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Proposed Rule

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

Action

Proposed Rules; Proposed Interpretations.

Summary

The Securities and Exchange Commission (“SEC” or “Commission”) is publishing for public comment proposed rules and interpretive guidance to address the application of the provisions of the Securities Exchange Act of 1934, as amended (“Exchange Act”), that were added by Subtitle B of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), to cross-border security-based swap activities. Our proposed rules and interpretive guidance address the application of Subtitle B of Title VII of the Dodd-Frank Act with respect to each of the major registration categories covered by Title VII relating to market intermediaries, participants, and infrastructures for security-based swaps, and certain transaction-related requirements under Title VII in connection with reporting and dissemination, clearing, and trade execution for security-based swaps. In this connection, we are re-proposing Regulation SBSR and certain rules and forms relating to the registration of security-based swap dealers and major security-based swap participants. The proposal also contains a proposed rule providing an exception from the aggregation requirement, in the context of the security-based swap dealer definition, for affiliated groups with a registered security-based swap dealer. Moreover, the proposal addresses the sharing of information and preservation of confidentiality with respect to data collected and maintained by SDRs. In addition, the Commission is proposing rules and interpretive guidance addressing the policy and procedural framework under which the Commission would consider permitting compliance with comparable regulatory requirements in a foreign jurisdiction to substitute for compliance with requirements of the Exchange Act, and the rules and regulations thereunder, relating to security-based swaps (i.e.,“substituted compliance”). Finally, the Commission is setting forth our view of the scope of our authority, with respect to enforcement proceedings, under Section 929P of the Dodd-Frank Act.

Unified Agenda

Regulation of Cross-Border Security-Based Swap Activities

3 actions from May 23rd, 2013 to March 2014

  • May 23rd, 2013
  • May 23rd, 2013
    • NPRM Comment Period End
  • March 2014
    • Final Action
 

Table of Contents Back to Top

Tables Back to Top

DATES: Back to Top

Submit comments on or before August 21, 2013.

ADDRESSES: Back to Top

Comments may be submitted by any of the following methods:

Electronic Comments

  • Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
  • Send an email to rule-comments@sec.gov. Please include File Number S7-02-13, and File Numbers S7-34-10 (Regulation SBSR) and/or S7-40-11 (registration of security-based swap dealers and major security-based swap participants), as applicable, on the subject line; or
  • Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

  • Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-02-13, and File Numbers S7-34-10 (Regulation SBSR) and/or S7-40-11 (registration of security-based swap dealers and major security-based swap participants), as applicable. This file number should be included on the subject line if email is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments also are available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Back to Top

Matthew A. Daigler, Senior Special Counsel, at 202-551-5578, Wenchi Hu, Senior Special Counsel, at 202-551-6268, Richard E. Grant, Special Counsel, at 202-551-5914, or Richard Gabbert, Special Counsel, at 202-551-7814, Office of Derivatives Policy, Division of Trading and Markets, regarding security-based swap dealers and major security-based swap participants; Jeffrey Mooney, Assistant Director, Matthew Landon, Senior Special Counsel, or Stephanie Park, Special Counsel, Office of Clearance and Settlement, Division of Trading and Markets, at 202-551-5710, regarding security-based swap clearing agencies, security-based swap data repositories, and the security-based swap clearing requirement; David Michehl, Senior Counsel, Office of Market Supervision, Division of Trading and Markets, at 202-551-5627, regarding security-based swap reporting; Leah Mesfin, Special Counsel, at 202-551-5655, or Michael P. Bradley, Special Counsel, at 202-551-5594, Office of Market Supervision, Division of Trading and Markets, regarding the trade execution requirement and swap execution facilities; Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: Back to Top

The Commission is proposing new rules and interpretive guidance under the Exchange Act relating to the application of Subtitle B of Title VII of the Dodd-Frank Act to cross-border activities and re-proposing Regulation SBSR and certain rules and forms relating to the registration of security-based swap dealers and major security-based swap participants.

The Commission is proposing the following rules under the Exchange Act: Rule 0-13 (Substituted Compliance Request Procedure); Rule 3a67-10 (Foreign Major Security-Based Swap Participants); Rule 3a71-3 (Cross-Border Security-Based Swap Dealing Activity); Rule 3a71-4 (Exception from Aggregation for Affiliated Groups with Registered Security-Based Swap Dealers); Rule 3a71-5 (Substituted Compliance for Foreign Security-Based Swap Dealers); Rule 3Ca-3 (Application of the Mandatory Clearing Requirement to Cross-Border Security-Based Swap Transactions); Rule 3Ch-1 (Application of the Mandatory Trade Execution Requirement to Cross-Border Security-Based Swap Transactions); Rule 3Ch-2 (Substituted Compliance for Mandatory Trade Execution); Rule 13n-4(d) (Exemption from the Indemnification Requirement); Rule 13n-12 (Exemption from Requirements Governing Security-Based Swap Data Repositories for Certain Non-U.S. Persons); Rule 18a-4(e) (Segregation Requirements for Foreign Security-Based Swap Dealers); and Rule 18a-4(f) (Segregation Requirements for Foreign Major Security-Based Swap Participants). The Commission also is re-proposing the following rules and forms: 17 CFR 242.900-242.911 (Regulation SBSR) (RIN 3235-AK80) and 17 CFR 249.1600 (Form SBSE), 249.1600a (Form SBSE-A), and 249.1600b (Form SBSE-BD) (RIN 3235-AL05).

Table of Contents Back to Top

I. Background

A. The Dodd-Frank Wall Street Reform and Consumer Protection Act

B. Overview of the Cross-Border Proposal

C. Consultation and Coordination

D. Substituted Compliance

E. Conclusion

II. Overview of the Security-Based Swap Market and the Legal and Policy Principles Guiding the Commission's Approach to the Application of Title VII to Cross-Border Activities

A. Overview of the Security-Based Swap Market

1. Global Nature of the Security-Based Swap Market

2. Dealing Structures

(a) U.S. Bank Dealer

(b) U.S. Non-Bank Dealer

(c) Foreign Subsidiary Guaranteed by a U.S. Person

(d) Foreign-Based Dealer

i. Direct Dealing

ii. Intermediation in the United States

3. Clearing Practices

4. Reporting Practices

5. Trade Execution Practices

6. Broad Economic Considerations of Cross-Border Security-Based Swaps

(a) Major Economic Considerations

(b) Global Nature and Interconnectedness of the Security-Based Swap Market

(c) Central Clearing

(d) Security-Based Swap Data Reporting

B. Scope of Title VII's Application to Cross-Border Security-Based Swap Activity

1. Commenters' Views

2. Scope of Application of Title VII in the Cross-Border Context

(a) Overview and General Approach

(b) Territorial Approach to Application of Title VII Security-Based Swap Dealer Registration Requirements

(c) Application of Other Title VII Requirements to Registered Entities

(d) Application of Title VII Regulatory Requirements to Transactions of Foreign Entities Receiving Guarantees From U.S. Persons

(e) Regulations Necessary or Appropriate To Prevent Evasion of Title VII

C. Principles Guiding Proposed Approach to Applying Title VII in the Cross-Border Context

D. Conclusion

III. Security-Based Swap Dealers

A. Introduction

B. Registration Requirement

1. Introduction

2. Background Discussion Regarding the Registration of Foreign Brokers and Dealers

3. Comment Summary

(a) Market Participants

(b) Foreign Regulators

4. Application of the De Minimis Exception to Cross-Border Security-Based Swap Dealing Activity

(a) Meaning of the Term “Person” in the Security-Based Swap Dealer Definition

(b) Proposed Rule

5. Proposed Definition of “U.S. Person”

(a) Introduction

(b) Discussion

i. Natural Persons

ii. Corporations, Organizations, Trusts, and Other Legal Persons

iii. Accounts of U.S. Persons

iv. International Organizations

(c) Conclusion

6. Proposed Definition of “Transaction Conducted Within the United States”

7. Proposed Treatment of Transactions With Foreign Branches of U.S. Banks

8. Proposed Rule Regarding Aggregation of Affiliate Positions

9. Treatment of Inter-Affiliate and Guaranteed Transactions

10. Comparison With Definition of “U.S. Person” in Regulation S

C. Regulation of Security-Based Swap Dealers in Title VII

1. Introduction

2. Comment Summary

3. Title VII Requirements Applicable to Security-Based Swap Dealers

(a) Transaction-Level Requirements

i. External Business Conduct Standards

ii. Segregation of Assets

(b) Entity-Level Requirements

i. Capital

ii. Margin

iii. Risk Management

iv. Recordkeeping and Reporting

v. Internal System and Controls

vi. Diligent Supervision

vii. Conflicts of Interest

viii. Chief Compliance Officer

ix. Inspection and Examination

x. Licensing Requirements and Statutory Disqualification

4. Application of Certain Transaction-Level Requirements

(a) Proposed Rule

(b) Discussion

i. External Business Conduct Standards

a. Foreign Security-Based Swap Dealers

b. U.S. Security-Based Swap Dealers

ii. Segregation Requirements

a. Foreign Security-Based Swap Dealers

b. Non-Cleared Security-Based Swaps

c. Cleared Security-Based Swaps

d. Disclosure

5. Application of Entity-Level Rules

(a) Introduction

(b) Proposed Approach

D. Intermediation

1. Introduction

2. Comment Summary

3. Discussion

E. Registration Application Re-Proposal

1. Introduction

2. Discussion

IV. Major Security-Based Swap Participants

A. Introduction

B. Comment Summary

C. Proposed Approach

1. In General

2. Guarantees

(a) Guarantees Provided by U.S. Persons to Non-U.S. Persons

(b) Guarantees Provided by Non-U.S. Persons to U.S. Persons and Guarantees Provided by Non-U.S. Persons to Non-U.S. Persons

(c) Limited Circumstances Where Attribution of Guaranteed Security-Based Swap Positions Does Not Apply

(d) Operational Compliance

3. Foreign Public Sector Financial Institutions (FPSFIs)

D. Title VII Requirements Applicable to Major Security-Based Swap Participants

1. Transaction-Level Requirements Related to Customer Protection

(a) Overview

(b) Proposed Rules

2. Entity-Level Requirements

3. Substituted Compliance

V. Security-Based Swap Clearing Agencies

A. Introduction

B. Proposed Title VII Approach

1. Clearing Agency Registration

(a) Clearing Agencies Acting as CCPs

(b) Proposed Interpretive Guidance

2. Exemption From Registration Under Section 17A(k)

3. Application of Alternative Standards to Certain Registrants

VI. Security-Based Swap Data Repositories

A. Introduction

B. Application of the SDR Requirements in the Cross-Border Context

1. Introduction

2. Comment Summary

3. Proposed Approach

(a) U.S. Persons Performing SDR Functions Are Required To Register With the Commission

(b) Interpretive Guidance and Exemption for Non-U.S. Persons That Perform the Functions of an SDR Within the United States

C. Relevant Authorities' Access to Security-Based Swap Information and the Indemnification Requirement

1. Information Sharing Under Sections 21 and 24 of the Exchange Act

2. Comment Summary

3. Proposed Guidance and Exemptive Relief

(a) Notification Requirement

(b) Determination of Appropriate Regulators

(c) Option for Exemptive Relief From the Indemnification Requirement

i. Impact of the Indemnification Requirement

ii. Proposed Rule 13n-4(d): Indemnification Exemption

VII. Security-Based Swap Execution Facilities

A. Introduction

B. Registration of Foreign Security-Based Swap Markets

C. Registration Exemption for Foreign Security-Based Swap Markets

VIII. Regulation SBSR—Regulatory Reporting and Public Dissemination of Security-Based Swap Information

A. Background

B. Modifications to the Definition of “U.S. Person”

C. Additional Modifications to Scope of Regulation SBSR

1. Revisions to Proposed Rule 908(a)

2. Revisions to Proposed Rule 908(b)

D. Modifications to “Reporting Party” Rules and Assigning Duty To Report

E. Other Technical and Conforming Changes

F. Cross-Border Inter-Affiliate Transactions

G. Foreign Privacy Laws versus Duty To Report Counterparty ID

H. Foreign Public Sector Financial Institutions

I. Summary and Additional Request for Comment

IX. Mandatory Security-Based Swap Clearing Requirement

A. Introduction

B. Summary of Comments

C. Application of Title VII Mandatory Clearing Requirements to Cross-Border Transactions

1. Statutory Framework

2. Proposed Rule

3. Discussion

(a) Security-Based Swap Transactions Involving U.S. Persons or Non-U.S. Persons Receiving Guarantees From U.S. Persons

i. Proposed Rule

ii. Proposed Exception for Certain Transactions Involving Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons

(b) Transactions Conducted Within the United States

i. Proposed Rule

ii. Proposed Exception for Transactions Conducted Within the United States by Certain Non-U.S. Persons

X. Mandatory Security-Based Swap Trade Execution Requirement

A. Introduction

B. Application of the Mandatory Trade Execution Requirement to Cross-Border Transactions

1. Statutory Framework

2. Proposed Rule

3. Discussion

(a) Security-Based Swap Transactions Involving U.S. Persons or Non-U.S. Persons Receiving Guarantees From U.S. Persons

i. Proposed Rule

ii. Proposed Exception for Certain Transactions Involving Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons

(b) Transactions Conducted Within the United States

i. Proposed Rule

ii. Proposed Exception for Transactions Conducted Within the United States by Certain Non-U.S. Persons

XI. Substituted Compliance

A. Introduction

B. Process for Making Substituted Compliance Requests

C. Security-Based Swap Dealer Requirements

1. Proposed Rule—Commission Substituted Compliance Determinations

2. Discussion

D. Regulatory Reporting and Public Dissemination

1. General

2. Security-Based Swaps Eligible and Not Eligible for Substituted Compliance

3. Requests for Substituted Compliance

4. Findings Necessary for Substituted Compliance

5. Modification or Withdrawal of Substituted Compliance Order

6. Regulatory Reporting and Public Dissemination Considered Together in the Commission's Analysis of Substituted Compliance

E. Clearing Requirement

F. Trade Execution Requirement

XII. Antifraud Authority

XIII. General Request for Comment

A. General Comments

B. Consistency With CFTC's Cross-Border Approach

XIV. Paperwork Reduction Act

A. Introduction

B. Re-Proposal of Form SBSE, Form SBSE-A, and Form SBSE-BD

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

(a) Paperwork Burden Associated With Filing Application Forms

(b) Paperwork Burden Associated With Amending Schedule F

(c) Paperwork Burden Associated With Amending Application Forms

5. Request for Comment on Paperwork Burden Estimates

C. Disclosures by Certain Foreign Security-Based Swap Dealers and Major Security-Based Swap Participants

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting Burdens

5. Request for Comment on Paperwork Burden Estimates

D. Reliance on Counterparty Representations Regarding Activity Within the United States

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

5. Request for Comment on Paperwork Burden Estimates

E. Requests for Cross-Border Substituted Compliance Determinations

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

(a) Proposed Rule 3a71-5

(b) Re-Proposed Rule 242.908(c)(2)(ii) of Regulation SBSR

(c) Proposed Rule 3Ch-2(c)

F. Reporting and Dissemination of Security-Based Swap Information

1. Background on the Re-Proposed Rules

2. Modifications to “Reporting Party” Rules

(a) Summary of Collection of Information

(b) Proposed Use of Information

(c) Respondents

(d) Total Initial and Annual Reporting and Recordkeeping Burdens

i. Baseline Burdens

ii. Re-Proposed Burdens

iii. Summary of Re-Proposed Burdens

iv. Recordkeeping Requirements

(e) Collection of Information Is Mandatory

(f) Confidentiality

3. Rules 902, 905, 906, 907, and 909

(a) Rule 902

(b) Rule 905

(c) Rule 906

(d) Rule 907

(e) Rule 909

i. Impact of Re-Proposed Rules 902, 905, 906, 907, and 909 on the Commission's PRA Analysis

4. Rules 900, 903, 908, 910, and 911

(a) Modification of the Definition of “U.S. Person”

(b) Rule 903

(c) Re-Proposed Rules 908(a) and 908(b)

(d) Rule 910

(e) Rule 911

G. Request for Comments by the Commission and Director of OMB

XV. Economic Analysis

A. Introduction

B. Economic Baseline

1. Overview

2. Current Security-Based Swap Market

(a) Security-Based Swap Market Participants

(b) Levels of Security-Based Swap Trading Activity

(c) Market Participant Domiciles

(d) Level of Current Cross-Border Activity in Single-Name CDS

(e) Levels of Security-Based Swap Clearing

C. Analysis of Potential Effects on Efficiency, Competition, and Capital Formation

1. Introduction

2. Competition

(a) Security-Based Swap Dealers

(b) Security-Based Swap Market Infrastructure Requirements

i. Registration of Clearing Agencies, SDRs and SB SEFs

ii. Application of Mandatory Clearing, Public Dissemination, Regulatory Reporting, and Trade Execution Requirements in the Cross-Border Context

3. Efficiency

4. Capital Formation

D. Economic Analysis of Proposed Rules Regarding “Security-Based Swap Dealers” and “Major Security-Based Swap Participants”

1. Programmatic Costs and Benefits

(a) Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants

(b) Security-Based Swap Dealers—De Minimis Exception

(c) Major Security-Based Swap Participants—“Substantial Position” and “Substantial Counterparty Exposure” Thresholds

2. Assessment Costs

(a) Security-Based Swap Dealers—De Minimis Exception

(b) Major Security-Based Swap Participants—“Substantial Position” and “Substantial Counterparty Exposure” Thresholds

3. Alternatives Considered

(a) De Minimis Exception

i. Alternatives to the Proposed Definition of U.S. Person

ii. Alternatives to the Proposed Rule Regarding Application of the De Minimis Exception

a. Calculation of U.S. Persons' Transactions for De Minimis Exception

b. Calculation of Non-U.S. Persons' Transactions for De Minimis Exception (Including Transactions Conducted Within the United States)

iii. Aggregation of Affiliate Dealing Activity

(b) Major Security-Based Swap Participants

E. Economic Analysis of the Proposed Application of the Entity-Level and Transaction-Level Requirements to Security-Based Swap Dealers and Major Security-Based Swap Participants

1. Entity-Level Requirements

2. Transaction-Level Requirements

(a) Proposed Rule 3a71-3(c)—Application of Customer Protection Requirements

i. Programmatic Benefits and Costs

ii. Assessment Costs

iii. Alternatives

(b) Proposed Rule 18a-4(e)—Application of Segregation Requirements

i. Programmatic Benefits and Costs

a. Pre-Dodd Frank Segregation Practice

b. Benefits of the Segregation Requirements

c. Costs of the Segregation Requirements

d. Costs and Benefits of Proposed Rules 18a-4(e)(1) and (2) Regarding Application of Segregation Requirements to Foreign Security-Based Swap Dealers

e. Costs and Benefits of Proposed Rule 18a-4(e)(3) Regarding Disclosures

ii. Assessment Costs

F. Economic Analysis of Application of Rules Governing Security-Based Swap Clearing in Cross-Border Context

1. Programmatic Benefits and Costs Associated With the Clearing Agency Registration

(a) Proposed Interpretive Guidance Regarding Clearing Agency Registration

(b) Proposed Exemption of Foreign Clearing Agency From Registration

(c) Programmatic Effects of Alternative Standards

2. Programmatic Benefits and Costs Associated With the Mandatory Clearing Requirement of Section 3C(a)(1) of the Exchange Act

(a) Programmatic Effects of the Mandatory Clearing Requirement

(b) Programmatic Benefits and Costs of the Mandatory Clearing Requirement

3. Programmatic Benefits and Costs of Proposed Rule 3Ca-3

(a) Programmatic Effect of Proposed Rule 3Ca-3

(b) Programmatic Benefits and Costs of Proposed Rule 3Ca-3

(c) Alternatives

(d) Assessment Costs

G. The Economic Analysis of Application of Rules Governing Security-Based Swap Trading in the Cross-Border Context

1. Programmatic Benefits and Costs of the Proposed Application of the Registration Requirements of Section 3D of the Exchange Act to Foreign Security-Based Swap Markets

(a) Programmatic Benefits

(b) Programmatic Costs

(c) Alternatives

2. Programmatic Benefits and Costs of the Potential Availability of Exemptive Relief to Foreign Security-Based Swap Markets

(a) Programmatic Benefits

(b) Programmatic Costs

(c) Alternatives

(d) Assessment Costs

3. Programmatic Benefits and Costs Associated With the Mandatory Trade Execution Requirement of Section 3C(h) of the Exchange Act

(a) Programmatic Effect of the Statutory Mandatory Trade Execution Requirement

(b) Programmatic Benefits of the Statutory Mandatory Trade Execution Requirement

(c) Programmatic Costs of the Statutory Mandatory Trade Execution Requirement

4. Programmatic Benefits and Costs of Proposed Rule 3Ch-1 Regarding Application of the Mandatory Trade Execution Requirement in Cross-Border Context

(a) Programmatic Effect of Proposed Rule 3Ch-1

(b) Programmatic Benefits and Costs of Proposed Rule 3Ch-1

H. Application of Rules Governing Security-Based Swap Data Repositories in Cross-Border Context

1. Benefits and Costs Associated With Application of the SDR Requirements in the Cross-Border Context

(a) Benefits of Proposed Approach to SDR Requirements

i. Programmatic Benefits of Proposed Guidance Regarding Registration

ii. Programmatic Benefits of the SDR Exemption

(b) Costs of Proposed Approach to SDR Requirements

i. Programmatic Costs of the Commission's Proposed Approach

ii. Assessment Costs

(c) Alternative to Proposed Approach

2. Relevant Authorities' Access to Security-Based Swap Information and the Indemnification Requirement

(a) Benefits and Costs of Relevant Authorities' Access to Security-Based Swap Data Under the Dodd-Frank Act

i. Benefits of Relevant Authorities' Access to Security-Based Swap Data

ii. Costs of Relevant Authorities' Access to Security-Based Swap Data

(b) Benefits and Costs of Proposed Guidance and Exemptive Rule

i. Notification Requirement

ii. Determination of Appropriate Regulators

iii. Exemptive Relief From the Indemnification Requirement

(c) Alternatives to Proposed Guidance and Exemptive Relief

i. Notification Requirement

ii. Determination of Appropriate Regulators

iii. Exemptive Relief From the Indemnification Requirement

3. Economic Analysis of the Re-Proposal of Regulation SBSR

(a) Modifications to “Reporting Party” Rules and Jurisdictional Reach of Regulation SBSR—Re-Proposed Rules 901(a) and 908(a)

i. Initial Proposal

a. Programmatic Benefits of Initial Proposal

b. Programmatic Costs of Initial Proposal

ii. Re-Proposal

a. Programmatic Benefits

b. Programmatic Costs

(b) Proposed Modification of the Definition of “U.S. Person”

(c) Revisions to Proposed Rule 908(b)

i. Initial Proposal

ii. Re-Proposal

a. Programmatic Benefits

b. Programmatic Costs

(d) Other Technical Revisions in Re-Proposed Regulation SBSR

(e) Aggregate Total Quantifiable Costs

I. Economic Analysis of Substituted Compliance

1. Programmatic Benefits and Costs

2. Alternatives

3. Assessment Costs

J. General Request for Comments

XVI. Consideration of Impact on the Economy

XVII. Regulatory Flexibility Act Certification

Statutory Basis and Text of Proposed Rules

Appendix A: Application of Subtitle B of Title VII in the Cross-Border Context

Table I—Registered U.S. Security-Based Swap Dealers

Table II—Registered Non-U.S. Security-Based Swap Dealer with U.S. Guarantee

Table III—Unregistered Non-U.S. Dealer (or Market Participant) With U.S. Guarantee

Table IV—Registered Non-U.S. Security-Based Swap Dealer Without U.S. Guarantee

Table V—Unregistered Non-U.S. Dealer (or Market Participant) Without U.S. Guarantee

Appendix B: Registration of Security-Based Swap Dealers

Appendix C: Re-Proposal of Registration Forms

Appendix D: List of Commenters

I. Background Back to Top

The global nature of the security-based swap market highlights the critical importance of addressing the application of the Title VII of the Dodd-Frank Act [1] (“Title VII”) to cross-border activities. [2] The Commission has received numerous inquiries and comments from market participants, foreign regulators, and other interested parties concerning how Title VII and the Commission's implementing regulations thereunder will apply to the cross-border activities of U.S. and non-U.S. market participants. To respond to these inquiries and comments, the Commission is providing our preliminary views on the application of Title VII to cross-border security-based swap activities [3] and non-U.S. persons that act in capacities regulated under the Dodd-Frank Act in the proposed rules and interpretations discussed below.

A. The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Act was enacted, among other reasons, to promote the financial stability of the United States by improving accountability and transparency in the financial system. [4] The 2008 financial crisis highlighted significant issues in the over-the-counter (“OTC”) derivatives markets, which have experienced dramatic growth in recent years [5] and are capable of affecting significant sectors of the U.S. economy. [6] Title VII of the Dodd-Frank Act provides for a comprehensive new regulatory framework for swaps and security-based swaps, including by: (i) Providing for the registration and comprehensive regulation of swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants; (ii) imposing clearing and trade execution requirements on swaps and security-based swaps, subject to certain exceptions; (iii) creating recordkeeping and real-time reporting regimes and public dissemination; and (iv) enhancing the rulemaking and enforcement authorities of the Commission and the Commodity Futures Trading Commission (“CFTC”). [7]

Specifically, the Dodd-Frank Act provides that the CFTC will regulate “swaps,” the Commission will regulate “security-based swaps,” [8] and both the CFTC and the Commission (together, the “Commissions”) will regulate “mixed swaps.” [9] Title VII also amends the Exchange Act to include many specific provisions governing security-based swaps that could apply to cross-border security-based swap transactions and to non-U.S. persons who act in capacities regulated under the Dodd-Frank Act. [10] These provisions primarily relate to Commission oversight of security-based swap dealers, [11] major security-based swap participants, [12] security-based swap data repositories (“SDRs”), [13] security-based swap clearing agencies, [14] security-based swap execution facilities (“SB SEFs”), [15] and mandatory security-based swap reporting and dissemination, [16] clearing, [17] and trade execution. [18]

B. Overview of the Cross-Border Proposal

With limited exceptions, the Commission has not proposed specific provisions of rules or forms or provided guidance regarding the application of Title VII to cross-border activities. [19] Rather than addressing these issues in a piecemeal fashion through the various substantive rulemaking proposals implementing Title VII, the Commission instead is addressing the application of Title VII to cross-border activities holistically in a single proposing release. [20] This approach provides market participants, foreign regulators, and other interested parties with an opportunity to consider, as an integrated whole, the Commission's proposed approach to the application of Title VII to cross-border security-based swap activities and non-U.S. persons that act in capacities regulated under the Dodd-Frank Act. [21]

After providing an overview of the security-based swap market, the Commission's preliminary views on the scope of application of Title VII to cross-border security-based swap activity, and the legal and policy principles guiding the Commission's approach to the application of Title VII to cross-border activities in Section II, we set forth our proposed approach in the subsequent sections of the release.

In Sections III and IV, we propose rules and interpretive guidance regarding the registration and regulation of security-based swap dealers and major security-based swap participants, including the treatment of foreign branches of U.S. banks and the provision of guarantees in the cross-border context. In connection with this, we are re-proposing the following rules and forms: 17 CFR 249.1600 (Form SBSE), 249.1600a (Form SBSE-A), and 249.1600b (Form SBSE-BD). [22]

In Sections V-VII, we propose rules and interpretive guidance regarding the registration of security-based swap clearing agencies, SDRs, and SB SEFs, as well as discuss generally under what circumstances the Commission would consider granting exemptions from registration for these infrastructures. To facilitate relevant authorities' access to security-based swap data collected and maintained by Commission-registered SDRs, the Commission also is proposing interpretive guidance to specify how SDRs may comply with the notification requirement in the Exchange Act and specifying how the Commission proposes to determine whether a relevant authority is appropriate for purposes of receiving security-based swap data from an SDR. [23] In addition, the Commission is proposing a tailored exemption from the indemnification requirement in the Exchange Act. [24]

In Sections VIII-X, we propose rules and interpretive guidance regarding the application of Title VII to cross-border activities with respect to certain transactional requirements in connection with reporting and dissemination, clearing, and trade execution for security-based swaps. As discussed further below, these requirements apply to persons independent of their registration status. In connection with this, we are re-proposing the following rules: 17 CFR 242.900-242.911 (Regulation SBSR). [25]

In Section XI, we set forth a proposed policy and procedural framework under which we would consider permitting compliance with comparable regulatory requirements in a foreign jurisdiction to substitute for compliance with certain requirements of the Exchange Act, and the rules and regulations thereunder, relating to security-based swaps (i.e.,“substituted compliance”). [26] Generally speaking, the Commission is proposing a policy and procedural framework that would allow for the possibility of substituted compliance in recognition of the potential, in a market as global as the security-based swap market, for market participants who engage in cross-border security-based swap activity to be subject to conflicting or duplicative compliance obligations. [27] In addition, the Commission is proposing a rule that would set forth procedures for requesting a substituted compliance determination.

In Section XII, the Commission sets forth our view of the scope of our authority, with respect to enforcement proceedings, under Section 929P of the Dodd-Frank Act. [28] Section XIII sets forth a general request for comment, including request for comment on the consistency of our proposed approach with the CFTC's proposed approach to applying the provisions of the CEA that were enacted by Title VII in the cross-border context.

Finally, in Section XIV, the Commission addresses the Paperwork Reduction Act, and Section XV provides an economic analysis of the proposed approach, including a discussion of the associated costs and benefits of the proposals discussed in Sections III-XI, as well as a discussion of issues related to efficiency, competition, and capital formation.

Because this release is directly related to security-based swap data reporting and dissemination, clearing, and trade execution, as well as the regulation of various persons required to register as a result of amendments made to the Exchange Act by Title VII, we anticipate that some of the rules, forms, and interpretive guidance proposed herein, and comments received thereon, will be addressed in the adopting releases relating to the impacted substantive rules. In some areas, we may decide to address comments received on the proposals contained in this release by adopting rules in a separate rulemaking. [29]

C. Consultation and Coordination

As discussed more fully below, a number of market participants, foreign regulators, and other interested parties have already provided their views on the application of Title VII to cross-border activities through both written comment letters to the Commission and/or the CFTC and meetings with Commissioners and Commission staff. [30] The Commission has taken the commenters' views expressed thus far into consideration in developing these proposed rules, forms, and interpretive guidance. [31] In addition, in developing this proposal, the Commission has, in compliance with Sections 712(a)(2) [32] and 752(a) [33] of the Dodd-Frank Act, consulted and coordinated with the CFTC, the prudential regulators, [34] and foreign regulatory authorities.

Efforts to regulate the swaps market are underway not only in the United States but also abroad. In 2009, leaders of the Group of 20 (“G20”)—whose membership includes the United States, 18 other countries, and the European Union (“EU”)—called for global improvements in the functioning, transparency, and regulatory oversight of OTC derivatives markets. Specifically, the G20 leaders declared that:

[a]ll standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements. We ask the [Financial Stability Board] and its relevant members to assess regularly implementation and whether it is sufficient to improve transparency in the derivatives markets, mitigate systemic risk and protect against market abuse. [35]

In subsequent summits, the G20 leaders have reiterated their commitment to OTC derivatives regulatory reform. [36] The Commission has participated in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC derivatives. [37] Through these discussions and our participation in various international task forces and working groups, [38] we have gathered information about foreign regulatory reform efforts and have discussed the possibility of conflicts and gaps, as well as inconsistencies and duplications, between U.S. and foreign regulatory regimes. We have taken these discussions into consideration in developing these proposed rules, forms, and interpretations.

In addition, the Commission and the CFTC have conducted staff studies to assess developments in OTC derivatives regulation abroad. As directed by Congress in Section 719(c) of the Dodd-Frank Act, on January 31, 2012, the Commission and the CFTC jointly submitted to Congress a “Joint Report on International Swap Regulation” (“Swap Report”). [39] The Swap Report discussed swap and security-based swap regulation and clearinghouse regulation in the Americas, Asia, and the European Union, and identified similarities and differences in jurisdictions' approaches to areas of regulation, as well as other areas of regulation that could be harmonized. The Swap Report also identified major clearinghouses, clearing members, and regulators in each geographic area and described the major contracts (including clearing volumes and notional values), methods for clearing swaps, and the systems used for setting margin in each geographic area. [40]

D. Substituted Compliance

As noted above, we recognize the potential, in a market as global as the security-based swap market, that market participants who engage in cross-border security-based swap activity may be subject to conflicting or duplicative compliance obligations. To address this possibility, we are proposing a “substituted compliance” framework under which we would consider permitting compliance with requirements in a foreign [41] regulatory system to substitute for compliance with certain requirements of the Exchange Act relating to security-based swaps, provided that the corresponding requirements in the foreign regulatory system are comparable to the relevant provisions of the Exchange Act. [42] The availability of substituted compliance should reduce the likelihood that market participants would be subject to potentially conflicting or duplicative sets of rules.

As discussed more fully below, the Commission would perform comparability analysis and make substituted compliance determinations with respect to four separate categories of requirements. [43] If, for example, a foreign regulatory system achieves comparable regulatory outcomes in three out of the four categories, then the Commission would permit substituted compliance with respect to those three categories of comparable requirements, but not for the one, non-comparable category for which comparable regulatory outcomes are not achieved. In other words, we are not proposing an “all-or-nothing” approach. In addition, in making comparability determinations within each category of requirements, the Commission is proposing to take a holistic approach; that is, we would ultimately focus on regulatory outcomes rather than a rule-by-rule comparison. Substituted compliance therefore should accept differences between regulatory regimes when those differences nevertheless accomplish comparable regulatory outcomes.

E. Conclusion

In proposing these rules, forms, and interpretations, the Commission is mindful that the security-based swap market is global in nature and developed prior to the enactment of the Dodd-Frank Act. [44] There are challenges involved in imposing a comprehensive regulatory regime on existing markets, particularly ones that have not been subject to the particular regulation that the Dodd-Frank Act provides. Any rules and interpretive guidance we adopt governing the application of Title VII to cross-border activities could significantly affect the global security-based swap market. As discussed further below, to the extent practicable and consistent with our statutory mandate, [45] the Commission has proposed these rules and interpretations with the intent to achieve the regulatory benefits intended by the Dodd-Frank Act and to facilitate a well-functioning global security-based swap market, including by taking into account the impact these proposed rules and interpretations will have on counterparty protection, transparency, systemic risk, liquidity, efficiency, and competition in the market. In addition, the Commission is mindful of the fact that the application of Title VII to cross-border activities raises issues of potential conflict or overlap with foreign regulatory regimes. Furthermore, the Commission is attentive to the fact that a number of registrants may be registered with both us and the CFTC. [46]

The rules and interpretations proposed today represent the Commission's preliminary views regarding the application of Title VII to cross-border security-based swap activities and to non-U.S. persons who act in capacities regulated under the Dodd-Frank Act. We note that these proposed rules and interpretations are tailored to the unique circumstances of the security-based swap market, and as such would not necessarily be appropriate to apply to the Commission's regulation of traditional securities markets. We also recognize that there are a number of possible alternative approaches to applying Title VII in the cross-border context. Accordingly, the Commission invites public comment regarding all aspects of the proposed approach, including each proposed rule and interpretation contained herein, and potential alternative approaches. In particular, data and comment from market participants and other interested parties with respect to the likely effect of each proposed rule and interpretation regarding application of a specific Title VII requirement, and the effect of such proposed application in the aggregate, will be particularly useful to the Commission in evaluating possible modifications to the proposal and understanding the consequences of the substantive rules that have not yet been adopted under Title VII.

II. Overview of the Security-Based Swap Market and the Legal and Policy Principles Guiding the Commission's Approach to the Application of Title VII to Cross-Border Activities Back to Top

In this section, the Commission provides a general overview of the security-based swap market that informs our proposed implementation of Title VII, including a description of the various dealing structures used by U.S.-based and foreign-based entities to conduct their security-based swap businesses, and existing clearing, reporting, and trade execution practices. We also discuss the Commission's preliminary views on the scope of application of Title VII and the principles guiding our proposed approach to applying Title VII in the cross-border context.

A. Overview of the Security-Based Swap Market

1. Global Nature of the Security-Based Swap Market

The security-based swap market is a global market. [47] Security-based swap business currently takes place across national borders, with agreements negotiated and executed between counterparties often in different jurisdictions (and at times booked and risk-managed in still other jurisdictions). [48]

The global nature of the security-based swap market is evidenced by the data available to the Commission. [49] Based on market data in the Depository Trust and Clearing Corporation's Trade Information Warehouse (“DTCC-TIW”), [50] viewed from the perspective of the domiciles of the counterparties booking credit default swap (“CDS”) transactions, approximately 49% of U.S. single-name CDS transactions in 2011 were cross-border transactions between a U.S.-domiciled [51] counterparty and a foreign-domiciled counterparty [52] and an additional 44% of such CDS transactions were between two foreign-domiciled counterparties. [53] Thus, approximately 7% of the U.S. single-name CDS transactions in 2011 were between two U.S.-domiciled counterparties. [54] These statistics indicate that cross-border transactions are the norm, not the exception, in the security-based swap market. [55] Accordingly, the question of how the Commission is implementing Title VII with respect to security-based swaps will, to a large extent, be affected by how the Commission applies Title VII to the cross-border transactions that are the majority of security-based swaps.

2. Dealing Structures

Dealers use a variety of business models and legal structures to conduct security-based swap dealing business [56] with counterparties in jurisdictions all around the world. [57] Commenters have indicated that both U.S.-based and foreign-based entities use certain dealing structures for a variety of legal, tax, strategic, and business reasons that often pre-date the enactment of the Dodd-Frank Act. [58] Among the reasons cited for the variety of dealing structures is the desire of counterparties to reduce risk and enhance credit protection based on the particular characteristics of each entity's business. [59]

In this subsection, we describe certain dealing structures that U.S.-based entities and foreign-based entities in the security-based swap market might use. In each of these dealing structures, because the booking entity is the counterparty to the security-based swap transaction resulting from the dealing activity (i.e., the principal) and bears the ongoing risk of performance on the transaction, we view the booking entity, and not the intermediary that acts as an agent on behalf of the booking entity to originate the transaction, as the dealing entity. [60]

(a) U.S. Bank Dealer

A U.S. bank holding company may use a U.S. subsidiary that is a banking entity to deal directly with U.S. and foreign counterparties. Such U.S. bank dealer may use a sales force in its U.S. home office to originate security-based swap transactions in the United States and use separate sales force in foreign branches to originate security-based swap transactions with counterparties in foreign local markets. [61] The resulting security-based swap transactions may be booked in the home office of the U.S. bank or in a foreign branch of the bank. [62]

(b) U.S. Non-bank Dealer

A U.S.-based holding company may use a non-bank subsidiary to conduct security-based swap dealing activity in the U.S. market and foreign local markets. The U.S. non-bank dealer may act as principal to originate and book transactions in the United States and use a sales force in the foreign local markets (e.g., salespersons employed by its foreign affiliate) as agent to originate transactions on its behalf, and then centrally book the resulting transactions in the U.S. non-bank dealer. In some situations, such as where the holding company has rated debt, but the U.S. non-bank dealer does not, the U.S. non-bank dealer's performance under security-based swaps may be supported by a parental guarantee provided by the holding company. [63] The guarantee would typically give counterparties to the U.S. non-bank dealer direct recourse to the holding company for obligations owed by such non-bank dealer under the security-based swaps as though the guarantor had entered into the transactions directly with the counterparties. [64]

(c) Foreign Subsidiary Guaranteed by a U.S. Person

A U.S.-based holding company also may conduct dealing activity in both U.S. markets and foreign markets out of a foreign subsidiary. [65] The foreign subsidiary may use a sales force in the United States (e.g., salespersons employed by its U.S. affiliate) to originate security-based swap transactions with counterparties in the U.S. markets, or may directly solicit, negotiate, and execute security-based swap transactions with counterparties in the U.S. markets from outside the United States, and centrally book the resulting transactions itself. The foreign subsidiary also may conduct security-based swap dealing activity in various foreign markets using local salespersons as agent to originate and centrally book the resulting security-based swap transactions itself. In some situations, such as where the U.S.-based holding company has rated debt, but the foreign subsidiary does not, the foreign subsidiary's performance under security-based swaps may be supported by a parental guarantee provided by the holding company. [66] Such guarantee would typically give its counterparty direct recourse to the U.S. parent acting as guarantor for obligations owed by such foreign subsidiary under the security-based swaps. As a result, a guarantee provided by a U.S. person of another person's obligations owed under a security-based swap transaction poses the same degree of risk to the United States as the risk posed by a transaction entered into directly by such U.S. person.

In circumstances where a foreign non-bank subsidiary of a U.S. holding company has sufficient credit-worthiness and does not rely on a U.S. parental guarantee to support its creditworthiness, the risk of the security-based swaps entered into by the foreign subsidiary of a U.S.-based holding company resides in the foreign subsidiary outside the United States.

(d) Foreign-Based Dealer

i. Direct Dealing

Foreign-based entities also may use a number of business models and legal structures to conduct global security-based swap dealing activity in both the U.S. and foreign markets. Like U.S. dealers, foreign dealers may deal directly with U.S. counterparties and non-U.S. counterparties without using any agents in the local market to intermediate and book the resulting transactions in the foreign entities themselves. [67]

ii. Intermediation in the United States

Foreign dealers also may use local personnel with knowledge of and expertise on the local markets to intermediate security-based swap transactions in each local market, for instance, using salespersons in the United States to originate security-based swaps in the U.S. market, and either book the resulting transactions in an entity based in the United States (such as a U.S. affiliate) or centrally book the resulting transactions in a foreign central booking affiliate. [68]

Intermediation activity within the United States on behalf of foreign entities may occur in two principal legal structures.

First, foreign dealers that are banking entities may conduct dealing activity with U.S. counterparties out of their U.S. branches. In this structure, a foreign banking entity may originate and book transactions in its U.S. branch, or the U.S. branch may originate transactions that are booked in the foreign home office. [69]

Second, both bank and non-bank foreign dealers may conduct dealing activity out of their U.S. subsidiaries. The U.S. subsidiaries may act as principal to originate and book security-based swaps in the United States and enter into inter-affiliate back-to-back transactions with the foreign central booking entity (usually the foreign parent) for purposes of centralized booking and centralized risk management. [70] The U.S. subsidiary also may act as agent to originate security-based swaps in the United States on behalf of the foreign entity and the resulting transactions would be booked in a centralized foreign booking entity, usually the foreign parent. In some situations, such as where the foreign-based entity has rated debt, but the U.S. subsidiary does not, the U.S.-based subsidiary's performance under security-based swaps that it enters into as principal may be supported by a parental guarantee provided by the foreign-based entity. [71]

The transactions originated by the U.S. branch of a foreign bank or a U.S. subsidiary of a foreign bank or non-bank entity may not be limited to those with U.S. counterparties in the U.S. security-based swap market. Foreign bank or non-bank entities may utilize their U.S. branches or U.S. subsidiaries to conduct dealing activity with, for instance, non-U.S. counterparties located in various jurisdictions within the same region or same time zones, such as Canada or Latin America, and centrally book the resulting transactions in the home offices of the foreign entities themselves. For example, a Canadian counterparty might enter into a security-based swap with a non-U.S.-based dealer that solicits and negotiates the transaction out of a U.S subsidiary acting as agent but books the transaction itself outside the United States.

3. Clearing Practices

Prior to the enactment of the Dodd-Frank Act, there was no provision in the Exchange Act or any other laws in the United States for the mandatory clearing of OTC derivatives. Although initiatives related to central clearing had been considered before 2008, the 2008 financial crisis brought a new focus on CDS as a source of systemic risk and contributed to a more general recognition that central clearing parties (“CCPs”) could play a role in helping to manage bilateral counterparty credit risk in OTC CDS. [72]

In November 2008, the Commission, in consultation and coordination with the Federal Reserve Board and the CFTC, took steps to help facilitate the prompt development of CCPs for OTC derivatives. [73] Specifically, the Commission authorized the clearing of OTC security-based swaps by permitting certain clearing agencies to clear CDS on a temporary conditional basis. [74] As the Commission and other regulatory agencies monitored the activities of those clearing agencies, a significant volume of interdealer OTC CDS transactions and a smaller volume of dealer-to-non-dealer OTC CDS transactions were centrally cleared on a voluntary basis. [75] The level of voluntary clearing in swaps and security-based swaps has steadily increased since that time. Although the volume of interdealer CDS cleared to date is quite large, [76] many security-based swap transactions are still ineligible for central clearing, and many transactions in security-based swaps eligible for clearing at a CCP continue to settle bilaterally.

Voluntary clearing of security-based swaps in the United States is currently limited to CDS products. Central clearing of security-based swaps began in March 2009 for index CDS products, in December 2009 for single-name corporate CDS products, and in November 2011 for single-name sovereign CDS products. At present, there is no central clearing in the United States for security-based swaps that are not CDS products, such as those based on equity securities. The level of clearing activity appears to have steadily increased as more CDS have become eligible to be cleared. [77]

4. Reporting Practices

The OTC derivatives markets have historically been largely opaque. [78] With respect to CDS, for example, the Government Accountability Office found in 2009 that “comprehensive and consistent data on the overall market have not been readily available,” that “authoritative information about the actual size of the CDS market is generally not available,” and that regulators currently are unable “to monitor activities across the market.” [79] The reporting of comprehensive OTC derivative transaction data to trade repositories is intended to address the lack of transparency in this market, and as such it was one of the G20 regulatory reform commitments previously discussed. [80]

The first trade repositories were established in the mid-2000s. [81] The development of trade repositories for different asset classes accelerated following the 2009 G20 commitment in this area, and as legislative and regulatory requirements began to be put in place. As of the end of the first quarter of 2013, fourteen FSB member jurisdictions had legislation in place either requiring reporting of OTC derivatives contracts or authorizing regulators to implement such regulations. [82] In addition, as of the date of publication of the FSB Progress Report April 2013, eighteen trade repositories were either registered or in the process of becoming registered and twelve were operational, meaning, typically, that they were at least accepting transaction reports from more than one asset class. [83]

Prior to the Dodd-Frank Act, global trade repositories had been established for credit, interest rate, and equity derivatives. [84] In addition, in June 2010, the OTC Derivatives Regulators' Forum (“ODRF”) [85] developed indicative guidance for Warehouse Trust [86] aiming to identify data that authorities would expect to request from Warehouse Trust to carry out their mandates. [87]

Public availability of trade repository data varies globally and has changed significantly over time. For example, since October 2008, on a weekly basis, DTCC has published aggregated data via its Web site. [88] More generally, in a recent FSB survey, all trade repositories that responded stated that they provide or intend to provide, transaction data on OTC derivatives to the public. In some cases and for some products, trading information is provided on a real-time basis. Some trade repositories publicly disclose only aggregated, end-of-day information. [89]

5. Trade Execution Practices

Unlike the markets for cash equity securities and listed options, the market for security-based swaps currently is characterized generally by bilateral negotiation directly between two counterparties in the OTC market and is largely decentralized; many instruments are individually negotiated and often customized; and many security-based swaps are not centrally cleared. [90] The historical one-to-one nature of trade negotiation in security-based swaps has fostered various types of trading venues and execution practices, ranging among the following:

Bilateral Negotiations

“Bilateral negotiation” refers to the execution practice whereby one party uses the telephone, email or other means of communication to directly contact a potential counterparty to negotiate and execute a security-based swap. In bilateral negotiation and execution, only the two parties to the transaction are aware of the terms of the negotiation and the final terms of the agreement. [91]

Single-Dealer RFQ Platforms

A single-dealer request for quote (“RFQ”) platform refers to an electronic trading platform where a dealer may post indicative quotes for security-based swaps in various asset classes that the dealer is willing to trade. Only the dealer's approved customers have access to the platform. When a customer wishes to transact in a security-based swap, the customer requests an executable quote, the dealer provides one, and if the customer accepts the dealer's quote, the transaction is executed electronically. This type of platform generally provides indicative quotes on a pricing screen, but only from one dealer to its customers. [92]

Multi-Dealer RFQ Platforms

A multi-dealer RFQ electronic trading platform refers to a multi-dealer RFQ system whereby a requester can send an RFQ to solicit quotes on a certain security-based swap from multiple dealers at the same time. After the RFQ is submitted, the recipients have a prescribed amount of time in which to respond to the RFQ with a quote. Responses to the RFQ are firm. The requestor then has the opportunity to review the responses and accept the best quote. A multi-dealer RFQ platform provides a certain amount of pricing information, depending on its characteristics. [93]

Central Limit Order Books

A central limit order book system or similar system refers to a trading system in which firm bids and offers are posted for all participants to see, with the identity of the parties withheld until a transaction occurs. Bids and offers are then matched based on price-time priority or other established parameters and trades are executed accordingly. The quotes on a limit order book system are firm. In general, a limit order book system provides greater pricing information than the three platforms described above because all participants can view bids and offers before placing their bids and offers. [94] Currently, limit order books for the trading of security-based swaps in the United States are utilized by inter-dealer brokers for dealer-to-dealer transactions.

Brokerage Trading

“Brokerage trading” refers to an execution practice used by brokers to execute security-based swaps on behalf of customers, often in larger sized transactions. In such a system, a broker receives a request from a customer (which may be a dealer) who seeks to execute a specific type of security-based swap. The broker then interacts with other customers (which may also be dealers) to fill the request and execute the transaction. This model often is used by dealers that seek to transact with other dealers through the use of an interdealer broker as an intermediary. In this model, participants may or may not be able to see bids and offers of other participants. [95]

These various trading venues and execution practices provide different degrees of pre-trade pricing information and different levels of access. The Commission currently does not have sufficient information with respect to the volume of security-based swap transactions executed across these different trading venues and execution practices to evaluate the individual impact of such venues and practices on pricing information available in the security-based swap market.

6. Broad Economic Considerations of Cross-Border Security-Based Swaps [96]

Our primary economic considerations for promulgating rules and interpretations regarding the application of Title VII to cross-border activities include the potential risks of security-based swaps to the U.S. financial system [97] that could affect financial stability, the level of transparency and counterparty protection in the security-based swap market, the costs to market participants, and the impact of such rules and interpretations on liquidity, efficiency, and competition in the market. Unlike most other securities transactions, a security-based swap gives rise to ongoing obligations between transaction counterparties during the life of the transaction. This means that each counterparty to the transaction undertakes the obligation to perform the security-based swap in accordance with its terms and bears the counterparty credit risk and market risk until the transaction is terminated. [98] The cross-border rules ultimately adopted by the Commission could materially impact the economic effects of the final Title VII regulatory requirements.

(a) Major Economic Considerations

In determining how Title VII requirements should apply to persons and transactions in the cross-border context, the Commission is aware of the potentially significant trade-offs inherent in our policy decisions. For example, it is possible that counterparties excluded from the Title VII regulatory framework would not, among other things, receive the same level of counterparty protection or impartial access to trading venues and information as those included in the Title VII regulatory framework. However, it is also possible that market participants excluded from the Title VII regulatory framework would face lower regulatory burdens and lower compliance costs associated with their security-based swap activity. Further, it is possible that these trade-offs could alter the incentives for individuals to participate in the security-based swap market, which may impact the overall market, affecting its liquidity, as well as its efficiency and the competitive dynamics among participants. In addition, we also recognize that regulators in other jurisdictions are currently engaged in implementing their own regulatory reforms of the OTC derivatives markets and that our proposed application of Title VII to cross-border activities may affect the policy decisions of these other regulators as they seek to address potential conflicts or duplication in the regulatory requirements that apply to market participants under their authority. In proposing our rules and interpretations in this release, the Commission has considered the benefits of the Title VII regulatory framework, including counterparty protection and access to information, as well as the costs of compliance, taking into account the potential impact of the rules and interpretations on liquidity, efficiency, and competition in the security-based swap market.

Moreover, the costs and benefits of various Title VII substantive requirements may not be the same for each individual market participant, depending on the role it plays, the market function it performs, and the activity it engages in in the security-based swap market. For example, Title VII requirements for security-based swap dealers and major security-based swap participants may impose significant costs on persons falling within the definitions of security-based swap dealer and major security-based swap participant that are not borne by other market participants. The costs of these requirements may provide economic incentive for some market participants falling within the definitions of security-based swap dealer and major security-based swap participant to restructure their security-based swap business to operate wholly outside of the Title VII regulatory framework, exiting the security-based swap market in the United States and not transacting with U.S. persons. Conversely, certain Title VII requirements may promote financial stability and increase market participants' confidence in entering into security-based swap transactions.

(b) Global Nature and Interconnectedness of the Security-Based Swap Market

In considering the proposed approach to the application of the Title VII requirements, the Commission has been informed by the analysis of current market activity described in this release, [99] including the extent of cross-border trading activity in the security-based swap market. [100] The security-based swap transactions between U.S.- and non-U.S. domiciled market participants provide conduits of risk into the U.S. financial system, which could affect the safety and soundness of the U.S. financial system. Similarly, such transactions also provide conduits for liquidity into the U.S. financial system. As a consequence, changes to incentives or costs that result from the application of U.S. regulatory requirements may have effects on the liquidity of the global market, as well as its efficiency and competitive dynamics.

With respect to conduits of risk, one area of particular concern in the current security-based swap market is the risks that arise when a large market participant becomes financially distressed, including the potential for sequential counterparty failure. A default by one or more security-based swap dealers or major security-based swap participants could produce spillovers or contagion by reducing the willingness and/or ability of market participants to extend credit to each other, and thus could substantially reduce liquidity and valuations for particular types of financial instruments. [101]

The experience of American International Group, Inc. (“AIG”), a Delaware corporation based in New York, and its subsidiary, AIG Financial Products Corp. (“AIG FP”), a Delaware corporation based in Connecticut, during and after the 2008 financial crisis both illustrates spillovers and contagion arising from security-based swap transactions and demonstrates how cross-border transactions could contribute to the destabilization of the U.S. financial system if the security-based swap market were not adequately regulated. [102] AIG FP sold extensive amounts of credit protection in the form of CDS in the years leading up to the crisis, [103] largely on the strength of AIG's AAA rating; AIG FP's obligations were guaranteed by its parent AIG. [104] AIG FP's CDS business reflected the global nature of the security-based swap market because, although both AIG and AIG FP were headquartered in the United States, much of AIG FP's CDS business was run out of its London office, [105] and AIG FP sold credit protection to counterparties both within the United States and around the world. [106]

As the subprime mortgage market in the United States collapsed, the ongoing obligations borne by AIG FP and, through its guarantees, its parent AIG, arising from AIG FP's CDS transactions produced losses that threatened to overwhelm both AIG FP and AIG. The Federal Reserve Bank of New York established a credit facility to prevent AIG from collapsing. These funds were later supplemented by financial support from the U.S. Treasury and the Federal Reserve, resulting in over $180 billion in financial assistance. [107]

As we discuss in more detail below, security-based swap market regulators need to take into account the spillover and contagion effect of security-based swap risk to avoid overburdening the financial system. One way to mitigate the spillover effect of a firm failure is to impose capital standards that take into account the security-based swap risk the firm undertakes while allowing flexibility in how it conducts security-based swap business. [108] At the same time, the Commission is mindful that the application of Title VII prudential requirements such as capital and margin impose costs on market participants that could provide economic incentives to restructure or separate their security-based swap activity according to geographical or jurisdictional regions, or to engage in less security-based swap activity, which may reduce the liquidity or efficiency of the overall market. [109]

There are circumstances where risk generated by security-based swaps may reside in the United States while conduits of such risk (e.g., security-based swap transactions or persons engaged in security-based swap transactions) could take place or reside outside the United States or outside the scope of application of the Title VII requirements. In these instances, the Commission has considered the nature of the risk, the magnitude of the risk, and the existence of other financial regulations, such as regulation of systemically important financial institutions in Title I and Title II of the Dodd-Frank Act and banking regulations.

The Commission is mindful that the same interconnectedness in the security-based swap market that may provide conduits for risk also may mean that changes to incentives or costs caused by the application of U.S. regulatory requirements may have effects on the liquidity of the global market, as well as its efficiency and competitive dynamics. As described below in Section XV.C, there are a myriad of paths for liquidity as well as risk to move throughout the financial system in this interconnected market. In addition, differences in regulatory requirements between the United States and non-U.S. jurisdictions may also impact markets by changing the competitive dynamics currently at play in the interconnected global market. For example, as articulated in Section XV.C, some potential responses by market participants to the proposed rules and interpretations in this release may result in lessened competition in the security-based swap market within the United States. Among other considerations, some entities may determine that the compliance costs arising from the requirements of Title VII warrant exiting the security-based swap market in the United States and not transacting with U.S. persons. These exits could result in higher spreads and affect the ability and willingness of end users to engage in security-based swaps.

(c) Central Clearing

Many of the bilateral counterparty credit risks associated with security-based swaps can be mitigated by central clearing. Central clearing of security-based swaps provides a mechanism for market participants to engage in security-based swap activity without having to assess the creditworthiness of each counterparty. Clearing of security-based swaps shifts the counterparty risk from individual counterparties to CCPs whose members collectively share the default risk of all members. [110] Central clearing also requires consistent application of mark-to-market pricing and margin requirements, which standardizes the settling of payment or collateral delivery resulting from market movements and minimizes the risk of clearing member defaults. [111]

However, central clearing may also pose risk to financial systems. Because a CCP necessarily concentrates a large number of otherwise bilateral contracts into a single location, a CCP could itself become systemically important. [112] While a loss by any single member in excess of its margin posted with the CCP is likely to be absorbed by the CCP's risk capital structure, correlated losses among many members, such as those which occurred among many asset classes during the 2008 financial crisis, could diminish the effectiveness of the risk mutualization structure of a CCP. Its failure could create financial instability through its members if the members, as residual obligors to the default related losses are unable to absorb the resulting financial impact. Such an outcome could lead to failure among CCP member counterparties, particularly when obligations are sizable, which may be the case if the members are themselves systemically important.

Certain aspects of Title VII are intended to reduce the risk of CCP failure by promoting sound risk management practices among registered clearing agencies, while also providing open access to market participants. [113] Sound risk management practices are important among both domestic and foreign CCPs, given the global nature of CCP membership. [114] When a CCP in the United States has significant number of foreign members, the CCP and its U.S.-domiciled members would be exposed to the foreign members. Similarly, when U.S.-domiciled entities are members of foreign domiciled CCPs, U.S. exposure to a foreign institution is created that may be systemically important.

(d) Security-Based Swap Data Reporting

Certain Title VII requirements are designed to increase market transparency for regulators and among security-based swap market participants. Requirements of regulatory reporting are designed to provide regulators with a broad view of the market and help monitor pockets of risk that might not otherwise be observed by market participants with an incomplete view of the market. Separately, requirements of post-trade reporting of prices in real-time are intended to promote price discovery and lower the trading costs by lessening the information advantage afforded certain OTC market participants with the largest order flow. Allowing all market participants access to more information about transactions' prices and sizes should create a more level playing field and may promote the efficiency of exchange or SEF trading of security-based swaps. In particular, as in other security markets, quoted bids and offers should form and adjust according to the reporting of executed trades. At the same time, however, we recognize that increased post-trade transparency also could impact the liquidity of, and competition in, the security-based swap market. [115] For example, market participants may be less willing to provide liquidity for large, potentially market-moving trades if the implementation of the Title VII public dissemination requirements reveals private information about future hedging and inventory needs.

The increased transparency caused by the Title VII reporting requirements could be diminished if consistent reporting requirements are not applied to transactions across various jurisdictions and information regarding security-based swaps taking place in the global market is not shared among jurisdictions. For instance, the aggregate exposures created by a particular security-based swap or class of security-based swaps may only be partially observed if security-based swap transactions span multiple jurisdictions. As a result any single regulator may not have a complete view of the security-based swap risks and may underestimate such risks. Separately, if some regulatory regimes do not require, or provide for less informative, post-trade reporting rules, then certain transactions may gravitate to these jurisdictions so that market participants can escape reporting their transaction prices. In both instances the increased transparency contemplated by the Title VII reporting requirements may be diluted.

B. Scope of Title VII's Application to Cross-Border Security-Based Swap Activity

Congress has given the Commission authority in Title VII to implement a security-based swap regulatory framework. In the statutory definitions and registration requirements for market intermediaries and participants (i.e., security-based swap dealers and major security-based swap participants) and security-based swap infrastructures (i.e., SDRs, security-based swap clearing agencies, and SB SEFs), Congress has identified the types of security-based swap activity that triggers Title VII registration and regulatory requirements relevant to such persons or the application of Title VII transaction-level requirements.

