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Statement on Proposed Rules for U.S. Personnel and Certain Activities of Non-U.S. Person’s Security-Based Swaps Dealing

Commissioner Kara M. Stein

April 29, 2015

During the financial crisis, the world witnessed how financial contracts known as swaps played a key role in creating a global financial hurricane.  These financial contracts tied together the destinies of seemingly unrelated financial firms.  The threat of a daisy chain of failures drove bailouts to companies no one dreamed would ever be risky.  What’s more, the crisis and bailouts flooded across international borders.  Indeed, over half of the largest recipients of the AIG bailouts were foreign organizations.[1]

Following the crisis, policymakers around the world committed to stop this from happening again.  The resulting reform legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), directed the Securities and Exchange Commission (“Commission”) and its fellow regulators to bring the swaps marketplace into the light and to make it resilient enough to weather the next storm. 

Because swaps between a U.S. party and a foreign party make up such a large part of the global security-based swaps market – about 50 percent – a key piece of the reform effort must be appropriately overseeing cross-border swaps.[2]  Today’s release picks up where the Commission left off last year.  It proposes to answer the question of what to do when only certain activities involving a security-based swap transaction occur within the United States. 

To summarize the answer, we are proposing that if a security-based swap is arranged, negotiated, or executed by personnel located here in the United States, the transaction should be subject to both reporting and public dissemination requirements.  The transaction should also be counted towards the amount of security-based swaps activity in the U.S. used to trigger the Commission’s dealer registration requirement.

The central challenge in today’s rulemaking is how we handle the situation in which different parts or pieces of a security-based swap transaction are broken up across national borders.  Let’s think through some of the issues, starting with risk management.  

If a security-based swap is executed in the U.S. but booked, for example, in Europe, does it make sense that the swap should be subject to the U.S. clearing mandate?  One could argue that the Commission’s territorial approach to swaps regulation demands that any time a trade touches the U.S. at all, it should trigger full regulatory U.S. coverage.  Moreover, the U.S. is such an important market center, and the swaps marketplace is so interconnected.  Are there really many situations in which swaps booked abroad would actually pose no risk to the United States?  So, would a broad clearing mandate make sense from that perspective?  Moreover, when combined with appropriate substituted compliance, might that be one of the best ways to strengthen the regulatory floor internationally? 

On the other hand, one could argue that the purpose of clearing swaps is to reduce the chain of interconnectedness that could threaten the U.S. swaps marketplace and the U.S. financial system.  Thus, if a given security-based swap is booked such that its risk truly is not coming back to the U.S., then would subjecting the transaction to the U.S. clearing mandate actually increase risk to the U.S.?  It is also worth thinking through whether the application of substituted compliance in these circumstances would sufficiently ameliorate that concern, or whether it might actually pressure the U.S. to lower its substituted compliance standards, which might be harmful in other contexts.

Conceptual challenges also exist with regards to the requirement that standardized security-based swaps trade generally through a swap execution facility (SEF).  The goal of that requirement is to pool liquidity and facilitate efficient trading, including through pre-trade price transparency. Clearly, where a security-based swap is being arranged, negotiated, or executed by U.S. personnel, price discovery is occurring in the United States.  Today’s proposal recognizes our regulatory interests in that by requiring public dissemination.  But if the transactions governed by today’s proposed rules are swept out of the U.S. SEF execution requirement, that could result in an unfortunate loss of liquidity for U.S. SEFs.  It seems to me that we risk losing some, or even all, interdealer liquidity from the U.S. SEF marketplace. 

On the other hand, if that liquidity is very likely to leave if we do apply the SEF requirements to these cross-border trades, are the proposed rules today a measured response to that reality?  Moreover, security-based swaps, at least today, are thinly traded products, and thus may be less likely to go through SEFs anyway.[3]  So, are today’s proposed rules reasonably well tailored to balance the competing risks and regulatory interests of our security-based swap marketplace?  These are all questions that I hope commenters can explore.

