The new security-based swaps rules would trigger the implementation period for compliance with Dodd-Frank’s security-based swap regime generally and establish a compliance date for SEC registration.
The SEC has adopted new rules to govern security-based swaps, including new risk mitigation and cross-border requirements. The Commission has also proposed to amend the definition of "accredited investor" to include certain sophisticated individuals and entities that do not meet the current thresholds and separately proposed a new resource extraction disclosure rule to replace previously vacated Exchange Act Rule 13q-1.
The SEC also approved the Public Company Accounting Oversight Board’s budget for 2020 (Risk Mitigation Techniques for Uncleared Security-Based Swaps, Release No. 34-87782; Rule Amendments and Guidance Addressing Cross-Border Application of Certain Security-Based Swap Requirements, Release No. 34-87780; Order Designating Certain Jurisdictions as "Listed Jurisdictions" for Purposes of Applying the Security-Based Swap Dealer De Minimis Exception of Rule 3a71-3(d) Under the Exchange Act to Certain Cross-Border Security-Based Swap Transactions, Release No. 34-87781; Amending the "Accredited Investor" Definition, Release No. 33-10734; Disclosure of Payments by Resource Extraction Issuers, Release No. 34-87783; Order Approving Public Company Accounting Oversight Board Budget and Annual Accounting Support Fee For Calendar Year 2020, Release No. 33-10735 (December 18, 2019)).
Risk mitigation for security-based swaps. The SEC unanimously voted to adopt rules requiring the application of risk mitigation techniques to portfolios of uncleared security-based swaps. Specifically, new Rules 15Fi-3, 15Fi-4, and 15Fi-5 establish requirements for registered security-based swap dealers and major security-based swap participants (SBS entities) to reconcile outstanding security-based swaps with counterparties on an ongoing basis and engage in certain forms of portfolio compression exercises. The entities must also execute trading relationship documentation with each of their counterparties in conjunction with executing a security-based swap transaction. Relatedly, the Commission also adopted amendments to its existing cross-border rule to provide a means to request substituted compliance with respect to the requirements and amended its recently adopted recordkeeping, reporting, and notification rules to incorporate records relating to the new risk mitigation requirements.
"These rules are designed to guide and drive security-based swap entities to accurately and effectively manage their market and credit risks throughout the life of a security-based swap transaction, including by mitigating the risk that a disagreement, ambiguity or omission will affect performance," said Chairman Jay Clayton. Commissioner Hester Peirce concurred, noting that these changes will help ensure that the firms that play a central role in our security-based swap market are appropriately managing key risks associated with their activities. Further, "because they substantially track existing CFTC requirements, they should not impose unnecessary additional burdens on dually registered firms," she said.
Cross-border security-based swaps. By a 3-2 vote, the Commission also adopted a package of rule amendments, guidance, and a related order to expand and improve the framework for regulating cross-border security-based swaps, including single-name credit default swaps. The changes build upon the requirement that non-resident security-based swap entities provide a certification and opinion of counsel regarding Commission access to information the cross-border application of statutory disqualification provisions and information that registered SBS entities must maintain regarding foreign associated persons.
Specifically, the Commission: (1) adopted a conditional exception to the requirement that non-U.S. persons count against the thresholds of the de minimis exception security-based swap transactions with non-U.S. counterparties when U.S. personnel arrange, negotiate, or execute the transactions; and (2) adopted an amendment to Exchange Act Rule 15Fb2-1 to allow SBS entities unable to provide the required certification and opinion of counsel to be conditionally registered under certain circumstances.
The SEC also provided guidance regarding the requirement to provide the Commission with a certification and opinion of counsel and how to address certain requirements under Title VII of the Dodd-Frank Act regarding transactions involving limited activities by U.S. personnel.
In addition, the Commission adopted rule amendments to create a process by which it may consider designating a jurisdiction as a "listed jurisdiction" and issued a separate order designating Australia, Canada, France, Germany, Japan, Singapore, Switzerland, and the United Kingdom as listed jurisdictions. The Commission also adopted revisions to Rule of Practice 194 to more closely harmonize its rules with the CFTC’s approach to the statutory disqualification of non-domestic associated persons of CFTC registered swap entities.
Commissioner Elad Roisman noted that the changes minimize distinctions with the CFTC swaps rules and present a thoughtful means by which to fulfill the mandates of the Dodd-Frank Act in the confines of a complex regulatory field. Peirce agreed, noting that the measures will provide foreign dealers a realistic path to register with the SEC and maintain an active presence in U.S. markets using U.S. personnel to serve their clients.
