[Federal Register Volume 81, Number 33 (Friday, February 19, 2016)]
[Rules and Regulations]
[Pages 8598-8637]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-03178]
[[Page 8597]]
Vol. 81
Friday,
No. 33
February 19, 2016
Part II
Securities and Exchange Commission
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17 CFR Part 240
Security-Based Swap Transactions Connected With a Non-U.S. Person's
Dealing Activity That Are Arranged, Negotiated, or Executed by
Personnel Located in a U.S. Branch or Office or in a U.S. Branch or
Office of an Agent; Security-Based Swap Dealer De Minimis Exception;
Final Rule
Federal Register / Vol. 81 , No. 33 / Friday, February 19, 2016 /
Rules and Regulations
[[Page 8598]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-77104; File No. S7-06-15]
RIN 3235-AL73
Security-Based Swap Transactions Connected With a Non-U.S.
Person's Dealing Activity That Are Arranged, Negotiated, or Executed by
Personnel Located in a U.S. Branch or Office or in a U.S. Branch or
Office of an Agent; Security-Based Swap Dealer De Minimis Exception
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting amendments to Exchange Act rules 3a71-3 and
3a71-5 that address the application of the de minimis exception to
security-based swap transactions connected with a non-U.S. person's
security-based swap dealing activity that are arranged, negotiated, or
executed by personnel of such person located in a U.S. branch or
office, or by personnel of such person's agent, located in a U.S.
branch or office.
DATES: Effective Date: April 19, 2016. Compliance Date: The later of
(a) February 21, 2017 or (b) the SBS Entity Counting Date, as defined
in Section VII of the Supplementary Information.
FOR FURTHER INFORMATION CONTACT: Carol McGee, Assistant Director,
Richard Gabbert, Senior Special Counsel, or Margaret Rubin, Special
Counsel, Office of Derivatives Policy, at 202-551-5870, Division of
Trading and Markets, Securities and Exchange Commission, 100 F Street
NE., Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is amending Exchange Act rule
3a71-3 (addressing the cross-border implementation of the de minimis
exception to the ``security-based swap dealer'' definition and the
definition of certain terms) and Exchange Act rule 3a71-5 (regarding
availability of an exception from the dealer de minimis analysis for
cleared anonymous transactions that fall within rule 3a71-
3(b)(1)(iii)(C)).
Table of Contents
I. Background
A. Scope of This Rulemaking
B. The Dodd-Frank Act
C. Relevant Proposing Releases
D. Relevant CFTC Guidance
E. Overview of Comments Received
II. Economic Considerations and Baseline Analysis
A. Baseline
1. Available Data Regarding Security-Based Swap Activity
2. Security-Based Swap Market: Market Participants and Dealing
Structures
3. Security-Based Swap Market: Levels of Security-Based Swap
Trading Activity
4. Global Regulatory Efforts
5. Cross-Market Participation
B. Economic Considerations
III. Overview of Prior Proposals
IV. Final Rules
A. Overview
B. Statutory Scope and Policy Concerns Arising From Security-
Based Swap Dealing Activity in the United States
1. Territorial Application of ``Security-Based Swap Dealer''
Definition
2. Policy Concerns Associated With Security-Based Swap Dealing
Activity in the United States
3. Existing Regulatory Frameworks and Security-Based Swap Dealer
Regulation
C. Application of the Dealer De Minimis Exception to Non-U.S.
Persons Using Personnel Located in a U.S. Branch or Office To
Arrange, Negotiate, or Execute Security-Based Swap Transactions
1. ``Arranging, Negotiating, or Executing'' a Security-Based
Swap Transaction
2. ``Located in a U.S. Branch or Office''
3. ``Personnel of Such Non-U.S. Person'' or ``Personnel of an
Agent''
4. Exception for Transactions Involving Certain International
Organizations
D. Availability of the Exception for Cleared Anonymous
Transactions
V. Economic Analysis
A. Assessment Costs
1. Costs Associated With Increase in Number of Firms Performing
Analysis
2. Costs Associated With Determining the Location of Relevant
Personnel Who Arrange, Negotiate, or Execute a Transaction
B. Programmatic Costs and Benefits
1. Benefits and Costs of the Final Rules
2. Effects of Rule Amendments on Efficiency, Competition, and
Capital Formation
C. Alternatives Considered
1. Retention of the Definition of ``Transaction Conducted Within
the United States''
2. Limited Exception From Title VII Requirements for
Transactions Arranged, Negotiated, and Executed by Personnel Subject
to Existing Domestic or Foreign Regulatory Requirements
3. Non-Inclusion of Security-Based Swap Transactions Involving
Dealing Activity in the United States in the De minimis Threshold
Calculations
4. Exception for Transactions Entered Into Anonymously on an
Exchange and Cleared
5. Exception for Transactions Cleared Through Foreign Clearing
Agencies
6. Exception for Transactions Arranged, Negotiated, or Executed
in the United States Merely to Accommodate Foreign Clients' Needs
When Foreign Markets Are Closed
VI. Regulatory Flexibility Act Certification
VII. Effective Date and Implementation
Statutory Basis and Text of Final Rules
I. Background
A. Scope of This Rulemaking
In April 2015, the Commission proposed to amend certain rules and
to re-propose a rule regarding the application of Title VII of the
Dodd-Frank Act \1\ (``Title VII'') to cross-border security-based swap
transactions and persons engaged in those transactions.\2\ The proposed
amendments included rules regarding the application of the de minimis
exception to the dealing activity of non-U.S. persons carried out, in
relevant part, by personnel located in the United States,\3\ and the
application of Regulation SBSR \4\ to such transactions and to
transactions effected by or through a registered broker-dealer, along
with certain related issues. We also re-proposed a rule regarding the
application of business conduct requirements to the foreign business
and U.S. business of registered security-based swap dealers.\5\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010). Unless otherwise
indicated, references to Title VII in this release are to Subtitle B
of Title VII.
\2\ Application of Certain Title VII Requirements to Security-
Based Swap Transactions Connected With a Non-U.S. Person's Dealing
Activity That Are Arranged, Negotiated, or Executed by Personnel
Located in a U.S. Branch or Office or in a U.S. Branch or Office of
an Agent, Exchange Act Release No. 74834 (April 29, 2015), 80 FR
27443 (May 13, 2015) (``U.S. Activity Proposing Release'').
\3\ In this release, unless otherwise noted, we use the terms
``personnel located in the United States'' or ``personnel located in
a U.S. branch or office'' interchangeably to refer to personnel of
the non-U.S. person engaged in security-based swap dealing activity
who are located in a U.S. branch or office, or to personnel of an
agent of such non-U.S. person who are located in a U.S. branch or
office.
\4\ Regulation SBSR--Reporting and Dissemination of Security-
Based Swap Information; Final Rule, Exchange Act Release No. 74244
(February 11, 2015), 80 FR 14563 (March 19, 2015) (``Regulation SBSR
Adopting Release'').
\5\ Each of these issues had previously been considered in our
May 23, 2013 proposal, in which we proposed rules regarding the
application of Title VII in the cross-border context more generally.
See 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, Exchange Act Release No. 69490 (May 1, 2013), 78
FR 30967 (May 23, 2013) (``Cross-Border Proposing Release'').
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In this release, we are adopting rule amendments relating
specifically to the first of these issues: The application of the de
minimis exception to non-U.S. persons that are engaged in dealing
activity with other non-U.S. persons using personnel located in the
United States. Consistent with the proposal, these amendments focus on
the activity of the person or persons acting in a dealing capacity in
the transaction. Specifically, Exchange Act rule 3a71-3(b)(1)(iii)(C)
requires a non-U.S. person to include in its de minimis calculation
[[Page 8599]]
any transaction with a non-U.S.-person counterparty that is, in
connection with its dealing activity, arranged, negotiated, or executed
by personnel of the non-U.S. person located in a U.S. branch or office
or by personnel of the non-U.S. person's agent located in a U.S. branch
or office. This test (``U.S. Activity Test'') focuses on the location
of the personnel acting on behalf of the non-U.S. person engaged in
dealing activity. This approach focuses on the activities of non-U.S.
persons that are most likely to raise the types of concerns addressed
by Title VII security-based swap dealer regulation. At the same time,
it avoids the unnecessary complexity of the initially proposed
application of the de minimis exception to transactions between two
non-U.S. persons based on the location of dealing activity. The final
rules do not require a non-U.S. person engaging in dealing activity to
consider the location of any activity carried out by or on behalf of
its counterparty in determining whether the transaction needs to be
included in its own de minimis calculation.
We are not addressing in this release any of the other elements of
the April 2015 proposal. We anticipate addressing the remaining issues
(including the application of business conduct standards, of Regulation
SBSR to certain transactions, and the application of clearing and trade
execution requirements more generally) in subsequent releases.\6\
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\6\ Cf. Letter from Citadel, dated February 2, 2016, at 12
(urging the Commission to address the scope of the Title VII
mandatory clearing or trading requirement ``in the context of those
specific rulemakings, rather than in an overarching cross-border
rule'').
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Further, we note that these rules complete our rulemaking
implementing the de minimis exception for security-based swap dealers.
However, in the Intermediary Definitions Adopting Release we adopted
rule 3a71-2 establishing a phase-in period in connection with a
person's status as a security-based swap dealer and other regulatory
requirements arising from dealer status.\7\ We established a $3 billion
notional threshold for the de minimis exception with respect to single-
name credit default swaps (``CDS''), subject to a phase-in level of $8
billion.\8\ During the phase-in period Commission staff will study the
security-based swap market as it evolves under the new regulatory
framework, resulting in a report that will consider the operation of
the ``security-based swap dealer'' and ``major security-based swap
participant'' definitions. As we explained in the Intermediary
Definitions Adopting Release, at the end of the phase-in period, we
will take into account the report, as well as public comment on the
report, in determining whether to terminate the phase-in period or
propose any changes to the rules implementing the de minimis exception,
including any increases or decreases to both the $3 billion threshold
for credit default swaps and the $150 million threshold for other types
of security-based swaps.\9\
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\7\ 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 (April 27, 2012), 77 FR 30595, 30640 (May 23,
2012) (``Intermediary Definitions Adopting Release'').
\8\ See Exchange Act rule 3a71-2. The threshold and phase-in
levels for other types of security-based swaps are $150 million and
$400 million, respectively. See id.
\9\ See Intermediary Definitions Adopting Release, 77 FR 30640-
41 and n.523.
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B. The Dodd-Frank Act
As we have previously noted, Title VII of the Dodd-Frank Act
provides for a comprehensive new regulatory framework for swaps and
security-based swaps.\10\ Under this framework, the Commodity Futures
Trading Commission (``CFTC'') regulates ``swaps'' while the Commission
regulates ``security-based swaps,'' and the Commission and CFTC jointly
regulate ``mixed swaps.'' Security-based swap transactions are largely
cross-border in practice,\11\ and the various market participants and
infrastructures operate in a global market. A key part of this
framework is the regulation of security-based swap dealers, which may
transact extensively with counterparties established or located in
other jurisdictions and, in doing so, may conduct sales and trading
activity in one jurisdiction and book the resulting transactions in
another. These market realities and the potential impact that these
activities may have on U.S. persons and potentially the U.S. financial
system have informed our consideration of these rules.
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\10\ See U.S. Activity Proposing Release, 80 FR 27446.
\11\ See Section II.A.3, infra, regarding the preponderance of
cross-border activity in the security-based swap market.
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In developing these final rules, we have consulted and coordinated
with the CFTC and the prudential regulators \12\ in accordance with the
consultation mandate of the Dodd-Frank Act.\13\ We also have consulted
and coordinated with foreign regulatory authorities through Commission
staff participation in numerous bilateral and multilateral discussions
with foreign regulatory authorities addressing the regulation of OTC
(over-the-counter) derivatives.\14\ Through these discussions and the
Commission staff's participation in various international task forces
and working groups,\15\ we have gathered information about foreign
regulatory reform efforts and their impact on and relationship with the
U.S. regulatory regime. The Commission has taken and will continue to
take these discussions into consideration in developing rules, forms,
and interpretations for implementing Title VII of the Dodd-Frank
Act.\16\
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\12\ The term ``prudential regulator'' is defined in section
1a(39) of the Commodity Exchange Act, 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, 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 or major
security-based swap participant if the entity is directly supervised
by that regulator.
\13\ Section 712(a)(2) of the Dodd-Frank Act provides in part
that the 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.'' See Letter
from Managed Funds Association, dated July 13, 2015 (``MFA
Letter''), at 4 (emphasizing need for Commission and its U.S.
counterparts to develop a single, harmonized approach to cross-
border derivatives regulation).
\14\ For example, senior representatives of authorities with
responsibility for regulation of OTC derivatives have met on a
number of occasions to discuss international coordination of OTC
derivatives regulations. See, e.g., Report of the OTC Derivatives
Regulators Group to G20 Leaders on Cross-Border Implementation
Issues November 2015 (November 2015), available at: http://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/file/odrgreportg20_1115.pdf.
\15\ Commission representatives participate in the Financial
Stability Board's Working Group on OTC Derivatives Regulation
(``ODWG''), both on the Commission's behalf and as the
representative of the International Organization of Securities
Commissions (``IOSCO''), which is co-chair of the ODWG. A Commission
representative serves as one of the co-chairs of the IOSCO Task
Force on OTC Derivatives Regulation. Commission representatives
participate in joint working groups of the Committee on Payments and
Market Infrastructures (``CPMI'') and IOSCO that examine key data
elements of OTC derivatives transactions and participated in the
Financial Stability Board's review of OTC derivatives trade
reporting. Commission representatives also participate in
international working groups that impact OTC derivatives financial
market infrastructures, such as CPMI-IOSCO joint working groups that
assess legal and regulatory frameworks for central counterparties
and trade repositories and that examine central counterparty
resilience and recovery.
\16\ See Section 752(a) of the Dodd-Frank Act (providing 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 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.'').
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[[Page 8600]]
C. Relevant Proposing Releases
As discussed in further detail below, we have twice proposed rules
related to the application of the dealer de minimis calculations to
security-based swap transactions that involve activity in the United
States. In both proposals, we discussed the global nature of the
security-based swap market and explained our view that dealing activity
carried out by a non-U.S. person through a branch, office, affiliate,
or agent acting on its behalf in the United States may raise concerns
that Title VII addresses, even if a significant proportion--or all--of
those transactions involve non-U.S.-person counterparties.\17\
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\17\ See Cross-Border Proposing Release, 78 FR 31000-01; U.S.
Activity Proposing Release, 80 FR 27463.
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We initially proposed to require any non-U.S. person engaged in
dealing activity to include in its de minimis calculation any
``transaction conducted within the United States.'' \18\ Thus, under
the Cross-Border Proposing Release, a non-U.S. person engaged in
security-based-swap dealing activity would have been required to
include in its de minimis calculation any dealing transaction entered
into with another non-U.S. person that was conducted in the United
States by either the non-U.S. person engaged in dealing activity or its
counterparty. In our April 2015 proposal, we proposed a modified
approach to applying the dealer de minimis exception to transactions
between two non-U.S. persons based on activity in the United States
that focused exclusively on the location of personnel engaged in
relevant activity in connection with a non-U.S. person's dealing
activity.\19\
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\18\ Cross-Border Proposing Release, 78 FR 30999-31000.
\19\ See U.S. Activity Proposing Release, 80 FR 27459.
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D. Relevant CFTC Guidance
As discussed in our April 2015 proposal, the CFTC's Division of
Swap Dealer and Intermediary Oversight issued a Staff Advisory (``CFTC
Staff Advisory'') in November 2013 that addressed the applicability of
the CFTC's transaction-level requirements to certain activity by non-
U.S. registered swap dealers arranged, negotiated, or executed by
personnel or agents of the non-U.S. swap dealer located in the United
States.\20\ The CFTC subsequently solicited and received public comment
on various aspects of the CFTC Staff Advisory,\21\ and we discussed
these comments in our April 2015 proposal.\22\ On August 13, 2015, the
CFTC staff extended no-action relief related to the CFTC Staff Advisory
until the earlier of September 30, 2016, or the effective date of any
CFTC action addressing related issues.\23\
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\20\ See CFTC Staff Advisory No. 13-69, ``Division of Swap
Dealer and Intermediary Oversight Advisory: Applicability of
Transaction-Level Requirements to Activity in the United States''
(November 14, 2013), available at: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-69.pdf.
In the Interpretive Guidance and Policy Statement Regarding
Compliance with Certain Swap Regulations (July 17, 2013), 78 FR
45292 (July 26, 2013) (``CFTC Cross-Border Guidance''), the CFTC
defined transaction-level requirements to include the following: (i)
Required clearing and swap processing; (ii) margining (and
segregation) for uncleared swaps; (iii) mandatory trade execution;
(iv) swap trading relationship documentation; (v) portfolio
reconciliation and compression; (vi) real-time public reporting;
(vii) trade confirmation; (viii) daily trading records; and (ix)
external business conduct standards. See CFTC Cross-Border Guidance,
78 FR 45333.
\21\ See Request for Comment on Application of Commission
Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S.
Counterparties Involving Personnel or Agents of the Non-U.S. Swap
Dealers Located in the United States, 79 FR 1347 (January 8, 2014)
(``CFTC Request for Comment'').
\22\ See U.S. Activity Proposing Release, 80 FR 27461-63.
\23\ See Extension of No-Action Relief: Transaction-Level
Requirements for Non-U.S. Swap Dealers, CFTC Letter No. 15-48
(August 13, 2015), available at: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-48.pdf.
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E. Overview of Comments Received
As we discuss in more detail below, we received fifteen comment
letters in response to our U.S. Activity Proposing Release. These
comment letters address a range of issues, including the scope of the
proposed U.S. Activity Test and concerns about its use as a trigger for
the counting of transactions toward the de minimis thresholds of non-
U.S. persons, as well as other issues--such as external business
conduct, regulatory reporting and public dissemination, and mandatory
trade execution and clearing--that we anticipate addressing in
subsequent releases. Several commenters expressed support for our
proposed U.S. Activity Test, and one commenter expressed general
support for the rules proposed in the U.S. Activity Proposing
Release.\24\ Several commenters, however, raised concerns about the use
of the U.S. Activity Test to identify transactions that non-U.S.
persons are required to include in their dealer de minimis
calculations, arguing, among other things, that capturing these
transactions would not advance the mitigation of risk, which commenters
identified as the principal concern of Title VII dealer regulation,\25\
would impose excessive costs on market participants,\26\ and would
cause market fragmentation and decreased liquidity for U.S. market
participants.\27\
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\24\ See Letter from Chris Barnard, dated June 26, 2015 (``Chris
Barnard Letter''), at 2.
\25\ See, e.g., Letter from International Swaps and Derivatives
Association (``ISDA''), dated July 13, 2015 (``ISDA Letter''), at 5-
6.
\26\ See Letter from Institute of International Bankers, dated
July 13, 2015 (``IIB Letter''), at 7; ISDA Letter at 6; Letter from
Securities Industry and Financial Markets Association and Financial
Services Roundtable, dated July 13, 2015 (``SIFMA/FSR Letter''), at
6; Letter from HSBC, dated July 13, 2015 (``HSBC Letter''), at 1-3;
Letter from Securities Industry and Financial Markets Association,
dated January 13, 2015 (``SIFMA Sequencing Letter''), at 5.
\27\ See, e.g., SIFMA/FSR Letter at 2, 6; IIB Letter at 2; ISDA
Letter at 5.
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II. Economic Considerations and Baseline Analysis
These final rules will determine when a non-U.S. person engaged in
dealing activity and whose obligations under a security-based swap are
not guaranteed by a U.S. person and that is not a conduit affiliate is
required to include in its dealer de minimis threshold calculations
transactions with another non-U.S. person.\28\ To provide context for
understanding our final rules and the related economic analysis that
follows, this section provides an overview of the current state of the
security-based swap market and the existing regulatory framework; it
also identifies economic considerations that we believe underlie the
likely economic effects of these rules.
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\28\ Pursuant to Exchange Act rules 3a71-3(b)(1)(ii) and
(iii)(B), any transaction of a non-U.S. person engaged in dealing
activity and that is a conduit affiliate or whose counterparty to
the security-based swap has rights of recourse against a U.S. person
that is controlling, controlled by, or under common control with the
non-U.S. person is already required to be counted toward the non-
U.S. person's de minimis thresholds regardless of where personnel of
the non-U.S. person arranges, negotiates, or executes the
transactions.
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A. Baseline
To assess the economic impact of the final rules described in this
release, we are using as our baseline the security-based swap market as
it exists at the time of this release, including applicable rules we
have already adopted but excluding rules that we have proposed but not
yet finalized.\29\ The analysis includes the statutory provisions that
currently govern the security-based swap market pursuant to the Dodd-
Frank Act and rules adopted in the Intermediary Definitions Adopting
Release, the Cross-Border
[[Page 8601]]
Adopting Release,\30\ the SDR Rules and Core Principles Adopting
Release,\31\ the SBS Entity Registration Adopting Release,\32\ and the
Regulation SBSR Adopting Release,\33\ as these final rules--even if
compliance is not yet required--are part of the existing regulatory
landscape that market participants expect to govern their security-
based swap activity. The following sections describe current security-
based swap market activity, participants, common dealing structures,
counterparties, and patterns of cross-border and cross-market
participation.
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\29\ We also considered, where appropriate, the impact of rules
and technical standards promulgated by other regulators, such as the
CFTC and the European Securities and Markets Authority, on practices
in the security-based swap market.
\30\ See Application of ``Security-Based Swap Dealer'' and
``Major-Security-Based Swap Participant'' Definitions to Cross-
Border Security-Based Swap Activities, Exchange Act Release No.
72472 (June 25, 2014), 79 FR 47277 (August 12, 2014 (republication))
(``Cross-Border Adopting Release'').
\31\ See Security-Based Swap Data Repository Registration,
Duties, and Core Principles, Exchange Act Release No. 74246
(February 11, 2015), 80 FR 14437 (March 19, 2015) (``SDR Rules and
Core Principles Adopting Release'').
\32\ See Registration Process for Security-Based Swap Dealers
and Major Security-Based Swap Participants, Exchange Act Release No.
75611 (August 5, 2015), 80 FR 48963 (August 14, 2015) (``SBS Entity
Registration Adopting Release'').
\33\ See Regulation SBSR-Reporting and Dissemination of
Security-Based Swap Information, Exchange Act Release No. 74244
(February 11, 2015), 80 FR 14563 (March 19, 2015) (``Regulation SBSR
Adopting Release'').
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1. Available Data Regarding Security-Based Swap Activity
Our understanding of the market is informed in part by available
data on security-based swap transactions, though we acknowledge that
limitations in the data limit the extent to which we can quantitatively
characterize the market.\34\ Because these data do not cover the entire
market, we have developed an understanding of market activity using a
sample of transactions data that includes only certain portions of the
market. We believe, however, that the data underlying our analysis here
provide reasonably comprehensive information regarding single-name CDS
transactions and the composition of participants in the single-name CDS
market.
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\34\ We also rely on qualitative information regarding market
structure and evolving market practices provided by commenters, both
in letters and in meetings with Commission staff, and knowledge and
expertise of Commission staff.
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Specifically, our analysis of the state of the current security-
based swap market is based on data obtained from the DTCC Derivatives
Repository Limited Trade Information Warehouse (``TIW''), especially
data regarding the activity of market participants in the single-name
CDS market during the period from 2008 to 2014. According to data
published by the Bank for International Settlements (``BIS''), the
global notional amount outstanding in single-name CDS was approximately
$9.04 trillion,\35\ in multi-name index CDS was approximately $6.75
trillion, and in multi-name, non-index CDS was approximately $611
billion. The total gross market value outstanding in single-name CDS
was approximately $366 billion, and in multi-name CDS instruments was
approximately $227 billion.\36\ The global notional amount outstanding
in equity forwards and swaps as of December 2014 was $2.50 trillion,
with total gross market value of $177 billion.\37\ As these figures
show (and as we have previously noted), although the definition of
security-based swaps is not limited to single-name CDS, single-name CDS
contracts make up a majority of security-based swaps, and we believe
that the single-name CDS data are sufficiently representative of the
market to inform our analysis of the state of the current security-
based swap market.\38\
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\35\ The global notional amount outstanding represents the total
face amount used to calculate payments under outstanding contracts.
The gross market value is the cost of replacing all open contracts
at current market prices.
\36\ See semi-annual OTC derivatives statistics at December
2014, Table 19, available at http://www.bis.org/statistics/dt1920a.pdf (accessed July 29, 2015).
\37\ These totals include both swaps and security-based swaps,
as well as products that are excluded from the definition of
``swap,'' such as certain equity forwards.
\38\ While other repositories may collect data on transactions
in total return swaps on equity and debt, we do not currently have
access to such data for these products (or other products that are
security-based swaps). Consistent with the Cross-Border Proposing
Release, we believe that data related to single-name CDS provide
reasonably comprehensive information for purposes of this analysis,
as such transactions appear to constitute roughly 74 percent of the
security-based swap market as measured on the basis of gross
notional outstanding. See Cross-Border Proposing Release, 78 FR
31120 n.1301.
Also consistent with our approach in that release, with the
exception of the analysis regarding the degree of overlap between
participation in the single-name CDS market and the index CDS market
(cross-market activity), our analysis below does not include data
regarding index CDS as we do not currently have sufficient
information to classify index CDS as swaps or security-based swaps.
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We note that the data available to us from TIW do not encompass
those CDS transactions that both: (i) Do not involve U.S.
counterparties; \39\ and (ii) are based on non-U.S. reference entities.
Notwithstanding this limitation, the TIW data should provide sufficient
information to permit us to identify the types of market participants
active in the security-based swap market and the general pattern of
dealing within that market.\40\
---------------------------------------------------------------------------
\39\ Following publication of the Warehouse Trust Guidance on
CDS data access, TIW surveyed market participants, asking for the
physical address associated with each of their accounts (i.e., where
the account is organized as a legal entity). This physical address
is designated the registered office location by TIW. When an account
reports a registered office location, we have assumed that the
registered office location reflects the place of domicile for the
fund or account. When an account does not report a registered office
location, we have assumed that the settlement country reported by
the investment adviser or parent entity to the fund or account is
the place of domicile. Thus, for purposes of this analysis, we have
classified accounts as ``U.S. counterparties'' when they have
reported a registered office location in the United States. We note,
however, that this classification is not necessarily identical in
all cases to the definition of ``U.S. person'' under Exchange Act
rule 3a71-3(a)(4).
\40\ The challenges we face in estimating measures of current
market activity stem, in part, from the absence of comprehensive
reporting requirements for security-based swap market participants.
The Commission has adopted rules regarding trade reporting, data
elements, and public reporting for security-based swaps that are
designed to, when fully implemented, provide the Commission with
additional measures of market activity that will allow us to better
understand and monitor activity in the security-based swap market.
See Regulation SBSR Adopting Release, 80 FR 14699-14700.
---------------------------------------------------------------------------
One commenter recommended that we collect a more complete set of
data to more precisely estimate the number of non-U.S. persons that
would be affected by the proposed rules.\41\ Given the absence of
comprehensive reporting requirements for security-based swap
transactions, and the fact that the location of personnel that arrange,
negotiate, or execute a security-based swap transaction is not
currently available in TIW, a more precise estimate of the number of
non-U.S. persons affected by this rule is not currently feasible.
However, because we assume that all transactions by dealers classified
as non-U.S. persons with other persons classified as non-U.S. persons
on U.S. reference entities are arranged, negotiated, or executed by
personnel located in the United States, we believe our analysis of the
available data reflects a reasonable estimate for identifying broad
market effects and estimating the number of firms that would likely
assess the location of their dealing activity.\42\
---------------------------------------------------------------------------
\41\ See ISDA Letter at 3, 7 (arguing that the Commission lacks
complete data to estimate the number of non-U.S. persons that use
U.S. personnel to arrange, negotiate, or execute security-based swap
transactions or the number of registered U.S. broker-dealers that
intermediate these transactions and that this ``makes it difficult
or impossible for the Commission to formulate a useful estimate of
the market impact, cost and benefits of the Proposal''; suggesting
that the Commission ``gather[ ] more robust and complete data prior
to finalizing a rulemaking that will have meaningful impact on a
global market.'').
\42\ See Section V.A.1, infra.
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[[Page 8602]]
2. Security-Based Swap Market: Market Participants and Dealing
Structures
a. Security-Based Swap Market Participants
Activity in the security-based swap market is concentrated among a
relatively small number of entities that act as dealers in this market.
In addition to these entities, thousands of other participants appear
as counterparties to security-based swap contracts in our sample, and
include, but are not limited to, investment companies, pension funds,
private (hedge) funds, sovereign entities, and industrial companies. We
observe that most non-dealer users of security-based swaps do not
engage directly in the trading of swaps, but trade through banks,
investment advisers, or other types of firms acting as dealers or
agents. Based on an analysis of the counterparties to trades reported
to the TIW, there are 1,875 entities that engaged directly in trading
between November 2006 and December 2014.\43\
---------------------------------------------------------------------------
\43\ These 1,875 entities, which are presented in more detail in
Table 1, below, include all DTCC-defined ``firms'' shown in TIW as
transaction counterparties that report at least one transaction to
TIW as of December 2014. The staff in the Division of Economic and
Risk Analysis classified these firms, which are shown as transaction
counterparties, by machine matching names to known third-party
databases and by manual classification. See, e.g., Cross-Border
Proposing Release, 78 FR 31120 n.1304. Manual classification was
based in part on searches of the EDGAR and Bloomberg databases, the
SEC's Investment Adviser Public Disclosure database, and a firm's
public Web site or the public Web site of the account represented by
a firm. The staff also referred to ISDA protocol adherence letters
available on the ISDA Web site.
---------------------------------------------------------------------------
As shown in Table 1, below, close to three-quarters of these
entities (DTCC-defined ``firms'' shown in TIW, which we refer to here
as ``transacting agents'') were identified as investment advisers, of
which approximately 40 percent (about 30 percent of all transacting
agents) were registered as investment advisers under the Investment
Advisers Act of 1940 (``Investment Advisers Act'').\44\ Although
investment advisers comprise the vast majority of transacting agents,
the transactions they executed account for only 11.5 percent of all
single-name CDS trading activity reported to the TIW, measured by
number of transaction-sides (each transaction has two transaction
sides, i.e., two transaction counterparties). The vast majority of
transactions (83.7 percent) measured by number of transaction-sides
were executed by ISDA-recognized dealers.
---------------------------------------------------------------------------
\44\ See 15 U.S.C. 80b1-80b21. Transacting agents participate
directly in the security-based swap market, without relying on an
intermediary, on behalf of principals. For example, a university
endowment may hold a position in a security-based swap that is
established by an investment adviser that transacts on the
endowment's behalf. In this case, the university endowment is a
principal that uses the investment adviser as its transacting agent.
Table 1--The Number of Transacting Agents by Counterparty Type and the Fraction of Total Trading Activity, From
November 2006 Through December 2014, Represented by Each Counterparty Type \45\
----------------------------------------------------------------------------------------------------------------
Transacting agents Number Percent Transaction share
----------------------------------------------------------------------------------------------------------------
Investment Advisers.................................... 1,425 76.0 11.5%
--SEC registered................................... 571 30.5 7.7%
Banks.................................................. 252 13.4 4.3%
Pension Funds.......................................... 27 1.4 0.1%
Insurance Companies.................................... 38 2.0 0.2%
ISDA-Recognized Dealers \46\........................... 17 0.9 83.7%
Other.................................................. 116 6.2 0.2%
--------------------------------------------------------
Total.......................................... 1,875 99.9 100%
----------------------------------------------------------------------------------------------------------------
Principal holders of CDS risk exposure are represented by
``accounts'' in the TIW.\47\ The staff's analysis of these accounts in
TIW shows that the 1,875 transacting agents classified in Table 1
represent 10,900 principal risk holders. Table 2, below, classifies
these principal risk holders by their counterparty type and whether
they are represented by a registered or unregistered investment
adviser.\48\ For instance, banks in Table 1 allocated transactions
across 327 accounts, of which 23 were represented by investment
advisers. In the remaining 304 instances, banks traded for their own
accounts. Meanwhile, ISDA-recognized dealers in Table 1 allocated
transactions across 75 accounts.
---------------------------------------------------------------------------
\45\ Adjustments to these statistics from the proposal reflect
updated classifications of counterparties and transactions
classification resulting from further analysis of the TIW data.
