Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities; Republication

17 CFR Parts 240, 241, and 250

Application of ``Security-Based Swap Dealer'' and ``Major Security-

Based Swap Participant'' Definitions to Cross-Border Security-Based

Swap Activities; Final Rule; Republication

Federal Register / Vol. 79 , No. 155 / Tuesday, August 12, 2014 /

Rules and Regulations

[[Page 47278]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 241, and 250

[Release No. 34-72472; File No. S7-02-13]

RIN 3235-AL25

Application of ``Security-Based Swap Dealer'' and ``Major

Security-Based Swap Participant'' Definitions to Cross-Border Security-

Based Swap Activities; Republication

Editorial Note: Proposed rule document 2014-15337 was originally

published on pages 39067 through 39162 in the issue of Wednesday,

July 9, 2014. In that publication the footnotes contained erroneous

entries. The corrected document is republished in its entirety.

AGENCY: Securities and Exchange Commission.

ACTION: Final rules; interpretation.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or

``Commission'') is adopting rules and providing guidance to address the

application of certain provisions of the Securities Exchange Act of

1934 (``Exchange Act'') that were added by Subtitle B of Title VII of

the Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-

Frank Act''), to cross-border security-based swap activities. These

rules and guidance in large part focus on the application of the Title

VII definitions of ``security-based swap dealer'' and ``major security-

based swap participant'' in the cross-border context. The Commission

also is adopting a procedural rule related to the submission of

applications for substituted compliance. In addition, the Commission is

adopting a rule addressing the scope of our authority, with respect to

enforcement proceedings, under section 929P of the Dodd-Frank Act.

DATES: Effective September 8, 2014.

FOR FURTHER INFORMATION CONTACT: Richard Gabbert, Senior Special

Counsel, Joshua Kans, Senior Special Counsel, or Margaret Rubin,

Special Counsel, Office of Derivatives Policy, at 202-551-5870,

Division of Trading and Markets, Securities and Exchange Commission,

100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is adopting the following

rules under the Exchange Act, accompanied by related guidance,

regarding the application of Subtitle B of Title VII of the Dodd-Frank

Act to cross-border activities: Rule 0-13 (filing procedures regarding

substituted compliance requests); Rule 3a67-10 (regarding the cross-

border implementation of the ``major security-based swap participant''

definition); Rule 3a71-3 (regarding the cross-border implementation of

the de minimis exception to the ``security-based swap dealer''

definition); Rule 3a71-4 (regarding the cross-border implementation of

the aggregation provisions of the dealer de minimis exception); and

Rule 3a71-5 (regarding an exception, from the dealer de minimis

analysis, for certain cleared anonymous transactions). The Commission

is not addressing, as part of this release, certain other rules that we

proposed regarding the application of Subtitle B of Title VII in the

cross-border context. The Commission also is adopting Rule 250.1 to

clarify the scope of its antifraud civil law-enforcement authority,

with respect to enforcement proceedings, in the cross-border context.

Table of Contents

I. Background

A. Scope of This Rulemaking

B. The Dodd-Frank Act

C. The Cross-Border Proposing Release and the CFTC Cross-Border

Guidance

D. Comments on the Proposal

II. The Economic, Legal, and Policy Principles Guiding the

Commission's Approach to the Application of Title VII to Cross-

Border Activities

A. Economic Considerations in the Cross-Border Regulation of

Security-Based Swaps

1. Economic Features of the Security-Based Swap Market

2. Context for Regulatory Determinations

B. Scope of Title VII's Application to Cross-Border Security-

Based Swap Activity

1. Commenters' Views

2. Scope of Application of Title VII in the Cross-Border Context

C. Principles Guiding Final Approach To Applying ``Security-

Based Swap Dealer'' and ``Major Security-Based Swap Participant''

Definitions in the Cross-Border Context

III. Baseline

A. Current Security-Based Swap Market

1. Security-Based Swap Market Participants

2. Levels of Security-Based Swap Trading Activity

B. Global Regulatory Efforts

C. Cross-Market Participation

IV. Cross-Border Application of Dealer De Minimis Exception

A. Overview

B. Application of De Minimis Exception To Dealing Activities of

U.S. Persons

1. Proposed Approach and Commenters' Views

2. Final Rule

C. Definition of ``U.S. Person''

1. Proposed Approach

2. Commenters' Views

3. Final Rule

4. Representations Regarding U.S.-Person Status

D. Application of De Minimis Exception To Dealing Activities of

Conduit Affiliates

1. Proposed Approach and Commenters' Views

2. Final Rule

E. Application of De Minimis Exception To Dealing Activities of

Other Non-U.S. Persons

1. Dealing Transactions of Non-U.S. Persons That Are Subject to

Recourse Guarantees by Their U.S. Affiliates

2. Dealing Transactions of Non-U.S. Persons Involving U.S. and

Other Counterparties

F. Application of the Exception's Aggregation Principles to

Cross-Border Dealing Activity

1. Proposed Approach and Commenters' Views

2. Final Rule

G. Exception for Cleared Anonymous Transactions

1. Proposed Approach and Commenters' Views

2. Final Rule

H. Additional Issues

1. Particular Activities and Entities

2. Foreign Public Sector Financial Institutions and Government-

Related Entities

I. Economic Analysis of the Final Cross-Border Dealer De Minimis

Rule

1. Programmatic Costs and Benefits

2. Assessment Costs

3. Alternative Approaches

V. Cross-Border Application of Major Security-Based Swap Participant

Thresholds

A. Overview

B. Application of the Major Security-Based Swap Participant

Definition to U.S. Persons

1. Proposed Approach and Commenters' Views

2. Final Rule

C. Application of the Major Security-Based Swap Participant

Definition to Conduit Affiliates

1. Proposed Approach and Commenters' Views

2. Final Rule

D. Application to Other Non-U.S. Persons

1. Positions With U.S. Persons Other Than Foreign Branches of

U.S. Banks

2. Positions With Foreign Branches of U.S. Banks

3. Positions of Non-U.S. Persons That Are Subject to Recourse

Guarantees by a U.S. Person

E. Attribution

1. Positions Attributed to U.S. Person Guarantors

2. Positions Attributed to Non-U.S. Person Guarantors

3. Limited Circumstances Where Attribution of Guaranteed

Security-Based Swap Positions Does Not Apply

F. Other Issues Related to the Application of the Major

Security-Based Swap Participant Definition

1. Threshold for Registration as a Major Security-Based Swap

Participant

2. Entities That Maintain Legacy Portfolios

[[Page 47279]]

G. Foreign Public Sector Financial Institutions and Government-

Related Entities

H. Economic Analysis of Final Rules Regarding ``Major Security-

Based Swap Participants''

1. Programmatic Costs and Benefits

2. Assessment Costs

3. Alternative Approaches

VI. Substituted Compliance Procedural Rule

A. Proposed Approach and Commenters' Views

B. Final Rule

C. Economic Analysis

VII. Antifraud Authority

A. Final Rule

B. Economic Analysis

VIII. Impacts on Efficiency, Competition, and Capital Formation

A. Competition

B. Efficiency

C. Capital Formation

IX. Paperwork Reduction Act

A. Introduction

B. Reliance on Counterparty Representations Regarding

Transactions Conducted Through a Foreign Branch

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

C. Reliance on Counterparty Representations Regarding Non-U.S.

Person Status

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

X. Regulatory Flexibility Act Certification

XI. Effective Date and Implementation

Statutory Authority and Text of Final Rules

I. Background

A. Scope of This Rulemaking

The Commission is adopting the first of a series of rules and

providing guidance regarding the application of Title VII of the Dodd-

Frank Act \1\ (``Title VII'') to cross-border security-based swap

activities and persons engaged in those activities.\2\ This rulemaking

primarily focuses on the application of the de minimis exception to the

definition of ``security-based swap dealer'' in the cross-border

context, and on the application of thresholds related to the definition

of ``major security-based swap participant'' in the cross-border

context. We also are adopting a procedural rule regarding the

submission of ``substituted compliance'' requests to allow market

participants to satisfy certain Title VII obligations by complying with

comparable foreign regulatory requirements.\3\

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\1\ Public Law 111-203, 124 Stat. 1376 (2010). Unless otherwise

indicated, references to Title VII in this release are to Subtitle B

of Title VII.

\2\ Consistent with the scope of the final rules as discussed

below, the references in this release to the application of Title

VII to ``cross-border activities'' refer to security-based swap

transactions involving: (i) A U.S. person and a non-U.S. person, or

(ii) two non-U.S. persons conducting a security-based swap

transaction that otherwise occurs in relevant part within the United

States, including where performance of one or both counterparties

under the security-based swap are guaranteed by a U.S. person. For

purposes of this release only, ``cross-border activities'' do not

indicate activities involving a transaction between two non-U.S.

persons where one or both are conducting dealing activity within the

United States, because, as discussed below, we anticipate

considering this issue in a subsequent release.

\3\ The procedural rule addresses only the process for

submitting such substituted compliance requests to the Commission.

It does not address issues regarding whether substituted compliance

would be available in connection with particular regulatory

requirements, and, if so, under what conditions. We expect to

address those matters as part of later rulemakings.

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The rules and guidance we are adopting are based on our May 23,

2013 proposal, which addressed the application of Title VII in the

cross-border context.\4\ Aside from addressing the definitions and

procedural rule noted above, the Cross-Border Proposing Release also

addressed a range of other cross-border issues, including issues

regarding the requirements applicable to dealers and major

participants, and requirements relating to mandatory clearing, trade

execution, regulatory reporting, and public dissemination. The Cross-

Border Proposing Release stated that it was possible that we would

consider final rules and guidance related to some of those issues in

the adopting releases related to the relevant substantive rulemakings,

and that we would address others in a separate rulemaking.\5\

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\4\ See Cross-Border Security-Based Swap Activities; Re-Proposal

of Regulation SBSR and Certain Rules and Forms Relating to the

Registration of Security-Based Swap Dealers and Major Security-Based

Swap Participants, Exchange Act Release No. 69490 (May 1, 2013), 78

FR 30968 (May 23, 2013) (``Cross-Border Proposing Release'').

\5\ See id. at 30974.

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This rulemaking's focus on the cross-border application of the

dealer and major participant definitions reflects the critical and

foundational role that those definitions occupy with regard to the

implementation of Title VII.\6\ We expect to address other matters

raised by the Cross-Border Proposing Release as part of subsequent

rulemakings, to allow us to consider the cross-border application of

the substantive requirements imposed by Title VII--including the

economic consequences of that cross-border application--in conjunction

with the final rules that will implement those substantive

requirements.\7\ Market participants are not required to comply with

certain of those Title VII requirements pending the publication of

final rules or other Commission action, and temporarily are exempt from

having to comply with certain other requirements added by or arising

from Title VII.\8\

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\6\ This rulemaking does not address the requirements under

section 5 of the Securities Act applicable to security-based swap

transactions. Security-based swaps, as securities, are subject to

the provisions of the Securities Act of 1933 (15 U.S.C. 77a et seq.)

(``Securities Act'') and the rules and regulations thereunder

applicable to securities. The Securities Act requires that any offer

and sale of a security must either be registered under the

Securities Act (see section 5 of the Securities Act, 15 U.S.C. 77e)

or made pursuant to an exemption from registration (see, e.g.,

sections 3 and 4 of the Securities Act, 15 U.S.C. 77c and 77d,

respectively). In addition, the Securities Act requires that any

offer to sell, offer to buy or purchase, or purchase or sale of, a

security-based swap to any person who is not an eligible contract

participant must be registered under the Securities Act (see section

5(e) of the Securities Act, 15 U.S.C. 77e(e)). Because of the

statutory language of section 5(e) of the Securities Act, exemptions

from this requirement in sections 3 and 4 of the Securities Act are

not available.

\7\ Those subsequent rulemakings may make use of definitions of

``U.S. person'' and certain other terms that we are adopting today.

\8\ See Temporary Exemptions and Other Temporary Relief,

Together With Information on Compliance Dates for New Provisions of

the Securities Exchange Act of 1934 Applicable to Security-Based

Swaps, Exchange Act Release No. 64678 (Jun. 15, 2011), 76 FR 36287

(Jun. 22, 2011) (clarifying the compliance date for certain

requirements added by Title VII, and in some cases providing

temporary exemptive relief in connection with those requirements);

Order Extending Temporary Exemptions under the Securities Exchange

Act of 1934 in Connection with the Revision of the Definition of

``Security'' to Encompass Security-Based Swaps, and Request for

Comment, Exchange Act Release No. 71485 (Feb. 5, 2014), 79 FR 7731

(Feb. 10, 2014) (extending exemptive relief from certain Exchange

Act provisions in connection with Title VII's revision of the

Exchange Act definition of ``security'' to encompass security-based

swaps).

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These final rules and guidance do not address one key issue related

to the application of the ``security-based swap dealer'' definition in

the cross-border context. In the Cross-Border Proposing Release, we

proposed that non-U.S. persons must count, against the relevant

thresholds of the de minimis exemption, their dealing activity

involving ``transactions conducted within the United States.'' \9\

Commenters raised a number of significant issues related to this

proposed requirement, including issues regarding the Commission's

authority to impose this requirement and regarding the costs associated

with this requirement. While we continue to preliminarily believe that

the cross-border application of the security-based

[[Page 47280]]

swap dealer definition should account for activities in the United

States related to dealing--even when neither party to the transaction

is a U.S. person--we also believe that the final resolution of this

issue can benefit from further consideration and public comment.

Accordingly, we anticipate soliciting additional public comment

regarding approaches by which the cross-border application of the

dealer definition appropriately can reflect activity between two non-

U.S. persons where one or both are conducting dealing activity within

the United States.

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\9\ See proposed Exchange Act rule 3a71-3(b). The proposal

further would have defined a ``transaction conducted within the

United States'' to encompass transactions that are solicited,

executed, or booked within the United States by or on behalf of

either counterparty, regardless of either counterparty's location,

domicile or residence status, subject to an exception for

transactions conducted through the foreign branches of U.S. banks.

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

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B. The Dodd-Frank Act

As discussed in the Cross-Border Proposing Release, the 2008

financial crisis highlighted significant issues in the over-the-counter

(``OTC'') derivatives markets, which had experienced dramatic growth in

the years leading up to the crisis and are capable of affecting

significant sectors of the U.S. economy.\10\ The Dodd-Frank Act was

enacted, among other reasons, to promote the financial stability of the

United States by improving accountability and transparency in the

financial system, including in connection with swaps and security-based

swaps.\11\

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\10\ See generally Cross-Border Proposing Release, 78 FR 30972-

73.

\11\ See 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'').