The answers to these challenging questions may depend in part on what happens with the international regulatory coordination process.  We certainly do not want a race-to-the-bottom in swaps trading that ultimately threatens the U.S. or important economic partner jurisdictions. 

The Commission’s proposal today takes a tailored approach, and I am supporting it.  Its’ positives are clear.  Counting security-based swaps transactions towards the registration requirement is important. Registration ultimately triggers important oversight and financial responsibility obligations, especially related to margin.  Those components are essential for improving the resiliency of the swaps marketplace. 

In addition, the requirement for public dissemination brings significant amounts of transparency.  This is fundamental to investor protection and ensuring an orderly, fair, and efficient marketplace.  Public dissemination may be one of the most important parts of this rule. It should allow market participants to help patrol the markets and keep in check the build-up of large or abusive positions, such as the London Whale or Abacus-type trades. 

Although the Commission is proposing not to apply U.S. clearing or trade execution requirements to the transactions being discussed today, we note our intention to monitor future developments and take additional steps as necessary.  These are tools I take seriously. 

I also would like to highlight that today’s proposal is specifically tailored for the security-based swap market.  Its structure and policy choices may not be appropriate in other swaps marketplaces, such as the more liquid markets for interest rates and index swaps that are regulated by the Commodity Futures Trading Commission (CFTC).  We at the Securities and Exchange Commission may also wish to tailor our rules even further based on the liquidity or other characteristics of particular security-based swaps, which may change over time too.  Where we regulate similar marketplaces, the Commission and the CFTC should seek to coordinate our rules.  But everyone should remember that the marketplaces we regulate sometimes display notably different characteristics.  One size may not fit all. 

Before closing, I would like to call attention to two pieces of our upcoming work on swaps.  First, the Commission’s regimes for swap data repository registration and swaps reporting require a uniform product identifier and a uniform transaction identifier for every trade.  And, we are already moving ahead on developing taxonomies in these areas.  Pushing these priorities forward quickly, in close coordination with our international partners, is enormously important to getting the global swaps regulatory structure up and running, quickly and smartly.

Second, we need to make similar progress at moving margin rules forward in the near future.   However, I am concerned that international recommendations, and the domestic proposals that have followed to date, allow for a high floor before margin requirements kick in.  I am also concerned about pressure that would permit swaps between financial affiliates to go un-margined.  Let’s remember that if we don’t get margin right, we could aggravate the challenges of cross-border resolution of large financial groups, concentrate and underestimate risk within large financial groups, and undermine competition in the swaps market.  We need to think through all of these issues very carefully.    

In conclusion, I look forward to hearing commenter’s views on the rules we have proposed today and on all the issues before us related to getting our swaps regulatory regime up and running. 

I would like to thank the staff for their hard work  on this proposed rule, including Brian Bussey, Carol McGee, Richard Gabbert, Margaret Rubin, Lori Price, Robert Bagnall, Cynthia Ginsberg, Mykaila DeLesDernier, Vanessa Countryman, Hari Phatak, Charles Lin, Carl Emigholz, and Malou Huth. 

I look forward to seeing the next set of Title VII rules and proposals soon.

[1] Press Release: AIG Discloses Counterparties to CDS, GIA, and Securities Lending Transactions, American International Group, March 15, 2009, available at

[2] Securities and Exchange Commission, Application of Certain Title VII Requirements to Security-Based Swap Transactions Connected with a Non-U.S. Person’s Dealing Activity That Are Arranged, Negotiated, or Executed By Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent, April 29, 2015, Rel. No. 34-XXXX at 34-35.

[3] See Securities and Exchange Commission, Application of Certain Title VII Requirements to Security-Based Swap Transactions Connected with a Non-U.S. Person’s Dealing Activity That Are Arranged, Negotiated, or Executed By Personnel Located in a U.S. Branch or Office or in a U.S. Branch or Office of an Agent, April 29, 2015, Rel. No. 34-XXXX at 42 (Figure 5) and 135 (fn. 308).

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