# Cross-Border Application of Certain Security-Based Swap Requirements

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2019-27760

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** February 4, 2020
- **Citation:** 85 FR 6270

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 201 and 240
[Release No. 34-87780; File No. S7-07-19]
RIN 3235-AM13
Cross-Border Application of Certain Security-Based Swap Requirements

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rules; guidance.

SUMMARY:

The Securities and Exchange Commission (“SEC” or “Commission”) is adopting rule amendments and providing guidance to address the cross-border application of certain security-based swap requirements under the Securities Exchange Act of 1934 (“Exchange Act”) that were added by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Commission also is issuing a statement regarding compliance with rules for security-based swap data repositories and Regulation SBSR.

DATES:

Effective date:
These rules are effective April 6, 2020.

Compliance date:
The compliance dates are discussed in Part X.B of this final release.

FOR FURTHER INFORMATION CONTACT:

Carol M. McGee, Assistant Director, Laura Compton, Senior Special Counsel, or Kateryna Imus, Special Counsel, regarding the guidance related to security-based swap transactions that have been “arranged” or “negotiated” by personnel located in the United States, the amendment to Exchange Act Rule 3a71-3, applications for substituted compliance, the amendments to Rule 0-13 related to designation as a listed jurisdiction, and the compliance dates and statement regarding compliance with rules for security-based swap data repositories and Regulation SBSR referenced in Part X, at 202-551-5870; Devin Ryan, Senior Special Counsel, and Edward Schellhorn, Special Counsel, regarding the amendment to Commission Rule of Practice 194; Joanne Rutkowski, Assistant Chief Counsel, and Bonnie Gauch, Senior Special Counsel, regarding the amendments to Exchange Act Rule 15Fb2-1 and guidance related to Exchange Act Rule 15Fb2-4; and Joseph Levinson, Senior Special Counsel, regarding the modifications to Exchange Act Rule 18a-5, at 202-551-5777; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission is providing guidance regarding the application of certain uses of the terms “arranged” and “negotiated” in connection with the cross-border application of security-based swap regulation under the Exchange Act; providing guidance regarding the certification and opinion of counsel requirements in Exchange Act Rule 15Fb2-4 and Rule 3a71-6 and adequate assurance requirement in Exchange Act Rule 3a71-6; adopting amendments to Exchange Act Rules 0-13, 3a71-3, 15Fb2-1, and 18a-5 and Commission Rule of Practice 194; and issuing a statement regarding compliance with rules for security-based swap data repositories and Regulation SBSR.

I. Overview

The Commission is enhancing the effectiveness and the efficiency, in the cross-border context, of rules that implement requirements under Title VII of the Dodd-Frank Act
1

to provide for the regulation of security-based swap activity. The amendments finalize proposals that the Commission made to address issues regarding the cross-border application of Title VII.
2

Previously, market participants and other commenters had raised concerns regarding possible disruptive effects associated with several requirements that implicate cross-border activity in the security-based swap market, suggesting that those requirements would create significant operational burdens and impose unwarranted costs. The Commission also noted that those concerns may be exacerbated by differences between the Commission's rules in those areas and corresponding rules of the Commodity Futures Trading Commission (“CFTC”) in connection with the regulation of the swaps market.
3

1
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 of the Dodd-Frank Act.

2
Proposed Rule Amendments and Guidance Addressing Cross-Border Application of Certain Security-Based Swap Requirements, Exchange Act Release No. 85823 (May 10, 2019), 84 FR 24206 (May 24, 2019) (“Proposing Release”).

3

See
Proposing Release, 84 FR at 24207.

Commenters addressed a range of issues regarding the proposed rules and guidance, and those comments are addressed below.
4

The Commission has carefully considered commenters' views. For the reasons discussed below, the Commission is taking the following actions:

4
The comment letters are available at
https://www.sec.gov/comments/s7-07-19/s70719.htm.
The Commission also received comments on topics outside the scope of the proposal that are not addressed in this release.
See
letter from Scott O'Malia, CEO, International Swaps and Derivatives Association, dated July 23, 2019 (“ISDA letter”) at 3-4 (arguing that the CFTC's rules for swaps and the Commission's rules regarding security-based swaps, including those not proposed to be amended, should not materially differ); Yolanda Lewis, dated July 23, 2019 (generally discussing certain issues related to certificate-less bonds and employees' securities companies).

• The Commission is providing guidance regarding the terms “arrange” and “negotiate,” as those terms are used within certain rules connected to the cross-border application of Title VII.
5

5
As discussed in more detail below, these rules include provisions of Exchange Act Rule 3a71-3 regarding the cross-border application of the “security-based swap dealer” definition, the cross-border application of security-based swap dealer business conduct requirements, and provisions related to activities of foreign branches of U.S. banks. These also include provisions of Regulation SBSR regarding the cross-border application of regulatory reporting and public dissemination requirements, and provisions of Rule 3a67-10 regarding the cross-border application of definitions and requirements applicable to major security-based swap participants.
See generally
Part II.B,
infra.

• The Commission is adopting a conditional exception to provisions of Exchange Act Rule 3a71-3 that otherwise would require non-U.S. persons to count—against the thresholds associated with the
de minimis
exception to the “security-based swap dealer” definition—security-based swap dealing transactions with non-U.S. counterparties when U.S. personnel arrange, negotiate, or execute those transactions.
6

6
In connection with that exception, the Commission also is adopting a technical amendment to Exchange Act Rule 0-13.

• The Commission is adopting an amendment to Exchange Act Rule 15Fb2-1 to allow a nonresident security-based swap dealer or major security-based swap participant (each, an “SBS Entity”) that is unable to provide the certification and opinion of counsel required by Rule 15Fb2-4, to be conditionally registered if the nonresident SBS Entity instead submits a certification and an opinion of counsel that identify, and are conditioned upon, the occurrence of a future action that would provide the Commission with adequate assurances of prompt access to the books and records of the nonresident SBS Entity, and the ability of the nonresident SBS Entity to submit to onsite inspection and examination by the Commission. A nonresident SBS Entity that submits a conditional certification and opinion of counsel in connection with an application that otherwise is complete in all respects shall be conditionally registered and

will remain conditionally registered until the Commission acts to grant or deny ongoing registration. If none of the future actions that are included in an applicant's conditional certification and opinion of counsel occurs within 24 months of the compliance date for Rule 15Fb2-1, and there is not otherwise a basis that would provide the Commission with the required assurances, the Commission may institute proceedings thereafter to determine whether ongoing registration should be denied.

• The Commission is providing guidance regarding the requirements, in Exchange Act Rules 15Fb2-4(c) and 3a71-6, to provide the Commission with a certification and opinion of counsel, including with respect to the foreign laws to be covered in the certification and opinion of counsel of a nonresident SBS Entity; the scope of the books and records covered by the certification and opinion of counsel; whether the certification and opinion of counsel can be predicated on consents (if consents are allowed in the relevant jurisdiction); and whether the certification and opinion of counsel can rely on a memorandum of understanding (“MOU”), agreement, protocol, or other regulatory arrangement with the Commission facilitating access to the books and records of SBS Entities located in that jurisdiction, an applicant's understanding of the general experience with the application of the relevant local law or rule, or a Commission order granting substituted compliance based on a finding of “adequate assurances” in accordance with Exchange Act Rule 3a71-6(c).

• The Commission is adopting, as proposed, an amendment to Rule of Practice 194, by including proposed paragraph (c)(2), to exclude an SBS Entity, subject to certain limitations, from the prohibition in Exchange Act Section 15F(b)(6) with respect to an associated person who is a natural person who (i) is not a U.S. person and (ii) does not effect and is not involved in effecting security-based swap transactions with or for counterparties that are U.S. persons, other than a security-based swap transaction conducted through a foreign branch of a counterparty that is a U.S. person.

• The Commission is adopting, as proposed, amendments to Rule 18a-5 to provide that a bank
7

or stand-alone
8

SBS Entity is not required to make and keep current a questionnaire or application for employment executed by an associated person if the SBS Entity is excluded from the prohibition in Section 15F(b)(6) of the Exchange Act with respect to such associated person. The Commission also is adopting amendments to Rule 18a-5 to provide that a questionnaire or application for employment executed by an associated person who is not a U.S. person need not include all of the information described in paragraphs (a)(10)(i)(A) through (H) and (b)(8)(i)(A) through (H) of Rule 18a-5 unless the SBS Entity (1) is required to obtain such information under applicable law in the jurisdiction in which the associated person is employed or located or (2) obtains such information in conducting a background check that is customary for such firms in that jurisdiction, and the creation or maintenance of records reflecting that information would not result in a violation of applicable law in the jurisdiction in which the associated person is employed or located.
9

7
The Exchange Act distinguishes between SBS Entities for which there is a prudential regulator as defined in Section 1a(39) of the Commodity Exchange Act (“CEA”), 7 U.S.C. 1a(39), incorporated by reference in Section 3(a)(74) of the Exchange Act, 15 U.S.C. 78c(a)(74), and those that are not subject to supervision by a prudential regulator (
see, e.g.,
15 U.S.C. 78o-10(f)(1)(B)). SBS Entities for which there is a prudential regulator are referred to herein as “bank SBS Entities.”

8
An SBS Entity for which there is no prudential regulator could be dually registered with the Commission as a broker-dealer (“broker-dealer SBS Entity”) or registered with the Commission only as an SBS Entity (“stand-alone SBS Entity”).

9
17 CFR 240.17a-3(a)(12) requires broker-dealers, including broker-dealer SBS Entities, to make and keep current a questionnaire or application for employment for each associated person that contains information about the associated person (the “questionnaire requirement”) as well other information about associated persons. The Commission adopted parallel requirements in Rule 18a-5 for stand-alone and bank SBS Entities.
See
Requirements for Security-Based Swap Dealers, Major Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain Security-Based Swap Dealers, Exchange Act Release No. 87005 (Sep. 19, 2019), 84 FR 68550 (Dec. 16, 2019) (“Recordkeeping and Reporting Adopting Release”).

• The Commission is issuing a statement regarding compliance with rules for security-based swap data repositories and Regulation SBSR.

A number of these final actions have been modified from the proposals to address issues raised by commenters, and more generally to enhance the actions' effectiveness and efficiency. The Commission has consulted and coordinated with staff of the CFTC and the prudential regulators,
10

in accordance with the consultation mandate of the Dodd-Frank Act.
11

The Commission also has consulted and coordinated with foreign regulatory authorities through Commission staff participation in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC (over-the-counter) derivatives.
12

10
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, 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.

11
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.”

12
Staff participates in a number of international standard-setting bodies and workstreams working on OTC derivatives reforms. For example, Commission staff participates in the Financial Stability Board's Working Group on OTC Derivatives Regulation. Commission staff also participates in the International Organization of Securities Commissions (“IOSCO”) Committee on Derivatives, the joint Basel Committee on Banking Supervision (“BCBS”) and IOSCO Working Group on Margin Requirements' Monitoring Group and participates in international working groups that impact OTC derivatives financial market infrastructures, such as Committee on Payment Market Infrastructures (“CPMI”)—IOSCO joint working groups assessing legal and regulatory frameworks for central counterparties and trade repositories and examining central counterparty resilience and recovery.

II. Security-Based Swap Transactions Arranged, Negotiated, or Executed by U.S. Personnel

A. Use of “Arranged, Negotiated, or Executed” Criteria

1. Background

A number of the rules implementing Title VII in the cross-border context account for whether security-based swap transactions have been arranged, negotiated, or executed by personnel located in the United States. In 2016, the Commission adopted Exchange Act Rule 3a71-3(b)(1)(C)(iii). The rule provides that for purposes of determining whether non-U.S. persons will be deemed to be security-based swap dealers—and hence subject to the Title VII requirements applicable to

security-based swap dealers—non-U.S. persons (other than conduit affiliates as defined in the rule) must count, against the applicable
de minimis
threshold, their security-based swap dealing transactions with non-U.S. counterparties that were “arranged, negotiated, or executed” by personnel within the United States.
13

The Commission also incorporated the “arranged, negotiated, or executed” criteria into the cross-border application of other parts of the security-based swap dealer
de minimis
counting rules,
14

of the cross-border application of business conduct provisions for SBS Entities,
15

of Regulation SBSR's regulatory reporting and public dissemination provisions,
16

and of Title VII rules regarding major security-based swap participants.
17

13

See
Proposing Release, 84 FR at 24208 nn.12-13.