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Title VII provides for a comprehensive new regulatory framework for

swaps and security-based swaps. Under this framework, the Commodity

Futures Trading Commission (``CFTC'') regulates ``swaps'' while the

Commission regulates ``security-based swaps,'' and the Commission and

CFTC jointly regulate ``mixed swaps.'' The new framework encompasses

the registration and comprehensive regulation of dealers and major

participants, as well as requirements related to clearing, trade

execution, regulatory reporting, and public dissemination.\12\

Security-based swap transactions are largely cross-border in

practice,\13\ and the various market participants and infrastructures

operate in a global market. To ensure that our regulatory framework

appropriately reflects and addresses the nature and extent of the

potential impact that the global market can have on U.S. persons and

the U.S. financial system, it is critically important that we provide

market participants with clear rules and guidance regarding how the

regulatory framework mandated by Title VII will apply in the cross-

border context.

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\12\ The Commission has proposed a series of rules regarding

these matters. See Cross-Border Proposing Release, 78 FR 30972

nn.11-18. Most recently, the Commission proposed rules governing

recordkeeping, reporting, and notification requirements for dealers

and major participants. See Exchange Act Release No. 71958 (Apr. 17,

2014), 79 FR 25194 (May 2, 2014).

The Dodd-Frank Act further provides that the SEC and CFTC

jointly should further define certain terms, including ``security-

based swap dealer'' and ``major security-based swap participant.''

See Dodd-Frank Act section 712(d). Pursuant to that requirement, the

SEC and CFTC jointly adopted rules to further define those terms.

See Further Definition of ``Swap Dealer,'' ``Security-Based Swap

Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap

Participant'' and ``Eligible Contract Participant,'' Exchange Act

Release No. 66868 (Apr. 27, 2012), 77 FR 30596 (May 23, 2012)

(``Intermediary Definitions Adopting Release''); see also Cross-

Border Proposing Release, 78 FR 30972 n.9 (discussing joint

rulemaking to further define various Title VII terms).

\13\ See section II.A, infra, regarding the preponderance of

cross-border activity in the security-based swap market.

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In developing these final rules and guidance, we have consulted and

coordinated with the CFTC, the prudential regulators,\14\ and foreign

regulatory authorities in accordance with the consultation provisions

of the Dodd-Frank Act,\15\ and more generally as part of our domestic

and international coordination efforts.\16\ Commission staff has

participated in numerous bilateral and multilateral discussions with

foreign regulatory authorities addressing the regulation of OTC

derivatives.\17\ Through these discussions and the Commission staff's

participation in various international task forces and working

groups,\18\ we have gathered information about foreign regulatory

reform efforts and the possibility of conflicts and gaps, as well as

inconsistencies and overlaps, between U.S. and foreign regulatory

regimes. We have taken this information into consideration in

developing the final rules and guidance.

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\14\ The term ``prudential regulator'' is defined in section

1a(39) of the CEA, 7 U.S.C. 1a(39), and that definition is

incorporated by reference in section 3(a)(74) of the Exchange Act,

15 U.S.C. 78c(a)(74). Pursuant to the definition, the Board of

Governors of the Federal Reserve System (``Federal Reserve Board''),

the Office of the Comptroller of the Currency, the Federal Deposit

Insurance Corporation, the Farm Credit Administration, or the

Federal Housing Finance Agency (collectively, the ``prudential

regulators'') is the ``prudential regulator'' of a security-based

swap dealer or major security-based swap participant if the entity

is directly supervised by that regulator.

\15\ Section 712(a)(2) of the Dodd-Frank Act provides in part

that the Commission shall ``consult and coordinate to the extent

possible with the Commodity Futures Trading Commission and the

prudential regulators for the purposes of assuring regulatory

consistency and comparability, to the extent possible.''

In addition, section 752(a) of the Dodd-Frank Act provides in

part that ``[i]n order to promote effective and consistent global

regulation of swaps and security-based swaps, the Commodity Futures

Trading Commission, the Securities and Exchange Commission, and the

prudential regulators . . . as appropriate, shall consult and

coordinate with foreign regulatory authorities on the establishment

of consistent international standards with respect to the regulation

(including fees) of swaps.''

\16\ In 2009, leaders of the Group of 20 (``G20'')--whose

membership includes the United States, 18 other countries, and the

European Union (``EU'')--called for global improvements in the

functioning, transparency, and regulatory oversight of OTC

derivatives markets. See G20 Leaders' Statement, Pittsburgh, United

States, September 24-25, 2009, available at: http://www.treasury.gov/resource-center/international/g7-g20/Documents/pittsburgh_summit_leaders_statement_250909.pdf. (``G20 Leaders'

Pittsburgh Statement'').

In subsequent summits, the G20 leaders have reiterated their

commitment to OTC derivatives regulatory reform. For example, in

September 2013, the leaders of the G20 reaffirmed their commitments

with respect to the regulation of the OTC derivatives markets,

welcoming Financial Stability Board (``FSB'') members' confirmed

actions and committed timetables to put the agreed OTC derivatives

reforms into practice. See the G20 Leaders Declaration (September

2013), para. 71, available at: https://www.g20.org/sites/default/files/g20_resources/library/Saint_Petersburg_Declaration_ENGpdf

(``G20 Leaders' St. Petersburg Declaration'').

\17\ Senior representatives of authorities with responsibility

for regulation of OTC derivatives have met on a number of occasions

to discuss international coordination of OTC derivatives

regulations. See, e.g., Report of the OTC Derivatives Regulators

Group (``ODRG'') on Cross-Border Implementation Issues March 2014

(Mar. 31, 2014), available at: http://www.cftc.gov/ucm/groups/public/@internationalaffairs/documents/file/odrgreport033114.pdf.

\18\ Commission representatives participate in the FSB's Working

Group on OTC Derivatives Regulation (``ODWG''), both on its own

behalf and as the representative of the International Organization

of Securities Commissions (``IOSCO''), which is co-chair of the

ODWG. A Commission representative also serves as one of the co-

chairs of the IOSCO Task Force on OTC Derivatives Regulation.

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C. The Cross-Border Proposing Release and the CFTC Cross-Border

Guidance

In expressing our preliminary views regarding the application of

Title VII to security-based swap activity carried out in the cross-

border context (including to persons engaged in such activities), the

Cross-Border Proposing Release recognized that the security-based swap

market is global in nature and that it developed prior to the enactment

of the Dodd-Frank Act.\19\ The proposal further recognized that the

rules we adopt and guidance we provide regarding the cross-border

application of Title VII could significantly affect the global

security-based swap market.\20\

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\19\ See Cross-Border Proposing Release, 78 FR 30975-76.

\20\ See id. at 30975.

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Reflecting the range of regulatory requirements that Title VII

imposes upon the security-based swap market,

[[Page 47281]]

the Cross-Border Proposing Release addressed the cross-border

application of: (a) The de minimis exception to the ``security-based

swap dealer'' definition; (b) the entity-level and transaction-level

requirements applicable to security-based swap dealers (e.g., margin,

capital, and business conduct requirements); (c) the ``substantial

position'' and ``substantial counterparty exposure'' thresholds for the

``major security-based swap participant'' definition and the

requirements applicable to major participants; (d) the registration of

security-based swap clearing agencies and mandatory clearing

requirements; (e) the registration of security-based swap execution

facilities and mandatory trade execution requirements; and (f) the

registration of security-based swap data repositories and regulatory

reporting and public dissemination requirements. The proposal also

addressed the potential for market participants to satisfy certain of

those Title VII requirements by complying with comparable foreign rules

as a substitute. This rulemaking establishes a process for submission

of such requests.

Following the Commission's proposal, the CFTC issued guidance

regarding Title VII's application to cross-border swap activity.\21\

The CFTC Cross-Border Guidance differed from the Commission's proposed

rules in certain ways, including, as discussed below, with regard to

the meaning of ``U.S. person,'' the cross-border application of the de

minimis exception to the dealer definition, the cross-border

application of the major participant definition, and the process for

submitting substituted compliance requests.\22\

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\21\ See ``Interpretive Guidance and Policy Statement Regarding

Compliance With Certain Swap Regulations'' (Jul. 17, 2013), 78 FR

45292 (Jul. 26, 2013) (``CFTC Cross-Border Guidance'').

\22\ The CFTC Cross-Border Guidance currently is subject to

legal challenge. See Complaint, Securities Indus. & Fin. Mkts.

Ass'n. v. CFTC, No. 1:13-cv-1916 (D.D.C. filed Dec. 4, 2013).

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Certain foreign regulators also have addressed or are in the

process of addressing issues related to the cross-border implementation

of requirements applicable to OTC derivatives.\23\

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\23\ See section III.B, infra.

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D. Comments on the Proposal

The Commission received 36 comments in connection with the

proposal.\24\ Several of the commenters addressed differences between

the SEC's proposed rules and the CFTC Cross-Border Guidance, and urged

the Commission to harmonize its rules with the approaches taken by the

CFTC and by foreign regulators.\25\

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\24\ The comment letters are located at: http://www.sec.gov/comments/s7-02-13/s70213.shtml. The majority of those commenters

addressed, at least in part, the definitional issues that are the

subject of this release. A number of commenters also addressed

aspects of the proposal that are outside the scope of this release,

and a few of those commenters only addressed issues that were

outside the scope of this release (for example, addressing only

proposed Regulation SBSR). We will consider those comments in

connection with the relevant rulemakings.

\25\ See, e.g., Managed Funds Assoc. and Alternative Investment

Management Assoc. (``MFA/AIMA'') Letter at 3 (``We recognize that

there are differences between the Commission's proposed approach and

the CFTC Cross-Border Guidance, and we expect that other

international regulators will similarly issue proposals related to

the cross-border application of their regulations. Thus, in light of

the global nature of the derivatives market, we urge continued

harmonization with the CFTC and other regulatory authorities with

respect to the extraterritorial scope of all these regimes. In

particular, we encourage international coordination of substituted

compliance regimes to ensure appropriate recognition of comparable

regulations, create practical and administrable frameworks, and

alleviate duplicative regulation.'' (footnotes omitted)). See also

letter from six members of the United States Senate at 2 (stating

that there should be no gaps or loopholes between the Commission's

and the CFTC's rules); Futures and Options Association (``FOA'')

Letter at 8 (urging the Commission and the CFTC ``to coordinate, to

the extent possible, on their approaches in order to minimise

distortions or other unintended consequences for market

participants''); letter from Senator Jeffrey A. Merkley, et al.,

Congress of the United States (Aug. 6, 2013).

Some commenters generally suggested that we harmonize with

aspects of the CFTC Cross-Border Guidance, but also expressed

preferences for particular elements of our proposed approach. See,

e.g., Institute of International Bankers (``IIB'') Letter at 3-4

(generally emphasizing the need for consistency with the CFTC and

European Securities and Markets Authority (``ESMA'') approaches,

unless the SEC requirement is more flexible than those other

requirements). One commenter took the view that the Commission's

rules should be at least as strong as the CFTC Cross-Border

Guidance, but should go further than the CFTC wherever necessary.

See Better Markets (``BM'') Letter. See also Chris Barnard Letter at

2 (recommending that the Commission and the CFTC propose one set of

rules applicable to cross-border activities to avoid duplicative and

conflicting rules).

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Many of those commenters particularly focused on differences

between the two regulators' meanings of the term ``U.S. person,'' with

several suggesting that we change our proposed definition to align with

the CFTC's approach.\26\ A number of commenters also addressed the

definition of ``transaction conducted within the United States,'' with

several opposing any use of the concept as part of the Commission's

rules.\27\

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\26\ See notes 192-224, infra, and accompanying text.

\27\ As noted above, these final rules and guidance do not

address the application of the ``transaction conducted within the

United States'' concept to the dealer definition. We instead

anticipate soliciting additional public comment regarding the issue.

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Commenters further raised a number of more general concerns in

connection with the proposal, including concerns regarding cost-benefit

issues,\28\ the clarity of the proposal as a whole,\29\ the link

between the rules and the location of the associated risk,\30\ and

perceived concessions to the financial industry.\31\

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\28\ For example, a few commenters took the view that cost-

benefit principles weighed in favor of consistency with the CFTC

Cross-Border Guidance. See Securities Industry and Financial Markets

Association/Futures Industry Association/Financial Services

Roundtable (``SIFMA/FIA/FSR'') Letter at 3; PensionsEurope Letter

(incorporating by reference SIFMA/FIA/FSR Letter; all references to

SIFMA/FIA/FSR Letter incorporate reference to PensionsEurope

Letter); IIB Letter at 2, 3. One commenter further took the view

that cost-benefit principles merited rejection of the use of the

``transaction conducted within the United States'' concept. See

SIFMA/FIA/FSR Letter at 3. See also Chris Barnard Letter at 2

(suggesting that there is insufficient administrative, legal, or

economic rationale for having ``very different rules'' of cross-

border application between the SEC and the CFTC); Coalition for

Derivatives End-Users (``CDEU'') Letter at 2 (stating that

conflicting regulatory regimes will result in increased compliance

and regulatory costs and an inefficient financial system);

Association of Financial Guaranty Insurers (``AFGI'') Letter, dated

August 20, 2013 (``AFGI Letter I'') at 2 (stating that the security-

based swap dealer and major security-based swap participant regime

would be disruptive and have financial consequences for guaranty

insurers and their counterparties who have legacy transactions with

a projected run-off date in the near future); AFGI letter, dated

July 22, 2013 (``AFGI Letter II'') at 4 (incorporated by reference

in AFGI Letter I); AFGI letter, dated February 15, 2013 (``AFGI

Letter III'') at 4 (incorporated by reference in AFGI Letter I).

One commenter conversely argued that, in lieu of cost-benefit

principles, the Commission instead should be guided by public

interest and investor protection principles, as well as the Dodd-

Frank Act's intent to increase financial system soundness and

prevent another financial crisis. See BM Letter at 4, 37-45

(stating, inter alia, that ``Congress passed the Dodd-Frank Act

knowing full well that it would impose significant costs on

industry, yet it determined those costs were not only justified but

necessary to stabilize our financial system and avoid another

financial crisis'').

One commenter challenged the adequacy--indeed, the existence--of

the cost-benefit analysis in the proposing release. See CDEU Letter

at 6 (``To better understand the negative effects of imposing

conflicting rules on the market, the SEC should conduct a direct

cost-benefit analysis of the conflicting rule regimes (e.g., with

the European Market Infrastructure Regulation and the CFTC's cross-

border guidance). Instead, the SEC asks the public to conduct such

an analysis for the SEC: `what would be the economic impact,

including the costs and benefits, of these differences on market

participants . . . ?' '').

\29\ See BM Letter at 2-3, 7-8; CDEU Letter at 5.

