Notice2021-17644
Notice of Application for the Amendment of Substituted Compliance Determination Regarding Security-Based Swap Entities Subject to Regulation in the Federal Republic of Germany; Proposed Amendments to Order
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Published
August 18, 2021
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("Commission") is soliciting public comment on an application by the Bundesanstalt f[uuml]r Finanzdienstleistungsaufsicht ("BaFin"), pursuant to rule 3a71-6 under the Securities Exchange Act of 1934 ("Exchange Act"), requesting that the Commission amend an existing substituted compliance Order for Germany to extend the Order to nonbank capital and margin requirements (the "Amended Application"). The Commission also is soliciting comment on proposed amendments to the Order and is proposing to amend and restate the Order (the "proposed Amended Order").
Full Text
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<title>Federal Register, Volume 86 Issue 157 (Wednesday, August 18, 2021)</title>
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[Federal Register Volume 86, Number 157 (Wednesday, August 18, 2021)]
[Notices]
[Pages 46500-46534]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-17644]
[[Page 46499]]
Vol. 86
Wednesday,
No. 157
August 18, 2021
Part IV
Securities and Exchange Commission
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Notice of Application for the Amendment of Substituted Compliance
Determination Regarding Security-Based Swap Entities Subject to
Regulation in the Federal Republic of Germany; Proposed Amendments to
Order; Notice
Federal Register / Vol. 86 , No. 157 / Wednesday, August 18, 2021 /
Notices
[[Page 46500]]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-92647; File No. S7-08-21]
Notice of Application for the Amendment of Substituted Compliance
Determination Regarding Security-Based Swap Entities Subject to
Regulation in the Federal Republic of Germany; Proposed Amendments to
Order
August 12, 2021.
AGENCY: Securities and Exchange Commission.
ACTION: Notice of application for amended substituted compliance
determination; proposed amendments to order.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
soliciting public comment on an application by the Bundesanstalt
f[uuml]r Finanzdienstleistungsaufsicht (``BaFin''), pursuant to rule
3a71-6 under the Securities Exchange Act of 1934 (``Exchange Act''),
requesting that the Commission amend an existing substituted compliance
Order for Germany to extend the Order to nonbank capital and margin
requirements (the ``Amended Application''). The Commission also is
soliciting comment on proposed amendments to the Order and is proposing
to amend and restate the Order (the ``proposed Amended Order'').
DATES: Submit comments on or before September 13, 2021.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#4a383f262f67292527272f243e390a392f29642d253c"><span class="__cf_email__" data-cfemail="dfadaab3baf2bcb0b2b2bab1abac9facbabcf1b8b0a9">[email protected]</span></a>. Please include
File Number S7-08-21 on the subject line.
Paper Comments
<bullet> Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.
All submissions should refer to File Number S7-08-21. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (<a href="http://www.sec.gov/rules/other.shtml">http://www.sec.gov/rules/other.shtml</a>).
Typically, comments are also available for website viewing and printing
in the Commission's Public Reference Room, 100 F Street NW, Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Due to pandemic conditions, however, access to the
Commission's public reference room is not permitted at this time. All
comments received will be posted without change. Persons submitting
comments are cautioned that the Commission does not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make publicly available.
FOR FURTHER INFORMATION CONTACT: Carol M. McGee, Assistant Director, at
202-551-5870, Office of Derivatives Policy, Division of Trading and
Markets, Securities and Exchange Commission, 100 F Street NE,
Washington, DC 20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is soliciting public comment
on the Amended Application. The Commission also is proposing to amend
and restate the Order in certain other ways, and is soliciting comment
on the proposed Amended Order set forth in Attachment A.
I. Introduction
Rule 3a71-6 under the Exchange Act provides a framework whereby
non-U.S. security-based swap dealers and major security-based swap
participants (``SBS Entities'') may satisfy certain requirements under
Exchange Act section 15F by complying with comparable regulatory
requirements of a foreign jurisdiction. Substituted compliance is
intended to promote efficiency and competition within the security-
based swap market by helping to address potential duplication and
inconsistency between relevant U.S. and foreign requirements, making it
possible for SBS Entities to leverage their existing systems and
practices to comply with relevant Exchange Act requirements in
conjunction with their compliance with relevant foreign
requirements.\1\
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\1\ Exchange Act Release No. 90765 (Dec. 22, 2020), 85 FR 85686,
85687 (Dec. 29, 2020) (``Order'').
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Pursuant to rule 3a71-6, in December 2020 the Commission issued a
substituted compliance Order to provide that German SBS Entities may
use substituted compliance with conditions to satisfy certain
requirements under the Exchange Act related to risk control, internal
supervision and compliance, counterparty protection, and books and
records.\2\ That Order (and the underlying application from BaFin) did
not address substituted compliance for Exchange Act capital and margin
requirements applicable to SBS Entities without a prudential
regulator.\3\
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\2\ Id. at 85689-97.
\3\ Section 15F(e)(1)(B) of the Exchange Act provides that SBS
Entities for which there is not a prudential regulator shall meet
such minimum capital requirements and minimum initial and variation
margin requirements as the Commission shall by rule or regulation
prescribe. The term ``prudential regulator'' is defined in Section
1(a)(39) of the Commodity Exchange Act (7 U.S.C. 1(a)(39)) and that
definition is incorporated by reference in Section 3(a)(74) of the
Exchange Act. Pursuant to the definition, the Board of Governors of
the Federal Reserve System (``Federal Reserve''), the Office of the
Comptroller of the Currency (``OCC''), the Federal Deposit Insurance
Corporation (``FDIC''), the Farm Credit Administration, or the
Federal Housing Finance Agency is the ``prudential regulator'' of an
SBS Entity if the entity is directly supervised by that agency. The
Commission adopted Exchange Act rules 18a-1 through 18a-1d (capital)
and 18a-3 (margin) pursuant to Section 15F(e)(1)(B) of the Exchange
Act. See Exchange Act Release No. 86175 (June 21, 2019) 84 FR 43872,
43879 (Aug. 22, 2019) (``Capital and Margin Adopting Release'').
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In the Commission's preliminary view, certain developments warrant
modifications to the substituted compliance Order for Germany. First,
since finalizing the Order, the Commission has finalized substituted
compliance orders for SBS Entities subject to regulation in the French
Republic (``France'') \4\ and the United Kingdom (``UK'').\5\ When
finalizing the French and UK Orders, the Commission had the benefit of
additional public comment, some of which also referenced the Order.\6\
Particularly given
[[Page 46501]]
substantial similarity of the three regimes, the Commission believes
that modifications to the Order may be necessary for consistency. The
Commission is therefore proposing to amend the Order to align with the
French and UK orders where appropriate.
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\4\ Exchange Act Release No. 92494 (July 23, 2021], 86 FR 41612
(Aug. 2, 2021) (``French Order''). See also Exchange Act 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) (``Reopening
Release'').
\5\ Exchange Act Release No. 92529 (July 30, 2021), 86 FR 43318
(August 6, 2021) (``UK Order''). See also Exchange Act Release No.
91476 (Apr. 5, 2021), 86 FR 18378 (Apr. 8, 2021) (``UK Substituted
Compliance Notice and Proposed Order'').
\6\ See, e.g., Letter from Kyle Brandon, Managing Director, Head
of Derivative Policy, SIFMA (Jan. 25, 2021) (``SIFMA Letter I'');
Letter from Wim Mijs, Chief Executive Officer, European Banking
Federation (Jan. 25, 2021) (``EBF Letter I'') (generally supporting
the SIFMA Letter I); Letter from Etienne Barel, Deputy Chief
Executive Officer, French Banking Federation (Jan. 25, 2021) (``FBF
Letter I''), Letter from Kyle Brandon, Managing Director, Head of
Derivative Policy, SIFMA (May 3, 2021) (``SIFMA Letter II''); Letter
from Wim Mijs, Chief Executive Officer, European Banking Federation
(May 3, 2021) (``EBF Letter II''); Letter from Etienne Barel, Deputy
Chief Executive Officer, French Banking Federation (May 3, 2021)
(``FBF Letter II''); Letter from Americans for Financial Reform
Education Fund (May 3, 2021) (``AFREF Letter''); 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''). Comments
may be found on the Commission's website at: <a href="https://www.sec.gov/comments/s7-22-20/s72220.htm">https://www.sec.gov/comments/s7-22-20/s72220.htm</a>.
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Moreover, BaFin's Amended Application requests that the Commission
extend the Order to also provide for substituted compliance for the
capital requirements of Exchange Act Section 15F(e) and Exchange Act
rules 18a-1 through 18a-1d (collectively, ``Exchange Act Rule 18a-1''),
the margin requirements Exchange Act Section 15F(e) and Exchange Act
rule 18a-3, and related recordkeeping, reporting, notification, and
securities count requirements.\7\ As discussed in parts IV and VII
below, the Commission is proposing to amend the Order to conditionally
permit German SBS Entities to comply with these requirements via
substituted compliance.\8\
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\7\ Letter from Thorsten P[ouml]tzsch, Chief Executive Director
of BaFin's Resolution Sector, BaFin, to Vanessa Countryman,
Secretary, Commission, dated August 12, 2021. The Amended
Application is available on the Commission's website at: <a href="https://www.sec.gov/page/exchange-act-substituted-compliance-and-listed-jurisdiction-applications-security-based-swap">https://www.sec.gov/page/exchange-act-substituted-compliance-and-listed-jurisdiction-applications-security-based-swap</a>.
\8\ The Amended Application requests substituted compliance with
respect to investment firms and credit institutions that are
authorized by BaFin to provide investment services or perform
investment activities in Germany and are supervised by the ECB (or
have a licensing application pending with the ECB as of the date of
this application letter) as a significant institution. See Amended
Application at 1. As such, the Commission is proposing to amend the
definition of Covered Entity to conform to the request and the
information provided. See para. (g)(1)(iii).
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II. Scope of Substituted Compliance and Additional General Conditions
A. Scope of Substituted Compliance
For entity-level Exchange Act requirements,\9\ a Covered Entity
must choose either to apply substituted compliance pursuant to the
Order with respect to all security-based swap business subject to the
relevant German and EU requirements or to comply directly with the
Exchange Act with respect to all such business; a Covered Entity may
not choose to apply substituted compliance for some of the business
subject to the relevant German or EU requirements and comply directly
with the Exchange Act for another part of the business that is subject
to the relevant German and EU requirements. Additionally, for entity-
level Exchange Act requirements, if the Covered Entity also has
security-based swap business that is not subject to the relevant German
requirements, 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.\10\ For transaction-level
Exchange Act requirements,\11\ 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.
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\9\ The entity-level requirements relate to non-bank capital and
margin, books and records (other than those linked to the
counterparty protection rules), internal risk management systems,
trade acknowledgement and verification, portfolio reconciliation,
compression, trading relationship documentation, and internal
supervision and chief compliance officer requirements See Capital
and Margin Adopting Release, 84 FR 43879; Exchange Act Release No.
87005 (June 19, 2019) 84 FR 68550, 68596 (Dec. 16, 2019) (``Books
and Records Adopting Release''); Exchange Act Release No. 78011
(June 8, 2016) 81 FR 39808, 39827 (June 17, 2016) (``TAV Adopting
Release''); Exchange Act Release No. 87782 (Dec. 18, 2019) 85 FR
6359, 6378 (Feb. 4, 2020) (``Risk Mitigation Adopting Release'');
Exchange Act Release No. 77617 (Apr. 14, 2016), 81 FR 29960, 30064
(May 13, 2016) (``Business Conduct Adopting Release''). Transaction-
level requirements encompass business conduct requirements for the
protection of counterparties, and additional provisions for the
protection of special entities. See also Business Conduct Adopting
Release, 81 FR 30065.
\10\ In the context of the EMIR counterparties condition in
para. (a)(5) of the proposed Amended Order, a Covered Entity must
choose (1) to apply substituted compliance pursuant to the Order--
including compliance with para. (a)(5) as applicable--for a
particular set of entity-level requirements with respect to all of
its business that would be subject to the relevant 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.
\11\ Transaction-level requirements are the counterparty
protection requirements and the books and records requirements
related to those counterparty protection requirements.
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B. Proposed Revision of General Condition Regarding Notice
The Commission also is proposing to modify the Order's general
condition requiring that Covered Entities provide the Commission with
written notice of their intent to rely on substituted compliance. To
promote clarity in the notice regarding the Covered Entity's intended
use of substituted compliance, the Commission is proposing to amend the
general condition to require that the notice identify each specific
substituted compliance determination for which the Covered Entity
intends to apply substituted compliance.\12\ The modification would be
consistent with the conditions for notification included in the
Commission's other substituted compliance orders.\13\
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\12\ See para. (a)(9) of the proposed Amended Order. To promote
up-to-date notice, the proposal further would require the Covered
Entity to amend the notice if it modifies the scope of its reliance
on substituted compliance. In addition, the proposal would make a
technical modification to the general condition to clarify that the
notice must be sent to the Commission in the manner specified on the
Commission's website (in lieu of the condition's current reference
to an email address specified on that website).
\13\ See French Order, 86 FR 41658; UK Order, 86 FR 43371. As
explained in the French and UK Orders, under the proposed amended
notification provision, if a Covered Entity intends to rely on all
the substituted compliance determinations in a given paragraph of
the Order, it could 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 proposed Amended Order, it
would 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 would need to indicate in the notice that it is
relying on paragraph (c)(2) of the proposed Amended Order (the
margin determination). In this case, paragraph (c)(1) of the
proposed Amended Order (the capital determination) would be excluded
from the notice and the Covered Entity would need to comply with the
Exchange Act capital requirements. Further, as discussed below in
part VII.B.1, the amended recordkeeping and reporting determinations
in the proposed Amended 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
proposed Amended Order sets forth the Commission's substituted
compliance preliminary determinations with respect to the
requirements of Exchange Act rule 18a-5, 17 CFR 240.18a-5. These
preliminary determinations are set forth in paragraphs (f)(1)(i)(A)
through (O) of the proposed Amended Order. If a Covered Entity
intends to rely on some but not all of the preliminary
determinations, it would need to identify in the notice the specific
preliminary 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 would need to comply with the Exchange Act rule 18a-5
requirement. Finally, a Covered Entity would be 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 would 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 would be 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
proposed Amended 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 proposed Amended
Order. In this case, the notice would 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 proposed Amended Order.
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[[Page 46502]]
C. Additional Condition Regarding Notification Requirements Related to
Changes in Capital
Consistent with the UK and French Orders, the Commission is
proposing to add a general condition that Covered Entities with a
prudential regulator relying on substituted compliance pursuant to the
proposed Amended Order 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 18a-
8(c).\14\ In the UK and French Orders, the Commission took a granular
approach with respect to substituted compliance determinations
regarding the Exchange Act recordkeeping, reporting, and notification
requirements. Consequently, a Covered Entity may comply directly with
certain of the Exchange Act's recordkeeping, reporting, and
notification provisions while applying substituted compliance to
others. In taking this granular approach, the Commission conditioned
substituted compliance with certain of the discrete recordkeeping,
reporting, and notification requirements on the Covered Entity applying
substituted compliance for the substantive Exchange Act requirement to
which they are linked.\15\ Further, the Commission conditioned
substituted compliance with respect to the substantive requirement on
the Covered Entity applying substituted compliance for the linked
recordkeeping, reporting, or notification requirement. These linked
conditions are 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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\14\ See para. (a)(11) of the proposed Amended Order. See also
French Order, 86 FR 41620-22; UK Order, 86 FR 43330-31.
\15\ See French Order, 86 FR 41621; UK Order, 86 FR 43330.
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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, the OCC, or
the FDIC to give notice of this fact that same day by transmitting a
copy of the notice of adjustment of reported capital category in
accordance with Exchange Act rule 18a-8(h).\16\ 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.\17\ 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, the
OCC, or the FDIC). Therefore, to implement the granular approach
adopted in the U.K. and French Orders, the Commission is proposing to
add a general condition that Covered Entities with a prudential
regulator relying on 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).
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\16\ See 17 CFR 240.18a-8(c).
\17\ See 17 CFR 240.18a-8(h).
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In its application, BaFin citied several German and EU provisions
as providing similar outcomes to the notification requirements of
Exchange Act rule 18a-8.\18\ This general condition is necessary 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 German or
EU law. In particular, absent this condition, 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, the OCC, or the FDIC, ``compliance'' with the provisions of
Exchange Act rule 18a-8(c) raises a question as to the Covered Entity's
obligations under this proposed Amended Order to provide the Commission
with notification of changes in capital.
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\18\ These German provisions include KWG section 25a(1) sentence
6 no. 3, and FinDAG section 4d, which provide, among other things,
processes for employees to report breaches of certain EU
regulations, and the establishment of systems by BaFin to accept
reports of potential or actual violations of laws, ordinances,
general rulings, and regulations and directives of the EU.
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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.\19\ 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 proposed Amended 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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\19\ See Exchange Act Release No. 71958 (Sept. 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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D. Proposed Amendment to General Condition Regarding EU Cross-Border
Matters
The Commission also is proposing to modify the Order's general
condition related to EU cross-border matters. Substituted compliance
under the Order in part is predicated on BaFin being responsible for
the supervision and enforcement of Covered Entities in connection with
certain MiFID provisions that constitute conditions to individual
substituted compliance provisions.\20\ That general condition is
intended to help ensure that the prerequisites to substituted
compliance with respect to supervision and enforcement are satisfied in
practice when MiFID allocates responsibility for ensuring compliance to
another EU Member State. Because MiFIR is subject to similar allocation
provisions,\21\ the Commission is proposing to incorporate references
to MiFIR requirements into the general condition.\22\ This change would
be consistent with the French Order.\23\
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\20\ See part III.A, infra.
\21\ See MiFID art. 35(8) (in part allocating responsibility
over MiFIR articles 14 to 26 to competent authorities in member
states in which branches are located).
\22\ See article (a)(10) of the proposed Amended Order.
\23\ See para. (a)(10) of the French Order.
