Washington, D.C., May 1, 2013 — The Securities and Exchange Commission today voted unanimously to propose rules and interpretive guidance for parties to cross-border security-based swap transactions.
The proposal explains which regulatory requirements apply when a transaction occurs partially within and partially outside the U.S. The proposed rules also set forth when security-based swap dealers, major security-based swap participants, and other entities — such as clearing agencies, execution facilities, and data repositories — must register with the SEC.
The proposal outlines a "substituted compliance" framework in order to facilitate a well-functioning global security-based swap market. It is an approach that recognizes that market participants may be subject to conflicting or duplicative compliance obligations in the global derivatives market.
"We should take a robust and workable approach to this particularly complex and predominantly global market," said Mary Jo White, SEC Chair. "The global nature of this market means that participants may be subject to requirements in multiple countries, and this type of overlapping regulatory oversight could lead to conflicting or costly duplicative regulatory requirements. Market participants need to know which rules to follow, and I believe that this proposal will serve as the road map."
The comment period for the proposed rules and interpretive guidance for cross-border security-based swap activities will occur for 90 days after they are published in the Federal Register.
Separately, the Commission voted unanimously to reopen the public comment period for all rules not yet finalized, stemming from Title VII of the Dodd-Frank Act. The comment periods for these rules — and a policy statement describing the expected order for these new rules to take effect — will be reopened for 60 days after notice is published in the Federal Register.
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The Dodd-Frank Act — In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. Title VII of this Act established a comprehensive framework for regulating the over-the-counter derivatives market.
Under Title VII, the SEC has regulatory authority over a type of derivative known as security-based swaps, as well as certain intermediaries and major players in that market, known as security-based swap dealers and major security-based swap participants. The agency also has authority over certain entities that perform infrastructure functions within the security-based swap market, such as clearing agencies, execution facilities, and data repositories.
Security-Based Swaps — In general, a derivative is a financial instrument or contract, such as a swap, whose value is "derived" from an underlying asset such as a commodity, bond, or equity security. Derivatives provide a way to transfer risk related to the underlying assets between two counterparties. They are flexible products that can be designed to achieve almost any financial purpose.
A security-based swap is a swap tied to a single security, loan, or issuer of securities, a narrow-based security index, or the occurrence of certain events relating to an issuer of securities or the issuers of securities in a narrow-based security index.
The Security-Based Swap Market — The market in security-based swaps involves counterparties located in different countries whose activities frequently span the globe. Indeed, according to data analyzed by SEC staff, the majority of single-name U.S. reference security-based swap transactions by market participants involve one or more counterparties located abroad. In addition, some swaps may be negotiated and executed by persons located in two different countries and then booked in yet other countries.
Implementing Title VII in a Global Market — Regulating this market is challenging because of the global nature and the interconnectedness of this market. These characteristics mean that a market participant located in a foreign country can create concerns within the U.S. of the type addressed by the Dodd-Frank Act. To address these concerns, the U.S. and many other countries are at various stages in the implementation of their own derivatives regulatory reform efforts.
Once the major derivatives jurisdictions adopt regulations, market participants could be subject to multiple and overlapping regulatory regimes, potentially resulting in regulatory conflicts and duplications. This, in turn, could adversely affect liquidity and efficiency in the global security-based swap market.
An SEC webpage — http://www.sec.gov/swaps-chart/swaps-chart.shtml — depicts the regulatory regime for security-based swaps and details what happens as a transaction occurs.
In light of these market realities, the proposal includes rules and interpretive guidance that, among other things, would inform parties to a security-based swap transaction which regulatory requirements apply when their transaction occurs in part within and in part outside the U.S.
The proposal generally would subject security-based swap transactions to the requirements of Title VII if they are entered into with a U.S. person or otherwise conducted within the U.S. However, under the proposal, a party may have the ability to instead comply with SEC requirements by complying with some or all of the requirements of a foreign regulatory regime, provided that those requirements have been determined by the Commission to achieve comparable regulatory outcomes.
In addition, the proposal would provide interpretive guidance regarding when a particular market infrastructure is required to register with the SEC.
The proposed rules and interpretive guidance reflect a territorial approach to application of Title VII requirements to security-based swap transactions.
Under this approach, Title VII requirements generally would apply:
or…
Under the proposed approach, Title VII requirements generally would apply to transactions involving a person in the U.S. engaged in counterparty-facing activity, regardless of whether the transaction is booked in a U.S.-based or a foreign-based booking entity.
If Title VII requirements apply, market participants, under certain circumstances, may comply with foreign regulatory requirements in substitution for Title VII requirements. The proposal calls this approach "substituted compliance."
Under this proposal, a market participant or group of market
participants could request a substituted compliance determination with
respect to a particular category or categories of foreign regulatory
requirements. Any determination to grant substituted compliance
generally would be available to all market participants in the
particular foreign jurisdiction.
