Order Granting Conditional Substituted Compliance in Connection With Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap Participants Subject to Regulation in the French Republic

Federal RegisterAug 2, 2021

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-92484; File No. S7-22-20]

Order Granting Conditional Substituted Compliance in Connection With Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap Participants Subject to Regulation in the French Republic

July 23, 2021.

I. Overview

The French Autorité des Marchés Financiers (“AMF”) and the Autorité de Contrôle Prudentiel et de Résolution (“ACPR”), the French financial authorities, have submitted a “substituted compliance” application requesting that the Securities and Exchange Commission (“Commission”) determine, pursuant to the Securities Exchange Act of 1934 (“Exchange Act”) rule 3a71-6, that security-based swap dealers and major security-based swap participants (“SBS Entities”) subject to regulation in the French Republic (“France”) conditionally may satisfy requirements under the Exchange Act by complying with comparable French and European Union (“EU”) requirements.

The AMF and the ACPR (“French Authorities”) sought substituted compliance in connection with certain Exchange Act requirements related to risk control, capital and margin, internal supervision and compliance, counterparty protection, and record keeping, reporting, notification, and securities counts.

The application incorporated comparability analyses between the relevant requirements in Exchange Act section 15F and the rules and regulations thereunder and applicable French and EU law, as well as information regarding French supervisory and enforcement frameworks.

See

Letter from Robert Ophèle, Chairman, AMF, and Denis Beau, Chairman, ACPR, to Vanessa Countryman, Secretary, Commission, dated Dec. 9, 2020 (“French Authorities' Application”). The application is available on the Commission's website at:

https://www.sec.gov/files/full-french-application.pdf.

“Risk control” includes requirements related to internal risk management, trade acknowledgment and verification, portfolio reconciliation and dispute resolution, portfolio compression and trading relationship documentation; “capital and margin” includes requirements related to capital applicable to non-prudentially regulated security-based swap dealers and to margin applicable to non-prudentially regulated SBS Entities; “internal supervision and compliance” includes requirements related to diligent supervision, conflicts of interest, information gathering under Exchange Act section 15F(j), 15 U.S.C. 78

-10(j), and chief compliance officers; “counterparty protection” includes requirements related to disclosure of material risks and characteristics and material incentives or conflicts of interest, “know your counterparty,” suitability of recommendations, fair and balanced communications, disclosure of daily marks and disclosure of clearing rights; and “record keeping, reporting, notification, and securities counts” includes requirements related to making and keeping current certain prescribed records, preservation of records, reporting, notification and securities counts.

On December 22, 2020, the Commission issued a notice of the French Authorities' Application, accompanied by a proposed order to grant substituted compliance with conditions in connection with the French Authorities' Application (the “proposed Order”).

The proposed Order incorporated a number of conditions to tailor the scope of substituted compliance consistent with the prerequisite that relevant French and EU requirements produce regulatory outcomes that are comparable to relevant requirements under the Exchange Act. The Commission reopened the comment period for the proposed Order on April 5, 2021.

See

Exchange Act Release No. 90766 (Dec. 22, 2020), 85 FR 85720, 85721 (Dec. 29, 2020) (“French Substituted Compliance Notice and Proposed Order”).

See

Exchange Act Release No. 91477 (Apr. 5, 2021), 86 FR 18341 (Apr. 8, 2021) (“Reopening Release”). The reopened comment period ended on May 3, 2021.

As discussed below, the Commission is adopting a final Order that has been modified from the proposal in certain respects to address commenter concerns and to make clarifying changes.

II. Substituted Compliance Framework, Prerequisites and Commenter Issues of General Applicability

A. Substituted Compliance Framework and Purpose

As the Commission has discussed previously,

Exchange Act rule 3a71-6 provides a framework whereby non-U.S. SBS Entities may satisfy certain requirements under Exchange Act section 15F by complying with comparable regulatory requirements of a foreign jurisdiction.

Because substituted compliance does not constitute exemptive relief, but instead provides an alternative method by which non-U.S. SBS Entities may comply with applicable Exchange Act requirements, the non-U.S. SBS Entities would remain subject to the relevant requirements under section 15F. The Commission accordingly will retain the authority to inspect, examine and supervise those SBS Entities' compliance and take enforcement action as appropriate. Under the substituted compliance framework, failure to comply with the applicable foreign requirements and other conditions to a substituted compliance order would lead to a violation of the applicable requirements under the Exchange Act and potential enforcement action by the Commission (as opposed to automatic revocation of the substituted compliance order).

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85721; Exchange Act Release No. 90765 (Dec. 22, 2020), 85 FR 85686, 85687 (Dec. 29, 2020) (“German Substituted Compliance Order”).

See

Exchange Act Release No. 77617 (Apr. 14, 2016), 81 FR 29960, 30079 (May 13, 2016) (“Business Conduct Adopting Release”).

Under rule 3a71-6, substituted compliance potentially is available in connection with certain section 15F requirements,

but is not available in connection with antifraud prohibitions and certain other requirements under the Federal securities laws.

SBS Entities in France accordingly must comply directly with those requirements notwithstanding the availability of substituted compliance for other requirements.

17 CFR 240.3a71-6(d).

French Substituted Compliance Notice and Proposed Order, 85 FR at 85721 n.2 (addressing unavailability of substituted compliance in connection with antifraud provisions, as well as provisions related to transactions with counterparties that are not eligible contract participants (“ECPs”), segregation of customer assets, required clearing upon counterparty election, regulatory reporting and public dissemination, and registration of offerings).

The substituted compliance framework reflects the cross-border nature of the security-based swap market, and is intended to promote efficiency and competition by helping to address potential duplication and inconsistency between relevant U.S. and foreign requirements.

In practice, substituted compliance may be expected to help SBS Entities leverage their existing systems and practices to comply with relevant Exchange Act requirements in conjunction with their compliance with relevant foreign requirements. Market participants will begin to count security-based swap transactions toward the thresholds for registration with the Commission as an SBS Entity on August 6, 2021, and will be required to begin registering with the Commission on November 1, 2021.

Substituted compliance should assist relevant non-U.S. security-based swap market participants in preparing for registration.

See generally

Business Conduct Adopting Release, 81 FR at 30073 (noting that the cross-border nature of the security-based swap market poses special regulatory challenges, in that relevant U.S. requirements “have the potential to lead to requirements that are duplicative of or in conflict with applicable foreign business conduct requirements, even when the two sets of requirements implement similar goals and lead to similar results”).

See

“Key Dates for Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants,” available at

https://www.sec.gov/page/key-dates-registration-security-

based-swap-dealers-and-major-security-based-swap-participants.

B. Scope of Substituted Compliance

For entity-level Exchange Act requirements,

a Covered Entity must choose either to apply substituted compliance pursuant to the Order with respect to all security-based swap business subject to the relevant French and EU requirements or to comply directly with the Exchange Act with respect to all such business; a Covered Entity may not choose to apply substituted compliance for some of the business subject to the relevant French or EU requirements and comply directly with the Exchange Act for another part of the business that is subject to the relevant French and EU requirements. Additionally, for entity-level Exchange Act requirements, if the Covered Entity also has security-based swap business that is not subject to the relevant French requirements, the Covered Entity must either comply directly with the Exchange Act for that business or comply with the terms of another applicable substituted compliance order.

For transaction-level Exchange Act requirements,

a Covered Entity may decide to apply substituted compliance for some of its security-based swap business and to comply directly with the Exchange Act (or comply with another applicable substituted compliance order) for other parts of its security-based swap business.

The entity-level requirements relate to capital and margin, books and records (other than those linked to the counterparty protection rules), internal risk management systems, trade acknowledgement and verification, portfolio reconciliation, compression, trading relationship documentation, and internal supervision and chief compliance officer requirements.

See

Exchange Act Release No. 86175 (June 21, 2019) 84 FR 43872, 43879 (Aug 22, 2019) (“Capital and Margin Adopting Release”); Exchange Act Release No. 87005 (June 19, 2019) 84 FR 68550, 68596 (Dec. 16, 2019) (“Books and Records Adopting Release”); Exchange Act Release No. 78011 (June 8, 2016) 81 FR 39808, 39827 (June 17, 2016) (“TAV Adopting Release”); Exchange Act Adopting Release No. 87782 (Dec. 18, 2019) 85 FR 6359, 6378 (Feb. 4, 2020) (“Risk Mitigation Adopting Release”); Business Conduct Adopting Release, 81 FR at 30064. Transaction-level requirements encompass business conduct requirements for the protection of counterparties, and additional provisions for the protection of special entities.

See also

Business Conduct Adopting Release, 81 FR at 30065.

In the context of the EMIR counterparties condition in paragraph (a)(5), a Covered Entity must choose: (1) To apply substituted compliance pursuant to the Order—including compliance with paragraph (a)(5) as applicable—for a particular set of entity-level requirements with respect to all of its business that would be subject to the relevant EMIR-based requirement if the counterparty were the relevant type of counterparty; or (2) to comply directly with the Exchange Act with respect to such business.

Transaction-level requirements are the counterparty protection requirements and the books and records requirements related to those counterparty protection requirements.

C. Specific Prerequisites

1. Comparability of Regulatory Outcomes

Rule 3a71-6, adopted by the Commission in 2016, describes the requirements for the Commission to make a substituted compliance determination. Under the rule, the Commission must determine that the analogous foreign requirements are comparable to otherwise applicable requirements under the Exchange Act (

i.e.,

the relevant requirements in the Exchange Act and the rules and regulations thereunder), after accounting for factors such as “the scope and objectives of the relevant foreign regulatory requirements” and “the effectiveness of the supervisory compliance program administered, and the enforcement authority exercised” by the foreign authority.

The comparability assessments are to be based on a “holistic approach” that “will focus on the comparability of regulatory outcomes rather than predicating substituted compliance on requirement-by-requirement similarity.”

Exchange Act rule 3a71-6(a)(2)(i).

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85722;

see also

Business Conduct Adopting Release, 81 FR at 30078-79 (further recognizing that “different regulatory systems may be able to achieve some or all of those regulatory outcomes by using more or fewer specific requirements than the Commission, and that in assessing comparability the Commission may need to take into account the manner in which other regulatory systems are informed by business and market practices in those jurisdictions”). The Commission's assessment of a foreign authority's supervisory and enforcement effectiveness—as part of the broader comparability analysis—would be expected to consider not only overall oversight activities, but also oversight specifically directed at conduct and activity relevant to the substituted compliance determination. “For example, it would be difficult for the Commission to make a comparability determination in support of substituted compliance if oversight is directed solely at the local activities of foreign security-based swap dealers, as opposed to the cross-border activities of such dealers.” Business Conduct Adopting Release, 81 FR at 30079 (footnote omitted). In the French Substituted Compliance Notice and Proposed Order, the Commission preliminarily concluded that this comparability prerequisite was met in connection with a number of requirements under the Exchange Act, in some cases with the addition of conditions to help ensure the comparability of regulatory outcomes.

2. Memoranda of Understanding

Exchange Act rule 3a71-6(a)(2)(ii) further predicates the availability of substituted compliance on the Commission and the foreign financial regulatory authority or authorities entering into a supervisory and enforcement memorandum of understanding and/or other arrangement with the relevant foreign financial regulatory authorities “addressing supervisory and enforcement cooperation and other matters arising under the substituted compliance determination.”

Accordingly, the Commission and the AMF and the ACPR recently entered into a relevant memorandum of understanding.

Moreover, the Commission and the European Central Bank (“ECB”) are in the process of developing a memorandum of understanding or other arrangement to address cooperation matters related to substituted compliance.

Those memoranda of understanding or other arrangements must be in place before Covered Entities may use substituted compliance to satisfy obligations under the Exchange Act.

Exchange Act rule 3a71-6(a)(2)(ii).

The Commission, the AMF and the ACPR have entered into a memorandum of understanding to address substituted compliance cooperation, a copy of which is on the Commission's website at

www.sec.gov

under the “Substituted Compliance” tab, which is located on the “Security-Based Swap Markets” page in the Division of Trading and Markets section of the site (“AMF and ACPR MOU”). The AMF, ACPR and the ECB share responsibility for supervising compliance with certain provisions of EU and French law.

The memorandum of understanding will set forth the conditions under which supervisory and enforcement information for certain subject matters, including but not limited to margin and capital, that is owned by the ECB, can be requested, shared, used and protected from unauthorized disclosure by the SEC and ECB. The memorandum of understanding will also serve as a framework for consultation, cooperation and the exchange of information between the SEC and the ECB in the supervision, enforcement and oversight of the covered firms.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85721 n.4. The Commission expects to publish any such memoranda of understanding or arrangements on its website at

www.sec.gov

under the “Substituted Compliance” tab, which is located on the “Security-Based Swap Markets” page in the Division of Trading and Markets section of the site.

3. “Adequate assurances”

A foreign financial regulatory authority may submit a substituted compliance application only if the authority provides “adequate assurances” that no law or policy would impede the ability of any entity that is directly supervised by the authority and that may register with the Commission “to provide prompt access to the Commission to such entity's books and records or to submit to onsite inspection or examination by the Commission.”

In the French Substituted Compliance Notice and Proposed Order, the Commission stated that the French Authorities had satisfied this prerequisite in the Commission's preliminary view, taking into account information and representations that the French Authorities provided regarding certain French and EU requirements that are relevant to the Commission's ability to inspect, and access the books and records of, firms using substituted compliance pursuant to the Order.

The Commission received no comments on this preliminary view and has not changed its view.

See

Exchange Act rule 3a71-6(c)(3).

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85721 n.5.

D. Commenter Views of General Applicability

As the Commission previously discussed, commenters raised a variety of concerns and other views regarding specific aspects of the proposed Order (apart from certain global concerns addressed below in part II.D.1 through 4.

Those included: Concerns that the interplay between certain proposed MiFID-related conditions to substituted compliance for risk control requirements and a proposed EU cross-border condition would undermine the availability of substituted compliance;

views regarding the possibility of substituted compliance related to capital;

and views regarding substituted compliance in connection with books and records requirements.

See generally

Reopening Release, 86 FR 18341.

See also

Letter from Kyle Brandon, Managing Director, Head of Derivative Policy, SIFMA (Jan. 25, 2021) (“SIFMA Letter I”); Letter from Wim Mijs, Chief Executive Officer, European Banking Federation (Jan. 25, 2021) (“EBF Letter I”) (generally supporting the SIFMA Letter I); and Letter from Etienne Barel, Deputy Chief Executive Officer, French Banking Federation (Jan. 25, 2021) (“FBF Letter I”). Comments may be found on the Commission's website at:

https://www.sec.gov/comments/s7-22-20/s72220.htm.

Reopening Release, 86 FR at 18343 (expressing the view that the interplay of those MiFID conditions and the proposed EU cross-border condition “in practice would undermine the availability of substituted compliance for Covered Entities that have branches in EU Member States for which the Commission has not entered into an applicable substituted compliance memorandum of understanding”).

