[Federal Register Volume 80, Number 92 (Wednesday, May 13, 2015)]
[Proposed Rules]
[Pages 27444-27512]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2015-10382]
[[Page 27443]]
Vol. 80
Wednesday,
No. 92
May 13, 2015
Part II
Securities and Exchange Commission
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17 CFR Parts 240 and 242
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; Proposed
Rules
Federal Register / Vol. 80 , No. 92 / Wednesday, May 13, 2015 /
Proposed Rules
[[Page 27444]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240 and 242
[Release No. 34-74834; File No. S7-06-15]
RIN 3235-AL73
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
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rules.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is publishing for comment proposed amendments and a re-
proposed rule to address the application of certain provisions of the
Securities Exchange Act of 1934 (``Exchange Act'') that were added by
Subtitle B of Title VII of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (``Dodd-Frank Act'') to cross-border security-
based swap activities. The Commission is proposing amendments to
Exchange Act rules 3a71-3 and 3a71-5 that would 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. The Commission is also re-
proposing Exchange Act rule 3a71-3(c) and proposing certain amendments
to Exchange Act rule 3a71-3(a) to address the applicability of external
business conduct requirements to the U.S. business and foreign business
of registered security-based swap dealers. The Commission also is
proposing amendments to Regulation SBSR to apply the regulatory
reporting and public dissemination requirements to transactions that
are arranged, negotiated, or executed by personnel of non-U.S. persons,
or personnel of such non-U.S. persons' agents, that are located in the
United States and to transactions effected by or through a registered
broker-dealer (including a registered security-based swap execution
facility), along with certain related issues, including requiring
registered broker-dealers (including registered security-based swap
execution facilities) to report certain transactions that are effected
by or through the registered broker-dealer.
DATES: Comments should be received on or before July 13, 2015.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-06-15 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number S7-06-15. This file number
should be included on the subject line if email is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street NE., Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. All comments received will be posted without change; the
Commission does not edit personal identifying information from
submissions. You should submit only information that you wish to make
available publicly.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the SEC's Web site. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
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 proposing the following
rules under the Exchange Act regarding the application of Subtitle B of
Title VII of the Dodd-Frank Act to cross-border activities.
The Commission is proposing to amend the following rules under the
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); rule 3a71-5 (regarding
availability of an exception from the dealer de minimis analysis for
cleared anonymous transactions that fall within proposed rule 3a71-
3(b)(1)(iii)(C)); and Rules 900, 901, 906, 907, 908(a)(1), and 908(b)
of Regulation SBSR. The Commission also is re-proposing Exchange Act
rule 3a71-3(c) (application of external business conduct requirements).
I. Background
A. Scope of This Rulemaking
B. The Dodd-Frank Act
C. The Cross-Border Proposing Release
D. The CFTC Staff Advisory
E. Comments on the Proposed Definition of ``Transaction
Conducted Within the United States'' and Application of the
Definition in the Cross-Border Proposing Release
II. Economic Considerations and Baseline Analysis
A. Broad Economic Considerations
B. Baseline
1. Current Security-Based Swap Market
2. Levels of Security-Based Swap Trading Activity
3. Regulatory Reporting, Clearing, and Trade Execution of
Security-Based Swap Transactions
4. Global Regulatory Efforts
5. Cross-Market Participation
III. Application of the Dealer De Minimis Exception to U.S.
Security-Based Swap Dealing Operations of Non-U.S. Persons
A. Overview
B. Proposed Application of De Minimis Exception to Non-U.S.
Persons Arranging, Negotiating, or Executing Security-Based Swap
Transactions Using Personnel Located in a U.S. Branch or Office
1. Overview of the Initially Proposed Approach
2. Commenters' Views on the Cross-Border Proposing Release
3. The CFTC Staff Advisory and Responses to the CFTC Request for
Comment
4. Dealing Activity of Non-U.S. Persons in the United States
5. Proposed Amendments Regarding 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
6. Other Commenter Concerns and Alternatives
7. Request for Comment
C. Availability of the Exception for Cleared Anonymous
Transactions
1. Proposed Rule
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2. Request for Comment
IV. Application of the External Business Conduct Requirements to the
Foreign Business and U.S. Business of Registered Security-Based Swap
Dealers
A. Overview
B. Statutory Framework for External Business Conduct
C. Prior Proposals
1. Business Conduct Proposal
2. Cross-Border Proposing Release
D. Comments
E. Discussion
F. Request for Comment
V. Application of Other Requirements to Cross-Border Security-Based
Swap Activity
A. Overview
B. Previously Proposed and Adopted Rules Relating to Application
of Clearing, Trade Execution, Regulatory Reporting, and Public
Dissemination Requirements
1. Mandatory Clearing and Trade Execution
2. Regulatory Reporting and Public Dissemination
C. Commenters' Views
1. General Comments on Application of Clearing, Trade Execution,
Regulatory Reporting, and Public Dissemination Requirements
2. Comments on Mandatory Clearing and Mandatory Trade Execution
3. Comments on Regulatory Reporting and Public Dissemination
4. The CFTC Staff Advisory and Responses to the CFTC Request for
Comment
D. Mandatory Clearing and Trade Execution
E. Regulation SBSR
1. Statutory Framework
2. Proposed Amendments Regarding Application of Regulation SBSR
to Certain Security-Based Swap Transactions
3. Application of the Public Dissemination Requirement to
Certain Transactions
4. Proposed Amendments Regarding Limitations on Reporting
Obligations of Certain Persons Engaged in Security-Based Swaps
Subject to Regulation SBSR
5. Proposed Amendment Regarding Reporting Duties of Certain
Persons That Are Not Registered Security-Based Swap Dealers or
Registered Major Security-Based Swap Participants
6. Proposed Amendments to Rules 900(u), 901(d)(9), 906(b),
906(c), and 907(a) of Regulation SBSR to Accommodate Proposed Rule
901(a)(2)(ii)(E)(4)
7. Availability of Substituted Compliance
F. Request for Comment
1. Mandatory Clearing and Trade Execution
2. Regulation SBSR
VI. Economic Analysis of the Proposed Rules
A. Assessment Costs
1. Discussion
2. Request for Comment
B. Programmatic Costs and Benefits
1. De minimis Exception
2. External Business Conduct Requirements
3. Regulatory Reporting and Public Dissemination
4. Efficiency, Competition, and Capital Formation
5. Request for Comment
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 Associated
Persons of Broker-Dealers
3. Exclusion of Security-Based Swap Transactions That Do Not
Involve a U.S.-Person Counterparty, a Counterparty Whose Obligations
Under the Security-Based Swap are Guaranteed by a U.S. Person, or a
Conduit Affiliate From the de minimis Threshold Requirements
4. Extension of the Activity-Based Test to the Clearing and
Execution Requirements
VII. Paperwork Reduction Act
A. Introduction
B. Reporting Obligations--Rule 901
1. Summary of Collection of Information
2. Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
of Rule 901 of Regulation SBSR
C. Correction of Errors in Security-Based Swap Information--Rule
905
1. Summary of Collection of Information
2. Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
D. Policies and Procedures for Registered Broker-Dealers--Rule
906(c)
1. Summary of Collection of Information
2. Use of Information
3. Respondents
4. Total Initial and Annual Reporting and Recordkeeping Burdens
E. Collection of Information is Mandatory
F. Confidentiality of Responses to Collection of Information
G. Request for Comment
VIII. Consideration of Impact on the Economy
IX. Regulatory Flexibility Act Certification
A. Certification for Proposed Rule and Proposed Amendments to
Exchange Act Rules 3a71-3 and 3a71-5
B. Initial Regulatory Flexibility Analysis for Proposed
Amendments to Regulation SBSR
1. Reasons for, and Objectives of, the Proposed Action and Legal
Basis
2. Small Entities Subject to the Proposed Rules
3. Projected Reporting, Recordkeeping and Other Compliance
Requirements
4. Duplicative, Overlapping or Conflicting Federal Rules
5. Significant Alternatives
6. Solicitation of Comment
X. Statutory Basis and Text of Proposed Rules
I. Background
A. Scope of This Rulemaking
The Commission is proposing to amend certain rules and is re-
proposing 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. The proposed
amendments include 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,\2\ and the
application of Regulation SBSR \3\ to such transactions and to
transactions effected by or through a registered broker-dealer, along
with certain related issues. We are also re-proposing a rule regarding
the application of external business conduct requirements to the
foreign business and U.S. business of registered security-based swap
dealers.
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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\ 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.
\3\ 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''). With these proposed rules and rule amendments,
the Commission is not re-opening comment on the rules adopted in
Regulation SBSR Adopting Release.
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Each of these issues was 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.\4\ On June 25, 2014, we
adopted rules and guidance based on the May 23, 2013 proposal
addressing the application of the ``security-based swap dealer'' and
``major security-based swap participant'' definitions to cross-border
security-based swap activities.\5\ In that release, among other things,
we adopted rules specifying which cross-border transactions must be
included in a person's security-based swap dealer de minimis or major
security-based swap participant calculations.\6\ We explained,
[[Page 27446]]
however, that we were not addressing the application of the ``security-
based swap dealer'' definition to ``transaction[s] conducted within the
United States'' because commenters had raised several significant
issues related to this requirement of the proposal.\7\ We stated that
we anticipated soliciting additional public comment on the application
of the ``security-based swap dealer'' definition to transactions
between two non-U.S. persons where one or both are conducting dealing
activity within the United States.\8\
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\4\ 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 30968 (May 23, 2013) (``Cross-Border Proposing Release'').
\5\ 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 47278 (August 12, 2014 (republication))
(``Cross-Border Adopting Release''). With these proposed rules and
rule amendments the Commission is not re-opening comment on the
rules adopted in the Cross-Border Adopting Release.
\6\ See id. at 47279.
\7\ See id. at 47279-80.
\8\ See id. at 47280.
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In this release, we propose amendments to Exchange Act rules 3a71-3
and 3a71-5 that reflect a modified approach to this element of the
initial proposal and solicit comment on the proposed amendments and re-
proposed rule. The proposed amendments would address the activity of a
non-U.S. person in the United States in a way that more closely focuses
on where personnel of the non-U.S. person engaged in dealing activity
(or on where personnel of its agent) are arranging, negotiating, or
executing a security-based swap. The proposed amendments would not
require a non-U.S. person engaging in dealing activity to consider the
location of its non-U.S.-person counterparty or the counterparty's
agent in determining whether the transaction needs to be included in
its own de minimis calculation. Instead, the proposed amendments would
require a non-U.S. person to include in its de minimis calculation any
transaction with another non-U.S. person 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.
We also are re-proposing rules regarding the application of the
external business conduct requirements to the foreign business of
registered security-based swap dealers, and we are proposing to amend
Regulation SBSR to address the reporting and public dissemination
requirements applicable to security-based swap transactions involving
non-U.S. persons that engage in relevant activity in the United States
and to transactions effected by or through a registered broker-dealer,
along with certain related issues.
B. The Dodd-Frank Act
Title VII of the Dodd-Frank Act provides for a comprehensive new
regulatory framework for swaps and security-based swaps. 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.''
The new framework encompasses the registration and comprehensive
regulation of security-based swap dealers and major security-based swap
participants, as well as requirements related to clearing, trade
execution, regulatory reporting, and public dissemination.\9\ Security-
based swap transactions are largely cross-border in practice,\10\ and
the various market participants and infrastructures operate in a global
market. Dealers and other market participants 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 proposed rules.
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\9\ We have proposed a series of rules regarding these matters.
See Cross-Border Proposing Release, 78 FR 30972 nn.11-18.
The Dodd-Frank Act further provides that the SEC and CFTC
jointly should further define certain terms, including ``security-
based swap dealer'' and ``major security-based swap participant.''
See Dodd-Frank Act section 712(d). Pursuant to that requirement, the
SEC and CFTC jointly adopted rules to further define those terms.
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 30596 (May 23, 2012)
(``Intermediary Definitions Adopting Release''); see also Cross-
Border Proposing Release, 78 FR 30972 n.9 (discussing joint
rulemaking to further define various Title VII terms).
\10\ See Section II.B.2, infra, regarding the preponderance of
cross-border activity in the security-based swap market.
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In developing this proposal, we have consulted and coordinated with
the CFTC, the prudential regulators,\11\ and foreign regulatory
authorities in accordance with the consultation mandate of the Dodd-
Frank Act.\12\ More generally, as part of our domestic and
international efforts, Commission staff has participated in numerous
bilateral and multilateral discussions with foreign regulatory
authorities addressing the regulation of OTC derivatives.\13\ Through
these discussions and the Commission staff's participation in various
international task forces and working groups,\14\ we have gathered
information about foreign regulatory reform efforts and their impact on
and relationship with the U.S. regulatory regime. We have taken this
information into consideration in developing this proposal.
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\11\ The term ``prudential regulator'' is defined in section
1a(39) of the CEA, 7 U.S.C. 1a(39), and that definition is
incorporated by reference in section 3(a)(74) of the Exchange Act,
15 U.S.C. 78c(a)(74). Pursuant to the definition, the Board of
Governors of the Federal Reserve System (``Federal Reserve Board''),
the Office of the Comptroller of the Currency, the Federal Deposit
Insurance Corporation, the Farm Credit Administration, or the
Federal Housing Finance Agency (collectively, the ``prudential
regulators'') is the ``prudential regulator'' of a security-based
swap dealer or major security-based swap participant if the entity
is directly supervised by that regulator.
\12\ 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.''
In addition, section 752(a) of the Dodd-Frank Act provides 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.''
\13\ 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 (``ODRG'') on Cross-Border Implementation Issues November 2014
(November 7, 2014), available at: http://www.cftc.gov/ucm/groups/public/@internationalaffairs/documents/file/oia_odrgreportg20_1114.pdf.
\14\ 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 also serves as one of the co-chairs of the IOSCO Task
Force on OTC Derivatives Regulation.
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C. The Cross-Border Proposing Release
Our prior proposals and final rules regarding the application of
Title VII to security-based swap activity carried out in the cross-
border context (including to persons engaged in such activities)
reflect the global nature of the security-based swap market and its
development prior to the enactment of the Dodd-Frank Act.\15\ We also
noted our preliminary belief that dealing activity carried out by a
non-U.S. person through a branch, office, affiliate, or an 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.\16\ We initially
proposed to require any non-U.S. person engaged
[[Page 27447]]
in dealing activity to include in its de minimis calculation any
``transaction conducted within the United States.'' Thus, under the
Cross-Border Proposing Release, a non-U.S. person engaged in dealing
activity would have been required to include in its de minimis
calculation any transaction where either the person itself or its
counterparty performed relevant security-based swap activity within the
United States.
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\15\ See Cross-Border Proposing Release, 78 FR 30975-76;
Regulation SBSR Adopting Release, 80 FR 14724.
\16\ See Cross-Border Proposing Release, 78 FR 31000-01.
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The Cross-Border Proposing Release also included proposed rules
regarding the application of the clearing, trade execution, regulatory
reporting, and public dissemination requirements. Under the rules
proposed in that release, the clearing requirement and the trade
execution requirement also would have applied to a ``transaction
conducted within the United States,'' a transaction having a U.S.-
person counterparty, or a transaction having a counterparty that is a
non-U.S. person whose counterparty has a right of recourse against a
U.S. person,\17\ with certain exceptions.\18\ The regulatory reporting
requirement under that proposal would have applied to a ``transaction
conducted within the United States,'' a transaction in which either
side of the security-based swap includes an indirect or direct U.S.
person counterparty, a transaction in which a security-based swap
dealer or major security-based swap participant is a direct or indirect
counterparty to the security-based swap, or a transaction that is
cleared through a clearing agency having its principal place of
business in the United States.\19\ The public dissemination requirement
would have applied to a ``transaction conducted within the United
States,'' a transaction in which a U.S. person is a direct or indirect
counterparty on each side of the security-based swap, a transaction in
which at least one direct counterparty is a U.S. person (except in the
case of a transaction conducted through a foreign branch), a
transaction in which one side includes a U.S. person and the other side
includes a non-U.S. person that is a security-based swap dealer, or a
transaction cleared through a clearing agency having its principal
place of business in the United States.\20\
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\17\ In this release, we use the terms ``non-U.S. persons whose
counterparties have a right of recourse against a U.S. person under
a security-based swap,'' ``non-U.S. persons whose obligations under
a security-based swap are guaranteed by a U.S. person,'' and
``guaranteed non-U.S. persons'' interchangeably.
\18\ See initially proposed Exchange Act rules 3Ca-3 and 3Ch-1.
\19\ See rule 908(a)(1), as re-proposed in the Cross-Border
Proposing Release.
\20\ See rule 908(a)(2), as re-proposed in the Cross-Border
Proposing Release.
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D. The CFTC Staff Advisory
In November 2013, the CFTC's Division of Swap Dealer and
Intermediary Oversight issued a Staff Advisory (``CFTC Staff
Advisory'') addressing 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.\21\ The CFTC Staff
Advisory stated CFTC staff's belief that the CFTC ``has a strong
supervisory interest in swap dealing activities that occur within the
United States, regardless of the status of the counterparties'' and
that a non-U.S. swap dealer ``regularly using personnel or agents
located in the U.S. to arrange, negotiate, or execute a swap with a
non-U.S. person generally would be required to comply with'' the CFTC's
transaction-level requirements.\22\ On January 8, 2014, the CFTC
published a request for comment on various aspects of the CFTC Staff
Advisory, including whether the CFTC ``should adopt the Staff Advisory
as Commission policy, in whole or in part.'' \23\ In response to this
request, the CFTC received approximately 20 comment letters addressing
various aspects of the CFTC Staff Advisory.\24\ CFTC staff subsequently
extended no-action relief related to the CFTC Staff Advisory until the
earlier of September 30, 2015, or the effective date of any CFTC action
in response to the CFTC Request for Comment.\25\ We understand that the
CFTC Staff Advisory and comments received in response to the CFTC
Request for Comment are under review at the CFTC.
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\21\ 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.
\22\ Id. at 2.
\23\ 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'').
\24\ The comment file is available at http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1452.
\25\ See Extension of No-Action Relief: Transaction-Level
Requirements for Non-U.S. Swap Dealers, CFTC Letter No. 14-140
(November 14, 2014), available at: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-140.pdf.
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E. Comments on the Proposed Definition of ``Transaction Conducted
Within the United States'' and Application of the Definition in the
Cross-Border Proposing Release
A number of commenters on our Cross-Border Proposing Release
addressed the definition of ``transaction conducted within the United
States.'' Although two commenters supported our proposed use of this
defined term,\26\ commenters generally criticized the proposed
definition. These criticisms generally focused on four areas: The scope
of activity potentially captured by the initially proposed defined
term, the operational difficulties of implementing the defined term,
the costs of implementation, and competitive concerns. Market
participants also expressed a variety of views on the application of
the regulatory reporting, public dissemination, clearing, and trade
execution requirements. Several market participants opposed the
application of the requirements to ``transaction[s] conducted within
the United States'' because of concerns about workability or the scope
of the statute, while other commenters argued that the application of
the requirements should be expanded to apply to any ``transaction
conducted within the United States.'' \27\ In light of these
[[Page 27448]]
comments and our understanding of the structure of the security-based
swap market, we determined that our proposed treatment of
``transactions conducted within the United States'' would benefit from
further consideration and solicitation of further comment.
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\26\ See Letter from Citadel Letter to SEC, dated August 21,
2013 (``Citadel Letter'') at 1-2; Letter from ABA to SEC, dated
October 2, 2013 (``ABA Letter'') at 3 (noting that the initially
proposed conduct-based approach is consistent with longstanding
Commission practice but also noting potential ambiguities). One of
these commenters supported the initially proposed definition because
it would help ensure that Title VII requirements applied to
security-based swaps of offshore funds with a connection to the
United States. See Citadel Letter at 1-2.
\27\ These comments are discussed in further detail below, in
Sections III.B.2, IV.D, and V.C. As reflected in our discussion
throughout this release, we have carefully considered both the CFTC
Staff Advisory and the comments submitted in response to the CFTC's
request for comment on the CFTC Staff Advisory in developing this
proposal. Moreover, in connection with our statutory obligation to
consult with the CFTC in connection with Title VII rulemaking, our
staff have engaged in extensive discussion with CFTC staff regarding
our proposed rules. We note, however, that our discussion of both
the CFTC Staff Advisory and the comments received by the CFTC about
it reflects our understanding of these documents. Accordingly,
neither our discussions of these documents nor any preliminary views
expressed herein should be interpreted as necessarily reflecting the
views of any other agency or regulator, including the CFTC.
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II. Economic Considerations and Baseline Analysis
A. Broad Economic Considerations
These proposed amendments and re-proposed rule would determine when
a non-U.S. person 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 calculation transactions
with another non-U.S. person and when certain regulatory requirements
apply to these and certain other transactions. To provide context for
understanding our proposed rules and the related economic analysis that
follows, this section discusses how this particular proposal fits
within the Title VII framework and identifies broad economic
considerations that we preliminarily believe underlie the proposal's
likely economic effects.
This analysis considers the effects of the proposed rules on
security-based swap market participants and transactions that, as a
result of these proposed rules, would be subject to rules that we have
already adopted, or that we have proposed but not yet adopted, pursuant
to Title VII. In particular, we consider the potential adverse effect
on market participants of a security-based swap market that may remain
opaque to regulators and market participants and that may lack robust
customer protections.\28\ We also consider possible competitive
disparities arising under current and proposed rules.
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\28\ See Section VI.B.2, infra, for further discussion of the
economic effects of our proposed application of external business
conduct requirements. See Section III.B.4, infra, for a discussion
of how our proposed approach would support regulatory transparency.
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Title VII provides a statutory framework for the OTC derivatives
market and divides authority to regulate that market between the CFTC
(which regulates swaps) and the Commission (which regulates security-
based swaps). The Title VII framework requires certain market
participants to register with the Commission as security-based swap
dealers or major security-based swap participants and subjects such
entities to certain requirements. The Title VII framework mandates that
we establish rules that apply to certain security-based swap
transactions, including mandatory clearing, mandatory trade execution,
regulatory reporting, and public dissemination.
These proposed amendments and re-proposed rule, together with our
previously adopted rules defining ``security-based swap dealer'' and
``major security-based swap participant'' and applying those
definitions in the cross-border context, would define the scope of
entities and transactions that are subject to the requirements of Title
VII. Although these proposed amendments and re-proposed rule do not
define the specific substantive requirements, the scope of application
that they define 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.\29\ For example, to the
extent that the proposed application of the de minimis exception leads
to a higher number of registered security-based swap dealers, it is
reasonable to expect that the aggregate costs and benefits associated
with requirements applicable to such dealers will increase.\30\
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\29\ 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 will lead to
programmatic costs and benefits).
\30\ See Section VI.B.1, infra.
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Several broad economic considerations have informed our proposed
approach to identify transactions between two non-U.S. persons that
should be subject to certain Title VII requirements. First, to the
extent that a financial group carries out security-based swap business
in the United States, our ability to monitor dealers for market
manipulation or other abusive practices may be limited, even with
respect to a registered security-based swap dealer's security-based
swaps with U.S. persons. For example, permitting a financial group to
carry out a dealing business with U.S. persons through a registered
security-based swap dealer and to hedge transactions arising out of
that business in the inter-dealer market using the same personnel
operating out of the same branch or office in the United States, but
acting on behalf of an unregistered non-U.S.-person affiliate, would
limit our ability to obtain records that would facilitate our ability
to identify potentially abusive conduct in connection with the U.S.
person's transactions with U.S.-person counterparties both within the
security-based swap market as well as in markets for related underlying
assets, such as corporate bonds. Moreover, a non-U.S. person engaged in
dealing activity with non-U.S. persons in the United States but not
subject to Regulation SBSR would not be required to report its trades,
which could make it more difficult for the Commission to monitor that
activity for compliance with the federal securities laws and could
reduce the transparency of prices in the security-based swap market in
the United States. The proposed rules thus reflect our assessment of
the impact that the scope of security-based swap transactions and
security-based swap dealers subject to regulatory reporting and
relevant security-based swap dealer requirements (such as external
business conduct standards and recordkeeping and reporting
requirements) may have on our ability to detect abusive and
manipulative practices in the security-based swap market.
Second, in formulating these proposed rules, we have taken into
account the potential impact that rules adopted as part of the
Intermediary Definitions Adopting Release and the Cross-Border Adopting
Release might have on competition between U.S. persons and non-U.S.
persons when they engage in security-based swap transactions with non-
U.S. persons, and the implications of these competitive frictions for
market integrity. As noted in prior Commission releases, although the
Dodd-Frank Act, including Title VII, seeks to achieve a number of
benefits,\31\ it also imposes costs on registered security-based swap
dealers that unregistered persons are not required to bear.\32\ For
example, section 15F of the Exchange Act imposes various requirements
on registered security-based swap dealers, including capital and margin
requirements, recordkeeping and reporting requirements, and external
business conduct requirements. While the Commission currently applies
similar requirements to registered broker-dealers, Title VII applies
these requirements only to persons that are registered as security-
based swap dealers. Under current Exchange Act rule 3a71-3(b)(1)(iii),
adopted in the Cross-Border Adopting Release, a non-U.S. person that
engages in more than a de minimis amount of dealing activity with non-
U.S.-person counterparties
[[Page 27449]]
using personnel located in the United States may face lower regulatory
costs than a U.S. competitor engaging in identical activity, because
the non-U.S. person is not required to include such transactions in its
de minimis calculation. Competitive disparities may also arise as a
result of differences in application of other Title VII requirements
between U.S. persons and non-U.S. persons that are engaged in dealing
activity using personnel located in the United States. As a result,
such a non-U.S. person may be able to offer liquidity to its
counterparties on more favorable terms than its U.S. competitors.
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\31\ See Cross-Border Adopting Release, 79 FR 47280 n.11 (citing
Dodd-Frank Act preamble, which states that the Dodd-Frank Act was
enacted ``[t]o promote the financial stability of the United States
by improving accountability and transparency in the financial
system, to end `too big to fail', to protect the American taxpayer
by ending bailouts, to protect consumers from abusive financial
services practices, and for other purposes'').
\32\ See id. at 47327.
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Under Exchange Act rule 3a71-3, non-U.S. persons may be able to
subsidize their transactions with U.S. persons with profits from
transactions with non-U.S. persons, allowing them to gain a competitive
advantage with respect to transactions with U.S. persons from other
dealing activity that is not subject to Title VII, even though it is
carried out using personnel located in a U.S. branch or office. In the
absence of the rules being proposed in this release, these competitive
effects of disparate regulatory treatment may create an incentive for
U.S. persons to use non-U.S.-person affiliates or non-U.S.-person
agents that are located in the United States to engage in dealing
activity with non-U.S.-person counterparties, because these non-U.S.
persons could continue to deal with non-U.S.-person counterparties
without being required to comply with any Title VII requirements.\33\
This disparity could make transactions with U.S.-person dealers less
attractive than transactions with non-U.S.-person dealers, even if the
latter are arranging, negotiating, or executing the transaction using
personnel located in a U.S. branch or office.
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\33\ 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).
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Moreover, differences in the application of the Title VII
regulatory requirements may impose differing direct costs on different
counterparties. For example, 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. Even though both dealers are likely to arrange, negotiate, or
execute a transaction on a U.S. reference entity using personnel
located in a U.S. branch or office, the non-U.S.-person dealer may be
more attractive because, for example, a transaction with that dealer
may not involve a requirement to post collateral consistent with Title
VII margin requirements or to comply with Regulation SBSR. The prospect
of directly incurring the costs associated with compliance with Title
VII requirements may cause these non-U.S. persons to prefer dealing
with unregistered non-U.S.-person dealers, particularly if they can
obtain the benefits associated with arranging, negotiating, or
executing such a transaction using personnel located in a U.S. branch
or office. The rules being proposed in this release are designed to
mitigate this outcome.
Regulatory frictions arising from a difference in the treatment of
dealing activity occurring in the United States could fragment
security-based swap liquidity into two pools, one for U.S. persons and
non-U.S. persons whose obligations under a security-based swap are
guaranteed by a U.S. person, and the other for non-U.S. persons. Non-
U.S. persons that arrange, negotiate, or execute transactions in
connection with their dealing activity using personnel located in a
U.S. branch or office may, under current Exchange Act rule 3a71-3(b),
seek to limit dealing activity with U.S. persons (for example, by
quoting larger spreads to compensate for the expected costs of entity-
level requirements) or may entirely refuse to supply liquidity to U.S.
persons. This disparity in treatment may provide further incentives for
U.S. persons to restructure their business to permit them to carry out
their business with non-U.S. persons on similar terms.\34\ This
incentive may be particularly strong among U.S. dealers that are active
in the inter-dealer market.
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\34\ See Section VI.B, infra, for further discussion of
potential effects of the proposed 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.
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To the extent that the large inter-dealer market \35\ shifts in
significant part to non-U.S. dealers as a result of current rules,
security-based swap activity in the United States could consist of one
very large pool of transactions unregulated under Title VII (inter-
dealer trades, and transactions between dealers and non-U.S. person
non-dealers) and one much smaller pool limited to transactions between
dealers and U.S.-person counterparties. This fragmentation could
adversely affect the efficiency of risk sharing among security-based
swap market participants, as discussed further in Sections VI.B.4(a)
and VI.B.4(b), below.
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\35\ See Section II.B.2, infra, for an analysis of the
proportion of the security-based swap market that constitutes inter-
dealer transactions. For the purposes of this analysis we classify
any security-based swap transaction between two ISDA-recognized
dealers as inter-dealer activity.
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Different treatment of transactions depending on whether they are
arranged, negotiated, or executed by personnel located in a U.S. branch
or office may create similar fragmentation among agents that may seek
to provide services to foreign dealers. To the extent that using agents
with personnel located in the United States results in substantial
regulatory costs to foreign dealers, such foreign dealers may prefer
and primarily use agents located outside the United States, while U.S.
dealers may continue to use agents located in the United States. This
fragmentation of dealer and agent relationships, as in the case of
liquidity fragmentation discussed earlier, may adversely affect the
efficiency of risk sharing by security-based swap market participants.
B. Baseline
To assess the economic impact of the proposed amendments and rule
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 have not yet finalized.\36\ The analysis includes the
statutory provisions that currently govern the security-based swap
market pursuant to the Dodd-Frank Act as well as rules adopted in the
Intermediary Definitions Adopting Release, the Cross-Border Adopting
Release, Regulation SBSR, and the Security-Based Swap Data Repository
(``SDR'') Rules and Core Principles.\37\ Our understanding of the
market is informed by available data on security-based swap
transactions, though we acknowledge the data limit the extent to which
we can quantitatively characterize the market. Because these data do
not cover the entire market, we have developed an understanding of
market activity using a sample that includes only certain portions of
the market.
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\36\ We also take into account, where appropriate, current
industry practice in response to the actions of other regulators,
such as the CFTC and the European Securities and Markets Authority.
\37\ Exchange Act Release No. 74246 (February 11, 2015), 80 FR
14437 (March 19, 2015). As noted above, we have not yet adopted
other substantive requirements of Title VII that may affect how
firms structure their security-based swap business and market
practices more generally.
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[[Page 27450]]
1. Current Security-Based Swap Market
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 credit default swap
(``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 equity forwards and swaps as of
June 2014 was $2.43 trillion. The notional amount outstanding in
single-name CDS was approximately $10.85 trillion, in multi-name index
CDS was approximately $7.94 trillion, and in multi-name, non-index CDS
was approximately $678 billion.\38\ Our analysis in this release
focuses on the data relating to single-name CDS. As we have previously
noted, although the definition of ``security-based swap'' is not
limited to single-name CDS, we believe that the single-name CDS
transactions that we observe are sufficiently representative of the
market and therefore can directly inform the analysis of the security-
based swap market.\39\
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\38\ See Semi-annual OTC derivatives statistics at end--June
2014 (December 2014), Table 19, available at: http://www.bis.org/statistics/dt1920a.pdf.
\39\ 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). In the Cross-Border Proposing Release, we
explained that we believed that data related to single-name CDS was
reasonable for purposes of this analysis, as such transactions
appear to constitute roughly 82% of the security-based swap market
as measured on a notional basis. See Cross-Border Proposing Release,
78 FR 31120 n.1301. No commenters disputed these assumptions, and we
therefore continue to believe that, although the BIS data reflect
the global OTC derivatives market, and not just the U.S. market,
these ratios are an adequate representation of the U.S. market.
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 identify the relative volumes of index CDS that are
swaps or security-based swaps.
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We preliminarily believe that the data underlying our analysis here
provide reasonably comprehensive information regarding single-name CDS
transactions and the composition of the single-name CDS market
participants. 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; \40\ and (ii) are based on non-U.S. reference entities.
Notwithstanding this limitation, we preliminarily believe that the TIW
data provide sufficient information to identify the types of market
participants active in the security-based swap market and the general
pattern of dealing within that market.\41\
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\40\ We note that TIW's entity domicile determinations may not
reflect our definition of ``U.S. person'' in all cases.
\41\ 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.
We have adopted rules regarding trade reporting, data elements, and
public reporting for security-based swaps that will, when fully
implemented, provide us with appropriate measures of market
activity. See Regulation SBSR Adopting Release, 80 FR 14699-700.
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(a) Dealing Structures and Participant Domiciles
Dealers occupy a central role in the security based swap market and
security-based swap dealers use a variety of business models and legal
structures to engage in dealing activity with counterparties in
jurisdictions all around the world.\42\ As we noted in the Cross-Border
Adopting Release and as discussed below in Section III.B.4(a), both
U.S.-based and foreign-based entities use certain dealing structures
for a variety of legal, tax, strategic, and business reasons.\43\
Dealers may use a variety of structures in part to reduce risk and
enhance credit protection based on the particular characteristics of
each entity's business.
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\42\ Commission staff analysis of TIW transaction records
indicates that approximately 99% of single-name CDS price-forming
transactions in 2014 involved an ISDA-recognized dealer. ``Price-
forming transactions'' include all new transactions, assignments,
modifications to increase the notional amounts of previously
executed transactions, and terminations of previously executed
transactions. Transactions terminated, transactions entered into in
connection with a compression exercise, and expiration of contracts
at maturity are not considered price forming and are therefore
excluded, as are replacement trades and all bookkeeping-related
trades. See Cross-Border Proposing Release, 78 FR 31121 n.1312. For
the purpose of this analysis, the ISDA-recognized dealers are those
identified by ISDA as belonging to the dealer group, including JP
Morgan Chase, Morgan Stanley, Bank of America, Goldman Sachs,
Deutsche Bank, Barclays, Citigroup, UBS, Credit Suisse, RBS Group,
BNP Paribas, HSBC, Soci[eacute]t[eacute] G[eacute]n[eacute]rale,
Credit Agricole, Wells Fargo, and Nomura. See, e.g., http://www2.isda.org/functional-areas/research/surveys/operations-benchmarking-surveys/.
\43\ See Cross-Border Adopting Release, 79 FR 30976.
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Bank and non-bank holding companies may use subsidiaries to deal
with counterparties. A U.S.-based holding company may engage in dealing
activity through a foreign subsidiary that faces both U.S. and foreign
counterparties, and foreign dealers may choose to deal with U.S. and
foreign counterparties through U.S. subsidiaries. Similarly, a non-
dealer user of security-based swaps may participate in the market using
an agent in its home country or abroad. An investment adviser located
in one jurisdiction may transact in security-based swaps on behalf of
beneficial owners that reside in another.
In some situations, an entity's performance under security-based
swaps may be supported by a guarantee provided by an affiliate. Such a
guarantee may take the form of a blanket guarantee of an affiliate's
performance on all security-based swap contracts, or a guarantee may
apply only to a specified transaction or counterparty. Guarantees may
give counterparties to a dealer direct recourse to the holding company
or another affiliate for its dealer-affiliate's obligations under
security-based swaps for which that dealer-affiliate acts as
counterparty.
[[Page 27451]]
[GRAPHIC] [TIFF OMITTED] TP13MY15.000
As depicted in Figure 1, the domicile of new accounts participating
in the market has shifted over time. A greater share of accounts
entering the market either have a foreign domicile, or have a foreign
domicile while being managed by a U.S. person. The increase in foreign
accounts may reflect an increase in participation by foreign
accountholders while the increase in foreign accounts managed by U.S.
persons may reflect the flexibility with which market participants can
restructure their market participation in response to regulatory
intervention, competitive pressures, and other stimuli. Alternatively,
the shifts in new account domicile that we observe in Figure 1 may be
unrelated to restructuring or increased foreign participation. For
example, changes in the domicile of new accounts over time may reflect
improvements in reporting by market participants to TIW rather than a
change in market participant structure.\45\ Additionally, because the
data include only accounts that are domiciled in the United States,
that transact with U.S.-domiciled counterparties, or that transact in
single-name CDS with U.S. reference entities, changes in the domicile
of new accounts may reflect increased transaction activity between U.S.
and non-U.S.-person counterparties or increased transactions in single-
name CDS on U.S. reference entities by foreign persons.
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\44\ 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 is designated the
registered office location by TIW. 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. This treatment assumes
that the registered office location reflects the place of domicile
for the fund or account.
\45\ See note 44, supra.
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(b) Market Centers
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 the location where economic decisions are
made by managers on behalf of beneficial owners. Similarly, a
participant in the security-based swap market may be exposed to
counterparty risk from a jurisdiction that is different from the market
center or centers in which it primarily operates. These participants
appear to be active in market centers across the globe.
The TIW transaction records include, in many cases, information on
particular branches involved in transactions, which may provide limited
insight as to where security-based swap activity is actually being
carried out.\46\ These data indicate branch locations located in New
York, London, Tokyo, Hong Kong, Chicago, Sydney, Toronto, Frankfurt,
Singapore, and the Cayman Islands. Because transaction records in the
TIW data provided to us do not indicate explicitly the location in
which particular transactions were arranged, negotiated, or executed,
these locations
[[Page 27452]]
may not represent the full set of locations in which activities
relevant for these proposed rules take place. Moreover, because we
cannot identify the location of transactions within TIW, we are unable
to estimate the general distribution of transaction volume across
market centers.
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\46\ The value of this information is limited in part because
some market participants may use business models that do not involve
branches to carry out business in jurisdictions other than their
home jurisdiction. For example, some market participants may use
affiliated or unaffiliated agents to enter into security-based swap
transactions in other jurisdictions on their behalf. The available
data currently does not allow us to identify with certainty which
type of structure is being used in any particular transaction.
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(c) Current Estimates of Number of Dealers
In the Regulation SBSR Adopting Release, we estimated, based on an
analysis of TIW data, that out of more than 4,000 entities engaged in
single-name CDS activity worldwide in 2013, 170 entities engaged in
single-name CDS activity at a sufficiently high level that they would
be expected to incur assessment costs to determine whether they meet
the ``security-based swap dealer'' definition.\47\ Approximately 45 of
these entities are non-U.S. persons and are expected to incur
assessment costs as a result of engaging in dealing activity with
counterparties that are U.S. persons or engaging in dealing activity
that involves recourse to U.S. persons.\48\ Analysis of those data
further indicated that potentially 50 entities may engage in dealing
activity that would exceed the de minimis threshold and thus ultimately
have to register as security-based swap dealers.\49\
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\47\ See Regulation SBSR Adopting Release, 80 FR 14693.
\48\ See Exchange Act rule 3a71-3(b).
\49\ See Regulation SBSR Adopting Release, 80 FR 14693.
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Updated analysis of 2014 data leaves many of these estimates
largely unchanged. We estimate that approximately 170 entities engaged
in single-name CDS activity at a sufficiently high level that they
would be expected to incur assessment costs to determine whether they
meet the ``security-based swap dealer'' definition. Approximately 56 of
these entities are non-U.S. persons. Of the approximately 50 entities
that we estimate may potentially register as security-based swap
dealers, we preliminarily believe it is reasonable to expect 22 to be
non-U.S. persons.
2. Levels of Security-Based Swap Trading Activity
Single-name CDS contracts make up the vast majority of security-
based swaps, and most are written on corporate issuers, corporate
securities, sovereign countries, or sovereign debt (reference entities
or securities). 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 2013, separated
by whether transactions are between two ISDA-recognized dealers (inter-
dealer transactions) or whether a transaction has at least one non-
dealer counterparty.
Annual trading activity with respect to North American corporate
single-name CDS in terms of notional volume has declined from more than
$6 trillion in 2008 to less than $3 trillion in 2014.\50\ While
notional volume has declined over the past six years, the portion of
the notional volume represented by inter-dealer transactions has
remained fairly constant and inter-dealer transactions continue to
represent a significant majority of trading activity, whether measured
in terms of notional value or number of transactions (see Figure 2).
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\50\ 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. The timing of this decline seems to
indicate that CDS market demand shrank prior to the enactment of the
Dodd-Frank Act, and therefore the causes of this reduction in
trading volume may be related to market dynamics and not directly
related to the enactment of legislation and the development of
security-based swap market regulation.
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The high level of inter-dealer trading activity reflects the
central position of a small number of dealers, each of which
intermediates trades between many hundreds of counterparties. 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. This market power in turn appears to be a key
determinant of trading costs in this market.
[[Page 27453]]
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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 that we analyzed
was between counterparties domiciled in the United States and
counterparties domiciled abroad. Basing counterparty domicile on the
self-reported registered office location of the TIW accounts, we
estimate that only 12% of the global transaction volume by notional
volume between 2008 and 2014 was between two U.S.-domiciled
counterparties, compared to 48% entered into between one U.S.-domiciled
counterparty and a foreign-domiciled counterparty and 40% entered into
between two foreign-domiciled counterparties (see Figure 3).\51\
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\51\ See note 44, supra. 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.
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When the domicile of TIW accounts is instead defined according to
the domicile of an account's ultimate parents, headquarters, or home
office (e.g., classifying a foreign bank branch or foreign subsidiary
of a U.S. entity as domiciled in the United States), the fraction of
transactions entered into between two U.S.-domiciled counterparties
increases to 32%, and to 51% for transactions entered into between a
U.S.-domiciled counterparty and a foreign-domiciled counterparty.
Differences in classifications across different definitions of
domicile illustrate the effect of participant structures that operate
across jurisdictions. Notably, the proportion of activity between two
foreign-domiciled counterparties drops from 40% to 17% when domicile is
defined as the ultimate parent's domicile. As noted earlier, foreign
subsidiaries of U.S. parent companies and foreign branches of U.S.
banks, and U.S. subsidiaries of foreign parent companies and U.S.
branches of foreign banks may transact with U.S. and foreign
counterparties. However, 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 is
generally higher than the activity of U.S. subsidiaries of foreign
firms and U.S. branches of foreign banks.
[[Page 27454]]
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3. Regulatory Reporting, Clearing, and Trade Execution of Security-
Based Swap Transactions
We have adopted final rules implementing regulatory reporting
requirements for security-based swap transactions, although compliance
with most aspects of this regime is not yet required.\52\ Although
counterparties are not yet required to comply with rules that require
them to report transaction information, virtually all market
participants voluntarily report their trades in single-name CDS to TIW,
which maintains a record of these transactions, in some cases with the
assistance of post-trade processors.\53\ Among other things, this
centralized record-keeping facilitates settlement of obligations
between counterparties when a default event occurs as well as bulk
transfers of positions between accounts at a single firm or between
firms.
---------------------------------------------------------------------------
\52\ See Regulation SBSR Adopting Release, 80 FR 14566.
\53\ See http://www.isdacdsmarketplace.com/exposures_and_activity (last visited September 22, 2014).
---------------------------------------------------------------------------
Clearing of security-based swaps, which is currently voluntary in
the United States, is currently limited to CDS products, and a
substantial proportion of single-name CDS accepted for clearing are
already being cleared. Prior to the Dodd-Frank Act, ICE Clear Credit
and ICE Clear Europe engaged in CDS clearing activities pursuant to
exemptive orders issued by the Commission.\54\ Pursuant to the Dodd-
Frank Act, ICE Clear Credit and ICE Clear Europe were deemed to be
registered with the Commission in July 2011 as clearing agencies for
security-based swaps.\55\ ICE Clear Credit began clearing corporate
single-name CDS in December 2009,\56\ and, as of March 17, 2015, had
cleared a total of $3.06 trillion gross notional of single-name CDS on
368 North American and European instruments.\57\ As of the beginning of
this year, ICE Clear Credit accepted for clearing a total of 207 CDS
products based on North American instruments, 168 CDS products based on
European instruments, and fifteen CDS products based on individual
sovereign (nation-state) reference entities.
---------------------------------------------------------------------------
\54\ See, e.g., Exchange Act Release No. 59527 (March 6, 2009),
74 FR 10791 (March 12, 2009) (``ICE Clear Credit Exemptive Order'');
Exchange Act Release No. 60372 (July 23, 2009), 74 FR 37748 (July
29, 2009) (``ICE Clear Europe Exemptive Order''). In connection with
those orders, Commission considered clearing practices of those
central counterparties (``CCPs''), including, inter alia, their risk
management methodologies.
\55\ Section 17A(l) of the Exchange Act provides in relevant
part that a derivative clearing organization registered with the
CFTC that clears security-based swaps would be deemed to be
registered as a clearing agency under section 17A if, prior to the
enactment of the Dodd-Frank Act, it cleared swaps pursuant to an
exemption from registration as a clearing agency. Both ICE Clear
Credit and ICE Clear Europe also are registered with the CFTC as
derivative clearing organizations.
\56\ See Exchange Act Release No. 61662 (March 5, 2010), 75 FR
11589, 11591 (March 11, 2010) (discussing ICE Clear Credit's CDS
clearing activities as of March 2010).
ICE Clear Credit (then known as ICE US Trust LLC) began clearing
index CDS in March 2009. See Exchange Act Release No. 59527 (March.
6, 2009), 74 FR 10791 (March 12, 2009) (order granting temporary
exemptions under the Exchange Act on behalf of ICE US Trust LLC).
\57\ ICE Clear Credit also has cleared a total of $37.3 trillion
gross notional on 137 index CDS as of March 20, 2015. See ICE Clear
Credit, Volume of ICE CDS Clearing, available at: https://www.theice.com/clear_credit.jhtml.
In addition to clearing single-name CDS on North American
corporate reference entities, ICE Clear Credit also clears CDS on
certain non-U.S. sovereign entities, and on certain indices based on
North American reference entities.
---------------------------------------------------------------------------
Staff analysis of trade activity from July 2012 to December 2013
indicate that, out of $938 billion of notional traded in North American
corporate single-name CDS contracts that have reference entities that
are accepted for clearing during the 18 months ending December 2013,
approximately 71%, or $666 billion, had characteristics making them
suitable for clearing by ICE Clear Credit and represented trades
between two ICE Clear Credit clearing members.
[[Page 27455]]
Approximately 79% of this notional value, or $525 billion, was cleared
through ICE Clear Credit, or 56% of the $938 billion in new trade
activity.
Figure 4 shows the proportion of new trades and assign-entries
defined as clearable at ICE Clear Credit that were ultimately
cleared.\58\
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\58\ For the purposes of this analysis, ``clearable'' describes
CDS contracts on North American single-name corporate reference
entities between clearing members that reference the ISDA Standard
North American Corporate (SNAC) documentation, are denominated in
U.S. dollars, do not include restructuring as a credit event and
have a standard coupon. If ICE Clear Credit accepts CDS on the
reference entity for clearing, then a standard coupon is one that is
accepted for clearing for that reference entity by ICE Clear Credit;
otherwise, standard coupon means a coupon of either 100 or 500 basis
points. See SEC Division of Economic and Risk Analysis, Single-Name
Corporate Credit Default Swaps: Background Data Analysis on
Voluntary Clearing Activity, 15 (April 2015), available at http://www.sec.gov/dera/staff-papers/white-papers/voluntary-clearing-activity.pdf.
