Finishing the Work of Regulating Security-Based Derivatives

Commissioner Luis A. Aguilar

Sept. 15, 2015

About seven years ago, our country suffered a financial crisis that resulted in devastating economic damage.[1] A close look at what happened made clear that one of the major contributing factors to the crisis was the role of the unregulated derivatives market.[2] In response to the regulatory deficiencies exposed during the financial crisis, Congress passed, among other things, Title VII of the Dodd-Frank Act,[3] which requires the SEC and the CFTC[4] to establish a framework for regulating the over-the-counter swaps market.[5] In particular, the Commission became responsible, per the Dodd-Frank Act, for coming up with rules to regulate the security-based swap (“SBS”) market, which comprises approximately $14 trillion in SBS notional value.[6]

Today, five years removed from the passage of the Dodd-Frank Act in July 2010, the presumptive regulatory regime for the SBS market is still a work-in-progress. Simply stated, as currently structured—and since many of the main Title VII rules are intertwined—the regulatory regime for the SBS market can only go into effect when the Commission has adopted all of the necessary rules to implement the main components of Title VII.[7]

Due to Chair White’s efforts, the Commission has now proposed all of the Title VII rules, and adopted a number of these rules, including several complex SBS rules.[8] Notwithstanding these efforts, many rules remain to be adopted, and the Commission has had to grant several exemptions and exceptions over the years so as to prevent rules from becoming effective until the Commission has adopted all of the necessary rules to finalize the Title VII regulatory framework.[9]

Today, the Commission is again compelled to issue another exemption and exception affecting SBS intermediaries—the tenth over the last four years—because it has not yet adopted all of the necessary rules to implement the main components of Title VII dealing with SBS intermediaries.[10] Specifically, the Commission is needing to extend a temporary exemption for SBS dealers and major SBS participants (i.e., certain large players in the SBS market) from the segregation and margin provisions under the Securities Exchange Act of 1934 (the “Exchange Act”).[11] In addition, the Commission is extending a separate temporary exception from rules that would prohibit SBS dealers or major participants from allowing certain disqualified persons to effect SBS transactions on their behalf.[12] These temporary extensions are tied to the compliance date of registration rules for SBS dealers and major participants, as well as other essential Title VII rules.[13] Accordingly, these temporary extensions are necessary to prevent, among other things, unwarranted market disruptions caused by regulatory uncertainty (e.g., where the applicability and operation of certain final SBS rules are contingent or dependent on certain proposed rules that have yet to be adopted and finalized).[14]

While these extensions are unavoidable in the short term, I am hopeful that, under Chair White’s leadership, the Commission will move quickly to adopt all of the remaining Title VII rules.[15] Congress mandated these rules to inject transparency into the derivatives market, promote accountability, and prevent future crises, and it is important for the Commission to fulfill this mandate.



[1] Better Markets, Inc., The Cost of the Crisis: $20 trillion and counting (July 2015), available at http://www.bettermarkets.com/sites/default/files/Better%20Markets%20-%20Cost%20of%20the%20Crisis.pdf.

[2] See, e.g., Report of the Senate Committee on Banking, Housing, and Urban Affairs, The Restoring American Financial Stability Act of 2010, S. Rep. No. 111-176 at 29 (2010) (“Many factors led to the unraveling of this country’s financial sector and the government intervention to correct it, but a major contributor to the financial crisis was the unregulated over-the-counter (‘OTC’) derivatives market.”), available at http://www.gpo.gov/fdsys/pkg/CRPT-111srpt176/pdf/CRPT-111srpt176.pdf.

[3] Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Pub. L. 111-203, § 410 (2010).

[4] United States Commodity Futures Trading Commission (CFTC).

[5] See Section 712(a) of the Dodd-Frank Act.

[6] See, Bank for International Settlements, Statistical release: OTC derivatives statistics at end-December 2014, at 15 (Table 1) (Apr. 2015), available at http://www.bis.org/publ/otc_hy1504.pdf. The SBS market was estimated to be about $14 trillion worldwide. See id. (According to data published by the Bank for International Settlements, the global notional amounts outstanding in equity forwards and swaps and single-name credit default swaps as of December 2014 were approximately $2.50 trillion and $9 trillion, respectively. This analysis assumes that all equity forwards and swaps and single-name credit default swaps are SBS, and single-name credit default swaps constitute approximately 80% of the SBS market.)

