Securities Regulation Daily SEC reopens comment period on Dodd-Frank security-based swaps proposals
Thursday, October 11, 2018

SEC reopens comment period on Dodd-Frank security-based swaps proposals

By Amanda Maine, J.D.

By a 4 to 1 vote, the Securities and Exchange Commission has authorized the re-opening the comment period on three proposals relating to security-based swap dealers and major security-based swap participants. Chairman Jay Clayton and Commissioners Hester Peirce and Elad Roisman strongly supported reopening the comment period, noting that the CFTC, prudential regulators, and international regulators have already moved forward on swaps regulation. Commissioner Kara Stein, while ultimately voting in favor of reopening the comment period, expressed concern that the Commission’s action more closely resembled a reproposal and not a simple re-opening of the comment period. Commissioner Robert Jackson dissented, stating that the proposal would incentive excessive risk-taking by financial institutions.

Original proposals. The proposals at issue were originally issued for comment by the Commission in October 2012, May 2013, and April 2014. The 2012 release proposed rules governing capital, margin, and segregation requirements for security-based swap dealers (SBSDs) and major security-based swap participants (MSBSs), including how much capital SBSDs need to hold, when and how the dealers need to collect margin to protect against losses from counterparties, and how dealers segregate and protect funds and securities held for customers.

The 2013 proposal outlined rules and interpretive guidance for parties to cross-border security-based swap transactions, including regulatory requirements for when a transaction occurs partially within and partially outside the U.S. and a "substituted compliance" framework. The 2014 release established an additional capital requirement for SBSDs that do not have a prudential regulator.

Reopening the comment period. Chairman Clayton noted that the SEC has finalized many, but not all of the required rulemaking under Title VII of the Dodd-Frank Act, which governs the OTC swaps market, while the CFTC and prudential regulators have also adopted or proposed Title VII rules. The SEC is seeking to complete its work on its remaining Title VII rules. Reopening the comment period on these three proposals is a common-sense step as the SEC continually evaluates its approach to regulation, Clayton said.

Commissioner Peirce has actively encouraged the Commission to move forward on these proposals, including during a recent speech at ISDA’s Annual North America Conference. In light of the regulatory actions taken by the CFTC, prudential regulators, and regulators around the world, as well as changes in the markets and comments the Commission has already received on the proposals, it is important to solicit additional comments before finalizing the rules, Peirce said. According to Peirce, the staff of the Division of Trading and Markets has created a recommendation that will both elicit comments on the prior proposals generally and also request public input on the Commission’s understanding of previously submitted comments on specific, technical issues, including comments on how the proposed language might be modified.

In his first open meeting since being sworn is as commissioner last month, Roisman also voiced his support of the re-opening of the comment period. He noted that the SEC’s regulatory approach to implementing the rest of the Title VII rules can bring certainty, encourage participation, and generate liquidity, although he warned that new rules could generate high costs, friction, and increasing complexity. The staff’s recommendation sends a message that the Commission will be thoughtful and tailor its rules to today’s regulatory environment, Roisman said.

Stein’s concerns. Commissioner Stein voted in favor of reopening the comment period but advised that there were "significant policy shifts" buried within the "re-opening of the comment period" document. According to Stein, the proposed financial responsibility rules would be changed so that margin for securities-based swaps would no longer need to be collected from dealers. The document for this re-opening of the comment period would also make significant changes to the calculation of capital and the calculation of margin amounts for security-based swap transactions, she said. In addition, the rule text would significantly expand the comingling of swaps and security-based swaps, which could lead to uncertainty, Stein observed. "There are some big changes here, and some we are seeing for the first time," Stein said. The Commission’s action appears to be more akin to a reproposal than simply the re-opening of a comment period, Stein remarked, referring to the Commission’s approach as a "shadow rulemaking."

Stein also noted that the 2012 proposal used a baseline that included data on the OTC derivatives market from 2011. New baseline data has not been included in this "reproposal," which would have greatly improved the quality of the proposal, according to Stein. The Commission needs to understand the changes in the market that have occurred in the past seven years, Stein implored, but encouraged the public to weigh in on the significant changes that the Commission is proposing.

Jackson’s dissent. In voting against reopening the comment period, Commissioner Jackson voiced his concern that the proposal invites financial institutions to take excessive risks. As the U.S. is in the midst of one of the longest bull markets in its history, it is not surprising that market participants would be in favor of taking on more risk in this environment, he said. He also advised that regulators should view the comments of financial institutions in light of their inherent incentives to take excessive risk. Jackson explained that it has been over a decade since the financial crisis, and the caution that came in its wake has faded.

Congress mandated regulation of the swaps industry after the fallout of the financial crisis, Jackson reminded his fellow commissioners. "When companies hoping for bailouts fail to internalize the systemic effects of their own failure, they take excessive risks, forcing taxpayers to bear the costs of their mistakes," Jackson warned. Echoing some of Steins concerns, Jackson said that significantly paring back capital and margin requirements would incentivize excessive risk-taking. This is why he must dissent from approving the proposal, Jackson explained.

The comment period will be open for 30 days following publication of the release in the Federal Register.

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