Application of “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions to Cross-Border Security-Based Swap Activities; Republication

Editorial Note:

Proposed rule document 2014-15337 was originally published on pages 39067 through 39162 in the issue of Wednesday, July 9, 2014. In that publication the footnotes contained erroneous entries. The corrected document is republished in its entirety.

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rules; interpretation.

SUMMARY:

The Securities and Exchange Commission (“SEC” or “Commission”) is adopting rules and providing guidance to address the application of certain provisions of the Securities Exchange Act of 1934 (“Exchange Act”) that were added by Subtitle B of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), to cross-border security-based swap activities. These rules and guidance in large part focus on the application of the Title VII definitions of “security-based swap dealer” and “major security-based swap participant” in the cross-border context. The Commission also is adopting a procedural rule related to the submission of applications for substituted compliance. In addition, the Commission is adopting a rule addressing the scope of our authority, with respect to enforcement proceedings, under section 929P of the Dodd-Frank Act.

DATES:

Effective September 8, 2014.

FOR FURTHER INFORMATION CONTACT:

Richard Gabbert, Senior Special Counsel, Joshua Kans, Senior Special Counsel, or Margaret Rubin, Special Counsel, Office of Derivatives Policy, at 202-551-5870, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549-7010.

SUPPLEMENTARY INFORMATION:

The Commission is adopting the following rules under the Exchange Act, accompanied by related guidance, regarding the application of Subtitle B of Title VII of the Dodd-Frank Act to cross-border activities: Rule 0-13 (filing procedures regarding substituted compliance requests); Rule 3a67-10 (regarding the cross-border implementation of the “major security-based swap participant” definition); Rule 3a71-3 (regarding the cross-border implementation of the de minimis exception to the “security-based swap dealer” definition); Rule 3a71-4 (regarding the cross-border implementation of the aggregation provisions of the dealer de minimis exception); and Rule 3a71-5 (regarding an exception, from the dealer de minimis analysis, for certain cleared anonymous transactions). The Commission is not addressing, as part of this release, certain other rules that we proposed regarding the application of Subtitle B of Title VII in the cross-border context. The Commission also is adopting Rule 250.1 to clarify the scope of its antifraud civil law-enforcement authority, with respect to enforcement proceedings, in the cross-border context.

Table of Contents

I. Background

A. Scope of This Rulemaking

B. The Dodd-Frank Act

C. The Cross-Border Proposing Release and the CFTC Cross-Border Guidance

D. Comments on the Proposal

II. The Economic, Legal, and Policy Principles Guiding the Commission's Approach to the Application of Title VII to Cross-Border Activities

A. Economic Considerations in the Cross-Border Regulation of Security-Based Swaps

1. Economic Features of the Security-Based Swap Market

2. Context for Regulatory Determinations

B. Scope of Title VII's Application to Cross-Border Security-Based Swap Activity

1. Commenters' Views

2. Scope of Application of Title VII in the Cross-Border Context

C. Principles Guiding Final Approach To Applying “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions in the Cross-Border Context

