participants employ one of these strategies, they intend to obtain
gains from the positions they hold that go beyond those corresponding
to the initial profit and loss expectation (the initial payoff
function) at trade execution. This additional gain would be obtained to
the direct detriment of a counterparty that is unaware of that
additional loss potential.\183\ Currently there is limited, if any,
public information about the size of security-based swap positions held
by a counterparty, so the average CDS market participant, despite being
sophisticated and well-informed, is often unaware of the risk of being
on the losing side of an opportunistic strategy. Because market
participants could incur heavier-than-expected losses if their
counterparty employed such a strategy, they may be disincentivized to
participate in the market. This type of scenario--where a party's need
to anticipate a bad outcome in a future transaction without full
information could disincentivize certain behavior--is referred to as
``adverse selection.''
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    \182\ Researchers, using a sample period from the fourth quarter
of 2010 to the second quarter of 2018, have argued that these types
of strategies have likely increased over time. See Danis & Gamba,
supra note 22 at Figure 1.
    \183\ The market participant's gain from the transaction is
inversely proportional to the gain of the counterparty, so the
larger the market participant's position (and gain), the larger the
counterparty's loss.
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    Adverse selection has been thoroughly documented in the economic
literature, and its deleterious effects on market participation and
efficiency are well known in sectors such as banking,\184\
insurance,\185\ and used cars.\186\ Though the Commission lacks data
that would show the direct link between the current CDS market
condition (and the degree of adverse selection) and participants'
appetite to trade, ``opportunistic strategies'' (which are symptomatic
of a market with adverse selection) increase inefficiency in the
market. To the extent that market participants anticipate
``opportunistic strategies,'' the CDS spread or price becomes a
reflection of the likelihood of a ``manufactured'' strategy being
announced (or, if already announced, of succeeding) and decouples from
the credit fundamentals of the reference entity. This effect reduces
the utility of the market as a venue to offload or take on the credit
risk of a company because prices no longer reflect credit risk; bona
fide hedgers or speculators in this market would be more likely to
exit, as they cannot readily ``trade'' the credit of a company.\187\
---------------------------------------------------------------------------

    \184\ Joseph E. Stiglitz & Andrew Weiss, Credit Rationing in
Markets with Imperfect Information, 71 The Am. Econ. Rev., at 393
(June 1981) (presenting a model showing that, in a world with
imperfect information, the use of interest rates or collateral in
the screening process can introduce adverse selection and reduce
overall expected loan profitability).
    \185\ See Amy Finkelstein & James M. Poterba, Adverse Selection
in Insurance Markets: Policyholder Evidence from the U.K. Annuity
Market, Nat'l Bureau of Econ. Rsch. NBER Working Paper, Paper No.
8045 (Dec. 2000), (available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=489682).
    \186\ George A. Akerlof, The Market for `Lemons': Quality
Uncertainty and the Market Mechanism, 84 Q. J. of Econ., at 488,
488-500 (Aug. 1970) (discussing a single-sided market for used cars
where the seller is more informed then the buyer, leading to
asymmetric information and potential market failure).
    \187\ See Fletcher, supra note 21 (explaining that
``engineered'' or ``manufactured'' transactions distort the
information reflected in CDS spreads, to the point where the default
risk expressed in CDS spreads is no longer connected to the
financial condition of the underlying entity).
---------------------------------------------------------------------------

    Furthermore, the adverse selection problem in the CDS market runs
in both directions. In contrast to the used car market, where the
seller nearly always has more information and therefore the buyer must
preempt the possibility of buying a ``lemon,'' in the CDS markets both
buyers and sellers have the potential to leverage their market
positions and engage in ``opportunistic

strategies,'' to the detriment of their counterparties.
    In addition to the market imperfection mentioned above, the
resemblance of a CDS contract to an insurance policy on an asset may
give rise to information asymmetries amongst its counterparties. Since
buying a CDS contract offers insurance to bondholders in the case of
default, bondholders who buy CDS (pay a periodic premium) are less
concerned about the health of the cash flows of the underlying asset,
and in general less likely to renegotiate the terms in a bond
contract.\188\ This divergence in the expected outcomes of a
transaction after a transaction occurs is called ``moral hazard'' or,
specific to the CDS market, an ``empty creditor.'' \189\ In this
particular scenario, CDS sellers would likely prefer not to transact
with such CDS buyers or could have trouble pricing this risk, to the
extent they are unaware of which counterparty is such an empty
creditor.\190\ Additional information for market participants in the
form of reporting, however, may also alleviate part of this information
asymmetry \191\ by making it easier for CDS sellers to identify such
counterparties, thus mitigating the potential for moral hazard.
---------------------------------------------------------------------------

    \188\ Bolton & Oehmke, supra note 112 at 2617, 2617-2655; see
also Andr[aacute]s Danis, Do Empty Creditors Matter? Evidence from
Distressed Exchange Offers, 63 Mgmt Sci., at 1271, 1271-1656 (Oct.
2015) (available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2001467).
    \189\ Bengt Holmstr[ouml]m, Moral Hazard and Observability, 10
The Bell J. of Econ., at 74, 74-91 (Spring, 1979).
    \190\ There is evidence that even sophisticated market
participants were unable to ex-ante price events characterized as
``empty creditor'' scenarios. See Solus Alternative Asset Management
LP v. GSO Capital Partners L.P., No. 18 CV 232-LTS-BCM (SDNY Jan.
29, 2018).
    \191\ The additional reporting could inform the market of the
filer's interest in the underlying entity's solvency by allowing the
observance of a conventional, hedging CDS position. For example, a
CDS participant with a large long CDS position may be less
interested in the underlying entity's solvency as compared to the
issuing entity itself or to a bond investor without CDS insurance.
Further, to the extent that a counterparty has not reported pursuant
to the proposed rule, a market participant could infer information
about a potentially lower level of risk associated with transacting
with that counterparty.
---------------------------------------------------------------------------

Total Return Swaps
    The total return swap (TRS) \192\ market differs from the CDS
market in that the counterparties in a TRS take on the price and
dividend risk of a reference stock and not the risk of default.
Counterparties in the TRS market use the contracts to obtain exposure,
usually leveraged, to the price movement and dividend payments of a
stock or index and benefit from not having to own the stock itself.
Market participants, such as mutual funds, hedge funds, and endowments,
use TRS to obtain exposure in markets where they would face
difficulties \193\ purchasing or selling the underlying stock while
taking advantage of the capital efficiencies of not holding shares in
their inventories.
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    \192\ TRS include non-CDS debt-based security swaps, equity-
based security swaps, and mixed swaps.
    \193\ A market participant may find it difficult to buy stock of
a foreign company, or may have trouble locating a stock to sell
short.
---------------------------------------------------------------------------

    The risks attendant to the accumulation of large positions in TRS
are different from CDS: With TRS, the main risk is that highly
leveraged positions are very sensitive to price fluctuations of the
underlying asset. The larger the position, the higher the risk that
drastic price fluctuations may impair the solvency of the investor and,
as a result, may create default risk for the security-based swap
counterparty.
    As in the CDS market,\194\ the lack of public information about
market positions means that market participants may not be aware of the
risk of default of their counterparties, especially to those with
concentrated, large positons who would be more prone to risks from
price fluctuations. While counterparties could attempt to price in the
risk of additional default risk, they currently lack the information
necessary to accurately calculate the magnitude of that additional
risk.
---------------------------------------------------------------------------

    \194\ Navneet Arora, Priyank Gandhi & Francis A. Longstaff,
Counterparty Credit Risk and the Credit Default Swap Market, 103 J.
of Fin. Econ., at 280, 280-293 (March 1, 2011) (available at:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1830321)
(arguing that, ''[they] find that counterparty credit risk is priced
in the CDS market.'').
---------------------------------------------------------------------------

    The existence of this information asymmetry that ensues from the
party attaining the large position may create an economic externality.
This externality is one where a market participant who decides to take
on a large leveraged position in the underlying entity through a TRS
will not internalize the total societal cost of a negative outcome
where it declares bankruptcy. When the market participant amassing the
large position fails, the costs of the participant's behavior on the
issuer of the security, its counterparty, and the reputation of the
market could be larger than those internalized by the failing party.
Reporting could alleviate the externality by making information public
that could be incorporated into TRS prices, thus requiring the party
with the equity exposure to fully pay for the additional risks that it
is incurring. Counterparties that have amassed large economic exposures
in a specific security or TRS on that security (or both) and are
therefore at greater risk of default could then be more easily
identified.

C. Baseline

1. Existing Regulatory Frameworks
    As discussed in section I.A, because security-based swaps are
included in the Exchange Act's definition of ``security,'' participants
in the SBS market are currently subject to the general antifraud and
anti-manipulation provisions of the Federal securities laws, including
Sections 9(a), 10(b) and Rule 10b-5 under the Exchange Act, and Section
17(a) of the Securities Act. In addition, the Dodd-Frank Act expanded
the anti-manipulation provisions of Section 9 of the Exchange Act to
encompass security-based swap transactions and requires the Commission
to adopt rules to prevent fraud, manipulation, and deception in
connection with security-based swaps.\195\
---------------------------------------------------------------------------

    \195\ See supra note 5 and accompanying text.
---------------------------------------------------------------------------

    In addition, the Commission has now finalized a majority of its
Title VII rules related to SBS Entities, including rules that allow
such persons to manage the market, counterparty, operational and legal
risks associated with their security-based swap business. These include
the Risk Mitigation Rules; rules relating to capital, margin, and
segregation requirements for SBSDs, MSBSPs, and broker-dealers (the
``Capital, Margin, and Segregation Rules''); \196\ and rules relating
to recordkeeping and reporting requirements for SBSDs, MSBSPs, and
broker-dealers (the ``Recordkeeping Rules'').\197\ The Risk Mitigation
Rules, which consist of 17 CFR 240.15Fi-3 (``Rule 15Fi-3''), 17 CFR
240.15Fi-4 (``Rule 15Fi-4''), and Rule 15Fi-5, relate to, other things,
reconciling outstanding security-based swaps with applicable
counterparties on a periodic basis, engaging in certain forms of
portfolio compression exercises, as appropriate, and executing written
security-based swap trading relationship documentation with each of its
counterparties prior to, or contemporaneously with, executing a
security-based swap transaction. When the Commission adopted those
rules in December 2019, we explained that they were intended to play an
important role in addressing risks to an SBS Entity as a whole,
including risks related to the

entity's safety and soundness.\198\ For example, portfolio
reconciliation is designed to allow SBS Entities to manage their
internal risks by better ensuring agreement with their counterparties
with respect to the material terms and valuation of each transaction
(and thereby avoiding complications at various points throughout the
life of the transaction).\199\ Further, requiring an SBS Entity to
document the terms of the trading relationship with each of its
counterparties before executing a new security-based swap transaction
should promote sound collateral and risk management practices by
enhancing transparency and legal certainty regarding each party's
rights and obligations under the transaction.\200\ Similarly, portfolio
compression, by allowing an SBS Entity to potentially eliminate
offsetting and redundant uncleared derivatives transactions--as
measured both by the number of contracts and the total notional value--
reduces its gross exposure to its direct counterparties, including by
eliminating all exposure (and credit risk) to certain
counterparties.\201\
---------------------------------------------------------------------------

    \196\ See Capital, Margin, and Segregation Adopting Release, 84
FR 43872.
    \197\ See Recordkeeping and Reporting Adopting Release, 84 FR
68550.
    \198\ See Risk Mitigation Adopting Release, 85 FR at 6378-79.
    \199\ See Risk Mitigation Adopting Release, 85 FR at 6361.
    \200\ See id. Both of the portfolio reconciliation and
documentation requirements should also help to reduce counterparty
credit risk and promote certainty regarding the agreed upon
valuation and other material terms of a security-based swap. See id.
    \201\ See id.
---------------------------------------------------------------------------

    The Capital, Margin, and Segregation Rules, among other things: (1)
Established minimum capital requirements for non-bank SBSDs and MSBSPs
(i.e., SBSDs and MSBSPs for which there is not a prudential regulator);
(2) increased the minimum tentative net capital and net capital
requirements for broker-dealers that use internal models to compute net
capital; (3) established capital requirements tailored to security-
based swaps and swaps for broker-dealers that are not registered as an
SBSD or MSBSP to the extent they trade these instruments; and (4)
established margin requirements for non-bank SBSDs and MSBSPs with
respect to non-cleared security-based swaps.\202\ That rulemaking also
established segregation requirements for SBSDs and notification
requirements with respect to segregation for SBSDs and MSBSPs.\203\
---------------------------------------------------------------------------