\46\ For the purpose of this analysis, the ISDA-recognized
dealers are those identified by ISDA as belonging to the G14 or G16
dealer group during the period: JP Morgan Chase NA (and Bear
Stearns), Morgan Stanley, Bank of America NA (and Merrill Lynch),
Goldman Sachs, Deutsche Bank AG, Barclays Capital, Citigroup, UBS,
Credit Suisse AG, RBS Group, BNP Paribas, HSBC Bank, Lehman
Brothers, Soci[eacute]t[eacute] G[eacute]n[eacute]rale, Credit
Agricole, Wells Fargo and Nomura. See, e.g., http://www.isda.org/c_and_a/pdf/ISDA-Operations-Survey-2010.pdf.
\47\ ``Accounts'' as defined in the TIW context are not
equivalent to ``accounts'' in the definition of ``U.S. person''
provided by Exchange Act rule 3a71-3(a)(4)(i)(C). They also do not
necessarily represent separate legal persons. One entity or legal
person may have multiple accounts. For example, a bank may have one
DTCC account for its U.S. headquarters and one DTCC account for one
of its foreign branches.
\48\ Unregistered investment advisers include all investment
advisers not registered under the Investment Advisers Act and may
include investment advisers registered with a state or a foreign
authority.
[[Page 8603]]
Table 2--The Number and Percentage of Account Holders--by Type--Who Participate in the Security-Based Swap
Market Through a Registered Investment Adviser, an Unregistered Investment Adviser, or Directly as a Transacting
Agent, From November 2006 Through December 2014 \49\
----------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
Account holders by type Number Represented by a
registered
investment adviser
Represented by an
unregistered
investment adviser
Participant is
transacting agent
\50\
----------------------------------------------------------------------------------------------------------------
Private Funds...................... 3,168 1,569 50% 1,565 49% 34 1%
DFA Special Entities............... 1,141 1,088 95% 33 3% 20 2%
Registered Investment Companies.... 800 768 96% 30 4% 2 0%
Banks (non-ISDA-recognized dealers) 327 17 5% 6 2% 304 93%
Insurance Companies................ 232 150 65% 21 9% 61 26%
ISDA-Recognized Dealers............ 75 0 0% 0 0% 75 100%
Foreign Sovereigns................. 72 53 74% 3 4% 16 22%
Non-Financial Corporations......... 61 43 70% 3 5% 15 25%
Finance Companies.................. 13 6 46% 0 0% 7 54%
Other/Unclassified................. 5,011 3,327 66% 1,452 29% 232 5%
----------------------------------------------------------------------------
All............................ 10,900 7,021 64% 3,113 29% 766 7%
----------------------------------------------------------------------------------------------------------------
Among the accounts, there are 1,141 Dodd-Frank Act-defined special
entities and 800 investment companies registered under the Investment
Company Act of 1940.\51\ Private funds comprise the largest type of
account holders that we were able to classify, and, although not
verified through a recognized database, most of the funds we were not
able to classify appear to be private funds.\52\
---------------------------------------------------------------------------
\49\ Adjustments to these statistics from the proposal reflect
updated counterparty and transaction classification resulting from
additional analysis of the TIW data.
\50\ This column reflects the number of participants who are
also trading for their own accounts.
\51\ See 15 U.S.C. 80a1-80a64. There remain approximately 5,000
DTCC ``accounts'' unclassified by type. Although unclassified, each
was manually reviewed to verify that it was not likely to be a
special entity within the meaning of the Dodd-Frank Act and instead
was likely to be an entity such as a corporation, an insurance
company, or a bank.
\52\ For the purposes of this discussion, ``private fund''
encompasses various unregistered pooled investment vehicles,
including hedge funds, private equity funds, and venture capital
funds.
[GRAPHIC] [TIFF OMITTED] TR19FE16.001
[[Page 8604]]
b. Participant Domiciles
As depicted in Figure 1 above, the domiciles of new accounts
participating in the market have shifted over time. It is unclear
whether these shifts represent changes in the types of participants
active in this market, changes in reporting, or changes in transaction
volumes in particular underliers. For example, the increased percentage
of new entrants that are foreign accounts may reflect an increase in
participation by foreign account holders in the security-based swap
market, and the increased percentage of the subset of new entrants that
are foreign accounts managed by U.S. persons also may reflect more
specifically the flexibility with which market participants can
restructure their market participation in response to regulatory
intervention, competitive pressures, and other stimuli.\54\ On the
other hand, apparent changes in the percentage of new accounts with
foreign domiciles may reflect improvements in reporting by market
participants to TIW, an increase in the percentage of transactions
between U.S. and non-U.S. counterparties, and/or increased transactions
in single-name CDS on U.S. reference entities by foreign persons.\55\
---------------------------------------------------------------------------
\53\ See note 39, supra (explaining how domiciles for firms were
identified for purposes of this analysis).
\54\ See Charles Levinson, ``U.S. banks moved billions in trades
beyond the CFTC's reach,'' Reuters (August 21, 2015), available at:
http://www.reuters.com/article/2015/08/21/usa-banks-swaps-idUSL3N10S57R20150821.
\55\ As noted above, the available data do not include all
security-based swap transactions but only transactions in single-
name CDS that involve either (1) at least one account domiciled in
the United States (regardless of the reference entity) or (2)
single-name CDS on a U.S. reference entity (regardless of the U.S.-
person status of the counterparties).
---------------------------------------------------------------------------
c. Market Centers
A market participant's domicile, however, does not necessarily
correspond to where it engages in security-based swap activity. In
particular, financial groups engaged in security-based swap dealing
activity operate in multiple market centers and carry out such activity
with counterparties around the world.\56\ Several commenters noted that
many market participants that are engaged in dealing activity prefer to
use traders and manage risk for security-based swaps in the
jurisdiction where the underlier is traded.\57\ Thus, although a
significant amount of the dealing activity in security-based swaps on
U.S. reference entities involves non-U.S. dealers, we understand that
these dealers tend to carry out much of the security-based swap trading
and related risk-management activities in these security-based swaps
within the United States.\58\ Some dealers have explained that being
able to centralize their trading, sales, risk management and other
activities related to U.S. reference entities in U.S. operations (even
when the resulting transaction is booked in a foreign entity) improves
the efficiency of their dealing business.\59\
---------------------------------------------------------------------------
\56\ See U.S. Activity Proposing Release, 80 FR 27449-52.
\57\ See IIB Letter at 2; SIFMA/FSR Letter at 6; ISDA Letter at
5. One commenter indicated that a significant number of interdealer
transactions between two non-U.S. dealers involve trades arranged,
negotiated, or executed within the United States, although this
commenter did not specifically identify what underliers these trades
involved. See MFA/AIMA Letter at 7, note 34.
\58\ See IIB Letter at 2; SIFMA/FSR Letter at 6; ISDA Letter at
5.
\59\ See IIB Letter at 2; SIFMA/FSR Letter at 6; ISDA Letter at
5.
---------------------------------------------------------------------------
Consistent with these operational concerns and the global nature of
the security-based swap market, the available data appear to confirm
that participants in this market are in fact active in market centers
around the globe. Although, as noted above, the available data do not
permit us to identify the location of personnel in a transaction, TIW
transaction records indicate that firms that are likely to be security-
based swap dealers operate out of branch locations in key market
centers around the world, including New York, London, Tokyo, Hong Kong,
Chicago, Sydney, Toronto, Frankfurt, Singapore and the Cayman
Islands.\60\
---------------------------------------------------------------------------
\60\ TIW transaction records contain a proxy for the domicile of
an entity, which may differ from branch locations, which are
separately identified in the transaction records.
---------------------------------------------------------------------------
Given these market characteristics and practices, participants in
the security-based swap market may bear the financial risk of a
security-based swap transaction in a location different from the
location where the transaction is arranged, negotiated, or executed, or
where economic decisions are made by managers on behalf of beneficial
owners. And market activity may occur in a jurisdiction other than
where the market participant or its counterparty books the transaction.
Similarly, a participant in the security-based swap market may be
exposed to counterparty risk from a counterparty located in a
jurisdiction that is different from the market center or centers in
which it participates.
d. Common Business Structures for Firms Engaged in Security-Based Swap
Dealing Activity
A financial group that engages in a global security-based swap
dealing business in multiple market centers may choose to structure its
dealing business in a number of different ways. This structure,
including where it books the transactions that constitute that business
and how it carries out market-facing activities that generate those
transactions, reflects a range of business and regulatory
considerations, which each financial group may weigh differently.
A financial group may choose to book all of its security-based swap
transactions, regardless of where the transaction originated, in a
single, central booking entity. That entity generally retains the risk
associated with that transaction, but it also may lay off that risk to
another affiliate via a back-to-back transaction or an assignment of
the security-based swap.\61\ Alternatively, a financial group may book
security-based swaps arising from its dealing business in separate
affiliates, which may be located in the jurisdiction where it
originates the risk associated with the security-based swap or,
alternatively, the jurisdiction where it manages that risk.\62\ Some
financial groups may book transactions originating in a particular
region to an affiliate established in a jurisdiction located in that
region.\63\
---------------------------------------------------------------------------
\61\ See U.S. Activity Proposing Release, 80 FR 27463; Cross-
Border Proposing Release, 78 FR 30977-78.
\62\ See, e.g., HSBC Letter at 2; SIFMA/FSR Letter at 6-7.
\63\ There is some indication that this booking structure is
becoming increasingly common in the market. See, e.g., ``Regional
swaps booking replacing global hubs,'' Risk.net (September 4, 2015),
available at: http://www.risk.net/risk-magazine/feature/2423975/regional-swaps-booking-replacing-global-hubs. Such a development may
be reflected in the increasing percentage of new entrants that have
a foreign domicile, as described above in Section II.A.2.b.
---------------------------------------------------------------------------
Regardless of where a financial group determines to book its
security-based swaps arising out of its dealing activity, it is likely
to operate offices that perform sales or trading functions in one or
more market centers in other jurisdictions. Maintaining sales and
trading desks in global market centers permits the financial group to
deal with counterparties in that jurisdiction or in a specific
geographic region, or to ensure that it is able to provide liquidity to
counterparties in other jurisdictions,\64\ for example, when a
counterparty's home financial markets
[[Page 8605]]
are closed.\65\ A financial group engaged in a security-based swap
dealing business also may choose to manage its trading book in
particular reference entities or securities primarily from a trading
desk that can take advantage of local expertise in such products or
that can gain access to better liquidity, which may permit it to more
efficiently price such products or to otherwise compete more
effectively in the security-based swap market.\66\ Some financial
groups prefer to centralize risk management, pricing, and hedging for
specific products with the personnel responsible for carrying out the
trading of such products to mitigate operational risk associated with
transactions in those products.\67\
---------------------------------------------------------------------------
\64\ These offices may be branches or offices of the booking
entity itself, or branches or offices of an affiliated agent, such
as, in the United States, a registered broker-dealer.
\65\ See SIFMA/FSR Letter at 3; HSBC Letter at 2.
\66\ See HSBC Letter at 2.
\67\ See note 59, supra.
---------------------------------------------------------------------------
The financial group affiliate that books these transactions may
carry out related market-facing activities, whether in its home
jurisdiction or in a foreign jurisdiction, using either its own
personnel or the personnel of an affiliated or unaffiliated agent. For
example, the financial group may determine that another affiliate in
the financial group employs personnel who possess expertise in relevant
products or who have established sales relationships with key
counterparties in a foreign jurisdiction, making it more efficient to
use the personnel of the affiliate to engage in security-based swap
dealing activity on its behalf in that jurisdiction.\68\ In these
cases, the affiliate that books these transactions and its affiliated
agent may operate as an integrated dealing business, each performing
distinct core functions in carrying out that business.
---------------------------------------------------------------------------
\68\ See HSBC Letter at 2.
---------------------------------------------------------------------------
Alternatively, the financial group affiliate that books these
transactions may in some circumstances determine to engage the services
of an unaffiliated agent through which it can engage in dealing
activity. For example, a financial group may determine that using an
interdealer broker may provide an efficient means of participating in
the interdealer market in its own, or in another, jurisdiction,
particularly if it is seeking to do so anonymously or to take a
position in products that trade relatively infrequently.\69\ A
financial group may also use unaffiliated agents that operate at its
direction. Such an arrangement may be particularly valuable in enabling
a financial group to service clients or access liquidity in
jurisdictions in which it has no security-based swap operations of its
own.
---------------------------------------------------------------------------
\69\ We understand that interdealer brokers may provide voice or
electronic trading services that, among other things, permit dealers
to take positions or hedge risks in a manner that preserves their
anonymity until the trade is executed. These interdealer brokers
also may play a particularly important role in facilitating
transactions in less-liquid security-based swaps.
---------------------------------------------------------------------------
We understand that financial group affiliates (whether affiliated
with U.S.-based financial groups or not) that are established in
foreign jurisdictions may use any of these structures to engage in
dealing activity in the United States, and that they may seek to engage
in dealing activity in the United States to transact with both U.S.-
person and non-U.S.-person counterparties. In transactions with non-
U.S.-person counterparties, these foreign affiliates may affirmatively
seek to engage in dealing activity in the United States because the
sales personnel of the non-U.S.-person dealer (or of its agent) in the
United States have existing relationships with counterparties in other
locations (such as Canada or Latin America) or because the trading
personnel of the non-U.S.-person dealer (or of its agent) in the United
States have the expertise to manage the trading books for security-
based swaps on U.S. reference securities or entities. We understand
that some of these foreign affiliates engage in dealing activity in the
United States through their personnel (or personnel of their
affiliates) in part to ensure that they are able to provide their own
counterparties, or those of financial group affiliates in other
jurisdictions, with access to liquidity (often in non-U.S. reference
entities) during U.S. business hours, permitting them to meet client
demand even when the home markets are closed.\70\ In some cases, such
as when seeking to transact with other dealers through an interdealer
broker, these foreign affiliates may act, in a dealing capacity, in the
United States through an unaffiliated, third-party agent.
---------------------------------------------------------------------------
\70\ See IIB Letter at 18-19.
---------------------------------------------------------------------------
e. Current Estimates of Number of Security-Based Wwap Dealers
As discussed above, security-based swap activity is concentrated in
a relatively small number of dealers, which already represent a small
percentage of all market participants active in the security-based swap
market.\71\ Based on analysis of 2014 data, our earlier estimates of
the number of entities likely to register as security-based swap
dealers remain largely unchanged.\72\ Of the approximately 50 entities
that we estimate may potentially register as security-based swap
dealers, we believe it is reasonable to expect 22 to be non-U.S.
persons.\73\ Under the rules as they currently exist, we identified
approximately 170 entities engaged in single-name CDS activity, with
all counterparties, of $2 billion or more. Of those entities, 155 would
be expected to incur assessment costs to determine whether they meet
the ``security-based swap dealer'' definition. Approximately 57 of
these entities are non-U.S. persons.\74\
---------------------------------------------------------------------------
\71\ See II.A.2.a,, supra.
\72\ See U.S. Activity Proposing Release, 80 FR 27452.
\73\ These estimates are based on the number of accounts in TIW
data with total notional volume in excess of de minimis thresholds,
increased by a factor of two, to account for any potential growth in
the security-based swap market, to account for the fact that we are
limited in observing transaction records for activity between non-
U.S. persons to those that reference U.S. underliers, and to account
for the fact that we do not observe security-based swap transactions
other than in single-name CDS. See U.S. Activity Proposing Release,
80 FR 27452. See also Intermediary Definitions Adopting Release, 77
FR 30725 n.1457.
\74\ Adjustments to these statistics from the proposal reflect
further analysis of the TIW data. Cf. U.S. Activity Proposing
Release, 80 FR 27452 (providing an estimate of 56 entities that are
non-U.S. persons).
---------------------------------------------------------------------------
Many of these dealers are already subject to other regulatory
frameworks under U.S. law based on their role as intermediaries or on
the volume of their positions in other products, such as swaps.
Available data supports our prior estimates, based on our experience
and understanding of the swap and security-based swap market, that of
the 55 firms that might register as security-based swap dealers or
major security-based swap participants, approximately 35 would also be
registered with the CFTC as swap dealers or major swap
participants.\75\ Based on our analysis of TIW data and filings with
the Commission, we estimate that 16 market participants expected to
register as security-based swap dealers have already registered with
the Commission as broker-dealers and are thus subject to Exchange Act
and Financial Industry Regulatory Authority (``FINRA'') requirements
applicable to such entities. Finally, as we discuss below, some dealers
may be subject to similar
[[Page 8606]]
requirements in one or more foreign jurisdictions.\76\
---------------------------------------------------------------------------
\75\ Based on our analysis of 2014 TIW data and the list of swap
dealers provisionally registered with the CFTC, and applying the
methodology used in the Intermediary Definitions Adopting Release,
we estimate that substantially all registered security-based swap
dealers would also be registered as swap dealers with the CFTC. See
U.S. Activity Proposing Release, 80 FR 27458; SBS Entity
Registration Adopting Release, 80 FR 49000. See also CFTC list of
provisionally registered swap dealers, available at: http://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.
\76\ See, e.g., ISDA Letter at 5, 6.
---------------------------------------------------------------------------
3. Security-Based Swap Market: Levels of Security-Based Swap Trading
Activity
As already noted, firms that act as dealers play a central role in
the security-based swap market. Based on an analysis of 2014 single-
name CDS data in TIW, accounts of those firms that are likely to exceed
the security-based swap dealer de minimis thresholds and trigger
registration requirements intermediated transactions with a gross
notional amount of approximately $8.5 trillion, over 60 percent of
which was intermediated by top 5 dealer accounts.\77\
---------------------------------------------------------------------------
\77\ Commission staff analysis of TIW transaction records
indicates that approximately 99 percent of single-name CDS price-
forming transactions in 2014 involved an ISDA-recognized dealer.
---------------------------------------------------------------------------
These dealers transact with hundreds or thousands of
counterparties. Approximately 35 percent of accounts of firms expected
to register as security-based dealers and observable in TIW have
entered into security-based swaps with over 1,000 unique counterparty
accounts as of year-end 2014.\78\ Approximately 9 percent of these
accounts transacted with 500-1,000 unique counterparty accounts;
another 35 percent transacted with 100-500 unique accounts, and only 22
percent of these accounts intermediated swaps with fewer than 100
unique counterparties in 2014. The median dealer account transacted
with 453 unique accounts (with an average of approximately 759 unique
accounts). Non-dealer counterparties transact almost exclusively with
these dealers. The median non-dealer counterparty transacted with 3
dealer accounts (with an average of approximately 4 dealer accounts) in
2014.
---------------------------------------------------------------------------
\78\ Many dealer entities and financial groups transact through
numerous accounts. Given that individual accounts may transact with
hundreds of counterparties, we may infer that entities and financial
groups, which may have multiple accounts, transact with at least as
many counterparties as the largest of their accounts in terms of
number of counterparties.
---------------------------------------------------------------------------
Figure 2 below describes the percentage of global, notional
transaction volume in North American corporate single-name CDS reported
to the TIW between January 2008 and December 2014, separated by whether
transactions are between two ISDA-recognized dealers (interdealer
transactions) or whether a transaction has at least one non-dealer
counterparty.
Figure 2 also shows that the portion of the notional volume of
North American corporate single-name CDS represented by interdealer
transactions has remained fairly constant and that interdealer
transactions continue to represent a significant majority of trading
activity, even as notional volume has declined over the past six
years,\79\ from more than $6 trillion in 2008 to less than $3 trillion
in 2014.\80\
---------------------------------------------------------------------------
\79\ The start of this decline predates the enactment of the
Dodd-Frank Act and the proposal of rules thereunder, which is
important to note for the purpose of understanding the economic
baseline for this rulemaking.
\80\ This estimate is lower than the gross notional amount of
$8.5 trillion noted above as it includes only the subset of single-
name CDS referencing North American corporate documentation. See
note 77 and accompanying text, supra.
---------------------------------------------------------------------------
The high level of interdealer trading activity reflects the central
position of a small number of dealers, each of which intermediates
trades with many hundreds of counterparties.\81\ While we are unable to
quantify the current level of trading costs for single-name CDS, those
dealers appear to enjoy market power as a result of their small number
and the large proportion of order flow they privately observe.
---------------------------------------------------------------------------
\81\ One commenter criticized the analysis in the U.S. Activity
Proposing Release as ``appear[ing] to suffer from certain defects''
because the data implied that security-based swap dealing was not a
``customer-driven business.'' See Letter from Citadel, dated July
13, 2015 (``Citadel Letter''), at 9. We note that our current
estimate of the relative size of the interdealer business, based on
our updated analysis, is somewhat lower than the 80 percent figure
cited by the commenter. Nonetheless, we continue to estimate that
interdealer transactions comprise the majority of price-forming
transactions. Accordingly, it remains our view that dealers play a
central role in the security-based swap market.
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[[Page 8607]]
[GRAPHIC] [TIFF OMITTED] TR19FE16.002
Against this backdrop of declining North American corporate single-
name CDS activity, about half of the trading activity in North American
corporate single-name CDS reflected in the set of data we analyzed was
between counterparties domiciled in the United States and
counterparties domiciled abroad, as shown in Figure 3 below. Using the
self-reported registered office location of the TIW accounts as a proxy
for domicile, we estimate that only 12 percent of the global
transaction volume by notional volume between 2008 and 2014 was between
two U.S.-domiciled counterparties, compared to 48 percent entered into
between one U.S.-domiciled counterparty and a foreign-domiciled
counterparty and 40 percent entered into between two foreign-domiciled
counterparties.\83\
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\82\ Adjustments to these statistics from the proposal reflect
additional analysis of TIW data. Cf. U.S. Activity Proposing Release
80 FR 27453 (showing slightly different values for 2012 through
2014). For the purposes of this analysis, we assume that same-day
cleared transactions reflect inter-dealer activity.
\83\ For purposes of this discussion, we have assumed that the
registered office location reflects the place of domicile for the
fund or account, but we note that this domicile does not necessarily
correspond to the location of an entity's sales or trading desk. See
U.S. Activity Proposing Release, 80 FR 27541 n.44. See also note 39,
supra.
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If we consider the number of cross-border transactions instead from
the perspective of the domicile of the corporate group (e.g., by
classifying a foreign bank branch or foreign subsidiary of a U.S.
entity as domiciled in the United States), the percentages shift
significantly. Under this approach, the fraction of transactions
entered into between two U.S.-domiciled counterparties increases to 32
percent, and to 51 percent for transactions entered into between a
U.S.-domiciled counterparty and a foreign-domiciled counterparty. By
contrast, the proportion of activity between two foreign-domiciled
counterparties drops from 40 percent to 17 percent. This change in
respective shares based on different classifications suggests that the
activity of foreign subsidiaries of U.S. firms and foreign branches of
U.S. banks accounts for a higher percentage of security-based swap
activity than U.S. subsidiaries of foreign firms and U.S. branches of
foreign banks. It also demonstrates that financial groups based in the
United States are involved in an overwhelming majority (approximately
83 percent) of all reported transactions in North American corporate
single-name CDS.
Financial groups based in the United States are also involved in a
majority of interdealer transactions in North American corporate
single-name CDS: Of transactions on North American corporate single-
name CDS between two ISDA-recognized dealers and their branches or
affiliates, 65 percent of transaction notional volume involved at least
one account of an entity with a U.S. parent.
In addition, we note that a significant majority of North American
corporate single-name CDS transactions occur in the interdealer market
or between dealers and non-U.S.-person non-dealers, with the remaining
(and much smaller) portion of the market consisting of transactions
between dealers and U.S.-person non-dealers. Specifically, 79.5 percent
of North American corporate single-name CDS transactions involved
either two ISDA-recognized dealers or an ISDA-recognized dealer and a
non-U.S.-person non-dealer. Approximately 20 percent of such
transactions involved an ISDA-recognized dealer and a U.S.-person non-
dealer.
[[Page 8608]]
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4. Global Regulatory Efforts
In 2009, the G20 Leaders--whose membership includes the United
States, 18 other countries, and the European Union (``EU'')--addressed
global improvements in the OTC derivatives markets. They expressed
their view on a variety of issues relating to OTC derivatives
contracts. In subsequent summits, the G20 Leaders have returned to OTC
derivatives regulatory reform and encouraged international consultation
in developing standards for these markets.\84\
---------------------------------------------------------------------------
\84\ See, e.g., G20 Leaders' Final Declaration, November 2011,
para. 24, available at: https://g20.org/wp-content/uploads/2014/12/Declaration_eng_Cannes.pdf.
---------------------------------------------------------------------------
Many security-based swap dealers likely will be subject to foreign
regulation of their security-based swap activities that are similar to
regulations that may apply to them pursuant to Title VII, even if the
relevant foreign jurisdictions do not classify certain market
participants as ``dealers'' for regulatory purposes. Some of these
regulations may duplicate, and in some cases conflict with, certain
elements of the Title VII regulatory framework.\85\
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\85\ Several commenters raised concerns about the potential for
overlap or conflict of Title VII security-based swap dealer
requirements and similar requirements under foreign law. See Citadel
Letter at 8; Letter from ICI Global, dated July 13, 2015 (``ICI
Global Letter''), at 8; SIFMA/FSR Letter at 9; IIB Letter at 4, 6;
ISDA Letter at 5, 10.
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Foreign legislative and regulatory efforts have focused on five
general areas: Moving OTC derivatives onto organized trading platforms,
requiring central clearing of OTC derivatives, requiring post-trade
reporting of transaction data for regulatory purposes and public
dissemination of anonymized versions of such data, establishing or
enhancing capital requirements for non-centrally cleared OTC
derivatives transactions, and establishing or enhancing margin and
other risk mitigation requirements for non-centrally cleared OTC
derivatives transactions. The rules being adopted in this release will
affect a person's obligations with respect to the latter three of these
requirements, as a person's status as a security-based swap dealer will
affect its post-trade reporting obligations under Regulation SBSR,\86\
and, as proposed, would subject it to capital, margin, and other risk
mitigation requirements under the Title VII dealer framework, such as
trade acknowledgement and verification requirements.\87\
---------------------------------------------------------------------------
\86\ See Regulation SBSR, Rule 901(a)(2)(ii).
\87\ See 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 (October 18, 2012), 77 FR 70213 (November 23,
2012) (``Capital, Margin, and Segregation Proposing Release'');
Trade Acknowledgment and Verification of Security-Based Swap
Transactions, Exchange Act Release No. 63727 (January 14, 2011), 76
FR 3859 (January 21, 2011). The Commission anticipates that it may
address the impact, if any, of a person's status as a registered
security-based swap dealer on the first two of those requirements
(application of the clearing requirement and trade execution
requirement) in a subsequent release or releases.
---------------------------------------------------------------------------
Foreign jurisdictions have been actively implementing regulations
in connection with each of these three categories of requirements.
Regulatory transaction reporting requirements are in force in a number
of jurisdictions including the EU, Hong Kong SAR, Japan, Australia,
Brazil, Canada, China, India, Indonesia, South Korea, Mexico, Russia,
Saudi Arabia, and Singapore; other jurisdictions are in the process of
proposing legislation and rules to implement these requirements.\88\ In
addition, a number of major foreign jurisdictions have initiated the
process of implementing margin and other risk mitigation requirements
for non-centrally cleared OTC derivatives transactions.\89\ Several
jurisdictions
[[Page 8609]]
have also taken steps to implement the Basel III recommendations
governing capital requirements for financial entities, which include
enhanced capital charges for non-centrally cleared OTC derivatives
transactions.\90\
---------------------------------------------------------------------------
\88\ Information regarding ongoing regulatory developments
described in this section was primarily obtained from progress
reports on implementation of OTC derivatives market reforms
published by the Financial Stability Board. These are available at:
http://www.financialstabilityboard.org/list/fsb_publications/index.htm.
\89\ In November 2015, the Financial Stability Board reported
that 12 member jurisdictions participating in its tenth progress
report on OTC derivatives market reforms had in force a legislative
framework or other authority to require exchange of margin for non-
centrally cleared transactions and had published implementing
standards or requirements for consultation or proposal. A further 11
member jurisdictions had a legislative framework or other authority
in force or published for consultation or proposal. See Financial
Stability Board, OTC Derivatives Market Reforms Tenth Progress
Report on Implementation (November 2015), available at http://www.financialstabilityboard.org/wp-content/uploads/OTC-Derivatives-10th-Progress-Report.pdf.
\90\ In November 2015, the Financial Stability Board reported
that 18 member jurisdictions participating in its tenth progress
report on OTC derivatives market reforms had in force standards or
requirements covering more than 90 percent of transactions that
require enhanced capital charges for non-centrally cleared
transactions. A further three member jurisdictions had a legislative
framework or other authority in force and had adopted implementing
standards or requirements that were not yet in force. An additional
three member jurisdictions had a legislative framework or other
authority in force or published for consultation or proposal. See
Financial Stability Board, OTC Derivatives Market Reforms Tenth
Progress Report on Implementation (November 2015), available at
http://www.financialstabilityboard.org/wp-content/uploads/OTC-Derivatives-10th-Progress-Report.pdf.
---------------------------------------------------------------------------
5. Cross-Market Participation
As noted above, persons registered as security-based swap dealers
and major security-based swap participants are likely also to engage in
swap activity, which is subject to regulation by the CFTC.\91\ This
overlap reflects the relationship between single-name CDS contracts,
which are security-based swaps, and index CDS contracts, which may be
swaps or security-based swaps. A single-name CDS contract covers
default events for a single reference entity or reference security.
Index CDS contracts and related products make payouts that are
contingent on the default of index components and allow participants in
these instruments to gain exposure to the credit risk of the basket of
reference entities that comprise the index, which is a function of the
credit risk of the index components. A default event for a reference
entity that is an index component will result in payoffs on both
single-name CDS written on the reference entity and index CDS written
on indices that contain the reference entity. Because of this
relationship between the payoffs of single-name CDS and index CDS
products, prices of these products depend upon one another,\92\
creating hedging opportunities across these markets.
---------------------------------------------------------------------------
\91\ See note 75 and accompanying text, supra. See also U.S.
Activity Proposing Release, 80 FR 27458; SBS Entity Registration
Adopting Release, 80 FR 49000.
\92\ ``Correlation'' typically refers to linear relationships
between variables; ``dependence'' captures a broader set of
relationships that may be more appropriate for certain swaps and
security-based swaps. See, e.g., George Casella and Roger L. Berger,
``Statistical Inference'' (2002), at 171.
---------------------------------------------------------------------------
These hedging opportunities mean that participants that are active
in one market are likely to be active in the other. Commission staff
analysis of approximately 4,500 TIW accounts that participated in the
market for single-name CDS in 2014 revealed that approximately 3,000 of
those accounts, or 67 percent, also participated in the market for
index CDS. Of the accounts that participated in both markets, data
regarding transactions in 2014 suggest that, conditional on an account
transacting in notional volume of index CDS in the top third of
accounts, the probability of the same account landing in the top third
of accounts in terms of single-name CDS notional volume is
approximately 64 percent; by contrast, the probability of the same
account landing in the bottom third of accounts in terms of single-name
CDS notional volume is only 10 percent.\93\
---------------------------------------------------------------------------
\93\ The Commission recently revised its methodology for
estimating cross-market participation of TIW accounts. This has
resulted in an increase in the reported number of accounts that
participated in both markets relative to previous Commission
releases.
---------------------------------------------------------------------------
Similarly, since the payoffs of security-based swaps are dependent
upon the value of underlying securities, activity in the security-based
swap market can be correlated with activity in underlying securities
markets. Security-based swaps may be used in order to hedge or
speculate on price movements of reference securities or the credit risk
of reference securities. For instance, prices of both CDS and corporate
bonds are sensitive to the credit risk of underlying reference
securities. As a result, trading across markets may sometimes result in
information and risk spillovers between these markets, with
informational efficiency, pricing, and liquidity in the security-based
swap market affecting informational efficiency, pricing, and liquidity
in markets for related assets, such as equities and corporate
bonds.\94\
---------------------------------------------------------------------------
\94\ See SBS Entity Registration Adopting Release, 80 FR 49003.
Empirical evidence on the direction and significance of the CDS-bond
market spillover is mixed. See also Massimo Massa & Lei Zhang, CDS
and the Liquidity Provision in the Bond Market (INSEAD Working Paper
No. 2012/114/FIN, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2164675 (considering whether the presence of
CDS improves pricing and liquidity of investment grade bonds in
2001-2009); Sanjiv Ranjan Das, Madhu Kalimipalli & Subhankar Nayak,
Did CDS Trading Improve the Market for Corporate Bonds?, 111 J. Fin.
Econ. 495 (2014) (considering the effects of CDS trading on the
efficiency, pricing error and liquidity of corporate bond markets);
Martin Oehmke & Adam Zawadowski, The Anatomy of the CDS Market
(Working Paper, 2014), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2023108 (suggesting a standardization and
liquidity role of CDS markets and documenting cross-market arbitrage
links between the CDS market and the bond market); and Ekkehart
Boehmer, Sudheer Chava, & Heather Tookes, Related Securities and
Equity Market Quality: The Cases of CDS, forthcoming, J. Fin. &
Quant. Analysis (2015) (providing evidence that firms with traded
CDS contracts on their debt experience significantly lower liquidity
and price efficiency in equity markets when these firms are closer
to default and in times of high market volatility).