Rule 3a71-3 further requires that such non-U.S. persons count their dealing transactions with certain U.S. counterparties, their dealing transactions in which their performance under the security-based swap is guaranteed by a U.S. affiliate, and, in some circumstances, certain transactions of affiliates.
See
Exchange Act Rules 3a71-3(b)(1)(iii)(A)-(B), (b)(2) and 3a71-4, 17 CFR 240.3a71-3(b)(1)(iii)(A)-(B), (b)(2) and 3a71-4.

Persons whose dealing activities exceed the
de minimis
thresholds will be required to register as security-based swap dealers.
See
Exchange Act Section 3(a)(71)(D), 15 U.S.C. 78(c)(a)(71)(D); Exchange Act Rule 3a71-2, 17 CFR 240.3a71-2. For a discussion of the compliance date for registration of security-based swap dealers, see Part X.B.

14

See
Proposing Release, 84 FR at 24208 n.81.

15

See
Exchange Act Rule 3a71-3(c), 17 CFR 240.3a71-3(c).
See
Proposing Release, 84 FR at 24208 n.79 for further discussion.

16

See
Regulation SBSR Rules 908(a)(1)(v) and 908(b)(5), 17 CFR 242.908(a)(1)(v) and 908(b)(5) (incorporating an “arranged, negotiated, or executed” standard).
See
Proposing Release, 84 FR at 24208 n.80 for further discussion.

17

See
Exchange Act Rule 3a67-10(b)(3)(i), 17 CFR 240.3a67-10(b)(3)(i) (setting out that the “major security-based swap participant” excludes positions that arise from transactions conducted through a foreign branch of a counterparty that is a registered security-based swap dealer and thus incorporating the definition of “transaction conducted through a foreign branch,” which makes use of “arranged, negotiated, and executed” criteria); Exchange Act Rule 3a67-10(d), 17 CFR 240.3a67-10(d) (stating that U.S. and non-U.S. major security-based swap participants are excluded from having to comply with certain business conduct requirements in connection with transactions conducted through a foreign branch, based on that same definition).
See
Proposing Release, 84 FR at 24208 n.82 for further discussion.

In the Proposing Release, the Commission solicited comment regarding how U.S. personnel are used in connection with cross-border security-based swap transactions, and regarding the impacts of tests that account for the activity of U.S. personnel.
18

The Commission also solicited comment on guidance regarding the use of the terms “arranged” and “negotiated” in the cross-border application of Title VII rules, as well as on two alternative approaches to a conditional exception to Rule 3a71-3(b)(1)(C)(iii).
19

The proposals sought to address concerns that had been raised regarding the consequences associated with the incorporation of “arranged, negotiated, or executed” criteria in the cross-border application of Title VII, in a manner that balanced two competing considerations.
20

On one hand, the proposals reflected the Commission's continued belief that the use of “arranged, negotiated, or executed” criteria appropriately should constitute part of the security-based swap dealer
de minimis
counting requirement in connection with transactions involving two non-U.S. counterparties, in part due to the risk that non-U.S. persons engaged in security-based swap dealing activity in the United States otherwise could avoid regulation under Title VII.
21

On the other hand, the proposals also reflected the Commission's recognition that the use of “arranged, negotiated, or executed” criteria as part of the
de minimis
counting requirement might produce negative consequences such as causing financial groups “to relocate U.S. personnel or relocate the activities performed by U.S. personnel, to avoid security-based swap dealer registration,” and that those results “have the potential to increase fragmentation and harm U.S. market participants and the U.S. economy.”
22

18

See
Proposing Release, 84 FR at 24217, 24227-28.

19

See
Proposing Release, 84 FR at 24217-18, 24237-43.

20

See
Proposing Release, 84 FR at 24207-08.

21

See
Proposing Release, 84 FR at 24208-09, 24218.

22

See id.
at 24216, 24218.

2. Commission Action

After considering comments submitted in response to the Proposing Release, the Commission continues to believe the “arranged, negotiated, or executed” criteria form an appropriate basis for applying Title VII requirements in the cross-border context.
23

At the same time, after considering commenters' views, the Commission continues to recognize that the use of “arranged, negotiated, or executed” criteria has the potential to lead to a variety of negative consequences. Accordingly, the Commission is issuing guidance regarding the application of the terms “arranged” and “negotiated” in the cross-border application of Title VII rules to the provision of “market color,” as well as adopting a conditional exception from the incorporation of “arranged, negotiated, or executed” criteria as part of the
de minimis
counting test.
24

23
Some commenters supported these criteria, with one noting that failure to regulate these transactions under Title VII would create competitive disparities between U.S. and non-U.S. market participants, while regulating these transactions “will enable the Commission to better monitor for disruptive trading practices and will also provide the necessary data regarding overall market trading activity to allow the Commission to evaluate market trends and accurately assess the impact of other reforms implemented in the security-based swap market.”
See
letter from Stephen Berger, Managing Director, Citadel, dated July 23, 2019 (“Citadel letter”) at 2-5;
see also
letter from Dennis Kelleher, President and CEO, Better Markets, dated July 23, 2019 (“Better Markets letter”) at 11 (“Better Markets would like to commend the SEC for affirming fundamental legal bases for continuing to apply Dodd-Frank Act requirements to ANE Transactions based on a territorial analysis of the SEC's cross-border jurisdiction”); letter from Americans for Financial Reform Education Fund, dated July 23, 2019 (“AFR letter”) at 2 (“we also pointed out that given the narrow definition of U.S. person under the rule, the inclusion of ANE transactions in the de minimis count was an absolutely crucial protection to include in the rule”).

In contrast, some commenters reiterated opposition to any use of “arranged, negotiated, or executed” criteria in connection with Title VII implementation, including cross-border tests related not only to the
de minimis
exception to the “security-based swap dealer” definition, but also to other requirements related to security-based swap dealer registration, to business conduct requirements and to reporting and public dissemination requirements.
See
letter from Briget Polichene, CEO, Institute of International Bankers, and Kenneth E. Bentsen, President and CEO, Securities Industry and Financial Markets Association, dated July 23, 2019 (“IIB/SIFMA letter”) at 7-8, 16-18; ISDA letter at 4-7; letter from Wim Mijs, CEO, European Banking Federation, dated July 23, 2019 (“EBF letter”) at 7; letter from Mark Hutchinson, Managing Director & General Counsel, HSBC Bank USA, N.A., dated July 23, 2019 (“HSBC letter”) at 2-3. Some of these commenters also expressed the view, however, that the proposed exception would partially—but not completely—address the problems they identified in connection with the use of those criteria.
See
IIB/SIFMA letter at 2 (stating that if the Commission does not adopt the commenter's recommended approach of not incorporating “arranged, negotiated, or executed” criteria as part of Title VII implementation, it should “adopt a modified version of the Proposal's conditional exception from the
de minimis
calculation”); ISDA letter at 7-9; HSBC letter at 1, 5. One commenter also argued that the Commission should exempt all non-U.S. registered security-based swap dealers from business conduct requirements other than those that also apply to transactions subject to the proposed exception to the
de minimis
counting requirement.
See
IIB/SIFMA letter at 16.

24
As noted in the Proposing Release, the antifraud provisions of the federal securities laws and certain relevant Title VII requirements would continue to apply to the transactions subject to the exception.
See
Proposing Release, 84 FR at 24219.

As the Commission previously recognized, the “arranged, negotiated, or executed” criteria serve important regulatory interests, including helping protect against the potential that market participants would use booking practices to engage in an unregistered security-based swap dealing business in the United States. Those criteria further

reflect the activity-based focus of the “security-based swap dealer” definition,
25

as well as considerations regarding competitive disparities, market fragmentation, and public transparency. Similarly, the Title VII SBS Entity requirements more generally serve a number of regulatory purposes apart from mitigating counterparty and operational risks, “including enhancing counterparty protections and market integrity, increasing transparency, and mitigating risk to participants in the financial markets and the U.S. financial system more broadly.”
26

25
As the Commission has previously noted, “Exchange Act Section 3(a)(71)(A) identifies specific activities that bring a person within the definition of a `security-based swap dealer': (1) [h]olding 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.” 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; Security-Based Swap Dealer
De Minimis
Exception, Exchange Act Release No. 77104 (Feb. 10, 2016), 81 FR 8598, 8614 (Feb. 19, 2016) (“ANE Adopting Release”) (citing Exchange Act Section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A)).

The Commission has interpreted this definition to apply to persons engaged in indicia of dealing activity.
See
ANE Adopting Release, 81 FR at 8614 (citing 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 (Apr. 27, 2012), 77 FR 30596, 30617-18 (May 23, 2012) (“Intermediary Definitions Adopting Release”)).

Consistent with the statutory definition, the Commission has stated that the
de minimis
threshold relates to the volume of dealing activity and not to specific risk-related factors. Moreover, the fact that risk from a transaction between two non-U.S. persons exists largely outside the United States does not determine whether a sufficient nexus exists to require a non-U.S. person to count the transaction toward its
de minimis
threshold. Rather, “the appropriate analysis . . . also considers 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 the Commission's further definition] of `security-based swap dealer.'” ANE Adopting Release, 81 FR at 8614.

26

See
Proposing Release, 84 FR at 24201 n.20. The Commission's actions to mitigate the negative consequences potentially associated with the various uses of this type of test accordingly are designed to do so while preserving the important Title VII interests that the Commission advanced when it incorporated the test into the various cross-border rules.
See
Proposing Release, 84 FR at 24208.

For similar reasons, the Commission is unpersuaded by one commenter's suggestion
27

to replace the “arranged, negotiated, or executed” criteria for applying Title VII in the cross-border context with a “primary trading relationship” test. Moreover, the Commission recognizes that a test, such as a primary trading relationship test, that purports to distinguish between “direct” and “meaningful” involvement in a transaction on the one hand, and “occasional” and “incidental” involvement on the other hand, in practice would be subject to subjective and inconsistent application.

27

See
HSBC letter (highlighting operational issues associated with the use of an “arranged, negotiated, or executed test” and stating that it would be more practical to make use of a “primary trading relationship” test that looks at “the nature of the trading relationship between the non-U.S. parties and the U.S. personnel involved in the trade”; adding that that test would apply “if U.S. personnel are directly and meaningfully involved in the trading relationship with the non-U.S. parties at the relationship level (
e.g.,
the client's primary point of contact for the SBS is located in the United States), but not when “U.S. personnel are only occasionally and incidentally involved in the trading relationship with the non-U.S. parties”).

At the same time, commenters argued that the use of “arranged, negotiated, or executed” criteria has the potential to lead to a variety of negative consequences. In particular, commenters expressed concern that these criteria may cause the relocation of operations and personnel out of the United States, inhibit the use of centralized risk management, reduce liquidity in the U.S. market, increase fragmentation in global markets, impose significant compliance costs and logistical challenges, and produce competitive disparities.
28

As discussed below, the conditional exception should help mitigate the negative consequences that otherwise may arise from the use of those criteria to their security-based swap business, while also helping to avoid allowing persons to engage in an unregulated security-based swap dealing business in the United States.

28

See
IIB/SIFMA letter at 7-8, 16-18; ISDA letter at 4-7; EBF letter at 7; HSBC letter at 2-3.