    \202\ See Capital, Margin, and Segregation Adopting Release, 84
FR at 43874.
    \203\ See id.
---------------------------------------------------------------------------

    When the Commission adopted the Capital, Margin, and Segregation
Rules, we explained that the capital requirements were designed to
ensure that non-bank SBSDs and stand-alone broker-dealers,
respectively, have sufficient liquidity to meet all unsubordinated
obligations to customers and counterparties and, consequently, if the
non-bank SBSD or stand-alone broker-dealer fails, sufficient resources
to wind-down in an orderly manner without the need for a formal
proceeding.\204\ Similarly, in the course of discussing the margin
requirements, the Commission explained that ``[i]n the market for non-
cleared security-based swaps and in the market for OTC derivatives
generally, collateral is the means for mitigating counterparty credit
risk.'' \205\ Finally, the Commission explained that segregation
requirements were designed ``to protect the rights of security-based
swap customers and their ability to promptly obtain their property from
an SBSD or stand-alone broker-dealer.'' \206\
---------------------------------------------------------------------------

    \204\ See Capital, Margin, and Segregation Adopting Release, 84
FR at 43959.
    \205\ See Capital, Margin, and Segregation Adopting Release, 84
FR at 44012.
    \206\ See Capital, Margin, and Segregation Adopting Release, 84
FR at 43959.
---------------------------------------------------------------------------

    The Commission's Recordkeeping Rules also play an important role in
reducing certain types of risk. Among other things, those rules, which
also were adopted in 2019, establish recordkeeping, reporting, and
notification requirements for SBSDs and MSBSPs and securities count
requirements for stand-alone SBSDs, and also establish additional
recordkeeping requirements applicable to stand-alone broker-dealers to
the extent they engage in security-based swap or swap activities.\207\
Many of those rules have been designed expressly to ``promote
compliance with the financial responsibility requirements for broker-
dealers, SBSDs, and MSBSPs, facilitate regulators' oversight and
examinations of such firms, and promote transparency of their financial
condition and operation.'' \208\
---------------------------------------------------------------------------

    \207\ See Recordkeeping and Reporting Adopting Release, 84 FR at
68607.
    \208\ See id.
---------------------------------------------------------------------------

    Market participants are already subject to the requirements of
Regulation SBSR, which governs regulatory reporting of security-based
swap transactions to SBSDRs. Regulation SBSR provides for real-time
public reporting of individual security-based swap transactions to a
SBSDR within 24 hours of the trade execution and the immediate public
dissemination by the SBSDR of security-based swap transaction
information, including pricing and volume information. Regulation SBSR
requires certain items to be reported about each security-based swap
transaction, such as the ``product ID'' \209\; date and time of the
transaction; price and amount of up-front payments; notional amount;
indication of whether the transaction will be submitted to clearing;
and identification of the parties to the transaction. On November 8,
2021, mandatory reporting of new security-based swap transactions to
SBSDRs began, with public dissemination of those transactions set to
begin on February 14, 2022.\210\ As of November 9, 2021, there are
currently two registered SDRs: DTCC Data Repository (``DDR'') and ICE
Trade Vault (``ITV''). As discussed above, any position reporting
pursuant to Regulation SBSR is completely anonymous, and would
therefore not inform participants that a specific counterparty was
building up large, concentrated security-based swap positions.\211\
---------------------------------------------------------------------------

    \209\ The term ``product ID'' is defined in Regulation SBSR to
mean the ``unique identification code'' assigned to a product. See
17 CFR 242.900(bb) (defining ``product ID'') and 900(qq) (defining
``unique identification code''). Pursuant to Rule 901(c)(1) of
Regulation SBSR, if there is no product ID, the reporting party is
required to report certain information about the security-based
swap, including, among other things, the asset class of the
security-based swap, the specific underlying security, effective
date, termination date, and certain payment terms.
    \210\ See 17 CFR 242.901(c).
    \211\ See supra note 5 and accompanying text.
---------------------------------------------------------------------------

    In addition, section 30(b) and 17 CFR 270.30b1-9 (``Rule 30b1-9'')
of the Investment Company Act of 1940 require that registered
investment companies and certain exchange-traded funds report
information quarterly about their portfolios and each of their
portfolio holdings, including security-based swaps, as of the last
business day, or last calendar day, of each month. With the exception
of certain non-public information, the information reported on Form N-
PORT for the third month of each fund's fiscal quarter is made publicly
available.
    Finally, Rule 15Fk-1 requires an SBS Entity to designate a CCO and
imposes certain duties and responsibilities on that CCO.\212\ Further,
existing rules require that a majority of the board approve the
compensation and removal of the CCO.\213\ Rule 15Fh-4(a) makes it
unlawful for an SBS Entity to: (i) Employ any device, scheme, or
artifice to defraud any special entity or prospective customer who is a
special entity; (ii) engage in any transaction, practice, or course of
business that operates as a fraud or deceit on any special entity or
prospective customer

who is a special entity; or (iii) to engage in any act, practice, or
course of business that is fraudulent, deceptive, or manipulative.
Further, existing Rule 15Fh-3(h) requires an SBS Entity to establish
and maintain a system to supervise its business and the activities of
its associated persons; the system must be reasonably designed to
prevent violations of the provisions of applicable Federal securities
laws and the rules and regulations thereunder.\214\ In addition, the
Commission's Risk Mitigation Rules are designed to foster effective
risk management by requiring the existence of sound documentation,
periodic reconciliation of portfolios, rigorously tested valuation
methodologies, and sound collateralization practices.\215\ Attempts by
officers, directors or employees to hide transactions, submit false
valuations or manipulate or fraudulently influence CCOs in the
performance of their duties related to the Risk Mitigation Rules would
undermine the SBS Entity's risk management.\216\
---------------------------------------------------------------------------

    \212\ See 17 CFR 240.15Fk-1.
    \213\ See supra section II.D.
    \214\ See 17 CFR 240.15Fh-3(h).
    \215\ See Risk Mitigation Adopting Release, 85 FR 6359.
    \216\ See supra section II.D.
---------------------------------------------------------------------------

2. Security-Based Swap Data, Market Participants, Dealing Structures,
Levels of Security-Based Swap Trading Activity, and Position
Concentration
    As of November 9, 2021, there are 41 entities registered with the
Commission as SBSDs, and no entities have registered as MSBSPs.
According to data published by the Bank for International Settlements
(``BIS''), as of December 2020, there was approximately: (i) $3.5
trillion \217\ in global notional amount outstanding of single-name
CDS; (ii) $4.5 trillion in multi-name index CDS outstanding; and (iii)
$347 billion in multi-name, non-index CDS outstanding.\218\ The total
gross market value outstanding in single-name CDS was approximately $77
billion, and in multi-name CDS instruments, there was approximately
$125 billion outstanding. The global notional amount outstanding in
equity forwards and swaps was $3.6 trillion, with total gross market
value of $321 billion.\219\
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    \217\ The global notional amount outstanding represents the
total face amount used to calculate payments under outstanding
contracts. The gross market value is the cost of replacing all open
contracts at current market prices.
    \218\ See BIS, Semi-annual OTC derivatives statistics at
December 2020, Table D5.2, (available at: https://stats.bis.org/statx/srs/table/d5.2 (accessed Aug. 18, 2021).
    \219\ These totals include swaps and security-based swaps, as
well as products that are excluded from the definition of ``swap,''
such as certain equity forwards. See OTC, equity-linked derivatives
statistics, Table D5.1, available at https://stats.bis.org/statx/srs/table/d5.1 (accessed Aug. 18, 2021). For the purposes of this
analysis, the Commission assumes that multi-name index CDS are not
narrow-based index CDS and therefore, do not fall within the
`security-based swap' definition. See 15 U.S.C. 78c(a)(68)(A); see
also Products Release, 77 FR 48208. The Commission also assumes that
all instruments reported as equity forwards and swaps are security-
based swaps, potentially resulting in underestimation of the
proportion of the security-based swap market represented by single-
name CDS. Therefore, when measured on the basis of gross notional
outstanding single-name CDS contracts appear to constitute roughly
49% of the security-based swap market. Although the BIS data reflect
the global OTC derivatives market, and not just the U.S. market, the
Commission has no reason to believe that these percentages differ
significantly in the U.S. market. Note that these data do not
include TRS on debt which are covered by the proposal.
---------------------------------------------------------------------------

    The above-described data is provided on an aggregate and global
basis. The Commission's primary source for disaggregated transactions
and positions in the market for security-based swaps is the DTCC
Derivatives Repository Limited Trade Information Warehouse (``DTCC-
TIW''). DTCC-TIW provides data regarding the activity of market
participants in the single-name CDS market during the period from 2006
to the end of 2020.\220\ The Commission acknowledges that limitations
in the data constrain the extent to which it is possible to
quantitatively characterize the security-based swap market.\221\ Based
on an analysis of DTCC-TIW data, staff concluded that there are 2,321
transacting agents that engaged directly in trading between November
2006 and December 2020 with 15,187 accounts.\222\
---------------------------------------------------------------------------

    \220\ DTCC Derivatives Repository Limited Trade Information
Warehouse provides weekly positions and monthly transaction files on
a voluntary basis for single-name and index-based CDS. These data
cover all positions and transactions where one of the counterparties
is a U.S. entity or the reference entity is U.S. entity, with status
as a U.S. entity determined by DTCC-TIW. In DTCC-TIW, the Commission
observes end of week CDS positions for all U.S. entities, foreign
counterparties to a U.S. entity, or foreign counterparties trading a
CDS referencing a U.S. underlying entity. The DTCC-TIW data have
limitations. Data do not address two foreign counterparties with CDS
referencing foreign underlying entities. In addition, the DTCC-TIW
data does not provide any intra-weekly CDS position information, nor
any information on the underlying security holdings of reference
entities. Further, DTCC-TIW is a voluntary database where market
participants on a voluntary basis submit transactions, and end of
week holdings.
    \221\ While the Commission has limited data regarding the
activity of market participants in equity swaps, the Commission
believes that the market for security-based swaps is sufficiently
representative of the market. DTCC Derivatives Repository Limited
Trade Information Warehouse provides weekly positions and monthly
transaction files on a voluntary basis for single-name and index-
based CDS. These data cover all positions and transactions where one
of the counterparties is a U.S. entity or the reference entity is
U.S. entity, with status as a U.S. entity determined by DTCC-TIW.
The Commission also relies on qualitative information regarding
market structure and evolving market practices provided by
commenters and the knowledge and expertise of Commission staff.
    \222\ These 2,321 entities, which are presented in more detail
in Table 1, below, include all DTCC-TIW-defined ``firms'' shown in
DTCC-TIW as transaction counterparties that report at least one
transaction to DTCC-TIW as of December 2017. The staff in the
Division of Economic and Risk Analysis classified these firms, by
machine-matching names to known third-party databases and by manual
classification. See, e.g., Dealing Activity Adopting Release, 81 FR
8602, n.43. Manual classification was based in part on searches of
the EDGAR and Bloomberg databases, the SEC's Investment Adviser
Public Disclosure database, and a firm's public website or the
public website of the account represented by a firm. As mentioned
above, data on CDS market participants come from DTCC-TIW. Principal
holders of CDS risk exposure are represented by ``accounts'' in the
DTCC-TIW. ``Accounts'' as defined in the DTCC-TIW context are not
equivalent to ``accounts'' in the definition of ``U.S. person''
provided by Exchange Act rule 3a71-3(a)(4)(i)(C). One entity or
legal person (known as ``transacting agent'' in the terminology of
TIW) may have multiple accounts. For example, a bank that is a
transacting agent may have one DTCC-TIW account for its U.S.
headquarters and one DTCC-TIW account for one of its foreign
branches.
---------------------------------------------------------------------------

