Defining Security-Based Swap Dealers and Major Security-Based Swap Participants

Today, the Commission considers adopting our first final rules under Title VII of the Dodd-Frank Act. Title VII mandates that the SEC and CFTC promulgate rules to provide comprehensive oversight to the over-the-counter derivatives market, which contributed significantly to the recent financial crisis. Today’s rule, to be issued jointly with the CFTC, would define which entities must register with the SEC as security-based swap dealers or major security-based swap participants, and which entities must register with the CFTC as swap dealers or major swap participants.

Dealers and major participants are central players in a market that is estimated to exceed $700 trillion worldwide.¹ The definitions of dealer and major participant will determine which entities will be subject to crucial provisions of Title VII. For example, Title VII directs the SEC and the CFTC to adopt rules subjecting dealers and major participants to capital, margin, and collateral segregation requirements.² And Title VII also directs the SEC and CFTC to adopt rules to impose business conduct standards designed to protect the counterparties of dealers and major participants from conflicts of interest, misrepresentations, and unsuitable recommendations.³

In today’s rulemaking, an issue that has presented particular challenges is defining the meaning of the term “de minimis” in the context of determining which entities need to register as dealers. In Title VII, Congress directed the SEC and the CFTC to exclude from the definition of swap dealers and security-based swap dealers any entity “that engages in a de minimis quantity of . . . dealing.”⁴ This Congressional mandate has resulted in a great deal of attention from commenters. In truth, attaching meaning to the term “de minimis” in the context of an opaque market encompassing hundreds of trillions of dollars of activity has been a difficult process. The truth of the matter is that no one has comprehensive information about the derivatives market.

Determining the appropriate de minimis amount has required balancing a number of considerations, and, in fact, today’s proposal provides different “de minimis” amounts for different categories of security-based swaps. For security-based swaps that are credit default swaps (“CDS”), the de minimis amount would be $3 billion of gross notional activity in a year, and for other security-based swaps, the de minimis amount would be $150 million.

I have been concerned that the $3 billion de minimis amount is 30 times higher than the $100 million figure that was originally proposed. Ultimately, however, I am persuaded by numerous conversations with the staff that, based on the limited information currently available, the rule’s de minimis provisions are reasonable. For example, the staff’s analysis of single-name CDS transactions for all of 2011 indicates that a $3 billion de minimis level is likely to capture approximately 99.9% of dealing activity.⁵ I note that the de minimis provisions includes a phase-in period, which would last several years, during which the de minimis amount for credit-related security-based swaps would be $8 billion, before dropping to $3 billion.⁶ During the phase-in period, the staff will conduct a study to examine how the security-based swap market develops in its newly regulated state. The study will have a particular focus on the de minimis amounts for security-based swap dealing and whether the amounts should be adjusted up or down. In addition, the study will also examine elements of the definition of “major security-based swap participant.”

It is important that this study address both what today’s rules capture and what they exclude. The study should also consider the impact on all participants in the market and on the financial system and the economy as a whole. A study focused solely, or even primarily, on the impact on the entities defined as “security-based swap dealers” and “major security-based swap participants” may exclude vital information. We must remember that Title VII was enacted to protect the economy as a whole, not with a narrow focus on the impact on those entities that may be regulated.

I will support today’s recommendation, and I want to thank the staff for many months of hard work on this rulemaking. I also recognize that today is just one step in the process of increasing transparency, reducing risk, and promoting integrity in the derivatives market. Clearly, the staff has serious work ahead in finalizing our remaining derivatives rulemaking. It is important that the derivative reforms mandated by the Dodd-Frank Act be faithfully promulgated to protect the economy, the financial markets, and, most importantly, investors.

¹ See, e.g., Bank for International Settlements, Semiannual OTC Derivatives Statistics for end-June 2011, Table 19 (Nov. 2011), available at http://www.bis.org/statistics/otcder/dt1920a.pdf.

² See, e.g., Dodd-Frank Wall Street Reform and Customer Protection Act of 2010, Pub. L. 111-203, § 764 (2010); Securities Exchange Act of 1934, § 15F(e).

³ See, e.g., Dodd-Frank Wall Street Reform and Customer Protection Act of 2010, Pub. L. 111-203, § 764 (2010); Securities Exchange Act of 1934, § 15F(h); Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, Release No. 34-64766 (June 29, 2011) (Proposed Rule), available at http://sec.gov/rules/proposed/2011/34-64766.pdf.

⁴ Dodd-Frank Wall Street Reform and Customer Protection Act of 2010, Pub. L. 111-203, § 761(a)(6) (2010); Securities Exchange Act of 1934 § 3(a)(71).

⁵ See, e.g., Memorandum from the Division of Risk, Strategy, and Financial Innovation to File, at 20, Fig. 8 (Mar. 15, 2012) (regarding “Information regarding activities and positions of participants in the single-name credit default swap market), available at http://sec.gov/comments/s7-39-10/s73910-154.pdf. As reflected in Section II.D.5.b.i. of the adopting release, the staff estimates, based on derivatives figures from the Bank for International Settlements and the Office of the Comptroller of the Currency, that single-name CDS will constitute 95 percent of the market for security-based swaps.

⁶ For security-based swaps that are not credit default swaps, the de minimis amount during the phase-in period would be $400 million, before dropping to $150 million.