Why and Whither Title VII?: Remarks before the 2018 ISDA Annual North America Conference

Remarks before the 2018 ISDA Annual North America Conference

Thank you, Scott, for that kind introduction.  It is an honor to be here at ISDA’s Annual North America Conference, at the beginning of what looks to be a stimulating day of speeches and panel discussions on a range of topics that are once again at the top of the agenda at the Securities and Exchange Commission.

Before I proceed any further, let me provide you with my required disclaimer: My remarks today reflect only my own views and not those of the Commission or my fellow Commissioners.  Now, those of you familiar with my work prior to joining the Commission may be wondering why this disclaimer is necessary in a speech about derivatives regulation.  My prior written work, I think it is fair to say, looks critically at Dodd-Frank in general and Congress’s Title VII mandates, in particular.  In prior writings, I pointed, for example, to the great Dodd-Frank prophet, Frederic Bastiat, who wrote:

In the economic sphere, an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.[1]

Why Me?  Why Title VII?

I was certainly a bit surprised, therefore, when, in the first few weeks of my tenure as a commissioner, Chairman Clayton asked me whether I would be willing to help him stand up the SEC’s Title VII regime, with an initial focus on the framework for the registration and regulation of security-based swap dealers and major security-based swap participants.  (For simplicity, I’ll refer just to “security-based swap dealers” in my remarks today.)  I will admit that implementing a regulatory framework that I had long criticized was certainly not at the top of my bucket list for my time at the Commission, even if I understood that it would occupy at least some of our energy over my tenure.  Issues like equity and fixed-income market structure, combating retail fraud, and facilitating innovation and capital formation are more interesting to ponder and—with the exception of those of you here this morning—are more invigorating for conference audiences.

Life has taught me, however, that we are often called to tasks that we do not anticipate. In fact, often it is those unanticipated calls that offer the greatest opportunity to make a difference.  The task of helping to lead the Commission’s effort on Title VII, I am convinced, is one such opportunity.  The CFTC has implemented most of its Title VII framework, and our fellow regulators around the world have made significant progress in standing up the reforms articulated in the 2009 Pittsburgh summit.[2]  The Commission, on the other hand, has lagged in implementing its own regulatory framework in accordance with our statutory mandate.  I agree with the Chairman that we need to move forward with these rules.  The Dodd-Frank Act, including Title VII, remains the law of the land, and Congress has directed us to implement reforms of the security-based swap market.  We have a responsibility to fulfill this obligation.  Moreover, continued delay creates market uncertainty, may permit firms to engage in risky behavior, and threatens to undermine the SEC’s ability to contribute meaningfully to the global regulatory dialogue in these markets.

At the same time, the slow progress of the Commission has created unique opportunities that made the Chairman’s invitation particularly attractive to me.  We have the fortune of which Bastiat spoke; because of the quicker efforts of other regulators, we are able to foresee some of the effects of our regime before putting it into place.  As you know, the CFTC and other regulators have implemented much of their respective regulatory regimes.[3]  The Commission and our staff have the chance to implement our rules in the light of their experiences while, I hope, avoiding some of their mistakes.  We thus have the opportunity to reflect on our proposed and perhaps our already-adopted rules to identify areas where we may be able to make changes that will make our regime more efficient and more effective.  We also have the opportunity to identify differences with the CFTC’s rules, and those in other jurisdictions, and to work toward reducing the likelihood of unnecessary friction, whether due to duplication of—or conflicts between—our rules.  In short, now is our chance to ensure that our rules under Title VII accomplish the objectives Congress laid out for us in a way that respects the important role that security-based swap markets play in our global financial system.