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E. Additional MOU-Related General Condition
In light of the Amended Application, the Commission also is
proposing to add a new general condition that would predicate
substituted compliance on the presence of a supervisory and enforcement
memorandum of understanding between the Commission and the European
Central Bank (``ECB'')
[[Page 46503]]
and/or BaFin, pertaining to information owned by the ECB.\24\ The
Commission's access to this ECB information will assist the
Commission's effective oversight of Covered Entities that use
substituted compliance in connection with capital and margin
requirements.
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\24\ See para. (a)(8) of the proposed Amended Order.
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III. Proposed Changes to Risk Control and Internal Supervision
A. Background--Order's MiFID Prerequisites Related to Trade
Acknowledgment and Verification and Trading Relationship Documentation
Under the Order, substituted compliance for trade acknowledgement
and verification and for trading relationship documentation in part
requires that relevant SBS Entities (``Covered Entities'' as defined in
the Order) comply with certain requirements under MiFID (plus the
German implementation of MiFID) and with certain requirements under
EMIR.\25\ Commenters expressed concern that the interplay between those
particular MiFID conditions and a separate EU cross-border condition to
the Order in practice would preclude the availability of substituted
compliance for entities that have branches in other EU Member
States.\26\
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\25\ See paras. (b)(2) and (b)(5) of the proposed Amended Order.
\26\ See SIFMA Letter I at 3-6 (commenting on the French
Substituted Compliance Notice and Proposed Order but stating that
the concerns applied equally to the German Order). In relevant part,
the cross-border condition of paragraph (a)(10) of the proposed
Amended Order states that if responsibility for ensuring compliance
with any provision of MiFID or MiFIR (or EU or German implementing
requirement) that is a condition for substituted compliance is
allocated to an authority in a Member State of the EU in whose
territory a Covered Entity provides a service, BaFin must be the
authority responsible for supervision and enforcement of that
provision. In practice (pursuant to MiFID article 35), this
allocation of oversight applies to requirements pursuant to MiFID
article 25 (``assessment of suitability and appropriateness and
reporting to clients'') as well as certain other MiFID provisions
not relevant here. In the commenter's view, application of those
MiFID article 25 conditions in connection with trade acknowledgment
and verification requirements and trading relationship documentation
requirements would ``in practice lead to an untenable patchwork of
substituted compliance.'' See SIFMA Letter I at 3. The commenter
further states that SBS Entities ``operating branches throughout the
EU'' would not be able to avail themselves of substituted compliance
in connection with these requirements ``unless authorities or
regulated SBS Entities in every or nearly every one of the 27 EU
Member States submit their own substituted compliance applications
covering local branches of SBS Entities, and the Commission reviews
and responds to those applications and enters into memoranda of
understanding . . . with authorities in each of these Member
States.'' That problem does not arise in connection with
requirements under EMIR, which does not allocate oversight of a
German entity's compliance to authorities in other EU Member States.
That problem also does not arise in connection with other
requirements under MiFID (e.g., MiFID art. 16 organizational
provisions) that are not subject to the same allocation of
oversight.
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The commenters requested that the Commission remove those
particular MiFID conditions, arguing that compliance with EMIR
conditions standing alone still would produce regulatory outcomes
comparable to those of the trade acknowledgement and verification
requirement and the trading relationship documentation requirement
under the Exchange Act.\27\
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\27\ See SIFMA letter I at 5-6.
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After careful consideration, the Commission is proposing to amend
the Order to address those concerns and for consistency with the French
Order. The Order's EU cross-border condition provides an important
safeguard to help ensure that firms that avail themselves of
substituted compliance are subject to appropriate regulatory
supervision and enforcement. At the same time, the Commission
recognizes the significance of commenter concerns that the interplay
between the EU cross-border condition and the MiFID conditions
associated with trade acknowledgment and verification and with trading
relationship documentation could have the effect of unnecessarily
interfering with the use of substituted compliance when other
provisions standing alone are sufficient for the Commission to make a
positive substituted compliance determination.\28\ As discussed below,
the Commission is proposing to revise the Order's conditions related to
trade acknowledgment and verification and to trading relationship
documentation, by removing MiFID-related conditions and instead relying
solely on EMIR conditions to establish comparability for those
requirements.
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\28\ SBS Entities subject to regulation in France are subject to
the condition, and the proposed change would be consistent with the
French Order. See para. (a)(10) of the French Order. The Commission
addressed certain of the other issues raised by commenters when
extending the comment period for the French Substituted Compliance
Notice and Proposed Order. See Reopening Release, 86 FR 18341
(discussing commenter concerns regarding the scope of reliance on
substituted compliance and the EU cross-border condition).
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B. Proposed Addition of EMIR-Related General Conditions
The proposed amendments addressed below would remove MiFID
conditions and rely solely on EMIR conditions to establish
comparability in connection with trade acknowledgment and verification
and trading relationship documentation. This heightened reliance on
EMIR highlights the need for safeguards to help ensure that there will
be no opportunity for gaps that may prevent the EMIR provisions in
practice from producing outcomes consistent with those of the Exchange
Act rules. The Commission accordingly is proposing to add two EMIR-
related general conditions to the Order to help preclude such gaps.\29\
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\29\ The proposed addition of two new EMIR-related general
conditions as paragraphs (a)(5) and (a)(6) of the proposed Amended
Order would necessitate renumbering of certain of the extant general
conditions, and also suggests the need to clarify the captions for
certain of the other proposed general conditions (e.g., recaptioning
proposed general conditions (a)(1) through (a)(3) of the proposed
Amended Order to specifically refer to MiFID, and recaptioning of
proposed general condition (a)(4) to specifically refer to CRD/CRR).
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The first condition provides that the Covered Entity must comply
with the applicable condition of the proposed Amended Order as if the
counterparty were the type of counterparty that would trigger the
application of the relevant EMIR-based requirements. If the Covered
Entity reasonably determines that its counterparty would be a financial
counterparty \30\ if not for the counterparty's location and/or lack of
regulatory authorization in the EU, 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 EMIR-based requirements may apply.\31\ By requiring
a Covered Entity to treat its counterparty as a type of counterparty
that would trigger the application of the relevant EMIR-based
requirements, the condition will require the Covered Entity to perform
the relevant obligations pursuant to those EMIR-based requirements and
thus to act in a way that is comparable to Exchange Act
requirements.\32\
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\30\ 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 EU law. Under 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 EMIR RTS article
12.
\31\ See para. (a)(5) of the proposed Amended Order.
\32\ In other words, the Covered Entity would be subject to the
relevant requirements under EMIR even if the counterparty is not an
``undertaking'' (such as by virtue of being a natural person), or is
not established in the EU (by virtue of being a U.S. person or
otherwise being established in some non-EU jurisdiction). The issue
of whether the Covered Entity must treat the counterparty as a
``financial counterparty'' or ``non-financial counterparty'' would
turn on whether the counterparty's business would require that it be
registered pursuant to the categories identified in the EMIR article
2(8) ``financial counterparty'' definition (e.g., an authorized
investment firm, credit institution, insurance undertaking) were the
counterparty subject to the applicable authorization requirements.
This approach generally appears to be consistent with European
guidance. 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)'' (<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>) answer 5(a)
(stating that compliance with the EMIR confirmation requirement
necessitates that the counterparties must reach a legally binding
agreement to all terms of the OTC derivative contract, and that the
EMIR RTS ``implies'' that both parties must comply and agree in
advance to a specific process to do so); answer 12(b) (stating that
where an EU counterparty transacts with a third country entity, the
EU counterparty generally must ensure that the EMIR requirements for
portfolio reconciliation, dispute resolution, timely confirmation
and portfolio compression are met for the relevant portfolio and/or
transactions even though the third country entity would not itself
be subject to EMIR; this is subject to special processes when the
European Commission has declared the third country requirements to
be comparable to EU requirements).
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[[Page 46504]]
In addition, the Commission is proposing to revise the Order to
account for the fact that the relevant trade acknowledgement and
verification and trading relationship documentation rules under the
Exchange Act do not apply to security-based swaps cleared by a clearing
agency registered with the Commission (or exempt from registration),
while the analogous EMIR provisions exclude instruments that are
cleared by a central counterparty that has been authorized or
recognized to clear derivatives contracts in the EU. In particular--to
help ensure that substituted compliance is available in connection with
an instrument that has been cleared at an EU-authorized or EU-
recognized central counterparty (and hence is not within the Exchange
Act rule's exclusion but also is not subject to relevant EMIR
requirements)--the Commission is proposing a new general condition
that, for each part of the Order that requires compliance with EMIR-
related requirements, either: (i) The relevant security-based swap is
an ``OTC derivative'' or ``OTC derivative contract,'' as defined in
EMIR article 2(7), that has not been cleared by a central counterparty
and otherwise is subject to the provisions of EMIR article 11, EMIR RTS
articles 11 through 15, and EMIR Margin RTS article 2; or (ii) the
relevant security-based swap has been cleared by a central counterparty
that has been authorized or recognized to clear derivatives contracts
by a relevant authority in the EU.\33\
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\33\ See para. (a)(6) of the proposed Amended Order. Prong (i)
to this proposed condition would be satisfied by uncleared
instruments that fall within the ambit of the EMIR requirements at
issue. The alternative prong (ii) would be satisfied when
instruments fall outside the ambit of those EMIR requirements by
virtue of being cleared in the EU, akin to the Exchange Act rules'
exclusion for security-based swaps cleared by clearing agencies
registered with the Commission.
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C. Proposed Revisions to Conditions Related to Trade Acknowledgment and
Verification, and Trading Relationship Documentation
Consistent with the French Order \34\ the Commission is proposing
to modify the Order to remove the existing MiFID conditions to
substituted compliance for trade acknowledgment and verification.
Substituted compliance instead would be conditioned solely on
compliance with the confirmation provisions of EMIR article 11(1)(a)
and EMIR RTS article 12.\35\ Those EMIR provisions promote comparable
risk control goals as the Exchange Act rule by providing for definitive
written records of transactions. While the Commission recognizes that
MiFID confirmation requirements also help to promote that goal, the
Commission preliminarily believes that the EMIR provisions alone are
sufficient for regulatory comparability, and recognizes that in
practice the interplay between the EU cross-border condition and MiFID
confirmation requirements may unnecessarily limit the use of
substituted compliance and its associated efficiency benefits.
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\34\ See para. (b)(2) of the French Order.
\35\ See para. (b)(2) of the proposed Amended Order.
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The Commission similarly is proposing to modify the Order to remove
the existing MiFID conditions to substituted compliance for trading
relationship documentation, and also to add the above EMIR confirmation
provisions (reflecting that the Exchange Act trading relationship
documentation rule requires that the necessary documentation include
trade acknowledgments and verifications \36\). Together with EMIR
Margin RTS article 2 provisions that address 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), the EMIR conditions promote
comparable risk mitigation purposes as the trading relationship
documentation rule under the Exchange Act by promoting certainty
regarding the relevant framework governing the counterparties. Here
too, while the Commission recognizes that MiFID documentation
requirements also promote that goal, the Commission preliminarily
believes the EMIR provisions alone are sufficient for regulatory
comparability, and recognizes that in practice the interplay between
the EU cross-border condition and MiFID documentation provisions may
limit the use of substituted compliance and its associated regulatory
benefits.\37\
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\36\ See Exchange Act rule 15Fi-5(b)(2).
\37\ These proposed changes are consistent with the French
Order. See paras. (a)(5) and (a)(6) of the French Order.
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D. Proposed Revisions to Internal Risk Management and Internal
Supervision
The Commission is also proposing to incorporate--as part of the
relevant conditions in paragraph (b)(1) of the proposed Amended Order
relating to internal risk management--MiFID articles 16 and 23 and the
related implementing provisions, MiFID Org Reg articles 25 through 37,
72 through 76 and Annex IV, as well as CRD articles 88(1), 91(1)-(2)
and (7)-(9) and the related implementing provisions.\38\ 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 and were part of the Commission's
comparability determination for entities subject to regulation in
France. The Commission is also incorporating CRR articles 286-88 and
293 and EMIR Margin RTS article 2 to the conditions of paragraph (d)(3)
of the proposed Amended Order relating to internal supervision.\39\
These provisions relate to counterparty credit risk and risk management
generally and collateral-related risk management procedures and were
also part of the Commission's comparability analysis in the French
Order.\40\ Also consistent with the French Order, the Commission is
proposing to delete CRD article 93 and the related implementing
provisions from both paragraph (d)(1) and (d)(3), as those provisions
relate to remuneration policies for institutions that benefit from
exceptional (German and EU) government intervention. \41\
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\38\ See para. (b)(1) of the proposed Amended Order.
\39\ See para. (d)(3) of the proposed Amended Order.
\40\ See paras. (b)(1) and (d)(3) of the French Order.
\41\ See paras. (b)(1) and (d)(3) of the proposed Amended Order.
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IV. Proposed Substituted Compliance in Connection With Capital and
Margin
A. BaFin's Request and Associated Analytic Considerations
The Amended Application in part requests substituted compliance in
connection with requirements under the Exchange Act relating to:
[[Page 46505]]
<bullet> Capital--Capital requirements pursuant to Exchange Act
section 15F(e) and Exchange Act rule 18a-1 and 18a-1a through 18a-1d
applicable to certain SBS Entities.\42\ 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.\43\ 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.\44\ 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 Rule
15c3-4 with respect to certain activities.\45\
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\42\ 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).
\43\ See Capital and Margin Adopting Release, 84 FR 43947. The
Amended Application discusses EU and German requirements that
address firms' capital requirements. See Amended Application Annex A
category 3 (Side Letter Addressing Capital Requirements). See also
Amended Application Annex A category 4 (Internal Risk Management
Requirements) (generally discussing internal risk management
requirements).
\44\ See Capital and Margin Adopting Release, 84 FR 43879-83.
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. Id. 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 id. at
43879. See Amended Application Annex A category 3 (Side Letter
Addressing Capital Requirements).
\45\ 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.\46\ The margin requirements are designed to
protect SBS Entities from the consequences of a counterparty's
default.\47\
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\46\ 17 CFR 240.18a-3.
\47\ See Capital and Margin Adopting Release, 84 FR 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'').
The Amended Application discusses EU and German requirements that
address firms' margin requirements. See Amended Application Annex A
category 4 (Margin Requirements for Nonbank Firms).
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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. The Commission's comparability assessment
accordingly focuses on whether the analogous foreign requirements--
taken as a whole--produce comparable outcomes with regard to providing
that Covered Entities follow capital and margin requirements that
address the risks associated with their security-based swap businesses.
B. Capital--Preliminary Views and Proposed Amended Order
In the Commission's preliminary view, based on the Amended
Application and the Commission's review of applicable provisions,
additional conditions on applying substituted compliance with respect
to the Exchange Act capital requirements are necessary in order to
produce comparable regulatory outcomes. Consequently, substituted
compliance with respect to the capital requirements of Exchange Act
rule 18a-1 would be conditioned on Covered Entities being subject to
and complying with relevant EU and German capital requirements.\48\
However, the proposed Amended Order would include the additional
conditions discussed below that, in the aggregate, would be designed to
establish a framework that produces outcomes comparable to those
associated with the capital requirements of Exchange Act rule 18a-1.
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\48\ In connection with capital requirements, Covered Entities
must comply with: CRR, Part One (General Provisions) Article 6(1),
Part Two (Own Funds), Part Three (Capital Requirements), Part Four
(Large Exposures), Part Five (Exposures to Transferred Credit Risk),
Part Six (Liquidity), and Part Seven (Leverage); MiFID Org Reg
article 23; BRRD articles 45(6) and 81(1); CRD articles 73, 79, 86,
129, 129(1), 130, 130(1), 130(5), 131, 133, 133(1), 133(4), 141, and
142(1) and (2); EMIR Margin RTS articles 2, 3(b), 7, and 19(1)(d)
and (e), (3) and (8); KWG sections 10b-10h, 10i(2)-(9), 25a(1)
sentence 3 no. 2 and no. 3b), 33(1) sentence 1c),; SAG section
49(2), 49d, 62(1), 138(1); and SolvV section 37. See para. (c)(1)(i)
of the proposed Amended Order.
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The first additional capital condition would require that the
Covered Entity apply 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 relating to
capital).\49\ These recordkeeping and notification requirements are
directly linked to the capital requirements of Exchange Act rule 18a-1.
As discussed below in part VII.B.1 of this release, the proposed
Amended Order conditions 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.\50\ This proposed capital condition would do the reverse: Condition
substituted compliance with respect to Exchange Act rule 18a-1 on the
Covered Entity applying substituted compliance for these linked
recordkeeping and notification requirements. 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 the proposed Amended Order.
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\49\ See para. (c)(1)(ii) of the proposed Amended Order. This
additional condition is included in the French and UK Orders. See
French Order, 86 FR 41659; UK Order, 86 FR 43372.
\50\ See paras. (f)(1)(i)(J), (f)(2)(i)(J), and (f)(4)(i)(A) of
the proposed Amended Order.
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The second additional capital condition would be designed to ensure
comparable regulatory outcomes between the standard of Exchange Act
rule 18a-1 and the capital standard of the relevant EU and German laws,
which is based on the international capital standard for banks (the
``Basel capital standard'').\51\ In particular, the capital standard of
Exchange Act rule 18a-1 is the net liquid assets test. This is the same
capital standard that applies to broker-dealers under Exchange Act rule
15c3-1.\52\ The net liquid assets test
[[Page 46506]]
is designed to promote liquidity.\53\ In particular, Exchange Act rule
18a-1 allows an SBS Entity to engage in activities that are part of
conducting a securities business (e.g., taking securities into
inventory) but in a manner that places the firm in the position of
holding at all times more than one dollar of highly liquid assets for
each dollar of unsubordinated liabilities (e.g., money owed to
customers, counterparties, and creditors).\54\ For example, Exchange
Act rule 18a-1 allows securities positions to count as allowable net
capital, subject to standardized or internal model-based haircuts. The
rule, however, does not permit most unsecured receivables to count as
allowable net capital. This aspect of the rule severely limits the
ability of SBS Entities to engage in activities, such as
uncollateralized lending, that generate unsecured receivables. The rule
also does not permit fixed assets or other illiquid assets to count as
allowable net capital, which creates disincentives for SBS Entities to
own real estate and other fixed assets that cannot be readily converted
into cash. For these reasons, Exchange Act rule 18a-1 incentivizes SBS
Entities to confine their business activities and devote capital to
security-based swap activities.