\30\ See Americans for Financial Reform (``AFR'') Letter, dated

August 22, 2013 (``AFR Letter I'') at 3-4 (criticizing the proposal

as having failed to apply the rules based on the geographic location

of the entity ultimately responsible for the resulting liabilities,

and stating that the rules should apply to transactions engaged in

by ``guaranteed foreign subsidiaries of U.S. entities'').

\31\ See BM Letter at 7-8 (stating that the proposal was the

result of unwarranted and inappropriate concessions, such as with

regard to the application of the de minimis threshold to U.S.-

guaranteed entities). See also Karim Shariff letter at 1 (stating

that the proposal will allow banks to take risks that will lead to

an economic collapse).

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In addition, commenters addressed issues specific to the cross-

border

[[Page 47282]]

application of the entity-level and transaction-level requirements for

dealers,\32\ as well as requirements specific to clearing, trade

execution, regulatory reporting and public disclosure.\33\ We expect to

address those comments regarding the relevant substantive requirements

in subsequent rulemakings and guidance regarding the relevant

substantive requirements.

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\32\ See, e.g., BM Letter at 3, 20-21, 28 (stating that

transactions conducted through foreign branches of U.S. dealers with

non-U.S. persons should be subject to external business conduct

requirements, and that margin should be treated as a transaction-

level requirement); SIFMA/FIA/FSR Letter at A-22 to A-26 (addressing

application of margin, segregation, external business conduct and

certain other requirements).

\33\ See, e.g., BM Letter at 3, 21-22 (criticizing exceptions

from mandatory clearing and trade execution requirements); SIFMA/

FIA/FSR Letter at A-38 to A-52 (in part urging that application of

regulatory reporting, public dissemination, trade execution and

clearing requirements should follow the same rules as external

business conduct requirements).

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Commenters also addressed the proposed availability of substituted

compliance.\34\ Although today we are adopting a procedural rule

regarding requests for substituted compliance, we generally expect to

address the potential availability of substituted compliance for

specific Title VII requirements in connection with subsequent

rulemakings regarding each substantive requirement.

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\34\ See, e.g., AFR Letter I at 8, 12 (opposing rationale for

substituted compliance, and noting need for the Commission to retain

discretion to find a lack of comparability based on substantive

enforcement issues); AFR letter to CFTC, dated August 27, 2012

(``AFR Letter II'') (stating that CFTC should narrow the scope of

substituted compliance) (incorporated by reference in AFR Letter I);

Michael Greenberger letter to CFTC, dated February 6, 2013 at 13

(``Greenberger Letter I'') (stating that substituted compliance

should be a last resort and that the CFTC regime be enforced

vigorously) (incorporated by reference in AFR Letter I); Michael

Greenberger letter to CFTC, dated August 27, 2012 at 8, 19-23

(``Greenberger Letter II'') (explaining that international comity

does not require that the CFTC exempt foreign subsidiaries from

compliance with U.S. financial regulation) (incorporated by

reference in AFR Letter I); BM Letter at 3, 26-27 (questioning

authority for substituted compliance and suggesting potential for

loopholes; also stating that substituted compliance should not be

allowed for transactions with U.S. persons or for transactions in

the United States and urging limited use of exemptive authority;

further stating that the proposal gave only passing reference to

foreign supervision and enforcement); SIFMA/FIA/FSR Letter at A-30

to A-38 (in part supporting the approach to focus on similar

regulatory objectives rather than requiring foreign rules to be

identical, stating that foreign branches should be able to make use

of substituted compliance for certain purposes, stating that

variations in foreign supervisory practices should not be assumed to

be defects, and requesting further clarity regarding substituted

compliance assessment factors); ESMA Letter at 1, 3-4 (suggesting

particular expansions of the proposed scope of substituted

compliance); European Commission (``EC'') Letter (supporting

``holistic'' approach toward substituted compliance based on

comparison of regulatory outcomes).

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We have carefully considered the comments received in adopting the

final rules and providing guidance. Our final rules and guidance

further reflect consultation with the CFTC, prudential regulators, and

foreign regulatory authorities with regard to the development of

consistent and comparable standards. Accordingly, certain aspects of

the final rules and guidance--such as, for example, the treatment of

guaranteed affiliates of U.S. persons for purposes of the dealer de

minimis exception--have been modified from the proposal.\35\

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\35\ In this regard, the final rules in a number of areas take

approaches that are similar to the approaches taken by the CFTC in

its own cross-border guidance, although independent considerations

have driven our approaches. Moreover, throughout the Cross-Border

Proposing Release we recognized and solicited comment on the

differences between our proposal and the CFTC's proposed guidance on

the cross-border application of swap regulation. As noted above,

many commenters urged harmonization with various aspects of the

CFTC's guidance. We have taken these comments into account, and in

developing final rules we have carefully considered the CFTC's

guidance and the underlying policy rationales. Further, where we

have determined such policy rationales and approaches are applicable

in the context of the market for security-based swaps, we have

adopted similar approaches to the CFTC (see, e.g., application of

the de minimis exception to non-U.S. persons' dealing transactions

with foreign branches of U.S. banks).

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II. The Economic, Legal, and Policy Principles Guiding the Commission's

Approach to the Application of Title VII to Cross-Border Activities

In this section, we describe the most significant economic

considerations regarding the security-based swap market that we have

taken into account in implementing the cross-border application of the

security-based swap dealer and major security-based swap participant

definitions of Title VII. We are sensitive to the economic consequences

and effects, including costs and benefits, of our rules, including with

respect to the scope of our application of the security-based swap

dealer and major security-based swap participant definitions in the

cross-border context. We have taken into consideration the costs and

benefits associated with persons being brought within one of these

definitions through our cross-border application, as well as the costs

market participants may incur in determining whether they are within

the scope of these definitions and thus subject to Title VII, while

recognizing that the ultimate economic impact of these definitions will

be determined in part by the final rules regarding the substantive

requirements applicable to security-based swap dealers and major

security-based swap participants. Some of these economic consequences

and effects stem from statutory mandates, while others result from the

discretion we exercise in implementing the mandates.

A. Economic Considerations in the Cross-Border Regulation of Security-

Based Swaps

1. Economic Features of the Security-Based Swap Market

As noted above, the cross-border implementation of the rules

defining security-based swap dealer and major security-based swap

participant is the first in a series of final rules that consider the

cross-border implications of security-based swaps and Title VII. In

determining how Title VII security-based swap dealer and major

security-based swap participant definitions should apply to persons and

transactions in the cross-border context, the Commission has been

informed by our analysis of current market activity, including the

extent of cross-border trading activity in the security-based swap

market. Several key features of the market inform our analysis.

First, the security-based swap market is a global market. Security-

based swap business currently takes place across national borders, with

agreements negotiated and executed between counterparties often in

different jurisdictions (and at times booked, managed, and hedged in

still other jurisdictions). The global nature of the security-based

swap market is evidenced by the data available to the Commission.\36\

Based on market data in the Depository Trust and Clearing Corporation's

Trade Information Warehouse (``DTCC-TIW''),\37\ viewed from the

perspective of the domiciles of the counterparties booking credit

default swap (``CDS'') transactions, approximately 48 percent of price

forming North American corporate single-name CDS transactions \38\ from

[[Page 47283]]

January 2008 to December 2012 were cross-border transactions between a

U.S.-domiciled \39\ counterparty and a foreign-domiciled counterparty

\40\ and an additional 39 percent of such CDS transactions were between

two foreign-domiciled counterparties.\41\ Thus, approximately 13

percent of the North American corporate single-name CDS transactions in

2008-2012 were between two U.S.-domiciled counterparties.\42\ These

statistics indicate that, rather than being an exception, cross-border

North American corporate single-name CDS transactions are as common as

intra-jurisdictional transactions in the security-based swap

market.\43\

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\36\ See section III.A.2, infra (discussing in detail the global

nature of the security-based swap market).

\37\ The information was made available to the Commission under

an agreement with the DTCC-TIW and in accordance with guidance

provided to DTCC-TIW by the OTC Derivatives Regulatory Forum

(``ODRF'').

\38\ This figure is based on all price-forming DTCC-TIW North

American corporate single-name CDS transactions. Price-forming

transactions include all new transactions, assignments,

modifications to increase the notional amounts of previously

executed transactions, and terminations of previously executed

transactions. Transactions terminated, transactions entered into in

connection with a compression exercise, and expiration of contracts

at maturity are not considered price-forming and are therefore

excluded, as are replacement trades and all bookkeeping-related

trades.

``North American corporate single-name CDS transactions'' are

classified as such because they use The International Swaps and

Derivatives Association, Inc. (``ISDA'') North American

documentation. These may include certain transactions involving non-

U.S. reference entities. We do not have sufficiently reliable data

on reference entity domicile (as opposed to counterparty domicile,

which we have sought to identify in the manner described in note 39,

infra) to limit our analysis to only U.S. single-name CDS. Although

the inclusion of transactions involving such non-U.S. reference

entities introduces some noise into the data, we do not believe that

this noise is sufficiently significant to alter the conclusions we

draw from the data.

\39\ The domicile classifications in DTCC-TIW are based on the

market participants' own reporting and have not been verified by

Commission staff. Prior to enactment of the Dodd-Frank Act, funds

and accounts did not formally report their domicile to DTCC-TIW

because there was no systematic requirement to do so. After

enactment of the Dodd-Frank Act, the DTCC-TIW has collected the

registered office location of the account or fund. This information

is self-reported on a voluntary basis. It is possible that some

market participants may misclassify their domicile status because

the databases in DTCC-TIW do not assign a unique legal entity

identifier to each separate entity. It is also possible that the

domicile classifications may not correspond precisely to treatment

as a U.S. person under the rules adopted today. Notwithstanding

these limitations, we believe that the cross-border and foreign

activity presented in the analysis by the Commission's Division of

Economic and Risk Analysis demonstrates the nature of the single-

name CDS market. See section III.A.2, infra.

\40\ DTCC-TIW classifies a foreign branch or foreign subsidiary

of a U.S.-domiciled entity as foreign-domiciled. Therefore, CDS

transactions classified as involving a foreign-domiciled

counterparty in the DTCC-TIW data may include CDS transactions with

a foreign branch or foreign subsidiary of a U.S.-domiciled entity as

counterparty.

\41\ Put another way, between 2008 and 2012, a vast majority

(approximately 87 percent) of North American corporate single-name

CDS transactions directly involved at least one foreign-domiciled

counterparty. This observation is based on the data compiled by the

Commission's Division of Economic and Risk Analysis on North

American corporate single-name CDS transactions from DTCC-TIW

between January 1, 2008, and December 31, 2012. See section III.A.2,

infra.

\42\ See id.

\43\ We note, however, that, in addition to classifying

transactions between a U.S. counterparty and a foreign branch of a

U.S. bank as cross-border transactions, see note 40, supra, these

statistics characterize as cross-border transactions some

transactions in which all or substantially all of the activity takes

place in the United States and all or much of the risk of the

transactions ultimately is borne by U.S. persons. That is, a

transaction is classified as cross-border if the legal domicile of

at least one of the counterparties to the transaction is outside the

United States, but if the transaction is classified as cross-border

solely on the basis of legal domicile, the risk associated with

these transactions may still ultimately be borne by U.S. persons. In

this sense, our estimates of the cross-border allocation of

security-based swap activity may not precisely reflect the

proportion of transactions that are cross-border in nature.

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Second, dealers and other market participants are highly

interconnected within this global market. While most market

participants have only a few counterparties, dealers can have hundreds

of counterparties, consisting of both non-dealing market participants

(e.g., non-dealers, including commercial and financial market

participants and investment funds) and other dealers.\44\ Furthermore,

as described in more detail below, the great majority of trades are

dealer-to-dealer, rather than dealer-to-non-dealer or non-dealer-to-

non-dealer, and a large fraction of single-name CDS volume is between

counterparties domiciled in different jurisdictions. This

interconnectedness facilitates the use of security-based swaps as a

tool for sharing financial and commercial risks. In an environment in

which market participants can have diverse and offsetting risk

exposures, security-based swap transactions can allow participants to

transfer risks so that they are borne by those who can do so

efficiently. The global scale of the security-based swap market allows

counterparties to access liquidity across jurisdictional boundaries,

providing U.S. market participants with opportunities to share these

risks with counterparties around the world. As discussed further in

section VIII, a broad set of counterparties across which risks can be

shared may result in more efficient risk sharing.

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\44\ Based on an analysis of 2012 transaction data by staff in

the Division of Economic and Risk Analysis, accounts associated with

market participants recognized by ISDA as dealers had on average 403

counterparties. All other accounts (i.e., those more likely to

belong to non-dealers) averaged four counterparties.

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However, these opportunities for international risk sharing also

represent channels for risk transmission. In other words, the

interconnectedness of security-based swap market participants provides

paths for liquidity and risk to flow throughout the system, so that it

can be difficult to isolate risks to a particular entity or geographic

segment. Because dealers facilitate the great majority of security-

based swap transactions, with bilateral relationships that extend to

potentially hundreds of counterparties, liquidity problems or other

forms of financial distress that begin in one entity or one corner of

the globe can potentially spread throughout the network, with dealers

as a central conduit.

Third, as highlighted in the Intermediary Definitions Adopting

Release, dealing activity within the market for security-based swaps is

highly concentrated.\45\ This concentration in large part appears to

reflect the fact that larger entities possess competitive advantages in

engaging in OTC security-based swap dealing activities, particularly

with regard to having sufficient financial resources to provide

potential counterparties with adequate assurances of financial

performance.

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\45\ See Intermediary Definitions Adopting Release, 77 FR 30639-

42.

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The security-based swap market developed as an OTC market, without

centralized trading venues or dissemination of pre- or post-trade

pricing and volume information. In markets without transparent pricing,

access to information confers a competitive advantage. In the current

security-based swap market, large dealers and other large market

participants with a large share of order flow have an informational

advantage over smaller dealers and non-dealers who, in the absence of

pre-trade transparency, observe a smaller subset of the market. Greater

private information about order flow enables better assessment of

current market values by dealers, permitting them to extract economic

rents from counterparties who are less informed.\46\ Non-dealers are

aware of this information asymmetry, and certain non-dealers--

particularly larger entities who transact with many dealers--may be

able to obtain access to competitive pricing or otherwise demand a

price discount that reflects the information asymmetry. Typically,

however, the value of private information (i.e., the economic rent or

informational premium) will be earned by those who have the most

information. In the case of security-based swap markets, it is

predominantly dealers who observe the greatest order flow and benefit

from market opacity.

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\46\ In this situation, economic rents are the profits that

dealers earn by trading with counterparties who are less informed.

In a market with competitive access to information, there is no

informational premium; dealers only earn a liquidity premium. The

difference between the competitive liquidity premium and the actual

profits that dealers earn is the economic rent.

