in the security-based swap dealer definition, as discussed above,\1463\
we are proposing to define the term ``U.S. person'' to include the
entire entity, including its foreign branches. In addition, such
separation is inconsistent with the focus in Title VII on the effect of
a person's dealing activity on the U.S. financial system, including the
risks such person bears as a result of its dealing activity. Although
we recognize that certain U.S.-based banks have chosen to conduct some
or all of their foreign security-based swap business through foreign
branches,\1464\ we preliminarily believe that, given Title VII's goal
of addressing potential dealing risk to the U.S. financial system
caused by security-based swap dealing activity, the de minimis
exception should apply to all security-based swap dealing activity of a
person that has its principal place of business within, or is
incorporated or organized within, the United States, regardless of
which part of such person carries out such dealing activity wherever
its counterparties are located, even if elements of that activity occur
outside the United States.
---------------------------------------------------------------------------

    \1462\ See Section III.B.3, supra
    \1463\ See Section III.B.4, supra.
    \1464\ See Sections II.A.2 and III.B.6, supra (discussing the
dealing structures used by U.S.-based entities).
---------------------------------------------------------------------------

    We preliminarily believe that the alternative approach suggested by
commenters could reduce the programmatic benefits of security-based
swap dealer registration under Title VII and the ensuing substantive
requirements applicable to registered security-based swap dealers if
the de minimis calculation for U.S. persons engaged in dealing activity
does not include the entire volume of such persons' dealing activity.
Drawing a distinction between the branches, desks, or offices of a U.S.
person and the entity as a whole would be inconsistent with the fact
that the U.S. person as a whole bears the risk of all security-based
swap transactions that it enters into, including those transactions
conducted through a foreign branch or office with non-U.S. person
counterparties located outside the United States.\1465\
---------------------------------------------------------------------------

    \1465\ See Section II.A.3, supra (discussing the example of AIG
FP).
---------------------------------------------------------------------------

    Even if the headquarters of a U.S. bank were already registered by
virtue of its own security-based swap dealing activity in the United
States, the commenters' suggested approach would presumably allow the
same bank, through its foreign branches, to engage in unlimited dealing
activity with non-U.S. persons outside the United States without
registering those branches.\1466\ We do not view such disparate
regulatory treatment of two parts of the same legal entity to be
consistent with the purposes of Title VII, particularly given that this
approach would appear to place entirely outside the scope of regulation
under Title VII transactions that pose risks to a U.S. bank that are
indistinguishable from those arising from transactions done directly
from the home office of that bank.\1467\ We believe that excluding
transactions conducted through foreign branches from the de minimis
calculations would not achieve the programmatic benefits intended by

the Title VII requirements because it would leave unaddressed risks
associated with security-based swap dealing activity that occurs within
the United States and therefore raises the types of concerns with
respect to the U.S. market that Title VII's dealer requirements were
intended to address.
---------------------------------------------------------------------------

    \1466\ For example, treating the branch differently may remove
the branch entirely from Title VII's rules. This could prevent
regulation of capital adequacy and other risk mitigating
requirements, even though all of the risk from the transaction is
residing within the entity as a whole, creating risk for the U.S.
financial system.
    \1467\ Security-based swap activity conducted through a foreign
branch poses risks to the entire entity to which the branch belongs
that are generally indistinguishable from those posed by security-
based swap activity conducted through an office. The experience of
AIG FP demonstrates that the security-based swap activity of a
foreign office can lead to the default of the entire entity. See
Section II.A.3, supra.
---------------------------------------------------------------------------

b. Calculation of Non-U.S. Persons' Transactions for De Minimis
Exception (including transactions conducted within the United States)
    Our proposed application of the de minimis exception to non-U.S.
persons engaged in security-based swap dealing activity would require
them to include in their de minimis calculations any transactions with
U.S. persons or any transactions otherwise conducted within the United
States, to the extent they are entered into in a dealing capacity.
Given the focus on Title VII on the stability and transparency of the
U.S. financial system and the protection of counterparties,\1468\ we
preliminarily believe that it is appropriate to require non-U.S.
persons that engage in dealing activity within the United States and
therefore are likely to raise these types of concerns to count such
dealing activity toward their de minimis thresholds. To the extent that
the aggregate notional amount of transactions arising from a non-U.S.
person's dealing activity involving U.S. persons or otherwise conducted
within the United States exceeds the de minimis threshold in the
trailing 12-month period, we would require a non-U.S. person to
register as a security-based swap dealer.
---------------------------------------------------------------------------

    \1468\ Pub. L. No. 111-203 Preamble. See Section I and note 4,
supra.
---------------------------------------------------------------------------

    In developing our proposed application of the de minimis threshold
to non-U.S. persons, we have considered alternatives suggested by
commenters or proposed by the CFTC. We declined to incorporate these
alternatives into our approach.
    Some commenters suggested that a non-U.S. person that engages in
dealing activity with U.S.-person counterparties through an affiliated
U.S. intermediary should be permitted to register in a limited capacity
or should not be required to register as a security-based swap
dealer.\1469\ Specifically, some commenters suggested that the
Commission adopt an approach that is modeled on the Commissions'
existing regimes, permitting non-U.S. security-based swap dealers to
transact with U.S. persons without registering in the United States if
those transactions are intermediated by a U.S.-registered security-
based swap dealer.\1470\
---------------------------------------------------------------------------

    \1469\ See, e.g., Soci[eacute]t[eacute] G[eacute]n[eacute]rale
Letter II; Cleary Letter IV.
    \1470\ See, e.g., Davis Polk Letter I at 11 n.17 (``This model
is similar to the mode of operation permitted by Rule 15a-6 under
the Securities Exchange Act of 1934, pursuant to which foreign
broker-dealers interface with U.S. customers under arrangements with
affiliated or non-affiliated broker-dealers without themselves
registering as broker-dealers in the U.S.''); Cleary Letter IV at 22
(``Accordingly, as one alternative, we suggest that the Commissions
adopt an approach that is modeled on the Commissions' existing
regimes, permitting non-U.S. swap dealers to transact with U.S.
persons without registering in the U.S. if those transactions are
intermediated by a U.S.-registered swap dealer. This would be
consistent with the approach adopted by the SEC under Rule 15a-6 and
prior interpretative precedents with respect to non-U.S. securities
dealers.'').
---------------------------------------------------------------------------

    We preliminarily believe that the above alternative suggested by
commenters would potentially reduce the programmatic benefits intended
by Title VII. To the extent that a non-U.S. person engages in security-
based swap dealing entirely with U.S. persons or within the United
States, that person's security-based swap activity raises the concerns
that security-based swap dealer regulation under Title VII intends to
address: First, the entity's dealing activity raises customer
protection concerns, which the external business conduct standards and
segregation requirements of Title VII are intended to address; second,
the entity's dealing activity raises financial responsibility concerns,
which Title VII's entity-level requirements applicable to registered
security-based swap dealers are intended to address; finally, the
entity's dealing activity raises transparency, regulatory oversight,
counterparty risk and systemic risk concerns, which Title VII intends
to address through its regulatory reporting, public reporting,
mandatory clearing, and mandatory trade execution requirements.
Although the Commission recognizes that some of these concerns might be
addressed by regulating the intermediary, as in the broker-dealer
context, we preliminarily believe that only if the non-U.S. person
dealer itself is subject to Title VII would it be possible to address
the entire range of concerns that Title VII dealer regulation is
intended to address.\1471\
---------------------------------------------------------------------------

    \1471\ See Section III.B.4, supra.
---------------------------------------------------------------------------

    The CFTC has proposed that non-U.S. persons that are guaranteed by
U.S. persons be required to include in their de minimis calculation all
transactions carried out in a dealing capacity with any counterparty,
wherever that counterparty is located, just as a U.S. person acting in
a dealing capacity would be required to do.\1472\ As discussed above,
the Commission recognizes that such guarantees of the security-based
swap transactions of non-U.S. persons may pose risk to the U.S.
financial system; however, the Commission does not believe that the
security-based swap dealer regulation in Title VII is the appropriate
vehicle for regulating the dealing activity of non-U.S. persons
occurring outside the United States with other non-U.S. persons.\1473\
As discussed above, the Commission preliminarily believes that the risk
posed to the U.S. markets by the dealing activity of non-U.S. persons
outside the United States whose performance under security-based swaps
is guaranteed by a U.S. person does not necessarily raise the full
range of concerns that Title VII dealer regulation is intended to
address. Such activity may give rise to security-based swap positions
that raise concerns within the United States that are relevant to the
purposes of Title VII if those positions are large enough to affect the
stability of the institution providing the guarantee and potentially
the stability of the U.S. financial system more generally. This risk,
however, arises from attribution of security-based swap positions to
the guarantor due to the guarantee rather than the dealing activity per
se. In these circumstances, we preliminarily believe that the risks
relating to these positions warrant registration only to the extent
that the positions exceed the thresholds established for major
security-based swap participant registration.\1474\
---------------------------------------------------------------------------

    \1472\ See CFTC Cross-Border Proposal, 77 FR 41221.
    \1473\ See Section III.B.7, supra.
    \1474\ Id.
---------------------------------------------------------------------------

    In light of the foregoing, we do not believe that requiring a non-
U.S. person that is guaranteed by a U.S. person to count every
transaction entered into in a dealing capacity toward its de minimis
threshold and to register as a security-based swap dealer even if it
engaged in no dealing activity with U.S. persons or otherwise within
the United States would materially increase the programmatic benefits
of the dealer registration requirements. Although it is likely that
such an approach would cause more entities to register as dealers than
does our proposed approach, to the extent that these entities were
required to register as security-based swap dealers even though they
engaged in dealing activity only with non-U.S. persons outside the
United States, we preliminarily believe that this alternative would
impose programmatic costs on these entities without a corresponding
increase of the programmatic benefits to the U.S. security-based swap
markets that are intended by the security-based swap dealer
requirements in Title VII, as we

do not believe that the dealing activity of such persons (to the extent
that it involves only non-U.S. counterparties outside the United
States) raises the types of concerns within the United States that
Title VII dealer registration was intended to address.
    Another alternative to our proposed approach would be not to
require non-U.S. persons that engage in dealing activity with other
non-U.S. persons through transactions conducted within the United
States to include such transactions in their de minimis
calculations.\1475\ As noted above, Title VII is intended to promote
accountability and transparency in the U.S. financial system,\1476\ and
to do so, it is necessary to ensure that security-based swap dealing
activity that occurs within the United States is subjected to the
requirements of Title VII,\1477\ including those related to external
business conduct protections and other transaction-level requirements.
Even if a non-U.S. person located outside the United States is engaging
in dealing activity with non-U.S. persons located in the United States,
it is, among other things, providing liquidity in the U.S. security-
based swap market and thus engaging in dealing activity within the
United States. Excluding such dealing activity from Title VII would
reduce the programmatic benefits of security-based swap dealer
regulation because it would reduce the transparency of the U.S. market
and deprive counterparties within the United States of the protections
of Title VII. We recognize that the ultimate programmatic benefits
discussed here associated with the application of the security-based
swap dealer regulation in the cross-border context would be affected by
the substantive rules adopted by the Commission. The Commission is
reopening the comment periods for our outstanding rulemaking releases
that concern security-based swaps and security-based swap market
participants and were proposed pursuant to certain provisions of the
Exchange Act, as amended by Title VII of the Dodd-Frank Act.
---------------------------------------------------------------------------

    \1475\ The CFTC's proposed guidance does not trigger application
of Title VII requirements based on the location of the security-
based swap activity.
    \1476\ See Section II, supra.
    \1477\ See proposed Rule 3a71-3(a)(5) under the Exchange Act
(defining ``transaction conducted within the United States''), as
discussed in Section III.B.5, supra.
---------------------------------------------------------------------------

iii. Aggregation of Affiliate Dealing Activity
    Our proposed rule regarding the application of the de minimis
exception in the cross-border context also requires a U.S. person who
enters into security-based swap transactions in a dealing capacity, or
non-U.S. person who enters into security-based swap transactions with
U.S. persons or transactions conducted within the United Sates in a
dealing capacity, to count toward such person's de minimis threshold
certain transactions of its affiliates. Specifically, such persons
would be required to include in the de minimis calculation the notional
amount of (1) the transactions entered into in a dealing capacity by
all of their commonly controlled affiliates who are U.S. persons and
(2) the transactions with U.S. persons or transactions conducted within
the United States entered into in a dealing capacity by all of its
commonly controlled affiliates who are non-U.S. persons. However, such
calculation would exclude any affiliate that is a registered security-
based swap dealer if such person who relies on the de minimis exception
maintains separate operations independent of any affiliate who is a
registered security-based swap dealer and does not involve, or act in
concert with, any affiliate that is a registered security-based swap
dealer in any stage of a security-based swap transaction that arises
out of its dealing activity.\1478\
---------------------------------------------------------------------------