III. Baseline

A. Current Security-Based Swap Market

1. Security-Based Swap Market Participants

2. Levels of Security-Based Swap Trading Activity

B. Global Regulatory Efforts

C. Cross-Market Participation

IV. Cross-Border Application of Dealer De Minimis Exception

A. Overview

B. Application of De Minimis Exception To Dealing Activities of U.S. Persons

1. Proposed Approach and Commenters' Views

2. Final Rule

C. Definition of “U.S. Person”

1. Proposed Approach

2. Commenters' Views

3. Final Rule

4. Representations Regarding U.S.-Person Status

D. Application of De Minimis Exception To Dealing Activities of Conduit Affiliates

1. Proposed Approach and Commenters' Views

2. Final Rule

E. Application of De Minimis Exception To Dealing Activities of Other Non-U.S. Persons

1. Dealing Transactions of Non-U.S. Persons That Are Subject to Recourse Guarantees by Their U.S. Affiliates

2. Dealing Transactions of Non-U.S. Persons Involving U.S. and Other Counterparties

F. Application of the Exception's Aggregation Principles to Cross-Border Dealing Activity

1. Proposed Approach and Commenters' Views

2. Final Rule

G. Exception for Cleared Anonymous Transactions

1. Proposed Approach and Commenters' Views

2. Final Rule

H. Additional Issues

1. Particular Activities and Entities

2. Foreign Public Sector Financial Institutions and Government-Related Entities

I. Economic Analysis of the Final Cross-Border Dealer De Minimis Rule

1. Programmatic Costs and Benefits

2. Assessment Costs

3. Alternative Approaches

V. Cross-Border Application of Major Security-Based Swap Participant Thresholds

A. Overview

B. Application of the Major Security-Based Swap Participant Definition to U.S. Persons

1. Proposed Approach and Commenters' Views

2. Final Rule

C. Application of the Major Security-Based Swap Participant Definition to Conduit Affiliates

1. Proposed Approach and Commenters' Views

2. Final Rule

D. Application to Other Non-U.S. Persons

1. Positions With U.S. Persons Other Than Foreign Branches of U.S. Banks

2. Positions With Foreign Branches of U.S. Banks

3. Positions of Non-U.S. Persons That Are Subject to Recourse Guarantees by a U.S. Person

E. Attribution

1. Positions Attributed to U.S. Person Guarantors

2. Positions Attributed to Non-U.S. Person Guarantors

3. Limited Circumstances Where Attribution of Guaranteed Security-Based Swap Positions Does Not Apply

F. Other Issues Related to the Application of the Major Security-Based Swap Participant Definition

1. Threshold for Registration as a Major Security-Based Swap Participant

2. Entities That Maintain Legacy Portfolios

G. Foreign Public Sector Financial Institutions and Government-Related Entities

H. Economic Analysis of Final Rules Regarding “Major Security-Based Swap Participants”

1. Programmatic Costs and Benefits

2. Assessment Costs

3. Alternative Approaches

VI. Substituted Compliance Procedural Rule

A. Proposed Approach and Commenters' Views

B. Final Rule

C. Economic Analysis

VII. Antifraud Authority

A. Final Rule

B. Economic Analysis

VIII. Impacts on Efficiency, Competition, and Capital Formation

A. Competition

B. Efficiency

C. Capital Formation

IX. Paperwork Reduction Act

A. Introduction

B. Reliance on Counterparty Representations Regarding Transactions Conducted Through a Foreign Branch

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

C. Reliance on Counterparty Representations Regarding Non-U.S. Person Status

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Total Initial and Annual Reporting and Recordkeeping Burdens

X. Regulatory Flexibility Act Certification

XI. Effective Date and Implementation

Statutory Authority and Text of Final Rules

I. Background

A. Scope of This Rulemaking

The Commission is adopting the first of a series of rules and providing guidance regarding the application of Title VII of the Dodd-Frank Act (“Title VII”) to cross-border security-based swap activities and persons engaged in those activities. This rulemaking primarily focuses on the application of the de minimis exception to the definition of “security-based swap dealer” in the cross-border context, and on the application of thresholds related to the definition of “major security-based swap participant” in the cross-border context. We also are adopting a procedural rule regarding the submission of “substituted compliance” requests to allow market participants to satisfy certain Title VII obligations by complying with comparable foreign regulatory requirements.

The rules and guidance we are adopting are based on our May 23, 2013 proposal, which addressed the application of Title VII in the cross-border context. Aside from addressing the definitions and procedural rule noted above, the Cross-Border Proposing Release also addressed a range of other cross-border issues, including issues regarding the requirements applicable to dealers and major participants, and requirements relating to mandatory clearing, trade execution, regulatory reporting, and public dissemination. The Cross-Border Proposing Release stated that it was possible that we would consider final rules and guidance related to some of those issues in the adopting releases related to the relevant substantive rulemakings, and that we would address others in a separate rulemaking.

This rulemaking's focus on the cross-border application of the dealer and major participant definitions reflects the critical and foundational role that those definitions occupy with regard to the implementation of Title VII. We expect to address other matters raised by the Cross-Border Proposing Release as part of subsequent rulemakings, to allow us to consider the cross-border application of the substantive requirements imposed by Title VII—including the economic consequences of that cross-border application—in conjunction with the final rules that will implement those substantive requirements. Market participants are not required to comply with certain of those Title VII requirements pending the publication of final rules or other Commission action, and temporarily are exempt from having to comply with certain other requirements added by or arising from Title VII.