Commenters expressed concerns about both the proposed “market color” guidance and the proposed conditional exception. Some commenters asserted that the proposed guidance would encourage market participants to restructure their security-based swaps business to avoid the requirements of the Dodd-Frank Act.
29

Commenters argued that this evasion would impede the Commission's ability to monitor compliance,
30

as well as to exercise its anti-fraud authority.
31

Commenters also worried that the Commission would lose the ability to oversee the vast majority of “arranging” and “negotiating” activity.
32

Similarly, some commenters objected to the proposed exception to the
de minimis
counting rule, asserting that the proposal reflected industry preference contrary to the Commission's public interest mandate,
33

was unsupported by new information,
34

and would permit certain market participants to use booking practices to avoid having to register as security-based swap dealers.
35

The Commission recognizes that the guidance addresses certain activity that will not be cross-border “arranging” and “negotiating” subject to the application of certain Title VII rules. Further, the Commission is mindful that the exception modifies the approach taken in 2016, when the Commission incorporated the “arranged, negotiated, or executed” criteria into the
de minimis
counting rule. Though the exception does permit market participants to avoid counting certain “arranging, negotiating, or executing” activity towards the security-based swap dealer registration thresholds, in the Commission's view, its approach appropriately balances the recent concerns presented by commenters
36

and helps avoid the potential negative consequences that some have suggested may be associated with the current “arranging, negotiating, or executing” standard. In the Commission's view, this approach is in the public interest because it should help facilitate implementation of the Title VII security-based swap dealer requirements in a manner that is both effective and efficient.
37

29

See
Citadel letter at 5;
see also
Better Markets letter at 17.

30

See
Citadel letter at 5.

31

See
Better Markets letter at 21.

32

See
Citadel letter at 5.

33

See
Better Markets letter at 1-2.

34

See
Better Markets letter at 25; AFR letter at 3-4.

35

See
AFR letter at 4;
see also
Citadel letter at 5 (expressing concerns regarding permitting counterparties to “engage in dealing activity using U.S.-based personnel without being appropriately registered with the Commission” in connection with expressing opposition to Alternative 2); letter from Karl Muth, dated July 19, 2019 (“Muth letter”) (expressing view that “the risk that non-U.S. persons engaged in security-based swap dealing activity in the United States could avoid regulation under Title VII . . . is a more serious risk than the risk that the ambit of Title VII may be expanded nominally in some unanticipated way”).

36

See
note 23,
supra,
and Parts II.B and II.C,
infra.

37
Three commenters expressed concerns regarding documentation-related compliance burdens in connection with the use of the “arranging, negotiating, or executing” standard in Title VII rules.
See
IIB/SIFMA letter at 16 (asserting that many business conduct requirements “would impose documentation burdens on non-U.S. counterparties that would deter them from having the interactions with U.S. personnel that would trigger these requirements”; suggesting an exemption from all business conduct requirements as applied to non-U.S. security-based swap dealers' “arranging, negotiating, or executing” activity,” except for those requirements that are conditions to the new exception from the
de minimis
counting rule); ISDA letter at 7 (asserting that “certain

business conduct requirements would impose documentation burdens on non-U.S. counterparties that may incentivize them not to transact with nonresident [security-based swap dealers] that utilize U.S. personnel”; suggesting either an exemption from, or substituted compliance for, all business conduct requirements as applied to non-U.S. security-based swap dealers' “arranging, negotiating, or executing” activity”); HSBC letter at 3-4 (noting that it would be “immensely cumbersome to modify [OTC derivatives regulation compliance systems] to systematically monitor and track the location of any front office personnel acting for HSBC”). Another commenter did not cite documentation burdens but called for an exemption from all business conduct requirements for transactions between two non-U.S. persons that are “arranged, negotiated, or executed” by U.S. personnel.
See
EBF letter at 7. For the reasons discussed above, the Commission continues to believe the “arranged, negotiated, or executed” criteria form an appropriate basis for applying Title VII requirements, including business conduct requirements, in the cross-border context. The Commission encourages potential foreign SBS Entity registrants, however, to contact the staff to discuss concerns regarding any disruption that may be associated with any documentation requirements arising from transactions that are arranged, negotiated, or executed by U.S. personnel. In this regard, the Commission notes that certain of these business conduct requirements are required by statute.

Similarly, three commenters expressed concerns regarding the application of Regulation SBSR to transactions between non-U.S. persons that are “arranged, negotiated, or executed” by U.S. personnel.
See
IIB/SIFMA letter at 16-18 (suggesting an exemption from Regulation SBSR for such transactions when they are reported in another jurisdiction but not publicly disseminated due to insufficient liquidity in that jurisdiction); ISDA letter at 5-7 (suggesting an exemption from Regulation SBSR for such transactions until the Commission issues substituted compliance determinations for all G-20 jurisdictions); EBF letter at 7 (suggesting an exemption from Regulation SBSR for such transactions). One commenter urged the Commission to continue applying Regulation SBSR to transactions between non-U.S. persons that are “arranged, negotiated, or executed” by U.S. personnel, to promote the Commission's supervisory interest in monitoring U.S. trading activity and to increase transparency and enhance price discovery for U.S. market participants.
See
Citadel letter at 1, 2-5. For the reasons discussed above, the Commission continues to believe the “arranged, negotiated, or executed” criteria form an appropriate basis for applying Title VII requirements, including Regulation SBSR, in the cross-border context. Another commenter asked the Commission to allow transaction reports made pursuant to Regulation SBSR to mask counterparty information when a foreign legal barrier requires counterparty consent and/or regulatory authorization to report unmasked data.
See
IIB/SIFMA letter at 28-29. As discussed in Part X.C, the Commission is issuing a statement regarding compliance with Regulation SBSR. This statement takes account of these comments.

B. Guidance Regarding the Meaning of “Arranged” and “Negotiated” in Connection With the Cross-Border Application of Title VII

1. Proposed Approach

For purposes of the “arranged, negotiated, or executed” test, the Commission intended for the terms “arrange” and “negotiate” to “indicate market-facing activity of sales or trading personnel in connection with a particular transaction, including interactions with counterparties or their agents.”
38

Recognizing that market-facing activity may vary significantly in connection with security-based swap transactions, the Commission proposed guidance regarding activity that is not “arranging” or “negotiating” for purposes of Title VII requirements.
39

The proposed guidance would have applied to the “arranged, negotiated, or executed” test that is used in connection with the
de minimis
counting rules
40

and in the cross-border application of business conduct rules,
41

regulatory reporting and public dissemination requirements,
42

and major security-based swap participant rules.
43

38

See
ANE Adopting Release, 81 FR at 8622;
see also
Proposing Release, 84 FR at 24215.

39

See
Proposing Release, 84 FR at 24216.

40
In connection with
de minimis
counting, this guidance would apply to: (1) Exchange Act Rule 3a71-3(b)(1)(iii)(C), which requires the counting of security-based swap dealing transactions between non-U.S. counterparties that have been “arranged, negotiated, or executed” in the United States, 17 CFR 240.3a71-3(b)(1)(iii)(C); (2) Exchange Act Rule 3a71-3(b)(2), which addresses the counting of affiliate transactions described by paragraph (b)(1) (which includes the (b)(1)(iii)(C) requirement), 17 CFR 240.3a71-3(b)(2); (3) Exchange Act Rule 3a71-5, which excepts certain cleared anonymous transactions from the individual counting requirement of paragraph (b)(1) of Rule 3a71-3 and from the affiliate counting requirement of paragraph (b)(2), but is unavailable to transactions “arranged, negotiated, or executed” by U.S. personnel, 17 CFR 240.3a71-5; and (4) the
de minimis
counting requirement of Exchange Act Rule 3a71-3(b)(1)(iii)(A), requiring the counting of dealing transactions involving a foreign branch of a registered security-based swap dealer and a non-U.S. counterparty (or another foreign branch), 17 CFR 240.3a71-3(b)(1)(iii)(A). The regulatory interests underlying the Rule 3a71-3(b)(1)(iii)(C) and Rule 3a71-3(b)(1)(iii)(A) uses of arranged, negotiated, and/or executed criteria to implement the
de minimis
counting requirement are similar (as are, derivatively, the Rule 3a71-3(b)(2) and Rule 3a71-5 uses).

The guidance also would apply to the definition of “transaction conducted through a foreign branch” in Rule 3a71-3(a)(3), which incorporates the functionally equivalent “arranged, negotiated, and executed” terminology.

41

See
note 14,
supra.

42

See
note 16,
supra.

43

See
note 17,
supra.

In the Proposing Release, the Commission explained that in certain circumstances the market-facing activity of U.S. personnel is so limited that it would not implicate the regulatory interests underlying the relevant Title VII requirements.
44

The Commission proposed that such circumstances arise when U.S. personnel provide “market color” in connection with security-based swap transactions, but otherwise have no client responsibility and receive no transaction-linked compensation.
45

The Commission further proposed that, for those purposes, the term “market color” would mean background information regarding pricing or market conditions associated with particular instruments or with markets more generally, including information regarding current or historic pricing, volatility, or market depth, and trends or predictions regarding pricing, volatility, or market depth, as well as other types of information reflecting market conditions and trends.
46

The Commission proposed that U.S. personnel who have no client responsibility and receive no transaction-linked compensation could provide market color in connection with security-based swap transactions in support of non-U.S. persons who actually arrange, negotiate, and execute those transactions on behalf of their clients, without triggering the requirements under Title VII that incorporate the “arranged, negotiated, or executed” test.
47

The Commission explained that, for purposes of the proposed guidance, having no client responsibility would mean that the U.S. personnel providing market color must not have been assigned, and must not otherwise exercise, client responsibility in connection with the transaction.
48

The Commission noted that the involvement of U.S. personnel who are designated as sales persons or traders would not necessarily trigger the “arranged, negotiated, or executed” test as long as such personnel's activity is limited to the provision of market color, rather than arranging or negotiating.
49

The Commission also explained that U.S. personnel not receiving transaction-linked compensation means that the U.S. personnel do not receive compensation based on or otherwise linked to the completion of transactions on which the U.S. personnel provide market color.
50

The Commission clarified, however, that this does not include profit-sharing arrangements or other compensation practices that account for aggregated profits, as such arrangements would not be expected to incentivize U.S. personnel in a similar manner or to a similar degree as compensation that is directly linked to the success of individual transactions.
51

44

See
Proposing Release, 84 FR at 24216.

45

See id.
at 24216-17.

46

See id.
at 24216.

47

See id.
at 24217.

48

See id.
at 24217.

49

See id.
at 24216 n.95.

50

See id.
at 24217.

51

See id.
at 24217 n.96.

In proposing the guidance, the Commission reasoned that the provision of market color by U.S. personnel who have no client responsibility and receive

no transaction-linked compensation is a type of limited market-facing activity by U.S. personnel that, standing alone, would not trigger the concerns and regulatory interests that underpin the various uses of the “arranged, negotiated, or executed” test, as such activity would not appear comprehensive enough to pose a significant risk of allowing an entity to exit the Title VII regulatory regime without exiting the U.S. market.
52

Moreover, non-U.S. counterparties reasonably would not expect Title VII business conduct requirements to apply merely as the result of receiving technical information from U.S. personnel.
53

As noted in the Proposing Release, in circumstances where limited market-facing activity by U.S. personnel does not trigger the “arranged, negotiated, or executed” test, the federal securities laws, including applicable anti-fraud provisions, still may apply to that activity depending on the particular facts and circumstances.
54

52

See id.
at 24216 n.94.

53

See id.

54

See id.
at 24217 n.97.

2. Commission Action

The Commission is providing the guidance largely as proposed, modified to further explain the term “market color.”
55

The Commission believes that, as revised, the guidance will help entities evaluate what is, and what is not, “market color.”

55
Three commenters expressed general support for the guidance as proposed.
See
IIB/SIFMA letter at 3, 9-10; HSBC letter at 1, 5 (expressing general support for the comments in the IIB/SIFMA letter); ISDA letter at 2.

