Notice2021-16657
Order Granting Conditional Substituted Compliance in Connection With Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers and Major Security-Based Swap Participants Subject to Regulation in the United Kingdom
Primary source
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Published
August 6, 2021
Issuing agencies
Securities and Exchange Commission
Full Text
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[Federal Register Volume 86, Number 149 (Friday, August 6, 2021)]
[Notices]
[Pages 43318-43380]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-16657]
[[Page 43317]]
Vol. 86
Friday,
No. 149
August 6, 2021
Part II
Securities and Exchange Commission
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Order Granting Conditional Substituted Compliance in Connection With
Certain Requirements Applicable to Non-U.S. Security-Based Swap Dealers
and Major Security-Based Swap Participants Subject to Regulation in the
United Kingdom; Notice
Federal Register / Vol. 86 , No. 149 / Friday, August 6, 2021 /
Notices
[[Page 43318]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-92529; File No. S7-04-21]
Order Granting Conditional Substituted Compliance in Connection
With Certain Requirements Applicable to Non-U.S. Security-Based Swap
Dealers and Major Security-Based Swap Participants Subject to
Regulation in the United Kingdom
July 30, 2021.
I. Overview
The United Kingdom Financial Conduct Authority (``FCA'') has
submitted a ``substituted compliance'' application (``FCA
Application'') requesting that the Securities and Exchange Commission
determine, pursuant to the Securities Exchange Act of 1934 (``Exchange
Act'') rule 3a71-6,\1\ that security-based swap dealers and major-
security based swap participants (``SBS Entities'') subject to
regulation in the United Kingdom (``UK'') conditionally may satisfy
requirements under the Exchange Act by complying with comparable UK
requirements.\2\ The FCA Application sought substituted compliance in
connection with certain Exchange Act requirements related to risk
control; capital and margin; internal supervision and compliance;
counterparty protection; and record keeping, reporting, notification,
and securities counts.\3\ The FCA Application included comparability
analyses between the relevant requirements in Exchange Act section 15F
and the rules and regulations thereunder and applicable UK law,\4\ as
well as information regarding UK supervisory and enforcement
frameworks.
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\1\ 17 CFR 240.3a71-6.
\2\ See Letter from Nausicaa Delfas, Executive Director of
International, FCA, dated March 19, 2021. The FCA Application is
available on the Commission's website at: <a href="https://www.sec.gov/files/uk-financial-conduct-authority-complete-application-substituted-compliance-031921.pdf">https://www.sec.gov/files/uk-financial-conduct-authority-complete-application-substituted-compliance-031921.pdf</a>.
\3\ ``Risk control'' includes requirements related to internal
risk management, trade acknowledgment and verification, portfolio
reconciliation and dispute resolution, portfolio compression, and
trading relationship documentation; ``capital and margin'' includes
requirements related to capital applicable to security-based swap
dealers without a prudential regulator and to margin applicable to
SBS Entities without a prudential regulator; ``internal supervision
and compliance'' includes requirements related to diligent
supervision, conflicts of interest, information gathering under
Exchange Act section 15F(j), 15 U.S.C. 78o-10(j), and chief
compliance officers; ``counterparty protection'' includes
requirements related to disclosure of material risks and
characteristics and material incentives or conflicts of interest,
``know your counterparty,'' suitability of recommendations, fair and
balanced communications, disclosure of daily marks, and disclosure
of clearing rights; and ``record keeping, reporting, notification,
and securities counts'' includes requirements related to making and
keeping current certain prescribed records, preservation of records,
reporting, notification, and securities counts.
\4\ Though the UK ceased to be a member of the European Union
(``EU'') on January 31, 2020, market participants in the UK remain
subject to UK requirements implemented pursuant to EU directives,
and to EU regulations that have been added to UK law. In adding EU
regulations to UK law, the UK in some cases has adopted UK versions
of these regulations that differ from the original EU versions ``as
necessary to account for the effects of Brexit.'' See FCA
Application Appendix A at 7. The Commission has reviewed the FCA
Application in light of the UK versions of these regulations.
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On April 5, 2021, the Commission issued a notice of the FCA
Application, accompanied by a proposed order to grant substituted
compliance with conditions in connection with the FCA Application
(``proposed Order'').\5\ The proposed Order incorporated a number of
conditions to tailor the scope of substituted compliance consistent
with the prerequisite that relevant UK requirements produce regulatory
outcomes that are comparable to relevant requirements under the
Exchange Act.
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\5\ See Exchange Act Release No. 91476 (Apr. 5, 2021), 86 FR
18378 (Apr. 8, 2021) (``UK Substituted Compliance Notice and
Proposed Order'').
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As discussed below, the Commission is adopting a final order
(``Order'') that has been modified from the proposed Order in certain
respects to address commenter concerns and to make clarifying changes.
II. Substituted Compliance Framework and Prerequisites
A. Substituted Compliance Availability and Purpose
As discussed in the UK Substituted Compliance Notice and Proposed
Order, Exchange Act rule 3a71-6 provides a framework whereby non-U.S.
SBS Entities may satisfy certain requirements under Exchange Act
section 15F by complying with comparable regulatory requirements of a
foreign jurisdiction.\6\ Because substituted compliance does not
constitute exemptive relief, but instead provides an alternative method
by which non-U.S. SBS Entities may comply with applicable Exchange Act
requirements, the non-U.S. SBS Entities would remain subject to the
relevant requirements under section 15F. The Commission accordingly
will retain the authority to inspect, examine, and supervise those SBS
Entities' compliance and take enforcement action as appropriate. Under
the substituted compliance framework, failure to comply with the
applicable foreign requirements and other conditions to a substituted
compliance order would lead to a violation of the applicable
requirements under the Exchange Act and potential enforcement action by
the Commission (as opposed to automatic revocation of the substituted
compliance order).
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\6\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18378; see also Exchange Act Release No. 90378 (Nov. 9, 2020),
85 FR 72726, 72727 (Nov. 13, 2020) (``German Substituted Compliance
Notice and Proposed Order''); Exchange Act Release No. 90765 (Dec.
22, 2020), 85 FR 85686 (Dec. 29, 2020) (``German Substituted
Compliance Order''); Exchange Act Release No. 90766 (Dec. 22, 2020),
85 FR 85720 (Dec. 29, 2020) (``French Substituted Compliance Notice
and Proposed Order''); Exchange Act Release No. 91477 (Apr. 5,
2021), 86 FR 18341 (Apr. 8, 2021) (``French Substituted Compliance
Re-Opening Release''); Exchange Act Release No. 92484 (Jul. 23,
2021) (``French Substituted Compliance Order'').
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Under rule 3a71-6, substituted compliance potentially is available
in connection with certain section 15F requirements,\7\ but is not
available in connection with antifraud prohibitions and certain other
requirements under the Federal securities laws.\8\ SBS Entities in the
UK accordingly must comply directly with those requirements
notwithstanding the availability of substituted compliance for other
requirements.
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\7\ See Exchange Act rule 3a71-6(d); see also UK Substituted
Compliance Notice and Proposed Order, 86 FR at 18378.
\8\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18378 n.5 (addressing unavailability of substituted compliance
in connection with certain information-related requirements under
section 15F, as well as provisions related to anti-fraud,
transactions with counterparties that are not eligible contract
participants, segregation of customer assets, required clearing upon
counterparty election, regulatory reporting and public
dissemination, SBS Entity registration, and registration of
offerings).
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The substituted compliance framework reflects the cross-border
nature of the security-based swap market, and is intended to promote
efficiency and competition by helping to address potential duplication
and inconsistency between relevant U.S. and foreign requirements.\9\ In
practice, substituted compliance may be expected to help SBS Entities
leverage their existing systems and practices to comply with relevant
Exchange Act requirements in conjunction with their compliance with
relevant foreign requirements. Market participants will begin to count
security-based swap transactions toward the thresholds for registration
with the Commission as an SBS Entity on August 6, 2021, and will be
required to begin registering with the
[[Page 43319]]
Commission on November 1, 2021.\10\ Substituted compliance should
assist relevant non-U.S. security-based swap market participants in
preparing for registration.
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\9\ See generally Exchange Act Release No. 77617 (Apr. 14,
2016), 81 FR 29960, 30073 (May 13, 2016) (``Business Conduct
Adopting Release'') (stating that U.S. security-based swap
regulation has ``the potential to lead to requirements that are
duplicative of or in conflict with applicable foreign business
conduct requirements, even when the two sets of requirements
implement similar goals and lead to similar results'').
\10\ See ``Key Dates for Registration of Security-Based Swap
Dealers and Major Security-Based Swap Participants,'' available at:
<a href="https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants">https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants</a>.
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B. Specific Prerequisites
1. Comparability of Regulatory Outcomes
Rule 3a71-6, adopted by the Commission in 2016, describes the
requirements for the Commission to make a substituted compliance
determination. Under that rule, the Commission must determine that the
analogous foreign requirements are comparable to otherwise applicable
requirements under the Exchange Act (i.e., the relevant requirements in
the Exchange Act and the rules and regulations thereunder), after
accounting for factors such as ``the scope and objectives of the
relevant foreign regulatory requirements'' and ``the effectiveness of
the supervisory compliance program administered, and the enforcement
authority exercised'' by the foreign authority.\11\ The comparability
assessments are to be based on a ``holistic approach'' that ``will
focus on the comparability of regulatory outcomes rather than
predicating substituted compliance on requirement-by-requirement
similarity.'' \12\
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\11\ See Exchange Act rule 3a71-6(a)(2).
\12\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18380; see also Business Conduct Adopting Release, 81 FR at
30078-79 (recognizing that ``different regulatory systems may be
able to achieve some or all of those regulatory outcomes by using
more or fewer specific requirements than the Commission, and that in
assessing comparability the Commission may need to take into account
the manner in which other regulatory systems are informed by
business and market practices in those jurisdictions''). The
Commission's assessment of a foreign authority's supervisory and
enforcement effectiveness--as part of the broader comparability
analysis--would be expected to consider not only overall oversight
activities, but also oversight specifically directed at conduct and
activity relevant to the substituted compliance determination. ``For
example, it would be difficult for the Commission to make a
comparability determination in support of substituted compliance if
oversight is directed solely at the local activities of foreign
security-based swap dealers, as opposed to the cross-border
activities of such dealers.'' Business Conduct Adopting Release, 81
FR at 30079 (footnote omitted). In the UK Substituted Compliance
Notice and Proposed Order, the Commission preliminarily concluded
that this comparability prerequisite was met in connection with a
number of requirements under the Exchange Act, in some cases with
the addition of conditions to help ensure the comparability of
regulatory outcomes.
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2. Memorandum of Understanding
Exchange Act rule 3a71-6(a)(2)(ii) further predicates the
availability of substituted compliance on the Commission having entered
into a memorandum of understanding and/or other arrangement with the
relevant foreign financial regulatory authority or authorities
``addressing supervisory and enforcement cooperation and other matters
arising under the substituted compliance determination.'' \13\ The FCA
Application asked the Commission to permit certain entities regulated
and supervised by both the FCA and the UK's Prudential Regulation
Authority (``PRA'') to use substituted compliance. Accordingly, the
Commission recently entered into a memorandum of understanding with the
FCA and the Bank of England (including in its capacity as the PRA),
thus satisfying this prerequisite.\14\
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\13\ Exchange Act rule 3a71-6(a)(2)(ii).
\14\ The Commission expects to publish a copy of the memorandum
of understanding on its website at <a href="http://www.sec.gov">www.sec.gov</a> under the
``Substituted Compliance'' tab, which is located on the ``Security-
Based Swap Markets'' page in the Division of Trading and Markets
section of the site.
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3. ``Adequate Assurances''
A foreign financial regulatory authority may submit a substituted
compliance application only if the authority provides ``adequate
assurances'' that no law or policy would impede the ability of any
entity that is directly supervised by the authority and that may
register with the Commission ``to provide prompt access to the
Commission to such entity's books and records or to submit to onsite
inspection or examination by the Commission.'' \15\ In the UK
Substituted Compliance Notice and Proposed Order, the Commission stated
that the FCA had satisfied this prerequisite in the Commission's
preliminary view, taking into account information and representations
that the FCA provided regarding certain UK requirements that are
relevant to the Commission's ability to inspect, and access the books
and records of, firms using substituted compliance pursuant to the
Order.\16\ The Commission received no comments on this preliminary view
and has not changed its view.
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\15\ See Exchange Act rule 3a71-6(c)(3).
\16\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18379 n.8.
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C. Commenter Views
1. Prerequisites to Substituted Compliance
One commenter stated that the Commission should make a positive
substituted compliance determination only when the Commission
determines that granting substituted compliance promotes the protection
of the U.S. financial system.\17\ The commenter also stated that grants
of substituted compliance must be predicated on a ``well-supported,
evidence-based determination'' that the relevant foreign requirements
will produce ``substantially similar'' regulatory outcomes.\18\
Congress gave the Commission authority in Title VII to implement a
security-based swap framework to address the potential effects of
security-based swap activity on U.S. market participants, the financial
stability of the United States, the transparency of the U.S. financial
system and the protection of counterparties.\19\ When adopting rules
regarding the application of Title VII's definitions of ``security-
based swap dealer'' and ``major security-based swap participant'' in
the cross-border context, the Commission was guided by the purposes of
Title VII and the applicable requirements of the Exchange Act, which
include consideration of not only risk to the U.S. financial system but
also other factors such as counterparty protection, transparency,
prevention of evasion, economic impacts and consultation and
coordination with other U.S. financial regulatory authorities and
foreign financial regulatory authorities.\20\ In its
[[Page 43320]]
registration rules for these SBS Entities, the Commission determined
that a foreign market participant whose U.S.-nexus security-based swap
activity qualifies it as an SBS Entity would be required to register as
such, without substituted compliance available for registration
requirements.\21\ The Commission concluded that obliging these foreign
persons to register serves an important regulatory function that would
be significantly impaired by permitting substituted compliance for
registration requirements.\22\ This registration requirement thus puts
into practice the Commission's consideration of the purposes of Title
VII and the applicable requirements of the Exchange Act in its adoption
of the definitions of ``security-based swap dealer'' and ``major
security-based swap participant'' in the cross-border context, and
ensures that such firms will be subject to the jurisdiction of the
Commission. Moreover, the rules applicable to these registered foreign
SBS Entities reflect the Commission's best judgment for how to achieve
the purposes of Title VII and satisfy the requirements of the Exchange
Act, including the Commission's consideration of risk to the U.S.
financial system.\23\ The Commission's rules for registered foreign SBS
Entities thus reflect the Commission's consistent consideration of all
of the purposes of Title VII and relevant parts of the Exchange Act,
first in the context of its adoption of the definitions of ``security-
based swap dealer'' and ``major security-based swap participant,'' then
in its decision to require foreign SBS Entities to register and finally
in its adoption of cross-border rules for SBS Entities pursuant to
Title VII.
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\17\ See Letter from Dennis M. Kelleher, President and CEO,
Stephen Hall, Legal Director and Securities Specialist, and Jason
Grimes, Senior Counsel, Better Markets, Inc. (May 3, 2021) (``Better
Markets Letter'') at 3-4. Comments may be found on the Commission's
website at: <a href="https://www.sec.gov/comments/s7-04-21/s70421.htm">https://www.sec.gov/comments/s7-04-21/s70421.htm</a>.
\18\ See Better Markets Letter at 4.
\19\ See Exchange Act Release No. 72472 (June 25, 2014), 79 FR
47278, 47286 (Aug. 12, 2014) (``Cross-Border Entity Definitions
Adopting Release'') (citing Pub. L. 111-203, Preamble (stating that
the Dodd-Frank Act was enacted ``[t]o promote the financial
stability of the United States by improving accountability and
transparency in the financial system, to end `too big to fail', to
protect the American taxpayer by ending bailouts, to protect
consumers from abusive financial services practices, and for other
purposes''); Public Law 111-203, sections 701-774 (providing for,
among other things, a comprehensive new regulatory framework for
security-based swaps, including by: (i) Providing for the
registration and comprehensive regulation of security-based swap
dealers and major security-based swap participants; (ii) imposing
clearing and trade execution requirements on security-based swaps,
subject to certain exceptions; and (iii) creating real-time
reporting and public dissemination regimes for security-based
swaps)).
\20\ See Cross-Border Entity Definitions Adopting Release, 79 FR
at 47292 (purposes of Title VII include consideration of risk to the
U.S. financial system and promotion of transparency in the U.S.
financial system); Exchange Act section 30(c), 15 U.S.C. 78dd(c)
(Commission rulemaking authority to prevent evasion of Title VII);
Exchange Act section 3(f), 15 U.S.C. 78c(f) (requirement to consider
whether certain Commission rulemaking actions would promote
efficiency, competition, and capital formation); Exchange Act
section 23(a)(2), 15 U.S.C. 78w(a)(2) (requirement to consider the
impact of Exchange Act rules and regulations on competition and
prohibition on adopting rules or regulations that would impose a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act); Dodd-Frank Act section 712(a)(2),
15 U.S.C. 8302 (requirement to consult and coordinate with U.S.
financial regulatory authorities on Title VII rulemaking); Dodd-
Frank Act section 752(a), 15 U.S.C. 8325 (requirement to consult and
coordinate, as appropriate, with foreign regulatory authorities on
the establishment of consistent international standards with respect
to the regulation of security-based swaps and security-based swap
entities)); see also Exchange Act Release No. 77104 (Feb. 10, 2016),
81 FR 8598, 8599 (Feb. 19, 2016) (``ANE Adopting Release'') (``A key
part of [the Title VII] framework is the regulation of security-
based swap dealers, which may transact extensively with
counterparties established or located in other jurisdictions and, in
doing so, may conduct sales and trading activity in one jurisdiction
and book the resulting transactions in another. These market
realities and the potential impact that these activities may have on
U.S. persons and potentially the U.S. financial system have informed
our consideration of these rules.''); Exchange Act Release No. 87780
(Dec. 18, 2019), 85 FR 6270, 6272 and n.26 (Feb. 4, 2020) (``Cross-
Border Adopting Release'') (``[T]he Title VII SBS Entity
requirements . . . serve a number of regulatory purposes apart from
mitigating counterparty and operational risks, `including enhancing
counterparty protections and market integrity, increasing
transparency, and mitigating risk to participants in the financial
markets and the U.S. financial system more broadly.' '' ``The
Commission's actions to mitigate the negative consequences
potentially associated with the various uses of [the `arranged,
negotiated, or executed' test] accordingly are designed to do so
while preserving the important Title VII interests that the
Commission advanced when it incorporated the test into the various
cross-border rules.'') (internal citations omitted).
\21\ See Exchange Act Release No. 75611 (Aug. 5, 2015), 80 FR
48964, 48972-73 (Aug. 14, 2015) (``Registration Adopting Release'').
\22\ See Registration Adopting Release, 80 FR at 48972-73.
\23\ See Cross-Border Entity Definitions Adopting Release, 79 FR
at 47286 n.65 (``Future rulemakings that depend on [the definitions
of `security-based swap dealer' and `major security-based swap
participant'] are intended to address the transparency, risk, and
customer protection goals of Title VII.'').
