The Securities and Exchange Commission proposed on May 1 a new set of rules and interpretive guidance to ease the concerns of some overseas parties and regulators over cross-border security-based swaps.
This is an extremely complicated proposal, taking up 650 pages, designed to clarify the significance of Title VII, the swap-markets-specific portion of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It may set the stage for further tension between the SEC on the one hand and the Commodity Futures Trading Commission, which has taken a very different view of the same issue, on the other.
The SEC staff has calculated determined that the majority of U.S. reference-security based swap transactions involve at least one counterparty located outside the U.S. Further, the question of where the transactions are booked is separate from the question of where the parties are located, and adding the latter to the mix brings about another level of globalization.
The new proposal provides that Title VII requirements apply if a transaction is entered into by a U.S. person or conducted within the U.S. but that a party may be able to substitute foreign regulatory requirements for the U.S. requirements if the foreign system produces comparable regulatory outcomes. Under this “substituted compliance” approach, the SEC will separately assess four distinct categories of Title VII requirements. The categories are: requirements applicable to registered non-U.S. security-based swap dealers; requirements relating to regulatory reporting and the public dissemination of security-based swap data; to mandatory clearing; and to trade execution.
The SEC contemplates separate assessments so that, for example, a Mexican party to swaps may receive substituted compliance treatment with regard to reporting and clearing but not with regard to execution.
The SEC says, “Any determination to grant substituted compliance generally would be available to all market participants in the particular foreign jurisdiction.”
One key point: the grant of substituted compliance will depend as noted above on comparable outcomes, not on a textual rule-by-rule comparison. The rules in a particular jurisdiction might be quite different but given a “holistic approach” achieve outcomes analogous to those at which Title VII aims.
Two Thresholds for Swap Dealers or Major Participants
In 2012, the SEC and the Commodity Futures Trading Commission agreed that a security-based swap dealer is required to register as such only when its transactions over a 12 month period exceed a de minimis level. The same principle will apply to foreign swap dealers. They will need to register in the U.S. as security-based swap dealers only once they pass a low threshold notional value of dealings either conducted within the U.S. or with U.S. persons.
Once a foreign party is registered as a security-based swap dealer in the U.S., it will be subject both to entity requirements and transaction requirements. The entity requirements apply to the dealer’s capital, margin, and risk management operations. The transactions requirements apply to its external business conduct.
Another threshold for registration involves parties whose swap activities do not cause them to be dealers, but whose activities are nonetheless such that they “could pose a high degree of risk to the U.S. financial system generally.” This is a relatively high threshold but, again, when passed it imposes a registration obligation for these Major Security Based Swap Participants, along with capital and margin requirements and the like.
Again, the proposal applies to the cross-border situation rules that the SEC and CFTC developed together with an eye to domestic registrants in 2012. As a matter of interpretive guidance, the proposal says, “a non-U.S. person would consider only transactions that it has entered into with U.S. persons, including foreign branches of U.S. banks” to determine whether it has become an MSBSP.
The proposed rule would not require any foreign entity to comply with the transaction-level requirements specific to the MSBSP in their transactions with counterparties that are not U.S. persons., But it would require compliance with the entity-level requirements specific thereto.
The proposal also addresses security based swap infrastructures (clearing, swap execution, and swap data repositories), providing guidance as to when they, too, will be required to register with the SEC despite their foreign base. It takes a generally territorial approach, in which each entity will determine for itself whether it performs a particular infrastructure function within the U.S.
Infrastructure entities, too, may be exempt from U.S. regulation when they are subject to comparable regulation in the home country.