    Data from the DTCC-TIW show that activity in the single-name CDS
market is concentrated among a relatively small number of entities,
predominantly ISDA-recognized dealers and large banks, who act as
dealers in this market.\223\ The top five dealers (when accounts are
sorted by number of counterparties) when combined transact with over a
thousand counterparty accounts, consisting of both other dealers and
non-dealers. The next 23% of dealers transacted with 500 to 1,000
counterparty accounts; 38% transacted with 100 to 500 unique accounts;
and 31% of dealer accounts intermediated security-based swaps with
fewer than 100 unique counterparties accounts in 2020. The median
number of counterparty accounts across dealers is 276 (the mean is
approximately 570). Dealer-intermediated transactions reached a gross
notional amount of approximately $1.99 trillion, approximately 55% of
which was intermediated by the top five dealer accounts. The median
non-dealer counterparty transacted with only two dealer accounts (with
an average of approximately 2.5 dealer accounts) in 2020.
---------------------------------------------------------------------------

    \223\ Dealers are generally persons engaged in the business of
buying and selling securities for their own account, through a
broker or otherwise. 15 U.S.C.78c(a)(5). Security-based swap dealers
are generally defined as persons who hold themselves out as dealers
in security-based swaps; make markets in security-based swaps;
regularly enter into security-based swaps as an ordinary course of
business for their own account; or engages in any activity causing
them to be commonly known in the trade as a dealer or market maker
in security-based swaps. 17 CFR 240.3a71-1.
---------------------------------------------------------------------------

    Non-dealer single-name CDS market participants include, but are not
limited

to, investment companies, pension funds, private funds, sovereign
entities, and industrial companies. We observe that most non-dealer
market participants of single-name CDS do not engage directly in the
trading of security-based swaps, but trade through banks, investment
advisers or funds, or other types of firms, which we refer to as
transacting parties, consistent with DTCC-TIW terminology.\224\ As
shown in Table 1, close to 78 percent of transacting parties are
identified as investment advisers or funds, of which approximately 40
percent (about 32 percent of all transacting parties) are registered as
investment advisers under the Advisers Act.\225\ Although investment
advisers and funds are the vast majority of transacting parties, the
transactions they executed account for only 9.5 percent of all single-
name CDS trading activity reported to the DTCC-TIW, measured by the
number of transaction sides.\226\ The vast majority of transactions,
82.1 percent, measured by number of transaction-sides were executed by
ISDA-recognized dealers.
---------------------------------------------------------------------------

    \224\ See 15 U.S.C. 80b1 through 80b21. Transacting parties
participate directly in the security-based swap market, without
relying on an intermediary, on behalf of their principals,
investment companies, pension funds, private funds, sovereign
entities, and industrial companies. For example, a university
endowment may hold a position in a security-based swap that is
established by an investment adviser that transacts on the
endowment's behalf. In this case, the university endowment is a
principal that uses the investment adviser as its transacting party.
    \225\ DTCC-defined ``firms'' shown in DTCC-TIW, which we refer
to here as ``transacting parties.''
    \226\ Each transaction has two transaction sides, i.e., two
transaction counterparties.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TP04FE22.000

    Figure 1 describes the percentage of global, notional transaction
volume in North American corporate single-name CDS reported to the
DTCC-TIW from January 2011 through December 2020, separated by whether
transactions are between two ISDA-recognized dealers (interdealer
transactions) or whether a transaction has at least one non-dealer
counterparty. As proposed Rule 10B-1 would affect U.S. market
participants as well as foreign entities who trade in both the
security-based swap and underlying asset, Figure 1 compares the
notional trading volume of all North American corporate single-name CDS
to notional trading of U.S. counterparties. The observed declining
trend seems to impact proportionally all types of exposures. As Figure
1 shows, all types of exposures have declined approximately
proportionally since 2011.

[GRAPHIC] [TIFF OMITTED] TP04FE22.001

BILLING CODE 8011-01-C
    As mentioned above, DTCC-TIW data covers only CDS positions.
However, the Commission staff has access to some information on
affected parties using filings from Form N-PORT. As discussed above,
certain registered investment companies must report information
quarterly about their portfolios to the Commission in Form N-PORT.
DTCC-TIW data is summarized in Table 1, indicate that in the CDS
market, mutual funds and Exchange Traded Funds (ETFs) that report on
Form N-PORT represent approximately 17% of firms in DTCC-TIW, and make
up approximately 6% of all transactions available in DTCC-TIW.\227\ As
a percentage of US-only firms, mutual funds and ETFs that report on
Form N-PORT represent approximately 29% of firms in the U.S. and
approximately 5% of total U.S. transactions reported in DTCC-TIW. These
transactions provide a sample of the entities participating in the CDS
market that are mutual funds and ETFs, which are required to file Form
N-PORT.\228\
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    \227\ The analysis in Table 1 using DTCC-TIW data is performed
on transacting party level, while analysis of Form N-PORT data is
performed at fund level. Due to data limitations and no direct
linkages between DTCC-TIW and N-PORT data, the Commission cannot
directly compare entities reporting to DTCC-TIW to entities that
file Form N-PORT.
    \228\ Form N-PORT is to be used by a registered management
investment company, or an exchange-traded fund organized as a unit
investment trust, or series thereof (``Fund''), other than a Fund
that is regulated as a money market fund (``money market fund'')
under 17 CFR 270.2a-7 (``Rule 2a-7'') under the Investment Company
Act of 1940, 15 U.S.C. 80a (``Act'') or a small business investment
company (``SBIC'') registered on Form N-5 (17 CFR 239.24 and 274.5),
to file reports of monthly portfolio holdings pursuant to Rule 30b1-
9 under the Act (17 CFR 270.30b1-9).
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D. Consideration of Costs and Benefits; Consideration of Burden on
Competition and Promotion of Efficiency, Competition and Capital
Formation

1. Re-proposed Rule 9j-1 and Proposed Rule 15Fh-4(c)
i. Benefits
    The Commission believes that re-proposed Rule 9j-1 would decrease
fraudulent activity, affect compliance costs, and lower litigation
costs. In addition, re-proposed Rule 9j-1 may indirectly increase price
efficiency and decrease capital costs of underlying entities. The
Commission discusses each of these individual benefits in more detail
below.
    The Commission believes that re-proposed Rule 9j-1 would reduce the
risk of fraud in the security-based swap market, including risk of
fraudulent behavior undertaken in connection with opportunistic trading
strategies. The additional specificity offered by re-proposed Rule 9j-1
may enhance Commission oversight of the security-based swap market,
which may ultimately benefit market participants through reducing the
risk of fraud. Further, by reducing these risks, re-proposed Rule 9j-1
could encourage participation in the market, which may result in
increased competition.\229\ More security-based swap entities would be
willing to supply (issue) and/or demand (buy) security-based swaps,
with increased confidence that their

counterparties would have limited abilities to impact the market using,
among other things, opportunistic strategies.
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    \229\ See Joint Statement, supra note 29.
---------------------------------------------------------------------------

    The Commission also believes that, by providing additional
precision and specificity regarding the application of existing
antifraud and anti-manipulation laws to misconduct in the security-
based swap market, re-proposed Rule 9j-1 could prompt some market
participants to devote greater resources to ensure that they are
compliant with their obligations under antifraud and anti-manipulation
law, which could also decrease the risk of fraud in the security-based
swap market. Because of this decreased risk of fraud, market
participants may have fewer disputes with their counterparties
regarding security-based swap contracts, which in turn, could lower
litigation costs for security-based swap participants and underlying
entities. Lower litigation costs could contribute to reducing the cost
of CDS and, to the extent that the cost of CDS is reduced, lower costs
of borrowing. Conversely, by providing additional precision and
specificity regarding the application of existing antifraud and anti-
manipulation provisions of the Federal securities laws to misconduct in
the security-based swap market, the re-proposed Rule 9j-1 could
decrease compliance costs for some market participants who may, as a
result of the additional specificity of the rule, need to spend fewer
resources determining appropriate compliance under Section 9(j).
    Decreased risk of fraud, including risk of fraudulent behavior
undertaken in connection with opportunistic trading strategies, in the
security-based swap market may also lead to increased price efficiency,
as new trading could lead to a greater exchange of market expectations
from buyers and sellers transacting in the market. This would
consequently lead to greater security-based swap market efficiency, as
security-based swap prices would provide greater confidence that their
prices more likely reflect fundamental values and risk in more liquid
markets. For example, prices of single-name CDS contracts would more
likely reflect the fundamental credit risk of the underlying entity, as
opposed to counterparty credit risk or the probability that an
``opportunistic'' or ``manufactured credit'' strategy were
successful.\230\ Further, by providing specificity, re-proposed Rule
9j-1 would help prevent prohibited conduct from distorting the market
and artificially increasing or decreasing prices for security-based
swaps. Thus, we believe the proposed rules would help to ensure more
efficient pricing.
---------------------------------------------------------------------------

    \230\ See Fletcher, supra note 21.
---------------------------------------------------------------------------

    In addition, the Commission expects the price efficiency in the
underlying securities markets to have a positive impact on capital
formation and the cost of capital for the underlying entities. The
market participation increases in security-based swaps may enhance
liquidity in the underlying market and related swap indices, and in
general, lower debt and equity capital costs for security-based swaps
referenced entities. For example, if prices of single-name CDS are more
reflective of the fundamental credit risk of the underlying entity, as
a second order effect, participants in the market for the underlying
security would be better informed about the underlying security's
attributes through the price signal, likely increasing their
willingness to re-enter or engage in the underlying security's market.
Specifically, the underlying security market uses the derivative market
to assess its quality, as the derivative market in some circumstances
is forward looking, liquid, and more informative than the underlying
market.\231\ Greater activity in the underlying security market due to
price efficiency and greater availability to hedge these securities in
the security-based swap market could lead to lower capital costs and
increase capital formation for the underlying entities.
---------------------------------------------------------------------------

    \231\ See Haibin Zhu, An Empirical Comparison of Credit Spreads
between the Bond Market and the Credit Default Swap Market, EFMA
2004 Basel Meetings Paper, BIS Working Paper No. 160, (Aug. 2004)
(available at: https://ssrn.com/abstract=477501); see also Jongsub
Lee, Andy Naranjo, and Guner Velioglu, When do CDS Spreads Lead?
Rating Events, Private Entities, and Firm-specific Information
Flows, 13 J. of Fin. Econ., 556, at 556-578 (2017) (available at:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2933052)
(addressing the size of US single-name reference entities).
---------------------------------------------------------------------------

    Proposed Rule 15Fh-4(c) would make it unlawful for any officer,
director, supervised person, or employee of an SBS Entity, or any
person acting under such person's direction, to directly or indirectly
take any action to coerce, mislead, or otherwise interfere with the SBS
Entity's CCO. This prohibition would support the ability of the CCO to
meet the CCO's important obligations to foster compliance in its role
of overseeing compliance within the SBS Entity. We expect that this
rule change would make it more likely that a CCO would be able to more
efficiently and effectively execute the CCO's responsibilities to
foster compliance, including for example, by ensuring that the SBS
Entity maintains and reviews written policies and procedures reasonably
designed to achieve compliance with the rules and regulations relating
to the business of the security-based swap entity. Ultimately, we
expect that these effects would likely also reduce the risk of fraud,
market manipulation, or other fraudulent activities in the security-
based swap market, providing additional protection for both
counterparties in the security-based swap transaction and the
underlying entity.
    Proposed Rule 15Fh-4(c) would likely have minor indirect positive
impacts on price efficiency, competition, and capital formation.
Because Rule 15Fh-4(c) would support the ability of the CCO to oversee
compliance with the federal securities laws within the SBS Entity and
likely reduce the risk of fraud, security-based swaps would be more
likely to be reflective of the fundamental credit risk of the
underlying entity, positively influencing price efficiency and
competition among market participants. Capital formation could, as a
result, further indirectly increase, as greater price efficiency and
competition among market participants could lead to a decrease in
security-based swaps prices, in turn, lower costs of borrowing (as a
result of cheaper CDS).
ii. Costs
    Some security-based swap market participants may incur costs
associated taking actions to update existing compliance systems for
compliance with re-proposed Rule 9(j)-1. We expect, however, that these
additional costs would be relatively small because many of these
practices and systems are already in place to ensure compliance with
Section 9(j) of the Exchange Act and the other general antifraud and
anti-manipulation statutory and regulatory provisions.\232\
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    \232\ As noted above, some commenters to the 2010 proposed rule
argued that not requiring scienter with respect to paragraphs (3)
and (4) of re-proposed Rule 9j-1(a) (which were paragraphs (c) and
(d) in the 2010 proposed rule) ``could potentially deter many
parties from entering into SBS, increase their cost and have other
distorting effects on the markets.'' Because Rule 9j-1(a), as
discussed above, does not apply a new scienter standard to market
conduct, we do not expect such increases in costs or distorting
effects on the market. See supra section II.B.1.
---------------------------------------------------------------------------

