Application of Certain Title VII Requirements to Security-Based Swap Transactions Connected With a Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent

Federal RegisterMay 13, 2015

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242

[Release No. 34-74834; File No. S7-06-15]

RIN 3235-AL73

Application of Certain Title VII Requirements to Security-Based Swap Transactions Connected With a Non-U.S. Person's Dealing Activity That Are Arranged, Negotiated, or Executed by Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rules.

SUMMARY:

The Securities and Exchange Commission (“SEC” or “Commission”) is publishing for comment proposed amendments and a re-proposed rule to address the application of certain provisions of the Securities Exchange Act of 1934 (“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. The Commission is proposing amendments to Exchange Act rules 3a71-3 and 3a71-5 that would address the application of the

de minimis

exception to security-based swap transactions connected with a non-U.S. person's security-based swap dealing activity that are arranged, negotiated, or executed by personnel of such person located in a U.S. branch or office, or by personnel of such person's agent, located in a U.S. branch or office. The Commission is also re-proposing Exchange Act rule 3a71-3(c) and proposing certain amendments to Exchange Act rule 3a71-3(a) to address the applicability of external business conduct requirements to the U.S. business and foreign business of registered security-based swap dealers. The Commission also is proposing amendments to Regulation SBSR to apply the regulatory reporting and public dissemination requirements to transactions that are arranged, negotiated, or executed by personnel of non-U.S. persons, or personnel of such non-U.S. persons' agents, that are located in the United States and to transactions effected by or through a registered broker-dealer (including a registered security-based swap execution facility), along with certain related issues, including requiring registered broker-dealers (including registered security-based swap execution facilities) to report certain transactions that are effected by or through the registered broker-dealer.

DATES:

Comments should be received on or before July 13, 2015.

ADDRESSES:

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

); or

• Send an email to

rule-comments@sec.gov

. Please include File Number S7-06-15 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 to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-06-15. 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 are also 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; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

Studies, memoranda, or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the SEC's Web site. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at

www.sec.gov

to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:

Carol McGee, Assistant Director, Richard Gabbert, Senior Special Counsel, or Margaret Rubin, Special Counsel, Office of Derivatives Policy, at 202-551-5870, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission is proposing the following rules under the Exchange Act regarding the application of Subtitle B of Title VII of the Dodd-Frank Act to cross-border activities.

The Commission is proposing to amend the following rules under the Exchange Act: Rule 3a71-3 (addressing the cross-border implementation of the

de minimis

exception to the “security-based swap dealer” definition and the definition of certain terms); rule 3a71-5 (regarding availability of an exception from the dealer

de minimis

analysis for cleared anonymous transactions that fall within proposed rule 3a71-3(b)(1)(iii)(C)); and Rules 900, 901, 906, 907, 908(a)(1), and 908(b) of Regulation SBSR. The Commission also is re-proposing Exchange Act rule 3a71-3(c) (application of external business conduct requirements).

I. Background

A. Scope of This Rulemaking

B. The Dodd-Frank Act

C. The Cross-Border Proposing Release

D. The CFTC Staff Advisory

E. Comments on the Proposed Definition of “Transaction Conducted Within the United States” and Application of the Definition in the Cross-Border Proposing Release

II. Economic Considerations and Baseline Analysis

A. Broad Economic Considerations

B. Baseline

1. Current Security-Based Swap Market

2. Levels of Security-Based Swap Trading Activity

3. Regulatory Reporting, Clearing, and Trade Execution of Security-Based Swap Transactions

4. Global Regulatory Efforts

5. Cross-Market Participation

III. Application of the Dealer De Minimis Exception to U.S. Security-Based Swap Dealing Operations of Non-U.S. Persons

A. Overview

B. Proposed Application of De Minimis Exception to Non-U.S. Persons Arranging, Negotiating, or Executing Security-Based Swap Transactions Using Personnel Located in a U.S. Branch or Office

1. Overview of the Initially Proposed Approach

2. Commenters' Views on the Cross-Border Proposing Release

3. The CFTC Staff Advisory and Responses to the CFTC Request for Comment

4. Dealing Activity of Non-U.S. Persons in the United States

5. Proposed Amendments Regarding Application of the Dealer de minimis Exception to Non-U.S. Persons Using Personnel Located in a U.S. Branch or Office to Arrange, Negotiate, or Execute Security-Based Swap Transactions

6. Other Commenter Concerns and Alternatives

7. Request for Comment

C. Availability of the Exception for Cleared Anonymous Transactions

1. Proposed Rule

2. Request for Comment

IV. Application of the External Business Conduct Requirements to the Foreign Business and U.S. Business of Registered Security-Based Swap Dealers

A. Overview

B. Statutory Framework for External Business Conduct

C. Prior Proposals

1. Business Conduct Proposal

2. Cross-Border Proposing Release

D. Comments

E. Discussion

F. Request for Comment

V. Application of Other Requirements to Cross-Border Security-Based Swap Activity

A. Overview

B. Previously Proposed and Adopted Rules Relating to Application of Clearing, Trade Execution, Regulatory Reporting, and Public Dissemination Requirements

1. Mandatory Clearing and Trade Execution

2. Regulatory Reporting and Public Dissemination

C. Commenters' Views

1. General Comments on Application of Clearing, Trade Execution, Regulatory Reporting, and Public Dissemination Requirements

2. Comments on Mandatory Clearing and Mandatory Trade Execution

3. Comments on Regulatory Reporting and Public Dissemination

4. The CFTC Staff Advisory and Responses to the CFTC Request for Comment

D. Mandatory Clearing and Trade Execution

E. Regulation SBSR

1. Statutory Framework

2. Proposed Amendments Regarding Application of Regulation SBSR to Certain Security-Based Swap Transactions

3. Application of the Public Dissemination Requirement to Certain Transactions

4. Proposed Amendments Regarding Limitations on Reporting Obligations of Certain Persons Engaged in Security-Based Swaps Subject to Regulation SBSR

5. Proposed Amendment Regarding Reporting Duties of Certain Persons That Are Not Registered Security-Based Swap Dealers or Registered Major Security-Based Swap Participants

6. Proposed Amendments to Rules 900(u), 901(d)(9), 906(b), 906(c), and 907(a) of Regulation SBSR to Accommodate Proposed Rule 901(a)(2)(ii)(E)(4)

7. Availability of Substituted Compliance

F. Request for Comment

1. Mandatory Clearing and Trade Execution

2. Regulation SBSR

VI. Economic Analysis of the Proposed Rules

A. Assessment Costs

1. Discussion

2. Request for Comment

B. Programmatic Costs and Benefits

1. De minimis Exception

2. External Business Conduct Requirements

3. Regulatory Reporting and Public Dissemination

4. Efficiency, Competition, and Capital Formation

5. Request for Comment

C. Alternatives Considered

1. Retention of the Definition of “transaction conducted within the United States”

2. Limited Exception from Title VII Requirements for Transactions Arranged, Negotiated, and Executed by Associated Persons of Broker-Dealers

3. Exclusion of Security-Based Swap Transactions That Do Not Involve a U.S.-Person Counterparty, a Counterparty Whose Obligations Under the Security-Based Swap are Guaranteed by a U.S. Person, or a Conduit Affiliate From the de minimis Threshold Requirements

4. Extension of the Activity-Based Test to the Clearing and Execution Requirements

VII. Paperwork Reduction Act

A. Introduction

B. Reporting Obligations—Rule 901

1. Summary of Collection of Information

2. Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens of Rule 901 of Regulation SBSR

C. Correction of Errors in Security-Based Swap Information—Rule 905

1. Summary of Collection of Information

2. Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

D. Policies and Procedures for Registered Broker-Dealers—Rule 906(c)

1. Summary of Collection of Information

2. Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

E. Collection of Information is Mandatory

F. Confidentiality of Responses to Collection of Information

G. Request for Comment

VIII. Consideration of Impact on the Economy

IX. Regulatory Flexibility Act Certification

A. Certification for Proposed Rule and Proposed Amendments to Exchange Act Rules 3a71-3 and 3a71-5

B. Initial Regulatory Flexibility Analysis for Proposed Amendments to Regulation SBSR

1. Reasons for, and Objectives of, the Proposed Action and Legal Basis

2. Small Entities Subject to the Proposed Rules

3. Projected Reporting, Recordkeeping and Other Compliance Requirements

4. Duplicative, Overlapping or Conflicting Federal Rules

5. Significant Alternatives

6. Solicitation of Comment

X. Statutory Basis and Text of Proposed Rules

I. Background

A. Scope of This Rulemaking

The Commission is proposing to amend certain rules and is re-proposing a rule regarding the application of Title VII of the Dodd-Frank Act

(“Title VII”) to cross-border security-based swap transactions and persons engaged in those transactions. The proposed amendments include rules regarding the application of the

de minimis

exception to the dealing activity of non-U.S. persons carried out, in relevant part, by personnel located in the United States,

and the application of Regulation SBSR

to such transactions and to transactions effected by or through a registered broker-dealer, along with certain related issues. We are also re-proposing a rule regarding the application of external business conduct requirements to the foreign business and U.S. business of registered security-based swap dealers.

Public Law 111-203, 124 Stat. 1376 (2010). Unless otherwise indicated, references to Title VII in this release are to Subtitle B of Title VII.

In this release, unless otherwise noted, we use the terms “personnel located in the United States” or “personnel located in a U.S. branch or office” interchangeably to refer to personnel of the non-U.S. person engaged in security-based swap dealing activity who are located in a U.S. branch or office, or to personnel of an agent of such non-U.S. person who are located in a U.S. branch or office.

Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information; Final Rule, Exchange Act Release No. 74244 (February 11, 2015), 80 FR 14563 (March 19, 2015) (“Regulation SBSR Adopting Release”). With these proposed rules and rule amendments, the Commission is not re-opening comment on the rules adopted in Regulation SBSR Adopting Release.

Each of these issues was considered in our May 23, 2013 proposal, in which we proposed rules regarding the application of Title VII in the cross-border context more generally.

On June 25, 2014, we adopted rules and guidance based on the May 23, 2013 proposal addressing the application of the “security-based swap dealer” and “major security-based swap participant” definitions to cross-border security-based swap activities.

In that release, among other things, we adopted rules specifying which cross-border transactions must be included in a person's security-based swap dealer

de minimis

or major security-based swap participant calculations.

We explained,

however, that we were not addressing the application of the “security-based swap dealer” definition to “transaction[s] conducted within the United States” because commenters had raised several significant issues related to this requirement of the proposal.

We stated that we anticipated soliciting additional public comment on the application of the “security-based swap dealer” definition to transactions between two non-U.S. persons where one or both are conducting dealing activity within the United States.

See

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, Exchange Act Release No. 69490 (May 1, 2013), 78 FR 30968 (May 23, 2013) (“Cross-Border Proposing Release”).

See

Application of “Security-Based Swap Dealer” and “Major-Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities, Exchange Act Release No. 72472 (June 25, 2014), 79 FR 47278 (August 12, 2014 (republication)) (“Cross-Border Adopting Release”). With these proposed rules and rule amendments the Commission is not re-opening comment on the rules adopted in the Cross-Border Adopting Release.

See id.

at 47279.

See id.

at 47279-80.

See id.

at 47280.

In this release, we propose amendments to Exchange Act rules 3a71-3 and 3a71-5 that reflect a modified approach to this element of the initial proposal and solicit comment on the proposed amendments and re-proposed rule. The proposed amendments would address the activity of a non-U.S. person in the United States in a way that more closely focuses on where personnel of the non-U.S. person engaged in dealing activity (or on where personnel of its agent) are arranging, negotiating, or executing a security-based swap. The proposed amendments would not require a non-U.S. person engaging in dealing activity to consider the location of its non-U.S.-person counterparty or the counterparty's agent in determining whether the transaction needs to be included in its own

de minimis

calculation. Instead, the proposed amendments would require a non-U.S. person to include in its

de minimis

calculation any transaction with another non-U.S. person that is, in connection with its dealing activity, arranged, negotiated, or executed by personnel of the non-U.S. person located in a U.S. branch or office or by personnel of the non-U.S. person's agent located in a U.S. branch or office.

We also are re-proposing rules regarding the application of the external business conduct requirements to the foreign business of registered security-based swap dealers, and we are proposing to amend Regulation SBSR to address the reporting and public dissemination requirements applicable to security-based swap transactions involving non-U.S. persons that engage in relevant activity in the United States and to transactions effected by or through a registered broker-dealer, along with certain related issues.

B. The Dodd-Frank Act

Title VII of the Dodd-Frank Act provides for a comprehensive new regulatory framework for swaps and security-based swaps. Under this framework, the Commodity Futures Trading Commission (“CFTC”) regulates “swaps” while the Commission regulates “security-based swaps,” and the Commission and CFTC jointly regulate “mixed swaps.” The new framework encompasses the registration and comprehensive regulation of security-based swap dealers and major security-based swap participants, as well as requirements related to clearing, trade execution, regulatory reporting, and public dissemination.

Security-based swap transactions are largely cross-border in practice,

and the various market participants and infrastructures operate in a global market. Dealers and other market participants may transact extensively with counterparties established or located in other jurisdictions and, in doing so, may conduct sales and trading activity in one jurisdiction and book the resulting transactions in another. These market realities and the potential impact that these activities may have on U.S. persons and potentially the U.S. financial system have informed our consideration of these proposed rules.

We have proposed a series of rules regarding these matters.

See

Cross-Border Proposing Release, 78 FR 30972 nn.11-18.

The Dodd-Frank Act further provides that the SEC and CFTC jointly should further define certain terms, including “security-based swap dealer” and “major security-based swap participant.”

See

Dodd-Frank Act section 712(d). Pursuant to that requirement, the SEC and CFTC jointly adopted rules to further define those terms.

See

Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” Exchange Act Release No. 66868 (April 27, 2012), 77 FR 30596 (May 23, 2012) (“Intermediary Definitions Adopting Release”);

see also

Cross-Border Proposing Release, 78 FR 30972 n.9 (discussing joint rulemaking to further define various Title VII terms).

See

Section II.B.2,

infra,

regarding the preponderance of cross-border activity in the security-based swap market.

In developing this proposal, we have consulted and coordinated with the CFTC, the prudential regulators,

and foreign regulatory authorities in accordance with the consultation mandate of the Dodd-Frank Act.

More generally, as part of our domestic and international efforts, Commission staff has participated in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC derivatives.

Through these discussions and the Commission staff's participation in various international task forces and working groups,

we have gathered information about foreign regulatory reform efforts and their impact on and relationship with the U.S. regulatory regime. We have taken this information into consideration in developing this proposal.

