Federal Register: December 30, 2010 (Volume 75, Number 250)
DOCID: fr30de10-42 FR Doc 2010-32085
SECURITIES AND EXCHANGE COMMISSION
Veterans Affairs Department
CFR Citation: 17 CFR Parts 240 and 249
RIN ID: RIN 3235-AK87
NOTICE: Part IV
DOCID: fr30de10-42
DOCUMENT ACTION: Proposed rule.
SUBJECT CATEGORY:
Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing and Notice Filing Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory Organizations
DATES: Comments should be received on or before February 14, 2011.
DOCUMENT SUMMARY:
In accordance with Section 763(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (``DoddFrank Act''), the Securities and Exchange Commission (``Commission'') is proposing rules under the Securities Exchange Act of 1934 (``Exchange Act'') to specify the process for a registered clearing agency's submission for review of any securitybased swap, or any group, category, type or class of securitybased swaps, that the clearing agency plans to accept for clearing, the manner of notice the clearing agency must provide to its members of such submission and the procedure by which the Commission may stay the requirement that a securitybased swap is subject to mandatory clearing while the clearing of the securitybased swap is reviewed. The Commission also is proposing to specify that when a securitybased swap is required to be cleared, the submission of the securitybased swap for clearing must be for central clearing to a clearing agency that functions as a central counterparty. In addition, the Commission is proposing rules to define and describe when notices of proposed changes to rules, procedures or operations are required to be filed by designated financial market utilities in accordance with Section 806(e) of Title VIII of the DoddFrank Act and to set forth the process for filing such notices with the Commission. Furthermore, the Commission is proposing rules to make conforming changes as required by the amendments to Section 19(b) of the Exchange Act contained in Section 916 of the DoddFrank Act.
SUMMARY:
Securities and Exchange Commission
SUPPLEMENTAL INFORMATION
The Dodd-Frank Act seeks to ensure that,
wherever possible and appropriate, derivatives contracts formerly
traded exclusively in the overthecounter (``OTC'') market be
cleared.\1\ One key way in which the DoddFrank Act promotes clearing
of such contracts is by setting forth a process by which the Commission
would determine whether a securitybased swap is required to be
cleared; if the Commission makes a determination that a securitybased
swap is required to be cleared, then parties may not engage in such
securitybased swap without submitting it for clearing unless an exception applies.
\1\ See, e.g., Report of the Senate Committee on Banking,
Housing, and Urban Affairs regarding The Restoring American
Financial Stability Act of 2010, S. Rep. No. 111176 at 34 (stating
that ``[s]ome parts of the OTC market may not be suitable for
clearing and exchange trading due to individual business needs of
certain users. Those users should retain the ability to engage in
customized, uncleared contracts while bringing in as much of the OTC
market under the centrally cleared and exchangetraded framework as possible.'').
The Commission may determine that a securitybased swap is required
to be cleared based on a review of a clearing agency's submission
regarding a securitybased swap, or any group, category, type or class
of securitybased swaps, that the clearing agency plans to accept for
clearing (i.e., a SecurityBased Swap Submission (as defined
below)).\2\ If the Commission determines that a securitybased swap is
not required to be cleared, such securitybased swap may still be
cleared on a nonmandatory basis by the clearing agency if the clearing
agency has rules that permit it to clear such securitybased swap.\3\
In addition, paragraph (b)(1) of new Section 3C of the Exchange Act, as
added by Section 763(a) of the DoddFrank Act (``Exchange Act Section
3C'') provides that ``[t]he Commission on an ongoing basis shall review
each securitybased swap, or any group, category, type, or class of
securitybased swaps to make a determination that such securitybased
swap, or group, category, type, or class of securitybased swaps should
be required to be cleared'' (``Commissioninitiated Review'').\4\
\2\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(b)(2)(C)) (``[t]he Commission shall * * * review each
submission made under subparagraphs (A) and (B), and determine
whether the securitybased swap, or group, category, type, or class
of securitybased swaps, described in the submission is required to be cleared.'').
\3\ See 15 U.S.C. 78s(b) and 12 U.S.C. 5465(e).
\4\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(b)(1)). The DoddFrank Act does not require rulemaking with respect to Commissioninitiated Reviews.
Consistent with the policy objective of the DoddFrank Act to bring
securitybased swaps into a central clearing environment where
appropriate, the Commission is proposing to amend Rule 19b4 under the
Exchange Act to incorporate two new requirements applicable to clearing
agencies under Exchange Act Section 3C, and under Section 806(e) of the
DoddFrank Act (``Section 806(e)''). The proposed amendments to Rule
19b4 would mandate that submissions required under Exchange Act
Section 3C for a securitybased swap, or any group, category, type or
class of securitybased swaps, that a clearing agency plans to accept
for clearing (``SecurityBased Swap Submissions'') and advance notices
required under Section 806(e) of proposed changes to rules, procedures [[Page 82491]]
or operations of financial market utilities (``Advance Notices'') be
filed with the Commission on Form 19b4. The proposed amendments to
Rule 19b4 also would specify the manner of notice the clearing agency
must provide to its members of SecurityBased Swap Submissions.
Additionally, the Commission is proposing two related rules under Exchange Act Section 3C. Proposed Rule 3Ca1 would establish the procedure by which the Commission, at the request of a counterparty or on its own initiative, may stay the requirement that a securitybased swap is subject to mandatory clearing. Proposed Rule 3Ca2 is intended to prevent evasions of the clearing requirement by specifying that securitybased swaps required to be cleared must be submitted for central clearing to a clearing agency that functions as a central counterparty. Finally, the Commission is proposing technical, conforming and clarifying amendments to Rule 19b4 and Form 19b4 to conform the rule and form with new deadlines and approval, disapproval and temporary suspension standards with respect to proposed rule changes filed under Section 19(b) of the Exchange Act, as modified by Section 916 of the DoddFrank Act (``Exchange Act Section 19(b)''). I. Introduction
On July 21, 2010, the President signed the DoddFrank Act into
law.\5\ The DoddFrank Act was enacted to, among other purposes,
promote the financial stability of the United States by improving
accountability and transparency in the financial system and by
providing for enhanced regulation and oversight of institutions
designated as systemically important.\6\ Title VII and Title VIII of
the DoddFrank Act are intended to further these goals and to mitigate
systemic risk in part by imposing new requirements with respect to clearance and settlement systems.