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\51\ See note 48, supra (citing EU and German capital
requirements under the CRR). See also 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>.
\52\ See, e.g., Capital and Margin Adopting Release, 84 FR 43881
(``The Commission believes that the broker-dealer capital standard
is the most appropriate alternative for nonbank SBSDs, given the
nature of their business activities and the Commission's experience
administering the standard with respect to broker-dealers. The
objective of the broker-dealer capital standard is to protect
customers and counterparties and to mitigate the consequences of a
firm's failure by promoting the ability of these entities to absorb
financial shocks and, if necessary, to self-liquidate in an orderly
manner.'').
\53\ See id. (``Consequently, in the Commission's judgment, the
broker-dealer capital standard is the appropriate standard for
nonbank SBSDs because it is designed to promote a firm's liquidity
and self-sufficiency (in other words, to account for the lack of
inexpensive funding sources that are available to banks, such as
deposits and central bank support).'').
\54\ See, e.g., Exchange Act Release No. 8024 (Jan. 18, 1967),
32 FR 856 (Jan. 25, 1967) (``Rule 15c3-1 (17 CFR 240.15c3-1) was
adopted to provide safeguards for public investors by setting
standards of financial responsibility to be met by brokers and
dealers. The basic concept of the rule is liquidity; its object
being to require a broker-dealer to have at all times sufficient
liquid assets to cover his current indebtedness.'') (footnotes
omitted); Exchange Act Release No. 10209 (June 8, 1973), 38 FR 16774
(June 26, 1973) (Commission release of a letter from the Division of
Market Regulation) (``The purpose of the net capital rule is to
require a broker or dealer to have at all times sufficient liquid
assets to cover its current indebtedness. The need for liquidity has
long been recognized as vital to the public interest and for the
protection of investors and is predicated on the belief that
accounts are not opened and maintained with broker-dealers in
anticipation of relying upon suit, judgment and execution to collect
claims but rather on a reasonable demand one can liquidate his cash
or securities positions.''); Exchange Act Release No. 15426 (Dec.
21, 1978), 44 FR 1754 (Jan. 8, 1979) (``The rule requires brokers or
dealers to have sufficient cash or liquid assets to protect the cash
or securities positions carried in their customers' accounts. The
thrust of the rule is to insure that a broker or dealer has
sufficient liquid assets to cover current indebtedness.''); Exchange
Act Release No. 26402 (Dec. 28, 1988), 54 FR 315 (Jan. 5, 1989)
(``The rule's design is that broker-dealers maintain liquid assets
in sufficient amounts to enable them to satisfy promptly their
liabilities. The rule accomplishes this by requiring broker-dealers
to maintain liquid assets in excess of their liabilities to protect
against potential market and credit risks.'') (footnote omitted).
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The net liquid assets test is imposed through how an SBS Entity is
required to compute net capital pursuant to Exchange Act rule 18a-1.
The first step is to compute the SBS Entity's net worth under generally
accepted accounting principles (``GAAP''). Next, the SBS Entity must
make certain adjustments to its net worth to calculate net capital,
such as deducting illiquid assets and taking other capital charges and
adding qualifying subordinated loans.\55\ The amount remaining after
these deductions is defined as ``tentative net capital.'' Exchange Act
rule 18a-1 prescribes a minimum tentative net capital requirement of
$100 million for SBS Entities approved to use models to calculate net
capital. An SBS Entity that is meeting its minimum tentative net
capital requirement will be in the position where each dollar of
unsubordinated liabilities is matched by more than a dollar of highly
liquid assets.\56\ The final step in computing net capital is to take
prescribed percentage deductions (standardized haircuts) or model-based
deductions from the mark-to-market value of the SBS Entity's
proprietary positions (e.g., securities, money market instruments, and
commodities) that are included in its tentative net capital. The amount
remaining is the firm's net capital, which must exceed the greater of
$20 million or a ratio amount.
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\55\ See 17 CFR 240.15c3-1(c)(2).
\56\ The highly liquid assets under Exchange Act Rule 18a-1 are
otherwise known as ``allowable assets'' because they are not
deducted when computing net capital. See Books and Records Adopting
Release, 84 FR 68673-74, 68677-80 (the sections of the amended Part
II of the FOCUS Report setting forth the assets side of the balance
sheet and the net capital computation). Illiquid assets otherwise
known as ``non-allowable assets'' are deducted when computing net
capital. Id. Allowable assets include cash, certain unsecured
receivables from broker-dealers and clearing organizations, reverse
repurchase agreements, securities borrowed, fully secured customer
margin loans, and proprietary securities, commodities, and swaps
positions. Id. The term ``high quality liquid assets'' or ``HQLA''
are defined under the Basel capital standard's liquidity coverage
ratio (``LCR'') and generally consist of cash and specific classes
of liquid securities. See BCBS, LCR30--High-quality liquid assets
(under the Basel capital standards), available at: <a href="https://www.bis.org/basel_framework/chapter/LCR/30.htm">https://www.bis.org/basel_framework/chapter/LCR/30.htm</a>?. Generally, cash and
securities that qualify as HQLA under the LCR would be allowable
assets under Exchange Act rule 18a-1.
---------------------------------------------------------------------------
In comparison, the Basel capital standard counts as capital assets
that Exchange Act rule 18a-1 would exclude (e.g., loans and most other
types of uncollateralized receivables, furniture and fixtures, real
estate). The Basel capital standard accommodates the business of
banking: Making loans (including extending unsecured credit) and taking
deposits. While the Covered Entities that would apply substituted
compliance with respect to Exchange Act rule 18a-1 will not be banks,
the Basel capital standard allows them to count illiquid assets such as
real estate and fixtures as capital. It also allows them to treat
unsecured receivables related to activities beyond dealing in security-
based swaps as capital notwithstanding the illiquidity of these assets.
Further, one critical example of the difference between the
requirements of Exchange Act rule 18a-1 and the Basel capital standard
relates to the treatment of initial margin with respect to security-
based swaps and swaps. Under the EU margin requirements, Covered
Entities will be required to post initial margin to counterparties
unless an exception applies.\57\ Under Exchange Act rule 18a-1, an SBS
Entity cannot count as capital the amount of initial margin posted to a
counterparty unless it enters into a special loan agreement with an
affiliate.\58\ The special loan agreement requires the affiliate to
fund the initial margin amount and the agreement must be structured so
that the affiliate--rather than the SBS Entity--bears the risk that the
counterparty may default on the obligation to return the initial
margin. The reason for this restrictive approach to initial margin
posted away is that it ``would not be available [to the SBS Entity] for
other purposes, and, therefore, the firm's liquidity would be
reduced.'' \59\ Under the Basel capital standard, a Covered Entity can
count initial margin posted away as capital without the need to enter
into a special loan arrangement with an affiliate. Consequently,
because of the ability to include illiquid assets and margin posted
away as capital, Covered Entities subject to the Basel capital standard
may have less balance sheet liquidity than SBS Entities subject to
Exchange Act rule 18a-1.
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\57\ Exchange Act rule 18a-3 does not require SBS Entities to
post initial margin (though it does not prohibit the practice).
\58\ See Capital and Margin Adopting Release, 84 FR 43887-88.
\59\ See id. at 43887.
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In summary, there are key differences between the net liquid assets
test of Exchange Act rule 18a-1 and the Basel capital standard
applicable to Covered Entities. Those differences in terms of the types
of assets that count as regulatory capital and how regulatory
[[Page 46507]]
capital is calculated lead to different regulatory outcomes. In
particular, the net liquid assets test produces a regulatory outcome in
which the SBS Entity has more than one dollar of highly liquid assets
for each dollar of unsubordinated liabilities.\60\ The Basel capital
standard--while having measures designed to promote liquidity--does not
produce this regulatory outcome.\61\ Therefore, the Commission
preliminarily believes that an additional capital condition is needed
to bridge the gap between these two capital standards and thereby
achieve more comparable regulatory outcomes in terms of promoting
liquid balance sheets for SBS Entities and Covered Entities.
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\60\ As discussed above, highly liquid assets under Exchange Act
rule 18a-1 are also known as ``allowable assets'' and generally are
consistent with the LCR's HQLA.
\61\ The Basel capital standard does not preclude a firm from
having more than a dollar of highly liquid assets for each dollar of
unsubordinated liabilities. Thus, a firm operating pursuant to the
standard may structure its assets and liabilities in a manner that
achieves this result. However, the standard does not mandate this
result. Rather, it would accommodate a firm that seeks to maintain
this level of liquidity on its own accord.
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However, in seeking to bridge this regulatory gap, the additional
condition should take into account that Covered Entities are or will be
subject to EU and German laws and measures designed to promote
liquidity. In particular, Covered Entities are or will be subject to:
(1) Requirements to hold an amount of HQLA to meet expected payment
obligations under stressed conditions for thirty days (the ``LCR
requirement''); \62\ (2) requirements to hold a diversity of stable
funding instruments sufficient to meet long-term obligations under both
normal and stressed conditions (the ``NSFR requirements''); \63\ (3)
requirements to perform liquidity stress tests and manage liquidity
risk (the ``internal liquidity assessment requirements''); \64\ and (4)
regular reviews of a Covered Entity's liquidity risk management
processes (the ``liquidity review process'').\65\ These EU and German
laws and measures will require Covered Entities to hold significant
levels of liquid assets. However, the laws and measures on their own,
do not impose a net liquid assets test. Therefore, the Commission
preliminarily believes that an additional condition is necessary to
supplement these requirements.
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\62\ See CRR, Article 412(1).
\63\ See CRR, Articles 413, 428a and 428az.
\64\ See KWG, Article 25a(1), sentence 3 no. 3b).
\65\ See KWG, Article 6b(2) no.7.
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The Commission has taken into account the EU and German liquidity
laws and measures discussed above in making a substituted compliance
determination with respect to Exchange Act rule 18a-1, and in tailoring
additional capital conditions designed to achieve comparable regulatory
outcomes. The LCR, NSFR, and internal liquidity assessment requirements
collectively will require Covered Entities to maintain pools of
unencumbered HQLA to cover potential cash outflows during a 30-day
stress period, to fund long-term obligations with stable funding
instruments, and to manage liquidity risk. These requirements--coupled
with supervisory reviews of the liquidity risk management practices of
Covered Entities--will require Covered Entities to hold significant
levels of liquid assets. These requirements and measures in combination
with the other capital requirements applicable to Covered Entities
provide a starting foundation for making a positive substituted
compliance determination with respect to the capital requirements of
Exchange Act section 15F(e) and Exchange Act rule 18a-1. However, the
Commission preliminarily believes that more is needed to achieve a
comparable regulatory outcome to the net liquid assets test of Exchange
Act rule 18a-1.
For these reasons, the proposed Amended Order includes an
additional capital condition that would impose a simplified net liquid
assets test.\66\ This simplified test would require the Covered Entity
to hold more than one dollar of liquid assets for each dollar of
liabilities. The simplified net liquid assets test--when coupled with
the CRR capital requirements,\67\ LCR requirements, NSFR requirements,
internal liquidity assessment requirements, and liquidity review
process--is designed to produce a regulatory outcome that is comparable
to the net liquid assets test of Exchange Act rule 18a-1 (i.e.,
sufficient liquidity to cover liabilities and to promote the
maintenance of highly liquid balance sheets).
---------------------------------------------------------------------------
\66\ See para. (c)(1)(iii) of the proposed Amended Order. This
additional condition is included in the French and UK Orders. See
French Order, 86 FR 41659; UK Order, 86 FR 43372.
See paras. (f)(1)(i)(J), (f)(2)(i)(J), and (f)(4)(i)(A) of the
proposed Amended Order.
\67\ See, e.g., CRR, Part 1 (Own Funds, including Tier 1
capital) and Part 2 (Capital Requirements).
---------------------------------------------------------------------------
More specifically, substituted compliance with respect to Exchange
Act rule 18a-1 would be subject to the condition that a Covered Entity:
(1) Maintains liquid assets (as defined in the proposed condition) that
have an aggregate market value that exceeds the amount of the Covered
Entity's total liabilities by at least $100 million before applying the
deduction specified in the proposed condition, and by at least $20
million after applying the deduction specified in the proposed
condition; (2) makes and preserves for three years a quarterly record
that: (a) Identifies and values the liquid assets maintained as defined
in the proposed condition, (b) compares the amount of the aggregate
value the liquid assets maintained pursuant to the proposed condition
to the amount of the Covered Entity's total liabilities and shows the
amount of the difference between the two amounts (``the excess liquid
assets amount''), and (c) shows the amount of the deduction specified
in the proposed condition and the amount that deduction reduces the
excess liquid assets amount; (3) notifies the Commission in writing
within 24 hours in the manner specified on the Commission's website if
the Covered Entity fails to meet the requirements of the proposed
condition and includes in the notice the contact information of an
individual who can provide further information about the failure to
meet the requirements; and (4) includes its most recent statement of
financial condition filed with its local supervisor (whether audited or
unaudited) with its initial written notice to the Commission of its
intent to rely on substituted compliance.\68\
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\68\ See para. (c)(1)(iii) of the proposed Amended Order. This
proposed additional condition is included in the French and UK
Orders. See French Order, 86 FR 41659; UK Order, 86 FR 43372.
---------------------------------------------------------------------------
Under the first prong of this additional capital condition, the
Covered Entity would be required to maintain liquid assets (as defined
in the proposed capital condition) that have an aggregate market value
that exceeds the amount of the Covered Entity's total liabilities by at
least: (1) $100 million before applying a deduction (as specified in
the proposed capital condition); and (2) $20 million after applying the
deduction.\69\ The first prong is designed to be consistent with the
$100 million tentative net capital requirement of Exchange Act rule
18a-1 applicable to SBS Entities approved to use models. As discussed
above, Exchange Act rule 18a-1 requires SBS Entities that have been
approved to use models to maintain at least $100 million in tentative
net capital. And, tentative net capital is the amount that an SBS
Entity's liquid assets exceed its total unsubordinated liabilities
before applying haircuts. The first prong would require the Covered
Entity to subtract
[[Page 46508]]
total liabilities from total liquid assets. The amount remaining will
need to equal or exceed $100 million. The first prong also is designed
to be consistent with the $20 million fixed-dollar minimum net capital
requirement of Exchange Act rule 18a-1. As discussed above, net capital
is calculated by applying haircuts (deductions) to tentative net
capital and the fixed-dollar minimum requires that net capital must
equal or exceed $20 million. The first prong would require the Covered
Entity to subtract total liabilities from total liquid assets and then
apply the deduction to the difference. The amount remaining after the
deduction would need to equal or exceed $20 million.
---------------------------------------------------------------------------
\69\ See para. (c)(1)(iii)(A)(1) of the proposed Amended Order.
The definition of ``liquid assets'' and the method of calculating
the deductions are discussed below.
---------------------------------------------------------------------------
For the purposes of the first prong, ``liquid assets'' would be
defined as: (1) Cash and cash equivalents; (2) collateralized
agreements; (3) customer and other trading related receivables; (4)
trading and financial assets; and (5) initial margin posted by the
Covered Entity to a counterparty or third-party (subject to certain
conditions discussed below).\70\ These categories of liquid assets are
designed to align with assets that are considered allowable assets for
purposes of calculating net capital under Exchange Act rule 18a-1.\71\
Further, the first four categories of liquid assets also are designed
to align with how Covered Entities categorize liquid assets on their
financial statements.
---------------------------------------------------------------------------
\70\ See para. (c)(1)(iii)(B) of the proposed Amended Order.
\71\ See supra notes 56 and 60 (describing allowable assets
under Exchange Act rule 18a-1).
---------------------------------------------------------------------------
The first category of liquid assets would be cash and cash
equivalents.\72\ These assets would consist of cash and demand deposits
at banks (net of overdrafts) and highly liquid investments with
original maturities of three months or less that are readily
convertible into known amounts of cash and subject to insignificant
risk of change in value.\73\ The second category of liquid assets would
be collateralized agreements.\74\ These assets would consist of secured
financings where securities serve as collateral such as repurchase
agreements and securities loaned transactions.\75\ The third category
of liquid assets would be customer and other trading related
receivables.\76\ These assets would consist of customer margin loans,
receivables from broker-dealers, receivables related to fails to
deliver, and receivables from clearing organizations.\77\ The fourth
category of liquid assets would be trading and financial assets.\78\
These assets would consist of cash market securities positions and
listed and over-the-counter derivatives positions.\79\
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\72\ See para. (c)(1)(iii)(B)(1) of the proposed Amended Order.
\73\ See, e.g., International Financial Reporting Standards
Foundation (``IFRS''), IAS 7 Statement of Cash Flows (defining
``cash'' as comprising cash on hand and demand deposits and ``cash
equivalents'' as short-term, highly liquid investments that are
readily convertible to known amounts of cash and which are subject
to an insignificant risk of changes in value). See also Books and
Records Adopting Release, 84 FR 68673-74 (the section of the amended
Part II of the FOCUS Report setting forth the assets side of the
balance sheet and identifying cash as an allowable asset in Box
200).
\74\ See para. (c)(1)(iii)(B)(2) of the proposed Amended Order.
\75\ See Books and Records Adopting Release, 84 FR 68673-74 (the
section of the amended Part II of the FOCUS Report setting forth the
assets side of the balance sheet and identifying securities borrowed
as an allowable asset in Boxes 240 and 250 and securities purchased
under agreements to resell as an allowable asset in Box 360).
\76\ See para. (c)(1)(iii)(B)(3) of the proposed Amended Order.
