When the Securities and Exchange Commission (SEC) adopted final rules in June 2014 on the cross-border activities of security-based swap (SBS) dealers and major SBS participants, the SEC indicated that it would reserve the definition of the phrase “transaction conducted within the United States” until after it solicited more comments from the public. This phrase is key in that it is used to determine the type of dealer conduct that would be covered under Title VII of the Dodd–Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act.)  Specifically, this phrase is used to determine when foreign market participants engaged in cross-border SBS would be subject to SEC Regulation.

On April 29, 2015, the SEC re-proposed the rules addressing when foreign dealer conduct would be covered under Title VII (the Re-proposed Rules) for purposes of determining whether or not a foreign entity is regulated as an SBS dealer. The SEC is replacing “transactions conducted within the United States” with “transactions that are arranged, negotiated, or executed through personnel in the United States (US) branch or office.” The SEC is also, among other things, re-proposing a rule which applies external business conduct requirements to the foreign business and US business of registered SBS dealers.

Public comments on the Re-proposed Rules are due on July 13, 2015.

I.   SBS Dealer De Minimis Threshold for Non-US Persons

In 2012, the SEC and the Commodity Futures Trading Commission jointly adopted rules indicating that a security-based swap dealer would be required to register with the SEC if its notional amount of dealing transactions conducted in the past 12 months exceeded a de minimis threshold of $3 billion, with a phase-in threshold of $8 billion.

In 2013, the SEC proposed a rule (the Initial Proposed Rule) that provided guidance on the de minimis threshold calculation. Non-US persons engaged in dealing activity were required to count toward their de minimis thresholds transactions arising from their (1) dealing activity with US persons and (2) dealing activity “conducted within the United States.”

Many commenters raised concerns with the “conducted within the United States” concept. Thus, when the SEC finalized the Initial Proposed Rule in 2014 (the Final Rules), it neglected to address the application of the “transactions conducted within the United States” concept to the dealer definition. The SEC planned to solicit additional comments regarding this particular issue.

The Final Rules included the following activities toward the calculation of a non-US person’s de minimis threshold:

  • SBS transactions entered with a US person, except for transactions with a US counterparty that are conducted through a foreign branch of the counterparty when the counterparty is a registered SBS dealer, and transactions with a US person counterparty that constitute transactions conducted through a foreign branch of the counterparty when the transaction is entered into prior to 60 days following the earlier date on which the registration of the SBS dealers is first required.
  • SBS transactions connected with the dealing activity in which such person engages for which the counterparty to the security-based swap has rights of recourse against a US person or an affiliate of the non-US person; for these purposes a counterparty has rights of recourse against the US person if the counterparty has a conditional or unconditional legally enforceable right, in whole or in part, to receive payments from, or otherwise collect from, the US person in connection with the security-based swap.1

II.   Arranged, Negotiated or Executed through Personnel in the US Branch or Office

Under the Re-proposed Rules, the transactions “conducted within the United States” were deleted from the calculation of the de minimis threshold calculation. The term was replaced by “transactions entered into by a non-US person that are arranged, negotiated, or executed through its personnel located in a US branch or office, or through an agent of a non-US person located in a US branch or office.”

The change was meant to reach a narrower type of activity. “Arrange and negotiate” indicate market-facing activity of sales or trading personnel in connection with a particular transaction, while “execute” means the act that causes the person to be irrevocably bound under the SBS. Moreover, the non-US person need not look to the location of its counterparty. The non-US person only needs to identify the location of its own personnel or its agent’s personnel involved in market-facing activity.

If the Re-Proposed Rules are finalized without any changes, SBS transactions entered into by a non-US person that are arranged, negotiated, or executed through its personnel located in a US branch or office, or through an agent of a non-US person located in a US branch or office, would count toward the de minimis threshold calculation of the SBS dealer definition.

III.   External Business Conduct Standards

The SEC is re-proposing a rule which applies external business conduct requirements to the US business of foreign-registered SBS dealers. This rule ensures that all dealers conducting business in the US are registered with the SEC and are covered by the external business conduct rules. These external business conduct rules include conflict of interest and know your counterparty rules, and obligations regarding diligent supervision.

The external business conduct rules will apply to the “US business” of a registered SBS dealer but not to the “foreign business” of the registered SBS dealer. “US business” includes transactions entered into or offered to be entered into by or on behalf of a non-US SBS dealer with a US person (other than a transaction conducted through a foreign branch of the US person), or to transactions “arranged, negotiated or executed by personnel located in a US branch or office” of non-US SBS dealers with non-US counterparties. “Foreign business” would be any business that is not defined as a “US business.”

IV.   Significance

The Re-proposed Rules center on activity that is carried out by a non-US person or its agent in the US in connection with its dealing activity, instead of focusing on the activity of any counterparty to an SBS transaction. Under the Re-proposed Rules, a non-US dealer would need to look only to where its own personnel or its agent’s personnel engage in certain market-facing activity with respect to a particular SBS transaction.

The SEC’s approach to cross-border trading reflected in the Re-proposed Rules, is distinct from the approach taken by the Commodity Futures Trading Commission under its interpretation of the cross-border provisions of the Dodd-Frank Act.