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[[Page 47284]]

Taken together, the need for financial resources and the private

information conveyed by order flow suggest that new entrants who intend

to engage in security-based swap dealing activity in fact face high

barriers to entry. One consequence of the current concentrated market

structure is the potential for risk spillovers and contagion, which can

occur when the financial sector as a whole (or certain key segments)

becomes undercapitalized.\47\ Unlike most other securities

transactions, a security-based swap gives rise to ongoing obligations

between transaction counterparties during the life of the transaction.

This means that each counterparty to the transaction undertakes the

obligation to perform the security-based swap in accordance with its

terms and bears counterparty credit risk and market risk until the

transaction expires or is terminated.\48\ Within this interconnected

market, participants may have ongoing bilateral obligations with

multiple counterparties, allowing for efficient risk-sharing and access

to liquidity throughout the global network. However, a primary risk of

the integrated market is the potential for sequential counterparty

failure and contagion when one or more large market participants become

financially distressed, causing the market participant to default on

its obligations to its counterparties.\49\ A default by one or more

security-based swap dealers or major security-based swap participants,

or even the perceived lack of creditworthiness of these large entities,

could produce contagion, either through direct defaults and risk

spillovers, reduced willingness to extend credit, reduced liquidity, or

reduced valuations for financial instruments. As financial distress

spreads, the aggregate financial system may become undercapitalized,

hindering its ability to provide financial intermediation services,

including security-based swap intermediation services.

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\47\ See Viral V. Acharya, Lasse H. Pedersen, Thomas Philippon,

and Matthew Richardson, ``Measuring Systemic Risk'' (May 2010),

available at: http://vlab.stern.nyu.edu/public/static/SR-v3.pdf. The

authors use a theoretical model of the banking sector to show that,

unless the external costs of their trades are considered, financial

institutions will have an incentive to take risks that are borne by

the aggregate financial sector. Under this theory, in the context of

Title VII, the relevant external cost is the potential for risk

spillovers and sequential counterparty failure, leading to an

aggregate capital shortfall and breakdown of financial

intermediation in the financial sector.

\48\ See Intermediary Definitions Adopting Release, 77 FR 30616-

17 (noting that ``the completion of a purchase or sale transaction''

in the secondary equity or debt markets ``can be expected to

terminate the mutual obligations of the parties,'' unlike security-

based swap transactions, which often give rise to ``an ongoing

obligation to exchange cash flows over the life of the agreement'').

\49\ See Brunnermeier, Markus K., Andrew Crockett, Charles A.

Goodhart, Avinash Persaud, and Hyun Song Shin. ``The Fundamental

Principles of Financial Regulation.'' (2009) at 15, available at:

www.princeton.edu/~markus/research/papers/Geneva11.pdf.

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In other words, the failure of a single large firm active in the

security-based swap market can have consequences beyond the firm

itself. One firm's default may reduce the willingness of dealers to

trade with, or extend credit to, both non-dealers and other dealers. By

reducing the availability of sufficient credit to provide

intermediation services, and by reducing transaction volume that

reveals information about underlying asset values, the effects of a

dealer default may, through asset price and liquidity channels, spill

over into other jurisdictions and even other markets in which security-

based swap dealers participate.

Given that firms may be expected to consider the implications of

security-based swap activity only on their own operations, without

considering aggregate financial sector risk,\50\ the financial system

may end up bearing more risk than the aggregate capital of the

intermediaries in the system can support and may cease to function

normally during times of market distress. For example, during times of

financial distress a dealer's leverage constraints may begin to bind,

either because lenders require more collateral or because market

declines erode a dealer's capital position, forcing the dealer to de-

lever, either by selling assets or raising additional capital. Without

adequate capital, the dealer may be unable to intermediate trades,

potentially reducing liquidity in the markets it serves. Security-based

swap positions replicate leveraged positions in the underlying asset,

with a small amount of capital supporting large notional exposures.\51\

Given the leveraged nature of swap transactions, and the concentrated

structure of the dealer market, in which a large amount of highly

leveraged risk exposures may be concentrated in a relatively small

number of entities that are responsible for the vast majority of global

dealing activity,\52\ the potential consequences arising from financial

instability in the security-based swap market may be acute.

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\50\ See Daron Acemoglu, Asuman Ozdaglar & Alireza Tahbaz-

Salehi, Systemic Risk and Stability in Financial Networks (NBER

Working Paper No. 18727, Jan. 2013), available at: http://www.nber.org/papers/w18727.

\51\ See Giulio Girardi, Craig Lewis, and Mila Getmansky,

``Interconnectedness in the CDS Market,'' Division of Economic and

Risk Analysis White Paper, April 2014, available at http://www.sec.gov/servlet/sec/dera/staff-papers/white-papers/credit-defaul-swaps-interconnectivity-04-2014.pdf (describing institutional

features of credit default swaps).

\52\ The Commission estimates that, of approximately 1,000

transacting agents that participated in single-name CDS transactions

in 2012, nearly 80 percent of transactions, by notional volume, can

be attributed to the 13 largest entities. See also section III.A.2,

infra.

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In sum, the security-based swap market is characterized by a high

level of interconnectedness, facilitating risk sharing by

counterparties. Further, it is a global market, in which the potential

for significant inter-jurisdictional activity and access to liquidity

may enhance risk sharing among counterparties. At the same time,

channels for risk sharing also represent channels for risk

transmission. The global nature of this market, combined with the

interconnectedness of market participants, means that liquidity

shortfalls or risks that begin pooling in one corner of the market can

potentially spread beyond that corner to the entire security-based swap

market, with dealers as a key conduit. Because dealers and major

participants are a large subset of all participants in the global

security-based swap market and facilitate the majority of transactions

(and thus reach many counterparties), concerns surrounding these types

of spillovers are part of the framework in which we analyze the

economic effects of our final rules implementing the security-based

swap dealer and major participant definitions in the cross-border

context.\53\

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\53\ We have previously noted that, depending on the size of the

security-based swap dealer, default by a security-based swap dealer

``could have adverse spillover or contagion effects that could

create instability for the financial markets more generally.'' See

Capital, Margin, and Segregation Requirements for Security-Based

Swap Dealers and Major Security-Based Swap Participants and Capital

Requirements for Broker-Dealers, Exchange Act Release No. 68071

(Oct. 18, 2012), 77 FR 70214, 70304 (Nov. 23, 2012) (``Capital and

Margin Proposing Release'').

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2. Context for Regulatory Determinations

In determining how Title VII requirements should apply to persons

and transactions in a market characterized by the types of risks we

have described, we are aware of the potentially significant tradeoffs

inherent in our policy decisions. Our primary economic considerations

for promulgating rules and guidance regarding the application of the

security-based swap dealer and major participant definitions to cross-

border activities include the effect of our choices on efficiency,

competition, and

[[Page 47285]]

capital formation,\54\ the potential risks of security-based swaps to

U.S. market participants that could affect financial stability,\55\ the

level of transparency and counterparty protection in the security-based

swap market, and the costs to market participants.\56\

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\54\ See Exchange Act section 3(f).

\55\ Title VII imposes financial responsibility and risk

mitigation requirements on registered security-based swap dealers

and major security-based swap participants. As we noted in proposing

rules regarding capital and margin requirements applicable to

security-based swap dealers, ``the capital and margin requirements

in particular are broadly intended to work in tandem to strengthen

the financial system by reducing the potential for default to an

acceptable level and limiting the amount of leverage that can be

employed by [security-based swap dealers] and other market

participants.'' See Capital and Margin Proposing Release, 77 FR

70304. We also noted that ``[r]equiring particular firms to hold

more capital or exchange more margin may reduce the risk of default

by one or more market participants and reduce the amount of leverage

employed in the system generally, which in turn may have a number of

important benefits.'' Id.

\56\ As we noted in the Cross-Border Proposing Release, the

Commission generally understands the ``U.S. financial system'' to

include the U.S. banking system and the U.S. financial markets,

including the U.S. security-based swap market, the traditional

securities markets (e.g., the debt and equity markets), and the

markets for other financial activities (e.g., lending). See Cross-

Border Proposing Release, 78 FR 30980 n.97.

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As noted above, participants may use security-based swaps to manage

financial and commercial risks and benefit from a liquid market with

broad participation that facilitates risk sharing. We also recognize

the possibility that the same channels that enable risk sharing also

facilitate the transmission of risks and liquidity problems that begin

pooling in one geographic segment of the market to the global security-

based swap market. As described more fully in section III.A.1, U.S.

entities may take on risk exposures in the security-based swap market

by transacting with non-U.S. counterparties through non-U.S.

affiliates. This suggests that an approach that applied these Title VII

definitions to transactions only where all activity occurs inside the

United States would have little effect in addressing the risks

associated with security-based swaps, including risks and associated

economic consequences flowing from contagion that may originate abroad

and reach U.S. market participants through security-based swap

activities and the multiple bilateral relationships that may form as a

result of those activities. The global reach of security-based swap

dealers, including U.S. dealers, participating in the vast majority of

trades \57\ and extending to upwards of hundreds of counterparties,\58\

provides paths for these risks to flow back into the United States.\59\

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\57\ See note 139, infra, and accompanying text.

\58\ See note 44, supra.

\59\ As discussed above, the global security-based swaps

network, characterized by multiple bilateral relationships between

counterparties, has the potential for risk spillovers and sequential

counterparty failure. These exposures are not unique to the U.S.

financial system. Indeed, the global scope of the security-based

swap market suggests that, given our territorial approach to Title

VII, there will be the fewest potential gaps in coverage if other

jurisdictions also adopt similar comprehensive and comparable

derivative regulations. See Section III.B for a discussion of global

regulatory efforts in this space.

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At the same time, the Commission recognizes that the regulatory

requirements we adopt for security-based swap dealers and major

participants under Title VII may not reach all market participants that

act as dealers or that have positions that pose considerable risk

concerns in the global security-based swap markets. These limits to the

application of Title VII raise several issues. First, market

participants may shift their behavior. Final Title VII requirements may

impose significant direct costs on participants falling within the

security-based swap dealer and major security-based swap participant

definitions that are not borne by other market participants, including

costs related to capital and margin requirements, regulatory reporting

requirements, and business conduct requirements. The costs of these

requirements may provide economic incentive for some market

participants falling within the dealer and major participant

definitions to restructure their security-based swap business to seek

to operate wholly outside of the Title VII regulatory framework by

exiting the security-based swap market in the United States and not

transacting with U.S. persons, potentially fragmenting liquidity across

geographic boundaries.\60\ Conversely, such incentives potentially may

be mitigated by the fact that capital and margin requirements,

counterparty protections, and business conduct standards required by

Title VII \61\ may promote financial stability and lead to non-dealer

market participants exhibiting a preference for transacting with

registered dealers and major participants.

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\60\ To the extent that registered dealers are ultimately

subject to more extensive reporting and public dissemination

requirements than other market participants under Title VII, these

requirements may also alter the incentives of market participants to

transact with registered dealers if, for example, public

dissemination requirements reveal information that participants wish

to treat as confidential about trading strategies or future hedging

needs. Incentives for these participants to avoid registered dealers

could potentially isolate liquidity to less transparent corners of

the market.

\61\ See, e.g., Exchange Act sections 15F(e), (f), (h)

(providing that security-based swap dealers and major security-based

swap participants be subject to requirements relating to capital and

margin, reporting and recordkeeping, and business conduct).

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Second, to the extent that other jurisdictions may adopt

requirements with different scopes or on different timelines, the

requirements we adopt may also result in competitive distortions. That

is, differences in regulatory requirements across jurisdictions, or the

ability of certain non-U.S. market participants to avoid security-based

swap dealer regulation under Title VII, may generate competitive

burdens and provide incentives for non-U.S. persons to avoid

transacting with U.S. persons.

Third, key elements of the rules adopted today--the definition of

``U.S. person,'' as well as rules covering treatment of guaranteed

transactions, transactions with foreign branches, transactions

conducted through conduit affiliates, and cleared anonymous

transactions, and rules covering aggregation standards--all have

implications for how U.S. and non-U.S. entities perform their de

minimis and major participant threshold calculations and may affect the

number of participants who ultimately register as security-based swap

dealers or major security-based swap participants. The number of

persons required to register will affect the costs and benefits of the

substantive Title VII requirements that will ultimately be adopted;

depending on the final rules, more or fewer entities, and therefore

more or fewer security-based swaps, will be subject to Title VII

requirements applicable to security-based swap dealers and major

security-based swap participants.\62\ Title VII requires the Commission

to create a new regulatory regime that includes capital, margin,

registration and reporting requirements aimed at increasing

transparency and customer protections as well as mitigating the risk of

financial contagion. Each of these requirements will impose new costs

and regulatory burdens on persons that engage in security-based swap

dealing activity at levels above the de minimis thresholds and on

persons whose security-based swap positions are large enough to cause

them to be major security-based swap participants.

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\62\ Any forward-looking analysis of the costs and benefits that

flow from these Title VII requirements necessarily encompasses

uncertain elements, since the final requirements have not been

adopted. For example, whether foreign security-based swap dealers

will be subject to the full range of Title VII requirements in all

of their transactions will be determined in subsequent rulemaking.

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We expect that these requirements' application to security-based

swap

[[Page 47286]]

dealers and major security-based swap participants subject to Title VII

will be associated with a number of benefits to the security-based swap

market and security-based swap market participants, including

transparency, accountability, and increased counterparty

protections.\63\ Nevertheless, as we discuss later in this release, the

de minimis rules for non-U.S. persons could allow certain non-U.S.

entities to avoid the costs of dealer registration, which could reduce

the number of entities that register as security-based swap dealers,

relative to the Commission's estimates in the Intermediary Definitions

Adopting Release. Although the number of entities that are not required

to register will depend on the availability of the de minimis

exclusions, we believe that, to the extent that the final rules change

the number of eventual registrants, the ultimate programmatic costs and

benefits expected from Title VII may differ from those that were

described in the Intermediary Definitions Adopting Release.\64\

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\63\ Title VII imposes a number of business conduct requirements

designed to protect counterparties to security-based swaps,

including disclosures about material risks and conflicts of

interest, disclosures concerning the daily mark, or value of the

position, and segregation of customer assets and collateral from the

dealer's assets.

\64\ See section IV.I.1 for a discussion of how we expect the

cross-border application of the de minimis exception to alter the

number of entities required to register with the Commission, and how

that may affect the programmatic costs and benefits of Title VII.