\5\ The DoddFrank Wall Street Reform and Consumer Protection Act (Pub. L. 111203, H.R. 4173).
\6\ See Public Law 111203, Preamble.
Title VII of the DoddFrank Act (``Title VII'') provides the
Commission and the Commodity Futures Trading Commission (``CFTC'') with
enhanced authority to regulate OTC derivatives following the recent
financial crisis.\7\ The DoddFrank Act is intended to bolster the
existing regulatory structure and provide regulatory tools to oversee
the OTC derivatives market, which has grown exponentially in recent
years and is capable of affecting significant sectors of the U.S.
economy. Title VII provides that the CFTC will regulate ``swaps,'' the
Commission will regulate ``securitybased swaps,'' and the CFTC and the Commission will jointly regulate ``mixed swaps.'' \8\
\7\ See, e.g, Report of the Senate Committee on Banking,
Housing, and Urban Affairs regarding The Restoring American
Financial Stability Act of 2010, S. Rep. No. 111176 at 29 (2010)
(stating that ``[m]any factors led to the unraveling of this
country's financial sector and the government intervention to
correct it, but a major contributor to the financial crisis was the unregulated [OTC] derivatives market.'')
\8\ Section 712(d) of the DoddFrank Act provides that the
Commission and the CFTC, in consultation with the Board of Governors
of the Federal Reserve System, shall jointly further define the terms ``swap,'' ``securitybased swap,'' ``swap dealer,''
``securitybased swap dealer,'' ``major swap participant,'' ``major securitybased swap participant,'' ``eligible contract
participant,'' and ``securitybased swap agreement.'' These terms
are defined in Sections 721 and 761 of the DoddFrank Act and, with
respect to the term ``eligible contract participant,'' in Section
1a(18) of the Commodity Exchange Act, 7 U.S.C. 1a(18), as re
designated and amended by Section 721 of the DoddFrank Act.
Further, Section 721(c) of the DoddFrank Act requires the CFTC to
adopt a rule to further define the terms ``swap,'' ``swap dealer,''
``major swap participant,'' and ``eligible contract participant,''
and Section 761(b) of the DoddFrank Act permits the Commission to
adopt a rule to further define the terms ``securitybased swap,'' ``securitybased swap dealer,'' ``major securitybased swap
participant,'' and ``eligible contract participant,'' with regard to
securitybased swaps, for the purpose of including transactions and
entities that have been structured to evade Title VII of the Dodd
Frank Act. Finally, Section 712(a) of the DoddFrank Act provides
that the Commission and CFTC, after consultation with the Board,
shall jointly prescribe regulations regarding ``mixed swaps'' as may
be necessary to carry out the purposes of Title VII. To assist the
Commission and CFTC in further defining the terms specified above,
and to prescribe regulations regarding ``mixed swaps'' as may be
necessary to carry out the purposes of Title VII, the Commission and
the CFTC have requested comment from interested parties. See
Securities Exchange Act Release No. 62717 (Aug. 13, 2010), 75 FR
51429 (Aug. 20, 2010) (Advance Joint Notice of Proposed Rulemaking
Regarding Definitions Contained in Title VII of the DoddFrank Act).
The OTC derivatives markets traditionally have been characterized by privately negotiated transactions entered into by two
counterparties, in which each assumes the credit risk of the other
counterparty.\9\ Clearing of swaps and securitybased swaps was at the
heart of Congressional reform of the derivatives markets in Title VII
of the Dodd Frank Act.\10\ Clearing agencies are broadly defined under
the Exchange Act and undertake a variety of functions.\11\ One such
function is to act as a central counterparty (``CCP''), which is an
entity that interposes itself between the counterparties to a
trade.\12\ For example, when an OTC derivatives contract between two
counterparties that are members of a CCP is executed and submitted for
clearing, it is typically replaced by two new contractsseparate
contracts between the CCP and each of the two original counterparties.
At that point, the original counterparties are no longer counterparties
to each other. Instead, each acquires the CCP as its counterparty, and
the CCP assumes the counterparty credit risk of each of the original
counterparties that are members of the CCP.\13\ Structured and operated
appropriately, CCPs may improve the management of counterparty risk and
may provide additional benefits such as multilateral netting of trades.
\9\ See, e.g., Financial Stability Board, Implementing OTC
Derivatives Market Reforms (Oct. 25, 2010) available at http://
www.financialstabilityboard.org/publications/r_101025.pdf.
\10\ As previously noted, the DoddFrank Act seeks to ensure
that, wherever possible and appropriate, derivatives contracts
formerly traded exclusively in the OTC market be cleared. See Letter
from Christopher Dodd, Chairman, Committee on Banking, Housing and
Urban Affairs, United States Senate and Blanche Lincoln, Chairman,
Committee on Agriculture, Nutrition, and Forestry, United States
Senate, to Barney Frank, Chairman, Financial Services Committee,
United States House of Representatives and Colin Peterson, Chairman,
Committee on Agriculture, United States House of Representatives (June 30, 2010) (on file with the United States Senate).
\11\ The term ``clearing agency'' means any person who acts as
an intermediary in making payments or deliveries or both in
connection with transactions in securities or who provides
facilities for the comparison of data regarding the terms of
settlement of securities transactions, to reduce the number of
settlements of securities transactions, or the allocation of
securities settlement responsibilities. Such term also means any
person, such as a securities depository, who (i) acts as a custodian
of securities in connection with a system for the central handling
of securities whereby all securities of a particular class or series
of any issuer deposited within the system are treated as fungible
and may be transferred, loaned, or pledged by bookkeeping entry
without physical delivery of securities certificates, or (ii)
otherwise permits or facilitates the settlement of securities
transactions or the hypothecation or lending of securities without physical delivery of securities certificates. 15 U.S.C.
