Speech by SEC Commissioner:
Opening Remarks Regarding the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants (Proposed Rules 15Fb1-1 through 15Fb6-1)
Commissioner Elisse B. Walter
U.S. Securities and Exchange Commission
October 12, 2011
Thank you, Chairman Schapiro. I, too, would like to thank the staff for its hard work on the proposal before us today. In particular, I’d like to thank Bonnie Gauch, Joe Furey, and Nathaniel Stankard of the Division of Trading and Markets for their tireless effort and unyielding professionalism relating to this and many other matters. And, I’d like to thank David Blass and say how good it is to see you here in your new capacity as Chief Counsel of the Division. I’d also like to thank the staff of the Office of Compliance Inspections and Examinations for their critical input into this proposal. I truly appreciate all the effort reflected in this important release and, in particular, your responsiveness to my questions and comments. Last, but not least, I’d like to thank my counsel, Brian Murphy, who has done such exceptional work on this matter.
As you have just heard, the proposal before us today establishes the necessary framework for the Commission to grant or deny registration to security-based swap dealers and major security-based swap participants (known together as “SBS Entities”). This framework is based on the existing registration programs applicable to other Commission registrants - such as broker-dealers, exchanges, and clearing agencies - and includes the forms necessary to apply for registration, the process by which one must apply for registration, and the actions the Commission will take in this area to carry out its mission.
I suspect most of you are here today due to our earlier consideration of the so-called “Volcker rule” and are not as focused on the facially technical process by which the Commission grants or denies potential registrants the privilege of acting in certain capacities in the marketplace. So I’d like to focus your attention on the importance of having a functional and effective registration program for all Commission registrants and particularly for SBS Entities. I know this sounds dry, but it is a fundamental component of the regulatory system that the Commission administers to maintain efficient markets and protect investors.
II. The Commission’s Registration Program
As you know, the Commission’s core mission is to protect investors, maintain orderly and efficient markets, and facilitate capital formation. The Commission seeks to fulfill its mission through a regulatory regime that consists of, among other things, a registration program that properly vets market participants seeking the Commission’s imprimatur, an examination program that subsequently evaluates the behavior of the market participants that become Commission registrants, and an enforcement program that holds those registrants accountable for their actions.
An effective registration program is central to a successful regulatory regime. Registration is the first time that the Commission is introduced to, interacts with, and begins to evaluate potential registrants before granting or denying them a license to conduct important financial intermediary functions in the securities markets. It allows the Commission to figuratively “kick-the-tires” and “look under the hood” of potential registrants to ensure they have the minimum capabilities necessary to operate their business, such as the capability to comply with the law.
In an ideal world, our registration program would include a comprehensive evaluation of each potential registrant immediately after it files an application for registration and subsequently on a periodic basis once registration is granted. But we do not live in an ideal world. We must account for practical realities and, given the Commission’s current resources and the low probability that we will be given sufficient resources to fulfill our historical and new mandates, I do not believe that we can perform all the functions I would like to see us perform when an entity applies for registration. In these tough times, we unfortunately have to do more with not enough. At the same time, we have to continue pursuing innovative solutions to the various problems arising from the rapid growth in number, size, and complexity of our markets and registrants.
That is why I am extremely pleased that the Commission, in this release, is publicly announcing its intent to conduct a comprehensive review of its existing registration programs.1 This is particularly timely given the number of potential new registrants that may seek registration with the Commission as a result of the Dodd-Frank Act. Such a comprehensive review of the vetting process associated with the Commission’s registration program should help the Commission construct an effective and consistent registration program for all Commission registrants and to ensure that we only grant registration to market participants that have the requisite capabilities to perform their important market functions.
III. The Commission’s Proposed Registration Program for SBS Entities
Ideally, this comprehensive review of the Commission’s existing registration programs would precede our consideration of registration programs for new categories of registrants, such as SBS Entities or swap data repositories. However, such sequencing is impossible given the urgent need to establish registration programs for such new registrants and the time it necessarily will take to conduct a comprehensive review of existing registration programs. Accordingly, the proposal draws on existing registration programs, and leverages potential registrants’ own resources, to craft what I hope will be a temporary - but nonetheless sufficient - registration program for SBS Entities.
