based swap itself and its counterparty were subject to
Regulation SBSR.
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\908\ Regulation SBSR Proposing Release, 75 FR 75240.
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In light of other revisions being made to Regulation SBSR discussed
above, the Commission is now proposing several conforming revisions to
proposed Rule 908(b). First, consistent with the other revisions
described above, Rule 908(b) is being re-proposed to account for the
possibility that a non-U.S. person security-based swap dealer or major
security-based swap participant could incur a duty to report. Second,
consistent with the broader conceptual framework set forth in this
release, the ``interstate commerce clause,'' used in the initial
proposal to describe a security-based swap that may generate reporting
duties for counterparties under Regulation SBSR,\909\ is being replaced
with the new concept of a ``transaction conducted within the United
States'' that is being used throughout the Commission's proposed cross-
border rules.\910\ Therefore, re-proposed Rule 908(b) would provide
that a direct or indirect counterparty to a security-based swap would
not incur any obligation under Regulation SBSR unless the counterparty
were:
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\909\ See Rule 908(b)(2) of Regulation SBSR, as originally
proposed.
\910\ See Section III.B.6, supra (discussing the proposed
definition of ``transaction conducted within the Unites States'').
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A U.S. person;