Nearly three years after Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has at last proposed new trading rules for foreign banks that do business with US entities in the over-the-counter (OTC) derivatives market.
On May 1, 2013, the SEC issued an extensive set of proposals applicable to market participants engaged in cross-border trading of security-based swaps. These proposals provide guidance for foreign and domestic entities, but also offer insight into the SEC’s own interpretation of its role as a regulator of extraterritorial activity in the securities markets.
Title VII of the Dodd-Frank Act sets forth a series of regulations concerning the cross-border derivatives market, which prior to 2010 was largely unregulated. This market, which is estimated to involve US$630 trillion of activity worldwide, generally involves trading, outside of a formal exchange, of derivatives by a foreign entity with a US-based person or institution. Since the financial crisis of 2008, global regulators have issued a series of directives and guidelines concerning derivatives trading intended to increase transparency and reduce systematic risks. Dodd-Frank categorizes derivatives as either “swaps,” to be regulated by the Commodity Futures Trading Commission (CFTC), or “security-based swaps,” to be regulated by the SEC.
Months after the CFTC began implementing its own rules for swaps, the SEC has finally offered some guidance for security-based swaps. The SEC’s proposals are lengthy and complex. Consisting of 1,000 pages, complete with 2,000 footnotes and hundreds of questions, the release (1) aims to set forth regulations for registration and transactional requirements under Dodd-Frank; (2) distinguishes between US and non-US entities that are subject to Title VII; (3) addresses the issue raised by overseas regulators regarding potential conflicts between US and foreign regulations; and (4) invites comments about the rulemaking releases and policies concerning security-based swaps.
Registration and transactional requirements. The SEC’s proposed rules implement Dodd-Frank oversight of security-based swaps to certain large foreign firms that deal with “U.S. entities” by requiring the registration of security-based swap clearing agencies, data repositories, and swap execution facilities involved in cross-border activities as defined by Title VII of the Dodd-Frank Act. Moreover, the rules implement Title VII for reporting and dissemination, clearing and trade execution of security-based swaps.
Foreign subsidiaries and branches. The SEC’s proposed rules define foreign subsidiaries of US companies as “non-U.S.” entities under all circumstances and foreign branches of US companies as “non-U.S.” entities under certain circumstances. In seeking comment about these provisions, Commissioner Luis A. Aguilar has noted that these distinctions create uncertainty for financial entities and expose a risky regulatory loophole that may permit institutions to avoid Title VII even though such transactions may impact the US market.
Substituted compliance. In response to foreign regulators’ concerns about the confusion and impact of Dodd-Frank on non-US firms, the release proposes that the SEC allow for so-called “substituted compliance,” in which non-US regulators may substitute their own rules if the SEC deems them comparable to Dodd-Frank. Conversely, if the SEC deems the foreign regulators’ rules incomparable or insufficient, then SEC rules will apply. The SEC’s proposal includes rules and interpretive guidance that aim to inform parties to a security-based swap transaction which regulatory requirements apply when their transaction occurs in part within and in part outside the US.
Comment period. As part of its release, the SEC reopened the comment period in an effort to incite a “healthy debate and dialogue” about the proposals and the “Commission’s processes.” The comment period runs 60 days from the date the proposals are published in the Federal Register, after which the SEC will issue its final trading rules.
Perhaps most significantly, these proposals offer insight into the SEC’s own view of its extraterritorial regulatory reach under Dodd-Frank. In its Summary section, the SEC states explicitly that it is “setting forth [its] view of the scope of [its] authority, with respect to enforcement proceedings, under Section 929P of the Dodd-Frank Act.” Section 929P, enacted immediately after the Supreme Court’s June 2010 ruling in Morrison v. National Australia Bank, provides US district courts with jurisdiction over any action or proceeding brought by the SEC for violations of the securities laws against foreign entities for conduct occurring outside the US that has a “substantial effect within the U.S.” While the breadth of this provision remains to be seen, it appears that the SEC is mindful of Congress’s intention to confer expansive regulatory authority, particularly with respect to oversight of the derivatives markets.
The bottom line, for now, is this: the SEC’s long-awaited proposal opens the curtain on the SEC’s view of its role in regulating cross-border trading of security-based swaps. The OTC derivatives market, largely unregulated before the financial crisis, will soon face a complex new regulatory regime. We will continue to update our analysis on regulation of cross-border securities transactions and the SEC’s regulatory authority under Section 929P in future alerts and articles.
The SEC’s press release announcing the proposed rules is available here.
For more information about this proposal, please contact John Vukelj.
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