SEC Issues Substituted Compliance Order for Germany and Notice of Substituted Compliance Application and Proposed Substituted Compliance Order for France

The Securities and Exchange Commission voted to take two actions to advance implementation of security-based swap regulation under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  First, the Commission is publishing a final substituted compliance order in response to an application by Germany’s Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).  In addition, the Commission is publishing a notice of application and proposed substituted compliance order in response to an application by France’s Autorité des Marchés Financiers (AMF) and Autorité de Contrôle Prudential et de Résolution (ACPR).       

“These actions reflect the latest of the Commission’s ongoing efforts, including engagement with multiple agencies and foreign counterparts, to stand up the Dodd-Frank Title VII regime and prepare for the registration of security-based swap dealers in 2021,” said SEC Chairman Jay Clayton.  “I thank our German, French and EU colleagues for their tireless efforts to advance cross-border regulatory cooperation, and SEC Commissioner Hester Peirce for her leadership in advancing efforts to stand up the Dodd-Frank Title VII regime.”

The substituted compliance order for Germany provides that certain German firms that are registered with the Commission as security-based swap dealers and major security-based swap participants conditionally may satisfy certain requirements under the Securities Exchange Act of 1934 by complying with comparable German and European Union (EU) requirements.  The Commission retains the authority to inspect, examine and supervise non-U.S. firms and take enforcement action as appropriate.  The Commission and BaFin also have entered into a memorandum of understanding to address supervisory and enforcement cooperation and other matters arising under substituted compliance.

The French application similarly seeks substituted compliance for French security-based swap entities based on compliance with French and EU requirements.  In contrast to the German order, the French proposed order also makes a proposed substituted compliance determination with respect to non-prudentially regulated firms’ capital, margin, recordkeeping, reporting, notification, and securities count requirements under the Exchange Act. 

These actions reflect the Commission’s consideration of the comparability of applicable non-U.S. requirements, and incorporate conditions intended to help promote comparability in practice.

“Substituted compliance is a critical component to the workable yet effective regulation of the global OTC derivatives markets,” said SEC Commissioner Hester Peirce.  “I am pleased that the Commission is taking these steps, including considering substituted compliance with respect to capital and margin requirements in connection with the French application.  I look forward to considering applications for substituted compliance for additional jurisdictions in the near future.”

The public comment period for the French application will remain open for 25 days following publication of the notice and proposed order in the Federal Register.  Additional information about substituted compliance applications is available at: https://www.sec.gov/page/exchange-act-substituted-compliance-and-listed-jurisdiction-applications-security-based-swap.

FACT SHEET

Commission Substituted Compliance Order for Germany and French Substituted Compliance Application and Proposed Commission Order

Dec. 22, 2020

Action

The Commission is taking two actions to advance the availability of substituted compliance for certain non-U.S. security-based swap dealers and major security-based swap participants, in anticipation of those firms’ registration with the Commission in 2021.

First, in response to an application by Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the Commission is publishing an order to conditionally permit certain German firms registered with the Commission as security-based swap dealers or major security-based swap participants to satisfy certain requirements under the Securities Exchange Act of 1934 by complying with comparable German and EU requirements.  In connection with this order, the Commission and BaFin have entered into a memorandum of understanding to address supervisory and enforcement cooperation and other matters arising under substituted compliance.

Separately, the Commission is publishing notice of an application by the French Autorité des Marchés Financiers (AMF) and the Autorité de Contrôle Prudential et de Résolution (ACPR), requesting substituted compliance for French security-based swap dealers and major security-based swap participants.  The Commission also is publishing a proposed order to conditionally provide substituted compliance to French firms. 

Substituted Compliance Framework

Exchange Act rule 3a71-6 conditionally provides that non-U.S. security-based swap dealers and major security-based swap participants may satisfy certain requirements under Section 15F of the Exchange Act by complying with foreign requirements that the Commission has found to be comparable.  The Commission’s comparability assessment must consider the scope and objectives of the foreign requirements and also the effectiveness of the foreign financial supervisory and enforcement frameworks.   

Rule 3a71-6 further conditions substituted compliance on the Commission and the foreign financial regulatory authority entering into a supervisory and enforcement memorandum of understanding and/or other arrangement addressing supervisory and enforcement cooperation and other matters related to substituted compliance.  

Substituted compliance does not constitute exemptive relief, but instead provides an alternative method by which non-U.S. dealers and major participants may comply with applicable U.S. requirements.  The Commission retains the authority to inspect, examine and supervise those firms and take enforcement action as appropriate.

The registration compliance date for security-based swap dealers and major security-based swap participants is October 6, 2021, and market participants will begin counting security-based swap transactions and positions toward the registration thresholds on August 6, 2021.  See “Key Dates for Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants,” available at https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants.