We recognize that applying Title VII to persons and transactions that fall within the statutory definitions or requirements may subject some persons based outside the United States, or some transactions arising from activity that occurs in part inside and in part outside the United States, to the various provisions of Title VII. At the same time, however, the global nature of the security-based swap market and the characteristics of the risk associated with security-based swap activity suggest that applying Title VII only to the conduct of persons located within the United States or to security-based swap activity occurring entirely within the United States would exclude from regulation a significant proportion of security-based swap activity that occurs in part inside and in part outside the United States. [116] Our proposed approach is intended to strike a reasonable balance in light of the authority provided by Congress, the structure of the security-based swap market, and the transfer of risk within that market. Accordingly, among other things, our proposed approach does not impose Title VII requirements on persons whose relevant security-based swap activity occurs entirely outside the United States and thus likely does not raise the types of concerns in the U.S. financial system that would warrant application of Title VII.

Commenters have raised concerns about the application of Title VII to security-based swap activity in the cross-border context and specifically about the possibility that the Commission may apply our security-based swap regulations to “extraterritorial” conduct. In this subsection, we discuss commenters' views regarding the applicability of Title VII to cross-border security-based swap activity, explain our proposed approach to determining whether the relevant security-based swap activity takes place, in whole or in part, within the United States, and interpret what it means for a person to “transact a business in security-based swaps without the jurisdiction of the United States” as set forth in Section 30(c) of the Exchange Act (“Section 30(c)”). [117] In subsequent sections of the release, we discuss in more detail our proposed application of Title VII to cross-border security-based swap activity.

1. Commenters' Views

Commenters generally expressed the view that Section 30(c) restricts the Commission's authority to apply Title VII to “extraterritorial” conduct and thus, that the Commission follow a territorial approach in applying Title VII to cross-border security-based swap activity. One commenter interpreted Section 30(c) as prescribing a strictly territorial approach to the application of Title VII, arguing that this section codifies the territorial approach that we have historically taken in our existing securities regulations. [118] Several commenters argued that a narrow interpretation of the “extraterritorial” reach of Title VII was consistent with both Commission precedent [119] and the Supreme Court's decision in Morrison v. National Australia Bank. [120]

Based on this interpretation of Section 30(c), commenters generally argued that Title VII does not give the Commission authority to regulate entities that transact a business in security-based swaps outside the United States. [121] Some commenters suggested that non-U.S. entities (including affiliates of U.S. persons) that conduct business entirely with counterparties outside the United States should not be required to register as swap or security-based swap dealers or comply with Title VII. [122] Some of these commenters also urged the Commission not to subject foreign branches and affiliates of U.S. banks to Title VII registration requirements to the extent that they transact solely with foreign persons. [123] Some commenters urged that, even within a single entity, only those branches, departments, or divisions that engage in business within the United States should be required to register. [124]

Commenters generally took the view that Section 30(c) does not permit the Commission to apply Title VII to transactions occurring outside the United States. Accordingly, commenters suggested that Section 30(c) restricts the Commission's ability to apply Title VII requirements to the foreign business of entities that are required to register with the Commission. [125] For example, one commenter interpreted Section 30(c) to prohibit application of Title VII to any of a person's “activity” or “business” outside the United States, even if that person otherwise transacts a business in security-based swaps within the jurisdiction of the United States. [126]

Similarly, some commenters suggested that Section 30(c) prohibits the application of Title VII to transactions involving the foreign affiliates of U.S. persons, on the basis that such transactions occur “without the jurisdiction of the United States” when no U.S. person is a counterparty to the trade. [127] One commenter explained that, because such transactions involve parties outside the United States and occur outside the United States, they are “removed from the stream of U.S. commerce.” [128]

Commenters also generally recommended a narrower interpretation of the language in Section 30(c) permitting the application of Title VII regulations to persons transacting a business in security-based swaps without the jurisdiction of the United States to the extent that they are doing so in contravention of rules the Commission has prescribed as “necessary or appropriate to prevent the evasion of any provision of [the Exchange Act that was added by the Dodd-Frank Act].” Under this view, Section 30(c) permits “extraterritorial” application of Title VII only to entities that have themselves engaged in willful or intentional evasion. [129] These commenters argued that the longstanding use of foreign branches and affiliates by security-based swap market entities demonstrates that these types of business structures are not evasive and, therefore, do not fall within the exception to the limits on the applicability of Title VII as set forth in Section 30(c). [130]

2. Scope of Application of Title VII in the Cross-Border Context

(a) Overview and General Approach

Section 772(b) of the Dodd-Frank Act amends Section 30 of the Exchange Act to provide that “[n]o provision of [Title VII] . . . shall apply to any person insofar as such person transacts a business in security-based swaps without the jurisdiction of the United States,” unless that business is transacted in contravention of rules prescribed to prevent evasion of Title VII. [131] In so amending Section 30 of the Exchange Act, Congress directly appropriated nearly identical language defining the scope of the Exchange Act's application that appears in subsection (b) of Section 30 of the Exchange Act, [132] indicating that Congress intended the territorial application of Title VII to entities and transactions in the security-based swap market to follow similar principles to those applicable to the securities market under the Exchange Act. [133]

In light of this similar language, commenters have urged us to follow a territorial approach in applying Title VII to cross-border security-based swap activity. [134] We preliminarily agree that a territorial approach, if properly tailored to the characteristics of the security-based swap market, should help ensure that our regulatory framework focuses on security-based swap activity that is most likely to raise the concerns that Congress intended to address in Title VII, including the effects of security-based swap activity on the financial stability of the United States, on the transparency of the U.S. financial system, and on the protection of counterparties.

We differ from commenters, however, in our understanding of what a territorial approach means in the context of a global security-based swap market. As noted above, some commenters suggested that the security-based swap activity of foreign branches and affiliates of U.S. persons with non-U.S. persons occurs outside the United States and has only an indirect connection with the United States and that, therefore, subjecting transactions resulting from that activity to Title VII would involve extraterritorial application of the statute. [135] Although we recognize that some of the security-based swap activity involving these foreign branches and affiliates occur outside the United States, we believe that a properly tailored territorial approach should look to both the full range of activities described in the statutory text as well as to the concerns that Congress intended Title VII to address in determining whether the relevant activity, considered in its entirety, occurs at least in part within the United States. [136]

As noted above, security-based swap transactions differ from most traditional securities transactions in that they give rise to an ongoing obligation between the counterparties to the trade: the counterparties bear the risks that result from those transactions for the duration of the transactions. [137] The Dodd-Frank Act was enacted, in part, to address the risks to the financial stability of the United States posed by entities bearing such risks, and a territorial approach to the application of Title VII should be consistent with achieving these statutory purposes. A territorial approach to the application of Title VII that excluded from the application of Title VII any activity conducted by the foreign operations of a U.S. person where they do business only with non-U.S. counterparties located outside the United States would likely fail to achieve the financial stability goals of Title VII, as such an approach would not account for the security-based swap risks that may be borne by entities located within the United States whose foreign operations solicit, negotiate, or execute transactions outside the United States. In addition, it is not clear that a different territorial approach that focused solely on the location of the entity bearing the risk (and disregarded whether certain relevant activity, including execution of the transaction, occurred within the United States) would adequately address the Dodd-Frank Act's concern with promoting transparency in the U.S. financial system and protecting counterparties, concerns that are likely to be raised by the solicitation, negotiation, or execution within the United States, even if the risk arising from those security-based swaps transactions is borne by entities outside the United States. For example, some transactions characterized by commenters as occurring outside the United States, even with non-U.S. persons, are entered into by persons located within the United States and would appear to raise the same types of risk concerns as transactions occurring wholly within the United States.

Similarly, the Commission preliminarily believes that a territorial approach should be informed by the text of the statutory provision that imposes the registration or other regulatory requirement. [138] Some commenters suggested, for instance, that a territorial approach would necessarily exclude certain foreign operations of U.S. persons from registration as security-based swap dealers so long as they did not enter into security-based swap transactions with counterparties located within the United States. [139] However, in this instance, these commenters did not show how their suggested approach relates to the statutory definition of security-based swap dealer or to the rules and interpretation adopted by the Commission and the CFTC to further define “security-based swap dealer” in the Intermediary Definitions Adopting Release, including our discussion of conduct that is indicative of dealing activity. [140] In our preliminary view, we should identify the activity that the statutory provision regulates before reaching a determination of whether relevant activity is occurring within the United States. [141] Only after we identify the activity that the statutory provision regulates would we then be able to determine whether the conduct at issue involves activity that the statutory provision regulates and whether this conduct occurs within the United States. To the extent that conduct involving activity that the statutory provision regulates occurs within the United States, application of Title VII to that conduct would be consistent with a territorial approach.

(b) Territorial Approach to Application of Title VII Security-Based Swap Dealer Registration Requirements

We discuss our application of this approach with respect to each of the major Title VII registration categories and requirements in connection with reporting, public dissemination, clearing, and trade execution for security-based swaps in further detail in the sections below, [142] but for sake of illustration, we provide a brief overview of our territorial approach as it applies to the security-based swap dealer definition.

Section 3(a)(71) of the Exchange Act [143] defines security-based swap dealer as a person that engages in any of the following types of activity:

(i) Holding oneself out as a dealer in security-based swaps,

(ii) making a market in security-based swaps,

(iii) regularly entering into security-based swaps with counterparties as an ordinary course of business for one's own account,

(iv) engaging in any activity causing oneself to be commonly known in the trade as a dealer in security-based swaps. [144]

We have further interpreted this definition by jointly adopting interpretive guidance with the CFTC that identifies the types of activity that is relevant in determining whether a person is a security-based swap dealer. [145] In this interpretive guidance, we have identified indicia of security-based swap dealing activity to include the following activities:

  • Providing liquidity to market professionals or other persons in connection with security-based swaps,
  • seeking to profit by providing liquidity in connection with security-based swaps,
  • providing advice in connection with security-based swaps or structuring security-based swaps,
  • having a regular clientele and actively soliciting clients,
  • using inter-dealer brokers, and
  • acting as a market maker on an organized security-based swap exchange or trading system. [146]

As the foregoing list of relevant activities illustrates, both the statutory text and our interpretation of that text include within the security-based swap dealer definition a range of activities. The broad scope of activities listed above identifies various characteristics of dealing activity. Given the risks associated with dealing activity that the dealer definition and associated regulatory framework in Title VII are intended to address, we preliminarily believe that a territorial approach consistent with these statutory purposes should consider whether the entity performs any of these indicia of dealing activity within the United States (even if some of these indicia also arise in activity conducted outside the United States). This type of analysis appears to us more consistent with the statutory text and with the Supreme Court's approach to statutory analysis in its decision in Morrison than an approach that excludes from jurisdiction certain foreign operations of U.S. persons transacting with foreign counterparties. We also believe that our proposed approach would better help ensure that our regulatory framework achieves the various purposes of security-based swap dealer regulation under Title VII, while avoiding application of security-based swap dealer registration to persons whose dealing activity is unlikely to raise the types of dealer-specific risks that Title VII dealer registration was intended to address because it occurs entirely outside the United States. [147]

Under our proposed territorial approach to the security-based swap dealer definition, as explained further below, we would require persons resident or organized in the United States, or with their principal place of business in the United States, to count all of their dealing transactions toward their de minimis threshold, including transactions that arise from dealing activity that occurs in part outside the United States (for example, because it is negotiated and executed through that person's foreign branch or office). [148]

An interpretation of Section 30(c) that advances the view that security-based swap activity conducted by a U.S. person through a foreign branch constitutes activity “without the jurisdiction of the United States” or that a transaction arising from such activity constitutes “transacting a business in security-based swaps without the jurisdiction of the United States” for purposes of Section 30(c) may not fully account for the statutory definition of “security-based swap dealer,” the purposes of Title VII, or the global nature of the security-based swap market. It does not account for the entire range of activities performed by entities active in the security-based swap market, including security-based swap dealers, and the relevance of such activities to the statutory definitions and requirements, given the purposes of Title VII, and it would leave unaddressed significant levels of activity that poses precisely the sorts of risks that Title VII was intended to address.

In our preliminary view, to the extent that a U.S. person engages in dealing activity through a foreign operation that is part of the U.S. legal person (such as a foreign branch or office), relevant activity for purposes of the security-based swap dealer definition occurs, at least in part, within the United States because we believe it is the U.S. entity as a whole, and not just the foreign branch or office, that is holding itself out as a dealer and making a market in security-based swaps. Moreover, it is necessarily the U.S. person as a whole that is seeking to profit by providing liquidity and engaging in market-making in security-based swaps, and it is the financial resources of the entire entity that enable it to provide liquidity and engage in market-making in connection with security-based swaps. Its dealing counterparties will look to the entire U.S. person, and not just the foreign branch or office, for performance on the transaction. The entire U.S. person assumes, and stands behind, the obligations arising from the resulting agreement. For these reasons, to the extent that a dealer resides or is organized, or has its principal place of business, within the United States, we believe that it cannot hold itself out as a security-based swap dealer, even through a foreign branch, as anything other than a single person, given that it generally could not operate as a dealer absent the financial and other resources of the entire U.S. person. Its dealing activity with all of its counterparties, including dealing activity conducted through its foreign branch or office, is best characterized as occurring, at least in part, within the United States and should therefore be counted toward the entity's de minimis threshold.

More generally, we preliminarily believe that transactions that create ongoing obligations that are borne by a U.S. person are properly described as directly occurring within the United States, particularly given Title VII's focus on, among other things, addressing risks to the financial stability of the United States. [149] Indeed, the history of AIG FP confirms that such transactions of U.S. persons can pose risks to the U.S. financial system even if they are conducted through foreign operations. The nature of such risks, and their role in the financial crisis and in the enactment of Title VII, suggest that the statutory framework established by Congress and the objectives of Title VII may require a broader analysis than excluding transactions involving U.S. persons from the application of Title VII solely because they are conducted through operations outside the United States, while others by the same U.S. persons occur within the United States. [150]

However, we preliminarily believe that non-U.S. persons engaged in dealing activity would be required to count toward their de minimis thresholds only transactions arising from their dealing activity with U.S. persons [151] or dealing activity otherwise conducted within the United States. In addition, to the extent that a non-U.S. person engages in security-based swap dealing activity within the United States, we preliminarily believe that such dealing activity should be counted toward the non-U.S. person's de minimis threshold regardless of whether its counterparties are U.S. persons. [152] This view is consistent with the fact that such security-based swap activity raises the types of concerns that the Dodd-Frank Act was intended to address.

We preliminarily believe that a non-U.S. person not engaged in any security-based swap activity within the United States (or engaged only at levels below the de minimis threshold) is unlikely to pose the types of concerns within the U.S. financial system that Title VII dealer regulation was intended to address. [153] Thus, under our proposed approach, a non-U.S. person that engages in dealing activity entirely outside the United States (i.e., does not enter into transactions with a U.S. person or otherwise conduct any part of its dealing activity within the United States) would not be required to register as a security-based swap dealer. [154]

(c) Application of Other Title VII Requirements to Registered Entities

We are proposing to apply the Title VII requirements associated with registration (including, among others, capital and margin requirements and external business conduct requirements [155] ) to the activities of registered entities to the extent we have determined that doing so advances the purposes of Title VII. [156] Although some commenters suggested that a territorial approach would prohibit the Commission from applying Title VII to the foreign security-based swap activities of even registered entities, such an interpretation of the application of Title VII to registered entities is difficult to reconcile with the statutory language describing the requirements applicable to registered security-based swap dealers, with the text of Section 30(c), [157] or with the purposes of Title VII and the nature of risks in the security-based swap market as described above. We have long taken the view that an entity that has registered with the Commission subjects itself to the entire regulatory system governing such registered entities. [158]

(d) Application of Title VII Regulatory Requirements to Transactions of Foreign Entities Receiving Guarantees From U.S. Persons

We also are proposing to apply certain Title VII transaction-level requirements (e.g., mandatory clearing, reporting and dissemination, and mandatory trade execution of security-based swaps) to certain transactions involving one or more non-U.S. persons whose performance under the security-based swaps is guaranteed by a U.S. person. We discuss the statutory basis for applying specific Title VII requirements to such transactions in the relevant substantive discussions below. [159] In this subsection, we briefly explain why we believe that a territorial approach that is consistent with the purposes and text of the Dodd-Frank Act supports the application of Title VII to such transactions.

In a security-based swap transaction between two non-U.S. persons where the performance of at least one side of the transaction is guaranteed by a U.S. person, the guarantee gives the guaranteed entity's counterparty direct recourse to the U.S. person for performance of obligations owed by the guaranteed entity under the security-based swap, [160] and the U.S. guarantor exposes itself to the security-based swap risk as if it were a direct counterparty to the security-based swap through the security-based swap activity engaged in by the guaranteed entity. As a result, the guarantee creates risk to the U.S. financial system and counterparties (including U.S. guarantors) to the same degree as if the transaction were entered into directly by a U.S. person. In addition, in many cases, the counterparty would not enter into the transaction (or would not do so on the same terms) with the guaranteed entity, and the guaranteed entity would not be able to engage in any security-based swaps, absent the presence of the guarantee. Given that the guarantee is provided by a U.S. person and poses risks to the U.S. financial system, and considering the reliance by both the guaranteed entity and its counterparty on the creditworthiness of the guarantor in the course of engaging in security-based swap transactions and for the duration of the security-based swap, we preliminarily believe that a transaction entered into by a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person is within the United States by virtue of the involvement of the U.S. guarantor in the security-based swap. Therefore, we preliminarily believe that subjecting such transactions to Title VII is consistent with our territorial approach.

(e) Regulations Necessary or Appropriate to Prevent Evasion of Title VII

As noted above, several commenters expressed the view that Section 30(c) of the Exchange Act restricts the Commission's authority to apply amendments made to the Exchange Act by Title VII to “extraterritorial” conduct. Section 30(c) provides the Commission with the express authority to prescribe rules and regulations for persons that transact a business in security-based swaps without the jurisdiction of the United States to the extent the Commission determines that doing so is necessary or appropriate to prevent evasion. Some commenters have expressed the view that this authority extends to “extraterritorial” activity only when such activity is intended to evade Title VII or to conceal a domestic violation of Title VII, suggesting that Section 30(c) prohibits application of Title VII to transactions by foreign affiliates or operations established for a legitimate business purpose, as the existence of such a purpose is evidence that the conduct is not intended to be evasive. [161]

While recognizing the concerns expressed by commenters, the Commission preliminarily believes that Section 30(c) does not require the Commission to find actual evasion in order to invoke our authority to reach activity “without the jurisdiction of the United States.” Section 30(c) also does not require that every particular application of Title VII to security-based swap activity “without the jurisdiction of the United States” address only business that is transacted in a way that evades Title VII. Section 30(c) authorizes the Commission to apply Title VII to persons transacting a business “without the jurisdiction of the United States” if they violate rules that the Commission has prescribed as “necessary or appropriate to prevent the evasion of any provision” of Title VII. The focus of this provision is not whether such rules impose Title VII requirements only on entities engaged in evasive activity but whether the rules are generally “necessary or appropriate” to prevent evasion of Title VII. In other words, Section 30(c) permits the Commission to impose prophylactic rules intended to prevent possible evasion, even if they affect both evasive and non-evasive conduct. Thus, under our preliminary proposed interpretation of Section 30(c), the statute permits us to prescribe such rules to conduct without the jurisdiction of the United States, even if those rules would also apply to a market participant that has been transacting business through a pre-existing market structure such as a foreign branch or guaranteed foreign affiliate established for valid business purposes, provided the proposed rule or interpretation is designed to prevent possible evasive conduct. [162]

C. Principles Guiding Proposed Approach to Applying Title VII in the Cross-Border Context

In considering how to apply Title VII in the cross-border context, the Commission has been mindful of the global nature of the security-based swap market and the types of risks created by security-based swap activity to the U.S. financial system and market participants, as well as the needs of a well-functioning security-based swap market. [163] We also have been guided by the purpose of the Dodd-Frank Act [164] and the applicable requirements of the Exchange Act, including the following:

  • Risk to the U.S. Financial System—The Dodd-Frank Act was intended to promote, among other things, the financial stability of the United States by limiting/mitigating risks to the financial system. [165]
  • Transparency—The Dodd-Frank Act was intended to promote transparency in the U.S. financial system. [166]
  • Counterparty Protection—The Dodd-Frank Act adds provisions to the Exchange Act relating to counterparty protection, particularly with respect to “special entities.” [167]
  • Economic Impacts—The Exchange Act requires the Commission to consider the impact of our rulemakings on efficiency, competition, and capital formation. [168]
  • Harmonization with Other U.S. Regulators—In connection with implementation of Title VII, the Dodd Frank Act requires the Commission to consult and coordinate with the CFTC and prudential regulators to ensure “regulatory consistency and comparability, to the extent possible.” [169]
  • Consistent International Standards—To promote effective and consistent global regulation of swaps and security-based swaps, the Dodd-Frank Act requires the Commission and the CFTC to consult and coordinate with foreign regulatory authorities on the “establishment of consistent international standards” with respect to the regulation of swaps and security-based swaps. [170] In this regard, the Commission recognizes that regulators in other jurisdictions are currently engaged in implementing their own regulatory reforms of the OTC derivatives markets and that our proposed application of Title VII to cross-border activities may affect the policy decisions of these other regulators as they seek to address potential conflicts or duplication in the regulatory requirements that apply to market participants under their authority. [171]
  • Anti-Evasion—The Dodd-Frank Act amends the Exchange Act to provide the Commission with authority to prescribe rules and regulations as necessary or appropriate to prevent the evasion of any provision of the Exchange Act that was added by the Dodd-Frank Act. [172]

At times these principles reinforce one another; at other times they compete with each other. For instance, attempts to regulate risk posed to the United States may, depending on what is proposed, make it more costly for U.S.-based firms to conduct security-based swap business, particularly in foreign markets, compared to foreign firms, or could make foreign firms less willing to deal with U.S. persons. On the other hand, attempts to provide U.S. persons greater access to foreign security-based swap markets may, depending on what is proposed, fail to appropriately address the risk posed to the United States from transactions conducted outside the United States or create opportunities for market participants to evade the application of Title VII, particularly until such time as global initiatives to regulate the derivatives markets are fully enacted and implemented.

Balancing these sometimes competing principles is complicated by the fact that Title VII imposes a new regulatory regime on a marketplace that already exists as a functioning, global market. Title VII establishes reforms that will have implications for entities that compete internationally in the global security-based swap market. As we have formulated our proposal, we have generally sought, in accordance with the statutory factors described above, to avoid creating opportunities for regulatory arbitrage or evasion or the potential for duplicative or conflicting regulations. We also have considered the needs for a well-functioning security-based swap market and for avoiding disruption that may reduce liquidity, competition, efficiency, transparency, or stability in the security-based swap market.

D. Conclusion

Consistent with the principles and requirements outlined above, we are proposing to structure our implementation of Title VII around an approach that focuses on identifying market participants whose presence or activity within the United States or activity involving market participants within the United States may give rise to the types of risk to the U.S. financial system and counterparties that Title VII seeks to address, as described more fully below in the subsequent sections of the release.

Request for Comment

The Commission requests comment on all aspects of the discussion and analysis above, including the following:

  • Is our understanding of the global nature of the security-based swap market accurate? If not, why not? Please elaborate.
  • Is our understanding of the dealing structures used by U.S. and non-U.S. persons accurate? If not, why not? Are there other dealing structures used by market participants? If so, please elaborate.
  • Is our understanding of clearing, reporting, and trade execution practices accurate? If not, why not? Please elaborate.
  • As discussed above in Section II.B.1, some commenters recommend a narrower approach to the cross-border application of Title VII than this proposal sets forth. We request further comment on these and any other potential alternative approaches to determining the extent to which Title VII should be applied to cross-border transactions, non-U.S. persons, and registered entities.

III. Security-Based Swap Dealers Back to Top

A. Introduction

Among the market participants subject to regulation under Title VII as a result of their security-based swap activities are security-based swap dealers. [173] As discussed above, a “security-based swap dealer” generally is defined as any person that (i) Holds itself out as a dealer in security-based swaps; (ii) makes a market in security-based swaps; (iii) regularly enters into security-based swaps with counterparties as an ordinary course of business for its own account; or (iv) engages in any activity causing the person to be commonly known in the trade as a dealer or market maker in security-based swaps. [174] The Commission, jointly with the CFTC, issued final rules and interpretive guidance to further define the term security-based swap dealer, [175] including rules implementing the de minimis exception. [176] As part of these final rules and interpretive guidance, the Commission stated that the relevant statutory provisions suggest that, rather than focusing solely on the risk these entities pose to the financial markets, we should interpret the “security-based swap dealer definition in a way that identifies those persons for which regulation is warranted either: (i) [D]ue to the nature of their interactions with counterparties; or (ii) to promote market stability and transparency, in light of the role those persons occupy within the security-based swap markets.” [177] Security-based swap dealers are subject to a comprehensive regulatory regime under Title VII. The statutory provisions added to the Exchange Act by Title VII are intended to provide for financial responsibility associated with security-based swap dealers' activities (e.g., the ability to satisfy obligations and the protection of counterparties' funds and assets), and other counterparty protections, as well as market stability and transparency. [178]

By its terms, application of the security-based swap dealer definition set forth in Section 3(a)(71) of the Exchange Act [179] does not depend on whether a security-based swap dealer or its counterparty is a U.S. person. [180] Rather, the security-based swap dealer definition encompasses persons engaged in security-based swap dealing activities without regard to the geographic location or legal residence of either the dealing person or such person's counterparties. The Commission did not provide guidance on the application of the security-based swap dealer definition to non-U.S. persons or to U.S. persons that conduct dealing activities in the cross-border context in either our proposed or final rules. [181] As discussed above [182] and as further discussed below, market participants, foreign regulators, and other interested parties have raised concerns regarding, among other things, the application of Title VII to non-U.S. persons that engage in security-based swap dealing activity and U.S. persons who conduct dealing activities “outside the United States.” [183]

The rules and interpretations described below represent the Commission's proposed approach to applying the security-based swap dealer definition to non-U.S. persons and to U.S. persons who conduct dealing activities in the cross-border context in light of the principles discussed above. [184] Our proposal reflects a particular balancing of these principles, informed by, among other things, the particular nature of the security-based swap market, [185] the structure of security-based swap dealing activity, [186] and our experience in applying the federal securities laws in the cross-border context in the past. [187] We recognize that other approaches are possible to achieve the goals of the Dodd-Frank Act, in whole or in part. Accordingly, we invite comment regarding all aspects of the proposal described below, and each proposed rule and interpretation contained therein, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of each proposed rule and interpretation and potential alternative approaches will be particularly useful to the Commission in evaluating possible modifications to the proposal.

B. Registration Requirement

1. Introduction

In the Intermediary Definitions Adopting Release, which was adopted jointly with the CFTC, the Commission set forth a de minimis threshold of security-based swap dealing that takes into account the notional amount of security-based swap positions connected with a person's security-based swap dealing activity over the prior 12 months. [188] When a person engages in security-based swap dealing in connection with transactions above that threshold, such person meets the definition of a security-based swap dealer under Section 3(a)(71) of the Exchange Act, [189] and the rules and regulations thereunder, [190] and is required to register as a security-based swap dealer with the Commission pursuant to Section 15F(a)(1) of the Exchange Act. [191]

The de minimis exception in Section 3(a)(71) of the Exchange Act is silent on its application to the cross-border security-based swap dealing activity of U.S. persons and non-U.S. persons, and the Commission did not address this issue in the Intermediary Definitions Adopting Release. [192] Without additional Commission guidance, it would be unclear how persons would be required to calculate the notional amount of their security-based swaps for purposes of the de minimis exception based on their global book of security-based swap dealing activity. In addition, as discussed below, commenters have raised questions regarding how the de minimis threshold should be applied in the cross-border context, expressing concern that, among other things, if a non-U.S. person were required to register as a security-based swap dealer with the Commission because its security-based swap dealing activity exceeded the de minimis threshold, it might be subject to duplicative and potentially conflicting requirements by the Commission and a foreign jurisdiction. [193]

Under the Commission's proposal, as described more fully in the following subsections of this release, a non-U.S. person [194] would be required to register as a security-based swap dealer with the Commission pursuant to Section 15F(a)(1) of the Exchange Act [195] if the notional amount of security-based swap positions connected with its security-based swap dealing activity [196] with U.S. persons (other than with foreign branches of U.S. banks) [197] or otherwise conducted within the United States [198] exceeds the de minimis threshold in the security-based swap dealer definition. [199] Thus, a non-U.S. person with a global security-based swap dealing business, but whose positions connected with its security-based swap dealing activity with U.S persons (other than with foreign branches of U.S. banks) or otherwise conducted within the United States fall below the de minimis threshold, would not be required to register with the Commission as a security-based swap dealer. [200] A U.S. person, by contrast, would be required to count all of its security-based swap transactions (including transactions conducted through a foreign branch), [201] conducted in a dealing capacity, toward the de minimis threshold to determine whether it would be required to register as a security-based swap dealer with the Commission pursuant to Section 15F(a)(1) of the Exchange Act. [202]

As further discussed below, however, we are not proposing to require a non-U.S. person engaged in security-based swap dealing activity to count a transaction with a non-U.S. person conducted outside the United States toward its de minimis threshold, even if its performance (or the performance of its counterparty) on the security-based swap is guaranteed by a U.S. person. [203] In addition, in conformity with the position that the Commissions took in the Intermediary Definitions Adopting Release, [204] we are not proposing to require cross-border security-based swap transactions between majority-owned affiliates to be considered when determining whether a person is a security-based swap dealer. [205]

In the following subsections, we first briefly discuss the Commission's approach to the registration of foreign brokers and dealers, as background, and the views of commenters on the application of Title VII to cross-border activities, particularly as such views relate to security-based swap dealing activity. Then we propose a rule regarding the application of the de minimis exception to cross-border security-based swap dealing activity. [206] In order to give further definition to this proposed rule, we are proposing rules defining a number of relevant terms, including “U.S. person” [207] and “transaction conducted within the United States.” [208] We also are proposing a rule excluding from a non-U.S. person's de minimis calculation security-based swap transactions entered into, in a dealing capacity, with a foreign branch of a U.S. bank. [209] In addition, we are proposing a rule providing an exception from the aggregation requirement, in the context of the security-based swap dealer definition, for affiliated groups with a registered security-based swap dealer. [210] Finally, we are proposing interpretive guidance regarding and requesting comment on the treatment of inter-affiliate and guaranteed transactions in the cross-border context for purposes of the de minimis threshold. [211]

2. Background Discussion Regarding the Registration of Foreign Brokers and Dealers

Under the Commission's traditional approach to the registration of brokers and dealers under the Exchange Act, registration and other requirements generally are triggered by a broker or dealer physically operating in the United States, even if such activities are directed only to non-U.S. persons outside the United States. [212] The Commission's territorial approach also generally requires broker-dealer registration by foreign brokers or dealers that, from outside the United States, induce or attempt to induce securities transactions by persons within the United States. [213] By contrast, the Commission has not required foreign entities to register as broker-dealers if they conduct their “sales activities” entirely outside the United States. [214]

In addition to our territorial approach to registration of broker-dealers under the Exchange Act, the Commission traditionally has taken an “entity” approach to the application of regulation to registered broker-dealers. [215] Pursuant to this approach, we have not limited the application of the Exchange Act, and rules and regulations thereunder, solely to the transactions of such entities that result in the registration requirement. Instead, we have taken the position that a registered broker-dealer is generally subject to registration and consequent substantive requirements with respect to all of its securities activity, including the activity of its branches and offices, regardless of whether the activity occurs in the United States or with U.S. persons. [216] For instance, under this approach, if a foreign broker-dealer is required to register with the Commission as a result of conducting securities activity through a branch in the United States, the registration requirements and the regulatory system governing U.S. broker-dealers, including capital, margin, and recordkeeping requirements, would apply to the entire foreign broker-dealer entity, including its head office, not just the U.S. branch. [217] By contrast, the Commission traditionally has not extended our regulatory oversight of broker-dealers to the activities of their corporate parents, subsidiaries, or other affiliates. [218]

The Commission's approach to registration and regulation of foreign broker-dealers thus extends Commission oversight to the global activities of non-U.S.-based securities market intermediaries that are registered broker-dealers because of their securities activities with U.S. persons or that physically operate within the United States. [219] In recognition of the internationalization of securities markets, however, the Commission has used available exemptive authority to tailor rules and regulations to the specific circumstances of foreign markets and market participants. For example, we used our exemptive authority under Section 15(a)(2) of the Exchange Act to adopt Rule 15a-6 under the Exchange Act (“Rule 15a-6”), [220] which provides limited exemptions from registration to foreign brokers or dealers engaging in securities transactions, or offering to engage in securities transactions, within the United States or with U.S. persons, subject to certain conditions. [221]

3. Comment Summary

(a) Market Participants

As noted above, various commenters expressed concerns about the “extraterritorial” application of Title VII, and many of these commenters expressed particular concerns about the possible extraterritorial application of security-based swap dealer regulation and registration requirements. [222] In addition to concerns described above regarding the application of Title VII to cross-border security-based swap activity, [223] commenters noted that the derivatives industry functions in a global market and that new regulations pose the potential to disrupt this market if they do not take into account the nature of the industry and the appropriate extraterritorial reach of the regulations. [224] A consistent theme in many of these comment letters was the importance of taking into account the principles of international comity in limiting the extraterritorial reach of the proposed rules, including entering into coordination agreements with our foreign regulatory counterparts on the jurisdictional reach of U.S. and foreign derivatives rules. [225]

For example, a number of commenters recommended that the Commission take a territorial approach in determining when a person engaging in security-based swap dealing activity would be required to register with the Commission as a security-based swap dealer, generally recommending registration of an entity for its security-based swaps dealing activity from within the United States or with regard to its dealings with U.S. counterparties. [226] Several commenters further suggested that a non-U.S. person's de minimis amount of swap activities with U.S. persons should not trigger security-based swap dealer registration. [227] Some commenters expressed the view that the Commission's cross-border framework should seek to avoid imposing duplicative regulation and unnecessary cost on entities that are already regulated in a foreign jurisdiction. [228] Some commenters have suggested that the Commission use an approach that would be modeled after the approach the Commission has applied to foreign broker-dealers in Rule 15a-6 to address issues related to cross-border security- based swap transactions and foreign security-based swap dealers. [229]

For purposes of analyzing the appropriate definition of U.S. person in the security-based swap dealer context, several commenters suggested that the Commission look to rules adopted under the Securities Act and adopt a definition of U.S. person based on Regulation S under the Securities Act (“Regulation S”). [230] Some commenters stated the view that under Regulation S, only affiliates or branches located within the United States would be considered U.S. persons. [231] Some commenters argued that a foreign affiliate of a U.S. person and non-U.S. branches of a U.S. bank should be treated as non-U.S. persons and, depending on their dealing activity, not be required to register as security-based swap dealers because such entities may not have direct and significant connection with, or effect on, U.S. commerce. [232] One commenter further argued that a non-U.S. affiliate of a U.S. person, in its insolvency, is subject to separate resolution from its parent, and thus should be treated as a non-U.S. entity. [233]

Several commenters stated that a foreign branch or office of a U.S. person also should be treated as a non-U.S. person, despite the fact that, as a few commenters acknowledged, foreign branches of U.S. banks are not separate legal entities from their U.S. head office and typically are not separately capitalized, although in some cases they may be subject to certain local capital or reserve maintenance requirements. [234] Several commenters suggested that broker-dealer registration, not security-based swap dealer registration, may be more appropriate for a U.S. branch, agency, or affiliate that acts as an agent of a non-U.S. person for security-based swaps transactions. [235]

Several commenters acknowledged concerns that persons may seek to book transactions through non-U.S. branches or subsidiaries in an effort to evade the requirements of Title VII. [236] These commenters, however, urged that the Commissions not seek to address the potential for evasion through an overbroad definition of a security-based swap dealer, noting that there are legitimate business reasons for conducting security-based swap transactions with non-U.S. persons through non-U.S. operations. [237]

(b) Foreign Regulators

Foreign regulators have reached out to the Commission through correspondence and bilateral and multilateral discussions to better understand the approach being considered by the Commission, to express concern about the potential impact of potential approaches on their markets, and to seek regulatory coordination. [238] One of the principal concerns of foreign regulators is that the Commission would require foreign entities to register with the Commission and subject them to regulatory requirements that are duplicative of, or potentially conflict with, the requirements imposed by their home country or host country. [239] In their view, the Commission's application of Title VII requirements to foreign entities in jurisdictions that commit to developing or have developed similar OTC derivatives regulations would fail to acknowledge, under general principles of international comity, the effectiveness, suitability, and scope of foreign regulatory regimes and place undue regulatory burdens on foreign entities that conduct security-based swap business with U.S. persons. [240]

Such concerns from foreign regulators include comments that U.S. regulators should not ask financial institutions domiciled in their jurisdictions to register as security-based swap dealers because this would create undesirable redundancies for those financial institutions that are already regulated in the foreign jurisdiction. [241] Certain foreign regulators also argued that the Commission should not regulate foreign subsidiaries of U.S. security-based swap dealers because these entities would already be regulated by a foreign regulator. [242] Some foreign regulators expressed the expectation that the Commission would limit the registration of foreign banks as security-based swap dealers to operations conducting activities with U.S. counterparties or clients and would not apply the registration and regulation requirements to foreign banks as a whole. [243]

4. Application of the De Minimis Exception to Cross-Border Security-Based Swap Dealing Activity

The Commission recognizes the concerns raised by commenters regarding the potential for imposing inconsistent or conflicting requirements on security-based swap dealers with global operations, as well as their desire that the Commission take into account the principles of international comity when applying Title VII to cross-border dealing activity. After considering the goals of the Dodd-Frank Act and the scope of the provisions of Title VII covering security-based swap dealers, in light of the global nature of the security-based swap market, the various structures of dealing operations, and the views of commenters, the Commission is proposing an approach to the application of the Title VII registration requirement to cross-border security-based swap dealing activity that focuses on whether dealing conduct occurs with U.S. persons or otherwise occurs within the United States.

Specifically, as explained below, the Commission is proposing to require a non-U.S. person engaged in security-based swap dealing activity to register with the Commission as a security-based swap dealer pursuant to Section 15F(a)(1) of the Exchange Act [244] if the notional amount of security-based swap transactions connected with its dealing activity with U.S. persons (other than with foreign branches of U.S. banks) [245] or otherwise conducted within the United States [246] exceeds the de minimis threshold in the security-based swap dealer definition. [247] A U.S. person engaged in security-based swap dealing activity would be required to count all security-based swap transactions connected with its dealing activity toward the de minimis threshold, including transactions conducted through a foreign branch. [248]

(a) Meaning of the Term “Person” in the Security-Based Swap Dealer Definition

As a preliminary matter, we note that, as the Commission discussed in the Intermediary Definitions Adopting Release, the term “person” as used in the security-based swap dealer definition should be interpreted to refer to a particular legal person. [249] Accordingly, a trading desk, department, office, branch, or other discrete business unit that is not a separately organized legal person would not be viewed as a security-based swap dealer (regardless of where located); rather, the legal person of which it is a part would be the security-based swap dealer. [250] Similarly, the term “person” in the Commission's rules implementing the de minimis exception should be interpreted to refer to a particular legal person. [251]

Thus, the security-based swap dealer definition would apply to the particular legal person performing the dealing activity, even if that person's dealing activity is limited to a trading desk or discrete business unit. [252] The presumption is that a person who falls within the security-based swap dealer definition is a dealer with regard to all of its security-based swap activities. [253] As a result, a legal person with a branch, agency, or office that is engaged in dealing activity in connection with transactions above the de minimis threshold would be required to register as a security-based swap dealer, even if the legal person's dealing activity were limited to such branch, agency, or office. By contrast, each affiliate of a security-based swap dealer would need to separately consider whether it falls within the de minimis exception if that affiliate engages in security-based swap dealing activity. [254]

(b) Proposed Rule

We are proposing a rule identifying the types of security-based swap transactions that should be included in a person's calculation of the notional amount of security-based swap transactions connected with dealing activity for purposes of determining whether the de minimis exception excludes that dealer from the security-based swap dealer definition. [255] The proposed rule confirms that all of a U.S. person's security-based swap transactions conducted in a dealing capacity would count toward its de minimis threshold, wherever those transactions are solicited, negotiated, executed, or booked. [256] Although we recognize that some commenters have suggested that the Commission should not require U.S. persons to include positions connected with dealing activity conducted through foreign branches in calculating the amount of their dealing activity, [257] we are not proposing to adopt this approach. The security-based swap dealing activity of a foreign branch is activity of the U.S. legal person regardless of the role played by the foreign branch or the location of the security-based swap dealing activity. We believe that any dealing activity undertaken by a U.S. person occurs at least in part within the United States and therefore warrants application of Title VII, regardless of where particular dealing activity in connection with the transactions is conducted. [258] The security-based swap dealing activity of a U.S. person creates risk to the U.S. person and to the U.S. financial system, because the risk of such transactions ultimately is borne by the U.S. person, even if the transactions in connection with that dealing activity are conducted in part outside the United States, and because the U.S. person is part of the U.S. financial system. [259] To achieve the purposes of Title VII, including the reduction of systemic risk, we preliminarily believe that U.S. persons that engage in security-based swap dealing activity through foreign branches should be subject to the regulatory framework for dealers established by Congress in Title VII, even if they deal exclusively with non-U.S. persons.

By contrast, a non-U.S. person would be required to consider only the security-based swap transactions connected with its dealing activity with U.S. persons (other than foreign branches of U.S. banks) [260] or otherwise conducted within the United States [261] for purposes of the de minimis exception. [262] Under this proposed approach, a non-U.S. person would be required to calculate its security-based swap position for purposes of the de minimis threshold by adding together the notional amount of transactions connected with dealing activity with U.S. persons (other than foreign branches of U.S. banks) [263] or otherwise conducted within the United States. [264] As a result, a foreign entity with a global security-based swap dealing business, but whose transactions connected with its dealing activity with U.S. persons (other than foreign branches of U.S. banks) or otherwise conducted within the United States fall under the de minimis threshold, would not fall within the security-based swap dealer definition and, therefore, would not be required to register as a security-based swap dealer. [265]

This approach to the de minimis exception for non-U.S. persons engaged in cross-border dealing activity preliminarily appears to us to focus appropriately on a non-U.S. person's security-based swap dealing activity in the United States. In addition, this proposed approach, when combined with our broader approach to the registration and regulation of foreign security-based swap dealers, appears to us to appropriately focus our oversight on those non-U.S. persons engaged in security-based swap dealing activities that most directly impact the U.S. security-based swap market and U.S. financial system and that, therefore, warrant the application of the provisions of Title VII covering security-based swap dealers. [266]

The Commission is not proposing, as some commenters have suggested, an approach modeled on Rule 15a-6(a)(3), which would permit non-U.S. persons to conduct security-based swap dealing activity with U.S. persons without registering with the Commission if such dealing activity were intermediated by a registered security-based swap dealer. [267] The Commission preliminarily believes that such an approach would not address the risk to the U.S. financial system by dealing activity of non-U.S. persons within the United States or with U.S. persons. As a dealer, the non-U.S. person would be the party to the security-based swap transaction and, therefore, the party that bears the financial risk of such transaction and whose financial integrity is of primary concern to the Commission. This concern is heightened by the fact, noted above, that, unlike most other securities transactions, security-based swap transactions give rise to ongoing obligations between the transaction counterparties. [268] Under the alternative suggested, the important financial responsibility requirements that Title VII imposes on security-based swap dealers would not apply to the non-U.S. person with respect to that transaction. Instead, the intermediating registered security-based swap dealer would be subject to the financial responsibility rules with respect to the transaction, but since it would not be a party to, and would not bear the financial risk of, the security-based swap transaction, it would not bear the ongoing financial risk of such transaction. As a result, the financial responsibility requirements imposed on the intermediating dealer would not address the dealing risk posed by the non-U.S. person in this context. [269]

Request for Comment

The Commission requests comment on all aspects of the proposed rule regarding the application of the de minimis exception to U.S. persons and non-U.S. persons, including the following:

  • Should the proposed rule limit the de minimis test to the notional amount of a U.S. person's positions connected with its dealing activity involving transactions with other U.S. persons or otherwise conducted within the United States? For example, should the proposed rule be altered to provide that U.S. banks would not include the notional amount of transactions connected with the dealing activity of their foreign branches in the de minimis calculation, rather than counting these transactions against the de minimis threshold as required under the proposed approach? Why or why not?
  • Should the proposed rule require non-U.S. persons to count transactions with the foreign branches of U.S. banks towards their de minimis calculations? Why or why not?
  • Should the proposed rule follow an approach modeled on Rule 15a-6(a)(3), which would permit non-U.S. persons to conduct security-based swap dealing activity within the United States without registering with the Commission if those transactions were intermediated by a registered U.S. security-based swap dealer? If so, what compliance obligations, if any, should the unregistered non-U.S. person be subject to? What obligations should the U.S. security-based swap dealer be subject to with respect to such intermediated transactions, particularly with respect to capital, margin, and segregation requirements? How would this approach deal with risk concerns, especially with any security-based swaps not subject to clearing?
  • Should the proposed rule follow an approach modeled on Rule 15a-6(a)(4)(i), which would permit non-U.S. persons to conduct security-based swap dealing activity within the United States without registering with the Commission if those transactions were with a registered U.S. security-based swap dealer? If so, what conditions, if any, should the Commission impose on such an exception?
  • Should non-U.S. persons acting in a dealing capacity be required to count transactions entered into with registered security-based swap dealers toward their de minimis threshold? Why or why not? If non-U.S. persons are not required to count security-based swap transactions, conducted in a dealing capacity, with registered security-based swap dealers, should U.S. persons be required to count security-based swap transactions, conducted in a dealing capacity, with registered security-based swap dealers? If not, why not? If so, why?
  • The CFTC has proposed an interpretation that would require a non-U.S. person to consider the aggregate notional value of its swap dealing transactions (or any swap dealing transactions of its affiliates under common control) where the non-U.S. person's obligations are guaranteed by a U.S. person. [270] Should the proposed rule require a non-U.S. person whose security-based swap transactions are guaranteed by a U.S. person to count all of its security-based swap dealing transactions that are guaranteed by a U.S. person toward the de minimis threshold, even if they are not entered into with U.S. persons or otherwise conducted within the United States?
  • Should the proposed rule require counting against the de minimis threshold the notional amount of a non-U.S. person's transactions entered into in its dealing capacity within the United States or with a U.S. person? Should a non-U.S. person be required instead to aggregate the total worldwide notional amount of its security-based swap transactions entered into in a dealing capacity, regardless of the geographic location of the dealing activity or the counterparty's status as a U.S. person if it engages in any dealing transactions with U.S. persons? Why or why not?
  • What circumstances, if any, would justify requiring a non-U.S. person to register with the Commission if its dealing activity arising from its transactions with non-U.S. persons outside the United States would exceed the de minimis threshold if it had been conducted within the United States or with U.S. persons but the non-U.S. person enters into transactions within the United States or with U.S. persons solely in a non-dealing capacity?
  • What circumstances would justify following a different territorial approach that would treat transactions connected with the dealing activity conducted by a U.S. person through its foreign locations with non-U.S. persons as outside the United States and not required to be counted against such U.S. person's de minimis threshold?
  • Does the Commission's proposed approach adequately address the concerns of FPSFIs? Is our understanding of the security-based swap activity of FPSFIs accurate? If not, please explain.
  • What would be the market impact of the proposed approach to apply the de minimis exception in the cross-border context? How would the proposed application of the de minimis exception to U.S. persons and non-U.S. persons affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the de minimis exception? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

5. Proposed Definition of “U.S. Person”

Introduction

The proposed rule defining “U.S. person” would identify a person's status as a U.S. person for purposes of applying the calculation for the de minimis exception in the cross-border context. [271] The proposed definition of U.S. person generally follows an approach to defining U.S. person similar to that used by the Commission in other contexts. [272] Specifically, the proposed rule would define U.S. person to mean any of the following:

  • Any natural person resident in the United States;
  • Any partnership, corporation, trust, or other legal person organized or incorporated under the laws of the United States [273] or having its principal place of business in the United States; or
  • Any account (whether discretionary or non-discretionary) of a U.S. person. [274]

The proposed rule also would provide that the term “U.S. person” would not include the following international organizations: The International Monetary Fund (“IMF”), the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans. [275]

We preliminarily believe that the proposed definition of U.S. person would achieve three objectives necessary to effective application of Title VII in the cross-border context. First, it would identify those types of individuals or entities that, by virtue of their location within the United States or their legal or other relationship with the United States, are likely to impact the U.S. market even if they transact with security-based swap dealers that are not U.S. persons. [276] Second, it would identify those types of individuals or entities that, by virtue of their location within the United States or their legal or other relationship with the United States, are part of the U.S. security-based swap market and should receive the protections of Title VII. Third, it would permit us to identify dealing entities that most likely would be active in the U.S. security-based swap market and whose dealing activity most likely would pose a risk to the U.S. financial system by virtue of their counterparties' resident or domicile status.

Because of the nature of the risks posed by security-based swaps, which are borne by the entire corporate entity even if the transaction is entered into by a specific trading desk, office, or branch of such entity, consistent with the Commission's approach to the meaning of “person” in the security-based swap dealer definition, as discussed above, we are proposing to define the term “U.S. person” to include the entire entity, including its branches and offices that may be located in a foreign jurisdiction. [277] Thus, under this approach, the term “U.S. person” would be interpreted to include any foreign trading desk, office, or branch of an entity that is organized under U.S. law or whose principal place of business is located in the United States. [278]

(b) Discussion

i. Natural Persons

Under the proposed rule, any natural person resident in the United States would be a U.S. person, regardless of that individual's citizenship status. [279] Individuals resident abroad, on the other hand, would not be treated as U.S. persons, even if they possess U.S. citizenship. [280] We preliminarily believe that natural persons residing within the United States who engage in security-based swap transactions may raise the types of concerns intended to be addressed by Title VII, including those related to transparency and customer protection. [281] We also note that this approach is generally consistent with the approach we have taken in prior rulemakings relating to the cross-border application of certain similar regulatory requirements. [282] Moreover, any risk to such person arising from its security-based swap activity may manifest itself most directly within the United States, where a significant portion of its commercial and legal relationships exist because that is where its residency is (unlike a U.S. citizen resident abroad).

ii. Corporations, Organizations, Trusts, and Other Legal Persons

Under the proposed rule, any partnership, corporation, trust, or other legal person organized or incorporated under the laws of the United States [283] or having as its principal place of business in the United States would be a U.S. person. [284] We have previously looked to an entity's place of organization or incorporation to determine whether it is a U.S. person in adopting rules under the federal securities laws, [285] and we preliminarily believe that it is also appropriate to do so in the context of Title VII. We preliminarily believe that the decision of a corporation, trustee, or other entity to organize under the laws of the United States indicates a degree of involvement in the U.S. economy or legal system that warrants ensuring that its security-based swap activity is subject to the requirements of Title VII. [286]

Similarly, we believe that the proposed definition should ensure that Title VII applies to entities that are organized or incorporated in a jurisdiction outside the United States if they have their principal place of business in the United States. [287] Any risk to such entities arising from their security-based swap activity is likely to manifest itself most directly within the United States, where a significant portion of their commercial and legal relationships would be likely to exist. Moreover, focusing exclusively on whether an entity is organized or incorporated in the United States could encourage some entities that are currently organized or incorporated in the United States to incorporate in a non-U.S. jurisdiction to avoid the costs of complying with Title VII while maintaining their principal place of business—and thus in all likelihood, the risks arising from their security-based swap transactions—within the United States. To prevent this possibility, we are proposing to define “U.S. person” to include entities that are organized or incorporated abroad but have their principal place of business within the United States. [288]

An entity's status as a U.S. person under the proposed rule would be determined at the legal entity-level and thus apply to the entire legal entity, including any foreign operations that are part of the U.S. legal entity. [289] Consistent with this entity-level approach, a foreign branch, agency, or office of a U.S. person would be treated as a U.S. person under the proposed definition. [290] As the Commission noted in proposing Regulation SBSR, “[b]ecause a branch or office has no separate legal existence under corporate law, the branch or office would be an integral part of the U.S. person itself.” [291] In other words, because a branch or office is merely an extension of the head office, not a separately incorporated or organized legal entity, we preliminarily believe that it lacks the legal independence to be considered a non-U.S. person for purposes of Title VII if its head office is a U.S. person. We preliminarily believe a wholesale exclusion from the requirements of Title VII for a foreign branch, agency, or office of a U.S. person is not warranted with respect to its security-based swap transactions because the legal obligations and economic risks associated with the transactions directly affect a U.S. person, of which the branch, agency, or office is merely a part.

Under the proposed definition, the status of an entity as a U.S. person would have no bearing on whether separately incorporated or organized legal entities in its affiliated corporate group are U.S. persons. Accordingly, a foreign subsidiary of a U.S. person would not be a U.S. person by virtue of its relationship with its U.S. parent. Similarly, a foreign entity with a U.S. subsidiary would not be a U.S. person simply by virtue of its relationship with its U.S. subsidiary. [292] The Commission preliminarily believes that it is appropriate to treat each affiliate separately because of the distinct legal status of each of the affiliates. [293]

iii. Accounts of U.S. Persons

Consistent with the proposed definition's focus on the location of the person bearing the actual risk arising from the security-based swap transaction, the proposed definition of U.S. person would include any accounts (whether discretionary or not) of U.S. persons. [294] Such accounts would be U.S. persons regardless of whether the entity at which the account is held or maintained is a U.S. person. Conversely, accounts of non-U.S. persons would not be U.S. persons solely because they are held by a U.S. financial institution or other entity that is itself a U.S. person. [295] In our view, the purposes of Title VII require that its provisions apply to the person that actually bears the risks arising from the security-based swap transaction. [296] For this reason, we preliminarily believe that the status of accounts, wherever located, should turn on whether any owner of the account is itself a U.S. person, [297] and not on the status of the fiduciary or other person managing the account, the discretionary or non-discretionary nature of the account, or the status of the entity at which the account is held or maintained. [298] Thus any account of a U.S. person would be a U.S. person for purposes of Title VII.

iv. International Organizations

In addition to identifying the persons that fall within the U.S. person definition, the proposed rule also provides a list of specific international organizations that do not fall within such definition. [299] This list includes “the International Monetary Fund, the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans.” [300] Although these organizations may have headquarters in the United States, the Commission preliminarily believes that most of their membership and financial activity are outside the United States. Thus, based on the nature of these entities as international organizations the Commission is proposing not to treat them as U.S. persons for purposes of Title VII. [301]

(c) Conclusion

In short, by following a territorial approach, the Commission preliminarily believes that the proposed definition of U.S. person describes the types of individuals and entities residing, organized, or conducting business within the United States, and the types of accounts that should be designated as U.S. persons for purposes of the proposed rule regarding application of the de minimis exception to security-based swap dealers. [302]

Request for Comment

The Commission requests comment on all aspects of the proposed definition of “U.S. person,” including the following:

  • Does the proposed definition of “U.S. person” appropriately address the concerns of security-based swap dealer regulation under Title VII?
  • Does the proposed definition appropriately identify all individuals or entities that should be designated as U.S. persons? Is the proposed definition too narrow or too broad? Why? Do the proposed criteria for determining whether an entity is a U.S. person effectively describe the types of counterparties that are relevant to identifying the transactions a security-based swap dealer must count when calculating its de minimis threshold for purposes of determining whether it is required to register as a security-based swap dealer and comply with the requirements of Title VII? Does the proposed definition appropriately identify the types of entities that should be entitled to the protections afforded to counterparties of security-based swap dealers under Title VII?
  • Does the proposed definition appropriately treat natural persons residing in the United States as U.S. persons? Should certain categories of persons residing in the United States be excluded from the definition of U.S. person? Should certain categories of persons (such as U.S. citizens or permanent residents) residing abroad be included in the definition of U.S. person? Please explain why excluding or including particular categories of natural persons would be consistent with and further the objectives of dealer regulation under Title VII.
  • Is the proposed approach to the U.S. person status of natural persons based on residency, rather than citizenship, appropriate? In particular, is the proposed approach to natural persons, which differs from the proposed approach to legal entities, such as partnerships and corporations, appropriate in light of the fact that, as the Commission understands, natural persons rarely enter into security-based swaps?
  • Does incorporation or organization under the laws of the United States appropriately define the types of entities (both for-profit and non-profit) that should be treated as U.S. persons under Title VII? Is it appropriate to define an entity as a U.S. person if it has its principal place of business in the United States, even if it is incorporated or organized under the laws of a foreign jurisdiction? Why or why not?
  • Does the proposed rule adequately address the risk of evasion or avoidance of Title VII requirements? Are there entities incorporated or organized under foreign law that should be defined as a U.S. person under the proposed rule that are not currently so defined? For example, should an entity incorporated or organized under foreign law but whose security-based swap transactions are guaranteed by a U.S. person be defined as a U.S. person? Why or why not? Should a foreign entity that conducts security-based swap dealing activity predominantly with U.S. persons or within the United States be defined as a U.S. person? If so, why?
  • Is it appropriate to determine the U.S. person status of a corporation or organization on an entity-wide basis? Why or why not? Should foreign branches, offices, or agencies of U.S. persons be U.S. persons? Why or why not? What distinguishes transactions mediated or entered into by a foreign branch of a U.S. bank from transactions entered into by the head office of such U.S. bank for purposes of Title VII regulation?
  • What, if any, competitive concerns would be raised by defining foreign branches, offices, or agencies of U.S. persons as non-U.S. persons? Please explain the mechanism of any competitive effects. For example, would particular business structures become unworkable under this approach and what would be the relevant impact? If so, please explain possible alternatives and their relative competitiveness.
  • Should the proposed rule include within the definition of U.S. person foreign affiliates of U.S. persons? Should other factors be taken into account in determining the status of such affiliated entities, such as, for example, whether performance on the security-based swap obligations of the foreign entity is guaranteed by a U.S. affiliate? Should a foreign entity with performance on its security-based swap obligations guaranteed by a U.S. affiliate, where such foreign entity's security-based swap dealing activity is conducted predominantly or exclusively with non-U.S. persons, be included within the definition of U.S. person? Why or why not?
  • Should a foreign branch of a U.S. parent, including a foreign branch of a U.S. bank, be included in the definition of “U.S. person” for all purposes under Title VII? Why or why not?
  • Should a majority-owned subsidiary of a U.S. parent, regardless of whether the subsidiary has financial guarantees from the U.S. parent, be included in the definition of “U.S. person” for purposes of Title VII? Why or why not?
  • Should an account of one U.S. person and one or more non-U.S. persons be treated as a U.S. person? Should the Commission instead establish a de minimis threshold amount or otherwise allows some U.S. person ownership without triggering U.S. person status for the account? If so, how?
  • The CFTC has proposed a definition of U.S. person that would include a legal entity that is directly or indirectly majority-owned by one or more U.S. persons and in which such person(s) bears unlimited responsibility for the obligations and liabilities of the legal entity (other than a limited liability company or limited liability partnership where partners have limited liability). [303] Should the Commission adopt a similar approach? If so, why? How should majority ownership be determined? Is majority ownership the appropriate test? If not, should some other percentage test be used (e.g., 25% or some other measure of control)? Are there operational or other difficulties in implementing such an approach?
  • Should entities, whatever their place of domicile, that guarantee the performance of U.S. person counterparties to security-based swaps themselves be deemed U.S. persons? Why or why not? How would treating such indirect counterparties to security-based swaps as U.S. persons affect the application of Title VII rules?
  • Is the proposed definition's focus on the status of the person bearing the actual risk in the transaction (e.g., looking at the status of the account owner rather than the person with authority to direct the investment decisions) appropriate in determining whether the person is a U.S. person?
  • The CFTC has proposed a definition of U.S. person that would include any pension plan for the employees, officers or principals of a legal entity with its principal place of business inside the United States. Should the Commission adopt a similar approach? If so, what categories of entities would or would not be U.S. persons when compared to the Commission's proposed approach? How is including or excluding such entities, as applicable, from the definition of U.S. person consistent with and in furtherance of the objectives of Title VII?
  • Does the proposed rule appropriately address the treatment of certain international organizations with respect to the definition of U.S. person? Should any or all of the organizations specifically identified in the proposed rule be treated as U.S. persons? If so, why? Are there other similarly situated international organizations that should also be explicitly excluded from the U.S. person definition? Should the affiliates of international organizations be treated as non-U.S. persons, even if organized under U.S. law? If so, why? If not, why not?
  • Should the proposed definition expressly exclude from the definition of U.S. person any other entity or category of entities? If so, which ones and why?
  • The CFTC has proposed a definition of U.S. person that would include any commodity pool, pooled account, or collective investment vehicle (whether or not it is organized or incorporated in the United States) of which a majority ownership is held, directly or indirectly, by a U.S. person. Should the Commission adopt a similar definition that includes any investment fund, commodity pool, pooled account, or collective investment vehicle of which a majority ownership is held by one or more U.S. persons, even if such entity is not incorporated or organized under the laws of the United States, or does not have its principal place of business in the United States? If so, why and how should majority ownership be determined? Is majority ownership the appropriate test? If not, should some other percentage test be used (e.g., 25% or some other measure of control)? Are there operational or other difficulties in implementing such an approach?
  • The CFTC has proposed a definition of U.S. person that would include any commodity pool, pooled account, or collective investment vehicle the operator of which would be required to register as a commodity pool operator under the CEA. [304] Should the Commission adopt a similar definition that includes any investment fund, commodity pool, pooled account, or collective investment vehicle the operator of which would be required to register as a commodity pool operator under the CEA or an investment adviser under the Investment Advisers Act of 1940 (“Investment Advisers Act”)? If so, why?
  • Should the definition of U.S. person specifically address the status of estates, which is specifically addressed in Regulation S? [305] If so, please explain the types of security-based swap transaction such entities typically engage in and describe any problems created by the proposed definition of U.S. person relative to the goals of Title VII.
  • The CFTC has proposed a definition of U.S. person that would include any estate or trust, the income of which is subject to U.S. income tax regardless of source. Should the Commission adopt a similar approach? If so, why?
  • Should the Commission define the term “principal place of business” for purposes of the proposed definition of “U.S. person”? If so, should the Commission define “principal place of business” as the location of the personnel who direct, control, or coordinate the security-based swap activities of the entity? [306] If no, how should the Commission define it?

