SEC Adopts Cross-Border Swap Rules

June 26, 2014

The SEC proposed a series of rules addressing the application of security-based swap regulatory requirements under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) to cross-border activities.  The security-based swap market often involves counterparties located in different countries.  According to the SEC, a majority of transactions involving single-name credit default swaps on U.S. reference entities involve one or more counterparties located abroad. The SEC acknowledged that regulating the swap market is challenging because of its global and interconnected nature.

The Dodd-Frank Act established a comprehensive framework for regulating the over-the-counter derivatives market.  Title VII of the Dodd-Frank Act gave the SEC regulatory authority over security-based swaps and certain key players in that market, including security-based swap dealers and major security-based swap participants.

Pursuant to this authority, the SEC previously has defined “security-based swap.” In general, a derivative is a financial instrument or contract, such as a swap, whose value is “derived” from an underlying asset such as a commodity, bond, or equity security.  Derivatives provide a way for counterparties to transfer risk related to the underlying assets.  A “security-based swap” is a swap tied to a single security, loan, or issuer of securities, a narrow-based security index, or the occurrence of certain events relating to an issuer or issuers of securities in a narrow-based security index.

The new rules address one aspect of the proposal: determining when market participants are deemed to be security-based swap dealers or major security-based swap participants as a result of their cross-border activities and thus subject to dealer or major participant regulation. In 2012, the SEC adopted rules jointly with the CFTC, providing that a market participant would be considered a security-based swap dealer required to register with the SEC if its dealing transactions conducted in the past 12 months exceeded certain thresholds.  The new rules specify which cross-border dealing transactions count toward these dealer thresholds.

The new rules require U.S. persons are required to count their security-based swap dealing transactions toward the thresholds, including dealing transactions conducted through their foreign branches.

Non-U.S. persons are required to count the following against the thresholds:

  • Dealing transactions with counterparties that are U.S. persons, including foreign branches of U.S. banks (unless the foreign branch is a branch of a registered security-based swap dealer).
  • Dealing transactions with any counterparty that has rights of recourse against a U.S. affiliate of the non-U.S. person in connection with the non-U.S. person’s obligation under the security-based swap.
  • All dealing activity if a non-U.S. person acts as a “conduit affiliate.”

For purposes of the rules, a “U.S. person” is defined in a territorial manner that encompasses:

  • Any natural person who resides in the U.S.
  • Any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the U.S. or having its principal place of business in the U.S.
  • Any discretionary or non-discretionary account of a U.S. person.
  • Any estate of a decedent who was a resident of the United States at the time of death.

The rules define a principal place of business to mean the location from which the officers, partners, or managers of the legal person primarily direct, control and coordinate the activities of the legal person.  The definition provides that with respect to an externally managed investment vehicle, this location is the office from which the manager of the investment vehicle primarily directs, controls, and coordinates the investment activities of the investment vehicle.

The SEC also established procedures for foreign regulators or market participants to apply for substituted compliance, which would permit market participants to comply with U.S. requirements by complying with foreign requirements. The SEC stated that This rule represents a first step in the SEC’s efforts to establish a framework to address the possibility that market participants may be subject to more than one set of comparable regulations across different jurisdictions as a result of their cross-border swaps activity.  If the SEC were to grant a request for substituted compliance, it would permit market participants to satisfy certain Title VII security-based swap regulatory requirements by complying with comparable non-U.S. rules.

Lastly, the SEC adopted an anti-fraud rule that addresses the scope of the SEC’s cross border anti-fraud enforcement authority, clarifying that the authority applies where the fraud occurs or is felt within the U.S.

In future rulemakings, the SEC is expected to address trade reporting and dissemination of trade details to the public, mandatory clearing and trade execution, and rules applicable to registered security-based swap dealers and major security-based swap participants, and security-based swap market infrastructure.

Please click here to access the rule.




Investment Advisers, Investment Companies