[Federal Register Volume 84, Number 101 (Friday, May 24, 2019)]
[Proposed Rules]
[Pages 24206-24294]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-10016]
[[Page 24205]]
Vol. 84
Friday,
No. 101
May 24, 2019
Part II
Securities and Exchange Commission
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17 CFR Parts 201 and 240
Proposed Rule Amendments and Guidance Addressing Cross-Border
Application of Certain Security-Based Swap Requirements; Proposed Rule
Federal Register / Vol. 84, No. 101 / Friday, May 24, 2019 / Proposed
Rules
[[Page 24206]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 201 and 240
[Release No. 34-85823; File No. S7-07-19]
RIN 3235-AM13
Proposed Rule Amendments and Guidance Addressing Cross-Border
Application of Certain Security-Based Swap Requirements
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rules; proposed interpretations.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is proposing a number of actions to address the cross-
border application of certain security-based swap requirements under
the Securities Exchange Act of 1934 (``Exchange Act'') that were added
by Title VII of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the ``Dodd-Frank Act'').
DATES: Submit comments on or before July 23, 2019.
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 S7-07-19 on the subject line.
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 S7-07-19. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (http://www.sec.gov/rules/proposed.shtml). Comments are also available for website 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. Persons submitting comments are cautioned that the Commission
does not redact or edit personal identifying information from comment
submissions. You should submit only information that you wish to make
publicly available.
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 Commission's website. 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 M. McGee, Assistant Director, at
202-551-5870, regarding the proposed interpretive guidance related to
security-based swap transactions that have been ``arranged'' or
``negotiated'' by personnel located in the United States and the
proposed amendment to Exchange Act Rule 3a71-3; Devin Ryan, Senior
Special Counsel and Edward Schellhorn, Special Counsel regarding the
proposed amendment to Commission Rule of Practice 194; Joanne
Rutkowski, Assistant Chief Counsel and Bonnie Gauch, Senior Special
Counsel, regarding the proposed amendments to Exchange Act Rule 15Fb2-1
and proposed interpretive guidance related to Exchange Act Rule 15Fb2-
4; and Joseph Levinson, Senior Special Counsel, regarding the proposed
modifications to proposed Exchange Act Rule 18a-5; at 202-551-5777,
Division of Trading and Markets, Securities and Exchange Commission,
100 F Street NE, Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment guidance regarding the application of certain uses of the terms
``arranged'' and ``negotiated'' in connection with the cross-border
application of security-based swap regulation under the Exchange Act,
guidance regarding the certification and opinion of counsel
requirements in Exchange Act Rule 15Fb2-4 and Rule 3a71-6, amendments
to Exchange Act Rules 0-13, 3a71-3, 15Fb2-1, and Commission Rule of
Practice 194, and modifications to proposed Rule 18a-5.
First, the Commission is proposing supplemental guidance to address
how certain requirements under Title VII--related to security-based
swap transactions that have been ``arranged'' or ``negotiated'' by
personnel located in the United States--apply to transactions involving
limited activities by those U.S. personnel. Separately, the Commission
is requesting comment on two alternative proposals to amend Rule 3a71-3
under the Exchange Act to modify a provision addressing the cross-
border application of the ``security-based swap dealer'' de minimis
exception. Both of the alternative proposals for the amendment would
add an exception to the rule's existing requirement that, for purposes
of determining whether an entity must register as a security-based swap
dealer, non-U.S. persons must count, as part of their de minimis
calculations, security-based swap dealing transactions that have been
``arranged, negotiated, or executed'' by personnel located in a U.S.
branch or office. The Commission also is proposing corresponding
technical revisions to Exchange Act Rule 0-13 in conjunction with the
proposed amendment. The Commission further is requesting comment on
whether to provide other conditional exceptions for certain other
requirements that apply to such ``arranged, negotiated, or executed''
transactions, including regulatory reporting and public dissemination
requirements and security-based swap dealer business conduct
requirements. Separately, the Commission is proposing to provide
guidance regarding the certification and opinion of counsel
requirements in Exchange Act Rule 15Fb2-4. The Commission is proposing
to amend Exchange Act Rule 15Fb2-1 to provide additional time for a
security-based swap dealer or major security-based swap participant
(collectively defined as ``SBS Entity'') to submit the certification
and opinion of counsel required under Rule 15Fb2-4(c)(1). In addition,
the Commission is proposing to amend Rule of Practice 194 to exclude an
SBS Entity, subject to certain limitations, from the prohibition in
Exchange Act Section 15F(b)(6) with respect to an associated person who
is a natural person who (i) is not a U.S. person and (ii) does not
effect and is not involved in effecting security-based swap
transactions with or for counterparties that are U.S. persons, other
than a security-based swap transaction conducted through a foreign
branch of a counterparty that is a U.S. person. Finally, the Commission
is proposing certain modifications to proposed Exchange Act Rule 18a-5
to address the questionnaire or application for employment that an SBS
Entity is required to make and keep current with respect to certain
foreign associated persons.
I. Background
The Commission has proposed and finalized a number of rules to
implement requirements under Title VII
[[Page 24207]]
of the Dodd-Frank Act \1\ providing for the regulation of security-
based swap activity. Several of those rules include provisions to
address unique concerns raised by cross-border activity in security-
based swaps, including:
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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.
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Exchange Act Rule 3a71-3, which, among other things,
requires (1) non-U.S. persons to include security-based swap dealing
transactions that have been ``arranged, negotiated, or executed'' using
U.S. personnel \2\ in their calculations under the de minimis exception
to the ``security-based swap dealer'' definition,\3\ and (2) registered
security-based swap dealers to comply with business conduct
requirements in connection with certain transactions that have been
arranged, negotiated or executed by U.S. personnel.
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\2\ For purposes of this release, the term ``U.S. personnel''
means personnel located in a branch or office in the United States
of an entity that is engaged in security-based swap activity, or by
personnel of an agent of that entity.
\3\ The term ``security-based swap dealer'' is defined in
Exchange Act Section 3(a)(71), and further defined by Exchange Act
Rules 3a71-1 through 3a71-5. Section 3(a)(71)(D) provides that the
Commission shall promulgate regulations to establish factors with
respect to the making of any determination to exempt a security-
based swap dealer that engages in a de minimis quantity of security-
based swap dealing.
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Regulation SBSR Rules 908(a)(1)(v) and 908(b)(5), which
require regulatory reporting and public dissemination of security-based
swap transactions ``arranged, negotiated, or executed'' using personnel
located within the United States.
Exchange Act Rule 15Fb2-4, which requires, among other
things, that each nonresident security-based swap dealer and
nonresident major security-based swap participant (each as defined in
Exchange Act Rule 15Fb2-4, collectively ``nonresident SBS Entity'')
registering with the Commission provide a certification and opinion of
counsel regarding its willingness and ability to provide the Commission
with prompt access to its books and records and submit to onsite
inspection and examination by the Commission, on Schedule F to Forms
SBSE, SBSE-A and SBSE-BD, as appropriate, which applicants use to
provide the certification.
Exchange Act Rule 15Fb6-2, and proposed Rule 18a-5, which
together would require each registered SBS Entity, whether a U.S. or
non-U.S. person, (1) to certify that it neither knows, nor in the
exercise of reasonable care should have known, that any person
associated with it who effects or is involved in effecting security-
based swaps on its behalf is subject to a statutory disqualification
and (2) to make and retain a background questionnaire to support this
certification.
As discussed in more detail below, market participants and other
commenters have raised concerns regarding possible disruptive effects
of the above requirements, suggesting that the requirements would
create significant operational burdens and impose unwarranted costs.
Such costs and operational burdens may be exacerbated by differences
between the Commission's rules in these areas and corresponding rules
of the Commodity Futures Trading Commission (``CFTC'') in connection
with the regulation of the swaps market. For these reasons, the
Commission has determined that it is appropriate to reconsider its
approach to these issues and consider whether those rules could be
tailored in a manner that would continue to advance the objectives of
Title VII while reducing associated costs and burdens and, where
appropriate, minimizing differences from the approach taken by the
CFTC.
In developing these proposals, the Commission has consulted and
coordinated with staff of the CFTC and the prudential regulators,\4\ in
accordance with the consultation mandate of the Dodd-Frank Act.\5\ The
Commission also has consulted and coordinated with foreign regulatory
authorities through Commission staff participation in numerous
bilateral and multilateral discussions with foreign regulatory
authorities addressing the regulation of OTC (over-the-counter)
derivatives.\6\ Through these multilateral and bilateral discussions
and the Commission staff's participation in various international task
forces and working groups, the Commission has gathered information
about foreign regulatory reform efforts and their effect on and
relationship with the U.S. regulatory regime. The Commission has taken
and will continue to take these discussions into consideration in
developing rules, forms, and interpretations for implementing Title VII
of the Dodd-Frank Act.
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\4\ The term ``prudential regulator'' is defined in Section
1a(39) of the Commodity Exchange Act (``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.
\5\ 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.''
\6\ Staff participates in a number of international standard-
setting bodies and workstreams working on OTC derivatives reforms.
For example, Commission staff participates in the Financial
Stability Board's Working Group on OTC Derivatives Regulation.
Commission staff also participates in the International Organization
of Securities Commissions (``IOSCO'')'s Committee on Derivatives,
the joint Basel Committee on Banking Supervision (``BCBS'') and
IOSCO Working Group on Margin Requirements' Monitoring Group and
participates in international working groups that impact OTC
derivatives financial market infrastructures, such as CPMI-IOSCO
joint working groups assessing legal and regulatory frameworks for
central counterparties and trade repositories and examining central
counterparty resilience and recovery.
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A. Application of Title VII to Transactions ``Arranged, Negotiated, or
Executed'' Using Personnel Located Within the United States
1. Proposed Guidance, Exception, and Solicitation of Comment
The Commission is taking a number of steps to address continuing
concerns that have been raised regarding the various uses of an
``arranged, negotiated, or executed'' test in the cross-border
application of Title VII.
First, the Commission is proposing supplemental guidance regarding
the types of activities by U.S. personnel that would--and would not--
constitute ``arranging'' or ``negotiating'' security-based swap
transactions for purposes of tests that are used to implement a number
of Title VII requirements in the cross-border context.\7\ Separately,
the Commission is proposing two alternatives for a conditional
exception from the ``arranged, negotiated, or execute'' test that forms
part of the de minimis counting provisions of Exchange Act Rule 3a71-3.
Both alternatives would provide an exception from the requirement that
non-U.S.
[[Page 24208]]
persons count, against the thresholds associated with the de minimis
exception, their security-based swap dealing transactions with non-U.S.
counterparties that were arranged, negotiated, or executed by U.S.
personnel.\8\ Finally, the Commission is soliciting comment as to
whether to provide additional conditional exceptions from certain other
requirements under Title VII that otherwise would apply to transactions
``arranged, negotiated, or executed'' by U.S. personnel.\9\
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\7\ The proposed guidance would address the application of
``arranged'' and ``negotiated'' criteria as used in connection with:
Two provisions addressing the cross-border application of the de
minimis exception to the ``security-based swap dealer'' definition,
security-based swap dealer business conduct requirements, the
regulatory reporting and public dissemination requirements of
Regulation SBSR, and certain major security-based swap participant
requirements. See part II, infra.
\8\ See Exchange Act Rule 3a71-3(b)(1)(iii)(C).
\9\ Those requests particularly address the use of ``arranged,
negotiated, or executed'' or equivalent criteria in connection with:
The application of the de minimis counting standard of Exchange Act
Rule 3a71-3(b)(1)(iii)(A) to certain dealing transactions involving
counterparties that are foreign branches of registered security-
based swap dealers, regulatory reporting and public dissemination
requirements in Rules 908(a)(1)(v) and 908(b)(5) of Regulation SBSR,
security-based swap dealer business conduct standards that are not
exempted by Exchange Act Rule 3a71-3(c), and major security-based
swap requirements in Exchange Act Rule 3a67-10.
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These actions--the proposed guidance, the proposed alternatives for
a conditional exception from the ``arranged, negotiated, or executed''
de minimis counting provision, and the solicitation of comment
regarding other possible exceptions from ``arranged, negotiated, or
executed'' test used to implement Title VII--are intended to help
appropriately tailor the application of Title VII to the U.S. market
concerns raised by the transactions that do not involve U.S.
counterparties but that nonetheless result from activity within the
United States.
In proposing this guidance and exception, the Commission is mindful
that the various uses of ``arranged, negotiated, or executed'' criteria
are intended to serve important interests related to avoiding
competitive disparities and market fragmentation, and to public
transparency.\10\ The use of the ``arranged, negotiated, or executed''
test in the context of the security-based swap dealer de minimis
counting provision particularly plays an important role in helping to
prevent entities from using booking practices to avoid registering as
security-based swap dealers, despite being engaged in security-based
swap dealing activity in the United States.\11\ The Commission's
proposals to mitigate the negative consequences potentially associated
with the various uses of this type of test accordingly are designed to
promote the important Title VII interests that the Commission advanced
when it incorporated the test into the various cross-border rules.
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\10\ See notes 19 and 20, infra.
\11\ See note 18, infra.
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2. Current Uses of ``Arranged, Negotiated, or Executed'' Criteria
Exchange Act Rule 3a71-3 provides in part that, when determining
whether non-U.S. persons will be deemed to be security-based swap
dealers--and hence subject to the Title VII requirements applicable to
security-based swap dealers--non-U.S. persons must count, against the
applicable de minimis threshold, their security-based swap dealing
transactions with non-U.S. counterparties that were ``arranged,
negotiated, or executed'' by personnel within the United States.\12\
The rule separately requires that non-U.S. persons count dealing
transactions with U.S. counterparties, and dealing transactions in
which their performance under the security-based swap is guaranteed by
a U.S. affiliate.\13\
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\12\ See Exchange Act Rule 3a71-3(b)(1)(iii)(C). Rule 3a71-3(b)
specifically addresses which cross-border security-based swap
transactions must be counted against thresholds associated with the
de minimis exception to the security-based swap dealer definition.
Persons whose dealing activities exceed the de minimis thresholds
will be required to register as security-based swap dealers once a
compliance date is set. See Exchange Act Section 3(a)(71)(D);
Exchange Act Rule 3a71-2.
The requirement that non-U.S. persons count transactions that
have been arranged, negotiated or executed in the United States does
not apply to non-U.S. persons that are international organizations
such as the International Monetary Fund, the International Bank for
Reconstruction and Development and the United Nations. See Exchange
Act Rule 3a71-3(a)(4)(iii) and Rule 3a71-3(b)(1)(iii)(C).
\13\ Overall, Rule 3a71-3 provides that non-U.S. persons (other
than conduit affiliates as defined in paragraph (a)(1) of the rule)
must count against the de minimis thresholds the following types of
security-based swap dealing transactions: (i) Transactions entered
into with U.S. persons (other than certain transactions involving
foreign branches of the U.S. person); (ii) guaranteed transactions
in which the counterparty has rights of recourse against a U.S.
person affiliated with the non-U.S. person; and (iii) transactions
that are arranged, negotiated or executed by personnel of the non-
U.S. person located in a U.S. branch or office, or by personnel of
an agent of the non-U.S. person located in a U.S. branch or office.
See Exchange Act Rule 3a71-3(b)(1)(iii).
A non-U.S. person's transactions with foreign branches of
registered security-based swap dealers need not be counted so long
as the transaction was not arranged, negotiated or executed by U.S.
personnel on behalf of the foreign branch. See Exchange Act Rules
3a71-3(b)(1)(iii)(A) (counting standard) and 3a71-3(a)(3)
(definition of ``transaction conducted through a foreign branch'');
see also note 81, infra.
The de minimis counting rule further provides that a person
engaged in transactions that are required to be counted also must
count certain transactions of its affiliates, other than affiliates
that are registered as security-based swap dealers (and certain
others). See Exchange Act Rules 3a71-3(b)(2), 3a71-4.
In addition, Rule 3a71-5, which provides an exception from the
de minimis counting requirement for certain cleared anonymous
transactions, is not available to transactions arranged, negotiated
or executed by U.S. personnel. As discussed below, the proposed Rule
3a71-5 exception would not be relevant to the transactions subject
to that proposed exception. See note 100, infra. The proposed
guidance regarding what activity would trigger the ``arranged,
negotiated, or executed'' test would be relevant to the application
of the Rule 3a71-5 exception, however. See note 90, infra.
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Subsequent to incorporating the ``arranged, negotiated, or
executed'' test into the de minimis counting standard, the Commission
also incorporated the test into other rules addressing the cross-border
application of Title VII. Regulation SBSR in part subjects transactions
``arranged, negotiated, or executed'' in the United States to
regulatory reporting and public dissemination requirements.\14\
Registered security-based swap dealers also are subject to certain
business conduct standards with respect to transactions arranged,
negotiated or executed by personnel within the United States.\15\
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\14\ In particular, Regulation SBSR Rule 908(a)(1)(v) requires
regulatory reporting and public dissemination of transactions,
connected with a non-U.S. person's security-based swap dealing
activity, that are arranged, negotiated or executed by the U.S.
personnel of the non-U.S. person, or by U.S. personnel of the non-
U.S. person's agent. Rule 908(b)(5) further specifies that non-U.S.
persons may be subject to regulatory reporting and public
dissemination requirements in conjunction with security-based swap
transactions arranged, negotiated or executed by U.S. personnel. See
also note 80, infra.
\15\ Exchange Act Rule 3a71-3(c) provides that security-based
swap dealers are not subject to certain business conduct standards
with regard to their ``foreign business,'' a term that incorporates
additional definitions of ``U.S. business'' and ``transaction
conducted through a foreign branch'' (see Exchange Act Rules 3a71-
3(a)(3), (8) and (9)). The rule in effect applies business conduct
requirements to certain security-based swap transactions of foreign
security-based swap dealers, and certain transactions conducted
through foreign branches of U.S. security-based swap dealers, only
when the transactions were arranged, negotiated or executed by U.S.
personnel. See also note 79, infra.
Equivalent criteria also have been incorporated into rules
regarding the cross-border application of Title VII requirements
applicable to major security-based swap participants. See note 82,
infra.
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The use of ``arranged, negotiated, or executed'' criteria as part
of the de minimis counting test reflects the Commission's view that a
non-U.S. person that, as part of its dealing, ``engages in market-
facing activity using personnel located in the United States'' would
perform activities that fall within the security-based swap dealer
definition ``at least in part in the United States.'' \16\ When
adopting that test and
[[Page 24209]]
addressing alternative views suggested by commenters, the Commission
stated that it was appropriate to impose Title VII requirements on such
activity given, among other things, the focus of the ``security-based
swap dealer'' definition on a person's dealing activity,\17\ the risk
that non-U.S. persons engaged in security-based swap dealing activity
in the United States could avoid regulation under Title VII,\18\
concerns about competitive disparities and possible market
fragmentation absent such a test,\19\ and the role of public
transparency.\20\
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\16\ ``Security-Based Swap Transactions Connected with a Non-
U.S. Person's Dealing Activity That Are Arranged, Negotiated, or
Executed By Personnel Located in a U.S. Branch or Office or in a
U.S. Branch or Office of an Agent; Security-Based Swap Dealer De
Minimis Exception,'' Exchange Act Release No. 77104 (Feb. 10, 2016),
81 FR 8598, 8621 (Feb. 19, 2016) (``ANE Adopting Release''); see
also id. at 8622 (``a non-U.S. person's market-facing activity in
the United States suggests the type of involvement in the U.S.
security-based swap market that may raise financial contagion,
customer protection, market integrity, and market transparency
concerns'').
\17\ The statutory definition of ``security-based swap dealer''
encompasses the following activities: (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. See
Exchange Act Section 3(a)(71)(A); see also ANE Adopting Release, 81
FR at 8614-15 & n.158 (further concluding that the appropriate
analysis also considers whether a non-U.S. person is engaged in the
United States in an amount above the de minimis thresholds in any of
the activities set forth in the statutory security-based swap dealer
definition or in the Commission's further definition of that term,
and that the final rule's treatment of activity performed by an
agent on behalf of a non-U.S. person in connection with its dealing
activity was consistent with Exchange Act Section 30(c), which
prohibits the application of Title VII requirements to a person that
transacts a security-based swap business ``without the jurisdiction
of the United States'').
\18\ See id. at 8615. ``As long as a non-U.S. person limited its
dealing activity with U.S. persons to levels below the dealer de
minimis thresholds, it could enter into an unlimited number of
transactions connected with its dealing activity in the United
States without being required to register as a security-based swap
dealer.'' Id.
\19\ See id. at 8616. The Commission stated that if financial
groups using non-U.S. persons to carry out dealing business in the
United States can ``exit the Title VII regulatory regime without
exiting the U.S. market with respect to their security-based swap
dealing business with non-U.S.-person counterparties (including non-
U.S.-person dealers),'' those non-U.S.-person dealers likely would
incur fewer costs related to their U.S. dealing activity than U.S.-
person dealers transacting with the same counterparties, and that
non-U.S. person counterparties likely would incur lower costs and
obtain better pricing by entering into security-based swaps with
non-U.S. dealers that are not required to register as security-based
swap dealers. The Commission added that U.S.-person dealers would be
at a disadvantage as financial groups use their non-registered
dealers to cross-subsidize the dealing activity of affiliated
registered security-based swap dealers that engage in dealing
activity with U.S.-person counterparties. See id.
\20\ See id. at 8615 (stating that aside from mitigating
counterparty and operational risks, Title VII security-based swap
dealer requirements also ``advance other important policy objectives
of security-based swap dealer regulation under Title VII, including
enhancing counterparty protections and market integrity, increasing
transparency, and mitigating risk to participants in the financial
markets and the U.S. financial system more broadly'').
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3. Commission Consideration of Alternatives Relying on Registered
Broker-Dealers and Banks
Before the Commission incorporated an ``arranged, negotiated, or
executed'' test into the Rule 3a71-3(b)(1)(iii)(C) de minimis counting
standard applicable to transactions involving two non-U.S. persons,
certain commenters had expressed the view that other Exchange Act
protections would obviate the need to use Title VII security-based swap
dealer regulation to address regulatory concerns arising from non-U.S.
persons' dealing activity using U.S. personnel. Some commenters
particularly depicted the concerns raised by such U.S. market-facing
activity as relating primarily to counterparty protection, and argued
that it would be duplicative to apply Title VII security-based swap
dealer requirements to that activity--on the grounds that agents acting
on behalf of non-U.S. persons engaged in security-based swap dealing
activity generally would be required to register as brokers and could
be required to comply with relevant Exchange Act and Financial Industry
Regulatory Authority (``FINRA'') requirements with respect to the
security-based swap transactions that they intermediate.\21\
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\21\ See id. at 8617-18.
Exchange Act Section 15(a) requires persons who engage in
brokerage activities involving securities to register with the
Commission unless they can avail themselves of an exception from the
registration requirement. The definition of ``broker'' in Exchange
Act Section 3(a)(10), generally encompasses persons engaged in the
business of effecting transactions in securities for the account of
others, but does not encompass banks that are engaged in certain
activities, which may include a significant proportion of banks'
security-based swap dealing activity. See ANE Adopting Release, 81
FR at 8619.
The definition of ``security'' in the Exchange Act (see Exchange
Act Section 3(a)(10)) encompasses security-based swaps. The
Commission has provided time-limited exemptive relief, expiring
February 5, 2020, from the application of certain Exchange Act
requirements related to securities activities involving security-
based swaps. See Exchange Act Release No. 84991 (Jan. 25, 2019), 84
FR 863 (Jan. 31, 2019).
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Commenters further sought to draw parallels between those
circumstances and Exchange Act Rule 15a-6(a)(3), which provides an
exemption from the broker-dealer registration requirement for a foreign
broker-dealer that uses a registered broker-dealer to intermediate
certain transactions.\22\ Certain commenters particularly suggested
that non-U.S. persons should not be required to count the transactions
at issue against the security-based swap dealer de minimis thresholds
subject to conditions such as: That the U.S. activity be conducted by a
registered broker-dealer; or by a bank that complies with certain
business conduct and books and records requirements; or that the non-
U.S. person be registered in a jurisdiction that the Commission
recognizes as comparable; or that the non-U.S. person be subject to
Basel capital standards or be located in a G-20 jurisdiction.\23\
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\22\ See ANE Adopting Release, 81 FR at 8618.
\23\ See id. at 8619.
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In rejecting those alternatives, the Commission stated its belief
that ``the approach suggested by commenters is inconsistent with the
comprehensive, uniform statutory framework established by Congress for
the regulation of security-based swap dealers in Title VII.'' \24\
Significantly, in the Commission's view, broker-dealer regulation does
not apply to banks engaged in certain activities.\25\ The Commission
also emphasized that there are distinctions between the regulatory
requirements applicable to broker-dealers and those applicable to
security-based swap dealers.\26\ The Commission further explained that
the absence of a U.S. activity trigger for de minimis threshold
calculations would create a strong incentive to move booking for
transactions with non-U.S. persons to booking entities that are non-
U.S. persons.\27\
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\24\ Id.
\25\ Id.
\26\ Id.
\27\ Id. at 8620.
The Commission also addressed one comment that suggested that
allowing U.S. personnel to rely on broker-dealer requirements would
increase efficiency by permitting such personnel to ``be subject to
a single set of regulatory compliance obligations with respect to
both their underlying securities transactions and derivatives
transactions.'' In response, the Commission noted that such
efficiencies would be unavailable to banks that are excepted from
the ``broker'' definition for certain activities, that any such
intra-firm efficiencies would be accompanied by competitive
disparities, and that Exchange Act and FINRA rules applicable to
broker-dealers may incorporate ``similar requirements'' once
relevant exemptions terminate. See id. at 8620.
The Commission further noted that concerns expressed by
commenters could be mitigated in part by the availability of
substituted compliance, which would permit non-U.S. person-dealers
to comply with comparable foreign requirements as an alternative to
complying with certain Title VII requirements. The Commission
recognized, however, that substituted compliance may not be
available for some requirements, and that the availability of
substituted compliance would be contingent on the relevant foreign
requirements being comparable to Title VII requirements. See id. at
8620.
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[[Page 24210]]
4. Reconsideration of the Use of ``Arranged, Negotiated, or Executed''
Criteria
Although the ``arranged, negotiated, or executed'' test for de
minimis counting has yet to be implemented, as the prerequisites for
the registration of security-based swap dealers have not yet been
finalized, the Commission believes that it is appropriate to reconsider
the approach it adopted in 2016 in light of ongoing concern among
market participants and other commenters, potential reconsideration by
the CFTC of the cross-border application provisions under Title VII
governing swap market participants and swaps activities, and regulatory
developments in other jurisdictions.
First, market participants have continued to raise several concerns
about the use of ``arranged, negotiated, or executed'' criteria. They
argue that requiring a non-U.S. dealer to identify transactions that it
arranges, negotiates or executes using personnel located in the United
States for purposes of compliance with the rule poses significant
operational challenges.\28\ In addition, they express concern that
foreign non-dealer counterparties will avoid interacting with personnel
located in the United States if doing so would subject them to U.S.
regulatory requirements, given the potential for duplication or
conflict with foreign regulatory requirements and the concomitant
burden.\29\ To address these concerns, they state that they will be
required to ``implement compliance systems that eliminate U.S.-located
personnel from arranging, negotiating and executing the clients' non-
U.S. transactions,'' which in turn will lead to market fragmentation,
lower levels of security-based swap activity by foreign dealers in the
U.S. market, and potentially lower levels of liquidity, globally and in
the U.S. market.\30\ These market participants argue that the risk that
such transactions present to the U.S. financial market (and thus the
benefit of subjecting such activity to the Commission's regulatory
framework) is negligible and cannot justify the imposition of these
requirements with their concomitant direct and indirect costs.\31\
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\28\ See Institute of International Bankers (``IIB''), ``U.S.
Supervision and Regulation of International Banks: Recommendations
for the Report of the Treasury Secretary'' (Apr. 28, 2017) at 64-65
(``IIB Treasury Letter'') (``These systems will create barriers
within entities and corporate groups based solely on the geographic
location of personnel, to the detriment of globalized risk
management and at increased cost to clients. Personnel-based tests
are also cumbersome to administer, requiring entities to make
seemingly arbitrary distinctions about permitted activities of
personnel based on their geographic location at any time.''); see
also, e.g., Memorandum from Richard Gabbert, Counsel to Commissioner
Hester M. Peirce, dated Nov. 30, 2018 (regarding a November 16, 2018
meeting with representatives of SIFMA), available at https://www.sec.gov/comments/s7-05-14/s70514-4714190-176653.pdf; Memorandum
from Richard Gabbert, Counsel to Commissioner Hester M. Peirce,
dated Nov. 30, 2018 (regarding a November 16, 2018 meeting with
representatives of the International Swaps and Derivatives
Association (ISDA)), available at https://www.sec.gov/comments/s7-05-14/s70514-4714187-176649.pdf.
\29\ In particular, IIB noted concerns raised by the need under
this test for foreign clients interacting with personnel located in
the United States to ``amend[ ] their trading documentation,''
change their trading practices to account for public reporting
requirements, and change their interactions with trading platforms
and clearing houses in order to comply with the Commission's rules.
See id. at 64.
\30\ See id. at 65 (``The increased costs of compliance and
changes to market behavior will impede the ability of non-U.S.
dealers to invest and participate in U.S. markets and could lead to
the elimination of a significant number of jobs for U.S.-located
personnel.''); see also Securities Industry and Financial Markets
Association (``SIFMA''), ``Capital Markets Report--Modernizing and
Rationalizing Regulation of U.S. Capital Markets'' (Aug. 10, 2017)
at 115 (``SIFMA Treasury Letter'') (arguing that the test should be
modified ``[t]o encourage firms to hire U.S. front office personnel
and promote global market liquidity'').
\31\ See IIB Treasury Letter at 65 (``The costs of these rules
far exceed any risk-mitigating benefit. For non-U.S. transactions,
the presence of U.S.-located personnel in arranging, negotiating or
executing does not result in risk flowing to the United States.'');
SIFMA Treasury Letter at 120 (``The participation of U.S. personnel
does not create risks justifying the imposition of Title VII
requirements to these otherwise non-U.S. swaps.'').
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The Treasury Department issued a report in October 2017 expressing
the view that the Commission and the CFTC should ``reconsider the
implications'' of applying Title VII rules--including the Commission's
de minimis counting rules as well as other Commission and CFTC
requirements--to certain transactions ``merely on the basis that U.S.-
located personnel arrange, negotiate, or execute the swap, especially
for entities in comparably regulated jurisdictions.'' \32\ Since the
publication of this report, market participants have reiterated their
concerns. For example, two commenters jointly restated their concern
that the test ``would discourage non-U.S. clients from interacting with
U.S. personnel and impede risk management by expert trading personnel
located in the U.S.'' and impose significant operational burdens, even
though ``the benefits of applying additional requirements to
[transactions captured by the test] are limited.'' \33\
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\32\ See Treasury Department, ``A Financial System That Creates
Economic Opportunities: Capital Markets'' (Oct. 2017) at 133-36,
available at https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf.
\33\ IIB and SIFMA, ``SEC-CFTC Harmonization: Key Issues under
Title VII of the Dodd-Frank Act'' (June 21, 2018) at 5-6 (``IIB/
SIFMA 6/21/18 Letter''), available at https://www.sec.gov/comments/s7-05-14/s70514-3938974-167037.pdf.
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The Commission further is aware of concerns that application of the
counting rule could require a financial group to register multiple non-
U.S. entities as security-based swap dealers solely because each of
those entities makes use of affiliated persons based in the United
States to arrange, negotiate or execute security-based swap
transactions with non-U.S. counterparties at levels exceeding the de
minimis threshold. This may incentivize such groups to relocate U.S.
personnel (or the activities performed by U.S. personnel) abroad to
avoid triggering security-based swap dealer registration--a result that
may raise issues similar to those raised by the commenters described
above, including increased fragmentation to the detriment of U.S.
market participants, which could harm U.S. markets and the U.S.
economy. These concerns may be particularly acute for non-U.S.
financial groups with dealers located in jurisdictions for which the
Commission has not made a substituted compliance determination.\34\
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\34\ Exchange Act Rule 3a71-6 permits registered non-U.S.
security-based swap dealers to satisfy certain security-based swap
dealer requirements--related to business conduct, supervision, chief
compliance officers and trade acknowledgment and verification--by
complying with foreign requirements that the Commission by order has
determined are comparable to the analogous Title VII requirements.
---------------------------------------------------------------------------
Additionally, commenters have continued to urge the Commission to
harmonize its rules under Title VII with those of the CFTC, as the CFTC
has largely implemented its regulatory framework for swaps and many, if
not most, market participants that transact security-based swaps also
transact swaps pursuant to the CFTC's rules.\35\ Market participants
have noted potential inefficiencies that may arise from differences
between the Commission's and the CFTC's rules and guidance, including
the operational challenges that face a dealer's trading desk that
transacts in both swaps and security-based swaps, as different or
overlapping requirements may apply
[[Page 24211]]
depending on the specific product or products being traded in
connection with a particular transaction.\36\ Commenters specifically
have urged the Commission to amend its rules to be consistent with the
CFTC's approach, which would not require transactions arranged,
negotiated, or executed in the United States to be counted toward the
de minimis thresholds.\37\ In the alternative, these commenters have
suggested that the Commission consider an exception for such activity
to the extent that it is carried out by U.S. personnel employed by an
affiliate that is either a registered security-based swap dealer or a
registered broker-dealer and the affiliated foreign dealer is ``subject
to BCBS-IOSCO compliant capital and margin requirements.'' \38\
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\35\ See IIB/SIFMA 6/21/18 Letter at 1; see also Futures
Industry Association, ``Harmonization of SEC and CFTC Regulatory
Frameworks,'' (Nov. 29, 2018) at 9, available at https://www.sec.gov/comments/s7-08-12/s70812-4722398-176717.pdf (encouraging
the Commission and the CFTC to ``jointly propose and adopt rules
reflecting a harmonized and unified approach to the cross-border
application of the swaps and security-based swaps provisions of
Title VII'').
\36\ See IIB/SIFMA 6/21/18 Letter at 1.
\37\ See id. at 5.
\38\ Id.
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In October 2018, CFTC Chairman Giancarlo issued a document setting
forth his views regarding possible modifications to the CFTC's cross-
border application of its swap regulations.\39\ Among other things, the
Giancarlo White Paper suggests an approach to the regulation of
transactions arranged, negotiated, or executed by personnel located in
the United States on behalf of a foreign dealer.\40\ The Giancarlo
White Paper suggests that these transactions generally should be
subject to U.S. requirements but also suggests that it may be
appropriate to defer to the foreign jurisdiction's requirements if the
foreign dealer is subject to regulation in a ``Comparable
Jurisdiction.'' \41\
---------------------------------------------------------------------------
\39\ See Chris Giancarlo, CFTC Chairman, ``Cross-Border Swaps
Regulation Version 2.0: A Risk-Based Approach with Deference to
Comparable Non-U.S. Regulation'' (Oct. 1, 2018) (``Giancarlo White
Paper''), available at https://www.cftc.gov/sites/default/files/2018-10/Whitepaper_CBSR100118.pdf.
\40\ See Giancarlo White Paper at 76.
\41\ See id. at 79, 80-81.
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Finally, in recent years, foreign jurisdictions have continued to
implement their own regulatory reforms of the OTC derivatives markets,
making it important to explore possible ways to try to reduce
conflicts, gaps, inconsistencies and overlaps between Title VII
requirements and corresponding foreign requirements. For example,
according to the Financial Stability Board (``FSB'') OTC Derivatives
Working Group's 12th and 13th Progress Reports, only three FSB member
jurisdictions had margin requirements for non-centrally cleared
derivatives in force at the end of August 2016, while 16 FSB member
jurisdictions had such margin requirements in force at the end of
September 2018.\42\
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\42\ See FSB, ``OTC Derivatives Market Reforms: Twelfth Progress
Report on Implementation'' (Jun. 29, 2017) at 2, available at http://www.fsb.org/2017/06/otc-derivatives-market-reforms-twelfth-progress-report-on-implementation; and FSB, ``OTC Derivatives Market
Reforms: Thirteenth Progress Report on Implementation'' (Nov. 19,
2018) at 1, available at http://www.fsb.org/wp-content/uploads/P191118-5.pdf.
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In light of the foregoing, the Commission believes that it is
appropriate to reconsider its approach to these transactions before
foreign dealers and other foreign market participants are required to
comply with requirements based on ``arranged, negotiated, or executed''
criteria, as used in Exchange Act Rule 3a71-3 and elsewhere to
implement Title VII in the cross-border context, to enable the
Commission to avoid or mitigate any negative effects that the test may
create if firms were required to comply with it as adopted. First, the
Commission preliminarily believes that it is appropriate to provide
guidance to market participants regarding the types of market-facing
activity that the ``arranged'' or ``negotiated'' criteria would not
encompass. Second, the Commission preliminarily believes that it is
possible that an alternative approach may better balance any risks
posed by such transactions to the U.S. market against the market-
fragmentation and operational risks of subjecting foreign dealers
engaged in such transactions to the full range of Title VII regulatory
requirements. Moreover, reconsideration of the Commission's approach
would be consistent both with its statutory obligation to consult and
coordinate with the CFTC and with both agencies' recent efforts to
harmonize more closely, to the extent possible, their respective
requirements under Title VII.\43\ Finally, reconsideration would permit
the Commission to evaluate whether the implementation of regulatory
reforms in foreign jurisdictions may address some of the concerns that
led the Commission to adopt the various uses of the ``arranged,
negotiated, or executed'' test in connection with the cross-border
application of Title VII.
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\43\ See ``Chief Compliance Officer Duties and Annual Report
Requirements for Futures Commission Merchants, Swap Dealers, and
Major Swap Participants,'' 83 FR 43510 (Aug. 27, 2018); ``Capital,
Margin, and Segregation Requirements for Security-Based Swap Dealers
and Major Security-Based Swap Participants and Capital Requirements
for Broker-Dealers,'' Exchange Act Release No. 84409 (Oct. 11,
2018), 83 FR 53007 (Oct. 19, 2018).
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For all of these reasons, the Commission preliminarily believes
that it is appropriate to provide guidance about the scope of the
``arranged'' or ``negotiated'' criteria. The proposed guidance is
designed to provide market participants with additional information
regarding the types of conduct that would trigger the Title VII
requirements that use those criteria, and hence provide improved
clarity regarding the types of market-facing conduct that would not be
subject to the relevant Title VII requirements.
Separately, the Commission is proposing an exception from the
application of the ``arranged, negotiated, or executed'' test in
connection with the de minimis counting requirement in Exchange Act
Rule 3a71-3(b)(1)(iii)(C), and is soliciting comment regarding possible
additional exceptions to the use of those criteria in Exchange Act
Rules 3a71-3(b)(1)(iii)(A) (with regard to certain dealing transactions
involving certain foreign branches of a registered security-based swap
dealer), 3a71-3(c) (with regard to the cross-border application of
security-based swap dealer business conduct requirements), 3a67-10
(with regard to the cross-border application of security-based swap
dealer business conduct requirements), and Regulation SBSR Rules
908(a)(1)(v) and 908(b)(5) (relating to cross-border application of
regulatory reporting and public dissemination requirements). The
Commission preliminarily believes that the proposed exception to Rule
3a71-3(b)(1)(iii)(C) would reduce the market fragmentation and
operational risks associated with the ``arranged, negotiated, or
executed'' test, provide a possible framework for reducing divergence
from the CFTC in connection with the treatment of these transactions,
and appropriately recognize the role that foreign regulation may play
in addressing certain risks that may arise from these transactions,
while protecting the important interests that underpin that use of the
``arranged, negotiated, or executed'' test.
B. Proposed Guidance and Amendments Related to the Certification and
Opinion of Counsel Requirements
In 2015, the Commission adopted rules regarding the registration of
SBS Entities.\44\ These rules include certain requirements specific to
nonresident SBS Entities. In particular, Exchange Act Rule 15Fb2-4
requires, among other things, that each nonresident SBS Entity
registering with the Commission certify that it can, as a matter of
law, and will provide the Commission with prompt access to its books
and records and
[[Page 24212]]
submit to on-site inspection and examination by the Commission.\45\ It
also requires that the nonresident SBS Entity obtain and provide to the
Commission an opinion of counsel to support this certification.\46\ As
the Commission stated when adopting these requirements, significant
elements of an effective regulatory regime are the Commission's
abilities to access registered SBS Entities' books and records and to
inspect and examine the operations of registered SBS Entities.\47\
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\44\ See Registration Process for Security-Based Swap Dealers
and Major Security-Based Swap Participants, Exchange Act Release No.
75611 (Aug. 5, 2015), 80 FR 48964 (Aug. 14, 2015) (``Registration
Adopting Release'').
\45\ See 17 CFR 240.15Fb2-4(c)(1)(i).
\46\ See 17 CFR 240.15Fb2-4(c)(1)(ii). As discussed below, the
Commission has incorporated these certification and opinion of
counsel requirements into Exchange Act Rule 3a71-6, which governs
applications for substituted compliance.
\47\ See Registration Adopting Release, 80 FR at 48981.
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The certification and opinion of counsel requirements adopted by
the Commission are designed to provide assurances that the Commission
is able to access directly the books and records of a nonresident SBS
Entity as provided under Sections 15F and 17 of the Exchange Act and
the Commission's rules thereunder, and conduct on-site inspections and
examinations of those records.\48\ In support of these endeavors, the
Commission has proposed recordkeeping rules that would require an SBS
Entity to furnish promptly to a representative of the Commission
legible, true, complete, and current copies of those records of the SBS
Entity that are required to be preserved by the rules, or any other
records of the SBS Entity subject to examination or required to be made
or maintained pursuant to the Exchange Act that are requested by a
representative of the Commission.\49\
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\48\ See id.
\49\ See paragraph (j) of Exchange Act Rule 17a-4, and paragraph
(g) of proposed Exchange Act Rule 18a-6 (Recordkeeping and Reporting
Requirements for Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers; Capital Rule for Certain
Security-Based Swap Dealers, Exchange Act Release No. 71958 (Apr.
17, 2014), 79 FR 25194 (May 2, 2014) (``Recordkeeping and Reporting
Proposing Release'')).
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The Commission is proposing guidance to Exchange Act Rule 15Fb2-4
regarding: (i) The foreign laws that must be covered by the
certification and opinion of counsel; (ii) the scope of the books and
records that are the subject of the certification and opinion of
counsel, namely that the certification and opinion of counsel need only
address: (1) Records that relate to the ``U.S. business'' (as defined
in Exchange Act Rule 3a71-3(a)(8)) of the nonresident SBS Entity; and
(2) financial records necessary for the Commission to assess the
compliance of the nonresident SBS Entity with capital and margin
requirements under the Exchange Act and rules promulgated by the
Commission thereunder, if these capital and margin requirements apply
to the nonresident SBS Entity; (iii) predication of a firm's
certification and opinion of counsel, as necessary, on the nonresident
SBS Entity obtaining prior consent of the persons whose information is
or will be included in the books and records to allow the firm to
promptly provide the Commission with direct access to its books and
records and to submit to on-site inspection and examination; (iv)
applicability of the certification and opinion of counsel to contracts
entered into prior to the date on which the SBS Entity submits an
application for registration pursuant to Section 15F(b); and (v)
whether the certification and opinion of counsel submitted by a
nonresident SBS Entity can take into account approvals, authorizations,
waivers or consents provided by local regulators.
The Commission is also proposing to amend Exchange Act Rule 15Fb2-1
to provide additional time for a nonresident SBS Entity to submit the
certification and opinion of counsel required under Exchange Act Rule
15Fb2-4(c)(1). The Commission is proposing to add new paragraphs (d)(2)
and (e)(2) to Exchange Act Rule 15Fb2-1. Proposed paragraph (d)(2)
would provide that a nonresident applicant that is unable to provide
the certification and opinion of counsel required under Rule 15Fb2-
4(c)(1) shall be conditionally registered, for up to 24 months after
the compliance date for Rule 15Fb2-1, if the applicant submits a Form
SBSE-C and a Form SBSE, SBSE-A, or SBSE-BD, as appropriate, that is
complete in all respects but for the failure to provide the
certification and the opinion of counsel required by Rule 15Fb2-
4(c)(1). Proposed paragraph (e)(2) would provide that if a nonresident
SBS Entity became conditionally registered in reliance on paragraph
(d)(2), the firm would remain conditionally registered until the
Commission acts to grant or deny ongoing registration, and that if the
nonresident SBS Entity fails to provide the certification and opinion
of counsel within 24 months of the compliance date for Rule 15Fb2-1,
the Commission may institute proceedings to determine whether ongoing
registration should be denied. As indicated in the Registration
Adopting Release, once an SBS Entity is conditionally registered, all
of the Commission's rules applicable to registered SBS Entities apply
to the entity and it must comply with them.
The guidance regarding the certification and opinion of counsel
requirements would also be relevant to Exchange Act Rule 3a71-6, which
allows SBS Entities to comply with certain requirements under Section
15F of the Exchange Act through substituted compliance.\50\ Paragraph
(c)(2)(ii) of Rule 3a71-6 provides that substituted compliance
applications by parties or groups of parties--other than foreign
financial regulatory authorities--must include the certification and
opinion of counsel associated with the SBS Entity registration
requirements as if the party were subject to that requirement at the
time of the request. Recognizing the expected time necessary for the
Commission to consider substituted compliance applications it receives,
the Commission welcomes submissions of such applications with respect
to any of its final rules for which substituted compliance is
potentially available. Consistent with this position, the Commission
wishes to clarify that, during the pendency of this proposal, the
Commission will consider all substituted compliance applications
submitted by parties or groups of parties who are not foreign
regulatory authorities even when not accompanied by a certification or
opinion of counsel.\51\ This clarification, however, does not mean that
the Commission would grant any application for substituted compliance
submitted by such parties or groups of parties before the required
certification and opinion of counsel are filed.
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\50\ Exchange Act Rule 3a71-6.
\51\ The Commission's rules do not require that applications
submitted by foreign regulatory authorities be accompanied by a
certification or opinion of counsel. Exchange Act Rule 3a71-6(c).
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C. Proposed Amendment to Commission Rule of Practice 194
Exchange Act Section 15F(b)(6) makes it unlawful for an SBS Entity
to permit an associated person \52\ who is subject to a statutory
disqualification \53\ to effect or
[[Page 24213]]
be involved in effecting security-based swaps on behalf of the SBS
Entity if the SBS Entity knew, or in the exercise of reasonable care
should have known, of the statutory disqualification, ``[e]xcept to the
extent otherwise specifically provided by rule, regulation, or order of
the Commission.'' \54\ In this regard, Exchange Act Section 15F(b)(6)
gives the Commission the discretion to determine, by rule, regulation
or order, that a statutorily disqualified associated person may effect
or be involved in effecting security-based swaps on behalf of an SBS
Entity, and/or to establish rules concerning the statutory prohibition
in Exchange Act Section 15F(b)(6).\55\ As outlined below, the
Commission has taken several actions with respect to the prohibition in
Section 15F(b)(6) of the Exchange Act in its implementation of Title
VII of the Dodd-Frank Act.\56\
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\52\ Exchange Act Section 3(a)(70) generally defines the term
``person associated with'' an SBS Entity to include (i) any partner,
officer, director, or branch manager of an SBS Entity (or any person
occupying a similar status or performing similar functions); (ii)
any person directly or indirectly controlling, controlled by, or
under common control with an SBS Entity; or (iii) any employee of an
SBS Entity. See 15 U.S.C. 78c(a)(70). The definition generally
excludes persons whose functions are solely clerical or ministerial.
Id. The definition of ``person'' under Exchange Act Section 3(a)(9)
is not limited to natural persons, but extends to both entities and
natural persons. 15 U.S.C. 78c(a)(9) (``The term `person' means a
natural person, company, government, or political subdivision,
agent, or instrumentality of a government.'').
\53\ The term statutory disqualification as used in Exchange Act
Section 15F(b)(6) parallels the definition of statutory
disqualification in Exchange Act Section 3(a)(39)(A)-(F), 15 U.S.C.
78c(a)(39)(A)-(F). See ``Applications by Security-Based Swap Dealers
or Major Security-Based Swap Participants for Statutorily
Disqualified Associated Persons To Effect or Be Involved in
Effecting Security-Based Swaps,'' Exchange Act Release No. 84858
(Dec. 19, 2018), 84 FR 4906 (Feb. 19, 2019) (``Rule of Practice 194
Adopting Release'').
\54\ 15 U.S.C. 78o-10(b)(6). The statutory prohibition in
Exchange Act Section 15F(b)(6) is substantially the same as the
statutory provision for a swap dealer or major swap participant
(collectively ``Swap Entities'') in Section 4s(b)(6) of the CEA, 7
U.S.C. 6s(b)(6).
\55\ See id.
\56\ On June 15, 2011, the Commission issued an order that,
among other things, granted temporary relief from compliance with
Exchange Act Section 15F(b)(6) for persons subject to a statutory
disqualification who were, as of July 16, 2011, associated with an
SBS Entity and who effected or were involved in effecting security-
based swaps on behalf of such SBS Entity and allowed such persons to
continue to be associated with an SBS Entity until the date upon
which rules adopted by the Commission to register SBS Entities
became effective. See ``Temporary Exemptions and Other Temporary
Relief, Together With Information on Compliance Dates for New
Provisions of the Securities Exchange Act of 1934 Applicable to
Security-Based Swaps,'' Exchange Act Release No. 64678 (June 15,
2011), 76 FR 36287, 36301, 36305-07 (Jun. 22, 2011) (``June 2011
Temporary Exemptions Order''); see also ``Order Extending Certain
Temporary Exemptions and a Temporary and Limited Exception Related
to Security-Based Swaps,'' Exchange Act Release No. 75919 (Sept. 15,
2015), 80 FR 56519 (Sep. 18, 2015) (extending the June 2011
Temporary Exemptions Order).
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1. Registration Requirements for SBS Entities
On August 5, 2015, the Commission adopted registration requirements
for SBS Entities.\57\ Several aspects of the adopted rules relate to
the statutory prohibition in Exchange Act Section 15F(b)(6). In
particular, the Commission adopted Rule 15Fb6-2(a), which requires that
an SBS Entity certify electronically on its Form SBSE-C that it neither
knows, nor in the exercise of reasonable care should have known, that
any person associated with that SBS Entity who effects or is involved
in effecting security-based swaps on its behalf is subject to a
statutory disqualification, unless otherwise specifically provided by
rule, regulation or order of the Commission.\58\ In addition, Rule
15Fb6-2(b) requires that, to support the certification required by Rule
15Fb6-2(a), the Chief Compliance Officer of an SBS Entity, or his or
her designee, must review and sign a questionnaire or application for
employment--that the SBS Entity is required to obtain pursuant to the
relevant recordkeeping rule--which has been executed by each associated
person who is a natural person and who effects or is involved in
effecting security-based swaps on behalf of the SBS Entity. The
questionnaire or application for employment, in turn, would serve to
verify that the associated natural person is not subject to statutory
disqualification.\59\
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\57\ See Registration Adopting Release.
\58\ See 17 CFR 240.15Fb6-2(a) and Form SBSE-C (17 CFR
249.1600c).
\59\ See 17 CFR 240.15Fb6-2(b).
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The Commission also included within the Registration Adopting
Release guidance on the scope of the phrase ``involved in effecting
security-based swaps,'' as that phrase is used in Exchange Act Section
15F(b)(6).\60\ Specifically, the Commission stated that the term
``involved in effecting security-based swaps'' generally means engaged
in functions necessary to facilitate the SBS Entity's security-based
swap business, including, but not limited to the following activities:
(1) Drafting and negotiating master agreements and confirmations; (2)
recommending security-based swap transactions to counterparties; (3)
being involved in executing security-based swap transactions on a
trading desk; (4) pricing security-based swap positions; (5) managing
collateral for the SBS Entity; and (6) directly supervising persons
engaged in the above-described activities.\61\
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\60\ See Registration Adopting Release, 80 FR at 48974, 48976.
\61\ See id. at 48976.
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2. Commission Rule of Practice 194
On December 19, 2018, the Commission adopted Rule of Practice 194,
which provides, among other things, a process by which an SBS Entity
could apply to the Commission to permit an associated person who is a
natural person and who is subject to a statutory disqualification to
effect or be involved in effecting security-based swaps on behalf of
the SBS Entity.\62\ Rule of Practice 194 establishes a process by which
the Commission can assess on a case-by-case basis whether to grant
relief from the statutory prohibition in Exchange Act Section
15F(b)(6).
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\62\ See Rule of Practice 194 Adopting Release, 84 FR at 4906-
47; see also 17 CFR 240.194(a)-(i).
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Rule of Practice 194 excludes associated persons that are not
natural persons (defined herein as ``associated person entities'') from
the statutory disqualification prohibition in Exchange Act Section
15F(b)(6).\63\ As the Commission explained when adopting Rule of
Practice 194, granting an automatic exclusion for associated person
entities could reduce potential disruptions to the business of SBS
Entities that could lead to possible market disruption.\64\ The
exclusion for associated person entities also results in consistency
with the CFTC's approach with respect to the statutory prohibition for
Swap Entities as set forth in CEA Section 4s(b)(6).\65\
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\63\ See 17 CFR 240.194(c); see also Rule of Practice 194
Adopting Release, 84 FR at 4906.
\64\ See Rule of Practice 194 Adopting Release, 84 FR at 4911.
\65\ See 7 U.S.C. 6s(b)(6). The CFTC, with respect to
statutorily disqualified associated persons of swap entities, limits
the definition of associated persons of swap entities to natural
persons. See 17 CFR 1.3. As a result, the prohibition in CEA Section
4s(b)(6) applies to natural persons (not entities) associated with a
swap entity.
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3. Proposed Rule of Practice 194(c)(2)
As the Commission noted in adopting Rule of Practice 194, there may
be instances where it is consistent with the public interest to permit
an associated person who is subject to a statutory disqualification to
effect or be involved in effecting security-based swaps on behalf of an
SBS Entity.\66\ As discussed in greater detail below, the Commission is
now proposing to amend Rule of Practice 194, by including proposed
paragraph (c)(2), to exclude an SBS Entity, subject to certain
limitations, from the prohibition in Exchange Act Section 15F(b)(6)
with respect to an associated person who is a natural person who (i) is
not a U.S. person and (ii) does not effect and is not involved in
effecting security-based swap transactions with or for counterparties
that are U.S. persons, other than a security-based swap transaction
conducted through a foreign branch of a counterparty that is a U.S.
person.
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\66\ See Rule of Practice 194 Adopting Release, 84 FR at 4908.
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D. Proposed Exchange Act Rule 18a-5
In April 2014, the Commission proposed recordkeeping, reporting,
and notification requirements applicable to SBS Entities, securities
count requirements applicable to certain security-based swap dealers,
and
[[Page 24214]]
additional recordkeeping requirements applicable to broker-dealers to
account for their security-based swap and swap activities.\67\ The
proposed requirements were modeled on existing broker-dealer
requirements.\68\ The Commission received a number of comments in
response to these proposals.\69\ Separately, the Commission proposed
rules governing the cross-border treatment of recordkeeping and
reporting requirements with respect to SBS Entities.\70\ The Commission
received comments in response to these cross-border proposals as
well.\71\
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\67\ See Recordkeeping and Reporting Proposing Release.
\68\ See id., 79 FR at 25196-97 (providing the rationale for
modeling the proposed requirements on the relevant broker-dealer
requirements).
\69\ The comment letters are available at https://www.sec.gov/comments/s7-05-14/s70514.shtml.
\70\ 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'').
\71\ The comment letters are available at https://www.sec.gov/comments/s7-02-13/s70213.shtml.
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In the Recordkeeping and Reporting Proposing Release, the
Commission, among other things, proposed new Exchange Act Rule 18a-5
(patterned after Exchange Act Rule 17a-3--the recordkeeping rule for
registered broker-dealers) to establish recordkeeping standards for
firms without a prudential regulator that are registered with the
Commission only as an SBS Entity (and not as a broker-dealer as well)
and SBS Entities for which there is a prudential regulator
(collectively, ``stand-alone and bank SBS Entities'').\72\
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\72\ See Recordkeeping and Reporting Proposing Release, 79 FR at
25205.
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As part of that rulemaking, the Commission proposed to require that
an SBS Entity make and keep current a questionnaire or application for
employment for each associated person who is a natural person, that
includes the associated person's identifying information, business
affiliations for the past ten years, relevant disciplinary history,
relevant criminal record, and place of business, among other things
(hereinafter the ``questionnaire requirement'').\73\ The Commission
also proposed a definition of the term ``associated person'' that would
include persons associated with an SBS Entity as defined under Section
3(a)(70) of the Exchange Act.\74\ One commenter requested that the
Commission modify the rule for foreign SBS Entities so that the
questionnaire requirement would not apply to associated persons who
effect or are involved in effecting security-based swap transactions
with non-U.S. persons or foreign branches.\75\ In a subsequent letter,
this commenter also requested that the rule be modified to exclude from
the questionnaire requirement an associated person employed or located
in a non-U.S. branch, office, or affiliate of the firm in circumstances
where: (1) Applicable non-U.S. law prohibits the firm from conducting
background checks on the associated person and consent does not cure
the prohibition or may not be a condition of employment; (2) the
associated person is not subject to a statutory disqualification that
the firm actually knows about; (3) the associated person does not
effect and is not involved in effecting security-based swaps with U.S.
counterparties on behalf of the firm; and (4) the associated person
complies with applicable registration and licensing requirements in the
jurisdiction(s) where he or she effects or is involved in effecting
security-based swaps on behalf of the firm.\76\
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\73\ Paragraphs (a)(10)(i) and (b)(8)(i) of proposed Rule 18a-5.
\74\ Id.
\75\ See SIFMA letter to Kevin M. O'Neill, dated Sep. 5, 2014
(``SIFMA 9/5/14 Letter'') at 9, available at https://www.sec.gov/comments/s7-05-14/s70514-10.pdf.
\76\ See Letter from IIB and SIFMA, dated Aug. 26, 2016 (``IIB/
SIFMA 8/26/16 Letter''), available at https://www.sec.gov/comments/s7-05-14/s70514-18.pdf.
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As indicated in Exchange Act Rule 15Fb6-2, the questionnaire
requirement is intended to serve as a basis for a background check of
the associated person who is a natural person and who effects or is
involved in effecting security-based swap transactions on the SBS
Entity's behalf to verify that the person is not subject to statutory
disqualification.\77\ The Commission preliminarily believes that it is
appropriate to provide flexibility with respect to the questionnaire
requirement as applied to associated persons of stand-alone and bank
SBS Entities. As discussed above in Section I.C.3., the Commission is
proposing to add paragraph (c)(2) to Rule of Practice 194 in order to
provide an exclusion from the prohibition in Section 15F(b)(6) of the
Exchange Act with respect to an associated person who is not a U.S.
person and does not effect and is not involved in effecting security-
based swap transactions with or for counterparties that are U.S.
persons, other than a security-based swap transaction conducted through
a foreign branch of a counterparty that is a U.S. person, subject to
certain conditions. Consistent with this proposal, the Commission is
also proposing modifications to proposed Rule 18a-5 to provide that a
stand-alone or bank SBS Entity is not required to make and keep current
a questionnaire or application for employment executed by an associated
person if the SBS Entity is excluded from the prohibition in Section
15F(b)(6) of the Exchange Act with respect to such associated person.
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\77\ See 17 CFR 240.15Fb6-2(b).
---------------------------------------------------------------------------
The Commission also is proposing modifications to proposed Rule
18a-5 to address situations where the laws of a non-U.S. jurisdiction
in which an associated person is employed or located may prohibit a
stand-alone or bank SBS Entity from receiving, creating or maintaining
a record of any of the information mandated by the questionnaire
requirement.\78\ The modifications would apply with respect to an
associated person who is not a U.S. person and would provide that the
stand-alone or bank SBS Entity need not record certain information
mandated by the questionnaire requirement with respect to that person
if the receipt of that information, or the creation or maintenance of
records reflecting such information, would result in a violation of
applicable law in the jurisdiction in which the associated person is
employed or located. The Commission emphasizes, however, that every SBS
Entity must still comply with Section 15F(b)(6) of the Exchange Act and
Rule 15Fb6-2 with respect to every associated person who effects or is
involved in effecting security-based swaps on behalf of the SBS Entity
absent an exclusion from the statutory disqualification prohibition in
Section 15F(b)(6) of the Exchange Act.
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\78\ See paragraphs (a)(10)(iii) and (b)(8)(iii) of Rule 18a-5,
as proposed.
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II. Proposed Guidance Regarding the Meaning of ``Arranged'' and
``Negotiated'' in Connection With the Cross-Border Application of Title
VII
A. Provision of ``Market Color''
1. Earlier Guidance
In adopting the Exchange Act Rule 3a71-3(b)(1)(iii)(C) ``arranged,
negotiated, or executed'' de minimis counting standard applicable to
transactions between two non-U.S. counterparties, the Commission
addressed the types of activity that would--and would not--trigger that
portion of the de minimis test. The Commission subsequently relied on
the analysis underpinning that use of the ``arranged, negotiated, or
executed'' test within the de minimis counting standard when the
Commission adopted final rules incorporating those criteria
[[Page 24215]]
into the cross-border application of security-based swap dealer
business conduct provisions,\79\ and into the cross-border application
of Regulation SBSR's regulatory reporting and public dissemination
provisions.\80\ The Commission previously incorporated those criteria
into the portion of the security-based swap dealer de minimis exception
related to transactions involving counterparties that are foreign
branches of registered security-based swap dealers,\81\ and also has
incorporated those criteria into Title VII rules regarding major
security-based swap participants.\82\
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\79\ Exchange Act Rule 3a71-3(c) excuses a registered security-
based swap dealer from compliance with certain security-based swap
dealer business conduct standards with respect to its foreign
business. That rule incorporates a standard, via underlying
definitions of ``foreign business,'' ``U.S. business'' and
``transaction conducted through a foreign branch'' (see Exchange Act
Rules 3a71-3(a)(3), (8) and (9)), that uses ``arranged, negotiated,
and executed'' terminology that functionally is equivalent to the
``arranged, negotiated, or executed'' standard incorporated by Rule
3a71-3(b)(1)(iii)(C).
In adopting Rule 3a71-3(c), the Commission particularly stated
that the business conduct rules should apply to transactions that a
foreign security-based swap dealer ``arranges, negotiates, or
executes using personnel located in a U.S. branch or office,'' both
to ``preserve customer protections for U.S. counterparties that
would expect to benefit from the protection afforded to them by
Title VII'' and to ``help maintain market integrity by subjecting
the large number of transactions that involve relevant dealing
activity in the United States to these requirements, even if both
counterparties are non-U.S. persons.'' See Business Conduct
Standards for Security-Based Swap Dealers and Major Security-Based
Swap Participants, Exchange Act Release No. 77617 (Apr. 14, 2016),
81 FR 29960, 30065 (May 13, 2016) (``Business Conduct Adopting
Release''). The Commission further stated that the business conduct
rules need not be applied to a U.S. dealer's transactions that have
been arranged, negotiated or executed through a foreign branch with
a non-U.S. counterparty (or with another foreign branch
counterparty), reasoning that ``Title VII is concerned with the
protection of U.S. markets and participants in those markets, and it
remains our view that imposing these requirements on a U.S.-person
dealer when it arranges, negotiates, or executes through its foreign
branch with another foreign branch or a non-U.S. person would
produce little or no benefit to U.S. market participants.'' Id., 81
FR at 30066.
\80\ In incorporating an ``arranged, negotiated, or executed''
standard into Regulation SBSR Rules 908(a)(1)(v) and 908(b)(5),
regarding the cross-border application of regulatory reporting and
public dissemination requirements, the Commission stated that
``[c]onsistent with its territorial application of Title VII
requirements, the Commission believes that, when a foreign dealing
entity uses U.S. personnel to arrange, negotiate, or execute a
transaction in a dealing capacity, that transaction occurs at least
in part within the United States and is relevant to the U.S.
security-based swap market,'' and that ``[a]s the Commission has
stated previously, declining to apply Title VII requirements to
security-based swaps of foreign dealing entities that use U.S.
personnel to engage in ANE activity would have the effect of
allowing such entities `to exit the Title VII regulatory regime
without exiting the U.S. market.' '' See Regulation SBSR--Reporting
and Dissemination of Security-Based Swap Information, Exchange Act
Release No. 78321 (Jul. 14, 2016), 81 FR 53546, 53590-91 (footnote
omitted).
\81\ Exchange Act Rule 3a71-3(b)(1)(iii)(A) generally requires
non-U.S. persons to count transactions with U.S. counterparties for
purposes of the de minimis thresholds, but carves out transactions
that constitute ``transactions conducted through a foreign branch of
the counterparty.'' The definition of ``transaction conducted
through a foreign branch'' in part requires that the transaction be
``arranged, negotiated, and executed on behalf of the foreign branch
solely by persons located outside the United States.'' See Exchange
Act Rule 3a71-3(a)(3)(i)(B).
When the Commission adopted that foreign branch-related de
minimis counting requirement, the Commission concluded that the
definition of ``transaction conducted through a foreign branch''
identifies the functions associated with foreign branch activity
``in a manner that appropriately focuses the exclusion for non-U.S.
person's transactions toward situations in which the branch performs
the core dealing functions outside the United States.'' See
``Application of `Security-Based Swap Dealer' and `Major Security-
Based Swap Participant' Definitions to Cross-Border Security-Based
Swap Activities; Republication'' Exchange Act Release No. 72472
(Jun. 25, 2014), 81 FR 47278, 47322 (Aug. 12, 2014) (``Cross-Border
Adopting Release''). That is consistent with the analysis underlying
the use of ``arranged, negotiated, or executed'' test in connection
with the de minimis counting provisions of Rule 3a71-
3(b)(1)(iii)(C), related to transactions between two non-U.S.
persons, which was intended to prevent the conduct of an
unregistered security-based swap dealing business in the United
States. See notes 18 and 19, supra.
Unless specified otherwise, references to the application of the
``arranged, negotiated, or executed'' test in the context of de
minimis counting refer both to the Rule 3a71-3(b)(1)(iii)(C) test
regarding dealing transactions involving two non-U.S. persons, and
the Rule 3a71-3(b)(1)(iii)(A) test regarding dealing transactions
involving a counterparty that is the foreign branch of a registered
security-based swap dealer.
\82\ The rule implementing the ``major security-based swap
participant'' definition generally requires consideration of a non-
U.S. person's security-based swap positions with U.S.
counterparties, but excludes positions that arise from transactions
conducted through a foreign branch of a counterparty that is a
registered security-based swap dealer. See Exchange Act Rule 3a67-
10(b)(3)(i). This rule incorporates the Rule 3a71-3 definition of
``transaction conducted through a foreign branch,'' which makes use
of ``arranged, negotiated, and executed'' criteria. In adopting that
provision, the Commission noted its consistency with the security-
based swap dealer de minimis counting provision related to
transactions with counterparties that are foreign branches of
registered security-based swap dealers. See Cross-Border Adopting
Release, 79 FR at 47343.
U.S. and non-U.S. major security-based swap participants
similarly are excluded from having to comply with certain business
conduct requirements in connection with transactions conducted
through a foreign branch, based on that same definition. See
Exchange Act Rule 3a67-10(d). In adopting that provision, the
Commission noted its consistency with the cross-border application
of security-based swap dealer business conduct rules. See Business
Conduct Adopting Release, 81 FR at 30069.
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In discussing the ``arranged, negotiated, or executed'' test in the
context of the de minimis counting standard applicable to transactions
involving two non-U.S. counterparties, the Commission explained that
the terms ``arrange'' and ``negotiate'' were intended to ``indicate
market-facing activity of sales or trading personnel in connection with
a particular transaction, including interactions with counterparties or
their agents.'' \83\ The Commission added that the term ``execute'' in
the rule ``refers to the market-facing act that, in connection with a
particular transaction, causes the person to become irrevocably bound
under the security-based swap under applicable law.'' \84\
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\83\ See ANE Adopting Release, 81 FR at 8622.
\84\ See id. The Commission added that the test also applies
when U.S. persons direct other persons to arrange, negotiate or
execute particular security-based swaps. ``In other words, sales and
trading personnel of a non-U.S. person who are located in the United
States cannot avoid application of this rule by simply directing
other personnel to carry out dealing activity[.]'' The Commission
further noted that the test includes transactions in which personnel
located in a U.S. branch or office ``specify the trading strategy or
techniques carried out through algorithmic trading or automated
electronic execution of security-based swaps, even if the related
server is located outside the United States.'' Id. at 8623.
---------------------------------------------------------------------------
The Commission further distinguished market-facing activity by
sales and trading personnel from activity by personnel who perform
back-office functions that generally do not involve direct contact with
counterparties. In doing so, the Commission identified types of
activities that would not require counting of transactions against the
de minimis thresholds, including: Processing trades and other back-
office activities; designing security-based swaps without engaging in
market-facing activity in connection with specific transactions;
preparing underlying documentation including negotiating master
agreements (``as opposed to negotiating with the counterparty the
specific economic terms of a particular security-based swap
transaction''); and clerical and ministerial tasks such as entering
executed transactions on a non-U.S. person's books.\85\
---------------------------------------------------------------------------
\85\ See id. at 8622.
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In addition, the Commission stated that it generally viewed the
test as requiring the counting of transactions arranged, negotiated or
executed by, for example, ``personnel assigned to, on an ongoing or
temporary basis, or regularly working in a U.S. branch or office.''
\86\
[[Page 24216]]
On the other hand, the counting standard does not extend to
transactions arranged, negotiated or executed ``by personnel assigned
to a foreign office if such personnel are only incidentally in the
United States,'' such as while attending an educational or industry
conference.\87\
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\86\ Id. at 8623. The Commission separately explained that the
rule applies to security-based swap transactions that the non-U.S.
person, in connection with its dealing activity, arranges,
negotiates or executes, using personnel located in a U.S. branch or
office, even when such transactions are in response to inquiries
from a non-U.S. person counterparty outside business hours in the
counterparty's jurisdiction and occur pursuant to product, credit
and market risk parameters set by management personnel outside the
United States. See id. at 8623-24.
\87\ See id. at 8623. The Commission stated that this should
mitigate the burdens of determining whether a particular transaction
needs to be counted. See id.
More generally, the Commission emphasized that the rule would
avoid the need for the non-U.S. person to monitor the location of
its counterparty's personnel or receive associated representations.
See id. at 8621-22; see also id. at 8612-13 (discussing prior
Commission proposal to address the cross-border application of the
security-based swap dealer definition via a test that would have
required counting of transactions that were solicited, negotiated,
executed or booked in the United States by or on behalf of either
counterparty).
