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Statement at Open Meeting on Final Rules Regarding Application of Title VII Dealer De Minimis Requirements to Security-Based Swap Dealing Activity in the United States

Commissioner Kara M. Stein

Feb. 10, 2016

I too would like to thank the staff for their work in bringing this recommendation to the Commission, including Brian Bussey, Carol McGee, Richard Gabbert, Margaret Rubin, Hari Phatak, Charles Lin, Lori Price, Robert Bagnall, and Mykaila DeLesDernier.

Today, the Commission considers an important rule that clarifies who should register as a security-based swap dealer under U.S. law.  This rule acknowledges the global nature of swaps and their attendant risk.  It is designed to ensure that foreign dealers operating in the U.S. who pose a risk to United States markets cannot evade registering in the United States.  This rule does this by appropriately focusing on the location of the agents or the personnel engaged in the firm’s security-based swaps dealing activity. 

Swaps are financial contracts that can provide buyers and sellers with the ability to better control certain cash flows.   While these financial instruments may be helpful to market participants in managing their risks, they can also transfer risk in unpredictable ways.  During the financial crisis, we witnessed such risk transfer with nearly devastating effect. 

Over the course of a few days in 2008, AIG, who had sold credit default swaps (CDS) covering billions and billions of dollars in assets and was a major participant in the global trade of derivatives, helped to further a growing loss of confidence in the U.S. and global financial markets.  Credit default swaps function much like insurance for bonds.  AIG was promising that the bonds would pay or it would make up the difference.  As AIG’s own credit-worthiness came into question, a drumbeat of collateral calls questioned AIG’s ability to make good on its promises.  The shortfall was growing by billions of dollars each day, and AIG simply couldn’t pay.  As AIG neared catastrophic failure, the New York Federal Reserve Bank stepped in with an $85 billion emergency loan.  Within months, AIG borrowed nearly $128 billion from the government.[1]

The concentration of swap dealing activity amongst a few financial firms, as well as the opacity of the CDS market, contributed to the threat of a daisy chain of failures.  This resulted in the government having to bailout companies no one had ever dreamed would be risky.  Moreover, the global nature of swaps allowed the crisis to spread quickly around the world.  As a result, the bailouts and other effects of the crisis spilled across international borders. 

Today, the market for security-based swaps remains truly global.  About half of the trading activity in North American corporate single-name CDS occurs between U.S. counterparties and those based abroad, while approximately 40 percent occurs between non-U.S. counterparties.  Many of these non-U.S. counterparties are foreign affiliates of a U.S. financial group.  Foreign affiliates of a U.S. financial group may expose the U.S. financial group to “reputational risk.”  Such risk is inherent in the relationship between a U.S. financial group and its foreign affiliate.   A U.S. parent financial group is subject to consequences of the dealing activity of its foreign affiliate, regardless of any explicit guarantees.  A U.S. financial group can face this exposure by absorbing its foreign affiliate’s liabilities.  However, it can also face this exposure if market participants question the group’s creditworthiness in the event that it decides to not support its foreign affiliate.  Today’s final rule considers this potential spillover risk or contagion. 

Accordingly, when security-based swap transactions occur between two non-U.S. persons, but are arranged, negotiated, or executed by personnel or agents located in a U.S branch or office of a dealer, those transactions cannot be excluded from the volume test used to trigger dealer registration requirements.   Conversely, transactions that do not involve personnel or agents located in a U.S. branch or office of a dealer are excluded from the volume test.  As a result, today’s rule will help ensure that any dealer that exceeds the $8 billion notional threshold, including any of its dealing activity in the U.S., would need to register with the Commission during the initial phase in period.[2]

As I have said before, the determination of what security-based swaps transactions count for purposes of the registration requirement is very important.  Registration triggers important obligations and responsibilities for the good of the overall marketplace, for the good of the entities that may transmit those risks, as well as enhancing resilience in times of stress.  This rule appropriately considers the risks to the U.S. financial markets. 

While I am pleased to support today’s rule, there are a number of important Title VII rules that still need to be finalized prior to turning on the new dealer registration regime, including the application of business conduct standards, the application of capital and margin, as well as other dealer requirements.  Other key elements of the Title VII framework also remain outstanding, including reporting and dissemination of transactions and the application of clearing and trade execution requirements.  I look forward to the staff’s recommendation on these outstanding items in the near future.

Thank you.

[1]           The New York Federal Reserve Bank and the U.S. Department of the Treasury worked with AIG to stabilize the company so that it no longer posed a systemic risk and to ensure repayment of taxpayer assistance.  The failure of AIG, a company with more than 76 million customers in approximately 140 countries—more than 30 million customers in the United States alone—posed a direct threat to millions of policyholders, state and local government agencies, 401(k) participants, banks and other financial institutions in the United States and abroad, and would have shattered confidence in already fragile financial markets.  See

[2]               The Commission has established an $8 billion notional threshold for the de minimis exception with respect to single-name CDS for the initial phase in.  At the end of the phase in, the Commission will publicly report its findings.  The Commission may revise the level downward to $3 billion or implement other changes to the de minimis exception.  See Exchange Act Rule 3a71-2.  The threshold and phase in levels for other types of security-based swaps are $150 million and $400 million, respectively.  

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