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When making a substituted compliance determination, the
Commission's task, as outlined in rule 3a71-6, is to evaluate whether
the relevant foreign requirements are comparable to Title VII-based
requirements and relevant provisions of the Exchange Act. The
comparability assessments are to be based on a ``holistic, outcomes-
oriented framework,'' \24\ which in the Commission's view--consistent
with the commenter's view--includes ``inquiry regarding whether foreign
requirements adequately reflect the interests and protections
associated with the particular Title VII requirement.'' \25\ Also
consistent with the commenter's view, the Commission's comparability
assessments reflect a close reading of the relevant UK requirements. In
addition, the Commission recognizes that ``other regulatory regimes
will have exclusions, exceptions, and exemptions that may not align
perfectly with the corresponding requirements under the Exchange Act.''
\26\ Accordingly, where UK requirements produce comparable outcomes--
with or without conditions as discussed in part III.B below--
notwithstanding those particular differences, and taking into account
the scope and objectives and the effectiveness of supervision and
enforcement of those requirements, the Commission has determined that
the relevant UK requirements are comparable and has made a positive
substituted compliance determination. Conversely, where those
exclusions, exemptions, and exceptions lead to outcomes that are not
comparable--taking into account potential conditions--the Commission
has not made a positive substituted compliance determination.
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\24\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18380; see also Business Conduct Adopting Release, 81 FR at
30076, 30078-79.
\25\ See Business Conduct Adopting Release, 81 FR at 30067.
\26\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18380; see also Business Conduct Adopting Release, 81 FR at
30076, 30078-79.
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The Commission also is including certain conditions in the Order.
The commenter stated that the inclusion of conditions should be viewed
as an indication that the requirements of substituted compliance have
not been met and as creating ``ad hoc, custom-made rules to supplement
inadequate rules of other jurisdictions.'' \27\ Pursuant to rule 3a71-
6, the Commission may make a conditional or unconditional substituted
compliance determination.\28\ As described in greater detail in part
III.B below, many of the conditions in the Order are designed to make
substituted compliance available only when the relevant UK requirements
in fact apply to the relevant security-based swap activity in a way
that promotes comparable regulatory outcomes. The commenter correctly
states that the Order also employs conditions to promote comparability.
For example, substituted compliance in connection with Exchange Act
rule 15Fi-3(c) \29\ dispute reporting provisions is conditioned in part
on the Covered Entity (as such term is defined in the Order) providing
the Commission with the dispute reports required under UK law.\30\
Consistent with rule 3a71-6, conditioning substituted compliance on the
Commission receiving those reports helps to promote timely notice of
disputes to support a comparable regulatory outcome.
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\27\ See Better Markets Letter at 4.
\28\ See Exchange Act rule 3a71-6(a)(1).
\29\ 17 CFR 240.15Fi-3(c).
\30\ See para. (b)(3)(ii) of the Order.
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2. Ensuring Ongoing Appropriateness of Substituted Compliance
One commenter stated that the Commission ``must ensure, on an
ongoing basis, that each grant of substituted compliance remains
appropriate over time.'' The commenter added that substituted
compliance orders and memoranda of understanding should incorporate the
obligation that the Commission be apprised of the activities and
results of the jurisdiction's supervision and enforcement programs, and
to immediately apprise the Commission of
[[Page 43321]]
material changes to the foreign regulatory regime.\31\
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\31\ See Better Markets Letter at 5.
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The Commission concurs that the ongoing availability of substituted
compliance should account for relevant changes in the foreign
jurisdiction's regulatory requirements and in the effectiveness of that
jurisdiction's supervisory and enforcement program.\32\ Accordingly,
the Commission and the FCA and the Bank of England in its capacity as
the PRA recently entered into a substituted compliance memorandum of
understanding that addresses ongoing information regarding potential
changes to substantive legal requirements and supervisory and
enforcement effectiveness.\33\ The Commission believes that these
arrangements will provide timely information to ensure that the
Commission is aware of material developments that may affect the
comparability of the relevant UK requirements, including the scope and
objectives of those requirements and the effectiveness of the FCA and
the Bank of England's supervision and enforcement programs. In response
to any such developments, the Commission may amend the Order as needed
to ensure that it continues to require a Covered Entity to comply with
comparable UK requirements, or may withdraw the Order if the relevant
UK requirements are no longer comparable.\34\ Moreover, substituted
compliance under the Order is conditioned on the Commission having this
memorandum of understanding, or another arrangement with the FCA and
the Bank of England addressing cooperation with respect to the Order,
at the time the Covered Entity makes use of substituted compliance.\35\
If the arrangements in the memorandum of understanding prove in
practice not to provide information about relevant developments, the
Commission could terminate the memorandum of understanding in
accordance with its terms and/or amend or withdraw the Order.\36\ If
the Commission, the FCA, or the Bank of England terminates the
memorandum of understanding, Covered Entities would not be able to rely
on substituted compliance under the Order to satisfy Exchange Act
compliance obligations that arise after the termination takes effect.
For these reasons, in the Commission's view, the Order's memorandum of
understanding condition, coupled with the ongoing information sharing
provisions in the memorandum of understanding with the FCA and the Bank
of England, establishes the commenter's suggested mechanism to apprise
the Commission of changes that may affect the ongoing appropriateness
of substituted compliance.
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\32\ See Business Conduct Adopting Release, 81 FR at 30078-79
(stating that order conditions and memorandum of understanding were
possible tools for providing that the Commission be notified of
material changes).
\33\ The memorandum of understanding between the Commission and
the FCA and the Bank of England in part provides that the FCA and
the Bank of England will provide ``ongoing information sharing''
regarding Firm Information (incorporating supervisory and related
information as to the Covered Entities using substituted compliance)
and regarding Regulatory Change Information (incorporating
information about any material publicly available draft, proposed,
or final change in law, regulation, or order of the jurisdiction of
the FCA or the Bank of England that may have a material impact on
the firms at issue with respect to their relevant activities). See
supra note 14 (information on publication of memorandum of
understanding with the FCA and the Bank of England).
\34\ Any such amendment or withdrawal may be at the Commission's
own initiative after appropriate notice and opportunity for comment.
See Exchange Act rule 3a71-6(a)(3).
\35\ See supra part II.B.2; para. (a)(15) of the Order.
\36\ See supra note 14.
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III. General Availability of Substituted Compliance Under the Order
A. Covered Entities
1. Proposed Approach
Under the proposed Order, the definition of ``Covered Entity''
specified which entities could make use of substituted compliance.
Consistent with the availability of substituted compliance under
Exchange Act rule 3a71-6, the proposed definition in part would limit
the availability of substituted compliance to registered SBS Entities
that are not U.S. persons. In addition, to help ensure that firms that
rely on substituted compliance are subject to relevant UK requirements
and oversight, the proposed definition would require that a Covered
Entity is a ``MiFID investment firm'' or ``third country investment
firm,'' as such terms are defined in the FCA Handbook Glossary, that
(a) has permission from the FCA or PRA under Part 4A of the UK's
Financial Services and Markets Act 2000 (``FSMA'') to carry on
regulated activities relating to investment services and activities in
the UK; (b) is supervised by the FCA under the fixed supervision model;
and (c) if the firm is a PRA-authorized person, also is supervised by
the PRA as a Category 1 firm.\37\
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\37\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18380.
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2. Final Provisions
Commenters did not address the proposed ``Covered Entity''
definition, and the Commission is issuing the definition as
proposed.\38\ Substituted compliance accordingly is available only to
non-U.S. SBS Entities that have the relevant UK regulatory permission
and are subject to UK oversight.
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\38\ See para. (g)(1) of the Order.
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B. Additional General Conditions and Other Prerequisites
1. Proposed Approach
The proposed Order incorporated a number of additional general
conditions and other prerequisites, to help ensure that the relevant UK
requirements that form the basis for substituted compliance in practice
will apply to the Covered Entity's security-based swap business and
activities, and to promote the Commission's oversight over entities
that avail themselves of substituted compliance:
<bullet> ``Subject to and complies with'' applicability condition--
For each relevant section of the proposed Order, a positive substituted
compliance determination would be subject to the condition that the
Covered Entity be subject to and comply with the applicable UK
requirements needed to establish comparability.\39\
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\39\ The Commission stated, as an example, that this proposed
condition would not be satisfied when the comparable UK requirements
would not apply to the security-based swap activities of a non-UK
branch of a MiFID investment firm or to a third country investment
firm. See UK Substituted Compliance Notice and Proposed Order, 86 FR
at 18380.
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<bullet> ``Regulated activities''--For each condition in the
proposed Order that requires the application of, and compliance with,
provisions of the Senior Management Arrangements, Systems and Controls
Sourcebook of the FCA Handbook (``FCA SYSC'') 4, 5, 6, 7, 9, and/or 10,
certain parts of the PRA Rulebook and/or MLR 2017, the Covered Entity's
relevant security-based swap activities must constitute ``regulated
activities'' as defined for purposes of the relevant UK provisions,
must be carried on by the Covered Entity from an establishment in the
UK and must fall within the scope of the Covered Entity's authorization
from the FCA and/or PRA to conduct regulated activities in the UK.\40\
---------------------------------------------------------------------------
\40\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
---------------------------------------------------------------------------
<bullet> UK MiFID ``investment services or activities''--For each
condition in the proposed Order that requires the application of, and
compliance with, provisions of the Product Intervention and Product
Governance Sourcebook of the FCA Handbook (``FCA PROD'') 3 and/or the
UK version of Commission Delegated Regulation (EU) 2017/565
[[Page 43322]]
(``UK MiFID Org Reg''), the Covered Entity's relevant security-based
swap activities must constitute ``investment services or activities,''
as defined in the FCA Handbook Glossary, must be carried on by the
Covered Entity from an establishment in the UK and must fall within the
scope of the Covered Entity's authorization from the FCA and/or PRA to
conduct regulated activities in the UK.\41\
---------------------------------------------------------------------------
\41\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
---------------------------------------------------------------------------
<bullet> UK ``MiFID or equivalent third country business''--For
each condition in the proposed Order that requires the application of,
and compliance with, provisions of the Conduct of Business Sourcebook
of the FCA Handbook (``FCA COBS'') 2, 4, 6, 8A, 9A, 14, and/or 14A, the
Covered Entity's relevant security-based swap activities must
constitute ``MiFID or equivalent third country business,'' as defined
in the FCA Handbook Glossary, must be carried on by the Covered Entity
from an establishment in the UK and must fall within the scope of the
Covered Entity's authorization from the FCA and/or PRA to conduct
regulated activities in the UK.\42\
---------------------------------------------------------------------------
\42\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381. In the final Order, the Commission has corrected the
typographical error in paragraph (a)(3) by changing FCA COBS 14A to
16A. See para. (a)(3) of the Order.
---------------------------------------------------------------------------
<bullet> UK ``designated investment business''--For each condition
in the proposed Order that requires the application of, and compliance
with, provisions of FCA COBS 11, the Covered Entity's relevant
security-based swap activities must constitute ``MiFID business'' that
is also ``designated investment business,'' each as defined in the FCA
Handbook Glossary, must be carried on by the Covered Entity from an
establishment in the UK and must fall within the scope of the Covered
Entity's authorization from the FCA and/or PRA to conduct regulated
activities in the UK.\43\
---------------------------------------------------------------------------
\43\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
---------------------------------------------------------------------------
<bullet> UK ``MiFID business''--For each condition in the proposed
Order that requires the application of, and compliance with, provisions
of the Client Asset Sourcebook of the FCA Handbook (``FCA CASS'') 6
and/or 7, the Covered Entity must not be an ``investment company with
variable capital'' as defined in the FCA Handbook Glossary,\44\ the
Covered Entity's relevant security-based swap activities must
constitute ``regulated activities'' as defined for purposes of the
relevant UK provisions and ``MiFID business'' as defined in the FCA
Handbook Glossary, must be carried on by the Covered Entity from an
establishment in the UK and must fall within the scope of the Covered
Entity's authorization from the FCA and/or PRA to conduct regulated
activities in the UK.\45\
---------------------------------------------------------------------------
\44\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
\45\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
---------------------------------------------------------------------------
<bullet> Activities covered by FCA SYSC 10A--For each condition in
the proposed Order that requires the application of, and compliance
with, provisions of FCA SYSC 10A, the Covered Entity's relevant
security-based swap activities must constitute activities described in
FCA SYSC 10A.1.1(2)(a), (b) and/or (c), must be carried on by the
Covered Entity from an establishment in the UK and must fall within the
scope of the Covered Entity's authorization from the FCA and/or PRA to
conduct regulated activities in the UK.\46\
---------------------------------------------------------------------------
\46\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381.
---------------------------------------------------------------------------
<bullet> UK MiFID ``clients''--For each condition in the proposed
Order that requires the application of, and compliance with, provisions
of FCA CASS 6 and/or 7, FCA COBS 2, 4, 6, 8A, 9A, 11, 14, and/or 14A,
FCA PROD 3, FCA SYSC 10.1.8, FCA SYSC 10A, and/or UK MiFID Org Reg, the
Covered Entity's relevant counterparties (or potential counterparties)
must be ``clients'' (or potential ``clients'') as defined in FCA COBS
3.2.1R.\47\
---------------------------------------------------------------------------
\47\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381. In the final Order, the Commission has corrected the
typographical error in paragraph (a)(7) by changing FCA COBS 14A to
16A. See para. (a)(7) of the Order.
---------------------------------------------------------------------------
<bullet> UK MiFID ``financial instruments''--For each condition in
the proposed Order that requires the application of, and compliance
with, provisions of FCA CASS 6 and/or 7, FCA COBS 2, 4, 6, 8A, 9A, 11,
14, and/or 14A, FCA PROD 3, FCA SYSC 10A, the UK version of Market
Abuse Regulation (EU) 596/2014 (``UK MAR''), the UK version of
Commission Delegated Regulation (EU) 2016/958 (``UK MAR Investment
Recommendations Regulation''), and/or UK MiFID Org Reg, the relevant
security-based swap must be a ``financial instrument'' as defined in
Part 1 of Schedule 2 of the UK Regulated Activities Order.\48\
---------------------------------------------------------------------------
\48\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18381-82. In the final Order, the Commission has corrected the
typographical error in paragraph (a)(8) by changing FCA COBS 14A to
16A. See para. (a)(8) of the Order.
---------------------------------------------------------------------------
<bullet> UK CRD/CRR ``institution''--For each condition in the
proposed Order that requires the application of, and compliance with,
provisions of the UK version of the Capital Requirements Regulation,
Regulation (EU) No 575/2013 (``UK CRR''), the Covered Entity must be an
``institution'' as defined in UK CRR article 4(1)(3).\49\
---------------------------------------------------------------------------
\49\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> ``Common platform firm'' or ``third country firm''--For
each condition in the proposed Order that requires the application of,
and compliance with, provisions of FCA SYSC 4, 5, 6, 7, 9, and/or 10,
the Covered Entity must be either a ``common platform firm'' (other
than a ``UCITS investment firm'') or a ``third country firm,'' each as
defined in the FCA Handbook Glossary.\50\
---------------------------------------------------------------------------
\50\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> ``IFPRU investment firm''--For each condition in the
proposed Order that requires the application of, and compliance with,
provisions of FCA SYSC 19A, the Prudential Sourcebook for Investment
Firms of the FCA Handbook (``FCA IFPRU''), and/or the Prudential
Sourcebook for Banks, Building Societies and Investment Firms of the
FCA Handbook (``FCA BIPRU''), the Covered Entity must be an ``IFPRU
investment firm'' as defined in the FCA Handbook Glossary.\51\
---------------------------------------------------------------------------
\51\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> ``UK bank'' or ``UK designated investment firm''--For each
condition in the proposed Order that requires the application of, and
compliance with, provisions of FCA SYSC 19D and/or certain parts of the
PRA Rulebook, the Covered Entity must be a ``UK bank'' or ``UK
designated investment firm,'' each as defined in the FCA Handbook
Glossary (in the case of chapter 19D of FCA SYSC) or in the PRA
Rulebook Glossary (in the case of a part of the PRA Rulebook).\52\
---------------------------------------------------------------------------
\52\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> Covered Entity's counterparties as UK EMIR
``counterparties''--For each condition in the proposed Order that
requires the application of, and compliance with, provisions of the UK
version of the European Market Infrastructure Regulation (``EMIR''),
Regulation (EU) No 648/2012 (``UK EMIR''), the UK version of Commission
Delegated Regulation (EU) No 149/2013 (``UK EMIR RTS''), and/or the UK
version of Commission Delegated Regulation (EU) 2016/2251 (``UK EMIR
Margin RTS''), if the counterparty to the Covered Entity is not a
``financial counterparty'' or ``non-financial counterparty'' as defined
in UK EMIR articles 2(8) or 2(9), respectively, the
[[Page 43323]]
Covered Entity must comply with the applicable condition as if the
counterparty were a financial counterparty or non-financial
counterparty. If the Covered Entity reasonably determines that the
counterparty conducts a financial business that would cause it to be a
financial counterparty if it were UK-established and UK-authorized,
then the proposed Order would require the Covered Entity to treat the
counterparty as a financial counterparty; otherwise, the proposed Order
would require the Covered Entity to treat the counterparty as a non-
financial counterparty. In addition, the proposed Order would provide
that a Covered Entity complying with UK EMIR could not apply
substituted compliance by complying with third country requirements
that UK authorities may determine to be equivalent to UK EMIR.\53\
---------------------------------------------------------------------------
\53\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> Security-based swap status under UK EMIR--For each
condition in the proposed Order that requires the application of, and
compliance with, provisions of UK EMIR, UK EMIR RTS, and/or UK EMIR
Margin RTS, either: (1) The relevant security-based swap must be an
``OTC derivative'' or ``OTC derivative contract,'' as defined in UK
EMIR article 2(7), that has not been cleared by a central counterparty
and otherwise is subject to the provisions of UK EMIR article 11, UK
EMIR RTS articles 11 through 15, and UK EMIR Margin RTS article 2; or
(2) the relevant security-based swap must have been cleared by a
central counterparty that has been authorized or recognized to clear
derivatives contracts in the UK.\54\
---------------------------------------------------------------------------
\54\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
<bullet> Memorandum of understanding--Consistent with the
requirements of rule 3a71-6 and the Commission's need for access to
information regarding registered entities, substituted compliance under
the proposed Order would be conditioned on the Commission having an
applicable memorandum of understanding or other arrangement with the
FCA and the PRA addressing cooperation with respect to the Order at the
time the Covered Entity makes use of substituted compliance.\55\
---------------------------------------------------------------------------
\55\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382. The Commission has entered into a memorandum of
understanding with the FCA and the PRA to address substituted
compliance cooperation. See supra note 14. Consistent with the final
Order, Covered Entities must ensure that this memorandum of
understanding remains in place at the time the Covered Entity relies
on substituted compliance.
---------------------------------------------------------------------------
<bullet> Notice of reliance on substituted compliance--To assist
the Commission's oversight of firms that avail themselves of
substituted compliance, a Covered Entity relying on the Order would
have to provide notice of its intent to rely on the Order by notifying
the Commission in writing. In the notice, the Covered Entity would need
to identify each specific substituted compliance determination in the
Order for which the Covered Entity intends to apply substituted
compliance. The Covered Entity would have to promptly update the notice
if it intends to modify its reliance on substituted compliance.\56\
---------------------------------------------------------------------------
\56\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18382.