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2. Proposed Supplemental Guidance
The Commission is proposing to provide supplemental guidance
regarding the types of market-facing activity that would--and would
not--constitute ``arranging'' or ``negotiating'' a security-based swap
for purposes of the relevant Title VII requirements.\88\ For the
reasons discussed below, this proposed guidance would take the position
that a person may provide ``market color'' in specific circumstances
without that activity constituting ``arranging'' or ``negotiating''
security-based swap transactions for purposes of the ``arranged,
negotiated, or executed'' test \89\ that is used in connection with de
minimis counting,\90\ the cross-border application of business conduct
rules,\91\ regulatory reporting and public dissemination
requirements,\92\ and major security-based swap participant rules.\93\
For purposes of this guidance, the term ``market color'' means
background information regarding pricing or market conditions
associated with particular instruments or with markets more generally,
including information regarding current or historic pricing, volatility
or market depth, and trends or predictions regarding pricing,
volatility or market depth, as well as other types of information
reflecting market conditions and trends.
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\88\ The Commission does not believe there is a reason to
revisit its prior guidance regarding the scope of the term
``execute''; the Commission therefore is not providing any
additional guidance regarding the interpretation of that term.
\89\ Certain provisions applying Title VII security-based swap
requirements in the cross-border context, such as the de minimis
counting test in Rule 3a71-3(b)(2)(iii), incorporate ``arranged,
negotiated, or executed'' terminology. Other cross-border provisions
make use of the definition of ``transaction conducted through a
foreign branch'' in Rule 3a71-3(a)(3), which incorporates the
functionally equivalent ``arranged, negotiated, and executed''
terminology. This proposed guidance would apply to both uses of that
terminology, as found in the rules discussed in notes 90 through 93,
infra, and accompanying text.
\90\ In connection with de minimis counting, this proposed
guidance would apply to: (1) Exchange Act Rule 3a71-3(b)(1)(iii)(C),
which requires the counting of security-based swap dealing
transactions between non-U.S. counterparties that have been
``arranged, negotiated, or executed'' in the United States; (2)
Exchange Act Rule 3a71-3(b)(2), which addresses the counting of
affiliate transactions described by paragraph (b)(1) (which includes
the (b)(1)(iii)(C) requirement); (3) Exchange Act Rule 3a71-5, which
excepts certain cleared anonymous transactions from the individual
counting requirement of paragraph (b)(1) of Rule 3a71-3 and from the
affiliate counting requirement of paragraph (b)(2), but is
unavailable to transactions ``arranged, negotiated, or executed'' by
U.S. personnel; and (4) the de minimis counting requirement of
Exchange Act Rule 3a71-3(b)(1)(iii)(A), requiring the counting of
dealing transactions between dealing transactions involving a
foreign branch of a registered security-based swap dealer and a non-
U.S. counterparty (or another foreign branch). The regulatory
interests underlying the Rule 3a71-3(b)(1)(iii)(C) and Rule 3a71-
3(b)(1)(iii)(A) uses of arranged, negotiated and/or executed
criteria to implement the de minimis counting requirement are
similar (as are, derivatively, the Rule 3a71-3(b)(2) and Rule 3a71-5
uses). See note 81, supra.
\91\ See note 79, supra (addressing Exchange Act Rule 3a71-3(c)
business conduct exclusion).
\92\ See note 80, supra (addressing Regulation SBSR Rules
908(a)(1)(v) and 908(b)(5), regarding the cross-border application
of regulatory reporting and public dissemination requirements).
\93\ See note 82, supra (addressing cross-border major security-
based swap participant provisions of Exchange Act Rules 3a67-
10(b)(3)(i) and 3a67-10(d)).
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The Commission believes that the earlier guidance, which focused on
the presence of market-facing activities by U.S. personnel, provides a
useful starting point for identifying the types of U.S. activity that
should trigger the various uses of the ``arranged, negotiated, or
executed'' test. The Commission nonetheless has come to recognize that
there are significant variations among the types of market-facing
activity that may occur in connection with security-based swap
transactions, and that U.S. personnel in some circumstances may engage
in activity that, although market-facing, reasonably may not be
characterized as ``arranging'' or ``negotiating'' a security-based swap
transaction--as those terms are understood generally and in the context
of the relevant regulatory interests.
On one hand, U.S. personnel may actively market security-based
swaps to counterparties on behalf of a firm. Those types of market-
facing activity by U.S. personnel appropriately would trigger the
various uses of the ``arranged, negotiated, or executed'' test, because
otherwise those activities could cause a firm to engage in a dealing
business in the United States without being subject to applicable Title
VII requirements.
At the other end of the spectrum, U.S. personnel may engage in
limited market-facing activity such as providing market-related
information to counterparties in response to inquiries, or providing
market data or other information that helps to set the price associated
with a security-based swap transaction that otherwise is negotiated by
non-U.S. personnel. When the remaining market-facing activity connected
with a transaction occurs outside the United States, such limited
market-facing activity by U.S. personnel standing alone does not
trigger the concerns and regulatory interests that underpin the various
uses of the ``arranged, negotiated, or executed'' test in connection
with the transaction.\94\
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\94\ Such limited U.S. market-facing activity of that type seems
unlikely to implicate the regulatory interests underlying the
various uses of the ``arranged, negotiated, or executed'' test for
purposes of the security-based swap dealer de minimis counting
requirement, or for purposes of the regulatory reporting and public
dissemination requirements of Regulation SBSR, because the activity
of the U.S. personnel standing alone would not appear comprehensive
enough to pose a significant risk of allowing an entity to exit the
Title VII regulatory regime without exiting the U.S. market.
That type of limited U.S. market-facing activity further seems
unlikely to implicate the regulatory interests underlying the use of
the ``arranged, negotiated, or executed'' test for purposes of the
security-based swap dealer business conduct requirements for the
same reason, and also because non-U.S. counterparties reasonably may
not expect Title VII business conduct requirements to apply merely
as the result of receiving technical information from U.S.
personnel.
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Accordingly, the earlier reliance on the presence of market-facing
activity may not sufficiently recognize circumstances in which the
market-facing activity of U.S. personnel is so limited that it would
not implicate the regulatory interests underlying the relevant Title
VII requirements.\95\
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\95\ When the Commission adopted the ``arranged, negotiated, or
executed'' counting rule applicable to transactions between two non-
U.S. counterparties, the Commission stated that ``to the extent that
personnel located in a U.S. branch or office engage in market-facing
activity normally associated with sales and trading, the location of
those personnel would be relevant, even if the personnel are not
formally designated as sales persons or traders.'' See ANE Adopting
Release, 81 FR at 8622 n.224. Just as the ``arranged, negotiated, or
executed'' test reasonably may be triggered by U.S. personnel that
are not formally designated as sales persons or traders when they
engage in arranging or negotiating activity, the Commission does not
believe that the test invariably must be triggered by the presence
of U.S. personnel who are designated as sales persons or traders
when their activity is too limited to implicate the principles
underlying the uses of the test.
---------------------------------------------------------------------------
For those reasons, the Commission is proposing guidance that U.S.
personnel who provide market color in connection with security-based
swap transactions--
[[Page 24217]]
in the form of information or data as described above, including
market-related information regarding the pricing of particular
instruments or background information regarding general market
conditions--do not trigger the Title VII requirements that use an
``arranged, negotiated, or executed'' test, when the following
circumstances exist:
No client responsibility--The U.S. personnel have not been
assigned, and do not otherwise exercise client responsibility in
connection with the transaction.
No transaction-linked compensation--The U.S. personnel do
not receive compensation based on or otherwise linked to the completion
of transactions on which the ``U.S. personnel'' provide market
color.\96\
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\96\ The Commission understands that it is commonplace for firms
to account for the overall profit or loss of the firm, or of a
particular division or office, in calculating bonuses. The language
regarding ``compensation based on or otherwise linked to the
completion of transactions'' is not intended to extend to such
profit-sharing arrangements or other compensation practices that
account for aggregated profits, as such arrangements would not be
expected to incentivize U.S. personnel in a similar manner or to a
similar degree as compensation that is directly linked to the
success of individual transactions.
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In those circumstances, U.S. personnel may provide information to
counterparties, pursuant to the proposed guidance, regarding pricing or
market conditions associated with particular instruments or with
markets more generally, including information regarding current or
historic market pricing, volatility or market depth, as well as general
trends or predictions regarding those matters and information related
to risk management. This should help promote the efficient use of such
U.S. personnel without raising concerns that such activity constitutes
``arranging'' or ``negotiating'' a security-based swap transaction for
purposes of the requirements under Title VII that incorporate the
``arranged, negotiated, or executed'' test--i.e., requirements related
to de minimis counting, the cross-border application of business
conduct and regulatory reporting and public dissemination requirements,
and the cross-border major security-based swap participant rules.\97\
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\97\ Nothing in this guidance would restrict the ability of
firms to risk manage their security-based swap positions on a global
basis.
Separately, in circumstances where the proposed guidance allows
for market-facing activity by U.S. personnel without triggering the
``arranged, negotiated, or executed'' standard, the federal
securities laws, including applicable antifraud provisions, still
may apply to that activity depending on the particular facts and
circumstances.
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Under the guidance, U.S. persons could provide market-based
information in connection with security-based swap transactions--
including but not limited to information regarding pricing, depth of
market, and anticipated demand--in support of non-U.S. persons who
actually arrange, negotiate and execute those transactions on behalf of
their clients.
B. Solicitation of Comments
The Commission is soliciting comment regarding all aspects of this
proposed guidance, including whether other approaches would be
appropriate--as a supplement to or in lieu of the proposed guidance--to
address particular types of market-facing activity that may not raise
the concerns that underpinned the ``arranged, negotiated, or executed''
test. Commenters particularly are invited to address the following:
1. To what extent do non-U.S. persons that engage in security-based
swap dealing activity with non-U.S. counterparties make use of U.S.
personnel in a market-facing capacity in connection with that dealing
activity? What specific types of market-facing activities do such U.S.
personnel conduct?
2. Would the proposed guidance provide a workable approach for
distinguishing between market-facing activity that falls within the
scope of ``arranging'' and ``negotiating'' security-based swap
transactions and that which does not? Would a different type of
Commission action (e.g., exemptive relief or some other approach) be
more appropriate?
3. Would the proposed guidance appropriately apply to the use of
the ``arranged, negotiated, or executed'' test in the context of de
minimis counting, the cross-border application of regulatory reporting
and public dissemination, and the cross-border application of business
conduct requirements? If not, in which circumstances would the proposed
guidance be more or less appropriate when applied to particular
requirements?
4. Would the use of U.S. personnel solely to provide ``market
color'' to the counterparties of non-U.S. dealers--such as by providing
information regarding pricing or market conditions, including
information regarding current or historic pricing, volatility or market
depth, and trends or predictions regarding those matters--raise
concerns regarding the uniform application of the Title VII security-
based swap dealer regime and/or the ability of firms to conduct an
unregistered security-based swap dealing business in the United States?
Commenters particularly are invited to address any gaps in regulation
that may result from guidance that excludes from the test transactions
involving such market-facing activity in the United States from the
ambit of the various requirements that make use of the ``arranged,
negotiated, or executed'' test, including, inter alia, issues
associated with the failure to apply security-based swap dealer
requirements to those U.S. market-facing activities as a result of
excluding certain transactions from the de minimis counting
requirement.
5. Would the proposed guidance effectively distinguish the types of
market-facing activity that appropriately should fall within the
``arranged, negotiated, or executed'' test from other types of market-
facing activity? Alternatively, are different or additional standards
appropriate to distinguish between those two types of activity? For
example, should the ``arranged, negotiated, or executed'' test
encompass activity by U.S. personnel that involves arranging or
finalizing non-pricing aspects of the transaction, such as underlier,
notional amounts or tenor, or otherwise play more than a peripheral
role with regard to the completion of the transaction? In regard to
these issues, commenters are invited to discuss current practices
regarding the use of U.S. personnel to provide limited information such
as ``market color,'' including the nature of the information provided,
the time of day such information is provided, and the underliers
typically associated with that type of activity.
6. Is the proposed distinction between market-facing activity that
involves transaction-based compensation of U.S. personnel and market-
facing activity that does not involve transaction-based compensation
workable in light of existing compensation practices associated with
such activity by U.S. personnel? Are there typical compensation
practices that would raise interpretive issues regarding the
application of the ``arranged, negotiated, or executed'' test under the
guidance? Commenters particularly are requested to discuss firm-
specific or other typical arrangements for compensating U.S. personnel
of foreign dealing entities in circumstances where the U.S. personnel
have some involvement with the firm's transactions with non-U.S.
counterparties. Commenters further are requested to address whether
firms may restructure their compensation arrangements to rely on this
type of guidance, and whether the resulting alternative compensation
practices
[[Page 24218]]
would incentivize U.S. personnel in a similar manner or to a similar
degree as compensation that is linked directly to the success of
individual transactions.
7. What other market practices, if any, should the Commission
address in any guidance it provides regarding the scope of
``arranging'' and ``negotiating'' for purposes of the test?
8. If the Commission separately were to adopt rules providing for
an exception from the application of the ``arranged, negotiated, or
executed'' test to the security-based swap dealer de minimis counting
requirement, pursuant to one of the alternatives being proposed (see
part III, infra), in what circumstances would non-U.S. persons have an
incentive to rely on the proposed guidance? For example--and depending
on the contours of this guidance--is it possible that such guidance
primarily would be used by a non-U.S. person that is not located in a
``listed jurisdiction''? \98\ Is it possible that such guidance
primarily would be used by a non-U.S. person that does not have a U.S.
broker-dealer affiliate, or that would prefer to use non-affiliated
personnel to engage in such market-facing activities?
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\98\ See part III.B.5, infra (addressing ``listed jurisdiction''
condition to availability of proposed conditional exception from use
of ``arranged, negotiated, or executed'' test in connection with
security-based swap dealer de minimis counting provisions).
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9. Would the proposed guidance obviate the need for the more
general exception to the ``arranged, negotiated, or executed'' test
that the Commission is proposing (related to de minimis counting of
transactions involving two non-U.S. counterparties)?
10. Are the limits to the proposed guidance sufficient to prevent
non-U.S. counterparties that interact with such U.S. personnel from
incorrectly presuming that the entire Title VII regulatory framework
would apply to the transaction? If not, what additional limits could be
appropriate to control that possibility?
11. Could the availability of the proposed market color guidance
potentially affect the security-based swap booking practices of U.S. or
non-U.S. dealing entities? For example, if this type of guidance were
available, would a non-U.S. person that currently uses U.S. personnel
to engage in dealing transactions with U.S. and non-U.S. counterparties
have the incentive to prospectively book transactions with U.S.
counterparties into a registered affiliate, so the non-U.S. person may
avoid registering as a security-based swap dealer while still being
able to use U.S. personnel to facilitate its dealing transactions with
non-U.S. counterparties? If so, would bifurcating dealing books in this
way limit the liquidity available to U.S. market participants?
III. Proposed Exception to Rule 3a71-3
A. Purpose
The Commission continues to believe that the use of the ``arranged,
negotiated, or executed'' test appropriately applies the security-based
swap dealer de minimis counting requirement in connection with
transactions involving two non-U.S. counterparties. At the same time,
based on the concerns that have been expressed regarding that use of
the test, the Commission recognizes that in some circumstances this use
of the test, among other possible outcomes, may cause financial groups
to relocate U.S. personnel or relocate the activities performed by U.S.
personnel, to avoid security-based swap dealer registration, and that
such results have the potential to increase fragmentation and harm U.S.
market participants and the U.S. economy.\99\
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\99\ See part I.A.4, supra. The potential ramifications of this
use of the ``arranged, negotiated, or executed'' test are linked in
part to whether market participants in practice would relocate
personnel or functions due to this use of the test, as well as to
the actual effects of such relocations. Alternative practices by
market participants--such as compliance with the counting
requirement with no relocation of personnel or functions--may
mitigate those ramifications and/or produce other ramifications.
Similarly, it is possible that relocation of personnel or functions
may not lead to the fragmentation and other consequences that have
been described. The Commission is soliciting comment regarding the
uses of U.S. personnel in connection with the transactions at issue,
and the potential ramifications of not providing this type of
exception. See parts III.D.1, III.D.2, infra.
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To address that concern, the Commission is soliciting public
comment on two alternative proposals for a conditional exception from
the use of the ``arranged, negotiated, or executed'' test in connection
with that part of the de minimis counting requirement, set forth in
Exchange Act Rule 3a71-3(b)(1)(iii)(C).\100\ These alternative
proposals are intended to protect the policy goals associated with
security-based swap dealer regulation by focusing relevant requirements
on the arranging, negotiating and executing activity occurring in the
United States, while avoiding potentially problematic consequences--
such as relocation of personnel outside the United States that may lead
to fragmentation that reduces market access available to persons within
the United States--that otherwise may be associated with that aspect of
the counting requirement.\101\
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\100\ The proposed conditional exception to Rule 3a71-
3(b)(1)(iii)(C) would have ramifications to the affiliate counting
provisions of paragraph (b)(2) of Rule 3a71-3. Paragraph (b)(2)
requires persons engaged in security-based swap transactions
described in paragraph (b)(1) of the rule--which includes the
transactions at issue--also to count certain dealing transactions of
affiliates under common control, including transactions described in
paragraph (b)(1)(iii) (unless, pursuant to Rule 3a71-4, the
affiliate itself is a registered security-based swap dealer or a
person in the process of registering as a security-based swap
dealer). As a result, transactions subject to the proposed Rule
3a71-3(b)(1)(iii)(C) exception further would not be subject to the
paragraph (b)(2) affiliate transaction counting requirement.
Also, Exchange Act Rule 3a71-5 excepts certain cleared anonymous
transactions from the individual counting requirement of paragraph
(b)(1) of Rule 3a71-3 (which includes the (b)(1)(iii)(C)
requirement) and from the affiliate counting requirement of
paragraph (b)(2), but the Rule 3a71-5 exception is unavailable to
transactions arranged, negotiated, or executed by U.S. personnel.
Because the proposed exception to (b)(1)(iii)(C) would prevent the
transactions at issue from triggering either the (b)(1) or (b)(2)
counting requirements, the Rule 3a71-5 exception would not be
relevant to those transactions.
\101\ In practice, the proposed exception would affect the set
of dealing transactions that a non-U.S. person must include within
the 12-month lookback for determining whether it can avail itself of
the de minimis exception from the ``security-based swap dealer''
definition. Exchange Act Rule 3a71-2(a)(1) determines the
availability of the de minimis exception based on whether a person's
security-based swap dealing activity over the prior 12 months is
below the applicable notional threshold, and the cross-border
counting provisions of Exchange Act Rule 3a71-2(b) (including the
``arranged, negotiated, or executed'' provision of Rule 3a71-
3(b)(1)(iii)(C)) partially determine which positions must be counted
pursuant to Rule 3a71-2(a)(1).
The structure of the de minimis counting provisions also would
make this proposed exception available to non-U.S. persons that are
registered as security-based swap dealers. In particular, Exchange
Act Rule 3a71-2(c) (in conjunction with paragraph (a) of that rule)
provides that a security-based swap dealer may apply to withdraw its
registration if it has been registered for at least 12 months and
its dealing activity over the preceding 12 months is below the
applicable de minimis thresholds. Because the proposed exception
from the ``arranged, negotiated, or executed'' counting requirement
of Rule 3a71-3(b)(1)(iii)(C) would cause the transactions at issues
not to be counted against the applicable thresholds, a registered
security-based swap dealer could rely on the exception to make use
of the withdrawal provision. The Commission is soliciting comment
regarding whether the proposed exception should be modified to make
it unavailable to registered security-based swap dealers. See part
III.D.10, infra.
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The first alternative proposal (Alternative 1) conditionally would
permit a non-U.S. person not to count the security-based swap dealing
transactions at issue against the de minimis thresholds so long as all
arranging, negotiating or executing activity within the United States
is performed by personnel associated with an affiliated entity that is
registered with the Commission as a security-based swap dealer. The
second alternative proposal (Alternative 2) would be broader than the
first alternative by also allowing for activity
[[Page 24219]]
in the United States to be performed by personnel associated with an
affiliate that is registered with the Commission as a broker (or, as
with the first alternative, that is registered as a security-based swap
dealer). As discussed in further detail below, under either alternative
the non-U.S. person and the affiliated registered entity would have to
comply with certain conditions related to business conduct, trade
acknowledgments, portfolio reconciliation, disclosure, records, and
financial responsibility.
The proposed exception may be particularly relevant, for example,
for financial groups that use one or more non-U.S. dealing entities to
transact (i.e., book transactions directly) with Canadian or Latin
American counterparties, but that manage the trading or sales
relationships with those counterparties out of an affiliated entity in
the United States--whether for customer convenience, for more direct
access to the market in which the underliers are traded, or for
operational or other reasons. Under the proposed exception,
transactions that are booked by the foreign dealing entity but
arranged, negotiated or executed by personnel associated with an
affiliated registered entity in the U.S. generally would not be counted
toward the foreign entity's de minimis threshold, and the entity
accordingly would not be required to register as a security-based swap
dealer by virtue of those transactions.\102\ Antifraud provisions of
the federal securities laws and certain relevant Title VII requirements
would continue to apply to the transaction--e.g., transaction reporting
and the prohibitions in Section 5(e) of the Securities Act of 1933 and
Section 6(l) of the Exchange Act with respect to transactions with
counterparties that are not eligible contract participants (``ECPs'').
The Commission preliminarily believes that this approach would
appropriately balance the application of Title VII requirements to any
risks presented by the activity while reducing the likelihood of market
fragmentation that otherwise might arise if the foreign dealing entity
were subject to requirements that are not tailored to the associated
risks.
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\102\ Other dealing activity of that foreign entity, such
entering into security-based swap transactions with U.S. person
counterparties, may cause the entity to exceed the de minimis
threshold and thus have to register as a security-based swap dealer.
The foreign entity also would be subject to provisions requiring it
to count certain dealing transactions of its affiliates. See notes
13 and 100, supra (addressing other prongs of the cross-border de
minimis counting test).
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As discussed below, although the proposed exception would subject
arranging, negotiating and executing activity in the United States to
certain Title VII requirements, the exception would not fully apply
certain other requirements, such as financial responsibility
requirements, in connection with security-based swaps resulting from
that U.S. activity. On balance, the Commission preliminarily believes
that the conditions that have been proposed for the exception would
mitigate any potential negative consequences that otherwise might arise
from tailoring the security-based swap dealer requirements that apply
to those activities.
In making this proposal, the Commission is mindful that U.S.-based
dealing entities may use this type of exception to structure their
booking practices to manage the application of Title VII to their
security-based swap dealing business--e.g., by booking dealing
transactions with non-U.S. counterparties into their non-U.S.
affiliates, to reduce the application of Title VII security-based swap
dealer requirements to those transactions. The Commission is soliciting
comment regarding the potential effect of the proposed exception on
booking practices, and further address those potential consequences as
part of the economic analysis.\103\
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\103\ See parts III.D.9 (solicitation of comment), VII.A.7
(estimate of persons that may rely on proposed exception) and
VII.B.1 (addressing costs and benefits of the proposed amendment),
infra.
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B. Alternative 1--First Alternative Proposed Conditional Exception
The Commission is proposing to amend Exchange Act Rule 3a71-3 to
incorporate a conditional exception from the ``arranged, negotiated, or
executed'' counting standard under conditions that would apply a
focused alternative method of regulation to the transactions at issue.
The proposal recognizes that certain arranging, negotiating or
executing activity involving U.S. personnel warrants Title VII
oversight, but also recognizes that U.S. activity in connection with
transactions between two non-U.S. persons may not implicate the same
types of risks to U.S. persons and to U.S. markets as other types of
dealing activity in the United States. The proposed exception hence is
intended to more closely align the application of Title VII oversight
to the U.S. market concerns associated with such transactions between
non-U.S. persons.
Proposed new paragraph (d) of Exchange Act Rule 3a71-3 would
incorporate this conditional exception.\104\ Under Alternative 1, this
paragraph (d) would except a non-U.S. person from having to count
transactions arranged, negotiated or executed in the United States for
purposes of the security-based swap dealer definition, subject to the
following conditions:
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\104\ Apart from adding a conditional exception as new paragraph
(d) of Rule 3a71-3, proposed Alternative 1 (as well as proposed
Alternative 2) would amend the introductory language of paragraph
(b)(1)(iii)(C) of Rule 3a71-3, to specify that the ``arranged,
negotiated, or executed'' counting requirement is subject to the
conditional exception.
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All such arranging, negotiating and executing activity in
the United States would be conducted by personnel located in a U.S.
branch or office in their capacity as associated persons of a majority-
owned affiliate that is registered with the Commission as a security-
based swap dealer;
That registered security-based swap dealer would comply
with specific requirements applicable to security-based swap dealers as
if the entity were a counterparty to the non-U.S. person's
counterparties;
The Commission could access relevant books, records and
testimony of the non-U.S. person, and the registered security-based
swap dealer would be required to maintain records related to the
transaction;
The non-U.S. person would consent to service of process
for any civil action brought by or proceeding before the Commission;
The registered security-based swap dealer would provide
certain disclosures to the counterparties of the non-U.S. person; and
The non-U.S. person would be subject to the margin and
capital requirements of a ``listed jurisdiction.''
For the reasons set forth below, the Commission preliminarily
believes that an exception that incorporates those elements would apply
security-based swap dealer requirements to arranging, negotiating or
executing activity in the United States, allow for Commission access to
related books and records, and eliminate incentives to alter
transaction booking practices to avoid security-based swap dealer
registration, in a manner that appropriately addresses the scope of the
regulatory concerns raised by this type of U.S. activity.\105\
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\105\ The conditional exception would address only the Rule
3a71-3(b)(1)(iii)(C) requirement that non-U.S. persons count
transactions that involve dealing activity in the United States.
Rule 3a71-3 would continue to require non-U.S. persons to count all
of their security-based swap dealing transactions with U.S.
counterparties, and all of their security-based swap dealing
transactions that are guaranteed by their U.S. affiliates.
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[[Page 24220]]
The Commission preliminarily believes that this type of arranging,
negotiating or executing conduct associated with security-based swap
transactions also would generally constitute ``broker'' activity under
the Exchange Act. Entities engaged in such conduct accordingly would be
required to register with the Commission as brokers unless they can
avail themselves of an exception from broker status, such as the
exception for bank brokerage activity, or an exemption from broker
registration.\106\
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\106\ See generally note 21, supra (addressing application of
``broker'' and ``security'' definitions in the security-based swap
context).
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1. U.S. Activity Conducted by a Majority-Owned Registered Security-
Based Swap Dealer Affiliate
Under Alternative 1, the arranging, negotiating and executing
activity by U.S. personnel that otherwise would need to be counted but
for the exception must be conducted by such personnel in their capacity
as persons associated with an entity that is: (a) Registered as a
security-based swap dealer, and (b) a majority-owned affiliate \107\ of
the non-U.S. person relying on the exception.\108\
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\107\ Proposed paragraph (a)(10) would define the term
``majority-owned affiliate'' to encompass a relationship whereby one
entity directly or indirectly owns a majority interest in another,
or where a third party directly or indirectly owns a majority
interest in both, where ``majority interest'' reflects voting power,
the right to sell, or the right to receive capital upon dissolution
or the contribution of capital.
\108\ See Alternative 1--proposed paragraph (d)(1)(i) of Rule
3a71-3. Exchange Act Section 3(a)(70) defines the term ``person
associated with a security-based swap dealer or major security-based
swap participant'' to encompass, inter alia, partners, officers,
directors, employees and persons controlling, controlled by, or
under common control with a security-based swap dealer or major
security-based swap participant.
Exchange Act Rule 3a71-2(e) provides for the voluntary
registration of a person that chooses to be a security-based swap
dealer, regardless of whether that person engages in dealing
activity that exceeds the de minimis thresholds.
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By requiring that the U.S. arranging, negotiating or executing
activity be conducted by U.S. personnel in their capacity as associated
persons of a registered security-based swap dealer, the proposed
condition would help ensure that the U.S. activity would be subject to
key security-based swap dealer requirements under Title VII, including
requirements regarding supervision, books and records, trade
acknowledgments and verifications, and business conduct, among other
things.\109\
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\109\ The relevant transactions also would remain subject to
regulatory reporting and public dissemination requirements under
Title VII. See note 52, supra. But see part III.D.10, infra
(soliciting comment regarding whether to make a similar exception
available in connection with the application of the ``arranged,
negotiated, or executed'' test in connection with the regulatory
reporting and public dissemination requirements of Regulation SBSR).
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The registered security-based swap dealer must be a majority-owned
affiliate of the non-U.S. person relying on the exception. As discussed
above, concerns have been expressed that the existing counting standard
could lead financial groups to relocate their U.S.-based personnel to
avoid triggering security-based swap dealer registration. To the extent
that such groups make use of this exception in lieu of relocating U.S.-
based personnel, the Commission would expect those groups to use
affiliated entities to satisfy the conditions of the exception.
Moreover, requiring that the arranging, negotiating or executing
activity be performed by U.S. personnel associated with an affiliated
registered security-based swap dealer would help guard against the risk
that a financial group may seek to attenuate its responsibility for any
shortcomings in the registered security-based swap dealer's compliance
with the requirements applicable to registered security-based swap
dealers.\110\ The proposal makes use of a majority-ownership standard
to achieve this goal--rather than other measures of affiliation such as
a common control standard or alternative ownership thresholds--to help
ensure that the financial group has a significant interest in the
registered security-based swap dealer, including its compliance with
the requirements applicable to security-based swap dealers (in addition
to the non-U.S. person's interest in the registered security-based swap
dealer complying with the conditions of the exception), to help promote
appropriate compliance and oversight practices.\111\
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\110\ The registered security-based swap dealer's non-compliance
with the conditions of the exception would make the exception
unavailable to the non-U.S. person.
\111\ The Commission has used a majority-ownership standard as
part of other rules implementing Title VII, including in a rule
providing that inter-affiliate security-based swaps need not be
considered in determining whether a person is a security-based swap
dealer. See Exchange Act Rule 3a71-1(d).
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Taken as a whole, those elements differentiate the proposal from
the approach commenters previously suggested that would have excused
the counting of such transactions when the relevant activity in the
United States is performed by a registered broker-dealer or by a U.S.
bank. When the Commission considered but rejected that type of approach
in adopting the ``arranged, negotiated, or executed'' counting
requirement, the Commission noted that the broker-dealer framework does
not apply to banks engaged in certain activities, which may include a
significant proportion of security-based swap dealing activity, and
stated that such an approach would effectively supplant Title VII
security-based swap dealer regulation for a majority of dealing
activity carried out in the United States with a ``cobbled together''
grouping of other requirements.\112\ Alternative 1, in contrast, would
apply Title VII security-based swap dealer regulation to arranging,
negotiating or executing activity in the United States, regardless of
whether that activity is conducted by banks or non-banks, consistent
with the uniform security-based swap dealer framework anticipated by
Title VII.
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\112\ See ANE Adopting Release, 81 FR at 8619; see also part
I.A.3, supra.
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2. Compliance With Specific Security-Based Swap Dealer Requirements
a. Conditions Regarding Application of Specific Requirements
The proposal would incorporate provisions related to how Title VII
requirements would apply to the registered security-based swap dealer's
activities conducted on behalf of its non-U.S. affiliate. As noted,
Alternative 1 would be conditioned on any U.S. personnel who arrange,
negotiate or execute security-based swap transactions in the United
States acting in their capacity as an associated person of a registered
security-based swap dealer. Security-based swap dealers in general must
comply with a variety of obligations, including those related to:
Financial responsibility; books, records and reports; trade
acknowledgment and verification; supervision and chief compliance
officers; and business conduct.\113\ Security-based swap dealers
[[Page 24221]]
also are subject to regulatory reporting and public dissemination
requirements.\114\
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\113\ See generally Exchange Act Section 15F. The Commission has
adopted final rules to implement certain security-based swap dealer
requirements under Section 15F. See Business Conduct Adopting
Release, 81 FR 29960 (final rules addressing business conduct,
supervision and chief compliance officer requirements); Exchange Act
Release No. 78011 (Jun. 8, 2016), 81 FR 39808 (Jun. 17, 2016) (final
rules addressing trade acknowledgment and verification requirements)
(``Trade Acknowledgment Adopting Release'').
The Commission also has proposed rules to implement security-
based swap dealer requirements regarding:
(1) Capital, margin and segregation (see Exchange Act Release
No. 68071, 77 FR 70214 (Nov. 23, 2012) (``Capital, Margin and
Segregation Proposing Release''); Exchange Act Release No. 71958
(Apr. 17, 2014), 79 FR 25194, 25254 (May 2, 2014));
(2) Recordkeeping and reporting (see Exchange Act Release No.
71958 (Apr. 17, 2014), 79 FR 25194 (May 2, 2014) (``Recordkeeping
and Reporting Proposing Release''));
(3) Risk mitigation, including requirements relating to
portfolio reconciliation, portfolio compression and trading
relationship documentation (see Exchange Act Release No. 84861 (Dec.
19, 2018), 84 FR 4614 (Feb. 15, 2019) (``Risk Mitigation Proposing
Release'')); and
(4) The cross-border application of various Title VII
requirements, including certain security-based swap dealer
requirements (see Cross-Border Proposing Release, 78 FR 30968).
\114\ See generally Regulation SBSR, 17 CFR 242.900 et seq.
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Absent additional conditions, however, the transactions that would
be subject to the proposed exception would not necessarily be subject
to certain of those security-based swap dealer requirements. In
particular, several provisions of the Exchange Act and the rules
thereunder impose obligations upon security-based swap dealers with
regard to their activities that involve a ``counterparty.'' \115\ For
transactions subject to the proposed exception, however, the registered
security-based swap dealer that engages in arranging, negotiating and
executing activity in the United States would not be a contractual
party to the security-based swaps resulting from that arranging,
negotiating or executing activity, and therefore would not be a
``counterparty'' to the transaction.
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\115\ See, e.g., Exchange Act Rule 15Fh-3(a) (eligible
counterparty verification); Rule 15Fh-3(b) (disclosure of risks,
characteristics, incentives and conflicts; Rule 15Fh-3(c) (daily
mark disclosure); Rule 15Fh-3(d) (clearing rights disclosure); Rule
15Fh-3(e) (``know your counterparty'' requirement); Rule 15Fh-3(f)
(suitability of recommendations); Rule 15Fh-3(g) (fair and balanced
communications); Exchange Act Rule 15Fi-2(a) (trade acknowledgment
and verification).
Certain of the Exchange Act provisions that underlie those rules
also explicitly refer to activities involving a ``counterparty.''
See Exchange Act Section 15F(h)(3)(A) (eligible counterparty
verification); Sections 15F(h)(3)(B)(i), (ii) (disclosure of risks,
characteristics, incentives and conflicts); Section
15F(h)(3)(B)(iii) (daily mark disclosure).
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The Commission accordingly is proposing to condition the exception
on the registered security-based swap dealer complying with the
following requirements ``as if'' the counterparties to the non-U.S.
person relying on the exception also were counterparties to the
registered security-based swap dealer: \116\
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\116\ See Alternative 1--proposed paragraph (d)(1)(ii)(A) of
Rule 3a71-3 (providing for ``as if'' compliance with certain
specified requirements).
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Disclosure of risks, characteristics, material incentives
and conflicts of interest. The registered security-based swap dealer
must disclose information regarding the material risks and
characteristics of the security-based swap, and regarding the material
incentives or conflicts of interest of the security-based swap dealer,
including the material incentives and conflicts of interest associated
with the non-U.S. person relying on the exception.\117\
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\117\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(1) of
Rule 3a71-3 (citing the requirements for the disclosure of risks,
characteristics, incentives and conflicts in Exchange Act Sections
15F(h)(3)(B)(i), (ii) and Rule 15Fh-3(b) thereunder). The underlying
Rule 15Fh-3(b) requirement states that disclosure is required only
so long as the identity of the counterparty is known to the
security-based swap dealer ``at a reasonably sufficient time prior
to execution of the transaction'' to permit compliance.
The proposed condition specifies that the disclosure should
address not only the material incentives and the conflicts of
interest of the registered security-based swap dealer engaged in the
arranging, negotiating or executing activity in the United States,
but also those of the affiliated non-U.S. person relying on the
exception, which is intended to allow the counterparty to the
transaction to be appropriately informed regarding incentives and
conflicts of interest relevant to the transaction.
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Suitability of recommendations. The registered security-
based swap dealer must comply with requirements regarding the
suitability of any recommendations that its associated persons
make.\118\
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\118\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(2) of
Rule 3a71-3 (citing the suitability requirements set forth in Rule
15Fh-3(f)).
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Fair and balanced communications. The registered security-
based swap dealer must comply with fair and balanced communication
requirements.\119\
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\119\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(3) of
Rule 3a71-3 (citing the fair and balanced communications requirement
set forth in Exchange Act Section 15F(h)(3)(C) and Rule 15Fh-3(g)
thereunder).
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Trade acknowledgment and verification. The registered
security-based swap dealer must comply with trade acknowledgment and
verification requirements.\120\
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\120\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(4) of
Rule 3a71-3 (citing the trade acknowledgment and verification
requirement set forth in Exchange Act Rules 15Fi-1 and 15Fi-2).
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Portfolio reconciliation requirements. The registered
security-based swap dealer must comply with the portfolio
reconciliation requirements applicable to security-based swap dealers
for the security-based swap resulting from the transaction as if the
security-based swap were being included in the security-based swap
dealer's portfolio, but only the first time that the security-based
swap would be reconciled by the security-based swap dealer.\121\
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\121\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(5) of
Rule 3a71-3 (citing the portfolio reconciliation requirement
proposed to be set forth in Exchange Act Rule 15Fi-3). In practice,
this condition would require the security-based swap dealer to
establish, maintain, and follow written policies and procedures
reasonably designed to ensure that it engages in the initial
portfolio reconciliation for transactions for which it arranges,
negotiates, or executes security-based swap transactions for its
foreign affiliates. See Risk Mitigation Proposing Release (proposing
Exchange Act Rule 15Fi-3).
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The Commission preliminarily believes that requiring the registered
security-based swap dealer engaged in arranging, negotiating or
executing activity in the United States to comply with the standards of
conduct required by the above requirements in connection with the
transactions at issue generally would not impose significant additional
information-gathering or documentation burdens on that registered
security-based swap dealer. At the same time, the Commission recognizes
that certain of those requirements, particularly the disclosure and
suitability requirements, in some cases may require the registered
security-based swap dealer to undertake potentially significant
additional efforts related to information-gathering and documentation.
In the Commission's view, however, the customer protections provided by
imposing those requirements would justify the associated burdens.
For example, disclosure of risks, characteristics, material
incentives, and conflicts of interest will permit a counterparty to
more effectively assess whether and under which terms to enter a
transaction. Although the compliance burdens associated with that
disclosure obligation may be significant, those burdens should be
mitigated by the underlying provision stating that the requirement to
disclose risks, characteristics, material incentives and conflicts of
interest will apply only when the registered security-based swap dealer
knows the identity of the counterparty at a reasonably sufficient time
prior to execution of the transaction.\122\
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\122\ See Exchange Act Rule 15Fh-3(b).
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The burden of complying with the suitability requirement, including
obtaining the required counterparty information and making a
suitability assessment using that information, similarly may be
significant in some cases, but the Commission preliminarily believes
that those burdens are justified by the importance of the counterparty
protections provided by the suitability requirement.\123\ The
Commission further
[[Page 24222]]
notes that the suitability requirement would apply only when the
registered security-based swap dealer makes a recommendation to the
counterparty, and that the associated burdens may be lessened by the
institutional suitability provisions of the requirement.\124\ In this
regard, moreover, we understand that in some cases, U.S. personnel
currently manage trading or sales relationships with counterparties,
and the registered security-based swap dealer accordingly may already
possess the information needed to comply with obligations such as
disclosure or suitability.\125\
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\123\ If the registered security-based swap dealer makes a
recommendation in connection with the transaction--apart from a
recommendation to a security-based swap dealer, swap dealer, major
security-based swap participant, or major swap participant--the
suitability rule would require the entity both to undertake
reasonable diligence to understand the potential risks and rewards
associated with a recommended security-based swap or trading
strategy involving a security-based swap (see Rule 15Fh-3(f)(1)(i)),
and to have a reasonable basis to believe that the recommended
security-based swap or trading strategy involving a security-based
swap is suitable for the counterparty (see Rule 15Fh-3(f)(1)(ii)).
\124\ In the case of recommendations to certain institutional
counterparties, the security-based swap dealer may satisfy the
counterparty-specific suitability requirement if it receives certain
written representations and provides certain disclosures. See Rules
15Fh-3(f)(2) and (3).
\125\ The Commission is soliciting comment regarding the
practicability of requiring compliance with the suitability
condition in the circumstances at issue. See part III.D.5, infra.
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The Commission is proposing to condition the exception on the
registered security-based swap dealer complying with the trade
acknowledgement and verification requirements to help assure that there
are definitive written records of the terms of the resulting
transactions and to help control legal and operational risks for the
counterparties.\126\
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\126\ See generally Trade Acknowledgment Adopting Release, 81 FR
at 39809.
This proposed condition has parallels to Exchange Act Rule 15a-
6(a)(3), which provides a conditional exemption from broker-dealer
regulation for foreign broker-dealers in connection with certain
activities that are intermediated (or ``chaperoned'') by registered
broker-dealers. Under Rule 15a-6(a)(3)(iii)(A)(2), the registered
broker-dealer must issue all required confirmations and statements.
In the present context the Commission would expect the registered
security-based swap dealer to use the same general techniques, to
obtain requisite information to satisfy the trade acknowledgment and
verification condition, as registered broker-dealers use to obtain
the information needed to satisfy the Rule 15a-6 confirmation
condition. Given that the registered-security-based swap dealer
would be affiliated with the non-U.S. person relying on the
exception, the use of common back office platforms may help
facilitate transfer of that information.
As further discussed in Section IV, the Commission is mindful
that foreign blocking laws, privacy laws, secrecy laws and other
foreign legal barriers may limit or prohibit firms from providing
books and records directly to the Commission, Similarly, such laws
may impede the transfer of relevant records among affiliates for
purposes of complying with the exception. The Commission
preliminarily believes that the exception should not be available if
such impediments to transferring information precluded compliance
with the trade acknowledgement and verification condition, given
those requirements' importance in providing for definitive records
and controlling risks.
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The proposal to condition the exception on the registered entity
complying with the portfolio reconciliation requirements as if it were
the counterparty to the transaction, but only for the initial
reconciliation, should help advance two goals: Helping to ensure the
accuracy of the data reported to security-based swap data repositories
(``SDRs''), and helping to facilitate the ability of registered SDRs to
comply with requirements that they verify the information they
receive.\127\
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\127\ In proposing the portfolio reconciliation requirements,
the Commission explained that the requirements have been designed
not only to help ensure that the counterparties to a transaction are
and remain in agreement with respect to all material terms, but also
to help ensure that the information reported to SDRs is complete and
accurate. See Risk Mitigation Proposing Release, 84 FR at 4634. This
objective is applicable to the transactions at issue because
transactions that are arranged, negotiated, or executed by U.S.
personnel of a registered security-based swap dealer are subject to
Regulation SBSR based on that activity. See Regulation SBSR Rule
908(a)(1)(v).
The portfolio reconciliation requirement further may assist SDRs
in satisfying their obligations under Section 13(n)(5)(B) of the
Exchange Act and rule 13n-4(b)(3) thereunder to verify the terms of
each security-based swap with both counterparties. See Risk
Mitigation Proposing Release, 84 FR at 4633-4644.
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The Commission believes that the condition would promote those
goals while imposing only minimal additional burdens on the registered
entity, based in part on the understanding that the registered entity
typically would have access to the necessary information because the
registered entity is likely to report the transaction to the SDR on
behalf of its non-U.S. affiliate (due to the registered entity being
the only U.S. person involved in the transaction). Moreover, for these
transactions the underlying proposed portfolio reconciliation rule
focuses on there being reasonable policies and procedures in
place,\128\ meaning that the registered entity would not fall out of
compliance with the condition merely because it has not been provided
necessary counterparty information.
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\128\ In the Risk Mitigation Proposing Release, the Commission
proposed that, with respect to transactions with persons who are not
SBS Entities, security-based swap dealers would be required to
establish, maintain, and follow written policies and procedures
reasonably designed to ensure that it engages in portfolio
reconciliation for those security-based swap transactions. As such,
conditioning the exception on security-based swap dealers complying
with the initial portfolio reconciliation requirements as if the
security-based swap dealer were the counterparty to the transaction,
will require that its required policies and procedures regarding
reconciliation include transactions for which the security-based
swap dealer arranges, negotiates or executes a security-based swap
transaction on behalf of another person.
By contrast, the proposed rule expressly requires portfolio
reconciliation to occur with respect to security-based swap
transactions between two SBS Entities. See Risk Mitigation Proposing
Release, 84 FR 4618-20.
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In addition, the Commission is conditioning the exception on the
registered security-based swap dealer complying with fair and balanced
communication requirements to promote investor protection, which
prohibit registered entities from overstating the expected benefits or
understating the expected risks of potential transactions in their
communications with counterparties.\129\
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\129\ See Business Conduct Adopting Release, 81 FR at 30001-02
(``we believe the requirement promotes investor protection by
prohibiting SBS Entities from overstating the benefits or
understating the risks to inappropriately influence counterparties'
investment decisions'').
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Conversely, this proposed compliance condition would not extend to
certain other ``counterparty''-related requirements applicable to
security-based swap dealers. In part, the proposed exception would not
be conditioned on compliance with ECP verification requirements \130\
and ``know your counterparty'' requirements \131\ because the
Commission preliminarily believes that in some circumstances the
registered security-based swap dealer would have limited interaction
with the counterparty to the transactions at issue, making it difficult
to obtain the information needed to satisfy those requirements. For
example, compliance with the ``know your counterparty'' requirement
would be expected to necessitate the creation of documentation that may
be infeasible for the registered security-based swap dealer.\132\
Compliance with the ECP verification requirement would require the
registered security-based swap dealer to verify that a counterparty
meets the eligibility standards for an ECP before entering into a
security-based swap with that counterparty--which could be problematic
in this context given the diverse set of circumstances in which the
registered security-based swap dealer may arrange, negotiate or execute
transactions subject to the exception. To be clear, however, although
the Commission is not proposing to condition the exception on
compliance with security-based swap dealer ECP verification
requirements, existing limitations on entering into
[[Page 24223]]
security-based swaps with non-ECPs would remain in effect.\133\
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\130\ See Alternative 1--proposed paragraph (d)(1)(ii)(C)(1) of
Rule 3a71-3 (citing the eligible contract participant verification
requirement set forth in Exchange Act Section 15F(h)(3)(A) and Rule
15Fh-3(a)(1) thereunder); see also Business Conduct Adopting
Release, 81 FR at 29978-79.
\131\ See Alternative 1--proposed paragraph (d)(1)(ii)(C)(4) of
Rule 3a71-3 (citing the ``know your counterparty'' requirement is
set forth in Rule 15Fh-3(e)); see also Business Conduct Adopting
Release, 81 FR at 29993-94.
\132\ The scope of the ``know your counterparty'' requirement is
in contrast the suitability requirements addressed above, which
would apply only when the registered security-based swap dealer
makes a recommendation.
\133\ See Exchange Act Section 6(l) (requiring security-based
swaps with non-ECPs to be effected on a national securities
exchange); Securities Act Section 5(e) (requiring registration of
the offer and sale of security-based swaps to non-ECPs). The
registered security-based swap dealer might use information obtained
from its non-U.S. affiliate to verify that a counterparty to the
security-based swap is in fact an ECP.
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In addition, the proposed exception would not be conditioned on
compliance with clearing rights disclosure requirements,\134\ because
the transactions at issue would not be expected to be subject to the
underlying clearing rights.\135\ Finally, the proposed exception would
not be conditioned on compliance with daily mark disclosure
requirements \136\ and with certain risk mitigation rules \137\ because
those requirements are predicated on there being an ongoing
relationship between the security-based swap dealer and the
counterparty that may not be present in connection with the
transactions at issue, and further would be linked to risk management
functions that are likely to be associated with the entity in which the
resulting security-based swap position is booked.
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\134\ See Alternative 1--proposed paragraph (d)(1)(ii)(C)(3) of
Rule 3a71-3 (citing the clearing rights disclosure requirement set
forth in Rule 15Fh-3(d)); see also Business Conduct Adopting
Release, 81 FR at 29992-93.
\135\ See Exchange Act Section 3C(g)(5) (addressing clearing
rights of transactions that have been ``entered into'' by security-
based swap dealers).
\136\ See Alternative 1--proposed paragraph (d)(1)(ii)(C)(2) of
Rule 3a71-3 (citing the requirement for the disclosure of daily
marks set forth in Exchange Act Section 15F(h)(3)(B)(iii) and Rule
15Fh-3(c) thereunder).
\137\ See Alternative 1--proposed paragraphs (d)(1)(ii)(C)(5)-
(6) of Rule 3a71-3. Those paragraphs cross-reference requirements
regarding the following:
(1) Security-based swap portfolio compression (proposed Exchange
Act Rule 15Fi-4). The proposed portfolio compression rule would
address processes whereby counterparties terminate or change the
notional value of security-based swap in the portfolio between the
counterparties.
(2) Security-based swap trading relationship documentation
(proposed Exchange Act Rule 15Fi-5). The proposed trading
documentation rule would address the trading relationship between
counterparties, including terms addressing payment obligations,
netting, default or termination events and allocation of reporting
obligations.
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Separately, although the Exchange Act and Commission rules apply
certain requirements to security-based swap dealers that act as
advisors or counterparties to special entities,\138\ the Commission has
defined the term ``special entity'' so as not to encompass non-U.S.
persons.\139\ Because the counterparties to the transactions that are
the subject of this exception would not be U.S. persons, the special
entity requirements would not apply to those transactions.
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\138\ See generally Exchange Act Sections 15F(h)(4) and (5), and
Exchange Act Rules 15Fh-3(a)(2), (3), 15Fh-4 and 15Fh-5.
\139\ See Exchange Act Rule 15Fh-2(d); see also Exchange Act
Release No. 77617 (Apr. 14, 2016), 81 FR 29960, 30013 (May 13,
2016).
Exchange Act Section 15F(h)(4)(A)(iii) and Exchange Act Rule
15Fh-4(a)(3), which prohibit security-based swap dealers from
engaging in any act, practice or course of business that is
fraudulent, deceptive or manipulative, still would apply to those
registered security-based swap dealers in connection with this
exception, notwithstanding those provisions' basis in Section
15F(h)(4) (which mostly addresses a security-based swap dealer's
obligations in dealing with special entities).
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b. Application of Other Requirements
By virtue of being a registered security-based swap dealer, the
entity engaged in arranging, negotiating or executing activity in the
United States would have to comply with additional requirements
applicable to security-based swap dealers, including, but not limited
to requirements related to supervision, chief compliance officers,
books and records and financial responsibility.
3. Commission Access to Relevant Books, Records and Testimony, and
Related Obligations
Under the proposal, the non-U.S. person relying on the conditional
exception would, upon request, promptly have to provide the Commission
or its representatives with any information or documents within the
non-U.S. person's possession, custody or control related to
transactions under the exception, as well as making its foreign
associated persons available for testimony, and providing assistance in
taking the evidence of other persons, wherever located, related to
those transactions.\140\
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\140\ See Alternative 1--proposed paragraph (d)(1)(iii)(A) of
Rule 3a71-3. That proposed paragraph further would specify that the
non-U.S. person must provide this information under request of the
Commission or its representatives or pursuant to arrangements or
agreements reached between any foreign securities authority,
including any foreign government, and the Commission or the U.S.
government.
Proposed paragraph (a)(11) of Rule 3a71-3 in general would
define the term ``foreign associated person'' as a natural person
domiciled outside the United States that is a partner, officer,
director, branch manager or employee of the non-U.S. person taking
advantage of the exception, or that controls, is controlled by or is
under common control with that non-U.S. person.
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In addition, the registered security-based swap dealer engaged in
that activity in the United States must create and maintain all
required books and records relating to the transaction subject to the
exception, including those required by Exchange Act Rules 17a-3 and
17a-4, or Rules 18a-5 and 18a-6, as applicable.\141\ The condition
further clarifies that this obligation would extend to books and
records requirements related to the conditions, discussed above,
requiring the registered security-based swap dealer to comply with
Title VII requirements relating to: Disclosure of risks,
characteristics, incentives and conflicts; suitability; fair and
balanced communications; trade acknowledgment and verification; and
portfolio reconciliation.\142\
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\141\ See Alternative 1--proposed paragraph (d)(1)(iii)(B)(1) of
Rule 3a71-3. Under proposed books and records requirements, a
registered security-based swap dealer would be required to comply
with the books and records requirements of Exchange Act Rules 17a-3
and 17a-4 if it is dually registered as a broker-dealer, or the
requirements of Rules 18a-5 and 18a-6 if it is not. See generally
Recordkeeping and Reporting Proposing Release, 79 FR at 25298-302,
25307-13; Risk Mitigation Proposing Release, 84 FR at 4674-75.
Consistent with the provisions of those proposed books and
records requirements, the registered entity would make and/or
preserve the following types of records related to the transactions
at issue: Records of communications; written agreements; copies of
trade acknowledgments; records related to transactions not verified
in a timely manner; documents related to compliance with security-
based swap dealer business conduct standards; and documents related
to compliance with portfolio reconciliation requirements. Other
types of records addressed by those proposed books and records
requirements--e.g., inclusion of trades in financial ledgers--
preliminarily would not appear to be required for the registered
entity in connection with these transactions, as the registered
entity would not have direct financial obligations under the
transactions.
\142\ See Alternative 1--proposed paragraph (d)(1)(iii)(B)(1) of
Rule 3a71-3 (requiring creation and maintenance of books and records
relating to the requirements specified in proposed paragraph
(d)(1)(ii)(B)).
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The registered security-based swap dealer further must obtain from
the non-U.S. person relying on the exception, and maintain,
documentation encompassing all terms governing the trading relationship
between the non-U.S. person and its counterparty relating to the
transactions subject to this exception, including terms addressing
payment obligations, netting of payments, events of default or other
termination events, calculation and netting of obligations upon
termination, transfer of rights and obligations, allocation of any
applicable regulatory reporting obligations, governing law, valuation,
and dispute resolution.\143\
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\143\ See Alternative 1--proposed paragraph (d)(1)(iii)(B)(2) of
Rule 3a71-3. These records are consistent with those required by the
Commission's proposed trading relationship documentation rule. See
Risk Mitigation Proposing Release, 84 FR at 4673-74 (proposing
Exchange Act Rule 15Fi-5).
As discussed above in connection with the implementation of the
trade acknowledgment and verification condition (see note 126,
supra), the Commission is mindful that foreign blocking laws,
privacy laws, secrecy laws and other foreign legal barriers may
impede the transfer of relevant records among affiliates for
purposes of complying with this condition. Here too, the Commission
preliminarily believes that the exception should not be available if
such impediments to transferring information precluded compliance
with the condition requiring the registered entity to obtain trading
relationship documentation, given the need for the Commission to
have a comprehensive view of the dealing activities connected with
transactions relying on the proposed exception, to facilitate the
Commission's ability to identify fraud and abuse in connection with
transactions that have been arranged, negotiated or executed in the
United States.
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[[Page 24224]]
In addition, the registered security-based swap dealer would have
to obtain from the non-U.S. person relying on the exception written
consent to service of process for any civil action brought by or
proceeding before the Commission, specifying that process may be served
on the non-U.S. person in the manner set forth in the registered
security-based swap dealer's current Form SBSE, SBSE-A or SBSE-BD, as
applicable.\144\
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\144\ See Alternative 1--proposed paragraph (d)(1)(iii)(B)(3) of
Rule 3a71-3. Form SBSE addresses applications for registration as
security-based swap dealers or major security-based swap
participants. Form SBSE-A addresses such applications by persons
that are registered or registering with the CFTC as swap dealers.
Form SBSE-BD addresses such applications by persons that are
registered broker-dealers. These forms may be found at https://www.sec.gov/forms.
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Those proposed requirements--relating to Commission access to
information of the non-U.S. person, the obligation of the registered
security-based swap dealer to create and maintain information related
to the transaction, and to obtain and maintain trading relationship
documentation from the non-U.S. person, and the obligation of the non-
U.S. person to consent to service of process--should help provide the
Commission with a comprehensive view of the dealing activities
connected with transactions relying on the proposed exception, and
facilitate the Commission's ability to identify fraud and abuse in
connection with transactions that have been arranged, negotiated or
executed in the United States.\145\
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\145\ The proposed conditions regarding Commission access to
information of the non-U.S. person, and regarding the need for the
non-U.S. person to consent to service of process, are similar to the
access and consent to service conditions in Exchange Act Rule 15a-
6(a)(3). Rule 15a-6 in part provides a conditional exemption from
broker-dealer regulation for foreign broker-dealers in connection
with certain activities that are intermediated by registered broker-
dealers. That rule in part requires that a foreign broker-dealer
provide the Commission (upon request or pursuant to agreements
reached between any foreign securities authority and the Commission
or the U.S. Government) with any information or documents within the
possession, custody, or control of the foreign broker or dealer, any
testimony of foreign associated persons, and any assistance in
taking the evidence of other persons, wherever located. See Exchange
Act Rule 15a-6(a)(3)(i)(B), (c). The proposed conditions would
modify the Rule 15a-6 access language to better describe the breadth
of the access afforded under this condition--e.g., the proposed
condition requires that the information be provided ``promptly,''
and specifically references supervisory or enforcement memoranda of
understanding and other arrangements with foreign authorities.
The proposed conditions regarding the obligation of the
registered security-based swap dealer contains elements comparable
to a condition of Rule 15a-6 that states that a registered broker-
dealer must be responsible for maintaining required books and
records relating to the transactions conducted pursuant to the
exemption, including books and records required by applicable
Exchange Act rules. See Exchange Act Rule 15a-6(a)(3)(iii)(A)(4).
The proposal also incorporates language providing for the registered
security-based swap dealer to obtain trading relationship
documentation to further promote effective Commission access to
relevant information.
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The proposed condition related to access to information, documents
or testimony further provides that if, despite the non-U.S. person's
best efforts, the non-U.S. person is prohibited by applicable foreign
law or regulations from providing such access to the Commission, the
non-U.S. person may continue to rely on the exception until the
Commission issues an order modifying or withdrawing an associated
``listed jurisdiction'' determination.\146\ As discussed below,
proposed provisions relating to the ``listed jurisdiction'' condition
to the exception in part would permit the Commission to withdraw a
listed jurisdiction determination if the jurisdiction's laws or
regulations have had the effect of preventing the Commission or its
representatives from accessing such information, documents and
testimony.\147\
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\146\ See Alternative 1--proposed paragraph (d)(1)(iii)(A) of
Rule 3a71-3 (referring to listed jurisdiction withdrawal provisions
of paragraph (d)(2)(iii)).
That continued reliance provision is limited to circumstances
in which the failure to provide access is due to applicable foreign
law or regulations. Accordingly, a non-U.S. person's failure to
provide the Commission with required information for any reason
other than prohibition by applicable foreign law or regulations
would cause the person to be in violation of the conditions to the
exception, making the exception unavailable to that person.
\147\ See part III.B.5, infra.
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4. Disclosures to Counterparties
The proposed exception further would be conditioned on the
registered security-based swap dealer notifying the counterparties of
the non-U.S. person relying on the exception that the non-U.S. person
is not registered as a security-based swap dealer, and that certain
Exchange Act provisions or rules addressing the regulation of security-
based swaps would not be applicable to the non-U.S. person in
connection with the transaction, including provisions affording
clearing rights to counterparties.\148\ To promote effective
disclosure, the registered security-based swap dealer would have to
provide this information contemporaneously with and in the same manner
(e.g., oral, electronic or otherwise) as the arranging, negotiating or
executing activity at issue.\149\
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\148\ See Alternative 1--proposed paragraph (d)(1)(iv) of Rule
3a71-3; see also notes 134 and 135, supra, and accompanying text
regarding clearing rights.
\149\ This disclosure requirement would not apply if the
identity of that counterparty is not known to that registered
security-based swap dealer at a reasonably sufficient time prior to
the execution of the transaction to permit such disclosure. Id.
Circumstances in which the registered security-based swap dealer
engaged in relevant activity may not know the identity of the
counterparty could include circumstances in which the registered
security-based swap dealer provides only execution services, and
does not arrange or negotiate the transactions at issue, as well as
circumstances where personnel in the United States specify a trading
strategy or techniques carried out through algorithmic trading or
automated electronic execution of security-based swaps. See also
note 117, supra (discussing a similar carveout in connection with
the security-based swap dealer requirements for disclosure of risks,
characteristics, material incentives and conflicts of interest).
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This proposed condition is intended to help guard against
counterparties assuming that the involvement of U.S. personnel in a
arranging, negotiating or executing capacity as part of the transaction
would be accompanied by all of the safeguards associated with Title VII
security-based swap dealer regulation. Because the disclosure must be
provided contemporaneously with, and in the same manner as, the
activity at issue (e.g., via oral disclosure in the event that the
market facing activity occurs via oral communications), the Commission
does not believe that such disclosure reasonably could be provided via
inclusion in standard trading documentation.
5. Applicability of Financial Responsibility Requirements of a Listed
Jurisdiction
Finally, the proposed exception would be conditioned on the
requirement that the non-U.S. person relying on the exception be
subject to the margin and capital requirements of a ``listed
jurisdiction'' when engaging in transactions subject to this
exception.\150\ The Commission conditionally or unconditionally may
determine ``listed jurisdictions'' by order, in response to
applications or upon the Commission's own initiative.\151\
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\150\ See Alternative 1--proposed paragraph (d)(1)(v) of Rule
3a71-3 (cross-referencing proposed the data access provisions of
proposed paragraph (d)(1)(iii)(A)).
\151\ See Alternative 1--proposed paragraph (d)(1) of Rule 3a71-
3.
Proposed paragraph (a)(12) of Rule 3a71-3 would define the term
``listed jurisdiction'' to mean any jurisdiction which the
Commission by order has designated as a listed jurisdiction for
purposes of the exception.
The proposal also specifies that applications for listed
jurisdiction status may be made by parties or groups of parties that
potentially would rely on the exception from the counting rule, and
by any foreign financial authorities supervising such parties. The
proposal further states that such applications must be filed
pursuant to the procedures specified in Exchange Act Rule 0-13. See
Alternative 1--proposed paragraph (d)(2)(i) of Rule 3a71-3. Rule 0-
13 currently addresses substituted compliance applications, and the
Commission is proposing to amend the caption of that rule and make
certain additions to the text of that rule so that it also
references ``listed jurisdiction'' applications.
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[[Page 24225]]
The proposed listed jurisdiction condition is intended to help
avoid creating an incentive for dealers to book their transactions into
entities that solely are subject to the regulation of jurisdictions
that do not effectively require security-based swap dealers or
comparable entities to meet certain financial responsibility standards.
Absent this type of condition, the exception from the de minimis
counting requirement could provide a competitive advantage to non-U.S.
persons that conduct security-based swap dealing activity in the United
States without being subject to sufficient financial responsibility
standards. More generally, the proposed condition is consistent with
the belief the Commission expressed when it adopted the ``arranged,
negotiated, or executed'' de minimis counting rule, that applying
capital and margin requirements to such transactions between two non-
U.S. persons can help mitigate the potential for financial contagion to
spread to U.S. market participants and to the U.S. financial system
more generally.\152\
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\152\ See ANE Adopting Release, 81 FR at 8616. The Commission
further has stated:
Subjecting non-U.S. persons that engage in security-based swap
dealing activity in the United States at levels above the dealer de
minimis threshold to capital and margin requirements also should
help reduce the likelihood of firm failure and the likelihood that
that the failure of a firm engaged in dealing activity in the United
States might adversely affect not only its counterparties (which may
include other firms engaged in security-based swap dealing activity
in the United States) but also other participants in that market.
Id. at 8617.
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Commenters to the Commission's proposal for the ``arranged,
negotiated, or executed'' counting requirement suggested that potential
concerns regarding that type of outcome could be addressed by
conditioning a broker-dealer-based alternative to the counting rule on
the non-U.S. entity being regulated in a ``local jurisdiction
recognized by the Commission as comparable,'' or in a G-20 jurisdiction
or in a jurisdiction where the entity would be subject to Basel capital
requirements.\153\ The Commission, however, does not believe that
concerns regarding potential risks associated with this type of
exception would adequately be addressed by a ``one size fits all''
approach that is linked simply to a jurisdiction's membership in the G-
20 or compliance with Basel standards, with no further opportunity to
consider relevant regulatory practices and requirements.\154\
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\153\ See note 23, supra, and accompanying text.
\154\ The Commission is mindful that a jurisdiction's membership
in the G-20 or its compliance with Basel standards can be a positive
indicator regarding the effectiveness of the jurisdiction's margin
and capital regimes. At the same time, the Commission also
recognizes that implementation and oversight practices may vary even
among those jurisdictions. Accordingly, the Commission preliminarily
believes that the proposed individualized ``listed jurisdiction''
assessment would provide us an appropriate degree of discretion to
consider whether the jurisdiction has implemented appropriate
financial responsibility standards and exercises appropriate
supervision in connection with those standards, and whether the
Commission as necessary could access relevant information.
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In considering a jurisdiction's potential status as a ``listed
jurisdiction''--whether upon the Commission's own initiative or in
response to an application for an order--the Commission would consider
whether the order would be in the public interest.\155\ Factors would
include consideration of the jurisdiction's applicable margin and
capital requirements, and the effectiveness of the foreign regime's
supervisory compliance program and enforcement authority in connection
with those requirements, including in the cross-border context.\156\
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\155\ See Alternative 1--proposed paragraph (d)(2)(ii) of Rule
3a71-3.
\156\ See Alternative 1--proposed paragraph (d)(2)(ii)(A), (B)
of Rule 3a71-3.
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The Commission further may by order, on its own initiative, modify
\157\ or withdraw a listed jurisdiction determination, after notice and
opportunity for comment, if the Commission determines that continued
listed jurisdiction status would not be in the public interest.\158\
The Commission may base that modification or withdrawal on the factors
discussed above regarding the foreign jurisdiction's margin and capital
requirements and associated supervisory and enforcement practices.\159\
The Commission may also consider whether the jurisdiction's laws or
regulations have had the effect of preventing the Commission or its
representatives from promptly being able to obtain information
regarding the non-U.S. persons relying on the exception.\160\ This
latter provision reflects the importance of the proposed exception's
information access condition,\161\ and the conclusion that it would be
appropriate to modify or withdraw listed jurisdiction status if, in
practice, the Commission or its representatives have been prevented
from accessing information required under the exception due to the
jurisdiction's laws or regulations.\162\
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\157\ As discussed below, the Commission may modify a listed
jurisdiction designation by broadening or narrowing the application
of listed jurisdiction status in connection with a particular class
of market participants or an individual market participant within
that jurisdiction.
\158\ See Alternative 1--proposed paragraph (d)(2)(iii) of Rule
3a71-3. The Commission preliminarily expects that any such notice
would be via publication in the Federal Register and on the
Commission's website, to allow all interested parties the
opportunity to comment, including persons that are located in the
jurisdiction at issue and are relying on the exception.
\159\ See Alternative 1--proposed paragraph (d)(2)(iii)(A) of
Rule 3a71-3 (cross-referencing paragraph (d)(2)(ii)).
\160\ See Alternative 1--proposed paragraph (d)(2)(iii)(B) of
Rule 3a71-3. These would include potential barriers to the
Commission's ability to obtain testimony of the non-U.S. person's
foreign associated persons, and to obtain the assistance of the non-
U.S. person in taking the evidence of other persons. Id.
\161\ As discussed, the proposed exception is conditioned in
part on the non-U.S. person promptly making relevant information
available to the Commission and its representatives. The access
condition is intended to help ensure that the Commission and its
representatives in practice can obtain a full view of the dealing
activities connected with transactions at issue, to avoid
impediments in identifying fraud and abuse in connection with
transactions that have been arranged, negotiated or executed in the
United States. See part III.B.3, supra.
\162\ Given the importance of the proposed access condition, the
Commission does not believe that persons from a foreign jurisdiction
should be able to continue relying on the exception if the
jurisdiction's law or regulations prevent the Commission from
obtaining access to relevant information.
At the same time, the Commission's initial consideration of
whether to designate a particular jurisdiction as a ``listed
jurisdiction'' would focus on the jurisdiction's applicable margin
and capital requirements and the foreign regime's supervisory
compliance program and enforcement authority in connection with
those requirements. This in part reflects the listed jurisdiction
condition's core role in helping to ensure that non-U.S. persons
that rely on the proposed exception are subject to adequate capital
and margin requirements. More generally, this approach also reflects
the expectation that, in practice, methods may be developed to help
provide the Commission with access to requested information.
Separately, the Commission's decision to modify or withdraw
listed jurisdiction status may be based on any other factor it
determines to be relevant to whether continued status as a listed
jurisdiction would be in the public interest. See Alternative 1--
proposed paragraph (d)(2)(iii)(C) of Rule 3a71-3.
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Because listed jurisdiction determinations may be conditional or
unconditional, the Commission may modify a determination, among other
circumstances, when: (1) Certain market participants or classes of
market participants in the jurisdiction are not required to comply with
the financial responsibility requirements that
[[Page 24226]]
underpin the designation; (2) the jurisdiction's supervisory or
enforcement practices oversee certain market participants or classes of
market participants differently than others; or (3) the jurisdiction's
barriers to data access apply to certain market participants or classes
of market participants but not others. In practice, the Commission's
use of this authority may cause the exception to be unavailable to
certain groups of market participants in a jurisdiction, or to
individual market participants.\163\
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\163\ For example, as discussed above in conjunction with the
information access provision, if a non-U.S. person is prohibited by
applicable foreign law or regulations from providing access to the
Commission or its representatives, the non-U.S. person may continue
to rely on the exception until the Commission issues an order
modifying or withdrawing an associated ``listed jurisdiction''
determination. To the extent that such prohibitions apply in
practice to a particular class of market participants, or to an
individual market participant in that jurisdiction, a modification
of a listed jurisdiction order may exclude that class of market
participants or that individual market participant from reliance on
the exception.
