Four key areas provided the foundation for the development and adoption of the rule package:

• the use of transactions that have been “arranged, negotiated, or executed” by personnel located in the US as a trigger for enhanced US regulation of security-based swaps and market participants
• the requirement that nonresident security-based swap dealers and major security-based swap participants (collectively known as “SBS entities”) provide certification and opinion of counsel regarding the ability of the SEC to access information and perform onsite examinations
• the cross-border application of statutory disqualification provisions
• questionnaires or employment applications that registered SBS Entities must maintain with regard to their foreign associated persons

The new rules should improve the regulatory framework by pragmatically addressing implementation issues and efficiency concerns, including jurisdiction-specific data privacy requirements and broader issues of international comity. Since many market participants are active in markets regulated by both the SEC and the Commodity Futures Trading Commission (CFTC), the CFTC also provided guidance on these issues, which the new rule set reflects.

The SEC has specifically done the following:

• Provided guidance to address how certain requirements under Title VII of the Dodd-Frank Act, which pertain to security-based swaps transactions that have been “arranged” or “negotiated” by personnel in the US, apply to transactions involving limited activities by those US personnel;
• Adopted a conditional exception to provisions of Exchange Act Rule 3a71-3 that otherwise would require non-US persons to count security-based swap transactions with non-US counterparties when US personnel arrange, negotiate, or execute those transactions (along with ancillary limited exemptions from related provisions of the Exchange Act and certain rules thereunder) against the thresholds associated with the de minimis exception to the “security-based swap dealer” definition;
• Adopted corresponding technical revisions to Exchange Act Rule 0-13 in conjunction with the revisions mentioned above to Rule 3a71-3;
• Adopted an amendment to Exchange Act Rule 15Fb2-1 that will allow a nonresident security-based SBS Entity that is unable to provide certification and opinion of counsel required by Rule 15Fb2-4 to be conditionally registered if the nonresident SBS Entity instead submits a certification and an opinion of counsel that identify and are condition upon the occurrence of a future action. This future action would provide the SEC with adequate assurances of prompt access to the books and records of the nonresident SBS Entity. It will also enable the nonresident SBS Entity to submit to onsite inspection and examination by the SEC;
• Provided guidance for requirements in Exchange Act Rules 15Fb2-4(c) and 3a71-6. This guidance pertains to an SBS Entity providing the SEC with a certification and opinion of counsel, including with respect to the foreign laws to be covered in the certification and opinion of counsel of a non-resident SBS Entity, the scope of the books and records covered, whether the certification and opinion of counsel can be predicated on consents (should they be permitted in that jurisdiction), and whether the certification and opinion of counsel can rely on a memorandum of understanding, agreement, protocol, or other regulatory arrangement with the SEC;
• Adopted revisions to Commission Rule of Practice 194 to exclude an SBS Entity from the prohibition in Exchange Act Section 15F(b)(6) with respect to an associated person who is a natural person who (i) is not a US person and (ii) does not effect and is not involved in effecting security-based swaps transactions with or for counterparties that are US persons (other than a security-based swap transaction conducted through a foreign branch of a counterparty that is a US person). Certain limitations apply;
• Adopted amendments to Rule 18a-5 to provide that a bank or stand-alone SBS Entity is not required to make and keep current a questionnaire or application for employment executed by an associated person if the SBS Entity is excluded from the prohibition in Section 15F(b)(6) of the Exchange Act with respect to the associated person. In addition, a questionnaire or application for employment executed by an associated person who is not a US person need not include some information described in Rule 18a-5 unless the SBS Entity 1) is required to obtain such information under applicable law in the jurisdiction in which the associated person is employed or located, or 2) obtains such information while conducting a background check that is customary for such firms in that jurisdiction, and the creation or maintenance of records reflecting that information would not result in a violation of applicable laws. The SBS Entity must comply with Section 15F(b)(6) of the Exchange Act; and
• Issued a statement regarding compliance with rules for security-based data repositories and Regulation SBSR.

The following highlights expand on some of the accepted rule changes.

Application of Title VII of the Dodd-Frank Act to certain transactions “arranged, negotiated, or executed” by US personnel

The SEC has provided guidance on the definition of “arranged” or “negotiated” that pertains to determining which transactions non-US persons must count against the de minimis thresholds to understand whether they must register as security-based swap dealers, certain security-based swap dealer business conduct requirements, regulatory reporting and public dissemination requirements under Regulation SBSR, and major security-based swap participant rules. With the guidance, Title VII requirements will not be triggered only because US personnel provide “market color” in the form of certain background information regarding pricing or market conditions. This is true so long as those US personnel do not receive transaction-linked compensation or exercise client responsibility in connection with those transactions.