    \1478\ See proposed Rule 3a71 under the Exchange Act. This
approach is consistent with the aggregation requirement described in
the Intermediary Definitions Release. See Intermediary Definitions
Release, 77 FR 30631 (requiring aggregation of dealing activity by
commonly controlled affiliates for purposes of de minimis
calculation).
---------------------------------------------------------------------------

    In developing this rule, we considered the approach proposed by the
CFTC, which we understand to permit non-U.S. persons to aggregate only
the transactions carried out in a dealing capacity by their commonly
controlled affiliates that are also non-U.S. persons, rather than
including all such transactions by all commonly controlled affiliates,
wherever located. As noted above,\1479\ we declined to follow the
CFTC's proposal in part out of concern that doing so could confer
competitive advantages on affiliated corporate groups that engage in
security-based swap dealing activity through both U.S. and foreign
affiliates by allowing them to operate with an effective de minimis
threshold twice higher than the threshold applicable to security-based
swap dealers operating solely within the United States or solely in one
or more foreign-based affiliates.
---------------------------------------------------------------------------

    \1479\ See Section III.B.4.(c), supra.
---------------------------------------------------------------------------

    We recognize that our approach may require some persons to register
that might not be required to register under the CFTC's approach and
thus would impose programmatic costs on those entities that they might
not otherwise incur. It may also require more firms to engage in
assessment, as even those with activity levels far below the threshold
will probably perform these calculations, if they are part of a larger
corporate family with a number of security-based swap dealers. However,
we believe that those corporate groups operating a centralized booking
model or centralized risk management should be able to have the central
booking entity or central risk management location perform the de
minimis aggregation calculation for the entire corporate group. For
purposes of this analysis, we have assumed that corporate groups are
likely to perform such assessments centrally.\1480\
---------------------------------------------------------------------------

    \1480\ We understand, based on comment letters and our staff's
discussion with market participants, that many market participants
keep a global swap book and operate a central booking model. See,
e.g., Cleary Letter I at 9. If this is not the case with respect to
a particular market participant, then the number of entities that
need to perform the de minimis calculation would increase. The
Commission currently does not have available information with
respect to the number of market participants active in the security-
based swap market that utilize a central booking model.
---------------------------------------------------------------------------

    We preliminarily conclude that our proposed application of the
aggregation requirement to the de minimis calculation in the cross-
border context is appropriate in light of the purposes of Title VII and
of dealer regulation in particular. The aggregation requirement is
designed to discourage evasion of the dealer registration requirement
by a corporate group by engaging in large volumes of dealing activity
through multiple affiliates, none of which engages in activity
exceeding the de minimis threshold.\1481\ Therefore, we have
preliminarily determined that a corporate group's dealing activity
should be considered as a whole.
---------------------------------------------------------------------------

    \1481\ See Intermediary Definitions Release, 77 FR 30631.
---------------------------------------------------------------------------

    Similarly, to be entitled to rely on the de minimis exception, an
unregistered affiliate within a corporate group must have an
independent operation separate from any affiliate who is a registered
security-based swap dealer and must not act in concert with the
registered affiliate in any stage of a security-based swap transaction.
The Commission preliminarily believes that this requirement would have
the benefit of preventing evasion.
(b) Major Security-Based Swap Participants
    Several commenters suggested that foreign government-related
entities, such as sovereign wealth funds and multilateral development
institutions,

should be excluded from the major security-based swap participant
definition.\1482\ By potentially capturing fewer major security-based
swap participants, this alternative approach would correspondingly
decrease the programmatic costs and benefits associated with Title VII
regulation of major security-based swap participants. We preliminarily
believe that security-based swap transactions entered into by these
types of foreign government-related entities with U.S. persons pose the
same risks to the U.S. security-based swap markets as transactions
entered into by entities that are not foreign-government related.
Moreover, as noted above,\1483\ based upon our conversations with
market participants we understand that foreign government-related
entities rarely enter into security-based swap transactions (as opposed
to other types of swap transactions) in amounts that would trigger the
obligation to register as a major security-based swap participant.
Therefore, we preliminarily believe that the proposed approach
considering only security-based swap transactions entered into with a
U.S. person as counterparty in determining a non-U.S. person's status
as a major security-based swap participant, regardless of whether such
non-U.S. person is a foreign government-related entity, is more
appropriately tailored to the objectives of Title VII.
---------------------------------------------------------------------------

    \1482\ See note 382, supra.
    \1483\ See Section IV.C.3, supra.
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comments on all aspects of the economic
analysis of the alternatives to the proposed definition of U.S. person,
the proposed application of the de minimis exception and the proposed
application of the major security-based swap participant definition in
the cross-border context. The Commission requests that commenters
provide data and sources of data to support any comments. In addition,
the Commission requests commenters' views on the following:
     Has the Commission appropriately considered the costs and
benefits associated with adopting the definition of U.S. person found
in Regulation S? If not, please explain why and provide information on
how such costs and benefits should be assessed.
     Has the Commission appropriately considered the costs and
benefits associated with adopting the same definition of U.S. person as
proposed by the CFTC? If not, please explain why and provide
information on how such costs and benefits should be assessed.
     Has the Commission appropriately considered the costs and
benefits associated with adopting a rule to permit foreign branches of
U.S. banks to exclude transactions conducted through a foreign branch
from their de minimis calculations? If not, please explain why and
provide information on how such costs and benefits should be assessed.
     Has the Commission appropriately considered the costs and
benefits associated with not requiring a non-U.S. person to count its
transactions conducted within the United States with non-U.S. persons
towards its de minimis threshold? If not, please explain why and
provide information on how such costs and benefits should be assessed.
     Has the Commission appropriately considered the costs and
benefits associated with requiring a non-U.S. person whose performance
under security-based swaps is guaranteed by a U.S. person to count all
transactions connected to its security-based swap dealing activity
toward its de minimis threshold, even though such non-U.S. person only
conducts dealing activity with non-U.S. persons outside the United
States? If not, please explain why and provide information on how such
costs and benefits should be assessed.
     Has the Commission appropriately considered the costs and
benefits associated with the proposed rule regarding aggregation of
security-based swap transactions entered into in a dealing capacity by
a person and its affiliates under common control and requiring that
such aggregated notional amount be included in such person's de minimis
calculation? If not, please explain why and provide information on how
such costs and benefits should be assessed. Should the Commission
require operational independence, from the cost and benefit point of
view, as a condition to excluding transactions of an affiliate that is
a registered security-based swap dealer from a person's de minimis
calculation?
     Has the Commission appropriately considered the costs and
benefits associated with excluding foreign government-related entities,
such as sovereign wealth funds and multilateral development
institutions, from the definition of major security-based swap
participant? If not, please explain why and provide information on how
such costs and benefits should be assessed.
     Should the Commission take into account the potential
impact of the Push-Out Rule and the Volcker Rule in considering the
approach to application of the Title VII requirements to foreign
branches of the U.S. banks? For example, what would the costs and
benefits be with respect to requiring foreign branches of U.S. banks to
include transaction conducted through a foreign branch in its de
minimis calculation, or requiring a non-U.S. person to include its
transactions with foreign branches in its major security-based swap
participant calculation, after taking into account the effects of the
Push-Out Rule and the Volcker Rule on U.S. banks? Please explain how
such costs and benefits should be assessed.

E. Economic Analysis of the Proposed Application of the Entity-Level
and Transaction-Level Requirements to Security-Based Swap Dealers and
Major Security-Based Swap Participants

    As stated above, persons who fall within the statutory definitions
of security-based swap dealer and major security-based swap
participant, as further defined by the rules adopted in the
Intermediary Definition Adopting Release, will be required to register
with the Commission and comply with a host of ensuing substantive
requirements.\1484\ These requirements include entity-level
requirements \1485\ and transaction-level requirements \1486\ set forth
in Sections 15F and 3E of the Exchange Act and rules and regulations
thereunder.\1487\
---------------------------------------------------------------------------

    \1484\ See Section XV.D.1, supra.
    \1485\ See Section III.C.3(a), supra.
    \1486\ See Section III.C.3(b), supra.
    \1487\ See Section 15F of the Exchange Act, 15 U.S.C. 78o-8, and
Section 3E of the Exchange Act, 15 U.S.C. 78c-4.
---------------------------------------------------------------------------

1. Entity-Level Requirements
    Section 764(a) of the Dodd Frank Act adds a new Section 15F(e) to
the Exchange Act, which imposes capital and margin requirements on
security-based swap dealers and major security-based swap
participants.\1488\ These requirements are designed to reduce the
probability of these institutions' failure, mitigate the consequences
of these institutions failures, protect customer assets, and contribute
to the stability of the security-based swap market in particular and
the U.S. financial system more generally.\1489\ The benefits of the
capital and margin requirements for security-based swap dealers are
expected to include enhancing protection of customer assets and
mitigation of the consequences of a firm failure, while allowing
security-based swap dealers appropriate flexibility in how they conduct
their security-based swaps business.\1490\ Similarly, the

benefits of the capital and margin requirements for major security-
based swap participants are expected to include neutralization of the
credit risk between a major security-based swap participant and a
counterparty, which would lessen the impact on the counterparty if the
major security-based swap participant failed.\1491\ We believe the
capital and margin requirements strengthen the financial system by
reducing the potential for defaults by entities engaging in security-
based swap activity and mitigating the impact of such defaults,
including the adverse spillover or contagion effect of a default by
security-based swap dealers and major security-based swap
participants.\1492\
---------------------------------------------------------------------------

    \1488\ See Section 15F(e) of the Exchange Act, 15 U.S.C. 78o-
10(e).
    \1489\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70218 and 70303.
    \1490\ See id. at 70218.
    \1491\ Id.
    \1492\ These spillover effects could create instability for the
financial markets more generally, such as by limiting the
willingness of market participants to extend credit to each other,
and thus substantially reduce liquidity and valuations for
particular types of financial instruments. See, e.g., Markus K.
Brunnermeier and Lasse Heje Pedersen, ``Market Liquidity and Funding
Liquidity,'' Review of Financial Studies (2009); Denis Gromb and
Dimitri Vayanos, ``A Model of Financial Market Liquidity,'' Journal
of the European Economic Association (2010).
---------------------------------------------------------------------------

    In addition, registered security-based swap dealers and major
security-based swap participants are required to establish robust risk
management systems adequate for managing their day-to-day
business,\1493\ keep books and records and maintain daily trading
records of the security-based swaps they enter into,\1494\ establish
internal systems and controls,\1495\ diligently supervise the security-
based swap business,\1496\ designate a chief compliance officer,\1497\
and keep books and records open to inspection and examination by the
Commission.\1498\
---------------------------------------------------------------------------

    \1493\ See Section 15F(j)(2) of the Exchange Act, 15 U.S.C. 78o-
10(j)(2); see also Section III.C.3(b)(3), supra.
    \1494\ See Sections 15F(f) and (g) of the Exchange Act, 15
U.S.C. 78o-10(f) and (g); see also Section III.C.3(b)(4), supra.
    \1495\ See Sections 15F(j)(3) and (4) of the Exchange Act, 15
U.S.C. 78o-10(j)(3) and (4); Section III.C.3(b)(5), supra. See also
proposed Rule 15Fh-3(i)(2)(iv) under the Exchange Act.
    \1496\ See Section 15F(h)(1)(B) of the Exchange Act, 15 U.S.C.
78o-10(h)(1)(B). The Commission has proposed a rule that would
establish supervisory obligations that incorporates principles from
Section 15(b) of the Exchange Act and existing SRO rules. Proposed
Rule 15fh-3(i) under the Exchange Act, as discussed in the External
Business Conduct Standards Proposing Release, 76 FR 42419-21. See
also Section IIIC.3(b)(6), supra.
    \1497\ See Section 15F(k) of the Exchange Act, 15 U.S.C. 78o-
10(k); see also Section III.C.3(b)(7), supra.
    \1498\ See Section 15F(l)(C) of the Exchange Act, 15 U.S.C. 78o-
10(l)(C); see also Section III.C.3(b)(8), supra.
---------------------------------------------------------------------------