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B. Economic Considerations
These final rules, together with our previously adopted rules
defining ``security-based swap dealer'' and applying that definition in
the cross-border context, define the scope of entities that are subject
to the Title VII dealer requirements. Although these final rules do not
define specific substantive requirements, the scope of the definition
will play a central role in determining the overall costs and benefits
of particular regulatory requirements, and of the Title VII regulatory
framework as a whole.\95\ In evaluating the expected benefits and costs
of our final rules in this context, we have identified several economic
considerations relevant to our analysis that have informed our final
rule, in light of the establishment in Title VII of the Dodd-Frank Act
of a statutory framework to reduce risk, increase transparency, and
promote market integrity within the financial system.\96\
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\95\ See Cross-Border Adopting Release, 79 FR 47327 (stating
that the registration and regulation of entities as security-based
swap dealers and major security-based swap participants would lead
to programmatic costs and benefits).
\96\ See Intermediary Definitions Adopting Release, 77 FR 30596.
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First, as we have previously noted, the security-based swap market
is a global market.\97\ A significant proportion of single-name CDS
transactions on U.S. reference entities is between counterparties that
are based in different jurisdictions, and these counterparties may use
personnel located in other jurisdictions to perform various functions
in connection with these transactions.\98\ Moreover, dealers that carry
out a global business, as noted above, have significant flexibility in
choosing how to structure their business.\99\ In determining the scope
of the rules specifying which transactions non-U.S. persons must
include in their dealer de minimis calculations, we are aware both that
non-U.S. persons engage in security-based swap dealing activity with
other non-U.S. persons in the
[[Page 8610]]
United States and that U.S. financial groups may choose to restructure
their business to ensure that transactions with non-U.S. persons that
involve dealing activity in the United States are booked in non-U.S.-
person affiliates.\100\ Thus, the scope of our final framework could
have a significant effect on the number of persons that ultimately
register as security-based swap dealers and the proportion of security-
based swap dealing activity carried out in the United States that will
ultimately be carried out by such dealers.
---------------------------------------------------------------------------
\97\ See Cross-Border Adopting Release, 79 FR 47282.
\98\ See Section II.A.3, supra.
\99\ See Section II.A.2d, supra.
\100\ See Cross-Border Adopting Release, 79 FR 47285 (noting
that ``market participants may shift their behavior'' in response to
our cross-border application of Title VII requirements).
---------------------------------------------------------------------------
Second, the final scope of our rules, and market participants'
reactions to our rules (including rules already adopted as part of the
Intermediary Definitions Adopting Release, and the Cross-Border
Adopting Release) may affect competition between U.S.-person and non-
U.S.-person dealers when they engage in security-based swap
transactions with non-U.S. persons. In particular, without these rules,
competitive disparities might arise between U.S.-person dealers, which
would be subject to these rules, and non-U.S.-person dealers, which may
not be, even if the non-U.S.-person dealers engage in dealing activity
at levels exceeding the relevant de minimis thresholds using personnel
located in the United States. This disparity in treatment likely would
produce disparities in the costs that different types of dealers might
bear, with significant effects on the structure and integrity of the
security-based swap market.
Under currently existing rules, for example, even if a U.S.-person
dealer and a non-U.S.-person dealer both engaged in dealing activity in
the United States in connection with transactions involving non-U.S.-
person counterparties, the non-U.S.-person dealer would be more likely
to be able to engage in this activity without registering as a
security-based swap dealer,\101\ which would permit it, unlike the
U.S.-person dealer, to avoid the costs associated with Title VII dealer
requirements, including compliance with registration, books and
records, and capital and margin requirements. To the extent that the
non-U.S.-person dealer does not incur these costs, it would be likely
to be able to offer more competitive pricing to its non-U.S.-person
counterparties.
---------------------------------------------------------------------------
\101\ We note that, under Exchange Act rule 3a71-3, a non-U.S.-
person affiliate of a U.S. person is not required to include such
transactions in its dealer de minimis threshold calculations if that
non-U.S. person's counterparties do not have recourse to a U.S.
person under the terms of the security-based swap and the non-U.S.
person is not a conduit affiliate. See Exchange Act rule 3171-
3(b)(1)(ii) and (iii) (applying the de minimis exception to cross-
border dealing activity of conduit affiliates and non-U.S. persons).
---------------------------------------------------------------------------
Similarly, a non-U.S. person seeking to trade in a security-based
swap on a U.S. reference entity may prefer to enter into the
transaction with a non-U.S.-person dealer rather than a U.S.-person
dealer not only because the non-U.S.-person dealer may offer more
competitive prices, but also because the non-U.S. counterparty may
itself incur lower costs in transacting with a non-U.S. person dealer.
For example, a non-U.S.-person counterparty may find transacting with
the non-U.S.-person dealer that is not required to register as a
security-based swap dealer to be more attractive because a transaction
with that dealer may not involve a requirement to post collateral
consistent with Title VII margin requirements, particularly if it can
do so without surrendering the benefits associated with facing
personnel located in the United States.
In addition, under currently existing rules, financial groups that
use non-U.S. persons to carry out their dealing business with non-U.S.-
person counterparties may be able to use profits from that dealing
business to subsidize their dealing business with U.S.-person
counterparties carried out through a registered security-based swap
dealer. This cross-subsidization would allow them to gain further
competitive advantage over financial groups whose dealers are U.S.
persons, even with respect to transactions with U.S.-person
counterparties.
These competitive disparities likely would create an incentive for
financial groups (whether based in the United States or abroad) to book
security-based swap transactions with non-U.S.-person counterparties in
a non-U.S.-person affiliate while continuing to use affiliates or
agents that are located in the United States to engage in dealing
activity with those counterparties. As discussed further below, market
participants may respond in different ways to these incentives, but any
such response likely would lead to significant changes in market
structure, exacerbating market fragmentation. The final amendments
reflect our consideration of the likely competitive effects of the
scope of Title VII dealer requirements on participants in the security-
based swap market.
Third, as just noted, the scope of our rules may provide incentives
for market fragmentation and negatively affect liquidity and pricing in
the U.S. market. Subjecting certain transactions but not others to
regulatory requirements, including the security-based swap dealer de
minimis counting requirements, may lead certain dealers to seek to
limit dealing activity with certain counterparties, to cease dealing
with certain counterparties altogether, or to restructure their dealing
business to minimize the volume that it carries out in a firm that is
required to register as a security-based swap dealer.\102\ One
commenter noted that requiring certain transactions but not others to
be subject to Title VII requirements may lead dealers to quote less
competitive prices to counterparties for transactions that are subject
to these requirements,\103\ and it appears that some U.S.-based
financial groups, in response to similar regulatory reforms, have
already restructured their swap business to book their transactions in
non-U.S.-person affiliates.\104\ Such responses by market participants
are likely to fragment security-based swap liquidity into two pools,
one for U.S. persons and the other for non-U.S. persons, even if non-
U.S.-person dealers continue to engage in security-based swap dealing
activity with non-U.S. persons (including other dealers) in the United
States. This fragmentation could adversely affect the security-based
swap market's ability to efficiently allocate risk among its
participants,\105\ as discussed further below.\106\
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\102\ See IIB Letter at 2-3; ISDA Letter at 5; SIFMA/FSR Letter
at 6. See Section V.B, infra, for further discussion of potential
effects of the final rules on non-U.S. persons' incentives to use
personnel located in U.S. branches or offices to arrange, negotiate,
or execute security-based swap transactions. See also HSBC Letter at
2 (discussing the possibility of moving security-based swap trading
relationships with non-U.S. customers from a U.S.-based affiliate to
a registered security-based swap dealer affiliate while noting the
impracticability of this response).
\103\ See IIB Letter at 15 (explaining that a dealer may widen
its bid-ask spread for security-based swaps that are subject to
public dissemination requirements to account for the risk that, due
to the requirements the dealer may not be able to hedge the
security-based swap before it is publicly disclosed).
\104\ See Charles Levinson, ``U.S. banks moved billions in
trades beyond CFTC's reach,'' Reuters (August 21, 2015), available
at: http://www.reuters.com/article/2015/08/21/usa-banks-swaps-idUSL3N10S57R20150821.
\105\ See note 27, supra (citing IIB Letter at 2).
\106\ See Section V.B.2, infra.
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Depending on the final scope of Title VII application, the nature
of the fragmentation could have a particularly deleterious effect on
pricing and liquidity for U.S. persons seeking to enter into security-
based swap transactions. To the extent that dealers seek to carry out
transactions with other dealers in affiliates that are not subject
[[Page 8611]]
to Title VII security-based swap dealer requirements, the large
interdealer market, which accounts for a large majority of all
security-based swap transactions,\107\ could shift to non-U.S. dealers
that are not required to register as security-based swap dealers under
currently existing rules. Such a shift likely would exacerbate the
effects of market fragmentation on U.S. market participants, as
security-based swap activity would be split into two very different
pools: One very large pool of transactions unregulated by Title VII
(interdealer trades, carried out primarily by unregistered non-U.S.
persons, and transactions between unregistered non-U.S.-person dealers
and non-U.S.-person non-dealers) and one much smaller pool limited to
transactions between registered dealers (whether U.S. persons or non-
U.S. persons) and U.S.-person counterparties.\108\ The final amendments
reflect our consideration of the relationship between the scope of
Title VII dealer requirements and market fragmentation, including
related effects on market liquidity and pricing, particularly for U.S.
market participants.
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\107\ See Section III.A.3, supra, for an analysis of the
proportion of the security-based swap market that constitutes
interdealer transactions. For the purposes of this analysis we
classify any security-based swap transaction between two ISDA-
recognized dealers as interdealer activity.
\108\ Reducing the ability of market participants to find
counterparties may increase bid-ask spreads. See, e.g., Darrell
Duffie, Nicolae Garleanu and Lasse Heje Pedersen, ``Over-the-Counter
Markets'' Econometrica, Vol. 73, No. 6 (2005).
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Fourth, in addition to creating an incentive for market
fragmentation, applying Title VII dealer requirements only to certain
transactions carried out in the United States could affect the
integrity of the U.S. security-based swap market as well as our ability
to monitor the activity of participants in that market. To the extent
that subjecting transactions involving dealing activity carried out by
personnel located in the United States increases the likelihood that a
non-U.S. person must register as a dealer, Title VII dealer
recordkeeping requirements may enhance our ability to evaluate dealers'
records for evidence of market manipulation or other abusive practices
within the United States. For example, such records, when combined with
information from other sources available to the Commission,\109\ could
help reveal situations where a registered security-based swap dealer is
engaging in abusive or manipulative conduct with respect to a series of
transactions in which it lays off risk from a transaction with a U.S.-
person counterparty to a non-U.S.-person via an affiliated non-U.S.-
person dealer, using personnel located in a U.S. branch or office.
Absent these final amendments, the affiliated non-U.S.-person dealer
might not need to register, which would inhibit our ability to evaluate
the affiliated non-U.S.-person dealer's records for the offsetting
transaction with the non-U.S.-person counterparty, or related
transactions, effected by the same personnel located in a U.S. branch
or office that effected the transaction with the U.S.-person
counterparty. The final amendments thus reflect our consideration of
the impact that the scope of Title VII dealer requirements under our
final rules may have on our ability to detect abusive and manipulative
practices in the security-based swap market.
---------------------------------------------------------------------------
\109\ Such information may include records of transactions
reported to a swap data repository pursuant to rule 901(a)(2)(ii),
which subjects all transactions that include a registered security-
based swap dealer on a transaction side to regulatory reporting
requirements.
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Finally, the global security-based swap market is highly
interconnected and highly concentrated.\110\ As we have previously
described, most market participants have only a few counterparties, but
dealers can have hundreds of counterparties, consisting of both non-
dealing market participants (including registered investment companies
and private funds) and other dealers.\111\ Furthermore, as we have
described above, a majority of security-based swap trades are dealer-
to-dealer, rather than dealer-to-non-dealer or non-dealer-to-non-
dealer, and a large fraction of single-name CDS volume is between
counterparties domiciled in different jurisdictions.\112\ This
interconnectedness facilitates the use of security-based swaps as a
tool for sharing financial and commercial risks. The global scale of
the security-based swap market allows counterparties to access
liquidity across jurisdictional boundaries, providing U.S. market
participants with opportunities to share these risks with
counterparties around the world.\113\
---------------------------------------------------------------------------
\110\ See Section II.A.2.a., supra. See also Cross-Border
Adopting Release, 79 FR 47283.
\111\ See Cross-Border Adopting Release, 79 FR 47283. Based on
an analysis of 2014 transaction data by staff in the Division of
Economic and Risk Analysis, the median account associated with
market participants recognized by ISDA as dealers had 453
counterparties. The median of all other accounts (i.e., those more
likely to belong to non-dealers) was 3 counterparties. See Section
0, supra.
\112\ See Section II.A.3, supra. See also Cross-Border Adopting
Release, 79 FR 47283.
\113\ See Cross-Border Adopting Release, 79 FR 47283.
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However, as we have also noted, these opportunities for
international risk sharing also represent channels for risk
transmission.\114\ In other words, the interconnectedness of security-
based swap market participants provides paths for both liquidity and
risk to flow throughout the system, meaning that it can be difficult to
isolate risks to a particular entity or geographic segment. Because
dealers facilitate the great majority of security-based swap
transactions, with bilateral relationships that extend to potentially
thousands of counterparties, liquidity problems or other forms of
financial distress that begin in one entity or one corner of the globe
can potentially spread throughout the network, with dealers as a
central conduit.\115\
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\114\ See id. As discussed in more detail below, several
commenters argued that the Commission should not finalize the
proposed rules because they encompassed transactions that pose no
risk to the United States. See notes 159-160 and accompanying text,
infra (citing IIB Letter at 3, 5; ISDA Letter at 4, 5-6, SIFMA/FSR
Letter at 5; and HSBC Letter at 3).
\115\ We have previously stated that spillover and contagion
risks are important characteristics of the security-based swap
market that are important considerations in our rulemaking. See
Cross-Border Adopting Release, 79 FR 47284. In particular, given the
structure of the security-based swap market and the concentration of
security-based swap dealing activities among a relatively small
number of firms, ``the failure of a single large firm active in the
security-based swap market can have consequences beyond the firm
itself,'' including that risk may eventually ``spill over into other
jurisdictions and even other markets in which security-based swap
dealers participate.'' See id.
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As we have previously recognized, a non-U.S.-person dealer
affiliated with a U.S. financial group may pose ``reputational risk''
to its U.S. parent, irrespective of the existence of any explicit
guarantee from a U.S. person.\116\ This risk may affect the U.S.
financial system in a number of ways. Specifically, if market
participants generally expect a U.S. financial group to provide support
to a foreign affiliate engaged in security-based swap dealing activity
for reasons other than fulfilling obligations arising from an express
guarantee from the U.S. financial group, financial contagion may spread
to U.S. financial markets through the U.S. financial group, regardless
of whether the U.S. parent financial group decides to support its
foreign affiliate. If the U.S. financial group supports its foreign
affiliate by bringing the foreign affiliate's liabilities onto its
balance sheet, the resulting capital deficiencies on the parent's
balance sheet may reduce its creditworthiness and increase the U.S.
financial group's risk of default. Alternatively, if the financial
group acts contrary to the expectations of market participants by
deciding not to support the foreign affiliate, this could be
[[Page 8612]]
viewed as a negative signal by investors about the U.S. financial
group's risk of default. Consequently, even though the U.S. financial
group is not exposed to any counterparty credit risk arising from its
foreign affiliate's security-based swap transactions, it may still be
exposed to reputational risk from its foreign affiliates engaged in
security-based swap activity. The final amendments reflect our
consideration of the likely effects of the scope of Title VII dealer
requirements on the degree of reputational risk posed to U.S. persons
by their foreign affiliates.\117\
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\116\ See U.S. Activity Proposing Release, 80 FR 27482.
\117\ See Section IV.B.2, infra (noting, among other things,
that, as the market develops, foreign affiliates that might
otherwise avoid Title VII dealer requirements, including margin, may
be required to register as security-based swap dealers because they
arrange, negotiate, or execute transactions in connection with their
dealing activity using personnel located in the United States).
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Another potential channel of the propagation of risk is through
liquidity shocks from the failure of one market participant to other
participants in the same market.\118\ In a highly concentrated market,
the failure of a key liquidity provider poses a particularly high risk
of propagating this kind of shock not only to its counterparties but to
other participants, including other dealers. To the extent that U.S.
persons are significant participants in the market, the liquidity shock
may propagate to these U.S. persons, and from these U.S. persons to the
U.S. financial system as a whole, even if the liquidity shock
originates with the failure of a non-U.S. person liquidity provider. As
already discussed, the security-based swap market is highly
concentrated, with a relatively small number of dealers responsible for
most of the activity in the market. Moreover, security-based swap
activity carried out in U.S. market centers largely involves security-
based swaps on U.S. reference entities,\119\ and the overwhelming
majority of non-dealer counterparties to these transactions are U.S.
persons; similarly, a significant proportion of the dealers active in
this market are either U.S. persons or foreign affiliates of U.S.
financial groups.\120\ In light of these market characteristics, we
have considered the potential propagation of such risks through the
failure of one or more non-U.S. persons engaged in dealing activity in
the United States.\121\
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\118\ See Cross-Border Adopting Release, 79 FR 47284 (noting
that ``the failure of a single large firm active in the security-
based swap market can have consequences beyond the firm itself'' and
that ``[o]ne firm's default may reduce the willingness of dealers to
trade with, or extend credit to, both non-dealers and other
dealers'').
\119\ See note 57 and accompanying text, supra.
\120\ See Section II.A.3, supra.
\121\ For more on liquidity shocks and contagion, see Rodrigo
Vald[eacute]s, ``Emerging Market Contagion: Evidence and Theory''
(1996). See also Guillermo Calvo and Enrique Mendoza, ``Contagion,
Globalization, and the Volatility of Capital Flows,'' Capital Flows
and the Emerging Economies (2000).
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III. Overview of Prior Proposals
The Exchange Act excepts from designation as a ``security-based
swap dealer'' an entity that engages in a ``de minimis'' quantity of
security-based swap dealing activity with or on behalf of
customers.\122\ Under the final rules adopted in the Intermediary
Definitions Adopting Release, a person may take advantage of that
exception if, in connection with CDS that constitute security-based
swaps, the person's dealing activity over the preceding 12 months does
not exceed a gross notional amount of $3 billion, subject to a phase-in
level of $8 billion.\123\ The phase-in level will remain in place
until--following a study regarding the definitions of ``security-based
swap dealer'' and ``major security-based swap participant''--we either
terminate the phase-in period or establish an alternative threshold
following rulemaking.\124\
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\122\ See Exchange Act section 3(a)(71)(D).
\123\ See Exchange Act rule 3a71-2(a)(1)(i). Lower thresholds
are set forth in connection with dealing activity involving other
types of security-based swaps. See Exchange Act rule 3a71-
2(a)(1)(ii).
\124\ See Intermediary Definitions Adopting Release, 77 FR
30640-41. Exchange Act rule 3a71-2 establishes a phase-in period
during which the de minimis threshold for CDS will be $8 billion and
during which Commission staff will study the security-based swap
market as it evolves under the new regulatory framework, resulting
in a report that will consider the operation of the ``security-based
swap dealer'' and ``major security-based swap participant''
definitions. In that release we explained that, at the end of the
phase-in period, we will take into account the report, as well as
public comment on the report, in determining whether to terminate
the phase-in period or propose any changes to the rule implementing
the de minimis exception, including any increases or decreases to
the $3 billion threshold. See id. at 30640.
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As noted above, we have twice proposed rules to address the
application of the security-based swap dealer de minimis exception to
transactions between two non-U.S. persons on the basis of activity in
the United States.\125\ In the Cross-Border Proposing Release, we
stated that a non-U.S. person engaged in dealing activity through a
U.S. branch, office, or affiliate or by a non-U.S. person that
otherwise engages in security-based swap dealing activity in the United
States, particularly at levels exceeding the relevant de minimis
thresholds, may raise concerns that Title VII addresses, even if a
significant proportion--or all--of its transactions involve non-U.S.-
person counterparties.\126\ Accordingly, we initially proposed to
require any non-U.S. person to include in its de minimis calculation
any security-based swap transaction connected with its dealing
activities that is a ``transaction conducted within the United
States.'' \127\ We proposed to define ``transaction conducted within
the United States'' as 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 to
the transaction.'' \128\ Thus, under this initially proposed
definition, a non-U.S. person engaged in dealing activity would have
been required to include in its de minimis calculation any dealing
transaction entered into with another non-U.S. person that was
conducted in the United States by either the non-U.S. person engaged in
dealing activity or its counterparty or an agent of either the dealer
or the counterparty.\129\ Given the number of concerns raised by
commenters in connection with this element of the Cross-Border
Proposing Release, we subsequently determined that final resolution of
this issue would benefit from further consideration and public
comment.\130\ Accordingly, we did not address this issue in our Cross-
Border Adopting Release.
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\125\ See Cross-Border Proposing Release, 78 FR 30999; U.S.
Activity Proposing Release, 80 FR 27444.
\126\ See Cross-Border Proposing Release, 78 FR 31000-01.
\127\ See initially proposed Exchange Act rule 3a71-3(b)(1)(ii).
\128\ See initially proposed Exchange Act rule 3a71-3(a)(5). See
also Cross-Border Proposing Release, 78 FR 30999-31000.
\129\ The initially proposed definition of ``transaction
conducted within the United States'' did not include submitting a
transaction for clearing in the United States, reporting a
transaction to a security-based swap data repository in the United
States, or performing collateral management activities (such as
exchanging margin) within the United States. See Cross-Border
Proposing Release, 78 FR 31000.
\130\ See, e.g., Cross-Border Adopting Release, 79 FR 47280.
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In light of comments received on the initial proposal, subsequent
regulatory and other developments in the security-based swap market,
and further consideration of policy concerns arising from these
transactions, we proposed a modified approach in April 2015 that would
amend Exchange Act rule 3a71-3 to address the regulatory concerns
associated with dealing activity in the United States while mitigating
many of the concerns expressed by commenters on the initial proposal.
The modified approach did
[[Page 8613]]
not include the initially proposed defined term ``transaction conducted
in the United States'' and would not require a non-U.S. person engaging
in dealing activity to consider the location of its non-U.S.-person
counterparty or that counterparty's agent in determining whether the
transaction needs to be included in its own de minimis calculation.
Instead, we proposed to require a non-U.S. person to include in its de
minimis calculation any transaction connected with its security-based
swap dealing activity that it enters into with a non-U.S.-person
counterparty only when the transaction is arranged, negotiated, or
executed by personnel of the non-U.S. person located in a U.S. branch
or office, or by personnel of such person's agent located in a U.S.
branch or office.\131\
---------------------------------------------------------------------------
\131\ See proposed Exchange Act rule 3a71-3(b)(1)(iii)(C).
---------------------------------------------------------------------------
Various statutory and policy concerns underpinned our proposed
revisions to the initial approach. We noted in the U.S. Activity
Proposing Release that requiring non-U.S. persons to include such
transactions in their de minimis threshold calculations would help to
ensure that all persons that engage in significant relevant dealing
activity, including activity engaged in by personnel located in a U.S.
branch or office, are required to register as security-based swap
dealers and to comply with relevant Title VII requirements applicable
to security-based swap dealers.\132\ We also explained that subjecting
security-based swap activity involving activity in the United States to
Title VII, even when a transaction is between two non-U.S. persons, is
consistent with Section 30(c) of the Exchange Act and is appropriate
under a territorial approach.\133\ We also noted that the modified
approach would prevent market participants from engaging in significant
dealing activity in the United States while avoiding Title VII by
booking such transactions in non-U.S. person dealers who are not
conduit affiliates and whose obligations under such transactions are
not guaranteed by a U.S. person.\134\
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\132\ See U.S. Activity Proposing Release, 80 FR 27467.
\133\ See id. at 27464.
\134\ See id. at 27465. As we have stated elsewhere, the
transactions of a guaranteed non-U.S. person exist, at least in
part, within the United States, and the economic reality of these
transactions is substantially identical to transactions entered into
directly by a U.S. person (including through a foreign branch). See
Regulation SBSR Adopting Release, 80 FR 14651. See also Cross-Border
Adopting Release, 79 FR 47289-90.
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IV. Final Rules
A. Overview
Having carefully considered comments received in response to our
proposal as well as the objectives of Title VII dealer regulation and
recent regulatory and market developments (including market
participants' responses to the implementation of regulatory reforms of
the OTC derivatives markets),\135\ we are amending Exchange Act rules
3a71-3 and 3a71-5 in a manner generally consistent with the amendments
proposed in our U.S. Activity Proposing Release.\136\ As discussed in
the proposal, Exchange Act rule 3a71-3, as amended, focuses on certain
activity carried out, at least in part, by personnel located in the
United States in connection with a non-U.S. person's dealing activity,
but it does not require a non-U.S. person engaging in dealing activity
to consider the location of its non-U.S.-person counterparty or that
counterparty's agent in determining whether the transaction needs to be
included in its own de minimis calculation. Specifically, the amendment
to final rule 3a71-3(b) requires a non-U.S. person to include in its de
minimis calculation any transaction connected with its security-based
swap dealing activity that it enters into with a non-U.S.-person
counterparty only when the transaction is arranged, negotiated, or
executed by that person's personnel who are located in a U.S. branch or
office, or by its agent's personnel who are located in a U.S. branch or
office.\137\ Final Exchange Act rule 3a71-5(c) makes the exception for
cleared anonymous transactions unavailable for trades that non-U.S.
persons are required to count under proposed Exchange Act rule 3a71-
3(b)(1)(iii)(C).\138\ The following sections discuss these rules, as
well as guidance regarding the application of Exchange Act rule 3a71-
3(b)(1)(iii)(C) to specific categories of transactions raised by
commenters.
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\135\ See note 164, infra (noting our understanding that some
U.S.-based financial groups have restructured their swap business to
book their transactions in non-U.S. person affiliates).
\136\ See Exchange Act rule 3a71-3(b)(1)(iii)(C); Exchange Act
rule 3a71-5(c).
\137\ See Exchange Act rule 3a71-3(b)(1)(iii)(C). The final rule
does not incorporate a broker-dealer exception as requested by some
commenters, but it does except transactions connected with the
dealing activity of those international organizations excluded from
the definition of U.S. person in Exchange Act rule 3a71-
3(a)(4)(iii). See Section IV.C.4, infra.
\138\ See Exchange Act rule 3a71-5(c).
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B. Statutory Scope and Policy Concerns Arising from Security-Based Swap
Dealing Activity in the United States
1. Territorial Application of ``Security-Based Swap Dealer'' Definition
Some commenters have suggested that the modified approach to the de
minimis exception set forth in our U.S. Activity Proposing Release
would impose U.S. regulation on transactions and market participants
lacking a sufficient ``nexus'' to the United States or to the U.S.
financial system and, consequently, would produce few or no
benefits.\139\ Several commenters argued that the primary focus of the
security-based swap dealer registration regime is on protecting U.S.
market participants, and the market as a whole, against risk and that
these transactions lack a sufficient ``nexus'' to the United States and
to the U.S. financial system because they do not give rise to risk in
the United States.\140\ One commenter further argued that the proposed
rule was inconsistent with the concept of a de minimis threshold,
stating that, under the Commission's rules, the
[[Page 8614]]
threshold is ``based on the aggregate notional size of security-based
swaps, not the extent of U.S. involvement,'' suggesting, in the
commenter's view, that ``the threshold is concerned with risk posed to
the entity, not the extent of involvement by the entity.''\141\
Accordingly, these commenters argued that imposing security-based swap
dealer regulation on non-U.S. persons on the basis of transactions with
other non-U.S. persons--even if arranged, negotiated, or executed by
personnel located in the United States--is inappropriate.\142\
---------------------------------------------------------------------------
\139\ See ISDA Letter at 4-5 (arguing that the proposed rule
would capture firms that ``have no material connection with the
United States''); SIFMA/FSR Letter at 5 (arguing that ``[a] non-U.S.
entity should not be required to count a security-based swap toward
its security-based swap dealer de minimis threshold solely on the
basis of the conduct of its or its agent's U.S.-located personnel,''
as ``such transactions between non-U.S. persons, where none of the
risks of the transactions reside in the United States, do not have a
sufficient nexus to the United States to be included in a
determination of whether a non-U.S. entity should need to register
with the Commission''). We discuss the benefits of the final rule
below. See Sections IV.B.2 and V.B, infra.
\140\ See SIFMA/FSR Letter at 5; IIB Letter at 5-6 (arguing that
the ``Commission's policy interests in regulating the [security-
based swap] and its counterparties are much more limited than if one
of the parties was a U.S. person, guaranteed affiliate or conduit
affiliate,'' as only the sales and trading activity at the inception
of the transaction is occurring in the United States and the risks
of such transactions ``do not flow back to the U.S. financial
system''); HSBC Letter at 3 (arguing that subjecting foreign
subsidiaries to entity-level dealer requirements would not provide
additional benefits ``since no risk-based nexus would exist between
those subsidiaries and the U.S. financial system,'' particularly
given that the Commission could use existing recordkeeping
requirements to access the books and records relating to
transactions involving U.S. activity); ISDA Letter at 5-6 (arguing
that the Commission's principal concern in regulating these entities
is risk mitigation and that such transactions do not transmit risk
into the U.S. financial system). Other commenters, in the context of
discussing the Commission's proposed approach to the clearing and
trade execution requirements, argued that these types of
transactions do pose counterparty credit risk to the U.S. financial
system. See MFA Letter at 6 (disagreeing with our preliminary view
that counterparty credit risk and operational risk of such
transactions reside primarily outside the United States); Citadel
Letter at 6-7 (discussing the significant risks to the U.S.
financial system posed by ``offshore'' transactions).
\141\ See SIFMA/FSR Letter at 6.
\142\ See, e.g., id. at 5.
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To the extent that these comments are directed at whether
transactions arising from this activity or persons engaged in this
activity fall within the scope of Title VII,\143\ we reiterate our view
that it is consistent with a territorial approach to the application of
the Exchange Act to require non-U.S. persons that use personnel located
in the United States to arrange, negotiate, or execute a security-based
swap to include those transactions in their de minimis calculations. In
the Cross-Border Adopting Release, we rejected the suggestion that
``the location of risk alone should . . . determine the scope of an
appropriate territorial application of every Title VII requirement,''
including the application of the ``security-based swap dealer''
definition.\144\ In doing so, we stated that ``neither the statutory
definition of `security-based swap dealer,' our subsequent further
definition of the term pursuant to section 712(d) of the Dodd-Frank
Act, nor the regulatory requirements applicable to security-based swap
dealers focus solely on risk to the U.S. financial system.'' \145\ And
we have noted that the definition of ``security-based swap dealer''
focuses on a person's activity, not solely on the amount of risk
created by that activity.\146\ Accordingly, we do not believe that
security-based swap dealing activity must create counterparty credit
risk in the United States for there to be a ``nexus'' sufficient to
warrant security-based swap dealer registration.\147\
---------------------------------------------------------------------------
\143\ Cf. ISDA Letter at 6, note 11.
\144\ Cross-Border Adopting Release, 79 FR 47287-88.
\145\ Id. at 47288. We have also stated that security-based swap
dealer regulation may be warranted either to promote market
stability and transparency in light of the role that these dealers
occupy in the security-based swap market or to address concerns
raised by the nature of the interactions between such dealers and
their counterparties. See Intermediary Definitions Adopting Release,
77 FR 30617.
\146\ See Cross-Border Proposing Release, 78 FR 30988 (noting
our view that the statutory provisions suggest that our focus should
be not ``solely on the risk these entities pose to the financial
markets'' but also on whether regulation is warranted due to the
nature of their interactions with counterparties or in order to
promote market stability and transparency, given the role these
persons play in the security-based swap market). See Intermediary
Definitions Adopting Release, 77 FR 30612. Indeed, we expressly
contrasted this focus of the ``security-based swap dealer''
definition with the focus of the ``major security-based swap
participant'' definition, which is focused on ``the market impacts
and risks associated with a person's . . . security-based swap
positions.'' Id. at 30661.
\147\ See note 140, supra.
