On December 18, 2019, the Securities and Exchange Commission (SEC) adopted a package of rule amendments, guidance and a related order to expand and improve the framework for regulating cross-border security-based swaps, including single-name credit default swaps.1 The amendments and guidance expand on prior SEC rulemakings applying Title VII of the Dodd-Frank Act to certain cross-border security-based swap transactions.2 The adoption of this package triggers the compliance date for security-based swap entities to register with the SEC and the implementation period for registration of security-based swap dealers (SBSDs) and a number of security-based swap rules (discussed in Section I, below). The release was approved by a 3-2 vote, with Commissioners Jackson and Lee dissenting.
The final amendments and guidance will, among other things:
- provide guidance as to when security-based swap transactions between non-US persons are considered to have been “arranged” or “negotiated” by US personnel for purposes of counting such transactions against the non-US person’s de minimis threshold. The guidance includes what it means for a US person to provide “market color” that will not cause the transaction to count toward the non-US person’s de minimis threshold;
- provide a conditional exception from the requirement in Exchange Act Rule 3a71-3(b)(1)(iii)(C) that foreign persons count against the de minimis thresholds associated with SBSD registration security-based swap dealing transactions that are with non-US counterparties but that were arranged, negotiated or executed (ANE’d) by US personnel. Thus, a foreign person can avoid registration as a swap dealer by complying with this new exception and keeping the sum of all trades with US counterparties under the de minimis threshold, despite transactions being ANE’d in the United States. The exception is subject to a number of conditions;
- establish a cap on certain interdealer ANE activities of $50 billion (limiting the availability of the new exception to Rule 3a71-3, described above);
- amend the certification and opinion of counsel requirements in Exchange Act Rule 15Fb2-4, which addresses the registration of non-US resident security-based swap dealers and major security-based swap participants (SBS Entities), and requires the nonresident SBS Entities to certify and provide an opinion of counsel that the SEC can access their books and records and conduct on-site inspections and examinations. The amendments permit nonresident SBS Entities to submit certification and an opinion of counsel that identify, and are conditioned on, the occurrence of a future action that would provide the SEC with adequate assurances of prompt access to the books and records of the nonresident SBS Entity. The amendments also extend the filing time for SBSDs to submit certification and opinion of counsel;
- amend SEC Rule of Practice 194 to exclude certain non-US employees involved only in soliciting business from non-US persons from the application of statutory disqualification provisions; and
- modify recordkeeping requirements for SBSDs relating to employment questionnaires under proposed Exchange Act Rule 18a-5 to provide that (1) SBSDs are not required to maintain a questionnaire for a person excluded from the prohibition in Exchange Section 15F(b)(6), and (2) certain information that may not be available under applicable law need not be obtained.
The SEC also issued a statement with regard to compliance with rules for security-based swap data repositories and Regulation SBSR (Reporting and Dissemination of Security-Based Swap Information) governing regulatory reporting and public dissemination of security-based swap transactions. The release provides that for four years after a compliance date for Regulation SBSR for an asset class, certain reporting rules will not provide a basis for enforcement action.
I. Compliance Dates
The final rules will be effective April 6, 2020 (the Effective Date). The compliance date for registration of SBSDs will be 18 months thereafter (i.e., October 6, 2021) (the Registration Compliance Date). The compliance date for amendments to Rule 3a71-3 will be August 6, 2021, or two months prior to the Registration Compliance Date. The compliance date for the amendments to Exchange Act Rules 18a-5 and 15Fb2-1 will be the Registration Compliance date. The compliance date for amendments to Rule 0-13 and Rule of Practice 194 will be the Effective Date.
The compliance date for a number of other security-based swap rules, including (1) segregation, capital and margin; (2) SBSD recordkeeping; (3) business conduct standards; and (4) trade acknowledgment and verification requirements will be the Registration Compliance Date. The release provides that for four years after a compliance date for Regulation SBSR for an asset class, certain reporting rules will not provide a basis for enforcement action.
II. Security-Based Swap Transactions ANE’d by US Personnel
The SEC issued guidance regarding the definition of “arranged” or “negotiated” in connection with determining which transactions non-US persons must count against their de minimis thresholds for purposes of SBSD registration. As discussed in more detail below, the guidance specifies that Title VII requirements will not be triggered merely because US personnel provide “market color” in the form of certain background information regarding pricing or market conditions associated with particular instruments or with markets more generally, so long as those US personnel do not receive transaction-linked compensation or exercise client responsibility in connection with those transactions. The SEC also adopted a conditional exemption to provisions of Exchange Act Rule 3a71-3 that excludes certain ANE transactions from counting against non US persons’ de minimis threshold for purposes of the SBSD registration requirement.