These final rules and guidance do not address one key issue related to the application of the “security-based swap dealer” definition in the cross-border context. In the Cross-Border Proposing Release, we proposed that non-U.S. persons must count, against the relevant thresholds of the de minimis exemption, their dealing activity involving “transactions conducted within the United States.” Commenters raised a number of significant issues related to this proposed requirement, including issues regarding the Commission's authority to impose this requirement and regarding the costs associated with this requirement. While we continue to preliminarily believe that the cross-border application of the security-based swap dealer definition should account for activities in the United States related to dealing—even when neither party to the transaction is a U.S. person—we also believe that the final resolution of this issue can benefit from further consideration and public comment. Accordingly, we anticipate soliciting additional public comment regarding approaches by which the cross-border application of the dealer definition appropriately can reflect activity between two non-U.S. persons where one or both are conducting dealing activity within the United States.

B. The Dodd-Frank Act

As discussed in the Cross-Border Proposing Release, the 2008 financial crisis highlighted significant issues in the over-the-counter (“OTC”) derivatives markets, which had experienced dramatic growth in the years leading up to the crisis and are capable of affecting significant sectors of the U.S. economy. The Dodd-Frank Act was enacted, among other reasons, to promote the financial stability of the United States by improving accountability and transparency in the financial system, including in connection with swaps and security-based swaps.

Title VII provides for a comprehensive new regulatory framework for swaps and security-based swaps. Under this framework, the Commodity Futures Trading Commission (“CFTC”) regulates “swaps” while the Commission regulates “security-based swaps,” and the Commission and CFTC jointly regulate “mixed swaps.” The new framework encompasses the registration and comprehensive regulation of dealers and major participants, as well as requirements related to clearing, trade execution, regulatory reporting, and public dissemination. Security-based swap transactions are largely cross-border in practice, and the various market participants and infrastructures operate in a global market. To ensure that our regulatory framework appropriately reflects and addresses the nature and extent of the potential impact that the global market can have on U.S. persons and the U.S. financial system, it is critically important that we provide market participants with clear rules and guidance regarding how the regulatory framework mandated by Title VII will apply in the cross-border context.

In developing these final rules and guidance, we have consulted and coordinated with the CFTC, the prudential regulators, and foreign regulatory authorities in accordance with the consultation provisions of the Dodd-Frank Act, and more generally as part of our domestic and international coordination efforts. Commission staff has participated in numerous bilateral and multilateral discussions with foreign regulatory authorities addressing the regulation of OTC derivatives. Through these discussions and the Commission staff's participation in various international task forces and working groups, we have gathered information about foreign regulatory reform efforts and the possibility of conflicts and gaps, as well as inconsistencies and overlaps, between U.S. and foreign regulatory regimes. We have taken this information into consideration in developing the final rules and guidance.

C. The Cross-Border Proposing Release and the CFTC Cross-Border Guidance

In expressing our preliminary views regarding the application of Title VII to security-based swap activity carried out in the cross-border context (including to persons engaged in such activities), the Cross-Border Proposing Release recognized that the security-based swap market is global in nature and that it developed prior to the enactment of the Dodd-Frank Act. The proposal further recognized that the rules we adopt and guidance we provide regarding the cross-border application of Title VII could significantly affect the global security-based swap market.

Reflecting the range of regulatory requirements that Title VII imposes upon the security-based swap market, the Cross-Border Proposing Release addressed the cross-border application of: (a) The de minimis exception to the “security-based swap dealer” definition; (b) the entity-level and transaction-level requirements applicable to security-based swap dealers (e.g., margin, capital, and business conduct requirements); (c) the “substantial position” and “substantial counterparty exposure” thresholds for the “major security-based swap participant” definition and the requirements applicable to major participants; (d) the registration of security-based swap clearing agencies and mandatory clearing requirements; (e) the registration of security-based swap execution facilities and mandatory trade execution requirements; and (f) the registration of security-based swap data repositories and regulatory reporting and public dissemination requirements. The proposal also addressed the potential for market participants to satisfy certain of those Title VII requirements by complying with comparable foreign rules as a substitute. This rulemaking establishes a process for submission of such requests.