6. Proposed Definition of “Transaction Conducted Within the United States”

We are proposing a definition of “transaction conducted within the United States” to identify security-based swap transactions that involve activities in the United States that the Commission preliminarily believes would warrant requiring a non-U.S. person to count such transactions toward its de minimis threshold in the security-based swap dealer definition. [307] Under the proposed rule, “transaction conducted within the United States” would be defined to mean any “security-based swap transaction that is solicited, negotiated, executed, or booked within the United States, by or on behalf of either counterparty to the transaction, regardless of the location, domicile, or residence status of either counterparty to the transaction.” [308] It would not, however, include a transaction conducted through a foreign branch of a U.S. bank, for reasons discussed below. [309]

As noted above, dealing activity is normally carried out through interactions with counterparties or potential counterparties that include solicitation, negotiation, execution, or booking of a security-based swap. [310] Engaging in any of these activities within the United States, as part of dealing activity, would involve a level of involvement in a security-based swap transaction that the Commission believes should require such transaction to count toward a potential security-based swap dealer's de minimis threshold. The proposed rule, therefore, is designed to identify for market participants the key aspects of a security-based swap transaction that the Commission believes should trigger security-based swap dealer registration requirements.

By contrast, we are not proposing to include either submitting a transaction for clearing in the United States or reporting a transaction to an SDR in the United States as activity that would cause a transaction to be conducted within the United States under the proposed rule, nor are we proposing to treat activities related to collateral management (e.g., exchange of margin payments) that may occur in the United States or involve U.S. banks or custodians as activity conducted within the United States for these purposes. We recognize that submission of a transaction for clearing to a CCP located in the United States poses risk to the U.S. financial system, and collateral management plays a vital role in an entity's financial responsibility program and risk management. However, we preliminarily believe that none of these activities, by themselves, involves activities conducted between a potential dealer and its counterparty that may be characterized as dealing activity, although clearing and collateral management services may be offered in conjunction with dealing activity.

Under the rule adopted by the Commission, jointly with the CFTC, a potential security-based swap dealer is required to consider the security-based swap positions “connected with” the dealing activity in which the potential dealer—or any other entity controlling, controlled by or under common control with the potential dealer—engages over the course of the immediately preceding 12 months (or following the effective date of final rules implementing Section 3(a)(68) of the Exchange Act, 15 U.S.C. 78c(a)(68), if that period is less than 12 months). [311] By incorporating the definition of a “transaction conducted within the United States” into the proposed rule applying the de minimis exception in the cross-border context, [312] the Commission is proposing that non-U.S. persons engaged in cross-border dealing activity include in their de minimis calculations any security-based swap transaction that is connected with [313] an entity's dealing activity with another non-U.S. person if a U.S. branch or office of either counterparty, or an associated person [314] of either counterparty—including any affiliate and any associated person of any affiliate, or a third party agent, located within the United States—is directly involved in the transaction. Thus, a non-U.S. person engaged in security-based swap dealing activity would be required to count toward its de minimis threshold any dealing transaction entered into with another non-U.S. person that was conducted in the United States, whether the transaction falls within the “conducted within the United States” definition through such non-U.S. person's own activity (or that of an agent within the United States), or that of its non-U.S. person counterparty (or such counterparty's agent). [315] Similarly, if any transaction connected with a non-U.S. person's dealing activity is executed within the United States, the non-U.S. person would be required to count that transaction toward its de minimis threshold. [316]

We recognize that many of a non-U.S. person's transactions conducted within the United States that arise out of its dealing activity may also be transactions with U.S. persons, and thus would already be counted for purposes of the de minimis threshold. However, requiring non-U.S. persons to include in their de minimis calculations only transactions with U.S. person counterparties would enable such persons to engage in significant amounts of security-based swap dealing activity within the United States without Commission oversight as a security-based swap dealer, so long as the dealing activity were limited to non-U.S. persons. [317] This would be the case if the potential dealer operated out of a branch, office, or affiliate, or utilized a third-party agent acting on its behalf within the United States, or merely directed its dealing activity to non-U.S. persons that themselves operate out of the United States, either through branches, office, or affiliates, or by utilizing third party agents. [318] The Commission preliminarily does not believe that this would be consistent with the purposes of the Dodd-Frank Act, which is intended, in part, to promote accountability and transparency in the U.S. security-based swap market. [319]

First, we preliminarily believe that when a non-U.S. person engages in dealing activity with another non-U.S. person from within the United States either through an agent, branch, or office, or otherwise engages in security-based swap dealing activity within the United States (such as by soliciting persons within the United States from outside the United States), the solicitation, negotiation, or execution activity that occurs within the United States constitutes dealing activity that is described by the security-based swap dealer definition. [320] This is the case even where such transaction is ultimately booked by the two non-U.S. entities outside the United States. Second, most market participants, including non-U.S. persons, entering into a security-based swap transaction with a security-based swap dealer, particularly through personnel located in the United States, could reasonably expect to be entitled to the customer protections of Title VII because of Title VII's role in setting the standards for the U.S. security-based swap market and the market participant's decision to engage in a transaction within that market. [321] Given the Commission's responsibility in Title VII to regulate the U.S. security-based swap market, as well as reasonable market expectations and the risk of creating confusion among market participants, [322] we preliminarily do not believe that it is appropriate to diverge from our traditional approach to the regulation of broker-dealers by establishing a regulatory regime for the security-based swap market that would allow non-U.S. persons to engage in unregulated dealing activity within the United States, either when it acts through U.S. branches, office, or agents or it solicits, negotiates, or executes transactions with non-U.S. persons that themselves are operating out of the United States.

Moreover, suppose non-U.S. persons were not required to register when engaging in security-based swap dealing activity within the United States with other non-U.S. persons. Non-U.S. persons seeking to negotiate security-based swap transactions using personnel in the United States may choose to enter into security-based swap transactions with such unregistered non-U.S. persons rather than with a U.S. person to avoid the application of Title VII. In this way, customers may choose to forego the protections of Title VII in order to achieve potential cost savings. This could limit the access of U.S. persons engaged in dealing activity within the United States to non-U.S. persons, as well as more generally limiting the ability of U.S. persons to access liquidity in the security-based swap market. Accordingly, the Commission is proposing that a non-U.S. person would be required to count its security-based swap transactions conducted within the United States (as well as its transactions with U.S. persons) that arise out of its dealing activity to determine whether the notional amount of its dealing transactions exceeds the de minimis threshold. This would have the effect of subjecting both non-U.S. persons engaged in dealing activity within the United States and U.S. persons engaged in dealing activity within the United States to the same set of rules, thus providing their counterparties the same set of protections.

Finally, although the proposed rule reflects the importance of ensuring that neither non-U.S. person counterparty is engaged in the relevant activities within the United States for purposes of this definition, we also recognize the operational difficulties that could arise in investigating the activities of a counterparty to ensure compliance with the rule. As a result, we are preliminarily proposing to allow parties to rely on a representation received from a counterparty indicating that a given transaction “is not solicited, negotiated, executed, or booked within the United States by or on behalf of such counterparty.” [323] A party may rely on such a representation by its counterparty unless the party knows that the representation is not accurate. [324] The Commission preliminarily believes that this would address whatever operational difficulties parties may have in determining whether or not their counterparty is conducting a transaction within the United States.

Request for Comment

The Commission requests comment on all aspects of the proposed rule regarding registration by non-U.S persons who engage in dealing activity within the United States, including the following:

  • Should non-U.S. persons be required to register by virtue of engaging in security-based swap dealing activity within the United States, even if none of this dealing activity is directed to, or otherwise involves, U.S. persons? Why or why not?
  • Does the proposed approach appropriately impose the dealer registration requirement on non-U.S. persons based on their dealing activities conducted within the United States? Should a non-U.S. person be required to register as a security-based swap dealer if it enters into, or offers to enter into, security-based swap transactions that are transactions conducted within the United States if such non-U.S. person's dealing activity is limited to its foreign business? What about if the non-U.S. person engages in non-U.S. dealing activity, but also enters into transactions with U.S. persons in a non-dealing capacity?
  • What, if any, market-transparency or counterparty-protection issues would be likely to arise if non-U.S. persons were not required to register if they engaged in dealing activity solely with non-U.S. persons from within the United States?
  • What, if any, competition issues would be likely to arise if non-U.S. persons were not required to register if they engaged in dealing activity solely with non-U.S. persons from within the United States?
  • Is the proposed approach toward determining whether dealing activity is conducted within the United States appropriate? Does the proposed rule identify appropriate factors in determining whether a transaction has been conducted within the United States? If not, what factors should be modified, removed, or added?
  • Is the proposed identification of activities appropriate in the context of determining whether a security-based swap is a transaction conducted within the United States? If not, which activities should the Commission consider as key evidence of a transaction that is conducted within the United States?
  • Is direct participation by a branch, agency, office, or associated person, including any affiliate and any associated person of any affiliate, within the United States an appropriate element for identifying whether a security-based swap transaction is a transaction conducted within the United States? Are there functions routinely performed by these entities that should not trigger a registration requirement, even if performed within the United States?
  • Is the direct participation of a third-party agent an appropriate element for identifying whether a security-based swap transaction is a transaction conducted within the United States? If not, why not?
  • From an operational perspective, what, if any, changes to policies and procedures would be required to identify transactions conducted within the United States under the proposed approach? What changes would be required, for example, to monitor circumstances that would prevent a party from relying on representations?
  • Does the proposed rule appropriately identify the range of security-based swap activities (i.e., solicitation, negotiation, execution, and booking) that should be considered in determining whether dealing activity is conducted within the United States? If not, what activities should be excluded or included? Why?
  • Should a transaction entered into by a non-U.S. person in its capacity as a dealer be treated as dealing activity conducted within the United States if it is executed on an SB SEF, submitted to an SDR, or cleared by a security-based swap clearing agency physically located within the United States, even if no other activity related to the transaction were conducted within the United States?
  • Should the Commission allow parties to rely on representations from their counterparties regarding compliance with the definition of “transaction conducted within the United States”? Are there alternatives to relying on representations to ensure compliance? Should parties be required to exercise reasonable standards of care and due diligence?
  • Is the standard used for the proposed ability to rely on a representation appropriate? Should another standard of knowledge be used? If so, what standard would be more appropriate for this purpose?
  • The CFTC has proposed an interpretation that does not consider whether swap dealing activity is conducted inside or outside the United States when determining whether the de minimis threshold is met. [325] Should the Commission adopt this approach? If yes, please address the effect of both approaches on customer protection, market transparency, competition, and capital formation in the U.S. security-based swap market.
  • What would be the market impact of the proposed approach to determining whether dealing activity occurred within the United States? How would the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

7. Proposed Treatment of Transactions With Foreign Branches of U.S. Banks

As noted above, under the proposed rule, a non-U.S. person would not be required to count toward the de minimis threshold in the security-based swap dealer definition its transactions with the foreign branch of a U.S. bank. [326] For purposes of this proposed approach, and as described more fully below, “foreign branch” would be defined as any branch of a U.S. bank if:

  • The branch is located outside the United States;
  • The branch operates for valid business reasons;

and

  • The branch is engaged in the business of banking and is subject to substantive banking regulation in the jurisdiction where located. [327]

We preliminarily believe that these factors are appropriate for determining which entities fall within the definition of a foreign branch for purposes of this proposed approach due to their focus on the physical location of the branch and the nature of the branch's business and regulation in a foreign jurisdiction. Requiring the branch to be located outside the United States is consistent with the goal of the proposed rule, which is to identify security-based swap activity that is not conducted within the United States. Requiring the branch to be operated for valid business purposes and to be engaged in the business of banking and subject to substantive banking regulation in a foreign jurisdiction is intended to help ensure that U.S. banks are not able to take advantage of the proposed rule by setting up offshore operations to evade the application of Title VII.

In order for a transaction to be a “transaction conducted through a foreign branch,” and therefore excluded from a non-U.S. person's de minimis threshold calculation, [328] the foreign branch must be the named counterparty to the transaction [329] and the transaction must not be solicited, negotiated, or executed by a person within the United States on behalf of the foreign branch or its counterparty. [330] To the extent that the transaction is conducted within the United States, as described in the immediately preceding section (whether on behalf of the U.S. bank to which the branch belongs or of the foreign counterparty), the non-U.S. person would be required to count such transaction arising out of its dealing activity toward its de minimis threshold for purposes of determining whether it is required to register as a security-based swap dealer. [331]

We believe that counting transactions with a foreign branch toward the de minimis threshold would be consistent with the view that a foreign branch of a U.S. bank is part of a U.S. person within the proposed definition. [332] We also recognize that such transactions pose risk to the U.S. financial system. At the same time, however, we believe that imposing registration requirements on non-U.S. persons solely by virtue of their transactions with foreign branches of U.S. banks could limit the access of U.S. banks to non-U.S. counterparties when they conduct their foreign security-based swap dealing activity through foreign branches because non-U.S. persons may not be willing to enter into transactions with them in order to avoid being required to register as a security-based swap dealer. [333] We have preliminary concluded that not requiring such transactions to be counted toward the foreign counterparty's de minimis threshold for purposes of the security-based swap dealer registration requirement would minimize this disparate treatment while ensuring that transactions involving foreign branches of U.S. banks remain subject to certain Title VII requirements (as described below). [334]

Finally, although the proposed rule reflects the importance of ensuring that neither counterparty is operating from within the United States for purposes of conducting a transaction through a foreign branch, we also recognize the operational difficulties that could arise in investigating the activities of a counterparty to ensure compliance with the rule. As a result, we are proposing to allow parties to rely on a representation received from a counterparty indicating that “no person within the United States is directly involved in soliciting, negotiating, executing, or booking” a given transaction on behalf of the counterparty. [335] A party may rely on such a representation by its counterparty unless the party knows that the representation is not accurate. The Commission preliminarily believes that this would address whatever operational difficulties parties may have in determining whether or not their counterparty is conducting a transaction conducted through a foreign branch.

Request for Comment

The Commission requests comment on all aspects of the proposed treatment of transactions with foreign branches of U.S. persons for purposes of the de minimis exception, including the following:

  • Would the proposed approach reduce the effectiveness of customer protections or any other provisions of Title VII? If so, how should these concerns be balanced against the competitiveness concerns identified as part of the rationale behind the proposed approach?
  • Does the proposed approach appropriately address the potential for disparate competitive impacts related to the application of the de minimis exception to dealers operating out of foreign branches? If not, how might the Commission more effectively address these concerns?
  • Does the proposed approach provide an advantage to U.S. banks engaging in security-based swap dealing activity through foreign branches? Are there competitiveness concerns raised by this approach for entities (either banks or nonbanks) that do not utilize the branch model? Are there competitiveness concerns for non-U.S. persons, including non-U.S. persons whose performance under security-based swaps is guaranteed by a U.S. person? If so, what are they?
  • Should the Commission allow parties to rely on representations from their counterparties regarding compliance with the definition of “transaction conducted through a foreign branch”? Should the Commission separately allow parties to rely on representations from their counterparties regarding status under the “foreign branch” definition?
  • Is the standard used for the proposed ability to rely on a representation appropriate? Should another standard of knowledge be used? If so, what standard would be more appropriate for this purpose?
  • Should the definition of a “foreign branch” be broadened to include “agencies” of U.S. banks in addition to branches? If so, what rationale justifies the inclusion of agencies? In particular, what are the similarities (or differences) in the legal status and regulatory treatment of the foreign branches and foreign agencies of U.S. banks that would warrant similar treatment? How do foreign agencies of U.S. banks differ from foreign offices of U.S. persons that are not banks?
  • How might the proposed approach to the foreign branches of U.S. banks be impacted by the Volcker Rule and the Push-Out Rule? How might security-based swap dealers alter their business practices in response to the Volcker Rule and the Push-Out Rule? Should the proposed approach to the foreign branches of U.S. banks be altered to account for these changes to business practice?
  • What would be the market impact of the proposed treatment of transactions with foreign branches of U.S. banks? How would the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

8. Proposed Rule Regarding Aggregation of Affiliate Positions

One key issue related to our proposed approach to the de minimis exception, both in the cross-border context and domestically, is the aggregation of transactions connected with the dealing activity of an affiliate. In the Intermediary Definitions Adopting Release, the Commission and the CFTC jointly stated that the notional thresholds in the de minimis exception encompass swap and security-based swap dealing positions entered into by an affiliate controlling, controlled by, or under common control with the person at issue. [336] The Commission and the CFTC further noted that for these purposes, control would be interpreted to mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise. [337] This aggregation of affiliate positions was deemed necessary to prevent persons from avoiding dealer regulation by dividing up dealing activity in excess of the notional thresholds among multiple affiliates. [338]

The Commission is proposing a rule that would describe how this aggregation requirement would apply to U.S. persons and non-U.S. persons engaged in cross-border security-based swap dealing activity, as well as to U.S. persons engaged in purely domestic transactions. [339] As set forth in the Intermediary Definitions Adopting Release, the affiliate aggregation principle requires that a person aggregate the entire security-based swap dealing activity of any of its affiliates, without distinguishing whether the dealing positions are entered into by U.S. person affiliates or non-U.S. person affiliates, and without distinguishing whether the dealing positions are entered into with U.S. persons or non-U.S. persons. [340] The proposed rule takes an approach that generally is consistent with the affiliate aggregation interpretive guidance jointly adopted by the Commission and the CFTC to require a person to aggregate all of the security-based swap dealing positions entered into by its U.S. person affiliates, [341] except that it excludes from such aggregation the positions of an affiliate that is a registered security-based swap dealer, under certain conditions. [342] The proposed rule also provides that such aggregation must include any security-based swap transactions of such person's non-U.S. person affiliates that would be required to be counted by such affiliates toward their respective de minimis thresholds in accordance with the proposed approach described above (i.e., a non-U.S. person affiliate would be required to calculate its security-based swap transactions connected with dealing activity conducted with U.S. persons (other than foreign branches of U.S. banks) or otherwise conducted within the United States). [343]

The proposed rule similarly provides that the affiliate aggregation principle also would apply to non-U.S. persons that engage in transactions in a dealing capacity with U.S. persons (other than foreign branches of U.S. banks) or otherwise within the United States. In determining whether its dealing activity exceeds the de minimis threshold, a non-U.S. person must aggregate the amount of its own transactions connected with its dealing activity with U.S. persons (other than foreign branches) or otherwise conducted within the United States with the amount of any security-based swap transactions connected with the dealing activity conducted by its affiliates, whether U.S. persons or non-U.S. persons, that such affiliates would be required to count toward their respective de minimis thresholds in accordance with the proposed approach described above [344] (other than the transactions of affiliates that are registered security-based swap dealers). [345] Transactions of affiliates that are themselves non-U.S. persons with other non-U.S. persons (or foreign branches of U.S. banks) outside the United States would not need to be aggregated for purposes of the de minimis exception. [346]

Thus, the Commission's proposal would require aggregation of the amount of dealing transactions of all affiliates, both U.S. persons and non-U.S. persons, other than registered security-based swap dealers. We believe that the Commission's proposed approach implements the de minimis exception in a manner that is consistent with the Dodd-Frank Act's focus on the U.S. security-based swap market. [347] The proposed approach reflects the fact that all of a U.S. affiliate's security-based swap dealing transactions impact the U.S. financial system, regardless of whether such entity's counterparties are located in the United States or abroad. The same is not true of non-U.S. affiliates, however, because the security-based swap transactions entered into by a non-U.S. affiliate with other non-U.S. persons outside the United States would not impact the U.S. financial system to the same extent as transactions with U.S. persons. Thus, because the statutory focus is on the U.S. security-based swap market, we preliminarily believe it is appropriate to distinguish between U.S. and non-U.S. affiliates based on the disparate impact of their security-based swap dealing transactions on the U.S. financial system when determining which dealing transactions should be aggregated for purposes of the de minimis threshold. This further suggests that we should aggregate the dealing positions of both U.S. and non-U.S. person affiliates that are not already registered security-based swap dealers, in accordance with the rule and guidance described in the following paragraph regarding aggregation of the positions of registered dealers, with the goal of capturing all dealing transactions that warrant imposing dealer registration and regulation [348] and minimizing the opportunity for a person to evasively engage in large amounts of dealing activity. [349] As a result, where the aggregate security-based swap dealing activity of an affiliated group, calculated as described above, exceeds the de minimis threshold, then each affiliate within such group that engages in the security-based swap dealing activity included in such aggregation calculation would be required to register with the Commission as a security-based swap dealer, subject to the exception described below.

The Commission also is proposing a rule to address the affiliate aggregation of dealing positions for purposes of the de minimis threshold where one or more affiliates within a corporate group are registered with the Commission as security-based swap dealers. [350] Under the proposed approach, a person calculating the amount of its security-based swap positions for purposes of the de minimis threshold would not need to include in such calculation the security-based swap transactions of an affiliate controlling, controlled by, or under common control with the person if such affiliate is registered with the Commission as a security-based swap dealer. [351] The application of this proposed rule would be limited to circumstances where a person's security-based swap activities are operationally independent from those of its registered security-based swap dealer affiliate. For purposes of this proposed rule, the security-based swap activities of two affiliates would be considered operationally independent if the two affiliated persons maintained separate sales and trading functions, operations (including separate back offices), and risk management with respect to any security-based swap dealing activity conducted by either affiliate that is required to be counted against their respective de minimis thresholds. If any of these functions were jointly administered by the two affiliates, or were managed at a central location within the affiliates' corporate group (e.g., at the entity serving as the central booking entity) with respect to any security-based swap dealing activity conducted by either affiliate that is required to be counted against their respective de minimis thresholds, then an unregistered person would not be able to exclude the security-based swap dealing activities of its registered security-based swap dealer affiliate under the proposed rule.

Absent the proposed exclusion of the dealing positions of a registered security-based swap dealer affiliate in the proposed rule, any affiliate of a registered security-based swap dealer that engaged in security-based swap dealing activity with U.S. persons or within the United States would be required to aggregate the dealing positions of the registered security-based swap dealer with its own dealing positions for purposes of the de minimis threshold. Given that a registered security-based swap dealer would presumably conduct relevant security-based swap dealing positions in excess of the de minimis threshold over the course of the immediately preceding 12 months, all persons affiliated with a registered security-based swap dealer that engaged in any level of security-based swap dealing activity that is required to be counted against the de minimis threshold would necessarily be required to register with the Commission as security-based swap dealers because of the affiliate aggregation principle. We preliminarily do not believe that this outcome would be consistent with the statutory purpose of the de minimis exception, because it would prevent all affiliates of a registered dealer from taking advantage of the exception, even those engaged in a minimal amount of dealing activity relevant to Title VII dealer registration and regulation. We also do not believe that this scenario raises the concerns about evasion that underlie the de minimis affiliate aggregation rule jointly adopted by the Commission and the CFTC in the Intermediary Definitions Adopting Release, given that this proposed rule would apply only where a corporate group already included a registered dealer subject to Commission oversight, and the dealing positions of all commonly controlled unregistered affiliates in the corporate group would still be aggregated for purposes of the de minimis threshold. [352] For these reasons, we believe that it is appropriate not to include the security-based swap dealing positions of registered security-based swap dealers in the de minimis calculations of their commonly controlled affiliates provided that their security-based swap dealing activities that are relevant to the de minimis calculation are operationally independent of the registered security-based swap dealer affiliates.

Request for Comment

The Commission requests comment on all aspects of the proposed rule regarding the aggregation of affiliate positions, including the following:

  • Should the Commission permit affiliated persons to exclude the security-based swap dealing positions of affiliated registered security-based swap dealers from their de minimis calculations, as proposed? Why or why not?
  • Would permitting affiliated entities to exclude the security-based swap dealing positions of registered security-based swap dealers from their de minimis calculations undermine any of the Title VII protections associated with security-based swap dealer registration and regulation? If so, please explain. Should the Commission further explain what “operationally independent” means? If so, what should the Commission consider?
  • Should the Commission permit affiliated entities to exclude the security-based swap dealing positions of operationally independent affiliates from their de minimis calculations, even if such affiliates are not registered security-based swap dealers?
  • The CFTC has adopted temporary conditional relief that would permit a non-U.S. person to exclude from its de minimis calculation the security-based swap dealing positions of an affiliated non-U.S. person that is registered as a swap dealer and not guaranteed by a U.S. person with respect to its swap obligations. [353] Should the Commission adopt a similar interpretation to permit a non-U.S. person (but not a U.S. person) to exclude the dealing positions of its affiliated registered non-U.S. security-based swap dealer (but not the dealing positions of its affiliated registered U.S. security-based swap dealer)? Should the Commission condition such exclusion on the affiliated registered security-based swap dealer not being guaranteed by a U.S. person? If so, please describe the likely economic effects of providing different exclusions from the affiliate aggregation principle for U.S. and non-U.S. security-based swap dealers and how the Commission should best address them.
  • The CFTC has also proposed an interpretation that would permit non-U.S. persons engaged in dealing activity with U.S. persons to aggregate the notional amounts of security-based swap dealing transactions by their non-U.S. affiliates separately from any dealing activity performed by their U.S. affiliates. [354] Should the Commission adopt a similar approach? If so, please explain how this approach is consistent with the de minimis threshold and the rationale provided for the affiliate aggregation principle in the Intermediaries Definitions Adopting Release. In addition, please describe the likely economic effects of providing an effectively higher de minimis threshold for corporate groups that engage in dealing activity with U.S. persons or within the United States through affiliates located in the United States and in foreign jurisdictions.
  • What would be the market impact of the proposed approach to aggregation of affiliate positions? How would the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

9. Treatment of Inter-Affiliate and Guaranteed Transactions

Consistent with the approach taken in the Intermediary Definitions Adopting Release, the Commission is proposing that cross-border security-based swap transactions between majority-owned affiliates would not need to be considered when determining whether a person is a security-based swap dealer. [355] Thus, a non-U.S. person engaged in dealing activity outside the United States would not be required to register as a security-based swap dealer simply by virtue of entering into security-based swap transactions with its majority-owned U.S. affiliate, even if such inter-affiliate security-based swaps were back-to-back transactions (i.e., the foreign subsidiary was acting as a “conduit” for the U.S. person). Similarly, a U.S. person would not be required to register as a security-based swap dealer as a result of back-to-back transactions with a non-U.S. person subsidiary that acts as a conduit for such U.S. person. [356] Instead, as proposed, there must be an independent basis for requiring a person to register as a security-based swap dealer that is unrelated to its inter-affiliate transactions. [357]

Furthermore, the Commission is proposing not to require a non-U.S. person that receives a guarantee from a U.S. person of its performance on security-based swaps with non-U.S. persons outside the United States to count its dealing transactions with those non-U.S. persons toward the de minimis threshold as a U.S. person would be required to do. [358] We believe that the primary risk related to these transactions is the risk posed to the United States via the guarantee from a U.S. person, not the dealing activity occurring between two non-U.S. persons outside the United States. As a result, we do not believe that the risk posed by the existence of the U.S. guarantee would be better addressed through requiring non-U.S. persons receiving such guarantees to register with the Commission as security-based swap dealers. One way that the accumulation of risk resulting from security-based swap positions is addressed in Title VII is through the major security-based swap participant registration category. We preliminarily believe that the risk associated with guarantees by U.S. persons of the performance on security-based swap obligations of non-U.S. persons may be best addressed through the application of principles of attribution in the major security-based swap participant definition described in the Intermediary Definitions Adopting Release. [359] We preliminarily believe that use of the major security-based swap participant definition to address the risks posed to the United States as a result of guarantees by U.S. persons effectively deals with the specific regulatory concerns posed by the risks these guarantees present to the U.S. financial system and is consistent with the regulatory framework set forth in the Dodd-Frank Act. [360]

The Commission also is proposing not to require a foreign dealer to count security-based swap transactions with non-U.S. persons that receive guarantees from U.S. persons toward the de minimis threshold. The Commission notes that, in many respects, the risk created for U.S. persons and the U.S. financial system in these transactions is the same as the risk posed if the U.S. person who provides the guarantee had entered into transactions directly with non-U.S. persons. The U.S. guarantor would be held responsible to settle those obligations, thus maintaining similar liability as though the U.S. person had entered into security-based swap transactions directly with a non-U.S person. The Commission preliminarily believes that the risk posed to the U.S. markets by non-U.S. persons engaged in dealing activity with non-U.S. persons outside the United States whose performance under security-based swaps is guaranteed by a U.S. person can be best addressed through the major security-based swap participant definition and requirements applicable to major security-based swap participants, as the risks to the United States appear to arise only from the resulting positions and not the dealing activity as such.

Finally, as discussed below, the Commission is proposing to subject a security-based swap transaction between two non-U.S. persons where at least one of the persons receives a guarantee on the performance of its obligations from a U.S. person to the regulatory reporting requirement (but not, in some cases, to real-time public reporting). [361] If the proposed approach is adopted, the Commission would gain an understanding of market developments in this area as a result of the proposed de minimis exception.

Request for Comment

The Commission requests comment on all aspects of the proposed treatment of inter-affiliate and guaranteed transactions, including the following:

  • Should the Commission revise our proposed approach to inter-affiliate transactions to require those transactions to be considered when determining whether a person is a security-based swap dealer? If so, why?
  • If the Commission determines not to exclude inter-affiliate transactions from security-based swap dealing activity in the cross-border context, how could such a decision be reconciled with the exclusion for inter-affiliate transactions provided in the Intermediary Definitions Adopting Release? Should the Commission and the CFTC jointly reconsider the approach to inter-affiliate transactions provided in the Intermediary Definitions Adopting Release?
  • Should the Commission require the registration of non-U.S. dealers that receive guarantees on the performance of their security-based swap obligations from U.S. persons based on their transactions with non-U.S. persons as well as U.S. persons? Why or why not? Should the U.S. guarantor be viewed as engaging indirectly in dealing activity through its affiliate and, therefore, required to register as a security-based swap dealer if the security-based swap transactions in connection with its dealing activity exceed the de minimis threshold? Should there be a concern that the U.S. guarantor is using the non-US affiliate to evade the requirements of Title VII?
  • Does the proposed approach to guarantees effectively address concerns related to the risk posed to the U.S. financial system resulting from guarantees by U.S. persons of security-based swap dealing activity by non-U.S. persons?
  • Are there competitiveness concerns related to the proposed approach to guarantees with regard to U.S. entities that engage in non-U.S. security-based swap dealing activity through business models that do not rely on guarantees of non-U.S. persons, such as those that operate through foreign branches?
  • The CFTC has proposed an interpretation that would subject an entity that operates a “central booking system” where swaps are booked into a single legal entity, to any applicable swap dealer registration requirement as if it had entered into such swaps directly, irrespective of whether such entity is a U.S. person or whether the booking entity is a counterparty to the swap or enters into the swap indirectly through a back-to-back swap or other arrangement with its affiliate or subsidiary. [362] Should the Commission adopt a similar approach? If so, please describe how such a decision could be reconciled with the exclusion for inter-affiliate transactions provided in the Intermediary Definitions Adopting Release.
  • What would be the market impact of the proposed approach to inter-affiliate and guaranteed transactions? How would the application of the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

10. Comparison With Definition of “U.S. Person” in Regulation S

In proposing an entity-based approach to the definition of a U.S. person, we have declined to follow the suggestions by some commenters that we adopt the definition of “U.S. person” used in Regulation S, which among other things expressly excludes from the definition of “U.S. person” agencies or branches of U.S. persons located outside the United States. [363] Although we recognize that the Regulation S definition of U.S. person has the advantage of familiarity for many market participants, Regulation S addresses specific policy concerns that are different from those addressed by Title VII. [364] Specifically, the definition of U.S. person in Regulation S was adopted in the context of providing an “issuer safe harbor” from the registration requirements of Section 5 of the Securities Act, which was intended “to ensure that the [unregistered] securities offered [abroad] come to rest offshore.” [365] In that context, providing a safe harbor based in part on the location of the person, branch, or office making the investment decision is consistent with the goals of that regulatory framework, which include protecting the integrity of the registration requirements applicable to securities publicly offered in the United States under the Securities Act. The Regulation S definition of “U.S. person” reflects this policy judgment.

We preliminarily believe that the definition of U.S. person in Title VII should encompass, for example, not only a person that has its place of residence or legal organization within the United States, but also its principal place of business within the United States, as the security-based swap activities of such entities are likely to manifest themselves most directly within the United States, where the majority of their commercial, legal, and financial relationships would be likely to exist because that is where their business principally occurs. [366]

Similarly, we preliminarily believe that the definition of U.S. person in Title VII should include accounts of a U.S. person, regardless of whether the account is a discretionary account or is held by a dealer or other person that is not resident in the United States, because the U.S. person bears the direct risk of transactions in the account, regardless of where the investment decision is made. [367] Moreover, we are proposing that an entity's U.S.-person status would apply to the entity as a whole, since the risks related to the concerns of Title VII are borne by the entire entity and not just by the specific business unit (or branch or office) engaged in security-based swap activity. [368] With its exclusions for certain foreign branches and agencies of U.S. persons from the definition of “U.S. person,” Regulation S would not address the entity-wide nature of the risks that Title VII seeks to address. [369]

The Commission preliminarily believes that adopting the definition of “U.S. person” in Regulation S without significant modifications would not achieve the goals of Title VII. As discussed above, we are instead proposing a definition of U.S. person that focuses primarily on the location of the person bearing the direct risk of the transaction. Regulation S, with its focus on the person making the investment decision (rather than the person actually bearing the risk), would not necessarily capture the entity that actually bears the risks arising from security-based swap transactions that Title VII seeks to address. [370]

In light of the specific objectives of Title VII, the Commission preliminarily believes that a definition of U.S. person specifically tailored to the regulatory objectives it is meant to serve, as described above, is appropriate. [371]

Request for Comment

The Commission requests comment on all aspects of the proposed definition of U.S. person, including the following:

  • Should the Commission adopt the definition of U.S. person in Regulation S? If so, how should the Commission reconcile the objectives of Title VII with the objectives that Regulation S is meant to serve?
  • Should the Commission include all U.S. citizens in the definition of U.S. person, regardless of a person's residence or domicile?
  • Should the Commission include within the definition of U.S. person entities and accounts where the discretion to enter into security-based swaps resides with a U.S. person? To what extent would this approach produce a result that differs from the current approach reflected in the proposed rule and the definitions of “security-based swap dealer” and “major security-based swap participant”?

C. Regulation of Security-Based Swap Dealers in Title VII

I. Introduction

To help address the potential effects of registration, and attendant regulatory requirements, on foreign security-based swap dealers [372] with global security-based swap businesses and U.S. security-based swap dealers [373] that engage in security-based swap dealing activity through foreign branches that also may be subject to registration or regulation in foreign jurisdictions, the Commission is proposing not to apply the external business conduct standards and segregation requirements in Title VII to the Foreign Business [374] of such registered foreign security-based swap dealers and registered U.S. security-based swap dealers that engage in dealing activity through foreign branches with non-U.S. persons and foreign branches of U.S. banks. [375] In addition, while we are not proposing a rule to limit the application of entity-level requirements in Title VII to foreign security-based swap dealers, we are proposing to establish a policy and procedural framework under which the Commission would permit substituted compliance in some circumstances by registered foreign security-based swap dealers with certain Title VII requirements specifically applicable to security-based swap dealers. [376]

In the following sections, we discuss the views of commenters, describe the transaction-level and entity-level requirements specifically applicable to security-based swap dealers in Title VII, and discuss the proposed application of transaction-level and entity-level requirements to registered security-based swap dealers in the cross-border context.

2. Comment Summary

Various foreign dealers expressed their views about the application of the Dodd-Frank Act requirements to their derivatives businesses. A number of them expressed concern that if the Commission applies security-based swap dealer regulations, not only to entities conducting business from within the United States, but also to foreign-domiciled entities, it could effectively prevent foreign dealers from, among other things, managing their global security-based swap business out of a centralized booking entity (i.e., the entity that acts as principal—the named counterparty—to a security-based swap transaction), which they maintain has many advantages for foreign dealers and their clients, including more efficient counterparty netting, greater transparency, greater financial counterparty financial strength, and operational efficiencies. [377] One commenter cautioned that if the regulations lead foreign dealers to create “fragmented booking structures” to avoid duplicative and conflicting regulatory regimes, it could harm U.S. consumers through increased transaction costs with foreign dealers. [378]

Many commenters suggested that to preserve a registration framework that would allow foreign dealers to continue to book their global security-based swap business out of a central non-U.S. entity, the Commission should use our limited designation authority under the Dodd-Frank Act's swap dealer definition to designate and regulate only specific activities and particular branches or agencies of foreign banks that transact with U.S. customers, without subjecting the whole entity or its other branches to regulation. [379]

In addition, various commenters suggested a variety of operational models through which foreign dealers could operate in the U.S. security-based swap market, generally premising the proposed registration and regulatory regime on the notion that home country supervision should apply to entity-level regulations (e.g., capital, risk management, and conflicts of interest), while Title VII transaction-level regulations should apply only to security-based swaps involving a U.S. counterparty. [380] A number of commenters emphasized that transaction-level requirements should not apply to security-based swaps entered into between foreign counterparties. [381] Other commenters remarked that if the Commission regulates both the U.S.-facing business (i.e., transactions with U.S. persons) and the foreign-facing business (i.e., transactions with non-U.S. persons) of U.S. security-based swap dealers, but only the U.S.-facing business of foreign security-based swap dealers, then U.S. firms would be at a competitive disadvantage vis-à-vis their foreign counterparts with respect to transactions with foreign counterparties. [382]

Several commenters further expressed concern that a requirement for foreign persons to register with the Commission as security-based swap dealers could be particularly problematic in the case of capital requirements, where foreign security-based swap dealers already would be subject to their home country's prudential requirements. These commenters favored deferring to foreign regulators the regulation and supervision of entity-level requirements when a foreign security-based swap dealer is subject to comprehensive and comparable home country regulation. [383] One commenter recommended a comparability standard whereby the Federal Reserve and the Commission determine comparability even when a home country regulator does not require margin for non-cleared security-based swaps, if the home country's capital regime takes into account functionally equivalent capital charges. [384] Several commenters recommended that, for monitoring purposes, U.S. regulators could rely on information-sharing arrangements with home regulators regarding foreign swap transactions and activities. [385] A few commenters argued that U.S. regulators should not have examination authority over foreign swap transactions and activities located outside the United States, and suggested that the Commissions obtain any necessary information about U.S. swap transactions and activities from U.S. affiliates of the foreign security-based swap dealer. [386]

3. Title VII Requirements Applicable to Security-Based Swap Dealers

Certain Title VII requirements specifically applicable to security-based swap dealers apply at a transaction level, that is, to security-based swap transactions with specific counterparties. Examples of transaction-level requirements in Title VII principally include requirements relating to external business conduct standards such as the requirement that a security-based swap dealer or major security-based swap participant verify that any counterparty meets the eligibility standards for an eligible contract participant [387] and requirements relating to segregation of assets held as collateral in security-based swap transactions. [388] Other requirements apply to security-based swap dealers at an entity level, that is, to the dealing entity as a whole. Examples of entity-level requirements include, among others, requirements relating to capital, [389] risk management procedures, [390] recordkeeping and reporting, [391] supervision, [392] and designation of a chief compliance officer. [393] Some requirements can be considered both entity-level and transaction-level requirements. For instance, the margin requirement in Section 15F(e) of the Exchange Act can be considered both an entity-level requirement because margin affects the financial soundness of an entity and a transaction-level requirement because margin calculation is based on particular transactions (i.e., an entity calculates margin based on the market value of specific transactions or on a portfolio basis). [394]

Below, we describe in more detail various transaction-level and entity-level requirements in Title VII applicable to security-based swap dealers. [395]

(a) Transaction-Level Requirements

In general, transaction-level requirements primarily focus on protecting counterparties by requiring security-based swap dealers to, among other things, provide certain disclosures to counterparties, adhere to certain standards of business conduct, and segregate customer funds, securities, and other assets. The following briefly describes the most significant transaction-level requirements applicable to security-based swap dealers in Title VII.

i. External Business Conduct Standards

Section 15F(h) of the Exchange Act requires the Commission to adopt rules specifying external business conduct standards for security-based swap dealers in their dealings with counterparties, [396] including counterparties that are “special entities.” [397] Congress granted the Commission broad authority to promulgate business conduct requirements, as the Commission determines to be appropriate in the public interest, for the protection of investors or otherwise in furtherance of the purposes of the Exchange Act. [398]

These standards, as described in Section 15F(h)(3) of the Exchange Act, must require security-based swap dealers to: (i) Verify that a counterparty meets the eligibility standards for an ECP; (ii) disclose to the counterparty material information about the security-based swap, including material risks and characteristics of the security-based swap, and material incentives and conflicts of interest of the security-based swap dealer in connection with the security-based swap; and (iii) provide the counterparty with information concerning the daily mark for the security-based swap. Section 15F(h)(3) also directs the Commission to establish a duty for security-based swap dealers to communicate information in a fair and balanced manner based on principles of fair dealing and good faith.

In addition, Section 15F(h)(4) of the Exchange Act requires that a security-based swap dealer that “acts as an advisor to a special entity” must act in the “best interests” of the special entity and undertake “reasonable efforts to obtain such information as is necessary to make a reasonable determination” that a recommended security-based swap is in the best interests of the special entity. [399] Section 15F(h)(5) requires that security-based swap dealers that enter into, or offer to enter into, security-based swaps with a special entity comply with any duty established by the Commission that requires a security-based swap dealer to have a “reasonable basis” for believing that a special entity has an “independent representative” that meets certain criteria and undertakes a duty to act in the “best interests” of the special entity.

The Commission has proposed Rules 15Fh-1 through 15Fh-6 under the Exchange Act to implement the business conduct requirements described above. [400] In addition to external business conduct standards expressly addressed by Title VII, the Commission has proposed certain other business conduct requirements for security-based swap dealers that the Commission preliminarily believed would further the principles that underlie the Dodd-Frank Act. These rules would, among other things, impose certain “know your counterparty” and suitability obligations on security-based swap dealers, as well as restrict security-based swap dealers from engaging in certain “pay to play” activities. [401]

ii. Segregation of Assets

Segregation requirements are designed to identify and protect customer property held by a security-based swap dealer as collateral in order to facilitate the prompt return of the property to customers or counterparties in a liquidation proceeding of such security-based swap dealer. [402] Segregation not only protects counterparties who are customers of a security-based swap dealer but also facilitates orderly liquidation of a security-based swap dealer and minimizes the disruption to and impact on the U.S. security-based swap market and the U.S. financial system overall caused by insolvency and liquidation of a security-based swap dealer.

Section 3E of the Exchange Act provides the Commission with rulemaking authority to prescribe segregation requirements for securities-based swap dealers that receive assets from, for, or on behalf of a counterparty to margin, guarantee, or secure a security-based swap transaction. [403] Section 3E(c) provides the Commission with rulemaking authority to prescribe how any margin received by a security-based swap dealer with respect to cleared security-based swap transactions may be maintained, accounted for, treated and dealt with by the security-based swap dealer. [404] In addition, Section 3E(g) extended the customer protections of the U.S. Bankruptcy Code to counterparties of a security-based swap dealer with respect to cleared security-based swaps, and with respect to non-cleared security-based swaps, if there is a customer protection requirement under Section 15(c)(3) or a segregation requirement prescribed by the Commission. [405] The Commission has proposed Rule 18a-4 under the Exchange Act to establish segregation requirements for security-based swap dealers with respect to both cleared and non-cleared security-based swap transactions. [406] The provisions of proposed Rule 18a-4 were modeled on the broker-dealer customer protection rule and take into account the characteristics of security-based swaps. [407]

(b) Entity-Level Requirements

Entity-level requirements in Title VII primarily address concerns relating to the security-based swap dealer as a whole, with a particular focus on safety and soundness of the entity to reduce systemic risk in the U.S. financial system. [408] The most significant entity-level requirements, as discussed below, are capital and margin requirements. Certain other entity-level requirements relate to the capital and margin requirements because, at their core, they relate to how the firm identifies and manages its risk exposure arising from its activities (e.g., risk management requirements). Given their functions, these entity-level requirements would be applied under our proposal on a firm-wide basis to address risks to the security-based swap dealer as a whole.

i. Capital

The Commission is required to establish minimum requirements relating to capital for security-based swap dealers for which there is not a prudential regulator (“nonbank security-based swap dealers”). [409] The prudential regulators are required to establish requirements relating to capital for bank security-based swap dealers. [410] Some security-based swap dealers may also be registered as swap dealers with the CFTC. The CFTC is required to establish capital requirements for nonbank swap dealers. [411] The prudential regulators are required to establish capital requirements for bank swap dealers. [412]

The objective of the Commission's proposed capital rule for security-based swap dealers is the same as the Commission's capital rule for broker-dealers; specifically, to ensure that the entity maintains at all times sufficient liquid assets to (i) promptly satisfy its liabilities—the claims of customers, creditors, and other security-based swap dealers, and (ii) provide a cushion of liquid assets in excess of liabilities to cover potential market, credit, and other risks. [413]

As noted above, the Commission's proposed capital rules focus on the liquid assets of a nonbank security-based swap dealer available to satisfy its liabilities or cover its risks in a liquidation scenario. This focus on liquid assets would distinguish the Commission's capital rules applicable to security-based swap dealers from those applicable to banks, which generally include a more permissive list of assets that may be taken into account for purposes of capital calculations. [414] The difference in approach between the capital rules applicable to nonbank dealers and bank dealers is supported by certain operational, policy, and legal differences between nonbank security-based swap dealers and bank security-based swap dealers. [415] Notably, existing capital standards for banks and broker-dealers reflect, in part, differences in their funding models and access to certain types of financial support, and we expect that those same differences also will exist between bank security-based swap dealers and nonbank security-based swap dealers. For example, banks obtain funding through customer deposits and can generally obtain liquidity through the Federal Reserve's discount window to meet their obligations, [416] whereas broker-dealers and nonbank security-based swap dealers cannot. [417] Thus all of a nonbank entity's counterparty obligations must be met through the nonbank entity's own liquid assets. For these reasons, the Commission's proposed capital standard for nonbank security-based swap dealers is a net liquid assets test modeled on the broker-dealer capital standard in Rule 15c3-1 under the Exchange Act. [418]

ii. Margin

Margin may be viewed as an entity-level requirement given its effect on the financial soundness of an entity, as well as a transaction-level requirement due to the fact that margin is calculated based on particular transactions and positions. Although margin is calculated based on individual transactions, the cumulative effect of collecting margin from counterparties is to protect an entity from the default of its counterparties. Given the emphasis placed on the financial soundness of security-based swap dealers in Title VII, [419] we believe that margin should be treated as an entity-level requirement for purposes of implementing Title VII in the cross-border context.

We recognize that this approach differs from the approach to margin proposed by the CFTC in its cross-border guidance, which focused on the transaction-by-transaction nature of margin and thus treated it as a transaction-level requirement. [420] However, we preliminarily believe that treating margin as an entity-level requirement is consistent with the role margin plays as part of an integrated program of financial responsibility requirements, along with the capital standards and segregation requirements, that are intended to enhance the financial integrity of security-based swap dealers. [421] The margin requirements proposed by the Commission are intended to work in tandem with the capital requirements to strengthen the financial system by reducing the potential for default to an acceptable level and limiting the amount of leverage that can be employed by security-based swap dealers and other market participants. [422] For example, the capital requirements proposed by the Commission take into account whether a security-based swap is cleared or non-cleared, the amount of margin collateral imposed by registered clearing agencies with respect to cleared security-based swaps, and the circumstances where non-cleared security-based swaps are excepted from the margin collection requirements imposed by the Commission, and would impose a capital charge in certain cases for uncollateralized or insufficiently collateralized exposures arising from cleared or non-cleared security-based swaps in order to account for the counterparty default risk that is not adequately addressed by margin collateral. [423] We preliminarily do not believe that margin would effectively fulfill its purpose as part of a comprehensive financial responsibility program for non-bank security-based swap dealers if the Commission were to treat margin solely as a transaction-level requirement.

The division of regulatory responsibilities related to margin requirements in Title VII mirrors that of the capital requirements discussed above. As with capital, the Commission is required to establish minimum requirements relating to initial and variation margin on all security-based swaps that are not cleared by a registered clearing agency for nonbank security-based swap dealers. [424] The prudential regulators are required to establish requirements relating to margin for bank security-based swap dealers. [425] Security-based swap dealers that are also registered as swap dealers with the CFTC also would be subject to CFTC requirements for nonbank swap dealers with respect to initial and variation margin requirements on all swaps that are not cleared by a registered derivatives clearing organization. [426]

The objective of the margin requirements for security-based swap dealers is to offset the greater risk to the security-based swap dealer and the financial system arising from the use of security-based swaps that are not cleared. [427] Margin serves as a buffer in the event a counterparty fails to meet an obligation to the security-based swap dealer and the security-based swap dealer must liquidate the assets posted by the counterparty to satisfy the obligation. [428] More generally, under Title VII, the Commission is specifically required to set both capital and margin requirements for nonbank security-based swap dealers that (i) help ensure the safety and soundness of the nonbank security-based swap dealer and (ii) are appropriate for the risk associated with the non-cleared swaps held as a security-based swap dealer. [429]

Pursuant to Section 15F(e) of the Exchange Act, the Commission has proposed Rule 18a-3 to establish margin requirements for nonbank security-based swap dealers with respect to non-cleared security-based swaps. [430] Proposed Rule 18a-3 is based on the margin rules applicable to broker-dealers. [431] The goal of modeling proposed Rule 18a-3 on the broker-dealer margin rules is to promote consistency with existing rules and to facilitate the portfolio margining of security-based swaps with other types of securities. [432] Proposed Rule 18a-3 is intended to form part of an integrated program of financial responsibility requirements, along with the proposed capital and segregation standards. [433]

The Commission preliminarily believes that it is necessary to treat margin as an entity-level requirement applicable to all of a dealer's security-based swap transactions in order to effectively address the Dodd-Frank Act requirements for setting margin. We preliminarily believe that treating margin solely as a transaction-level requirement, and applying margin requirements differently to a security-based swap dealer's U.S. Business and Foreign Business, [434] would not adequately further the goals of using margin to ensure the safety and soundness of security-based swap dealers because it could result in security-based swap dealers with global businesses collecting significantly less collateral than would otherwise be required to the extent that they are not required by local law to collect margin from their counterparties. Further, separately applying margin in this way would force those counterparties entering into transactions that constitute the U.S. Business of a dealer to bear a greater burden in ensuring the safety and soundness of such dealer than counterparties that are part of the dealer's Foreign Business. [435] We thus preliminarily believe that it is appropriate to treat margin as an entity-level requirement applicable to the security-based swap transactions of registered security-based swap dealers regardless of the location of their counterparties. As noted below, the Commission is soliciting comment on this approach.

iii. Risk Management

Registered security-based swap dealers are required to establish robust and professional risk management systems adequate for managing their day-to-day business. [436] The Commission has proposed that nonbank security-based swap dealers would be required to comply with existing Rule 15c3-4 under the Exchange Act. [437] This rule, originally adopted for OTC derivative dealers, requires firms subject to its provisions to establish, document, and maintain a comprehensive system of internal risk management controls to assist in managing the risks associated with its business activities, including market, credit, leverage, liquidity, legal, and operational risks. [438] These various risks arise from both the U.S. Business and Foreign Business of a global security-based swap dealer. A risk management system limited in scope to cover only one type of business, or limited to certain security-based swap transactions, would not effectively control the risks undertaken by a security-based swap dealer because the risks stemming from business outside the scope of such risk management system could still negatively impact the dealer. As a result, we preliminarily believe that it is necessary to treat risk management requirements as entity-level requirements in order to place risk controls over the entire security-based swap business, thus effectively addressing the Dodd-Frank Act requirements for managing risk within security-based swap dealers.

Rule 15c3-4 identifies a number of qualitative factors that would need to be a part of the risk management controls of a nonbank security-based swap dealer. For example, a nonbank security-based swap dealer would need to have a risk control unit that reports directly to senior management and is independent from business trading units, and it would be required to separate duties between personnel responsible for entering into a transaction and those responsible for recording the transaction in the books and records of the firm. [439] In addition, the Commission is authorized to adopt rules governing documentation standards of security-based swap dealers for timely and accurate confirmation, processing, netting, documentation, and valuation of security-based swaps. [440] Pursuant to this authority, the Commission has proposed rules regarding trade acknowledgement and verification related to security-based swap transactions. [441]

iv. Recordkeeping and Reporting

Registered nonbank security-based swap dealers are required to keep books and records in such form and manner and for such period as may be prescribed by the Commission by rule or regulation; registered bank security-based swap dealers are required to keep books and records of all activities related to their “business as a security-based swap dealer” in such form and manner and for such period as may be prescribed by the Commission. [442] Registered security-based swap dealers also are required to make such reports as are required by the Commission regarding the transactions and positions, and financial condition of the registrant. [443]

In addition, security-based swap dealers are required to maintain daily trading records of the security-based swaps they enter into. [444] Security-based swap dealers also are required to disclose to the Commission and the prudential regulators information concerning: (i) Terms and conditions of their security-based swaps; (ii) security-based swap trading operations, mechanisms, and practices; (iii) financial integrity protections relating to security-based swaps; and (iv) other information relevant to their trading in security-based swaps. [445]

Each of these types of records is an important part of the Commission's oversight of our registrants because it provides the Commission with vital information regarding such entities. If the Commission's information were limited in scope to cover only one type of business, or limited to only certain security-based swap activities, the Commission would not be able to effectively regulate our registered security-based swap dealers because it would not have a full picture of the business of such registrants. As a result, we preliminarily believe that it is necessary to treat recordkeeping and reporting as entity-level requirements in order to provide the Commission with the information necessary to regulate registered security-based swap dealers and thus effectively address the Dodd-Frank Act requirements for maintaining books and records.

The Commission has not yet proposed rules regarding the recordkeeping and reporting requirements under Section 15F of the Exchange Act and solicits comment regarding the application of recordkeeping and reporting requirements in the cross-border context.

v. Internal System and Controls

Security-based swap dealers are required to establish and enforce systems and procedures to obtain any information that is necessary to perform any of the functions that are required under Section 15F(j) of the Exchange Act [446] and to provide this information to the Commission, or the responsible prudential regulator, upon request. [447] The Commission has proposed a rule that would require a registered security-based swap dealer to establish policies and procedures that are reasonably designed to comply with its responsibilities under Section 15F(j) of the Exchange Act. [448]

Many of the functions required under Section 15F(j) of the Exchange Act are entity-level in nature (e.g., risk management procedures [449] and conflicts of interest [450] ). As a result, we preliminarily believe that the requirement to establish and enforce systems and procedures to obtain any information that is necessary to perform these functions cannot be effectively implemented unless it also is treated as an entity-level requirement, or else it would not cover the full scope of the requirements under Section 15F(j) of the Exchange Act to which it applies.

vi. Diligent Supervision

The Commission is authorized under the Dodd-Frank Act to adopt rules requiring diligent supervision of the business of security-based swap dealers. [451] The Commission has proposed a rule that would establish supervisory obligations and that would incorporate principles from Section 15(b) of the Exchange Act and existing SRO rules. [452] Among other things, under proposed Rule 15Fh-3(h), a security-based swap dealer would be required to establish, maintain, and enforce a system to supervise, and would be required to supervise diligently, its business and its associated persons, with a view to preventing violations of applicable federal securities laws, and the rules and regulations thereunder, relating to its business as a security-based swap dealer. [453] The rule proposed by the Commission also would establish certain minimum requirements relating to the supervisory systems that are prescriptive in nature, that is, they would impose specific obligations on security-based swap dealers. [454]

As previously noted, the purpose of diligent supervision requirements is to prevent violations of applicable federal securities laws, and the rules and regulations thereunder, relating to an entity's business as a security-based swap dealer. An entity's business as a security-based swap dealer is not limited to either its Foreign Business or its U.S. Business, but rather is comprised of its entire global security-based swap dealing activity. As a result, we preliminarily believe that it is necessary to treat diligent supervision as an entity-level requirement applicable to all of a dealer's security-based swap transactions in order to effectively address the Dodd-Frank Act requirements for diligent supervision. We believe that treating diligent supervision solely as a transaction-level requirement, and applying supervisory requirements differently to a security-based swap dealer's U.S. Business and Foreign Business, would not further the Dodd-Frank Act goal of establishing effective supervisory systems for security-based swap dealers.

vii. Conflicts of Interest

Section 15F(j)(5) of the Exchange Act requires security-based swap dealers to implement conflict-of-interest systems and procedures. Such policies and procedures must establish structural and institutional safeguards to ensure that the activities of any person within the firm relating to research or analysis of the price or market for any security-based swap, or acting in the role of providing clearing activities, or making determinations as to accepting clearing customers are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of persons whose involvement in pricing, trading, or clearing activities might potentially bias their judgment or supervision, and contravene the core principles of open access and the business conduct standards addressed in Title VII. [455] The Commission has proposed a rule that would require a security-based swap dealer to establish policies and procedures that are reasonably designed to comply with its responsibilities under Section 15F(j)(5). [456]

The Commission preliminarily believes that it is necessary to treat conflicts of interest as an entity-level requirement applicable to all of a dealer's security-based swap transactions in order to effectively address the Dodd-Frank Act requirements for setting systems and procedures to prevent conflicts of interest from biasing the judgment or supervision of security-based swap dealers. We believe that treating conflicts of interest solely as a transaction-level requirement, and applying the required structural and institutional safeguards differently to a security-based swap dealer's U.S. Business and Foreign Business, would not further the goals of preventing conflicts of interest from influencing the security-based swap dealing activities of registered security-based swap dealers because such safeguards would only be in place for a portion of a security-based swap dealer's activities.

viii. Chief Compliance Officer

Registered security-based swap dealers are required to designate a chief compliance officer who reports directly to the board of directors or to the senior officer of the security-based swap dealer. [457] The chief compliance officer's responsibilities include reviewing and ensuring compliance of the security-based swap dealer with applicable requirements in the Exchange Act and the rules and regulations thereunder, resolution of conflicts of interest, administration of business conduct policies and procedures, and establishment of procedures for the remediation of noncompliance issues. [458] The chief compliance officer also is required to prepare and sign a report that contains a description of the security-based swap dealer's compliance with applicable requirements in the Exchange Act, and the rules and regulations thereunder, and each of the security-based swap dealer's policies and procedures. [459] The Commission has proposed a rule to implement these statutory requirements relating to the designation and functions of a chief compliance officer. [460]

As noted above, part of the chief compliance officer's responsibilities, under the proposed rule, include establishing, maintaining, and reviewing policies and procedures reasonably designed to ensure compliance with applicable requirements in the Exchange Act and the rules and regulations thereunder. [461] Many of Title VII requirements, such as those applicable to security-based swap dealers that are described in this section, apply at the entity level. As a result, we preliminarily believe that it is necessary to treat the chief compliance officer as an entity-level requirement applicable to all of a dealer's security- based swap business in order to effectively address the Dodd-Frank Act requirements for the chief compliance officer. We believe that treating the chief compliance officer solely as a transaction-level requirement, and applying the chief compliance officer requirements differently to a security-based swap dealer's U.S. Business and Foreign Business, would be unworkable given the chief compliance officer's oversight responsibilities over entity-level requirements and thus would not further the goals of establishing the chief compliance officer role for security-based swap dealers.

ix. Inspection and Examination

Registered bank and nonbank security-based swap dealers are obligated to keep their books and records required pursuant to Commission rules and regulations open to inspection and examination by any representative of the Commission. [462] The Commission has proposed a rule that would require, among other things, “nonresident security-based swap dealers” that are required to register with the Commission to appoint and identify to the Commission an agent in the United States (other than the Commission or a Commission member, official, or employee) for service of process. [463] In addition, the proposed rule would require that a nonresident security-based swap dealer certify that the firm can, as a matter of law, provide the Commission with prompt access to its books and records and can, as a matter of law, submit to onsite inspection and examination by the Commission. [464] The proposed rule also would require that the nonresident security-based swap dealer provide the Commission with an opinion of counsel concurring that the firm can, as a matter of law, provide the Commission with prompt access to its books and records and can, as a matter of law, submit to onsite inspection and examination by the Commission. [465]

In proposing this rule, the Commission stated that it preliminarily believed that the nonresident security-based swap certification and supporting opinion of counsel were important to confirm that each registered nonresident security-based swap dealer has taken the necessary steps to be in the position to provide the Commission with prompt access to its books and records and to be subject to inspection and examination by the Commission. [466] To effectively fulfill our regulatory oversight responsibilities with respect to nonresident security-based swap dealers registered with it, the Commission stated that it must have access to those entities' records and the ability to examine them. The Commission recognized, however, that certain foreign jurisdictions may have laws that complicate the ability of financial institutions, such as nonresident security-based swap dealers located in their jurisdictions, to share and/or transfer certain information including personal financial data of individuals that the financial institutions come to possess from third persons (e.g., personal data relating to the identity of market participants or their customers). [467] The Commission further stated that the required certification and opinion of counsel regarding the nonresident security-based swap dealer's ability to provide prompt access to books and records and to be subject to inspection and examination would allow the Commission to better evaluate a nonresident security-based swap dealer's ability to meet the requirements of registration and ongoing supervision. [468]

The Commission's inspection and examination authority is vital to our oversight of registered security-based swap dealers. If the Commission's inspection and examination were limited in scope to cover only one type of business, or limited to only certain security-based swap activities, the Commission would not be able to effectively regulate our registered security-based swap dealers because it would not have a full picture of the business of such registrants. As a result, we preliminarily believe that it is necessary to treat inspection and examination requirements as entity-level in order to provide the Commission with the information and access necessary to regulate registered security-based swap dealers.

x. Licensing Requirements and Statutory Disqualification

The Commission has not proposed any licensing requirements for associated persons of registered security-based swap dealers, that are specifically related to their security-based swap dealing activities. However, the Commission has proposed a rule that would require security-based swap dealers (and major security-based swap participants) to certify that no person associated with such entities who effects or is involved in effecting security-based swaps on their behalf is subject to statutory disqualification, as defined in Section 3(a)(39) of the Exchange Act. [469] This proposed rule relates to paragraph (b)(6) of Section 15F of the Exchange Act, [470] which generally prohibits security-based swap dealers (and major security-based swap participants) from permitting any of their associated persons [471] [] who are subject to a “statutory disqualification” to effect or be involved in effecting [472] [] security-based swaps on behalf of such entities if the security-based swap dealer (or major security-based swap participant) knew, or in the exercise of reasonable care should have known, of the statutory disqualification. [473]

The Commission preliminarily believes that it is necessary to treat requirements related to licensing and statutory disqualification as entity-level requirements applicable to all of a dealer's security-based swap business in order to effectively address the Exchange Act's statutory disqualification provision. We believe that treating licensing requirements and statutory disqualification solely as transaction-level requirements, and applying the statutory disqualification differently to a security-based swap dealer's U.S. Business and Foreign Business, would not further the goals of preventing statutorily disqualified persons from effecting security-based swaps on behalf of registered security-based swap dealers because such disqualifications would only be in place for a portion of a security-based swap dealer's activities.