78c(a)(23)(A).
\12\ See id. An entity that acts as a CCP for securities
transactions is a clearing agency as defined in the Exchange Act and is required to register with the Commission.
\13\ See Cecchetti, Gyntelberg and Hollanders, Central
counterparties for overthecounter derivatives, BIS Quarterly
Review, September 2009, available at http://www.bis.org/publ/qtrpdf/ r_qt0909f.pdf.
Exchange Act Section 3C sets forth a mandatory clearing requirement
for securitybased swaps. This section requires the Commission to adopt
rules for submissions for review of securitybased swaps that a
clearing agency plans to accept for clearing for a determination by the
Commission of whether the securitybased swap (or group, category, type
or class of securitybased swaps) is required to be cleared, i.e., is subject to mandatory
[[Page 82492]]
clearing.\14\ The Commission is proposing amendments to Rule 19b4
under the Exchange Act to implement the requirement in Exchange Act
Section 3C that a clearing agency submit for Commission review each
securitybased swap, or any group, category, type or class of security
based swaps, that the clearing agency plans to accept for clearing and
provide notice to its members of such SecurityBased Swap Submission.
The Commission also is proposing new Rules 3Ca1 and 3Ca2 under the
Exchange Act. Proposed Rule 3Ca1 specifies the procedure for staying
the clearing requirement applicable to a securitybased swap, based
either on an application of a counterparty to a securitybased swap or
on the Commission's own initiative, until the Commission completes a
review of the terms of the securitybased swap and the clearing
arrangement. Proposed Rule 3Ca2 establishes a rule designed to prevent
evasions of the clearing requirement by specifying that securitybased
swaps required to be cleared must be submitted for central clearing to
a clearing agency that functions as a central counterparty.
\14\ Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(2)(C)).
The Commission also is proposing rules to implement a filing
requirement applicable to certain clearing agencies under Title VIII of
the DoddFrank Act (``Title VIII''). Title VIII provides for enhanced
regulation of financial market utilities, which include clearing
agencies, that manage or operate a multilateral system for the purpose
of transferring, clearing or settling payments, securities or other
financial transactions among financial institutions or between
financial institutions and the financial market utility.\15\ The
regulatory regime in Title VIII will only apply, however, to financial
market utilities that the Financial Stability Oversight Council (``Council'') designates as systemically important.\16\
\15\ The definition of ``financial market utility'' in Section
803(6) of the DoddFrank Act contains a number of exclusions
including but not limited to certain designated contract markets,
registered futures associations, swap data repositories, swap
execution facilities, national securities exchanges, national
securities associations, alternative trading systems, securitybased
swap data repositories, securitybased swap execution facilities,
brokers, dealers, transfer agents, investment companies and futures commission merchants. 12 U.S.C. 5462(6)(B).
\16\ Pursuant to Section 803(9) of the DoddFrank Act, a
financial market utility is systemically important if the failure of
or a disruption to the functioning of such financial market utility
could create, or increase, the risk of significant liquidity or
credit problems spreading among financial institutions or markets
and thereby threaten the stability of the financial system of the
United States. 12 U.S.C. 5462(9). Under Section 804 of the Dodd
Frank Act, the Council has the authority, on a nondelegable basis
and by a vote of not fewer than twothirds of the members then
serving, including the affirmative vote of its chairperson, to
designate those financial market utilities that the Council
determines are, or are likely to become, systemically important. The
Council may, using the same procedures as discussed above, rescind
such designation if it determines that the financial market utility
no longer meets the standards for systemic importance. Before making
either determination, the Council is required to consult with the
Board and the relevant Supervisory Agency (as determined in
accordance with Section 803(8) of the DoddFrank Act). Finally,
Section 804 of the DoddFrank Act sets forth the procedures for
giving entities a 30day notice and the opportunity for a hearing
prior to a designation or rescission of the designation of systemic importance. 12 U.S.C. 5463.
Section 806(e)(1)(A) of Title VIII requires any financial market
utility designated by the Council under Section 804 of the DoddFrank
Act as systemically important to file 60 days advance notice of changes
to its rules, procedures or operations that could materially affect the
nature or level of risk presented by the financial market utility.\17\
In addition, Section 806(e)(1)(B) requires each Supervisory Agency \18\
to adopt rules, in consultation with the Board of Governors of the
Federal Reserve System (``Board''), that define and describe when
designated financial market utilities are required to file Advance Notices with their Supervisory Agency.\19\
\17\ 12 U.S.C. 5465(e)(1)(A).
\18\ Section 803(8) of the DoddFrank Act defines the term
``Supervisory Agency'' in reference to the primary regulatory
authority for the financial market utility. For example, Section
803(8) of the DoddFrank Act provides that the Commission is the
Supervisory Agency for any financial market utility that is a
Commissionregistered clearing agency. See 12 U.S.C. 5462(8). To the
extent that an entity is both a Commissionregistered clearing
agency and registered with another agency, such as a CFTCregistered
derivatives clearing organization, the statute requires the two
agencies to agree on one agency to act as the Supervisory Agency,
and if the agencies cannot agree on which agency has primary
jurisdiction, the Council shall decide which agency is the
Supervisory Agency for purposes of the DoddFrank Act. 12 U.S.C. 5462(8).
\19\ 12 U.S.C. 5465(e)(1)(B).