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Preliminarily--based on the Commission's understanding of relevant
margin and capital requirements in those jurisdictions--the Commission
anticipates that the initial set of listed jurisdiction determinations
may include some or all of the following jurisdictions: Australia,
Canada, France, Germany, Hong Kong, Japan, Singapore, Switzerland, and
the United Kingdom. The Commission is soliciting comment as to whether
listed jurisdiction status may be appropriate for any of those
jurisdictions, based on those jurisdictions' financial responsibility
requirements and associated supervisory and enforcement programs.\164\
The Commission further anticipates that it may issue a set of listed
jurisdiction orders in conjunction with its final action on this
proposal, including orders addressing the jurisdictions specified
above. As discussed above, however, if the Commission determines that
the laws or regulations of a listed jurisdiction have prevented the
Commission from obtaining relevant information required pursuant to
this exception in relation to any person in the listed jurisdiction
availing itself of the exception, the Commission may modify or withdraw
a listed jurisdiction designation for that reason.
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\164\ See part III.D.3, infra.
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``Listed jurisdiction'' applications may be expected to raise
issues that are analogous to those that would accompany applications
for substituted compliance in connection with margin and capital rules,
in that both types of applications would require the Commission to
consider the substance and implementation of foreign margin and capital
standards.\165\ Those two types of applications, however, would arise
in materially distinct contexts. In particular, ``listed jurisdiction''
status would be relevant only with regard to non-U.S. persons whose
dealing transactions with U.S.-person counterparties, if any, would be
below the de minimis thresholds. This de minimis cap on its dealing
transactions with U.S. persons likely would attenuate--although not
eliminate--the potential effect of the firm's failure on U.S. persons
and markets. Substituted compliance, in contrast, would address the
margin and capital requirements applicable to registered security-based
swap dealers that may engage in dealing transactions with U.S.
counterparties in amounts above the de minimis thresholds, and whose
failure is likely to pose greater direct threats to U.S. persons and
markets. Substituted compliance accordingly would be predicated on the
foreign margin and capital regime producing regulatory outcomes that
are comparable to the analogous requirements under Title VII.
Similarly, although the Commission will also consider, in connection
with a substituted compliance determination, the effectiveness with
which a regime administers its supervisory compliance program and
exercises its enforcement authority, the different purposes of these
proposed exclusions and a substituted compliance determination mean
that the Commission may reach different conclusions regarding these
issues when considering a substituted compliance determination than it
does when considering listed status.
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\165\ The Commission has proposed to make a mechanism for
substituted compliance orders generally available in connection with
security-based swap dealer requirements under Exchange Act Section
15F. 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'' (May 1, 2013), 78 FR 30968, 31207-08 (May 23,
2013) (proposing substituted compliance rule for section 15F
requirements; since then a mechanism for substituted compliance has
been adopted via Exchange Act Rule 3a71-6 in connection with
business conduct and trade acknowledgment and verification
requirements). Those Section 15F requirements include security-based
swap dealer margin and capital requirements. Substituted compliance
provides a mechanism by which a non-U.S. security-based swap dealer
may satisfy its requirements under Title VII via compliance with
analogous requirements of a foreign regime, contingent in part on
the Commission deeming the scope and objectives of the relevant
foreign requirements to be comparable to analogous Title VII
requirements. As proposed, substituted compliance would not be
available in connection with the Commission's segregation
requirements.
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C. Alternative 2--Second Alternative Proposed Conditional Exception
Alternative 2 for the proposed conditional exception would share a
number of elements with Alternative 1, but instead would allow the
arranging, negotiating or executing activity in the United States to be
conducted by an entity that is registered as a broker, without
requiring that entity also to register as a security-based swap
dealer.\166\ Alternative 2 also would permit that conduct to be
conducted by a registered security-based swap dealer, consistent with
the Alternative 1.\167\
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\166\ Alternative 2 would not be satisfied if this arranging,
negotiating or executing activity is conducted by a bank that has
not registered as a broker due to the Exchange Act's ``broker''
definition's exceptions for bank brokerage activity, unless the bank
is registered as a security-based swap dealer.
\167\ For the reasons set forth above (see note 106, supra, and
accompanying text), the Commission believes that such a security-
based swap dealer also generally would be required to register as a
broker unless it can avail itself of an exception or exemption from
broker registration.
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Certain proposed conditions to Alternative 2 would be the same as
those of Alternative 1, while others would be modified to reflect the
potential for the activity in the United States to be conducted by a
registered broker that is not also registered as a security-based swap
dealer. Alternative 2 accordingly would make use of broker regulation
to provide for oversight of the transactions at issue while adding
certain conditions to fill gaps in regulation that otherwise may arise
absent the involvement of a registered security-based swap dealer.
Those conditions should help mitigate the previously expressed concerns
that a broker-focused approach may effectively supplant Title VII
security-based swap dealer regulation for a majority of dealing
activity carried out in the United States.\168\
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\168\ See part I.A.3, supra. Because Alternative 2 would not be
satisfied by the use of a bank that is not registered as a broker,
the Commission's previously expressed concerns regarding differences
in oversight between brokers and banks should not be a concern here.
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1. U.S. Activity Conducted by a Majority-Owned Registered Broker
Affiliate or by a Security-Based Swap Dealer Affiliate
Under Alternative 2, the U.S.-based arranging, negotiating and
executing activity that otherwise would trigger the counting
requirement must be conducted by the U.S. personnel in their capacity
as persons associated with an entity that: (a) Is registered as a
broker or a security-based swap dealer, and (b)
[[Page 24227]]
is a majority-owned affiliate of the non-U.S. person relying on the
exception.\169\
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\169\ See Alternative 2--proposed paragraph (d)(1)(i) of Rule
3a71-3. Exchange Act Section 3(a)(18) defines the terms ``person
associated with a broker or dealer'' and ``associated person of a
broker or dealer'' to encompass, inter alia, partners, officers,
directors, employees and persons controlling, controlled by, or
under common control with a broker or dealer.
Alternative 2 shares, with Alternative 1, the definitions of
``majority-owned affiliate,'' ``foreign associated person'' and
``listed jurisdiction.''
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Consistent with Alternative 1, the affiliation requirement is
intended to help tailor the exception to reflect the proposed
exception's objective of helping to avoid personnel relocation, and to
also help ensure that the financial group has a significant financial
interest in the registered entity's compliance with applicable
requirements.\170\
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\170\ See part III.A, supra.
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2. Compliance With Certain Security-Based Swap Dealer Requirements
For a non-U.S. person to rely on Alternative 2, the registered
broker or security-based swap dealer that conducts the arranging,
negotiating or executing activity in the United States would be
required to comply with certain security-based swap dealer requirements
``as if'': (a) The counterparties to the non-U.S. person relying on the
exception also were counterparties to that entity, and (b) that entity
were registered with the Commission as a security-based swap dealer (in
the event the entity is registered only as a broker and not as a
security-based swap dealer). As with Alternative 1, the Commission
preliminarily believes that it would be appropriate to condition
Alternative 2 on compliance by the registered entity with the following
requirements applicable to security-based swap dealers: Disclosure of
risks, characteristics, incentives and conflicts; suitability of
recommendations; fair and balanced communications; trade acknowledgment
and verification; and portfolio reconciliation.\171\
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\171\ See Alternative 2--proposed paragraphs (d)(1)(ii)(A), (B)
of Rule 3a71-3.
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As discussed in connection with Alternative 1, those requirements
would impose standards of conduct in connection with the transactions
at issue, but would not be expected to impose significant additional
information-gathering or documentation burdens on the registered
entity.\172\ While recognizing that certain of the Title VII security-
based swap dealer requirements have similarities to the requirements
applicable to broker-dealers, the Commission preliminarily believes
that the arranging, negotiating or executing security-based swap
activity of U.S. personnel should be carried out pursuant to standards
of conduct imposed under Title VII, regardless of whether the ultimate
counterparties are U.S. or non-U.S. persons.
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\172\ See part III.B.2.a, supra.
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Alternative 2, like Alternative 1, also would provide that the
exception would not be conditioned on the registered entity's
compliance with eligible contract participant verification, clearing
rights disclosure, ``know your counterparty,'' daily mark disclosure
and certain proposed risk mitigation requirements.\173\ As discussed
above, the fact that the proposal would not be conditioned on
compliance with the ECP verification requirement would not affect
existing limitations on entering into security-based swaps with non-
ECPs.\174\
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\173\ See second alternative--proposed paragraph (d)(1)(ii)(C)
of Rule 3a71-3; see also notes 130 through 137, supra, and
accompanying text. Those particular Title VII requirements would be
at issue only if the entity is registered as a security-based swap
dealer.
\174\ See note 133, supra, and accompanying text.
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By virtue of being a registered broker, the registered entity also
would be subject to all other applicable broker-dealer requirements
under the federal securities laws and self-regulatory organization
(``SRO'') rules.
3. Other Conditions
Consistent with Alternative 1, and for the same reasons,
Alternative 2 further would encompass conditions related to: Commission
access to books, records and testimony of the non-U.S. person relying
on the exception; the registered entity's maintenance of trading
relationship documentation; consent to service of process;\175\
disclosures to counterparties; and the non-U.S. person being subject to
the financial responsibility requirements of a listed
jurisdiction.\176\
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\175\ Because the registered entity under Alternative 2 may be a
registered broker, Alternative 2 allows for process to be served on
the non-U.S. person in the manner set forth in the registered
entity's Form BD (or, consistent with Alternative 1, in the manner
set forth in the registered entity's Forms SBSD, SBSE-A or SBSE-BD).
\176\ See Alternative 2--proposed paragraphs (d)(1)(iii) through
(d)(1)(v), (d)(2) and (d)(3) of Rule 3a71-3; see also parts
III.B.3--III.B.5, supra.
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4. Carveout From De Minimis Counting Requirements
In adopting the ``arranged, negotiated, or executed'' counting
requirement, the Commission recognized that arranging, negotiating or
executing conduct by personnel in the United States could constitute
dealing activity in the United States, regardless of the fact that the
parties to the transactions are not U.S. persons.\177\ To avoid
ambiguity regarding whether a registered broker's U.S. activity under
this alternative independently must be counted against the applicable
de minimis thresholds--and hence potentially require the registered
broker also to register as a security-based swap dealer--Alternative 2
would provide that the persons that engage in such conduct pursuant to
the exception would not have to count the associated security-based
swap transactions against the de minimis thresholds.\178\ Absent such
an exception, the Commission is concerned that Alternative 2
potentially would be ineffective due to the reluctance of entities that
are not registered as security-based swap dealers to engage in the
arranging, negotiating or executing conduct envisioned by the proposed
alternative.
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\177\ See ANE Adopting Release, 81 FR at 8621.
\178\ See Alternative 2--proposed paragraph (d)(4) of Rule 3a71-
3.
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D. Solicitation of Comments Regarding the Proposed Amendment to Rule
3a71-3
The Commission requests comment on all aspects of the proposed
amendment to Rule 3a71-3, including the following issues:
1. Involvement of U.S. Personnel in Arranging, Negotiating and
Executing Transactions Between Non-U.S. Counterparties
To what extent do U.S. personnel participate in arranging,
negotiating or executing activities in connection with security-based
swap dealing transactions involving two non-U.S. counterparties?
Commenters particularly are invited to address the following:
a. What particular services do U.S. personnel typically provide as
part of such activities?
b. What types of information do U.S. personnel typically
communicate to an affiliate's security-based swap counterparties in
connection with such activities?
c. To what extent are U.S. personnel typically involved in
negotiating pricing or other terms of security-based swaps in
connection with such activities?
d. What is the typical mode of communication (e.g., telephonic,
written, in-person) used between those U.S. personnel and an
affiliate's security-based swap counterparties in connection with such
activities?
e. What types of instruments (e.g., securities issued by U.S.
persons)
[[Page 24228]]
typically underlie the security-based swaps that are the subject of
such transactions involving arranging, negotiating or executing
activity by U.S. personnel?
f. Are U.S. personnel involved in such arranging, negotiating or
executing activities on behalf of non-U.S. persons that are not
affiliates? If so, what services do U.S. personnel provide and what
types of instruments are the subject of such activities by U.S.
personnel on behalf of unaffiliated non-U.S. persons?
g. Are there particular categories of arranging, negotiating or
executing activity that U.S. personnel typically perform, to facilitate
a non-U.S. person's security-based swap dealing transactions with non-
U.S. counterparties, that are so limited in scope that they may not
trigger the concerns that led to the adoption of the ``arranged,
negotiated, or executed'' counting standard?
h. To what extent do U.S. personnel typically provide the primary
point of contact for managing sales and trading relationships with non-
U.S. person counterparties on behalf of non-U.S. affiliates engaged in
security-based swap dealing activity? Conversely, to what extent is the
involvement of such U.S. personnel typically incidental to a
relationship that the non-U.S. person dealer manages primarily from an
office outside the United States, and what is the nature of any such
incidental involvement?
i. To the extent U.S. personnel perform both types of functions--
serving as a primary point of contact for some transactions and serving
an incidental role for other transactions--are those functions
determined on the basis of counterparty location, product
characteristics, or on the basis of some other factors?
2. Implementation Issues Associated With the Existing ``Arranged,
Negotiated, or Executed'' Counting Requirement
To what extent would a conditional exception from the ``arranged,
negotiated, or executed'' counting requirement be appropriate to
address implementation issues potentially associated with that
requirement? Commenters particularly are invited to address the
following:
a. What would be the expected consequences if the Commission does
not adopt either proposed alternative for an exception to the de
minimis counting requirement? For example, how many financial groups
would expect to register one or more non-U.S. entities as security-
based swap dealers absent an exception? How many non-U.S. entities
would such financial groups typically expect to have to register in
those circumstances? Conversely, how many financial groups would be
expected to register non-U.S. entities as security-based swap dealers
in the presence of this type of exception?
b. What contingency plans, if any, have such financial groups drawn
up to address the potential consequences associated with compliance
with the ``arranged, negotiated, or executed'' counting standard?
c. In practice, would such financial groups be expected to relocate
U.S. personnel and/or relocate functions out of the United States to
avoid having to count security-based swap transactions pursuant to the
``arranged, negotiated, or executed'' counting standard?
3. ``Listed Jurisdiction'' Condition and Definition, and Potential
Effect of Barriers to the Transfer of Information
Would the proposed ``listed jurisdiction'' condition and associated
definition appropriately prevent the proposed exception from permitting
persons that engage in security-based swap dealing activity in the
United States from booking transactions into affiliated non-U.S.
booking entities that are not subject to adequate financial
responsibility oversight or that would not allow for sufficient access
to information by the Commission? Commenters particularly are invited
to address the following:
a. What criteria should the Commission use to help ensure that non-
U.S. persons relying on the exception are subject to adequate financial
responsibility requirements?
b. Would it be appropriate, as commenters previously suggested, to
exclude transactions that are arranged, negotiated or executed by U.S.
personnel if the non-U.S. dealer is located in a G-20 jurisdiction or
is subject to the margin and capital requirements of a Basel-compliant
jurisdiction?
c. Would ``listed jurisdiction'' status be appropriate for the
following jurisdictions: Australia, Canada, France, Germany, Hong Kong,
Japan, Singapore, Switzerland, and the United Kingdom?
In this regard commenters particularly are invited to
address whether listed jurisdiction status would be warranted in light
of those jurisdictions' applicable margin and capital requirements, and
the effectiveness of those jurisdictions' supervisory compliance
program and enforcement authority in connection with those
requirements, including in the cross-border context.
Commenters also are invited to address potential
impediments to the Commission's ability to promptly access information
or documents regarding the activities of persons in those
jurisdictions, to obtain the testimony of non-U.S. persons that are
associated with those persons, and to obtain the assistance of persons
relying on the exception in taking the evidence of other persons,
wherever located.\179\
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\179\ As discussed above (see notes 160 through 162, supra, and
accompanying text), although the Commission preliminarily does not
expect to consider impediments to information access as part of
initial listed jurisdiction determinations, the Commission may
modify or withdraw listed jurisdiction status in the event that, in
practice, the Commission or its representatives have been prevented
from accessing information due to the jurisdiction's laws and
regulations.
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d. What criteria should the Commission use to help ensure that it
can access information from non-U.S. persons relying on the exception?
Commenters also are invited to address how potential impediments to the
cross-border transfer of information may affect compliance with the
information access condition and other conditions to the exception,
including the effect of any such impediments on the registered entity's
ability to comply with conditions related to the trade acknowledgment
and verification, and to the registered entity's obligation to obtain
trading relationship documentation from its non-U.S. affiliate.
4. Appropriate Counterparty Protections
What conditions are appropriate to afford protections to the
counterparties to the security-based swap transactions at issue,
consistent with by Title VII and its implementing regulations?
Commenters particularly are invited to address the following issues,
and, to the extent possible, address similarities and differences
between the activities implicated by the proposed exception and the
activities that unregistered foreign broker-dealers may conduct
pursuant to the exemption provided by Exchange Act Rule 15a-6: \180\
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\180\ Exchange Act Rule 15a-6 in part permits unregistered
foreign broker-dealers to engage in certain activities in the United
States in connection with major institutional investors represented
by U.S. fiduciaries on an ``unchaperoned'' basis. See Rule 15a-
6(a)(3). The Rule 15a-6(a)(3) exemption in part is conditioned on
the requirement that a registered broker-dealer is responsible for
effecting the resulting transactions, the requirement that an
associated person of the registered broker-dealer be involved in all
of the foreign entity's visits to defined U.S. institutional
investors, and prohibitions against the involvement of statutorily
disqualified foreign associated persons of the foreign-broker
dealer.
Commission staff has provided statements regarding the
operation of Rule 15a-6. For example, a 1997 staff no-action letter,
inter alia, stated that the staff would not recommend enforcement
action when foreign associated persons of a foreign broker-dealer:
(i) Engaged in oral communications from outside the U.S. with
certain U.S. institutional investors outside of U.S. trading hours,
so long as the foreign associated persons do not accept orders
(other than those involving foreign securities); and (ii) have in-
person visits with certain ``major'' U.S. institutional investors,
so long as those contacts do not exceed 30 days a year and the
foreign associated persons do not accept orders. That letter also
provided a staff statement regarding the meaning of ``major U.S.
institutional investor.'' See Letter re Securities Activities of
U.S.-Affiliated Foreign Dealers from Richard R. Lindsey, Director,
Division of Market Regulation to Giovanni P. Prezioso, Cleary,
Gottlieb, Steen & Hamilton, dated Apr. 9, 1997 (``Nine Firms
Letter''), available at http://www.sec.gov/divisions/marketreg/mr-noaction/cleary040997.pdf. Staff guidance regarding the operation of
Rule 15a-6 is summarized in ``Frequently Asked Questions Regarding
Rule 15a-6 and Foreign Broker-Dealers,'' available at https://www.sec.gov/divisions/marketreg/faq-15a-6-foreign-bd.htm.
In contrast to Rule 15a-6, which provides an exemption for
foreign entities' transactions with activities involving U.S. person
customers, the proposed exception to Rule 3a71-3 would permit
foreign entities to make use of U.S. activity only in connection
with security-based swaps with non-U.S. counterparties.
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[[Page 24229]]
a. Do the alternatives for the proposed exception appropriately
distinguish between certain security-based swap dealer requirements
that will be applied to the arranging, negotiating or executing
activity in the United States as a condition to the exception (i.e.,
requirements related to disclosures of risks, characteristics,
incentives and conflicts, suitability, fair and balanced
communications, trade acknowledgement and verification, initial
portfolio reconciliation, and books and records), and other
requirements that the Commission is not proposing to apply to that
activity as a condition to the exception (i.e., requirements related to
ECP verification, daily mark disclosure, clearing rights disclosure,
``know your counterparty'' and proposed risk mitigation requirements)?
b. To the extent that commenters believe that there should be
changes to the proposed allocation of security-based swap dealer
requirements between those that are conditions to the exception, and
those that are not, please explain how those requirements should be
allocated for purposes of the exception, and describe how that
alternative allocation would address concerns raised by the activity of
the registered entity. Please also describe the practical challenges
raised by the Commission's proposed allocation, how a different
allocation would address those challenges, and whether there are any
inconsistencies in the proposed allocation.
c. To what extent would the transactions at issue be subject to
requirements in foreign jurisdictions that are analogous to the Title
VII requirements that are proposed to be applied as conditions to the
exception? To what extent would the transactions at issue be subject to
requirements in foreign jurisdictions that are analogous to the Title
VII requirements that are not proposed to be applied as conditions to
the exception? To what extent would analogous FINRA requirements apply
to these transactions if the registrant is registered as a broker?
d. As an alternative to the proposed conditions to this exception,
should this exception instead be subject to conditions that are styled
after the staff guidance that describes conditions under which foreign
broker-dealers may operate in the United States pursuant to Exchange
Act Rule 15a-6(a)(3)? \181\ In this regard the Commission notes that
foreign broker-dealers relying on Rule 15a-6 differ from foreign
dealers that would avail themselves of proposed exceptions in at least
two respects: First, the former are permitted to engage in only limited
activity inside the United States, while the latter would be arranging,
negotiating, and executing transactions using U.S. personnel on an
ongoing basis; second, the former exemption applies to transactions
with U.S. persons while the latter exception would apply only to
transactions with non-U.S. persons. How should those differences affect
the scope of any relief provided and any conditions placed on that
relief? Should compliance with any or all of the requirements that are
a condition to the proposed exception be eliminated, either entirely or
for certain ``sophisticated'' counterparties? If so, how should
``sophisticated'' be defined for these purposes? Should any eligible
contract participant be considered ``sophisticated,'' or should
``sophisticated'' encompass only a counterparty that meets a higher
standard, such as a standard similar to the standards applicable to:
(1) Qualified institutional buyers under Rule 144A(a)(1)-(4) \182\
under the Securities Act of 1933; (2) major institutional investors, as
defined in Exchange Act Rule 15a-6 and discussed in subsequent staff
guidance; or (3) the security-based swap dealer suitability
requirement's institutional counterparty standard under Rule 15Fh-
3(f)(4)? \183\ Would this alternative type of approach appropriately
balance the implementation concerns associated with the use of the
``arranged, negotiated, or executed'' test against the regulatory
interests underlying the de minimis counting requirement?
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\181\ See note 180, supra.
\182\ See 17 CFR 230.144A.
\183\ See note 180, supra.
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e. Are additional conditions necessary to help ensure that the
entity that engages in arranging, negotiating or executing activity in
the United States appropriately would be subject to all relevant
security-based swap dealer requirements, notwithstanding a lack of
contractual privity with the counterparty to the transaction?
5. Issues Potentially Associated With Specific Conditions
Are there specific conditions to the proposed exception that may
pose implementation issues, or that otherwise should be modified?
Commenters particularly are invited to address the following:
a. Suitability--Are there any aspects of the suitability
requirements applicable to security-based swap dealers that would raise
implementation issues in the event that the entity engaged in
arranging, negotiating or executing activity in the United States makes
recommendations in connection with the transactions at issue? In this
regard please describe the nature of the relationship between U.S.
personnel operating pursuant to the exception and the foreign
counterparties, and any challenges to obtaining the information
necessary to comply with the suitability requirement. To what extent,
if at all, is the suitability requirement necessary in light of the
institutional nature of the market and the limited suitability
requirements that apply to transactions with institutional
counterparties? Could the concerns addressed by Rule 15Fh-3(f) be
mitigated if the suitability condition to the exception were instead
limited solely to the security-based swap dealer's compliance with Rule
15Fh-3(f)(2)(iii), which would require the security-based swap dealer
to disclose that it is acting in its capacity as a counterparty, and is
not undertaking to assess the suitability of the security-based swap or
trading strategy for the counterparty?
b. Disclosure of risks, characteristics, material incentives and
conflicts of interest--Are there implementation issues that may arise
in connection with the proposed condition requiring the registered
entity engaged in arranging, negotiating or executing activity in the
United States to comply with requirements related to the disclosure of
information regarding risks, characteristics, material incentives and
conflicts of interest? Commenters particularly are invited to address
whether there may be impediments related to the ability of the
registered entity to disclose or gather information
[[Page 24230]]
regarding material incentives and conflicts of interest associated with
the non-U.S. person relying on the proposed exception, and regarding
how to address any such potential impediments. For example, should the
disclosure requirement be limited to information regarding material
incentives and conflicts of interest associated with the registered
entity engaged in such activity in the United States?
c. Disclosure that non-U.S. person is not registered--Are there
implementation issues that may arise in connection with the proposed
condition requiring disclosure that the non-U.S. person relying on this
exception is not registered with the Commission as a security-based
swap dealer, and that certain Exchange Act security-based swap
requirements may not be applicable? Commenters particularly are invited
to address whether disclosure of less information or additional
information would be appropriate, and to address whether alternative
approaches regarding the timing and manner of disclosure would be
appropriate.
d. Trade Acknowledgment and Verification--Should the Commission, as
is proposed under Alternatives 1 and 2, condition the exception on the
registered entity that engages in arranging, negotiating or executing
activity in the United States complying with trade acknowledgment and
verification requirements under Title VII as if they were a
counterparty to the transaction? The trade acknowledgment and
verification requirements apply in connection with a transaction in
which a security-based swap dealer purchases or sells to any
counterparty a security-based swap. For purposes of this exception,
should the Commission treat the registered entity that arranges,
negotiates, or executes a security-based swap as if it purchased or
sold a security-based swap for purposes of the trade acknowledgment and
verification requirements? Will a security-based swap dealer (under
Alternative 1 or 2) or a registered broker-dealer (under Alternative 2)
that provides limited services in connection with arranging,
negotiating, or executing a transaction necessarily be able to comply
with the trade acknowledgment and verification requirements as if it
were a party to the transaction? Will the security-based swap dealer or
registered broker-dealer necessarily have all the information required
for a trade acknowledgment to which it is not a party? How will it
obtain verification? Would there be potential impediments to the
registered entity's ability to accurately reflect the terms of the
transaction on the trade acknowledgement? Would it be sufficient to
condition the exception on the broker-dealer complying with the
transaction confirmation requirements of Exchange Act Rule 10b-10 as if
the counterparty were the ``customer'' of the broker-dealer? \184\
Would it be necessary to modify the information required to be
confirmed under Exchange Act Rule 10b-10 to accommodate security-based
swaps?
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\184\ The transaction confirmation requirements apply when a
broker-dealer ``effect[s] for or with any customer any transaction
in, or [induces] the purchase or sale by such customer'' of
securities. See Exchange Act Rule 10b-10(a).
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e. Affiliation condition--Are there implementation issues that
would arise in connection with the proposed condition that would
require the registered entity engaged in arranging, negotiating or
executing activity in the United States to be a majority-owned
affiliate of the non-U.S. person relying on the exception? Commenters
particularly are invited to address the appropriateness of an
affiliation condition, the potential use of alternatives to a majority-
ownership standard in connection with the condition (e.g., common
control or ``wholly owned'' standards), and any technical or other
implementation issues that may accompany the use of an affiliation
standard.
f. Portfolio reconciliation condition--The Commission further
requests comment regarding the proposed condition that would require
the registered entity engaged in arranging, negotiating or executing
conduct in the United States to perform the initial portfolio
reconciliation required by proposed Exchange Act Rule 15Fi-3.
Commenters particularly are invited to address implementation issues
that may be associated with that proposed condition. Commenters also
are invited to address the potential effectiveness of that proposed
condition in helping registered security-based swap data repositories
comply with their verification requirements.
6. Potential Additional Conditions
Should the proposed exception be subject to additional conditions?
Commenters particularly are invited to address the following:
a. Should the exception be made unavailable in circumstances in
which U.S. entities or their personnel manage the relationship with the
non-U.S. counterparty to the transaction? Alternatively, should
additional conditions (e.g., compliance with ECP verification and
``know your counterparty'' requirements) be applied to the exception in
those circumstances?
b. Should the exception be conditioned on the registered entity
complying with ECP verification and ``know your counterparty''
requirements ``as if'' the counterparties to the non-U.S. person
relying on the exception also were counterparties to the registered
entity? In this regard, commenters are requested to discuss whether the
registered entity reasonably would be expected to possess information
regarding the counterparty to the transaction that is sufficient to
permit compliance with those requirements.
c. Instead, should the treatment of ECP verification and ``know
your counterparty'' requirements for purposes of the exception depend
in part on whether the Commission also has issued ``market color''
guidance, as discussed in part II supra. For example, if the Commission
issues ``market color'' guidance, would it be likely that non-U.S.
persons would rely on the guidance when their U.S. personnel have only
a peripheral involvement with the resulting transaction, and that non-
U.S. persons would rely on the exception when their U.S. personnel
engage with the counterparty more comprehensively? In that event,
should the exception require compliance with the ECP verification and
``know your counterparty'' provisions, based on the assumption that the
exception would be used when U.S. personnel have a comparatively
comprehensive degree of engagement with the counterparty, which would
allow for compliance with those conditions?
d. Alternatively, should the exception from the de minimis counting
requirement be conditioned on ``as if'' compliance with those ECP
verification and ``know your counterparty'' requirements, unless the
registered entity has had no prior interactions with the counterparty,
and there is no basis to believe that the registered entity would have
further interactions with that counterparty?
e. Should the exception further be conditioned on the registered
entity having to disclose information regarding clearing rights?
Commenters particularly are invited to address the expected application
of the underlying clearing rights provisions in Exchange Act Section
3C(g)(5) to the transactions at issue.
f. Should the proposed exception be conditioned on the non-U.S.
person relying on the condition having some involvement in the
registered entity's arranging, negotiating or executing activity to the
extent practicable, to help prevent the counterparties to these
transactions from misconstruing the role
[[Page 24231]]
of the registered entity and the application of Title VII safeguards to
the transactions at issue.
g. Are there additional conditions that would be appropriate for
incorporation into the exception?
7. Treatment of the Non-U.S. Person Relying on the Exception, Including
Commission Access to Information
To what extent would the absence of direct security-based swap
dealer regulation of the non-U.S. person relying on the proposed
exception--notwithstanding its use of U.S. personnel to conduct
security-based swap dealing activity--raise concerns regarding gaps in
the application of Title VII to transactions arising from security-
based swap dealing in the United States? \185\ Commenters particularly
are invited to address the following:
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\185\ Absent additional Commission action, see part III.D.10,
infra, under the proposed exception the regulatory reporting and
public dissemination requirements of Regulation SBSR still would
apply directly to the security-based swap, by virtue of the
transaction having been arranged, negotiated or executed in the
United States, see Regulation SBSR Sections 908(a)(1)(v) and
908(b)(5) (and, under alternative 2, by virtue of the transaction
having been effected by or through a registered broker-dealer, see
Regulation SBSR Section 908(a)(1)(iv)).
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a. What issues may arise due to the lack of Commission regulation
of communications between the non-U.S. person and its counterparties?
Could this lack of regulation potentially facilitate improper practices
in connection with dealing transactions that occur in part in the
United States?
b. What issues may arise due to the lack of direct Commission
financial responsibility regulation of the non-U.S. person? How
significant are associated concerns regarding spillovers and contagion
arising from reputational effects that an affiliate's failure may have
on other affiliates within the same corporate group?
c. Do the proposed provisions to (a) require the non-U.S. person
relying on the exception to promptly provide the Commission with
information, documents and testimony in connection with the
transaction, and (b) require the registered entity to obtain and
maintain related books and records, adequately provide for transparency
into the dealing activities associated with transactions subject to the
exception? Should the rules provide further specificity regarding the
procedures for withdrawing the exception in the event of impediments to
such access? Should the exception incorporate a notice provision to
require the non-U.S. person relying on the exception (or the registered
entity engaged in arranging, negotiating or executing activity in the
United States) to inform the Commission as to the transactions being
conducted in reliance on the exception? Are there modifications that
would allow the Commission to obtain the necessary access to books and
records at a lower cost to the non-U.S. person and the registered
entity?
d. For purposes of the access provisions of proposed paragraph
(d)(1)(iii)(A) of Rule 3a71-3--which would require non-U.S. persons
relying on the exception to promptly make their ``foreign associated
persons'' available to the Commission for testimony--is the proposed
``foreign associated person'' definition in paragraph (a)(11) of the
rule crafted appropriately? For example, should the proposed definition
be limited so it applies only to persons who effect or who are involved
in effecting security based swaps? If so, why?
8. Distinctions Between the Two Proposed Alternatives
Comparatively, to what extent would the two proposed alternatives
for the conditional exception effectively address implementation
concerns while continuing to preserve the principles that underpin the
``arranged, negotiated, or executed'' standard? Commenters particularly
are invited to address the following:
a. Under the second alternative, what concerns may arise from
applying Title VII business conduct requirements to brokers via
condition in lieu of security-based swap dealer registration?
b. How would comparative security-based swap dealer capital
requirements and broker-dealer capital requirements affect the
implementation of the two alternatives? \186\ Would those capital
requirements limit the ability to use a stand-alone entity to engage in
arranging, negotiating or executing conduct in the United States on
behalf of a non-U.S. affiliate? Would those capital requirements affect
the potential use of a registered entity that also engages in a
separate security-based swap dealing business, or that is registered as
a swap dealer or as a bank? \187\
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\186\ The proposed capital requirements applicable to those
entities would depend on whether they are a stand-alone nonbank
security-based swap dealer, a security-based swap dealer that is
dually registered as a broker-dealer, a bank security-based swap
dealer, or stand-alone broker-dealer. See Capital, Margin and
Segregation Proposing Release, 77 FR at 70333 (proposing capital
requirements for nonbank security-based swap dealers, including
security-based swap dealers dually registered as broker-dealers); 80
FR 74840 (Nov. 30, 2015) (adopting capital requirements for bank
security-based swap dealers); 17 CFR 240.15c3-1 (prescribing capital
requirements for broker-dealers). Those existing and proposed
capital requirements are tailored, among other reasons, based on the
different types of entities (e.g., a bank, a security-based swap
dealer, or a broker-dealer) and the activities those entities engage
in. Therefore, two different types of entities may be subject to
substantially different capital requirements.
\187\ For example, would the security-based swap dealer capital
requirements associated with Alternative 1 effectively limit the use
of that alternative to situations in which the arranging,
negotiating or executing activity is conducted through a registered
security-based swap dealer that engages in a separate security-based
swap dealing business (apart from conducting arranging, negotiating
or executing activity on behalf of an affiliate), or that also
engages in a swap dealing business, or that is a bank? Conversely,
would Alternative 2 better accommodate the establishment of new
registered entities to conduct arranging, negotiating or executing
activity consistent with the conditions to the proposed exception?
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9. Effect on Booking Practices
The Commission requests comment regarding how the availability of
the proposed exception would be expected to affect prospective booking
practices by industry participants. Commenters particularly are invited
to address the following:
a. Would the proposed exception incentivize U.S.-based dealing
entities to bifurcate their dealing books by prospectively booking
security-based swap transactions with non-U.S. counterparties into non-
U.S. affiliates, to avoid having that portion of their security-based
swap businesses being subject to Title VII security-based swap dealer
requirements? If so, what would be the expected extent of such booking
practices? What would be the expected economic consequences? \188\
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\188\ See part VII.A.7, infra (addressing potential number of
U.S.-based dealing entities that may seek to use the exception in
connection with those types of prospective booking practices).
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b. Are the proposed conditions appropriate to help guard against
any negative consequences (e.g., loss of business conduct protection,
potential market fragmentation) that potentially would result from
U.S.-based dealing entities using such booking practices to limit the
application of Title VII to their dealing businesses involving non-U.S.
counterparties? If not, what additional conditions--e.g., restrictions
on the availability of the exception when the counterparty relationship
is managed by U.S. personnel rather than by non-U.S. personnel of the
booking entity--would be appropriate to help prevent those negative
consequences?
c. Would a differently tailored application of the counting
requirements to cross-border transactions be appropriate, instead of or
in addition to the alternatives being proposed in this release? For
example,
[[Page 24232]]
should a non-U.S. person engaged in dealing activity be permitted to
exclude certain transactions with a U.S.-person dealer from its de
minimis calculations, subject to certain conditions? If so, please
describe the conditions that should apply to such an exception.
Alternatively, should a non-U.S. person engaged in dealing activity be
permitted to avail itself of such an exception only to the extent that
it is located in a ``listed jurisdiction''?
10. Availability to Registered Security-Based Swap Dealers
As proposed, the exception not only would affect the set of dealing
transactions that non-registered persons would consider when evaluating
whether they fall under the security-based swap dealer de minimis
thresholds, but also would be relevant to non-U.S. persons that are
registered as security-based swap dealers but that wish to withdraw
their registration based on their dealing activity over the prior 12
months.\189\ Should the exception be made unavailable to registered
security-based swap dealers in connection with the potential withdrawal
of registration? Commenters particularly are invited to address whether
the rationale that underpins the proposed exception, related in large
part to the consequences of actions that non-U.S. persons otherwise may
take to avoid security-based swap dealer registration, would also be
relevant in connection with non-U.S. persons that have registered with
the Commission.
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\189\ See note 101, supra (discussing application of proposal to
registered security-based swap dealers).
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11. Other Uses of ``Arranged, Negotiated, or Executed'' Criteria
Should similar exceptions also be made available in connection with
other Title VII requirements that in part rely on ``arranged,
negotiated, or executed'' test? Commenters particularly are invited to
address the following:
a. Regulation SBSR
Commenters are invited to address the application of ``arranged,
negotiated, or executed'' criteria in connection with the cross-border
application of the regulatory reporting and public dissemination
requirements of Regulation SBSR. Regulation SBSR requires reporting and
dissemination of transactions, connected with a non-U.S. person's
security-based swap dealing activity, that have been ``arranged,
negotiated, or executed'' by U.S. personnel of the non-U.S. person, or
by U.S. personnel of the non-U.S. person's agent.\190\ In adopting
Regulation SBSR, the Commission determined that requiring those
transactions to be reported to a registered swap data repository would
``enhance the Commission's ability to oversee relevant security-based
swap activity within the United States as well as to evaluate market
participants for compliance with specific Title VII requirements'' and
monitor for fraudulent activity.\191\ The Commission further stated
that public dissemination of those transactions would ``contribute to
price discovery and price competition in the U.S. security-based swap
market'' by providing a ``more comprehensive view of activity in the
U.S. market.'' \192\
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\190\ See Regulation SBSR Sections 908(a)(1)(v) and 908(b)(5);
see also note 14, supra. Regulation SBSR was adopted pursuant to the
regulatory reporting and public dissemination requirements set forth
in Exchange Act Sections 13(m)(1)(C), 13(m)(1)(G) and 13A(a)(1).
\191\ 81 FR at 53591.
\192\ Id. at 53592.
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The Commission is soliciting comment regarding those prior
conclusions. Commenters particularly are invited to address whether the
existing requirements related to the cross-border application of
Regulation SBSR could cause non-U.S. person counterparties to avoid
transacting with foreign dealers who use U.S. personnel to arrange,
negotiate or execute security-based swap transactions.
In this regard, commenters are invited to address whether there
should be any modifications to existing provisions of Regulation SBSR
(and, if so, which) regarding the application of regulatory reporting
and public dissemination requirements to transactions arranged,
negotiated or executed in the United States. Commenters also are
invited to provide their views as to whether, for a security-based swap
where a non-U.S. person engages in dealing activity but relies on an
exception from having to count that transaction against its de minimis
threshold, Regulation SBSR should be amended to re-assign the duty to
report that transaction from the non-U.S. person engaged in dealing
activity to its affiliated U.S. entity (be it a registered broker-
dealer or registered security-based swap dealer) that is conducting the
arranging, negotiating or executing activity in the United States.
Commenters further are invited to comment on possible alternative
compliance mechanisms for the regulatory reporting and public
dissemination requirements. For example, should Regulation SBSR be
amended to conditionally permit the transaction to be reported pursuant
to the requirements of the foreign jurisdiction which applies its
reporting requirements to the affiliated non-U.S. person? If so, what
conditions should apply to such an approach (e.g., limiting the
approach to circumstances where that jurisdiction's reporting and
dissemination requirements and practices meet certain criteria), and
how should the Commission or market participants determine whether a
jurisdiction meets any relevant criteria for this purpose?
Alternatively, is the availability of substituted compliance in
connection with the regulatory reporting and public dissemination
requirements sufficient to address concerns regarding regulatory
burdens potentially associated with this use of an ``arranged,
negotiated, or executed'' test?\193\
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\193\ Rule 908(c) of Regulation SBSR provides that the Title VII
requirements for regulatory reporting and public dissemination of
security-based swaps may be satisfied by compliance with the rules
of a foreign jurisdiction that the Commission has found to have
requirements that are comparable to those of Title VII.
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b. Additional Title VII Requirements
Commenters also are invited to address the use of an ``arranged,
negotiated, or executed'' test in connection with the cross-border
application of certain security-based swap dealer business conduct
requirements.\194\ Here too, the Commission particularly requests
comment regarding the potential relevance of Exchange Act Rule 15a-
6(a)(3), which in part conditionally allows unregistered foreign
broker-dealers to communicate with U.S. institutional investors and
major institutional investors without having to register with the
Commission as broker-dealers.\195\ Would it be appropriate to provide
conditional relief--akin to the proposed exception from the de minimis
counting requirement or to the conditional broker-dealer registration
exemption set forth in Rule 15a-6(a)(3)--from relevant business conduct
requirements for registered foreign security-based swap dealers in
security-based swap transactions with non-U.S. persons that the foreign
dealers arrange, negotiate, or execute using personnel located within
the United States? If so, should such relief be conditioned on the
sophistication of the counterparty or its
[[Page 24233]]
advisor or compliance with any other conditions?
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\194\ Exchange Act Rule 3a71-3(c) states that a registered
security-based swap dealer is not subject to certain business
conduct requirements ``with respect to its foreign business.'' The
``foreign business'' definition (Rule 3a71-3(a)(9)) references the
definition of ``U.S. business,'' which in relevant part includes
transactions of foreign security-based swap dealers that have been
arranged, negotiated or executed by personnel located in a U.S.
branch or office. See Exchange Act Rule 3a71-3(a)(8)(i)(B).
\195\ See note 180, supra.
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In addition, commenters are invited to address the application of
``arranged, negotiated, and executed'' criteria in connection with the
exception from the de minimis counting requirement related to the
dealing transactions of non-U.S. persons with counterparties that are
foreign branches of registered security-based swap dealers.\196\ To the
extent that this counting test raises operational or other challenges,
are these addressed by the guidance that the Commission has proposed to
provide in Part II above regarding the scope of activity that is
encompassed by the terms ``arranging'' and ``negotiating'' under the
test? Alternatively, should the definition of ``transaction conducted
through a foreign branch'' in Exchange Act Rule 3a71-3(b)(1)(iii)(A) be
modified to incorporate exceptions similar to those being proposed
here? Would such an exception from that aspect of the de minimis
counting requirement potentially lead to unlimited involvement of U.S.-
based personnel in such transactions? If so, how could the exception be
tailored appropriately to avoid such a result?
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\196\ See note 81, supra.
---------------------------------------------------------------------------
Commenters also are invited to address the use of those criteria in
connection with rules regarding the cross-border application of
requirements applicable to major security-based swap participants.\197\
---------------------------------------------------------------------------
\197\ See note 82, supra.
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12. Additional Issues
The Commission further requests comment regarding any additional
issues associated with the proposed exception, or regarding other
potential approaches toward addressing issues associated with the
``arranged, negotiated, or executed'' counting standard.
IV. Proposed Guidance and Amendments Related to the Certification and
Opinion of Counsel Requirements
A. Discussion
Since the adoption of the registration rules for SBS Entities,\198\
the Commission staff has received a number of questions regarding the
scope of the certification and opinion of counsel requirement in
Exchange Act Rule 15Fb2-4.\199\ Certain of these questions related to
issues raised by foreign blocking laws, privacy laws, secrecy laws and
other foreign legal barriers that may limit or prohibit firms from: (i)
Providing books and records directly to the Commission; or (ii)
submitting to an onsite inspection or examination by SEC staff.\200\
Specifically, firms have requested guidance as to whether the
certification and opinion of counsel may take into account different
approaches available under foreign blocking laws, privacy laws, secrecy
laws or other legal barriers that may facilitate firms' ability to
provide books and records to the Commission and submit to an
examination or inspection by Commission staff in a manner consistent
with a particular foreign legal requirement.
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\198\ See Registration Adopting Release.
\199\ See, e.g., IIB/SIFMA 8/26/2016 Letter; see also IIB 11/16/
2016 Email.
\200\ See, e.g., Registration Adopting Release, 80 FR at 48981.
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The Commission recognizes that foreign blocking laws, privacy laws,
secrecy laws or other legal barriers may vary in purpose and scope,
among other aspects. For example, while some foreign laws may affect
the ability of a Commission registrant to provide personal data to the
Commission, other laws may prevent a Commission registrant from
providing any information to the Commission or submitting to an onsite
visit without specific authorization from the foreign government. In
light of the differences among foreign laws, the Commission deems it
appropriate to propose guidance to firms seeking clarification as to
the Commission's requirements for the certification and opinion of
counsel.
For example, firms have asked whether the required certification
and opinion of counsel may take into account the ability in some
jurisdictions for a firm to provide the Commission with access to books
and records if the firm obtains the consent of the person whose
information is documented in the books and records.\201\ One commenter
also asked that the Commission clarify that in certain circumstances
the certification and opinion of counsel may be based on the assumption
that the nonresident security-based swap dealer will provide the
Commission access to its books and records through, and submit to on-
site inspection and examination with the approval of, the relevant
foreign regulatory authority.\202\ In addition, firms have asked
whether the certification and opinion of counsel should address only
the laws of the ``home country'' of the nonresident SBS Entity (for
example, its principal place of business or where it is incorporated),
or if the Commission expects a nonresident SBS Entity to address
applicable law in every jurisdiction in which the nonresident SBS
Entity may conduct business or in which its counterparties, customers,
or personnel may be located.\203\ Firms also have asked if the
certification and opinion of counsel are meant to cover Commission
inspection and examination of books and records in the jurisdictions in
which they are located.\204\ The Commission has been considering these
issues, and believes it would be appropriate to address certain of
these concerns as described below.
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\201\ See, e.g., Memorandum from the Division of Trading and
Markets regarding a April 3, 2018 meeting with representatives of
Societe Generale, April 3, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-3405388-162169.pdf; Memorandum from the
Division of Trading and Markets regarding a April 4, 2018 meeting
with representatives of Barclays, April 4, 2018, available at
https://www.sec.gov/comments/s7-05-14/s70514-3405597-162172.pdf;
Memorandum from the Division of Trading and Markets regarding a
April 11, 2018 meeting with representatives of UBS, April 11, 2018,
available at https://www.sec.gov/comments/s7-05-14/s70514-3461169-162204.pdf; Memorandum from the Division of Trading and Markets
regarding a April 11, 2018 meeting with representatives of Morgan
Stanley, April 11, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4035093-168391.pdf; Memorandum from the Division of
Trading and Markets regarding a April 30, 2018 meeting with
representatives of UBS, April 30, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4042895-168865.pdf; Memorandum
from the Division of Trading and Markets regarding a June 4, 2018
meeting with representatives of Credit Suisse, June 5, 2018,
available at https://www.sec.gov/comments/s7-08-12/s70812-3785770-162712.pdf; and Memorandum from the Division of Trading and Markets
regarding a July 18, 2018 meeting with representatives of BNP
Paribas, July 24, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4107153-170272.pdf.
\202\ IIB/SIFMA 8/26/2016 Letter, at page 3.
\203\ See note 201, supra.
\204\ See IIB/SIFMA 8/26/2016 Letter, at page 2.
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The guidance set forth below regarding the certification and
opinion of counsel requirements would also be relevant to Exchange Act
Rule 3a71-6, which allows SBS Entities to comply with certain
requirements under Section 15F of the Exchange Act through substituted
compliance.\205\ In particular, Paragraph (c)(2)(ii) of Rule 3a71-6
provides that substituted compliance applications by parties or groups
of parties--other than foreign financial regulatory authorities--must
include the certification and opinion of counsel associated with the
SBS Entity registration requirements as if such party were subject to
that requirement at the time of the request.\206\ Recognizing
[[Page 24234]]
the expected time necessary for the Commission to consider substituted
compliance applications it receives, the Commission welcomes submission
of such applications with respect to any of its final rules for which
substituted compliance is potentially available. Consistent with this
position, the Commission wishes to clarify that, during the pendency of
this proposal, the Commission will consider all such applications,
including those submitted without a certification or opinion of
counsel, by parties or groups of parties who are not foreign regulatory
authorities.\207\ This clarification, however, does not mean that the
Commission would grant any application for substituted compliance
submitted by such parties or groups of parties until the required
certification and opinion are filed.
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\205\ Exchange Act Rule 3a71-6.
\206\ Separately, paragraph (c)(3) of Rule 3a71-6 provides that
foreign financial regulatory authorities may make substituted
compliance requests only if they provide adequate assurances that no
law or policy of any relevant foreign jurisdiction would impede the
ability of any entity that is directly supervised by the foreign
financial regulatory authority and that may register with the
Commission as an SBS Entity to provide the Commission with prompt
access to the entity's books or records, or to submit to on-site
inspection and examination by the Commission. The above guidance
regarding the application of the certification and opinion of
counsel requirements also will inform the Commission's assessment of
whether a foreign financial regulatory authority has provided such
adequate assurances as part of a substituted compliance application.
\207\ The Commission does not require that applications
submitted by foreign regulatory authorities be accompanied by a
certification or opinion of counsel. Exchange Act Rule 3a71-6(c)(3).
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1. Foreign Laws Covered by the Certification and Opinion of Counsel
Requirements
The Commission understands that the security-based swap market and
the security-based swap dealing activities of many firms are global in
scope. In this market, the business of any single security-based swap
dealer, whether a resident or nonresident of the United States, may
span multiple jurisdictions. The certification and opinion of counsel
requirement was intended to address distinct challenges that may arise
with respect to a nonresident SBS Entity that, unlike a resident SBS
Entity, is incorporated or has its principal place of business outside
the United States. In particular, the requirement is intended to
provide a level of assurance regarding the Commission's access to
relevant books and records of a nonresident SBS Entity and its ability
to inspect and examine them.
Given the underlying objective of this requirement, the Commission
is proposing to provide guidance that it would be appropriate for the
certification and opinion of counsel to address only the laws of the
jurisdiction or jurisdictions in which the nonresident SBS Entity
maintains the covered books and records as described in part IV.B.2,
infra (``covered books and records''). Under this proposed guidance,
the certification and opinion of counsel would not need to cover other
jurisdictions where customers or counterparties of the nonresident SBS
Entity may be located or where the nonresident SBS Entity may have
additional offices or conduct business. For example, if the nonresident
SBS Entity maintains the covered books and records in the jurisdiction
of its incorporation or principal place of business, the certification
and opinion of counsel would address that jurisdiction. If the
nonresident SBS Entity maintains its covered books and records in a
jurisdiction or jurisdictions other than where it is incorporated or
has its principal place of business (e.g., in a jurisdiction where it
maintains a foreign branch office that conducts its security-based swap
activities), the certification and opinion of counsel should address
such jurisdiction or jurisdictions, provided that the laws of the
jurisdiction where the firm is incorporated or jurisdictions in which
it is doing business would not prevent the Commission from having
direct access to the covered books and records, nor prevent the
nonresident SBS Entity from promptly furnishing them to the Commission
or opening them up to the Commission for an on-site inspection or
examination.
The Commission preliminarily believes that a certification and
opinion of counsel from a nonresident SBS Entity that covers the laws
of the jurisdiction or jurisdictions where its covered books and
records are located, rather than the laws of all possible jurisdictions
where its customers or counterparties may be located or where it may
conduct business, would provide the Commission with a sufficient level
of assurance that it will be able to access the relevant books and
records of nonresident SBS Entities registered with it.
2. Clarification on Covered Books and Records
One commenter requested that the Commission clarify that the scope
of the certification and opinion of counsel requirement applies only to
``U.S.-Related Records'' (as defined by the commenter) and, for a
nonresident security-based swap dealer subject to the Commission's
capital and margin regulations, ``Financial Records'' (as defined by
the commenter).\208\ The commenter also would limit the scope of the
certification and opinion of counsel to on-site inspection and
examination of books and records located at a U.S. branch or office of
a nonresident security-based swap dealer or U.S. Related Records
located at the nonresident security-based swap dealer's ``U.S.-Related
Foreign Locations'' (as defined by the commenter).\209\ Among other
things, the commenter states that this would ensure Commission access
to the types of records most relevant to the Commission's oversight
responsibilities.\210\
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\208\ See IIB/SIFMA 8/26/2016 Letter (proposing that ``U.S.-
Related Records'' be defined to mean ``books and records relating to
security-based swap transactions entered into by the non-resident
security-based swap dealer after the effective date of its
registration (i) with U.S. persons, (ii) for which the nonresident
[security-based swap dealer's] obligations are guaranteed by a U.S.
person or (iii) arranged, negotiated or executed on behalf of the
non-resident [security-based swap dealer] by personnel located in a
U.S. branch or office of the non-resident [security-based swap
dealer] or its agent. Where [a security-based swap dealer] maintains
such books and records in multiple locations, the [security-based
swap dealer] would designate the location that is relevant for
purposes of the certification and opinion;'' and ``Financial
Records'' would be defined to mean ``books and records necessary for
the Commission to assess the non-resident [security-based swap
dealer's] compliance with Commission capital and margin
requirements.'').
\209\ See id. (proposing that ``U.S.-Related Foreign Locations''
be defined to mean ``non-U.S. branches and offices of the
nonresident [security-based swap dealer] from which personnel
arrange, negotiate or execute [security-based swap] transactions on
behalf of the non-resident [security-based swap dealer] (i) with a
counterparty that is a U.S. person or (ii) for which the non-
resident [security-based swap dealer's] obligations are guaranteed
by a U.S. person'').
\210\ Id.
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The Commission believes that it would be beneficial to propose
guidance on this issue to help firms that must comply with these rules
understand the scope of what is covered by the certification and
opinion of counsel. The Commission is proposing to provide guidance
that the certification and opinion of counsel need only address: (1)
Books and records that relate to the ``U.S. business'' of the
nonresident SBS Entity (as defined in 17 CFR 240.3a71-3(a)(8)); and (2)
financial records necessary for the Commission to assess the compliance
of the nonresident SBS Entity with capital and margin requirements
under the Exchange Act and rules promulgated by the Commission
thereunder, if these capital and margin requirements apply to the
nonresident SBS Entity.
While this formulation is similar to that suggested by commenters,
the Commission preliminarily believes it would be appropriate to tie
the scope of the books and records covered by the certification and
opinion of counsel to a firm's ``U.S. business'' and relevant
[[Page 24235]]
financial records, rather than to propose a new ``U.S. Related
Records'' definition as suggested by the commenter. As the Commission
explained in adopting a definition of ``U.S business'' in the
Commission's Title VII cross-border rules, the intent is to encompass
those transactions that appear particularly likely to affect the
integrity of the security-based swap market in the United States and
the U.S. financial markets more generally or that raise concerns about
the protection of participants in those markets.\211\ Accordingly, this
approach would more effectively tailor the certification and opinion of
counsel to the types of records the Commission would need to review,
inspect or examine to determine compliance with applicable substantive
requirements.
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\211\ See Business Conduct Adopting Release, 81 FR at 30065.
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Even with such clarification, however, the Commission emphasizes
that, as proposed, Exchange Act Rule 18a-6(g) would require that a
nonresident SBS Entity must provide the Commission with direct access
to its books and records--i.e., the nonresident SBS Entity must
``furnish promptly to a representative of the Commission legible, true,
complete, and current copies'' of its books and records, and permit on-
site inspections and examinations of its books and records.\212\ The
guidance above with respect to the certification and opinion of counsel
would not reduce or eliminate these obligations as they are independent
of, and in addition to, the certification and opinion of counsel
requirement.
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\212\ See proposed Rule 18a-6(g) and discussion in Recordkeeping
and Reporting Proposing Release, 79 FR at 25220.
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3. Consents
Firms have noted that certain jurisdictions' laws may permit a firm
to promptly provide books and records directly to the Commission and to
submit to an on-site inspection and examination at the offices of the
firm located in the jurisdiction if the firm obtains consent from the
natural person whose information is documented in the books and
records.\213\ In this case, the Commission preliminarily believes that
it would be appropriate for the firm's certification and opinion of
counsel to be predicated, as necessary, on the nonresident SBS Entity
obtaining the prior consent of the persons whose information is or will
be included in the books and records to allow the firm to promptly
provide the Commission with direct access to its books and records and
to submit to on-site inspection and examination.\214\
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\213\ See note 201, supra.
\214\ The firm's opinion of counsel should, as necessary,
address all relevant considerations involving consent.
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As noted above, the security-based swap recordkeeping rules as
proposed would require that a nonresident SBS Entity must provide the
Commission with direct access to its books and records. This
requirement exists independently of, and in addition to, the
certification and opinion of counsel requirements. Thus if a
nonresident SBS Entity intends to rely on consents, it should obtain
such consents prior to registering as an SBS Entity so that it will be
able to provide Commission staff with direct access to its books and
records while it is conditionally registered. The certification and
opinion of counsel, if provided at a later date, would be able to rely
on those consents in effect when they are provided. In addition, if a
nonresident SBS Entity certifies that it may rely on consents, it
should continue to obtain consents on an ongoing basis so that it can
continue to provide the Commission with access to books and records. In
determining whether to rely on consent, a nonresident SBS Entity may
also seek to explore whether an alternative basis exists under the
foreign privacy laws that would permit the nonresident SBS Entity to
collect and maintain the necessary data and to provide the information
directly to Commission staff.
Before registering with the Commission, a nonresident SBS Entity
should assess whether it would be able to meet these obligations and
take appropriate steps to ensure that, if registered, it will be able
to comply with them. For example, if a nonresident SBS Entity is unable
to obtain consent from a customer or counterparty whose information
will be documented in a book or record subject to these obligations or
if a customer or counterparty provides a consent then later withdraws
that consent, the firm may need to cease conducting a security-based
swap business with that person in order to comply with the Exchange Act
and the Commission's rules thereunder or to seek an alternative basis
exists under the foreign laws that allows the nonresident SBS Entity to
satisfy its obligations under the federal securities laws.
4. Open Contracts
Some firms have asked for clarification that the certification and
opinion of counsel would not need to cover books and records related to
open contracts,\215\ and expressed concern it could require firms to
re-negotiate those contracts.\216\
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\215\ For purposes of this guidance, the term ``open contracts''
would include any contract entered into by the SBS Entity prior to
the date on which an SBS Entity submits an application for
registration which the SBS Entity continues to hold on its books and
records and under which it may have continuing obligations.
\216\ See notes 201 and 209, supra.
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The Commission preliminarily believes that the certification and
opinion of counsel need not address the books and records of security-
based swap transactions that were entered into prior to the date on
which a nonresident SBS Entity submits an application for registration
pursuant to Section 15F(b) of the Exchange Act and the rules
thereunder.\217\ The Commission recognizes that there may be practical
impediments to obtaining consents with respect to open contracts
because, for example, the counterparty is in a dispute with the
nonresident SBS Entity. Further, there may be questions of fairness to
the extent that any potential application to open contracts could
undermine the expectations that the parties had when entering into the
security-based swap.
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\217\ Cf. Business Conduct Adopting Release, 81 FR at 29969, in
which the Commission stated that the business conduct rules
generally would not apply to any security-based swap entered into
prior to the compliance date of the rules, and generally would apply
to any security-based swap entered into after the compliance date of
these rules, including a new security-based swap that results from
an amendment or modification to a pre-existing security-based swap.
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5. Commission Arrangements With Foreign Regulatory Authorities or
Approvals, Authorizations, Waivers or Consents
Firms have noted that while local laws or rules in some foreign
jurisdictions may prevent a nonresident SBS Entity from providing the
Commission with direct access to its books and records or submitting to
onsite inspections or examinations, in some cases the relevant foreign
regulatory authority may have entered into a Memorandum of
Understanding (``MOU'') or other arrangement with the Commission to
facilitate Commission access to records of nonresident SBS Entities
located in the jurisdiction.\218\ Firms have requested guidance
regarding whether the certification and opinion of counsel submitted by
a nonresident SBS Entity can rely on MOUs or other arrangements foreign
regulatory authorities may have entered into with the Commission to
facilitate
[[Page 24236]]
Commission access to records at the request of the SBS Entity.
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\218\ See note 201, supra.
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The Commission preliminarily believes that it would be appropriate,
under the factors discussed below, for the certification and opinion of
counsel to take into account whether the relevant regulatory authority
in the foreign jurisdiction has: (i) Issued an approval, authorization,
waiver or consent; or (ii) entered into an MOU or other arrangement
with the Commission facilitating direct access to the books and records
of SBS Entities located in that jurisdiction, including the
Commission's inspections and examinations at the offices of SBS
Entities located in that jurisdiction, provided that such an approval,
authorization, waiver, consent or MOU or arrangement is necessary to
address legal barriers to the Commission's direct access to books and
records of the SBS Entities in that jurisdiction.
However, consideration of such an approval or MOU would need to be
consistent with the registration program that has been adopted by the
Commission. Specifically, the Commission stated when adopting the
registration rules that it must be able to access directly the books
and records of nonresident SBS Entities and inspect and examine them
without going through a third party, such as a foreign regulatory
authority, to effectively fulfill its regulatory oversight
responsibilities. Thus, it would not be appropriate to take into
account such an approval or MOU if it contemplates that the nonresident
SBS Entity must provide the covered books and records, as described in
Section IV.A.2. above, to the foreign regulatory authority in order for
that body then to provide them to the Commission.
At the same time, it would be appropriate to take into
consideration an MOU or other arrangement that provided for
consultation or cooperation with a foreign regulatory authority in
conducting onsite inspections and examinations at the foreign offices
of nonresident SBS Entities. The Commission also believes it would be
consistent with its registration program if the Commission is required
to notify the relevant foreign regulatory authority, as described in
Section IV.A.1. above, of its intent to conduct an onsite inspection or
examination and staff from the foreign regulatory authority can
accompany the Commission when it visits the foreign office of the
nonresident SBS Entity. However, it would not be consistent with the
Commission's interpretation of the requirement to rely on an MOU or
other arrangement if, whether by the terms of any relevant agreement,
under provisions of local law, or in light of prior practice,
consultation or cooperation with the foreign regulatory authority
restricts the Commission's ability to conduct timely inspections and
examinations of the books and records in the foreign office of the
nonresident SBS Entity.
6. Proposed Amendment to Rule 15Fb2-1 Related to the Timing of
Certification and Opinion of Counsel Required by Rule 15Fb2-4(c)(1)
As described in the SBS Entity Registration Adopting Release, an
SBS Entity is conditionally registered with the Commission when it
submits a complete application on Form SBSE, SBSE-A, or SBSE-BD, as
appropriate, and the Form SBSE-C senior officer certifications.\219\ To
be complete, a Form SBSE, SBSE-A, or SBSE-BD would generally need to
include the Schedule F certification and opinion of counsel. The
Commission acknowledges that a nonresident SBS Entity may be unable to
provide the certification or opinion of counsel required under Rule
15Fb2-4(c)(1) by the time the entity will be required to register
because efforts to address legal barriers to the Commission's direct
access to books and records are still ongoing. For example, the
relevant regulatory authority in the foreign jurisdiction where the
nonresident SBS entity maintains its covered books and records may be
in the process of (i) issuing an approval, authorization, waiver or
consent or (ii) negotiating an MOU or other arrangement with the
Commission. The Commission recognizes that absent relief such
nonresident SBS Entities will bear the cost of lowering or
restructuring the market activity below the annual thresholds that
would trigger registration requirements, an outcome that could create
significant market disruptions.\220\
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\219\ 17 CFR 240.15Fb2-1(d).
\220\ See Registration Adopting Release, 80 FR at 49008.
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Accordingly, the Commission is proposing to amend Exchange Act Rule
15Fb2-1 to provide additional time for a nonresident SBS Entity to
submit the certification and opinion of counsel required under Rule
15Fb2-4(c)(1). Specifically, the Commission is proposing new paragraphs
(d)(2) and (e)(2) of Exchange Act Rule 15Fb2-1. Proposed paragraph
(d)(2) would provide that a nonresident applicant that is unable to
provide the certification and opinion of counsel required under Rule
15Fb2-4(c)(1) shall be conditionally registered for up to 24 months
after the compliance date for Rule 15Fb2-1 if the applicant submits a
Form SBSE-C and a Form SBSE, SBSE-A or SBSE-BD, as appropriate, that is
complete in all respects but for the failure to provide the
certification and the opinion of counsel required by Rule 15Fb2-
4(c)(1). Proposed paragraph (e)(2) would provide that if a nonresident
SBS Entity became conditionally registered in reliance on paragraph
(d)(2), the firm would remain conditionally registered until the
Commission acts to grant or deny ongoing registration, and that if the
nonresident SBS Entity fails to provide the certification and opinion
of counsel within 24 months of the compliance date for Rule 15Fb2-1,
the Commission may institute proceedings to determine whether ongoing
registration should be denied. As indicated in the Registration
Adopting Release,\221\ once an SBS Entity is conditionally registered,
all of the Commission's rules applicable to registered SBS Entities
will apply to the entity and it must comply with them. Further, this
proposed relief would be available only for the duration of the 24
month period immediately following the compliance date for Rule 15Fb2-
1.
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\221\ Registration Adopting Release, 80 FR at 48970 n.52.
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B. Solicitation of Comments Regarding Proposed Guidance and Amendments
Related to the Certification and Opinion of Counsel Requirements
The Commission requests comment on all aspects of the proposed
guidance and amendments.
1. Foreign Laws Covered by the Certification and Opinion of Counsel
Requirements
a. If the scope of the certification and opinion of counsel
requirements are limited as described above, are there situations in
which a nonresident SBS Entity will nonetheless be unable to provide
the required certification and opinion of counsel because the laws
of another jurisdiction prevent a nonresident SBS Entity from
providing the Commission with access to its books and records? If
so, in what jurisdictions?
b. Are there any other types of foreign laws, regulations or
requirements that may prevent a nonresident SBS Entity from
providing Commission staff with access to its books and records or
impede the staff's ability to conduct onsite examinations?
c. Could there be a situation where the laws of a jurisdiction
where customers, counterparties or employees of a nonresident SBS
Entity may be located, but where the nonresident SBS Entity
maintains no books and records, could impose a legal barrier that
would limit or prohibit the nonresident SBS Entity's ability to
either collect personal or transactional data regarding a customer,
counterparty or employee or provide that
[[Page 24237]]
data directly to the Commission? If so, should a nonresident SBS
Entity that has customers, counterparties or employees in such a
jurisdiction also be required to include consideration of that
jurisdiction or jurisdictions as part of its certification and
opinion of counsel? In this situation, how could the Commission
staff obtain adequate assurance that it would be able to access a
nonresident registrant's books and records?
2. Clarification on Covered Books and Records
a. Does the proposed guidance adequately address the concerns
raised by commenters? Would the guidance appropriately define the
scope of the books and records covered by the certification and
opinion of counsel to ``U.S. business'' as defined in Rule 3a71-
3(a)(8) and the financial records of certain registrants? Should
additional books and records be included? If so, which books and
records and why? Alternatively, are there other books and records
that should be excluded from the scope of what is covered by the
certification and opinion of counsel? If so, which books and records
and why?
b. Rather than using the U.S. business definition, should the
Commission instead follow the approach suggested by the commenter--
to establish definitions for ``U.S. Related Records,'' ``Financial
Records,'' and ``U.S. Related Foreign Locations'' solely for the
purpose of scoping records in or out of the requirements? If so why?
c. Would the proposed approach limit the Commission's ability to
assess how a nonresident SBS Entity may address conflicts between
the trades with a U.S. counterparty and other trades outside the
U.S.? If so, are there any other methods the Commission could use to
investigate those conflicts?
3. Consents
a. Does the proposed guidance adequately address the concerns
raised by commenters?
b. Is reliance on consents a viable option to address not only
data privacy, but secrecy and blocking laws or regulations?
c. Should the Commission allow nonresident SBS Entities to rely
on consents if the person providing consent is able to later
withdraw that consent? How do nonresident SBS Entities plan to
address situations where a customer, counterparty, employee or other
person later withdraws consent?
d. If a nonresident SBS Entity intends both to rely on consents
as a basis for its certification and opinion of counsel and to delay
the submission of the certification and opinion of counsel in
reliance on proposed Rule 15Fb2-1(d)(2), should the nonresident SBS
Entity be allowed to operate without consents in place until it
provides the certification and opinion of counsel rather than when
it is conditionally registered as contemplated by the proposed
amendments?
e. If relying on consents as a basis for the certification and
opinion of counsel, should a nonresident SBS Entity be required to
notify the Commission, as well as make and keep current books and
records to reflect these consents and whether a consent is later
withdrawn?
f. Should nonresident SBS Entities obtain consents every time
they enter into a new transaction with a counterparty or should a
global consent in a master agreement be sufficient?
g. Is the consent mechanism a feasible long term solution for
providing the Commission with direct access to an SBS Entity's books
and records and submitting to onsite inspections and examinations?
If not, what are the legal and regulatory challenges for a
nonresident SBS Entity seeking to rely on consents? For example, how
would nonresident SBS Entities subject to the European Union General
Data Protection Regulation (``GDPR'') plan to address guidance that,
due to the nature of the relationship between employees and
employers, employee consent may not be considered to be freely given
under the GDPR,\222\ and that consent might prove not to be a
feasible long term solution for transfers to third countries under
the GDPR? \223\ Are there any other factors that should be
considered such as, for example, the jurisdiction and the type of
law at issue (e.g., privacy, secrecy, blocking statute, etc.)?
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\222\ See Article 29 Working Party, Guidelines on consent under
Regulation 2016/679 (adopted Apr. 10, 2018), available at http://ec.europa.eu/newsroom/article29/item-detail.cfm?item_id=623051.
\223\ See European Data Protection Board, Guidelines 2/2018 on
derogations of Article 49 under Regulation 2016/679 (adopted May 25,
2018), available at https://edpb.europa.eu/sites/edpb/files/files/file1/edpb_guidelines_2_2018_derogations_en.pdf.
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4. Open Contracts
a. Would the guidance adequately address the concerns raised by
commenters? Is the date on which a nonresident SBS Entity submits a
registration the appropriate point from which to apply the
certification and opinion of counsel requirement?
b. Should nonresident SBS Entities nonetheless be required to
provide Commission staff with aggregated information, such as the
number of open contracts, the total dollar value of open contracts,
or percentage of open contracts for which it may have or lack
consent to provide information to regulators?
c. Should the proposed guidance also exclude contracts open on
the date a nonresident SBS Entity submits a registration where there
is no renegotiation of terms and the position is simply serviced
until it rolls off the firm's books and records? If so, why? Would
that impair the Commission's ability to adequately regulate
nonresident SBS Entities?
5. Reliance on Commission Arrangements With Foreign Regulatory
Authorities
a. Does the guidance adequately address the concerns that have
been raised in this regard? If not, why not and what additional
guidance is needed?
b. Should arrangements with foreign regulatory authorities
contain any special language or terms to assure that Commission
staff has direct access to a nonresident SBS Entity's books and
records and the ability to conduct onsite inspections or
examinations?
c. Are there situations in which multiple foreign regulatory
authorities would enter into an MOU or other arrangement?