---------------------------------------------------------------------------
Evidence from the TIW data suggests that even single-name CDS
written on reference entities that were initially accepted for clearing
by ICE Clear Credit were traded infrequently. Figure 5 plots of the
daily mean number of transactions per trading day for each of the 538
North American single-name corporate reference entities with at least
one transaction per month on average during the period from January
2011 to December 2013.\59\ Each vertical bar represents the mean number
of transactions per day for a reference entity.\60\ The 538 reference
entities are presented in decreasing order of the mean number of
transactions per trading day. Commission staff has identified the 68
reference entities in the sample that were cleared by ICE Clear Credit
prior to the enactment of the Dodd-Frank Act (the ``deemed submitted''
reference entities). The 68 deemed submitted reference entities are
marked by Xs forming a line near the horizontal axis. The remaining Xs
(those not on the line of Xs near the horizontal axis) represent, for
each reference entity, the fraction of days with no transactions. The
evidence in Figure 5 suggests that within the sample period, the most
traded entity of the 68 ``deemed submitted'' reference entities was
traded approximately 15 times per day on average. Despite the low
average number of transactions per day, these 68 reference entities
generally have a lower proportion of days with no transactions relative
to the rest of the single-name CDS market represented in the sample.
---------------------------------------------------------------------------
\59\ We analyze single-name corporate reference entities with at
least one transaction per month on average from January 2011 to
December 2013 to avoid including outliers that trade extremely
infrequently. Of the 573 North American single-name corporate
reference entities with at least 36 transactions included in Figure
5, only 538 had at least 36 new trades, implying that the other 35
had price forming transactions that were not associated with new
trading activity, such as terminations or assignments. See id. at
41.
\60\ Transaction types include all price forming transactions:
New trades, amendments that change economic terms of the contract,
assignments, and terminations.
---------------------------------------------------------------------------
ICE Clear Europe began clearing CDS on single-name corporate
reference entities in December 2009,\61\ and, as of March 17, 2015, had
cleared a total [euro]2.48 trillion in gross notional of single-name
CDS on 161 European corporate reference entities.\62\ As of the
beginning of 2015, ICE Clear Europe accepted for clearing a total of
161 CDS products based on European corporate reference entities.
---------------------------------------------------------------------------
\61\ See Exchange Act Release No. 61973 (April 23, 2010), 75 FR
22656, 22657 (April 29, 2010) (discussing ICE Clear Europe's CDS
clearing activity as of April 2010).
ICE Clear Europe commenced clearing index CDS in July 2009. See
Exchange Act Release No. 60372 (July 23, 2009), 74 FR 37748 (July
29, 2009) (order granting temporary exemptions under the Exchange
Act on behalf of ICE Clear Europe).
\62\ ICE Clear Europe also has cleared a total of [euro]14.4
trillion in gross notional on 64 index CDS as of March 20, 2015. See
ICE Clear Europe, Volume of ICE CDS Clearing, available at: https://www.theice.com/clear_credit.jhtml.
Aside from clearing single-name CDS on European corporate
reference entities, ICE Clear Europe also clears CDS on indices
based on European reference entities, as well as futures and
instruments on OTC energy and emissions markets.
---------------------------------------------------------------------------
Staff analysis of new trade activity from July 2012 to December
2013 indicate that out of [euro]531 billion of notional traded in
European corporate single-name CDS contracts that have reference
entities that are accepted for clearing during the 18 months ending
December 2013, approximately 70%, or [euro]372 billion had
characteristics making them suitable for clearing by ICE Clear Europe
and represented trades between two ICE Clear Europe clearing members.
Approximately 51% of this notional value, or [euro]191 billion was
cleared through ICE Clear Europe, representing 36% of the total volume
of new trade activity.\63\
---------------------------------------------------------------------------
\63\ These numbers do not include transactions in European
corporate single-name CDS that were cleared by ICE Clear Credit.
However, during the sample period, there was only one day on which
there were transactions that were cleared by ICE Clear Credit
(December 20, 2013) and the traded notional of these transactions
was minimal. For historical data, see https://www.theice.com/marketdata/reports/99.
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[[Page 27456]]
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[GRAPHIC] [TIFF OMITTED] TP13MY15.004
[[Page 27457]]
Unlike the markets for cash equity securities and listed options,
the market for security-based swaps is characterized almost exclusively
by bilateral OTC negotiation and is largely decentralized.\65\ The lack
of uniform rules concerning the trading of security-based swaps and the
historical one-to-one nature of trade negotiation in security-based
swaps has resulted in the formation of distinct types of trading venues
and execution practices, ranging from bilateral negotiations carried
out over the telephone,\66\ single-dealer RFQ platforms,\67\ multi-
dealer RFQ platforms,\68\ central limit order books,\69\ and brokerage
trading.\70\ These various trading venues and execution practices
provide different degrees of pre-trade transparency and afford market
participants different levels of access. We currently do not have
sufficient information with respect to the volume of security-based
swap transactions executed across these different trading venues and
using these various execution practices.
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\64\ We preliminarily believe that it is reasonable to assume
that, when clearing occurs within 14 days of execution,
counterparties made the decision to clear at the time of execution
and not as a result of information arriving after execution.
An ``assign-entry'' involves the substitution of one of the
contract counterparties in an existing instrument for a new
counterparty in exchange for cash consideration. It is economically
equivalent to a termination of the initial contract between the
``old'' counterparty and the ``static'' counterparty and a new trade
between the ``replacement'' counterparty and the ``static''
counterparty.
\65\ See SB SEF Proposing Release, 76 FR 10951.
\66\ ``Bilateral negotiation'' refers to the execution practice
whereby one party uses telephone, email, or other communication
methods to contact directly a potential counterparty to negotiate
and execute a security-based swap. The bilateral negotiation and
execution practice provides no pre-trade or post-trade transparency
because only the two parties to the transaction are aware of the
terms of the negotiation and the final terms of the agreement. See
SB SEF Proposing Release, 76 FR 10951.
\67\ A single-dealer RFQ platform refers to an electronic
trading platform where a dealer may post indicative quotes for
security-based swaps in various asset classes that the dealer is
willing to trade. Only the dealer's approved customers would have
access to the platform. When a customer wishes to transact in a
security-based swap, the customer requests an executable quote, the
dealer provides one, and if the customer accepts the dealer's quote,
the transaction is executed electronically. This type of platform
generally provides pre-trade transparency in the form of indicative
quotes on a pricing screen, but only from one dealer to its
customer. See SB SEF Proposing Release, 76 FR 10951.
\68\ A multi-dealer RFQ electronic trading platform refers to a
multi-dealer RFQ system whereby a requester can send an RFQ to
solicit quotes on a certain security-based swap from multiple
dealers at the same time. After the RFQ is submitted, the recipients
have a prescribed amount of time in which to respond to the RFQ with
a quote. Responses to the RFQ are firm. The requestor then has the
opportunity to review the responses and accept the best quote. A
multi-dealer RFQ platform provides a certain degree of pre-trade
transparency, depending on its characteristics. See SB SEF Proposing
Release, 76 FR 10952.
\69\ A limit order book system or similar system refers to a
trading system in which firm bids and offers are posted for all
participants to see, with the identity of the parties withheld until
a transaction occurs. Bids and offers are then matched based on
price-time priority or other established parameters and trades are
executed accordingly. The quotes on a limit order book system are
firm. In general, a limit order book system provides greater pre-
trade transparency than the three models described above because all
participants can view bids and offers before placing their bids and
offers. See SB SEF Proposing Release, 76 FR 10952. Currently, limit
order books for the trading of security-based swaps in the United
States are utilized by inter-dealer brokers for dealer-to-dealer
transactions.
\70\ ``Brokerage trading'' refers to an execution practice used
by brokers to execute security-based swaps on behalf of customers,
often in larger-sized or bespoke transactions. In such a system, a
broker receives a request from a customer (which may be a dealer)
that seeks to execute a specific type of security-based swap. The
broker then interacts with other customers to fill the request and
execute the transaction. This model often is used by dealers that
seek to transact with other dealers through the use of an inter-
dealer broker as an intermediary. In this model, there may be pre-
trade transparency to the extent that participants are able to see
bids and offers of other participants. See SB SEF Proposing Release,
76 FR 10952.
---------------------------------------------------------------------------
We have proposed, but have not yet adopted, rules establishing a
registration regime and core principles for security-based swap
execution facilities (``SB SEFs''). We have not proposed to implement
the mandatory trade execution requirement contained in section 3C(h) of
the Exchange Act. Currently, there are no SB SEFs registered with the
Commission, and as a result, there is no registered SB SEF trading
activity to report. There are, however, currently 25 trading platforms
that either are temporarily registered with the CFTC as SEFs or have
SEF temporary registration applications pending with the CFTC and
currently are exempt from registration with the Commission.\71\ As we
discuss in Section II.B.5, the cash flows of security-based swaps and
swaps are closely related and many participants in the security-based
swap also participate in the swap market and so we preliminarily
believe that many SEFs that currently serve as trading venues for swaps
are likely also to register with the Commission as SB SEFs. However,
owing to the smaller size of the security-based swap market, we
currently expect that there will be fewer exchanges and SB SEFs that
will eventually host transactions in security-based swaps than the 25
SEFs reported within the CFTC's jurisdiction.
---------------------------------------------------------------------------
\71\ See Effective Date Release, 76 FR at 36306 (exempting
persons that operate a facility for the trading or processing of
security-based swaps that is not currently registered as a national
securities exchange, or that cannot yet register as an SB SEF
because final rules for such registration have not yet been adopted,
from the requirements of Section 3D(a)(1) of the Exchange Act until
the earliest compliance date set forth in any of the final rules
regarding registration of SB SEFs). A list of platforms that either
are temporarily registered with the CFTC or have SEF temporary
registration applications pending with the CFTC is available at:
http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities
(last visited March 2, 2015).
---------------------------------------------------------------------------
4. Global Regulatory Efforts
Efforts to regulate the swaps market are underway not only in the
United States but also abroad, and these efforts have received
significant attention in international fora. For example, in 2009,
leaders of the G20--whose membership includes the United States, 18
other countries, and the EU--addressed global improvements in the
functioning, transparency, and regulatory oversight of OTC derivatives
markets. They expressed their view on a variety of issues relating to
OTC derivatives contracts, including trading on exchanges or electronic
trading platforms, clearing through CCPs, and reporting to trade
repositories.\72\ In subsequent summits, the G20 leaders have returned
to OTC derivatives regulatory reform and encouraged international
consultation in developing standards for these markets.\73\
---------------------------------------------------------------------------
\72\ See G20 Leaders' Statement, Pittsburgh, United States,
September 24-25, 2009, available at: http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf.
\73\ See the G20 Leaders Communique (November 2014), para. 12,
available at: https://www.g20.org/sites/default/files/g20_resources/library/brisbane_g20_leaders_summit_communique.pdf.
---------------------------------------------------------------------------
Jurisdictions with major OTC derivatives markets have taken steps
toward substantive regulation of these markets, though the pace of
regulation varies. Accordingly, many foreign participants likely will
be required to comply with substantive regulation of their security-
based swap activities apart from regulations that may apply to them
pursuant to Title VII. The concerns foreign jurisdictions seek to
address with their regulations may overlap or be similar to those
addressed by the Title VII regulatory framework.
Foreign legislative and regulatory efforts have focused on five
general areas: Requiring post-trade reporting of transactions data for
regulatory purposes, moving OTC derivatives onto organized trading
platforms, requiring central clearing of OTC derivatives, establishing
or enhancing capital requirements, and establishing or enhancing margin
requirements for OTC derivatives transactions. The first two areas of
regulation should help improve transparency in OTC derivatives markets,
both to regulators and market participants. Regulatory transaction
reporting requirements are mandated in a number of jurisdictions
including the
[[Page 27458]]
EU, Hong Kong SAR, Japan, and Singapore; other jurisdictions are in the
process of proposing legislation and rules to implement these
requirements.\74\ The EU has adopted legislation for markets in
financial instruments that addresses trading OTC derivatives on
regulated trading platforms.\75\ This legislation also should promote
post-trade public transparency in OTC derivatives markets by requiring
the price, volume, and time of derivatives transactions conducted on
these regulated trading platforms to be made public in as close to real
time as technically possible.\76\
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\74\ Information regarding ongoing regulatory developments
described in this section was primarily obtained from progress
reports published by the Financial Stability Board. These are
available at: http://www.financialstabilityboard.org/list/fsb_publications/index.htm.
\75\ See id.
\76\ See Regulation (EU) No 600/2014 of the European Parliament
and of the Council of 15 May 2014 on markets in financial
instruments and amending Regulation (EU) no 648/2012), available at:
http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32014R0600&from=EN.
---------------------------------------------------------------------------
Regulation of derivatives central clearing, capital requirements,
and margin requirements aims, among other things, to improve management
of financial risks in these markets.\77\ Japan has rules in force
mandating central clearing of certain OTC derivatives transactions.\78\
The EU has its legislation in place but has not yet made any
determinations of specific OTC derivatives transactions subject to
mandatory central clearing. Most other jurisdictions are still in the
process of formulating their legal frameworks that govern central
clearing. A number of major foreign jurisdictions have initiated the
process of drafting rules to implement margin requirements for OTC
derivatives transactions.
---------------------------------------------------------------------------
\77\ See note 74, supra.
\78\ See id.
---------------------------------------------------------------------------
5. Cross-Market Participation
Persons registered as security-based swap dealers or major
security-based swap participants are likely also to engage in swap
activity, which is subject to regulation by the CFTC. In the release
proposing registration requirements for security-based swap dealers and
major security-based swap participants, we estimated, based on our
experience and understanding of the swap and security-based swap
markets that of the 55 firms that might register as security-based swap
dealers or major security-based swap participants, approximately 35
would also register with the CFTC as swap dealers or major swap
participants.\79\ Available data suggest that these numbers remain
largely unchanged.\80\
---------------------------------------------------------------------------
\79\ See Registration of Security-Based Swap Dealers and Major
Security-Based Swap Participants, Exchange Act Release No. 65543
(October 12, 2011), 76 FR 65784, 65808 (October 24, 2011).
\80\ Based on its 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 register as swap dealers with the CFTC. See also
CFTC list of provisionally registered swap dealers, available at:
http://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer.
---------------------------------------------------------------------------
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 contracts, prices of these products depend upon one another,\81\
creating hedging opportunities across these markets.
---------------------------------------------------------------------------
\81\ ``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., Casella, George 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 2,500 of
those accounts, or 56%, 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 60%; 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 11%.
As discussed in more detail below,\82\ the CFTC Staff Advisory
issued in November 2013 stated the CFTC staff's belief that the CFTC
has a strong supervisory interest in swap dealing activities that occur
within the United States, regardless of the status of the
counterparties. The CFTC Staff Advisory, which we understand to be
under review at the CFTC,\83\ also stated the CFTC staff's belief that
a non-U.S. swap dealer ``regularly using personnel or agents located in
the U.S. to arrange, negotiate, or execute a swap with a non-U.S.
person generally would be required to comply with'' the CFTC's
transaction-level requirements.\84\ While CFTC staff has granted relief
from certain aspects of the CFTC Staff Advisory,\85\ at least one
commenter has argued that the CFTC's approach to regulation of swap
dealers taken in the CFTC Cross-Border Guidance has influenced the
information that market participants collect and maintain about the
swap transactions they enter into and the counterparties they face.\86\
Although that commenter suggested that swap market participants have
also adopted business practices consistent with the CFTC Cross-Border
Guidance, the commenter did not supply particular details as to the
scope of the changes to its operations.\87\
---------------------------------------------------------------------------
\82\ See Section III.B.3, infra.
\83\ See CFTC Request for Comment.
\84\ See CFTC Staff Advisory at 1-2.
\85\ See note 25, supra.
\86\ See, e.g., Letter from Securities Industry and Financial
Markets Association/Futures Industry Association/Financial Services
Roundtable (``SIFMA/FIA/FSR'') to SEC, dated August 21, 2013
(``SIFMA/FIA/FSR Letter'') at 2-3.
\87\ Id. at 2-4. The commenter notes the ``technological,
operational, legal and compliance systems'' necessary for complying
with our proposed rules, and taking account of the CFTC Cross-Border
Guidance, outlining the general categories of changes to practice
necessary for compliance. Id. The commenter further indicates a
potential need to ``build[] separate systems for a small percentage
of the combined swaps and SBS market instead of using the systems
already built for compliance with the CFTC's cross-border
approach,'' suggesting that market participants have adopted market
practices consistent with the CFTC Cross-Border Guidance. Id.
---------------------------------------------------------------------------
The proposed amendments and proposed rule may, to the extent that
they are not in conflict with the approach taken in the CFTC Cross-
Border Guidance, permit non-U.S. persons to use infrastructures
developed to be consistent with the CFTC's approach, to comply with
Commission requirements as well. Among those entities that participate
in both markets, entities that are able to apply to security-based swap
activity capabilities that are consistent with the CFTC Cross-Border
Guidance may experience lower costs associated with assessing which
[[Page 27459]]
cross-border security-based swap activity counts against the dealer de
minimis exception or towards the major participant threshold, relative
to those that are unable to redeploy such capabilities. We remain
sensitive to the fact that in cases where our final rules differ from
the CFTC approach, additional outlays related to information collection
and storage may be required.
III. Application of the Dealer De Minimis Exception to U.S. Security-
Based Swap Dealing Operations of Non-U.S. Persons
A. Overview
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.\88\ Under the final rules adopted in the Intermediary
Definitions Adopting Release, a person may take advantage of that
exception if, in connection with credit default swaps 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.\89\ 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.\90\
---------------------------------------------------------------------------
\88\ See Exchange Act section 3(a)(71)(D).
\89\ 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).
\90\ 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 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.
---------------------------------------------------------------------------
The Cross-Border Adopting Release finalized rules specifying, among
other things, when a non-U.S. person is required to include
transactions arising from its dealing activity in its de minimis
threshold calculations.\91\ These final rules addressed the application
of the security-based swap dealer de minimis exception to such person's
dealing activity involving U.S.-person counterparties, as well as the
dealing activity of a non-U.S. person that is a conduit affiliate \92\
or whose counterparty has a right of recourse under the security-based
swap against an affiliated U.S. person.\93\ Although we had proposed
requiring a non-U.S. person to include in this calculation any dealing
activity involving another non-U.S.-person counterparty if it resulted
in a ``transaction conducted within the United States'' as defined in
the proposed rule,\94\ we did not address this issue in our Cross-
Border Adopting Release. As we noted in that adopting release,
commenters raised a number of significant issues related to this
element of the Cross-Border Proposing Release, including our authority
to impose, and the costs of complying with, this requirement, and we
determined that final resolution of this issue would benefit from
further consideration and public comment.\95\
---------------------------------------------------------------------------
\91\ See Cross-Border Adopting Release, 79 FR 47319-322. See
also Exchange Act rules 3a71-3(b), 3a71-4.
\92\ See Exchange Act rule 3a71-3(a)(1); Cross-Border Adopting
Release, 79 FR 47313.
\93\ See Cross-Border Adopting Release, 79 FR 47316.
\94\ See Cross-Border Proposing Release, 78 FR 30999-31001.
\95\ See, e.g., Cross-Border Adopting Release, 79 FR 47280.
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In light of those comments and further consideration of the
concerns raised by such transactions and subsequent regulatory and
market developments, the statutory objectives, and the practicability
of our initially proposed approach, we have determined to propose an
amendment to Exchange Act rules 3a71-3 and 3a71-5 that more closely
focuses on certain dealing activity carried out, at least in part, by
personnel located in the United States.\96\ The proposed amendments
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, the proposed
amendments would 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 of office.
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\96\ See proposed Exchange Act rule 3a71-3(b)(1)(iii)(C);
proposed Exchange Act rule 3a71-5(c).
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As described in more detail below, we preliminarily believe that
this proposed approach would mitigate many of the concerns raised by
commenters in response to our initial proposal, while requiring persons
that engage in dealing activity at levels that may raise the types of
concerns that Title VII addresses to register as security-based swap
dealers and comply with appropriate regulation. We also note that this
approach would be generally consistent with the approach that we have
followed with respect to the registration of brokers and dealers under
the Exchange Act, which among other things requires that a broker-
dealer physically operating in the United States register with the
Commission and comply with relevant regulatory requirements, even if it
directs its activities solely toward non-U.S. persons outside the
United States.\97\
---------------------------------------------------------------------------
\97\ See Registration Requirements for Foreign Broker-Dealers,
Exchange Act Release No. 27017 (July 11, 1989), 54 FR 30013 (July
18, 1989).
---------------------------------------------------------------------------
B. Proposed Application of De Minimis Exception to Non-U.S. Persons
Arranging, Negotiating, or Executing Security-Based Swap Transactions
Using Personnel Located in a U.S. Branch or Office
1. Overview of the Initially Proposed Approach
As we noted in the Cross-Border Proposing Release, dealing activity
carried out by a non-U.S. person 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
those transactions involve non-U.S.-person counterparties.\98\
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.'' \99\ 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.'' \100\
[[Page 27460]]
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 transaction where either the dealer itself
or its counterparty, or the agent of either the dealer or the
counterparty, performed relevant security-based swap dealing activity
within the United States.\101\
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\98\ See Cross-Border Proposing Release, 78 FR 31000-01.
\99\ See initially proposed 3a71-3(b)(1)(ii).
\100\ See initially proposed Exchange Act rule 3a71-3(a)(5). See
also Cross-Border Proposing Release, 78 FR 30999-31000. To address
anticipated operational challenges associated with determining
whether a person's counterparty is engaging in dealing activity
within the United States that would make the transaction a
``transaction conducted within the United States,'' we also proposed
permitting reliance on a representation by a counterparty that the
transaction was not solicited, negotiated, executed, or booked
within the United States by or on behalf of that counterparty. See
id. at 31001.
\101\ As we noted in the Cross-Border Proposing Release, the
term ``transaction conducted within the United States'' was intended
to identify key aspects of a transaction that, if carried out within
the United States by either counterparty, would trigger the need for
a non-U.S. person acting in a dealing capacity to include
transactions arising out of that activity in its de minimis
calculation. See id. at 30999-31000. 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
id. at 31000.
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2. Commenters' Views on the Cross-Border Proposing Release
Our initially proposed definition of ``transaction conducted within
the United States'' and our proposed use of that term to trigger
various Title VII requirements generated a significant volume of
comment addressing a wide range of issues. Although two commenters
supported our proposal,\102\ commenters generally criticized the
proposed definition. These criticisms generally focused on four areas:
the scope of activity potentially captured by the initially proposed
defined term, the operational difficulties of implementing the defined
term, the costs of implementation, and competitive concerns.
---------------------------------------------------------------------------
\102\ See note 26, supra.
---------------------------------------------------------------------------
(a) Scope of the Initially Proposed Definition of ``Transaction
Conducted Within the United States''
Several commenters took issue with the scope of the initially
proposed defined term. Some commenters argued that the initially
proposed definition was inappropriate in the context of Title VII
because it would capture transactions between two non-U.S. persons that
happened to involve conduct within the United States, even though such
transactions are unlikely to create risk to the U.S. financial
system.\103\ Commenters also expressed concern that the initially
proposed definition was overly broad because it would capture
incidental or peripheral activity within the United States,\104\
arguing that such overbreadth could lead to conflicting or duplicative
application of regulations for certain market participants.\105\
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\103\ See SIFMA/FIA/FSR Letter at 4, A-3 (explaining that a
transaction between two non-U.S. counterparties does not create risk
in the United States, even where it is conducted within the United
States); Letter from European Commission (``EC'') to SEC, dated
August 21, 2013 (``EC Letter'') at 2 (suggesting that the
Commission's rules should not apply to transactions when conduct
within the United States involves two non-U.S. counterparties
because no U.S. firms are at risk); Letter from European Securities
and Markets Authority (``ESMA'') to SEC, dated August 21, 2013
(``ESMA Letter'') at 2 (requesting the Commission limit the
definition of ``transaction conducted within the United States'' to
transactions booked within the United States because that is the
only activity that directly creates risk within the United States);
Letter from Futures and Options Association (``FOA'') to SEC, dated
August 21, 2013 (``FOA Letter'') at 7 (arguing that the test as
initially proposed does not serve the goals of preserving the
integrity of U.S. financial markets and protecting U.S.
counterparties because it reaches transactions with minimal nexus to
the United States).
Two of these commenters suggested that the initially proposed
approach exceeded the Commission's authority under section 30(c) of
the Exchange Act. See SIFMA/FIA/FSR Letter at 4 and A-4 to A-5
(suggesting that Exchange Act section 30(c) does not authorize the
Commission to extend its authority through a conduct-based approach
where no risk is imported to the United States); FOA Letter at 7
(stating that test goes beyond limits of Exchange Act section
30(c)). Another commenter stated that the initially proposed
approach was inappropriate because it would have the effect of
applying Title VII to transactions between two non-U.S. persons
without having an international agreement regarding extraterritorial
application of each jurisdiction's regulations. See Letter from
Japan Securities Dealers Association (``JSDA'') to SEC, dated August
21, 2013 (``JSDA Letter'') at 3.
\104\ See Letter from Managed Funds Assoc. and Alternative
Investment Management Assoc. (``MFA/AIMA'') to SEC, dated August 19,
2013 (``MFA/AIMA Letter'') at 4 and n.18 (stating that the lack of a
materiality threshold would inappropriately subject transactions to
Commission regulation, including transactions negotiated during an
employee's visit to the United States); SIFMA/FIA/FSR Letter at A-2
(explaining that ``transaction conducted within the United States''
may include incidental conduct, which includes, in this commenter's
view, a decision by a non-U.S. counterparty to use a contact based
in the United States to execute a transaction only because executing
it in the non-U.S. counterparties' jurisdictions would be
inconvenient or impossible due to the timing of the transaction);
Letter from Pensions Europe to SEC, dated September 3, 2013
(``Pensions Europe Letter'') at 1 (stating that trades executed
outside the United States by European pension fund managers should
not be brought within Title VII only because the managers wish to
``benefit from the expertise and experience of U.S. operations'');
Letter from Institute of International Bankers (``IIB'') to SEC,
dated August 21, 2013 (``IIB Letter'') at 10 (noting that the
initially proposed test could capture transactions where the U.S.-
based conduct is only clerical or ministerial); Letter from
Investment Adviser Association (``IAA'') to SEC, dated August 21,
2013 (``IAA Letter'') at 6-7 (stating that the initially proposed
test may capture parties with minimal connection to the United
States, such as a non-U.S. counterparty using a U.S. investment
adviser to manage its assets); Letter from Investment Company
Institute (``ICI'') to SEC, dated August 21, 2013 (``ICI Letter'')
at 4, 8-9 (stating that exception from the definition should be
broader for non-U.S. counterparties that use U.S.-based investment
managers and that the retention of a U.S. asset manager should not
cause transactions to be subject to various regulatory requirements
because a non-U.S. entity would not expect to be subject to U.S.
regulation based on its retention of a U.S. asset manager); Letter
from Japan Financial Markets Council (``JFMC'') to SEC, dated August
15, 2013 (``JFMC Letter'') at 5 (stating that the transactions could
be captured by the definition solely because they are executed
through a U.S. trading facility).
\105\ See IIB Letter at 8-9 (explaining that, because European
regulations would apply to transactions between two U.S. branches of
European firms, the initially proposed approach would cause
duplicative and conflicting regulation); IIB letter at 10 (stating
that a conduct-based test would subject U.S. agents already
registered with the Commission or exempted from registration under
broker-dealer or investment adviser regulations to additional
regulation). See also EC Letter at 2 (suggesting that the
Commission's rules should not apply to transactions when the legal
counterparty to a transaction conducted within the United States is
a non-U.S. entity because such persons are subject to regulation in
their home jurisdiction); ESMA Letter at 2-3 (noting that the
initially proposed approach could subject a transaction between two
non-U.S. persons that is solicited in the United States to the
regulations of multiple jurisdictions); FOA Letter at 7 (requesting
that the Commission defer to regulatory oversight of counterparties'
home country regulators).
---------------------------------------------------------------------------
(b) Operational Challenges
One commenter recognized the concerns that the initially proposed
definition of ``transaction conducted within the United States'' was
intended to address but expressed doubt as to whether funds would be
able to monitor and confirm whether their dealing counterparties were
engaging in dealing activity within the United States.\106\ A number of
commenters expressed concern that the defined term and its initially
proposed application in the context of specific Title VII requirements,
would present significant operational challenges for market
participants more generally.\107\ For
[[Page 27461]]
example, one commenter noted that the approach would require market
participants to make determinations on a trade-by-trade basis as to
whether a transaction was ``conducted within the United States'' and
would create inefficiencies and uncertainty in the market.\108\ This
commenter stated that the initially proposed approach was vague, and
would be difficult to enforce and easy to manipulate.\109\ One
commenter specifically argued that operational difficulties in tracking
the location of conduct on a trade-by-trade basis might be impossible
to overcome.\110\
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\106\ See MFA/AIMA Letter at 4 (acknowledging the Commission's
interest in preventing evasion of Title VII but expressing concern
that private funds that are not U.S. persons may not be able to
determine whether dealer counterparties have engaged in relevant
conduct within the United States and may not be able to obtain
relevant representations from such counterparties).
\107\ See, e.g., IIB Letter at 11 (stating that the initially
proposed definition is ill suited to the global nature of the
derivatives markets where activity may involve multiple physical
locations); JFMC Letter at 4-5 (noting that the initially proposed
definition is impracticable and would subject participants to
duplicative and conflicting rules); JSDA Letter at 3 (expressing
concern about the activity-based approach because of the operational
confusion it may cause by subjecting market participants to the two
separate approaches of the Commission and CFTC); ABA Letter at 3
(identifying ambiguities in the initially proposed definition,
including whether negotiations over ISDA documentation are relevant
conduct for purposes of the transaction).
\108\ See Letter from Americans for Financial Reform (``AFR'')
to SEC, dated August 22, 2013 (``AFR Letter'') at 3, A-2 to A-3.
\109\ See AFR Letter at 3.
\110\ See IIB Letter at 8.
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(c) Cost Concerns
Some commenters stated that applying Title VII to transactions
merely because they involve conduct within the United States could not
be justified from a cost-benefit perspective. Some contended that the
CFTC had not taken such an approach and that divergence from the CFTC
on the treatment of such conduct would impose a significant additional
cost on market participants.\111\ One commenter also noted that,
whereas the ``U.S. person'' definition would typically be applied only
at the beginning of a trading relationship, market participants would
potentially be required to perform a trade-by-trade analysis to
determine whether it involved conduct within the United States, which
could significantly increase costs.\112\
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\111\ See SIFMA/FIA/FSR Letter at 3, A-3, A-6 (arguing that the
Commission should harmonize its approach to cross-border security-
based swap activity to the approach reflected in the commenter's
view of the CFTC Cross-Border Guidance); Pensions Europe Letter at 2
(preferring its view of the CFTC approach in the CFTC Cross-Border
Guidance, which the commenter argues focuses on the location of
principal headquarters); IIB Letter at 8 (stating that market
participants would incur costs and burdens to modify their existing
systems in order to comply with two different tests); JFMC Letter at
4-5 (urging that the Commission not adopt the defined term
``transaction conducted within the United States'' because the CFTC
did not discuss such an approach in the CFTC Cross-Border Guidance).
\112\ See IIB Letter at 8 (stating that a conduct-based test
would be costly and disruptive).
---------------------------------------------------------------------------
(d) Competitive Concerns
Some commenters expressed concern that focusing on ``transactions
conducted within the United States'' would put brokers and investment
managers located in the United States at a competitive disadvantage to
their foreign counterparts, on the grounds that foreign clients would
avoid doing business with them to avoid having their transactions
become subject to Commission regulations.\113\ Another commenter,
although critical of our initially proposed definition as excessively
costly to implement, urged that any alternative to the conduct-based
test described in the Cross-Border Proposal Release be designed to
ensure that market participants from the United States were not put at
a competitive disadvantage.\114\
---------------------------------------------------------------------------
\113\ See IIB Letter at 8-9.
\114\ See SIFMA/FIA/FSR Letter at A-6.
---------------------------------------------------------------------------
(e) Other concerns
A few commenters, including some who expressed the concerns
outlined above, sought clarification or made suggestions related to
limiting the scope of the initially proposed defined term.\115\ One
commenter expressed support for the SEC's position in the proposal that
the location where a transaction is cleared should not factor into
determining whether a non-U.S. person qualifies as a security-based
swap dealer.\116\ Another commenter requested that, if the Commission
adopts the ``transaction conducted within the United States'' test,
market participants should be permitted to rely on their
counterparties' representations as to whether the transaction was
conducted within the United States.\117\
---------------------------------------------------------------------------
\115\ See IIB Letter at 9-11 (requesting clarification as to
what degree of solicitation, negotiation, or execution activity
would trigger the initially proposed definition); ESMA Letter at 2-3
(inviting the Commission to clarify which transactions between a
U.S. branch of a foreign firm would be considered ``conducted within
the United States'' and arguing that location of booking alone
should be considered); FOA Letter at 7 (suggesting that, if a
transaction has more than a de minimis connection to the United
States as a result of solicitation or negotiation in the United
States, the Commission should focus its regulatory authority on the
intermediary performing those activities); JSDA Letter at 3
(suggesting that the Commission limit the application of Title VII
to those transactions booked by non-U.S. persons with U.S. persons
and requesting that certain activity related to ``operational
activities'' be excluded from the activity covered by the initially
proposed definition); ABA Letter at 3-4 (supporting the initially
proposed definition but suggesting clarification that it excludes a
firm's centralized risk management and legal and compliance
functions).
\116\ See Letter from CME Group (``CME'') to SEC, dated August
21, 2013 (``CME Letter'') at 2 (citing Cross-Border Proposing
Release, 78 FR 31000).
\117\ See JSDA Letter at 4. Another commenter, however,
expressed concern about being able to obtain, and being able to
confirm the accuracy of, such representations. See MFA/AIMA Letter
at 4.
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3. The CFTC Staff Advisory and responses to the CFTC Request for
Comment
As already noted, in November 2013, subsequent to the close of the
comment period for our Cross-Border Proposing Release, CFTC staff
issued the CFTC Staff Advisory, which addressed activity by registered
swap dealers occurring within the United States.\118\ The CFTC Staff
Advisory stated the CFTC staff's belief that the CFTC ``has a strong
supervisory interest in swap dealing activities that occur within the
United States, regardless of the status of the counterparties'' and
that a non-U.S. swap dealer ``regularly using personnel or agents
located in the U.S. to arrange, negotiate, or execute a swap with a
non-U.S. person generally would be required to comply with'' the CFTC's
transaction-level requirements.\119\
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\118\ See CFTC Staff Advisory.
\119\ Id. at 2.
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As noted above, on January 8, 2014, the CFTC published the CFTC
Request for Comment on various aspects of the CFTC Staff Advisory,
including whether the CFTC ``should adopt the Staff Advisory as
Commission policy, in whole or in part.'' \120\ In response to this
request, the CFTC received approximately 20 comment letters addressing
various aspects of the CFTC Staff Advisory, including its relationship
to the CFTC Cross-Border Guidance and its general workability given
current market practices. CFTC staff subsequently extended no-action
relief related to the CFTC Staff Advisory until the earlier of
September 30, 2015, or the effective date of any CFTC action in
response to the CFTC Request for Comment.\121\ We understand that the
CFTC Staff Advisory and the related comment letters are currently under
review by the CFTC. Although the CFTC Staff Advisory raises issues that
are, to a certain degree, distinct from those raised by our initially
proposed definition and use of ``transaction conducted within the
United States,'' the comments received by the CFTC in response to the
CFTC Request for Comment in many cases elaborate on issues that
commenters raised in response to our Cross-Border Proposing Release.
Given similarities between the approach set forth in the CFTC Staff
Advisory and our proposed amendments identifying relevant conduct
within the United States, in this section we provide our own brief
[[Page 27462]]
summary of relevant comments received by the CFTC.\122\
---------------------------------------------------------------------------
\120\ See CFTC Request for Comment, 79 FR 1347.
\121\ See note 25, supra.
\122\ As reflected in our discussion throughout this release, we
have carefully considered both the CFTC Staff Advisory and the
comments submitted in response to the CFTC's request for comment on
the CFTC Staff Advisory in developing this proposal. Moreover, in
connection with our statutory obligation to consult with the CFTC in
connection with Title VII rulemaking, our staff have engaged in
extensive discussion with CFTC staff regarding our proposed rules.
We note, however, that our discussion of both the CFTC Staff
Advisory and the comments received by the CFTC about it reflects our
understanding of these documents. Accordingly, neither our
discussions of these documents nor any preliminary views expressed
herein should be interpreted as necessarily reflecting the views of
any other agency or regulator, including the CFTC.
---------------------------------------------------------------------------
A few commenters supported the CFTC Staff Advisory. One commenter
urged the CFTC to formally adopt the approach in the CFTC Staff
Advisory, arguing that any weakening of it would permit ``nominally
foreign entities'' to do business within the United States in
compliance with foreign laws and regulations, or potentially subject to
no legal requirements, rather than with U.S. law.\123\ Another
commenter stated that formal adoption of the CFTC Staff Advisory was
unnecessary but urged the CFTC to leave it undisturbed, arguing that
without the CFTC Staff Advisory, a U.S. person would effectively be
able to enter into transactions with non-U.S. persons through its
foreign affiliates while using U.S.-based trading operations, ``thereby
evading and gutting the key components of financial reform.'' \124\
---------------------------------------------------------------------------
\123\ See Letter from American for Financial Reform (``AFR'') to
CFTC, dated March 10, 2014 (``AFR Letter to CFTC'') at 3-4. See also
Letter from Institute for Agriculture and Trade Policy (``IATP'') to
CFTC, dated March 10, 2014 (``IATP Letter to CFTC'') at 1-2.
\124\ Letter from Better Markets to CFTC, dated March 10, 2014
(``Better Markets Letter to CFTC'') at 6.
---------------------------------------------------------------------------
Most commenters, however, opposed the approach taken in the CFTC
Staff Advisory. These commenters expressed several concerns that may
also be relevant to our own proposal to impose certain Title VII
requirements on security-based swap activity that is carried out from a
U.S. location, including the following: (1) the scope of the activity
that would trigger application of Title VII, (2) the workability and
costs of complying with such a test and resulting effects on
competition and comity, and (3) the CFTC's transaction-level
requirements that should be triggered by such a test. We will discuss
the first two sets of concerns here and the third in Section V below.
(a) Scope of the CFTC Staff Advisory
Several commenters argued that the scope and types of activity by
non-U.S. swap dealers captured by the CFTC Staff Advisory were unclear.
The CFTC Staff Advisory notes that ``persons regularly arranging,
negotiating, or executing swaps for or on behalf of [a swap dealer] are
performing core, front-office activities of that [swap dealer's]
dealing business.'' \125\ Accordingly, it expresses the CFTC staff's
view that the CFTC's transaction-level requirements apply to
transactions of registered non-U.S. swap dealers with non-U.S.-person
counterparties when they ``arrange, negotiate, or execute'' those
transactions ``using personnel or agents located in the U.S.'' \126\
Commenters argued that ``arrange'' and ``negotiate'' were overly broad
and could encompass activity that occurred only incidentally in the
United States.\127\ Some commenters also noted that the apparent scope
of the CFTC Staff Advisory was overly broad because non-U.S.-person
counterparties may not typically know where the dealer engages in
relevant conduct with respect to a particular swap transaction.\128\
---------------------------------------------------------------------------
\125\ CFTC Staff Advisory at 2.
\126\ Id.
\127\ See, e.g., Letter from Investment Adviser Association to
CFTC, dated March 10, 2014 (``IAA Letter to CFTC'') at 5;
Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to CFTC at 7-8
(arguing that key terms of CFTC Staff Advisory are ambiguous and do
not reflect how swap business is carried out). Some commenters also
raised concerns regarding ambiguity in the CFTC Staff Advisory's use
of the term ``regularly.'' See, e.g., Letter from Securities
Industry and Financial Markets Association/Futures Industry
Association/Financial Services Roundtable to CFTC, dated March 10,
2014 (``SIFMA/FIA/FSR Letter to CFTC'') at 16.
\128\ See, e.g., Letter from Soci[eacute]t[eacute]
G[eacute]n[eacute]rale to CFTC, dated March 10, 2014
(``Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to CFTC'') at
8 (stating that ``[m]ost clients have no control or knowledge over
where their swap is structured or designed, where the salesperson
responsible for a particular product is located, where the booking
of their swap is entered into a trading system, or where their swap
is hedged'').
---------------------------------------------------------------------------
Some commenters encouraged the CFTC to address these concerns by
providing ``detailed definitions'' of the relevant terms or to focus
only on execution or other discrete activities related to the
transaction.\129\ Several commenters urged the CFTC to abandon the CFTC
Staff Advisory's approach altogether, or, if not, to revise the CFTC
Staff Advisory's approach to focus on activities involving direct
communication with the counterparty to the swap.\130\
---------------------------------------------------------------------------
\129\ See, e.g., Letter from European Commission to CFTC,
received March 10, 2014 (``EC Letter to CFTC'') at 3. See also
SIFMA/FIA/FSR Letter to CFTC at A-8 to A-9; IAA Letter to CFTC at 5
(urging CFTC to focus on where the swap was executed or cleared).
\130\ See Letter from ISDA to CFTC, dated March 7, 2014 (``ISDA
Letter to CFTC'') at 8 n.16 (arguing that, if the CFTC determines to
adopt the CFTC Staff Advisory, it should limit triggering conduct
solely to ``direct communications by SD personnel located in the
United States with counterparties, which communications commit the
SD to the execution of a particular swap transaction''); Letter from
Barclays to CFTC, dated March 10, 2014 (``Barclays Letter to CFTC'')
at 4 (arguing that ``only direct communication with counterparties
by non-U.S. swap dealers to the execution of the transaction should
trigger application of the pre-trade disclosure requirements'' and
that ``the [CFTC] should explicitly exclude electronic or screen-
based execution'' as such conduct ``does not involve direct
interaction'' and the ``non-U.S. person counterparty will not know
who is responding on behalf of the non-U.S. swap dealer, let alone
the responder's location,'' meaning that ``the non-U.S. counterparty
will not have a reasonable expectation that the transaction may be
subject to protection under U.S. law''); SIFMA/FIA/FSR Letter to
CFTC at A-11 to A-12 (arguing that, if the CFTC decides to adopt the
approach in the CFTC Staff Advisory, it should capture only ``direct
communications by personnel in the United States with counterparties
that commit the SD to the execution of the transaction'' because,
absent direct communication, the counterparty has no reason to
expect that U.S. law will apply to the transaction). See also
Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to CFTC at 8
(stating that, if the CFTC does adopt the CFTC Staff Advisory, the
CFTC should focus only on salespersons based in the United States
that deal directly with clients).
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(b) Workability, Costs, and Competitive Effects of the CFTC's Activity-
Based Approach
Some commenters expressed concern that the CFTC Staff Advisory
reflected a significant departure from the approach that these
commenters understood to be the focus of the CFTC Cross-Border
Guidance.\131\ These commenters argued that developing systems
consistent with the CFTC Staff Advisory would cause them to incur
significant additional
[[Page 27463]]
costs.\132\ In particular, commenters stated their belief that
developing systems consistent with the CFTC Staff Advisory would
require a trade-by-trade analysis, which would be impracticable.\133\
One commenter argued that these costs would not be justified by
corresponding benefits because market participants likely would already
be subject to similar requirements in their home jurisdiction.\134\
---------------------------------------------------------------------------
\131\ See Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to
CFTC at 2 (explaining that market participants have already
developed systems to reflect the status-based approach); Letter from
Institute of International Bankers to CFTC, dated March 10, 2014
(``IIB Letter to CFTC'') at 2-3 (noting among other things that
market participants have built policies and systems to reflect their
view of the CFTC's approach in the CFTC Cross-Border Guidance and
that they believe the approach taken in the CFTC Staff Advisory is
fundamentally different); ISDA Letter to CFTC at 5 (arguing that
systems are not configured to identify personnel that are involved
in a transaction but rather to be consistent with the CFTC Cross-
Border Guidance, and that the CFTC Staff Advisory raises complex
questions about, e.g., portfolio margining); SIFMA/FIA/FSR Letter to
CFTC at A-2 (stating that the CFTC's approach in the CFTC Cross-
Border Guidance is already overbroad, and applying the CFTC Staff
Advisory on top of the entity-based approach is ``particularly
flawed,'' ``compound[ing] the excessive breadth and burden of the
existing, entity-based regulatory structure by approaching swaps
regulation from an entirely different direction, layering even more
requirements and burdens onto market participants, and doing so in
the absence of any discernible risk to U.S. markets'').
\132\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter to CFTC at 2.
\133\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter to CFTC at 8; SIFMA/FIA/FSR Letter to CFTC at A-4 (explaining
that the approach taken in the CFTC Staff Advisory is impracticable
in the swap market, as it would require a trade-by-trade analysis
that is not feasible and that requiring such trades to be fully
isolated from the United States would interfere with the operations
of these markets and market participants).
\134\ See IIB Letter to CFTC at 3.
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One commenter criticized the CFTC Staff Advisory's focus on whether
a registered non-U.S. swap dealer is arranging, negotiating, or
executing a swap using personnel or agents in the United States as
providing insufficient guidance to market participants, arguing that
these activities do not reflect current business practices among swap
dealers.\135\ For example, this commenter stated that some personnel of
a dealer may design swaps and hedging solutions but lack authority to
book the resulting swaps and have no interaction with clients; these
same personnel may book swaps that other employees have sold or
negotiated for risk mitigation purposes.\136\ The commenter further
noted that personnel involved in a particular swap may be located in
multiple jurisdictions.\137\
---------------------------------------------------------------------------
\135\ See Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to
CFTC at 8.
\136\ See id.
\137\ See id.
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Several commenters argued that the costs and impracticability of
the approach taken in the CFTC Staff Advisory would have competitive
effects, although they disagreed whether it would enhance or degrade
competition. One commenter supported the CFTC Staff Advisory in its
current form, noting that without it, U.S. firms would be at a
competitive disadvantage compared to non-U.S. firms operating in the
United States.\138\ Other commenters argued that the CFTC Staff
Advisory, if adopted, would have adverse competitive effects on certain
end users.\139\
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\138\ See AFR Letter to CFTC at 3 (explaining that ``any
weakening of [the] advisory would open the door to regular and
significant levels of swaps activities being performed within the
U.S. by nominally foreign entities under foreign rules, or in some
cases no rules at all,'' whereas U.S. firms operating in the United
States would be subject to different rules for the same transactions
operating in the same market).
\139\ See Letter from Coalition for Derivatives End-Users
(``CDEU'') to CFTC, dated March 10, 2014 (``CDEU Letter to CFTC'')
at 2 (arguing that the CFTC Staff Advisory would lead to competitive
disadvantages for certain non-U.S. end-user affiliates that had
relied on trading with non-U.S. swap dealers compared to other non-
U.S. end users in the same markets that currently hedge with
unregistered counterparties).
---------------------------------------------------------------------------
Some commenters also suggested that, if adopted by the CFTC, the
approach taken in the CFTC Staff Advisory could present difficulties
for, and impose costs on, non-U.S.-person counterparties of dealers, as
such counterparties may not currently have systems in place for
complying with certain CFTC requirements, particularly if they are
imposed only because the swap dealer (and not the counterparty) happens
to have carried out certain activities using personnel or agents
located in the United States.\140\ As a result, commenters argued non-
U.S. swap dealers may no longer service non-U.S.-person counterparties
from U.S. locations.\141\
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\140\ See, e.g., SIFMA/FIA/FSR Letter to CFTC at A-4 (explaining
that certain non-U.S.-person counterparties may not have a clearing
relationship with a futures commission merchant (``FCM''), and
requiring them to clear through an FCM simply because the dealer
happens to use personnel within the United States in the transaction
will be costly).
\141\ See ISDA Letter to CFTC at 4.