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As we have previously noted, Exchange Act section 3(a)(71)(A)
identifies specific activities that bring a person within the
definition of ``security-based swap dealer'': (1) Holding oneself out
as a dealer in security-based swaps, (2) making a market in security-
based swaps; (3) regularly entering into security-based swaps with
counterparties as an ordinary course of business for one's own account;
or (4) engaging in any activity causing oneself to be commonly known in
the trade as a dealer in security-based swaps.\148\ We have further
interpreted this definition to apply to persons engaged in indicia of
dealing activity, including, among other things, providing liquidity to
market professionals, providing advice in connection with security-
based swaps, having regular clientele and actively soliciting clients,
and using interdealer brokers.\149\ Neither the statutory definition of
``security-based swap dealer'' nor our further definition of that term
turns primarily on the presence of risk or on the purchase or sale of
any security, including a security-based swap.\150\ Accordingly, we
disagree with the view that the ``de minimis threshold is based on the
aggregate notional size of security-based swaps'' and that this
suggests that ``the de minimis threshold is concerned with the risk
posed to the entity, not the extent of involvement by the entity.''
\151\ The de minimis exception relates to the volume of dealing
activity and not to specifically risk-related factors, such as the
notional volume of positions held by the dealer.\152\
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\148\ See Exchange Act section 3(a)(71)(A), 15 U.S.C.
78c(a)(71)(A).
\149\ See Intermediary Definitions Adopting Release, 77 FR
30617-18. As we stated in the Cross-Border Adopting Release, when
the statutory text does not describe the relevant activity with
specificity or provides for further Commission interpretation of
statutory terms or requirements, our territorial analysis may
require us to identify through interpretation of the statutory text
the specific activity that is relevant under the statute or to
incorporate prior interpretations of the relevant statutory text.
See Cross-Border Adopting Release, 79 FR 47287.
\150\ See Exchange Act section 3(a)(71)(A), 15 U.S.C.
78c(a)(71)(A); Intermediary Definitions Adopting Release, 77 FR
30617-18.
\151\ See note 141, supra (citing SIFMA/FSR Letter). Cf.
Intermediary Definitions Adopting Release, 77 FR 30620 (noting the
focus of the ``security-based swap dealer'' definition on dealing
activity).
\152\ See Exchange Act section 3(a)(71)(D), 15 U.S.C.
78c(a)(71)(D) (providing that the 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''); Exchange
Act rule 3a71-2 (establishing transaction-based notional thresholds
for the security-based swap dealer de minimis exception).
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Accordingly, the fact that the counterparty credit risk from a
transaction between two non-U.S. persons, which are not conduit
affiliates and where neither counterparty has a right of recourse
against a U.S. person under the security-based swap, exists largely
outside the United States is not determinative under our territorial
analysis as to whether a sufficient ``nexus'' exists to require a non-
U.S. person to count the transaction toward its de minimis threshold.
The appropriate analysis, in our view, also considers whether a non-
U.S. person in such a transaction is engaged, in the United States, in
any of the activities set forth in the statutory definition or in our
further definition of ``security-based swap dealer.'' \153\ If it is so
engaged, it is appropriate under a territorial approach to require the
non-U.S. person to include such transactions in its security-based swap
dealer de minimis threshold calculations and, if those security-based
swaps (together with any other security-based swaps it is required to
include in its threshold calculations) exceed the de minimis threshold,
to register as a security-based swap dealer.\154\
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\153\ See, e.g., Intermediary Definitions Adopting Release, 77
FR 30612 (noting the focus of the ``security-based swap dealer''
definition on dealing activity).
\154\ See Cross-Border Adopting Release, 79 FR 47286-92
(describing the Commission's territorial approach). In light of the
foregoing analysis, we believe that the statutory prohibition on
application of Title VII requirements to persons that ``transact[] a
business in security-based swaps without the jurisdiction of the
United States'' has no bearing on the final rule. See Exchange Act
section 30(c). Under this rule, a non-U.S. person must include a
transaction with another non-U.S. person in its dealer de minimis
threshold calculations only when, in connection with its dealing
activity, it arranges, negotiates, or executes a security-based swap
using its personnel (or personnel of its agent) located in the
United States. See Exchange Act rule 3a71-3(b)(1)(iii)(C). The final
rule, accordingly, would not impose requirements on non-U.S. persons
that are ``transacting a business in security-based swaps without
the jurisdiction of the United States'' for purposes of section
30(c).
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As we stated in the U.S. Activity Proposing Release, this analysis
applies regardless of whether the non-U.S. person engages in dealing
activity (as described in the statutory definition and in our further
definition of ``security-
[[Page 8615]]
based swap dealer'') in the United States using its own personnel or
using the personnel of an agent acting on its behalf.\155\ As described
above, persons engaged in security-based swap dealing activity
routinely do so both directly and through their agents, including as
part of an integrated dealing business. Indeed, our further definition
of ``security-based swap dealer'' specifically identifies the use of
interdealer brokers as one of several indicia of security-based swap
dealing activity, and engaging an interdealer broker as agent or
sending a trade to such a broker generally would be dealing
activity.\156\ To the extent that this activity is directed to a broker
in the United States, the non-U.S. person is engaged in dealing
activity in the United States.\157\ Accordingly, a non-U.S. person that
reaches into the United States by engaging an agent (including an
interdealer broker) to perform dealing activity on its behalf is itself
engaged, at least in part, in dealing activity in the United States. It
is therefore consistent with our territorial approach to require the
non-U.S. person to include transactions arising out of those activities
in its own de minimis threshold calculations.\158\
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\155\ See U.S. Activity Proposing Release, 80 FR 27465.
\156\ See Exchange Act rule 3a71-1(a) (defining ``security-based
swap dealer''); Intermediary Definitions Adopting Release, 77 FR
30617-18 (providing guidance to ``further clarify the scope of the
security-based swap dealer definition'').
\157\ More generally, we believe that the routine use by dealers
of the structures described in this discussion suggests that a
person may engage in dealing activity through an agent in a manner
very similar to engaging in such activity through its own branch or
office. Cf. Exchange Act section 3(a)(71)(A) (defining ``security-
based swap dealer''); Intermediary Definitions Adopting Release, 77
FR 30617-18 (further defining ``security-based swap dealer'').
\158\ Our treatment of activity performed by an agent on behalf
of a non-U.S. person in connection with its dealing activity does
not apply Title VII to persons that 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 note 154, supra. An approach that treated a non-U.S. person
dealer that used an agent, whether affiliated or unaffiliated, in
the United States to carry out some or all of its dealing business
with non-U.S. persons as transacting a business in security-based
swaps without jurisdiction of the United States, would, in our view,
reflect an understanding of what it means to conduct a security-
based swap business within the jurisdiction of the United States
that is divorced from the definition of ``security-based swap
dealer,'' from Title VII's statutory objectives, and from the
various structures that non-U.S. persons use to engage in security-
based swap dealing activity. But in any event we also believe that
this final rule is necessary or appropriate as a prophylactic
measure to help prevent the evasion of the provision of the Exchange
Act that were added to the Dodd-Frank Act, and thus would help
prevent the relevant purposes of the Dodd-Frank Act from being
undermined. See Cross-Border Adopting Release, 79 FR 47291-92
(interpreting anti-evasion provisions of Exchange Act section
30(c)). Without this rule, non-U.S. persons could simply carry on a
dealing business within the United States with other non-U.S.
persons through agents and remain outside of the application of the
dealer requirements of Title VII, as described more fully in the
following sections.
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2. Policy Concerns Associated With Security-Based Swap Dealing Activity
in the United States
Requiring transactions that, in connection with a non-U.S. person's
dealing activity, are arranged, negotiated, or executed by personnel
located in the United States to be counted toward the non-U.S. person's
security-based swap dealer de minimis threshold is also consistent with
the policy objectives of Title VII dealer regulation. Some commenters
interpreted the primary, or even the sole, goal of Title VII dealer
regulation as risk mitigation, generally arguing that no policy
rationale warranted requiring non-U.S. persons to count transactions
with other non-U.S. persons based on their activity in the United
States.\159\ One commenter specifically urged us not to adopt the
proposed rule, arguing that application of U.S. requirements to these
transactions should ``be tailored to address only the specific policy
considerations raised by use of U.S. personnel,'' such as certain
concerns related to counterparty protection.\160\
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\159\ See SIFMA/FSR Letter at 5 (``[S]uch transactions between
non-U.S. persons . . . do not have a sufficient nexus to the United
States to be included in a determination of whether a non-U.S.
entity should need to register with the Commission.''); IIB Letter
at 5 (arguing that the Commission's policy interests in such
transactions are more limited than in transactions involving a U.S.
person and that ``[i]t is not necessary for one of the parties to
register with the Commission as an SBSD for the Commission to
address these more limited policy objectives.''); ISDA Letter at 5
(``In the absence of risks to the U.S. financial system and U.S.
counterparties, the Commission has not identified any benefit
associated with regulating SBS transactions between non-U.S.
persons.'') (emphasis added). Several commenters argued that the
location of personnel involved in a transaction on behalf of a non-
U.S.-person dealer is not particularly relevant to the policy
considerations addressed by security-based swap dealer registration
and accordingly should not ``form the sole basis for requiring''
firms to register as security-based swap dealers and to comply with
the Title VII rules. See, e.g., ISDA Letter at 4.
\160\ See IIB Letter at 3.
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We believe that these characterizations of the policy objectives of
Title VII are incomplete. Although it is true that mitigating
counterparty and operational risks--which we have acknowledged lie
primarily outside the United States in these transactions \161\--is an
important objective of the Title VII dealer requirements, these
requirements also advance other important policy objectives of
security-based swap dealer regulation under Title VII, including
enhancing counterparty protections and market integrity, increasing
transparency, and mitigating risk to participants in the financial
markets and the U.S. financial system more broadly.\162\
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\161\ See U.S. Activity Proposing Release, 80 FR 27481.
\162\ See note 145, supra. These policy objectives reflect the
goals of Title VII of the Dodd-Frank Act, which established a
statutory framework to reduce risk, increase transparency, and
promote market integrity within the financial system. See
Intermediary Definitions Adopting Release, 77 FR 30596.
---------------------------------------------------------------------------
We believe that not requiring non-U.S. persons to count these
trades toward their de minimis thresholds would significantly impair
the effectiveness of the Title VII dealer framework in advancing these
objectives. As noted above, financial groups engaged in security-based
swap dealing activity may structure their business in many different
ways.\163\ Many non-U.S. persons engaged in dealing activity in the
United States do so through an affiliated or unaffiliated agent in the
United States and, under currently existing rules, are not required,
absent a guarantee, to include transactions arising from such activity
in their dealer de minimis calculations if the counterparty is also a
non-U.S. person. Some financial groups also use U.S. persons to book
such transactions, but even U.S.-based financial groups may opt to book
their security-based swap transactions in non-U.S. persons in response
to regulation or to competitive disparities between U.S. persons and
non-U.S. persons.
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\163\ See Sections II.A.2.d and II.B, supra.
---------------------------------------------------------------------------
Given these dynamics, failure to require non-U.S. persons to count
the transactions encompassed by the final rule toward the dealer de
minimis thresholds, even though doing so is entirely consistent with
our territorial approach, would permit financial groups that have a
security-based swap dealing business to avoid registering non-U.S.
persons that engage in security-based swap dealing activity in the
United States. As long as a non-U.S. person limited its dealing
activity with U.S. persons to levels below the dealer de minimis
thresholds, it could enter into an unlimited number of transactions
connected with its dealing activity in the United States without being
required to register as a security-based swap dealer.
Subjecting the transactions of certain dealers engaged in dealing
activity in the United States, but not others, to the Title VII dealer
requirements would undermine each of the policy objectives
[[Page 8616]]
described above. Under currently existing rules, a significant
proportion of activity in the security-based swap market that is
carried out within the United States--particularly as financial groups
respond to the competitive pressures discussed in more detail below--
likely would involve counterparties that are not subject to our
regulations or oversight. Dealers accounting for significant volumes of
security-based swap dealing activity in the United States--and together
potentially accounting for a significant majority of all security-based
swap activity in the United States--would not be subject to Title VII
recordkeeping and reporting requirements, which would significantly
impede our ability to monitor the market for manipulative and abusive
conduct on the part of dealers or other market participants. Similarly,
these dealers would not be subject to the Title VII business conduct
requirements with respect to any of their transactions, which could
significantly impair market integrity or raise other concerns, as
counterparties seeking to enter into transactions with dealers through
those dealers' personnel located in the United States would not receive
the full range of disclosures and other protections provided by Title
VII. And these firms would not be subject to Title VII capital, margin,
or segregation requirements. These requirements are intended to play a
key role in mitigating the potential for financial contagion to spread
to participants in the U.S. security-based swap market and to the U.S.
financial system more generally by mitigating the risk of firm failure.
Subjecting only a limited subset of transactions involving activity
in the United States to Title VII dealer requirements would also likely
produce competitive disparities and exacerbate market fragmentation,
which would not only further undermine the policy objectives just
described but also create potentially significant market distortions.
Competitive disparities would arise as financial groups that use non-
U.S.-person dealers to carry out their dealing business in the United
States find themselves able to exit the Title VII regulatory regime
without exiting the U.S. market with respect to their security-based
swap dealing business with non-U.S.-person counterparties (including
non-U.S.-person dealers). These dealers likely would incur fewer costs
related to their dealing activity in the United States than U.S.-person
dealers transacting with the same counterparties, and non-U.S. person
counterparties likely would also find that they incur lower costs and
obtain better pricing by entering into security-based swaps with non-
U.S. dealers that are not required to register as security-based swap
dealers. U.S.-person dealers would be at a further disadvantage as
financial groups that carry out a significant proportion of their
security-based swap dealing activity in the United States through non-
registered dealers cross-subsidize the dealing activity of their
affiliated registered security-based swap dealers that engage in
dealing activity with U.S.-person counterparties, permitting financial
groups that have shifted a significant proportion of their dealing
activity to non-U.S.-person dealers to offer even U.S.-person
counterparties better pricing than financial groups that have not made
this shift are able to provide.
These competitive pressures would provide a strong incentive for
financial groups to book transactions with non-U.S. person
counterparties (including with other dealers) in non-U.S.-person
affiliates of those financial groups.\164\ Eventually, both U.S. and
foreign financial groups may restructure their business in a way that
would permit them to do the vast majority of their security-based swap
dealing activity--including a significant majority of that activity
that they continue to carry out using personnel located in the United
States--outside the Title VII framework.
---------------------------------------------------------------------------
\164\ See Section II.B, supra (discussing relationship between
the scope of Title VII regulations and likely competitive
disparities between different types of dealers). See also Charles
Levinson, ``U.S. banks moved billions in trades beyond CFTC's
reach,'' Reuters (August 21, 2015), available at: http://www.reuters.com/article/2015/08/21/usa-banks-swaps-idUSL3N10S57R20150821.
---------------------------------------------------------------------------
This potential response to competitive disparities demonstrates the
``nexus'' between the regulatory concerns addressed by the Title VII
security-based swap dealer regulatory framework and our final rule. As
already noted, the security-based swap market is a highly concentrated
market in which dealers play a central role.\165\ Absent the amendment
to rule 3a71-3(b), restructuring could lead to a market where the
largest dealers representing a significant majority of security-based
swap activity in the United States would not be required to register as
security-based swap dealers or comply with Title VII dealer
requirements because they would limit their transactions to other non-
U.S.-person dealers (some affiliated with U.S.-based financial groups)
and non-U.S. persons that are not dealers. In other words, the
commenters' suggested approach potentially would permit hundreds of
billions of dollars in annual notional transaction activity (including
most or all of the interdealer business in security-based swaps with
U.S. underliers), representing two-thirds or more of all security-based
swap transactions that currently involve U.S. counterparties or U.S.
activity, to be carried out, at least in part, within the United States
without being subject to Title VII dealer regulation, much as if Title
VII had never been enacted.\166\ Thus, while we acknowledge the
potential for this rule to increase the number of security-based swap
dealers from the number that would be required to register under
currently existing rules,\167\ we believe that it will mitigate these
competitive disparities and help ensure the ability of the Title VII
dealer requirements to advance the regulatory objectives described
above.
---------------------------------------------------------------------------
\165\ See Section II.B, supra.
\166\ See Section II.A.3, supra. For this reason, we do not
agree with the commenters that suggested that we should not require
a firm to register as a security-based swap dealer solely on the
basis that it has transactions with non-U.S. persons arising out of
dealing activity in the United States that exceed the dealer de
minimis threshold. See ISDA Letter at 4; SIFMA/FSR Letter at 5; IIB
Letter at 4-5. The overwhelming majority of transactions captured by
this rule are likely to be transactions carried out by non-U.S.
persons whose dealing activity likely exceeds the de minimis
threshold by at least an order of magnitude.
\167\ The available data and analysis suggest that all entities
that will exceed the de minimis threshold for credit default swaps
under Exchange Act rule 3a71-3(b), as amended by this release, will
already exceed the threshold by virtue of the transactions they are
required to count under Exchange Act rule 3a71-3(b) as adopted in
June 2014. However, as we describe more fully below, we acknowledge
the potential for a change in the number of registrants based on a
number of factors. See Section V.B, infra.
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We further expect that the rule will be essential to reducing the
likelihood of significant market fragmentation that would impair the
liquidity available to, and increase costs for, U.S. market
participants. As we have noted above, if a majority of security-based
swap dealing activity in the United States, including most or all
interdealer activity in the United States, is carried out by non-U.S.
persons that are not subject to Title VII dealer regulation, the market
is likely to fragment into two pools. The larger pool likely would
consist of transactions that are carried out by unregistered non-U.S.-
person dealers with non-U.S.-person counterparties, including the
largest dealers in the security-based swap market, while the smaller
pool likely would be limited to U.S.-person counterparties and
registered dealers that do business exclusively with those U.S.-person
counterparties (and that may or may not themselves be U.S. persons). In
other words, absent these rules, U.S. market participants likely would
find
[[Page 8617]]
themselves confined to a shallower liquidity pool with worse pricing
than would be available to non-U.S. persons, even though those non-U.S.
persons likely would themselves be using personnel, or facing dealers
using personnel, located in the United States to arrange, negotiate, or
execute similar transactions.
Finally, as we have noted, a significant proportion of the dealing
activity that is likely to be captured by this rule is actually carried
out by foreign affiliates of U.S. financial groups.\168\ Given the
significant volumes arising from the U.S. dealing activity of such
foreign affiliates and the potential reputational effect that an
affiliate's failure can have on other affiliates in the same corporate
group, this activity may pose a risk of contagion to the U.S. financial
markets, as we have already discussed above.\169\ We previously
acknowledged these concerns in explaining why we were not proposing to
impose the clearing requirement on these transactions in the U.S.
Activity Proposing Release, noting our view that other regulatory
provisions, including Title VII margin requirements, were better suited
to address the risk of spillovers and contagion arising from these
affiliate relationships.\170\ But it is important to note that, as the
market develops, many of those foreign affiliates may be required to
register as security-based swap dealers and to comply with the Title
VII margin requirements only because they arrange, negotiate, or
execute transactions in connection with their dealing activity using
personnel located in the United States.\171\ The final rule ensures
that these affiliates, to the extent that they are engaged in such
activity at levels above the relevant dealer de minimis threshold, are
in fact required to register and comply with these requirements, which
should mitigate the risks described above.\172\
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\168\ See Section II.A.3, supra.
\169\ See Section II.B, supra.
\170\ See U.S. Activity Proposing Release, 80 FR 27482. See also
note 115, supra (noting the importance of these issues in our
consideration of rules for the security-based swap market).
\171\ See U.S. Activity Proposing Release, 80 FR 27482. This is
particularly likely if most or all of the interdealer activity is
carried out by non-U.S. persons using personnel located in the
United States.
\172\ For these reasons, we do not agree with those commenters
that suggested that our proposed approach was inconsistent with our
determination not to propose to subject transactions to the
mandatory clearing requirement solely on the basis of U.S. activity.
See SIFMA/FSR Letter at 5-6; IIB Letter at 13-14. See also Citadel
Letter at 6-7 (arguing that the Commission's assertion that the
risks of transactions involving U.S. activity reside primarily
offshore is inconsistent with other Commission rulemakings, namely
the Volcker Rule, and the statutory interpretation adopted by the
CFTC).
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Subjecting non-U.S. persons that engage in security-based swap
dealing activity in the United States \173\ at levels above the dealer
de minimis threshold to capital and margin requirements also should
help reduce the likelihood of firm failure and the likelihood that that
the failure of a firm engaged in dealing activity in the United States
might adversely affect not only its counterparties (which may include
other firms engaged in security-based swap dealing activity in the
United States) but also other participants in that market.\174\ The
amendments being adopted today should also, in a manner consistent with
our territorial approach, reduce gaps in the application of these types
of requirements to global firms that are engaged in security-based swap
dealing activity.\175\
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\173\ See Section IV.B.1, supra (describing territorial
application of the dealer definition); Cross-Border Adopting
Release, 79 FR 47287-88 (same).
\174\ See Section II.B, supra (discussing the potential that a
liquidity shock resulting from the failure of a non-U.S.-person
dealer engaged in dealing activity in the United States might
propagate risks to, and adversely affect the stability of, U.S.
persons also active in those market centers and to the U.S.
financial system more broadly). See also Capital, Margin, and
Segregation Proposing Release, 77 FR 70222 (noting that the
``failure of a stand-alone SBSD could have a broader adverse impact
on a larger number of market participants, including customers and
counterparties'' and that the proposed capital requirements ``are
meant to account for this potential broader impact on market
participants''); id. at 70304 (describing the primary benefit of the
proposed capital and margin requirements as reducing the probability
of the failure of a security-based swap dealer, noting that such a
default ``could have adverse spillover or contagion effects that
could create instability for the financial markets more
generally'').
\175\ Certain other Title VII dealer requirements may similarly
help to mitigate these types of risks. For example, the risk
management provision requires a security-based swap dealer to have
systems in place to manage its exposure to risks arising from its
security-based swap dealing activity. See Exchange Act section
15F(j)(2). See also Capital, Margin, and Segregation Proposing
Release, 77 FR 70213. In that release, the Commission proposed to
(1) amend Rule 15c3-1 by adding a new paragraph (a)(10)(ii); (2) add
new Rule 18a-1(g) and; (3) add new Rule 18a-2(c) which, taken
together, generally would require each nonbank security-based swap
dealer and major security-based swap participant to comply with
existing Rule 15c3-4 (except for certain specified provisions of
that rule), as if it were an OTC derivatives dealer. Rule 15c3-4
currently requires each person subject to the rule to ``establish,
document, and maintain a system of internal risk management controls
to assist it in managing the risks associated with its business
activities, including market, credit, leverage, liquidity, legal,
and operational risks.'' 17 CFR 240.15c3-4.
---------------------------------------------------------------------------
We note that one commenter suggested that our amendments should
exclude dealing activity by a non-U.S. person that ``is part of or
supports a business that is primarily based outside the United
States.'' \176\ However, we do not believe that the fact that dealing
activity is part of or supports a business primarily based outside the
United States is relevant to the concerns described above regarding
regulatory effectiveness, competitive disparities, market
fragmentation, or contagion. Non-U.S.-person dealers, whose business
may be characterized as ``primarily based outside the United States,''
account for a significant volume of transactions in North American
single-name CDS and may be expected to raise these concerns, even when
``the bilateral, executory credit risk'' in the transaction is borne by
two non-U.S. persons.\177\
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\176\ ISDA Letter at 3.
\177\ See Section II.B, supra. Cf. IIB Letter at 8 (stating that
the Commission's rationale for taking an approach different from
broker-dealer regulation to regulate persons engaged in security-
based swap activity does not hold where, among other things, ``the
bilateral, executory credit risk inherent in [security-based
swaps]'' is not borne by a U.S. counterparty).
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3. Existing Regulatory Frameworks and Security-Based Swap Dealer
Regulation
Several commenters suggested that we need not rely on Title VII
dealer regulation at all to address regulatory concerns arising from
dealing activity carried out by non-U.S. persons using personnel
located in the United States.\178\ According to these commenters, the
existing U.S. and foreign requirements (including broker-dealer
regulation, and anti-fraud and anti-manipulation provisions) provide us
with the tools needed to address what, in their view, are the primary
regulatory concerns raised by this dealing activity, and using these
tools would ``essentially sever[ ] the nexus between the dealer
counterparty and the U.S. market,'' \179\ eliminating the need to
include the transaction in a firm's dealer de minimis threshold
calculations.\180\
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\178\ See, e.g., IIB Letter at 5, 8; ISDA Letter at 8; SIFMA/FSR
Letter at 6; HSBC Letter at 2-3.
\179\ SIFMA/FSR Letter at 7-8.
\180\ See, e.g., IIB Letter at 4, 5, 6, 8; ISDA Letter at 8-9
(arguing that the Commission could reasonably limit the impact of
the proposal on market participants by ``leveraging the existing
components of the SEC's regulatory program,'' specifically
identifying the Commission's existing regime that applies to broker-
dealers and pointing out that cleared transactions are subject to
regulations in other jurisdictions). One commenter argued that
``[t]o the extent the Commission is concerned about conduct of non-
registered dealers, it has more targeted tools at its disposal,
including existing antifraud and anti-manipulation provisions and
broker-dealer regulatory obligations applicable to registered
agents.'' SIFMA/FSR Letter at 6.
---------------------------------------------------------------------------
Because they view the concerns potentially raised by this activity
as relating primarily to counterparty protection concerns and because
registered broker-dealers are already
[[Page 8618]]
subject to customer protection requirements, these commenters argued
that adding security-based swap dealer requirements would simply
duplicate protections already available under existing law or impose
requirements that address concerns (such as counterparty credit risk)
that arise only outside the United States.\181\ Because the Exchange
Act defines security-based swaps as securities,\182\ they asserted that
an agent acting on behalf of a non-U.S. person that is engaged in
security-based swap dealing activity generally would be required to
register as a broker \183\ and could be required to comply with
relevant Exchange Act and FINRA requirements with respect to the
security-based swap transactions that it intermediates.\184\ Some
commenters argued that sales practice and recordkeeping rules
applicable to registered U.S. security-based swap dealers and broker-
dealers that intermediate these transactions would adequately address
the key policy interests that underlie the requirement to count U.S.
activity towards the de minimis thresholds.\185\ Another commenter
suggested that this approach would be consistent with our historical
approach to cross-border issues in cash markets, which provides an
exemption from registration for foreign broker-dealers that use a
registered broker-dealer to intermediate transactions on their
behalf.\186\ One commenter argued that such an approach would help
ensure consistency in rules applicable to cash and derivatives markets,
``reduce the incentives for regulatory arbitrage,'' and help mitigate
compliance costs that would arise from ``applying different
registration standards to activity in economically comparable
instruments.'' \187\
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\181\ See, e.g., IIB Letter at 6, 17. Commenters argued that
permitting the personnel of non-U.S.-person dealers, or their
agents, located in the United States to rely on existing regulatory
requirements would be more efficient as these personnel could comply
with a uniform set of requirements with respect to all of their
business, whether in securities or in security-based swap
transactions, on their own account or in their capacity as an
intermediary for a non-U.S. person. See ISDA Letter at 9 (citing
anti-fraud provisions of Securities Act section 17(a) and the fraud
prohibitions in Rule 10b-5); IIB Letter at 6, 8, 17 (stating that
broker-dealer and FINRA rules, including sales practice, books and
records, and examination and inspection requirements, will apply to
broker-dealers arranging, negotiating, and executing security-based
swaps on behalf of non-U.S.-person dealers and arguing that applying
only broker-dealer rules would avoid unnecessary duplication).
\182\ See also U.S. Activity Proposing Release, 80 FR 27470
n.198 (noting that Title VII of the Dodd-Frank Act amended the
Exchange Act definition of ``security'' to encompass security-based
swaps); Exchange Act section 3(a)(10), 15 U.S.C. 78c(a)(10)
(defining ``security'') as revised by section 761(a)(2) of the Dodd-
Frank Act.
\183\ See Exchange Act section 3(a)(4) (defining ``broker'').
\184\ See, e.g., note 181, supra (citing IIB Letter).
We have granted temporary exemptive relief from compliance with
certain provisions of the Exchange Act in connection with the Dodd-
Frank Act's amendment of the definition of ``security'' in order
generally to maintain the status quo during the implementation
process for the Dodd-Frank Act. See Order Granting Temporary
Exemptions under the Securities Exchange Act of 1934 in Connection
with the Pending Revisions of the Definition of ``Security'' to
Encompass Security-Based Swaps, Exchange Act Release No. 64795 (July
1, 2011), 76 FR 39927 (July 7, 2011) (``Exchange Act Exemptive
Order''). Among other things, this relief granted temporary
exemptions specific to security-based swap activities by registered
brokers and dealers. See id. at 39-44. In February 2014, we extended
the expiration dates (1) for exemptions that are generally not
directly related to specific security-based swap rulemakings until
the earlier of such time that we issue an order or rule determining
whether any continuing exemptive relief is appropriate for security-
based swap activities with respect to any of the Exchange Act
provisions or until three years following the effective date of that
order; and (2) for exemptions that are directly related to specific
security-based swap rulemakings, until the compliance date for the
relevant security-based swap rulemaking. 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. 71485 (February 5, 2014), 79 FR 7731 (February 10,
2014).
FINRA also adopted a rule, FINRA Rule 0180 (Application of Rules
to Security-Based Swaps), which temporarily limits the application
of certain FINRA rules with respect to security-based swaps. On
January 4, 2016, FINRA filed a proposed rule change, which was
effective upon receipt by the Commission, extending the expiration
date of FINRA Rule 0180 to February 11, 2017. See Self-Regulatory
Organizations; Financial Industry Regulatory Authority, Inc.; Notice
of Filing and Immediate Effectiveness of Proposed Rule Change to
Extend the Expiration Date of FINRA Rule 0180 (Application of Rules
to Security-Based Swaps), Exchange Act Release No.76850 (January 7,
2016).
\185\ See HSBC Letter at 2-3 (stating that relevant U.S.
personnel would already be subject to U.S. security-based swap
dealer or broker-dealer regulation, ``including extensive sales
practice and recordkeeping rules'' and suggesting that the
Commission could require certain non-U.S. person subsidiaries to
provide access to books and records in a manner similar to Rule 15a-
6(a)(3) applicable to foreign broker-dealers); ISDA Letter at 3
(requesting that, if the Commission adopts the proposed U.S.
activity test, it minimize the impact by relying on certain already
existing requirements on registered broker-dealers, such as
recordkeeping); IIB Letter at 7. See also ISDA Letter at 6 (stating
that the proposal would regulate these transactions ``solely on the
basis of some de minimis level of U.S. nexus during the initial
stage of the transaction''); id. at 9 (describing how existing rules
would address regulatory concerns).
\186\ See ISDA Letter at 6, 8 (arguing that ``the Commission
already possesses a range of regulatory tools (such as books and
records requirements and direct regulation of U.S.-based
intermediaries) that it can use to satisfy its important regulatory
interests in protecting against issues such as fraud and
manipulation'').
\187\ IIB Letter at 7. This commenter stated that such an
approach ``also would be consistent with Congress' decision to
define [security-based swaps] as a type of security.'' See id. To
the extent that a firm uses a U.S. person to intermediate a
security-based swap transaction, that U.S. person may be required to
register as a broker and comply with relevant broker requirements,
but nothing in the statute suggests that the regulation of the
broker under the Exchange Act affects the Title VII obligations of
the non-U.S.-person dealer that uses the U.S. broker--perhaps as
part of an integrated dealing business--to engage in dealing
activity within the United States under the comprehensive Title VII
regulatory framework for security-based swap dealers.
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We recognize that some parallels exist between the Title VII dealer
framework and the broker-dealer regime; we also recognize that there is
at least a possibility of duplication between some of the requirements
that would apply to the non-U.S.-person dealer's security-based swap
transactions if it is required to register as a security-based swap
dealer, the requirements that likely would apply to the registered
broker-dealer whose personnel arrange, negotiate, or execute the
relevant security-based swap transactions, and some requirements that
may apply to the foreign security-based swap dealer under foreign law.
However, as we discussed at some length in the U.S. Activity Proposing
Release in response to similar comments, we do not believe it
appropriate to except non-U.S.-person dealers from this requirement
merely because some transactions of some non-U.S.-person dealers could
be subject to broker-dealer or other requirements that could duplicate
some of the security-based swap dealer requirements.\188\
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\188\ See U.S. Activity Proposing Release, 80 FR 27470-71.
