SEC Proposes Cross-Border Regulatory Framework for Security-Based Swaps

The U.S. Securities and Exchange Commission (the “SEC”) reproposed rules addressing the application of certain requirements under Title VII of the Dodd-Frank Act (the “Reproposal”) to non-U.S. persons dealing in security-based swaps (“SBSs”).[1]


I. Amendments to De Minimis Counting Requirements

Under the Reproposal and in addition to the circumstances set forth in the Cross-Border Final Rules,[2] an SBS-dealing transaction that is entered into by a non-U.S. person and is “arranged, negotiated or executed” (“ANE”) through personnel located in a U.S. branch or office, or through an (affiliated or unaffiliated) agent of such non-U.S. person located in the United States (such transaction, an “ANE Transaction”), will count toward that non-U.S. person’s de minimis threshold for registration as a security-based swap dealer (“SBSD”).[3]

II. What Is an ANE Transaction?

The Reproposal does not define what an “ANE Transaction” is in the rule text; rather, the Reproposal provides extensive guidance on the meaning of this term.[4] A transaction generally is considered to be an ANE Transaction if it involves (1) “market-facing” activity (i.e., the activity of sales and trading personnel, including communications with potential counterparties) that is (2) conducted through a permanent location in the territorial United States, (3) whether by personnel of the non-U.S. person or an (affiliated or unaffiliated) agent of such person.

Notably, only activities conducted by personnel or agents of the non-U.S. person that involve material, trade-specific terms would be considered to be “market-facing” under the proposed rules. Thus, certain activities may be conducted in the U.S. without rendering such a transaction an ANE Transaction, including the following:

  • collateral management activities (e.g., the exchange of margin payments);
  • the preparation of master agreement documentation and/or collateral terms;
  • the submission of SBS transactions for clearing;
  • reporting SBS transactions to swap execution facilities; and
  • the negotiation of trade-specific terms by U.S. counsel.

The ANE Transaction requirement replaces an aspect of the Original Proposal that would have required a dealing party to consider the location of its counterparty’s trading personnel (as well as whether the counterparty or its guarantor was a U.S. person) in determining whether a given transaction was required to be counted against its de minimis threshold. Under the Reproposal, a non-U.S. person need only look to the location of its own SBS dealing activity in making this determination. However, ANE Transactions must be counted against the threshold even if executed anonymously on a security-based swap execution facility, since the identity of the counterparty is irrelevant for purposes of the de minimis determination.

With regard to ANE Transactions executed through an agent (instead of an employee of the SBSD), the SEC rejected a proposal provisionally by commenters on the Original Proposal to regulate the agent solely as a “broker” under the existing Exchange Act scheme. The SEC did so because it reasoned that (1) banks acting as agents would be outside the scope of SEC jurisdiction (pursuant to various exemptions from the definition of “broker” in the Exchange Act) and (2) the SEC enforcement of the Exchange Act’s antifraud provisions could be frustrated by difficulties in obtaining the books and records of the principal.[5] The SEC specifically requested comment on the treatment of this issue – i.e., how it should regulate agents of SBSDs, since SBSs are also “securities” under the securities laws and acting as a “broker” of such products could subject a person to broker-dealer registration.

III. External Business Conduct Requirements; Additional Aspects of the Reproposal

  • In line with the CFTC Staff Advisory discussed in footnote 4 below, the Reproposal would apply the (yet-to-be-adopted) external business conduct requirements applicable to SBSDs[6] to ANE Transactions of non-U.S. SBSDs.
  • The Reproposal dropped an aspect of the Original Proposal that would have required an SBS between a registered non-U.S. SBSD and a non-U.S. counterparty to be subject to mandatory clearing and trading requirements. This exclusion would extend to ANE Transactions of non-U.S. SBSDs.
  • The scope of the SBS trade reporting requirements under recently adopted Reg. SBSR[7] would be amended by:
  • requiring subsequent ANE Transactions (including ANE Transactions of non-U.S. “de minimis” dealers) to be reported and publicly disseminated;
  • amending the reporting hierarchy so that when a non-U.S. de minimis dealer faces a U.S. person, the parties may choose who reports (rather than putting the burden on the U.S. person); and
  • subject to certain proposed modifications in the reporting rule, requiring reporting when two non-U.S. persons trade through a U.S. platform or broker-dealer.

Lofchie Comment: The CFTC also uses the phrase “ANE” to describe trades that are entered into by non-U.S. swap dealers but which have a connection with the United States that brings them within the scope of U.S. jurisdiction. However, the CFTC provides far less guidance than the SEC on how the phrase should be interpreted. If the CFTC were to formally (or even informally) adopt the interpretation provided by the SEC, the result would be two material benefits: the market’s uncertainty about how the CFTC interprets the term would be reduced and non-U.S. swap dealers could conduct their SEC and CFTC-regulated swaps activities under fairly consistent guidance on the extent of U.S. jurisdiction (and, in the intermediate run, perhaps the CFTC would abandon its guidance on cross-border jurisdiction and instead adopt the SEC’s rule).

Separately, we note that the SEC’s approach to the application of the cross-border rules assumes that an agent, which is a different legal entity than the swaps dealer, could be responsible for complying with the relevant requirements as to sales practices. In fact, the SEC asks specifically for comment on the legal structure through which sales practice duties may be imposed on such an entity. The absence of that structure is a material gap in the CFTC rules, which do not provide any clear method for an entity acting as a swaps broker to use to comply with sales practice requirements for swaps. Such a structure would be particularly useful in situations in which a U.S. entity is acting as sales agent for a non-U.S. swaps dealer.