Following the Commission's proposal, the CFTC issued guidance regarding Title VII's application to cross-border swap activity. The CFTC Cross-Border Guidance differed from the Commission's proposed rules in certain ways, including, as discussed below, with regard to the meaning of “U.S. person,” the cross-border application of the de minimis exception to the dealer definition, the cross-border application of the major participant definition, and the process for submitting substituted compliance requests.

Certain foreign regulators also have addressed or are in the process of addressing issues related to the cross-border implementation of requirements applicable to OTC derivatives.

D. Comments on the Proposal

The Commission received 36 comments in connection with the proposal. Several of the commenters addressed differences between the SEC's proposed rules and the CFTC Cross-Border Guidance, and urged the Commission to harmonize its rules with the approaches taken by the CFTC and by foreign regulators.

Many of those commenters particularly focused on differences between the two regulators' meanings of the term “U.S. person,” with several suggesting that we change our proposed definition to align with the CFTC's approach. A number of commenters also addressed the definition of “transaction conducted within the United States,” with several opposing any use of the concept as part of the Commission's rules.

Commenters further raised a number of more general concerns in connection with the proposal, including concerns regarding cost-benefit issues, the clarity of the proposal as a whole, the link between the rules and the location of the associated risk, and perceived concessions to the financial industry.

In addition, commenters addressed issues specific to the cross-border application of the entity-level and transaction-level requirements for dealers, as well as requirements specific to clearing, trade execution, regulatory reporting and public disclosure. We expect to address those comments regarding the relevant substantive requirements in subsequent rulemakings and guidance regarding the relevant substantive requirements.

Commenters also addressed the proposed availability of substituted compliance. Although today we are adopting a procedural rule regarding requests for substituted compliance, we generally expect to address the potential availability of substituted compliance for specific Title VII requirements in connection with subsequent rulemakings regarding each substantive requirement.

We have carefully considered the comments received in adopting the final rules and providing guidance. Our final rules and guidance further reflect consultation with the CFTC, prudential regulators, and foreign regulatory authorities with regard to the development of consistent and comparable standards. Accordingly, certain aspects of the final rules and guidance—such as, for example, the treatment of guaranteed affiliates of U.S. persons for purposes of the dealer de minimis exception—have been modified from the proposal.

II. The Economic, Legal, and Policy Principles Guiding the Commission's Approach to the Application of Title VII to Cross-Border Activities

In this section, we describe the most significant economic considerations regarding the security-based swap market that we have taken into account in implementing the cross-border application of the security-based swap dealer and major security-based swap participant definitions of Title VII. We are sensitive to the economic consequences and effects, including costs and benefits, of our rules, including with respect to the scope of our application of the security-based swap dealer and major security-based swap participant definitions in the cross-border context. We have taken into consideration the costs and benefits associated with persons being brought within one of these definitions through our cross-border application, as well as the costs market participants may incur in determining whether they are within the scope of these definitions and thus subject to Title VII, while recognizing that the ultimate economic impact of these definitions will be determined in part by the final rules regarding the substantive requirements applicable to security-based swap dealers and major security-based swap participants. Some of these economic consequences and effects stem from statutory mandates, while others result from the discretion we exercise in implementing the mandates.

A. Economic Considerations in the Cross-Border Regulation of Security-Based Swaps

1. Economic Features of the Security-Based Swap Market

As noted above, the cross-border implementation of the rules defining security-based swap dealer and major security-based swap participant is the first in a series of final rules that consider the cross-border implications of security-based swaps and Title VII. In determining how Title VII security-based swap dealer and major security-based swap participant definitions should apply to persons and transactions in the cross-border context, the Commission has been informed by our analysis of current market activity, including the extent of cross-border trading activity in the security-based swap market. Several key features of the market inform our analysis.