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As we noted in that release, this type of approach has two
significant weaknesses. First, the definition of ``broker'' includes a
number of exceptions for banks, including U.S. branches of foreign
banks, that are engaged in certain activities, and these exceptions may
be used by non-U.S.-person dealers to engage in market-facing activity
in the United States in connection with their dealing activity in
security-based swaps.\189\ Second, broker-dealer regulation of the
agent operating in the United States on behalf of the non-U.S.-person
dealer would not address all of the concerns raised by non-U.S. persons
engaged in this activity, as described above.\190\
[[Page 8619]]
Accordingly, while we recognized that the statutory framework provides
for the regulation of brokers that intermediate security-based swap
transactions,\191\ we preliminarily took the position that this
provision neither warrants nor compels the adoption of an exception
from the Title VII regime governing security-based swap dealers.\192\
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\189\ Compare Exchange Act section 3(a)(71) (defining
``security-based swap dealer'' with no exceptions for banks or
banking activities) with Exchange Act section 3(a)(4)(B) (creating
exception from broker definition for banks engaged in certain
activities) and Exchange Act section 3(a)(5)(C) (creating exception
from dealer definition for banks engaged in certain activities).
\190\ See U.S. Activity Proposing Release, 80 FR 27466-67;
Section IV.B.2, supra (describing regulatory concerns raised by
security-based swap dealing activity, including risk, market
integrity and transparency, and counterparty protection).
Regulation of the agent, whether as a broker-dealer or as a
security-based swap dealer, also does nothing to address concerns
about the potential spillover risk or contagion from the activity of
non-U.S.-person dealers--including affiliates of U.S.-based
financial groups--that are engaged in potentially significant
volumes of security-based swap activity in the United States. See
Section IV.B.2, supra.
\191\ See U.S. Activity Proposing Release, 80 FR 27470 n.198
(noting that Title VII of the Dodd-Frank Act amended the Exchange
Act definition of ``security'' to encompass security-based swaps);
Exchange Act section 3(a)(10), 15 U.S.C. 78c(a)(10) (defining
``security''), revised by section 761(a)(2) of the Dodd-Frank Act.
\192\ See U.S. Activity Proposing Release, 80 FR 27470-471.
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In response to our preliminary determination, several commenters
suggested that, to the extent that the existing framework (including
the broker-dealer regulatory regime) does not fully address our
concerns, we could adopt an exception to the counting requirement
subject to certain conditions that would help ensure that the non-U.S.
person engaged in dealing activity is subject to requirements, whether
under domestic or foreign law, that are similar to those imposed on
security-based swap dealers by Title VII dealer requirements.\193\ For
example, one commenter suggested that the non-U.S.-person dealer not be
required to count any transaction entered into in a dealing capacity if
the U.S. personnel are (a) personnel of a registered broker-dealer; or
(b) personnel of a U.S. bank or U.S. branch of a foreign bank that, in
connection with the arranging, negotiating, or executing activity, (i)
complies with external business conduct requirements, (ii) maintains
related books and records, and (iii) provides the Commission with
access to such books and records and testimony of the relevant U.S.
personnel.\194\ Another commenter suggested that we except transactions
from the requirement that they be counted toward a non-U.S.-person
dealer's de minimis threshold if the non-U.S.-person dealer is ``(i) [
] an affiliate of the U.S.-located registered broker-dealer, (ii) [ ]
registered as a dealer in a local jurisdiction recognized by the
Commission as comparable, and/or (iii) [ ] located in a Basel-compliant
jurisdiction and subject to such capital requirements under its local
regime.'' \195\ In the commenters' view, this type of alternative
approach would leverage certain additional elements of domestic and
foreign law, avoiding the costs of registering foreign affiliates and
complying with potentially duplicative requirements, while achieving
similar regulatory objectives.\196\
---------------------------------------------------------------------------
\193\ See IIB Letter at 8-10; SIFMA/FSR Letter at 8; ISDA Letter
at 9-10.
\194\ See IIB Letter at 8-10. The commenter suggested that the
Commission could use its anti-evasion authority to require access to
books and records of the non-U.S.-person dealer and consent to
service of process and that it could ensure adequate capital
regulation of the non-U.S.-person dealer by requiring the non-U.S.-
person dealer to count these transactions toward the de minimis
exception if it is not supervised by a home country prudential
supervisor that is a member of the Basel Committee or located in a
G20 jurisdiction. See id. at 9. See also ISDA Letter at 8 (stating
that such an approach would be consistent with Exchange Act rule
15a-6, which provides an exemption from broker-dealer registration
on the condition that, among other things, the foreign broker or
dealer maintains books and records and makes them available to the
Commission upon request).
\195\ See SIFMA/FSR Letter at 8. See also IIB Letter at 9
(suggesting that any exception could be conditioned on the non-U.S.
person being supervised by a home country prudential supervisor that
is either a member of the Basel Committee or located in a G-20
jurisdiction).
\196\ See IIB Letter at 8-10; SIFMA/FSR Letter at 7-8.
---------------------------------------------------------------------------
In offering these alternative approaches, commenters attempted to
encompass all structures that non-U.S.-person dealers use to engage in
dealing activity in the United States with non-U.S. counterparties and
address the full range of regulatory concerns raised by that activity.
But instead of a uniform set of comprehensive requirements using the
framework that Congress established in Title VII, they urged us to
develop an alternative approach that would cobble together existing
foreign and domestic regulations in an attempt to replicate--and, as we
discuss below, effectively replace--the statutory framework established
by Congress by using a combination of pre-Dodd Frank Act regulatory
authority, anti-fraud and anti-manipulation authority, anti-evasion
authority, and certain foreign requirements. After careful
consideration of these alternatives, we believe that such an approach
would undermine the policy objectives advanced by Title VII that we
describe above.\197\
---------------------------------------------------------------------------
\197\ See Section IV.B.2, supra.
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As an initial matter, we believe that the approach suggested by
commenters is inconsistent with the comprehensive, uniform statutory
framework established by Congress for the regulation of security-based
swap dealers in Title VII. The statutory definition of ``security-based
swap dealer'' and the consequent regulatory requirements that apply to
such persons apply to any person that engages in relevant activity
above the dealer de minimis thresholds. The comprehensive scope of this
definition and of the related requirements differs from the broker-
dealer framework under the Exchange Act. Most significantly, as already
discussed, the broker-dealer framework does not apply to banks engaged
in certain activities, which may include a significant proportion of
security-based swap dealing activity. Title VII, on the other hand,
provides that both banks and non-banks--whether engaged in dealing
activity with other dealers or with non-dealers--are subject to the
same comprehensive regulatory framework, suggesting that the Title VII
security-based swap dealer framework is designed to establish a uniform
regulatory regime for all persons engaged in security-based swap
dealing activity at levels above the de minimis threshold, regardless
of the business structure that they use to carry out their business.
Commenters argued that precedent for an approach that provides an
exception for trades intermediated by a registered broker-dealer exists
in the exemption available for foreign broker-dealers under Exchange
Act rule 15a-6.\198\ However, this comparison is inapposite. First, the
rule 15a-6(a)(3) exemption that commenters would have us follow \199\
permits a foreign broker-dealer to effect transactions in the United
States without being required to register only if the intermediating
broker under rule 15a-6 is itself a registered broker-dealer. In other
words, rule 15a-6(a)(3) exempts the foreign dealer only if its U.S.
intermediary is subject to the same regulatory regime that otherwise
would apply to the foreign broker-dealer absent the exemption. The
commenters, on the other hand, urged us to permit a non-U.S.-person
dealer engaged in security-based swap dealing activity in the United
States to substitute broker regulation (subject to certain conditions,
including compliance with certain foreign requirements) of the U.S.
intermediary for comprehensive Title VII security-based swap dealer
regulation of the non-U.S. person engaged in security-based swap
dealing activity.
---------------------------------------------------------------------------
\198\ See IIB Letter at 7-8; ISDA Letter at 8-9; HSBC Letter at
3, note 3.
\199\ See IIB Letter at 7-8; ISDA Letter at 8-9; HSBC Letter at
3, note 3.
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Second, an exception of this type likely would effectively supplant
Title VII dealer regulation for a majority of dealing activity carried
out in the United States, replacing it with a less effective
alternative cobbled together from other domestic and foreign
requirements. As described above, much
[[Page 8620]]
of the dealing activity carried out in the United States is currently
booked in non-U.S. persons, and the absence of a U.S. activity trigger
for de minimis threshold calculations would create a strong incentive
to move booking for all transactions with non-U.S. persons--including,
eventually, potentially all dealer-to-dealer transactions--to booking
entities that are themselves non-U.S. persons.\200\ Doing so would
permit all of this activity--potentially a significant majority of
security-based swap activity in the United States--to be regulated
under an alternative to Title VII. Thus, whereas the exemption under
Exchange Act rule 15a-6 permits a foreign broker-dealer to effect
transactions in the United States without being required to register if
the intermediating broker is subject to the same requirements that
would apply to the foreign broker-dealer absent the exemption, the
commenters' alternative would potentially enable most security-based
swap dealing activity in the United States to be regulated under an
entirely different regime from the comprehensive dealer regulatory
framework established by Congress.
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\200\ As already discussed, the security-based swap market is a
global market, and firms engaged in security-based swap dealing
activity can restructure their dealing business to ensure that
security-based swap transactions are not booked in U.S. persons. See
Section II.B, supra.
---------------------------------------------------------------------------
One commenter argued that permitting personnel located in the
United States to comply with the requirements that apply to registered
broker-dealers would increase efficiency because such personnel would
be subject to a single set of regulatory compliance obligations with
respect to both their underlying securities transactions and
derivatives transactions.\201\ Another commenter argued that our
``generally favorable view of substituted compliance'' suggests that we
should be willing to refrain from adopting these amendments on the
basis that existing Exchange Act and FINRA requirements ``already
secure the regulatory aims sought to be provided by the SBS dealer
regime.'' \202\ However, banks engaged in certain activities, including
U.S. branches of foreign banks, are, as noted above, excepted from the
definition of ``broker'' and would not benefit from the efficiencies
described by commenters, whether they are required to register as
security-based swap dealers (because the exemption is not available to
them) or required to comply with broker-dealer requirements as a
condition of an exception, as suggested by one commenter.\203\ In
addition, while permitting reliance on broker-dealer requirements for
certain non-U.S.-person dealers may provide intra-firm efficiencies, it
is also likely to create unnecessary competitive disparities between
non-U.S.-person dealers that are eligible for the exception, on one
hand, and U.S. dealers and other non-U.S.-person dealers that are not
eligible.\204\ And to the extent that the commenters' concerns relate
to the difficulties in persuading non-U.S.-person counterparties to
make representations and accept disclosures pursuant to business
conduct requirements as proposed,\205\ reliance on broker-dealer
regulation is unlikely to eliminate these concerns, as it is likely
that similar requirements may apply under the Exchange Act or under
FINRA rules, following the termination of relevant exemptions.\206\ For
these reasons, we do not agree with commenters that existing
requirements in fact secure the same regulatory aims as those secured
by the Title VII dealer regulatory framework.\207\
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\201\ See IIB Letter at 7.
\202\ See ISDA Letter at 9-10.
\203\ See IIB Letter at 8-9.
\204\ Indeed, we note that any exception from the uniform
application of the requirement that non-U.S.-person dealers that
engage in security-based swap dealing activity in the United States
include the resulting transactions in their dealer de minimis
threshold calculations is likely to create similar competitive
disparities and exacerbate market fragmentation in the manner
described in the previous section. See Section IV.B.2, supra. For
this reason, and the reasons given in note 190, supra, we do not
agree that compliance by the agent with either broker-dealer or
security-based swap dealer requirements would warrant an exception
from counting transactions under the U.S. Activity Test. Cf. note
185, supra (citing HSBC Letter at 3).
\205\ See IIB Letter at 11; SIFMA/FSR Letter at 9. For example,
one commenter explained that a non-U.S. counterparty ``would be
surprised by any need to provide representations, agree to covenants
or fill out questionnaires designed to comply with U.S.
requirements'' that would only apply if U.S. personnel is used in a
subsequent transaction, particularly if such requirements differ
from any local requirements that are already applicable. IIB Letter
at 11.
\206\ See note 184, supra.
\207\ See notes 201-203, supra.
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Finally, many of the concerns expressed by commenters could be
mitigated by the availability of substituted compliance, which, as
proposed, may permit non-U.S.-person dealers to comply with comparable
foreign requirements as an alternative means of complying with certain
Title VII requirements.\208\ A person relying on substituted compliance
would remain subject to the applicable Exchange Act requirements, but
could comply with those requirements in an alternative fashion.\209\
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\208\ See proposed Exchange Act Rule 3a71-5; Cross-Border
Proposing Release, 78 FR 31088. See also IIB Letter at 19 (noting
that significant modifications to existing compliance and risk
management systems in response to adoption of the U.S. Activity Test
``may prove unnecessary'' if foreign security-based swap dealers
``are ultimately able to rely on substituted compliance'').
Although we did not directly address substituted compliance with
respect to security-based swap dealer requirements in the U.S.
Activity Proposing Release, we noted in that release that we had
previously proposed such an approach and continued to believe that
substituted compliance for such requirements would be the
appropriate means of addressing potential overlap or duplication in
their application, rather than forgoing regulation entirely. See
U.S. Activity Proposing Release, 80 FR 27471 and 27473 n.223. Cf.
ISDA Letter at 10 (expressing concern that the U.S. Activity
Proposing Release had proposed substituted compliance only with
respect to Regulation SBSR).
\209\ See Cross-Border Proposing Release, 78 FR 31085. Under the
proposal, the Commission would not permit dealer requirements to be
satisfied by substituted compliance unless (i) the Commission
determined that the foreign regime's requirements were comparable to
the otherwise applicable requirements, after taking into account
such factors as the Commission determines are appropriate, including
the scope and objectives of the relevant foreign regulatory
requirements the effectiveness of the supervisory compliance program
administered, and the enforcement authority exercised by the foreign
financial regulatory authority in support of its oversight; and (ii)
the Commission has entered into a supervisory and enforcement
memorandum of understanding or other arrangement with the relevant
foreign financial regulatory authority or authorities. See proposed
Exchange Act Rule 3a71-5(a)(2)(i) and (ii); Cross-Border Proposing
Release, 78 FR 31086-88.
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In practice, however, we recognize that there will be limits to the
availability of substituted compliance. For example, it is possible
that substituted compliance may be permitted with regard to some
requirements and not others with respect to a particular jurisdiction.
For certain jurisdictions, moreover, substituted compliance may not be
available with respect to any requirements depending on our assessment
of the comparability of the relevant foreign requirements, as well as
the availability of supervisory and enforcement arrangements among the
Commission and relevant foreign financial regulatory authorities.
Although comparability assessments will focus on regulatory outcomes
rather than rule-by-rule comparisons, the assessments will require
inquiry regarding whether foreign regulatory requirements adequately
reflect the interests and protections associated with the particular
Title VII requirement. In some circumstances, such a conclusion may be
difficult to achieve.
In the event that we are unable to determine that an entity may
satisfy certain Title VII requirements via substituted compliance, we
recognize that such persons may, as a result, be subject to
requirements that are duplicative of particular Title VII requirements.
While we recognize the
[[Page 8621]]
significance of such a result, in our view compliance with the Title
VII requirements is necessary to advance the policy objectives of Title
VII. This would be undermined by permitting non-U.S.-person dealers to
comply with their Title VII obligations by satisfying foreign
requirements, unless the alternative route provided by substituted
compliance has been made available.
C. Application of the Dealer De Minimis Exception to Non-U.S. Persons
Using Personnel Located in a U.S. Branch or Office to Arrange,
Negotiate, or Execute Security-Based Swap Transactions
We are amending Exchange Act rule 3a71-3(b)(1)(iii) in a manner
generally consistent with our proposal. The final rule requires a non-
U.S. person engaged in security-based swap dealing activity to include
in its de minimis calculations any transactions connected with its
security-based swap dealing activity that it arranges, negotiates, or
executes using its personnel located in a U.S. branch or office, or
using personnel of its agent located in a U.S. branch or office.\210\
This approach reflects our view that it is reasonable to conclude that
a non-U.S. person that, in connection with its dealing activity,
engages in market-facing activity using personnel located in the United
States, is performing activities that fall within the statutory
definition of ``security-based swap dealer'' or our further definition
of that term, as described above, at least in part in the United
States.\211\
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\210\ See Exchange Act rule 3a71-3(b)(1)(iii)(C). Consistent
with our proposal, a person would be required to include in its de
minimis calculations only security-based swaps that, in connection
with its dealing activity, are arranged, negotiated, or executed by
personnel located in the United States. A non-U.S. person is not
required to include in this calculation transactions connected with
that person's dealing activity solely on the basis that they were
submitted for clearing in the United States, reported to a security-
based swap data repository in the United States, or because
activities related to collateral management of the transaction, such
as the exchange of margin, occurred within the United States. See
U.S. Activity Proposing Release, 80 FR 27467 n.166; 27468 n.180;
Cross-Border Proposing Release, 78 FR 31000. In our view, none of
these activities, by themselves, indicate that a non-U.S. person is
likely to raise the types of concerns addressed by Title VII
security-based swap dealer regulation.
\211\ Non-U.S. persons engaged in security-based swap dealing
activity may include persons whose counterparties have legal
recourse against a U.S. person arising out of the security-based
swap transactions of the non-U.S. person or persons that are conduit
affiliates. Our Cross-Border Adopting Release finalized rules
providing that a non-U.S. person must include in its dealer de
minimis calculation transactions arising out of its dealing activity
with counterparties that are U.S. persons, or such transactions with
non-U.S. person counterparties if the non-U.S. person affiliate of
the non-U.S. person is a conduit affiliate or if its counterparty
has a right of recourse against a U.S.-person affiliate of the non-
U.S. person under the security-based swap, even if the non-U.S.
person is not engaging in dealing activity using personnel located
in the United States to arrange, negotiate, or execute the
transaction. See Exchange Act rules 3a71-3(a)(1), (b)(1)(ii), and
(b)(1)(iii)(B).
---------------------------------------------------------------------------
This amendment reflects our further consideration of the issues
raised by non-U.S. persons engaged in this activity. We continue to
believe that requiring non-U.S. persons to include such transactions in
their de minimis threshold calculations will help to ensure that all
persons that engage in a significant level of relevant dealing
activity, including activity carried out through personnel located in a
U.S. branch or office, are required to register as security-based swap
dealers and to comply with relevant Title VII requirements applicable
to security-based swap dealers when the volume of that activity exceeds
the dealer de minimis threshold.\212\
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\212\ Several commenters urged the Commission to work with the
CFTC to harmonize the Commissions' approaches to cross-border and
other issues, arguing that no administrative or economic rationale
exists for different approaches. See Chris Barnard Letter at 2
(noting that the U.S. Activity Proposing Release differs in its
application of mandatory clearing and trade execution from the CFTC
and that, ideally, the SEC and CFTC should work together to create
one set of rules); ICI Global Letter at 3-4 (emphasizing the need
for coordination among regulators to determine the treatment of
cross-border transactions); MFA Letter at 2-4 (urging that the
Commission work with the CFTC and the prudential regulators to adopt
a single approach, particularly with respect to the definition of
``U.S. person''); SIFMA Sequencing Letter at 5 (requesting that the
Commission coordinate with the CFTC on cross-border rules generally
and on any rules governing U.S. activity in particular). One
commenter expressed concern about differences among cross-border
approaches proposed by U.S. regulators particularly in light of the
close relationship between the single-name CDS market and the index
CDS market, given that many market participants are active in both
markets. See MFA Letter at 3. We recognize the commenters' concerns
and continue to consult and coordinate with the CFTC and other
regulators to minimize differences in our Title VII rules, including
with respect to the issues addressed in this release.
Another commenter specifically urged that the Commission's
proposed interpretation of ``arrange, negotiate, and execute'' be
applied consistently to the use of these terms in other contexts,
including the CFTC Staff Advisory and the Volcker Rule. See SIFMA/
FSR Letter at 2-4. The Commission adopted the Volcker Rule together
with the Board of Governors of the Federal Reserve System, the
Office of the Comptroller of the Currency, the Federal Deposit
Insurance Corporation, and the CFTC under a provision of the Dodd-
Frank Act separate from the provisions under which the rules
addressed in this release are being adopted. See Prohibitions and
Restrictions on Proprietary Trading and Certain Interests in, and
Relationships With, Hedge Funds and Private Equity Funds, Release
No. BHCA-1 (December 10, 2013), 79 FR 5535 (January 31, 2014)
(``Volcker Rule'').
---------------------------------------------------------------------------
Most commenters that expressed a view on the U.S. Activity Test set
forth in the U.S. Activity Proposing Release supported the changes made
from our initially proposed approach.\213\ Under that initial approach,
market participants would have been required to determine, in
connection with several different Title VII rules, whether a
transaction was a ``transaction conducted within the United States,''
and this determination would have required an analysis of the location
of relevant activity performed by either counterparty or its agent in
connection with that transaction.\214\ These commenters supported the
narrower approach set forth in our U.S. Activity Proposing Release,
which focused only on the location of relevant activity of a
counterparty acting in a dealing capacity in the transaction of such
counterparty's agent \215\ and limited relevant activity to ``market-
facing'' activity of that counterparty or the counterparty's
agent.\216\ One commenter stated that the modified approach created ``a
definable standard that will bring clarity to the application of
security-based swap requirements to security-based swap dealers, and is
appropriate and consistent with the expectations of the parties as to
when U.S. security-based swap requirements will apply.'' \217\
---------------------------------------------------------------------------
\213\ See ICI Letter at 1-2, 5; SIFMA/FSR Letter at 3; IIB
Letter at 2.
\214\ See Cross-Border Proposing Release, 78 FR 30999.
\215\ See ICI Global Letter at 1-2, 5 (stating that the modified
proposal would enable non-U.S. dealers to enter into transactions
with non-U.S. persons that may use a U.S. fund manager without
requiring the non-U.S. dealer to include the transaction in its de
minimis calculations).
\216\ See IIB Letter at 17; SIFMA/FSR Letter at 3 (stating that
``market-facing focus is appropriate and consistent with the
expectations of the parties as to when U.S. regulations will
apply'').
\217\ SIFMA/FSR Letter at 2-3 (stating also that the commenters
``strongly believe that the Commission has taken the correct
approach in focusing on market-facing activity of sales and trading
personnel in defining the `arrange, negotiate, or execute' nexus
that subjects security-based swap activity to the Commission's
regulations based on location of conduct'').
---------------------------------------------------------------------------
We have considered commenters' concerns about the potential costs
associated with the final rule, including the systems and monitoring
costs, as well as the likelihood of market fragmentation arising from
the full or partial exit of some dealing firms from the U.S.
market.\218\ As discussed above, however, we believe that imposing the
counting requirements on non-U.S.-person dealers engaged in such
transactions will advance important regulatory objectives.\219\
However, the
[[Page 8622]]
final rule is intended to avoid unnecessary costs and complexity that
may make it difficult for market participants to comply with such
requirements. As we stated in connection with the proposed rule, this
approach reflects our recognition of commenters' concerns that our
initially proposed approach to ``transactions conducted within the
United States'' potentially could have imposed significant costs on,
and presented compliance challenges to, market participants.\220\ The
final rule should reduce the likelihood that personnel who are
incidentally within the United States will trigger the counting
requirement, and it will eliminate any need on the part of the non-
U.S.-person dealer either to monitor the location of relevant personnel
acting on behalf of its counterparty or to obtain relevant
representations regarding the location of the counterparty's or the
counterparty's agent's personnel from their counterparty on a
transaction-by-transaction basis.
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\218\ See Sections V.A and V.B, infra (discussing comment
letters addressing costs, competition, and market fragmentation).
\219\ See Section IV.B.2, supra. We recognize, as two commenters
argued, that it is possible that the final rule will result in
additional registrants and that this increase in the number of
security-based swap dealers will impose additional responsibilities
on the Commission and its staff. See IIB Letter at 7, 10; HSBC
Letter at 2. As discussed above, the final rule is intended to
subject to registration requirements only those firms whose activity
in the United States suggests that they raise the types of concerns
addressed by Title VII dealer regulation, and we believe that the
concern regarding Commission resources is not relevant, given that
the final rule appears reasonably tailored to achieve our policy
interests.
\220\ See U.S. Activity Proposing Release, 80 FR 27468.
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In the following subsections, we describe key elements of the
amendment to Exchange Act rule 3a71-3(b)(1)(iii) and address comments
received in response to the U.S. Activity Proposing Release that are of
particular relevance with respect to each element.
1. ``Arranging, Negotiating, or Executing'' a Security-Based Swap
Transaction
Exchange Act rule 3a71-3(b)(1)(iii)(C) applies only to transactions
connected with a non-U.S. person's security-based swap dealing activity
that its personnel (or the personnel of an agent) located in the United
States arrange, negotiate, or execute. The final rule, accordingly,
would reach a narrower range of activity than did the initially
proposed rules that would have required a non-U.S.-person dealer to
count any ``transaction conducted within the United States'' \221\ that
it entered into in connection with its dealing activity.
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\221\ As noted above, the initially proposed rule would have
required non-U.S. persons to include in their de minimis calculation
any ``transaction conducted within the United States'' related to
their dealing activity. See Cross-Border Proposing Release, 78 FR
30999-31000. Under that proposal, this term would have included any
transaction solicited, negotiated, executed, or booked, by either
party or either party's agent, within the United States. See id. at
30999.
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Consistent with our preliminary views set forth in the U.S.
Activity Proposing Release, ``arrange'' and ``negotiate'' in the final
rule indicate market-facing activity of sales or trading personnel in
connection with a particular transaction, including interactions with
counterparties or their agents.\222\ ``Execute'' refers to the market-
facing act that, in connection with a particular transaction, causes
the person to become irrevocably bound under the security-based swap
under applicable law.\223\
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\222\ See U.S. Activity Proposing Release, 80 FR 27467-68.
Consistent with the approach taken to the final definition of
``transaction conducted through a foreign branch'' adopted in the
Cross-Border Adopting Release, the amendment includes ``arrange''
instead of ``solicit'' in recognition of the fact that a dealer, by
virtue of being commonly known in the trade as a dealer, may respond
to requests by counterparties to enter into dealing transactions, in
addition to actively seeking out such counterparties. See id. at
27467 n.173 (citing Cross-Border Adopting Release, 79 FR 47322
n.381; 15 U.S.C. 78c(a)(71)(A)(iv)).
\223\ See U.S. Activity Proposing Release, 80 FR 27468.
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As noted in the proposal, this limitation to market-facing activity
should enable market participants to identify the location of relevant
activity in a relatively efficient manner. The final rule requires a
market participant to focus on whether its sales or trading personnel
(or such personnel of its agent) located in the United States engage in
this market-facing activity in connection with a particular
transaction, not on where these or other personnel perform internal
functions (such as the processing of trades or other back-office
activities) in connection with that transaction. Accordingly, the
involvement of personnel located in a U.S. branch or office in a
transaction, where such personnel do not engage in market-facing
activities with respect to a specific transaction (such as a person who
designs the security-based swap but does not communicate with the
counterparty regarding the contract in connection with a specific
transaction and does not execute trades in the contract), and does not
direct these activities (as described below), does not fall within the
scope of the final rule.\224\ Similarly, the final rule also does not
include the preparation of underlying documentation for the
transaction, including negotiation of a master agreement and related
documentation, or performing ministerial or clerical tasks in
connection with the transaction as opposed to negotiating with the
counterparty the specific economic terms of a particular security-based
swap transaction.\225\
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\224\ On the other hand, to the extent that personnel located in
a U.S. branch or office engage in market-facing activity normally
associated with sales and trading, the location of those personnel
would be relevant, even if the personnel are not formally designated
as sales persons or traders.
\225\ Similarly, the final rule does not encompass a transaction
solely on the basis that a U.S.-based attorney is involved in
negotiations regarding the terms of the transaction.
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The final rule also does not require persons engaged in dealing
activity to consider the location of personnel booking the transaction.
As we have noted elsewhere, the booking entity is the counterparty to a
transaction and bears the ongoing risk of performance on the
transaction,\226\ and the entity in which the transaction is booked is
the entity that may be required to include a transaction in its de
minimis threshold calculations.\227\ However, the ministerial task of
entering transactions on a non-U.S. person's books once the transaction
has been executed by market-facing personnel does not appear to involve
the type of market-facing activity that reflects an involvement in the
U.S. financial market that would indicate that the non-U.S. person may
be likely to raise the types of regulatory concerns addressed by the
Title VII dealer requirements, particularly if both counterparties to
the transaction are non-U.S. persons and all relevant market-facing
activity occurs outside the United States.\228\ On the other hand, a
non-U.S. person's market-facing activity in the United States suggests
the type of involvement in the U.S. security-based swap market that may
raise financial contagion, customer protection, market integrity, and
market transparency concerns, for the reasons described in detail
above,\229\ particularly when its
[[Page 8623]]
relevant dealing transactions exceed a de minimis threshold.
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\226\ See Cross-Border Proposing Release, 78 FR 30976. See also
Intermediary Definitions Adopting Release, 77 FR 30617 n.264. For
further discussion of this issue, see note 244, infra.
\227\ For example, if the transaction is booked in a U.S.
person, that U.S. person is a counterparty to the security-based
swap and is required to include the security-based swap in its own
de minimis calculation if the transaction is in connection with its
dealing activity, irrespective of whether the U.S. person used its
own personnel or an agent's personnel to carry out that dealing
activity. See Exchange Act rule 3a71-3(b)(1)(i).
\228\ See Section IV.B.2, supra (describing concerns addressed
by the final rule, including uniform application of Title VII dealer
requirements, market integrity and fragmentation, and potential
channels of financial contagion arising from dealing activity in the
United States). See also U.S. Activity Proposing Release, 80 FR
27467 n.173 (stating our preliminary view that it is market-facing
activity, rather than the booking of the transaction, that raises
the types of concerns underlying our proposal of the U.S. Activity
Test).
\229\ See note 162 and accompanying text, supra.
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Finally, we note that, consistent with our proposal, ``arranging,''
``negotiating,'' and ``executing'' also include directing other
personnel to arrange, negotiate, or execute a particular security-based
swap. In other words, sales and trading personnel of a non-U.S. person
who are located in the United States cannot avoid application of this
rule by simply directing other personnel to carry out dealing activity,
and we would view personnel located in a U.S. branch or office who
direct personnel not located in the United States to arrange,
negotiate, or execute a security-based swap transaction as themselves
arranging, negotiating, or executing the transaction. Similarly,
personnel directing the arranging, negotiation, or execution of
security-based swaps include personnel located in a U.S. branch or
office that specify the trading strategy or techniques carried out
through algorithmic trading or automated electronic execution of
security-based swaps, even if the related server is located outside the
United States.\230\ Some commenters requested that certain requirements
not apply to transactions that involve U.S. activity if parties have no
reasonable basis to expect that Title VII regulations will apply, for
example, because the trade has been executed on an anonymous electronic
platform or in algorithmic/program driven trading, in which a
counterparty may have personnel in the U.S. but there is no human
contact within the U.S. related to the transaction.\231\ However, we do
not believe that it is appropriate to create a blanket exclusion for
these transactions from the de minimis counting requirement, as neither
algorithmic trading nor automated electronic execution of security-
based swaps eliminates the concerns addressed by Title VII dealer
regulation, which exist irrespective of the expectations of the
counterparty to a particular transaction.\232\
---------------------------------------------------------------------------
\230\ We would not view personnel responsible solely for coding
the algorithm as specifying the trading strategy or techniques
carried out through such trading or execution.
\231\ See ISDA Letter at 7-8; SIFMA/FSR Letter at 7 (stating
that transactions should not be counted towards the de minimis
calculations if executed anonymously on an exchange and cleared, or
through algorithmic or program-driven trading); IIB Letter at 17-18
(same, noting that doing so could deter non-U.S. counterparties from
trading on those platforms).
\232\ Cf. ISDA Letter at 5 (acknowledging that ``the
Commission's concern that electronic trading does not eliminate the
possibility of abusive or manipulative conduct'' and requesting
further clarification of the application of the proposed rule to
electronic trading).
---------------------------------------------------------------------------
2. ``Located in a U.S. Branch or Office''
Exchange Act rule 3a71-3(b)(1)(iii)(C) applies only to transactions
connected with a non-U.S. person's security-based swap dealing activity
that are arranged, negotiated, or executed by personnel located in a
U.S. branch or office.\233\ Thus, on the one hand, we generally would
view the rule to require a non-U.S.-person dealer to include in its de
minimis calculations any transactions arranged, negotiated, or executed
in the United States by, for example, personnel assigned to, on an
ongoing or temporary basis, or regularly working in a U.S. branch or
office. On the other hand, we would not view the rule to require a non-
U.S.-person dealer to include in its de minimis calculations
transactions arranged, negotiated, or executed by personnel assigned to
a foreign office if such personnel are only incidentally in the United
States. For example, the amendment does not require a non-U.S. person
to include transactions that such personnel arrange, negotiate, or
execute while traveling in the United States to attend an educational
or industry conference.