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Commenters suggested that pressure from non-U.S.-person
counterparties that do not want their transactions to be subject to
Title VII would lead at least some non-U.S.-person dealers to exit the
United States.\142\ Commenters suggested that the adoption of the CFTC
Staff Advisory would likely interfere with the ability of certain swap
dealers to cover U.S. market hours for foreign counterparties with
U.S.-based personnel, increasing costs to counterparties and end
users.\143\
---------------------------------------------------------------------------
\142\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter to CFTC at 8 (stating that, if the CFTC adopts the CFTC Staff
Advisory, or even an alternative suggested by the commenter, swap
dealers ``will move personnel currently based in the United States
offshore'').
\143\ See, e.g., Letter from Paul Hunter for the Japan Financial
Markets Council to CFTC, dated March 4, 2014 (``JFMC Letter to
CFTC'') at 1-2 (explaining that the approach in the CFTC Staff
Advisory ``unfairly precludes options open to Asia-based Swap
Dealers to cover U.S. market hours and service their non-U.S. based
clients by using U.S.-based personnel or agents''); CDEU Letter to
CFTC at 2-3 (arguing that the CFTC Staff Advisory's approach would
``force non-U.S. [swap dealers] that use personnel or agents to
`arrange, negotiate, or execute' swaps to exit certain markets or
move personnel outside the U.S. in order to remain competitive in
non-U.S. markets[,]'' and that the costs associated with such
movements would ``undoubtedly be passed on to derivatives end-users
and ultimately to customers . . . [which] would result in a loss of
liquidity that will leave non-U.S. end-user affiliates scrambling to
find counterparties to hedge their risks''). See also SIFMA/FIA/FSR
Letter to CFTC at A-6 (explaining that the desire of counterparties
to swap dealers to keep their transactions out of the reach of Dodd-
Frank will lead them to pressure non-U.S.-person dealers and foreign
branches to move personnel out of the United States); IAA Letter to
CFTC at 3 (explaining that non-U.S.-person dealers may incur
expenses associated with moving personnel out of the United States
or hiring personnel in other jurisdictions, which may potentially
lead to increased transaction costs and reduced services for
advisers' non-U.S. clients, and that these higher costs may drive
non-U.S. clients away from U.S. investment advisers).
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4. Dealing Activity of Non-U.S. Persons in the United States
We have carefully considered the views of commenters, as discussed
above, that dealing activity carried out in the United States by a non-
U.S. person with a counterparty that is also a non-U.S. person lacks a
significant nexus to the United States and does not raise any
significant regulatory concerns in the United States because the
ongoing obligations associated with such transactions do not reside in
the United States.\144\ However, as we discuss below, we continue to
believe that such activity falls squarely within our territorial
approach to the application of Title VII \145\ and that it raises
regulatory concerns of the type that Title VII addresses.
---------------------------------------------------------------------------
\144\ See note 103, supra (identifying comment letters arguing
that such transactions pose no risk to the United States or that the
Commission lacks a regulatory interest in such transactions).
\145\ See Cross-Border Proposing Release, 78 FR 30986; Cross-
Border Adopting Release, 79 FR 47290.
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(a) Overview of Common Business Structures for Firms Engaged in
Security-Based Swap Dealing Activity
As we noted in our Cross-Border Proposing Release, financial groups
engaged in security-based swap dealing activity use a variety of
business models and legal structures to carry out such activity with
counterparties around the world. Most such financial groups operate in
multiple jurisdictions, and they will typically have one or more dealer
affiliates in one or more jurisdictions that book the security-based
swap transactions related to their security-based swap dealing
business. An affiliate that initially books a transaction may retain
the risk associated with that transaction, or it may lay off that risk
to another affiliate via a back-to-back transaction or an assignment of
the security-based swap.\146\ These decisions generally reflect the
financial group's consideration of, among other things, how it may most
efficiently manage the risks associated with its security-based swap
positions.
---------------------------------------------------------------------------
\146\ See Cross-Border Proposing Release, 78 FR 30977-978.
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[[Page 27464]]
The structure of the group's market-facing activities that generate
the transactions booked in these affiliates often reflects different
considerations. A dealing affiliate established in one jurisdiction may
operate offices (which may serve sales or trading functions) in one or
more other jurisdictions 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,
even when a counterparty's home financial markets are closed. A dealer
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 to 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. We understand that a financial group that engages in a
dealing business may have business lines that are carried out in a
number of affiliates located in different jurisdictions, and that
personnel of an affiliate may operate under the direction of, or in
some cases, report to personnel of another affiliate within the group;
in some cases, such personnel work on behalf of, or under the
supervision of, more than one affiliate in the group.
Moreover, a dealer may carry out these 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 dealer may determine that another
affiliate in the financial group employs personnel who possess
expertise in relevant products or that 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.
Alternatively, the dealer may in some circumstances determine to
engage the services of an unaffiliated agent through which it can
engage in dealing activity. For example, a dealer may determine that
using an inter-dealer broker may provide an efficient means of
participating in the inter-dealer 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.\147\
Dealers may also use unaffiliated agents that operate at the direction
or request of the dealer to engage in dealing activity. Such
arrangement may be particularly valuable in enabling the dealer to
service clients or access liquidity in jurisdictions in which the
dealer or its affiliates have no security-based swap operations of
their own.
---------------------------------------------------------------------------
\147\ We understand that inter-dealer 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 inter-dealer
brokers also may play a particularly important role in facilitating
transactions in less-liquid security-based swaps.
---------------------------------------------------------------------------
We understand that dealers established in foreign jurisdictions
(whether affiliated with U.S.-based financial groups or not) 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. and non-U.S.-person
counterparties. In transactions with non-U.S.-person counterparties, a
foreign dealer may affirmatively seek to engage in dealing activity in
the United States because the sales personnel of the foreign 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 foreign 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. And we
understand that some foreign dealers 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. In some cases, such as
when seeking to transact with other dealers through an inter-dealer
broker, a foreign dealer may act, in a dealing capacity, in the United
States through an unaffiliated, third-party agent.
(b) Statutory Scope and Policy Concerns Arising From Security-Based
Swap Dealing Activity in the United States
As discussed above, some commenters have suggested that the Title
VII statutory framework does not extend to transactions between two
non-U.S. persons, even if security-based swap activity occurs in the
United States, and have argued that section 30(c) of the Exchange Act
limits our authority to reach this conduct.\148\ We continue to
believe, however, that it is consistent with the Exchange Act to impose
specific Title VII requirements on non-U.S. persons that engage in
activity within the United States that is regulated by the relevant
statutory provision.\149\
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\148\ See note 103, supra.
\149\ See Cross-Border Adopting Release, 79 FR 47287. As we
noted 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 id.
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In the Cross-Border Adopting release, we described how this
approach applies in the specific context of the definition of
``security-based swap dealer.'' We rejected the view 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.\150\ In doing so, we noted 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.'' \151\
---------------------------------------------------------------------------
\150\ Id. at 47287-88.
\151\ Id. at 47288. We have also noted 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.
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Instead, the statute 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.\152\ 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 inter-dealer brokers.\153\
Neither the statutory definition of ``security-based
[[Page 27465]]
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.\154\
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\152\ See Exchange Act section 3(a)(71)(A), 15 U.S.C.
78c(a)(71)(A).
\153\ See Intermediary Definitions Adopting Release, 77 FR
30617-18.
\154\ See Exchange Act section 3(a)(71)(A), 15 U.S.C.
78c(a)(71)(A); Intermediary Definitions Adopting Release, 77 FR
30617-18.
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Accordingly, the fact that the counterparty credit risk from a
transaction between two non-U.S. persons, 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. The appropriate analysis, in our view,
is 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.'' If it is so engaged, in our view, it is appropriate under a
territorial approach to require the non-U.S. person to include such
transaction in its security-based swap dealer de minimis threshold
calculations and, if those security-based swaps (and 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.\155\
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\155\ See Cross-Border Adopting Release, 79 FR 47286-92
(describing the Commission's territorial approach). We note that
another commenter argued that it was inappropriate to use activity
in the United States to trigger application of Title VII absent an
international agreement between regulators. See note 103, supra. As
discussed above, we have continued to consult and coordinate with
other regulators in the United States and abroad in connection with
financial market reforms, see note 12 and accompanying discussion,
but we do not believe that an international agreement is relevant as
a legal or policy matter in determining whether to impose Title VII
requirements on security-based swap activity, particularly given
that we are proposing to do so with respect to activity that is
being carried out in the United States.
---------------------------------------------------------------------------
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-based swap dealers'') in
the United States using its own personnel or using the personnel of an
agent acting on its behalf. As described above, persons engaged in
security-based swap dealing activity routinely do so both directly and
through their agents. Indeed, our further definition of ``security-
based swap dealer'' specifically identifies the use of inter-dealer
brokers as one of several indicia of security-based swap dealing
activity,\156\ and, in our preliminary view, engaging an inter-dealer
broker as agent or sending a trade to such a broker generally would be
dealing activity; to the extent that this activity is directed to a
broker in the United States, we preliminarily believe that the non-U.S.
person would be 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 inter-dealer broker) to perform dealing
activity on its behalf is itself engaged, at least in part, in dealing
activity in the United States. We preliminarily believe that it is
appropriate under a territorial approach to require the non-U.S. person
to include transactions arising out of those activities in its own de
minimis threshold calculations.
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\156\ See Intermediary Definitions Adopting Release, 77 FR
30617-18 (further defining ``security-based swap dealer'').
\157\ More generally, we note that the routine use by dealers of
the structures described in this discussion suggest that a person
may engage in dealing activity through an agent in a manner very
similar to such activity carried out 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'').
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Finally, in light of the foregoing analysis, we note 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 these
proposed rules.\158\ Our proposed approach, as described in further
detail below, would require transactions to be included in a non-U.S.
person's 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.\159\ Because we are focusing in
this proposal solely on transactions in which the non-U.S. person is
engaged, directly or indirectly, in dealing activity in the United
States, the proposed rules 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).\160\ Accordingly, because such activities occur within the
United States, they, and any resulting transaction, are within the
scope of Title VII.
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\158\ See Exchange Act section 30(c).
\159\ See Exchange Act rule 3a71-3(a)(1).
\160\ As noted above, we do not believe that our proposed
approach applies 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. An approach that, for example, 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 (for example, because using a U.S. agent allowed it
to leverage higher liquidity and lower spreads in U.S. reference
entities) as transacting a business in security-based swaps without
the jurisdiction of the United States, would, in our view, reflect
an understanding of what it means to conduct a security-based swaps
business within the jurisdiction of the United States that is
divorced both 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 preliminarily
believe that this proposed rule is necessary or appropriate as a
prophylactic measure to help prevent the evasion of the provisions
of the Exchange Act that were added by 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. Permitting this activity would
allow these firms to retain full access to the benefits of operating
in the United States while avoiding compliance with, for example,
recordkeeping and reporting requirements and Regulation SBSR, which
could reduce transparency in the U.S. market and make it
considerably more difficult for the Commission to monitor the market
for manipulation or other abusive practices.
---------------------------------------------------------------------------
Moreover, we preliminarily believe that requiring these
transactions to be included in a non-U.S. person's dealer de minimis
threshold calculations (and subjecting them to certain other Title VII
requirements, as discussed below) is consistent with the regulatory
objectives furthered by the relevant Title VII requirements. Under the
rules we adopted in the Cross-Border Adopting Release, financial groups
may seek to avoid application of Title VII requirements to their
security-based swap dealing activity with non-U.S. persons (including
with other dealers), even though they continue to carry out day-to-day
sales and trading operations in the United States in a manner largely
unchanged from what we understand to be current business
practices.\161\ For market participants, avoiding Title VII in such
transactions in the absence of these proposed rules would require them
only to book any such transactions in non-U.S. person dealers whose
obligations under such swaps are not guaranteed by a U.S. person. Doing
so would allow them to perform any other activities in connection with
the transaction in the United States without complying with Title VII
requirements.
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\161\ We understand that there may be significant advantages in
continuing to carry out certain market-facing activities using
personnel located in the United States, depending on the location of
the counterparty and the nature of the reference security or entity.
For example, market expertise in security-based swaps on U.S.
reference entities may be located primarily in the United States,
and relationships with counterparties in certain geographical
regions may be managed out of a U.S. branch or office. See Section
III.B.4(a), supra.
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[[Page 27466]]
Such a reaction could result in a significant amount of security-
based swap dealing activity continuing to be engaged in by personnel
located in a U.S. branch or office,\162\ but, because the financial
group chooses to book the transactions in a non-U.S.-person affiliate
whose obligations under a security-based swap are not guaranteed by a
U.S. person, certain Title VII requirements may not apply to such
dealing activity. A dealer could continue to transact security-based
swaps with other dealers (and with non-U.S. persons that are not
dealers) through a U.S. sales and trading desk that is staffed by its
own personnel or the personnel of its agent, continuing to engage in
market-facing activity in the United States without complying with any
Title VII requirements.
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\162\ This dealing activity likely would constitute inter-dealer
activity, which, as noted above, accounts for a majority of activity
in the security-based swap market. See Section II.B.2, supra. To the
extent that there are advantages to trading U.S. reference entities
from a U.S. location, activity by personnel located in the United
States may account for a significant proportion of the inter-dealer
business on those reference entities.
---------------------------------------------------------------------------
Although such transactions may not give rise to counterparty-credit
risk within the United States, they do raise other regulatory concerns,
particularly when a firm is engaged in such activity at levels above
the dealer de minimis thresholds. We note that significant levels of
security-based swap dealing activity occurring within the United States
without being subject to dealer regulation or Regulation SBSR may pose
a risk to the integrity of the U.S. financial market, as the absence of
regulation--and of access, for example, to the security-based swap
dealer's books and records--may make it significantly more difficult
for the Commission to monitor the market for abusive and manipulative
practices connected with security-based swap activity in the United
States. As we have noted elsewhere, Title VII recordkeeping
requirements will likely be the Commission's primary tool in monitoring
compliance with applicable securities laws, including the antifraud
provisions of these laws.\163\ To the extent that we do not have access
to reports of such transactions available through registered SDRs or to
the books and records of non-U.S.-person dealers using personnel
located in a U.S. branch or office, manipulative or abusive trading
practices within the United States are more likely to go undetected,
which may undermine the integrity of the security-based swap market in
the United States, and of the U.S. financial market more
generally.\164\ For example, a dealer using personnel located in a U.S.
branch or office may employ a trader who engages in trading practices
in connection with security-based swap transactions that render the
dealing activity in the United States abusive or manipulative, but we
may not be able to readily identify the abusive or manipulative nature
of that dealing activity without access to the dealer's books and
records.\165\ Detecting misconduct may be particularly challenging if a
significant proportion of transactions in the relevant security-based
swaps are carried out in the United States by traders employed by
unregistered dealers.
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\163\ See Requirements for Security-Based Swap Dealers, Major
Security-Based Swap Participants, and Broker-Dealers; Capital Rule
for Certain SBSDs; Proposed Rules, Exchange Act Release No. 71958
(April 17, 2014), 79 FR 25194, 25199 (May 2, 2014) (citing
Commission Guidance to Broker-Dealers on the Use of Electronic
Storage Media under the Electronic Signatures in Global and National
Commerce Act of 2000 with Respect to Rule 17a-4(f), Exchange Act
Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001); Books
and Records Requirements for Brokers and Dealers Under the
Securities Exchange Act of 1934, Exchange Act Release No. 44992
(October 26, 2001), 66 FR 55818 (November 2, 2001)).
\164\ These concerns may arise whether the dealer is using its
own personnel or personnel of an affiliated or unaffiliated agent.
For example, a security-based swap dealer may provide its agent's
personnel located in a U.S. branch or office with false or
misleading information concerning the transaction, which the agent's
personnel then may deliver to the counterparty.
\165\ A registered security-based swap dealer that is engaged in
abusive or manipulative conduct with respect to a series of
transactions may lay off risk from a transaction with a U.S. person
counterparty to a foreign unregistered dealer via an affiliated
foreign unregistered dealer, using personnel located in a U.S.
branch or office. This conduct may not be apparent from the U.S.
counterparty-facing leg or the inter-affiliate leg. Thus, even if
the affiliated or unaffiliated agent has independent obligations
arising from its role in the transaction, these obligations may not
address potential abusive or manipulative practices in the
transactions. Moreover, detecting such misconduct on the part of the
affiliated foreign unregistered dealer, as discussed above, may be
difficult absent access to regulatory reports of the relevant
transactions and to the books and records of such dealer.
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Moreover, these dealers could continue to trade--using U.S. sales
and trading desks, and potentially the same sales and trading desks
used by their registered security-based swap dealer affiliates--in the
inter-dealer market in a manner that may be opaque to regulators and
non-dealers alike. This risk, in our preliminary view, is particularly
high given that, as we have noted, inter-dealer activity accounts for a
significant proportion of all security-based swap activity. This
activity, to the extent it is carried out by personnel located in the
United States, should be subject to relevant regulatory requirements.
Subjecting such transactions to Regulation SBSR and potentially
requiring firms engaged in such activity to register as security-based
swap dealers should bring additional transparency to what is likely to
be a significant proportion of the security-based swap activity that
occurs in the United States and provide market participants more
confidence in the integrity of the market.
In light of these concerns, we preliminarily believe that it is
appropriate to propose rules that would impose certain Title VII
requirements on dealers using personnel located in the United States to
engage in security-based swap dealing activity.
5. Proposed Amendments Regarding 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 have carefully considered the proposed application of the dealer
de minimis exception to ``transactions conducted within the United
States'' in light of comments received on the proposal, subsequent
regulatory and other developments in the security-based swap market,
and the policy concerns described in the preceding section. As a
result, we are proposing an amendment to Exchange Act rule 3a71-3 that
should address the regulatory concerns raised by dealing activity
carried out using personnel located in the United States while
mitigating many of the concerns expressed by commenters. Under this
modified approach, we focus on market-facing activity by personnel
located in the United States that reflects, in our view, a dealer's
determination to engage in dealing activity in the United States in a
manner that warrants, if the dealer exceeds the security-based swap
dealer de minimis thresholds, application of Title VII security-based
swap dealer regulation.
Unlike the initial proposal, which included the defined term
``transaction conducted within the United States,'' the proposed
amendment would not include a separate defined term identifying such
activity. Rather, we propose to amend Exchange Act rule 3a71-
3(b)(1)(iii) to require 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
[[Page 27467]]
located in a U.S. branch or office.\166\ To the extent that a non-U.S.
person, in connection with its dealing activity, engages in market-
facing activity using personnel located in the United States, we
preliminarily believe that it is reasonable to conclude that the person
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.\167\
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\166\ See proposed Exchange Act rule 3a71-3(b)(1)(iii)(C).
Because, as a threshold matter, a person would be required to
include in its de minimis calculations only security-based swaps
that are arranged, negotiated, or executed in connection with its
dealing activity, a non-U.S. person would not be required to include
in this calculation transactions solely on the basis that they were
submitted for clearing 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 Cross-
Border Proposing Release, 78 FR 31000.
\167\ 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. As noted above, 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. persons if it is a conduit affiliate or
if its counterparty has a right of recourse against a U.S. person
under the security-based swap, even if it 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). Nothing in the proposed
amendment to Exchange Act rule 3a71-3 should be construed to affect
any person's obligations created by any of these previously adopted
rules.
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This proposed amendment reflects our reconsideration of the issues
raised by security-based swap dealing activity involving two non-U.S.
persons in which one or both parties, or the agents of one or both
parties, using personnel located in the United States, engage in some
dealing activity.\168\ We preliminarily 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
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.\169\
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\168\ As noted above, some commenters argued that transactions
between two non-U.S. persons do not create risk within the United
States and should therefore not be subject to Title VII. See note
103, supra. As we have discussed above, however, even if such
transactions do not raise counterparty credit risk in the United
States, such transactions raise concerns about the integrity and
transparency of the U.S. financial market. See discussion in Section
III.B.4, supra (citing and responding to comment letters making this
argument).
\169\ We note that some commenters urged us to abandon an
activity-based approach entirely because, in their view, the CFTC
had not adopted such an approach and, diverging from the CFTC by
imposing such an approach on security-based swap transactions would
result in significant additional costs for market participants. See
note 111, supra. As noted above, however, although the CFTC has not
finalized its view on such an approach, the CFTC Staff Advisory
provided the CFTC staff view that non-U.S. swap dealers should
comply with certain requirements with respect to swap transactions
arranged, negotiated, or executed in the United States. See note 21,
supra, and accompanying discussion. Although the CFTC Staff Advisory
does not appear to address inclusion of swaps arranged, negotiated,
or executed in the United States in the dealer de minimis
calculations of non-U.S. persons, the test set forth in proposed
Exchange Act rule 3a71-3(b)(1)(iii)(C) is similar to the approach
suggested by the CFTC Staff Advisory for determining the
applicability of certain transaction-level requirements. See Section
III.B.3, supra.
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At the same time, this proposed approach is intended to avoid
unnecessary costs and complexity that may make it difficult for market
participants to comply with such requirements. We recognize 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. As some commenters noted, the initially proposed
definition of ``transaction conducted within the United States'' was
sufficiently broad that it might have encompassed conduct within the
United States by either counterparty to the transaction that could be
characterized as ``incidental.'' \170\ In addition, market participants
may have incurred costs associated with monitoring the location of
relevant personnel acting on behalf of their counterparty and/or
obtaining relevant representations from their counterparty on a
transaction-by-transaction basis, potentially increasing compliance
costs significantly.\171\ We preliminarily believe that our proposed
approach of focusing solely on whether the non-U.S. person engaged in
dealing activity is using personnel located in the United States to
arrange, negotiate, or execute the security-based swap would address
these concerns in a more workable manner. Consistent with this focus on
the location of activity carried out by the personnel of the dealer or
of its agent, the non-U.S. person engaged in dealing activity would not
be required to consider the location of its counterparty's operations
(or that of the counterparty's agent) in determining whether the
transaction should be included in its own de minimis calculation.
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\170\ See note 104, supra (citing comments expressing concern
that the initially proposed definition of ``transaction conducted
within the United States'' would capture incidental conduct within
the United States).
\171\ See notes 108-110, supra.
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In the following subsections, we describe key elements of the
proposed amendment to Exchange Act rule 3a71-3(b)(1)(iii), and address
comments of particular relevance with respect to each element.
(a) ``Arranging, Negotiating, or Executing'' a Security-Based Swap
Transaction
Proposed rule 3a71-3(b)(1)(iii)(C) would apply 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 proposed approach,
accordingly, would reach a narrower range of activity than did the
initially proposed rules that included the term ``transaction conducted
within the United States,'' which would have included any transaction
solicited, negotiated, executed, or booked, by either party, within the
United States.\172\
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\172\ 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
30999-00.
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Consistent with our explanation for initially proposing the term
``transaction conducted within the United States,'' we intend, for
purposes of the proposed rule, ``arrange'' and ``negotiate'' to
indicate market-facing activity of sales or trading personnel in
connection with a particular transaction, including interactions with
counterparties or their agents.\173\ Also for purposes of the
[[Page 27468]]
proposed rule, we intend ``execute'' to refer 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. ``Arranging,'' ``negotiating,'' and ``executing'' also include
directing other personnel to arrange, negotiate, or execute a
particular security-based swap.\174\
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\173\ See Cross-Border Proposing Release, 78 FR 31000 (noting
that ``dealing activity is normally carried out through interactions
with counterparties or potential counterparties that include
solicitation, negotiation, execution, or booking of a security-based
swap'').
Consistent with the approach taken to the final definition of
``transaction conducted through a foreign branch'' adopted in the
Cross-Border Adopting Release, the proposed 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 Cross-Border Adopting Release, 79 FR 47322
n.381; 15 U.S.C. 78c(a)(71)(A)(iv). Similarly, the proposed
amendment omits reference to where a transaction is booked because,
in determining whether dealing activity involving two non-U.S.-
person counterparties occurs within the United States, we
preliminarily believe it is appropriate to focus on the location of
the market-facing activity of personnel arranging, negotiating, or
executing the security-based swap on behalf of a non-U.S. person in
connection with its security-based swap dealing activity, as it is
the market-facing activity that raises the types of concerns
described above. Cf. note 115, supra. If the transaction is booked
in a U.S. person, of course, 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. See Exchange Act rule 3a71-
3(b)(1)(i).
\174\ In other words, sales and trading personnel of a non-U.S.
person who are located in the United States cannot simply direct
other personnel in carrying out dealing activity that those
personnel would otherwise carry out were those personnel not
attempting to avoid application of this rule.
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We recognize that several commenters expressed concern about the
terms used in our proposed definition of ``transaction conducted within
the United States'' \175\ and criticized the use of the terms
``arrange, negotiate, or execute'' in the CFTC Staff Advisory,\176\
objecting to those terms both as ambiguous and as not reflective of how
swap dealing activity is actually carried out by market participants,
and therefore as unworkable on a trade-by-trade basis.\177\ In
response, we clarify that under this proposed amendment, we do not
intend market participants to look beyond those personnel who are
involved in, or directing, market-facing activity in connection with a
particular security-based swap. This should enable market participants
to identify the location of relevant activity more efficiently than a
test that would require market participants to categorize personnel
according to their functions. The proposed amendment would require such
market participants to focus on whether sales or trading personnel
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.\178\ 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) would not fall within the scope of the proposed
amendment.\179\ Accordingly, preparing 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, also would not be encompassed by the proposed
approach. We preliminarily believe that activities in the United States
that do not involve the arrangement or negotiation of the economic
terms of a specific transaction are unlikely to raise the types of
concerns addressed by the Title VII requirements that we are proposing
to apply to such transactions.\180\ Consistent with customary
Commission practice, we expect that Commission staff will monitor the
practices of market participants as they develop under any final rules
that we adopt and, if necessary and appropriate, make recommendations
to address such developments.
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\175\ See note 115, supra.
\176\ See, e.g., notes 127 and 129, supra.
\177\ See notes 127 and 129, supra. See also notes 107, 112, and
135, supra.
\178\ One commenter urged the CFTC to exclude from Title VII
requirements any transaction executed electronically. See note 130,
supra (citing Barclays Letter to CFTC). However, we do not think
that such an exclusion would be appropriate under our proposed
approach given its focus on, among other things, the location of
personnel executing the transaction on behalf of the non-U.S.
person. To the extent that a non-U.S. person is using personnel
located in the United States to execute a security-based swap
transaction, that transaction raises regulatory concerns that, at
sufficient volumes, warrant regulation under Title VII. In
particular, we note that electronic execution does not eliminate
concerns about abusive or manipulative conduct. See also Section
III.C, infra (discussing proposal to make exception for cleared
anonymous transactions unavailable for security-based swaps
arranged, negotiated, or executed by personnel located in the United
States).
\179\ See note 104, supra (citing IIB Letter arguing that
ministerial or clerical activity in the United States should not
trigger application of Title VII). On the other hand, to the extent
that personnel located in a U.S. branch or office engages in market-
facing activity normally associated with sales and trading, the
location of that personnel would be relevant, even if the personnel
are not formally designated as sales persons or traders.
\180\ Similarly, a transaction would not be captured under the
proposed amendment merely because a U.S.-based attorney is involved
in negotiations regarding the terms of the transaction.
We also are not proposing to include either submitting a
transaction for clearing in the United States or reporting a
transaction to an SDR in the United States as activity that would
cause a transaction to be arranged, negotiated, or executed by
personnel located in the United States under the proposed rule, nor
are we proposing to treat activities related to collateral
management (e.g., exchange of margin payments) that may occur in the
United States or involve U.S. banks or custodians as activity
conducted within the United States for these purposes. We recognize
that submission of a transaction for clearing to a CCP located in
the United States poses risk to the U.S. financial system, and
collateral management plays a vital role in an entity's financial
responsibility program and risk management. However, we
preliminarily believe that none of these activities, by themselves,
would raise the types of concerns associated with dealing activity.
See Cross-Border Proposing Release, 78 FR 31000. Cf. note 116, supra
(citing comment letter urging that application of Title VII not be
triggered by the location at which a transaction is cleared).
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We preliminarily believe that our proposed amendment should
considerably mitigate concerns raised by commenters regarding the scope
and workability of an activity-based test for application of Title VII
requirements.\181\ Because the proposed amendment requires a non-U.S.
person to include a security-based swap in its de minimis calculation
based solely on where it (and not its counterparty) arranges,
negotiates, or executes the security-based swap, a non-U.S. person that
is acting in a dealing capacity in a particular transaction would need
to identify the location of its personnel (or that of its agent's
personnel) involved in market-facing activity with respect to the
transaction, but not the location of its counterparty.\182\
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\181\ See, e.g., notes 108-110 and 115, supra.
\182\ One commenter supported the initially proposed term
``transaction conducted within the United States'' in part because
the commenter believed that it would help capture offshore funds
with a ``U.S. nexus,'' given that it would have encompassed all
security-based swap trading activity carried out by investment
managers within the United States. See note 26, supra (citing
Citadel Letter). Under the narrower scope of activity captured in
our proposed amendment, such activity of a person not engaged in
dealing activity would not require the transaction to be included in
the de minimis threshold calculation of its dealer counterparty. We
note, however, that our rule defining ``principal place of business
in the United States'' as applied to externally managed investment
vehicles should help ensure that those funds whose security-based
swap activities may pose risks to U.S. financial institutions, even
when transacting with non-U.S. dealers, are treated as U.S. persons.
See Exchange Act rule 3a71-3(a)(4)(ii); Cross-Border Adopting
Release, 79 FR 47310.
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Some commenters urged that an activity-based test, if implemented,
should look only to where the relevant transaction was executed, or
where the dealer's personnel committed the dealer to the trade.\183\
Although we recognize that focusing solely on where a security-based
swap was executed (and not where it was arranged or negotiated) may
meaningfully reduce certain costs associated with the proposed
[[Page 27469]]
amendment, we preliminarily believe that looking solely to the location
of execution could permit non-U.S. persons engaged in security-based
swap dealing activity using personnel located in a U.S. branch or
office to avoid falling within the definition of ``security-based swap
dealer'' simply by ensuring that execution is performed by personnel
located outside the United States, even if the non-U.S. person uses
personnel located in a U.S. branch or office to perform all other key
aspects of its dealing activity. We also note that the ``security-based
swap dealer'' definition encompasses a number of activities, including
holding oneself out as a dealer or market-making,\184\ which suggests
that it is appropriate to focus on the location of a wider range of
market-facing activity.
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\183\ See notes 129-130, supra.
\184\ See Exchange Act section 3(a)(71)(A)(ii); Intermediary
Definitions Adopting Release, 77 FR 30617-18.
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(b) ``Located in a U.S. Branch or Office''
Proposed rule 3a71-3(b)(1)(iii)(C) would apply 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.\185\ This element of the proposed amendment
should mitigate the likelihood, noted by several commenters,\186\ that
a non-U.S.-person dealer would be required to include in its de minimis
calculations transactions that involve activity by personnel of the
non-U.S. person or personnel of its agent who are not assigned to a
U.S. branch or office, but instead are only incidentally present in the
United States when they arrange, negotiate, or execute the transaction.
The proposed amendment generally would not require a non-U.S. person to
consider activity of personnel who are not located in a U.S. branch or
office, such as participation in negotiations of the terms of a
security-based swap by an employee of the dealer assigned to a foreign
office who happens to be traveling within the United States.\187\ We
preliminarily believe that this type of activity is incidental and
therefore not likely to raise the concerns that the proposed approach
is intended to address to the same degree as dealing activity carried
out by personnel who are located in a U.S. branch or office.\188\
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\185\ As noted above, however, if personnel located in a non-
U.S. branch or office are arranging, negotiating, or executing a
particular security-based swap at the specific direction (i.e.,
engaging in dealing activity of the U.S. person that the U.S. person
would carry out itself were it not attempting to avoid Title VII) of
personnel located in a U.S. branch or office, we would view that
transaction as having been arranged, negotiated, or executed by the
personnel located in the United States. See note 174 and
accompanying text, supra.
\186\ See note 104, supra (citing comments expressing concern
that the initially proposed definition of ``transaction conducted
within the United States'' would capture incidental conduct within
the United States).
\187\ Because proposed Exchange Act rule 3a71-3(b)(1)(iii)(C)
applies only to the security-based swap dealing activity, it does
not limit, alter, or address any guidance regarding our views or
interpretation of any similar provisions of the federal securities
laws, including those applicable to brokers or dealers under the
Exchange Act, or investment advisers under the Investment Advisers
Act of 1940, Commission rules, regulations, interpretations, or
guidance.
\188\ See Section III.B.4, supra.
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The proposed amendment would, however, not exclude 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 to respond to inquiries from a non-
U.S.-person counterparty outside business hours in the counterparty's
jurisdiction. We preliminarily 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 is
likely to raise Title VII concerns, regardless of either counterparty's
motivations for entering into the transaction.\189\ Accordingly, we
preliminarily do not believe that it would be appropriate to exclude
from the de minimis calculation transactions arising from such activity
by personnel located in a U.S. branch or office because their
assignment to a U.S. branch or office suggests that the presence of
such personnel in the United States is not ``incidental.''
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\189\ One commenter described these transactions as being
carried out on an ``exception basis.'' See IIB Letter to CFTC at 12.
See also note 143, supra. Other commenters urged us not to use
``incidental'' activity in the United States to trigger application
of Title VII or suggested that we establish a materiality threshold.
See note 104, supra (citing MFA/AIMA Letter and SIFMA/FIA/FSR
Letter).
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We preliminarily believe that this element of the proposed
amendment 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.\190\ We acknowledge that the proposed
amendment 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 proposed amendment 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.\191\ Alternatively, such non-U.S. person may establish
policies and procedures that would facilitate compliance with this
proposed amendment by requiring transactions connected with its dealing
activity to be arranged, negotiated, and executed by personnel located
outside the United States.\192\
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\190\ See notes 108-110, and 133-134, supra.
\191\ We preliminarily 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.
\192\ In addition, we note that some market participants engaged
in both swap dealing and security-based swap dealing activity may
perform a similar analysis consistent with CFTC Staff Advisory,
which clarifies 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 notes 21 and
169, supra, and accompanying discussion.
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(c) ``Personnel of Such Non-U.S. Person'' or ``Personnel of an Agent''
Proposed 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 the United States, 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.\193\ We
[[Page 27470]]
preliminarily believe that dealing activity carried out within the
United States by a non-U.S. person is likely to raise the concerns that
the proposed approach is intended to address,\194\ 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.\195\ Accordingly, we are proposing
to require non-U.S. persons to include in their de minimis calculations
any transactions in connection with their security-based swap dealing
activity that are arranged, negotiated, or executed by personnel of
such persons located in a U.S. branch or office, or by personnel of its
agent located in a U.S. branch or office.\196\
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\193\ For purposes of proposed rule 3a71-3(b)(1)(iii)(C), we
would 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 would
expect to examine whether a particular entity is able to control or
supervise the actions of an individual when determining whether such
person 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 (Dec. 10, 2013), 59 FR 5535, 5591 (Jan. 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).
\194\ See Section III.B.4, supra.
\195\ We preliminarily believe that it is appropriate for the
proposed amendment 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 may
raise the same concerns as such activity carried out through an
affiliated agent. See note 164, supra.
\196\ Two commenters raised concerns that our initially proposed
rule could put U.S. brokers and investment managers at a competitive
disadvantage by subjecting all security-based swap transactions in
which they are involved, including those in which they are
performing services on behalf of non-U.S. persons, to the relevant
provisions of Title VII under the initially proposed definition of
``transaction conducted within the United States.'' See note 113,
supra (citing IIB Letter and SIFMA/FIA/FSR Letter); note 104, supra
(citing Pensions Europe Letter, IAA Letter, and ICI Letter). The re-
proposed approach should mitigate this concern on the part of
investment managers, as proposed Exchange Act rule 3a71-
3(b)(1)(iii)(C) would look only to the location of the dealing
counterparty's activity, meaning that the location of the investment
adviser will be immaterial to its dealing counterparty's de minimis
calculation under the proposed amendment. This approach would also
address concerns expressed by one commenter that private funds may
have difficulty identifying whether their dealer counterparties are
engaged in dealing activity in the United States. See note 106,
supra.
However, under the proposed approach 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 Section III.B.4, supra.
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We considered the view of at least one commenter that our existing
broker-dealer regime would be sufficient to address any concerns raised
by personnel of its agent in the United States acting on behalf of a
non-U.S. person engaged in security-based swap dealing activity.\197\
Because the Exchange Act defines security-based swaps as securities, 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 and, with respect to the transactions that it
intermediates, could be required to comply with relevant Exchange Act
requirements with respect to those transactions.\198\ The commenter
suggested that direct regulation of this agent would address ``most of
the . . . objectives to be served by [security-based swap dealer]
registration, as well as the external business conduct standards.''
\199\
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\197\ See IIB Letter at 10.
\198\ Title VII of the Dodd-Frank Act amended the Exchange Act
definition of ``security'' to encompass security-based swaps. See
Exchange Act section 3(a)(10), 15 U.S.C. 78c(a)(10), as revised by
section 761(a)(2) of the Dodd-Frank Act. See also Exchange Act
section 3(a)(4) (defining ``broker''). We previously granted
temporary exemptive relief from compliance with certain provisions
of the Exchange Act in connection with this revision of the
statutory requirements 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 (Jul. 1, 2011), 76 FR 39927 (Jul. 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).
\199\ IIB Letter at 10.
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After careful consideration of this alternative approach, we have
preliminarily concluded that broker-dealer regulation would not, on its
own, adequately address the concerns raised by agents located in the
United States acting on behalf of non-U.S. persons to facilitate the
security-based swap dealing activity of such non-U.S. persons. Given
the range of regulatory concerns such activity raises,\200\ we
preliminarily believe that, irrespective of any other regulatory
framework that may apply to the agent, the non-U.S. person engaged in
security-based swap dealing activity through the agent, if it exceeds
the de minimis threshold, should also be subject to security-based swap
dealer regulation.\201\
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\200\ See Section III.B.4, supra.
\201\ 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 first person involve
arrangement, negotiation, or execution of security-based swaps as
agent for the booking entity engaged in dealing activity, our
proposed amendment would treat 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 security-based swap
dealer may itself be subject to regulation as a broker under the
Exchange Act. See note 198, supra.
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First, as that commenter acknowledged, an agent using personnel
located in a U.S. branch or office would not be required to register as
a broker-dealer if it could avail itself of certain exceptions under
the Exchange Act and the rules or regulations thereunder.\202\
[[Page 27471]]
Given these exceptions, reliance on the broker-dealer regime to address
the regulatory concerns raised by security-based swap dealing activity
that a non-U.S. person carries out in the United States through an
agent could result in significant non-U.S. person security-based swap
dealing activity being carried out using an agent that, because, for
example, it is a bank, is not in fact subject to the broker-dealer
regulatory framework. We preliminarily believe that this result would
not be appropriate, particularly given that, in Title VII, Congress
established a new, separate regulatory framework for security-based
swap dealers that was designed specifically to encompass the security-
based swap dealing activities of banks.\203\
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\202\ See note 105, supra (citing IIB Letter). For example,
Exchange Act section 3(a)(4)(B) excepts banks from the definition of
``broker'' with respect to certain activity.
\203\ See Exchange Act section 15F. Notably, the definition of
``security-based swap dealer,'' unlike the definitions of ``broker''
and ``dealer'' under the Exchange Act, does not include any
exceptions for banks or banking activities. See Exchange Act section
3(a)(71) (defining ``security-based swap dealer'').
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Second, even absent the bank exception to the definition of
``broker,'' we are not persuaded that broker-dealer regulation of the
agent operating in the United States would address the concerns raised
by this security-based swap dealing activity. For example, although
regulation of the agent acting as a broker would provide the Commission
with access to the books and records of the agent relating to a
particular transaction, it would not provide us access to the relevant
books and records of the non-U.S.-person dealer on whose behalf the
agent is acting, which likely would reduce our ability to monitor that
non-U.S. person engaging in the dealing activity for compliance with
the securities laws, including with the anti-fraud provisions of those
laws.\204\
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\204\ See Section III.B.4, supra.
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As noted above, access to books and records is the primary tool for
oversight of the financial entity and for conducting market
surveillance. But the broker's books and records are likely to be
insufficient for this purpose, given that foreign dealers may allocate
different duties in connection with a particular security-based swap to
their own personnel and other functions to their agents, both in and
outside the United States. The records of the agents would not be
sufficient to document other market-facing activity of the foreign
dealer that is not carried out through the agent, but that may be
relevant to identifying activity in the United States both within the
security-based swap market as well as in markets for related underlying
assets, such as corporate bonds, that, in light of the other security-
based swap activity of the foreign dealer, may be abusive or
manipulative. We would have access to these books and records necessary
to identify fraudulent or abusive conduct on the part of the foreign
dealer only if the foreign dealer is required to register as a
security-based swap dealer. In addition, identifying certain
manipulative or abusive market practices may require information about
security-based swap transactions of the non-U.S.-person dealer that are
not arranged, negotiated, or executed in the United States. To
effectively monitor for fraud and manipulation in a market where a
significant proportion of transactions are likely to be carried out by
(and between) dealers using these types of business structures, we
preliminarily believe that the non-U.S.-person dealers that are the
counterparties to these transactions should be required to include
these transactions in their de minimis calculations. To the extent that
they exceed the relevant thresholds, these dealers would be subject to
security-based swap dealer regulation, which would enable the
Commission to obtain access to the dealer's books and records.
6. Other Commenter Concerns and Alternatives
(a) Potential Duplication and Comity Concerns
Some commenters expressed concern that an activity-based approach
to the de minimis exception and other Title VII requirements could lead
to regulatory conflicts and overlaps,\205\ or that it does not
adequately take into account the actions and interests of other
regulators.\206\ As we noted above, Commission staff has participated
in numerous bilateral and multilateral discussions with foreign
regulatory authorities addressing the regulation of OTC derivatives,
and, through these discussions, we have gathered information about
foreign regulatory reform efforts and their impact on and relationship
with the U.S. regulatory regime.\207\
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\205\ See note 105, supra.
\206\ See note 295, infra.
\207\ See Section I.B, supra.
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We recognize that some non-U.S. persons that may be required to
register as security-based swap dealers as a result of proposed
Exchange Act rule 3a71-3(b)(1)(iii)(C) may already be subject to
regulation similar to our security-based swap dealer regulatory
framework in other jurisdictions. At the same time, we preliminarily
believe that it is appropriate to regulate dealing activity that occurs
within the United States, including by subjecting to security-based
swap dealer registration non-U.S. persons that exceed the relevant de
minimis threshold by virtue of security-based swap dealing activity
involving the arrangement, negotiation, or execution of security-based
swaps on behalf of such person by personnel located in a U.S. branch or
office.\208\ We previously have proposed to provide the opportunity for
substituted compliance with respect to certain security-based swap
dealer requirements as set forth in our Cross-Border Proposing
Release.\209\ We received comments on this proposal, which we continue
to consider, and we continue preliminarily to believe that the
appropriate means of addressing potential overlap or duplication is
through substituted compliance rather than by forgoing regulation
entirely.\210\
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\208\ As noted above, one commenter specifically argued that the
initially proposed approach would subject U.S. branches of EU banks
to duplicative regulations because EU regulations also apply to the
transactions of such branches. See note 105, supra. We do not
believe the possibility that a person may be subject to similar
regulation by a foreign regulatory authority can be determinative of
the scope of our regulatory framework, given the specific authority
Congress provided us to regulate, among other things, security-based
swap dealing activity in the United States and given the potential
for differences in regulatory interests and in supervisory and
enforcement priorities among different regulatory jurisdictions. We
also note that EU regulations similarly apply to transactions
between two EU branches of U.S. banks. See Commission Delegated
Regulation supplementing Regulation (EU) No 648/2012 of the European
Parliament and of the Council of 4 July 2012 with regard to
regulatory technical standards on direct, substantial and
foreseeable effect of contracts within the Union and to prevent the
evasion of rules and obligations, Article 2(1).
\209\ See Cross-Border Proposing Release, 78 FR 31088-90
(discussing proposed substituted compliance framework for security-
based swap dealers); id. at 31024-25 (same).
\210\ See Cross-Border Proposing Release, 78 FR 31088-90
(describing proposed substituted compliance framework for foreign
security-based swap dealers); initially proposed Exchange Act rule
3a71-5 (providing for substituted compliance with respect to
security-based swap dealer requirements).
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(b) Reliance on Representations
At least one commenter specifically requested that we retain the
provision in the proposal permitting reliance on a representation
concerning whether a counterparty was engaging in activity within the
United States.\211\ The proposed amendment does not incorporate such a
provision, as the more limited scope of the re-proposed rule appears to
make it unnecessary in this context. The proposed rule would focus
solely on the conduct of a non-U.S. person acting in a dealing
capacity, and only that person is required to account for such activity
in its de
[[Page 27472]]
minimis calculations. Accordingly, whether one counterparty's dealing
activity occurs within or outside the United States has no legal effect
on the obligations of the other counterparty under the proposed rule,
and the location of the other counterparty has no effect on whether the
transaction falls within the scope of the proposed rule.\212\
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\211\ See note 117, supra.
\212\ Also for this reason, the re-proposed approach addresses
comments regarding potential difficulties private funds may have in
obtaining such representations from their dealer counterparties. See
id. (citing MFA/AIMA Letter). See also note 106, supra.
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7. Request for Comment
We request comment on all aspects of the discussion and analysis
above, including the following:
Is our understanding of the global nature of the security-
based swap market accurate? If not, why not?
Is our understanding of the dealing structures used by
U.S. and non-U.S. persons accurate? If not, why not? Are there other
dealing structures used by market participants?
Is our understanding of the use of affiliated or
unaffiliated persons, such as registered broker-dealers in the United
States (including inter-dealer brokers) accurate? If not, why not?
Should a non-U.S. person that engages in dealing activity
with other non-U.S. persons be required to consider, for purposes of
counting a transaction towards its de minimis calculation, the location
of its counterparty's dealing activity in addition to the location of
its own or its agent's dealing activity? Would the proposed amendment
requiring such a non-U.S. person to consider only the location of its
own dealing activity appropriately mitigate commenters' concerns while
also ensuring that a non-U.S. person that engages in significant levels
of dealing activity using personnel located in the United States would
be subject to regulation as a security-based swap dealer?
Does proposed rule 3a71-3(b)(1)(iii)(C), which would apply
only to transactions connected with a non-U.S. person's security-based
swap dealing activity that it (or its agent) arranges, negotiates, or
executes using personnel located in a U.S. branch or office,
appropriately focus on activity that is likely to raise the types of
concern addressed by Title VII? Is it appropriate to generally focus on
market-facing activities? Is the scope of activities too narrow or too
broad? Why? Will the approach be workable for market participants? Why
or why not?
Is the use of the terms ``arrange,'' ``negotiate,'' and
``execute'' in the release and rule text sufficiently clear? How could
the terms be further clarified if necessary?
Is the focus on market-facing activities of the sales and
trading desks appropriate in identifying transactions between two non-
U.S. persons that should be subject to Title VII requirements?
Does the change to proposed rule 3a71-3(b)(1)(iii)(C) that
would require transactions to be included in a person's de minimis
calculation only if personnel arranging, negotiating, or executing the
security-based swap are ``located in a U.S. branch or office'' address
the type of activity within the United States that is likely to raise
concerns under Title VII? Is the approach too narrow or too broad? Why?
Should the proposed amendment incorporate an exception
from security-based swap dealer regulation for a non-U.S. person that
arranges, negotiates, or executes transactions using personnel of its
agent located in a U.S. branch or office to the extent that the agent
is a registered broker-dealer? If so, how should this dealing activity
be regulated? Specifically, to the extent that security-based swap
brokering activity is carried out by personnel of the non-U.S. person
engaged in dealing activity who are located in a U.S. branch or office,
how should we address it? To the extent that security-based swap
brokering activity is carried out by a bank, how should we regulate it?