[7] The main components of Title VII consists of four main clusters of rules—intermediary rules, clearing rules, trading rules, and reporting rules—that have been proposed and need to be adopted. See, e.g., 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. 75612 (Aug. 5, 2015), available at http://www.sec.gov/rules/proposed/2015/34-75612.pdf; Ownership Limitations and Governance Requirements for Security-Based Swap Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges with Respect to Security-Based Swaps under Regulation MC, Exchange Act Release No. 63107 (Oct. 14, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63107.pdf; Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 64766 (June 29, 2011), available at http://www.sec.gov/rules/proposed/2011/34-64766.pdf; 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. 68071 (Oct. 18, 2012), available at http://www.sec.gov/rules/proposed/2012/34-68071.pdf; 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), available at http://www.sec.gov/rules/proposed/2013/34-69490.pdf; End-User Exception to Mandatory Clearing of Security-Based Swaps, Exchange Act Release No. 63556 (Dec. 15, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63556.pdf; 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), available at http://www.sec.gov/rules/proposed/2014/34-71958.pdf; Registration and Regulation of Security-Based Swap Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011), available at http://www.sec.gov/rules/proposed/2011/34-63825.pdf; Prohibition Against Fraud, Manipulation, and Deception in Connection with Security-Based Swaps, Exchange Act Release No. 63236 (Nov. 3, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63236.pdf; Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Exchange Act Release No. 74245 (Feb. 11, 2015), available at http://www.sec.gov/rules/proposed/2015/34-74245.pdf; Trade Acknowledgment and Verification of Security-Based Swap Transactions, Exchange Act Release No. 63727 (Jan. 14, 2011), available at http://www.sec.gov/rules/proposed/2011/34-63727.pdf; see also Commissioner Luis A. Aguilar, Establishing a Registration Framework for Dealers and Major Participants in the Derivatives Market (Aug. 5, 2015), available at http://www.sec.gov/news/statement/establishing-a-registration-framework-for-dealers.html; Commissioner Luis A. Aguilar, Regulating Key Players in Security-Based Swaps (Oct. 12, 2011), available at https://www.sec.gov/news/speech/2011/spch101211laa-sbs.htm.

[8] The following is a non-exhaustive list of the SBS rules that have been proposed or adopted since the passage of the Dodd-Frank Act. See, e.g., Registration Process for Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-75611 (Aug. 5, 2015), available at http://www.sec.gov/rules/final/2015/34-75611.pdf; 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. 75612 (Aug. 5, 2015), available at http://www.sec.gov/rules/proposed/2015/34-75612.pdf; 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), available at http://www.sec.gov/rules/final/2012/34-66868.pdf; Section 15F of the Exchange Act; Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing and Notice Filing Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory Organizations, Exchange Act Release No. 67286 (June 28, 2012), available at http://www.sec.gov/rules/final/2012/34-67286.pdf; Clearing Agency Standards, Exchange Act Release No. 68080 (Oct. 22, 2012), available at http://www.sec.gov/rules/final/2012/34-68080.pdf; Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities, Exchange Act Release No. 72472, at 3 (June 25, 2014), available at http://www.sec.gov/rules/final/2014/34-72472.pdf; Security-Based Swap Data Repository Registration, Duties, and Core Principles, Exchange Act Release No. 74246 (Feb. 11, 2015), available at http://www.sec.gov/rules/final/2015/34-74246.pdf; Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Exchange Act Release No. 74244 (Feb. 11, 2015), available at http://www.sec.gov/rules/final/2015/34-74244.pdf; Ownership Limitations and Governance Requirements for Security-Based Swap Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges with Respect to Security-Based Swaps under Regulation MC, Exchange Act Release No. 63107 (Oct. 14, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63107.pdf; End-User Exception to Mandatory Clearing of Security-Based Swaps, Exchange Act Release No. 63556 (Dec. 15, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63556.pdf; 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), available at http://www.sec.gov/rules/proposed/2014/34-71958.pdf; Registration and Regulation of Security-Based Swap Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011), available at http://www.sec.gov/rules/proposed/2011/34-63825.pdf; Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 64766 (June 29, 2011), available at http://www.sec.gov/rules/proposed/2011/34-64766.pdf; 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. 68071 (Oct. 18, 2012), available at http://www.sec.gov/rules/proposed/2012/34-68071.pdf; 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), available at http://www.sec.gov/rules/proposed/2013/34-69490.pdf; Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Exchange Act Release No. 74245 (Feb. 11, 2015), available at http://www.sec.gov/rules/proposed/2015/34-74245.pdf; Trade Acknowledgment and Verification of Security-Based Swap Transactions, Exchange Act Release No. 63727 (Jan. 14, 2011), available at http://www.sec.gov/rules/proposed/2011/34-63727.pdf.

