This Summer, the Securities and Exchange Commission (SEC) adopted long-awaited rules on cross-border security-based swap activities. The SEC’s rules provide: 1) an explanation of when a cross-border transaction must be counted towards the requirement to register as a security-based swap dealer (SBSD) or major security-based swap participant (MSBSP), including transactions guaranteed by a US person and transactions by a “conduit affiliate;” 2) procedures for submitting requests for “substituted compliance,” which would permit market participants to comply with US requirements by complying with comparable foreign requirements; and 3) an anti-fraud rule that addresses the scope of the SEC’s cross-border anti-fraud enforcement authority, clarifying that the authority applies where sufficient conduct in furtherance of the fraud occurs, or sufficient effects of the fraud are felt, within the US.
The big picture
A security-based swap is a swap tied to a single security, loan, or issuer of securities, a narrow-based security index, or the occurrence of certain events relating to an issuer of securities in a narrow-based security index.
Many market participants trade both security-based swaps and other types of swaps that are regulated by the Commodity Futures Trading Commission (CFTC), which already has issued its cross-border interpretive guidance. The SEC has stated publicly that its rules generally would produce similar outcomes in terms of whether an entity is a “US person” and whether a particular transaction is counted toward the relevant dealer or major participant thresholds. Indeed, the SEC’s Director of Trading and Markets, Steve Luparello, has stressed the rules’ “workability with the existing CFTC regime.”
There are some differences, though, such as funds majority-owned by US persons being deemed US persons by the CFTC but not by the SEC. But to the extent the SEC and CFTC approaches are harmonized, steps that market participants have taken to comply with the CFTC’s cross-border guidance may be transferable to compliance with the SEC’s cross-border rules.
Yet, the extent of that harmonization may not be fully known for some time. The cross-border rules issued by the SEC this Summer represent just the first of a series. Future rulemakings on specific security-based swap requirements, such as reporting of transactions to data repositories, will address the cross-border application of those requirements. In addition, the SEC anticipates soliciting additional public comment on the cross-border application of the SBSD definition to transactions involving two non-US counterparties where activity related to the transaction occurs at least in part within the US.
The rules issued by the SEC to date will not impose any requirements on market participants until after all relevant substantive security-based swap rulemakings have been completed. That is likely to be a matter of years, not weeks or months.
Rule highlights regarding SBSDs
Transactions included in the dealer calculation: US persons must count all their security-based swap dealing transactions toward the SBSD thresholds, including dealing transactions conducted through foreign branches. Non-US persons, by contrast, must count the following:
- Dealing transactions with US persons, including foreign branches of US banks;
- For any of its swap activity that is subject to a guarantee by a US affiliate, dealing transactions with any counterparty that has rights of recourse against the US affiliate of the non-US person in connection with the non-US person’s obligation under the security-based swap (recourse exists if the counterparty has a legally enforceable right against the US affiliate); and
- All dealing transactions if the non-US person acts as a “conduit affiliate” (i.e., a non-US affiliate of a US person that enters into security-based swaps with non-US persons, or with certain foreign branches of a US bank, on behalf of its US affiliates and enters into offsetting transactions with its US affiliates to transfer the risks and benefits of those security-based swaps).
Definition of US person: A “US person” is defined in a territorial manner that encompasses, among others, any:
- Natural person who resides in the US;
- Legal person organized, incorporated, or established under the laws of the US or having its principal place of business in the US; and
- Discretionary or non-discretionary account of a US person.
A “principal place of business” is the location from which the officers, partners, or managers of the legal person primarily direct, control and coordinate the activities of the legal person (or, in the case of an externally-managed investment vehicle, the office from which the manager primarily directs, controls, and coordinates the investment activities of the vehicle).
Foreign branches of US banks and US branches of foreign banks are not separate legal persons. Thus, they have the same US person status as the bank’s home office.
Cleared anonymous transactions: Non-US persons do not have to count against the SBSD thresholds any security-based swap dealing transactions entered into anonymously and cleared.
MSBSPs: The rules also contain provisions regarding cross-border transactions to be included in the MSBSP calculation, and attribution of guaranteed positions for these purposes. At this time, though, there are only two major swap participants registered with the CFTC, and it is not anticipated that there will be materially more registered MSBSPs.