How would we obtain access to the books and records for transactions
outside the United States of an unregistered dealer also doing business
in the United States through a broker to monitor for market
manipulation or other abusive practices?
Do you agree with proposed rule 3a71-3(b)(1)(iii)(C),
which requires a non-U.S. person to include in its de minimis
calculation, transactions that it arranges, negotiates, or executes
using personnel of an affiliated agent of such non-U.S. person located
in a U.S. branch or office?
Do you agree with proposed rule 3a71-3(b)(1)(iii)(C),
which requires a non-U.S. person to include in its de minimis
calculation, transactions that it arranges, negotiates, or executes
using personnel of an unaffiliated agent of such non-U.S. person
located in a U.S. branch or office?
What types of controls would be necessary to ensure that a
non-U.S. person engaged in dealing activity counts transactions that it
is required to include in its dealer de minimis calculations under
proposed rule 3a71-3(b)(1)(iii)(C)? How would this work as an
operational matter?
Is this proposed approach to applying Title VII to
transactions connected with a non-U.S. person's security-based swap
dealing activity that it (or its agent) arranges, negotiates, or
executed using personnel located in a U.S. office workable in light of
the approach set forth in the CFTC Staff Advisory? Why or why not?
C. Availability of the Exception for Cleared Anonymous Transactions
1. Proposed Rule
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.'' \213\ As we noted in the Cross-Border
Adopting Release, this rule is intended 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
(e.g., the U.S.-person status of the counterparty) is unavailable to
them.\214\ We also noted that, absent such an exception, execution
facilities outside the United States might determine to 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.\215\
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\213\ Exchange Act rule 3a71-5.
\214\ See Cross-Border Adopting Release, 79 FR 47325 n.412.
\215\ See Cross-Border Adopting Release, 79 FR 47325.
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We are proposing 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). We preliminarily believe that excepting such
transactions would be inconsistent with the purposes underlying the
requirement that a non-U.S. person include transactions arranged,
negotiated, or executed by personnel located in a U.S. branch or office
in connection with its dealing activity in its de minimis calculations.
To the extent that a non-U.S. person is, in connection with its dealing
activity, arranging, negotiating, or executing security-based swap
transactions using personnel located in a U.S. branch or
[[Page 27473]]
office, it raises the concerns described above,\216\ regardless of
whether such transactions are entered into over-the-counter or on an SB
SEF or national securities exchange. Requiring a non-U.S. person to
include these transactions in its dealer de minimis calculations does
not appear to raise the concerns that led us to adopt Exchange Act rule
3a71-5, given that proposed Exchange Act rule 3a71-3(b)(1)(iii)(C)
requires the non-U.S. person to look only to the location of its own
security-based swap dealing activity in determining whether it is
required to count the trade against its de minimis threshold. Finally,
as with disparities in the application of Title VII to transactions
arranged, negotiated, or executed in the United States more
generally,\217\ we note that, 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, it could have a significant
competitive advantage over U.S. persons, even with respect to
transactions that are executed on an SB SEF or national securities
exchange and cleared on a clearing agency located in the United States.
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\216\ See Section III.B.4, supra.
\217\ See Section II.A, supra (discussing competitive effects of
disparate regulatory treatment of activity in the United States);
notes 114 and 138, supra (citing comment letters expressing concern
about potential competitive disparities).
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2. Request for Comment
We request comment on all aspects of the proposed amendment
regarding availability of the exception for cleared, anonymous
transactions with respect to identifying security-based swap
transactions that do not need to be included in the de minimis
threshold calculations of non-U.S. persons, including the following:
With respect to transactions that a non-U.S. person would
be required to count under proposed rule 3a71-3(b)(1)(iii)(C), should
there be an exception from counting such transactions if they are
entered into anonymously on an SB SEF or national securities exchange
and are cleared through a clearing agency? Why or why not?
Do security-based swap transactions entered into
anonymously on an SB SEF or national securities exchange and cleared
through a clearing agency mitigate the risk of fraud or market abuse or
other concerns with respect to transactions between two non-U.S.
persons that are arranged, negotiated, or executed by personnel located
in a U.S. branch or office? Why or why not?
IV. Application of the External Business Conduct Requirements to the
Foreign Business and U.S. Business of Registered Security-Based Swap
Dealers
A. Overview
In the Cross-Border Proposing Release, we proposed an approach to
the application of the security-based swap dealer requirements set
forth in section 15F of the Exchange Act that would classify each of
these requirements either as entity-level requirements, which apply to
the dealing entity as a whole, or as transaction-level requirements,
which apply to specific transactions. In this taxonomy, entity-level
requirements include requirements relating to capital and margin, risk
management procedures, recordkeeping and reporting, supervision, and
designation of a chief compliance officer.\218\ Transaction-level
requirements include, among others, requirements relating to external
business conduct and segregation, which are intended primarily to
protect counterparties by requiring registered security-based swap
dealers to, among other things, provide certain disclosures to
counterparties, adhere to certain standards of business conduct, and
segregate customer funds, securities, and other assets.\219\
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\218\ See Cross-Border Proposing Release, 78 FR 31009.
\219\ See id.
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We proposed generally to apply all requirements in section 15F of
the Exchange Act, and the rules and regulations thereunder, to both
registered U.S. and foreign security-based swap dealers.\220\ We also
proposed to establish a policy and procedural framework under which we
would consider permitting substituted compliance for registered foreign
security-based swap dealers under certain circumstances (but not for
registered U.S. security-based swap dealers).\221\ We proposed,
however, to except the foreign business of registered security-based
swap dealers from the external business conduct requirements.\222\
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\220\ See id.
\221\ See id. at 31088.
\222\ See id. at 31016.
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We are re-proposing this exception, which, as originally proposed,
incorporated the term ``transaction conducted within the United
States,'' to reflect the re-proposed approach to identifying relevant
security-based swap activity of registered foreign security-based swap
dealers that they carry out using personnel located in the United
States. We continue to believe that the foreign business of registered
security-based swap dealers should be excepted from the external
business conduct requirements of Title VII. We also preliminarily
believe that it is desirable that the types of activities in the United
States that trigger application of the external business conduct
requirements to transactions of a registered foreign security-based
swap dealer with another non-U.S. person should be identical to those
that require a transaction to be included in a non-U.S. person's de
minimis threshold calculations, as a consistent test should be more
workable for market participants to implement and we preliminarily
believe that the proposed test captures the activity that is likely to
raise concerns about business conduct in the United States.
Accordingly, we are re-proposing initially proposed Exchange Act rule
3a71-3(c) and related definitions solely to conform to the proposed
amendments to the de minimis exception.\223\
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\223\ This proposal does not address application of any of the
other elements of the Title VII security-based swap dealer
requirements described in the Cross-Border Proposing Release,
including those related to the application of entity-level
requirements to security-based swap dealers; the application of
segregation requirements under Exchange Act section 3E, and the
rules and regulations thereunder; and the availability of the
opportunity for substituted compliance (including initially proposed
Exchange Act rule 3a71-5, which set forth, among other things, the
process for submitting substituted compliance determination requests
and the standard we would use in evaluating those requests). We
anticipate addressing the comments on these elements of that
proposal in the context of our consideration of final rules
regarding each of the respective security-based swap dealer
requirements.
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B. Statutory Framework for External Business Conduct
Section 15F(h) of the Exchange Act requires the Commission to adopt
rules specifying external business conduct standards for registered
security-based swap dealers in their dealings with counterparties,\224\
including counterparties that are ``special entities.'' \225\ Congress
granted the Commission broad authority to promulgate business conduct
standards
[[Page 27474]]
that the Commission determines to be appropriate in the public
interest, for the protection of investors, or otherwise in furtherance
of the purposes of the Exchange Act.\226\
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\224\ Exchange Act section 15F(h)(6), 15 U.S.C. 78o-10(h)(6),
directs the Commission to prescribe rules governing external
business conduct standards for security-based swap dealers.
\225\ Exchange Act section 15F(h)(2)(C), 15 U.S.C. 78o-
10(h)(2)(C) (defining ``special entities''). As discussed below, we
have previously proposed business conduct rules and continue to
consider comments received on that proposal. See IV.C.1, infra. We
intend to address these comments in a subsequent adopting release
finalizing rules establishing external business conduct standards,
including provisions applicable in transactions with ``special
entities.''
\226\ See Exchange Act section 15F(h)(3)(D), 15 U.S.C. 78o-
10(h)(3)(D) (``[b]usiness conduct requirements adopted by the
Commission shall establish such other standards and requirements as
the Commission may determine are appropriate in the public interest,
for the protection of investors, or otherwise in furtherance of the
purposes of this Act''). See also Exchange Act section 15F(h)(1)(D)
(requiring security-based swap dealers to comply with ``such
business conduct standards . . . as may be prescribed by the
Commission by rule or regulation that relate to . . . such other
matters as the Commission determines to be appropriate'').
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These standards, as described in section 15F(h)(3) of the Exchange
Act, must require security-based swap dealers to: (i) Verify that a
counterparty meets the eligibility standards for an eligible contract
participant; (ii) disclose to the counterparty material information
about the security-based swap, including material risks and
characteristics of the security-based swap, and material incentives and
conflicts of interest of the security-based swap dealer in connection
with the security-based swap; and (iii) provide the counterparty with
information concerning the daily mark for the security-based swap.
Section 15F(h)(3) also directs the Commission to establish a duty for
security-based swap dealers to communicate information in a fair and
balanced manner based on principles of fair dealing and good faith and
to establish other standards as the Commission determines are in
furtherance of the purposes of the Exchange Act.
In addition, section 15F(h)(4) of the Exchange Act requires that a
security-based swap dealer that ``acts as an advisor to a special
entity'' must act in the ``best interests'' of the special entity and
undertake ``reasonable efforts to obtain such information as is
necessary to make a reasonable determination'' that a recommended
security-based swap is in the best interests of the special
entity.\227\ Section 15F(h)(5) requires that a security-based swap
dealer that enters into, or offers to enter into, security-based swaps
with a special entity comply with any duty established by the
Commission that requires the security-based swap dealer to have a
``reasonable basis'' for believing that the special entity has an
``independent representative'' that meets certain criteria and
undertakes a duty to act in the ``best interests'' of the special
entity.
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\227\ See Business Conduct Standards for Security-Based Swap
Dealers and Major Security-Based Swap Participants (``Business
Conduct Proposal''), Exchange Act Release No. 64766 (June 29, 2011),
76 FR 42423-25 (July 18, 2011).
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C. Prior Proposals
2. Business Conduct Proposal
We have proposed rules 15Fh-1 through 15Fh-6 under the Exchange Act
to implement the business conduct requirements described above.\228\ In
addition to external business conduct standards expressly addressed by
Title VII, we have proposed certain other business conduct requirements
for security-based swap dealers that we preliminarily believed would
further the principles that underlie the Dodd-Frank Act. These rules
would, among other things, impose certain ``know your counterparty''
and suitability obligations on security-based swap dealers, as well as
restrict security-based swap dealers from engaging in certain ``pay to
play'' activities and provide certain protections for ``special
entities.'' \229\
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\228\ See Business Conduct Proposal, 76 FR 42396.
\229\ See Business Conduct Proposal, 76 FR 42399-400; proposed
Exchange Act rules 15Fh-3(e) (``know your counterparty''), 15Fh-3(f)
(``suitability''), and 15Fh-6 (``pay to play'').
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2. Cross-Border Proposing Release
In the Cross-Border Proposing Release, we proposed a rule that
would have provided that a registered foreign security-based swap
dealer and a foreign branch of a registered U.S. security-based swap
dealer, with respect to their foreign business, shall not be subject to
the requirements relating to external business conduct standards
described in section 15F(h) of the Exchange Act,\230\ and the rules and
regulations thereunder, other than the rules and regulations prescribed
by the Commission pursuant to section 15F(h)(1)(B).\231\
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\230\ 15 U.S.C. 78o-10(h).
\231\ See Cross-Border Proposing Release, 78 FR 31016. Section
15F(h)(1)(B) requires registered security-based swap dealers to
conform with such business conduct standards relating to diligent
supervision as the Commission shall prescribe. See 15 U.S.C. 78o-
10(h)(1)(B). All other requirements in section 15F of the Exchange
Act, and the rules and regulations thereunder, would apply to both
U.S. and registered foreign security-based swap dealers, although we
proposed to establish a framework under which we would consider
permitting substituted compliance for foreign security-based swap
dealers under certain circumstances (but not for U.S. security-based
swap dealers, even when they conduct dealing activity through
foreign branches). See id. The approach under the initially proposed
rule would not have affected applicability of the general antifraud
provisions of the federal securities laws to the activity of a
foreign security-based swap dealer. See Cross-Border Proposing
Release, 78 FR 31016 n.476.
---------------------------------------------------------------------------
As described more fully in the Cross-Border Proposing Release, the
proposed rule would have defined ``U.S. business'' and ``foreign
business'' with respect to both foreign and U.S. security-based swap
dealers. For a foreign security-based swap dealer, ``U.S. business''
would have been defined to mean (i) any transaction entered into, or
offered to be entered into, by or on behalf of such foreign security-
based swap dealer, with a U.S. person (other than with a foreign
branch), or (ii) any transaction conducted within the United
States.\232\ For a U.S. security-based swap dealer, ``U.S. business''
would have been defined to mean any transaction by or on behalf of such
U.S. security-based swap dealer, wherever entered into or offered to be
entered into, other than a transaction conducted through a foreign
branch with a non-U.S. person or another foreign branch of a U.S.
person.\233\ With respect to both a foreign security-based swap dealer
and a U.S. security-based swap dealer, ``foreign business'' would have
been defined to mean any security-based swap transactions entered into,
or offered to be entered into, by or on behalf of the foreign security-
based swap dealer or the U.S. security-based swap dealer that do not
include its U.S. business.\234\
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\232\ See id. at 31016. Whether the activity in a transaction
involving a registered foreign security-based swap dealer occurred
within the United States or with a U.S. person for purposes of
identifying whether security-based swap transactions are part of
U.S. business would have turned on the same factors used in that
proposal to determine whether a foreign security-based swap dealer
is engaging in dealing activity within the United States or with
U.S. persons and whether a U.S. person was conducting a transaction
through a foreign branch, as set forth in that proposal. See id.
\233\ See id.
\234\ See id.
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D. Comments
We received relatively few comments specifically addressing our
initially proposed approach to application of the external business
conduct requirements to security-based swap dealers. One commenter
disagreed with our proposed approach with respect to U.S. security-
based swap dealers, arguing that all transactions of such persons must
always be subject to external business conduct standards, including
those conducted through their foreign branches with non-U.S. persons
and foreign branches of U.S. banks.\235\
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\235\ See Letter from Better Markets to SEC, dated August 21,
2013 (``Better Markets Letter'') at 28.
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Two commenters generally agreed with the initially proposed
approach but suggested certain modifications to address specific
concerns. One commenter generally agreed with the proposed approach
that would not have imposed external business conduct
[[Page 27475]]
requirements with respect to the ``foreign business'' of a foreign
security-based swap dealer but argued that these requirements also
should not apply to transactions with non-U.S. regulated funds whose
security-based swap activity is managed by a U.S. asset manager.\236\
This commenter argued that such funds would not expect to receive the
protections of Title VII's business conduct standards merely because
they use a U.S. asset manager and expressed concern that such
requirements would disadvantage these entities because foreign
security-based swap dealers might prefer to transact with non-U.S.
funds managed by non-U.S. asset managers to avoid compliance with the
requirements.\237\
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\236\ See ICI Letter at 11.
\237\ See id. This commenter suggested that we modify the
proposed definition of ``U.S. business'' for foreign security-based
swap dealers by removing prong (ii) of the initially proposed rule,
which includes ``any transactions conducted within the U.S.'' in the
definition of ``U.S. business.'' In this commenter's view, this
change would help ensure that the transactions of such funds with
registered foreign security-based swap dealers are not subject to
the external business conduct requirements. See ICI Letter at 11
n.28 and accompanying text.
---------------------------------------------------------------------------
Another commenter argued that the definition of ``U.S. business''
should be limited to transactions with counterparties that are U.S.
persons, and that this definition should apply to the business of U.S.
and foreign security-based swap dealers.\238\ This commenter argued
that adopting a uniform definition of ``U.S. business'' and eliminating
``transaction conducted within the United States'' from that definition
would better accord with the purpose of the requirements, with
counterparty expectations, and with international comity concerns.\239\
This commenter further stated that there was insufficient
``jurisdictional nexus'' to warrant applying the external business
conduct requirements to all transactions conducted within the United
States, regardless of the U.S.-person status of the
counterparties.\240\
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\238\ See SIFMA/FIA/FSR Letter at A-24.
\239\ See id. at A-24 to A-25.
\240\ See id. at A-25.
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E. Discussion
We are re-proposing Exchange Act rule 3a71-3(c) regarding
application of the external business conduct requirements, and
proposing amendments to Exchange Act rule 3a71-3(a) to define certain
terms to conform to the proposed amendments to Exchange Act rule 3a71-
3(b)(1)(iii)(C), which identifies relevant security-based swap activity
of registered foreign security-based swap dealers in which they engage
using personnel located in the United States for purposes of the de
minimis exception. Our general approach, however, remains unchanged:
The re-proposed rule would distinguish between ``U.S. business'' and
``foreign business'' and except the foreign business of a registered
foreign security-based swap dealer and a registered U.S. security-based
swap dealer from the external business conduct standards in section
15F(h) and the rules and regulations thereunder (other than rules and
requirements prescribed by the Commission pursuant to section
15F(h)(1)(B)) of the Exchange Act, and proposed amendments to Exchange
Act rule 3a71-3(a) would incorporate these defined terms in the
rule.\241\
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\241\ See proposed Exchange Act rules 3a71-3(a)(6), (7), (8),
and (9) (defining, respectively, ``U.S. security-based swap
dealer,'' ``foreign security-based swap dealer,'' ``U.S. business,''
and ``foreign business''); re-proposed Exchange Act rule 3a71-3(c)
(setting forth exceptions from certain external business conduct
requirements with respect to the ``foreign business'' of registered
foreign security-based swap dealers and registered U.S. security-
based swap dealers).
This proposed approach to external business conduct standards
would not except registered security-based swap dealers from the
rules and requirements prescribed by the Commission pursuant to
section 15F(h)(1)(B) of the Exchange Act with respect to their
foreign business. As already noted, section 15F(h)(1)(B) requires
registered security-based swap dealers to conform with such business
conduct standards relating to diligent supervision as the Commission
shall prescribe. See 15 U.S.C. 78o-10(h)(1)(B). We preliminarily
believe that it is not appropriate to except registered security-
based swap dealers from compliance with such requirements. Because
registered security-based swap dealers would be subject to a number
of obligations under the federal securities laws with respect to
their security-based swap business, we preliminarily believe that
having systems in place reasonably designed to ensure diligent
supervision would be an important aspect of their compliance with
the federal securities laws. Under our Cross-Border Proposing
Release, these entity-level requirements would apply to a security-
based swap dealer on a firm-wide basis to address risks to the
security-based swap dealer as a whole. See Cross-Border Proposing
Release, 78 FR 31011.
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Specifically, our re-proposed amendment to Exchange Act rule 3a71-
3(a) would modify the initially proposed definition of ``U.S.
business'' with respect to foreign security-based swap dealers to refer
to any security-based swap transaction arranged, negotiated, or
executed by personnel of the foreign security-based swap dealer located
in a U.S. branch or office, or by personnel of its agent located in a
U.S. branch or office.\242\ The definition of ``U.S. business'' for
foreign security-based swap dealers and U.S. security-based swap
dealers would continue to exclude certain transactions involving the
foreign branches of U.S. persons.\243\ The definitions of ``U.S.
security-based swap dealer,'' \244\ ``foreign security-based swap
dealer,'' \245\ and ``foreign business'' \246\ would remain unchanged
from the initial proposal, as would the text of re-proposed rule 3a71-
3(c), which would create the exception to the external business conduct
requirements (other than rules and requirements prescribed by the
Commission pursuant to section 15F(h)(1)(B)) for the foreign business
of registered security-based swap dealers.
---------------------------------------------------------------------------
\242\ Proposed Exchange Act rule 3a71-3(a)(8)(i)(B). We intend
the proposed rule to indicate the same type of activity by personnel
located in the United States as described in Section III.B.5, supra.
Moreover, for purposes of proposed Exchange Act rule 3a71-
3(a)(8)(i)(B), we would 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. See note 193, supra (discussing the Commission's
proposed interpretation of the term ``personnel'' for purposes of
proposed rule 3a71-3(b)(1)(iii)(C)).
\243\ Initially proposed Exchange Act rule 3a71-3(a)(6)(i)(A)
provided that the U.S. business of a foreign security-based swap
dealer included any transaction with a U.S. person, ``other than
with a foreign branch.'' The proposed amendment replaces this
language with ``other than a transaction conducted through a foreign
branch of that person.'' Similarly, initially proposed Exchange Act
rule 3a71-3(a)(6)(ii) provided that the U.S. business of a U.S.
security-based swap dealer included any transaction of such dealer,
other than transactions conducted through a foreign branch with a
non-U.S. person ``or another foreign branch.'' Proposed Exchange Act
rule 3a71-3(a)(8)(ii) replaces this language with ``or a transaction
with a U.S. person counterparty that constitutes a transaction
conducted through a foreign branch of the counterparty.''
These changes are intended to clarify that the counterparty's
activity in each such transaction must meet the definition of
``transaction conducted through a foreign branch'' set forth in
Exchange Act rule 3a71-3(a)(3). These proposed changes are
consistent with Exchange Act rule 3a71-3(b)(1)(iii)(A), which
permits non-U.S. persons to exclude from the de minimis calculation
transactions with U.S. persons, to the extent that such U.S. persons
are engaging in transactions conducted through a foreign branch.
\244\ See proposed Exchange Act rule 3a71-3(a)(6).
\245\ See proposed Exchange Act rule 3a71-3(a)(7).
\246\ See proposed Exchange Act rule 3a71-3(a)(9).
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We continue to believe that a registered security-based swap dealer
should be required to comply with the external business conduct
requirements with respect to its U.S. business. The proposed external
business conduct standards are intended to bring professional standards
of conduct to, and increase transparency in, the security-based swap
market and to require registered security-based swap dealers to treat
parties to these transactions fairly. As noted above, the proposed
rules would require, among other things, that registered security-based
swap dealers communicate in a fair and balanced manner with potential
counterparties and that they disclose conflicts of interest and
material incentives to potential counterparties.
[[Page 27476]]
Imposing these requirements on the U.S. business of registered
security-based swap dealers should help protect the integrity of U.S.
financial markets for all market participants.
We recognize that, depending on the particular structure used by a
registered foreign security-based swap dealer to do business in the
United States, its personnel (or personnel of its agent acting on its
behalf) in the United States may be subject to other business conduct
requirements under U.S. law (such as broker-dealer regulation) that
govern the professional interactions of such personnel or agents with
counterparties to a security-based swap.\247\ We also recognize that
these other requirements may afford security-based swap counterparties
protections that may appear to be similar in many respects to the Title
VII external business conduct standards. We preliminarily believe,
however, that, notwithstanding any requirements that may apply to such
intermediaries, it is appropriate to impose these Title VII
requirements directly on registered foreign security-based swap dealers
when they use personnel located in the United States to arrange,
negotiate, or execute security-based swaps, even with counterparties
that are also non-U.S. persons.
---------------------------------------------------------------------------
\247\ See note 198, supra (discussing the Exchange Act Exemptive
Order). The Financial Industry Regulatory Authority (``FINRA'') also
adopted a rule, FINRA Rule 0180 (Application of Rules to Security-
Based Swaps), which temporary limits the application of certain
FINRA rules with respect to security-based swaps. On January 14,
2015, 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, 2016. 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. 74049 (Jan. 14,
2015).
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We note that, in Title VII, Congress has established a
comprehensive framework of business conduct standards that applies to
registered security-based swap dealers, and we preliminarily believe
that this framework should govern their transactions with
counterparties when such transactions raise transparency and market
integrity concerns that are addressed by these requirements. Although
other business conduct frameworks (such as broker-dealer regulation)
may achieve similar regulatory goals, the availability of exceptions
may mean that alternative frameworks may not apply to certain business
structures used by registered security-based swap dealers to carry out
their business in the United States.\248\ In our preliminary view, it
is appropriate to subject all registered security-based swap dealers
engaged in U.S. business to the same external business conduct
framework, rather than encouraging a patchwork of business conduct
protections under U.S. law that may offer counterparties varying levels
of protection with respect to their transactions with different
registered security-based swap dealers depending on the business model
(or models) that each registered security-based swap dealer has chosen
to use in its U.S. business.\249\
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\248\ See note 202, supra (noting exception from broker-dealer
definition for banks).
\249\ Consistent with the view we expressed in the Cross-Border
Proposing Release, to the extent that a registered foreign security-
based swap dealer uses personnel of an agent to arrange, negotiate,
or execute security-based swap transactions from a U.S. branch or
office, the dealer and its agent may choose to allocate between
themselves specific responsibilities in connection with these
external business conduct requirements. See Cross-Border Proposing
Release, 78 FR 31026-27. However, we note that the registered
foreign security-based swap dealer would remain responsible for
ensuring that all relevant Title VII requirements applicable to a
given security-based swap transaction are fulfilled. See id. at
31026. As noted above, the agent may also be required to register as
a broker (or, potentially, as a security-based swap dealer), or as
another regulated entity, depending on the nature of its security-
based swap or other activity. See note 198 and accompanying text,
supra; Cross-Border Proposing Release, 78 FR 31027 n.574. An agent
may, accordingly, be subject to independent business conduct or
other requirements with respect to its interactions with the
registered foreign security-based swap dealer's counterparties that
occur in the course of its intermediation of such transactions.
---------------------------------------------------------------------------
We also note that imposing these external business conduct
requirements on a registered foreign security-based swap dealer when it
uses personnel located in a U.S. branch or office to arrange,
negotiate, or execute security-based swaps with another non-U.S. person
should mitigate competitive disparities between different categories of
security-based swap dealers operating in the United States.\250\ This
concern is particularly acute given the ease with which U.S. security-
based swap dealers may seek to avoid such competitive disparities by
booking in non-U.S.-person affiliates any transactions arranged,
negotiated, or executed by personnel located in the United States. As
noted above, this restructuring would allow these dealers to continue
using U.S. sales and trading personnel to carry on their security-based
swap dealing business in a manner largely unchanged from what we
understand to be current business practices while avoiding the external
business conduct requirements of Title VII.\251\
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\250\ See Section II.A, supra (discussing competitive effects of
disparate regulatory treatment of activity in the United States).
\251\ See Section III.B.4, supra.
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We have considered the views of the commenters that opposed
imposing external business conduct requirements on transactions between
a registered foreign security-based swap dealer and a non-U.S.-person
counterparty,\252\ but we do not believe that the issues raised by
commenters warrant refraining from imposing these requirements on all
such transactions. The re-proposed approach, which focuses on a
transaction of a registered foreign security-based swap dealer with
another non-U.S. person only when the registered foreign security-based
swap dealer is using personnel located in the United States to arrange,
negotiate, or execute the security-based swap, should mitigate the
concerns raised by one commenter regarding the potential effect of the
initially proposed rule on U.S. fund managers that manage offshore
funds, because, to the extent an offshore fund is not a U.S. person by
virtue of having its principal place of business in the United States,
only the location of personnel of the registered foreign security-based
swap dealer or the location of personnel of its agent, and not that of
persons acting on behalf of a non-U.S.-person fund in the transaction,
would be relevant to whether the transaction is U.S. business or
foreign business of the registered foreign security-based swap
dealer.\253\
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\252\ See, e.g., ICI Letter at 11.
\253\ See notes 236-237, supra. To the extent that a non-U.S.
regulated fund is a U.S. person (including because it has its
principal place of business in the United States), a foreign
security-based swap dealer would be required to comply with external
business conduct requirements in any transaction with that fund
because the counterparty is a U.S. person. See proposed Exchange Act
rule 3a71-3(a)(8). Cf. Exchange Act rule 3a71-3(b)(1)(iii)(A)
(requiring non-U.S. persons to include in their de minimis threshold
calculations security-based swap transactions with U.S. persons in
connection with their dealing activity); Cross-Border Adopting
Release, 79 FR 47320 (describing Exchange Act rule 3a71-
3(b)(1)(iii)(A)).
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We also disagree with the commenter that suggested that such
transactions have an insufficient nexus to the United States to warrant
application of the external business conduct requirements and that the
external business conduct requirement should apply only to transactions
with U.S.-person counterparties.\254\ As we discussed in the context of
the de minimis exception above, a foreign security-based swap dealer
arranging, negotiating, or executing a security-based swap transaction
using personnel located in a U.S. branch or office is not solely
``transacting a business in security-
[[Page 27477]]
based swaps without the jurisdiction of the United States.''\255\ If
the Commission adopts a rule that makes substituted compliance
available for external business conduct requirements and, pursuant to
further Commission action, makes a substituted compliance
determination, substituted compliance may be permitted in such
transactions.\256\
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\254\ See notes 238-240, supra.
\255\ Exchange Act section 30(c). See also Section III.B.4(b),
supra.
As noted above, we do not believe that our proposed approach
applies 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.
An approach that did not treat security-based swaps that a
registered foreign security-based swap dealer has arranged,
negotiated, or executed using its personnel or personnel of its
agent located in the United States as the ``U.S. business'' of that
dealer for purposes of proposed Exchange Act rule 3a71-3(c) would,
in our view, reflect an understanding of what it means to conduct a
security-based swaps business within the jurisdiction of the United
States that is divorced both 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
preliminarily believe that this proposed rule is necessary or
appropriate as a prophylactic measure to help prevent the evasion of
the provisions of the Exchange Act that were added by the Dodd-Frank
Act, and thus 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 non-U.S.
persons. Permitting this activity could allow these firms to retain
full access to the benefits of operating in the United States while
avoiding compliance with external business conduct requirements,
which could increase the risk of misconduct. See Section III.B.4,
supra.
\256\ As noted above, in the Cross-Border Proposing Release, we
proposed an approach to substituted compliance with respect to the
external business conduct requirements. See note 223, supra. We
received comments on this proposed rule that we continue to
consider, and we anticipate addressing those comments in the context
of our consideration of final rules regarding the external business
conduct requirement.
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Our re-proposed rule maintains our initially proposed approach to
the foreign business of registered U.S. security-based swap dealers. We
recognize that at least one commenter suggested that all transactions
of a registered U.S. security-based swap dealer should be subject to
the external business conduct requirements of Exchange Act section
15F,\257\ but we continue to believe it is appropriate to provide this
exception for the foreign business of such persons. As we noted in our
initial proposal, the Dodd-Frank Act generally is concerned with the
protection of U.S. markets and participants in those markets.\258\ We
continue to believe that subjecting U.S. security-based swap dealers to
the Title VII customer protection requirements with respect to their
security-based swap transactions conducted through their foreign
branches outside the United States with non-U.S. persons would not
appreciably further the goal of protecting the U.S. market or U.S.
market participants.
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\257\ See note 235, supra.
\258\ See Cross-Border Proposing Release, 78 FR 31018.
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F. Request for Comment
We request comment on all aspects of the re-proposed rule regarding
application of the external business conduct requirements to registered
security-based swap dealers, including the following:
The re-proposed rule would apply the external business
conduct standards to transactions that a registered foreign security-
based swap dealer arranges, negotiates, or executes using personnel
located in a U.S. branch or office, even if the counterparty is also a
non-U.S. person. Are the external business conduct rules appropriately
applied in this release? Should the external business conduct rules be
expanded to cover other transactions discussed in this release? Should
some or all of the external business conduct standards not apply to
these activities? Why or why not? Please be specific in identifying why
the concerns addressed by the external business conduct requirements do
not arise in this context.
The re-proposed rule would not apply the external business
conduct standards to the foreign business of any registered security-
based swap dealer. Should some or all of the external business conduct
standards apply to the foreign business of these registered entities?
Why or why not? Please be specific as to what policy objectives would
be advanced by subjecting transactions resulting from the foreign
business of a registered security-based swap dealer to the external
business conduct requirement.
The re-proposed rule would not apply the external business
conduct standards to a transaction of a registered U.S. security-based
swap dealer that is a transaction conducted through a foreign branch
(assuming that the counterparty is a non-U.S. person or is a U.S.
person for whom the transaction is also a transaction conducted through
a foreign branch). Should some or all of the external business conduct
standards apply to these transactions? Why or why not?
What types of controls would be necessary to identify
foreign business and U.S. business and ensure that the registered
security-based swap dealer complies with the external business conduct
standards with respect to its U.S. business? How would this work as an
operational matter? Should U.S. business be generally defined with
reference to the type of activity that, if performed in a dealing
capacity, triggers the registration requirement?
Should some or all of the external business conduct rules
apply in transactions between a registered foreign security-based swap
dealer and a foreign branch of a U.S. bank? Why or why not?
Should some or all of the external business conduct rules
apply in transactions between a registered non-U.S. security-based swap
dealer and a non-U.S. person whose obligations under a security-based
swap are guaranteed by a U.S. person that is conducted outside the
United States? Why or why not?
What would be the market impact of the re-proposed
approach to application of the customer protection requirements? Would
non-U.S. persons that engage in dealing activities seek to relocate to
locations outside the United States personnel who currently arrange,
negotiate, and execute transactions from locations within the United
States? Would the potential benefits of applying external business
conduct requirements to transactions that are arranged, negotiated, or
executed by a registered foreign security-based swap dealer in the
United States reduce any incentives to relocate to locations outside
the United States? What are the costs of such relocation? What factors
would weigh against relocation in spite of those costs?
How would the proposed application of the requirements
affect the competitiveness of U.S. entities in the global marketplace
(both in the United States as well as in foreign jurisdictions)? Would
the proposed approach place any market participants at a competitive
disadvantage or advantage? Why or why not? What other measures should
we consider to implement the transaction-level requirements?
V. Application of Other Requirements to Cross-Border Security-Based
Swap Activity
A. Overview
In light of our proposed amendment to Exchange Act rule 3a71-3(b),
which would apply the de minimis exception to transactions of a non-
U.S. person that are arranged, negotiated, or executed by personnel
located in a U.S. branch or office in connection with the non-U.S.
person's dealing activity, we have determined also to propose certain
[[Page 27478]]
amendments to Regulation SBSR to address the applicability of the
regulatory reporting and public dissemination requirements to such
transactions.\259\ However, we are not proposing to subject
transactions between two non-U.S. persons that are arranged,
negotiated, or executed in the United States to mandatory clearing or
trade execution.
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\259\ We also are soliciting comment on whether certain
transactions of non-U.S. persons whose obligations under a security-
based swap are guaranteed by a U.S. person should be exempt from the
public dissemination requirement. See Section V.E.3, infra.
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B. Previously Proposed and Adopted Rules Relating to Application of
Clearing, Trade Execution, Regulatory Reporting, and Public
Dissemination Requirements
1. Mandatory Clearing and Trade Execution
In the Cross-Border Proposing Release, we proposed to impose both
mandatory clearing and trade execution on ``transactions conducted
within the United States,'' subject to certain exceptions. Proposed
rules 3Ca-3 and 3Ch-1 would have subjected such transactions to
mandatory clearing (provided that we had issued a mandatory clearing
determination with respect to the security-based swap) and mandatory
trade execution (provided that the transaction had been made available
to trade) if a person engaged in a security-based swap transaction that
is a ``transaction conducted within the United States,'' as defined in
initially proposed Exchange Act rule 3a71-3(a)(5).\260\ We also
proposed an exception to this general requirement, under which a
``transaction conducted within the United States'' would not have been
subject to the clearing or trade execution requirements if (i) neither
counterparty to the transaction was a U.S. person; (ii) neither
counterparty's performance under the security-based swap was guaranteed
by a U.S. person; and (iii) neither counterparty to the transaction was
a foreign security-based swap dealer. We proposed that the clearing and
trade execution requirements would not apply to transactions that did
not involve any of these three types of counterparties due to our
preliminary view that, although such transactions conducted within the
United States may give rise to operational risks in the United States,
the financial risk of such transactions would reside outside the United
States.\261\
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\260\ In addition, the proposed rules generally would have
imposed these requirements on a security-based swap transaction if a
counterparty to the transaction is a U.S. person or a non-U.S.
person whose counterparty has a right of recourse against a U.S.
person. See Cross-Border Proposing Release, 78 FR 31078, 31083. We
also proposed an approach to substituted compliance with respect to
each requirement. See id. at 31098, 31099-100. Although these
provisions of the initial proposal are outside the scope of this
release, we received comments on these provisions of the proposed
rules, which we continue to consider and anticipate addressing in
the context of our consideration of final rules regarding each
requirement.
\261\ See Cross-Border Proposing Release, 78 FR 31080, 31084.
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2. Regulatory Reporting and Public Dissemination
In the Cross-Border Proposing Release, we re-proposed the entirety
of Regulation SBSR, including rule 908(a) thereof, which, among other
things, would have specified when a security-based swap was subject to
the regulatory reporting and public dissemination requirements of
Regulation SBSR.\262\ Security-based swaps that fell within the
proposed definition of ``transaction conducted within the United
States'' would have been among the security-based swaps subjected both
to regulatory reporting and to public dissemination under rule 908(a),
as re-proposed in the Cross-Border Proposing Release.\263\
---------------------------------------------------------------------------
\262\ Rule 908(a), as initially proposed, would have required
regulatory reporting of any security-based swap that is ``executed
in the United States or through any means of interstate commerce.''
See Regulation SBSR Proposing Release, 75 FR 75287. When we re-
proposed rule 908(a)(1)(i) in the Cross-Border Proposing Release, we
expressed concern that the language in the Regulation SBSR Proposing
Release could have unduly required a security-based swap to be
reported if it had only the slightest connection with the United
States. See Cross-Border Proposing Release, 78 FR 31061.
\263\ Rule 900(ii), as re-proposed in the Cross-Border Proposing
Release, would have defined ``transaction conducted within the
United States'' to have the meaning as given in the definition of
the term under previously proposed Exchange Act rule 3a71-
3(a)(5)(i).
---------------------------------------------------------------------------
We recently adopted rule 908(a)(1), which requires regulatory
reporting and public dissemination of security-based swap transactions
that (i) have a direct or indirect counterparty \264\ that is a U.S.
person on either or both sides of the transaction, or (ii) are accepted
for clearing by a clearing agency having its principal place of
business in the United States. In addition, rule 908(a)(2), as adopted,
requires regulatory reporting but not public dissemination of
transactions that have a direct or indirect counterparty that is a
registered security-based swap dealer or registered major security-
based swap participant on either or both sides of the transaction but
do not otherwise fall within rule 908(a)(1).\265\ We did not, however,
include in that final rule a provision addressing a security-based swap
transaction that is a ``transaction conducted within the United
States,'' noting that commenters had expressed divergent views on this
particular element of the re-proposed rule. We also noted that we
anticipated seeking additional public comment on whether and, if so,
how regulatory reporting and public dissemination requirements should
be applied to transactions involving non-U.S. persons when they carry
out relevant activities in the United States.\266\
---------------------------------------------------------------------------
\264\ Rule 900(hh) of Regulation SBSR defines ``side'' to mean
``a direct counterparty and any guarantor of that direct
counterparty's performance who meets the definition of indirect
counterparty in connection with the security-based swap.'' Rule
900(p) of Regulation SBSR defines ``indirect counterparty'' to mean
``a guarantor of a direct counterparty's performance of any
obligation under a security-based swap such that the direct
counterparty on the other side can exercise a right of recourse
against the indirect counterparty in connection with the security-
based swap; for these purposes a direct counterparty has a right of
recourse against a guarantor on the other side if the direct
counterparty has a conditional or unconditional legally enforceable
right, in whole or in part, to receive payments from, or otherwise
collect from, the guarantor in connection with the security-based
swap.'' A ``direct counterparty'' is a person that is a primary
obligor on a security-based swap. See Exchange Act rule 900(k)
(defining ``direct counterparty'').
\265\ See rule 908(a). We also simultaneously proposed certain
amendments to Regulation SBSR. See Regulation SBSR--Reporting and
Dissemination of Security-Based Swap Information; Proposed Rule
(``Regulation SBSR Proposed Amendments Release''), Exchange Act
Release No. 74245 (February 11, 2015), 80 FR 14739 (March 19, 2015).
These proposed amendments generally address issues separate from
those being addressed in this release.
\266\ See Regulation SBSR Adopting Release, 80 FR 14655.
---------------------------------------------------------------------------
We also previously proposed rule 908(b), which would have provided
that, notwithstanding any other provision of Regulation SBSR, a person
would not incur any obligation under Regulation SBSR unless the person
is:
(1) a U.S. person;
(2) a security-based swap dealer or major security-based swap
participant; or
(3) a counterparty to a transaction conducted within the United
States.\267\ Our recently adopted rule 908(b) included only the first
two of these prongs, and the Regulation SBSR Adopting Release clarified
that a security-based swap dealer or major security-based swap
participant that is not a U.S. person would incur an obligation under
Regulation SBSR only if it is registered.\268\ We noted that we
anticipated soliciting additional public comment on whether regulatory
reporting and/or public dissemination
[[Page 27479]]
requirements should be extended to transactions occurring within the
United States between non-U.S. persons and, if so, which non-U.S.
persons should incur reporting duties under Regulation SBSR.\269\
---------------------------------------------------------------------------
\267\ See Cross-Border Proposing Release, 78 FR 31065.
\268\ See rule 908(b); Regulation SBSR Adopting Release, 80 FR
14656.
\269\ See Regulation SBSR Adopting Release, 80 FR 14655.
---------------------------------------------------------------------------
Finally, in the Cross-Border Proposing Release, we re-proposed rule
901(a), which set forth a reporting hierarchy for identifying which
side has a duty to report in a variety of transactions. This rule would
have provided, among other things, that, in a transaction in which
neither side included a security-based swap dealer or major security-
based swap participant, if one side included a U.S. person while the
other side did not, the side with the U.S. person would have been the
reporting side; if both sides in such transaction included a U.S.
person or neither side included a U.S. person, the sides would have
been required to select the reporting side.\270\ In the Regulation SBSR
Adopting Release, we adopted rules establishing the reporting hierarchy
for a range of transactions, including a provision that, in a
transaction in which neither side includes a registered security-based
swap dealer or registered major security-based swap participant but
both sides include a U.S. person, the sides shall select the reporting
side.\271\ We noted in that release that we anticipated soliciting
additional comment about how to apply Regulation SBSR, including which
side should incur the reporting duty, in transactions between two
unregistered non-U.S. persons and transactions between an unregistered
U.S. person and an unregistered non-U.S. person.\272\
---------------------------------------------------------------------------
\270\ See Regulation SBSR Adopting Release, 80 FR 14597.
\271\ See rule 901(a)(2)(ii)(E)(1).
\272\ See Regulation SBSR Adopting Release, 80 FR 14598.
---------------------------------------------------------------------------
C. Commenters' Views
1. General Comments on Application of Clearing, Trade Execution,
Regulatory Reporting, and Public Dissemination Requirements
One commenter generally supported our proposed territorial approach
to applying these requirements, noting that the requirements ``would
encompass any transaction with a U.S. person or within the U.S.'' \273\
Similarly, another market participant agreed with our proposed
application of these requirements to security-based swaps entered into
by offshore funds that have a U.S. nexus, arguing that a failure to
apply such requirements would undermine central objectives of the Dodd-
Frank Act, create opportunities for regulatory arbitrage, and risk
fragmenting the security-based swap market.\274\
---------------------------------------------------------------------------
\273\ Better Markets Letter at 19-20.
\274\ See Citadel Letter at 1.
---------------------------------------------------------------------------
At the same time, other commenters raised concerns about our
proposed approach.\275\ Some commenters explained that applying
mandatory clearing, mandatory trading, regulatory reporting, and public
dissemination requirements to transactions between non-U.S. branches of
two U.S. persons would lead to duplication of, and conflicts with,
foreign requirements.\276\ Another commenter criticized the proposed
approach to categorization of these requirements, stating that the
proposal did not classify regulatory reporting, public dissemination,
mandatory clearing, or mandatory trade execution as either entity-level
requirements or transaction-level requirements but as a distinct
category of ``transactional requirements'' that apply to persons
regardless of their registration status.\277\ This commenter argued
that multiple categories of requirements make it more difficult for
market participants to determine which requirements apply and whether
substituted compliance is available.\278\ The commenter contended that
it would be simpler and more rational to apply the clearing, trade
execution, regulatory reporting, and public dissemination requirements
in the same way that we proposed to apply the external business conduct
requirements.\279\
---------------------------------------------------------------------------
\275\ See, e.g., IIB Letter at 6-7, 23 (stating that the
registration requirement, external business conduct standards,
clearing, trade execution, regulatory reporting, and public
dissemination requirements should not apply to transactions of non-
U.S. persons with foreign security-based swap dealers based on
conduct in the United States when neither counterparty's obligations
under the security-based swap are guaranteed by a U.S. person,
because such an application would create ``serious operational,
legal and economic difficulties for foreign security-based swap
market participants'').
\276\ See IIB Letter at 9; EC Letter at 2.
\277\ See SIFMA/FIA/FSR Letter at A-38 to A-39.
\278\ See id.
\279\ See id.
---------------------------------------------------------------------------
2. Comments on Mandatory Clearing and Mandatory Trade Execution
Market participants expressed a range of views regarding the
application of mandatory clearing and mandatory trade execution to
transactions of non-U.S. persons conducted within the United States.
One commenter supported our proposed definition of ``transaction
conducted within the United States'' together with our proposal to
impose the clearing requirement on such transactions because this
approach would help ensure that the security-based swap activity of
offshore funds managed by U.S.-based investment managers is subject to
our clearing requirements.\280\ Two commenters specifically argued that
the proposed exceptions from the application of mandatory clearing
should be eliminated,\281\ and one commenter urged the same with
respect to mandatory trade execution.\282\ One of these commenters
suggested that, at most, we should permit substituted compliance for
the transactions rather than excepting them from any application of the
clearing requirement.\283\
---------------------------------------------------------------------------
\280\ See Citadel Letter at 3.
\281\ See AFR Letter at 10 (arguing that the exceptions were
unreasonable because ``no provision of Dodd-Frank justifies
exempting security-based swaps that occur within our borders from
U.S. regulatory requirements''); Better Markets Letter at 22
(arguing that the exception for the clearing requirement conflicts
with the Commission's territorial approach). Cf. Letter from AFR to
CFTC and SEC, dated November 25, 2014 (arguing that foreign
subsidiaries of U.S. firms without guarantees may present risk to
the United States).
\282\ See Better Markets Letter at 22.
\283\ See AFR Letter at 10.
---------------------------------------------------------------------------
Other commenters opposed an activity-based application of mandatory
clearing or trade execution. One market participant argued that conduct
in the United States should not trigger the application of the clearing
requirement because the test ``is impractical, cannot be justified by
cost-benefit analysis and exceeds the Commission's SBS authority under
the Exchange Act.'' \284\ Another commenter opposed applying regulatory
requirements, including clearing and trade execution, to transactions
between two unguaranteed non-U.S. persons that involve activity in the
United States, regardless of their status as registered security-based
swap dealers.\285\
---------------------------------------------------------------------------
\284\ See SIFMA/FIA/FSR Letter A-48. See also FOA Letter at 8
(stating that a transaction conducted within the United States that
involves one non-U.S. person security-based swap dealer is
insufficiently connected to the United States to require mandatory
clearing and mandatory trade execution).
\285\ See ICI Letter at 8-10 n.23 (explaining that the risk in
such transactions is outside the United States, that the
counterparties would have no expectation that the requirements would
apply, and that U.S. persons and non-U.S. persons that use U.S.
asset managers would be placed at a competitive disadvantage); EC
Letter at 2 (submitting that the Commission's rules should not apply
to a transaction where the legal counterparty is a non-U.S. person,
on the basis that there is no counterparty risk to a U.S. person in
such a transaction).