    The programmatic costs and benefits associated with the entity-
level requirements applicable to security-based dealers and major
security-based swap participants under Title VII are (or will be)
addressed in more detail in connection with the applicable rulemakings
implementing Title VII.\1499\
---------------------------------------------------------------------------

    \1499\ See, e.g., Capital, Margin, and Segregation Proposing
Release, 77 FR 70214.
---------------------------------------------------------------------------

    With respect to the application of the entity-level requirements in
the cross-border context, as stated above, the Commission preliminarily
believes that it would be consistent with the objective of Title VII to
ensure the safety and soundness of registered security-based swap
dealers \1500\ to require foreign security-based swap dealers to comply
with the entity-level requirements.\1501\ Similarly, the Commission
preliminarily does not believe that foreign major security-based swap
participants should be excluded from the application of any entity-
level requirements.\1502\ However, the Commission recognizes the
concerns raised by commenters regarding the possibility that foreign
security-based swap dealers may be subject to conflicting or
duplicative regulatory requirements and proposes to mitigate the costs
associated with the potential duplicative compliance obligations
through the Commission's proposed approach to substituted
compliance.\1503\ We have considered the effect of the proposed rules
regarding substituted compliance on its effect on efficiency,
competition and capital formation above \1504\ and will discuss the
economic considerations of the proposed rules regarding substituted
compliance more fully below.\1505\
---------------------------------------------------------------------------

    \1500\ See Section 15F(e)(3)(A) of the Exchange Act, 15 U.S.C.
78o-8(e)(3)(A) (``To offset the greater risk to the security-based
swap dealer . . . and the financial system arising from the use of
security-based swaps that are not cleared, the requirements imposed
under paragraph (2) shall--(i) help ensure the safety and soundness
of the security-based swap dealer . . . .'').
    \1501\ See Section III.C.5, supra.
    \1502\ Id.
    \1503\ See Section XI, supra (discussing the Commission's
overall proposed approach to substituted compliance in the context
of Title VII).
    \1504\ See Section XV.C, supra.
    \1505\ See Section XV.I, infra.
---------------------------------------------------------------------------

Alternative
    The CFTC proposed to treat Title VII margin requirements with
respect to non-cleared swaps as transaction-level requirements and
would not apply the margin requirements to foreign non-bank swap
dealers (including foreign affiliates of U.S. persons regardless of
whether such foreign affiliates' performance obligations under swaps
are guaranteed by U.S. persons) when they transact swaps with non-U.S.
person counterparties whose performance obligations under the swaps are
not guaranteed by U.S. persons.\1506\ The prudential regulators' margin
proposal does not apply Title VII margin requirements to a foreign
covered swap entity \1507\ with respect to foreign non-cleared swaps or
foreign non-cleared security-based swaps.\1508\ In practice, the
Commission's proposed treatment of the margin requirements as an
entity-level requirement differs from the CFTC's and the Prudential
regulators' proposals in that non-bank foreign security-based swap
dealers (regardless of whether their performance of obligations under
security-based swaps are guaranteed by U.S. persons) would be subject
to the margin requirements with respect to their transactions with non-
U.S. person counterparties whose performance obligations under the
security-based swaps are not guaranteed by U.S. persons.
---------------------------------------------------------------------------

    \1506\ See CFTC Cross-Border Proposal, 77 FR 41226, 41228, and
41237.
    \1507\ A ``foreign covered swap entity'' is defined as any
entity prudentially regulated by the prudential regulators and
required to register as a swap dealer, major swap participant,
security-based swap dealer or major security-based swap participant
under section 4s of the Commodity Exchange Act or section 15F of the
Exchange Act that (i) is not a company organized under the laws of
the United States or any State; (ii) is not a branch or office of a
company organized under the laws of the United States or any State;
(iii) is not a U.S. branch, agency or subsidiary of a foreign bank;
and (iv) is not controlled, directly or indirectly, by a company
that is organized under the laws of the United States or any State.
See Prudential Regulator Margin and Capital Proposal, 76 FR 27581.
    \1508\ A ``foreign non-cleared swap or foreign non-cleared
security-based swap'' is defined as a non-cleared swap or non-
cleared security-based swap with respect to which: (i) The
counterparty to the foreign covered swap entity is not a company
organized under the laws of the United States or any State, not a
branch or office of a company organized under the laws of the United
States or any State, and not a person resident in the United States;
and (ii) performance of the counterparty's obligations to the
foreign covered swap entity under the swap or security-based swap
has not been guaranteed by an affiliate of the counterparty that is
a company organized under the laws of the United States or any
State, a branch of a company organized under the laws of the United
States or any State, or a person resident in the United States. See
Prudential Regulator Margin and Capital Proposal, 76 FR 27581.
---------------------------------------------------------------------------

    The Commission could have taken the CFTC's approach to treat margin
requirements as transaction-level requirements by proposing not to
apply margin to non-bank foreign security-based swap dealers with
respect to their transactions with non-U.S. person counterparties whose
performance obligations under the security-based swaps are not
guaranteed by U.S. persons. We also could have taken the prudential
regulators' approach by proposing not to apply margin to foreign non-
bank security-based swap dealers

that are not controlled by a U.S. person with respect to their
transactions with non-U.S. person counterparties whose performance
obligations under the security-based swaps are not guaranteed by U.S.
persons. Either approach would not treat margin as an entity-wide
requirement.
    The Dodd-Frank Act seeks to address the counterparty credit risk
exposures arising from OTC derivatives by, among other things, imposing
mandatory clearing and margin requirements for non-cleared security-
based swaps.\1509\ The margin requirements established by the
Commission with respect to non-cleared security-based swaps will
operate in tandem with mandatory clearing provisions in the Dodd-Frank
Act.\1510\ Registered clearing agencies that operate as CCPs manage
credit and other risks through a range of controls and methods,
including prescribed margin rules for their participants.\1511\ Thus,
the mandatory clearing requirements in effect will establish margin
requirements for cleared security-based swaps and, thereby, complement
the margin requirements for non-cleared security-based swaps
established by the Commission and the prudential regulators.\1512\
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    \1509\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70258; see also Section 3C(a)(1) and Section 15F(e)(1) of the
Exchange Act, 15 U.S.C. 78c-3(a)(1) and 78o-10(e)(1).
    \1510\ See Section 3C(a)(1) of the Exchange Act, 15 U.S.C. 78c-
3(a)(1) (requiring that security-based swaps must be cleared through
a registered clearing agency unless an exception to mandatory
clearing exists).
    \1511\ See Clearing Agency Standards Adopting Release, 77 FR
66230-32.
    \1512\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70259; see also Prudential Regulator Margin and Capital
Proposal, 76 FR 27567 (``In the derivatives clearing process,
central counterparties (CCPs) manage the credit risk through a range
of controls and methods, including a margining regime that imposes
both initial margin and variation margin requirements on parties to
cleared transactions. Thus, the mandatory clearing requirement
established by the Dodd-Frank Act for swaps and security-based swaps
will effectively require any party to any transaction subject to the
clearing mandate to post initial and variation margin to the CCP in
connection with that transaction.'').
---------------------------------------------------------------------------

    In addition, margin requirements, along with the capital standards
and segregation requirements, are an integral part of the proposed
financial responsibility requirements for security-based swap dealers
that are intended to enhance the financial integrity of these
entities.\1513\ The margin requirements proposed by the Commission are
intended to work in tandem with the capital requirements to strengthen
the financial system by reducing the potential for default to an
acceptable level and limiting the amount of leverage that can be
employed by security-based swap dealers and other market
participants.\1514\ For example, with respect to cleared security-based
swaps, for which margin requirements will not be established by the
Commission, the Commission proposed a capital charge that would apply
if a nonbank security-based swap dealer collects margin collateral from
a counterparty in an amount that is less than the deduction that would
apply to the security-based swap if it was a proprietary position of
the non-bank security-based swap dealer.\1515\ In addition, the
Commission proposed capital charges to address exceptions from the
margin collection requirements with respect to non-cleared security-
based swaps, as an alternative to margin collateral by requiring a non-
bank security-based swap dealer to hold sufficient net capital to
enable it to withstand losses if a counterparty defaults.\1516\
---------------------------------------------------------------------------

    \1513\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70303 and 70259.
    \1514\ See id. at 70304.
    \1515\ See id. at 70245-46.
    \1516\ See id. at 70246.
---------------------------------------------------------------------------

    In the context of the statutory framework and the Commission's
proposed financial responsibility program for non-bank security-based
swap dealers, if the Commission were to treat margin as a transaction-
level requirement and apply margin to certain non-cleared transactions
but not others, any credit risk of such other transactions that are not
collateralized by mutually agreed contractual arrangement between a
security-based swap dealer and its counterparty would need to be
addressed by imposing capital charges, which would increase the amount
of net capital a non-bank security-based swap dealer is required to set
aside. While the increased liquid capital would provide an additional
buffer for a non-bank security-based swap dealer to withstand losses
resulting from a default of its counterparties, it also would increase
business costs. Depending on the size of a foreign security-based swap
dealers' foreign business that is not collateralized, the size of the
increased amount of the capital charge may be very large. As discussed
in the Capital, Margin, and Segregation Proposing Release, if security-
based swap dealers are required to maintain an excessive amount of
capital, that amount may result in certain costs for the markets and
the financial system, including the potential for the reduced
availability of security-based swaps for market participants who would
otherwise use such transactions to hedge the risks of their business,
or engage in other activities that would promote capital
formation.\1517\ End users also may incur increased transaction costs
in connection with the increased capital charges as security-based swap
dealers are likely to pass on the financial burden of any increased
capital requirements to customers.\1518\ If the transaction costs are
too high, end users may seek other cheaper alternatives, such as
cleared security-based swaps or voluntary collateral posting to reduce
transaction pricing, or they may decide not to transact security-based
swaps at all.
---------------------------------------------------------------------------

    \1517\ See id. at 70306.
    \1518\ Id.
---------------------------------------------------------------------------

    In the cross-border context, the Commission is proposing not to
apply the mandatory clearing requirement to transactions between a
foreign security-based swap dealer and non-U.S. person counterparties
whose performance obligations under security-based swaps are not
guaranteed by U.S. persons. Therefore, a foreign security-based swap
dealer's exposure to counterparty credit risk arising from its
transactions with these non-U.S. person counterparties would not be
addressed by the Title VII mandatory clearing requirement. If margin
requirements do not apply to these transactions, the counterparty
credit risk arising from such transactions may be left
uncollateralized. In the event that non-U.S. counterparties experience
financial difficulties, and the foreign security-based swap dealer's
uncollateralized exposures to such counterparties have grown
exponentially due to severe market movement, the uncollateralized
foreign credit exposures may jeopardize the safety and soundness of the
foreign security-based swap dealer, whose failure would have negative
impact on the U.S. security-based swap market and present risk to the
U.S. financial system. Such uncollateralized credit risk could be
addressed by imposing capital charges under the Commission's proposed
capital rule, but taking this approach would result in increased costs
and higher barrier for new foreign entrants into the U.S. security-
based swap market. To mitigate the cost of increased capital charges, a
foreign security-based swap dealer may choose to enter into credit
support arrangements and request some or all counterparties to post
collateral. This would be particularly the case when a foreign
security-based swap dealer is transacting in a foreign market where
collateral posting is a common market practice to manage counterparty
credit risk or in a foreign jurisdiction that

imposes margin requirements because the foreign security-based swap
dealer would encounter less resistance to posting margin from foreign
counterparties. To the extent that the costs of capital charges drive
foreign security-based swap dealers to voluntarily collateralize their
exposures to counterparty credit risks, the differences in the economic
consequences between treating margin as an entity-level requirement as
opposed to a transaction-level requirement would narrow.
    By contrast, under the proposed approach, the counterparty credit
exposures arising from a foreign non-bank security-based swap dealers
transactions with non-U.S. persons whose performance of obligations
under non-cleared security-based swaps are not guaranteed by U.S.
persons would be collateralized but the collateral would not be
segregated.\1519\ The collateral received would protect the foreign
security-based swap dealer against the default risk of the foreign
counterparty and reduce the probability of the failure of the foreign
security-based swap dealer and the spillover and contagion risk of a
foreign counterparty's default that may impact the U.S. financial
system. In addition, such collateral could finance the business needs
of the foreign security-based swap dealer and increase its liquidity.
The Commission preliminarily believes that the proposed treatment of
margin as an entity-level requirement would generate the benefit of
offsetting the greater risk to the foreign security-based swap dealer
and the U.S. financial system arising from the use of non-cleared
security-based swaps and help ensure the safety and soundness of the
security-based swap dealers \1520\ without imposing excessive capital
charges at the same time, which may raise the barrier for foreign
dealers to enter the U.S. security-based swap market. The proposed
treatment of margin also may increase funds available to finance a
foreign security-based swap dealer's business activity, which would
decrease the borrowing needs and lower the costs of business.
---------------------------------------------------------------------------