First, the security-based swap market is a global market. Security-based swap business currently takes place across national borders, with agreements negotiated and executed between counterparties often in different jurisdictions (and at times booked, managed, and hedged in still other jurisdictions). The global nature of the security-based swap market is evidenced by the data available to the Commission. Based on market data in the Depository Trust and Clearing Corporation's Trade Information Warehouse (“DTCC-TIW”), viewed from the perspective of the domiciles of the counterparties booking credit default swap (“CDS”) transactions, approximately 48 percent of price forming North American corporate single-name CDS transactions from January 2008 to December 2012 were cross-border transactions between a U.S.-domiciled counterparty and a foreign-domiciled counterparty and an additional 39 percent of such CDS transactions were between two foreign-domiciled counterparties. Thus, approximately 13 percent of the North American corporate single-name CDS transactions in 2008-2012 were between two U.S.-domiciled counterparties. These statistics indicate that, rather than being an exception, cross-border North American corporate single-name CDS transactions are as common as intra-jurisdictional transactions in the security-based swap market.

Second, dealers and other market participants are highly interconnected within this global market. While most market participants have only a few counterparties, dealers can have hundreds of counterparties, consisting of both non-dealing market participants (e.g., non-dealers, including commercial and financial market participants and investment funds) and other dealers. Furthermore, as described in more detail below, the great majority of trades are dealer-to-dealer, rather than dealer-to-non-dealer or non-dealer-to-non-dealer, and a large fraction of single-name CDS volume is between counterparties domiciled in different jurisdictions. This interconnectedness facilitates the use of security-based swaps as a tool for sharing financial and commercial risks. In an environment in which market participants can have diverse and offsetting risk exposures, security-based swap transactions can allow participants to transfer risks so that they are borne by those who can do so efficiently. The global scale of the security-based swap market allows counterparties to access liquidity across jurisdictional boundaries, providing U.S. market participants with opportunities to share these risks with counterparties around the world. As discussed further in section VIII, a broad set of counterparties across which risks can be shared may result in more efficient risk sharing.

However, these opportunities for international risk sharing also represent channels for risk transmission. In other words, the interconnectedness of security-based swap market participants provides paths for liquidity and risk to flow throughout the system, so that it can be difficult to isolate risks to a particular entity or geographic segment. Because dealers facilitate the great majority of security-based swap transactions, with bilateral relationships that extend to potentially hundreds of counterparties, liquidity problems or other forms of financial distress that begin in one entity or one corner of the globe can potentially spread throughout the network, with dealers as a central conduit.

Third, as highlighted in the Intermediary Definitions Adopting Release, dealing activity within the market for security-based swaps is highly concentrated. This concentration in large part appears to reflect the fact that larger entities possess competitive advantages in engaging in OTC security-based swap dealing activities, particularly with regard to having sufficient financial resources to provide potential counterparties with adequate assurances of financial performance.

The security-based swap market developed as an OTC market, without centralized trading venues or dissemination of pre- or post-trade pricing and volume information. In markets without transparent pricing, access to information confers a competitive advantage. In the current security-based swap market, large dealers and other large market participants with a large share of order flow have an informational advantage over smaller dealers and non-dealers who, in the absence of pre-trade transparency, observe a smaller subset of the market. Greater private information about order flow enables better assessment of current market values by dealers, permitting them to extract economic rents from counterparties who are less informed. Non-dealers are aware of this information asymmetry, and certain non-dealers—particularly larger entities who transact with many dealers—may be able to obtain access to competitive pricing or otherwise demand a price discount that reflects the information asymmetry. Typically, however, the value of private information (i.e., the economic rent or informational premium) will be earned by those who have the most information. In the case of security-based swap markets, it is predominantly dealers who observe the greatest order flow and benefit from market opacity.

