SEC Issues Substituted Compliance Determination for France
The Securities and Exchange Commission today announced the approval of a substituted compliance determination order with respect to security-based swap dealers and major security-based swap participants (SBS Entities) subject to regulation in the French Republic (the French Order). This is the first determination that addresses substituted compliance in connection with the Commission’s capital and margin requirements.
“Friday’s action reflects the latest of the Commission’s continued efforts to stand up Congressional mandates under Title VII of the Dodd-Frank Act and prepare for the registration of security-based swap dealers this fall,” said SEC Chair Gary Gensler. “In issuing the determination order, the Commission was guided by our commitment to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
The French Order, which was approved Friday, provides that certain French firms that are registered with the Commission as SBS Entities conditionally may satisfy certain requirements under the Securities Exchange Act of 1934 (Exchange Act) by complying with comparable French and European Union (EU) requirements. The Commission and the French Autorité des Marchés Financiers (AMF) and the Autorité de Contrôle Prudentiel et de Résolution (ACPR) have entered into a memorandum of understanding to address supervisory and enforcement cooperation and other matters arising under substituted compliance. The Commission retains the authority to inspect, examine and supervise non-U.S. firms and take enforcement action as appropriate.
This action reflects the Commission’s consideration of the comparability of applicable non-U.S. requirements, and incorporate conditions intended to help promote comparability in practice.
Additional information about substituted compliance application is available at https://www.sec.gov/page/exchange-act-substituted-compliance-and-listed-jurisdiction-applications-security-based-swap.
Commission Substituted Compliance Order for France
The Commission is issuing the substituted compliance determination order addressing the availability of substituted compliance for certain non-U.S. security-based swap dealers and major security-based swap participants, in anticipation of those firms’ registration with the Commission this fall.
In response to an application by AMF and ACPR, the Commission is publishing an Order to conditionally permit certain French firms registered with the Commission as SBS Entities to satisfy certain requirements under the Securities Exchange Act of 1934 by complying with comparable French and EU requirements. The Commission and the AMF and ACPR have entered into a memorandum of understanding to address supervisory and enforcement cooperation and other matters arising under substituted compliance.
Substituted Compliance Framework
Exchange Act rule 3a71-6 conditionally provides that non-U.S. security-based swap dealers and major security-based swap participants may satisfy certain requirements under Section 15F of the Exchange Act by complying with foreign requirements that the Commission has found to be comparable. The Commission’s comparability assessment must consider the scope and objectives of the foreign requirements and also the effectiveness of the foreign financial supervisory and enforcement frameworks.
Rule 3a71-6 further conditions substituted compliance on the Commission and the foreign financial regulatory authority entering into 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, but instead provides an alternative method by which non-U.S. dealers and major participants may comply with applicable U.S. requirements. The Commission retains the authority to inspect, examine and supervise those firms and take enforcement action as appropriate.
The registration compliance date for security-based swap dealers and major security-based swap participants is Oct. 6, 2021, and market participants will begin counting security-based swap transactions and positions toward the registration thresholds on Aug. 6, 2021. See “Key Dates for Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants,” available at https://www.sec.gov/page/key-dates-registration-security-based-swap-dealers-and-major-security-based-swap-participants.
The Substituted Compliance Order
The French Order provides for conditional substituted compliance in connection with requirements under the Exchange Act regarding:
- Risk control – requirements related to capital, margin, risk management systems, trade acknowledgment and verification, portfolio reconciliation, portfolio compression and trading relationship documentation.
- Recordkeeping and reporting – requirements related to record creation, record maintenance, reporting, notices, and securities count.
- Internal supervision and compliance – requirements related to supervision, conflicts of interest and chief compliance officers, and certain related matters.
- Counterparty protection – requirements related to fair and balanced communications; disclosure of material risks and characteristics; disclosure of material incentives or conflicts of interest; daily mark disclosure; “know your counterparty;” and suitability.
Consistent with rule 3a71-6, the availability of substituted compliance reflects the comparability of applicable French and EU requirements, taking into account the effectiveness of their financial supervisory and enforcement framework. The Order incorporates certain conditions and other limits to promote the comparability of regulatory outcomes, including:
- Trading Relationship Documentation – Firms would not receive substituted compliance in connection with certain disclosure-related provisions for transactions with U.S. counterparties, but would receive it for transactions with non-U.S. counterparties.
- Portfolio Reconciliation and Dispute Reporting – Firms would have to report counterparty valuation disputes directly to the Commission, based on French and EU timing requirements.