The term “prudential regulator” is defined in section 1a(39) of the CEA, 7 U.S.C. 1a(39), and that definition is incorporated by reference in section 3(a)(74) of the Exchange Act, 15 U.S.C. 78c(a)(74). Pursuant to the definition, the Board of Governors of the Federal Reserve System (“Federal Reserve Board”), the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration, or the Federal Housing Finance Agency (collectively, the “prudential regulators”) is the “prudential regulator” of a security-based swap dealer or major security-based swap participant if the entity is directly supervised by that regulator.

Section 712(a)(2) of the Dodd-Frank Act provides in part that the Commission shall “consult and coordinate to the extent possible with the Commodity Futures Trading Commission and the prudential regulators for the purposes of assuring regulatory consistency and comparability, to the extent possible.”

In addition, section 752(a) of the Dodd-Frank Act provides in part that “[i]n order to promote effective and consistent global regulation of swaps and security-based swaps, the Commodity Futures Trading Commission, the Securities and Exchange Commission, and the prudential regulators . . . as appropriate, shall consult and coordinate with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation (including fees) of swaps.”

Senior representatives of authorities with responsibility for regulation of OTC derivatives have met on a number of occasions to discuss international coordination of OTC derivatives regulations.

See, e.g.,

Report of the OTC Derivatives Regulators Group (“ODRG”) on Cross-Border Implementation Issues November 2014 (November 7, 2014), available at:

http://www.cftc.gov/ucm/groups/public/@internationalaffairs/documents/file/oia_odrgreportg20_1114.pdf

Commission representatives participate in the Financial Stability Board's Working Group on OTC Derivatives Regulation (“ODWG”), both on the Commission's behalf and as the representative of the International Organization of Securities Commissions (“IOSCO”), which is co-chair of the ODWG. A Commission representative also serves as one of the co-chairs of the IOSCO Task Force on OTC Derivatives Regulation.

C. The Cross-Border Proposing Release

Our prior proposals and final rules regarding the application of Title VII to security-based swap activity carried out in the cross-border context (including to persons engaged in such activities) reflect the global nature of the security-based swap market and its development prior to the enactment of the Dodd-Frank Act.

We also noted our preliminary belief that dealing activity carried out by a non-U.S. person through a branch, office, affiliate, or an agent acting on its behalf in the United States may raise concerns that Title VII addresses, even if a significant proportion—or all—of those transactions involve non-U.S.-person counterparties.

We initially proposed to require any non-U.S. person engaged

in dealing activity to include in its

de minimis

calculation any “transaction conducted within the United States.” Thus, under the Cross-Border Proposing Release, a non-U.S. person engaged in dealing activity would have been required to include in its

de minimis

calculation any transaction where either the person itself or its counterparty performed relevant security-based swap activity within the United States.

See

Cross-Border Proposing Release, 78 FR 30975-76; Regulation SBSR Adopting Release, 80 FR 14724.

See

Cross-Border Proposing Release, 78 FR 31000-01.

The Cross-Border Proposing Release also included proposed rules regarding the application of the clearing, trade execution, regulatory reporting, and public dissemination requirements. Under the rules proposed in that release, the clearing requirement and the trade execution requirement also would have applied to a “transaction conducted within the United States,” a transaction having a U.S.-person counterparty, or a transaction having a counterparty that is a non-U.S. person whose counterparty has a right of recourse against a U.S. person,

with certain exceptions.

The regulatory reporting requirement under that proposal would have applied to a “transaction conducted within the United States,” a transaction in which either side of the security-based swap includes an indirect or direct U.S. person counterparty, a transaction in which a security-based swap dealer or major security-based swap participant is a direct or indirect counterparty to the security-based swap, or a transaction that is cleared through a clearing agency having its principal place of business in the United States.

The public dissemination requirement would have applied to a “transaction conducted within the United States,” a transaction in which a U.S. person is a direct or indirect counterparty on

each

side of the security-based swap, a transaction in which at least one direct counterparty is a U.S. person (except in the case of a transaction conducted through a foreign branch), a transaction in which 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 a transaction cleared through a clearing agency having its principal place of business in the United States.

In this release, we use the terms “non-U.S. persons whose counterparties have a right of recourse against a U.S. person under a security-based swap,” “non-U.S. persons whose obligations under a security-based swap are guaranteed by a U.S. person,” and “guaranteed non-U.S. persons” interchangeably.

See

initially proposed Exchange Act rules 3Ca-3 and 3Ch-1.

See

rule 908(a)(1), as re-proposed in the Cross-Border Proposing Release.

See

rule 908(a)(2), as re-proposed in the Cross-Border Proposing Release.

D. The CFTC Staff Advisory

In November 2013, the CFTC's Division of Swap Dealer and Intermediary Oversight issued a Staff Advisory (“CFTC Staff Advisory”) addressing the applicability of the CFTC's transaction-level requirements to certain activity by non-U.S. registered swap dealers arranged, negotiated, or executed by personnel or agents of the non-U.S. swap dealer located in the United States.

The CFTC Staff Advisory stated CFTC staff's belief that the CFTC “has a strong supervisory interest in swap dealing activities that occur within the United States, regardless of the status of the counterparties” and that a non-U.S. swap dealer “regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person generally would be required to comply with” the CFTC's transaction-level requirements.

On January 8, 2014, the CFTC published a request for comment on various aspects of the CFTC Staff Advisory, including whether the CFTC “should adopt the Staff Advisory as Commission policy, in whole or in part.”

In response to this request, the CFTC received approximately 20 comment letters addressing various aspects of the CFTC Staff Advisory.

CFTC staff subsequently extended no-action relief related to the CFTC Staff Advisory until the earlier of September 30, 2015, or the effective date of any CFTC action in response to the CFTC Request for Comment.

We understand that the CFTC Staff Advisory and comments received in response to the CFTC Request for Comment are under review at the CFTC.

See

CFTC Staff Advisory No. 13-69, “Division of Swap Dealer and Intermediary Oversight Advisory: Applicability of Transaction-Level Requirements to Activity in the United States” (November 14, 2013), available at:

http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-69.pdf

In the Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (July 17, 2013), 78 FR 45292 (July 26, 2013) (“CFTC Cross-Border Guidance”), the CFTC defined transaction-level requirements to include the following: (i) Required clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) mandatory trade execution; (iv) swap trading relationship documentation; (v) portfolio reconciliation and compression; (vi) real-time public reporting; (vii) trade confirmation; (viii) daily trading records; and (ix) external business conduct standards.

See

CFTC Cross-Border Guidance, 78 FR 45333.

Id.

at 2.

See

Request for Comment on Application of Commission Regulations to Swaps Between Non-U.S. Swap Dealers and Non-U.S. Counterparties Involving Personnel or Agents of the Non-U.S. Swap Dealers Located in the United States, 79 FR 1347 (January 8, 2014) (“CFTC Request for Comment”).

The comment file is available at

http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1452

See

Extension of No-Action Relief: Transaction-Level Requirements for Non-U.S. Swap Dealers, CFTC Letter No. 14-140 (November 14, 2014), available at:

http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/14-140.pdf

E. Comments on the Proposed Definition of “Transaction Conducted Within the United States” and Application of the Definition in the Cross-Border Proposing Release

A number of commenters on our Cross-Border Proposing Release addressed the definition of “transaction conducted within the United States.” Although two commenters supported our proposed use of this defined term,

commenters generally criticized the proposed definition. These criticisms generally focused on four areas: The scope of activity potentially captured by the initially proposed defined term, the operational difficulties of implementing the defined term, the costs of implementation, and competitive concerns. Market participants also expressed a variety of views on the application of the regulatory reporting, public dissemination, clearing, and trade execution requirements. Several market participants opposed the application of the requirements to “transaction[s] conducted within the United States” because of concerns about workability or the scope of the statute, while other commenters argued that the application of the requirements should be expanded to apply to any “transaction conducted within the United States.”

In light of these

comments and our understanding of the structure of the security-based swap market, we determined that our proposed treatment of “transactions conducted within the United States” would benefit from further consideration and solicitation of further comment.

See

Letter from Citadel Letter to SEC, dated August 21, 2013 (“Citadel Letter”) at 1-2; Letter from ABA to SEC, dated October 2, 2013 (“ABA Letter”) at 3 (noting that the initially proposed conduct-based approach is consistent with longstanding Commission practice but also noting potential ambiguities). One of these commenters supported the initially proposed definition because it would help ensure that Title VII requirements applied to security-based swaps of offshore funds with a connection to the United States.

See

Citadel Letter at 1-2.

These comments are discussed in further detail below, in Sections III.B.2, IV.D, and V.C. As reflected in our discussion throughout this release, we have carefully considered both the CFTC Staff Advisory and the comments submitted in response to the CFTC's request for comment on the CFTC Staff Advisory in developing this proposal. Moreover, in connection with our statutory obligation to consult with the CFTC in connection with Title VII rulemaking, our staff have engaged in extensive discussion with CFTC staff regarding our proposed rules. We note, however, that our discussion of both the CFTC Staff Advisory and the comments received by the CFTC about it reflects our understanding of these documents. Accordingly, neither our discussions of these documents nor any preliminary views expressed herein should be interpreted as necessarily

reflecting the views of any other agency or regulator, including the CFTC.

II. Economic Considerations and Baseline Analysis

A. Broad Economic Considerations

These proposed amendments and re-proposed rule would determine when a non-U.S. person whose obligations under a security-based swap are not guaranteed by a U.S. person and that is not a conduit affiliate is required to include in its dealer

de minimis

calculation transactions with another non-U.S. person and when certain regulatory requirements apply to these and certain other transactions. To provide context for understanding our proposed rules and the related economic analysis that follows, this section discusses how this particular proposal fits within the Title VII framework and identifies broad economic considerations that we preliminarily believe underlie the proposal's likely economic effects.

This analysis considers the effects of the proposed rules on security-based swap market participants and transactions that, as a result of these proposed rules, would be subject to rules that we have already adopted, or that we have proposed but not yet adopted, pursuant to Title VII. In particular, we consider the potential adverse effect on market participants of a security-based swap market that may remain opaque to regulators and market participants and that may lack robust customer protections.

We also consider possible competitive disparities arising under current and proposed rules.

See

Section VI.B.2,

infra,

for further discussion of the economic effects of our proposed application of external business conduct requirements.

See

Section III.B.4,

infra,

for a discussion of how our proposed approach would support regulatory transparency.

Title VII provides a statutory framework for the OTC derivatives market and divides authority to regulate that market between the CFTC (which regulates swaps) and the Commission (which regulates security-based swaps). The Title VII framework requires certain market participants to register with the Commission as security-based swap dealers or major security-based swap participants and subjects such entities to certain requirements. The Title VII framework mandates that we establish rules that apply to certain security-based swap transactions, including mandatory clearing, mandatory trade execution, regulatory reporting, and public dissemination.

These proposed amendments and re-proposed rule, together with our previously adopted rules defining “security-based swap dealer” and “major security-based swap participant” and applying those definitions in the cross-border context, would define the scope of entities and transactions that are subject to the requirements of Title VII. Although these proposed amendments and re-proposed rule do not define the specific substantive requirements, the scope of application that they define will play a central role in determining the overall costs and benefits of particular regulatory requirements, and of the Title VII regulatory framework as a whole.

For example, to the extent that the proposed application of the

de minimis

exception leads to a higher number of registered security-based swap dealers, it is reasonable to expect that the aggregate costs and benefits associated with requirements applicable to such dealers will increase.

See

Cross-Border Adopting Release, 79 FR 47327 (stating that the registration and regulation of entities as security-based swap dealers and major security-based swap participants will lead to programmatic costs and benefits).

See

Section VI.B.1,

infra.

Several broad economic considerations have informed our proposed approach to identify transactions between two non-U.S. persons that should be subject to certain Title VII requirements. First, to the extent that a financial group carries out security-based swap business in the United States, our ability to monitor dealers for market manipulation or other abusive practices may be limited, even with respect to a registered security-based swap dealer's security-based swaps with U.S. persons. For example, permitting a financial group to carry out a dealing business with U.S. persons through a registered security-based swap dealer and to hedge transactions arising out of that business in the inter-dealer market using the same personnel operating out of the same branch or office in the United States, but acting on behalf of an unregistered non-U.S.-person affiliate, would limit our ability to obtain records that would facilitate our ability to identify potentially abusive conduct in connection with the U.S. person's transactions with U.S.-person counterparties both within the security-based swap market as well as in markets for related underlying assets, such as corporate bonds. Moreover, a non-U.S. person engaged in dealing activity with non-U.S. persons in the United States but not subject to Regulation SBSR would not be required to report its trades, which could make it more difficult for the Commission to monitor that activity for compliance with the federal securities laws and could reduce the transparency of prices in the security-based swap market in the United States. The proposed rules thus reflect our assessment of the impact that the scope of security-based swap transactions and security-based swap dealers subject to regulatory reporting and relevant security-based swap dealer requirements (such as external business conduct standards and recordkeeping and reporting requirements) may have on our ability to detect abusive and manipulative practices in the security-based swap market.

Second, in formulating these proposed rules, we have taken into account the potential impact that rules adopted as part of the Intermediary Definitions Adopting Release and the Cross-Border Adopting Release might have on competition between U.S. persons and non-U.S. persons when they engage in security-based swap transactions with non-U.S. persons, and the implications of these competitive frictions for market integrity. As noted in prior Commission releases, although the Dodd-Frank Act, including Title VII, seeks to achieve a number of benefits,

it also imposes costs on registered security-based swap dealers that unregistered persons are not required to bear.

For example, section 15F of the Exchange Act imposes various requirements on registered security-based swap dealers, including capital and margin requirements, recordkeeping and reporting requirements, and external business conduct requirements. While the Commission currently applies similar requirements to registered broker-dealers, Title VII applies these requirements only to persons that are registered as security-based swap dealers. Under current Exchange Act rule 3a71-3(b)(1)(iii), adopted in the Cross-Border Adopting Release, a non-U.S. person that engages in more than a

de minimis

amount of dealing activity with non-U.S.-person counterparties

using personnel located in the United States may face lower regulatory costs than a U.S. competitor engaging in identical activity, because the non-U.S. person is not required to include such transactions in its

de minimis

calculation. Competitive disparities may also arise as a result of differences in application of other Title VII requirements between U.S. persons and non-U.S. persons that are engaged in dealing activity using personnel located in the United States. As a result, such a non-U.S. person may be able to offer liquidity to its counterparties on more favorable terms than its U.S. competitors.

See

Cross-Border Adopting Release, 79 FR 47280 n.11 (citing Dodd-Frank Act preamble, which states that the Dodd-Frank Act was enacted “[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end `too big to fail', to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes”).

See id.

at 47327.

Under Exchange Act rule 3a71-3, non-U.S. persons may be able to subsidize their transactions with U.S. persons with profits from transactions with non-U.S. persons, allowing them to gain a competitive advantage with respect to transactions with U.S. persons from other dealing activity that is not subject to Title VII, even though it is carried out using personnel located in a U.S. branch or office. In the absence of the rules being proposed in this release, these competitive effects of disparate regulatory treatment may create an incentive for U.S. persons to use non-U.S.-person affiliates or non-U.S.-person agents that are located in the United States to engage in dealing activity with non-U.S.-person counterparties, because these non-U.S. persons could continue to deal with non-U.S.-person counterparties without being required to comply with any Title VII requirements.