After considering the urgency of the task and the opportunity for the Commission to stand up a good regulatory regime in a responsible manner, I enthusiastically accepted the Chairman’s invitation.  Since then, Richard Gabbert in my office has been working closely with the Commission staff and the Chairman’s office to advance this agenda.  I have particularly enjoyed developing a close and effective working relationship with the Chairman, and I have welcomed the opportunity to engage on an ongoing basis with the staff, particularly the rulemaking teams in the Division of Trading and Markets.  The staff has responded with remarkable alacrity to the Chairman’s clear desire to start standing up the Title VII regime and has worked hard to engage creatively with the many thorny challenges as they arise on what has been an accelerated timetable. I am also grateful to my fellow Commissioners, who are strong advocates for getting our rules up and running, even though that means that they have to balance Title VII work with other Commission priorities.  It also has been a real pleasure to work with my colleagues over at the CFTC, including Chairman Giancarlo and my counterpart Brian Quintenz, looking for ways to harmonize our approaches where harmonization can produce significant benefits.

Where Are We Now?

I hope that you all will soon have the opportunity to see the fruits of the Commission’s work over the past nearly nine months, and, in a few moments, I would like to give you a sense as to where I hope that we are headed.  But first, let me provide a little bit of background as to where we stand today, as it may have been some time since many of you have given any thought to the regulation of security-based swaps. 

As you all know, the Dodd-Frank Act was enacted in July 2010, and Congress established an aggressive twelve-month deadline for completing the many rules that were required to implement the security-based swap market reforms mandated by the Act.  The Commission, which had many competing Dodd-Frank mandates, obviously did not meet that deadline.  We have adopted many of our security-based swap dealer rules and have finalized our security-based swap reporting rules.  Although these final rules are effective, the Commission has conditioned compliance on the finalization of three remaining security-based swap dealer rules: (1) rules establishing capital, margin, and segregation requirements for security-based swap dealers and major participants; (2) rules establishing recordkeeping and reporting requirements for these entities; and (3) Rule of Practice 194, which would establish a process that would allow a statutory disqualified associated person to effect or be involved in effecting security-based swaps on behalf of the registered entity.  Security-based swap dealers are not required to comply with these and other security-based swap dealer regulations until they are registered, which they are not yet required to be.[4] 

Under our current approach, the registration compliance date for dealers and major participants will be the later of the following three dates: (1) six months after the capital, margin, or segregation rules are published in the Federal Register; (2) the compliance date for the books and records requirement; or (3) the compliance date for Rule 194.[5]  Security-based swap data reporting will be required the later of one month after the security-based swap dealer registration compliance date or six months after a security-based swap data repository is registered with the Commission.[6]  The Commission has not yet proposed any mandatory clearing or trading determinations for any security-based swaps.

In light of where things stand now, the immediate task is to take the steps necessary to stand up our dealer regime.  I believe we need to finalize these three remaining rules expeditiously.  I also believe we need to make some adjustments in other areas, including, in some cases, rules that have already been finalized, to ensure that dealers are able to register and come into compliance with the relevant Title VII requirements in a way that avoids unnecessary market disruption.  In my view, once we have completed this work, we will need to turn to the task of getting transactions reported and disseminated to the public.

What Motivates the Work?

I will discuss my expectations for the next several months momentarily.  Before I do that, I thought it might be helpful to lay out for you a few core principles that are guiding my thinking as we move forward with what I hope will be both a rapid and thoughtful implementation of our Title VII rules.

First, our rules must effectively and efficiently advance the objectives of the Dodd-Frank Act.  Congress directed, among other things, that security-based swap dealers be subject to a comprehensive regulatory framework.  It is critical that the Commission fulfill that mandate and that it do so in a way that both effectively achieves the policy objectives of the statutory framework and avoids burdening the market in ways that are unnecessary to achieve those objectives.  In certain areas, I believe we may need to reconsider elements of our proposed or final requirements for the purpose of building a strong, solid, lasting regulatory framework.  For example, in my view, to the extent that our rules may interfere with the ability of our registrants to do business with firms regulated by other domestic or foreign authorities, or may otherwise increase the risk of geographic market fragmentation, we will need to engage in the hard work of exploring possible alternative approaches to implementing Congress’s mandate.