The Commission is providing guidance
56

regarding the “arranged, negotiated, or executed” test that is used in connection with
de minimis
counting,
57

the cross-border application of business conduct rules,
58

regulatory reporting and public dissemination requirements,
59

and major security-based swap participant rules.
60

56
The Commission continues to believe there is no reason to revisit its prior guidance regarding the scope of the term “execute”; the Commission therefore did not in the Proposing Release and does not now provide any additional guidance regarding the interpretation of that term. Moreover, although the Commission is providing guidance with respect to certain market-facing activities that in its view do not constitute arranging or negotiating for purposes of the relevant Title VII requirements, the Commission's view otherwise remains unchanged with respect to guidance provided in the ANE Adopting Release regarding what constitutes arranging, negotiating, or executing security-based swaps.

57
In connection with
de minimis
counting, this guidance applies to: (1) Exchange Act Rule 3a71-3(b)(1)(iii)(C), which requires the counting of security-based swap dealing transactions between non-U.S. counterparties that have been “arranged, negotiated, or executed” in the United States, 17 CFR 240.3a71-3(b)(1)(iii)(C); (2) Exchange Act Rule 3a71-3(b)(2), which addresses the counting of affiliate transactions described by paragraph (b)(1) (which includes the (b)(1)(iii)(C) requirement), 17 CFR 240.3a71-3(b)(2); (3) Exchange Act Rule 3a71-5, which excepts certain cleared anonymous transactions from the individual counting requirement of paragraph (b)(1) of Rule 3a71-3 and from the affiliate counting requirement of paragraph (b)(2), but is unavailable to transactions “arranged, negotiated, or executed” by U.S. personnel, 17 CFR 240.3a71-5; and (4) the
de minimis
counting requirement of Exchange Act Rule 3a71-3(b)(1)(iii)(A), requiring the counting of dealing transactions involving a foreign branch of a registered security-based swap dealer and a non-U.S. counterparty (or another foreign branch), 17 CFR 240.3a71-3(b)(1)(iii)(A). The regulatory interests underlying the Rule 3a71-3(b)(1)(iii)(C) and Rule 3a71-3(b)(1)(iii)(A) uses of arranged, negotiated, and/or executed criteria to implement the
de minimis
counting requirement are similar (as are, derivatively, the Rule 3a71-3(b)(2) and Rule 3a71-5 uses).

The guidance also applies to the definition of “transaction conducted through a foreign branch” in Rule 3a71-3(a)(3), which incorporates the functionally equivalent “arranged, negotiated, and executed” terminology.

58

See
note 15,
supra
(addressing Exchange Act Rule 3a71-3(c), 17 CFR 240.3a71-3(c), business conduct exclusion).

59

See
note 16,
supra
(addressing Regulation SBSR Rules 908(a)(1)(v) and 908(b)(5), 17 CFR 242.908(a)(1)(v) and 908(b)(5), regarding the cross-border application of regulatory reporting and public dissemination requirements).

60

See
note 18,
supra
(addressing cross-border major security-based swap participant provisions of Exchange Act Rules 3a67-10(b)(3)(i) and 3a67-10(d), 17 CFR 240.3a67-10(b)(3)(i) and 3a67-10(d)).

In the Commission's view, “market color” is limited to background information regarding pricing or market conditions associated with particular instruments or with markets more generally in support of persons who arrange, negotiate, or execute security-based swap transactions on behalf of their clients. Background information includes information regarding (1) current or historic pricing, volatility, or market depth, and (2) trends or predictions regarding pricing, volatility, or market depth, as well as information related to risk management.

The Commission is clarifying that U.S personnel who provide market color in connection with security-based swap transactions—in the form of information or data as described above—do not trigger the Title VII requirements that use an “arranged, negotiated, or executed” test when both the following circumstances exist:

•
No client responsibility
—The U.S. personnel have not been assigned, and do not otherwise exercise, client responsibility in connection with the transaction.

•
No transaction-linked compensation
—The U.S. personnel do not receive compensation based on, or otherwise linked to, the completion of individual transactions on which the U.S. personnel provide market color.
61

61
As stated in the Proposing Release, the Commission understands that it is commonplace for firms to account for the overall profit or loss of the firm, or of a particular division or office, in calculating compensation for personnel. Solely for the purposes of this guidance, the Commission does not view profit-sharing arrangements or other compensation practices that account for aggregated profits as transaction-linked compensation, as such arrangements would not be expected to incentivize U.S. personnel in a similar manner or to a similar degree as compensation that is directly linked to the success of individual transactions.

In contrast, in the Commission's view, any solicitation activity by personnel located in the United States or activity to respond to requests by counterparties to enter into transactions when such requests are made directly to personnel located in the United States would
not
be “market color.”
62

Moreover, market-facing activity by personnel located in the United States also would not be “market color” if such activity involves:

62

See
Intermediary Definitions Adopting Release, 77 FR at 30618 (identifying actively soliciting clients in security-based swaps as a factor in indicating that a person meets the statutory definition of security-based swap dealer);
see also
Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities, Exchange Act Release 34-72472 (Jun. 25, 2014), 79 FR 47278, 47322 n.364 (Aug. 12, 2014) (“Cross-Border Adopting Release”) (stating that the term “arranging” was used in lieu of “solicit” to reflect the fact that a person may engage in dealing activity not only through transactions that the person actively solicits, but also through transactions that result from counterparties reaching out to the person); ANE Adopting Release, 81 FR 8622 n.221.

• Providing recommendations, such as recommending particular instruments;

• providing predictions regarding potential merits or risks of, or providing trading ideas or strategies relating to, a proposed security-based swap transaction;

• structuring a particular security-based swap transaction; or

• finalizing or reaching agreement with respect to any pricing or non-pricing element, such as underlier, notional amount or tenor, that must be resolved to complete a security-based swap transaction.

The language above is different from the language in the proposal in response to a number of commenters who expressed concern that it would be difficult to distinguish “market color” activity from “arranging” and “negotiating” activity.
63

63

See
Citadel letter at 5; Better Markets letter at 13-14.

Commenters expressed concern that the guidance would encourage entities (including U.S. entities) to restructure to avoid or evade requirements applicable

under the Dodd-Frank Act.
64

One commenter warned that “market color” was “highly facts and circumstances-specific, complicating monitoring and surveillance by the Commission regarding whether dealer firms are appropriately classifying ANE transactions,”
65

as well as the exercise of the Commission's anti-fraud authority
66

and would result in the Commission losing oversight over the vast majority of transactions that are currently classified as “arranging” or “negotiating.”
67

Finally, a commenter stated that the guidance would lead to “bifurcation of U.S. and non-U.S. markets” that would be “almost certain to impair liquidity and increase costs on U.S. counterparties” and lead to increased fragmentation.
68

64

See
Citadel letter at 5;
see also
Better Markets letter at 17.

65

See
Citadel letter at 5.

66

See
Better Markets letter at 21.

67

See
Citadel letter at 5.

68

See
Better Markets letter at 23-24.

The Commission is not making additional changes in response to these comments. The Commission believes the guidance describes activities that are sufficiently limited and should not encourage entities (including U.S. entities) to restructure to avoid requirements applicable under the Dodd-Frank Act or to lead to market fragmentation. Moreover, contrary to one commenter's suggestion, the Commission is not taking the position that market color activities are not within its jurisdiction.
69

Indeed, to the extent federal securities laws, including anti-fraud, apply to U.S. personnel's provision of market color, nothing in this guidance affects requirements for U.S. personnel to comply with those laws. Moreover, any U.S. personnel who would have the requisite expertise to provide market color, likely would be associated persons of an entity registered with the Commission in an appropriate capacity, such as a security-based swap dealer or broker-dealer.

69
Nothing in the amendments or guidance should be interpreted as a limitation or further clarification of the “outer bounds of the agency's cross-border jurisdiction.”
See
ISDA letter at 2.

C. Conditional Exception to Required De Minimis Counting of Certain Dealing Transactions Arranged, Negotiated, or Executed by U.S. Personnel

For the reasons discussed above in part A.2, and after carefully considering comments received, the Commission is adopting a conditional exception to the
de minimis
counting requirement of Rule 3a71-3(b)(1)(iii)(C), subject to certain modifications from the proposal that are addressed below.
70

70
As discussed below, the Commission is adopting a modified version of Alternative 2 of the proposed exception, which requires that the U.S. personnel at issue be associated either with a registered broker or with a registered security-based swap dealer.
See
Part II.C.1,
infra.

This conditional exception to Rule 3a71-3(b)(1)(iii)(C) also would have ramifications to affiliate counting provisions of paragraph (b)(2) of Rule 3a71-3. Paragraph (b)(2) requires persons engaged in security-based swap transactions described in paragraph (b)(1) of the rule -which includes the transactions at issue—also to count certain dealing transactions of affiliates under common control, including transactions described in paragraph (b)(1)(iii) (unless, pursuant to Rule 3a71-4, the affiliate itself is a registered security-based swap dealer or a person in the process of registering as a security-based swap dealer). As a result, transactions subject to the proposed Rule 3a71-3(b)(1)(iii)(C) exception further would not be subject to the paragraph (b)(2) affiliate transaction counting requirement.

Also, Exchange Act Rule 3a71-5 excepts certain cleared anonymous transactions from the individual counting requirement of paragraph (b)(1) of Rule 3a71-3 (which includes the (b)(1)(iii)(C) requirement) and from the affiliate counting requirement of paragraph (b)(2), but the Rule 3a71-5 exception is unavailable to transactions arranged, negotiated, or executed by U.S. personnel. Because the exception to (b)(1)(iii)(C) will prevent the transactions at issue from triggering either the (b)(1) or (b)(2) counting requirements, the Rule 3a71-5 exception would not be relevant to those transactions.

1. Registration and Ownership Status of the Entity With Which U.S. Personnel Is Associated

(a) Proposed Approach

The proposal set forth two alternatives that differed with regard to the registration status of the entity with which personnel engaged in arranging, negotiating, or executing activity within the United States is associated. Under Alternative 1, all such arranging, negotiating, or executing activity within the United States would have to be performed by personnel associated with an entity that is registered with the Commission as a security-based swap dealer.
71

Alternative 1 was predicated on the reasoning that requiring this U.S. activity to be conducted by personnel in their capacity as associated persons of a registered security-based swap dealer would help ensure that the U.S. activity would be subject to key security-based swap dealer requirements under Title VII, including requirements regarding supervision, books and records, trade acknowledgments and verifications, and business conduct standards. Alternative 2 as proposed was broader, allowing for the U.S. activity to be performed by personnel associated with an entity that is registered with the Commission as a broker (or, as with the first alternative, an entity that is registered as a security-based swap dealer).
72

The other proposed conditions to the two alternatives were intended to be functionally identical.
73

71

See
Alternative 1—proposed Rule 3a71-3(d)(1)(i)(A).

72

See
Alternative 2—proposed Rule 3a71-3(d)(1)(i)(A).

73
There were certain technical differences between the two alternatives, to reflect the potential that, under Alternative 2, the U.S. activity could be conducted by a registered broker that is not also registered as a security-based swap dealer.
See
note 154,
infra.

Both proposed alternatives required that the registered entity (whether it is a registered security-based swap dealer or a registered broker) be a majority-owned affiliate of the non-U.S. person relying on the exception.
74

The affiliation condition in part reflected the expectation that financial groups that use the exception to avoid having to relocate their U.S.-based personnel (so as to avoid triggering security-based swap dealer registration) would use affiliated entities to satisfy the exception.
75

The affiliation condition also was intended to help guard against the risk that a financial group may seek to attenuate its responsibility for any shortcomings in the registered entity's compliance with the conditions to the exception.
76

The proposal made use of a majority-ownership standard
77

to achieve that goal—rather than other measures of affiliation such as a common control standard or alternative ownership thresholds—to help ensure that the financial group has a significant interest in the registered entity, including the registered entity's compliance with applicable requirements.
78

74

See
Alternatives 1 and 2—proposed Exchange Act Rule 3a71-3(d)(1)(i)(B).