This disparity could make transactions with U.S.-person dealers less attractive than transactions with non-U.S.-person dealers, even if the latter are arranging, negotiating, or executing the transaction using personnel located in a U.S. branch or office.

We note that, under Exchange Act rule 3a71-3, a non-U.S.-person affiliate of a U.S. person is not required to include such transactions in its dealer

de minimis

threshold calculations if that non-U.S. person's counterparties do not have recourse to a U.S. person under the terms of the security-based swap and the non-U.S. person is not a conduit affiliate.

See

Exchange Act rule 3171-3(b)(1)(ii) and (iii) (applying the

de minimis

exception to cross-border dealing activity of conduit affiliates and non-U.S. persons).

Moreover, differences in the application of the Title VII regulatory requirements may impose differing direct costs on different counterparties. For example, a non-U.S. person seeking to trade in a security-based swap on a U.S. reference entity may prefer to enter into the transaction with a non-U.S.-person dealer rather than a U.S.-person dealer. Even though both dealers are likely to arrange, negotiate, or execute a transaction on a U.S. reference entity using personnel located in a U.S. branch or office, the non-U.S.-person dealer may be more attractive because, for example, a transaction with that dealer may not involve a requirement to post collateral consistent with Title VII margin requirements or to comply with Regulation SBSR. The prospect of directly incurring the costs associated with compliance with Title VII requirements may cause these non-U.S. persons to prefer dealing with unregistered non-U.S.-person dealers, particularly if they can obtain the benefits associated with arranging, negotiating, or executing such a transaction using personnel located in a U.S. branch or office. The rules being proposed in this release are designed to mitigate this outcome.

Regulatory frictions arising from a difference in the treatment of dealing activity occurring in the United States could fragment security-based swap liquidity into two pools, one for U.S. persons and non-U.S. persons whose obligations under a security-based swap are guaranteed by a U.S. person, and the other for non-U.S. persons. Non-U.S. persons that arrange, negotiate, or execute transactions in connection with their dealing activity using personnel located in a U.S. branch or office may, under current Exchange Act rule 3a71-3(b), seek to limit dealing activity with U.S. persons (for example, by quoting larger spreads to compensate for the expected costs of entity-level requirements) or may entirely refuse to supply liquidity to U.S. persons. This disparity in treatment may provide further incentives for U.S. persons to restructure their business to permit them to carry out their business with non-U.S. persons on similar terms.

This incentive may be particularly strong among U.S. dealers that are active in the inter-dealer market.

See

Section VI.B,

infra,

for further discussion of potential effects of the proposed rules on non-U.S. persons' incentives to use personnel located in U.S. branches or offices to arrange, negotiate, or execute security-based swap transactions.

To the extent that the large inter-dealer market

shifts in significant part to non-U.S. dealers as a result of current rules, security-based swap activity in the United States could consist of one very large pool of transactions unregulated under Title VII (inter-dealer trades, and transactions between dealers and non-U.S. person non-dealers) and one much smaller pool limited to transactions between dealers and U.S.-person counterparties. This fragmentation could adversely affect the efficiency of risk sharing among security-based swap market participants, as discussed further in Sections VI.B.4(a) and VI.B.4(b), below.

See

Section II.B.2,

infra,

for an analysis of the proportion of the security-based swap market that constitutes inter-dealer transactions. For the purposes of this analysis we classify any security-based swap transaction between two ISDA-recognized dealers as inter-dealer activity.

Different treatment of transactions depending on whether they are arranged, negotiated, or executed by personnel located in a U.S. branch or office may create similar fragmentation among agents that may seek to provide services to foreign dealers. To the extent that using agents with personnel located in the United States results in substantial regulatory costs to foreign dealers, such foreign dealers may prefer and primarily use agents located outside the United States, while U.S. dealers may continue to use agents located in the United States. This fragmentation of dealer and agent relationships, as in the case of liquidity fragmentation discussed earlier, may adversely affect the efficiency of risk sharing by security-based swap market participants.

B. Baseline

To assess the economic impact of the proposed amendments and rule described in this release, we are using as our baseline the security-based swap market as it exists at the time of this release, including applicable rules we have already adopted but excluding rules that we have proposed but have not yet finalized.

The analysis includes the statutory provisions that currently govern the security-based swap market pursuant to the Dodd-Frank Act as well as rules adopted in the Intermediary Definitions Adopting Release, the Cross-Border Adopting Release, Regulation SBSR, and the Security-Based Swap Data Repository (“SDR”) Rules and Core Principles.

Our understanding of the market is informed by available data on security-based swap transactions, though we acknowledge the data limit the extent to which we can quantitatively characterize the market. Because these data do not cover the entire market, we have developed an understanding of market activity using a sample that includes only certain portions of the market.

We also take into account, where appropriate, current industry practice in response to the actions of other regulators, such as the CFTC and the European Securities and Markets Authority.

Exchange Act Release No. 74246 (February 11, 2015), 80 FR 14437 (March 19, 2015). As noted above, we have not yet adopted other substantive requirements of Title VII that may affect how firms structure their security-based swap business and market practices more generally.

1. Current Security-Based Swap Market

Our analysis of the state of the current security-based swap market is based on data obtained from the DTCC Derivatives Repository Limited Trade Information Warehouse (“TIW”), especially data regarding the activity of market participants in the single-name credit default swap (“CDS”) market during the period from 2008 to 2014. According to data published by the Bank for International Settlements (“BIS”), the global notional amount outstanding in equity forwards and swaps as of June 2014 was $2.43 trillion. The notional amount outstanding in single-name CDS was approximately $10.85 trillion, in multi-name index CDS was approximately $7.94 trillion, and in multi-name, non-index CDS was approximately $678 billion.

Our analysis in this release focuses on the data relating to single-name CDS. As we have previously noted, although the definition of “security-based swap” is not limited to single-name CDS, we believe that the single-name CDS transactions that we observe are sufficiently representative of the market and therefore can directly inform the analysis of the security-based swap market.

See

Semi-annual OTC derivatives statistics at end—June 2014 (December 2014), Table 19, available at:

http://www.bis.org/statistics/dt1920a.pdf

While other repositories may collect data on transactions in total return swaps on equity and debt, we do not currently have access to such data for these products (or other products that are security-based swaps). In the Cross-Border Proposing Release, we explained that we believed that data related to single-name CDS was reasonable for purposes of this analysis, as such transactions appear to constitute roughly 82% of the security-based swap market as measured on a notional basis.

See

Cross-Border Proposing Release, 78 FR 31120 n.1301. No commenters disputed these assumptions, and we therefore continue to believe that, although the BIS data reflect the global OTC derivatives market, and not just the U.S. market, these ratios are an adequate representation of the U.S. market.

Also consistent with our approach in that release, with the exception of the analysis regarding the degree of overlap between participation in the single-name CDS market and the index CDS market (cross-market activity), our analysis below does not include data regarding index CDS as we do not currently have sufficient information to identify the relative volumes of index CDS that are swaps or security-based swaps.

We preliminarily believe that the data underlying our analysis here provide reasonably comprehensive information regarding single-name CDS transactions and the composition of the single-name CDS market participants. We note that the data available to us from TIW do not encompass those CDS transactions that both: (i) Do not involve U.S. counterparties;

and (ii) are based on non-U.S. reference entities. Notwithstanding this limitation, we preliminarily believe that the TIW data provide sufficient information to identify the types of market participants active in the security-based swap market and the general pattern of dealing within that market.

We note that TIW's entity domicile determinations may not reflect our definition of “U.S. person” in all cases.

The challenges we face in estimating measures of current market activity stem, in part, from the absence of comprehensive reporting requirements for security-based swap market participants. We have adopted rules regarding trade reporting, data elements, and public reporting for security-based swaps that will, when fully implemented, provide us with appropriate measures of market activity.

See

Regulation SBSR Adopting Release, 80 FR 14699-700.

(a) Dealing Structures and Participant Domiciles

Dealers occupy a central role in the security based swap market and security-based swap dealers use a variety of business models and legal structures to engage in dealing activity with counterparties in jurisdictions all around the world.

As we noted in the Cross-Border Adopting Release and as discussed below in Section III.B.4(a), both U.S.-based and foreign-based entities use certain dealing structures for a variety of legal, tax, strategic, and business reasons.

Dealers may use a variety of structures in part to reduce risk and enhance credit protection based on the particular characteristics of each entity's business.

Commission staff analysis of TIW transaction records indicates that approximately 99% of single-name CDS price-forming transactions in 2014 involved an ISDA-recognized dealer. “Price-forming transactions” include all new transactions, assignments, modifications to increase the notional amounts of previously executed transactions, and terminations of previously executed transactions. Transactions terminated, transactions entered into in connection with a compression exercise, and expiration of contracts at maturity are not considered price forming and are therefore excluded, as are replacement trades and all bookkeeping-related trades.

See

Cross-Border Proposing Release, 78 FR 31121 n.1312. For the purpose of this analysis, the ISDA-recognized dealers are those identified by ISDA as belonging to the dealer group, including JP Morgan Chase, Morgan Stanley, Bank of America, Goldman Sachs, Deutsche Bank, Barclays, Citigroup, UBS, Credit Suisse, RBS Group, BNP Paribas, HSBC, Société Générale, Credit Agricole, Wells Fargo, and Nomura.

See, e.g., http://www2.isda.org/functional-areas/research/surveys/operations-benchmarking-surveys/

See

Cross-Border Adopting Release, 79 FR 30976.

Bank and non-bank holding companies may use subsidiaries to deal with counterparties. A U.S.-based holding company may engage in dealing activity through a foreign subsidiary that faces both U.S. and foreign counterparties, and foreign dealers may choose to deal with U.S. and foreign counterparties through U.S. subsidiaries. Similarly, a non-dealer user of security-based swaps may participate in the market using an agent in its home country or abroad. An investment adviser located in one jurisdiction may transact in security-based swaps on behalf of beneficial owners that reside in another.

In some situations, an entity's performance under security-based swaps may be supported by a guarantee provided by an affiliate. Such a guarantee may take the form of a blanket guarantee of an affiliate's performance on all security-based swap contracts, or a guarantee may apply only to a specified transaction or counterparty. Guarantees may give counterparties to a dealer direct recourse to the holding company or another affiliate for its dealer-affiliate's obligations under security-based swaps for which that dealer-affiliate acts as counterparty.

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As depicted

in Figure 1, the domicile of new accounts participating in the market has shifted over time. A greater share of accounts entering the market either have a foreign domicile, or have a foreign domicile while being managed by a U.S. person. The increase in foreign accounts may reflect an increase in participation by foreign accountholders while the increase in foreign accounts managed by U.S. persons may reflect the flexibility with which market participants can restructure their market participation in response to regulatory intervention, competitive pressures, and other stimuli. Alternatively, the shifts in new account domicile that we observe in Figure 1 may be unrelated to restructuring or increased foreign participation. For example, changes in the domicile of new accounts over time may reflect improvements in reporting by market participants to TIW rather than a change in market participant structure.

Additionally, because the data include only accounts that are domiciled in the United States, that transact with U.S.-domiciled counterparties, or that transact in single-name CDS with U.S. reference entities, changes in the domicile of new accounts may reflect increased transaction activity between U.S. and non-U.S.-person counterparties or increased transactions in single-name CDS on U.S. reference entities by foreign persons.

Following publication of the Warehouse Trust Guidance on CDS data access, TIW surveyed market participants, asking for the physical address associated with each of their accounts (

i.e.,

where the account is organized as a legal entity). This is designated the registered office location by TIW. When an account does not report a registered office location, we have assumed that the settlement country reported by the investment adviser or parent entity to the fund or account is the place of domicile. This treatment assumes that the registered office location reflects the place of domicile for the fund or account.

See

note 44,

supra.

(b) Market Centers

Participants in the security-based swap market may bear the financial risk of a security-based swap transaction in a location different from the location where the transaction is arranged, negotiated, or executed or the location where economic decisions are made by managers on behalf of beneficial owners. Similarly, a participant in the security-based swap market may be exposed to counterparty risk from a jurisdiction that is different from the market center or centers in which it primarily operates. These participants appear to be active in market centers across the globe.

The TIW transaction records include, in many cases, information on particular branches involved in transactions, which may provide limited insight as to where security-based swap activity is actually being carried out.

These data indicate branch locations located in New York, London, Tokyo, Hong Kong, Chicago, Sydney, Toronto, Frankfurt, Singapore, and the Cayman Islands. Because transaction records in the TIW data provided to us do not indicate explicitly the location in which particular transactions were arranged, negotiated, or executed, these locations

may not represent the full set of locations in which activities relevant for these proposed rules take place. Moreover, because we cannot identify the location of transactions within TIW, we are unable to estimate the general distribution of transaction volume across market centers.

The value of this information is limited in part because some market participants may use business models that do not involve branches to carry out business in jurisdictions other than their home jurisdiction. For example, some market participants may use affiliated or unaffiliated agents to enter into security-based swap transactions in other jurisdictions on their behalf. The available data currently does not allow us to identify with certainty which type of structure is being used in any particular transaction.

In the Regulation SBSR Adopting Release, we estimated, based on an analysis of TIW data, that out of more than 4,000 entities engaged in single-name CDS activity worldwide in 2013, 170 entities engaged in single-name CDS activity at a sufficiently high level that they would be expected to incur assessment costs to determine whether they meet the “security-based swap dealer” definition.

Approximately 45 of these entities are non-U.S. persons and are expected to incur assessment costs as a result of engaging in dealing activity with counterparties that are U.S. persons or engaging in dealing activity that involves recourse to U.S. persons.

Analysis of those data further indicated that potentially 50 entities may engage in dealing activity that would exceed the

de minimis

threshold and thus ultimately have to register as security-based swap dealers.

See

Regulation SBSR Adopting Release, 80 FR 14693.

See

Exchange Act rule 3a71-3(b).

See

Regulation SBSR Adopting Release, 80 FR 14693.

Updated analysis of 2014 data leaves many of these estimates largely unchanged. We estimate that approximately 170 entities engaged in single-name CDS activity at a sufficiently high level that they would be expected to incur assessment costs to determine whether they meet the “security-based swap dealer” definition. Approximately 56 of these entities are non-U.S. persons. Of the approximately 50 entities that we estimate may potentially register as security-based swap dealers, we preliminarily believe it is reasonable to expect 22 to be non-U.S. persons.