    \1519\ A foreign security-based swap dealer that is not a
registered broker-dealer would not be required to segregate assets
held as collateral received from a non-U.S. person counterparty with
respect to non-cleared security-based swap transactions. A foreign
security-based swap dealer that is a registered broker-dealer would
be required to segregate margin collateral received from all
counterparties. See proposed Rule 18a-4(e)(1) under the Exchange Act
and discussion in Section III.C.4(b).ii, supra.
    \1520\ See Section 15F(e)(3)(A) of the Exchange Act, 15 U.S.C.
78o-10(e)(3)(A).
---------------------------------------------------------------------------

    Commenters raised concerns about the potential costs and burdens of
applying duplicative margin collection requirements to foreign
transactions.\1521\ The Commission preliminarily believes that the
costs of complying with duplicative margin requirements can be
addressed by the proposed substituted compliance framework. As stated
in our cost and benefit analysis with respect to substituted compliance
below, the Commission preliminarily believes that substituted
compliance would not substantially change the programmatic benefits
intended by the entity-level requirements in Section 15F of the
Exchange Act, including margin requirements; however, to the extent
that substituted compliance eliminates duplicative compliance costs,
registered foreign security-based swap dealers that are eligible for a
substituted compliance determination may incur lower programmatic costs
associated with implementation or compliance with the specified Title
VII requirements (including margin requirements).\1522\
---------------------------------------------------------------------------

    \1521\ See Cleary Letter IV at 18 (``If non-U.S. margin
requirements are essentially the same, or are merely different, but
not significantly different, it is not obvious how the Agencies
could justify their proposal or ex ante cost-benefit analysis.'')
    \1522\ See Section XV.I, infra.
---------------------------------------------------------------------------

Request for Comment
    The Commission requests comments on all aspects of the economic
analysis of the alternatives to the proposed definition of U.S. person,
the proposed application of the de minimis exception and the proposed
application of the major security-based swap participant definition in
the cross-border context. The Commission requests that commenters
provide data and sources of data to support any comments. In addition,
the Commission requests commenters' views on particular issues below.
Responses that are supported by empirical data and analysis provide
great assistance to the Commission in considering the economic
consequences of the proposed treatment of certain requirements as
entity-level and other requirements as transaction-level requirements.
     Has the Commission appropriately considered the costs and
benefits associated with an approach that would treat all the
requirements set forth in Section 15F of the Exchange Act, and rules
and regulations thereunder, as entity-level requirements and apply them
on an entity-wide basis, except for the external business conduct
standards and segregation requirements? Has the Commission
appropriately estimated the costs and benefits associated with
requiring a foreign security-based swap dealer to conform its capital
and risk management practices to the rules proposed by the Commission?
If not, please explain why and provide information on how such costs
and benefits should be assessed.
     Are there any requirements that are treated as entity-
level in the Commission's cross-border proposal that should be treated
as transaction-level requirements from the cost and benefit point of
view? If so, please explain how such treatment would affect the costs
and benefits of the proposed approach.
     Has the Commission appropriately considered the costs and
benefits associated with treating margin as an entity-level
requirement, taking into account the interplay between the minimum
capital requirement and margin requirement? If not, please explain why
and provide information on how such costs and benefits should be
assessed. What would be the economic impact of treating margin as an
entity-level requirement? Should the Commission adopt the CFTC's
approach by treating margin as a transaction-level requirement, given
the costs and benefits of this alternative? Should the Commission adopt
the prudential regulators' approach to exclude certain foreign
security-based swaps from application of the margin requirement, given
the costs and benefits of this alternative?
2. Transaction-Level Requirements
    With respect to the application of these transaction-level
requirements to security-based swap dealers active in the cross-border
context, the Commission proposes Rule 3a71-3(c) under the Exchange Act
regarding application of customer protection requirements to security-
based swap dealers,\1523\ Rule 18a-4(e) regarding application of
segregation requirements to foreign security-based swap dealers,\1524\
Rule 3a67-10(b) regarding application of customer protection
requirements to foreign major security-based swap participants,\1525\
and Rule 18a-4(f) regarding application of segregation requirements to
foreign major security-based swap participants.\1526\ In the following
sections, we discuss the economic considerations of these proposed
rules regarding application of transaction-

level requirements to security-based swap dealers or major security-
based swap participants in the cross-border context.
---------------------------------------------------------------------------

    \1523\ See proposed Rule 3a71-3(c) under the Exchange Act, as
discussed in Section III.C.4(b).i, supra.
    \1524\ See proposed Rule 18a-4(e) under the Exchange Act, as
discussed in Section III.C.4(b).ii, supra.
    \1525\ See proposed Rule 3a67-10(b) under the Exchange Act, as
discussed in Section IV.D.1(b), supra.
    \1526\ Id.
---------------------------------------------------------------------------

(a) Proposed Rule 3a71-3(c)--Application of Customer Protection
Requirements
    Title VII imposes certain external business conduct requirements on
registered security-based swap dealers that govern their interactions
with counterparties to security-based swap transactions.\1527\ These
provisions are intended to protect the counterparties of registered
dealers in such transactions by ensuring that security-based swap
dealers, among other things, provide adequate disclosures to their
counterparties about the risks of the transaction.\1528\
---------------------------------------------------------------------------

    \1527\ See Sections 15F(h) and 15F(j)(5) of the Exchange Act.
    \1528\ See Section III.C.3(a)i, supra.
---------------------------------------------------------------------------

    Proposed Rule 3a71-3(c) provides that registered security-based
swap dealers, with respect to their Foreign Business, shall not be
subject to the requirements relating to business conduct standards
described in Section 15F(h) of the Exchange Act, and the rules and
regulations thereunder, other than Section 15F(h)(1)(B) of the Exchange
Act, and the rules and regulations thereunder. We are proposing to
define ``Foreign Business'' as security-based swap transactions entered
into, or offered to be entered into, by or on behalf of a foreign
security-based swap dealer or a U.S. security-based swap dealer in a
dealing capacity that are not its ``U.S. Business.'' \1529\
---------------------------------------------------------------------------

    \1529\ Proposed Rule 3a71-3(a)(2) under the Exchange Act, as
discussed in Section III.C.4.(a), supra.
---------------------------------------------------------------------------

    ``U.S. Business'' would be defined separately for foreign security-
based swap dealers and U.S. security-based swap dealers. With respect
to a foreign security-based swap dealer, ``U.S. Business'' would
include any transaction entered into, or offered to be entered into, by
or on behalf of such foreign security-based swap dealer, with a U.S.
person (other than a foreign branch), or any transaction conducted
within the United States.\1530\ With respect to a U.S. security-based
swap dealer, ``U.S. Business'' would include any transaction by or on
behalf of the U.S. security-based swap dealer, wherever entered into or
offered to be entered into, other than a transaction conducted through
a foreign branch with a non-U.S. person or another foreign
branch.\1531\ With the exception of the exclusion of transactions
conducted through a foreign branch from the definition of a U.S.
security-based swap dealer's U.S. Business, these definitions closely
track the application of the de minimis exception to the transactions
of U.S. persons and non-U.S. persons under proposed Rule 3a71-3(b)
under the Exchange Act. Moreover, whether a transaction occurs within
the United States or with a U.S. person, which are key elements of the
Foreign Business and U.S. Business definitions, would turn on the same
factors that are used to determine whether the de minimis exception
applies to the security-based swap activity of a non-U.S. person
engaged in dealing activity.\1532\
---------------------------------------------------------------------------

    \1530\ Proposed Rule 3a71-3(a)(6)(i) under the Exchange Act, as
discussed in Section III.C.4.(a), supra.
    \1531\ Proposed Rule 3a71-3(a)(6)(ii) under the Exchange Act, as
discussed in Section III.C.4.(a), supra.
    \1532\ See proposed Rule 3a71-3(b)(1)(i) under the Exchange Act
(identifying transactions that U.S. persons and non-U.S. persons
must include in their de minimis calculations); proposed Rule 3a71-
3(a)(2) under the Exchange Act (defining ``Foreign Business'');
proposed Rule 3a71-3(a)(6) under the Exchange Act (defining ``U.S.
Business'').
---------------------------------------------------------------------------

    In the External Business Conduct Standards Proposing Release, we
have considered the expected benefits and costs of the proposed rules
regarding external business conduct standards as they apply to dealers
generally, and we expect to discuss the benefits and costs associated
with the final rules in our adopting release. In the proposing release,
we noted that these rules may be expected to benefit security-based
swap dealers and other market participants in a number of ways. For
example, the requirement for security-based swap dealers to provide a
daily mark should enable counterparties to have a clearer picture of
their relationship with security-based swap dealers, including by
providing a meaningful reference point for calculating variation
margin.\1533\ Similarly, our proposed rules regarding security-based
swap dealers' obligations to know their counterparties may be expected
to help ensure that security-based swap dealers recommend only
transactions that are appropriate to the needs and resources of their
counterparties.\1534\ Proposed rules regarding the standards of conduct
in transactions involving special entities should likewise help ensure
that such business is awarded on the merits of the transaction.\1535\
---------------------------------------------------------------------------

    \1533\ External Business Conduct Standards Proposing Release, 76
FR 42449.
    \1534\ See id. at 42450.
    \1535\ See id. at 42450.
---------------------------------------------------------------------------

    We also noted that the proposed external business conduct rules
would be likely to impose certain costs on security-based swap dealers
and other market participants. For example, they would require
security-based swap dealers to make various disclosures and establish
systems for monitoring compliance with these requirements.\1536\
---------------------------------------------------------------------------

    \1536\ See id. at 42443-448.
---------------------------------------------------------------------------

    Because this proposing release does not change the substantive
external business conduct requirements but only potentially reduces the
number of registered security-based swap dealers and the number of
transactions involving registered security-based swap dealers that
would be subject to the external business conduct requirements, our
discussion below focuses on how proposed Rule 3a71-3(c) affects the
scope of application of these rules. This change in scope will directly
affect the resulting programmatic benefits and costs. We also discuss
the assessment costs associated with distinguishing Foreign Business
from U.S. Business.
i. Programmatic Benefits and Costs
    Our proposed rules may affect the programmatic costs and benefits
associated with requirements regarding external business conduct
standards in two ways. First, we are proposing rules regarding
application of the de minimis exception in the cross-border context
that may be expected to reduce the number of non-U.S. persons that
would otherwise be required to register as security-based swap
dealers.\1537\ Because the business conduct and conflict-of-interest
rules apply only to registered dealers, reducing the number of
registered dealers would reduce the number of entities required to
comply with these dealer-specific rules. Second, we are proposing not
to require foreign or U.S. security-based swap dealers to comply with
requirements relating to external business conduct standards with
respect to their Foreign Business, which would reduce the proportion of
registered dealers' transactions that are required to comply with these
rules. We preliminarily believe that these proposed rules will not
significantly affect the programmatic benefits of the rules but should
reduce programmatic costs that they impose on market participants.
---------------------------------------------------------------------------

    \1537\ See proposed Rule 3a71-3(b) under the Exchange Act, as
discussed in Section III.B.3, supra.
---------------------------------------------------------------------------