6. Proposed Amendment to Rule 15Fb2-1 Related to the Timing of
Certification and Opinion of Counsel Required by Rule 15Fb2-4(c)(1)
a. Does 24 months from the compliance date for Rule 15Fb2-1
provide an appropriate time period to allow a nonresident SBS Entity
to submit the required certification and opinion of counsel? Should
the Commission shorten the time period? Should the Commission extend
the time period? Should the Commission provide for a process by
which an applicant can submit a request for an extension of time?
For example, where good cause is shown, should the Commission or its
staff be able to extend the time period upon request by a
nonresident firm?
b. How would the 24 month period facilitate the ability of a
nonresident SBS entity to submit the required certification and
opinion of counsel when foreign blocking laws, privacy laws, secrecy
laws and other foreign legal barriers exist in the jurisdiction
where the offices of the nonresident SBS Entity are located? Are
there circumstances other than those contemplated in Section IV
under which a nonresident SBS Entity would be unable to submit the
required certification and opinion of counsel? If so, would the 24
month period address such circumstances?
c. Proposed Rule 15Fb2-1(e)(2) provides that if an nonresident
applicant is unable to provide the certification and opinion of
counsel as required by Rule 15Fb2-4(c)(1) within the 24 month time
period, the Commission may institute proceedings to determine
whether ongoing registration should be denied. Should the Commission
adopt a different approach in cases where a nonresident application
fails to provide the certification or opinion of counsel within the
24 month time period? If so, please explain why and provide a
description of the approach. For example, should the Commission
consider the application incomplete if the nonresident applicant is
unable to provide the required certification and opinion of counsel
within the 24 month time period, thereby automatically terminating
the applicant's conditional registration and eliminating the need
for the Commission to institute proceedings to determine whether the
application should be denied? In the alternative, should the
Commission require nonresident applicants to certify that if they do
not provide the certification and opinion of counsel within the 24
month period, they will withdraw from registration and cease any
security-based swap dealing activities that otherwise would require
registration within a specified period after the 24 month period
expires? \224\ If so, what period would be reasonable?
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\224\ In other contexts, the Commission has permitted the
registration of a person that was not immediately eligible to
register as an investment adviser, subject to an undertaking that
the person will withdraw from registration if it did not meet the
registration requirements within a specified period of time. See
Rule 203A-2(c) under the Investment Advisers Act of 1940.
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d. Should SBS Entities that conditionally register without
signing the Schedule F certification and providing an opinion of
counsel be required to disclose to counterparties the risk that the
Commission
[[Page 24238]]
may institute proceedings to deny registration if the firm is, after
24 months, still unable to file with the Commission a complete
Schedule F certification and opinion of counsel? Should the
Commission impose any additional requirements on nonresident SBS
Entities that are conditionally registered pursuant to proposed Rule
15Fb2-1(d)(2)? If so, which requirements and why?
e. Alternatively, should the Commission eliminate the
certification and opinion of counsel requirements and instead rely
solely on the underlying obligations of the registered nonresident
SBS Entity to comply with all applicable regulatory requirements?
Why or why not?
f. As an another alternative, should the Commission publish a
list of nonresident SBS Entities registered with it on the
Commission's public website and note the conditional registration
status of any nonresident SBS Entities that have not yet provided a
Schedule F certification and opinion of counsel? Why or why not?
Would provision of this type of information be beneficial to
counterparties?
V. Proposed Amendment to Commission Rule of Practice 194
A. Overview of Proposed Rule of Practice 194(c)(2)
In furtherance of the goal of more closely harmonizing Commission
rules with the approach followed under the CFTC regime, and based on
renewed concerns raised by certain market participants,\225\ the
Commission is proposing new paragraph (c)(2) of Rule of Practice
194.\226\ Proposed paragraph (c)(2) would provide an exclusion from the
statutory disqualification prohibition in Section 15F(b)(6) of the
Exchange Act for an SBS Entity with respect to an associated person who
is a natural person who (i) is not a U.S. person \227\ and (ii) does
not effect and is not involved in effecting security-based swap
transactions with or for counterparties that are U.S. persons, other
than a security-based swap transaction conducted through a foreign
branch \228\ of a counterparty that is a U.S. person.\229\
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\225\ See note 243, supra.
\226\ As discussed above, Exchange Act Section 15F(b)(6)
provides that the Commission may establish exceptions to its
statutory prohibition by ``rule, regulation, or order.'' 15 U.S.C.
78o-10(b)(6). In addition, Exchange Act Section 15F(b)(4) provides
the Commission with authority (other than certain inapplicable
exceptions specified in Exchange Act Section 15F(b)(4)(d) and (e))
to ``prescribe rules applicable to security-based swap dealers and
major security-based swap participants.'' 15 U.S.C. 78o-10(b)(4).
\227\ The term ``U.S. Person'' is defined in Exchange Act Rule
3a71-3(a)(4). See 17 CFR 240.3a71-3(a)(4).
\228\ The term ``transaction conducted through a foreign
branch'' is defined in Exchange Act Rule 3a71-3(a)(3). See 17 CFR
240.3a71-3(a)(3).
\229\ This relief, however, is not relevant to an associated
person effecting or involved in effecting security-based swaps, to
the extent that such person's ``functions are solely clerical or
ministerial,'' given that such persons are excluded from the
definition of associated person under to 15 U.S.C. 78c(a)(70)(B)
and, therefore, not subject to the prohibition in Section 15F(b)(6).
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However, an SBS Entity would not be able to avail itself of this
exclusion if the associated person of that SBS Entity is currently
subject to any order described in subparagraphs (A) and (B) of Section
3(a)(39) of the Exchange Act, with the limitation that an order by a
foreign financial regulatory authority \230\ as provided in
subparagraphs (B)(i) and (B)(iii) of Section 3(a)(39) shall only apply
to orders by a foreign financial regulatory authority in the
jurisdiction where the associated person is employed or located. By way
of example, the limitation concerning an associated person of an SBS
Entity who is currently subject to an order described in subparagraphs
(A) and (B) of Exchange Act Section 3(a)(39) would include, among other
things, situations where the associated person of an SBS Entity has
been barred or suspended from being associated with a member of an SRO
\231\ or is subject to an order by the Commission barring or suspending
such person from being associated with certain regulated entities,
including, but not limited to, SBS Entities and broker-dealers.\232\ As
discussed further below, this provision is meant to address situations
where the Commission, CFTC, a SRO (e.g., FINRA), a registered futures
association (the National Futures Association, ``NFA''),\233\ or a
foreign financial regulatory authority has affirmatively made a
determination to not allow an associated person to participate in, for
example, the security-based swap market, some other sector of the U.S.
securities markets (e.g., as broker-dealers or as investment advisers),
some other sector of the U.S. financial market (e.g., the U.S. swap
market) or some sector of the foreign financial markets.
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\230\ See 15 U.S.C. 78c(a)(52) (defining the term ``foreign
financial regulatory authority'' to include, among other regulatory
authorities, ``foreign securities authorities'' as defined in
Exchange Act Section 3(a)(50) (15 U.S.C. 78c(a)(50)).
\231\ See 15 U.S.C. 78c(a)(26) (defining the term ``self-
regulatory organization'').
\232\ See, e.g., 15 U.S.C. 78c(a)(39)(A) and (B)(i)(II).
\233\ See 7 U.S.C. 21.
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Additionally, the exclusion would only apply to associated persons
who are natural persons, as the Commission has separately within Rule
of Practice 194 provided an exclusion for an SBS Entity from the
prohibition in Exchange Act Section 15F(b)(6) with respect to all
associated person entities--regardless of whether the associated person
entity is located within or outside of the U.S.\234\
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\234\ See 17 CFR 240.194(c); see also part I.C.3, supra
(discussing the Rule of Practice 194 Adopting Release, 84 FR at
4906).
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B. Comments Received Requesting That the Commission Provide Relief
Both before and after the Commission adopted its SBS Entity
registration rules, commenters requested that the Commission provide an
exclusion from or, in the alternative, narrow the scope of, the
prohibition in Exchange Act Section 15F(b)(6) with respect to
associated persons of SBS Entities who are not U.S. persons and who do
not interact with U.S. persons.\235\
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\235\ See, e.g., Letter from IIB, dated Aug. 21, 2013 (``IIB 8/
21/13 Letter'') at 20, available at https://www.sec.gov/comments/s7-02-13/s70213-46.pdf; see also IIB/SIFMA 6/21/18 Letter at 2, 4,
available at https://www.sec.gov/comments/s7-05-14/s70514-3938974-167037.pdf; IIB/SIFMA 8/26/16 Letter, at 3-5; Letter from SIFMA,
dated Dec. 16, 2011 (``SIFMA 12/16/11 Letter'') at 8, available at
https://www.sec.gov/comments/s7-40-11/s74011-4.pdf.
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For example, in connection with the Commission proposing
registration requirements for SBS Entities, a commenter stated that it
was concerned that the statutory disqualification requirements in
Exchange Act Section 15F(b)(6) would apply to a foreign registered SBS
Entity on an entity-level, as opposed to as a transaction-level
requirement, without regard to the identity of the counterparty and,
therefore, would be applicable to all associated persons of the foreign
registered SBS Entity that effect or are involved in effecting
security-based swap transactions.\236\ The commenter noted that this
would result in situations where non-U.S. associated persons of non-
U.S. SBS Entities who do not interact with U.S. customers would be
subject to the statutory disqualification requirements in Exchange Act
Rule 15Fb6-2(b) and, as a result, non-U.S. associated persons of non-
U.S. SBS Entities would be required to submit to U.S. background checks
for statutory disqualification purposes.\237\ In support of the
commenter's request that the Commission re-categorize the statutory
disqualification requirements as a transaction-level requirement, the
commenter noted that the Commission's current approach diverges from
that adopted by the CFTC,\238\ as well as the Commission's treatment of
``foreign
[[Page 24239]]
associated persons'' of foreign broker-dealers.\239\ The commenter also
stated that a transaction-level approach would preserve the
Commission's resources to better serve customer protection interests
within the United States, and that the Commission's interests in
protecting foreign customers are limited, while ``foreign regulators
have a strong interest in regulating such activity.'' \240\ Finally,
the commenter opined that limiting background checks to personnel
interacting with U.S. persons would also help eliminate potential
conflicts with local privacy laws, which in some cases may prohibit
background checks for foreign employees.\241\
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\236\ See Registration Adopting Release, 80 FR at 48977 nn.109-
11 (citing IIB 8/21/13 Letter at 20).
\237\ See IIB 8/21/13 Letter at 20.
\238\ See id. at 20 (noting that the CFTC does not apply its
statutory disqualification requirements to associated persons of its
registrants who engage in activity outside the United States and
limit such activity to customers located outside the United States).
\239\ See id. (citing Rule 15a-6(b)(2) and stating that the
Commission, in that rule, limited the definition of ``foreign
associated person'' to those associated persons of a foreign broker
or dealer who participate in the solicitation of certain U.S.
investors).
\240\ Id.
\241\ See id.
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In response to the commenter, the Commission explained that the
requirements in Rule 15Fb6-2(b) regarding questionnaires or
applications and background checks are important elements of each SBS
Entity's determination with respect to whether its associated persons
that effect or are involved in effecting security-based swap
transactions are subject to statutory disqualifications. The Commission
also stated that it was not convinced, at the time, of the need or
basis to provide an exclusion for SBS Entities from the statutory
disqualification requirements with respect to certain of their
associated persons, and made a determination to treat the statutory
disqualification requirements as entity-level requirements, as opposed
to a transaction-level requirement, applicable to all associated
persons of the registered foreign SBS Entity that effect or are
involved in effecting security-based swap transactions.\242\
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\242\ See Registration Adopting Release, 80 FR at 48978.
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More recently, market participants have raised the same concerns
expressed in the comment letters outlined above.\243\ For example,
commenters have argued that, because most of the CFTC's rules have been
in effect for several years, greater harmonization would ``help
facilitate prompt implementation of the Commission's Title VII regime
with minimal disruption to the SBS market and robust protections and
lower costs for investors and other end-users.'' \244\ Relatedly, the
Commission also received comments requesting that the Commission
harmonize aspects of its Rule 15Fb6-2(b) with the CFTC's regulations or
allow for substituted compliance.\245\ As discussed above, Rule 15Fb6-
2(b) requires an SBS Entity to obtain a questionnaire or application
for employment--documents that are required under paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5--which would serve as a basis for a
background check to verify that an associated person is not subject to
statutory disqualification. However, as discussed below in Section
VI.A., the proposed modification to proposed Rule 18a-5 would provide
that a stand-alone or bank SBS Entity is not required to make and keep
current a questionnaire or application for employment executed by an
associated person if the SBS Entity is excluded from the statutory
disqualification prohibition in Exchange Act Section 15F(b)(6) with
respect to such associated person (e.g., the exclusion from the
statutory disqualification prohibition in Section 15F(b)(6) provided by
proposed Commission Rule of Practice 194(c)(2)).
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\243\ See, e.g., note 28, supra.
\244\ IIB/SIFMA 6/21/18 Letter at 1.
\245\ See IIB/SIFMA 8/26/16 Letter, at 3-5 (requesting that the
Commission exclude associated persons employed or located in a non-
U.S. branch or office of an SBS Entity or an affiliate from the
requirement in Rule 15Fb6-2(b) to prepare and maintain a
questionnaire or application for employment executed by such
associated person where certain conditions are met, including that
the associated person does not effect and is not involved in
effecting security-based swaps with U.S. counterparties on behalf of
the SBS Entity); see also IIB/SIFMA 6/21/18 Letter, at 2.
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C. Proposed Rule of Practice 194(c)(2)
Proposed Rule of Practice 194(c)(2) would more closely harmonize
the Commission's rules with the CFTC's approach to statutory
disqualification as it applies to the activities of non-domestic
associated persons of CFTC registered Swap Entities. Under CEA Section
4s(b)(6), which parallels Exchange Act Section 15F(b)(6), and CFTC
staff's related guidance \246\ Swap Entities are not required to comply
with the prohibition in CFTC Regulation 23.22(b) with respect to non-
domestic associated persons who deal only with non-domestic swap
counterparties.\247\ Absent such relief, a Swap Entity would be subject
to the prohibition in CFTC Regulation 23.22(b) even with respect to an
associated person who engages in activity from a location outside the
United States and even when such person limits their activity to
counterparties located outside the United States.\248\
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\246\ Under the CFTC's and the NFA's current process for
granting relief from CEA Section 4s(b)(6)--which is available
through no-action relief granted by CFTC staff with respect to
persons that are not exempt from Section 4s(b)(6) pursuant to CFTC
Regulation 23.22(b)--a swap entity may make an application to the
NFA, the sole registered futures association, to permit an
associated person of a Swap Entity subject to a statutory
disqualification to effect or be involved in effecting swaps on
behalf of the swap entity. See CFTC Letter No. 12-15, at 5-8 (Oct.
11, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-15.pdf.
\247\ See CFTC Letter No. 12-43 (Dec. 7, 2012) at 2-4, available
at https://www.cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/12-43.pdf. Specifically, CFTC
staff stated in the letter, in relevant part, that staff's no-action
position was limited to associated persons who effect or are
involved in effecting swaps from a location outside of the United
States, its territories or possessions, and limit such activities to
counterparties located outside the United States, its territories or
possessions. CFTC staff also noted that the no-action positions
provided in this letter represent the positions of CFTC staff only,
and do not necessarily represent the positions of the CFTC or its
Commissioners.
\248\ See id. at 4.
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In proposing Rule of Practice 194(c)(2), the Commission is seeking
to balance harmonization with the approach to regulating the activities
that non-domestic associated persons of Swap Entities engage in under
the CFTC regime and the attendant benefits and cost savings against the
potential effect of certain risks, including financial, counterparty,
compliance, and reputational risks of having statutorily disqualified
associated persons effecting or involved in effecting security-based
swap transactions for registered SBS Entities.
Given the high degree of integration between the swap and security-
based swap markets,\249\ more closely aligning with the existing
baseline for disqualification of swap dealer personnel could result in
certain benefits, such as reducing regulatory complexity and lessening
costs on market participants that are dually-registered as Swap
Entities with the CFTC. For example, as a result of the proposed
exclusion, SBS Entities dually-registered as Swap Entities with the
CFTC could experience economies of scope in employing non-U.S. natural
persons in their swap and security-based swap businesses.\250\ As
discussed in the Rule of Practice 194 Adopting Release, the Commission
estimates that approximately 46 out of 50 entities likely to register
with the Commission as security-based swap dealers are already
registered with the CFTC as
[[Page 24240]]
swap dealers.\251\ The proposed exclusion should, at least to some
extent, reduce the likelihood of security-based swap dealers exiting
the security-based swap business and, as a result, not registering with
the Commission, which could affect competition in the provision of
security-based swap dealing services.
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\249\ See part VII.D, infra (noting that the swap and security-
based swap markets involve largely the same group of dealers and
most of the same counterparties).
\250\ See part VII.D.1, infra.
\251\ See Rule of Practice 194 Adopting Release, 84 FR at 4935-
36 (discussing the economic baseline for Rule of Practice 194 and
stating that approximately 46 out of 50 entities likely to register
with the Commission as security-based swap dealers are already
registered with the CFTC as swap dealers).
---------------------------------------------------------------------------
Absent the proposed exclusion, SBS Entities would be unable to have
an associated person subject to a statutory disqualification, who would
be permitted to effect certain swap transactions under the CFTC's
approach, also effect security-based swap transactions, unless the SBS
Entity obtained relief from the Commission under Rule of Practice 194.
This difference between the CFTC's approach and the Commission's rules
would result in costs related to replacing or reassigning statutorily
disqualified associated non-U.S. persons or applying to the Commission
for relief. In addition, this difference could disrupt existing
counterparty relationships across closely linked swap and security-
based swap markets. However, under the proposed exclusion, non-U.S.
person counterparties of SBS Entities would be able to continue
interacting with the same non-U.S. associated persons of the same SBS
Entities across interconnected markets without delays related to
Commission review under Rule of Practice 194. As noted above, this may
result in lower transaction costs for SBS Entities that, in turn, may
flow to both their U.S. and non-U.S. person counterparties.
This proposal is consistent with exceptions the Commission provided
in its business conduct rules for SBS Entities.\252\ The Commission
also notes that, in adopting the definition of ``U.S. business''--which
does not include transactions conducted through a foreign branch of a
U.S. person \253\--the Commission stated that it is concerned
principally with those transactions that appear particularly likely to
affect the integrity of the security-based swap market in the United
States and the U.S. financial markets more generally or that raise
concerns about the protection of participants in those markets.\254\
The Commission explained that this exception reflected its view at the
time that transactions between the foreign branch of a U.S. person and
a non-U.S. person, in which the personnel arranging, negotiating, and
executing the transaction are all located outside the United States,
are less likely to affect the integrity of the U.S. market and reflects
the Commission's consideration of the role of foreign regulators in
non-U.S. markets.\255\ As the Commission has explained previously, the
Dodd-Frank Act generally is concerned with the protection of U.S.
markets and participants in those markets.\256\
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\252\ Under Exchange Act Rule 3a71-3(c), a registered security-
based swap dealer, with respect to its ``foreign business'' (as that
term is defined in Rule 3a71-3(a)(9)), shall not be subject to
requirements of the Commission's business conduct rules--other than
the supervision requirements pursuant to Exchange Act Section
15F(h)(1)(B). See also Exchange Act Rule 3a67-10(d) (providing an
analogous exclusion for registered U.S. major security-based swap
participants).
\253\ See 17 CFR 3a71-3(a)(8)(i)-(ii).
\254\ See ``Business Conduct Standards for Security-Based Swap
Dealers and Major Security-Based Swap Participants,'' Exchange Act
Release No. 77617, (Apr. 14, 2016) 81 FR 29960, 30065 (May 13, 2016)
(``Business Conduct Adopting Release'').
\255\ See id. at 30065-66, n.1330 (citing the Cross-Border
Proposing Release, 78 FR at 31017).
\256\ See id. at 30065.
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The proposed amendment would exclude, subject to certain
limitations, SBS Entities from the statutory disqualification
prohibition in Exchange Act Section 15F(b)(6) with respect to their
associated natural persons who (i) are not U.S. persons and (ii) do not
effect and are not involved in effecting security-based swap
transactions with or for counterparties that are U.S. persons, other
than a security-based swap transaction conducted through a foreign
branch of a counterparty that is a U.S. person.
As the Commission discussed in the Rule of Practice 194 Adopting
Release,\257\ and in part VII.D.2 of the Economic Analysis below, the
Commission appreciates that there is a dearth of research on the
economic effect of statutory disqualification in derivatives markets,
and the broader economic research on other markets is somewhat
ambiguous. Nevertheless, some research suggests that increasing the
ability of a statutorily disqualified person to continue to effect or
be involved in effecting transactions on behalf of a registered SBS
Entities may give rise to higher compliance and counterparty risks, may
increase adverse selection costs,\258\ and may reduce competition among
higher quality associated persons.\259\ On the other hand, some
research suggests that greater flexibility in employing disqualified
persons may actually increase competition among SBS Entities and their
associated persons and benefit counterparties.\260\
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\257\ See Rule of Practice 194 Adopting Release, 84 FR at 4941.
\258\ See note 477, infra (noting that, with respect to a
problem commonly known as adverse selection, when information about
counterparty quality is scarce, market participants may be less
willing to enter into transactions and the overall level of trading
may fall).
\259\ See part VII.D, infra.
\260\ See id.; see also Jonathan Berk & Jules H. van Binsbergen,
``Regulation of Charlatans in High-Skill Professions'' (Stanford
University Graduate School of Business, Research Paper No. 17-43,
2017), available at https://ssrn.com/abstract=2979134.
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The Commission also notes that the scope of conduct that gives rise
to disqualification is broad and includes conduct that may not pose
ongoing risks to counterparties.\261\ In addition, because the
overwhelming majority of dealers and most counterparties transact
across both swap and security-based swap markets, differential
regulatory treatment of disqualification in swap and security-based
swap markets may increase costs of intermediating transactions for some
SBS Entities, which may be passed along to counterparties in the form
of higher transaction costs, and may disrupt existing counterparty
relationships.\262\
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\261\ See id.
\262\ See id.
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The potential for increased risk may be mitigated by other factors.
For example, the proposed exclusion would not limit or otherwise affect
the Commission's existing authority to institute proceedings under
Exchange Act Section 15F(l)(3) to censure, place limitations on the
activities or functions of such person, or suspend for a period not
exceeding 12 months, or bar such person from being associated with an
SBS Entity.\263\ In addition, SBS Entities may choose not to use this
proposed exclusion if the reputational and compliance risks associated
with hiring and retaining statutorily disqualified persons may outweigh
the costs SBS Entities may face if they decide to fire or replace
statutorily disqualified persons who may otherwise have valuable
skills, expertise, or counterparty relationships.\264\ Furthermore, the
security-based swap market is largely an institutional one,\265\ and
institutional counterparties (e.g., banks, pension funds and insurance
companies) may be better able to mitigate or offset the potential for
higher counterparty risks, including, by among
[[Page 24241]]
other things, requesting, as a business practice, representations that
the associated persons they deal with have not triggered an event
giving rise to statutory disqualification.
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\263\ See 15 U.S.C. 78o-10(l)(3); see also 15 U.S.C. 78u-3
(authorizing cease-and-desist proceedings by the Commission). Accord
Rule of Practice 194 Adopting Release, 84 FR at 4912 n.72
(discussing the same statutory authority).
\264\ See part VII.D.1 and VII.D.2, infra.
\265\ See id. (citing the economic baseline in the Rule of
Practice 194 Adopting Release, and noting that investment advisers,
banks, pension funds, insurance companies, and ISDA-recognized
dealers account for 99.8% of security-based swaps transaction
activity).
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Accordingly, the Commission is proposing an exclusion from the
statutory disqualification prohibition in Section 15F(b)(6) of the
Exchange Act for SBS Entities with respect to an associated person who
is a natural person who: (i) Is a not a U.S. person, and (ii) does not
effect and is not involved in effecting security-based swap
transactions with or for counterparties that are U.S. persons, other
than a security-based swap transaction conducted through a foreign
branch of a counterparty that is a U.S. person. The Commission also
notes that, as discussed further below in Section VI.A., proposed
modifications to proposed Rule 18a-5 would provide that a stand-alone
or bank SBS Entity is not required to make and keep current a
questionnaire or application for employment executed by an associated
person if the SBS Entity is excluded from the statutory
disqualification prohibition in Exchange Act Section 15F(b)(6) with
respect to such associated person (e.g., the exclusion proposed in Rule
of Practice 194(c)(2)).
D. Limitation on Proposed Rule of Practice 194(c)(2)
The Commission also is proposing a limitation where an SBS Entity
would not be able to avail itself of the exclusion from the prohibition
in Exchange Act Section 15F(b)(6) as set forth in proposed paragraph
(c)(2)--and would therefore need to use the process outlined in Rule of
Practice 194 to seek relief from the statutory prohibition in Exchange
Act Section 15F(b)(6).
Under the proposed limitation, an SBS Entity would not be able to
avail itself of the exclusion if the associated person of that SBS
Entity is currently subject to an order that prohibits such person from
participating in the U.S. financial market, including the U.S.
securities or swap market, or foreign financial markets. More
specifically, an SBS Entity would not be able to avail itself of the
exclusion from the prohibition in Exchange Act Section 15F(b)(6) set
forth in proposed paragraph (c)(2) with respect to an associated person
if that associated person is currently subject to an order described in
subparagraphs (A) and (B) of Section 3(a)(39) of the Exchange Act, with
the limitation that an order by a foreign financial regulatory
authority described in subparagraphs (B)(i) and (B)(iii) of Section
3(a)(39) shall only apply to orders by a foreign financial regulatory
authority in the jurisdiction where the associated person is employed
or located. For example, this would include current orders, which are
still in effect, from the Commission, the CFTC, an SRO (e.g., FINRA), a
registered futures association (e.g., the NFA), or a foreign financial
regulatory authority in the jurisdiction where the associated person is
employed or located (e.g., the Financial Conduct Authority), that
suspends or bars such person from being associated with any entity
regulated by such authorities or otherwise places limitations on the
activities or functions of the associated person.\266\ As another
example, the exclusion from the prohibition in Exchange Act Section
15F(b)(6) would also not be available in cases where the CFTC, an SRO,
a registered futures association, or a foreign financial regulatory
authority where the associated person is employed or located has, as
applicable, issued an order that that denies, revokes, cancels,
suspends the membership, association, registration or listing as a
principal with respect to the associated person.\267\ In these
circumstances, for example, the Commission, the CFTC, an SRO, a
registered futures association or a foreign financial regulatory
authority will have affirmatively made a determination to not allow an
associated person to participate in the U.S. securities markets
generally (e.g., as an associated person of a broker-dealer or
investment adviser), some other sector of the U.S. financial market
(e.g., the U.S. swap market), or some sector of the foreign financial
markets. The Commission preliminarily believes that an SBS Entity
should not be able to avail itself of the exclusion in proposed
paragraph (c)(2) with respect to such associated persons given this
prior determination by the relevant regulatory authorities.
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\266\ By way of example, Exchange Act Section 15F(l)(3) provides
the Commission with authority to institute proceedings under to
censure, place limitations on the activities or functions of such
person, or suspend for a period not exceeding 12 months, or bar such
person from being associated with an SBS Entity. See 15 U.S.C. 78o-
10(l)(3).
\267\ For example, under Exchange Act Section 15A(g)(2), 15
U.S.C. 78o-3(g)(2), where it is necessary or appropriate in the
public interest or for the protection of investors, the Commission
may, by order, direct the SRO to deny membership to any registered
broker or dealer, and bar from becoming associated with a member any
person, who is subject to a statutory disqualification. Section
17(h) of the CEA provides for the CFTC to review certain NFA
decisions, including the NFA's disciplinary actions and member
responsibility actions, as do the CFTC's Part 171 Rules, 17 CFR
171.1-171.50.
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E. Solicitation of Comments Regarding Proposed Amendment to Commission
Rule of Practice 194
The Commission is requesting comment regarding all aspects of
proposed paragraph (c)(2) of Rule of Practice 194, including any of the
potential benefits, risks and costs outlined above or in the Economic
Analysis below, as well as any concerns, including investor protection
concerns. The Commission also seeks comment on the specific questions
below. The Commission particularly requests comment from entities that
intend to register as SBS Entities and that anticipate making an
application under proposed Rule of Practice 194, as well as
counterparties to such SBS Entities. This information will help inform
the Commission's consideration of proposed paragraph (c)(2) of Rule of
Practice 194.
1. Are there other potential benefits to the exclusion provided
in proposed Rule of Practice 194(c)(2) that are not outlined in the
proposal? Are there other potential risks or costs to this proposed
exclusion that are not outlined in the proposal? Does the exclusion
provided in proposed Rule of Practice 194(c)(2) appropriately
consider the potential benefits, risks and costs? In each instance,
please explain why or why not.
2. Proposed Rule of Practice 194(c)(2) would apply to all SBS
Entities, whether U.S. persons or nonresident SBS Entities. Do
commenters agree with this approach? Why or why not?
3. Proposed Rule of Practice 194(c)(2) would apply to an
associated person who is a natural person who (i) is not a U.S.
person and (ii) does not effect and is not involved in effecting
security-based swap transactions with or for counterparties that are
U.S. persons, other than a security-based swap transaction conducted
through a foreign branch of a counterparty that is a U.S. person. Do
commenters agree with this approach? Why or why not?
4. Under Proposed Rule of Practice 194(c)(2), an SBS Entity
would not be able to avail itself of the exclusion if the following
limitation applies: if the associated person of that SBS Entity is
currently subject to an order described in subparagraphs (A) and (B)
of Section 3(a)(39) of the Exchange Act, with the limitation that an
order by a foreign financial regulatory authority described in
subparagraphs (B)(i) or (B)(iii) of Section 3(a)(39) shall only
apply to orders by a foreign financial regulatory authority in the
jurisdiction where the associated person is employed or located. Do
commenters agree with these limitations? Why or why not? Should the
Commission require any additional conditions or limitations to the
proposal? If so, please explain what additional conditions or
limitations should apply.
5. Are there any other categories of associated persons of an
SBS Entity for which the Commission should provide an exclusion from
the statutory prohibition in
[[Page 24242]]
Exchange Act Section 15F(b)(6)? If so, please specify the category
and the reasons for requesting the Commission to exclude that
category of associated person from the statutory prohibition.
6. Would the exclusion from the statutory disqualification
prohibition for certain foreign associated persons under the
proposed approach differ materially from relief provided with
respect to the corresponding prohibition under the CEA or rules and
regulations thereunder? If so, please describe any differences,
including any compliance or other challenges posed by such
differences.
7. As described above, in the Registration Adopting Release the
Commission included an interpretation of the scope of the phrase
``involved in effecting security-based swaps,'' as that phrase is
used in Exchange Act Section 15F(b)(6).\268\ Based on this
interpretation, are there additional categories of non-U.S.
associated persons of an SBS Entity that should be excluded from the
statutory disqualification prohibition in Section 15F(b)(6)? If so,
please describe the functions carried out by such non-U.S.
associated persons of an SBS Entity and why you believe those
functions do not present the types of concerns addressed by the
prohibition on associating with a statutorily disqualified person.
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\268\ See Registration Adopting Release, 80 FR at 48974, 48976.
Specifically, the Commission stated that the term ``involved in
effecting security-based swaps'' generally means engaged in
functions necessary to facilitate the SBS Entity's security-based
swap business, including, but not limited to the following
activities: (1) Drafting and negotiating master agreements and
confirmations; (2) recommending security-based swap transactions to
counterparties; (3) being involved in executing security-based swap
transactions on a trading desk; (4) pricing security-based swap
positions; (5) managing collateral for the SBS Entity; and (6)
directly supervising persons engaged in the above-described
activities. See id.
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VI. Proposed Modifications to Proposed Rule 18a-5
A. Proposed Rule
The Commission proposed recordkeeping, reporting, and notification
requirements applicable to SBS Entities, securities count requirements
applicable to certain SBS Entities, and additional recordkeeping
requirements applicable to broker-dealers to account for their
security-based swap and swap activities.\269\ The proposed requirements
were modeled on existing broker-dealer requirements.\270\ The
Commission received a number of comments in response to these
proposals.\271\ Separately, the Commission proposed rules governing the
cross-border treatment of recordkeeping and reporting requirements with
respect to SBS Entities.\272\ The Commission received comments to the
cross-border proposals as well.\273\
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\269\ See Recordkeeping and Reporting Proposing Release.
\270\ See id. at 25196-97 (proving the rationale for modeling
the proposed requirements on the relevant broker-dealer
requirements).
\271\ The comment letters are available at https://www.sec.gov/comments/s7-05-14/s70514.shtml.
\272\ See Cross-Border Proposing Release.
\273\ The comment letters are available at https://www.sec.gov/comments/s7-02-13/s70213.shtml.
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In the Recordkeeping and Reporting Proposing Release, the
Commission proposed new Exchange Act Rule 18a-5 (patterned after
Exchange Act Rule 17a-3--the recordkeeping rule for registered broker-
dealers), to establish recordkeeping standards for stand-alone and bank
SBS Entities.\274\ As part of that rulemaking, the Commission proposed
to require that a stand-alone or bank SBS Entity make and keep current
a questionnaire or application for employment for each associated
person who is a natural person and, in the case of bank SBS Entities,
whose activities relate to the bank SBS Entity's business as an SBS
Entity. The proposal required that the questionnaire or application for
employment include an associated person's identifying information,
business affiliations for the past ten years, relevant disciplinary
history, relevant criminal record, and place of business, among other
things.\275\ The Commission also proposed a definition of the term
associated person that would include persons associated with an SBS
Entity as defined under Section 3(a)(70) of the Exchange Act.\276\
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\274\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25205.
\275\ Paragraph (b)(8) of proposed Rule 18a-5.
\276\ Paragraph (c) of proposed Rule 18a-5.
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One commenter requested that the Commission modify the proposed
rule for foreign SBS Entities so that the questionnaire requirement
would not apply to associated persons who effect or are involved in
effecting security-based swap transactions with non-U.S. persons or
foreign branches.\277\ In a subsequent letter, the commenter also
requested that the proposal be modified to exclude from the
questionnaire requirement an associated person employed or located in a
non-U.S. branch, office, or affiliate of the firm in circumstances
where: (1) Applicable non-U.S. law prohibits the firm from conducting
background checks on the associated person and consent does not cure
the prohibition or may not be a condition of employment; (2) the
associated person is not subject to a statutory disqualification that
the firm actually knows about; (3) the associated person does not
effect and is not involved in effecting security-based swaps with U.S.
counterparties on behalf of the firm; and (4) the associated person
complies with applicable registration and licensing requirements in the
jurisdiction(s) where he or she effects or is involved in effecting
security-based swaps on behalf of the firm.\278\ This commenter also
suggested that the proposal be modified to permit an SBS Entity to use
alternative measures to confirm that a non-resident associated person
is not subject to a statutory disqualification in situations where (1)
using a standard U.S. questionnaire or application and background check
would conflict with local law or the associated person does not
interact with U.S. counterparties, and (2) the associated person
complies with applicable registration or licensing requirements in the
jurisdictions where the associated person is located.\279\
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\277\ See SIFMA 9/5/2014 Letter.
\278\ See IIB/SIFMA 8/26/2016 Letter.
\279\ See IIB/SIFMA 6/21/2018 Letter.
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The Commission preliminarily believes that it is appropriate to
provide flexibility with respect to the questionnaire requirement as
applied to associated persons of both stand-alone and bank SBS
Entities. Thus, the Commission is proposing to add two sets of
exemptions under new paragraphs (a)(10) and (b)(8) to proposed Rule
18a-5.
The first exemption would provide that an SBS Entity need
not make and keep current a questionnaire or application for employment
with respect to any associated person if the SBS Entity is excluded
from the prohibition in Exchange Act 15F(b)(6). This could include, for
example, a situation in which the SBS Entity relies on the exclusion
pursuant to proposed Rule of Practice 194(c)(2) as discussed above with
respect to a non-U.S. associated person who does not effect and is not
involved in effecting security-based swap transactions with or for a
counterparty that is a U.S. person, other than a security-based swap
transaction conducted through a foreign branch of a counterparty that
is a U.S. person.
The second exemption would provide that a questionnaire or
application for employment executed by an associated person that is not
a U.S. person need not include certain information if the receipt of
that information, or the creation or maintenance of records reflecting
that information, would result in a violation of applicable law in the
jurisdiction in which the associated person is employed or located. In
accordance with Rule 15Fb6-2, this exemption would be available with
respect to non-U.S. associated persons that effect or are involved in
effecting security-based transactions on behalf of the SBS Entity
[[Page 24243]]
with counterparties that are U.S. persons, as well as counterparties
that are not.
1. Exemption Based on the Exclusion From the Prohibition Under Section
15F(b)(6)
The Commission is proposing to add new paragraphs (a)(10)(iii)(A)
and (b)(8)(iii)(A) to proposed Rule 18a-5. As discussed above, the
questionnaire requirement is intended to serve as a basis for a
background check of the associated person to verify that the person is
not subject to statutory disqualification under Section 15(b)(6), and
so to support the certification required under Rule 15Fb6-2(b). These
new paragraphs would provide that a stand-alone or bank SBS Entity is
not required to make and keep current a questionnaire or application
for employment with respect to an associated person if the stand-alone
or bank SBS Entity is excluded from the prohibition in Section
15F(b)(6) of the Exchange Act with respect to that associated person.
The proposed modifications would complement the Commission's proposal,
discussed above in Section V.C., to amend Rule of Practice 194 to
provide an exclusion from the prohibition in Section 15F(b)(6) of the
Exchange Act with respect to an associated person who is not a U.S.
person and does not effect and is not involved in effecting security-
based swap transactions with or for counterparties that are U.S.
persons, other than a security-based swap transaction conducted through
a foreign branch of a counterparty that is a U.S. person, subject to
certain conditions. Given that the proposed amendment to Rule of
Practice 194 would allow an SBS Entity to exclude such associated
persons when making the certification required by Rule 15Fb6-2(a), the
Commission preliminarily believes that it is unnecessary to require
that the SBS Entity make and keep current the questionnaire or
application for employment contemplated by proposed paragraphs 18a-
5(a)(10)(i) and (b)(8)(i) with respect to those associated persons.
Thus, under proposed Rule 18a-5 paragraphs (a)(10)(iii)(A) and
(b)(8)(iii)(A), an SBS Entity generally would not be required to obtain
the questionnaire or application for employment, otherwise required by
proposed Rule 18a-5, with respect to any associated person who is not a
U.S. person and who does not effect and is not involved in effecting
security-based swap transactions with or for counterparties that are
U.S. persons (other than a security-based swap transaction conducted
through a foreign branch of a counterparty that is a U.S. person). More
broadly, proposed new paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A)
would provide that an SBS Entity need not make and keep current a
questionnaire or application for employment with respect to any
associated person if the SBS Entity is excluded from the prohibition in
Exchange Act 15F(b)(6) with respect to that associated person.
2. Exemption Based on Local Law
The Commission also is proposing to add new paragraphs
(a)(10)(iii)(B) and (b)(8)(iii)(B) to proposed Rule 18a-5 to address
situations where the law of a non-U.S. jurisdiction in which an
associated person is employed or located may prohibit a stand-alone or
bank SBS Entity from receiving, creating or maintaining a record of any
of the information mandated by the questionnaire requirement.
Specifically, the provisions would apply to an associated person who is
not a U.S. person (as defined in Exchange Act Rule 3a71-
3(a)(4)(i)(A)),\280\ and would be available, in accordance with Rule
15Fb6-2, to non-U.S. associated persons who effect or are involved in
effecting security-based swaps transactions on behalf of an SBS Entity.
Paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) to proposed Rule 18a-5
would permit the exclusion of certain information mandated by the
questionnaire requirement with respect to those associated persons if
the receipt of that information, or the creation or maintenance of
records reflecting such information, would result in a violation of
applicable law in the jurisdiction in which the associated person is
employed or located. Rather than fully excluding these associated
persons from the questionnaire requirement, the provisions would
provide that the stand-alone or bank SBS Entity need not record
information mandated by the questionnaire requirement with respect to
such associated persons if the receipt of that information, or the
creation or maintenance of records reflecting such information, would
result in a violation of applicable law in the jurisdiction in which
the associated person is employed or located.\281\
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\280\ Exchange Act Rule 3a71-3(a)(4)(i)(A) defines the term U.S.
person to mean, with respect to natural persons, ``a natural person
resident in the United States.''
\281\ To the extent an nonresident SBS Entity is able to rely on
either paragraph (a)(10)(iii)(A) or (b)(8)(iii)(A) with respect to a
particular associated person, the firm would not need to also rely
on the relief provided under (a)(10)(iii)(B) or (b)(8)(iii)(B)
because the firm would be exempt from the questionnaire requirement
with respect to that associated person.
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This proposed change is designed to address commenters' concerns,
and would provide SBS Entities with flexibility to not record
information that might result in a violation of the law in the
jurisdiction in which the associated person is employed or located,
while continuing to require that they record information not restricted
by the law in that jurisdiction. SBS Entities should still make and
keep current information included in the questionnaire or application
requirement that would not result in a violation of local law. In
addition, if an SBS Entity would be able to obtain the information
required by the questionnaire or application requirement if it obtained
the consent of the associated person, the SBS Entity generally should
try to obtain such consent before relying on new paragraphs
(a)(10)(iii)(B) and (b)(8)(iii)(B).\282\
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\282\ However, we recognize that there may be other issues
raised with respect to consents. See part IV.A.2, supra.
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As noted above, the questionnaire serves as a basis for a
background check of the associated person to verify that the person is
not subject to a statutory disqualification, which in turn supports the
substantive prohibition in Section 15F(b)(6) of the Exchange Act and
the related certification and background check requirements in Rule
15Fb6-2.\283\ The Commission recognizes that there may be various means
by which an SBS Entity could meet its obligations under Section
15F(b)(6) of the Exchange Act and Rule 15Fb6-2. In the release adopting
Rule 15Fb6-2, the Commission did not prescribe a particular means by
which an SBS Entity must conduct the required background check.\284\
Rather, the Commission indicated that whatever steps are taken, the SBS
Entity must have sufficient comfort to be able to comply with Section
15F(b)(6) of the Exchange Act, and make the certification required by
Rule 15Fb6-2.\285\ While an SBS Entity may be prohibited by local laws
from obtaining certain information from an associated person, the SBS
Entity may still be able to review public records (in foreign
[[Page 24244]]
jurisdictions or in the U.S.) or take other steps to help provide it
with sufficient comfort to comply with Section 15F(b)(6). The
Commission emphasizes that every SBS Entity must still comply with
Section 15F(b)(6) of the Exchange Act and Rule 15Fb6-2 with respect to
every associated person that is not subject to an exclusion from the
statutory disqualification prohibition in Section 15F(b)(6) of the
Exchange Act.
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\283\ See 17 CFR 240.15Fb6-2(b); see also ``Registration of
Security-Based Swap Dealers and Major Security-Based Swap
Participants,'' 76 FR 65784 (Oct. 24, 2011), and the discussion
regarding proposed Rule 15Fb6-1(b) at 65796. Proposed paragraph
15Fb6-1(b) was not adopted because it was duplicative of the
requirement in the Recordkeeping and Reporting Proposing release.
Specifically, the Commission stated in the Registration Adopting
Release, ``We do not believe that it would be efficient or necessary
to repeat the same requirement for obtaining such questionnaires or
applications in two separate Commission rules.'' See Registration
Adopting Release, 80 FR at 48978.
\284\ See id. at 48977.
\285\ 17 CFR 240.15Fb6-2.
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B. Solicitation of Comments Regarding Proposed Modifications to
Proposed Rule 18a-5
The Commission requests comment on all aspects of these proposed
modifications to proposed Rule 18a-5 and the guidance described above.
1. Will the proposed modifications adequately address the
concerns raised by the commenter? If not, why not, and what further
modifications should the Commission make?
2. Are there processes that foreign regulators use in lieu of
employing an equivalent to the questionnaire requirement? If so,
please cite examples.
3. What information do entities that may seek to register as SBS
Entities currently collect regarding their employees as part of
their normal operations for various purposes (e.g., to pay
employees, to pay taxes, to provide employees with other benefits,
and to know what functions each employee performs and who supervises
them)?
4. Section 15F(b)(6) generally makes it illegal to permit a
person who is subject to a statutory disqualification to effect or
be involved in effecting security-based swaps on behalf of an SBS
Entity if the SBS Entity ``knew, or in the exercise of reasonable
care should have known'' of the statutory disqualification. Should
the Commission provide guidance on the minimum level of due
diligence in which an SBS Entity must engage to satisfy that
``reasonable care'' standard in the event that the receipt of
information, or the creation or maintenance of records reflecting
information that would otherwise be required under Rule 18a-5, would
result in a violation of applicable law in the jurisdiction in which
the associated person is employed or located? If so, what guidance
should the Commission provide, and why?
5. Would the laws in jurisdictions other than the jurisdiction
where an associated person is employed or located limit an SBS
Entity's ability to make and retain information contained in the
questionnaire or application for employment? If so, should proposed
paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) be modified to instead
focus on the laws of other jurisdictions? For instance, should these
paragraphs instead focus on the law of the jurisdiction in which an
SBS Entity is incorporated, or where the SBS Entity maintains its
books and records? Why or why not? Or, should these proposed
paragraphs be expanded to include other jurisdictions? Why or why
not? Alternatively, should the rule be more narrowly focused on
either where the associated person is ``employed'' or where the
associated person is ``located?'' If so, why should one be used and
the other excluded?
6. What role would consents play in terms of nonresident SBS
Entities' ability to meet the questionnaire requirement?
7. Will the proposed addition of new paragraphs (a)(10)(iii)(A)
and (b)(8)(iii)(A) adequately address the concerns raised by the
commenter by providing, as proposed, that a stand-alone or bank SBS
Entity is not required to make and keep current a questionnaire or
application for employment executed by an associated person if they
are excluded from the prohibition in Section 15F(b)(6) of the
Exchange Act with respect to that associated person. If not, why
not, and what further changes should the Commission make?
VII. Economic Analysis
The Commission is mindful of the economic effects, including the
costs and benefits, of the proposed amendments and guidance. Section
3(f) of the Exchange Act provides that whenever the Commission is
engaged in rulemaking pursuant to the Exchange Act and is required to
consider or determine whether an action is necessary or appropriate in
the public interest, the Commission shall also consider, in addition to
the protection of investors, whether the action will promote
efficiency, competition, and capital formation.\286\ In addition,
Section 23(a)(2) of the Exchange Act requires the Commission, when
making rules under the Exchange Act, to consider the impact such rules
would have on competition.\287\ Exchange Act Section 23(a)(2) also
provides that the Commission shall not adopt any rule which would
impose a burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Exchange Act.
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\286\ See 15 U.S.C. 78c(f).
\287\ See 15 U.S.C. 78w(a)(2).
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The analysis below addresses the likely economic effects of the
proposed amendments and interpretive guidance, including the
anticipated and estimated benefits and costs of the amendments and
interpretive guidance and their likely effects on efficiency,
competition, and capital formation. The Commission also discusses the
potential economic effects of certain alternatives to the approaches
taken in this proposal. Many of the benefits and costs discussed below
are difficult to quantify. For example, the Commission cannot quantify
the costs that potentially could result from competitive disparities
associated with either proposed Alternative 1 or proposed Alternative 2
to the exception to Rule 3a71-3 because these costs will depend, in
part, on foreign regulatory requirements applicable to non-U.S.
entities. This is because the extent to which a non-U.S. entity would
need to develop or modify systems to allow it and its majority-owned
affiliate to meet the conditions of the proposed exception likely
depends on the extent to which the non-U.S. entity's local regulatory
obligations differ from analogous conditions of the proposed exception.
These potential costs could also depend on the business decisions of
non-U.S. persons that may avail themselves of the proposed exception.
Furthermore, the likelihood of a non-U.S. entity availing itself of the
proposed exception under either alternative depends on whether the non-
U.S. entity is regulated in a listed jurisdiction, a determination
that, in turn, depends on the foreign regulatory regime. Also, in
connection with the proposed amendments to Commission Rule of Practice
194, the Commission has no data or information allowing us to quantify
the number of disqualified non-U.S. employees transacting with foreign
counterparties or foreign branches of U.S. counterparties on behalf of
U.S. and non-U.S. SBS Entities; the direct costs of relocating
disqualified U.S. personnel outside of the United States for U.S. and
non-U.S. SBS Entities; or reputational and compliance costs of U.S. and
non-U.S. SBS Entities from continuing to transact through disqualified
non-U.S. associated persons with foreign counterparties and foreign
branches of U.S. counterparties. Therefore, while the Commission has
attempted to quantify economic effects where possible, much of the
discussion of economic effects is qualitative in nature.
[[Page 24245]]
A. Baseline
To assess the economic effects of the proposed amendments, the
Commission is using as the baseline the security-based swap market as
it exists at the time of this release, including applicable rules the
Commission has already adopted, but excluding rules the Commission has
proposed but not yet finalized. The analysis includes the statutory
provisions that currently govern the security-based swap market
pursuant to the Dodd-Frank Act and rules adopted in the Intermediary
Definitions Adopting Release, the Cross-Border Adopting Release, the
SDR Rules and Core Principles Adopting Release,\288\ and the Rule of
Practice 194 Adopting Release.\289\ Additionally, the baseline includes
rules that have been adopted but for which compliance is not yet
required, including the ANE Adopting Release, Registration Adopting
Release,\290\ Regulation SBSR Amendments Adopting Release,\291\ and the
Business Conduct Adopting Release,\292\ as these final rules--even if
compliance is not yet required--are part of the existing regulatory
landscape that market participants expect to govern their security-
based swap activity. The following sections discuss available data from
the security-based swap market, security-based swap market participants
and dealing structures, market-facing and non-market-facing activities
of dealing entities, security-based swap market activity, global
regulatory efforts, other markets and existing regulatory frameworks,
current estimates of entities likely to incur assessment costs under
rules adopted in the ANE Adopting Release, and an estimate of non-U.S.
persons that could be affected by the proposed amendments and guidance.
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\288\ See Security-Based Swap Data Repository Registration,
Duties, and Core Principles, Exchange Act Release No. 74246 (Feb.
11, 2015), 80 FR 14437 (Mar. 19, 2015) (``SDR Rules and Core
Principles Adopting Release'').
\289\ See Rule of Practice 194 Adopting Release, 84 FR at 4906.
\290\ See Registration Adopting Release, 80 FR at 48997-49003.
\291\ See Regulation SBSR-Reporting and Dissemination of
Security-Based Swap Information, Exchange Act Release No. 78321
(Jul.14, 2016), 81 FR 53546 (Aug. 12, 2016) (``Regulation SBSR
Amendments Adopting Release'').
\292\ See Business Conduct Adopting Release, 81 FR at 30105.
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1. Available Data From the Security-Based Swap Market
The Commission's understanding of the market is informed, in part,
by available data on security-based swap transactions, though the
Commission acknowledges that limitations in the data limit the extent
to which it is possible to quantitatively characterize the market.\293\
The Commission's analysis of the current state of the security-based
swap market is based on data obtained from the DTCC Derivatives
Repository Limited Trade Information Warehouse (``TIW''), especially
data regarding the activity of market participants in the single-name
CDS market during the period from 2008 to 2017. The details of this
data set, including its limitations, have been discussed in a prior
release.\294\
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\293\ The Commission also relies on qualitative information
regarding market structure and evolving market practices provided by
commenters and knowledge and expertise of Commission staff.
\294\ See Rule of Practice 194 Adopting Release, 84 FR at 4924.
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2. Security-Based Swap Market: Market Participants and Dealing
Structures
a. Security-Based Swap Market Participants
Activity in the security-based swap market is concentrated among a
relatively small number of entities that act as dealers in this market.
In addition to these entities, thousands of other participants appear
as counterparties to security-based swap contracts in the TIW sample,
and include, but are not limited to, investment companies, pension
funds, private (hedge) funds, sovereign entities, and industrial
companies. A discussion of security-based swap market participants can
be found in a prior release.\295\
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\295\ See Rule of Practice 194 Adopting Release, 84 FR at 4925.
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b. Security-Based Swap Market Participant Domiciles
As depicted in Figure 1 below, domiciles of new accounts
participating in the security-based swap market have shifted over time.
It is unclear whether these shifts represent changes in the types of
participants active in this market, changes in reporting, or changes in
transaction volumes in particular underliers. For example, the
percentage of new entrants that are foreign accounts increased from
24.4% in the first quarter of 2008 to 32.3% in the last quarter of
2017, which may reflect an increase in participation by foreign account
holders in the security-based swap market, though the total number of
new entrants that are foreign accounts decreased from 112 in the first
quarter of 2008 to 48 in the last quarter of 2017.\296\ Additionally,
the percentage of the subset of new entrants that are foreign accounts
managed by U.S. persons increased from 4.6% in the first quarter of
2008 to 16.8% in the last quarter of 2017, and the absolute number rose
from 21 to 25, which also may reflect more specifically the flexibility
with which market participants can restructure their market
participation in response to regulatory intervention, competitive
pressures, and other stimuli.\297\ At the same time, apparent changes
in the percentage of new accounts with foreign domiciles may also
reflect improvements in reporting by market participants to TIW, an
increase in the percentage of transactions between U.S. and non-U.S.
counterparties, and/or increased transactions in single-name CDS on
U.S. reference entities by foreign persons.\298\
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\296\ These estimates were calculated by Commission staff using
TIW data.
\297\ See Charles Levinson, ``U.S. banks moved billions in
trades beyond the CFTC's reach,'' Reuters, Aug. 21, 2015, available
at http://www.reuters.com/article/2015/08/21/usa-banks-swaps-idUSL3N10S57R20150821. The estimates of 21 and 25 were calculated by
Commission staff using TIW data.
\298\ The available data do not include all security-based swap
transactions but only transactions in single-name CDS that involve
either (1) at least one account domiciled in the United States
(regardless of the reference entity) or (2) single-name CDS on a
U.S. reference entity (regardless of the U.S.-person status of the
counterparties). See note 294, supra, for a discussion of the TIW
data set.
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[[Page 24246]]
[GRAPHIC] [TIFF OMITTED] TP24MY19.000
c. Market Centers \299\
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\299\ Following publication of the Warehouse Trust Guidance on
CDS data access, DTCC-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 the DTCC-TIW. When an
account does not report a registered office location, the Commission
has 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.
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A market participant's domicile, however, does not necessarily
correspond to where it engages in security-based swap activity. In
particular, non-U.S. persons engaged in security-based swap dealing
activity operate in multiple market centers and carry out such activity
with counterparties around the world.\300\ Many market participants
that are engaged in dealing activity prefer to use traders and manage
risk for security-based swaps in the jurisdiction where the underlier
is traded. Thus, although a significant amount of the dealing activity
in security-based swaps on U.S. reference entities involves non-U.S.
dealers, the Commission understands that these dealers tend to carry
out much of the security-based swap trading and related risk-management
activities in these security-based swaps within the United States.\301\
Some dealers have explained that being able to centralize their
trading, sales, risk management, and other activities related to U.S.
reference entities in U.S. operations (even when the resulting
transaction is booked in a foreign entity) improves the efficiency of
their dealing business.
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\300\ See ANE Adopting Release, 81 FR at 8604 n.56.
\301\ See id. note 58.
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Consistent with these operational concerns and the global nature of
the security-based swap market, the available data appear to confirm
that participants in this market are in fact active in market centers
around the globe. Although, as noted above, the available data do not
permit us to identify the location of personnel in a transaction, TIW
transaction records, supplemented with legal entity location data,
indicate that firms that are likely to be security-based swap dealers
operate out of branch locations in key market centers around the world,
including New York, London, Paris, Zurich, Tokyo, Hong Kong, Chicago,
Sydney, Toronto, Frankfurt, Singapore, and the Cayman Islands.\302\
---------------------------------------------------------------------------
\302\ TIW transaction records contain a proxy for the domicile
of an entity, which may differ from branch locations, which are
separately identified in the transaction records. The legal entity
location data are from Avox.
---------------------------------------------------------------------------
Given these market characteristics and practices, participants in
the security-based swap market may bear the financial risk of a
security-based swap transaction in a location different from the
location where the transaction is arranged, negotiated, or executed, or
where economic decisions are made by managers on behalf of beneficial
owners. Market activity may also occur in a jurisdiction other than
where the market participant or its counterparty books the transaction.
Similarly, a participant in the security-based swap market may be
exposed to counterparty risk from a counterparty located in a
jurisdiction that is different from the market center or centers in
which it participates.
[[Page 24247]]
d. Common Business Structures
A non-U.S. person that engages in a global security-based swap
dealing business in multiple market centers may choose to structure its
dealing business in a number of different ways. This structure,
including where it books the transactions that constitute that business
and how it carries out market-facing activities that generate those
transactions, reflects a range of business and regulatory
considerations, which each non-U.S. person may weigh differently.
A non-U.S. person may choose to book all of its security-based swap
transactions, regardless of where the transaction originated, in a
single, central booking entity. That entity generally retains the risk
associated with that transaction, but it also may lay off that risk to
another affiliate via a back-to-back transaction or an assignment of
the security-based swap.\303\ Alternatively, a non-U.S. person may book
security-based swaps arising from its dealing business in separate
affiliates, which may be located in the jurisdiction where it
originates the risk associated with the security-based swap, or,
alternatively, the jurisdiction where it manages that risk. Some non-
U.S. persons may book transactions originating in a particular region
to an affiliate established in a jurisdiction located in that
region.\304\ As discussed earlier,\305\ a non-U.S. person may choose to
book its security-based swap transactions in one jurisdiction in part
to avoid triggering regulatory requirements associated with another
jurisdiction.
---------------------------------------------------------------------------
\303\ See Exchange Act Release No. 74834 (Apr. 29, 2015), 80 FR
27444, 27463 (May 13, 2015) (``U.S. Activity Proposing Release'');
Cross-Border Proposing Release, 78 FR 30977-78.
\304\ There is some indication that this booking structure is
becoming increasingly common in the market. See, e.g., Catherine
Contiguglia, ``Regional swaps booking replacing global hubs,''
Risk.net, Sep. 4, 2015, available at http://www.risk.net/risk-magazine/feature/2423975/regional-swaps-booking-replacing-global-hubs. Such a development may be reflected in the increasing
percentage of new entrants that have a foreign domicile, as
described above.
\305\ See part III.B.4, supra.
---------------------------------------------------------------------------
Regardless of where a non-U.S. person determines to book its
security-based swaps arising out of its dealing activity, it is likely
to operate offices that perform sales or trading functions in one or
more market centers in other jurisdictions. Maintaining sales and
trading desks in global market centers permits the non-U.S. person 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,\306\ for example, when a
counterparty's home financial markets are closed. A non-U.S. person
engaged in a security-based swap dealing business also may choose to
manage its trading book in particular reference entities or securities
primarily from a trading desk that can utilize local expertise in such
products or that can gain access to better liquidity, which may permit
it to more efficiently price such products or to otherwise compete more
effectively in the security-based swap market. Some non-U.S. persons
prefer to centralize risk management, pricing, and hedging for specific
products with the personnel responsible for carrying out the trading of
such products to mitigate operational risk associated with transactions
in those products.
---------------------------------------------------------------------------
\306\ These offices may be branches or offices of the booking
entity itself, or branches or offices of an affiliated agent, such
as, in the United States, a registered broker-dealer.
---------------------------------------------------------------------------
The non-U.S. person affiliate that books these transactions may
carry out related market-facing activities, whether in its home
jurisdiction or in a foreign jurisdiction, using either its own
personnel or the personnel of an affiliated or unaffiliated agent. For
example, the non-U.S. person may determine that another of its
affiliates employs personnel who possess expertise in relevant products
or who have established sales relationships with key counterparties in
a foreign jurisdiction, making it more efficient to use the personnel
of the affiliate to engage in security-based swap market-facing
activity on its behalf in that jurisdiction. In these cases, the
affiliate that books these transactions and its affiliated agent may
operate as an integrated dealing business, each performing distinct
core functions in carrying out that business.
Alternatively, the non-U.S. person affiliate that books these
transactions may, in some circumstances, determine to engage the
services of an unaffiliated agent through which it can engage in
market-facing activity. For example, a non-U.S. person may determine
that using an interdealer broker may provide an efficient means of
participating in the interdealer market in its own, or in another,
jurisdiction, particularly if it is seeking to do so anonymously or to
take a position in products that trade relatively infrequently.\307\ A
non-U.S. person may also use unaffiliated agents that operate at its
direction. Such an arrangement may be particularly valuable in enabling
a non-U.S. person to service clients or access liquidity in
jurisdictions in which it has no security-based swap operations of its
own.
---------------------------------------------------------------------------
\307\ The Commission understands that interdealer brokers may
provide voice or electronic trading services that, among other
things, permit dealers to take positions or hedge risks in a manner
that preserves their anonymity until the trade is executed. These
interdealer brokers also may play a particularly important role in
facilitating transactions in less-liquid security-based swaps.
---------------------------------------------------------------------------
The Commission understands that non-U.S. person affiliates (whether
affiliated with U.S.-based non-U.S. persons or not) that are
established in foreign jurisdictions may use any of these structures to
engage in dealing activity in the United States, and that they may seek
to engage in dealing activity in the United States to transact with
both U.S.-person and non-U.S.-person counterparties. In transactions
with non-U.S.-person counterparties, these foreign affiliates may
affirmatively seek to engage in dealing activity in the United States
because the sales personnel of the non-U.S.-person dealer (or of its
agent) in the United States have existing relationships with
counterparties in other locations (such as Canada or Latin America) or
because the trading personnel of the non-U.S.-person dealer (or of its
agent) in the United States have the expertise to manage the trading
books for security-based swaps on U.S. reference securities or
entities. The Commission understands that some of these foreign
affiliates engage in dealing activity in the United States through
their personnel (or personnel of their affiliates) in part to ensure
that they are able to provide their own counterparties, or those of
non-U.S. person 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 interdealer broker, these foreign affiliates may
act, in a dealing capacity, in the United States through an
unaffiliated, third-party agent.
3. Market-Facing and Non-Market-Facing Activities
As discussed above, the activities of a security-based swap dealer
involve both market-facing activities and non-market-facing
activities.\308\ Market-facing activities would include arranging,
negotiating, or executing a security-based swap transaction. The terms
``arrange'' and ``negotiate'' indicate market-facing activity of sales
or trading personnel in connection with a particular transaction,
including interactions with counterparties or their
[[Page 24248]]
agents. The term ``execute'' refers to the market-facing act that, in
connection with a particular transaction, causes the person to become
irrevocably bound under the security-based swap under applicable law.
Non-market-facing activities include processing trades and other back-
office activities; designing security-based swaps without communicating
with counterparties in connection with specific transactions; preparing
underlying documentation, including negotiating master agreements (as
opposed to negotiating with the counterparty the specific economic
terms of a particular security-based swap transaction); and clerical
and ministerial tasks such as entering executed transactions on a non-
U.S. person's books.
---------------------------------------------------------------------------
\308\ See part I.A.2, supra.
---------------------------------------------------------------------------
4. Security-Based Swap Market Activity
As already noted, firms that act as dealers play a central role in
the security-based swap market. Based on an analysis of 2017 single-
name CDS data in TIW, accounts of those firms that are likely to exceed
the security-based swap dealer de minimis thresholds and trigger
registration requirements intermediated transactions with a gross
notional amount of approximately $2.9 trillion, approximately 55% of
which was intermediated by the top five dealer accounts.\309\
---------------------------------------------------------------------------
\309\ The Commission staff analysis of TIW transaction records
indicates that approximately 99% of single-name CDS price-forming
transactions in 2017 involved an ISDA-recognized dealer.
---------------------------------------------------------------------------
These dealers transact with hundreds or thousands of
counterparties. Approximately 21% of accounts of firms expected to
register as security-based dealers and observable in TIW have entered
into security-based swaps with over 1,000 unique counterparty accounts
as of year-end 2017.\310\ Another 25% of these accounts transacted with
500 to 1,000 unique counterparty accounts; 29% transacted with 100 to
500 unique accounts; and 25% of these accounts intermediated security-
based swaps with fewer than 100 unique counterparties in 2017. The
median dealer account transacted with 495 unique accounts (with an
average of approximately 570 unique accounts). Non-dealer
counterparties transacted almost exclusively with these dealers. The
median non-dealer counterparty transacted with two dealer accounts
(with an average of approximately three dealer accounts) in 2017.
---------------------------------------------------------------------------
\310\ Many dealer entities and financial groups transact through
numerous accounts. Given that individual accounts may transact with
hundreds of counterparties, the Commission may infer that entities
and financial groups may transact with at least as many
counterparties as the largest of their accounts.
---------------------------------------------------------------------------
Figure 2 below describes the percentage of global, notional
transaction volume in North American corporate single-name CDS reported
to TIW between January 2008 and December 2017, separated by whether
transactions are between two ISDA-recognized dealers (interdealer
transactions) or whether a transaction has at least one non-dealer
counterparty. Figure 2 also shows that the portion of the notional
volume of North American corporate single-name CDS represented by
interdealer transactions has remained fairly constant through 2015
before falling from approximately 72% in 2015 to approximately 40% in
2017. This fall corresponds to the availability of clearing to non-
dealers. Interdealer transactions continue to represent a significant
fraction of trading activity, even as notional volume has declined over
the past ten years,\311\ from more than $6 trillion in 2008 to less
than $700 billion in 2017.\312\
---------------------------------------------------------------------------
\311\ 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.
\312\ This estimate is lower than the gross notional amount of
$4.6 trillion noted in note 294 above as it includes only the subset
of single-name CDS referencing North American corporate
documentation.
---------------------------------------------------------------------------
[[Page 24249]]
[GRAPHIC] [TIFF OMITTED] TP24MY19.001
The high level of interdealer trading activity reflects the central
position of a small number of dealers, each of which intermediates
trades with many hundreds of counterparties. While the Commission is
unable to quantify the current level of trading costs for single-name
CDS, these dealers appear to enjoy market power as a result of their
small number and the large proportion of order flow that they privately
observe.
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 the
Commission analyzed was between counterparties domiciled in the United
States and counterparties domiciled abroad, as shown in Figure 3 below.
Using the self-reported registered office location of the TIW accounts
as a proxy for domicile, the Commission estimates that only 12% of the
global transaction volume by notional volume between 2008 and 2017 was
between two U.S.-domiciled counterparties, compared to 49% entered into
between one U.S.-domiciled counterparty and a foreign-domiciled
counterparty and 39% entered into between two foreign-domiciled
counterparties.\313\
---------------------------------------------------------------------------
\313\ For purposes of this discussion, the Commission has
assumed that the registered office location reflects the place of
domicile for the fund or account, but the Commission notes that this
domicile does not necessarily correspond to the location of an
entity's sales or trading desk. ANE Adopting Release, 81 FR at 8607
n.83.
---------------------------------------------------------------------------
If the Commission instead considers the number of cross-border
transactions from the perspective of the domicile of the corporate
group (e.g., by classifying a foreign bank branch or foreign subsidiary
of a U.S. entity as domiciled in the United States), the percentages
shift significantly. Under this approach, the fraction of transactions
entered into between two U.S.-domiciled counterparties increases to
34%, and to 51% for transactions entered into between a U.S.-domiciled
counterparty and a foreign-domiciled counterparty. By contrast, the
proportion of activity between two foreign-domiciled counterparties
drops from 39% to 15%. This change in respective shares based on
different classifications suggests that the activity of foreign
subsidiaries of U.S. firms and foreign branches of U.S. banks accounts
for a higher percentage of security-based swap activity than U.S.
subsidiaries of foreign firms and U.S. branches of foreign banks. It
also demonstrates that financial groups based in the United States are
involved in an overwhelming majority (approximately 85%) of all
reported transactions in North American corporate single-name CDS.
Financial groups based in the United States are also involved in a
majority of interdealer transactions in North American corporate
single-name CDS. Of the 2017 transactions on North American corporate
single-name CDS between two ISDA-recognized dealers and their branches
or affiliates, 94% of transaction notional volume involved at least one
account of an entity with a U.S. parent. The Commission notes, in
addition, that a majority of North American corporate single-name CDS
transactions occur in the interdealer market or between dealers and
foreign non-dealers, with the remaining portion of the market
consisting of transactions between dealers and U.S.-person non-dealers.
Specifically, 60% of North American corporate single-name CDS
[[Page 24250]]
transactions involved either two ISDA-recognized dealers or an ISDA-
recognized dealer and a foreign non-dealer. Approximately 39% of such
transactions involved an ISDA-recognized dealer and a U.S.-person non-
dealer.
[GRAPHIC] [TIFF OMITTED] TP24MY19.002
5. Global Regulatory Efforts
In 2009, the G20 leaders--whose membership includes the United
States, 18 other countries, and the European Union--addressed global
improvements in the OTC derivatives market. They expressed their view
on a variety of issues relating to OTC derivatives contracts. In
subsequent summits, the G20 leaders have returned to OTC derivatives
regulatory reform and encouraged international consultation in
developing standards for these markets.\314\
---------------------------------------------------------------------------
\314\ See, e.g., G20 Leaders' Final Declaration, November 2011,
para. 24, available at https://g20.org/wp-content/uploads/2014/12/Declaration_eng_Cannes.pdf.
---------------------------------------------------------------------------
Many security-based swap dealers likely will be subject to foreign
regulation of their security-based swap activities that is similar to
regulations that may apply to them pursuant to Title VII of the Dodd-
Frank Act, even if the relevant foreign jurisdictions do not classify
certain market participants as ``dealers'' for regulatory purposes.
Some of these regulations may duplicate, and in some cases conflict
with, certain elements of the Title VII regulatory framework.
Foreign legislative and regulatory efforts have generally focused
on five areas: (1) Moving OTC derivatives onto organized trading
platforms, (2) requiring central clearing of OTC derivatives, (3)
requiring post-trade reporting of transaction data for regulatory
purposes and public dissemination of anonymized versions of such data,
(4) establishing or enhancing capital requirements for non-centrally
cleared OTC derivatives transactions, and (5) establishing or enhancing
margin and other risk mitigation requirements for non-centrally cleared
OTC derivatives transactions. Foreign jurisdictions have been actively
implementing regulations in connection with each of these categories of
requirements. A number of major foreign jurisdictions have initiated
the process of implementing margin and other risk mitigation
requirements for non-centrally cleared OTC derivatives
transactions.\315\
---------------------------------------------------------------------------
\315\ In November 2018, the Financial Stability Board reported
that 16 member jurisdictions participating in its thirteenth
progress report on OTC derivatives market reforms had in force
margin requirements for non-centrally cleared derivatives. A further
4 jurisdictions made some progress in implementation leading to a
change in reported implementation status during the reporting
period. See Financial Stability Board, ``OTC Derivatives Market
Reforms Thirteenth Progress Report on Implementation'' (Nov. 2018),
available at http://www.fsb.org/wp-content/uploads/P191118-5.pdf.