2. Levels of Security-Based Swap Trading Activity

Single-name CDS contracts make up the vast majority of security-based swaps, and most are written on corporate issuers, corporate securities, sovereign countries, or sovereign debt (reference entities or securities). Figure 2 below describes the percentage of global, notional transaction volume in North American corporate single-name CDS reported to the TIW between January 2008 and December 2013, separated by whether transactions are between two ISDA-recognized dealers (inter-dealer transactions) or whether a transaction has at least one non-dealer counterparty.

Annual trading activity with respect to North American corporate single-name CDS in terms of notional volume has declined from more than $6 trillion in 2008 to less than $3 trillion in 2014.

While notional volume has declined over the past six years, the portion of the notional volume represented by inter-dealer transactions has remained fairly constant and inter-dealer transactions continue to represent a significant majority of trading activity, whether measured in terms of notional value or number of transactions (see Figure 2).

The start of this decline predates the enactment of the Dodd-Frank Act and the proposal of rules thereunder, which is important to note for the purpose of understanding the economic baseline for this rulemaking. The timing of this decline seems to indicate that CDS market demand shrank prior to the enactment of the Dodd-Frank Act, and therefore the causes of this reduction in trading volume may be related to market dynamics and not directly related to the enactment of legislation and the development of security-based swap market regulation.

The high level of inter-dealer trading activity reflects the central position of a small number of dealers, each of which intermediates trades between many hundreds of counterparties. While we are unable to quantify the current level of trading costs for single-name CDS, those dealers appear to enjoy market power as a result of their small number and the large proportion of order flow they privately observe. This market power in turn appears to be a key determinant of trading costs in this market.

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Against this backdrop of declining North American corporate single-name CDS activity, about half of the trading activity in North American corporate single-name CDS reflected in the set of data that we analyzed was between counterparties domiciled in the United States and counterparties domiciled abroad. Basing counterparty domicile on the self-reported registered office location of the TIW accounts, we estimate that only 12% of the global transaction volume by notional volume between 2008 and 2014 was between two U.S.-domiciled counterparties, compared to 48% entered into between one U.S.-domiciled counterparty and a foreign-domiciled counterparty and 40% entered into between two foreign-domiciled counterparties (see Figure 3).

See

note 44,

supra.

For purposes of this discussion, we have assumed that the registered office location reflects the place of domicile for the fund or account, but we note that this domicile does not necessarily correspond to the location of an entity's sales or trading desk.

When the domicile of TIW accounts is instead defined according to the domicile of an account's ultimate parents, headquarters, or home office (

e.g.,

classifying a foreign bank branch or foreign subsidiary of a U.S. entity as domiciled in the United States), the fraction of transactions entered into between two U.S.-domiciled counterparties increases to 32%, and to 51% for transactions entered into between a U.S.-domiciled counterparty and a foreign-domiciled counterparty.

Differences in classifications across different definitions of domicile illustrate the effect of participant structures that operate across jurisdictions. Notably, the proportion of activity between two foreign-domiciled counterparties drops from 40% to 17% when domicile is defined as the ultimate parent's domicile. As noted earlier, foreign subsidiaries of U.S. parent companies and foreign branches of U.S. banks, and U.S. subsidiaries of foreign parent companies and U.S. branches of foreign banks may transact with U.S. and foreign counterparties. However, this change in respective shares based on different classifications suggests that the activity of foreign subsidiaries of U.S. firms and foreign branches of U.S. banks is generally higher than the activity of U.S. subsidiaries of foreign firms and U.S. branches of foreign banks.

EP13MY15.002

3. Regulatory Reporting, Clearing, and Trade Execution of Security-Based Swap Transactions

We have adopted final rules implementing regulatory reporting requirements for security-based swap transactions, although compliance with most aspects of this regime is not yet required.

Although counterparties are not yet required to comply with rules that require them to report transaction information, virtually all market participants voluntarily report their trades in single-name CDS to TIW, which maintains a record of these transactions, in some cases with the assistance of post-trade processors.

Among other things, this centralized record-keeping facilitates settlement of obligations between counterparties when a default event occurs as well as bulk transfers of positions between accounts at a single firm or between firms.

See

Regulation SBSR Adopting Release, 80 FR 14566.

See http://www.isdacdsmarketplace.com/exposures_and_activity

(last visited September 22, 2014).

Clearing of security-based swaps, which is currently voluntary in the United States, is currently limited to CDS products, and a substantial proportion of single-name CDS accepted for clearing are already being cleared. Prior to the Dodd-Frank Act, ICE Clear Credit and ICE Clear Europe engaged in CDS clearing activities pursuant to exemptive orders issued by the Commission.

Pursuant to the Dodd-Frank Act, ICE Clear Credit and ICE Clear Europe were deemed to be registered with the Commission in July 2011 as clearing agencies for security-based swaps.

ICE Clear Credit began clearing corporate single-name CDS in December 2009,

and, as of March 17, 2015, had cleared a total of $3.06 trillion gross notional of single-name CDS on 368 North American and European instruments.

As of the beginning of this year, ICE Clear Credit accepted for clearing a total of 207 CDS products based on North American instruments, 168 CDS products based on European instruments, and fifteen CDS products based on individual sovereign (nation-state) reference entities.

See, e.g.,

Exchange Act Release No. 59527 (March 6, 2009), 74 FR 10791 (March 12, 2009) (“ICE Clear Credit Exemptive Order”); Exchange Act Release No. 60372 (July 23, 2009), 74 FR 37748 (July 29, 2009) (“ICE Clear Europe Exemptive Order”). In connection with those orders, Commission considered clearing practices of those central counterparties (“CCPs”), including,

inter alia,

their risk management methodologies.

Section 17A(

) of the Exchange Act provides in relevant part that a derivative clearing organization registered with the CFTC that clears security-based swaps would be deemed to be registered as a clearing agency under section 17A if, prior to the enactment of the Dodd-Frank Act, it cleared swaps pursuant to an exemption from registration as a clearing agency. Both ICE Clear Credit and ICE Clear Europe also are registered with the CFTC as derivative clearing organizations.

See

Exchange Act Release No. 61662 (March 5, 2010), 75 FR 11589, 11591 (March 11, 2010) (discussing ICE Clear Credit's CDS clearing activities as of March 2010).

ICE Clear Credit (then known as ICE US Trust LLC) began clearing index CDS in March 2009.

See

Exchange Act Release No. 59527 (March. 6, 2009), 74 FR 10791 (March 12, 2009) (order granting temporary exemptions under the Exchange Act on behalf of ICE US Trust LLC).

ICE Clear Credit also has cleared a total of $37.3 trillion gross notional on 137 index CDS as of March 20, 2015.

See

ICE Clear Credit, Volume of ICE CDS Clearing, available at:

https://www.theice.com/clear_credit.jhtml.

In addition to clearing single-name CDS on North American corporate reference entities, ICE Clear Credit also clears CDS on certain non-U.S. sovereign entities, and on certain indices based on North American reference entities.

Staff analysis of trade activity from July 2012 to December 2013 indicate that, out of $938 billion of notional traded in North American corporate single-name CDS contracts that have reference entities that are accepted for clearing during the 18 months ending December 2013, approximately 71%, or $666 billion, had characteristics making them suitable for clearing by ICE Clear Credit and represented trades between two ICE Clear Credit clearing members.

Approximately 79% of this notional value, or $525 billion, was cleared through ICE Clear Credit, or 56% of the $938 billion in new trade activity.

Figure 4 shows the proportion of new trades and assign-entries defined as clearable at ICE Clear Credit that were ultimately cleared.

For the purposes of this analysis, “clearable” describes CDS contracts on North American single-name corporate reference entities between clearing members that reference the ISDA Standard North American Corporate (SNAC) documentation, are denominated in U.S. dollars, do not include restructuring as a credit event and have a standard coupon. If ICE Clear Credit accepts CDS on the reference entity for clearing, then a standard coupon is one that is accepted for clearing for that reference entity by ICE Clear Credit; otherwise, standard coupon means a coupon of either 100 or 500 basis points.

See

SEC Division of Economic and Risk Analysis, Single-Name Corporate Credit Default Swaps: Background Data Analysis on Voluntary Clearing Activity, 15 (April 2015), available at

http://www.sec.gov/dera/staff-papers/white-papers/voluntary-clearing-activity.pdf

Evidence from the TIW data suggests that even single-name CDS written on reference entities that were initially accepted for clearing by ICE Clear Credit were traded infrequently. Figure 5 plots of the daily mean number of transactions per trading day for each of the 538 North American single-name corporate reference entities with at least one transaction per month on average during the period from January 2011 to December 2013.

Each vertical bar represents the mean number of transactions per day for a reference entity.

The 538 reference entities are presented in decreasing order of the mean number of transactions per trading day. Commission staff has identified the 68 reference entities in the sample that were cleared by ICE Clear Credit prior to the enactment of the Dodd-Frank Act (the “deemed submitted” reference entities). The 68 deemed submitted reference entities are marked by Xs forming a line near the horizontal axis. The remaining Xs (those not on the line of Xs near the horizontal axis) represent, for each reference entity, the fraction of days with no transactions. The evidence in Figure 5 suggests that within the sample period, the most traded entity of the 68 “deemed submitted” reference entities was traded approximately 15 times per day on average. Despite the low average number of transactions per day, these 68 reference entities generally have a lower proportion of days with no transactions relative to the rest of the single-name CDS market represented in the sample.

We analyze single-name corporate reference entities with at least one transaction per month on average from January 2011 to December 2013 to avoid including outliers that trade extremely infrequently. Of the 573 North American single-name corporate reference entities with at least 36 transactions included in Figure 5, only 538 had at least 36 new trades, implying that the other 35 had price forming transactions that were not associated with new trading activity, such as terminations or assignments.

See id.

at 41.

Transaction types include all price forming transactions: New trades, amendments that change economic terms of the contract, assignments, and terminations.

ICE Clear Europe began clearing CDS on single-name corporate reference entities in December 2009,

and, as of March 17, 2015, had cleared a total €2.48 trillion in gross notional of single-name CDS on 161 European corporate reference entities.

As of the beginning of 2015, ICE Clear Europe accepted for clearing a total of 161 CDS products based on European corporate reference entities.

See

Exchange Act Release No. 61973 (April 23, 2010), 75 FR 22656, 22657 (April 29, 2010) (discussing ICE Clear Europe's CDS clearing activity as of April 2010).

ICE Clear Europe commenced clearing index CDS in July 2009.

See

Exchange Act Release No. 60372 (July 23, 2009), 74 FR 37748 (July 29, 2009) (order granting temporary exemptions under the Exchange Act on behalf of ICE Clear Europe).

ICE Clear Europe also has cleared a total of €14.4 trillion in gross notional on 64 index CDS as of March 20, 2015.

See

ICE Clear Europe, Volume of ICE CDS Clearing, available at:

https://www.theice.com/clear_credit.jhtml.

Aside from clearing single-name CDS on European corporate reference entities, ICE Clear Europe also clears CDS on indices based on European reference entities, as well as futures and instruments on OTC energy and emissions markets.

Staff analysis of new trade activity from July 2012 to December 2013 indicate that out of €531 billion of notional traded in European corporate single-name CDS contracts that have reference entities that are accepted for clearing during the 18 months ending December 2013, approximately 70%, or €372 billion had characteristics making them suitable for clearing by ICE Clear Europe and represented trades between two ICE Clear Europe clearing members. Approximately 51% of this notional value, or €191 billion was cleared through ICE Clear Europe, representing 36% of the total volume of new trade activity.

These numbers do not include transactions in European corporate single-name CDS that were cleared by ICE Clear Credit. However, during the sample period, there was only one day on which there were transactions that were cleared by ICE Clear Credit (December 20, 2013) and the traded notional of these transactions was minimal. For historical data,

see https://www.theice.com/marketdata/reports/99

EP13MY15.003

EP13MY15.004

Unlike the

markets for cash equity securities and listed options, the market for security-based swaps is characterized almost exclusively by bilateral OTC negotiation and is largely decentralized.

The lack of uniform rules concerning the trading of security-based swaps and the historical one-to-one nature of trade negotiation in security-based swaps has resulted in the formation of distinct types of trading venues and execution practices, ranging from bilateral negotiations carried out over the telephone,

single-dealer RFQ platforms,

multi-dealer RFQ platforms,

central limit order books,

and brokerage trading.

These various trading venues and execution practices provide different degrees of pre-trade transparency and afford market participants different levels of access. We currently do not have sufficient information with respect to the volume of security-based swap transactions executed across these different trading venues and using these various execution practices.

We preliminarily believe that it is reasonable to assume that, when clearing occurs within 14 days of execution, counterparties made the decision to clear at the time of execution and not as a result of information arriving after execution.

An “assign-entry” involves the substitution of one of the contract counterparties in an existing instrument for a new counterparty in exchange for cash consideration. It is economically equivalent to a termination of the initial contract between the “old” counterparty and the “static” counterparty and a new trade between the “replacement” counterparty and the “static” counterparty.

See

SB SEF Proposing Release, 76 FR 10951.

“Bilateral negotiation” refers to the execution practice whereby one party uses telephone, email, or other communication methods to contact directly a potential counterparty to negotiate and execute a security-based swap. The bilateral negotiation and execution practice provides no pre-trade or post-trade transparency because only the two parties to the transaction are aware of the terms of the negotiation and the final terms of the agreement.

See

SB SEF Proposing Release, 76 FR 10951.

A single-dealer 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 would 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 pre-trade transparency in the form of indicative quotes on a pricing screen, but only from one dealer to its customer.

See

SB SEF Proposing Release, 76 FR 10951.

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 degree of pre-trade transparency, depending on its characteristics.

See

SB SEF Proposing Release, 76 FR 10952.

A 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 pre-trade transparency than the three models described above because all participants can view bids and offers before placing their bids and offers.

See

SB SEF Proposing Release, 76 FR 10952. 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” refers to an execution practice used by brokers to execute security-based swaps on behalf of customers, often in larger-sized or bespoke transactions. In such a system, a broker receives a request from a customer (which may be a dealer) that seeks to execute a specific type of security-based swap. The broker then interacts with other customers 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 inter-dealer broker as an intermediary. In this model, there may be pre-trade transparency to the extent that participants are able to see bids and offers of other participants.

See

SB SEF Proposing Release, 76 FR 10952.

We have proposed, but have not yet adopted, rules establishing a registration regime and core principles for security-based swap execution facilities (“SB SEFs”). We have not proposed to implement the mandatory trade execution requirement contained in section 3C(h) of the Exchange Act. Currently, there are no SB SEFs registered with the Commission, and as a result, there is no registered SB SEF trading activity to report. There are, however, currently 25 trading platforms that either are temporarily registered with the CFTC as SEFs or have SEF temporary registration applications pending with the CFTC and currently are exempt from registration with the Commission.