    As already noted, Title VII is concerned directly with risk to the
U.S. financial system, transparency, and the protection of
investors,\1538\ and we preliminarily believe that our proposed

approach to applying requirements related to external business conduct
standards is consistent with these goals. As noted above in our
discussion of the programmatic costs and benefits associated with our
application of the de minimis exception in the cross-border context, we
believe that our proposed approach to the de minimis calculation
appropriately identifies those entities whose dealing activity poses
the type of stability, transparency, and counterparty-protection
concerns that Title VII is intended to address.\1539\ To the extent
that the number of entities required to comply with these requirements
relating to external business conduct standards decline because the
number of registered foreign security-based swap dealers declines, we
do not believe that there will be a significant change in programmatic
benefits, as foreign security-based swap dealers whose transactions
with U.S. persons and transaction conducted within the United States
falls below the de minimis threshold raise concerns no different from
those posed by U.S. security-based swap dealers whose security-based
swap activity falls below the threshold. We see no reason, therefore,
for treating these two types of entities differently.
---------------------------------------------------------------------------

    \1538\ See note 4, supra.
    \1539\ See Section III.B.4, supra.
---------------------------------------------------------------------------

    We also preliminarily believe that our proposal not to require
compliance with these requirements with respect to Foreign Business,
even if a security-based swap dealer is registered, will have an
insignificant effect, if any, on programmatic benefits and should
reduce programmatic costs. We recognize that our proposed rule would
not require foreign and U.S. security-based swap dealers to comply with
these rules with respect to a significant proportion of their
transactions. However, because Title VII is directed to the promoting
the stability of the U.S. financial system and protecting
counterparties, we do not believe that this proposed approach would
reduce the programmatic benefits of our regulatory framework, given
that such transactions, including any customer-facing activity, occur
entirely or in significant part outside the United States where the
parties typically do not expect U.S. customer-protection requirements
to apply. At the same time, our definition of U.S. Business should
ensure that registered dealers are required to comply with these
requirements in their transactions with those counterparties that are
entitled to protection in light of the purposes of Title VII or that
reasonably expect to be protected in their dealings with registered
security-based swap dealers.
    We preliminarily believe that our proposed approach will reduce
programmatic costs for registered security-based swap dealers generally
in proportion to their relative volume of Foreign Business, although
certain of the costs associated with policies and procedures
established to comply with these requirements are likely to remain
fairly constant to the extent that a security-based swap dealer has any
U.S. Business. Permitting security-based swap dealers to enter into
transactions arising out of their Foreign Business without complying
with these requirements should reduce the costs of compliance with
Title VII for such registered security-based swap dealers and reduce
the competitive effects of the Title VII dealer requirements by
reducing unnecessary disparities between registered and unregistered
security-based swap dealers in their foreign business.
ii. Assessment Costs
    The assessment costs associated with the proposed rules regarding
these requirements would primarily flow from the determination of
whether a given transaction is part of a registered security-based swap
dealer's U.S. Business or its Foreign Business. Both for U.S. and
foreign security-based swap dealers, ``U.S. Business'' is defined to
capture largely the same transactions that these entities are required
to calculate in determining whether they are required to register as
security-based swap dealers.\1540\ Because of this overlap with the
information needed to perform the de minimis calculation, the
incremental costs of these determinations for registered security-based
swap dealers should be minimal. We preliminarily believe that a
registered foreign security-based swap dealer would not incur
additional assessment costs above those already incurred in
establishing and maintaining a system to identify and monitor the
status of its counterparties and transactions for purposes of the de
minimis calculation, as described above.\1541\
---------------------------------------------------------------------------

    \1540\ The sole exception is that, for U.S. security-based swap
dealers, transactions conducted through a foreign branch, which
would be counted toward the U.S. person's de minimis threshold,
would not be treated as U.S. Business for purposes of applying the
external business conduct requirements.
    \1541\ See Section XV.D.2, supra.
---------------------------------------------------------------------------

    U.S. security-based swap dealers would likely not have incurred
these types of systems costs in performing the de minimis calculation
because our proposed approach would require U.S. persons to count all
of their dealing transactions toward their de minimis threshold.
However, U.S. security-based swap dealers who conduct some or all of
their security-based swap business through foreign branches and seek to
rely on the Foreign Business exception to the external business conduct
requirement would likely establish a similar system to identify such
transactions. We believe that the costs of such a system would closely
track the costs associated with the systems that non-U.S. persons are
likely to establish to perform the dealer de minimis calculation and to
determine whether a foreign security-based swap dealer must comply with
Title VII external business conduct requirements, as described above,
as U.S. security-based swap dealers conducting business through a
foreign branch will also need to classify their counterparties and
transactions in order to determine whether external business conduct
requirements apply.\1542\ Based on a review of DTCC-TIW data relating
to single-name credit default swap activity in 2011, there were no more
than five U.S. security-based swap dealers that conducted dealing
activity through foreign branches. Assuming that all such entities
elected to establish a system to identify their Foreign Business, the
total assessment costs associated with our proposed rule would be
approximately $85,200 in one-time annual programming costs and $76,435
in ongoing annual costs.\1543\
---------------------------------------------------------------------------

    \1542\ See Section XV.D.2(a), supra.
    \1543\ As noted above in connection with the calculation of the
de minimis threshold by foreign security-based swap dealers, we
estimate the per-entity one-time annual programming costs to total
approximately $17,040 and the per-entity ongoing annual costs to
total $15,287. See note 1425, supra.
---------------------------------------------------------------------------

iii. Alternatives
    The Commission's proposed approach to the application of the
requirements relating to external business conduct standards is similar
to the CFTC's proposed approach in certain aspects but differs from the
CFTC's proposed approach in other aspects. With respect to U.S.
security-based swap dealers, both the Commission's and the CFTC's
proposed approaches would not apply the requirements relating to
external business conduct standards to such U.S. security-based swap
dealers' transactions conducted through a foreign branch outside the
United States with non-U.S. person counterparties.\1544\ On the other
hand,

with respect to foreign security-based swap dealers, the Commission's
proposed approach would apply the requirements relating to external
business conduct standards to such foreign security-based swap dealers'
transactions conducted within the United States with all counterparties
and transactions conducted outside the United States with foreign
branches while the CFTC's proposed approach would not apply external
business conduct standards to non-U.S. swap dealers' swap transactions
with non-U.S. person counterparties even though such transactions are
conducted within the United States.\1545\
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    \1544\ See CFTC Cross-Border Proposal, 77 FR 41230 and the text
accompanying note 116. However, the CFTC's cross-border proposal did
not address whether external business conduct standards would apply
to transactions conducted through a foreign branch or agency of a
U.S. security-based swap dealer within the United States where the
counterparty is a non-U.S. person.
    \1545\ See CFTC Cross-Border Proposal, 77 FR 41229 and 41237.
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    The Commission could have proposed an approach to the application
of the external business conduct standards that is the same as the
CFTC's but instead, is proposing a territorial approach with a focus on
counterparty protection in the United States. The Commission
preliminarily believes that imposing external business conduct
standards on U.S. security-based swap dealers with respect to their
transactions conducted outside the United States through foreign
branches would cause U.S. security-based swap dealers to incur
compliance costs with respect to their foreign business \1546\
conducted through foreign branches, which would not be incurred by
foreign security-based swap dealers when foreign security-based swap
dealers conduct security-based swap transactions outside the United
States in foreign markets.
---------------------------------------------------------------------------

    \1546\ See proposed Rule 3a71-3(a)(2) and the discussion in
Section III.C.4(a), supra.
---------------------------------------------------------------------------

    The Commission recognizes that non-bank U.S. security-based swap
dealers who do not conduct transactions through foreign branches would
be subject to the external business conduct standards with respect to
all transactions, including transactions with non-U.S. persons. The
Commission preliminarily believes that, unlike U.S. security-based swap
dealers who are banks and conduct foreign business through their
foreign branches, a non-bank U.S. security-based swap dealer may
conduct dealing activity with non-U.S. persons directly from its U.S.
location or from its foreign offices that may not have separate
operations that are subject to substantive local financial regulation
and may not operate for valid business reasons. Therefore, transactions
conducted by a non-bank U.S. security-based swap dealer with non-U.S.
persons are an inseparable part of such non-bank dealer's security-
based swap business. Consistent with our traditional entity approach to
the regulation of broker-dealers, the Commission preliminarily believes
that it is appropriate to apply the external business conduct standards
to a non-bank U.S. security-based swap dealer with respect to all
transactions. To the extent that non-bank U.S. security-based swap
dealers conduct dealing activity with non-U.S. persons through foreign
affiliates, the proposed approach to application of the external
business conduct standards would not impose burdens on non-bank U.S.
security-based swap dealers' activity in the foreign security-based
swap markets and would achieve the benefits of protecting investors
from abusive financial services practices in the United States. The
Commission requests comments on the costs and benefits associated with
the proposed application of external business conduct standards to U.S.
security-based swap dealers and whether the proposed approach would
burden bank and non-bank U.S. security-based swap dealers' foreign
dealing business.
    With respect to foreign security-based swap dealers, the Commission
proposes to apply the external business conduct standards to their
transactions with non-U.S. persons if such transactions are conducted
within the United States. As stated above, the proposed approach to
application of the external business conduct standards to transactions
conducted within the United States would generate the benefit of
protecting investors from abusive financial services practices. To
permit registered foreign security-based swap dealers not to comply
with the external business conduct standards when they conduct
transactions in the United States with non-U.S. person may not
adequately prevent abusive financial services practices in the U.S.
security-based swap market and would permit double standards in
security-based swap dealings in the United States. Therefore, the
Commission preliminarily believes that the proposed territorial
approach with a focus on counterparty protection in the United States
is appropriate.
Request for Comment
     The Commission requests data to assess the costs and
benefits of the proposed rule regarding application of external
business conduct standards described above. Specifically, the
Commission requests comment on (1) whether the proposed rule not to
require a registered U.S. bank security-based swap dealer and foreign
security-based swap dealer to comply with the external business conduct
standards with respect to its foreign business would compromise
counterparty protection from abusive financial services practices in
the United States; (2) whether the proposed rule to require a
registered non-bank U.S. security-based swap dealer to comply with the
external business conduct standards with respect to all transactions
regardless of whether the counterparties are U.S. persons or non-U.S.
persons would affect its foreign dealing business; and (3) the
Commission's estimate of the assessment costs with respect to the
proposed rule. Commenters should provide an assessment of these costs
and benefits, as well as any costs and benefits not already defined,
that may result from the adoption of the proposed rule. Commenters
should provide analysis and empirical data to support their views on
the costs and benefits associated with the proposals.
(b) Proposed Rule 18a-4(e)--Application of Segregation Requirements
i. Programmatic Benefits and Costs
a. Pre-Dodd Frank Segregation Practice
    Segregation is intended to protect customer assets by ensuring that
cash and securities that a registered security-based swap dealer holds
for security-based swap customers are isolated from the proprietary
assets of the security-based swap dealer and identified as property of
such customers.\1547\ Customer assets related to OTC derivatives are
currently not consistently segregated from dealer proprietary assets in
today's OTC derivatives markets.\1548\ With respect to non-cleared
derivatives, available information suggests that there is no uniform
segregation practice but that collateral for most accounts is not
segregated.\1549\ In the absence of a