---------------------------------------------------------------------------
3. Comments on Regulatory Reporting and Public Dissemination
Commenters expressed divergent views regarding application of
Regulation SBSR to transactions
[[Page 27480]]
involving the conduct of non-U.S. persons within the United
States.\286\ Noting its general opposition to the proposed
``transaction conducted within the United States'' concept, one
commenter argued that the regulatory reporting and public dissemination
requirements should not apply to transactions conducted within the
United States between two non-U.S.-person counterparties because the
proposed requirement would likely result in ``duplicative reporting
requirements.'' \287\ Another commenter argued that it would be
``unnecessary and unworkable'' to require transactions that are between
non-U.S. persons and are executed but not cleared in the United States
to be reported, noting that such transactions would generally be
subject to reporting in the counterparties' jurisdictions and
additional reporting to a U.S. SDR would impose additional significant
costs.\288\ Another commenter argued that applying Regulation SBSR on
the basis of conduct in the United States would not be workable because
it would require a trade-by-trade analysis rather than ``party level
static data,'' for which system architecture does not currently
exist.\289\ This commenter also stated that market participants do not
have the capability to determine whether their counterparty's
activities trigger the proposed conduct test.\290\
---------------------------------------------------------------------------
\286\ See Citadel Letter at 1-2; ABA Letter at 3 (noting that
the initially proposed activity-based approach is consistent with
longstanding Commission practice but also noting potential
ambiguities); IAA Letter at 6 (explaining that the proposed term may
capture parties with minimal connection to the United States); IIB
Letter at 8-9 (explaining that application of the term may result in
duplicative and conflicting regulation); EC Letter at 2 (explaining
that the Commission's rules should not apply because no U.S. firms
are subject to counterparty credit risk in such transactions); FOA
Letter at 7-8 (explaining that the test would reach transactions
with minimal nexus to the United States); JFMC Letter at 4-5
(requesting that the Commission not apply its rules to such
transactions based on its belief that such an approach would
conflict with the CFTC approach).
\287\ SIFMA/FIA/FSR Letter at A-42.
\288\ Letter from Cleary Gottlieb Steen & Hamilton LLP to CFTC,
SEC, Board of Governors of the Federal Reserve System, Office of the
Comptroller of the Currency, Federal Deposit Insurance Corporation,
Federal Housing Finance Agency, and Farm Credit Administration
(``Cleary Letter''), dated September 20, 2011 at 28 (suggesting that
the Commission adopt accommodations for the use of non-U.S. SDRs in
appropriate cases).
\289\ See Letter from ISDA to SEC dated November 14, 2014
(``ISDA Letter'') at 18 (urging us not to apply Regulation SBSR on
the basis of conduct within the United States as it would not be
practicable). This commenter also argued that counterparties to a
transaction executed on an SB SEF, and not the SB SEF itself, should
be required to report such transactions. See id. at 7. See also
Regulation SBSR Proposed Amendments Release, 80 FR 14748-49 (citing
additional comment letters addressing this issue).
\290\ See ISDA Letter at 18. This commenter also argued that,
because in its view a security-based swap involving only non-U.S.
persons that are not registered as a security-based swap dealer or
as a major security-based swap participant should not be required to
be reported, the reporting hierarchy need not address the reporting
obligations arising from such security-based swap transactions. See
id. at 19.
---------------------------------------------------------------------------
4. The CFTC Staff Advisory and Responses to the CFTC Request for
Comment
As noted above, in response to the solicitation of comment on the
CFTC Staff Advisory, commenters raised concerns specifically with
respect to the application of the approach in that document to the
CFTC's transaction-level requirements.
Some commenters suggested that only those CFTC transaction-level
requirements directly relevant to the specific activities that the swap
dealer carries out from a U.S. location should apply to the
transaction, generally taking the view that the CFTC's regulatory
interest extends only to counterparty-facing activities and not, for
example, to the risk-mitigation aspects of Title VII.\291\ One
commenter suggested, however, that certain counterparty-facing
communications raise no concerns relevant to Title VII and therefore
should not trigger application of transaction-level requirements, even
if a swap dealer engages in such communications within the United
States.\292\ Another commenter noted that this approach would help
ensure that costs and benefits of such an approach were
commensurate.\293\
---------------------------------------------------------------------------
\291\ See IIB Letter to CFTC at 8-10 (arguing that, if the CFTC
adopts the CFTC Staff Advisory, it should apply only the
transaction-level requirements relevant to the activity that occurs
within the United States); SIFMA/FIA/FSR Letter to CFTC at A-9 to A-
11 (any approach adopted by the CFTC that is based on the use of
personnel located in the United States should trigger only
requirements that relate to concerns raised by the conduct that
triggered the requirements); Barclays Letter to CFTC at 3 (arguing
that the only transaction-level requirements whose objectives are
implicated by activity in which the ``sole nexus to the U.S. is the
participation of U.S.-based personnel of a non-U.S. swap dealer''
are requirements related to ``sales practices'' and that, therefore,
the only relevant transaction-level requirements that should apply
to such transactions, should the CFTC adopt an approach that is
based on the use of personnel located in the United States, are pre-
trade disclosure requirements); ISDA Letter to CFTC at 9 (suggesting
that, should the CFTC adopt the approach in the CFTC Staff Advisory,
only those transaction-level requirements that are transaction-
specific and that relate to the triggering communication--
transaction specific disclosure and communications--should apply to
the transaction).
\292\ See SIFMA/FIA/FSR Letter at A-11 to A-12 (stating that
``arranging and negotiating trading relationships and legal
documentation and providing legal advice as well as providing credit
terms and technical terms, market color, market research or a
general discussion of the swap transaction'' have no relation to any
concerns of the Dodd-Frank Act in transactions between two non-U.S.
persons).
\293\ See Barclays Letter to CFTC at 3.
---------------------------------------------------------------------------
Commenters also noted that a non-U.S.-person swap dealer using
personnel or agents located in the United States to arrange, negotiate,
or execute swap transactions generally would already be subject to
regulation in its home jurisdiction.\294\ In their view, adoption of
the CFTC Staff Advisory would raise the possibility of conflicting and
duplicative regulation of such non-U.S.-person swap dealers and
reflected a lack of comity on the CFTC's part toward regulators in
other jurisdictions.\295\
---------------------------------------------------------------------------
\294\ See CDEU Letter to CFTC at 2, 3 (arguing that the approach
in the CFTC Staff Advisory represents a departure from the CFTC
Cross-Border Guidance in that a transaction between two entities
organized under German law would be subject to the Title VII
requirements and the EMIR requirements, which would be duplicative
and unnecessary, without any ability for substituted compliance);
IIB Letter to CFTC at 5 (explaining that ``[i]t would stand
international comity on its head for the [CFTC]'' to adopt the CFTC
Staff Advisory's approach of imposing regulatory requirements on
non-U.S. firms on the basis of ``limited activities'' of their U.S.
personnel or agents when the foreign jurisdiction has strong
supervisory interests in the risks arising from the transactions);
JFMC Letter to CFTC at 1 (explaining that the CFTC Staff Advisory's
approach to applying transaction-level requirements does not account
for the application of foreign regimes to the transaction).
\295\ See SIFMA/FIA/FSR Letter to CFTC at A-6 (explaining that
the CFTC Staff Advisory fails to respect comity principles because
it would not ``give due recognition to the compelling supervisory
interests of home regulators in the jurisdictions in which these
transactions occur''). See also IIB Letter to CFTC at 6 (arguing
that Dodd-Frank incorporates mechanism for addressing competition
concerns: a ``mandate'' for international harmonization).
Accordingly, they urged the CFTC to make substituted compliance
available in such transactions. See CDEU Letter to CFTC at 5 (urging
the CFTC to make substituted compliance determinations with respect
to the transaction-level requirements and to defer to foreign
regulators to regulate entities that are organized under the laws of
their jurisdiction); ISDA Letter to CFTC at 4 (arguing that
substituted compliance should be available for transactions between
a non-U.S. swap dealer and a non-U.S. counterparty if the CFTC
adopts the approach in the CFTC Staff Advisory); SIFMA/FIA/FSR
Letter to CFTC at A-13 (suggesting that substituted compliance be
available for the transaction-level requirements).
---------------------------------------------------------------------------
Some commenters suggested that adoption of the CFTC Staff Advisory
could present difficulties for, and impose costs on, non-U.S.-person
counterparties of dealers, as such counterparties may not currently
have systems in place for complying with certain CFTC requirements,
particularly if they are imposed only because the swap dealer (and not
the counterparty) happens to have carried out certain activities using
personnel or agents
[[Page 27481]]
located in the United States.\296\ As a result, commenters argued that
non-U.S. swap dealers may no longer be able to service non-U.S.-person
counterparties from U.S. locations.\297\ Some commenters noted possible
competitive effects of imposing, or not imposing, transaction-level
requirements on such transactions. One commenter supported the CFTC
Staff Advisory, arguing that without it, U.S. firms would be at a
competitive disadvantage compared to non-U.S. firms operating in the
United States, because U.S. firms would be subject to different rules
for the same transactions.\298\
---------------------------------------------------------------------------
\296\ See, e.g., SIFMA/FIA/FSR Letter to CFTC at A-4 (explaining
that certain non-U.S.-person counterparties may not have clearing
relationships with FCMs, and requiring them to clear through an FCM
simply because the dealer happens to use personnel within the United
States in the transaction would be costly).
\297\ See, e.g., ISDA Letter to CFTC at 4.
\298\ See AFR Letter to CFTC at 3 (explaining that ``any
weakening of [the] advisory would open the door to regular and
significant levels of swaps activities being performed within the
U.S. by nominally foreign entities under foreign rules, or in some
cases no rules at all,'' whereas U.S. firms operating in the United
States would be subject to different rules for the same transactions
operating in the same market).
---------------------------------------------------------------------------
Some commenters indicated that adoption of the CFTC Staff Advisory
would also disadvantage non-dealing counterparties. For example, one
commenter argued that, were the CFTC Staff Advisory adopted, end users
that trade with non-U.S. swap dealers might face competitive
disadvantages.\299\ Other commenters noted that the application of
transaction-level requirements to such transactions could put foreign
swap dealers at a competitive disadvantage because it would be overly
burdensome for them to use U.S.-based personnel or agents to perform
certain function in connection with their dealing activity,
particularly with respect to transactions with foreign counterparties
that may oppose being subject to transaction-level requirements, and
that the adoption of the CFTC Staff Advisory would therefore encourage
dealers not to use their U.S.-based personnel.\300\
---------------------------------------------------------------------------
\299\ See CDEU Letter to CFTC at 2 (urging the CFTC not to adopt
the Staff Advisory because it would lead to competitive
disadvantages for certain non-U.S. end-user affiliates that had
relied on trading with non-U.S. swap dealers compared to other non-
U.S. end users in the same markets that currently hedge with
unregistered counterparties). This commenter also expressed concern
that applying the transaction-level requirements to such
transactions would disadvantage non-U.S.-person non-dealers that
choose to hedge with non-U.S. swap dealers using personnel or agents
in the United States, as compared to non-U.S. persons that choose to
hedge with unregistered counterparties or dealers that do not use
personnel or agents in the United States. See CDEU Letter to CFTC at
1-2.
\300\ See ISDA Letter to CFTC at 4 (noting that non-U.S.
counterparties have insisted that a swap dealer not use its U.S.-
based personnel so as to avoid being subject to transaction-level
requirements). See also JFMC Letter to CFTC at 1 (explaining that
adoption of the CFTC Staff Advisory would create regulatory
uncertainty and disrupt the planning of firms' systems and put Asia-
based swap dealers at a disadvantage if they want to use U.S.-based
personnel or agents).
---------------------------------------------------------------------------
D. Mandatory Clearing and Trade Execution
After careful consideration of concerns raised by commenters and
our further consideration of policy concerns relevant to the security-
based swap market, we are not proposing to subject transactions between
two non-U.S. persons to the clearing requirement (and, by extension, to
the trade execution requirement \301\) on the basis of dealing activity
in the United States, including transactions that are arranged,
negotiated, or executed by personnel located in a U.S. branch or
office.
---------------------------------------------------------------------------
\301\ We continue to believe that, under the statutory
framework, a security-based swap transaction is potentially subject
to the trade execution requirement only if it is first subject to
the clearing requirement. See Cross-Border Proposing Release, 78 FR
31082. Accordingly, to the extent that the clearing requirement does
not apply to a particular security-based swap transaction, the trade
execution requirement also would not apply. See id. (noting that, to
the extent that we are proposing not to apply the clearing
requirement to a particular transaction, the trade execution
requirement would not apply to such transaction).
---------------------------------------------------------------------------
As we noted in the Cross-Border Proposing Release, because the
financial risks of such a transaction reside outside the United States,
``it is not necessary to apply the mandatory clearing requirement to a
transaction between two non-U.S. persons solely'' because the
transaction involves activity in the United States.\302\ However, the
proposed approach would have subjected a ``transaction conducted within
the United States'' involving at least one registered foreign security-
based swap dealer to the clearing requirement (and, as noted, to the
trade execution requirement). We proposed this approach because we
preliminarily believed that registered foreign security-based swap
dealers would have a more significant connection to the United States
and to minimize potential competitive disparities between U.S. persons
and non-U.S. persons.\303\
---------------------------------------------------------------------------
\302\ Cross-Border Proposing Release, 78 FR 31080.
\303\ See id. at 31080.
---------------------------------------------------------------------------
On further consideration, however, we now preliminarily believe
that we should not impose the clearing requirement on a security-based
swap transaction between two non-U.S. persons where neither
counterparty's obligations under the security-based swap are guaranteed
by a U.S. person, even if the transaction involves one or more
registered foreign security-based swap dealers. In our view, a key
objective of the clearing requirement is to mitigate systemic and
operational risk in the United States, but the counterparty credit risk
and operational risk of such transactions reside primarily outside the
United States.\304\ Accordingly, we preliminarily believe that
subjecting such security-based swaps to the clearing requirement would
not significantly advance what we view as a key policy objective of the
clearing requirement applicable to security-based swaps under the Dodd-
Frank Act.\305\
---------------------------------------------------------------------------
\304\ See id. at 31077; note 285, supra (citing EC Letter
arguing that activity between two non-U.S. persons in the United
States does not create counterparty credit risk in the United
States). We recognize that even if a transaction involving one or
more registered foreign security-based swap dealers that is
arranged, negotiated, or executed by personnel located in the United
States does not create financial or counterparty credit risk that
resides in the United States, it may create operational risks
associated, for example, with the processing of the transaction. See
id. However, such risks are borne primarily by the counterparties to
the transaction, both of whom are by definition--in the transactions
being addressed in this release--non-U.S. persons (because they are
incorporated outside the United States and do not have their
principal place of business in the United States). Accordingly, any
reduction of operational risks in the U.S. financial market that
would be produced by requiring these transactions to be cleared by a
U.S.-registered clearing agency would likely be insignificant. On
the other hand, imposing the clearing requirement on a transaction
between two non-U.S. persons involving at least one registered
foreign security-based swap dealer because the transaction was
arranged, negotiated, or executed in the United States to be cleared
by a U.S.-registered clearing agency would directly expose that
clearing agency and, through it, the U.S. financial system to the
counterparty credit risk of the transaction.
\305\ For these reasons, we disagree with commenters that
characterized any exception from the clearing requirement as
``indefensible'' or ``unreasonable.'' See note 281, supra.
We recognize that another commenter suggested that our initially
proposed approach, which would have required a ``transaction
conducted within the United States'' to be cleared, subject to
certain exceptions, would help ensure that transactions of non-U.S.-
person funds that are managed by U.S.-based investment managers are
subject to the Title VII clearing requirement. See note 280, supra
(citing Citadel Letter). Under the approach set forth in this
release, the transactions of such funds may not be subject to the
clearing requirement when the counterparty is not a U.S. person,
but, as already noted, the risks of such transactions reside
primarily outside the United States, and we preliminarily do not
believe that requiring such transactions to be cleared would further
the purposes of the clearing requirement. To the extent that the
fund has its principal place of business in the United States, of
course, it would be a U.S. person and, under the approach set forth
in our Cross-Border Proposing Release, would be subject to the
clearing requirement. See Exchange Act rule 3a71-3(a)(4)(B)
(defining ``U.S. person'' to include, among other things, an
investment vehicle ``having its principal place of business in the
United States''); Cross-Border Proposing Release, 78 FR 31078
(describing applicability of clearing requirement to U.S. persons
under that proposal). Cf. note 285, supra (citing ICI Letter noting
that mere presence of an investment manager in the United States
does not necessarily create risk in the United States).
---------------------------------------------------------------------------
[[Page 27482]]
We recognize that, to the extent that a non-U.S. person using
personnel located in a U.S. branch or office to arrange, negotiate, or
execute security-based swap transactions in connection with its dealing
activity is affiliated with a U.S. financial firm, the non-U.S.
person's security-based swap exposures may pose risk to its U.S.
affiliates in the United States, as U.S. entities that are affiliated
with non-U.S. persons may determine for reputational reasons that they
must support their non-U.S. affiliates at times of crisis.\306\
However, as we noted in the Cross-Border Adopting Release, Congress has
established other regulatory tools that are specifically intended, and
better suited, to address risks to bank holding companies and financial
holding companies, arising from the financial services activities of a
foreign affiliate of those holding companies where the foreign
affiliate does not engage in security-based swap activity in the United
States,\307\ and we preliminarily believe the same principle applies
here. Moreover, we note that it is likely that such a non-U.S. person
engaged in significant security-based swap dealing activity would be a
registered security-based swap dealer under our proposed approach and
subject to Title VII capital and margin requirements, which we
preliminarily believe would be a more narrowly tailored and appropriate
way of mitigating any such risk in this context.\308\ Under proposed
rule 3a71-3(b)(1)(iii)(C), the non-U.S. person would be required to
include in its dealer de minimis threshold calculations any security-
based swap transaction that it arranged, negotiated, or executed in
connection with its dealing activity using personnel located in a U.S.
branch or office. Any non-U.S. person engaged in significant activity
in the United States, including a non-U.S.-person affiliate of a U.S.
financial firm whose obligations under a security-based swap are not
guaranteed by its U.S. parent, would be required to register as a
security-based swap dealer and comply with Title VII capital and margin
requirements (along with other entity-level requirements). Whereas the
clearing requirement would have applied only to certain transactions of
registered foreign security-based swap dealers, capital and margin
requirements would apply to all of their security-based swap
transactions, including those that do not involve personnel located in
a U.S. branch or office.\309\
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\306\ See Cross-Border Adopting Release, 79 FR 47318. As we
noted in the Cross-Border Adopting Release, however, any U.S. person
that is subject to the reporting requirements of section 13(a) or
section 15(d) of the Exchange Act, 15 U.S.C. 78m(a) or 15 U.S.C.
78o(d) respectively, regardless of whether that person provides a
recourse guarantee relating to its non-U.S. affiliates' obligations,
must consider whether there are disclosures that must be made in its
periodic reports regarding any of its obligations. See Cross-Border
Adopting Release, 79 FR 47318 n.348.
\307\ See id. at 47318-19.
\308\ We also note in this regard the relatively low liquidity
of the security-based swap market in general, even for the most
liquid products. See Section II.B.3, supra.
\309\ See, e.g., Cross-Border Proposing Release, 78 FR 31011-12
(proposing to treat margin as an entity-level requirement).
---------------------------------------------------------------------------
We also preliminarily believe that requiring such security-based
swap transactions to be cleared (and executed on a platform) would
impose a significant burden on certain market participants. Some non-
U.S. person counterparties may not currently have a direct or indirect
relationship with a U.S.-registered clearing agency, and the burdens of
establishing such a relationship may deter these non-U.S. persons--
particularly those not engaged in dealing activity--from entering into
security-based swap transactions with non-U.S. persons that, in
connection with their dealing activity arrange, negotiate, or execute
such transactions using personnel located in a U.S. branch or
office.\310\ Given that, under our proposed approach, a non-U.S. person
that engages in significant security-based swap activity using
personnel located in a U.S. branch or office is likely to be required
to register and be subject to Title VII capital and margin requirements
with respect to all of its transactions, we preliminarily do not
believe that subjecting a subset of these persons' activities to the
clearing requirement is likely to provide a significant additional
reduction in counterparty credit risk in the United States. Consistent
with customary Commission practice, we expect that Commission staff
will monitor developments in the security-based swap market, including
changes in liquidity or market fragmentation, that may warrant
reconsideration of this proposed approach and, if necessary and
appropriate, make recommendations to address such developments.
---------------------------------------------------------------------------
\310\ See notes 296-297, supra. Establishing a direct
relationship with a clearing agency may entail upfront costs that
include, among other things, meeting minimum capital requirements
and making minimum clearing fund contributions. See, e.g., ICE Clear
Credit Clearing Rules at 12 and 90 (available at: https://www.theice.com/publicdocs/clear_credit/ICE_Clear_Credit_Rules.pdf,
last visited April 15, 2015).
---------------------------------------------------------------------------
Because such security-based swap transactions would not be subject
to the clearing requirement, under our proposed approach they would
also not be subject to mandatory trade execution. While we acknowledge
that trading between two non-U.S. persons in the OTC market may
indirectly affect liquidity available to market participants subject to
mandatory trade execution,\311\ we preliminarily do not believe that it
is appropriate to require such non-U.S. persons to shift their non-U.S.
business to trading platforms merely because one of the counterparties
to the transaction uses personnel located in a U.S. branch or office to
arrange, negotiate, or execute the transaction.\312\ As with the
clearing requirement, and consistent with customary Commission
practice, we expect that Commission staff will monitor developments in
the security-based swap market, including changes in liquidity or
market fragmentation, that may warrant reconsideration of this proposed
approach and, if necessary and appropriate, make recommendations to
address such developments.
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\311\ See Section VI.C.4, infra.
\312\ See note 308, supra.
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E. Regulation SBSR
We are proposing amendments to Regulation SBSR to address the
application of the regulatory reporting and public dissemination
requirements to certain transactions not addressed in the Regulation
SBSR Adopting Release or the Regulation SBSR Proposed Amendments
Release.
1. Statutory Framework
Section 13A(a)(1) of the Exchange Act \313\ provides that ``[e]ach
security-based swap that is not accepted for clearing by any clearing
agency or derivatives clearing organization shall be reported to--(A) a
registered security-based swap data repository described in section
13(n); or (B) in the case in which there is no security-based swap data
repository that would accept the security-based swap, to the
Commission.'' Section 13(m)(1)(G) of the Exchange Act \314\ provides
that ``[e]ach security-based swap (whether cleared or uncleared) shall
be reported to a registered security-based swap data repository.''
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\313\ 15 U.S.C. 78m-1(a)(1).
\314\ 15 U.S.C. 78m(m)(1)(G). See also 15 U.S.C. 78q(a)(1).
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[[Page 27483]]
Section 13(m)(1)(B) of the Exchange Act \315\ directs the
Commission ``to make security-based swap transaction and pricing data
available to the public in such form and at such times as the
Commission determines appropriate to enhance price discovery.'' Section
13(m)(1)(C) of the Exchange Act \316\ authorizes the Commission to
provide by rule for the public availability of security-based swap
transaction, volume, and pricing data. Furthermore, section 13(m)(1)(D)
of the Exchange Act \317\ authorizes the Commission to require
registered entities (such as registered SDRs) to publicly disseminate
the security-based swap transaction and pricing data required to be
reported under section 13(m) of the Exchange Act. Finally, section
13(n)(5)(D)(ii) of the Exchange Act \318\ requires SDRs to provide
security-based swap information ``in such form and at such frequency as
the Commission may require to comply with the public reporting
requirements.''
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\315\ 15 U.S.C. 78m(m)(1)(B). See also 15 U.S.C. 78q(a)(1).
\316\ 15 U.S.C. 78m(m)(1)(C).
\317\ 15 U.S.C. 78m(m)(1)(D).
\318\ 15 U.S.C. 78m(n)(5)(D)(ii).
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In the Regulation SBSR Adopting Release, we interpreted the
regulatory reporting and public dissemination requirements to apply to
security-based swaps that ``exist, at least in part, within the United
States'' \319\ and noted that a security-based swap with a direct or
indirect counterparty that is a U.S. person necessarily would exist
within the United States.\320\ This view is consistent with a
territorial approach to the statutory language requiring the reporting
of ``[e]ach security-based swap,'' and with the statutory requirement
that security-based swaps that are reported must be publicly
disseminated, unless an exception applies.\321\ In our view, it is also
consistent with a territorial approach to these statutory provisions to
require each security-based swap that is otherwise subject to
regulatory requirements under Title VII (as implemented under our
territorial approach to implementing those requirements) to be reported
and publicly disseminated pursuant to Regulation SBSR.
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\319\ See, e.g., Regulation SBSR Adopting Release, 80 FR 14651.
\320\ See Regulation SBSR Adopting Release, 80 FR 14650.
\321\ See Regulation SBSR Adopting Release, 80 FR 14649-50.
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2. Proposed Amendments Regarding Application of Regulation SBSR to
Certain Security-Based Swap Transactions
(a) Security-Based Swap Transactions That a Non-U.S. Person, in
Connection With its Dealing Activity, Arranges, Negotiates, or Executes
Using Personnel Located in a U.S. Branch or Office
We propose to amend rule 908(a)(1) of Regulation SBSR to include a
provision that would require any security-based swap transaction
connected with a person's security-based swap dealing activity that is
arranged, negotiated, or executed by personnel of such non-U.S. person
located in a U.S. branch or office--or by personnel of its agent
located in a U.S. branch or office--to be reported to a registered SDR
and publicly disseminated pursuant to Regulation SBSR.\322\ This
proposed amendment generally reflects the approach described in our
Cross-Border Proposing Release, which would have subjected
``transactions conducted within the United States'' to both regulatory
reporting and public dissemination requirements.\323\ Consistent with
that approach, it would expand the scope of Regulation SBSR in two
ways. First, it would require the security-based swaps that a
registered foreign security-based swap dealer arranges, negotiates, or
executes using personnel located in a U.S. branch or office to be
publicly disseminated, even if the counterparty to such transaction is
another non-U.S. person whose obligations under the security-based swap
are not guaranteed by a U.S. person.\324\ Second, it would require that
a transaction of a non-U.S. person that is not a registered security-
based swap dealer be subject to both regulatory reporting and public
dissemination under Regulation SBSR if that non-U.S. person would be
required to include the transaction in its de minimis threshold
calculations under proposed Exchange Act rule 3a71-3(b)(1)(iii)(C), as
described above.
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\322\ See proposed rule 908(a)(1)(v). We intend the proposed
rule to indicate the same type of activity by personnel located in
the United States as described in Section III.B.5, supra. Moreover,
for purposes of proposed rule 908(a)(1)(v), we would 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. See note 193, supra
(discussing the Commission's proposed interpretation of the term
``personnel'' for purposes of proposed rule 3a71-3(b)(1)(iii)(C)).
\323\ We preliminarily believe that the approach reflected in
this release, which focuses only on whether a counterparty in
connection with its dealing activity has arranged, negotiated, or
executed the security-based swap transaction using personnel located
in the United States, should mitigate many of the concerns raised by
commenters. See note 286, supra (citing several comment letters
arguing, among other things, that requirements, including Regulation
SBSR, should not apply to transactions with only a minimal
connection to the United States). See also notes 289-290, supra
(citing comment letters arguing that looking to activity in the
United States as a trigger for Regulation SBSR would not be
practicable); note 292, supra (citing SIFMA/FIA/FSR Letter).
We recognize that some commenters suggested that certain Title
VII requirements, including the regulatory reporting and public
dissemination requirements implemented by Regulation SBSR, should
not apply to transactions between two non-U.S. persons even if they
involve activity in the United States because of operational
complications or potential regulatory overlap or duplication. See
note 275-276, 286-287, and 294-295, supra. We do not believe,
however, that reporting a security-based swap to a registered SDR is
likely to pose significant challenges, as the burden is borne under
our rules only by one side of the transaction, and at least one
counterparty to any transaction arranged, negotiated, or executed by
a non-U.S. person, in connection with its dealing activity, using
personnel located in a U.S. branch or office is already likely to
have infrastructure in place to report transactions to a registered
SDR.
\324\ Under Exchange Act rule 3a71-1(c), absent a limitation by
the Commission, a security-based swap dealer is deemed to be a
security-based swap dealer with respect to each security-based swap
it enters into, regardless of the type, class, or category of the
security-based swap or the person's activities in connection with
the security-based swap. Accordingly, for purposes of this proposed
amendment, any transaction that a registered security-based swap
dealer arranged, negotiated, or executed using personnel located in
a U.S. branch or office would be ``in connection with its dealing
activity'' and subject to both regulatory reporting and public
dissemination.
---------------------------------------------------------------------------
Requiring these transactions to be reported to a registered SDR
should enhance our ability to oversee relevant activity related to
security-based swap dealing occurring within the United States as well
as to monitor market participants for compliance with specific Title
VII requirements (including the requirement that a person register with
the Commission as a security-based swap dealer if it exceeds the de
minimis threshold). We preliminarily believe it would also likely
enhance our ability to monitor for manipulative and abusive practices
involving security-based swap transactions or transactions in related
underlying assets, such as corporate bonds or other securities
transactions that result from dealing activity, or other relevant
activity, in the U.S. market.
Subjecting these transactions to the public dissemination
requirements of Regulation SBSR should enhance the level of
transparency in the U.S. security-based swap market, potentially
reducing implicit transaction costs \325\
[[Page 27484]]
and promoting greater price efficiency. As we noted in the Regulation
SBSR Adopting Release, the current market for security-based swaps is
opaque.\326\ Dealers can observe order flow submitted to them by
customers and other potential counterparties and know about their own
executions, and may know about other dealers' transactions in certain
instances, but information about executed transactions is not
widespread. Market participants--particularly non-dealers--have to
arrive at a price at which they would be willing to assume risk with
little or no knowledge of how other market participants would or have
arrived at prices at which they have assumed or would be willing to
assume risk. We preliminarily believe that, by reducing information
asymmetries between non-dealers and persons acting in a dealing
capacity and providing more equal access to post-trade information in
the security-based swap market, implicit transaction costs could be
reduced, which could in turn promote greater price efficiency.\327\
Ensuring that post-trade information encompasses transactions involving
a non-U.S. person that arranged, negotiated, or executed the security-
based swap in connection with its dealing activity using personnel
located in a U.S. branch or office could increase price competition and
price efficiency in the security-based swap market and should enable
all market participants to have more comprehensive information with
which to make trading and valuation determinations.\328\
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\325\ As discussed in the Regulation SBSR Adopting Release,
dealing activity in the single-name CDS market is concentrated among
a small number of firms that each enjoy informational advantages as
a result of the large quantity of order flow they privately observe.
Implicit transaction costs are the difference between the
transaction price and the fundamental value, which could reflect
adverse selection or could reflect compensation for inventory risk.
In addition to these implicit transaction costs, security-based swap
market participants may face explicit transaction costs such as
commissions and other fees that dealers might charge non-dealers for
access to the market. See Regulation SBSR Adopting Release, 80 FR
14704 n.1254.
\326\ See Regulation SBSR Adopting Release, 80 FR 14605.
\327\ Security-based swaps are complex derivative products, and
there is no single accepted way to model a security-based swap for
pricing purposes. As we noted in the Regulation SBSR Adopting
Release, making post-trade pricing and volume information publicly
available should allow valuation models to be adjusted to reflect
how other market participants have valued a security-based swap
product at a specific moment in time. Public dissemination of last-
sale information also should aid persons engaged in dealing activity
in deriving better quotations, because they will know the prices at
which other market participants have traded. Last-sale information
also should aid end users and other non-dealing entities in
evaluating current quotations, by allowing them to question why a
dealer's quote differs from the prices of the most recent
transactions. Furthermore, smaller market participants that view
last-sale information should be able to test whether quotations
offered by dealers before the last sale were close to the price at
which the last sale was executed. In this manner, post-trade
transparency should promote price competition and more efficient
price discovery in the security-based swap market. See Regulation
SBSR Adopting Release, 80 FR 14606.
\328\ See id.
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(b) Security-Based Swaps Executed on a Platform Having Its Principal
Place of Business in the United States
We also are proposing to amend rule 908(a)(1) of Regulation SBSR by
adding a provision that would require any security-based swap
transaction that is executed on a platform \329\ having its principal
place of business in the United States both to be reported to a
registered SDR and to be publicly disseminated pursuant to Regulation
SBSR.\330\ Under our previously re-proposed rule, such transactions
generally would have been subjected to Regulation SBSR as
``transactions conducted within the United States'' under the proposed
definition of that term.
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\329\ Regulation SBSR defines ``platform'' to mean ``a national
securities exchange or security-based swap execution facility that
is registered or exempt from registration.'' Rule 900(v).
\330\ See proposed rule 908(a)(1)(iii).
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As noted above, our proposed amendments to Regulation SBSR focus on
transactions that a non-U.S. person, in connection with its dealing
activity, arranges, negotiates, or executes using personnel located in
a U.S. branch or office rather than on the broader range of activity
reflected in our proposed definition of ``transaction conducted in the
United States.'' We preliminarily continue to believe, however, that a
transaction executed on a platform that has its principal place of
business in the United States also should be subject to Regulation
SBSR, even when the transaction involves two non-U.S. persons that are
not engaged in dealing activity in connection with the transaction.
Transactions executed on a platform having its principal place of
business in the United States are consummated within the United States
and therefore exist, at least in part, in the United States.\331\
Requiring these security-based swaps to be reported to a registered SDR
will permit the Commission and other relevant authorities to observe,
in a registered SDR, all transactions executed on such a platform and
to carry out oversight of such security-based swaps. Furthermore, we
preliminarily believe that public dissemination of such transactions
would have value to participants in the U.S. security-based swap
market, who are likely to trade the same or similar products, as these
products will have been listed by a platform having its principal place
of business in the United States.
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\331\ Cf. Regulation SBSR Adopting Release, 80 FR 14654 (noting
that a security-based swap that is accepted for clearing by a
clearing agency having its principal place of business in the United
States also exists, at least in part, within the United States).
Requiring these transactions to be reported should enable
registered SDRs to have a complete record of all security-based
swaps that are executed on platforms that have their principal place
of business in the United States, which should enhance our ability
to monitor these platforms, and activity in the security-based swap
market more generally, for manipulation and other abusive practices.
Cf. Cross-Border Proposing Release, 78 FR 31040 (noting importance
of having a complete record of security-based swaps). Requiring
these transactions to be reported should also enhance our ability to
monitor activity on these platforms for compliance with
recordkeeping and reporting and other requirements. See Cross-Border
Proposing Release, 78 FR 31183 (discussing the market-wide benefits
of enhanced transparency).
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(c) Security-Based Swaps Effected by or Through a Registered Broker-
Dealer
We are also proposing to amend rule 901(a) of Regulation SBSR by
adding a provision that would require the reporting and public
dissemination of any security-based swap transaction that is effected
by or through a registered broker-dealer (including a registered SB
SEF).\332\ As noted above, existing rule 908(a)(1) already provides
that any transaction involving a U.S. person, either directly or
indirectly, on one or both sides of the transaction subjects that
transaction to both regulatory reporting and public dissemination;
proposed rule 908(a)(1)(v) would impose the same requirements with
respect to any transaction that a non-U.S. person in connection with
its dealing activity arranges, negotiates, or executes using its
personnel or the personnel of its agent located in a U.S. branch or
office. Given the limitation on reporting duties set forth in rule
908(b) and in the proposed amendments to that rule, we expect that
most, if not all, registered broker-dealers required to report under
this proposed amendment would be U.S. persons intermediating security-
based swap transactions between non-U.S. person counterparties and that
such persons would be effecting transactions in security-based swaps
from their offices in the United States. Moreover, under the proposed
amendments to the reporting hierarchy described below, a registered
broker-dealer (including a registered SB SEF) would be required to
report transactions effected by or through it only when neither side of
that transaction includes a U.S. person, neither side is a
[[Page 27485]]
registered security-based swap dealer or registered major security-
based swap participant, and neither side of that transaction involves a
non-U.S. person that has, in connection with its dealing activity,
arranged, negotiated, or executed the security-based swap using its
personnel or the personnel of its agent located in a U.S. branch or
office.\333\
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\332\ See proposed rule 908(a)(1)(iv).
\333\ We acknowledge that some commenters urged us not to
require SB SEFs to report transactions under Regulation SBSR. See
note 289, supra. We preliminarily believe, however, that a
registered broker-dealer (including a registered SB SEF) is likely
to be better positioned to report than either counterparty to a
transaction described in proposed rule 901(a)(2)(ii)(E)(4). We note
that proposed rule 901(a)(2)(ii)(E)(4) applies only when two non-
U.S. persons who are not registered security-based swap dealers,
registered major security-based swap participants, or non-U.S.
persons that fall within proposed rule 908(b)(5) effect a security-
based swap through a registered broker-dealer. In the Regulation
SBSR Adopting Release, we observed that non-registered persons are
less likely than Commission registrants to have systems in place to
support the reporting required by Regulation SBSR, and we
preliminarily believe that the same applies here. See Regulation
SBSR Adopting Release, 80 FR 14600.
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To the extent that a registered broker-dealer intermediates a
security-based swap transaction, we preliminarily believe that the
transaction should be both reported to a registered SDR and publicly
disseminated. Registered broker-dealers play a key role as
intermediaries in the U.S. financial markets. To improve integrity and
transparency in those markets, we believe that it is important that the
Commission, and other relevant authorities, have ready access to
detailed information about the security-based swap transactions that
such persons intermediate. Furthermore, we preliminarily believe that
public dissemination of such transactions will have value to
participants in the U.S. security-based swap market, who are likely to
trade the same or similar products.
3. Application of the Public Dissemination Requirement to Certain
Transactions
In the Regulation SBSR Adopting Release, we adopted rule
908(a)(1)(i), which requires, among other things, public dissemination
of all security-based swap transactions having a U.S.-person guarantor,
including transactions in which the other side includes no counterparty
that is a U.S. person, registered security-based swap dealer, or
registered major security-based swap participant (a ``covered cross-
border transaction'').\334\ This represented a departure from the re-
proposed approach described in the Cross-Border Proposing Release,
which would have excepted covered cross-border transactions from the
public dissemination requirement.\335\ We noted, however, that we had
determined to continue considering whether to except covered cross-
border transactions from the public dissemination requirement and that
we would solicit additional comment regarding whether such an exception
would be appropriate. We solicit comment on this approach in the
request for comments below.
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\334\ See rule 908(a)(1)(i); Regulation SBSR Adopting Release,
80 FR 14652-53. As in the Regulation SBSR Adopting Release, a
``covered cross-border transaction'' refers to a transaction that
meets the description above and will not be submitted to clearing at
a registered clearing agency having its principal place of business
in the United States. See Regulation SBSR Adopting Release, 80 FR
14653.
\335\ See Cross-Border Proposing Release, 78 FR 31062; initially
re-proposed rule 908(a)(2) (requiring that security-based swaps be
publicly disseminated if there is a direct or indirect counterparty
that is a U.S. person on each side of the transaction).
---------------------------------------------------------------------------
In light of our determination to require all security-based swap
transactions of U.S. persons, including all transactions conducted
through a foreign branch, to be publicly disseminated, we preliminarily
do not think that it would be appropriate to exempt covered cross-
border transactions from the public dissemination requirement. As we
have noted 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).\336\ Failure to require such transactions to be
publicly disseminated would treat these economically substantially
identical transactions differently, potentially creating competitive
disparities between U.S. persons, depending on how they have structured
their business, as a guaranteed non-U.S. person would be able to carry
out an unlimited volume of covered cross-border transactions without
being subject to the public dissemination requirement.\337\
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\336\ See note 319, supra.
\337\ However, if the transactions of a guaranteed non-U.S.
person are subject to regulatory reporting and public dissemination
requirements in a foreign jurisdiction that are comparable to those
imposed by Regulation SBSR, such transactions could be eligible for
substituted compliance. See rule 908(c).
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4. Proposed Amendments Regarding Limitations on Reporting Obligations
of Certain Persons Engaged in Security-Based Swaps Subject to
Regulation SBSR
Rule 908(b) of Regulation SBSR provides that, notwithstanding any
other provision of Regulation SBSR, a person shall not incur any
obligation under Regulation SBSR unless it is a U.S. person, a
registered security-based swap dealer, or a registered major security-
based swap participant.\338\ We noted that rule 908(b) is designed to
specify the types of persons that will incur duties under Regulation
SBSR. If a person does not come within any of the categories enumerated
by rule 908(b), it would not incur any duties under Regulation
SBSR.\339\ Rule 908(b) was designed to reduce assessment costs and
provide greater legal certainty to counterparties engaging in cross-
border security-based swaps, and we explained that we anticipated
soliciting additional public comment regarding whether regulatory
reporting and/or public dissemination requirements should be extended
to transactions between non-U.S. persons occurring within the United
States and, if so, which non-U.S. persons should incur reporting duties
under Regulation SBSR.\340\
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\338\ See rule 908(b). In the Regulation SBSR Proposed
Amendments Release, we proposed to amend rule 908(b) by adding
platforms and registered clearing agencies to the list of persons
that might incur obligations under Regulation SBSR. See Regulation
SBSR Proposed Amendments Release, 80 FR 14759.
\339\ See Regulation SBSR Adopting Release, 80 FR 14656.
\340\ See id.
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Consistent with the proposed amendments described above, and so
that at least one counterparty to a transaction that is subject to
Regulation SBSR has an obligation to report the transaction to a
registered SDR, we are proposing to add subparagraph (5) to rule 908(b)
to include a non-U.S. person that, in connection with such person's
security-based swap dealing activity, arranged, negotiated, or executed
the security-based swap 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.\341\ Because
[[Page 27486]]
existing rule 908(b)(2) already covers a non-U.S. person that is
registered as a security-based swap dealer, the effect of proposed rule
908(b)(5) would be to cover a non-U.S. person that engages in dealing
activity in the United States but that does not meet the de minimis
threshold and thus would not be registered as a security-based swap
dealer.
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\341\ See proposed rule 908(b)(5). We intend the proposed rule
to indicate the same type of activity by personnel located in the
United States as described in Section III.B.5, supra. Moreover, for
purposes of proposed rule 908(b)(5), we would 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. See note 193, supra
(discussing the Commission's proposed interpretation of the term
``personnel'' for purposes of proposed rule 3a71-3(b)(1)(iii)(C)).
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5. Proposed Amendment Regarding Reporting Duties of Certain Persons
That are not Registered Security-Based Swap Dealers or Registered Major
Security-Based Swap Participants
Rule 901(a)(2)(ii) of Regulation SBSR establishes a reporting
hierarchy that specifies the side that has the duty to report a
security-based swap, taking into account the types of entities present
on each side of the transaction.\342\ The reporting side, as determined
by the reporting hierarchy, is required to submit the information
required by rule 901 of Regulation SBSR to a registered SDR.\343\ The
reporting side may select the registered SDR to which it makes the
required report.
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\342\ See rule 901(a).
\343\ Rule 900(gg) defines ``reporting side'' to mean ``the side
of a security-based swap identified by Sec. 242.901(a)(2).'' As
noted above, rule 901(a)(2) identifies the person that will be
obligated to report a security-based swap under various
circumstances.
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Rule 901(a)(2) of Regulation SBSR does not assign reporting
obligations for certain transactions having only unregistered entities
on both sides of the transaction. In the Regulation SBSR Adopting
Release, we specifically noted that we anticipated soliciting further
comment regarding the duty to report a security-based swap where
neither side includes a registered security-based swap dealer or a
registered major security-based swap participant and neither side
includes a U.S. person or only one side includes a U.S. person.\344\ In
this release we are proposing additional provisions setting forth which
sides would have the duty to report such transactions.
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\344\ See Regulation SBSR Adopting Release, 80 FR 14600, 14655.
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As noted above, and as discussed in the Regulation SBSR Adopting
Release, one commenter raised concerns about burdens that the
previously re-proposed reporting hierarchy might place on U.S. persons
in transactions with certain non-U.S.-person counterparties.\345\ Under
that approach, in a transaction between a non-U.S. person and a U.S.
person, where neither side included a security-based swap dealer or
major security-based swap participant, the U.S. person would have had
the duty to report. The commenter noted that in such transactions the
non-U.S.-person counterparty might be engaged in dealing activity but
at levels below the security-based swap dealer de minimis threshold and
the U.S. person may not be acting in a dealing capacity in any of its
security-based swap transactions. The commenter argued that, in such
cases, the non-U.S. person may be better equipped to report the
transaction and accordingly that, when two non-registered persons enter
into a security-based swap, the counterparties should be permitted to
select which counterparty would report, even if one counterparty is a
U.S. person.\346\
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\345\ See IIB Letter at 26; Regulation SBSR Adopting Release, 80
FR 14600.
\346\ See IIB Letter at 26 (stating that, in such transactions,
``it would be more efficient and fair for the Commission to modify
its rules to allow a De Minimis SBSD to agree with its counterparty
to be the reporting party when facing a U.S. non-registrant
counterparty'').
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Proposed rule 901(a)(2)(ii)(E)(2) is intended in part to address
this concern when the non-U.S. person is engaged in dealing activity
using personnel located in the United States. Under the proposed rule,
in a transaction between such a non-U.S. person and a U.S. person,
where neither side includes a registered security-based swap dealer or
a registered major security-based swap participant, the sides would be
permitted to select which side has the duty to report the
transaction.\347\ We preliminarily believe that this approach should
facilitate efficient allocation of reporting duties between the sides
by permitting the counterparties to select the reporting side.
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\347\ See proposed rule 901(a)(2)(ii)(E)(2).
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For similar reasons, proposed rule 901(a)(2)(ii)(E)(2) also
provides that, in a transaction between two non-U.S. persons in which
both sides include a non-U.S. person that is carrying out relevant
security-based swap dealing activity using personnel located in a U.S.
branch or office, as described in proposed rule 908(b)(5), the sides
would be permitted to select which side has the duty to report the
transaction. We preliminarily believe that, because both sides of such
a transaction are engaging in dealing activity in the United States but
both fall beneath the de minimis thresholds, both sides are likely to
have approximately equivalent levels of infrastructure to support their
U.S. business, including the infrastructure for reporting transactions
to a registered SDR. In such cases, we preliminarily believe that it
would be reasonable and appropriate to permit them to select which side
will have the duty to report.\348\
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\348\ Similar considerations have informed our proposal to
permit counterparties to a transaction where both sides include only
non-U.S. persons that do not fall within proposed rule 908(b)(5) to
select the reporting side. See proposed rule 901(a)(2)(ii)(E)(4).
Such a transaction would be subject to Regulation SBSR because it
has been accepted for clearing by a clearing agency that has its
principal place of business in the United States or because it has
been executed on a platform that has its principal place of business
in the United States. See proposed rules 908(a)(ii) and (iii).
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With respect to transactions in which one side includes only
unregistered non-U.S. persons that do not fall within proposed rule
908(b)(5) and the other side includes at least one unregistered non-
U.S. person that does fall within proposed rule 908(b)(5) or one
unregistered U.S. person, we preliminarily believe that it is
appropriate to place the reporting duty on the side that includes the
unregistered non-U.S. person that falls within proposed rule 908(b)(5)
or the unregistered U.S. person.\349\ We preliminarily believe that, in
such a transaction, the U.S. person or the non-U.S. person engaged in a
security-based swap transaction, in connection with its dealing
activity, using personnel located in a U.S. branch or office may
generally be more likely than its counterparty to have the ability to
report the transaction to a registered SDR given that it has operations
in the United States. We also note that, in a transaction where neither
side includes a registered security-based swap dealer or a registered
major security-based swap participant, placing the duty on the side
that has a presence in the United States should better enable us to
monitor and enforce compliance with the reporting requirement.