Second, unless there are extenuating circumstances, I believe that the Commission needs to articulate clear rules and provide its own guidance rather than relying on subsequent staff no-action letters or other staff-level guidance to make the regime workable.  I firmly believe that the Commission needs to grapple with hard questions, determine whether there is an appropriate policy response, and articulate that response through a transparent, Commission-level process.  Thus, although the Chairman and I hope to work with the staff to bring the remaining Title VII issues before the Commission quickly, I want to ensure that our process is also careful and deliberate, that we listen closely to market participants and other interested parties, and that we get things as close to right as possible the first time around.  I am also advocating that the Commission streamline its processes so that the Commission can respond more nimbly when implementation issues arise, as they will.

Third, I believe that we need to account for the challenges that market participants will face as they come into compliance with an entirely new, comprehensive, and extremely complicated regulatory regime.  For example, it is likely that dealer registration is going to pose significant operational challenges.  Dealers will be required to come into compliance with a number of new Title VII requirements, which may lead them to create new systems, establish new policies and procedures, and redirect human and capital resources.  Some dealers may choose to re-evaluate their business structures.  And so on.  Of even greater concern to me is that dealers’ counterparties are also going to have to contend with many of these challenges, even if they are not required to register as dealers under Title VII. 

I think there are a couple of ways we can mitigate these challenges.  One is to ensure that the compliance periods for our rules provide the market with adequate time to prepare for and then comply with these requirements.  Another is to work with the CFTC to minimize, where possible, differences between our rule sets that result in particularly significant additional burdens on market participants.  Both the Chairman and I have been in regular contact with our counterparts at the CFTC, and our staffs have been meeting routinely—many teams have scheduled weekly or bi-weekly calls—to identify specific issues where we can minimize these differences. 

Early results of this cooperation include the agencies’ newly executed memorandum of understanding[7] and the CFTC’s chief compliance officer rules adopted in August after consultation with SEC staff.[8]  As the CFTC noted in the release finalizing its CCO rules, “the CFTC and SEC have taken steps through ongoing communication and coordination to harmonize similar regulations, including the regulations addressed in this release.”[9]  You should be seeing more fruits of this cooperation over the coming months.  Note that I do not expect this work to produce much in the way of joint rulemaking.  Rather, as illustrated by the CFTC’s CCO rules, I think it is more likely that much of this work will lead to action by one or the other of our agencies, designed to reduce or eliminate differences in our rules, rather than joint action.

Fourth, and finally, I believe that we need to consider with care the effect of our regulations outside the United States.  The Commission has limited resources, and many of our fellow regulators have also implemented regulatory frameworks designed to advance the same policy goals.  Regulatory efficiency and international comity counsel strongly for careful tailoring of the contours of our regulatory oversight.  We share common goals and only an integrated, mutually respectful approach will enable us to achieve them.  Where possible, we should avoid duplicating regulatory and supervisory efforts and reduce the attendant risk of fragmenting the market along territorial lines.  As a practical matter, then, I believe that the Commission’s implementation of Title VII must allow for robust substituted compliance with broadly comparable foreign requirements.  I also hope that we can begin engaging with foreign authorities as soon as our relevant rules are finalized so that we can, where appropriate, make such determinations well before our registration compliance date.

What’s Next?

At this point you may be saying to yourselves, “This is all fine and good as a theoretical matter, but when will we start to see the Commission taking steps to implement this regime?”  Given past performance, that is a fair question.  As we tell investors, albeit usually not exactly in this context, past performance is not necessarily predictive of future performance. Let me assure you, first, that work in my office, in the Chairman’s office, in the other Commissioners’ offices, and among the staff in Trading and Markets, DERA, and other divisions and offices has been intense over the last several months. 

In terms of visible work product, my hope is that you will start seeing the Commission considering a variety of actions over the coming weeks and months.  You may have seen that the Commission noticed yesterday an open meeting for a week from today to consider whether to reopen the comment period and request additional comment (including potential modifications to proposed rule language) regarding capital, margin, and segregation requirements for security-based swap dealers and major security-based swap participants, including, among other things, the cross-border treatment of these requirements. 