---------------------------------------------------------------------------
2. Commenter Views and Final Provisions
One commenter expressed general support for several of the general
conditions, subject to certain changes and clarifications.\57\ Another
commenter stated that, if the Commission makes a positive substituted
compliance determination, it must ensure that the conditions in the
proposed Order are applied ``with full force and without exception or
dilution.\58\ The Commission is issuing the general conditions largely
as proposed,\59\ and details its responses to the requested changes and
clarifications below. In the Commission's view, the conditions are
structured appropriately to predicate a positive substituted compliance
determination on the applicability of relevant UK requirements needed
to establish comparability, as well as on the continued effectiveness
of the requisite memorandum of understanding, and the provision of
notice to the Commission regarding the Covered Entity's intent to rely
on substituted compliance.
---------------------------------------------------------------------------
\57\ See Letter from Kyle L. Brandon, Managing Director, Head of
Derivatives Policy, SIFMA (May 3, 2021) (``SIFMA 5/3/2021 Letter'')
at 3-9.
\58\ See Better Markets Letter at 2.
\59\ See paras. (a)(1) through (16) of the Order. The Commission
is correcting typographical errors in paragraphs (a)(3), (a)(7), and
(a)(8) of the Order by replacing references to FCA COBS 14A with
references to FCA COBS 16A.
---------------------------------------------------------------------------
a. UK Territorial Condition
A commenter stated that the Commission should delete the
requirement in paragraphs (a)(1) through (a)(6) of the Order that, for
purposes of certain UK requirements, a Covered Entity's relevant
security-based swap activities be ``carried on . . . from an
establishment in the United Kingdom.'' \60\ The commenter stated that
this UK territorial aspect of the conditions was not necessary because
some of the UK requirements listed in these conditions apply to a
Covered Entity with respect to activities wherever they are carried
on.\61\ The commenter suggested that the Commission instead add a new
general condition that would require a Covered Entity, when relying on
a part of the Order that requires it to be subject to and comply with
the UK requirements listed in paragraphs (a)(1) through (a)(6) of the
Order, to carry on the relevant security-based swap activities from a
UK establishment, but only to the extent that those UK requirements
``are limited in their applicability to activity carried on from [a UK
establishment].'' \62\ The commenter did not identify any specific
instances in which it believes that a Covered Entity would carry on a
particular security-based swap activity outside the United Kingdom and
that activity would be subject to the UK requirements listed in
paragraphs (a)(1) through (a)(6) of the Order.
---------------------------------------------------------------------------
\60\ See SIFMA 5/3/2021 Letter at 3-4.
\61\ See SIFMA 5/3/2021 Letter at 3.
\62\ See SIFMA 5/3/2021 Letter at 3-4 and Appendix A. Together
with its request to amend the UK territorial condition in paragraphs
(a)(1) through (a)(6) of the Order, the commenter requested that the
Commission delete, where feasible, references to compliance with
territorially limited UK laws as conditions to substituted
compliance. See SIFMA 5/3/2021 Letter at 4. The Commission addresses
this additional request below in the relevant parts of this release.
---------------------------------------------------------------------------
Many, though not all, of these UK requirements contain clearly
articulated scoping provisions that apply the requirements to Covered
Entities only when the relevant activity is carried on from an
establishment in the UK.\63\ Other requirements contain more complex
scoping provisions, and the Commission is aware that in limited cases
it is possible for these requirements to apply to some aspects of a
Covered Entity's activities carried on from an establishment outside
the UK. For example, the FCA commented that certain organizational
requirements generally apply in a prudential context to activities
wherever they are carried on.\64\ In addition, PRA General
[[Page 43324]]
Organisational Requirements, PRA Recordkeeping Rules, PRA Risk Control
Rules, and PRA Remuneration Rules generally apply to a Covered Entity
that is a ``CRR firm'' with respect to activities carried on from a UK
establishment,\65\ but also apply to activities anywhere in the world
``in a prudential context,'' \66\ which the PRA defines to mean when
the Covered Entity's activities have, or might reasonably be regarded
as likely to have, a negative effect on the Covered Entity's safety and
soundness or its ability to continue to meet certain other UK
regulatory tests.\67\ The Commission cannot, however, determine ex ante
whether a Covered Entity's particular activity outside the UK would
fall within these limited wider scope provisions. The commenter also
did not identify any circumstances that would trigger the limited wider
scope of these provisions. Moreover, it is unclear whether any such
wider scope even would be relevant in the context of the Order or, if
so, how that wider scope would impact the operation of the Order in
practice. For these reasons, the Commission is retaining the
requirement in paragraph (a)(1) of the Order for the Covered Entity to
carry on the relevant activities from an establishment in the UK.\68\
---------------------------------------------------------------------------
\63\ See FCA SYSC 1 Annex 1 2.15R (The common platform
requirements, which include FCA SYSC 4, 5, 6, 7, and 10, apply in
relation to activities carried on from an establishment in the UK.);
FCA SYSC 10A.1.1R(2) (FCA SYSC 10A applies only to activities
carried on from an establishment in the UK.); Money Laundering,
Terrorist Financing and Transfer of Funds (Information on the Payer)
Regulations 2017 (``MLR 2017'') Regulation 8 (The relevant
requirements of MLR 2017 apply to persons acting in the course of
business carried on by them in the UK.); FCA CASS 1.3.2R (FCA CASS 6
and 7 apply to regulated activities carried on from an establishment
in the UK.).
\64\ See comments from FCA (May 20, 2021) (``FCA Comments'')
(noting that common platform organizational requirements, including
FCA SYSC 4 to 9, and parallel PRA General Organisational
Requirements, generally apply in a prudential context to activities
wherever they are carried on).
\65\ See PRA General Organisational Requirements Rule 1.1(1);
PRA Recordkeeping Rule 1.1(1); PRA Risk Control Rule 1.1(1); see
also PRA Remuneration Rule 1.1(1)(a) (PRA Remuneration Rules apply
to a CRR firm in relation to its ``UK activities.'').
\66\ See PRA General Organisational Requirements Rule 1.1(3);
PRA Recordkeeping Rule 1.1(3); PRA Risk Control Rule 1.1(3); PRA
Remuneration Rule 1.1(c).
\67\ See PRA Rulebook Glossary.
\68\ The Commission also is retaining the same requirement in
paragraphs (a)(5) and (a)(6) of the Order, as the UK requirements
referenced in those paragraphs apply only to activities carried on
from an establishment in the UK.
---------------------------------------------------------------------------
Other UK requirements listed in paragraphs (a)(2) through (a)(4) of
the Order apply to limited activities outside the UK for which a
Covered Entity might apply substituted compliance. UK MiFID Org Reg
generally applies to a Covered Entity that is a third country
investment firm only when it carries on the relevant security-based
swap activity from an establishment in the UK,\69\ but provisions of UK
MiFID Org Reg in some instances can apply to a broader range of
activities if the Covered Entity is a MiFID investment firm. Similarly,
FCA PROD 3 and FCA COBS generally apply to a Covered Entity with
respect to activities carried on from an establishment in the UK,\70\
but also apply to a Covered Entity with respect to certain activities
with a client in the UK that are carried on from an establishment
outside the UK.\71\ The Commission is amending the general conditions
in paragraphs (a)(2) through (a)(4) of the Order to provide that a
Covered Entity's relevant security-based swap activities must be either
carried on by the Covered Entity from an establishment in the UK or
from any other place that would cause UK MiFID Org Reg, FCA PROD 3,
and/or the relevant provision(s) of FCA COBS, as applicable, to apply
to those activities.
---------------------------------------------------------------------------
\69\ See General Provisions Sourcebook of the FCA Handbook
(``FCA GEN'') 2.2.22AR.
\70\ See FCA PROD 1.3.4R.
\71\ See FCA PROD 1.3.5R(1) (general UK territorial rule for FCA
PROD 3); FCA COBS 4.1.8R (general UK territorial rule for FCA COBS
4) (citing FCA COBS 1.1.1R); but see FCA PROD 1.3.5(2) (exclusions
from FCA PROD 3 for activities from an establishment outside the
UK); FCA COBS 1 Annex 1 Part 2 2.1R (exclusions from FCA COBS 4 for
activities from an establishment outside the UK).
---------------------------------------------------------------------------
In applying these amended general conditions, a Covered Entity
still must satisfy all of the applicable general conditions, as well as
the other applicable provisions of the Order, relating to a particular
Exchange Act requirement for which it applies substituted compliance. A
Covered Entity will satisfy the conditions of the Order only when it is
subject to and complies with all of the comparable UK requirements
listed in the relevant provision(s) of the Order. If any one of these
comparable UK requirements is subject to a general condition with a
territorial limitation, the relevant security-based swap activity for
which the Covered Entity applies substituted compliance would have to
satisfy that territorial limitation, even if another of the comparable
UK requirements applies to a wider scope of activities. As a result, in
these instances a Covered Entity would be able to use substituted
compliance only for security-based swap activities that satisfy the
territorial limitation.
b. Scope of Substituted Compliance
The same commenter requested that the Commission delete, where
feasible, references in the Order to territorially limited UK
requirements.\72\ Where these deletions are not feasible, the commenter
requested that the Commission confirm that, in relation to entity-level
Exchange Act requirements, a Covered Entity may (a) rely on substituted
compliance for its relevant security-based swap activities carried on
from an establishment in the UK and (b) comply with Exchange Act
requirements or another applicable substituted compliance order for its
relevant security-based swap activities carried on from an
establishment outside the UK.\73\ The Commission is addressing here the
commenter's request for clarification of the availability of
substituted compliance for entity-level Exchange Act requirements, and
is addressing the commenter's various requested deletions below in the
relevant parts of this release.\74\
---------------------------------------------------------------------------
\72\ See SIFMA 5/3/2021 Letter at 4.
\73\ See SIFMA 5/3/2021 Letter at 4.
\74\ See infra parts IV.B, V.B, VI.B, VII.B, and VIII.B.
---------------------------------------------------------------------------
In the proposed Order, the Commission stated that a Covered Entity
applying substituted compliance for one or more entity-level Exchange
Act requirements (including risk control, capital, margin, internal
supervision and chief compliance officer requirements, as well as
recordkeeping and reporting requirements other than those linked to
counterparty protection requirements) would have to apply substituted
compliance at an entity level, i.e., to all of its activities subject
to that particular Exchange Act requirement.\75\ By contrast, the
Commission stated that a Covered Entity applying substituted compliance
for one or more transaction-level Exchange Act requirements (including
counterparty protection requirements, as well as recordkeeping and
reporting requirements linked to them) could choose to apply
substituted compliance under the proposed Order for some activities and
comply directly with Exchange Act requirements for other
activities.\76\ The proposed Order thus would provide substituted
compliance for transaction-level Exchange Act requirements ``in
relation to [a specific security-based swap, counterparty,
recommendation, or communication];'' the proposed Order did not include
this proviso in relation to substituted compliance for entity-level
Exchange Act requirements.\77\ The Commission proposed this approach in
the context of assisting Covered Entities in choosing between applying
substituted compliance pursuant to the Order or complying directly with
relevant Exchange Act requirements. This approach did not address, and
does not
[[Page 43325]]
apply to, security-based swap business for which a Covered Entity could
not apply substituted compliance under the proposed Order because the
Covered Entity is not subject to the relevant UK requirements listed in
the Order with respect to that business.\78\
---------------------------------------------------------------------------
\75\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18384 (risk control requirements), 18386-87 (capital and
margin requirements), 18389-90 (internal supervision and chief
compliance officer requirements), 18395-96 (recordkeeping,
reporting, notification, and securities count requirements other
than those linked to counterparty protection requirements).
\76\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18392 (counterparty protection requirements), 18396
(recordkeeping and reporting requirements linked to counterparty
protection requirements).
\77\ See UK Substituted Compliance Notice and Proposed Order, 86
FR at 18413-20.
\78\ For example, this approach did not address and would not
apply to a Covered Entity's security-based swap business carried on
from an establishment outside the UK, when the relevant part of the
proposed Order would require the Covered Entity to comply with one
or more UK requirements to which a UK territorial condition applies.
---------------------------------------------------------------------------
Consistent with the commenter's request, for any particular set of
entity-level Exchange Act requirements,\79\ a Covered Entity must
choose either (1) to apply substituted compliance pursuant to the Order
with respect to all security-based swap business that is subject to the
relevant UK requirements listed in the Order and that can satisfy any
general conditions related to those UK requirements (including any
applicable UK territorial condition) (``UK business''), or (2) to
comply directly with the Exchange Act with respect to all UK business.
A Covered Entity may not choose to apply substituted compliance for
those entity-level requirements in respect of some of its UK business
and comply directly with the Exchange Act in respect of another part of
its UK business. However, if the conditions in the relevant part of the
Order require the Covered Entity to comply with UK requirements that
are subject to a UK territorial condition, the Covered Entity's UK
business would not include business carried on from an establishment
outside the UK, as that business would not be subject to the relevant
UK requirements and would not satisfy the applicable UK territorial
condition. Rather, the Covered Entity could apply substituted
compliance for the Exchange Act requirements in that part of the Order
so long as it applies substituted compliance for all of its business
that is subject to the relevant UK requirements and can satisfy any
general conditions related to those UK requirements, which in this
example would include only business that is carried on from an
establishment in the UK and that otherwise is both subject to the
relevant UK requirements and able to satisfy any other general
conditions related to those requirements. Also consistent with the
commenter's request, for any particular set of entity-level Exchange
Act requirements, if the Covered Entity also has security-based swap
business that is not subject to the relevant UK requirements \80\ or
that cannot satisfy an applicable general condition related to those UK
requirements (including business carried on from an establishment
outside the UK where the Order imposes a UK territorial condition) the
Covered Entity must either comply directly with the Exchange Act for
that business or comply with the terms of another applicable
substituted compliance order.\81\ Consistent with the proposed Order,
for transaction-level Exchange Act requirements, a Covered Entity may
decide to apply substituted compliance for some of its security-based
swap business and to comply directly with the Exchange Act (or comply
with another applicable substituted compliance order) for other parts
of its security-based swap business.\82\ The Commission believes that
this scope of substituted compliance strikes the right balance to
ensure that substituted compliance is consistent with Commission's
classification of Exchange Act requirements as either entity-level or
transaction-level requirements. The Commission has made no changes to
the text of the Order in connection with these issues.
---------------------------------------------------------------------------
\79\ A Covered Entity may use substituted compliance consistent
with the Order for any one or more sets of entity-level Exchange Act
requirements specified in the Order. See supra note 74 and
accompanying text. For example, a Covered Entity could use
substituted compliance for internal risk management, trade
acknowledgment and verification, internal supervision, and chief
compliance officer requirements, but comply directly with Exchange
Act portfolio reconciliation and dispute reporting, portfolio
compression, trading relationship documentation, recordkeeping,
reporting, notification, and securities count requirements.
\80\ In the context of the UK EMIR counterparties condition in
paragraph (a)(13) of the Order, a Covered Entity must choose (1) to
apply substituted compliance pursuant to the Order--including
compliance with paragraph (a)(13) as applicable--for a particular
set of entity-level requirements with respect to all of its business
that would be subject to the relevant UK EMIR-based requirement if
the counterparty were the relevant type of counterparty, or (2) to
comply directly with the Exchange Act with respect to such business.
See infra note 106 and accompanying text.
\81\ A third country investment firm regulated in the UK might
be able to satisfy the definitions of ``Covered Entity'' in both
this Order and the German Substituted Compliance Order, and thus may
be eligible to apply substituted compliance under both orders. This
Order defines Covered Entities to include both MiFID investment
firms (i.e., firms with a UK head office) and third country
investment firms (i.e., firms with a head office outside the UK).
The German Substituted Compliance Order defines Covered Entities to
include only investment firms and credit institutions ``authorized
by BaFin to provide investment services or perform investment
activities in the Federal Republic of Germany.'' See German
Substituted Compliance Order, 85 FR at 85700. A non-EU firm (such as
a UK firm) registered by the European Securities and Markets
Authority (``ESMA'') to provide investment services and/or perform
investment activities to certain counterparties in the EU pursuant
to articles 46 through 48 of the Markets in Financial Instruments
Regulation is not ``authorized by BaFin'' and thus does not satisfy
the Covered Entity definition in the German Substituted Compliance
Order. Accordingly, an investment firm or credit institution
authorized by BaFin and regulated in the UK as a third country
investment firm may, for example, be eligible for substituted
compliance under both this Order and the German Substituted
Compliance Order. If such a firm has security-based swap business
that is not UK business, but is subject to the relevant German
requirements under the German Substituted Compliance Order, it may
choose to comply directly with the relevant Exchange Act
requirements or to use substituted compliance pursuant to the terms
of the German Substituted Compliance Order. If such a firm has
security-based swap business that is both UK business and subject to
the relevant German requirements under the German Substituted
Compliance Order, it may choose to comply with the conditions to
both orders or, alternatively, it may choose one order that it will
comply with in respect of that business. For each set of entity-
level Exchange Act requirements, such a firm must apply this choice
to all such dually regulated security-based swap business. Such a
firm must specify this choice in its notice to the Commission
pursuant to para. (a)(16) of the Order. A firm's choice to comply
with only one applicable substituted compliance order in respect of
security-based swap business that is subject to the relevant foreign
requirements listed in multiple substituted compliance orders will
not affect the firm's ability to apply substituted compliance for
Exchange Act entity-level requirements in respect of other, non-
dually regulated security-based swap business under the other
substituted compliance order(s).
\82\ For example, a Covered Entity may use substituted
compliance consistent with the Order for fair and balanced
communications requirements in respect of communications with UK
counterparties that are subject to the Exchange Act and comply
directly with Exchange Act fair and balanced communications
requirements in respect of U.S. person counterparties. A Covered
Entity also may use substituted compliance consistent with the Order
for any one or more sets of transaction-level Exchange Act
requirements specified in the Order. See supra note 76 and
accompanying text. For example, a Covered Entity could use
substituted compliance for fair and balanced communications
requirements, but comply directly with Exchange Act requirements
related to disclosure of information regarding material risks and
characteristics, disclosure of information regarding material
incentives or conflicts of interest, ``know your counterparty,''
suitability, and daily mark disclosure.
---------------------------------------------------------------------------
In the Covered Entity's notice to the Commission pursuant to
paragraph (a)(16) of the Order, the Covered Entity must specify the
parts of its security-based swap business for which it will apply
substituted compliance consistent with the individual parts of the
Order. Every SBS Entity registered with the Commission, whether
complying directly with Exchange Act requirements or relying on
substituted compliance as a means of complying with the Exchange Act,
is required to satisfy the inspection and production requirements
imposed on such entities under the Exchange Act,\83\ and specificity as
to the scope of the entity's reliance on substituted compliance is
[[Page 43326]]
necessary to facilitate the Commission's oversight under the Order.
---------------------------------------------------------------------------
\83\ See, e.g., Exchange Act section 15F(f); Exchange Act rule
18a-6(g).
---------------------------------------------------------------------------
c. Activities as UK ``Designated Investment Business''
One commenter recommended deleting paragraph (a)(4) of the proposed
Order because ``MiFID business'' is a subset of ``designated investment
business.'' \84\ The commenter instead suggested adding FCA COBS 11 to
the general condition in paragraph (a)(3) of the proposed Order, which
is identical to paragraph (a)(4) except for the reference to
``designated investment business'' in paragraph (a)(4).