As we discuss in Section II.B.5, the cash flows of security-based swaps and swaps are closely related and many participants in the security-based swap also participate in the swap market and so we preliminarily believe that many SEFs that currently serve as trading venues for swaps are likely also to register with the Commission as SB SEFs. However, owing to the smaller size of the security-based swap market, we currently expect that there will be fewer exchanges and SB SEFs that will eventually host transactions in security-based swaps than the 25 SEFs reported within the CFTC's jurisdiction.

See

Effective Date Release, 76 FR at 36306 (exempting persons that operate a facility for the trading or processing of security-based swaps that is not currently registered as a national securities exchange, or that cannot yet register as an SB SEF because final rules for such registration have not yet been adopted, from the requirements of Section 3D(a)(1) of the Exchange Act until the earliest compliance date set forth in any of the final rules regarding registration of SB SEFs). A list of platforms that either are temporarily registered with the CFTC or have SEF temporary registration applications pending with the CFTC is available at:

http://sirt.cftc.gov/SIRT/SIRT.aspx?Topic=SwapExecutionFacilities

(last visited March 2, 2015).

4. Global Regulatory Efforts

Efforts to regulate the swaps market are underway not only in the United States but also abroad, and these efforts have received significant attention in international fora. For example, in 2009, leaders of the G20—whose membership includes the United States, 18 other countries, and the EU—addressed global improvements in the functioning, transparency, and regulatory oversight of OTC derivatives markets. They expressed their view on a variety of issues relating to OTC derivatives contracts, including trading on exchanges or electronic trading platforms, clearing through CCPs, and reporting to trade repositories.

In subsequent summits, the G20 leaders have returned to OTC derivatives regulatory reform and encouraged international consultation in developing standards for these markets.

See

G20 Leaders'

Statement,

Pittsburgh, United States, September 24-25, 2009, available at:

http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf

See

the G20 Leaders Communique (November 2014), para. 12, available at:

https://www.g20.org/sites/default/files/g20_resources/library/brisbane_g20_leaders_summit_communique.pdf

Jurisdictions with major OTC derivatives markets have taken steps toward substantive regulation of these markets, though the pace of regulation varies. Accordingly, many foreign participants likely will be required to comply with substantive regulation of their security-based swap activities apart from regulations that may apply to them pursuant to Title VII. The concerns foreign jurisdictions seek to address with their regulations may overlap or be similar to those addressed by the Title VII regulatory framework.

Foreign legislative and regulatory efforts have focused on five general areas: Requiring post-trade reporting of transactions data for regulatory purposes, moving OTC derivatives onto organized trading platforms, requiring central clearing of OTC derivatives, establishing or enhancing capital requirements, and establishing or enhancing margin requirements for OTC derivatives transactions. The first two areas of regulation should help improve transparency in OTC derivatives markets, both to regulators and market participants. Regulatory transaction reporting requirements are mandated in a number of jurisdictions including the

EU, Hong Kong SAR, Japan, and Singapore; other jurisdictions are in the process of proposing legislation and rules to implement these requirements.

The EU has adopted legislation for markets in financial instruments that addresses trading OTC derivatives on regulated trading platforms.

This legislation also should promote post-trade public transparency in OTC derivatives markets by requiring the price, volume, and time of derivatives transactions conducted on these regulated trading platforms to be made public in as close to real time as technically possible.

Information regarding ongoing regulatory developments described in this section was primarily obtained from progress reports published by the Financial Stability Board. These are available at:

http://www.financialstabilityboard.org/list/fsb_publications/index.htm

See id.

See Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) no 648/2012), available at:

http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32014R0600&from=EN

Regulation of derivatives central clearing, capital requirements, and margin requirements aims, among other things, to improve management of financial risks in these markets.

Japan has rules in force mandating central clearing of certain OTC derivatives transactions.

The EU has its legislation in place but has not yet made any determinations of specific OTC derivatives transactions subject to mandatory central clearing. Most other jurisdictions are still in the process of formulating their legal frameworks that govern central clearing. A number of major foreign jurisdictions have initiated the process of drafting rules to implement margin requirements for OTC derivatives transactions.

See

note 74,

supra.

See id.

5. Cross-Market Participation

Persons registered as security-based swap dealers or major security-based swap participants are likely also to engage in swap activity, which is subject to regulation by the CFTC. In the release proposing registration requirements for security-based swap dealers and major security-based swap participants, we estimated, based on our experience and understanding of the swap and security-based swap markets that of the 55 firms that might register as security-based swap dealers or major security-based swap participants, approximately 35 would also register with the CFTC as swap dealers or major swap participants.

Available data suggest that these numbers remain largely unchanged.

See

Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 65543 (October 12, 2011), 76 FR 65784, 65808 (October 24, 2011).

Based on its analysis of 2014 TIW data and the list of swap dealers provisionally-registered with the CFTC, and applying the methodology used in the Intermediary Definitions Adopting Release, we estimate that substantially all registered security-based swap dealers would also register as swap dealers with the CFTC.

See also

CFTC list of provisionally registered swap dealers, available at:

http://www.cftc.gov/LawRegulation/DoddFrankAct/registerswapdealer

This overlap reflects the relationship between single-name CDS contracts, which are security-based swaps, and index CDS contracts, which may be swaps or security-based swaps. A single-name CDS contract covers default events for a single reference entity or reference security. Index CDS contracts and related products make payouts that are contingent on the default of index components and allow participants in these instruments to gain exposure to the credit risk of the basket of reference entities that comprise the index, which is a function of the credit risk of the index components. A default event for a reference entity that is an index component will result in payoffs on both single-name CDS written on the reference entity and index CDS written on indices that contain the reference entity. Because of this relationship between the payoffs of single-name CDS and index CDS contracts, prices of these products depend upon one another,

creating hedging opportunities across these markets.

“Correlation” typically refers to linear relationships between variables; “dependence” captures a broader set of relationships that may be more appropriate for certain swaps and security-based swaps.

See, e.g.,

Casella, George and Roger L. Berger, Statistical Inference (2002), at 171.

These hedging opportunities mean that participants that are active in one market are likely to be active in the other. Commission staff analysis of approximately 4,500 TIW accounts that participated in the market for single-name CDS in 2014 revealed that approximately 2,500 of those accounts, or 56%, also participated in the market for index CDS. Of the accounts that participated in both markets, data regarding transactions in 2014 suggest that, conditional on an account transacting in notional volume of index CDS in the top third of accounts, the probability of the same account landing in the top third of accounts in terms of single-name CDS notional volume is approximately 60%; by contrast, the probability of the same account landing in the bottom third of accounts in terms of single-name CDS notional volume is only 11%.

As discussed in more detail below,

the CFTC Staff Advisory issued in November 2013 stated the CFTC staff's belief that the CFTC has a strong supervisory interest in swap dealing activities that occur within the United States, regardless of the status of the counterparties. The CFTC Staff Advisory, which we understand to be under review at the CFTC,

also stated the CFTC staff's belief that a non-U.S. swap dealer “regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person generally would be required to comply with” the CFTC's transaction-level requirements.

While CFTC staff has granted relief from certain aspects of the CFTC Staff Advisory,

at least one commenter has argued that the CFTC's approach to regulation of swap dealers taken in the CFTC Cross-Border Guidance has influenced the information that market participants collect and maintain about the swap transactions they enter into and the counterparties they face.

Although that commenter suggested that swap market participants have also adopted business practices consistent with the CFTC Cross-Border Guidance, the commenter did not supply particular details as to the scope of the changes to its operations.

See

Section III.B.3,

infra.

See

CFTC Request for Comment.

See

CFTC Staff Advisory at 1-2.

See

note 25,

supra.

See, e.g.,

Letter from Securities Industry and Financial Markets Association/Futures Industry Association/Financial Services Roundtable (“SIFMA/FIA/FSR”) to SEC, dated August 21, 2013 (“SIFMA/FIA/FSR Letter”) at 2-3.

Id.

at 2-4. The commenter notes the “technological, operational, legal and compliance systems” necessary for complying with our proposed rules, and taking account of the CFTC Cross-Border Guidance, outlining the general categories of changes to practice necessary for compliance.

Id.

The commenter further indicates a potential need to “build[] separate systems for a small percentage of the combined swaps and SBS market instead of using the systems already built for compliance with the CFTC's cross-border approach,” suggesting that market participants have adopted market practices consistent with the CFTC Cross-Border Guidance.

Id.

The proposed amendments and proposed rule may, to the extent that they are not in conflict with the approach taken in the CFTC Cross-Border Guidance, permit non-U.S. persons to use infrastructures developed to be consistent with the CFTC's approach, to comply with Commission requirements as well. Among those entities that participate in both markets, entities that are able to apply to security-based swap activity capabilities that are consistent with the CFTC Cross-Border Guidance may experience lower costs associated with assessing which

cross-border security-based swap activity counts against the dealer

de minimis

exception or towards the major participant threshold, relative to those that are unable to redeploy such capabilities. We remain sensitive to the fact that in cases where our final rules differ from the CFTC approach, additional outlays related to information collection and storage may be required.

III. Application of the Dealer

De Minimis

Exception to U.S. Security-Based Swap Dealing Operations of Non-U.S. Persons

A. Overview

The Exchange Act excepts from designation as a “security-based swap dealer” an entity that engages in a “

de minimis

” quantity of security-based swap dealing activity with or on behalf of customers.

Under the final rules adopted in the Intermediary Definitions Adopting Release, a person may take advantage of that exception if, in connection with credit default swaps that constitute security-based swaps, the person's dealing activity over the preceding 12 months does not exceed a gross notional amount of $3 billion, subject to a phase-in level of $8 billion.

The phase-in level will remain in place until—following a study regarding the definitions of “security-based swap dealer” and “major security-based swap participant”—we either terminate the phase-in period or establish an alternative threshold following rulemaking.

See

Exchange Act section 3(a)(71)(D).

See

Exchange Act rule 3a71-2(a)(1)(i). Lower thresholds are set forth in connection with dealing activity involving other types of security-based swaps.

See

Exchange Act rule 3a71-2(a)(1)(ii).

See

Intermediary Definitions Adopting Release, 77 FR 30640-41. Exchange Act rule 3a71-2 establishes a phase-in period during which the

de minimis

threshold will be $8 billion and during which Commission staff will study the security-based swap market as it evolves under the new regulatory framework, resulting in a report that will consider the operation of the “security-based swap dealer” and “major security-based swap participant” definitions. In that release we explained that at the end of the phase-in period, we will take into account the report, as well as public comment on the report, in determining whether to terminate the phase-in period or propose any changes to the rule implementing the

de minimis

exception, including any increases or decreases to the $3 billion threshold.

See id.

at 30640.

The Cross-Border Adopting Release finalized rules specifying, among other things, when a non-U.S. person is required to include transactions arising from its dealing activity in its

de minimis

threshold calculations.

These final rules addressed the application of the security-based swap dealer

de minimis

exception to such person's dealing activity involving U.S.-person counterparties, as well as the dealing activity of a non-U.S. person that is a conduit affiliate

or whose counterparty has a right of recourse under the security-based swap against an affiliated U.S. person.

Although we had proposed requiring a non-U.S. person to include in this calculation any dealing activity involving another non-U.S.-person counterparty if it resulted in a “transaction conducted within the United States” as defined in the proposed rule,

we did not address this issue in our Cross-Border Adopting Release. As we noted in that adopting release, commenters raised a number of significant issues related to this element of the Cross-Border Proposing Release, including our authority to impose, and the costs of complying with, this requirement, and we determined that final resolution of this issue would benefit from further consideration and public comment.

See

Cross-Border Adopting Release, 79 FR 47319-322.

See also

Exchange Act rules 3a71-3(b), 3a71-4.

See

Exchange Act rule 3a71-3(a)(1); Cross-Border Adopting Release, 79 FR 47313.

See

Cross-Border Adopting Release, 79 FR 47316.

See

Cross-Border Proposing Release, 78 FR 30999-31001.

See, e.g.,

Cross-Border Adopting Release, 79 FR 47280.

In light of those comments and further consideration of the concerns raised by such transactions and subsequent regulatory and market developments, the statutory objectives, and the practicability of our initially proposed approach, we have determined to propose an amendment to Exchange Act rules 3a71-3 and 3a71-5 that more closely focuses on certain dealing activity carried out, at least in part, by personnel located in the United States.

The proposed amendments would not require a non-U.S. person engaging in dealing activity to consider the location of its non-U.S.-person counterparty or that counterparty's agent in determining whether the transaction needs to be included in its own

de minimis

calculation. Instead, the proposed amendments would require a non-U.S. person to include in its

de minimis

calculation any transaction connected with its security-based swap dealing activity that it enters into with a non-U.S.-person counterparty only when the transaction is arranged, negotiated, or executed by personnel of the non-U.S. person located in a U.S. branch or office, or by personnel of such person's agent located in a U.S. branch of office.

See

proposed Exchange Act rule 3a71-3(b)(1)(iii)(C); proposed Exchange Act rule 3a71-5(c).

As described in more detail below, we preliminarily believe that this proposed approach would mitigate many of the concerns raised by commenters in response to our initial proposal, while requiring persons that engage in dealing activity at levels that may raise the types of concerns that Title VII addresses to register as security-based swap dealers and comply with appropriate regulation. We also note that this approach would be generally consistent with the approach that we have followed with respect to the registration of brokers and dealers under the Exchange Act, which among other things requires that a broker-dealer physically operating in the United States register with the Commission and comply with relevant regulatory requirements, even if it directs its activities solely toward non-U.S. persons outside the United States.

See

Registration Requirements for Foreign Broker-Dealers, Exchange Act Release No. 27017 (July 11, 1989), 54 FR 30013 (July 18, 1989).

B. Proposed Application of De Minimis Exception to Non-U.S. Persons Arranging, Negotiating, or Executing Security-Based Swap Transactions Using Personnel Located in a U.S. Branch or Office

1. Overview of the Initially Proposed Approach

As we noted in the Cross-Border Proposing Release, dealing activity carried out by a non-U.S. person through a U.S. branch, office, or affiliate or by a non-U.S. person that otherwise engages in security-based swap dealing activity in the United States, particularly at levels exceeding the relevant

de minimis

thresholds, may raise concerns that Title VII addresses, even if a significant proportion—or all—of those transactions involve non-U.S.-person counterparties.

Accordingly, we initially proposed to require any non-U.S. person to include in its

de minimis

calculation any security-based swap transaction connected with its dealing activities that is a “transaction conducted within the United States.”

We proposed to define “transaction conducted within the United States” as 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.”

100

Thus, under this initially proposed definition, a non-U.S. person engaged in dealing activity would have been required to include in its

de minimis

calculation any transaction where either the dealer itself or its counterparty, or the agent of either the dealer or the counterparty, performed relevant security-based swap dealing activity within the United States.

101

See

Cross-Border Proposing Release, 78 FR 31000-01.

See

initially proposed 3a71-3(b)(1)(ii).

100

See

initially proposed Exchange Act rule 3a71-3(a)(5).