Commissioners Robert Jackson and Allison Herren Lee voted against adopting the amendments. In her dissent, Commissioner Lee argued that the cross-border changes "significantly undercut" the framework put in place by the Dodd-Frank Act. The large volume of cross-border activity in security-based swaps presents serious risks for the U.S. markets, and the Commission is pulling back on regulations adopted in 2016 before they even take effect. She also noted that the Commission has already implemented a substituted compliance framework that could alleviate concerns and took issue to the "further weakening" of the bad actor disqualification under Rule 194.
The changes take "a broad approach in rolling back a number of the requirements and protections applicable to security-based swap dealers. In doing so, it both undermines and complicates the Commission’s oversight of security-based swap dealing activity occurring within our borders," Lee stated.
Accredited investors. The SEC also proposed amendments to the "accredited investor" definition, which is used in determining eligibility for participating in private markets. The proposal seeks to update the definition and add new categories of qualifying natural persons and entities that have the expertise necessary to engage in these markets but do not meet the current income and net worth requirements.
Specifically, the proposed accredited investor amendments would add new categories of natural persons who may qualify as accredited investors based on expertise, certain professional certifications or designations, and experience or their status as a private fund’s "knowledgeable employee." The proposal would also expand the list of entities that may qualify as accredited investors by allowing entities meeting an investments test to qualify and add family offices with at least $5 million in assets under management and their family clients. The "qualified institutional buyer" definition in Securities Act Rule 144A also would be amended to expand the list of qualifying entities.
Roisman voiced his support for the proposal but urged the Commission to further deliberate before considering adoption of the staff’s recommendations. While the proposal makes headway toward a more rational framework, he said that more can be done. As an example, he noted that even as an SEC commissioner, he is not an accredited investor and would not be one even if the amendments are adopted as proposed. "[D]epriving people of investment opportunities based on certain income and wealth thresholds objectively makes little sense," he said. The proposed changes to increase the pool of accredited investors also will provide additional flexibility to smaller companies seeking to raise capital, Roisman opined.
Commissioner Jackson dissented from the proposal, noting that more data-driven analysis of how to best balance risks with potential investment rewards is necessary before expanding eligibility to participate in exempt offerings. "The evidence makes clear that the Commission must do more to protect investors in private markets than hope that brokers will do it for us," he said. Lee also noted that further analysis is necessary, including with respect to indexing for inflation. Further, the proposal seeks to address the under-inclusiveness in the "accredited investor" definition, but there is also over-inclusiveness inherent in the current definition, she said. That a person has spent a lifetime saving does not automatically mean that he or she is able to actively manage investments in the private markets, according to Lee.
Resource extraction disclosure. Following court proceedings and congressional action, by a 3-2 vote, the SEC has again proposed a rule to implement Dodd-Frank Act Section 1504 that would require resource extraction issuers to disclose payments made to foreign governments or the federal government for the development of natural resources, including oil, natural gas, and minerals. Similar to the previously vacated rule, proposed new Rule 13q-1 would require resource extraction issuers to submit on an annual basis a Form SD that includes information about these payments, but, according to the Commission, the rule is not in substantially the same form as the 2016 rule and, therefore, in compliance with the congressional mandate.
Among other things, the proposed new rule would: (1) revise the definition of "project" to require disclosure at the national and major subnational political jurisdiction lever instead of the contract level; (2) revise the definition of "not de minimis" to include both a project threshold and an individual payment threshold; (3) add two new conditional exemptions for situations in which a foreign law or a pre-existing contract prohibits the disclosure; (4) add an exemption for smaller companies; (5) limit liability by deeming payment information to be furnished to, but not filed with, the Commission.
Dissenting from the proposal, Commissioners Jackson and Lee questioned whether the proposal would provide any increased transparency. According to Jackson, the proposal does not give investors nearly enough information about how their money is used to pay for the extraction rights. The proposal’s de minimis threshold will keep many payments in the dark, and its suggestion that the Commission could allow issuers to file confidential disclosures would make it harder to hold corporate insiders to account for the choices. Lee agreed, noting that the proposal does not further the goal of fighting global corruption through transparency. The proposal deviates from existing international disclosure regimes, and the disclosure that would be required by does not provide the necessary transparency, she said.
PCAOB budget. The Commission also approved the 2020 $284.7 million budget of the Public Company Accounting Oversight Board, which represents an increase of approximately 4 percent over 2019 budget. The agency also approved the related the $270.2 million annual accounting support fee, from which $239.7 million will be assessed on public companies and $30.5 million will be assessed on broker-dealers. The 2020 budget will be funded primarily by the accounting support fee, which was increased by approximately 2.8 percent from 2019.
According to PCAOB Chairman William Duhnke, the increases are largely attributable to additional personnel needs and ongoing efforts to transform the PCAOB’s inspection program and internal systems. The board also intends to engage in more interactions with audit committees and increase outreach efforts, he said.
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