Clearing agencies registered with the Commission are financial
market utilities, as defined in Section 803(6) of Title VIII; \20\
thus, the Commission may be the Supervisory Agency of a clearing agency
that is designated as systemically important by the Council
(``designated clearing agency'').\21\ A clearing agency must begin
filing Advance Notices pursuant to Section 806(e) once the Council
designates the clearing agency as systemically important.\22\ The
Commission is proposing to implement the Section 806(e) filing
requirement by amending Rule 19b4 to define and determine when Advance
Notices must be filed by designated clearing agencies and to require that Advance Notices be filed on Form 19b4.
\20\ 12 U.S.C. 5462(6).
\21\ See supra note 18 discussing the definition of
``Supervisory Agency'' under the DoddFrank Act.
\22\ Pursuant to Section 814 of the Dodd Frank Act, Title VIII took effect on the date of enactment.
The Commission is proposing that SecurityBased Swap Submissions
and Advance Notices be filed with the Commission on Form 19b4 using
the existing Electronic Form 19b4 Filing System (``EFFS''). Currently,
EFFS is used by selfregulatory organizations (``SROs''), which include
registered clearing agencies,\23\ to file proposed rule changes
electronically with the Commission pursuant to Exchange Act Section
19(b).\24\ The Commission is proposing to require clearing agencies to
use EFFS for the filing of SecurityBased Swap Submissions and Advance
Notices because registered clearing agencies already use EFFS for
Exchange Act Section 19(b) filings and because there are similarities
between the requirement to file proposed rule changes under Exchange
Act Section 19(b) and the new requirements under the DoddFrank Act to
file SecurityBased Swap Submissions and Advance Notices. For example,
a proposed rule change under Exchange Act Section 19(b) includes a
change in a ``stated policy, practice, or interpretation'' of an SRO
rule. A ``stated policy, practice, or interpretation'' is defined in
Exchange Act Section 19(b) as ``any material aspect of the operation of
the facilities of the SRO; or any statement made generally available to
the membership of, to all participants in, or to persons having or
seeking access * * * to facilities of, the selfregulatory organization
(``specified persons''), or to a group or category of specified
persons, that establishes or changes any standard, limit, or guideline
with respect to (1) the rights, obligations, or privileges of specified
persons * * *; or (2) the meaning, administration, or enforcement of an
existing rule.'' \25\ In cases where accepting a securitybased swap
(or group, category, type or class of securitybased swaps) for
clearing constitutes a change in a ``stated policy, practice, or
interpretation'' of the clearing agency, the clearing agency also [[Page 82493]]
would be required to file a proposed rule change. Similarly, if a
change that a designated clearing agency proposes to make that would
require an Advance Notice would also constitute a change in a ``stated
policy, practice, or interpretation'' of the clearing agency, the
clearing agency would be required to file a proposed rule change in addition to the Advance Notice.
\23\ The definition of SRO in Section 3(a)(26) of the Exchange
Act includes any registered clearing agency. 15 U.S.C. 78c(a)(26).
All SROs are required to file proposed rule changes with the
Commission under Exchange Act Section 19(b). 15 U.S.C. 78s(b).
\24\ SROs are required to file with the Commission, in
accordance with rules prescribed by the Commission, copies of any
proposed rule or any proposed change in, addition to, or deletion
from the rules of the SRO (collectively referred to as a ``proposed rule change''). 15 U.S.C. 78s(b)(1).
\25\ 17 CFR 240.19b4(c).
The Commission also is proposing to amend Rule 19b4 and Form 19b4 to conform to the requirements specified in Exchange Act Section 19(b), as amended by Section 916 of the Dodd Frank Act.\26\ Section 916 provides new deadlines by which the Commission must publish and act upon proposed rule changes submitted by SROs and new standards for approval, disapproval and temporary suspension of proposed rule changes.\27\ In addition, the Commission is proposing a number of technical and clarifying amendments to Rule 19b4 and Form 19b4. \26\ Public Law 111203, section 916 (amending Exchange Act Section 19(b)(2)).
\27\ Id.
In proposing these rules, the Commission is mindful that there are differences between the securitybased swap market and the other securities markets that the Commission regulates. The Commission also is mindful that over time and as a result of Commission proposals to implement the DoddFrank Act, further development of the securitybased swap market may alter the policy objectives and considerations relating to the clearing of securitybased swaps. During the process of implementing the DoddFrank Act and beyond, the Commission therefore will closely monitor developments in the securitybased swap market, including how the SecurityBased Swap Submission and clearing processes interact with the evolving business and practices of securitybased swap clearing agencies and other entities.
II. Discussion of the Proposed Rules
The Commission is proposing to adopt rules to implement the new requirements imposed by Title VII and Title VIII discussed above. In accordance with the requirements set forth in Exchange Act Section 3C (found in Title VII), the Commission is proposing amendments to Rule 19b4 and Form 19b4 and new Rule 3Ca1 under the Exchange Act to establish processes for (i) clearing agencies registered with the Commission to submit for review each securitybased swap, or any group, category, type or class of securitybased swaps, that the clearing agency plans to accept for clearing for a determination by the Commission of whether the securitybased swap (or group, category, type or class of securitybased swaps) is required to be cleared, and to determine the manner of notice the clearing agency must provide to its members of such submission and (ii) how the Commission may stay the requirement that a securitybased swap is subject to mandatory clearing. The Commission also is proposing new Rule 3Ca2 to prevent evasions of the clearing requirement. In addition, the Commission is proposing amendments to Rule 19b4 and Form 19b4 to implement the requirement, pursuant to Section 806(e), that any designated clearing agency for which the Commission is the Supervisory Agency will be required to provide advance notice to the Commission of changes to its rules, procedures or operations that could materially affect the nature or level of risks presented by the designated clearing agency. This release also discusses the filing requirements in Exchange Act Section 19(b), Exchange Act Section 3C, and Section 806(e) and a clearing agency's obligation to fully comply with and seek a determination pursuant to each separate statutory requirement, when applicable. A. SecurityBased Swap Submissions
Exchange Act Section 3C creates, among other things, a clearing requirement with respect to securitybased swaps. Specifically, the section provides that ``[i]t shall be unlawful for any person to engage in a securitybased swap unless that person submits such securitybased swap for clearing to a clearing agency that is registered under this Act or a clearing agency that is exempt from registration under this Act if the securitybased swap is required to be cleared.'' \28\ \28\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(a)(1)). The requirement that a securitybased swap be cleared stems from a determination by the Commission. Such determination may be made in connection with the review of a clearing agency's submission regarding a securitybased swap, or any group, category, type or class of securitybased swaps, that the clearing agency plans to accept for clearing (i.e., a SecurityBased Swap Submission). See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(2)(C)) (``[t]he Commission shall * * * review each submission made under subparagraphs (A) and (B), and determine whether the securitybased swap, or group, category, type, or class of securitybased swaps, described in the submission is required to be cleared.''). In addition, Exchange Act Section 3C(b)(1) provides that ``[t]he Commission on an ongoing basis shall review each securitybased swap, or any group, category, type, or class of securitybased swaps to make a determination that such securitybased swap, or group, category, type, or class of security based swaps should be required to be cleared.''