4. Application of Certain Transaction-Level Requirements [474]

(a) Proposed Rule

The Commission is proposing a rule that would provide that a registered foreign security-based swap dealer and a foreign branch of a registered U.S. security-based swap dealer, with respect to their Foreign Business, shall not be subject to the requirements relating to external business conduct standards described in Section 15F(h) of the Exchange Act, [475] and the rules and regulations thereunder, other than the rules and regulations prescribed by the Commission pursuant to Section 15F(h)(1)(B). [476]

The proposed rule would define “Foreign Business” as security-based swap transactions entered into, or offered to be entered into, by or on behalf of a foreign security-based swap dealer or a U.S. security-based swap dealer that do not include its U.S. Business. [477] The proposed rule would define “U.S. Business” as:

  • With respect to a foreign security-based swap dealer, (i) any transaction entered into, or offered to be entered into, by or on behalf of such foreign security-based swap dealer, with a U.S. person (other than with a foreign branch), or (ii) any transaction conducted within the United States; [478] and
  • With respect to a U.S. security-based swap dealer, any transaction by or on behalf of such U.S. security-based swap dealer, wherever entered into or offered to be entered into, other than a transaction conducted through a foreign branch with a non-U.S. person or another foreign branch. [479]

Whether the activity occurred within the United States or with a U.S. person for purposes of identifying whether security-based swap transactions are part of a U.S. Business or Foreign Business would turn on the same factors used to determine whether a foreign security-based swap dealer is engaging in dealing activity within the United States or with U.S. persons, as discussed above. [480] The proposed rule provides that a U.S. security-based swap dealer would be considered to have conducted a security-based swap transaction through a foreign branch if:

  • The foreign branch is the counterparty to such security-based swap transaction; and
  • No person within the United States is directly involved in soliciting, negotiating, or executing the security-based swap transaction on behalf of the foreign branch or its counterparty. [481]

As discussed above, [482] the proposed rule would define “foreign branch” as any branch of a U.S. bank if:

  • The branch is located outside the United States;
  • The branch operates for valid business reasons; and
  • The branch is engaged in the business of banking and is subject to substantive banking regulation in the jurisdiction where located. [483]

All other requirements in Section 15F of the Exchange Act, and the rules and regulations thereunder, would apply to both U.S. and foreign security-based swap dealers registered with the Commission, although the Commission is proposing to establish a policy and procedural framework under which it would consider permitting substituted compliance for foreign security-based swap dealers (but not for U.S. security-based swap dealers that conduct dealing activity through foreign branches) under certain circumstances, as discussed below. [484]

The Commission also is proposing a rule that would provide that a foreign security-based swap dealer would not be required to comply with the segregation requirements set forth in Section 3E of the Exchange Act, and the rules and regulations thereunder, with respect to security-based transactions with non-U.S. person counterparties in certain circumstances. [485] Specifically, the Commission is proposing a rule that would provide the following:

  • With respect to non-cleared security-based swap transactions:

○ A registered foreign security-based swap dealer that is a registered broker-dealer would be subject to the requirements relating to segregation of assets held as collateral set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, with respect to assets collected from, for, or on behalf of any counterparty to margin a non-cleared security-based swap transaction.

○ a registered foreign security-based swap dealer that is not a registered broker-dealer would be subject to the requirements relating to segregation of assets held as collateral set forth in Section 3E of the Exchange Act, and Rules 18a-4(a)-(d), solely with respect to assets collected from, for, or on behalf of a counterparty that is a U.S. person to margin a non-cleared security-based swap transaction. The special account maintained by a registered foreign security-based swap dealer that is not a registered broker-dealer in accordance with proposed Rule 18a-4(c) would be required to be designated for the exclusive benefit of U.S. person security-based swap customers. [486]

  • With respect to cleared security-based swap transactions:

○ A registered foreign security-based swap dealer that is not a foreign bank with a branch or agency in the United States and is a registered broker-dealer shall be subject to the requirements relating to segregation of assets held as collateral set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, with respect to assets collected from, for, or on behalf of any counterparty to margin a cleared security-based swap transaction.

○ a registered foreign security-based swap dealer that is not a foreign bank with a branch or agency in the United States and that is not a registered broker-dealer shall be subject to the requirements relating to segregation of assets held as collateral set forth in Section 3E of the Exchange Act, and Rules 18a-4(a)-(d), only if such registered foreign security-based swap dealer accepts any assets from, for, or on behalf of a counterparty that is a U.S. person to margin, guarantee, or secure a cleared security-based swap transaction. [487]

○ a registered foreign security-based swap dealer that is a foreign bank with a branch or agency in the United States would be subject to the requirements relating to segregation of assets held as collateral set forth in Section 3E of the Exchange Act, and Rules 18a-4(a)-(d), [488] solely with respect to assets collected from a counterparty that is a U.S. person to margin a cleared security-based swap transaction. The special account maintained by a registered foreign security-based swap dealer that is a foreign bank with a branch or agency in the United States in accordance with proposed Rule 18a-4(c) would be required to be designated for the exclusive benefit of U.S. person security-based swap customers. [489]

In addition, a registered foreign security-based swap dealer would be required to disclose to its counterparty the potential treatment of the assets segregated by such registered foreign security-based swap dealer pursuant to Section 3E of the Exchange Act, and rules and regulations thereunder, in insolvency proceedings under the U.S. bankruptcy law and applicable foreign insolvency laws. [490]

(b) Discussion

i. External Business Conduct Standards

a. Foreign Security-Based Swap Dealers

The Commission preliminarily believes it is appropriate not to impose on foreign security-based swap dealers the external business conduct standards in Section 15F(h) (other than rules and requirements prescribed by the Commission pursuant to Section 15F(h)(1)(B)) of the Exchange Act, and the rules and regulations thereunder, described in the proposed rule, [491] with respect to their Foreign Business, because these requirements relate primarily to customer protection. The Dodd-Frank Act's counterparty protection mandate focuses on the United States and the U.S. markets. [492] In addition, we preliminarily believe that foreign counterparties typically would not expect to receive the customer protections of Title VII when dealing with a foreign security-based swap dealer outside the United States. At the same time, our proposed approach would preserve customer protections for U.S. counterparties that would expect to benefit from the protection afforded to them by Title VII of the Dodd-Frank Act.

Therefore, the Commission preliminarily believes that requiring foreign security-based swap dealers to comply with the external business conduct standards requirement with respect to their security-based swap transactions conducted outside the United States with non-U.S. persons (or with foreign branches of U.S. banks) would not advance this statutory purpose. Although this approach represents a departure from the entity approach the Commission has traditionally taken in the regulation of foreign broker-dealers, as discussed above, whereby the Commission applies our regulations to the entire global business of a registered broker-dealer, we preliminarily believe this departure is appropriate in the context of a global security-based swap market in order to create a regulatory framework that provides effective protections for counterparties that are U.S. persons while recognizing the role of foreign regulators in non-U.S. markets.

The Commission also preliminarily believes that this approach addresses many of the concerns raised by commenters, including foreign regulators, concerning the potential application of Title VII to transactions between registered foreign security-based swap dealers and non-U.S. counterparties. In addition, this approach is consistent with the reasonable expectations of U.S. person counterparties, who would expect to receive the protection of external business conduct standards and conflicts of interest requirements when dealing with a foreign security-based swap dealer within the United States. [493]

The Commission's proposed approach to external business conduct standards would not except foreign security-based swap dealers from the rules and requirements prescribed by the Commission pursuant to Section 15F(h)(1)(B) of the Exchange Act with respect to their Foreign Business. [494] Section 15F(h)(1)(B) requires security-based swap dealers to conform with such business conduct standards relating to diligent supervision as the Commission shall prescribe. [495] The Commission preliminarily believes that it is not appropriate to except foreign security-based swap dealers from compliance with such requirements. Because registered foreign security-based swap dealers would be subject to a number of obligations under the federal securities laws with respect to their security-based swap business, the Commission preliminarily believes that having systems in place reasonably designed to ensure diligent supervision would be an important aspect of their compliance with the federal securities laws. However, as discussed below, the Commission is proposing to permit substituted compliance with the diligent supervision requirement in Section 15F(h)(1)(B), and the rules and regulations thereunder, by foreign security-based swap dealers. [496] The Commission preliminarily believes that foreign security-based swap dealers subject to regulation in a foreign jurisdiction are very likely to be subject to diligent supervision requirements and to the extent that such requirements are comparable to Commission requirements, we would consider permitting substituted compliance, as discussed below. [497]

The Commission is proposing to except foreign security-based swap dealers from complying with the rules and regulations that the Commission may prescribe pursuant to Section 15F(h)(1)(A) or (C) of the Exchange Act. [498] Section 15F(h)(1)(A) requires security-based swap dealers to conform with such business conduct standards relating to fraud, manipulation, and other abusive practices involving security-based swaps (including security-based swaps that are offered but not entered into) as prescribed by the Commission. Section 15F(h)(1)(C) requires security-based swap dealers to adhere to rules and regulations prescribed by the Commission with respect to applicable position limits. The Commission has not engaged in rulemaking pursuant to these provisions. [499] If the Commission does propose rules pursuant to these provisions in the future, the Commission would consider, at that time, whether it would be appropriate to subject foreign security-based swap dealers to such requirements with respect to their Foreign Business.

b. U.S. Security-Based Swap Dealers

The Commission preliminarily believes it is appropriate not to subject U.S. security-based swap dealers to the external business conduct standards in Section 15F(h) (other than Section 15F(h)(1)(B)) of the Exchange Act, and the rules and regulations thereunder, as specified in the proposed rule, with respect to security-based swap transactions conducted through their foreign branches outside the United States with non-U.S. counterparties, because such requirements relate primarily to customer protection requirements. The Dodd-Frank Act generally is concerned with the protection of U.S. markets and participants in those markets. [500] Therefore, we preliminarily believe that subjecting U.S. security-based swap dealers to the Title VII customer protection requirements with respect to their security-based swap transactions conducted through their foreign branches outside the United States (even though the transactions may pose risk to the U.S. financial system) with non-U.S. persons would produce little or no benefit to U.S. market participants. Although this approach would represent a departure from the entity approach the Commission has traditionally taken in the regulation of broker-dealers, whereby the Commission applies our regulations to the entire global business of a registered broker-dealer, we preliminarily believe it is appropriate in the context of a global security-based swap market in order to develop a national regulatory framework that provides effective protections for counterparties who are U.S. persons while recognizing the role of foreign regulators in non-U.S. markets.

The Commission also preliminarily believes that this approach would help address the potential application of duplicative and conflicting regulatory requirements to security-based swap transactions between the foreign branches of registered U.S. bank security-based swap dealers and non-U.S. counterparties. In addition, the Commission preliminarily believes this approach is consistent with the reasonable expectations of foreign counterparties, who would not necessarily expect to receive the protections of Title VII when dealing with a foreign branch of a U.S. bank outside the United States, even if it is registered as a security-based swap dealer with the Commission. [501]

The purpose of the proposed provision defining when a security-based swap transaction would be considered to have been conducted through a foreign branch is intended to prevent U.S. security-based swap dealers from using the proposed rule to evade the application of Title VII. [502] Requiring that the foreign branch be the named counterparty to the security-based swap transaction and that no person within the United States be directly involved in soliciting, negotiating, or executing the security-based swap transaction on behalf of the foreign branch or its counterparty is intended to help ensure that the security-based swap transaction occurs outside the United States, even though the Commission recognizes that the risk of the transaction would ultimately be borne by the U.S. security-based swap dealer, of which the foreign branch is merely a part. [503] The U.S. security-based swap dealer would still be subject to the entity-level requirements described above intended to address the risk the transactions pose to the U.S. financial system.

ii. Segregation Requirements

The segregation requirements set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, are closely tied to U.S. bankruptcy laws. [504] Subchapter III of Chapter 7, Title 11 of the United States Code (the “stockbroker liquidation provisions”) [505] provides special protections for “customers” of stockbrokers. Among other protections, “customers” share ratably with other customers ahead of virtually all other creditors in the “customer property” held by the failed stockbroker. [506] The Dodd-Frank Act contains provisions designed to ensure that cash and securities held by a security-based swap dealer relating to security-based swaps will be deemed customer property under the stockbroker liquidation provisions. [507] In particular, Section 3E(g) of the Exchange Act [508] provides, among other things, that a security-based swap shall be considered to be a “security” as such term is used in section 101(53A)(B) [509] and the stockbroker liquidation provisions. Section 3E(g) also provides that an account that holds a security-based swap shall be considered to be a “securities account” as that term is defined in the stockbroker liquidation provisions. [510] In addition, Section 3E(g) provides that the terms “purchase” and “sale” as defined in Sections 3(a)(13) and (14) of the Exchange Act, respectively, shall be applied to the terms “purchase” and “sale” as used in the stockbroker liquidation provisions. [511] Finally, Section 3E(g) provides that the term “customer” as defined in the stockbroker liquidation provisions excludes any person to the extent the person has a claim based on a non-cleared security-based swap transaction except to the extent of any margin delivered to or by the customer with respect to which there is a customer protection requirement under Section 15(c)(3) of the Exchange Act or a segregation requirement. [512]

The provisions of Section 3E(g) of the Exchange Act apply the customer protection elements of the stockbroker liquidation provisions to cleared security-based swaps, including related collateral, and, if subject to customer protection requirements under Section 15(c)(3) of the Exchange Act or a segregation requirement prescribed by the Commission, to collateral delivered as margin for non-cleared security-based swaps. [513] The Commission has proposed Rule 18a-4(a)-(d) to establish segregation requirements for security-based swap dealers with respect to cleared and non-cleared security-based swaps pursuant to Section 3E of the Exchange Act and pursuant to Section 15(c)(3) of the Exchange Act [514] with respect to security-based swap dealers that are broker-dealers. [515]

Specifically, proposed Rule 18a-4(b) requires a security-based swap dealer to promptly obtain and thereafter maintain physical possession or control of all excess securities collateral carried for the accounts of security-based swap customers. Such possession or control requirement is designed to ensure the securities held for the accounts of security-based swap customers are under the control of the security-based swap dealer and, therefore, readily available to be returned to security-based swap customers. Proposed Rule 18a-4(c) requires a security-based swap dealer to maintain a special account for the exclusive benefit of security-based swap customers and have on deposit in that account at all times an amount of cash or qualified securities determined by computing the net amount of credits owed to customers. [516] The objective of the possession or control and special account requirements in proposed Rule 18a-4 is to facilitate the prompt return of “customer property” to security-based swap customers either before or during a liquidation proceeding if the firm fails. In the event of a failure of the security-based swap dealer, customers would share the “customer property” ratably with other customers and ahead of virtually all other creditors. [517] In addition, with respect to non-cleared security-based swaps, proposed Rule 18a-4(d) requires a security-based swap dealer to provide the notice required under Section 3E(f)(1)(A) of the Exchange Act [518] to a counterparty in writing prior to the execution of the first non-cleared security-based swap transaction with such counterparty. If a counterparty to a non-cleared security-based swap elects to segregate funds or other property with a third-party custodian pursuant to Section 3E(f) of the Exchange Act or elects not to require the omnibus segregation of funds or other property pursuant to proposed Rule 18a-4(c), the security-based swap dealer must obtain an agreement from such counterparty to subordinate all claims against the security-based swap dealer to the claims of security-based swap customers of such security-based swap dealer. [519]

As proposed in the Capital, Margin and Segregation Proposing Release, the segregation requirements in proposed Rule 18a-4(a)-(d) do not distinguish between U.S. security-based swap dealers and foreign security-based swap dealers or between U.S. person and non-U.S. person security-based swap counterparties, and do not address application of the segregation requirements in the cross-border context. The Commission preliminarily believes that the Dodd-Frank Act's mandate to promote financial stability, improve accountability, and protect counterparties focuses territorially on the United States and the U.S. security-based swap market [520] and, therefore, is not proposing any changes with respect to U.S. security-based swap dealers to the segregation requirements already proposed. [521] The Commission's proposed approach to application of segregation requirements to foreign security-based swap dealers intends to protect U.S. person counterparties and minimize the impact of a failed security-based swap dealer on the U.S. financial system generally and the U.S. security-based swap market in particular.

a. Foreign Security-Based Swap Dealers

As stated above, Section 3E(g) extends the customer protection provided by the stockbroker liquidation provisions of the U.S. Bankruptcy Code to cleared security-based swaps and non-cleared security-based swaps in different ways. In addition, a foreign security-based swap dealer may not be subject to the stockbroker liquidation provisions if it is a foreign bank with a branch or agency in the United States. [522] Such foreign security-based swap dealer's insolvency and liquidation would be subject to banking regulations. [523] On the other hand, if a foreign security-based swap dealer is not a foreign bank with a branch or agency in the United States, it may be subject to the stockbroker liquidation provisions [524] in a stockbroker liquidation proceeding in a U.S. bankruptcy court. Moreover, if a foreign security-based swap dealer is a registered broker-dealer, it is a member of the Securities Investor Protection Corporation (“SIPC”) [525] and is subject to segregation requirements under Section 15(c)(3) of the Exchange Act, [526] and rules and regulations thereunder. [527] Such a foreign security-based swap dealer would be subject to the liquidation proceeding under the Securities Investor Protection Act of 1970 (the “SIPA”). [528] Therefore, we propose an approach that would apply the segregation requirements to a foreign security-based swap dealer depending on whether it holds assets to secure cleared security-based swap transactions or non-cleared security-based swap transactions and whether such foreign security-based swap dealer is a registered broker-dealer, a foreign bank with a branch or agency in the United States, or neither of the above. [529]

We recognize that a foreign security-based swap dealer may not be subject to the stockbroker liquidation provisions and its insolvency or liquidation proceeding in the United States may be administered under SIPA or banking regulations concurrently with other potential insolvency proceedings outside the United States under applicable foreign insolvency laws. Therefore, the effectiveness of the segregation requirements with respect to a foreign security-based swap dealer in practice may depend on many factors, including the type and objectives of the insolvency or liquidation proceeding and how the U.S. Bankruptcy Code, SIPA, banking regulations and applicable foreign insolvency laws are interpreted by the U.S. bankruptcy court, SIPC, Federal Deposit Insurance Corporation and relevant foreign authorities.

b. Non-Cleared Security-Based Swaps

i. Foreign Security-Based Swap Dealer That Is a Registered Broker-Dealer

With respect to non-cleared security-based swaps, the Commission proposes to apply segregation requirements differently to foreign security-based swap dealers depending on whether they also are registered broker-dealers. Specifically, the Commission proposes to require a foreign security-based swap dealer that is a registered broker-dealer to segregate margin received from all counterparties to secure non-cleared security-based swap transactions, in accordance with Section 3E of the Exchange Act, and rules and regulations thereunder. [530]

If a foreign security-based swap dealer is a registered broker-dealer, it already would: (i) be subject to the customer protection requirements under Section 15(c)(3) of the Exchange Act, [531] and rules and regulations thereunder, including Rule 15c3-3 if it carries customer securities and cash; (ii) be required to maintain possession or control of customer securities and maintain cash or qualified securities in a special reserve account if it carries customer securities and cash; and (iii) if it is a member of SIPC, be liquidated in a formal proceeding under the SIPA. [532] Rule 15c3-3 under Section 15(c)(3) of the Exchange Act provides customer protection and defines “customer” broadly to include any person from whom or on whose behalf a broker or dealer has received or acquired or holds funds or securities for the account of that person. [533] Therefore, if a foreign security-based swap dealer that is a registered broker-dealer receives collateral from a non-cleared security-based swap counterparty, such counterparty would be a “customer” and is afforded customer protection with respect to such collateral under Rule 15c3-3. As stated above, Section 3E(g) extends “customer” status to non-cleared security-based swap counterparties to the extent of any margin delivered to or by the counterparties with respect to which there is a customer protection requirement under Section 15(c)(3). [534] Therefore, non-cleared security-based swap counterparties of a foreign security-based swap dealer that is a registered broker-dealer are “customers” within the meaning of the stockbroker liquidation provisions. [535]

As such, if the Commission does not require a foreign security-based swap dealer that is a registered broker-dealer to segregate all counterparties' assets posted to secure non-cleared security-based swaps, in a SIPA liquidation proceeding of such foreign security-based swap dealer and broker-dealer, [536] the pool of assets segregated pursuant to Rule 15c3-3 and proposed Rule 18a-4 may be insufficient to satisfy the combined claims of all customers, resulting in losses to all customers. Therefore, the Commission proposes to subject a foreign security-based swap dealer that is a registered broker-dealer to the segregation requirements set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, relating to assets received from all counterparties held as collateral to secure non-cleared security-based swap transactions.

ii. Non-Cleared Security-Based Swaps—Foreign Security-Based Swap Dealer That is Not a Registered Broker-Dealer

If a foreign security-based swap dealer is not a registered broker-dealer, its non-cleared security-based swap counterparties would be “customers” under the stockbroker liquidation provisions only to the extent that there is a segregation requirement prescribed by the Commission. [537] The Commission proposes to subject such foreign security-based swap dealer to the segregation requirements set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, solely with respect to non-cleared security-based swaps with U.S. person counterparties. [538] This approach would provide U.S. person counterparties “customer” status under the stockbroker liquidation provisions and their assets would be segregated for their exclusive benefit. Non-U.S. person counterparties would not be “customers” and would not have “customer” status with respect to the segregated assets. As stated above, the Commission preliminarily believes that the objective of the Dodd-Frank Act is to protect U.S. counterparties and to minimize disruption to the U.S. financial system caused by a security-based swap dealer's failure. Therefore, the Commission preliminarily believes that the proposed approach would achieve the benefit intended by the segregation requirements set forth in Section 3E of the Exchange Act, and rules and regulations thereunder.

The Commission recognizes that a foreign security-based swap dealer that is not a broker-dealer but is a foreign bank with a branch or agency (as defined in Section 1(b) of the International Banking Act of 1978) [539] in the United States may not be eligible to be liquidated pursuant to the stockbroker liquidation provisions. [540] Such foreign security-based swap dealer's insolvency proceeding in the United States would be administered under banking regulations. [541] Nevertheless, the Commission preliminarily believes that imposing segregation requirements on such foreign security-based swap dealer when it receives collateral from U.S. person counterparties would reduce the likelihood of U.S. person counterparties incurring losses by helping identify U.S. customers' assets in an insolvency proceeding of such foreign security-based swap dealer in the United States and would potentially minimize disruption to the U.S. security-based swap market, thereby producing potential benefits to the U.S. financial system and U.S. counterparties that are consistent with the objectives of the Dodd-Frank Act.

c. Cleared Security-Based Swaps

In applying the segregation requirements to a foreign security-based swap dealer with respect to cleared security-based swap transactions, the Commission also proposes to distinguish among: (1) a foreign security-based swap dealer that is a registered broker-dealer; (2) a foreign security-based swap dealer that is not a registered broker-dealer and is not a foreign bank with a branch or agency in the United States; and (3) a foreign security-based swap dealer that is a foreign bank with a branch or agency in the United States. In the following paragraphs, we will discuss how we propose to apply the segregation requirements to foreign security-based swap dealers in each of these categories with respect to assets held by them as collateral to secure cleared security-based swaps.

i. Foreign Security-Based Swap Dealer That Is a Registered Broker-Dealer

The proposed rule would apply segregation requirements to a foreign security-based swap dealer that is a registered broker-dealer with respect to assets received from all counterparties to secure cleared security-based swaps. [542] As stated above, Section 3E(g) of the Exchange Act extends customer protection under the stockbroker liquidation provisions to all cleared security-based swap counterparties and to all non-cleared security-based swap counterparties, with respect to which there is a customer protection requirement under Section 15(c)(3) of the Exchange Act. [543] Therefore, all security-based swap counterparties of a foreign security-based swap dealer that is a registered broker-dealer are customers under the stockbroker liquidation provisions. [544] In the absence of a Commission requirement that a foreign security-based swap dealer that is a registered broker-dealer segregate all cleared security-based swap counterparties' collateral, if such an entity were liquidated pursuant to SIPA, the amount of assets segregated could be less than the combined priority claims of all security-based swap customers, potentially resulting in losses to customers. Therefore, the Commission proposes to subject a foreign security-based swap dealer who is a registered broker-dealer to segregation requirements set forth in Section 3E of the Exchange Act, and rules and regulations thereunder, with respect to assets received from all counterparties to secure cleared security-based swaps.

ii. Foreign Security-Based Swap Dealer That Is Not a Registered Broker-Dealer and Is Not a Foreign Bank With Branch or Agency in the United States

If a foreign security-based swap dealer is not a registered broker-dealer and is not a foreign bank that has a branch or agency (as defined in Section 1(b) of the International Banking Act of 1978) in the United States, such foreign security-based swap dealer may be eligible to be a debtor under Chapter 7 of the U.S. Bankruptcy Code and may therefore be subject to the stockbroker liquidation provisions in the U.S. Bankruptcy Code. [545] As stated above, Section 3E(g) of the Exchange Act provides “customer” status to all counterparties to cleared security-based swaps, making no distinction between U.S. customers or counterparties and non-U.S. person customers or counterparties. [546] Therefore, in the case where such foreign security-based swap dealer receives any assets from, for, or on behalf of a U.S. person customer to margin, guarantee, or secure security-based swaps, if the Commission were to apply the segregation requirements only to assets posted by U.S. person customers but not to assets posted by non-U.S. person customers, in a stockbroker liquidation proceeding of such foreign security-based swap dealer, the assets segregated (i.e., assets posted by U.S. person customers) could be insufficient to satisfy the combined priority claims of both U.S person and non-U.S. person customers, potentially resulting in losses to U.S. person customers. As stated above, the Commission preliminarily believes that Section 3E intends to provide customer protection to U.S. person counterparties and apply segregation requirements in a way that would protect the U.S. financial system and counterparties in the United States. Therefore, the Commission proposes to apply segregation requirements described in Section 3E of the Exchange Act, and the rules and regulations thereunder, to a foreign security-based swap dealer that is not a registered broker-dealer and is not a foreign bank with a branch or agency in the United States with respect to assets received from both U.S. person counterparties and non-U.S. person counterparties if such foreign security-based swap dealer receives collateral from U.S. person counterparties to secure security-based swaps. [547]

iii. Foreign Security-Based Swap Dealer That is Not a Registered Broker-Dealer and is a Foreign Bank With Branch or Agency in the United States

Finally, if a foreign security-based swap dealer is not a registered broker-dealer and is a foreign bank that has a branch or agency in the United States, it is not eligible to be a debtor under Chapter 7 and will therefore not be subject to the stockbroker liquidation provisions of the U.S. Bankruptcy Code [548] and its insolvency proceeding in the United States would be administered under banking regulations. [549] Consistent with the objective of protecting U.S. person counterparties, the Commission is proposing that such foreign security-based swap dealer shall be subject to the segregation requirements set forth in Section 3E of the Exchange Act, and the rules and regulations thereunder, with respect to any assets received from, for or on behalf of a counterparty who is a U.S. person to margin, guarantee, or secure a cleared security-based swap, but shall not be required to segregate assets received from, for or on behalf of all other counterparties to margin, guarantee, or secure a cleared security-based swap. [550] The special account maintained by the foreign security-based swap dealer shall be designated for the exclusive benefit of U.S. person security-based swap customers. The Commission preliminarily believes that imposing segregation requirements on such foreign security-based swap dealer when it receives collateral from U.S. person counterparties would reduce the likelihood of U.S. person counterparties incurring losses by helping identify U.S. customers' assets in an insolvency proceeding of such foreign security-based swap dealer in the United States and would potentially minimize disruption to the U.S. security-based swap market, thereby producing potential benefits to the U.S. financial system and U.S. counterparties that are consistent with the objectives of the Dodd-Frank Act. For the same reason, the Commission preliminarily does not believe that extending segregation requirements and customer protection to such foreign security-based swap dealer's transactions with non-U.S. persons would advance the purposes of the Dodd-Frank Act.

d. Disclosure

In addition to the proposed rules described above relating to application of the segregation requirements to foreign security-based swap dealers, the Commission also is proposing to require foreign security-based swap dealers to make certain disclosures. [551] Since the treatment of the special account under Sections 3E(b) and (g) or individually segregated assets pursuant to Section 3E(f) of the Exchange Act in insolvency proceedings of a foreign security-based swap dealer may vary depending on the status of the foreign security-based swap dealer and the insolvency proceedings such foreign security-based swap dealer is subject to, the Commission proposes to require a foreign security-based swap dealer to disclose to each counterparty that is a U.S. person, prior to accepting any assets from, for, or on behalf of such counterparty to margin, guarantee, or secure a security-based swap, the potential treatment of the assets segregated by such foreign security-based swap dealer pursuant to Section 3E of the Exchange Act, and the rules and regulations thereunder, in insolvency proceedings relating to such foreign security-based swap dealer under U.S. bankruptcy law and applicable foreign insolvency laws. Pursuant to this proposed rule, the Commission intends to require that a foreign security-based swap dealer disclose whether it is subject to the segregation requirement set forth in Section 3E of the Exchange Act, and the rules and regulations thereunder, with respect to the assets collected from the U.S. person counterparty who will receive the disclosure, whether the foreign security-based swap dealer could be subject to the stockbroker liquidation provisions in the U.S. Bankruptcy Code, whether the segregated assets could be afforded customer property treatment under the U.S. bankruptcy law, and any other relevant considerations that may affect the treatment of the assets segregated under Section 3E of the Exchange Act in insolvency proceedings of a foreign security-based swap dealer. [552] Since the proposed rule regarding application of the segregation requirements in the cross-border context is designed to advance the goals of protecting U.S. person counterparties, the Commission believes that such disclosure would enhance U.S. person counterparty protection and the objectives that segregation requirements intend to achieve in the context of cross-border security-based swap dealing.

Request for Comment

The Commission requests comment on all aspects of the proposed rule regarding the application of transaction- level requirements relating to customer protection and segregation, including the following:

  • What, if any, are the likely competitive effects, within the U.S. security-based swap market and among U.S. security-based swap dealers, of the proposed approach for foreign security-based swap dealers? Please describe the specific nature of any such effects.
  • Should a foreign security-based swap dealer automatically be eligible for the proposed approach by virtue of being a nonresident entity? Alternatively, should the Commission consider other factors, such as the share of the foreign security-based swap dealer's business that constitutes U.S. Business, in determining how to apply transaction-level requirements?
  • From an operational perspective, what types of internal controls would be necessary to identify Foreign Business and U.S. Business and ensure that the foreign security-based swap dealer complies with the external business conduct standards with respect to its U.S. Business? Should U.S. Business be generally defined with reference to the type of activity that, if performed in a dealing capacity, triggers the registration requirement?
  • Does the proposed approach appropriately classify entity-level and transaction-level requirements? Does it appropriately identify those transaction-level requirements that relate to the operation of the security-based swap dealer on an entity level? If not, please identify those requirements that should be classified differently and how doing so is consistent with the goals of Title VII.
  • To what extent would foreign security-based swap dealers in various jurisdictions be prohibited from complying, under local law, with the Commission's requirements to provide the Commission with prompt access to their books and records and to submit to onsite inspection and examination by the Commission? If there are limitations, what are they, and under what circumstances would they arise? Are there other entity-level requirements that foreign security-based swap dealers would not be permitted to comply with under local law? If so, what are they?
  • Should the external business conduct rules apply in transactions between a registered non-U.S. security-based swap dealer and foreign branches of a U.S. bank?
  • Should the external business conduct rules apply in transactions between a registered non-U.S. security-based swap dealer and non-U.S. persons with U.S. guarantees in transactions outside the United States?
  • Does the proposed application of the business conduct standards in the cross-border context appropriately implement the business conduct standards as described in Section 15F(h) of the Exchange Act?
  • As described above, the Commission does not, at this time, propose to apply the business conduct standards in Section 15F(h) of the Exchange Act, and the rules and regulations thereunder (other than the rules and regulations relating to diligent supervision prescribed by the Commission pursuant to Section 15F(h)(1)(B)), to the Foreign Business of registered security-based swap dealers. Should such standards apply to the Foreign Business of registered security-based swap dealers? Would such application of business conduct standards further the goals of Title VII of the Dodd-Frank Act?
  • Should the Commission apply rules and regulations pursuant to Section 15F(h)(1)(A) of the Exchange Act relating to fraud, manipulation, and other abusive practices involving security-based swaps (including security-based swaps that are offered but not entered into) to the Foreign Business of registered foreign security-based swap dealers?
  • Should the Commission apply rules and regulations pursuant to Section 15F(h)(1)(C) of the Exchange Act relating to position limits to the Foreign Business of foreign security-based swap dealers?
  • Should the proposed rule relating to conflicts of interest set forth in Section 15F(j)(5) of the Exchange Act apply to both the U.S. Business and Foreign Business of security-based swap dealers?
  • Does the proposed approach appropriately treat the rules and regulations prescribed by the Commission relating to diligent supervision pursuant to Section 15F(h)(1)(B) as entity-level requirements applicable to both the U.S. Business and the Foreign Business of foreign security-based swap dealers? Why or why not?
  • Is it appropriate that the proposed rule does not apply future rules and regulations that the Commission may prescribe pursuant to Section 15F(h)(1)(A) of the Exchange Act relating to fraud, manipulation, and other abusive practices involving security-based swaps (including security-based swaps that are offered but not entered into) to the Foreign Business of foreign security-based swap dealers? Why or why not?
  • Is it appropriate that the proposed rule does not apply future rules and regulations that the Commission may prescribe pursuant to Section 15F(h)(1)(C) of the Exchange Act relating to position limits to the Foreign Business of foreign security-based swap dealers? Why or why not?
  • Does the proposed approach appropriately treat the requirements relating to conflicts of interest set forth in Section 15F(j)(5) of the Exchange Act as entity-level requirements applicable to both the U.S. Business and Foreign Business of foreign security-based swap dealers? If not, please identify any requirements that should not be applied to a foreign security-based swap dealer and explain how such an approach would be consistent with the goals of Title VII. Please identify what the costs or operational challenges would be, if any, for a registered security-based swap dealer to establish conflict-of-interest systems and procedures that would apply to its U.S. Business but not its Foreign Business.
  • Does the proposed approach appropriately implement the requirements relating to segregation of assets held as collateral in Section 3E of the Exchange Act, and rules and regulations thereunder, in light of various statuses of foreign security-based swap dealers?
  • Should the Commission apply segregation requirements to a foreign security-based swap dealer that is not subject to the stockbroker liquidation provisions in the U.S. Bankruptcy Code? If not, what are the reasons for not applying segregation requirements? If the segregation requirements do not apply, how would the objective of customer protection be achieved?
  • Should the Commission adopt the disclosure requirement with respect to foreign security-based swap dealers? Why or why not? Is the proposed disclosure requirement feasible? What would the difficulties be in complying with the proposed disclosure requirement?
  • The CFTC has proposed an interpretation that would effectively treat a non-U.S. person whose obligations are guaranteed by a U.S. person as a U.S. person for purposes of determining whether a swap between it and a non-U.S. swap dealer or major swap participant would be subject to transaction-level requirements as interpreted by the CFTC to include, without limitation, margin and segregation requirements, reporting, clearing, and trade execution. [553] Should the Commission adopt a similar approach? What would be the effects on efficiency, competition and capital formation in the event that there are overlapping or duplicative requirements across multiple jurisdictions?
  • In addition, the CFTC has proposed an interpretation that includes a description of a “conduit affiliate” that includes: (1) a non-U.S. person that is majority-owned, directly or indirectly, by a U.S. person where (2) the non-U.S. person regularly enters into swaps with one or more U.S. affiliates or subsidiaries of the U.S. person, and (3) the financial statements of the non-U.S. person are included in the consolidated financial statements of the U.S. person. [554] Conduit affiliates would be subject to transaction-level requirements as if they were U.S. persons. Should the Commission consider a similar approach?
  • The CFTC's proposed interpretation would subject foreign branches of U.S.-based bank swap dealers and major swap participants to the CFTC's entity-level requirements and transaction-level requirements (other than external business conduct standards for swaps with non-U.S. persons), provided that foreign branches would be eligible for a limited exception in emerging markets where foreign regulations are not comparable. [555] Should the Commission consider a similar approach? If so, please explain how such an approach would be consistent with the goals of Title VII.
  • What would be the market impact of the proposed approach to application of the transaction-level requirements relating to customer protection and segregation? How would the proposed application of transaction-level requirements affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the transaction-level requirements? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

5. Application of Entity-Level Rules

(a) Introduction

As noted above, by their very nature, entity-level requirements apply to the operation of a security-based swap dealer as a whole. The Commission recognizes that the capital, margin, and other entity-level requirements that it adopts could have a substantial impact on international commerce and the relative competitive position of intermediaries operating in various, or multiple, jurisdictions. In particular, if these requirements are substantially more or less stringent than corresponding requirements, if any, that apply to intermediaries operating in security-based swap markets outside the United States, depending on how the rules are written, these differences could impact the ability of firms based in the United States to participate in non-U.S. markets, access to U.S. markets by foreign-based firms, and how and whether international firms make use of global “booking entities” to centralize risks related to security-based swaps, among other possible impacts. These issues have been the focus of numerous comments to the Commission and other regulators, as discussed above, as well as Congressional inquiries and other public dialogue.

(b) Proposed Approach

The Commission is not proposing to provide specific relief for foreign security-based swap dealers from Title VII entity-level requirements, although, as discussed in Section XI below, under a Commission substituted compliance determination, a foreign security-based swap dealer would be able to satisfy relevant Title VII entity-level requirements by substituting compliance with corresponding requirements under a foreign regulatory system. [556] The Commission preliminarily believes that entity-level requirements are core requirements of the Commission's responsibility to ensure the safety and soundness of registered security-based swap dealers. [557] The Commission preliminarily believes that it would not be consistent with this mandate to provide a blanket exclusion to foreign security-based swap dealers from entity-level requirements applicable to such entities. [558]

For example, capital requirements play an essential role in ensuring the safety and soundness of security-based swap dealers. As discussed above, the Commission's proposed capital rules for nonbank security-based swap dealers are modeled on the net liquid assets test found in the capital requirements applicable to broker-dealers. [559] We believe that this capital standard is necessary to ensure the safety and soundness of nonbank security-based swap dealers, and thus we are not proposing to exclude foreign nonbank security-based swap dealers from our capital rules. In addition, we believe that the capital, margin, and other entity-level requirements proposed and adopted by the Commission work together to provide a comprehensive regulatory scheme that is vital for ensuring the safety and soundness of registered security-based swap dealers, and that the benefits of Title VII's entity-level requirements are equally important to both foreign and U.S. dealers registered with the Commission. As a result, we are not proposing to provide specific relief from individual entity-level requirements for foreign dealers.

We do, however, recognize the concerns raised by commenters regarding the application of entity-level requirements to foreign security-based swap dealers. [560] We preliminarily believe that these concerns are largely addressed through the Commission's overall proposed approach to substituted compliance in the context of Title VII, which is discussed in detail in Section XI below. In general, the Commission is proposing a framework under which it may permit a registered foreign security-based swap dealer (or class thereof) to satisfy the capital, margin, and other requirements in Section 15F of the Exchange Act, and the rules and regulations thereunder, by complying with the corresponding requirements established by its foreign financial regulatory authority, [561] subject to certain conditions. [562] We preliminarily believe that providing foreign security-based swap dealers with the possibility of substituted compliance in this way will help address concerns related to competitiveness and overlapping regulations related to entity-level requirements, while still ensuring that registered foreign security-based swap dealers are subject to appropriate regulatory oversight.

Request for Comment

The Commission requests comment on all aspects of the proposed interpretive guidance regarding the proposed provision of substituted compliance for certain requirements in Section 15F of the Exchange Act for foreign security-based swap dealers, including the following:

  • What types of conflicts might a foreign security-based swap dealer face if subjected to capital requirements in more than one jurisdiction? In what situations would compliance with more than one capital requirement be difficult or impossible?
  • Should the Commission provide specific relief to foreign security-based swap dealers with respect to entity-level requirements? If so, please indicate the specific relief that should be provided and the rationale for providing such relief.
  • Would the provision of relief from entity-level requirements undermine the Commission's efforts to set capital requirements to ensure the safety and soundness of security-based swap dealers, as required by Section 15F(e)(2)(C) of the Exchange Act? Why or why not?
  • Should the Commission treat margin as an entity-level requirement or a transaction-level requirement? If only a transaction-level requirement, why?
  • Should the Commission consider providing relief for foreign security-based swap dealers from the statutory disqualification requirement in Section 15F(b)(6) of the Exchange Act with respect to their transactions with non-U.S. persons? For example, should the Commission permit associated persons of a foreign security-based swap dealer that are subject to a statutory disqualification to conduct security-based swap activity with non-U.S. persons outside the United States? If so, why?
  • The CFTC has proposed an interpretation that categorizes certain entity-level requirements and transaction-level requirements differently when compared to the Commission's proposed approach. [563] For example, the CFTC has proposed classifying margin requirements applicable to uncleared swaps as a transaction-level requirement, where the Commission has proposed categorizing margin as an entity-level requirement. Should the Commission adopt portions of the CFTC's approach to categorization? If so, which requirements should be re-categorized and why?
  • What would be the market impact of the proposed approach to applying entity-level requirements to registered foreign security-based swap dealers? How would the proposed application of the entity-level requirements affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the entity-level requirements? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

D. Intermediation

1. Introduction

Security-based swap dealers currently use a variety of business models and legal structures to do business with customers in jurisdictions around the world. For instance, many security-based swap dealers with global businesses use local personnel to provide security-based swap services to customers in a particular jurisdiction while booking transactions originated from multiple jurisdictions in a single entity (i.e., a centralized booking model). Some security-based swap dealers also use unique organizational structures to provide local customers with access to market or product specialists in other jurisdictions. As discussed below, commenters have indicated that, in the U.S. market, these scenarios are particularly prevalent in the case of foreign security-based swap dealers seeking access to U.S. customers or providing non-U.S. customers with expertise from employees located in the United States. [564]

In the following discussion, we briefly describe comments received regarding various intermediation models. Throughout this release we use the term “intermediation” generally to refer to origination activity (e.g., solicitation and negotiation of transactions) in connection with a security-based swap transaction.

2. Comment Summary

Commenters stated that foreign security-based swap dealers use different types of business models to service U.S. customers and provide their global customer base with specialized information, while at the same time reducing both customer costs and entity risks through centralized netting and risk management of their global security-based swap businesses. [565] In support of these perceived benefits, commenters have urged the Commission not to apply Title VII to cross-border transactions in a way that would either prohibit or disincentivize the existing security-based swap dealing business models of foreign security-based swap dealers. [566]

A number of commenters recommended that a foreign dealer that engages in security-based swap transactions with U.S. counterparties, but only through U.S. registered swap or security-based swap dealers, should not be subject to security-based swap dealer registration. [567] One commenter stated that in such situations, the Commission should either not require security-based swap dealer registration of the non-U.S. security-based swap dealer at all, or require a limited registration, whereby the non-U.S. security-based swap dealer would be subject to only capital and related prudential requirements and be permitted to rely on comparable home country regulation. [568] In situations where a foreign security-based swap dealer uses a U.S. domiciled subsidiary or affiliate as its agent to solicit and negotiate the terms of security-based swap transactions, several commenters suggested that the Commission allow for a bifurcated registration and regulation framework allowing the foreign security-based swap dealer to comply with Title VII's requirements by registering both the foreign dealer and its agent in limited capacities and allocating the compliance responsibilities between the two entities. [569] Other commenters remarked that the foreign security-based swap dealer should remain ultimately responsible for ensuring compliance with all the applicable Title VII requirements whether or not the regulated activities were carried out by the foreign security-based swap dealer or its agent. [570]

3. Discussion

The Commission is not at this time proposing any specific rules regarding security-based swap dealing activities undertaken through intermediation. At the same time, we recognize the importance of intermediation, particularly with respect to foreign security-based swap dealers accessing U.S. customers or product specialists located in the United States. Based on the Commission's experience in the securities markets, we expect that many foreign security-based swap dealers will operate within the U.S. market by utilizing their U.S. affiliates or other U.S. entities as agents [571] in the United States, while booking transactions facilitated by such U.S. personnel in a central booking entity located abroad. We preliminarily believe that the approach proposed in this release for the cross-border regulation of security-based swap dealing activity will not impede the use of these types of intermediation business models by foreign security-based swap dealers. More specifically, we believe that the Commission's proposed approach to the application of transaction-level requirements related to Foreign Business [572] and proposed framework for substituted compliance on entity-level requirements [573] should help to address commenter concerns that a foreign security-based swap dealer engaging in Foreign Business would be subject to potentially duplicative and conflicting transaction-level requirements in a foreign jurisdiction with respect to its Foreign Business.

While the foreign security-based swap dealer would remain responsible for ensuring that all relevant Title VII requirements applicable to a given security-based swap transaction are fulfilled, the dealer and its agent(s) may choose to allocate the specific responsibilities such as taking responsibility that all U.S. external business conduct requirements are complied with, margin is collected and segregated, and required trading records are maintained and available, to be undertaken by each entity depending on the intermediation model it adopts. [574]

Further, although a foreign security-based swap dealer could use an entity that is not a security-based swap dealer to act as its agent, the foreign security-based swap dealer would nonetheless be responsible for ensuring compliance with all the requirements applicable to security-based swap dealers under Title VII (and the federal securities laws) whether or not the regulated activities were carried out by the foreign security-based swap dealer or its non-security-based swap dealer agent. [575]

Request for Comment

The Commission requests comment on all aspects of the proposed approach to intermediation. In addition, the Commission requests comment in response to the following questions:

  • Should the Commission revise our proposed approach to address directly the concerns of entities using the intermediation model to access the U.S. market? If so, what type of approach should the Commission use to address these concerns consistent with the protection of counterparties' interests and the purposes of Title VII?
  • Should the Commission adopt a model on intermediation similar to the approach laid out in Rule 15a-6(a)(3) (17 CFR 240.15a-6(a)(3)) governing foreign broker-dealers, which would permit non-U.S. persons to conduct security-based swap dealing activity within the United States without registering with the Commission if those transactions were intermediated by a registered U.S. security-based swap dealer? If so, how would it work in the security-based swap context, and how would it address Title VII policy concerns?
  • What would be the market impact of the proposed approach to intermediation? How would the application of the proposed approach to intermediation affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach to intermediation? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

E. Registration Application Re-Proposal

1. Introduction

As discussed in Section XI.C below, the Commission is proposing a rule that would create a framework under which the Commission would consider permitting a foreign security-based swap dealer, where appropriate, to rely on a substituted compliance determination by the Commission with respect to certain of the requirements in Section 15F of the Exchange Act and the rules and regulations thereunder. [576] In discussing the application of this proposed framework below, the Commission indicated that certain entity-level requirements under Section 15F of the Exchange Act may be candidates for substituted compliance determinations. [577]

The Commission preliminarily believes that the most appropriate time for a foreign security-based swap dealer to notify the Commission of its intention to avail itself of an existing substituted compliance determination [578] would be at the time the foreign security-based swap dealer files an application to register with the Commission as a security-based swap dealer. [579] As part of its application, the foreign security-based swap dealer would already be providing the Commission with detailed information in support of its application. The intent of a foreign security-based swap dealer to avail itself of a previously granted substituted compliance determination would be relevant to the Commission's review of such application because it would impact how the Commission will conduct oversight of the security-based swap dealer. In addition, if a security-based swap dealer determines, after it registered with the Commission, that it intends to rely on a substituted compliance determination, proposed Rule 15Fb2-3 would require that it promptly update its application. [580]

Accordingly, the Commission preliminarily believes it is appropriate to require foreign security-based swap dealers to provide additional information in their applications for registration as security-based swap dealers, as described below.

The Commission previously proposed Form SBSE, Form SBSE-A, and Form SBSE-BD for the purpose of registering security-based swap dealers and major security-based swap participants. [581] All of these forms are generally based on Form BD, which is the consolidated form used by broker-dealers to register with the Commission, states, and SROs. [582] Forms SBSE-A and SBSE-BD are shorter forms that have been modified to provide a more streamlined application process for entities that are registered or registering with the CFTC or registered or registering with the Commission as a broker-dealer. [583] Each of these forms is designed to be used to gather information concerning a registrant's business operations to facilitate the Commission's initial registration decisions, as well as ongoing examination and monitoring of registration.” [584] While the Commission received four comments on the Registration Proposing Release, only one specifically expressed views on the Forms SBSE, SBSE-A, and SBSE-BD. [585]

2. Discussion

To address the Commission's proposed rule regarding substituted compliance, the Commission is re-proposing Forms SBSE, SBSE-A, and SBSE-BD to add two questions to Form SBSE and Form SBSE-A, add one question to all three Forms, and to modify Schedule F to all the Forms. In addition, we are proposing one new instruction to the Forms, which is unrelated to substituted compliance, to clarify that if an application is not filed properly or completely, it may be delayed or rejected. [586] Key differences from the originally proposed forms are discussed more fully below. The Commission is not proposing to modify or eliminate any of the other Forms, or any of the rules, proposed in the Registration Proposing Release.

Re-proposed Forms SBSE and SBSE-A would include two new questions, question 3 (which has three parts) and question 6. [587] The new question 3.A. would ask whether an applicant is a foreign security-based swap dealer that intends to work with the Commission and its primary regulator to have the Commission determine whether the requirements of its primary regulator's regulatory system are comparable to the Commission's, or avail itself of a substituted compliance determination previously granted by the Commission with respect to the requirements of Section 15F of the Exchange Act and the rules and regulations thereunder. If the applicant responds in the affirmative to either part of the question, new question 3.B. would require that the applicant identify the foreign financial regulatory authority that serves as the applicant's primary regulator and for which the Commission has made, or may make, a substituted compliance determination. If the applicant indicates that it is relying on a previously granted substituted compliance determination, new question 3.C. would require the applicant to describe how it satisfies any conditions the Commission may have placed on the use of such substituted compliance determination. New question 3 would elicit basic information from an applicant to inform the Commission with respect to its intent to rely upon a substituted compliance determination.

New question 6 would ask whether the applicant is a U.S. branch of a non-resident entity. If the applicant responds in the affirmative, the applicant would need to identify the non-resident entity and its location. This question would provide the Commission with information regarding whether the firm would be subject to the rules of the foreign regulator or the rules of one of the U.S. banking regulators, which would, in turn, elicit which rules may be applicable to the entity's U.S. security-based swap business.

Re-proposed Forms SBSE and SBSE-A would also include new question 17, which would be identified as new question 15 in re-proposed Form SBSE-BD. This new question would ask if the applicant is registered with or subject to the jurisdiction of a foreign financial regulatory authority. If the applicant answered this question in the affirmative, it would be directed to provide additional information on Schedule F as discussed below. This question would apply to all applicants, not just foreign security-based swap applicants, and would provide the Commission with information regarding other regulatory schemes that may be applicable to an applicant.

The proposed revisions to Schedule F would divide Schedule F into two sections. Section I would include the full text of the originally proposed Schedule F. Section II would elicit additional information regarding foreign regulators with which the applicant may be registered or that otherwise have jurisdiction over the applicant.

The Commission preliminarily believes that modifying Forms SBSE, SBSE-A, and SBSE-BD (including the changes to Schedule F), as described above, would be appropriate because it would provide foreign security-based swap dealers with a convenient and cost-effective way of informing the Commission of their intention to rely on or seek a substituted compliance determination, as discussed above. In addition, we believe these modifications to our original proposal would provide the Commission with additional information necessary to make a determination as to whether it is appropriate to grant or institute proceedings to deny registration to a person applying to become a non-resident security-based swap dealer.

Request for Comment

The Commission requests comment on all aspects of the proposed modifications and additions to proposed Forms SBSE, SBSE-A and SBSE-BD (including the proposed changes to Schedule F). The Commission also specifically requests comment on the following:

  • Please explain whether Form SBSE and Form SBSE-A are the appropriate places to identify whether an entity is intending to rely on a substituted compliance determination. If not, please explain why and what other method of notifying the Commission might be appropriate as well as when such notification to the Commission should be required to be made.
  • Please explain whether Forms SBSE, SBSE-A, and SBSE-BD (and Schedule F) are the appropriate places to identify whether an entity is subject to oversight by a foreign regulator, and if so, which regulators. If so, why? If not, why not?
  • Should any additional questions be added to Form SBSE to elicit information related to a registrant's reliance on a substituted compliance determination?
  • Should any additional questions be added to Form SBSE-A to elicit information related to a registrant's reliance on a substituted compliance determination?
  • Should Form SBSE-BD also be modified to include any of the additional questions the Commission is proposing to include in re-proposed Form SBSE or Form SBSE-A? If so, which questions and why?
  • The Commission previously indicated in the Intermediary Definitions Adopting Release that it would consider applications for limited purpose designations from the major security-based swap participant and security-based swap dealer definitions under Rules 3a67-1(b) and 3a71-1(c) under the Exchange Act, respectively, [588] and requested comment on this topic in the Registration Proposing Release. [589] Since that time, we have adopted and proposed, both jointly with the CFTC and individually, various rules that further clarify the regulations that will be applicable to security-based swap dealers, [590] and today we propose a substituted compliance framework to potentially address the concerns of foreign security-based swap dealers. Given these developments, are there any situations addressed by previous comments where limited registration designation would no longer be appropriate? Are there any situations, addressed by previous comments or otherwise, where a limited registration designation may be appropriate for security-based swap dealers? If so, in what situations would a limited registration designation be warranted, and how should the registration forms be amended to facilitate such limited registration? If not, why not?

IV. Major Security-Based Swap Participants Back to Top

A. Introduction

Title VII defines a new type of entity regulated by the Commission, the “major security-based swap participant.” [591] The statutory definition of major security-based swap participant encompasses persons whose security-based swap activities do not cause them to be dealers, but nonetheless could pose a high degree of risk to the U.S. financial system generally. [592] This term was further defined in the Intermediary Definitions Adopting Release, focusing on the potential market impact and risks associated with a person's security-based swap positions. [593] In this respect, the major security-based swap participant definition differs from the security-based swap dealer definition, which generally focuses on a person's activities and how it holds itself out to the market. The amount or significance of those activities is relevant only in the context of the de minimis exception. [594] As a result, we believe that the cross-border issues that are raised by the definition of major security-based swap participant differ from those raised by the definition of security-based swap dealer. The application of the major security-based swap participant definition to cross-border activities was not addressed in the Intermediary Definitions Adopting Release. [595]

B. Comment Summary

A variety of commenters provided their views on the application of the major security-based swap participant definition and its related thresholds in the cross-border context, generally suggesting that the major participant tests focus on the systemic risk that an entity's swap transactions poses to the U.S. market. [596] Commenters further suggested that major security-based swap participant threshold calculations should exclude security-based swap transactions that do not involve a U.S. counterparty. [597] Several FPSFIs further requested specific exclusions from the major security-based swap participant definition, suggesting that as a matter of comity, swap transactions involving foreign central banks as a counterparty, [598] international financial institutions, and/or foreign SWFs should be excluded from the major participant definitions. [599]

Certain entities managed or controlled by foreign governments also have asked for exemptions or exclusions from Commission registration or the Dodd-Frank Act's substantive requirements. For example, SWFs commented that they believe SWFs should be excluded from the definition of major security-based swap participant and thus the related regulatory obligations. [600] These entities argued that the Commission should not subject SWFs to registration requirements based on principles of international comity and cooperation and noted that SWFs are typically subject to comparable home country supervision that would render SEC regulation largely duplicative. They also argued that excluding SWFs from the major security-based swap participant definition would not increase systemic risks given that SWFs make long-term investments across diverse asset classes, use swaps or security-based swaps to hedge portfolio risks rather than generate returns, and are more likely to ensure that risk management measures are in place because of SWFs' heightened concerns regarding reputational risk. [601]

Another entity, which operates with an explicit government guarantee of its swap and security-based swap obligations, argued that it should be excluded from the major participant definition due to its lack of risk to the market resulting from this government support. [602]

C. Proposed Approach

In light of the comments received on the application of the major security-based swap participant definition in the cross-border context and the principles discussed above, [603] the Commission is proposing a rule and interpretive guidance regarding the application of the major security-based swap participant definition to cross-border activities.

