Monday, April 19. 2021
SEC Issues Substituted and Proposed Compliance Applications for the UK and Reopens Comment Period for Proposed Substituted Compliance Order for France
The measures taken reflect the SEC’s commitment to:
- promoting and protecting the interests of the Dodd-Frank Title VII regime
- preparing for the registration of security-based swap dealers later this year
- continuing engagement with the agency’s foreign counterparts
- respecting the comparability of applicable non-US requirements and incorporate conditions intended to help promote comparability in practice
UK and France Substituted Compliance Applications and Proposed SEC Orders
Substituted Compliance Framework
Exchange Act rule 3a71-6 provisionally provides that non-US security-based swap dealers and major security-based swap participants may meet certain requirements under section 15F of the Exchange Act by complying with foreign requirements that the SEC has deemed comparable. The SEC’s comparability assessment must consider the following:
- the scope and objectives of the foreign requirements
- effectiveness of the foreign financial supervisory and enforcement frameworks
Rule 3a71-6 further conditions substituted compliance on the SEC and the foreign financial regulatory authority entering a supervisory and enforcement memorandum of understanding and/or other arrangement addressing supervisory and enforcement cooperation and other matters related to substituted compliance. Substituted compliance does not constitute exemptive relief. It does, however, provide another method by which foreign dealers and major participants may comply with applicable US requirements. The SEC will still have the authority to inspect, examine, and supervise those firms and, when appropriate, take enforcement action.
October 6, 2021 is the registration compliance date for security-based swap dealers and major security-based swap participants. Market participants will begin counting security-based swap transactions and positions toward the registration thresholds on August 6, 2021. For more information, refer to the “Key Dates for Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants” webpage on sec.gov.
The UK’s FCA Application
The FCA requests that the SEC allow substituted compliance concerning requirements pursuant to the Exchange Act regarding:
- Counterparty protection – requirements associated with balanced, fair communications, disclosure of material risks and characteristics, daily mark disclosure, disclosure of material incentives or conflicts of interest, “know your counterparty,” suitability of recommendations and clearing rights disclosure
- Recordkeeping and reporting – requirements associated with record maintenance, reporting, record creation, notices, and quarterly securities counts
- Risk control – requirements associated with capital, margin, trade acknowledgment and verification, risk management systems, portfolio reconciliation and dispute reporting, portfolio compression and trading relationship documentation
- Internal supervision and compliance – requirements associated with supervision, conflicts of interest and chief compliance officers, and certain related matters
Included in the FCA’s application are findings that compare UK requirements with relevant requirements under the Exchange Act as well as information regarding the financial supervisory and enforcement structures in the UK. The FCA's application is available at sec.gov.
Proposed Substituted Compliance Order for UK Firms
The SEC is publishing a proposed substituted compliance order in connection with the FCA’s application which reflects the SEC’s initial review of the comparability of relevant UK requirements, as well as the effectiveness of the UK financial oversight and enforcement structures. The proposed order includes certain conditions or other limits including:
- Internal Supervision – Each firm’s internal supervision structure must also encourage compliance with certain residual US requirements and the conditions to the proposed order.
- Compliance Reports – Firms would be required to submit compliance reports directly to the SEC.
- Suitability – The firm’s counterparty may not be a “special entity” as defined in Exchange Act section 15F(h)(2)(C) and Exchange Act rule 15Fh-2(d); it must be treated as a “per se professional client” under UK requirements.
- Daily Mark Disclosure – The firm is required to reconcile the portfolio containing the applicable security-based swap on each business day.
- Annual Audited Reports – Firms would need to:
- concurrently transmit to the SEC a copy of audited financial reports filed with UK authorities
- with each filing, include contact information of a person who can provide further information about the reports
- file accountants reports covering the financial reports if the firm is not required by UK law to have its financial reports audited
- file compliance or exemption reports regarding statements related to Exchange Act rule 18a-4 for which substituted compliance is not available
- file supporting schedules related to Exchange Act rule 18a-4
- apply substituted compliance to Exchange Act rule 18a-1. Firms that change their fiscal year end would need to a) concurrently transmit to the SEC a copy of any notice required to be sent by comparable UK laws; and b) include contact information of a person who can provide further details about the notice
- Notification – Firms would be required to: a) concurrently transmit to the SEC a copy of any notice required to be sent by comparable UK laws; b) include contact information of a person who can provide further details about the notice; c) apply substituted compliance to Exchange Act rule 18a-1 (if subject to that rule) regarding any required notifications related to that rule; and d) apply substituted compliance concerning a category of records required to be made and kept current under Exchange Act rule 18a-5 with respect to the requirement to submit notification of a failure to make and keep current that category of records.