\77\ See Books and Records Adopting Release, 84 FR 68673-74 (the
section of the amended Part II of the FOCUS Report setting forth the
assets side of the balance sheet and identifying fails to deliver as
allowable assets in Boxes 220 and 230, receivables from clearing
organizations as allowable assets in Boxes 280 and 290, and
receivables from customers as allowable assets in Boxes 310, 320,
and 330).
\78\ See para. (c)(1)(iii)(B)(4) of the proposed Amended Order.
\79\ See Books and Records Adopting Release, 84 FR 68673-74 (the
section of the amended Part II of the FOCUS Report setting forth the
assets side of the balance sheet and identifying securities,
commodities, and swaps positions as allowable assets in Box 12019).
---------------------------------------------------------------------------
As discussed above, initial margin posted to a counterparty is
treated differently under Exchange Act rule 18a-1 and the Basel capital
standard. The fifth category of liquid assets would be initial margin
posted by the Covered Entity to a counterparty or a third-party
custodian, provided: (1) The initial margin requirement is funded by a
fully executed written loan agreement with an affiliate of the Covered
Entity; (2) the loan agreement provides that the lender waives re-
payment of the loan until the initial margin is returned to the Covered
Entity; and (3) the liability of the Covered Entity to the lender can
be fully satisfied by delivering the collateral serving as initial
margin to the lender.\80\ As discussed above, one critical difference
between Exchange Act rule 18a-1 and the Basel capital standard is that
an SBS Entity cannot count as capital the amount of initial margin
posted to a counterparty or third-party custodian unless it enters into
a special loan agreement with an affiliate.\81\ Under the Basel capital
standard, a Covered Entity can count initial margin posted away as
capital without the need to enter into a special loan arrangement with
an affiliate. Consequently, to count initial margin posted away as a
liquid asset for purposes of this capital condition, the Covered Entity
would be required to enter into the same type of special agreement that
an SBS Entity must execute to count initial margin as an allowable
asset for purposes of Exchange Act rule 18a-1.\82\
---------------------------------------------------------------------------
\80\ See para. (c)(1)(iii)(B)(5) of the proposed Amended Order.
\81\ See Capital and Margin Adopting Release, 84 FR 43887-88.
\82\ Id.
---------------------------------------------------------------------------
If an asset does not fall within one of the five categories of
``liquid assets'' as defined in the proposed Amended Order,\83\ it
would be considered non-liquid, and could not be treated as a liquid
asset for purposes of this capital condition. For example, the
following categories of assets generally could not be treated as liquid
assets: (1) Investments; (2) loans; and (3) other assets. The non-
liquid ``investment'' category would include the Covered Entity's
ownership interests in subsidiaries or other affiliates. The non-liquid
``loans'' category would include unsecured loans and advances. The non-
liquid ``other'' assets category would refer to assets that do not fall
into any of the other categories of liquid or non-liquid assets. These
non-liquid ``other'' assets would include furniture, fixtures,
equipment, real estate, property, leasehold improvements, deferred tax
assets, prepayments, and intangible assets.
---------------------------------------------------------------------------
\83\ See para. (c)(1)(iii)(B) of the proposed Amended Order.
---------------------------------------------------------------------------
As discussed above, the first prong of this capital condition would
require the Covered Entity to subtract total liabilities from total
liquid assets and then apply a deduction (haircut) to the
difference.\84\ The amount remaining after the deduction would need to
equal or exceed $20 million. The method of calculating the amount of
the deduction would rely on the calculations Covered Entities must make
under the Basel capital standard.\85\ In particular, under the Basel
standard, Covered Entities must risk-weight their assets. This involves
adjusting the nominal value of each asset based on the inherent risk of
the asset. Less risky assets are adjusted to lower values (i.e., have
less weight) than more risky assets. As a result, Covered Entities must
hold lower levels of regulatory capital for less risky assets and
higher levels of capital for riskier assets. Similarly, under Exchange
Act rule 18a-1, less risky assets incur lower haircuts than riskier
assets and,
[[Page 46509]]
therefore, require less net capital to be held in relation to them.
Consequently, the process of risk-weighting assets under the Basel
capital standard provides a method to account for the inherent risk in
an asset held by a Covered Entity similar to how the haircuts under the
Exchange Act rule 18a-1 account for the risk of assets held by SBS
Entities. For these reasons, the Commission preliminarily believes it
would be appropriate to use the process of risk-weighting assets under
the Basel capital standard to determine the amount of the deduction
(haircuts) under the first prong of the third additional capital
condition.
---------------------------------------------------------------------------
\84\ See para. (c)(1)(iii)(A)(1) of the proposed Amended Order.
\85\ See BCBS, Risk-based capital requirements (RBC20),
available at: <a href="https://www.bis.org/basel_framework/chapter/RBC/20.htm?inforce=20191215&published=20191215">https://www.bis.org/basel_framework/chapter/RBC/20.htm?inforce=20191215&published=20191215</a>.
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Under the Basel capital standard, Covered Entities must hold
regulatory capital equal to at least 8% of the amount of their risk-
weighted assets.\86\ Therefore, the deduction (haircut) required for
purposes of this capital condition would be determined by dividing the
amount of the Covered Entity's risk-weighted assets by 12.5 (i.e., the
reciprocal of 8%).\87\ In sum, the Covered Entity would be required to
maintain an excess of liquid assets over total liabilities that equals
or exceeds $100 million before the deduction (derived from the firm's
risk-weighted assets) and $20 million after the deduction.\88\
---------------------------------------------------------------------------
\86\ Id.
\87\ See para. (c)(1)(iii)(C) of the proposed Amended Order. The
Commission acknowledges that a Covered Entity's risk-weighted assets
will include components in addition to market and credit risk
charges (e.g., operational risk charges). However, the Commission
expects the combined market and credit risk charges would make up
the substantial majority of the risk-weighted assets. In addition,
the Commission believes that this method of calculating the
deduction in the first prong of the third additional capital
condition is a reasonable approach in that it addresses market and
credit risk similar to the process used by security-based swap
dealers authorized to use internal models to compute market and
credit risk deductions under Exchange Act rule 18a-1. See, e.g.,
Exchange Act rule 18a-1(e) (prescribing requirements to calculate
market and credit risk charges, including use of an 8%
multiplication factor for calculating the credit risk charges).
\88\ For example, assume a Covered Entity has total assets of
$600 million (of which $595 million are liquid and $5 million are
illiquid) and total liabilities of $450 million. In this case, the
Covered Entity's liquid assets would exceed total liabilities by
$145 million ($590 million minus $450 million) and, therefore, the
Covered Entity would have excess liquid assets greater than $100
million as required by the first prong of this capital condition.
Assume further that the Covered Entity's risk-weighted assets under
the Basel capital standard equal $400 million. In this case, the
Covered Entity's deduction would equal $32 million ($400 million
divided by 12.5). Subtracting $32 million from $145 million leaves
$113 million, which exceeds $20 million. Therefore, the Covered
Entity would meet the second requirement of the first prong of this
capital condition.
---------------------------------------------------------------------------
The second prong of this capital condition would require the
Covered Entity to make and preserve for three years a quarterly record
that: (1) Identifies and values the liquid assets maintained pursuant
to the first prong; (2) compares the amount of the aggregate value the
liquid assets maintained pursuant to the first prong to the amount of
the Covered Entity's total liabilities and shows the excess liquid
assets amount; and (3) shows the amount of the deduction required under
the first prong and the amount that deduction reduces the excess liquid
assets amount.\89\ Consequently, the quarterly record would include
details showing whether the Covered Entity is meeting the $100 million
and $20 million requirements of the first prong.
---------------------------------------------------------------------------
\89\ See para. (c)(1)(iii)(A)(2) of the proposed Amended Order.
---------------------------------------------------------------------------
The third prong of this capital condition would require the Covered
Entity to notify the Commission in writing within 24 hours in the
manner specified on the Commission's website if the Covered Entity
fails to meet the requirements of the first prong and include in the
notice the contact information of an individual who can provide further
information about the failure to meet the requirements.\90\ As
discussed above, the first additional capital condition would require
the Covered Entity to apply substituted compliance with respect to
notification requirements of Exchange Act rule 18a-8 relating to
capital.\91\ A Covered Entity applying substituted compliance with
respect to Exchange Act rule 18a-8 under the proposed Amended Order
would need to simultaneously submit to the Commission any notifications
relating to capital that it must submit to the EU and German
authorities. However, EU and German notification requirements do not
address a failure to adhere to the simplified net liquid assets test
that would be required by the first prong of this capital condition.
Moreover, due to the differences between Exchange Act rule 18a-1 and
the Basel capital standard discussed above, a Covered Entity could fall
out of compliance with the requirements of the first prong but still
remain in compliance with the requirements of the Basel capital
standard. Accordingly, the third prong would require the Covered Entity
to notify the Commission if the firm fails to meet the requirements of
the first prong. This would alert the Commission of potential issues
with the Covered Entity's financial condition that could pose risks to
the firm's customers and counterparties.
---------------------------------------------------------------------------
\90\ See para. (c)(1)(iii)(A)(3) of the proposed Amended Order.
\91\ See para. (c)(1)(ii) of the proposed Amended Order.
---------------------------------------------------------------------------
The fourth prong of this condition 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.\92\ This
one-time obligation would provide the Commission with information about
the assets, liabilities, and capital of Covered Entities applying
substituted compliance with respect to Exchange Act rule 18a-1. The
Commission would use the statement of financial condition and the
periodic audited and unaudited reports Covered Entities would file with
the Commission to monitor the appropriateness of the capital condition
if it is included in an amended order. The Commission expects that most
Covered Entities will file their initial notice of intent to apply
substituted compliance with respect to Exchange Act rule 18a-1 at or
around the time they file their registration applications with the
Commission. Therefore, receipt of the statement of financial condition
at that time would allow the Commission to begin this monitoring
process before Covered Entities begin filing audited and unaudited
reports with the Commission pursuant to Exchange Act rule 18a-7 or an
amended order providing substituted compliance for Exchange Act rule
18a-7.\93\
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\92\ See para. (c)(1)(iii)(A)(4) of the proposed Amended Order.
\93\ See part VII.B.4, infra (discussing proposed reporting
conditions with respect to applying substituted compliance for
Exchange Act rule 18a-7).
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C. Margin--Preliminary Views and Proposed Amended Order
In the Commission's preliminary view, based on the Amended
Application and the Commission's review of applicable provisions,
relevant EU and German margin requirements would produce regulatory
outcomes that are comparable to those associated with Exchange Act rule
18a-3, provided Covered Entities are subject to additional conditions
(discussed below) to address differences between the two margining
regimes with respect to counterparty exceptions.
In terms of producing comparable outcomes, in adopting Exchange Act
rule 18a-3, the Commission stated that it modified the proposal to more
closely align the final rule with the margin rules of the Commodity
Futures Trading Commission and the U.S. prudential regulators and, in
doing so, with the recommendations made by the BCBS and the Board of
the International
[[Page 46510]]
Organization of Securities Commissions (``IOSCO'') with respect to
margin requirements for non-centrally cleared derivatives.\94\ In this
regard, Exchange Act rule 18a-3 and the EU and German margin rules
require firms to collect liquid collateral from a counterparty to cover
variation and/or initial margin requirements.\95\ Both sets of rules
also require firms to deliver liquid collateral to a counterparty to
cover variation margin requirements. Under both sets of rules, the fair
market value of collateral used to meet a margin requirement must be
reduced by a haircut.\96\ Further, both sets of rules permit the use of
a model (including a third party model such as ISDA's SIMM\TM\ model)
to calculate initial margin.\97\ The initial margin model under both
sets of rules must meet certain minimum qualitative and quantitative
requirements, including that the model must use a 99 percent, one-
tailed confidence level with price changes equivalent to a 10-day
movement in rates and prices.\98\ Both sets of rules have common
exceptions to the requirements to collect and/or post initial or
variation margin, including exceptions for certain commercial end
users, the Bank for International Settlements, and certain multilateral
development banks.\99\ Both sets of rules also permit a threshold below
which initial margin is not required to be collected and incorporate a
minimum transfer amount.\100\ For these reasons, substituted compliance
with respect to Exchange Act rule 18a-3 would be conditioned on Covered
Entities being subject to and complying with these EU and German margin
requirements.\101\
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\94\ See Capital and Margin Adopting Release, 84 FR 43908-09;
see also BCBS/IOSCO, Margin Requirements for Non-centrally Cleared
Derivatives (April 2020), available at: <a href="https://www.bis.org/bcbs/publ/d499.pdf">https://www.bis.org/bcbs/publ/d499.pdf</a> (``BCBS/IOSCO Paper''). The EU and German margin
requirements also are based on the recommendation in the BCBS/IOSCO
Paper.
\95\ See 17 CFR 240.18a-3(c)(1)(ii) and the Amended Application
Annex A category 4 at 28-31.
\96\ See 17 CFR 240.18a-3(c)(1)(ii) and the Amended Application
Annex A category 4 at 38-39.
\97\ See 17 CFR 240.18a-3(d)(2)(i) and the Amended Application
Annex A category 4 at 12-18.
\98\ See 17 CFR 240.18a-3(d)(2)(i) and the Amended Application
Annex A category 4 at 12. The Commission must approve the use of an
initial margin model. 17 CFR 240.18a-3(d)(2)(i). EMIR article 11(15)
directs European supervisory authorities to develop regulatory
technical standards under which initial margin models have to be
approved (initial and ongoing approval). EU and German requirements
currently provide that, upon request, counterparties using an
initial margin model shall provide the regulators with any
documentation relating to the risk management procedures relating to
such model at any time. EMIR Margin RTS article 2(6).
\99\ See 17 CFR 240.18a-3(c)(1)(iii) and the Amended Application
Annex A category 4 at 54-63.
\100\ See 17 CFR 240.18a-3(c)(1)(iii) and the Amended
Application Annex A category 4 at 64-66.
\101\ See para. (c)(2)(i) of the proposed Amended Order. In
connection with margin requirements, Covered Entities would need to
comply with: EMIR article 11; EMIR Margin RTS; CRR articles 103,
105(3); 105(10); 111(2), 224, 285, 286, 286(7), 290, 295, 296(2)(b),
297(1), 297(3), and 298(1); MiFID Org Reg article 23(1); CRD
articles 74 and 79(b); and KWG section 25a(1). See para. (c)(2)(i)
of the proposed Amended Order.
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However, there would be additional conditions to address
differences in the exceptions to collecting variation and/or initial
margin between Exchange Act rule 18a-3 and the EU and German margin
rules. In this regard, the Commission stated when proposing Exchange
Act rule 18a-3 that the ``Dodd-Frank Act seeks to address the risk of
uncollateralized credit risk exposure arising from OTC derivatives by,
among other things, mandating margin requirements for non-cleared
security-based swaps and swaps.'' \102\ Further, the comparability
criteria for margin requirements under Exchange Act rule 3a71-6
provides that prior to making a substituted compliance determination,
the Commission intends to consider (in addition to any conditions
imposed) whether the foreign financial regulatory system requires
registrants to adequately cover their current and future exposure to
OTC derivatives counterparties, and ensures registrants' safety and
soundness, in a manner comparable to the applicable provisions arising
under the Exchange Act and its rules and regulations.\103\ In adopting
this comparability criteria for margin requirements, the Commission
stated that obtaining collateral is one of the ways OTC derivatives
dealers manage their credit risk exposure to OTC derivatives
counterparties.\104\
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\102\ See Capital, Margin, and Segregation Requirements for
Security-Based Swap Dealers and Major Security-Based Swap
Participants and Capital Requirements for Broker-Dealers; Proposed
Rule, Exchange Act Release No. 68071 (Oct. 18, 2012), 77 FR 70214,
70258 (Nov. 23, 2012).
\103\ See 17 CFR 240.3a71-6(d)(5)(i) and (ii).
\104\ See Capital and Margin Adopting Release, 84 FR 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.). Id.
---------------------------------------------------------------------------
To address the risk of uncollateralized exposures, Exchange Act
rule 18a-3 requires SBS Entities without a prudential regulator to
collect variation margin from all counterparties, including affiliates,
unless an exception applies.\105\ Under the EU and German margin
requirements, there are exceptions from the variation margin
requirements for certain intragroup transactions (i.e., transactions
between affiliates).\106\ In addition, Exchange Act rule 18a-3 requires
firms to collect initial margin from all counterparties, unless an
exception applies.\107\ This initial margin requirement under Exchange
Act rule 18a-3 requires the firm to collect initial margin from a
financial counterparty such as a hedge fund without regard to whether
the counterparty has material exposures to non-cleared security-based
swaps and uncleared swaps. In contrast, EU and German margin
requirements do not require Covered Entities to collect initial margin
from financial counterparties, if their notional exposure to non-
centrally cleared derivatives does not exceed a certain threshold on a
group basis.\108\
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\105\ See 17 CFR 240.18a-3(c)(ii)(A)(1) and (2).
\106\ See the Amended Application Annex A category 4 at 60-61.
\107\ See 17 CFR 240.18a-3(c)(ii)(B).
\108\ See the Amended Application Annex A category 4 at 7 and
63. These thresholds are being phased-in with the last initial
margin threshold set at EUR 8 billion.
---------------------------------------------------------------------------
In some cases these differences may result in a Covered Entity not
being adequately collateralized to cover its current or future exposure
to these counterparties with respect to its OTC derivatives
transactions. In addition, differences in the counterparty exceptions
could potentially incentivize market participants to engage in non-
cleared security-based swap transactions outside of the United
States.\109\ Consequently, the Commission preliminarily believes it
would be appropriate to propose additional margin conditions to produce
comparable regulatory outcomes in terms of counterparty exceptions
between Exchange Act rule 18a-3 and the EU and German requirements.
---------------------------------------------------------------------------
\109\ The Commission recognizes there are also cases where the
EU and German margin rules are more restrictive than Exchange Act
rule 18a-3. EU margin rules require Covered Entities to post initial
margin to covered counterparties, while the Exchange Act rule 18a-3
would permit posting but not require it. In addition, EU margin
rules also require a Covered Entity to collect (and post) initial
margin to financial and non-financial counterparties if their
notional exposure to non-centrally cleared derivatives exceeds a
certain threshold on a group basis. In contrast, Exchange Act rule
18a-3 does not require (but permits) a nonbank security-based swap
dealer to collect initial margin from counterparties that are
financial market intermediaries. 17 CFR 240.18a-3(c)(1)(iii)(B). The
comparability analysis, however, focuses on determining whether the
EU and German margin rules are comparable to Exchange Act rule 18a-
3.