1. In General

The Commission is proposing a rule under which a U.S. person would consider all security-based swap transactions entered into by it, while a non-U.S. person would consider only transactions entered into with U.S. persons, [604] when determining whether the person falls within the major security-based swap participant definition. [605] Under this proposed approach, a non-U.S. person would calculate its security-based swap positions under the three prongs of the major security-based swap participant definition [606] based solely on its transactions with U.S. persons (including foreign branches of U.S. banks). All security-based swap transactions by a non-U.S. person with other non-U.S. person counterparties, regardless of whether they are conducted within the United States or whether the non-U.S. person counterparties are guaranteed by a U.S. person, would be excluded from the major security-based swap participant analysis.

The proposed rule would use the same definition of “U.S. person” as proposed in the context of foreign security-based swap dealer registration. [607] As previously discussed, this definition generally follows a territorial approach to defining U.S. person. [608] The proposed approach to the U.S. person definition is intended to identify individuals or legal persons that, by virtue of their location within the United States or their legal or other relationship with the United States, are likely to impact the U.S. financial market and the U.S. financial system. [609] Therefore, we preliminarily believe that requiring a non-U.S. person to take into account its security-based swap positions with U.S. persons, as proposed to be defined, for purposes of the major security-based swap participant definition would provide an appropriate indication of the degree of default risk posed by such non-U.S. person's security-based swap positions to the U.S. financial system, which we view as the focus of the major security-based swap participant definition. [610] Consistent with the rules further defining the definition of major security-based swap participant adopted in the Intermediary Definitions Adopting Release, such risk to the U.S. financial system would be measured by calculating such non-U.S. person's aggregate outward exposures [611] to U.S. persons (that is, what such non-U.S. person owes, or potentially could owe, on its security-based swaps with U.S. persons). [612] If such non-U.S. person's aggregate outward exposures to U.S. persons exceed one of the thresholds set forth in the rules further defining “major security-based swap participant,” [613] the non-U.S. person would be required to register as a major security-based swap participant.

Given the focus of the major security-based swap participant definition on the degree of risk to the U.S. financial system, [614] the Commission preliminarily believes that the location in which security-based swap transactions are conducted is not relevant to the calculation of a person's security-based swap positions for purposes of determining such person's status as a major security-based swap participant. Such an approach would differ from the approach we are proposing with respect to the security-based swap dealer definition, where we would count transactions connected with security-based swap dealing activity conducted within the United States toward a potential security-based swap dealer's de minimis threshold even if the transactions were with non-U.S. persons. [615] This difference in approach is driven by the different focuses of the statutory definitions of the terms security-based swap dealer and major security-based swap participant. While the statutory major security-based swap participant definition is focused specifically on risk, [616] the statutory security-based swap dealer definition is focused on, in addition to risk, the nature of the activities undertaken by an entity, its interactions with counterparties, and its role within the security-based swap market. [617] These different statutory emphases lead us to treat major security-based swap participants differently from security-based swap dealers with respect to whether activities conducted within the United States should be counted toward their respective thresholds.

In addition, as stated above, the U.S. person definition applies to the entire entity, including its branches and offices that may be located in a foreign jurisdiction. [618] Therefore, under the proposed approach, a non-U.S. person would need to include its security-based swap transactions with foreign branches of U.S. banks when calculating its security-based swap positions for purposes of the major security-based swap participant definition.

Some commenters on the CFTC Cross-Border Proposal have suggested that a non-U.S. person should be allowed to exclude swap transactions with foreign branches of U.S. banks for purposes of determining whether it is a major swap participant because otherwise non-U.S. persons would have a strong incentive to limit or even stop trading with U.S. banks that operate outside the United States via foreign branches. [619] We are mindful of these concerns. However, because foreign branches are not separate legal persons, [620] the Commission believes that the potential losses that a U.S. bank would suffer due to a non-U.S. person counterparty's default, and the potential impact on the U.S. banking system and the U.S. financial system generally, would not differ depending on whether the non-U.S. person counterparty entered into the security-based swap with the home office of the U.S. bank or with a foreign branch of the U.S. bank. Therefore, the Commission preliminarily believes that it is appropriate to require a non-U.S. person to include its security-based swap transactions with foreign branches of U.S. banks for purposes of determining its major security-based swap participant status.

By contrast, the Commission preliminarily believes that a non-U.S. person (the “potential non-U.S. person major security-based swap participant”) does not need to include its security-based swap transactions with non-U.S. person counterparties in determining whether it is a major security-based swap participant. As stated above, the focus of the major security-based swap participant definition is on the degree of risk posed by a person's security-based swap positions to the U.S. financial system. [621] In the case of transactions with non-U.S. person counterparties, the risk that a potential non-U.S. person major security-based swap participant will not pay what it owes (or potentially could owe) under its security-based swaps to its non-U.S. counterparties is not transmitted directly and fully to the U.S. financial system in the way that such risk would be transmitted if the potential non-U.S. person major security-based swap participant engaged in security-based swap transactions with U.S. person counterparties. Instead, the non-U.S. person counterparties bear the direct and full risk of loss. [622] We recognize that there may be indirect spillover effects related to the security-based swap positions arising from the activity conducted by a potential non-U.S. person major security-based swap participant and a non-U.S. person counterparty (e.g., a U.S. person that has an ownership interest in such a non-U.S. person counterparty would potentially face losses on the value of its investment in such a non-U.S. person counterparty due to failure of the potential non-U.S. person major security-based swap participant), but the Commission preliminarily believes that the major security-based swap participant tests do not need to address the potential indirect spillover risk to the U.S. financial system from foreign investments by U.S. persons in non-U.S. persons, or other non-security-based swap activities by U.S. persons with non-U.S. persons. [623]

The Commission recognizes that this proposed approach results in different treatment of U.S. and non-U.S. persons under the major security-based swap participant definition (i.e., a non-U.S. person would consider its security-based swap transactions with only U.S. persons, while a U.S. person would consider all of its security-based swap transactions). However, the Commission preliminarily believes that this approach is appropriate in light of the focus in the major security-based swap participant definition on the U.S. financial system. More specifically, the need for separate analysis of U.S. and non-U.S. entities results from the fact that all of a U.S. person's security-based swap transactions are part of and create risk to the U.S. financial system, regardless of whether such entity's counterparties are U.S. persons or non-U.S. persons. The same is not true of non-U.S. persons, however, because the security-based swap transactions entered into by a non-U.S. person with other non-U.S. persons are not fundamentally part of the U.S. financial system, while such non-U.S. person's security-based swap transactions with U.S. persons would directly impact the U.S. financial system. Thus, we preliminarily believe that the statutory major security-based swap participant definition's focus on the U.S. financial system, justifies treating U.S. and non-U.S. persons differently for purposes of the major participant analysis based on the disparate impacts of their security-based swap transactions on the U.S. financial system.

We recognize that a non-U.S. person's transactions with other non-U.S. person counterparties could still have an impact on the U.S. financial system, including where those transactions threatened the financial integrity of a non-U.S. person counterparty and such person had significant security-based swap positions with U.S. persons. However, the amount of risk the non-U.S. person poses to the U.S. financial system would most directly stem from the size of its direct positions with U.S. persons. As a result, the Commission preliminarily believes it is appropriate to limit the international application of the major security-based swap participant definition to a non-U.S. person's security-based swaps entered into with U.S. persons.

2. Guarantees

The application of the major security-based swap participant definition to security-based swap positions guaranteed by a parent, other affiliate, or guarantor raises unique issues in the cross-border context. These issues were not addressed in the Intermediary Definitions Adopting Release. [624]

As a general principle, the Commission and the CFTC did note in the Intermediary Definitions Adopting Release that an entity's security-based swap positions are attributed to a parent, other affiliate, or guarantor for purposes of the major participant analysis to the extent that the counterparties to those positions have recourse to that parent, other affiliate, or guarantor in connection with the position. [625] Positions are not attributed in the absence of recourse. [626] The Commission and the CFTC further stated that attribution of these positions for purposes of the major participant definitions is intended to reflect the risk focus of the major participant definitions by providing that entities will be regulated as major participants when they pose a high level of risk in connection with the swap and security-based swap positions they guarantee.

The application of these general principles in the cross-border context is discussed below, including the attribution of guaranteed security-based swap positions to U.S. persons and non-U.S. persons, respectively, when they provide guarantees on performance of the security-based swap obligations of other persons, the limited circumstances where attribution of guaranteed security-based swap positions is not required, and operational compliance.

(a) Guarantees Provided by U.S. Persons to Non-U.S. Persons

One cross-border issue that arises from the general approach to guarantees set forth in the Intermediary Definitions Adopting Release is how the attribution of guarantees for purposes of the major security-based swap participant definition would apply to a guarantee provided by a U.S. person for performance on the obligations of a non-U.S. person, such as a U.S. holding company providing a guarantee on the obligations of a foreign subsidiary. As noted in the Intermediary Definitions Adopting Release, the attribution of guaranteed positions for purposes of the major participant definitions is intended to reflect the risk that a guarantor might pose to, and the systemic impact of such risk may impose on, the U.S. financial system as a result of the guarantees that it provides. [627] The Commission preliminarily believes that these risk concerns are the same when U.S. persons act as guarantors for foreign persons regardless of whether the underlying security-based swap transactions that they guarantee are entered into with U.S. persons or non-U.S. persons, given that the risk borne by the U.S. person guarantor would not be impacted by the status of the guaranteed non-U.S. person's counterparty as either a U.S. person or non-U.S. person. As a result, the Commission is proposing that, other than in the limited circumstances described below, [628] all security-based swaps entered into by a non-U.S. person and guaranteed by a U.S. person be attributed to such U.S. person guarantor for purposes of determining such U.S. person guarantor's major security-based swap participant status, regardless of whether the underlying transaction was entered into with a U.S. person counterparty or non-U.S. person counterparty. [629]

(b) Guarantees Provided by Non-U.S. Persons to U.S. Persons and Guarantees Provided by Non-U.S. Persons to Non-U.S. Persons

Another cross-border issue related to the Commission's approach to the attribution of guarantees is how guarantees provided by non-U.S. persons are treated for purposes of the major security-based swap participant definition. As previously noted, the statutory major security-based swap participant definition's focus on the accumulation of security-based swap risk by non-U.S. persons is primarily centered on the impact such risk could have on the U.S. financial system. [630] Where a non-U.S. person provides a guarantee on performance of the security-based swap obligations of a U.S. person (e.g., a non-U.S. holding company providing a guarantee on performance of the obligations owed by its U.S. subsidiary under security-based swaps entered into by the U.S. subsidiary), the counterparties of such U.S. person would be taking the credit risk of the non-U.S. person guarantor as well as the U.S. person. If the non-U.S. person guarantor defaults, the full amount of risk accumulated under the guaranteed U.S. person's security-based swap positions would impact the U.S. financial system. As a result, subject to the limited circumstances described in the Intermediary Definitions Adopting Release, [631] a non-U.S. person providing a guarantee on performance of the security-based swap obligations of a U.S. person would attribute to itself all of the U.S. person's security-based swap positions that are guaranteed by the non-U.S. person guarantor for purposes of determining the non-U.S. person guarantor's major security-based swap participant status. [632]

By contrast, where a non-U.S. person provides a guarantee on performance of the security-based swap obligations of another non-U.S. person (e.g., a non-U.S. holding company providing a guarantee on performance of the obligations owed by its non-U.S. subsidiary under security-based swaps entered into by the non-U.S. subsidiary), the ultimate counterparty credit risk associated with the transaction would generally reside outside of the United States with the non-U.S. guarantor. In this scenario, the potential impact on the U.S. financial system would be limited to transactions entered into by the guaranteed non-U.S. person with U.S. person counterparties. Therefore, the Commission preliminarily believes that, other than in the limited circumstances described below, [633] where a non-U.S. person guarantees performance on the security-based swap transactions of another non-U.S. person, the non-U.S. guarantor need only attribute to itself such guaranteed security-based swap transactions entered into with U.S. person counterparties for purposes of determining its major security-based swap participant status. [634]

(c) Limited Circumstances Where Attribution of Guaranteed Security-Based Swap Positions Does Not Apply

In addition to setting forth general principles regarding the attribution of guaranteed swap or security-based swap positions to the guarantor for the major participant definitions, the Intermediary Definitions Adopting Release also provided interpretive guidance related to the limited circumstances under which attribution of guaranteed swap or security-based swap positions is not required. [635] Specifically, it stated that even in the presence of a guarantee, it is not necessary to attribute a person's swap or security-based swap positions to a parent or other guarantor if the person already is subject to capital regulation by the Commission or the CFTC (i.e., swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, FCMs, and broker-dealers) or if the person is a U.S. entity regulated as a bank in the United States. [636] In providing this interpretive guidance, the Commission and the CFTC explained that the positions of those regulated entities already will be subject to capital and other requirements, making it unnecessary to separately address, via major participant regulations, the risks associated with guarantees of those positions of a regulated entity. [637]

The Intermediary Definitions Adopting Release did not address the application of the interpretive guidance regarding attribution of guaranteed positions where a guarantee is provided to support a non-U.S. person's performance on the obligations under security-based swaps in the cross-border context. The Commission preliminarily believes that the interpretation jointly adopted by the Commission and the CFTC in the Intermediary Definitions Adopting Release regarding security-based swap positions of a person subject to capital regulation by the CFTC or the Commission should equally apply to a non-U.S. person whose security-based swap positions are guaranteed by another person. Therefore, the Commission is proposing to interpret that it is not necessary to attribute a non-U.S. person's security-based swap positions to a parent or other guarantor if such non-U.S. person already is subject to capital regulation by the Commission or the CFTC (i.e., swap dealers, security-based swap dealers, major swap participants, major security-based swap participants, FCMs and broker-dealers).

In addition, in the cross-border context and with respect to a non-U.S. person, if such non-U.S. person is not subject to capital regulation by the Commission or the CFTC, consistent with the rationale for the approach to attribution of security-based swap positions of a person that is a U.S. entity regulated as a bank in the United States, it would not be necessary to attribute such non-U.S. person's security-based swap positions to its guarantor if such non-U.S. person is subject to capital standards that are consistent with the capital standards such non-U.S. person would have been subject to if such non-U.S. person were a bank subject to the prudential regulators' capital regulation. Therefore, the Commission preliminarily believes that it is not necessary to attribute such non-U.S. person's security-based swap positions to its guarantor for purposes of determining the guarantor's major security-based swap participant status, if such non-U.S. person is subject to capital standards adopted by its home country supervisor that are consistent in all respects with the Capital Accord of the Basel Committee on Banking Supervision (the “Basel Accord”). [638] This proposed approach also is consistent with the capital standards proposed by the prudential regulators for a foreign bank that is a swap dealer, major swap participant, security-based swap dealer or major security-based swap participant, which require such foreign bank to comply with regulatory capital rules already made applicable to such foreign bank as part of the existing prudential regulatory regime. [639] The Commission preliminarily believes that security-based swap positions of a non-U.S. person subject to foreign regulatory capital requirements consistent with the Basel Accord would be subject to risk-based capital requirements that take into account the unique risks (including the credit risk, market risk, and other risks) arising from security-based swap transactions, in such a way as to make it unnecessary to separately address, via major security-based swap participant regulation, the risks associated with guarantees of those security-based swap positions.

(d) Operational Compliance

Finally, the Commission believes that it is necessary to provide interpretive guidance regarding operational compliance and the special issues that may result from the attribution of security-based swap positions to a parent or guarantor. As the Commission and the CFTC noted in the Intermediary Definitions Adopting Release, these include issues regarding the application of the transaction-focused requirements applicable to registered major participants (e.g., certain requirements related to trading records and transaction confirmations), given that the entity that is the direct counterparty to the swap or security-based swap may be better positioned to comply with those requirements. [640] In the Intermediary Definitions Adopting Release, the Commission and the CFTC stated that “an entity that becomes a major participant by virtue of swaps or security-based swaps directly entered into by others must be responsible for compliance with all applicable major participant requirements with respect to those swaps or security-based swaps (and must be liable for failures to comply), but may delegate operational compliance with transaction-focused requirements to entities that directly are party to the transactions. The entity that is the major participant, however, cannot delegate compliance duties with the entity-level requirements applicable to major participants (e.g., requirements related to registration and capital).” [641]

The Commission preliminarily believes that the same approach should apply in the cross-border context when the guarantor and the guaranteed person are located in different jurisdictions (e.g., U.S. holding companies that act as guarantors of the security-based swap obligations of their non-U.S. dealing subsidiaries). In each case, the major security-based swap participant may delegate compliance duties for transaction-focused requirements to the entities that are counterparties to the transactions, but the major security-based swap participant would remain responsible for ensuring that the Title VII requirements applicable to such transactions are fulfilled. However, major security-based swap participants must comply with all relevant entity-level requirements themselves that are not transaction-focused, such as registration and capital. Entity-level requirements that have a transaction focus, such as margin, may be delegated to the guaranteed entities that directly are party to the transactions. However, the major security-based swap participants would remain responsible for ensuring compliance with these requirements.

3. Foreign Public Sector Financial Institutions (FPSFIs)

The proposed approach to the cross-border application of the major security-based swap participant definition described above provides a general framework for applying the definition to non-U.S. persons. That framework does not separately address questions raised by commenters regarding how the major security-based swap participant definition applies to FPSFIs. Specifically, some commenters requested explicit exclusions from the major security-based swap participant definition for these types of entities. [642]

We note that FPSFIs encompass a wide range of institutions and organizations, ranging from divisions of foreign central banks, to international financial institutions established under treaties, to multilateral development banks formed, owned, and controlled by sovereign members, to sovereign wealth funds and other investment corporations owned by foreign governments. Some FPSFIs' obligations are guaranteed or backed by foreign governments; others may not be. The purposes and activities of these institutions and organizations vary. For example, some FPSFIs (such as the Bank for International Settlements) provide banking services to foreign central banks who are their members. Some FPSFIs provide credits and grants to promote economic development in developing countries (e.g., multilateral development banks) or distribute funds of regional recovery programs to promote regional economies (e.g., KfW for the European Recovery Program). Other FPSFIs conduct investment activities around the world and their exclusive customers are the foreign governments to which they are linked. Depending on their purposes and activities, FPSFIs may engage in different types of swaps or security-based swaps to various degrees, although the Commission is not aware of data reflecting the nature and amount of such transactions across the FPSFI population. One commenter stated that it enters into swaps to manage interest rates and foreign exchange risks but does not use swaps to generate returns. [643]

Several commenters requested that FPSFIs be excluded from the major security-based swap participant definition. They provided various reasons and basis to support their requests. Some FPSFIs commented that they are subject to exceptionally high risk controls and have extremely strong capital bases and therefore pose no risk to systemic stability. [644] Others argued that they already are subject to comparable or comprehensive substantive regulation of their respective governments in their home countries and therefore, subjecting them to the major security-based swap participant regulation would create regulatory duplication or conflicts. [645] One FPSFI argued that it only conducts swap activities with dealers, which would be regulated under Title VII, and therefore it is not necessary to subject it to duplicative regulation and supervision. [646] Another FPSFI, which operates with an explicit government guarantee of its swap and security-based swap obligations, argued that it should be excluded from the major participant definition due to its lack of risk to the market resulting from this government support. [647] Intergovernmental organizations, such as multilateral development banks, argued that multilateral development institutions are never subject to national regulations and their privileges and immunities should be fully respected. [648]

After considering the concerns of these commenters, we recognize that FPSFIs raise unique and complex issues because of the diversity of the special purposes they are serving, their differing governance structures and sources of financial strength, and their supranational, intergovernmental, or sovereign nature. The Commission also recognizes that we have received relatively little information from commenters regarding the types, levels, and natures of security-based swap activity that FPSFIs regularly engage in (although some information has been received regarding their swap transactions) and that, consequently, the Commission has comparatively little basis on which to understand their roles in the security-based swap markets and, as appropriate, exclude them from the major security-based swap participant definition. Therefore, we are not proposing to specifically address the treatment of FPSFIs at this time. Instead, we are soliciting comment to help determine the basis on which it may be appropriate to exclude FPSFIs from the proposed rule regarding application of the major security-based swap participant definition to non-U.S. persons. In particular, we invite public comment regarding the types, levels, and nature of the security-based swap activity that various types of FPSFIs may engage in on a regular basis, the roles of FPSFIs in the security-based swap market, the mitigating factors and reasons that FPSFIs may not pose systemic risk as a result of their security-based swap activity, and whether it would be more appropriate for the Commission to address FPSFI concerns on an individual basis. We also request considerations, information, and data regarding potential definitions of a FPSFI for purposes of the major security-based swap definition. Responses that are supported by empirical data and analysis are encouraged in assisting the Commission in considering whether excluding FPSFIs from the definition of the major security-based swap participant is warranted.

D. Title VII Requirements Applicable to Major Security-Based Swap Participants

1. Transaction-Level Requirements Related to Customer Protection

(a) Overview

As previously noted, the Dodd-Frank Act is generally concerned with the protection of the U.S. financial system and counterparties in the U.S. security-based swap market. [649] This general principle is particularly relevant to the customer protection, including segregation, requirements in Title VII, which are focused on the protection of the counterparties or customers of security-based swap dealers. As a result, the Commission preliminarily believes that it is not necessary to the objective of Title VII to subject foreign major security-based swap participants to certain of the customer protection requirements in Title VII with respect to their transactions with non-U.S. persons. Accordingly, the Commission is proposing rules that would identify specific transaction-level requirements that would not apply to foreign major security-based swap participants with respect to their transactions with non-U.S. persons.

(b) Proposed Rules

The proposed rules would provide that foreign major security-based swap participants would not be subject, solely with respect to their transactions with non-U.S. persons, to certain of the transaction-level requirements that apply to major security-based swap participants. [650] Specifically, under the proposed rules registered foreign major security-based swap participants would not have to comply with business conduct standards as described in Section 15F(h) of the Exchange Act, and the rules and regulations thereunder, other than the rules and regulations prescribed by the Commission relating to diligent supervision pursuant to Section 15F(h)(1)(B) [651] and the rules and regulations thereunder, with respect to their transactions with non-U.S. persons. [652] In addition, under the proposed rules, registered foreign major security-based swap participants that are not registered broker-dealers would not have to comply with requirements related to the segregation of assets held as collateral in Section 3E of the Exchange Act and the rules and regulations thereunder with respect to their transactions with non-U.S. persons. [653]

Our rationale for this proposed approach to the application of transaction-level requirements for foreign major security-based swap participants is substantially the same as that discussed previously in the context of foreign security-based swap dealers. [654] This rationale includes our belief that applying these customer protections and segregation requirements to security-based swap transactions with non-U.S. persons outside the United States would not advance the objectives of Title VII to protect the U.S. financial system or U.S. counterparties. At the same time, this approach would preserve customer protections for U.S. person counterparties who would expect to benefit from the protections afforded by Title VII.

(2) Entity-Level Requirements

Entity-level requirements in Title VII primarily address concerns relating to the major security-based swap participant as a whole, with a particular focus on safety and soundness of the entity to reduce systemic risk in the U.S. financial system. The most significant entity-level requirements are capital and margin requirements. Because these requirements address the financial, operational, and business integrity of the entity engaged in security-based swap activity, the Commission preliminarily believes that a registered foreign major security-based swap participant should be required to adhere to these standards. As noted above, other requirements that the Commission believes should apply at the entity, rather than the transactional, level include, but are not limited to, risk management procedures, books and records requirements, conflicts of interest systems and procedures, and designation of a chief compliance officer. [655] These entity-level requirements ensure the safety and soundness of the entire registrant and are thus distinguishable from the transaction-level requirements discussed above, which apply to transactions with individual counterparties and thus may be applied differently based on the U.S. person status of a counterparty.

3. Substituted Compliance

The Commission is not proposing, at this time, to establish a policy and procedural framework under which we would consider permitting compliance by a foreign major security-based swap participant with comparable regulatory requirements in a foreign jurisdiction to substitute for compliance with requirements of the Exchange Act, and the rules and regulations thereunder, applicable to major security-based swap participants, as it is proposing to do for foreign security-based swap dealers. [656]

Unlike foreign security-based swap dealers whose primary businesses are in securities, security-based swaps, swaps, banking and other financial and investment banking activities, the non-U.S. persons that may need to register as nonbank major security-based swap participants may engage in a diverse range of business activities different from, and broader than, the activities conducted by broker-dealers or security-based swap dealers (otherwise they may be required to register as a security-based swap dealer and/or broker-dealer) or the activities conducted by banks. For example, as stated in the Capital, Margin and Segregation Proposing Release, persons that may need to register as nonbank major security-based swap participants may engage in commercial activities that require them to have substantial fixed assets to support manufacturing and/or result in them having significant assets comprised of unsecured receivables. [657] Therefore, it is not clear what types of entity-level regulatory oversight, if any, especially with respect to capital and margin, a foreign major security-based swap participant would be subject to in the foreign regulatory system.

Accordingly, in light of the limited information currently available to us regarding what types of foreign entities may become major security-base swap participants, if any, and the foreign regulation of such entities, we are not, at this time, proposing to extend the proposed policy and procedural framework for substituted compliance to foreign major-security-based swap participants. Nevertheless, we will continue to consider the appropriateness of permitting substituted compliance for major security-based swap participants in light of comments received on this proposal and market developments more generally and will consider what further steps to take, if any, at adoption. In this regard, we request considerations, information, and data regarding potential foreign major security-based swap participants. Responses that are supported by empirical data and analysis are encouraged in assisting the Commission in considering whether permitting substituted compliance by foreign major security-based swap participants would be warranted.

Request for Comment

The proposed rules and interpretations regarding the application of the major security-based swap participant definition and transaction-level and entity-level requirements to registered major security-based swap participants discussed above represent the Commission's preliminary views. The Commission seeks comment on the proposed rules and interpretations in all aspects. Interested persons are encouraged to provide supporting data and analysis and, when appropriate, suggest modifications to proposed rule text and interpretations. Responses that are supported by data and analysis provide great assistance to the Commission in considering the practicality and effectiveness of the proposed application as well as considering the benefits and costs of proposed requirements. In addition, the Commission seeks comment on the following specific questions:

  • Should the major security-based swap participant definition focus only on a non-U.S. person's security-based swap transactions entered into with U.S. persons, or should the major security-based swap participant definition incorporate some or all of a non-U.S. person's other security-based swap transactions? Which transactions? For example, should a non-U.S. person include security-based swap transactions with non-U.S. person counterparties guaranteed by U.S. persons in such non-U.S. person's major security-based swap participant calculation? Why or why not?
  • Should the proposed approach toward determining whether a non-U.S. person should count its security-based swap transactions that are cleared through CCPs be adopted? Why or why not? Should the Commission adopt a different approach to the treatment of security-based swap transactions cleared through CCPs for purposes of the cross-border application of the major security-based swap participant test? If so, how should cleared transactions be treated for purposes of the cross-border application of the major security-based swap participant test?
  • Should a non-U.S. person be permitted to exclude its security-based swap transactions entered into with foreign branches of U.S. banks from the calculation for purposes of determining whether it is a major security-based swap participant? Why? If a non-U.S. person's security-based swaps with foreign branches of U.S. banks are not required to be considered in determining such non-U.S. person's major security-based swap participant status, how should the risk (in terms of outward exposures) that such non-U.S. person poses to U.S. banks be addressed?
  • Should the Commission permit a non-U.S. person to exclude from its major security-based swap participant calculations its security-based swap positions arising from transactions with the foreign branches of U.S. banks if such non-U.S. person is subject to capital standards adopted by its home country supervisor that are consistent in all respect with the Basel Accord? Are there other conditions or standards the Commission should consider that a non-U.S. person may satisfy or comply with that should allow a non-U.S. person to exclude its security-based swap positions arising from transactions with foreign branches of U.S. banks from its major security-based swap participant calculation?
  • Are there competitiveness concerns related to the proposed different treatment of U.S. persons and non-U.S. persons for purposes of calculating their status under the major security-based swap participant definition? If so, what are these concerns, and how should they be addressed?
  • Should the proposed approach towards the attribution of security-based swap positions guaranteed by U.S. persons and non-U.S. persons be altered? What justifications would support an alternate approach?
  • Should the Commission adopt the proposed approach to the attribution of guaranteed security-based swap positions whereby the positions of guaranteed entities subject to capital standards adopted by its home country supervisor that are consistent in all respects with the Basel Accord would not need to be attributed? Is Basel Accord capital standard an appropriate standard for determining whether it is not necessary to attribute guaranteed security-based swap positions to a guarantor, or should another standard be used? Is this proposed standard clear, or is additional guidance necessary? In addition to the proposed capital standard, should the Commission's approach to the attribution of guaranteed security-based swap positions also include a requirement that the guaranteed entities be subject to effective capital oversight by its home country supervisor as determined by the Commission in order not to attribute the guaranteed security-based swap positions to the guarantor?
  • Are there FPSFIs that would fall within the definition of major security-based swap participant based on the proposed rules and interpretive guidance? If so, should the Commission provide relief to such FPSFIs? If so, what type of relief, what types of entities should be eligible for such relief, and what factors would justify such relief? Would it be more appropriate for the Commission to address these concerns on an individual basis?
  • Should the Commission adopt the proposed approach to the application of certain customer protection requirements and segregation requirements to foreign major security-based swap participants with respect to their transactions with non-U.S. persons? If so, are there other transaction-level requirements that should be included within this proposed approach?
  • Should substituted compliance be provided to foreign major security-based swap participants with respect to entity-level requirements? Transaction-level requirements? If so, how should the Commission make such a determination? In particular, what standard should be used for determining whether existing regulation merits a substituted compliance determination?
  • What would be the market impact of the proposed approach to major security-based swap participants? How would the application of the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach to major security-based swap participants? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

V. Security-Based Swap Clearing Agencies Back to Top

A. Introduction

Title VII of the Dodd-Frank Act adds a number of provisions to the Exchange Act relating to the registration and regulation of clearing agencies that provide clearance and settlement services for security-based swaps. [658] Such provisions augment the Commission's existing authority to register and regulate clearing agencies in Section 17A of the Exchange Act. [659] In particular, Section 17A(g) of the Exchange Act, as added by Section 763(b) of the Dodd-Frank Act, requires clearing agencies that use interstate commerce to perform the functions of a clearing agency with respect to security-based swaps to register with the Commission. [660] Section 17A(k) of the Exchange Act, as added by Section 763(b) of the Dodd-Frank Act, provides the Commission with authority to exempt a security-based swap clearing agency from registration if the Commission determines that the clearing agency is subject to comparable, comprehensive supervision and regulation by the CFTC or the appropriate government authorities in the home country of the clearing agency. [661] The Dodd-Frank Act also added provisions to Section 17A of the Exchange Act relating to voluntary clearing agency registration and the establishment of clearing agency standards. [662] Finally, Section 17A(j) requires the Commission to adopt rules governing persons that are registered as clearing agencies for security-based swaps. [663]

Because of the global nature of the security-based swap market, the Commission recognizes that there may be some uncertainty regarding when a foreign security-based swap clearing agency [664] that provides central counterparty (“CCP”) services [665] for security-based swaps would be required to register with the Commission as a clearing agency. Accordingly, we are proposing interpretive guidance regarding the application of the registration requirement in Section 17A(g) of the Exchange Act for security-based swap clearing agencies that act as CCPs. [666] We also address our exemptive authority under Section 17A(k) to exempt a foreign security-based swap clearing agency from the registration requirement in Section 17A(g). [667] In addition, we discuss the potential application of alternative standards to certain foreign clearing agency registrants.

The proposed interpretation discussed below represents the Commission's preliminary views regarding the application of the registration requirement in Section 17A(g) for security-based swap clearing agencies acting as CCPs in the cross-border context. Our proposal reflects a balancing of the principles described above, including, in particular, the goal of the Dodd-Frank Act to address the risk to the U.S. financial system. [668] We recognize, however, that the proposed interpretation represents one of a number of possible alternative approaches in applying Title VII in the cross-border context. Accordingly, the Commission invites comment regarding all aspects of the proposal discussed below, including potential alternative approaches. Responses that are supported by data and analysis provide great assistance to the Commission in considering the practicality and effectiveness of the proposed application as well as considering the benefits and costs of proposed requirements.

B. Proposed Title VII Approach

1. Clearing Agency Registration

Section 17A(g) of the Exchange Act, entitled “Registration Requirement,” provides that “[i]t shall be unlawful for a clearing agency, unless registered with the Commission, directly or indirectly to make use of the mails or any means or instrumentality of interstate commerce to perform the functions of a clearing agency with respect to a security-based swap.” [669] The Commission preliminarily believes that Title VII was intended to apply to clearing agencies that perform clearing agency functions within the United States, regardless of their principal place of business or their place of incorporation or organization. [670] For reasons discussed below, the proposed interpretive guidance would provide that a security-based swap clearing agency performs the functions of a CCP within the United States if it has a U.S. person as a member.

(a) Clearing Agencies Acting as CCPs

Clearing agencies are broadly defined under the Exchange Act and undertake a variety of functions. [671] One such function is to act as a CCP, [672] which is an entity that interposes itself between the counterparties to a securities transaction. For example, when a security-based swap contract between two counterparties that are members of a CCP is executed and submitted for clearing, it is typically replaced by two new contracts—separate contracts between the CCP and each of the two original counterparties. At that point, the original counterparties are no longer counterparties to each other. Instead, each acquires the CCP as its counterparty, and the CCP assumes the counterparty credit risk of each of the original counterparties that are members of the CCP. Structured and operated appropriately, CCPs may improve the management of counterparty risk and may provide additional benefits such as multilateral netting of trades. [673]

Although technology and risk management practices frequently change and vary from CCP to CCP, the following are some of the functions performed by the subset of clearing agencies that are CCPs: [674]

  • The extinguishing of a security-based swap contract between two counterparties and the associated novation of it with two new contracts between the CCP and each of the two original counterparties;
  • The assumption of counterparty credit risk of members of the CCP through the novated security-based swap contracts;
  • The calculation and collection of initial and variation margin during the life of the security-based swap contract;
  • The determination of settlement obligations under a security-based swap contract;
  • The determination of a default under a security-based swap contract;
  • The collection of funds from members for contributions to a clearing fund;
  • The implementation of a loss-sharing arrangement among members to respond to a member insolvency or default; and
  • The multilateral netting of trades. [675]

In performing these functions, CCPs help facilitate over-the-counter trading, and trading on exchanges and other platforms, through the assumption of counterparty risk by the CCP from the original counterparties. During times of market stress, a CCP would mitigate the potential for a market participant's failure to be transmitted to other market participants, and would increase transparency of the risks borne by its members, as well as confidence of the market participants in the performance of their transactions. [676]

Furthermore, the agreements among members and between members and a CCP play a key role in the CCP's performance of the functions of a clearing agency. The Exchange Act permits clearing agencies to deny membership if a person does not meet a clearing agency's financial responsibility, operational capacity, experience and competence standards. [677] In a scenario where risk is mutualized under loss-sharing arrangements, the strength of the CCP hinges upon the strength of its members. The legal arrangements between a CCP and its members are of significant importance to the operational resilience of the CCP itself.

(b) Proposed Interpretive Guidance

The Commission is proposing interpretive guidance that a security-based swap clearing agency performing the functions of a CCP within the United States would be required to register pursuant to Section 17A(g) of the Exchange Act. [678] In our preliminary view, a foreign security-based swap clearing agency that provides CCP services, as described above, to a member that is a U.S. person for security-based swaps would be performing the functions of a CCP within the United States and, therefore, would be required to register pursuant to Section 17A(g) of the Exchange Act. The Commission preliminarily believes that such an approach is consistent with the Dodd-Frank Act's goal of reducing systemic risk in the U.S. financial system. [679] Foreign security-based swap clearing agencies that provide CCP services to U.S. members could pose a risk to the United States due to the risk mutualization among members of these clearing agencies. [680] Further, the more complete information about relationships between security-based swap market participants that registration would provide to regulators and the marketplace may help reduce the risk of crises. [681] Accordingly, to address the risk to the U.S. financial system posed by foreign security-based swap clearing agencies with U.S. members, the Commission preliminarily is proposing to require foreign security-based swap clearing agencies that provide CCP services to U.S. members to register pursuant to Section 17A(g) of the Exchange Act.

The Commission anticipates, however, that some U.S. persons may choose to clear transactions at a foreign security-based swap clearing agency on an indirect basis through a correspondent clearing arrangement with a non-U.S. member of the clearing agency. [682] We preliminarily do not believe that such a correspondent clearing arrangement of a U.S. person with a non-U.S. person member alone would cause the foreign security-based swap clearing agency to be required to register with the Commission because the clearing agency's business is conducted directly with its member firms, which in this example would be located outside of the United States. Correspondent clearing arrangements do not pose the same type of direct risk to the U.S. financial system that foreign security-based swap clearing agencies with U.S. members pose because customers, unlike clearing agency members, do not take mutual responsibility for the obligations of the clearing agency. [683]

2. Exemption from Registration under Section 17A(k)

Section 17A(k) of the Exchange Act, as added by Section 763(b) of the Dodd-Frank Act, provides that the Commission may grant a conditional or unconditional exemption from clearing agency registration for the clearing of security-based swaps if the Commission determines that the clearing agency is subject to comparable, comprehensive supervision and regulation by the CFTC or the appropriate government authorities in the home country of the clearing agency. [684]

The Commission preliminarily believes that it may be appropriate to consider an exemption as an alternative to registration in circumstances where the clearing agency is subject to comparable, comprehensive supervision and regulation by appropriate government authorities in the home country of the clearing agency, and the nature of the clearing agency's activities and performance of functions within the United States suggest that registration is not necessary to achieve the Commission's regulatory objectives. Exemptions that are carefully targeted could help to improve clearing agency supervision overall by allowing the Commission to devote resources most efficiently where U.S. interests are more directly implicated, while reducing duplication of efforts in areas where its interests are aligned with those of other regulators. Section 17A(k) further provides that any such exemption may be subject to appropriate conditions that may include, but are not limited to, requiring the clearing agency to be available for inspection by the Commission and to make available all information requested by the Commission. [685]

The Commission is not at this point specifying how such determinations might be made. The Commission notes that market structure and clearing agency supervision and regulation vary in other jurisdictions, and these variances in combination would affect the Commission's ability to make a determination under Section 17A(k) of the Exchange Act in a particular case, as well as the conditions that would be applied to any exemption. In addition to these factors, differences among individual clearing agencies on matters such as organizational governance, rules for members, and risk management procedures would inform individual exemption determinations.

3. Application of Alternative Standards to Certain Registrants

In addition, the Commission may consider, as an alternative to an exemption from registration, proposing rules that are specific to foreign-based CCPs that are registered with the Commission under Section 17A(g). We believe that this approach is contemplated by Section 17A(i) of the Exchange Act, which permits the Commission to adopt rules for registered CCPs that clear security-based swaps and conform our regulatory standards and supervisory practices to reflect evolving United States and international standards. [686] This approach may be particularly appropriate where the Commission determines not to grant a general exemption from registration under Section 17A(k) of the Exchange Act, based on consideration of the factors described above, but where consistency with some regulatory standards suggests that a targeted regulatory approach may be warranted.

Request for comment

The Commission requests comment on all aspects of the proposed interpretation, including the following:

  • Should performing the functions of a CCP for only one U.S. person member of the CCP warrant requiring a foreign security-based swap clearing agency to register with the Commission? If not, why not? Further, are there other kinds of activities in the United States or outside the United States that would warrant requiring a CCP to be registered? If so, what are they?
  • To what extent might the proposed approach create incentives for foreign CCPs to restrict access to U.S. person members? Please explain.
  • Are there any other circumstances where a foreign security-based swap CCP should be required to register with the Commission? For example, is there a circumstance where a CCP that has no U.S. members but clears security-based swaps with a U.S. security as an underlying security should be required to register with the Commission as a clearing agency? Similarly, is there a circumstance where a CCP that has no U.S. members and does not conduct activities within the United States but that clears security-based swaps for the U.S. customers of its members should be required to register with the Commission as a clearing agency? Would the provision of omnibus or individual segregation of U.S. customer funds affect this analysis? Why or why not? Should a security-based swap CCP that relies on a financial guaranty of a U.S. person in allowing a non-U.S. person to become a member be required to register with the Commission? If not, why not?
  • How will Commission registration of, exemption from registration for, or promulgation of alternative standards applicable to registered foreign security-based swap CCPs affect the central clearing of security-based swaps? How would it affect the management of counterparty credit risk? How would it affect systemic risk? What impact would it have on the continued development of the global security-based swap market?
  • What factors should the Commission consider in determining whether a foreign security-based swap CCP is subject to comparable, comprehensive supervision and regulation by appropriate government authorities in the home country of the CCP? What level of similarity should be required in order for a home country supervision and regulatory framework to be considered comparable and comprehensive when compared to that of the United States?
  • How should the Commission determine the home country of a CCP for purposes of Section 17A(k) of the Exchange Act? Should it be the country in which the CCP is incorporated or organized or the country in which it conducts the principal amount of its clearance and settlement activities?
  • What other facts and circumstances should the Commission review in determining whether an exemption may be granted under Exchange Act Section 17A(k)? What terms and conditions should be required in connection with an exemption from registration? For example, should the Commission consider whether a jurisdiction has implemented any international standards, such as the CPSS-IOSCO Principles for Financial Market Infrastructures in its regulatory framework? [687] In addition, should the existence of a cooperative agreement with the home country be a factor?
  • What would be the market impact of the proposed approach to the registration of foreign CCPs? How would the application of the proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

VI. Security-Based Swap Data Repositories Back to Top

A. Introduction

Under the Dodd-Frank Act, SDRs are intended to play a key role in enhancing transparency in the security-based swap market by retaining complete records of security-based swap transactions, maintaining the integrity of those records, and providing effective access to those records to relevant authorities and the public consistent with their respective information needs. [688] Title VII provides the Commission with authority to adopt rules governing SDRs. [689] Using this authority, the Commission has proposed rules governing the SDR registration process, duties, and core principles, including duties related to data maintenance and access by relevant authorities and those seeking to use the SDR's repository services. [690]

As noted above, the security-based swap market is global in scope and transactions often involve counterparties in different jurisdictions. [691] The Commission recognizes that, as a result, there may be uncertainty regarding the application of Section 13(n) of the Exchange Act [692] and the rules and regulations thereunder (collectively, “SDR Requirements”). [693] In addition, the Commission is concerned that an overly broad application of the SDR Requirements may unnecessarily restrict global regulators' access to, and sharing of, security-based swap data in various jurisdictions and present difficulties in enhancing transparency in the global security-based swap market. [694] To address these concerns, and as explained more fully below, the Commission is proposing to limit the application of the SDR Requirements to certain persons that perform the functions of an SDR, including proposing a new rule to provide non-U.S. persons performing the functions of an SDR within the United States with exemptive relief from the SDR Requirements. In addition, to facilitate relevant authorities' access to security-based swap data collected and maintained by Commission-registered SDRs, the Commission is proposing interpretive guidance to specify how SDRs may comply with the notification requirement set forth in Section 13(n)(5)(G) of the Exchange Act [695] and previously proposed Rule 13n-4(b)(9) thereunder. The Commission also is specifying how the Commission proposes to determine whether a relevant authority is appropriate for purposes of receiving security-based swap data from an SDR. In addition, the Commission is proposing a new rule to provide SDRs with exemptive relief from the indemnification requirement set forth in Section 13(n)(5)(H)(ii) of the Exchange Act [696] and previously proposed Rule 13n-4(b)(10) thereunder.

In formulating this proposal, the Commission has sought to balance the policy considerations discussed above [697] and the particular concerns related to security-based swap reporting discussed below. The Commission recognizes that other approaches may exist in achieving the mandate of the Dodd-Frank Act, in whole or in part. Accordingly, the Commission invites comment regarding all aspects of the proposal described below, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of the Commission's proposed rules and interpretative guidance as well as potential alternative approaches will be particularly useful to the Commission in evaluating possible modifications to the proposal.

B. Application of the SDR Requirements in the Cross-Border Context

1. Introduction

Section 3(a)(75) of the Exchange Act defines a “security-based swap data repository” to mean “any person that collects and maintains information or records with respect to transactions or positions in, or the terms and conditions of, security-based swaps entered into by third parties for the purpose of providing a centralized recordkeeping facility for security-based swaps.” [698] Section 13(n)(1) of the Exchange Act provides that “[i]t shall be unlawful for any person, unless registered with the Commission, directly or indirectly, to make use of the mails or any means or instrumentality of interstate commerce to perform the functions of a security-based swap data repository.” [699]

Although the Commission has previously proposed a rule governing the registration process for SDRs, [700] which includes requirements for “non-resident security-based swap data repositor[ies],” [701] the Commission has not explicitly explained under what circumstances in the cross-border context would a person performing the functions of an SDR be required to register with the Commission pursuant to Section 13(n)(1) of the Exchange Act [702] and previously proposed Rule 13n-1 thereunder, and to comply with the other SDR Requirements. [703] As discussed further below, the Commission is proposing interpretative guidance to discuss such circumstances and a new rule to provide exemptive relief from the SDR Requirements.

2. Comment Summary

The Commission received several comment letters concerning the registration and regulation of SDRs in the cross-border context. As a general matter, commenters suggested that the Commission should apply principles of international comity. [704]

In addition, two commenters expressed concerns about the potential impact of duplicative registration requirements imposed on SDRs. [705] Specifically, one of these commenters remarked that the Commission's previously proposed rules governing SDRs “would seem to force a non-resident SDR to be subject to multiple regimes and to the jurisdiction of several authorities” and that the SDR Proposing Release made no “reference to equivalency of regulatory regimes or cooperation with the authorities of the country of establishment of the non-resident SDRs.” [706] To address this concern, the commenter suggested that the Commission adopt a regime under which foreign SDRs would be deemed to comply with the SDR Requirements if the laws and regulations of the relevant foreign jurisdiction were equivalent to those of the Commission and an MOU has been entered into between the Commission and the relevant foreign authority. [707] The commenter noted that the recommended “regime would have the following advantages: (i) facilitating cooperation among authorities from different jurisdictions; (ii) ensuring the mutual recognition of [SDRs]; and (iii) establishing convergent regulatory and supervisory regimes which is necessary in a global market such as the OTC derivatives one.” [708]

Recognizing that some SDRs would function solely outside of the United States and, therefore, would be regulated by an authority in another jurisdiction, commenters suggested possible approaches to the SDR registration regime. One commenter, for example, believed that “a non-U.S. SDR should not be subject to U.S. registration so long as it collects and maintains information from outside the U.S., even if such information is collected from non-U.S. swap dealer or [major security-based swap participant] registrants.” [709] Another commenter supported “cross-registration” of SDRs, whereby SDRs in all major jurisdictions may register with the appropriate regulators in each jurisdiction. [710]

3. Proposed Approach

In light of the concerns raised by commenters and the policy considerations discussed above, [711] the Commission is proposing (i) interpretive guidance regarding the application of the SDR Requirements to U.S. persons that perform the functions of an SDR; and (ii) interpretive guidance regarding the application of the SDR Requirements to non-U.S. persons that perform the functions of an SDR within the United States and a new rule providing exemptive relief from the SDR Requirements for such non-U.S. persons, subject to a condition.

(a) U.S. Persons Performing SDR Functions Are Required to Register With the Commission

Consistent with the approach taken elsewhere in this release, [712] the Commission preliminarily believes that any U.S. person [713] that performs the functions of an SDR [714] would be required to register with the Commission pursuant to Section 13(n)(1) of the Exchange Act [715] and previously proposed Rule 13n-1 thereunder. The Commission preliminarily believes that requiring U.S. persons that perform the functions of an SDR to register with the Commission and comply with the SDR Requirements, as well as other requirements applicable to SDRs registered with the Commission, [716] is necessary to achieve the policy objectives of Title VII. [717] Requiring U.S. persons that perform the functions of an SDR to be operated in a manner consistent with the Title VII regulatory framework and subject to the Commission's oversight, would, among other things, help ensure that relevant authorities are able to monitor the build-up and concentration of risk exposure in the security-based swap market, reduce operational risk in that market, and increase operational efficiency. [718] As the Commission noted in the SDR Proposing Release, SDRs themselves are subject to certain operational risks that may impede the ability of SDRs to meet these goals, [719] and the Title VII regulatory framework is intended to address these risks.

(b) Interpretive Guidance and Exemption for Non-U.S. Persons That Perform the Functions of an SDR Within the United States

In the context of the cross-border reporting of security-based swap data, the Commission recognizes that some uncertainty may arise regarding when the SDR Requirements, and other requirements applicable to SDRs registered with the Commission, [720] apply to non-U.S. persons that perform the functions of an SDR. The Commission preliminarily believes that a non-U.S. person that performs the functions of an SDR within the United States would be required to register with the Commission, absent an exemption. [721]

In order to provide legal certainty to market participants and address concerns raised by commenters, and consistent with the proposed interpretive guidance discussed above, the Commission is proposing, pursuant to our authority under Section 36 of the Exchange Act, [722] an exemption from the SDR Requirements for non-U.S. persons that perform the functions of an SDR within the United States, subject to a condition. Specifically, the Commission is proposing Rule 13n-12 (“SDR Exemption”), which states as follows: “A non-U.S. person [723] that performs the functions of a security-based swap data repository within the United States shall be exempt from the registration and other requirements set forth in Section 13(n) of the [Exchange] Act . . . and the rules and regulations thereunder, provided that each regulator with supervisory authority over such non-U.S. person has entered into a supervisory and enforcement memorandum of understanding (`MOU') or other arrangement with the Commission that addresses the confidentiality of data collected and maintained by such non-U.S. person, access by the Commission to such data, and any other matters determined by the Commission.” [724]

The Commission preliminarily believes that a non-U.S. person would be performing “the functions of a security-based swap data repository within the United States” if, for example, it enters into contracts, such as user or technical agreements, with a U.S. person to enable the U.S. person to report security-based swap data to such non-U.S. person. As another example, a non-U.S. person would be performing “the functions of a security-based swap data repository within the United States” if it has operations in the United States, such as maintaining security-based swap data on servers physically located in the United States, even if its principal place of business is not in the United States. [725] Given the constant innovation in the market and the fact-specific nature of the determination, it is not possible to provide here a comprehensive discussion of every activity that would constitute a non-U.S. person performing “the functions of a security-based swap data repository within the United States.”

The Commission preliminarily believes that the SDR Exemption is necessary or appropriate in the public interest, and consistent with the protection of investors. Because the reporting requirements of Title VII and re-proposed Regulation SBSR can be satisfied only if a security-based swap transaction is reported to an SDR that is registered with the Commission, [726] the Commission preliminarily believes that the primary reason for a person subject to the reporting requirements of Title VII and re-proposed Regulation SBSR to report a security-based swap transaction to an SDR that is not registered with the Commission would likely be to satisfy reporting obligations that it or its counterparty has under foreign law. Such person would still be required to fulfill its reporting obligations under Title VII and re-proposed Regulation SBSR by reporting its security-based swap transaction to an SDR registered with the Commission, absent other relief from the Commission, [727] even if the transaction were also reported to a non-U.S. person that relies on the SDR Exemption. The Commission preliminarily believes that this proposed approach to the SDR Requirements appropriately would balance the Commission's interest in having access to security-based swap data involving U.S. persons, while addressing commenters' concerns regarding the potential for duplicative regulatory requirements [728] as well as furthering the goals of the Dodd-Frank Act.

The SDR Exemption would be subject to the condition that each regulator with supervisory authority over the non-U.S. person that performs the functions of an SDR within the United States enters into a supervisory and enforcement MOU or other arrangement with the Commission, as specified in proposed Rule 13n-12(b) under the Exchange Act. The Commission anticipates that in determining whether to enter into such an MOU or other arrangement with a relevant authority, the Commission would consider whether the relevant authority would keep data collected and maintained by the non-U.S. person that performs the functions of an SDR within the United States confidential [729] and whether the Commission would have access to data collected and maintained by such non-U.S. person. [730] The Commission anticipates that it would consider other matters, including, for example, whether the relevant authority agrees to provide the Commission with reciprocal assistance in securities matters within the Commission's jurisdiction and whether a supervisory and enforcement MOU or other arrangement would be in the public interest. [731] The Commission preliminarily believes that, in lieu of requiring non-U.S. persons that perform the functions of an SDR within the United States to register with the Commission, the condition in the SDR Exemption is appropriate to address the Commission's interest in having access to security-based swap data involving U.S. persons and U.S. market participants that is maintained by non-U.S. persons that perform the functions of an SDR within the United States and protecting the confidentiality of such security-based swap data involving U.S. persons and U.S. market participants.

Request for comment

The Commission requests comment on all aspects of the Commission's proposed interpretive guidance and the SDR Exemption, including the following:

  • Is the Commission's proposed interpretive guidance and the SDR Exemption appropriate and sufficiently clear? Why or why not? Do you agree with the Commission's proposed interpretive guidance and SDR Exemption? Is it overly broad or narrow? If so, why? Is there a better alternative?
  • Under the Commission's proposed interpretive guidance and SDR Exemption, will SDRs be subject to duplicative regulatory requirements? If so, will the Commission's proposed interpretive guidance and SDR Exemption reduce the costs of compliance with duplicative regulatory requirements? Why or why not?
  • How may the Commission's proposed interpretive guidance and SDR Exemption affect the duplicative reporting of security-based swap data? Would the Commission's ability to exercise oversight of our registrants be compromised if it did not have the ability to learn and/or obtain all security-based swap data from non-U.S. persons that perform the functions of an SDR within the United States that have chosen not to register with the Commission and that are not subject to a substituted compliance order? Why or why not?
  • Are there any circumstances where a U.S. person performing the functions of an SDR should not be required to register with the Commission? If so, what are those circumstances?
  • Should the Commission require all non-U.S. persons that perform the functions of an SDR within the United States to register with the Commission? Why or why not?
  • Non-U.S. persons that perform the functions of an SDR within the United States may rely on the SDR Exemption. Are there any circumstances where non-U.S. persons that perform the functions of an SDR within the United States should be required to register with the Commission? If so, what are those circumstances? Do any of the following facts and circumstances, either individually or in combination, warrant requiring non-U.S. persons that perform the functions of an SDR within the United States to register with the Commission: maintaining security-based swap data pertaining to a U.S. person or U.S. financial product; facilitating or supporting in the United States the submission of security-based swap data by U.S. persons; having any operations within the United States; entering into contracts, such as user or technical agreements, in order to accept security-based swap data from U.S. persons? If so, which one(s) and why? If not, why not? What types of activities and SDR functions performed within the United States do not warrant requiring a non-U.S. person that performs the functions of an SDR within the United States to be registered with the Commission? What if, for example, a non-U.S person that performs the functions of an SDR within the United States accepts only data from persons that are “U.S. persons” solely because they are foreign branches of U.S. persons?
  • Does the proposed definition of “U.S. person” or “non-U.S. person” in the SDR Exemption need to be clarified or modified? If so, which terms and how should they be defined?
  • Do you agree with the proposed condition in the SDR Exemption? Why or why not? Should the condition include additional requirements? If so, what requirements would be appropriate? Are the Commission's estimates of the time required to establish an MOU reasonable? Why or why not? Should the condition apply only to certain non-U.S. persons that perform the functions of an SDR within the United States? Please explain. Should the condition apply if, for example, the only connection to the United States by a non-U.S. person that performs the functions of an SDR within the United States is that it maintains a back-up server physically located in the United States? Should the condition apply only to non-U.S. persons that perform the functions of an SDR within the United States that collect security-based swap data from a reporting side that includes at least one counterparty that is a U.S. person?
  • Do you believe that most, if not all, non-U.S. persons that perform the functions of an SDR within the United States will maintain at least some security-based swap data involving U.S. persons or U.S. market participants? Why or why not?
  • Is the Commission's reference in the SDR Exemption to a “non-U.S. person that performs the functions of a security-based swap data repository” sufficiently clear? If not, what is a better alternative? Should the Commission replace, for example, “non-U.S. person” with “non-resident security-based swap data repository,” as defined in previously proposed Rule 13n-1(a)(2) under the Exchange Act, instead? Why or why not? Are there circumstances that would be covered by using “non-U.S. person that performs the functions of a security-based swap data repository” in the SDR Exemption rather than using “non-resident security-based swap data repository that performs the functions of a security-based swap data repository” in the SDR Exemption, and vice versa? If so, what circumstances and does it matter for practical purposes?
  • Is the SDR Exemption's reference to “within the United States” sufficiently clear? What are the implications of this reference in the SDR Exemption?
  • Are there any other factors that the Commission should consider in our interpretive guidance or the SDR Exemption, but that are not addressed above? If so, please explain.
  • What would be the market impact of proposed approach to the registration of SDRs? How would the application of proposed approach affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

C. Relevant Authorities' Access to Security-Based Swap Information and the Indemnification Requirement

Section 13(n)(5)(G) of the Exchange Act [732] and previously proposed Rule 13n-4(b)(9) thereunder provide that an SDR shall on a confidential basis, pursuant to Section 24 of the Exchange Act, and the rules and regulations thereunder, upon request, and after notifying the Commission of the request (“Notification Requirement”), make available all data obtained by the SDR, including individual counterparty trade and position data, to each appropriate prudential regulator, the Financial Stability Oversight Council, the CFTC, the Department of Justice, the Federal Deposit Insurance Corporation and any other person that the Commission determines to be appropriate, including, but not limited to, foreign financial supervisors (including foreign futures authorities), foreign central banks, and foreign ministries. Further, Section 13(n)(5)(H) of the Exchange Act [733] and previously proposed Rule 13n-4(b)(10) provide that before sharing information with any entity described in Section 13(n)(5)(G) [734] or previously proposed Rule 13n-4(b)(9), [735] respectively, an SDR must obtain a written agreement from the entity stating that the entity shall abide by the confidentiality requirements described in Section 24 of the Exchange Act, [736] and the rules and regulations thereunder, relating to the information on security-based swap transactions that is provided; in addition, the entity shall agree to indemnify the SDR and the Commission for any expenses arising from litigation relating to the information provided under Section 24 of the Exchange Act [737] and the rules and regulations thereunder (“Indemnification Requirement”).

The Commission believes that the goals of Sections 13(n)(5)(G) and 13(n)(5)(H) of the Exchange Act [738] are, among other things, to obligate SDRs to make available security-based swap information to relevant authorities and maintain the confidentiality of such information. More broadly, the goal of the Dodd-Frank Act is, among other things, to promote the financial stability of the U.S. by improving accountability and transparency in the financial system. [739]

As discussed further below, the Commission recognizes that the Indemnification Requirement raises a number of concerns, including, among other things, the inability of certain relevant authorities to provide, as a matter of law or practice, an open-ended indemnification agreement and the possibility of security-based swap data being fragmented among trade repositories globally if foreign authorities establish trade repositories in their jurisdictions to ensure access to data that they need to perform their regulatory mandates and legal responsibilities. [740]

In this section, the Commission will first describe the alternatives to the Notification Requirement and Indemnification Requirement that were discussed in the SDR Proposing Release. The Commission will then summarize the comments received, primarily in response to the SDR Proposing Release. Finally, the Commission will discuss our proposed interpretive guidance regarding relevant authorities' access to security-based swap information and our proposed exemptive relief from the Indemnification Requirement.

1. Information Sharing Under Sections 21 and 24 of the Exchange Act

In the SDR Proposing Release, the Commission highlighted two alternative ways for relevant authorities to obtain data maintained by SDRs directly from the Commission (rather than directly from SDRs) without providing an indemnification agreement. [741] Specifically, the Commission noted that there is existing independent authority in the Exchange Act for certain domestic and foreign authorities to obtain data maintained by SDRs directly from the Commission (rather than directly from SDRs) pursuant to Sections 21(a) and 24(c) of the Exchange Act [742] in certain circumstances and without application of the Indemnification Requirement. [743]

Section 21(a)(2) of the Exchange Act [744] provides that the Commission may provide assistance to a foreign securities authority. The term “foreign securities authority” is broadly defined in Section 3(a)(50) of the Exchange Act [745] to include “any foreign government, or any governmental body or regulatory organization empowered by a foreign government to administer or enforce its laws as they relate to securities matters.” The Commission may provide assistance under Section 21(a)(2) of the Exchange Act [746] to the foreign securities authority in connection with an investigation being conducted by the foreign securities authority to determine whether any person has violated, is violating, or is about to violate any laws or rules relating to securities matters that the authority administers or enforces. Section 21(a)(2) further provides that, as part of this assistance, the Commission may conduct an investigation to collect information and evidence pertinent to the foreign securities authority's request for assistance. [747] The Commission believes that Section 21(a)(2) provides the Commission with independent authority to assist foreign securities authorities in certain circumstances by, for example, collecting security-based swap data from an SDR and providing such authorities with the data.