---------------------------------------------------------------------------
Notably, the European Parliament and the European Council have
adopted the European Market Infrastructure Regulation (``EMIR''), which
includes provisions aimed at increasing the safety and transparency of
the OTC derivatives market. EMIR mandates the European Supervisory
Authorities (``ESAs'') to develop regulatory technical standards
specifying margin requirements for non-centrally cleared OTC
derivatives contracts. The ESAs have developed, and in October 2016
[[Page 24251]]
the European Commission adopted, these regulatory technical
standards.\316\
---------------------------------------------------------------------------
\316\ See EBA, EIOPA, and ESMA, ``Regulatory Technical Standards
(RTS) on risk mitigation techniques for OTC derivatives not cleared
by a central counterparty (CCP)'' (March 2016), available at https://www.eba.europa.eu/documents/10180/1398349/RTS+on+Risk+Mitigation+Techniques+for+OTC+contracts+%28JC-2016-+18%29.pdf/fb0b3387-3366-4c56-9e25-74b2a4997e1d; see also EC
Delegated Regulation, supplementing Regulation (EU) No 648/2012 of
the European Parliament and of the Council on OTC derivatives,
central counterparties and trade repositories with regard to
regulatory technical standards for risk-mitigation techniques for
OTC derivative contracts not cleared by a central counterparty (Oct.
4, 2016), available at http://ec.europa.eu/finance/financial-markets/docs/derivatives/161004-delegated-act_en.pdf. After the non-
objection from the European Parliament and Council, Delegated
Regulation (EU) 2016/2251 was published in the Official Journal of
the European Union and entered into force on January 4, 2017.
---------------------------------------------------------------------------
Several jurisdictions have also taken steps to implement the Basel
III recommendations governing capital requirements for financial
entities, which include enhanced capital charges for non-centrally
cleared OTC derivatives transactions.\317\ Moreover, as discussed
above, subsequent to the publication of the proposing release, the
Basel Committee on Banking Supervision (``BCBS'') and the Board of the
International Organization of Securities Commissions (``IOSCO'') issued
the Margin Requirements for Non-centrally Cleared Derivatives (``WGMR
Paper'') that recommends minimum standards for margin requirements for
non-centrally cleared derivatives.\318\ The recommendations in the WGMR
Paper included a recommendation that all financial entities and
systemically important non-financial entities exchange variation and
initial margin appropriate for the counterparty risk posed by such
transactions, that initial margin should be exchanged without
provisions for ``netting'' and held in a manner that protects both
parties in the event of the other's default, and that the margin
regimes of the various regulators should interact so as to be
sufficiently consistent and non-duplicative.
---------------------------------------------------------------------------
\317\ In November 2018, the Financial Stability Board reported
that 23 of the 24 member jurisdictions participating in its
thirteenth progress report on OTC derivatives market reforms had in
force interim standards for higher capital requirements for non-
centrally cleared transactions. See Financial Stability Board, OTC
Derivatives Market Reforms Thirteenth Progress Report on
Implementation (Nov. 2018), available at http://www.fsb.org/wp-content/uploads/P191118-5.pdf.
\318\ See BCBS, IOSCO, ``Margin Requirements for Non-centrally
Cleared Derivatives'' (Mar. 2015), available at http://www.bis.org/bcbs/publ/d317.pdf.
---------------------------------------------------------------------------
6. Other Markets and Existing Regulatory Frameworks
The numerous financial markets are integrated, often attracting the
same market participants that trade across corporate bond, swap, and
security-based swap markets, among others. A discussion of other
markets and existing regulatory frameworks can be found in a prior
release.\319\
---------------------------------------------------------------------------
\319\ See Rule of Practice 194 Adopting Release, 84 FR at 4927.
---------------------------------------------------------------------------
7. Estimates of Persons That May Use the Proposed Exception to Rule
3a71-3
To analyze the economic effects of the proposed exception to Rule
3a71-3, the Commission has analyzed 2017 TIW data to identify persons
that may use the proposed exception. The Commission preliminarily
believes that these persons fall into several categories, which we
discuss below.
a. Non-U.S. Persons Seeking To Reduce Assessment Costs
One category of persons that may use the proposed exception are
those non-U.S. persons that may need to assess the amount of their
market-facing activity against the de minimis thresholds solely because
of the inclusion of security-based swap transactions between two non-
U.S. persons that are arranged, negotiated, or executed by personnel
located in the U.S. for the purposes of the de minimis threshold
analysis. These non-U.S. persons may have an incentive to rely on the
proposed exception as a means of avoiding assessment and business
restructuring if the cost of compliance associated with the proposed
exception is less than assessment costs and the costs of business
restructuring. In the ANE Adopting Release, the Commission provided an
estimate of this category of persons.\320\ However, in light of the
reduction in security-based swap market activity since the publication
of the ANE Adopting Release,\321\ the Commission preliminarily believes
that it would be appropriate to update that estimate to more accurately
identify the set of persons that potentially may use the proposed
exception. Analyses of the 2017 TIW data indicate that approximately
five additional non-U.S. persons,\322\ beyond those non-U.S. persons
likely to incur assessment costs in connection with the other cross-
border counting rules that the Commission previously had adopted in the
Cross-Border Adopting Release,\323\ are likely to exceed the $2 billion
threshold \324\ the Commission has previously employed to estimate the
number of persons likely to incur assessment costs under Exchange Act
rule 3a71-3(b). These non-U.S. persons may have an incentive to rely on
the proposed exception as a means of avoiding assessment if the cost of
compliance associated with the proposed exception is less than the
assessment costs.
---------------------------------------------------------------------------
\320\ See ANE Adopting Release, 81 FR at 8627.
\321\ See part VII.A.4, supra.
\322\ Adjustments to these statistics from the ANE Adopting
Release reflect further analysis of the TIW data. Cf. ANE Adopting
Release, 81 FR at 8627 (providing an estimate of 10 additional non-
U.S. persons based on 2014 TIW data).
\323\ See note 13, supra.
\324\ See ANE Adopting Release, 81 FR at 8626.
---------------------------------------------------------------------------
b. Non-U.S. Persons Seeking To Avoid Security-Based Swap Dealer
Regulation
Another category of persons that potentially may use the proposed
exception are those non-U.S. persons whose dealing transaction volume
would have fallen below the $3 billion de minimis threshold if their
transactions with non-U.S. counterparties were not counted toward the
de minimis threshold under the current ``arranged, negotiated, or
executed'' counting requirement, but absent the exception, would have
dealing transactions in excess of that threshold.\325\ Such non-U.S.
persons may choose to use the proposed exception if they expect the
compliance cost associated with the proposed exception to be lower than
the compliance cost associated with being subject to the full set of
security-based swap dealer regulation and the cost of business
restructuring. The Commission's analysis of 2017 TIW data indicates
that there is one non-U.S. person whose transaction volume would have
fallen below the $3 billion de minimis threshold if that person's
transactions with non-U.S. counterparties were not counted toward the
de minimis threshold under the current ``arranged, negotiated, or
executed'' counting requirement.\326\
---------------------------------------------------------------------------
\325\ The $3 billion threshold is being used to help identify
potential impacts of the proposal. A phase-in threshold of $8
billion currently is in effect. See Exchange Act Rule 3a71-2(a)(1).
\326\ The analysis begins by considering the single-name CDS
transactions of each of the non-U.S. persons against both U.S.
person and non-U.S. person counterparties. The Commission then
excluded transactions involving these non-U.S. persons and their
non-U.S. person counterparties. For this analysis, we assume that
all transactions between non-U.S. person dealers and non-U.S.
counterparties are arranged, negotiated, or executed using U.S.
personnel.
---------------------------------------------------------------------------
c. U.S. Dealing Entities Considering Changes to Booking Practices
A third category of persons that potentially may use the
conditional exception are those U.S. dealers that use U.S. personnel to
arrange, negotiate, or execute transactions with non-U.S.
counterparties. If the proposed exception were available, such dealers
[[Page 24252]]
may consider booking future transactions with non-U.S. counterparties
to their non-U.S. affiliates, while still using U.S. personnel to
arrange, negotiate, or execute such transactions. These U.S. dealers
may have an incentive to engage in such booking practices in order to
utilize the proposed exception to the extent that they wish to continue
using U.S. personnel to arrange, negotiate, or execute transactions
with non-U.S. counterparties and the compliance cost associated with
the proposed exception is less than the cost of compliance with Title
VII requirements (if they choose not to book transactions to avail
themselves of the proposed exception) and the cost of business
restructuring (if they choose to both book transactions to their non-
U.S. affiliates and also refrain from using U.S. personnel to arrange,
negotiate or execute such transactions).\327\ The Commission's analysis
of 2017 TIW data indicates that there are six U.S. dealers who transact
with non-U.S. counterparties, who are likely to register as security-
based swap dealers,\328\ and have non-U.S. affiliates that also
transact in the CDS market. To the extent that these U.S. dealers
anticipate booking future transactions with non-U.S. counterparties
that are arranged, negotiated, or executed by U.S. personnel to their
non-U.S. affiliates, the Commission preliminarily believes that these
U.S. dealers may potentially make use of the proposed exception.
---------------------------------------------------------------------------
\327\ The Commission recognizes that this potential use of the
proposed exception by U.S. dealing entities is distinct from the
rationale underlying the proposed exception, which is to help avoid
market fragmentation and operational risks resulting from the
relocation of U.S. personnel by non-U.S. dealers. See part I.A.4,
supra. Nonetheless, such changes in booking practices by U.S.
dealing entities might be a consequence of the proposal.
\328\ To the extent that U.S. persons with transaction volumes
that are insufficient to trigger dealer registration potentially
might also make use of the proposed exception, this estimate would
be a lower bound estimate of the number of U.S. persons that
potentially may make use of the proposed exception.
---------------------------------------------------------------------------
d. Additional Considerations and Summary
Under Alternative 1,\329\ the U.S. arranging, negotiating, and
executing activity could be conducted by a registered security-based
swap dealer. Under Alternative 2, the U.S. arranging, negotiating, and
executing could be conducted by a registered broker.\330\ The economic
analysis of these alternatives depends, in part, on whether non-U.S.
persons that might make use of the proposed exception have U.S.
affiliates that are likely to register as security-based swap dealers
(under Alternative 1) or that are registered broker-dealers (under
Alternative 2). Of the six non-U.S. persons discussed above,\331\ four
have majority-owned affiliates that are registered broker-dealers. Of
these non-U.S. persons, one has a majority-owned affiliate that is
likely to register as a security-based swap dealer. Of the six U.S.
persons discussed above, all have majority-owned affiliates that are
registered broker-dealers, and all have majority-owned affiliates that
are likely to register as security-based swap dealers. Of these 12
persons, eight are banks, and three are affiliated with banks. These
estimates are summarized in Table 1 below. The Commission's analysis of
2017 TIW data indicates that these 12 persons transacted with 807 non-
U.S. counterparties, of which 558 participate in the swap markets and
249 do not.
---------------------------------------------------------------------------
\329\ See part III.B, supra.
\330\ See part III.C, supra.
\331\ Calculated as the 5 non-U.S. persons seeking to reduce
assessment costs (part VII.A.7.a) + 1 non-U.S. person seeking to
avoid security-based swap dealer regulation (part VII.A.7.b) = 6
non-U.S. persons.
Table 1--Affiliates of Persons That May Use the Proposed Exception
------------------------------------------------------------------------
Persons identified in TIW data that may use
the proposed exception Non-U.S. U.S.
------------------------------------------------------------------------
Estimate...................................... 6 6
Breakdown:
Has majority-owned registered broker- 4 6
dealer affiliate.........................
Has majority-owned registered security- 1 6
based swap dealer affiliate..............
Is a bank................................. 4 4
Is a bank affiliate....................... 1 2
------------------------------------------------------------------------
3In summary, the Commission's analysis of 2017 TIW data indicates
that 12 persons \332\ may make use of the proposed exception. In light
of the uncertainty associated with this estimate \333\ and to account
for potential growth of the security-based swap market, and consistent
with the approach in the ANE Adopting Release, the Commission believes
that it is reasonable to increase this estimate by a factor of
two.\334\ As a result, the Commission preliminarily estimates that up
to 24 persons potentially may make use of the proposed exception. The
Commission also doubles the number of non-U.S. counterparties discussed
above and preliminarily estimates that persons that may make use of the
proposed exception may transact with up to 1,614 non-U.S.
counterparties, of which 1,116 participate in the swap markets and 498
do not.\335\
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\332\ Calculated as 5 non-U.S. persons seeking to reduce
assessment costs (part VII.A.7.a) + 1 non-U.S. person seeking to
avoid security-based swap dealer regulation (part VII.A.7.b) + 6
U.S. persons considering changes to booking practices (part
VII.A.7.c) = 12 persons.
\333\ The estimate may be overinclusive, as it is unlikely that
all transactions between two non-U.S. persons are arranged,
negotiated, or executed by personnel located in a U.S. branch or
office; it may also be underinclusive, as our TIW data do not
include single-name CDS transactions between two non-U.S. entities
written on non-U.S. underliers, some of which may be arranged,
negotiated, or executed by personnel located in a U.S. branch or
office, or transactions on other types of security-based swaps
(including equity swaps) whether on U.S. or non-U.S. underliers. See
ANE Adopting Release, 81 FR at 8627.
\334\ See ANE Adopting Release, 81 FR at 8627.
\335\ See part VII.B.3.a, infra where we use these estimates to
calculate certain costs associated with an additional alternative.
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8. Estimates of Persons That Potentially May Be Affected by the
Proposed Market Color Guidance
As discussed in part II supra, the ``arranged, negotiated, or
executed'' test has been incorporated within the de minimis counting
standard, the cross-border application of security-based swap dealer
business conduct provisions, and the cross-border application of
Regulation SBSR's regulatory reporting and public dissemination
provisions. The Commission preliminarily believes that the persons that
may rely on this proposed guidance fall into a number of categories,
which we discuss below.
[[Page 24253]]
a. Non-U.S. Dealing Entities That Use Guidance in Connection With
Counting, Business Conduct, and Regulatory Reporting and Public
Dissemination Requirements
Because non-U.S. security-based swap dealers are entities that fall
within the scope of the de minimis counting, business conduct, and
regulatory reporting and public dissemination provisions due to their
dealing activities and their obligations under these provisions depend
in part on the ``arranged, negotiated, or executed'' test, the
Commission preliminarily believes that non-U.S. security-based swap
dealers would be persons that potentially may change their assessment
with respect to compliance with security-based swap dealer regulation
generally as a result of the proposed guidance. Based on 2017 TIW data,
the Commission estimates that up to 22 non-U.S. persons \336\ will
register as security-based swap dealers.
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\336\ This estimate is based on the number of accounts in TIW
data with total notional volume in excess of de minimis thresholds,
increased by a factor of two, to account for any potential growth in
the security-based swap market, to account for the fact that the
Commission is limited in observing transaction records for activity
between non-U.S. persons to those that reference U.S. underliers,
and to account for the fact that the Commission does not observe
security-based swap transactions other than in single-name CDS. See
Business Conduct Adopting Release, 81 FR at 30105 and note 1633
therein.
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b. Non-U.S. Persons That Use Guidance in Connection With de minimis
assessment
A second group of persons that may be affected by the proposed
guidance are non-U.S. persons that may need to assess the amount of
their market-facing activity against the de minimis thresholds solely
because of the inclusion for the purposes of the de minimis threshold
analysis of security-based swap transactions between two non-U.S.
persons that are arranged, negotiated, or executed by personnel located
in the U.S. As discussed elsewhere,\337\ the Commission preliminarily
believes that these non-U.S. persons will incur reporting obligations
under Regulation SBSR in connection with security-based swap
transactions with other non-U.S. persons that are arranged, negotiated,
or executed by U.S. personnel. As discussed in part VII.A.7 above, this
group consists of five non-U.S. persons based on the analysis of 2017
TIW data, which the Commission has increased by a factor of two to 10.
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\337\ See Regulation SBSR Amendments Adopting Release, 81 FR 156
at 53614 & n.657.
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c. Non-U.S. Persons That Use Guidance in Connection With Assessing
Regulatory Reporting and Public Dissemination Requirements
A third group of persons that may be affected by the proposed
guidance are unregistered non-U.S. persons that will incur costs, under
Rule 908(b)(5), to assess whether they engage in security-based swap
transactions with non-U.S. persons that are arranged, negotiated, or
executed by U.S. personnel, and if so, whether they will incur
reporting duties under Rule 901(a)(2)(ii)(E).\338\ The Commission
preliminarily estimates that this group consists of five non-U.S.
persons,\339\ who are in addition to the non-U.S. persons described in
part VII.A.8.b above.
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\338\ See Regulation SBSR Amendments Adopting Release, 81 FR 156
at 53638.
\339\ The Commission has previously estimated that there are
four unregistered non-U.S. persons that will incur assessment costs
as a result of Rule 908(b)(5). See Regulation SBSR Amendments
Adopting Release, 81 FR 156 at 53638 n.919. In light of the changes
in the security-based swap market, as noted in part VII.A.4 supra,
the Commission has updated the estimate using 2017 TIW data and
preliminarily believes that there are five unregistered non-U.S.
persons that will incur assessment costs as a result of Rule
908(b)(5). Because of the relatively low volume of transaction
activity of these five entities during 2017 and the existence of
affiliations with other entities expected to register as security-
based swap dealers, the Commission preliminarily believes that, even
after accounting for growth in the security-based swap market and
acknowledging the limitations of the transaction data available for
analysis, five is a reasonable estimate of the number of
unregistered dealing entities likely to incur assessment costs as a
result of Rule 908(b)(5).
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d. Non-U.S. Persons Affiliated With U.S. Dealing Entities That Consider
Changes to Booking Practices
A fourth group of persons that may be affected by the proposed
guidance are the non-U.S. persons affiliated with those U.S. dealers
that may use U.S. personnel to arrange, negotiate, or execute
transactions with non-U.S. counterparties and book those transactions
to the non-U.S. persons. As discussed in part VII.A.7 above, these U.S.
dealers may have an incentive to engage in such booking practices in
order to utilize the proposed exception to the extent that they wish to
continue using U.S. personnel to arrange, negotiate, or execute
transactions with non-U.S. counterparties and the compliance cost
associated with the proposed exception is less than the cost of
compliance with Title VII requirements and the cost of business
restructuring. As discussed in part VII.A.7 above, the Commission
preliminarily estimates that up to 12 U.S. dealers \340\ potentially
may use the proposed exception. To the extent that each of these
dealers chooses to book transactions subject to the proposed exception
to one unregistered non-U.S. person affiliate, the Commission
preliminarily believes that this fourth group of non-U.S. persons would
consist of 12 unregistered non-U.S. persons. The Commission
preliminarily believes that these non-U.S. persons may incur reporting
duties under Rule 901(a)(2)(ii)(E) \341\ and are in addition to the
non-U.S. persons described in part VII.A.8.c above.
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\340\ This is calculated as the six U.S. dealers identified in
2017 TIW data increased by a factor of 2 to 12.
\341\ See Regulation SBSR Amendments Adopting Release, 81 FR 156
at 53638.
---------------------------------------------------------------------------
All told, the Commission preliminarily believes that up to 49 non-
U.S. persons \342\ potentially may be affected by the proposed
guidance.
---------------------------------------------------------------------------
\342\ Calculated as 22 non-U.S. dealing entities that use the
proposed guidance in connection with counting, business conduct, and
regulatory reporting and public dissemination requirements (part
VII.A.8.a) + 10 non-U.S. persons that use the proposed guidance in
connection with de minimis assessment (part VII.A.8.b) + 5 non-U.S.
persons that use the proposed guidance in connection with assessing
regulatory reporting and public dissemination requirements (part
VII.A.8.c) + 12 non-U.S. persons affiliated with U.S. dealing
entities that consider changes to booking practices (part VII.A.8.d)
= 49 non-U.S. persons.
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9. Statutory Disqualification
In the Rule of Practice 194 Adopting Release, the Commission
analyzed, among others, data on the number of natural persons
associated with SBS Entities, applications for review under parallel
review processes, and relevant research on statutory disqualification.
In that release, the Commission estimated that SBS Entities may file up
to five applications per year with respect to their associated natural
persons. A more detailed discussion of these data and estimates can be
found in that release.\343\ If associated natural persons who become
statutorily disqualified are located outside of the U.S. and transact
exclusively with foreign counterparties and foreign branches of U.S.
counterparties, the proposal may decrease the number of these
applications for relief and corresponding direct costs. Based on the
Commission's experience with broker-dealers and on the Commission's
understanding of current market activity in security-based swaps, the
Commission preliminarily estimates that the proposed exclusion may
reduce the number of applications under Rule
[[Page 24254]]
of Practice 194 by between zero and two applications.
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\343\ See Rule of Practice 194 Adopting Release, 84 FR at 4925.
---------------------------------------------------------------------------
10. Certification, Opinion of Counsel, and Employee Questionnaires
As a baseline matter, SBS Entity Registration rules, including Rule
15Fb2-1 and the certification and opinion of counsel requirements in
Rule 15Fb2-4, have been adopted but compliance with registration rules
is not yet required.
In addition, Rule 17a-3(a)(12) requires all broker-dealers,
including broker-dealers that may seek to register with the Commission
as SBS Entities, to make and keep current a questionnaire or
application for employment for each associated person. In the
Recordkeeping and Reporting Proposing Release, the Commission proposed
a parallel requirement, in Rule 18a-5, for stand-alone and bank SBS
Entities. The Commission is proposing modifications to proposed Rule
18a-5(a)(10) and Rule 18a-5(b)(8). Based on 2017 TIW data, of 22 non-
U.S. persons that may register with the Commission as security-based
swap dealers, the Commission estimates that approximately 12 security-
based swap dealers will be foreign banks and another 3 will be foreign
stand-alone security-based swap dealers that may be affected by these
proposed modifications.
B. Proposed Amendment to Rule 3a71-3
This section discusses the potential costs and benefits associated
with the proposed amendment to Rule 3a71-3, the effects of the proposed
amendment on efficiency, competition, and capital formation, and
alternative approaches to the proposed amendment. The Commission's
analysis considers the costs and benefits of both Alternative 1 and
Alternative 2. Because many of the conditions associated with the
exception are the same in both proposed alternatives, the Commission
expects them to produce many of the same economic consequences. Where
the Commission believes those costs and benefits would be the same
under either proposed alternative, they are discussed together. Where
the costs and benefits may differ, they are discussed separately.
Under either Alternative 1 or Alternative 2, each person that
engages in arranging, negotiating, and executing activity with non-U.S.
counterparties using affiliated U.S.-based personnel would have two
possible options for complying with the Commission's Title VII
regulations regarding the cross-border application of the ``security-
based swap dealer'' definition. The first option would be for the
persons to follow current security-based swap dealer counting
requirements without regard for the exception afforded by the proposed
amendment (whichever alternative is adopted). Specifically, a person
could opt to incur the assessment costs to determine (i) whether any
portion of their security-based swap transaction activities must be
counted against the dealer de minimis thresholds, and (ii) whether the
total notional amount of relevant transaction activities exceeds the de
minimis threshold.\344\ If the amount of its activities crosses the de
minimis thresholds, then the person would have to register as a
security-based swap dealer and become subject to Title VII security-
based swap dealer requirements. A person that chooses to comply in this
manner would experience no incremental economic effects under the
proposed alternative as compared to the baseline.
---------------------------------------------------------------------------
\344\ See part I.A.2, supra.
---------------------------------------------------------------------------
The second option would be to rely on the exception afforded by the
proposed amendment (whichever alternative is adopted). Under the
proposed amendment, a person could register one entity as a registered
security-based swap dealer (under both proposed alternatives) or as a
registered broker (only under Alternative 2) \345\ to arrange,
negotiate, or execute transactions with non-U.S. counterparties on its
behalf using personnel located in a U.S. branch or office. Doing so
could allow it to avoid the direct regulation of itself (or multiple
affiliated entities) as a security-based swap dealer. A person that
chooses to use this exception and incur the associated costs to meet
the conditions of this exception, detailed below, likely would not
incur assessment costs with respect to security-based swap transactions
with non-U.S. counterparties that are arranged, negotiated, or executed
by personnel located in the United States.
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\345\ Under Alternative 2, registration may not be required if,
as discussed in part VII.A.7, supra, persons who may take advantage
of this exception already have a registered broker-dealer affiliate
and choose to use their existing registered broker-dealer affiliate
to take advantage of the exception. See also part VII.B.1.a, infra.
---------------------------------------------------------------------------
As discussed above, the Commission preliminarily believes that up
to 24 \346\ persons potentially may use the proposed exception to the
extent that the compliance costs associated with the proposed exception
are lower than the compliance costs in the absence of the proposed
exception.
---------------------------------------------------------------------------
\346\ See part VII.A.7, supra.
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1. Costs and Benefits of the Proposed Amendment
The Commission preliminarily believes that the proposed amendment
would provide increased flexibility to security-based swap market
participants to comply with the Title VII framework while preserving
their existing business practices. This could reduce their compliance
burdens, while supporting the Title VII regime's benefit of mitigating
risks in foreign security-based swap markets that may flow into U.S.
financial markets through liquidity spillovers. The Commission also
preliminarily believes that the amendments could reduce market
fragmentation and associated distortions. At the same time, and as
detailed later in this section, the Commission acknowledges that the
proposed amendment potentially limits certain other programmatic
benefits of the Title VII regime by excusing security-based swap market
participants that elect to use the exception from some of the Title VII
requirements that would otherwise apply to their activity. The
Commission preliminarily believes that the proposed amendment will
result in compliance costs for persons that elect to use the exception,
as described below. However, the Commission expects that persons will
elect to incur those costs only where it would be less costly than
either complying with the Title VII framework or restructuring to avoid
using U.S. personnel to arrange, negotiate, or execute transactions
with non-U.S. counterparties.
[[Page 24255]]
a. Costs and Benefits for Persons That May Use the Proposed Amendment
The primary benefit of the proposed amendment is that it would
permit a person further flexibility to opt into a Title VII compliance
framework that is compatible with its existing business practices.
While the registered U.S. person would be the entity adhering to most
of the conditions set forth in the proposed amendment and the non-U.S.
person would be responsible for complying with some of the other
conditions,\347\ for the purposes of this analysis, the Commission
assumes that the costs of complying with these conditions will be
passed on to the non-U.S. person affiliate. In the absence of the
proposed amendment, a non-U.S. person could incur the cost of
registering as a security-based swap dealer and a financial group may
incur the cost of registering at least one security-based swap dealer
\348\ due to the ``arranged, negotiated, or executed'' counting
test.\349\ The non-U.S. person or group accordingly would incur the
cost necessary for compliance with the full set of security-based swap
dealer requirements by one or more registered security-based swap
dealers. These burdens, contingent on exceeding the de minimis
threshold, are in addition to the assessment costs that the non-U.S.
person would incur to identify and count relevant market-facing
activity toward the de minimis threshold.
---------------------------------------------------------------------------
\347\ See, e.g., proposed Alternative 1--proposed paragraph
(d)(1)(iii)(A) of Rule 3a71-3.
\348\ The available data limit the Commission's ability to
discern the multiple different legal entities each of which engages
in security-based swap market-facing activity at levels above the de
minimis thresholds because the way in which non-U.S. persons
organize their dealing business may not align with the way their
transaction volumes are accounted for in TIW. In particular, it is
possible that some of the 10 non-U.S. persons identified in the TIW
data as potential registrants aggregate transaction volumes of
multiple non-U.S. person dealers. In such cases, the exclusion of
transactions between these non-U.S. person dealers and non-U.S.
counterparties from the de minimis calculations may result in
multiple non-U.S. person dealers no longer meeting the de minimis
threshold.
\349\ See id.
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As discussed in the ANE Adopting Release, such a non-U.S. person
could respond to these costs by restructuring its security-based swap
business to avoid using U.S. personnel to arrange, negotiate, or
execute transactions with non-U.S. counterparties. Such a strategy
would allow the non-U.S. person to avoid counting transactions between
the non-U.S. person and its non-U.S. counterparties toward the non-U.S.
person's de minimis threshold. In addition to reducing the likelihood
of incurring the programmatic costs associated with the full set of
security-based swap dealer requirements under Title VII, this response
to current requirements could reduce the assessment costs associated
with counting transactions toward the de minimis threshold and fully
abrogate the need to identify transactions with non-U.S. counterparties
that involve U.S. personnel.\350\
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\350\ In 2016, the Commission estimated a cost of $410,000 per
entity to establish systems to identify market-facing activity
arranged, negotiated, or executed using U.S. personnel and $6,500
per entity per year for training, compliance and verification costs.
See ANE Adopting Release, 81 FR at 8627. Adjusted for inflation,
these amounts are approximately $435,000 and $6,900 in 2018 dollars.
---------------------------------------------------------------------------
However, the Commission also noted in the ANE Adopting Release that
restructuring is itself costly. To reduce the costs of assessment and
potential dealer registration, a non-U.S. person may need to incur
costs to ensure that U.S. personnel are not involved in arranging,
negotiating, or executing transactions with non-U.S. counterparties.
The Commission was able to quantify some, but not all of the costs of
restructuring in the ANE adopting release.\351\ As discussed above in
part VII.A.2.d, non-U.S. persons may make their location decisions
based on business considerations such as maintaining 24-hour operations
or the value of local market expertise. Thus, restructuring business
lines or relocating personnel (or the activities performed by U.S.
personnel) to avoid the United States could result in less efficient
operations for non-U.S. persons active in the security-based swap
market.
---------------------------------------------------------------------------
\351\ In 2016, the Commission estimated it would cost
approximately $28,300 per entity to establish 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 market-facing activity. See ANE Adopting
Release, 81 FR at 8628. Adjusted for inflation, this is
approximately $30,000. The Commission notes that the foregoing is
one of the ways in which a non-U.S. person might choose to
restructure its business activities. Other restructuring methods,
such as the relocation of U.S. personnel to locations outside the
United States, potentially would be more costly.
---------------------------------------------------------------------------
The proposed exception would benefit non-U.S. persons by offering
them an alternative to costly relocation or restructuring that would
still permit them to avoid some of the costs associated with assessing
their market-facing activity while also reducing the likelihood that
their market-facing activity crosses the de minimis threshold. As
discussed in detail below, the availability of the proposed exception
would be conditioned on the use of a registered entity and compliance
with certain Title VII requirements designed to protect counterparties
but not all Title VII requirements. To the extent that the costs of
compliance with these proposed conditions as part of Alternative 1 and
Alternative 2 are lower than the compliance costs in the absence of the
proposed amendment and the costs of business restructuring, the
exception could reduce the regulatory cost burden for the non-U.S.
person or group.
The Commission recognizes that U.S.-based dealing entities may use
the proposed exception by booking transactions with non-U.S.
counterparties into non-U.S. affiliates, thereby avoiding the
application of the full set of security-based swap dealer requirements
to those transactions and the associated security-based swaps.\352\ As
discussed further in part VII.B.1.b infra, U.S.-based dealing entities
that use the conditional exception in this manner may benefit by
incurring lower compliance costs when providing liquidity to non-U.S.
counterparties.
---------------------------------------------------------------------------
\352\ See parts III.A and VII.A.7, supra.
---------------------------------------------------------------------------
The Commission's designation of a listed jurisdiction by order
could signal to non-U.S. counterparties that a non-U.S. person was
subject to a regulatory regime that, at a minimum, is consistent with
the public interest in terms of financial responsibility requirements,
the jurisdiction's supervisory compliance program, the enforcement
authority in connection with those requirements, and other factors the
Commission may consider. This process potentially provides a
certification benefit to non-U.S. persons availing themselves of the
proposed exception by demonstrating to non-U.S. counterparties the
applicability of regulatory requirements that would be in the public
interest.
Table 2 summarizes the quantifiable costs the Commission estimates
non-U.S. persons could incur as a result of the conditions associated
with the proposed exception. The per-entity cost estimates assume the
de novo formation of a security-based swap dealer or broker-dealer. The
Commission expects that these are likely upper bounds for per-entity
costs for two reasons. First, non-U.S. persons may already be regulated
by jurisdictions with similar requirements and, as a consequence of
foreign regulatory requirements, may already have established
infrastructure, policies, and procedures that would facilitate meeting
the conditions of the proposed exception. For example, a non-U.S.
person regulated by a jurisdiction with similar trade acknowledgement
and verification requirements would likely already have an order
management system in place capable of complying with Rule 15Fi-2,
[[Page 24256]]
making development of a novel system for the purpose of taking
advantage of the proposed exception unnecessary. Second, non-U.S.
persons that already have an affiliated registered security-based swap
dealer (under Alternative 1 or 2) or an affiliated registered broker-
dealer (under Alternative 2) likely would use their existing registered
affiliates to rely on the proposed exception rather than register new
entities.
Table 2--Estimates of Quantifiable Costs Associated With Proposed Amendment to Rule 3a71-3 \353\
----------------------------------------------------------------------------------------------------------------
Initial costs Ongoing costs
---------------------------------------------------------------
Per entity Aggregate Per entity Aggregate
----------------------------------------------------------------------------------------------------------------
Registered entity:
Security-based swap dealer registration..... $514,000 $12,336,000 $2,705 * $64,920
Security-based swap dealer capital .............. .............. 3,000,000 72,000,000
requirement................................
Applicable SBSD requirements................ 11,688,700 280,528,800 522,900 12,549,600
Recordkeeping:
If registered entity is a 437,444 10,498,656 101,278 2,430,672
registered security-based swap dealer
and registered broker-dealer...........
If registered entity is a stand- 231,988 5,567,712 59,541 1,428,984
alone registered SBSD..................
If registered entity is a bank 178,534 4,284,816 42,952 1,030,848
registered SBSD........................
Trading relationship documentation.............. 3,000 72,000 3,528 84,672
Consent to service of process................... 409 9,816 .............. ..............
Broker-dealer registration \354\................ 291,500 7,000,000 53,000 1,272,000
Broker-dealer capital requirement \355\......... .............. .............. 35,300 847,200
Non-U.S. entity:
Trading relationship documentation.......... 3,000 72,000 7,056 169,344
Consent to service of process............... 409 9,816 .............. ..............
Disclosure of limited Title VII * 29,715 [dagger] .............. ..............
applicability.............................. 713,160
``Listed jurisdiction'' applications............ 115,920 347,760 .............. ..............
----------------------------------------------------------------------------------------------------------------
* and 100 hours.
[dagger] and 2,400 hours.
Under Alternative 1, if a non-U.S. person, or its affiliated group,
seeks to utilize the exception, that person, or its affiliated group,
would incur the cost of registering one U.S. based entity as a
security-based swap dealer (if there otherwise is not an affiliated
security-based swap dealer present).\356\ The Commission estimates per
entity initial costs of registering a security-based swap dealer of
approximately $514,000.\357\ In addition, the non-U.S. person or its
affiliated group would incur ongoing costs associated with its
registered security-based swap dealer of approximately $2,705.\358\
Based on the Commission's estimate that up to 24 \359\ persons might
avail themselves of Alternative 1, the aggregate initial costs
associated with registering security-based swap dealers under
Alternative 1 would be approximately $12,336,000 and the aggregate
ongoing costs would be approximately $64,920.\360\ The U.S. person
affiliate of such a non-U.S. person or affiliated group would also be
required to meet minimum capital requirements as a registered security-
based swap dealer.\361\ At a minimum, the Commission estimates the
ongoing cost of this capital to be approximately $3 million \362\ per
entity and $72 million in aggregate.\363\ To the extent that this
capital is held in liquid assets \364\ that
[[Page 24257]]
generate a positive return to the registered security-based swap
dealer, that positive return could be used to offset, at least in part,
the ongoing cost of capital.
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\353\ Unless otherwise stated, cost estimates presented in Table
2 apply to both Alternatives 1 and 2.
\354\ Cost applicable only to Alternative 2.
\355\ Cost applicable only to Alternative 2.
\356\ This is a Title VII programmatic cost and is in addition
to other Title VII programmatic costs discussed in part VII.B.1.b,
infra.
\357\ These estimates incorporate quantifiable initial costs
presented in the Registration Adopting Release, 80 FR at 48990-48995
and 49005-49006, adjusted for CPI inflation using data from the
Bureau of Labor Statistics between 2015 and 2018. Specifically, per
entity initial costs are estimated in 2015 dollars as $11,886
(filing Form SBSE) + $12,125 (senior officer certification) +
$410,310 (associated natural person certifications) + $24,735
(associated entity person certifications) + $25,424.50 (initial
filing of Schedule F) = $484,480.50, and adjusted by 1.06 to
$513,549.30 or approximately $514,000 in current dollars.
\358\ These estimates incorporate quantifiable annual costs
presented in the Registration Adopting Release, 80 FR at 48990-48995
and 49005-49006, adjusted for CPI inflation using data from the
Bureau of Labor Statistics between 2015 and 2018. Specifically,
ongoing costs are estimated in 2015 dollars as $849 (amending Form
SBSE) + $1,373.25 (amending Schedule F) + $46.31 (retaining
signature pages) + $283 (filing withdrawal form) = $2,551.56, and
adjusted by 1.06 to $2,704.65 or approximately $2,705 in current
dollars.
\359\ See part VII.A.7, supra.
\360\ Aggregate initial costs calculated as 24 x $514,000 =
$12,336,000. Aggregate ongoing costs calculated as 24 x $2,705 =
$64,920.
\361\ Under proposed rules, a registered non-bank security-based
swap dealer may be subject to minimum fixed-dollar capital
requirements of $20 million or $1 billion in net capital and $100
million or $5 billion in tentative net capital, depending in part on
whether it is a stand-alone security-based swap dealer or a
security-based swap dealer that is dually registered as a broker-
dealer, and on whether it uses models to compute deductions for
market and credit risk. See Capital, Margin and Segregation
Proposing Release, 77 FR at 70329, 70333. Registered security-based
swap dealers that have a prudential regulator must comply with
capital requirements that the prudential regulators have prescribed.
See 80 FR 74840 (Nov. 30, 2015) (adopting capital requirements for
bank security-based swap dealers).
\362\ This estimation assumes that the registered entity must
maintain a minimum of $20 million in net capital. See note 361,
supra. The Commission estimated the cost of capital in two ways.
First, the time series of average return on equity for all U.S.
banks between the fourth quarter 1983 and the first quarter 2018
(see Federal Financial Institutions Examination Council (US), Return
on Average Equity for all U.S. Banks [USROE], retrieved from FRED,
Federal Reserve Bank of St. Louis on December 7, 2018, available at
https://fred.stlouisfed.org/series/USROE), are averaged to arrive at
an estimate of 11.26%. The cost of capital is calculated as 11.26% x
$20 million = $2.252 million or approximately $2.3 million. The
Commission preliminarily believes that use of the historical return
on equity for U.S. banks adequately captures the cost of capital
because of the 12 persons that potentially may use the proposed
exception, eight are banks and three have bank affiliates. See part
VII.A.7 supra. To the extent that this approach does not adequately
capture the cost of capital of persons that are not banks or have no
bank affiliates, the Commission supplements the estimation by also
using the annual stock returns on financial stocks to calculate the
cost of capital. With this second approach, the annual stock returns
on a value-weighted portfolio of financial stocks from 1983 to 2017
(see Professor Ken French's website, available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html)
are averaged to arrive at an estimate of 16.96%. The cost of capital
is calculated as 16.96% x $20 million = $3.392 million or
approximately $3.4 million. The final estimate of the cost of
capital is the average of $2.3 million and $3.4 million = (2.3 +
3.4)/2 = $2.85 million or approximately $3 million.
\363\ Aggregate costs calculated as $3 million x 24 entities =
$72 million.
\364\ See Capital, Margin and Segregation Proposing Release, 77
FR at 70219.
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In addition to registering security-based swap dealers, U.S. person
affiliates of non-U.S. persons seeking to rely on Alternative 1 would
be required to comply with applicable security-based swap dealer
requirements, including those related to disclosures of risks,
characteristics, incentives, and conflicts of interest, suitability,
communications, trade acknowledgment and verification, and portfolio
reconciliation.\365\ The Commission estimates initial costs associated
with these requirements of up to approximately $11,688,700 per
entity,\366\ or up to $280,528,800 in aggregate,\367\ and ongoing costs
associated with these requirements of approximately $522,900 per
entity,\368\ or up to $12,549,600 in aggregate.\369\
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\365\ See proposed Rule 3a71-3(d)(1)(ii)(B). The costs of
complying with applicable security-based swap dealer requirements
under proposed Alternative 1 are Title VII programmatic costs and
are in addition to other Title VII programmatic costs discussed in
part VII.B.1.b, infra.
\366\ These estimates incorporate quantifiable initial costs
presented in the Business Conduct Adopting Release, 81 FR at 30092-
30093, 30111, 30117, 30126, the Trade Acknowledgement and
Verification Adopting Release, 81 FR at 39839, and the Risk
Mitigation Proposing Release, 84 FR at 4658-4659, adjusted for CPI
inflation, where applicable, using data from the Bureau of Labor
Statistics between 2016 and 2018. Specifically, initial costs
associated with disclosures, suitability, communications, and trade
acknowledgement and verification are estimated in 2016 dollars as
$906,666.67 (disclosures) + $ 523,640 (suitability) + $16,680
(communications) + $128,550 (trade acknowledgement and verification)
= $1,575,536.67, and adjusted by 1.05 to $1,654,313.50 in current
dollars. The cost associated with disclosures has been adjusted to
account for the fact that the disclosures of clearing rights and
daily mark are not part of proposed paragraph (d)(1)(ii)(B)(1) of
Rule 3a71-3. Initial costs associated with portfolio reconciliation
are estimated in current dollars as $10,034,360. Per entity initial
costs = $1,654,313.50 + $10,034,360 = $11,688,673.50 or
approximately $11,688,700.00.
\367\ Aggregate initial costs = Per entity initial costs of
$11,688,700.00 x 24 entities = $280,528,800.
\368\ These estimates incorporate quantifiable ongoing costs
presented in the Business Conduct Adopting Release, 81 FR at 30092-
30093, 30111, 30126, the Trade Acknowledgement and Verification
Adopting Release, 81 FR at 39839, and the Risk Mitigation Proposing
Release, 84 FR at 4658-4659, adjusted for CPI inflation, where
applicable, using data from the Bureau of Labor Statistics between
2016 and 2018. Specifically, ongoing costs associated with
disclosures, communications, and trade acknowledgement and
verification are estimated in 2016 dollars as $392,533.33
(disclosures) + $89,094 (trade acknowledgement and verification) =
$481,627.33, and adjusted by 1.05 to $505,708.70 in current dollars.
The cost associated with disclosures has been adjusted to account
for the fact that the disclosures of clearing rights and daily mark
are not part of proposed paragraph (d)(1)(ii)(B)(1) of Rule 3a71-3.
Ongoing costs associated with portfolio reconciliation are estimated
in current dollars as $17,180. Per entity ongoing costs =
$505,708.70 + $17,180 = $522,888.70 or approximately $522,900.
\369\ Aggregate ongoing costs = Per entity ongoing costs of
$522,900 x 24 entities = $12,549,600.
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Under Alternative 1, the registered security-based swap dealer also
would be responsible for creating and maintaining books and records
related to the transactions subject to the exception that are required,
as applicable, by Exchange Act Rules 18a-5 and 18a-6, including any
books and records requirements relating to the provisions specified in
proposed paragraph (d)(1)(iii)(B).\370\ If the registered security-
based swap dealer is also a registered broker-dealer, then it would
need to comply with Exchange Act Rules 17a-3 and 17a-4. The Commission
estimates the initial costs associated with these rules to be
approximately $437,444 per entity,\371\ or up to $10,498,656 in
aggregate,\372\ and ongoing costs associated with these rules of
approximately $101,278 per entity,\373\ or up to $2,430,672 in
[[Page 24258]]
aggregate.\374\ If the registered security-based swap dealer is a
stand-alone registered security-based swap dealer, then it would need
to comply with Exchange Act Rules 18a-5 and 18a-6. The Commission
estimates the initial costs associated with these rules to be
approximately $231,988 per entity,\375\ or up to $5,567,712 in
aggregate,\376\ and ongoing costs associated with these rules of
approximately $59,541 per entity,\377\ or up to $1,428,984 in
aggregate.\378\ The discussion in part VII.A.7 above suggests that a
number of the persons that may make use of the proposed exception
likely would be banks.\379\ In light of this finding, the Commission
also presents cost estimates associated with Exchange Act Rules 18a-5
and 18a-6 under the assumption that the registered security-based swap
dealer is a bank registered security-based swap dealer. The Commission
estimates the initial costs associated with these rules to be
approximately $178,534 per entity,\380\ or up to $4,284,816 in
aggregate,\381\ and ongoing costs associated with these rules of
approximately $42,952 per entity,\382\ or up to $1,030,848 in
aggregate.\383\
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\370\ See proposed paragraph (d)(1)(iii)(B) of Rule 3a71-3.
\371\ The per entity initial costs associated with proposed
amendments to Exchange Act Rule 17a-3 (assuming the entity is not an
ANC broker-dealer) = 150 hours x $283/hour national hourly rate for
a compliance manager = $42,450 (See Recordkeeping Proposing Release,
79 FR at 25262 for burden hours). The $283 per hour figure for a
compliance manager is from SIFMA's Management & Professional
Earnings in the Securities Industry 2013, as modified by Commission
staff to account for an 1,800-hour work-year, and multiplied by 5.35
to account for bonuses, firm size, employee benefits, and overhead.
See Recordkeeping Proposing Release, 79 FR at 25295 n.1403.
To estimate the per entity initial costs associated with current
Exchange Act Rule 17a-3, the Commission assumes these costs are
proportional to the per entity ongoing costs associated with current
Exchange Act Rule 17a-3. Further, the Commission assumes that this
proportion is equal to the proportion of per entity initial costs to
per entity ongoing costs associated with proposed amendments to
Exchange Act Rule 17a-3. As discussed in note 373 infra, the
Commission estimates the per entity ongoing costs associated with
proposed amendments to Exchange Act Rule 17a-3 as $12,288. The
proportion of per entity initial costs to per entity ongoing costs
associated with proposed amendments to Exchange Act Rule 17a-3 is
$42,450/$12,288 or approximately 3.5. The per entity initial costs
associated with current Exchange Act Rule 17a-3 is estimated as 3.5
x $53,880.83 (per entity ongoing costs associated with current
Exchange Act Rule 17a-3, see note 373 infra) = $188,582.91.
The per entity initial costs associated with proposed amendments
to Exchange Act Rule 17a-4 (assuming the entity is not an ANC
broker-dealer) = 156 hours x $312/hour national hourly rate for a
senior database administrator = $48,672. (See Recordkeeping
Proposing Release, 79 FR at 25265 for burden hours). The $312 per
hour figure for a senior database administrator is from SIFMA's
Management & Professional Earnings in the Securities Industry 2013,
as modified by Commission staff to account for an 1,800-hour work-
year, and multiplied by 5.35 to account for bonuses, firm size,
employee benefits, and overhead.
To estimate the per entity initial costs associated with current
Exchange Act Rule 17a-4, the Commission assumes these costs are
proportional to the per entity ongoing costs associated with current
Exchange Act Rule 17a-4. Further, the Commission assumes that this
proportion is equal to the proportion of per entity initial costs to
per entity ongoing costs associated with proposed amendments to
Exchange Act Rule 17a-4. As discussed in note 373 infra, the
Commission estimates the per entity ongoing costs associated with
proposed amendments to Exchange Act Rule 17a-4 as $7,928. The
proportion of per entity initial costs to per entity ongoing costs
associated with proposed amendments to Exchange Act Rule 17a-4 is
$48,672/$7,928 or approximately 6.2. The per entity initial costs
associated with current Exchange Act Rule 17a-4 is estimated as 6.2
- $21,448 (per entity ongoing costs associated with current Exchange
Act Rule 17a-4, see note 373 infra) = $132,977.60.
The per entity initial costs associated with amendments to
Exchange Act Rules 17a-3 and 17a-4 = $42,450 + $188,582.91 + 48,672
+ $132,977.60 = $412,682.51, and adjusted by 1.06 CPI inflation
between 2014 and 2018 (from the Bureau of Labor Statistics) to
$437,443.46 in current dollars or approximately $437,444.
\372\ Aggregate initial costs = Per entity initial costs of
$437,444 x 24 entities = $10,498,656.
\373\ The per entity ongoing costs associated with current
Exchange Act Rule 17a-3 = 673.40 hours x $64/hour national hourly
rate for a compliance clerk + per entity external costs of
$10,783.23 = $53,880.83. Per entity ongoing burden hours = total
burden hours of 2,763,612/4,104 broker-dealer respondents = 673.40
hours. Per entity external costs = total external costs of
$44,254,361/4,104 broker-dealer respondents = $10,783.23. For number
of respondents, total burden hours, and total external costs, see
Commission, ``Supporting Statement for the Paperwork Reduction Act
Information Collection Submission for Rule 17a-3'' (Mar. 9, 2017),
available at https://www.reginfo.gov/public/do/DownloadDocument?objectID=72125401. The $64 per hour figure for a
compliance clerk is from SIFMA's Office Salaries in the Securities
Industry 2013, as modified by Commission staff to account for an
1,800-hour work-year, and multiplied by 2.93 to account for bonuses,
firm size, employee benefits, and overhead.
The per entity ongoing costs associated with proposed amendments
to Exchange Act Rule 17a-3 (assuming the entity is not an ANC
broker-dealer) = 192 hours x $64/hour national hourly rate for a
compliance clerk = $12,288 (See Recordkeeping Proposing Release, 79
FR at 25262 for burden hours).
The per entity ongoing costs associated with current Exchange
Act Rule 17a-4 = 257 hours x $64/hour national hourly rate for a
compliance clerk + per entity external costs of $5,000 = $21,448.
See Commission, ``Supporting Statement for the Paperwork Reduction
Act Information Collection Submission for Rule 17a-4'' (Oct. 19,
2016), available at https://www.reginfo.gov/public/do/DownloadDocument?objectID=68823501.
The per entity on going costs associated with proposed
amendments to Exchange Act Rule 17a-4 (assuming the entity is not an
ANC broker-dealer) = 72 hours x $64/hour national hourly rate for a
compliance clerk + per entity external costs of $3,320 = $7,928 (See
Recordkeeping Proposing Release, 79 FR at 25265 for burden hours and
external costs).
The total per entity ongoing costs = $53,880.83 + $12,288 +
$21,448 + $7,928 = $95,544.83, and adjusted by 1.06 CPI inflation
between 2014 and 2018 (from the Bureau of Labor Statistics) to
$101,277.52 in current dollars or approximately $101,278.
\374\ Aggregate ongoing costs = Per entity ongoing costs of
$101,278 x 24 entities = $2,430,672.
\375\ The per entity initial costs associated with Exchange Act
Rule 18a-5 (assuming that the stand-alone registered security-based
swap dealer does not have a prudential regulator and is not an ANC
stand-alone registered security-based swap dealer) = 320 hours x
$283/hour national hourly rate for a compliance manager + per entity
external costs of $1,000 = $91,560 (See Recordkeeping Proposing
Release, 79 FR at 25262 for burden hours and external costs). See
note 371, supra, for a derivation of the national hourly rate for a
compliance manager.
The per entity initial costs associated with Exchange Act Rule
18a-6 (assuming that the stand-alone registered security-based swap
dealer does not have a prudential regulator and is not an ANC stand-
alone registered security-based swap dealer) = 408 hours x $312/hour
national hourly rate for a senior database administrator = $127,296
(See Recordkeeping Proposing Release, 79 FR at 25265 for burden
hours). See note 371, supra, for a derivation of the national hourly
rate for a senior database administrator.
The per entity initial costs associated with Exchange Act Rules
18a-5 and 18a-6 = $91,560 + 127,296 = $218,856, and adjusted by 1.06
CPI inflation between 2014 and 2018 (from the Bureau of Labor
Statistics) to $231,987.36 in current dollars or approximately
$231,988.
\376\ Aggregate initial costs = Per entity initial costs of
$231,988 x 24 entities = $5,567,712.
\377\ The per entity ongoing costs associated with Exchange Act
Rule 18a-5 (assuming that the stand-alone registered security-based
swap dealer does not have a prudential regulator and is not an ANC
stand-alone registered security-based swap dealer) = 400 hours x
$64/hour national hourly rate for a compliance clerk + per entity
external costs of $4,650 = $30,250 (See Recordkeeping Proposing
Release, 79 FR at 25262 for burden hours and external costs). See
note 373, supra, for a derivation of the national hourly rate for a
compliance clerk.
The per entity ongoing costs associated with Exchange Act Rule
18a-6 (assuming that the stand-alone registered security-based swap
dealer does not have a prudential regulator and is not an ANC stand-
alone registered security-based swap dealer) = 310 hours x $64/hour
national hourly rate for a compliance clerk + per entity external
costs of $6,080 = $25,920. (See Recordkeeping Proposing Release, 79
FR at 25265 for burden hours and external costs).
The per entity ongoing costs associated with Exchange Act Rules
18a-5 and 18a-6 = $30,250 + 25,920 = $56,170, and adjusted by 1.06
CPI inflation between 2014 and 2018 (from the Bureau of Labor
Statistics) to $59,540.20 in current dollars or approximately
$59,541.
\378\ Aggregate ongoing costs = Per entity ongoing costs of
$59,541 x 24 entities = $1,428,984.
\379\ See part VII.A.7, supra, stating that of the 12 persons
identified in 2017 TIW data as potential users of the proposed
exception, eight are banks.
\380\ The per entity initial costs associated with Exchange Act
Rule 18a-5 (assuming that the registered security-based swap dealer
has a prudential regulator) = 260 hours x $283/hour national hourly
rate for a compliance manager = $73,580 (See Recordkeeping Proposing
Release, 79 FR at 25262 for burden hours). See note 371, supra, for
a derivation of the national hourly rate for a compliance manager.
The per entity initial costs associated with Exchange Act Rule
18a-6 (assuming that the registered security-based swap dealer has a
prudential regulator) = 304 hours x $312/hour national hourly rate
for a senior database administrator = $94,848 (See Recordkeeping
Proposing Release, 79 FR at 25265 for burden hours). See note 371,
supra, for a derivation of the national hourly rate for a senior
database administrator.
The per entity initial costs associated with Exchange Act Rules
18a-5 and 18a-6 = $73,580 + $94,848 = $168,428, and adjusted by 1.06
CPI inflation between 2014 and 2018 (from the Bureau of Labor
Statistics) to $178,533.68 in current dollars or approximately
$178,534.
\381\ Aggregate initial costs = Per entity initial costs of
$178,534 x 24 entities = $4,284,816.
\382\ The per entity ongoing costs associated with Exchange Act
Rule 18a-5 (assuming that the registered security-based swap dealer
has a prudential regulator) = 325 hours x $64/hour national hourly
rate for a compliance clerk = $20,800 (See Recordkeeping Proposing
Release, 79 FR at 25262 for burden hours). See note 373, supra, for
a derivation of the national hourly rate for a compliance clerk.
The per entity ongoing costs associated with Exchange Act Rule
18a-6 (assuming that the registered security-based swap dealer has a
prudential regulator) = 230 hours x $64/hour national hourly rate
for a compliance clerk + per entity external costs of $5,000 =
$19,720. (See Recordkeeping Proposing Release, 79 FR at 25265 for
burden hours and external costs).
The per entity ongoing costs associated with Exchange Act Rules
18a-5 and 18a-6 = $20,800 + 19,720 = $40,520, and adjusted by 1.06
CPI inflation between 2014 and 2018 (from the Bureau of Labor
Statistics) to $42,951.20 in current dollars or approximately
$42,952.
\383\ Aggregate ongoing costs = Per entity ongoing costs of
$42,952 x 24 entities = $1,030,848.
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The registered security-based swap dealer also must obtain from the
non-U.S. person relying on the exception, and maintain, documentation
encompassing all terms governing the trading relationship between the
non-U.S. person and its counterparty relating to the transactions
subject to this exception, including, without limitation, terms
addressing payment obligations, netting of payments, events of default
or other termination events, calculation and netting of obligations
upon termination, transfer of rights and obligations, allocation of any
applicable regulatory reporting obligations, governing law, valuation,
and dispute resolution.\384\ The Commission preliminarily believes that
both the registered entity and its non-U.S. affiliate will incur costs
to comply with this condition. However as discussed above, the
Commission preliminarily believes that the costs incurred by the
registered entity would be passed on to the non-U.S. affiliate.\385\
For registered entities, the Commission estimates the initial costs
associated with this condition to be approximately $3,000 per
registered entity,\386\ or up to $72,000 in aggregate,\387\ and ongoing
costs associated with this condition of approximately $3,528 per
registered entity,\388\ or up to $84,672 in
[[Page 24259]]
aggregate.\389\ For non-U.S. entities, the Commission estimates the
initial costs associated with this condition to be approximately $3,000
per non-U.S. entity,\390\ or up to $72,000 in aggregate,\391\ and
ongoing costs associated with this condition of approximately $7,056
per non-U.S. entity,\392\ or up to $169,344 in aggregate.\393\
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\384\ See note 370, supra.
\385\ See part VIII.A.4.e, infra.
\386\ Per entity initial costs = 10 hours x $283/hour national
hourly rate for a compliance manager = $2,830. See note 371, supra,
for a derivation of the national hourly rate for a compliance
manager. Adjusting for CPI inflation using data from the Bureau of
Labor Statistics between 2014 and 2018, the per entity initial costs
in current dollars = $2,830 x 1.06 = $2,999.80 or approximately
$3,000.
\387\ Aggregate initial costs = Per entity initial costs of
$3,000 x 24 entities = $72,000.
\388\ Per entity ongoing costs = 1 hour x 52 weeks x $64/hour
national hourly rate for a compliance clerk= $3,328. See note 373,
supra, for a derivation of the national hourly rate for a compliance
clerk. Adjusting for CPI inflation using data from the Bureau of
Labor Statistics between 2014 and 2018, the per entity initial costs
in current dollars = $3,328 x 1.06 = $3,527.68 or approximately
$3,528.
\389\ Aggregate ongoing costs = Per entity ongoing costs of
$3,528 x 24 entities = $84,672.
\390\ Per entity initial costs in current dollars = 10 hours x
$283/hour national hourly rate for a compliance manager x 1.06 CPI
inflation adjustment = $2,999.80 or approximately $3,000. See note
386, supra.
\391\ Aggregate initial costs = Per entity initial costs of
$3,000 x 24 entities = $72,000.
\392\ Per entity ongoing costs in current dollars = 2 hours x 52
weeks x $64/hour national hourly rate for a compliance clerk x 1.06
CPI inflation adjustment = $7,055.36 or approximately $7,056. See
note 388, supra.
\393\ Aggregate ongoing costs = Per entity ongoing costs of
$7,056 x 24 entities = $169,344.
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The registered security-based swap dealer also would be responsible
for obtaining from the non-U.S. person relying on this exception
written consent to service of process for any civil action brought by
or proceeding before the Commission, providing that process may be
served on the non-U.S. person by service on the registered entity in
the manner set forth in the registered entity's current Form SBSE,
SBSE-A, or SBSE-BD, as applicable.\394\ The Commission preliminarily
believes that both the registered entity and its non-U.S. affiliate
will incur one-time costs to comply with this condition.\395\ For
registered entities, the Commission estimates the one-time costs
associated with this condition to be approximately $409 per registered
entity,\396\ or up to $9,816 in aggregate.\397\ For non-U.S. entities,
the Commission estimates the one-time costs associated with this
condition to be approximately $409 per non-U.S. entity,\398\ or up to
$9,816 in aggregate.\399\ To the extent both parties agree to use an
industry-standard consent provision,\400\ these costs may be limited.
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\394\ See proposed paragraph (d)(1)(iii)(B)(3) of Rule 3a71-3.
\395\ See part VIII.A.2.f, infra. The Commission assumes that
the burden will be allocated equally between the registered entity
and the non-U.S. affiliate.
\396\ Per entity initial costs = 1 hour x $409/hour for national
hourly rate for an attorney = $409. The hourly cost figure is based
upon data from SIFMA's Management & Professional Earnings in the
Securities Industry 2013 (modified by the Commission staff to adjust
for inflation and to account for an 1,800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, and overhead).
\397\ Aggregate initial costs = Per entity initial costs of $409
x 24 entities = $9,816.
\398\ See note 396, supra.
\399\ See note 397 supra.
\400\ See part VIII.A.2.f, infra.
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Under Alternative 2, if a non-U.S. person, or its affiliated group,
seeks to utilize the exception, that person, or its affiliated group,
may incur the cost of registering one entity as a broker-dealer (if
there otherwise is not an affiliated broker-dealer present) or as a
security-based swap dealer. Because the conditions for using a
security-based swap dealer to utilize the exception under Alternative 1
are identical to the conditions under Alternative 2, non-U.S. persons
who avail themselves of the proposed exception by registering a
security-based swap dealer under Alternative 2 would incur the same
costs described above for registering a security-based swap dealer
under Alternative 1.
Alternatively, a non-U.S. person could choose to use the exception
permitted under Alternative 2 by using a registered broker-dealer to
conduct U.S. activity. A non-U.S. person choosing this option could
incur initial and ongoing costs associated with registering an
affiliate as a broker-dealer. The Commission preliminarily estimates
the costs of registering a new broker-dealer to be approximately
$291,500,\401\ and estimate ongoing costs of meeting registration
requirements as a broker-dealer to be approximately $53,000 \402\ per
year. Based on the Commission's estimate that up to 24 \403\ persons
might avail themselves of the proposed exception and assuming that
these persons choose to do so by using registered broker-dealers
permitted under Alternative 2, the Commission preliminarily estimates
the aggregate costs of broker-dealer registration to be approximately
$7 million \404\ and the aggregate ongoing costs of meeting broker-
dealer registration requirements to be approximately $1.272 million
\405\ per year. Non-U.S. persons meeting the conditions of the proposed
exception under Alternative 2 by using a registered broker-dealer would
additionally incur the cost of complying with applicable requirements
associated with the registered broker-dealer status, including
maintaining a minimum level of net capital. The Commission estimates
the ongoing cost of this capital to be approximately $35,300 \406\ per
entity. If the up to 24 persons that might use the proposed exception
choose to do so by using registered broker-dealers permitted under
Alternative 2, the estimated aggregate ongoing cost of capital is
approximately $847,200.\407\ To the extent that this capital is held in
liquid assets \408\ that generate a positive return to the registered
broker-dealer, that positive return would offset, at least in part, the
ongoing cost of capital.
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\401\ The Commission previously estimated that an entity would
incur costs of $275,000 to register as a broker-dealer and become a
member of a national securities association. See Crowdfunding,
Exchange Act Release No. 76324 (October 30, 2015), 80 FR 71388
(November 16, 2015) (``Regulation Crowdfunding Adopting Release''),
80 FR at 71509. Accounting for CPI inflation between 2015 and 2018,
the Commission now estimates that an entity would incur costs of
$275,000 x 1.06 = $291,500 to register as a broker-dealer and become
a member of a national securities association.
\402\ The Commission previously estimated that an entity would
incur ongoing annual costs of $50,000 to maintain broker-dealer
registration and membership of a national securities association.
See Regulation Crowdfunding Adopting Release, 80 FR at 71509.
Accounting for CPI inflation between 2015 and 2018, the Commission
now estimates that an entity would incur ongoing annual costs of
$50,000 x 1.06 = $53,000 to maintain broker-dealer registration and
membership of a national securities association. The estimation of
ongoing annual costs is based on the assumption that the entity
would use existing staff to perform the functions of the registered
broker-dealer and would not incur incremental costs to hire new
staff. To the extent that the entity chooses to hire new staff, the
ongoing annual costs may be higher.
\403\ See part VII.A.7, supra.
\404\ Aggregate broker-dealer registration costs calculated as
$291,500 x 24 entities = $6,996,000 or approximately $7,000,000.
\405\ Aggregate ongoing costs of meeting broker-dealer
registration requirements calculated as = $53,000 x 24 entities =
$1,272,000.
\406\ The Commission assumes that the registered entity must
maintain a minimum of $250,000 in net capital. See Exchange Act Rule
15c3-1. The Commission preliminarily believes that the methodology
for estimating the cost of capital of a registered security-based
swap dealer under proposed Alternative 1 is also appropriate for
estimating the cost of capital of a registered broker-dealer under
proposed Alternative 2 (see note 362, supra). Using the historical
return on equity for all U.S. banks, the Commission calculated the
cost of capital as 11.26% x $250,000 = $28,150 or approximately
$28,200. The Commission preliminarily believes that use of the
historical return on equity for U.S. banks adequately captures the
cost of capital because of the 12 persons that potentially may use
the proposed exception, 8 are banks and 3 have bank affiliates. See
part VII.A.7 supra. To the extent that this approach does not
adequately capture the cost of capital of persons that are not banks
or have no bank affiliates, the Commission supplements the
estimation by also using the annual stock returns on financial
stocks to calculate the cost of capital. With this second approach,
the Commission calculated the cost of capital as 16.96% x $250,000 =
$42,400. The final estimate of the cost of capital is the average of
$28,200 and $42,400 = (28,200 + 42,400)/2 = $35,300.
\407\ Aggregate ongoing cost of capital calculated as $35,300 x
24 entities = $847,200.
\408\ See Exchange Act Rule 15c3-1.
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All non-U.S. persons using the proposed exception under Alternative
2 would incur the cost of complying with security-based swap dealer
requirements related to disclosures of risks, characteristics,
incentives, and conflicts of interest, suitability,
[[Page 24260]]
communications, trade acknowledgment and verification, and portfolio
reconciliation; \409\ and requirements related to providing the
Commission access to books, records and testimony \410\ quantified
above in connection with Alternative 1, regardless of whether these
persons meet the conditions of Alternative 2 using a registered broker-
dealer or a registered security-based swap dealer.
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\409\ See Alternative 2 proposed paragraph (d)(1)(ii)(B) of Rule
3a71-3.
\410\ See Alternative 2 proposed paragraph (d)(1)(iii)(B) and
(C) of Rule 3a71-3.
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To the extent that a non-U.S. person has an existing, registered
broker-dealer affiliate \411\ and uses that affiliate to rely on the
conditional exception under Alternative 2, the non-U.S. person would
not incur costs associated with registering a broker-dealer and the
incremental compliance cost would be limited to costs associated with
complying with the restricted set of security-based swap dealer
requirements as discussed above.
---------------------------------------------------------------------------
\411\ Analyses of 2017 TIW data indicate that of the six non-
U.S. persons that potentially may use the proposed exception, four
have majority-owned registered broker-dealer affiliates. See part
VII.A.7, supra.
---------------------------------------------------------------------------
Although costly, the Commission preliminarily believes that the
conditions associated with the proposed exception afford appropriate
counterparty protections under Title VII and the Commission has
considered the benefits of these specific Rule provisions in prior
Commission releases.\412\ In the context of the proposed exception,
these conditions would benefit non-U.S. counterparties. Moreover, the
registered entity that is a majority-owned affiliate of the non-U.S.
person availing itself of the proposed exception under Alternative 1 or
Alternative 2 would be required to disclose to non-U.S. counterparties,
in connection with each transaction covered by the proposed exception,
that the non-U.S. person is not registered with the Commission and that
certain Exchange Act provisions or rules addressing the regulation of
security-based swaps do not apply in connection with the transaction.
The Commission preliminarily believes that non-U.S. persons would incur
an upfront cost of $713,160 and 2,400 hours \413\ to develop
appropriate disclosures, but that non-U.S. persons using the proposed
exception would integrate these disclosures into existing trading
systems so that the ongoing costs of delivering these disclosures would
be insubstantial. Furthermore, disclosures are only required when the
identity of the counterparty is known to the registered entity, so
anonymous transactions would not be subject to this requirement.\414\
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\412\ See Business Conduct Adopting Release, Trade
Acknowledgement and Verification Adopting Release, Recordkeeping
Proposing Release, and Risk Mitigation Proposing Release.
\413\ See part VIII.A.4.a and note 525, infra stating that each
non-U.S. person would spend 100 hours and incur approximate costs of
$29,715 to develop policies and procedures to help ensure that
appropriate disclosures are provided. The aggregate upfront costs
are = $29,715 x 24 entities = $713,160. The aggregate burden hours
are = 100 x 24 entities = 2,400 hours.
\414\ See note 148, supra, for circumstances in which the
registered entity engaged would not know the identity of the
counterparty.
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These required disclosures would benefit non-U.S. counterparties by
informing them of the regulatory treatment of transactions under the
proposed exception. To the extent that non-U.S. counterparties value
elements of the Title VII regulatory framework that do not apply to
transactions under the proposed exception, they may attempt to
negotiate more favorable prices to compensate themselves for the
additional risks they may perceive. Alternatively, non-U.S.
counterparties that prefer transactions fully covered by the
Commission's security-based swap regulatory framework could search for
a registered security-based swap dealer willing to transact with all
Title VII protections in place.
In connection with the proposal, a situation may arise where some
jurisdictions are designated by order as listed jurisdictions before
other jurisdictions, whether the designation is on the Commission's own
initiative or in response to applications. To the extent that some
jurisdictions become listed jurisdictions earlier than other
jurisdictions, non-U.S. persons operating in jurisdictions that become
listed jurisdictions earlier than other jurisdictions potentially could
rely on the conditional exception sooner than, and may gain a
competitive advantage over, non-U.S. persons operating in jurisdictions
that become listed jurisdictions at a later date. In particular, non-
U.S. persons operating in jurisdictions that become listed
jurisdictions earlier than other jurisdictions and that rely on the
exception may incur lower regulatory burdens \415\ than non-U.S.
persons operating in jurisdictions that become listed jurisdictions at
a later date. That said, this cost advantage may be limited if non-U.S.
persons operating in jurisdictions that currently are not listed
jurisdictions could set up operations in a listed jurisdiction to rely
on the exception.
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\415\ These non-U.S. persons may incur lower regulatory burdens
to the extent that they avoid the costs of assessing market-facing
activity and the costs of compliance with conditions set forth under
the proposed exception are lower than the compliance costs in the
absence of the proposed amendment and the costs of business
restructuring. In contrast, non-U.S. persons in unlisted
jurisdictions may have to incur the costs of assessing market-facing
activity. Further, for these non-U.S. persons, the costs of
complying with the full set of security-based swap dealer
requirements and business restructuring may be higher than
compliance costs associated with the proposed exception.