Id.

at 18343-47.

Id.

at 18347-48.

The Commission reopened the comment period in April 2021.

The Commission also requested comment on a number of specific issues, including: The potential removal of MiFID provisions from the trade acknowledgment and verification and trading relationship documentation conditions in conjunction with additional general conditions to address the resulting increased reliance upon EMIR;

the inclusion of additional capital standards;

the availability of greater flexibility in distinguishing between recordkeeping and reporting requirements;

limiting the definition of “covered entity”;

and supplementing the internal supervision and compliance conditions.

In response, commenters expressed a range of views and identified a number of specific issues with the proposed conditions and prerequisites for each subject matter of the proposed Order for which substituted compliance is available.

See

Reopening Release, 86 FR 18341. The reopened comment period ended on May 3, 2021.

Id.

at 18341-43.

Id.

at 18343-47.

Id.

at 18347-48.

Id.

at 18348.

Id.

See

Letter from Kyle Brandon, Managing Director, Head of Derivative Policy, SIFMA (May 3, 2021) (“SIFMA Letter II”); Letter from Wim Mijs, Chief Executive Officer, European Banking Federation (May 3, 2021) (“EBF Letter II”); Letter from Etienne Barel, Deputy Chief Executive Officer, French Banking Federation (May 3, 2021) (“FBF Letter II”); Letter from Americans for Financial Reform Education Fund (May 3, 2021) (“AFREF Letter”); Letter from Dennis M. Kelleher, President and CEO, Stephen Hall, Legal Director and Securities Specialist, and Jason Grimes, Senior Counsel, Better Markets, Inc. (May 3, 2021) (“Better Markets Letter”) at 3-4. Comments may be found on the Commission's website at:

https://www.sec.gov/comments/s7-22-20/s72220.htm.

1. Effects of Non-Compliance

One commenter addressed a Commission statement that non-compliance with applicable French and EU requirements would lead to a violation of relevant requirements under the Exchange Act. The commenter particularly requested that the Commission represent that SBS Entities “would not violate the Commission's requirements where the relevant foreign regulatory authority has found no violation of the comparable French or EU requirement and the SBS Entity's conduct would have complied with the Commission's requirements (even if the SBS Entity relied on French and EU rules that imposed stricter or additional requirements).”

The commenter also expressed a concern that the Commission might find a violation of the foreign laws even where the Commission's own requirements would be fulfilled.

The commenter further requested that the Commission state that it “will not independently examine for or otherwise assess whether an SBS Entity is complying with EU or French requirements.”

SIFMA Letter I at 9;

see also

FBF Letter I at 2.

See

SIFMA Letter I at 9 n.22.

SIFMA Letter I at 9.

Although the Commission expects to take the views of foreign regulatory authorities into account when it considers whether registered entities have complied with the conditions to substituted compliance, the Commission cannot make the requested representations. It is for the Commission—not foreign regulators—to determine whether a non-U.S. SBS Entity has complied with the conditions to substituted compliance and with the Federal securities laws. Moreover, as noted, even with substituted compliance the Commission retains its full authority to inspect, examine and supervise registered entities' compliance with the Federal securities laws, and to take enforcement action as appropriate.

See

Business Conduct Adopting Release, 81 FR at 30079.

2. Prerequisites to Substituted Compliance

One commenter stated that the Commission should make a positive substituted compliance determination only when the Commission determines that granting substituted compliance promotes the protection of the U.S. financial system.

The commenter also stated that grants of substituted compliance must be predicated on a “well-supported, evidence-based determination” that the relevant foreign requirements will produce “substantially similar” regulatory outcomes.

Congress gave the Commission authority in Title VII to implement a security-based swap framework to address the potential effects of security-based swap activity on U.S. market participants, the financial stability of the United States, the transparency of the U.S. financial system and the protection of counterparties.

When adopting rules regarding the application of Title VII's

definitions of “security-based swap dealer” and “major security-based swap participant” in the cross-border context, the Commission was guided by the purposes of Title VII and the applicable requirements of the Exchange Act, which include consideration of not only risk to the U.S. financial system but also other factors such as counterparty protection, transparency, prevention of evasion, economic impacts and consultation and coordination with other U.S. financial regulatory authorities and foreign financial regulatory authorities.

In its registration rules for these SBS Entities, the Commission determined that a foreign market participant whose U.S.-nexus security-based swap activity qualifies it as an SBS Entity would be required to register as such, without substituted compliance available for registration requirements.

The Commission concluded that obliging these foreign persons to register serves an important regulatory function that would be significantly impaired by permitting substituted compliance for registration requirements.

This registration requirement thus puts into practice the Commission's consideration of the purposes of Title VII and the applicable requirements of the Exchange Act in its adoption of the definitions of “security-based swap dealer” and “major security-based swap participant” in the cross-border context, and ensures that such firms will be subject to the jurisdiction of the Commission. Moreover, the rules applicable to these registered foreign SBS Entities reflect the Commission's best judgment for how to achieve the purposes of Title VII and satisfy the requirements of the Exchange Act, including the Commission's consideration of risk to the U.S. financial system.

See

Better Markets Letter at 3-4.

See id.

at 4.

See

Exchange Act Release No. 72472 (June 25, 2014), 79 FR 47278, 47286 (Aug. 12, 2014) (“Cross-Border Entity Definitions Adopting Release”) (citing Pub. L. 111-203, Preamble (stating that the Dodd-Frank Act was enacted “[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end `too big to fail', to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes”); Public Law 111-203, sections 701-774 (providing for, among other things, a comprehensive new regulatory framework for security-based swaps, including by: (i) Providing for the registration and comprehensive regulation of security-based swap dealers and major security-based swap participants; (ii) imposing clearing and trade execution requirements on security-based swaps, subject to certain exceptions; and (iii) creating real-time reporting and public dissemination regimes for security-based swaps)).

See

Cross-Border Entity Definitions Adopting Release, 79 FR at 47292 (purposes of Title VII include consideration of risk to the U.S. financial system and promotion of transparency in the U.S. financial system); Exchange Act section 30(c), 15 U.S.C. 78dd(c) (Commission rulemaking authority to prevent evasion of Title VII); Exchange Act section 3(f), 15 U.S.C. 78c(f) (requirement to consider whether certain Commission rulemaking actions would promote efficiency, competition and capital formation); Exchange Act section 23(a)(2), 15 U.S.C. 78w(a)(2) (requirement to consider the impact of Exchange Act rules and regulations on competition and prohibition on adopting rules or regulations that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act); Dodd-Frank Act section 712(a)(2), 15 U.S.C. 8302 (requirement to consult and coordinate with U.S. financial regulatory authorities on Title VII rulemaking); Dodd-Frank Act section 752(a), 15 U.S.C. 8325 (requirement to consult and coordinate, as appropriate, with foreign regulatory authorities on the establishment of consistent international standards with respect to the regulation of security-based swaps and security-based swap entities);

see also

Exchange Act Release No. 77104 (Feb. 10, 2016), 81 FR 8598, 8599 (Feb. 19, 2016) (“ANE Adopting Release”) (“A key part of [the Title VII] framework is the regulation of security-based swap dealers, which may transact extensively with counterparties established or located in other jurisdictions and, in doing so, may conduct sales and trading activity in one jurisdiction and book the resulting transactions in another. These market realities and the potential impact that these activities may have on U.S. persons and potentially the U.S. financial system have informed our consideration of these rules.”); Exchange Act Release No. 87780 (Dec. 18, 2019), 85 FR 6270, 6272 and n.26 (Feb. 4, 2020) (“Cross-Border Adopting Release”) (“[T]he Title VII SBS Entity requirements . . . 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.' ” “The Commission's actions to mitigate the negative consequences potentially associated with the various uses of [the `arranged, negotiated or executed' 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.”) (internal citations omitted).

See

Exchange Act Release No. 75611 (Aug. 5, 2015), 80 FR 48964, 48972-73 (Aug. 14, 2015) (“Registration Adopting Release”).

See id.

See

Cross-Border Entity Definitions Adopting Release, 79 FR at 47286 n.65 (“Future rulemakings that depend on [the definitions of `security-based swap dealer' and `major security-based swap participant'] are intended to address the transparency, risk, and customer protection goals of Title VII.”).

The Commission's rules for registered foreign SBS Entities thus reflect the Commission's consistent consideration of all of the purposes of Title VII and relevant parts of the Exchange Act, first in the context of its adoption of the definitions of “security-based swap dealer” and “major security-based swap participant,” then in its decision to require foreign SBS Entities to register and finally in its adoption of cross-border rules for SBS Entities pursuant to Title VII. When making a substituted compliance determination, the Commission's task, as outlined in rule 3a71-6, is to evaluate whether the relevant foreign requirements are comparable to these Title VII-based requirements and relevant provisions of the Exchange Act. The comparability assessments are to be based on a “holistic, outcomes-oriented framework,”

which in the Commission's view—consistent with the commenter's view—includes “inquiry regarding whether foreign requirements adequately reflect the interests and protections associated with the particular Title VII requirement.”

Also consistent with the commenter's view, the Commission's comparability assessments reflect a close reading of the relevant French and EU requirements. In addition, the Commission recognizes that other regulatory regimes will have exclusions, exceptions and exemptions that may not align perfectly with the corresponding requirements under the Exchange Act.

Accordingly, where French and EU requirements produce comparable outcomes—with or without conditions as discussed in part III.B below—notwithstanding those particular differences, and taking into account the scope and objectives and the effectiveness of supervision and enforcement of those requirements, the Commission has determined that the relevant French and EU requirements are comparable and has made a positive substituted compliance determination. Conversely, where those exclusions, exemptions and exceptions lead to outcomes that are not comparable—taking into account potential conditions—the Commission has not made a positive substituted compliance determination.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85722;

see also

Business Conduct Adopting Release, 81 FR at 30076, 30078-79.

See

Business Conduct Adopting Release, 81 FR at 30067.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85722 n.17;

see also

Business Conduct Adopting Release, 81 FR at 30076, 30078-79.

The Commission also is including certain conditions in the Order. The commenter stated that the inclusion of conditions should be viewed as an indication that the requirements of substituted compliance have not been met and as creating “ad hoc, custom-made rules to supplement inadequate rules of other jurisdictions.”

Pursuant to rule 3a71-6, the Commission may make a conditional or unconditional substituted compliance determination.

As described in greater detail in part III.B below, many of the conditions in the Order are designed to make substituted compliance available to Covered Entities only when the relevant French and EU requirements in fact apply to the relevant security-based swap activity in a way that promotes comparable regulatory outcomes. The commenter correctly notes that the Order also employs conditions to promote comparability.

For example, substituted compliance in connection with Exchange Act rule 15Fi-3(c) dispute reporting provisions is conditioned in part on the Covered Entity providing the Commission with

the dispute reports required under French law.

Consistent with rule 3a71-6, conditioning substituted compliance on the Commission receiving those reports helps to promote timely notice of disputes to support a comparable regulatory outcome.

See

Better Markets Letter at 4.

See

Exchange Act rule 3a71-6(a)(1).

See

Better Markets Letter at 2.

See

para. (b)(3)(ii) of the Order.

3. Ensuring Ongoing Appropriateness of Substituted Compliance

One commenter stated that the Commission “must ensure, on an ongoing basis, that each grant of substituted compliance remains appropriate over time.”

The commenter added that substituted compliance orders and memoranda of understanding should incorporate the obligation that the Commission be apprised regarding the effectiveness of the jurisdiction's supervision and enforcement programs, and to immediately apprise the Commission of material changes to the regulatory regime.

The Commission concurs that the ongoing availability of substituted compliance should account for relevant changes in the foreign jurisdiction's regulatory requirements and in the effectiveness of that jurisdiction's supervisory and enforcement program.

Accordingly, the Commission and the French Authorities recently entered into a substituted compliance memorandum of understanding that addresses ongoing information regarding potential changes to substantive legal requirements and supervisory and enforcement effectiveness.

Additionally, the Commission and the ECB are in the process of developing a memorandum of understanding to address cooperation matters related to substituted compliance. The Commission believes that these arrangements will provide timely information to ensure that the Commission is aware of material developments that may affect the comparability of the relevant French and EU requirements, including the scope and objectives of those requirements and the effectiveness of the French Authorities' supervision and enforcement programs. In response to any such developments, the Commission may amend the Order as needed to ensure that it continues to require a Covered Entity to comply with comparable French and EU requirements, or may withdraw the Order if the relevant French or EU requirements are no longer comparable.

Moreover, substituted compliance under the Order is conditioned on the Commission having these memoranda of understanding, or another arrangement with the French Authorities and ECB addressing cooperation with respect to the Order, at the time the Covered Entity makes use of substituted compliance.

If the arrangements in the memoranda of understanding prove in practice not to provide information about relevant developments, the Commission could terminate the memoranda of understanding in accordance with its terms and/or amend or withdraw the Order.

If the Commission, the French Authorities or the ECB terminates either memorandum of understanding, Covered Entities would not be able to rely on substituted compliance under the Order to satisfy Exchange Act compliance obligations that arise after the termination takes effect. For these reasons, in the Commission's view, the Order's memoranda of understanding conditions, coupled with the ongoing information sharing provisions in the memoranda of understanding with the French Authorities and with the ECB, establish the commenter's suggested mechanism to apprise the Commission of changes that may affect the ongoing appropriateness of substituted compliance.

Better Markets Letter at 5.

Id.

See

Business Conduct Adopting Release, 81 FR at 30078-79 (stating that order conditions and memoranda of understanding are possible tools for providing that the Commission be notified of material changes).

The memorandum of understanding between the Commission and the French Authorities in part provides that the French Authorities will provide “ongoing information sharing” regarding Firm Information (incorporating supervisory and related information as to the Covered Entities using substituted compliance) and regarding Regulatory Change Information (incorporating information about any material publicly available draft, proposed, or final change in law, regulation, or order of the jurisdiction of the French Authorities that may have a material impact on the firms at issue with respect to their relevant activities).

See

note 17,

supra

(information on publication of memoranda of understanding with the French Authorities and ECB).

Any such amendment or withdrawal may be at the Commission's own initiative after appropriate notice and opportunity for comment.

See

Exchange Act rule 3a71-6(a)(3).

See

part II.C.2,

supra;

paras. (a)(7) and (a)(8) of the Order.

See

note 18,

supra.

4. Request for Transition Period

Commenters stated that the Commission's proposed approach to certain entity-level requirements could result in the Commission's requirements still applying to a non-U.S. Entity's security-based swap transaction with non-U.S. counterparties and a resulting need for SBS Entities to obtain written agreement from their non-U.S. counterparties.

As a result, commenters requested a one-year transition period from the November 1, 2021, date by which security-based swap dealers must register with the Commission to come into compliance with any documentation requirements.

See

SIFMA Letter I at 10; FBF Letter I at 3.