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Finally, the final rules determining how non-U.S. persons must

perform their de minimis and major participant threshold calculations

may face limits as to how precisely they address the risk mitigation

goals of Title VII that are reflected in our rules implementing the de

minimis exception and the ``major security-based swap participant''

definition. On the one hand, the scope of dealer and major participant

regulation under Title VII may be subject to limitations on the ability

to control risk because the global nature of counterparty

interconnections means that it is difficult to prevent risk that pools

in one geographic segment of the market from flowing throughout the

entire security-based swap network. On the other hand, there is a

possibility that the rules defining the scope of dealer and major

participant regulation, including the territorial application of the

definitions, may capture certain activity that does not represent risk

to the U.S. financial system. Because these rules and guidance

implementing Title VII regulatory definitions will not capture all

transactions and all entities that engage in security-based swap

activity, these rules and guidance therefore may create incentives for

those entities at the boundaries of the definitions to restructure

their business in a way that allows them to operate outside the scope

of Title VII. However, as we described in the Intermediary Definitions

Adopting Release, we have sought to implement the statutory dealer and

major participant definitions in such a way as to impose the

substantive rules of Title VII on those entities most likely to

contribute to those risks that Title VII is intended to address without

imposing unnecessary burdens on those who do not pose comparable risks

to the U.S. financial system.\65\

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\65\ In adopting the definition of ``security-based swap

dealer,'' we intended to determine the set of entities in the

security-based swap market for whom regulation ``is warranted due to

the nature of their interactions with counterparties, or is

warranted to promote market stability and transparency.'' See

Intermediary Definitions Adopting Release, 77 FR 30726. Similarly,

in adopting rules governing the ``major security-based swap

participant'' definition, we sought to impose regulations applicable

to major security-based swap participants in a way that reflects

``when it would be `prudent' that particular entities be subject to

monitoring, management and oversight of entities that may be

systemically important or may significantly impact the U.S.

financial system.'' See id. at 30666.

Future rulemakings that depend on these definitions are

intended to address the transparency, risk, and customer protection

goals of Title VII. For example, to further risk mitigation in the

security-based swap market, we explained that ``section 15F(e) of

the Exchange Act and related rules impose capital and margin

requirements on dealers and major participants, which will reduce

the financial risks of these institutions and contribute to the

stability of the security-based swap market in particular and the

U.S. financial system more generally.'' See id. at 30723.

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B. Scope of Title VII's Application to Cross-Border Security-Based Swap

Activity

Congress has given the Commission authority in Title VII to

implement a security-based swap regulatory framework to address the

potential effects of security-based swap activity on U.S. market

participants, the financial stability of the United States, on the

transparency of the U.S. financial system, and on the protection of

counterparties.\66\ The global nature of the security-based swap market

and the high proportion of cross-border transactions in that market

\67\ mean that much of this activity occurs at least in part outside

the United States and frequently involves persons that are

incorporated, organized, or established in a location outside the

United States.\68\ In light of these market realities, we noted in the

proposal that applying Title VII only to persons incorporated,

organized, or established within the United States or only to security-

based swap activity occurring entirely within the United States would

inappropriately exclude from regulation a majority of security-based

swap activity that involves U.S. persons or otherwise involves conduct

within the United States, even though such activity raises the types of

concerns that we believe Congress intended to address through Title

VII.\69\

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\66\ See note 11, supra. See also Pub. L. 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).

\67\ See section II.A, supra (noting that cross-border activity

accounts for the majority of security-based swaps involving U.S.

firms).

\68\ For example, a single financial firm engaged in dealing

activity may utilize two or more entities domiciled in different

countries to effectuate a single transaction with a counterparty

that may similarly use multiple entities domiciled in different

countries.

\69\ See Cross-Border Proposing Release, 78 FR 30984.

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Because some commenters had, prior to the proposal, argued that

section 30(c) of the Exchange Act limited our ability to reach certain

types of activity occurring at least in part outside the United

States,\70\ we discussed in some detail in the proposal our preliminary

views on the appropriate approach to determining whether certain

security-based swap activity that involves some conduct outside the

United States also occurs within the United States for purposes of

Title VII.\71\ In this subsection, we discuss comments received on this

question following publication of our proposal and explain our final

views--which remain largely unchanged from the proposal--on the proper

approach to determining whether cross-border security-based swap

activity occurs, in relevant part, within the United States.\72\ We

then briefly describe how this framework

[[Page 47287]]

applies to specific types of transactions relevant to the rules we are

adopting here.\73\

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\70\ See id. at 30983. Exchange Act section 30(c) was added to

the Act by Title VII and provides, among other things, that ``[n]o

provision of [Title VII] . . . shall apply to any person insofar as

such person transacts a business in security-based swaps without the

jurisdiction of the United States,'' unless that business is

transacted in contravention of rules prescribed to prevent evasion

of Title VII. See section 30(c) of the Exchange Act, 15 U.S.C.

78dd(c), added by section 772(b) of the Dodd-Frank Act.

\71\ See Cross-Border Proposing Release, 78 FR 30984-87.

\72\ We also interpret what it means for a person to ``transact

a business in security-based swaps without the jurisdiction of the

United States'' as set forth in Exchange Act section 30(c). 15

U.S.C. 78dd(c).

\73\ The following discussion does not reflect a comprehensive

analysis of the full range of transactions that may fall within our

territorial approach to application of Title VII or of the full

range of substantive requirements to which such transactions may be

subject under Title VII.

It is important to note that our approach to the application of

Title VII security-based swap dealer and major security-based swap

participant registration requirements does not limit, alter, or

address the cross-border reach or extraterritorial application of

any other provisions of the federal securities laws, including

Commission rules, regulations, interpretations, or guidance.

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1. Commenters' Views

Prior to our proposal, several commenters raised concerns about the

application of Title VII to security-based swap activity in the cross-

border context and specifically about the possibility that we would

impose Title VII requirements on ``extraterritorial'' conduct. We

received only a few comments on this issue in response to our

preliminary views set forth in the proposal, and these generally

focused on the application of section 30(c) of the Exchange Act to

specific types of activity that we proposed to subject to Title VII

rather than the proposed territorial framework more broadly.

One commenter expressed general agreement with our proposed

guidance.\74\ Three commenters suggested that textual differences

between section 30(c) of the Exchange Act and section 2(i) of the

Commodity Exchange Act (``CEA'') do not require the Commission to take

a different approach to application of Title VII to cross-border

security-based swap activity from that taken by the CFTC.\75\ Two

commenters expressed the view that section 30(c) of the Exchange Act,

considered in light of what they described as the risk-based focus of

Title VII, prohibited the Commission from imposing Title VII

requirements on transactions carried out within the United States but

booked in locations outside the United States.\76\ One commenter stated

that section 30(c) of the Exchange Act prevents us from imposing Title

VII requirements on transactions of guaranteed foreign affiliates of

U.S. persons.\77\ One commenter argued that section 30(c) prevents

application of Title VII to certain joint ventures.\78\

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\74\ See BM Letter at 6.

\75\ See IIB Letter at 4 (noting, inter alia, that section 712

of the Dodd-Frank Act requires consultation and coordination between

the SEC, CFTC, and prudential regulators, and arguing that

differences between Exchange Act section 30(c) and CEA section 2(i)

do not require the Commission to take an approach to regulation of

cross-border security-based swap activity that is ``fundamentally

different'' from that taken by the CFTC); SIFMA/FIA/FSR Letter at A-

4 to A-5 (stating that Exchange Act section 30(c) must be read to

harmonize with CFTC approach in light of congressional intent that

rules be harmonized); FOA Letter at 7 (referring to this element of

the SIFMA/FIA/FSR Letter). Section 2(i) of the CEA provides, inter

alia, that Title VII requirements will not apply to activities

outside the United States unless they ``have a direct and

significant connection with activities in, or effect on, commerce of

the United States.'' 7 U.S.C. 2(i). The CFTC Cross-Border Guidance

was adopted as an interpretation of this provision. See CFTC Cross-

Border Guidance, 78 FR 45295.

\76\ See SIFMA/FIA/FSR Letter at 4, A-4 to A-6 (acknowledging

that proposed application of Title VII to transactions conducted

within the United States between two non-U.S. persons is consistent

with Commission practice in traditional securities markets but

arguing that similar language in sections 30(b) and 30(c) of the

Exchange Act should be read differently, given the different nature

of security-based swap transactions and focus of Title VII on risk);

FOA Letter at 7 (referring to this element of the SIFMA/FIA/FSR

Letter). These commenters argue that we should focus on risks to the

U.S. financial system and the protection of U.S. counterparties, and

that neither concern is raised by transactions between two non-U.S.

persons that happen to occur within the United States. See SIFMA/

FIA/FSR Letter at A-5 to A-6. We continue to believe that this

argument does not account for the full range of concerns addressed

by Title VII, but, as discussed further below, we are not addressing

issues surrounding the proposed ``transaction conducted within the

United States'' definition in this release.

Because, as discussed above, we are not adopting ``transaction

conducted within the United States'' as part of the final rule, we

anticipate considering these comments in connection with soliciting

additional public comment.

\77\ See id. at A-11 (stating that a guarantee may not

necessarily import risk into the United States and thus creates ``no

nexus for purposes of [s]ection 30(c) of the Exchange Act'').

\78\ See Mitsubishi UFJ Financial Group (``MUFJ'') Letter at 4-5

(urging the Commission not to require both participants in a foreign

joint venture to aggregate the dealing transactions of the joint

venture for purposes of the dealer de minimis calculation).

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2. Scope of Application of Title VII in the Cross-Border Context

We continue to believe that a territorial approach to the

application of Title VII is appropriate. This approach, properly

understood, is grounded in the text of the relevant statutory

provisions and is designed to help ensure that our application of the

relevant provisions is consistent with the goals that the statute was

intended to achieve.

(a) Overview and General Approach

As in our proposal, our analysis begins with an examination of the

text of the statutory provision that imposes the relevant requirement.

The statutory language generally identifies the types of conduct that

trigger the relevant requirement and, by extension, the focus of the

statute.\79\ Once we have identified the activity regulated by the

statutory provision, we can determine whether a person is engaged in

conduct that the statutory provision regulates and whether this conduct

occurs within the United States. When the statutory text does not

describe the relevant activity with specificity or provides for further

Commission interpretation of statutory terms or requirements, this

analysis may require us to identify through interpretation of the

statutory text the specific activity that is relevant under the statute

or to incorporate prior interpretations of the relevant statutory

text.\80\

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\79\ See Morrison v. National Australia Bank, Ltd., 130 S. Ct.

2869, 2884 (2010) (identifying focus of statutory language to

determine what conduct was relevant in determining whether the

statute was being applied to domestic conduct).

Section 772(b) of the Dodd-Frank Act amends section 30 of the

Exchange Act to provide that ``[n]o provision of [Title VII] * * *

shall apply to any person insofar as such person transacts a

business in security-based swaps without the jurisdiction of the

United States,'' unless that business is transacted in contravention

of rules prescribed to prevent evasion of Title VII. See section

30(c) of the Exchange Act. As noted above, some commenters suggest

that statutory language requiring us to coordinate and consult with

the CFTC also requires us to interpret section 30(c) of the Exchange

Act in a manner similar to the CFTC's interpretation of CEA section

2(i). See note 75, supra. However, in light of the differences

between Exchange Act section 30(c) and CEA section 2(i), we do not

find this argument persuasive. As noted above, however, in

developing final rules we have carefully considered the CFTC's

guidance and the underlying policy rationales, consistent with the

statutory requirement that we consult and coordinate with the CFTC.

\80\ The Dodd-Frank Act provides that the CFTC and SEC ``shall

further define'' several terms, including ``security-based swap

dealer'' and ``major security-based swap participant.'' Dodd-Frank

Act section 712(d) (emphasis added). The Commissions fulfilled this

mandate in the Intermediary Definitions Adopting Release. See

Intermediary Definitions Adopting Release, 77 FR 30973.

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As noted above, the Dodd-Frank Act was enacted, in part, with the

intent to address the risks to the financial stability of the United

States posed by entities engaged in security-based swap activity, to

promote transparency in the U.S. financial system, and to protect

counterparties to such transactions.\81\ These purposes, considered

together with the specific statutory requirement, lead us to conclude

that it is appropriate to impose the statutory requirements, and rules

or regulations thereunder, on security-based swap activity occurring

within the United States even if certain conduct in connection with the

security-based swap also occurs in part outside the United States.

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\81\ See e.g., note 11, supra. See also Exchange Act section

15F(h) (establishing business conduct standards for security-based

swap dealers and major security-based swap participants).

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Contrary to the views expressed by some commenters,\82\ we do not

agree that the location of risk alone should necessarily determine the

scope of an appropriate territorial application of

[[Page 47288]]

every Title VII requirement, given that the definition and the relevant

regulatory regime address not only risk but other concerns as well, as

just described. For example, neither the statutory definition of

``security-based swap dealer,'' our subsequent further definition of

the term pursuant to section 712(d) of the Dodd-Frank Act, nor the

regulatory requirements applicable to security-based swap dealers focus

solely on risk to the U.S. financial system.\83\

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\82\ See notes 76-77, supra.

\83\ See note 88, infra, and accompanying text (describing

elements of statutory definition of ``security-based swap dealer'');

note 90, infra, and accompanying text (describing elements of the

further definition of ``security-based swap dealer'' adopted by the

Commission and the CFTC pursuant to section 712(d) of the Dodd-Frank

Act); Exchange Act section 15F(h) (establishing business conduct

standards for security-based swap dealers).

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We believe that this approach to territorial application of Title

VII provides a reasonable means of helping to ensure that our

regulatory framework focuses on security-based swap activity that is

most likely to raise the concerns that Congress intended to address in

Title VII, including the potential effects of security-based swap

activity on U.S. market participants, on the financial stability of the

United States, on the transparency of the U.S. financial markets, and

on the protection of counterparties.\84\ Persons that engage in

relevant conduct, as identified through this analysis, within the

United States are not, in our view, ``transact[ing] a business in

security-based swaps without the jurisdiction of the United States,''

\85\ and thus are properly subject to regulation under Title VII.

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\84\ See note 11, supra.

\85\ Exchange Act section 30(c).

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(b) Territorial Approach to Application of Title VII Security-Based

Swap Dealer Registration Requirements

In determining whether specific transactions should be included in

a person's dealer de minimis calculation, we begin by looking to the

statutory text to identify the type of dealing activity that the

statute describes as relevant to a person's status as a security-based

swap dealer.\86\ Section 3(a)(71) of the Exchange Act \87\ defines

security-based swap dealer as a person that engages in any of the

following types of activity:

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\86\ See Intermediary Definitions Adopting Release, 77 FR 30616-

30619 (further defining ``security-based swap dealer'' by

identifying the types of activities that characterize dealing and

that would therefore lead a transaction to be required to be

included in a person's de minimis calculation under Exchange Act

rule 3a71-2).

\87\ 15 U.S.C. 78c(a)(71).