    In addition, the proposed rule could discourage some legitimate
market activities, including some hedging activity, because of concerns
that such activities might be viewed as rule violations. As a result,
compliance costs related to evaluating whether or not

certain activities are permissible may increase for some market
participants. However, because re-proposed Rule 9j-1 would provide
additional precision and specificity regarding the application of
existing antifraud and anti-manipulation laws to misconduct in the
security-based swap market, the Commission believes that these costs
would not be significant. Further, these costs would be mitigated to
the extent that the limited safe harbor from certain provisions of re-
proposed Rule 9(j)-1 addresses situations in which a counterparty is
required to take certain pre-agreed actions with respect to the
security-based swap, or to effect certain transactions related to
portfolio compression exercises, in each case while in possession of
material non-public information.
    Proposed Rule 15Fh-4(c)'s prohibition on taking actions to coerce,
mislead, or otherwise interfere with the SBS Entity's CCO, may create
additional costs for SBS Entities. For example, to the extent that any
current practices of an SBS Entity may include activities that would be
explicitly prohibited under Rule 15Fh-4(c), applicable policies and
procedures would need to be updated. In addition, it is possible that
the proposed rule could cause SBS Entity employees to be overly
cautious when consulting with a CCO. We do not, however, believe that
any such effects will be significant, given the specificity of the
rule's prohibition on certain interference with the SBS Entity's CCO.
2. Proposed Rule 10B-1
i. Benefits
    Proposed Rule 10B-1 could increase market integrity, increase
liquidity, decrease counterparty risk, lower litigation costs, decrease
cost of capital for underlying entities, decrease contagion risk in the
market, and assist the Commission in identifying concentrated position
and holdings in related securities. We discuss each of these benefits
below.
    The Commission expects proposed Rule 10B-1 reporting requirements
to enhance the integrity of the security-based swap market. The
proposed reporting requirements would inform market participants of
large concentrated positions that might give the holder incentives to
affect the timing or the payoff size of the CDS contract for the CDS
buyer's benefit. As a result, market participants would be better able
to assess counterparty risk. In this respect, the Commission recognizes
that the Risk Mitigation Rules; Capital, Margin, and Segregation Rules;
and Recordkeeping Rules may address similar risks, to the extent that
these rules are intended to, among other things, promote safety and
soundness of SBS Entities, enhance the transparency of obligations
under transactions with SBS Entities, protect the ability of security-
based swap customers to promptly obtain their property, and promote
compliance with financial responsibility requirements for broker-
dealers, SBSDs, and MSBSPs. However, because of proposed Rule 10B-1's
application to non-SBS Entities, in addition to SBS Entities, and the
proposed rule's reporting-based method to the reduction of counterparty
risk, the proposed rule would afford additional protections to market
participants, including with respect to large position concentration
risk. In contrast to the Risk Mitigation Rules; Capital, Margin, and
Segregation Rules; and Recordkeeping Rules, proposed Rule 10B-1 would
provide information to market participants for them to take specific
mitigating actions to limit counterparty risk exposure.
    Further, to the extent that market participants are better able to
assess counterparty risk as a result of the reporting that would be
required under proposed Rule 10B-1, it would likely become more
expensive to build such positions, because market participants may
refrain from trading with a reporting counterparty, trade only at
prices that account for additional risk, or ask for larger margin
postings of collateral. These actions would likely make it unprofitable
to create market conditions that would impact the timing or the size
payoff of the CDS contract. Further, because the reporting required
under proposed Rule 10B-1 would inform the Commission of material,
directional positions, it may enhance Commission oversight of the
security-based swap market, which may ultimately benefit market
participants. In particular, it would provide the Commission tools to
monitor for large concentrated positions, counterparty risk, and
potentially detect fraudulent behavior, as the Commission would have
access and complete visibility to both the security-based swap and the
related underlying asset for participants that would be required to
report.
    Because proposed Rule 10B-1 would make it more challenging to
create market conditions that would affect the timing or the size
payoff of the CDS contract, proposed Rule 10B-1 would likely result in
greater overall market integrity. Through better information for market
participants, the Commission expects proposed Rule 10B-1 to encourage
participants to increase capital buffers (i.e., both initial and
variation margins) where needed and help to prevent the impact of
defaults from spreading through exposed counterparties, thereby
limiting ``contagion risk'' (i.e., risk that might result from indirect
counterparty risk) in the market.
    Further, by requiring large CDS buyers to report their positions,
proposed Rule 10B-1 may help reduce the presence of moral hazard in
single-name CDS markets. As described in the Broad Economic
Considerations, in the presence of asymmetric information, bondholders
who are also CDS buyers may become disinterested in the solvency of the
underlying asset, and may become less inclined to renegotiate contracts
in order to avoid a default in bond payments. Proposed Rule 10B-1 would
benefit market participants by requiring reporting of large CDS
positions and allowing market participants to identify counterparty
risk, adjust prices for counterparty risk, and limit the scope of moral
hazard.
    Such increases in market integrity may allow market participants to
trade with more and with greater confidence in the market. As a result,
proposed Rule 10B-1 could lead to increased supply and demand for
security-based swaps, leading to greater competition as more security-
based swap market participants enter the market. Further, this would
consequently lead to greater security-based swap market efficiency, as
security-based swap prices would more likely reflect fundamental values
and risk in more liquid markets. For example, prices of single-name CDS
contracts would more likely reflect the fundamental credit risk of the
underlying entity. Thus, we expect the proposed rules would help to
ensure more efficient pricing in the security-based swap market. Price
efficiency would increase, as participants would be better informed of
likely outcomes. Further, we expect that such increases in price
efficiency in the underlying securities markets would have some
positive impact on capital formation and capital costs for the
underlying entities, similar to the effect described above for re-
proposed Rule 9j-1. As security-based swap prices become more
informative, more likely reflecting the fundamental risk of the
underlying entity, more market activity could follow.
    Because of both the decreased counterparty risk and greater market
integrity, the proposed Rule 10B-1 reporting requirements may also lead
to lower litigation costs between security-based swap participants. As
discussed above, the proposed rule would likely

limit or constrain exposure buildup in the security-based swap market,
making it less profitable to accumulate positions at sizes that might
incentivize market participants to affect the timing or the size payoff
of the CDS contract. Although those actions may not be fraudulent,
manipulative, or deceptive, there are situations (which are discussed
in section I.B) where the accumulation of a large CDS position could
signify misconduct. To the extent that an increased risk of litigation
is associated with such potentially manipulative or unexpected
behavior, proposed Rule 10B-1 would make it more likely that market
participants can avoid such costs.
    With respect to the requirements to report certain
information,\233\ public reporting of certain identifying information
would have the benefit of increasing market liquidity, as a result of
the counterparties being able to identify the market participant who
exceeded the reporting threshold and limit their counterparty risk
exposure to them.\234\ In that regard, the use of standard
identifiers--namely, the product ID for the security-based swaps, the
FIGI for securities (or any other unique security identifier(s) that
may be included at the filer's option), and the LEI for legal
entities--on Schedule 10B would augment transparency by providing
consistent identification of entities and securities across datasets
and jurisdictions, allowing market participants to cross-reference the
data reported on Schedule 10B with data reported from any other sources
that use those standard identifiers.\235\ In turn, enhanced
transparency would reduce transactional and operational costs of
trading, making transactions cheaper and more frequent.
---------------------------------------------------------------------------

    \233\ See proposed Rule 10B-1(a) and Schedule 10B (providing a
complete list of information required to be disclosed). Proposed
Rule 10B-1 would require persons subject to the proposed rule to
report, among other things: (1) Identifying information, including
for example, the name of reporting party, the reporting party's LEI
and the LEIs of the issuers of underlying and related securities (if
available), place of organization, type of reporting person; and (2)
the notional amount of the applicable related security-based swap,
the underlying security's FIGI, and the FIGIs of related securities
that share the same underlying asset.
    \234\ Having a reporting requirement with no identification
might only partially solve the informational asymmetry problem
described in the Basic Economic Considerations section. For example,
if the report was designed to only disclose information about the
security-based swap and underlying securities, but withheld
information about the security-based swap participant, it would
potentially lead to all market participants to believe their
particular counterparty was the one that breached the threshold. The
missing information would likely cause market participants to
unnecessarily withdraw from the market, decreasing either supply or
demand.
    \235\ Product IDs, if available, are a required element of
security-based swap reporting obligations under Regulation SBSR. See
17 CFR 242.901(c)(1). Regulation SBSR reporting obligations do not
require LEI or FIGI.
---------------------------------------------------------------------------

    Requiring the reporting of the notional amount of the applicable
security-based swap, and related securities with the same underlying
asset would allow market participants to quantify the size of the
position in the security-based swap, the underlying security, and
related securities, meaning that participants would know the exact size
of the concentrated position that led to the threshold being exceeded.
The information required to be reported by proposed Rule 10B-1
complements what is required to be reported pursuant to Regulation
SBSR, and because market participants would, as a result of the
proposed rule, be aware of counterparty risks, proposed Rule 10B-1 may
encourage more participation in the market, which would increase
liquidity in the market for security-based swaps.
    In addition, as a second order effect, the proposed Rule 10B-1
could have positive spillover benefits in markets of the specific
underlying entity, i.e., bond markets for CDS and bond swaps, or equity
markets for TRS, respectively. Specifically, the increased liquidity in
the security-based swap market could allow participants in capital
markets to more easily hedge capital investments they make in
underlying entity securities (e.g., both bond and equities). To the
extent that capital investments are more easily hedged, capital market
participants may be more likely to participate in these markets and
hence more likely to provide capital to the underlying entities.
    As discussed above, the Commission has access to single-name CDS
data through DTCC-TIW and a subsample of TRS data through Form N-
PORT.\236\ In addition, reporting of security-based swap transactions
is now required.\237\ The Commission's oversight of the security-based
swap market would be enhanced by the proposed reporting requirement in
the proposed Rule 10B regarding related securities, which are not
reported through DTCC-TIW or security-based swap transaction reporting.
Proposed Rule 10B-1 would give the Commission access to information
that would allow it to better evaluate a reporting firm's security-
based swap positions (and in many cases, information about other
securities positions), thereby allowing the Commission to identify
potential market misconduct (e.g., insider trading or market
manipulation), default and contagion risk related to large concentrated
positions.
---------------------------------------------------------------------------

    \236\ See supra section VI.C.2 (describing security-based swap
data).
    \237\ See supra section VI.C.1 (describing existing major
regulatory reporting regimes for security-based swap market).
---------------------------------------------------------------------------