---------------------------------------------------------------------------
\233\ As noted in Section IV.C.1, however, if personnel located
in a U.S. branch or office are arranging, negotiating, or executing
a particular security-based swap by directing personnel not located
in a U.S. branch or office to arrange, negotiate, or execute a
security-based swap transaction, we would view that transaction as
having been arranged, negotiated, or executed by the personnel
located in the United States.
---------------------------------------------------------------------------
As we noted in our U.S. Activity Proposing Release, this element of
the final rule also should mitigate the burdens associated with
determining whether a particular transaction needs to be included in a
non-U.S. person's de minimis calculation.\234\ We acknowledge that the
final rule potentially would lead a market participant to perform a
trade-by-trade analysis to determine the location of relevant personnel
performing market-facing activity in connection with the transaction.
However, because the final rule encompasses a person's dealing activity
only when its personnel or personnel of its agent located in a U.S.
branch or office have arranged, negotiated, or executed the
transaction, a non-U.S. person performing this analysis should be able
to identify for purposes of ongoing compliance the specific sales and
trading personnel whose involvement in market-facing activity would
require a transaction to be included in its de minimis
calculation.\235\ Alternatively, such non-U.S. person may establish
policies and procedures that would facilitate compliance with this
final amendment by requiring transactions connected with its dealing
activity to be arranged, negotiated, and executed by personnel located
outside the United States.
---------------------------------------------------------------------------
\234\ See U.S. Activity Proposing Release, 80 FR 27469.
\235\ Based on our staff's discussions with market participants,
we continue to believe that persons engaged in dealing activity may
already identify personnel involved in market-facing activity with
respect to specific transactions in connection with regulatory
compliance policies and procedures and to facilitate compensation.
See id. at 27469 n.191.
In addition, we believe that some market participants engaged
in both swap dealing and security-based swap dealing activity may
perform a similar analysis consistent with the CFTC Staff Advisory,
which sets forth the CFTC staff's view that Title VII requirements
apply to transactions arranged, negotiated, or executed in the
United States by, or on behalf of, swap dealers. See note 20, supra.
---------------------------------------------------------------------------
Consistent with our proposed approach, the final rule applies to
security-based swap transactions that the non-U.S. person, in
connection with its dealing activity, arranges, negotiates, or
executes, using personnel located in a U.S. branch or office, even in
response to inquiries from a non-U.S.-person counterparty outside
business hours in the counterparty's jurisdiction. One commenter urged
us not to include such transactions in the U.S. Activity Test, arguing
that dealing activity carried out in the United States in response to
inquiries is generally occurring pursuant to ``product, credit and
market risk parameters'' set by management personnel outside the United
States and that the activity is not ``regular business'' because the
location of the activity is ``solely incidental to the hour of the day
when the non-U.S. counterparty desires to trade.'' \236\
---------------------------------------------------------------------------
\236\ See IIB Letter at 18-19 (arguing that the dealing activity
of the U.S. personnel in the trade is solely based on the hour of
the day and thus incidental and that maintaining the proposed
approach would be difficult as it would require non-U.S. persons to
hire staff to work after-hours in the non-U.S. offices). See also
HSBC Letter at 2 (explaining that U.S. sales and trading personnel
may arrange, negotiate, or execute security-based swaps solely due
to time-zone differences).
---------------------------------------------------------------------------
We do not agree that these circumstances, including the fact that
the dealer's counterparty made the initial contact leading to the
transaction, are relevant in determining whether a transaction should
be included in a non-U.S. person's de minimis threshold calculations.
The focus of our U.S. Activity Test is on the location of the personnel
used to arrange, negotiate, or execute the security-based swap
transaction, as we continue to believe that a non-U.S. person that uses
sales or trading personnel located in a U.S. branch or office to engage
in market-facing activity in connection with its dealing activity, at
least to the extent that its relevant dealing activity exceeds the de
minimis threshold, is likely to
[[Page 8624]]
raise concerns addressed by Title VII dealer regulation.\237\ As noted
above, to the extent that personnel assigned to a foreign office are
themselves only incidentally present in the United States, we would not
view the final rule as encompassing any transactions that they arrange,
negotiate, or execute. But we do not believe that either the nature of
the initial contact made by the foreign counterparty or the fact that
parameters for the market-facing activity in the United States are
established by management personnel outside the United States mitigates
the concerns arising from a non-U.S. person that, in connection with
its dealing activity, uses personnel located in the United States to
arrange, negotiate, or execute a security-based swap.\238\ Accordingly,
we would view the final rule as encompassing transactions under such
circumstances to the extent that the personnel arranging, negotiating,
or executing the transaction on behalf of the non-U.S. person dealer
are located in a U.S. branch or office as described above.\239\
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\237\ See Sections IV.B.2 and II.B, supra.
\238\ Cf. note 222, supra (noting that the amendment includes
``arrange'' instead of ``solicit'' in recognition of the fact that a
dealer, by virtue of being commonly known in the trade as a dealer,
may respond to requests by counterparties to enter into dealing
transactions, in addition to actively seeking out such
counterparties).
\239\ We also recognize that Exchange Act section 3(a)(71)(C)
excepts from the security-based swap dealer definition a person that
enters into security-based swaps for its own account, but not as a
part of regular business. However, we have previously interpreted
``regular business'' to focus on activities of a person that are
usual and normal in the person's course of business and identifiable
as a security-based swap dealing business. See Intermediary
Definitions Adopting Release, 77 FR 30610 (interpreting ``regular
business'' for purposes of the ``swap dealer'' definition). We do
not agree with the commenter that, because the non-U.S. person's use
of the personnel located in a U.S. branch or office is to
accommodate the non-U.S. person counterparty outside its local
market hours, the use of the trading or sales personnel located in a
U.S. branch or office is incidental and thus not ``regular
business'' of the non-U.S. person. Under our interpretation of
``regular business,'' it is important to consider whether the non-
U.S. person's usual and normal course of business is identifiable as
a security-based swap dealing business, not the frequency of or
reasons for using personnel located in a U.S. branch or office.
---------------------------------------------------------------------------
3. ``Personnel of Such Non-U.S. Person'' or ``Personnel of an Agent''
Exchange Act rule 3a71-3(b)(1)(iii)(C) would apply to transactions
connected with a non-U.S. person's security-based swap dealing activity
that are arranged, negotiated, or executed by personnel located in a
U.S. branch or office, whether the non-U.S. person arranges,
negotiates, or executes the transaction directly using its own
personnel located in a U.S. branch or office, or does so using
personnel of an agent of such non-U.S. person, located in a U.S. branch
or office.
As noted above, a non-U.S. person engaged in security-based swap
dealing activity with other non-U.S. persons, if it wishes to avail
itself of the expertise of sales, trading, and other personnel located
in a U.S. branch or office, may carry out that activity using its own
personnel located in a U.S. branch or office, or using the personnel of
its agent, located in a U.S. branch or office.\240\ We continue to
believe that the location of personnel carrying out market-facing
activity appears particularly relevant for identifying non-U.S. persons
that may raise the types of concerns described above,\241\ whether that
dealing activity is carried out by the non-U.S. person's personnel
located in a U.S. branch or office or on its behalf by the personnel of
its agent, located in a U.S. branch or office.\242\ Accordingly, the
final rule requires a non-U.S. person to include in its de minimis
calculations any transactions in connection with its security-based
swap dealing activity that are arranged, negotiated, or executed by
personnel of such person located in a U.S. branch or office, or by
personnel of its agent located in a U.S. branch or office.\243\ For the
reasons discussed in Section IV.B.3, above, the final rule does not
include any exception from the de minimis counting requirement for
security-based swap transactions that a non-U.S. person, in connection
with its dealing activity, arranges, negotiates, or executes using
personnel located in the United States.\244\
---------------------------------------------------------------------------
\240\ For purposes of Exchange Act rule 3a71-3(b)(1)(iii)(C), we
interpret the term ``personnel'' in a manner consistent with the
definition of ``associated person of a security-based swap dealer''
contained in section 3(a)(70) of the Exchange Act, 15 U.S.C.
78c(a)(70), regardless of whether such non-U.S. person or such non-
U.S. person's agent is itself a security-based swap dealer. This
definition is, in turn, substantially similar to the definition of
``associated person of a broker or dealer'' in section 3(a)(18) of
the Exchange Act, 15 U.S.C. 78c(a)(18). The definition in section
3(a)(18) is intended to encompass a broad range of relationships
that can be used by firms to engage in and effect securities
transactions, and is not dependent solely on whether a natural
person is technically an ``employee'' of the entity in question. See
Alexander C. Dill, Broker-Dealer Regulation Under the Securities
Exchange Act of 1934: The Case of Independent Contracting, 1994
Colum. Bus. L. Rev. 189, 211-213 (1994) (noting that the Securities
Act Amendments of 1964, which amended section 3(a)(18) of the
Exchange Act, ``rationalized and refined the concept of `control' by
firms over their sales force by introducing the concept of an
`associated person' of a broker-dealer.''). Accordingly, we expect
to consider whether a particular entity is able to control or
supervise the actions of an individual when determining whether the
individual is considered to be ``personnel'' of a U.S. branch,
office, or agent of a security-based swap dealer. This is
particularly relevant in the context of a financial group that
engages in a security-based swap dealing business, where personnel
of one affiliate may operate under the direction of, or in some
cases, report to personnel of another affiliate within the group.
See also Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships with, Hedge Funds and
Private Equity Funds, BHCA-1 (December 10, 2013), 59 FR 5535, 5591
(January 31, 2014) (explaining, in the context of adopting certain
provisions of what is commonly referred to as the Volcker Rule, that
the relevant ``trading desk'' of a banking entity ``may manage a
financial exposure that includes positions in different affiliated
legal entities'' and similarly ``may include employees working on
behalf of multiple affiliated legal entities or booking trades in
multiple affiliated entities'') (internal citations omitted).
\241\ See Section IV.B, supra. One commenter urged the
Commission to return to its initially proposed approach, which would
have looked to the location of relevant activity of both
counterparties. Letter from Better Markets, dated July 13, 2015
(``Better Markets Letter''), at 3, 6. The commenter urged the
Commission to ``strengthen its proposal by requiring that if either
non-U.S. counterparty uses U.S.-based personnel, then the
transaction must be included within U.S./Foreign Personnel
Activity,'' explaining that the involvement of personnel in the
United States would be consistent with the Supreme Court's decision
in Morrison v. National Australia Bank, Ltd., 130 S. Ct. 2869, 2884
(2010) (``Morrison''), and that a counterparty engaged in dealing
activity can reasonably be required to consider the location of its
counterparty's activity, as well as its own). Id. at 3. Given the
structure of the security-based swap market and the concentration of
security-based swap dealing among a small group of firms, we believe
the final rule is appropriately tailored to capture the dealing
activity that is likely to raise the types of concerns addressed by
the Title VII dealer regime. See Section IV.B.2.
\242\ We continue to believe that it is appropriate for the
final rule to take into account where personnel of the non-U.S.
person's agent are arranging, negotiating, or executing the
transaction on behalf of the non-U.S. person, regardless of whether
the agent is affiliated with the non-U.S. person, as security-based
swap dealing activity carried out through an unaffiliated agent is
likely to raise the same concerns as such activity carried out
through an affiliated agent.
\243\ A non-U.S. person that uses a broker as its agent to
arrange, negotiate, or execute security-based swap transactions in
connection with that non-U.S. person's dealing activity would be
required to include those transactions in its own de minimis
calculations. We recognize that this approach may make certain
brokers less able to compete for the business of non-U.S.-person
dealers that would otherwise not be arranging, negotiating, or
executing transactions using personnel located in a U.S. branch or
office, but given the regulatory concerns such transactions may
raise, we think it is appropriate to require such transactions to be
included in the non-U.S. person's de minimis threshold calculations.
See Sections IV.B.2, IV.B.3, and II.B, supra.
\244\ Consistent with our views expressed in prior releases, if
a financial group used one entity to perform the sales and trading
functions of its dealing business and another to book the resulting
transactions, we would ``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.'' Cross-Border
Proposing Release, 78 FR 30976. See also 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 engages in dealing activity can fall
within the dealer definition even if it uses an affiliated entity to
market and/or negotiate those security-based swaps connected with
its dealing activity (e.g., the person is a booking entity).'').
To the extent that the activities performed by the entity
performing the sales and trading functions involve arranging,
negotiating, or executing security-based swaps as agent for the
booking entity in connection with the booking entity's dealing
activity, this amendment treats the booking entity's transmission of
an order and instructions to the agent as part of the dealing
activity of the booking entity itself. As already noted, a person
engaged in these activities on behalf of the booking entity may
itself be subject to regulation as a broker under the Exchange Act.
See note 187, and accompanying discussion, supra.
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[[Page 8625]]
4. Exception for Transactions Involving Certain International
Organizations
In response to the Cross-Border Proposing Release, certain
commenters raised concerns about the potential application of various
Title VII provisions to multilateral development banks (``MDBs''),
including the International Bank for Reconstruction and Development (or
the World Bank) and the International Finance Corporation.\245\ These
commenters argued that MDBs have absolute immunity under federal law
and should be excluded from regulation under Title VII entirely; in
addition, they argued that MDBs should be excluded from the definition
of U.S. person.\246\ In the Cross-Border Adopting Release, which
addressed the cross-border application of the ``security-based swap
dealer'' and ``major security-based swap participant'' definitions, we
took the position that such issues were outside the scope of the
release, as the source of any such immunities lies outside the Dodd-
Frank Act and the federal securities laws.\247\ However, we concluded
that their status as international organizations warranted excluding
them from the definition of ``U.S. person.'' \248\
---------------------------------------------------------------------------
\245\ See Cross-Border Adopting Release, 79 FR 47305-06, nn.
224, 225 (citing commenters expressing concern about application of
Title VII to certain MDBs).
\246\ See id. at 47305-06.
\247\ See id. at 47349.
\248\ See id. at 47312-313; Exchange Act rule 3a71-3(a)(4)(iii)
(excluding certain international organizations from the definition
of U.S. person).
---------------------------------------------------------------------------
One commenter on the U.S. Activity Proposing Release objected to
the view set forth in the Cross-Border Adopting Release that the scope
of these entities' immunities was outside the scope of our prior
release, arguing that we had left unaddressed the effect of that
immunity on relevant statutory provisions and that we should have
entirely excluded MDBs from any obligation to register as a security-
based swap dealer or major security-based swap participant, as the CFTC
had done in the jointly adopted Intermediaries Definition Adopting
Release.\249\
---------------------------------------------------------------------------
\249\ See Letter from Sullivan and Cromwell, dated July 13, 2015
(``Sullivan and Cromwell Letter''), at 1-2.
---------------------------------------------------------------------------
As an initial matter, we reiterate our view that issues related to
the immunities of MDBs or other international organizations are outside
the scope of our Title VII rulemaking, given that the source of any
such immunities lies outside the scope of the Dodd-Frank Act and the
federal securities laws. We recognize that to the extent that an MDB or
other international organization believes that its security-based swap
activities fall within the scope of the immunities available to it
under U.S. law, the organization may decide not to register as either a
security-based swap dealer or a major security-based swap participant,
even if the volume of its transactions in these instruments exceed the
de minimis threshold.\250\ However, we are not, in adopting rules under
Title VII, expressing any views as to the immunities such entities may
possess generally under international or U.S. law.
---------------------------------------------------------------------------
\250\ The commenter noted that MDBs currently do not engage in
security-based swap transactions in volumes that would require them
to register either as security-based swap dealers or as major
security-based swap participants. See Sullivan and Cromwell Letter
at 2, note 5.
---------------------------------------------------------------------------
In any event, on further consideration, and consistent with the
considerations underlying the exclusion of certain international
organizations from the definition of U.S. person, the final rule
excepts the same international organizations, as defined in Exchange
Act rule 3a71-3(a)(4)(iii), from the requirement to count a security-
based swap transaction with another non-U.S. person toward their de
minimis thresholds when they use personnel located in the United States
to arrange, negotiate, or execute the transaction.\251\ Independent of
any immunities that may be applicable to these international
organizations, including MDBs, we do not believe that their dealing
activity with other non-U.S. persons should be included in any de
minimis calculations that such organizations may make.\252\
---------------------------------------------------------------------------
\251\ See Exchange Act rule 3a71-3(b)(1)(iii)(C).
\252\ Cf. Cross-Border Adopting Release, 79 FR 47313
(determining that the MDBs' status as international organizations
warranted excluding them from the definition of ``U.S. person'').
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D. Availability of the Exception for Cleared Anonymous Transactions
Under Exchange Act rule 3a71-5, a non-U.S. person, other than a
conduit affiliate, is not required to include in its de minimis
calculation transactions that are entered into anonymously on an
execution facility or national securities exchange and are cleared
through a clearing agency.\253\ This rule mitigates the likelihood that
market participants will find themselves in a position where they are
required to determine the treatment of the transaction under the de
minimis exception in circumstances where the information necessary to
that determination (e.g., the U.S.-person status of the counterparty)
is unavailable to them.\254\ In addition, this exception should reduce
the likelihood that execution facilities outside the United States will
exclude U.S. market participants to prevent a non-U.S. market
participant from potentially being required to register as a security-
based swap dealer based on information unavailable to the non-U.S.
market participant at the time of the transaction.\255\
---------------------------------------------------------------------------
\253\ See Exchange Act rule 3a71-5.
\254\ See Cross-Border Adopting Release, 79 FR 47325 n.412.
\255\ See id. at 47325.
---------------------------------------------------------------------------
As we noted in the U.S. Activity Proposing Release, neither risk
arises under the revised approach to transactions that are arranged,
negotiated, or executed by personnel located in the United States that
was proposed in that release.\256\ Accordingly, we proposed to amend
rule 3a71-5 by adding new paragraph (c) to make this exception
unavailable to transactions that non-U.S. persons would be required to
count under proposed Exchange Act rule 3a71-3(b)(1)(iii)(C). Several
commenters have urged us to exclude from this modified approach
transactions that are traded on an electronic exchange or platform,
whether registered or not, or that are cleared through a clearing
agency located outside the United States, as such transactions do not
create risk in the United States and such a rule would interfere with
access to such platforms.\257\
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\256\ See U.S. Activity Proposing Release, 80 FR 27472-73.
\257\ See ISDA Letter at 3, 8 (stating that transactions cleared
outside the United States should not be subject to Title VII, as
they ``are subject to regulatory oversight in the clearing
jurisdiction and are subject to reporting and recordkeeping
requirements in that jurisdiction''); IIB Letter at 17-18
(explaining that non-U.S. counterparties trading on a platform may
not know that their non-U.S. dealer counterparty is using U.S.
personnel and therefore would not expect or want such trades to be
subject to sales practice and reporting requirements, so they may be
deterred from trading on the platforms or the platform may prohibit
access by U.S. personnel). See also SIFMA/FSR Letter at 7 (stating
that transactions should not be counted towards the de minimis
calculations if executed anonymously on an exchange and cleared).
---------------------------------------------------------------------------
However, as we have noted already, to the extent that personnel
located in the
[[Page 8626]]
United States are arranging, negotiating, or executing a security-based
swap transaction, the fact that a transaction is traded on a platform
or exchange does not eliminate the regulatory concerns that would
warrant applying Title VII dealer regulation to the extent the non-U.S.
person's dealing activity exceeds the de minimis thresholds: Dealing
activity carried out by personnel located in the United States on
behalf of a non-U.S. person, whether in over-the-counter markets or on
a platform, may raise the risk of financial contagion and may present
counterparty protection, market integrity, and transparency
concerns.\258\ Moreover, although we recognize that clearing a
security-based swap transaction can be expected to reduce operational
and counterparty credit risks, we do not believe it entirely addresses
these other regulatory concerns.
---------------------------------------------------------------------------
\258\ See Section IV.B.2, supra.
---------------------------------------------------------------------------
Indeed, we note that a significant proportion of the interdealer
market consists of cleared transactions, which suggests that the
exception urged by commenters may lead to a similar result as is likely
under a broker-dealer exception to the counting requirement described
above, namely a shift of a significant portion of the interdealer
market to foreign clearing agencies, taking that part of the market
entirely outside the Title VII dealer framework even though the dealing
activity continues to occur in the United States.\259\ In addition, we
note that nothing in Title VII suggests that clearing a transaction
should except a dealer from the requirement to include it in the
dealer's de minimis calculations.
---------------------------------------------------------------------------
\259\ See Section IV.B.2, supra.
---------------------------------------------------------------------------
Because excepting such transactions could leave significant volumes
of dealing activity carried out by non-U.S. persons in the United
States outside the scope of Title VII dealer regulation and undermine
the effectiveness of that regulatory framework to address the risks
created by such activity, we are adopting Exchange Act rule 3a71-5(c)
as proposed, with technical edits to clarify that the rule's exclusion
applies to the exceptions in both Exchange Act rules 3a71-5(a) and (b).
Accordingly, under the final rule, to the extent that a non-U.S. person
is required to count a transaction under Exchange Act rule 3a71-
3(b)(1)(iii)(C), it must count the trade toward its de minimis
threshold, even if the trade is executed anonymously on a platform and
cleared.\260\
---------------------------------------------------------------------------
\260\ The final rule should also help avoid competitive
disparities that could arise if a non-U.S. person could avail itself
of this exception even when arranging, negotiating, or executing a
transaction in connection with its dealing activity using personnel
located in a U.S. branch or office.
---------------------------------------------------------------------------
V. Economic Analysis
We are sensitive to the economic consequences and effects,
including costs and benefits, of our rules. In the following economic
analysis, we identify and consider the assessment costs and
programmatic costs and benefits of the rules we are now adopting, as
well as the likely effects of the rules on efficiency, competition, and
capital formation. We also discuss the potential economic effects of
certain alternatives to the approach taken by the final rules. Our
analysis addresses several issues that are particularly relevant to the
security-based swap market--including the market's global nature, the
concentration of dealing activity, and the ease with which dealers can
relocate their operations to different jurisdictions--and has informed
the policy choices we have described throughout this release.
A. Assessment Costs
Several commenters argued that the proposed rule would impose
significant costs on market participants, including costs related to
identifying transactions that needed to be counted toward the de
minimis thresholds.\261\ We recognize that under the final rules non-
U.S. persons will incur costs to assess whether their activities must
be counted against the dealer de minimis thresholds and subjected to
Title VII dealer requirements.\262\ The analysis of assessment costs in
the U.S. Activity Proposing Release accounted for these costs, and we
continue to believe that the final rule represents a reasonable
approach that mitigates the burden to market participants while
applying the Title VII dealer framework to non-U.S. persons that are
likely to raise the types of concerns that framework seeks to
address.\263\
---------------------------------------------------------------------------
\261\ One commenter stated that these costs ``would include the
establishment and maintenance of compliance systems, controls,
policies and procedures that track and control the interactions of
U.S. personnel with non-U.S. counterparties across a wide range of
communication media, including telephone, chat, instant messaging
and electronic trading platforms.'' See IIB Letter at 3. Another
commenter stated that the global nature of the security-based swap
market means that participants will arrange, negotiate, and execute
security-based swap transactions in multiple jurisdictions, meaning
that ``elements of a single [security-based swap] transaction may
take place in different parts of the world, which may often make it
difficult, or even impossible to determine what, if any, activity
has taken place in the United States.'' See ISDA Letter at 5. See
also HSBC Letter at 2 (stating that establishing a robust control
framework for tracking these transactions would present challenges).
\262\ We refer to these costs as ``assessment costs.'' See
Intermediary Definitions Adopting Release, 77 FR 30722.
\263\ The amendments the Commission is adopting do not make
substantive or material modifications to any collection of
information requirements as defined by the Paperwork Reduction Act
of 1995, as amended.
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As in the U.S. Activity Proposing Release, we first estimate the
likely increase in the number of entities that are likely to incur
costs associated with the de minimis analyses because the final rule
requires additional transactions to be included in these
calculations.\264\ We then consider the effect on assessment costs
associated with building, operating, and maintaining systems to
identify security-based swap activity that non-U.S. persons would be
required to count toward their de minimis thresholds under Exchange Act
rules 3a71-3(b)(1)(iii)(C) and 3a71-5(c).
---------------------------------------------------------------------------
\264\ Cf. HSBC Letter at 2 (noting that even firms that are not
required to register as security-based swap dealers as a result of
the final rule could face significant costs and challenges
associated with performing the de minimis analysis).
---------------------------------------------------------------------------
1. Costs Associated With Increase in Number of Firms Performing
Analysis
We have previously assumed that any non-U.S. person that annually
enters into more than $2 billion, in notional value, of security-based
swap transactions that would count toward its de minimis threshold
would be likely to incur assessment costs under Exchange Act rule 3a71-
3(b).\265\ Under Exchange Act rules 3a71-3(b)(1)(iii)(C) and 3a71-5(c),
these non-U.S. persons would likely also incur assessment costs in
connection with their transactions with other non-U.S. persons if they
use personnel located in a U.S. branch or office to arrange, negotiate,
or execute the transactions.
---------------------------------------------------------------------------
\265\ See U.S. Activity Proposing Release 80 FR 27490; Cross-
Border Adopting Release, 79 FR 47331.
---------------------------------------------------------------------------
As we have previously noted, the TIW transaction data do not permit
us to determine whether particular transactions were arranged,
negotiated, or executed by personnel located in the United States.\266\
However, as discussed above, it appears that many dealers prefer to use
personnel located in the United States to arrange, negotiate, or
execute transactions in security-based swaps on U.S. reference
entities.\267\ Accordingly, we believe that we can estimate the
increase in the number of firms that would incur assessment costs in
connection with determining the location of relevant activity involving
single-name CDS, by assuming that all
[[Page 8627]]
transactions by non-U.S. person \268\ dealers with other non-U.S.
persons on U.S. reference entities are arranged, negotiated, or
executed by personnel located in the United States.
---------------------------------------------------------------------------
\266\ See Section II.A.1, supra.
\267\ See, e.g., Section II.A.2.c, supra.
\268\ We note that TIW's definitions of U.S. and non-U.S.
entities do not necessarily correspond to the definition of U.S.
person under Exchange Act rule 3a71-3(a)(4). See note 39, supra.
---------------------------------------------------------------------------
Under these assumptions, we can estimate that a total of
approximately 10 additional non-U.S. persons,\269\ beyond those already
incorporated into baseline estimates, that are likely to exceed the $2
billion threshold we have previously employed under Exchange Act rule
3a71-3(b), as amended, and to incur assessment costs associated with
the de minimis exception based on 2014 TIW transactions data. We
acknowledge, however, that this estimate reflects some uncertainty: On
one hand, it may be overinclusive, as it is unlikely that all such
transactions are arranged, negotiated, or executed by personnel located
in a U.S. branch or office; it may also be underinclusive, as our TIW
data do not include single-name CDS transactions between two non-U.S.
entities written on non-U.S. underliers, some of which may be arranged,
negotiated, or executed by personnel located in a U.S. branch or
office, or transactions on other types of security-based swaps
(including equity swaps) whether on U.S. or non-U.S. underliers.\270\
---------------------------------------------------------------------------
\269\ Adjustments to these statistics from the proposal reflect
further analysis of the TIW data. Cf. U.S. Activity Proposing
Release 80 FR 27491 (providing an estimate of 15 additional entities
that would be non-U.S. persons).
\270\ Although the total gross notional for equity swaps is
significantly smaller than credit default swaps, some number of
market participants may incur assessment costs as a result of their
equity swap activity.
---------------------------------------------------------------------------
In light of this uncertainty and to account for potential growth in
the security-based swap market, we believe that it is reasonable to
increase this estimate by a factor of two. As a result, our estimate
for the purposes of analysis is that the rules being adopted today will
increase the number of non-U.S. persons likely to incur any assessment
costs in connection with the de minimis exception by 20. In addition to
the assessment costs directly connected with determining where
personnel who arrange, negotiate, or execute a security-based swap
transaction are located, as described more fully below, these 20
persons would also be required to perform the analyses, and incur the
assessment costs, associated with the dealer de minimis rules adopted
in the Cross-Border Adopting Release.\271\
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\271\ See Cross-Border Adopting Release, 79 FR 47331-33.
---------------------------------------------------------------------------
2. Costs Associated With Determining the Location of Relevant Personnel
Who Arrange, Negotiate, or Execute a Transaction
In addition, these 20 non-U.S. persons, as well as the 114 persons
that are likely to incur assessment costs in connection with the rules
adopted in the Cross-Border Adopting Release,\272\ will incur costs to
identify transactions that they are required to include in their de
minimis thresholds under Exchange Act rules 3a71-3(b)(1)(iii)(C) and
3a71-5(c). We note that our final rule should mitigate the concerns of
some commenters regarding the costs associated with the use of the
defined term ``transactions conducted within the United States'' as
originally proposed in the Cross-Border Proposing Release.\273\ In
particular, by focusing on the location of relevant personnel of only
the dealer (or of its agent), this approach should eliminate the need
for non-U.S. persons that engage in dealing activity to assess whether
their counterparties (or the counterparties' agents) engage in relevant
activity in the United States.\274\ Accordingly, the assessment costs
arising from the final rule should be lower than under an approach that
required a dealer to consider both the location of its own personnel
(or the personnel of its agents) and of the personnel of its
counterparties (or their agents).
---------------------------------------------------------------------------
\272\ Although firms that would already be registered under
existing Exchange Act rule 3a71-3 may not establish systems to count
these transactions for purposes of the de minimis exception because
they would already be registered, for purposes of the following
analysis, we assume that they would also incur these costs. In the
Cross-Border Adopting Release, we identified 71 persons that would
incur systems and analysis costs, but based on 2014 data, as noted
above, we have identified only 57 firms that are likely to incur
these costs pursuant to current rules. See Section II.A.2.e, supra.
We continue to believe it is reasonable to increase this estimate by
a factor of two, to account for any potential growth in the
security-based swap market and to account for the fact that we are
limited to observing transaction records for activity between non-
U.S. persons that reference U.S. underliers. See U.S. Activity
Proposing Release, 80 FR 27491.
\273\ See U.S. Activity Proposing Release, 80 FR 27467, supra
(discussing cost concerns about initially proposed approach).
\274\ See ICI Global Letter at 5.
---------------------------------------------------------------------------
The costs these persons incur under the final rule will, to a
significant extent, be influenced by the business structures employed
by non-U.S. persons to engage in this dealing activity, and it is
reasonable to expect that non-U.S. persons will generally choose a
business structure that reflects, among other things, a careful
consideration of their regulatory costs for both compliance and
assessment. In this section, we discuss the approaches that these
market participants may use to determine which transactions must be
counted towards dealer de minimis thresholds under our approach and, to
the extent possible, estimate the per-entity assessment costs they
would incur.
First, non-U.S. persons may perform assessments on a per-
transaction basis. We continue to believe that the approach reflected
in our final rule should be less costly to implement than the approach
that we initially proposed in the Cross-Border Proposing Release, which
looked to whether a transaction was conducted, by either counterparty,
within the United States. At the same time, we recognize that
performing these assessments could involve significant costs for
persons engaged in dealing activity in the United States. These costs
likely would include one-time costs associated with developing computer
systems to capture information about the location of personnel involved
with each transaction in addition to ongoing costs of analyzing these
data and modifying classification of transaction activity as personnel
or offices change locations over time.\275\
---------------------------------------------------------------------------
\275\ See note 261, supra.
---------------------------------------------------------------------------
Based on analogous situations dealing with the development and
modification of information technology (IT) systems that track the
location of firm inputs, we estimate the start-up costs associated with
developing and modifying these systems to track the location of persons
with dealing activity will be $410,000 for the average non-U.S. entity.
To the extent that non-U.S. persons already employ such systems, the
costs of modifying such IT systems may be lower than our estimate. In
addition to the development or modification of IT systems, we believe
that entities would incur the cost of $6,500 per location per year on
an ongoing basis for training, compliance, and verification costs.\276\
We believe a reasonable estimate of these costs in aggregate is
$8,710,000.\277\
---------------------------------------------------------------------------
\276\ Calculated as Internal Cost, 90 hours x $50 per hour =
$4,500 plus Consulting Costs, 10 hours x $200 per hour = $2000, for
a total cost of $6,500.
\277\ Calculated as 134 entities x 10 market centers as
identified in TIW x $6,500 per location, for a total cost of
$8,710,000. This estimate assumes that each of the 134 persons that
we believe are likely to incur costs to identify transactions that
they are required to include in their de minimis thresholds under
Exchange Act rules 3a71-3(b)(1)(iii)(C) and 3a71-5(c) perform
assessments on a per-transaction basis and further assumes that each
person has personnel located in each market center identified in the
TIW. See supra Section II.A.2.c.