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(i) Holding oneself out as a dealer in security-based swaps,

(ii) making a market in security-based swaps,

(iii) regularly entering into security-based swaps with

counterparties as an ordinary course of business for one's own account,

or

(iv) engaging in any activity causing oneself to be commonly known

in the trade as a dealer in security-based swaps.\88\

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\88\ Exchange Act section 3(a)(71)(A), 15 U.S.C. 78c(a)(71)(A).

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In accordance with the authority provided by section 712(d)(1) of

the Dodd-Frank Act, which provides that the CFTC and the Commission

shall by rule further define, among other things, ``security-based swap

dealer,'' \89\ we further interpreted the statutory definition by

identifying the types of activities that are relevant in determining

whether a person is a security-based swap dealer.\90\ Pursuant to this

further definition, indicia of security-based swap dealing activity

include any of the following activities:

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\89\ See Dodd-Frank Act section 712(d)(1).

\90\ See Intermediary Definitions Adopting Release, 77 FR 30617-

18.

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Providing liquidity to market professionals or other

persons in connection with security-based swaps;

seeking to profit by providing liquidity in connection

with security-based swaps,

providing advice in connection with security-based swaps

or structuring security-based swaps;

having a regular clientele and actively soliciting

clients;

using inter-dealer brokers; and

acting as a market maker on an organized security-based

swap exchange or trading system.\91\

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\91\ Id.

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As the foregoing lists illustrate, both the statutory text and our

interpretation further defining the statutory term include within the

security-based swap dealer definition a range of activities. In the

Intermediary Definitions Adopting Release, we stated that transactions

arising from dealing activity, as identified by the indicia described

above, would generally be subject to relevant Title VII requirements

applicable to dealers, including that such transactions be included in

a person's calculations for purposes of the dealer de minimis

calculations. Our territorial approach applying Title VII to dealing

activity similarly looks to whether any of the activities described

above occur within the United States, and not simply to the location of

the risk, as some commenters suggested is required under section 30(c)

of the Exchange Act.\92\ To the extent that such activity does occur

within the United States, the person engaged in such activity, in our

view, is transacting a business in security-based swaps within the

United States,\93\ and therefore applying Title VII to the activity by,

among other things, requiring the person to include transactions

arising from such activity in its de minimis calculation is consistent

with a territorial approach, even if some of this activity (or other

activity bearing the indicia of dealing activity) relating to the

transaction also occurs outside the United States.

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\92\ See notes 76-77, supra.

\93\ Cf. Exchange Act section 30(c) (limiting the application

of, among other provisions, Title VII to ``any person insofar as

such person transacts a business in security-based swaps without the

jurisdiction of the United States'').

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This approach is consistent with the purposes of the dealer

definition and the de minimis exception as they relate to dealer

regulation under Title VII. The de minimis exception excludes from the

dealer registration requirement those entities that may engage in

dealing activity but that do so in amounts that may not raise, to a

degree that warrants application of security-based swap dealer

requirements, the risk, counterparty protection, or other concerns that

the dealer registration and regulatory framework were intended to

address.\94\ On the other hand, dealing activity, as identified by the

types of activities described above, carried out within the United

States at levels exceeding the de minimis threshold is likely to raise

these concerns, which would be addressed by requiring persons engaged

in that volume of dealing activity to register as security-based swap

dealers under Title VII and to comply with relevant requirements

applicable to security-based swap dealers. Accordingly, to the extent

that a person engages in dealing activity within the United States that

results in transactions in a notional amount exceeding the applicable

de minimis threshold, it is appropriate to require the person to

register as a security-based swap dealer.

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\94\ See, e.g., Intermediary Definitions Adopting Release, 77 FR

30629-30 (noting that the de minimis threshold is intended to

capture firms that engage in a level of dealing activity that is

likely to raise the types of concerns that the dealer regulatory

framework is intended to address).

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i. Dealing Activity of U.S. Persons

Under the foregoing analysis and consistent with our proposal, when

a U.S. person as defined under this final rule \95\ engages in dealing

activity, it necessarily engages in such activity within the United

States, even when it enters into such transactions through a

[[Page 47289]]

foreign branch or office. As discussed in further detail below, the

definition of ``U.S. person'' in the final rule is intended, in part,

to identify those persons for whom it is reasonable to infer that a

significant portion of their financial and legal relationships are

likely to exist within the United States and that it is therefore

reasonable to conclude that risk arising from their security-based swap

activities could manifest itself within the United States, regardless

of the location of their counterparties, given the ongoing nature of

the obligations that result from security-based swap transactions.\96\

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\95\ See Exchange Act rule 3a71-3(a)(4).

\96\ See section IV.C, infra. In our view, dealing activity

involving such persons is particularly likely to raise the types of

concerns Title VII was intended to address, including those related

to risk to the U.S. financial system, transparency of the U.S.

financial markets, and customer protection.

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Wherever a U.S. person enters into a transaction in a dealing

capacity, it is the U.S. person as a whole that is holding itself out

as a dealer in security-based swaps, given that the financial resources

of the entire person stand behind any dealing activity of the U.S.

person, both at the time it enters into the transaction and for the

life of the contract, even when the U.S. person enters into the

transaction through a foreign branch or office. Moreover, the U.S.

person as a whole seeks to profit by providing liquidity and engaging

in market-making in security-based swaps, and the financial resources

of the entire person enable it to provide liquidity and engage in

market-making in connection with security-based swaps. Its dealing

counterparties will look to the entire U.S. person, even when the U.S.

person enters into the transaction through a foreign branch or office,

for performance on the transaction. The entire U.S. person assumes, and

stands behind, the obligations arising from the resulting agreement and

is directly exposed to liability arising from non-performance of the

non-U.S. person.\97\

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\97\ Cf. SIFMA/FIA/FSR Letter at 4, A-5 (stating that main

purpose of Title VII is to address risk arising from security-based

swap activity).

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For these reasons, in our view a person does not hold itself out as

a security-based swap dealer as anything other than a single person

even when it enters into transactions through its foreign branch or

office.\98\ Because the foreign branch generally could not operate as a

dealer absent the financial and other resources of the entire U.S.

person, its dealing activity with all of its counterparties, including

dealing activity conducted through its foreign branch or office, is

best characterized as occurring, at least in part, within the United

States and should therefore be included in the person's de minimis

threshold calculation.\99\

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\98\ This is consistent with the view expressed in our proposing

release. See Cross-Border Proposing Release, 78 FR 30985.

\99\ As discussed in further detail below, this interpretation

is consistent with the goals of dealer regulation under Title VII.

Security-based swap activity that results in a transaction involving

a U.S.-person counterparty creates ongoing obligations that are

borne by a U.S. person and, as such, is properly viewed as occurring

within the United States. See note 186, infra.

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ii. Dealing Transactions of Non-U.S. Persons That Are Subject to

Recourse Guarantees by Their U.S. Affiliates

In the proposing release, we explained that we preliminarily

believed that a territorial approach consistent with the text and

purposes of the Dodd-Frank Act encompasses transactions involving a

non-U.S. person counterparty whose dealing activity is guaranteed by a

U.S. person.\100\ However, because we proposed to treat non-U.S.

persons receiving a guarantee on their security-based swap transactions

from a U.S. person like any other non-U.S. person for purposes of the

de minimis exception (i.e., requiring them to include in their

calculations only dealing activity involving U.S.-person counterparties

or transactions conducted within the United States), we did not

elaborate specifically on how the presence of a guarantee related to a

territorial application of the dealer definition, including the de

minimis exception. Because our final rule requires transactions of non-

U.S. persons whose obligations under the security-based swap are

subject to recourse guarantees enforceable against their U.S.

affiliates to be included in the dealer de minimis calculation of the

non-U.S. person, we address it here.

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\100\ In our proposal, we noted that in a security-based swap

transaction between two non-U.S. persons where the performance of at

least one side of the transaction is guaranteed by a U.S. person,

the guarantee gives the guaranteed person's counterparty recourse to

the U.S. person for performance of obligations owed by the

guaranteed person under the security-based swap, and the U.S.

guarantor exposes itself to the risk of the security-based swap as

if it were a counterparty to the security-based swap through the

security-based swap activity engaged in by the guaranteed person.

See Cross-Border Proposing Release, 78 FR 30986-87. This

interpretation of guarantee was consistent with our discussion of

the application of the major participant tests to guaranteed

positions in the Intermediary Definitions Adopting Release, where

we, together with the CFTC, noted that a person's security-based

swap positions are attributed to a parent, other affiliate, or

guarantor for purposes of the major participant analysis to the

extent that the counterparties to those positions have recourse to

that parent, other affiliate, or guarantor in connection with the

position; as we noted in that release, positions are not attributed

in the absence of recourse. See Intermediary Definitions Adopting

Release, 77 FR 30689. In this release, we continue to use the term

``guarantee'' to refer to an arrangement pursuant to which one party

to a security-based swap transaction has recourse to its

counterparty's parent, other affiliate, or guarantor with respect to

the counterparty's obligations owed under the transaction. See

section IV.E.1(b), infra.

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In our view, a non-U.S. person engaged in dealing activity, to the

extent that one or more transactions arising from such activity are

guaranteed by a U.S. person, is engaged in relevant activity for

purposes of the security-based swap dealer definition within the United

States, with respect to those transactions. By virtue of the guarantee,

the non-U.S. person effectively acts together with the U.S. person to

engage in the dealing activity that results in the transactions, and

the non-U.S. person's dealing activity with respect to such

transactions cannot reasonably be isolated from the U.S. person's

activity in providing the guarantee. The U.S.-person guarantor together

with the non-U.S. person whose dealing activity it guarantees, and not

just the non-U.S. person, may seek to profit by providing liquidity and

engaging in market-making in security-based swaps, and the non-U.S.

person provides liquidity and engages in market-making in connection

with security-based swaps by drawing on the U.S. person's financial

resources.\101\ The non-U.S. person's counterparty, pursuant to the

recourse guarantee, looks to both the non-U.S. person and its U.S.

guarantor, which is responsible for performance on the transaction that

is part of the non-U.S. person's dealing activity. In sum, the non-U.S.

person is engaged in the United States in relevant dealing activity

identified in the statutory definition and in our jointly adopted

further definition of ``security-based swap dealer.''

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\101\ Even if the U.S. guarantor generally does not hold itself

out as a dealer or make a market in security-based swaps, the U.S.

guarantor enables the non-U.S. person whose dealing activity it

guarantees to engage in dealing activity by providing financial

backing. We note that references to ``guarantee,'' ``recourse

guarantee,'' or ``rights of recourse,'' as those terms are used in

this release, may describe economic relationships that are different

from ``guarantee'' under section 2(a)(1) of the Securities Act. We

note, however, that, depending on the nature of the ``guarantee,''

``recourse guarantee,'' or ``rights of recourse'' provided by the

guarantor, the transaction at issue may involve not only a security-

based swap between two non-U.S. persons but also the offer and sale

of a security by a U.S. person, given that a ``guarantee'' of a

security-based swap is itself a separate security issued by the U.S.

guarantor. See, e.g., Securities Act section 2(a)(1), 15 U.S.C.

77b(a)(1) (including in the statutory definition of ``security'' a

guarantee of a security).

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Moreover, the economic reality of the non-U.S. person's dealing

activity, where the resulting transactions are guaranteed by a U.S.

person, is identical, in relevant respects, to a transaction entered

into directly by the

[[Page 47290]]

U.S. guarantor. By virtue of the guarantee, transactions arising from

the non-U.S. person's dealing activity result in risk from the

transaction being borne by a U.S. person (the guarantor, which is

responsible for the transactions it guarantees in a manner similar to a

direct counterparty to the transactions) and potentially the U.S.

financial system in a manner similar to a dealing transaction entered

into directly by a U.S. person. As with transactions entered into

directly by a U.S. person, transactions for which a counterparty has a

right of recourse against a U.S. person create risk to a U.S. person

and potentially the U.S. financial system regardless of the location of

the counterparty.

Our interpretation of the statutory text of the definition, as well

as our further definition of the term, as it applies to these entities

is consistent with the purposes of Title VII, as discussed above. The

exposure of the U.S. guarantor creates risk to U.S. persons and

potentially to the U.S. financial system via the guarantor to a

comparable degree as if the transaction were entered into directly by a

U.S. person. We understand that in some circumstances a counterparty

may choose not to enter into a security-based swap transaction (or may

not do so on the same terms) with a non-U.S. subsidiary of a U.S.

person when that non-U.S. subsidiary is acting in a dealing capacity to

the extent that its dealing activity is not subject to a recourse

guarantee by a U.S. affiliate, absent other circumstances (e.g.,

adequate capitalization of the hitherto-guaranteed affiliate).

One commenter noted that U.S. guarantors may provide guarantees for

a variety of reasons, including to satisfy regulatory requirements, to

``manage capital treatment across an entity,'' and to ``avoid negative

credit rating consequences,'' and argued that a guarantee may therefore

not create risk within the United States.\102\ Absent the creation of

such risk, this commenter further argued that a guarantee creates ``no

nexus for purposes of section 30(c) of the Exchange Act.'' \103\

However, regardless of the motivation for providing the guarantee, the

non-U.S. person's dealing activity still occurs within the United

States and creates risk within the United States in the manner

described above. The commenter provided no evidence that the motivation

for providing a guarantee affects this analysis: It neither alters the

risk created within the United States by such a guarantee when it is

provided by a U.S. person nor affects the economic reality of the

transaction. Moreover, even if a person provides guarantees not in

response to counterparty demands but to satisfy regulatory requirements

or to avoid negative credit rating consequences, the very reasons for

issuing the guarantee suggest that the non-U.S. person would not be

able to engage in dealing activity, or to do so on the same terms,

without the guarantee.\104\

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\102\ SIFMA/FIA/FSR Letter at A-11.

\103\ Id.

\104\ In addition, this commenter suggested that any risk

created by guarantees provided to prudentially regulated foreign

entities is adequately addressed by the foreign prudential

regulation. See id. Although we recognize that foreign prudential

regulation may reduce the risk that a guaranteed foreign affiliate's

counterparties will seek to enforce the terms of the guarantee

against the U.S. guarantor (depending on the quality of prudential

regulation in the foreign jurisdiction), it does not eliminate this

risk, and the counterparty continues to retain a right of recourse

under the guarantee against the guarantor.

Given the role of a foreign person whose activity is guaranteed

in creating risk within the United States through its dealing

activity, we believe that it is important to ensure that such a

foreign person be required to register as a security-based swap

dealer to the extent that its guaranteed dealing transactions

(together with any dealing transactions with U.S. persons) are

included in its de minimis threshold calculations. As noted above,

our proposal set forth a framework under which substituted

compliance potentially would be available for certain Title VII

requirements, including for dealer-specific requirements such as

capital and margin, which should mitigate concerns about overlapping

regulation of such entities.