As mentioned above, the SEC has also adopted a conditional exception from the requirement in Exchange Act Rule 3a71-3(b)(1)(iii)(C) such that non-US persons count those security-based swap dealing transactions that are with non-US counterparties but were arranged, negotiated, or executed by US personnel against the de minimis threshold associated with security-based swap dealer registration. The exception is subject to particular conditions which were designed to safeguard the interests associated with security-based swap dealer regulation under Title VII while reducing negative consequences that otherwise may be associated with the counting rule. Some of the conditions are:

• use of personnel of a registered security-based swap dealer or registered broker (the “registered entity”) which is a majority-owned affiliate of the non-US person relying on the exception (the “relying entity”) in connection with the arranging, negotiating, and executing activity in the United States; if the registered entity is a broker not approved to use models to compute deductions for market or credit risk, a requirement that the broker maintain minimum net capital and establish and maintain risk management control systems as if the broker were also registered as a security-based swap dealer,
• a requirement that the registered entity comply with certain security-based swap dealer requirements as if it were a counterparty to the transaction and, if the registered entity is a registered broker but not a registered security-based swap dealer, as as if it were a registered-security based swap dealer,
• a limitation on the availability of the exception to no more than $50 billion of the inter-dealer transactions over the immediately preceding 12-month period,
• a requirement that the relying entity provide relevant books, records, and testimony to representatives of the SEC and consent to service of the process, and that the registered entity create and maintain books and records of the transactions subject to the exception, as well as obtain from the relying entity, and maintain documentation of the terms of the trading relationship with the counterparty and documentation regarding the relying entity’s compliance with the $50 billion limitation,
• notification by the registered entity to the counterparties that the relying entity is not a registered security-based swap dealer and that certain US securities laws do not apply to the transaction,
• a requirement that the relying entity be subject to the margin and capital requirements of a jurisdiction that the SEC has designated as a “listed jurisdiction”,
• the registered entity filing a notice that its associated persons may conduct “arranging, negotiating, or executing” activity in the US.

As ancillaries to the conditional exception, the SEC has adopted exemptions from the broker registration requirement as it is written in Section 15(a) of the Exchange Act and from the transaction confirmation requirement in the Exchange Act Rule 10b-10 as applied to the registered entities whose personnel “arrange, negotiate, or execute” transactions on behalf of a non-US affiliate relying on the exception.

Also, along with the “listed jurisdiction” condition, the SEC has adopted rule changes to create a process by which the SEC may consider designating a jurisdiction as a “listed jurisdiction” and has issued a separate order designating Australia, Canada, France, Germany, Japan, Singapore, Switzerland, and the United Kingdom as listed jurisdictions.

Certification and opinion of counsel requirements

Exchange Act Rule 15Fb2-4(c)(1) addresses the registration of non-US resident SBS Entities. It stipulates that these entities must certify and provide an opinion of counsel that the SEC can access their books and records and conduct onsite inspections.

During the public comment period and other times, firms have raised concerns about the interplay between the certification and opinion of counsel requirement interacting with various foreign blocking laws, privacy laws, secrecy laws, and other legal issues. The SEC recognizes that because of these situations, a nonresident SBS Entity may not be able to provide the certification and opinion of counsel as required by Rule 15Fb2-4 at the time the entity is required to register. The SEC has adopted amendments to Rule 15Fb2-1 to address this by allowing a nonresident SBS Entity to submit a certification and an opinion of counsel that identifies, and is conditioned upon, the occurrence of a future action that would provide the SEC with adequate assurances of prompt access to the books and records of the nonresident SBS Entity. The nonresident SBS Entity would also be able to submit to onsite inspection and examination by the SEC.

Rule 15Fb2-1(d)(3) sets forth these possible future actions, including:

• entry by the SEC and the foreign financial regulatory authority of the jurisdiction(s) in which the nonresident SBS Entity maintains its books and records into a memorandum of understanding, agreement, protocol, or other regulatory arrangement providing the SEC with adequate assurances of (i) prompt access to the books and records of the nonresident SBS Entity, and (ii) the ability of the nonresident SBS Entity to submit to onsite inspection by the SEC,
• issuance by the SEC of an order granting substituted compliance in accordance with Rule 3a71-6 based on adequate assurances by the foreign financial authority in the jurisdiction(s) in which the nonresident SBS Entity maintains the books and records that are addressed by the certification and opinion of counsel,
• any other action that would provide the SEC with assurances regarding prompt access to the books and records and the ability to conduct onsite inspection of the nonresident SBS Entity.

Rules 15Fb2-1(d) and (e) set forth that a nonresident SBS Entity that submits a conditional certification and opinion of counsel in connection with an application that otherwise is complete in all respects will be conditionally registered and will remain conditionally registered until the SEC acts to grant or deny ongoing registration. If none of the future actions that are included in an applicant’s conditional certification and opinion of counsel occurs within 24 months of the compliance date for Rule 15Fb2-1, and there is also not a basis that would provide the SEC with the required assurances, the SEC may determine thereafter whether ongoing registration should be denied.