A. Guidance Regarding the Meaning of “Arranged” and “Negotiated” in Connection with the Cross-Border Application of Title VII.
A number of US rules implementing Title VII in the cross-border context are triggered when security-based swap transactions are ANE’d by personnel located in the United States. In 2016, the SEC adopted Exchange Act Rule 3a71-3(b)(1)(C)(iii) providing that, for purposes of determining whether non-US persons are required to register as SBSDs (and subject to the Title VII requirements applicable thereto), non-US persons must count against the applicable de minimis threshold security-based swap dealing transactions between non-US counterparties that are ANE’d by personnel in the United States. The SEC also incorporated the ANE criteria into the cross-border application of other Title VII rules, including the application of the business conduct provisions for nonresident SBSDs and major security-based swap participants, of Regulation SBSR’s regulatory reporting and public dissemination provisions, and of Title VII rules regarding major security-based swap participants. On the other hand, if the involvement by US persons in a transaction between foreign counterparties is so limited that the US persons are not involved with ANE’ing the transaction, the transaction between foreign counterparties should not count against the non-US person’s de minimis threshold or otherwise be subject to US regulatory requirements. Given the significance of the ANE test, market participants have sought clarity regarding the scope of activities that may be performed by US personnel without causing the transaction to count against the foreign person’s de minimis threshold.
In evaluating whether US personnel are involved in “arranging” or “negotiating” a transaction for purposes of the ANE criteria, the SEC interprets the terms as meaning “market-facing activity” of sales or trading personnel in connection with a particular transaction, including interactions with the counterparties or their agents. The SEC recognized, however, that there are circumstances where market-facing activity of US personnel is so limited that it would not implicate the regulatory interests underlying the relevant Title VII requirements. According to the SEC, one circumstance where the US personnel’s market-facing activity is so limited is when the US personnel only provide “market color” in connection with security-based swap transactions, but otherwise have no client responsibility and receive no transaction-linked compensation.
The final guidance clarifies that US personnel will not be deemed to have “arranged” or “negotiated” a transaction merely because the US personnel provide “market color” in the form of certain background information regarding pricing or market conditions associated with particular instruments or with markets more generally, so long as those US personnel do not receive transaction-linked compensation or exercise client responsibility in connection with those transactions. According to the final guidance, “market color” is limited to “background information regarding pricing or market conditions associated with particular instruments or with markets more generally in support of persons who arrange, negotiate, or execute security-based swap transaction on behalf of their clients.” “Background information,” according to the release, includes information regarding (1) current or historic pricing, volatility or market depth, and (2) trends or predictions regarding pricing, volatility or market depth as well as information related to risk management.
B. Conditional Exception to Required De Minimis Counting of Certain Dealing Transactions ANE’d by US Personnel.
The SEC adopted a conditional exemption to provisions of Exchange Act Rule 3a71-3 that excludes certain ANE transactions from counting against non US persons’ de minimis threshold for purposes of the SBSD registration requirement. The exclusion from counting ANE transactions from the de minimis threshold applies where the security-based swap dealing transactions are between non-US counterparties and US-based personnel ANE the transactions, provided the conditions of the exception are met. The conditions require, among other things, the transactions to be (1) subject to the SEC’s reporting requirements, (2) ANE’d by an associated person of a registered SBSD or registered broker-dealer (BD) (subject to certain net capital requirements), (3) subject to business conduct requirements, and (iv) subject to an interdealer cap of $50 billion across all transactions. Additionally, reliance on the exception is permitted only for entities based in certain “listed jurisdictions,” which currently are only Australia, Canada, France, Germany, Japan, Singapore, Switzerland and the United Kingdom.
In order to rely on this exemption:
- The registered entity must file with the SEC a notice that its associated persons may conduct the ANE activity.
- Each registered entity whose associated persons may conduct ANE activity pursuant to the exception must obtain from the relying entity documentation regarding the relying entity’s compliance with the limit. The registered entity must maintain this documentation for not less than three years following the ANE activity subject to the exception, the first two years in an easily accessible place.
- All transactions connected with a relying entity’s dealing activity that are ANE’d by US personnel in reliance on the exception must be reported to a security-based swap data repository and in certain cases be subject to public dissemination.
i. Compliance with “as if” SBSD Requirements.