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\349\ See proposed rule 901(a)(2)(ii)(E)(3).
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Finally, we are proposing a rule that would provide that a
registered broker-dealer (including a registered SB SEF) shall report
the information required by rules 901(c) and 901(d) for any transaction
in which neither side includes a U.S. person and neither side includes
a non-U.S. person that falls within proposed rule 908(b)(5) but the
security-based swap is effected by or through the registered broker-
dealer (including a registered SB SEF).\350\ We preliminarily believe
that, in such a transaction, the registered broker-dealer (including a
registered SB SEF) may generally be more likely than the counterparties
to the transaction (neither of which may have any operations or
presence in the United States) to have the ability to report the
transaction to a registered SDR given its
[[Page 27487]]
presence in the United States and its familiarity with the Commission's
regulatory requirements.\351\
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\350\ See proposed rule 901(a)(2)(ii)(E)(4).
\351\ Cf. Letter from ISDA to SEC, dated January 18, 2011
(``ISDA/SIFMA Letter'') at 17 (noting that market participants,
including brokers, may provide reporting services on behalf of their
customers).
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6. Proposed Amendments to Rules 900(u), 901(d)(9), 906(b), 906(c), and
907(a) of Regulation SBSR To Accommodate Proposed Rule
901(a)(2)(ii)(E)(4).
(a) Proposed Amendment to Rule 900(u)
Rule 900(u) defines a ``participant'' of a registered SDR as ``a
counterparty, that meets the criteria of [rule 908(b) of Regulation
SBSR], of a security-based swap that is reported to that [registered
SDR] to satisfy an obligation under [rule 901(a) of Regulation SBSR].''
In the Regulation SBSR Proposed Amendments Release, we proposed to
expand the definition of ``participant'' to include registered clearing
agencies and platforms.\352\ This proposed definition would not include
a registered broker-dealer that incurs reporting obligations solely
because it effects a transaction between unregistered non-U.S. persons
that do not fall within proposed rule 908(b)(5). We believe that such
registered broker-dealers should be participants of any registered SDR
to which they are required to report security-based swap transaction
information. Imposing participant status on such registered broker-
dealers would explicitly require those entities to report security-
based swap transaction information to a registered SDR in a format
required by that registered SDR under rule 901(h). If such registered
broker-dealers were not participants of the registered SDR and were
permitted to report data in a format of their own choosing, it could be
difficult or impossible for the registered SDR to understand individual
transaction reports or aggregate them with other reports in a
meaningful way. This could adversely affect the ability of the
Commission and other relevant authorities to carry out their oversight
responsibilities and could interfere with the ability of a registered
SDR to publicly disseminate security-based swap transaction information
as required by rule 902 of Regulation SBSR. Therefore, we are proposing
to amend the definition of ``participant'' in rule 900(u) to include a
registered broker-dealer that is required to report a security-based
swap by rule 901(a)(2)(ii)(E)(4).
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\352\ See Regulation SBSR Adopting Release, 80 FR 14751. As
proposed to be amended, rule 900(u) would define ``participant'' to
mean: (1) A person that is a counterparty to a security-based swap,
provided that the security-based swap is subject to regulatory
reporting under Regulation SBSR and is reported to a registered SDR
pursuant to Regulation SBSR; (2) a platform that is required to
report a security-based swap pursuant to Rule 901(a)(1); or (3) a
registered clearing agency that is required to report a life cycle
event pursuant to Rule 901(e).
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If we ultimately adopt both this amendment to rule 900(u) and the
amendment proposed in the Regulation SBSR Proposed Amendments Release,
``participant'' would mean: ``with respect to a registered security-
based swap data repository, [ ] (1) A counterparty, that meets the
criteria of Sec. 242.908(b), of a security-based swap that is reported
to that registered security-based swap data repository to satisfy an
obligation under Sec. 242.901(a); (2) a platform that reports a
security-based swap to that registered security-based swap data
repository to satisfy an obligation under Sec. 242.901(a); (3) a
registered clearing agency that is required to report to that
registered security-based swap data repository whether or not it has
accepted a security-based swap for clearing pursuant to Sec.
242.901(e)(1)(ii); or (4) a registered broker-dealer (including a
registered security-based swap execution facility) that is required to
report a security-based swap to that registered security-based swap
data repository by Sec. 242.901(a).''
(b) Proposed Amendment to Rule 901(d)(9)
In the Regulation SBSR Adopting Release, we noted the importance of
identifying whether a broker is involved in the execution of a
security-based swap. Identifying the broker for a security-based swap
will provide regulators with a more complete understanding of the
transaction and could provide useful information for market
surveillance purposes.\353\ To obtain information about brokers that
facilitate security-based swap transactions--as well as other persons
involved in a security-based swap--existing rule 901(d)(2) requires the
reporting side to report, as applicable, the branch ID, broker ID,
execution agent ID, trade ID, and trading desk ID of the direct
counterparty on the reporting side. In the Regulation SBSR Adopting
Release, we also recognized the importance of identifying the venue on
which a security-based swap is executed, because this information
should enhance the ability of relevant authorities to conduct
surveillance in the security-based swap market and understand
developments in the security-based swap market generally.\354\
Therefore, we adopted rule 901(d)(9), which requires reporting of the
platform ID, if applicable.
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\353\ See Regulation SBSR Adopting Release, 80 FR 14583.
\354\ See Regulation SBSR Adopting Release, 80 FR 14589.
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As described above, proposed rule 901(a)(2)(ii)(E)(4) would require
a registered broker-dealer to report the information in rules 901(c)
and 901(d) for any transaction between two unregistered non-U.S.
persons that do not fall within rule 908(b)(5) where the transaction is
effected by or through the registered broker-dealer. Because a
security-based swap reported under rule 901(a)(2)(ii)(E)(4) will not
have a reporting side, no one would have the obligation to report the
information required by existing rule 901(d)(2). We preliminarily
believe, however, that being able to identify any registered broker-
dealer that effects a security-based swap transaction in the manner
described in rule 901(a)(2)(ii)(E)(4) would enhance our understanding
of the security-based swap market and would improve our ability, and
the ability of other relevant authorities, to conduct surveillance of
security-based swap market activities. We therefore propose to amend
rule 901(d)(9) to assure that the identity of any such registered
broker-dealer is included in the report of a security-based swap
transaction reported pursuant to rule 901(a)(2)(ii)(E)(4). As proposed
to be amended, rule 901(d)(9) would require reporting of ``[t]he
platform ID, if applicable, or if a registered broker-dealer (including
a registered security-based swap execution facility) is required to
report the security based swap by Sec. 242.901(a)(2)(ii)(E)(4), the
broker ID of that registered broker-dealer (including a registered
security-based swap execution facility).''
(c) Proposed Amendments to Rules 906 and 907
Under the proposed amendment to rule 900(u) described above,\355\
the definition of ``participant'' would be expanded to include a
registered broker-dealer that incurs reporting obligations solely
because it effects a transaction between two unregistered non-U.S.
persons that do not fall within proposed rule 908(b)(5). Rule 906(b) of
Regulation SBSR generally requires a participant of a registered SDR to
provide the identity of its ultimate parent and any affiliates that
also are participants of that registered SDR. In the Regulation SBSR
Proposed Amendments Release, we proposed to except platforms and
registered clearing agencies from rule
[[Page 27488]]
906(b).\356\ We preliminarily believe that the purposes of rule
906(b)--namely, facilitating our ability to measure derivatives
exposure within the same ownership group--would not be advanced by
applying the requirement to a registered broker-dealer that incurs
reporting obligations solely because it effects a transaction between
two unregistered non-U.S. persons that do not fall within proposed rule
908(b)(5) to report parent and affiliate information to a registered
SDR. A registered broker-dealer acting solely as a broker with respect
to a security-based swap is not taking a principal position in the
security-based swap. To the extent that such a registered broker-dealer
has an affiliate that transacts in security-based swaps, such positions
could be derived from other transaction reports indicating that
affiliate as a counterparty. Accordingly, we propose to amend rule
906(b) to state that reporting obligations under rule 906(b) do not
apply to a registered broker-dealer that becomes a participant solely
as a result of making a report to satisfy an obligation under rule
901(a)(2)(ii)(E)(4).
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\355\ See Section V.E.6, supra.
\356\ See Regulation SBSR Adopting Release, 80 FR 14645-46.
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We propose to make a similar amendment to rule 907(a)(6). In the
Regulation SBSR Proposed Amendments Release, we proposed to amend this
rule to require a registered SDR to have policies and ``[f]or
periodically obtaining from each participant other than a platform or a
registered clearing agency information that identifies the
participant's ultimate parent(s) and any participant(s) with which the
participant is affiliated, using ultimate parent IDs and counterparty
IDs.'' \357\ We now propose to further amend rule 907(a)(6) and except
from this requirement a registered broker-dealer that incurs reporting
obligations solely because it effects a transaction between two
unregistered non-U.S. persons that do not fall within proposed rule
908(b)(5). Thus, if we ultimately adopt both this amendment to rule
907(a)(6) and the amendment to rule 907(a)(6) proposed in the
Regulation SBSR Proposed Amendments Release, rule 907(a)(6) would
require a registered SDR to have policies and procedures ``[f]or
periodically obtaining from each participant other than a platform, a
registered clearing agency, or a registered broker-dealer (including a
registered security-based swap execution facility) that becomes a
participant solely as a result of making a report to satisfy an
obligation under Sec. 242.901(a)(2)(ii)(E)(4) information that
identifies the participant's ultimate parent(s) and any participant(s)
with which the participant is affiliated, using ultimate parent IDs and
counterparty IDs.''
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\357\ Once a participant reports parent and affiliate
information to a registered SDR, rule 906(b) requires the
participant to ``promptly notify the registered [SDR] of any
changes'' to its parent and affiliate information.
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(d) Extending the Applicability of Rule 906(c)
Rule 906(c) requires certain participants of a registered SDR to
establish, maintain, and enforce written policies and procedures that
are reasonably designed to ensure that the participant complies with
any obligations to report information to a registered SDR in a manner
consistent with Regulation SBSR. Rule 906(c) also requires participants
covered by the rule to review and update their policies and procedures
at least annually. In the Regulation SBSR Adopting Release, we stated
that the policies and procedures required by rule 906(c) are intended
to promote complete and accurate reporting of security-based swap
information by SDR participants that are registered security-based swap
dealers or registered major security-based swap participants.\358\
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\358\ See Regulation SBSR Adopting Release, 80 FR 14648.
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In the Regulation SBSR Proposed Amendments Release, we proposed to
amend rule 906(c) by extending the requirement to have such policies
and procedures to platforms and registered clearing agencies.\359\ In
light of the proposed amendments to rule 901(a) relating to registered
broker-dealers, described above, we now preliminarily believe that a
registered broker-dealer that incurs reporting obligations solely
because it effects transactions between two unregistered non-U.S.
persons that do not fall within proposed rule 908(b)(5) also should be
required to establish, maintain, and enforce the policies and
procedures required by rule 906(c).\360\
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\359\ See id. at 14758-59.
\360\ We are also proposing to revise the title of the rule. As
adopted, the title of rule 906(c) was: ``Policies and procedures of
registered security-based swap dealers and registered major
security-based swap participants.'' In the Regulation SBSR Proposed
Amendments Release, we proposed to add registered clearing agencies
and platforms to the rule's title. Rather than adding registered
broker-dealers to the entities delineated in the title to 906(c), we
are proposing to revise the title to ``Policies and procedures to
support reporting compliance.''
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We preliminarily believe that the proposed amendment to rule 906(c)
should result in greater accuracy and completeness of the security-
based swap transaction data reported to registered SDRs. Without
written policies and procedures, compliance with reporting obligations
of such a registered broker-dealer might depend too heavily on key
individuals or unreliable processes. For example, if knowledge of the
reporting function was not reflected in written policies and procedures
but existed solely in the memories of one or a few individuals,
compliance with applicable reporting requirements by the firm might
suffer if these key individuals depart the firm. We preliminarily
believe, therefore, that requiring participants that are registered
broker-dealers that incur reporting obligations solely because they
effect a transaction between two non-U.S. persons that do not fall
within proposed rule 908(b)(5) to establish, maintain, and enforce
written policies and procedures should promote clear, reliable
reporting that can continue independent of any specific individuals. We
further believe that requiring such a participant to establish,
maintain, and enforce written policies and procedures relevant to its
reporting responsibilities, as would be required by the proposed
amendment to rule 906(c), would help to improve the degree and quality
of overall compliance with the reporting requirements of Regulation
SBSR.
7. Availability of Substituted Compliance
Rule 908(c)(1) of Regulation SBSR describes the security-based swap
transactions that potentially would be eligible for substituted
compliance with respect to regulatory reporting and public
dissemination of security-based swap transactions. Accordingly,
substituted compliance would potentially be available for transactions
that would become subject to Regulation SBSR pursuant to the proposed
amendments described above, as the location of relevant dealing
activity or of execution of the transaction would continue to be
irrelevant for purposes of rule 908(c).\361\
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\361\ See note 295, supra.
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Rule 908(c)(1) does not condition substituted compliance
eligibility on where a particular transaction was arranged, negotiated,
or executed.\362\ Under rule 908(c)(1), a security-based swap is
eligible for substituted
[[Page 27489]]
compliance with respect to regulatory reporting and public
dissemination, provided that at least one of the direct counterparties
to the security-based swap is either a non-U.S. person or a foreign
branch. Thus, rule 908(c)(1) permits a security-based swap between a
U.S. person and the New York branch of a foreign bank (i.e., a non-U.S.
person with operations inside the United States) to be eligible for
substituted compliance, provided that such compliance is with the rules
of a foreign jurisdiction that is the subject of a Commission
substituted compliance order.
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\362\ Rule 908(c)(1) provides: ``Compliance with the regulatory
reporting and public dissemination requirements in sections 13(m)
and 13A of the Act (15 U.S.C. 78m(m) and 78m-1), and the rules and
regulations thereunder, may be satisfied by compliance with the
rules of a foreign jurisdiction that is the subject of a Commission
order described in paragraph (c)(2) of this section, provided that
at least one of the direct counterparties to the security-based swap
is either a non-U.S. person or a foreign branch.''
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In adopting rule 908(c)(1), we noted that the final rule was
consistent with our decision to solicit additional comments regarding
whether to impose reporting or public dissemination requirements based
solely on whether a transaction is conducted within the United
States.\363\ Although we are now proposing an amendment that would
impose these requirements on certain transactions that a non-U.S.
person arranges, negotiates, or executes using personnel located in a
U.S. branch or office, we are not proposing an amendment that would
limit the availability of substituted compliance for such transactions
based on the location of this relevant activity. Accordingly, under our
proposed approach, and consistent with our final rule, counterparties
to a transaction that is required to be reported because a non-U.S.-
person counterparty to the transaction, in connection with its dealing
activity, arranged, negotiated, or executed the transaction using
personnel located in a U.S. branch or office or because it was executed
on a platform or effected by or through a registered broker-dealer
would be eligible for substituted compliance, provided that such
compliance is with the rules of a foreign jurisdiction that is the
subject of a Commission order.\364\
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\363\ See Regulation SBSR Adopting Release, 80 FR 14658.
\364\ A non-U.S. person engaged in relevant dealing activity
using personnel located in a U.S. branch or office may incur the
duty to report a transaction under Exchange Act rules
901(a)(2)(ii)(A), (B), (C), or (D), or under proposed rules
901(a)(2)(ii)(E)(2), (3), or (4) of Regulation SBSR.
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This approach would subject transactions that are arranged,
negotiated, or executed by personnel located in a U.S. branch or
office, in connection with a non-U.S. person's dealing activity, to
regulatory reporting and public dissemination requirements in a manner
consistent with Title VII, while mitigating the potential to duplicate
compliance burdens. The proposed approach is also consistent with the
determination in our final rule that certain transactions involving
U.S.-person counterparties are eligible for substituted compliance
(i.e., when the transaction is through the foreign branch of the U.S.
person) even if the non-U.S.-person counterparty has engaged in dealing
activity in connection with the transaction in the United States.\365\
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\365\ See Exchange Act rule 908(c)(1) (permitting compliance
with the regulatory reporting and public dissemination requirements
by complying with the rules of a foreign jurisdiction if at least
one of the direct counterparties to the security-based swap
transaction is either a non-U.S. person or a foreign branch).
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F. Request for Comment
We invite comment regarding all aspects of the proposed approach to
clearing, trade execution, regulatory reporting, and public
dissemination described here, as well as potential alternative
approaches. Data and comment from market participants and other
interested parties regarding the likely effect of the proposed approach
and of potential alternative approaches will be particularly useful to
us in evaluating potential modifications to the re-proposal.
In addition, we specifically request comment with respect to each
of the requirements discussed above, as follows.
1. Mandatory Clearing and Trade Execution
We seek comment on the re-proposed rule regarding application of
mandatory clearing and trade execution in all aspects, including the
following:
Is it appropriate not to apply the clearing and trade
execution requirements to transactions that a non-U.S. person, in
connection with its dealing activity, arranges, negotiates, or executes
using personnel located in a U.S. branch or office? Why or why not?
What would be the likely market impact of our proposal not
to subject such transactions to the clearing and trade execution
requirements? How would this proposed approach affect the
competitiveness of U.S. persons and other market participants in the
global marketplace (both in the United States as well as in foreign
jurisdictions)? How do you believe any competitive disparity that may
result under our proposed approach should be addressed by our rules?
Would there be any potential effect from our proposal on
U.S. financial stability? If so, how should any such effect be
addressed?
Would there be any potential effect from our proposal on
the liquidity available on any SB SEFs? If so, how should any such
effect be addressed?
To what extent do non-U.S. persons that are not engaged in
security-based swap dealing but do enter into security-based swaps with
dealers that use personnel located in the United States already have
clearing relationships with clearing agencies located in the United
States or with entities that may qualify for a substituted compliance
determination? For such persons that do not already have such
relationships, what costs and other burdens would be involved with
establishing such relationships? To what extent would permitting
substituted compliance as proposed in the Cross-Border Proposing
Release address these concerns?
2. Regulation SBSR
We request comment on all aspects of the proposed amendments to
Regulation SBSR, including the following:
Do you agree with the approach taken in the proposed
amendments to rule 908(a) that a security-based swap should be subject
to regulatory reporting and public dissemination regardless of the
nationality or place of domicile of the counterparties if it is a
transaction connected with a person's security-based swap dealing
activity that is arranged, negotiated, or executed by personnel located
in the United States? Why or why not?
Do you agree with the approach taken in the proposed
amendments to rule 908(a) that a security-based swap executed on a
platform having its principal place of business in the United States
should be subject to the regulatory reporting and public dissemination
requirements? Why or why not?
Do you agree with the approach taken in the proposed
amendments to rule 908(a) that would subject a security-based swap
effected by or through a registered broker-dealer (including a
registered security-based swap execution facility) to the regulatory
reporting and public dissemination requirements? Why or why not? Should
transactions that would be required to be reported under the proposed
amendments to rule 908(a) solely because they were effected by or
through a registered broker-dealer (including a registered security-
based swap execution facility) be required to be reported by a
counterparty to the transaction, rather than by a registered broker-
dealer (including a registered security-based swap execution facility),
as proposed?
Do you agree with the proposed amendment to the hierarchy
of reporting obligations in rule 901(a)? Why or why
[[Page 27490]]
not? Are there any prongs where you believe the result should be
different? If so, which prong(s) and why?
Should we provide an exemption from Regulation SBSR's
public dissemination requirement for transactions having a U.S. person
guarantor in which the other side includes no counterparty (direct or
indirect) that is a U.S. person, registered security-based swap dealer,
or registered major security-based swap participant? Why or why not?
What types of controls would be necessary to identify
transactions required to be reported under rule 908(a)(1)(v)? How would
this work as an operational matter? What are the costs and benefits
associated with developing and maintaining such controls?
As noted above, given the limitation on reporting duties
set forth in rule 908(b) and in the proposed amendments to that rule,
we expect that most, if not all, registered broker-dealers required to
report under this proposed amendment would be U.S. persons
intermediating security-based swap transactions between non-U.S. person
counterparties and that such persons would be effecting transactions in
security-based swaps from their offices in the United States. Is this
expectation consistent with market practices by registered broker-
dealers?
Should a registered broker-dealer that is required to
report transactions pursuant to rule 901(a)(2)(ii)(E)(4) be a
participant of the registered SDRs to which they report? If not, how
would a registered SDR ensure that such persons provide data in a
format required by the registered SDR? Would a registered broker-dealer
likely be required to be a participant of a registered SDR under
existing rule 901(d) by virtue of its other security-based swap
activity?
Do you agree that the Commission should require reporting
of the identity of any registered broker-dealer that effects a
security-based swap for two non-U.S. person that do not fall within
rule 908(b)(5)? Why or why not? If so, do you believe that the proposed
amendment to rule 901(d)(9) is the appropriate way to accomplish that
goal? Why or why not?
Do you agree with the Commission's proposal to exclude
registered broker-dealers that incur reporting obligations solely
because they effect a transaction between two non-U.S. persons that do
not fall within proposed rule 908(b)(5) from rule 906(b)? Why or why
not?
Do you believe that rule 906(c) should be expanded to
include registered broker-dealers that incur reporting obligations
solely because they effect a transaction between two non-U.S. persons
that do not fall within proposed rule 908(b)(5)? Why or why not?
What would be the costs to registered broker-dealers that
would be subject to rule 901(a)(2)(ii)(E)(4) for establishing and
maintaining policies and procedures under rule 906(c) to support
compliance with Regulation SBSR? Are these registered broker-dealers
likely to have affiliates that will become registered security-based
swap dealers, which are already subject to rule 906(c)? If so, would
these registered broker-dealers be able to reduce implementation
burdens under rule 906(c) by adapting the policies and procedures of
their affiliates for their own usage?
VI. Economic Analysis of the Proposed Rules
The proposed amendments and proposed rule would determine when a
non-U.S. person 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 calculation transactions
with another non-U.S. person and when transactions of a non-U.S. person
whose obligations under a security-based swap are not guaranteed by a
U.S. person are subject to the external business conduct requirements
and to Regulation SBSR.
We are sensitive to the economic consequences and effects,
including costs and benefits, of our rules. The following economic
analysis identifies and considers the costs and benefits--including the
effects on efficiency, competition, and capital formation--that may
result from the rules being proposed today. These costs and benefits
are discussed below and have informed the policy choices described
throughout this release. Because of the attributes of the security-
based swap market, the market's global nature, the concentration of
dealing activity, and the ease with which dealers can relocate their
operations to different jurisdictions, we preliminarily believe that
the territorial approach to transactions proposed in these rules is
consistent with the statutory focus of the Title VII framework for
security-based swaps. Below, we discuss the likely economic effects of
the proposed rules, including the assessment and programmatic costs and
benefits. We also discuss the potential economic effects of certain
alternatives to the approach taken by the proposed rules.
A. Assessment Costs
1. Discussion
Under the proposed rules we preliminarily believe that non-U.S.
persons would incur costs to assess whether their activities must be
counted against de minimis thresholds and subjected to Title VII
requirements.\366\ This section begins by considering the effect on
assessment costs of increasing the scope of transactions required to be
counted towards de minimis thresholds and proceeds to consider the
effect on assessment costs of identifying security-based swap activity
that, under the proposed rules, would count towards de minimis
thresholds or become subject to external business conduct, regulatory
reporting, and public dissemination requirements.
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\366\ We refer to these costs as ``Assessment Costs.'' See
Intermediary Definitions Adopting Release, 77 FR 30722.
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Because the proposed amendment would expand the scope of security-
based swap transactions that non-U.S. persons would need to include in
their de minimis calculations, we preliminarily believe that the
proposed amendment may result in an increase in the number of non-U.S.
persons exceeding $2 billion in transaction notional in a given year
and incurring assessment costs as a result of counting transactions
against the de minimis threshold.\367\
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\367\ We preliminarily believe that it is likely that entities
that exceed $2 billion in transaction notional in a 12 month period
are likely to incur assessment costs to determine whether they
exceed the de minimis threshold. Because the proposed rules add to
the set of transactions that must be counted towards the de minimis
threshold, non-U.S. persons are more likely to exceed $2 billion in
transaction notional and incur these assessment costs. These non-
U.S. persons would have to assess not only transactions scoped in by
the proposed rule, but also transactions with U.S. persons against
their de minimis threshold. See Cross-Border Adopting Release, 79 FR
47331-33.
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Estimating the number of additional non-U.S. persons that we expect
to incur assessment costs as a result of the proposed amendment would
require adding transactions arranged, negotiated, or executed by
personnel located in the United States, including cleared anonymous
transactions subject to proposed rule 3a71-5(c), to the set of
transactions that these non-U.S. persons are currently required to
count as a result of rule 3a71-3(b)(1)(iii) and computing the total
notional value of these transactions. We cannot determine, based on the
TIW transactions data, whether particular transactions were arranged,
negotiated, or executed by personnel located in the United States. If
we assume that all observable transactions of non-U.S.
[[Page 27491]]
persons on U.S. reference entities that are not already required to be
applied towards the de minimis threshold as a result of proposed rule
3a71-3(b)(1)(iii) are arranged, negotiated, or executed by personnel
located in a U.S. branch or office, we estimate that a total of
approximately 15 non-U.S. persons likely would incur assessment costs
as a result of the proposed amendment based on 2014 TIW transactions
data. However, we note that this estimate may be overinclusive, as we
do not believe that all such transactions are likely to be arranged,
negotiated, or executed by personnel located in a U.S. branch or
office, and at the same time it may also be underinclusive because our
TIW data does not include single-name CDS transactions between two non-
U.S. entities written on non-U.S. underliers.\368\
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\368\ 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 Rule 3a71-3(a)(4).
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The additional 15 non-U.S. persons that are likely to incur
assessment costs associated with de minimis counting would join the 56
non-U.S. persons identified in the TIW 2014 transactions data as having
relevant activity under rule 3a-71-3(b),\369\ for a total of 71 persons
who would likely incur assessment costs under the proposed rules based
on 2014 data. We preliminarily believe it is reasonable to increase
these estimates 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.\370\ As a result, we
preliminarily believe that the assessment costs discussed below apply
to 142 entities.
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\369\ See Section II.B.1(c).
\370\ See Intermediary Definitions Adopting Release, 77 FR 30725
n.1457.
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Although foreign security-based swap dealers that are required to
register under existing Exchange Act rule 3a71-3 would not be likely to
incur assessment costs as a result of 3a71-3(b)(1)(iii), as this
proposed rule would not affect their need to register as security-based
swap dealers, they are included in our total estimate of 142 entities
above. We have included them because they likely would incur identical
assessment costs in order to identify transactions subject to those
requirements under proposed Exchange Act rule 3a71-5(c), which imposes
external business conduct requirements on the U.S. business of
registered security-based swap dealers, and the proposed amendments to
Regulation SBSR.
As noted above, we preliminarily believe that, as a result of the
proposed rules, non-U.S. persons would incur costs to identify
transaction activity that is relevant for de minimis counting and
subject to external business conduct, regulatory reporting, and public
dissemination requirements. We preliminarily believe that the business
structures employed by non-U.S. persons may determine the magnitude of
these assessment costs, and that non-U.S. persons will generally choose
a business structure that considers its regulatory costs for both
compliance and assessment. The following section discusses the
approaches that these market participants may use to determine which
transactions are subject to Title VII regulation under our proposed
approach and, to the extent possible, presents estimates of assessment
costs on a per-entity basis.
First, non-U.S. persons may perform assessments on a per-
transaction basis, which some commenters have suggested could lead
market participants to incur significant costs.\371\ We recognize that
performing these assessments could involve 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. However, we preliminarily believe that the approach we are
proposing in this release should considerably mitigate these costs.
This proposed approach should be considerably easier than the initially
proposed approach for market participants to integrate into existing
transaction monitoring systems or order management systems given its
focus on market-facing activity of personnel of the entity (or
personnel of the agent of the entity) engaged in dealing activity that
is located in the United States.
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\371\ See note 289, supra (citing ISDA Letter); note 108, supra
(citing SIFMA/FIA/FSR Letter); note 109, supra (citing AFR Letter);
notes 110 and 112, supra (citing IIB Letter). Other commenters noted
the additional cost burden that market participants would face if
the definition diverged from that of the CFTC. See note 111 (citing
SIFMA/FIA/FSR Letter, Pensions Europe Letter, IIB Letter, and JFMC
Letter). Comments on the CFTC Cross-Border Guidance also identified
the issue of costs associated with an activity-based approach. See
notes 131 and 133-134, supra (citing letters raising this concern).
---------------------------------------------------------------------------
Accordingly, based on staff understanding regarding the development
and modification of information technology (IT) systems that track the
location of firm inputs, we preliminarily 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
preliminarily believe that entities would incur the cost of $6500 per
year on an ongoing basis for training, compliance, and verification
costs.\372\
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\372\ Calculated as Internal Cost, 90 hours x $50 per hour =
$4,500 plus Consulting Costs, 10 hours x $200 per hour = $2,000, for
a total cost of $6,500.
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Second, non-U.S. firms might additionally restrict personnel
located in the United States from arranging, negotiating, or executing
security-based swaps in connection with the non-U.S. firm's dealing
activity with non-U.S.-person counterparties. Such restrictions on
communication and staffing for the purposes of avoiding certain Title
VII requirements would reduce the costs of assessing the territorial
status of 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 of duplicating personnel in foreign and U.S.
locations.
While we do not currently have data necessary to precisely estimate
these costs in total, 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 preliminarily 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.\373\
Further, we preliminarily
[[Page 27492]]
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.
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\373\ 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 1,800-hour work-week 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 U.S. and non-U.S.
personnel 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.
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We preliminarily 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 is a U.S.
entity, we cannot at this time estimate the size of this set of
participants.
Third, a dealer may choose to comply with applicable Title VII
requirements, regardless of whether they in fact apply, to avoid
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 trades in
U.S. reference entities and generally relies on personnel located in
the United States to perform market-facing activities. For these
participants, the savings from not following policies and procedures
developed for Title VII compliance purposes for the few transactions
that do not involve dealing activity by personnel from a location in
the United States might be less costly than the costs of implementing a
system to track the locations of personnel on a trade-by-trade basis.
Similarly, registered foreign security-based swap dealers may also
prefer this approach, as they would only be required to comply with
Title VII external business conduct requirements, and their security-
based swap transactions, which would already be required to be reported
under Regulation SBSR, also would be publicly disseminated.
We preliminarily 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 these agents of non-
U.S. persons may employ any of the strategies above to comply with the
proposed rules. Non-U.S. persons may rely on representations from their
agents about whether transactions conducted on its behalf contained
dealing activity by personnel from a location in the United States.
This may occur on a transaction-by-transaction basis, or, if the agent
complies with Title VII requirements by default, via a representation
about the entirety of the agent's business.
We preliminarily 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 would encompass both
employees of potential registrants as well as employees of agents used
by potential registrants and would 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 the
United States. 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 below. 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 preliminarily believe that this type
of review of business lines would be similar in nature to the analysis
needed to produce financial statements for a large financial
institution. However, we acknowledge that evaluating alternative
structures to determine costs associated with assessment and compliance
may require additional legal analysis. We preliminarily estimate that
the per-entity initial costs of a review of business lines would be
approximately $102,000.\374\ Further, we preliminarily believe that
periodic reassessment of business lines would cost, on average, $52,000
per year, per entity.\375\
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\374\ Calculated as (Senior Accountant, 500 hours x $198 per
hour) + (Compliance Attorney, 2 hours x $334 per hour) + (Compliance
Manager, 8 hours x $283 per hour) = $101,932.
\375\ 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 a 1,800-hour
work-week and multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
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Additionally, we preliminarily believe that our proposed approach
may impose certain costs on U.S. security-based swap dealers conducting
business through a foreign branch, and registered broker-dealers
(including registered SB SEFs) that intermediate trade in the security-
based swap market. First, under the proposed approach, U.S. security-
based swap dealers conducting business through a foreign branch will
also need to classify their counterparties and transactions in order to
determine what activity constitutes their foreign business. Based on
analysis of 2014 TIW transactions data, we continue to estimate that no
more than five security-based swap dealers will conduct dealing
activity through foreign branches. Assuming that all such entities
elect to establish a system to identify their foreign business, we
preliminarily estimate the total assessment costs associated with the
proposed approach to be approximately $75,000, with ongoing, annual
costs of approximately $84,000.\376\
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\376\ These figures correspond to estimates provided initially
in the Cross-Border Proposing Release and updated in the Cross-
Border Adopting Release. See Cross-Border Proposing Release, 78 FR
31153. See also Cross-Border Adopting Release, 79 FR 47332.
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Second, registered broker-dealers (including registered SB SEFs)
may incur assessment costs in connection with proposed rule
901(a)(2)(ii)(E)(4). Under the proposed rule, these entities would be
required to report security-based swap transactions that they
intermediate if neither side includes a U.S. person; a registered
security-based swap dealer or major security-based swap participant; or
a non-U.S. person that arranged, negotiated, or executed the security-
based swap using its personnel, or using personnel of its agent, in a
U.S. branch or office. As a result, we preliminarily believe that these
entities would be required to assess the nature of transactions they
intermediate.
We preliminarily believe that assessment by registered broker-
dealers (including registered SB SEFs) would require an analysis of
their clients (in the case of registered-broker dealers that are not
registered SB SEFs) and members (in the case of registered SB SEFs). We
preliminarily believe that registered broker-dealers and SB SEFs are
likely to collect information about the counterparties they serve and
maintain these records as part of their existing business. On the basis
of these existing data, registered broker-dealers and SB SEFs would be
able to determine the U.S. person status, registration status, and the
location of personnel of their clients and members (or the personnel of
agents of their clients and members) that submit orders.
Further, we preliminarily believe that registered broker-dealers
and SB SEFs may be able to determine, on the basis of their own
business models or on the basis of activity they support, whether
[[Page 27493]]
their unregistered non-U.S. clients' and members' transactions are a
result of dealing activity, and so would be able to identify which
transactions of unregistered non-U.S. persons would need to be
reported. For example, a registered broker-dealer that operates as an
interdealer broker can likely expect that unregistered non-U.S. person
clients are engaging in dealing activity.
As a result, we preliminarily believe that the assessment costs
incurred by registered broker-dealer (including registered SB SEFs) are
likely limited to an analysis of clients and members to identify the
subset of clients and members whose trades they are obligated to report
under the proposed rules, supported by systems that would record and
maintain this information over time. We preliminarily believe that
these costs are similar in nature to legal costs related to systems and
analysis, as well as the direct costs of systems and analysis,
discussed in the Cross-Border Proposing Release. We estimate that, as a
result of the proposed rules imposing reporting obligations on
registered broker-dealers (including SB SEFs), each of these entities
would incur upfront costs of $45,304,\377\ and ongoing costs of $16,612
per year.\378\ We note that registered broker-dealers and SB SEFs may,
like counterparties, choose alternative business structures to mitigate
these costs, as discussed above. For example, they may offer
transaction reporting services to their clients for a fee and report
all transactions they intermediate, thus precluding the need to assess
their clients' and members' activity.
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\377\ This estimate is calculated as the sum of (Attorney at
$380 per hour x 80 hours) = $30,400, and the upfront costs of
systems as calculated in the Cross-Border Adopting Release. See
Cross-Border Adopting Release, 79 FR 47332. 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-week and multiplied by 5.35 to account for bonuses, firm size,
employee benefits and overhead.
\378\ See Cross-Border Adopting Release, 79 FR 47332.
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Finally, we preliminarily believe that this proposed approach
mitigates 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.\379\ In particular, by focusing on dealing activity,
the proposed approach should eliminate the need for non-U.S. persons
that do not engage in dealing activity to assess whether they or their
counterparties engage in relevant activity in the United States.\380\
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\379\ See, e.g., Section III.B.2(c), supra (discussing letters
raising cost concerns about initially proposed approach).
\380\ See, e.g., note 104, supra (citing MFA/AIMA Letter).
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2. Request for Comment
We request comment on all aspects of the re-proposed rule regarding
its economic analysis of the application of the de minimis exception to
non-U.S. persons arranging, negotiating, or executing security-based
swaps using personnel located in the United States, as well as the
application of external business conduct requirements for registered
security-based swap dealers, associated with such transactions,
including the following:
We have preliminarily estimated assessment costs
associated with determining whether transaction activity is arranged,
negotiated, or executed using personnel, or the personnel of agents,
located in a U.S. branch or office on a transaction-by-transaction
basis, by identifying market-facing personnel involved in each
transaction. Are these estimates reasonable with respect to both the
use of a non-U.S. person's personnel and of its agent's personnel?
Please provide data that would assist us in making more accurate
estimates of these assessment costs.
We have preliminarily suggested that some non-U.S. persons
might comply with Title VII by default to reduce assessment costs. Is
this suggestion reasonable? Please provide data that would assist us in
making more accurate estimates of the assessment costs in these
situations.
We have preliminarily suggested that non-U.S. market
participants would review business lines to determine which compliance
and assessment program is optimal. Are non-U.S. market participants
likely to carry out such reviews under the proposed rules? Please
provide data that would assist us in computing estimates of the costs
of these reviews on an ongoing basis.
Are there alternative methods that market participants may
use to comply with the proposed rules other than those described above?
If so, please describe the method and the costs of such method.
Under the proposed rules, registered brokers-dealers
(including registered SB SEFs) would be required to report certain
transactions to a registered SDR. Please provide any additional
information or data that would assist us in estimating the assessment
costs such registered broker-dealers (including registered SB SEFs) may
incur in determining their obligation to report.
We have preliminarily suggested that registered broker-
dealers (including registered SB SEFs) would require an analysis of
their clients (in the case of registered broker-dealers) and members
(in the case of registered SB SEFs), for purposes of reporting
transactions pursuant to proposed rule 901(a)(2)(ii)(E)(4). We stated
that we preliminarily believe that registered broker-dealers and SB
SEFs are likely to collect information about the counterparties they
serve and maintain these records as part of their existing business and
that registered broker-dealers and SB SEFs would be able to determine
the U.S.-person status, registration status, and the location of
personnel of their clients and members (or the personnel of agents of
their clients and members) that submit orders. Please provide comments
as to whether registered broker-dealers and SB SEFs will be able to
determine the U.S.-person status, registration status, and location of
personnel of their clients and members (or the personnel of agents of
their clients and members) that submit orders. Please explain why or
why not.
We have stated that we preliminarily believe that
registered broker-dealers and SB SEFs may be able to determine, on the
basis of their own business models or on the basis of activity they
support, whether their unregistered non-U.S. clients' and members'
transactions are a result of dealing activity, enabling them to
identify which transactions of unregistered non-U.S. persons are
connected with that non-U.S. person's dealing activity and should be
reported. Please provide comments as to whether registered broker-
dealers and SB SEFs may be able to make this determination. Please
explain why or why not.
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.\381\ In the following
sections, we discuss the costs and benefits of each of the Title VII
requirements that the proposed rule would apply to transactions with
dealing activity by personnel from a location in the United States.
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\381\ See Intermediary Definitions Adopting Release, 77 FR
30722.
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1. De minimis Exception
Under our proposed amendment, a non-U.S. person that, in connection
[[Page 27494]]
with its dealing activity, enters into a transaction with another non-
U.S. person would be required to include the transaction in its de
minimis calculation if it arranges, negotiates, or executes the
transaction using personnel located in a U.S. branch or office. This
requirement would also apply to cleared anonymous transactions that are
currently exempt from application of the de minimis thresholds under
rule 3a71-5. We are proposing rules that require the dealing
counterparty to look only at the location of dealing activity of its
own personnel or of its agent's personnel rather than require the
dealer to look at the location of both its own activity and that of its
counterparty in connection with the transaction, as was originally
proposed.\382\ This approach is designed to address concerns expressed
by some commenters that they would, under the test proposed in the
Cross-Border Proposing Release, need to track, on a trade-by-trade
basis, where their counterparties are carrying out activities with
respect to each transaction.\383\
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\382\ See initially proposed Exchange Act rules 3a71-3(b)(1)(ii)
and 3a71-3(a)(5); Cross-Border Proposing Release, 78 FR 30999.
\383\ See note 110, supra.
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Because the set of market participants that are subject to dealer
regulation, including entity-level requirements under Title VII, will
determine the allocation and flow of programmatic costs and benefits
arising from these Title VII requirements, the inclusion of these
transactions would 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. If we assume that all security-based
swap dealing activity takes place in the United States, then we
currently estimate that no additional entities would be required to
register as a result of this proposed rule.\384\ However, we believe it
is important to acknowledge the potential for additional registrants as
a result of the proposed rules as the market evolves.
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\384\ In Section VI.A.1, supra, we estimate that 15 entities
would exceeded the $2 billion threshold in 2014 as a result of this
rule and thus would assess their transactions to determine whether
they are required to register as a dealer. Of these 15 entities, we
preliminarily believe that none would exceed the $3 billion dealer
de minimis threshold and thus be required to register as security-
based swap dealers.
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If these proposed rules regarding the de minimis exception result
in an increased number of non-U.S. persons that eventually register as
security-based swap dealers, a larger number of dealers would become
subject to requirements applicable to registered dealers under Title
VII, including, among others, capital requirements, recordkeeping
requirements, and designation of a chief compliance officer.
Additionally, an increase in the number of registered dealers would
also mean that external business conduct requirements and Regulation
SBSR also apply to larger number of transactions, as well as a larger
notional volume of transactions.\385\ If the proposed rules and
amendments result in an increased volume of transaction activity
carried out by registered security-based swap dealers, then U.S.
financial markets should benefit from more consistent application of
Title VII rules designed to mitigate the risk of financial contagion
and enhance transparency and counterparty protections, as addressed by
regulatory reporting and external business conduct requirements. Our
proposed approach to determining which transactions are counted toward
a non-U.S. person's de minimis threshold would also bring persons
engaged in significant levels of dealing activity using personnel
located in in the United States within the Title VII regulatory
framework.
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\385\ 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 proposed approach will result in these
requirements being applied to a larger number of transaction and
notional volume of transactions requires the assumption that the
demand for liquidity from security-based 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 proposed
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 applied to a smaller number and
lower notional value of transactions.
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Furthermore, status as a security-based swap dealer brings with it
specific responsibilities that are categorized as programmatic costs
with respect to certain other Title VII requirements. For example,
Regulation SBSR places registered security-based swap dealers at the
top of the reporting hierarchy for uncleared transactions.\386\ Within
this hierarchy, if a registered dealer transacts with an unregistered
person, the registered dealer is obligated to report.\387\ Thus, as a
result of being classified as a dealer, a market participant that may
have previously negotiated to place regulatory reporting
responsibilities on its counterparties might incur the obligation to
report instead.
---------------------------------------------------------------------------
\386\ See Exchange Act rule 901(a)(2)(ii)(A); Regulation SBSR
Adopting Release, 80 FR 14596.
\387\ See Exchange Act rules 901(a)(2)(ii)(A) and
901(a)(2)(ii)(B); Regulation SBSR Adopting Release, 80 FR 14596.
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Finally, certain elements of the Title VII regulatory regime may
apply to the existing business of entities that are regulated as
security-based swap dealers because they apply not only to transaction
activity that cause an entity to meet the definition of a security-
based swap dealer, but also to other transaction activity in which the
entity participates. Entities that are required to register as
security-based swap dealers under rule 3a71-3(b) incur, for example,
not only the programmatic costs of external business conduct
requirements for their transactions arranged, negotiated, or executed
by personnel located in the United States in connection with their
dealing activity, but would also be required to comply with external
business conduct requirements with respect to all transactions that
would be ``U.S. business'' under the proposed rules. As a result, they
may need to develop systems or personnel, such as the designation of a
chief compliance officer or the development of recordkeeping and
reporting systems, for compliance purposes with respect to their U.S.
business.
2. External Business Conduct Requirements
Registered security-based swap dealers must comply with external
business conduct requirements. Proposed rule 3a71-3(c) would limit
application of these external business conduct requirements to the U.S.
business both of registered foreign security-based swap dealers and of
registered U.S. security-based swap dealers, rather than applying the
requirements to all transactions of such dealers.\388\
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\388\ The proposed rules address only the scope of transactions
that are subject to the external business conduct requirements; they
would not change the substance of those requirements.
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Requiring registered security-based swap dealers to comply with
external business conduct requirements with respect to their U.S.
business would have two major benefits. First, this requirement would
apply to all transactions that constitute U.S. business, as defined
under the proposed amendment, requirements that would reduce
information asymmetries
[[Page 27495]]
between security-based swap entities and their counterparties in the
security-based swap market in the United States, which should reduce
the incidence of fraudulent or misleading representations.\389\
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\389\ See Business Conduct Proposal, 76 FR 42452.
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Second, requiring registered foreign security-based swap dealers to
comply with external business conduct requirements with respect to
their U.S. business should facilitate more uniform regulatory treatment
of the security-based swap activity of registered security-based swap
dealers operating in the United States.\390\ As we discussed above,
although other business conduct frameworks (such as broker-dealer
regulation) may achieve similar regulatory goals, the availability of
exceptions may mean that alternative frameworks may not apply to
certain business structures used by registered security-based swap
dealers to carry out their business in the United States.\391\ Our
proposed rules would subject all registered security-based swap dealers
engaged in U.S. business to the same external business conduct
framework, rather than encouraging a patchwork of business conduct
protections under U.S. law that may offer counterparties varying levels
of protection with respect to their transactions with different
registered security-based swap dealers depending on the business model
(or models) that each registered security-based swap dealer has chosen
to use in its U.S. business.
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\390\ As discussed above, we recgnize that, depending on the
business structure that a registered U.S. or foreign security-based
swap dealer employs, an intermediary (such as an agent that is a
registered broker-dealer) may already be subject to certain business
conduct requirements with respect to the registered security-based
swap dealer's counterparty in the transaction. See Section IV.E,
supra. However, as we also noted above, we think it important that
the registered security-based swap dealer itself be subject to Title
VII external business conduct requirements with respect to security-
based swap transactions that are part of its U.S. business. See id.
Because the security-based swap dealer and its agent may allocate
between themselves specific responsibilities in connection with
these external business conduct requirements, to the extent that
these requirements overlap with requirements applicable directly to
the agent (for example, in its capacity as a broker), and the dealer
allocates responsibility for complying with relevant requirements to
its agent, we expect any increase in costs arising from the proposed
rules to be mitigated.
\391\ See note 202, supra (noting exception from broker-dealer
definition for banks).
---------------------------------------------------------------------------
We recognize that adjusting the scope of transactions subject to
external business conduct requirements may affect the programmatic
costs incurred by participants in the security-based swap market. For
entities already required to register as security-based swap dealers
under current rules, the proposed rules adjust the set of transactions
and counterparties to which they must apply external business conduct
requirements. To the extent that the proposed rules add counterparties
and their transactions to this set, registered security-based swap
dealers will incur additional costs for each additional
transaction.\392\ However, we preliminarily believe that the approach
taken in this proposal mitigates some of the commenter concerns with
the originally proposed definition of ``transactions conducted within
the United States'' by focusing only on the location of the non-U.S.
dealer's market-facing personnel and the personnel of the non-U.S.
dealer's agents, and not the location of its counterparties' activity.
---------------------------------------------------------------------------
\392\ See note 275, supra (citing IIB Letter stating that the
application of certain Title VII requirements, including external
business conduct standards on the transactions of non-U.S. persons
with foreign security-based swap dealers based on activity in the
United States when neither counterparty is guaranteed would create
``serious operational, legal, and economic difficulties for foreign
security-based swap market participants.'').
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3. Regulatory Reporting and Public Dissemination
Proposed amendments to Regulation SBSR would require certain
transactions in connection with a person's dealing activity, where that
person arranged, negotiated, or executed the transaction using
personnel located in a U.S. branch or office, to be reported to a
registered SDR and publicly disseminated. The proposed amendments would
also assign reporting duties in certain transactions and further
delineate limitations on reporting obligations of non-registered
persons engaged in security-based swaps subject to Regulation SBSR.