---------------------------------------------------------------------------
Second, non-U.S. firms might instead restrict personnel located in
a U.S. branch or office from arranging, negotiating, or executing
security-based
[[Page 8628]]
swaps in connection with the non-U.S. firm's dealing activity with non-
U.S.-person counterparties.\278\ Such restrictions on communication and
staffing for the purposes of avoiding certain Title VII requirements
would reduce the costs of assessing the location of personnel involved
in arranging, negotiating, or executing each trade, and may entirely
remove the need for a system that assesses the location of personnel on
a trade-by-trade basis. However, this reduction in assessment costs may
be offset by the additional costs and inefficiencies of duplicating
personnel in foreign and U.S. locations.\279\ Accordingly, we believe
that non-U.S. persons that primarily trade with non-U.S. persons on
non-U.S. reference entities may be most likely to undertake this
approach. However, because our access to TIW transactions data is
limited to transactions in which at least one counterparty is U.S.-
domiciled or the reference entity or security is a U.S. entity or
security, we cannot at this time estimate the size of this set of
participants.
---------------------------------------------------------------------------
\278\ See SIFMA/FSR Letter at 2, 6; IIB Letter at 2-3; ISDA
Letter at 5.
\279\ See IIB Letter at 2-3.
---------------------------------------------------------------------------
While we do not currently have data necessary to precisely estimate
these costs in total,\280\ we can estimate the costs of establishing
policies and procedures to restrict communication between personnel
located in the United States employed by non-U.S. persons (or their
agents) and other personnel involved in dealing activity. Based on
staff experience, we estimate that establishing policies would take a
non-U.S. person approximately 100 hours and would cost approximately
$28,300 for each entity that chooses this approach.\281\ Further, we
believe that the total costs incurred by entities that choose to
restrict communication between personnel would be determined by the
number of entities that choose such an approach as well as the number
of additional personnel that these entities must hire as a result of
restricted communication.
---------------------------------------------------------------------------
\280\ The aggregate cost of this rule will ultimately depend on
how the affected non-U.S. persons adjust their security-based swap
activity because of this rule. For example, if a non-U.S. person
chooses to relocate its operations abroad, it will not incur any
direct assessment costs as a result of this rule, but it will incur
the costs to relocate its operations. The cost of relocation will
depend on many factors, such as the number of positions being
relocated, the location of new operations, the costs of operating at
the new location, and other factors. These factors in turn will
depend on the relative volumes of dealing activity that a firm
carries out on different underliers and with counterparties in
different jurisdictions. As a result of these dependencies, we
cannot reliably quantify the costs of these alternative approaches
to compliance. However, we believe that firms would rely on these
approaches only if they expect them to result in higher net profits
than assessments on a per-transaction basis.
\281\ Calculated as Compliance Manager, 100 hours x $283 per
hour = $28,300. We use salary figures from SIFMA's Management &
Professional Earnings in the Securities Industry 2013, modified by
SEC staff to account for an 1800-hour work-year and multiplied by
5.35 to account for bonuses, firm size, employee benefits, and
overhead.
The costs of policies and procedures are based on burden
estimates in the recent Nationally Recognized Statistical Rating
Organizations; Final Rule, Exchange Act Release No. 72936 (August
27, 2014), 79 FR 55078 (September 15, 2015) (``NRSRO Adopting
Release''). Specifically, we assume that the policies and procedures
required to restrict communication between personnel located in a
U.S. branch or office and personnel not located in a U.S. branch or
office are similar to policies and procedures required to eliminate
conflicts of interest under Rule 17g-5(c)(8). See NRSRO Adopting
Release, 79 FR 55239, 55249.
---------------------------------------------------------------------------
Third, a dealer may choose to count all transactions with other
non-U.S. persons towards its de minimis threshold, regardless of
whether counting them is required, to avoid the cost of assessing the
locations of personnel involved with each transaction. This strategy
may be preferred by a non-U.S. person engaged in dealing activity that
expects few transactions involving other non-U.S. persons to be
arranged, negotiated, and executed by personnel located outside the
United States, such as a non-U.S. person that primarily transacts in
security-based swaps on U.S. reference entities or securities, and
generally relies on personnel located in the United States to perform
market-facing activities. For these non-U.S. persons, the expected
benefits of identifying a few transactions that do not involve dealing
activity by personnel from a location in the United States, which would
not be required to be counted toward the person's de minimis threshold,
might be lower than the costs of implementing a system to track the
locations of personnel on a trade-by-trade basis.
We believe that the same principles apply to non-U.S. persons that
rely on agents to arrange, negotiate, or execute security-based swaps
on their behalf. We anticipate that non-U.S. persons may employ any of
the strategies above to comply with the final rules through the choice
of their agents. For example, a non-U.S. person may choose agents that
do not use U.S.-based personnel to avoid the assessment and
programmatic costs of this rule. We also anticipate that a non-U.S.
person might rely on representations from its agents about whether
transactions conducted on its behalf involved relevant dealing activity
by personnel from a location in the United States. This may occur on a
transaction-by-transaction basis, or, if the agent uses personnel
located in the United States in all or none of its transactions, it may
choose to make a representation about the entirety of the agent's
business.
We believe that all the methods described above are likely to
involve an initial one-time review of security-based swap business
lines to help each entity determine which of the business structures
outlined above is optimal. This review likely will encompass both
employees of potential registrants as well as employees of agents used
by potential registrants and identify whether these personnel are
involved in arranging, negotiating, or executing security-based swaps.
The information gathered as a result of this review would allow a
foreign security-based swap dealer to assess the revenues it expects to
flow from transaction activity performed by personnel located in a U.S.
branch or office. This information would also help these market
participants form preliminary estimates about the costs associated with
various alternative structures, including the trade-by-trade analysis
outlined above. This initial review may be followed with reassessment
at regular intervals or subsequent to major changes in the market
participant's security-based swap business, such as acquisition or
divestiture of business units. We estimate that the per-entity initial
costs of a review of business lines would be approximately
$104,000.\282\ Further, we believe that periodic reassessment of
business lines would cost, on average, $52,000 per year, per
entity.\283\
---------------------------------------------------------------------------
\282\ Calculated as (Senior Accountant, 500 hours x $198 per
hour) + (Outside Counsel, 5 hours x $400 per hour) + (Compliance
Attorney, 2 hours x $334 per hour) + (Compliance Manager, 8 hours x
$283 per hour) = $103,932.
\283\ This estimate is based on previous experience with cost
estimates for financial statements for a large financial
institution. An entity's assessment costs may require it to
determine the amount of profits that it expected to flow from
transaction activity performed by personnel located in the United
States and compare it to the flow of profits from transaction
activity performed by personnel not located in a U.S. branch or
office. To the extent that the preparation of financial statements
also involves analysis of the flow of profits from an entity's
different business lines, we believe that the cost of preparing
financial statements provide a reasonable estimate of assessment
costs. However, we acknowledge that costs associated with assessment
and compliance for a given firm will depend on the firm's size and
structure. Calculated as (Senior Accountant, 250 hours x $198 per
hour) + (Compliance Attorney, 4 hours x $334 per hour) + (Compliance
Manager, 4 hours x $283 per hour) = $51,968. We use salary figures
from SIFMA's Management & Professional Earnings in the Securities
Industry 2013, modified by SEC staff to account for an 1800-hour
work-year and multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
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[[Page 8629]]
B. Programmatic Costs and Benefits
Programmatic costs and benefits arise from applying substantive
regulation to those transactions and entities that fall within the
scope of the Title VII regulatory regime.\284\ Commenters raised a wide
range of concerns about costs, both the direct costs of compliance with
Title VII dealer requirements on the part of persons required to
register and broader costs to the market as a whole. With respect to
the former, commenters generally argued that the proposed rules would
impose significant additional and unwarranted costs on firms that are
required to register as security-based swap dealers, given that the
proposed rules are not likely to generate significant benefits.\285\
Several commenters specifically urged the Commission to perform
``additional cost-benefit analysis'' that reflects the ease with which
market participants can move their business out of the United
States.\286\ Some commenters noted that the proposed approach may
impose disproportionate costs on certain market participants that carry
out their dealing business using separately incorporated subsidiaries
or affiliates in other jurisdictions.\287\
---------------------------------------------------------------------------
\284\ See Intermediary Definitions Adopting Release, 77 FR
30722.
\285\ According to commenters, costs include those associated
with compliance with the various requirements that apply to
registered security-based swap dealers under Title VII, and costs
arising from relocation of personnel and operations to avoid
application of Title VII requirements and any market fragmentation
that results. See, e.g., ISDA Letter at 6 (arguing that the proposed
approach ``will result in the unnecessary application of onerous and
costly U.S. regulatory requirements to non-U.S. entities''); HSBC
Letter at 3 (arguing that costs of requiring firms to register on
the basis of U.S. activity would exceed the benefits and cause both
non-U.S. subsidiaries and the Commission to incur significant
costs); IIB Letter at 3-4, 6-7 (arguing that the proposed rules
would not only result in costs to the market such as market
fragmentation, decentralized risk management, and home country
compliance costs, but also significant costs to the Commission in
overseeing the additional registered security-based swap dealers);
SIFMA Sequencing Letter at 5 (arguing that the Commission's approach
should accommodate the risk management and operational structures
that market participants already have in place). See also ISDA
Letter at 9 (suggesting that by not leveraging existing broker-
dealer recordkeeping requirements to include access to the books and
records relating to SBS transaction between non-U.S. persons in
their dealing capacity, the proposal ``only adds complexity and cost
without offering any corresponding benefit'').
\286\ See IIB Letter at 4 (stating, among other things, that
non-U.S. persons can opt not to do business with U.S. security-based
swap dealers or with non-U.S. security-based swap dealers that use
personnel in the United States, and non-U.S. security-based swap
dealers may feel compelled to move personnel out of the United
States, limiting the security-based swap dealers' ability to
centralize risk management and increase costs and affect pricing to
non-U.S. persons); ISDA Letter at 6 (urging the Commission to
complete its cost-benefit analysis, including by providing a
quantitative account of the benefits that would result from adoption
of the proposal and comparing the costs of regulatory approaches
that may be less burdensome).
\287\ See SIFMA/FSR Letter at 6-7; HSBC Letter at 2 (stating
also that firms may be required to register multiple foreign
affiliates as security-based swap dealers to the extent that they
rely on personnel of affiliates located in the United States to
interact with the foreign customers of these foreign subsidiaries,
in part because it may not be practicable for counterparties to
shift their trading relationship to an affiliate of its dealer,
given that security-based swap transactions may represent only a
small portion of their overall trading relationship with the
dealer).
---------------------------------------------------------------------------
Several commenters expressed concerns that our approach would
create a strong incentive to move dealing business out of the United
States, and that this exit would have negative effects on market
structure, risk management, and market efficiency.\288\ Some commenters
also suggested that foreign counterparties of non-U.S. persons engaged
in dealing activity may be reluctant to devote the resources necessary
to comply with Title VII rules, and may instead opt to exit the U.S.
security-based-swap market.\289\
---------------------------------------------------------------------------
\288\ See IIB Letter at 2-3; ISDA Letter at 5; SIFMA/FSR Letter
at 6. Commenters argued that exit from U.S. market centers would
potentially interfere with efficient pricing and prudent risk
management, as this depends on centralization of pricing, hedging,
and other risk-management functions with trading personnel,
preferably ``in the region of the underlying asset.'' One commenter
also argued that centralizing these functions in the United States,
where the traders are located ``also helps promote U.S. market
liquidity by integrating trading interest from non-U.S.
counterparties into the U.S. market.'' See IIB Letter at 2.
\289\ See, e.g., IIB Letter at 4 (stating that ``[n]on-U.S.
counterparties have shown great reluctance to undertake significant
documentation changes due to the costs and resources necessary to
obtain familiarity with a complicated body of foreign law'').
---------------------------------------------------------------------------
In the following sections, we discuss the costs and benefits of
requiring a non-U.S. person to include in its de minimis threshold
calculations any transaction that it, in connection with its dealing
activity, arranges, negotiates, or executes using personnel located in
a U.S. branch or office.
1. Benefits and Costs of the Final Rules
Because the set of market participants that are subject to
security-based swap dealer regulation under Title VII will determine
the allocation and flow of programmatic costs and benefits arising from
these Title VII requirements, the inclusion of additional transactions
that must be counted under Exchange Act rule 3a71-3(b), as amended,
will affect the ultimate costs and benefits of our transaction-level
and entity-level rules. At this time, we are unable to precisely
estimate the number of potential new dealers that would be required to
register because we cannot observe in the data the location of
entities' dealing activity. However, even if we assume that all North
American single-name CDS security-based swap dealing activity takes
place in the United States, currently available data suggest that no
additional entities above the baseline would be required to
register.\290\
---------------------------------------------------------------------------
\290\ In Section V.A, supra, we have identified, as a result of
this rule, approximately 10 non-U.S. entities that would exceed the
$2 billion threshold we used in 2014 to identify entities that may
incur assessment costs and thus would be likely to assess their
transactions to determine whether they are required to register as a
dealer. Of these 10 entities, we believe that none would exceed the
$3 billion dealer de minimis threshold and thus be required to
register as a security-based swap dealer. Given that we have
multiplied our estimates by two to take into account portions of the
security-based swap market we are unable to observe with our data,
we estimate that 20 additional entities would incur assessment costs
as a result of relevant activity exceeding the $2 billion threshold,
and that zero additional entities will exceed the $3 billion dealer
de minimis threshold.
---------------------------------------------------------------------------
At the same time, we believe it is important to acknowledge the
potential for a change in the number of registrants as a result of,
among other things, security-based swap dealing activity located in the
United States that is not reflected in the data, including equity swaps
transactions that are not in our available data, transactions on non-
U.S. underliers that non-U.S.-person dealers carry out in the United
States that are not accounted for under the assumptions underlying this
analysis, and the aggregation of the transactions of affiliated
entities that do not themselves exceed the de minimis thresholds but
must count transactions that involve market-facing activity by
personnel located in a U.S. branch or office.\291\ The notional amounts
of these additional types of transactions may cause some additional
non-U.S. entities to exceed the de minimis threshold as a result of
this rule.
---------------------------------------------------------------------------
\291\ Under Exchange Act rules 3a71-2(a) and 3a71-4, a person
engaged in dealing activity must aggregate the notional amount of
its dealing activity that must be counted toward the de minimis
threshold with that of any person controlling, controlled by, or
under common control with such person, unless that person is
registered with the Commission as a security-based swap dealer or
deemed not to be a security-based swap dealer pursuant to Exchange
Act rule 3a71-2(b). Cf. IIB Letter at 3 (stating that the proposed
approach to the de minimis counting requirement could impose
prohibitive costs on non-U.S.-person dealers that intend to operate
under the de minimis threshold).
---------------------------------------------------------------------------
However, it is unclear how market participants might react to the
final rules. Some non-U.S. entities, including those that might be
required to register as a result of this rule because of transactions
that lie beyond the scope of our available data, may instead prefer to
restructure or relocate to avoid
[[Page 8630]]
registration as a result of this rule.\292\ Other non-U.S. entities may
otherwise alter their behavior in response to these amendments, given
the potential change in costs of conducting dealing activity using
personnel or their agents located in a U.S. branch or office. Although
we are able to provide some estimates of the direct programmatic costs
of these amendments, the extent to which market participants'
activities are sensitive to these costs is difficult to quantify.
---------------------------------------------------------------------------
\292\ See note 286, supra.
---------------------------------------------------------------------------
Notwithstanding these uncertainties, we believe the rules being
considered for adoption today represent an important step towards
treating substantially all dealing activity occurring in the United
States similarly for purposes of determining whether a market
participant is subject to the Title VII security-based swap dealer
regime. We expect the final rules to yield benefits by reducing
differences in the treatment of similar activity by U.S. persons and
non-U.S. persons in the United States and potential gaps in the Title
VII regulatory regime for security-based swap entities.
Additionally, we expect consistent treatment of dealing activity
carried out within the United States to affect competition and market
fragmentation. As discussed elsewhere in this release,\293\ we believe
these amendments may mitigate the competitive disparities that would
result from application of the Title VII dealer requirements under
existing rules and that would permit non-U.S. persons to carry out
significant volumes of dealing activity using personnel located in the
United States without being required to register as a security-based
swap dealer. The competitive disparities would create an incentive for,
among other things, financial groups that carry out their security-
based swap dealing business in a U.S.-person dealer to restructure a
potentially significant proportion of this business to be carried out
in a non-U.S.-person dealer.
---------------------------------------------------------------------------
\293\ See Section IV.B.2, supra; Section V.B.2, infra.
---------------------------------------------------------------------------
Even if the non-U.S.-person dealers continued using personnel
located in a U.S. branch or office to arrange, negotiate, or execute
security-based swap transactions, this type of restructuring could
fragment the market into two pools, as the non-U.S.-person dealers that
engage in dealing activity with other non-U.S. persons (whether dealers
or otherwise) would have a strong incentive not to engage in dealing
activity with U.S.-person counterparties. To the extent that the
interdealer business and other dealing business with non-U.S.-person
counterparties is moved to non-U.S.-person dealers, a significant
majority of security-based swap dealing activity carried out in the
United States could be inaccessible to U.S. persons. These
counterparties would instead be limited to a much smaller pool of
liquidity consisting of U.S. persons and dealers (whether U.S. persons
or non-U.S. persons) that are willing to face U.S.-person
counterparties.
However, under these amendments, non-U.S. dealers that carry out a
large volume of transaction activity using personnel located in a U.S.
branch or office would not be able to avoid registration obligations
under Title VII unless they relocate these personnel to locations
outside the United States or restructure operations to use different
personnel that are located outside the United States. Because these
forms of restructuring, and the resulting market fragmentation, would
impose costs on non-U.S. dealers associated with moving personnel
outside the United States and/or foregoing the expertise of sales,
trading, and other personnel located in a U.S. branch or office, these
amendments should reduce the likelihood or extent of market
fragmentation and associated distortions.\294\
---------------------------------------------------------------------------
\294\ See note 108, supra.
---------------------------------------------------------------------------
Given that the ultimate number of non-U.S. entities that are
required to register as a result of this rule will depend on several
factors that are beyond the scope of our available data or are
inherently difficult to quantify, we believe that it is appropriate for
purposes of this analysis to assume that it is possible that more
entities will register as SBS dealers.\295\ We also note that we expect
a significant benefit of this rule to be its role in preventing
significant volumes of dealing activity from being carried out in the
United States without being subject to Title VII dealer
requirements.\296\
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\295\ We do not believe that the exception for certain
international organizations in the final rule will have any effect
on the number of security-based swap dealers, as such entities do
not appear to engage in dealing activity to any significant extent.
See Sullivan and Cromwell Letter at 2, note 5. Similarly, given our
current understanding of the market, we do not believe it likely
that final Exchange Act rule 3a71-5(c) will increase the number of
security-based swap dealers, as any non-U.S. persons engaged in
significant dealing activity in cleared, anonymous transactions are
likely to already be required to register on the basis of their
other dealing activity.
\296\ See Section IV.B.2, supra.
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If these final rules regarding the de minimis exception result in
an increased number of non-U.S. persons that eventually register as
security-based swap dealers or if they prevent firms from carrying on
dealing activity in the United States without complying with Title VII
dealer requirements, requirements applicable to registered dealers
under Title VII (including, among others, capital requirements,
recordkeeping requirements, and designation of a chief compliance
officer) would apply to a larger number of dealers than without these
rules.\297\ Additionally, an increase in the number of registered
dealers would also mean that business conduct requirements and
Regulation SBSR would apply to a larger number of transactions, as well
as to a larger notional volume of transactions.\298\
---------------------------------------------------------------------------
\297\ See IIB Letter at 5-7, 10 (arguing that registration with
the Commission would subject certain non-U.S. market participants to
various requirements despite posing no risk to the U.S. financial
system; arguing that not adopting the proposed approach would permit
the Commission to avoid expending resources on overseeing non-U.S.
persons that may be required to register solely on the basis of
aggregation with other affiliates); ISDA Letter at 6 (arguing that
the proposed approach ``will result in the unnecessary application
of onerous and costly U.S. regulatory requirements to non-U.S.
entities''); HSBC Letter at 2-3 (arguing that costs of requiring
firms to register on the basis of U.S. activity would exceed the
benefits and cause both non-U.S. subsidiaries and the Commission to
incur significant costs).
\298\ Under rule 901(a)(2)(ii), all transactions that include a
registered security-based swap dealer on a transaction side are
subject to regulatory reporting requirements.
We note that our conclusion that the adopted approach will
result in these requirements being applied to a larger number of
transactions and notional volume of transactions requires the
assumption that the demand for liquidity from security-based swap
dealers is not very sensitive to price. Put another way, so long as
market participants' demand for risk sharing opportunities provided
by security-based swap transactions is relatively inelastic, any
reduction in transaction volume due to the costs of Title VII
regulation is unlikely to fully offset the increase in the scope of
security-based swap transactions subject to Title VII regulation
under the final rules. If, on the other hand, demand for liquidity
is elastic, then the effects of higher costs may dominate any
increase in the scope of external business conduct and regulatory
reporting requirements, resulting in these requirements being
applied to a smaller number and lower notional value of
transactions.
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In addition, these final rules may mitigate the risk that might
flow into U.S. financial markets by requiring the inclusion in dealer
de minimis calculations of transactions that, while less likely to
directly expose U.S. persons to counterparty risk, may allow financial
risk to spill over into U.S. markets. As noted above,\299\ reputational
risk and liquidity spillovers represent two channels by which risks in
foreign security-based swap markets may manifest in U.S. financial
markets without the involvement of U.S. persons as counterparties. By
requiring that all non-U.S. persons that use personnel located in a
U.S. branch or office to
[[Page 8631]]
arrange, negotiate, or execute security-based swaps in connection with
their dealing activity include such transactions in their de minimis
threshold calculations, the final rules should mitigate risk from both
channels. The final rules should increase the likelihood that the Title
VII dealer framework, including capital and margin requirements,
applies both to the foreign affiliates of U.S. persons and to other
foreign dealers that engage in dealing activity in U.S. security-based
swap markets. Increasing the likelihood that this activity, which may
represent the overwhelming majority of security-based swap dealing
activity in the United States, is carried out by firms subject to Title
VII capital, margin, and other security-based swap dealer requirements
should mitigate the likelihood of the types of firm failures that may
be likely to give rise to such risks.
---------------------------------------------------------------------------
\299\ See Section II.B, supra.
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We recognize that compliance with these requirements will impose
direct costs on persons that are required to register as a result of
these amendments, and that some firms may be required to register
multiple entities because of how they have chosen to structure their
business.\300\ Other firms may be required to register as security-
based swap dealers even though they use personnel located in a U.S.
branch or office in connection with dealing activity only for certain
asset classes in which they carry on a dealing business.\301\ We also
understand that firms may incur other costs associated with maintaining
separate sales and trading operations, in part because non-U.S.-person
counterparties are reluctant to trade with dealers that are required to
register under Title VII,\302\ or in connection with otherwise
accommodating the preferences of non-U.S.-person counterparties. In
some cases, these adjustments may reduce the efficiency of a non-U.S.-
person's operations and increase operational risks, depending on the
response of a particular firm to the final rules.\303\
---------------------------------------------------------------------------
\300\ See note 287, supra.
\301\ See SIFMA/FSR Letter at 7. We note, however, that this is
true of any dealer that exceeds the de minimis threshold with
respect to only one asset class in which it carries on a dealing
business: In the Intermediaries Definitions Adopting Release, the
Commission and the CFTC stated that the final rules reflected the
presumption that ``a person who meets one of the dealer definitions
will be deemed to be a dealer with regard to all of its swaps or
security-based swaps activities'' absent a limitation on this
designation in response to application from the registrant. See
Intermediaries Definition Adopting Release, 77 FR 30644-645.
\302\ See note 289, supra.
\303\ See, e.g., IIB Letter at 2-3.
---------------------------------------------------------------------------
At the same time, we continue to believe that, notwithstanding
these costs, the final rules will produce significant benefits to the
U.S. financial markets and participants in those markets, in terms of
promoting uniform application of Title VII dealer requirements,
reducing competitive disparities, mitigating the likelihood or extent
of market fragmentation, and mitigating the risk of spillovers and
contagion, as we have discussed in detail above.\304\ Given these
benefits, particularly in light of the magnitude of the potential
competitive disparities that a more consistent application of Title VII
dealer regulation may be expected to mitigate, we believe that the
approach reflected in the final rules is appropriate even in light of
the potential costs described by commenters.
---------------------------------------------------------------------------
\304\ See, e.g., Sections II.B and IV.B.2, supra.
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2. Effects of Rule Amendments on Efficiency, Competition, and Capital
Formation
The final rules are likely to affect efficiency, competition and
capital formation in the security-based swap market through their
effect on the scope of participants subject to dealer requirements
under Title VII. In particular, the amendments may increase the
likelihood that certain non-U.S. dealers would exceed de minimis levels
of dealing activity and be required to register with the Commission. At
the same time, they may make it more difficult to continue engaging in
dealing activity in U.S. market centers while avoiding Title VII dealer
requirements.
Accordingly, the final rules and amendments will affect the
security-based swap market in a number of ways. A number of the
potential effects that we discuss below are related to price
efficiency, liquidity, and risk sharing. These effects are difficult to
quantify for a number of reasons. First, in many cases the effects are
contingent upon strategic responses of market participants. For
instance, several commenters have noted that non-U.S. persons may
choose to relocate personnel, which may make it more difficult for U.S.
counterparties to access liquidity in security-based swaps.\305\ The
magnitude of these effects on liquidity and on risk sharing depend upon
a number of factors that we cannot estimate, including the likelihood
of relocation, the availability of substitute liquidity suppliers, and
the availability of substitute hedging assets. Therefore, much of the
discussion below is qualitative in nature, although we try to describe,
where possible, the direction of these effects.
---------------------------------------------------------------------------
\305\ See IIB Letter at 2-3; ISDA Letter at 5; SIFMA/FSR Letter
at 6. See also HSBC Letter at 2. See Section II.B, supra, for a
discussion of potential effects of the final rules on non-U.S.
persons' incentives to use personnel located in U.S. branches or
offices to arrange, negotiate, or execute security-based swap
transactions in the context of our economic considerations in
formulating these rules. But see Citadel Letter at 12 (arguing that
other commenters are overstating the possibility that U.S. personnel
will be relocated outside of the United States in reaction to the
adopted rules).
---------------------------------------------------------------------------
Moreover, there are many cases in which a rule could have two
opposing effects, making it difficult to estimate a net impact on
efficiency, competition, or capital formation. For example, while non-
U.S. person dealers may have an incentive to relocate their operations
outside of the United States to avoid the potential costs of dealer
registration and requirements as a result of these rules, we assume
that dealers would prefer to relocate their operations only if the
benefits to the dealer of avoiding Title VII dealer registration and
requirements exceed the cost of relocation.\306\ By defining the scope
of transactions that must be counted toward a non-U.S. person's de
minimis threshold, this final approach not only affects the set of
entities that would be subject to dealer registration and regulatory
requirements, but also affects the extent--and cost--of relocation
necessary to avoid dealer registration. The magnitude of these two
opposing effects will depend on factors such as the sensitivity of
traders to information about order flow, the impact of public
dissemination of transaction information on the execution costs of
large orders, and the ease with which non-U.S. persons can find
substitutes that avoid contact with personnel located in a U.S. branch
or office.\307\ Each of these factors is difficult to quantify
individually, which makes the net impact on efficiency difficult to
quantify.
---------------------------------------------------------------------------
\306\ See Citadel Letter at 12; Section II.A.2.c, supra. But see
IIB Letter at 2-3 (stating that non-U.S. security-based swap dealers
may need to relocate front office personnel from the United States
in response to a U.S. activity test); ISDA Letter at 5 (stating that
to continue to transact in U.S. products dealers will have
incentives to move market-facing employees outside the United
States); SIFMA/FSR Letter at 6 (explaining that dealers may move
experts in U.S.-listed products outside of the United States to
avoid the SEC's registration and regulatory requirements).
\307\ See notes 57-59 and accompanying text, supra.
---------------------------------------------------------------------------
Notwithstanding this uncertainty, the amendments related to the
treatment of transactions arranged, negotiated, or executed by
personnel located in a U.S. branch or office for the purposes of de
minimis calculations likely broaden the scope of security-based swap
transactions and entities to which the Title VII regulatory regime for
security-
[[Page 8632]]
based swap dealers applies. As a result, the amendments may amplify the
effects on efficiency, competition, and capital formation of rules
already adopted as well as of future substantive rulemakings that place
responsibilities on registered security-based swap dealers to carry out
entity- or transaction-level requirements applicable to security-based
swap dealers under Title VII.\308\
---------------------------------------------------------------------------
\308\ See Cross-Border Adopting Release, 79 FR 47361.
---------------------------------------------------------------------------
Our amendments reflect consideration of the potentially inefficient
restructuring and reduced access to the security-based swap markets by
U.S. persons on the one hand \309\ and, on the other, advancing the
objectives of Title VII as discussed in detail above.\310\ Requiring
these transactions to be included in their de minimis calculations may
cause these non-U.S. dealers to incur registration costs (or prevent
them from avoiding these costs while continuing to engage in dealing
activity in the United States) and costs arising from dealer
requirements under the Title VII regulatory regime, such as certain
business conduct requirements, as well as under other Title VII
requirements, such as Regulation SBSR. These costs may represent
barriers to entry for non-U.S. persons that contemplate engaging in
dealing activity using their own personnel or personnel of their agents
located in a U.S. branch or office or may provide incentives for non-
U.S. persons that currently engage in relevant activity using personnel
or personnel of their agents located in a U.S. branch or office to
restructure their business and move operations abroad or use agents
with personnel outside of the United States.\311\ The barriers to entry
and incentives to exit the market may reduce the number of security-
based swap dealers willing to trade with U.S. person counterparties,
which may impede the incorporation of new information into prices.
---------------------------------------------------------------------------
\309\ See note 102, supra.
\310\ See Section IV.B.2, supra. In particular, these final
rules potentially reduce the risk of financial contagion and
fraudulent or manipulative conduct by applying security-based swap
dealer regulation to the appropriate set of entities whose
activities raise these concerns. See id.
\311\ See Cross-Border Adopting Release, 79 FR 47362.
---------------------------------------------------------------------------
The application of this approach to agents acting on behalf of non-
U.S. persons may have similar effects on efficiency, competition, and
capital formation. For example, the regulatory costs stemming from
dealer registration may provide direct incentives for non-U.S. persons
to avoid using personnel of agents located in a U.S. branch or office
(or agents with such personnel) to arrange, negotiate, or execute
security-based swaps on their behalf. By reducing the ability of these
agents to compete for business from non-U.S. persons, the final rules
may reduce entry by potential agents because of this competitive
disadvantage, or cause existing agents to relocate or restructure their
business to minimize contact with the United States.\312\ In addition,
to the extent that using agents with personnel located in a U.S. branch
or office might result in substantial regulatory costs to non-U.S.-
person dealers, such non-U.S.-person dealers might prefer and primarily
use agents located outside the United States, while U.S. dealers might
continue to use agents located in the United States. This incentive to
split dealer and agent relationships on the basis of the location of
personnel, as with the potential relocation of personnel discussed
above, might also adversely affect the efficiency of risk sharing by
security-based swap market participants.
---------------------------------------------------------------------------
\312\ We also note that, under the final rules, non-U.S. persons
may be willing to pay higher prices for higher quality services
provided by non-U.S.-person counterparties that use personnel or
agents located in the United States because the ability of these
counterparties to meet the standards set by Title VII may be a
credible signal of high quality. See Cross-Border Adopting Release,
79 FR 47362 n.762.
---------------------------------------------------------------------------
Reduced market entry or restructuring by non-U.S. persons and their
agents, and efforts by non-U.S. persons to choose agents, solely for
the purposes of avoiding Title VII regulation in response to our final
rules, may be inefficient, may raise costs to market participants, and
may reduce the level of participation by personnel of non-U.S. persons
located in the United States, or personnel of their agents located in
the United States.\313\
---------------------------------------------------------------------------
\313\ See id. at 47364.
---------------------------------------------------------------------------
We also believe that the amendments will affect competition among
security-based swap dealers. Several commenters noted this possibility.