Exchange Act Section 3C requires the Commission, not later than one
year after the date of the enactment of the DoddFrank Act, to adopt
rules for a clearing agency's SecurityBased Swap Submissions and to
determine the manner of notice the clearing agency must provide to its
members of such SecurityBased Swap Submission.\29\ In connection with
rulemaking related to SecurityBased Swap Submissions, the Commission
is proposing rules related to (i) the process for making SecurityBased
Swap Submissions to the Commission, (ii) the substance of Security
Based Swap Submissions and (iii) the timing related to SecurityBased
Swap Submissions. The Commission also is proposing a process and timing
for clearing agencies to provide notice to their members of Security Based Swap Submissions.
\29\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(2)(A)).
1. Process for Making SecurityBased Swap Submissions to the Commission
A clearing agency that plans to accept a securitybased swap for clearing must file a SecurityBased Swap Submission with the Commission for a determination by the Commission of whether a securitybased swap, or a group, category, type or class of securitybased swaps, is required to be cleared. As discussed in Section I, in cases where accepting a securitybased swap (or group, category, type or class of securitybased swaps) for clearing constitutes a change in a ``stated policy, practice, or interpretation'' of the clearing agency, the clearing agency also would be required to file a proposed rule change. In such cases, the Commission must determine (i) whether to approve the clearing agency's proposed rule change to clear the applicable securitybased swap and (ii) whether the securitybased swap would be subject to the mandatory clearing requirement.
The Commission is proposing to require clearing agencies to use
EFFS and Form 19b4 for SecurityBased Swap Submissions. Clearing
agencies, as SROs, are already required to file proposed rule changes
on Form 19b4 on EFFS. Using the same filing process for SecurityBased
Swap Submissions would leverage existing technology and reduce the
resources clearing agencies would have to expend on meeting Commission
filing requirements. In addition, the Commission anticipates that a
submission to clear a securitybased swap, or any group, category, type
or class of securitybased swaps, may be required to be filed under both
[[Page 82494]]
Exchange Act Section 19(b) and Exchange Act Section 3C. This is because
a submission that must be filed with the Commission for a determination
under new Exchange Act Section 3C also may qualify as a proposed rule
change that must be filed with the Commission under Exchange Act
Section 19(b).\30\ In other words, the two filing requirements are not
mutually exclusive. Because a clearing agency may be required to file
the same proposal under Exchange Act Section 3C and Exchange Act
Section 19(b), the Commission preliminarily believes that the most
efficient use of the Commission's and clearing agencies' resources
would be to require clearing agencies to use the existing Form 19b4
filing process for both types of filings. Accordingly, the proposed
rules related to the SecurityBased Swap Submission process would be
added to existing Rule 19b4, which currently governs the process for filing proposed rule changes.
\30\ A clearing agency rule is defined broadly in the Exchange
Act to include the constitution, articles of incorporation, bylaws,
and rules, or instruments corresponding to the foregoing. 15 U.S.C.
78c(a)(27). The Commission anticipates that a proposal to clear a
new type, category or class of securitybased swap will in many
cases also be a change to the rules of a registered clearing agency
that must be filed with the Commission for approval pursuant to Exchange Act Section 19(b).
The Commission's proposed approach would eliminate the need for
multiple submissions to the Commission and could be accomplished by
adding a box to Form 19b4 that clearing agencies would check to
indicate that they are making a SecurityBased Swap Submission. As a
practical matter, the Commission believes that when a securitybased
swap is submitted for review under Exchange Act Section 3C and
concurrently filed under Exchange Act Section 19(b) as a proposed rule
change, the two reviews will be carried out in tandem. In circumstances
where no proposed rule change filing would be required, such as a case
where a clearing agency's rules already permit it to clear the
securitybased swap in question, EFFS and Form 19b4 still would be used for the SecurityBased Swap Submission.
a. Substance of SecurityBased Swap Submissions: Consistency With Exchange Act Section 17A
In reviewing a SecurityBased Swap Submission, the Commission is
required to review whether the submission is consistent with Exchange
Act Section 17A.\31\ Accordingly, the Commission is proposing that each
SecurityBased Swap Submission contain a statement regarding how the
submission is consistent with Exchange Act Section 17A.\32\ Exchange
Act Section 17A specifies, among other things, that the Commission is
directed, having due regard for the public interest, the protection of
investors, the safeguarding of securities and funds and maintenance of
fair competition among brokers and dealers, clearing agencies, and
transfer agents, to use its authority to facilitate the establishment
of a national system for the prompt and accurate clearance and settlement of transactions in securities.\33\
\31\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(4)(A)).
\32\ Proposed Rule 19b4(o)(3)(i).
\33\ 15 U.S.C. 78q1.