Id.

The Commission is not providing an additional transition period at this time for documentation requirements related to Exchange Act requirements that will apply to Covered Entities' existing non-U.S. counterparties. The registration compliance date for U.S. and non-U.S. SBS Entities is October 6, 2021, and that is also the compliance date for the entity-level requirements at issue. These dates have been known to potential SBS Entities since February 4, 2020.

In areas where the Commission makes a positive substituted compliance determination under the Order, Covered Entities will have additional flexibility with respect to how to comply with the relevant Exchange Act requirements, but they, like all registered SBS Entities, must comply with the Exchange Act as of the registration compliance date. The Commission staff will be available to discuss implementation issues with Covered Entities during the implementation period.

See

Exchange Act Release No. 87780 (Dec. 18, 2019), 85 FR 6270 at 6345-46 (Feb. 4, 2020).

III. General Availability of Substituted Compliance Under the Order

A. Covered Entities

1. Proposed Approach

Under the proposed Order, the definition of “Covered Entity” specified which entities could make use of substituted compliance. Consistent with the availability of substituted compliance under Exchange Act rule 3a71-6, the proposed definition in part would limit the availability of substituted compliance to registered SBS Entities that are not U.S. persons. In addition, to help ensure that firms that rely on substituted compliance are subject to relevant French and EU requirements and oversight, the proposed definition would require that Covered Entities be investment firms authorized to provide investment services by the AMF or credit institutions authorized by the ACPR after approval by the AMF of its program of operations to provide investment services or perform investment activities in France.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723.

2. Commenter Views and Final Provisions

One commenter requested changes to the proposed “Covered Entity” definition, to reflect that under the French framework the requisite authorizations to provide credit and investment services are provided by the ACPR, in conjunction with the AMF's approval of the provision of investment services.

In addition, as described in the French Substituted Compliance Notice and Proposed Order, and confirmed by the AMF,

the AMF uses a risk-based approach to supervision whereby investment firms are categorized within four Tiers. Tier 1 firms receive the most supervisory attention and the staff has been told that all firms that use substituted compliance will be treated as Tier 1 firms.

The Commission has revised the Order in response to the comment and to reflect the AMF's approach.

See

SIFMA Letter II at Appendix A.

See

Memorandum, dated June 10, 2021, from Patrice Aguesse of the French AMF.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85735.

See

para. (g)(1)(iii) of the Order (providing that a Covered Entity in part means “an investment firm authorized by the ACPR to provide investment services or perform investment activities in the French Republic, or a credit institution authorized by the ACPR, after approval by the AMF of its program of operations to provide investment services or perform investment activities in the French Republic, and supervised by the AMF under its Tier 1 framework”).

B. Additional General Conditions

1. Proposed Approach

The proposed Order incorporated a number of additional general conditions and other prerequisites, to help ensure that the relevant French and EU requirements that form the basis for substituted compliance in practice will apply to the Covered Entity's security-based swap business and activities, and to promote the Commission's oversight over entities that avail themselves of substituted compliance:

•

“Subject to and Complies with” applicability condition

—For each relevant section of the proposed Order, a positive substituted compliance determination would be predicated on the entity being subject to and complying with the applicable French and EU requirements needed to establish comparability.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723. The Commission stated, as an example, that this proposed condition would not be satisfied when the comparable French or EU requirements would not apply to the security-based swap activities of a third-country branch of a French SBS Entity.

•

MiFID “investment services or activities”

—The Covered Entity's security-based swap activities would have to constitute “investment services or activities” for purposes of applicable provisions

under MiFID, MFC and related EU and French requirements, and must fall within the scope of the firm's authorization from the AMF or from the ACPR after approval by the AMF of the firm's program of operations.

Under this condition, a Covered Entity's security-based swap activities must constitute “investment services or activities” only to the extent that the relevant part of the Order requires the Covered Entity to be subject to and comply with a provision of MiFID, provisions under MFC that implement MiFID and related EU and French requirements. If the relevant part of the Order does not require the Covered Entity to be subject to and comply with one of those provisions, then the Covered Entity's security-based swap activities do not have to constitute “investment services or activities” to be able to use substituted compliance under that part of the Order.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723. The EU's Markets in Financial Instruments Directive (“MiFID”), Directive 2014/65/EU, has been implemented in France as part of article L. 511 to the French Monetary and Financial Code—Code monétaire et financier (“MFC”). MiFID and MFC address,

inter alia,

organizational, compliance and conduct requirements applicable to nonbank “investment firms.” In significant part, those requirements also apply to credit institutions that provide investment services or perform investment activities. Commission Delegated Regulation (EU) 2017/565 (“MiFID Org Reg”) in part supplements MiFID with respect to organizational requirements for firms. The Markets in Financial Instruments Regulation (“MiFIR”), Regulation (EU) 648/2012, generally addresses trading venues and transparency. Commission Delegated Directive (EU) 2017/593 (“MiFID Delegated Directive”) in part supplements MiFID with regard to safeguarding client property, and in France is implemented in relevant part by the Règlement Général de L'Autorité des Marchés Financiers (“AMF General Regulation”). Directive (EU) 2015/849 (“MLD”) addresses requirements on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and in France is implemented by article L. 561 to the MFC.

•

Counterparties as MiFID “clients”

—The Covered Entity's counterparties (or potential counterparties) would have to be “clients” (or potential “clients”) for purposes of MiFID, provisions under MFC that implement MiFID and/or other EU and French requirements adopted pursuant to those provisions.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723.

•

MiFID “financial instruments”

—The relevant security-based swaps would have to be “financial instruments” for purposes of applicable provisions under MiFID, MFC and related EU and French requirements.

Id.

•

CRD “institutions”

—The Covered Entity would have to be an “institution” for purposes of applicable provisions under CRD, MFC, CRR and related EU and French requirements.

Id.

The EU's Capital Requirements Directive IV (“CRD”), Directive 2013/36/EU has been adopted in France as part of article L. 533 to the MFC, and sets forth prudential requirements and certain related requirements applicable to credit institutions and certain nonbank investment firms. Certain CRD requirements regarding reporting obligations have been incorporated into French law as part of articles L. 511 and L. 634 to the MFC. The Capital Requirements Regulation (“CRR”), Regulation (EU) 575/2013, further addresses prudential requirements and related recordkeeping requirements for credit institutions and certain investment firms. Commission Implementing Regulation (EU) 680/2014 (“CRR Reporting ITS”) sets forth implementing technical standards regarding supervisory reporting. Pursuant to amendments that will become effective in June 2021, the requirements of CRD and the CRR will apply to credit institutions and to certain nonbank undertakings (that carry on activities involving dealing, portfolio management, investment advice and underwriting/placing) that meet specified thresholds (

e.g.,

consolidated assets of €30 billion or more).

See generally

Investment Firms Regulation (“IFR”), Regulation (EU) 2019/2033, art. 62 (amending certain definitions in the CRR).

•

Memoranda of understanding

—Consistent with the requirements of rule 3a71-6 and the Commission's need for access to information regarding registered entities, substituted compliance under the proposed Order would be conditioned on the Commission having applicable memoranda of understanding or other arrangements in place with the French Authorities and with the ECB, addressing cooperation with respect to the Order at the time the Covered Entity makes use of substituted compliance.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723. The Commission, AMF and ACPR have entered into a memorandum of understanding to address substituted compliance cooperation. The Commission and the ECB are also in the process of developing a memorandum of understanding or other arrangement to address cooperation matters related to substituted compliance.

See

notes 17-19,

supra.

Consistent with the Order, Covered Entities must ensure that this memorandum of understanding remains in place at the time the Covered Entity relies on substituted compliance.

•

Notice of reliance on substituted compliance

—To assist the Commission's oversight of firms that avail themselves of substituted compliance, a Covered Entity relying on the substituted compliance order would have to provide notice of its intent to rely on the Order by notifying the Commission in writing.

French Substituted Compliance Notice and Proposed Order, 85 FR at 85723.

When the Commission reopened the comment period and addressed the possible removal of certain MiFID-related conditions, the Commission also discussed the possibility of adding two new EMIR-related conditions related to “counterparty” status under EMIR and related to products subject to the European Market Infrastructure Regulation (“EMIR”), to satisfy the prerequisites to substituted

compliance.

The Commission explained that those additional two conditions may “promote certainty that EMIR will apply and help preclude gaps between the regulatory outcomes associated with the Exchange Act and those associated with the relevant EMIR provisions.”

This is particularly significant due to the Order's removal of proposed MiFID-related conditions with respect to substituted compliance for trade acknowledgement and verification requirements and for trading relationship documentation requirements, and the accompanying heightened reliance on certain EMIR-related conditions.

The two additional EMIR-related conditions are:

Reopening Release, 86 FR at 18342.

Id.

See generally

parts IV.B.2 and IV.B.5

infra.

•

Covered Entity's counterparties as EMIR “counterparties”

—For each condition in the proposed Order that requires the application of, and compliance with, provisions of EMIR, Commission Delegated Regulation (EU) 149/2013 (“EMIR RTS”) and/or Delegated Regulation (EU) 2016/2251 (“EMIR Margin RTS”), if the counterparty to the Covered Entity is not a “financial counterparty” or “non-financial counterparty” as defined in EMIR articles 2(8) or 2(9), respectively, the Covered Entity must comply with the applicable condition as if the counterparty were a financial counterparty or non-financial counterparty. In other words, the Covered Entity would be subject to the relevant requirements under EMIR even if the counterparty is not authorized pursuant to EU law as anticipated by the EMIR article 2(8) “financial counterparty” definition, or if the counterparty is not an “undertaking” (such as by virtue of being a natural person), or is not established in the EU (by virtue of being a U.S. person or otherwise being established in some non-EU jurisdiction), as anticipated by the EMIR article 2(9) “non-financial counterparty” definition.

See

Reopening Release, 86 FR at 18342 n.9.

•

Security-based swap status under EMIR

—For each condition in the proposed Order that requires the application of, and compliance with, provisions of EMIR, EMIR RTS and/or EMIR Margin RTS, either: (1) The relevant security-based swap must be an “OTC derivative” or “OTC derivative contract,” as defined in EMIR article 2(7), that has not been cleared by a central counterparty (“CCP”) and otherwise is subject to the provisions of EMIR; or (2) the relevant security-based swap must have been cleared by a central counterparty that has been authorized or recognized to clear derivatives contracts in the EU.

Id.

at 18342.

2. Commenter Views and Final Provisions

Commenters addressed the proposed general conditions related to MiFID “clients,” the memoranda of understanding, and the notice to the Commission.

Commenters also addressed the two additional EMIR-related conditions the Commission discussed when it reopened the comment period.

For the reasons discussed below, the Order largely incorporates the general conditions as proposed, subject to certain changes and the addition of the two EMIR-related conditions.

In the Commission's view, the conditions are structured appropriately to predicate a positive substituted compliance determination on the applicability of relevant French and EU requirements needed to establish comparability, as well as on the continued effectiveness of the requisite MOU, and the provision of notice to the Commission regarding the Covered Entity's intent to rely on substituted compliance.

See

SIFMA Letter II at 7, 16, and Appendix A; FBF Letter II at 3 (addressing counterparties as MiFID “clients”); Better Markets Letter at 5 (addressing the memorandum of understanding).

See

SIFMA Letter II at 4; FBF Letter II at 2; Better Markets Letter at 5-7.

The Commission is adopting, largely as proposed, other general conditions that were not the subject of comments and that are not otherwise addressed below.

See

paras. (a)(1), (a)(3), and (a)(4) of the Order. The Commission is making technical changes to clarify the captions of certain of the general conditions (

e.g.,

in the final Order the caption to the proposed condition related to “Activities as `investment services or activities'” now refers to “Activities as MiFID `investment services or activities'”). Certain of the general conditions also have been renumbered from the proposal.

a. Counterparties as MiFID “clients”

One commenter requested that the Commission modify the general condition regarding MiFID client status, which as proposed required that the counterparty be a “client” (or potential “client”) as defined in MiFID, such that the condition also would encompass counterparties that are “acting through an agent which the Covered Entity treats as its `client' (or potential `client').”

The commenter stated that this change would address circumstances in which an agent acted on its counterparty's behalf, “such as an investment manager acting for a fund,” reasoning that in practice entities “will look to the agent” rather than the agent's principal when satisfying applicable requirements.

SIFMA Letter II at Appendix A.

SIFMA Letter II at 7.

As noted above, the proposed Order would require a Covered Entity to be “subject to and comply with” relevant MiFID-based requirements. The Commission proposed that requirement of the proposed Order to ensure that comparable MiFID-based requirements in practice would apply to a Covered Entity using substituted compliance. The condition in paragraph (a)(2) to the proposed Order would ensure that the Covered Entity's counterparty—

i.e.,

the entity to whom it owes its various duties under the Exchange Act—is the “client” to whom the Covered Entity owes its performance of the duties to which it is subject under the comparable MiFID-based requirements.

The Commission believes that, in the case of an agent acting on behalf of a principal, if the principal is the counterparty for purposes of the relevant Exchange Act requirement, then this condition should require the principal, as the counterparty, to be the “client” for purposes of the relevant MiFID-based requirements. If the Covered Entity instead treats the agent as the “client,” then the Covered Entity would not be “subject to” French and EU requirements that are comparable to Exchange Act requirements related to counterparties. Accordingly, the Commission is not amending the Order to modify the condition in paragraph (a)(2) to permit a Covered Entity to treat an agent, rather than the agent's principal, as its client with regard to the relevant MiFID-based requirements. In taking this position, the Commission does not prohibit Covered Entities from working with agents or others acting on behalf of a counterparty. Rather, the Covered Entity must ensure that, in working with the agent, it fulfills any duties owed to a “client” (or potential “client”) in relation to the counterparty.

Some provisions of the MiFID-based requirements cited in the condition, such as certain organizational requirements, do not pertain to counterparties or clients. In those cases, there is no “relevant counterparty (or potential counterparty)” for purposes of the condition, and the condition would have no effect.

MiFID article 26 permits firms to rely upon information about a client received from another French and EU-regulated firm. Under that provision, the other firm is legally responsible for the completeness and accuracy of any information about the client that the other firm receives from the first firm. The Commission believes that it is appropriate to permit a Covered Entity to rely on information about its client communicated by another French and EU-regulated firm on behalf of the client. Accordingly, the application of this provision would not cause the Covered Entity to be

not “subject to” the relevant French and EU requirements listed in the Order, and thus would not impact the Covered Entity's ability to use substituted compliance in relation to those communications. On the other hand, MiFID article 26 also provides that the other firm is legally responsible for the suitability of advice and recommendations provided to the client. The other firm, however, may not be a Covered Entity applying substituted compliance pursuant to the Order. Accordingly, the Commission believes that a Covered Entity relying on the suitability assessment of another firm pursuant to MiFID article 26 is not “subject to” the relevant French suitability requirements listed in the Order, and thus may not apply substituted compliance for those recommendations.

b. Memoranda of Understanding

Commenters stated that a separate memorandum of understanding with the ECB need not be in place before SBS Entities can rely on the Order, based on the rationale that a memorandum of understanding containing certain assurances from the AMF and ACPR would be sufficient to ensure the Commission can promptly obtain relevant ECB-controlled information.