[9] See, e.g., Order Granting Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment, Exchange Act Release No. 71485 (Feb. 5, 2014), available at http://www.sec.gov/rules/exorders/2014/34-71485.pdf; Order Granting Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, Exchange Act Release No. 68864 (Feb. 7, 2013), available at http://www.sec.gov/rules/exorders/2013/34-68864.pdf; Order Extending Temporary Conditional Exemption in Connection With the Effectiveness of the Definition of Eligible Contract Participant, Exchange Act Release No. 67480 (Jul. 20, 2012), available at http://www.sec.gov/rules/other/2012/34-67480.pdf; Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Exchange Act Release No. 67453 (Jul. 18, 2012), available at http://www.sec.gov/rules/final/2012/33-9338.pdf; Order Granting Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Pending Revision of the Definition of “Security” to Encompass Security-Based Swaps, Exchange Act Release No. 64795 (July 1, 2011) available at http://www.sec.gov/rules/exorders/2011/34-64795.pdf; Order Pursuant to Section 17A of the Securities Exchange Act of 1934 Granting Exemption from the Clearing Agency Registration Requirement under Section 17A(b) of the Exchange Act for ICE Clear Europe Limited in Connection With its Proposal to Clear Contracts Traded on the LIFFE Administration and Management Market, Exchange Act Release No. 69872 (June 27, 2013), available at http://www.sec.gov/rules/exorders/2013/34-69872.pdf; Order Granting Conditional Exemptions under the Securities Exchange Act of 1934 in Connection with Portfolio Margining of Swaps and Security-Based Swaps, Exchange Act Release No. 68433 (Dec. 14, 2012), available at http://www.sec.gov/rules/exorders/2012/34-68433.pdf; Order Pursuant to Section 36 of the Securities Exchange Act of 1934 Granting Temporary Exemptions from Clearing Agency Registration Requirements under Section 17A(b) of the Exchange Act for Entities Providing Certain Clearing Services for Security-Based Swaps, Exchange Act Release No. 64796 (Jul. 1, 2011), available at http://www.sec.gov/rules/exorders/2011/34-64796.pdf; 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), available at http://www.sec.gov/rules/exorders/2011/34-64678.pdf.