---------------------------------------------------------------------------
The first additional condition is designed to address differences
in the counterparty exceptions with respect to
[[Page 46511]]
variation margin. It would require a Covered Entity to collect
variation margin, as defined in the EMIR Margin RTS, from a
counterparty with respect to a transaction in non-cleared security-
based swaps, unless the counterparty would qualify for an exception
under Exchange Act rule 18a-3 from the requirement to deliver variation
margin to the Covered Entity.\110\ This condition would define
variation margin by referencing EMIR Margin RTS to facilitate
implementation of the condition by Covered Entities. Under this
condition, for example, Covered Entities would be required to collect
variation margin from their affiliates, but would be permitted to
comply with all other EU and German margin requirements, including
calculation, collateral, documentation, and timing of collection
requirements. The first proposed additional condition would close the
gap between the counterparty exceptions of Exchange Act rule 18a-3 and
the EU and German margin rules with respect to variation margin.
---------------------------------------------------------------------------
\110\ See para. (c)(2)(ii) of the proposed Amended Order. This
proposed additional condition is included in the French and UK
Orders. See French Order, 86 FR 41659; UK Order, 86 FR 43372.
---------------------------------------------------------------------------
The second proposed additional condition is designed to address the
counterparty exceptions with respect to initial margin. It would
require a Covered Entity to collect initial margin, as defined in the
EMIR Margin RTS, from a counterparty with respect to transactions in
non-cleared security-based swaps, unless the counterparty would qualify
for an exception under Exchange Act rule 18a-3 from the requirement to
deliver initial margin to a Covered Entity.\111\ The condition would
define initial margin by referencing EMIR Margin RTS to facilitate
implementation of the condition by Covered Entities. Under this
condition, for example, Covered Entities would be required to collect
initial margin from their certain counterparties, but would be
permitted to comply with all other EU and German margin requirements,
including calculation, collateral, documentation, and timing of
collection requirements. The second proposed additional condition would
close the gap between the counterparty exceptions of Exchange Act rule
18a-3 and the EU and German margin rules with respect to initial
margin.
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\111\ See para. (c)(2)(iii) of the proposed Amended Order. This
proposed additional condition is included in the French and UK
Orders. See French Order, 86 FR 41659; UK Order, 86 FR 43372.
---------------------------------------------------------------------------
Finally, the proposed Amended Order also includes as a proposed
margin condition that the Covered Entity apply substituted compliance
with respect to Exchange Act rule 18a-5(a)(12) (a record making
requirement).\112\ This record making requirement is directly linked to
the margin requirements of Exchange Act rule 18a-3. The proposed
Amended Order conditions substituted compliance with respect to this
record making requirement on the Covered Entity applying substituted
compliance with respect to Exchange Act rule 18a-3.\113\ This condition
would do the reverse: Condition substituted compliance with respect to
Exchange Act rule 18a-3 on the Covered Entity applying substituted
compliance with respect to Exchange Act rule 18a-5(a)(12). This
condition is designed to provide clarity as to the Covered Entity's
obligations under this record making requirement when applying
substituted compliance with respect to Exchange Act rule 18a-3 pursuant
this proposed Amended Order.
---------------------------------------------------------------------------
\112\ See para. (c)(2)(iv) of the proposed Amended Order. This
proposed additional condition is included in the French and UK
Orders. See French Order, 86 FR 41659; UK Order, 86 FR 43372.
\113\ See para. (f)(1)(i)(L) of the proposed Amended Order.
---------------------------------------------------------------------------
V. Proposed Amendments Related to CCO Reports
A. Compliance Report Certifications
Rule 15Fk-1 states that the required reports must include ``a
certification by the chief compliance officer or senior officer that,
to the best of his or her knowledge and reasonable belief and under
penalty of law, the information contained in the compliance report is
accurate and complete in all material respects.'' \114\ The standard
applied in the Order required certification that ``under penalty of
law, the report is accurate and complete.'' \115\ The Commission
preliminarily believes that, consistent with the French Order,\116\
further alignment of the proposed Amended Order's certification
requirement with that of the applicable Exchange Act rule is
appropriate. Therefore, the proposed Amended Order would clarify that
the required reports should be certified by ``the chief compliance
officer or senior officer'' of the Covered Entity and that the same
certification standard contained in Exchange Act rule 15Fk-1 would
apply.\117\
---------------------------------------------------------------------------
\114\ Exchange Act rule 15Fk-1(c)(2)(ii)(D); see also Exchange
Act rule 15Fk-1(e)(2) (defining ``senior officer'' as ``the chief
executive officer or other equivalent officer'').
\115\ See para. (d)(2) of the Order.
\116\ See French Order, 86 FR 41659.
\117\ See para. (d)(2)(ii)(B) of the proposed Amended Order. In
addition, for consistency with the French Order, the Commission is
proposing to incorporate CRR articles 286-88 and 293 and EMIR Margin
RTS article 2 as part of para. (d)(3) of the proposed Amended Order.
---------------------------------------------------------------------------
B. Timing of Compliance Report Submission
Also consistent with the French Order,\118\ the Commission is
proposing to amend the Order to clarify the timing for Covered Entities
to submit compliance reports to the Commission. To promote timely
notice comparable to what the Exchange Act rule provides, the
Commission is proposing to incorporate a timing standard that accounts
for MiFID-required timing as well as the possibility that the relevant
reports may be submitted to the management body early. Under the
proposed Amended Order, the applicable compliance reports must be
provided to the Commission no later than 15 days following the earlier
of: (i) The submission of the report to the Covered Entity's management
body; or (ii) the time the report is required to be submitted to the
management body.\119\ The proposed Amended Order would also clarify
that together the reports must cover the entire period that the Covered
Entity's annual compliance report referenced in Exchange Act section
15F(k)(3) and Exchange Act rule 15Fk-1(c) would be required to
cover.\120\
---------------------------------------------------------------------------
\118\ See French Order, 86 FR 41659.
\119\ See para. (d)(2)(D) of the proposed Amended Order.
\120\ See para. (d)(2)(E) of the proposed Amended Order.
---------------------------------------------------------------------------
VI. Proposed Amendments Counterparty Protection Requirements
A. Disclosure of Information Regarding Material Risks and
Characteristics
The Commission is proposing to add two requirements to the list of
German and EU disclosure of information regarding material incentives
or conflicts of interest requirements that the Covered Entity must be
subject to and comply with. The MAR Investment Recommendations
Regulation articles 5 and 6 enumerate specific obligations in relation
to disclosure of interests or of conflicts of interest. Article 5
requires that persons who produce recommendations disclose in their
recommendations all relationships and circumstances that may reasonably
be expected to impair the objectivity of the recommendation, including
interests or conflicts of interest. Article 6 imposes additional
obligations on certain entities, including the disclosure of
information on their interests and conflicts of interest concerning the
issuer to which a recommendation relates. The Commission preliminarily
believes that requiring Covered Entities
[[Page 46512]]
to be subject to and comply with MAR Investment Recommendations
Regulation articles 5 and 6 contributes to a determination that
relevant German and EU requirements produce regulatory outcomes that
are comparable to relevant requirements of Exchange Act rule 15Fh-3(b).
B. Fair and Balanced Communications
The Commission is also proposing to modify the fair and balanced
communications section of the proposed Amended Order.\121\ First, the
Commission believes that German and EU fair and balanced communications
requirements are more comparable to Exchange Act requirements when
considering three additional EU requirements: MAR article 20(1) would
require the Covered Entity to present recommendations in a manner that
ensures the information is objectively presented and to disclose
interests and conflicts of interest concerning the financial
instruments to which the information relates. MAR Investment
Recommendations Regulation article 3 would require a Covered Entity to
communicate only recommendations that present facts in a way that they
are clearly distinguished from interpretations, estimates, opinions and
other types of non-factual information; label clearly and prominently
projections, forecasts and price targets; indicate the relevant
material assumptions and substantial material sources of information;
and include only reliable information or a clear indication when there
is doubt about reliability. MAR Investment Recommendations Regulation
article 4 would require the Covered Entity to provide in its
recommendation additional information about the factual basis of its
recommendation. Accordingly, the Commission is adding these three
requirements to the Order's list of German and EU fair and balanced
communications requirements that the Covered Entity must be subject to
and comply with.\122\ Second, the Order required the Covered Entity to
be subject to and comply with MAR Investment Recommendations Regulation
article 5,\123\ which relates to obligations to disclose conflicts of
interest. As discussed above, the Commission is requiring Covered
Entities to comply with this requirement and with MAR Investment
Recommendations Regulation article 6 when using substituted compliance
for disclosure of material incentives and conflicts of interest
requirements. Accordingly, the Commission believes that MAR Investment
Recommendations Regulation article 5 is less relevant to comparability
of fair and balanced communications requirements and is proposing to
delete the reference to it in relation to substituted compliance for
fair and balanced communications.
---------------------------------------------------------------------------
\121\ See para. (e)(2)(iii) of the proposed Amended Order.
\122\ See para. (e)(5) of the Order.
\123\ See para. (d)(2) of the Order.
---------------------------------------------------------------------------
VII. Proposed Amendments Related to Recordkeeping, Reporting,
Notification, and Securities Count Requirements
A. BaFin Request and Associated Analytic Considerations
In its initial application (the ``BaFin Application''), in part,
requests substituted compliance for requirements applicable to SBS
Entities with and without a prudential regulator under the Exchange Act
relating to:
<bullet> Recordmaking--Exchange Act rule 18a-5 requires prescribed
records to be made and kept current.\124\
---------------------------------------------------------------------------
\124\ See 17 CFR 240.18a-5. The BaFin Application discusses
German requirements that address firms' record creation obligations
related to matters such as financial condition, operations,
transactions, counterparties and their property, personnel and
business conduct. See BaFin Application Annex A category 2 at 4-34.
---------------------------------------------------------------------------
<bullet> Record Preservation--Exchange Act rule 18a-6 requires
preservation of records.\125\
---------------------------------------------------------------------------
\125\ See 17 CFR 240.18a-6. The BaFin Application discusses
German requirements that address firms' record preservation
obligations related to records that firms are required to create, as
well as additional records such as records of communications. See
BaFin Application Annex A category 2 at 35-79.
---------------------------------------------------------------------------
<bullet> Reporting--Exchange Act rule 18a-7 requires certain
reports.\126\
---------------------------------------------------------------------------
\126\ See 17 CFR 240.18a-7. The BaFin Application discusses
German requirements that address firms' obligations to make certain
reports. See BaFin Application Annex A category 2 at 80-91, 96-102.
---------------------------------------------------------------------------
<bullet> Notification--Exchange Act rule 18a-8 requires
notification to the Commission when certain financial or operational
problems occur.\127\
---------------------------------------------------------------------------
\127\ See 17 CFR 240.18a-8. The BaFin Application discusses
German requirements that address firms' obligations to make certain
notifications. See BaFin Application Annex A category 2 at 92-96,
102.
---------------------------------------------------------------------------
<bullet> Securities Count--Exchange Act rule 18a-9 requires non-
prudentially regulated security-based swap dealers to perform a
quarterly securities count.\128\
---------------------------------------------------------------------------
\128\ See 17 CFR 240.18a-9. The BaFin Application discusses
German requirements that address firms' obligations to perform
securities counts. See BaFin Application Annex A category 2 at 27-
30.
---------------------------------------------------------------------------
<bullet> Daily Trading Records--Exchange Act section 15F(g)
requires SBS Entities to maintain daily trading records.\129\
---------------------------------------------------------------------------
\129\ See 15 U.S.C. 78o-10(g). The BaFin Application discusses
German requirements that address firms' record preservation
obligations related to records that firms are required to create, as
well as additional records such as records of communications. See
BaFin Application Annex A category 2 at 35-79.
---------------------------------------------------------------------------
Taken as a whole, the recordkeeping, reporting, notification, and
securities count requirements that apply to SBS Entities are designed
to promote the prudent operation of the firm's security-based swap
activities, assist the Commission in conducting compliance examinations
of those activities, and alert the Commission to potential financial or
operational problems that could impact the firm and its customers.
B. Preliminary Views and Proposed Amended Order
1. General Considerations
In issuing the Order, the Commission found that relevant EU and
German requirements, subject to conditions and limitations, would
produce regulatory outcomes that are comparable to the outcomes
associated with the recordkeeping, reporting, and notification
requirements of Exchange Act rules 18a-5, 18a-6, 18a-7, and 18a-8
applicable to SBS Entities with a prudential regulator. However, the
BaFin Application did not seek substituted compliance for the Exchange
Act capital and margin requirements applicable to SBS Entities without
a prudential regulator. Because of the close relationship between many
of the Exchange Act recordkeeping, reporting, and notification
requirements and the administration and oversight of Exchange Act
capital and margin requirements, the Order did not address substituted
compliance for recordkeeping, reporting, notification, and securities
count requirements applicable to SBS Entities without a prudential
regulator. The Commission is now considering substituted compliance for
these Exchange Act requirements because the Amended Application
requests substituted compliance for the Exchange Act capital and margin
requirements applicable to SBS Entities without a prudential regulator.
The Commission also is considering substituted compliance with respect
to the trading record preservation requirements of Exchange Act section
15F(g), which are applicable to SBS Entities with and without a
prudential regulator.
The Commission preliminarily concludes that the relevant EU and
German requirements, subject to conditions and limitations, would
produce regulatory outcomes that are comparable to the outcomes
associated with the requirements of Exchange Act rules 18a-5, 18a-6,
18a-7, 18a-8, and 18a-9 applicable to SBS Entities without a prudential
regulator and to the outcomes associated with Exchange Act section
15F(g) applicable to all SBS
[[Page 46513]]
Entities. In reaching this preliminary conclusion, the Commission
recognizes that there are certain differences between the EU and German
requirements and the Exchange Act requirements. In the Commission's
preliminary view, on balance, those differences generally would not be
inconsistent with substituted compliance for these requirements.
Requirement-by-requirement similarity is not needed for substituted
compliance.
The Order makes substituted compliance available with respect to
the entirety of Exchange Act rules 18a-5, 18a-6, 18a-7, and 18a-8 as
applicable to Covered Entities with a prudential regulator.
Consequently, under the Order, the Covered Entity can elect to apply
substituted compliance with respect to the entire rule (subject to
conditions and limitations) or, alternatively, comply with the Exchange
Act rule. The proposed Amended Order would modify this approach to
provide all Covered Entities with greater flexibility to select which
distinct requirements within the broader rule for which they would
apply substituted compliance. This would not preclude a Covered Entity
from applying substituted compliance for the entire rule (subject to
conditions and limitations). However, it would permit the Covered
Entity to apply substituted compliance with respect to certain
requirements of a given rule and to comply directly with the remaining
requirements. This more granular approach to making substituted
compliance determinations with respect to discrete requirements within
Exchange Act rules 18a-5, 18a-6, 18a-7, and 18a-8 (collectively, the
``recordkeeping, reporting, and notification rules'') is intended to
permit Covered Entities to leverage existing recordkeeping and
reporting systems that are designed to comply with the broker-dealer
recordkeeping and reporting requirements on which the recordkeeping,
reporting, and notification requirements applicable to SBS Entities are
based. For example, it may be more efficient for a Covered Entity to
comply with certain Exchange Act requirements within a given
recordkeeping, reporting, or notification rule (rather than apply
substituted compliance) because it can utilize systems that its
affiliated broker-dealer has implemented to comply with them. This
proposed approach is consistent with the approach taken by the
Commission in the French and UK Orders.\130\
---------------------------------------------------------------------------
\130\ See French Order, 86 FR 41649; UK Order, 86 FR 43360.
---------------------------------------------------------------------------
As applied to Exchange Act rules 18a-5 and 18a-6, this approach of
providing greater flexibility results in preliminary substituted
compliance determinations with respect to the different categories of
records these rules require SBS Entities to make, keep current, and/or
preserve. The objective of these rules--taken as a whole--is to assist
the Commission in monitoring and examining for compliance with
substantive Exchange Act requirements applicable to SBS Entities (e.g.,
capital and margin requirements) as well as to promote the prudent
operation of these firms.\131\ The Commission preliminarily believes
the comparable EU and German recordkeeping rules achieve these outcomes
with respect to compliance with substantive EU and German requirements
for which preliminary positive substituted compliance determinations
are being made in this proposed Amended Order (e.g., the preliminary
positive substituted compliance determinations with respect to the
Exchange Act capital and margin requirements). At the same time, the
recordkeeping rules address different categories of records through
distinct requirements within the rules. Each requirement with respect
to a specific category of records (e.g., paragraph (a)(2) of Exchange
Act rule 18a-5 addressing ledgers (or other records) reflecting all
assets and liabilities, income and expense and capital accounts) can be
viewed in isolation as a distinct recordkeeping rule. Therefore, it may
be appropriate to make substituted compliance determinations at this
level of Exchange Act rules 18a-5 and 18a-6.