The Commission disagrees that such assurances would be sufficient. As the Order in part addresses substituted compliance for matters within the purview of the ECB, including but not limited to capital and margin requirements, the Commission believes that a memorandum of understanding with the ECB must be in place at the time an SBS Entity relies on the Order. As a result, the Order incorporates, as proposed, separate conditions related to the French Authorities and to the ECB memoranda of understanding.

See

SIFMA Letter I at 16;

see also

FBF Letter I at 3.

See

paras. (a)(7) and (a)(8) of the Order.

c. Notice of Reliance on Substituted Compliance

One commenter

requested that the Commission modify the proposed notice condition to correspond with the analogous condition that the Commission proposed in connection with the proposed substituted compliance order for the United Kingdom (UK).

The Commission agrees that the notice requirements for the substituted compliance orders should be consistent. As a result, the condition has been modified from the French proposed Order to add flexibility by stating that the notice must be sent to the Commission in the manner specified on the Commission's website (while the proposed Order instead referred to an email address).

Moreover, the condition further has been modified from the proposal by stating that the notice must identify each specific substituted compliance determination for which the Covered Entity intends to apply substituted compliance.

Further, a Covered Entity must promptly update the notice if it intends to modify its reliance on the positive substituted compliance determinations in the Order.

Every SBS Entity registered with the Commission, whether complying directly with Exchange Act requirements or relying on substituted compliance as a means of complying with the Exchange Act, is required to satisfy the inspection and production requirements imposed on such entities under the Exchange Act,

and specificity as to the scope of the entity's reliance on substituted compliance is necessary to facilitate the Commission's oversight under the Order.

SIFMA Letter II at Appendix A.

Exchange Act Release No. 91476 (Apr. 5, 2021), 86 FR 18378 (Apr. 8, 2021) (“UK Proposed Order”).

See

para. (a)(9) of the proposed Order.

See

para. (a)(9) of the Order. If the Covered Entity intends to rely on all the substituted compliance determinations in a given paragraph of the Order, it can cite that paragraph in the notice. For example, if the Covered Entity intends to rely on the capital and margin determinations in paragraph (c) of the Order, it can indicate in the notice that it is relying on the determinations in paragraph (c). However, if the Covered Entity intends to rely on the margin determination but not the capital determination, it will need to indicate in the notice that it is relying on paragraph (c)(2) of the Order (the margin determination). In this case, paragraph (c)(1) of the Order (the capital determination) will be excluded from the notice and the Covered Entity will need to comply with the Exchange Act capital requirements. Further, as discussed below, the recordkeeping and reporting determinations in the Order have been structured to provide Covered Entities with a high level of flexibility in selecting specific requirements within those rules for which they want to rely on substituted compliance. For example, paragraph (f)(1)(i) of the Order sets forth the Commission's substituted compliance determinations with respect to the requirements of Exchange Act rule 18a-5, 17 CFR 240.18a-5. These determinations are set forth in paragraphs (f)(1)(i)(A) through (O) of the Order. If a Covered Entity intends to rely on some but not all of the determinations, it will need to identify in the notice the specific determinations in this paragraph it intends to rely on (

e.g.,

paragraphs (f)(1)(i)(A), (B), (C), (D), (G), (H), (I), and (O)). For any determinations excluded from the notice, the Covered Entity will need to comply with the Exchange Act rule 18a-5 requirement. Finally, a Covered Entity is able to apply substituted compliance at the transaction level (rather than the entity level) for certain counterparty protection requirements and the recordkeeping requirements that are linked to them. In this case, the notice will need to indicate the class of transactions (

e.g.,

transactions with French counterparties) for which the Covered Entity is applying substituted compliance with respect to the Exchange Act counterparty protection requirements and linked recordkeeping requirements. Similarly, as discussed above, a Covered Entity is able to apply substituted compliance for entity-level Exchange Act requirements to all of its security-based swap business that is eligible for substituted compliance under the Order, and may either comply directly with the Exchange Act or apply substituted compliance under another applicable order for its security-based swap business that is not eligible for substituted compliance under the Order. In this case, the notice will need to indicate the scope of security-based swap business (

e.g.,

security-based swap business carried on from an establishment in France) for which the Covered Entity is applying substituted compliance with respect to the relevant Exchange Act entity-level requirements.

A Covered Entity would modify its reliance on the positive substituted compliance determinations in the Order, and thereby trigger the requirement to update its notice, if it adds or subtracts determinations for which it is applying substituted compliance or completely discontinues its reliance on the Order.

See

French Substituted Compliance Notice and Proposed Order, 85 FR 85734.

d. Additional EMIR-Related Conditions

The final rules have been modified from the proposal to add two general conditions that address Covered Entities' reliance on the EMIR-related provisions. The additions should help ensure that the relevant EMIR-related provisions will apply in fact, and help avoid any gaps between the regulatory outcomes associated with Exchange Act requirements and regulatory outcomes associated with those EMIR-related provisions. Consistent with the discussion regarding scope of substituted compliance in part II.B, in the context of the EMIR counterparties condition in paragraph (a)(5), a Covered Entity must choose (1) to apply substituted compliance pursuant to the Order—including compliance with paragraph (a)(5) as applicable—for a particular set of entity-level requirements with respect to all of its business that would be subject to the relevant EMIR-based requirement if the counterparty were the relevant type of counterparty, or (2) to comply directly with the Exchange Act with respect to such business.

Some commenters expressed general support for adding the two additional EMIR-related general conditions to the Order.

One commenter disagreed with including any additional EMIR-related conditions, expressing the view that if “some industry participants may not be able to take advantage of substituted compliance under the SEC's proposed framework is not, in and of itself, a reason to change the framework.”

See

FBF Letter II at 2 (stating that “[t]he FBF is generally welcoming of the new general EMIR conditions that are introduced as a corollary to the above changes. As applied in the context of trading relationship documentation, trade acknowledgment and verification, they largely convey the manner in which EMIR has been interpreted.”);

see also

SIFMA Letter II at 4.

Better Markets Letter at 6.

The first new general condition addresses the fact that the “financial counterparty” and “non-financial counterparty” definitions that trigger the application of the relevant EMIR provisions are predicated on the entity being an undertaking established in the

EU.

The conditions are not based upon the concern that some industry participants may not be able to take advantage of substituted compliance, but rather the conditions are intended to help ensure that the relevant EMIR requirements will apply in practice regardless of the counterparty's location or status as “an undertaking”. As such, the condition provides that the Covered Entity must comply with the applicable condition of this Order as if the counterparty were the type of counterparty that would trigger the application of the relevant EMIR-based requirements. If the Covered Entity reasonably determines that its counterparty would be a financial counterparty if not for the counterparty's location and/or lack of authorization in the EU, the condition further requires the Covered Entity to treat the counterparty as if the counterparty were a financial counterparty, rather than as another type of counterparty to which the relevant EMIR-based requirements apply.

By requiring a Covered Entity to treat its counterparty as the type of counterparty that would trigger the application of the relevant EMIR-based requirements, the EMIR-based requirements require the Covered Entity to act in a way that is comparable to Exchange Act requirements. The Commission is modifying the Order to include this condition to ensure that a Covered Entity can apply substituted compliance only when it treats its counterparty as a type that will trigger the Covered Entity's performance of obligations pursuant to those EMIR-based requirements.

Because each EMIR-based requirement applies to different types of counterparties, the Commission is amending the condition to make clear that a Covered Entity must treat its counterparty as if the counterparty were the type of counterparty specified in the relevant EMIR-based requirement and that a Covered Entity may not rely on EMIR article 13 to comply with another jurisdiction's requirement.

See

EMIR articles 2(8) and 2(9).

EMIR article 2(8) defines “financial counterparty” to encompass investment firms, credit institutions, insurers and certain other types of businesses that have been authorized in accordance with EU directives. The distinction between “financial” and “non-financial” counterparties under EMIR is manifested,

inter alia,

in connection with confirmation timing standards (

see

EMIR RTS article 12).

See

para. (a)(5) of the Order.

Another commenter requested that the Commission clarify that this condition would not require a Covered Entity to treat as financial counterparties or non-financial counterparties certain public sector counterparties, such as multilateral development banks, that are exempt from EMIR or counterparties that are not “undertakings” for purposes of EMIR's definitions of “financial counterparty” and “non-financial counterparty.”

The Commission declines to do so, given that the relevant requirements under the Exchange Act lack analogous carve-outs based on counterparty status. The Commission is, however, clarifying that the condition applies only if the relevant EMIR-based provision applies to the Covered Entity's activities with specified types of counterparties.

100

SIFMA Letter II at 4.

100

See

para. (a)(5) of the Order.

The second new general condition accounts for the fact that: (a) The relevant trade acknowledgement and verification and trading relationship documentation rules under the Exchange Act do not apply to security-based swaps cleared by a clearing agency registered with the Commission or a clearing agency that is exempt from registration with the Commission, and (b) the analogous EMIR provisions only apply to over-the-counter derivatives that are not cleared on a CCP (as defined in EMIR article 2(1)). To help ensure that substituted compliance is not precluded in connection with instruments that have been cleared in the EU, this second condition provides that for the applicable EMIR-related conditions, the relevant security-based swap must be an “OTC derivative” or “OTC derivative contract” (as defined under EMIR) that has not been cleared and otherwise is subject to the provisions of the relevant requirements under EMIR, or else that the relevant security-based swap must have been cleared by a central counterparty that has been authorized or recognized by a relevant authority to clear derivatives contracts in the EU.

101

See

para. (a)(6) of the Order. Absent this type of condition, instruments that have been cleared at an EU-authorized or recognized central counterparty neither would be excluded from the application of those Exchange Act rules nor would be subject to the EMIR requirements that otherwise would underpin substituted compliance. That would make direct compliance with the Exchange Act rules problematic, but compliance with the conditions of a positive substituted compliance order unworkable.

One commenter requested that the second new general condition be revised to include transactions cleared by

any

central counterparty—not merely central counterparties authorized or recognized by the EU.

102

The commenter stated that in certain circumstances French and EU law permit counterparties to agree to submit certain transactions to third-country central counterparties, and that it would be impractical to require Covered Entities to satisfy Exchange Act requirements that are “principally targeted to non-cleared [security-based swaps] in relation to these transactions.”

103

The Commission has modified the condition to clarify that it extends to instruments cleared by central counterparties that have been authorized or recognized by a “relevant authority” in the EU, but the Commission declines to extend it to instruments cleared on “any” central counterparty, as such a standard would provide no safeguard against the risks potentially associated with central counterparties that are not subject to adequate safeguards. In application, the central counterparties described by the provision would extend to those that have been authorized by a competent authority pursuant to EMIR article 14, and those that have been recognized by the European Securities and Markets Authority (“ESMA”) pursuant to EMIR article 25.

104

102

SIFMA Letter II at 4-5.

103

Id.

at 4.

104

In light of these considerations, the condition does not extend to clearing permitted pursuant to the equivalence framework of EMIR article 13.

Finally, the Commission is amending the condition to clarify that the condition applies only if the relevant EMIR-based provision applies to OTC derivatives that have not been cleared by a central counterparty, as some provisions of EMIR cited in the Order, such as EMIR articles 39(4) and (5), are not limited in their application to non-centrally cleared OTC derivatives. Consistent with the condition in paragraph (a)(6) of the Order, the Commission is also adding to the condition references to EMIR RTS and EMIR Margin RTS.

e. Notification Requirements Related to Changes in Capital

A commenter requested that the Commission make more granular substituted compliance determinations with respect to the Exchange Act recordkeeping requirements.

105

The commenter stated that for “operational reasons” a Covered Entity may “prefer to comply directly with certain Exchange Act requirements (

i.e.,

not to rely on substituted compliance with those requirements).”

106

The Commission took this approach in the UK Proposed Order with respect to the Exchange Act recordkeeping, reporting, and notification requirements.

107

part of this approach, the Commission also conditioned substituted compliance with certain of the discrete recordkeeping, reporting, and notification requirements on the Covered Entity applying substituted compliance with respect to the substantive Exchange Act requirement to which they were linked.

108

This linked condition was designed to ensure that a Covered Entity consistently applies substituted compliance with respect to the substantive Exchange Act requirement and the Exchange Act recordkeeping, reporting, or notification requirement that complements the substantive requirement. The Commission sought comment in the Reopening Release on whether it should take a similar granular approach to the Exchange Act recordkeeping, reporting, and notification requirements.

109

105

See

SIFMA Letter I at 8.

106

Id.

107

See

UK Substituted Compliance Notice and Proposed Order, 86 FR 18394-403, 18415-420.

108

Id.

109

See

Reopening Release, 86 FR at 18347-48.

On further consideration and in light of the more granular approach requested by the commenter, the Commission believes it necessary to do the reverse with respect to certain substantive financial responsibility requirements: Condition substituted compliance with respect to the substantive requirement on the Covered Entity applying substituted compliance with respect to the linked recordkeeping, reporting, or notification requirement. The Exchange Act financial responsibility requirements addressed in this Order (capital, margin, recordkeeping, reporting, notification, and securities count requirements) are highly integrated. Therefore, implementing the reverse conditional link is designed to ensure that the granular approach requested by the commenter results in comparable regulatory outcomes in terms of obligations to make and preserve records, and to submit reports and notifications to the Commission concerning the Covered Entity's compliance with the financial responsibility rules. It also is designed to provide clarity as to the obligations of a Covered Entity under this Order when using the granular approach to the Exchange Act recordkeeping, reporting, and notification requirements linked to the financial responsibility rules.

For example, because of the granular approach, a Covered Entity could elect to apply substituted compliance with respect to a substantive Exchange Act requirement such as the capital requirements of Exchange Act rule 18a-1 but elect not to apply substituted compliance with respect to a linked requirement under Exchange Act rule 18a-8 to provide the Commission notice of a capital deficiency under Exchange Act rule 18a-1. In this scenario, the Covered Entity would not be subject to the condition for applying substituted compliance with respect to Exchange Act rule 18a-8; namely, that the firm provide the Commission copies of notifications relating to French and EU capital requirements required under French and EU law. Consequently, as discussed below in this section and other sections of this release, the Commission is conditioning substituted compliance with respect to certain substantive Exchange Act requirements on the Covered Entity applying substituted compliance with respect to linked recordkeeping reporting, or notification requirements.