- Access to Books and Records – Firms must still comply with Exchange Act requirements to keep books and records open to inspection by the SEC. They must also furnish promptly to the SEC legible, true, complete, and up-to-date copies of those records of the firm that are required to be preserved.
- English Translations – Firms must promptly provide an English translation of any record, report, or notification upon request
- Recordmaking – Firms would be required to:
- apply substituted compliance to a linked substantive Exchange Act requirement, when a recordmaking requirement is linked to that substantive Exchange Act requirement for which a positive substituted compliance determination is being made
- apply substituted compliance to Exchange Act rule 18a-1 regarding certain records that are important for the SEC to examine for compliance with Exchange Act rule 18a-1
- maintain the data elements to create certain records required by the SEC's rule and furnish the record in the format required by that rule
- Trading Relationship Documentation – Firms would not receive substituted compliance in association with certain disclosure-related provisions for transactions with US counterparties; however, firms would receive it for transactions with non-US counterparties.
- Portfolio Reconciliation and Dispute Reporting – Based on UK timing requirements, firms must report counterparty valuation disputes directly to the SEC.
- Capital – Firms would need to:
- maintain an amount of assets that are allowable under Exchange Act rule 18a-1 (after applying applicable rules under the Basel capital standard) that equals or exceeds the firm's current liabilities coming due in the next 365 days
- make a quarterly record listing of: 1) the assets maintained under the condition described above, their value, and the amount of their applicable cuts; and 2) the combined amount of the liabilities coming due in the next 365 days
- maintain at least $100 million of equity capital composed of highly liquid assets, as defined in the Basel capital standard
- include its most recent statement of financial condition filed with its local supervisor, whether audited or unaudited, with its written notice to the SEC of its intent to rely on substituted compliance
- Record Preservation – Firms would need to: a) apply substituted compliance to a linked substantive Exchange Act requirement when a record preservation requirement is linked to that substantive Exchange Act requirement for which a positive substituted compliance determination is being made; and b) apply substituted compliance to Exchange Act rule 18a-1 with respect to certain records that are vital for the SEC to examine for compliance with Exchange Act rule 18a-1.
- Unaudited Financial and Operational Reporting – Firms would need to: a) submit periodic, unaudited financial and operational information in the manner and format specified by SEC order or rule; b) present the financial information in the filing in compliance with generally accepted accounting principles that the firm uses to prepare general purpose publicly available or available to be issued financial statements in the UK; and c) apply substituted compliance to Exchange Act rule 18a-1 if subject to that rule
Re-Opening of Comment Period on Substituted Compliance Notice and Proposed Order for France
The French substituted compliance application addresses the same Exchange Act requirements that are included in the UK notice and proposed substituted compliance order. Included in the application are assessments that compare French and European Union requirements with related requirements under the Exchange Act, as well as information regarding the financial supervisory and enforcement structures in France. The application can be found on sec.gov.
The SEC is re-opening the comment period for the French proposed substituted compliance order and notice of application, allowing market participants and the public an opportunity to consider possible changes to the proposed order and additional relevant questions. The proposed requirements relate to capital, trade acknowledgement and verification, and trading relationship documentation. These conditions reflect those included in the UK proposed substituted compliance order. Feedback is being sought to determine whether the granular approach to recordmaking, record preservation, and reporting taken in the proposed UK substituted compliance order should be made a part of the French final substituted compliance order.
The SEC will seek public comment on all the measures taken for a period of 25 days following publication in the Federal Register. Security-based swap market participants should be aware of the October 2021 registration compliance date for security-based swap dealers and major security-based swap participants, and relevant firms should prepare for registration. For additional information, firms may call the Office of Derivatives Policy in the SEC’s Division of Trading and Markets at (202) 551-5870.
SEC Issues Notice of Substituted Compliance Application and Proposed Substituted Compliance Order for United Kingdom and Reopens Comment Period for Notice and Proposed Substituted Compliance Order for France (sec.gov)