The Commission must review whether a proposed rule change filed by
an SRO pursuant to Exchange Act Section 19(b) is consistent with
Exchange Act Section 17A.\34\ In connection with proposed rule changes,
an SRO is required to ``explain why the proposed rule change is
consistent with the requirements of the [Exchange] Act and the rules
and regulations thereunder applicable to the [SRO]. A mere assertion
that the proposed rule change is consistent with those requirements is
not sufficient.'' \35\ Presently, in complying with this requirement,
registered clearing agencies, among other things, specify how the
proposed rule change is consistent with the requirements under Exchange
Act Section 17A(b)(3). All registered clearing agencies must comply
with the standards in Exchange Act Section 17A, which include
requirements under Exchange Act Section 17A(b)(3) to maintain rules for
promoting the prompt and accurate clearance and settlement of
securities transactions, assuring the safeguarding of securities and
funds which are in the custody or control of the clearing agency or for
which it is responsible, fostering cooperation and coordination with
persons engaged in the clearance and settlement of securities
transactions, removing impediments to and perfecting the mechanism of a
national system for the prompt and accurate clearance and settlement of
securities transactions, and, in general, protecting investors and the
public interest.\36\\\ A registered clearing agency is also required
under Exchange Act Section 17A(b)(3) to provide fair access to clearing
and to have the capacity to facilitate the prompt and accurate
clearance and settlement of securities transactions and derivative
agreements, contracts, and transactions for which it is responsible, as
well as to safeguard securities and funds in its custody or control or
for which it is responsible.\37\ Under the proposed amendments to Rule
19b4, a clearing agency would be required to specify how the Security
Based Swap Submission is consistent with Exchange Act Section 17A and
specifically the requirements applicable under subsection 17A(b)(3).
\34\ See 15 U.S.C. 78s(b)(2)(C)(i), which provides that the
Commission shall approve a proposed rule change of an SRO if it
finds that such proposed rule change is consistent with the
requirements of the Exchange Act and the rules and regulations
issued thereunder that are applicable to such organization.
\35\ Item 3(b) of Form 19b4. 17 CFR 240.819. Exchange Act
Section 19(b) has a similar but not identical requirement. It
requires that an SRO provide a statement of the basis of the
proposed rule change and provides that the Commission shall only
approve a proposed rule change if it finds that it is consistent
with the requirements of the Exchange Act and the rules and regulations thereunder. 15 U.S.C. 78s(b).
\36\ See 15 U.S.C. 78q1(b)(3)(F).
\37\ 15 U.S.C. 78q1(b)(3)(A), (B) and (F).
b. Substance of SecurityBased Swap Submissions: Quantitative and Qualitative Factors
The DoddFrank Act requires the Commission to take into account
several factors in addition to consistency with Exchange Act Section 17A in reviewing a clearing agency's SecurityBased Swap
Submission.\38\ The Commission is proposing to require clearing
agencies to provide information relevant to these factors through the
proposed amendments to Rule 19b4 and Form 19b4. Specifically,
clearing agencies would be required to submit quantitative and
qualitative information to assist the Commission in the consideration
of the five factors Exchange Act Section 3C requires the Commission to
take into account in reviewing a SecurityBased Swap Submission, which include:
\38\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(4)(B)(i)(v)).
(i) The existence of significant outstanding notional exposures, trading liquidity and adequate pricing data.
(ii) The availability of a rule framework, capacity, operational
expertise and resources, and credit support infrastructure to clear the
contract on terms that are consistent with the material terms and trading conventions on which the contact is then traded.
(iii) The effect on the mitigation of systemic risk, taking into
account the size of the market for such contract and the resources of the clearing agency available to clear the contract.
(iv) The effect on competition, including appropriate fees and charges applied to clearing.
(v) The existence of reasonable legal certainty in the event of the insolvency of the relevant clearing agency or one or
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more of its clearing members with regard to the treatment of customer and securitybased swap counterparty positions, funds, and
property.\39\
\39\ Proposed Rule 19b4(o)(3)(ii).
Each SecurityBased Swap Submission would be required to address the factors listed above to the extent they are applicable to the securitybased swap, the clearing agency and the market.
For example, in connection with the discussion responsive to factor (i) above, the clearing agency could address pricing sources, models and procedures demonstrating an ability to obtain price data to measure credit exposures in a timely and accurate manner, as well as measures of historical market liquidity and trading activity, and expected market liquidity and trading activity if the securitybased swap is required to be cleared (including information on the sources of such measures). With respect to the discussion of factor (ii) above, the statement describing the availability of a rule framework could include a discussion of the rules, policies or procedures applicable to the clearing of the relevant securitybased swap. Additionally, the discussion of credit support infrastructure could include the methods to address and communicate requests for, and posting of, collateral. With respect to factor (iii) above, the discussion of systemic risk could include a statement on the clearing agency's risk management procedures, including among other things the measurement and monitoring of credit exposures, initial and variation margin methodology, methodologies for stress testing and back testing, settlement procedures and default management procedures. With respect to factor (iv) above, the discussion of fees and charges could address any volume incentive programs that may apply or impact the fees and charges. With respect to factor (v) above, the discussion could address segregation of accounts and all other customer protection measures under insolvency.
In describing the securitybased swap, or any group, category, type
or class of securitybased swaps, that a clearing agency plans to
accept for clearing, the clearing agency could include the relevant
product specifications, including copies of any standardized legal
documentation, generally accepted contract terms,\40\ standard
practices for managing and communicating any life cycle events
associated with the securitybased swap and related adjustments,\41\
and the manner in which the information contained in the confirmation
of the securitybased swap trade is transmitted. The clearing agency
also could discuss its financial and operational capacity to provide
clearing services to all customers subject to the clearing requirements
as applicable to the particular securitybased swap. Finally, the
clearing agency could include an analysis of the effect of a clearing
requirement on the market for the group, category, type, or class of
securitybased swaps, both domestically and globally, including the
potential effect on market liquidity, trading activity, use of
securitybased swaps by direct and indirect market participants and any
potential market disruption or benefits. This analysis could include
whether the members of the clearing agency are operationally and
financially capable of absorbing clearing business (including indirect
access market participants) that may result from a determination that
the securitybased swap (or group, category, type or class of security based swaps) is required to be cleared.