Exchange Act Rule 18a-8(c)

Exchange Act rule 18a-8(c) generally requires every security-based swap dealer with a prudential regulator that files a notice of adjustment of its reported capital category with the Federal Reserve Board, the Office of the Comptroller of the Currency, or the Federal Deposit Insurance Corporation to give notice of this fact that same day by transmitting a copy of the notice of adjustment of reported capital category in accordance with Exchange Act rule 18a-8(h).

110

Exchange Act rule 18a-8(h) sets forth the manner in which every notice or report required to be given or transmitted pursuant to Exchange Act rule 18a-8 must be made.

111

While Exchange Act rule 18a-8(c) is not linked to a substantive Exchange Act requirement, it is linked to substantive capital requirements applicable to prudentially regulated SBS Entities in the U.S. (

i.e.,

capital requirements of the Federal Reserve Board, the Office of the Comptroller of the Currency, or the Federal Deposit Insurance Corporation). Therefore, to implement the granular approach requested by the commenter, the Commission is adding a general condition that Covered Entities with a prudential regulator relying on the final Order for substituted compliance must apply substituted compliance with respect to the requirements of Exchange Act rule 18a-8(c) and the requirements of Exchange Act rule 18a-8(h) as applied to Exchange Act rule (c).

112

110

See

17 CFR 240.18a-8(c).

111

See

17 CFR 240.18a-8(h).

112

Better Markets Letter at 2-3.

In their application, the French Authorities cited several French provisions as providing similar outcomes to the notifications requirements of Exchange Act rule 18a-8. Additionally, based on comments received, the Commission has identified additional provisions that are relevant.

113

This general condition is necessary in order to clarify that a prudentially regulated Covered Entity must provide the Commission with copies of any notifications regarding changes in the Covered Entity's capital situation required by French and EU law. In particular, a prudentially regulated Covered Entity could elect not to apply substituted compliance with respect to Exchange Act rule 18a-8(c). However, because the Covered Entity is not required to provide any notifications to the Federal Reserve Board, the Office of the Comptroller of the Currency, or the Federal Deposit Insurance Corporation, “compliance” with the provisions of Exchange Act rule 18a-8(c) raises a question as to the Covered Entity's obligations under this Order to provide the Commission with notification of changes in capital.

113

These French provisions include: (1) MFC Articles L. 511-33II, L. 634-1, and L. 634-2, which provide, among other things, that the staff of firms may report potential or actual breaches related to certain specified provisions, and provide for the establishment of procedures and secure communication channels through which French regulatory and prudential authorities can be informed of failures to comply with applicable regulations; and (2) Internal Control Order articles 249 and 249-1, which require notification to the ACPR, without delay, of significant incidents with respect to certain thresholds related to the firm's risk analysis and measurement systems, and with respect to operational incidents.

Moreover, a commenter stated that foreign financial services firms were among the entities that used emergency lending facilities in the U.S. along with other U.S. measures to address the 2008 financial crisis.

114

The Commission adopted Exchange Act rule 18a-8(c) to require SBS Entities with a prudential regulator to give notice to the Commission when filing an adjustment of reported capital category because such notices may indicate that the entity is in or is approaching financial difficulty.

115

The Commission has a regulatory interest in being notified of changes in the capital of a prudentially regulated Covered Entity, as it could signal the firm is in or approaching financial difficulty and presents a risk to U.S. security-based swap markets and participants. For the foregoing reasons, the Commission is conditioning applying substituted compliance pursuant to the Order on the general condition that a prudentially regulated Covered Entity apply substituted compliance with respect to Exchange Act rule 18a-8(c) and the requirements

of Exchange Act rule 18a-8(h) as applied to Exchange Act rule 18a-8(c).

114

Better Markets Letter at 2.

115

See

Exchange Act Release No. 71958 (Sept. 19, 2019), 84 FR 68550, 68589-90 (Dec. 16, 2019) (“Recordkeeping and Reporting Adopting Release”) (citing Exchange Act Release No. 71958 (Aug. 17, 2014) 79 FR 25193, 25249 (May 2, 2014)).

C. European Union Cross-Border Matters

1. Proposed Approach

The proposed Order also included general conditions to address the cross-border application of MiFID and MAR, along with EU and French requirements adopted pursuant to those directives. For some requirements under MiFID (and other EU and Member State requirements adopted pursuant to MiFID), EU law allocates the responsibility for supervising and enforcing those requirements to authorities of the Member State where an entity provides certain services. Similarly, for some requirements under MAR (and other EU and Member State requirements adopted pursuant to MAR), EU law allocates the responsibility for supervising and enforcing those requirements to authorities of potentially multiple Member States. To help ensure that the prerequisites to substituted compliance with respect to supervision and enforcement are satisfied in fact, the proposed Order provided substituted compliance only if one of the authorities responsible for supervision and enforcement of those requirements is the AMF or the ACPR.

116

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85724, 85739.

2. Commenter Views and Final Provisions

Commenters raised concerns with the proposed approach to European Union cross-border matters. The commenters did not object to the Commission's underlying premise, with one commenter noting that they “[understood] that the Commission has included these conditions in the order to ensure that the prerequisites with respect to supervision and enforcement are satisfied.”

117

Commenters instead asserted that the proposed condition would significantly curtail the ability to rely on the Order, with one commenter stating that requiring the AMF or ACPR to be allocated responsibility for the supervision and enforcement of applicable MiFID and MAR provisions, “will in practice lead to an untenable patchwork of substituted compliance.”

118

To address these issues, commenters urged the Commission to consider whether it could dispense with certain of the requirements cited in the proposed Order and still make a holistic, outcomes based comparability determination.

117

See

SIFMA Letter I at 2-8.

118

See

SIFMA Letter I at 3.

The Commission continues to believe that requiring that the AMF or ACPR have responsibility for applicable MiFID and MAR provisions will help ensure that the supervision and enforcement prerequisites to substituted compliance are satisfied.

119

Additionally, the proposed approach helps ensure that applicable MiFID and MAR provisions are interpreted and applied in a consistent manner by entities that are party to the MOUs and/or other arrangements which are a prerequisite to substituted compliance.

120

In light of these considerations the Commission is issuing the general conditions related to EU cross-border matters largely as proposed.

121

In the Commission's view, these conditions are structured appropriately to permit the use of substituted compliance only when the AMF or the ACPR is the entity responsible for supervising a Covered Entity's compliance with a relevant provision of MiFID, MAR or related EU or French requirements.

119

See

Business Conduct Adopting Release, 81 FR at 30080;

See also

discussion in part III.B.2.d.

This part of the Order has been modified from the proposed Order to incorporate references to conditions requiring compliance with MiFIR, given that certain relevant MiFIR conditions to substituted compliance are subject to the same principles regarding the allocation of authority.

123

MiFID article 35(8) particularly provides that these allocation principles apply in connection with MiFIR articles 14 to 26. The Commission requested comment on the addition of MiFIR and received no comment.

IV. Substituted Compliance for Risk Control Requirements

A. Proposed Approach

The French Authorities' Application in part requested substituted compliance in connection with risk control requirements relating to:

• Internal risk management—Internal risk management system requirements that address the obligation of registered entities to follow policies and procedures reasonably designed to help manage the risks associated with their business activities.

• Trade acknowledgment and verification—Trade acknowledgment and verification requirements intended to help avoid legal and operational risks by requiring definitive written records of transactions and procedures to avoid disagreements regarding the meaning of transaction terms.

• Portfolio reconciliation and dispute reporting—Portfolio reconciliation and dispute reporting provisions that require that counterparties engage in portfolio reconciliation and resolve discrepancies in connection with uncleared security-based swaps, and to provide prompt notification to the Commission and applicable prudential regulators regarding certain valuation disputes.

• Portfolio compression—Portfolio compression provisions that require that SBS Entities have procedures addressing bilateral offset, bilateral compression and multilateral compression in connection with uncleared security-based swaps.

• Trading relationship documentation—Trading relationship documentation provisions that require SBS Entities to have procedures to execute written security-based swap trading relationship documentation with their counterparties prior to, or contemporaneously with, executing certain security-based swaps.

124

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85724.

Taken as a whole, these risk control requirements help to promote market stability by mandating that registered entities follow practices that are appropriate to manage the market, counterparty, operational, and legal risks associated with their security-based swap businesses.

In considering conditional substituted compliance for the risk control portion of the French Authorities' Application, the Commission preliminarily concluded that the relevant French and EU requirements generally would help to produce regulatory outcomes that are comparable to those under the Exchange Act by subjecting Covered Entities to risk mitigation and documentation practices that are appropriate to the risks associated with their security-based swap businesses.

125

Substituted compliance under the proposed Order was to be conditioned in part on Covered Entities being subject to and

complying with the specified French and EU provisions that in the aggregate help to produce regulatory outcomes that are comparable to those associated with the risk control requirements under the Exchange Act.

126

125

Id.

at 85724.

126

Id.

at 85724 n.37.

Substituted compliance under the proposed Order also was to be subject to certain additional conditions to help ensure the comparability of outcomes: (a) Substituted compliance in connection with the trading relationship documentation provisions would be conditioned on the requirement that the Covered Entity not treat its counterparties as “eligible counterparties” for purposes of relevant MiFID provisions;

127

(b) substituted compliance related to trading relationship documentation under the proposed Order would not extend to certain disclosures regarding legal and bankruptcy status;

128

and (c) substituted compliance in connection with portfolio reconciliation and dispute reporting requirements would be conditioned on the Covered Entity having to provide the Commission with reports regarding disputes between counterparties on the same basis as they provide those reports to competent authorities pursuant to EU law.

129

127

Id.

at 85725. Certain relevant French and EU requirements that provide for this type of documentation do not apply to investment firms' transactions with “eligible counterparties.”

128

Id.

The trading relationship documentation provisions of rule 15F(b)(5) require certain disclosures regarding the status of the SBS Entity or its counterparty as an insured depository institution or financial counterparty, and regarding the possible application of the insolvency regime set forth under Title II of the Dodd-Frank Act or the Federal Deposit Insurance Act. Documentation requirements under applicable French and EU law would not be expected to address the disclosure of information related to insolvency procedures under U.S. law.

129

Id.

Under the Exchange Act requirement, SBS Entities must promptly report, to the Commission, valuation disputes in excess of $20 million that have been outstanding for three or five business days (depending on counterparty types). EU requirements provide that firms must report at least monthly, to competent authorities, disputes between counterparties in excess of €15 million and outstanding for at least 15 business days.

B. Commenter Views and Final Provisions

Commenters initially expressed the view that the Commission should modify certain of the proposed conditions related to substituted compliance in connection with internal risk management, trade acknowledgement and verification, and trading relationship documentation requirements.

130

Specifically, commenters expressed concerns with proposed MiFID requirements for trade acknowledgement and verification and trading relationship documentation that “cover the same ground” as proposed EMIR requirements and “would result in undue burdens for French [security-based swap dealers].”

131

Partially in light of those concerns, the Commission reopened the comment period and solicited additional comment on whether EMIR requirements standing alone could produce comparable results such that certain MiFID provisions may be removed as prerequisites to substituted compliance for trade acknowledgement and verification and trading relationship documentation requirements.

132

Certain commenters generally supported changes contemplated by the Commission in the Reopening Release.

133

Another commenter stated that French and EU requirements are not sufficiently comparable to Exchange Act requirements.

134

130

See

SIFMA Letter I at 4-6; FBF Letter I at 2.

131

See

FBF Letter I at 2.

See also

SIFMA Letter I at 3 (noting that the application of certain proposed MiFID and EMIR rules would “lead to an untenable patchwork of substituted compliance.”)

132

See

Reopening Release, 86 FR at 18343.

133

See

SIFMA Letter II at 6 (stating that “[w]e generally support these proposed modifications to the French Order”);

see also

FBF Letter II at 2.

But see

Better Markets Letter at 6 (“It is understandable that industry groups would urge the SEC to make it easier for more members of the industry to avail themselves of the privilege of substituted compliance . . . . However, easing regulatory burdens for the industry is not the SEC's job.”).

134

See

Better Markets Letter at 1-2.

After considering commenters' recommendations regarding the risk control requirements, the Commission is making positive substituted compliance determinations in connection with internal risk management, trade acknowledgment and verification, portfolio reconciliation and dispute reporting, portfolio compression and trading relationship documentation requirements. As discussed below, the final Order has been changed from the proposed Order in certain respects in response to comments following the proposed Order and Reopening Release. The Commission continues to conclude that, taken as a whole, applicable requirements under French and EU law subject Covered Entities to risk mitigation and documentation practices that are appropriate to the risks associated with their security-based swap businesses, and thus help to produce regulatory outcomes that are comparable to the outcomes associated with the relevant risk control requirements under the Exchange Act. Although the Commission recognizes that there are differences between the approaches taken by the relevant risk control requirements under the Exchange Act and relevant French and EU requirements, the Commission continues to believe that those differences on balance should not preclude substituted compliance for these requirements, as the relevant French and EU requirements taken as a whole help to produce comparable regulatory outcomes.

To help ensure the comparability of outcomes, substituted compliance for risk control requirements is subject to certain conditions. Substituted compliance for internal risk management, trade acknowledgment and verification, portfolio reconciliation and dispute reporting, portfolio compression and trading relationship documentation requirements is conditioned on the Covered Entity being subject to, and complying with, relevant French and EU requirements.

135

In addition, consistent with the proposed Order, substituted compliance for trading relationship documentation does not extend to disclosures regarding legal and bankruptcy status that are required by Exchange Act rule 15Fi-5(b)(5) when the counterparty is a U.S. person.

136

Finally, consistent with the proposed Order, substituted compliance for portfolio reconciliation and dispute reporting requirements is conditioned on the Covered Entity providing the Commission with reports regarding disputes between counterparties on the same basis as the Covered Entity provides those reports to its competent authority pursuant to French and EU

law.

137

A Covered Entity that is unable to comply with an applicable condition—and thus is not eligible to use substituted compliance for the particular set of Exchange Act risk control requirements related to that condition—nevertheless may use substituted compliance for another set of Exchange Act requirements addressed in the Order if it complies with the conditions to the relevant parts of the Order.

135

See

paras. (b)(1) through (5) of the Order.

136

See

para. (b)(5) of the Order. The Exchange Act rule 15Fi-5, 17 CFR 240.15Fi-5, disclosures address information regarding: (1) The status of the SBS Entity or its counterparty as an insured depository institution or financial counterparty, and (2) the possibility that in certain circumstances the SBS Entity or its counterparty may be subject to the insolvency regime set forth in Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act or the Federal Deposit Insurance Act, which may affect rights to terminate, liquidate or net security-based swaps.