Rule 3a71-3 requires a registered entity to comply with certain SBSD requirements, in addition to the requirements noted above, as if it were a counterparty to the transaction. If the registered entity is a BD but not a registered SBSD, the registered entity will be required to comply with the requirements as if it were registered as an SBSD. These “as if” requirements include:
- disclosure of risks, characteristics, material incentives and conflicts of interest associated with the non-US person relying on the exception (the disclosure condition);
- suitability of recommendations (the suitability condition);
- fair and balanced communications (the communications condition); and
- trade acknowledgment and verification (the trade acknowledgment and verification condition).
ii. SEC Access to Relevant Books, Records and Testimony, and Related Obligations.
Non-US persons relying on the conditional exception must promptly provide the SEC or its representatives with any information or documents within the non-US persons’ possession, custody or control related to transactions made pursuant to the exception and must make its foreign associated persons available for testimony, and provide assistance in taking the evidence of other persons, wherever located, related to those transactions. Registered entities engaging in ANE activity in the United States will be required to create and maintain all required books and records relating to the transaction at issue, trading relationship documentation involving the counterparty to the transaction from the relying entity, and written consent of the relying entity to service of process for any civil action brought by or proceeding before the SEC.
iii. Notices to Counterparties.
To rely on the exception, the registered entity must notify the counterparty that the entity relying on the exception is not registered as an SBSD and that certain Exchange Act provisions or rules do not apply to the transaction.
iv. Applicability of Financial Responsibility Requirements of a Listed Jurisdiction.
The proposed exception requires that the relying entity be subject to the margin and capital requirements of a listed jurisdiction. The Commission may issue an order designating a jurisdiction on its own initiative or in response to applications by persons that may rely on the exception, or by foreign financial authorities, which must be filed pursuant to the procedures set forth in Exchange Act Rule 0-13. In making its determination as to whether a foreign jurisdiction warrants a listed jurisdiction designation, in addition to the other requirements of the exception, the SEC may consider “factors relevant for purposes of assessing whether such a designation would be in the public interest.” Currently listed jurisdictions include Australia, Canada, France, Germany, Japan, Singapore, Switzerland and the United Kingdom.
v. Limited Exemption from Broker Registration.
Ancillary to the conditional exception for ANE activities, the release includes a limited exemption from the broker registration requirement in Section 15(a) of the Exchange Act for ANE activity that is conducted in compliance with the exception and that is with or for a counterparty that is an eligible contract participant, subject to certain disclosure requirements. Without the exemption, ANE activity could be deemed to constitute “broker” activity under the Exchange Act, subjecting SBSDs not registered as BDs serving as the registered entity to registration under Section 15(a) of the Exchange Act.3 BD registration will be required with respect to ANE activity with or for a counterparty that is not an eligible contract participant.
III. Amendment to Rule 15fb2-1 and Guidance on the Certification and Opinion of Counsel Requirements
Exchange Act Rule 15Fb2-4 requires that nonresident SBS Entities seeking to register with the Commission certify that they can, as a matter of law, and will provide the SEC with access to their books and records and submit to on-site examination. The rule also requires that nonresident SBS Entities submit with their Forms SBSE, SBSE-A or SBSE-BD, as appropriate, an opinion of counsel determining that they can, as a matter of law, provide the SEC with access to their books and records and submit to on-site examination. Market participants have raised concerns regarding the interplay between this certification and opinion of counsel requirements and various foreign block laws, privacy laws, secrecy laws and other legal requirements.
A. Conditional Certification and Opinion of Counsel.
Under Rule 15Fb2-1(d)(2) as adopted, a nonresident SBS Entity that is unable to provide the certification and opinion of counsel required by Rule 15Fb2-4(c) by the time the entity is required to register can instead provide a conditional certification and opinion of counsel. This conditional certification and opinion must identify and be conditioned upon the occurrence of a “future action” that would provide the SEC with adequate assurances of prompt access to the books and records of the nonresident SBS entity, and the ability of the nonresident SBS Entity to submit to on-site inspection and examination by the SEC. The SBSD will then be conditionally registered. If the future actions that are included in an applicant’s conditional certification and opinion of counsel do not occur within 24 months of the compliance date for Rule 15b2-1, and there is no other basis for concluding that the SEC will have the necessary access and ability to conduct on-site inspection and examination, the SEC may institute proceedings to determine whether ongoing registration should be denied.
B. Foreign Laws to Be Addressed by the Certification and Opinion of Counsel.
The SEC clarified that the SBS Entity’s certification and opinion of counsel need only address the jurisdiction(s) where the nonresident SBS Entity maintains its covered books and records rather than every jurisdiction where customers or counterparties of the nonresident SBS Entity may be located or where the nonresident SBS Entity may have additional offices or conduct business.