The proposal and interpretive guidance would address, among other things:
Conducting the De Minimis Calculation — In 2012, the SEC and the CFTC jointly adopted rules indicating that a security-based swap dealer would be required to register with the Commission if its notional amount of dealing transactions conducted in the past 12 months exceeded a de minimis level.
This proposal would require foreign dealers, in determining whether they have exceeded this de minimis amount, generally to count only dealing activity:
However, a non-U.S. person would not be required to include in this calculation its security-based swap dealing transactions with foreign branches of U.S. banks. By contrast, the proposal would require U.S. persons to count all of their security-based swap transactions toward the de minimis threshold.
Guaranteed Non-U.S. Dealer Affiliates — Under the proposal, a non-U.S. person that receives a guarantee from a U.S. person on its performance on security-based swaps would not be required to count its dealing transactions with non-U.S. persons outside the United States toward its de minimis threshold.
Aggregating Transactions Involving Dealing Activity of Affiliates — In 2012, the SEC and the CFTC jointly adopted a rule providing that persons engaged in dealing activity would be required to aggregate certain security-based swap dealing transactions of their commonly controlled affiliates. This proposal would clarify that a person may exclude the dealing transactions of any commonly controlled affiliate that is registered with the Commission as a security-based swap dealer from its de minimis calculation, so long as the person´s security-based swap activities are operationally independent from those of its registered security-based swap dealer affiliate.
The proposal separates the requirements of a security-based swap dealer into two categories:
Under the proposal, registered foreign security-based swap dealers would be required to comply with:
Security-based swap dealers that are U.S. persons would be required to comply with all Title VII requirements, but U.S. banks that conduct security-based swap activity out of a foreign branch would not be required to comply with external business conduct requirements with respect to their foreign business. (The application of non-dealer-specific requirements to activity out of a foreign branch is addressed below.)
The proposal would define U.S. business:
The proposal would define foreign business for any security-based swap dealer to be any transactions that are not defined as U.S. business for that dealer.
Conducting the Threshold Calculations — In 2012, the SEC and the CFTC jointly adopted rules indicating that a major security-based swap participant would be required to register with the SEC if its security-based swap positions exceed a defined substantial position or substantial counterparty exposure threshold.
The proposal would require that, when determining whether a person falls within the major security-based swap participant definition, a U.S. person consider all security-based swap transactions that it has entered into. A non-U.S. person, on the other hand, would consider only transactions that it has entered into with U.S. persons, including foreign branches of U.S. banks.
Attribution of Guaranteed Positions — A guarantee on a security-based swap allows a counterparty to demand that the person providing the guarantee perform the obligations of the guaranteed entity under the security-based swap. In 2012, the SEC and the CFTC jointly adopted interpretive guidance generally requiring persons to include in their calculations of the major security-based swap threshold any positions resulting from transactions that they guarantee.
The proposal provides interpretive guidance that certain security-based swaps guaranteed by U.S. persons and non-U.S. persons would be attributed for purposes of the major security-based swap participant threshold to the person providing that guarantee.
Under the proposed approach, guaranteed positions would be attributed as follows:
Under the proposed approach, however, a guarantor would not be required to attribute to itself any guaranteed positions entered into by a non-U.S. person that is subject to Basel capital standards.
As with security-based swap dealers, Title VII subjects registered major security-based swap participants to both entity-level and transaction-level requirements. Under the proposed approach, foreign major security-based swap participants would be required to comply with the entity-level requirements.
The proposed approach would not require foreign major security-based swap participants to comply with the transaction-level requirements that are specific to major security-based swap requirements in their transactions with counterparties that are non-U.S. persons.
The proposal generally would require security-based swap transactions to be reported to a data repository if any of the following are counterparties to the transaction:
In addition, the proposal also generally would require compliance with public dissemination, clearing, and trade execution requirements for security-based swap transactions when:
However, under the proposed approach, these transaction-level requirements generally would not apply to transactions conducted outside the U.S. between:
Under Title VII, the new regulatory regime would include a number of market infrastructures, such as security-based swap clearing agencies, execution facilities, and data repositories.
The proposal would provide a rule and interpretive guidance regarding when entities that perform these infrastructure functions would be required to register with the Commission. The proposed guidance generally would take a territorial approach to registration, requiring each entity to determine whether it performs the relevant infrastructure function within the U.S.
The focus of this analysis for each type of entity would include, among other things, the following:
The proposal also provides interpretive guidance regarding availability of exemptions for non-resident infrastructure entities when, among other things, they are subject to comparable regulation in their home countries.
Under Title VII, any government agency — foreign or domestic — that seeks information from a security-based swap data repository must first provide the data repository with an indemnification agreement. The agreement would ensure that, if sued, the data repository could be reimbursed by the requesting government agency for any expenses arising from litigation relating to the information.
The proposal would enable the data repository to waive the indemnification requirement if:
The comment period for the proposed rules and interpretive guidance will last for 90 days after their publication in the Federal Register.