Establishing a Registration Framework for Dealers and Major Participants in the Derivatives Market
Commissioner Luis A. Aguilar
Aug. 5, 2015
The financial crisis of 2008, and the ensuing turmoil, shook the global economy to its core and exposed the weaknesses of our regulatory regime. Years of lax attitudes, deregulation, and complacency allowed an unregulated derivatives marketplace to cause serious damage to the U.S. economy, resulting in significant losses to investors. As a result, Title VII of the Dodd-Frank Act tasked the SEC and the CFTC with establishing a regulatory framework for the over-the-counter swaps market. In particular, the SEC was tasked with regulating the security-based swap (SBS) market and the CFTC was given regulatory authority over the much larger swaps market, covering products such as energy and agricultural swaps.
Today, the global derivatives market is estimated to exceed $630 trillion worldwide—with approximately $14 trillion representing transactions in SBS regulated by the SEC. The regulatory regime for the SBS market, however, cannot go into effect until the SEC has put in place the necessary rules to implement Title VII.
To that end, one of the crucial components of Title VII is the addition of Section 15F to the Exchange Act, which requires the Commission to adopt rules to provide for the registration of SBS dealers and major participants. Moreover, the statute makes it unlawful for these entities to permit any statutorily disqualified associated person to effect or be involved in effecting SBS transactions on their behalf.
To fulfill these mandates, today, the Commission adopts rules and forms that largely follow the rules it proposed in 2011. If adopted, these rules would allow the Commission to oversee the derivatives market and protect investors in a number of ways:
- First, the registration rules will provide the Commission with pertinent information and oversight authority as to all of its registrants—both foreign and domestic—and thus avoid any cross-border limitation on its oversight that could impair its ability to regulate and monitor the SBS market.
- Second, the rules require a senior officer to certify that there are policies and procedures in place to prevent violations of the federal securities laws, and to maintain documentation supporting this certification. The rules will also require a Chief Compliance Officer (CCO) to certify that the registrant has determined that none of its associated persons are subject to a statutory disqualification—whether they are natural persons or entities—unless relief is specifically provided by the Commission. These certifications will help facilitate the Commission’s ongoing risk assessments and oversight of the SBS market; help market participants make informed counterparty choices; and help keep the bad apples out of the industry.
- Finally, the rules will deem an applicant to be conditionally registered as soon as its completed application for registration is submitted. As a result, the Title VII rules, such as the recordkeeping rules, will apply to the applicant immediately. In addition, the conditional registration will allow the SEC staff, if appropriate or necessary, to conduct promptly an examination of the registrant.
In conjunction with today’s adoption of the registration rules, the Commission is also proposing Rule 194 to the Commission’s Rules of Practice. This rule provides a process for the Commission to determine whether it is in the public interest to permit a statutorily disqualified associated person to continue to engage in SBS transactions on behalf of an SBS entity.
Specifically, proposed Rule 194 would provide registered SBS entities with an initial 30-day temporary exclusion from the statutory prohibition. This will allow them to continue to engage in transactions with associated persons that have become statutorily disqualified. If, however, before this temporary exclusion elapses, an SBS entity seeks a permanent exclusion by filing for relief under proposed Rule 194, then the SBS entity’s exclusion will be automatically extended for up to a maximum of 180 days. The proposed time period is based on the staff’s preliminary belief that up to 180 days may be needed to appropriately process an application for relief. During this time frame, the Commission staff would conduct its due diligence, make a recommendation to the Commission, and seek a Commission decision as to whether a permanent exclusion should be granted or denied.  If the Commission does not grant the permanent relief, the SBS entity would have 60 days to comply with the statutory prohibition.
Clearly, the need for having adequate time to evaluate properly these applications must be balanced against the concerns raised by the prospect of having a statutorily disqualified associated person continuing to engage in transactions with registered SBS entities. Accordingly, the proposing release invites public comments on whether the proposed 180-day time period is appropriate. Simply stated, is the time period for temporary exclusion too long or too short, and are there better alternatives to the current proposal?
