Statement at an Open Meeting on Final Rules Regarding the Application of Business Conduct Rules to Security-Based Swap Dealers and Major Security-Based Swap Participants

Chair Mary Jo White

April 13, 2016

Good Morning.  This is an open meeting of the U.S. Securities and Exchange Commission on April 13, 2016, under the Government in the Sunshine Act.

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The Commission will consider today a staff recommendation to adopt final rules implementing a comprehensive set of business conduct requirements under Title VII of the Dodd-Frank Act for security-based swap dealers and major security-based swap participants ("security-based swap entities").  These rules, if adopted, will be another significant step in standing up the regulatory framework for the security-based swaps markets.

For years, the over-the-counter derivatives market operated without basic customer protections.  As the securities-based swap market grew, customers bought complex derivatives instruments that were created and marketed by sophisticated financial services firms operating in multiple capacities within the context of a single transaction.  Today's rules represent fundamental reforms to the conduct of security-based swap activity by these market intermediaries that are designed to address the specific issues presented by the nature of the products and relationships in the security-based swap market.

Dealers are central figures in the security-based swap markets, and they provide a range of services to a broad customer base that includes municipalities, pension plans, endowments and similar entities.  Dealers offer liquidity by entering into transactions with customers on a principal basis.  They can facilitate those transactions through their relationships with central counterparties, providing customers with access to central clearing.  And as experts in financial services, they often provide customers with guidance concerning product options and transaction structures to help customers achieve their business objectives.

These services are vital to the functioning of a healthy security-based swap market, but they can also create incentives and conflicts of interest that, without proper regulation and oversight, can pose unchecked risks to other market participants.  Today's rules seek to facilitate the important services provided by security-based swap entities, while at the same time establishing a robust set of rules to promote the integrity of the security-based swap market for the benefit of all market participants.

A Workable Approach

In crafting these rules, we have been mindful that the security-based swap market is an established market with existing structures, relationships, and conventions that have evolved over time and in response to a range of commercial and regulatory parameters.  For example, CFTC-registered swap dealers and major swap participants, many of which likely will also be SEC-registered entities, are already complying with business conduct obligations for swaps under rules that the CFTC has adopted.  The Commission staff has worked closely with the staff of the CFTC throughout the rulemaking process, and today's recommendations are designed to be broadly consistent with the CFTC's regulatory framework to the extent practicable.

At the same time, the Commission and self-regulatory organizations have a long history of regulating the business conduct of broker-dealers, some of which will also be security-based swap dealers.  This expertise was also drawn upon in formulating these new obligations. 

The rules we are considering reflect a robust and workable approach to regulation in the context in which they are expected to operate, and are sensitive to avoiding disruption to security-based swap entities or the larger market.

Robust Supervisory Structures and Compliance Programs

Today's rules establish a variety of business conduct requirements that will be applicable to security-based swap entities at the entity level.  All security-based swap entities, for example, would be required to establish and maintain comprehensive supervisory structures for the oversight of their security-based swap business and personnel.  This supervisory structure would require, among other things, the designation of qualified personnel responsible for performing supervisory functions and the establishment of detailed policies and procedures designed to promote compliance with the federal securities laws by the entity and its personnel.  The rules would also require the designation of a chief compliance officer with a range of responsibilities for administering the compliance program and for preparing annual compliance reports that must be filed with the Commission.

Promoting Transparency and Informed Decision-Making

Today's rules are designed to address issues that arise as a result of the complex products and relationships that characterize the security-based swap market and take into consideration the position that sophisticated financial service firms occupy within this market relative to their customers.  Under the rules, these firms would become subject to specific obligations any time they transact in a principal capacity – requirements intended to protect counterparties by providing certain minimum standards of conduct designed to inform the counterparty of relevant information concerning the transaction. 

