Testimony on Implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act by the U.S. Securities and Exchange Commission
by Chairman Mary L. Schapiro
Before the United States Senate Committee on Agriculture, Nutrition and Forestry
March 3, 2011
Chairman Stabenow, Ranking Member Roberts, and members of the Committee:
Thank you for inviting me to testify today on behalf of the Securities and Exchange Commission regarding its implementation of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act” or “Act”), which primarily relates to the regulation of over-the-counter (“OTC”) derivatives. Title VII of the Act requires the SEC, among other regulators, to conduct a substantial number of rulemakings and studies. Although this task is challenging, particularly when viewed in the context of the SEC’s other Dodd-Frank Act rulemaking responsibilities, we are committed to fulfilling the objectives of the Act in a responsible and diligent manner, while seeking the broad public input and consultation needed to get these important rules right. My testimony today will briefly describe our progress and plans for implementing Title VII of the Dodd-Frank Act.
OTC Derivative Marketplace
As has been frequently noted, the growth of the OTC derivatives marketplace has been dramatic over the past three decades. From its beginnings in the early 1980s, when the first swap agreements were negotiated, the notional value of these markets has grown to almost $600 trillion globally.1 However, OTC derivatives were largely excluded from the financial regulatory framework by the Commodity Futures Modernization Act of 2000. As a securities and capital markets regulator, the SEC has been particularly concerned about OTC derivatives products that are related to, or based on, securities or securities issuers, and as such are connected with the markets the SEC is charged with overseeing.
The Dodd-Frank Act mandates oversight of the OTC derivatives marketplace. Title VII of the Act requires that the SEC write rules that address, among other things, mandatory clearing, the operation of security-based swap execution facilities and data repositories, capital and margin requirements and business conduct standards for security-based swap dealers and major security-based swap participants, and regulatory access to and public transparency for information regarding security-based swap transactions. This series of rulemakings should improve transparency and facilitate the centralized clearing of security-based swaps, helping, among other things, to reduce counterparty risk. It should also enhance investor protection by increasing disclosure regarding security-based swap transactions and helping to mitigate conflicts of interest involving security-based swaps. In addition, these rulemakings should establish a regulatory framework that allows OTC derivatives markets to continue to develop in a more transparent, efficient, accessible, and competitive manner.
The implementation of Title VII is a substantial undertaking and raises a number of challenges. Accordingly, we have been engaging in an open and transparent implementation process, seeking input on the various rulemakings from interested parties even before issuing formal rule proposals. We will continue to seek input on each proposal with the goal of producing effective and workable regulation of derivatives activities.
We have enhanced our public consultative process by expanding the opportunity for public comment beyond what is required by law. For instance, we have made available to the public a series of e-mail boxes to which interested parties can send preliminary comments before rules are proposed and the official comment periods begin. These e-mail boxes are on the SEC website, organized by topic. We also specifically solicited comment, along with the CFTC, on the definitions contained in Title VII of the Act.
In addition, our staff has sought the views of affected stakeholders. This approach has resulted in meetings with a broad cross-section of interested parties. To further this public outreach effort, the SEC staff has held joint public roundtables and hearings with the CFTC staff on select key topics. Through these processes, we have received a wide variety of views and information that is useful to us in proposing and, ultimately, adopting rules that are appropriate for these markets.
Coordination with the CFTC and Other Regulators
In implementing Title VII, our staff is meeting regularly, both formally and informally, with the staffs of the CFTC, Federal Reserve Board, and other financial regulators. In particular, SEC staff has consulted and coordinated extensively with CFTC staff in the development of the proposed rules. Although the timing and sequencing of the CFTC’s and SEC’s proposed rules may vary, they are the subject of extensive interagency discussions. The SEC’s rules will apply to security-based swaps and the CFTC’s rules will apply to swaps, but our objective is to establish consistent and comparable requirements, to the extent possible, for swaps and security-based swaps. Due in part to differences in products, participants, and markets, some of our rule proposals contain different approaches to various issues. Nonetheless, as we move toward adoption, the objective of consistent and comparable requirements will continue to guide our efforts.
In addition, as required by the Act, we are working with the CFTC to adopt joint rules further defining key terms relating to the products covered by Title VII and certain categories of market intermediaries and participants. Joint rulemaking regarding key definitions will promote regulatory consistency and comparability, and thus help to prevent regulatory gaps that could foster regulatory arbitrage and overlaps that could confuse, or impose unnecessary added costs upon, market participants.
Finally, we recognize that other jurisdictions are also developing regulatory frameworks that will address many of the areas covered by Title VII. The manner and extent to which we and foreign regulators regulate derivatives will affect both U.S. and foreign entities and markets. Consequently, as we progress with the implementation of Title VII, we will continue to consult with regulatory counterparts abroad in an effort to promote robust and consistent standards and avoid conflicting requirements, where possible. The SEC and CFTC are, in fact, directed by the legislation to consult and coordinate with foreign regulators on the establishment of consistent international standards governing swaps, security-based swaps, swap entities, and security-based swap entities. We believe that bilateral discussions with foreign regulators, as well as our engagement in the recently formed IOSCO Task Force on OTC Derivatives Regulation, which the SEC co-chairs, and our participation in other international forums will help us achieve this goal.
In short, we remain committed to working closely, cooperatively, and regularly with our fellow regulators to facilitate our implementation of the regulatory structure established by the Dodd-Frank Act.