75

See
Proposing Release, 84 FR at 24220, 24227.

76

See id.

77
Paragraph (a)(10) of Rule 3a71-3 defines the term “majority-owned affiliate” to encompass relationships whereby one entity directly or indirectly owns a majority interest in another, or whereby a third party directly or indirectly owns a majority interest in both, where “majority interest” is the right to vote or direct the vote of a majority of a class of voting securities of an entity, the power to sell or direct the sale of a majority of a class of voting securities of an entity, or the right to receive upon dissolution, or the contribution of, a majority of the capital of a partnership.

78

See id.

(b) Commission Action

As discussed above in part II.A.2, “arranging,” “negotiating,” and “executing” are core components of security-based swap dealing activity.

79

Moreover, a non-U.S. person that, as part of its security-based swap dealing, “`engages in market-facing activity using personnel located in the United States' would perform activities that fall within the security-based swap dealer definition `at least in part in the United States.' ”
80

The Commission is adopting Alternative 2—which requires that the “arranging, negotiating, or executing” activity in the United States be performed by personnel associated with either a registered security-based swap dealer or a registered broker
81

—but is modifying elements of Alternative 2 from the proposal in response to concerns raised by commenters.
82

In addition, the Commission is adopting, as proposed, the condition requiring that the registered entity be a majority-owned affiliate of the non-U.S. person relying on the exception.
83

79
The “arranged, negotiated, or executed” criteria do not encompass non market-facing activity, such as:

Processing trades and other back-office activities; designing security-based swaps without engaging in market-facing activity in connection with specific transactions; preparing underlying documentation including negotiating master agreements (“as

opposed to negotiating with the counterparty the specific economic terms of a particular security-based swap transaction”); and clerical and ministerial tasks such as entering executed transactions on a non-U.S. person's books.

Proposing Release, 84 FR at 24215 (citing ANE Adopting Release, 81 FR at 8622). Further, the “arranged” and “negotiated” criteria do not include certain types of market-facing activity consistent with the “market color” guidance discussed in Part II.B,
supra.

80

See
Proposing Release, 84 FR at 24208.

As noted in the Proposing Release, the exception applies only to the Rule 3a71-3(b)(1)(iii)(C) requirement for non-U.S. persons to count transactions that involve dealing activity in the United States. Rule 3a71-3 continues to require non-U.S. persons to count all of their security-based swap dealing transactions with U.S. person counterparties, all of their security-based swap dealing transactions that are guaranteed by their U.S. person affiliates, and certain dealing transactions of their affiliates.
See
Proposing Release, 84 FR at 24219 nn.102, 105.

81
As noted in the Proposing Release, the exception would not be satisfied if the “arranging, negotiating, or executing” activity is conducted by a bank that has not registered as a broker due to exceptions for bank brokerage activity in the Exchange Act's definition of “broker,” unless the bank is registered as a security-based swap dealer.
See
Proposing Release, 84 FR at 24226 n.166.

82

See
Exchange Act Rule 3a71-3(d)(1)(i)(A).

83
The Commission received no comments specific to that proposed condition. As discussed in the Proposing Release, that condition is intended to help ensure that the financial group of the non-U.S. person has a significant interest in the registered security-based swap dealer or registered broker-dealer, to help promote appropriate compliance and oversight practices.
See
Proposing Release, 84 FR at 24220.

Paragraph (a)(10) to Rule 3a71-3 defines “majority-owned affiliate” to encompass a relationship whereby one entity directly or indirectly owns a majority interest in another, or where a third party directly or indirectly owns a majority interest in both, where “majority interest” reflects voting power, the right to sell, or the right to receive capital upon dissolution or the contribution of capital.

The Commission believes that its modified approach to Alternative 2 is preferable both to Alternative 1—which would have required the U.S. activity to be performed by persons associated with a registered security-based swap dealer—and to Alternative 2 as proposed in supporting the use of “arranged, negotiated, or executed” criteria as part of
de minimis
counting, while avoiding negative consequences that otherwise may be associated with those criteria. The Commission also believes that the modified approach to Alternative 2 will provide important relief to non-U.S. persons from the potential need to register multiple entities. This conclusion in part reflects the reasons outlined below and in part reflects the fact that, although the registration status of the entity engaged in U.S. activity is different, the two alternatives are subject to other conditions that are nearly identical (as one commenter also noted).
84

Though the registered entity is not the counterparty to the transaction, the registered entity must comply with certain requirements for security-based swap dealers who act as counterparties to a security-based swap. The registered entity must comply with these requirements as if it were the counterparty to the transaction. Moreover, even when the U.S. activity at issue is conducted through a registered broker that is not also registered as a security-based swap dealer, the entity nonetheless must comply with these requirements as if it were a registered security-based swap dealer. These additional conditions protect both counterparties and the Commission's ability to access information, as well as avoid the potential that the exception could be relied upon by non-U.S. persons that are not subject to certain minimum financial responsibility requirements.
85

These conditions also materially distinguish the modified version of Alternative 2 from alternatives that the Commission previously rejected when it incorporated “arranged, negotiated, or executed” criteria into the
de minimis
counting test.
86

Further, the Commission agrees with the commenters who supported Alternative 2 because it provides more flexibility to market participants to utilize U.S. personnel associated with either a registered broker or a registered security-based swap dealer.
87

84

See
IIB/SIFMA letter at 10-11 (stating that under Alternative 2 the relevant transactions would be “no less protected” than under Alternative 1 because Alternative 2 would require compliance with the same conditions as Alternative 1).

85

See id.

86
In particular, when the Commission adopted rule amendments incorporating “arranged, negotiated, or executed” criteria as part of the
de minimis
counting test, and rejected an alternative approach based on the use of registered broker-dealers or U.S. banks:

The Commission noted that the broker-dealer framework does not apply to banks engaged in certain activities, which may include a significant proportion of security-based swap dealing activity, and stated that such an approach would effectively supplant Title VII security-based swap dealer regulation for a majority of dealing activity carried out in the United States with a “cobbled together” grouping of other requirements.

Proposing Release, 84 FR at 24220.

Alternative 2, in contrast, does not permit any carve-out for banks, and would require compliance with security-based swap dealer requirements in connection with key protections, including security-based swap dealer requirements regarding disclosure of risks, characteristics, material incentives, and conflicts of interest; suitability; fair and balanced communications; and trade acknowledgment and verification.

87

See
ISDA letter at 7-8 (“We believe that this flexible approach is important given that certain non-U.S. entities that enter into SBSs with other non-U.S. persons do not intend to register as an SBSD in the United States.”); HSBC letter at 2-3 (noting that U.S. personnel associated with two registered security-based swap dealers and one registered broker-dealer engage in arranging, negotiating, or executing activity for non-U.S. entities in the HSBC group).

For the same reasons, and for the avoidance of doubt, the Commission is adopting as proposed the provision of Alternative 2 that permits the registered entity not to count against the
de minimis
thresholds for security-based swap dealer registration the transactions that its associated persons arrange, negotiate, or execute pursuant to the exception.
See
Exchange Act Rule 3a71-3(d)(3).

In adopting its modified approach to Alternative 2, the Commission also is mindful both of the comments in opposition to any exception as discussed above in Part II.A.2 and of one commenter's view that the exception should not permit a non-U.S. firm to engage in security-based swap dealing activity in the United States without it or an affiliate being registered as a security-based swap dealer.
88

On

balance, however, the Commission is persuaded that the modified version of Alternative 2 will help to address the potential negative consequences that otherwise would be associated with the use of “arranged, negotiated, or executed” criteria as part of the
de minimis
counting test, while providing flexibility to market participants and promoting effective, efficient cross-border implementation of security-based swap dealer registration requirements in a manner consistent with the public interest.
89

Importantly, the exception does not apply to dealing activities involving U.S. counterparties or U.S. guarantees and thus does not permit market participants to avoid counting those transactions against the
de minimis
thresholds.
90

88

See
Citadel letter at 5-6 (“While we have concerns about permitting a dealer counterparty to engage in dealing activity using U.S.-based personnel without being appropriately registered with the Commission, in no event should the Commission adopt Alternative 2. This would allow a non-U.S. firm to engage in dealing activity in the U.S. in security-based swaps without either it, or an affiliate, being registered in the appropriate capacity with the Commission. As a result, key entity-level requirements designed specifically for firms engaged in security-based swap dealing activities would not apply. The Exchange Act is clear that `[i]t shall be unlawful for any person to act as a security-based swap dealer unless the person is registered as a security-based swap dealer with the Commission.' ANE Transactions constitute dealing activity in the U.S. and therefore should be taken into account for security-based swap dealer registration.” (footnote omitted)). The same commenter also stated that a failure to regulate the transactions at issue would create competitive disparities between U.S. and non-U.S. dealers with respect to the requirements applicable to the trading activities conducted by their U.S. personnel.
See
Citadel letter at 2. Finally, the commenter viewed Alternative 2 as allowing non-U.S. persons to “exit the Title VII regulatory regime without exiting the U.S. market” and to conduct “an unregistered security-based swap dealing business in the United

States.”
See
Citadel letter at 2 (quoting the Proposing Release, 84 FR at 24215 nn.80-81).

89
As discussed in Part II.A.2,
supra,
the Commission reiterates its conclusion that the “arranged, negotiated, or executed” criteria appropriately belong in the
de minimis
counting requirement.

90
To be clear, the exception to the
de minimis
counting requirement does not reflect a determination by the Commission that these transactions are without the jurisdiction of the United States under Exchange Act Section 30(c). Consistent with the Commission's view expressed in the ANE Adopting Release, transactions that are arranged, negotiated, or executed by personnel located in the United States in connection with a foreign person's dealing activity constitute dealing activity within the United States. Accordingly, and as noted above, although the Commission is providing a limited exception from the requirement to count certain of these trades toward the
de minimis
threshold, the antifraud provisions of the federal securities laws and certain relevant Title VII requirements would continue to apply to the transactions subject to the exception.

(1) Minimum Capital Requirement

The Commission is modifying Alternative 2 from the proposal to require any broker that serves as the registered entity for purposes of the exception, and that is not approved to use models to compute deductions for market or credit risk, to maintain minimum net capital and establish and maintain risk management control systems as if the broker were also registered as a security-based swap dealer.
91

The Commission is mindful that, as proposed, Alternative 2 would have permitted a registered broker holding significantly less capital than a registered security-based swap dealer to serve as the registered entity for purposes of the exception. Indeed, one commenter favored Alternative 2 precisely because it would not require a broker to dually register as a security-based swap dealer, nor require it to hold the potentially higher minimum net capital required of registered security-based swap dealer, if it wished to serve as the registered entity for purposes of the exception.
92

The lowest fixed-dollar minimum net capital requirement for registered broker-dealers is $5,000, so long as the broker-dealer does not receive, owe, or hold customer funds or securities, does not carry customer accounts, and does not engage in certain other activities.
93

However, broker-dealers may be subject to significantly higher capital requirements depending on their businesses. For example, broker-dealers that carry customer funds or securities must maintain at least $250,000 in net capital.
94

These minimum net capital requirements nonetheless are significantly lower than the minimum net capital required of brokers who are also registered security-based swap dealers. A broker dually registered as a security-based swap dealer must maintain at least $20 million in net capital if it does not use models to compute deductions for market or credit risk (or the sum of an indebtedness-based ratio and up to eight percent of the risk margin amount, if that sum is greater than $20 million).
95

91

See
Exchange Act Rule 3a71-3(d)(1)(i)(A)(
1
)-(
2
).

92

See
IIB/SIFMA letter at 10-11 & n.18 (arguing that the higher security-based swap dealer capital requirements would be disproportionate to the associated risk to the registered entity).

93

See
Exchange Act Rule 15c3-1(a)(2)(vi), 17 CFR 240.15c3-1(a)(2)(vi).