Moreover, proposed Rule 194(j) would permit, in general, an SBS entity to engage in transactions with statutorily disqualified associated persons where another regulatory authority, such as FINRA or the CFTC, has permitted an associated person to continue to engage in transactions with the SBS entity, notwithstanding what would otherwise be a statutory disqualification. Obviously, such deference raises, among other things, complex regulatory issues and potential tensions between providing comity to certain regulators and the need for the Commission to fulfill its Congressional mandate in a way that does not abrogate its own regulatory responsibilities. Accordingly, the proposing release discusses this subject and asks a number of important questions. Clearly, this is a difficult and thorny issue, and the Commission’s decision at the adopting stage will be greatly benefited by hearing from commenters.
Ultimately, I will support both the adopting release for the registration of SBS entities and the Rule 194 proposing release. They are vital steps for putting in place a registration framework for SBS dealers and major participants. I note, however, that the registration rules will not become effective until the Commission adopts the capital, margin, and segregation rules; the recordkeeping and reporting rules; the business conduct rules; and today’s proposed rules dealing with statutorily disqualified associated persons involved in SBS transactions. To this end, I urge my fellow Commissioners to move with urgency and adopt these rules, as well as the rest of the long-overdue Title VII rules. We need these rules to promote transparency and accountability in the derivatives market.
Finally, I want to thank the SEC staff for your work in this release, especially the staff from the Office of Chief Counsel in the Division of Trading and Markets. I appreciate your engagement with my office and for responding to all of my questions and comments.
 Better Markets, Inc., The Cost of the Crisis: $20 trillion and counting (July 2015), available at http://www.bettermarkets.com/sites/default/files/Better%20Markets%20-%20Cost%20of%20the%20Crisis.pdf. See, e.g., Report of the Senate Committee on Banking, Housing, and Urban Affairs, The Restoring American Financial Stability Act of 2010, S. Rep. No. 111-176 at 29 (2010) (“Many factors led to the unraveling of this country’s financial sector and the government intervention to correct it, but a major contributor to the financial crisis was the unregulated over-the-counter (‘OTC’) derivatives market.”), available at http://www.gpo.gov/fdsys/pkg/CRPT-111srpt176/pdf/CRPT-111srpt176.pdf.
 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Pub. L. 111-203, § 410 (2010).
 United States Commodity Futures Trading Commission (CFTC).
 See Section 712(a) of the Dodd-Frank Act.
 SEC Website, Derivatives, available at https://www.sec.gov/spotlight/dodd-frank/derivatives.shtml (last visited Aug. 3, 2015). The SEC and the CFTC share regulatory authority over “mixed swaps,” which are SBS that have a commodity component. Id.
 See, Bank for International Settlements, Statistical release: OTC derivatives statistics at end-December 2014, at 15 (Table 1) (Apr. 2015), available at http://www.bis.org/publ/otc_hy1504.pdf. The SBS market was estimated to be about $14 trillion worldwide. See id. (According to data published by the Bank for International Settlements, the global notional amounts outstanding in equity forwards and swaps and single-name credit default swaps as of December 2014 were approximately $2.50 trillion and $9 trillion, respectively. This analysis assumes that all equity forwards and swaps and single-name credit default swaps are SBS, and single-name credit default swaps constitute approximately 80% of the SBS market.).
 See Commissioner Luis A. Aguilar, Regulating Key Players in Security-Based Swaps (Oct. 12, 2011), available at https://www.sec.gov/news/speech/2011/spch101211laa-sbs.htm.
 Securities Exchange Act of 1934 (“Exchange Act”).
 See Registration Process for Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-________, at I.A. (Aug. , 2015), available at ________________________________ (hereinafter “Adopting Release”).
 See Applications by Security-Based Swap Dealers or Major Security-Based Swap Participants for Statutorily Disqualified Associated Persons to Effect or be Involved in Effecting Security-Based Swaps, at I. (Aug. , 2015), available at ___________________________________ (hereinafter “Proposing Release”); Section 15F(b)(6) of the Exchange Act.
 See Section 15F(a) and (b) of the Exchange Act.
 See Adopting Release at I.D.; see Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-65543 (Oct. 12, 2011), available at http://www.sec.gov/rules/proposed/2011/34-65543.pdf.
 To help facilitate the Commission’s supervisory and oversight roles, including the exercise of its inspection and examination authority, the rules require non-resident SBS dealers and major participants to appoint an agent for service of process in the U.S., maintain books and records and provide them promptly upon request, and submit to inspections and examinations by the Commission. See Adopting Release at II.D. and § 240.15Fb2-4. In light of the global nature of the SBS market, the Commission must have the ability to access information promptly in order to supervise its registrants and enforce its laws.