One commenter argued that the competitive issues arising from the
Commission's proposal were very complex and did not depend solely on
the scope of application of Title VII regulatory requirements.\314\ For
example, many, if not all, foreign security-based swap dealers are
likely to be subject to regulatory requirements in their home
jurisdiction and may, therefore, already be subject to a competitive
disparity with respect to U.S. firms, entirely independent of whether
they are also required to register as security-based swap dealers.\315\
This commenter also argued that the proposal would generate competitive
disparities between U.S. and non-U.S. personnel of foreign security-
based swap dealers.\316\ Another commenter supported the re-proposed
approach over the original proposal, arguing that it would prevent
foreign funds that have a U.S. asset manager from being put at a
competitive disadvantage compared to foreign funds with a foreign asset
manager and would therefore avoid driving business overseas (as the
commenter believed that the original proposal would have done).\317\
---------------------------------------------------------------------------
\314\ See IIB Letter at 4.
\315\ See id.
\316\ See id. One commenter argued that the Commission's
proposed approach likely would impose a particularly significant
burden on firms that carry out their business, and book their
security-based swap transactions, through local affiliates. See HSBC
Letter. This commenter argued that this would create a ``severe and
disparate'' impact on such firms, even though they have organized
their business using this structure ``for bona fide commercial
reasons.'' Id. at 3.
\317\ See ICI Global Letter at 2, 5. The commenter stated that
``the Commission's modified approach would no longer incentivize
non-U.S. dealers to avoid engaging in swaps transactions with a non-
U.S. regulated fund with a U.S. manager to stay under the [de
minimis] threshold''. Id. at 2.
---------------------------------------------------------------------------
As noted in Section II.B, in the absence of these amendments, a
U.S. person engaged in dealing activity and facing a non-U.S.-person
counterparty or its agent would face different regulatory treatment
under Title VII from a non-U.S. person engaged in the same activity
with the same counterparty or its agent, even if both are arranging,
negotiating, or executing the security-based swap using personnel
located in a U.S. branch or office. As a result, and as some commenters
argue, current rules may introduce different costs for U.S. security-
based swap dealers and foreign security-based swap dealers, as well as
their respective agents, that seek to supply liquidity to non-U.S.
persons as a result of Title VII regulation. Under the current rules,
non-U.S. persons seeking or supplying liquidity may also be reluctant
to transact with a U.S. person because of the additional expected costs
of dealer regulation and of future substantive regulations under Title
VII that rest on the U.S.-person status of counterparties.\318\
---------------------------------------------------------------------------
\318\ See note 289, supra.
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These differences could introduce competitive disparities between
U.S. persons and non-U.S. persons or their respective agents even if
both, in connection with their dealing activity, use personnel located
in the United States.\319\ As a result, to the extent that dealers may
have the flexibility to restructure their operations in response
[[Page 8633]]
to competitive disparities in regulation, a significant portion of the
security-based swap market may exit from the Title VII regime, and a
significant portion of the market may be susceptible to fragmentation
as a result.\320\ We believe that a significant portion of the costs of
such a fragmentation would be borne by U.S.-person counterparties
through higher spreads and by U.S. security-based swap dealers through
the loss of non-U.S. person customers. The amendments may mitigate
these competitive frictions because non-U.S. persons would be required
to count transactions arranged, negotiated, or executed by personnel
located in a U.S. branch or office towards their de minimis thresholds
in a way that is identical to their U.S.-person competitors.\321\
---------------------------------------------------------------------------
\319\ See section II.B, supra. See also IIB Letter at 2-3; ISDA
Letter at 5; SIFMA/FSR Letter at 6.
\320\ As noted in Section II.A.3, supra, analysis of TIW data
shows that 79.5 percent of North American corporate single-name CDS
transactions in 2014 involved either two ISDA-recognized dealers or
an ISDA-recognized dealer and a non-U.S.-person non-dealer. We
believe that restructuring as a response to competitive disparities
stemming from Title VII regulation is more likely to occur within
this subset of the market because these dealers currently operate
from locations throughout the world and enjoy a volume of business
that is more likely to make such restructuring profitable.
\321\ See Cross-Border Adopting Release, 79 FR 39152; Cross-
Border Proposing Release, 78 FR 31127.
---------------------------------------------------------------------------
At the same time, we acknowledge that this account of competitive
impacts is complicated by the fact that many non-U.S. persons are
likely to be subject to foreign regulatory frameworks that may, in
certain respects, be similar to the Title VII dealer requirements.\322\
To the extent that these requirements achieve comparable regulatory
outcomes, we note that we have proposed rules for a substituted
compliance mechanism, which should mitigate this source of competitive
disparity to the extent that we make substituted compliance
determinations and the other prerequisites to substituted compliance
have been satisfied. At the same time, we recognize that there will be
limits to the availability of substituted compliance, including the
possibility that substituted compliance may be permitted with regard to
some requirements and not others, or that, in certain circumstances,
substituted compliance may not be permitted with respect to any
requirements with regard to a particular jurisdiction, depending on our
assessment of the comparability of the relevant foreign requirements
and the availability of supervisory and enforcement arrangements among
the Commission and relevant foreign financial regulatory authorities.
As we have noted above, however, we do not believe it would be
appropriate to permit foreign security-based swap dealers to satisfy
their obligations under Title VII by complying with foreign
requirements when the prerequisites to substituted compliance have not
been satisfied.\323\
---------------------------------------------------------------------------
\322\ See Section II.A.4, supra.
\323\ See Section IV.B.3, supra.
---------------------------------------------------------------------------
The amendment to rule 3a71-5 provides that its exception for
cleared, anonymous transactions does not apply to non-U.S. persons that
arrange, negotiate or execute transactions using personnel located in a
U.S. branch or office or using agents with personnel located in a U.S.
branch or office. Although non-U.S. persons engaged in dealing activity
in the United States may also, as some commenters have suggested, find
it more difficult to access foreign trading platforms,\324\ this
amendment may also reduce the competitive frictions that would exist if
the final rules retained the exception for such non-U.S. person
dealers. Such an exception would provide such non-U.S.-person dealers a
potential competitive advantage relative to U.S. persons through lower
regulatory compliance and assessment costs, as the non-U.S. persons
would be able to avoid including these transactions in their de minimis
calculations, while U.S. persons would be required to count all such
transactions towards their de minimis thresholds.
---------------------------------------------------------------------------
\324\ See note 231, supra.
---------------------------------------------------------------------------
However, we also note that, to the extent that non-U.S. persons
otherwise would have relied upon this exception to engage in cleared,
anonymous transactions using personnel located in a U.S. branch or
office, our final approach may impair efficiency and capital formation
by reducing liquidity in anonymous markets, increasing transaction
costs, and reducing opportunities for risk-sharing among security-based
swap market participants as non-U.S. persons reduce their security-
based swap activity or switch to alternative methods to hedge
risk.\325\
---------------------------------------------------------------------------
\325\ See Cross-Border Adopting Release, 79 FR 47363.
---------------------------------------------------------------------------
As some commenters have argued,\326\ the final rule may result in
inefficient restructuring to move the arrangement, negotiation, and
execution of cleared, anonymous transactions abroad, in order to avoid
activities that would require counting towards de minimis thresholds.
This shift in the market could reduce the expected programmatic
benefits described above.\327\ It also may have adverse consequences
for the availability of liquidity and the amount of transaction costs
for U.S. persons seeking to hedge risk using security-based swaps. If
non-U.S. persons relocate their dealing activity abroad in ways that
make it more difficult for U.S. persons to find liquidity in the United
States, those U.S. persons that might otherwise use security-based
swaps to hedge financial and commercial risks may reduce their hedging
activity and assume an inefficient amount of risk, or engage in
precautionary savings by accumulating capital to mitigate the effects
of market risks, which would inhibit capital formation. To the extent
that non-U.S. persons use personnel located in a U.S. branch or office
to engage in dealing activity only in particular categories of
security-based swaps, such as those involving U.S. reference entities,
we believe that the potential consequences of relocation on liquidity
and risk sharing would be most concentrated in those categories.
---------------------------------------------------------------------------
\326\ See note 102, supra (citing comment letters asserting that
the final rules may result in inefficient restructuring of business
generally).
\327\ See IIB Letter at 4 (arguing that avoidance of U.S.
personnel by non-U.S. counterparties would likely reduce the
transparency benefits of the proposed approach).
---------------------------------------------------------------------------
Finally, we note that relocation of dealing activity by non-U.S.
persons in response to today's amendments may produce the same type of
market fragmentation we seek to avoid under existing rules. However, we
expect fewer non-U.S. entities may exit U.S. markets under the
amendments than in their absence. As noted above, in the absence of
these amendments, non-U.S. entities that wished to avoid Title VII
regulation would incur potentially lower costs, as they would not have
to relocate their personnel and would only need to change the booking
entity for their U.S.-facing business above the de minimis thresholds.
This type of restructuring would likely lead to market fragmentation,
as described above, given that non-U.S.-person dealers would have a
strong incentive not to engage in dealing activity with U.S.-person
counterparties, even if they continued to use personnel located in a
U.S. branch or office to arrange, negotiate, or execute their
transactions. On the other hand, the amendments being adopted today
likely will increase the costs of the types of restructuring that would
lead to market fragmentation. As noted above, in addition to the costs
of relocating personnel who arrange, negotiate, or execute security-
based swap transactions, non-U.S. persons who choose to relocate
dealing activity as a result of the amendments would forgo
[[Page 8634]]
the benefits of access to local expertise in security-based swaps based
on U.S. reference entities. As a result, we believe that the likelihood
or extent of market fragmentation should be lower under the amendments
being adopted today.
C. Alternatives Considered
In developing these amendments we considered a number of
alternative approaches.\328\ This section outlines these alternatives
and discusses the potential economic effects of each.
---------------------------------------------------------------------------
\328\ Cf. ISDA Letter at 6 (urging the Commission to complete a
cost-benefit analysis of the proposed approach that considers the
benefits and costs that would apply to non-U.S. persons, taking into
account alternative approaches that would achieve the goals
preventing fraud and manipulation).
---------------------------------------------------------------------------
1. Retention of the Definition of ``Transaction Conducted Within the
United States''
In the Cross-Border Proposing Release, we originally proposed the
definition ``transaction conducted within the United States'' and used
it to identify (i) transactions that should be included in an entity's
de minimis threshold calculations, and (ii) transactions that, subject
to certain exceptions, would be subject to business conduct, clearing,
trade execution, regulatory reporting, and public dissemination
requirements under Title VII. The original objective of the initially
proposed definition was identical to this rule: To capture relevant
dealing activity within the United States in order to mitigate
competitive frictions and prevent a non-U.S. person from shifting its
security-based swap dealing activity to a non-U.S. person and
continuing to carry out this dealing activity in the United States
while avoiding application of the Title VII requirements. That initial
approach would have looked to whether dealing activity involved a
``transaction conducted within the United States,'' which, as defined
in that proposal, turned on the location of personnel on both sides of
the transaction.
Most commenters supported the narrower approach set forth in our
U.S. Activity Proposing Release, which focused only on the location of
relevant activity of a counterparty acting in a dealing capacity in the
transaction \329\ and the limitation of relevant activity to ``market-
facing'' activity of that counterparty.\330\ One commenter stated that
the modified approach created ``a definable standard that will bring
clarity to the application of security-based swap requirements to
security-based swap dealers, and is appropriate and consistent with the
expectations of parties as to when U.S. security-based swap
requirements will apply.'' \331\ Although one commenter argued that a
non-U.S. person should be required to include a transaction with
another non-U.S. person in its dealer de minimis threshold calculations
if either counterparty is engaged in relevant activity in the United
States,\332\ we have determined to adopt the approach proposed in our
U.S. Activity Proposing Release in part because we agree with other
commenters that the initially proposed approach likely would have
increased assessment costs significantly without materially enhancing
the benefits of our Title VII dealer framework.\333\ Under the rule as
initially proposed, gathering the information regarding the location of
the personnel of the counterparty (or its agent), communicating it to
relevant counterparties, and keeping records of this information on a
per-transaction basis could be costly. We believe that our approach,
which focuses only on the location of the personnel of the dealer or
its agent, achieves similar programmatic benefits while likely
resulting in lower assessment costs.
---------------------------------------------------------------------------
\329\ See ICI Global Letter at 1-2, 5-6 (stating that the
modified proposal would enable non-U.S. dealers to enter into
transactions with non-U.S. persons that may use a U.S. fund manager
without requiring the non-U.S. dealer to include the transaction in
its de minimis calculations).
\330\ See IIB Letter at 17; SIFMA/FSR Letter at 3.
\331\ SIFMA/FSR Letter at 2-3 (stating also that the commenters
``strongly believe that the Commission has taken the correct
approach in focusing on market-facing activity of sales and trading
personnel in defining the `arrange, negotiate, or execute' nexus
that subjects security-based swap activity to the Commission's
regulations based on location of conduct'').
\332\ See Better Markets Letter at 3, 6 (urging that the
Commission ``strengthen its proposal by requiring that if either
non-U.S. counterparty uses U.S.-based personnel, then the
transaction must be included within U.S./Foreign Personnel
Activity,'' explaining that the involvement of personnel in the
United States would be consistent with Morrison and that a
counterparty engaged in dealing activity can reasonably be required
to consider the location of its counterparty's activity, as well as
its own (emphasis in original)).
\333\ See U.S. Activity Proposing Release, 80 FR 27461
(discussing commenters' concerns related to costs of the initially
proposed approach).
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2. Limited Exception From Title VII Requirements for Transactions
Arranged, Negotiated, and Executed by Personnel Subject to Existing
Domestic or Foreign Regulatory Requirements
In response to suggestions from several commenters,\334\ we
reconsidered providing an exception from the requirement to include a
transaction in a person's de minimis threshold calculations if it is
arranged, negotiated, or executed in the United States solely using
personnel of a registered broker-dealer acting in their capacity as
associated persons of that broker-dealer, of a registered security-
based swap dealer, or of a U.S. branch of a non-U.S. person, pursuant
to certain conditions.
---------------------------------------------------------------------------
\334\ See IIB Letter at 7; HSBC Letter at 3; SIFMA/FSR Letter at
7-8.
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Such an exception could reduce programmatic and assessment costs
associated with engaging in customer-facing activity in connection with
dealing activity in security-based swaps in the United States, which
may mitigate incentives for inefficient relocation by financial groups
that use a non-U.S. dealer to carry out their dealing activity in the
United States. However, financial groups that use a U.S. dealer may
respond to the incentives created by this exception by restructuring
their security-based swap dealing business so that it is carried out by
a non-U.S. person that relies on a registered broker-dealer, a
registered security-based swap dealer, or a U.S. branch, that meets the
conditions of the exception.
However, as described in more detail above,\335\ such an exception
could significantly reduce the expected benefits of our Title VII
dealer framework: It could create potentially significant compliance
gaps in the Title VII framework, impeding our effective enforcement of
Title VII and other federal securities laws, by permitting non-U.S.
persons to continue to carry out significant dealing activity--
including dealing activity accounting for most or all of the
interdealer market in security-based swaps on U.S. underliers--in the
United States but outside the scope of Title VII dealer
requirements.\336\
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\335\ See Section IV.B.3, supra.
\336\ Quantifying the programmatic and assessment costs of this
alternative is challenging given that we cannot observe the
propensity of non-U.S. persons to use the limited exception.
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3. Non-Inclusion of Security-Based Swap Transactions Involving Dealing
Activity in the United States in the De Minimis Threshold Calculations
Another alternative to the final rules would be not to require any
transactions other than those required in Exchange Act rule 3a71-3 as
adopted in June 2014 to be counted toward a person's dealer de minimis
threshold.\337\
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\337\ See SIFMA/FSR Letter at 5; IIB Letter at 5.
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As with the alternative just discussed, this alternative could
reduce programmatic and assessment costs associated with engaging in
customer-facing activity in connection with dealing activity in
security-based swaps in the United States, which may mitigate any
incentives for inefficient
[[Page 8635]]
relocation by financial groups that use a non-U.S. dealer to carry out
their dealing activity in the United States. However, as with the
preceding alternative, financial groups that use a U.S. dealer may
respond to the incentives created under the currently existing rules by
restructuring their security-based swap dealing business so that it is
carried out by a non-U.S. person, in which case none of its
transactions with other non-U.S. persons would be counted toward the de
minimis thresholds.
In our view, in the absence of some form of activity-based test,
the current scope of Exchange Act rule 3a71-3 raises the full range of
concerns arising from the ability of non-U.S. persons to continue to
engage in security-based swap dealing activity in the United States
without complying with Title VII dealer requirements, as described in
detail above.\338\ Moreover, to the extent that there are no
limitations on a non-U.S. person's ability to exclude these
transactions from its de minimis calculations, it is possible that a
significant portion of that activity, including potentially all
interdealer activity, eventually would occur entirely outside the scope
of Title VII security-based swap dealer regulation, to the extent that
financial groups restructure their dealing business in response to the
incentives created by the resulting competitive disparities and market
fragmentation. As we have already noted, this alternative would not
only reduce the current volume of security-based swap transactions by
non-U.S. persons included in such persons' dealer de minimis threshold
calculations, but financial groups that currently use U.S. persons to
carry out their dealing business in the United States may have an
incentive to migrate that business to affiliated non-U.S. persons to
stay competitive with their non-U.S. competitors.\339\
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\338\ See Section IV.B.2, supra.
\339\ For additional discussion of the likely effects of this
alternative, see the discussion in Sections IV.B.2 and IV.B.3,
supra.
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The absence of an activity-based test might also be costly because
of its adverse competitive effects between U.S. and non-U.S. persons.
Under current rules, the disparity in regulatory treatment means U.S.
and non-U.S. persons would face disparate regulatory costs even if both
engage in dealing activity using personnel located in a U.S. office.
Given these cost differences, non-U.S. persons or their agents
transacting with other non-U.S. persons or their agents in the United
States would potentially be able to provide liquidity at lower cost
than U.S. persons because of differing regulatory treatment in other
jurisdictions. As a result, non-U.S. persons could prefer to transact
with non-U.S. persons or their agents, and a substantial portion of
liquidity from non-U.S. persons might become unavailable to U.S.
persons.
4. Exception for Transactions Entered Into Anonymously on an Exchange
and Cleared
Another alternative to these amendments would be to not require
transactions that are entered into anonymously on an exchange and are
cleared to be counted towards an entity's dealer de minimis
threshold.\340\ As we noted in the U.S. Activity Proposing Release, the
purpose of the exception was to avoid putting market participants in a
position where they are required to determine the treatment of the
transaction under the de minimis exception in circumstances where the
information necessary to that determination is unavailable to
them.\341\ We do not believe that anonymous trades raise these concerns
in the context of the amendment to Exchange Act rule 3a71-3(b), given
that it does not require non-U.S. persons to look to the location or
status of their counterparty but only at that of its own personnel. We
do, however, believe that allowing such an exception would have adverse
consequences for competition between U.S. and non-U.S. dealers in the
United States. If non-U.S. dealers could transact in the United States
with non-U.S. counterparties but not be required to apply those
transactions to their de minimis thresholds because their transactions
were entered into anonymously on an exchange and cleared, non-U.S.
dealers would be able to continue to operate in the U.S. without being
subject to the dealer requirements of Title VII. The disparate costs
generated by the unequal application of Title VII dealer requirements
may further fragment liquidity into U.S. and non-U.S. pools, reducing
the liquidity available to participants in the U.S. security-based swap
market.
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\340\ See ISDA Letter at 7-8; SIFMA/FSR Letter at 7 (stating
that transactions should not be counted towards the de minimis
calculations if executed anonymously on an exchange and cleared).
See also ISDA Letter at 5 (stating that the Commission correctly
noted that electronic execution ``does not eliminate the possibility
of abusive or manipulative conduct,'' but expressing concern that
the proposed rules did not provide sufficient guidance regarding
application of this test to electronic trading).
\341\ See U.S. Activity Proposing Release, 80 FR 27472; Cross-
Border Adopting Release 79 FR 47325.
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5. Exception for Transactions Cleared Through Foreign Clearing Agencies
One commenter suggested that we should not apply Title VII
requirements to any transaction between two non-U.S. persons that is
cleared outside the United States. \342\ As we have noted elsewhere,
however, clearing of security-based swaps reduces counterparty risk and
operational risk, but the benefits of Title VII dealer regulations
extend beyond the concerns addressed by clearing, to concerns about
contagion, market fragmentation, and counterparty protection, among
others. Because clearing these transactions does not address these
concerns, whether a transaction is cleared does not appear to provide a
useful basis for determining whether a transaction should be excepted
from the de minimis counting requirement.\343\ It is also important to
note that such an exception would allow non-U.S. security-based swap
dealers to operate using personnel or personnel of agents located in
the United States, without being subject to Title VII dealer
requirements by clearing their transactions through a foreign clearing
agency. This disparity, as already discussed, could cause security-
based swap liquidity to fragment into two pools, and reduce the amount
of liquidity available to U.S. security-based swap market
participants.\344\
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\342\ See ISDA Letter at 3, 8 (stating that transactions cleared
outside the United States should not be subject to Title VII, as
they ``are subject to regulatory oversight in the clearing
jurisdiction and are subject to reporting and recordkeeping
requirements in that jurisdiction'').
\343\ See text accompanying note 259, supra.
\344\ See Section II.B, supra.
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6. Exception for Transactions Arranged, Negotiated, or Executed in the
United States Merely To Accommodate Foreign Clients' Needs When Foreign
Markets Are Closed
Another alternative would be to provide an exception for
transactions arranged, negotiated, or executed in the United States
merely to accommodate foreign clients' needs when foreign markets are
closed. For example, one commenter argued that the U.S. Activity Test
should not include security-based swaps in which U.S. personnel are
involved only to accommodate a non-U.S. counterparty outside of
operating hours in the counterparty's time zone.\345\ Under these
amendments, a
[[Page 8636]]
non-U.S. person is required to include in its dealer de minimis
threshold calculations transactions that it arranges, negotiates, or
executes using personnel located in the United States even if it does
so for the sole purpose of accommodating a foreign client's needs when
foreign markets are closed.\346\ Commenters have argued that requiring
these transactions to be included in a dealer's de minimis threshold
calculations may discourage non-U.S.-person dealers from providing
these services to their non-U.S.-person clients, which may increase the
transaction costs and the time necessary to execute their clients'
transactions.\347\ An exception for these types of transactions might
improve the liquidity available to non-U.S. security-based swap market
participants by allowing non-U.S. dealers to use personnel or personnel
of their agents located in the United States to arrange, negotiate, or
execute certain transactions when foreign markets are closed.
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\345\ See IIB Letter at 18-19 (arguing that the dealing activity
of the U.S. personnel in the trade is solely based on the hour of
the day and thus incidental and that maintaining the proposed
approach would be difficult as it would require non-U.S. persons to
hire staff to work after-hours in the non-U.S. offices); HSBC Letter
at 2.
\346\ See Section IV.C.2, supra.
\347\ See note 236, supra.
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However, the implementation of such an exception might have several
adverse consequences. For example, such an exception might create an
incentive for non-U.S. person dealers to claim such an exception for
trades that, at any other time of day, they would still have arranged,
negotiated, or executed using personnel located in the United States.
In addition, non-U.S. person dealers may have incentives to
artificially delay or advance the timing of trades to claim such an
exception. By abusing such an exception, non-U.S. dealers might create
a significant disparity in the way that they account for transactions
that they arrange, negotiate, or execute using personnel located in the
United States under the dealer de minimis exception. As a result, non-
U.S. dealers might not exceed a de minimis threshold and therefore may
not be required to register with the Commission, even if these non-U.S.
dealers continue with substantial amounts of dealing activity located
within the United States. The subsequent difference in the application
of dealer requirements between U.S. and non-U.S. dealers operating in
the United States may have the adverse market fragmentation and
competition effects discussed earlier.\348\
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\348\ See Section V.C.3, supra.
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VI. Regulatory Flexibility Act Certification
The Regulatory Flexibility Act (``RFA'') \349\ requires Federal
agencies, in promulgating rules, to consider the impact of those rules
on small entities. The Commission certified in the U.S. Activity
Proposing Release, pursuant to Section 605(b) of the RFA,\350\ that the
proposed amendments to Exchange Act rule 3a71-3 and 3a71-5 would not,
if adopted, have a significant impact on a substantial number of
``small entities.'' \351\ The Commission received no comments on this
certification.
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\349\ 5 U.S.C. 601 et seq.
\350\ 5 U.S.C. 605(b).
\351\ Although Section 601(b) of the RFA defines the term
``small entity,'' the statute permits agencies to formulate their
own definitions. The Commission has adopted definitions for the term
small entity for the purposes of Commission rulemaking in accordance
with the RFA. Those definitions, as relevant to this rulemaking, are
set forth in Rule 0-10, 17 CFR 240.0-10. See Statement of Management
on Internal Control, Exchange Act Release No. 18451 (January 28,
1982), 47 FR 5215 (February 4, 1982).
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For purposes of Commission rulemaking in connection with the RFA, a
small entity includes: (1) When used with reference to an ``issuer'' or
a ``person,'' other than an investment company, an ``issuer'' or
``person'' that, on the last day of its most recent fiscal year, had
total assets of $5 million or less; \352\ or (2) a broker-dealer with
total capital (net worth plus subordinated liabilities) of less than
$500,000 on the date in the prior fiscal year as of which its audited
financial statements were prepared pursuant to Rule 17a-5(d) under the
Exchange Act,\353\ or, if not required to file such statements, a
broker-dealer with total capital (net worth plus subordinated
liabilities) of less than $500,000 on the last day of the preceding
fiscal year (or in the time that it has been in business, if shorter);
and is not affiliated with any person (other than a natural person)
that is not a small business or small organization.\354\ Under the
standards adopted by the Small Business Administration, small entities
in the finance and insurance industry include the following: (i) For
entities in credit intermediation and related activities,\355\ entities
with $550 million or less in assets or; (ii) for non-depository credit
intermediation and certain other activities,\356\ entities engaged in
non-depository credit intermediation and related activities, $38.5
million or less in annual receipts; (iii) for entities in financial
investments and related activities,\357\ entities with $38.5 million or
less in annual receipts; (iv) for insurance carriers and entities in
related activities,\358\ entities with $38.5 million or less in annual
receipts, or 1,500 employees for direct property and casualty insurance
carriers; and (v) for funds, trusts, and other financial vehicles,\359\
entities with $32.5 million or less in annual receipts.\360\ Based on
feedback from market participants and our information about the
security-based swap markets, the Commission continues to believe that
the types of entities that would engage in more than a de minimis
amount of dealing activity involving security-based swaps--which
generally would be large financial institutions--would not be ``small
entities'' for purposes of the RFA.\361\
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\352\ See 17 CFR 240.0-10(a).
\353\ See 17 CFR 240.17a-5(d).
\354\ See 17 CFR 240.0-10(c).
\355\ Including commercial banks, savings institutions, credit
unions, firms involved in other depository credit intermediation,
credit card issuing, sales financing, consumer lending, real estate
credit, and international trade financing. 13 CFR 121.201 at
Subsector 522.
\356\ Including firms involved in secondary market financing,
all other non-depository credit intermediation, mortgage and
nonmortgage loan brokers, financial transactions processing,
reserve, and clearing house activities, and other activities related
to credit intermediation. 13 CFR 121.201 at Subsector 522.
\357\ Including firms involved in investment banking and
securities dealing, securities brokerage, commodity contracts
dealing, commodity contracts brokerage, securities and commodity
exchanges, miscellaneous intermediation, portfolio management,
providing investment advice, trust, fiduciary and custody
activities, and miscellaneous financial investment activities. 13
CFR 121.201 at Subsector 523.
\358\ Including direct life insurance carriers, direct health
and medical insurance carriers, direct property and casualty
insurance carriers, direct title insurance carriers, other direct
insurance (except life, health and medical) carriers, reinsurance
carriers, insurance agencies and brokerages, claims adjusting, third
party administration of insurance and pension funds, and all other
insurance related activities. 13 CFR 121.201 at Subsector 524.
\359\ Including pension funds, health and welfare funds, other
insurance funds, open-end investment funds, trusts, estates, and
agency accounts, real estate investment trusts and other financial
vehicles. 13 CFR 121.201 at Subsector 525.
\360\ See 13 CFR 121.201.
\361\ See U.S. Activity Proposing Release, 80 FR 27505-08;
Cross-Border Adopting Release, 79 FR 47368.
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For the foregoing reasons, the Commission certifies that the final
amendments, as adopted, would not have a significant economic impact on
a substantial number of small entities for purposes of the RFA.
VII. Effective Date and Implementation
These final rules will be effective April 19, 2016.
Three commenters requested that we provide market participants
adequate time to comply with any final rule that would require them to
monitor the location of personnel engaged in relevant activity with
respect to security-based swap transactions. One commenter stated that
we should provide a 12-month transition period and clarify that the de
minimis counting would only apply prospectively to security-based swap
transactions executed after the transition period.\362\
[[Page 8637]]
Two commenters urged the Commission to defer the compliance date until
it has made comparability determinations for a number of jurisdictions
so that non-U.S. dealers can rely on substituted compliance.\363\
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\362\ See HSBC Letter at 3-4.
\363\ See IIB Letter at 19; SIFMA/FSR Letter at 15.
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In the SBS Entity Registration Adopting Release, we established a
compliance date for the final rules adopted in that release as the
later of: Six months after the date of publication in the Federal
Register of a final rule release adopting rules establishing capital,
margin and segregation requirements for security-based swap dealers and
major security-based swap participants (``SBS Entities''); the
compliance date of final rules establishing recordkeeping and reporting
requirements for SBS Entities; the compliance date of final rules
establishing business conduct requirements under Exchange Act sections
15F(h) and 15F(k); or the compliance date for final rules establishing
a process for a registered SBS Entity to make an application to the
Commission to permit an associated person who is subject to a statutory
disqualification to effect or be involved in effecting security-based
swaps on its behalf (such date referred to as the ``Registration
Compliance Date'').
In addition, we noted that, for purposes of complying with the
registration and other requirements, persons engaged in dealing
activity are not required to begin calculating whether their
transactions meet or exceed the thresholds established in Exchange Act
rule 3a71-2 until two months prior to the Registration Compliance Date
(``SBS Entity Counting Date''). Accordingly, a person engaged in
security-based swap dealing activity will not be required to include in
its dealer de minimis threshold calculations any transactions entered
into prior to the SBS Entity Counting Date. However, given the
potential complexities of implementing the amendments being adopted
today, we believe it is appropriate to establish a compliance date
solely for Exchange Act rule 3a71-3(b)(1)(iii)(C) of the later of (a)
February 21, 2017, or (b) the SBS Entity Counting Date.
Statutory Basis and Text of Final Rules
Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and
particularly sections 3(a)(71), 3(b), 23(a)(1), and 30(c) thereof, and
section 761(b) of the Dodd-Frank Act, the SEC is amending rules 3a71-3
and 3a71-5 under the Exchange Act.
List of Subjects in 17 CFR Part 240
Brokers, Confidential business information, Fraud, Reporting and
recordkeeping requirements, Securities.
Text of Final Rules
For the reasons stated in the preamble, the SEC is amending Title
17, Chapter II of the Code of the Federal Regulations as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The authority citation for part 240 continues to read, and a
sectional authority is added in numerical order to read as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78dd, 78ll, 78mm,
80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.,
and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350;
and Pub. L. 111-203, 939A, 124 Stat. 1376 (2010), unless otherwise
noted.
* * * * *
Sections 240.3a71-3 and 240.3a71-5 are also issued under Pub. L.
111-203, sec. 761(b), 124 Stat. 1754 (2010), and 15 U.S.C. 78dd(c).
* * * * *
0
2. Sec. 240.3a71-3 is amended by adding paragraph (b)(1)(iii)(C) to
read as follows:
Sec. 240.3a71-3 Cross-border security-based swap dealing activity.
* * * * *
(b) * * *
(1) * * *
(iii) * * *
(C) Unless such person is a person described in paragraph
(a)(4)(iii) of this section, security-based swap transactions connected
with such person's security-based swap dealing activity that are
arranged, negotiated, or executed by personnel of such non-U.S. person
located in a U.S. branch or office, or by personnel of an agent of such
non-U.S. person located in a U.S. branch or office; and
* * * * *
0
3. Sec. 240.3a71-5 is amended by adding paragraph (c) to read as
follows:
Sec. 240.3a71-5 Exception for cleared transactions executed on a swap
execution facility.
* * * * *
(c) The exceptions in paragraphs (a) and (b) of this section shall
not apply to any security-based swap transactions of a non-U.S. person
or of an affiliated non-U.S. person connected with the person's
security-based swap dealing activity that are arranged, negotiated, or
executed by personnel of such non-U.S. person located in a U.S. branch
or office, or by personnel of an agent of such non-U.S. person located
in a U.S. branch or office.
By the Commission.
Dated: February 10, 2016.
Brent J. Fields,
Secretary.
[FR Doc. 2016-03178 Filed 2-18-16; 8:45 am]
BILLING CODE 8011-01-P