Jan. 14, 2015
Good morning. This is an open meeting of the U.S. Securities and Exchange Commission on January 14, 2015, under the Government in the Sunshine Act.
Today, our agenda has three recommendations from the staff related to the reporting and public dissemination of security-based swap transaction data, a key component of the derivatives reform mandated by Title VII of the Dodd-Frank Act. We will discuss all three recommendations together and then will vote on each separately following the discussion. The first two recommendations are to adopt final rules and the third recommendation is a proposal for additional rules. These rules go to the core of derivatives reform by establishing a strong foundation for transparency and efficiency in the market. They provide a powerful framework for trade reporting and the public dissemination of information that addresses blind spots exposed by the financial crisis.
For decades, the over-the-counter derivatives market was unregulated and operated behind closed doors. Regulators lacked data regarding potential market abuses and significant, system-impacting risk exposures. Market participants lacked information about their counterparties and the prices at which others were trading. Without this transparency, both regulators and market participants were ill-prepared to deal with derivative exposures during the events that sparked the financial crisis, which even today continues to deeply affect our economy.
Responding to these events, Title VII of the Dodd-Frank Act created an entirely new regulatory framework for the derivatives market, assigning the Commission responsibility for security-based swaps. Fully implementing this framework is an important remaining mandate for the Commission under the Dodd-Frank Act — a mandate we need to execute well, but expeditiously and in careful coordination with the efforts of our fellow regulators here and abroad.
Transparency stands at the heart of this effort. Taken together, today´s rules will implement this central principle of Title VII by: first, setting the foundation for robust and well-governed security-based swap data repositories; and second, establishing the regime for reporting and publicly disseminating security-based swap transaction information. Once operational, the reporting and dissemination requirements of these rules will produce the detailed, comprehensive data for regulators and market participants that was missing before and during the financial crisis.
* * *
Regulation for security-based swap data repositories, or SDRs, is the first of today´s recommendations. The recommendation establishes a comprehensive regulatory framework for SDRs, which, as required by law, will act as centralized recordkeeping facilities for security-based swap data.
The staff´s recommendation will enable the Commission to oversee these critical facilities by establishing a comprehensive registration regime and requiring direct electronic access to their data by the Commission. It also addresses the core principles explicitly identified by Congress as essential for SDRs, including those that relate to an SDR´s governance arrangements. In line with our statutory mandate, the recommendation includes important requirements designed to promote strong compliance programs at SDRs and the independence, integrity, and effectiveness of their chief compliance officers.
SDRs will be critical to the security-based swap market infrastructure, just as exchanges and securities information processors are to the equity markets. Regulators will rely on SDRs for timely, accurate information to monitor concentrations of risk exposures and address potential market abuses. The last-sale information disseminated by SDRs will help facilitate price discovery. In addition, the operation of SDRs will have important consequences for market participants, who will, for example, need to represent and report data as specified by the SDRs.
The staff´s recommendation sets forth four basic, common-sense governance requirements for SDRs, all broadly supported by commenters and consistent with what the CFTC already requires today for repositories in the swap markets. Specifically, these provisions require the establishment of well-defined governance arrangements with effective internal controls; fair representation of market participants; the opportunity for representatives of market participants, including end users, to participate in the process for nominating and electing directors of the SDR; and the implementation of written policies and procedures reasonably designed to ensure that the SDRs´ senior leadership have the requisite skills and expertise to fulfill their responsibilities.
The staff´s recommendation also describes a sensible package of protections for the integrity and independence of the SDR´s compliance function, while avoiding requirements that would unduly burden the SDR´s operations. An important safeguard for ensuring the essential independence of the compliance function is the requirement that the board of each SDR approve the appointment, compensation, and removal of the chief compliance officer. The recommendation also prohibits SDR personnel from seeking to improperly influence the chief compliance officer in the performance of her duties. This provision is designed to help promote honest communications with the CCO and increase the accuracy of the information made available to the CCO for preparing the annual reports required by the statute.
The staff´s second recommendation today — to adopt a set of rules known as Regulation SBSR — focuses on delivering transparency through the reporting and public dissemination of the information collected by SDRs. Specifically, Regulation SBSR would require security-based swaps to be reported to an SDR within 24 hours after execution. Once at the SDR, this data will be directly accessible by Commission for use in its oversight of the security-based swap market. Regulation SBSR also generally requires SDRs to publicly disseminate a report of any transaction that it receives immediately upon receipt.
The recommendation establishes a robust and workable framework for implementing these important requirements. First, in light of the absence of current data on how transparency will impact market liquidity, Regulation SBSR begins with an interim phase where all security-based swap transactions are required to be reported within 24 hours. There is no carve-out for "block trades," those transactions for which delayed reporting may be required to avoid a negative impact on liquidity. During this interim phase, the Commission should have access to meaningful data about how different security-based swap trades of different sizes and with different reporting delays are, for example, affecting subsequent behavior and liquidity in the market. This data-driven approach — which I support here, as well as in other areas — will enable our economists and market experts to undertake an extensive review of the market following implementation of post-trade transparency. Based on this review, the Commission can then consider how to distinguish between block trades and other trades in a manner firmly rooted in data, and assign appropriate reporting timeframes.