See

Exchange Act Release No. 87782 (Dec. 18, 2019), 85 FR 6359, 6374 (Feb. 4, 2020) (“Risk Mitigation Adopting Release”). Documentation requirements under applicable French and EU law do not address the disclosure of information related to insolvency procedures under U.S. law. However, the absence of such disclosures would not appear to preclude a comparable regulatory outcome when the counterparty is not a U.S. person, as the insolvency-related consequences that are the subject of the disclosure would not apply to non-U.S. counterparties in most cases. Moreover, EMIR Margin RTS article 2 requires counterparties to establish, apply and document risk management procedures providing for or specifying the terms of agreements entered into by the counterparties, including applicable governing law for non-centrally cleared derivatives. When counterparties enter into a netting or collateral exchange agreement, they also must perform an independent legal review of the enforceability of those agreements.

137

See

paras. (b)(3)(ii) of the Order. This condition promotes comparability with the Exchange Act rule requiring reports to the Commission regarding significant valuation disputes, while leveraging French and EU reporting provisions to avoid the need for Covered Entities to create additional reporting frameworks. When it proposed the condition to report valuation disputes, the Commission recognized that valuation inaccuracies may lead to uncollateralized credit exposure and the potential for loss in the event of default.

See

Exchange Act Release No. 84861 (Dec. 19, 2018), 84 FR 4614, 4621 (Feb. 15, 2019). It thus is important that the Commission be informed regarding valuation disputes affecting SBS Entities. The principal difference between the Exchange Act and French and EU valuation dispute reporting requirements concerns the timing of notices. Exchange Act rule 15Fi-3, 17 CFR 240.15Fi-3, requires SBS Entities to report promptly to the Commission valuation disputes in excess of $20 million that have been outstanding for three or five business days (depending on the counterparty type). EMIR RTS article 15(2) requires financial counterparties to report to the relevant competent authority at least monthly any disputes between counterparties in excess of €15 million and outstanding for at least 15 business days. The Commission is mindful that the French and EU provision does not provide for notice as quickly as rule 15Fi-3, but in the Commission's view on balance this difference would not be inconsistent with the conclusion that the two sets of requirements, taken as a whole, promote comparable regulatory outcomes.

Under the Order, substituted compliance for risk control requirements (relating to internal risk management, trade acknowledgment and verification, portfolio reconciliation and dispute reporting, portfolio compression and trading relationship documentation) is not subject to a condition that the Covered Entity apply substituted compliance for related recordkeeping requirements in Exchange Act rules 18a-5 and 18a-6. A Covered Entity that applies substituted compliance for one or more risk control requirements, but does not apply substituted compliance for the related recordkeeping requirements in Exchange Act rules 18a-5 and 18a-6, will remain subject to the relevant provisions of Exchange Act rules 18a-5 and 18a-6. Those rules require the Covered Entity to make and preserve records of its compliance with Exchange Act risk control requirements and of its security-based swap activities required or governed by those requirements. A Covered Entity that applies substituted compliance for a risk control requirement, but complies directly with related recordkeeping requirements in rules 18a-5 and 18a-6, therefore must make and preserve records of its compliance with the relevant conditions of the Order and of its security-based swap activities required or governed by those conditions and/or referenced in the relevant parts of rules 18a-5 and 18a-6.

1. Internal Risk Management

Exchange Act section 15F(j)(2) requires a registered SBS Entity to establish robust and professional risk management systems adequate for managing its day-to-day business. In addition, Exchange Act rule 15Fh-3(h)(2)(iii)(I) requires an SBS Entity to establish and maintain a system to supervise, and to diligently supervise, its business and the activities of its associated persons. This system of internal supervision must include, in relevant part, the establishment, maintenance and enforcement of written policies and procedures reasonably designed, taking into consideration the nature of the SBS Entity's business, to comply with its duty under Exchange Act section 15F(j)(2) to establish an internal risk management system.

Under the proposed Order, substituted compliance in connection with internal risk management requirements would have been conditioned on Covered Entities being subject to and complying with certain MiFID, CRD and EMIR requirements related to internal risk management. One commenter expressed the view that the scope of this proposed condition would require SBS Entities to be subject to and comply with “an expansive range of detailed and prescriptive requirements” that are not necessary to produce comparable regulatory outcomes.

138

The commenter further criticized conditions requiring compliance with certain internal risk management requirements prescribed by the CRD, stating that those prescriptive requirements go beyond the “high-level” internal risk management requirements set forth by Exchange Act section 15F(j)(2).

139

The commenter also expressed the view that the conditions should not extend to the compliance system requirements of MiFID Org Reg article 22, on the grounds that compliance system requirements do not relate to risk management.

140

Commenters reiterated these same concerns following the reopening of the comment period, requesting the removal of specific MiFID, MFC, MiFID Org Reg, CRD, CRR, Prudential Supervision and Risk Assessment Order, and EMIR Margin RTS requirements for internal risk management.

141

By contrast, another commenter requested that the Commission “not weaken [the risk control] conditions any further.”

142

138

SIFMA Letter I at 4-5.

139

Id.

at 5.

140

Id.

141

SIFMA Letter II at Appendix A; FBF Letter II at 2.

142

Better Markets Letter at 2.

The proposed Order included CRD articles 79 through 87, MiFID articles 16(4) and (5), CRR articles 286 through 288 and 293, EMIR Margin RTS article 2, MiFID Org Reg articles 21, 22 and 24, and the implementing provisions of French law. A commenter stated that the Commission should delete those provisions because they do not correspond to and go beyond Exchange Act internal risk management requirements.

143

However:

143

SIFMA Letter II at Appendix A.

• CRD article 79 and the implementing provisions of French law address a Covered Entity's management of credit and counterparty risk. CRD article 80 and the implementing provisions of French law address a Covered Entity's management of residual risk. CRD article 81 and the implementing provisions of French law address a Covered Entity's management of concentration risk. CRD article 82 and the implementing provisions of French law address a Covered Entity's management of securitization risk. CRD article 83 and the implementing provisions of French law address a Covered Entity's management of market risk. CRD article 84 and the implementing provisions of French law address a Covered Entity's management of interest rate risk. CRD article 85 and the implementing provisions of French law address a Covered Entity's management of operational risk. CRD article 86 and the implementing provisions of French law address a Covered Entity's management of liquidity risk and funding risk. CRD article 87 and the implementing provisions of French law address a Covered Entity's management of risk from excessive leverage.

• MiFID article 16(4) and the implementing provisions of French law require a Covered Entity to take reasonable steps to ensure continuity and regularity in the performance of investment services and activities, including by employing appropriate and proportionate systems, resources and procedures. MiFID article 16(5) and the implementing provisions of French law require a Covered Entity to ensure that it manages the operational risk of

relying on third parties for the performance of operational functions that are critical to the continuous and satisfactory provision of service to clients and performance of investment services and activities.

• CRR article 286 requires a Covered Entity to establish and maintain a counterparty credit risk management framework, including policies, processes and systems to ensure the identification, measurement, approval and internal reporting of counterparty credit risk and procedures for ensuring that those policies, processes and systems are complied with. CRR article 287 addresses the internal governance of risk control and collateral management functions for Covered Entities that use internal models to calculate capital requirements. CRR article 288 requires the Covered Entity to conduct regular, independent reviews of its counterparty credit risk management systems and any risk control and collateral management functions required by CRR article 287. CRR article 293 addresses internal governance of the Covered Entity's internal risk management systems and validation of risk models that the Covered Entity uses.

• EMIR Margin RTS article 2 requires counterparties to non-centrally cleared OTC derivative contracts to establish, apply and document risk management procedures for the exchange of collateral.

• MiFID Org Reg article 21 addresses a Covered Entity's systems, internal controls and arrangements for management of a variety of risk areas, including internal decision-making, allocation and proper discharge of responsibilities, compliance with decisions and internal procedures, employment of personnel able to discharge their responsibilities, internal reporting and communication of information, adequate and orderly recordkeeping, safeguarding information, business continuity, accounting policies and procedures, as well as regular evaluation of the adequacy and effectiveness of those systems, internal controls and arrangements. MiFID Org Reg article 22 addresses a Covered Entity's policies and procedures for detecting and minimizing risk of failure to comply with its obligations under EU provisions that implement MiFID, as well as the Covered Entity's independent compliance function that monitors and assesses the adequacy and effectiveness of those policies and procedures. MiFID Org Reg article 24 addresses a Covered Entity's internal audit function that evaluates the adequacy and effectiveness of the Covered Entity's systems, internal controls and arrangements.

Each of these requirements helps to produce regulatory outcomes comparable to Exchange Act requirements to establish robust and professional internal risk management systems adequate for managing the Covered Entity's day-to-day business. The comparability analysis requires consideration of Exchange Act requirements as a whole against analogous French and EU requirements as a whole, recognizing that U.S. and non-U.S. regimes may follow materially different approaches in terms of specificity and technical content. This “as a whole” approach—which the Commission is following in lieu of requiring requirement-by-requirement similarity—further means that the conditions to substituted compliance should encompass all French and EU requirements that establish comparability with the applicable regulatory outcome, and helps to avoid ambiguity in the application of substituted compliance. It would be inconsistent with the holistic approach to excise relevant requirements and leave only the residual French and EU provisions that most closely resemble the analogous Exchange Act requirements.

144

Accordingly, the Commission is retaining the references to these provisions. Retaining conditions of the Order necessary to help produce regulatory outcomes comparable to Exchange Act internal risk management requirements also should address another commenter's concern that any substituted compliance determination not weaken the risk control conditions in the proposed Order.

145

144

The Commission further believes that those conditions to substituted compliance do not expand the scope of Exchange Act requirements because substituted compliance is an option available to non-U.S. person SBS Entities—not a mandate.

145

See

Better Markets Letter at 1-2.

The Commission is making three changes from the proposed Order for this portion of the Order. First, the Commission concurs with a commenter recommendation that the prerequisites to substituted compliance for internal risk management should not extend to the Covered Entity being subject to and complying with French Prudential Supervision and Risk Assessment Order article 7, which does not impose obligations on regulated entities.

146

Second, the Commission is incorporating, as part of the relevant conditions a Covered Entity using substituted compliance for internal risk management must be subject to and comply with, MFC L. 533-2, which is the French implementation of the internal risk management requirements set forth in the second paragraph of MiFID article 16(5).

147

Finally, the Commission is incorporating, as part of the relevant conditions, MiFID articles 16 and 23 and the related implementing provisions;

148

MiFID Org Reg articles 25 through 37, 72 through 76 and Annex IV; and CRD articles 88(1), 91(1) and (2), and (7) through (9), 92, 94, and 95 and the related implementing provisions.

149

These provisions address additional aspects of a Covered Entity's management of the risks posed by internal governance and organization, business operations, conflicts of interest with and between clients and senior staff remuneration policies.

146

SIFMA Letter II at Appendix A.

147

That cross-reference inadvertently was omitted from the proposed Order, but was incorporated within the proposed conditions related to internal supervision and compliance (

see

para. (d)(3) of the Order), and was cited by the French Authorities' Application as supporting comparability in connection with internal risk management system requirements (

see

French Authorities' Application at 68).

148

MFC articles L. 533-10.II (1) through (3) and (6) through (9), L. 533-10.III, L. 533-24 and L. 533-24-1.

149

MFC articles L. 511-51, L. 511-52.I, L. 511-53, L. 511-58, L. 511-59, L. 511-67 through L. 511-69, L. 511-71 through L. 511-85, L. 511-102, R. 511-18-2 and R. 511-16-3.

In deciding to make a positive substituted compliance determination for French and EU internal risk management requirements, the Commission considers that the Order's condition requiring a Covered Entity to be subject to and comply with all of the French and EU internal risk management requirements listed in paragraph (b)(1) of the Order help to produce regulatory outcomes comparable to Exchange Act internal risk management requirements. The Commission recognizes that some of the French and EU requirements related to risk management follow a more granular approach than the high-level approach of Exchange Act internal risk management requirements, but these French and EU requirements, taken as a whole, are crafted to promote a Covered Entity's risk management. Within the requisite outcomes-oriented approach for analyzing comparability, the Commission concludes that a Covered Entity's failure to comply with any of those French and EU internal risk management requirements would be inconsistent with a Covered Entity's obligation under Exchange Act internal risk management requirements.

150

contrast to the assertion that such provisions “go beyond the general requirements of Exchange Act section 15(j)(2),”

151

the Commission concludes that compliance with the full set of French and EU internal risk management requirements listed in paragraph (b)(1) of the Order would promote comparable regulatory outcomes.

150

One commenter recognized that the application addressed CRD requirements in connection with internal risk management

requirements, but expressed the view that those discussions address comparability in connection with Exchange Act rule 18a-1(f), relating to risk management systems in connection with capital requirements.

See

SIFMA Letter I at 5 n.9. Regardless of applicants' rationale for citing those CRD requirements as supporting comparability, the Commission believes that the appropriate comparability analysis generally should seek to compare regulatory regimes taken as a whole, and that a Covered Entity's failure to comply with the applicable CRD risk management system requirements would not lead to a regulatory outcome consistent with that established by Exchange Act internal risk management requirements.

151

SIFMA Letter II at Appendix A.

2. Trade Acknowledgement and Verification

Under the proposed Order, substituted compliance in connection with the Exchange Act rule 15Fi-2 trade acknowledgment and verification requirement would have been conditioned on firms having to comply with relevant confirmation requirements under MiFID and EMIR. Commenters expressed the view that the conditions should not incorporate MiFID confirmation provisions, based in part on the view that EMIR requirements standing alone would be sufficient to produce regulatory outcomes comparable to those under Exchange Act trade acknowledgement and verification requirements.

152

One commenter further stated that conditioning substituted compliance on SBS Entities having to comply with MiFID confirmation requirements in practice would undermine the availability of substituted compliance for SBS Entities that have branches in EU member states for which the Commission has not entered into an applicable substituted compliance memorandum of understanding.

153

152

See

SIFMA Letter I at 5-6; FBF Letter I at 2; EBF Letter I (providing general support for SIFMA Letter I).

153

See

SIFMA Letter I at 2-4.

When the Commission reopened the comment period, it solicited additional comment on whether EMIR requirements were sufficient to produce comparable results, such that MiFID provisions may be removed as conditions to substituted compliance for trade acknowledgement and verification.

154

Some commenters generally supported the associated changes contemplated by the Commission in the Reopening Release.

155

On the other hand, one commenter stated its opinion that “some industry participants may not be able to take advantage of substituted compliance under the SEC's proposed framework is not, in and of itself, a reason to change the framework”.

156

The same commenter stated that “the French regulatory framework governing [trade acknowledgement] . . . does not satisfy the test for substituted compliance” and that “the Commission should certainly not weaken [the trade acknowledgment] conditions any further.”

157

154

See

Reopening Release, 86 FR at 18343.

155

See

SIFMA Letter II at 6-7 (stating that the EMIR requirements “are sufficient, standing alone, to reach comparable outcomes” to the Exchange Act trade acknowledgement and verification (and trading relationship documentation) requirements, and that “further requiring compliance with MiFID documentation requirements would substantially reduce the overall availability of substituted compliance in these areas because those MiFID requirements are not necessarily applicable on an entity-wide basis like the EMIR requirements are”);

see also

FBF Letter II at 2.