94

See
Exchange Act Rule 15c3-1(a)(2)(i), 17 CFR 240.15c3-1(a)(2)(i).

95

See
Exchange Act Rule 15c3-1(a)(10), 17 CFR 204.15c3-1(a)(10).

The Commission believes it is appropriate to require a broker serving as the registered entity for purposes of the exception to maintain minimum net capital at least equal to the minimum net capital requirements for brokers that are also security-based swap dealers. A minimum capital requirement for brokers serving as the registered entity for purposes of the exception ensures that every financial group that has foreign dealers engaged in U.S. security-based swap dealing activity pursuant to the exception—whether through a registered security-based swap dealer or a registered broker—must maintain the same amount of net capital. The Commission believes that this requirement reduces the potential for competitive disparities between firms that make use of a registered broker for purposes of the exception and those that make use of a registered security-based swap dealer. Reducing the potential for such disparities should help to mitigate one commenter's concern that Alternative 2 could allow non-U.S. persons to “exit the Title VII regulatory regime without exiting the U.S. market” and to conduct “an unregistered security-based swap dealing business in the United States.”
96

On balance, the Commission believes that these concerns regarding the potential for evasion of Title VII weigh more heavily than another commenter's preference for the flexibility to use a minimally capitalized broker for purposes of the exception.
97

Accordingly, a broker not approved to use models may not serve as the registered entity for purposes of the exception unless it maintains at least as much net capital as that required for a broker that is also registered as a security-based swap dealer (
i.e.,
currently a minimum of $20 million).
98

Because the use of a broker subject to higher capital requirements mitigates concerns regarding the potential for avoidance of Title VII, a broker that is approved to use models also could serve as the registered entity for purposes of the exception. In addition to complying with the other conditions to the exception, such brokers must comply with the higher minimum net capital and tentative net capital requirements that apply to them (
i.e.,
currently minimums of $1 billion and $5 billion, respectively).
99

96

See
Citadel letter at 2 (quoting the Proposing Release, 84 FR at 24215 nn.80-81).

97

See
IIB/SIFMA letter at 10-11 & n.18.

98

See
Exchange Act Rule 15c3-1(a)(10), 17 CFR 240.15c3-1(a)(10). The minimum net capital requirement for a broker that serves as the registered entity for purposes of the exception does not lower the minimum net capital or tentative net capital that a broker must maintain if required pursuant to other applicable requirements.

99

See
Exchange Act Rule 15c3-1(a)(7), 17 CFR 240.15c3-1(a)(7).

For analogous reasons, the Commission is modifying the proposal to require any broker that is not approved to use models and that serves as the registered entity for purposes of the exception to establish and maintain risk management control systems as if the entity also were a security-based swap dealer.
100

This condition imposes a new requirement to comply with portions of Rule 15c3-4 only for brokers who engage in “arranging, negotiating, or executing” activity pursuant to the exception and who are not approved to use models and are not dually registered as a security-based swap dealer or an OTC derivatives dealer. Other registered entities who may engage in “arranging, negotiating, or executing” activity pursuant to the exception—brokers who are approved to use models, non-model brokers who are dually registered as

either a security-based swap dealer or an OTC derivatives dealer, and stand-alone security-based swap dealers—are already required to comply with Rule 15c3-4.
101

As the Commission noted when adopting rules regarding risk management control systems for non-model-approved broker-dealers also registered as security-based swap dealers, “[t]he Commission believes that establishing and maintaining a strong risk management control system is necessary for entities engaged in security-based swap business.”
102

Appropriate risk management controls help a firm to reduce its risk of significant loss, which also reduces the risk of spreading the losses to other market participants or throughout the financial markets as a whole.
103

The Commission recognizes that service as the registered entity for purposes of the exception would not by itself be expected to create the same level of market or credit risk for a registered broker as it would for dealing entities that hold positions in security-based swaps. The Commission would expect the registered broker to establish such controls appropriate to the risk it undertakes. If the registered broker does not undertake any other activities other than arranging, negotiating, or executing transactions for its affiliates, the system of internal risk management controls regarding market and credit risk could, for example, entail guidelines, policies, and procedures that the broker does not undertake activities that create market or credit risk. Accordingly, the Commission is requiring that a broker that is not approved to use models and that serves as the registered entity for the purposes of the exception, must comply with Rule 15c3-1(a)(10)(ii) as if that entity were registered with the Commission as a security-based swap dealer.

100

See
Exchange Act Rule 3a71-3(d)(1)(i)(B)(
2
) (requiring compliance with Exchange Act Rule 15c3-1(a)(10)), which in turn requires compliance with portions of Exchange Act Rule 15c3-4, when the registered entity is a broker not approved to use models to compute deductions for market or credit risk).

101

See
Exchange Act Rule 15c3-1(a)(7) (requiring brokers approved to use models to comply with portions of Exchange Act Rule 15c3-4); Exchange Act Rule 15c3-1(a)(10) (requiring brokers not approved to use models who are dually registered as security-based swap dealers to comply with portions of Exchange Act Rule 15c3-4); Exchange Act Rule 15c3-4 (requiring compliance by OTC derivatives dealers); Exchange Act Rule 18a-1(f) (requiring security-based swap dealers to comply with portions of Exchange Act Rule 15c3-4).

102
Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital and Segregation Requirements for Broker-Dealers, Exchange Act Release No. 86175 (June 21, 2019), 84 FR 43872, 43907 (Aug. 22, 2019) (“Capital, Margin, and Segregation Adopting Release”).

103

See id.

(2) Limited Exemption From Broker Registration

The Commission is modifying Alternative 2 from the proposal to include, as an ancillary to the conditional exception, a limited exemption from the broker registration requirement in Section 15(a) of the Exchange Act for “arranging, negotiating, or executing” activity that is conducted in compliance with the exception and that is with or for a counterparty that is an eligible contract participant. Consistent with the Proposing Release, the Commission also recognizes that the “arranging, negotiating, or executing” activity subject to the exception generally would constitute “broker” activity under the Exchange Act.
104

As a result, a security-based swap dealer not already registered as a broker that serves as the registered entity for purposes of the exception, and its associated persons, could be required to register as brokers pursuant to Section 15(a) of the Exchange Act unless they can avail themselves of an exception from broker status or an exemption from broker registration.
105

One commenter suggested that the Commission exempt from broker registration any registered security-based swap dealer whose only securities brokerage activity is the “arranging, negotiating, or executing” activity that its U.S. personnel conducts in connection with the exception.
106

That commenter noted that a security-based swap dealer not dually registered as a broker-dealer and approved to use models to compute deductions for market or credit risk is subject to a minimum net capital requirement of $20 million and a minimum tentative net capital requirement of $100 million, versus minimum requirements of $1 billion and $5 billion, respectively, for a broker-dealer approved to use models.
107

The Commission believes that applying the heightened broker-dealer capital requirements to all security-based swap dealers approved to use models who serve as the registered entity for purposes of the exception could limit the usefulness of the exception, and is adopting the limited exemption from broker registration to avoid that potential outcome.
108

104

See
Proposing Release, 84 FR at 24220. Although the Dodd-Frank Act excludes from the Exchange Act definition of “dealer” persons who engage in security-based swaps with or for persons who are eligible contract participants,
see
Section 3(a)(5) of the Exchange Act, 15 U.S.C. 78c(a)(5), as amended by Section 761(a)(1) of the Dodd-Frank Act, it does not include comparable provisions for persons who act as brokers in security-based swaps. Because security-based swaps, as defined in Section 3(a)(68) of the Exchange Act, are included in the Exchange Act Section 3(a)(10) definition of “security,” persons who act as brokers in connection with security-based swaps must, absent an exception or exemption, register with the Commission as a broker pursuant to Exchange Act Section 15(a), and comply with the Exchange Act's requirements applicable to brokers.
See
Intermediary Definitions Adopting Release, 77 FR at 30597 n.9

105

See
Proposing Release, 84 FR at 24220. Exchange Act Section 15(a) requires persons who engage in brokerage activities involving securities (including security-based swaps) to register with the Commission unless they can avail themselves of an exception or exemption from the registration requirement. The definition of “broker” in Exchange Act Section 3(a)(4) generally encompasses persons engaged in the business of effecting transactions in securities for the account of others, but does not encompass banks that are engaged in certain activities, which may include a significant portion of banks' security-based swap dealing activity.
See
Proposing Release, 84 FR at 24209 n.21 (citing ANE Adopting Release, 81 FR at 9619).

106

See
IIB/SIFMA letter at 11.

107

See
IIB/SIFMA letter at 11 n.18; Exchange Act Rules 18a-1(a) and 15c3-1(a)(7), (10), 17 CFR 240.18a-1(a) and 15c3-1(a)(7), (10).

108
The Commission also acknowledges that the exemption creates the potential for competitive disparities between market participants who engage in “arranging, negotiating, or executing” activity with non-U.S. eligible contract participants pursuant to the exception, for whom an exemption from broker registration potentially would be available, and market participants who engage in similar activity with U.S. persons, for whom the Rule 3a71-3 exception is not available and thus the related exemption from broker registration also would not apply. For example, an exemption from broker registration available only with respect to “arranging, negotiating, or executing” activity with non-U.S. persons could create an incentive for market participants to provide greater liquidity and/or liquidity at a lower cost to non-U.S. eligible contract participants than to U.S. eligible contract participants. The limitations on the availability of the exemption should minimize the potential for these competitive disparities while also making the exception from the
de minimis
counting standard a practicable alternative.

At the same time, the Commission is mindful that the exception applies to “arranging, negotiating, or executing” activity with both eligible contract participants and non-eligible contract participants. As noted above, the exemption from broker registration applies only to “arranging, negotiating, or executing” activity that is conducted in compliance with the exception and that is with or for a counterparty that is an eligible contract participant. The Commission believes that requiring broker registration with respect to “arranging, negotiating, and executing” activity with or for a counterparty that is not an eligible contract participant is consistent with the heightened protections that Congress applied to security-based swap transactions with or for non-eligible contract participants.
109

109
In its Title VII statutory framework, Congress applied heightened protections for security-based swap counterparties who are not eligible contract participants, requiring, for example, security-based swap transactions with or for a person who is not

an eligible contract participant to be effected only on a registered national securities exchange.
See
Exchange Act Section 6(l), 15 U.S.C. 78f(
l
), as added by Section 763(e) of the Dodd-Frank Act. Congress' Title VII statutory framework also includes an exception from the definition of dealer for persons engaged in the business of buying and selling security-based swaps with or for eligible contract participants, but provides no exception from the dealer definition for persons engaged in the business of buying and selling security-based swaps with or for non-eligible contract participants.
See
Exchange Act Section 3(a)(5), 15 U.S.C. 78c(a)(5), as amended by Section 761(a)(1) of the Dodd-Frank Act.

Finally, Exchange Act Rule 10b-10 requires brokers to provide certain disclosures in connection with “transactions” that involve “customers” of the broker.
110

Although many of the disclosures required by Rule 10b-10 would be included in a trade acknowledgment and verification
111

delivered pursuant to the condition discussed in Part II.C.2 below, some of the Rule 10b-10-required disclosures may not duplicate the information provided in a trade acknowledgment and verification. These additional disclosures required under Rule 10b-10 provide the customer with important information regarding the brokerage activity.
112

The Commission thus believes that the limited exemption from broker registration should be conditioned upon the security-based swap dealer providing these non-duplicative disclosures to the customer if Rule 10b-10 otherwise would apply to the activity subject to the exception.
113

Accordingly, pursuant to Section 15(a)(2) of the Exchange Act, the Commission deems consistent with the public interest and the protection of investors to adopt a limited exemption from the broker registration requirements of Section 15(a)(1) of the Exchange Act for “arranging, negotiating, or executing” activity conducted pursuant to the exception with or for eligible contract participants. New paragraph (d)(4) of Rule 3a71-3 provides that a registered security-based swap dealer that serves as the registered entity for purposes of the exception and its associated persons shall not be subject to registration as a broker pursuant to Section 15(a)(1) solely because that registered entity or the associated person engages in “arranging, negotiating, or executing” activity pursuant to the exception with or for an eligible contract participant, provided that (i) the conditions to the availability of the exception are satisfied in connection with such activities and (ii) if Rule 10b-10 would apply to an activity subject to the exception, the registered security-based swap dealer provides to the customer
114

the disclosures required by Rule 10b-10(a)(2) (excluding Rule 10b-10(a)(2)(i)-(ii)) and Rule 10b-10(a)(8) in accordance with the time and form requirements set forth in Rule 15Fi-2(b)-(c), or, alternatively, promptly after discovery of any defect in the registered security-based swap dealer's good faith effort to comply with such requirements.