You may ask why the Commission will be considering requesting additional comment.  Almost six years have passed since the rules were originally proposed.  During that time, the Commission has adopted a number of Title VII rules, and the prudential regulators and the CFTC have made further progress in implementing their Title VII requirements.  In light of these regulatory developments, changes in the markets, and comments the Commission has received on the proposal, the Commission intends to consider whether to provide an additional opportunity for public comment on the proposed rules.  Given the complexity of these issues and their centrality to the Title VII statutory framework, I am looking forward to the opportunity to consider the staff’s recommendation. 

Over the next several months, I hope the Commission will address other outstanding issues.  Of course, our dealer regime cannot be implemented until we finalize the three rules I mentioned earlier.  If the comment period for the capital, margin, and segregation rules is reopened, I hope that the Commission will move quickly to finalize those rules and books and records requirements after the comment period closes.  And I would like to see a recommendation for the finalizing of Rule 194 in the coming months as well.

In addition to these key rules, I am interested in finding solutions to other key issues that may present obstacles to an efficient transition to Title VII regulation, including the certification and opinion of counsel requirement adopted in the Registration Release, the associated person definition and background check requirements, and the ability of dealers to rely on representations made in connection with the CFTC external business conduct requirements.  I am also interested in exploring whether it may be appropriate to impose certain risk mitigation requirements on dealers and whether the Commission should consider possible alternative approaches to our so-called arrange-negotiate-and-execute—or, more melodiously, ANE—requirements to reduce the possibility of market fragmentation.

As you can imagine, managing these several projects simultaneously involves a herculean effort on the part of our staff in Trading and Markets and DERA in particular.  It has been a great pleasure to see the staff respond so enthusiastically to the Chairman’s desire to see the dealer regime stood up in the coming months.  Brett Redfearn, Carol McGee, and Ajay Sutaria have done yeoman’s work in coordinating efforts across the Division of Trading and Markets and with the CFTC, and serving as the focal point for communications between the Chairman’s office, my office, and the staff.  The additions of Lizzie Baird, as deputy director in the Division, and Mark Wolfe, as associate director of the Division’s Offices of Derivatives Policy and Trading Practices, will be very helpful as we proceed.  There are, of course, many others in Trading and Markets, DERA, and other offices and divisions that I do not have time to name here who are putting in long hours to move these projects along.  Seeing the staff’s dedication and the quality of their work has been, for me, the highlight thus far of the Title VII project. 

One issue that I touched on briefly above and that I would like to mention again because it causes me particular concern is whether our current compliance period is consistent with an orderly registration process both for the Commission and for market participants.  The Commission may have a series of determinations to make before firms decide whether to register.  Moreover, as I have already noted, market participants likely will need to execute myriad tasks in the months leading up to registration.  These concerns warrant, in my view, careful consideration by the Commission as to when we should expect firms to comply with our registration requirements and as to whether we should phase in compliance with particular elements of our dealer and/or data reporting rules over time rather than expecting full compliance immediately upon registration (or, in the case of data reporting, almost immediately after registration).  I would, of course, welcome your views on the challenges of implementation of both the dealer requirements and the data reporting requirements.

In a near-term effort to obtain input from outside the Commission, I hope to join Commissioner Quintenz in visits to market participants who will be affected by our rules.  Anyone who is interested in meeting with us should reach out to our offices.  In the longer term, I hope that we can hold a public roundtable at which we can discuss areas for future collaboration and harmonization between the CFTC and SEC. 

Thank you all for your attention this morning.  Title VII has been with a lot of us for nearly a decade.  I hope that a decade from now, we will look back to see that our current efforts have given our financial markets and the Main Street investors and businesses served by them a strong, effective, resilient regulatory framework for security-based swaps.  I am happy to take some questions.