[10] See Order Pursuant to Sections 15F(b)(6) and 36 of the Securities Exchange Act of 1934 Extending Certain Temporary Exemptions and a Temporary and Limited Exception Related to Security-Based Swaps, Release No. 34-75919 (Sept. 15, 2015), available at http://www.sec.gov/rules/exorders/2015/34-75919.pdf (hereinafter “SBS Temporary Extensions Order”); Order Extending Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment, Exchange Act Release No. 71485 (Feb. 5, 2014), available at http://www.sec.gov/rules/exorders/2014/34-71485.pdf; Order Extending Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment, Exchange Act Release No. 68864 (Feb. 7, 2013), available at http://www.sec.gov/rules/exorders/2013/34-68864.pdf; Order Extending Temporary Conditional Exemption in Connection With the Effectiveness of the Definition of Eligible Contract Participant, Exchange Act Release No. 67480 (Jul. 20, 2012), available at http://www.sec.gov/rules/other/2012/34-67480.pdf; Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Exchange Act Release No. 67453 (Jul. 18, 2012), available at http://www.sec.gov/rules/final/2012/33-9338.pdf; Order Granting Temporary Exemptions under the Securities Exchange Act of 1934 in Connection with the Pending Revision of the Definition of “Security” to Encompass Security-Based Swaps, and Request for Comment, Exchange Act Release No. 64795 (July 1, 2011) available at http://www.sec.gov/rules/exorders/2011/34-64795.pdf; Order Pursuant to Section 17A of the Securities Exchange Act of 1934 Granting Exemption from the Clearing Agency Registration Requirement under Section 17A(b) of the Exchange Act for ICE Clear Europe Limited in Connection With its Proposal to Clear Contracts Traded on the LIFFE Administration and Management Market, Exchange Act Release No. 69872 (June 27, 2013), available at http://www.sec.gov/rules/exorders/2013/34-69872.pdf; Order Granting Conditional Exemptions under the Securities Exchange Act of 1934 in Connection with Portfolio Margining of Swaps and Security-Based Swaps, Exchange Act Release No. 68433 (Dec. 14, 2012), available at http://www.sec.gov/rules/exorders/2012/34-68433.pdf; Order Pursuant to Section 36 of the Securities Exchange Act of 1934 Granting Temporary Exemptions from Clearing Agency Registration Requirements under Section 17A(b) of the Exchange Act for Entities Providing Certain Clearing Services for Security-Based Swaps, Exchange Act Release No. 64796 (Jul. 1, 2011), available at http://www.sec.gov/rules/exorders/2011/34-64796.pdf; 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), available at http://www.sec.gov/rules/exorders/2011/34-64678.pdf.

[11] See SBS Temporary Extensions Order. Exchange Act Section 3E(f) requires SBS dealers and major participants to segregate initial margin amounts delivered by their counterparties in uncleared SBS transactions, if requested to do so by such counterparties. See SBS Temporary Extensions Order. A temporary exemption would allow persons to register as an SBS dealer or major participant before they spend the resources to comply with the provisions of Section 3E(f). See SBS Temporary Extensions Order. This would also give SBS dealers and major participants additional time to establish the necessary accounts and adopt the policies and procedures required by the statute. See SBS Temporary Extensions Order.

[12] See SBS Temporary Extensions Order. Exchange Act Section 15F(b)(6) provides that, except as provided by the Commission, it will be unlawful for an SBS dealer or major participant to permit an associated person who is subject to a statutory disqualification to effect or be involved in effecting SBS transactions on its behalf. See SBS Temporary Extensions Order.

[13] See SBS Temporary Extensions Order. In addition, the Commission is specifying when the related exemption for Exchange Act Section 29(b) will expire with respect to SBS contracts involving violations of Sections 3E(f) or 15F(b)(6). See SBS Temporary Extensions Order. Like Section 15F(b)(6), Exchange Act Section 29(b) prohibits contracts made in violation of the Act. See SBS Temporary Extensions Order.

[14] See SBS Temporary Extensions Order.

[15] See, e.g., Ownership Limitations and Governance Requirements for Security-Based Swap Clearing Agencies, Security-Based Swap Execution Facilities, and National Securities Exchanges with Respect to Security-Based Swaps under Regulation MC, Exchange Act Release No. 63107 (Oct. 14, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63107.pdf; End-User Exception to Mandatory Clearing of Security-Based Swaps, Exchange Act Release No. 63556 (Dec. 15, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63556.pdf; Registration and Regulation of Security-Based Swap Execution Facilities, Exchange Act Release No. 63825 (Feb. 2, 2011), available at http://www.sec.gov/rules/proposed/2011/34-63825.pdf; Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 64766 (June 29, 2011), available at http://www.sec.gov/rules/proposed/2011/34-64766.pdf; Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 65543 (Oct. 12, 2011), available at http://www.sec.gov/rules/proposed/2011/34-65543.pdf; 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. 68071 (Oct. 18, 2012), available at http://www.sec.gov/rules/proposed/2012/34-68071.pdf; 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), available at http://www.sec.gov/rules/proposed/2013/34-69490.pdf; Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Exchange Act Release No. 74245 (Feb. 11, 2015), available at http://www.sec.gov/rules/proposed/2015/34-74245.pdf; 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. 75612 (Aug. 5, 2015), available at http://www.sec.gov/rules/proposed/2015/34-75612.pdf.