---------------------------------------------------------------------------
\131\ See, e.g., Exchange Act Release No. 71958 (Apr. 17, 2014),
79 FR 25194, 25199-200 (May 2, 2014).
---------------------------------------------------------------------------
As discussed in more detail below, the Commission's preliminary
view is that substituted compliance is appropriate for most of the
requirements within the recordkeeping, reporting, and notification
rules. However, certain of the discrete requirements in these rules are
fully or partially linked to substantive Exchange Act requirements for
which substituted compliance is not available or for which a positive
substituted compliance determination would not be made under the
proposed Amended Order. In these cases, a preliminary positive
substituted compliance determination would not be made for the
requirement that is fully linked to the substantive requirement or to
the part of the requirement that is linked to the substantive
requirement. In particular, a preliminary positive substituted
compliance determination would not be made, in full or in part, for
recordkeeping, reporting, or notification requirements linked to the
following Exchange Act rules for which substituted compliance is not
available or a positive substituted compliance determination would not
be made: (1) Exchange Act rule 15Fh-4 (``Rule 15Fh-4 Exclusion''); (2)
Exchange Act rule 15Fh-5 (``Rule 15Fh-5 Exclusion''); (3) Exchange Act
rule 15Fh-6 (``Rule 15Fh-6 Exclusion''); (4) Exchange Act rule 18a-2
(``Rule 18a-2 Exclusion''); (5) Exchange Act rule 18a-4 (``Rule 18a-4
Exclusion''); (6) Regulation SBSR (``Regulation SBSR Exclusion''); and
(7) Form SBSE and its variations (``Form SBSE Exclusion''). This
proposed approach is consistent with the approach taken by the
Commission in the French and UK Orders.\132\
---------------------------------------------------------------------------
\132\ See French Order, 86 FR 41650; UK Order, 86 FR 43361.
---------------------------------------------------------------------------
In addition, certain of the requirements in the recordkeeping,
reporting, and notification rules are expressly linked to substantive
Exchange Act requirements where a preliminary positive substituted
compliance determination would be made under the proposed Amended
Order. In these cases, substituted compliance with the linked
requirement in the recordkeeping, reporting, or notification rule would
be conditioned on the Covered Entity applying substituted compliance to
the linked substantive Exchange Act requirement. This would be the case
regardless of whether the requirement is fully or partially linked to
the substantive Exchange Act requirement. The recordkeeping, reporting,
and notification requirements that are linked to a substantive Exchange
Act requirement are designed and tailored to assist the Commission in
monitoring and examining an SBS Entity's compliance with the
substantive Exchange Act requirement. EU and German recordkeeping,
reporting, and notification requirements are designed to perform a
similar role with respect to the substantive EU and German requirements
to which they are linked. Consequently, this condition would be
designed to ensure that the records, reports, and notifications of a
Covered Entity align with the substantive Exchange Act or EU or German
requirement to which they are linked. For these reasons, under the
proposed Amended Order, substituted compliance for recordkeeping,
[[Page 46514]]
reporting, and notification requirements linked to the following
Exchange Act rules would be conditioned on the Covered Entity applying
substituted compliance to the linked substantive Exchange Act rule: (1)
Exchange Act rule 15Fh-3 (``Rule 15Fh-3 Condition''); (2) Exchange Act
rule 15Fi-2 (``Rule 15Fi-2 Condition''); (3) Exchange Act rule 15Fi-3
(``Rule 15Fi-3 Condition''); (4) Exchange Act rule 15Fi-4 (``Rule 15Fi-
4 Condition''); (5) Exchange Act rule 15Fi-5 (``Rule 15Fi-5
Condition''); (6) Exchange Act rule 15Fk-1 (``Rule 15Fk-1 Condition'');
(7) Exchange Act rule 18a-1 (``Rule 18a-1 Condition''); (8) Exchange
Act rule 18a-3 (``Rule 18a-3 Condition''); (9) Exchange Act rule 18a-5
(``Rule 18a-5 Condition'') and (10) Exchange Act rule 18a-7 (``Rule
18a-7 Condition''). This proposed approach is consistent with the
approach taken by the Commission in the French and UK Orders.\133\
---------------------------------------------------------------------------
\133\ See French Order, 86 FR 41650; UK Order, 86 FR 43361.
---------------------------------------------------------------------------
Moreover, while certain recordkeeping and reporting requirements
are not expressly linked to Exchange Act rule 18a-1, they would be
important to the Commission's ability to monitor or examine for
compliance with the capital requirements of this rule. The records also
would assist the firm in monitoring its net capital position and,
therefore, in complying with Exchange rule 18a-1. Therefore,
substituted compliance with respect to these recordkeeping and
reporting requirements would be subject to the condition that the
Covered Entity applies substituted compliance with respect to Exchange
Act rule 18a-1 (i.e., the ``Rule 18a-1 Condition''). This approach
would be designed to ensure that, if the Covered Entity does not apply
substituted compliance with respect to Exchange Act rule 18a-1, it
makes and preserves records and files reports that the Commission uses
to monitor and examine for compliance with the Exchange Act rule 18a-1,
and that the firm makes and preserves records to assist it in complying
with these rules.
Additionally, substituted compliance with respect to paragraphs
(a)(1), (b), and (c) through (h) of Exchange Act rule 18a-7 would be
subject to the additional condition that the Covered Entity applies
substituted compliance with respect to Exchange Act rule 18a-
6(b)(1)(viii) (the ``Rule 18a-6(b)(1)(viii) Condition''). This record
preservation requirement is directly linked to the financial and
operational reporting requirements of paragraphs (a)(1), (b), and (c)
through (h) of Exchange Act rule 18a-7 and this additional condition
would be designed to provide clarity as to the Covered Entity's
obligations under this record preservation requirement when applying
substituted compliance with respect to paragraphs (a)(1), (b), and (c)
through (h) of Exchange Act rule 18a-7 pursuant to this proposed
Amended Order. This proposed approach is consistent with the approach
taken by the Commission in the French and UK Orders.\134\
---------------------------------------------------------------------------
\134\ See French Order, 86 FR 41650; UK Order, 86 FR 43361.
---------------------------------------------------------------------------
2. Exchange Act Rule 18a-5
Exchange Act rule 18a-5 requires SBS Entities to make and keep
current various types of records. The requirements for SBS Entities
without a prudential regulator are set forth in paragraph (a) of the
rule.\135\ The requirements for SBS Entities with a prudential
regulator are set forth in paragraph (b) of the rule.\136\ The Order
makes substituted compliance available for the requirements of
paragraph (b) of Exchange Act rule 18a-5 (subject to conditions and
limitations). The Commission is making a preliminary positive
substituted compliance determination for many of the requirements of
paragraph (a) of Exchange Act rule 18a-5 and making preliminary
positive substituted compliance determinations with respect to
paragraph (b) in a more granular manner than the Order.\137\
---------------------------------------------------------------------------
\135\ See paras. (a)(1) through (18) of Exchange Act rule 18a-5.
\136\ See paras. (b)(1) through (14) of Exchange Act rule 18a-6.
\137\ See para. (f)(1) of the proposed Amended Order.
---------------------------------------------------------------------------
However, certain of the requirements in these paragraphs are linked
to substantive Exchange Act requirements for which substituted
compliance is not available or a positive substituted compliance would
not be made under the proposed Amended Order. In these cases, a
positive substituted compliance determination would not be made for the
linked requirement in Exchange Act rule 18a-5 or the portion of the
requirement in Exchange Act rule 18a-5 that is linked to the
substantive Exchange Act requirement.\138\
---------------------------------------------------------------------------
\138\ A positive preliminary substituted compliance
determination would not be made for the following requirements of
Exchange Act rule 18a-5 because they are linked to a substantive
Exchange Act requirement for which the proposed Amended Order would
not provide substituted compliance: (1) The portion of Exchange Act
rule 18a-5(a)(9) that relates to Exchange Act rule 18a-2 would be
subject to the Rule 18a-2 Exclusion; (2) Exchange Act rules 18a-
5(a)(13) and (14) and (b)(9) and (10) are fully linked to Exchange
Act rule 18a-4 and, therefore, would be subject to the Rule 18a-4
Exclusion; (3) the portions of Exchange Act rules 18a-5(a)(16) and
(b)(12) that relate to Exchange Act rule 15Fh-6 would be subject to
the Rule 15Fh-6 Exclusion; (4) the portions of Exchange Act rules
18a-5(a)(17) and (b)(13) that relate to Exchange Act rule 15Fh-4
would be subject to the Rule 15Fh-4 Exclusion; and (5) the portions
of Exchange Act rules 18a-5(a)(17) and (b)(13) that relate to
Exchange Act rule 15Fh-5 would be subject to the 15Fh-5 Exclusion.
---------------------------------------------------------------------------
In addition, certain of the requirements in Exchange Act rule 18a-5
are fully or partially linked to substantive Exchange Act requirements
where a preliminary positive substituted compliance determination would
be made under the proposed Amended Order. In these cases, substituted
compliance with the requirement in Exchange Act rule 18a-5 would be
conditioned on the Covered Entity applying substituted compliance to
the linked substantive Exchange Act requirement.\139\
---------------------------------------------------------------------------
\139\ Substituted compliance with the following requirements of
Exchange Act rule 18a-5 would be conditioned on the Covered Entity
applying substituted compliance to the linked substantive Exchange
Act requirement: (1) Exchange Act rules 18a-5(a)(6), (a)(15), (b)(6)
and (b)(11) are linked to Exchange Act rule 15Fi-2 and, therefore,
would be subject to the Rule 15Fi-2 Condition; (2) Exchange Act rule
18a-5(a)(9) is linked to Exchange Act rule 18a-1 and, therefore,
would be subject to the Rule 18a-1 Condition; (3) Exchange Act rule
18a-5(a)(12) is linked to Exchange Act rule 18a-3 and, therefore,
would be subject to the Rule 18a-3 Condition; (4) Exchange Act rules
18a-5(a)(17) and (b)(13) are linked to Exchange Act rule 15Fh-3 and,
therefore, would be subject to the Rule 15Fh-3 Condition; (5)
Exchange Act rules 18a-5(a)(17) and (b)(13) are linked to Exchange
Act rule 15Fk-1 and, therefore, would be subject to the Rule 15Fk-1
Condition; (6) Exchange Act rules 18a-5(a)(18)(i) and (ii) and
(b)(14)(i) and (ii) are linked to Exchange Act rule 15Fi-3 and,
therefore, would be subject to the Rule 15Fi-3 Condition; and (7)
Exchange Act rules 18a-5(a)(18)(iii) and (b)(14)(iii) are linked to
Exchange Act rule 15Fi-4 and, therefore, would be subject to the
Rule 15Fi-4 Condition.
---------------------------------------------------------------------------
Moreover, there are certain requirements in Exchange Act rule 18a-5
that are not expressly linked to Exchange Act rule 18a-1, but that
would be important records in terms of the Commission's ability to
examine for compliance with that rule, and the Covered Entity's ability
to monitor its net capital position. Therefore, substituted compliance
with respect to these requirements of Exchange Act rule 18a-5 would be
subject to the condition that the Covered Entity applies substituted
compliance for Exchange Act rule 18a-1 (i.e., the Rule 18a-1
Condition).\140\
---------------------------------------------------------------------------
\140\ Substituted compliance with the requirements of Exchange
Act rules 18a-5(a)(1), (2), (3), (4), (5), (7), (8), and (9) would
be conditioned on the Covered Entity applying substituted compliance
to Exchange Act rule 18a-1.
---------------------------------------------------------------------------
In addition, the proposed Amended Order would allow a Covered
Entity to apply substituted compliance on a transaction-by-transaction
basis to the Commission's recordkeeping
[[Page 46515]]
requirements that are linked with the counterparty protection
requirements of Exchange Act rule 15Fh-3.\141\ This approach would
align with the proposed Amended Order allowing Covered Entities to
apply substituted compliance on a transaction-by-transaction basis for
the Commission's counterparty protection requirements.
---------------------------------------------------------------------------
\141\ See para. (f)(1)(ii)(B) of the proposed Amended Order.
---------------------------------------------------------------------------
Under the proposed Amended Order, substituted compliance in
connection with the record making requirements of Exchange Act rule
18a-5 would be subject to the condition that the Covered Entity: (1)
Preserves all of the data elements necessary to create the records
required by Exchange Act rules 18a-5(a)(1), (2), (3), (4), and (7) (if
not prudentially regulated) or Exchange Act rules 18a-5(b)(1), (2),
(3), and (7) (if prudentially regulated); and (2) upon request
furnishes promptly to representatives of the Commission the records
required by those rules (``SEC Format Condition'').\142\ This proposed
condition is modeled on the alternative compliance mechanism in
paragraph (c) of Exchange Act rule 18a-5. In effect, a Covered Entity
applying substituted compliance with respect to these requirements of
Exchange Act rule 18a-5 would need to comply with the comparable EU and
German requirements. However, under the SEC Format Condition, the
Covered Entity would need to produce a record that is formatted in
accordance with the requirements of Exchange Act rule 18a-5 at the
request of Commission staff. The objective would be to require--on a
very limited basis--the production of a record that consolidates the
information required by Exchange Act rules 18a-5(a)(1), (2), (3), (4),
and (7) (if not prudentially regulated) or Exchange Act rules 18a-
5(b)(1), (2), (3), and (7) (if prudentially regulated) in a single
record and, as applicable, in a blotter or ledger format. This would
assist the Commission staff in reviewing the information on the record.
---------------------------------------------------------------------------
\142\ See para. (f)(1)(ii)(A) of the proposed Amended Order. The
Order includes this condition for a Covered Entity with a prudential
regular to apply substituted compliance for Exchange Act rule 18a-5.
The proposed Amended Order would extend the scope of this condition
to address Covered Entities without a prudential regulator applying
substituted compliance for the requirements of Exchange Act rule
18a-5.
---------------------------------------------------------------------------
The following table summarizes the Commission's preliminary
positive substituted compliance determinations with respect to
requirements of Exchange Act rule 18a-5 by listing in each row: (1) The
paragraph of the proposed Amended Order that sets forth the preliminary
determination; (2) the paragraph(s) of Exchange Act rule 18a-5 to which
the preliminary determination applies; (3) a brief description of the
records required by the paragraph(s); and (4) a brief description of
any additional conditions to applying substituted compliance to the
requirements, including any partial exclusions because portions of the
requirements are linked to substantive Exchange Act requirements for
which the proposed Amended Order would not provide substituted
compliance.\143\
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\143\ The table does not include the proposed conditions for
applying substituted compliance to Exchange Act rule 18a-5; namely
that the Covered Entity: (1) Must be subject to and comply with
specified requirements of foreign law; and (2) as discussed below,
must promptly furnish to a representative of the Commission upon
request an English translation of a record. See para. (f)(8) of the
proposed Amended Order (setting forth the English translation
requirement).
Exchange Act Rule 18a-5
[Record making]
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Order paragraph Rule paragraph Rule description Additional conditions
and
partial exclusions
----------------------------------------------------------------------------------------------------------------
(f)(1)(i)(A).............. (a)(1)............. (b)(1)............ Trade blotters.... (1) SEC Format
Condition.
(2) Rule 18a-1
Condition for ]
(a)(1).
(f)(1)(i)(B).............. (a)(2)............. .................. General ledger.... (1) SEC Format
Condition.
(2) Rule 18a-1
Condition for ]
(a)(2).
(f)(1)(i)(C).............. (a)(3)............. (b)(2)............ Account ledgers... (1) SEC Format
Condition.
(2) Rule 18a-1
Condition for ]
(a)(3).
(f)(1)(i)(D).............. (a)(4)............. (b)(3)............ Stock record...... (1) SEC Format
Condition.
(2) Rule 18a-1
Condition for ]
(a)(4).
(f)(1)(i)(E).............. ................... (b)(4)............ Memoranda of N/A.
brokerage orders.
(f)(1)(i)(F).............. (a)(5)............. (b)(5)............ Memoranda of Rule 18a-1 Condition
proprietary for ] (a)(5).
orders.
(f)(1)(i)(G).............. (a)(6)............. (b)(6)............ Confirmations, Rule 15Fi-2 Condition.
(a)(15)............ (b)(11)........... trade
verification.
(f)(1)(i)(H).............. (a)(7)............. (b)(7)............ Accountholder (1) SEC Format
information. Condition.
(2) Rule 18a-1
Condition for ]
(a)(7).
(f)(1)(i)(I).............. (a)(8)............. .................. Options positions. Rule 18a-1 Condition.
(f)(1)(i)(J).............. (a)(9)............. .................. Trial balances, (1) Rule 18a-1
computation of Condition.
net capital and (2) Rule 18a-2
tangible net Exclusion.
worth.
(f)(1)(i)(K).............. (a)(10)............ (b)(8)............ Associated N/A.
person's
employment
application.
(f)(1)(i)(L).............. (a)(12)............ .................. Non-cleared margin Rule 18a-3 Condition.
rule calculations.
(f)(1)(i)(M).............. (a)(17)............ (b)(13)........... Compliance with (1) Rule 15Fh-3
business conduct Condition.
requirements. (2) Rule 15Fk-1
Condition.
(3) Rule 15Fh-4
Exclusion.
(4) Rule 15Fh-5
Exclusion.
(f)(1)(i)(N).............. (a)(18)(i)......... (b)(14)(i)........ Portfolio Rule 15Fi-3 Condition.
(a)(18)(ii)........ (b)(14)(ii)....... reconciliation.
(f)(1)(i)(O).............. (a)(18)(iii)....... (b)(14)(iii)...... Portfolio Rule 15Fi-4 Condition.
compression.
----------------------------------------------------------------------------------------------------------------
[[Page 46516]]
The following table summarizes the Commission's preliminary
determinations with respect to requirements of Exchange Act rule 18a-5
for which a positive substituted compliance determination would not be
made because they are fully linked to substantive Exchange Act
requirements for which the proposed Amended Order would not provide
substituted compliance by listing in each row: (1) The paragraph of the
proposed Amended Order that sets forth the determination; (2) the
paragraphs of Exchange Act rule 18a-5 to which the determination
applies; (3) a brief description of the records required by the
paragraphs; and (4) a brief description of why the requirement is
excluded from substituted compliance.
Exchange Act Rule 18a-5
[Record making]
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Order paragraph Rule paragraph Rule description Exclusion
----------------------------------------------------------------------------------------------------------------
(f)(1)(ii)(C)............. (a)(13)............ (b)(9)............ Possession or Rule 18a-4 Exclusion.
control records.
(f)(1)(ii)(C)............. (a)(14)............ (b)(10)........... Reserve Rule 18a-4 Exclusion.
computations.
(f)(1)(ii)(C)............. (a)(16)............ (b)(12)........... Political Rule 15Fh-6 Exclusion.
contribution
records.