The SEC also has provided guidance to address the application of the certification and opinion of counsel requirement when such potential legal impediments and barriers are prohibitive or limiting. Consistent with the amendment to Rule 15Fb2-1 discussed above, the guidance provides that the certification and opinion of counsel:

• need only address the law of the jurisdiction or jurisdictions in which the nonresident SBS Entity maintains the relevant books and records.
• need only address books and records related to the US-related business of the nonresident SBS Entity, and for a nonresident SBS Entity subject to the Exchange Act capital and margin requirements, the financial records necessary for the SEC to assess the nonresident SBS Entity’s compliance with Exchange Act capital and margin requirements.
• may be predicated on the nonresident SBS Entity obtaining the prior consent of the persons whose information is or will be included in the books and records.
• need not address contracts entered into prior to the date on which the SBS Entity submits an application for registration pursuant to Section 15F(b).
• may take into account whether the relevant regulatory authority in a foreign jurisdiction has entered into a memorandum of understanding, agreement, protocol, or other regulatory arrangement providing the Commission with adequate assurances of (1) prompt access to the books and records of the nonresident SBS Entity, and (2) the ability of the nonresident SBS Entity to submit to onsite inspection or examination by the Commission.

The guidance, and the certification and opinion of counsel requirement generally, does not affect the independent requirement that nonresident SBS Entities must provide the Commission with prompt access to their books and records.

Cross-border application of statutory disqualification provision

As stated in Exchange Act Section 15F(b)(6), it is illegal for an SBS Entity to allow an associated person who is subject to a statutory disqualification to influence or be involved in security-based swaps transactions on behalf of the SBS Entity if the SBS Entity knew (or in the exercise of reasonable care should have known) of the statutory disqualification. This is the case except when otherwise specifically provided by SEC rule, regulation, or order. Commission Rule of Practice 194 provides a process by which an SBS Entity could apply to the SEC so that the SEC can assess on a case-by-case basis whether to grant relief from the statutory disqualification prohibition outlined in the above section. In the adopted rule set, the SEC has implemented revisions to Rule of Practice 194 to more closely align the SEC’s rules with the CFTC’s approach to the statutory disqualification of non-domestic associated persons of CFTC registered swap entities.

Specifically:

• New paragraph(c)(2) of Rule of Practice 194 provides an exclusion from the statutory prohibition in Exchange Act Section 15F(b)(6) for SBS Entities with respect to an associated person who is a natural person who: (i) is a not a U.S. person, and (ii) does not effect and is not involved in effecting security-based swap transactions with or for counterparties that are U.S. persons, other than a security-based swap transaction conducted through a foreign branch of a counterparty that is a U.S. person.
• An SBS Entity would not be able to avail itself of the exclusion provided in Rule of Practice 194(c)(2) if the associated person of that SBS Entity is currently subject to an regulatory or legal order that prohibits that person from participating in the U.S. financial market, including the U.S. securities or swap market, or the foreign financial markets of the jurisdiction in which the associated person is employed.

Questionnaires and employment applications

Recordkeeping standards for stand-alone and bank SBS Entities are established by Exchange Act Rule 18a-5 such that each SBS Entity is required to make and keep current a questionnaire or application for employment for each associated person who is a natural person. Through the new rule set, the SEC is adopting an amendment to Rule 18a-5 that an SBS Entity does not need to make or keep current such questionnaires or employment applications if the entity is excluded from the statutory disqualification prohibition in Exchange Act 15F(b)(6) with respect to the associated person.

In addition, amendments to Rule 18a-5 have also been adopted to provide that a questionnaire or application for employment executed by an associated person who is not a U.S. person need not include certain information unless the SBS Entity (i) is required to obtain such information under applicable law in the jurisdiction in which the associated person is employed or located or (ii) obtains such information in conducting a background check that is customary for such firms in that jurisdiction. In this second case, the creation or maintenance of records reflecting that information cannot result in a violation of applicable law in the jurisdiction in which the associated person is employed or located. Notwithstanding this recordkeeping relief, the SBS Entity must comply with Section 15F(b)(6) of the Exchange Act.

Other information

Finally, the SEC also issued a statement with regard to compliance with rules for security-based swap data repositories and Regulation SBSR governing regulatory reporting and public dissemination of security-based swap transactions. The statement sets forth which actions with respect to security-based swap reporting rules will not provide a basis for enforcement action for four years following Regulation SBSR’s first compliance date. 

These rule amendments become effective on March 1, 2020 or 60 days after publication of the adopting release in the Federal Register, whichever is later. As noted in previous Commission releases, the compliance date for registration of SBS Entities will be 18 months after the effective date (the “Registration Compliance Date”). The compliance date for the amendments to Rule 3a71-3 will be two months prior to the Registration Compliance Date. The
compliance date for the amendments to Rules 18a-5 and 15Fb2-1 will be the same as the Registration Compliance Date. The compliance date associated with the other rule amendments adopted today will be the same as the effective date.

Sources:

SEC Adopts Actions to Stand Up Security-Based Swap Regulatory Regime (www.sec.gov)

Rule Amendments and Guidance Addressing Cross-Border Application of Certain Security-Based Swap Requirements (www.sec.gov)