SEC Security-Based Swaps Regulatory Regime

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) is a United States federal law that was enacted on the 21^st July 2010 to overhaul the U.S. financial landscape following the Global Financial Crisis in 2008. Title VII of Dodd-Frank established a regulatory framework to be jointly implemented by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The SEC regulates Security-Based Swaps (SBS) and Security-Based Swap Dealers (SBSD). The CFTC regulates Swaps and Swap Dealers. Shortly after, the regulatory bodies adopted rules to provide further clarity for the characteristics of SBS, SBSD, Swaps and Swap Dealers.¹

The CFTC required firms to register as Swap Dealers in advance of a number of major rules being adopted by the CFTC; those requirements have been in place since 2012/13. In comparison, the SEC made the determination that it would not require SBSD registration until all the key requirements that apply to registered dealers were determined and adopted by the SEC.

The SEC has jurisdiction over Security-Based Swaps: All swaps based on a single security or loan, a narrow-based security index (generally, an index or basket composed of nine or fewer securities), and credit default swaps on a single loan or security or issuers of securities in a narrow-based securities index.

The CFTC has jurisdiction over Swaps: derivatives based on rates, currencies, commodities, securities, evidences of indebtedness, indices, quantitative measures, or any other financial or economic interests. Swaps include FX Forwards, Index based CDS, Interest Rate Swaps and OTC derivatives on commodities. Among other exceptions, the Swap definition excludes (i) notes, bonds and other debt securities, and (ii) options on a single security or group or index of securities.

The SEC and the CFTC have joint jurisdiction over Mixed Swaps: any derivative which is a Swap, as well as a SBS.

On the 18^th December 2019, the SEC concluded its final rules, which include a clearer path for registration by dealers for cross-border application of certain SBS requirements (SBSR) ² and the SEC's Risk Mitigation Rules, requiring SBSDs to execute trading relationship documentation and to engage in portfolio reconciliation and compression exercises for certain portfolios of uncleared SBS.³ On the 1^st November 2021, the SEC SBS Regulatory Regime became effective. On the 13^th November 2020, the CFTC’s Final Cross-Border Rules became effective.

The applicability of the obligations set out in 15 U.S. Code 78o-10 and the SEC rules, regulations and interpretations issued thereunder (the SBS Obligations) to a SBSD who is not a U.S. Person depends on the cross-border scope of the specific rule. In general terms, a distinction between “entity-level requirements" and “transaction-level requirements" can be made, where:

1. entity-level requirements apply to UBS AG (including its branches) as a whole, irrespective of the status of its counterparty, and
   
2. transaction-level requirements apply to SBS transactions with U.S. Persons and SBS transactions with non-U.S. Persons.

¹ Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant, “ “Major Security-Based Swap Participant,” and “Eligible Contract Participant,” 77 Fed Reg. 30595 (May 23, 2012); Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48207 (Aug. 13, 2012)

² Exchange Act Release No. 87780 (Dec. 18, 2019) “Cross-Border Amendments Adopting Release”

³ Exchange Act Release No. 87782 (Dec. 18, 2019) “Risk Mitigation Rules Adopting Release”

Please note, these FAQs will be updated as necessary.

What is the SBS Regulatory Regime and what does it seek to do?

What is the U.S. Self Disclosure Letter?

What are the ISDA 2021 SBS Protocols and who needs to adhere?

What action do I need to take as a result of the SEC SBSD rules? 

In 2010, the Dodd-Frank Act amended the Commodities Exchange Act and the Securities Exchange Act of 1934 to, among other things, establish a new regulatory framework for Swaps and Security-Based Swaps (SBS). Adopted in the wake of the 2008 financial crisis, the Dodd-Frank Act was enacted to reduce systemic risk, increase transparency, and promote market integrity within the financial system, in line with the G20 commitments to reform and improve OTC derivatives market structure.

The “ISDA U.S. Self Disclosure Letter” (SDL) is required to facilitate compliance with certain U.S. Swap and Security-Based Swap rules. The industry-developed SDL was published by the International Swaps and Derivatives Association, Inc. (ISDA) on 15^th January 2021. It is intended to assist market participants with the exchange of the information necessary to determine whether compliance with CFTC and/or Prudential Regulator Swap regulations and/or SEC Security-Based Swap regulations is required, as well as if, and when, their trading relationship will become subject to CFTC, Prudential Regulator or SEC regulatory margin requirements for uncleared Swaps and/or Security-Based Swaps (as applicable).

Originally in 2013, the CFTC defined the meaning of U.S Person (U.S. Person 2013). The CFTC required counterparties to complete a Cross-Border Representation Letter (CBR) or equivalent.