C. Covered Books and Records.
An SBS Entity’s certification and opinion of counsel need only address (1) books and records that relate to the “US business” (as defined in Exchange Act Rule 3a71-3(a)(8)) of the nonresident SBS Entity, and (2) financial records necessary for the SEC to assess the compliance of the nonresident SBS Entity with applicable capital and margin requirements under the Exchange Act and rules promulgated thereunder. The SEC clarified that the certification and opinion of counsel need not cover books and records held in the United States, either directly or by an associated person of the nonresident SBS Entity or a third party in accordance with Rule 18a-6(f).
An SBS Entity’s certification and opinion of counsel may be predicated upon the receipt of customer consents allowing the nonresident SBS Entity to promptly provide the SEC with access to its books and records and submit to on-site inspection and examination. In the event a counterparty subsequently withdraws consent, the SEC stated its view that the withdrawals should not affect the validity of transactions entered into when the counterparty’s consent was in force. Further, the counterparty’s withdrawal of consent would not necessarily require an amendment of an SBS Entity’s certification and opinion of counsel under Exchange Rule 15b2-4(c)(2). The SBS Entity will still need to comply with the underlying requirements of Exchange Act Section 15F(f)(1)(C) and of Exchange Act Rule 18a-6(g), and the SEC encourages nonresident SBS Entities to explore whether an alternative basis exists under foreign privacy laws to permit the nonresident SBS Entity to collect and maintain the necessary data and to provide the information to SEC staff.
E. Open Contracts.
An SBS Entity’s certification and opinion of counsel will not need to address the books and records of security-based swap transactions that were entered into prior to the date on which a nonresident SBS Entity submits an application for registration, pursuant to Section 15F(b) of the Exchange Act, which the nonresident SBS Entity continues to hold on its books and records and under which it may have continuing obligations.
F. Memoranda of Understanding, Agreements, Protocols or Other Regulatory Arrangements with Foreign Financial Regulatory Authorities.
A nonresident SBS Entity’s certification and opinion of counsel may take into account whether the relevant regulatory authority in a foreign jurisdiction has entered into a memorandum of understanding, agreement, protocol or other regulatory arrangement providing the SEC with adequate assurances of (1) prompt access to the books and records of the nonresident SBS Entity, and (2) the ability of the nonresident SBS Entity to submit to on-site inspection or examination by the SEC.
IV. Amendment to SEC Rule of Practice 194 (Cross-border Application of Statutory Disqualification Provision)
Exchange Act Section 15F(b)(6) makes it unlawful for an SBS Entity to permit an associated person who is subject to a statutory disqualification to effect or be involved in effecting security-based swaps on behalf of the SBS Entity if the SBS Entity knew, or in the exercise of reasonable care should have known, of the statutory disqualification, “[e]xcept to the extent otherwise specifically provided by rule, regulation, or order of the Commission.” SEC Rule of Practice 194 provides, among other things, a process by which an SBS Entity could apply to the SEC so that the SEC can assess on a case-by-case basis whether to grant relief from the statutory disqualification prohibition in Exchange Act Section 15F(b)(6).
The SEC adopted amendments to Rule of Practice 194 to more closely harmonize the SEC’s rules with the CFTC’s approach to the statutory disqualification of non-US associated persons of CFTC registered swap entities. An SBS Entity would not be able to avail itself of the exclusion provided in Rule of Practice 194(c)(2) if the associated person of that SBS Entity is currently subject to an order—i.e., an affirmative determination by the SEC, the CFTC, a self-regulatory organization (SRO) or a foreign financial regulatory authority—prohibiting such associated person from participating in the US financial market, including the US securities or swaps market, or the foreign financial markets of the jurisdiction in which the associated person is employed. In such circumstances, affected SBS Entities will be required to apply for relief under Rule of Practice 194 and will be unable to allow their disqualified associated person entities to effect or be involved in effecting security-based swaps on their behalf, pending review by the SEC.
V. Modification to Rule 18a-5 (Questionnaires and Employment Applications)
The SEC modified recordkeeping requirements for SBSDs relating to questionnaires or applications for employment under proposed Exchange Act Rule 18a-5 to provide that SBSDs are not required to maintain a questionnaire for persons excluded from the statutory disqualification prohibition in Exchange Section 15F(b)(6) (such as due to the amendment to Rule of Practice 194, discussed above). The SEC also adopted modifications to Rule 18a-5 to provide that a questionnaire or application for employment executed by an associated person who is not a US person need not include certain information prohibited by the law of a non-US jurisdiction. Notwithstanding this recordkeeping relief, the SBS Entity must comply with Section 15F(b)(6) of the Exchange Act.