110

See
Exchange Act Rule 10b-10(a), 17 CFR 240.10b-10(a) (prohibiting a broker or dealer to effect for or with an account of a customer any transaction in, or to induce the purchase or sale by such customer of, a security unless the broker or dealer delivers a written confirmation at or before completion of the transaction).

111
While Rule 15Fi-2 requires a trade acknowledgment to disclose all terms of the security-based swap transaction,
see
Exchange Act Rule 15Fi-2(c), 17 CFR 240.15Fi-2(c), Rule 10b-10 includes provisions requiring disclosures that may not form part of the terms of the security-based swap transaction between the relying entity and its counterparty, including the capacity in which the broker (who would not be party to the transaction) is acting,
see
Exchange Act Rule 10b-10(a)(2), CFR 240.10b-10(a)(2), and the fact that the broker is not a member of the Securities Investor Protection Corporation, if such is the case,
see
Exchange Act Rule 10b-10(a)(8), 17 CFR 240.10b-10(a)(8).

112
For example, customers may use disclosures regarding the capacity in which the broker is acting and membership in the Securities Investor Protection Corporation to determine whether the broker is able to meet the customer's needs.

113
For the reasons discussed in Part II.C.2,
infra,
these disclosures may be delivered to the customer in accordance with the time and form requirements set forth in Rule 15Fi-2(b)-(c), rather than in accordance with the slightly different timing standards set forth in Rule 10b-10. If the registered security-based swap dealer relying on this exemption from registration as a broker makes a good faith effort to comply with the requirement to deliver these disclosures to the customer as and when required, the failure to do so will not make the exemption from broker registration unavailable so long as the registered security-based swap dealer delivers the disclosures to the customer promptly after discovery of the defect in compliance.
See
Exchange Act Rule 3a71-3(d)(4).

114
For example, the Rule 10b-10 disclosures could be provided as part of the disclosures required pursuant to the disclosure condition in Rule 3a71-3(d)(1)(ii)(B)(
1
) discussed below.

(3) Limit on Use of the Exception for Covered Inter-Dealer Security-Based Swaps and Related Notice and Recordkeeping Provisions

The final rule limits the availability of the exception in connection with certain inter-dealer security-based swaps, and provides for related notices and recordkeeping requirements to facilitate implementation of this limit. In particular, the final rule provides that the availability of the exception is conditioned on the aggregate gross notional amount of certain inter-dealer security-based swap positions connected with dealing activity subject to the exception over the course of the immediately preceding 12 months remaining below $50 billion.
115

If that threshold is exceeded, the exception will not be available and all of the relevant transactions (including transactions below the $50 billion threshold) must be counted against the
de minimis
thresholds to the “security-based swap dealer” definition.
116

The rules further condition the availability of the exception on the registered entity whose associated persons conduct the “arranging, negotiating, or executing” activity in the United States filing a notice with the Commission prior to commencing such activity.
117

Finally, the registered entity must comply with certain recordkeeping requirements designed to facilitate compliance with this $50 billion threshold.
118

115

See
Exchange Act Rule 3a71-3(d)(1)(vii).

116

See
Exchange Act Rule 3a71-3(d)(6)(ii).

117

See
Exchange Act Rule 3a71-3(d)(1)(vi).

118

See
Exchange Act Rule 3a71-3(d)(1)(iii)(B)(
2
).

(a) Purpose of the Limit

In its releases adopting rules applying Title VII requirements to cross-border transactions in 2014 and 2016, the Commission recognized and sought to reduce the risk that market participants might restructure their business or develop novel business structures to permit them to characterize their security-based swap dealing activity as occurring outside the United States.
119

Section 30(c) of the Exchange Act provides the Commission with authority to adopt rules that apply to a “person that transacts a business in security-based swaps without the jurisdiction of the United States” if it determines that such rules are “necessary or appropriate to prevent the evasion” of any Title VII requirements.
120

The Commission invoked this authority in connection with several of its cross-border requirements.
121

In particular, the Commission identified this provision as the basis for adopting a rule requiring conduit affiliates to count certain of their dealing transactions against the
de minimis
threshold.
122

The Commission

also explained that several other of its cross-border requirements that apply to activity occurring in the United States are “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 help ensure that the relevant purposes of the Dodd-Frank Act are not undermined.”
123

119

See
Cross-Border Adopting Release, 79 FR at 47363-64; ANE Adopting Release, 81 FR at 8609.

120
Exchange Act Section 30(c), 15 U.S.C. 78dd(c).

121

See, e.g.,
Cross-Border Adopting Release, 79 FR at 47291-92 (interpreting the Commission's anti-evasion authority under section 30(c) of the Exchange Act and including anti-evasion among the principles informing the Commission's approach to cross-border regulation of these markets).

122

See
Cross-Border Adopting Release, 79 FR at 47314. A conduit affiliate is “a non-U.S. affiliate of a U.S. person that enters into security-based swaps with non-U.S. persons, or with certain foreign branches of U.S. banks, on behalf of one or more of its U.S. affiliates (other than U.S. affiliates that are registered as security-based swap dealers or major security-based swap participants), and enters into offsetting transactions with its U.S. affiliates to transfer the risks and benefits of those security-based swaps.”
Id.
The Commission noted in that release that “[t]he conduit affiliate concept serves as a prophylactic anti-evasion measure” and that it

did “not believe that any entities currently act as conduit affiliates in the security-based swap market.”
Id.
at 47315.

123
The Commission stated in these releases that, apart from the
de minimis
counting requirements applicable to conduit affiliates, the rules it adopted apply to conduct occurring within the United States and thus are within the Commission's authority apart from this anti-evasion provision. However, it went on to state that it also viewed these rules as necessary or appropriate as an anti-evasion measure under Section 30(c) of the Exchange Act.
See, e.g.,
Cross-Border Adopting Release, 79 FR at 47302 n.186 (definitions of “foreign branch” and “transaction conducted through a foreign branch”);
id.
at 47309 n.262 (definition of “principal place of business”);
id.
at 47320 n.365 (requirement that non-U.S. persons count dealing transactions with U.S. persons toward their
de minimis
thresholds); ANE Adopting Release, 81 FR at 8615 n.158 (requirement that non-U.S. persons count transactions in connection with their dealing activity that are arranged, negotiated, or executed by personnel located in the United States).

Similarly, when the Commission adopted the “arranged, negotiated, or executed” test, it recognized the possibility that financial groups might seek to avoid this requirement by having personnel outside the United States perform market-facing activities under the direction of personnel located in the United States.
124

It addressed this concern by explaining that “arranging, negotiating, and executing” as used in Exchange Act Rule 3a71-3 “also include directing other personnel to arrange, negotiate, or execute a particular security-based swap.”
125

The Commission explained that it “would view personnel located in a U.S. branch or office who direct personnel not located in the United States to arrange, negotiate, or execute a security-based swap transaction as themselves arranging, negotiating, or executing the transaction.”
126

Consequently, “sales and trading personnel of a non-U.S. person who are located in the United States cannot avoid application of this rule by simply directing other personnel to carry out dealing activity.”
127

124
ANE Adopting Release, 81 FR at 8623.

125

Id.

126

Id.

127

Id.

The Commission recognizes that the exception it is adopting may also create incentives for financial groups to restructure their business to avoid the application of certain Title VII requirements in some circumstances. Available data suggests that the majority of inter-dealer transaction activity in North American corporate single-name credit default swaps involved at least one non-U.S.-domiciled dealer in 2017.
128

Although the data also suggests that these non-U.S.-domiciled dealers would be likely to register as security-based swap dealers even absent a requirement to count their transactions arranged, negotiated, or executed by U.S. personnel,
129

a financial group could restructure its dealing business in response to this exception in such a way that it could carry out this inter-dealer business in significant part in one or more unregistered non-U.S. dealers, while continuing to arrange, negotiate, or execute transactions using personnel located in the United States. Further, as the Commission recognized in proposing the exception, U.S. dealing entities also may use this type of exception from the counting requirement to reduce the application of Title VII requirements to their transactions.
130

Two commenters expressed similar concerns that the exception as proposed could allow firms to structure large portions of their business to avoid Title VII while continuing to pose risks to the U.S. financial system.
131

Allowing this type of restructuring of the inter-dealer business could have potentially undesirable effects on the underlying credit and equity markets in the United States.

128
Using data obtained from the DTCC Derivatives Repository Limited Trade Information Warehouse (s
ee
Part IV.A.1,
infra
), the Commission estimates that approximately 82% of the notional amount of bilateral (
i.e.,
uncleared) inter-dealer transactions referencing North American single-name corporate underliers involve at least one non-U.S.-domicile dealer.

129
Each of these dealers currently transacts significant volumes security-based swaps with U.S. persons, including with counterparties that are themselves not dealers, which they would be required to count against their
de minimis
thresholds. These dealers would exceed the $8 billion
de minimis
threshold that applies to credit default swap transactions based solely on transactions with U.S. persons.

130

See
Proposing Release, 84 FR at 24219 (“In making this proposal, the Commission is mindful that U.S.-based dealing entities may use this type of exception to structure their booking practices to manage the application of Title VII to their security-based swap dealing business—
e.g.,
by booking dealing transactions with non-U.S. counterparties into their non-U.S. affiliates, to reduce the application of Title VII security-based swap dealer requirements to those transactions.”).

131

See
Better Markets letter at 1, 25 (noting that the proposed exception could “facilitate[e] evasion or avoidance of critical pillars of the [security-based swap] framework” and expressing concern that this framework must “reach far enough” to prevent restructuring that would “expos[e] [the] U.S. financial system and U.S. taxpayers to the risks arising from [security-based swap] activities”); AFR letter at 1-3 (noting that the proposed exception could prompt U.S.-based financial groups to “easily avoid swap dealer designation for large shares of their U.S.-related business”).

To help to mitigate these concerns, the Commission is imposing a limit on covered inter-dealer security-based swap transactions that a non-U.S. dealer or its affiliates may conduct in reliance on the exception. In adopting this limit, the Commission is balancing the concerns discussed above regarding the potential negative consequences associated with both the “arranging, negotiating, or executing” counting standard and the exception as proposed. The Commission is choosing not to apply the limit to non-inter-dealer security-based swaps at this time because it is not clear that a broader limitation is necessary to avoid the potential negative consequences associated with the exception. Rather, the Commission believes that a limit on inter-dealer security-based swaps will mitigate concerns regarding the proposed exception without unduly restricting the non-inter-dealer security-based swap market. Taken as a whole, the limit and related notice and recordkeeping provisions are designed to focus the availability of the exception in a manner that will promote the exception's benefits for market efficiency as addressed above, but that also will help reduce incentives for financial groups to restructure their business to avoid the application of certain Title VII requirements.

The limit on use of the exception applies to any non-U.S. person, regardless of whether it is affiliated with a U.S or non-U.S. financial group, as the Commission has concerns about potential evasive activity on the part of non-U.S. affiliates of U.S. financial groups as well as of non-U.S. financial groups. The Commission is concerned that failing to apply the same limit to non-U.S. dealers relying on the exception, whether they belong to U.S. or non-U.S. financial groups, could distort competition in this market. Moreover, the regulatory status of the relying entity's counterparty does not impact these potentially undesirable effects, and thus is not relevant to application of the $50 billion limit.