\40\ For example, for some securitybased swaps, industry
standard documentation would include the applicable International
Swaps and Derivatives Association, Inc. Master Agreement and any related assetclassspecific definitions.
\41\ The Commission has proposed Regulation SBSR, which contains
a definition of ``life cycle event.'' See Exchange Act Release No.
63346 (Nov. 19, 2010), 75 FR 75208 (Dec. 2, 2010) (``Regulation SBSRReporting and Dissemination of SecurityBased Swap
Information'').
c. Substance of SecurityBased Swap Submissions: Open Access
New Exchange Act Section 3C also requires that the rules of a
clearing agency that clears securitybased swaps subject to the
clearing requirement provide for open access.\42\ In the course of
reviewing a SecurityBased Swap Submission, the Commission may assess
whether a clearing agency's rules provide for open access, particularly
with respect to the relevant SecurityBased Swap Submission.
Accordingly, the proposed rule provides that the SecurityBased Swap
Submission must include a statement regarding how a clearing agency's rules:
\42\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(a)(2) (``[t]he rules of a clearing agency described in
paragraph (1) shall(A) prescribe that all securitybased swaps
submitted to the clearing agency with the same terms and conditions
are economically equivalent within the clearing agency and may be
offset with each other within the clearing agency; and (B) provide
for nondiscriminatory clearing of a securitybased swap executed
bilaterally or on or through the rules of an unaffiliated national
securities exchange or securitybased swap execution facility.'').
(i) Prescribe that all securitybased swaps submitted to the
clearing agency with the same terms and conditions are economically
equivalent within the clearing agency and may be offset with each other within the clearing agency; and
(ii) Provide for nondiscriminatory clearing of a securitybased
swap executed bilaterally or on or through the rules of an unaffiliated
national securities exchange or securitybased swap execution facility.\43\
\43\ Proposed Rule 19b4(o)(3)(ii).
In making a determination, the Commission proposes to take into
account the factors specified in Exchange Act Section 3C and any
additional information the Commission determines to be appropriate. The
proposed rule also requires a clearing agency to provide any additional
information requested by the Commission as necessary to make a
determination.\44\ The Commission believes that such a requirement
would provide appropriate flexibility to facilitate our regulatory
responsibilities. In making a determination of whether or not the
clearing requirement would apply to the securitybased swap, or any
group, category, type, or class of securitybased swaps, described in
the submission, the Commission may require such terms and conditions as
the Commission determines to be appropriate in the public interest.\45\ \44\ Proposed Rule 19b4(o)(6)(i).
\45\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(4)(C)) and Proposed Rule 19b4(o)(6)(ii).
d. Timing Related to SecurityBased Swap Submissions
Under Exchange Act Section 3C, as added by Section 763(a) of the
DoddFrank Act, the Commission is required to make its determination of
whether a securitybased swap described in a clearing agency's
SecurityBased Swap Submission is required to be cleared not later than
90 days after receiving such SecurityBased Swap Submission.\46\ The
90day determination period may be extended with the consent of the
clearing agency making such SecurityBased Swap Submission.\47\ The
Commission is required to make available to the public any Security
Based Swap Submission it receives and to provide at least a 30day public comment period ``regarding its
[[Page 82496]]
determination whether the clearing requirement shall apply to the
submission.'' \48\ This 30day comment period enables the public to
have an opportunity to comment on the SecurityBased Swap Submission
and to provide information for the Commission to consider as part of
making its determination whether the clearing requirement should apply
to the submission. Accordingly, the Commission proposes to make the
SecurityBased Swap Submission available for a 30day public comment
period within the 90day determination period. The Commission would
publish notice of the SecurityBased Swap Submission in the Federal
Register and publish notice on the Commission's publiclyavailable Web
site at http://www.sec.gov. Such notice would include the solicitation
of public comment. This proposed publication process would be
consistent with the current process that is in place for proposed rule changes under Exchange Act Section 19(b)(2) and Rule 19b4.
\46\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(b)(3)). Further, pursuant to proposed Rule 19b4(o)(2),
if any information submitted to the Commission by a clearing agency
on Form 19b4 were not complete or otherwise in compliance with Rule
19b4 and Form 19b4, such information would not be considered a
SecurityBased Swap Submission and the Commission would be required
to inform the clearing agency within twentyone business days of such submission.
\47\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(3)).
\48\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(2)(C)).
e. Notice to Clearing Agency Members
New Exchange Act Section 3C requires that a clearing agency provide
notice to its members, in a manner determined by the Commission, of its
SecurityBased Swap Submissions.\49\ To meet the requirement of
providing notice of SecurityBased Swap Submissions to members, the
Commission is proposing amendments to Rule 19b4 that would require
clearing agencies to post on their Web sites such submissions to the
Commission, and any amendments thereto.\50\ This public posting would
be required to be completed within two business days following the
SecurityBased Swap Submission to the Commission. This timeframe is
consistent with the notice requirement that currently applies to
proposed rule changes,\51\ and the Commission believes that such
timeframe would provide members of the clearing agency and the public
with timely notice of the submission. The clearing agency would be
required to maintain such material on its Web site until the Commission
makes a determination regarding the SecurityBased Swap Submission, the
clearing agency withdraws the SecurityBased Swap Submission or the
clearing agency is notified that the SecurityBased Swap Submission is
not properly filed.\52\ These requirements should help ensure that
submissions that are being actively considered by the Commission are
readily available to the members of the clearing agency and the public and help provide for a more transparent process.
\49\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(b)(2)(A)).
\50\ Proposed Rule 19b4(o)(5).