See also

Cross-Border Proposing

Release, 78 FR 30999-31000. To address anticipated operational challenges associated with determining whether a person's counterparty is engaging in dealing activity within the United States that would make the transaction a “transaction conducted within the United States,” we also proposed permitting reliance on a representation by a counterparty that the transaction was not solicited, negotiated, executed, or booked within the United States by or on behalf of that counterparty.

See id.

at 31001.

101

As we noted in the Cross-Border Proposing Release, the term “transaction conducted within the United States” was intended to identify key aspects of a transaction that, if carried out within the United States by either counterparty, would trigger the need for a non-U.S. person acting in a dealing capacity to include transactions arising out of that activity in its

de minimis

calculation.

See id.

at 30999-31000. The initially proposed definition of “transaction conducted within the United States” did not include submitting a transaction for clearing in the United States, reporting a transaction to a security-based swap data repository in the United States, or performing collateral management activities (such as exchanging margin) within the United States.

See id.

at 31000.

2. Commenters' Views on the Cross-Border Proposing Release

Our initially proposed definition of “transaction conducted within the United States” and our proposed use of that term to trigger various Title VII requirements generated a significant volume of comment addressing a wide range of issues. Although two commenters supported our proposal,

102

commenters generally criticized the proposed definition. These criticisms generally focused on four areas: the scope of activity potentially captured by the initially proposed defined term, the operational difficulties of implementing the defined term, the costs of implementation, and competitive concerns.

102

See

note 26,

supra.

(a) Scope of the Initially Proposed Definition of “Transaction Conducted Within the United States”

Several commenters took issue with the scope of the initially proposed defined term. Some commenters argued that the initially proposed definition was inappropriate in the context of Title VII because it would capture transactions between two non-U.S. persons that happened to involve conduct within the United States, even though such transactions are unlikely to create risk to the U.S. financial system.

103

Commenters also expressed concern that the initially proposed definition was overly broad because it would capture incidental or peripheral activity within the United States,

104

arguing that such overbreadth could lead to conflicting or duplicative application of regulations for certain market participants.

105

103

See

SIFMA/FIA/FSR Letter at 4, A-3 (explaining that a transaction between two non-U.S. counterparties does not create risk in the United States, even where it is conducted within the United States); Letter from European Commission (“EC”) to SEC, dated August 21, 2013 (“EC Letter”) at 2 (suggesting that the Commission's rules should not apply to transactions when conduct within the United States involves two non-U.S. counterparties because no U.S. firms are at risk); Letter from European Securities and Markets Authority (“ESMA”) to SEC, dated August 21, 2013 (“ESMA Letter”) at 2 (requesting the Commission limit the definition of “transaction conducted within the United States” to transactions booked within the United States because that is the only activity that directly creates risk within the United States); Letter from Futures and Options Association (“FOA”) to SEC, dated August 21, 2013 (“FOA Letter”) at 7 (arguing that the test as initially proposed does not serve the goals of preserving the integrity of U.S. financial markets and protecting U.S. counterparties because it reaches transactions with minimal nexus to the United States).

Two of these commenters suggested that the initially proposed approach exceeded the Commission's authority under section 30(c) of the Exchange Act.

See

SIFMA/FIA/FSR Letter at 4 and A-4 to A-5 (suggesting that Exchange Act section 30(c) does not authorize the Commission to extend its authority through a conduct-based approach where no risk is imported to the United States); FOA Letter at 7 (stating that test goes beyond limits of Exchange Act section 30(c)). Another commenter stated that the initially proposed approach was inappropriate because it would have the effect of applying Title VII to transactions between two non-U.S. persons without having an international agreement regarding extraterritorial application of each jurisdiction's regulations.

See

Letter from Japan Securities Dealers Association (“JSDA”) to SEC, dated August 21, 2013 (“JSDA Letter”) at 3.

104

See

Letter from Managed Funds Assoc. and Alternative Investment Management Assoc. (“MFA/AIMA”) to SEC, dated August 19, 2013 (“MFA/AIMA Letter”) at 4 and n.18 (stating that the lack of a materiality threshold would inappropriately subject transactions to Commission regulation, including transactions negotiated during an employee's visit to the United States); SIFMA/FIA/FSR Letter at A-2 (explaining that “transaction conducted within the United States” may include incidental conduct, which includes, in this commenter's view, a decision by a non-U.S. counterparty to use a contact based in the United States to execute a transaction only because executing it in the non-U.S. counterparties' jurisdictions would be inconvenient or impossible due to the timing of the transaction); Letter from Pensions Europe to SEC, dated September 3, 2013 (“Pensions Europe Letter”) at 1 (stating that trades executed outside the United States by European pension fund managers should not be brought within Title VII only because the managers wish to “benefit from the expertise and experience of U.S. operations”); Letter from Institute of International Bankers (“IIB”) to SEC, dated August 21, 2013 (“IIB Letter”) at 10 (noting that the initially proposed test could capture transactions where the U.S.-based conduct is only clerical or ministerial); Letter from Investment Adviser Association (“IAA”) to SEC, dated August 21, 2013 (“IAA Letter”) at 6-7 (stating that the initially proposed test may capture parties with minimal connection to the United States, such as a non-U.S. counterparty using a U.S. investment adviser to manage its assets); Letter from Investment Company Institute (“ICI”) to SEC, dated August 21, 2013 (“ICI Letter”) at 4, 8-9 (stating that exception from the definition should be broader for non-U.S. counterparties that use U.S.-based investment managers and that the retention of a U.S. asset manager should not cause transactions to be subject to various regulatory requirements because a non-U.S. entity would not expect to be subject to U.S. regulation based on its retention of a U.S. asset manager); Letter from Japan Financial Markets Council (“JFMC”) to SEC, dated August 15, 2013 (“JFMC Letter”) at 5 (stating that the transactions could be captured by the definition solely because they are executed through a U.S. trading facility).

105

See

IIB Letter at 8-9 (explaining that, because European regulations would apply to transactions between two U.S. branches of European firms, the initially proposed approach would cause duplicative and conflicting regulation); IIB letter at 10 (stating that a conduct-based test would subject U.S. agents already registered with the Commission or exempted from registration under broker-dealer or investment adviser regulations to additional regulation).

See also

EC Letter at 2 (suggesting that the Commission's rules should not apply to transactions when the legal counterparty to a transaction conducted within the United States is a non-U.S. entity because such persons are subject to regulation in their home jurisdiction); ESMA Letter at 2-3 (noting that the initially proposed approach could subject a transaction between two non-U.S. persons that is solicited in the United States to the regulations of multiple jurisdictions); FOA Letter at 7 (requesting that the Commission defer to regulatory oversight of counterparties' home country regulators).

(b) Operational Challenges

One commenter recognized the concerns that the initially proposed definition of “transaction conducted within the United States” was intended to address but expressed doubt as to whether funds would be able to monitor and confirm whether their dealing counterparties were engaging in dealing activity within the United States.

106

A number of commenters expressed concern that the defined term and its initially proposed application in the context of specific Title VII requirements, would present significant operational challenges for market participants more generally.

107

For

example, one commenter noted that the approach would require market participants to make determinations on a trade-by-trade basis as to whether a transaction was “conducted within the United States” and would create inefficiencies and uncertainty in the market.

108

This commenter stated that the initially proposed approach was vague, and would be difficult to enforce and easy to manipulate.

109

One commenter specifically argued that operational difficulties in tracking the location of conduct on a trade-by-trade basis might be impossible to overcome.

110

106

See

MFA/AIMA Letter at 4 (acknowledging the Commission's interest in preventing evasion of Title VII but expressing concern that private funds that are not U.S. persons may not be able to determine whether dealer counterparties have engaged in relevant conduct within the United States and may not be able to obtain relevant representations from such counterparties).

107

See, e.g.,

IIB Letter at 11 (stating that the initially proposed definition is ill suited to the global nature of the derivatives markets where activity may involve multiple physical locations); JFMC Letter at 4-5 (noting that the initially proposed definition is impracticable and would subject participants to duplicative and conflicting rules); JSDA Letter at 3 (expressing concern about the activity-based approach because of the operational confusion it may cause by subjecting market participants to the two separate approaches of the Commission and CFTC); ABA Letter at 3 (identifying ambiguities in the initially proposed definition, including whether negotiations over

ISDA documentation are relevant conduct for purposes of the transaction).

108

See

Letter from Americans for Financial Reform (“AFR”) to SEC, dated August 22, 2013 (“AFR Letter”) at 3, A-2 to A-3.

109

See

AFR Letter at 3.

110

See

IIB Letter at 8.

Some commenters stated that applying Title VII to transactions merely because they involve conduct within the United States could not be justified from a cost-benefit perspective. Some contended that the CFTC had not taken such an approach and that divergence from the CFTC on the treatment of such conduct would impose a significant additional cost on market participants.

111

One commenter also noted that, whereas the “U.S. person” definition would typically be applied only at the beginning of a trading relationship, market participants would potentially be required to perform a trade-by-trade analysis to determine whether it involved conduct within the United States, which could significantly increase costs.

112

111

See

SIFMA/FIA/FSR Letter at 3, A-3, A-6 (arguing that the Commission should harmonize its approach to cross-border security-based swap activity to the approach reflected in the commenter's view of the CFTC Cross-Border Guidance); Pensions Europe Letter at 2 (preferring its view of the CFTC approach in the CFTC Cross-Border Guidance, which the commenter argues focuses on the location of principal headquarters); IIB Letter at 8 (stating that market participants would incur costs and burdens to modify their existing systems in order to comply with two different tests); JFMC Letter at 4-5 (urging that the Commission not adopt the defined term “transaction conducted within the United States” because the CFTC did not discuss such an approach in the CFTC Cross-Border Guidance).

112

See

IIB Letter at 8 (stating that a conduct-based test would be costly and disruptive).

(d) Competitive Concerns

Some commenters expressed concern that focusing on “transactions conducted within the United States” would put brokers and investment managers located in the United States at a competitive disadvantage to their foreign counterparts, on the grounds that foreign clients would avoid doing business with them to avoid having their transactions become subject to Commission regulations.

113

Another commenter, although critical of our initially proposed definition as excessively costly to implement, urged that any alternative to the conduct-based test described in the Cross-Border Proposal Release be designed to ensure that market participants from the United States were not put at a competitive disadvantage.

114

113

See

IIB Letter at 8-9.

114

See

SIFMA/FIA/FSR Letter at A-6.

(e) Other concerns

A few commenters, including some who expressed the concerns outlined above, sought clarification or made suggestions related to limiting the scope of the initially proposed defined term.

115

One commenter expressed support for the SEC's position in the proposal that the location where a transaction is cleared should not factor into determining whether a non-U.S. person qualifies as a security-based swap dealer.

116

Another commenter requested that, if the Commission adopts the “transaction conducted within the United States” test, market participants should be permitted to rely on their counterparties' representations as to whether the transaction was conducted within the United States.

117

115

See

IIB Letter at 9-11 (requesting clarification as to what degree of solicitation, negotiation, or execution activity would trigger the initially proposed definition); ESMA Letter at 2-3 (inviting the Commission to clarify which transactions between a U.S. branch of a foreign firm would be considered “conducted within the United States” and arguing that location of booking alone should be considered); FOA Letter at 7 (suggesting that, if a transaction has more than a

de minimis

connection to the United States as a result of solicitation or negotiation in the United States, the Commission should focus its regulatory authority on the intermediary performing those activities); JSDA Letter at 3 (suggesting that the Commission limit the application of Title VII to those transactions booked by non-U.S. persons with U.S. persons and requesting that certain activity related to “operational activities” be excluded from the activity covered by the initially proposed definition); ABA Letter at 3-4 (supporting the initially proposed definition but suggesting clarification that it excludes a firm's centralized risk management and legal and compliance functions).

116

See

Letter from CME Group (“CME”) to SEC, dated August 21, 2013 (“CME Letter”) at 2 (citing Cross-Border Proposing Release, 78 FR 31000).

117

See

JSDA Letter at 4. Another commenter, however, expressed concern about being able to obtain, and being able to confirm the accuracy of, such representations.

See

MFA/AIMA Letter at 4.

3. The CFTC Staff Advisory and responses to the CFTC Request for Comment

As already noted, in November 2013, subsequent to the close of the comment period for our Cross-Border Proposing Release, CFTC staff issued the CFTC Staff Advisory, which addressed activity by registered swap dealers occurring within the United States.

118

The CFTC Staff Advisory stated the CFTC staff's belief that the CFTC “has a strong supervisory interest in swap dealing activities that occur within the United States, regardless of the status of the counterparties” and that a non-U.S. swap dealer “regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person generally would be required to comply with” the CFTC's transaction-level requirements.

119

118

See

CFTC Staff Advisory.

119

Id.

at 2.

As noted above, on January 8, 2014, the CFTC published the CFTC Request for Comment on various aspects of the CFTC Staff Advisory, including whether the CFTC “should adopt the Staff Advisory as Commission policy, in whole or in part.”

120

In response to this request, the CFTC received approximately 20 comment letters addressing various aspects of the CFTC Staff Advisory, including its relationship to the CFTC Cross-Border Guidance and its general workability given current market practices. CFTC staff subsequently extended no-action relief related to the CFTC Staff Advisory until the earlier of September 30, 2015, or the effective date of any CFTC action in response to the CFTC Request for Comment.

121

We understand that the CFTC Staff Advisory and the related comment letters are currently under review by the CFTC. Although the CFTC Staff Advisory raises issues that are, to a certain degree, distinct from those raised by our initially proposed definition and use of “transaction conducted within the United States,” the comments received by the CFTC in response to the CFTC Request for Comment in many cases elaborate on issues that commenters raised in response to our Cross-Border Proposing Release. Given similarities between the approach set forth in the CFTC Staff Advisory and our proposed amendments identifying relevant conduct within the United States, in this section we provide our own brief

summary of relevant comments received by the CFTC.

122

120

See

CFTC Request for Comment, 79 FR 1347.

121

See

note 25,

supra.

122

As reflected in our discussion throughout this release, we have carefully considered both the CFTC Staff Advisory and the comments submitted in response to the CFTC's request for comment on the CFTC Staff Advisory in developing this proposal. Moreover, in connection with our statutory obligation to consult with the CFTC in connection with Title VII rulemaking, our staff have engaged in extensive discussion with CFTC staff regarding our proposed rules. We note, however, that our discussion of both the CFTC Staff Advisory and the comments received by the CFTC about it reflects our understanding of these documents. Accordingly, neither our discussions of these documents nor any preliminary views expressed herein should be interpreted as necessarily reflecting the views of any other agency or regulator, including the CFTC.

A few commenters supported the CFTC Staff Advisory. One commenter urged the CFTC to formally adopt the approach in the CFTC Staff Advisory, arguing that any weakening of it would permit “nominally foreign entities” to do business within the United States in compliance with foreign laws and regulations, or potentially subject to no legal requirements, rather than with U.S. law.