Pursuant to Section 24(c) of the Exchange Act [748] and Rule 24c-1 thereunder, [749] the Commission may share nonpublic information [750] in our possession with, among others, any “federal, state, local, or foreign government, or any political subdivision, authority, agency or instrumentality of such government . . . [or] a foreign financial regulatory authority.” [751] Because the Exchange Act provides the Commission with the statutory authority to share information in our possession with other authorities, the Commission is of the view that if security-based swap transaction data is in our possession, then it may share this information with other authorities. In this regard, the Commission notes that the indemnification requirement set forth in Section 13(n)(5)(H)(ii) of the Exchange Act [752] does not apply to the Commission, and would be inapplicable to the Commission's provision of security-based swap data to relevant authorities pursuant to our independent authority in Section 24(c) of the Exchange Act. [753]

2. Comment Summary

Four commenters submitted comments relating to relevant authorities' access to security-based swap information, three of which were in response to the SDR Proposing Release and one of which was in response to a joint public roundtable regarding the cross-border application of Title VII held by the Commission and the CFTC on August 1, 2011. [754] Commenters were generally supportive of relevant authorities having access to security-based swap data maintained by SDRs when such access is within the scope of the authorities' mandate, but these commenters expressed particular concerns relating to the Indemnification Requirement and relevant authorities' unfettered access to security-based swap data.

As a general matter, one commenter stated that an SDR should be able to provide: (i) Enforcement authorities with necessary trading information; (ii) regulatory agencies with counterparty-specific information about systemic risk based on trading activity; (iii) aggregate trade information on market-wide activity and aggregate gross and net open interest for publication; and (iv) real-time reporting from SB SEFs and bilateral counterparties and related dissemination. [755] The same commenter supported relevant authorities' access to reports from SDRs that are scheduled on a regular basis or triggered by certain events, and believed that the Commission's regulatory model regarding regulatory access should be “location agnostic, without preferential access for [a] prudential regulator, except to perform its prudential duties.” [756] The commenter also believed that “it is important to preserve [the] spirit of cooperation and coordination between regulators around the world” in the context of ensuring global regulators' access to security-based swap data. [757]

Two commenters concurred with the Commission's statements in the SDR Proposing Release that relevant authorities will likely be unable to agree to provide SDRs and the Commission with indemnification, as required by Section 13(n)(5)(H)(ii) of the Exchange Act prior to receiving security-based swap data maintained by SDRs. [758] One of these commenters described the Indemnification Requirement as contravening the purpose of SDRs by diminishing transparency if regulators are not allowed to have ready access to information and thereby jeopardizing market stability. [759] Specifically, the commenter believed that the Indemnification Requirement should not apply where relevant authorities are carrying out their regulatory responsibilities, in accordance with international agreements and while maintaining the confidentiality of data provided to them. [760] Recognizing that the Indemnification Requirement is mandated by the Dodd-Frank Act, however, the commenter suggested that in order to ensure consistent application of the requirement and to “minimize any disruption to the global repository framework,” the Commission should provide model indemnification language for all SDRs to use. [761] Further, the commenter believed that “any indemnity should be limited in scope to minimize the potential reduction in value of registered SDRs to the regulatory community.” [762]

In discussing the Indemnification Requirement, another commenter reiterated the notion that relevant authorities must ensure the confidentiality of security-based swap data provided to them. [763] The commenter believed that the Indemnification Requirement “undermines the key principle of trust according to which exchange of information [among relevant authorities] should occur.” [764] Thus, the commenter recommended that the Commission's rules help streamline the Indemnification Requirement for an “efficient exchange of information.” [765]

One commenter voiced concerns about unfettered access to security-based swap information by regulators, including foreign financial supervisors, foreign central banks, and foreign ministries, beyond their regulatory authority and mandate. [766] This commenter was concerned that the statutory language incorporated in previously proposed Rule 13n-4(b)(9), which provides that in addition to the entities specifically listed in the rule, an SDR could make available data to “any other person that the Commission determines to be appropriate,” is vague and could result in an SDR providing access to persons without proper authority. [767] The commenter suggested that the Commission adopt an approach similar to the CFTC's proposed Rule 49.17(d), [768] and that the Commission and the CFTC “endeavor to adopt similar procedures to control regulator requests for security-based swap information.” [769]

3. Proposed Guidance and Exemptive Relief

Consistent with the goals of the Dodd-Frank Act [770] and the purposes of SDRs, [771] and after considering the comments received to date, the Commission is proposing additional guidance regarding relevant authorities' access to security-based swap information and proposing exemptive relief from the Indemnification Requirement. For the reasons discussed further below, the Commission preliminarily believes that our proposed guidance and exemption from the Indemnification Requirement is necessary or appropriate to, among other things, further the goals of the Dodd-Frank Act and the purposes of SDRs while preserving the confidentiality of the security-based swap information maintained by SDRs, as necessary. The Commission also preliminarily believes that our proposed guidance and exemption will, as one commenter suggested, help provide for an “efficient exchange of information.” [772]

(a) Notification Requirement

Section 13(n)(5)(G) of the Exchange Act requires an SDR, upon request, to “make available all data obtained by the SDR, including individual counterparty trade and position data,” to certain specified relevant authorities, as well as “other persons that the Commission determines to be appropriate.” [773] However, the SDR may make such data available only “after notifying the Commission of the request.” [774] The Commission preliminarily believes that an SDR can fulfill its obligation to notify “the Commission of the request” under Section 13(n)(5)(G) of the Exchange Act [775] and previously proposed Rule 13n-4(b)(9) by notifying the Commission, upon the initial request for security-based swap data by a relevant authority, of the request for security-based swap data from the SDR, and maintaining records of the initial request and all subsequent requests. [776] The Commission would consider the notice provided and records maintained as satisfying the Notification Requirement. [777] The Commission preliminarily believes that this approach is an efficient way for an SDR to satisfy its statutory notification obligation. [778]

(b) Determination of Appropriate Regulators

Section 13(n)(5)(G) of the Exchange Act requires an SDR, upon request, to “make available all data obtained by the [SDR], including individual counterparty trade and position data,” to certain specified relevant authorities, as well as “each appropriate prudential regulator” and “other persons that the Commission determines to be appropriate,” including, but not limited to, foreign financial supervisors (including foreign futures authorities), foreign central banks, and foreign ministries. [779] The Commission contemplates that a relevant authority will be able to request that the Commission make a determination that the relevant authority is appropriate for requesting security-based swap data from an SDR. The Commission preliminarily believes that it will make such a determination through the issuance of a Commission order.

In making such a determination, the Commission expects that we would consider a variety of factors, and our order may include, among other things, conditions on determining that a relevant authority is appropriate for purposes of receiving security-based swap data directly from SDRs. The Commission preliminarily believes that such determination will likely be conditioned on a supervisory and enforcement MOU or other arrangement between the Commission and the relevant authority. [780] Given the necessity of maintaining the confidentiality of the proprietary and highly sensitive data maintained by an SDR, such an MOU or arrangement [781] would be designed to protect the confidentiality of the security-based swap data provided to the relevant authority by an SDR. [782] The Commission anticipates that in determining whether to enter into such an MOU or other arrangement with a relevant authority, the Commission may consider whether, among other things, the relevant authority needs security-based swap information from an SDR to fulfill its regulatory mandate or legal responsibilities and the relevant authority agrees to protect the confidentiality of the security-based swap information provided to it. The Commission preliminarily believes that this MOU or arrangement could also satisfy the condition in proposed Rule 13n-4(d)(3) for an SDR to avail itself of the Indemnification Exemption, which is discussed below. [783]

In addition, the Commission preliminarily believes that in making the determination, it would be reasonable for the Commission to consider whether the relevant authority has a legitimate need for access to the security-based swaps maintained by an SDR in order to help safeguard such information. [784] Confirming that the relevant authority has a legitimate need could reduce the risk of unauthorized disclosure, misappropriation, or misuse of security-based swap data. In this regard, the Commission would be furthering the objectives of the Dodd-Frank Act, which created a number of protections for proprietary and highly sensitive data, including “individual counterparty trade and position data,” maintained by an SDR. [785] The Commission, therefore, preliminarily believes that a reasonable approach for our determination of an appropriate authority is for the Commission to consider the scope of the relevant authority's regulatory mandate and legal responsibilities. The Commission preliminarily believes that our consideration of these factors will further the Dodd-Frank Act's objective to safeguard security-based swap data and should address a commenter's concerns over unfettered access to such proprietary data. [786] The Commission also anticipates considering, among other things, whether the relevant authority agrees to provide the Commission with reciprocal assistance in securities matters within the Commission's jurisdiction, and whether such a determination would be in the public interest. The Commission may take into account any other factors as the Commission determines are appropriate in making our determination.

In addition, the Commission preliminarily believes that it is not necessary to prescribe by rule—as one commenter suggested [787] —a specific process such as the one proposed by the CFTC [788] that sets forth criteria for relevant authorities and the SDR to use in order to facilitate relevant authorities' access to security-based swap data maintained by the SDR. The Commission preliminarily believes that our determination of an appropriate authority, pursuant to the process described above, represents a reasonable approach to provide appropriate access by relevant authorities, while at the same time providing safeguards against access by persons without proper authority. [789] The Commission also preliminarily believes that SDRs should have the flexibility to consider whether to provide relevant authorities with access to requested security-based swap data. [790] The Commission preliminarily believes that a specific rule that delineates a process governing relevant authorities' access requests, as suggested by the commenter, would limit the flexibility of SDRs in considering whether to provide relevant authorities with access to requested security-based swap data.

The Commission contemplates that, in our sole discretion, we would determine whether to grant or deny a request for a determination that the relevant authority is appropriate for purposes of requesting security-based swap data from an SDR. [791] In addition, the Commission could revoke our determination at any time. [792] For example, the Commission may revoke a determination or request additional information from a relevant authority to support continuation of the determination if a relevant authority fails to keep confidential security-based swap data provided to it by an SDR.

(c) Option for Exemptive Relief from the Indemnification Requirement

i. Impact of the Indemnification Requirement

As noted above, Section 13(n)(5)(G) of the Exchange Act [793] and previously proposed Rule 13n-4(b)(9) thereunder provide that an SDR shall on a confidential basis, pursuant to Section 24 of the Exchange Act, and the rules and regulations thereunder, upon request, and after notifying the Commission of the request, make available all data obtained by the SDR to each appropriate prudential regulator, the Financial Stability Oversight Council, the CFTC, the Department of Justice, the Federal Deposit Insurance Corporation and any other person that the Commission determines to be appropriate. Section 13(n)(5)(H)(ii) of the Exchange Act requires that before an SDR shares security-based swap information with a relevant authority requesting such information from the SDR, the relevant authority must “agree to indemnify the security-based swap data repository and the Commission for any expenses arising from litigation relating to the information provided under section 24 [of the Exchange Act].” [794] Based on the Commission's understanding that certain relevant authorities may be unable to agree to indemnify any SDR and the Commission, the Commission preliminarily believes that the Indemnification Requirement could significantly frustrate the purpose of Section 13(n)(5)(G) of the Exchange Act [795] by preventing SDRs from making available security-based swap information to relevant authorities.

As stated in the SDR Proposing Release, “under the Dodd-Frank Act, SDRs are intended to play a key role in enhancing transparency in the [security-based swap] market by retaining complete records of [security-based swap] transactions, maintaining the integrity of those records, and providing effective access to those records to relevant authorities and the public in line with their respective information needs.” [796] Commenters [797] as well as relevant authorities, however, have expressed concerns about how the Indemnification Requirement would contravene the purposes of the Dodd-Frank Act, and more specifically, the statutory purposes of SDRs. [798] The Commission preliminarily believes that the Indemnification Requirement should not be applied rigidly so as to frustrate such purposes.

Specifically, the Commission recognizes that certain domestic authorities, including some of those expressly identified in Section 13(n)(5)(G) of the Exchange Act [799] and the Commission, cannot, as a matter of law, provide an open-ended indemnification agreement. For example, the Antideficiency Act prohibits certain U.S. federal agencies from obligating or expending federal funds in advance or in excess of an appropriation, apportionment, or certain administrative subdivisions of those funds (e.g., through an unlimited or unfunded indemnification). [800] Similarly, the Commission understands that foreign authorities may also be prohibited under applicable foreign laws from satisfying the Indemnification Requirement. [801] As such, the Commission agrees with three commenters' views that the Indemnification Requirement could hinder the ability of relevant authorities to fulfill their regulatory mandates and legal responsibilities. [802]

Moreover, the Commission understands from foreign authorities that their regulatory regimes will require them to have direct access to data maintained by trade repositories, including SDRs registered with the Commission, in order to fulfill their regulatory mandates and legal responsibilities. [803] Many foreign regulators [804] and market participants have indicated, however, that because foreign authorities cannot, as a matter of law or practice, comply with the Indemnification Requirement, the practical effect of having an open-ended indemnification requirement may be the fragmentation of security-based swap data across multiple SDRs, as foreign authorities establish trade repositories in their jurisdictions to ensure access to data that they need to perform their regulatory mandates and legal responsibilities. [805] Such fragmentation may lead to duplicative reporting requirements in multiple jurisdictions, higher reporting costs for market participants, and less transparency in the security-based swap market. [806] In light of these concerns, the Commission preliminarily believes that an exemption from the Indemnification Requirement may be necessary or appropriate, as a practical matter, to minimize fragmentation of security-based swap data that could otherwise be consolidated and reduce duplicative reporting requirements. [807]

ii. Proposed Rule 13n-4(d): Indemnification Exemption

The Commission is proposing, pursuant to our authority under Section 36 of the Exchange Act, [808] a tailored exemption from the Indemnification Requirement. To avoid a result that could significantly frustrate the purpose of Section 13(n)(5)(G) and the purpose of SDRs, the Commission preliminarily believes that the Indemnification Exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors, [809] particularly given that the exemption is narrowly tailored and could be applied in only limited circumstances.

Specifically, the Commission is proposing Rule 13n-4(d) (“Indemnification Exemption”), which states as follows: “A registered security-based swap data repository is not required to comply with the indemnification requirement set forth in Section 13(n)(5)(H)(ii) of the [Exchange] Act and [Rule 13n-4(b)(9) thereunder] with respect to disclosure of security-based swap information by the security-based swap data repository if: (1) [a]n entity described in [Rule 13n-4(b)(9)] requests security-based swap information from the security-based swap data repository to fulfill a regulatory mandate and/or legal responsibility of the entity; (2) [t]he request of such entity pertains to a person or financial product subject to the jurisdiction, supervision, or oversight of the entity; and (3) [s]uch entity has entered into a supervisory and enforcement memorandum of understanding or other arrangement with the Commission that addresses the confidentiality of the security-based swap information provided and any other matters as determined by the Commission.”

In proposing the Indemnification Exemption, the Commission is mindful of the comments received. The Commission intends for the Indemnification Exemption to—as one commenter suggested—“preserve [the] spirit of cooperation and coordination between regulators around the world” in the context of ensuring global regulators' access to security-based swap data. [810] By identifying specific conditions that are applicable to requests by any relevant authority, the Commission also intends for the Indemnification Exemption to be—as one commenter suggested—“location agnostic,” [811] whereby relevant authorities are treated similarly regardless of whether they are domestic authorities or foreign authorities. [812] In addition, the Indemnification Exemption is consistent with one commenter's suggestion that the Commission should not apply the Indemnification Requirement where relevant authorities are carrying out their regulatory responsibilities, in accordance with international agreements and while maintaining the confidentiality of data provided to them. [813] In order for an SDR to share security-based swap information with a relevant authority without an indemnification agreement, the three proposed conditions specified in the Indemnification Exemption, as discussed further below, must be met.

First, the relevant authority's request for security-based swap information from an SDR must be for the purpose of fulfilling the relevant authority's regulatory mandate and/or legal responsibility. The Commission preliminarily believes that this condition is aligned with the Dodd-Frank Act's requirements to protect security-based swap information, including proprietary and highly sensitive data, maintained by an SDR from unauthorized disclosure, misappropriation, or misuse of security-based swap information. [814] In particular, the Commission preliminarily believes that this condition is consistent with an SDR's statutory duty to maintain the privacy of security-based swap information that it receives. [815] In complying with its duty to maintain the privacy of security-based swap information, an SDR would need to determine when it can or cannot provide security-based swap information to others. The Commission preliminarily believes that, for the limited purposes of satisfying the Indemnification Exemption, it is appropriate for the SDR to include in its consideration of whether to provide security-based swap information to relevant authorities whether a relevant authority's specific request for security-based swap information is indeed within its regulatory mandate or legal responsibilities before the SDR provides the information to the relevant authority. [816] Finally, the Commission notes that establishing such a condition in the Indemnification Exemption is consistent with guidelines that one commenter indicated that it followed on a voluntary basis in providing relevant authorities with access to security-based swap information. [817]

Second, the relevant authority's request must pertain to a person or financial product subject to that authority's jurisdiction, supervision, or oversight. If, for instance, the relevant authority requests information on a security-based swap that pertains to a counterparty or underlier that is subject to the authority's jurisdiction, supervision, or oversight, then this condition to the Indemnification Exemption would be satisfied. The Commission preliminarily believes that the person or financial product need not be registered or licensed with the authority in order for this condition to be satisfied. Similar to the first condition of the Indemnification Exemption, the Commission preliminarily believes that this condition is aligned with the Dodd-Frank Act's requirements to protect security-based swap information, including proprietary and highly sensitive data, maintained by an SDR from unauthorized disclosure, misappropriation, or misuse of security-based swap information. [818] In particular, the Commission preliminarily believes that the second condition is consistent with an SDR's statutory duty to maintain the privacy of security-based swap information that it receives. [819] In complying with its duty to maintain the privacy of security-based swap information, an SDR would need to determine when it can or cannot provide security-based swap information to others. The Commission preliminarily believes that, for the limited purposes of satisfying the Indemnification Exemption, it is appropriate for the SDR to include in its consideration of whether to provide security-based swap information to relevant authorities whether a relevant authority's specific request pertains to a person or financial product that is subject to the authority's jurisdiction, supervision, or oversight. [820] Finally, the Commission notes that establishing such a condition in the Indemnification Exemption is consistent with guidelines that one commenter indicated that it followed on a voluntary basis in providing relevant authorities with access to security-based swap information. [821]

Third, the requesting relevant authority must enter into a supervisory and enforcement MOU or other arrangement with the Commission that addresses the confidentiality of the security-based swap information provided and any other matters as determined by the Commission. [822] For those entities not expressly identified in Section 13(n)(5)(G) of the Exchange Act [823] or the rules thereunder, such an MOU or other arrangement can be entered into during the Commission's determination process, as discussed in Section VI.C.3(b) above. On the other hand, entities expressly identified in Section 13(n)(5)(G) of the Exchange Act and the rules thereunder, which are not subject to the Commission's process to determine appropriate regulators, would need to enter into such an MOU or other arrangement to satisfy this condition of the Indemnification Exemption. The Commission anticipates that in determining whether to enter into such a supervisory and enforcement MOU or other arrangement with a relevant authority, the Commission will consider whether, among other things, the relevant authority needs security-based swap information from an SDR to fulfill its regulatory mandate or legal responsibilities; the relevant authority agrees to protect the confidentiality of the security-based swap information provided to it; the relevant authority agrees to provide the Commission with reciprocal assistance in securities matters within the Commission's jurisdiction; and a supervisory and enforcement MOU or other arrangement would be in the public interest.

The Commission preliminarily believes that the third condition in the Indemnification Exemption is—as one commenter suggested—an effective way to streamline the Indemnification Requirement for an “efficient exchange of information.” [824] The Commission also preliminarily believes that the third condition in the Indemnification Exemption is appropriate to help protect the confidentiality of the security-based swap data provided to relevant authorities, and also to further the purposes of the Dodd-Frank Act. In this regard, the Commission preliminarily believes that where a relevant authority cannot agree to indemnification, a supervisory and enforcement MOU or other arrangement, which a relevant authority can legally enter into, may be a reasonable alternative because, similar to an indemnification agreement, a supervisory and enforcement MOU or other arrangement would serve as another mechanism to protect the confidentiality of security-based swap data provided to a relevant authority by committing the authority to maintain such confidentiality. [825] In light of the confidentiality agreement required under Section 13(n)(5)(H)(i) of the Exchange Act and previously proposed Rule 13n-4(b)(10) [826] as well as the importance of maintaining good relations and trust among relevant authorities, the Commission also preliminarily believes that a relevant authority will have strong incentives to take reasonable measures and precautions to comply with its obligation to protect the confidentiality of the security-based swap information received from an SDR. In lieu of providing an indemnification agreement, a supervisory and enforcement MOU or other arrangement would provide an SDR and the Commission with an additional layer of protection in maintaining the confidentiality of security-based swap information shared by the SDR. [827]

For the reasons stated above, the Commission preliminarily believes that the Indemnification Exemption is a reasonable alternative to the Indemnification Requirement. The Commission recognizes, however, that a supervisory and enforcement MOU or other arrangement would not necessarily provide SDRs that invoke the exemption with the same level of protection that an indemnification agreement would provide (i.e., coverage for any expenses arising from litigation relating to information provided to a relevant authority) and thus, an SDR may prefer the benefits of the Indemnification Requirement rather than rely on the Indemnification Exemption. Therefore, under the Commission's proposed exemption, an SDR would have the option to require an indemnification agreement from a relevant authority should the SDR choose to do so rather than rely on the Indemnification Exemption.

The Commission expects that where an SDR seeks to obtain an indemnification agreement from a relevant authority, the SDR should negotiate in good faith an indemnification agreement. In this regard, the Commission agrees with one commenter's view that “any indemnity should be limited in scope” [828] and expects that an SDR will not unreasonably hinder the ability of relevant authorities to obtain security-based swap information from the SDR. [829] Regarding the same commenter's suggestion that the Commission provide model indemnification language, [830] the Commission does not believe that it is appropriate to prescribe by rule specific language that an SDR would be required to use when requesting indemnification from relevant authorities. Because such language could vary on a case-by-case basis depending on various factors, such as the laws applicable to the relevant authority, the Commission preliminarily believes that it is appropriate to allow for flexibility in negotiation of an indemnification agreement.

Request for comment

The Commission requests comment on all aspects of the proposed guidance, interpretation, and the Indemnification Exemption, including the following:

  • Is the Commission's proposed interpretation of the Notification Requirement appropriate and sufficiently clear? Why or why not? Is it overly broad or narrow? If so, why? Does the Commission's proposed interpretation provide the Commission with sufficient information to fulfill our responsibilities?
  • Should the Commission require SDRs to provide the Commission with actual notice of all of requests for security-based swap data by relevant authorities? Why or why not? If so, what should such notice include? Why?
  • What would be the advantage of requiring SDRs to provide actual notice to the Commission of requests for security-based swap data by relevant authorities before making the data available to the relevant authorities?
  • With regard to the Notification Requirement, should the Commission adopt a rule that is consistent with the approach taken by the CFTC in its Rule 49.17(d)(4), 17 CFR 49.17(d)(4), which requires a swap data repository to promptly notify the CFTC regarding any request received by an appropriate foreign or domestic regulator to gain access to the swap data maintained by such swap data repository? Why or why not?
  • Should the Commission provide an exemption from the Notification Requirement similar to the Indemnification Exemption? Why or why not? For example, should proposed Rule 13n-4(d) be revised to begin with “[a] registered security-based swap data repository is not required to comply with the notification requirements set forth in Section 13(n)(5)(G) of the Act and paragraph (b)(9) of this section and the indemnification requirement set forth in Section 13(n)(5)(H)(ii) of the Act and paragraph (b)(10) of this section . . .”? Why or why not?
  • Should the Commission propose a rule with regard to the application of the Notification Requirement? Why or why not? If so, what should the rule stipulate?
  • In determining whether a person is appropriate to obtain security-based swap data from SDRs, should the Commission establish the process set forth in this release for persons to request a Commission determination? Why or why not? Should the Commission make such a determination by order? Why or why not? Should the Commission delegate this determination to the staff? Why or why not?
  • In determining whether a person is appropriate to obtain security-based swap data from SDRs, should the Commission require a supervisory and enforcement MOU or other arrangement? Why or why not? If so, what matters should be addressed in the MOU or other arrangement? What factors should the Commission take into consideration when determining whether to enter into an MOU or other arrangement with the person?
  • In determining whether a person is appropriate to obtain security-based swap data from SDRs, does the Commission need to understand the scope of a relevant authority's regulatory mandate or legal responsibilities? Why or why not? What other factors should the Commission take into account in making such a determination?
  • Should the Commission's process for determining whether a person is appropriate to obtain security-based swap data from SDRs be memorialized in a rule? If so, what should the rule stipulate?
  • Should the Commission require by rule or in our determination orders that SDRs not provide relevant authorities with access to security-based swap data beyond their regulatory mandates or legal responsibilities? Why or why not? Should the Commission adopt a process such as the one adopted by the CFTC in its Rule 49.17(d), 17 CFR 49.17(d), which requires certain regulators seeking to gain access to the swap data maintained by a swap data repository to certify that they are acting within the scope of their jurisdiction?
  • Are there any reasons why the Commission should determine a person appropriate to obtain security-based swap data from one or more SDRs, but not all SDRs? If so, what are they?
  • Should the Commission, when it determines that a person is appropriate to obtain security-based swap data from SDRs, include limitations on such determination? Why or why not? For example, should the Commission limit the determination to a certain period of time or to certain individual persons at a relevant authority?
  • Under what circumstances should the Commission be able to revoke our determination order? Under what circumstances would it be appropriate for the Commission to request a relevant authority to provide additional information in order to maintain such a determination?
  • Should the Commission provide additional clarification with respect to how parties comply with the confidentiality requirements in Section 24 of the Exchange Act? In what aspect would clarification be helpful?
  • Is the Commission's proposed interpretation of the Indemnification Requirement appropriate and sufficiently clear? Should the Commission interpret the Indemnification Requirement more broadly or narrowly? If so, explain.
  • Should the Commission interpret the Indemnification Requirement to be limited to the liability that a relevant authority otherwise would have to an SDR pursuant to the laws applicable to that relevant authority, such as the Federal Tort Claims Act, which is applicable to domestic authorities?
  • Is the Commission's Indemnification Exemption appropriate and sufficiently clear? If not, what would be a better alternative? Please also explain the costs and benefits of any alternative, including how the alternative would be consistent with and further the goals of Title VII.
  • Is the Indemnification Exemption overly broad or narrow? If so, what would be a better alternative? Please also explain the costs and benefits of any alternative, including how the alternative would be consistent with and further the goals of Title VII.
  • Are there ways to narrowly tailor the Indemnification Exemption further without hindering a relevant authority's ability to obtain security-based swap data information from SDRs?
  • Should the SDRs have the option to require a relevant authority to provide an indemnification agreement even if the three conditions in the Indemnification Exemption can be satisfied? Why or why not? Does providing SDRs with such an option raise any competiveness concerns?
  • If the Commission were to modify the Indemnification Exemption so that SDRs do not have the option to require an indemnification agreement pursuant to Section 13(n)(5)(H)(ii) of the Exchange Act even if the three conditions in the exemption are satisfied, would this be appropriate and consistent with the Indemnification Requirement?
  • What is the likelihood of an SDR not availing itself of the Indemnification Exemption even if the three conditions are met? Are there any measures that the Commission should take to address or mitigate this scenario? Are there any restrictions that the Commission should impose on an SDR that requires an indemnification agreement even if it can avail itself of the Indemnification Exemption?
  • Should an SDR be required to make and keep records of its decision to rely on the Indemnification Exemption?
  • Are the Indemnification Exemption and the Commission's proposed interpretive guidance sufficient to address the possibility that SDRs may be registered with ESMA and national regulators at the European Union (“EU”) member state level will obtain security-based swap information from ESMA? Are there any regulatory regime or circumstances that the Commission should take into consideration that is not addressed by the Indemnification Exemption or the Commission's interpretive guidance? Please explain.
  • Will organizations such as FINRA and other self-regulatory organizations, the National Futures Association, the IMF, and the International Bank for Reconstruction and Development be able to meet the three conditions of the Indemnification Exemption? Why or why not? If not, should the Indemnification Exemption be modified to explicitly exempt such organizations from the Indemnification Requirement? Why or why not? If so, which organizations and why?
  • Does the Indemnification Exemption adequately address the concerns of relevant authorities with respect to the Indemnification Requirement? Are there any circumstances that would warrant an exemption from the Indemnification Requirement, but that would not satisfy all the conditions in the Indemnification Exemption? If so, how could the Indemnification Exemption be modified and narrowly tailored to capture such circumstances so as not to have the effect of nullifying the Indemnification Requirement?
  • Is it appropriate to provide SDRs with the flexibility to determine, on a case-by-case basis, whether a relevant authority that is requesting security-based swap information is acting within the scope of its regulatory mandate or legal responsibilities? Why or why not?
  • Should the Commission impose any additional requirements on SDRs to confirm that a relevant authority is requesting security-based swap information for the purpose of fulfilling its regulatory mandate or legal responsibilities? For example, should the Commission prescribe, as a condition in the Indemnification Exemption, that the SDR obtain a written confirmation from the requesting relevant authority that it is acting within its regulatory mandate or legal responsibilities?
  • Should the Commission impose any additional requirements on SDRs to confirm that a relevant authority is requesting security-based swap information that pertains to a person or financial product subject to the jurisdiction, supervision, or oversight of the authority? For example, should the Commission prescribe, as a condition in the Indemnification Exemption, that the SDR obtain a written confirmation from the requesting relevant authority that its request pertains to a person or financial product subject to the jurisdiction, supervision, or oversight of the authority?
  • Would an MOU between the Commission and a relevant authority in lieu of an indemnification agreement provide protection of security-based swap information shared with the relevant authority comparable to that of an indemnification agreement? If not, why not?
  • Should the Commission specify in the Indemnification Exemption any other matters that may be in a supervisory and enforcement MOU or other arrangement? If so, what?
  • On January 25, 2012, the European Commission proposed reforms to strengthen online privacy rights and to modernize the principles set forth in the EU's 1995 Data Protection Directive (“EU Directive”) to protect personal data. Will the EU Directive affect the ability of SDRs to provide security-based swap data to other relevant authorities, including the Commission? If so, please explain. Will the EU Directive affect the ability of the EU and its member countries to provide reciprocal assistance in securities matters, as contemplated by the supervisory and enforcement MOU or other arrangement discussed above? If so, please explain.
  • Should the Commission impose any additional conditions in the Indemnification Exemption? If so, what? Are there any conditions in the Indemnification Exemption that the Commission should not require? If so, what conditions and why?
  • For the purpose of satisfying the Indemnification Exemption, should an SDR be required to maintain policies and procedures setting forth how to determine (i) whether security-based swap information being requested is needed to fulfill a regulatory mandate and/or legal responsibility of the requesting entity, (ii) whether a relevant authority's requests pertain to a person or financial product subject to the authority's jurisdiction, supervision, or oversight, or (iii) whether the requesting relevant authority has entered into a supervisory and enforcement MOU or other arrangement with the Commission? To the extent such policies and procedures require each requesting relevant authority to provide a written representation with respect to one or more of the conditions in the Indemnification Exemption, should such written representations be considered sufficient to satisfy the relevant conditions in the Indemnification Exemption?
  • Are there better ways that the Commission could address the Indemnification Requirement besides the Indemnification Exemption that would be consistent with and further the goals of Title VII? Please explain the costs and benefits of any alternative.
  • What is the likely impact of the Indemnification Exemption on the security-based swap market? Would the Indemnification Exemption potentially promote or impede the establishment of SDRs?
  • Is the Commission's proposed interpretation of how the Indemnification Requirement applies to SDRs dually registered with the Commission and a foreign regulator appropriate and sufficiently clear? If not, why not? Should the Commission apply the Indemnification Requirement when an SDR is registered with the Commission and is also registered or licensed with a foreign authority and that foreign authority is obtaining information from the SDR pursuant to its regulatory regime? Why or why not? Should there be any additional conditions in such instances? If so, what conditions and why?
  • Should the Commission provide guidance on what it means for a “person or financial product” to be “subject to [an] authority's jurisdiction, supervision, or oversight”? Why or why not?
  • What would be the market impact of the proposed approach to providing an exemption from the Indemnification Requirement? How would the proposed application of the Indemnification Requirement, including the proposed exemption, affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the Indemnification Requirement? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

VII. Security-Based Swap Execution Facilities Back to Top

A. Introduction

As discussed throughout this release, the market for security-based swaps is global in scope, with transactions in security-based swaps often involving counterparties in different jurisdictions. The Commission recognizes that, as a result, there may be uncertainty regarding the application of our proposed SB SEF registration requirements for a security-based swap market whose principal place of business is outside of the United States. The Commission believes, therefore, that guidance and clarification on the application of our proposed registration requirements would be useful with respect to security-based swap markets operating in the cross-border context.

Under the Dodd-Frank Act, new Section 3D(a)(1) of the Exchange Act provides that “no person may operate a facility for the trading or processing of security-based swaps, unless the facility is registered as a security-based swap execution facility or as a national securities exchange under this section.” [831] In our release proposing rules governing SB SEFs, [832] the Commission expressed the view that the registration requirement of Section 3D(a)(1) would apply only to a facility that meets the definition of “security-based swap execution facility” in Section 3(a)(77) of the Exchange Act. [833] The SB SEF Proposing Release, however, did not explicitly address the circumstances under which a foreign [834] security-based swap market would be required to register with the Commission under Section 3D of the Exchange Act. [835] As discussed below, the Commission herein proposes to interpret when the registration requirements of Section 3D of the Exchange Act would apply to a foreign security-based swap market. [836] The Commission also discusses below the circumstances under which it may consider granting an exemption from registration for a foreign security-based swap market.

The proposed interpretations described below represent the Commission's proposed approach to applying the SB SEF registration requirements to foreign security-based swap markets. We recognize that other approaches may achieve the goals of the Dodd-Frank Act, in whole or in part. Accordingly, we invite comment regarding all aspects of the proposal described below, and each proposed interpretation contained therein, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of each proposed interpretation and potential alternative approaches would be particularly useful to the Commission in evaluating modifications to the proposals.

B. Registration of Foreign Security-Based Swap Markets

As noted above, in our SB SEF Proposing Release, the Commission expressed the view that the registration requirement of Section 3D(a)(1) would apply only to a facility that meets the definition of “security-based swap execution facility” in Section 3(a)(77) of the Exchange Act. [837] A “security-based swap execution facility” is defined as “a trading system or platform in which multiple participants have the ability to execute or trade security-based swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce, including any trading facility, that (A) facilitates the execution of security-based swaps between persons and (B) is not a national securities exchange.” [838]

As outlined further below, the Commission preliminarily believes that, when evaluating whether a foreign security-based swap market would have to register under Section 3D(a)(1), activities by the foreign security-based swap market that provide U.S. persons, or non-U.S. persons located in the United States, the ability to directly execute or trade security-based swaps on the foreign security-based swap market or facilitate the execution or trading of security-based swaps by U.S. persons, or non-U.S. persons located in the United States, on the foreign security-based swap market should be considered. [839] The Commission also preliminarily believes that, if a foreign security-based swap market takes affirmative actions to induce the execution or trading of security-based swaps on its market by U.S. persons, or non-U.S. persons located in the United States, including by inducing such execution or trading through marketing its services relating to the ability to execute or trade security-based swaps on its market to U.S. persons, or non-U.S. persons located in the United States, or otherwise initiating contact with such persons for the purpose of inducing such execution or trading, then those activities could be viewed as facilitating the execution or trading of security-based swaps on its market and could cause the foreign security-based swap market to fall within the scope of the registration requirements of Section 3D of the Exchange Act.

The Commission believes that it would be useful to provide some discussion of the types of activities that it preliminarily believes would place a foreign security-based swap market within the scope of Section 3D of the Exchange Act under the Commission's proposed interpretation. Given the constant innovation of trading mechanisms and methods, as well as technological and communication developments, however, it would not be possible to provide a comprehensive, final discussion of every activity for which a foreign security-based swap market would be considered to be providing U.S. persons or non-U.S. persons located in the United States the ability to execute or trade security-based swaps, or to be facilitating the execution or trading of security-based swaps, on its market, thereby triggering the requirement to register as a SB SEF under Section 3D(a)(1).

The Commission preliminarily believes that when a foreign security-based swap market provides U.S. persons, or non-U.S. persons located in the United States, with the direct ability to trade or execute security-based swaps on the foreign security-based swap market by accepting bids and offers made by one or more participants on the foreign security-based swap market, then such market would be required to register as a SB SEF. The Commission notes that a foreign security-based swap market could grant such direct access to U.S. persons, and non-U.S. persons located in the United States, through a variety of means, such as (i) providing proprietary electronic screens, market terminals, monitors or other devices for trading security-based swaps on its market; (ii) granting direct electronic access to the foreign security-based swap market's trading system or network, including by providing data feeds or codes for use with software operated through the computer of a U.S. person, or non-U.S. person located in the United States, or by allowing such persons to access the foreign security-based swap market through third-party service vendors or public networks (such as the Internet); or (iii) allowing its members or participants to provide U.S. persons or non-U.S. persons located in the United States with direct electronic access to trading in security-based swaps on the foreign security-based swap market.

The Commission also preliminarily believes that, if a foreign security-based swap market were to grant membership or participation in the foreign security-based swap market to U.S. persons, or non-U.S. persons located in the United States, which would provide such persons with the ability to directly execute or trade security-based swaps by accepting bids and offers made by one or more participants on the foreign security-based swap market, then such market would be required to register as a SB SEF.

Although the Commission preliminarily believes that the foregoing activities are the types of activities that would warrant application of the registration requirement of Section 3D, the Commission emphasizes that these activities are not intended to be an exclusive or exhaustive discussion of all the activities that could trigger the registration requirements of Section 3D by a foreign security-based swap market. In addition, as trading and communication mechanisms and methods evolve, other activities that aim at providing U.S. persons, or non-U.S. persons located in the United States, the ability to directly execute or trade security-based swaps by accepting bids and offers made by multiple participants on a foreign security-based swap market, or that aim to facilitate the execution or trading of security-based swaps by U.S. persons or non-U.S. persons located in the United States on a trading platform or system operated by a foreign security-based swap market, could cause a foreign security-based swap market to fall within the ambit of the registration requirements of Section 3D. [840]

The Commission anticipates that some U.S. persons or non-U.S. persons located in the United States may choose to transact on a foreign security-based swap market on an indirect basis through a non-U.S. person that is not located in the United States and that is a member or participant of a foreign security-based swap market. The Commission preliminarily believes that, to the extent that the U.S. person, or non-U.S. person located in the United States, initiates the contact and the foreign security-based swap market does not attempt to solicit such business, such a transaction would not on its own warrant requiring the foreign security-based swap market to register under Section 3D of the Exchange Act. [841] However, as discussed above, to the extent that a foreign security-based swap market initiates contacts with U.S. persons or non-U.S. persons located in the United States to induce or facilitate the execution or trading of security-based swaps by such persons on its market, such activity would trigger the requirement to register under Section 3D. [842]

The Commission also anticipates that, given the global nature of the security-based swap business, a foreign security-based swap market could, at some point, seek to enter into a business combination with a registered SB SEF. Under the Commission's proposed interpretation, such business combination also could trigger the registration requirements of Section 3D of the Exchange Act for the foreign security-based swap market, depending on the nature and extent of integration of the entities' operations and activities. In this regard, the Commission's experience in recent years with national securities exchanges that have engaged in cross-border combinations may be illustrative for these purposes. Several national securities exchanges in recent years have entered into transactions to combine under common ownership with certain non-U.S. markets, such as NYSE Group, Inc.'s transaction with Euronext N.V. to form NYSE Euronext in 2007; [843] Eurex Frankfurt AG's acquisition of the International Securities Exchange, LLC in 2007; [844] and The Nasdaq Stock Market, Inc.'s transaction with Borse Dubai Limited to form NASDAQ OMX Group, Inc. in 2008. [845] In each case, the U.S. and the foreign markets, under their respective parent companies, generally have continued to operate as separate legal entities, maintained separate liquidity pools in their respective jurisdictions without integrating trading interest among markets under common ownership, and continued to be regulated subject to their own home country's requirements. Similarly, a registered SB SEF and a foreign security-based swap market could come under common ownership but continue to be separate legal entities, maintain separate liquidity pools for their security-based swap businesses without integrating trading interest among affiliated markets, and be separately regulated in their own home jurisdictions. However, if a registered SB SEF and foreign security-based swap market were to integrate their security-based swap trading facilities, for example, by the foreign security-based swap market providing direct access to the SB SEF's participants, or by the foreign security-based swap market and the registered SB SEF integrating their liquidity pools, [846] under the Commission's proposed interpretation, such actions would trigger the registration requirements of Section 3D of the Exchange Act for the foreign security-based swap market because the market would then be operating a facility for trading security-based swaps within the United States.

C. Registration Exemption for Foreign Security-Based Swap Markets

The prior section discusses when a foreign security-based swap market would be required to register as a SB SEF under Section 3D of the Exchange Act. The Commission recognizes, however, that the security-based swap market is global in nature and therefore one or more foreign security-based swap markets may seek relief from the Commission to allow some of the activities discussed above that would trigger the SB SEF registration requirement to continue without the foreign security-based swap market having to register as a SB SEF under Section 3D of the Exchange Act.

Following the publication of the SB SEF Proposing Release, the Commission received comments from the public expressing concerns about the implications of the proposed rules and the requirements of Section 3D of the Exchange Act for foreign security-based swap markets and the global markets for security-based swaps generally. [847] Several commenters urged the Commission to work with foreign regulators to develop harmonized rules for the trading of security-based swaps. [848] Some commenters believed that harmonization or flexibility with regard to foreign security-based swap markets would help reduce the risk of regulatory arbitrage. [849] One commenter stated that such harmonization would reduce the burdens of duplicative or conflicting requirements that could be faced by security-based swap markets operating in multiple jurisdictions. [850]

Although a number of foreign jurisdictions are in the process of developing standards for the regulation of security-based swaps and security-based swap markets, at this time few foreign jurisdictions have enacted legislation or adopted standards for the regulation of security-based swap markets. [851] The Commission, however, is in discussions with its foreign counterparts to explore steps toward harmonizing standards for such regulation in the future. [852] In the meantime, the Commission is considering how best to address commenters' concerns about the risks of regulatory arbitrage and duplicative regulatory burdens on security-based swap markets that operate on a cross-border basis, in a manner consistent with the requirements of the Dodd-Frank Act and the federal securities laws generally.

The Commission preliminarily believes that it may be appropriate to consider an exemption as an alternative approach to SB SEF registration depending on the nature or scope of the foreign security-based swap market's activities in, or the nature or scope of the contacts the foreign security-based swap market has with, the United States. Exemptions that are carefully tailored to achieve the objectives of Section 3D could help to improve security-based swap market supervision overall by allowing the Commission to focus our resources on areas where it has a substantial interest, while reducing duplication of efforts in areas where our interests are aligned with those of other regulators.

The Commission could exempt from the registration requirements of Section 3D a foreign security-based swap market that is subject to comparable, comprehensive supervision and regulation under appropriate governmental authorities in its home country. [853] The availability of such an exemption could serve to reduce any potential duplicative regulatory burdens faced by security-based swap markets that operate on a cross-border basis and that otherwise would be required to register both in the United States and in a non-U.S. jurisdiction.

Before the Commission would consider issuing an exemption from the registration requirements of Section 3D for a particular foreign security-based swap market, the Commission could consider whether the foreign security-based swap market is subject to comparable, comprehensive supervision and regulation by the appropriate governmental authorities in its home country, as compared to the supervision and regulation of SB SEFs under the Dodd-Frank Act and the Commission's implementing regulations. This process could include a review of the foreign jurisdiction's laws, rules, regulatory standards and practices governing the foreign security-based swap market and would entail consultation and cooperation with the foreign security-based swap market's home country governmental authorities.

The Commission expects that any such registration exemption could be subject to appropriate conditions that could include, but not be limited to, requiring a foreign security-based swap market to certify that it would provide the Commission with prompt access to its books and records, including, for example, data relating to orders, quotes, and transactions, as well as provide an opinion of counsel that, as a matter of law, it is able to provide such access. The Commission also could require, as a condition to receiving an exemption from registration, that a foreign security-based swap market would appoint an agent for service of process in the United States who is not an employee or official of the Commission. These potential conditions would be consistent with the proposed requirements for non-resident registered SB SEFs [854] and would allow the Commission to exercise, as necessary or appropriate, supervisory oversight of a foreign security-based swap market that receives an exemption from Section 3D's registration requirements. The Commission also could require that, before issuing an exemption from registration, the Commission and the appropriate financial regulatory authority or authorities in the foreign security-based swap market's home jurisdiction enter into a MOU that addresses the oversight and supervision of that market.

In certain cases, the Commission also could require, as a condition to granting such an exemption, that a foreign security-based swap market meet some of the requirements applicable to registered SB SEFs. Such a condition may be useful where the Commission is unable to make a determination regarding the broader comparability of the home jurisdiction's regulation and supervision, but where there is comparability with respect to some of the requirements applicable to registered SB SEFs and to a foreign security-based swap market (or class of security-based swap markets) in its home country. Therefore, the terms and conditions of any exemption that the Commission may grant to a foreign security-based swap market (or class of security-based swap markets) could depend on the degree to which the foreign jurisdiction's laws, rules, regulatory standards, and practices governing security-based swaps “compare” to those of the United States.

In considering the above, the Commission may consider any requirements of the home country that would conflict with the requirements applicable to SB SEFs under the Dodd-Frank Act. For example, Section 3D of the Exchange Act seeks to ensure fair and open access to SB SEFs by requiring that a SB SEF establish and enforce rules that include means to provide market participants with impartial access to the market. [855] The Commission also could consider whether a home country regulator imposes a regulation or policy limiting fair and open access to its security-based swap markets.

The Commission notes that security-based swap market structure and security-based swap market supervision and regulation could vary in other jurisdictions and could affect the Commission's ability to make a comparability determination. In addition, such differences in supervision and regulation would necessitate that each exemption request be reviewed on a jurisdiction-by-jurisdiction basis by the Commission. The conditions to any such exemption also would be based on the differences in the market structure and supervisory regime in the jurisdiction under consideration in comparison to U.S. oversight of SB SEFs.

As noted above, few foreign jurisdictions have adopted a comprehensive framework for the regulation of security-based swap markets and the Commission has not yet adopted rules governing SB SEFs. Thus, the Commission believes that it is premature to specify the precise criteria that the Commission may use for our evaluation and comparison of the regulatory and supervision programs for foreign security-based swap markets, should the Commission choose to consider exempting from registration as a SB SEF a foreign security-based swap market that becomes subject to regulation in its home country at a future date. Nonetheless, the Commission believes that it is useful now to elicit comment from interested persons regarding our proposed approach, should it choose to consider providing such an exemption.

The Commission preliminarily believes that the proposed approach, which may condition any exemption for a foreign security-based swap market on the existence of comparable, comprehensive supervision and regulation under the appropriate financial regulatory authority or authorities in the foreign security-based swap market's home country, should provide comparable regulatory oversight and supervision as that afforded by the Commission's regulation and supervision of SB SEFs. The standard of “comparability” discussed above should allow the Commission sufficient flexibility to make exemption determinations based on the similarity of the requirements and practices of the foreign jurisdiction's regulatory program governing security-based swaps. In this regard, the Commission preliminarily believes that the comparability standard could extend not only to the written laws and rules of the foreign jurisdiction, but also to the jurisdiction's comprehensive supervision and regulation of its security-based swap markets, including the jurisdiction's oversight of its markets and enforcement of its laws and rules. The breadth of the proposed comparability standard (i.e., to consider actual practices as well as written laws and rules) could help ensure that the regulatory protections provided in the foreign jurisdiction's security-based swap markets are substantially realized by sufficiently vigorous supervision and enforcement.

Finally, as discussed below, [856] the Commission proposes to permit substituted compliance, under certain circumstances, with respect to the mandatory trade execution requirement in Section 3C(h)(1) of the Exchange Act, if the Commission finds that a foreign-based security-based swap market (or class of security-based swap markets) is subject to comparable, comprehensive supervision and regulation by a foreign financial regulatory authority in such foreign jurisdiction. [857] While the proposed comparability standard for our granting an exemption from SB SEF registration could be similar to the proposed comparability standard for a substituted compliance determination with respect to the mandatory trade execution requirement, which is discussed below, the factors that the Commission could find relevant to a comparability determination with respect to SB SEF registration would not necessarily be the same factors that it would consider when making a comparability determination with respect to mandatory trade execution. This is because Section 3D of the Exchange Act is focused on the registration of SB SEFs and compliance by registered SB SEFs with the 14 enumerated core principles governing SB SEFs, [858] whereas Section 3C(h)(1) of the Exchange Act is focused on the circumstances where execution of a security-based swap on a SB SEF (or an exchange) is required. [859] However, the Commission solicits comment on the appropriateness or feasibility of our proposed approach.

Request for Comment

The Commission generally requests comment on the discussion regarding SB SEFs, including the following:

  • The Commission requests comment on all aspects of our discussion regarding when a foreign security-based swap market would be required to register as a SB SEF under Section 3D and on the non-exhaustive discussion of the types of activities, noted above, that would trigger registration of the foreign security-based swap market as a SB SEF. The Commission also requests comment on all aspects of our proposal to consider requests for an exemption from SB SEF registration for a foreign security-based swap market under certain circumstances.
  • The Commission seeks commenters' views on the potential impact of applying the proposed SB SEF registration requirements to foreign security-based swap markets that engage in activities that would require such markets to register as a SB SEF. Are there aspects of the proposed SB SEF rules and registration requirements that present issues for foreign security-based swap markets that would be required to register as a SB SEF? If so, please explain in detail.
  • The Commission requests commenters' views on whether the non-exhaustive discussion of the types of activities, noted above, which would trigger the application of Section 3D registration requirements to a foreign security-based swap market, is appropriate to aid foreign security-based swap markets in assessing whether they would be required to register as a SB SEF. Are there other activities that foreign security-based swap markets currently engage in that should be evaluated for consideration as to whether those activities would trigger Section 3D registration requirements? If so, please describe those activities in detail. Are there specific items set forth in the non-exhaustive discussion of the types of activities noted above or any other specific activities engaged in by foreign security-based swap markets that should not trigger Section 3D registration requirements? If so, commenters should describe those activities in detail and explain their rationale. Does the proposed interpretation regarding the application of Section 3D and the proposed non-exhaustive discussion of the types of activities provide sufficient guidance for a foreign security-based swap market to assess whether it would have to register, or seek an exemption from registration, as a SB SEF? If not, what kind of further guidance would be helpful for making that determination? Does the proposed approach provide sufficient guidance to a foreign security-based swap market that may seek an exemption? If not, what kind of further guidance would be helpful?
  • The Commission seeks comment on the appropriateness of the proposed interpretation that the registration requirements of Section 3D should be triggered by certain activities directed at “U.S. persons, or non-U.S. persons located in the United States.” Are the categories of persons captured by this proposed approach too broad? Too narrow? Please specify and explain. For example, foreign branches would be included by the proposed approach, such that a foreign security-based swap market's provision of direct access or participation in its market to a foreign branch, or activities facilitating execution or trading of security-based swaps on its market by such a foreign branch, would trigger the Section 3D registration requirement. Do commenters agree with this approach? If not, why not? What would be a better approach? If so, how so?
  • The Commission requests comment on what would be the appropriate circumstances under which the Commission should consider granting an exemption from the registration requirements of Section 3D. Should the Commission consider granting an exemption from registration for a foreign security-based swap market when the nature or scope of its activities in the United States are limited? If so, why? Or should the Commission also consider granting an exemption for a foreign security-based swap market when the nature or scope of its activities in the United States are more extensive? Why or why not? What would be the advantages and disadvantages of either approach? What would be the appropriate criteria for the Commission to apply when it considers whether to grant an exemption from the registration requirements of Section 3D? Please specify and explain.
  • The Commission seeks comment on whether the proposed standard of comparability is an appropriate standard for the Commission to determine whether to grant an exemption from Section 3D's registration requirements for a foreign security-based swap market. Should a different standard be used? If so, what should be the standard and why? Should it be stricter or more lenient than the proposed standard? If it should be stricter or more lenient, in what respects and in what manner? Why or why not? As proposed, when making a comparability determination, the Commission would look not just at the rules of a foreign jurisdiction, but also at the comprehensiveness of the supervision and regulation by the appropriate governmental authorities of that jurisdiction. Is the Commission's holistic approach to making a comparability determination appropriate? Why or why not? Comment also is requested regarding whether the Commission should put in place a more detailed standard for granting an exemption, for example, by providing specific criteria that the Commission would look to in determining whether there is comparable, comprehensive regulation and supervision of a foreign security-based swap market by the appropriate financial regulatory authority or authorities in the home country. If so, what criteria should the Commission include and why? Commenters also are requested to explain how the Commission should develop such criteria in the absence of existing regulations in other jurisdictions at the present time. Are there specific procedures or comparability considerations that commenters believe that the Commission would find useful to incorporate in our proposed exemption approach at this time? If so, please describe. What would be the advantages of adopting such measures now? What would be the disadvantages of adopting such measures now?
  • The Commission solicits comment on the appropriateness or feasibility of distinguishing between the comparability determination for purposes of an exemption from registration as a SB SEF and for purposes of substituted compliance for the mandatory trade execution requirement. Should the Commission consider the same factors in making a comparability determination for mandatory trade execution and a comparability determination for SB SEF registration? If so, what factors would be relevant and appropriate to both determinations? Please describe. What factors, if any, would only be relevant or appropriate to a comparability determination for SB SEF registration or a comparability determination for mandatory trade execution, respectively? Please describe.
  • The Commission seeks comment on the proposed process for granting an exemption from Section 3D's registration requirements for a foreign security-based swap market. Is the process explained in a sufficiently clear manner? Does the process provide foreign security-based swap markets with an efficient method for obtaining exemptions? If not, what aspects of the process would be burdensome for foreign security-based swap markets? Are there other ways to streamline the exemption process? Please describe.
  • What would be the market impact of the proposed approach to the registration of foreign security-based swap markets? How would the proposed application of the SB SEF registration requirement affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed approach place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed approach be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the proposed approach to the registration of foreign security-based swap markets? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

VIII. Regulation SBSR—Regulatory Reporting and Public Dissemination of Security-Based Swap Information Back to Top

A. Background

Section 13A(a)(1) of the Exchange Act [860] provides that all security-based swaps that are not accepted for clearing shall be subject to regulatory reporting. Section 13(m)(1)(G) of the Exchange Act [861] provides that each security-based swap (whether cleared or uncleared) shall be reported to a registered SDR, and Section 13(m)(1)(C) of the Exchange Act [862] generally provides that transaction, volume, and pricing data of all security-based swaps shall be publicly disseminated in real time, except in the case of block trades. [863] On November 19, 2010, the Commission proposed Regulation SBSR to implement these requirements. [864]

Rule 908 of Regulation SBSR as initially proposed was designed to clarify the application of Regulation SBSR to cross-border security-based swaps. Proposed Rule 908(a) would require a security-based swap to be reported and publicly disseminated if the security-based swap: (i) Has at least one counterparty that is a U.S. person; (ii) was executed in the United States or through any means of interstate commerce; or (iii) was cleared through a registered clearing agency having its principal place of business in the United States. Proposed Rule 908(b) provided that, notwithstanding any other provision of Regulation SBSR, no counterparty to a security-based swap would incur any obligation under Regulation SBSR unless it is: (i) A U.S. person; (ii) a counterparty to a security-based swap executed in the United States or through any means of interstate commerce; or (iii) a counterparty to a security-based swap cleared through a clearing agency having its principal place of business in the United States. Thus, under the Commission's initial proposal, a security-based swap—wherever it is executed or cleared—would be required to be reported pursuant to Regulation SBSR if at least one counterparty were a U.S. person. Furthermore, a security-based swap—even if both counterparties were non-U.S. persons—would be required to be reported if the security-based swap were executed in the United States or through any means of interstate commerce, or cleared through a clearing agency having its principal place of business in the United States.

Rule 901(a)(1), as initially proposed, also provided that, where only one counterparty to a security-based swap is a U.S. person, the U.S. person would be the “reporting party” (i.e., the party that incurs the duty to report the security-based swap pursuant to Regulation SBSR). Rule 901(a)(3), as initially proposed, provided that, where neither counterparty to a security-based swap that must be reported is a U.S. person, the counterparties must select which of them would be the reporting party.

To date, the Commission has received 48 comment letters specifically in response to proposed Regulation SBSR, many of which raised issues relating to the cross-border aspects of the proposal. The Commission has received other letters that, while not specifically referencing proposed Regulation SBSR, raised cross-border issues that are germane to proposed Regulation SBSR. [865] In response to these comments—which are described further herein—and upon further consideration of issues related to cross-border security-based swap transactions across all of the various areas of Title VII, the Commission is proposing various modifications to proposed Regulation SBSR, particularly Rule 908 thereof, which address cross-border transactions.

One significant modification being proposed here would take into account situations in which a U.S. person, although not a “direct counterparty,” as defined below, to a security-based swap, guarantees the performance of one of the direct counterparties. As discussed above, [866] the Commission is proposing to apply various Title VII provisions to the security-based swap transactions of non-U.S. persons that are guaranteed by U.S. persons—including the regulatory reporting and public dissemination requirements of Regulation SBSR, as discussed below. [867] A second significant modification is to propose a “substituted compliance” regime. As explained in more detail below, the Commission is now proposing a framework that would allow certain Title VII requirements to be satisfied by compliance with the rules of a foreign jurisdiction rather than the specific requirements under U.S. rules. Below, the Commission describes the circumstances under which compliance with the rules of such a foreign jurisdiction could, under re-proposed Regulation SBSR, be “substituted” for compliance with the specific regulatory reporting and public dissemination requirements of Regulation SBSR. [868]

A number of new definitions are being added to re-proposed Rule 900 in light of the changes being proposed. [869] For example, new paragraph (g) of Rule 900 would define the term “counterparty” to mean “a person that is a direct counterparty or indirect counterparty of a security-based swap.” A direct counterparty would be “a person that enters directly with another person into a contract that constitutes a security-based swap.” An indirect counterparty would be “a person that guarantees the performance of a direct counterparty to a security-based swap or that otherwise provides recourse to the other side for the failure of the direct counterparty to perform any obligation under the security-based swap.” Although a guarantor is not a direct counterparty to the security-based swap, the duties to be performed under the security-based swap, and thus the risks associated with the security-based swap, ultimately fall to the guarantor. [870] Therefore, the Commission preliminarily believes that it is appropriate to deem a guarantor to be a counterparty to the security-based swap for purposes of the regulatory reporting requirements of Title VII and the rules proposed thereunder. As discussed in detail below, the concept of “reporting party” used in Regulation SBSR as initially proposed would be replaced by the newly proposed term “reporting side,” to reflect the fact that reporting obligations could attach to both direct and indirect counterparties. [871]

The Commission has received and continues to consider comments on the Regulation SBSR Proposing Release that address areas other than those relating to cross-border security-based swap activity. In this release, the Commission is re-proposing only changes relating to cross-border security-based swap activity, technical and conforming changes necessitated by these larger revisions, and certain other minor changes that would help to clarify these re-proposed revisions (such as numbering each definition in re-proposed Rule 900, so that each defined term can more readily be identified). Changes to Regulation SBSR in other areas could, if appropriate, be addressed in a future release. [872]

Regulation SBSR, as re-proposed today, represents the Commission's preliminary views regarding the application of Title VII's provisions relating to regulatory reporting and public dissemination of cross-border security-based swap transactions, and how those provisions would apply to non-U.S. persons who act in capacities regulated under the Dodd-Frank Act. The Commission invites comment regarding all aspects of the approaches taken by the Commission and each provision of re-proposed Regulation SBSR, including potential alternative approaches. In particular, data and comment from market participants and other interested parties regarding the likely effect of each re-proposed rule regarding application of a specific Title VII requirement, the effect of such proposed application in the aggregate, and potential alternative approaches will be particularly useful to the Commission in evaluating possible modifications to re-proposed Regulation SBSR.