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An application for listed jurisdiction designation would be filed
pursuant to Rule 0-13 and, like the proposed exception, is purely
voluntary. Thus, the Commission expects that, to the extent that market
participants submit applications for designation of one or more listed
jurisdictions, non-U.S. persons would do so only to the extent that
they believe that compliance with each relevant jurisdiction's
regulatory regime, in combination with the other conditions of the
proposed exception, was less burdensome than the alternatives of (i)
incurring assessment costs related to de minimis calculations and
potential compliance with the Title VII regulatory framework for
dealers, and (ii) restructuring their security-based swap businesses to
avoid arranging, negotiating, or executing transactions with non-U.S.
counterparties using personnel located in the United States. The
Commission estimates that three non-U.S. persons that seek to rely on
the exception would file listed jurisdiction applications.\416\ The
Commission estimates the costs associated with each application to be
approximately $115,920, or up to $347,760 in aggregate.\417\ The
Commission notes that any costs incurred by a non-U.S. person in filing
an application for a listed jurisdiction may be obviated in part by the
provision that permits a foreign financial regulatory authority or
authorities supervising such a non-U.S. person or its security-based
swap activities to file such an application. Further, to the extent
that certain jurisdictions are designated as listed jurisdictions if
this
[[Page 24261]]
proposed amendment is adopted, the non-U.S. persons (or their financial
regulatory authorities) in these jurisdictions may avoid the costs of
filing an application.
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\416\ See part VIII.A.4.g, infra.
\417\ The Commission assumes that the costs associated with
filing an application for a qualified jurisdiction designation are
the same as the costs associated with filing a substituted
compliance request with respect to business conduct requirements.
See Business Conduct Adopting Release, 81 FR at 30097 and 30137 and
part VIII.A.4.g, infra. The Commission estimates the per entity
costs of filing an application in 2016 dollars as: $30,400 (internal
counsel) + $80,000 (external counsel) = $110,400. Adjusted for CPI
inflation from 2016 to 2018, the per entity costs of filing an
application in current dollars are = $110,400 x 1.05 = $115,920. The
aggregate costs of filing applications = Per entity costs of
$115,920 x 3 entities = $347,760.
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b. Title VII Programmatic Costs and Benefits
The proposed exclusion of transactions that must be counted against
the de minimis threshold will affect the set of registered security-
based swap dealers subject to security-based swap dealer regulation and
in turn determine the allocation and flow of programmatic costs and
benefits arising from such regulation.
The Commission preliminarily believes that requiring a non-U.S.
person that wishes to make use of the proposed exception to be subject
to the margin and capital requirements of a listed jurisdiction when
engaging in transactions subject to the proposed exception would
support the Title VII regime's programmatic benefit of mitigating risks
in foreign security-based swap markets that may flow into U.S.
financial markets through liquidity spillovers.\418\ Specifically,
proposed Rule 3a71-3(d)(1)(v) under both alternatives would require a
non-U.S. person relying on the proposed exception to be subject to the
margin and capital requirements of a listed jurisdiction when engaging
in transactions subject to the proposed exception. As discussed
earlier,\419\ the listed jurisdiction condition is intended to help
avoid creating an incentive for dealers to book their transactions into
entities that solely are subject to the regulation of jurisdictions
that do not effectively require security-based swap dealers or
comparable entities to meet certain financial responsibility standards.
Absent this type of condition, non-U.S. persons that rely on the
proposed exception could gain a competitive advantage because they
would be able to conduct security-based swap dealing activity in the
United States without being subject to even minimal financial
responsibility standards and incurring the associated compliance costs.
Such non-U.S. persons potentially could provide liquidity to market
participants at more favorable prices, but potentially also at greater
risk, compared to registered security-based swap dealers. Generally,
this proposed condition would benefit non-U.S. counterparties by
providing them with assurances that the non-U.S. person has sufficient
financial resources to engage in security-based swap activity and that
the non-U.S. person's risk exposures to other counterparties are
appropriately managed, supporting the Title VII regime's programmatic
benefit of preventing risks in foreign security-based swap markets from
flowing into U.S. financial markets through liquidity spillovers.
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\418\ As the Commission noted elsewhere, in a highly
concentrated global security-based swap market, the failure of a key
liquidity provider poses a particularly high risk of propagating
liquidity shocks not only to its counterparties but to other
participants, including other dealers. To the extent that U.S.
persons are significant participants in the market, the liquidity
shock may propagate to these U.S. persons, and from these U.S.
persons to the U.S. financial system as a whole, even if the
liquidity shock originates with the failure of a non-U.S. person
liquidity provider. See ANE Adopting Release, 81 FR at 8611-12,
8630.
\419\ See III.B.5, supra.
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The Commission preliminarily believes that another potential
programmatic benefit of the proposed amendment is to reduce market
fragmentation and associated distortions. In the ANE Adopting Release,
the Commission noted that the ``arranged, negotiated, or executed''
counting requirement may cause non-U.S. dealers to restructure their
operations to avoid using U.S. personnel in order to avoid triggering
security-based swap dealer obligations. Such restructuring may result
in market fragmentation. Nevertheless, to the extent that the
restructuring costs incurred by non-U.S. dealers offset the benefits
from avoiding dealer registration, the likelihood or extent of market
fragmentation and associated distortions may be attenuated, but not
eliminated.\420\ The Commission believes that the proposed amendment,
by permitting a non-U.S. person further flexibility to opt into a Title
VII compliance framework that is compatible with its existing business
practices, could further reduce the incentives of non-U.S. persons to
restructure and further reduce the likelihood or extent of market
fragmentation and associated distortions.
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\420\ See ANE Adopting Release, 81 FR at 8630.
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The above discussion notwithstanding, the Commission is mindful
that the likelihood of market fragmentation and associated distortions
might increase if U.S.-based dealing entities rely on the conditional
exception by booking transactions with non-U.S. counterparties into
non-U.S. affiliates, thereby avoiding the application of the full set
of security-based swap dealer requirements to those transactions and
the associated security-based swaps.\421\ As discussed further below,
U.S.-based dealing entities that use the conditional exception in this
manner may incur lower compliance costs when providing liquidity to
non-U.S. counterparties and may decide to limit their liquidity
provision only to non-U.S. counterparties. To the extent that these
U.S.-based dealing entities choose to provide liquidity only to non-
U.S. counterparties, security-based swap liquidity may fragment into
two pools: One pool that caters to U.S. counterparties and another pool
that caters to non-U.S. counterparties.
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\421\ See parts III.A and VII.A.7, supra.
---------------------------------------------------------------------------
The proposed amendment could promote competition in the security-
based swap market to the extent that competitive effects arise from
differences between the full set of requirements for registered
security-based swap dealers (that otherwise would apply to the non-U.S.
entity) and the conditions applicable to the registered U.S. entity
under the proposed amendment. As discussed more fully below,\422\ a
non-U.S. person dealer that uses the exception may become more
competitive in the market for liquidity provision because (a) the non-
U.S. person dealer may incur lower compliance costs when providing
liquidity to non-U.S. counterparties and (b) non-U.S. counterparties
may incur lower costs when transacting with the non-U.S. person dealer.
The set of dealing entities that benefit from such competitive effects
might expand to the extent that U.S.-based dealing entities that are
primarily or wholly responsible for managing interactions with non-U.S.
counterparties may rely on the conditional exception by booking
transactions into non-U.S. affiliates.\423\ Nevertheless, this
competitive effect may be attenuated by the condition that makes the
exception available only to non-U.S. persons that are subject to the
margin and capital requirements of a listed jurisdiction.
---------------------------------------------------------------------------
\422\ See part VII.B.2, infra.
\423\ See part III.A, supra.
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The proposed amendment potentially could limit the programmatic
benefits of Title VII regulation because the non-U.S. person taking
advantage of the conditional exception would not be subject to the full
suite of Title VII business conduct and financial responsibility
requirements. This limitation of programmatic benefits might increase
to the extent that U.S.-based dealing entities that primarily or wholly
are responsible for managing interactions with non-U.S. counterparties
may rely on the conditional exception by booking transactions into non-
U.S. affiliates.\424\ Because the non-U.S. person would not be subject
to Title VII business conduct
[[Page 24262]]
requirements, the associated Title VII counterparty protections would
not apply to the non-U.S. person's communications with non-U.S.
counterparties. The non-U.S. counterparties thus would not benefit from
those protections in their dealings with the non-U.S. person relying on
the exception, notwithstanding the U.S. arranging, negotiating, and
executing activity that led to the transactions at issue.\425\
---------------------------------------------------------------------------
\424\ See id.
\425\ As discussed in part III.A, supra, the antifraud
provisions of the federal securities laws and certain relevant Title
VII requirements would continue to apply to the transactions.
---------------------------------------------------------------------------
Similarly, Title VII financial responsibility requirements
applicable to security-based swap dealers would not apply to the non-
U.S. person, notwithstanding that the transactions would result from
arranging, negotiating, and executing activity in the United States. To
the extent that the financial responsibility requirements serve to
prevent the spread to U.S. financial markets of financial contagion
that originates from the failure of one or more non-U.S. persons
engaged in arranging, negotiating, and executing activity in the United
States,\426\ the fact that these requirements would not apply to non-
U.S. persons taking advantage of the conditional exception could limit
the ability of the Title VII regulatory regime to protect U.S.
financial markets from financial contagion. This concern would be
mitigated by the condition that makes the exception available only to
non-U.S. persons that are subject to the margin and capital
requirements of a listed jurisdiction, which would afford the
Commission flexibility to designate jurisdictions with appropriately
robust financial responsibility requirements as listed jurisdictions.
More generally, competitive disparities and limits to the programmatic
effects of Title VII may be offset to the extent that non-U.S.
counterparties value the protections afforded them by Title VII
regulation and prefer to transact with dealing entities that are
subject to the full scope of Title VII regulation, rather than with
non-U.S. persons that rely on the conditional exception.
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\426\ See ANE Adopting Release, 81 FR at 8612.
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2. Effects on Efficiency, Competition, and Capital Formation
As discussed earlier, the proposed amendment could reduce the
regulatory burden for non-U.S. persons that engage in security-based
swap arranging, negotiating, and executing activity with non-U.S.
counterparties using affiliated U.S.-based personnel because these non-
U.S. persons could avail themselves of an additional, potentially
lower-cost, means of engaging in arranging, negotiating, and executing
activity with non-U.S. counterparties.\427\ To the extent that the
regulatory burden for such non-U.S. persons is reduced as a result of
the proposed amendment, resources could be freed up for investing in
profitable projects, which would promote investment efficiency and
capital formation. In addition, a reduction in regulatory burden for
such non-U.S. persons could allow these persons to operate their
security-based swap dealing business more efficiently. To the extent
that these non-U.S. persons carry out security-based swap dealing
activity with counterparties around the world \428\ and choose to pass
on cost savings flowing from their improved efficiency in the form of
lower prices for liquidity provision, counterparties around the world
could benefit by being able to transact at lower costs. A reduction in
regulatory burden associated with the proposed amendment could lower
entry barriers into the security-based swap market and increase the
number of non-U.S. person dealers that are willing to provide liquidity
to non-U.S. counterparties using affiliated U.S.-based personnel. An
increase in the number of such non-U.S. person dealers may increase
competition for liquidity provision to non-U.S. counterparties, which
could lower transaction costs for these counterparties and improve
their ability to hedge economic exposures. To the extent that non-U.S.
person dealers focus their market-making activities on non-U.S.
counterparties and avoid U.S. counterparties, the competition for
liquidity provision to U.S. counterparties may decline, which could
increase transaction costs for U.S. counterparties and impair their
ability to hedge their economic exposures or to incur economic
exposures. In addition, to the extent that increased transaction costs
reduce the expected profits from trading on new information, market
participants may be less willing to transact in the security-based swap
market in response to new information. Such reduced participation in
the security-based swap market might impede the incorporation of new
information into security-based swap prices, reducing the informational
efficiency of these markets.
---------------------------------------------------------------------------
\427\ See part VII.B.1, supra.
\428\ See part VII.A.2.c, supra.
---------------------------------------------------------------------------
The proposed amendment might generate certain competitive effects
due to gaps between the full set of requirements for registered
security-based swap dealers and the conditions applicable to the
registered entity of the non-U.S. person under the proposed
amendment,\429\ though these effects will be tempered to the extent
that the non-U.S. person dealer passes on compliance costs incurred by
its U.S. registered entity to the non-U.S. counterparty. First, under
proposed Rule 3a71-3(d)(1)(C), the exception would not be conditioned
on the registered entity of the non-U.S. person dealer having to comply
with requirements pertaining to ECP verification, daily mark
disclosure, and ``know your counterparty.'' \430\ Thus, to the extent
that the non-U.S. person adheres only to the provisions specifically
required by the conditions set forth under the proposed amendment, the
non-U.S. person dealer could incur lower compliance costs in providing
liquidity to non-U.S. counterparties than under current rules, relative
to the baseline. In that case, the non-U.S. person dealer might be able
to lower the price at which it offers liquidity to a non-U.S.
counterparty. However, under both alternatives the non-U.S. person must
have a U.S. affiliate that is registered with the Commission. The
extent to which the non-U.S. person dealer may offer a more competitive
price would depend in part on whether the non-U.S. person dealer will
pass on compliance costs incurred by its U.S. registered entity to the
non-U.S. counterparty in the form of a higher price for providing
liquidity to the non-U.S. counterparty. To the extent that the non-U.S.
person dealer offers liquidity to the non-U.S. counterparty at a price
that fully recovers the compliance costs incurred by its U.S.
registered entity, any price reduction that could be offered by the
non-U.S. person dealer might be limited.
---------------------------------------------------------------------------
\429\ As context, the use of the ``arranged, negotiated, or
executed'' counting standard was intended in part to avoid allowing
competitive disparities between registered security-based swap
dealers and entities that otherwise could engage in security-based
swap market-facing activity in the United States without having to
register as security-based swap dealers. See part I.A.2, supra.
\430\ See Business Conduct Adopting Release, part II.G.
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Second, a non-U.S. counterparty may prefer to enter into a
security-based swap transaction with a non-U.S.-person dealer that
takes advantage of the conditional exception, rather than a U.S.
registered security-based swap dealer, not only because the non-U.S.-
person dealer may offer more competitive prices, but also because the
non-U.S. counterparty may itself avoid certain costs by transacting
with a non-U.S. person dealer. For example, Title VII financial
responsibility requirements applicable to security-based swap
[[Page 24263]]
dealers would not apply to the non-U.S. person dealer under the
proposed amendment, although the non-U.S. person dealer would be
subject to the margin and capital requirements of a listed
jurisdiction. To the extent that a non-U.S. counterparty has already
established with the non-U.S. person dealer the necessary margin
agreement that is compliant with the margin requirements of the listed
jurisdiction, the non-U.S. counterparty could avoid the additional
costs of negotiating and adhering to a new margin agreement that is
compliant with the Commission's Title VII margin requirements, if the
non-U.S. counterparty transacts with the non-U.S. person dealer.
These competitive effects may create an incentive for entities that
carry out their security-based swap dealing business in a U.S.-person
dealer with non-U.S. person counterparties to restructure a proportion
of this business to be carried out in a non-U.S.-person dealer
affiliate.
3. Additional Alternatives Considered
In developing these proposed amendments, the Commission considered
a number of additional alternatives. This section outlines these
alternatives and discusses the potential economic effects of each.
a. Requiring the Registered Entity To Comply With ECP Verification and
``Know Your Counterparty''
When identifying the security-based swap dealer requirements that
are applicable to a registered entity for purposes of this rulemaking,
the Commission considered requiring the registered entity to comply
with ECP verification and ``know your counterparty'' requirements,
along with other security-based swap dealer requirements, even if the
registered entity is not a party to the resulting security-based swap.
Although this alternative would lead to greater conformity with the
full set of security-based swap dealer requirements, the provisions in
question may require knowledge that may not be readily available to the
registered entity when it engages in limited arranging, negotiating,
and executing activity in connection with the security-based swaps
addressed by the proposed exception. These operational difficulties may
prevent the registered entity from complying with the provisions or may
require the registered entity to incur costs to ensure compliance. The
Commission estimates that, if included as part of the conditions of the
exception, the ECP verification and know your counterparty requirements
would impose initial costs of approximately $2,919 per registered
entity,\431\ or $70,056 in aggregate,\432\ and ongoing costs of
approximately $91,770 per registered entity,\433\ or $2,202,480 in
aggregate.\434\ Further, the non-U.S. counterparties transacting with
the non-U.S. persons making use of the proposed exception that are not
also participating in swap markets and relying on industry established
verification of status protocol may incur initial costs associated with
the verification of status requirement and related adherence
letters.\435\ The Commission estimates these aggregate initial costs at
approximately $460,152.\436\ All non-U.S. counterparties (or their
agents) transacting with the non-U.S. persons making use of the
proposed exception would also be required to collect and provide
essential facts to the registered entities to comply with the ``know
your counterparty'' obligations for an aggregate initial cost of
approximately $6,439,860.\437\ To the extent that the knowledge needed
to comply with these requirements may not be readily available to the
registered entity and the registered entity has to expend additional
resources to obtain that knowledge, the actual costs incurred by the
registered entity to comply with these requirements may be higher. The
Commission acknowledges that a non-U.S. person making use of the
proposed exception potentially could mitigate the compliance costs of
the registered entity by transacting only with non-U.S. counterparties
that are known ECPs to the registered entity. By doing so, the
registered entity could avoid expending additional resources to learn
about the non-U.S. counterparties' ECP status. However, as a result of
this approach, the non-U.S. person may have to forgo transacting with
new non-U.S. counterparties whose ECP status is not known to the
registered entity. The non-U.S. person would thus have to balance the
cost savings associated with transacting only with a set of known non-
U.S. counterparties against the revenues that may be forgone by not
transacting with new non-U.S. counterparties whose ECP status is
unknown to the registered entity.
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\431\ These estimates incorporate quantifiable initial costs
presented in the Business Conduct Adopting Release, 81 FR at 30090-
30092, 30110 adjusted for CPI inflation using data from the Bureau
of Labor Statistics between 2016 and 2018. Specifically, per entity
initial costs are estimated in 2016 dollars as $880 (ECP
verification) + $1,900 (know your counterparty) = $2,780, and
adjusted by 1.05 to $2,919 in current dollars.
\432\ Aggregate initial costs = Per entity initial costs of
$2,919 x 24 entities = $70,056.
\433\ These estimates incorporate quantifiable initial costs
presented in the Business Conduct Adopting Release, 81 FR at 30090-
30092, 30110 adjusted for CPI inflation using data from the Bureau
of Labor Statistics between 2016 and 2018. Specifically, per entity
ongoing costs are estimated in 2016 dollars as $87,400, and adjusted
by 1.05 to $91,770 in current dollars.
\434\ Aggregate initial costs = Per entity initial costs of
$91,770 x 24 entities = $2,202,480.
\435\ In the Business Conduct Adopting Release, the Commission
assumed that counterparties that are swap market participants likely
already adhere to the relevant protocol and would not have any
start-up or ongoing burdens with respect to verification. See 81 FR
at 30091. The Commission continues to believe that this assumption
is valid and thus, for purposes of this alternative, the Commission
believes that only non-U.S. counterparties that are not swap market
participants will incur verification-related costs. As discussed in
part VII.A.7 supra, the Commission preliminarily estimates that up
to 24 persons likely may use the proposed exception, and that their
registered entity affiliates may arrange, negotiate, or execute
transactions with up to 1,614 non-U.S. counterparties, of which 498
do not participate in swap markets.
\436\ This estimate incorporates quantifiable initial costs
presented in the Business Conduct Adopting Release, 81 FR at 30090-
30092, 30110 adjusted for CPI inflation using data from the Bureau
of Labor Statistics between 2016 and 2018. Per counterparty initial
costs are estimated in 2016 dollars as $500 (initial costs of
disclosure of essential facts) + $380 (initial costs of adherence
letters) = $880, and adjusted by 1.05 to $924 in current dollars.
Aggregate initial costs = Per entity initial costs of $924 x 498
counterparties = $460,152.
\437\ This estimate incorporates quantifiable initial costs
presented in the Business Conduct Adopting Release, 81 FR at 30090-
30092, 30110 adjusted for CPI inflation using data from the Bureau
of Labor Statistics between 2016 and 2018. Per counterparty initial
costs are estimated in 2016 dollars as (In-house attorney at $380
per hour) x 10 hours = $3,800, and adjusted by 1.05 to $3,990 in
current dollars. Aggregate initial costs = Per entity initial costs
of $3,990 x 1,614 counterparties = $6,439,860.
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As another alternative, the Commission considered requiring
compliance with the ECP verification and ``know your counterparty''
requirements with a one-time carve out when the non-U.S. counterparty
is unknown to the registered entity and there is no basis to believe
that the registered entity would have further interactions with that
non-U.S. counterparty. Although such a carve out may reduce compliance
costs by excluding transactions that likely would pose the greatest
operational difficulties in terms of obtaining knowledge needed for
complying with the ECP verification and know your counterparty
requirements, the Commission is also cognizant that the carve out may
create new costs associated with assessing when the carve out would
apply. The Commission is concerned that these new assessment costs may
impose an additional burden on the registered entity and may offset any
reduction in compliance costs associated with a one-time carve out. As
with the previous alternative, a non-U.S. person making use of the
proposed exception potentially could mitigate the
[[Page 24264]]
compliance costs of the registered entity by transacting only with non-
U.S. counterparties that are ECPs known to the registered entity. As
discussed above, the non-U.S. person would thus have to balance the
cost savings associated with this approach against the revenues that
may be forgone by not transacting with new non-U.S. counterparties
whose ECP status is unknown to the registered entity.
In light of these compliance challenges and the fact that the
proposed amendment does include conditions designed to impose a minimum
standard of conduct upon security-based swap dealers in connection with
their transaction-related activities, the Commission preliminarily
believes that the proposed approach is preferable to these
alternatives.
b. Requiring the Registered Entity To Comply With Daily Mark Disclosure
The Commission also considered requiring the registered entity to
comply with daily mark disclosure, along with other security-based swap
dealer requirements, even if the registered entity is not a party to
the resulting security-based swap. Similar to the discussion of ECP
verification and know your counterparty requirements above, this
alternative would lead to greater conformity with the full set of
security-based swap dealer requirements, but may require knowledge that
may not be readily available to the registered entity when it engages
in limited arranging, negotiating, and executing activity in connection
with the security-based swaps addressed by the proposed exception.
Further, the daily mark disclosure is predicated on the existence of an
ongoing relationship between the security-based swap dealer and the
counterparty that may not be present in connection with the
transactions at issue, and would be linked to risk management functions
that are likely to be associated with the entity in which the resulting
security-based swap position is located.\438\ These operational
difficulties may prevent the registered entity from complying with the
daily mark disclosure requirement or may require the registered entity
to incur an unreasonably high cost to ensure compliance. In light of
these compliance challenges and the fact that the proposed amendment
does include conditions designed to impose a minimum standard of
conduct upon security-based swap dealers in connection with their
transaction-related activities, the Commission preliminarily believes
that the proposed approach is preferable to this alternative.
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\438\ See part III.B.2.a, supra.
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c. Requiring a Limited Disclosure of Incentives and Conflicts
As an alternative to the disclosure requirements set forth under
proposed Rule 3a71-3(d)(1)(ii)(B)(1), the Commission considered
requiring the registered entity to disclose its own material incentives
and conflicts of interest, but not requiring the registered entity to
disclose the incentives and conflicts of interest of its non-U.S.
affiliate. While this alternative might help to mitigate the costs
associated with disclosing the incentives and conflicts of interest of
the non-U.S. affiliate,\439\ the benefits associated with such
disclosures \440\ may also decrease because non-U.S. counterparties
would not know about the incentives and conflicts of interest of the
non-U.S. affiliate prior to entering into security-based swaps with the
non-U.S. affiliate. In light of this concern, the Commission
preliminarily believes that the proposed approach is preferable to this
alternative.
---------------------------------------------------------------------------
\439\ See Business Conduct Adopting Release, 81 FR at 30112.
\440\ See Business Conduct Adopting Release, 81 FR at 30111-12.
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d. Requiring the Non-U.S. Person To Be Domiciled in a G-20 Jurisdiction
or in a Jurisdiction Where the Non-U.S. Person Would Be Subject to
Basel Capital Requirements
As alternatives to proposed paragraph (d)(1)(v), the Commission
considered proposing a requirement that the non-U.S. person be
domiciled in a G-20 jurisdiction or in a jurisdiction where the non-
U.S. person would be subject to Basel capital requirements as
commenters have suggested. While the Commission acknowledges that these
alternatives are clearly defined and would provide certainty to market
participants, the Commission preliminarily believes these alternatives
potentially could create opportunities for regulatory arbitrage whereby
a non-U.S. person may relocate its operations to a jurisdiction that
imposes lower financial responsibility standards. The non-U.S. person
may thus enjoy a cost advantage relative to other dealers that operate
under higher regulatory burdens, while not being subject to equally
rigorous financial responsibility standards. Further, as discussed
earlier,\441\ the fact that a jurisdiction is a member of the G-20 or
subscribes to Basel standards does not by itself provide assurance that
the jurisdiction has implemented appropriate financial responsibility
standards.
---------------------------------------------------------------------------
\441\ See part III.B.5, supra.
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e. Not Requiring Notification to Counterparties of the Non-U.S. Person
In proposing the conditions that would apply to the non-U.S. person
under Alternative 1 and Alternative 2, the Commission considered
omitting the condition that non-U.S. counterparties of the non-U.S.
person relying on the exception be notified contemporaneously by the
registered entity that the non-U.S. person is not registered as a
security-based swap dealer, and that certain Exchange Act provisions or
rules addressing the regulation of security-based swaps would not be
applicable in connection with the transaction. The omission of this
notification condition may reduce cost and thus regulatory burden for
the non-U.S. persons that rely on the exception.
However, the absence of this notification condition potentially
could reinforce the competitive disparity between the non-U.S. persons
that make use of the exception and registered security-based swap
dealers that comply with the full set of Title VII security-based swap
dealer requirements. As discussed above,\442\ non-U.S. persons that
avail themselves of the exception could bear lower costs compared to
registered security-based swap dealers that have to comply with the
full set of security-based swap dealer requirements.
---------------------------------------------------------------------------
\442\ See part VII.B.2, supra.
---------------------------------------------------------------------------
To the extent that non-U.S. counterparties prefer to trade with
dealers that are subject to the full set of Title VII security-based
swap dealer requirements and the associated safeguards, in the absence
of the notification condition, non-U.S. persons that rely on the
exception could bear lower regulatory costs than registered security-
based swap dealers but may nevertheless be regarded by non-U.S.
counterparties to be no different than registered security-based swap
dealers, at least with respect to Title VII safeguards. As a result,
these non-U.S. persons potentially could capture the business of non-
U.S. counterparties from registered security-based swap dealers that
they otherwise might not have captured if the notification condition
had been part of the exception. In light of this concern, the
Commission preliminarily believes that requiring such notification to
non-U.S. counterparties is preferable to this alternative.
[[Page 24265]]
f. ``No Management of Relationship'' Condition
When identifying the conditions of the proposed exception, the
Commission considered making the exception unavailable where U.S.
personnel manage the relationship with the non-U.S. counterparty to the
security-based swap. Such a condition might help address concerns that
U.S.-based dealers could use the proposed exception to rebook
transactions, which are managed by U.S. personnel, to a non-U.S.
affiliate to avoid triggering security-based swap dealer registration.
However, the Commission recognizes that there may be challenges in
articulating objective criteria to identify when the proposed exception
would or would not be available under this type of approach. Even if
objective criteria could be articulated, non-U.S. persons seeking to
use the proposed exception may have to incur costs to satisfy these
criteria on an ongoing basis. In light of these concerns, the
Commission preliminarily believes that the proposed approach is
preferable to this alternative.
g. Rule 10b-10 in Lieu of Trade Acknowledgement and Verification
Requirement
In specifying the requirements that are applicable to the
registered entity under Alternative 2, the Commission considered
requiring the registered entity to comply with Rule 10b-10 in lieu of
the security-based swap dealer trade acknowledgement and verification
requirement (Rules 15Fi-1 and 15Fi-2), if the registered entity is a
registered broker-dealer that is not also a security-based swap dealer.
As discussed earlier,\443\ if a non-U.S. person chooses to use a
registered broker-dealer under Alternative 2, the non-U.S. person could
incur costs associated with the registered broker status, including the
cost of complying with Rule 10b-10. Additionally, the non-U.S. person
would incur the cost of complying with certain security-based swap
dealer requirements, including the trade acknowledgement and
verification requirement. The alternative approach could reduce the
regulatory burden on the non-U.S. person by obviating the need for its
registered broker-dealer affiliate to comply with the trade
acknowledgement and verification requirement. However, the Commission
preliminarily believes that compliance with the trade acknowledgement
and verification requirement may better support the regulation of the
security-based swap market. First, the Rule 15Fi-2 requirement that a
trade acknowledgement ``must disclose all of the terms of the security-
based swap transaction'' \444\ is tailored to the security-based swap
market and is more likely to effectively communicate the relevant terms
of the transaction to the counterparty. A more effective communication
of transaction terms could facilitate timely and accurate confirmations
and in turn reduce the likelihood of a confirmation backlog and
associated market, credit, settlement, and financial stability
risks.\445\ Second, while Rule 10b-10 requires only the registered
broker-dealer to provide a trade confirmation to a customer, Rule 15Fi-
2 requires a security-based swap dealer or major security-based swap
participant to provide a trade acknowledgement to, as well as obtain a
verification of that acknowledgement from, the counterparty. As
discussed elsewhere,\446\ unlike most other securities transactions, a
security-based swap gives rise to ongoing obligations between
transaction counterparties during the life of the transaction,
including payments contingent on specific events, such as a corporate
default. Consequently, the acknowledgement and verification of the
terms of a security-based swap transaction help ensure that security-
based swap market participants effectively measure and manage market
and credit risk. Third, the trade acknowledgement and verification
requirement would better promote a uniform regulatory framework for
security-based swap transactions because the requirement would apply to
all security-based swap transactions that are arranged, negotiated, or
executed in the United States. In light of the foregoing, the
Commission preliminarily believes that the proposed approach is
preferable to this alternative.
---------------------------------------------------------------------------
\443\ See part VII.B.1, supra.
\444\ See Exchange Act Rule 15Fi-2(c).
\445\ See Trade Acknowledgement and Verification Adopting
Release part VII.C.
\446\ See id., 81 FR at 39833.
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C. Proposed Guidance Regarding the Scope of the ``Arranged, Negotiated,
or Executed'' Test
As discussed in part II supra, the Commission is proposing guidance
regarding the scope of the ``arranged, negotiated, or executed'' test.
This guidance could have economic effects to the extent that, in the
absence of such guidance, some market participants may have understood
the scope of the test differently.
As discussed in part VII.A.8 above, the Commission preliminarily
believes that up to 49 non-U.S. persons could be affected by the
proposed guidance. To the extent that some of these non-U.S. persons
currently understand the scope of the ``arranged, negotiated, or
executed'' test to be different from the scope of the test set forth in
the proposed guidance, there might be certain potential economic
effects associated with (1) counting toward the de minimis threshold
for security-based dealer registration,\447\ (2) cross-border
application of security-based swap dealer business conduct provisions,
and (3) cross-border application of Regulation SBSR's regulatory
reporting and public dissemination provisions. The Commission discusses
these potential economic effects below.
---------------------------------------------------------------------------
\447\ See note 90, supra.
---------------------------------------------------------------------------
Under rules adopted in the Cross-Border Adopting Release, a non-
U.S. person is permitted to exclude from the de minimis analysis
certain dealing transactions conducted through a foreign branch of a
counterparty that is a U.S. bank. For this exclusion to be effective,
persons located within the United States cannot be involved in
arranging, negotiating, or executing the transaction. Moreover, the
counterparty U.S. bank must be registered as a security-based swap
dealer,\448\ unless the transaction occurs prior to 60 days following
the effective date of final rules providing for the registration of
security-based swap dealers.\449\ Under rules adopted in the ANE
Adopting Release, a non-U.S. person has to count toward its de minimis
threshold, transactions with a non-U.S. counterparty that are arranged,
negotiated, or executed by U.S. personnel. The Commission preliminarily
believes that the proposed guidance might have certain economic effects
in connection with the application of the ``arranged, negotiated, or
executed'' test to the de minimis threshold.
---------------------------------------------------------------------------
\448\ See Exchange Act Rule 3a71-3(b)(1)(iii)(A)(1).
\449\ See Exchange Act Rule 3a71-3(b)(1)(iii)(A)(2).
---------------------------------------------------------------------------
First, the proposed guidance may cause a change in behavior of
those non-U.S. persons, if any, who currently interpret the scope of
the ``arranged, negotiated, or executed'' test to be different from the
proposed guidance. To the extent that the proposed guidance reduces the
likelihood of non-U.S. persons mistakenly believing they have exceeded
the de minimis threshold, it would potentially eliminate costs that
non-U.S. persons may otherwise incur related to security-based swap
dealer registration and compliance. Specifically, the proposed guidance
potentially could reduce the
[[Page 24266]]
compliance burden of those non-U.S. persons that employ U.S. personnel
to provide market color to non-U.S. counterparties or foreign branches
of U.S. persons, and understood the provision of market color to fall
within the scope of the ``arranged, negotiated, or executed'' test. In
the absence of the proposed guidance, such a non-U.S. person could
incur the cost of registering as a security-based swap dealer if it
counts transactions involving the provision of market color by U.S.
personnel toward the de minimis threshold, and as a consequence of this
treatment, its market-facing activity exceeds the de minimis threshold.
The non-U.S. person accordingly would incur the cost necessary for
compliance with the full set of security-based swap dealer requirements
by one or more registered security-based swap dealers. These burdens
are in addition to the assessment costs that the non-U.S. person would
incur to identify and count relevant market-facing activity toward the
de minimis threshold.
To the extent that the proposed guidance reduces the likelihood of
restructuring due to perceived regulatory burdens, it would potentially
eliminate costs that non-U.S. persons may otherwise incur. In the
absence of the proposed guidance, non-U.S. persons that employ U.S.
personnel to provide market color to non-U.S. counterparties or foreign
branches of U.S. persons, and understand the provision of market color
to fall within the scope of the ``arranged, negotiated, or executed''
test, may choose to avoid security-based swap dealer registration by
relocating those U.S. personnel (or the activities performed by those
U.S. personnel) to locations outside the United States or by
restructuring operations to use non-U.S. personnel to provide market
color to non-U.S. counterparties or foreign branches of U.S. persons.
These forms of restructuring would impose costs on these non-U.S.
persons associated with moving personnel outside the United States or
forgoing the market knowledge and expertise of the U.S. personnel that
provide market color. The proposed guidance, by clarifying that
transactions involving the provision of market color by U.S. personnel
would not fall within the scope of the arranged, negotiated, or
executed counting test, may obviate the need for these forms of
restructuring and potentially limit the associated costs for these non-
U.S. persons.
The proposed guidance may affect the approach to assessment chosen
by different market participants. In the ANE Adopting Release, the
Commission noted that non-U.S. persons likely would consider three
possible approaches to determine which transactions must be counted
toward the de minimis threshold.\450\ The Commission also discussed
potential costs associated with each approach. The proposed guidance
might affect such assessment costs to the extent that non-U.S. persons
that employ U.S. personnel to provide market color to non-U.S.
counterparties would have, in the absence of the proposed guidance,
interpreted the provision of market color to fall within the scope of
the ``arranged, negotiated, or executed'' test, and further to the
extent that such persons would change their approach to assessment in
light of the proposed guidance. The Commission preliminarily believes
that a non-U.S. person may choose to make such a change if the
associated benefits outweigh the associated costs.
---------------------------------------------------------------------------
\450\ See ANE Adopting Release, 81 FR at 8627-28.
---------------------------------------------------------------------------
In light of the proposed guidance, a non-U.S. person who has opted
to perform assessments on a per-transaction basis \451\ may modify its
information system \452\ to track transactions involving only the
provision of market color by U.S. personnel, if the system does not
already possess this capability. The potential benefit of such
modifications would be to allow the non-U.S. person to avoid security-
based swap dealer registration and the associated regulatory burdens by
excluding transactions involving only the provision of market color by
U.S. personnel from being counted toward the de minimis threshold.
These costs likely would not be incurred to the extent that the non-
U.S. person already employs an information system that can track
transactions involving only the provision of market color by U.S.
personnel.
---------------------------------------------------------------------------
\451\ See id. at 8627.
\452\ In the ANE Adopting Release, the Commission estimated the
costs associated with developing and modifying information
technology systems to track the location of persons with dealing
activity. The Commission preliminarily believes that this approach
also would be appropriate for estimating the costs incurred by the
non-U.S. person to modify its information system in light of the
proposed guidance. The Commission estimates that the average non-
U.S. person will incur start-up costs of $410,000 to modify its
information system to track transactions involving only the
provision of market color by U.S. personnel. Further, the Commission
preliminarily believes that non-U.S. persons would incur the cost of
$6,500 per location per year on an ongoing basis for training,
compliance, and verification costs (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). See ANE Adopting
Release, 81 FR at 8627.
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Instead of performing assessments on a per-transaction basis, a
non-U.S. person might: (1) Restrict its U.S. personnel from arranging,
negotiating, or executing security-based swaps with non-U.S.
counterparties,\453\ or (2) count transactions with other non-U.S.
persons toward its de minimis threshold, regardless of whether counting
them is required, to avoid the cost of assessing the locations of
personnel involved with each transaction.\454\ In light of the proposed
guidance, a non-U.S. person that intends to take either approach likely
would continue to use such approach to the extent that the costs
associated with assessments on a per-transaction basis outweigh any
potential cost savings from excluding transactions involving only the
provision of market color by U.S. personnel from the de minimis
threshold, and consequently avoiding having to register as a security-
based swap dealer.
---------------------------------------------------------------------------
\453\ See ANE Adopting Release, 81 FR at 8627-28.
\454\ See ANE Adopting Release, 81 FR at 8628.
---------------------------------------------------------------------------
Under rules adopted in the Business Conduct Adopting Release, a
non-U.S. security-based swap dealer has to comply with transaction-
level business conduct requirements for transactions between the non-
U.S. security-based swap dealer and non-U.S. counterparties that are
arranged, negotiated, or executed by personnel of the non-U.S.
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.\455\
---------------------------------------------------------------------------
\455\ See Business Conduct Adopting Release, 81 FR at 30065;
Exchange Act Rules 3a71-3(c) and 3a71-3(a)(8)(i).
---------------------------------------------------------------------------
To the extent that the proposed guidance reduces the likelihood of
non-U.S. security-based swap dealers mistakenly believing they will
enter into security-based swaps that fall within the scope of the
``arranged, negotiated, or executed'' test in connection with
transaction-level business conduct requirements, it would potentially
eliminate costs that non-U.S. security-based swap dealers may otherwise
incur. Specifically, the proposed guidance potentially could reduce the
compliance burden of those non-U.S. security-based swap dealers that
employ U.S. personnel to provide market color to non-U.S.
counterparties, and that previously understood the provision of market
color to fall within the scope of the ``arranged, negotiated, or
executed'' test. In the absence of the proposed guidance, such a non-
U.S. security-based swap dealer could incur the cost of complying with
transaction-level business conduct requirements (e.g., disclosure of
material risks and characteristics) if it considers
[[Page 24267]]
transactions involving the provision of market color by U.S. personnel
to fall within the scope of the test. These burdens are in addition to
the assessment costs that the non-U.S. security-based swap dealers
would incur to identify transactions that fall within the scope of the
test.\456\
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\456\ See Business Conduct Adopting Release, 81 FR at 30135.
---------------------------------------------------------------------------
Under Regulation SBSR, a security-based swap transaction between
two non-U.S. persons that is arranged, negotiated, or executed using
U.S. personnel may be subject to regulatory reporting and public
dissemination. Rule 908(b)(2) of Regulation SBSR provides that a
registered security-based swap dealer or major security-based swap
participant will incur reporting obligations.\457\ This rule covers
both U.S. and non-U.S. registered entities. Rule 908(b)(5) imposes
reporting obligations on a non-U.S. person that, in connection with the
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 an agent located in a U.S.
branch or office.\458\ Rule 908(a)(1)(v) \459\ provides that a
security-based swap transaction shall be subject to regulatory
reporting and public dissemination if the transaction 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. Rule 901(a)(2)(ii) assigns
reporting duties for various types of uncleared security-based swap
transactions including, but not limited to, transactions in which (a)
one or both sides include a registered security-based swap dealer and
(b) both sides include unregistered non-U.S. persons and at least one
side includes a non-U.S. person that falls within Rule 908(b)(5).
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\457\ See Exchange Act Rule 908(b)(2).
\458\ See Exchange Act Rule 908(b)(5).
\459\ See Exchange Act Rule 908(a)(1)(v).
---------------------------------------------------------------------------
To the extent that the proposed guidance reduces the likelihood of
non-U.S. persons (i.e., non-U.S. security-based swap dealers and
unregistered non-U.S. dealing entities) mistakenly believing they have
entered into security-based swaps that fall within the scope of the
``arranged, negotiated, or executed'' test in connection with
Regulation SBSR regulatory reporting requirements, it would potentially
eliminate costs that non-U.S. persons may otherwise incur.
Specifically, the proposed guidance potentially could reduce the
compliance burden of those non-U.S. persons that employ U.S. personnel
to provide market color to non-U.S. counterparties and that previously
understood the provision of market color to fall within the scope of
the ``arranged, negotiated, or executed'' test. In the absence of the
proposed guidance, such a non-U.S. person could incur the cost of
complying with reporting requirements (e.g., reporting of an initial
security-based swap transaction to a registered security-based swap
data repository) if it considers transactions involving the provision
of market color by U.S. personnel to fall within the scope of the test.
These burdens are in addition to the assessment costs that unregistered
non-U.S. dealing entities would incur to identify transactions that
fall within the scope of the test and to determine if they will incur
reporting duties under Rule 901(a)(2)(ii)(E).\460\
---------------------------------------------------------------------------
\460\ See Regulation SBSR Amendments Adopting Release, 81 FR 156
at 53638.
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The proposed guidance may affect the incentives of those non-U.S.
persons, if any, who currently interpret the scope of the ``arranged,
negotiated, or executed'' test to be different from the proposed
guidance, to request substituted compliance determinations for business
conduct requirements and regulatory reporting and public dissemination
requirements.\461\ In the absence of the proposed guidance, a non-U.S.
person could incur the cost of applying for a substituted compliance
determination if it considers transactions involving the provision of
market color by U.S. personnel to fall within the scope of the test and
believes that the cost savings from complying with comparable foreign
requirements for these transactions outweigh the costs of applying for
a substituted compliance determination and complying with any
conditions that the Commission may attach to the substituted compliance
determination. To the extent that the proposed guidance reduces the
likelihood of non-U.S. persons mistakenly believing that transactions
involving the provision of market color by U.S. personnel fall within
the scope of the test, it may reduce the incentive of non-U.S. persons
to apply for substituted compliance determinations and the associated
costs.
---------------------------------------------------------------------------
\461\ See Exchange Act Rule 3a71-6(d) (addressing substituted
compliance for business conduct requirements) and Regulation SBSR
Rule 908(c) (addressing substituted compliance for regulatory
reporting and public dissemination requirements).
---------------------------------------------------------------------------
As discussed above, the proposed guidance could reduce the
regulatory burden (including substituted compliance application costs,
if any) of those non-U.S. persons that employ U.S. personnel to provide
market color to non-U.S. counterparties, and who would otherwise have
interpreted the provision of market color to fall within the scope of
the ``arranged, negotiated, or executed'' test. Additionally, the
proposed guidance may obviate the need for restructuring and
potentially limit the associated costs for such non-U.S. persons that
employ U.S. personnel to provide market color to non-U.S.
counterparties. To the extent that the regulatory cost burden and
restructuring costs for such non-U.S. persons are reduced as a result
of the proposed guidance, resources could be freed up for investing in
profitable projects, which would promote investment efficiency and
capital formation. The non-U.S. persons alternatively could pass on the
reductions in regulatory cost burden and restructuring costs to their
counterparties in the form of a lower price for liquidity provision
(e.g., through posting narrower bid-ask spreads), thereby allowing the
non-U.S. persons to compete more effectively in providing liquidity to
market participants. Such actions in turn may increase competition in
the market for liquidity provision if they prompt other liquidity
providers to lower their prices for liquidity provision.
D. Proposed Amendment to Rule of Practice 194(c)(2)
Several key economic effects and tradeoffs inform the Commission's
analysis of proposed Rule of Practice 194(c)(2).\462\
---------------------------------------------------------------------------
\462\ See Rule of Practice 194 Adopting Release, 84 FR at 4922-
43.
---------------------------------------------------------------------------
First, as the Commission discussed in the Rule of Practice 194
Adopting Release,\463\ increasing the ability of statutorily
disqualified persons to effect or be involved in effecting security-
based swaps on behalf of SBS Entities may give rise to higher
compliance and counterparty risks, increase costs of adverse selection,
decrease market participation, and reduce competition among higher
quality associated persons and SBS Entities.
---------------------------------------------------------------------------
\463\ See id.
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Second, at the same time, the scope of conduct that gives rise to
disqualification is broad and includes conduct that may not pose
ongoing risks to counterparties.\464\ In addition, as
[[Page 24268]]
discussed in the Rule of Practice 194 Adopting Release and in greater
detail below, strong disqualification standards can also reduce
competition and the volume of service provision.
---------------------------------------------------------------------------
\464\ As discussed in Section V.A. of the Rule of Practice 194
Adopting Release, the definition of disqualified persons, as applied
in the statutory prohibition in Exchange Act Section 15F(b)(6), is
broad. That definition disqualifies associated persons due to
violations of the securities laws, but also for felonies and
misdemeanors not related to the securities laws and/or financial
markets, and certain foreign sanctions. See Rule of Practice 194
Adopting Release, 84 FR at 4922, 4929.
---------------------------------------------------------------------------
Third, public information about misconduct can give rise to capital
market participants voting with their feet (reputational costs), and
labor markets frequently penalize misconduct through firing or worse
career outcomes in other settings, as discussed in the Rule of Practice
194 Adopting Release. If counterparties perceive the risks related to
disqualified associated persons to be high, counterparties may choose
to perform more in-depth due diligence related to their SBS Entity
counterparties or to transact with SBS Entities without disqualified
associated persons.
Fourth, an overwhelming majority of dealers and most counterparties
transact across both swap and security-based swap markets, including in
financial products that are similar or identical in their payoff
profiles and risks. Differential regulatory treatment of
disqualification in swap and security-based swap markets may disrupt
existing counterparty relationships and may increase costs of
intermediating transactions for some SBS Entities, which may be passed
along to certain counterparties in the form of higher transaction
costs.
Fifth, as discussed in the Rule of Practice 194 Adopting Release,
market participants may value bilateral relationships with SBS
Entities, including with SBS Entities dually-registered as Swap
Entities, and searching for and initiating bilateral relationships with
new SBS Entities may involve costs for counterparties. For example,
security-based swaps are long-term contracts that are often
renegotiated, and disruptions to existing counterparty relationships
can reduce the potential future ability to modify a contract, which may
be priced in widening spreads.\465\
---------------------------------------------------------------------------
\465\ See Rule of Practice 194 Adopting Release, 84 FR at 4922.
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1. Costs and Benefits of the Proposed Amendment
Once compliance with SBS Entity registration rules is required,
registered SBS Entities will be unable to utilize any statutorily
disqualified associated natural person, including natural persons with
potentially valuable capabilities, skills, or expertise, to effect or
be involved in effecting security-based swaps, absent exemptive relief,
including an order under Rule of Practice 194. This restriction would
apply to all associated natural persons of all registered SBS Entities,
with respect to all counterparties, and regardless of the nature of the
conduct giving rise to disqualification. SBS Entities are, under the
baseline regulatory regime, unable to rely on disqualified associated
persons even if such persons are non-U.S. persons transacting
exclusively with non-U.S. counterparties. However, absent the proposed
Rule, SBS Entities would still be able to apply to the Commission for
relief, and the Commission would still be able to grant relief,
including under Rule of Practice 194.
Under the proposed Rule, unless a limitation applies, SBS Entities
will be able to allow disqualified associated persons that are not U.S.
persons to effect or be involved in effecting security-based swap
transactions with non-U.S. counterparties and foreign branches of U.S.
counterparties. The Commission preliminarily believes that the proposed
Rule involves three groups of benefits.
First, SBS Entities may benefit from greater flexibility in hiring
and managing non-U.S. employees transacting with foreign counterparties
and foreign branches of U.S. counterparties. To the degree that such
employees may have valuable skills, expertise, or counterparty
relationships that are difficult to replace and outweigh the
reputational and compliance costs of continued association, SBS
Entities would be able to continue employing them without being
required to apply for relief with the Commission. In addition, cross-
registered SBS Entities would experience economies of scope in
employing non-U.S. natural persons in their swap and security-based
swap businesses. Specifically, SBS Entities will be able to rely on the
same non-U.S. natural persons in transactions with the same
counterparties across integrated swap and security-based swap markets.
In addition, SBS Entities will no longer be required to apply for
relief under Rule of Practice 194 with respect to non-U.S. persons
transacting with foreign counterparties and foreign branches of U.S.
counterparties.\466\
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\466\ As discussed in the economic baseline, we preliminarily
believe that the proposed exclusion may reduce the number of
applications by between zero and two applications, resulting in
potential cost savings of between zero and $24,540 (=2 x 30 hours x
Attorney at $409 per hour). The hourly cost figure is based on data
from SIFMA's Management & Professional Earnings in the Securities
Industry 2013 (modified by the Commission staff to adjust for
inflation and to account for an 1,800-hour work-year and multiplied
by 5.35 to account for bonuses, firm size, employee benefits, and
overhead). See Rule of Practice 194 Adopting Release, 84 FR at 4922.
---------------------------------------------------------------------------
Second, to the degree that SBS Entities currently pass along costs
to counterparties in the form of, for example, higher transaction
costs, the proposed amendment may benefit non-U.S. counterparties and
foreign branches of U.S. counterparties through lower prices of
available security-based swaps. In addition, such counterparties of SBS
Entities would be able to continue transacting with the same non-U.S.
associated persons of the same SBS Entities across interconnected
markets without delays related to Commission review under Rule of
Practice 194. The Commission notes that both the returns and the risks
from security-based swap transactions by foreign branches of U.S.
persons may flow to the U.S. business of U.S. persons, contributing to
profits and losses of U.S. persons.
Third, the proposed amendment may benefit disqualified non-U.S.
natural persons seeking to engage in security-based swap activity.
Under the proposal, an SBS Entity would no longer be required to incur
costs related to applying for exemptive relief under Rule of Practice
194 in order to allow a disqualified non-U.S. natural person to
transact with foreign counterparties and foreign branches of U.S.
counterparties. The proposal may reduce direct costs to SBS Entities of
hiring and retaining disqualified non-U.S. employees. This may improve
employment opportunities for disqualified non-U.S. natural persons in
the security-based swap industry. However, research in other contexts
points to large reputational costs from misconduct, and some papers
show that employers may often fire and replace employees engaging in
misconduct to manage these reputational costs, as discussed in the Rule
of Practice 194 Adopting Release.\467\
---------------------------------------------------------------------------
\467\ See Rule of Practice 194 Adopting Release, 84 FR at 4932.
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The proposed Rule would result in SBS Entities being less
constrained by the general statutory prohibition in their security-
based swap activity with foreign counterparties and foreign branches of
U.S. counterparties. The Commission continues to recognize that
associating with statutorily disqualified natural persons effecting or
involved in effecting security-based swaps on behalf of SBS Entities
may give rise to counterparty and compliance risks. For example, as the
Commission discussed elsewhere, in other settings, individuals engaged
in misconduct are significantly more likely to engage in repeated
[[Page 24269]]
misconduct.\468\ Data in the Rule of Practice 194 Adopting Release
suggests that, in parallel disqualification review processes in swap
and broker-dealer settings, the application rate is low, but there are
incidences of repeated misconduct.\469\ The Commission also continues
to recognize that statutory disqualification and an inability to
continue associating with SBS Entities creates disincentives against
underlying misconduct for associated persons and that there may be
spillover effects on other associated persons within the same SBS
Entity.\470\ Further, the Commission recognizes that, under the
proposed amendment, the Commission would be unable to make an
individualized determination about whether permitting a given non-U.S.
associated natural person to effect or be involved in effecting
security-based swaps on behalf of an SBS Entity is consistent with the
public interest.
---------------------------------------------------------------------------
\468\ For a more detailed discussion, see Rule of Practice 194
Adopting Release, 84 FR at 4932.
\469\ See Rule of Practice 194 Adopting Release, 84 FR at 4928.
\470\ For example, as discussed in the Rule of Practice Adopting
Release, Dimmock, Gerken, and Graham (2018) examine customer
complaints against FINRA-registered representatives in 1999 through
2011, and argue that misconduct of individuals influences the
misconduct of their coworkers. Using mergers of firms as a quasi-
exogenous shock, the paper examines changes in an adviser's
misconduct around changes to an employee's coworkers due to a
merger. The paper estimates that an employee is 37% more likely to
commit misconduct if her new coworkers encountered in the merger
have a history of misconduct. The paper contributes to broader
evidence on peer effects, connectedness, and commonality of
misconduct, and can help explain the distributional properties in
the prevalence of misconduct across firms documented in Egan,
Matvos, and Seru (2017). See Stephen G. Dimmock, William C. Gerken,
& Nathaniel P. Graham, ``Is Fraud Contagious? Coworker Influence on
Misconduct by Financial Advisors,'' 73 J. Fin. 1417 (2018); see also
Mark Egan, Gregor Matvos, & Amit Seru, ``The Market for Financial
Adviser Misconduct,'' 127 J. Pol. Econ. 233 (2019), available at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2739170.
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The Commission also notes that the proposed amendment would allow
SBS Entities to rely on disqualified non-U.S. personnel in their
transactions with both foreign counterparties and foreign branches of
U.S. counterparties. To the degree that statutory disqualification may
increase risks to counterparties, to the degree that SBS Entities may
choose to rely on disqualified foreign personnel despite reputational
and compliance costs of association, and to the extent that such
counterparties do not move their business to other personnel or SBS
Entity, this may increase risks to foreign branches of U.S.
counterparties. Depending on the consolidation and ownership structure
of counterparties, some of the returns as well as losses in foreign
branches may flow through to some U.S. parent firms. However, the
proposed approach provides for identical treatment of foreign
counterparties and foreign branches of U.S. counterparties, reducing
potential competitive disparities between them in security-based swap
markets.
The Commission notes that, importantly, the proposed exclusion
would more closely harmonize the Commission's approach with the
approach already being followed with respect to foreign personnel of
Swap Entities. As such, the Commission's assessment of the benefits and
potential counterparty risks of the proposed relief discussed above is
informed by experience and data with respect to CFTC/NFA statutory
disqualification review in swap markets, including, among others: (i)
The low incidence of statutory disqualification of associated persons;
(ii) the majority of applications arising out of non-investment related
conduct by associated persons; (iii) absence of additional statutory
disqualification forms filed by swap dealers to request NFA
determination with respect to a new statutory disqualification for any
of the individuals.\471\ The Commission also notes that parallel swap
markets remain large, with multi-name credit default swaps representing
an increasing share of credit-default swap notional outstanding, and
highly liquid.\472\
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\471\ See Rule of Practice Adopting Release, 84 FR at 4931.
\472\ See, e.g., Inaki Aldasoro & Torsten Ehlers, ``The Credit
Default Swap Market: What a Difference a Decade Makes,'' BIS
Quarterly Review, June 2018, at 3 (Graph 1), available at https://www.bis.org/publ/qtrpdf/r_qt1806b.pdf, last accessed March 26, 2019;
see also Richard Haynes & Lihong McPhail, ``The Liquidity of Credit
Default Index Swap Networks'' (Working Paper, 2017).
---------------------------------------------------------------------------
Three factors may reduce the magnitude of the above economic costs
and benefits. First, the Commission will continue to be able, in
appropriate cases, to institute proceedings under Exchange Act Section
15F(l)(3) to determine whether the Commission should censure, place
limitations on the activities or functions of such person, suspend for
a period not exceeding 12 months, or bar such person from being
associated with an SBS Entity.\473\
---------------------------------------------------------------------------
\473\ See 15 U.S.C. 78o-10(l)(3).
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Second, the security-based swap market is an institutional one,
with investment advisers, banks, pension funds, insurance companies,
and ISDA-recognized dealers accounting for 99.8% of transaction
activity.\474\ While security-based swaps may be more opaque than
equity and bonds and may give rise to greater information asymmetries
between dealers and non-dealer counterparties, institutional
counterparties may be more informed and sophisticated compared to
retail clients. However, given limited data availability on the
domiciles of non-dealer counterparties, the Commission is unable to
quantify how many non-institutional foreign counterparties may be
affected by the proposed Rule.
---------------------------------------------------------------------------
\474\ See Rule of Practice 194 Adopting Release, Table 1 of the
economic baseline.
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Importantly, the concentrated nature of security-based swap market-
facing activity may reduce the ability of counterparties to choose to
transact with SBS Entities that do not rely on disqualified personnel.
As the Commission estimated elsewhere, the top five dealer accounts
intermediated approximately 55% of all SBS Entity transactions by gross
notional, and the median counterparty transacted with 2 dealers in
2017.\475\ While reputational incentives may flow from a customer's
willingness to deal with an SBS Entity, the fact that the customer may
not have many dealers to choose from weakens those incentives. However,
the Commission also notes that market concentration is itself
endogenous to market participants' counterparty selection. That is,
counterparties trade off the potentially higher counterparty risk of
transacting with SBS Entities that rely on disqualified associated
persons against the attractiveness of security-based swaps (price and
non-price terms) that they may offer. If a large number of
counterparties choose to move their business to SBS Entities that do
not rely on disqualified associated persons (including those SBS
Entities that may currently have lower market share), market
concentration itself can decrease.
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\475\ See Rule of Practice 194 Adopting Release, 84 FR at 4925.
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Third, as discussed above, the exclusion will not be available with
respect to an associated person if that associated person is currently
subject to an order described in subparagraphs (A) and (B) of Section
3(a)(39) of the Exchange Act, with the limitation that an order by a
foreign financial regulatory authority described in subparagraphs
(B)(i) and (B)(iii) of Section 3(a)(39) shall only apply to orders by a
foreign financial regulatory authority in the jurisdiction where the
associated person is employed or located. In such circumstances,
affected SBS Entities will be required to apply for relief under Rule
of Practice 194 and will be unable to allow their disqualified
associated person entities to effect or be involved in effecting
[[Page 24270]]
security-based swaps on their behalf, pending review by the Commission.
2. Effects on Efficiency, Competition, and Capital Formation
The Commission has assessed the effects of the proposed amendment
on efficiency, competition, and capital formation. As noted above,
limiting the ability of statutorily disqualified persons to effect or
be involved in effecting security-based swaps on behalf of SBS Entities
may reduce compliance and counterparty risks and may facilitate
competition among higher quality associated persons and SBS Entities,
thereby enhancing integrity of security-based swap markets. At the same
time, limits on the participation of disqualified employees in
security-based swap markets may result in costs related to replacing or
reassigning an employee to SBS Entities or applying to the Commission
for relief. This may disrupt existing counterparty relationships across
closely linked swap and security-based swap markets and increase
transaction costs borne by counterparties, adversely effecting
efficiency and capital formation in swap and security-based swap
markets.
In addition, if more SBS Entities seek to avail themselves of the
exclusion and retain, hire, or increase their reliance on disqualified
foreign personnel in their transactions with foreign counterparties, a
greater number of disqualified persons may seek employment and business
opportunities in security-based swap markets. As discussed in the Rule
of Practice 194 Adopting Release,\476\ there is a dearth of economic
research on these issues in derivatives markets, and the research in
other settings cuts both ways. On the one hand, a greater number of
disqualified persons active in security-based swaps could increase the
``lemons'' problem and related costs of adverse selection,\477\ since
market participants may demand a discount from counterparties if they
expect a greater chance that counterparties have employed disqualified
persons that are involved in arranging transactions. This effect could
lead to a reduction in informational efficiency and capital formation.
On the other hand, more flexibility in employing disqualified persons
may also increase competition and consumer surplus.\478\
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\476\ See Rule of Practice 194 Adopting Release, 84 FR at 4923.
\477\ See, e.g., George A. Akerlof, ``The Market for ``Lemons'':
Quality Uncertainty and the Market Mechanism,'' 84 Q. J. Econ. 488
(1970). Informational asymmetry about quality can negatively affect
market participation and decrease the amount of trading--a problem
commonly known as adverse selection. When information about
counterparty quality is scarce, market participants may be less
willing to enter into transactions, and the overall level of trading
may fall.
\478\ See Jonathan Berk & Jules H. van Binsbergen, ``Regulation
of Charlatans in High-Skill Professions'' (Stanford University
Graduate School of Business, Research Paper No. 17-43, 2017),
available at https://ssrn.com/abstract=2979134. The paper models the
costs and benefits of both disclosure and standards regulation of
``charlatans'' (professionals who sell a service they do not
deliver) in high skill professions. When there is a mismatch between
high demand for a skill and short supply of the skill, the presence
of charlatans in a profession is an equilibrium outcome.
Importantly, reducing the number of charlatans by regulation
decreases consumer surplus in their model. Both standards and
disclosure regulations drive charlatans out of the market, but the
resulting reduction in competition amongst producers actually
reduces consumer surplus. In turn, producers strictly benefit from
such regulation.
---------------------------------------------------------------------------
The proposed amendment would preserve an equal competitive standing
of U.S. and non-U.S. SBS Entities with disqualified foreign personnel
as they compete for business with foreign counterparties and foreign
branches of U.S. counterparties. Importantly, under the baseline, both
U.S. and non-U.S. Swap Entities are able to transact with foreign
counterparties relying on their foreign disqualified personnel without
applying to the CFTC for relief from the statutory prohibition. As
discussed in the economic baseline, the Commission expects extensive
cross-registration of dealers across the two markets. As a result,
dually registered U.S. SBS Entities would be able to rely on the same
disqualified foreign personnel in transacting with the same
counterparties in both swap (e.g., index CDS) and security-based swap
(e.g., single-name CDS) markets.
The proposed amendment may create incentives for SBS Entities to
relocate their personnel (or the activities performed by U.S.
personnel) outside the U.S. to be able to avail themselves of the
proposed exclusion and avoid being bound by the statutory prohibition.
The cost of relocation will depend on many factors, such as the number
of positions being relocated, the location of new operations, the costs
of operating at the new location, and other factors. These factors
will, in turn, depend on the relative volumes of market-facing activity
that a firm carries out on different underliers and with counterparties
in different jurisdictions. As a result of these dependencies, the
Commission cannot reliably quantify the costs of these alternative
approaches to compliance. However, the Commission believes that firms
would seek to relocate their personnel (or the activities performed by
U.S. personnel) only if they expect the relocations to be profitable.
Further, the proposed amendment may improve the employment and
career outcomes of disqualified foreign personnel relative to
disqualified U.S. personnel. As a result, disqualified personnel may
seek to relocate outside the U.S. and seek employment by SBS Entities
in their foreign business. To the degree that such relocation occurs,
it may reduce the effective scope of application of the statutory
prohibition. This may also lead to a separating equilibrium: It may
decrease counterparty risks and adverse selection costs of security-
based swaps in SBS Entities and in transactions with U.S.
counterparties, and increase counterparty risks and adverse selection
costs in transactions with foreign counterparties and foreign branches
of U.S. counterparties.
3. Alternatives Considered
The Commission has considered several alternatives to the proposed
amendment to Rule of Practice 194(c)(2).
a. Relief for All SBS Entities With Respect to Non-U.S. Personnel
Transacting With Non-U.S. Counterparties But Not With Foreign Branches
of U.S. Counterparties
The Commission could have proposed an exclusion for all SBS
Entities with respect to foreign personnel transacting with foreign
counterparties, without making the exclusion available to foreign
personnel transacting with foreign branches of U.S. counterparties. As
discussed above, a history of statutorily disqualifying conduct may
signal higher ongoing risks to counterparties. SBS Entities may choose
to replace disqualified foreign personnel due to reputational and
compliance costs. In addition, the security-based swap market is
institutional in nature, and better informed institutional
counterparties may choose to move their business to another employee or
another SBS Entity without disqualified personnel. To the degree that
SBS Entities do not replace disqualified personnel and counterparties
do not move their business, the alternative may decrease risks to
foreign branches of U.S. counterparties relative to the proposed
approach. Since both potential returns and potential risks of foreign
branches may flow through to some U.S. parents (depending on the
counterparty's ownership and organizational structure), the alternative
could reduce the returns and risks of such U.S. counterparties'
parents.
At the same time, the alternative approach would involve unequal
effects on foreign counterparties and foreign
[[Page 24271]]
branches of U.S. counterparties. Specifically, under the alternative,
foreign counterparties would be able to choose between transacting with
those SBS Entities that employ statutorily disqualified personnel and
those that do not, whereas foreign branches of U.S. counterparties
would only be able to transact with SBS Entities that do not employ
statutorily disqualified personnel. If SBS Entities with disqualified
personnel compensate for potentially higher counterparty risks with,
for example, more attractive terms of security-based swaps, the
alternative may introduce disparities in access and cost of security-
based swaps available to foreign counterparties as compared to those
available to foreign branches of U.S. counterparties.
b. Relief for Non-U.S. Person SBS Entities With Respect to Non-U.S.
Personnel Transacting With Non-U.S. Counterparties and Foreign Branches
of U.S. Counterparties
The Commission has considered a narrower alternative exclusion
limited to non-U.S. person SBS Entities relying on non-U.S. personnel
in their transactions with foreign counterparties and foreign branches
of U.S. counterparties. The alternative exclusion would be subject to
the same limitation as the proposal, discussed above: An SBS Entity
would not be able to rely on the exclusion with respect to an
associated person currently subject to an order that prohibits such
person from participating in the U.S. financial markets, including the
securities or swap market, or foreign financial markets.
Relative to the proposed amendment, this alternative would broaden
the effective scope of application of the statutory prohibition and
might reduce ongoing compliance and counterparty risks for foreign
counterparties and foreign branches of U.S. counterparties. Under the
alternative, disqualified foreign personnel of U.S. SBS Entities would
be unable to transact without the costs and delays related to
applications for relief. This might decrease the number of disqualified
foreign personnel transacting in security-based swap markets and
seeking to associate with U.S. SBS Entities. Lower market participation
of disqualified personnel on behalf of U.S. SBS Entities in their
foreign transactions may reduce the costs of adverse selection and
increase foreign counterparty willingness to transact with U.S. SBS
Entities in security-based swaps.
At the same time, it would result in a disparate competitive
standing between U.S. SBS Entities and non-U.S. person SBS Entities as
they are competing for business with foreign counterparties and foreign
branches of U.S. counterparties. This alternative would allow non-U.S.
SBS Entities to enjoy flexibility in hiring, retaining, and replacing
non-U.S. personnel and in staffing foreign offices with personnel
engaged in transactions with foreign counterparties. However, U.S. SBS
Entities would be unable to rely on the exclusion and would have to
either replace an employee or apply under Rule of Practice 194,
incurring related costs and delays. To the degree that SBS Entities
pass along costs to their counterparties, relative to the proposed
exclusion, this narrower alternative may result in somewhat lower
availability or worse terms of security-based swaps and may somewhat
reduce the choice of dealers for foreign counterparties and foreign
branches of U.S. counterparties. Finally, this approach would be
inconsistent with the CFTC's relief for Swap Entities. Given expected
extensive cross-registration and active cross-market participation by
counterparties, a lack of comparable treatment of disqualification
across swaps and security-based swaps would make it harder for the same
U.S. SBS Entities to transact relying on the same foreign personnel
with the same foreign counterparties in related markets.
Further, under the alternative, foreign personnel of U.S. SBS
Entities would not have the same competitive standing as foreign
personnel of non-U.S. SBS Entities when engaging in business with the
same foreign counterparties. The Commission also notes that the
definition of a U.S. person is based on a natural person's residency in
the United States. As discussed above, excluding foreign personnel of
foreign SBS Entities creates incentives for all disqualified U.S.
personnel employed by foreign SBS Entities to be transferred to a
foreign office in order to legally become non-U.S. personnel eligible
for the alternative exclusion. Of course, the choice made by a non-U.S.
SBS Entity to transfer disqualified U.S. personnel abroad will reflect
the value of an employee's skills and expertise, costs to reputation
with counterparties, the number of positions being moved, and internal
organizational structures of a non-U.S. SBS Entity. However, SBS
Entities are commonly part of large financial groups with many domestic
and foreign regional offices. Therefore many non-U.S. SBS Entities may
be able to relocate statutorily disqualified U.S. personnel to foreign
offices and rely on the exclusion.
Under this alternative, however, disqualified personnel of U.S. SBS
Entities would be unable to relocate to a foreign office and rely on
the exclusion, adding to the competitive disparities between
disqualified personnel of U.S. and foreign SBS Entities transacting
with the same foreign counterparties. As a result, under the
alternative, statutorily disqualified personnel of U.S. SBS Entities
may seek employment with foreign SBS Entities and continue to transact
with the same foreign counterparties on behalf of non-U.S. SBS
Entities.
The Commission continues to recognize that, due to adverse
selection costs and compliance risks related to hiring and retaining
disqualified persons, many SBS Entities may choose not to hire or may
fire and replace statutorily disqualified employees. However, this
incentive may be weaker with respect to personnel whose conduct giving
rise to disqualification occurred in jurisdictions where statutory
disqualification is not public information.
c. Relief for Non-U.S. SBS Entities With Respect to Both U.S. and Non-
U.S. Personnel Transacting With Foreign Counterparties and Foreign
Branches of U.S. Counterparties
The Commission has considered excluding from the statutory
prohibition both U.S. and foreign disqualified personnel, but limiting
the relief to non-U.S. person SBS Entities transacting exclusively with
foreign counterparties or foreign branches of U.S. counterparties. The
alternative exclusion would be subject to the same limitation as the
proposal, discussed above: An SBS Entity would not be able to rely on
the exclusion with respect to an associated person currently subject to
an order that prohibits such person from participating in the U.S.
financial markets, including the securities or swap market, or foreign
financial markets.
Under the alternative, non-U.S. SBS Entities would enjoy full
flexibility in hiring, retaining, and replacing personnel and in
staffing both U.S. and non-U.S. offices with personnel engaged in
transactions with foreign counterparties. To the degree that non-U.S.