    Reporting entities would be required to file Schedule 10B on EDGAR
in a structured, machine-readable data language (specifically, FIXML).
This would benefit market participants by improving the usability,
accessibility, and reliability of the Schedule 10B reports. By
requiring a machine-readable language and a centralized, publicly
accessible filing location for Schedule 10B, the Commission would
enable market participants to download the reported information
directly into their databases and analyze the information using various
tools and applications, thus augmenting the informational benefits that
Rule 10B-1 would create. The requirement to use FIXML, an open standard
maintained by a market standard setting organization, for the Schedule
10B reports would allow those market participants that already use
FIXML for financial information exchange to leverage their existing
systems and processes in preparing the reports (if applicable) and/or
using the reports for analysis. Use of FIXML may also allow greater
comparability of the data to that from other reports to the Commission.
Furthermore, because the EDGAR system provides basic validation
capabilities, the requirement to submit Schedule 10B on EDGAR would
reduce the incidence of non-discretionary errors of Schedule 10B,
thereby improving the quality of Schedule 10B reports.
    Concerning timing, proposed Rule 10B-1 would require security-based
swap entities to file promptly, but in no event later than the end of
the first business day following the day of execution of the security-
based swap transaction that results in the exposure exceeding the
reporting threshold. The benefit of filing promptly would likely lead
to increases in market and price efficiency as prices would reflect
this information quickly. That is, counterparties would be able to
react quickly if warranted to this additional information by adjusting
their security-based swap, underlying security, or related security
positions, or margin requirements.
ii. Costs
    The Commission expects Rule 10B-1 to create reporting costs for
counterparties that have large concentrated exposures that breach the
reporting thresholds, and decrease liquidity or increase trading costs
for

entities who have triggered reporting thresholds. As discussed above,
to the extent that market participants are better able to assess
counterparty risk as a result of the reporting that would be required
under proposed Rule 10B-1, market participants may limit their
security-based swap activity with counterparties who have triggered the
proposed rule's reporting thresholds. A market participant may
determine that a counterparty that has triggered the reporting
thresholds is too risky to trade with, or may increase initial or
variation margins. While we believe that, as discussed above, liquidity
for the overall market would improve as a result of the proposed rule,
we believe that this the rule could decrease liquidity for these
particular market participants.
    Proposed Rule 10B-1 would impose reporting costs on market
participants who trigger the proposed rule's thresholds. The Commission
estimates that the number of reports would generally be less than 136
reports per week for U.S. security-based swap participants in the
single-name CDS market.\238\ The Commission expects this number to
represent an upper limit for reports, as it is possible that some CDS
counterparties would refrain to some extent from acquiring exposures
that would require reporting. Additionally, the Commission expects the
number of reports related to TRS positions to be smaller than the
number of reports related to CDS positions, although the Commission
cannot yet estimate a precise number due to the data limitations
discussed above.\239\ Some market participants are already subject to
the reporting obligations of Regulation SBSR or SDR or Section 30(b)
and Rule 30b1-9 of the Investment Company Act of 1940, so these
entities may have already made previous relevant expenditures to build
a technology system for reporting. Nonetheless, the monitoring of
positions and, to the extent thresholds are triggered, public reporting
of positions represents an additional reporting expense for all market
participants, some of whom may not be familiar with reporting to the
Commission.
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    \238\ The Commission estimates, at most, approximately, 136
reports per week (79 as a result of net threshold breaches, and 57
as a result of gross thresholds breaches) related to single-name
thresholds. The analysis is based on DTCC-TIW data, which uses
weekly holdings of single-name. See infra section VI.D.2.iii.(A).
    \239\ The Commission believes that the market for TRS is smaller
than the market for CDS, and the CDS single name market is the
representative market for security-based swaps in general, hence the
Commission expects fewer reports from TRS compared to single-name
CDS.
---------------------------------------------------------------------------

    As discussed above, up to 850 respondents will likely need to
develop a technological infrastructure to calculate and monitor their
security-based swap positions, even if some of those entities do not
have at least one Security-Based Swap Position that is required to be
reported pursuant to proposed Rule 10B-1(a).\240\ We estimate that each
respondent will incur a one-time initial cost of approximately $101,740
to develop such technological infrastructure, or $86,479,000 in the
aggregate for all 850 respondents. In addition to developing the
technological infrastructure to calculate and monitor their Security-
Based Swap Positions in order to comply with the requirements of
proposed Rule 10B-1, each respondent will be required to maintain and
operate such system on an ongoing basis. The Commission estimates such
annual costs will be $77,000 per respondent, or $65,450,000 in the
aggregate for all 850 respondents. In addition to maintaining and
operating such technological infrastructure, the Commission also
believes that each respondent will incur a $1,000 annual cost to store
such security-based swap position data, or $850,000 in the aggregate
for all 850 respondents.
---------------------------------------------------------------------------

    \240\ See supra section V (quantifying a subset of the costs
associated with proposed Rule 10B-1--specifically, the burden of
information collection costs estimated for the purposes of the
Paperwork Reduction Act).
---------------------------------------------------------------------------

    In addition, to the extent that market participants are better able
to assess counterparty risk as a result of the reporting that would be
required under proposed Rule 10B-1, market participants may limit their
security-based swap activity with counterparties who have triggered the
proposed rules' reporting thresholds. Where a counterparty has
triggered reporting thresholds, the market participant may determine
that the party is too risky to trade with, or may increase initial or
variation margins. Under these circumstances, market participants may
not trade with a reporting counterparty, trade only at prices that
account for additional risk, or ask for larger margin postings of
collateral.
    As discussed above, proposed Rule 10B-1 would require persons
subject to the proposed rule to report, among other things, identifying
information, the notional amount of the applicable security-based swap
(and in the case of equity-based security-based swaps, the percentage
of shares represented by the security-based swap as a percentage of the
outstanding number of shares), and related securities. The requirement
to report information that identifies the market participant, for
example the LEI, would allow market participants to identify the
security-based swap participant that breached the threshold. With
respect to the LEI requirement in particular, the Commission does not
expect the requirement would impose compliance costs on reporting
persons, because reporting persons would only have to provide LEIs only
if they possess one at the time of submitting the report, and thus
would not have to incur the cost to obtain and renew an LEI for the
purpose of filing Schedule 10B.\241\
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    \241\ Should a reporting entity choose to obtain an LEI, the
initial and renewal fees would vary based on the home jurisdiction
of the reporting entity. See https://www.gleif.org/en/about-lei/get-an-lei-find-lei-issuing-organizations. A U.S. entity can obtain for
a one-time fee of $65 and an annual maintenance fee of $50 per year.
See, e.g., https://lei.bloomberg.com/docs/faq#what-fees-are-involved. Prices were retrieved from Bloomberg Finance, L.P., one of
twelve LEI Operating Units that are accredited to issue LEIs to U.S.
entities. Similarly, the other standard identifier requirements
(FIGI for securities and product ID for security-based swaps) are
not expected to result in compliance costs for reporting persons.
FIGIs are automatically assigned and are retrievable and
redistributable at no cost. Product IDs are required to be reported
for all security-based swap transactions per Rule 901 of Regulation
SBSR, so a reporting person would not incur any incremental cost
associated with obtaining a product ID for the purposes of Schedule
10B. See 17 CFR 242.901(c)(1).
---------------------------------------------------------------------------

    Other components of the reporting requirements would be costly to
market participants because these reports could make their trading
strategies public (by virtue of disclosing the size of their position),
potentially causing their strategy to be less profitable in the future.
For example, this information might lead other parties to replicate and
use the reporting party's trading strategy for their own purpose.
However, the information provided would be limited to only security-
based swaps and related securities, and would not include information
about the reporting parties' entire portfolios.
    The requirement to file Schedule 10B reports on EDGAR would impose
upon those reporting parties without prior access to EDGAR a one-time
compliance burden of submitting a Form ID as required by Rule 10(b) of
Regulation S-T and following the processes detailed in Volume I of the
EDGAR Filer Manual. The FIXML data language requirement for Schedule
10B would not impose additional incremental compliance costs on
reporting parties, because any reporting party without experience or
expertise surrounding FIXML could choose to input its Schedule 10B
reports in a fillable online form, rather than submit its reports
directly in the FIXML data language. Filers who choose the

submit the required Schedule 10B reports directly in FIXML rather than
use the online form, and who do not have experience structuring data in
FIXML, would incur incremental implementation costs associated with
developing the necessary expertise and establishing the necessary
compliance processes (e.g., encoding and maintaining the required data
in FIXML and transmitting the data to EDGAR) to comply with the FIXML
requirement. For those filers, and for other filers choosing to submit
Schedule 10B reports directly in FIXML, the Commission expects that the
automated processing enabled by the structured data requirement would
make subsequent compliance costs lower than the compliance costs of
manually inputting Schedule 10B reporting into the web form with each
submission.
    With respect to timing, proposed Rule 10B-1 would require security-
based swap entities to file promptly but in no event later than the end
of the first business day following the day of execution of the
security-based swap transaction that results in the security-based swap
exposure exceeding the reporting threshold. The cost of filing no later
than the end of the first business day following the day of execution
of the security-based swap transaction would likely not require the
reporting party to invest in new IT infrastructure and automation. As
discussed above, the Commission estimates 136 reports from U.S.
entities per week in the single-name CDS market.\242\
---------------------------------------------------------------------------

    \242\ See supra section VI.D.2.iii (disclosure thresholds) on
discussion related to how the Commission estimated the number of
reports for single-name CDS market.
---------------------------------------------------------------------------

    In addition, proposed Rule 10B-1 may impact how security-based swap
transactions take place across national borders. As discussed above,
the reporting requirements of proposed Rule 10B-1 would be based on the
reporting and public dissemination requirements in Regulation SBSR and,
in addition, apply under certain circumstances when the reporting
person holds any amount of reference securities underlying the
Security-Based Swap Position (or would be deemed to be the beneficial
owner of such reference securities, pursuant to Section 13(d) of the
Exchange Act and the rules and regulations thereunder). This could
place reporting persons at a disadvantage compared to non-reporting
ones. U.S. security-based swap market participants and some foreign
entities that would be required to report would be at a disadvantage,
because they would be required to comply with proposed 10B-1 while some
foreign participants would not be required to comply, while they would
be able to access the publicly available reports required by proposed
Rule 10B-1. As a result, a portion of reporting entities for whom these
reporting costs are large might be incentivized to change their
geographical location of operation to a non-U.S. jurisdiction and limit
their participation in the underlying securities' markets. On the other
hand, proposed Rule 10B-1 would likely increase the trading of non-
reporting U.S. persons, as these thresholds would not affect them while
providing them with additional transparency and reporting in the
security-based swap market. Because of lower counterparty risk and
improved market conditions, non-reporting U.S. persons may become more
active in the security-based swap market.
iii. Reporting Thresholds
    The costs and benefits of proposed Rule 10B-1 are dependent, in
part, on which parties would be subject to the reporting requirements,
as determined by the selected thresholds for each type of security-
based swap. As a general matter, a higher threshold will lead to fewer
reports. This may limit the benefits of the proposed rule, but decrease
both the direct compliance costs and costs that investors face, as
discussed above, when revealing information to the market that they
consider material. In other words, a higher threshold would likely
decrease reporting costs, but higher thresholds would resolve fewer of
the asymmetric information scenarios that amplify the market
imperfection. Similarly, a lower threshold, with more reports, may
increase benefits associated with the proposed rule, but increase
costs. We discuss below the expected number of affected parties at
various thresholds, including the thresholds proposed in the rule.
(A) Thresholds for Credit Default Swaps
    For single-name CDS and for narrow index-based CDS, the Commission
has identified the threshold as the lesser of: (i) A long notional
amount of $150 million, calculated by subtracting the notional amount
of any long positions in a deliverable debt security underlying a
security-based swap included in the CDS from the long notional amount
of the CDS (the ``$150 million long threshold''); (ii) a short notional
amount of $150 million; or (iii) a gross notional amount of $300
million. Calculations for the short notional amount threshold of $150
million would not add or subtract the notional amount of any positions
in a deliverable underlying debt security, and calculations for the
both the long and short $150 million notional amount thresholds would
not net out any other Security Based Swap. In addition, persons who
have previously filed a Schedule 10B with the Commission would be
required to file amendments if any material change occurs in the facts
set forth in a previously filed Schedule 10B including, but not limited
to, acquisitions in an amount equal to 10% or more of the position
previously reported in Schedule 10B.
    Reporting following a trigger of the $150 million long or short
threshold would inform the Commission, market participants, and the
public in general about market positions with large potential market
impact, which could lead to significant reduction of asymmetric
information when reported. Further, the calculation method for the $150
million long threshold would limit reporting and reporting costs by
excluding deliverable bonds, and help market participants identify
situations where a counterparty has a higher likelihood of having
incentives to undertake opportunistic trading strategies. However, at
larger notional amounts, quickly converting to a long position
potentially netted by deliverable bonds to only a long gross positon
presents additional risk; \243\ accordingly, the Commission is
proposing a second larger threshold, $300 million notional on a gross
basis, to capture overall large exposures.\244\ By knowing that a
counterparty has a large gross notional amount and is directionally
\245\ neutral, the party could accordingly adjust its price
expectations and margin requirement of trading with that counterparty.
This adjustment would account for the risk associated with trading with
a counterparty that could quickly transform its directionally

neutral position to one directional in nature.
---------------------------------------------------------------------------