---------------------------------------------------------------------------
\84\ See SIFMA 5/3/2021 Letter Appendix A.
---------------------------------------------------------------------------
The only provision of FCA COBS 11 included in the Order is FCA COBS
11.7A.3R.\85\ By its terms, FCA COBS 11.7A.3R applies to a firm's
``designated investment business.'' FCA COBS 11.7A.1R further states
that FCA COBS 11.7A.3R applies, in relevant part, to a firm in relation
to its ``MiFID or equivalent third country business.'' The condition as
proposed thus accurately reflects the activities that FCA COBS
describes as subject to FCA COBS 11.7A.3R. The Commission believes that
deleting the reference to ``designated investment business'' would be
inconsistent with the terms of the relevant provisions of FCA COBS 11.
Moreover, the definitions of ``designated investment business'' and
``MiFID or equivalent third country business'' vary substantially.
``Designated investment business'' includes, among other things,
dealing in investments as principal or agent, arranging deals in
investments, making arrangements with a view to transactions in
investments, managing investments, and advising on investments.\86\ By
contrast, ``MiFID or equivalent third country business'' includes,
among other things, reception and transmission of orders in relation to
one or more financial instruments, execution of orders on behalf of
clients, dealing on own account, portfolio management, and the making
of a personal recommendation.\87\ Given the lack of overlap in
terminology used in these two definitions, the Commission believes that
deleting the reference to ``designated investment business'' could
cause confusion among Covered Entities, while keeping the reference
would not restrict a Covered Entity from being able to comply with the
condition in respect of MiFID or equivalent third country business that
is a subset of designated investment business. Accordingly the
Commission has determined not to delete this paragraph.
---------------------------------------------------------------------------
\85\ See para. (d)(3)(ii) of the Order.
\86\ See FCA Handbook Glossary, definition of ``designated
investment business.''
\87\ See FCA Handbook Glossary, definitions of ``MiFID or
equivalent third country business,'' ``MiFID business,''
``equivalent third country business,'' and ``investment services
and/or activities.''
---------------------------------------------------------------------------
d. Activities as UK ``MiFID Business''
One commenter recommended deleting paragraph (a)(5) of the proposed
Order to reflect its recommendations to delete any FCA CASS provisions
elsewhere in the Order as conditions to substituted compliance.\88\ The
commenter believes that the FCA CASS rules, which address client asset
requirements, expand the scope of applicable Exchange Act requirements
and are inappropriate as conditions to substituted compliance.\89\ As
discussed below in the relevant parts of this release,\90\ the
Commission has determined to retain the citations to FCA CASS as
conditions to substituted compliance and, accordingly, has not deleted
this paragraph.
---------------------------------------------------------------------------
\88\ See SIFMA 5/3/2021 Letter Appendix A.
\89\ See SIFMA 5/3/2021 Letter Appendix A.
\90\ See infra part VI.B.1.
---------------------------------------------------------------------------
e. Covered Entity as UK ``IFPRU Investment Firm''
One commenter recommended deleting paragraph (a)(11) of the
proposed Order because the UK requirements listed in that paragraph do
not apply to UK banks or UK designated investment firms and the
commenter expects only ``banks and PRA-designated investment firms'' to
apply substituted compliance pursuant to the Order.\91\ These
requirements apply to IFPRU investment firms--that is, certain
investment firms regulated by the FCA but not the PRA--and are nearly
identical to requirements that apply to UK banks and UK designated
investment firms. For the same reason, the commenter also recommended
deleting the references to firms regulated only by the FCA from the
general conditions in paragraphs (a)(1) through (a)(3) and (a)(6) of
the proposed Order and the UK requirements in paragraphs (b), (d), and
(e) of the proposed Order that apply only to IFPRU investment
firms.\92\ The proposed Order would not require a Covered Entity that
is a UK bank or UK designated investment firm to be subject to and
comply with these requirements. Rather, in each place that the proposed
Order refers to these requirements that are unique to IFPRU investment
firms, the proposed Order would require the Covered Entity to be
subject to and comply with either the provisions that apply to IFPRU
investment firms (in which case paragraph (a)(11) of the proposed Order
would require the Covered Entity to be an IFPRU investment firm) or
analogous provisions of the FCA Handbook and PRA Rulebook that apply to
UK banks and UK designated investment firms (in which case paragraph
(a)(12) of the proposed Order would require the Covered Entity to be a
UK bank or UK designated investment firm). Moreover, the FCA
Application requested substituted compliance for all investment firms,
and was not limited to the entities described by the commenter.
Accordingly, the Commission is retaining the references to these
requirements in paragraph (a)(11) and in paragraphs (b), (d), and (e)
of the Order and the references to firms regulated only by the FCA in
paragraphs (a)(1) through (a)(6) of the Order.
---------------------------------------------------------------------------
\91\ See SIFMA 5/3/2021 Letter Appendix A.
\92\ See SIFMA 5/3/2021 Letter Appendix A parts (a), (b), (d),
and (e).
---------------------------------------------------------------------------
f. Counterparties as UK MiFID ``Clients''
A commenter requested that the Commission modify paragraph (a)(7)
of the proposed Order to permit a Covered Entity to treat an agent,
rather than the agent's principal, as the Covered Entity's client for
purposes of the MiFID-based requirements listed in the Order.\93\ The
commenter stated that this modification would be consistent with the
FCA's ``agent as client'' rule, which provides that a firm, if it is
aware that a person with or for whom it is providing services is acting
as agent for another person and satisfies certain other conditions,
must treat the agent, and not the agent's principal, as the firm's
client in respect of that business.\94\ The firm may override the
``agent as client'' rule by agreeing in writing with the agent to treat
the agent's principal as the firm's client instead.\95\
---------------------------------------------------------------------------
\93\ See SIFMA 5/3/2021 Letter at 4-6.
\94\ See FCA COBS 2.4.3R.
\95\ See FCA COBS 2.4.3R(2).
---------------------------------------------------------------------------
The proposed Order would require a Covered Entity to be ``subject
to and comply with'' relevant MiFID-based requirements. The Commission
proposed that requirement of the proposed Order to ensure that
comparable MiFID-based requirements in practice would apply to a
Covered Entity using substituted compliance. The condition in paragraph
(a)(7) to the proposed Order would ensure that the Covered Entity's
counterparty--i.e., the entity to whom it owes its various duties under
the Exchange Act--is the ``client'' to whom the Covered Entity owes its
performance of the duties to which it is subject under the
[[Page 43327]]
comparable MiFID-based requirements.\96\ The Commission believes that,
in the case of an agent acting on behalf of a principal, if the
principal is the counterparty for purposes of the relevant Exchange Act
requirement, then this condition should require the principal, as the
counterparty, to be the ``client'' for purposes of the relevant MiFID-
based requirements. If the Covered Entity instead treats the agent as
the ``client,'' then the Covered Entity would not be ``subject to'' UK
requirements that are comparable to Exchange Act requirements related
to counterparties. Accordingly, the Commission is not amending the
condition in paragraph (a)(7) to permit a Covered Entity to treat an
agent, rather than the agent's principal, as its client with regard to
the relevant MiFID-based requirements. In taking this position, the
Commission does not prohibit Covered Entities from working with agents
or others acting on behalf of a counterparty. Rather, the Covered
Entity must ensure that, in working with the agent, it fulfills any
duties owed to a ``client'' (or potential ``client'') in relation to
the counterparty.\97\
---------------------------------------------------------------------------
\96\ Some provisions of the MiFID-based requirements cited in
the condition, such as certain organizational requirements, do not
pertain to counterparties or clients. In those cases, there is no
``relevant counterparty (or potential counterparty)'' for purposes
of the condition, and the condition would have no effect.
\97\ FCA COBS 2.4.4R permits firms to rely upon information
about a client received from another UK-regulated firm. Under this
provision, the other firm is legally responsible for the
completeness and accuracy of any information about the client that
the other firm receives from the first firm. The Commission believes
that it is appropriate to permit a Covered Entity to rely on
information about its client communicated by another UK-regulated
firm on behalf of the client. Accordingly, the application of this
provision would not cause the Covered Entity to be not ``subject
to'' the relevant UK requirements listed in the Order, and thus
would not impact the Covered Entity's ability to use substituted
compliance in relation to those communications. On the other hand,
FCA COBS 2.4.4R also provides that the other firm is legally
responsible for the suitability of advice and recommendations
provided to the client. The other firm, however, may not be a
Covered Entity applying substituted compliance pursuant to the
Order. Accordingly, the Commission believes that a Covered Entity
relying on the suitability assessment of another firm pursuant to
FCA COBS 2.4.4R is not ``subject to'' the relevant UK suitability
requirements listed in the Order, and thus may not apply substituted
compliance for those recommendations.
---------------------------------------------------------------------------
g. UK EMIR Counterparties
A commenter requested that the Commission clarify that the
condition in paragraph (a)(13) of the proposed Order would not require
a Covered Entity to treat as financial counterparties or non-financial
counterparties certain public sector counterparties, such as
multilateral development banks, that are exempt from UK EMIR or
counterparties that are not ``undertakings'' for purposes of UK EMIR's
definitions of ``financial counterparty'' and ``non-financial
counterparty.'' \98\
---------------------------------------------------------------------------
\98\ See SIFMA 5/3/2021 Letter at 6 and Appendix A part (a)
(recommending that the order text of paragraph (a)(13) of the Order
require application of the condition ``if the counterparty to the
Covered Entity is not a ``financial counterparty'' or ``non-
financial counterparty'' as defined in UK EMIR articles 2(8) or 2(9)
respectively, solely because the counterparty is not established in
the United Kingdom'').
---------------------------------------------------------------------------
This condition addresses the fact that some of the UK EMIR-based
requirements \99\ are expressed to apply only to transactions between
specified types of counterparties, such as transactions between
financial counterparties and non-financial counterparties, between
financial counterparties and non-financial counterparties above the
clearing threshold, and/or between counterparties that are not excluded
from the application of UK EMIR. The definitions of ``financial
counterparty'' and ``non-financial counterparty'' are predicated on the
counterparty being an ``undertaking'' established in the UK.\100\ In
addition, UK EMIR does not apply to transactions with certain excluded
counterparties.\101\ The condition is not based upon the concern that
some industry participants may not be able to take advantage of
substituted compliance, but, rather, the condition is intended to help
ensure that the relevant UK EMIR-based requirements will apply in
practice regardless of the counterparty's location or status as ``an
undertaking.'' The condition provides that the Covered Entity must
comply with the applicable condition of this Order as if the
counterparty were the type of counterparty that would trigger the
application of the relevant UK EMIR-based requirements. If the Covered
Entity reasonably determines that its counterparty would be a financial
counterparty\102\ if not for the counterparty's location and/or lack of
regulatory authorization in the UK, the condition further requires the
Covered Entity to treat the counterparty as if the counterparty were a
financial counterparty, rather than as another type of counterparty to
which the relevant UK EMIR-based requirements may apply.\103\ By
requiring a Covered Entity to treat its counterparty as a type of
counterparty that would trigger the application of the relevant UK
EMIR-based requirements, the condition will require the Covered Entity
to perform the relevant obligations pursuant to those UK EMIR-based
requirements and thus to act in a way that is comparable to Exchange
Act requirements. Accordingly, the Commission is retaining this
condition to ensure that a Covered Entity can apply substituted
compliance only when it treats its counterparty as a type of
counterparty that will trigger the Covered Entity's performance of
obligations pursuant to those UK EMIR-based requirements.\104\ Because
each UK EMIR-based requirement applies to different types of
counterparties, the Commission is amending the condition to make clear
that a Covered Entity must treat its
[[Page 43328]]
counterparty as if the counterparty were the type of counterparty
specified in the relevant UK EMIR-based requirement. The Commission
also is amending the Order to clarify that the condition applies only
if the relevant UK EMIR-based requirement applies solely to the Covered
Entity's activities with specified types of counterparties. If the
relevant UK EMIR-based requirement applies to a Covered Entity's
activities without regard to the status of its counterparty,\105\ the
Covered Entity would not be required to treat its counterparty as any
particular type of counterparty for purposes of that UK EMIR-based
requirement.
---------------------------------------------------------------------------
\99\ See, e.g., UK EMIR RTS article 12 (timely confirmation
requirements for OTC derivatives contracts concluded between
financial counterparties and non-financial counterparties).
\100\ See UK EMIR article 2(8) (financial counterparties include
specified UK financial firms and generally exclude non-UK entities);
UK EMIR article 2(9) (non-financial counterparties include UK
undertakings that are not financial counterparties and generally
exclude natural persons, central counterparties, and non-UK
entities).
\101\ See UK EMIR articles 1(4) and 1(5) (UK EMIR does not apply
to certain public sector and multilateral entities). Several of the
multilateral development banks that the commenter mentioned are
exempt from the definition of ``U.S. person'' in Exchange Act rule
3a71-3, 17 CFR 240.3a71-3, and, as a result, transactions between a
foreign SBS Entity and one of those banks (without being arranged,
negotiated, or executed by U.S. personnel) are not subject to most
Exchange Act business conduct requirements. See UK EMIR article
1(5)(a) (exempting from UK EMIR multilateral development banks
listed in UK CRR article 117); UK CRR article 117 (listed
multilateral development banks include, among others, the
International Bank for Reconstruction and Development, the Inter-
American Development Bank, the Asian Development Bank, and the
African Development Bank); Exchange Act rules 3a71-3(a)(4)(iii),
(a)(7), (a)(8)(i), (a)(9) and (c); Exchange Act rules 3a67-10(a)(4),
(a)(6) and (d)(1), 17 CFR 240.3a67-10(a)(4), (a)(6) and (d)(1).
\102\ UK EMIR article 2(8) defines ``financial counterparty'' to
encompass investment firms, credit institutions, insurers, and
certain other types of businesses that have been authorized in
accordance with UK law. Under UK EMIR, the distinction between
financial counterparties and other types of counterparties such as
non-financial counterparties is manifested, inter alia, in
connection with confirmation timing standards. See UK EMIR RTS
article 12.
\103\ See para. (a)(13) of the Order. The condition will help
clarify that the Covered Entity would be subject to the relevant UK
EMIR-based requirements even if the counterparty is not an
``undertaking'' (such as by virtue of being a natural person), is
not established in the EU (by virtue of being a U.S. person or
otherwise being established outside the UK), or is excluded from the
application of UK EMIR to its transactions (by virtue of being one
of the public sector or multilateral entities identified in UK EMIR
articles 1(4) and (5)).
\104\ See para. (a)(13) of the Order. To correct a typographical
error in the UK Substituted Compliance Notice and Proposed Order, in
paragraph (a)(13) of the Order the Commission is changing the phrase
``paragraphs (b) through (e) of this Order'' to ``paragraphs (b)
through (f) of this Order.'' This correction is consistent with the
description of the proposed condition in the UK Substituted
Compliance Notice and Proposed Order. See UK Substituted Compliance
Notice and Proposed Order, 86 FR at 18382.
\105\ See, e.g., UK EMIR articles 39(4) and (5).
---------------------------------------------------------------------------
As discussed in part III.B.2.b above, for any particular set of
entity-level Exchange Act requirements, a Covered Entity must choose
either (1) to apply substituted compliance pursuant to the Order with
respect to all UK business, i.e., security-based swap business that is
subject to the relevant UK requirements listed in the Order and that
can satisfy any general conditions related to those UK requirements; or
(2) to comply directly with the Exchange Act with respect to all UK
business. In the context of the UK EMIR counterparties condition in
paragraph (a)(13), this scoping means that a Covered Entity's UK
business includes security-based swap business that, but for the
counterparty's failure to qualify as a type of counterparty specified
in the relevant UK EMIR-based requirement, would be subject to the
relevant UK EMIR-based requirement, and otherwise is subject to all
other relevant UK requirements listed in the Order and can satisfy any
other applicable general conditions.\106\ Accordingly, a Covered Entity
must choose (1) to apply substituted compliance pursuant to the Order--
including compliance with paragraph (a)(13) as applicable--for a
particular set of entity-level requirements with respect to all UK
business, including its business that would be subject to the relevant
UK EMIR-based requirement if the counterparty were the relevant type of
counterparty; or (2) to comply directly with the Exchange Act with
respect to all UK business.
---------------------------------------------------------------------------
\106\ A Covered Entity's business that is not subject to other
non-UK EMIR-based requirements listed in the Order or that does not
satisfy any other applicable general condition would not form part
of a Covered Entity's UK business for which the Covered Entity must
make a single choice between using substituted compliance or
complying directly with the Exchange Act. For example, for purposes
of its choice to apply substituted compliance or comply directly
with Exchange Act internal risk management requirements, a Covered
Entity need not treat as UK business a transaction that is not
subject to FCA SYSC 4.1.1R(1) or that cannot satisfy the general
conditions in paragraphs (a)(1) and (a)(10) of the Order, even if
the sole reason the transaction is not subject to UK EMIR Margin RTS
article 2 is that the counterparty is not the type of counterparty
to which that requirement applies.
---------------------------------------------------------------------------
H. Security-Based Swap Status Under UK EMIR
A commenter asked the Commission to amend the condition in
paragraph (a)(14) of the proposed Order to permit a Covered Entity to
apply substituted compliance for transactions cleared by a non-UK-
regulated central counterparty.\107\ As proposed, the condition helps
to ensure that the relevant UK EMIR-based requirements will require the
Covered Entity to treat its security-based swap in a manner comparable
to Exchange Act requirements, while also clarifying that a Covered
Entity still may apply substituted compliance in respect of
transactions cleared by a UK-regulated central counterparty, even if
the relevant UK EMIR-based requirements do not require the Covered
Entity to take any action in respect of such a centrally cleared
transaction. Many of the UK EMIR-based requirements cited in the Order
relate to risk mitigation techniques for non-centrally cleared
transactions and apply only to a non-centrally cleared OTC
derivative,\108\ consistent with analogous Exchange Act risk mitigation
and margin requirements for non-centrally cleared security-based
swaps.\109\ However, transactions that have been cleared by any central
counterparty, whether or not it is regulated by UK authorities, are
exempt from these UK EMIR-based requirements, while only transactions
that have been cleared by an SEC-registered or exempt clearing agency
are exempt from their Exchange Act analogues. With respect to non-
centrally cleared security-based swaps, the Commission believes that
these UK requirements produce comparable outcomes to the analogous
Exchange Act requirements, as both sets of requirements impose similar
obligations on the Covered Entity. In addition, to the extent that
these UK EMIR-based requirements do not require the Covered Entity to
apply risk mitigation techniques to a security-based swap cleared by a
UK-regulated central counterparty, the Commission also believes that
these UK requirements produce comparable outcomes to the analogous
Exchange Act requirements. The Commission reached this conclusion
because neither set of requirements imposes risk mitigation techniques
on transactions that have been cleared by central counterparties
subject to regulation in the jurisdiction of the authority that
supervises compliance with the risk mitigation requirements. However,
to the extent that these UK EMIR-based requirements do not require the
Covered Entity to apply risk mitigation techniques to the relevant
security-based swap because it has been cleared by a non-UK-regulated
central counterparty, the Commission does not believe that these UK
requirements produce comparable outcomes to Exchange Act trade
acknowledgment and verification, portfolio reconciliation and dispute
reporting, portfolio compression, and trading relationship
documentation requirements for non-centrally cleared security-based
swaps. The Commission reached this conclusion because these Exchange
Act requirements exempt centrally cleared security-based swaps only if
they have been cleared by an SEC-registered clearing agency (or, in the
case of portfolio reconciliation and dispute reporting, portfolio
compression, and trading relationship documentation requirements, a
clearing agency that the Commission has exempted from registration).