The proposed registration program for SBS Entities largely mirrors the registration program applicable to, among others, broker-dealers because the broker-dealer registration regime should be familiar to, and understood by, many SBS Entities. In fact, many SBS Dealers may already be registered and regulated as broker-dealers or may be affiliated with broker-dealers.2 The proposed approach would seek to ensure that a market participant registered as both an SBS Entity and a broker-dealer is subject to a similar and complementary registration program.
A key aspect of the broker-dealer registration program,3 as well as the registration program applicable to other Commission registrants,4 is an assessment of whether the potential registrant possesses the basic capabilities to conduct its business in a registered capacity, such as the capability to comply with the law. While traditional securities activities certainly can have systemic implications, the Dodd-Frank Act reflects Congress’ particular concern about the systemic risk potentially posed by security-based swap activities, which would be exacerbated by entities engaging in such activities without sufficient operational, financial, or compliance capabilities. This assessment is especially important for SBS Dealers because their business involves a high degree of operational complexity, as well as significant financial resources and – with the enactment of the Dodd-Frank Act – compliance with a number of new statutorily-mandated requirements. It may also be important for major security-based swap participants to make such an assessment, as proposed. However, I look forward to public comment on this particular issue given the presumably different role major security-based swap participants play in the market.
In light of these risks, the Commission is proposing to require each SBS Entity to certify that it has performed certain of the assessments that would be made by an SRO in the course of a broker-dealer application process or by the Commission in the course of certain other registrants’ application processes. This proposed Senior Officer Certification would require that the senior officer attest that, after due inquiry, he or she has reasonably determined that the SBS Entity has the operational, financial, and compliance capabilities to act as an SBS Entity and has documented the process by which he or she reached such determination.
Recognizing that there are similarities and differences between security-based swap dealers, major security-based swap participants, brokers, dealers, and other Commission registrants, the Commission specifically avoids proposing a Senior Officer Certification requirement that dictates a “one-size-fits-all” approach to the certification process. Rather, the proposed Senior Officer Certification requirement allows SBS Entities the freedom to tailor their certification process to their particular business models.
The goal is quite simple – a potential registrant must be able to reasonably conclude that it can conduct the business for which it seeks a license from the Commission. This review, which I don’t think is particularly complicated, should seek to answer obvious, common sense questions. For example, if you propose to engage in the business of a security-based swap dealer, do you have necessary infrastructure to even function? Do you have the computing capacity you need? Do you have a person who understands, and can price, a security-based swap? Do you have a business plan? Do you have the necessary business relationships to conduct your business, such as those necessary to finance operations and clear transactions? Do you have the necessary internal systems to track and manage your positions? Do you have policies and procedures reasonably designed to prevent violations of the securities laws? Put simply, we need to know whether a potential registrant can function without putting investors or markets at risk.
In some ways, this Senior Officer Certification can be compared to the relatively straightforward and well-known process for obtaining a driver’s license. When a new driver applies for a driver’s license, the relevant regulator typically requires the applicant to demonstrate the ability to operate a car, the existence of financial resources necessary to account for accidents (i.e. insurance), and an understanding of the relevant motor vehicle laws. Similarly, the proposed SBS Entity registration program containing the Senior Officer Certification will help ensure that the Commission only grants licenses to SBS Entities that possess the minimal capabilities to operate a registered security-based swap business without harming investors or markets.