    \243\ For example, a market participant may hold a large gross
position that is net neutral (non-directional), just below the gross
reporting threshold and not be required to file Schedule 10B.
Thereafter, the participant quickly converts the gross position to a
directional position by offloading the more liquid side of the
trade, thus quickly converting the net neutral to a large
directional position.
    \244\ The Commission believes that these thresholds, together
with those described below for non-CDS debt security-based swaps and
security-based swaps on equity, would likely have triggered position
reporting under circumstances similar to those described above with
respect to observed instances of ``opportunistic strategies'' and
scenarios of high counterparty risk. See supra section I.B.
    \245\ Directional positions are holdings where market
participants are not net neutral (i.e., their long and short
positions do not net out) because said participants have an
expectation about the future movement of an asset and expect to
profit from the risk taken with the position.
---------------------------------------------------------------------------

    These thresholds limit the number of reporting parties that would
be required to report and the related costs (including related to
compliance and analyzing this information), while still addressing the
market failure as a result of the adverse selection caused by
asymmetric information in the market. For example, if the thresholds
were lower the Commission would expect a larger number of reports,
likely more uninformative ones with not sizable exposure, while
increasing the burden to understand the reports, limiting the benefit
of the overall reporting.
    The Commission used single-name CDS positions data from DTCC-TIW to
estimate: (a) The number of market counterparties in the CDS market
affected by proposed Rule 10B-1 for various thresholds; (b) the number
of initial reports that would likely need to be filed on a weekly basis
for various thresholds, as well as the number or amendments that might
as a result of material changes; and (c) the percent of market
participants that would be required to file no reports per week, (0-10)
reports per week, [10-20) reports per week, or more than 20 reports per
week, based on data from January 1, 2020 to December 31, 2020.\246\ We
discuss these estimates in detail below.
---------------------------------------------------------------------------

    \246\ For specific notation, the following bucket, [0-50), means
that 0 is included in this bucket, while 50 is not included in the
bucket.
---------------------------------------------------------------------------

Estimate of the Number of Market Counterparties in the CDS Market
Affected by Proposed Rule 10B-1
    To understand the number of market counterparties in the CDS market
affected by proposed Rule 10B-1 at potentially different threshold
levels, the Commission calculated concentration statistics for the year
2020, as shown in Figure 2 below. To perform this estimate, the
Commission calculated the number of parties that might be impacted at
different long/short notional amounts and gross thresholds represented
with seven buckets: [0-50), [50-100), [100-150), [150-200), [200-250),
[250-300), and [300+) in millions of US dollars. Each bucket represents
the percent of accounts with exposure in a week for at least one
underlying entity.\247\
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    \247\ DTCC-TIW includes weekly CDS positions for all U.S.
entities, or foreign counterparties to a U.S. entity, or foreign
counterparties trading CDS referencing a U.S. underlying entity. By
aggregating available position information, the Commission is able
to calculate exposure.
[GRAPHIC] [TIFF OMITTED] TP04FE22.002

---------------------------------------------------------------------------

    \248\ A long notional exposure is indicated with positive
values, while a short notional exposure is indicated with negative
values.
---------------------------------------------------------------------------

    As shown in Figure 2 (left), roughly 88% of accounts--hold a
position larger than the short notional exposure of $150 million, and
less than the long net exposure of $150 million. 5% of accounts have a
position larger short position than the $150 million short notional
exposure, while 7% of accounts have a larger long position than the
$150 million long notional exposure. This estimate for accounts
affected by the long dollar exposure threshold is an upper bound, as it
does not account for offsetting holdings in the deliverable bonds.
\249\ The Commission does not have access to granular data on bond
holdings and so cannot compute the net positions if these positions
were hedged by deliverable bonds. Hence, the Commission expects that
fewer than 12% (5% from short positions larger than $150 million, and
7% from long positions larger than $150 million) of market participants
would be impacted by the reporting requirements in proposed Rule 10B-1,
as a result of the $150 million notional amount threshold for both long
and short positions. Similarly, only 9% of accounts on average hold a
gross exposure on a single name underlying entity of more than $300
million, the last of the thresholds, [300, +).
---------------------------------------------------------------------------

    \249\ Bonds of the underlying entity that are delivered in the
auction are a subset of all underlying referenced debt that the
underlying entity may have. This subset more closely tracks the
value of the CDS as only those bonds would determine the final
recovery value and the CDS payoff. See, e.g., the Big Bang protocol:
https://www.cdsdeterminationscommittees.org/companies/auctionhardwiring/auctionhardwiring.html.
---------------------------------------------------------------------------

    Further, to understand the size and jurisdiction of underlying
entities referenced by single-name CDS, Commission staff performed
additional

analysis using the DTCC-TIW data. The left chart shows the size
distribution of US firms. Most US firms that have a referencing CDS are
large, with 57% of them having an average of $10 billion or more in
total book value of assets at the end of year from 2009 to 2020.\250\
The right chart shows the country distribution of single-name CDS
reported in DTCC-TIW. 33% are underlying entities referenced in the US,
followed by approximately 22% in the European Union.
---------------------------------------------------------------------------

    \250\ This value represents the average end of year book value
for each firm, as reported in Compustat. Similar statistics
regarding the size of the single-name CDS are reported in Lee,
Naranjo, and Velioglu, supra note 229 at 556-78.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P
[GRAPHIC] [TIFF OMITTED] TP04FE22.003

    Commission staff used single-name CDS positions data from DTCC-TIW
to evaluate the number of initial reporting that would likely need to
be filed on a weekly basis, as well as the number of amendments that
may need to be filed because of the requirement to file amendments in
connection with material changes. Commission staff performed this
analysis on two samples. The first sample, shown in Figure 4, uses all
exposures on single name North-American CDS underlying entities and all
exposures of U.S. single-name CDS participants. The second sample,
shown in Figure 5, narrows the analysis to only U.S. single-name CDS
participants (counterparties), and does not consider foreign single-
name counterparties who have exposure to North-American CDS.\251\ This
is a subset of the DTCC-TIW data, which includes U.S. counterparties in
the single-name CDS market, and covers both U.S. counterparties' North
American and foreign underlying entities CDS holdings. The left charts
in Figure 4 and Figure 5 show the number of reports the Commission
expects to receive weekly (y-axis) for each sample across various long/
short thresholds (x-axis) and for different material percent changes,
represented by different lines in the chart. The black line represents
the threshold levels selected by the Commission.
---------------------------------------------------------------------------

    \251\ Commission staff considered all DTCC-TIW entities'
aggregate weekly holdings across accounts all single-name CDS in
2020, for 52 weeks. Commission staff then assumed that the proposed
reporting requirements from proposed Rule 10B-1 were implemented
from the first week of 2020. For entities on an aggregate level,
Commission staff then assessed the number of reports different
potential reporting thresholds and weekly material changes would
have. The analysis then aggregates the number of triggers for each
firm's entire single-name CDS positions in 2020 across 52 weeks. For
example, Figure 5, considers the following reporting net (left plot)
and gross (right plot) thresholds listed on the x-axis: $50 million,
$100 million, $150 million, $200 million, $250 million, $300 million
and $500 million and material percentage change (lines at 1%, 5%,
10%, 20%, and 30%).

---------------------------------------------------------------------------

[GRAPHIC] [TIFF OMITTED] TP04FE22.004

[GRAPHIC] [TIFF OMITTED] TP04FE22.005

    The left chart in Figure 5 shows that the Commission expects
slightly more than 79 reports per week as a result of U.S. entities
triggering the long/short proposed thresholds of $150 million with a
material percent change threshold of 10%, as it relates to CDS.
Similarly, the right chart in Figure 5 represents the number of reports
the Commission expects to receive weekly from U.S. entities across
gross thresholds (x-axis) and different material percent changes. The
right chart in Figure 5 shows that the Commission expects an additional
57 reports per week as a result of U.S. entities exceeding the gross
proposed threshold of $300 million with a percent change of 10%. In
total, the Commission expects at most 136 reports per week from U.S.
entities with respect to CDS positions, 79 reports as a result of the
long/short thresholds and 57 reports as a result of the gross
threshold.\252\
---------------------------------------------------------------------------

    \252\ In addition to these 136 reports, the Commission also
expects a number of foreign entities to report based on a similar
analysis using DTCC-TIW data. Including foreign entities, the
Commission believes that there will be is a total of 362 reports a
week as a result of the net threshold, 79 reports from U.S. entities
and 283 from foreign entities. If the gross threshold is used, the
Commission estimates 291 reports a week, including 57 reports from
U.S. entities and 234 reports from foreign entities. The Commission
believes that these numbers may be overestimated because: (i) Only
foreign entities that hold underlying U.S. securities would need to
report; (ii) the Commission's analysis considers aggregate holdings
across all accounts, hence this methodology correctly captures
entities that might directly report to DTCC-TIW across several
account, but overestimates the size of holdings of parties that
directly report to DTCC-TIW, but while acting as dealers in the
single-name CDS market by having accounts other participants; and
(iii) there may be entities that trigger both thresholds
simultaneously (e.g., if an entity hold as a gross position of $300
million with a net position of $150 million) so those entities would
be double counted in these figures.
---------------------------------------------------------------------------

    These estimates are upper bounds for U.S. entities because
Commission staff cannot net out deliverable bonds due to limited data.
Such data limitations relate to the bond holdings of security-based
swap participants that would be eligible to offset the net positions
and that would decrease the single-name net exposure. In addition, the
proposal would require reporting by the party with the swap exposure
(e.g., a pension fund or industrial company, but not the investment
adviser who trades on behalf of this party). Because Commission staff
analysis is at the level of entities in Table 1, which pools exposures
of the underlying parties, the analysis overestimates the right-
skewness of the distribution of exposures, and hence overestimates the
number of entities reporting. As a result, this methodology correctly
captures entities that might directly report to DTCC-TIW across several
of their individual accounts, as the methodology captures the entities'
aggregate exposure. Parallel to this, the methodology overestimates the
size of the holdings of parties that act as dealers in the single-name
CDS market because it aggregates the accounts of market participants
that are reported to DTCC-TIW as being held by the dealer. In addition,
Commission staff only observed end-of-week exposures, hence intra-
weekly changes in position that might breach these thresholds were not
accounted for. There are a limited

number of such dynamic intra-weekly changes in positions, as
participants are more likely to hold longer-term swaps positions.\253\
In addition, the analysis does not account for reports that might be
filed as a result of an entity triggering both long/short and gross
threshold breaches in the same week. For example, a large long or short
position and a large gross position happening contemporaneously would
be counted twice in the estimation (once in each sample). These
overestimations, for the number of U.S. entities and for all reporting
parties in DTCC-TIW, lead the Commission to believe that the estimated
number of weekly reports are likely overestimated, and the Commission
expects significantly fewer reports per week in practice.
Estimate of the Percent of Market Participants That Would be Required
To File Certain Numbers of Reports
    In Figure 6 below, using DTCC-TIW data, the Commission estimated
the percent of market participants that would be required to file
reports based on data as of January 1, 2020. Specifically, the analysis
breaks down how many participants would file, on average, no reports
per week, (0-10) reports per week, [10-20) reports per week, or more
than 20 reports per week.\254\ Figure 6, is based on global security-
based swap participants with exposure to North American single-name CDS
and U.S. security-based swap participants with exposure to any single-
name CDS. Because Figure 6 includes all available positions in the
DTCC-TIW data (including some positions of foreign entities not trading
securities referencing U.S. entities, who would not be required to
report under the proposed rule), this analysis likely overestimates the
percent of the market participants required to report. The Commission
has, therefore, provided a second estimate in Figure 7, below, which
represents only U.S. security-based swap participants' exposure to any
single-name CDS. The Commission expects that many reports will be filed
by SBSDs because, as liquidity providers, they will likely interact
with clients executing large positions in CDS or TRS, and further,
SBSDs are likely to hedge these positions.
---------------------------------------------------------------------------

    \254\ The following bucket, (0-10), means that neither 0 nor 10
are included in this bucket.
[GRAPHIC] [TIFF OMITTED] TP04FE22.006