Among other things, these rules would require security-based swap entities to communicate in a fair and balanced manner with their counterparties and inform them of material information concerning the security-based swap to enable the counterparty to assess the material risks and characteristics of the relevant product.  In addition, security-based swap entities would be obligated to disclose material conflicts of interest and incentives to counterparties prior to entering into the transactions.  And they would be required to disclose daily pricing information and other information concerning the availability of clearing for specified transactions. 

When transacting in a principal capacity with certain entities (called "special entities"), such as municipalities, pension plans, and endowments, dealers also would be required to disclose in writing the capacity in which the dealer is acting in connection with the transaction.  This is an important enhanced disclosure requirement for such entities that recognizes that dealers often provide a range of services to these counterparties that may pose conflicts of interest and could cause confusion to counterparties when entering into a security-based swap transaction.

Professional Standards of Conduct and Heightened Duties

Security-based swap entities also would be required to adhere to professional standards of conduct beyond communications and disclosure requirements.  Significantly, when making a recommendation to any counterparty, these rules would require dealers to have a reasonable basis to believe that their recommendation is suitable.  To fulfill this obligation, the dealer would be required to obtain relevant information concerning the counterparty, including its investment profile, trading objectives and ability to absorb potential losses associated with the recommended product.

The requirements of today's rules also reflect the distinct statutory protections afforded to special entities.  When acting as an advisor to such entities, a dealer would be required to act in the entities' best interests.  And to transact on a principal basis with these entities, security-based swap entities would be required to have a reasonable basis to believe that such entity is appropriately represented by a qualified and independent representative in the transaction.  This requirement is a key protection to help ensure that the representatives of such entities, among other things, will act in the best interests of the special entity, have sufficient knowledge to evaluate the transaction on behalf of the entity, and are not subject to a statutory disqualification that calls into question the representatives' integrity.

The rules being considered today also would address their cross-border application and the potential availability of substituted compliance. 

It is a high priority for the Commission to finish all of its Title VII rulemakings, as all of us have stated publicly, so that this market will function transparently, fairly and under appropriate regulatory oversight.  And I expect the Commission will next turn its attention to the remaining rules required to stand up the security-based swap entity regulatory framework, rules related to capital, margin and segregation, recordkeeping, and statutory disqualification.

Before I ask Steve Luparello, Director of the Division of Trading and Markets, to discuss the proposed rules, I would like to thank Steve and his Deputy Directors, Gary Barnett and Goldsholle, for their leadership in this rulemaking, as well as Steve's counsels, Malou Huth, Carl Emigholz and Moshe Rothman.  I also would like to commend the rulemaking team for their hard and very thoughtful work:  Heather Seidel, Lourdes Gonzalez, Joanne Rutkowski, Lindsay Kidwell, Cindy Oh, Stacy Puente, and Devin Ryan from the Office of Chief Counsel; Brian Bussey, Carol McGee, Richard Gabbert, Margaret Rubin, and Joshua Kans from the Office of Derivatives Policy; Michelle Danis and Lourdes Toro from the Office of Broker-Dealer Finance and Mark Flannery, Jennifer Marietta-Westberg, Vanessa Countryman, Adam Yonce and Diana Knyazeva from the Division of Economic and Risk Analysis.

Many thanks as well to Lori Price, Robert Teply, Cynthia Ginsberg, Maureen Johansen, and Jill Felker from the Office of General Counsel.  As usual they have provided invaluable input for this final rule.

In addition, I would like to thank other staff throughout the agency for their contributions, including Paul Dudek, Amy Starr and Andrew Schoeffler from the Division of Corporation Finance; Sara Crovitz, Michael Didiuk and Rachel Loko from the Division of Investment Management; Carrie O'Brien and Elizabeth Pflaum from the Office of Compliance Inspections and Examinations; Michael Osnato, Reid Muoio and Charlotte Buford from the Division of Enforcement; and Katherine Martin and Laura Compton from the Office of International Affairs. 

Finally, I would like to express my gratitude to my fellow Commissioners and their counsel for their hard work and dedication to completing the Commission's Title VII rules.

Now I will turn to Steve to discuss the recommendation.