156

Better Markets Letter at 2.

157

Id.

The Commission agrees that, in and of itself, the fact that some may not be able to rely on the Order is not a sufficient reason to modify the Order. On the other hand, the Commission believes that the duplicative nature of the MiFID-related conditions and the EMIR-related conditions in light of the implementation issues warrants the removal of the MiFID-related conditions, and the Order has been modified accordingly.

158

In taking this step, the Commission has considered French and EU timely confirmation requirements. EMIR article 11 requires “financial counterparties” and “non-financial counterparties” to ensure appropriate procedures and arrangements are in place to achieve timely confirmation of the terms of an OTC derivative contract.

159

Similarly, EMIR RTS article 12 requires non-centrally cleared OTC derivative contracts between “financial counterparties” and “non-financial counterparties” to be confirmed.

160

These counterparty categories do not include entities organized outside the EU, such as U.S. persons.

161

Confirmation means the documentation of the agreement of the counterparties to all the terms of the OTC derivative contract.

162

The French and EU requirements as a whole thus require a Covered Entity

163

to provide a confirmation that serves as a trade acknowledgment, without regard to where its counterparty is organized, and also require the Covered Entity's counterparty, when it is a financial counterparty or non-financial counterparty, to provide a confirmation that serves as the trade verification, and the Commission considers these requirements to promote regulatory outcomes comparable to Exchange Act trade acknowledgment and verification requirements for those counterparties. The French and EU requirements in most instances do not require a Covered Entity's counterparty that is organized outside the EU to provide a French confirmation that serves as a trade verification,

164

though they do require the Covered Entity to confirm the transaction.

165

Confirmation is defined as documenting the agreement of the Covered Entity and its counterparties to all the terms of the OTC derivative contract.

166

To ensure that a Covered

Entity using substituted compliance for trade acknowledgment and verification requirements will be required to document the agreement of the counterparties to all the terms of the relevant transaction, the Commission is issuing the Order with two new general conditions that will require the Covered Entity to treat its counterparty as a financial counterparty or non-financial counterparty when complying with French and EU trade acknowledgment and verification requirements and to ensure that the relevant security-based swap is either non-centrally cleared and subject to EMIR or cleared by a central counterparty that has been authorized or recognized to clear derivatives contracts by a relevant authority in the EU.

167

158

See

para. (b)(2) of the Order.

159

See

EMIR article 11(1)(a).

160

See

EMIR RTS articles 12(1) and (2).

161

See

EMIR article 2(8) (definition of “financial counterparty”); EMIR article 2(9) (definition of “non-financial counterparty”).

162

See

EMIR RTS article 1(c).

163

The Order defines a Covered Entity to include an investment firm or credit institution authorized by the ACPR. Investment firms and credit institutions are included in the definition of “financial counterparty,” so a Covered Entity is also a financial counterparty and thus is “subject to” EMIR article 11 and related provisions of EMIR RTS and EMIR Margin RTS for purposes of the Order.

164

See

EMIR article 2(8) (definition of “financial counterparty” limited to entities defined or authorized in a manner that in most instances is reserved for EU-established entities); EMIR article 2(9) (definition of “non-financial counterparty” limited to EU-established entities); EMIR articles 11(1)(a) and 11(12) (confirmation requirement applies to financial counterparties, non-financial counterparties and third-country entities that would be subject to the confirmation requirement if established in the EU and either the relevant contract has a direct, substantial and foreseeable effect in the EU or the obligation is necessary or appropriate to prevent the evasion of any provision of EMIR).

165

As defined in paragraph (g)(1) of the Order, a Covered Entity must be an investment firm or credit institution authorized by the ACPR to provide investment services or perform investment activities in the French Republic. These investment firms and credit institutions are limited to French-established entities and do not include third-country firms.

See

MiFID article 4(57) (definition of “third-country firm” is a firm that would be a credit institution providing investment services or performing investment activities or an investment firm if its registered office or head office were located in the EU); MFC article L. 532-47 (same). Each of these investment firms and credit institutions also is among the entities that qualify as a “financial counterparty.”

See

EMIR article 2(8) (definition of “financial counterparty” includes credit institutions and investment firms).

166

See

EMIR RTS article 1(c). In other words, the Covered Entity would be subject to the relevant requirements under EMIR even if the counterparty is not authorized pursuant to EU law as anticipated by the EMIR article 2(8) “financial counterparty” definition or if the counterparty is not an “undertaking” (such as by virtue of being a natural

person) or is not established in the EU (by virtue of being a U.S. person or otherwise being established in some non-EU jurisdiction), as anticipated by the EMIR article 2(9) “non-financial counterparty” definition. This approach appears to be consistent with EU guidance.

See

European Securities and Markets Authority, “Questions and Answers: Implementation of the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (EMIR)” (

https://www.esma.europa.eu/sites/default/files/library/esma70-1861941480-52_qa_on_emir_implementation.pdf

) answer 5(a) (stating that compliance with the EMIR confirmation requirement necessitates that the counterparties must reach a legally binding agreement to all terms of the OTC derivative contract, and that the EMIR RTS “implies” that both parties must comply and agree in advance to a specific process to do so); answer 12(b) (stating that where an EU counterparty transacts with a third-country entity, the EU counterparty generally must ensure that the EMIR requirements for portfolio reconciliation, dispute resolution, timely confirmation and portfolio compression are met for the relevant portfolio and/or transactions even though the third country entity would not itself be subject to EMIR).

167

See

paras. (a)(5) and (a)(6) of the Order;

see also

part III.B,

supra.

Commenters supported those additions.

See

See also

SIFMA Letter II at 6 (stating that “we agree with the Commission that the cited provisions of EMIR are comparable to the Exchange Act trade acknowledgment and verification and trading relationship documentation requirements.”).

Another commenter recommended removal of conditions requiring compliance with EMIR RTS article 12(4) because it does not relate to and goes beyond Exchange Act trade acknowledgment and verification requirements.

168

As part of the French and EU framework for trade acknowledgment and verification, EMIR RTS article 12(4) requires a Covered Entity to have the necessary procedures to report on a monthly basis to the competent authority the number of unconfirmed, non-centrally cleared OTC derivative transactions that have been outstanding for more than five business days. Though Exchange Act rule 15Fi-2 does not have a similar requirement to report unconfirmed trades, the Commission considers that EMIR RTS article 12(4)'s requirement to report unconfirmed trades to the competent authority is an inseparable part of the French and EU framework for trade acknowledgment and verification, as those reports support the framework's mandate to confirm transactions. Requiring a Covered Entity to be subject to and comply with EMIR RTS article 12(4) thus is consistent with a holistic approach for comparing regulatory outcomes that reflects the whole of a jurisdiction's relevant requirements. Accordingly, the Order retains as a condition to substituted compliance for trade acknowledgment and verification requirements the requirement that the Covered Entity be subject to and comply with the entirety of EMIR RTS article 12.

168

See

SIFMA Letter II at Appendix A (stating that the requirements of the rule, which relate to the obligation of financial counterparties to report, on a monthly basis, the number of unconfirmed OTC derivative transactions that have been outstanding for more than five business days, “do not correspond to and go beyond the general requirements of” rule 15Fi-2).

In summary, the Commission believes that French and EU requirements promote the goal of avoiding legal and operational risks by requiring definitive written records of transactions and procedures to avoid disagreements regarding the meaning of transaction terms, in a manner that is comparable to the purpose of Exchange Act rule 15Fi-2.

169

The Commission recognizes that the MiFID confirmation requirements, particularly MiFID Org Reg article 59, are more specific regarding relevant categories of information to be disclosed (in the context of a one-way requirement for firms to provide reports to their clients), but does not believe that those additional one-way confirmation provisions are necessary to achieve the policy goal of avoiding legal and operational risks. While the Commission recognizes the differences between French and EU requirements and Exchange Act trade acknowledgment and verification requirements, in the Commission's view those differences on balance would not preclude substituted compliance, particularly as requirement-by-requirement similarity is not needed for substituted compliance. The Commission is not persuaded by a commenter view that “denying substituted compliance under the applicable circumstances seems perfectly reasonable,” given the Commission's conclusion that the relevant EMIR-related conditions provide regulatory outcomes that are comparable to those associated with the Exchange Act requirement, and the regulatory efficiency benefits associated with substituted compliance.

170

That commenter's request for a “robust, evidence-based analysis” has been met here in the context of the requisite holistic analysis,

171

and the commenter's suggestion that there is a need for analysis regarding protection of the American financial system has been addressed above.

172

169

The two new EMIR-related general conditions addressed above should further help ensure that the EMIR confirmation provisions comprehensively apply to relevant non-cleared transactions of SBS Entities.

170

Better Markets Letter at 6.

171

See

Better Markets Letter at 6 (alluding to the need for a “robust, evidence-based analysis”). As discussed above (

see

part II.D.2,

supra

), the Commission believes that the present approach toward comparability analyses—which are based on a close reading of relevant foreign requirements and careful consideration of regulatory outcomes—appropriately reflects the holistic comparability approach and the rejection of requirement-by-requirement similarity.

172

See

Better Markets Letter at 6 (stating that the Commission must provide analysis that the change would protect the American financial system).

See also

discussion in part II.D.2

supra

3. Portfolio Reconciliation and Dispute Reporting

In the French Substituted Compliance Notice and Proposed Order, the Commission proposed to make a positive substituted compliance determination conditioned on the Covered Entity being subject to and complying with specific French portfolio reconciliation and dispute reporting requirements.

173

One commenter expressed general support for the proposed approach toward substituted compliance for the risk control provisions.

174

Another commenter stated that, if the Commission makes a positive substituted compliance determination, it must at a minimum ensure that it does “not weaken [the] conditions any further.”

175

The Commission continues to believe that French portfolio reconciliation and dispute reporting requirements promote regulatory outcomes comparable to Exchange Act requirements, by subjecting Covered Entities to risk mitigation practices that are appropriate to the risks associated with their security-based swap businesses, and is making a positive substituted compliance determination

for portfolio reconciliation and dispute reporting requirements consistent with the proposed Order.

176

Substituted compliance in connection with the dispute reporting requirements is conditioned in part on the Covered Entities providing the Commission with reports regarding disputes between counterparties on the same basis as the entities provide those reports to competent authorities pursuant to EU law, to allow the Commission to obtain notice regarding key information in a manner that makes use of existing obligations under EU law.

177

173

French Substituted Compliance Notice and Proposed Order, 85 FR at 85740.

174

See

SIFMA Letter II at 6.

175

See

Better Markets Letter at 2.

176

See

para. (b)(3) of the Order.

177

See

para. (b)(3)(ii) of the Order. The Commission recognizes the differences between the two sets of requirements—under which Exchange Act rule 15Fi-3 requires SBS Entities to report valuation disputes in excess of $20 million that have been outstanding for three or five business days (depending on counterparty types), while EMIR RTS art. 15(2) requires firms to report disputes between counterparties in excess of €15 million and outstanding for at least 15 business days. In the Commission's view, the two requirements produce comparable regulatory outcomes notwithstanding those differences.

4. Portfolio Compression

178

One commenter expressed general support for the proposed approach toward substituted compliance for the risk control provisions.

179

Another commenter stated that, if the Commission makes a positive substituted compliance determination, it must at a minimum ensure that it does “not weaken [the] conditions any further.”

180

The Commission continues to believe that French portfolio compression requirements promote regulatory outcomes comparable to Exchange Act requirements, by subjecting Covered Entities to risk mitigation practices that are appropriate to the risks associated with their security-based swap businesses, and is making a positive substituted compliance determination for portfolio compression requirements consistent with the proposed Order.

181

178

French Substituted Compliance Notice and Proposed Order, 85 FR at 85740.

179

See

SIFMA Letter II at 6.

180

See

Better Markets Letter at 2.

181

See

para. (b)(4) of the Order.

5. Trading Relationship Documentation

Under the proposed Order, substituted compliance in connection with the Exchange Act rule 15Fi-5 trading relationship documentation requirement would have been conditioned on Covered Entities being subject to and complying with MiFID and EMIR provisions that address records regarding counterparty relationships and entities.

182

Substituted compliance under the proposed Order would not extend to rule 15Fi-5(b)(5) insolvency-related disclosures when the counterparty is a U.S. person.

183

182

See

para. (b)(5) of the proposed Order.

183

French Substituted Compliance Notice and Proposed Order, 85 FR at 85725.

Consistent with the comments addressed above with respect to trade acknowledgement and verification, some commenters requested that substituted compliance for trading relationship documentation not incorporate conditions requiring compliance with MiFID documentation requirements.

184

Those commenters expressed the view that compliance with MiFID requirements would not be feasible for Covered Entities that have branches in third countries, and that the EMIR risk management provisions connected to the exchange of collateral are sufficient to produce regulatory outcomes comparable to those under the Exchange Act trading relationship documentation rule.

185

184

See

SIFMA Letter I at 6.

185

See

SIFMA Letter I at 3-4.

As noted above, the Commission reopened the comment period and solicited additional comment on whether EMIR requirements standing alone could produce comparable results such that certain MiFID provisions may be removed as prerequisites to substituted compliance.

186

Some commenters generally supported the associated changes contemplated by the Commission in the Reopening Release

187

(including the addition of two new EMIR-related general conditions addressed above),

188

while one commenter opposed removal of the MiFID conditions.

189

186

See

part III.B,

supra.

187

See

SIFMA Letter II at 6;

see also

FBF Letter II at 2.

188

See

part III.B.2.d,

supra.

189

See

Better Markets Letter at 6-7.

The Commission concludes that the implementation issues raised by commenters warrant removal of the MiFID-related condition, and that compliance with EMIR-based risk management requirements are sufficient to produce risk-mitigating outcomes that are comparable to those associated with the Exchange Act rule. The Order accordingly has been modified from the proposed Order to remove conditions requiring compliance with MiFID trading relationship documentation requirements, including corollary conditions related to the application of the MiFID to “eligible counterparties.”

190

In reaching this conclusion, the Commission highlights the special importance of EMIR Margin RTS article 2, which addresses risk management procedures related to the exchange of collateral, including procedures related to the terms of all necessary agreements to be entered into by counterparties (

e.g.,

payment obligations, netting conditions, events of default, calculation methods, transfers of rights and obligations upon termination, and governing law). Those obligations are denoted as being connected to collateral exchange obligations, and the Commission believes that they are necessary to help produce a regulatory outcome that mitigates risk in a manner that is comparable to the outcome associated with the Exchange Act trading relationship documentation rule. To bridge any gap left by EMIR Margin RTS article 2, the Commission is also requiring compliance with EMIR article 11(1)(a) and EMIR RTS article 12, which require the Covered Entity to confirm the transaction, with confirmation defined as documentation of the agreement of the counterparties to all the terms of the OTC derivative contract.