Substituted Compliance Order for Germany

The Commission’s order for Germany provides for conditional substituted compliance in connection with requirements under the Exchange Act regarding: 

• Risk control – requirements related to risk management systems, trade acknowledgment and verification, portfolio reconciliation, portfolio compression and trading relationship documentation.
• Recordkeeping and reporting – requirements related to record creation, record maintenance, reporting and notices (with respect to prudentially regulated firms only).
• Internal supervision and compliance – requirements related to supervision, conflicts of interest and chief compliance officers, and certain related matters.
• Counterparty protection – requirements related to fair and balanced communications; disclosure of material risks and characteristics; disclosure of material incentives or conflicts of interest; daily mark disclosure; “know your counterparty;” and suitability.

Consistent with rule 3a71-6, the availability of substituted compliance reflects the comparability of applicable German and EU requirements, and the effectiveness of the German financial supervisory and enforcement frameworks.  The order incorporates certain conditions and other limits to promote the comparability of regulatory outcomes, including: 

• Portfolio reconciliation and dispute reporting – Firms would have to report counterparty valuation disputes directly to the Commission, based on EU timing requirements.
• Trading relationship documentation – Firms could not apply the MiFID “eligible counterparty” exception in connection with applicable German and EU requirements.  Also, firms would not receive substituted compliance in connection with certain disclosure-related provisions except with respect to non-U.S. counterparties.
• Internal supervision requirements – Firms’ internal supervision framework must promote compliance with certain residual U.S. requirements and the conditions to the order.
• Compliance reports – Firms must provide compliance reports directly to the Commission.  This condition does not require that the reports be provided to EU or German authorities.
• Suitability – The firm’s counterparty must be treated as a “per se professional client” under German and EU requirements and must not be a “special entity” as defined in Exchange Act section 15F(h)(2)(C) and Exchange Act rule 15Fh-2(d). 
• Daily mark disclosure – The firm must be required to reconcile, and in fact reconcile, the portfolio containing the relevant security-based swap on each business day.
• Recordmaking – The firm would need to: (a) preserve the data elements to create certain records required by the Commission’s rule and furnish the record in the format (e.g., blotter or ledger) required by that rule; (b) make certain records related to the security-based swap dealer segregation rule if the firm is not exempt from that rule; and (c) make certain records related to business conduct requirements for which substituted compliance is not available.
• Record preservation – The firm would need to: (a) preserve records related to the security-based swap dealer segregation rule if the firm is not exempt from that rule; and (b) preserve certain records related to Regulation SBSR and business conduct requirements for which substituted compliance is not available.
• Financial and Operational Reporting – The firm would need to report financial and operational information in the manner and format specified by Commission order or rule and present the financial information in accordance with GAAP that the firm uses to prepare general purpose publicly available or available to be issued financial statements in Germany.
• Notification – The firm would need to:  (a) simultaneously transmit to the Commission a copy of any notice required to be sent by comparable German and EU laws and include contact information of a person who can provide further details about the notice; and (b) comply with the requirement in the Commission’s rule to provide notice of failure to make a required deposit into the reserve account required by the segregation rule for security-based swap dealers. 

German firms would remain subject to Exchange Act requirements to keep books and records open to inspection by the Commission and to furnish promptly to the Commission legible, true, complete, and current copies of those records of the firm that are required to be preserved.  BaFin has provided adequate assurances that firms subject to the order can meet these Exchange Act requirements.     

Substituted Compliance Notice and Proposed Order for France

The substituted compliance application for France generally addresses the same Exchange Act requirements that are the subject of the German substituted compliance order, but also encompasses non-prudentially regulated firms’ capital, margin, recordkeeping, reporting, and notification requirements under the Exchange Act. 

The application includes analyses that compare French and EU requirements with relevant requirements under the Exchange Act, as well as information regarding the financial supervisory and enforcement frameworks in France. The application is available on the Commission’s website at https://www.sec.gov/files/full-french-application.pdf.

The French proposed order would be conditioned on compliance with relevant French and EU requirements and, in large part, incorporates similar conditions to those for Germany.  Unlike the German order, the proposed French order also includes conditions addressing non-prudentially regulated firms’ recordkeeping and reporting requirements, including conditions regarding their audited financial statements. 

The Commission is requesting comment on each of these proposed determinations and conditions.

Next Steps

The Germany order is effective immediately.  The Commission will seek public comment on the French application and proposed order for 25 days following publication in the Federal Register. 

Security-based swap market participants are urged to be mindful of the October 2021 registration compliance date for security-based swap dealers and major security-based swap participants, and relevant firms should take action to prepare for registration.  For further information, firms may contact the Office of Derivatives Policy in the Commission’s Division of Trading and Markets, at 202-551-5870.