\51\ Commission rules currently require SROs to post on their
Web sites a copy of any proposed rule change the SRO filed with the
Commission, and any amendments thereto. Such posting is required
within two business days after filing the proposed rule change with
the Commission. See 17 CFR 240.19b4(l). In adopting this rule, the
Commission stated that all market participants, investors and other
interested parties should have access to proposed rule changes filed
with the Commission, and any amendments, as soon as practicable, and
that it did not believe that a twobusinessday timeframe would be
impractical or unduly burdensome on SROs. See Securities Exchange
Act Release No. 50486 (Oct. 4, 2004), 69 FR 60287 (Oct. 8, 2004)
(Final Rules Regarding Proposed Rule Changes of SelfRegulatory Organizations).
\52\ Proposed Rule 19b4(o)(5).
The Commission notes that the current instructions for Form 19b4
require an SRO to file with the Commission copies of notices issued by
the SRO soliciting comment on the proposed rule change and copies of
all written comments on the proposed rule change received by the SRO
(whether or not comments were solicited) from its members or
participants. Any correspondence the SRO receives after it files a
proposed rule change, but before the Commission takes final action on
the proposed rule change, also is required to be filed with the
Commission.\53\ The SRO is required to summarize the substance of all
such comments received and respond in detail to any significant issues
raised in the comments about the proposed rule change.\54\ The
Commission is proposing that in connection with SecurityBased Swap
Submissions, clearing agencies would be subject to these same
requirements. The Commission preliminarily believes that its proposal
to apply such requirements in the instructions to Form 19b4 to
SecurityBased Swap Submissions would provide the Commission with an
opportunity to consider the various viewpoints expressed by commenters
by making sure relevant comments are included in the materials provided to the Commission.
\53\ See Items 5 and 9 (Exhibit 2) of Form 19b4. 17 CFR 240.819.
\54\ Item 5 of Form 19b4. 17 CFR 240.819.
f. Submissions of a Group, Category, Type or Class of SecurityBased Swaps
The proposed amendments to Rule 19b4 and Form 19b4 would require
that clearing agencies submit securitybased swaps for review by group,
category, type, or class to the extent it is practicable and reasonable
to do so.\55\ Any aggregation would be required to be clearly described
in a SecurityBased Swap Submission so that market participants and the
public know which securitybased swaps may be subject to a clearing
requirement. The Commission preliminarily believes that including
multiple securitybased swaps in each submissionto the extent that
such groupings are practicable and reasonable (e.g., by taking into
consideration appropriate risk management issues applicable to the
aggregation)would streamline the submission process for Commission
staff and the clearing agencies. This in turn would allow more securitybased swaps to be reviewed in a timely manner.
\55\ Proposed Rule 19b4(o)(4). In its release proposing rules
to implement Section 723 of the DoddFrank Act, the CFTC has proposed a similar rule. 75 FR 67277 (November 2, 2010).
Request for Comments
The Commission generally requests comments on all aspects of the
proposed amendments to Rule 19b4 that would incorporate the process
for making SecurityBased Swap Submissions. In addition, the Commission requests comments on the following specific issues:
[[Page 82497]]
information be required in all cases and incorporated into the rules?
[[Page 82498]]
agency's submission of a group, category, type, or class of security based swaps, as appropriate, for review?
As discussed above, Exchange Act Section 3C provides, among other
things, for a determination by the Commission of whether securitybased
swaps are required to be cleared.\56\ The Commission may determine that
a securitybased swap is required to be cleared based on a review of a
clearing agency's submission regarding a securitybased swap, or any
group, category, type or class of securitybased swaps, that the
clearing agency plans to accept for clearing (i.e., a SecurityBased
Swap Submission).\57\ Consistent with proposal, if the Commission
determines that a securitybased swap is not required to be cleared,
such securitybased swap may still be cleared on a nonmandatory basis
by the clearing agency if the clearing agency has rules that permit it
to clear such securitybased swap.\58\ In addition, Exchange Act
Section 3C(b)(1) provides that ``[t]he Commission on an ongoing basis
shall review each securitybased swap, or any group, category, type, or
class of securitybased swaps to make a determination that such
securitybased swap, or group, category, type, or class of security
based swaps should be required to be cleared'' (i.e., a Commission initiated Review).\59\
\56\ See Public Law 111203, section 763(a) (adding Exchange Act Section 3C(a)(1)).
\57\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(b)(2)(C)) (``[t]he Commission shall * * * review each
submission made under subparagraphs (A) and (B), and determine
whether the securitybased swap, or group, category, type, or class
of securitybased swaps, described in the submission is required to be cleared.'').
\58\ See 15 U.S.C. 78s(b) (proposed rule changes) and 12 U.S.C. 5465(e) (Advance Notices).
\59\ See Public Law 111203, section 763(a) (adding Exchange Act
Section 3C(b)(1)). The DoddFrank Act does not require rulemaking with respect to Commissioninitiated Reviews.
The proposed addition of paragraph (o) to Rule 19b4 and related
amendments to Form 19b4 are intended to provide a process for
SecurityBased Swap Submissions. The Commission is required under the
DoddFrank Act to adopt rules specifying the process for SecurityBased
Swap Submissions. As part of the process of review of each Security
Based Swap Submission (and in each Commissioninitiated Review), the
Commission must take into account the five factors specified in Exchange Act Section 3C(b)(4)(B):
(i) The existence of significant outstanding notional exposures, trading liquidity and adequate pricing data.
(ii) The availability of a rule framework, capacity, operational
expertise and resources, and credit support infrastructure to clear the
contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded.
(iii) The effect on the mitigation of systemic risk, taking into
account the size of the market for such contract and the resources of the clearing agency available to clear the contract.
(iv) The effect on competition, including appropriate fees and
FOR FURTHER INFORMATION CONTACT
Kim Allen, Attorney Fellow, Catherine Moore, Senior Special Counsel, Kenneth Riitho, Special Counsel or Andrew Bernstein, AttorneyAdvisor, at (202) 5515710; Office of Clearance and Settlement, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 205497010.