Securities Regulation Daily Wrap Up, TOP STORY—SEC Cross-Border Swaps Proposal Employs Substituted Compliance, (May 1, 2013)

By Mark S. Nelson, J.D.

The SEC today voted unanimously to propose rules dealing with cross-border securities-based swaps. The over-1,000 page proposal employs substituted compliance as the framework for harmonizing the Commission’s proposed rules with global swaps regulations. The SEC also proposed interpretive guidance and re-opened the comment period for all non-final securities-based swaps proposals.

“The global nature of this market means that participants may be subject to requirements in multiple countries, and this type of overlapping regulatory oversight could lead to conflicting or costly duplicative regulatory requirements,” said SEC Chairman Mary Jo White in a fact sheet describing the proposal. “Market participants need to know which rules to follow, and I believe that this proposal will serve as the road map,” Ms. White added. In her opening remarks, Ms. White observed that the SEC has now almost completed its Title VII proposals.

Commissioner, and former Chairman, Ellise B. Walter, observed that today’s proposal is the “lynchpin” to the completion of the SEC’s security-based swaps rules. Commissioner Troy A. Paredes said he voted in favor of issuing the proposal, although he has concerns about its details. Commissioner Daniel M. Gallagher echoed Mr. Paredes’s concerns. Said Mr. Gallagher, “…I want to stress that, while I think we are generally moving in the right direction with this proposal, I am not convinced that we got it exactly right, so I look forward to receiving meaningful comment on these critically important issues.”

Commissioner Luis A. Aguilar said public comments on the nearly 630 questions asked by the proposal and related interpretive guidance should help to direct the SEC’s future efforts regarding security-based swaps regulations. However, Mr. Aguilar questioned whether certain proposals would adequately protect American investors.

U.S. person. The SEC noted the global nature of swaps markets and the potential for regulatory duplication of effort or even competition or retaliation. As a result, the SEC’s cross-border proposal relies extensively on substituted compliance. Generally, security-based swap transactions fall within the SEC’s jurisdiction if they are entered into with a U.S. person or take place in the United States.

The proposed cross-border rules incorporate a “territorial approach” to Dodd-Frank Act Title VII. Under this approach, “U.S. person” means a natural person who resides in the U.S., a business entity organized, incorporated, or having its principal place of business in the U.S., or any account of a U.S. person. The definition, however, would assign the same U.S. person status to U.S. banks’ foreign branches and foreign banks’ U.S. branches. Transactions by U.S. banks via foreign branches would have non-U.S. person status.

Substituted compliance. Substituted compliance would apply to the extent a foreign regulator’s securities-based swaps regime was comparable to SEC rules. Significantly, the SEC opted not to propose an “all-or-nothing” regime. As a result, the SEC would make comparability determinations based on four separate categories: (1) requirements for registered non-U.S. security-based swap dealers; (2) requirements for reporting and public disclosure of security-based swaps data; (3) requirements for mandatory clearing of security-based swaps; and (4) requirements for mandatory trade execution of security-based swaps.

Thus, the proposal would permit market participants to request substituted compliance for any one or more of the four categories. The SEC’s determination would then apply to all market participants in that foreign jurisdiction. The SEC emphasized that determinations would be rooted in “regulatory outcomes” instead of by comparing rules.

Interpretive guidance. Today’s cross-border proposal also contains interpretive guidance for market participants. For example, the proposal directs foreign dealers to count only dealing activities with U.S. persons or dealing that is conducted in the U.S. in calculating whether they have exceeded the de minimis threshold stated in prior joint SEC-CFTC rules. The SEC, however, said non-U.S. persons need not include these calculations for their swap dealing transactions with U.S. banks’ foreign branches. U.S. persons must count all security-based swap transactions against the de minimis threshold.

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