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In sum, the guarantee provided by a U.S. person poses risk to U.S.

persons and potentially to the U.S. financial system, and both the non-

U.S. person whose dealing activity is guaranteed and its counterparty

rely on the creditworthiness of the U.S. guarantor when entering into a

security-based swap transaction and for the duration of the security-

based swap. The economic reality of this transaction, even though

entered into by a non-U.S. person, is substantially identical, in

relevant respects, to a transaction entered into directly by a U.S.

person. Accordingly, in our view, it is consistent with both the

statutory text and with the purposes of the statute to identify such

transactions as occurring within the United States for purposes of

Title VII.

iii. Dealing Activity of Other Non-U.S. Persons

In our proposal, we stated that non-U.S. persons engaging in

dealing activity would be required to count toward their de minimis

thresholds only transactions arising from their dealing activity with

U.S. persons or dealing activity otherwise conducted within the United

States. Under the approach described above, and consistent with our

proposal, we believe that a non-U.S. person engaged in dealing activity

with U.S. persons engages in relevant activity for purposes of the

security-based swap dealer definition within the United States.\105\

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\105\ We continue to believe that security-based swap activity

carried out within the United States may also be relevant activity

under our territorial approach, even if the resulting transaction

involves two non-U.S. counterparties. As discussed below, however,

we anticipate soliciting additional public comment regarding the

issue.

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Dealing activity of non-U.S. persons that involves counterparties

who are U.S. persons, as that term is defined in the final rule,

necessarily involves the performance by the non-U.S. person of relevant

activity under the ``security-based swap dealer'' definition at least

in part within the United States. For example, in our view, a non-U.S.

person engaging in dealing activity with a U.S. person is holding

itself out as a dealer in security-based swaps within the United

States.\106\ Similarly, by entering into a transaction with a U.S.

person in a dealing capacity, it is seeking to profit by providing

liquidity within the United States and possibly engaging in market-

making in security-based swaps within the United States, given that its

decision to engage in dealing activity with U.S. persons, as defined by

the rule, affects the liquidity of the security-based swap market

within the United States. Particularly at volumes in excess of the de

minimis threshold, entering into security-based swap transactions in a

dealing capacity with U.S. persons likely is the type of activity that

would cause a non-U.S. person ``to be commonly known in the trade as a

dealer in security-based swaps'' \107\ within the United States, that

constitutes ``regularly entering into security-based swaps with

counterparties as an ordinary course of business for one's own

account'' \108\ within the United States, and that permits a reasonable

inference that it has a regular clientele and actively solicits clients

within the United States.\109\

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\106\ Given the global nature of the security-based swap market,

U.S. persons seeking to access this market may readily do so through

both U.S.-person dealers and foreign dealers. That a foreign dealer

holding itself out as a dealer to U.S. persons is based in, and

operating out of, a foreign jurisdiction does not alter the economic

reality of its activity: It is holding itself out as a dealer within

the United States in a manner largely indistinguishable from a U.S.-

person dealer that ``hangs out its shingle'' in Manhattan.

\107\ Exchange Act section 3(a)(71)(A)(iv).

\108\ Exchange Act section 3(a)(71)(A)(iii).

\109\ See Intermediary Definitions Adopting Release, 77 FR

30618.

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Our application of the statute to non-U.S. persons is consistent

with the purposes of Title VII, as discussed

[[Page 47291]]

above. U.S. persons incur risks arising from this dealing activity,

which in turn potentially creates risk to other market participants and

the U.S. financial system more generally, and transactions with U.S.

persons raise counterparty protection and market transparency concerns

that Title VII is intended to address. Accordingly, we believe that the

dealing activity of a non-U.S. person that involves a U.S.-person

counterparty is appropriately characterized as occurring, at least in

part, within the United States.\110\

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\110\ Although at least one commenter suggested that we lack the

authority under section 30(c) of the Exchange Act to require non-

U.S. person joint-ventures to aggregate relevant dealing

transactions with the relevant dealing transactions of multiple

investors in the joint-venture, see note 78, supra, we believe that

our limitation on application of the aggregation requirement only to

the transactions of such non-U.S. persons that occur within the

United States (because they involve U.S.-person counterparties or

are subject to a recourse guarantee against a U.S. person) is

consistent with our territorial approach.

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(c) Territorial Approach to Application of Title VII Major Security-

Based Swap Participant Registration Requirements

As in our territorial approach to the security-based swap dealer

definition (including the de minimis exception) described above, our

territorial approach to the application of the major security-based

swap participant definition looks first to the statutory text to

identify the types of activity that are relevant for purposes of the

definition. Section 3(a)(67) of the Exchange Act provides that a major

security-based swap participant is any person who is not a dealer and

who satisfies one or more of the following requirements:

(i) Maintains a substantial position in security-based swaps for

any of the major security-based swap categories,\111\ excluding certain

positions;

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\111\ The statute further provides the Commission with the

authority to determine the scope of these categories. See Exchange

Act section 3(a)(67)(A)(ii)(I).

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(ii) has outstanding security-based swaps that create substantial

counterparty exposure that could have serious adverse effects on the

financial stability of the U.S. banking system or financial markets; or

(iii) is a highly leveraged financial entity that maintains

substantial position in outstanding security-based swaps in any major

security-based swap category.\112\

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\112\ Exchange Act section 3(a)(67)(A).

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The statute directs us to further define, jointly with the CFTC,

``major security-based swap participant'' \113\ and separately provides

us with authority to ``define . . . the term `substantial position' at

the threshold that the Commission determines to be prudent for the

effective monitoring, management, and oversight of entities that are

systemically important or can significantly impact the financial system

of the United States.'' \114\

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\113\ Dodd-Frank Act section 712(d)(1).

\114\ Exchange Act section 3(a)(67)(B).

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Pursuant to these provisions, we further interpreted this

definition by, among other things, defining what constitutes a

``substantial position'' and ``substantial counterparty exposure'' for

purposes of the major security-based swap participant definition.\115\

In doing so, we set forth calculation methodologies and thresholds for

each and adopted rules requiring persons that exceeded these thresholds

to register as major security-based swap participants.\116\ These

thresholds were designed to identify persons that were likely to pose

counterparty credit risks, as such risks are ``more closely linked to

the statutory criteria that the definition focuses on entities that are

`systemically important' or can `significantly impact' the U.S.

financial system.'' \117\ We also noted that our definition of

``substantial position'' was intended to address the risk that would be

posed by the default of multiple entities close in time and the

aggregate risks presented by a person's security-based swap activity,

as these considerations reflect the market risk concerns expressly

identified in the statute.\118\

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\115\ See Intermediary Definitions Adopting Release, 77 FR

30663-84.

\116\ See id.

\117\ Id. at 30666.

\118\ See id. We defined ``substantial counterparty exposure''

in a similar manner, noting the focus of the statutory test on

``serious adverse effects on financial stability or financial

markets.'' Id. at 30683. Cf. Section 3(a)(67)(A)(ii)(II) of the

Exchange Act (encompassing in major security-based swap participant

definition persons whose ``outstanding security-based swaps create

substantial counterparty exposure that could have serious adverse

effects on the financial stability of the United States banking

system or financial markets'').

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The statutory focus of the major security-based swap participant

definition differs from that of security-based swap dealer, in that the

security-based swap dealer definition focuses on activity that may

raise the concerns that dealer regulation is intended to address, while

the major security-based swap participant definition focuses on

positions that may raise systemic risk concerns within the United

States. Accordingly, a territorial approach to application of the

definition of major security-based swap participant involves

identifying security-based swap positions that exist within the United

States.\119\ In our view, and consistent with the approach taken in our

proposal, a security-based swap position exists within the United

States when it is held by or with a U.S. person, or when it is subject

to a recourse guarantee against a U.S. person,\120\ as the risks

associated with such positions are borne within the United States, and

given the involvement of U.S. persons may, at the thresholds

established for the major security-based swap participant definition,

give rise to the types of systemic risk within the United States that

major security-based swap regulation is intended to address. To the

extent that a position exists within the United States in this sense,

we believe that it is appropriate under a territorial approach to

require a market participant, whether a U.S. person or otherwise, that

is a counterparty or guarantor with respect to that position, to

include that position in its major security-based swap participant

threshold calculations, wherever the security-based swap was entered

into.

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\119\ Cf. Morrison, 130 S. Ct. at 2884 (performing a textual

analysis to identify the focus of the statute).

\120\ The economic reality of a position subject to such a

guarantee, even though entered into by a non-U.S. person, is

substantially identical in relevant respects to a position entered

into directly by the U.S. guarantor. See section II.B.2(b)ii, supra.

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(d) Regulations Necessary or Appropriate To Prevent Evasion of Title

VII

Consistent with our proposal, we interpret section 30(c) of the

Exchange Act as not requiring us to find that actual evasion has

occurred or is occurring to invoke our authority to reach activity

``without the jurisdiction of the United States'' or to limit

application of Title VII to security-based swap activity ``without the

jurisdiction of the United States'' only to business that is transacted

in a way that is purposefully intended to evade Title VII. Section

30(c) of the Exchange Act authorizes the Commission to apply Title VII

to persons transacting a business ``without the jurisdiction of the

United States'' if they contravene rules that the Commission has

prescribed as ``necessary or appropriate to prevent the evasion of any

provision'' of Title VII. The focus of this provision is not whether

such rules impose Title VII requirements only on entities engaged in

evasive activity but whether the rules are generally ``necessary or

appropriate'' to prevent potential evasion of Title VII. In other

words, section 30(c) of the Exchange Act permits us to impose

prophylactic rules intended to prevent possible purposeful evasion,

even though such rules may affect or prohibit

[[Page 47292]]

some non-evasive conduct. Moreover, exercising the section 30(c)

authority does not require us to draw a distinction between conduct

``without the jurisdiction of the United States'' that is purposely

evasive as opposed to identical conduct that was motivated by some non-

evasive purpose. Indeed, to interpret section 30(c) authority otherwise

could create a bifurcated regulatory regime where the same conduct is

treated differently based on parties' underlying purpose for engaging

in it, which could create extraordinary oversight challenges involving

difficult subjective considerations concerning parties' true intentions

in entering any given transaction or establishing particular business

structures, and could create significant competitive advantages for

incumbent firms.\121\ Thus, we read the statute to permit us to

prescribe such rules to conduct without the jurisdiction of the United

States, even if those rules would also apply to a market participant

that has been transacting business through a pre-existing market

structure, such as a foreign branch or foreign affiliate whose

positions are guaranteed by the market participant, established for

valid business purposes, provided the proposed rule or guidance is

designed to prevent possibly evasive conduct.\122\

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\121\ Such an interpretation of our anti-evasion authority, for

example, could privilege incumbent firms by allowing them to

leverage existing business models that may not be available to new

entrants under rules promulgated pursuant to that authority.

\122\ As a general matter, the final rules adopted in this

release are not being applied to persons who are ``transacting a

business in security-based swaps without the jurisdiction of the

United States'' within the meaning of section 30(c) of the Exchange

Act. See sections II.B.2(a)-(c), supra. However, as noted below, the

Commission also believes that these rules are necessary or

appropriate as a prophylactic measure to help prevent the evasion of

the provisions of the Exchange Act that were added by the Dodd-Frank

Act and thus help ensure that the particular purposes of the Dodd-

Frank Act addressed by the rule are not undermined. See, e.g.,

section II.B.2(d) and note 186, infra.

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C. Principles Guiding Final Approach To Applying ``Security-Based Swap

Dealer'' and ``Major Security-Based Swap Participant'' Definitions in

the Cross-Border Context

As in our proposal, our final rules and guidance reflect our

careful consideration of the global nature of the security-based swap

market and the types of risks created by security-based swap activity

to the U.S. financial system and market participants and other concerns

that the dealer and major security-based swap participant definitions

were intended to address, as well as the needs of a well-functioning

security-based swap market.\123\ We also have been guided by the

purpose of Title VII \124\ and the applicable requirements of the

Exchange Act, including the following:

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\123\ See section II.A, supra.

\124\ See note 11, supra.

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Economic Impacts--The Exchange Act requires the Commission

to consider the impact of our rulemakings on efficiency, competition,

and capital formation.\125\

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\125\ Specifically, section 3(f) of the Exchange Act provides:

``Whenever pursuant to this title the Commission is engaged in

rulemaking, . . ., and is required to consider or determine whether

an action is necessary or appropriate in the public interest, the

Commission shall also consider, in addition to the protection of

investors, whether the action will promote efficiency, competition,

and capital formation.'' Section 23(a)(2) of the Exchange Act also

provides: ``The Commission . . . , in making rules and regulations

pursuant to any provisions of this title, shall consider among other

matters the impact any such rule or regulation would have on

competition. The Commission . . . shall not adopt any such rule or

regulation which would impose a burden on competition not necessary

or appropriate in furtherance of the purposes of [the Exchange

Act].''

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Counterparty Protection--The Dodd-Frank Act adds

provisions to the Exchange Act relating to counterparty protection,

particularly with respect to ``special entities.'' \126\

---------------------------------------------------------------------------

\126\ See Exchange Act section 15F(h), as added by section

764(a) of the Dodd-Frank Act, in particular.

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Transparency--The Dodd-Frank Act was intended to promote

transparency in the U.S. financial system.\127\

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\127\ See note 11, supra.

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Risk to the U.S. Financial System--The Dodd-Frank Act was

intended to promote, among other things, the financial stability of the

United States by limiting/mitigating risks to the financial

system.\128\

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\128\ Id.

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Anti-Evasion--The Dodd-Frank Act amends the Exchange Act

to provide the Commission with authority to prescribe rules and

regulations as necessary or appropriate to prevent the evasion of any

provision of the Exchange Act that was added by the Dodd-Frank

Act.\129\

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\129\ See Exchange Act section 30(c), 15 U.S.C. 78dd(c), as

discussed in section II.B.2(d), supra.

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Consultation and Coordination with Other U.S. Regulators--

In connection with implementation of Title VII, the Dodd Frank Act

requires the Commission to consult and coordinate with the CFTC and

prudential regulators for the purpose of ensuring ``regulatory

consistency and comparability, to the extent possible.'' \130\

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\130\ See section 712(a)(2) of the Dodd-Frank Act.

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Consistent International Standards--To promote effective

and consistent global regulation of swaps and security-based swaps, the

Dodd-Frank Act requires the Commission and the CFTC to consult and

coordinate with foreign regulatory authorities on the ``establishment

of consistent international standards'' with respect to the regulation

of swaps and security-based swaps.\131\ In this regard, the Commission

recognizes that regulators in other jurisdictions are currently engaged

in implementing their own regulatory reforms of the OTC derivatives

markets and that our application of Title VII to cross-border

activities may affect the policy decisions of these other regulators as

they seek to address potential conflicts or overlaps in the regulatory

requirements that apply to market participants under their

authority.\132\

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\131\ See section 752(a) of the Dodd-Frank Act.