[GRAPHIC] [TIFF OMITTED] TP04FE22.007

    As shown in the left chart in Figure 6, the Commission estimates
that 22% of global security-based swap participants with exposure to
North American single name CDS and U.S. entities with exposure to
single-name CDS would be required to file, on average, fewer than 10
reports per week as a result of reaching the $150 million long/short
thresholds and the 10% change in position that would require the filing
of an amendment. Furthermore, the Commission estimates that only 1% of
global participants in the security-based swap market with exposure to
North American single name CDS and U.S. entities with exposure to
single name CDS would be required to file more than 20 initial reports
or amendments on average in a week as a result of the $150 million
threshold. Similar estimates are shown for U.S. entities alone in
Figure 7, with a cumulative 99% of U.S. entities filling less than 10
initial reports or amendments on average a week. Likewise, only 1% of
U.S. single-name CDS market participants would need to file more than
10 initial reports or amendments per week on average. Similar to
previous estimates, long/short threshold estimates presented in Figures
6 and 7 are conservative upper bound estimates, as the Commission
cannot adjust for bond positions that would offset the size of the CDS
holdings, as well as aggregate positions that might be reported in
DTCC-TIW across one or many different dealers.
    Commission staff performed a similar analysis for the gross
threshold at $300 million for both groups of participants. As shown in
Figure 7, the Commission estimates that 90% of U.S. single-name CDS
market participants will, on average, not be required to file any
reports under the proposed Rule 10B-1 for the gross threshold, while if
required to file, 9% of U.S. single-name CDS participants would be
required to file fewer than 10 reports on an average week, and only 1%
of U.S. security-based swap market participants would be required to
file more than 20 initial reports or amendments per week on
average.\255\
---------------------------------------------------------------------------

    \255\ The analysis has a similar limitation as noted above in
``Estimate of the number of reports to be filed on a weekly basis.''
---------------------------------------------------------------------------

(B) Thresholds for Non-CDS Debt Security-Based Swaps and Security-Based
Swaps on Equity
    As discussed above, the Commission is proposing: (i) For security-
based swaps based on equity, a bifurcated approach, such that a
reporting obligation would be triggered by exceeding the lesser of a
threshold based on the notional amount of the Security-Based Swap
Position, and a threshold based on the total number of shares
attributable to the Security-Based Swap Position as a percentage of the
outstanding number of shares of that class of equity securities and
(ii) for other non-CDS debt security-based swaps, a notional based
threshold approach. In addition, persons who have previously filed a
Schedule 10B with the Commission would be required to file amendments
if any material change occurs in the facts set forth in a previously
filed Schedule 10B including, but not limited to, acquisitions in an
amount equal to 10% or more of the position previously reported in
Schedule 10B.
    The Commission believes that these thresholds achieve the goal of
informing the market and the public about impactful and directional
positions in TRS, which could lead to significant reduction of
asymmetric information when reported. The notional thresholds of $300
million (which includes not only the TRS or other equity security-based
swaps and related securities) of which $150 million (which includes
only the TRS or other equity security-based swaps) provides a bright-
line, absolute measure of position size and is similar to the approach
proposed for CDS. The bright-line provides a simple and specific
reporting threshold for participants. We are also proposing a threshold
based on the total number of shares attributable to the Security-Based
Swap Position as a percentage of the outstanding number of shares of
that class of equity securities. The 5% threshold relative to market
capitalization (out of which 2.5% are in TRS and equity security-based
swaps) is required because there are a large number of firms in the
market that would not be captured by the notional thresholds, which the
Commission believes should be captured in order to reduce asymmetric
information problems in the TRS market. Based on the Commission's
analysis, smaller underlying entities make up a significant portion of
the U.S. firms referenced by TRS. For smaller underlying entities to be
adequately captured and thereby effectively to reduce asymmetric
information in the market for swaps referencing their securities, the
Commission believes a percentage threshold is required. This is
demonstrated in Figure 7.
    In evaluating the effect of these thresholds, the Commission used
data from Form N-PORT filings, which include information on holdings
of, among other things, security-based swaps, to (a) estimate the
number of

market counterparties affected by proposed Rule 10B-1's notional
thresholds for non-CDS debt security-based swaps and security-based
swaps on equity and (b) analyze the size and jurisdiction of underlying
entities referenced by total return, equity, and other non-CDS, debt
security-based swaps. We discuss these analyses in detail below.
Estimate of the Number of Market Counterparties in the Market for Non-
CDS Debt Security-Based Swaps and Security-Based Swaps on Equity
Affected by Proposed Rule 10B-1
    Using data from each fund's \256\ latest Form N-PORT filing as of
November 15, 2021, Commission staff estimated the percent of accounts
with TRS aggregate positions within certain buckets of notional size,
where each bucket represents the percent of accounts with TRS aggregate
positions within the corresponding notional size. For example, 84% of
funds reporting on Form N-PORT hold an aggregate position of $300
million or less in TRS, while 16% of these funds have an aggregate
position to TRS of $300 million or more.
---------------------------------------------------------------------------

    \256\ For purposes of this discussion, ``funds'' are series of
registered investment companies or registered investment companies
if there are no series.
[GRAPHIC] [TIFF OMITTED] TP04FE22.008

    In addition, based on data from each fund's latest Form N-PORT
filing as of November 15, 2021, the Commission provides several
relevant summary statistics: First, there are 21,211 TRS being reported
across 652 funds from Form N-PORT fillings; second, the median size of
aggregate TRS positions of N-PORT reporting filers' funds is $131,000,
while the average size is $10.6 million. These summary statistics imply
that the TRS holdings of N-PORT-reporting filers' funds are right-
skewed \257\ and that these entities in aggregate hold a very limited
position in total returns swaps. Lastly, the 25th and 75th percentiles
are $24,000 and $713,000, which implies that 75% of N-PORT reporting
filers' funds participate in the TRS market hold less than $713,000 in
these products.\258\ Based on the distribution demonstrated by this
analysis, the Commission believes only a limited number of N-PORT
filers' funds would be exceed the 10B-1 reporting requirement.\259\
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    \257\ A ``right-skewed'' distribution is one in which the tail
is on the right side, and typically the mean (average) is greater
than the median.
    \258\ Due to data limitations, the Commission's analysis does
not separate the analysis into individual types of TRS.
    \259\ The Commission recognizes that Form N-PORT reporting
filers may not be representative of the ``average'' trading entity
in the security-based swap market and in particular, the ``average''
trading entity in the total return, or equity swap market. The
Commission believes that Form N-PORT-reporting investment funds are
likely to be less leveraged and participate in a smaller number of
transactions compared to other entities that participate TRS market.
See generally 17 CFR 270.18f-4 (``Rule 18f-4'') (limiting the
ability of registered investment companies and business development
companies to engage in transactions that involve potential future
payment obligations, including obligations under derivatives such as
forwards, futures, swaps and written options). Hence, the
quantitative analysis provided on TRS using Form N-PORT reporting
entities is likely to be biased towards TRS market participants that
are more risk averse, less active in the TRS market, and more likely
to currently be subject to reporting requirements and leverage
limitations. This will result in estimates that would likely suggest
a lower bound on the number of potential entities subject to the
Rule 10B-1 disclosure requirement. In addition, due to data
constraints, offsetting positions are not being reflected in this
analysis. This would mean that the ``average'' TRS market
participant is likely to be more active, less risk averse, and
likely have larger exposures and positions in the TRS market.
Despite the Commission's current data constraints regarding TRS, the
Commission believes that these data provide useful market insight
into the number of participants in the TRS market that might be
impacted by the new reporting requirements. Certain information on
Form N-PORT is non-public, while certain information reported on
Form N-PORT for the third month of each filer's fiscal quarter is
made publicly available upon filing.
---------------------------------------------------------------------------

Evaluation of Size and Jurisdiction of Underlying Entities Referenced
by Total Return, Equity, and Other Non-CDS, Debt Security-Based Swaps

    Commission staff also analyzed the size and jurisdiction of
underlying entities referenced by TRS, equity security-based swaps, and
other non-CDS, debt security-based swaps. In Figure 9, the Commission
performed a name matching procedure across Compustat \260\ and N-PORT
data as of November 15, 2021 determine the size of U.S. entities
referenced by total return, equity, and other non-CDS, debt security-
based swaps, and jurisdiction of entities referenced by total return,
equity, and other non-CDS, debt security-based swaps.\261\ Using total
assets and two digit ISIN country identifiers available from Compustat
for the merged dataset, the analysis resulted in two distributions. The
left distribution shows that 44% of entities referenced by TRS, equity
security-based swaps, and other non-CDS, debt security-based swaps
reported in Form N-PORT have total asset size less than $2 billion. The
right figure shows that a significant majority, 59%, of entities
referenced by TRS, equity security-based swaps, and other non-CDS, debt
security-based swaps reported in Form N-PORT have underlying securities
traded in the U.S.
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    \260\ The analysis uses Compustat Global and Compustat North
America. Compustat Global provides authoritative financial and
market data covering publicly traded companies in more than 80
countries, representing over 90% of the world's market
capitalization. Compustat Global includes coverage of over 96% of
European market capitalization and 88% of Asian market
capitalization.
    \261\ This analysis was subject to certain data limitations. In
particular, the Compustat and N-PORT data contain no common
identifiers between the two datasets. As a result, this might lead
to potential mismatches because the merge was performed through a
name-matching algorithm.
[GRAPHIC] [TIFF OMITTED] TP04FE22.009

BILLING CODE 8011-01-C
    This analysis indicates that there is likely a significant
proportion of smaller to medium sized firms--including, for example,
firms with less than $2 billion and between $2 and $6 billion in total
book value of assets, respectively--which are underlying entities to
total return, equity security-based swaps, and other non-CDS, debt
security-based swaps as reported by funds that file Form N-PORT. In
addition, the analysis indicates that the majority of these underlying
entities have securities issued in the U.S. as identified by their two-
digit ISIN code. A notional threshold (such as $300 million) would not
capture the security-based swap exposure in the initial stages of
accumulating a large position for a significant portion of smaller to
medium sized firms. A $300 million notional exposure would correspond
to a 5% percent threshold of an underlying entity with a $6 billion
market capitalization. This would correspond to less than approximately
34% of underlying entities, entities with total assets greater than $6
billion. Hence, the requirement of a percent threshold would help
inform the market of total return, equity security-based swaps, and
other non-CDS, debt security-based swaps exposures for medium and
smaller underlying entities.
    While the Commission acknowledges that TRS, equity security-based
swaps, and other non-CDS, debt security-based swaps exposures to the
medium and smaller underlying entities do not pose large counterparty
default risk compared to swap exposure on larger

firms, security-based swaps based on securities issued by medium and
smaller underlying entities have the potential to impact the underlying
entity and its shareholders. This is likely because the underlying
security referenced by such security-based swaps is more likely to be
less liquid than underlying securities of large entities. The lower
liquidity levels in the underlying security would be more prone to
movement away from fundamentals because of offsetting activity in the
total return, equity security-based swaps, and other non-CDS, debt
security-based swaps. For example, Firm XYZ might buy TRS on underlying
Firm ABC from Firm 123. To hedge its short exposure to the issued TRS,
Firm 123 buys the underlying security of Firm ABC. Volatile market
activity can result in margin calls from Firm 123 to Firm XYZ leading
Firm 123 to sell some or all of its position in the underlying
security. This quick and large selling of the underlying security by
only one agent may trigger a more pronounced fire sale, which is a
large sale of securities below market value. These sales dislocate the
price away from its fundamental value.
    A threshold based on the total number of shares attributable to the
security-based swap position (as a percentage of the outstanding number
of shares of that class of equity securities) could, however, help
alleviate large changes in prices due to purchase or sales of the
underlying security. Because this threshold would be tied to the
outstanding number of shares, this threshold would effectively be lower
for smaller firms--which would ensure that, when large positions are
acquired, market participants could be made aware through Schedule 10B
reports.
    In addition, data analysis undertaken by the Commission staff shows
that the number of investment companies that file Form N-PORT who would
be captured by this new reporting requirement is likely to be
small.\262\ Other types of market participants that are not registered
with the Commission under the Investment Company Act, such as family
offices, endowments and private funds, may have lower risk aversion,
higher TRS exposures, and may trigger the reporting threshold more than
N-PORT filers.\263\ The Commission estimates that 84% of the funds
reporting on Form N-PORT as of November 15, 2021 hold an aggregate
exposure of less than $300 million in TRS, while 14% of reporting funds
have an aggregate exposure to TRS of $300 million or more. These
percent estimates may not be indicative of the number of reports the
Commission expect to receive.
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    \262\ See discussion related to the size of TRS holdings in
Evaluation of Size and Jurisdiction of Underlying Entities
Referenced by Total Return, Equity, and Other Non-CDS, Debt
Security-Based Swaps.
    \263\ See discussion related to the limitation of Form N-PORT
data in Evaluation of Size and Jurisdiction of Underlying Entities
Referenced by Total Return, Equity, and Other Non-CDS, Debt
Security-Based Swaps.
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E. Reasonable Alternatives