----------------------------------------------------------------------------------------------------------------
3. Exchange Act Rule 18a-6
Exchange Act rule 18a-6 requires an SBS Entity to preserve certain
types of records if it makes or receives them (in addition to the
records the SBS Entity is required to make and keep current pursuant to
Exchange Act rule 18a-5).\144\ Exchange Act rule 18a-6 also prescribes
the time period that these additional records and the records required
to be made and kept current pursuant to Exchange Act rule 18a-5 must be
preserved and the manner in which they must be preserved.
---------------------------------------------------------------------------
\144\ See 17 CFR 240.18a-6.
---------------------------------------------------------------------------
Paragraphs (a) through (d) of Exchange Act rule 18a-6 identify the
records that an SBS Entity must retain if it makes or receives them and
prescribes the retention periods for these records as well as for the
records that must be made and kept current pursuant to Exchange Act
rule 18a-5. Certain of these paragraphs prescribe requirements
separately for SBS Entities without a prudential regulator and SBS
Entities with a prudential regulator.\145\ The Order makes substituted
compliance available for the requirements of these paragraphs
applicable to SBS Entities with a prudential regulator. As discussed
below, the Commission is making a preliminary positive substituted
compliance determination for many of the requirements of these
paragraphs applicable to SBS Entities without a prudential regulator.
Further, the Commission is making preliminary positive substituted
compliance determinations for many of the requirements of these
paragraphs applicable to SBS Entities with a prudential regulator in a
more granular manner than the Order.
---------------------------------------------------------------------------
\145\ Paras. (a)(1), (b)(1), (d)(2)(i), and (d)(3)(i) of
Exchange Act rule 18a-6 apply to SBS Entities without a prudential
regulator. Paras. (a)(2), (b)(2), (d)(2)(ii), and (d)(3)(ii) of
Exchange Act rule 18a-6 apply to SBS Entities with a prudential
regulator. Paras. (c), (d)(1), (d)(4), and (d)(5) of Exchange Act
rule 18a-6 apply to SBS Entities irrespective of whether they have a
prudential regulator.
---------------------------------------------------------------------------
However, certain of these requirements are fully or partially
linked to substantive Exchange Act requirements for which a positive
substituted compliance determination would not be made under the
proposed Amended Order. In these cases, a positive substituted
compliance determination would not be made for the linked requirement
in Exchange Act rule 18a-6.\146\
---------------------------------------------------------------------------
\146\ A positive substituted compliance determination would not
be made for the following requirements of Exchange Act rule 18a-6
because they are linked to a substantive Exchange Act requirement
for which the proposed Amended Order would not provide substituted
compliance: (1) The portion of Exchange Act rule 18a-6(b)(1)(v)
relating to Exchange Act rule 18a-2 would be subject to the Rule
18a-2 Exclusion; (2) Exchange Act rule 18a-6(b)(1)(viii)(L) is fully
linked to Exchange Act Rule 18a-4 and, therefore, would be subject
to the Rule 18a-4 Exclusion; (3) the portion of Exchange Act rule
18a-6(b)(1)(viii)(M) relating to Exchange Act rule 18a-2 would be
subject to the Rule 18a-2 Exclusion; (4) Exchange Act rules 18a-
6(b)(1)(xi) and (b)(2)(vi) are fully linked to Regulation SBSR and,
therefore, would be subject to the Regulation SBSR Exclusion; (5)
Exchange Act rules 18a-6(b)(1)(xiii) and 18a-6(b)(2)(viii) are fully
linked to Exchange Act rules 15Fh-4 and, therefore, would be subject
to the Rule 15Fh-4 Exclusion; (6) Exchange Act rules 18a-
6(b)(1)(xiii) and 18a-6(b)(2)(viii) are fully linked to Exchange Act
rule 15Fh-5 and, therefore, would be subject to the Rule 15Fh-5
Exclusion; (7) Exchange Act rule 18a-6(b)(2)(v) is fully linked to
Exchange Act rule 18a-4 and, therefore, would be subject to the Rule
18a-4 Exclusion; and (8) the portion of Exchange Act rule 18a-6(c)
relating to Form SBSE and its variations would be subject to the
Form SBSE Exclusion.
---------------------------------------------------------------------------
In addition, certain of the requirements in Exchange Act rule 18a-6
are fully or partially linked to substantive Exchange Act requirements
where a positive substituted compliance determination would be made
under the proposed Amended Order. In these cases, substituted
compliance with the requirement in Exchange Act rule 18a-6 would be
conditioned on the Covered Entity applying substituted compliance to
the linked substantive Exchange Act requirement.\147\
---------------------------------------------------------------------------
\147\ Substituted compliance with the following requirements of
Exchange Act rule 18a-6 would be conditioned on the Covered Entity
applying substituted compliance to the linked substantive Exchange
Act requirement: (1) Exchange Act rule 18a-6(b)(1)(v) is linked to
Exchange Act rule 18a-1 and, therefore, would be subject to the Rule
18a-1 Condition; (2) Exchange Act rules 18a-6(b)(1)(viii) and
(b)(2)(v) are linked to Exchange Act rule 18a-7 and, therefore,
would be subject to the Rule 18a-7 Condition; (3) Exchange Act rule
18a-6(b)(1)(viii) is linked to Exchange Act rule 18a-1 and,
therefore, would be subject to the Rule 18a-1 Condition; (4)
Exchange Act rule 18a-6(b)(1)(ix) is linked to Exchange Act rule
18a-1 and, therefore, would be subject to the Rule 18a-1 Condition;
(5) Exchange Act rule 18a-6(b)(1)(x) is linked to Exchange Act rule
18a-1 and, therefore, would be subject to the Rule 18a-1 Condition;
(6) Exchange Act rules 18a-6(b)(1)(xii) and (b)(2)(vii) are linked
to Exchange Act rule 15Fh-3 and, therefore, would be subject to the
Rule 15Fh-3 Condition; (7) Exchange Act rules 18a-6(b)(1)(xii) and
(b)(2)(vii) are linked to Exchange Act rule 15Fk-1 and, therefore,
would be subject to the Rule 15Fk-1 Condition; (8) Exchange Act
rules 18a-6(d)(4) and (d)(5) are linked to Exchange Act rule 15Fi-3
and, therefore, would be subject to the Rule 15Fi-3 Condition; (9)
Exchange Act rules 18a-6(d)(4) and (d)(5) are linked to Exchange Act
rule 15Fi-4 and, therefore, would be subject to the Rule 15Fi-4
Condition; and (10) Exchange Act rules 18a-6(d)(4) and (d)(5) are
linked to Exchange Act rule 15Fi-3 and, therefore, would be subject
to the Rule 15Fi-5 Condition.
---------------------------------------------------------------------------
Moreover, there are certain requirements in Exchange Act rule 18a-6
that are not expressly linked to Exchange Act rule 18a-1, but that
would be important records in terms of the Commission's ability to
examine for compliance with that rule, and the Covered Entity's ability
to monitor its net capital position. Therefore, under the proposed
Amended Order, substituted compliance for these requirements of
Exchange Act rule 18a-6 would be subject to the Rule 18a-1
Condition.\148\
---------------------------------------------------------------------------
\148\ Substituted compliance with the requirements of Exchange
Act rules 18a-6(b)(1)(ii), (b)(1)(iii), (b)(1)(vi), (b)(1)(vii),
(d)(2)(i), and (d)(3)(i) would be conditioned on the Covered Entity
applying substituted compliance to Exchange Act rule 18a-1.
---------------------------------------------------------------------------
Paragraph (e) of Exchange Act rule 18a-6 sets forth the
requirements for
[[Page 46517]]
preserving records electronically. Paragraph (f) sets forth
requirements for when records are prepared or maintained by a third
party. The Order makes substituted compliance available for the
requirements of paragraphs (e) and (f) of Exchange Act rule 18a-6 if
the Covered Entity has a prudential regulator. The proposed Amended
Order would extend this treatment to Covered Entities without a
prudential regulator.\149\
---------------------------------------------------------------------------
\149\ See paras. (f)(2)(i)(Q) and (R) of the proposed Amended
Order.
---------------------------------------------------------------------------
Paragraph (g) of Exchange Act rule 18a-6 requires an SBS Entity to
furnish promptly to a representative of the Commission legible, true,
complete, and current copies of those records of the SBS Entity that
are required to be preserved under Exchange Act rule 18a-6, or any
other records of the SBS Entity that are subject to examination or
required to be made or maintained pursuant to section 15F of the
Exchange Act that are requested by a representative of the Commission.
The Order does not make substituted compliance available for the
requirements of paragraph (g) of Exchange Act rule 18a-6 because there
is no comparable requirement in the EU or Germany to produce these
records to a representative of the Commission. The proposed Amended
Order similarly would not make substituted compliance available for
paragraph (g) of Exchange Act rule 18a-6.
The following table summarizes the Commission's preliminary
positive substituted compliance determinations with respect to
requirements of Exchange Act rule 18a-6 by listing in each row: (1) The
paragraph of the proposed Amended Order that sets forth the
determination; (2) the paragraph(s) of Exchange Act rule 18a-6 to which
the determination applies; (3) a brief description of the records
required by the paragraph(s); and (4) a brief description of any
additional conditions to applying substituted compliance to the
requirements, including any partial exclusions because portions of the
requirements are linked to substantive Exchange Act requirements for
which the proposed Amended Order would not provide substituted
compliance.\150\
---------------------------------------------------------------------------
\150\ The table does not include the proposed conditions for
applying substituted compliance to Exchange Act rule 18a-6; namely
that the Covered Entity: (1) Must be subject to and complies with
the requirements of foreign law; and (2) must promptly furnish to a
representative of the Commission upon request an English translation
of a record. See para. (f)(8) of the proposed Amended Order (setting
forth the English translation requirement).
Exchange Act Rule 18a-6
[Record preservation]
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Order paragraph Rule paragraph Rule description Conditions and partial
exclusions
----------------------------------------------------------------------------------------------------------------
(f)(2)(i)(A).............. (a)(1)............. (a)(2)............ 6 year record N/A.
preservation.
(f)(2)(i)(B).............. (b)(1)(i).......... (b)(2)(i)......... 3 year record N/A.
preservation.
(f)(2)(i)(C).............. (b)(1)(ii)......... .................. Bank records, Rule 18a-1 Condition.
(b)(1)(iii)........ bills.
(f)(2)(i)(D).............. (b)(1)(iv)......... (b)(2)(ii)........ Communications.... N/A.
(f)(2)(i)(E).............. (b)(1)(v).......... .................. Trial balances.... (1) Rule 18a-1
Condition.
(2) Rule 18a-2
Exclusion.
(f)(2)(i)(F).............. (b)(1)(vi)......... (b)(2)(iii)....... Account documents. Rule 18a-1 Condition
for ] (b)(1)(vi).
(f)(2)(i)(G).............. (b)(1)(vii)........ (b)(2)(iv)........ Written agreements Rule 18a-1 Condition
for ] (b)(1)(vii).
(f)(2)(i)(H).............. (b)(1)(viii)....... .................. Information (1) Rule 18a-7
supporting Condition.
financial reports. (2) Rule 18a-4
Exclusion for ]
(b)(1)(viii)(L).
(3) Rule 18a-2
Exclusion for ]
(b)(1)(viii)(M).
(f)(2)(i)(I).............. (b)(1)(ix)......... .................. Rule 15c3-4 risk Rule 18a-1 Condition.
management
records.
(f)(2)(i)(J).............. (b)(1)(x).......... .................. Credit risk Rule 18a-1 Condition.
determinations.
(f)(2)(i)(K).............. (b)(1)(xii)........ (b)(2)(vii)....... Business conduct (1) Rule 15Fh-3
standard records. Condition.
(2) Rule 15Fk-1
Condition.
-----------------------------------------
(f)(2)(i)(L).............. (c) Corporate Form SBSE Exclusion.
documents.
-----------------------------------------
(f)(2)(i)(M).............. (d)(1) Associated N/A.
person's
employment
application.
-----------------------------------------
(f)(2)(i)(N).............. (d)(2)(i).......... (d)(2)(ii)........ Regulatory Rule 18a-1 Condition
authority reports. for ] (d)(2)(i).
(f)(2)(i)(O).............. (d)(3)(i).......... (d)(3)(ii)........ Compliance, Rule 18a-1 Condition
supervisory, and for ] (d)(3)(i).
procedures
manuals.
-----------------------------------------
(f)(2)(i)(P).............. (d)(4) Portfolio (1) Rule 15Fi-3
reconciliation. Condition.
(d)(5) (2) Rule 15Fi-4
Condition.
(3) Rule 15Fi-5
Condition.
-----------------------------------------
(f)(2)(i)(Q).............. (e) Electronic storage N/A.
system.
(f)(2)(i)(R).............. (f) Third-party N/A.
recordkeeper.
----------------------------------------------------------------------------------------------------------------
The following table summarizes the Commission's preliminary
determinations with respect to requirements of Exchange Act rule 18a-6
for which a positive substituted compliance determination would not be
made because they are fully linked to substantive Exchange Act
requirements for which the proposed Amended Order would not provide
substituted compliance by listing in each row: (1) The paragraph of the
proposed Amended Order that sets forth the determination; (2) the
paragraph(s) of Exchange Act rule 18a-6 to which the
[[Page 46518]]
determination applies; (3) a brief description of the records required
by the paragraph(s); and (4) a brief description of why the requirement
is excluded from substituted compliance.
Exchange Act Rule 18a-6
[Preservation]
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Order paragraph Rule paragraph Rule description Exclusion
----------------------------------------------------------------------------------------------------------------
(f)(2)(ii)................ (b)(1)(xi)......... (b)(2)(vi)........ Regulation SBSR Regulation SBSR
information. Exclusion.
(f)(2)(i)(H).............. ................... (b)(2)(v)......... Information Rule 18a-4 Exclusion.
supporting
financial reports.
(f)(2)(ii)................ (b)(1)(xiii)....... (b)(2)(viii)...... Special entity (1) Rule 15Fh-4
documents. Exclusion.
(2) Rule 15Fh-5
Exclusion.
----------------------------------------------------------------------------------------------------------------
4. Exchange Act Rule 18a-7
Exchange Act rule 18a-7 requires SBS Entities, on a monthly basis
(if not prudentially regulated) or on a quarterly basis (if
prudentially regulated), to file an unaudited financial and operational
report on the FOCUS Report Part II (if not prudentially regulated) or
Part IIC (if prudentially regulated). The Commission will use the FOCUS
Reports filed by the SBS Entities to both monitor the financial and
operational condition of individual SBS Entities and to perform
comparisons across SBS Entities. The FOCUS Report Part IIC elicits less
information than the FOCUS Report Part II because the Commission does
not have responsibility for overseeing the capital and margin
requirements applicable to these entities.
The FOCUS Report Parts II and IIC are standardized forms that
elicit specific information through numbered line items. This
facilitates cross-firm analysis and comprehensive monitoring of all SBS
Entities registered with the Commission. Further, the Commission has
designated the Financial Industry Regulatory Authority, Inc.
(``FINRA'') to receive the FOCUS Reports from SBS Entities.\151\
Broker-dealers registered with the Commission currently file their
FOCUS Reports with FINRA through the eFOCUS system it administers.
Using FINRA's eFOCUS system will enable broker-dealers, security-based
swap dealers, and major security-based swap participants to file FOCUS
Reports on the same platform using the same preexisting templates,
software, and procedures.
---------------------------------------------------------------------------
\151\ See Order Designating Financial Industry Regulatory
Authority, Inc., to Receive Form X-17A-5 (FOCUS Report) from Certain
Security-Based Swap Dealers and Major Security-Based Swap
Participants, Exchange Act Release No. 88866 (May 14, 2020).
---------------------------------------------------------------------------
Paragraph (a)(2) of Exchange Act rule 18a-7 requires SBS Entities
with a prudential regulator to file the FOCUS Report Part IIC on a
quarterly basis. The Order provides substituted compliance for this
requirement subject to the condition that the Covered Entity file with
the Commission periodic unaudited financial and operational information
in the manner and format specified by the Commission by order or rule
(``Manner and Format Condition'') and present the financial information
in accordance with GAAP that the firm uses to prepare general purpose
publicly available or available to be issued financial statements in
Germany (``German GAAP Condition'').\152\ The proposed Amended Order
would continue to provide Covered Entities with a prudential regulator
substituted compliance for paragraph (a)(2) of Exchange Act rule 18a-7,
subject to the Manner and Format and German GAAP Conditions.\153\ The
Commission continues to believe that it would be appropriate to
condition substituted compliance with respect to Exchange Act rule 18a-
7 on the Covered Entity filing unaudited financial and operational
information in a manner and format that facilitates cross-firm analysis
and comprehensive monitoring of all SBS Entities registered with the
Commission.\154\ For example, the Commission could by order or rule
require SBS Entities to file the financial and operational information
with FINRA using the FOCUS Report Part II (if not prudentially
regulated) or Part IIC (if prudentially regulated) but permit the
information input into the form to be the same information the SBS
Entity reports to EU and German authorities.
---------------------------------------------------------------------------
\152\ Under the Order, Covered Entities with a prudential
regulator must present the information reported in the FOCUS Report
in accordance with GAAP that the firm uses to prepare publicly
available or available to be issued general purpose financial
statements in its home jurisdiction instead of U.S. GAAP if other
GAAP, such as International Financial Reporting Standards (IFRS) as
issued by the International Accounting Standards Board (IASB), is
used by the Covered Entity in preparing publicly available or
available to be issued general purpose financial statements in
Germany.
\153\ See para. (f)(3)(i) of the proposed Amended Order.
\154\ In addition to the Order, the Manner and Format condition
is included in the French and UK Orders. See French Order, 86 FR
41651; UK Order, 86 FR 43361-62.