segregation requirement, the likelihood that security-based swap
customers would suffer losses upon a security-based swap dealer's
default may be substantially higher than may be expected if security-
based swap dealers are subject to such a requirement.\1550\
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    \1547\ See Section III.C.4.(b)(2), supra. See also Capital,
Margin, and Segregation Proposing Release 77 FR 70274.
    \1548\ See ISDA Margin Survey 2012. See also Capital, Margin,
and Segregation Proposing Release, 77 FR 70325.
    \1549\ See generally ISDA Margin Survey 2012. According to this
survey, where an independent amount (initial margin) is collected,
ISDA members reported that most (approximately 72.2%) was commingled
with variation margin and not segregated, and only 4.8% of the
amount received was segregated with a third party custodian. The
survey also notes that while the holding of the independent amounts
and variation margin together continues to be the industry standard
both contractually and operationally, it is interesting to note that
the ability to segregate has been made increasingly available to
counterparties over the past three years on a voluntary basis, and
has led to 26% of independent amount received and 27.8% of
independent amount delivered being segregated in some respects. See
ISDA Margin Survey 2012 at 10. See also Capital, Margin, and
Segregation Proposing Release, 77 FR 70325.
    \1550\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70325.
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b. Benefits of the Segregation Requirements
    Segregation requirements would limit the potential losses for
security-based swap customers if a registered security-based swap
dealer fails.\1551\ The extent to which assets are in fact protected by
proposed Rule 18a-4(a)-(d) would depend on how effective they are in
practice in allowing assets to be readily returned to customers.\1552\
In the cross-border context, the effectiveness of the segregation
requirement with respect to foreign security-based swap dealers in
practice may depend on many factors, including the type and objective
of the insolvency or liquidation proceeding and how the U.S. Bankruptcy
Code, SIPA, banking regulations, and applicable foreign insolvency laws
are interpreted by the U.S. bankruptcy court, SIPC, Federal Deposit
Insurance Corporation, and relevant foreign authorities. In the
Capital, Margin, and Segregation Proposing Release, we stated that it
would be difficult to measure the benefits of the segregation
requirements proposed by the Commission under Section 3E of the
Exchange Act;\1553\ however, we believe that Rule 15c3-3, the existing
segregation rule for broker-dealers, would provide a reasonable
template for crafting the segregation requirements for security-based
swap dealers.\1554\ The ensuing increased confidence of market
participants when transacting in security-based swaps, as compared to
the OTC derivatives market as it exists today, should increase the
desire to trade security-based swaps and generally benefit market
participants.\1555\
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    \1551\ Id.; see also CFTC and Commission, Statement on MF Global
about the deficiencies in customer futures segregated accounts held
at the firm (Oct. 31, 2011).
    \1552\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70325.
    \1553\ Id.
    \1554\ Id.
    \1555\ Id. at 70326.
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c. Costs of the Segregation Requirements
    Segregation requirements also will impose certain costs on
registered security-based swap dealers as well as other market
participants. The costs associated with individual account segregation
include fees charged by custodians to monitor individual account assets
and to account for potential legal risks and liabilities of custodians
to account beneficiaries or dealers, as well as operational costs to
account for collateral on an individual customer basis.\1556\ The costs
associated with omnibus segregation would include operational costs and
increase in costs of funds to dealers due to inability to use customer
funds,\1557\ compared to the baseline today that dealers in general do
not segregate customer collateral for security-based swaps, and to the
extent collateral is segregated, it is not done so on the terms that
would be required by the segregation rules proposed by the Commission
in the Capital, Margin, and Segregation Proposing Release.\1558\ The
operational costs include costs to establish qualifying bank accounts
and to perform the calculations required to determine the amount that
is required at any one time to be maintained in the reserve
account.\1559\ The increase in costs of funds to the extent that
collateral a dealer holds that could otherwise be rehypothecated to
finance business activity would no longer be permitted for that purpose
could equal the borrowing costs of the dealer. The extent of the
increase of cost of funds to dealers would depend on how much
collateral associated with security-based swaps and held by dealers
today consists of initial margin that they can rehypothecate, i.e.,
that is not now segregated as would be required under the new Rules
18a-4(a)-(d) proposed by the Commission in the Capital, Margin and
Segregation Proposing Release.\1560\ The Commission currently does not
have sufficient information to quantify the increase of costs of funds
to dealers as a result of the proposed segregation requirement and
seeks comment on the impact of the proposed application of segregation
requirements on the increase of costs of funds.\1561\
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    \1556\ In the Capital, Margin, and Segregation Proposing
Release, we stated that a commenter to the CFTC raised concerns with
the length of time and the costs to comply with an individual
segregation mandate. Specifically, the commenter raised concerns
regarding the number of collateral arrangements that would be
required. The commenter estimated, based on discussion with its
members, that ``a rough estimate of the time it would take to
establish the necessary collateral arrangements is 1 year and eleven
months, with an associated cost of $141.8 million, per covered swap
entity.'' See Capital, Margin, and Segregation Proposing Release 77
FR 70326.
    \1557\ See Capital, Margin, and Segregation Proposing Release 77
FR 70326, citing SIFMA/ISDA Comment Letter to the Prudential
Regulators (``First, because the collateral cannot be
rehypothecated, and because the collateral amounts will be very
large, CSEs will be limited to investing very large amounts of
eligible collateral in assets that generate low returns.'').
    \1558\ See proposed Rules 18a-4(a)-(d) under the Exchange Act
and Capital, Margin, and Segregation Proposing Release 77 FR 70274-
78.
    \1559\ See section V.C. of the Capital, Margin, and Segregation
Proposing Release for a discussion of implementation costs. In cases
where an SBSD is jointly registered as a broker-dealer, the costs of
adapting existing systems to account for security-based swap
transactions may not be material in light of the similarities
between the systems and procedures required by Rule 15c3-3 and those
that would be required by proposed Rules 18a-4(a)-(d).
    \1560\ See Capital, Margin, and Segregation Proposing Release,
77 FR 70326. See also Manmohan Singh, ``Velocity of Pledged
Collateral: Analysis and Implications,'' IMF Working Paper (Nov.
2011), available at: http://nowandfutures.com/large/VelocityOfPledgedCollateral-wp11256(imf).pdf; Manmohan Singh and
James Aitken, ``The (sizable) Role of Rehypothecation in the Shadow
Banking System,'' IMF Working Paper (July 2010), available at:
http://www.imf.org/external/pubs/ft/wp/2010/wp10172.pdf.
    \1561\ The amount of initial margin collateral associated with
security-based swaps posted to and held by dealers today that they
can rehypothecate is unknown to the Commission.
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d. Costs and Benefits of Proposed Rules 18a-4(e)(1) and (2) Regarding
Application of Segregation Requirements to Foreign Security-Based Swap
Dealers
    Proposed Rules 18a-4(e)(1) and (2) would not apply segregation
requirements to a foreign security-based swap dealer in certain
circumstances. Specifically, with respect to non-cleared security-based
swap transactions, a foreign security-based swap dealer that is not a
broker-dealer would not be subject to the segregation requirements set
forth in Section 3E of the Exchange Act and paragraphs (a)-(d) of the
proposed Rule 18a-4 with respect to margin received from non-U.S.
person counterparties.\1562\ Therefore, under the proposed Rule 18a-
4(e)(1)(ii), non-U.S. person counterparties to non-cleared security-
based swaps with a registered foreign security-based swap dealer that
is not a registered broker-dealer would not be ``customers'' of such
registered foreign security-based swap dealer and would not be given
the preferred priority status with respect to the segregated assets in
the omnibus account maintained by such foreign security-based swap
dealer in a stockbroker liquidation proceeding

under the U.S. Bankruptcy Code.\1563\ With respect to a registered
foreign security-based swap dealer that is not a foreign bank with a
branch or agency in the United States and is not a registered broker-
dealer, the proposed Rule 18a-4(e)(2)(ii) would subject such foreign
security-based swap dealer to the segregation requirements with respect
to any assets posted by a non-U.S. person counterparty to secure a
cleared security-based swap transaction only if such foreign security-
based swap dealer accepts any assets from, for, or on behalf of a U.S.
person counterparty to secure a security-based swap.\1564\ The proposed
Rule 18a-4(e)(2)(iii) would not subject a registered foreign security-
based swap dealer that is a foreign bank with a branch or agency in the
United States to the segregation requirements with respect to any
assets posted by a non-U.S. person counterparty to a security-based
swap transaction.\1565\
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    \1562\ See proposed Rule 18a-4(e)(1)(ii) under the Exchange Act.
A foreign security-based swap dealer that is a broker-dealer shall
be subject to the segregation requirements set forth in Section 3E
of the Exchange Act and paragraphs (a)-(d) of the proposed Rule 18a-
4 with respect to margin received from any counterparties. See
proposed Rule 18a-4(e)(1)(i) under the Exchange Act.
    \1563\ See Section III.C.4.(b)(2), supra.
    \1564\ See proposed Rule 18a-4(e)(2)(ii) under the Exchange Act.
A registered foreign security-based swap dealer that is a registered
broker-dealer shall be subject to the segregation requirements set
forth in Section 3E of the Exchange Act and paragraphs (a)-(d) of
the proposed Rule 18a-4 under the Exchange Act with respect to
margin received from any counterparties. See proposed Rule 18a-
4(e)(2)(i) under the Exchange Act.
    \1565\ See proposed Rule 18a-4(e)(2)(iii) under the Exchange
Act.
---------------------------------------------------------------------------

    As stated above, the proposed Rules 18a-4(e)(1) and (2) regarding
application of the segregation requirements to foreign security-based
swap dealers would focus on applying the segregation requirements to
provide customer protection to U.S. person counterparties and would not
extend the same customer protection to non-U.S. person counterparties
unless not doing so would result in losses to U.S. person
counterparties.\1566\ To the extent that a foreign security-based swap
dealer would not be subject to the segregation requirements, the
programmatic benefits described above, such as prompt return of
customer assets and limiting the potential losses for security-based
swap customers in the event of a failure of a registered security-based
swap dealer, would not be extended to non-U.S. person counterparties.
In addition, the benefits of potential increased confidence of market
participants when transacting in security-based swaps, as brought about
by the segregation requirements, would not occur in the markets where
such foreign security-based swap dealer transacts with non-U.S. person
counterparties.
---------------------------------------------------------------------------

    \1566\ See Section III.C.4.(b)(2), supra.
---------------------------------------------------------------------------

    There also would be corresponding decrease in costs as a result of
the proposed Rule 18a-4(e)(1)(ii) not requiring a foreign security-
based swap dealer that is not a registered broker-dealer to segregate
assets collected from non-U.S. person counterparties as collateral to
secure non-cleared security-based swaps. A foreign security-based swap
dealer would not need to provide notice required pursuant to Section
3E(f)(1)(A) of the Exchange Act to a non-U.S. person counterparty with
respect to the right to elect individual account segregation.\1567\
This would save operational costs to account for collateral on an
individual customer basis and save fees charged by custodians as
described above.\1568\ A foreign security-based swap dealer that is not
a registered broker-dealer also would have cost-savings associated with
omnibus segregation, including less operational cost (such as the cost
to perform the calculations required to determine the amount that is
required at any one time to be maintained in the reserve account) as
described above, and may be able to rehypothecate non-U.S. person
counterparty's assets to finance its business activity, which would
result in borrowing cost savings. The extent of these cost savings
would depend on how much collateral posted by non-U.S. person
counterparties and held by dealers today to secure security-based swaps
consisting of margin that is available for dealers to use (i.e., that
is not now segregated).
---------------------------------------------------------------------------

    \1567\ See Section 3E(f)(1)(A) of the Exchange Act, 15 U.S.C.
78c-5(f), and proposed Rule 18a-4(d)(1) under the Exchange Act.
    \1568\ Although the segregation requirements with respect to
non-cleared security-based swaps described in Section 3E(f) and the
proposed Rule 18a-4(a)-(d) would not apply to a foreign security-
based swap dealer when such foreign security-based swap dealer
transacts with a non-U.S. person counterparty, proposed Rule 18a-
4(e)(1) does not prevent parties from making segregation
arrangements by contractual agreement under applicable local law. If
parties were to make segregation arrangements, certain benefits and
costs would arise; however, these benefits and costs would be
outside the Title VII regulatory regime and would not be
attributable to the Title VII regulatory regime.
---------------------------------------------------------------------------