While I would prefer that the Commission be given the resources necessary to, among other things, conduct a comprehensive evaluation of each potential registrant immediately after it files an application for registration, I recognize that practical realities necessitate an alternate approach. And the self-certification approach is a good, practical solution for now. Consequently, I support the inclusion of the Senior Officer Certification because it would likely have many positive effects on the marketplace. For example, it would help to assure investors, customers of, and counterparties to an SBS Entity that it has the requisite capabilities to act as an SBS Entity. This could serve to maintain and facilitate market efficiency and capital formation since potential investors may be comforted by the very existence of a deliberate and thoughtful self-assessment of an SBS Entity’s capabilities. It could also help maintain orderly and efficient markets, as well as protect investors, by preventing the potential failure of an SBS Entity that lacks the minimal capabilities necessary to operate a security-based swap business. Furthermore, the Senior Officer Certification could foster more orderly and efficient OTC derivatives markets by enhancing market participants’ ability to accurately assess the counterparty credit risk associated with a particular SBS Entity counterparty.
I support this proposal and, like my colleagues, urge you to review this proposal carefully and give us the benefit of your considered thoughts throughout the comment process. And I look forward to getting your input on our comprehensive registration review.
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1 Release at footnote 15 (stating: “…the Commission is presently reviewing the various standards and processes it uses to facilitate registration of the many types of entities required to register with it – including broker-dealers, investment advisers, nationally recognized statistical rating organizations, transfer agents, clearing agencies, exchanges, national securities associations, and others. In this regard, the Commission plans to issue a concept release designed to collect information and evaluate different aspects of these registration standards and processes...Recognizing that the Commission has finite resources to allocate to registration, examination, and enforcement functions, the Commission intends to use the concept release to seek comment as to how it can most effectively and efficiently utilize these registration and other functions to help ensure that entities registered by the Commission to perform important financial intermediary and other functions in the securities markets have the capability to carry out those functions and to fully comply with all applicable regulatory requirements.”).
2 Moreover, if an SBS Dealer enters into security-based swap transactions with persons that are not eligible contract participants, it must register as a broker-dealer. See 15 U.S.C. § 78c(a)(5) & 78o(a) (2011).
3 A broker-dealer who registers with the Commission under Section 15(b) of the Exchange Act also must become a member of an SRO. One such SRO, FINRA, has its own membership application procedures that include, among other things, an extensive review of the broker-dealer’s operational, financial, and compliance capabilities. See generally, NASD Rules 1013 & 1014. FINRA’s membership application review requires a new broker-dealer to, among other things, file a detailed business plan, explanation of its sources of funding, and description of the educational background and experience of its personnel. NASD Rule 1013. It also interviews each applicant prior to granting or denying membership and, at the conclusion of the registration process, may limit the functions the broker-dealer can perform. NASD Rule 1014(b)(3). Existing members that wish to enter into a materially new business, such as dealing in security-based swaps, must also file an application to do so. NASD Rule 1017. New business applications are reviewed with diligence comparable to a new member application to determine whether the broker-dealer has the requisite capabilities to conduct the new business. NASD Rule 1017(g). Moreover, as required by Exchange Act Rule 15b2-2, a new broker-dealer is also examined within six months to evaluate whether the broker-dealer is operating in conformity with applicable financial responsibility rules and again within twelve months to evaluate whether it is operating in conformity with all other applicable provisions of the Exchange Act and rules thereunder. 17 C.F.R. § 240.15b2-2(b)&(c) (2011). This membership and new business application process, the Commission’s oversight of such process, and the Commission’s other applicable regulations help ensure that registered broker-dealers have the necessary operational, financial, and compliance capabilities to engage in the broker-dealer business.
4 See, e.g., 15 U.S.C. § 78f(b)(1) (2011) (regarding registration of national securities exchanges); 15 U.S.C. § 78q-1(b)(3)(A) (2011) (regarding registration of clearing agencies); Security-Based Swap Data Repository Registration, Duties, and Core Principles, Exchange Act Release No. 63347 (Nov. 19, 2010), 75 FR 77306 (Dec. 10, 2010) (proposing registration rules for security-based swap data repositories that are intended to, among other things, assure the Commission that a swap data repository “is so organized, and has the capacity, to be able to assure the prompt, accurate, and reliable performance of its functions as a swap data repository, comply with any applicable provision of the Federal securities laws and the rules and regulations thereunder, and carry out its functions in a manner consistent with the purposes of Exchange Act.”).