132

This limit thus applies without regard to whether either counterparty is affiliated with a U.S or non-U.S. financial group and regardless of the regulatory status of the relying entity's counterparty. The $50 billion limit should help ensure that a relying entity, together with its non-U.S. person affiliates, cannot use the exception to enter into unlimited transactions with other firms that themselves could engage in dealing activity subject to the exception. Under this approach, the Commission believes these financial groups will have less incentive to structure their businesses to avoid regulation of their inter-dealer business under the relevant Title VII requirements. For example, with this limitation, a financial group will not be able to use the exception to move its inter-dealer business with non-U.S. persons involving “arranging, negotiating, or executing” activity above the $50 billion threshold to an unregistered non-U.S. affiliate.
133

Moreover, the requirement to aggregate transactions of covered affiliates, as discussed below, ensures that the $50 billion threshold applies to all unregistered non-U.S. persons in a financial group and thus prevents the financial group from allocating its inter-dealer transactions to multiple unregistered non-U.S. affiliates to avoid registration of any affiliate.

132
In many cases, the non-U.S. person counterparty may be recognized, registered, or regulated under U.S. or foreign law as a security-based swap dealer, swap dealer, bank, broker-dealer, or futures commission merchant, but the regulatory status of the counterparty is not relevant to the $50 billion limit, as a transaction will need to be counted toward that limit even if the counterparty is an unregulated entity.

Similarly, the regulatory status of the relying entity and its affiliates also is irrelevant for purposes of the $50 billion limit. The relying entity is required to count toward its
de minimis

thresholds all covered inter-dealer security-based swap positions connected with its own or an affiliate's “arranging, negotiating, or executing” dealing activity subject to the exception, regardless of the application of non-U.S. regulatory regimes to those transactions.

133
For the avoidance of doubt, the $50 billion limit does not apply transactions that are not eligible for the exception (or for which reliance on the exception is not sought). For example, if a non-U.S. person (“counterparty 1”) enters into a security-based swap with a U.S. person (“counterparty 2”), even if that U.S. person is an affiliate of a registered entity that acts pursuant to the exception, counterparty 1 would not be required to count that transaction towards its $50 billion limit, as transactions with U.S. persons are not eligible for the exception. Counterparty 1 would, of course, count such a transaction toward the
de minimis
thresholds for registration as a security-based swap dealer.

Similarly, if a non-U.S. person (“counterparty 1”) enters into a security-based swap that is “arranged, negotiated, or executed” by U.S. personnel with a non-U.S. person (“counterparty 2”), for which counterparty 1 does not seek reliance on the exception, counterparty 1 would not be required to count that transaction towards its $50 billion limit, even if counterparty 1 relies on the exception for other transactions and even if counterparty 2 is relying on the exception for that transaction. Counterparty 1 would, of course, count such a transaction toward the
de minimis
thresholds for registration as a security-based swap dealer.

The Commission intends to monitor changes in the market in response to this exception and initially will use the report that Commission staff is required to produce under Exchange Act Rule 3a71-2A to analyze the changes. Commission staff will repeat this analysis at least once every five years. If this initial analysis or subsequent monitoring suggests that firms are using the exception to avoid the
de minimis
counting requirement in a manner that is inconsistent with the statutory and regulatory objectives of Title VII or that non-U.S. persons are entering into disproportionately large volumes of security-based swaps pursuant to the exception, the Commission may determine that it is necessary to consider amendments to the exception or to the underlying counting requirements, including possible amendments pursuant to its anti-evasion authority in Exchange Act Section 30(c).

(b) Scope of the Limit and Related Recordkeeping Requirement

Under the final rule, the exception would be available to a relying entity only if the aggregate gross notional amount of covered inter-dealer security-based swap positions connected with dealing activity subject to the exception over the course of the immediately preceding 12 months does not exceed $50 billion.
134

Covered inter-dealer security-based swaps are those that are between, on the one hand, the non-U.S. person relying on the exception, and, on the other hand, a non-U.S. person that is either (1) a registered entity that has filed with the Commission a notice that its associated persons may conduct “arranging, negotiating, or executing” activity pursuant to the exception
135

or (2) an affiliate of such a registered entity.
136

A relying entity would count towards this $50 billion threshold two types of covered int er-dealer security-based swaps: (1) The covered inter-dealer security-based swap positions connected with the relying entity's dealing activity subject to the exception and (2) the covered inter-dealer security-based swap positions connected with dealing activity subject to the exception engaged in by non-U.S. person affiliates of the relying entity.
137

The Commission is applying the $50 billion limit to security-based swaps involving the relying entity's non-U.S. person affiliates because failure to count such affiliates could allow a financial group to structure its inter-dealer security-based swap business to avoid the limit. For example, absent a requirement to count the transactions of a relying entity's own affiliates, a financial group could organize a new legal entity to conduct inter-dealer security-based swap business each time a relying entity approached the $50 billion limit. Similarly, the requirement to count transactions with affiliates of another financial group's registered entity includes the non-U.S. majority-owned affiliates relying on the exception as well as other non-U.S. affiliates who do not rely on the exception. Absent such a requirement, a relying entity could conduct unlimited security-based swap business with the other financial group, so long as the counterparty is an entity not relying on the exception. The $50 billion limit applies to transactions of affiliates as described above to avoid such outcomes.

134

See
Exchange Act Rule 3a71-3(d)(1)(vii) (limitation on application of the exception to covered inter-dealer security-based swaps); Exchange Act Rule 3a71-3(a)(13) (definition of covered inter-dealer security-based swap); Exchange Act Rule 3a71-3(d)(6)(i) (description of the persons whose covered inter-dealer security-based swaps count towards the limitation).

135
If the counterparty to the security-based swap is a registered entity that is a U.S. person, then the exception would not be available for the security-based swap and the limitation on covered inter-dealer security-based swaps conducted pursuant to the exception thus would not apply.

136
Exchange Act Rule 3a71-3(a)(13) defines covered inter-dealer security-based swaps to include transactions with a registered entity that has filed a notice pursuant to Rule 3a71-3(d)(1)(vi) and with an affiliate of such a registered entity. As discussed more fully below, Rule 3a71-3(d)(1)(vi) requires the registered entity to file a notice with the Commission that its associated persons may conduct “arranging, negotiating, or executing” activity pursuant to the exception.

137

See
Exchange Act Rule 3a71-3(d)(1)(vii), (d)(6). This threshold extends to dealing transactions by affiliates of the relying entity to guard against a firm's evasion of the threshold by dividing transactions among multiple affiliates.

To identify the covered inter-dealer security-based swap positions connected with the relying entity's dealing activity subject to the exception, a relying entity first must determine whether a security-based swap is connected with its own dealing activity subject to the exception and, if it is, then it must determine whether the counterparty is a non-U.S. person that is either (i) a registered entity whose associated persons conduct “arranging, negotiating, or executing” activity pursuant to the exception or (ii) an affiliate of such a registered entity. The Commission believes that a relying entity will be able to structure its operations to answer this first question, as it and its registered affiliate must comply with certain recordkeeping conditions discussed below in connection with the specific “arranging, negotiating, or executing” activity that is subject to the exception. To assist the relying entity in determining whether its counterparty is a registered entity whose associated persons act pursuant

to the exception or an affiliate of such a registered entity, the final rules condition the availability of the exception on a registered entity first filing with the Commission a notice that its associated persons may conduct activity pursuant to the exception.
138

Further, the final rules provide a safe harbor from the limitation for any security-based swap if the relying entity reasonably determines at the time of execution of the security-based swap that its counterparty is neither another firm's registered entity nor an affiliate of such a registered entity.
139

For example, the Commission believes that it would be reasonable for a relying entity (or its affiliate) to determine a security-based swap is not a covered inter-dealer security-based swap if the relying entity or an affiliate requests at least quarterly, and diligently pursues, a list of affiliates from each registered entity whose name appears on the Commission's website and the relying entity determines at the time of execution of the security-based swap that the name of the counterparty to the security-based swap does not appear on any such list in the relying entity's possession at that time.
140

Further, the Commission believes that it would be reasonable for financial groups to produce and share a single list of their affiliates for use in connection with the $50 billion limit and in connection with determining eligibility for exceptions to the Commission's requirements for security-based swap dealers to collect initial margin from counterparties.
141

138

See
Exchange Act Rule 3a71-3(d)(1)(vi). This notice must be filed before an associated person of the registered entity commences any “arranging, negotiating, or executing” activity pursuant to the exception. The notice must be submitted to the electronic mailbox described on the Commission's website at
www.sec.gov
at the “ANE Exception Notices” section. The Commission will post the notice on its website. A registered entity whose associated persons will no longer conduct “arranging, negotiating, or executing” activity pursuant to the exception may request that the Commission remove such notice from its website by sending a message to the same electronic mailbox.

139

See
Exchange Act Rule 3a71-3(a)(13).

140
If a relying entity executes a security-based swap with a counterparty that, at the time of execution, the relying entity reasonably believes is not an affiliate of another firm's registered entity, the relying entity need not later re-characterize the security-based swap as a covered inter-dealer security-based swap, even if it later discovers that its counterparty is an affiliate of another firm's registered entity.

141
The Commission's margin rules for non-bank security-based swap dealers include an exception from the requirement to collect initial margin for non-cleared security-based swaps when certain exposures of the security-based swap dealer and its affiliates to the counterparty and its affiliates do not exceed $50 million.
See
Exchange Act Rule 18a-3(c)(1)(iii)(H)(
1
), 17 CFR 240.18a-3(c)(1)(iii)(H)(
1
);
see also
Capital, Margin, and Segregation Adopting Release, 84 FR at 43925-26 & nn.522-523 (citing Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 FR 636, 697 (Jan. 6, 2016); Margin and Capital Requirements for Covered Swap Entities, 80 FR 74840, 74901 (Nov. 30, 2015)).

The relying entity also must include in its calculation of covered inter-dealer security-based swap positions subject to the $50 billion limit all positions connected with dealing activity subject to the exception that its non-U.S. person affiliates engage in with another non-U.S. person that is either (i) a registered entity whose associated persons conduct “arranging, negotiating, or executing” activity pursuant to the exception or (ii) an affiliate of such a registered entity. The relying entity need not, however, include in this calculation the positions of its own non-U.S. person affiliate that is in the process of registering with the Commission as a security-based swap dealer.
142

This exclusion from the $50 billion limit ensures that a financial group does not lose the ability to make use of the exception as a result of the dealing activity of an entity that will register with the Commission. To assist the relying entity in obtaining information needed to determine the volume of its affiliates' transactions subject to the limit, and to assist the Commission in reviewing compliance with the limit, each registered entity whose associated persons may conduct “arranging, negotiating, or executing” activity pursuant to the exception must obtain from the relying entity documentation regarding the relying entity's compliance with the limit.
143

The registered entity must maintain this documentation for not less than three years following the “arranging, negotiating, or executing” activity subject to the exception, the first two years in an easily accessible place.
144

142

See
Exchange Act Rule 3a71-3(d)(6)(i)(B).

143

See
Exchange Act Rule 3a71-3(d)(1)(iii)(B)(
2
). The Commission recognizes that a single group of affiliates may include more than one registered entity whose associated persons act pursuant to the exception. In such a case, the relying entity would need to consult with each such registered entity with which it is affiliated.

144

See
Exchange Act Rule 3a71-3(d)(1)(iii)(B)(
2
).

(c) Impact of Breaching the Limit

Under the Commission's rules, a person not registered as a security-based swap dealer is deemed not to be a security-based swap dealer if the security-based swap dealing activity in which the person, or any other entity controlling, controlled by or under common control with that person, engages over the course of the immediately preceding twelve months falls below certain
de minimis

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2019-27760. Public record. Not legal advice.