Actions Already Taken
The SEC has taken significant steps in implementing the rulemaking required by Title VII. To date, the SEC has proposed a number of rulemakings required by this title.
In October 2010, we proposed rules to mitigate conflicts of interest involving security-based swaps. These proposed rules seek to address conflicts of interest at security-based swap clearing agencies, security-based swap execution facilities, and exchanges that trade security-based swaps.
In November 2010, we proposed anti-fraud and anti-manipulation rules for security-based swaps that would subject market conduct in connection with the offer, purchase, or sale of any security-based swap to the same general anti-fraud provisions that apply to all securities and reach misconduct in connection with ongoing payments and deliveries under a security-based swap. We also proposed rules regarding trade reporting, data elements, and real-time public dissemination of trade information for security-based swaps. Those rules lay out who must report security-based swap transactions, what information must be reported, and where and when it must be reported. In addition, we have proposed rules regarding the obligations of security-based swap data repositories, which would require security-based swap data repositories to register with the SEC and specify other requirements with which security-based swap data repositories must comply.
In December 2010, we proposed rules relating to mandatory clearing of security-based swaps. These rules would set out the way in which clearing agencies would provide information to the SEC about security-based swaps that the clearing agencies plan to accept for clearing. We also proposed rules relating to the exception to the mandatory clearing requirement for end users. These rules would specify the steps that end users must follow, as required under the Act, to notify the SEC of how they generally meet their financial obligations when engaging in security-based swap transactions exempt from the mandatory clearing requirement. In addition, we proposed joint rules with the CFTC regarding the definitions of swap and security-based swap dealers, and major swap and major security-based swap participants. These rules lay out objective criteria for these definitions and are a first step in helping the SEC appropriately address the market impacts and potential risks posed by these entities.
Thus far in 2011, we have proposed rules regarding the confirmation of security-based swap transactions, which would govern the way in which certain security-based swap transactions are acknowledged and verified by the parties who enter into them. We also proposed rules regarding registration and regulation of security-based swap execution facilities, which would define security-based swap execution facilities, specify their registration requirements, and establish their duties and core principles. And most recently, we proposed rules regarding standards for the operation and governance of clearing agencies. On the same day as this recent proposal, we also reopened the comment period for our October proposal regarding conflicts of interest at security-based swap clearing agencies, security-based swap execution facilities, and exchanges that trade security-based swaps.
In addition, we adopted interim final rules in October 2010 regarding the reporting of outstanding security-based swaps entered into prior to the date of enactment of the Dodd-Frank Act. These interim final rules require certain security-based swap dealers and other parties to preserve and report to the SEC or a registered security-based swap data repository certain information pertaining to any security-based swap entered into prior to the July 21, 2010 passage of the Dodd-Frank Act and whose terms had not expired as of that date.
This spring, we expect to propose rules regarding registration procedures, business conduct standards, and capital, margin, segregation, and recordkeeping requirements for security-based swap dealers and major security-based swap participants.
We also expect to propose joint rules with the CFTC governing the definitions of “swap” and “security-based swap”, as well as the regulation of “mixed swaps.”
The SEC has been carefully reviewing all the comments received regarding the rules that already have been proposed and we are in the process of considering those comments. We also are continuing discussions with various market participants about their concerns and ideas regarding the proposed rules. This information is invaluable as we move toward consideration of final rules designed to further the purposes of the Dodd-Frank Act and the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation and provide effective regulation of the security-based swap markets without imposing unjustified costs or having unforeseen adverse consequences. We will, of course, be engaged in the same process for our upcoming proposed rulemakings, and I would like to take this opportunity to encourage market participants and the public to continue submitting comments on these upcoming proposed rulemakings.
Anticipated Completion of Rulemaking
We are working to complete the rulemaking proposal and adoption process under Title VII within Congress’ deadlines for implementation. Nonetheless, this is a very challenging task. The OTC derivatives markets are large and interconnected. The issues are complex and do not lend themselves to easy solutions. We are progressing at a deliberate pace, taking the time necessary to thoughtfully consider the issues raised by the various rulemakings before proposing specific rules. We will take a similar approach as we move toward consideration of final rules.
There are unique challenges involved in imposing a comprehensive regulatory regime on existing markets, particularly ones that until now have been almost completely unregulated. For example, in proposing margin rules, we will be mindful both of the importance of security-based swaps as hedging tools for commercial end users and also of the need to set prudent risk rules for dealers in these instruments. We also need to carefully consider how our rules might impact pre-existing contracts. For example, in developing rules that concern the capital and margin requirements for security-based swap dealers, we will need to consider dealers’ pre-existing security-based swaps. The application of new rules to existing security-based swaps could be very disruptive and impose burdens on dealers or their counterparties that they did not bargain for or anticipate. We discussed this issue, along with the end-user margin issue, with various stakeholders at a joint SEC-CFTC roundtable in December, and are taking the input we received at the roundtable and from other sources into account in writing proposed rules.
The Dodd-Frank Act provides the SEC with important tools to better meet the challenges of today's financial marketplace and fulfill our mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. As we proceed with implementation, we look forward to continuing to work closely with Congress, our fellow regulators, and members of the financial and investing public. Thank you for inviting me to share with you our progress on and plans for implementation. I look forward to answering your questions.
1 See Bank of International Settlements, Positions in Global Over-the-Counter (OTC) Derivatives Markets at End-June 2010, Monetary and Economic Department (Nov. 2010), http://www.bis.org/publ/otc_hy1011.pdf.