A Registration Framework for the Derivatives Market

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement; 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.

The financial crisis of 2008, and the ensuing turmoil, shook the global economy to its core and exposed the weaknesses of our regulatory regime. Years of lax attitudes, deregulation, and complacency allowed an unregulated derivatives marketplace to cause serious damage to the U.S. economy, resulting in significant losses to investors. As a result, Title VII of the Dodd-Frank Act tasked the SEC and the CFTC with establishing a regulatory framework for the over-the-counter swaps market. In particular, the SEC was tasked with regulating the security-based swap (SBS) market and the CFTC was given regulatory authority over the much larger swaps market, covering products such as energy and agricultural swaps.

Today [August 5, 2015], the global derivatives market is estimated to exceed $630 trillion worldwide—with approximately $14 trillion representing transactions in SBS regulated by the SEC. The regulatory regime for the SBS market, however, cannot go into effect until the SEC has put in place the necessary rules to implement Title VII.

To that end, one of the crucial components of Title VII is the addition of Section 15F to the Exchange Act, which requires the Commission to adopt rules to provide for the registration of SBS dealers and major participants. Moreover, the statute makes it unlawful for these entities to permit any statutorily disqualified associated person to effect or be involved in effecting SBS transactions on their behalf.

To fulfill these mandates, today, the Commission adopts rules and forms that largely follow the rules it proposed in 2011. If adopted, these rules would allow the Commission to oversee the derivatives market and protect investors in a number of ways:

  • First, the registration rules will provide the Commission with pertinent information and oversight authority as to all of its registrants—both foreign and domestic—and thus avoid any cross-border limitation on its oversight that could impair its ability to regulate and monitor the SBS market.
  • Second, the rules require a senior officer to certify that there are policies and procedures in place to prevent violations of the federal securities laws, and to maintain documentation supporting this certification. The rules will also require a Chief Compliance Officer (CCO) to certify that the registrant has determined that none of its associated persons are subject to a statutory disqualification—whether they are natural persons or entities—unless relief is specifically provided by the Commission. These certifications will help facilitate the Commission’s ongoing risk assessments and oversight of the SBS market; help market participants make informed counterparty choices; and help keep the bad apples out of the industry.
  • Finally, the rules will deem an applicant to be conditionally registered as soon as its completed application for registration is submitted. As a result, the Title VII rules, such as the recordkeeping rules, will apply to the applicant immediately. In addition, the conditional registration will allow the SEC staff, if appropriate or necessary, to conduct promptly an examination of the registrant.

In conjunction with today’s adoption of the registration rules, the Commission is also proposing Rule 194 to the Commission’s Rules of Practice. This rule provides a process for the Commission to determine whether it is in the public interest to permit a statutorily disqualified associated person to continue to engage in SBS transactions on behalf of an SBS entity.

Specifically, proposed Rule 194 would provide registered SBS entities with an initial 30-day temporary exclusion from the statutory prohibition. This will allow them to continue to engage in transactions with associated persons that have become statutorily disqualified. If, however, before this temporary exclusion elapses, an SBS entity seeks a permanent exclusion by filing for relief under proposed Rule 194, then the SBS entity’s exclusion will be automatically extended for up to a maximum of 180 days. The proposed time period is based on the staff’s preliminary belief that up to 180 days may be needed to appropriately process an application for relief. During this time frame, the Commission staff would conduct its due diligence, make a recommendation to the Commission, and seek a Commission decision as to whether a permanent exclusion should be granted or denied. If the Commission does not grant the permanent relief, the SBS entity would have 60 days to comply with the statutory prohibition.

Clearly, the need for having adequate time to evaluate properly these applications must be balanced against the concerns raised by the prospect of having a statutorily disqualified associated person continuing to engage in transactions with registered SBS entities. Accordingly, the proposing release invites public comments on whether the proposed 180-day time period is appropriate. Simply stated, is the time period for temporary exclusion too long or too short, and are there better alternatives to the current proposal?

Moreover, proposed Rule 194(j) would permit, in general, an SBS entity to engage in transactions with statutorily disqualified associated persons where another regulatory authority, such as FINRA or the CFTC, has permitted an associated person to continue to engage in transactions with the SBS entity, notwithstanding what would otherwise be a statutory disqualification. Obviously, such deference raises, among other things, complex regulatory issues and potential tensions between providing comity to certain regulators and the need for the Commission to fulfill its Congressional mandate in a way that does not abrogate its own regulatory responsibilities. Accordingly, the proposing release discusses this subject and asks a number of important questions. Clearly, this is a difficult and thorny issue, and the Commission’s decision at the adopting stage will be greatly benefited by hearing from commenters.

Conclusion

Ultimately, I will support both the adopting release for the registration of SBS entities and the Rule 194 proposing release. They are vital steps for putting in place a registration framework for SBS dealers and major participants. I note, however, that the registration rules will not become effective until the Commission adopts the capital, margin, and segregation rules; the recordkeeping and reporting rules; the business conduct rules; and today’s proposed rules dealing with statutorily disqualified associated persons involved in SBS transactions. To this end, I urge my fellow Commissioners to move with urgency and adopt these rules, as well as the rest of the long-overdue Title VII rules. We need these rules to promote transparency and accountability in the derivatives market.

Finally, I want to thank the SEC staff for your work in this release, especially the staff from the Office of Chief Counsel in the Division of Trading and Markets. I appreciate your engagement with my office and for responding to all of my questions and comments.

 

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