Taken together, the need for financial resources and the private information conveyed by order flow suggest that new entrants who intend to engage in security-based swap dealing activity in fact face high barriers to entry. One consequence of the current concentrated market structure is the potential for risk spillovers and contagion, which can occur when the financial sector as a whole (or certain key segments) becomes undercapitalized. Unlike most other securities transactions, a security-based swap gives rise to ongoing obligations between transaction counterparties during the life of the transaction. This means that each counterparty to the transaction undertakes the obligation to perform the security-based swap in accordance with its terms and bears counterparty credit risk and market risk until the transaction expires or is terminated. Within this interconnected market, participants may have ongoing bilateral obligations with multiple counterparties, allowing for efficient risk-sharing and access to liquidity throughout the global network. However, a primary risk of the integrated market is the potential for sequential counterparty failure and contagion when one or more large market participants become financially distressed, causing the market participant to default on its obligations to its counterparties. A default by one or more security-based swap dealers or major security-based swap participants, or even the perceived lack of creditworthiness of these large entities, could produce contagion, either through direct defaults and risk spillovers, reduced willingness to extend credit, reduced liquidity, or reduced valuations for financial instruments. As financial distress spreads, the aggregate financial system may become undercapitalized, hindering its ability to provide financial intermediation services, including security-based swap intermediation services.

In other words, the failure of a single large firm active in the security-based swap market can have consequences beyond the firm itself. One firm's default may reduce the willingness of dealers to trade with, or extend credit to, both non-dealers and other dealers. By reducing the availability of sufficient credit to provide intermediation services, and by reducing transaction volume that reveals information about underlying asset values, the effects of a dealer default may, through asset price and liquidity channels, spill over into other jurisdictions and even other markets in which security-based swap dealers participate.

Given that firms may be expected to consider the implications of security-based swap activity only on their own operations, without considering aggregate financial sector risk, the financial system may end up bearing more risk than the aggregate capital of the intermediaries in the system can support and may cease to function normally during times of market distress. For example, during times of financial distress a dealer's leverage constraints may begin to bind, either because lenders require more collateral or because market declines erode a dealer's capital position, forcing the dealer to de-lever, either by selling assets or raising additional capital. Without adequate capital, the dealer may be unable to intermediate trades, potentially reducing liquidity in the markets it serves. Security-based swap positions replicate leveraged positions in the underlying asset, with a small amount of capital supporting large notional exposures. Given the leveraged nature of swap transactions, and the concentrated structure of the dealer market, in which a large amount of highly leveraged risk exposures may be concentrated in a relatively small number of entities that are responsible for the vast majority of global dealing activity, the potential consequences arising from financial instability in the security-based swap market may be acute.

In sum, the security-based swap market is characterized by a high level of interconnectedness, facilitating risk sharing by counterparties. Further, it is a global market, in which the potential for significant inter-jurisdictional activity and access to liquidity may enhance risk sharing among counterparties. At the same time, channels for risk sharing also represent channels for risk transmission. The global nature of this market, combined with the interconnectedness of market participants, means that liquidity shortfalls or risks that begin pooling in one corner of the market can potentially spread beyond that corner to the entire security-based swap market, with dealers as a key conduit. Because dealers and major participants are a large subset of all participants in the global security-based swap market and facilitate the majority of transactions (and thus reach many counterparties), concerns surrounding these types of spillovers are part of the framework in which we analyze the economic effects of our final rules implementing the security-based swap dealer and major participant definitions in the cross-border context.

2. Context for Regulatory Determinations

In determining how Title VII requirements should apply to persons and transactions in a market characterized by the types of risks we have described, we are aware of the potentially significant tradeoffs inherent in our policy decisions. Our primary economic considerations for promulgating rules and guidance regarding the application of the security-based swap dealer and major participant definitions to cross-border activities include the effect of our choices on efficiency, competition, and capital formation, the potential risks of security-based swaps to U.S. market participants that could affect financial stability, the level of transparency and counterparty protection in the security-based swap market, and the costs to market participants.

As noted above, participants may use security-based swaps to manage financial and commercial risks and benefit from a liquid market with broad participation that facilitates risk sharing. We also recognize the possibility that the same channels that enable risk sharing also facilitate the transmission of risks and liquidity problems that begin pooling in one geographic segment of the market to the global security-based swap market. As described more fully in section III.A.1, U.S. entities may take on risk exposures in the security-based swap market by transacting with non-U.S. counterparties through non-U.S. affiliates. This suggests that an approach that applied these Title VII definitions to transactions only where all activity occurs inside the United States would have little effect in addressing the risks associated with security-based swaps, including risks and associated economic consequences flowing from contagion that may originate abroad and reach U.S. market participants through security-based swap activities and the multiple bilateral relationships that may form as a result of those activities. The global reach of security-based swap dealers, including U.S. dealers, participating in the vast majority of trades and extending to upwards of hundreds of counterparties, provides paths for these risks to flow back into the United States.

