Introduction

The Securities and Exchange Commission (SEC) continues to take steps toward implementation of its security-based swap (SBS) dealer registration framework. A particular area of concern for market participants has been how the SEC’s requirements will apply in the cross-border context. In a recent proposal,^[1] the SEC has sought to address certain questions as to the cross-border implementation of its SBS regime, and, in some cases, to further harmonize its regulations with the Commodity Futures Trading Commission’s swaps regulatory framework. 

The proposal covers four areas of the SEC’s SBS regime, including:

• Transactions that have been “arranged, negotiated or executed” (ANE) by personnel located in the U.S. (ANE Transactions) in respect of SBS and market participant regulation; 
• The requirement that non-U.S. resident SBS dealers and major SBS participants (together, “SBS Entities”) provide a certification and an opinion of counsel that the SEC may access their books and records and conduct onsite inspections and examinations;
• The cross-border application of Rule of Practice 194,^[2] which covers statutory disqualification provisions; and 
• The requirement that SBS Entities maintain questionnaires or employment applications for their foreign associated persons (APs).

The Proposal

ANE Transactions

The proposal would clarify the use of the “arranged, negotiated or executed” test for purposes of the cross-border application of several of the SEC’s Title VII rulemakings, including the SBS dealer de minimis registration threshold. In general, pursuant to rules already adopted, ANE transactions may be subject to SEC requirements (including being counted towards the de minimis registration threshold), even if the transaction is otherwise between two non-U.S. persons. 

• The SEC is proposing to provide guidance in respect of ANE Transactions in order to further clarify the types of market-facing activities that may constitute “arranging” or “negotiating” a SBS. Specifically, the proposed guidance would take the position that a person may provide “market color”^[3] in specific circumstances without that activity constituting “arranging” or “negotiating” SBS transactions for purposes of certain of the Commission’s regulations, including counting resulting transactions towards the SBS dealer de minimis threshold. Such requirements will not be triggered if:
• The U.S. personnel have not been assigned and do not exercise client responsibility in connection with the transaction; or
• The U.S. personnel do not receive compensation based on or otherwise linked to the completion of the transactions for which the U.S. personnel provide market color.

In addition, the SEC has proposed two alternatives to its existing approach to counting certain ANE Transactions for purposes of the SBS dealer de minimis threshold calculation:

• The first alternative would permit a non-U.S. person not to count ANE Transactions towards the de minimis threshold under the condition that all arranging, negotiating or executing activity within the U.S. is performed by personnel associated with a majority-owned affiliate that is registered with the SEC as a SBS dealer.
• The second alternative would expand upon the first alternative by also allowing for activity in the U.S. to be performed by personnel associated with a majority-owned affiliate that is registered with the SEC as a broker. 

Under both proposed alternatives, the non-U.S. person and majority-owned affiliate would still be required to comply with certain other Title VII requirements, including those relating to business conduct, trade acknowledgements, portfolio reconciliation, disclosure, records and financial responsibility.^[4] In addition, the non-U.S. person and majority-owned affiliate upon request would be required to promptly provide the SEC with relevant information or documents within their control relating to the transactions. The affiliated SBS dealer would also be subject to certain counterparty disclosure requirements, and the non-U.S. person relying on either exception would have to be subject to the margin and capital requirements of a “listed jurisdiction”^[5] when engaging in transactions subject to either exception. 

Further, the SEC requested comment on whether or not the agency should propose additional conditional exceptions for certain other requirements that apply to ANE Transactions, such as regulatory reporting, public dissemination and SBS dealer business conduct requirements.

Certification and Opinion of Counsel

The proposal would provide guidance intended to clarify the application of the SEC’s certification and opinion of counsel requirement for each nonresident SBS Entity applicant that it can and will provide the agency with prompt access to its books and records and submit to on-site inspections and examinations.^[6] The guidance would clarify certain aspects of this requirement, including the following:

• The certification and opinion of counsel would be required to address only the laws of the jurisdiction or jurisdictions in which the nonresident SBS maintains the covered books and records;
• The certification and opinion of counsel would be required to address only (i) books and records related to the “U.S.” business of the nonresident SBS entity; and (ii) financial records that are necessary for purposes of assessing whether the nonresident SBS is in compliance with capital and margin requirements;
• The certification and opinion of counsel would be required to be predicated on the nonresident SBS Entity obtaining the prior consent of the persons whose information will be included in the books and records to be made available to the SEC;
• The SEC will take into account whether the relevant regulatory authority in the foreign jurisdiction has (i) issued an approval, authorization, waiver or consent; or (ii) entered in a memorandum of understanding (MOU) or similar arrangement with the SEC facilitating direct access to the books and records of SBS Entities within that jurisdiction. Such an approval or MOU would need to be consistent with the SEC’s registration program.

Further, the proposal would provide a nonresident SBS Entity with additional time to submit the certification and opinion of counsel. Under the proposal, if a nonresident applicant is unable to provide such certification and opinion of counsel at the time of registration, the applicant would be conditionally registered for up to 24 months following the proposal’s compliance date, under the condition that the applicant submits a Form SBSE-C and either a Form SBSE, SBSE-A or SBSE-BD that is complete except for the certification and opinion of counsel. 

Rule of Practice 194

The SEC is proposing to amend Rule of Practice 194, which establishes the process for SBS Entities to apply to the SEC for a waiver that would allow a statutorily disqualified natural person under Section 15F(b)(6) of the Securities Exchange Act of 1934 (Exchange Act) to effect or be involved in effecting SBS on behalf of the SBS Entity, subject to certain conditions.

The proposal would add an additional exclusion for an SBS Entity with respect to an AP who is a natural person who (i) is not a U.S. person; and (ii) does not effect or is not involved in effecting SBS transactions with or for U.S. person counterparties, except for an SBS transaction conducted through a foreign branch of the U.S. person counterparty.

However, this exclusion does not apply if the AP of the Swap Entity is currently subject to any order that prevents such AP from participating in U.S. or foreign financial markets,^[7] unless such an order by a foreign financial regulatory authority only applies in the jurisdiction where the AP is located or employed.

Questionnaire or Application for Employment

As part of its earlier proposed cross-border recordkeeping and reporting requirements for SBS Entities, the SEC proposed new Exchange Act Rule 18a-5, which would establish recordkeeping standards for stand-alone and bank SBS Entities. Such standards would require that a stand-alone or bank SBS Entity make and keep current a questionnaire or application for employment for each AP who is a natural person, and for bank SBS Entities, each AP who is a natural person and whose activities are associated with the bank SBS Entity’s business as an SBS Entity.

In order to provide greater flexibility, the SEC is proposing to provide the following exemptions to proposed Rule 18a-5:

• A stand-alone or bank SBS Entity would not be required to make and keep current a questionnaire or application for employment for an AP if the SBS Entity is excluded from the statutory disqualification under Exchange Act 15F(b)(6) with respect to that AP (i.e. by relying on the proposed exclusion to Rule of Practice 194).
• A stand-alone or bank SBS Entity would not be required to make and keep current a questionnaire or application for employment for non-U.S. APs that do not effect or are not involved in effecting SBS transactions on behalf of an SBS Entity if the receipt of such information, or the creation or maintenance of records containing such information, would result in a violation of applicable law in the jurisdiction where the AP is employed or located.

Comment

The proposed amendments and guidance represent a continuation of the agency’s efforts to implement its SBS requirements. At present, it is expected that SBS registration requirements will not be fully implemented until a number of other rulemakings are finalized.