Defining Dealers and Major Participants in the Cross-Border Context

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Dealers and major participants play a crucial role in the derivatives market, a market that has been estimated to exceed $710 trillion worldwide, of which more than $14 trillion represents transactions in security-based swaps. In the United States, the Commodity Futures Trading Commission (“CFTC”) and the SEC share responsibility for regulating the derivatives market. Out of the total derivatives market, the SEC is responsible for regulating security-based swaps. As evidenced in the most recent financial crisis, the unregulated derivatives market had devastating effects on our economy and U.S. investors. In response to this crisis, Congress enacted the Dodd-Frank Act and directed both the CFTC and SEC to promulgate an effective regulatory framework to oversee the derivatives market.

Unfortunately, to date, the SEC has failed to enact the necessary regulatory scheme for the securities-based swap market, as envisioned by Title VII of the Dodd-Frank Act. For example, if the Commission acts today, it will be the Commission’s first adoption of the series of proposed rules to regulate cross-border security-based swap activities. I hope today’s rule adoption will be quickly followed by a series of other adoptions so that the Title VII framework can be fully adopted and implemented, and satisfy the intended objective of preventing future financial crises by reducing systemic risk and increasing transparency in the derivatives marketplace. Because of the size of this market and its impact on the global economy, the Commission must act so that security-based swaps do not continue to be transacted in an opaque market with significant regulatory gaps.

Let me now turn to today’s rulemaking. Today, the Commission considers adopting final rules and guidance as to the application of the Title VII definitions of security-based swap dealer and major security-based swap participants in the cross-border context. Concurrently, the Commission also considers adopting a procedural rule for the submission of applications for substituted compliance, a framework for allowing market participants to satisfy certain Title VII obligations by complying with comparable foreign regulatory requirements. In addition, the Commission considers adopting a rule confirming the Commission’s broad, cross-border antifraud enforcement authority under Section 929P of the Dodd-Frank Act.

I believe that the final rules considered today are an improvement upon the Commission’s previous proposal, and that these final rules will enhance market transparency and investor protections in a number of ways. For example:

  • First, there is no longer a loophole for conduit affiliates and security-based swap transactions subject to recourse guarantees. The final rules on conduit affiliates prevent a U.S. parent company from using its foreign affiliates to enter into security-based swap transactions—on the parent’s behalf—with non-U.S. persons to evade Title VII. Similarly, the rules on recourse guarantees prevents a U.S. parent company from enticing foreign counterparties to enter into transactions with its foreign affiliates by providing assurances of its foreign affiliates’ performance.
  • Second, there is now stronger oversight of guaranteed foreign affiliates. Security-based swap transactions entered into by foreign affiliates that are guaranteed by a U.S. parent pose the same financial risks as transactions entered into directly by the U.S. parent. Thus, it is important that transactions serving the same economic purposes are treated the same way.
  • Finally, the final rules require a person to exercise reasonable care before it can rely on counterparty representations for purposes of ascertaining the counterparty’s U.S.-person status. These representations are important because they are part of the threshold determination of whether Title VII applies to a person or transaction.

The final rules also remind U.S. parent companies of their disclosures obligations with respect to their security-based swap transactions. This is particularly critical where a U.S. parent company’s exposures to security-based swap transactions are material to its financial well-being—taking into consideration all of its security-based swap positions that are explicitly or implicitly guaranteed.

With respect to the availability of substituted compliance, and as I mentioned when the rules were proposed in 2013, I continue to have concerns that permitting compliance with foreign regulatory requirements, as a substitute for compliance with U.S. laws, may inappropriately deny American investors the protection of American laws. It is very important to me that future applications are required to submit to a transparent and public process. This will benefit investors, the public, market participants, and the market overall. To that end, I am pleased to report that the final rules require mandatory public notice and comment for all applications for substituted compliance.

The rules being adopted today are not perfect, and there are concerns that the final rules still leave gaps that can be exploited—such as the risks posed by implicit guarantees—that could create contagion and spillover risks that can impact the U.S. financial system. In particular, I fear that the regulatory approach to foreign subsidiaries of U.S. parent companies may incentivize U.S. banks to conduct their security-based swap business through their foreign subsidiaries, thereby increasing the potential for regulatory arbitrage and creating risks that will ultimately be borne by U.S. financial institutions and our financial system.

For example, under the final rules, two non-guaranteed foreign subsidiaries of two separate U.S. entities could structure their security-based swap transactions in a way that allows them to engage in unlimited transactions with each other outside the United States and circumvent Title VII. In times of financial distress, these foreign subsidiaries could rely on their U.S. parents to bail them out through implicit guarantees. The concern is that, even without an explicit legal obligation, a U.S parent company could likely step in to save its financially troubled subsidiaries and protect its reputation.

Ultimately, however, after numerous in-depth conversations between my office and the staff, especially with the Office of the General Counsel, I have been told repeatedly that the staff’s view is that the Commission’s legal authority to adopt rules to effectively address the implicit guarantee issue is limited and does not allow us to address this gap. Although it is a disappointment that the Commission is unable to address this gap, in reliance on these representations, I am prepared to move forward to adopt the recommended final rules.


When all is said and done, I believe that the definitions to be adopted today are a significant step forward. While not perfect, the final rules will close many of the loopholes in our regulatory framework, and they are an initial step forward in accomplishing the goals of the Dodd-Frank Act. For this reason, I will support today’s recommendation and I thank the staff for their hard work on this rulemaking.

As the Commission continues to adopt the required cross-border Title VII rules, we must remember that a well-regulated market instills investor trust and confidence and protects our economy as a whole. To that end, the Commission is long overdue in enacting an effective and working regulatory oversight of the securities-based swap market. It is noteworthy that the Commission will not be acting today on the definition of “transaction conducted within the United States,” a key definition that will address what dealer conduct will be covered under the Title VII regulatory framework. This definition was proposed at the same time as the other definitions being acted upon today, but instead of being adopted today it continues to be reviewed by the staff.

There is a lot of important work ahead, and I call upon the Chair, my fellow Commissioners, and the staff to finalize with all appropriate haste the remaining mandated Title VII rulemaking. The derivative reforms required by the Dodd-Frank Act must be faithfully promulgated in order to protect our economy, our financial markets and, more importantly, our investors.

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