Last week John Ramsay, Acting Director, Division of Trading and Markets at the US SEC, gave a speech entitled Cross-Border at the Crossroads: The SEC’s “Middle Ground”. the speech laid out how the SEC views cross-border regulation, an issue that has created substantial disagreement and consternation among regulators of late. Excerpts from the speech are below.
Overview of the Proposal
We proposed the cross-border rules and interpretations relating to all of the Title VII requirements at the same time so that people could consider how the individual parts relate to each other and decide if they work as a coherent scheme. Also, we proposed our approach in the form of rules and interpretations subject to notice and comment and backed up by a very thorough economic analysis. In fact, the economic analysis substantially accounts for the length of the release.
The proposal covers many topics but primarily it addresses:
Regulation of dealers and major participants, which includes both entity requirements like capital and transaction requirements like certain business conduct rules;
Registration of infrastructure entities (data repositories, clearing agencies and execution facilities);
What I think of as “market-wide transaction requirements”, which apply to dealers and non-dealers, including regulatory reporting and trade dissemination, mandatory clearing requirements, and mandatory trade execution.
We also proposed a way to avoid adverse impacts from the provision of Dodd-Frank that asks for regulators to indemnify trade repositories before obtaining data from them.
In broad terms, it may be best to understand the proposal by separating two main questions that are addressed. The first is whether particular entities or transactions are captured by the rules because there is a sufficient nexus to the U.S. The second question is how they comply with the rules when the tripwire is crossed. It is in answer to the second question that the idea of substituted compliance comes into play.
Territorial Approach and the Definition of “U.S. Person”
As to the first question, in general we have taken a “territorial” and “entity-based” approach. A key issue under that first heading is whether an entity is conducting enough business to require it to register as a dealer in security-based swaps, after considering the rules we’ve previously adopted requiring that an entity conduct more than a threshold amount of dealing activity to trigger registration.
U.S. dealers have to register if they conduct more than a minimal amount of dealing business in derivatives that we regulate, while foreign-based firms need to register if they do more than a minimal amount of dealing business either with U.S. persons, or where key aspects of the business occur in the U.S.
The Treatment of Foreign Branches and Guaranteed Subsidiaries
We gave a lot of thought as to how Title VII should apply to foreign branches of U.S. banks and guaranteed subsidiaries of U.S. holding companies. We considered how to best account for the risk conducted in those entities while avoiding competitive distortions.
First, as to branches, foreign dealers would not be required to count trades with foreign branches of U.S. banks as U.S. business, even though for most purposes a branch is considered to be a part of the larger corporate entity. Our concern was that otherwise, foreign firms would curtail their business with those branches in order to avoid being subject to the U.S. dealer regime.
Also, in many cases those branches would not be subject to U.S. clearing, trade execution, and dissemination requirements when they deal with foreign counterparties. Again, we thought it made sense to give some flexibility for those firms to do business outside the U.S. on the same basis as their competitors.
Similarly, our proposal would not require guaranteed foreign subsidiaries of U.S. holding companies to register as dealers if they conduct no or minimal U.S. business. We understand that the fact of a U.S. guarantee could transfer risk back to the U.S. But, instead of applying the full raft of U.S. dealer rules to those entities, we thought that risk was better accounted for by the major participant regime.
So, in the case of a U.S. holding company guaranteeing trades of its foreign subsidiary, which does not itself conduct U.S. business, the guarantee would not cause the subsidiary to register as a dealer, but the holding company might well need to register as a major security-based swap participant and be subject to the standards of that regime.
In closing, I want to emphasize that in crafting our cross-border approach, our aim has been to apply our laws in a way that achieves the financial stability, market transparency, and investor protection objectives of the Dodd-Frank Act while preserving the globally-integrated, dynamic character of the OTC derivatives market. We have done our best to frame a proposal that achieves these twin goals, and we look forward to your comments as well as comments from others.
The full speech can be found here.