123

Another commenter stated that formal adoption of the CFTC Staff Advisory was unnecessary but urged the CFTC to leave it undisturbed, arguing that without the CFTC Staff Advisory, a U.S. person would effectively be able to enter into transactions with non-U.S. persons through its foreign affiliates while using U.S.-based trading operations, “thereby evading and gutting the key components of financial reform.”

124

123

See

Letter from American for Financial Reform (“AFR”) to CFTC, dated March 10, 2014 (“AFR Letter to CFTC”) at 3-4.

See also

Letter from Institute for Agriculture and Trade Policy (“IATP”) to CFTC, dated March 10, 2014 (“IATP Letter to CFTC”) at 1-2.

124

Letter from Better Markets to CFTC, dated March 10, 2014 (“Better Markets Letter to CFTC”) at 6.

Most commenters, however, opposed the approach taken in the CFTC Staff Advisory. These commenters expressed several concerns that may also be relevant to our own proposal to impose certain Title VII requirements on security-based swap activity that is carried out from a U.S. location, including the following: (1) the scope of the activity that would trigger application of Title VII, (2) the workability and costs of complying with such a test and resulting effects on competition and comity, and (3) the CFTC's transaction-level requirements that should be triggered by such a test. We will discuss the first two sets of concerns here and the third in Section V below.

(a) Scope of the CFTC Staff Advisory

Several commenters argued that the scope and types of activity by non-U.S. swap dealers captured by the CFTC Staff Advisory were unclear. The CFTC Staff Advisory notes that “persons regularly arranging, negotiating, or executing swaps for or on behalf of [a swap dealer] are performing core, front-office activities of that [swap dealer's] dealing business.”

125

Accordingly, it expresses the CFTC staff's view that the CFTC's transaction-level requirements apply to transactions of registered non-U.S. swap dealers with non-U.S.-person counterparties when they “arrange, negotiate, or execute” those transactions “using personnel or agents located in the U.S.”

126

Commenters argued that “arrange” and “negotiate” were overly broad and could encompass activity that occurred only incidentally in the United States.

127

Some commenters also noted that the apparent scope of the CFTC Staff Advisory was overly broad because non-U.S.-person counterparties may not typically know where the dealer engages in relevant conduct with respect to a particular swap transaction.

128

125

CFTC Staff Advisory at 2.

126

Id.

127

See, e.g.,

Letter from Investment Adviser Association to CFTC, dated March 10, 2014 (“IAA Letter to CFTC”) at 5; Société Générale Letter to CFTC at 7-8 (arguing that key terms of CFTC Staff Advisory are ambiguous and do not reflect how swap business is carried out). Some commenters also raised concerns regarding ambiguity in the CFTC Staff Advisory's use of the term “regularly.”

See, e.g.,

Letter from Securities Industry and Financial Markets Association/Futures Industry Association/Financial Services Roundtable to CFTC, dated March 10, 2014 (“SIFMA/FIA/FSR Letter to CFTC”) at 16.

128

See, e.g.,

Letter from Société Générale to CFTC, dated March 10, 2014 (“Société Générale Letter to CFTC”) at 8 (stating that “[m]ost clients have no control or knowledge over where their swap is structured or designed, where the salesperson responsible for a particular product is located, where the booking of their swap is entered into a trading system, or where their swap is hedged”).

Some commenters encouraged the CFTC to address these concerns by providing “detailed definitions” of the relevant terms or to focus only on execution or other discrete activities related to the transaction.

129

Several commenters urged the CFTC to abandon the CFTC Staff Advisory's approach altogether, or, if not, to revise the CFTC Staff Advisory's approach to focus on activities involving direct communication with the counterparty to the swap.

130

129

See, e.g.,

Letter from European Commission to CFTC, received March 10, 2014 (“EC Letter to CFTC”) at 3.

See also

SIFMA/FIA/FSR Letter to CFTC at A-8 to A-9; IAA Letter to CFTC at 5 (urging CFTC to focus on where the swap was executed or cleared).

130

See

Letter from ISDA to CFTC, dated March 7, 2014 (“ISDA Letter to CFTC”) at 8 n.16 (arguing that, if the CFTC determines to adopt the CFTC Staff Advisory, it should limit triggering conduct solely to “direct communications by SD personnel located in the United States with counterparties, which communications commit the SD to the execution of a particular swap transaction”); Letter from Barclays to CFTC, dated March 10, 2014 (“Barclays Letter to CFTC”) at 4 (arguing that “only direct communication with counterparties by non-U.S. swap dealers to the execution of the transaction should trigger application of the pre-trade disclosure requirements” and that “the [CFTC] should explicitly exclude electronic or screen-based execution” as such conduct “does not involve direct interaction” and the “non-U.S. person counterparty will not know who is responding on behalf of the non-U.S. swap dealer, let alone the responder's location,” meaning that “the non-U.S. counterparty will not have a reasonable expectation that the transaction may be subject to protection under U.S. law”); SIFMA/FIA/FSR Letter to CFTC at A-11 to A-12 (arguing that, if the CFTC decides to adopt the approach in the CFTC Staff Advisory, it should capture only “direct communications by personnel in the United States with counterparties that commit the SD to the execution of the transaction” because, absent direct communication, the counterparty has no reason to expect that U.S. law will apply to the transaction).

See also

Société Générale Letter to CFTC at 8 (stating that, if the CFTC does adopt the CFTC Staff Advisory, the CFTC should focus only on salespersons based in the United States that deal directly with clients).

(b) Workability, Costs, and Competitive Effects of the CFTC's Activity-Based Approach

Some commenters expressed concern that the CFTC Staff Advisory reflected a significant departure from the approach that these commenters understood to be the focus of the CFTC Cross-Border Guidance.

131

These commenters argued that developing systems consistent with the CFTC Staff Advisory would cause them to incur significant additional

costs.

132

In particular, commenters stated their belief that developing systems consistent with the CFTC Staff Advisory would require a trade-by-trade analysis, which would be impracticable.

133

One commenter argued that these costs would not be justified by corresponding benefits because market participants likely would already be subject to similar requirements in their home jurisdiction.

134

131

See

Société Générale Letter to CFTC at 2 (explaining that market participants have already developed systems to reflect the status-based approach); Letter from Institute of International Bankers to CFTC, dated March 10, 2014 (“IIB Letter to CFTC”) at 2-3 (noting among other things that market participants have built policies and systems to reflect their view of the CFTC's approach in the CFTC Cross-Border Guidance and that they believe the approach taken in the CFTC Staff Advisory is fundamentally different); ISDA Letter to CFTC at 5 (arguing that systems are not configured to identify personnel that are involved in a transaction but rather to be consistent with the CFTC Cross-Border Guidance, and that the CFTC Staff Advisory raises complex questions about,

e.g.,

portfolio margining); SIFMA/FIA/FSR Letter to CFTC at A-2 (stating that the CFTC's approach in the CFTC Cross-Border Guidance is already overbroad, and applying the CFTC Staff Advisory on top of the entity-based approach is “particularly flawed,” “compound[ing] the excessive breadth and burden of the existing, entity-based regulatory structure by approaching swaps regulation from an entirely different direction, layering even more requirements and burdens onto market participants, and doing so in the absence of any discernible risk to U.S. markets”).

132

See, e.g.,

Société Générale Letter to CFTC at 2.

133

See, e.g.,

Société Générale Letter to CFTC at 8; SIFMA/FIA/FSR Letter to CFTC at A-4 (explaining that the approach taken in the CFTC Staff Advisory is impracticable in the swap market, as it would require a trade-by-trade analysis that is not feasible and that requiring such trades to be fully isolated from the United States would interfere with the operations of these markets and market participants).

134

See

IIB Letter to CFTC at 3.

One commenter criticized the CFTC Staff Advisory's focus on whether a registered non-U.S. swap dealer is arranging, negotiating, or executing a swap using personnel or agents in the United States as providing insufficient guidance to market participants, arguing that these activities do not reflect current business practices among swap dealers.

135

For example, this commenter stated that some personnel of a dealer may design swaps and hedging solutions but lack authority to book the resulting swaps and have no interaction with clients; these same personnel may book swaps that other employees have sold or negotiated for risk mitigation purposes.

136

The commenter further noted that personnel involved in a particular swap may be located in multiple jurisdictions.

137

135

See

Société Générale Letter to CFTC at 8.

136

See id.

137

See id.

Several commenters argued that the costs and impracticability of the approach taken in the CFTC Staff Advisory would have competitive effects, although they disagreed whether it would enhance or degrade competition. One commenter supported the CFTC Staff Advisory in its current form, noting that without it, U.S. firms would be at a competitive disadvantage compared to non-U.S. firms operating in the United States.

138

Other commenters argued that the CFTC Staff Advisory, if adopted, would have adverse competitive effects on certain end users.

139

138

See

AFR Letter to CFTC at 3 (explaining that “any weakening of [the] advisory would open the door to regular and significant levels of swaps activities being performed within the U.S. by nominally foreign entities under foreign rules, or in some cases no rules at all,” whereas U.S. firms operating in the United States would be subject to different rules for the same transactions operating in the same market).

139

See

Letter from Coalition for Derivatives End-Users (“CDEU”) to CFTC, dated March 10, 2014 (“CDEU Letter to CFTC”) at 2 (arguing that the CFTC Staff Advisory would lead to competitive disadvantages for certain non-U.S. end-user affiliates that had relied on trading with non-U.S. swap dealers compared to other non-U.S. end users in the same markets that currently hedge with unregistered counterparties).

Some commenters also suggested that, if adopted by the CFTC, the approach taken in the CFTC Staff Advisory could present difficulties for, and impose costs on, non-U.S.-person counterparties of dealers, as such counterparties may not currently have systems in place for complying with certain CFTC requirements, particularly if they are imposed only because the swap dealer (and not the counterparty) happens to have carried out certain activities using personnel or agents located in the United States.

140

As a result, commenters argued non-U.S. swap dealers may no longer service non-U.S.-person counterparties from U.S. locations.

141

140

See, e.g.,

SIFMA/FIA/FSR Letter to CFTC at A-4 (explaining that certain non-U.S.-person counterparties may not have a clearing relationship with a futures commission merchant (“FCM”), and requiring them to clear through an FCM simply because the dealer happens to use personnel within the United States in the transaction will be costly).

141

See

ISDA Letter to CFTC at 4.

Commenters suggested that pressure from non-U.S.-person counterparties that do not want their transactions to be subject to Title VII would lead at least some non-U.S.-person dealers to exit the United States.

142

Commenters suggested that the adoption of the CFTC Staff Advisory would likely interfere with the ability of certain swap dealers to cover U.S. market hours for foreign counterparties with U.S.-based personnel, increasing costs to counterparties and end users.

143

142

See, e.g.,

Société Générale Letter to CFTC at 8 (stating that, if the CFTC adopts the CFTC Staff Advisory, or even an alternative suggested by the commenter, swap dealers “will move personnel currently based in the United States offshore”).

143

See, e.g.,

Letter from Paul Hunter for the Japan Financial Markets Council to CFTC, dated March 4, 2014 (“JFMC Letter to CFTC”) at 1-2 (explaining that the approach in the CFTC Staff Advisory “unfairly precludes options open to Asia-based Swap Dealers to cover U.S. market hours and service their non-U.S. based clients by using U.S.-based personnel or agents”); CDEU Letter to CFTC at 2-3 (arguing that the CFTC Staff Advisory's approach would “force non-U.S. [swap dealers] that use personnel or agents to `arrange, negotiate, or execute' swaps to exit certain markets or move personnel outside the U.S. in order to remain competitive in non-U.S. markets[,]” and that the costs associated with such movements would “undoubtedly be passed on to derivatives end-users and ultimately to customers . . . [which] would result in a loss of liquidity that will leave non-U.S. end-user affiliates scrambling to find counterparties to hedge their risks”).

See also

SIFMA/FIA/FSR Letter to CFTC at A-6 (explaining that the desire of counterparties to swap dealers to keep their transactions out of the reach of Dodd-Frank will lead them to pressure non-U.S.-person dealers and foreign branches to move personnel out of the United States); IAA Letter to CFTC at 3 (explaining that non-U.S.-person dealers may incur expenses associated with moving personnel out of the United States or hiring personnel in other jurisdictions, which may potentially lead to increased transaction costs and reduced services for advisers' non-U.S. clients, and that these higher costs may drive non-U.S. clients away from U.S. investment advisers).

4. Dealing Activity of Non-U.S. Persons in the United States

We have carefully considered the views of commenters, as discussed above, that dealing activity carried out in the United States by a non-U.S. person with a counterparty that is also a non-U.S. person lacks a significant nexus to the United States and does not raise any significant regulatory concerns in the United States because the ongoing obligations associated with such transactions do not reside in the United States.

144

However, as we discuss below, we continue to believe that such activity falls squarely within our territorial approach to the application of Title VII

145

and that it raises regulatory concerns of the type that Title VII addresses.

144

See

note 103,

supra

(identifying comment letters arguing that such transactions pose no risk to the United States or that the Commission lacks a regulatory interest in such transactions).

145

See

Cross-Border Proposing Release, 78 FR 30986; Cross-Border Adopting Release, 79 FR 47290.

(a) Overview of Common Business Structures for Firms Engaged in Security-Based Swap Dealing Activity

As we noted in our Cross-Border Proposing Release, financial groups engaged in security-based swap dealing activity use a variety of business models and legal structures to carry out such activity with counterparties around the world. Most such financial groups operate in multiple jurisdictions, and they will typically have one or more dealer affiliates in one or more jurisdictions that book the security-based swap transactions related to their security-based swap dealing business. An affiliate that initially books a transaction may retain the risk associated with that transaction, or it may lay off that risk to another affiliate via a back-to-back transaction or an assignment of the security-based swap.

146

These decisions generally reflect the financial group's consideration of, among other things, how it may most efficiently manage the risks associated with its security-based swap positions.

146

See

Cross-Border Proposing Release, 78 FR 30977-978.

The structure of the group's market-facing activities that generate the transactions booked in these affiliates often reflects different considerations. A dealing affiliate established in one jurisdiction may operate offices (which may serve sales or trading functions) in one or more other jurisdictions to deal with counterparties in that jurisdiction or in a specific geographic region, or to ensure that it is able to provide liquidity to counterparties in other jurisdictions, even when a counterparty's home financial markets are closed. A dealer also may choose to manage its trading book in particular reference entities or securities primarily from a trading desk that can take advantage of local expertise in such products or to gain access to better liquidity, which may permit it to more efficiently price such products or to otherwise compete more effectively in the security-based swap market. We understand that a financial group that engages in a dealing business may have business lines that are carried out in a number of affiliates located in different jurisdictions, and that personnel of an affiliate may operate under the direction of, or in some cases, report to personnel of another affiliate within the group; in some cases, such personnel work on behalf of, or under the supervision of, more than one affiliate in the group.