 See Adopting Release at II.A.1.vi.
 See Adopting Release at I.D. and § 240.15Fb2-1(b).
 See Adopting Release at II.A.1. and n. 30 (“While this certification is only required at the time of initial registration, Exchange Act Section 15F(k)(2) establishes duties for a CCO which include, among other things, a requirement that the CCO ensure compliance with Exchange Act Section 15F and the regulations thereunder relating to security-based swaps, including each rule prescribed by the Commission under this section. In addition, the Commission has proposed rules that would require each SBS Entity to establish, maintain and enforce a system to supervise, and to supervise diligently, the business of the SBS Entity involving security-based swaps. Those proposed rules would require that this system be reasonably designed to achieve compliance with applicable federal securities laws and the rules and regulations thereunder. See Proposed Rule 15Fh—3(i). In addition, the proposed rules would require that an SBS Entity establish, maintain, and enforce written policies and procedures addressing the types of business in which the security-based swap dealer or major security-based swap participant is engaged that are reasonably designed to achieve compliance with applicable securities laws and the rules and regulations thereunder. See Proposed Rule 15Fh-3(i)(2)(iii). The proposed rules also indicate that an SBS Entity would not be deemed to have failed to diligently supervise any other person if, among other things, it has established and maintained written policies and procedures, and a documented system for applying those policies and procedures, that would reasonably be expected to prevent and detect, insofar as practicable, any violation of the federal securities laws and the rules and regulations thereunder relating to security-based swaps. See Proposed Rule 15Fh-3(i)(3). See also, Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Exchange Act Release No. 64766 (Jun. 29, 2011), 76 FR 42396 (Jul. 18, 2011) (the “Business Conduct Standards Proposing Release”), at 42419 through 42421.”).
 See Adopting Release at I.D. and § 240.15Fb6-2.
 See Adopting Release at V.C.
 See Adopting Release at II.A.1.iii. and § 240.15Fb2-1(d). For the application to be considered complete, the senior officer and CCO certifications are required to be submitted to the Commission at the time the application is made. The conditional registration expires on the date the Commission grants or denies the person’s ongoing registration, or the registrant withdraws from registration. See § 240.15Fb3-1(b) (Duration of registration: Conditional registration); § 240.15Fb2-1(e) (Registration of security-based swap dealers and major security-based swap participants: Commission decision).
 See Adopting Release at II.A.1.iii.
 See Proposing Release.
 See Proposing Release at II.C.2. and § 201.194(b).
 See Proposing Release at I. and § 201.194(i)(1)(i).
 See id.
 See Proposing Release at II.C.8.
 See Proposing Release at I. and § 201.194(i)(1)(ii).
 See id.
 Financial Industry Regulatory Authority (FINRA).
 See Proposing Release at II.C.9. and § 201.194(j).
 Indeed, it is unclear whether proposed Rule 194(j) is even necessary. For example, since estimates show that there will be more than 21,000 associated natural persons and more than 860 associated entities available in the market, SBS dealers and major participants may find it more efficient to simply disassociate with statutorily disqualified persons than to apply for relief. See Proposing Release at V.B. and V.C.
 In particular, Question 35 of the Proposing Release asks whether Rule 194(j) should even be adopted. See Proposing Release at III. Likewise, with respect to the issue of comity, Question 39 asks whether the exclusion should be limited to associated persons not registered with the Commission. See id.
 Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers, Release No. 34-68071 (Oct. 18, 2012), available at http://www.sec.gov/rules/proposed/2012/34-68071.pdf.
 Recordkeeping and Reporting Requirements for Security-Based Swap Dealers, Major
Security-Based Swap Participants, and Broker-Dealers; Capital Rule for Certain Security-
Based Swap Dealers, Release No. 34-71958 (Apr. 17, 2014), available at http://www.sec.gov/rules/proposed/2014/34-71958.pdf; Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Release No. 34-74245 (Feb. 11, 2015), available at http://www.sec.gov/rules/proposed/2015/34-74245.pdf.
 Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-64766 (June 29, 2011), available at http://www.sec.gov/rules/proposed/2011/34-64766.pdf.
 See Adopting Release at III.