1. Implementing a More Prescriptive Approach in Re-Proposed Rule 9j-1
    One potential alternative to the approach taken in re-proposed Rule
9j-1 would be to identify and prohibit within the rule specific types
of events (for example, market behavior around certain events and fact
patterns) and ``opportunistic trading'' behavior that have been
observed. This alternative approach could provide even more certainty
and precision with respect to the particular types of activities that
are prohibited in the security-based swap market. This approach could,
however, lead to greater uncertainty with respect to circumstances not
explicitly contemplated in the rule, which could increase litigation
costs for market participants involved in such transactions. This may
also decrease the integrity of the market for security-based swaps, and
in addition, could cause market participants to bear greater compliance
costs in connection with the evaluation of circumstances not explicitly
contemplated in the rule. As a result, the more prescriptive
alternative approach would have limited benefits and greater costs as
compared to the proposed approach in the market for security-based
swaps, as well as the market for the referenced underlying of such
security-based swaps.
2. Safe Harbor for Hedging Exposure Arising Out of Lending Activities
    The Commission could add a conditional safe harbor from re-proposed
Rule 9j-1 for entering into security-based swap transactions, while in
possession of material non-public information, for purposes of hedging
some or all exposure arising out of lending activities with a reference
entity or the syndication of such lending activities. Such a
conditional safe harbor could minimize the effects of the re-proposed
rule on risk-reducing hedging activity, which is one of the central
purposes of CDS contracts and which provides important benefits to the
lending market. We believe that identifying legitimate, risk-reducing
hedging activity--undertaken with the intent of covering potential
losses in a position--and distinguishing such activity from other types
of speculative transactions would likely be difficult. Hence, even a
conditional safe harbor designed to apply solely to legitimate hedging
transactions could unintentionally apply to activities proposed Rule
9j-1 is designed to prohibit, reducing the benefits of the rule.
Further, such a conditional safe harbor would need to be balanced
against the risk that market participants undertake transactions for
which their counterparties should have the protections of the re-
proposed Rule 9j-1, including in circumstances involving potentially
opportunistic trading strategies.
3. Mandating That Security-Based Swap Data Repositories Report or
Publicly Disclose Positions
    The Commission could consider placing the reporting obligations on
registered SBSDRs. Although this alternative would relieve market
participants of additional reporting obligations and, given some
reporting requirements are already in place, eliminate some additional
reporting costs, this alternative would preclude inclusion in the
reported data of key aspects of the reporting requirement proposed to
be required by Rule 10B-1--the identity of the person building up a
large security-based swap position and information regarding the
underlying entity. Requiring that the SBSDRs report the applicable
information would be subject to significant limitations that could
undermine the effectiveness of the rule. Specifically, and as discussed
above, Section 13(m)(1)(C)(iii) of the Exchange Act provides that any
rulemaking pursuant to Section 13(m) (i.e., Regulation SBSR) must be
structured in such a manner ``that does not disclose the business
transactions and market positions of any person.'' \264\ Accordingly,
such an alternative could involve only anonymized reporting, thereby
negating one of the key benefits of the rule, i.e., providing
counterparties an opportunity to take certain protective actions when
transacting with counterparties with a large, concentrated security-
based swap position.
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    \264\ See 15 U.S.C. 78m(m)(1)(C)(iii).
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    Further, this alternative would likely impose significant burdens
on the SBSDRs, who would be required to report when the security-based
swap entity breaches the specified gross

thresholds. This would likely require investments from the SBSDR in an
automated reporting system, which would track, aggregate, monitor, and
report exposures. In addition, given SBSDRs may not be aware of all
positions held by a market participant, this alternative would limit
the potential thresholds to only gross thresholds. These limitations
could substantially undermine the benefits of the proposed rule.\265\
This additional data provides important context for the information,
such as whether holdings are hedged or not. In addition, if the rule
were to require reporting of only gross thresholds, market participants
may learn of large position buildup only. For example, a market
participant may hold a large gross position that is net neutral (non-
directional), just below the gross reporting threshold and not be
required to report on Schedule 10B. Thereafter, the participant could
quickly convert the gross position to a directional position by
offloading the more liquid side of the trade, thus quickly converting
the net neutral to a large directional position. As a result, the
Commission does not believe this is the appropriate method of
reporting.
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    \265\ Even to the extent that anonymized data would be
sufficient, the data provided to the SBSDRs pursuant to Regulation
SBSR is unlikely to be useful as a way of potentially alleviating
the compliance burdens of Rule 10B-1, absent a rulemaking to amend
Regulation SBSR. For example, SBSDRs are currently permitted to
apply a cap to the anonymized dissemination of CDS transactions,
such that if the trade exceeds $5 million, it will be disseminated
as ``$5MM+'' in lieu of the actual amount, mirroring how cash
corporate bonds are disseminated by TRACE. In addition, data
reported to an SBSDR relates only the security-based swaps
themselves. By contrast, Section 10B-1 allows the Commission to
require reporting of both a security-based swap position and any
security or loan or group or narrow-based security index of
securities or loans related to the security-based swap.
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4. Adopting Position Limits
    Another possible alternative to proposed Rule 10B-1 and 9j-1 would
be to adopt position limits in lieu of reporting requirements. These
position limits would prohibit market participants from building up
large, concentrated positions in security-based swaps. As compared with
reporting, this would limit the ability of market participants to hedge
underlying exposures. Further, given that transparency allows market
participants to adjust counterparty exposures, it is unclear whether
position limits would have substantially greater benefits to risk
reduction and exposure to opportunistic strategies as compared with the
proposed reporting. The Commission acknowledges, however, that to the
extent that market participants would not make such adjustments,
position limits could have risk reduction benefits beyond those
associated with reporting.
5. Threshold Alternatives for Security-Based Swaps Based on Equity and
Non-CDS Debt
    The Commission could consider alternative approaches for
calculating potential thresholds for security-based swaps based on
equity and non-CDS debt. Specifically, the Commission could consider
proposing reporting thresholds based on:

     The average daily trading volume (``ADTV'') of the
relevant securities, such that reporting would be required if the
number of shares represented by the security-based swap exceeded a
certain percentage of ADTV.
     Notional values that vary based on types of equity
underlying the equity-based swap, including for example, equity
issued by emerging market issuers or large and small capitalization
issuers. Such an alternative could resemble existing industry
methodologies for calculating margin on derivatives.\266\
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    \266\ See, e.g., ``ISDA SIMM Methodology, version 2.3,''
available at: https://www.isda.org/a/oDHTE/ISDA-SIMM-v2.3-PUBLIC.pdf.
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     For non-CDS debt, a bifurcated approach, such that the
threshold would be defined to include both a threshold based on the
notional amount of the position, and a threshold based on the
percentage component (for example, notional divided by market value
of total issuance).

    Using a threshold that would adjust based on ADTV could better
approximate when the market for an underlying security could be
impacted with a large security-based swap, as compared to the proposed
approach. For example, large positions relative to ADTV could affect
the market for the underlying security if a party needed to exit that
position in a short period of time, which could require having to
liquidate any securities being held to hedge the security-based swap.
Such a metric may not, however, be meaningful with respect to non-CDS
debt security-based swaps, given that debt securities do not trade
widely in the secondary market.
    However, because these alternatives would be inconsistent with the
proposed thresholds for CDS and be more complicated to calculate, they
could increase compliance costs for market participants. Moreover, a
metric based on ADTV would require security-based swap counterparties
to monitor the trading volume of those shares, and because ADTV can
fluctuate on a day-to-day basis, particularly during times of high
volatility, such fluctuations could require persons trading large
positions in security-based swaps to develop more sophisticated systems
for monitoring those positions as a function of ADTV. A threshold that
would vary based on the types of equity underlying the equity-based
swap could potentially lead to additional computation complications.
For example, it would require security-based swap market participants
to track different thresholds for different types of underlying
securities.
    With respect to the potential inclusion of a bifurcated approach
for non-CDS debt swaps, there would potentially not be a substantial
benefit to including a percent component in this threshold.
Specifically, comparing a notional amount to a bond market
capitalization denominator would likely not indicate meaningful
information about the holder's ability to affect the market for the
underlying bond market. In addition, a calculation based on a bond
market capitalization denominator \267\ would be bond issue specific,
making the calculation unique to every bond. This would likely increase
the costs to market participants to maintain compliance.
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    \267\ In addition, this methodology would not capture private
placement bonds as they are unregistered debt securities only sold
to accredited investors.
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6. Threshold Alternatives for Credit Default Swaps
    An alternative approach to the public reporting requirement in Rule
10B-1 would be to consider different methodologies for calculating the
reporting thresholds for single-name CDS. When considering different
reporting methodologies for single-name CDS, the Commission also could
consider proposing:

     A single gross threshold that would require single-name
CDS trading entities to report their exposure and related holdings
after the entity exceeds a certain level of their aggregate CDS
exposure for a single underlying entity without accounting for
offsetting deliverable securities. For example, even if a CDS market
participant were net neutral (i.e., no directional exposure),
because it has large exposures both in the long and short direction
it would have to reveal this information to the market at certain
thresholds.
     A single net threshold that would require single-name
CDS trading entities to report their exposure and related holdings
after the entity exceeds a certain level of their net single-name
CDS position (i.e., allows the reporting entity to offset or account
for hedged positions). This is one of the two components of the 10B-
1 reporting threshold. This alternative would thus only capture
large directional exposure.

     Thresholds based on net or gross notional of single-
name CDS positions relative to total net or gross outstanding CDS,
outstanding bonds, or total deliverable bonds related to the single-
name CDS. For example, market participants could be required to
report if their net CDS position, as discussed above, divided by
total outstanding bonds exceeds, for example, a 5% threshold or
other percent threshold.\268\
---------------------------------------------------------------------------

    \268\ For some underlying reference entities, it might be the
case that there are significantly more CDS outstanding than bonds.
Hence, the percent threshold could be greater than 100%.
---------------------------------------------------------------------------

     Calculating the short notional amount threshold of $150
million by adding or subtracting the notional amount of any
positions in a deliverable underlying debt security and/or
calculating both the long and short $150 million notional amount
thresholds by netting out any other Security Based Swap,
specifically, single-name CDS with the same maturity, referencing
the same underlying entity.

    The first two alternative approaches may be a less burdensome means
of achieving the goal of disclosing concentrated positions, as fewer
reports would be required. We believe, however, that requiring only
gross or netted reporting would substantially reduce the benefits of
the proposed rule. Specifically, without a netted reporting
requirement, market participants would not be aware of the true market
exposure, while without a gross reporting requirement, a single-name
CDS entity could present substantial systematic risks without
triggering a reporting obligation. For example, if there is no
requirement to report a net neutral position even though the aggregate
gross position is significant, then the entity's position could quickly
become directional by closing the offsetting position.\269\ The same
situation might happen for a small net exposure that is below the net
reporting threshold, but with a large aggregate gross exposure.
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    \269\ We provide an example of how a reporting entity might be
able to ``hide'': The entity bought $300 million in CDS and
simultaneously sold $300 million CDS, which yields a net exposure of
zero and therefore no need to report under the net thresholds. When
it becomes beneficial, the entity can relatively quickly obtain a
directional net position of $300 million by selling either leg of
the initial trade. This new position needs to be reported but the
position is already in place and does not leave time for
counterparties to adjust their positions in a timely manner.
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    Further, if the Commission were to use a single gross threshold, a
selected threshold would have to be significantly lower than the one
included in the proposal to capture market events similar to those
captured under the proposed threshold. This would increase the overall
number of reports and would likely capture a large number of positions
immaterial to addressing asymmetric information problems. Each
uninformative report would dilute the value of each informative report
by increasing overall costs of processing and providing the required
information to other market participants.
    With respect to the third alternative, a threshold based on the
notional of single-name CDS positions relative to total outstanding