Moreover, a dealer may carry out these market-facing activities, whether in its home jurisdiction or in a foreign jurisdiction, using either its own personnel or the personnel of an affiliated or unaffiliated agent. For example, the dealer may determine that another affiliate in the financial group employs personnel who possess expertise in relevant products or that have established sales relationships with key counterparties in a foreign jurisdiction, making it more efficient to use the personnel of the affiliate to engage in security-based swap dealing activity on its behalf in that jurisdiction.

Alternatively, the dealer may in some circumstances determine to engage the services of an unaffiliated agent through which it can engage in dealing activity. For example, a dealer may determine that using an inter-dealer broker may provide an efficient means of participating in the inter-dealer market in its own, or in another, jurisdiction, particularly if it is seeking to do so anonymously or to take a position in products that trade relatively infrequently.

147

Dealers may also use unaffiliated agents that operate at the direction or request of the dealer to engage in dealing activity. Such arrangement may be particularly valuable in enabling the dealer to service clients or access liquidity in jurisdictions in which the dealer or its affiliates have no security-based swap operations of their own.

147

We understand that inter-dealer brokers may provide voice or electronic trading services that, among other things, permit dealers to take positions or hedge risks in a manner that preserves their anonymity until the trade is executed. These inter-dealer brokers also may play a particularly important role in facilitating transactions in less-liquid security-based swaps.

We understand that dealers established in foreign jurisdictions (whether affiliated with U.S.-based financial groups or not) may use any of these structures to engage in dealing activity in the United States, and that they may seek to engage in dealing activity in the United States to transact with both U.S. and non-U.S.-person counterparties. In transactions with non-U.S.-person counterparties, a foreign dealer may affirmatively seek to engage in dealing activity in the United States because the sales personnel of the foreign dealer (or of its agent) in the United States have existing relationships with counterparties in other locations (such as Canada or Latin America) or because the trading personnel of the foreign dealer (or of its agent) in the United States have the expertise to manage the trading books for security-based swaps on U.S. reference securities or entities. And we understand that some foreign dealers engage in dealing activity in the United States through their personnel (or personnel of their affiliates) in part to ensure that they are able to provide their own counterparties, or those of financial group affiliates in other jurisdictions, with access to liquidity (often in non-U.S. reference entities) during U.S. business hours, permitting them to meet client demand even when the home markets are closed. In some cases, such as when seeking to transact with other dealers through an inter-dealer broker, a foreign dealer may act, in a dealing capacity, in the United States through an unaffiliated, third-party agent.

(b) Statutory Scope and Policy Concerns Arising From Security-Based Swap Dealing Activity in the United States

As discussed above, some commenters have suggested that the Title VII statutory framework does not extend to transactions between two non-U.S. persons, even if security-based swap activity occurs in the United States, and have argued that section 30(c) of the Exchange Act limits our authority to reach this conduct.

148

We continue to believe, however, that it is consistent with the Exchange Act to impose specific Title VII requirements on non-U.S. persons that engage in activity within the United States that is regulated by the relevant statutory provision.

149

148

See

note 103,

supra.

149

See

Cross-Border Adopting Release, 79 FR 47287. As we noted in the Cross-Border Adopting Release, when the statutory text does not describe the relevant activity with specificity or provides for further Commission interpretation of statutory terms or requirements, our territorial analysis may require us to identify through interpretation of the statutory text the specific activity that is relevant under the statute or to incorporate prior interpretations of the relevant statutory text.

See id.

In the Cross-Border Adopting release, we described how this approach applies in the specific context of the definition of “security-based swap dealer.” We rejected the view that “the location of risk alone should . . . determine the scope of an appropriate territorial application of every Title VII requirement,” including the application of the “security-based swap dealer” definition.

150

In doing so, we noted that “neither the statutory definition of `security-based swap dealer,' our subsequent further definition of the term pursuant to section 712(d) of the Dodd-Frank Act, nor the regulatory requirements applicable to security-based swap dealers focus solely on risk to the U.S. financial system.”

151

150

Id.

at 47287-88.

151

Id.

at 47288. We have also noted that security-based swap dealer regulation may be warranted either to promote market stability and transparency in light of the role that these dealers occupy in the security-based swap market or to address concerns raised by the nature of the interactions between such dealers and their counterparties.

See

Intermediary Definitions Adopting Release, 77 FR 30617.

Instead, the statute identifies specific activities that bring a person within the definition of “security-based swap dealer”: (1) Holding oneself out as a dealer in security-based swaps, (2) making a market in security-based swaps; (3) regularly entering into security-based swaps with counterparties as an ordinary course of business for one's own account; or (4) engaging in any activity causing oneself to be commonly known in the trade as a dealer in security-based swaps.

152

We have further interpreted this definition to apply to persons engaged in indicia of dealing activity, including, among other things, providing liquidity to market professionals, providing advice in connection with security-based swaps, having regular clientele and actively soliciting clients, and using inter-dealer brokers.

153

Neither the statutory definition of “security-based

swap dealer” nor our further definition of that term turns primarily on the presence of risk or on the purchase or sale of any security, including a security-based swap.

154

152

See

Exchange Act section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A).

153

See

Intermediary Definitions Adopting Release, 77 FR 30617-18.

154

See

Exchange Act section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A); Intermediary Definitions Adopting Release, 77 FR 30617-18.

Accordingly, the fact that the counterparty credit risk from a transaction between two non-U.S. persons, where neither counterparty has a right of recourse against a U.S. person under the security-based swap, exists largely outside the United States is not determinative under our territorial analysis. The appropriate analysis, in our view, is whether a non-U.S. person in such a transaction is engaged, in the United States, in any of the activities set forth in the statutory definition or in our further definition of “security-based swap dealer.” If it is so engaged, in our view, it is appropriate under a territorial approach to require the non-U.S. person to include such transaction in its security-based swap dealer

de minimis

threshold calculations and, if those security-based swaps (and any other security-based swaps it is required to include in its threshold calculations) exceed the

de minimis

threshold, to register as a security-based swap dealer.

155

See

Cross-Border Adopting Release, 79 FR 47286-92 (describing the Commission's territorial approach). We note that another commenter argued that it was inappropriate to use activity in the United States to trigger application of Title VII absent an international agreement between regulators.

See

note 103,

supra.

As discussed above, we have continued to consult and coordinate with other regulators in the United States and abroad in connection with financial market reforms,

see

note 12 and accompanying discussion, but we do not believe that an international agreement is relevant as a legal or policy matter in determining whether to impose Title VII requirements on security-based swap activity, particularly given that we are proposing to do so with respect to activity that is being carried out in the United States.

This analysis applies regardless of whether the non-U.S. person engages in dealing activity (as described in the statutory definition and in our further definition of “security-based swap dealers”) in the United States using its own personnel or using the personnel of an agent acting on its behalf. As described above, persons engaged in security-based swap dealing activity routinely do so both directly and through their agents. Indeed, our further definition of “security-based swap dealer” specifically identifies the use of inter-dealer brokers as one of several indicia of security-based swap dealing activity,

156

and, in our preliminary view, engaging an inter-dealer broker as agent or sending a trade to such a broker generally would be dealing activity; to the extent that this activity is directed to a broker in the United States, we preliminarily believe that the non-U.S. person would be engaged in dealing activity in the United States.

157

Accordingly, a non-U.S. person that reaches into the United States by engaging an agent (including an inter-dealer broker) to perform dealing activity on its behalf is itself engaged, at least in part, in dealing activity in the United States. We preliminarily believe that it is appropriate under a territorial approach to require the non-U.S. person to include transactions arising out of those activities in its own

de minimis

threshold calculations.

156

See

Intermediary Definitions Adopting Release, 77 FR 30617-18 (further defining “security-based swap dealer”).

157

More generally, we note that the routine use by dealers of the structures described in this discussion suggest that a person may engage in dealing activity through an agent in a manner very similar to such activity carried out through its own branch or office.

Cf.

Exchange Act section 3(a)(71)(A) (defining “security-based swap dealer”); Intermediary Definitions Adopting Release, 77 FR 30617-18 (further defining “security-based swap dealer”).

Finally, in light of the foregoing analysis, we note that the statutory prohibition on application of Title VII requirements to persons that “transact[] a business in security-based swaps without the jurisdiction of the United States” has no bearing on these proposed rules.

158

Our proposed approach, as described in further detail below, would require transactions to be included in a non-U.S. person's dealer

de minimis

threshold calculations only when, in connection with its dealing activity, it arranges, negotiates, or executes a security-based swap using its personnel (or personnel of its agent) located in the United States.

159

Because we are focusing in this proposal solely on transactions in which the non-U.S. person is engaged, directly or indirectly, in dealing activity in the United States, the proposed rules would not impose requirements on non-U.S. persons that are “transacting a business in security-based swaps without the jurisdiction of the United States” for purposes of section 30(c).

160

Accordingly, because such activities occur within the United States, they, and any resulting transaction, are within the scope of Title VII.

158

See

Exchange Act section 30(c).

159

See

Exchange Act rule 3a71-3(a)(1).

160

As noted above, we do not believe that our proposed approach applies Title VII to persons that are “transact[ing] a business in security-based swaps without the jurisdiction of the United States,” within the meaning of section 30(c) of the Exchange Act. An approach that, for example, treated a non-U.S. person dealer that used an agent, whether affiliated or unaffiliated, in the United States to carry out some or all of its dealing business with non-U.S. persons (for example, because using a U.S. agent allowed it to leverage higher liquidity and lower spreads in U.S. reference entities) as transacting a business in security-based swaps without the jurisdiction of the United States, would, in our view, reflect an understanding of what it means to conduct a security-based swaps business within the jurisdiction of the United States that is divorced both from Title VII's statutory objectives and from the various structures that non-U.S. persons use to engage in security-based swap dealing activity. But in any event we also preliminarily believe that this proposed rule is necessary or appropriate as a prophylactic measure to help prevent the evasion of the provisions of the Exchange Act that were added by the Dodd-Frank Act, and thus would help prevent the relevant purposes of the Dodd-Frank Act from being undermined.

See

Cross-Border Adopting Release, 79 FR 47291-92 (interpreting anti-evasion provisions of Exchange Act section 30(c)). Without this rule, non-U.S. persons could simply carry on a dealing business within the United States with other non-U.S. persons through agents and remain outside of the application of the dealer requirements of Title VII. Permitting this activity would allow these firms to retain full access to the benefits of operating in the United States while avoiding compliance with, for example, recordkeeping and reporting requirements and Regulation SBSR, which could reduce transparency in the U.S. market and make it considerably more difficult for the Commission to monitor the market for manipulation or other abusive practices.

Moreover, we preliminarily believe that requiring these transactions to be included in a non-U.S. person's dealer

de minimis

threshold calculations (and subjecting them to certain other Title VII requirements, as discussed below) is consistent with the regulatory objectives furthered by the relevant Title VII requirements. Under the rules we adopted in the Cross-Border Adopting Release, financial groups may seek to avoid application of Title VII requirements to their security-based swap dealing activity with non-U.S. persons (including with other dealers), even though they continue to carry out day-to-day sales and trading operations in the United States in a manner largely unchanged from what we understand to be current business practices.

161

For market participants, avoiding Title VII in such transactions in the absence of these proposed rules would require them only to book any such transactions in non-U.S. person dealers whose obligations under such swaps are not guaranteed by a U.S. person. Doing so would allow them to perform any other activities in connection with the transaction in the United States without complying with Title VII requirements.

161

We understand that there may be significant advantages in continuing to carry out certain market-facing activities using personnel located in the United States, depending on the location of the counterparty and the nature of the reference security or entity. For example, market expertise in security-based swaps on U.S. reference entities may be located primarily in the United States, and relationships with counterparties in certain geographical regions may be managed out of a U.S. branch or office.

See

Section III.B.4(a),

supra.

Such a reaction could result in a significant amount of security-based swap dealing activity continuing to be engaged in by personnel located in a U.S. branch or office,

162

but, because the financial group chooses to book the transactions in a non-U.S.-person affiliate whose obligations under a security-based swap are not guaranteed by a U.S. person, certain Title VII requirements may not apply to such dealing activity. A dealer could continue to transact security-based swaps with other dealers (and with non-U.S. persons that are not dealers) through a U.S. sales and trading desk that is staffed by its own personnel or the personnel of its agent, continuing to engage in market-facing activity in the United States without complying with any Title VII requirements.

162

This dealing activity likely would constitute inter-dealer activity, which, as noted above, accounts for a majority of activity in the security-based swap market.

See

Section II.B.2,

supra.

To the extent that there are advantages to trading U.S. reference entities from a U.S. location, activity by personnel located in the United States may account for a significant proportion of the inter-dealer business on those reference entities.

Although such transactions may not give rise to counterparty-credit risk within the United States, they do raise other regulatory concerns, particularly when a firm is engaged in such activity at levels above the dealer

de minimis

thresholds. We note that significant levels of security-based swap dealing activity occurring within the United States without being subject to dealer regulation or Regulation SBSR may pose a risk to the integrity of the U.S. financial market, as the absence of regulation—and of access, for example, to the security-based swap dealer's books and records—may make it significantly more difficult for the Commission to monitor the market for abusive and manipulative practices connected with security-based swap activity in the United States. As we have noted elsewhere, Title VII recordkeeping requirements will likely be the Commission's primary tool in monitoring compliance with applicable securities laws, including the antifraud provisions of these laws.

163

To the extent that we do not have access to reports of such transactions available through registered SDRs or to the books and records of non-U.S.-person dealers using personnel located in a U.S. branch or office, manipulative or abusive trading practices within the United States are more likely to go undetected, which may undermine the integrity of the security-based swap market in the United States, and of the U.S. financial market more generally.

164

For example, a dealer using personnel located in a U.S. branch or office may employ a trader who engages in trading practices in connection with security-based swap transactions that render the dealing activity in the United States abusive or manipulative, but we may not be able to readily identify the abusive or manipulative nature of that dealing activity without access to the dealer's books and records.

165

Detecting misconduct may be particularly challenging if a significant proportion of transactions in the relevant security-based swaps are carried out in the United States by traders employed by unregistered dealers.

163

See

Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain SBSDs; Proposed Rules, Exchange Act Release No. 71958 (April 17, 2014), 79 FR 25194, 25199 (May 2, 2014) (citing Commission Guidance to Broker-Dealers on the Use of Electronic Storage Media under the Electronic Signatures in Global and National Commerce Act of 2000 with Respect to Rule 17a-4(f), Exchange Act Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001); Books and Records Requirements for Brokers and Dealers Under the Securities Exchange Act of 1934, Exchange Act Release No. 44992 (October 26, 2001), 66 FR 55818 (November 2, 2

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