Security-based swaps that have been cleared by a central counterparty
that is not SEC-registered or exempt or UK-regulated are subject to
those Exchange Act requirements, but are not subject to the UK EMIR-
based risk mitigation requirements. Accordingly, the Commission is
issuing the condition as proposed to require that the relevant
security-based swap is either (a) an OTC derivative or OTC derivative
contract that has not been cleared by any central counterparty and is
otherwise subject to the relevant UK EMIR-based requirements or (b)
cleared by a UK-regulated central counterparty.\110\
---------------------------------------------------------------------------
\107\ See SIFMA 5/3/2021 Letter at 6-7.
\108\ See, e.g., UK EMIR article 11.
\109\ See, e.g., Exchange Act rules 15Fi-2, 17 CFR 240.15Fi-2
through 15Fi-4, 17 CFR 240.15Fi-4; Exchange Act rule 18a-3, 17 CFR
240.18a-3.
\110\ See para. (a)(14) of the Order. To correct a typographical
error in the UK Substituted Compliance Notice and Proposed Order, in
paragraph (a)(14) of the Order the Commission is changing the phrase
``paragraphs (b) through (e) of this Order'' to ``paragraphs (b)
through (f) of this Order.'' This correction is consistent with the
description of the proposed condition in the UK Substituted
Compliance Notice and Proposed Order. See UK Substituted Compliance
Notice and Proposed Order, 86 FR at 18382.
---------------------------------------------------------------------------
As an alternative to its suggested amendments to the condition, the
commenter asked the Commission to permit the Covered Entity to comply
directly with the Exchange Act (or with another applicable substituted
compliance order) with respect to transactions cleared by a non-UK-
[[Page 43329]]
regulated central counterparty, and to do so without affecting the
Covered Entity's ability to apply substituted compliance for entity-
level requirements with respect to other security-based swap business
that does satisfy the condition.\111\ Consistent with the discussion of
the scope of substituted compliance for entity-level requirements in
part III.B.2.b above, for entity-level Exchange Act requirements, a
Covered Entity must choose either (1) to apply substituted compliance
pursuant to the Order with respect to all UK business (that is,
security-based swap business that is both subject to the relevant UK
requirements listed in the Order and that can satisfy any general
conditions related to those UK requirements, including paragraph
(a)(14)); or (2) to comply directly with the Exchange Act with respect
to all UK business. A transaction cleared by a non-UK-regulated central
counterparty does not satisfy the condition in paragraph (a)(14) of the
Order. As a result, paragraph (a)(14) would not permit a Covered Entity
to use substituted compliance for any Exchange Act requirements that
apply to that transaction if the relevant conditions in parts (b)
through (f) of the Order include a requirement for the Covered Entity
to be subject to and comply with provisions of UK EMIR, UK EMIR RTS, UK
EMIR Margin RTS, and/or other UK requirements adopted pursuant to those
provisions. Instead, a Covered Entity must either comply directly with
the Exchange Act for such a transaction or comply with the terms of
another applicable substituted compliance order that the transaction is
able to satisfy.\112\ Such a transaction would not be included in the
UK business for which a Covered Entity must elect a single choice--use
substituted compliance under the Order or comply directly with the
Exchange Act--when complying with entity-level Exchange Act
requirements.
---------------------------------------------------------------------------
\111\ See SIFMA 5/3/2021 Letter at 7.
\112\ See supra note 80.
---------------------------------------------------------------------------
The commenter also requested that the Commission revise the
condition's description of UK-regulated central counterparties to
clarify that it includes UK-regulated third country central
counterparties, which may have a domicile outside the UK and thus may
not be viewed as ``recognized to clear derivatives contracts in the
UK.'' \113\ Similarly, the commenter asked the Commission to further
revise the description to encompass the UK's temporary recognition
regime for third country central counterparties implemented as a
consequence of the UK's exit from the European Union.\114\ The
Commission intends the condition's description of UK-regulated central
counterparties to include third country central counterparties that
relevant UK authorities allow to provide clearing services to UK
clearing members or trading venues.\115\ These central counterparties
include those ``taken to be'' recognized pursuant to the UK's temporary
recognition regime for third country central counterparties.\116\
Accordingly, the Commission is amending the condition's description of
UK-regulated central counterparties so that it describes ``a central
counterparty that is authorized, recognized, or taken to be recognized
by a relevant UK authority to provide clearing services to clearing
members or trading venues established in the UK.'' \117\
---------------------------------------------------------------------------
\113\ See SIFMA 5/3/2021 Letter at 7.
\114\ See SIFMA 5/3/2021 Letter at 7.
\115\ See UK EMIR article 25(1) (a third country central
counterparty may provide clearing services to UK clearing members or
trading venues only if it is recognized by the Bank of England); see
also The Over the Counter Derivatives, Central Counterparties and
Trade Repositories (Amendment, etc., and Transitional Provision) (EU
Exit) Regulations 2020 (2020/646), regulation 20(2).
\116\ See The Central Counterparties (Amendment, etc., and
Transitional Provision) (EU Exit) Regulations 2018 (2018/1184), part
6.
\117\ See para. (a)(14)(ii) of the Order. The Commission also is
amending the condition so that it applies to conditions of the Order
that require the application of, and the Covered Entity's compliance
with, UK EMIR, UK EMIR RTS, UK EMIR Margin RTS, and/or other UK
requirements adopted pursuant to those requirements.
---------------------------------------------------------------------------
Finally, the Commission is amending the condition to clarify that
the condition applies only if the relevant UK EMIR-based requirement
applies to OTC derivatives that have not been cleared by a central
counterparty, as some provisions of UK EMIR cited in the Order, such as
UK EMIR articles 39(4) and (5), are not limited in their application to
non-centrally cleared OTC derivatives. Consistent with the condition in
paragraph (a)(13) of the Order, the Commission also is adding
references to UK EMIR RTS and UK EMIR Margin RTS.
i. Memorandum of Understanding
As proposed, the Commission would need to have a supervisory and
enforcement memorandum of understanding and/or other arrangement with
the FCA and the PRA addressing cooperation with respect to the Order at
the time the Covered Entity makes use of substituted compliance.\118\
This condition has been modified from the proposed Order to reflect
that the executed version of the memorandum of understanding is between
the Commission, on the one hand, and the FCA and the Bank of England
(including in its capacity as the PRA), on the other hand.
---------------------------------------------------------------------------
\118\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18412.
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j. Notice of Reliance on Substituted Compliance
Commenters did not address the requirement in paragraph (a)(16) of
the proposed Order for the Covered Entity to notify the Commission in
writing of its intent to rely on substituted compliance, and the
Commission is adopting this requirement as proposed.\119\
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\119\ See para. (a)(16) of the Order. If the Covered Entity
intends to rely on all the substituted compliance determinations in
a given paragraph of the Order, it can cite that paragraph in the
notice. For example, if the Covered Entity intends to rely on the
capital and margin determinations in paragraph (c) of the Order, it
can indicate in the notice that it is relying on the determinations
in paragraph (c). However, if the Covered Entity intends to rely on
the margin determination but not the capital determination, it will
need to indicate in the notice that it is relying on paragraph
(c)(2) of the Order (the margin determination). In this case,
paragraph (c)(1) of the Order (the capital determination) will be
excluded from the notice and the Covered Entity will need to comply
with the Exchange Act capital requirements. Further, as discussed
below in part VIII.B.1, the recordkeeping and reporting
determinations in the Order have been structured to provide Covered
Entities with a high level of flexibility in selecting specific
requirements within those rules for which they want to rely on
substituted compliance. For example, paragraph (f)(1)(i) of the
Order sets forth the Commission's substituted compliance
determinations with respect to the requirements of Exchange Act rule
18a-5, 17 CFR 240.18a-5. These determinations are set forth in
paragraphs (f)(1)(i)(A) through (O) of the Order. If a Covered
Entity intends to rely on some but not all of the determinations, it
will need to identify in the notice the specific determinations in
this paragraph it intends to rely on (e.g., paragraphs (f)(1)(i)(A),
(B), (C), (D), (G), (H), (I), and (O)). For any determinations
excluded from the notice, the Covered Entity will need to comply
with the Exchange Act rule 18a-5 requirement. Finally, a Covered
Entity is able to apply substituted compliance at the transaction
level (rather than the entity level) for certain counterparty
protection requirements and the recordkeeping requirements that are
linked to them. In this case, the notice will need to indicate the
class of transactions (e.g., transactions with UK counterparties)
for which the Covered Entity is applying substituted compliance with
respect to the Exchange Act counterparty protection requirements and
linked recordkeeping requirements. Similarly, as discussed above, a
Covered Entity is able to apply substituted compliance for entity-
level Exchange Act requirements to all of its security-based swap
business that is eligible for substituted compliance under the
Order, and may either comply directly with the Exchange Act or apply
substituted compliance under another applicable order for its
security-based swap business that is not eligible for substituted
compliance under the Order. In this case, the notice will need to
indicate the scope of security-based swap business (e.g., security-
based swap business carried on from an establishment in the UK) for
which the Covered Entity is applying substituted compliance with
respect to the relevant Exchange Act entity-level requirements. A
Covered Entity would modify its reliance on the positive substituted
compliance determinations in the Order, and thereby trigger the
requirement to update its notice, if it adds or subtracts
determinations for which it is applying substituted compliance or
completely discontinues its reliance on the Order.
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[[Page 43330]]
k. Notification Requirements Related to Changes in Capital
In response to the French Substituted Compliance Notice and
Proposed Order, a commenter requested that the Commission make more
granular substituted compliance determinations with respect to the
Exchange Act recordkeeping requirements.\120\ The commenter stated that
for ``operational reasons'' a Covered Entity may ``prefer to comply
directly with certain Exchange Act requirements (i.e., not to rely on
substituted compliance with those requirements).'' \121\ The Commission
took this approach in the proposed Order with respect to the Exchange
Act recordkeeping, reporting, and notification requirements.\122\ As
part of this approach, the Commission also conditioned substituted
compliance with certain of the discrete recordkeeping, reporting, and
notification requirements on the Covered Entity applying substituted
compliance with respect to the substantive Exchange Act requirement to
which they were linked.\123\ This linked condition was designed to
ensure that a Covered Entity consistently applies substituted
compliance with respect to the substantive Exchange Act requirement and
the Exchange Act recordkeeping, reporting, or notification requirement
that complements the substantive requirement.
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\120\ See Letter from Kyle Brandon, Managing Director, Head of
Derivative Policy, SIFMA (Jan. 25, 2021) (``SIFMA 1/25/2021
Letter'') at 8.
\121\ SIFMA 1/25/2021 Letter at 8.
\122\ See UK Substituted Compliance Notice and Proposed Order,
86 FR 18394-403, 18415-420.
\123\ See UK Substituted Compliance Notice and Proposed Order,
86 FR 18394-403, 18415-420.
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On further consideration and in light of the more granular approach
requested by the commenter, the Commission believes it necessary to do
the reverse with respect to certain substantive financial
responsibility requirements: Condition substituted compliance with
respect to the substantive requirement on the Covered Entity applying
substituted compliance with respect to the linked recordkeeping,
reporting, or notification requirement. The Exchange Act financial
responsibility requirements addressed in this Order (capital, margin,
recordkeeping, reporting, notification, and securities count
requirements) are highly integrated. Therefore, implementing the
reverse conditional link is designed to ensure that the granular
approach requested by the commenter results in comparable regulatory
outcomes in terms of obligations to make and preserve records, and to
submit reports and notifications to the Commission concerning the
Covered Entity's compliance with the financial responsibility rules. It
also is designed to provide clarity as to the obligations of a Covered
Entity under this Order when using the granular approach to the
Exchange Act recordkeeping, reporting, and notification requirements
linked to the financial responsibility rules.
For example, because of the granular approach, a Covered Entity
could elect to apply substituted compliance with respect to a
substantive Exchange Act requirement such as the capital requirements
of Exchange Act rule 18a-1 but elect not to apply substituted
compliance with respect to a linked requirement under Exchange Act rule
18a-8 to provide the Commission notice of a capital deficiency under
Exchange Act rule 18a-1. In this scenario, the Covered Entity would not
be subject to the condition for applying substituted compliance with
respect to Exchange Act rule 18a-8; namely, that the firm provide the
Commission copies of notifications relating to UK capital requirements
required under UK law. Consequently, as discussed below in this section
and other sections of this release, the Commission is conditioning
substituted compliance with respect to certain substantive Exchange Act
requirements on the Covered Entity applying substituted compliance with
respect to linked recordkeeping, reporting, or notification
requirements.
Exchange Act Rule 18a-8(c)
Exchange Act rule 18a-8(c) generally requires every prudentially
regulated security-based swap dealer that files a notice of adjustment
of its reported capital category with the Federal Reserve Board, the
Office of the Comptroller of the Currency, or the Federal Deposit
Insurance Corporation to give notice of this fact that same day by
transmitting a copy to the Commission of the notice of adjustment of
reported capital category in accordance with Exchange Act rule 18a-
8(h).\124\ Exchange Act rule 18a-8(h) sets forth the manner in which
every notice or report required to be given or transmitted pursuant to
Exchange Act rule 18a-8 must be made.\125\ While Exchange Act rule 18a-
8(c) is not linked to a substantive Exchange Act requirement, it is
linked to substantive capital requirements applicable to prudentially
regulated SBS Entities in the U.S. (i.e., capital requirements of the
Federal Reserve Board, the Office of the Comptroller of the Currency,
or the Federal Deposit Insurance Corporation). Therefore, to implement
the granular approach requested by the commenter, the Commission is
adding a general condition that Covered Entities with a prudential
regulator relying on the final Order for substituted compliance must
apply substituted compliance with respect to the requirements of
Exchange Act rule 18a-8(c) and the requirements of Exchange Act rule
18a-8(h) as applied to Exchange Act rule (c).\126\
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\124\ See 17 CFR 240.18a-8(c).
\125\ See 17 CFR 240.18a-8(h).
\126\ Better Markets Letter at 2-3.
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In its application, the FCA cited several UK provisions as
providing similar outcomes to the notification requirements of Exchange
Act rule 18a-8.\127\ This general condition is necessary
[[Page 43331]]
in order to clarify that a prudentially regulated Covered Entity must
provide the Commission with copies of any notifications regarding
changes in the Covered Entity's capital situation required by UK law.
In particular, a prudentially regulated Covered Entity could elect not
to apply substituted compliance with respect to Exchange Act rule 18a-
8(c). However, because the Covered Entity is not required to provide
any notifications to the Federal Reserve Board, the Office of the
Comptroller of the Currency, or the Federal Deposit Insurance
Corporation, ``compliance'' with the provisions of Exchange Act rule
18a-8(c) raises a question as to the Covered Entity's obligations under
this Order to provide the Commission with notification of changes in
capital.
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\127\ These UK provisions include: (1) FCA PRIN 2.1.1R
(Principle 11) and PRA Fundamental Rule 7 requiring firms to deal
with regulators in an open and cooperative way, and to disclose to
regulators anything relating to the firm of which the regulator
would reasonably expect notice; (2) Supervision Sourcebook of the
FCA Handbook (``FCA SUP'') 15.3.1R and PRA Notification Rule 2.1,
which require immediate notification if a firm becomes aware that
certain events have occurred or may occur in the foreseeable future,
including the failure of the firm to satisfy certain threshold
conditions, any matter which could have a significant adverse impact
on the firm's reputation or that could affect the firm's ability to
continue to provide adequate services to its customers or result in
serious detriment to its customers, or any matter which could result
in serious financial consequences to the UK financial system or
other firms; (3) FCA SUP 15.3.11R and PRA Notification Rule 2.4,
which generally require, among other things, notification of a
significant breach of a rule or certain specified provisions or
regulations, or the bringing of a prosecution related to certain
offenses; (4) FCA SUP 15.3.15R and PRA Notification Rule 2.6, which
require a firm to provide immediate notification in the event that
civil proceedings or other specified actions are brought against the
firm, if disciplinary measures or sanctions are imposed on the firm,
if the firm is prosecuted for, or convicted of, any offense
involving fraud, or it is removed as a trustee of an occupational
pension scheme by a court order; (5) FCA SUP 15.17R and PRA
Notification Rule 2.8, which require a firm to provide notification
in the event that, among other things, the firm becomes aware that
an employee, or another person whether or not employed by the firm,
may have committed a fraud against a customer, or the firm
identifies irregularities in its accounting or other records; (6)
FCA SUP 15.3.21R and PRA Notification Rule 2.9, which require a firm
to provide immediate notification upon the calling of a meeting to
consider a resolution, or the presentation of a petition, for
winding up the firm, an application to dissolve the firm, or other
similar matters; (7) FCA CASS 6.6.57R and 7.15.33R, which require,
among other things, notification if a firm's internal records and
accounts related to client assets and money are materially out of
date, inaccurate, or invalid, the firm fails or is unable to respond
to shortfalls as required, or the firm fails or is unable to conduct
an internal asset reconciliation, external custody reconciliation,
or internal and external client money reconciliations; and (8) FCA
SYSC 18.6.1R and PRA Organisational Requirements 2A.1(2), 2A.2, and
2A.3 through 2A.6, which require firms to have arrangements or
procedures in place for employees to report potential or actual
breaches or reportable concerns.
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Moreover, a commenter stated that foreign financial services firms
were among the entities that used emergency lending facilities in the
U.S. along with other U.S. measures to address the 2008 financial
crisis.\128\ The Commission adopted Exchange Act rule 18a-8(c) to
require SBS Entities with a prudential regulator to give notice to the
Commission when filing an adjustment of reported capital category
because such notices may indicate that the entity is in or is
approaching financial difficulty.\129\ The Commission has a regulatory
interest in being notified of changes in the capital of a prudentially
regulated Covered Entity, as it could signal the firm is in or
approaching financial difficulty and presents a risk to U.S. security-
based swap markets and participants. For the foregoing reasons, the
Commission is conditioning applying substituted compliance pursuant to
the Order on the general condition that a prudentially regulated
Covered Entity apply substituted compliance with respect to Exchange
Act rule 18a-8(c) and the requirements of Exchange Act rule 18a-8(h) as
applied to Exchange Act rule 18a-8(c).
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\128\ Better Markets Letter at 2.
\129\ See Exchange Act Release No. 71958 (September 19, 2019),
84 FR 68550, 68589-90 (Dec. 16, 2019) (``Recordkeeping and Reporting
Adopting Release'') (citing Exchange Act Release No. 71958 (Aug. 17,
2014) 79 FR 25193 (May 2, 2014) at 25249).
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IV. Substituted Compliance for Risk Control Requirements
A. Proposed Approach
The FCA Application in part requested substituted compliance in
connection with risk control requirements relating to:
<bullet> Internal risk management--Internal risk management system
requirements that address the obligation of registered entities to
follow policies and procedures reasonably designed to help manage the
risks associated with their business activities.