    The Commission preliminarily believes that the above decreases in
benefits and costs as a result of the proposed Rule 18a-4(e)(1) and (2)
are not those programmatic benefits and costs intended by the
segregation requirements set forth in Section 3E of the Exchange Act,
and the rules and regulations thereunder. Such decreases reflect the
exclusion of foreign security-based swap dealers (that are not
registered broker-dealers) from the segregation requirements when they
transact with non-U.S. persons in the foreign markets, which we believe
is consistent with the objective of the Dodd-Frank Act to protect the
U.S. markets and participants in those markets.\1569\
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    \1569\ See Section III.C.4.(b)(2), supra.
---------------------------------------------------------------------------

e. Costs and Benefits of Proposed Rule 18a-4(e)(3) Regarding
Disclosures
    There would be new costs and benefits associated with compliance
with the segregation requirements for foreign security-based swap
dealers due to the disclosures requirements in the proposed Rule 18a-
4(e)(3). Specifically, proposed Rule 18a-4(e)(3) would require a
registered foreign security-based swap dealer to disclose to its
counterparty that is a U.S. person the potential treatment of the
assets segregated by such registered foreign security-based swap dealer
pursuant to Section 3E of the Exchange Act, and the rules and
regulations thereunder, in insolvency proceedings under U.S. bankruptcy
law and any applicable foreign insolvency laws. Such disclosure shall
include whether the foreign security-based swap dealer is subject to
the segregation requirement set forth in Section 3E of the Exchange
Act, and the rules and regulations thereunder, with respect to the
assets collected from the U.S. person counterparty who will receive the
disclosure, whether the foreign security-based swap dealer could be
subject to the stockbroker liquidation provisions in the U.S.
Bankruptcy Code, whether the segregated assets could be afforded
customer property treatment under the U.S. bankruptcy law, and any
other relevant considerations that may affect the treatment of the
assets segregated under Section 3E of the Exchange Act in insolvency
proceedings of the foreign security-based swap dealer. The Commission
preliminarily believes that such disclosure would greatly benefit U.S.
person counterparties and assist them in evaluating the legal risk in
respect of posting collateral to a foreign security-based swap dealer
and the likely treatment of their assets held as collateral in the
event of insolvency or liquidation of the foreign security-based swap
dealer whom they transact with and post collateral to.
    With respect to costs, the Commission preliminarily believes that a
foreign security-based swap dealer should be able to include such
disclosure in the credit support agreement pursuant to which assets
would be posted to margin, guarantee, or secure a security-based swap
transaction. The costs associated with such disclosure may include
legal costs related to consulting bankruptcy counsels, both U.S.
counsel and relevant foreign counsel, in respect of the

potential treatment of the segregated assets under U.S. bankruptcy law
and applicable foreign insolvency laws, the costs of drafting such
disclosure, and the costs of updating such disclosure whenever there is
a material change of U.S. bankruptcy law or applicable foreign laws
that may render the prior disclosure inaccurate or misleading. The
Commission preliminarily estimates that the average costs associated
with such disclosure would be less than $2,000,000 and a narrow range
could be between $760,000 and $920,000.\1570\
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    \1570\ This estimate is based on staff experience in undertaking
legal analysis of U.S. bankruptcy law treatment of customer assets
held by broker-dealers and assumes that foreign security-based swap
dealers would seek outside legal counsel to prepare the disclosures
described in proposed Rule 18a-4(e)(3) and that the legal analysis
of the treatment of customer property under a complex foreign
insolvency law regime may cost $50,000 per entity and the same legal
analysis under a less complex foreign insolvency law regime or the
U.S. bankruptcy law regime may cost $30,000 per entity. We recognize
that the complexity of the insolvency laws relating to liquidation
of a foreign security-based swap dealer may vary greatly, and that
we do not have insight into various insolvency law regimes such that
we could reasonably determine what insolvency law regime may be
considered more or less complex for these purposes. Thus, based on
our understanding of the U.S. bankruptcy law analysis relating to
liquidation of a broker-dealer, taking into account the potential
application of various foreign insolvency laws, we believe that an
average of the costs associated with more complex and less complex
insolvency law regimes equaling $40,000 per entity could reasonably
approximate the average costs for a foreign security-based swap
dealer to prepare the disclosures required in proposed Rule 18a-
4(e)(3). We have estimated that the total number of dealers that may
be required to register under the proposed de minimis rule is 50 or
fewer entities, and if the criterion of three or more non-ISDA
dealer counterparties is applied to the analysis, we estimated that
the total number of dealers that may be required to register is
between 27 and 31. See Section XV.D.1(b), supra. Out of these
dealers, we estimated that the number of non-U.S. domiciled dealers
is between 19 and 23. Therefore, the aggregate costs of the
disclosure requirement could be $2,000,000 ($40,000 * 50) or less
with a narrow range from $760,000 ($40,000 * 19) to $920,000
($40,000 * 23).
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ii. Assessment Costs
    The assessment cost associated with proposed Rule 18a-4(e)(1) and
(2) should primarily be related to inquiries about a counterparty's
U.S. person status, whether a security-based swap is a cleared or non-
cleared transaction, whether the foreign security-based swap dealer is
a registered broker-dealer, whether the foreign security-based swap
dealer, whether the foreign security-based swap dealer has a branch or
agency in the United States, and whether the foreign security-based
swap dealer accepts any assets from, or on behalf of, a U.S. person
counterparty to security a security-based swap, in order to determine
whether a transaction would be subject to the segregation requirements.
A security-based swap dealer should know whether it is a registered
broker-dealer and whether a particular transaction is submitted for
clearing and should not incur any assessment costs relating to
determining whether a transaction is cleared or non-cleared security-
based swap. A foreign security-based swap dealer may need to make an
internal inquiry as to whether it has a branch or agency in the United
States and whether it accepts collateral from, or on behalf of, a U.S.
person counterparty. Such inquiry should be a factual inquiry involving
consulting the corporate secretary, in-house attorney or compliance
manager without the need for further research and, therefore, the cost
of such inquiry should be minimal. The Commission preliminarily
believes that the costs associated with inquiring about a
counterparty's U.S. person status should be subsumed in the assessment
costs of the de minimis rule and the requirements relating to the
external business conduct standards since a security-based swap dealer
only needs to inquire about a counterparty's U.S. person status and
implement systems to record and track the counterparty status once in
order to assess and comply with all the Title VII requirements that
depend on such factual inquiry. Therefore, the Commission preliminarily
believes that the assessment costs associated with proposed Rules 18a-
4(e)(1) and (2) alone should be minimal.
    The assessment cost associated with the disclosures in proposed
Rule 18a-4(e)(3) would be related to inquiries about a counterparty's
U.S. person status, which also would be subsumed in the assessment
costs associated with proposed Rules relating to the de minimis
exception and the requirements relating to the external business
conduct standards.
Request for Comment
     Is it appropriate, from the cost and benefit point of
view, not to require foreign security-based swap dealers to comply with
the segregation requirements when they transact with non-U.S. person
counterparties? Are there other costs and benefits not mentioned above?
Specifically, the Commission requests comment on (1) whether the
proposed approach to application of the segregation requirements to
foreign security-based swap dealers based on their status as a broker-
dealer, foreign security-based swap dealer that is a bank with a branch
or agency in the United States, or foreign security-based swap dealer
that is not a broker-dealer and is not a bank with a branch or agency
in the United States would generate the benefit of effectively
administering the segregation requirement in practice and protecting
U.S. counterparties, (2) the costs of custodian fees, the operation
costs and the costs associated with increased costs of funds due to
inability to use customer asserts as a result of a foreign security-
based swap dealer being required to comply with the segregation
requirements, (3) the costs of preparing the disclosures required in
proposed Rule 18a-4(e)(3) and (4) the assessment costs associated with
the proposed Rule 18a-4(e).
     Is it appropriate, from the cost and benefit point of
view, to require a foreign security-based swap dealer to disclose
potential treatment of the assets segregated by such foreign security-
based swap dealer in insolvency proceedings under U.S. bankruptcy law
and any applicable foreign insolvency laws? Are there other costs and
benefits not mentioned above?
     Is it appropriate, from the cost and benefit point of
view, to require a foreign security-based swap dealer to disclose to
its non-U.S. person counterparty that it is not subject to the
segregation requirements and that funds or property provided by such
non-U.S. person counterparty would not be treated as ``customer
property'' as that term is defined in 11 U.S.C. 741?

F. Economic Analysis of Application of Rules Governing Security-Based
Swap Clearing in Cross-Border Context

    The Dodd-Frank Act amends the Exchange Act to require central
clearing of security-based swaps that the Commission determines should
be cleared,\1571\ and it directs entities that perform clearing agency
functions for security-based swaps to register with the
Commission.\1572\ In this section, we first discuss the costs and
benefits resulting from clearing agency registration and then consider
the costs and benefits associated with the proposed rule regarding
application of the clearing agency registration requirement to foreign
clearing agencies. Following this, we discuss the costs and benefits
that result from requiring security-based swap market participants to
centrally clear transactions and then examine the trade-offs associated
with the proposed rule implementing the mandatory clearing requirement
in the cross-border context.
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    \1571\ See Section 3C(a)(1) of the Exchange Act, 15 U.S.C. 78c-
3(a)(1).
    \1572\ See Section 17A(g) of the Exchange Act, 15 U.S.C. 78q-
1(g).