---------------------------------------------------------------------------
Paragraph (a)(1) of Exchange Act rule 18a-7 requires SBS Entities
without a prudential regulator to file the FOCUS Report Part II on a
monthly basis. The proposed Amended Order would provide Covered
Entities without a prudential regulator substituted compliance for
paragraph (a)(1) of Exchange Act rule 18a-7 subject to the Manner and
Format and German GAAP conditions.\155\ However, there would two
additional conditions. First, for the reasons discussed above, the
Covered Entity would need to apply substituted compliance for Exchange
Act Rule 18a-1 (i.e., substituted compliance would be subject to the
Rule 18a-1 Condition).\156\ Second, the Covered Entity would need to
apply substituted compliance with respect to Exchange Act rule 18a-
6(b)(1)(viii) (a record preservation requirement) (``Rule 18a-
6(b)(1)(viii) Condition'').\157\ This record preservation requirement
is directly linked to the financial and operational reporting
requirements of Exchange Act rule 18a-7(a)(1).
---------------------------------------------------------------------------
\155\ See para. (f)(3)(i) of the proposed Amended Order.
\156\ See para. (f)(3)(i)(C) of the proposed Amended Order. See
part VII.B.1, supra (discussing how certain recordkeeping and
reporting requirements are expressly linked to or important for
examining compliance with Rule 18a-1 condition).
\157\ See para. (f)(3)(i)(D) of the proposed Amended Order.
---------------------------------------------------------------------------
Paragraph (a)(3) of Exchange Act rule 18a-7 requires SBS Entities
without a prudential regulator that have been authorized by the
Commission to compute net capital under Exchange Act rule 18a-1 using
models to file certain monthly or quarterly information related to
their use of models.\158\ Paragraph (b) of Exchange Act rule 18a-7
requires SBS Entities that are not prudentially regulated to make
certain financial information available on their
[[Page 46519]]
websites.\159\ Paragraphs (c), (d), (e), (f), (g), and (h) of Exchange
Act rule 18a-7 set forth requirements for SBS Entities that are not
prudentially regulated to annually file financial statements and
certain reports, as well as reports covering those statements and
reports prepared by an independent public accountant.\160\ Paragraph
(i) of Exchange Act rule 18a-7 requires SBS Entities that do not have a
prudential regulator to notify the Commission when they change their
fiscal year.\161\ Finally, Paragraph (j) of Exchange Act rule 18a-7
sets forth requirements with respect to the reports that must be filed
with the Commission under the rule.\162\
---------------------------------------------------------------------------
\158\ See 17 CFR 240.18a-7(a)(3).
\159\ See 17 CFR 240.18a-7(b).
\160\ See 17 CFR 240.18a-7(c) through (h).
\161\ See 17 CFR 240.18a-7(i).
\162\ See 17 CFR 240.18a-7(i).
---------------------------------------------------------------------------
The Commission preliminarily is making a positive substituted
compliance determination for paragraphs (b) through (j) of Exchange Act
rule 18a-7. As discussed below, substituted compliance with respect to
these paragraphs of Exchange Act rule 18a-7 would be subject to certain
conditions and limitations.
First, certain of the requirements in Exchange Act rule 18a-7 are
fully or partially linked to substantive Exchange Act requirements for
which a positive substituted compliance determination would be made
under the proposed Amended Order. In these cases, substituted
compliance with the requirement in Exchange Act rule 18a-7 would be
conditioned on the Covered Entity applying substituted compliance to
the linked substantive Exchange Act requirement.\163\
---------------------------------------------------------------------------
\163\ Substituted compliance with the following requirements of
Exchange Act rule 18a-7 would be conditioned on the Covered Entity
applying substituted compliance to the linked substantive Exchange
Act requirement: (1) Exchange Act rule 18a-7(a)(1) is linked to
Exchange Act rules 18a-1 and 18a-6(b)(1)(viii) and, therefore, would
be subject to the Rule 18a-1 Condition and the Rule 18a-
6(b)(1)(viii) Condition; (2) Exchange Act rule 18a-7(a)(3) is linked
to Exchange Act rule 18a-1 and, therefore, would be subject to the
Rule 18a-1 Condition; (3) Exchange Act rule 18a-7(b) is linked to
Exchange Act rule 18a-6(b)(1)(viii) and, therefore, would be subject
to the Rule 18a-6(b)(1)(viii) Condition; and (4) Exchange Act rules
18a-7(c), (d), (e), (f), (g) and (h) taken as a whole are linked to
Exchange Act rules 18a-1 and 18a-6(b)(1)(viii) and, therefore, would
be subject to the Rule 18a-1 Condition and the Rule 18a-
6(b)(1)(viii) Condition.
---------------------------------------------------------------------------
Second, under the proposed Amended Order, substituted compliance in
connection with the requirement that Covered Entities without a
prudential regulator file audited annual reports under Exchange Act
rule 18a-7 would be subject to six conditions.\164\ The first condition
would be that the Covered Entity simultaneously sends a copy of the
financial statements the Covered Entity is required to file with EU or
German authorities, including a report of an independent public
accountant covering the financial statements, to the Commission in the
manner specified on the Commission's website (``SEC Filing
Condition''). Because EU and German laws would not otherwise require
the financial statements and report of the independent public
accountant covering the financial statements to be filed with the
Commission, the purpose of this condition would be to provide the
Commission with the financial statements and report to more effectively
supervise and monitor Covered Entities.
---------------------------------------------------------------------------
\164\ See para. (f)(3)(iv)(B) to the proposed Amended Order.
---------------------------------------------------------------------------
The second condition would be that the Covered Entity include with
the transmission of the annual financial statements and report the
contact information of an individual who can provide further
information about the financial statements and reports (``Contact
Information Condition''). This would assist the Commission staff in
promptly contacting an individual at the Covered Entity who can respond
to questions that information on the financial statements or report may
raise about the Covered Entity's financial or operational condition.
The third condition would be that the Covered Entity includes with
the transmission the report of an independent public accountant
required by Exchange Act rule 18a-7(c)(1)(i)(C) covering the annual
financial statements if EU and German laws do not require the Covered
Entity to engage an independent public accountant to prepare a report
covering the annual financial statements (``Accountant's Report
Condition''). The third condition further would provide that the report
of the independent public accountant may be prepared in accordance with
generally accepted auditing standards (``GAAS'') in Germany that are
used to perform audit and attestation services and the accountant
complies with German independence requirements. According to the BaFin
Application, German laws only require certain investment firms
(depending on their size) to have their financial statements audited,
so this condition would be designed to ensure that all SBS Entities
subject to the requirement in rule 18a-7 to file audited annual reports
are required to have their financial statements audited.
The fourth condition would be that a Covered Entity that is a
security-based swap dealer would need to file the reports required by
Exchange Act rule 18a-7(c)(1)(i)(B) and (C) addressing the statements
identified in Exchange Act rule 18a-7(c)(3) or (c)(4), as applicable,
that relate to Exchange Act rule 18a-4 (``Rule 18a-4 Limited
Exclusion'').\165\ These reports are designed to provide the Commission
with information about an SBS Entity's compliance with Rule 18a-4.
Substituted compliance is not available for Exchange Act rule 18a-4
and, therefore, this condition is designed to provide the Commission
with similar compliance information. Under this condition, Covered
Entities would need to file a limited compliance report that includes
the statements relating to Rule 18a-4 \166\ or an exemption report if
the Covered Entity claims an exemption from Rule 18a-4. The Covered
Entity also would need to file the report of an independent public
accountant covering the limited compliance report or exemption report.
The fourth condition further would provide that the report of the
independent public accountant may be prepared in accordance with GAAS
in Germany that are used to perform audit and attestation services and
the accountant complies with German independence requirements.
---------------------------------------------------------------------------
\165\ The Commission views this as a limited exclusion from the
availability of substituted compliance for these requirements
because the proposed Amended Order would permit these reports
relating Exchange Act rule 18a-4 to be included with the German
regulatory reports the Covered Entities will file with the
Commission and because the reports could be prepared in accordance
with German GAAS (as discussed below).
\166\ The limited compliance report would not need to address
Exchange Act rule 18a-9 if the Covered Entity is applying
substituted compliance to this requirement. Further, as discussed
above, substituted compliance with paras. (c) through (h) of
Exchange Act rule 18a-7 is conditioned on the Covered Entity
applying substituted compliance to Exchange Act rule 18a-1.
Therefore, the Covered Entity would not need to address that rule in
the compliance report. Finally, the Covered Entity would not need to
address an account statement rule of a self-regulatory organization.
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The fifth condition would be that a Covered Entity that is a major
security-based swap participant would need to file the supporting
schedules required by Exchange Act rule 18a-7(c)(1)(i)(A) and (C)
addressing the statements identified in Exchange Act rules 18a-
7(c)(2)(ii) and (iii) that relate to Exchange Act rule 18a-2 for which
the proposed Amended Order would not provide substituted compliance.
These supporting schedules are the Computation of Tangible Net Worth.
The sixth condition would be that a Covered Entity that is a
security-based swap dealer would need to file the supporting schedules
required by Exchange Act rule 18a-7(c)(1)(i)(A) and (C) addressing the
statements identified
[[Page 46520]]
in Exchange Act rules 18a-7(c)(2)(ii) and (iii) that relate to Exchange
Act rule 18a-4 and 18a-4a if the Covered Entity is not exempt from
Exchange Act rule 18a-4 (i.e., the Rule 18a-4 Limited Exclusion). These
supporting schedules are the Computation for Determination of Security-
Based Swap Customer Reserve Requirements and the Information Relating
to the Possession or Control Requirements for Security-Based Swap
Customers, which are designed to provide the Commission with
information about an SBS Entity's compliance with Rule 18a-4.
Substituted compliance for Exchange Act rule 18a-4 is not available.
The following table summarizes the Commission's proposed
preliminary positive substituted compliance determinations with respect
to requirements of Exchange Act rule 18a-7 by listing in each row: (1)
The paragraph of the proposed Amended Order that sets forth the
determination; (2) the paragraph(s) of Exchange Act rule 18a-7 to which
the determination applies; (3) a brief description of the records
required by the paragraph(s); and (4) a brief description of any
additional conditions to applying substituted compliance to the
requirements, including any partial exclusions because portions of the
requirements are linked to substantive Exchange Act requirements for
which the proposed Amended Order would not provide substituted
compliance.\167\
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\167\ The chart below does not include the proposed conditions
for applying substituted compliance to Exchange Act rule 18a-7;
namely that the Covered Entity: (1) Must be subject to and comply
with specified requirements of foreign law; and (2) must promptly
furnish to a representative of the Commission upon request an
English translation of a report. See para. (f)(8) of the proposed
Amended Order (setting forth the English translation requirement).
Exchange Act Rule 18a-7
[Reporting]
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Order paragraph Rule paragraph Rule description Conditions and partial
exclusions
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(f)(3)(i)................. (a)(1)............. (a)(2)............ File FOCUS Reports (1) Manner and Format
Condition.
(2) German GAAP
Condition.
(3) Rule 18a-1
Condition for ]
(a)(1).
(4) Rule 18a-
6(b)(1)(viii)
Condition for ]
(a)(1).
(f)(3)(ii)................ (a)(3)............. .................. Information (1) Rule 18a-1
related to Condition.
capital models.
(f)(3)(iii)............... (b)................ .................. Publish certain (1) Rule 18a-
financial 6(b)(1)(viii)
information. Condition.
(f)(3)(iv)................ (c)................ .................. File annual (1) SEC Filing
(d)................ audited reports. Condition.
(e)................ (2) Contact Information
(f)................ Condition.
(g)................ (3) Accountant's Report
(h)................ Condition.
(4) Rule 18a-4 Limited
Exclusion.
(5) Supporting
Schedules Condition.
(6) Rule 18a-1
Condition.
(7) Rule 18a-
6(b)(1)(viii)
Condition.
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5. Exchange Act Rule 18a-8
Exchange Act rule 18a-8 requires SBS Entities to send notifications
to the Commission if certain adverse events occur.\168\ The Order
provides substituted compliance for the requirements of Exchange Act
rule 18a-8 applicable to SBS Entities with a prudential regulator
(subject to conditions and limitations). In particular, the
requirements of: (1) Paragraph (c) of Exchange Act rule 18a-8 that an
SBS Entity that is a security-based swap dealer and that files a notice
of adjustment to its reported capital category with a U.S. prudential
regulator must transmit a copy of the notice to the Commission; (2)
paragraph (d) of the rule that an SBS Entity provide notification to
the Commission if it fails to make and keep current books and records
under Exchange Act rule 18a-5 and to transmit a subsequent report on
steps being taken to correct the situation; (3) and paragraph (h) of
the rule setting forth how to make the notifications required by
Exchange Act 18a-8.
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\168\ See 17 CFR 240.18a-8.
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Under the Order, substituted compliance in connection with the
notification requirements of Exchange Act rule 18a-8 are subject to the
conditions that the Covered Entity: (1) Simultaneously sends a copy of
any notice required to be sent by EU or German notification laws to the
Commission in the manner specified on the Commission's website (i.e.,
the ``SEC Filing Condition''); and (2) includes with the transmission
the contact information of an individual who can provide further
information about the matter that is the subject of the notice (i.e.,
the ``Contact Information Condition''). The purpose of these conditions
is to alert the Commission to financial or operational problems that
could adversely affect the firm--the objective of Exchange Act rule
18a-8. In addition, the Order does not provide substituted compliance
for paragraph (g) of Exchange Act rule 18a-8 that an SBS Entity that is
a security-based swap dealer provide notification if it fails to make a
required deposit into its special reserve account for the exclusive
benefit of security-based swap customers under Exchange Act rule 18a-4.
Substituted compliance is not available for Exchange Act rule 18a-4.
The proposed Amended Order would continue to provide Covered
Entities with a prudential regulator substituted compliance for the
notification requirements of Exchange Act rule 18a-8 discussed above
subject to the conditions and limitations. However, the substituted
compliance determinations would be made on a more granular basis.
Further, the proposed Amended Order would provide Covered Entities
without a prudential regulator substituted compliance for these
notification requirements (also on a granular basis), subject to the
SEC Filing and Contact Information Conditions. The proposed Amended
Order also would apply the limitation with respect to the notification
requirements linked to Exchange Act rule 18a-4 to Covered Entities
without a prudential regulator.
[[Page 46521]]
Exchange Act rule 18a-8 has notification requirements that apply
exclusively to Covered Entities without a prudential regulator. In
particular, paragraphs (a)(1)(i), (a)(1)(ii), (b)(1), (b)(2), and
(b)(4) of Exchange Act rule 18a-8 require an SBS Entity that is a
security-based swap dealer and that does not have a prudential
regulator to provide notifications related to the capital requirements
of Exchange Act rule 18a-1. Paragraphs (a)(2) and (b)(3) of Exchange
Act rule 18a-8 require an SBS Entity that is a major security-based
swap participant and that does not have a prudential regulator to
provide notifications related to the capital requirements of Exchange
Act rule 18a-2. Paragraph (e) of Exchange Act rule 18a-8, in pertinent
part, requires an SBS Entity that is a security-based swap dealer and
that does not have a prudential regulator to provide notification if it
has a material weakness under Exchange Act rule 18a-7 and to transmit a
subsequent report on the steps being taken to correct the situation.
The Commission is preliminarily making a positive substituted
compliance determination for a number of the notification requirements
set forth in these paragraphs, subject to the SEC Filing and Contact
Information Conditions. However, certain of these requirements are
linked to substantive Exchange Act requirements for which the proposed
Amended Order would not provide substituted compliance. In these cases,
a positive substituted compliance determination would not be made for
the linked requirement in Exchange Act rule 18a-8 or the portion of the
requirement in Exchange Act rule 18a-8 that is linked to the
substantive Exchange Act requirement.\169\
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\169\ A positive substituted compliance determination would not
be made for the following requirements of Exchange Act rule 18a-8
because they are linked to a substantive Exchange Act requirement
for which a positive substituted compliance determination is not
being made: (1) Exchange Act rules 18a-8(a)(3) and (b)(3) are fully
linked to Exchange Act rule 18a-2 and, therefore, would be subject
to the Rule 18a-2 Exclusion; (2) the portion of Exchange Act rule
18a-8(e) that relates to Exchange Act rule 18a-2 would be subject to
the Rule 18a-2 Exclusion; (3) the portion of Exchange Act rule 18a-
8(e) that relates to Exchange Act rule 18a-4 would be subject to the
Rule 18a-4 Exclusion; and (4) Exchange Act rule 18a-8(g) is fully
linked to Exchange act rule 18a-4 and, therefore, would be subject
to the Rule 18a-4 Exclusion.
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In addition, certain of the requirements in Exchange Act rule 18a-8
are fully or partially linked to substantive Exchange Act requirements
where a positive substituted compliance determination would be made
under the proposed Amended Order. In these cases, substituted
compliance with the requirement in Exchange Act rule 18a-8 would be
conditioned on the SBS Entity applying substituted compliance to the
linked substantive Exchange Act requirement.\170\
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\170\ Substituted compliance with the following requirements of
Exchange Act rule 18a-8 would be conditioned on the Covered Entity
applying substituted compliance to the linked substantive Exchange
Act requirement: (1) Exchange Act rules 18a-8(a)(1)(i) and (ii),
(b)(1), (b)(2), and (b)(4) are linked to Exchange Act rule 18a-1
and, therefore, would be subject to the Rule 18a-1 Condition; and
(2) Exchange Act rule 18a-8(d) is linked to Exchange Act rule 18a-5
and, therefore, would be subject to the Rule 18a-5 Condition with
respect to any category of records required to made and kept current
by that rule. With respect to Exchange Act rule 18a-8(d), if the
Covered Entity does not apply substituted compliance with respect to
a category of record required to be made and kept current by
Exchange Act rule 18a-5, the Covered Entity would need to provide
the notification required by Exchange Act rule 18a-8(d) if it fails
to make and keep current that category of record.
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The following table summarizes the Commission's proposed
preliminary positive substituted compliance determinations with respect
to requirements of Exchange Act rule 18a-8 by listing in each row: (1)
The paragraph of the proposed Amended Order that sets forth the
determination; (2) the paragraph(s) of Exchange Act rule 18a-
[…truncated; see source link]Indexed from Federal Register on August 18, 2021.
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