<bullet> Trade acknowledgment and verification--Trade
acknowledgment and verification requirements intended to help avoid
legal and operational risks by requiring definitive written records of
transactions and procedures to avoid disagreements regarding the
meaning of transaction terms.
<bullet> Portfolio reconciliation and dispute reporting--Portfolio
reconciliation and dispute reporting provisions that require that
counterparties engage in portfolio reconciliation and resolve
discrepancies in connection with uncleared security-based swaps, and to
provide prompt notification to the Commission and applicable prudential
regulators regarding certain valuation disputes.
<bullet> Portfolio compression--Portfolio compression provisions
that require that SBS Entities have procedures addressing bilateral
offset, bilateral compression, and multilateral compression in
connection with uncleared security-based swaps.
<bullet> Trading relationship documentation--Trading relationship
documentation provisions that require SBS Entities to have procedures
to execute written security-based swap trading relationship
documentation with their counterparties prior to, or contemporaneously
with, executing certain security-based swaps.\130\
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\130\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18383.
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Taken as a whole, these risk control requirements help to promote
market stability by mandating that registered entities follow practices
that are appropriate to manage the market, counterparty, operational,
and legal risks associated with their security-based swap businesses.
In proposing to provide conditional substituted compliance in
connection with this part of the FCA Application, the Commission
preliminarily concluded that the relevant UK requirements in general
would help to produce regulatory outcomes that are comparable to those
associated with Exchange Act risk control requirements, by subjecting
Covered Entities to risk mitigation and documentation practices that
are appropriate to the risks associated with their security-based swap
businesses.\131\ Substituted compliance under the proposed Order was to
be conditioned in part on Covered Entities being subject to and
complying with the specified UK provisions that in the aggregate help
to produce outcomes that are comparable to those associated with the
risk control requirements under the Exchange Act.\132\
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\131\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18383.
\132\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18383 and n.61. Each of the comparable UK requirements
listed in the proposed Order applies to a uniquely defined set of
UK-authorized firms. See UK Substituted Compliance Notice and
Proposed Order, 86 FR at 18384-85 and n.70. To assist UK firms in
determining whether they are subject to these requirements, the
Commission preliminarily determined that any Covered Entity that is
an ``IFPRU investment firm,'' ``UK bank'' or ``UK designated
investment firm,'' each as defined for purposes of UK law, would be
subject to all of the required UK requirements related to internal
risk management requirements and thus eligible to apply substituted
compliance for internal risk management requirements. The Commission
also preliminarily determined that a Covered Entity that is a
``financial counterparty'' would be subject to the required UK
requirements related to trade acknowledgment and verification,
portfolio reconciliation and dispute reporting, portfolio
compression, and trading relationship documentation and thus
eligible to apply substituted compliance in these areas. See UK
Substituted Compliance Notice and Proposed Order, 86 FR at 18384-85.
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Substituted compliance under the proposed Order further would be
subject to certain additional conditions to help ensure the
comparability of outcomes. First, substituted compliance for Exchange
Act trading relationship documentation requirements would not extend to
certain disclosures regarding legal and bankruptcy status.\133\ Second,
substituted compliance for portfolio reconciliation and dispute
reporting requirements would be conditioned on the Covered Entity
having to provide the Commission with reports regarding disputes
between counterparties on the same basis as the Covered Entity provides
those reports to the FCA pursuant to UK law.\134\
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\133\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18383. The trading relationship documentation provisions of
rule 15Fi-5(b)(5), 17 CFR 240.15Fi-5(b)(5), require certain
disclosures regarding the status of the SBS Entity or its
counterparty as an insured depository institution or financial
counterparty, and regarding the possible application of the
insolvency regime set forth under Title II of the Dodd-Frank Act or
the Federal Deposit Insurance Act. Documentation requirements under
applicable UK law would not be expected to address the disclosure of
information related to insolvency procedures under U.S. law.
\134\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18383. Under the Exchange Act requirement, SBS Entities
must promptly report, to the Commission, valuation disputes in
excess of $20 million that have been outstanding for three or five
business days (depending on counterparty types). UK requirements
provide that firms must report at least monthly, to the FCA,
disputes between counterparties in excess of [euro]15 million and
outstanding for at least 15 business days.
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[[Page 43332]]
B. Commenter Views and Final Provisions
After considering commenters' recommendations regarding the risk
control requirements, the Commission is making positive substituted
compliance determinations in connection with internal risk management,
trade acknowledgment and verification, portfolio reconciliation and
dispute reporting, portfolio compression, and trading relationship
documentation requirements. As discussed below, the final Order has
been changed from the proposed Order in certain respects in response to
comments.\135\
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\135\ See para. (b) of the Order.
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One commenter expressed general support for the proposed approach
toward substituted compliance for the risk control provisions.\136\
Another commenter stated that UK requirements are not sufficiently
comparable to Exchange Act requirements.\137\ The Commission continues
to conclude that, taken as a whole, applicable requirements under UK
law subject Covered Entities to risk mitigation and documentation
practices that are appropriate to the risks associated with their
security-based swap businesses, and thus help to produce regulatory
outcomes that are comparable to the outcomes associated with the
relevant risk control requirements under the Exchange Act. Although the
Commission recognizes that there are differences between the approaches
taken by the relevant risk control requirements under the Exchange Act
and relevant UK requirements, the Commission continues to believe that
those differences on balance should not preclude substituted compliance
for these requirements, as the relevant UK requirements taken as a
whole help to produce comparable regulatory outcomes.
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\136\ See SIFMA 5/3/2021 Letter at 9. The commenter also
requested that the Commission not require a Covered Entity to be
subject to and comply with some of the UK risk control requirements
listed in the proposed Order. See SIFMA 5/3/2021 Letter at 9 and
Appendix A part (b). The Commission addresses those requests in the
relevant sections of this part IV below.
\137\ See Better Markets Letter at 2. The commenter also stated
that, if the Commission nevertheless makes a positive substituted
compliance determination, it must at a minimum ensure that the
conditions in the proposed Order ``are applied with full force and
without exceptions or dilution.'' The Commission addresses that
comment in the relevant sections of this part IV below.
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To help ensure the comparability of outcomes, substituted
compliance for risk control requirements is subject to certain
conditions. Substituted compliance for internal risk management, trade
acknowledgment and verification, portfolio reconciliation and dispute
reporting, portfolio compression, and trading relationship
documentation requirements is conditioned on the Covered Entity being
subject to, and complying with, relevant UK requirements.\138\ In
addition, consistent with the proposed Order, substituted compliance
for portfolio reconciliation and dispute reporting requirements is
conditioned on the Covered Entity providing the Commission with reports
regarding disputes between counterparties on the same basis as the
Covered Entity provides those reports to the FCA pursuant to UK
law.\139\ Finally, consistent with the proposed Order, substituted
compliance for trading relationship documentation does not extend to
disclosures regarding legal and bankruptcy status that are required by
Exchange Act rule 15Fi-5(b)(5) when the counterparty is a U.S.
person.\140\ A Covered Entity that is unable to comply with an
applicable condition--and thus is not eligible to use substituted
compliance for the particular set of Exchange Act risk control
requirements related to that condition--nevertheless may use
substituted compliance for another set of Exchange Act requirements
addressed in the Order if it complies with the conditions to the
relevant parts of the Order.
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\138\ See paras. (b)(1) through (b)(5) of the Order.
\139\ See paras. (b)(3)(ii) of the Order. This condition
promotes comparability with the Exchange Act rule requiring reports
to the Commission regarding significant valuation disputes, while
leveraging UK reporting provisions to avoid the need for Covered
Entities to create additional reporting frameworks. When it proposed
the condition to report valuation disputes, the Commission
recognized that valuation inaccuracies may lead to uncollateralized
credit exposure and the potential for loss in the event of default.
See Exchange Act Release No. 84861 (Dec. 19, 2018), 84 FR 4614, 4621
(Feb. 15, 2019). It thus is important that the Commission be
informed regarding valuation disputes affecting SBS Entities. The
principal difference between the Exchange Act and UK valuation
dispute reporting requirements concerns the timing of notices.
Exchange Act rule 15Fi-3 requires SBS Entities to report promptly to
the Commission valuation disputes in excess of $20 million that have
been outstanding for three or five business days (depending on the
counterparty type). UK EMIR RTS article 15(2) requires financial
counterparties to report to the FCA at least monthly any disputes
between counterparties in excess of [euro]15 million and outstanding
for at least 15 business days. The Commission is mindful that the UK
provision does not provide for notice as quickly as rule 15Fi-3, but
in the Commission's view on balance this difference would not be
inconsistent with the conclusion that the two sets of requirements,
taken as a whole, promote comparable regulatory outcomes.
\140\ See para. (b)(5) of the Order. The Exchange Act rule 15Fi-
5 disclosures address information regarding (1) the status of the
SBS Entity or its counterparty as an insured depository institution
or financial counterparty and (2) the possibility that in certain
circumstances the SBS Entity or its counterparty may be subject to
the insolvency regime set forth in Title II of the Dodd-Frank Wall
Street Reform and Consumer Protection Act or the Federal Deposit
Insurance Act, which may affect rights to terminate, liquidate, or
net security-based swaps. See Exchange Act Release No. 87782 (Dec.
18, 2019), 85 FR 6359, 6374 (Feb. 4, 2020) (``Risk Mitigation
Adopting Release''). Documentation requirements under applicable UK
law do not address the disclosure of information related to
insolvency procedures under U.S. law. However, the absence of such
disclosures would not appear to preclude a comparable regulatory
outcome when the counterparty is not a U.S. person, as the
insolvency-related consequences that are the subject of the
disclosure would not apply to non-U.S. counterparties in most cases.
Moreover, UK EMIR Margin RTS article 2 requires counterparties to
establish, apply, and document risk management procedures providing
for or specifying the terms of agreements entered into by the
counterparties, including applicable governing law for non-centrally
cleared derivatives. When counterparties enter into a netting or
collateral exchange agreement, they also must perform an independent
legal review of the enforceability of those agreements.
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Under the Order, substituted compliance for risk control
requirements (relating to internal risk management, trade
acknowledgment and verification, portfolio reconciliation and dispute
reporting, portfolio compression, and trading relationship
documentation) is not subject to a condition that the Covered Entity
apply substituted compliance for related recordkeeping requirements in
Exchange Act rules 18a-5 and 18a-6. A Covered Entity that applies
substituted compliance for one or more risk control requirements, but
does not apply substituted compliance for the related recordkeeping
requirements in Exchange Act rules 18a-5 and 18a-6, will remain subject
to the relevant provisions of Exchange Act rules 18a-5 and 18a-6. Those
rules require the Covered Entity to make and preserve records of its
compliance with Exchange Act risk control requirements and of its
security-based swap activities required or governed by those
requirements. A Covered Entity that applies substituted compliance for
a risk control requirement, but complies directly with related
recordkeeping requirements in rules 18a-5 and 18a-6, therefore must
make and preserve records of its compliance with the relevant
conditions to the Order and of its security-based swap activities
required or governed by those conditions and/or referenced in the
relevant parts of rules 18a-5 and 18a-6.
The Commission details below its consideration of comments on the
proposed Order.
1. Internal Risk Management
Exchange Act section 15F(j)(2) requires a registered SBS Entity to
establish robust and professional risk
[[Page 43333]]
management systems adequate for managing its day-to-day business. In
addition, Exchange Act rule 15Fh-3(h)(2)(iii)(I) \141\ requires an SBS
Entity to establish and maintain a system to supervise, and to
diligently supervise, its business and the activities of its associated
persons. This system of internal supervision must include, in relevant
part, the establishment, maintenance, and enforcement of written
policies and procedures reasonably designed, taking into consideration
the nature of the SBS Entity's business, to comply with its duty under
Exchange Act section 15F(j)(2) to establish an internal risk management
system.
---------------------------------------------------------------------------
\141\ 17 CFR 240.15Fh-3(h)(2)(iii)(I).
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The Commission continues to believe that UK internal risk
management requirements promote regulatory outcomes comparable to
Exchange Act requirements, and is making a positive substituted
compliance determination for internal risk management requirements that
is consistent with the proposed Order except for the addition of
certain risk management requirements. A commenter requested that the
Commission not require a Covered Entity to be subject to and comply
with certain of the UK requirements specified in the proposed
Order.\142\ By contrast, another commenter stated that, if the
Commission makes a positive substituted compliance determination, it
must at a minimum ensure that the conditions in the proposed Order
``are applied with full force and without exceptions or dilution.''
\143\ The Commission details below its consideration of comments
received.
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\142\ See SIFMA 5/3/2021 Letter at 20-21 and Appendix A part
(d)(3).
\143\ See Better Markets Letter at 2.
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A commenter stated that the Commission should delete from the Order
the provisions of FCA IFPRU, FCA BIPRU, and FCA SYSC 19A listed in
paragraphs (b)(1)(i) and (b)(1)(iv) of the proposed Order. These
provisions apply only to IFPRU investment firms, and the commenter
stated that it expects only ``banks and PRA-designated investment
firms'' will register as SBS Entities.\144\ For the reasons described
in part III.B.2.e above, the Commission is retaining the references to
these provisions.
---------------------------------------------------------------------------
\144\ See SIFMA 5/3/2021 Letter Appendix A part (b)(1).
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Similarly, the commenter stated that the Commission should delete
from the Order the provisions of FSMA and FCA COND listed in paragraph
(b)(1)(v) of the proposed Order that apply to firms regulated only by
the FCA, rather than to firms dually regulated by both the FCA and the
PRA.\145\ The commenter again stated that it expects only dually
regulated ``banks and PRA-designated investment firms'' will register
as SBS Entities.\146\ The proposed Order would not require a Covered
Entity that is a dually regulated firm to be subject to and comply with
these provisions. Rather, paragraph (b)(1)(v) of the proposed Order
would require the Covered Entity to be subject to and comply with
either the provisions of FSMA and FCA COND that apply to solo-regulated
firms or analogous provisions that apply to dually regulated firms.
Accordingly, the Commission is retaining the references to these
provisions.
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\145\ See SIFMA 5/3/2021 Letter Appendix A part (b)(1).
\146\ See SIFMA 5/3/2021 Letter Appendix A part (b)(1) n.2.
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The commenter also recommended that the Commission delete from the
Order the following provisions because they do not correspond to and go
beyond Exchange Act internal risk management requirements: \147\
---------------------------------------------------------------------------
\147\ See SIFMA 5/3/2021 Letter Appendix A part (b)(1).
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<bullet> PRA Internal Capital Adequacy Assessment Rules 4.1 through
4.4, which implement CRD article 79, address a Covered Entity's
management of credit and counterparty risk. PRA Internal Capital
Adequacy Assessment Rule 5.1, which implements CRD article 80,
addresses a Covered Entity's management of residual risk. PRA Internal
Capital Adequacy Assessment Rule 6.1, which implements CRD article 81,
addresses a Covered Entity's management of concentration risk. PRA
Internal Capital Adequacy Assessment Rules 7.1 and 7.2, which implement
CRD article 82, address a Covered Entity's management of securitization
risk. PRA Internal Capital Adequacy Assessment Rules 8.1 through 8.5,
which implement CRD article 83, address a Covered Entity's management
of market risk. PRA Internal Capital Adequacy Assessment Rule 9.1,
which implements CRD article 84, addresses a Covered Entity's
management of interest rate risk. PRA Internal Capital Adequacy
Assessment Rules 10.1 and 10.2, which implement CRD article 85, address
a Covered Entity's management of operational risk. PRA Internal
Liquidity Adequacy Assessment Rules 3.1 through 3.3, 4.1, 7.2, 8.1,
9.2, 11.1, 11.2, 11.4, 12.1, 12.3, and 12.4, which implement CRD
article 86, address a Covered Entity's management of liquidity risk and
funding risk. PRA Internal Capital Adequacy Assessment Rules 11.1
through 11.3, which implement CRD article 87, address a Covered
Entity's management of risk from excessive leverage.
<bullet> FCA SYSC 4.1.1R, which implements a portion of CRD article
74(1), requires a Covered Entity to have robust governance
arrangements, including effective processes to identify, manage,
monitor, and report the risks it is or might be exposed to. FCA SYSC
4.1.2R and PRA General Organisational Requirement Rule 2.2, which
implement CRD article 74(2), requires these arrangements and processes
to be comprehensive and proportionate to the nature, scale, and
complexity of the risks of the Covered Entity's business and
activities. FCA SYSC 7.1.4R, 7.1.17R, 7.1.18R, 7.1.18BR, 7.1.19R,
7.1.20R, 7.1.21R, and 7.1.22R and PRA Risk Control Rules 2.3, 2.7, and
3.1 through 3.5, which implement CRD article 76, address the Covered
Entity's internal governance structures for risk management.
<bullet> FCA SYSC 19D.2.1R and PRA Remuneration Rule 6.2 require a
Covered Entity to establish and maintain a remuneration policy,
practices, and procedures that are consistent with and that promote
sound and effective risk management.\148\
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\148\ The FCA also recommended that the Commission delete from
the Order the requirement for a Covered Entity to be subject to and
comply with provisions of FCA SYSC 19D and PRA Remuneration Rule 6.2
(along with corollary provisions of FCA SYSC 19A applicable to IFPRU
firms) as a condition to substituted compliance for internal risk
management requirements. See FCA Comments (stating that ``these
provisions appear in excess of what is strictly required for
substituted compliance with the US provision'').
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<bullet> FSMA schedule 6 part 3C and FCA COND 2.4.1C, which address
issues similar to MiFID articles 16(4) and (5), require the Covered
Entity's non-financial resources to be appropriate in relation to its
regulated activities, taking into account factors such as the nature
and scale of the business, the risks to the continuity of the Covered
Entity's services, the Covered Entity's membership in a group or any
effect that membership may have, the skills and experience of those
managing the Covered Entity's affairs, and whether the Covered Entity's
non-financial resources are sufficient to enable it to comply with
applicable requirements of the FCA. FSMA schedule 6 part 5D, which also
addresses issues similar to MiFID articles 16(4) and (5), requires the
Covered Entity's business to be conducted in a prudent manner, which
requires the Covered Entity to have appropriate financial and non-
financial resources, taking into account factors such as the nature and
complexity of the
[[Page 43334]]
Covered Entity's regulated activities, the nature and scale of the
business, and the risks to the continuity of the Covered Entity's
services. To have appropriate non-financial resources, the Covered
Entity in particular must have resources to identify, monitor, measure,
and take action to remove or reduce risks to the accuracy of the
Covered Entity's valuation of its assets and liabilities, be managed to
a reasonable standard of effectiveness and have non-financial resources
sufficient to enable it to comply with applicable requirements of the
PRA. PRA Fundamental Rules 3 through 6 similarly require the Covered
Entity to act in a prudent manner, maintain adequate financial
resources at all times, have effective risk strategies and risk
management systems and organize and control its affairs responsibly and
effectively.
<bullet> UK CRR article 286 requires a Covered Entity to establish
and maintain a counterparty credit risk management framework, including
policies, processes, and systems to ensure the identification,
measurement, approval, and internal reporting of counterparty credit
risk and procedures for ensuring that those policies, processes, and
systems are complied with. UK CRR article 287 addresses the internal
governance of risk control and collateral management functions for
Covered Entities that use internal models to calculate capital
requirements. UK CRR article 288 requires the Covered Entity to conduct
regular, independent reviews of its counterparty credit risk management
systems and any risk control and collateral management functions
required by UK CRR article 287. UK CRR article 293 addresses internal
governance of the Covered Entity's internal risk management systems and
validation of risk models that the Covered Entity uses.
