SEC Proposes Title VII Regulatory Framework for Non-US Dealers Transacting in the United StatesApril 30, 2015
The U.S. Securities and Exchange Commission (the “SEC”) reproposed rules addressing the application of certain requirements under Title VII of the Dodd-Frank Act (the “Reproposal”) to non-U.S. persons dealing in security-based swaps (“SBSs”), where the transactions, or certain aspects of the transactions, take place in the United States.1
I. Amendments to De Minimis Counting Requirements
Under the Reproposal and in addition to the circumstances set forth in the Cross-Border Final Rules,2 an SBS-dealing transaction that is entered into by a non-U.S. person and is “arranged, negotiated or executed” (“ANE”) through personnel located in a U.S. branch or office, or through an (affiliated or unaffiliated) agent of such non-U.S. person located in the United States (such transaction, an “ANE Transaction”), will count toward that non-U.S. person’s de minimis threshold for registration as a security-based swap dealer (“SBSD”) regardless of whether the counterparty or any guarantor is a “U.S. person.”3
II. What Is an ANE Transaction?
The Reproposal does not define the meaning of “arranged, negotiated or executed” in the rule text; rather, the Reproposal preamble provides guidance on the meaning of these terms.4 A transaction generally is considered to be an ANE Transaction if it involves (1) “market-facing” activity (i.e., the activity of sales and trading personnel, including communications with potential counterparties) that is (2) conducted through a permanent location in the territorial United States, (3) whether by personnel of the non-U.S. person or an (affiliated or unaffiliated) agent of such person.
Notably, it appears that only activities conducted by personnel or agents of the non-U.S. person that involve material, trade-specific economic terms of SBS transactions would be considered to be “market-facing” under the proposed rules. Thus, certain activities could be conducted in the U.S. without rendering such a transaction an ANE Transaction, including:
- collateral management activities (e.g., the exchange of margin payments);
- the preparation of master agreement documentation and/or collateral terms;
- the submission of SBS transactions for clearing; and
- reporting SBS transactions to swap execution facilities.
In addition, the involvement of U.S.-based attorneys in the negotiation of the terms and/or legal documentation for a transaction would not, by itself, bring a transactions within scope.
The Reproposal replaces an aspect of the Original Proposal that would have required a dealing party to consider the location of its counterparty’s trading personnel (as well as whether the counterparty or its guarantor was a U.S. person) in determining whether a given transaction is required to be counted against its de minimis threshold. Under the Reproposal, a non-U.S. person would need only to look to the location of its own SBS dealing activity in making this determination. However, ANE Transactions must be counted against the de minimus threshold even if executed anonymously on a security-based swap execution facility, since the identity of the counterparty is irrelevant for purposes of the determination.
With regard to ANE Transactions executed through an agent (instead of an employee of the SBSD), the SEC provisionally rejected a proposal by commenters on the Original Proposal to limit its regulation to the agent (using its authority to regulate the agent as a “broker” under the existing Exchange Act). The SEC did so because it reasoned that (1) banks acting as agents would be outside the scope of SEC jurisdiction (pursuant to various exemptions from the definition of “broker” in the Exchange Act) and (2) the SEC enforcement of the Exchange Act’s antifraud and market integrity provisions could be frustrated by difficulties in obtaining the books and records of the principal.5 The SEC specifically requested comment on the treatment of this issue – i.e., how it should regulate agents of SBSDs, since SBSs are also “securities” under the securities laws and acting as a “broker” of such products could subject a person to broker-dealer registration.
III. External Business Conduct Requirements; Additional Aspects of the Reproposal
- In line with the CFTC Staff Advisory discussed in footnote 4 below, the Reproposal would apply the SEC's (yet-to-be-adopted) external business conduct requirements to ANE Transactions of non‑U.S. SBSDs with non-U.S. counterparties.6
- The Reproposal dropped an aspect of the Original Proposal that would have required an SBS between a registered non-U.S. SBSD and a non-U.S. counterparty to be subject to mandatory clearing and trading requirements. This exclusion would extend to ANE Transactions of non‑U.S. SBSDs.
- The scope of the SBS trade reporting requirements under recently adopted Reg. SBSR7 would be amended by:
- requiring all ANE Transactions (including ANE Transactions of non-U.S. “de minimis” dealers) to be both reported and publicly disseminated;
- changing the reporting hierarchy so that when a non-U.S. de minimis dealer faces a U.S. person, the parties may choose who reports (rather than putting the burden on the U.S. person); and
- requiring reporting when two non-U.S. persons trade through a U.S. platform or broker-dealer (reporting would be done by the platform or broker-dealer).
IV. Initial Commentary
The CFTC also uses the phrase "arranged, negotiated or executed" to describe trades that are entered into by non-U.S. swap dealers but which have a territorial connection with the United States that brings them within the scope of U.S. jurisdiction. However, the CFTC has provided far less guidance than the SEC on how the phrase should be interpreted. If the CFTC were to formally (or even informally) adopt the interpretation provided by the SEC, there would be two material benefits: first, the market's uncertainty about how the CFTC interprets the term would be reduced and second, non-U.S. swap dealers could conduct their SEC and CFTC-regulated swaps activities under fairly consistent guidance as to the extent of U.S. jurisdiction.
Separately, the SEC's approach to the application of the cross-border rules assumes that an agent, which is a different legal entity than the swap dealer, could be responsible for complying with the relevant requirements as to sales practices. The SEC asks specifically for comment on the legal structure through which sales practice duties may be imposed on such an entity. The absence of that structure is a material gap in the CFTC rules, which do not provide any clear method for an entity acting as a swaps broker to use to comply with sales practice requirements for swaps. Such a structure would be particularly useful in situations in which a U.S. entity is acting as sales agent for a non-U.S. swap dealer.
1 See Exchange Act Release No. 74834 (Apr. 29, 2015) (the “Reproposal”). See also Exchange Act Release No. 72472, 79 Fed. Reg. 47278 (Aug. 12, 2014) (the “Cross-Border Final Rules”); Exchange Act Release No. 69490, 78 Fed. Reg. 30968 (May 23, 2013) (the “Original Proposal”). Please see our summaries of the Cross-Border Final Rules and the Original Proposal here and here in the Cadwalader Cabinet.
2 Under Exchange Act Rule 3a71-3 as adopted, a non-U.S. person that is not a “conduit affiliate” generally must count, for de minimis purposes, SBS transactions (1) with U.S. persons other than non-U.S. branches of SBSDs and (2) where the counterparty has rights of recourse against a U.S. person that is an affiliate of the non-U.S. person. The Reproposal does not make any changes to these aspects of Rule 3a71-3.
4 See Reproposal at pp. 77-88. Notably, in defining what an “ANE Transaction” is, the SEC considered - at some length - how commenters responded to the CFTC’s request for comments on a similar and highly controversial issue under the Commodity Exchange Act. See Reproposal at pp. 56-63 (discussing CFTC Staff Advisory No. 13-69 (Applicability of Transaction-Level Requirements to Activity in the United States) and the subsequent withdrawal of the advisory and request for comment, 79 Fed. Reg. 1347 (Jan. 8, 2014)).
6 See Exchange Act Release No. 42396, 76 Fed. Reg. 42396 (July 18, 2011).
7 See here for a summary of the SBS reporting rules on the Cadwalader Cabinet.