- Capital – Firms would be required to: (1) maintain liquid assets (as defined in the condition) that have an aggregate market value that exceeds the amount of the firm’s total liabilities by at least $100 million before applying the deduction (haircut) specified in the capital condition (i.e., risk-weighted assets divided by 12.5), and by at least $20 million after applying the deduction (haircut); (2) make and preserve for three years a quarterly record demonstrating compliance with the capital condition; (3) notify the Commission in writing within 24 hours if the Covered Entity fails to meet the requirements of the capital condition; and (4) include its most recent statement of financial condition (i.e., balance sheet) 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. Firms also would be required to apply substituted compliance with respect to certain record making, record preservation, and notification requirements related to capital.
- Margin – Firms would be required to collect variation and/or initial margin from a counterparty with respect to transactions in non-cleared security-based swaps, unless the counterparty would qualify for an exception from the collateral collection requirements under the Commission’s margin rule for non-cleared security-based swaps. They also would be required to apply substituted compliance for the certain record making requirements related to margin.
- Internal Supervision – Firms’ internal supervision frameworks must also promote compliance with certain residual U.S. requirements and the conditions to the orders.
- Compliance Reports –Firms must provide, in English, the compliance reports they provide to their management bodies pursuant to French and EU law no later than no later than 15 days following the earlier of the submission of the report to their management body; or the time the report is required to be submitted to the management and the report must cover applicable Exchange Act requirements and conditions of the orders. Together the reports cover the entire period that the Covered Entity’s annual compliance report would be required to cover.
- Suitability – The firm’s counterparty must be treated as a “per se professional client” under French and EU requirements and must not be a “special entity” as defined in Exchange Act section 15F(h)(2)(C) and Exchange Act rule 15Fh-2(d).
- Daily Mark Disclosure – The firm must be required to reconcile, and in fact reconcile, the portfolio containing the relevant security-based swap on each business day.
- Recordmaking – Firms would need to: (a) 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 (and conversely, apply substituted compliance to a substantive Exchange Act requirement linked to a recordmaking requirement); (b) apply substituted compliance to Exchange Act rule 18a-1 with respect to certain records that are important for the Commission to examine for compliance with Exchange Act rule 18a-1; and (c) preserve the data elements to create certain records required by the Commission’s rule and furnish the record in the format (e.g., blotter or ledger) required by that rule.
- 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 conversely, apply substituted compliance to a substantive Exchange Act requirement linked to a record preservation requirement); and (b) apply substituted compliance to Exchange Act rule 18a-1 with respect to certain records that are important for the Commission to examine for compliance with Exchange Act rule 18a-1.
- Unaudited Financial and Operational Reporting – Firms would need to: (a) report periodic unaudited financial and operational information in the manner and format specified by Commission order or rule; (b) present the financial information in the filing in accordance with generally accepted accounting principles that the firm uses to prepare general purpose publicly available or available to be issued financial statements in France; and (c) apply substituted compliance to Exchange Act rule 18a-1 if subject to that rule.
- Annual Audited Reports – Firms would need to: (a) simultaneously transmit to the Commission a copy of audited financial reports filed with French authorities; (b) include with the filing contact information of a person who can provide further information about the reports; (c) file accountant’s reports covering the financial reports if the firm is not required by French law to have its financial reports audited; (d) file compliance or exemption reports addressing statements related to Exchange Act rule 18a-4 for which substituted compliance is not available; (e) file supporting schedules related to Exchange Act rule 18a-4; and (f) apply substituted compliance to Exchange Act rule 18a-1.
- Notification – Firms would need to: (a) simultaneously transmit to the Commission a copy of any notice required to be sent by comparable French 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) with respect to any required notifications related to that rule; and (d) apply substituted compliance with respect to a category of records required to made and kept current under Exchange Act rule 18a-5 with respect to the requirement to provide notification of a failure to make and keep current that category of records, and (e) apply substituted compliance to Exchange Act rule 18a-8(c) for Covered Entities with a prudential regulator.
- Access to Books and Records – Firms would remain subject to Exchange Act requirements to keep books and records open to inspection by the Commission and to furnish promptly to the Commission legible, true, complete, and current copies of those records of the firm that are required to be preserved.
- English Translations – Firms would need to promptly provide an English translation of any record, report, or notification upon request.
Security-based swap market participants are urged to be mindful of the October 2021 registration compliance date for security-based swap dealers and major security-based swap participants, and relevant firms should take action to prepare for registration. For further information, firms may contact the Office of Derivatives Policy in the Commission’s Division of Trading and Markets, at 202-551-5870.