<bullet> UK EMIR Margin RTS article 2 requires counterparties to
non-centrally cleared OTC derivative contracts to establish, apply, and
document risk management procedures for the exchange of collateral.
<bullet> UK MiFID Org Reg article 21 \149\ addresses a Covered
Entity's systems, internal controls, and arrangements for management of
a variety of risk areas, including internal decision-making,
allocation, proper discharge of responsibilities, compliance with
decisions and internal procedures, employment of personnel able to
discharge their responsibilities, internal reporting and communication
of information, adequate and orderly recordkeeping, safeguarding
information, business continuity, and accounting policies and
procedures, as well as regular evaluation of the adequacy and
effectiveness of those systems, internal controls, and arrangements. UK
MiFID Org Reg article 22 addresses a Covered Entity's policies and
procedures for detecting and minimizing risk of failure to comply with
its obligations under UK provisions that implement MiFID, as well as
the Covered Entity's independent compliance function that monitors and
assesses the adequacy and effectiveness of those policies and
procedures. UK MiFID Org Reg article 24 addresses a Covered Entity's
internal audit function that evaluates the adequacy and effectiveness
of the Covered Entity's systems, internal controls, and arrangements.
---------------------------------------------------------------------------
\149\ The commenter stated that these requirements are more
appropriately addressed in connection with substituted compliance
for internal supervision and chief compliance officer requirements.
As discussed below, the Commission believes that these UK
requirements are relevant to substituted compliance for Exchange Act
internal risk management requirements.
---------------------------------------------------------------------------
Taken as a whole, these UK requirements help to produce regulatory
outcomes comparable to Exchange Act requirements to establish robust
and professional internal risk management systems adequate for managing
the Covered Entity's day-to-day business. The comparability analysis
requires consideration of Exchange Act requirements as a whole against
analogous UK requirements as a whole, recognizing that U.S. and non-
U.S. regimes may follow materially different approaches in terms of
specificity and technical content. This ``as a whole'' approach--which
the Commission is following in lieu of requiring requirement-by-
requirement similarity--further means that the conditions to
substituted compliance should encompass all UK requirements that
establish comparability with the applicable regulatory outcome, and
helps to avoid ambiguity in the application of substituted compliance.
It would be inconsistent with the holistic approach to excise relevant
requirements and leave only the residual UK provisions that most
closely resemble the analogous Exchange Act requirements.\150\
Moreover, because Exchange Act internal risk management requirements
serve the purpose of establishing internal systems to manage the
Covered Entity's risks, including risks of non-compliance with
applicable laws, it would be paradoxical to conclude that an SBS Entity
that fails to implement requisite internal supervision practices
nonetheless may be considered to be following internal risk management
standards that are sufficient to meet the regulatory outcomes required
under the Exchange Act; an internal supervision-related failure
necessarily also constitutes a risk management failure. For these
reasons, the Commission concludes that these UK provisions
appropriately constitute part of the substituted compliance conditions
for internal risk management requirements and is retaining the
references to these provisions. In reaching this conclusion, the
Commission emphasizes the importance of ensuring that substituted
compliance is grounded on the comparability of regulatory outcomes.
Retaining the conditions of the Order related to these UK provisions
also should address another commenter's concern that any substituted
compliance determination not weaken the internal risk management
conditions in the proposed Order.\151\
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\150\ The Commission further believes that those conditions to
substituted compliance do not expand the scope of Exchange Act
requirements because substituted compliance is an option available
to non-U.S. person SBS Entities--not a mandate.
\151\ See Better Markets Letter at 2.
---------------------------------------------------------------------------
In addition, the Commission is adding a requirement for a Covered
Entity using substituted compliance for internal risk management
requirements to be subject to and comply with provisions that implement
MiFID articles 16 and 23, provisions of UK MiFID Org Reg related to
MiFID articles 16 and 23, and provisions that implement CRD articles
88(1), 91(1), (2), and (7) through (9), 92, 94, and 95.\152\ These
provisions address additional aspects of a Covered Entity's management
of the risks posed by internal governance and organization, business
operations, conflicts of interest with and between clients, and senior
staff remuneration policies. In deciding to make a positive substituted
compliance determination for UK internal risk management requirements,
the Commission considers that the Order's condition requiring a Covered
Entity to be subject to and comply with all of the UK internal risk
management requirements listed in paragraph (b)(1) of the Order help to
produce regulatory outcomes comparable to Exchange Act internal risk
management requirements. In deciding to make a positive substituted
compliance determination for UK internal risk management requirements,
the Commission considers that the Order's condition requiring a Covered
Entity to be subject to and comply with all of the UK requirements
listed in paragraph (b)(1)
[[Page 43335]]
of the Order help to produce regulatory outcomes comparable to Exchange
Act internal risk management requirements. The Commission recognizes
that some of the UK requirements related to internal risk management
follow a more granular approach than the high-level approach of
Exchange Act internal risk management requirements, but these UK
requirements, taken as a whole, are crafted to promote a Covered
Entity's risk management. Within the requisite outcomes-oriented
approach for analyzing comparability, the Commission concludes that a
Covered Entity's failure to comply with any of those UK internal risk
management requirements would be inconsistent with a Covered Entity's
obligations under Exchange Act internal risk management requirements
and that compliance with the full set of UK internal risk management
requirements listed in paragraph (b)(1) of the Order would promote
comparable regulatory outcomes.
---------------------------------------------------------------------------
\152\ See para. (b)(1) of the Order.
---------------------------------------------------------------------------
2. Trade Acknowledgement and Verification
The Commission continues to believe that UK trade acknowledgment
and verification requirements promote regulatory outcomes comparable to
Exchange Act requirements, and is making a positive substituted
compliance determination for trade acknowledgment and verification
requirements consistent with the proposed Order. The Commission details
below its consideration of comments received.
One commenter stated that the Commission inappropriately attempted
to compensate for inadequate UK trade acknowledgment and verification
requirements by relying on guidance.\153\ The same commenter stated
that, if the Commission nevertheless makes a positive substituted
compliance determination, it must at a minimum ensure that the
conditions in the proposed Order ``are applied with full force and
without exceptions or dilution.'' \154\ The commenter misinterpreted
the role of guidance in the Commission's comparability analysis.
---------------------------------------------------------------------------
\153\ See Better Markets Letter at 5-6 (arguing that the
Commission's reliance ``on multiple layers of non-binding guidance,
one of which is issued by a jurisdiction the UK does not belong to,
one of which is so vague as to border on useless, would be an
abdication of the SEC's responsibility to protect the U.S. financial
system'').
\154\ See Better Markets Letter at 2.
---------------------------------------------------------------------------
UK EMIR article 11 requires ``financial counterparties'' and ``non-
financial counterparties'' to ensure appropriate procedures and
arrangements are in place to achieve timely confirmation of the terms
of an OTC derivative contract.\155\ Similarly, UK EMIR RTS article 12
requires non-centrally cleared OTC derivative contracts between
``financial counterparties'' and ``non-financial counterparties'' to be
confirmed.\156\ These counterparty categories do not include entities
organized outside the UK, such as U.S. persons.\157\ Confirmation means
the documentation of the agreement of the counterparties to all the
terms of the OTC derivative contract.\158\ The UK requirements as a
whole thus require a Covered Entity \159\ to provide a confirmation
that serves as a trade acknowledgment, without regard to where its
counterparty is organized, and also require the Covered Entity's
counterparty, when it is a financial counterparty or non-financial
counterparty, to provide a confirmation that serves as the trade
verification, and the Commission considers these requirements to
promote regulatory outcomes comparable to Exchange Act trade
acknowledgment and verification requirements for those counterparties.
The UK requirements in most instances do not require a Covered Entity's
counterparty that is organized outside the UK to provide a confirmation
that serves as the Exchange Act trade verification,\160\ though they do
require the Covered Entity to confirm the transaction.\161\
Confirmation is defined as documenting the agreement of the Covered
Entity and its counterparty to all the terms of the OTC derivative
contract.\162\
---------------------------------------------------------------------------
\155\ See UK EMIR article 11(1)(a).
\156\ See UK EMIR RTS articles 12(1) and (2).
\157\ See UK EMIR article 2(8) (definition of ``financial
counterparty''); UK EMIR article 2(9) (definition of ``non-financial
counterparty'').
\158\ See UK EMIR RTS article 1(c).
\159\ The Order defines a Covered Entity to include a MiFID
investment or a third country investment firm. A MiFID investment
firm is included in the definition of ``financial counterparty,'' so
a Covered Entity that is a MiFID investment firm is also a financial
counterparty and thus is ``subject to'' UK EMIR article 11 and
related provisions of UK EMIR RTS and UK EMIR Margin RTS for
purposes of the Order. A third country investment firm is not
included in the definitions of ``financial counterparty'' or ``non-
financial counterparty,'' but may nevertheless be ``subject to'' UK
EMIR article 11 and related provisions of UK EMIR RTS and UK EMIR
Margin RTS for purposes of the Order if its OTC derivative contract
would be subject to those obligations if it were established in the
UK and either the contract has a direct, substantial, and
foreseeable effect within the UK or applying UK EMIR article 11 is
necessary or appropriate to prevent evasion of UK EMIR. See UK EMIR
article 11(12).
\160\ See UK EMIR article 2(8) (definition of ``financial
counterparty'' limited to entities defined or authorized in a manner
that in most instances is reserved for UK-established entities); UK
EMIR article 2(9) (definition of ``non-financial counterparty''
limited to UK-established entities); UK EMIR article 11(1)(a),
11(12) (confirmation requirement applies to financial
counterparties, non-financial counterparties, and third-country
entities that would be subject to the confirmation requirement if
established in the UK and either the relevant contract has a direct,
substantial, and foreseeable effect in the UK or the obligation is
necessary or appropriate to prevent the evasion of any provision of
UK EMIR).
\161\ Paragraph (b)(2) of the Order requires the Covered Entity
to be subject to and comply with UK EMIR-based trade acknowledgment
and verification requirements. A Covered Entity will be subject to
those requirements only if it is a financial counterparty, non-
financial counterparty, or third-country entity that would be
subject to the confirmation requirement if established in the UK and
either the relevant contract has a direct, substantial, and
foreseeable effect in the UK or the obligation is necessary or
appropriate to prevent the evasion of any provision of UK EMIR. See
UK EMIR article 11(1)(a), 11(12).
\162\ See UK EMIR RTS article 1(c).
---------------------------------------------------------------------------
To confirm that the Commission's analysis of the UK requirements
for OTC derivatives contracts with non-UK-organized counterparties is
consistent with the FCA's view of these requirements, the Commission
considered the requirements together with guidance on this exact point
from the FCA and ESMA.\163\ In interpreting EU confirmation
requirements that are identical to the relevant UK requirements, ESMA's
guidance provides that ``when an EU counterparty is transacting with a
third country entity, the EU counterparty would be required to ensure
that the requirements for . . . timely confirmation . . . are met for
the relevant . . . transactions even though the third country entity
would not itself be subject to EMIR.'' \164\ That guidance also
provides that compliance with the EMIR confirmation requirements means
``reach[ing] a legally binding agreement to all the terms of an OTC
derivative contract.'' \165\ The FCA has published guidance indicating
that ESMA's guidance ``will remain relevant [after the UK's exit from
the EU] to the FCA and market participants in their compliance with
regulatory requirements.'' \166\ This
[[Page 43336]]
guidance thus is consistent with the Commission's analysis of the
legally binding UK requirements discussed above, and provides the
Commission additional comfort that its analysis of complex UK
requirements is consistent with the FCA's view of those requirements.
For these reasons, the Commission disagrees with the commenter and
believes that the UK trade acknowledgment and verification requirements
promote regulatory outcomes comparable to Exchange Act requirements.
---------------------------------------------------------------------------
\163\ See European Securities and Markets Authority, Questions
and Answers: Implementation of the Regulation (EU) No 648/2012 on
OTC Derivatives, Central Counterparties and Trade Repositories
(EMIR), available at: <a href="https://www.esma.europa.eu/sites/default/files/library/esma70-1861941480-52_qa_on_emir_implementation.pdf">https://www.esma.europa.eu/sites/default/files/library/esma70-1861941480-52_qa_on_emir_implementation.pdf</a>
(``ESMA EMIR Q&A'').
\164\ See ESMA EMIR Q&A, OTC Answer 12(b).
\165\ See ESMA EMIR Q&A, OTC Answer 5(a).
\166\ See Financial Conduct Authority, ``Brexit: our approach to
EU non-legislative materials,'' para. 9, available at: <a href="https://www.fca.org.uk/publication/corporate/brexit-our-approach-to-eu-non-legislative-materials.pdf">https://www.fca.org.uk/publication/corporate/brexit-our-approach-to-eu-non-legislative-materials.pdf</a> (``FCA Brexit Guidance''); see also FCA
Brexit Guidance at para. 12 (``We will continue to have regard to
other EU non-legislative material where and if they are relevant,
taking account of Brexit and ongoing domestic legislation. Firms,
market participants and stakeholders should also continue to do
so.'').
---------------------------------------------------------------------------
The Commission agrees with the comments in the Better Markets
Letter that the proposed conditions to substituted compliance for trade
acknowledgment and verification requirements should be retained. To
further ensure that a Covered Entity using substituted compliance for
trade acknowledgment and verification requirements will be required to
document the agreement of the counterparties to all the terms of the
relevant transaction, the Commission is issuing the Order as proposed
with general conditions that will require the Covered Entity to treat
its counterparty as a counterparty with whom UK trade acknowledgment
and verification requirements require the Covered Entity to reach an
agreement to all the terms of the OTC derivative contract and to ensure
that the relevant security-based swap is either non-centrally cleared
and subject to UK EMIR or centrally cleared by a UK central
counterparty.\167\
---------------------------------------------------------------------------
\167\ See paras. (a)(13) and (a)(14) of the Order.
---------------------------------------------------------------------------
Another commenter expressed general support for the proposed
approach toward substituted compliance for the risk control provisions,
but requested that the Commission not require a Covered Entity to be
subject to and comply with UK EMIR RTS article 12(4) because it does
not relate to and goes beyond Exchange Act trade acknowledgment and
verification requirements.\168\ As part of the UK's framework for trade
acknowledgment and verification, UK EMIR RTS article 12(4) requires a
Covered Entity to have the necessary procedure to report on a monthly
basis to the FCA the number of unconfirmed, non-centrally cleared OTC
derivative transactions that have been outstanding for more than five
business days. Though Exchange Act rule 15Fi-2 does not have a similar
requirement to report unconfirmed trades, the Commission considers that
UK EMIR RTS article 12(4)'s requirement to report unconfirmed trades to
the FCA is an inseparable part of the UK's framework for trade
acknowledgment and verification, as those reports support the UK
framework's mandate to confirm transactions. Requiring a Covered Entity
to be subject to and comply with UK EMIR RTS article 12(4) thus is
consistent with a holistic approach for comparing regulatory outcomes
that reflects the whole of a jurisdiction's relevant requirements.
Accordingly, the Order retains as a condition to substituted compliance
for trade acknowledgment and verification requirements the requirement
that the Covered Entity be subject to and comply with the entirety of
UK EMIR RTS article 12.
---------------------------------------------------------------------------
\168\ See SIFMA 5/3/2021 Letter at 9 and Appendix A part (b)(2).
---------------------------------------------------------------------------
In summary, the Commission continues to believe that UK
requirements promote the goal of avoiding legal and operational risks
through requirements for written records of transactions and procedures
to avoid disagreements regarding the meaning of transaction terms, in a
manner that is comparable to the purpose of Exchange Act rule 15Fi-2.
The Commission is retaining the proposed conditions to substituted
compliance for trade acknowledgment and verification, consistent with
the approach advocated by a commenter.\169\ While the Commission
recognizes the differences between UK requirements and Exchange Act
trade acknowledgment and verification requirements, in the Commission's
view those differences on balance would not preclude substituted
compliance, particularly as requirement-by-requirement similarity is
not needed for substituted compliance. The commenter's request for a
``well-supported, evidence-based determination'' has been met here in
the context of the requisite holistic analysis,\170\ and the
commenter's suggestion that there is a need for analysis regarding
protection of the American financial system has been addressed
above.\171\
---------------------------------------------------------------------------
\169\ See Better Markets Letter at 2.
\170\ See Better Markets Letter at 4 (requesting the Commission
make a ``well-supported, evidence-based determination''). As
discussed in part II.C.1 above, the Commission believes that the
present approach toward comparability analyses--which are based on a
close reading of relevant foreign requirements and careful
consideration of regulatory outcomes--appropriately reflects the
holistic comparability approach and the rejection of requirement-by-
requirement similarity.
\171\ See Better Markets Letter at 3-4 (stating that the
Commission must provide analysis that the substituted compliance
determination would protect the American financial system). As
discussed in part II.C.1 above, the Commission believes that
additional conditions related to protection of the American
financial system would not be useful.
---------------------------------------------------------------------------
3. Portfolio Reconciliation and Dispute Reporting
One commenter expressed general support for the proposed approach
toward substituted compliance for the risk control provisions.\172\
Another commenter stated that, if the Commission makes a positive
substituted compliance determination, it must at a minimum ensure that
the conditions in the proposed Order ``are applied with full force and
without exceptions or dilution.'' \173\ The Commission continues to
believes that UK portfolio reconciliation and dispute reporting
requirements promote regulatory outcomes comparable to Exchange Act
requirements, by subjecting Covered Entities to risk mitigation
practices that are appropriate to the risks associated with their
security-based swap businesses, and is making a positive substituted
compliance determination for portfolio reconciliation and dispute
reporting requirements consistent with the proposed Order.\174\
Substituted compliance in connection with the dispute reporting
requirements is conditioned in part on the Covered Entities providing
the Commission with reports regarding disputes between counterparties
on the same basis as the entities provide those reports to competent
authorities pursuant to UK law, to allow the Commission to obtain
notice regarding key information in a manner that makes use of existing
obligations under UK law.\175\
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\172\ See SIFMA 5/3/2021 Letter at 9.
\173\ See Better Markets Letter at 2.
\174\ See para. (b)(3) of the Order.
\175\ See para. (b)(3)(ii) of the Order. The Commission
recognizes the differences between the two sets of requirements--
under which Exchange Act rule 15Fi-3 requires SBS Entities to report
valuation disputes in excess of $20 million that have been
outstanding for three or five business days (depending on
counterparty types), while UK EMIR RTS article 15(2) requires firms
to report disputes between counterparties in excess of [euro]15
million and outstanding for at least 15 business days. In the
Commission's view, the two requirements produce comparable
regulatory outcomes notwithstanding those differences.
---------------------------------------------------------------------------
4. Portfolio Compression
One commenter expressed general support for the proposed approach
toward substituted compliance for the risk control provisions.\176\
Another commenter stated that, if the Commission makes a positive
substituted compliance determination, it must at a minimum ensure that
the conditions in the proposed Order ``are applied with full force and
without exceptions or dilution.'' \177\ The
[[Page 43337]]
Commission continues to believe that UK portfolio compression
requirements promote regulatory outcomes comparable to Exchange Act
requirements, by subjecting Covered Entities to risk mitigation
practices that are appropriate to the risks associated with their
security-based swap businesses, and is making a positive substituted
compliance determination for portfolio compression requirements
consistent with the proposed Order.\178\
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\176\ See SIFMA 5/3/2021 Letter at 9.