B. Modifications to the Definition of “U.S. Person”

Rule 900 of re-proposed Regulation SBSR contains a revised definition of “U.S. person.” As initially proposed, “U.S. person” was defined as “a natural person that is a U.S. citizen or U.S. resident or a legal person that is organized under the corporate laws of any part of the United States or has its principal place of business in the United States.” Two persons who commented specifically on the Regulation SBSR proposal [873] argued that “U.S. person” as used in the Commission's Title VII rules should have the same definition as in Regulation S. [874]

Proposed Regulation SBSR was the only one of the Commission's proposals for implementing Title VII to propose to use and define the term “U.S. person.” Because the Commission is now addressing cross-border issues across multiple Title VII rules, the Commission has given further thought to the definition of “U.S. person” as initially proposed in Regulation SBSR. The Commission now believes that using a single definition of “U.S. person” in all Title VII rulemaking would promote consistency and transparency in understanding and complying with these various rules. However, as described above, [875] the Commission preliminarily believes that the Regulation S definition of “U.S. person” is not appropriate for Title VII rules. Proposed Rule 900(pp) would define “U.S. person” to have the same meaning as in proposed Rule 3a71-3(a)(7) under the Exchange Act. [876]

Under both the proposed and re-proposed definitions of “U.S. person,” a natural person resident in the United States would be a U.S. person, as would a legal person that is organized or incorporated under the laws of the United States or having its principal place of business in the United States. Furthermore, under both definitions, a foreign branch of a U.S. person would not be recognized as having an existence separate from the U.S. person. [877] The proposed rule also would cover partnerships, trusts, and other legal persons, as set forth in proposed Rule 3a71-3(a)(7) under the Exchange Act. The re-proposed definition of “U.S. person” also would clarify certain situations that were not specifically addressed in the initial proposal. For example, the initially proposed definition of “U.S. person” did not address whether—and, if so, when—an account would be considered a U.S. person. The re-proposed definition would provide that an account, whether discretionary or non-discretionary, of a U.S. person would be a U.S. person.

New paragraph (q) of re-proposed Rule 900 would define the term “non-U.S. person” as a person that is not a U.S. person.

Request for Comment

The Commission requests comment on all aspects of the re-proposed definition of “U.S. person” in Regulation SBSR. In particular:

  • Should the definition of “U.S. person” in Regulation SBSR be consistent with that proposed for the Commission's other Title VII rules? Why or why not? If so, what should that definition be and why? Would having a different definition of “U.S. person” in Regulation SBSR create ambiguity or conflict with other Title VII rules being issued by the Commission? If not, why not?

C. Additional Modifications to Scope of Regulation SBSR

1. Revisions to Proposed Rule 908(a)

Rule 908(a), as initially proposed, provided that a security-based swap would be subject to regulatory reporting and public dissemination under Regulation SBSR if the security-based swap: (i) Has at least one counterparty that is a U.S. person; (ii) is executed in the United States or through any means of interstate commerce; or (iii) is cleared through a registered clearing agency having its principal place of business in the United States. Thus, Rule 908(a), as originally proposed, would not impose reporting or public dissemination requirements in connection with a security-based swap solely because the obligations of one of the direct counterparties is guaranteed by a U.S. person. As noted above, the re-proposed definition of “U.S. person”—like the initially proposed definition—would not treat a direct counterparty that is guaranteed by a U.S. person as itself, solely due to the existence of the guarantee, a U.S. person. However, as noted below, the Commission is concerned about instances where—because of a guarantee extended by a U.S. person—the risk of a transaction resides in the United States, even if the direct counterparties of the transaction are domiciled outside the United States. Thus, upon further consideration, the Commission is now proposing to apply Title VII's regulatory reporting requirements to security-based swaps having at least one counterparty, whether direct or indirect, that is a U.S. person.

Guarantees provided by U.S. persons to their foreign affiliates or other non-U.S. persons could have the effect of concentrating significant risks within the United States that may rise to the systemic level. If a U.S. person guarantees the performance of a non-U.S. person, the financial resources of that U.S. person could be called upon to satisfy the contract. This activity is capable of posing risks to the stability of the U.S. financial system. The Commission preliminarily believes that, if it does not require regulatory reporting of security-based swaps that are guaranteed by U.S. persons, in addition to security-based swaps having a U.S. person direct counterparty, the Commission and other federal financial regulators would be less likely to detect the build-up of potentially significant risks within individual institutions or more widespread systemic risks to the U.S. financial system. The Dodd-Frank Act is intended to promote the financial stability of the United States by, among other things, reducing risks to the U.S. financial system by allowing regulators better access to necessary market data. [878]

In addition, the Commission is now proposing to require regulatory reporting of all security-based swaps entered into by non-U.S. person security-based swap dealers and major security-based swaps participants, wherever they may be executed. [879] This is a change from how the initial proposal applied to a security-based swap executed by a non-U.S. person security-based swap dealer or major security-based swap participant. Under the initial proposal, such a security-based swap would not be required to be reported solely based on an entity's status as a security-based swap dealer or major security-based swap participant, unless the security-based swap was executed in the United States or through any means of interstate commerce, or was cleared by a clearing agency having its principal place of business in the United States.

A non-U.S. person security-based swap dealer or major security-based swap participant generally would be subject to all rules applicable to security-based swap dealers or major security-based swaps participants, regardless of its principal place of business or where it is organized. [880] Having access to all of the security-based swap transactions entered into by a security-based swap dealer or major security-based swap participant is an important aspect of understanding its compliance with the applicable Title VII requirements, including without limitation, compliance with the capital, margin, and other applicable entity-level and transaction-level requirements. The Commission notes that Section 15F(f)(1)(a) of the Exchange Act provides that each registered security-based swap dealer and major security-based swap participant shall make such reports as are required by the Commission, by rule or regulation, regarding the transactions and financial condition of the registered security-based swap dealer or major security-based swap participant. [881] Therefore, the Commission is now proposing to require that all security-based swaps of all security-based swap dealers and major security-based swap participants, regardless of where such security-based swaps are executed or where these entities have their principal place of business or are organized, be subject to regulatory reporting to a registered SDR. [882]

To reflect these changes and to reincorporate other provisions that are not being substantially revised, the Commission is re-proposing Rule 908(a) as follows. The rule would be divided into two subparagraphs, (1) and (2), which would address regulatory reporting and public dissemination, respectively. Specifically, re-proposed Rule 908(a)(1) would provide that a security-based swap transaction would be subject to regulatory reporting if:

(i) The security-based swap is a transaction conducted within the United States;

(ii) There is a direct or indirect counterparty that is a U.S. person on either side of the transaction;

(iii) There is a direct or indirect counterparty that is a security-based swap dealer or major security-based swap participant on either side of the transaction; or

(iv) The security-based swap is cleared through a clearing agency having its principal place of business in the United States.

Re-proposed Rule 908(a)(1)(i) would preserve the principle from the original proposal that a security-based swap would be subject to regulatory reporting if it is executed in the United States. [883] As noted above, [884] the concept of a security-based swap transaction being solicited, negotiated, executed, or booked in the United States has been integrated into the new term “transaction conducted within the United States,” which also is being used in other Title VII proposals of the Commission. Proposed Rule 3a71-3(a)(5) under the Exchange Act would define “transaction conducted within the United States” as “a security-based swap transaction that is solicited, negotiated, executed, or booked within the United States, by or on behalf of either counterparty to the transaction, regardless of the location, domicile, or residence status of either counterparty to the transaction.” [885]

The Commission received no comments that specifically addressed our use of the phrase “through any means of interstate commerce” in three places in Regulation SBSR, as initially proposed. [886] However, upon further consideration, the Commission is concerned that this language could unduly require a security-based swap to be reported if it had only the slightest connection with the United States. Therefore, the Commission has decided to delete the phrase “through any means of interstate commerce” from re-proposed Regulation SBSR. Instead, the Commission is proposing to require reporting of a security-based swap that falls within the definition of “transaction conducted within the United States,” which would describe more precisely the nature of the activities in the United States that could result in a security-based swap becoming subject to Regulation SBSR. The Commission generally believes that security-based swaps that are solicited, negotiated, executed, or booked within the United States—by or on behalf of either counterparty to the transaction, and regardless of the location, domicile, or residence status of either counterparty to the transaction—generally should be subject to Regulation SBSR.

Re-proposed Rule 908(a)(1)(ii)—which would require regulatory reporting of any security-based swap if there is a direct or indirect counterparty that is a U.S. person on either side of the transaction—embodies the principle in the initial proposal that a security-based swap, wherever executed, must be reported if it has at least one counterparty that is a U.S. person. This revised prong, however, also would apply the reporting requirement to any security-based swap, wherever executed, that has at least one indirect counterparty [887] that is a U.S. person, even when no direct counterparty is a U.S. person. The original proposal, because it did not include guarantors as counterparties, would not have required regulatory reporting in such case. As discussed above, the Commission now preliminarily believes that—to satisfy Congressional intent that security-based swaps be subject to regulatory reporting, thereby informing the Commission and other financial regulators of potential systemic risks—any security-based swap having at least one direct counterparty that is a U.S. person should be reported. The Commission also preliminarily believes that, because guarantees extended by U.S. persons create risk to the U.S. financial system, regulatory reporting of security-based swaps should extend to any security-based swap transaction in which one or both direct counterparties is guaranteed by a U.S. person. In the absence of regulatory reporting of such security-based swaps, the Commission's ability to detect and analyze potentially significant sources of risk to the U.S. financial system could be limited.

Re-proposed Rule 908(a)(1)(iii) would, for reasons described above, require regulatory reporting of any security-based swap executed by a security-based swap dealer or major security-based swap participant, regardless of the entity's place of domicile and regardless of the place of execution.

Re-proposed Rule 908(a)(1)(iv) would preserve the principle from the original proposal that a security-based swap would be subject to regulatory reporting if it is cleared through a clearing agency having its principal place of business in the United States. [888] As noted in the Regulation SBSR Proposing Release, the Commission preliminarily believes that, if a security-based swap is cleared by a clearing agency having its principal place of business in the United States, U.S. regulators should have access to information regarding the security-based swap through a registered SDR. [889] This approach is premised on the view that, when a security-based swap is cleared through a clearing agency, the initial transaction is novated and two new transactions take its place, with the clearing agency becoming the seller to the buyer and the buyer to the seller. If the clearing agency is located within the United States, the new transactions necessarily would be executed within the United States. [890]

While subparagraph (1) of re-proposed Rule 908(a) would address when a security-based swap would be subject to regulatory reporting, subparagraph (2) would address when a security-based swap would be subject to public dissemination. Re-proposed Rule 908(a)(2) would provide that a security-based swap shall be subject to public dissemination if:

(i) The security-based swap is a transaction conducted within the United States;

(ii) There is a direct or indirect counterparty that is a U.S. person on each side of the transaction;

(iii) At least one direct counterparty is a U.S. person (except in the case of a transaction conducted through a foreign branch [891] );

(iv) One side includes a U.S. person and the other side includes a non-U.S. person that is a security-based swap dealer; or

(v) The security-based swap is cleared through a clearing agency having its principal place of business in the United States.

The Commission notes that Section 13(m)(1)(B) of the Exchange Act [892] “authorize[s] the Commission to make security-based swap transaction and pricing data available to the public in such form and at such times as the Commission determines appropriate to enhance price discovery.” Re-proposed Rule 908(a)(2) reflects the Commission's revised preliminary determination regarding an appropriate way to enhance price discovery in the U.S. market for security-based swaps. As noted below, since issuing the Regulation SBSR Proposing Release, the Commission has obtained and analyzed more extensive data regarding the overlap between the U.S. market and the global market for security-based swaps. [893] These data suggest that a vast majority of security-based swap transactions directly involved at least one non-U.S. domiciled counterparty. [894] Furthermore, these transactions frequently may be conducted with one direct counterparty located in one jurisdiction with the other direct counterparty located in another jurisdiction, further suggesting that no easy distinction can be made between the U.S. market and foreign or global markets. The Commission is concerned that limiting the application of Title VII's public dissemination requirement only to transactions that are wholly conducted within the United States or to transactions where both direct counterparties are U.S. persons would significantly reduce the potential benefits of post-trade transparency in the security-based swap market. The Commission stated in the Regulation SBSR Proposing Release that, “[b]y reducing information asymmetries, post-trade transparency has the potential to lower transaction costs, improve confidence in the market, encourage participation by a larger number of market participants, and increase liquidity in the [security-based swap] market.” [895] The Commission also noted that, “[i]n other markets, greater post-trade transparency has increased competition among market participants and reduced transaction costs.” [896]

Re-proposed Rule 908(a)(2) eliminates use of the term `interstate commerce” and instead incorporates the new concept of “transaction conducted within the United States,” which is being used throughout the Commission's proposed Title VII cross-border rules, to help delineate precisely the types of security-based swap transactions that would be subject to public dissemination under Regulation SBSR. Furthermore, re-proposed Rule 908(a)(2) is designed to achieve the goal of improving the transparency, fairness, and efficiency of the U.S. security-based swap market, as reflected in Section 13(m)(1)(B) of the Exchange Act. Re-proposed Rule 908(a)(2) also is designed, as far as practicable, to minimize competitive disparities that might result under the proposed public dissemination regime, as well as to minimize incentives for market participants to structure their operations for the purpose of evading Regulation SBSR. [897] Each individual subparagraph of re-proposed Rule 908(a)(2) is discussed below.

Re-proposed Rule 908(a)(2)(i), similar to re-proposed Rule 908(a)(1)(i), generally would preserve the principle from the original proposal that a security-based swap would be subject to public dissemination if it were executed in the United States. [898] That concept has been integrated into the new term “transaction conducted within the United States,” which also is being used in the Commission's other Title VII proposals.

Re-proposed Rule 908(a)(2)(ii) would provide that a security-based swap would be subject to public dissemination if there is a direct or indirect counterparty that is a U.S. person on each side of the transaction. Under the initial proposal, a security-based swap involving two non-U.S. person direct counterparties, but where each direct counterparty is guaranteed by a U.S. person, would not be required to be publicly disseminated. The Commission now preliminarily believes that, where U.S. persons have an interest on both sides of the transaction, even if indirectly, the transaction generally should be viewed as part of the U.S. security-based swap market and, as such, should be subject to Title VII's public dissemination requirement. Moreover, to the extent that U.S. persons might be incented to structure their trading operations through guaranteed foreign subsidiaries to avoid public dissemination that otherwise would apply to trades executed between U.S. person direct counterparties, the Commission seeks to minimize that incentive by re-proposing Rule 908(a)(2)(ii) to require public dissemination of a security-based swap transaction if a U.S. person is present on each side, whether directly or indirectly.

Re-proposed Rule 908(a)(2)(iii) would provide that a security-based swap would be subject to public dissemination if at least one direct counterparty is a U.S. person (except in the case of a transaction conducted through a foreign branch [899] ). This prong generally reincorporates the original proposal's approach that a security-based swap executed anywhere in the world and having just one U.S. person counterparty would be subject to public dissemination. The Commission generally believes that a security-based swap transaction having even just one U.S. person direct counterparty generally should be viewed as part of the U.S. security-based swap market and, as such, should be subject to Title VII's public dissemination requirement. The Commission preliminarily believes that the benefits of requiring public dissemination of all security-based swaps involving at least one U.S. person direct counterparty would inure to other U.S. persons that transact in the same or similar instruments.

However, re-proposed Rule 908(a)(2)(iii) would provide a limited exception to the general rule that any transaction involving a U.S. person direct counterparty would be subject to public dissemination; re-proposed Rule 908(a)(2)(iii) would not apply if the transaction is conducted through a foreign branch. [900] The Commission is concerned that, if it did not take this approach, non-U.S. market participants might avoid entering into security-based swaps with the foreign branches of U.S. banks so as to avoid their security-based swaps being publicly disseminated. The Commission notes that registration with the local regulatory authority to engage in banking business is inherent in the proposed definition of “foreign branch.” This approach would restrict the proposed exception to public dissemination for transactions conducted through a foreign branch. [901] The Commission further notes that the proposed exclusion for transactions conducted through a foreign branch is equivalent to the proposed approach for transactions conducted by foreign affiliates that are guaranteed by a U.S. person. In the case of a security-based swap transaction executed outside the United States between a non-U.S. person and either the guaranteed foreign affiliate or the foreign branch of the U.S. bank, re-proposed Rule 908(a)(2) would not require public dissemination of the transaction. Re-proposed Rule 908(a)(2)(iii) would not require public dissemination if the transaction were conducted through a foreign branch. Re-proposed Rule 908(a)(2)(ii) would not require public dissemination if the only U.S. person involved in the transaction were the U.S. person providing the guarantee.

Re-proposed Rule 908(a)(2)(iv) would provide that a security-based swap would be subject to public dissemination if one side includes a U.S. person and the other side includes a non-U.S. person that is a security-based swap dealer, as defined in Section 3(a)(71) of the Exchange Act and the rules and regulations thereunder. The Commission notes that re-proposed Rule 908(a)(2)(ii) would require public dissemination of a transaction if both sides include a U.S. person. Under re-proposed Rule 908(a)(2)(iv), however, public dissemination would be required when only one side includes a U.S. person, provided the other side includes a non-U.S. person security-based swap dealer. The Commission preliminarily believes that both types of transaction generally should be considered part of the U.S. security-based swap market and, as such, should be subject to Title VII's public dissemination requirement. As the Commission has previously stated, post-trade transparency of security-based swap transactions would reduce information asymmetries and could have the potential to lower transaction costs, improve confidence in the market, encourage participation by a larger number of market participants, and increase liquidity in the security-based swap market. [902] Post-trade transparency of security-based swap transactions also has the potential to improve valuation models and thereby contribute to more efficient capital allocation. [903] The Commission preliminarily believes that not subjecting transactions between U.S. persons (whether directly or indirectly) or between a U.S. person and a non-U.S. person security-based swap dealer to post-trade transparency would undermine these goals. The fact that both sides of the transaction include a U.S. person, or that one side includes a U.S. person and the other side includes a person that conducts enough U.S. business to warrant requiring it to register with the Commission, suggests that they are engaging in the types of transactions that might be engaged in by other U.S. persons or others who are required to register with the Commission. Furthermore, in the absence of re-proposed Rule 908(a)(2)(iv), a non-U.S. person security-based swap dealer could encourage foreign affiliates that are guaranteed by a U.S. parent to transact business with it outside the United States in order to evade the public dissemination requirement. [904] If re-proposed Rule 908(a)(2)(iv) applied, all transactions between a security-based swap dealer (regardless of whether it is a U.S. person) and a U.S. person (whether as a direct or indirect counterparty), would be required to be publicly disseminated, regardless of where such transactions are conducted. Finally, the Commission notes that Section 13(m)(1)(D) of the Exchange Act gives the Commission authority to require registered entities—such as security-based swap dealers—regardless of whether or not they are U.S. persons, to publicly disseminate security-based swap transaction and pricing data.

However, the Commission notes that re-proposed Rule 908(a)(2) would not require public dissemination of a security-based swap transacted outside the United States between two non-U.S. persons that are security-based swap dealers (assuming that neither side is guaranteed by a U.S. person). Non-U.S. person security-based swap dealers are likely to have significant operations in foreign security-based swap markets. A transaction between two such non-U.S. person security-based swap dealers conducted outside the United States is less likely than a transaction conducted within the United States or a transaction involving a U.S. person on the other side to affect the U.S. security-based swap market. Therefore, the Commission is not proposing to require public dissemination of transactions conducted outside the United States between two non-U.S. person security-based swap dealers.

Re-proposed Rule 908(a)(2)(v) would preserve the principle from the original proposal that a security-based swap would be subject to public dissemination if it is cleared through a clearing agency having its principal place of business in the United States. [905] As noted in the Regulation SBSR Proposing Release, the Commission preliminarily believes that, if non-U.S. persons determined to clear a security-based swap transaction through a clearing agency having its principal place of business in the United States, this suggests that the clearing agency has made the security-based swap eligible for clearing because at least some U.S. counterparties might wish to trade the security-based swap as well. [906] The Commission preliminarily believes, therefore, that requiring public dissemination of the security-based swap transaction would promote price discovery for market participants in the United States and elsewhere. [907]

A security-based swap transaction would need to meet only one prong of re-proposed Rule 908(a)(2) to trigger the public dissemination requirement. For example, assume a security-based swap is solicited, negotiated, executed, and cleared in London between (A) the London branch of a U.S. financial institution and (B) a London-based firm (i.e., a non-U.S. person) that has registered with the Commission as a security-based swap dealer. Re-proposed Rule 908(a)(2)(i) would not apply, because the transaction is not conducted within the United States. Re-proposed Rule 908(a)(2)(v) would not apply, because the security-based swap is not cleared in the United States. Re-proposed Rule 908(a)(2)(ii) would not apply, because there is not a direct or indirect counterparty that is a U.S. person on both sides of the transaction. Re-proposed Rule 908(a)(2)(iii) would not apply because neither side includes a direct counterparty that is a U.S. person that would trigger public dissemination; here, the U.S. person direct counterparty is acting through a foreign branch, which is carved out of re-proposed Rule 908(a)(2)(iii). However, this transaction would be subject to public dissemination under re-proposed Rule 908(a)(2)(iv): one side includes a U.S. person (in this case, the London branch of the U.S. bank) and the other side includes a non-U.S. person security-based swap dealer. The result would be the same if, instead of a London branch of a U.S. financial institution, one of the direct counterparties were the London-based affiliate of a U.S. person that guarantees the performance of the London subsidiary (i.e., the transaction is between, on one side, a security-based swap dealer and, on the other side, an indirect counterparty that is a U.S. person).

Request for Comment

The Commission requests comment on all aspects of the re-proposed Rule 908(a), including the following:

  • Do you agree with the approach taken in re-proposed Rule 908(a) that a security-based swap should be subject to regulatory reporting and public dissemination regardless of the nationality or place of domicile of the counterparties if it is a transaction conducted in the United States? Why or why not? Do you agree with the Commission's use of the term “transaction conducted within the United States” in re-proposed Rule 908? Why or why not?
  • Do you agree with the approach taken in re-proposed Rule 908(a) that a security-based swap cleared through a clearing agency having its principal place of business in the United States should be subject to the regulatory reporting and public dissemination requirements? Why or why not?
  • Do you agree with the Commission's general approach of treating guarantors as counterparties for purposes of security-based swap trade reporting requirements? Why or why not? Do you believe that a security-based swap should be subject to regulatory reporting solely because one side includes a guarantor that is a U.S. person? Why or why not? Would the Commission's ability to exercise prudential and regulatory oversight of the securities markets be compromised if it did not have the ability to learn about all security-based swap positions held by U.S. persons, including guarantors? Why or why not?
  • Do you believe that a security-based swap should be subject to regulatory reporting solely because one side includes a security-based swap dealer or major security-based swap participant, regardless of the nationality or place of domicile of that entity? Why or why not? Would the Commission's ability to exercise prudential and regulatory oversight of entities registered with it be compromised if it did not have the ability to learn about all security-based swap positions held by such entities? Why or why not?
  • In general, do you agree with how re-proposed Rule 908(a) would apply to security-based swaps entered into by non-U.S. person security-based swap dealers and major security-based swap participants? Why or why not?
  • Do you agree with the requirement, in re-proposed Rule 908(a)(2)(ii), that a security-based swap should be subject to public dissemination if there is a direct or indirect counterparty that is a U.S. person on each side of the transaction? Why or why not? What would be the benefits of requiring public dissemination in this scenario? What would be the costs? Please be specific.
  • Do you agree with the requirement, in re-proposed Rule 908(a)(2)(iii), that a security-based swap should be subject to public dissemination if at least one direct counterparty is a U.S. person, even if the transaction is not conducted within the United States? Why or why not? What would be the benefits of requiring public dissemination in this scenario? What would be the costs? Please be specific. Do you agree with the exception to this general rule for transactions conducted through a foreign branch of a U.S. person? Why or why not? Should the exception be limited to foreign branches? Why or why not? Are there any alternatives that the Commission should consider? If so, what are they?
  • Do you agree with the requirement, in re-proposed Rule 908(a)(2)(iv), that would provide that a security-based swap, even if not a transaction conducted within the United States, would be subject to public dissemination if one side includes a U.S. person and the other side includes a non-U.S. person security-based swap dealer? Why or why not? What would be the benefits of requiring public dissemination in this scenario? What would be the costs? Please be specific.
  • Should the Commission require public dissemination of security-based swaps cleared by any clearing agency registered with the Commission, even if its principal place of business is outside the United States? Why or why not?
  • In general, do you agree the distinctions drawn in the scenarios set forth in re-proposed Rule 908(a) regarding which security-based swaps would be subject to the regulatory reporting and public dissemination? Why or why not?

2. Revisions to Proposed Rule 908(b)

In the initial proposal, the Commission explained when duties would be imposed on non-U.S. person counterparties of security-based swaps when some connection to the United States might be present. Rule 908(b), as initially proposed, provided that no duties would be imposed on a counterparty unless one of the following conditions were true:

  • The counterparty is a U.S. person;
  • The security-based swap is executed in the United States or through any means of interstate commerce; or
  • The security-based swap is cleared through a clearing agency having its principal place of business in the United States.

Under the initial proposal, if none of these conditions were true, a foreign counterparty “would not become a `participant' of an SDR and would not become subject to proposed Regulation SBSR” [908] —even if the security-based swap itself and its counterparty were subject to Regulation SBSR.

In light of other revisions being made to Regulation SBSR discussed above, the Commission is now proposing several conforming revisions to proposed Rule 908(b). First, consistent with the other revisions described above, Rule 908(b) is being re-proposed to account for the possibility that a non-U.S. person security-based swap dealer or major security-based swap participant could incur a duty to report. Second, consistent with the broader conceptual framework set forth in this release, the “interstate commerce clause,” used in the initial proposal to describe a security-based swap that may generate reporting duties for counterparties under Regulation SBSR, [909] is being replaced with the new concept of a “transaction conducted within the United States” that is being used throughout the Commission's proposed cross-border rules. [910] Therefore, re-proposed Rule 908(b) would provide that a direct or indirect counterparty to a security-based swap would not incur any obligation under Regulation SBSR unless the counterparty were:

  • A U.S. person;
  • A security-based swap dealer or major security-based swap participant; or
  • A counterparty to a transaction conducted within the United States. [911]

Request for Comment

The Commission requests comment on all aspects of the re-proposed Rule 908(b), including the following:

  • Do you agree with the removal of the “interstate commerce clause” contained in Rules 908(a)(2) and 908(b)(2), as originally proposed, and its replacement with the new concept of “transaction conducted within the United States”? Does this new concept provide additional clarity? If not, what alternative formulations of the concept should the Commission consider, and why? Please be specific.

D. Modifications to “Reporting Party” Rules and Assigning Duty To Report

The Commission also is re-proposing aspects of Regulation SBSR that would specify who must report the security-based swap. Rule 900, as initially proposed, would define “reporting party” as “the counterparty to a security-based swap with the duty to report information in accordance with [Regulation SBSR] to a registered security-based swap data repository, or if there is no registered security-based swap data repository that would receive the information, to the Commission.” Because the Commission is now proposing to extend the reporting requirement to security-based swaps executed outside the United States if the performance of one or both direct counterparties under the security-based swap is guaranteed by a U.S. person, [912] the Commission also is re-proposing the rules that would assign the duty to report in a number of ways. Overall, these revisions are designed to assign the responsibility to report a security-based swap transaction to persons that the Commission preliminarily believes have greater capacity to fulfill that responsibility, and in a manner consistent with the reporting hierarchy set forth in Section 13A(a)(3) of the Exchange Act. [913]

First, the Commission is revising the proposed term “reporting party” to “reporting side.” A “side” would be defined in new paragraph (ee) of re-proposed Rule 900 to mean “a direct counterparty and any indirect counterparty.” “Reporting side” would be defined as “the side of a security-based swap having the duty to report information in accordance with §§ 242.900-911 to a registered security-based swap data repository, or if there is no registered security-based swap data repository that would receive the information, to the Commission.” Under this formulation, if a side has the duty to report a security-based swap transaction, any counterparty on that side—direct or indirect—would have responsibility for carrying out the reporting obligation. The Commission preliminarily believes that it would be impractical and unnecessarily complicated to attempt to assign the reporting duty to either the direct or indirect counterparty specifically, and is instead proposing to assign the duty to the side jointly. [914]

Furthermore, the Commission is revising our proposed approach to assigning the reporting duty to minimize consideration of the domicile of the counterparties, and to focus more on their status (i.e., whether or not a counterparty is a security-based swap dealer or major security-based swap participant). The initial proposal laid out three scenarios for assigning the reporting duty: Both direct counterparties are U.S. persons, only one direct counterparty is a U.S. person, and neither direct counterparty is a U.S. person. [915] The definition of “U.S. person”—as proposed and re-proposed—does not include a security-based swap dealer or major security-based swap participant that is organized under the laws of a foreign jurisdiction and has its principal place of business outside the United States, even though it is a security-based swap dealer or major security-based swap participant under Title VII. Thus, under the initial proposal, for a security-based swap between (A) an end user or other counterparty that is a U.S. person and is not a security-based swap dealer or major security-based swap participant (a “non-registered U.S. counterparty”) and (B) a security-based swap dealer or major security-based swap participant that is a non-U.S. person, the non-registered U.S. counterparty would have been the reporting party.

Several commenters argued that this requirement would unfairly place the reporting burden on the non-registered U.S. counterparty. These commenters generally argued that, due to their status as security-based swap dealers and major security-based swap participants, even security-based swap dealers and major security-based swap participants that are not U.S. persons have greater technological capability than non-registered U.S. counterparties to carry out the reporting function. [916] These commenters generally maintained that non-registered U.S. counterparties would incur significant costs to build the systems necessary to report security-based swaps. [917] Certain commenters noted the unequal treatment and potential consequences that could result if non-registered U.S. counterparties incurred the reporting obligation for security-based swaps that they entered into with non-U.S. security-based swap dealers and non-U.S. major security-based swap participants. [918] One commenter specifically recommended that security-based swap dealers and major security-based swap participants that are not U.S. persons be subject to the same regulatory reporting responsibilities as security-based swap dealers and major security-based swap participants that are U.S. persons, when transacting with non-registered U.S. counterparties. [919]

The Commission generally agrees with these arguments. The Commission preliminarily believes that non-U.S. person security-based swap dealers and major security-based swap participants, like U.S. person security-based swap dealers and major security-based swap participants, have greater technological capability than non-registered U.S. persons to carry out the reporting function. Furthermore, the Commission preliminarily sees no reason not to assign the duty to report to non-U.S. person security-based swap dealers and major security-based swap participants in appropriate circumstances. Although such entities are not U.S. persons, the fact that they are security-based swap dealers and major security-based swap participants necessarily implies that they have substantial contacts with the U.S. security-based swap market and thus could incur significant regulatory duties arising from their U.S. business. Accordingly, the Commission is re-proposing Rule 901(a) to provide that a security-based swap dealer or major security-based swap participant that is not a U.S. person could incur the duty to report a security-based swap in various cases. Re-proposed Rule 901(a) now provides as follows:

  • If both sides of the security-based swap include a security-based swap dealer, the sides would be required to select the reporting side.
  • If only one side of the security-based swap includes a security-based swap dealer, that side would be the reporting side.
  • If both sides of the security-based swap include a major security-based swap participant, the sides would be required to select the reporting side.
  • If one side of the security-based swap includes a major security-based swap participant and the other side includes neither a security-based swap dealer nor a major security-based swap participant, the side including the major security-based swap participant would be reporting side.
  • If neither side of the security-based swap includes a security-based swap dealer or major security-based swap participant: (i) if both sides include a U.S. person or neither side includes a U.S. person, the sides would be required to select the reporting side; and (ii) if only one side includes a U.S. person, that side would be the reporting side.

Re-proposed Rule 901(a)(2) would preserve the reporting hierarchy of proposed Rule 901(a), while additionally taking into account the possibility that a direct counterparty to a security-based swap might have a guarantor that is better suited for carrying out the reporting duty. Thus, the newly proposed approach set forth in re-proposed Rule 901(a) looks to the status of each person on a side (i.e., whether it is a security-based swap dealer or major security-based swap participant), not the status of only the direct counterparties. Under the initial proposal, if a non-U.S. person were a direct counterparty to a security-based swap executed outside the United States, that non-U.S. person would under no circumstances have had a duty to report the security-based swap, even if it were guaranteed by a U.S. person or if it were a security-based swap dealer or major security-based swap participant. The Commission is now proposing to refocus the reporting duty primarily on the status of the counterparties, rather than on their nationality or place of domicile.

Under re-proposed Rule 901(a), the only time that the domicile of the counterparties could determine who must report is if neither side includes a security-based swap dealer or major security-based swap participant. In such case, if one side includes a U.S. person while the other side does not, the side with the U.S. person would be the reporting side. Similar to the initial proposal, however, if both sides include a U.S. person or neither side includes a U.S. person, the sides would be required to select the reporting side.

These proposed revisions to Regulation SBSR are designed to more efficiently align the duty to report with the entities that the Commission preliminarily believes are best suited to carrying out that duty. The Commission has previously noted that it “understands that many reporting parties already have established linkages to entities that may register as SDRs, which could significantly reduce the out-of-pocket costs associated with establishing the reporting function.” [920] These proposed revisions also are designed to minimize the burdens faced by non-registered U.S. counterparties that might enter into security-based swaps with non-U.S. person security-based swap dealers or major security-based swap participants, as well as to clarify and simplify the reporting rules more generally.

The following examples explain the operation of re-proposed Rule 901(a).

  • Example 1. A non-registered U.S. counterparty executes a security-based swap with a security-based swap dealer that is a non-U.S. person. Neither side has a guarantor. The security-based swap dealer would be the reporting side.
  • Example 2. Same facts as Example 1, except that the non-registered U.S. counterparty is guaranteed by a security-based swap dealer. Because both sides include a person that is a security-based swap dealer, the sides would be required to select which is the reporting side.
  • Example 3. A security-based swap is executed in London between a foreign subsidiary of a U.S. person and a French hedge fund. The performance of the foreign subsidiary is guaranteed by its U.S. parent, a major security-based swap participant. The side consisting of the major security-based swap participant and its foreign subsidiary would be the reporting side.
  • Example 4. The New York branch of a German bank executes, in New York, a security-based swap with the New York branch of a Brazilian bank. Neither foreign bank is a security-based swap dealer or a major security-based swap participant and neither direct counterparty is guaranteed by a U.S. person. The sides must select which would be the reporting side.
  • Example 5. A U.S. hedge fund executes a security-based swap in London with a foreign bank that is registered as a dealer in its home jurisdiction, but is not a security-based swap dealer or major security-based swap participant under Title VII. Neither direct counterparty is guaranteed by a U.S. person. The U.S. hedge fund would be the reporting side, because its side includes the only U.S. person.

Request for Comment

The Commission generally requests comment on all aspects of issues regarding cross-border inter-affiliate transactions, including the following:

  • Do you agree with the proposed definitions for “counterparty,” “direct counterparty,” and “indirect counterparty”? Why or why not?
  • Do you agree with the new proposed definitions of “side” and “reporting side”? Why or why not? If you disagree with these proposed definitions, what alternative formulations should the Commission consider, and why?
  • Do you believe that the re-proposed provisions would appropriately reduce the potential reporting burdens of non-registered U.S. counterparties? Why or why not?
  • Do you agree with the shifting of reporting burdens as detailed in re-proposed Rule 901(a)? Why or why not? Do you believe it is appropriate to require a security-based swap dealer or major security-based swap participant that is not a U.S. person to incur the duty to report a security-based swap? Why or why not?
  • Should re-proposed Rule 901(a) focus only on the status of the direct counterparties (i.e., whether or not they are security-based swap dealers or major security-based swap participants) rather than also taking into account the status of any indirect counterparties? Why or why not?
  • Do you agree, as provided in re-proposed Rule 901(a), that the domicile of the counterparties should determine who must report only if neither side includes a security-based swap dealer or major security-based swap participant? Why or why not?
  • Do you believe that Rule 901(a), as re-proposed, would more efficiently align the burdens of reporting with the entities having the greatest technological capability to carry out the reporting function? If not, how could the Commission more efficiently align the burdens of reporting with the operational capabilities of security-based swap counterparties? Please be specific.
  • Are the examples provided sufficiently clear to inform entities of their reporting obligations? Would additional examples be helpful? If so, please provide specific examples that should be addressed by the Commission.

E. Other Technical and Conforming Changes

In connection with the new provisions of re-proposed Regulation SBSR discussed above, the Commission is proposing to make various minor technical and conforming changes to other parts of the regulation. These changes are described below.

Rule 902(a), as initially proposed, would require a registered SDRs to publicly disseminate a transaction report of any security-based swap immediately upon receipt of information about the security-based swap, except in the case of a block trade. Re-proposed Rule 908, however, contemplates situations where a security-based swap would be required to be reported to a registered SDR but not publicly disseminated. [921] Therefore, the Commission is re-proposing Rule 902(a) to provide that a registered SDR would not have an obligation to publicly disseminate a transaction report for any such security-based swap.

Similarly, Rule 910(b)(4), as initially proposed, would provide that, in Phase 4 of the Regulation SBSR compliance schedule, “[a]ll security-based swaps reported to the registered security-based swap data repository shall be subject to real-time public dissemination as specified in § 242.902.” As noted above, under the re-proposal of Rule 908, certain security-based swaps would be subject to regulatory reporting but not public dissemination requirements. Therefore, the Commission is re-proposing Rule 910(b)(4) to provide that, “All security-based swaps received by the registered security-based swap data repository shall be treated in a manner consistent with §§ 242.902, 242.905, and 242.908.” [922]

In addition, the Commission is proposing certain changes to proposed Rules 901(c) and 901(d), which address the data elements to be reported to a registered SDR, to reflect that, under the re-proposal, certain security-based swaps may be subject to regulatory reporting but not public dissemination. Rule 901(c), as initially proposed, was titled “Information to be reported in real time.” Under Rule 902(a), as originally proposed, the registered SDR to which such information was reported would be required to promptly disseminate to the public such information (except in the case of a block trade). However, the Commission preliminarily believes that, if a security-based swap were subject to regulatory reporting but not public dissemination, there is no need to require that information about the security-based swap be reported in real time. Therefore, the introductory language to Rule 901(c) is being re-proposed as follows: “For any security-based swap that must be publicly disseminated pursuant to §§ 242.902 and 242.908 and for which it is the reporting side, the reporting side shall report the following information in real time. If a security-based swap is required by §§ 242.901 and 242.908 to be reported but not publicly disseminated, the reporting side shall report the following information no later than the time that the reporting side is required to comply with paragraph (d) of this section.” In addition, re-proposed Rule 901(c) would be retitled “Primary trade information,” thus eliminating the reference to real-time reporting—since the information required to be reported under Rule 901(c) would no longer in all cases be required to be reported in real time. Furthermore, re-proposed Rule 901(d) would be retitled “Secondary trade information.” [923]

The Commission also is re-proposing Rule 905(b)(2) to clarify that, if a registered SDR receives corrected information relating to a previously submitted transaction report, it would be required to publicly disseminate a corrected transaction report only if the initial security-based swap were subject to public dissemination. [924]

Rule 901(c)(10), as initially proposed, provided that the following data element would be required to be reported: “If both counterparties to a security-based swap are security-based swap dealers, an indication to that effect.” As the Commission stated in the Regulation SBSR Proposing Release: “Prices of transactions involving a dealer and a non-dealer are typically `all-in' prices that include a mark-up or mark-down, while interdealer transaction prices typically do not. Thus, the Commission believes that requiring an indication of whether a [security-based swap] was an interdealer transaction or a transaction between a dealer and a non-dealer counterparty would enhance transparency by allowing market participants to more accurately assess the reported price for a [security-based swap].” [925] The Commission is now re-proposing Rule 901(c)(10) as follows: “If both sides of the security-based swap include a security-based swap dealer, an indication to that effect.” The re-proposed rule would clarify that a security-based swap dealer might be a direct or indirect counterparty to a security-based swap. The Commission continues to believe that, in either case, a security-based swap having a security-based swap dealer on each side could, all other things being equal, be priced differently than a security-based swap having a security-based swap dealer on only one side. Therefore, the Commission continues to believe that the existence of a security-based swap dealer on each side should be reported to the registered SDR and made known to the public.

The Commission is re-proposing Rule 901(d)(1)(ii) to require reporting of the broker ID, desk ID, and trader ID, as applicable, only of the direct counterparty on the reporting side. The Commission preliminarily believes that it would be impractical and unnecessary to report such data elements with respect to an indirect counterparty, as such elements might not be applicable to an indirect counterparty. [926] Similarly, Rule 901(d)(1)(iii) is being re-proposed to require reporting of a description of the terms and contingencies of the payment streams only of each direct counterparty to the other. The Commission is including the word “direct” to avoid extending Rule 901(d)(1)(iii) to indirect counterparty relationships, where payments generally would not flow to or from an indirect counterparty.

Proposed Rule 901(e) set forth provisions for reporting life cycle events of a security-based swap. The basic approach set forth in proposed Rule 901(e) was that, generally, the original reporting party of the initial transaction would have the responsibility to report any subsequent life cycle event; this approach remains unchanged in the re-proposal. However, if the life cycle event were an assignment or novation that removed the original reporting party, either the new counterparty or the original counterparty would have to be the reporting party. Further, Rule 901(e), as initially proposed, would provide that the new counterparty would be the reporting party if it were a U.S. person, whereas the other counterparty would be the new reporting party if the new counterparty were not a U.S. person.

However, as discussed above, the Commission is now proposing the concept of a “reporting side,” which would include the direct and any indirect counterparty. Further, as discussed above, the Commission is proposing that non-U.S. person security-based swap dealers or major security-based swap participants would, in certain instances, incur a duty to report. Thus, the Commission is re-proposing Rule 901(e) to provide that the duty to report would switch to the other side only if the new side did not include a U.S. person (as in the originally proposed rule) or a security-based swap dealer or major security-based swap participant (references to which are being added to Rule 901(e)). The Commission preliminarily believes that, if the new side includes a security-based swap dealer or major security-based swap participant, the new side should retain the duty to report. This approach is designed to align reporting duties with the market participants that the Commission preliminarily believes are better suited to carrying them out because non-U.S. person security-based swap dealers and major security-based swap participants likely have already taken significant steps to establish and maintain the systems, processes and procedures, and staff resources necessary to report security-based swaps currently. [927]

Request for Comment

The Commission generally requests comment on all aspects of all the technical and conforming changes in re-proposed Regulation SBSR, including the following:

  • Do you disagree with any of the technical and conforming changes in the re-proposed rules? If so, why?
  • Do you agree with the proposed change to Rule 902(a) which provides that a registered SDR would not have an obligation to publicly disseminate a transaction report for any security-based swap that is required to be reported but not publically disseminated? Why or why not?
  • Do you agree with the proposed change to Rule 910(b)(4) that would remove the requirement that “[a]ll security-based swaps reported to the registered security-based swap data repository [] be subject to real-time public dissemination as specified in § 242.902” and replace it with the requirement that “[a]ll security-based swaps received by the registered security-based swap data repository [] be treated in a manner consistent with §§ 242.902, 242.905, and 242.908”? Are there any alternative formulations of the re-proposed rule text that the Commission should consider? If so, what are they? Please be specific.
  • Do you agree with the proposed changes to the data elements initially contained in proposed Rules 901(c) and 901(d)? Specifically, do you agree with the reformulation of the introductory language contained in re-proposed Rule 901(c) to reflect situations in which a security-based swap could be subject to regulatory reporting but not public dissemination? Why or why not? Do you agree with the retitling of re-proposed Rule 901(c) to “Primary trade information” to eliminate the reference to real-time reporting? Why or why not?
  • Do you agree with the proposed change to re-proposed Rule 905(b)(2) to clarify that, if a registered SDR receives corrected information relating to a previously submitted transaction report, it would be required to publicly disseminate a corrected transaction report only if the initial security-based swap were subject to public dissemination? Why or why not?
  • Do you agree with the proposed change to re-proposed Rule 901(c)(10) to clarify that a security-based swap dealer might be a direct or indirect counterparty to a security-based swap? Why or why not?
  • Do you agree with the proposed change to re-proposed Rule 901(d)(1)(ii) to require the reporting of the broker ID, desk ID, and trader ID only of the direct counterparty on the reporting side? Why or why not? Similarly, do you agree with the requirement in re-proposed Rule 901(d)(1)(iii) for reporting of a description of the terms and contingencies of the payment streams only of each direct counterparty to the other in order to avoid extending the rule to indirect counterparty relationships? Why or why not?
  • Do you agree with the proposed change to re-proposed Rule 901(e) to provide that the duty to report would switch to the other side only if the new side did not include a U.S. person or a security-based swap dealer or major security-based swap participant? Why or why not?
  • Are there any other technical and conforming changes that the Commission should make to re-proposed Regulation SBSR?

F. Cross-Border Inter-Affiliate Transactions

Commenters raised concerns about applying Title VII reporting or dissemination requirements to cross-border inter-affiliate security-based swaps. [928] One commenter argued that, for a foreign entity registered as a bank holding company and subject to the consolidated supervision of the Federal Reserve, the reporting of inter-affiliate transactions would be superfluous because the Federal Reserve has “ample authority to monitor transactions among affiliates.” [929] The second commenter expressed concern about duplicative or conflicting regulation of inter-affiliate transactions. It stated that, for example, inter-affiliate security-based swaps “could be required to be publicly reported in multiple jurisdictions, even though they are not suitable for reporting in any jurisdiction.” [930] A third commenter argued that inter-affiliate security-based swaps generally—not referencing cross-border inter-affiliate transactions in particular—should not be subject to public dissemination requirements, stating that “public reporting could confuse market participants with irrelevant information and raise the costs to corporate groups of managing risk internally.” [931]

The Commission preliminarily believes that regulatory reporting and public dissemination serve different purposes and, while these two requirements are related, their application to cross-border inter-affiliate transactions should be considered separately. The Commission notes that the statutory provisions that require regulatory reporting and public dissemination of security-based swap transactions state that “each” security-based swap shall be reported; these statutory provisions do not by their terms distinguish such reporting based on particular characteristics (such as being negotiated at arm's length). Section 13A(a)(1) of the Exchange Act [932] provides that each security-based swap that is not accepted for clearing shall be subject to regulatory reporting. Section 13(m)(1)(G) of the Exchange Act [933] provides that each security-based swap (whether cleared or uncleared) shall be reported to a registered SDR, and Section 13(m)(1)(C) of the Exchange Act [934] generally provides that transaction, volume, and pricing data of security-based swaps shall be publicly disseminated. With respect to regulatory reporting of cross-border inter-affiliate security-based swaps, the Commission preliminarily believes that regulators should have ready access to information about the precise legal entities that hold risk positions in all security-based swaps. While it is true that the Federal Reserve or perhaps other regulators might exercise consolidated supervision over a group, this might not provide regulators with current and specific information about security-based swap positions taken by the group's subsidiaries. As a result, it would likely be more difficult for the Commission to conduct general market analysis or surveillance of market behavior, and could create particular problems during a crisis situation when having accurate and timely information about specific risk exposures could be crucial. Therefore, the Commission continues to believe that each cross-border inter-affiliate security-based swap that otherwise satisfies any of the criteria in re-proposed Rule 908(a)(1) should be subject to regulatory reporting.

With respect to public dissemination of cross-border inter-affiliate transaction data, the Commission preliminarily believes that the analysis of this issue in the cross-border context is in many ways similar to the analysis of dissemination of inter-affiliate transaction data in the domestic context. In particular, many of the issues raised by commenters with respect to the public dissemination of inter-affiliate transactions generally appear to be relevant whether a transaction is conducted within the United States or conducted on a cross-border basis. These general issues include a concern about information distortion, market confusion, and interference with internal risk management of a corporate group.

First, commenters stated that inter-affiliate transactions—whether cross-border or not—are typically risk transfers with no market impact. They believe that the market-facing transactions already would have been publicly reported, so requiring that inter-affiliate transactions also be publically reported would duplicate information already known to the public. The commenters express the concern that such “double counting” would distort information that is critical for price discovery and measuring liquidity, the depth of trading, and exposure to swaps in the market. [935] They also believe that it would distort the establishment of regulatory thresholds and analysis, as well as enforcement activities that require an accurate assessment of the swaps market. [936]

Second, commenters stated that affiliates often enter into an inter-affiliate transaction on terms linked to an external trade being hedged, which they are concerned could create confusion in the market if publicly reported. If markets move because of the external trade before the inter-affiliate transaction is entered into on a SEF or reported as an off-exchange trade, market participants could misconstrue the market's true direction and depth simply because of the disconnect in timing between the two offsetting trades. [937]

Third, commenters stated that public dissemination of inter-affiliate transactions could interfere with the internal risk management practices of a corporate group. For example, one entity in a group may be better positioned to take on a certain type of risk, even though another entity must, for unrelated reasons, actually enter into the transaction with an external counterparty. Public disclosure of a transaction between affiliates could prompt other market participants to act in a way that would prevent the corporate group from following through with its risk management strategy by, for instance, causing adverse price movements in the market that the risk-carrying affiliate would use to hedge. [938]

Beyond these concerns regarding the public dissemination of inter-affiliate transactions, commenters addressing the public reporting of cross-border inter-affiliate transactions focused more generally on duplicative and conflicting regulations. Using public dissemination as an example, one commenter stated that inter-affiliate security-based swaps “could be required to be publicly reported in multiple jurisdictions, even though they are not suitable for reporting in any jurisdiction.” [939] However, the Commission is not aware of any commenter proposing a treatment of cross-border inter-affiliate transactions under public dissemination requirements that differs substantively from proposals for the treatment of other inter-affiliate transactions.

The Commission has considered the issues raised by these commenters both with respect to inter-affiliate transactions generally and in the cross-border context. The common thread of the issues identified by commenters to date is that public dissemination should not be required for a security-based swap that is undertaken to transfer the risk of an initial security-based swap (between X and Y) to an affiliate (i.e., from X to XA) because it would have no price discovery value or could even give market observers a false understanding of the nature of the transaction. [940] The Commission acknowledges that the initial security-based swap between X and Y likely would have more price discovery value than the subsequent inter-affiliate transaction between X to XA, all else being equal. In this hypothetical, the initial transaction presumably represents the mutual agreement of parties operating on an arm's-length basis to execute a trade at a particular price, while the latter transaction generally would not involve negotiation of the terms, particularly as regards to price. It may not follow, however, that the subsequent inter-affiliate transaction would have no price discovery value whatsoever, particularly in a cross-border context where multiple public dissemination requirements may be involved. Arguing that an inter-affiliate security-based swap has no price discovery value appears to presuppose that the initial, arm's-length security-based swap had been publicly disseminated. This could be the case if the initial security-based swap were subject to the rules of a jurisdiction having public dissemination requirements. [941] However, if the initial security-based swap had not been publicly disseminated, public dissemination of the cross-border inter-affiliate transaction, assuming it were subject to Rule 908(a)(2) of re-proposed Regulation SBSR, [942] might be the only way for the market to obtain any pricing information about the series of transactions. These circumstances could be present if the initial security-based swap were not subject to the rules of a jurisdiction having public dissemination requirements. In this case, public dissemination of the cross-border inter-affiliate transaction, assuming it were subject to Rule 908(a)(2) of re-proposed Regulation SBSR, [943] might be the only way for the market to obtain any pricing information about the series of transactions.

As described above, commenters also raised a general concern about the potential for duplicative and conflicting regulation of cross-border inter-affiliate transactions. The Commission is sensitive to these concerns both generally and in the context of public dissemination. [944] The treatment of these issues in connection with public dissemination is not dissimilar to their treatment in other contexts under Title VII, including the context of regulatory reporting. Accordingly, the Commission preliminarily believes that the concern expressed by the commenters should be addressed by the proposed substituted compliance policy and framework discussed in detail below, as well as when the Commission considers the adopting release for public dissemination, which the Commission anticipates will address the issue of dissemination of inter-affiliate transactions. [945]

In light of these considerations, the Commission preliminarily believes that cross-border inter-affiliate security-based swaps should not be excluded from the public dissemination requirements to the extent that inter-affiliate security-based swaps are not excluded as a general matter. The Commission preliminarily believes that the considerations regarding whether or not to exclude inter-affiliate cross-border security-based swaps from public dissemination on the grounds that they could be misleading or have no price discovery value are similar to the considerations regarding whether or not to exclude inter-affiliate security-based swaps generally. Similarly, the Commission preliminarily believes that any steps short of exclusion that could be taken to maximize the price discovery value that inter-affiliate cross-border security-based swaps may have (while minimizing any concern that they might mislead the market) are similar to the steps that could be taken with respect to inter-affiliate security-based swaps generally. Although the Commission is not in this release re-proposing any provisions of Regulation SBSR regarding the public dissemination of inter-affiliate security- based swaps generally (whether or not cross-border), [946] as previously stated, the Commission invites public comment on whether there are specific concerns or reasons to support different treatment or analysis of public dissemination of cross-border inter-affiliate transactions from the treatment or analysis of the same issue in the domestic context, and, in particular, why cross-border inter-affiliate transactions may not be suitable for public dissemination.

For example, the concerns about the potentially limited price discovery value of inter-affiliate security-based swaps may be able to be addressed through the public dissemination of relevant data that may be indicative of such limitations, rather than suppressing these transactions entirely. In the Regulation SBSR Proposing Release, the Commission proposed to require a registered SDR to “publicly disseminate a transaction report of a security-based swap immediately upon receipt of information about the security-based swap from a reporting party.” [947] As the Commission noted in the Regulation SBSR Proposing Release, “[t]he transaction report that is disseminated would be required to consist of all the information reported by the reporting party pursuant to proposed Rule 901(c).” [948] One of the data elements enumerated in proposed Rule 901(c) would be “[i]f applicable, an indication that the transaction does not accurately reflect the market.” [949] Such data element should send a message to the market that the transaction was not conducted at arm's length on the open market. [950] Market participants could take such information into account when interpreting or analyzing the publicly-disseminated inter-affiliate transaction pricing information.

As noted above, one commenter expressed concern that public dissemination of an inter-affiliate transaction could interfere with the internal risk management of a corporate group by causing adverse price movements in the market that the risk-carrying affiliate might use to hedge. The commenter did not explain why the corporate group might be unable or might choose not to hedge the risk when the initial transaction is executed, or why the impact of the public dissemination of the subsequent inter-affiliate transaction might be different from the impact of the public dissemination of the initial transaction. The Commission preliminarily believes that, assuming that the corporate group does not hedge at the time the initial transaction was executed, a concern about the potential impact of public dissemination of the inter-affiliate transaction on the ability to hedge the position would be similar to the concern that commenters have expressed generally about public dissemination of block trades. [951] This concern about a potential impact of the public dissemination—either of the original transaction or the subsequent inter-affiliate transaction—may be addressed by delayed dissemination instead of suppressing dissemination of these transactions entirely. The broader issue of how to treat block trades, including how to define what is a block trade, is one that the Commission continues to evaluate. In addition, public dissemination of relevant data indicating the inter-affiliate nature of the transaction separately may help address concerns about potential impact on markets on which a hedge might if occur if such markets are made aware that there may be special considerations that should be taken into account when assessing the extent to which the transaction may reflect the current market.

Regulation SBSR would require registered SDRs, in their policies and procedures, to enumerate the specific data elements of a security-based swap or life cycle event that would be required to be reported, and to specify one or more acceptable data formats, connectivity requirements, and other protocols for submitting information. [952] The Commission itself did not propose to specify each data element that would have to be reported, but instead identified broad categories of information that must be reported. [953] Furthermore, the Commission initially proposed to require, in Rule 907(a)(4), that a registered SDR have policies and procedures “[d]escribing how reporting parties shall report and, consistent with the enhancement of price discovery, how the registered security-based swap data repository shall publicly disseminate . . . security-based swap transactions that do not involve an opportunity to negotiate any material terms, other than the counterparty; and any other security-based swap transactions that, in the estimation of the registered security-based swap data repository, do not accurately reflect the market.” [954] However, the Commission invites public comment on whether concerns about the inter-affiliate security-based swaps not accurately reflecting the market can be addressed in the policies and procedures of registered SDRs that would be required under re-proposed Rule 907(a)(4).

For example, such policies and procedures could be designed to maximize the price discovery value of cross-border (or other) inter-affiliate security-based swaps and to minimize their ability to mislead. These policies and procedures could require not only that reporting sides mark whether a security-based swap is an inter-affiliate transaction, but also whether the initial security-based swap was executed in a jurisdiction with public dissemination requirements. [955] Further, these policies and procedures also could require the reporting side to indicate the approximate time when the initial security-based swap was executed. [956] This would permit market observers to gauge how much price discovery value to assign to the price provided in the inter-affiliate security-based swap transaction report that would be publicly disseminated under Rule 902 of re-proposed Regulation SBSR. Information about an initial trade done less than 24 hours before (obtained indirectly from the later-appearing trade report of the inter-affiliate cross-border security-based swap) could have significant price discovery value, while information from an initial trade executed over a week before could, all things being equal, have less. [957] The Commission invites public comment on these approaches to the treatment of inter-affiliate security-based swaps generally, as well as their relative advantages and disadvantages. In particular, the Commission invites public comment on how these approaches would affect the internal risk management practices of a corporate group. In addition, as previously stated, the Commission invites public comment on whether there are specific concerns or reasons to support different treatment or analysis of public dissemination of cross-border inter-affiliate transactions from the treatment or analysis of the same issue in the domestic context.

Request for Comment

The Commission generally requests comment on all aspects of issues regarding cross-border inter-affiliate security-based swaps, including the following:

  • Do you believe that cross-border inter-affiliate security-based swaps should be excluded from the regulatory reporting requirements of Regulation SBSR? If so, under what circumstances should such security-based swaps be excluded, and why? What would be the harm of having such inter-affiliate security-based swaps reported to a registered SDR? What are the risks of not requiring regulatory reporting of inter-affiliate security-based swaps?
  • Do you believe that cross-border inter-affiliate security-based swaps should be analyzed differently from domestic inter-affiliate security-based swaps? Why or why not?
  • Do you believe that cross-border inter-affiliate security-based swaps should be excluded from the public dissemination requirements of Regulation SBSR? Why or why not? What are the risks or benefits of not requiring public dissemination of inter-affiliate security-based swaps? How should the Commission balance these risks and benefits?
  • Does your view about public dissemination for cross-border inter-affiliate security-based swaps change depending on whether an initial, arm's-length security-based swap was executed and publicly disseminated in a jurisdiction having public dissemination requirements? Why or why not? On what basis could or should the Commission exclude the cross-border inter-affiliate security-based swap from the public dissemination requirements if the initial, arm's-length security-based swap was executed and publicly disseminated in a jurisdiction having no public dissemination requirements, or public dissemination requirements that are not comparable to those in the United States?
  • Does your view on the application of regulatory reporting and public dissemination requirements to inter-affiliate security-based swaps change if the affiliates are subject to consolidated supervision? If so, please explain.
  • Can you suggest any additions to the policies and procedures of registered SDRs that could maximize the price discovery value, and minimize any potentially misleading aspects, of public trade reports of cross-border inter-affiliate security-based swaps? If so, what are they? Should the Commission more clearly specify in Rule 907(a)(4) how inter-affiliate security-based swaps should be publicly disseminated so as to maximize their price discovery value and minimize their potential for misleading market observers? If so, how?
  • Do you have any other concerns about public dissemination of cross-border inter-affiliate security-based swaps so long as they are appropriately marked?

G. Foreign Privacy Laws Versus Duty To Report Counterparty ID

Rule 901(d), as initially proposed, set forth the data elements that would constitute the required regulatory report of a security-based swap (i.e., information for use only by regulators that would not be included in the publicly disseminated report). One such element is the “participant ID” of the counterparty. [958] The Title VII provisions relating to security-based swap trade reporting and proposed Regulation SBSR that would implement those provisions contemplate only one counterparty to a security-based swap having a duty to report. However, the Commission preliminarily believes that being able to assess the positions and behavior of both counterparties to the security-based swap would facilitate our ability to carry out our regulatory duties for market oversight. [959] Because only one party would be required to report, the only way to obtain the identity of the non-reporting party counterparty would be to require the reporting party to disclose its counterparty's identity. [960]

Three comments on proposed Regulation SBSR cautioned that U.S. persons may be restricted from complying with such a requirement in cases where a security-based swap is executed outside the United States. [961] One commenter stated that the London branch of a U.S. person would need its counterparty's consent to identify that party under U.K. law. [962] The commenter added that, under French law, consent is required each time a report is made identifying the counterparty, and this restriction cannot be resolved by changes to the firm's terms of business. [963] Another commenter urged the Commission to “consider carefully and provide for consistency with, foreign privacy laws, some of which carry criminal penalties for wrongful disclosure of information,” [964] but did not provide further detail. A third commenter argued that allowing substituted compliance when both parties are not domiciled in the United States could avoid problems with foreign privacy laws conflicting with U.S. reporting requirements. [965]

The Commission seeks to understand more precisely if—and, if so, how—requiring a counterparty to report the transaction pursuant to Regulation SBSR (including disclosure of the counterparty's identity to a registered SDR) might cause it to violate local law in a foreign jurisdiction where it operates. Before determining whether any exception to reporting the counterparty's identity might be necessary or appropriate, the Commission seeks to obtain additional information about any such foreign privacy laws.