Additionally, the proposed amendments add provisions that would require
any security-based swap transaction that is either executed on a
platform having its principal place of business in the United States or
effected by or through a registered broker-dealer both to be reported
to a registered SDR and to be publicly disseminated pursuant to
Regulation SBSR.\393\
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\393\ See proposed rule 908(a)(1).
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Public dissemination of security-based swap transaction data may
result in several programmatic benefits for the security-based swap
market, such as improvements to liquidity and risk allocation by
reducing the information asymmetries in a security-based swap market
where activity is concentrated among a small number of dealers.\394\
Additionally, as noted in the Regulation SBSR Adopting Release,
participants in the security-based swap market with better information
about the risk characteristics of their security-based swaps will be
able to make more efficient investment decisions.\395\ To the extent
that the provision of security-based swap trade information enables
participants in the security-based swap market to make privately
optimal decisions, the transaction-level reporting and dissemination
requirements will provide programmatic benefits in the form of improved
liquidity and risk allocation.\396\ We preliminarily believe that the
proposed amendments would extend these effects by applying post-trade
transparency to additional transactions and transaction notional.
---------------------------------------------------------------------------
\394\ See Regulation SBSR Adopting Release, 80 FR 14704.
\395\ See id.
\396\ Public transaction data can improve the efficiency of
private decisions but there may still remain financial network
externalities as discussed in the Cross-Border Adopting Release. See
Cross-Border Adopting Release, 79 FR 47284.
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Regulatory reporting of transaction data to registered SDRs should
enable us to gain a better understanding of the security-based swap
market, including the size and scope of that market. This data should
enable us to identify exposure to risks undertaken by individual market
participants or at various levels of aggregation, as well as credit
exposures that arise between counterparties. Additionally, regulatory
reporting will help the Commission in the valuation of security-based
swaps. Taken together, regulatory data will enable us to conduct robust
monitoring of the security-based swap market for potential risks to
financial stability.
Regulatory reporting of security-based swap transactions should
also improve our ability to oversee the security-based swap market and
to detect and deter market abuse. We will be able, for example, to
observe trading activity at the level of both trading desk and
individual trader, using trading desk IDs and trader IDs, respectively.
This ability to aggregate the information contained in registered SDRs
using Unique Identification Codes facilitates our ability to examine
for noncompliance and pursue enforcement actions as appropriate.
On the other hand, as discussed in the Regulation SBSR Adopting
Release, other jurisdictions continue to develop rules related to post-
trade transparency of security-based swaps at a different pace, and we
are aware that the rules of these other regimes may result in
increasing incentives for non-U.S. market participants to avoid contact
with U.S. counterparties to avoid effecting transactions by or through
[[Page 27496]]
registered broker-dealers in an effort to avoid public
dissemination.\397\ Responses to these incentives could reduce
liquidity for U.S. market participants.\398\ We cannot readily quantify
the costs that might result from reduced market access for U.S.
persons.\399\ Moreover, we do not know definitively what rules other
jurisdictions may implement or at which time they may implement their
rules. In light of these limitations, we have analyzed them
qualitatively, and this analysis has informed our formulation of the
proposed rules and amendments contained in this release.\400\
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\397\ See Regulation SBSR Adopting Release, 80 FR 14714.
\398\ See id.
\399\ We noted in the Regulation SBSR Adopting Release that lack
of robust data and lack of experimental conditions make the costs
associated with market exit or reduced liquidity that might result
from post-trade transparency unquantifiable. The same limitations
make the costs of reduced access to liquidity by U.S. persons as a
result of public dissemination requirements under the proposed rules
and amendments unquantifiable. See Regulation SBSR Adopting Release,
80 FR 14706.
\400\ See Section II.B.4, supra.
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Application of regulatory reporting requirements under the proposed
amendments to rules 901 and 908 would likely impose costs on non-U.S.
persons while providing benefits to the security-based swap market more
generally. We preliminarily believe that the approach proposed in this
release is responsive to the views of commenters.\401\ Under the
proposed approach, and in contrast to the original proposal based on
``transactions conducted within the United States,'' non-U.S. persons
would not be required to understand or capture whether their non-U.S.-
person counterparties use personnel located in the United States, or
agents with personnel located in the United States, to determine
whether regulatory reporting and public dissemination requirements are
applicable to transaction activity. This modified approach focuses on
the location of a non-U.S. dealer's market-facing personnel in
determining whether regulatory reporting requirements apply to
transaction activity.
---------------------------------------------------------------------------
\401\ See note 275, supra (citing IIB Letter stating that the
application of certain Title VII requirements, including the
regulatory reporting and public dissemination requirements, on the
transactions of non-U.S. persons with foreign security-based swap
dealers based on activity in the United States when neither
counterparty is guaranteed would create ``serious operational,
legal, and economic difficulties for foreign security-based swap
market participants''); note 288, supra (citing Cleary Letter). See
also note 289, supra (citing ISDA Letter, urging us to not apply
Regulation SBSR on the basis of conduct within the United States as
it would be impracticable).
---------------------------------------------------------------------------
Nevertheless, we acknowledge that under the proposed rules and
amendments, non-U.S. persons would bear costs of reporting insofar as
they are allocated reporting responsibilities within the hierarchy laid
out in proposed rule 901(a)(2)(ii)(E), and if they fall within the set
of non-U.S. persons whose transactions are required to be reported
under rule 908(a). Additionally, registered broker-dealers would incur
reporting costs when they are involved in transactions between non-U.S.
persons that do not fall within proposed rule 908(b)(5). In the
Regulation SBSR Adopting Release, we estimated that 300 parties would
incur costs associated with reporting transactions to registered
SDRs.\402\
---------------------------------------------------------------------------
\402\ See Regulation SBSR Adopting Release, 80 FR 14701.
---------------------------------------------------------------------------
As noted above, we currently lack data necessary to estimate with
precision the number of non-U.S. persons that, in connection with their
dealing activity, arrange, negotiate, or execute security-based swaps
using personnel located in the United States or execute security-based
swaps on a platform with its principal place of business in the United
States, or the number of registered broker-dealers that intermediate
security-based swap transactions, and, as a result, cannot precisely
estimate the number of additional non-U.S. persons that might incur
reporting obligations under this proposal. However, assuming that all
observable transaction activity is arranged, negotiated, or executed
using personnel located in the United States, we estimate that 90
persons would become subject to regulatory reporting requirements under
the proposed rules, involving approximately 2,700 transactions and
$18.5 billion in notional value.\403\ Additionally, we preliminarily
estimate approximately 30 registered-broker dealers may be involved in
effecting transactions between non-U.S. persons that would not incur
any reporting duties under Regulation SBSR.
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\403\ Commission staff arrived at these estimates by
constructing a sample of TIW transaction records for activity
between two counterparties in 2014, removing those records that
involve counterparties that appear likely to register as security-
based swap dealers, to isolate activity that would likely fall
within the scope of proposed rule 901(a)(2)(ii)(E)(3). Staff arrived
at numerical estimates by counting unique TIW accounts, transaction
counts, and transaction notional represented in this sample. This
revealed approximately 45 accounts and approximately 1,650
transactions, involving $8.3 billion in notional value. As in prior
releases, we preliminarily believe it is appropriate to take a
conservative approach and estimate an upper bound of 90 affected
persons to account for growth in security-based swap participation.
See Intermediary Definitions Adopting Release, 77 FR 30725 n.1457.
Further, we preliminarily believe it is reasonable to increase
our estimates of transaction counts and notional volume by a factor
of 1.6 to account for data limitations. First, our access to single-
name CDS data is limited to activity involving one U.S. counterparty
or involving CDS written on U.S. reference entities. We estimated
that this limitation prevents us from observing approximately 23% of
transactions. See Regulation SBSR Adopting Release, 80 FR 14689
n.1183. Second, as we note in Section II.B.1, when measured in terms
of notional outstanding, the single-name CDS market accounts for
approximately 80% of the overall security-based swap market. As a
result, we scale up the number of observed transactions first by 1/
(1-0.23) and then by 1/0.80, or to approximately 1650 x 1/0.77 x 1/
0.80 = 2679 transactions, and our estimate of notional volume to
approximately $8.3 billion x 1/0.77 x 1/0.80 = $13.5 billion. We
acknowledge that this scaling rests on an implicit assumption that
transactions we do not observe are similar in nature to the single-
name CDS transaction we do observe.
Further we assume that 20% of these transactions would be
reported by registered-broker dealers pursuant to
901(a)(2)(ii)(E)(4) and so no reporting of life-cycle events would
be required. We use data in the Regulation SBSR Adopting Release to
develop our estimate of the number of events that are not life-cycle
events. See Regulation SBSR Adopting Release, 80 FR 14702.
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We preliminarily believe that regulatory reporting of transactions
that are arranged, negotiated, or executed using personnel located in a
U.S. branch or office or effected through a registered broker-dealer
would have benefits for the security-based swap market. Increasing the
scope of security-based swap transactions subject to regulatory
reporting would likely extend the programmatic benefits of regulatory
reporting discussed in the Regulation SBSR Adopting Release by giving
us a more complete view of transactions activity within the United
States.\404\ Moreover, in the context of market surveillance,
regulatory reporting of these transactions may be particularly
valuable. For example, these regulatory data would allow us to sequence
all security-based swap transaction activity involving U.S. personnel.
This potentially allows detection of cases in which U.S. personnel
could exploit their private information about the order flow of their
clients by placing proprietary orders ahead of clients' orders as an
employee of a non-U.S. affiliate, avoiding regulatory reporting
requirements under Regulation SBSR. Such a strategy could involve
front-running orders in an opaque part of the security-based swap
market at the expense of participants in a more transparent market.
Monitoring for these types of activities would be more difficult in the
absence of the proposed amendments to Rule 908. Finally, by
[[Page 27497]]
requiring registered broker-dealers to report transactions in which
they are involved, we preliminarily believe that our proposed approach
to regulatory reporting would enable us to improve oversight of
registered broker-dealers.
---------------------------------------------------------------------------
\404\ See Regulation SBSR Adopting Release, 80 FR 14700.
---------------------------------------------------------------------------
Regulatory reporting and public dissemination of transaction data
may entail two types of costs for security-based swap market
participants. First, as detailed below, requiring non-U.S. persons with
dealing activity in the United States to comply with the Title VII
reporting requirements even if they are not registered security-based
swap dealers may entail additional costs for recordkeeping,
supervision, and compliance. As some portion of these costs may be
fixed, security-based swap market participants with smaller volume may
be more adversely affected than larger ones. A second type of cost may
fall on non-U.S. persons, including registered foreign security-based
swap dealers, that wish to execute large orders or execute orders in
particularly illiquid contracts. Public dissemination of these types of
transactions, either because they involve security-based swap dealing
activity in the United States or because they are effected through a
registered broker-dealer, may increase the costs of hedging the
inventory risk generated by such transactions because it may signal the
direction of future order flow to potential counterparties to hedging
transactions. As we noted in the Regulation SBSR Adopting Release,
staff analysis of recent transactions in single-name CDS suggests that
the impact of public dissemination on large transactions may be limited
in light of the interim approach to public dissemination that allows up
to a 24-hour delay before transactions data is made public.\405\
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\405\ See Regulation SBSR Adopting Release, 80 FR 14709. See
also ``Inventory risk management by dealers in the single-name
credit default swap market'' (October 17, 2014, available at: http://www.sec.gov/comments/s7-34-10/s73410-184.pdf).
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The proposed amendments to Rule 901 would assign reporting duties
in certain transactions and we preliminarily believe that these duties
would result in costs for U.S. and non-U.S. persons and registered
broker-dealers (including registered SB SEFs) that incur a duty to
report. We estimated the costs of reporting on a per-entity basis in
the Regulation SBSR Adopting Release and we preliminarily believe that
these proposed rules would not affect these costs. We preliminarily
believe that additional persons required to report by the proposed
amendments would incur costs associated with establishing internal
order management systems of approximately $102,000. These entities with
reporting duties would also have to establish and maintain connectivity
to a registered SDR at a cost (initial and ongoing) of approximately
$200,000. We preliminarily believe that these persons would incur costs
associated with establishing a reporting mechanism for security-based
swaps of approximately $49,000. We preliminarily estimate that the
ongoing costs of internal order management would be $77,000 per year,
per reporting side, and the annual and ongoing costs of storage of
$1,000 per year, per reporting side. The Commission preliminarily
believes that under the proposed amendments, entities with reporting
duties would incur costs of approximately $54,000 per reporting side to
establish an appropriate compliance and support program for regulatory
reporting. We further estimate that such a program would require
approximately $38,500 per year in annual spending by each reporting
side. In aggregate, the costs of rule 901 for persons required to
report under the proposed amendments in the first year would be
approximately $521,500 and the annual ongoing costs would be
approximately $316,500.\406\ In aggregate, this suggests first-year
costs of approximately $62.5 million and ongoing costs of approximately
$38 million.\407\
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\406\ See Regulation SBSR Adopting Release, 80 FR 14702.
\407\ First-year costs of $521,500 x 120 entities with reporting
duties = $61,580,000; ongoing costs of $316,500 x 120 entities with
reporting duties = $37,980,000. These costs may be mitigated to the
extent that a registered broker-dealer may use the infrastructure
separately established by an affiliate that already incurs reporting
obligations under Regulation SBSR.
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As discussed in the Regulation SBSR Adopting Release, we
preliminarily estimated and continue to believe that the burden of
reporting additional transactions once a respondent's reporting
infrastructure and compliance systems are in place would be minimal
when compared to the costs of putting those systems in place and
maintaining them over time.\408\ If firms have order management systems
in place and currently utilize them, the costs of reporting an
additional individual transaction would be entering the required data
elements into the firm's order management system, which could
subsequently determine whether regulatory reporting requirements apply
to the transaction, and deliver the required transaction information to
a registered SDR if required.\409\
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\408\ See Regulation SBSR Adopting Release, 80 FR 14702.
\409\ See id.
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Besides incurring costs in connection with reporting
responsibilities under rule 901, we preliminarily believe that the
proposed rules would also require certain non-U.S. persons and
registered broker-dealers to incur costs associated with error
reporting under rule 905. As we noted in the Regulation SBSR Adopting
Release, requiring participants to promptly correct erroneous
transaction information should help ensure that the Commission and
other relevant authorities have an accurate view of the risks in the
security-based swap market. We preliminarily believe that non-U.S.
persons that incur reporting obligations under the proposed amendments
would incur an initial cost of $11,825 per reporting side and an
ongoing cost of $4,000 per reporting side.\410\
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\410\ See id. at 14778. Note that we preliminarily believe that
this proposal does not alter the number of participants that are not
reporting sides who, under rule 905(a)(1), are required to notify
the relevant reporting side after discovery of an error.
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These figures suggest aggregate initial costs of $1,419,000 and
ongoing costs of $480,000.\411\ As with rule 901, as adopted, we do not
believe that the additional amendments made to rule 901 in this release
would have any measurable impact on the costs previously discussed in
both the Regulation SBSR Proposing Release and the Cross-Border
Proposing Release.\412\
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\411\ Initial costs of $11,825 x 120 entities with reporting
duties = $1,419,000; ongoing costs of $4,000 x 120 entities with
reporting duties = $480,000.
\412\ See Regulation SBSR Adopting Release, 80 FR 14702. See
also Regulation SBSR Proposing Release, 75 FR 75261; Cross-Border
Proposing Release, 78 FR 31192.
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We preliminarily believe that, in addition, the 540 additional
transactions effected by or through registered broker-dealers may
impose costs on participants that are associated with notifying
registered broker-dealers after discovery of an error as required under
rule 905(a)(1). We preliminarily estimate an annual cost associated
with this obligation of approximately $17,280, which corresponds to
roughly $576 per participant.\413\
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\413\ These figures are based on the assumption that
approximately 540 additional trades per year would have to be
reported by registered broker-dealers pursuant to proposed rule
901(a)(2)(ii)(E)(4) and that these trades involve 30 entities with
reporting duties. Using cost estimated provided in the Regulation
SBSR Adopting Release, if each trade is reported in error, then the
aggregate annual cost of error notification is 540 errors x
Compliance Clerk at $64 per hour x 0.5 hours per report = $17,280,
or $576 per participant. See Regulation SBSR Adopting Release, 80 FR
14714. We use salary figures from SIFMA's Management & Professional
Earnings in the Securities Industry 2013, modified by SEC staff to
account for a 1800-hour work-week and multiplied by 5.35 to account
for bonuses, firm size, employee benefits and overhead.
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[[Page 27498]]
Finally, the proposed amendments to rule 906 may impose costs on
registered broker-dealers that must report transactions to satisfy an
obligation under proposed rule 901(a)(2)(ii)(E)(4). Under proposed
amendments to rule 906(c), these registered broker-dealers would be
required to establish, maintain, and enforce policies and procedures
that are reasonably designed to ensure that it complies with any
obligations to report information to a registered SDR in a manner
consistent with Regulation SBSR. Further, these registered broker-
dealers would be required to review these policies and procedures at
least annually. We preliminarily estimate that the cost associated with
establishing such policies and procedures would be approximately
$58,000 and the cost associated with annual updates would be
approximately $34,000, for each registered broker-dealer that incurs an
obligation to report transactions under our proposed approach.\414\
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\414\ See Regulation SBSR Adopting Release, 80 FR 14716.
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4. Efficiency, Competition, and Capital Formation
Our analysis of the proposed rules' potential impacts on
efficiency, competition, and capital formation begins by considering
the effects the proposed rules may have on the scope of participants
subject to dealer requirements under Title VII. Following this
discussion, we examine potential effects of the proposed rules related
to their effect on the application of Regulation SBSR.
We note that the proposed rules and amendments would, if adopted,
affect the security-based swap market in a number of ways, many of
which are difficult to quantify, if not unquantifiable. In particular,
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, we note in Section VI.B.4(b)i, infra, that, under our
proposed approach, non-U.S. persons may choose to relocate personnel
making it difficult for U.S. counterparties to access liquidity in
security-based swaps. 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.
Not only can some of these effects be difficult to quantify, but
there are many cases where a rule will have two opposing effects,
making it difficult to estimate a net impact on efficiency,
competition, or capital formation. For example, in our discussion of
the net effect of the proposed application of Regulation SBSR
requirements on efficiency, we expect that post-trade transparency may
have a positive effect on price efficiency, while it may negatively
affect liquidity by providing incentives for non-U.S. persons to avoid
contact with U.S. persons. 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 U.S. personnel. Each of these factors is difficult to
quantify individually, which makes the net impact on efficiency equally
difficult to quantify.
(a) De minimis Calculations
The proposed rules and amendments related to the treatment of
transactions arranged, negotiated, or executed by personnel located in
the United States for the purposes of de minimis calculations likely
broadens the scope of security-based swap transactions and entities to
which the Title VII regulatory regime for security-based swap dealers
applies. As a result, the proposal may increase 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.\415\
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\415\ See Cross-Border Adopting Release, 79 FR 47361.
---------------------------------------------------------------------------
The proposed rules and amendments may directly affect efficiency,
competition, and capital formation because the requirement that non-
U.S. persons include in their de minimis threshold calculations
security-based swaps in connection with their dealing activity that
they arrange, negotiate, or execute using personnel located in a U.S.
branch or office 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. Registration would cause
these dealers to incur registration costs as well as the costs of
dealer requirements under the Title VII regulatory regime.
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
provide incentives for non-U.S. persons that currently engage in
relevant activity using personnel located in a U.S. branch or office to
restructure their business and move operations abroad or use agents
with personnel outside of the U.S.\416\ These costs may additionally
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 proposed 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.\417\
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\416\ See id. at 47362.
\417\ We also note that, under the proposed 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 id. at 47362 n.762.
---------------------------------------------------------------------------
We acknowledge that, to the extent that it occurs solely for the
purposes of avoiding Title VII regulation, reduced market entry or
restructuring by non-U.S. persons responding to our proposed approach,
or by agents unable to compete for business from non-U.S. persons, may
be inefficient, raise costs to market participants and 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.\418\
Our proposed approach reflects consideration of the potentially
inefficient restructuring and reduced access to the security-based swap
market by U.S. persons on the one hand, and addressing the concerns of
Title VII on the other. In particular, this proposed approach
potentially reduces the risk of financial contagion and fraudulent or
manipulative conduct by ensuring that security-based swap dealer
regulation is
[[Page 27499]]
applied to the appropriate set of entities whose activities raise these
concerns.
---------------------------------------------------------------------------
\418\ See id. at 47364.
---------------------------------------------------------------------------
We also preliminarily believe that the proposed rules and
amendments would affect competition among security-based swap dealers.
Under proposed Exchange Act rule 3a71-3(b)(iii)(C), U.S. persons would
have to count their dealing activity towards their de minimis
thresholds while their non-U.S. competitors would not. As noted in
Section II.A, supra, in the absence of the proposal, a U.S. person
engaged in dealing activity and facing a non-U.S.-person counterparty
or its agent would face different regulatory treatment 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 noted by commenters,\419\ current rules may
introduce different costs for U.S. security-based swap dealers and
foreign security-based swap dealers and their agents that seek to
supply liquidity to non-U.S. persons as a result of Title VII
regulation, introducing competitive disparities even if the U.S. person
and the non-U.S. person or their agents are both, in connection with
their dealing activity, using personnel located in the United States.
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. We preliminarily believe that many of the
costs of these frictions would be borne by U.S. security-based swap
dealers. The proposed rules and 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.\420\
---------------------------------------------------------------------------
\419\ See note 196, supra (citing IIB Letter and SIFMA/FIA/FSR
Letter raising concerns that the proposed rule could put U.S.
brokers and investment managers at a competitive disadvantage). See
also note 138, supra (citing AFR Letter to CFTC); notes 139 and 299,
supra (citing CDEU Letter to CFTC); note 131, supra (citing ISDA
Letter to CFTC and SIFMA/FIA/FSR Letter to CFTC); note 142, supra
(citing Soci[eacute]t[eacute] G[eacute]n[eacute]rale Letter to
CFTC); note 143, supra (citing JFMC Letter to CFTC, CDEU Letter to
CFTC, SIFMA/FIA/FSR Letter to CFTC, and IAA Letter to CFTC); note
300, supra (citing ISDA Letter to CFTC). See also note 101, supra.
\420\ See Cross-Border Proposing Release, 78 FR 31127; Cross-
Border Adopting Release, 79 FR 39152.
---------------------------------------------------------------------------
As with the proposed amendment that would require non-U.S. persons
to count transactions arranged, negotiated, or executed by personnel
located in a U.S. branch or office towards de minimis thresholds, the
proposal does not retain an exception for cleared, anonymous
transactions and thus should reduce the competitive frictions that
would exist if the proposal retained the exception. Such an exception
would provide non-U.S.-person dealers that arrange, negotiate, or
execute cleared, anonymous transactions using personnel located in a
U.S. branch or office or using agents with personnel in a U.S. branch
or office a potential competitive advantage relative to U.S. persons,
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. 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, our proposed 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.\421\
---------------------------------------------------------------------------
\421\ See Cross-Border Adopting Release, 79 FR 47363.
---------------------------------------------------------------------------
Alternatively, the proposed 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 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 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 that inhibits capital
formation.\422\ To the extent that non-U.S. persons use U.S. personnel
to engage in dealing activity only in a subset of security-based swaps,
such as those involving certain reference entities, we preliminarily
believe that the potential consequences of relocation on liquidity and
risk sharing would be most concentrated in this subset.
---------------------------------------------------------------------------
\422\ See note 143, supra (citing CDEU Letter to CFTC).
---------------------------------------------------------------------------
(b) Other Title VII Requirements
The proposed rules regarding the regulatory reporting, public
dissemination and external business conduct requirements for
transactions arranged, negotiated, or executed by personnel located in
a U.S. branch or office would have several effects on efficiency,
competition, and capital formation in the U.S. financial market. These
effects implicate common economic themes and warrant a consolidated
discussion.
i. Efficiency
The application of public dissemination as set forth in the
proposed rule may improve the efficiency of the price discovery process
and improve the liquidity of traded security-based swaps. Market
participants with more information about the history of prices due to
enhanced post-trade transparency will be better able to price security-
based swaps, and as a result make better trading decisions. Market
observers will be able to incorporate information from the security-
based swap market to derive valuations for other assets that are more
accurate.\423\
---------------------------------------------------------------------------
\423\ See Regulation SBSR Adopting Release, 80 FR 14720.
---------------------------------------------------------------------------
We preliminarily believe that the magnitude of these efficiency
improvements is related to the number of transactions subject to public
dissemination. Data from more transactions may allow market
participants and observers to derive more precise estimates of
fundamental value. As a result, to the extent that the proposed rules
increase the scope of security-based swap transactions subject to
public dissemination, they may result in more efficient pricing and
valuation within and without the security-based swap market.\424\
---------------------------------------------------------------------------
\424\ See Gjergji Cici, Scott Gibson, and John J. Merrick, Jr.,
``Missing the Marks? Dispersion in Corporate Bond Valuations Across
Mutual Funds,'' Journal of Financial Economics, Volume 101, Issue 1
(July 2011), at 206-26 (providing evidence that the implementation
of post-trade transparency in the corporate bond market could have
contributed to a reduction in the dispersion of mutual fund
valuations during the study's sample period). See also Sugato
Chakravarty, Huseyin Gulen, and Stewart Mayhew, ``Informed Trading
in Stock and Option Markets,'' Journal of Finance, Vol. 59, No. 3
(2004) (estimating that the proportion of information about
underlying stocks revealed first in option markets ranges from 10%
to 20%).
---------------------------------------------------------------------------
At the same time, we recognize that particular Title VII
requirements may affect efficiency through their effects on the ability
of security-based swap
[[Page 27500]]
market participants to access liquidity. We preliminarily believe that
certain aspects of our proposal should reduce the likelihood of market
fragmentation. For example, the proposed rules and amendments, by
reducing the likelihood that transactions arranged, negotiated, or
executed within the United States are subject to disparate levels of
regulation under Title VII depending on counterparty identity, the
proposed rules may allow U.S. persons to more freely access liquidity
made available through dealing activity within the United States and
may discourage the formation of a two-tier market in which U.S. persons
and non-U.S. persons are offered liquidity on very different terms.
However, we also acknowledge that the proposed rules may provide
incentives for non-U.S. persons to move their operations and personnel
abroad to avoid external business conduct, regulatory reporting, and
public dissemination requirements. If, under the proposed rules, non-
U.S. security-based swap market participants relocate their sales
forces and trading desks to other jurisdictions, less liquidity may be
available within the United States, reducing the efficiency of prices
and risk sharing. U.S. counterparties may find it difficult to take
desired positions in security-based swaps if their access to non-U.S.
liquidity providers is limited or more costly. For example, if U.S.
persons seeking to hedge risk using security-based swaps have
difficulty obtaining liquidity solely from U.S. providers, they may
reduce their hedging activity in the security-based swap market, seek
substitutes in other asset markets, or assume an inefficient amount of
risk.\425\ We note that the incentive to relocate personnel may grow to
the extent that there is a substantial disparity in regulatory
requirements applicable to those transactions that are arranged,
negotiated, or executed by personnel from a location within the United
States and those transactions that are not.
---------------------------------------------------------------------------
\425\ See note 143, supra (citing CDEU Letter to CFTC).
---------------------------------------------------------------------------
As an alternative to relocating personnel, we acknowledge that
participants may implement or adapt existing controls or conventions
that restrict communication between non-U.S. trading personnel and
persons located in the United States to avoid triggering certain Title
VII requirements. For example, firms may adopt policies restricting
personnel located outside the United States from communicating with
personnel located in the United States when engaging in dealing
activity with non-U.S.-person counterparties. Non-U.S. firms might
additionally restrict personnel located in the United States from
arranging, negotiating, or executing security-based swaps in connection
with the non-U.S. firm's dealing activity with non-U.S.-person
counterparties.
Although non-U.S. persons may voluntarily impose internal
conventions and controls on their own personnel to avoid triggering
certain Title VII requirements, these conventions and controls may
result in inefficient duplication of personnel or expertise in foreign
and U.S. locations. Non-U.S. persons may choose to impose controls on
personnel if the costs of duplication are below the costs of applying
Title VII to relevant activity,\426\ but we preliminarily believe that
such a strategic choice may not take into account the programmatic
benefits of Title VII regulation. For example, public dissemination
requirements under Title VII improve the transparency of the security-
based swap market while causing market participants and SDRs to incur
costs. Other portions of the Title VII regulatory framework, such as
capital and margin requirements yield programmatic benefits by reducing
the risk of sequential counterparty default, but security-based swap
dealers may consider the impact of such requirements on their own
costs, without considering impacts on aggregate financial sector
risk.\427\ Thus, although internal personnel controls may be privately
optimal for firms that choose to implement them, their net impact on
efficiency will depend on how the costs of personnel duplication
compare to the overall costs and benefits of the Title VII dealer
regulation, external business conduct, regulatory reporting, and public
dissemination requirements.
---------------------------------------------------------------------------
\426\ See Section VI.A (discussing the estimated per-entity
costs of these controls).
\427\ See e.g. Daron Acemoglu, Asuman Ozdaglar & Alireza Tahbaz-
Salehi, Systemic Risk and Stability in Financial Networks (NBER
Working Paper No. 18727, Jan. 2013), available at: http://www.nber.org/papers/w18727 (showing the emergence of financial
network externalities in a theoretical model of banks, in which
banks may take into account the effect of their own risk taking on
their creditors, but may fail to internalize the effects of their
own risk taking on their creditors' creditors).
See also Viral V. Acharya, Lasse H. Pedersen, Thomas Philippon,
and Matthew Richardson, ``Measuring Systemic Risk'' (May 2010),
available at: http://vlab.stern.nyu.edu/public/static/SR-v3.pdf.
(using a theoretical model of the banking sector to show that,
unless the external costs of their trades are considered, financial
institutions will have an incentive to take risks that are borne by
the aggregate financial sector). Under this theory, in the context
of Title VII, the relevant external cost is the potential for risk
spillovers and sequential counterparty failure, leading to an
aggregate capital shortfall and breakdown of financial
intermediation in the financial sector.
---------------------------------------------------------------------------
Similarly, we preliminarily believe that our proposed approach more
consistently applies regulatory reporting and public dissemination
requirements to transactions effected by or through trading platforms
and registered broker-dealers, including registered SB SEFs. Both
trading platforms and registered broker-dealers may intermediate
transactions in the security-based swap market. By ensuring that both
types of intermediation are subject to regulatory reporting and public
dissemination requirements, the proposed approach reduces the risk
that, as a result of disparate treatment, liquidity migrates from
trading platforms to registered broker-dealers or from registered
broker-dealers to trading platforms. However, at the same time, we
acknowledge the risk that, in response to the proposed rules and
amendments, trading platforms may choose to move their principal place
of business offshore and registered broker-dealers may move their
security-based swap businesses into unregistered entities to avoid
regulatory reporting requirements.
Attempts to restructure by counterparties, trading platforms and
registered broker-dealers could have an adverse effect on the
efficiency of the security-based swap market by fragmenting liquidity
between a U.S. security-based swap market, occupied by U.S. persons and
non-U.S. persons willing to participate within the Title VII regulatory
framework, with intermediation services provided by registered broker-
dealers and U.S.-based trading platforms, and an offshore market whose
participants seek to avoid any activity that could trigger application
of Title VII to their security-based swap activity.\428\ Such market
fragmentation could reduce the amount of liquidity available to market
participants whose activity is regulated by Title VII and significantly
erode any gains in price efficiency and allocative efficiency that
might result from pre- and post-trade transparency.
---------------------------------------------------------------------------
\428\ See Cross-Border Adopting Release, 79 FR 47364.
---------------------------------------------------------------------------
ii. Competition
We preliminarily believe that our proposed approach would have
implications for competition among market participants that
intermediate transactions in security-based swaps as well as
counterparties to security-based swaps. First, the proposed rules and
amendments to rules 901 and 908 would apply consistent regulatory
reporting and public dissemination requirements to transactions between
non-U.S. persons that are platform-
[[Page 27501]]
executed or effected through registered broker-dealers. We
preliminarily believe that our proposed application of regulatory
requirements is unlikely to generate competitive frictions between
these different types of providers of intermediation services. At the
same time, we acknowledge that proposed rule 908(a)(1)(iv) may make it
difficult for suppliers of intermediation services (i.e., trading
platforms and broker-dealers) effecting or executing transactions
within the United States, to compete to serve non-U.S. persons.
Nonetheless, we preliminarily believe that our proposed approach would
appropriately reflect the transparency focus of Title VII and would
promote a robust regulatory regime for registered broker-dealers.
Applying external business conduct requirements and Regulation SBSR
to transactions in connection with a non-U.S. person's dealing activity
that the non-U.S. person arranges, negotiates, or executes using
personnel located in the United States would mitigate competitive
frictions between U.S. and non-U.S. persons \429\ by providing for a
generally consistent application of these requirements to U.S.-person
dealers and non-U.S.-person dealers or their agents to the extent that
the latter arrange, negotiate, or execute a security-based swap
transaction in connection with their dealing activity using personnel
located in a U.S. branch or office.\430\ If only U.S. dealers and their
agents were subject to disclosure requirements with respect to their
security-based swap transactions, the costs of such disclosures would
primarily affect U.S. dealers, their agents, and their counterparties.
In contrast, non-U.S. dealers and their agents, who may not necessarily
be subject to comparable disclosure requirements, could have a
competitive advantage over U.S. dealers in serving non-U.S.-person
counterparties using personnel located in a U.S. branch or office, were
their activities not subject to the same requirements.\431\
Furthermore, we preliminarily believe the ability to meet certain Title
VII regulatory requirements under the proposed rules may allow non-U.S.
persons who use personnel or personnel of agents located in the United
States to engage in dealing activity to credibly signal high quality
and better counterparty protection relative to other non-U.S. persons
that compete for the same order flow from weaker regulatory
environments.\432\ Non-U.S. persons that choose to use personnel or
personnel of agents for dealing activity from a location within the
United States may find fraud or abusive behavior more costly and
difficult to conduct, which may signal to other non-U.S. persons that
such fraud or abusive behavior is unlikely to occur.
---------------------------------------------------------------------------
\429\ Competitive effects would flow from each of the relevant
Title VII requirements. For instance, post-trade transparency may
increase competition between dealers by reducing the level of
private information that large dealers have relative to smaller
dealers and by improving the ability of non-dealers to negotiate
with dealers on prices. See Regulation SBSR Adopting Release, 80 FR
14704.
\430\ See Cross-Border Proposing Release, 78 FR 31127; Cross-
Border Adopting Release, 79 FR 47327 (providing earlier discussions
of these issues).
\431\ See, e.g., Arnoud W.A. Boot, Silva Dezelan, and Todd T.
Milbourn, ``Regulatory Distortions in a Competitive Financial
Services Industry,'' Journal of Financial Services Research, Vol.
17, No. 1 (2000) (showing that, in a simple industrial organization
model of bank lending, a change in the cost of capital resulting
from regulation results in a greater loss of profits when regulated
banks face competition from unregulated banks than when regulations
apply equally to all competitors).
\432\ See Cross-Border Adopting Release, 77 FR 47362 n.762.
---------------------------------------------------------------------------
We are not proposing, however, to apply the clearing and trade
execution requirements to security-based swap transactions that a non-
U.S. person, in connection with its dealing activity, arranges,
negotiates, or executes using personnel located in a U.S. branch or
office. This aspect of our proposal may contribute to a disparity in
the regulatory treatment of U.S. persons and non-U.S. persons in the
security-based swap market, as non-U.S. persons that engage in dealing
activity using personnel located in the United States would only be
subject to Title VII dealer regulation and Regulation SBSR, while U.S.
persons would also be required to comply with the clearing and trade
execution requirements. If clearing and trade execution requirements
comprise a large portion of the Title VII compliance costs, then a
competitive disparity between U.S. and non-U.S. participants in the
security-based swap market may remain, even with the addition of the
proposed rules. However, to the extent that U.S. persons and non-U.S.
persons whose obligations under a security-based swap are guaranteed by
U.S. persons must increase the price of the liquidity they supply in
response to this disparity in regulatory treatment, we preliminarily
believe that these higher prices reflect an efficient allocation of the
costs their activity may impose on the U.S. financial system, given
that the counterparty credit risk of such security-based swap
transactions resides primarily in the United States.
iii. Capital Formation
The proposed rules may affect capital formation in the security-
based swap and securities market by affecting the transparency,
liquidity, and stability of the market. Requiring transactions by non-
U.S. persons, in connection with their dealing activity, with relevant
activity in the United States to be reported and publicly disseminated
should facilitate monitoring of the security-based swap market and
improve the price discovery process and the liquidity of security-based
swaps.\433\ These improvements may lead to more efficient allocation of
capital by market participants and market observers, facilitating
capital formation.
---------------------------------------------------------------------------
\433\ See Regulation SBSR Adopting Release, 80 FR 14719-722.
---------------------------------------------------------------------------
We recognize that the effects of the proposed rule on market
fragmentation may affect capital formation. If the proposed rules
reduce the likelihood of fragmentation of the security-based swap
market, then they may promote capital formation. Under a regulatory
environment that facilitates U.S. persons' access to the global
security-based swap market, U.S. market participants will be able to
more efficiently hedge financial and commercial risks, reducing the
level of precautionary savings they choose to hold and instead
investing resources in more productive assets. However, if the proposed
rules cause non-U.S. persons to move personnel and operations abroad or
use agents operating outside the United States, the costs of the move
represent resources that could have been invested in productive assets.
Furthermore, to the extent that such restructuring results in a
fragmented market with reduced liquidity for security-based swaps and
related assets within the United States, the result could be less risk
sharing and impaired capital formation.\434\
---------------------------------------------------------------------------
\434\ See Cross-Border Adopting Release, 79 FR 47365.
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5. Request for Comment
The Commission requests comment on all aspects of our discussion
and analysis concerning programmatic costs and benefits, and potential
impacts, of the proposed rule on efficiency, competition, and capital
formation, including the following:
Does our discussion above accurately characterize,
qualitatively and quantitatively, the incentives for entities to
restructure in the absence of, or as a result of, the proposed rules?
Please explain and provide information that would be helpful in
performing further analysis.
Does our discussion above accurately characterize,
qualitatively and quantitatively, the benefits and
[[Page 27502]]
costs of application of external business conduct requirements to
transactions with dealing activity by personnel from a location within
the United States? Please explain and provide information that would be
helpful in performing further analysis.
Our proposal does not retain an exception for cleared,
anonymous transactions that would exclude these from the de minimis
calculations for non-U.S. persons. Please provide information that
would be helpful in estimating any effects of this approach on
liquidity on platforms that support anonymous trading.
Does our discussion above accurately characterize,
qualitatively and quantitatively, the benefits and costs of application
of Title VII requirements to transactions between two non-U.S. persons
in which at least one of the non-U.S. persons, in connection with its
security-based swap dealer activity, arranges, negotiates, or executes
the security-based swap using personnel located in the United States?
Please explain and provide information that would be helpful in
performing further analysis.
C. Alternatives Considered
In developing these proposed rules and amendments we considered a
number of alternative approaches. This section outlines these
alternatives and discusses the potential economic effects of each.
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 the set of Title VII
requirements for business conduct, clearing, trade execution,
regulatory reporting, and public dissemination. The original objective
of the initial definition was identical to this proposed 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 continue to carry out this dealing activity in the United States
while avoiding application of the Title VII requirements by using
personnel of the non-U.S. person located in the United States or
personnel of its agent located in the United States.
We have determined to propose a different approach in part because
we preliminarily agree with commenters that the initial approach likely
would have increased assessment costs significantly.\435\ 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. Accordingly, under the rule as initially proposed, an
entity would have been required to include a transaction in its de
minimis threshold calculations based on the location of its
counterparty's personnel. Gathering such information, communicating it
to relevant counterparties, and keeping records of this information on
a per-transaction basis could be costly. We preliminarily believe that
our re-proposed approach, which focuses only on whether the non-U.S.
person is arranging, negotiating, or executing a security-based swap,
in connection with its dealing activity, using personnel located in a
U.S. branch or office, achieves many of the same programmatic benefits,
while resulting in in lower assessment costs.\436\
---------------------------------------------------------------------------
\435\ See, e.g., note 289, supra (citing ISDA Letter).
\436\ As we noted in Section III.B.2, supra, some commenters
urged that an activity-based test should look only to where the
relevant transaction was executed or where the dealer's personnel
committed the dealer to that trade. Although we acknowledge that
such an alternative may result in costs that are meaningfully lower
than the costs of our proposed approach, because we do not believe
that such an alternative would adequately capture the range of
market-facing activities that appear likely to raise the types of
concerns addressed by security-based swap dealer regulation, we do
not believe that this approach reflects a reasonable alternative to
the proposed approach.
---------------------------------------------------------------------------
2. Limited Exception From Title VII Requirements for Transactions
Arranged, Negotiated, and Executed by Associated Persons of Broker-
Dealers
We also considered not requiring a non-U.S. person to include a
transaction in its de minimis threshold calculations if the security-
based swap dealing activity was arranged, negotiated, or executed in
the United States solely by personnel of a registered broker-dealer
that were acting in their capacity as associated persons of that
broker-dealer. One commenter suggested such an approach.\437\ Although
this approach could reduce costs associated with engaging in customer-
facing activity in connection with dealing activity in security-based
swaps in the United States, it would, as described in more detail
above,\438\ create potentially significant compliance gaps in our Title
VII framework, potentially impeding our effective enforcement of Title
VII and other federal securities laws by reducing the number of
transactions carried out by registered security-based swap dealers and
thus limiting our access to the books and records that are necessary
for effective enforcement.
---------------------------------------------------------------------------
\437\ See note 197, supra (citing IIB Letter).
\438\ See Section III.B.5(c), supra.
---------------------------------------------------------------------------
3. Exclusion of Security-Based Swap Transactions That Do Not Involve a
U.S.-Person Counterparty, a Counterparty Whose Obligations Under the
Security-Based Swap Are Guaranteed by a U.S. Person, or a Conduit
Affiliate From the de minimis Threshold Requirements
Although the Cross-Border Adopting Release stated that we
contemplated considering whether to subject certain security-based swap
transactions involving activity in the United States to certain Title
VII requirements, one alternative to the proposed rules would be not to
require any transactions other than those required in rule 3a71-3 to be
counted toward a person's dealer de minimis threshold. However, in our
preliminary view, in the absence of some form of activity-based test,
the current scope of rules may not adequately address fraud and
competitive fragmentation concerns. Further, personnel located in a
U.S. branch or office may be employed by both U.S. and non-U.S.
persons. Absent an activity-based test, our ability to enforce relevant
regulations may be hindered by our inability to monitor the activity of
such personnel carried out in their role as employee of the non-U.S.
person.
The absence of an activity-based test may also adversely affect
competition between U.S. and non-U.S. persons. Under current rules, the
disparity in regulatory treatment means U.S. and non-U.S. persons will
face disparate regulatory costs even if both engage in dealing activity
using personnel located in a U.S. office. 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 may become unavailable to
U.S. persons.
4. Extension of the Activity-Based Test to the Clearing and Execution
Requirements
As we discuss above in Section V.D, we are not proposing to require
[[Page 27503]]
mandatory clearing or mandatory trade execution for security-based swap
transactions that are arranged, negotiated, or executed using personnel
located in a U.S. branch or office.\439\ Under this alternative, we
would subject all transactions arranged, negotiated, or executed by
personnel located in a U.S. branch or office to the clearing and trade
execution requirements. Non-U.S. entities that are required to
determine whether a transaction must be included in their dealer de
minimis threshold calculations, or whether they are subject to the
external business conduct rules or Regulation SBSR would be able to use
the same assessment in determining whether such a transaction would be
subject to the clearing and trade execution requirements. Further,
transactions that were arranged, negotiated, or executed by non-U.S.
persons using personnel located in a U.S. branch or office would be
subject to clearing and trade execution requirements identical to those
faced by U.S. persons and counterparties to U.S. persons. Such
consistency in regulatory treatment could reduce competitive
disparities between U.S. persons and non-U.S. persons that operate in
the United States. This alternative may reduce the likelihood that a
two-tier security-based swap market emerges as a result of differences
in regulatory requirements across jurisdictions.
---------------------------------------------------------------------------
\439\ Because we have not yet issued any clearing
determinations, no security-based swaps are currently subject to
mandatory clearing. See Section II.B.3, supra.
---------------------------------------------------------------------------
However, we preliminarily believe that this policy choice would
adversely affect efficiency and increase the risk of market
fragmentation. We preliminarily believe that imposing the clearing and
execution requirements may impose unnecessary costs on certain non-U.S.
market participants in relation to the risks posed by their activity to
the United States. For example, these requirements may require non-U.S.
persons and their agents to form new relationships with clearing
agencies and trading platforms in the United States. Given that the
risk to the U.S. financial system in the security-based swap
transactions at issue in this release resides with non-U.S. persons
with no recourse guarantee against U.S. persons, we preliminarily
believe that any potential risk posed to the U.S. financial system does
not warrant imposing clearing and trade execution requirements on these
security-based swap transactions. In particular, we preliminarily
believe that the margin requirements for foreign security-based swap
dealers, which we have proposed to apply on an entity-level basis,
would be sufficient to address the risk to the U.S. from non-U.S.
persons with no recourse guarantee against U.S. persons and that the
costs of the margin requirement would be commensurate to the risks
involved.
VII. Paperwork Reduction Act
A. Introduction
Certain provisions of our proposal contain ``collection of
information'' \440\ requirements within the meaning of the Paperwork
Reduction Act of 1955 (``PRA'') and we are submitting the proposed
collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507 and 5 CFR
1320.11. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid OMB control number.
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\440\ 44 U.S.C. 3502(3).
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We are proposing amendments to previously adopted Regulation SBSR,
which contained 12 collections of information.\441\ The proposed
amendments amend the ``reporting hierarchy'' adopted in Regulation SBSR
that specifies the side that has the duty to report a security-based
swap that is a ``covered transaction'' \442\ and provides for public
dissemination of security-based swap transaction information (except as
provided in rule 902(c)) for certain transactions.\443\ As provided in
the Regulation SBSR Adopting Release, registered SDRs are required to
establish and maintain certain policies and procedures regarding how
transaction data are reported and disseminated, and participants of
registered SDRs that are registered security-based swap dealers or
registered major security-based swap participants are required to
establish and maintain policies and procedures that are reasonably
designed to ensure that they comply with applicable reporting
obligations.
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\441\ See SBSR Adopting Release, 80 FR 14673.
\442\ See Regulation SBSR Adopting Release, 14567, (describing
``covered transaction'' as ``all security-based swaps except: (1)
clearing transactions; (2) security-based swaps that are executed on
a platform and that will be submitted to clearing; (3) transactions
where there is no U.S. person, registered security-based swap
dealer, or registered major security-based swap participant on
either side; and (4) transactions where there is no registered
security-based swap dealer or registered major security-based swap
participant on either side and there is a U.S. person on only one
side'').
\443\ See proposed rules 908(a)(1)(iii), (iv) and (v).
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The hours and costs associated with complying with Regulation SBSR
constitute reporting and cost burdens imposed by each collection of
information. We preliminarily believe that the methodology used for
calculating the paperwork burdens set forth in the Regulation SBSR
Adopting Release is appropriate for calculating the paperwork burdens
associated with the amendments proposed here.
The proposed amendments containing these specific collections of
information are discussed further below.
B. Reporting Obligations--Rule 901
Rule 901 sets forth various requirements relating to the reporting
of covered transactions. The title of this collection is ``Rule 901--
Reporting Obligations.''