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1. Programmatic Benefits and Costs Associated With the Clearing Agency
Registration
(a) Proposed Interpretive Guidance Regarding Clearing Agency
Registration
(i) Current State of Clearing Agency Registration
    At present, voluntary clearing of security-based swaps in the
United States is limited to CDS products.\1573\ It began in December of
2008, when the Commission acted to facilitate the clearing of OTC
security-based swaps by permitting five clearing agencies, including
three foreign clearing agencies,\1574\ to clear CDS on a temporary,
conditional basis.\1575\ In each instance, these clearing agencies
wanted to perform clearing functions with respect to CDS in the United
States by providing CCP services directly to U.S. persons.\1576\ The
temporary exemptive orders granted to four of these clearing agencies
(including two foreign clearing agencies) were extended until July 16,
2011.\1577\ Title VII of the Dodd-Frank Act provides that (1) a
depository institution that cleared swaps as a multilateral clearing
organization prior to the date of enactment of the Dodd-Frank Act or
(2) a derivatives clearing organization registered with the CFTC that
cleared swaps pursuant to an exemption from registration as a clearing
agency prior to the date of enactment of the Dodd-Frank Act is deemed
registered as a clearing agency for the purposes of clearing security-
based swaps (``Deemed Registered Provision'').\1578\ The Deemed
Registered Provision, along with other general provisions under Title
VII of the Dodd-Frank Act, became effective on July 16, 2011.\1579\ As
a result, three clearing agencies, i.e., ICE Clear Europe, Limited, ICE
Clear Credit LLC (formerly ICE Trust US LLC), and Chicago Mercantile
Exchange Inc., which were performing CCP functions with respect to CDS
in the United States, were deemed registered with the Commission on
July 16, 2011.\1580\
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    \1573\ See Section XV.B.2(e), supra.
    \1574\ These three foreign clearing agencies are ICE Clear
Europe Limited, Eurex Clearing AG, and LIFFE A&M and LCH Clearnet
Ltd. See note 74, supra.
    \1575\ See note 74, supra.
    \1576\ Id.
    \1577\ See Exchange Act Release Nos. 63389 (Nov. 29, 2010), 75
FR 75520 (Dec. 3, 2010) (order extending temporary conditional
exemptions in connection with request on behalf of ICE Clear Europe,
Limited), 63390 (Nov. 29, 2010), 75 FR 75518 (Dec. 3, 2010), (order
extending temporary conditional exemptions in connection with
request on behalf of Eurex Clearing AG), 63388 (Nov. 29, 2010), 75
FR 75522 (Dec. 3, 2010) (order extending temporary conditional
exemptions in connection with request on behalf of Chicago
Mercantile Exchange, Inc.), and 63387 (Nov. 29, 2010) 75 FR 75502
(Dec. 3, 2010) (order extending and modifying temporary exemptions
in connection with request of ICE Trust US LLC); LIFFE A&M and
LCH.Clearnet Ltd. allowed their order to lapse without seeking
renewal.
    \1578\ See 15 U.S.C. 78q-1(l). Under this Deemed Registered
Provision, a clearing agency will be required to comply with all
requirements of the Exchange Act, and the rules thereunder,
applicable to registered clearing agencies to the extent it clears
security-based swaps after the effective date of the Deemed
Registered Provision, including, for example, the obligation to file
proposed rule changes under Section 19(b) of the Exchange Act.
    \1579\ See Section 774 of the Dodd-Frank Act (stating,
``[u]nless otherwise provided, the provisions of this subtitle shall
take effect on the later of 360 days after the date of the enactment
of this subtitle or, to the extent a provision of this subtitle
requires a rulemaking, not less than 60 days after publication of
the final rule or regulation implementing such provision of this
subtitle.'').
    \1580\ Eurex Clearing AG did not meet the criteria in the Deemed
Registered Provision and is not currently providing CCP services in
the United States with respect to security-based swaps. See, e.g.,
Order Granting Temporary Exemptions Under the Securities Exchange
Act of 1934 in Connection with the Pending Revision of the
Definition of ``Security'' to Encompass Security-Based Swaps, and
Request for Comment, Exchange Act Release No. 64795 (July 1, 2011)
at n. 76.
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(ii) Programmatic Effect of the Proposed Interpretive Guidance
    As stated above,\1581\ the Commission is proposing interpretive
guidance that a clearing agency performing the functions of a CCP for
security-based swaps within the United States would be required to
register pursuant to Section 17A(g) of the Exchange Act.\1582\ Under
this proposed interpretive guidance, a registration requirement
pursuant to Section 17A(g) of the Exchange Act would apply only to
clearing agencies that provide CCP services directly to a U.S. person
with respect to security-based swaps, since these entities would be
performing the functions of a CCP within the United States. Three
clearing agencies currently provide CCP services directly to U.S.
persons with respect to swaps and security-based swaps.\1583\ All of
these three clearing agencies are registered with the Commission under
the Deemed Registered Provision. Therefore, the proposed interpretation
would not increase the number of domestic or foreign clearing agencies
required to register with the Commission until new clearing agencies
desire to enter the U.S. market to provide CCP services directly to
U.S. persons with respect to security-based swaps.
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    \1581\ See Section V, supra.
    \1582\ 15 U.S.C. 78q-1(g).
    \1583\ See Clearing Agency Standards Adopting Release, 77 FR
66265. These three clearing agencies are ICE Clear Europe, Limited,
ICE Clear Credit LLC, and Chicago Mercantile Exchange, Inc.
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(iii) Costs and Benefits of the Proposed Interpretive Guidance
    The Commission has considered the costs and benefits associated
with the clearing agency registration requirement in Section 17A(g) of
the Exchange Act \1584\ in the cross-border context through the lens of
a key Title VII goal: systemic risk mitigation. We discuss below the
costs and benefits of the proposed interpretive guidance by looking at
the role of the clearing agency in the security-based swap market and
how clearing agencies transfer financial risks.
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    \1584\ 15 U.S.C. 78q-1(g).
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    The proposed interpretive guidance regarding clearing agency
registration would generate significant programmatic benefits. These
benefits are tied to mandatory clearing. As explained below, clearing
agency registration promotes sound management of the counterparty risk
concentrated in CCPs, the importance of which is magnified by the
application of a mandatory clearing requirement. Registration would
provide standards for CCPs' management of financial risks, including
counterparty credit risk, legal risk and liquidity risk. Mandatory
clearing of security-based swaps is one means by which Title VII of the
Dodd-Frank Act seeks to reduce systemic risk in the U.S. financial
system. Under Title VII, security-based swaps, ``whenever possible and
appropriate,'' \1585\ shall be centrally cleared through a clearing
agency that is registered or exempt from registration under the
Exchange Act.\1586\ In a world of bilateral transactions in which each
counterparty bears the other counterparty's credit risk, a large
counterparty who transacts with many other counterparties and cumulates
significant security-based swap positions may pose systemic risk when
its failure would generate sequential counterparty defaults.\1587\
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    \1585\ See, e.g., S. Comm. on Banking, Hous., & Urban Affairs,
The Restoring American Financial Stability Act of 2010, S. Rep. No.
111-176, at 32 (``As a key element of reducing systemic risk and
protecting taxpayers in the future, protections must include
comprehensive regulation and rules for how the OTC derivatives
market operates. Increasing the use of central clearinghouses,
exchanges, appropriate margining, capital requirements, and
reporting will provide safeguards for American taxpayers and the
financial system as a whole.''); id. at 34 (``Some parts of the OTC
market may not be suitable for clearing and exchange trading due to
individual business needs of certain users. Those users should
retain the ability to engage in customized, uncleared contracts
while bringing in as much of the OTC market under the centrally
cleared and exchange-traded framework as possible.'').
    \1586\ See 15 U.S.C. 78c-3(a)(1).
    \1587\ See Craig Pirrong, ``The Economics of Central Clearing:
Theory and Practice,'' ISDA Discussion Papers Series, No. 1 (2011),
at 6 (``Widespread defaults on derivatives contracts may harm more
than the counterparties on the defaulted contracts. The losses
suffered by the victims of the original defaults may be so severe as
to force those victims into financial distress, which harms those
who have entered into financial contracts with them--including their
creditors, and the counterparties to derivatives on which they owe
money. Such a cascade of defaults can result in a systemic financial
crisis.'').

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    Central clearing through a CCP generally reduces counterparty risk
by interposing a CCP as counterparty to all cleared transactions.\1588\
Where security-based swaps are subject to a mandatory clearing
requirement the role of the CCP becomes even more critical, as the
volume of positions in which the CCP is interposed and becomes the
central counterparty will likely increase.\1589\
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    \1588\ See Clearing Agency Standards Adopting Release, 77 FR
66264 (``Central clearing facilitates the management of counterparty
credit risk among dealers and other institutions by shifting that
risk from individual counterparties to CCPs, thereby helping protect
counterparties from each other's potential failures and preventing
the buildup of risk in such entities, which could be systemically
important.'').
    \1589\ See Clearing Procedures Adopting Release, 77 FR 41638.
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    While central clearing may make sequential counterparty defaults
less likely, it does not eliminate systemic risk. CCPs concentrate
counterparty risk.\1590\ CCPs manage and reduce such concentrated risk
by applying mark-to-market pricing and margin requirements to cleared
transactions in a consistent manner \1591\ and through netting (i.e.,
by reducing the amounts of funds or other assets that must be exchanged
at settlement).\1592\ In the event of a clearing member's default in
which the losses exceed the collateral posted to the CCP and other
available funds, residual losses will be mutualized among the other
non-defaulting members.\1593\ By placing members under financial
strain, mutualization may strain the entire financial system and create
systemic impact.\1594\ Even in the absence of this feature of CCPs, the
default of a CCP has the potential to harm the market in all financial
instruments cleared by that CCP, creating liquidity constraints with
respect to such financial instruments in the market. Such liquidity
constraints would affect all parties transacting in such
instruments.\1595\
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    \1590\ See Clearing Agency Standards Adopting Release, 77 FR
66264-65 (stating that ``a CCP also concentrates risks and
responsibility for risk management in the CCP.'').
    \1591\ See Culp, supra note 111. See also Clearing Agency
Standards Adopting Release, 77 FR 66264.
    \1592\ See e.g., Duffie and Zhu, supra note 110; see also
Clearing Agency Standards Adopting Release, 77 FR 66264.
    \1593\ See Risk Management Supervision of Designated Clearing
Entities (July 2011), Report by the Board of Governors of the
Federal Reserve System, Securities and Exchange Commission and
Commodity Futures Trading Commission to the Senate Committees on
Banking, Housing, and Urban Affairs and Agriculture in fulfillment
of Section 813 of Title VIII of the Dodd-Frank Act, at 12.
    \1594\ See Craig Pirrong, ``The Economics of Central Clearing:
Theory and Practice,'' ISDA Discussion Papers Series, No. 1 (2011),
at 34-35.
    \1595\ Id. See also Risk Management Supervision of Designated
Clearing Entities (July 2011), Report by the Board of Governors of
the Federal Reserve System, Securities and Exchange Commission and
Commodity Futures Trading Commission to the Senate Committees on
Banking, Housing, and Urban Affairs and Agriculture in fulfillment
of Section 813 of Title VIII of the Dodd-Frank Act, at 8-9.
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    Given the mutualization of losses, a CCP's concentration of risk,
and its responsibility for risk management, the effectiveness of a
CCP's risk controls and the adequacy of its financial resources are
critical aspects of the infrastructure of the market it serves.\1596\
Registration and clearing agency standards are designed to address
these considerations.
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    \1596\ See Clearing Agency Standards Adopting Release, 77 FR
66265.
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    The Commission preliminarily believes its interpretation that a
clearing agency that provides CCP services for security-based swaps
directly to U.S. persons must register pursuant to Section 17A(g) of
the Exchange Act \1597\ generates the benefits of protecting the U.S.
financial system against systemic risk that may arise from central
clearing functions performed in the United States. In the case of a
foreign clearing agency that provides CCP services directly to U.S.
persons, the Commission preliminarily believes that requiring such
foreign clearing agency to register with the Commission and comply with
the Commission's regulatory regime for security-based swap clearing
would generate the key benefit of reducing the magnitude of any
systemic risk flowing into or within the United States originating in
the activities of other members of a clearing agency.
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    \1597\ 15 U.S.C. 78q-1(g).
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    Specifically, the clearing agency standards would provide the
minimum standards for CCPs' management of financial risks, including
counterparty credit risk, legal risk, and liquidity risk. For example,
the clearing agency standards established by the Commission are
designed to minimize the CCPs' credit risk by, among other things,
establishing eligibility standards for clearing members and requiring
registered clearing agencies to measure their credit exposures on a
daily basis. The Commission's clearing agency standards also require a
registered clearing agency that acts as a CCP to collect initial and
variation margin from members, and maintain sufficient financial
resources to withstand, at a minimum, a default by the participant
family to which it has the largest exposure in extreme but plausible
market conditions and, with respect to a registered clearing agency
acting as a CCP for security-based swaps, maintain additional financial
resources sufficient to withstand, at a minimum, a default by the two
participant families to which it has the largest exposures in extreme
but plausible market conditions.\1598\ The benefits and costs of the
clearing agency standards have been discussed in detail in the Clearing
Agency Standards Adopting Release.\1599\ The proposed interpretive
guidance does not change the benefits associated with the substantive
registration requirement and clearing agency standards. The aggregate
programmatic benefits of the proposed interpretive guidance would flow
from its programmatic effect on the number of clearing agencies
registered as discussed above.
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    \1598\ See 17 CFR 240.17Ad-22(b)(3); see also Clearing Agency
Standards Adopting Release, 77 FR 66234-35 and 66274-75.
    \1599\ See Section V Economic analysis of the Clearing Agency
Standards Adopting Release, 77 FR 66263-84.
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    The proposed interpretive guidance would also entail certain costs,
such as direct registration and compliance costs on CCPs.\1600\ The
proposed interpretive guidance does not change the costs associated
with the substantive registration requirement and clearing agency
standards. As with the programmatic benefits, the aggregate
programmatic costs of the proposed interpretive guidance would flow
from its programmatic effect on the number of clearing agencies
registered as discussed above.
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    \1600\ The Commission previously estimated the costs for each
registered clearing agency associated with compliance with clearing
agency standards adopted in the Clearing Agency Standards Adopting
Release could total approximately $3.7 million in initial costs and
$10.1 million in annual ongoing costs. See Clearing Agency Standards
Adopting Release, 77 FR 66273.
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(iv) Assessment Costs
    A clearing agency would incur assessment costs to determine whether
it would be required to register by determining whether it provides CCP
services directly to a U.S. person. Such determination may be made as
part of its clearing membership application approval process. As part
of the membership application, a prospective clearing member would be
required to provide corporate organization documents, such as
certificates of incorporation or articles of organization, which would
enable the clearing agency

to determine whether a prospective clearing member is a U.S. person.
Since corporate organization documents are part of the clearing
membership application package,\1601\ the Commission preliminarily
believes that the assessment costs associated with the proposed
interpretive guidance should be minimal.
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    \1601\ See, e.g., Clearing membership Application Instructions
and Forms, ICE Clear U.S., Inc. (Aug. 2012), available at: https://www.theice.com/publicdocs/clear_us/Clear_US_Member_Application.pdf.
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(v) Alternatives
    An alternative to the proposed interpretive guidance would be to
require a clearing agency to register if such clearing agency provides
CCP services to non-U.S. intermediaries that have U.S. persons as
customers. Such an alternative would focus on the fact that
intermediaries, whose financial stress or failure would mostly likely
affect the U.S. financial system, are exposed to the risk of CCPs, and
also transmit that risk to their U.S. customers. However, the
Commission believes that the risk exposure that a U.S. customer could
incur under its contractual agreements with an intermediary is
generally much lower than the risk exposure a U.S. member could incur
under a membership agreement with a CCP because a customer is only
risking up to the full amount of property entrusted to an intermediary,
but is not under any obligation to perform under the contractual
agreements that the intermediary enters into with third parties.
Consequently, if a clearing agency provides CCP services to an
intermediary that has a U.S. person as a customer, the ripple effect of
the failure of such clearing agency on the U.S. financial system may
not rise to the systemic level.
    Alternatively, the Commission could have proposed to require a