SBS Entities pass along costs to their counterparties, this may result
in somewhat higher availability or improved terms of security-based
swaps for foreign counterparties. Further, under the alternative,
disqualified U.S. personnel would have the same competitive standing as
disqualified foreign personnel with similar skills and expertise
transacting on behalf of non-U.S. SBS Entities with the same foreign
[[Page 24272]]
counterparties. For example, disqualified U.S. personnel transacting
with foreign counterparties and foreign branches of U.S. counterparties
would not need to relocate to a foreign office of a foreign SBS Entity
to avail themselves of the exclusion.
Relative to the proposed Rule, this alternative would increase the
competitive gap between U.S. and non-U.S. SBS Entities in their ability
to hire, retain, and locate disqualified personnel as they compete for
business with foreign counterparties. To the degree that U.S. SBS
Entities may wish to begin or continue to associate with disqualified
personnel despite potential reputation costs, U.S. SBS Entities would
be required to apply with the Commission and disallow disqualified
personnel from effecting security-based swaps pending Commission
action. At the same time, foreign SBS Entities would be able to freely
hire and retain disqualified personnel in the U.S. and allow them to
engage in security-based swap transactions with foreign counterparties
and foreign branches of U.S. counterparties.
As noted in the economic baseline, this alternative approach is
inconsistent with the relief from the CFTC's requirements that is
available to both U.S. and non-U.S. SBS Entities with respect to only
foreign personnel. Given expected extensive cross-registration and
active cross-market participation by counterparties, differential
treatment of disqualification may disrupt counterparty relationships
between the same dually registered SBS Entities transacting with the
same foreign counterparties in related markets.
Under the alternative and relative to the proposed amendment,
disqualified U.S. personnel of non-U.S. SBS Entities may enjoy better
employment and career outcomes, which may increase the number of
disqualified personnel transacting in security-based swap markets and
seeking to associate with SBS Entities. Greater market participation of
disqualified personnel on behalf of non-U.S. SBS Entities, particularly
in jurisdictions where conduct giving rise to disqualification is not
public or easily accessible information, may increase the costs of
adverse selection and decrease counterparty willingness to transact
with non-U.S. SBS Entities in security-based swaps. As a result, some
foreign counterparties may choose to move their transaction activity
from non-U.S. to U.S. SBS Entities.
The magnitude of the above economic effects of the alternative
approach may be limited by three factors. First, many non-U.S. SBS
Entities may choose to locate personnel transacting with foreign
counterparties in foreign offices if most of their business is in
foreign underliers trading in foreign jurisdictions.\479\ As a result,
some non-U.S. SBS Entities may already locate personnel, including
statutorily disqualified personnel, dedicated to transacting with
foreign counterparties outside the United States.
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\479\ As discussed in part VII.A.2.c, supra, we understand that
many market participants engaged in market-facing activity prefer to
use traders and manage risk for security-based swaps in the
jurisdiction where the underlier is traded.
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Second, due to reputational and adverse selection costs and
compliance risks related to hiring and retaining disqualified persons,
many SBS Entities may choose not to hire, or may fire and replace
disqualified employees. The incentive to disassociate is strongest in
jurisdictions in which conduct giving rise to statutory
disqualification is public information (as in the U.S). As a result, it
is not clear how often non-U.S. SBS Entities would choose to hire or
continue to employ disqualified U.S. personnel even if they were able
to rely on an exclusion and avoid applying for relief under Rule of
Practice 194.
Third, the Commission notes that the primary difference between the
proposed approach and the alternative is in the treatment of U.S. SBS
Entity personnel. Specifically, under the proposal, U.S. SBS Entities
may permit non-U.S. personnel to transact with foreign counterparties
and foreign branches of U.S. counterparties, whereas under the
alternative they may not. With respect to non-U.S. SBS Entities, the
proposal provides relief for foreign personnel only; the alternative
provides relief with respect to both U.S. and foreign personnel. As
discussed above, the definition of a U.S. person in Rule 3a71-
3(a)(4)(i)(A) under the Exchange Act with respect to a natural person
is based on residency in the United States. Under the proposal, non-
U.S. SBS Entities may be able to simply transfer statutorily
disqualified U.S. personnel transacting with foreign counterparties to
a foreign office in order to become eligible for the proposed
exclusion. Of course, each non-U.S. SBS Entity's choice to continue to
employ disqualified U.S. personnel and relocate them abroad would
likely reflect the value of an employee's skills and expertise,
reputational costs of continued association, the number of positions
being moved, and internal organizational structures of each entity,
among others. However, non-U.S. SBS Entities are commonly members of
large financial groups with many domestic and foreign regional offices,
and such relocation is likely to be feasible for some non-U.S. SBS
Entities. As a result, depending on the ease and costs of such
relocation and the value of disqualified personnel to the non-U.S. SBS
Entity, the scope of this alternative with respect to non-U.S. SBS
Entities may be similar to the effective scope of the proposed
exclusion with respect to non-U.S. SBS Entities.
d. Relief for All SBS Entities With Respect to All Personnel
Transacting With Non-U.S. Counterparties and Foreign Branches of U.S.
Counterparties
The Commission has considered an exclusion for both U.S. and
foreign SBS Entities with respect to all personnel transacting with
foreign counterparties and foreign branches of U.S. counterparties. The
alternative exclusion would be subject to the same limitation as the
proposal, discussed above: An SBS Entity would not be able to rely on
the exclusion with respect to an associated person currently subject to
an order that prohibits such person from participating in the U.S.
financial markets, including the securities or swap market, or foreign
financial markets.
This alternative would allow both non-U.S. and U.S. SBS Entities to
enjoy full flexibility in hiring, retaining, and replacing personnel,
and in staffing both U.S. and non-U.S. offices with personnel engaged
in transacting with foreign counterparties and foreign branches of U.S.
counterparties. To the degree that SBS Entities currently pass along
costs to their counterparties or to the degree disqualified personnel
may have superior skills or expertise, this may benefit the terms of
security-based swaps and choice of dealers available to foreign
counterparties. Further, disqualified U.S. personnel would have the
same competitive standing as disqualified foreign personnel with
similar skills and expertise transacting on behalf of SBS Entities with
the same foreign counterparties.
Relative to the proposed exclusion, this alternative provides more
relief from the statutory prohibition and may, thus, increase ongoing
compliance and counterparty risks for foreign counterparties and
foreign branches of U.S counterparties. Since all disqualified
personnel of all SBS Entities transacting with foreign counterparties
and foreign branches of U.S. counterparties would be excluded from the
statutory prohibition, more disqualified personnel may seek to
associate with both U.S. and foreign SBS Entities and to transact with
foreign counterparties and foreign branches of
[[Page 24273]]
U.S. counterparties. However, as discussed elsewhere in this release
and in the Rule of Practice 194 Adopting Release, one of the key
disincentives against continued association with disqualified personnel
may be reputational. To the degree that information about the
disqualifying conduct by U.S. personnel may be public and institutional
customers perceive disqualification as increasing counterparty risk,
counterparties may move their business, and SBS Entities may simply
replace disqualified U.S. personnel. As a result, it is not clear that
SBS Entities would significantly increase their reliance on
disqualified personnel in transactions with foreign counterparties and
foreign branches of U.S. counterparties relative to the baseline or the
proposed approach. Nevertheless, to the degree that they may do so,
greater market participation of disqualified personnel may increase
adverse selection costs and decrease such counterparties' willingness
to participate in security-based swap markets.
As noted above, a natural person's residency in the United States
is endogenous. As a result, any exclusion for foreign personnel, but
not U.S. personnel, transacting with foreign counterparties may result
in SBS Entities simply transferring disqualified U.S. personnel to a
foreign office. As the Commission recognized above, this decision by an
SBS Entity will reflect the uniqueness and value of an employee's
skills, expertise, and client relationships relative to the
reputational costs and compliance risks of continuing to employ
disqualified personnel and directs costs of personnel transfers.
However, SBS Entities that belong to large global financial groups are
less likely to be constrained by the location of disqualified personnel
that they prefer to retain. As a result, the economic effects of this
alternative may be similar to those of the proposed approach.
e. Relief for All SBS Entities With Respect to Non-U.S. Personnel
Effecting and Involved in Effecting Security-Based Swaps With U.S. and
Non-U.S. Counterparties
The Commission has also considered alternatives excluding from the
statutory prohibition non-U.S. associated persons involved in effecting
security-based swaps with both U.S. and non-U.S. counterparties in
general, or under certain circumstances. For example, the Commission
has considered excluding from the statutory prohibition non-U.S.
associated persons involved in effecting security-based swaps with U.S.
counterparties, if such activity is limited in level or scope (e.g.,
collateral management).
As discussed in the economic baseline, security-based swap markets
are global and many SBS Entities actively participate across U.S. and
non-U.S. markets. Due to economies of scale and scope, some SBS
Entities may choose not to separate customer facing and/or operational
activities, such as collateral management and clearing, related to
security-based swaps with U.S. and non-U.S. counterparties. To the
degree that some SBS Entities rely on the same personnel across their
U.S. and non-U.S. business, they are currently unable to hire and
retain statutorily disqualified personnel absent exemptive relief by
the Commission. As discussed above, SBS Entities may face reputational
costs from retaining disqualified employees. To the degree that SBS
Entities would prefer to hire and retain certain disqualified employees
due to their superior expertise, skills, and abilities, and despite
such reputational costs, the alternative would provide beneficial
flexibility in personnel decisions without necessitating an SBS Entity
to completely separate the operational side of their U.S and non-U.S.
businesses (and more flexibility relative to the proposal). Some of
these benefits may flow through to counterparties in the form of more
efficient execution of security-based swaps and related services, or
better price and non-price terms.
To the degree that statutory disqualification of associated persons
may increase compliance and counterparty risks, the alternative may
involve greater risks to U.S. counterparties of SBS Entities relative
to the proposal. The Commission continues to note that the scope of
conduct that gives rise to statutory disqualification is broad and
includes conduct that is not related to investments or financial
markets. Moreover, the security-based swap market is an institutional
one, and conduct that gives rise to statutory disqualification in the
U.S. is generally public. U.S. counterparties that believe statutory
disqualification is a meaningful signal of quality may vote with their
feet and choose to transact with non-disqualified personnel or SBS
Entities that do not rely on disqualified personnel.
The Commission notes that the alternative would provide broader
relief compared to CFTC's requirements in swap markets and would not
result in a harmonized regulatory regime with respect to statutory
disqualification. Importantly, the full costs and benefits of an
alternative that provides broader relief from the statutory prohibition
in security-based swaps compared to the relief available in swap
markets may not be realized. Specifically, to the degree that market
participants transact across swap and security-based swap markets with
the same SBS Entity counterparties, SBS Entities may continue to rely
on the same personnel who are allowed to effect or be involved in both
swaps and security-based swap transactions.
E. Certification, Opinion of Counsel, and Employee Questionnaires
In addition, the Commission is proposing certain guidance on
requirements regarding the certification and opinion of counsel under
Rule 15Fb2-4, amendments to registration Rule 15Fb2-1, and
modifications to the requirement to obtain employee questionnaires
under proposed Rules 18a-5(a)(10) and (b)(8).
1. Guidance Regarding Rule 15Fb2-4 and Proposed Amendments to Rule
15Fb2-1
a. Background
The Commission's proposal retains the adopted certification and
opinion of counsel requirements, but proposes additional guidance
regarding the scope of the requirements. Specifically, the guidance
would clarify that the requirement applies only with respect to the
foreign laws of the jurisdiction or jurisdictions in which the
nonresident SBS Entity maintains the covered books and records and that
covered records include only records that relate to the ``U.S.
business'' of the nonresident SBS Entity and financial records
necessary for the Commission to assess compliance with its capital and
margin rules (if applicable). In addition, the proposed guidance would
clarify that the certification and opinion of counsel can be predicated
on the consent of persons whose information is or will be included in
the books and records, and can consider, under certain circumstances,
whether the relevant regulatory authority in the foreign jurisdiction
has previously approved or consented to the Commission requesting and
obtaining documents from, and conducting on-site inspections or
examinations at office of, nonresident SBS Entities located in the
jurisdiction. Finally, the proposed guidance would clarify that the
certification and opinion of counsel requirements would not need to
address open contracts predating the filing of the registration
application. In addition, the proposal would amend
[[Page 24274]]
Rule 15Fb2-1 and establish a conditional registration regime discussed
in Section IV.A.5 above.
b. Costs, Benefits, and Effects on Efficiency, Competition, and Capital
Formation
(1) Proposed Guidance
As the Commission stated in the Registration Adopting Release, the
Commission's access to books and records and the ability to inspect and
examine registered SBS Entities facilitates Commission oversight of
security-based swap markets.\480\ To the degree that the certification
and opinion of counsel requirements provide assurances regarding the
Commission's ability to oversee and inspect and examine nonresident SBS
Entities, the baseline rules may reduce counterparty and compliance
risks and adverse selection. However, certain nonresident entities may
lack clarity concerning the certification and opinion of counsel
requirements.
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\480\ See 80 FR at 48972.
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The recent passage of the EU General Data Protection Regulation
(GDPR), as well as the potential exit of the United Kingdom from the
European Union may create significant uncertainty for market
participants currently intermediating large volumes of security-based
swaps regarding their ability to comply with the certification and
opinion of counsel requirements, as well as the background check
recordkeeping requirements discussed below. In addition, since the
adoption of SBS Entity registration rules, the Commission has received
questions regarding specific aspects of the certification and opinion
of counsel requirements and is aware of concerns about the ability of
some nonresident market participants to comply with these
requirements.\481\
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\481\ See, e.g., IIB/SIFMA 8/26/2016 Letter; see also IIB 11/16/
2016 Email; Memo to File dated July 24, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4107153-170272.pdf; Memo to
File dated June 5, 2018, available at https://www.sec.gov/comments/s7-08-12/s70812-3785770-162712.pdf; Memo to File dated April 30,
2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4042895-168865.pdf; Memo to File dated April 30, 2018, available at
https://www.sec.gov/comments/s7-05-14/s70514-4042895-168865.pdf;
Memo to file dated April 11, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-4035093-168391.pdf; Memo to file dated
April 4, 2018, available at https://www.sec.gov/comments/s7-05-14/s70514-3405597-162172.pdf; Memo to file dated April 3, 2018,
available at https://www.sec.gov/comments/s7-05-14/s70514-3405388-162169.pdf.
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The Commission estimates that nonresident SBS Entities currently
intermediating approximately 59.8% of all security-based swap notional
are subject to foreign privacy and secrecy laws, blocking statutes, and
other legal barriers that may make it difficult or create uncertainty
about their ability to provide certification and opinion of counsel
and/or to be subject to inspections and examinations by the
Commission.\482\ To that extent, such nonresident SBS entities may be
less likely to apply or become unable to register as SBS Entities when
compliance with SBS Entity registration rules is required. As a result,
some nonresident SBS Entities currently intermediating large volumes of
security-based swap transactions may cease transaction activity or be
forced to relocate certain operations, books, and records. This may
result in disruptions to valuable counterparty relationships or
increased costs to counterparties (to the degree that nonresident SBS
Entities may pass along the costs of such restructuring in the form of
higher transaction costs or less attractive security-based swaps). In
addition, depending on whether and which SBS Entities step in to
intermediate the newly available market share, there may be significant
competitive effects.
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\482\ Since we expect a large number of U.S. SBS Entities will
have dually registered as Swap Entities, to inform our analysis we
considered foreign jurisdictions where CFTC staff previously
provided no-action relief for trade repository reporting
requirements as they apply to swap dealers (available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/15-01.pdf). This estimate was also informed by a legal analysis of the
EU General Data Protection Regulation, foreign blocking statutes,
bank secrecy and employment laws, jurisdiction specific privacy
laws, and other legal barriers that may inhibit compliance with
regulatory requirements. These jurisdictions were matched to the
domicile classifications of TIW accounts likely to trigger
requirements to register with the Commission as SBS Entities when
compliance with registration requirements becomes effective, using
2017 DTCC-TIW data. If foreign jurisdictions amend their data
privacy and blocking laws, provide guidance, or enter into
international agreements that would facilitate compliance with
Commission SBS Entity registration requirements before compliance
with SBS Entity registration rules becomes effective, or if SBS
Entities choose to restructure their operations and/or relocate
their books and records to other jurisdictions (for example, in
response to the potential exit of the U.K. from the E.U. or GDPR
restrictions), this figure may over- or under-estimate the security-
based swap market share impacted by the proposed guidance.
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The proposed approach could benefit some nonresident entities
currently intermediating security-based swap markets by reducing
uncertainty, allowing them to more easily comply with the certification
and opinion of counsel requirements, and register with the Commission
while avoiding disruptions to counterparty relationships and potential
competitive effects to security-based swap markets. For example, based
on an analysis of foreign privacy and secrecy laws, blocking statutes,
and other legal barriers and information from market participants, the
proposed guidance regarding consent may help SBS Entities currently
intermediating approximately 47.2% of all security-based swap notional
intermediated by SBS Entities to comply with the certification and
opinion of counsel requirements, to the extent that those entities
would otherwise have understood that the certification and opinion of
counsel cannot be predicated on customer consent.\483\
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\483\ This estimate is based on an analysis of 2017 DTCC TIW
account-level data on the transaction activity of entities likely to
trigger requirements to register with the Commission as SBS Entities
when compliance with registration requirements becomes effective. We
note that customer consent may serve as a part of a broader legal
basis for the opinion of counsel, and the proposed guidance may help
those nonresident SBS Entities that are subject to foreign privacy,
but not necessarily foreign secrecy laws, to comply with the
certification and opinion of counsel requirements. If foreign
jurisdictions amend their data privacy and blocking laws, provide
guidance, or enter into international agreements that would
facilitate compliance with the opinion of counsel requirement before
compliance with SBS Entity registration rules become effective, or
if SBS Entities choose to restructure their operations and/or
relocate their books and records to other jurisdictions (for
example, in response to the potential exit of the U.K. from the E.U.
or GDPR restrictions), this figure may over- or under-estimate the
security-based swap market share impacted by the proposed guidance.
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To the extent that aspects of the proposed guidance may reduce the
scope of the certification and opinion of counsel by nonresident SBS
Entities relative to their baseline understanding of Rule 15Fb2-4, the
proposed guidance may decrease the burden on nonresident SBS Entities
and the assurances that the Commission will be able to effectively and
efficiently oversee, inspect, and examine nonresident SBS Entities.
However, as discussed above, the proposed amendment to Rule 15Fb2-1
regarding the certification and opinion of counsel requirements would
not reduce or eliminate independent ongoing obligations of nonresident
SBS Entities to provide the Commission with direct access to their
books and records and to permit onsite inspections and examinations.
Importantly, the Commission recognizes that the magnitude of the
economic effects of the proposed guidance is influenced by how market
participants currently understand the scope of the certification and
opinion of counsel requirements. Specifically, the proposed guidance
will only have the economic effects discussed below, to the extent that
SBS Entities and their counterparties have a broader baseline
understanding of the scope of existing rules. If market participants
are
[[Page 24275]]
currently interpreting the scope of the certification and opinion of
counsel requirements in a manner similar to that provided by the
proposed guidance, the economic effects of the proposed guidance may be
de minimis.
(2) Proposed Conditional Registration
The proposal would also amend Exchange Act Rule 15Fb2-1 to allow
applicants unable to provide the certification and opinion of counsel
to become conditionally registered for up to 24 months after the
compliance date for registration rules. Under the proposal, if an
entity fails to provide the requisite certification and opinion of
counsel within 24 months, the Commission may institute proceedings to
determine whether ongoing registration should be denied.
The Commission is cognizant of the fact that SBS Entity
Registration rules and other elements of the Title VII regime will
apply to an active market. As analyzed in the economic baseline, the
Commission recognizes that security-based swap markets involve
extensive cross-border activity, and nonresident SBS Entities
intermediate a large percentage of security-based swaps. The Commission
preliminarily believes that the nonresident SBS entities that may face
uncertainty about their ability to comply with certification and
opinion of counsel requirements, and are likely to utilize conditional
registration, are those SBS Entities located in jurisdictions with
foreign privacy and secrecy laws, blocking statutes, and other legal
barriers described above.
The conditional registration element of the proposal may provide
SBS Entities currently active in security-based swap markets with
beneficial flexibility and time to relocate some of their operations
and/or books and records around the constraints of foreign privacy and
secrecy laws, blocking statutes, and other legal barriers, without
disrupting ongoing counterparty relationships and market activity. In
addition, the proposal may facilitate smooth functioning of active
security-based swap markets as compliance with the Commission's Title
VII rules becomes required, may benefit both SBS Entities and
counterparties by preserving SBS Entity--counterparty relationships,
and may enhance efficiency and capital formation in security-based
swaps.
However, conditional registration may reduce the assurances of the
certification and opinion of counsel regarding the Commission's ability
to inspect and examine some SBS Entities during the 24-month period. In
addition, 24 months may not be sufficient for the more complex SBS
Entities to relocate and restructure their security-based swap market
activity outside the reach of foreign privacy and secrecy laws,
blocking statutes, and other legal barriers, particularly as foreign
laws, statutes and legal barriers evolve. Thus, under the proposal
there may still be a risk of disruptions to counterparty relationships
and market activity if conditionally registered SBS Entities having
large market shares, and transacting with hundreds and thousands of
counterparties, are unable to meet the certification and opinion of
counsel requirements within the 24-month period. Moreover,
counterparties that may rely on the Commission's ability to inspect and
examine a registered SBS Entity as a signal of higher quality may
reduce their participation in security-based swap markets, which may
increase adverse selection. Alternatively, they may vote with their
feet and shift business from conditionally registered SBS Entities to
non-conditionally registered SBS Entities. This may enhance competition
between conditionally registered and non-conditionally registered SBS
Entities and may create a market incentive for conditionally registered
SBS Entities to provide the certification and opinion of counsel.
c. Alternatives Considered
The Commission considered alternative approaches to the proposed
guidance and amendments regarding the certification and opinion of
counsel requirements. Specifically, the Commission considered proposing
some, but not other, aspects of the above relief. For example, the
Commission considered proposing only elements of the guidance
concerning covered foreign laws and covered records. The Commission has
also considered proposing guidance about covered foreign laws and
covered records, as well as open contracts and timing of certification,
but not aspects of the relief allowing certification and opinion of
counsel to be predicated on customer consent or arrangements with
foreign regulators. The Commission has also considered shortening the
conditional registration period (e.g., to 12 or 18 months). Relative to
the proposal, these alternatives would provide less relief and greater
uncertainty to nonresident entities that may seek to register with the
Commission as an SBS Entity, which may increase the likelihood of
disruptions of counterparty relationships and risks of adverse effects
on market activity in security-based swaps. At the same time, these
alternatives may increase the scope, strength, and/or timeliness of the
certification and opinion of counsel requirement, which may give the
Commission further assurances regarding its ability to oversee
security-based swap activity of nonresident entities applying for
registration. Importantly, regardless of the certification and opinion
of counsel requirement, all nonresident SBS Entities would continue to
have independent ongoing obligations to provide the Commission with
access to their books and records and to permit on-site inspections and
examinations.
The Commission has considered an alternative under which all
conditionally registered SBS Entities would be required to provide
disclosures to U.S. counterparties or to all counterparties regarding
their conditional registration. Such disclosures may help inform
counterparties regarding the conditional registration status of SBS
Entities with which they may wish to transact. To the degree that
counterparties may consider conditional registration as a signal of
lower quality or may seek to build long-term relationships with non-
conditionally registered SBS Entity counterparties, and to the degree
such counterparties are otherwise uninformed about SBS Entities'
registration status, this alternative may facilitate more efficient
counterparty selection. The alternative may also create reputational
incentives for conditionally registered SBS Entities to provide the
requisite certification and opinion of counsel to the Commission, to
the degree that some counterparties may interpret conditional
registration as a signal of reduced quality.
However, such disclosure requirements would involve burdens on SBS
Entities related to the preparation and production of such disclosures.
Related costs may be partly or fully passed along to SBS Entities'
counterparties in the form of more expensive security-based swaps. As
noted above, the Commission preliminarily believes that nonresident SBS
Entities most likely to utilize conditional registration are those SBS
Entities that face uncertainty regarding their ability to comply with
certification and opinion of counsel requirements due to privacy and
secrecy laws, blocking statutes, and other legal barriers in their
foreign jurisdictions. Based on the analysis of 2017 TIW data, the
Commission estimates that there are approximately 9,611 unique
relationships (pairs of counterparties and accounts likely to trigger
SBS Entity registration requirements with
[[Page 24276]]
registered office locations in jurisdictions with foreign privacy and
secrecy laws, blocking statutes, and other legal barriers) or
approximately 72.6% of all unique dealer-counterparty pairs active in
security-based swap market that may become subject to the disclosure
requirement.\484\ Limiting such disclosure requirements to
relationships between dealer accounts in jurisdictions with foreign
privacy and secrecy laws, blocking statutes, and other legal barriers
and U.S. non-dealer counterparties may affect 4,322 unique dealer-U.S.
counterparty relationships. Since many of the dealer accounts belong to
large financial groups, the Commission can also use the domicile of the
parent organization to categorize dealers at the level of the financial
group (at the firm-level) instead of at the level of the dealer (at the
account-level). Using this more conservative approach, there may be 779
unique dealer-counterparty ties (or 25.7% of all ties) that may be
affected by foreign privacy and secrecy laws, blocking statutes, and
other legal barriers and the alternative disclosure requirement. The
Commission also notes that, as a baseline matter, SBS Entity
registration forms are public and the Commission may, in the course of
Commission business, publish a list of registered SBS Entities and note
the conditional registration status of such entities on the
Commission's public website.
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\484\ This estimate includes unique dealer-counterparty pairs
where the counterparty is another dealer. Excluding dealer-dealer
pairs reduces the estimate by 279, with an estimate of 9,332 unique
pairs between non-dealer counterparties and dealer accounts with
registered office locations in jurisdictions with foreign privacy
and secrecy laws, blocking statutes, and other legal barriers (or
approximately 70.5% of all unique dealer-counterparty pairs).
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As an alternative, the Commission has also considered lengthening
the conditional registration period (to, e.g., 5 or 10 years) or
eliminating the certification and opinion of counsel requirements. As
discussed in prior sections, the Commission continues to believe that
access to books and records and the ability to inspect and examine
registered SBS Entities facilitates Commission oversight of security-
based swap markets. These alternatives may limit the scope of
assurances provided to the Commission by SBS Entity applicants
regarding the Commission's ability to inspect and examine SBS Entities.
To the degree that some nonresident SBS Entities may be unable to
provide certification or opinion of counsel due to their inability to
become subject to Commission inspections and examinations (as a result
of, for example, foreign privacy and secrecy laws, blocking statutes,
and other legal barriers), these alternatives may reduce the extent of
Commission inspections and examinations. However, these alternatives
would reduce or eliminate certification and opinion of counsel burdens,
related uncertainty, and liability risk. Importantly, under these
alternatives, all nonresident SBS Entities would continue to have
independent ongoing obligations to provide the Commission with access
to their books and records and to permit onsite inspections and
examinations. The Commission preliminarily believes that the proposed
approach better balances these competing considerations and that 24
months is sufficient time for nonresident SBS Entities to comply with
the certification and opinion of counsel requirements (and relocate
their books, records, and other operations, if needed).
2. Proposed Modifications to Proposed Rules 18a-5(a)(10) and (b)(8)
a. Background
As discussed in the economic baseline, in the Recordkeeping and
Reporting Proposing Release, the Commission proposed a background
questionnaire recordkeeping requirement for stand-alone and bank SBS
Entities that parallels similar broker-dealer recordkeeping
requirements. The Commission is proposing modifications to the proposed
questionnaire recordkeeping requirement, which would modify proposed
Rules 18a-5(a)(10) and 18a-5(b)(8). The proposed modifications would
tailor the proposed questionnaire requirement in two ways. First, under
the proposed modifications, an SBS Entity would not be required to make
and keep current questionnaires if the SBS Entity is excluded from the
statutory prohibition in Section 15F(b)(6) with respect to the
associated person. Second, the questionnaire or application for
employment executed by an associated person who is not a U.S. person
need not include certain information if the law of the jurisdiction
where the associated person is located or employed prohibits the
receipt of that information or the creation or maintenance of records
reflecting that information.
b. Costs, Benefits, and Effects on Efficiency, Competition, and Capital
Formation
The proposed questionnaire recordkeeping requirements are intended
to support Commission oversight and entity compliance with the
substantive requirements of Rule 15Fb6 regarding statutory
disqualification. The proposed modifications to proposed Rule 18a-5
eliminate the questionnaire requirement with respect to associated
persons excluded from the statutory prohibition. These modifications
are unlikely to adversely affect Commission oversight of SBS Entity
compliance with the statutory prohibition since those associated
persons are already excluded from the statutory prohibition. At the
same time, the proposed modifications may involve modest reductions to
corresponding paperwork burdens. To the degree that SBS Entities may
pass along these burdens to counterparties, the proposed modifications
may also result in some benefits to counterparties of these SBS
Entities.
As discussed in section VIII.B, the Commission estimates that the
addition of paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A) to proposed
Rule 18a-5 would reduce initial costs associated with proposed rule
18a-5 by $51,943 and ongoing costs by $64,622.\485\ Therefore, the cost
savings to SBS Entities and counterparties from this proposed
modification are likely to be modest.
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\485\ Initial cost reduction for all stand-alone and bank SBS
Entities reduction: (127 x Attorney at $409 per hour) = $51,943.
Ongoing cost reduction for all stand-alone and bank SBS Entities
reduction: (158 x Attorney at $409 per hour) = $64,622.
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In addition, as discussed above, the Commission is proposing to
modify, by adding paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B), the
questionnaire requirement with respect to non-U.S. associated persons
of SBS Entities if the receipt of that information, or the creation or
maintenance of records reflecting that information, would result in a
violation of applicable law in the jurisdiction in which the associated
person is employed or located. The primary intended benefit of this
proposed modification is to enable certain nonresident SBS Entities to
continue intermediating transactions with their counterparties.
Specifically, due to the existence of foreign privacy and secrecy laws,
blocking statutes, and other legal barriers, the proposed tailoring of
the questionnaire requirement can enable more nonresident market
participants to register as SBS Entities without a potentially costly
relocation or business restructuring of certain operations and records
to jurisdictions outside the reach of such laws. This may also reduce
costs for counterparties (as nonresident SBS Entities may pass along
related costs to counterparties in the form of more expensive security-
[[Page 24277]]
based swaps) and may preserve valuable counterparty relationships.
In addition, this proposed modification may also involve some
modest burden reductions. As discussed in section VIII.B, the proposed
modification to add paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) to
proposed Rule 18a-5 is expected to decrease the initial costs
associated with proposed rule 18a-5 by $25,767 and ongoing costs by
$32,311.\486\ In aggregate, as estimated in section VIII.B, under both
of the proposed modifications, initial and ongoing costs of all stand-
alone and bank SBS Entities related to complying with proposed Rule
18a-5 are estimated at $233,130 and $291,617 respectively.\487\
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\486\ Initial cost reduction for all stand-alone and bank SBS
Entities reduction: (63 x Attorney at $409 per hour) = $25,767.
Ongoing cost reduction for all stand-alone and bank SBS Entities
reduction: (79 x Attorney at $409 per hour) = $32,311.
\487\ Initial costs for all stand-alone and bank SBS Entities
reduction under the proposed modifications to proposed Rule 18a-
5(a)(10) and (b)(8): ((760-127-63) x Attorney at $409 per hour) =
$233,130. Ongoing costs for all stand-alone and bank SBS Entities
reduction: ((950-158-79) x Attorney at $409 per hour) = $291,617.
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The Commission continues to recognize that certain recordkeeping
requirements may facilitate compliance and Commission oversight of SBS
Entities. In proposing a tailored questionnaire requirement with
respect to non-U.S. associated persons, the Commission has considered
the value of such recordkeeping for compliance with Rule 15Fb6-2 and
related oversight, as well as the costs and potential disruptions to
counterparty relationships and market activity that may result when
foreign jurisdictions do not allow nonresident SBS Entities to receive,
create, or maintain such records. Importantly, as discussed above, the
Commission continues to note that the proposed tailoring of the
requirement in (a)(10)(iii)(B) and (b)(8)(iii)(B) does not eliminate or
affect the scope of all SBS Entities' ongoing obligations to comply
with Section 15F(b)(6) of the Exchange Act and Rule 15Fb6-2, with
respect to every associated person that effects or is involved in
effecting security-based swaps and is not subject to an exclusion from
the statutory disqualification prohibition in Section 15F(b)(6) of the
Exchange Act.
Finally, the proposed approach involves a disparate treatment of
broker-dealer SBS Entities and stand-alone and bank SBS Entities. Based
on an analysis of 2017 TIW data and filings with the Commission, out of
50 participants likely to register with the Commission as security-
based swap dealers, the Commission estimates that 16 market
participants have already registered with the Commission as broker-
dealers; 9 market participants will be stand-alone security-based swap
dealers, and up to 25 participants will be bank security-based swap
dealers.\488\
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\488\ We note that these figures are based on current market
activity in security-based swaps. We are unable to quantify the
number of market participants currently expected to register as
broker-dealer, bank, or stand-alone security-based swap dealers that
may choose to restructure their U.S. security-based swap market
participation in response to the pending substantive requirements of
Title VII, such as capital and margin requirements.
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Under the proposal, SBS Entities that are not stand-alone or bank
SBS Entities would be required to make and keep current a questionnaire
or application for employment for associated persons with respect to
whom the broker-dealer SBS Entity is excluded from the prohibition in
Exchange Act 15F(b)(6), incurring corresponding compliance burdens,
albeit modest, estimated above. In addition, to the extent that some
SBS Entities that are not stand-alone or bank SBS Entities are heavily
reliant on employees in jurisdictions with foreign privacy and secrecy
laws, blocking statutes, and other legal barriers in their security-
based swap business, they may be unable to comply with the employee
questionnaire requirement and register with the Commission. These SBS
Entities would be unable to register without a relocation or
restructuring of various records and or operations, involving costs for
such SBS Entities--costs that may be passed along to counterparties or
disrupt existing counterparty relationships. This may reduce the
competitive standing of SBS Entities cross-registered as broker-dealers
and their employees in certain foreign jurisdictions and improve the
competitive standing of stand-alone and bank SBS Entities and their
employees in foreign data privacy jurisdictions.
The Commission notes that broker-dealer SBS Entities are already
subject to a questionnaire requirement under Rule 17a-3(a)(12). The
Commission preliminarily believes that such entities are making and
keeping current employment questionnaires and applications for all of
their associated persons in their normal course of business. In
addition, the Commission preliminarily believes that such SBS Entities
have already structured their security-based swap business in a manner
that would enable them to comply with this requirement without
disrupting transaction activity or ongoing counterparty relationships.
The sunk cost nature of such structuring of broker-dealers' security-
based swap business may partly mitigate the above competitive effects.
c. Alternatives Considered
The Commission has considered an alternative approach, which would
provide the same relief (by also amending Rule 17a-3(a)(12) and
providing the same relief to broker-dealer SBS Entities) with respect
to: (i) Exemption based on the non-U.S. associated SBS Entity's
exclusion from the prohibition under Section 15F(b); and (ii) exemption
based on local law.
The alternative would benefit a greater number of SBS Entities and
counterparties by extending the proposed relief (with its benefits
discussed above) to all SBS Entities in their security-based swap
business. Moreover, the alternative would eliminate the competitive
disparities between broker-dealer and stand-alone and bank SBS Entities
discussed above.
However, the Commission continues to recognize that recordkeeping
requirements are essential to the inspection and examination process
and facilitate effective oversight of the markets the Commission
regulates. Importantly, as discussed above, broker-dealer SBS Entities
are already subject to a questionnaire requirement under Rule 17a-
3(a)(12). The Commission preliminarily believes that broker-dealer SBS
Entities have already located and structured their security-based swap
business in a way that would allow them to comply with the
questionnaire requirement. At the same time, the Commission understands
that stand-alone and bank SBS Entities active in security-based swap
markets are not currently subject to similar recordkeeping requirements
and that the questionnaire requirement, as proposed, may require these
entities to relocate their security-based swap business and staff to
other jurisdictions. This may disrupt counterparty relationships and
ongoing business transactions between stand-alone and bank SBS Entities
and their customers.
The Commission also understands that broker-dealer SBS Entities are
routinely making and keeping current employment questionnaires and
applications for all of their associated persons, which may reduce the
benefits of the above alternative. However, if such baseline behavior
of broker-dealer SBS Entities is a result of Rule 17a-3 currently in
effect and not of compliance practices optimal for each broker-dealer
SBS Entity, the alternative
[[Page 24278]]
may reduce burdens \489\ and provide beneficial flexibility in
recordkeeping practices for broker-dealer SBS Entities with respect to
associated persons excluded from the statutory prohibition. The
Commission continues to note that the proposed recordkeeping
requirement in Rule 18a-5 is intended to support substantive
obligations with respect to statutory disqualification and that such
substantive obligations would no longer exist with respect to
associated persons of broker-dealer SBS Entities effecting or involved
in effecting security-based swaps and exempt from the statutory
prohibition under, for instance, proposed Rule of Practice 194(c)(2).
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\489\ As acknowledged above, the overall burdens of compliance
with proposed Rule 18a-5 are relatively modest; however, fixed costs
may be more significant for smaller entities.
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F. Request for Comment
The Commission requests comment on all aspects of the economic
analysis of the proposed amendment to Rule 3a71-3. To the extent
possible, the Commission requests that commenters provide supporting
data and analysis with respect to the benefits, costs, and effects on
competition, efficiency, and capital formation of adopting the proposed
amendment or any reasonable alternatives. In particular, the Commission
asks commenters to consider the following questions:
1. Are there costs and benefits associated with the proposed
amendment that the Commission has not identified? If so, please
identify them and if possible, offer ways of estimating these costs
and benefits.
2. In the commenter's view, what are the costs and benefits
associated with Alternative 1, and what are the costs and benefits
associated with Alternative 2?
3. Are there effects on efficiency, competition, and capital
formation stemming from the proposed amendment that the Commission
has not identified? If so, please identify them and explain how the
identified effects result from the proposed amendment.
4. Are there data sources or data sets that can help the
Commission refine its estimates of the costs and benefits associated
with the proposed amendment? If so, please identify them.
5. Are there alternatives to the proposed amendment that the
Commission has not considered? If so, please identify and describe
them.
6. In the commenter's view, is the estimation of the initial
costs of current Exchange Act Rules 17a-3 and 17a-4, including the
assumptions used, appropriate? If not, please explain how the
estimation can be improved.
7. In the commenter's view, is the estimation of the ongoing
costs of meeting registration requirements as a broker-dealer,\490\
including the assumption used, appropriate? If not, please explain
how the estimation can be improved.
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\490\ See part VII.B.1.a, supra.
The Commission also requests comment on all aspects of the economic
analysis of the proposed guidance regarding the scope of the
``arranged, negotiated, or executed'' test. To the extent possible, the
Commission requests that commenters provide supporting data and
analysis with respect to the benefits, costs, and effects on
competition, efficiency, and capital formation of adopting the proposed
guidance. In addition, the Commission asks commenters to consider the
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following questions:
8. Are there costs and benefits associated with the proposed
guidance that the Commission has not identified? If so, please
identify them and if possible, offer ways of estimating these costs
and benefits.
9. Are there effects on efficiency, competition, and capital
formation stemming from the proposed guidance that the Commission
has not identified? If so, please identify them and explain how the
identified effects result from the proposed amendment.
10. Are there data sources or data sets that can help the
Commission refine its estimates of the costs and benefits associated
with the proposed guidance? If so, please identify them.
11. Are there alternatives to the proposed guidance that the
Commission has not considered? If so, please identify and describe
them.
The Commission also requests comment on all aspects of the economic
analysis of the proposed amendment to Rule of Practice 194. To the
extent possible, the Commission requests that commenters provide
supporting data and analysis with respect to the benefits, costs, and
effects on competition, efficiency, and capital formation of adopting
the proposed amendment or any reasonable alternatives. In addition, the
Commission asks commenters to consider the following questions:
12. What additional qualitative or quantitative information
should the Commission consider as part of the baseline for its
economic analysis of the proposed Rule of Practice 194(c)(2)? To
what extent do entities likely to register with the Commission as
SBS Entities rely on non-U.S. personnel dealing with U.S. versus
non-U.S. counterparties?
13. Has the Commission accurately characterized the costs and
benefits of proposed Rule of Practice 194(c)(2)? If not, why not?
Should any of the costs or benefits be modified? What, if any, other
costs or benefits should the Commission take into account? Would
entities likely to register with the Commission as SBS Entities
choose not to register or deregister if Rule of Practice 194(c)(2)
is not adopted? If possible, please offer ways of estimating these
costs and benefits. What additional considerations can the
Commission use to estimate the costs and benefits of the proposed
amendment?
14. Has the Commission accurately characterized the effects on
competition, efficiency, and capital formation arising from proposed
Rule of Practice 194(c)(2)? If not, why not?
15. Has the Commission accurately characterized the costs,
benefits, and effects on competition, efficiency, and capital
formation of the above alternatives to the proposed Rule of Practice
194(c)(2)? If not, why not? Should any of the costs or benefits be
modified? What, if any, other costs or benefits should the
Commission take into account?
16. Are there other reasonable alternatives to the proposed Rule
of Practice 194(c)(2) that the Commission should consider? What are
the costs, benefits, and effects on competition, efficiency, and
capital formation of any other alternatives?
The Commission also requests comment on all aspects of the economic
analysis of the proposed guidance and amendments related to
certification and opinion of counsel, conditional registration, and the
employee questionnaire requirements. To the extent possible, the
Commission requests that commenters provide supporting data and
analysis with respect to the benefits, costs, and effects on
competition, efficiency, and capital formation of adopting the proposed
amendment or any reasonable alternatives. In addition, the Commission
asks commenters to consider the following questions:
17. What additional qualitative or quantitative information
should the Commission consider as part of the baseline for its
economic analysis of these amendments? Which jurisdictions and
security-based swap market participants are affected by foreign
privacy and secrecy laws, blocking statutes, and other legal
barriers? To what extent do entities likely to register with the
Commission as bank, stand-alone, or broker-dealer SBS Entities rely
on nonresident personnel located or employed in jurisdictions with
foreign privacy and secrecy laws, blocking statutes, and other legal
barriers? To what extent do such personnel transact across reference
security and security-based swap markets, and with institutional
versus retail clientele?
18. Has the Commission accurately characterized the costs and
benefits of the proposed conditional registration in Rule 15Fb2-1
and guidance regarding the certification and opinion of counsel
requirements in Rule 15Fb2-4? Has the Commission accurately
characterized the costs and benefits of the proposed modifications
to the questionnaire recordkeeping requirement in Rule 18a-5(a)(10)
and Rule 18a-5(b)(8)? If not, why not? Should any of the costs or
benefits be modified? What, if any, other costs or benefits should
the Commission take into account? Would entities likely to register
with the Commission as SBS Entities choose
[[Page 24279]]
not to register or deregister without the proposed conditional
registration in Rule 15Fb2-1 or guidance regarding Rule 15Fb2-4? If
possible, please offer ways of estimating these costs and benefits.
What additional considerations can the Commission use to estimate
the costs and benefits of the proposed guidance?
19. Has the Commission accurately characterized the effects on
competition, efficiency, and capital formation arising from proposed
guidance, amendments, and modifications regarding Rules 15Fb2-1 and
15Fb2-4, and proposed Rule 18a-5? If not, in what way?
20. Has the Commission accurately characterized the costs,
benefits, and effects on competition, efficiency, and capital
formation of the above alternatives to the proposed guidance and
amendments regarding conditional registration, certification and
opinion of counsel, and employee questionnaires? If not, why not?
Should any of the costs or benefits be modified? What, if any, other
costs or benefits should the Commission take into account?
21. Has the Commission accurately characterized the costs,
benefits, and effects on competition, efficiency, and capital
formation of alternatives to the proposed guidance, amendments, and
modifications regarding conditional registration, certification and
opinion of counsel, and employee questionnaires? Are there other
reasonable alternatives the Commission should consider? What are the
costs, benefits, and effects on competition, efficiency, and capital
formation of any other alternatives?
VIII. Paperwork Reduction Act
Certain provisions of the proposed amendments and modifications to
Exchange Act Rules 3a71-3 and 18a-5 contain ``collection of
information'' \491\ requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA''), and the Commission is 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.
---------------------------------------------------------------------------
\491\ 44 U.S.C. 3502(3).
---------------------------------------------------------------------------
The title of the new collection of information associated with the
proposed changes to Rule 3a71-3 is ``Rule 3a71-3(d)--Conditional
Exception from De Minimis Counting Requirement in Connection with
Certain Transactions Arranged, Negotiated or Executed in the United
States.'' \492\ OMB has not yet assigned a control number to this new
collection of information.
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\492\ This new collection of information is distinct from an
existing collection of information related to Exchange Act Rule
3a71-3(c), which provides an exception from the application of
certain business conduct requirements in connection with a security-
based swap dealer's ``foreign business.'' See generally Business
Conduct Adopting Release, 81 FR at 30082.
---------------------------------------------------------------------------
The title and OMB control number for the collection of information
the Commission is proposing to modify is Rule 18a-5--Records to be made
by certain security-based swap dealers and major security-based swap
participants, OMB Control Number 3235-0745. The Commission's earlier
PRA assessments have been revised to reflect the modifications to
proposed Rule 18a-5 from those that were proposed in the Recordkeeping
and Reporting Proposing Release.
A. Proposed Amendment to Rule 3a71-3
1. Summary of the Collection of Information \493\
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\493\ Because the proposed amendment to Rule 3a71-3 would
require the use of a registered security-based swap dealer or a
registered broker in connection with the transactions at issue, the
proposed amendment also would implicate collections of information
associated with security-based swap dealer or broker status (apart
from the collections associated with the specific conditions of the
exception). Separate collections of information address the
registration of security-based swap dealers and brokers, as well as
the requirements associated with those registered entities as a
matter of course, including recordkeeping requirements applicable to
such registered entities. The separate collections of information
associated with requirements of general applicability for registered
security-based swap dealers and brokers are not addressed as part of
this rulemaking, and instead are addressed by the collections of
information associated with those separate requirements.
---------------------------------------------------------------------------
a. Disclosure of Limited Title VII Applicability
Both alternatives to the proposed exception to Rule 3a71-3 would be
conditioned in part on the registered entity engaged in arranging,
negotiating or executing activity in the United States notifying the
counterparties of the non-U.S. person relying on the exception,
contemporaneously with and in the same manner as the conduct at issue,
that the non-U.S. person is not registered with the Commission as a
security-based swap dealer, and that certain Exchange Act provisions or
rules addressing the regulation of security-based swaps would not be
applicable in connection with the transaction. This disclosure would be
required only so long as the identity of the counterparty is known to
that registered entity at a reasonably sufficient time prior to the
execution of the transaction to permit the disclosure.\494\
---------------------------------------------------------------------------
\494\ See Alternatives 1 and 2--proposed paragraph (d)(1)(iv) of
Rule 3a71-3.
---------------------------------------------------------------------------
b. Business Conduct Condition
Alternative 1 would be conditioned in part on the registered
security-based swap dealer that engages in arranging, negotiating or
executing activity in the United States in connection with the
transactions at issue complying with certain security-based swap dealer
business conduct requirements--related to: Disclosure of material
risks, characteristics, incentives and conflicts of interest;
suitability of recommendations; and fair and balanced communications--
``as if'' the counterparty to the non-U.S. person relying on the
exception also were a counterparty to that registered security-based
swap dealer.\495\ Each of those underlying business conduct
requirements itself is associated with a collection of
information.\496\
---------------------------------------------------------------------------
\495\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(1)-(3)
of Rule 3a71-3.
\496\ See Business Conduct Adopting Release, 81 FR at 30083-85
(discussing collections of information regarding security-based swap
dealer requirement for disclosure of information regarding material
risks, characteristics, incentives and conflicts of interest,
suitability of recommendations, and fair and balanced
communications).
---------------------------------------------------------------------------
Alternative 2 would be conditioned in part on the registered broker
or a registered security-based swap dealer that engages in such
activity in the United States in connection with the transaction at
issue complying with those same business conduct requirements, ``as
if'' the counterparty to the non-U.S. person relying on the exception
also were a counterparty to that registered entity.\497\
---------------------------------------------------------------------------
\497\ See Alternative 2--proposed paragraph (d)(1)(ii)(B)(1)-(3)
of Rule 3a71-3.
---------------------------------------------------------------------------
c. Trade Acknowledgment and Verification Condition
Alternative 1 would be conditioned in part on the registered
security-based swap dealer that engages in arranging, negotiating or
executing activity in the United States in connection with the
transactions at issue complying with trade acknowledgment and
verification requirements--which themselves are associated with
collections of information \498\--``as if'' the counterparty to the
non-U.S. person relying on the exception also were a counterparty to
that registered security-based swap dealer.\499\
---------------------------------------------------------------------------
\498\ See Business Conduct Adopting Release, 81 FR at 30083-85
(discussing collections of information regarding security-based swap
dealer requirement for disclosure of information regarding material
risks, characteristics, incentives and conflicts of interest,
disclosure of information regarding clearing rights, suitability of
recommendations, and fair and balanced communications).
\499\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(4) of
Rule 3a71-3.
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[[Page 24280]]
Alternative 2 would be conditioned in part on the registered broker
or security-based swap dealer that engages in such activity in the
United States in connection with the transactions at issue complying
with those trade acknowledgment and verification requirements ``as if''
the counterparty to the non-U.S. person relying on the exception also
were a counterparty to that registered entity.\500\
---------------------------------------------------------------------------
\500\ See Alternative 2--proposed paragraph (d)(1)(ii)(B)(4) of
Rule 3a71-3.
---------------------------------------------------------------------------
d. Portfolio Reconciliation Condition
Alternative 1 would be conditioned in part on the registered
security-based swap dealer that engages in arranging, negotiating or
executing activity in the United States in connection with the
transactions at issue complying with proposed portfolio reconciliation
requirements, but only with respect to the initial portfolio
reconciliation required by the rule, ``as if'' the counterparty to the
non-U.S. person relying on the exception also is a counterparty to that
registered security-based swap dealer.\501\ That underlying proposed
portfolio reconciliation requirement itself is associated with a
collection of information.\502\
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\501\ See Alternative 1--proposed paragraph (d)(1)(ii)(B)(5) of
Rule 3a71-3.
\502\ See Risk Mitigation Proposing Release, 83 FR at 4640
(discussing collection of information regarding proposed security-
based swap dealer portfolio reconciliation requirement).
---------------------------------------------------------------------------
Alternative 2 for the exception would be conditioned in part on the
registered broker or security-based swap dealer that engages in such
activity in the United States in connection with the transactions at
issue complying with the proposed portfolio reconciliation requirement
with regard to the initial reconciliation ``as if'' that registered
entity is a counterparty to the non-U.S. person's counterparty (and
``as if'' that entity is registered as a security-based swap dealer if
it is not so registered).\503\
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\503\ See Alternative 2--proposed paragraph (d)(1)(ii)(B)(5) of
Rule 3a71-3.
---------------------------------------------------------------------------
e. Recordkeeping Condition
Both proposed alternatives would be conditioned in part on the
registered entity engaged in arranging, negotiating or executing
activity in the United States obtaining from the non-U.S. person
relying on the exception, and maintaining, trading relationship
documentation involving the counterparty to the transaction.\504\
---------------------------------------------------------------------------
\504\ See Alternatives 1 and 2--proposed paragraph
(d)(1)(iii)(B)(2) of Rule 3a71-3.
The proposed exception also would be conditioned in part on the
registered entity engaged in market facing activity in the United
States creating and maintaining books and records relating to the
transactions subject to this exception that are required, as
applicable, by Rule 17a-3 and 17a-4, or Rule 18a-5 and 18a-6,
including books and records relating to: Disclosure of risks,
characteristics, incentives and conflicts; suitability; fair and
balanced communications; trade acknowledgment and verification; and
portfolio reconciliation. See Alternatives 1 and 2--proposed
paragraph (d)(1)(iii)(B) of Rule 3a71-3 (requiring creation and
maintenance of books and records relating to the requirements
specified in proposed paragraph (d)(1)(ii)(B).
Because that part of the condition subsumes the collection of
information that the Commission would expect to be associated with
the final rules adopting those security-based swap dealer books and
records requirements, it does not constitute a separate collection
of information attributable to this proposed exception. See note
493, supra.
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f. Consent to Service Condition
Both proposed alternatives for the exception to Rule 3a71-3 would
be conditioned in part on the registered entity engaged in arranging,
negotiating or executing activity in the United States obtaining from
the non-U.S. person relying on the exception written consent to service
of process for any civil action brought by or proceeding before the
Commission, providing that process may be served on the non-U.S. person
by service on the registered entity in the manner set forth in the
registered entity's current Form BD, SBSE, SBSE-A or SBSE-BD, as
applicable.\505\
---------------------------------------------------------------------------
\505\ See Alternatives 1 and 2--proposed paragraph
(d)(1)(iii)(B)(3) of Rule 3a71-3.
---------------------------------------------------------------------------
g. ``Listed Jurisdiction'' Condition
Both proposed alternatives for the exception to Rule 3a71-3 would
be conditioned in part on the non-U.S. person relying on the exception
being subject to the margin and capital requirements of a ``listed
jurisdiction.'' \506\ The proposal specifies that applications for
orders requesting listed jurisdiction status may be made by persons
that may rely on the exception, or by foreign financial authorities, or
made on the Commission's own initiative, and must be filed pursuant to
the procedures set forth in Exchange Act Rule 0-13.\507\
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\506\ See Alternatives 1 and 2--proposed paragraph (d)(1)(v) of
Rule 3a71-3.
\507\ See Alternatives 1 and 2--proposed paragraph (d)(2)(i) of
Rule 3a71-3.
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2. Use of Information
a. Disclosure of Limited Title VII Applicability
The proposed disclosure condition is intended to help guard against
counterparties reasonably presuming that the involvement of U.S.
personnel in an arranging, negotiating or executing capacity as part of
the transaction would be accompanied by the safeguards associated with
Title VII security-based swap dealer regulation applying to the non-
U.S. person.
b. Business Conduct Condition
The use of the information associated with the business conduct
condition would be the same as the use of information associated with
the currently extant security-based swap dealer business conduct
requirements, given that the relevant condition simply would expand the
existing requirements to apply to transactions where they currently do
not apply. Accordingly, the condition requiring the registered entity
to comply with requirements for the disclosure of risks,
characteristics, incentives and conflicts, particularly would assist
the counterparty in assessing the transaction by providing it with a
better understanding of the expected performance of the security-based
swap, and provide additional transparency and insight into
pricing.\508\ The condition requiring the registered entity to comply
with requirements regarding the suitability of recommendations would
assist the registered entity in making appropriate
recommendations.\509\ The condition requiring the registered entity to
comply with fair and balanced communication requirements in part would
better equip the counterparty to make more informed investment
decisions.\510\
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\508\ See Business Conduct Adopting Release, 81 FR at 30088.
\509\ See id.
\510\ See id.
---------------------------------------------------------------------------
c. Trade Acknowledgment and Verification Condition
The use of the information associated with the trade
acknowledgement and verification condition would be the same as the use
of information associated with the currently extant security-based swap
dealer trade acknowledgment and verification requirements, given that
the relevant condition simply would expand the existing requirements to
apply to transactions where they currently do not apply. In general,
the trade acknowledgment would serve as a written record by which the
counterparties to the transaction may memorialize the terms of a
transaction, and the verification requirements are intended to ensure
that the written record of the transaction accurately reflects the
terms of the transaction as understood by the respective
counterparties.\511\
---------------------------------------------------------------------------
\511\ See Trade Acknowledgement Adopting Release, 81 FR at
39830.
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[[Page 24281]]
d. Portfolio Reconciliation Condition
The use of the information associated with the portfolio
reconciliation condition would be the same as the use of information
associated with the proposed security-based swap dealer portfolio
reconciliation requirement. In general, that proposed requirement is
intended to help ensure the accuracy of the data reported to SDRs, and
to help facilitate the ability of registered security-based swap data
repositories to comply with requirements that they verify the
information they receive.\512\
---------------------------------------------------------------------------
\512\ See Risk Mitigation Proposing Release, 83 FR at 4641.
---------------------------------------------------------------------------
e. Recordkeeping Condition
The proposed condition requiring the registered entity to obtain
and maintain trading relationship documentation involving the non-U.S.
person relying on the exception and its counterparty is intended to
help the Commission obtain a full view of the dealing activities
connected with transactions relying on the proposed exception,
including such activities that occur in the non-U.S. person taking
advantage of the exception. Absent such access, the Commission may be
impeded in identifying fraud and abuse in connection with transactions
that have been arranged, negotiated or executed in the United States,
where such fraud or abuse may be apparent only in light of relevant
information obtained from the non-U.S. person relying on the exception
or its associated persons.
f. Consent to Service Condition
The proposed use of the consent to service condition is to
facilitate the Commission's ability to serve process on the non-U.S.
person relying on the exception, to assist the Commission in
efficiently taking action to address potential violations of the
federal securities laws in connection with the transactions at issue.
g. ``Listed Jurisdiction'' Condition
The proposed use of information provided by applicants in
connection with ``listed jurisdiction'' applications is to assist the
Commission in evaluating the effectiveness of the financial
responsibility requirements of jurisdictions regulating non-U.S.
persons taking advantage of the exception. This is intended to help
avoid creating an incentive for persons engaged in a security-based
swap dealing business in the United States to book their transactions
into entities that solely are subject to the regulation of
jurisdictions that do not effectively require security-based swap
dealers or comparable entities to meet certain financial responsibility
standards. That should help avoid providing an unwarranted competitive
advantage to non-U.S. persons that conduct security-based swap dealing
activity in the United States without being subject to strong financial
responsibility standards. The condition also is consistent with the
view that applying financial responsibility requirements to such
transactions between two non-U.S. persons can help mitigate the
potential for financial contagion to spread to U.S. market participants
and to the U.S. financial system more generally.
3. Respondents
As discussed above, the Commission preliminarily estimates that up
to 24 entities that engage in security-based swap dealing activity may
rely on the proposed conditional exception from having to count dealing
transactions with non-U.S. counterparties against the de minimis
thresholds.\513\ To satisfy the proposed exception, each of those up to
24 entities would make use of an affiliated registered security-based
swap dealer and/or registered broker that would be required to comply
with--and incur collections of information in connection with--
conditions related to compliance with relevant Title VII security-based
swap dealer requirements related to business conduct, trade
acknowledgment and verification, and portfolio reconciliation. Each of
those up to 24 registered entities also would have to provide
disclosures to counterparties of the non-U.S. persons relying on the
exception, to obtain and maintain trading relationship documentation
involving the non-U.S. persons relying on the proposed exception and
their counterparties, and to comply with the condition that the
registered entity obtain from the non-U.S. person a consent to service
of process.
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\513\ This estimate is based on data (see part VII.A.7, supra)
indicating that: (1) Six U.S. entities are engaged in security-based
swap dealing activity above the de minimis thresholds may have the
incentive to book future security-based swaps with non-U.S.
counterparties into U.S. affiliates to make use of the proposed
exception in connection with those transactions. (2) One non-U.S.
entity would fall below the $3 billion de minimis threshold if its
transactions with non-U.S. counterparties were not counted. (3) The
``arranged, negotiated, or executed'' counting standard would result
in five additional non-U.S. entities incurring assessment costs in
connection with the de minimis exception.
The analysis has doubled those numbers--to up to twelve U.S.
persons that may change its booking practices involving security-
based swaps to make use of the exception, plus up to twelve
additional non-U.S. persons--to address potential growth of the
security-based swap market and to account for uncertainty associated
with the availability of data, leading to the final estimate of 24
entities. See id.
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Applications for listed jurisdiction determinations may be
submitted by the up to 24 non-U.S. persons that would rely on the
proposed exception. In practice the Commission expects that the greater
portion of such listed jurisdiction applications will be submitted by
foreign financial authorities, given their expertise in connection with
the relevant financial responsibility requirements and information
access provisions, and in connection with their supervisory and
enforcement oversight with regard to the financial responsibility
requirements.\514\
---------------------------------------------------------------------------
\514\ As discussed below, the Commission estimates that three
non-U.S. persons will submit listed jurisdiction applications.
---------------------------------------------------------------------------
4. Total Annual Reporting and Recordkeeping Burdens (Summarized in
Table 3)
a. Disclosure of Limited Title VII Applicability
The Commission preliminarily estimates that the up to 12 U.S.
entities that may book transactions into their non-U.S. affiliates to
make use of the proposed conditional exception in the aggregate would
annually engage in nearly 76,000 security-based swap dealing
transactions with non-U.S. counterparties.\515\ Here--and in connection
with the other two groups addressed below--the analysis doubles that
amount to estimate the number of total disclosures, recognizing that
there will be situations in which the registered entity engaged in
arranging, negotiating or executing activity in the United States makes
the required disclosures but a transaction does not result.\516\
---------------------------------------------------------------------------
\515\ Available data indicates that the six U.S. entities that
are engaged in security-based swap dealing activity above the de
minimis thresholds in the aggregate annually engage in 37,827
transactions with non-U.S. counterparties. To address potential
growth in the market and data-related uncertainty, the analysis
doubles that estimate to 75,654 transactions annually (and, as noted
above, have doubled the estimated number of entities).
\516\ This produces an estimate of 151,308 (75,654 x 2) annual
disclosures pursuant to the proposed condition.
---------------------------------------------------------------------------
The Commission also preliminary estimates that the two non-U.S.
persons that may fall below the de minimis thresholds due to the
proposed conditional exception in the aggregate would annually engage
approximately 20,000 security-based swap dealing transactions with non-
U.S. counterparties,\517\ doubled here to
[[Page 24282]]
account for disclosures that are not followed by a transaction.\518\
---------------------------------------------------------------------------
\517\ Available data indicates that the one non-U.S. entity that
would fall below the de minimis thresholds due to the exception
annually engages in 10,064 transactions with non-U.S.
counterparties. To address potential growth in the market and data-
related uncertainty, the analysis doubles that estimate to 20,128
transactions annually (and, as noted above, have doubled the
estimated number of entities).
\518\ This produces an estimate of 40,256 (20,128 x 2) annual
disclosures pursuant to the proposed condition.
---------------------------------------------------------------------------
The Commission further preliminarily estimates that the additional
ten non-U.S. entities that may rely on the proposed conditional
exception in the aggregate would annually engage in approximately 2,100
security-based swap dealing transactions, with non-U.S. persons, that
may be subject to the proposed exception,\519\ doubled here to account
for disclosures that are not followed by a transaction.\520\
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\519\ Available data indicates that would result in five
additional non-U.S. persons that would be expected to incur
assessment costs due to the ``arranged, negotiated, or executed''
counting standard engage in a total of 1,056 annual security-based
swap transactions with non-U.S. counterparties. To address potential
growth in the market and data-related uncertainty, the analysis
doubles that estimate to 2,112 transactions annually (and have
doubled the estimated number of entities).
\520\ This produces an estimate of 4,224 (2,112 x 2) annual
disclosures pursuant to the proposed condition.
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In light of the limited contents of those contemporaneous
disclosures, the Commission preliminarily believes that each such
disclosure on average would be expected to take no more than five
minutes.\521\ Accordingly, the Commission preliminarily estimates that
the 12 U.S. entities that may book transactions into their non-U.S.
affiliates to make use of the proposed conditional exception in the
aggregate will annually spend a total of approximately 12,609 hours to
provide the disclosures required by the conditions.\522\ The Commission
further preliminarily estimates that the two non-U.S. entities that may
fall below the de minimis thresholds due to the exception in the
aggregate will annually spend a total of approximately 3,355 hours to
provide the disclosures required by the conditions,\523\ while the
other ten non-U.S. entities that may rely on the proposed conditional
exception in the aggregate will annually spend a total of approximately
352 hours to provide the disclosures required by the conditions.\524\
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\521\ Given that the disclosure must be provided
contemporaneously with the market-facing activity by the registered
entity engaged in market-facing activity in the United States, the
disclosure could not reasonably be provided via inclusion in
standard trading documentation and would require the creation of
specific disclosure documentation.
\522\ 151,308 aggregate annual disclosures x 5 minutes per
transaction. This averages to approximately 1,050.75 hours for each
of those 12 firms.
\523\ 40,256 aggregate annual disclosures x 5 minutes per
transaction. This averages to approximately 1,677 hours for each of
those two firms.
\524\ 4,224 aggregate annual disclosures x 5 minutes per
transaction. This averages to 35.2 hours for each of those ten
firms.
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The Commission also preliminarily believes that each of those 24
total entities would initially spend 100 hours and incur approximate
costs of $29,715 to develop policies and procedures to help ensure that
appropriate disclosures are provided.\525\
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\525\ Applied to the estimated 24 entities at issue here, this
would amount to 2,400 hours and $713,160.
These estimates are based on prior estimates, made in connection
with the adoption of the ``arranged, negotiated, or executed''
counting standard, that non-U.S. persons would incur 100 hours and
$28,300 to establish policies and procedures to restrict
communications with U.S. personnel in connection with the non-U.S.
persons' dealing activity. See ANE Adopting Release, 81 FR at 8628.
That $28,300 estimate has been adjusted to $29,715 in current
dollars (28,300 x 1.05).
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b. Business Conduct Condition
The Commission estimated the reporting and recordkeeping burdens
associated with the relevant security-based swap dealer business
conduct requirements under Title VII when it adopted those
requirements. The Commission believes that those estimates are
instructive for calculating the per-entity reporting and recordkeeping
burdens associated with the proposed business conduct condition, given
that the condition in effect would require compliance with those
business conduct requirements.
Disclosures of material risks, characteristics, and
conflicts and incentives. When the Commission earlier considered the
compliance burdens associated with those disclosure requirements (along
with clearing rights and daily mark disclosure requirements not
applicable under this proposal),\526\ the Commission estimated that
implementation of those requirements: (i) Initially would require three
persons from trading and structuring, three persons from legal, two
persons from operations and four persons from compliance, for 100 hours
each; \527\ (ii) half of those persons would be required to spend 20
hours annually to re-evaluate and modify disclosures and systems
requirements; \528\ and (iii) those entities would require eight full-
time persons for six months of systems development, programming and
testing,\529\ along with two full-time persons annually for maintenance
of this system.\530\
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\526\ See Business Conduct Adopting Release, 81 FR at 30091-92.
In connection with those prior estimates, the Commission noted that
entities that are dually registered with the CFTC already provide
their counterparties with similar disclosures.
\527\ Applied to the 24 entities at issue here, this would
amount to an aggregate initial burden of 28,800 hours (24 entities x
12 persons x 100 hours).
\528\ Applied to the 24 entities at issue here, this would
amount to an aggregate annual burden of 2,880 hours (24 entities x 6
persons x 20 hours).
\529\ Applied to the 24 entities at issue here, this would
amount to an aggregate initial burden of 192,000 hours (24 entities
x 8 persons x 1,000 hours).
\530\ Applied to the 24 entities at issue here, this would
amount to an aggregate annual burden of 96,000 hours (24 entities x
2 persons x 2,000 hours).
In adopting those disclosure requirements, the Commission also
incorporated an estimate of one hour per security-based swap for an
entity to evaluate whether more particularized disclosures are
necessary and to develop additional disclosures. See Business
Conduct Adopting Release, 81 FR at 30092. The Commission does not
believe that particular category of costs would be applicable in the
context of the transactions at issue here.
Under the proposed exception, the disclosure condition extends
not only to incentives and conflicts of the registered entity, but
also disclosures and conflicts of its non-U.S. affiliate. The
Commission believes, however, that the existing burden estimates are
sufficient to account for this aspect of the disclosure, given that
the two entities' affiliation should facilitate the transfer of any
relevant incentive and conflict information for the registered
entity to convey.
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Suitability of recommendations. When the Commission
previously analyzed the burdens associated with the security-based swap
dealer recommendation suitability requirement, it estimated that most
security-based swap dealers would obtain representations from
counterparties to comply with the institutional suitability provisions
of the requirement.\531\ The Commission further particularly estimated:
(i) That for security-based swap market participants that also are swap
market participants, most of the requisite representations have been
drafted for the swaps context, and that to the extent that any
modifications are necessary to adapt those representations to the
security-based swap context, each market participant would require two
hours to assess the need for modifications and make any required
modifications; \532\
[[Page 24283]]
and (ii) other market participants (apart from special entities not
relevant here) would require five hours for each market participant to
review and agree to the relevant representations.\533\
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\531\ See id. at 30092-93.
\532\ Analysis of current data indicates that the six U.S.
entities engaged in security-based swap dealing activity above the
de minimis thresholds in the aggregate have 161 unique non-U.S.
counterparties that are swap market participants, and 70 unique non-
U.S. counterparties that are not swap market participants. The one
non-U.S. entity that may fall below the de minimis threshold due to
the exception has 391 unique non-U.S. counterparties that are swap
market participants, and 178 unique non-U.S. counterparties that are
not swap market participants. The five additional non-U.S. persons
that would be expected to incur assessment costs in connection with
the ``arranged, negotiated, or executed'' counting standard in the
aggregate have six unique non-U.S. counterparties that are swap
market participants, and one unique non-U.S. counterparty that are
not swap market participants. Adding together those estimates and
then doubling them (in light of the uncertainty associated with the
estimate and to account for potential growth of the security-based
swap market) produces a total estimate of 1,116 unique non-U.S
counterparties that are swap market participants, and 498 that are
not. Only non-U.S. counterparties are relevant for purposes of this
analysis because the proposed exception does not address security-
based swap transactions involving U.S. person counterparties.
Consistent with these assumptions, the potential burden
associated with such modifications in connection with the proposed
condition would amount to 2,232 hours (1,116 non-U.S. security-based
swap market participants that also are swap market participants x
two hours).
\533\ Consistent with the above assumptions, the potential
burden associated with such modifications in connection with the
proposed condition would amount to 2,490 hours (498 non-U.S.
security-based swap market participants that are not also swap
market participants x five hours).
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Fair and balanced communications. The Commission's earlier
analysis of the burdens associated with the fair and balanced
communications requirement \534\ took the view that each registered
entity would incur: (i) $6,000 in initial legal costs to draft or
review statements of potential opportunities and corresponding risks in
marketing materials; \535\ (ii) an additional initial six hours for
internal review of other communications such as emails and Bloomberg
messages; \536\ and (iii) $8,400 in initial legal costs associated with
marketing materials for more bespoke transactions.\537\
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\534\ See Business Conduct Adopting Release, 81 FR at 30093.
\535\ In connection with the proposed exception, the potential
burden associated with such drafting or review would amount to
$151,200 (24 entities x $6,000 x 1.05 adjustment to current
dollars).