191

190

See

para. (b)(5) of the Order. Consistent with the proposed Order, substituted compliance in connection with trading relationship documentation requirements does not extend to Exchange Act rule 15Fi-5(b)(5) provisions related to disclosures regarding legal and bankruptcy status when the counterparty is a U.S. person.

191

One commenter suggested including EMIR article 11(1)(a) and EMIR RTS article 12(1) through (3). The Commission agrees that these provisions are necessary to a finding of comparability.

See

SIFMA Letter II at Appendix A. As discussed in part IV.B.2 the Commission believes that EMIR RTS article 12(4) is relevant to its holistic, outcomes-oriented approach.

To ensure that a Covered Entity using substituted compliance for trading relationship documentation requirements will be required to document the agreement of the counterparties to all the terms of the relevant transaction, the Commission is issuing the Order with two new general conditions that will require the Covered Entity to treat its counterparty as a financial counterparty or non-financial counterparty when complying French and EU trading relationship documentation requirements and to ensure that the relevant security-based swap is either non-centrally cleared and subject to EMIR or cleared by a central counterparty that has been authorized or recognized to clear derivatives contracts

by a relevant authority in the EU.

192

The Commission agrees with a commenter that the other proposed conditions to substituted compliance for trading relationship documentation should be retained.

193

192

See

paras. (a)(5) and (a)(6) of the Order;

see also

part III.B,

supra.

Commenters supported those additions.

See

See also

193

See

Better Markets Letter at 1-2.

V. Substituted Compliance for Capital and Margin Requirements

A. Proposed Approach

The French Authorities' Application in part requests substituted compliance in connection with requirements under the Exchange Act relating to:

•

Capital

—Capital requirements pursuant to Exchange Act section 15F(e) and Exchange Act rule 18a-1 and its appendices (collectively “Exchange Act rule 18a-1”) applicable to certain SBS Entities.

194

Exchange Act rule 18a-1 helps to ensure the SBS Entity maintains at all times sufficient liquid assets to promptly satisfy its liabilities, and to provide a cushion of liquid assets in excess of liabilities to cover potential market, credit, and other risks. The rule's net liquid assets test standard protects customers and counterparties and mitigates the consequences of an SBS Entity's failure by promoting the ability of the firm to absorb financial shocks and, if necessary, to self-liquidate in an orderly manner.

195

As part of the capital requirements, security-based swap dealers without a prudential regulator also must comply with the internal risk management control requirements of Exchange Act rule 15c3-4 with respect to certain activities.

196

194

17 CFR 240.18a-1 through 18a-1d. Exchange Act rule 18a-1 applies to security-based swap dealers that: (1) Do not have a prudential regulator; and (2) are either (a) not dually registered with the Commission as a broker-dealer; or (b) are dually registered with the Commission as a special purpose broker-dealer known as an OTC derivatives dealer. Security-based swap dealers that are dually registered with the Commission as a full-service broker-dealer are subject to the capital requirements of Exchange Act rule 15c3-1 (17 CFR 240.15c3-1) for which substituted compliance is not available.

See

Exchange Act rule 3a71-6(d)(4)(i) (making substituted compliance available only with respect to the capital requirements of Exchange Act section 15F(e) and Exchange Act rule 18a-1).

195

See

Capital and Margin Adopting Release, 84 FR at 43879. The capital standard of Exchange Act rule 18a-1 is based on the net liquid assets test of Exchange Act rule 15c3-1 applicable to broker-dealers.

Id.

The net liquid assets test seeks to promote liquidity by requiring that a firm maintain sufficient liquid assets to meet all liabilities, including obligations to customers, counterparties, and other creditors, and, in the event a firm fails financially, to have adequate additional resources to wind-down its business in an orderly manner without the need for a formal proceeding.

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85726.

See

French Authorities' Application Annex 1 category 1 capital portion at 1-24.

196

See

17 CFR 240.15c3-4 and 18a-1(f).

•

Margin

—Margin requirements pursuant to Exchange Act section 15F(e) and Exchange Act rule 18a-3 for non-prudentially regulated SBS Entities.

197

The margin requirements are designed to protect SBS Entities from the consequences of a counterparty's default.

198

197

17 CFR 240.18a-3.

198

See

Capital and Margin Adopting Release, 84 FR at 43947, 43949 (“Obtaining collateral is one of the ways OTC derivatives dealers manage their credit risk exposure to OTC derivatives counterparties. Prior to the financial crisis, in certain circumstances, counterparties were able to enter into OTC derivatives transactions without having to deliver collateral. When `trigger events' occurred during the financial crisis, those counterparties faced significant liquidity strains when they were required to deliver collateral”).

Taken as a whole, these capital and margin requirements help to promote market stability by mandating that SBS Entities follow practices to manage the market, credit, liquidity, solvency, counterparty, and operational risks associated with their security-based swap businesses.

In proposing to provide conditional substituted compliance in connection with this part of the French Authorities' Application, the Commission's preliminary view was that relevant French and EU requirements would produce regulatory outcomes that are comparable to those associated with the above capital and margin requirements, by subjecting Covered Entities to financial responsibility requirements that are appropriate to the risks associated with their security-based swap businesses.

199

Substituted compliance accordingly would be conditioned on Covered Entities being subject to the French and EU provisions that, in the aggregate, establish a framework that produces outcomes comparable to those associated with the capital and margin requirements under the Exchange Act.

200

199

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85726.

200

Id.

at 85726 n.49.

However, the Commission also sought comment on whether substituted compliance with respect to Exchange Act capital requirements should be subject to additional conditions.

201

In particular, the Commission sought comment on the following potential conditions:

201

Id.

at 85736-37.

• A condition that would require a Covered Entity to maintain a minimum amount of liquid assets, such as a minimum ratio of liquid assets to illiquid assets (

e.g.,

a ratio of liquid assets to illiquid assets of 80% to 20%, 70% to 30%, 60% to 40%). With respect to such a ratio, the Commission also requested comment on whether liquid and illiquid assets should be defined using the concept of assets that are allowable or not allowable as capital under Exchange Act rule 18a-1.

• A condition that would require a Covered Entity to be subject to a specific liquidity requirement, such as a requirement to maintain a pool of highly liquid assets to cover cash outflows during a 30-day period of stress.

• A condition that a Covered Entity must maintain equity capital or Tier 1 capital at least equal to the minimum fixed-dollar capital requirements under Exchange Act rule 18a-1 (

e.g.,

equity capital or Tier 1 capital of at least $20 million).

Additionally, in the Reopening Release, the Commission again sought comment on whether substituted compliance with respect to Exchange Act capital requirements should be subject to additional conditions.

202

The Commission explained that the capital standard of Exchange Act rule 18a-1 is a net liquid assets test. Under this standard, an SBS Entity will have more than a dollar of highly liquid assets for each dollar of unsubordinated liabilities. Covered Entities, however, are subject to capital requirements applicable to prudentially regulated entities based on the international capital standard for banks (the “Basel capital standard”).

203

The Basel capital standard counts as capital assets that Exchange Act rule 18a-1 would exclude (

e.g.,

loans and most other types of uncollateralized receivables, furniture and fixtures, real estate, and initial margin posted to counterparties). Consequently, because of the ability to include illiquid assets and margin posted away as capital, Covered Entities subject to the Basel capital standard may have less balance sheet liquidity than SBS Entities subject to Exchange Act rule 18a-1. For this reason, the Commission sought comment on the following potential conditions to

applying substituted compliance to Exchange Act rule 18a-1:

202

See

Reopening Release, 86 FR at 18343-47.

203

See, e.g.,

Basel Committee on Banking Supervision (“BCBS”), The Basel Framework, available at:

https://www.bis.org/basel_framework/

• A condition that would require a Covered Entity to maintain an amount of assets that are allowable under Exchange Act rule 18a-1, after applying applicable haircuts under the Basel capital standard, that equals or exceeds the Covered Entity's current liabilities coming due in the next 365 days.

• A condition that would require a Covered Entity to make a quarterly record listing: (1) The assets maintained pursuant to the above condition, their value, and the amount of their applicable haircuts; and (2) the aggregate amount of the liabilities coming due in the next 365 days.

• A condition that would require a Covered Entity to maintains at least $100 million of equity capital composed of highly liquid assets, as defined in the Basel capital standard.

• A condition that would require a Covered Entity to include its most recent statement of financial condition (

i.e.,

balance sheet) filed with its local supervisor whether audited or unaudited with its written notice to the Commission of its intent to rely on substituted compliance.

B. Commenter Views and Final Provisions

1. Capital

Consistent with the proposed Order, the first capital condition requires the covered entity to be subject to and comply with certain identified French and EU capital requirements.

204

As discussed at the end of this section, the Commission made some modifications to the French and EU laws and regulations cited in this condition.

205

For the reasons discussed below, there are two additional conditions to applying substituted compliance with respect to Exchange Act rule 18a-1.

204

See

para. (c)(1)(i) of the order.

See also

French Substituted Compliance Notice and Proposed Order, 85 FR at 85726.

205

See

French Substituted Compliance Notice and Proposed Order, 85 FR at 85726, n.49.

For the reasons discussed above in part III.B.2.e of this release, the first additional capital condition is that the Covered Entity applies substituted compliance with respect to Exchange Act rules 18a-5(a)(9) (a record making requirement), 18a-6(b)(1)(x) (a record preservation requirement), and 18a-8(a)(1)(i), (a)(1)(ii), (b)(1), (b)(2), and (b)(4) (notification requirements).

206

These recordkeeping and notification requirements are directly linked to the capital requirements of Exchange Act rule 18a-1. The UK Proposed Order conditioned substituted compliance with respect to these recordkeeping and notification requirements on the Covered Entity applying substituted compliance with respect to Exchange Act rule 18a-1.

207

This additional capital condition is designed to provide clarity as to the Covered Entity's obligations under these recordkeeping and notification requirements when applying substituted compliance with respect to Exchange Act rule 18a-1 pursuant this Order.

206

See

para. (c)(1)(ii) of the Order.

207

See

UK Substituted Compliance Notice and Proposed Order, 86 FR at 18395-403, 18416-17, 19419. The Commission sought comment in the Reopening Release on whether this approach should be taken in the final Order.

See

Reopening Release, 86 FR at 18348.

The second additional capital condition builds on and modifies the proposed capital condition that was the subject of the Commission's questions in the Reopening Release and that was designed to address potential different regulatory outcomes between Exchange Act rule 18a-1 and the French and EU capital requirements. In particular, the Commission asked questions about a four pronged condition with respect to applying substituted compliance to the capital requirements of Exchange Act rule 18a-1.

208

The first prong would require a Covered Entity to maintain an amount of assets that are allowable under Exchange Act rule 18a-1, after applying applicable haircuts under the Basel capital standard, that equals or exceeds the Covered Entity's current liabilities coming due in the next 365 days.

209

The second prong was linked to the first prong as it would require that a Covered Entity make a quarterly record listing: (1) The assets maintained pursuant to the first condition, their value, and the amount of their applicable haircuts; and (2) the aggregate amount of the liabilities coming due in the next 365 days. The third prong would require the Covered Entity to maintain at least $100 million of equity capital composed of highly liquid assets as defined in the Basel capital standard. The fourth prong would require the Covered Entity to include its most recently filed statement of financial condition whether audited or unaudited with its initial notice to the Commission of its intent to rely on substituted compliance.

208

See id.

at 18387-89 (discussing the additional conditions).

209

As used in this part V.B.1 of the release, the term “Covered Entity” refers to a security-based swap dealer located in the UK that does not have a prudential regulator.

One commenter recommended that the Commission consider denying substituted compliance for capital requirements on the basis that France's capital requirements do not produce comparable regulatory outcomes.

210

This commenter stated that “granting substituted compliance with multiple conditions intended to mimic the Commission's capital requirements would seem to undermine the entire point of substituted compliance in the first place; namely, protecting the stability of the U.S. financial system by allowing substituted compliance

only when

foreign regimes are comparable.”

211

210

Better Markets Letter at 7-8.

211

Better Markets Letter at 8 (emphasis in the original).

In describing the differences in the capital frameworks between the net liquid assets test and the Basel capital standard, this commenter highlighted the treatment of initial margin posted to a counterparty.

212

Specifically, the commenter stated that in France initial margin posted to a counterparty counts as capital for that entity, while in the U.S. initial margin only counts as capital if the security-based swap dealer has a special loan agreement with an affiliate. The commenter stated that the U.S. requirement is intended to mitigate counterparty credit risk with respect to the return of the initial margin. The commenter argued that the result is that, not only are the French requirements different from the Commission's in both form and substance, but the regulatory outcome is not comparable.

212

Better Markets Letter at 7-8.

This commenter also stated that if a positive substituted compliance determination is made regarding capital, the Commission should not weaken the potential additional capital condition discussed in the Reopening Release in response to industry commenters, because these market participants are primarily concerned with reducing their own operational costs, without any regard to the systemic risk that would doing so would pose.

213

This commenter also stated that any determination to find Frances's capital requirements comparable to and as comprehensive as the Commission's capital framework without conditions at least as strong as proposed would not only contravene the Commission's own conception of substituted compliance “but expose the U.S. financial system to very risks Dodd-Frank instructed the SEC to contain.”

214

213

Better Markets Letter at 7-8.

214

Better Markets Letter at 7-8.

Another commenter supported the potential capital condition.

215

This commenter stated that the Commission should require Covered Entities to

comply with the net liquid assets test under Exchange Act rule 18a-1, rather than the Basel capital standards.

216

The commenter stated that the net liquid assets test “appropriately limits uncollateralized lending, fixed assets, and other illiquid assets such as real estate which have been proven repeatedly to be unreliable forms of capital but are currently counted” as allowable capital under the Basel capital standard.

217

This commenter also agreed with the Commission that “the initial margin that is posted is not available for other purposes and therefore, under the Basel standard, could swiftly result in less balance sheet liquidity than the standards under the Exchange Act's Rule 18a-1.”

218

215

AFREF Letter at 1.

216

See id.

(“We support the Commission's proposal to require foreign security-based swap dealers and participants (“Covered Entities”) to abide by capital and initial margin requirements that reflect Exchange Act rule 18a-1 standards appropriate for broker-dealers, as opposed to Basel capital requirements for banks that permit illiquid assets to count toward capital minimums.”).

217

Id.

218

Id.

at 2.

A commenter supported the Commission's proposed Order to grant substituted compliance in connection with the Exchange Act capital requirements.

219

This commenter, however, opposed additional capital conditions.

220

The commenter reiterated this opposition with respect to the potential four pronged capital condition for which the Commission sought comment in the Reopening Release.

221

The commenter stated that the potential capital condition was unnecessary, unduly rushed, and highly likely to be costly and disruptive to market participants and inconsistent with the Commission's substituted compliance framework.

222

More specifically, this commenter stated that the potential capital conditions was unnecessary because Covered Entities transact predominantly in securities and derivatives, do not extensively

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