Request for Comment

The Commission generally requests comment on all aspects of issues relating to foreign privacy laws with respect to proposed Regulation SBSR, including the following:

  • What jurisdictions have laws that might affect a reporting side's ability to report the participant ID of its counterparty? Please cite and describe specifically for each such law: To whom such restrictions would apply and under what circumstances; how the law might restrict reporting (e.g., what data elements that otherwise would be required to be reported under Regulation SBSR would be restricted); whether any exceptions under the law, particularly but not limited to consent provisions and provisions relating to compliance with applicable law, might be available to a reporting side that otherwise would be required to comply with re-proposed Rule 901(d)(1)(i), or explain why none of the exceptions would be available.
  • If no such exceptions are available under the local law and you believe that an exception by rule from re-proposed Rule 901(d)(1)(i) would be appropriate, how should that exception be crafted? Please suggest appropriate rule text.
  • How, if at all, would a substituted compliance regime for regulatory reporting avoid problems with foreign privacy laws? Would the Commission and other U.S. financial regulators be able to obtain information about security-based swap counterparties from foreign trade repositories or foreign regulatory authorities to which such transactions had been reported?

H. Foreign Public Sector Financial Institutions

Six commenters expressed concern about applying the requirements of Title VII to the activities of FPSFIs, such as foreign central banks and multilateral development banks. [966] One commenter, the European Central Bank (“ECB”), noted that security-based swaps entered into by the Federal Reserve Banks are excluded from the CEA's definition of “swap” [967] and that the functions of foreign central banks and the Federal Reserve are broadly comparable. The ECB argued, therefore, that security-based swaps entered into by foreign central banks should likewise be excluded from the definition of “swap.” [968] A second commenter, the World Bank (representing the International Bank for Reconstruction and Development, the International Finance Corporation, and other multilateral development institutions of which the United States is a member) also argued generally that the term “swap” should be defined to exclude any transaction involving a multilateral development bank. [969] The World Bank further noted that the EMIR—which is intended to serve as the E.U. counterpart to Title VII of the Dodd-Frank Act—would expressly exclude multilateral development banks from its coverage. [970]

The ECB and BIS stated that foreign central banks enter into security-based swaps solely in connection with their public mandates, which require them to act confidentially in certain circumstances. [971] The ECB argued in particular that public disclosure of its market activities could compromise its ability to take necessary actions and “could cause signaling effects to other market players and finally hinder the policy objectives of such actions.” [972] Another commenter, the Council of Europe Development Banks (“CEB”), while opposing application of Title VII requirements to multilateral development banks generally, did not object to the CFTC and SEC preserving their authority over certain aspects of swaps activity, including reporting requirements. [973] Similarly, the World Bank believed that the definition of “swap” could be qualified by a requirement that counterparties would treat such transactions as swaps solely for reporting purposes. [974]

The Commission preliminarily believes that security-based swaps to which an FPSFI is a counterparty (“FPSFI trades”) should not, for that fact alone, be exempt from regulatory reporting. [975] Under Regulation SBSR, as initially proposed, an FPSFI trade would be required to be reported to a registered SDR if the counterparty were a U.S. person. The Commission continues to believe that, if an FPSFI executes a security-based swap with a counterparty that is a U.S. person, the security-based swap should be subject to regulatory reporting. Under re-proposed Regulation SBSR, an FPSFI trade also would be required to be reported if the counterparty were a non-U.S. person security-based swap dealer or major security-based swap participant. In either case, without a regulatory report of such security-based swaps, the Commission would have an incomplete view of the risk positions held by security-based swap market participants that are U.S. persons or registered with the Commission. Regulatory reporting of such security-based swaps, despite the fact that an FPSFI is a counterparty, would facilitate the Commission's ability to carry out our regulatory oversight responsibilities with respect to registered entities and the security-based swap market. The Commission notes that this approach was endorsed by two commenters. [976]

Furthermore, the Commission believes that, at this time, a sufficient basis does not exist to support an exemption from public dissemination for FPSFI trades. The Commission preliminarily understands that FPSFI participation in the security-based swap market—rather than the swap market generally—may be limited. Comments submitted by FPSFIs generally were addressed to both the Commission and the CFTC and addressed participation in the swap market generally; it is unclear the extent to which these comments should be read to apply to the security-based swap market. [977] Furthermore, to the extent that FPSFI trades are subject to public dissemination under Regulation SBSR (e.g., because the direct counterparty is a U.S. person other than a foreign branch of a U.S. bank), such trades could provide useful price discovery information to other market participants.

The Commission is seeking more information with respect to the basis for the claim that public dissemination of FPSFI trades, as contemplated by re-proposed Regulation SBSR, would “hinder the policy objectives” [978] of FPSFIs. The Commission notes that proposed Regulation SBSR contains provisions relating to public dissemination that are designed to protect the identity of security-based swap counterparties [979] and prohibit a registered SDR (with respect to uncleared security-based swaps) from disclosing the business transactions and market positions of any person. [980] Furthermore, to the extent that an FPSFI trade is small enough not to constitute a block trade, the Commission questions the extent to which market observers would be able to distinguish the trade as having been conducted by an FPSFI. Given these provisions of Regulation SBSR, which are designed to prevent adverse market impacts due to disclosure of a counterparty's identity or the public dissemination of a block trade, the Commission preliminarily does not see a basis to exempt FPSFI trades from public dissemination. However, the Commission is open to receiving further information that might support an exemption.

Request for Comment

As noted above, certain FPSFI commenters stated that carrying out their policy mandates would require confidentiality in certain circumstances. [981] The Commission seeks additional information to assist our analysis of this issue, and requests answers to the following questions. In responding, please focus on the security-based swap market, not the market for other swaps. In addition, commenters are requested to answer only with respect to security-based swap activity that would be subject to Regulation SBSR, and not with respect to activity that, because of the place where the transaction is conducted or the nationality of the counterparties, would not be subject to Regulation SBSR in any case:

  • How many FPSFIs engage in security-based swap activity with U.S. persons? How active are they in the security-based swap market generally?
  • What policy goals might an FPSFI be attempting to carry out by participating in the security-based swap market?
  • What trading strategies might an FPSFI conduct in the security-based swap market?
  • Are there any characteristics of FPSFI activity in the security-based swap market that could make it easier for market observers to detect an FPSFI as a counterparty, or that could make it easier to detect an FPSFI's business transactions or market positions? If so, are there steps the Commission could take to minimize such information leakage short of suppressing all FPSFI trades from public dissemination? If so, what are they?
  • Do FPSFIs typically trade standardized or more bespoke security-based swap instruments? If the former, would market observers be less likely to detect the participation of an FPSFI in the security-based swap market?
  • What sizes do FPSFIs typically transact in? Does the size impact any concerns with publicly disseminating FPSFI trades? If so, how? Could the concerns of FPSFIs be addressed by crafting appropriate block thresholds and dissemination delays rather than by suppressing all FPSFI trades from public dissemination? Why or why not?
  • Do you believe that FPSFI trades should be included in public dissemination? Why or why not? To what extent, and how, would price transparency and market efficiency be affected if FPSFI trades were suppressed from public dissemination?

I. Summary and Additional Request for Comment

The provisions of re-proposed Regulation SBSR discussed above represent the Commission's preliminary views regarding the application of Title VII's provisions relating to regulatory reporting and public dissemination of security-based swap transactions in the cross-border context. This re-proposal reflects a particular balancing of the principles and applicable requirements described above, [982] informed by, among other things, the particular nature of the security-based swap market, the structure of security-based swap dealing activity, and the Commission's experience in applying the federal securities laws in the cross-border context. The Commission recognizes that other approaches are possible and might more effectively achieve the goals of the Dodd-Frank Act, in whole or in part. Accordingly, the Commission invites comment regarding all aspects of re-proposed Regulation SBSR, and each re-proposed rule contained therein, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of each re-proposed rule and potential alternative approaches will be particularly useful to the Commission in evaluating possible modifications to the proposals.

The Commission requests comment on any other cross-border issues relating to regulatory reporting and public dissemination of security-based swaps that may not have been addressed above. In particular, the Commission requests comment on how the Commission's re-proposal addressing cross-border issues related to regulatory reporting and public dissemination might differ from the CFTC's cross-border guidance on these matters. [983] For example, the CFTC Cross-Border Proposal provides that a swap between two unregistered non-U.S. persons, each of which is guaranteed by a U.S. person, would not be subject to regulatory reporting or public dissemination requirements. [984] The Commission, on the other hand, is proposing that a security-based swap between two such direct counterparties would be subject to both regulatory reporting and public dissemination requirements. [985] Furthermore, the CFTC Cross-Border Proposal provides that a swap between, on one side, an unregistered non-U.S. person that is guaranteed by a U.S. person and, on the other side, an unregistered non-U.S. person that is not guaranteed by a U.S. person also would not be subject to regulatory reporting or public dissemination requirements. [986] The Commission is proposing that a security-based swap between two such direct counterparties would be subject to regulatory reporting [987] (but, in accord with the CFTC's proposal, not subject to public dissemination). Please describe any other differences that you believe might exist and what would be the impact of any such differences.

In addition, the Commission requests comment on the market impact of the approach to re-proposed Regulation SBSR. For example, how would the application of re-proposed Regulation SBSR affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would re-proposed Regulation SBSR place any market participants at a competitive disadvantage or advantage? If so, please explain. Would re-proposed Regulation SBSR be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement re-proposed Regulation SBSR?

IX. Mandatory Security-Based Swap Clearing Requirement Back to Top

A. Introduction

Section 3C(a)(1) of the Exchange Act provides that it “shall be unlawful for any person to engage in a security-based swap unless that person submits such security-based swap for clearing to a clearing agency that is registered under [the Exchange] Act or a clearing agency that is exempt from registration under [the Exchange] Act if the security-based swap is required to be cleared.” [988] In this section, we are proposing a rule to specify when persons engaging in cross-border security-based swap transactions would be required to comply with a mandatory clearing determination. [989] Consistent with the approach we have taken elsewhere in this release, [990] the proposed rule is designed in general to help ensure that the mandatory clearing requirement applies to persons that engage in security-based swap transactions within the United States and who may pose financial or operational risk to the U.S. financial system that may be mitigated by requiring transactions to be centrally cleared. [991] The proposed rule also is designed to help avoid limiting the access of U.S. persons that conduct security-based swap activity through foreign branches or guaranteed non-U.S. persons to foreign security-based swap markets. To address concerns regarding the clearance and settlement of security-based swaps subject to the mandatory clearing requirement, as well as the potential for conflicting mandatory clearing requirements in different jurisdictions, we discuss under what circumstances the Commission would permit substituted compliance with the mandatory clearing requirement in Section XI.E below. [992]

Our proposed approach reflects a particular balancing of the principles discussed above. [993] We recognize that other approaches may achieve the goals of the Dodd-Frank Act and Section 17A of the Exchange Act, in whole or in part. Accordingly, we invite comment regarding all aspects of the proposed rule described here, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of the proposed rule and of potential alternative approaches will be particularly useful to the Commission in evaluating potential modifications to the proposal.

B. Summary of Comments

The Commission has published several rulemaking proposals under Title VII of the Dodd-Frank Act that relate to clearing security-based swaps. [994] The Commission solicited public comment on each of these proposals. The Commission also solicited public comment on regulatory initiatives under the Dodd-Frank Act related to clearing security-based swaps. [995] Generally, these commenters requested that the Commission take actions to limit duplicative or conflicting regulations with respect to clearing security-based swaps. [996]

Two commenters highlighted the global nature of the security-based swap market and raised concerns about the possible effect of foreign regulations on U.S. participants in the security-based swap market. [997] These commenters requested that U.S. and foreign regulators identify possible areas where rulemaking may overlap or conflict and actively coordinate to harmonize both the substance of related regulations and the timing of their implementation. [998] The commenters argued that, without such coordination, “the development of the swap markets will be vulnerable to false starts, significant revisions and inefficiencies, and possible regulatory arbitrage across, or the flight to, other jurisdictions.” [999]

Commenters representing several foreign banks requested that the Commission adopt implementing regulations under the Dodd-Frank Act “that enable and encourage foreign banks engaged in swap dealing activities to book their swaps businesses in a single well-capitalized, highly rated foreign-based banking institution.” [1000] These commenters did not comment specifically on the proposed rules, but rather argued in favor of a regulatory framework that relies on home country supervision where regulations operate at the entity level, and that relies on Title VII of the Dodd-Frank Act with respect to “U.S. swap transactions,” where regulations operate at the transaction level. [1001] In particular, these entities believe that the mandatory clearing requirement should not apply to “foreign swap transactions” (i.e., transactions they defined as not involving a U.S. counterparty) or, more broadly, to transactions that a counterparty thereto is required to submit for clearing pursuant to foreign law. [1002]

Commenters representing foreign financial institutions submitted a second, supplemental comment letter to elaborate on the above comments. [1003] In this letter, these commenters requested that the Commission modify the proposed definition of “security-based swap dealer” to make clear that “a security-based swap which is required to be cleared under foreign law (including by virtue of the fact that any counterparty thereto is required under foreign law to submit the same for clearing) is not required to be cleared under the [Dodd-Frank] Act.” [1004]

Moreover, commenters representing Japan's three largest bank groups requested that the Commission “adopt implementing regulations under the Dodd-Frank Act with the effect that Japanese banks, including their U.S. branches, are not made subject to the application of Title VII requirements.” [1005] Should the Commission not take such action, these commenters requested that the regulations issued pursuant to Title VII: (i) Not apply to transactions between affiliates of a bank group regulated as a bank holding company [1006] and (ii) not apply to “a foreign dealer”—particularly one that is “subject to comprehensive home country regulation”—with respect to transactions entered into by the foreign dealer with a U.S.-based dealer regulated as a swap dealer or security-based swap dealer pursuant to Title VII. [1007]

In addition, multiple commenters endorsed the use of mandatory clearing generally to further the goals of the Dodd-Frank Act. One commenter described mandatory clearing as “the centerpiece of reform embodied in Title VII of the Dodd-Frank Act” that, accordingly, should be subject to “only a very few, narrow, and limited exceptions.” [1008] Another commenter similarly urged the Commission to “prioritize the finalization and implementation of clearing-related rules.” [1009] Another stated that the Commission's “top priority should be to implement requirements that reduce systemic risk, such as the use of centralized Swap clearinghouses.” [1010]

C. Application of Title VII Mandatory Clearing Requirements to Cross-Border Transactions

1. Statutory Framework

By its terms, the mandatory clearing requirement in Section 3C(a)(1) of the Exchange Act applies to any person that “engage[s] in a security-based swap . . . if the security-based swap is required to be cleared.” [1011] We are proposing to apply the statutory language “engage in a security-based swap” to mean any transaction in which a U.S. person is a counterparty [1012] to a security-based swap or guarantees the performance of a non-U.S. person under a security-based swap because of the involvement of a U.S. person in the transaction. [1013] We also are proposing to apply the statutory language “engage in a security-based swap” to include any transaction in which a person performs any of the activities that are key stages in a security-based swap transaction (i.e., solicitation, negotiation, execution, or booking of the transaction) [1014] within the United States. As we noted above, a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5), includes soliciting, negotiating, executing, or booking a security-based swap transaction. [1015] Accordingly, subject to certain statutory exceptions [1016] and certain other exceptions described below, [1017] we are proposing to apply the mandatory clearing requirement to any person that engages in a security-based swap transaction in which at least one of the counterparties to the transaction is a U.S. person or a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person, or if the transaction is a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. [1018]

We preliminarily believe our proposed approach to the mandatory clearing requirement, including the interpretation of the statutory language discussed above and further discussed below, is consistent with the purposes of the mandatory clearing requirement in Section 3C(a)(1) of the Exchange Act. The Dodd-Frank Act is intended to promote the financial stability of the United States by, among other things, reducing risks to the U.S. financial system by ensuring that, whenever possible and appropriate, derivatives contracts are centrally cleared rather than traded exclusively in the OTC market. [1019] In making our mandatory clearing determination, the Commission is required to take into account certain factors, including, among other things, “the availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure” in clearing agencies to support clearing of the product in question, and “the effect on the mitigation of systemic risk.” [1020] The Commission preliminarily believes that the proposed approach generally would help to ensure that the goals of the Dodd-Frank Act to increase the use of available centralized market infrastructures to reduce operational risks and mitigate systemic risk are achieved, [1021] while not unnecessarily limiting the access of U.S. persons that conduct security-based swap activity through foreign branches or guaranteed non-U.S. persons to foreign security-based swap markets.

2. Proposed Rule

In light of the interpretation of the statutory language “engage in a security-based swap” and the policy concerns discussed above, we are proposing a rule that would apply the mandatory clearing requirement to a person that engages in a security-based swap transaction if a counterparty to the transaction is (i) a U.S. person or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person. [1022] We also are proposing a rule that would apply the mandatory clearing requirement to a person that engages in a security-based swap transaction if such transaction is a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. [1023] To limit the scope of the proposal, we are proposing exceptions to the mandatory clearing requirement in the following two scenarios:

  • If the security-based swap transaction is not a “transaction conducted within the United States,” the proposed rule would not apply the mandatory clearing requirement if one counterparty to the transaction is (i) a foreign branch of a U.S. bank [1024] or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person, [1025] and if the other counterparty to the transaction is a non-U.S. person (i) whose performance under the security-based swap is not guaranteed by a U.S. person and (ii) who is not a foreign security-based swap dealer. [1026]
  • If the security-based swap transaction is a “transaction conducted within the United States,” the proposed rule would not apply the mandatory clearing requirement if (i) neither counterparty to the transaction is a U.S. person; (ii) neither counterparty's performance under the security-based swap is guaranteed by a U.S. person; and (iii) neither counterparty to the transaction is a foreign security-based swap dealer. [1027]

We discuss below the proposed rule regarding the application of the mandatory clearing requirement in more detail.

3. Discussion

(a) Security-Based Swap Transactions Involving U.S. Persons or Non-U.S. Persons Receiving Guarantees From U.S. Persons

i. Proposed Rule

The proposed rule would apply the mandatory clearing requirement in Section 3C(a)(1) of the Exchange Act, and the rules and regulations thereunder, to a person that engages in a security-based swap transaction if a counterparty to the transaction is (i) a U.S. person or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person, [1028] subject to certain exceptions. [1029]

As discussed above, [1030] a U.S. person that is a counterparty to a security-based swap transaction bears the ongoing risk of the transaction. It is the financial resources of that U.S. person that will be called upon in performing any obligations pursuant to that transaction, and this activity is capable of posing risks to the stability of the U.S. financial system. Because these obligations and risks reside in the United States, the Commission preliminarily believes that when a U.S. person is a counterparty to a security-based swap transaction, such person necessarily engages in a security-based swap within the United States and, therefore, would be subject to the mandatory clearing requirement in Section 3C(a)(1) of the Exchange Act and the rules and regulations thereunder.

In the case of a non-U.S. person guaranteed by a U.S. person (“U.S. guarantor”), the guarantee provides the counterparty of the guaranteed entity direct recourse to the U.S. guarantor with respect to any obligations owed by the guaranteed entity under the security-based swap, and the U.S. guarantor exposes itself to the security-based swap risk as if it were a direct counterparty [1031] to the security-based swap through the security-based swap activity engaged in by the guaranteed entity. In many cases, the counterparty would not enter into the transaction (or would not do so on the same terms) with the guaranteed entity, and the guaranteed entity would not be able to engage in any security-based swaps, without the guarantee. Given the reliance by both the guaranteed entity and its counterparty on the creditworthiness of the guarantor in the course of engaging in security-based swap transactions and for the duration of the transaction, we preliminarily believe that a security-based swap transaction in which one of the counterparties is a non-U.S. person whose performance under a security-based swap is guaranteed by a U.S. person is a transaction that is engaged in within the United States by virtue of the involvement of the U.S. guarantor in the security-based swap. [1032] Our proposed rule, therefore, would subject transactions involving at least one counterparty whose performance under the security-based swap is guaranteed by a U.S. person to the mandatory clearing requirement, [1033] subject to certain exceptions discussed below. [1034]

We recognize that this proposed approach would subject certain security-based swap transactions with non-U.S. persons to the mandatory clearing requirement if a U.S. person is a counterparty to the transaction (e.g., U.S. dealer to foreign dealer transactions). We preliminarily believe that such an approach is appropriate, as a significant proportion of the risk borne by U.S. persons, and, therefore, the risk to the U.S. financial system as a result of the U.S. persons' security-based swap activity, arises from transactions entered into with non-U.S. persons. [1035] Even where a U.S person's security-based swap activity occurs in part outside the United States (e.g., the transaction is negotiated or executed outside the United States), this activity may pose risk to the U.S. financial system because security-based swap transactions give rise to ongoing obligations on the part of the U.S. person and credit risk exposures to its non-U.S. counterparties. Therefore, subjecting a transaction in which a U.S. person is a counterparty to the transaction to the mandatory clearing requirement would further the purposes of Title VII by ensuring that security-based swaps involving persons whose security-based swap activities create risk that Title VII is intended to address would be centrally cleared through a CCP. [1036]

ii. Proposed Exception for Certain Transactions Involving Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons

The Commission is proposing an exception from the mandatory clearing requirement described above for certain transactions that involve foreign branches of a U.S. bank or guaranteed non-U.S. persons, provided the transactions are not conducted within the United States. Specifically, under the proposed rule, the mandatory clearing requirement would not apply to a security-based swap transaction if one counterparty to the transaction is a foreign branch of a U.S. bank [1037] or a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person and if the other counterparty to the transaction is a non-U.S. person (i) whose performance under the security-based swap is not guaranteed by a U.S. person and (ii) who is not a foreign security-based swap dealer. [1038] Such exception would not apply if the security-based swap transaction were a transaction conducted within the United States, as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. [1039]

Without such an exception, U.S. persons conducting security-based swap activity out of foreign branches or guaranteed non-U.S. persons may have less access to foreign security-based swap markets because non-U.S. person counterparties may be less willing to enter into security-based swap transactions with them if such transactions are subject to a mandatory clearing requirement. We recognize that imposing the mandatory clearing requirement on a foreign branch of a U.S. bank or on a non-U.S. person whose performance under a security-based swap is guaranteed by a U.S. person would be consistent with the view that a foreign branch of a U.S. bank is part of a U.S. person [1040] and that a U.S. guarantor is an indirect counterparty [1041] to the transaction entered into by the guaranteed non-U.S. person. We also recognize that such transactions pose risk to the U.S. financial system. At the same time, however, imposing the mandatory clearing requirement on U.S. persons that conduct their foreign security-based swap dealing activity through foreign branches or guaranteed non-U.S. persons, without any exceptions, could put such U.S. persons at a significant competitive disadvantage to non-U.S. persons who conduct security-based swap business in the same foreign local market and thereby limit the access of such U.S. persons to foreign security-based swap markets. [1042] After balancing the various policy considerations, including the Dodd-Frank Act's goal of mitigating risk to the U.S. financial system, we have preliminarily concluded that the proposed exception from the mandatory clearing requirement for transactions by U.S. persons conducting security-based swap activity out of foreign branches or guaranteed non-U.S. persons with non-U.S. persons whose performance under the security-based swap is not guaranteed by a U.S. person is appropriate, provided that it is not a transaction conducted within the United States. [1043]

This exception from the mandatory clearing requirement would not apply under the proposed rule, however, when the non-U.S. person counterparty of the foreign branch of the U.S. bank or the guaranteed non-U.S. person is a foreign security-based swap dealer. [1044] As discussed above, a non-U.S. person would be required to register as a foreign security-based swap dealer if its transactions with U.S. persons or otherwise conducted within the United States, connected with its dealing capacity, exceed the de minimis threshold in the security-based swap dealer definition. [1045] Thus, a foreign security-based swap dealer would necessarily have a significant connection with the U.S. security-based swap market. As a result, the Commission preliminarily believes that it is not appropriate to provide an exception for U.S. persons conducting security-based swap activity out of foreign branches or guaranteed non-U.S. persons when they enter into security-based swaps with foreign security-based swap dealers.

We are not proposing to provide an exception from mandatory clearing for U.S. persons generally, however, although we recognize that such exception could increase access to foreign security-based swap markets for all U.S. persons. The Commission preliminarily believes that such a broad exception to the mandatory clearing requirement, in a market as global as the security-based swap market, [1046] would undermine the goal of the mandatory clearing requirement to reduce financial risk to the U.S. financial system. In light of the statutory goal, we preliminarily do not believe that the benefit of providing U.S. persons greater access to foreign security-based swap markets warrants expanding the exception beyond the scope we are proposing here. In this regard, we also note that a uniform mandatory clearing requirement for all U.S. persons other than foreign branches and guaranteed non-U.S. persons should facilitate the development of central clearing infrastructures and encourage the standardization of contract terms. [1047]

(b) Transactions Conducted Within the United States

i. Proposed Rule

Under the proposed rule, a security-based swap transaction that is a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act, would be subject to the mandatory clearing requirement. [1048] The Commission preliminarily believes that engaging in a security-based swap includes the performance by a person of any of the activities that represent key stages in a security-based swap transaction, including solicitation, negotiation, execution, or booking of a security-based swap transaction. As we have noted above, a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5), includes soliciting, negotiating, executing, or booking a security-based swap transaction. [1049] Accordingly, we preliminarily would interpret engaging in a security-based swap within the United States to encompass the same types of activities that characterize a transaction conducted within the United States, as that term is defined in proposed Rule 3a71-3(a)(5). [1050]

ii. Proposed Exception for Transactions Conducted Within the United States by Certain Non-U.S. Persons

The Commission recognizes that transactions between two non-U.S. persons whose performances under a security-based swap are not guaranteed by a U.S. person do not pose the same risk to the U.S. financial system that is posed by transactions with U.S. person counterparties or transactions in which a U.S. person provides a guarantee. In particular, while the operational risks associated with the transaction may reside in the United States and would potentially be reduced by required use of the central market infrastructure available to clear the products in question, we preliminarily believe that because the financial risks of the transaction would reside with non-U.S. persons outside the United States, it is not necessary to apply the mandatory clearing requirement to a transaction between two non-U.S. persons solely because the transaction is a “transaction conducted within the United States” as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. Accordingly, the Commission is proposing an exception from the mandatory clearing requirement for security-based swap transactions that are “transactions conducted within the United States” when no counterparty to the transaction is (i) a U.S. person; (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person; or (iii) a foreign security-based swap dealer. [1051]

The Commission preliminarily believes it is appropriate to limit the exception from the mandatory clearing requirement when one or both of the non-U.S. person counterparties is a foreign security-based swap dealer. Non-U.S. persons whose transactions arising from dealing activity with U.S. persons or otherwise conducted within the United States exceed the de minimis threshold in the security-based swap dealer definition have a sufficient connection to the U.S. security-based swap market to lead the Commission to preliminarily conclude that it would not be appropriate to except transactions involving them from the mandatory clearing requirement when they conduct security-based swap transactions within the United States. Permitting non-U.S. persons to engage in security-based swap transactions within the United States with foreign security-based swap dealers without being subject to the mandatory clearing requirement would potentially limit the access of U.S. persons to foreign security-based swap markets because non-U.S. persons seeking to engage in security-based swaps within the United States may prefer to engage in security-based swaps with foreign security-based swap dealers rather than U.S. persons to avoid the mandatory clearing requirement.

Request for Comment

The Commission seeks comment on the proposed rule in all aspects. In addition, the Commission seeks comment on the following specific questions:

  • Should the mandatory clearing requirement apply to all transactions conducted by a U.S. person, including transactions conducted out of a foreign branch, or by a guaranteed non-U.S. person? Why or why not? Should the mandatory clearing requirement apply to such transactions unless, for example, they are conducted in a foreign regime that has a mandatory clearing regime that is comparable to the mandatory clearing regime under the Dodd-Frank Act? In assessing comparability under this approach, to what extent should results of mandatory clearing determinations under the foreign regime be taken into account? Should the determinations with respect to “local” products be viewed differently than products that are subject to mandatory clearing determinations in one or more other jurisdictions, i.e.,“global” products? Would some other standard for assessing a foreign regime in these circumstances be appropriate?
  • Is the proposed approach over-broad or over-narrow? If so, why? Should a security-based swap that is required to be cleared under foreign law not be required to be cleared pursuant to Section 3C, as some commenters stated? If so, why?
  • When the conduct occurring in the United States is limited only to negotiating or soliciting a transaction, does the transaction carry risk into the U.S. financial system? If not, is application of the mandatory clearing requirement to such transactions appropriate?
  • How should the Commission weigh the operational risks that arise from requiring mandatory clearing? To what extent do the exceptions to the mandatory clearing requirement undermine the development of a central clearing infrastructure that will facilitate the prompt and accurate clearance and settlement of security-based swaps? Are persons excepted from the mandatory clearing requirement likely to develop the same operational capacity and safeguards to facilitate clearing as persons not excepted? If not, to what extent does this increase operational risk to the national system for clearance and settlement? To what extent, if any, should the exceptions to the mandatory clearing requirement be limited to minimize operational risks and market risks that may be experienced in the United States?
  • Are there other rationales besides risk mitigation that justify imposing the mandatory clearing requirement? If so, what are they and why? Do these alternative rationales support a different application of the requirement to U.S. persons and non-U.S. persons? As regards foreign branches of U.S. banks? As regards non-U.S. persons who receive guarantees from U.S. persons and non-U.S. persons who do not receive guarantees from U.S. persons? As regards security-based swap dealers?
  • How should the mandatory clearing requirement treat members of clearing agencies registered with the Commission? For instance, to what extent should the mandatory clearing requirement apply to members of clearing agencies registered with the Commission if the member is not a U.S. person, does not have its performance guaranteed by a U.S. person, is not a security-based swap dealer, or is not conducting the transaction within the United States? Please be specific.
  • How should the mandatory clearing requirement treat counterparties who are swap dealers? For instance, should non-U.S. persons who are swap dealers and whose performance under the swap is not guaranteed by a U.S. person be excepted from the mandatory clearing requirement in any circumstances? If so, under what circumstances? How should other financial entities be treated? How should major swap participants and major security-based swap participants be treated under the proposed rule? Should they be excepted from the mandatory clearing requirement, in certain circumstances, as we have proposed?
  • Are the proposed exceptions from the mandatory clearing requirement appropriate? Should other transactions also be excepted? If so, which? Should other categories of persons also be excepted? If so, whom?
  • Should any transactions conducted within the United States be subject to any exception from the mandatory clearing requirement? If so, why? For instance, should a transaction between two non-U.S. persons neither of whom is guaranteed by a U.S. person and neither of whom are security-based swap dealers, as excepted from the mandatory clearing requirement under proposed Rule 3Ca-3(b)(2), be subject to mandatory clearing? If so, why?
  • Should any transactions where one counterparty is a U.S. person be subject to an exception from the mandatory clearing requirement? If so, which transactions and why? For instance, should transactions not conducted in the United States in which one counterparty is a foreign branch of a U.S. bank be subject to any exceptions, such as the exception in proposed Rule 3Ca-3(b)(1)?
  • To what extent might the exceptions described in proposed Rule 3Ca-3(b) create competitive disparity between similarly situated persons competing in the same market? For instance, for transactions conducted within the United States, to what extent, if any, might proposed Rule 3Ca-3(b)(2) create competitive disparity between U.S. persons and non-U.S. persons? For transactions not conducted within the United States, to what extent, if any, might proposed Rule 3Ca-3(b)(1) create competitive disparity between counterparties who are security-based swap dealers and foreign branches of U.S. banks?
  • Should the Commission impose any conditions to the exceptions from the mandatory clearing requirement? What conditions would be appropriate?
  • If the proposed rule overlaps with a foreign mandatory clearing requirement, in what ways are the requirements likely to conflict? What would be the effects on efficiency, competition and capital formation in the event that there are overlapping or duplicative mandatory clearing requirements or varying exceptions to such requirements across multiple jurisdictions?
  • What provisions of Section 3C, or the Exchange Act and rules thereunder generally, would a counterparty be unable to comply with if the security-based swap transaction was subject to more than one mandatory clearing requirement? What categories of transactions are likely to be subject to such multiple mandatory clearing requirements? To what extent, if any, would a counterparty's membership in a clearing agency that clears security-based swaps affect the likelihood that multiple mandatory clearing requirements would apply to a security-based swap transaction? To what extent, if any, would a guaranteed non-U.S. person be subject to multiple mandatory clearing requirements? To what extent, if any, does the home country of the reference entity under a security-based swap affect the likelihood that multiple mandatory clearing requirements would apply to the transaction? Does proposed Rule 3Ca-3 provide sufficient regulatory guidance regarding such transactions? Why or why not?
  • What would be the market impact of proposed Rule 3Ca-3? How would the proposed application of the mandatory clearing requirement affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed rule place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed rule be a more general burden on competition? If so, please explain. What other measures should the Commission consider to implement the mandatory clearing requirement? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

X. Mandatory Security-Based Swap Trade Execution Requirement Back to Top

A. Introduction

Section 3C(h)(1) of the Exchange Act requires, with respect to transactions involving security-based swaps subject to the clearing requirement in Section 3C(a)(1) of the Exchange Act, that counterparties execute such transactions on an exchange or a security-based swap execution facility that is registered under Section 3D of the Exchange Act or exempt from registration under Section 3D(e) of the Exchange Act (the “mandatory trade execution requirement”). [1052] Section 3C(h) thus provides that security-based swap transactions subject to the mandatory trade execution requirement cannot be executed on an OTC basis, but must instead be executed on an exchange or security-based swap execution facility that is registered or exempt from registration under the Exchange Act, unless an exception applies. [1053] As such, the mandatory trade execution requirement is important in helping to bring the trading of security-based swaps onto transparent, regulated markets, from more opaque OTC markets. [1054]

Because transactions in security-based swaps are often conducted globally with counterparties and intermediaries from multiple jurisdictions, [1055] we recognize uncertainty may exist regarding how to apply the mandatory trade execution requirement to cross-border security-based swap transactions. [1056] The Commission is proposing Rule 3Ch-1 under the Exchange Act to specify the applicability of the mandatory trade execution requirement with respect to cross-border security-based swap transactions. Our proposed approach follows the territorial approach described above [1057] and imposes the mandatory trade execution requirement on transactions that would be subject to the mandatory clearing requirement [1058] unless they qualify for an exception. [1059] We discuss substituted compliance with the mandatory trade execution requirement in Section XI.F below. [1060]

We recognize that other approaches are possible to achieve the goals of the Dodd-Frank Act, in whole or in part. Accordingly, we invite comment regarding all aspects of the proposal described below, including potential alternative approaches. Data and comment from market participants and other interested parties regarding the likely effect of the proposed rule and potential alternative approaches will be particularly useful to the Commission in evaluating possible modifications to the proposal.

B. Application of the Mandatory Trade Execution Requirement to Cross-Border Transactions

1. Statutory Framework

Section 3C(h) of the Exchange Act provides that if a transaction is subject to the mandatory clearing requirement, counterparties shall execute the transaction on an exchange or on a registered or exempt SB SEF, unless an exception applies. [1061] Section 3C(a)(1) of the Exchange Act provides that it shall be unlawful for any person “to engage in a security-based swap unless that person submits such security-based swap for clearing . . . if the security-based swap is required to be cleared.” [1062] As discussed above, we are proposing to apply the statutory mandatory clearing requirement to any person who engages in a security-based swap transaction within the United States. [1063] We preliminarily believe that, to the extent that a cross-border transaction is subject to the mandatory clearing requirement under the proposed approach described above, it also would be subject to the mandatory trade execution requirement unless it qualifies for an exception. [1064] This approach is consistent with the statutory framework of Title VII of the Dodd-Frank Act, because a security-based swap transaction first must be subject to the mandatory clearing requirement before the counterparties to the transaction must comply with the mandatory trade execution requirement, unless an exception to the mandatory trade execution requirement applies. Thus, to the extent that we are proposing not to apply the mandatory clearing requirement to a particular transaction, the mandatory trade execution requirement would not apply to such transaction.

2. Proposed Rule

Consistent with our proposed rule applying the mandatory clearing requirement [1065] and our general approach in applying Title VII in the cross-border context, [1066] the Commission is proposing Rule 3Ch-1 under the Exchange Act. Under the proposed rule, the mandatory trade execution requirement would apply to any person that engages in a security-based swap transaction in which at least one of the counterparties to the transaction is (i) a U.S. person [1067] or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person. [1068] We also are proposing to apply the mandatory trade execution requirement to any person that engages in a security-based swap if such transaction is a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. [1069]

To limit the scope of the proposal, we are proposing exceptions to the mandatory trade execution requirement in the following two scenarios: [1070]

  • If the security-based swap transaction is not a “transaction conducted within the United States,” the proposed rule would not apply the mandatory trade execution requirement if one counterparty to the transaction is (i) a foreign branch of a U.S. bank [1071] or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person, [1072] and if the other counterparty to the transaction is a non-U.S. person (i) whose performance under the security-based swap is not guaranteed by a U.S. person and (ii) who is not a foreign security-based swap dealer. [1073]
  • If the security-based swap transaction is a “transaction conducted within the United States,” the proposed rule would not apply the mandatory trade execution requirement if (i) neither counterparty to the transaction is a U.S. person; (ii) neither counterparty's performance under the security-based swap is guaranteed by a U.S. person; and (iii) neither counterparty to the transaction is a foreign security-based swap dealer. [1074]

We discuss below the proposed rule regarding the application of the mandatory trade execution requirement in more detail.

3. Discussion

In considering how to apply the mandatory trade execution requirement, we have relied primarily on the express statutory relationship between the mandatory clearing requirement and the mandatory trade execution requirement. The statutory text, in our view, indicates that Congress viewed the clearing and trade execution requirements as complementary, since a security-based swap transaction that is subject to the mandatory clearing requirement is subject to the mandatory trade execution requirement, absent circumstances that trigger one of the exceptions to the mandatory trade execution requirement. In the following, we discuss the proposed rule regarding the application of the mandatory trade execution requirement in more detail.

(a) Security-Based Swap Transactions Involving U.S. Persons or Non-U.S. Persons Receiving Guarantees From U.S. Persons

i. Proposed Rule

The proposed rule would apply the mandatory trade execution requirement to transactions in which one of the counterparties is (i) a U.S. person or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person, [1075] subject to certain exceptions. [1076] We preliminarily believe that applying the mandatory trade execution requirement to transactions in which U.S. persons are counterparties or provide guarantees of the performance of non-U.S. persons under a security-based swap would be consistent with the purposes of the Dodd-Frank Act to improve transparency in the U.S. financial system. [1077] As noted above, the mandatory trade execution requirement in Title VII is critical to this goal because this requirement is designed promote the trading of security-based swap transactions on transparent, regulated markets. [1078] Therefore, by applying the mandatory trade execution requirement to transactions in which U.S. persons are counterparties or provide guarantees of the performance of non-U.S. persons under a security-based swap, the proposed rule would further the goals of the Dodd-Frank Act to improve the transparency of the U.S. financial system. [1079]

ii. Proposed Exception for Certain Transactions Involving Foreign Branches of U.S. Banks and Guaranteed Non-U.S. Persons

Consistent with the Commission's proposed approach to the mandatory clearing requirement discussed above, [1080] the Commission is proposing an exception from the mandatory trade execution requirement described above for certain transactions that involve foreign branches of U.S. banks or guaranteed non-U.S. persons, provided the transactions are not conducted within the United States. Specifically, under proposed Rule 3Ch-1(b)(1), the mandatory trade execution requirement would not apply to a security-based swap transaction if one counterparty to the transaction is (i) a foreign branch of a U.S. bank [1081] or (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person and if the other counterparty to the transaction is a non-U.S. person (i) whose performance under the security-based swap is not guaranteed by a U.S. person and (ii) who is not a foreign security-based swap dealer. [1082] Such exception would not apply if the security-based swap transaction were a transaction conducted within the United States, as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act. [1083]

The Commission preliminarily believes that imposing the mandatory trade execution requirement on all security-based swap transactions in which a U.S. person is a counterparty or in which a U.S. person provides a guarantee to a non-U.S. person counterparty may adversely affect the ability of U.S. persons to access foreign security-based swap markets because non-U.S. persons may be less willing to enter into transactions with them if such transactions are subject to the mandatory trade execution requirement. Accordingly, we are proposing an exception from the mandatory trade execution requirement for transactions in which a counterparty to the transaction is a foreign branch of a U.S. bank or a non-U.S. person who receives a guarantee from a U.S. person on its performance under the security-based swap and the other counterparty is a non-U.S. person whose performance under the security-based swap is not guaranteed by a U.S. person and who is not a foreign security-based swap dealer. [1084]

We recognize that imposing the mandatory trade execution requirement on a foreign branch of a U.S. bank or on a non-U.S. person whose performance under a security-based swap is guaranteed by a U.S. person would be consistent with the view that a foreign branch of a U.S. bank is part of a U.S. person [1085] and that a U.S. guarantor is an indirect counterparty [1086] to the transaction entered into by the guaranteed non-U.S. person. We also recognize that subjecting such transactions to the mandatory trade execution requirement could help to bring the trading of security-based swaps onto transparent, regulated markets, from more opaque OTC market. At the same time, however, imposing the mandatory trade execution requirement on U.S. persons that conduct their foreign security-based swap dealing activity through foreign branches or guaranteed non-U.S. persons, without any exceptions, could put such U.S. persons at a significant competitive disadvantage to non-U.S. persons who conduct security-based swap business in the same foreign local market and thereby limit the access of such U.S. persons to foreign security-based swap markets. After balancing the various policy considerations, including the Dodd-Frank Act's goal of promoting trading on transparent, regulated markets, we have preliminarily concluded that the proposed exception from the mandatory trade execution requirement for transactions by U.S. persons conducting security-based swap activity out of foreign branches, or transactions by guaranteed non-U.S. persons, with non-U.S. persons whose performance under the security-based swap is not guaranteed by a U.S. person (and who is not a foreign security-based swap dealer) is appropriate, provided that it is not a transaction conducted within the United States.

This exception from the mandatory trade execution requirement would not apply under the proposed rule, however, when the non-U.S. person counterparty of the foreign branch of the U.S. bank or the guaranteed non-U.S. person is a foreign security-based swap dealer. [1087] The reason for this proposed carve-out from the exception from the mandatory trade execution requirement is similar to the reason discussed above in the context of the mandatory clearing requirement. Because a foreign security-based swap dealer would necessarily have a significant connection with the U.S. security-based swap market because its dealing activity with U.S. persons or within the United States would trigger registration requirements, we preliminarily believe it is not appropriate to provide an exception for U.S. persons conducting security-based swap activity out of foreign branches or for guaranteed non-U.S. persons when they enter into security-based swaps with foreign security-based swap dealers.

(b) Transactions Conducted Within the United States

i. Proposed Rule

Under the proposed rule, a security-based swap transaction that is a transaction conducted within the United States, as defined in proposed Rule 3a71-3(a)(5) under the Exchange Act, would be subject to the mandatory trade execution requirement. [1088] As we have noted above, a “transaction conducted within the United States,” as defined in proposed Rule 3a71-3(a)(5), includes soliciting, negotiating, executing, or booking a security-based swap transaction. [1089] The Commission believes that applying the mandatory trade execution requirement to a security-based swap transaction when the activities that are key stages in that transaction are conducted within the United States furthers a goal of the mandatory trade execution requirement, namely, to bring the trading of security-based swaps within the United States onto regulated markets, unless an exception applies. Furthermore, such an approach is consistent with our proposed approach to the mandatory clearing requirement discussed above. [1090]

ii. Proposed Exception for Transactions Conducted Within the United States by Certain Non-U.S. Persons

We recognize that one commenter has recommended that transactions between two non-U.S. persons that utilize U.S. agents should not be subject to the mandatory trade execution requirement. [1091] The commenter noted that it is common for non-U.S. persons to utilize U.S. agents because of their expertise in the relevant market (such as in the case of a swap with an underlying U.S. security) or because of logistical matters (such as the time zones in which the parties conduct business). [1092] The commenter argued that applying the mandatory trade execution requirement to these transactions could curtail the use of U.S. agents to negotiate trades and encourage personnel in the United States to relocate elsewhere. [1093]

Consistent with our proposed approach to applying the mandatory clearing requirement to transactions conducted within the United States by non-U.S. persons, the Commission is proposing an exception from the mandatory trade execution requirement for security-based swap transactions that are transactions conducted within the United States when no counterparty to the transaction is (i) a U.S. person; (ii) a non-U.S. person whose performance under the security-based swap is guaranteed by a U.S. person; or (iii) a foreign security-based swap dealer. [1094]

The Commission preliminarily believes that it is appropriate to limit the exception from the mandatory trade execution requirement when one or both of the non-U.S. person counterparties is a foreign security-based swap dealer. Non-U.S. persons whose transactions arising from dealing activity with U.S. persons or otherwise conducted within the United States exceed the de minimis threshold in the security-based swap dealer definition have a sufficient connection to the U.S. security-based swap market to lead the Commission to preliminarily conclude that it would not be appropriate to except transactions involving them from the mandatory trade execution requirement when they conduct security-based swap transactions within the United States. Permitting non-U.S. persons to engage in security-based swap transactions within the United States with foreign security-based swap dealers without being subject to the mandatory trade execution requirement would potentially limit the access of U.S. persons to foreign security-based swap markets because non-U.S. persons seeking to engage in security-based swaps within the United States may prefer to engage in security-based swaps with foreign security-based swap dealers rather than U.S. persons to avoid the mandatory trade execution requirement.

Request for Comment

The Commission seeks comment on all aspects of proposed Rule 3Ch-1, including the following:

  • Should the mandatory trade execution requirement apply to all transactions conducted by a U.S. person, including transactions conducted out of a foreign branch of a U.S. bank or a non-U.S. person whose performance under a security-based swap is guaranteed by a U.S. person? Why or why not?
  • Is it appropriate for the application of the mandatory trade execution requirement in the cross-border context to follow our approach to the mandatory clearing requirement? If not, why not? What alternative approach would better suit the relationship between these two requirements under the statute? Please explain.
  • Is the proposed rule appropriate and sufficiently clear? Should additional details be included as to any aspect of the proposed rule? If so, what additional details should be provided and why?
  • As discussed above, under proposed Rule 3Ch-1(a), the mandatory trade execution requirement would apply to a person that engages in a security-based swap transaction if such person is a U.S. person, such person is a non-U.S. person whose performance under such security-based swap transaction is guaranteed by a U.S. person, or such security-based swap transaction is a transaction conducted within the United States. Are the circumstances in which the Commission proposes to apply the mandatory trade execution requirement sufficiently clear? If not, why not? Are these the appropriate circumstances in which to apply the mandatory trade execution requirement? If not, why not? Are there additional types of counterparties or security-based swap transactions to which the mandatory trade execution requirement should be applied? If so, who or what are they, and why? Are there types of counterparties or security-based swap transactions that should not be covered by the proposed rule? If so, why not?
  • Would the proposed rule apply the mandatory trade execution requirement in ways that appropriately promote the goals of Title VII? Would any objectives of Title VII be hindered by applying the mandatory trade execution requirement as proposed? Would there be any regulatory gaps created by the proposed rule? Please provide detail.
  • By requiring transactions conducted within the United States to be subject to the mandatory trade execution requirement, would the proposed rule appropriately create competitive parity between U.S. and non-U.S. persons that act as intermediaries within the United States to conduct transactions in security-based swaps? Why or why not? Please explain. Please provide specific recommendations and explain how any recommended approach would better promote competition than the proposed rule. More generally, should security-based swap transactions be subject to the mandatory trade execution requirement solely because a transaction was solicited or negotiated within the United States?
  • Under proposed Rule 3Ch-1(b), certain security-based swap transactions by foreign branches and guaranteed non-U.S. persons that are not conducted within the United States would be excluded from the mandatory trade execution requirement. The Commission generally solicits comments on the appropriateness of excluding the security-based swap transactions described in proposed Rule 3Ch-1(b) from the application of the mandatory trade execution requirement. Should additional types of transactions be excluded from the application of the mandatory trade execution requirement? Should some or all of the transactions covered by proposed Rule 3Ch-1(b) not be excluded? If so, in either case, please explain why. Does proposed Rule 3Ch-1(b) appropriately balance the competitiveness of U.S. persons in the global security-based swaps market and the goals of Title VII? If not, how could this balance be better achieved? Should proposed Rule 3Ch-1(b) also apply to non-U.S. persons that are security-based swap dealers? Why or why not?
  • What would be the market impact of proposed Rule 3Ch-1? How would the proposed application of the mandatory trade execution requirement affect the competitiveness of U.S. entities in the global marketplace (both in the United States as well as in foreign jurisdictions)? Would the proposed rule place any market participants at a competitive disadvantage or advantage? If so, please explain. Would the proposed rule be a more general burden on competition? If so, please explain. Would any burdens on competition be effectively mitigated by the proposed exception to mandatory trade execution in proposed Rule 3Ch-1(b)? Please explain. What other measures should the Commission consider to implement the mandatory trade execution requirement? What would be the market impacts and competitiveness effects of alternatives to the proposed approach discussed in this release?

XI. Substituted Compliance Back to Top

A. Introduction

As noted above, we are proposing to establish a policy and procedural framework pursuant to rules under the Exchange Act in which the Commission would consider permitting compliance with comparable regulatory requirements in a foreign jurisdiction to substitute for compliance with requirements in the Exchange Act, and rules and regulations thereunder, relating to security-based swaps (i.e., substituted compliance). As proposed, under a Commission substituted compliance determination, a person would be able to satisfy relevant requirements in the Exchange Act, and the rules and regulations thereunder, by substituting compliance with corresponding requirements under a foreign regulatory system. A person relying on a substituted compliance determination still would be subject to the particular Exchange Act requirement that is the subject of the substituted compliance determination, but would be permitted to comply with such requirement in an alternative fashion. Failure of a person to comply with the applicable foreign regulatory requirements would mean that such person would be in violation of the requirements in the Exchange Act.

The Commission is proposing to consider making substituted compliance determinations with respect to four distinct categories of requirements, each of which raises separate issues and will be discussed separately below. These categories are as follows: (i) Requirements applicable to registered security-based swap dealers in Section 15F of the Exchange Act and the rules and regulations thereunder; (ii) requirements relating to regulatory reporting and public dissemination of information on security-based swaps; (iii) requirements relating to clearing for security-based swaps; and (iv) requirements relating to trade execution for security-based swaps.

With respect to each of these categories of requirements, the Commission is proposing a “comparability” standard as the basis for making a substituted compliance determination. Generally, the Commission would endeavor to take a holistic approach in making substituted compliance determinations—that is, we would ultimately focus on regulatory outcomes as a whole with respect to the requirements within the same category rather than a rule-by-rule comparison. As noted above, [1095] efforts to regulate the derivatives market are underway, not only in the United States, but also in other jurisdictions. Since their 2009 statement, the G20 leaders have reiterated their commitment to OTC derivatives regulatory reform. And, as described above, [1096] the Commission has participated in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC derivatives and foreign regulatory reform efforts. We recognize that foreign regulatory systems differ in their approaches to achieving particular regulatory outcomes, and that foreign regulatory requirements may differ from those ultimately adopted by the Commission, but may nonetheless achieve regulatory outcomes comparable with the regulatory outcomes of the relevant provisions of the Exchange Act added by Title VII of the Dodd-Frank Act. In addition, we recognize that different regulatory systems may be able to achieve some or all of those regulatory outcomes by using more—or fewer—specific requirements than the Commission. For example, under certain circumstances, a foreign regulatory system may be able to achieve one of those regulatory outcomes in the absence of one or more specific requirements that the Commission has implemented under a particular set of provisions of the Dodd-Frank Act.

Accordingly, we do not envision that the Commission, in making a comparability determination, would look to whether a foreign jurisdiction has implemented specific rules and regulations that are comparable to rules and regulations adopted by the Commission. Rather, the Commission would determine whether the foreign regulatory system in a particular area, taking into consideration any relevant principles, regulations, or rules in other areas of the foreign regulatory system to the extent they are relevant to the analysis, achieves regulatory outcomes that are comparable to the regulatory outcomes of the relevant provisions of the Exchange Act. If it does, the Commission preliminarily believes that a comparability determination would be appropriate, notwithstanding differences in or the absence of specific requirements of particular regulatory provisions.

In addition, the Commission recognizes that other regulatory systems are informed by the business and market practices present in the foreign jurisdictions where those systems apply, and that such practices may differ in certain respects from practices described in this release. More broadly, other regulatory systems are informed by the characteristics of the markets for which they were designed, including the number and nature of their market participants to which they apply. In making a comparability determination, the Commission recognizes that it may need to take into account such practices and characteristics in understanding the design and application of another regulatory system and whether and how it may achieve regulatory outcomes comparable to the regulatory outcomes of the relevant provisions of the Exchange Act.

As explained below, how the Commission would find a foreign regulatory system “comparable” would vary depending on the category of requirements. Because the Commission is proposing to make substituted compliance determinations with respect to each of the aforementioned categories of requirements, it is possible that a foreign regulatory system would be comparable with respect to some, but not all, categories of requirements. For instance, a foreign regulatory system may impose requirements on non-U.S. dealers that achieve regulatory outcomes comparable to the requirements applicable to registered security-based swap dealers in Section 15F of the Exchange Act, but the same foreign regulatory system may not achieve comparable regulatory outcomes regarding public reporting of trade information for security-based swaps. Similarly, a foreign regulatory system may impose requirements on clearing agencies that achieve regulatory outcomes comparable to the requirements applicable to registered security-based swap clearing agencies under Section 17A of the Exchange Act, but may not provide for comparable regulation of SB SEFs. By assessing each of these categories separately, the Commission would have the flexibility to make a substituted compliance determination with respect to one category of requirements but not another. However, the Commission would also retain the flexibility to consider the extent to which principles, regulations, or rules in one category may bear on a determination with respect to another category. Such an approach also would allow substituted compliance in certain categories to address competition and market efficiency concerns when a foreign regime is not comparable across the full range of Title VII policy objectives.

In addition, as described below, in making substituted compliance determinations, the Commission would consider a variety of factors that the Commission deems appropriate, including the nature of the global security-based swap market and the scope and objectives of the relevant foreign regulatory requirements. As part of this holistic review, the Commission would consider the various ways in which a foreign regulatory system achieves its overall goals and purposes, including those undertaken in response to the G20 commitments. As noted above, the Commission would also consider the extent to which applicable principles, regulations, or rules in one category may bear on a determination with respect to another category. In addition, the Commission recognizes that our proposed application of Title VII to cross-border activities may affect the policy decisions of these other regulators as they seek to address potential conflicts or duplication in the regulatory requirements that apply to market participants under their authority.

More specifically, the proposed policy and procedural framework for substituted compliance recognizes the potential, in a market as global as the security-based swap market, for market participants who engage in cross-border security-based swap activity to be subject to conflicting or duplicative compliance obligations. As a result of the efforts to implement the G20 commitments in various jurisdictions described above, in some cases of cross-border activity, market participants may be subject to compliance obligations in a foreign jurisdiction that are similar to those imposed by the Exchange Act. The proposed framework would allow the Commission to provide for substituted compliance to address the effect of conflicting or duplicative regulations on competition and market efficiency and to facilitate a well-functioning global security-based swap market. In other cases, however, market participants may not be subject to conflicting or duplicative regulation because the foreign jurisdiction has not enacted comprehensive regulation of the security-based swap markets or is still in the process of implementing regulatory reforms that have been enacted. It also may be that the foreign jurisdiction's regulation does not apply to the market participant or entity or the foreign jurisdiction has established regulations that differ, in material respects, from requirements in the Exchange Act (e.g., requirements relating to real-time public reporting) and do not achieve comparable regulatory outcomes. In such cases, there would be less justification for allowing substituted compliance.

One alternative to making substituted compliance determinations by looking at separate categories of requirements would be to provide substituted compliance across the entire set of security-based swap requirements with respect to regimes that have implemented regulations consistent with the overall objectives of the G20 commitments. Preliminarily, however, we believe that making substituted compliance determinations on a regime-wide basis would be unworkable in light of the Commission's responsibility to implement the specific statutory provisions of the Exchange Act added by Title VII of the Dodd-Frank Act. While these provisions of the Exchange Act are consistent with the G20 commitments, they also contain provisions designed to achieve particular regulatory outcomes that may not be part of another jurisdiction's regulatory system. Thus, while the Commission would certainly consider the broader regulatory landscape in a foreign jurisdiction—including its approach to the G20 commitments—before making a substituted compliance determination, the Commission would also need to consider the particular regulatory outcomes achieved under the Exchange Act provisions added by Title VII of the Dodd-Frank Act.

In the following, we propose rules and interpretive guidance addressing the policy and procedural framework under which we would consider permitting compliance with comparable regulatory requirements in a foreign jurisdiction to substitute for compliance with requirements of the Exchange Act, and the rules and regulations thereunder, relating to security-based swaps, with respect to each of the aforementioned categories of requirements.

Request for Comment

The Commission requests comment on all aspects of our general approach to substituted compliance, including the following questions:

  • Should the Commission make substituted compliance determinations on a regime-wide basis for a jurisdiction rather than with respect to categories of requirements? If so, should the finding that the regulatory outcomes of a foreign regulatory system are not comparable with respect to the regulatory outcomes of one category of the Exchange Act requirements cause the Commission to find the entire foreign regulatory regime to be not comparable as a whole? More specifically, under a regime-wide approach, how should the Commission make substituted compliance determinations with respect to foreign regulatory systems that do not achieve regulatory outcomes comparable to the regulatory outcomes with respect to certain categories of the Exchange Act requirements, taking into account the Commission's responsibility and statutory authority to implement the requirements of the Exchange Act added by Title VII of the Dodd-Frank Act?
  • Should the Commission take into consideration the various ways in which a foreign regulatory system achieves its overall goals and purposes that are consistent with the G20 commitments in making a substituted compliance determination with respect a category of the Exchange Act requirements added by Title VII of the Dodd-Frank Act? Why or why not?
  • Should the Commission take a more granular approach to substituted compliance determinations, for example, conducting a rule-by-rule or requirement-by-requirement comparison? Why or why not?
  • Should the Commission identify more or less categories in our framework for substituted compliance? If so, how should those categories be demarcated?

B. Process for Making Substituted Compliance Requests

The Commission is proposing to amend our Rules of General Application to establish procedures pursuant to which it would consider applications for substituted compliance determinations with respect to each of the aforementioned categories of requirements. [1097] These procedures are similar to those now used by the Commission in considering exemptive order applications under Section 36 of the Exchange Act. [1098] All supporting documentation submitted pursuant to the proposed amendment would be made public.

Specifically, the proposed amendment would add new Rule 0-13 under the Exchange Act setting forth the general procedures for submission of requests for substituted compliance determinations. These procedures include the requirement that all applications for substituted compliance determinations must be in writing in the form of a letter, must include any supporting documents necessary to make the application complete, and otherwise must comply with 17 CFR 240.0-3 (Filing of Material with the Commission). [1099] All applications must be submitted to the Office of the Secretary of the Commission, and may be submitted either electronically [1100] or in paper format. [1101] In addition, all filings and supporting documentation filed pursuant to this proposed rule must be in the English language. [1102] If an application is incomplete, the Commission may request that the application be withdrawn unless the applicant can justify, based on all the facts and circumstances, why supporting materials have not been submitted and undertakes to submit promptly the omitted materials. [1103]

The Commission would not consider hypothetical or anonymous requests for a substituted compliance order. [1104] Consistent with this position, every application (electronic or paper) must contain the name, address, telephone number, and email address of each applicant and the name, address, telephone number, and email address of a person to whom any questions regarding the application should be directed. [1105] In addition, each applicant must provide the Commission with any supporting documentation it believes necessary for the Commission