\177\ See Better Markets Letter at 2.
\178\ See para. (b)(4) of the Order.
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5. Trading Relationship Documentation
The Commission continues to believe that UK trading relationship
documentation requirements promote regulatory outcomes comparable to
Exchange Act requirements, and is making a positive substituted
compliance determination for trading relationship documentation
requirements consistent with the proposed Order. The Commission details
below its consideration of comments received.
One commenter stated that the Commission inappropriately attempted
to compensate for inadequate UK trading relationship documentation
requirements by relying on guidance.\179\ The same commenter stated
that, if the Commission nevertheless makes a positive substituted
compliance determination, it must at a minimum ensure that the
conditions in the proposed Order ``are applied with full force and
without exceptions or dilution.'' \180\ The commenter misinterpreted
the role of guidance in the Commission's comparability analysis. The
proposed Order would require a Covered Entity to be subject to and
comply with UK EMIR article 11(1)(a), UK EMIR RTS article 12, and UK
EMIR Margin RTS article 2. The Commission highlights the special
importance of UK EMIR Margin RTS article 2, which addresses risk
management procedures related to the exchange of collateral, including
procedures related to the terms of all necessary agreements to be
entered into by counterparties (e.g., payment obligations, netting
conditions, events of default, calculation methods, transfers of rights
and obligations upon termination, and governing law). Those obligations
are denoted as being connected to collateral exchange obligations, and
the Commission believes that they are necessary to help produce a
regulatory outcome that mitigates risk in a manner that is comparable
to the outcome associated with the Exchange Act trading relationship
documentation requirements. To bridge any gap left by UK EMIR Margin
RTS article 2, the Commission is also requiring compliance with UK EMIR
article 11(1)(a) and UK EMIR RTS article 12, which, as discussed in
part IV.B.2 above, require the Covered Entity to confirm the
transaction, with confirmation defined as documentation of the
agreement of the counterparties to all the terms of the OTC derivative
contract. Also as discussed in part IV.B.2 above, the Commission
consulted guidance from the FCA and ESMA to confirm that the
Commission's analysis of those complex UK requirements was consistent
with the FCA's view of those requirements.\181\ The Commission thus
agrees with the commenter that the proposed conditions to substituted
compliance for trading relationship documentation requirements should
be retained. To further ensure that a Covered Entity using substituted
compliance for trading relationship documentation requirements will be
required to document the agreement of the counterparties to all the
terms of the relevant transaction, the Commission is issuing the Order
as proposed with two general conditions that will require the Covered
Entity to treat its counterparty as a financial counterparty or non-
financial counterparty when complying UK trade acknowledgment and
verification requirements.\182\
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\179\ See Better Markets Letter at 5-6.
\180\ See Better Markets Letter at 2.
\181\ See ESMA EMIR Q&A, OTC Answers 5(a), 12(b); FCA Brexit
Guidance at paras. 9, 12.
\182\ See para. (a)(13) of the Order.
---------------------------------------------------------------------------
Another commenter expressed general support for the proposed
approach toward substituted compliance for the risk control provisions,
but requested that the Commission not require a Covered Entity to be
subject to and comply with UK EMIR RTS article 12(4) because it does
not relate to and goes beyond Exchange Act trading relationship
documentation requirements.\183\ For the reasons described in part
IV.B.2 above, the Commission is retaining the reference to this
provision.
---------------------------------------------------------------------------
\183\ See SIFMA 5/3/2021 Letter at 9 and Appendix A part (b)(5).
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Accordingly, the Commission continues to believe that UK
requirements promote regulatory outcomes comparable to Exchange Act
trading relationship documentation requirements. While the Commission
recognizes that these and certain other differences between UK
requirements and Exchange Act trading relationship documentation
requirements, in the Commission's view those differences on balance
would not preclude substituted compliance, particularly as requirement-
by-requirement similarity is not needed for substituted compliance.
V. Substituted Compliance for Capital and Margin Requirements
A. Proposed Approach
The FCA Application in part requested substituted compliance in
connection with capital and margin requirements relating to:
<bullet> Capital--Capital requirements pursuant to Exchange Act
section 15F(e) and Exchange Act rule 18a-1 and its appendices
(collectively ``Exchange Act rule 18a-1'') applicable to certain SBS
Entities.\184\ Exchange Act rule 18a-1 helps to ensure the SBS Entity
maintains at all times sufficient liquid assets to promptly satisfy its
liabilities, and to provide a cushion of liquid assets in excess of
liabilities to cover potential market, credit, and other risks. The
rule's net liquid assets test standard protects customers and
counterparties and mitigates the consequences of an SBS Entity's
failure by promoting the ability of the firm to absorb financial shocks
and, if necessary, to self-liquidate in an orderly manner.\185\ As part
of the capital requirements, security-based swap dealers without a
prudential regulator also must comply with the internal risk management
control requirements of Exchange Act
[[Page 43338]]
rule 15c3-4 with respect to certain activities.\186\
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\184\ 17 CFR 240.18a-1 through 18a-1d. Exchange Act rule 18a-1
applies to security-based swap dealers that: (1) Do not have a
prudential regulator and (2) are either: (a) Not dually registered
with the Commission as a broker-dealer; or (b) are dually registered
with the Commission as a special purpose broker-dealer known as an
OTC derivatives dealer. Security-based swap dealers that are dually
registered with the Commission as a full-service broker-dealer are
subject to the capital requirements of Exchange Act rule 15c3-1 (17
CFR 240.15c3-1) for which substituted compliance is not available.
See 17 CFR 240.3a71-6(d)(4)(i) (making substituted compliance
available only with respect to the capital requirements of Exchange
Act section 15F(e) and Exchange Act rule 18a-1).
\185\ See Exchange Act Release No. 86175 (June 21, 2019), 84 FR
43872, 43879-83 (Aug. 22, 2019) (``Capital and Margin Adopting
Release''). The capital standard of Exchange Act rule 18a-1 is based
on the net liquid assets test of Exchange Act rule 15c3-1 applicable
to broker-dealers. See Capital and Margin Adopting Release, 84 FR
43872, 43879-83. The net liquid assets test seeks to promote
liquidity by requiring that a firm maintain sufficient liquid assets
to meet all liabilities, including obligations to customers,
counterparties, and other creditors, and, in the event a firm fails
financially, to have adequate additional resources to wind-down its
business in an orderly manner without the need for a formal
proceeding. See Capital and Margin Adopting Release, 84 FR at 43879.
See FCA Application Appendix B, Annex V (Side Letter Addressing
Capital Requirements).
\186\ See 17 CFR 240.15c3-4 and 18a-1(f).
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<bullet> Margin--Margin requirements pursuant to Exchange Act
section 15F(e) and Exchange Act rule 18a-3 for non-prudentially
regulated SBS Entities.\187\ The margin requirements are designed to
protect SBS Entities from the consequences of a counterparty's
default.\188\
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\187\ 17 CFR 240.18a-3.
\188\ See Capital and Margin Adopting Release, 84 FR at 43947,
43949 (``Obtaining collateral is one of the ways OTC derivatives
dealers manage their credit risk exposure to OTC derivatives
counterparties. Prior to the financial crisis, in certain
circumstances, counterparties were able to enter into OTC
derivatives transactions without having to deliver collateral. When
``trigger events'' occurred during the financial crisis, those
counterparties faced significant liquidity strains when they were
required to deliver collateral'').
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Taken as a whole, these capital and margin requirements help to
promote market stability by mandating that SBS Entities follow
practices to manage the market, credit, liquidity, solvency,
counterparty, and operational risks associated with their security-
based swap businesses.
In proposing to provide conditional substituted compliance in
connection with this part of the FCA Application, the Commission
preliminarily concluded that substituted compliance with respect to the
Exchange Act capital requirements would be subject to certain
additional conditions.\189\ The conditions were designed to help ensure
the comparability of regulatory outcomes between Exchange Act rule 18a-
1 (which imposes a net liquid assets test) and the capital requirements
applicable to nonbank security-based swap dealers in the UK that are
expected to register with the Commission. Those capital requirements
are based on the international capital standard for banks (``Basel
capital standard'').\190\
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\189\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18385-89, 18413.
\190\ See, e.g., Basel Committee on Banking Supervision
(``BCBS''), The Basel Framework, available at: <a href="https://www.bis.org/basel_framework/">https://www.bis.org/basel_framework/</a>.
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In proposing to provide conditional substituted compliance in
connection with this part of the FCA Application, the Commission
preliminarily concluded that relevant UK margin requirements would
produce regulatory outcomes that are comparable to those associated
with the Exchange Act margin requirements.\191\
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\191\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18386, 18413.
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Finally, the proposed Order would permit a Covered Entity to apply
substituted compliance for the capital and/or margin requirements.\192\
Thus, a Covered Entity could apply substituted compliance for Exchange
Act margin requirements by complying with UK margin requirements but
comply with Exchange Act capital requirements (rather than applying
substituted compliance to those requirements) and vice versa. However,
as to the various requirements within the capital and margin rules, the
Commission found the rules to be entity-level when adopting amendments
to Exchange Act rule 3a71-6 to make substituted compliance available
with respect to them. Consequently, under the proposed Order, a Covered
Entity must apply substituted compliance with respect to capital and
margin requirements at an entity level.
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\192\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18386-87.
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B. Commenter Views and Final Provisions
1. Capital
Consistent with the proposed Order, the first capital condition
requires the covered entity to be subject to and comply with certain
identified UK capital requirements.\193\ As discussed at the end of
this section, the Commission made some modifications to the UK laws and
regulations cited in this condition.\194\ For the reasons discussed
below, there are two additional conditions to applying substituted
compliance with respect to Exchange Act rule 18a-1.
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\193\ See para. (c)(1)(i) of the Order. See also UK Substituted
Compliance Notice and Proposed Order, 86 FR at 18386.
\194\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18386, n.81.
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For the reasons discussed above in part III.B.2.k of this release,
the first additional capital condition is that the Covered Entity
applies substituted compliance with respect to Exchange Act rules 18a-
5(a)(9) (a record making requirement), 18a-6(b)(1)(x) (a record
preservation requirement), and 18a-8(a)(1)(i), (a)(1)(ii), (b)(1),
(b)(2), and (b)(4) (notification requirements).\195\ These
recordkeeping and notification requirements are directly linked to the
capital requirements of Exchange Act rule 18a-1. The proposed Order
conditioned substituted compliance with respect to these recordkeeping
and notification requirements on the Covered Entity applying
substituted compliance with respect to Exchange Act rule 18a-1.\196\
This additional capital condition is designed to provide clarity as to
the Covered Entity's obligations under these recordkeeping and
notification requirements when applying substituted compliance with
respect to Exchange Act rule 18a-1 pursuant this Order.
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\195\ See para. (c)(1)(ii) of the Order.
\196\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18395-18403, 18416-17, 19419.
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The second additional capital condition builds on and modifies the
proposed capital condition that was designed to address potential
different regulatory outcomes between Exchange Act rule 18a-1and the UK
capital requirements. In particular, the Commission proposed a four
pronged condition with respect to applying substituted compliance to
the capital requirements of Exchange Act rule 18a-1.\197\ The first
prong would require a Covered Entity to maintain an amount of assets
that are allowable under Exchange Act rule 18a-1, after applying
applicable haircuts under the Basel capital standard, that equals or
exceeds the Covered Entity's current liabilities coming due in the next
365 days.\198\ The second prong was linked to the first prong as it
would require that a Covered Entity make a quarterly record listing:
(1) The assets maintained pursuant to the first prong, their value, and
the amount of their applicable haircuts; and (2) the aggregate amount
of the liabilities coming due in the next 365 days. The third prong
would require the Covered Entity to maintain at least $100 million of
equity capital composed of highly liquid assets as defined in the Basel
capital standard. The fourth prong would require the Covered Entity to
include its most recently filed statement of financial condition
whether audited or unaudited with its initial notice to the Commission
of its intent to rely on substituted compliance.
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\197\ See UK Substituted Compliance Notice and Proposed Order,
86 FR at 18387-89 (discussing the additional conditions).
\198\ As used in this part V.B.1. of the release, the term
``Covered Entity'' refers to a security-based swap dealer located in
the UK that does not have a prudential regulator.
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One commenter recommended that the Commission consider denying
substituted compliance for capital requirements on the basis that the
UK's capital requirements do not produce comparable regulatory
outcomes.\199\ This commenter stated that ``granting substituted
compliance with multiple conditions intended to mimic the Commission's
capital requirements would seem to undermine the entire point of
substituted compliance in the first place; namely, protecting the
stability of the U.S. financial system by allowing substituted
compliance only
[[Page 43339]]
when foreign regimes are comparable.'' \200\
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\199\ See Better Markets Letter at 8.
\200\ Better Markets Letter at 8 (emphasis in the original).
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In describing the differences in the capital frameworks between the
net liquid assets test and the Basel capital standard, this commenter
highlighted the treatment of initial margin posted to a
counterparty.\201\ Specifically, the commenter stated that in the UK
initial margin posted to a counterparty counts as capital for that
entity, while in the U.S. initial margin only counts as capital if the
security-based swap dealer has a special loan agreement with an
affiliate. The commenter stated that the U.S. requirement is intended
to mitigate counterparty credit risk with respect to the return of the
initial margin. The commenter argued that the result is that, not only
are the UK requirements different from the Commission's in both form
and substance, but the regulatory outcome is not comparable.
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\201\ Better Markets Letter at 7.
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This commenter also stated that if a positive substituted
compliance determination is made regarding capital, the Commission
should not weaken the proposed additional capital condition in response
to industry commenters, because these market participants are primarily
concerned with reducing their own operational costs, without any regard
to the systemic risk that would doing so would pose.\202\ This
commenter also stated that any determination to find the UK's capital
requirements comparable to and as comprehensive as the Commission's
capital framework without conditions at least as strong as proposed
would not only contravene the Commission's own conception of
substituted compliance ``but expose the U.S. financial system to very
risks Dodd-Frank instructed the SEC to contain.'' \203\
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\202\ Better Markets Letter at 7-8.
\203\ Better Markets Letter at 7-8.
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Another commenter supported the proposed additional capital
condition.\204\ This commenter stated that the Commission should
require Covered Entities to comply with the net liquid assets test
under Exchange Act rule 18a-1, rather than the Basel capital
standards.\205\ The commenter stated that the net liquid assets test
``appropriately limits uncollateralized lending, fixed assets, and
other illiquid assets such as real estate which have been proven
repeatedly to be unreliable forms of capital but are currently
counted'' as allowable capital under the Basel capital standard.\206\
This commenter also agreed with the Commission that ``the initial
margin that is posted is not available for other purposes and
therefore, under the Basel standard, could swiftly result in less
balance sheet liquidity than the standards under the Exchange Act's
Rule 18a-1.'' \207\
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\204\ See Letter from Americans for Financial Reform Education
Fund (May 3, 2021) (``Americans for Financial Reform Education Fund
Letter'') at 1.
\205\ See Americans for Financial Reform Education Fund Letter
at 1 (``We support the Commission's proposal to require foreign
security-based swap dealers and participants (``Covered Entities'')
to abide by capital and initial margin requirements that reflect
Exchange Act rule 18a-1 standards appropriate for broker-dealers, as
opposed to Basel capital requirements for banks that permit illiquid
assets to count toward capital minimums.'').
\206\ See Americans for Financial Reform Education Fund Letter
at 1.
\207\ See Americans for Financial Reform Education Fund Letter
at 2.
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A commenter supported the Commission's proposed Order to grant
substituted compliance in connection with the Exchange Act capital
requirements.\208\ This commenter, however, opposed the proposed
additional four pronged capital condition. The commenter stated that it
was unnecessary, unduly rushed, and highly likely to be costly and
disruptive to market participants and inconsistent with the
Commission's substituted compliance framework.\209\ More specifically,
this commenter stated that the proposed capital condition was
unnecessary because Covered Entities transact predominantly in
securities and derivatives, do not extensively engage in unsecured
lending or other activities more typical of banks, and are already
subject to extensive liquidity requirements.\210\ The commenter also
expressed concern that the proposed capital condition was inconsistent
with the Commission's substituted compliance framework in that it was
duplicative of and would contradict the liquidity requirements
established by the PRA.\211\ This commenter stated that the imposition
of the proposed capital condition would effectively substitute the
Commission's judgment for the PRA's in terms of the best way to address
liquidity risk, and may lead other regulators to refuse to extend
deference to the Commission's regulatory determinations.\212\
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\208\ SIFMA 5/3/2021 Letter at 10.
\209\ SIFMA 5/3/2021 Letter at 10, 17.
\210\ SIFMA 5/3/2021 Letter at 10-15.
\211\ SIFMA 5/3/2021 Letter at 15.
\212\ SIFMA 5/3/2021 Letter at 15-17.
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With respect to the using the concept of ``allowable'' and
``nonallowable'' assets under Exchange Act rule 18a-1, the commenter
stated that the first and second prongs of the capital condition do not
define these terms and there is no analogous concept in the capital
framework applicable in the UK.\213\ The commenter stated this would
require firms to re-categorize every asset on their balance sheets,
which would not be feasible in the near term.\214\ Further, this
commenter asked the Commission to clarify what it means by ``haircuts''
with respect to the first and second prongs, since the Basel capital
standard does not apply ``haircuts'' to assets, but instead applies a
risk-weighted approach.\215\
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\213\ SIFMA 5/3/2021 Letter at 17.
\214\ SIFMA 5/3/2021 Letter at 17.
\215\ SIFMA 5/3/2021 Letter at 17-18.
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This commenter also stated that the third prong of the proposed
additional capital condition requiring ``at least $100 million of
equity capital composed of `highly liquid assets' as defined in the
Basel capital standard,'' includes concepts that require
clarification.\216\ For example, this commenter stated that is unclear
how a firm would calculate the amount of its ``equity capital'' that is
``composed of highly liquid assets,'' since ``equity'' generally refers
to a firm's paid-in capital, retained earnings, and other items on the
liabilities/shareholders' equity side of the balance sheet.\217\
Finally, this commenter asserted that because it is approximately three
months until the August 6th counting date, and firms may encounter
significant operational challenges to meet the proposed or revised
capital condition, the proposed condition may cause firms to exit the
U.S. security-based swap market, or hope that the conditions are
modified and delayed in a manner that will make it feasible to satisfy
them.\218\
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\216\ SIFMA 5/3/2021 Letter at 18.
\217\ SIFMA 5/3/2021 Letter at 18.
\218\ SIFMA 5/3/2021 Letter at 19.
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Overall, this commenter stated that the Commission should take a
more incremental and deliberative approach to additional capital
conditions, and specifically recommended that the Commission: (1)
Delete the first prong of the capital condition; (2) replace the second
prong with a requirement that a nonbank Covered Entity provide the same
reports concerning liquidity metrics that the Covered Entity provides
to the PRA; (3) modify the third prong to require a nonbank Covered
Entity to maintain at least $100 million of high quality liquid assets,
as defined in the Basel capital standard; and (4) issue an order o
[…truncated; see source link]Indexed from Federal Register on August 6, 2021.
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