The CFTC cross-border rules were published in the Federal Register on 14^th September 2020. The SEC definition of U.S. Person (U.S. Person 2020)¹ is narrower than the original U.S. Person 2013.

On the 13^th November 2020, the CFTC’s Final Cross-Border Rules became effective. The final rules included aligning the CFTC’s U.S. Person 2013 with the SEC’s U.S. Person 2020.

There are some key differences between the CFTC 2013 and SEC / CFTC 2020 U.S. Person definitions.

ISDA published the U.S. Self-Disclosure Letter (SDL) on 15^th January 2021; a “self-disclosure document” providing 'check the box’ or similar optional statements for a counterparty to a SBS entity to provide Dodd-Frank Status information to facilitate compliance with certain U.S. Swap and Security-Based Swap Rules.

The SDL combines CFTC cross-border guidance, margin cross-border rules and prudential regulators’ margin cross-border rules with coverage of the new CFTC cross-border rule and SEC cross-border rules. Portions of this letter supersede:

1. the ISDA Regulatory Margin Self-Disclosure Letter (published 30^th June 2016) for purposes of determining applicability of U.S. regulatory margin requirements for uncleared swaps to trading relationships; and
2. the ISDA Cross-Border Swaps Representation Letter (published 19^th August 2013) also known as the CBR.

Self-Disclosure Letter

To be compliant with the SEC’s rules, counterparties are required to submit a U.S. Self-Disclosure Letter (SDL) via ISDA Amend.

The SDL can be completed directly by the principal counterparty or by persons representing the counterparty (e.g. agent/manager), who should complete on behalf of each 'named entity' that they represent.

A copy of the SDL is available via https://www.isda.org/book/isda-us-self-disclosure-letter/

Please click here to complete the SDL on the industry tool ISDA Amend. New users are able to set up an account free of charge.

The ISDA Dodd-Frank Documentation Initiative provides an industry solution to the need for amending existing documentation for the purpose of facilitating compliance with regulatory requirements in a manner that minimizes the need for bilateral negotiations and disruptions to trading. 

ISDA Protocols

To allow market participants to comply with, and simplify changes across documentation for, SEC rules in respect of SBS transactions, ISDA published two protocols; namely:

The Top-Up and Full SBS Protocol are part of ISDA's Dodd-Frank Documentation Initiative aimed at assisting the industry in implementing and complying with the regulatory requirements imposed under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Copies of the protocols are available via: https://www.isda.org/protocol/isda-2021-sbs-protocol/

ISDA FAQs explain which protocols should be used, available via: https://www.isda.org/protocol/isda-2021-sbs-protocol/

ISDA August 2012 DF Protocol ("DF1")

Published in August of 2012, DF1 on its own is intended to address requirements of seven CFTC final rules relating to External Business Conduct, portfolio reconciliation and documentation changes. It applies to U.S. persons (as defined by CFTC) counterparties in swaps, foreign exchange swaps or foreign exchange forwards (each a “Swap”) and is designed to supplement existing written agreements governing the terms and conditions of one or more Swap transactions. DF1 is not limited to ISDA Master Agreements and may be used to amend any written agreement between the two parties under which they enter Swaps. DF1 adds notices, representations and covenants that must be satisfied at or prior to the time that Swap transactions are offered and executed. 

ISDA March 2013 DF Protocol ("DF2")

Published in March of 2013, DF2 on its own is intended to facilitate industry compliance with three CFTC final rules by allowing market participants to (i) supplement the terms of existing written agreements or (ii) enter into an ISDA Lite and apply DF compliance provisions in respect of Swaps. Similarly to DF1, DF2 is not limited to ISDA Master Agreements and may be used to amend any written agreement between the two parties under which they enter Swaps. DF2 adds notices, representations and covenants that must be satisfied at or prior to the time that swap transactions are offered and executed.

Unlike with previous ISDA protocols where amendments were effected solely with delivery of an adherence letter by each party to the underlying document to be amended (i.e. a master agreement), DF1 and DF2 include additional bilateral delivery requirements in order to effectuate the amendments. Each party that submits an Adherence Letter must also deliver a completed Protocol Questionnaire to each relevant counterparty for the amendments to be effective.

¹ SEC US Person defined in § 240.3a71-3(a)(4))

Please contact your usual UBS representative with any additional questions. Clients of the Investment Bank are also able to contact us at ubs-ib-sec_sbsd@ubs.com

Please see below for additional SEC Security-Based Swaps Regulatory Regime informational resources.