\536\ In connection with the proposed exception, the potential
burden associated with such internal review would amount to 144
hours (24 entities x 6 hours).
\537\ In connection with the proposed exception, the potential
burden associated with such drafting or review would amount to
$211,680 (24 entities x $8,400 x 1.05 adjustment to current
dollars).
In adopting the fair and balanced communication requirement,
the Commission also incorporated an estimate of ongoing compliance
costs (associated with review of email communications sent to
counterparties) over the term of the security-based swap. See
Business Conduct Adopting Release, 81 FR at 30093. Those costs are
not incorporated into this estimate because the registered entity
that engaged in market-facing activity in the United States in
connection with the transactions at issue here would not be expected
to have ongoing communications with the counterparty to the
security-based swap.
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c. Trade Acknowledgment and Verification Condition
The Commission estimated the reporting and recordkeeping burdens
associated with the trade acknowledgment and verification requirements
under Title VII when it adopted those requirements.\538\ The Commission
believes that those estimates are instructive for calculating the per-
entity reporting and recordkeeping burdens associated with the proposed
trade acknowledgment and verification condition, given that the
condition in effect would require compliance with that trade
acknowledgment and verification requirement by additional persons and/
or in additional circumstances.
---------------------------------------------------------------------------
\538\ See id. at 39830-31.
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When the Commission earlier considered the compliance burdens
associated with the trade acknowledgement and verification
requirements, the Commission estimated that each applicable entity
would incur: (i) 355 hours initially to develop an internal order and
trade management system; \539\ (ii) 436 hours annually for day-to-day
technical support, as well as amortized annual burden associated with
system or platform upgrades and updates; \540\ (iii) 80 hours initially
for the preparation of written policies and procedures to obtain
verification of transaction terms; \541\ and (iv) 40 hours annually to
maintain those policies and procedures.\542\
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\539\ In connection with the proposed exception, the potential
burden associated with such system development would amount to 8,520
hours (24 entities x 355 hours).
\540\ In connection with the proposed exception, the potential
annual burden associated with such support and updates would amount
to 10,464 hours (24 entities x 436 hours).
\541\ In connection with the proposed exception, the potential
burden associated with such preparation would amount to 1,920 hours
(24 entities x 80 hours).
\542\ In connection with the proposed exception, the potential
annual burden associated with such policies and procedures would
amount to 960 hours (24 entities x 40 hours).
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d. Portfolio Reconciliation Condition
The Commission estimated the recordkeeping burdens associated with
the portfolio reconciliation requirements under Title VII when it
proposed those requirements.\543\ The Commission believes that those
estimates are instructive for calculating the per-entity recordkeeping
burdens associated with the proposed portfolio reconciliation
condition, given that the condition in effect would require compliance
with that portfolio reconciliation requirement by additional persons
and/or in additional circumstances.
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\543\ See Risk Mitigation Proposing Release, 84 FR at 4642-43.
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When the Commission considered the recordkeeping burden associated
with the portfolio reconciliation requirement, it estimated that each
respondent on average would incur an annual burden of 190 hours in
connection with proposed Rule 15Fi-3(a), which addresses portfolio
reconciliation obligations in connection with transactions where the
counterparty to the registered entity is a security-based swap dealer
and major security-based swap participant.\544\ The Commission further
estimated that each respondent on average would incur an annual burden
of 227.5 hours in connection with proposed Rule 15Fi-3(b), which
addresses portfolio reconciliation obligations in connection with
transactions where the counterparty to the registered entity is not a
security-based swap dealer and major security-based swap
participant,\545\ for a total of 417.5 hours.
---------------------------------------------------------------------------
\544\ See Risk Mitigation Proposing Release, 84 FR at 4642. That
was based on estimates regarding the time to perform each
reconciliation, and the number of counterparties associated with
each required frequency of portfolio reconciliation (i.e., daily
reconciliations for portfolios with more than 500 security-based
swaps, weekly reconciliations for portfolios with more than 50 but
fewer than 500 security-based swaps, and quarterly reconciliations
for portfolios with no more than 50 security-based swaps).
\545\ See id. at 4642-43. That was based on estimates regarding
the time to perform each reconciliation, and the number of
counterparties associated with each required frequency of portfolio
reconciliation (i.e., quarterly reconciliations for portfolios with
more than 100 security-based swaps, and annual reconciliations for
portfolios with no more than 100 security-based swaps).
---------------------------------------------------------------------------
While recognizing that the proposed condition requires only the
initial reconciliation of any particular instrument, the Commission
nonetheless believes that these estimates provide a useful upper bound
for the per-entity burden associated with this condition.\546\
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\546\ In connection with the proposed exception, the estimated
aggregate annual burden associated with this condition would be
10,020 hours (24 entities x 417.5 hours).
The Commission believes that the above estimate of 10,020
appropriately reflects the burden associated with the portfolio
reconciliation condition. At the same time, the Commission
recognizes that, depending on the applicable facts and
circumstances, the registered entity engaged in arranging,
negotiating or executing conduct in the United States may need to
obtain, from the non-U.S. affiliate relying on the transaction,
information needed to perform the initial portfolio reconciliation.
The Commission typically would not expect such transfers of
information to constitute an independent collection of information,
because the registered entity generally would be expected to possess
that information to comply with regulatory reporting obligations
pursuant to Regulation SBSR (leading any resulting burdens to be
subsumed within the collection of information associated with
Regulation SBSR).
Nonetheless, in the event that the registered entity is not
otherwise subject to regulatory reporting obligations pursuant to
Regulation SBSR, such transfers of information from the non-U.S.
affiliate to the registered entity may constitute an independent
collection of information. In those circumstances, and consistent
with the Paperwork Reduction Act analysis associated with Regulation
SBSR, the Commission anticipates that the upper bound on the initial
burden for each non-U.S. affiliate to construct an infrastructure to
provide for the transfer of this information would amount to 1,394
hours (see Exchange Act Release No. 74244 (Feb. 11, 2015), 80 FR
14564, 14676 (Mar. 19, 2015)), or 33,456 hours in the aggregate (24
non-U.S. entities x 1,394 hours). Also, based on prior estimates
that it would take 0.005 hours to report each security-based swap
transaction (see id.), and the estimate that this proposed exception
in the aggregate would address 97,894 transactions annually (see
notes 515, 517 and 519 supra), the Commission estimates that the
upper bound on the aggregate annual burden associated with such
transfers of information would amount to approximately 489 hours
(97,894 transactions x 0.005 hours).
Such burdens likely would be mitigated if, for example, the
registered entity and its non-U.S. affiliate jointly make use of
unified back-office systems, or if the counterparty relationship
largely is managed by personnel of the registered entity, or if the
non-U.S. entity independently is subject to Regulation SBSR or has
developed similar types of systems to comply with foreign reporting
requirements.
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[[Page 24284]]
e. Recordkeeping Condition
To comply with the proposed condition that the affiliated
registered entity obtain from the non-U.S. person, and maintain, copies
of trading relationship documentation the registered entity and the
non-U.S. person jointly would need to develop policies and procedures
to provide for the identification of such records and for their
transfer to the registered affiliate. For each use of the proposed
exception, the Commission preliminarily estimates that such policies
and procedures would impose require a one-time initial burden of 20
hours.\547\
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\547\ Across the 24 potential uses of the proposed exception,
this would amount to a total of 480 hours (24 entities x 20 hours).
---------------------------------------------------------------------------
The Commission also preliminarily estimates that the non-U.S.
person relying on this exception also would need to expend two hours
per week to identify such records and to electronically convey the
records to its registered affiliate.\548\ The Commission further
preliminarily estimates that the registered affiliate would need to
expend one hour per week in connection with the receipt and maintenance
of those records.\549\
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\548\ Across the 24 potential uses of the proposed exception,
this would amount to a total of 2,496 hours annually (24 entities x
2 hours x 52 weeks).
\549\ Across the 24 potential uses of the proposed exception,
this would amount to a total of 1,248 hours annually (24 entities x
1 hour x 52 weeks).
The recordkeeping condition also specifies that, for the
exception to be available, the registered entity must create and
maintain books and records as required by applicable rules,
including any books and records requirements relating to the
provisions specified in paragraph (d)(1)(ii)(B) (i.e., relating to
disclosure of risks, characteristics, incentives and conflicts;
suitability; fair and balanced communications; trade acknowledgment
and verification; and portfolio reconciliation). Because that part
of the condition subsumes the collection of information that we
would expect to be associated with the final rules adopting those
security-based swap dealer books and records requirements, it does
not constitute a separate collection of information. See note 493,
supra.
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f. Consent to Service Condition
To comply with the proposed condition that the affiliated
registered entity obtain from the non-U.S. person relying on the
exception written consent to service of process for civil actions, one
or the other of those parties would have to draft such a consent or use
an industry-standard consent provision, and the registered entity must
obtain that consent from the non-U.S. person. The Commission
preliminarily estimates that the parties jointly must expend [two]
hours in connection with this process.\550\
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\550\ Across the 24 expected uses of the proposed exception,
this would amount to a total of 48 hours (24 entities x 2 hours).
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g. ``Listed Jurisdiction'' Condition
The Commission believes that burden estimates associated with
applications for substituted compliance determinations are instructive
with regard to the burdens that would be associated with applications
by market participants in connection with ``listed jurisdiction''
status.\551\
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\551\ Notwithstanding the substantive differences between the
standards associated with listed jurisdiction determinations and
substituted compliance assessments, see part III.B.5, supra, the two
sets of applications will be submitted pursuant to Rule 0-13 and may
be expected to address certain analogous elements.
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When the Commission initially adopted Rules 0-13 and 3a71-6,
providing for substituted compliance in connection with security-based
swap dealer business conduct requirements, the Commission concluded
that the ``great majority'' of substituted compliance applications
would be submitted by foreign authorities, and that ``very few''
applications would be submitted by security-based swap dealers (or
major security-based swap participants), and the Commission concluded
that three such registered entities would submit substituted compliance
applications.\552\ The Commission further estimated that the one-time
paperwork burden associated with preparing and submitting all three
substituted compliance requests in connection with those requirements
would be approximately 240 hours, plus $240,000 for the services of
outside professionals.\553\ The Commission subsequently relied on those
estimates in connection with the paperwork burdens associated with
amendments to Rule 3a71-6 related to trade acknowledgement and
verification.\554\
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\552\ See Business Conduct Adopting Release, 81 FR at 30097.
\553\ This was based on the estimate that each request would
require approximately 80 hours of in-house counsel time, plus
$80,000 for the services of outside professionals (based on 200
hours of outside time x $400/hour). See id.
\554\ See Trade Acknowledgement Adopting Release, 81 FR at
39832.
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The Commission similarly believes that the majority of ``listed
jurisdiction'' applications would be made by foreign authorities rather
than by the up to 24 non-U.S. persons that potentially would rely on
the exception. Consistent with the estimates in connection with the
substituted compliance rule, moreover, the Commission estimates that
three non-U.S. persons that seek to rely on the exception would file
listed jurisdiction applications, and that in the aggregate those three
persons would incur initial paperwork burdens, associated with
preparing and submitting the requests, of approximately 240 hours, plus
$252,000 for the services of outside professionals (incorporating a
five percent addition to reflect current dollars).
Table 3--Proposed Rule 3a71-3 Amendment--Summary of Paperwork Reduction Act Burdens
----------------------------------------------------------------------------------------------------------------
Initial burden Annual burden
Burden type -------------------------------------------------------------------------------
Per-firm Aggregate Per-firm (hr) Aggregate (hr)
----------------------------------------------------------------------------------------------------------------
Disclosure of limited Title VII
applicability: *
disclosure by 12 U.S. ...................... ...................... 1,050.75 12,609
dealing entities (A).
disclosure by 2 non-U.S. ...................... ...................... 1,677.3 3,355
dealing entities (B).
disclosure by other non-U.S. ...................... ...................... 35.2 352
entities (C).
related policies and 100 hr................ 2,400 hr..............
procedures (same). $29,715............... $713,160..............
Disclosure of risks,
characteristics et al.:
structuring, legal, 1,200 hr.............. 28,800 hr.............
operations, compliance.
[[Page 24285]]
re-evaluation and ...................... ...................... 120 2,880
modification.
systems development, 8,000 hr.............. 192,000 hr............
programming, testing.
system maintenance.......... ...................... ...................... 4,000 96,000
Suitability:
reps. by participants also 2 hr.................. 2,232 hr..............
in swap market.
representations by other 5 hr.................. 2,490 hr..............
counterparties.
Fair and balanced
communications:
1statement drafting......... $6,300................ $151,200..............
additional internal review.. 6 hr.................. 144 hr................
legal costs................. $8,820................ $211,680..............
Trade acknowledgement and
verification:
internal order and trade 355 hr................ 8,520 hr..............
mgt. systems.
daily tech. support/ ...................... ...................... 436 10,464
amortized upgrades.
initial preparation of 80 hr................. 1,920 hr..............
policies and procedures.
maintenance of policies and ...................... ...................... 40 960
procedures.
Portfolio reconciliation:
initial reconciliation of ...................... ...................... 417.5 10,020
transactions.
Copies of trading relationship
documentation:
joint development of 20 hr................. 480 hr................
policies/procedures.
non-US entity identification ...................... ...................... 104 2,496
and conveyance.
registered entity receipt ...................... ...................... 52 hr 1,248 hr
and maintenance.
Consent to service of process:
joint drafting/transfer to 2 hr.................. 48 hr.................
registered entity.
``Listed jurisdiction''
applications:
applications by non- 80 hr................. 240 hr................
regulators.
(same)...................... $84,000............... $252,000
----------------------------------------------------------------------------------------------------------------
* (A) Twelve U.S. dealing entities may book future security-based swaps with non-U.S. counterparties into non-
U.S. affiliates. (B) Two non-U.S. entities may fall below the de minimis threshold if ``arranged, negotiated,
or executed'' transactions are not counted. (C) Ten additional non-U.S. entities may make use of the exception
to avoid incurring assessment costs in connection with the ``arranged, negotiated, or executed'' de minimis
test.
5. Collection of Information Is Mandatory
The collections of information associated with the proposed
amendments to Rule 3a71-3 are mandatory to the availability of the
exception.
6. Confidentiality
Any disclosures to be provided in connection with the arranging,
negotiating or executing of a registered security-based swap dealer or
of a registered broker (depending on the alternative adopted) in
compliance with the requirements of the proposed exception would be
provided to the non-U.S. counterparties of the non-U.S. person relying
on this exception; therefore, the Commission would not typically
receive confidential information as a result of this collection of
information. To the extent that the Commission receives records related
to such disclosures from a registered security-based swap dealer or
registered broker through the Commission's examination and oversight
program, or through an investigation, or some other means, such
information would be kept confidential, subject to the provisions of
applicable law.
Any applications for listed jurisdiction status will be made
public.
7. Retention Period of Recordkeeping Requirements
By virtue of being registered as a security-based swap dealer and/
or as a broker (depending on the alternative), the entity-engaged in
market facing conduct in the United States will be required to retain
the records and information required under the proposed amendment to
Rule 3a71-3 for the retention periods specified in Exchange Act Rules
17a-4 and 18a-6, as applicable.\555\
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\555\ The registered entity would have to create and/or maintain
certain records in connection with the following proposed conditions
(in conjunction with proposed Commission books and record rules and
rule amendments related to Title VII): Disclosure of limited Title
VII applicability; business conduct; trade acknowledgement and
verification; portfolio reconciliation; obtaining and maintaining
relationship documentation and questionnaires; consent to service of
process.
The proposed conditions do not require the non-U.S. person
relying on the exception to make or retain any particular types of
records (although that non-U.S. person will be required to convey
existing trading relationship documentation to its registered
affiliate).
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B. Proposed Modifications to Proposed Rule 18a-5
1. Summary of Collections of Information To Be Modified
The Commission is proposing to modify proposed Rule 18a-5--which is
modeled on Exchange Act Rule 17a-3, as amended--with respect to the
requirement that stand-alone and bank SBS Entities make and keep
current certain records.\556\ The proposed modifications to proposed
Rule 18a-5 would reduce the burden associated with Rule 18a-5, as
originally proposed, by providing generally that a stand-alone or bank
SBS Entity need not: (i) Make and keep current a questionnaire or
application for employment for an associated person if the SBS Entity
is excluded from the prohibition under Exchange Act Section 15F(b)(6)
with respect to such associated person (e.g., the exclusion proposed in
Rule of Practice 194(c)(2)), and (ii) include the information generally
required to be included on the questionnaire or application for
employment executed by an associated person if the associated person is
not a U.S. person and the receipt of that information, or the creation
or maintenance of records reflecting that information, would result in
a violation of applicable law in the jurisdiction in which the
associated person is employed or located.
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\556\ See proposed Rule 18a-5, Recordkeeping and Reporting
Proposing Release.
---------------------------------------------------------------------------
2. Use of Information
Proposed Rule 18a-5, as proposed to be modified, is designed, among
other things, to promote the prudent operation of SBS Entities, and to
assist the Commission, SROs, and state securities regulators in
conducting
[[Page 24286]]
effective examinations.\557\ Thus, the collections of information under
proposed Rule 18a-5 are expected to facilitate inspections and
examinations of SBS Entities.
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\557\ As noted above, proposed Rule 18a-5 is patterned after
Exchange Act Rule 17a-3, the recordkeeping rule for registered
broker-dealers. See, e.g., Books and Records Requirements for
Brokers and Dealers Under the Securities Exchange Act of 1934,
Exchange Act Release No. 47910 (Oct. 26, 2001), 66 FR 55818 (Nov. 2,
2001) (``The Commission has required that broker-dealers create and
maintain certain records so that, among other things, the
Commission, [SROs], and State Securities Regulators . . . may
conduct effective examinations of broker-dealers'' (footnote
omitted)).
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3. Respondents
The Commission estimated the number of respondents in the
Recordkeeping and Reporting Proposing Release. The Commission received
no comment on these estimates and continues to believe they are
appropriate.
Consistent with the Recordkeeping and Reporting Proposing Releases,
based on available data regarding the single-name CDS market--which the
Commission believes will comprise the majority of security-based
swaps--the Commission estimates that the number of major security-based
swap participants likely will be five or fewer and, in actuality, may
be zero.\558\ Therefore, to capture the likely number of major
security-based swap participants that may be subject to the collections
of information for purposes of this PRA, the Commission estimates for
purposes of this PRA that five entities will register with the
Commission as major security-based swap participants. Also consistent
with the Recordkeeping and Reporting Proposing Release, the Commission
estimates that approximately four major security-based swap
participants will be stand-alone entities.\559\
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\558\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25260; see also Registration Process for Security-Based Swap
Dealers and Major Security-Based Swap Participants; Final Rule, 80
FR at 48990; Further Definition of ``Swap Dealer,'' ``Security-Based
Swap Dealer,'' ``Major Swap Participant,'' ``Major Security-Based
Swap Participant'' and ``Eligible Contract Participant'' Exchange
Act Release No. 66868 (Apr. 27, 2012), 77 FR 30596 at 30727 (May 23,
2012).
\559\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25260.
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Consistent with prior releases, the Commission estimates that 50 or
fewer entities ultimately may be required to register with the
Commission as security-based swap dealers, of which 16 are broker-
dealers that will likely seek to register as security-based swap-
dealers.560 561 The Commission continues to estimate that
approximately 75% of the 34 non-broker-dealer security-based swap
dealers (i.e., 25 firms) will register as bank security-based swap
dealers, and the remaining 25% (i.e., 9 firms) will register as stand-
alone security-based swap dealers.\562\
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\560\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25260.
\561\ See Registration Process for Security-Based Swap Dealers
and Major Security-Based Swap Participants; Final Rule, 80 FR at
79002.
\562\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25261. The Commission does not anticipate that any firms will be
dually registered as a broker-dealer and a bank.
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Further, the Commission continues to estimate that each security-
based swap dealer will employ approximately 420 associated persons that
are natural persons and each major security-based swap participant will
employ approximately 62 associated persons that are natural
persons.\563\ The Commission has no data regarding how many associated
persons of SBS Entities who are non-U.S. natural persons may: (a) Not
effect or be involved in effecting security-based swap transactions
with or for counterparties that are U.S. persons (other than a
security-based swap transaction conducted through a foreign branch of a
counterparty that is a U.S. person); (b) effect or be involved in
effecting security-based swap transactions with or for counterparties
that are U.S. persons, but who may be employed or located in
jurisdictions where the receipt of information required by the
questionnaire or employment application, or the creation or maintenance
of records reflecting that information, would result in a violation of
applicable law; or (c) effect or be involved in effecting security-
based swap transactions with or for counterparties that are U.S.
persons, who are employed or located in jurisdictions where local law
would not restrict the receipt, creation or maintenance of information
required by the questionnaire or employment application. Given that,
the Commission will estimate, for purposes of this Paperwork Reduction
Act analysis, that non-U.S. associated persons are evenly split into
each of these categories.
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\563\ Id.
1 See Rule of Practice 194 Adopting Release, 84 FR at 4926.
Commission staff also checked with the staff at the National Futures
Association regarding an approximate number of associated persons
employed by registered swap dealers. NFA staff provided anecdotal
information indicating that the number of natural persons that are
associated persons of swap dealers is substantially similar to
Commission staff estimates. NFA staff further indicated that they
believe about half of the total number of natural persons that are
associated persons of swap dealers are located in the U.S. and the
other half are located in foreign jurisdictions.
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4. Total Initial and Annual Recordkeeping and Reporting Burden
As indicated in the Recordkeeping and Reporting Proposing Release,
proposed Rule 18a-5 will impose collection of information requirements
that result in initial and annual burdens for SBS Entities. The
proposed modifications to Rule 18a-5 will decrease these burdens for
certain SBS Entities.
In the Recordkeeping and Reporting Proposing Release, the
Commission indicated that proposed Rule 18a-5 would require that stand-
alone SBS Entities make and keep current 13 types of records, including
records on associated persons,\564\ and estimated that those 13
paragraphs would impose on each firm an initial burden of 260 hours and
an ongoing annual burden of 325 hours.\565\ In addition, the Commission
indicated that proposed Rule 18a-5 would require that bank SBS Entities
make and keep current 10 types of records, including records on
associated persons,\566\ and estimated that these ten paragraphs will
impose on each firm an initial burden of 200 hours per firm and an
ongoing burden of 250 hours per firm.\567\ The Commission further
stated that while proposed Rule 18a-5 would impose a burden to make and
keep current these records, it would not require the firm to perform
the underlying task.\568\
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\564\ See paragraph (a)(10) of proposed Rule 18a-5,
Recordkeeping and Reporting Proposing Release, 79 FR at 25308.
\565\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25264. Of these total initial and ongoing annual burdens for the
13 types of records a firm would be required to make and keep
current under paragraph (a)(10) of proposed Rule 18a-5, Commission
staff believes that the burdens associated with making and keeping
current questionnaires or applications for employment would be an
initial burden of 20 hours (or 260/13) and an ongoing burden of 25
hours (or 325/13).
\566\ See paragraph (b)(8) of proposed Rule 18a-5; Recordkeeping
and Reporting Proposing Release, 79 FR at 25309-10.
\567\ See id. at 25264. Of these total initial and ongoing
annual burdens for the 10 types of records a firm would be required
to make and keep current under paragraph (b)(8) of proposed Rule
18a-5, Commission staff believes that the burdens associated with
making and keeping current questionnaires or applications for
employment would be an initial burden of 20 hours (or 200/10) and an
ongoing burden of 25 hours (or 250/10).
\568\ In estimating the burden associated with Rule 18a-5, the
Commission recognizes that entities that will register stand-alone
SBS Entities likely make and keep current some records today as a
matter of routine business practice, but the Commission does not
have information about the records that such entities currently
keep. Therefore, the Commission assumes that these entities
currently keep no records when it estimates the PRA burden for these
entities.
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The Commission received no comments regarding its hour and cost
burden estimates for proposed Rule
[[Page 24287]]
18a-5 and continues to believe they are appropriate.
The proposed modifications to paragraphs (a)(10) and (b)(8) of
proposed Rule 18a-5 would (a) exempt stand-alone and bank SBS Entities
from the requirement to make and keep current a questionnaire or
application for employment for an associated person if the SBS Entity
is excluded from the prohibition in section 15F(b)(6) of the Exchange
Act with respect to the associated person (e.g., the exclusion proposed
in Rule of Practice 194(c)(2)), and (b) allow SBS Entities to exclude
certain information from their associated person records if receipt of
that information or the creation or maintenance of records reflecting
that information would result in a violation of applicable law in the
jurisdiction where the associated person is employed or located.
Proposed Addition of Paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A)
The Commission estimates that the proposed modification to add
paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A) to proposed Rule 18a-5
would eliminate the paperwork burden for stand-alone and bank security-
based swap dealers and major security-based swap participants
associated with making and keeping current questionnaires or
applications for employment records, otherwise required by proposed
Rule 18a-5, with respect to any associated person if the SBS Entity is
excluded from the prohibition in Exchange Act Section 15F(b)(6),
including the exclusion proposed in Rule of Practice 194(c)(2) with
respect to a natural person who is (i) not a U.S. person and (ii) does
not effect and is not involved in effecting security-based swap
transactions with or for counterparties that are U.S. persons (other
than a security-based swap transaction conducted through a foreign
branch of a counterparty that is a U.S. person).
As indicated above, the Commission estimates that there will be
approximately 4 stand-alone major security-based swap participants, 9
stand-alone security-based swap dealers and 25 bank security-based swap
dealers. Further, as indicated above, each security-based swap dealer
would have approximately 420 associated persons and half of those
associated persons, or 210, would not be employed or located in the
U.S. The Commission estimates that stand-alone and bank SBS dealers
would not need to obtain the questionnaire or application for
employment for one third of those associated persons, or 70, because
proposed Rule of Practice 194(c)(2) would provide an exclusion from the
prohibition in Section 15F(b)(6) of the Exchange Act with respect to
associated persons who are not located in the U.S. and do not effect
and are not involved in effecting security-based swap transactions with
or for counterparties that are U.S. persons (other than a security-
based swap transaction conducted through a foreign branch of a
counterparty that is a U.S. person).\569\ Similarly, as indicated
above, each major security-based swap participant would have
approximately 62 associated persons and half of those associated
persons, or 31, would not be employed or located in the U.S. The
Commission estimates that stand-alone and bank major security-based
swap participants would not need to obtain the questionnaire or
application for employment for one third of those associated persons,
or 10, because proposed Rule of Practice 194(c)(2) would provide an
exclusion from the prohibition in Section 15F(b)(6) of the Exchange Act
with respect to those associated persons.\570\
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\569\ 70 associated persons/420 associated persons per security-
based swap dealer = a reduction of approximately 16.7%. Security-
based swap dealers would be able to utilize this paragraph relative
to other exclusions from the requirements of Exchange Act Section
15F(b)(6) that the Commission may provide, however the analysis is
focusing solely on the exclusion provided by proposed new paragraph
(c)(2) to Rule of Practice 194 for purposes of the Paperwork
Reduction Act estimate.
\570\ 10 associated persons/62 associated persons per major
security-based swap participant = a reduction of approximately
16.1%. Major security-based swap participants would be able to
utilize this paragraph relative to other exclusions from the
requirements of Exchange Act Section 15F(b)(6) that the Commission
may provide, however the analysis is focusing solely on the
exclusion provided by proposed new paragraph (c)(2) to Rule of
Practice 194 for purposes of this Paperwork Reduction Act estimate.
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Given this, the addition of paragraphs (a)(10)(iii)(A) and
(b)(8)(iii)(A) to proposed Rule 18a-5 would reduce the initial burden
associated with proposed Rule 18a-5 by 127 hours \571\ and it would
reduce the ongoing burden associated with proposed Rule 18a-5 by 158
hours.\572\
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\571\ Initial burden hours associated with paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5 for stand-alone and bank security-
based swap dealers and major security-based swap participants, as
proposed--
20 hours x [9 stand-alone security-based swap dealers + 25 bank
security-based swap dealers] = 20 hours x 34 security-based swap
dealers = 680 initial burden hours for security-based swap dealers.
20 hours x 4 stand-alone major security-based swap participants
= 80 initial burden hours for major security-based swap
participants.
Initial burden hour reduction:
680 initial burden hours for security-based swap dealers x 16.7%
(see supra note 569) = 114 hours. 80 initial burden hours for major
security-based swap participants x 16.1% (see supra note 570) = 13
hours. A 114 hour reduction in the initial burden for security-based
swap dealers + a 13 hour reduction in the initial burden for major
security-based swap participants = a 127 hour reduction in initial
burden hours across all entities able to rely on paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5.
\572\ Ongoing burden hours associated with paragraph (a)(10) and
(b)(8) of proposed Rule 18a-5 for stand-alone and bank security-
based swap dealers and major security-based swap participants, as
proposed--
25 hours x [9 stand-alone security-based swap dealers + 25 bank
security-based swap dealers] = 20 hours x 34 security-based swap
dealers = 850 ongoing burden hours for security-based swap dealers.
25 hours x 4 stand-alone major security-based swap participants
= 100 ongoing burden hours for major security-based swap
participants.
Ongoing burden hour reduction:
850 ongoing burden hours for security-based swap dealers x 16.7%
(see supra note 569) = 142 hours. 100 ongoing burden hours for major
security-based swap participants x 16.1% (see supra note 570) = 16
hours. A 142 hour reduction in the ongoing burden for security-based
swap dealers + a 16 hour reduction in the ongoing burden for major
security-based swap participants = a 158 hour reduction in ongoing
burden hours across all entities able to rely on paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5.
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Proposed Addition of Paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B)
The Commission estimates that the proposed modification to add
paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) to proposed Rule 18a-5
would decrease the paperwork burden for stand-alone and bank SBS
Entities by permitting the exclusion of certain information mandated by
the questionnaire requirement with respect to associated natural
persons who effect or are involved in effecting security-based swap
transactions with U.S. counterparties where the receipt of that
information, or the creation or maintenance of records reflecting such
information, would result in a violation of applicable law in the
jurisdiction where the associated person is employed or located.
As indicated above, the Commission estimates that there will be
approximately 4 stand-alone major security-based swap participants, 9
stand-alone security-based swap dealers and 25 bank security-based swap
dealers. Further, as indicated above, each security-based swap dealer
would have approximately 420 associated persons and half of those
associated persons, or 210, would not be employed or located in the
U.S. The Commission estimates that these new paragraphs would permit
stand-alone and bank security-based swap dealers to exclude certain
information mandated by the questionnaire requirement for approximately
one third of those
[[Page 24288]]
associated persons, or 70.\573\ Similarly, as indicated above, each
major security-based swap participant would have approximately 62
associated persons and half of those associated persons, or 31, would
not be employed or located in the U.S. The Commission estimates that
these new paragraphs would permit stand-alone and bank major security-
based swap participants to exclude certain information mandated by the
questionnaire requirement for approximately one third of those
associated persons, or 10.\574\
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\573\ See note 569, supra.
\574\ See note 570, supra.
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The Commission estimates that this will reduce the burdens
associated with obtaining the information specified in the
questionnaire requirement by 50% for the affected associated persons.
Given this, the addition of paragraphs (a)(10)(iii)(B) and
(b)(8)(iii)(B) to proposed Rule 18a-5 would reduce the initial burden
associated with proposed Rule 18a-5 by 63 hours \575\ and would reduce
the ongoing burden associated with proposed Rule 18a-5 by 79
hours.\576\
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\575\ Initial burden hours associated with paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5 for stand-alone and bank security-
based swap dealers and major security-based swap participants, as
proposed--
20 hours x [9 stand-alone security-based swap dealers + 25 bank
security-based swap dealers] = 20 hours x 34 security-based swap
dealers = 680 initial burden hours for security-based swap dealers.
20 hours x 4 stand-alone major security-based swap participants
= 80 initial burden hours for major security-based swap
participants.
Initial burden hour reduction:
[680 initial burden hours for security-based swap dealers x
16.7% (see supra note 569 x 50%] = 57 hours. [80 initial burden
hours for major security-based swap participants x 16.1% (see supra
note 570) x 50%] = 6 hours. A 57 hour reduction in the initial
burden for security-based swap dealers + a 6 hour reduction in the
initial burden for major security-based swap participants = a 63
hour reduction in initial burden hours across all entities able to
rely on paragraphs (a)(10) and (b)(8) of proposed Rule 18a-5.
\576\ Ongoing burden hours associated with paragraph (a)(10) and
(b)(8) of proposed Rule 18a-5 for stand-alone and bank security-
based swap dealers and major security-based swap participants, as
proposed--
25 hours x [9 stand-alone security-based swap dealers + 25 bank
security-based swap dealers] = 20 hours x 34 security-based swap
dealers = 850 ongoing burden hours for security-based swap dealers.
25 hours x 4 stand-alone major security-based swap participants
= 100 ongoing burden hours for major security-based swap
participants.
Ongoing burden hour reduction:
[850 ongoing burden hours for security-based swap dealers x
16.7% (see supra note 569) x 50%] = 71 hours. [100 ongoing burden
hours for major security-based swap participants x 16.1% (see supra
note 570) x 50%] = 8 hours. A 71 hour reduction in the ongoing
burden for security-based swap dealers + a 8 hour reduction in the
ongoing burden for major security-based swap participants = a 79
hour reduction in ongoing burden hours across all entities able to
rely on paragraphs (a)(10) and (b)(8) of proposed Rule 18a-5.
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Thus, in total, the addition of both paragraphs (a)(10)(iii)(A) and
(b)(8)(iii)(A) and paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) would
reduce the initial burden associated with the questionnaire requirement
in proposed Rule 18a-5 by 190 hours,\577\ and the ongoing burden
associated with the questionnaire requirement in proposed Rule 18a-5 by
237 hours.\578\
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\577\ A 127 hour reduction in initial burden hours associated
with the addition of paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A)
and a 63 hour reduction in initial burden hours associated with the
addition of paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) = a 190
hour reduction in initial burden hours.
\578\ A 158 hour reduction in ongoing burden hours associated
with the addition of paragraphs (a)(10)(iii)(A) and (b)(8)(iii)(A)
and a 79 hour reduction in ongoing burden hours associated with the
addition of paragraphs (a)(10)(iii)(B) and (b)(8)(iii)(B) = a 237
hour reduction in ongoing burden hours.
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5. Collection of Information Is Mandatory
The collections of information pursuant to the proposed
modifications to the proposed new rule would be mandatory, as
applicable, for SBS Entities.
6. Confidentiality
Information that an SBS Entity would be required to make and keep
current under proposed Rule 18a-5 would be maintained by the firm. To
the extent that the Commission collects such records during an
inspection or examination of a registered SBS Entity, or through some
other means, such records would generally be kept confidential, subject
to the provisions of applicable law.\579\
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\579\ See, e.g., 5 U.S.C. 552 et seq.; 15 U.S.C. 78x (governing
the public availability of information obtained by the Commission).
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7. Retention Period for Recordkeeping Requirements
Proposed Rule 18a-6 would establish the required retention periods
for SBS Entities to maintain records collected in accorded with
proposed Rule 18a-5.\580\ Under paragraph (d)(1) of proposed Rule 18a-
6, an SBS Entity would be required to maintain and preserve in an
easily accessible place the records required under paragraphs (a)(10)
and (b)(8) of proposed Rule 18a-5 until at least three years after the
associated person's employment and any other connection with the SBS
Entity has terminated.
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\580\ See proposed Rule 18a-6, Recordkeeping and Reporting
Proposing Release.
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C. 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 the Commission's functions,
including whether the information shall have practical utility;
Evaluate the accuracy of the Commission's 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.
In addition, the Commission requests comment, including empirical
data in support of comments, in response to the following questions:
Are the Commission's estimates regarding the numbers of
respondents relative to the proposed modifications to proposed Rule
18a-5 accurate? If so, please provide empirical support for the
Commission's estimate. If not, please provide a suggested estimate and
empirical support for it.
Are the Commission's estimates regarding the amount of
time it would take to make and keep current the questionnaire or
application for employment or other related records accurate? If so,
please provide empirical support for the Commission's estimate. If not,
please provide a suggested estimate and empirical support for it.
Do stand-alone SBS Entities already have established
record making and record preservation systems? If so, please explain
those systems so they can be taken into account in the Commission's
burden estimates.
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 [ ], Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090,
with reference to File Number [ ]. 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 [ ] 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 collection of information
[[Page 24289]]
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.
IX. Consideration of Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996 (``SBREFA'') \581\ the Commission requests comment on the
potential effect of this proposal 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.
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\581\ 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).
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X. Regulatory Flexibility Act Certification
Section 3(a) of the Regulatory Flexibility Act of 1980 (``RFA'')
\582\ 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.'' \583\
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\582\ 5 U.S.C. 603(a).
\583\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
For purposes of Commission rulemaking in connection with the
RFA,\584\ 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; \585\ 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,\586\ 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.\587\ 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; \588\ (ii)
for entities engaged in non-depository credit intermediation and
certain other activities, entities with $7 million or less in annual
receipts;-\589\ (iii) for entities engaged in financial investments and
related activities, entities with $7 million or less in annual
receipts; \590\ (iv) for insurance carriers and entities engaged in
related activities, entities with $7 million or less in annual
receipts; \591\ and (v) for funds, trusts, and other financial
vehicles, entities with $7 million or less in annual receipts.\592\
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\584\ 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 (Jan. 28,
1982), 47 FR 5215 (Feb. 4, 1982) (File No. AS-305).
\585\ See 17 CFR 240.0-10(a).
\586\ See 17 CFR 240.17a-5(d).
\587\ See 17 CFR 240.0-10(c).
\588\ See 13 CFR 121.201 (Subsector 522).
\589\ See id. at Subsector 522.
\590\ See id. at Subsector 523.
\591\ See id. at Subsector 524.
\592\ See id. at Subsector 525.
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For purposes of the proposed exception to Exchange Act rule 3a71-3,
the Commission continues to believe that the types of entities that
would engage in more than a de minimis amount of dealing activity
involving security-based swaps would not be ``small entities'' for
purposes of the RFA.\593\ Moreover, based on feedback from market
participants and information about the security-based swap markets, the
Commission expects that all of the firms that are likely to make use of
the proposed exception to Rule 3a71-3--are part of large financial
institutions that exceed the thresholds defining ``small entities'' as
set forth above.\594\
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\593\ See Cross-Border Adopting Release, 79 FR at 47368.
\594\ See part VII.A.7, supra (discussing persons potentially
likely to use the proposed exception to Rule 3a71-3); see also U.S.
Activity Proposing Release, 80 FR at 27508 (``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'').
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As discussed, the proposed exception to Exchange Act Rule 3a71-3
would be subject to conditions requiring arranging, negotiating or
executing activity to be conducted by affiliated registered security-
based swap dealers (under alternatives 1 or 2) or by affiliated
registered brokers or security-based swap dealers (under alternative 2)
that are affiliated with the non-U.S. persons relying on the exception.
It is possible that some non-U.S. persons may set up new security-based
swap dealers or new brokers to make use of the exception, while
recognizing that other non-U.S. persons that seek to make use of the
proposed exception instead may make use of affiliated security-based
swap dealers that have an additional business of engaging in dealing
activity above the de minimis thresholds with U.S. counterparties
(under either alternative), or would make use of existing affiliated
registered broker-dealers (under alternative 2).\595\ By definition,
any such affiliated existing or new broker-dealer would not be a
``small entity.'' \596\ Moreover, even in the unlikely event that some
non-U.S. persons were to satisfy the exception's conditions via the use
of affiliated registered security-based swap dealers that fall within
the definition of ``small entity'' for purposes of the RFA,\597\ the
Commission preliminarily believes that there would not be a substantial
number of such entities.\598\
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\595\ See part VII.A.7, supra (discussing likely broker-dealer
or security-based swap dealer affiliates of persons expected to rely
on exemption).
\596\ The ``small entity'' definition applied to broker-dealers
excludes broker-dealers that are affiliated with a person that is
not a ``small entity.'' See Exchange Act Rule 0-10(c)(2), (i)(1)
(basing affiliation on an 25 percent ownership standard that is
narrower than the majority ownership standard used in connection
with this proposed conditional exception). Because the non-U.S.
persons relying on this exception would not be ``small entities,''
any such affiliated broker also would not be a ``small entity.''
\597\ As noted, if the person engaged in market-facing activity
in the United States is a registered security-based swap dealer (as
required by alternative 1 and permitted by alternative 2) that has
an additional business of engaging in dealing activity above the de
minimis thresholds with U.S. counterparties, the Commission
preliminarily believes that the person would not be a ``small
entity.''
\598\ Similarly, the Commission preliminarily believes that
there would not be a significant number of ``small entities'' that
may file ``listed jurisdiction'' applications pursuant to the
proposed amendments to Exchange Act Rule 0-13. This conclusion
reflects the same reasons, as well as the expectation that the
majority of such applications would be filed by foreign authorities.
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Based on feedback from industry participants about the security-
based swap markets, the Commission continues to believe that entities
that will qualify as SBS Entities exceed the thresholds defining
``small entities.'' Thus, the Commission believes that any SBS Entities
that may seek to rely on the proposed amendment to Rule 15Fb2-1
[[Page 24290]]
would not be ``small entities'' for purposes of the RFA.\599\
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\599\ See Registration Adopting Release, 80 FR at 49013.
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The Commission also continues to believe that any SBS Entities--
i.e., registered security-based swap dealers and registered major
security-based swap participants--with associated persons that may be
the subject of the proposed amendments to Rule of Practice 194 would
not be ``small entities'' for purposes of the RFA.\600\
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\600\ We previously have concluded, based on feedback from
market participants and the Commission's information regarding the
security-based swap market, that the types of entities that may have
security-based swap positions above the level required to register
as SBS Entities would not be ``small entities'' for purposes of the
RFA. See Cross-Border Adopting Release, 79 FR at 47368; see also
``Applications by Security-based Swap Dealers or Major Security-
Based Participants for Statutorily Disqualified Associated Persons
to Effect or Be Involved in Effecting Security-Based Swaps,'' 80 FR
51684 (Aug 25, 2015), at 51718, and Rule of Practice 194 Adopting
Release, 84 FR at 4944.
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The Commission further continues to believe that it is unlikely
that the requirements applicable to SBS Entities that would be
established under the proposed modifications to proposed Rule 18a-5
would have a significant economic impact on any small entity because no
SBS Entity will be a small entity.\601\
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\601\ See Recordkeeping and Reporting Proposing Release, 79 FR
at 25296.
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Accordingly, the Commission preliminarily believes that it is
unlikely that the proposed amendments regarding the security-based swap
dealer cross-border de minimis counting requirement and regarding
associated persons of SBS Entities would have a significant economic
impact on a substantial number of small entities.\602\
---------------------------------------------------------------------------
\602\ See also parts VI (Economic Analysis) and VII (Paperwork
Reduction Act) (discussing, among other things, the economic impact,
including the estimated compliance costs and burdens, of the
amendments).
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For the foregoing reasons, the Commission certifies that the
proposed amendments to Exchange Act Rules 3a71-3, 15Fb2-1, 0-13, and
Rule of Practice 194 and the proposed modifications to proposed Rule
18a-5 would not have a significant economic impact on a substantial
number of small entities for purposes of the RFA. The Commission
encourages written comments regarding this certification, and requests
that commenters describe the nature of any impact on small entities and
provide empirical data to illustrate the extent of the impact.
XI. Statutory Basis and Text of Proposed Rules
Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and
particularly Sections 3(a)(71), 3(b), 15F (as added by Section 764(a)
of the Dodd-Frank Act), 17(a), 23(a), and 30(c) thereof, and Section
761(b) of the Dodd-Frank Act, the Commission is proposing to amend Rule
of Practice 194 and Rules 0-13, 3a71-3, 15Fb2-1, and proposing to
modify proposed Rule 18a-5 under the Exchange Act.
List of Subjects
17 CFR Part 201
Administrative practice and procedure, Brokers, Claims,
Confidential business information, Equal access to justice, Lawyers,
Penalties, Securities.
17 CFR Part 240
Brokers, Confidential business information, 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 201--RULES OF PRACTICE
0
1. The general authority citation for Subpart D is revised to read as
follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77h-1, 77j, 77s, 77u,
77sss, 77ttt, 78(c)(b), 78d-1, 78d-2, 78l, 78m, 78n, 78o(d), 78o-3,
78o-10(b)(6), 78s, 78u-2, 78u-3, 78v, 78w, 80a-8, 80a-9, 80a-37,
80a-38, 80a-39, 80a-40, 80a-41, 80a-44, 80b-3, 80b-9, 80b-11, 80b-
12, 7202, 7215, and 7217.
* * * * *
0
2. Amend Sec. 201.194 by re-designating paragraph (c) as paragraph
(c)(1), adding a new heading to paragraph (c) and paragraph (c)(2) to
read as follows:
Sec. 201.194 Applications by Security-Based Swap Dealers or Major
Security-Based Swap Participants for Statutorily Disqualified
Associated Persons To Effect or Be Involved In Effecting Security-Based
Swaps.
* * * * *
(c) Exclusions. (1) * * *.
(2) Exclusion for Certain Associated Natural Persons. A security-
based swap dealer or major security-based swap participant shall be
excluded from the prohibition in Section 15F(b)(6) of the Exchange Act
(15 U.S.C. 78o-10(b)(6)) with respect to an associated person who is a
natural person who (i) is not a U.S. person (as defined in 17 CFR
240.3a71-3(a)(4)(i)(A)) and (ii) does not effect and is not involved in
effecting security-based swap transactions with or for counterparties
that are U.S. persons (as defined in 17 CFR 240.3a71-3(a)(4)), other
than a security-based swap transaction conducted through a foreign
branch (as that term is defined in 17 CFR 240.3a71-3(a)(3)) of a
counterparty that is a U.S. person; provided, however, that this
exclusion shall not be available if the associated person of that
security-based swap dealer or major security-based swap participant is
currently subject to any order described in subparagraphs (A) and (B)
of Section 3(a)(39) of the Exchange Act, with the limitation that an
order by a foreign financial regulatory authority described in
subparagraphs (B)(i) and (B)(iii) of Section 3(a)(39) (15 U.S.C.
78c(a)(39)(B)(i) and (B)(iii)) shall only apply to orders by a foreign
financial regulatory authority in the jurisdiction where the associated
person is employed or located.
* * * * *
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
3. The general authority citation for part 240 continues 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, 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. 1887 (2010); and secs. 503 and 602,
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
0
4. Amend Sec. 240.0-13 by revising the heading and paragraphs (a), (b)
and (e) to read as follows:
Sec. 240.0-13 Commission procedures for filing applications to
request a substituted compliance or listed jurisdiction order under the
Exchange Act.
(a) The application shall be in writing in the form of a letter,
must include any supporting documents necessary to make the application
complete, and otherwise must comply with Sec. 240.0-3. All
applications must be submitted to the Office of the Secretary of the
Commission, by a party that potentially would comply with requirements
under the Exchange Act pursuant to a substituted compliance or listed
jurisdiction order, or by the relevant foreign financial regulatory
authority or authorities. If an application is incomplete, the
Commission may request that the application be withdrawn unless the
applicant can justify, based on all the facts and circumstances, why
supporting materials have not been submitted and
[[Page 24291]]
undertakes to submit the omitted materials promptly.
(b) An applicant may submit a request electronically. The
electronic mailbox to use for these applications is described on the
Commission's website at www.sec.gov in the ``Exchange Act Substituted
Compliance and Listed Jurisdiction Applications'' section. In the event
electronic mailboxes are revised in the future, applicants can find the
appropriate mailbox by accessing the ``Electronic Mailboxes at the
Commission'' section.
* * * * *
(e) Every application (electronic or paper) must contain the name,
address, telephone number, and email address of each applicant and the
name, address, telephone number, and email address of a person to whom
any questions regarding the application should be directed. The
Commission will not consider hypothetical or anonymous requests for a
substituted compliance or listed jurisdiction order. Each applicant
shall provide the Commission with any supporting documentation it
believes necessary for the Commission to make such determination,
including information regarding applicable requirements established by
the foreign financial regulatory authority or authorities, as well as
the methods used by the foreign financial regulatory authority or
authorities to monitor and enforce compliance with such rules.
Applicants should also cite to and discuss applicable precedent.
* * * * *
0
5. Amend Sec. 240.3a71-3 by adding paragraphs (a)(10), (a)(11), and
(a)(12), amending paragraph (b)(1)(iii)(C), and adding paragraph (d) to
read as follows:
Sec. 240.3a71-3 Cross-border security-based swap dealing activity.
(a) * * *
(10) An entity is a majority-owned affiliate of another entity if
the entity directly or indirectly owns a majority interest in the
other, or if a third party directly or indirectly owns a majority
interest in both entities, where ``majority interest'' is the right to
vote or direct the vote of a majority of a class of voting securities
of an entity, the power to sell or direct the sale of a majority of a
class of voting securities of an entity, or the right to receive upon
dissolution, or the contribution of, a majority of the capital of a
partnership.
(11) Foreign associated person means a natural person domiciled
outside the United States who--with respect to a non-U.S. person
relying on the exception set forth in paragraph (d) of this section--is
a partner, officer, director, or branch manager of such non-U.S. person
(or any person occupying a similar status or performing similar
functions), any person directly or indirectly controlling, controlled
by, or under common control with such non-U.S. person, or any employee
of such non-U.S. person.
(12) Listed jurisdiction means any jurisdiction that the Commission
by order has designated as a listed jurisdiction for purposes of the
exception specified in paragraph (d) of this section.
(b) * * *
(1) * * *
(iii) * * *
(C) Except as provided in paragraph (d) of this section, or unless
such person is a person described in paragraph (a)(4)(iii) of this
section, security-based swap transactions connected with such person's
security-based swap dealing activity that are arranged, negotiated, or
executed by personnel of such non-U.S. person located in a U.S. branch
or office, or by personnel of an agent of such non-U.S. person located
in a U.S. branch or office; and
* * * * *
Alternative 1
(d) Exception from counting certain transactions. The counting
requirement described by paragraph (b)(1)(iii)(C) of this section will
not apply to the security-based swap dealing transactions of a non-U.S.
person if the conditions of paragraph (d)(1) of this section have been
satisfied.
(1) Conditions. (i) Entity conducting U.S. activity. All activity
that otherwise would cause a security-based swap transaction to be
described by paragraph (b)(1)(iii)(C) of this section--namely, all
arranging, negotiating or executing activity that is conducted by
personnel of the entity (or its agent) located in a branch or office in
the United States--is conducted by such U.S. personnel in their
capacity as persons associated with an entity that:
(A) Is registered with the Commission as a security-based swap
dealer; and
(B) Is a majority-owned affiliate of the non-U.S. person relying on
this exception.
(ii) Compliance with specified security-based swap dealer
requirements. (A) Compliance required. In connection with such
transactions, the registered entity described in paragraph (d)(1)(i) of
this section complies with the requirements described in paragraph
(d)(1)(ii)(B) of this section as if the counterparties to the non-U.S.
person relying on this exception also were counterparties to the
registered entity.
(B) Applicable requirements. The compliance obligation described in
paragraph (d)(1)(ii)(A) of this section applies to the following
provisions of the Act and the rules and regulations thereunder:
(1) Section 15F(h)(3)(B)(i), (ii) and rule 15Fh-3(b) thereunder,
including in connection with material incentives and conflicts of
interest associated with the non-U.S. person relying on the exception;
(2) Rule 15Fh-3(f);
(3) Section 15F(h)(3)(C) of the Act and rule 15Fh-3(g) thereunder;
(4) Rules 15Fi-1 and 15Fi-2; and
(5) Rule 15Fi-3, provided, however, that the registered entity
described in paragraph (d)(1)(i) of this section will not be required
to comply with rule 15Fi-3 in connection with the transaction following
the initial portfolio reconciliation of the security-based swap
resulting from the transaction.
(C) Other compliance requirements. The compliance obligation
described in paragraph (d)(1)(ii)(A) of this section does not apply to
the following provisions of the Act and the rules and regulations
thereunder:
(1) Section 15F(h)(3)(A) of the Act and rule 15Fh-3(a)(1)
thereunder;
(2) Section 15F(h)(3)(B)(iii) and rule 15Fh-3(c) thereunder; and
(3) Rule 15Fh-3(d);
(4) Rule 15Fh-3(e);
(5) Rule 15Fi-4; and
(6) Rule 15Fi-5.
(iii) Commission access to books, records and testimony. (A) The
non-U.S. person relying on this exception promptly provides
representatives of the Commission (upon request of the Commission or
its representatives or pursuant to a supervisory or enforcement
memorandum of understanding or other arrangement or agreement reached
between any foreign securities authority, including any foreign
government, as specified in section 3(a)(50) of the Act, and the
Commission or the U.S. Government) with any information or documents
within the non-U.S. person's possession, custody, or control, promptly
makes its foreign associated persons available for testimony, and
provides any assistance in taking the evidence of other persons,
wherever located, that the Commission or its representatives requests
and that relates to transactions subject to this exception, provided,
however, that if, after exercising its best efforts, the non-U.S.
person is prohibited by applicable foreign law or regulations from
providing such information, documents, testimony, or assistance, the
non-U.S.
[[Page 24292]]
person may continue to rely on this exception until the Commission
issues an order modifying or withdrawing an associated ``listed
jurisdiction'' determination pursuant to paragraph (d)(2)(iii) of this
section.
(B) The registered entity described in paragraph (d)(1)(i) of this
section:
(1) Creates and maintains books and records relating to the
transactions subject to this exception that are required, as
applicable, by rules 17a-3 and 17a-4, or by rules 18a-5 and 18a-6,
including any books and records requirements relating to the provisions
specified in paragraph (d)(1)(ii)(B) of this section;
(2) Obtains from the non-U.S. person relying on the exception, and
maintains, documentation encompassing all terms governing the trading
relationship between the non-U.S. person and its counterparty relating
to the transactions subject to this exception, including, without
limitation, terms addressing payment obligations, netting of payments,
events of default or other termination events, calculation and netting
of obligations upon termination, transfer of rights and obligations,
allocation of any applicable regulatory reporting obligations,
governing law, valuation, and dispute resolution; and
(3) Obtains from the non-U.S. person relying on this exception
written consent to service of process for any civil action brought by
or proceeding before the Commission, providing that process may be
served on the non-U.S. person by service on the registered entity in
the manner set forth in the registered entity's current Form SBSE,
SBSE-A or SBSE-BD, as applicable.
(iv) Disclosures. In connection with the transaction, the
registered entity described in paragraph (d)(1)(i) of this section
notifies the counterparties of the non-U.S. person relying on this
exception that the non-U.S. person is not registered with the
Commission as a security-based swap dealer, and that certain Exchange
Act provisions or rules addressing the regulation of security-based
swaps would not be applicable in connection with the transaction,
including provisions affording clearing rights to counterparties. Such
disclosure shall be provided contemporaneously with, and in the same
manner as, the arranging, negotiating, or executing activity at issue.
This disclosure will not be required if the identity of that
counterparty is not known to that registered entity at a reasonably
sufficient time prior to the execution of the transaction to permit
such disclosure.
(v) Subject to regulation of a listed jurisdiction. The non-U.S.
person relying on this exception is subject to the margin and capital
requirements of a listed jurisdiction when engaging in transactions
subject to this exception.
(2) Order for listed jurisdiction designation. The Commission by
order, may conditionally or unconditionally determine that a foreign
jurisdiction is a listed jurisdiction for purposes of this section. The
Commission may make listed jurisdiction determinations in response to
applications, or upon the Commission's own initiative.
(i) Applications. Applications for an order requesting listed
jurisdiction status may be made by a party or group of parties that
potentially would seek to rely on the exception provided by paragraph
(d) of this section, or by any foreign financial regulatory authority
or authorities supervising such a party or its security-based swap
activities. Applications must be filed pursuant to the procedures set
forth in Sec. 240.0-13.
(ii) Criteria considered. In considering a foreign jurisdiction's
potential status as a listed jurisdiction, the Commission may consider
factors relevant for purposes of assessing whether such an order would
be in the public interest, including:
(A) Applicable margin and capital requirements of the foreign
financial regulatory system; and
(B) The effectiveness of the supervisory compliance program
administered by, and the enforcement authority exercised by, the
foreign financial regulatory authority in connection with such
requirements, including the application of those requirements in
connection with an entity's cross-border business.
(iii) Withdrawal or modification of listed jurisdiction status. The
Commission may, on its own initiative, by order after notice and
opportunity for comment, modify or withdraw a jurisdiction's status as
a listed jurisdiction, if the Commission determines that continued
listed jurisdiction status no longer would be in the public interest,
based on:
(A) The criteria set forth in paragraph (d)(2)(ii) of this section;
(B) Any laws or regulations that have had the effect of preventing
the Commission or its representatives, on request, to promptly access
information or documents regarding the activities of persons relying on
the exception provided by this paragraph (d), to obtain the testimony
of foreign associated persons, and to obtain the assistance of persons
relying on this exception in taking the evidence of other persons,
wherever located, as described in paragraph (d)(1)(iii)(A) of this
section; and
(C) Any other factor the Commission determines to be relevant to
whether continued status as a listed jurisdiction would be in the
public interest.
Alternative 2
(d) Exception from counting certain transactions. The counting
requirement described by paragraph (b)(1)(iii)(C) of this section will
not apply to the security-based swap dealing transactions of a non-U.S.
person if the conditions of paragraph (d)(1) of this section have been
satisfied.
(1) Conditions. (i) Entity conducting U.S. activity. All activity
that otherwise would cause a security-based swap transaction to be
described by paragraph (b)(1)(iii)(C) of this section--namely, all
arranging, negotiating or executing activity that is conducted by
personnel of the entity (or its agent) located in a branch or office in
the United States--is conducted by such U.S. personnel in their
capacity as persons associated with an entity that:
(A) Is registered with the Commission as a broker or as a security-
based swap dealer; and
(B) Is a majority-owned affiliate of the non-U.S. person relying on
this exception.
(ii) Compliance with specified security-based swap dealer
requirements. (A) Compliance required. In connection with such
transactions, the registered entity described in paragraph (d)(1)(i) of
this section complies with the requirements described in paragraph
(d)(1)(ii)(B) of this section: (a) As if the counterparties to the non-
U.S. person relying on this exception also were counterparties to that
entity; and (b) as if that entity were registered with the Commission
as a security-based swap dealer, if it is not so registered.
(B) Applicable requirements. The compliance obligation described in
paragraph (d)(1)(ii)(A) of this section applies to the following
provisions of the Act and the rules and regulations thereunder:
(1) Section 15F(h)(3)(B)(i), (ii) and rule 15Fh-3(b) thereunder,
including in connection with material incentives and conflicts of
interest associated with the non-U.S. person relying on the exception;
(2) Rule 15Fh-3(f);
(3) Section 15F(h)(3)(C) of the Act and rule 15Fh-3(g) thereunder;
(4) Rules 15Fi-1 and 15Fi-2; and
(5) Rule 15Fi-3, provided, however, that the registered entity
described in paragraph (d)(1)(i) will not be required to comply with
rule 15Fi-3 in connection with the transaction following the initial
portfolio
[[Page 24293]]
reconciliation of the security-based swap resulting from the
transaction.
(C) Other compliance requirements. The compliance obligation
described in paragraph (d)(1)(ii)(A) of this section does not apply to
the following provisions of the Act and the rules and regulations
thereunder:
(1) Section 15F(h)(3)(A) of the Act and rule 15Fh-3(a)(1)
thereunder;
(2) Section 15F(h)(3)(B)(iii) and rule 15Fh-3(c) thereunder;
(3) Rule 15Fh-3(d);
(4) Rule 15Fh-3(e);
(5) Rule 15Fi-4; and
(6) Rule 15Fi-5.
(iii) Commission access to books, records and testimony. (A) The
non-U.S. person relying on this exception promptly provides
representatives of the Commission (upon request of the Commission or
its representatives or pursuant to a supervisory or enforcement
memorandum of understanding or other arrangement or agreement reached
between any foreign securities authority, including any foreign
government, as specified in section 3(a)(50) of the Act, and the
Commission or the U.S. Government) with any information or documents
within the non-U.S. person's possession, custody, or control, promptly
makes its foreign associated persons available for testimony, and
provides any assistance in taking the evidence of other persons,
wherever located, that the Commission or its representatives requests
and that relates to transactions subject to this exception, provided,
however, that if, after exercising its best efforts, the non-U.S.
person is prohibited by applicable foreign law or regulations from
providing such information, documents, testimony, or assistance, the
non-U.S. person may continue to rely on this exception until the
Commission issues an order modifying or withdrawing an associated
``listed jurisdiction'' determination pursuant to paragraph (d)(2)(iii)
of this section.
(B) The registered entity described in paragraph (d)(1)(i) of this
section:
(1) Creates and maintains books and records relating to the
transactions subject to this exception that are required, as
applicable, by rules 17a-3 and 17a-4, or by rules 18a-5 and 18a-6,
including any books and records requirements relating to the provisions
specified in paragraph (d)(1)(ii)(B) of this section;
(2) Obtains from the non-U.S. person relying on the exception, and
maintains, documentation encompassing all terms governing the trading
relationship between the non-U.S. person and its counterparty relating
to the transactions subject to this exception, including, without
limitation, terms addressing payment obligations, netting of payments,
events of default or other termination events, calculation and netting
of obligations upon termination, transfer of rights and obligations,
allocation of any applicable regulatory reporting obligations,
governing law, valuation, and dispute resolution; and
(3) Obtains from the non-U.S. person relying on this exception
written consent to service of process for any civil action brought by
or proceeding before the Commission, providing that process may be
served on the non-U.S. person by service on the registered entity in
the manner set forth in the registered entity's current Form BD, SBSE,
SBSE-A or SBSE-BD, as applicable.
(iv) Disclosures. In connection with the transaction, the
registered entity described in paragraph (d)(1)(i) of this section
notifies the counterparties of the non-U.S. person relying on this
exception that the non-U.S. person is not registered with the
Commission as a security-based swap dealer, and that certain Exchange
Act provisions or rules addressing the regulation of security-based
swaps would not be applicable in connection with the transaction,
including provisions affording clearing rights to counterparties. Such
disclosure shall be provided contemporaneously with, and in the same
manner as, the arranging, negotiating, or executing activity at issue.
This disclosure will not be required if the identity of that
counterparty is not known to that registered entity at a reasonably
sufficient time prior to the execution of the transaction to permit
such disclosure.
(v) Subject to regulation of a listed jurisdiction. The non-U.S.
person relying on this exception is subject to the margin and capital
requirements of a listed jurisdiction when engaging in the transactions
subject to this exception.
(2) Order for listed jurisdiction designation. The Commission by
order, may conditionally or unconditionally determine that a foreign
jurisdiction is a listed jurisdiction for purposes of this section. The
Commission may make listed jurisdiction determinations in response to
applications, or upon the Commission's own initiative.
(i) Applications. Applications for an order requesting listed
jurisdiction status may be made by a party or group of parties that
potentially would seek to rely on the exception provided by paragraph
(d) of this section, or by any foreign financial regulatory authority
or authorities supervising such a party or its security-based swap
activities. Applications must be filed pursuant to the procedures set
forth in Sec. 240.0-13.
(ii) Criteria considered. In considering a foreign jurisdiction's
potential status as a listed jurisdiction, the Commission may consider
factors relevant for purposes of assessing whether such an order would
be in the public interest, including:
(A) Applicable margin and capital requirements of the foreign
financial regulatory system; and
(B) The effectiveness of the supervisory compliance program
administered by, and the enforcement authority exercised by, the
foreign financial regulatory authority in connection with such
requirements, including the application of those requirements in
connection with an entity's cross-border business.
(iii) Withdrawal or modification of listed jurisdiction status. The
Commission may, on its own initiative, by order after notice and
opportunity for comment, modify or withdraw a jurisdiction's status as
a listed jurisdiction, if the Commission determines that continued
listed jurisdiction status no longer would be in the public interest,
based on:
(A) The criteria set forth in paragraph (d)(2)(ii) of this section;
(B) Any laws or regulations that have had the effect of preventing
the Commission or its representatives, on request, to promptly access
information or documents regarding the activities of persons relying on
the exception provided by this paragraph (d), to obtain the testimony
of their foreign associated persons, and to obtain the assistance of
persons relying on this exception in taking the evidence of other
persons, wherever located, as described in paragraph (d)(1)(iii)(A) of
this section; and
(C) Any other factor the Commission determines to be relevant to
whether continued status as a listed jurisdiction would be in the
public interest.
(4) Exception for person that engages in arranging, negotiating or
executing activity as agent. The registered entity described in
paragraph (d)(1)(i) of this section need not count, against the de
minimis thresholds described in Sec. 240.3a71-2(a)(1), the
transactions described by paragraph (d) of this section.
* * * * *
0
6. Amend Section 240.15Fb2-1 by revising paragraphs (d) and (e) to read
as follows:
The additions read as follows.
[[Page 24294]]
Sec. 240.15Fb2-1 Registration of security-based swap dealers and
major security-based swap participants.
* * * * *
(d) Conditional registration. (1) An applicant that has submitted a
complete Form SBSE-C (Sec. 249.1600c of this chapter) and a complete
Form SBSE (Sec. 249.1600 of this chapter) or Form SBSE-A (Sec.
249.1600a of this chapter) or Form SBSE-BD (Sec. 249.1600b of this
chapter), as applicable, in accordance with paragraph (b) within the
time periods set forth in Sec. 240.3a67-8 (if the person is a major
security-based swap participant) or Sec. 240.3a71-2(b) (if the person
is a security-based swap dealer), and has not withdrawn its
registration shall be conditionally registered.
(2) Notwithstanding paragraph (d)(1) of this section, an applicant
that is a nonresident security-based swap dealer or nonresident major
security-based swap participant (each as defined in Rule 15Fb2-4(a))
that is unable to provide the certification and opinion of counsel
required by Rule 15Fb2-4(c)(1) shall be conditionally registered, for
up to 24 months after the compliance date for Rule 15Fb2-1, if the
nonresident applicant submits a Form SBSE-C (Sec. 249.1600c of this
chapter) and a Form SBSE (Sec. 249.1600 of this chapter), SBSE-A
(Sec. 249.1600a of this chapter) or SBSE-BD (Sec. 249.1600b of this
chapter), as applicable, in accordance with paragraph (b) within the
time periods set forth in Rule 3a67-8 (if the person is a major
security-based swap participant) or Rule 3a71-2(b) (if the person is a
security-based swap dealer), that is complete in all respects but for
the failure to provide the certification and the opinion of counsel
required by Rule 15Fb2-4(c)(1), and has not withdrawn from
registration.
(e) Commission decision. (1) The Commission may deny or grant
ongoing registration to a security-based swap dealer or major security-
based swap participant based on a security-based swap dealer's or major
security-based swap participant's application, filed pursuant to
paragraph (a) of this section. The Commission will grant ongoing
registration if it finds that the requirements of Section 15F(b) of the
Securities Exchange Act of 1934 (15 U.S.C. 78o-10(b)) are satisfied.
The Commission may institute proceedings to determine whether ongoing
registration should be denied if it does not or cannot make such
finding or if the applicant is subject to a statutory disqualification
(as described in Sections 3(a)(39)(A) through (F) of the Securities
Exchange Act of 1934 (15 U.S.C. 78c(a)(39)(A)-(F)), or the Commission
is aware of inaccurate statements in the application. Such proceedings
shall include notice of the grounds for denial under consideration and
opportunity for hearing. At the conclusion of such proceedings, the
Commission shall grant or deny such registration.
(2) If an applicant that is a nonresident security-based swap
dealer or nonresident major security-based swap participant (each as
defined in Rule 15Fb2-4(a)) has become conditionally registered in
reliance on paragraph (d)(2) of this section and provides the
certification and opinion of counsel required by Rule 15Fb2-4(c)(1)
within 24 months of the compliance date for Rule 15Fb2-1, the applicant
will remain conditionally registered until the Commission acts to grant
or deny ongoing registration in accordance with (e)(1) of this section.
If such applicant fails to provide the certification and opinion of
counsel required by Rule 15Fb2-4(c)(1) within 24 months of the
compliance date for Rule 15Fb2-1, the Commission may institute
proceedings to determine whether ongoing registration should be denied,
in accordance with paragraph (e)(1) of this section.
0
7. Section 240.18a-5, as proposed to be added at 79 FR 25193, May 2,
2014, is further amended by adding paragraphs (a)(10)(iii) and
(b)(8)(iii) to read as follows:
Sec. 240.18a-5 Records to be made by certain security-based swap
dealers and major security-based swap participants.
* * * * *
(a) * * *
(10) * * *
(iii) Notwithstanding paragraph (a)(10)(i) of this section:
(A) A security-based swap dealer or major security-based swap
participant is not required to make and keep current a questionnaire or
application for employment executed by an associated person if the
security-based swap dealer or major security-based swap participant is
excluded from the prohibition in Section 15F(b)(6) of the Exchange Act
(15 U.S.C. 78o-10(b)(6)) with respect to such associated person; and
(B) a questionnaire or application for employment executed by an
associated person who is not a U.S. person (as that term is defined in
Sec. 240.3a71-3(a)(4)(i)(A)) need not include the information
described in paragraphs (a)(10)(i)(A) through (H) of this section if
the receipt of that information, or the creation or maintenance of
records reflecting that information, would result in a violation of
applicable law in the jurisdiction in which the associated person is
employed or located; provided, however, the security-based swap dealer
or major security-based swap participant must comply with Section
15F(b)(6) of the Exchange Act (15 U.S.C. 78o-10(b)(6)).
* * * * *
(b) * * *
(8) * * *
(iii) Notwithstanding paragraph (b)(8)(i) of this section;
(A) a security-based swap dealer or major security-based swap
participant is not required to make and keep current a questionnaire or
application for employment executed by an associated person if the
security-based swap dealer or major security-based swap participant is
excluded from the prohibition in Section 15F(b)(6) of the Exchange Act
(15 U.S.C. 78o-10(b)(6)) with respect to such associated person; and
(B) a questionnaire or application for employment executed by an
associated person who is not a U.S. person (as that term is defined in
Sec. 240.3a71-3(a)(4)(i)(A)) need not include the information
described in paragraphs (b)(8)(i)(A) through (H) of this section if the
receipt of that information, or the creation or maintenance of records
reflecting that information, would result in a violation of applicable
law in the jurisdiction in which the associated person is employed or
located; provided, however, the security-based swap dealer or major
security-based swap participant must comply with Section 15F(b)(6) of
the Exchange Act (15 U.S.C. 78o-10(b)(6)).
By the Commission.
Dated: May 10, 2019.
Vanessa A. Countryman,
Acting Secretary.
[FR Doc. 2019-10016 Filed 5-23-19; 8:45 am]
BILLING CODE 8011-01-P