1. Summary of Collection of Information
Title VII of the Dodd-Frank Act amended the Exchange Act to require
the reporting of security-based swap transactions. Accordingly, we
adopted rule 901 of Regulation SBSR under the Exchange Act to implement
this requirement. Rule 901 specifies, with respect to each reportable
event pertaining to covered transactions, who is required to report,
what data must be reported, when it must be reported, where it must be
reported, and how it must be reported. Rule 901(a), as adopted,
established a ``reporting hierarchy'' that specifies the side that has
the duty to report a security-based swap that is a covered
transaction.\444\ The reporting side, as determined by the reporting
hierarchy, is required to submit the information required by Regulation
SBSR to a registered SDR. The reporting side may select the registered
SDR to which it makes the required report. Pursuant to rule 901(b), as
adopted, if there is no registered SDR that will accept the report
required by rule 901(a), the person required to make the report must
report the transaction to the Commission. Rule 901(c) sets forth the
primary trade information and rule 901(d) sets forth the secondary
trade information that must be reported. Under the final rules, covered
transactions--regardless of their notional amount--must be reported to
a registered SDR at any point up to 24 hours after the time of
execution, or, in the case of a security-based swap that is subject to
regulatory reporting and public dissemination solely by operation of
rule 908(a)(1)(ii), within 24 hours after the time of acceptance for
clearing.\445\ Except as required by rule
[[Page 27504]]
902(c), the information reported pursuant to rule 901(c) must be
publicly disseminated. Information reported pursuant to rule 901(d) is
for regulatory purposes only and will not be publicly disseminated.
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\444\ See Regulation SBSR Adopting Release, 80 FR 14674 (citing
notes 11-12).
\445\ See Regulation SBSR Adopting Release, Section VII(B)(1)
(discussing rule 901(j) and the rationale for 24-hour reporting
timeframe). Rule 901(j) provides that, if 24 hours after the time of
execution would fall on a non-business day (i.e., a Saturday,
Sunday, or U.S. federal holiday), reporting is required by the same
time on the next business day. Rule 908(a)(1)(ii), as adopted,
provides that a security-based swap that is subject to regulatory
reporting and public dissemination solely by operation of rule
908(a)(1)(ii)--i.e., because the security-based swap has been
accepted for clearing by a clearing agency having its principal
place of business in the United States--must be reported within 24
hours of acceptance for clearing.
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Rule 901(e) requires the reporting of life cycle events, and
adjustments due to life cycle events, within 24 hours of the time of
occurrence, to the entity to which the original transaction was
reported. Reports of life cycle events must contain the transaction ID
of the original transaction.
In addition to assigning reporting duties, rule 901 also imposes
certain duties on a registered SDR that receives security-based swap
transaction data. Rule 901(f) requires a registered SDR to timestamp,
to the second, any information submitted to it pursuant to rule 901,
and rule 901(g) requires a registered SDR to assign a transaction ID to
each security-based swap, or establish or endorse a methodology for
transaction IDs to be assigned by third parties. Rule 901(h) requires
that all information required by rule 901 be transmitted electronically
in a format required by the registered SDR.
Rule 901(i) requires reporting of pre-enactment security-based
swaps and transitional security-based swaps to the extent that
information about such transactions is available.
2. Use of Information
The security-based swap transaction information required to be
reported pursuant to rule 901 will be used by registered SDRs, market
participants, the Commission, and other relevant authorities. The
information reported pursuant to rule 901 will be used by registered
SDRs to publicly disseminate reports of security-based swap
transactions, as well as to offer a resource for us and other relevant
authorities to obtain detailed information about the security-based
swap market. Market participants will use the public market data feed,
among other things, to assess the current market for security-based
swaps and to assist in the valuation of their own positions. We and
other relevant authorities will use information about security-based
swap transactions reported to and held by registered SDRs to monitor
and assess systemic risks, as well as for market surveillance purposes.
3. Respondents
Rule 901(a) assigns reporting duties for covered transactions. In
the Regulation SBSR Adopting Release we maintained our preliminary
estimate of 300 respondents.\446\ Based on an analysis of the TIW data,
we estimate that the proposed amendments set forth in this release
would result in an additional 120 respondents that would be required to
report transactions under the proposed amendments to Regulation SBSR
that are not already required to report under the Regulation SBSR as
adopted. Per estimates discussed above regarding the programmatic costs
and benefits of regulatory reporting and public dissemination, we
estimated that these 120 new respondents will be made up of 90 persons
and approximately 30 other persons that are registered broker-dealers
(including registered SB SEFs).\447\
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\446\ See Regulation SBSR Adopting Release, 80 FR 14674; Cross-
Border Proposing Release, 78 FR 31113 (lowering estimate of
respondents from 1,000 to 300).
\447\ See section VI.B.3 and n.403, supra.
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4. Total Initial and Annual Reporting and Recordkeeping Burdens of Rule
901 of Regulation SBSR
Pursuant to rule 901, covered transactions must be reported to a
registered SDR or to the Commission. Together, sections (a), (b), (c),
(d), (e), (h), and (j) of rule 901 set forth the parameters that govern
how covered transactions are reported. Rule 901(i) addresses the
reporting of pre-enactment and transitional security-based swaps. These
reporting requirements impose initial and ongoing burdens on
respondents. We preliminarily believe that these burdens would be a
function of, among other things, the number of reportable events and
the data elements required to be reported for each such event. Rule
901(f) requires a registered SDR to time stamp, to the second, all
reported information, and rule 901(g) requires a registered SDR to
assign a transaction ID to each security-based swap, or establish or
endorse a methodology for transaction IDs to be assigned by third
parties. These requirements impose initial and ongoing burdens on
registered SDRs. We preliminarily believe that the proposed amendments
addressed in this release would not impact the cost burdens resulting
from rules 901(f) and 901(g) on registered SDRs because the number of
respondents does not impact our calculation of these costs.\448\
Therefore we do not address the costs associated with these provisions.
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\448\ See Regulation SBSR Adopting Release, 80 FR 14676-77.
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For Respondents. The reporting hierarchy set forth in rule 901(a)
is designed to place the duty to report covered transactions on
counterparties who are most likely to have the resources and who are
best able to support the reporting function.
Respondents that fall under the reporting hierarchy in rule
901(a)(2)(ii) incur certain burdens as a result thereof with respect to
their reporting of covered transactions. As stated above, we
preliminarily believe that an estimate of 120 additional respondents
that would incur the duty to report under Regulation SBSR is reasonable
for estimating collection of information burdens. This estimate
includes all persons that would incur a reporting duty under proposed
amendments to Regulation SBSR, that are not already subject to burdens
under current rule 901.
In the Regulation SBSR Adopting Release, we estimated that there
were likely to be approximately 3 million reportable events per year
under rule 901.\449\ We further estimated that approximately 2 million
of these reportable events would consist of uncleared transactions. We
estimated that 2 million of the 3 million total reportable events would
consist of the initial reporting of security-based swaps as well as the
reporting of any life cycle events. We also estimated that of the 2
million reportable events, approximately 900,000 would involve the
reporting of new security-based swap transactions, and approximately
1,100,000 would involve the reporting of life cycle events under rule
901(e).
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\449\ See Regulation SBSR Adopting Release, 80 FR 14675.
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Based on our assessment of the effect of the proposed amendments to
Regulation SBSR, we estimate that they would result in approximately
2,700 additional reportable events per year under rule 901. Taking a
similar approach to the Regulation SBSR Adopting Release but also
accounting for security-based swaps that would be reported by a
registered broker-dealer, we estimate that, of the 2,700 new reportable
events, 1,512 would involve the reporting of new security-based swap
transactions, and approximately 1,188 would involve the reporting of
life cycle events under rule 901(e).\450\ Based
[[Page 27505]]
on these estimates, we preliminarily believe that rule 901(a) would
result in respondents having a total burden of 7.6 hours attributable
to the initial reporting of security-based swaps by respondents to
registered SDRs under rules 901(c) and 901(d) over the course of a
year.\451\ We further estimate that respondents would have a total
burden of 5.9 hours attributable to the reporting of life cycle events
under rule 901(e) over the course of a year.\452\ Therefore, we
preliminarily believe that the proposed amendments to Regulation SBSR
would result in a total reporting burden for respondents under rules
901(c) and 901(d) along with the reporting of life cycle events under
rule 901(e) of 13.5 burden hours per year. We continue to believe that
many reportable events would be reported through electronic means and
that the ratio of electronic reporting to manual reporting is likely to
increase over time. We continue to believe that the bulk of the burden
hours estimated above would be attributable to manually reported
transactions.\453\ Thus, respondents that capture and report
transactions electronically would likely incur fewer burden hours than
those respondents that capture and report transactions manually.
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\450\ As noted above, we expect that 20% of the new reportable
events would be reported by registered broker-dealers pursuant to
901(a)(2)(ii)(E)(4) and thus would involve the reporting only of new
security-based swap transactions and not of life-cycle events. See
note 403, supra. Under this assumption, we would expect 540
reportable events (2,700 * 0.2) to be new security-based swap
transactions reported by registered broker-dealers, and 972
reportable events to be other new security-based swap transactions
that would be required to be reported under the proposed rule
((2,700--540) * 0.45), for a total of 1,512 reportable events that
are new security-based swap transactions. The remaining 1,188
reportable events ((2,700--540) * 0.55) would be life-cycle events
reportable under rule 901(e). Cf. Regulation SBSR Adopting Release,
80 FR 14676.
\451\ In the Regulation SBSR Proposing Release, we estimated
that it would take approximately 0.005 hours for each security-based
swap transaction to be reported. See 75 FR at 75249 n.195. We
calculate the following: ((1,512* 0.005)/(120 respondents)) = 0.06
burden hours per respondent or 7.6 total burden hours attributable
to the initial reporting of security-based swaps.
\452\ In the Regulation SBSR Proposing Release, we estimated
that it would take approximately 0.005 hours for each security-based
swap transaction to be reported. See 75 FR at 75249 n.195. We
calculate the following: ((1,188 * 0.005)/(120 respondents)) = 0.05
burden hours per reporting side or 5.9 total burden hours
attributable to the reporting of life cycle events under rule
901(e).
\453\ See Regulation SBSR Adopting Release, 80 FR 14676.
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Based on the foregoing and applying the same calculation methods
used in the Regulation SBSR Adopting Release, we estimate that rule
901, as proposed in this release, would impose an estimated total
first-year burden of approximately 1,361 hours \454\ per respondent for
a total first-year burden of 163,320 hours for all respondents that
would incur the duty to report under the proposed amendments to rule
901(a)(2)(ii)(E).\455\ We estimate that rule 901, when applied to new
respondents resulting from the proposed amendments to rule 901(a),
would impose ongoing annualized aggregate burdens of approximately 654
hours \456\ per respondent for a total aggregate annualized burden of
78,480 hours for all new respondents.\457\ We further estimate that
rule 901 would impose initial and ongoing annualized dollar cost
burdens of $201,000 per respondent, for total aggregate initial and
ongoing annualized dollar cost burdens of $24,120,000.\458\
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\454\ We derived our estimate from the following: (355 hours
(one-time hourly burden for establishing an OMS) + 172 hours (one-
time hourly burden for establishing security-based swap reporting
mechanisms) + 180 hours (one-time hourly burden for compliance and
ongoing support) = 707 hours (one-time total hourly burden). See
Regulation SBSR Proposing Release, 75 FR 75248-50 nn.186, 194, and
201. (436 hours (annual-ongoing hourly burden for internal order
management) + 0.11 hours (revised annual-ongoing hourly burden for
security-based swap reporting mechanisms) + 218 hours (annual-
ongoing hourly burden for compliance and ongoing support) = 654
hours (one-time total hourly burden. See id. 75248-50 nn.187 and 201
(707 one-time hourly burden + 654 revised annual-ongoing hourly
burden = 1,361 total first-year hourly burden).
\455\ We derived our estimate from the following: (1,361 hours
per respondent * 120 respondents) = 163,320 hours.
\456\ See Regulation SBSR Adopting Release, 80 FR 14676 (citing
Cross-Border Adopting Release, 78 FR 31112-15).
\457\ We derived our estimate from the following: (654 hours per
respondent * 120 respondents) = 78,480 hours.
\458\ See Regulation SBSR Adopting Release, 80 FR 14676 nn.1066
and 1078. We derived our estimate from the following: ($201,000 per
respondent * 120 respondents) = $24,120,000.
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C. Correction of Errors in Security-Based Swap Information--Rule 905
Rule 905, as adopted, establishes procedures for correcting errors
in reported and disseminated security-based swap information. The title
of this collection is ``Rule 905--Correction of Errors in Security-
Based Swap Information.''
1. Summary of Collection of Information
Rule 905 establishes duties for security-based swap counterparties
and registered SDRs to correct errors in information that previously
has been reported.
Counterparty Reporting Error. Under rule 905(a)(1), where a side
that was not the respondent for a security-based swap transaction
discovers an error in the information reported with respect to such
security-based swap, the counterparty must promptly notify the
respondent of the error. Under rule 905(a)(2), where a respondent for a
security-based swap transaction discovers an error in the information
reported with respect to a security-based swap, or receives
notification from its counterparty of an error, the respondent must
promptly submit to the entity to which the security-based swap was
originally reported an amended report pertaining to the original
transaction. The amended report must be submitted to the registered SDR
in a manner consistent with the policies and procedures of the
registered SDR required pursuant to rule 907(a)(3).
Duty of Registered SDR to Correct. Rule 905(b) sets forth the
duties of a registered SDR relating to corrections. If the registered
SDR either discovers an error in a transaction on its system or
receives notice of an error from a respondent, rule 905(b)(1) requires
the registered SDR to verify the accuracy of the terms of the security-
based swap and, following such verification, promptly correct the
erroneous information contained in its system. Rule 905(b)(2) further
requires that, if such erroneous information relates to a security-
based swap that the registered SDR previously disseminated and falls
into any of the categories of information enumerated in rule 901(c),
the registered SDR must publicly disseminate a corrected transaction
report of the security-based swap promptly following verification of
the trade by the counterparties to the security-based swap, with an
indication that the report relates to a previously disseminated
transaction.
2. Use of Information
The security-based swap transaction information required to be
reported pursuant to rule 905 will be used by registered SDRs,
participants of those SDRs, the Commission, and other relevant
authorities. Participants will be able to use such information to
evaluate and manage their own risk positions and satisfy their duties
to report corrected information to a registered SDR. A registered SDR
will need the required information to correct security-based swap
transaction records, in order to maintain an accurate record of a
participant's positions as well as to disseminate corrected
information. The Commission and other relevant authorities will need
the corrected information to have an accurate understanding of the
market for surveillance and oversight purposes.
3. Respondents
Rule 905 applies to all participants of registered SDRs. As noted
above, we estimated that there would be approximately 300 respondents
that
[[Page 27506]]
incur the duty to report security-based swap transactions pursuant to
current rule 901. As noted above, we preliminarily estimate that an
additional 120 respondents would incur the duty to report under the
proposed amendments to Regulation SBSR. Because any of these additional
participants could become aware of errors in their reported transaction
data, we estimate that there may be 120 respondents for purposes of the
proposed amendments.
4. Total Initial and Annual Reporting and Recordkeeping Burdens
The duty to promptly submit amended transaction reports to the
appropriate registered SDR after discovery of an error, as required
under rule 905(a)(2), will impose burdens on respondents. The duty to
promptly notify the relevant respondent after discovery of an error, as
required under rule 905(a)(1), will impose burdens on non-reporting
participants.
With respect to respondents, we preliminarily believe that rule
905(a) will impose an initial, one-time burden associated with
designing and building the respondent's reporting system to be capable
of submitting amended security-based swap transactions to a registered
SDR. We continue to believe that designing and building appropriate
reporting system functionality to comply with rule 905(a)(2) would be a
component of, and represent an incremental ``add-on'' to, the cost to
build a reporting system and develop a compliance function as required
under existing rule 901. Based on discussions with industry
participants, we previously estimated this incremental burden to be
equal to 5% of the one-time and annual burdens associated with
designing and building a reporting system that is in compliance with
rule 901, plus 10% of the corresponding one-time and annual burdens
associated with developing the respondent's overall compliance program
required under rule 901.\459\ This estimate was based on similar
calculations contained in the Regulation SBSR Proposing Release,\460\
updated to reflect new estimates relating to the number of reportable
events and the number of entities with reporting duties. Taking a
similar approach with respect to the proposed amendments to Regulation
SBSR, we estimate that the new respondents would incur, as a result of
rule 905(a), an initial (first-year) aggregate burden of 5,808.7 hours,
which is 48.4 burden hours per respondent,\461\ and an ongoing
aggregate annualized burden of 2,616.7 hours, which is 21.8 burden
hours per respondent.\462\
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\459\ See Regulation SBSR Adopting Release, 80 FR 14682.
\460\ See Regulation SBSR Proposing Release, 75 FR 75254.
\461\ This figure is calculated as follows: [(((172 burden hours
for one-time development of reporting system) x (0.05)) + ((0.11
burden hours annual maintenance of reporting system) x (0.05)) +
((180 burden hours one-time compliance program development) x (0.1))
+ ((218 burden hours annual support of compliance program) x (0.1)))
x (120 respondents)] = 5,808.7 burden hours, which is 48.4 burden
hours per respondent.
\462\ This figure is calculated as follows: [(((0.11 burden
hours annual maintenance of reporting system) x (0.05)) + ((218
burden hours annual support of compliance program) x (0.1))) x (120
respondents)] = 2,616.7 burden hours, which is 21.8 burden hours per
respondent.
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We preliminarily believe that the actual submission of amended
transaction reports required under rule 905(a)(2) would not result in a
material burden because this would be done electronically though the
reporting system that the respondent must develop and maintain to
comply with rule 901. The overall burdens associated with such a
reporting system are addressed in our analysis of rule 901.\463\
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\463\ See Section VII.B, supra.
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D. Policies and Procedures for Registered Broker-Dealers--Rule 906(c)
1. Summary of Collection of Information
The proposed amendments to rule 906(c) would require each
participant that is a registered broker-dealer that becomes a
participant solely as a result of making a report to satisfy an
obligation under proposed rule 901(a)(2)(ii)(E)(4) to establish,
maintain, and enforce written policies and procedures that are
reasonably designed to ensure compliance with applicable security-based
swap transaction reporting obligations. Each such participant also
would be required to review and update its policies and procedures at
least annually.
2. Use of Information
The policies and procedures required under the proposed amendments
to rule 906(c) would be used by participants to aid in their compliance
with Regulation SBSR, and also used by the Commission as part of its
ongoing efforts to monitor and enforce compliance with the federal
securities laws, including Regulation SBSR, through, among other
things, examinations and inspections.
3. Respondents
The proposed amendments to rule 906(c) would result in the rule
applying to registered broker-dealers that are likely to become
participants solely as a result of making a report to satisfy an
obligation under proposed rule 901(a)(2)(ii)(E)(4). The Commission
estimates that there would be 30 such registered broker-dealers.
4. Total Initial and Annual Reporting and Recordkeeping Burdens
The proposed amendment to rule 906(c) would require each registered
broker-dealer that is likely to become a participant solely as a result
of making a report to satisfy an obligation under proposed rule
901(a)(2)(ii)(E)(4) to establish, maintain, and enforce written
policies and procedures that are reasonably designed to ensure
compliance with applicable security-based swap transaction reporting
obligations. The proposed amendment to rule 906(c) also would require
each such registered broker-dealer to review and update such policies
and procedures at least annually. We estimate that the one-time,
initial burden for each such registered broker-dealer to adopt written
policies and procedures as required under the proposed amendments to
rule 906(c) would be similar to the rule 906(c) burdens discussed in
the Regulation SBSR Adopting Release for covered participants, and
would be approximately 216 burden hours per registered broker-
dealer.\464\ As discussed in the Regulation SBSR Adopting Release,\465\
this figure is based on the estimated number of hours to develop a set
of written policies and procedures, program systems, implement controls
and oversight, train relevant employees, and perform necessary testing.
In addition, we estimate the burden of maintaining such policies and
procedures, including a full review at least annually would be
approximately 120 burden hours for each registered broker-dealer that
is likely to become a participant solely as a result of making a report
to satisfy an obligation under proposed rule 901(a)(2)(ii)(E)(4).\466\
This figure includes an estimate of hours related to
[[Page 27507]]
reviewing existing policies and procedures, making necessary updates,
conducting ongoing training, maintaining controls systems, and
performing necessary testing. Accordingly, the Commission estimates
that the initial aggregate annualized burden associated with the
proposed amendments to rule 906(c) would be 10,080 burden hours, which
corresponds to 336 burden hours per registered broker-dealer that is
likely to become a participant solely as a result of making a report to
satisfy an obligation under proposed rule 901(a)(2)(ii)(E)(4).\467\ The
Commission estimates that the ongoing aggregate annualized burden
associated with the proposed amendments to rule 906(c) would be 3,600
burden hours, which corresponds to 120 burden hours per registered
broker-dealer that is likely to become a participant solely as a result
of making a report to satisfy an obligation under proposed rule
901(a)(2)(ii)(E)(4).\468\
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\464\ See Regulation SBSR Adopting Release, 80 FR 14684. This
figure is based on the following: [(Sr. Programmer at 40 hours) +
(Compliance Manager at 40 hours) + (Compliance Attorney at 40 hours)
+ (Compliance Clerk at 40 hours) + (Sr. Systems Analyst at 32 hours)
+ (Director of Compliance at 24 hours)] = 216 burden hours per
registered broker-dealer that is likely to become a participant
solely as a result of making a report to satisfy an obligation under
proposed rule 901(a)(2)(ii)(E)(4).
\465\ See id.
\466\ See id. This figure is based on the following: [(Sr.
Programmer at 8 hours) + (Compliance Manager at 24 hours) +
(Compliance Attorney at 24 hours) + (Compliance Clerk at 24 hours) +
(Sr. Systems Analyst at 16 hours) + (Director of Compliance at 24
hours)] = 120 burden hours per registered clearing agency or
platform.
\467\ This figure is based on the following: [(216 + 120 burden
hours) x (30 registered broker-dealers that are likely to become a
participant solely as a result of making a report to satisfy an
obligation under proposed rule 901(a)(2)(ii)(E)(4))] = 10,080 burden
hours.
\468\ This figure is based on the following: [(120 burden hours)
x (30 registered broker-dealers that are likely to become a
participant solely as a result of making a report to satisfy an
obligation under proposed rule 901(a)(2)(ii)(E)(4))] = 3,600 burden
hours.
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E. Collection of Information Is Mandatory
Each collection of information discussed above is mandatory.
F. Confidentiality of Responses to Collection of Information
Information collected pursuant to rule 905 would be widely
available to the extent that it corrects information previously
reported pursuant to rule 901(c) and incorporated into security-based
swap transaction reports that are publicly disseminated by a registered
SDR pursuant to rule 902. Most of the information required under rule
902 would be widely available to the public to the extent it is
incorporated into security-based swap transaction reports that are
publicly disseminated by a registered SDR pursuant to rule 902.
However, rule 902(c) prohibits public dissemination of certain kinds of
transactions and certain kinds of transaction information. An SDR,
pursuant to section 13(n)(5) of the Exchange Act and rules 13n-4(b)(8)
and 13n-9 thereunder is required to maintain the privacy of this
security-based swap information. To the extent that we receive
confidential information pursuant to this collection of information, we
anticipate that we will keep such information confidential, subject to
the provisions of applicable law. The proposed amendments to rule
906(c) would require certain registered broker-dealers to establish,
maintain, and enforce certain written policies and procedures. The
collection of information required by rule 906(c) would not be widely
available. To the extent that the Commission receives confidential
information pursuant to this collection of information, we anticipate
that we would keep such information confidential, subject to applicable
law.
G. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comment to:
Evaluate whether the proposed collection of information is
necessary for the proper performance of our functions, including
whether the information shall have practical utility;
Evaluate the accuracy of our estimate of the burden of the
proposed collection of information;
Determine whether there are ways to enhance the quality, utility,
and clarity of the information to be collected; and
Evaluate whether there are ways to minimize the burden of
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Persons submitting comments on the collection of information
requirements should direct them to the Office of Management and Budget,
Attention: Desk Officer for the Securities and Exchange Commission,
Office of Information and Regulatory Affairs, Washington, DC 20503, and
should also send a copy of their comments to Brent J. Fields,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090, with reference to File Number S7-06-15.
Requests for materials submitted to OMB by the Commission with regard
to this collection of information should be in writing, with reference
to File Number S7-06-15 and be submitted to the Securities and Exchange
Commission, Office of FOIA/PA Services, 100 F Street NE., Washington,
DC 20549-2736. As OMB is required to make a decision concerning the
collections of information between 30 and 60 days after publication, a
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication.
VIII. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA'') \469\ the Commission requests comment on the
potential effect of these proposed amendments on the United States
economy on an annual basis. The Commission also requests comment on any
potential increases in costs or prices for consumers or individual
industries, and any potential effect on competition, investment, or
innovation. Commenters are requested to provide empirical data and
other factual support for their views to the extent possible.
---------------------------------------------------------------------------
\469\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------
IX. Regulatory Flexibility Act Certification
A. Certification for Proposed Rule and Proposed Amendments to Exchange
Act Rules 3a71-3 and 3a71-5
Section 3(a) of the Regulatory Flexibility Act of 1980 (``RFA'')
\470\ requires the Commission to undertake an initial regulatory
flexibility analysis of the impact of the proposed rule amendments on
small entities unless the Commission certifies that the rule, if
adopted, would not have a significant impact on a substantial number of
``small entities.'' \471\
---------------------------------------------------------------------------
\470\ 5 U.S.C. 603(a).
\471\ 5 U.S.C. 605(b)
---------------------------------------------------------------------------
For purposes of Commission rulemaking in connection with the
RFA,\472\ 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; \473\ 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,\474\ 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
[[Page 27508]]
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.\475\ Under the standards adopted by the Small Business
Administration, small entities in the finance and insurance industry
include the following: (i) For entities engaged in credit
intermediation and related activities, entities with $175 million or
less in assets; \476\ (ii) for entities engaged in non-depository
credit intermediation and certain other activities, entities with $7
million or less in annual receipts; \477\ (iii) for entities engaged in
financial investments and related activities, entities with $7 million
or less in annual receipts; \478\ (iv) for insurance carriers and
entities engaged in related activities, entities with $7 million or
less in annual receipts; \479\ and (v) for funds, trusts, and other
financial vehicles, entities with $7 million or less in annual
receipts.\480\
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\472\ 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
proposed rulemaking, are set forth in Rule 0-10 under the Exchange
Act, 17 CFR 240.0-10. See Exchange Act Release No. 18451 (January,
28, 1982), 47 FR 5215 (February, 4, 1982) (File No. AS-305).
\473\ See 17 CFR 240.0-10(a).
\474\ See 17 CFR 240.17a-5(d).
\475\ See 17 CFR 240.0-10(c).
\476\ See 13 CFR 121.201 (Subsector 522).
\477\ See id. at Subsector 522.
\478\ See id. at Subsector 523.
\479\ See id. at Subsector 524.
\480\ See id. at Subsector 525.
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As we stated in the Cross-Border Adopting Release, we continue to
believe that the types of entities that would engage in more than a de
minimis amount of dealing activity involving security-based swaps would
not be ``small entities'' for purposes of the RFA.\481\ Based on
feedback from market participants and our information about the
security-based swap markets, we believe that firms that are likely to
engage in security-based swap dealing activity at levels that may lead
them to perform de minimis calculations under the ``security-based swap
dealer'' definition are large financial institutions that exceed the
thresholds defining ``small entities'' as set forth above. Accordingly,
the Commission preliminarily believes that it is unlikely that the
proposed amendments regarding the registration of security-based swap
dealers would have a significant economic impact on a substantial
number of small entities.
---------------------------------------------------------------------------
\481\ See Cross-Border Adopting Release, 79 FR 47368.
---------------------------------------------------------------------------
For the foregoing reasons, the Commission certifies that the
proposed rule and amendments to Exchange Act 3a71-3 and 3a71-5 would
not have a significant economic impact on a substantial number of small
entities for purposes of the RFA. We encourage written comments
regarding this certification. We request that commenters describe the
nature of any impact on small entities and provide empirical data to
illustrate the extent of the impact.
B. Initial Regulatory Flexibility Analysis for Proposed Amendments to
Regulation SBSR
The Commission has prepared this Initial Regulatory Flexibility Act
Analysis in accordance with 5 U.S.C. 603. This initial Regulatory
Flexibility Act Analysis relates to the proposed amendments to
Regulation SBSR under the Exchange Act, specifically rules 900, 901,
906, 907, and 908 under the Exchange Act.
1. Reasons for, and Objectives of, the Proposed Action and Legal Basis
The primary reason for, and objective of, the proposed amendments
to Regulation SBSR is to address the application of the regulatory
reporting and public dissemination requirements to certain transactions
not addressed in the Regulation SBSR Adopting Release or the Regulation
SBSR Proposed Amendments Release and to incorporate our revised
approach to transactions of non-U.S. persons who are engaged in dealing
activity from a location in the United States into Regulation SBSR.
Pursuant to Exchange Act sections 13A(a)(1), 13(m)(1)(G), 13(m)(1)(B)-
(D), and 13(n)(5)(D)(ii), the Commission is proposing amendments to
Regulation SBSR regarding the reporting and public dissemination of
certain security-based swap transactions.\482\
---------------------------------------------------------------------------
\482\ See Section V.E, supra.
---------------------------------------------------------------------------
Proposed rule 908(a)(1)(v) would require a security-based swap
transaction connected with a non-U.S. person's security-based swap
dealing activity that is arranged, negotiated, or executed by personnel
of such non-U.S. person located in a U.S. branch or office, or by
personnel of such non-U.S. person's agent located in a U.S. branch or
office, to be reported to a registered SDR and publicly disseminated.
Requiring these transactions to be reported to a registered SDR should
enhance our ability to oversee relevant activity related to security-
based swap dealing occurring within the United States as well as our
ability to monitor market participants for compliance with specific
Title VII requirements.\483\ It should also improve our ability to
monitor for manipulative and abusive practices involving security-based
swap transactions or transactions in related underlying assets, such as
corporate bonds or other securities transactions that result from
dealing activity, or other relevant activity, in the U.S. market.\484\
Subjecting these transactions to the public dissemination requirements
of Regulation SBSR should enhance the level of transparency in the U.S.
security-based swap market, potentially reducing implicit transaction
costs and promoting greater price efficiency.\485\ Ensuring that post-
trade information encompasses transactions involving a non-U.S. person
that arranged, negotiated, or executed the security-based swap in
connection with its dealing activity using personnel (personnel of an
agent) located in a U.S. branch or office, could increase price
competition and price efficiency in the security-based swap market and
should enable all market participants to have more comprehensive
information with which to make trading and valuation
determinations.\486\
---------------------------------------------------------------------------
\483\ See section V.E.2(a), supra.
\484\ Id.
\485\ See id. and note 325, supra.
\486\ See section V.E.2(a), supra.
---------------------------------------------------------------------------
Proposed rule 908(a)(1)(iii) would require a security-based swap
transaction that is executed on a platform having its principal place
of business in the United States to be reported to a registered SDR and
publicly disseminated pursuant to Regulation SBSR. Requiring these
security-based swaps to be reported to a registered SDR would permit
the Commission and other relevant authorities to observe, in a
registered SDR, all transactions executed on such a platform and to
carry out oversight of such security-based swaps. Furthermore, we
preliminarily believe that public dissemination of such transactions
would have value to participants in the U.S. security-based swap
market, who are likely to trade the same or similar products, as these
products would have been listed by a platform having its principal
place of business in the United States.\487\
---------------------------------------------------------------------------
\487\ See section V.E.2(b), supra.
---------------------------------------------------------------------------
Proposed rule 908(a)(1)(iv) would require a security-based swap
transaction that is effected by or through a registered broker-dealer
(including a registered SB SEF) to be reported to a registered SDR and
publicly disseminated pursuant to Regulation SBSR. Under proposed rule
908(a)(2)(ii)(E)(4), the registered broker-dealer would be required to
report the transaction if neither side includes a U.S. person, a
registered security-based swap dealer, a registered major security-
based swap participant, or a non-U.S. person who arranged, negotiated,
or executed the security-based swap from a location in the United
States. Registered broker-dealers play a key role
[[Page 27509]]
as intermediaries in the U.S. financial markets. To improve integrity
and transparency in those markets, we believe that it is important that
the Commission, and other relevant authorities, have ready access to
detailed information about the security-based swap transactions that
such persons intermediate. Furthermore, we preliminarily believe that
public dissemination of such transactions would have value to
participants in the U.S. security-based swap market, who are likely to
trade the same or similar products.\488\
---------------------------------------------------------------------------
\488\ See section V.E.2(c), supra.
---------------------------------------------------------------------------
2. Small Entities Subject to the Proposed Rules
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; \489\ 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 Exchange Act rule 17a-
5(d),\490\ 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.\491\ Under the standards adopted by the
Small Business Administration, small entities in the finance and
insurance industry include the following: (i) For entities engaged in
credit intermediation and related activities, entities with $175
million or less in assets; \492\ (ii) for entities engaged in non-
depository credit intermediation and certain other activities, entities
with $7 million or less in annual receipts; \493\ (iii) for entities
engaged in financial investments and related activities, entities with
$7 million or less in annual receipts; \494\ (iv) for insurance
carriers and entities engaged in related activities, entities with $7
million or less in annual receipts; \495\ and (v) for funds, trusts,
and other financial vehicles, entities with $7 million or less in
annual receipts.\496\
---------------------------------------------------------------------------
\489\ See 17 CFR 240.0-10(a).
\490\ See 17 CFR 240.17a-5(d).
\491\ See 17 CFR 240.0-10(c).
\492\ See 13 CFR 121.201 (Subsector 522).
\493\ See id. at Subsector 522.
\494\ See id. at Subsector 523.
\495\ See id. at Subsector 524.
\496\ See id. at Subsector 525.
---------------------------------------------------------------------------
As noted in the Regulation SBSR Proposed Amendments Release, we
believe, based on input from security-based swap market participants,
that the majority of security-based swap transactions have at least one
counterparty that is either a security-based swap dealer or major
security-based swap participant, and that these entities--whether
registered broker-dealers or not--would exceed the thresholds defining
``small entities'' set out above.\497\ For this reason, we continue to
believe that the majority of proposed amendments to Regulation SBSR
would not have a significant economic impact on a substantial number of
small entities for purposes of the RFA. However, the proposed
amendments would require registered broker-dealers (including a
registered SB SEF) to report a security-based swap transaction that is
effected by or through it. As noted above, we estimate that 30
registered broker-dealers (including registered SB SEFs) may be
required to report such transactions,\498\ though we are not able to
estimate the number of these registered broker-dealers that would be
``small entities.'' Given the nature of the security-based swap market,
we preliminarily believe that it is unlikely that these registered
broker-dealers would be small entities, though we request comment on
the number of registered broker-dealers that are small entities that
would be impacted by our proposed amendments, including any available
empirical data.
---------------------------------------------------------------------------
\497\ See Regulation SBSR Proposed Amendments Release, 80 FR
14801. See also Regulation SBSR Adopting Release, 80 FR 14727-28.
\498\ See section VII.B.3, supra.
---------------------------------------------------------------------------
3. Projected Reporting, Recordkeeping and Other Compliance Requirements
As discussed above, the proposed amendments to Regulation SBSR
would require a security-based swap transaction that is effected by or
through a registered broker-dealer (including a registered SB SEF) to
be reported to a registered SDR by the registered broker-dealer if
neither side of the security-based swap transaction includes a U.S.
person, a registered security-based swap dealer, a registered major
security-based swap participant, or a non-U.S. person who arranged,
negotiated, or executed the security-based swap from a location in the
United States. We preliminarily believe, as discussed above, that
registered broker-dealers (including registered SB SEFs) would incur
certain assessment costs associated with performing an analysis of
their clients (in the case of registered-broker dealers) and members
(in the case of registered SB SEFs) \499\ to determine whose trades
they are obligated to report under the proposed rules, which would be
supported by systems that would record and maintain this information
over time.\500\
---------------------------------------------------------------------------
\499\ See section VI.A.1, supra.
\500\ Id.
---------------------------------------------------------------------------
Additionally, under the proposed amendments to rule 906(c), these
registered broker-dealers would be required to establish, maintain, and
enforce policies and procedures that are reasonably designed to ensure
that the registered broker-dealer complies with any obligations to
report information to a registered security-based swap data repository
in a manner consistent with Regulation SBSR. Further, these registered
broker-dealers would be required to review these policies and
procedures at least annually.\501\
---------------------------------------------------------------------------
\501\ See section VI.B.3, supra.
---------------------------------------------------------------------------
4. Duplicative, Overlapping or Conflicting Federal Rules
The Commission believes there are no rules that duplicate, overlap,
or conflict with the proposed amendments.
5. Significant Alternatives
Pursuant to section 3(a) of the Regulatory Flexibility Act,\502\
the Commission must consider certain types of alternatives, including:
(1) The establishment of differing compliance or reporting requirements
or timetables that take into account the resources available to small
entities; (2) the clarification, consolidation or simplification of
compliance and reporting requirements under the rule for small
entities; (3) the use of performance rather than design standards; and
(4) an exemption from coverage of the rule, or any part of the rule,
for small entities.
---------------------------------------------------------------------------
\502\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------
We are proposing to require registered broker-dealers (including
registered SB SEFs) to report security-based swap transactions that are
effected by or through it if neither side of the security-based swap
transaction includes a U.S. person, a registered security-based swap
dealer, a registered major security-based swap participant, or a non-
U.S. person who arranged, negotiated, or executed the security-based
swap from a location in the United States. The proposed amendments
would enable the Commission to gain a better understanding of the
security-based swap market, including the size and
[[Page 27510]]
scope that market, and should enable us to identify exposure to risks
undertaken by individual market participants or at various levels of
aggregation, as well as credit exposures that arise between
counterparties.\503\ The regulatory data collected as a result of the
proposed amendments would enable us to conduct robust monitoring of the
security-based swap market for potential risks to financial
stability.\504\ The Commission considered whether it is necessary or
appropriate to establish different compliance and reporting
requirements under the rule; or clarify, consolidate, or simplify the
compliance and reporting requirements for small entities under the
rule. Because the proposed rule amendments would enhance the
Commission's ability to oversee relevant activity related to security-
based swap dealing occurring within the United States, our ability to
monitor market participants for compliance with specific Title VII
requirements, and our ability to monitor for manipulative and abusive
practices involving security-based swap transactions, we preliminarily
believe that small entities should be covered by the proposed
amendments to Regulation SBSR. We preliminarily believe that
establishing different compliance or reporting requirements for small
entities, or exempting small entities from the proposed amendments
could complicate the rules and potentially create gaps in the
regulatory data that is reported and publicly disseminated that would
be inconsistent with the goals of Title VII and the proposed
amendments. Additionally, we do not consider performance rather than
design standards to be consistent with the statutory mandate requiring
reporting of security-based swaps to registered SDRs and the public
dissemination of transaction and pricing data to enhance price
discovery of security-based swaps.\505\
---------------------------------------------------------------------------
\503\ See Section VI.B.3, supra.
\504\ See Section VI.B.3, supra.
\505\ See Exchange Act sections 13(m)(1)(G) and 13(m)(1)(B).
---------------------------------------------------------------------------
6. Solicitation of Comment
We are soliciting comments regarding this analysis. We request
comment on the number of small entities that would be subject to the
amendments and whether the proposed amendments would have any effects
that have not been discussed. We request that commenters describe the
nature of any effects on small entities subject to the amendments and
provide empirical data to support the nature and extent of the effects.
X. Statutory Basis and Text of Proposed Rules
Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and
particularly, Sections 3(b), 23(a)(1), 3C(e), 11A(b), 13(m)(1), 13A(a),
17(a), and 30(c) thereof, Sections 712(a)(2), (6), and 761(b) of the
Dodd-Frank Act, the SEC is proposing to amend rules 3a71-3 and 3a71-5,
and 900, 901, 906, 907 and 908, under the Exchange Act.
List of Subjects
17 CFR Part 240
Brokers, Confidential business information, Fraud, Reporting and
recordkeeping requirements, Securities.
17 CFR Part 242
Brokers, Fraud, Reporting and recordkeeping requirements,
Securities.
Text of Proposed Rules
For the reasons stated in the preamble, the SEC is proposing to
amend 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 general 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, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, and 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 3a71-3 and 3a71-5 are also issued under Pub. L. 111-
203, sections 712, 761(b), 124 Stat. 1754 (2010), and 15 U.S.C.
78dd(c).
* * * * *
0
2. Sec. 240.3a71-3 is amended by:
0
a. Adding paragraphs (a)(6) through (a)(9);
0
b. Adding paragraph (b)(1)(iii)(C); and
0
c. Adding paragraph (c).
The additions read as follows:
Sec. 240.3a71-3 Cross-border security-based swap dealing activity.
(a) * * *
(6) U.S. security-based swap dealer means a security-based swap
dealer, as defined in section 3(a)(71) of the Act (15 U.S.C.
78c(a)(71)), and the rules and regulations thereunder, that is a U.S.
person.
(7) Foreign security-based swap dealer means a security-based swap
dealer, as defined in section 3(a)(71) of the Act (15 U.S.C.
78c(a)(71)), and the rules and regulations thereunder, that is not a
U.S. person.
(8) U.S. business means:
(i) With respect to a foreign security-based swap dealer:
(A) Any security-based swap transaction entered into, or offered to
be entered into, by or on behalf of such foreign security-based swap
dealer, with a U.S. person (other than a transaction conducted through
a foreign branch of that person); or
(B) Any security-based swap transaction arranged, negotiated, or
executed by personnel of the foreign security-based swap dealer located
in a U.S. branch or office, or by personnel of an agent of the foreign
security-based swap dealer located in a U.S. branch or office; and
(ii) With respect to a U.S. security-based swap dealer, any
transaction by or on behalf of such U.S. security-based swap dealer,
wherever entered into or offered to be entered into, other than a
transaction conducted through a foreign branch with a non-U.S. person
or with a U.S.-person counterparty that constitutes a transaction
conducted through a foreign branch of the counterparty.
(9) Foreign business means security-based swap transactions that
are entered into, or offered to be entered into, by or on behalf of, a
foreign security-based swap dealer or a U.S. security-based swap
dealer, other than the U.S. business of such person.
(b) * * *
(1) * * *
(iii) * * *
(C) 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
* * * * *
(c) Application of customer protection requirements. A registered
foreign security-based swap dealer and a registered U.S. security-based
swap dealer, with respect to their foreign business, shall not be
subject to the requirements relating to business conduct standards
described in section 15F(h) of the Act (15 U.S.C. 78o-10(h)), and the
rules and regulations thereunder, other than the rules and regulations
prescribed by the Commission pursuant to section 15F(h)(1)(B) of the
Act (15 U.S.C. 78o-10(h)(1)(B)).
[[Page 27511]]
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
connected with its 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.
* * * * *
PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SCI AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
4. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-l(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
5. Sec. 242.900 is further amended, as proposed at 80 FR 14801 (March
19, 2015), by:
0
a. In paragraph (u)(3), removing the period and adding in its place ``;
or''; and
0
b. Adding paragraph (u)(4) to read as follows:
Sec. 242.900 Definitions
* * * * *
(u) * * *
(4) A registered broker-dealer (including a registered security-
based swap execution facility) that is required to report a security-
based swap to that registered security-based swap data repository by
Sec. 242.901(a).
* * * * *
0
6. Sec. 242.901 is amended by:
0
a. Adding paragraphs (a)(2)(ii)(E)(2) through (4); and
0
b. Revising paragraph (d)(9).
The additions and revision read as follows:
Sec. 242.901 Reporting obligations.
(a) * * *
(2) * * *
(ii) * * *
(E) * * *
(2) If one side includes a non-U.S. person that falls within Sec.
242.908(b)(5) or a U.S. person and the other side includes a non-U.S.
person that falls within rule Sec. 242.908(b)(5), the sides shall
select the reporting side.
(3) If one side includes only non-U.S. persons that do not fall
within Sec. 242.908(b)(5) and the other side includes a non-U.S.
person that falls within rule Sec. 242.908(b)(5) or a U.S. person, the
side including a non-U.S. person that falls within rule Sec.
242.908(b)(5) or a U.S. person shall be the reporting side.
(4) If neither side includes a U.S. person and neither side
includes a non-U.S. person that falls within Sec. 242.908(b)(5) but
the security-based swap is effected by or through a registered broker-
dealer (including a registered security-based swap execution facility),
the registered broker-dealer (including a registered security-based
swap execution facility) shall report the information required by
Sec. Sec. 242.901(c) and 242.901(d).
* * * * *
(d) * * *
(9) The platform ID, if applicable, or if a registered broker-
dealer (including a registered security-based swap execution facility)
is required to report the security-based swap by Sec.
242.901(a)(2)(ii)(E)(4), the broker ID of that registered broker-dealer
(including a registered security-based swap execution facility);
* * * * *
0
7. Sec. 242.906 is amended by revising paragraphs (b) and (c) to read
as follows:
Sec. 242.906 Other duties of participants.
(a) * * *
(b) Duty to provide ultimate parent and affiliate information. Each
participant of a registered security-based swap data repository that is
not a platform, a registered clearing agency, or a registered broker-
dealer (including a registered security-based swap execution facility)
that becomes a participant solely as a result of making a report to
satisfy an obligation under Sec. 242.901(a)(2)(ii)(E)(4) shall provide
to the registered security-based swap data repository information
sufficient to identify its ultimate parent(s) and any affiliate(s) of
the participant that also are participants of the registered security-
based swap data repository, using ultimate parent IDs and counterparty
IDs. Any such participant shall promptly notify the registered
security-based swap data repository of any changes to that information.
(c) Policies and procedures to support reporting compliance. Each
participant of a registered security-based swap data repository that is
a security-based swap dealer, major security-based swap participant,
registered clearing agency, registered broker-dealer (including a
registered security-based swap execution facility) that becomes a
participant solely as a result of making a report to satisfy an
obligation under Sec. 242.901(a)(2)(ii)(E)(4), or platform shall
establish, maintain, and enforce written policies and procedures that
are reasonably designed to ensure that it complies with any obligations
to report information to a registered security-based swap data
repository in a manner consistent with Sec. Sec. 242.900 through
242.909. Each such participant shall review and update its policies and
procedures at least annually.
* * * * *
0
8. Sec. 242.907 is amended by revising paragraph (a)(6) to read as
follows:
Sec. 242.907 Policies and procedures of registered security-based
swap data repositories.
(a) * * *
(6) For periodically obtaining from each participant other than a
platform, a registered clearing agency, or a registered broker-dealer
(including a registered security-based swap execution facility) that
becomes a participant solely as a result of making a report to satisfy
an obligation under Sec. 242.901(a)(2)(ii)(E)(4) information that
identifies the participant's ultimate parent(s) and any participant(s)
with which the participant is affiliated, using ultimate parent IDs and
counterparty IDs.
* * * * *
0
9. Sec. 242.908 is amended by adding paragraphs (a)(1)(iii) through
(v); and is further amended as proposed at 80 FR 14801 (March 19,
2015), by adding paragraph (b)(5) to read as follows:
Sec. 242.908 Cross-border matters.
(a) * * *
(1) * * *
(iii) The security-based swap is executed on a platform having its
principal place of business in the United States;
(iv) The security-based swap is effected by or through a registered
broker-dealer (including a registered security-based swap execution
facility); or
(v) The transaction is connected with a non-U.S. person's security-
based swap dealing activity and is 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.
* * * * *
(b) * * *
(5) A non-U.S. person that, in connection with such person's
security-based swap dealing activity, arranged, negotiated, or executed
the security-based swap using its personnel located in a U.S. branch or
office, or using
[[Page 27512]]
personnel of an agent located in a U.S. branch or office.
By the Commission.
Dated: April 29, 2015.
Brent J. Fields,
Secretary.
[FR Doc. 2015-10382 Filed 5-12-15; 8:45 am]
BILLING CODE 8011-01-P