\132\ For example, subjecting non-U.S. persons to Title VII may

prompt a foreign jurisdiction to respond by subjecting U.S. persons

to the foreign jurisdiction's regulatory regime.

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At times, these principles reinforce one another; at other times,

they may be in tension. For instance, regulating risk posed to the

United States may, depending on the final rules, make it more costly

for U.S.-based firms to conduct security-based swap business,

particularly in foreign markets, compared to foreign firms; it could

make foreign firms less willing to deal with U.S. persons; and it could

discourage foreign firms from carrying out security-based swap dealing

activity through branches or offices located in the United States. On

the other hand, providing U.S. persons greater access to foreign

security-based swap markets may, depending on the final rules, fail to

appropriately address the risks posed to the United States from

transactions conducted in part outside the United States or create

opportunities for market participants to evade the application of Title

VII, particularly until such time as other jurisdictions adopt similar

comprehensive and comparable derivative regulations.

Balancing these sometimes competing principles has been complicated

by the fact that Title VII imposes a new regulatory regime in a global

marketplace. Title VII establishes reforms that will have implications

for entities that compete internationally in the global security-based

swap market. We have generally sought, in accordance with the statutory

factors described above, to avoid creating opportunities for market

participants to evade Title VII requirements, whether by restructuring

their business or other means, or the potential for overlapping or

conflicting regulations. We also have considered the needs for a well-

functioning security-based swap market and for avoiding disruption that

may

[[Page 47293]]

reduce liquidity, competition, efficiency, transparency, or stability

in the security-based swap market.

III. Baseline

To assess the economic impact of the final rules described in this

release, we are using as our baseline the security-based swap market as

it exists at the time of this release, including applicable rules we

have already adopted but excluding rules that we have proposed but not

yet finalized.\133\ The analysis includes the statutory and regulatory

provisions that currently govern the security-based swap market

pursuant to the Dodd-Frank Act.\134\ We acknowledge limitations in the

degree to which we can quantitatively characterize the current state of

the security-based swap market. As we describe in more detail below,

because the available data on security-based swap transactions do not

cover the entire market, we have developed an understanding of market

activity using a sample that includes only certain portions of the

market.

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\133\ We also consider, where appropriate, the impact of rules

and technical standards promulgated by other regulators, such as the

CFTC and the European Securities and Markets Authority, on practices

in the security-based swap market.

\134\ As noted above, we have not yet adopted other substantive

requirements of Title VII that may affect how firms structure their

security-based swap business and market practices more generally.

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A. Current Security-Based Swap Market

Our analysis of the state of the current security-based swap market

is based on data obtained from DTCC-TIW, especially data regarding the

activity of market participants in the single-name CDS market during

the period from 2008 to 2012. While other repositories may collect data

on transactions in total return swaps on equity and debt, we do not

currently have access to such data for these products (or other

products that are security-based swaps). We have previously noted that

the definition of security-based swaps is not limited to single-name

CDS but we believe that the single-name CDS data are sufficiently

representative of the market and therefore can directly inform the

analysis of the state of the current security-based swap market.\135\

Additionally, the data for index CDS encompass both broad-based

security indices and narrow-based security indices, and ``security-

based swap'' in relevant part encompasses swaps based on single

securities or reference entities or on narrow-based security indices.

Accordingly, with the exception of the analysis regarding the degree of

overlap between participation in the single-name CDS market and the

index CDS market (cross-market activity), our analysis below does not

include data regarding index CDS.

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\135\ According to data published by the Bank for International

Settlements (``BIS''), the global notional amount outstanding in

equity forwards and swaps as of June 2013 was $2.32 trillion. The

notional amount outstanding in single-name CDS was approximately

$13.14 trillion, in multi-name index CDS was approximately $10.17

trillion, and in multi-name, non-index CDS was approximately $1.04

trillion. See Semi-annual OTC derivatives statistics at end-June

2013 (Nov. 2013), Table 19, available at: http://www.bis.org/statistics/dt1920a.pdf. As we stated in the Cross-Border Proposing

Release, for the purposes of this analysis, we assume that multi-

name index CDS are not narrow-based index CDS and therefore, do not

fall within the security-based swap definition. See Cross-Border

Proposing Release, 78 FR 31120 n.1301; see also Exchange Act section

3(a)(68)(A); Further Definition of ``Swap,'' ``Security-Based-

Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;

Security-Based Swap Agreement Recordkeeping, Exchange Act Release

No. 67453 (July 18, 2012), 77 FR 48208 (Aug. 13, 2012) (``Product

Definitions Adopting Release''), 77 FR 48208. We also assume that

all instruments reported as equity forwards and swaps are security-

based swaps, potentially resulting in underestimation of the

proportion of the security-based swap market represented by single-

name CDS. Based on those assumptions, single-name CDS appear to

constitute roughly 80 percent of the security-based swap market. No

commenters disputed these assumptions, and we therefore continue to

believe that, although the BIS data reflect the global OTC

derivatives market, and not just the U.S. market, these ratios are

an adequate representation of the U.S. market.

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We believe that the data underlying our analysis here provide

reasonably comprehensive information regarding the single-name CDS

transactions and composition of the single-name CDS market

participants. We note that the data available to us from DTCC-TIW do

not encompass those CDS transactions that both: (i) Do not involve U.S.

counterparties; \136\ and (ii) are based on non-U.S. reference

entities. Notwithstanding this limitation, we believe that the DTCC-TIW

data provide sufficient information to identify the types of market

participants active in the security-based swap market and the general

pattern of dealing within that market.\137\

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\136\ We note that DTCC-TIW's entity domicile determinations may

not reflect our definition of ``U.S. person'' in all cases.

\137\ The challenges we face in estimating measures of current

market activity stems, in part, from the absence of comprehensive

reporting requirements for security-based swap market participants.

The Commission has proposed rules regarding trade reporting, data

elements, and real-time public reporting for security-based swaps

that would provide us with appropriate measures of market activity.

See Regulation SBSR--Reporting and Dissemination of Security-Based

Swap Information, Exchange Act Release No. 34-63346 (Nov. 19, 2010),

75 FR 75208 (Dec. 2, 2010).

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1. Security-Based Swap Market Participants

A key characteristic of security-based swap activity is that it is

concentrated among a relatively small number of entities that engage in

dealing activities. In addition to these entities, thousands of other

participants appear as counterparties to security-based swap contracts

in our sample, and include, but are not limited to, investment

companies, pension funds, private (hedge) funds, sovereign entities,

and industrial companies. We observe that most non-dealer users of

security-based swaps do not engage directly in the trading of swaps,

but use dealers, banks, or investment advisers as intermediaries or

agents to establish their positions. Based on an analysis of the

counterparties to trades reported to the DTCC-TIW, there are 1,695

entities that engaged directly in trading between November 2006 and

December 2012.

Table 1, below, highlights that more than three-quarters of these

entities (DTCC-defined ``firms'' shown in DTCC-TIW, which we refer to

here as ``transacting agents'') were identified as investment advisers,

of which approximately 40 percent (about 30 percent of all transacting

agents) were registered investment advisers under the Investment

Advisers Act of 1940 (``Investment Advisers Act'').\138\ Although

investment advisers comprise the vast majority of transacting agents,

the transactions they executed account for only 10.8 percent of all

single-name CDS trading activity reported to the DTCC-TIW, measured by

number of transaction-sides (each transaction has two transaction

sides, i.e., two transaction counterparties). The vast majority of

transactions (81.9 percent) measured by number of transaction-sides

were executed by ISDA-recognized dealers.\139\

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\138\ See 15 U.S.C. 80b1-80b21. Transacting agents participate

directly in the security-based swap market, without relying on an

intermediary, on behalf of principals. For example, a university

endowment may hold a position in a security-based swap that is built

up by an investment adviser that transacts on the endowment's

behalf. In this case, the university endowment is a principal that

uses the investment adviser as its transacting agent.

\139\ The 1,695 entities included all DTCC-defined ``firms''

shown in DTCC-TIW as transaction counterparties that report at least

one transaction to DTCC-TIW as of December 2012. The staff in the

Division of Economic and Risk Analysis classified these firms, which

are shown as transaction counterparties, by machine matching names

to known third-party databases and by manual classification. This is

consistent with the methodology used in the proposal. See Cross-

Border Proposing Release, 78 FR 31120 n.1304. Manual classification

was based in part on searches of the EDGAR and Bloomberg databases,

the SEC's Investment Adviser Public Disclosure database, and a

firm's public Web site or the public Web site of the account

represented by a firm. The staff also referred to ISDA protocol

adherence letters available on the ISDA Web site.

[[Page 47294]]

Table 1--The Number of Transacting Agents by Counterparty Type and the Fraction of Total Trading Activity, From

November 2006 Through December 2012, Represented by Each Counterparty Type

----------------------------------------------------------------------------------------------------------------

Transaction

Transacting agents Number Percent share

(percent)

----------------------------------------------------------------------------------------------------------------

Investment Advisers............................................. 1,261 74.4 10.9

--SEC registered............................................ 510 30.1 6.6

Banks........................................................... 256 15.1 5.9

Pension Funds................................................... 27 1.6 0.1

Insurance Companies............................................. 32 1.9 0.3

ISDA-Recognized Dealers \140\................................... 17 1.0 82.1

Other........................................................... 102 6.0 0.8

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Total....................................................... 1,695 100.0 100.0

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Principal holders of CDS risk exposure are represented by

``accounts'' in the DTCC-TIW.\141\ The staff's analysis of these

accounts in DTCC-TIW shows that the 1,695 transacting agents classified

in Table 1 represent over 9,238 principal risk holders. Table 2, below,

classifies these principal risk holders by their counterparty type and

whether they are represented by a registered or unregistered investment

adviser.\142\ For instance, 256 banks in Table 1 allocated transactions

across 364 accounts, of which 25 were represented by investment

advisers. In the remaining 339 instances, banks traded for their own

accounts. Meanwhile, 17 ISDA-recognized dealers in Table 1 allocated

transactions across 65 accounts.

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\140\ For the purpose of this analysis, the ISDA-recognized

dealers are those identified by ISDA as belonging to the G14 or G16

dealer group during the period: JP Morgan Chase NA (and Bear

Stearns), Morgan Stanley, Bank of America NA (and Merrill Lynch),

Goldman Sachs, Deutsche Bank AG, Barclays Capital, Citigroup, UBS,

Credit Suisse AG, RBS Group, BNP Paribas, HSBC Bank, Lehman

Brothers, Soci[eacute]t[eacute] G[eacute]n[eacute]rale, Credit

Agricole, Wells Fargo and Nomura. See, e.g., http://www.isda.org/c_and_a/pdf/ISDA-Operations-Survey-2010.pdf.

\141\ ``Accounts'' as defined in the DTCC-TIW context are not

equivalent to ``accounts'' in the definition of ``U.S. person''

provided by Exchange Act rule 3a71-3(a)(4)(i)(C). They also do not

necessarily represent separate legal persons. One entity or legal

person may have multiple accounts. For example, a bank may have one

DTCC account for its U.S. headquarters and one DTCC account for one

of its foreign branches.

\142\ Unregistered investment advisers include all investment

advisers not registered under the Investment Advisers Act and may

include investment advisers registered with a state or a foreign

authority.

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Among the accounts, there are 1,000 Dodd-Frank Act-defined special

entities and 570 investment companies registered under the Investment

Company Act of 1940.\143\ Private funds comprise the largest type of

account holders that we were able to classify, and although not

verified through a recognized database, most of the funds we were not

able to classify appear to be private funds.\144\

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\143\ See 15 U.S.C. 80a1 through 80a64. There remain over 4,000

DTCC ``accounts'' unclassified by type. Although unclassified, each

was manually reviewed to verify that it was not likely to be a

special entity within the meaning of the Dodd-Frank Act and instead

was likely to be an entity such as a corporation, an insurance

company, or a bank.

\144\ Private funds for this purposes encompasses various

unregistered pooled investment vehicles, including hedge funds,

private equity funds, and venture capital funds.

Table 2--The Number and Percentage of Account Holders--by Type--Who Participate in the Security-Based Swap Market Through a Registered Investment

Adviser, an Unregistered Investment Adviser, or Directly as a Transacting Agent, From November 2006 Through December 2012

--------------------------------------------------------------------------------------------------------------------------------------------------------

Represented by a Represented by an

Account holders by type Number registered investment unregistered investment Participant is

adviser adviser transacting agent \145\

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Private Funds................................................... 2,696 1,275 47% 1,400 52% 21 1%

DFA Special Entities............................................ 1,000 973 97% 7 1% 20 2%

Registered Investment Companies................................. 570 560 98% 8 1% 2 0%

Banks (non-ISDA-recognized dealers)............................. 364 21 6% 4 1% 339 93%

Insurance Companies............................................. 205 132 64% 20 10% 53 26%

ISDA-Recognized Dealers......................................... 65 0 0% 0 0% 65 100%

Foreign Sovereigns.............................................. 57 40 70% 2 4% 15 26%

Non-Financial Corporations...................................... 55 37 67% 3 5% 15 27%

Finance Companies............................................... 8 4 50% 0 0% 4 50%

Other/Unclassified.............................................. 4,218 2,885 68% 1,146 27% 187 4%

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All......................................................... 9,238 5,927 64% 2,590 28% 721 8%

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(a) Dealing Structures

Security-based swap dealers use a variety of business models and

legal structures to engage in dealing business with counterparties in

jurisdictions all around the world. As we noted in the proposal, both

U.S.-based and foreign-based entities use certain dealing structures

for a variety of legal, tax, strategic, and business reasons.\146\

Dealers may use a variety of structures in part to reduce risk and

enhance credit protection based on the particular characteristics of

each entity's business.

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\145\ This column reflects the number of participants who are

also trading for their own accounts.

\146\ See Cross-Border Proposing Release, 78 FR 30976-78.

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Bank and non-bank holding companies may use subsidiaries to deal

with counterparties. Further, dealers may rely on multiple sales forces

to

[[Page 47295]]

originate security-based swap transactions. For example, a U.S. bank

dealer may use a sales force in its U.S. home office to originate

security-based swap transactions in the United States and use separate

sales forces spread across foreign branches to originate security-based

swap transactions with counterparties in foreign markets.

In some situations, an entity's performance under security-based

swaps may be supported by a guarantee provided by an affiliate. More

generally, guarantees may take the form of a blanket guarantee of an

affiliate's performance on all security-based swap contracts, or a

guarantee may apply only to a specified transaction or counterparty.

Guarantees may give counterparties to the dealer direct rec

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