The reporting and dissemination framework also has an appropriate scope, covering any transaction involving a U.S. person or registered dealer. It also covers the transactions they guarantee. This scope of coverage should ensure that the Commission and market participants have the comprehensive information they need about the security-based swap market. Also, it is important that Regulation SBSR requires the use of the global legal entity identifier system, an initiative broadly supported by regulators and industry, to support reporting and analysis across multiple SDRs. Without these legal identifiers, the Commission and its fellow regulators would face greater challenges in rapidly aggregating and understanding activities that could harm investors and pose risks to the financial system.
To achieve the transparency sought by Congress, the recommendation includes — as mandated by statute — transactions by unregistered participants in the swap markets. Our overall approach here is consistent with the CFTC´s treatment of unregistered swap participants in its rules. Some of these unregistered participants are "end users" — which for our jurisdiction are primarily unregistered financial funds, rather than the energy, agricultural, and industrial firms that use the interest rate and commodity swaps within CFTC jurisdiction. Importantly and correctly, Regulation SBSR places its reporting obligations on registered counterparties as much as possible, and thereby minimizes the reporting burdens on unregistered persons. And, while the recommendation requires some end users, along with other SDR participants, to obtain a "legal entity identifier" to increase transparency, the cost -- approximately $200 -- is quite minimal and, in my view, significantly outweighed by the regulatory and operational benefits of a single, widely used counterparty identifier. Another provision — in the recommendation for SDR governance — also takes into account the interests of end users, requiring the SDR to afford them the opportunity to participate in the nomination of directors.
The third and final recommendation before us today is a rule proposal that addresses certain areas where further public comment is invited, including, among other things, prohibiting the fees that SDRs charge users and the compliance schedule for SBSR. Establishing and operationalizing the security-based swap regulatory regime is an extensive undertaking that requires careful calibration of all of the aspects of our rules and further Commission work in a number of related areas.
One area for further development where I have directed the staff to prepare a recommendation for the Commission´s consideration is a detailed specification of acceptable formats and taxonomies under which SDRs make security-based swap data that they will collect accessible to the Commission. Such specifications, if adopted, should facilitate accurate aggregation and analysis of security-based swap data across SDRs for use by the Commission and market participants. I expect the staff recommendation to maximize the use of any applicable industry standards for the description of security-based swap data, and build upon such standards to accommodate additional data fields as may be required. The staff recommendation should be developed in a timeframe consistent with the implementation of the rules to be voted on today.
The staff is also working on a recommendation for rules to provide for access to SDR data by other regulators, including an exemption from the SDR indemnification requirement in the Dodd-Frank Act. A primary purpose of SDRs is obviously to provide regulators with information so that they can do their jobs, and the indemnification requirement has presented a significant obstacle. While the Commission has endeavored in the past to address this issue, I have asked staff to revisit it.
The staff is also considering whether requirements like those established by Regulation SCI should be applied to SDRs. Like the exchanges, clearing agencies, and processors covered by Regulation SCI, SDRs are part of the critical market infrastructure. While today´s recommendation includes a rule, consistent with the proposal, to ensure the security and integrity of the automated systems of SDRs, the staff will do further work to assess and, as appropriate, to adapt this rule to the protections promoted by the principles of Regulation SCI.
Finally, although the recommendation addressed the application of the regulatory reporting and public dissemination requirements to cross-border security-based swap activity, the staff is continuing to study whether and, if so, how the requirements should be applied to transactions involving non-U.S. persons when they engage in conduct within the United States.
* * *
Before I ask Steve Luparello, Director of the Division of Trading and Markets, to discuss the recommendations, I would like to thank Steve, his Deputy Director, Gary Goldsholle, and Steve´s counsels, Christian Sabella and Malou Huth for their leadership on these rulemakings. I would also like to thank Mark Flannery, Scott Bauguess, and Vanessa Countryman for their leadership of the effort by the Division of Economic and Risk Analysis.
I am deeply grateful to the core rulemaking teams for all of their hard work over many months. The long list that I will acknowledge now reflects the exceptional complexity and importance of these rulemakings.
From the SDR rulemaking team:
From the Regulation SBSR rulemaking team:
Many thanks also to Annie Small, Meridith Mitchell, Lori Price, Robert Teply, Cynthia Ginsberg, Deborah Flynn, Robert Bagnall, Maureen Johansen, William Shirey, Leila Bham, and Mykaila DeLesDernier from the Office of the General Counsel. They provided substantial and very thoughtful assistance over many months on all three recommendations before us today.
In addition, I would like to thank many other staff throughout the agency for their contributions to these releases, including Jeffrey Minton and Mark Jacoby from the Office of the Chief Accountant; Michael Sanoki and Michael Hershaft from the Office of Compliance Inspections and Examinations; Amy Starr, Paul Dudek, Andrew Schoeffler, and Mark Green from the Division of Corporation Finance; Eric Pan, Kathleen Hutchinson, and Babback Sabahi from the Office of International Affairs; Sara Crovitz, Michael Didiuk, and Rachel Loko from the Division of Investment Management; Reid Muoio, Charlotte Buford, Jill Henderson, and Kerry Knowles from the Division of Enforcement; and Gregg Berman, Tom Eady, Brian Bussey, Carol McGee, Jeffrey Mooney, Stephanie Park, Elizabeth Fitzgerald, Richard Gabbert, Joshua Kans and Andrew Shanbrom from the Division of Trading and Markets.
Finally, I would like to express gratitude to my fellow Commissioners and all of our counsels for their engagement and comments on these recommendations.