At the same time, the Commission recognizes that the regulatory requirements we adopt for security-based swap dealers and major participants under Title VII may not reach all market participants that act as dealers or that have positions that pose considerable risk concerns in the global security-based swap markets. These limits to the application of Title VII raise several issues. First, market participants may shift their behavior. Final Title VII requirements may impose significant direct costs on participants falling within the security-based swap dealer and major security-based swap participant definitions that are not borne by other market participants, including costs related to capital and margin requirements, regulatory reporting requirements, and business conduct requirements. The costs of these requirements may provide economic incentive for some market participants falling within the dealer and major participant definitions to restructure their security-based swap business to seek to operate wholly outside of the Title VII regulatory framework by exiting the security-based swap market in the United States and not transacting with U.S. persons, potentially fragmenting liquidity across geographic boundaries. Conversely, such incentives potentially may be mitigated by the fact that capital and margin requirements, counterparty protections, and business conduct standards required by Title VII may promote financial stability and lead to non-dealer market participants exhibiting a preference for transacting with registered dealers and major participants.

Second, to the extent that other jurisdictions may adopt requirements with different scopes or on different timelines, the requirements we adopt may also result in competitive distortions. That is, differences in regulatory requirements across jurisdictions, or the ability of certain non-U.S. market participants to avoid security-based swap dealer regulation under Title VII, may generate competitive burdens and provide incentives for non-U.S. persons to avoid transacting with U.S. persons.

Third, key elements of the rules adopted today—the definition of “U.S. person,” as well as rules covering treatment of guaranteed transactions, transactions with foreign branches, transactions conducted through conduit affiliates, and cleared anonymous transactions, and rules covering aggregation standards—all have implications for how U.S. and non-U.S. entities perform their de minimis and major participant threshold calculations and may affect the number of participants who ultimately register as security-based swap dealers or major security-based swap participants. The number of persons required to register will affect the costs and benefits of the substantive Title VII requirements that will ultimately be adopted; depending on the final rules, more or fewer entities, and therefore more or fewer security-based swaps, will be subject to Title VII requirements applicable to security-based swap dealers and major security-based swap participants. Title VII requires the Commission to create a new regulatory regime that includes capital, margin, registration and reporting requirements aimed at increasing transparency and customer protections as well as mitigating the risk of financial contagion. Each of these requirements will impose new costs and regulatory burdens on persons that engage in security-based swap dealing activity at levels above the de minimis thresholds and on persons whose security-based swap positions are large enough to cause them to be major security-based swap participants.

We expect that these requirements' application to security-based swap dealers and major security-based swap participants subject to Title VII will be associated with a number of benefits to the security-based swap market and security-based swap market participants, including transparency, accountability, and increased counterparty protections. Nevertheless, as we discuss later in this release, the de minimis rules for non-U.S. persons could allow certain non-U.S. entities to avoid the costs of dealer registration, which could reduce the number of entities that register as security-based swap dealers, relative to the Commission's estimates in the Intermediary Definitions Adopting Release. Although the number of entities that are not required to register will depend on the availability of the de minimis exclusions, we believe that, to the extent that the final rules change the number of eventual registrants, the ultimate programmatic costs and benefits expected from Title VII may differ from those that were described in the Intermediary Definitions Adopting Release.

Finally, the final rules determining how non-U.S. persons must perform their de minimis and major participant threshold calculations may face limits as to how precisely they address the risk mitigation goals of Title VII that are reflected in our rules implementing the de minimis exception and the “major security-based swap participant” definition. On the one hand, the scope of dealer and major participant regulation under Title VII may be subject to limitations on the ability to control risk because the global nature of counterparty interconnections means that it is difficult to prevent risk that pools in one geographic segment of the market from flowing throughout the entire security-based swap network. On the other hand, there is a possibility that the rules defining the scope of dealer and major participant regulation, including the territorial application of the definitions, may capture certain activity that does not represent risk to the U.S. financial system. Because these rules and guidance implementing Title VII regulatory definitions will not capture all transactions and all entities that engage in security-based swap activity, these rules and guidance therefore may create incentives for those entities at the boundaries of the definitions to restructure their business in a way that allows them to operate outside the scope of Title VII. However, as we described in the Intermediary Definitions Adopting Release, we have sought to implement the statutory dealer and major participant definitions in such a way as to impose the substantive rules of Title VII on those entities most likely to contribute to those risks that Title VII is intended to address without imposing unnecessary burdens on those who do not pose comparable risks to the U.S. financial system.

B. Scope of Title VII's Application to Cross-Border Security-Based Swap Activity

Congress has given the Commission authority in Title VII to implement a security-based swap regulatory framework to address the potential effects of security-based swap activity on U.S. market participants, the financial stability of the United States, on the transparency of the U.S. financial system, and on the protection of counterparties. The global nature of the security-based swap market and the high proportion of cross-border transactions in that market mean that much of this activity occurs at least in part outside the United States and frequently involves persons that are incorporated, organized, or established in a location outside the United States. In light of these market realities, we noted in the proposal that applying Title VII only to persons incorporated, organized, or established within the United States or only to security-based swap activity occurring entirely within the United States would inappropriately exclude from regulation a majority of security-based swap activity that involves U.S. persons or otherwise involves conduct within the United States, even though such activity raises the types of concerns that we believe Congress intended to address through Title VII.

Because some commenters had, prior to the proposal, argued that section 30(c) of the Exchange Act limited our ability to reach certain types of activity occurring at least in part outside the United States, we discussed in some detail in the proposal our preliminary views on the appropriate approach to determining whether certain security-based swap activity that involves some conduct outside the United States also occurs within the United States for purposes of Title VII. In this subsection, we discuss comments received on this question following publication of our proposal and explain our final views—which remain largely unchanged from the proposal—on the proper approach to determining whether cross-border security-based swap activity occurs, in relevant part, within the United States. We then briefly describe how this framework applies to specific types of transactions relevant to the rules we are adopting here.

1. Commenters' Views

Prior to our proposal, several commenters raised concerns about the application of Title VII to security-based swap activity in the cross-border context and specifically about the possibility that we would impose Title VII requirements on “extraterritorial” conduct. We received only a few comments on this issue in response to our preliminary views set forth in the proposal, and these generally focused on the application of section 30(c) of the Exchange Act to specific types of activity that we proposed to subject to Title VII rather than the proposed territorial framework more broadly.

One commenter expressed general agreement with our proposed guidance. Three commenters suggested that textual differences between section 30(c) of the Exchange Act and section 2(i) of the Commodity Exchange Act (“CEA”) do not require the Commission to take a different approach to application of Title VII to cross-border security-based swap activity from that taken by the CFTC. Two commenters expressed the view that section 30(c) of the Exchange Act, considered in light of what they described as the risk-based focus of Title VII, prohibited the Commission from imposing Title VII requirements on transactions carried out within the United States but booked in locations outside the United States. One commenter stated that section 30(c) of the Exchange Act prevents us from imposing Title VII requirements on transactions of guaranteed foreign affiliates of U.S. persons. One commenter argued that section 30(c) prevents application of Title VII to certain joint ventures.

2. Scope of Application of Title VII in the Cross-Border Context

We continue to believe that a territorial approach to the application of Title VII is appropriate. This approach, properly understood, is grounded in the text of the relevant statutory provisions and is designed to help ensure that our application of the relevant provisions is consistent with the goals that the statute was intended to achieve.

(a) Overview and General Approach

As in our proposal, our analysis begins with an examination of the text of the statutory provision that imposes the relevant requirement. The statutory language generally identifies the types of conduct that trigger the relevant requirement and, by extension, the focus of the statute. Once we have identified the activity regulated by the statutory provision, we can determine whether a person is engaged in conduct that the statutory provision regulates and whether this conduct occurs within the United States. When the statutory text does not describe the relevant activity with specificity or provides for further Commission interpretation of statutory terms or requirements, this analysis may require us to identify through interpretation of the statutory text the specific activity that is relevant under the statute or to incorporate prior interpretations of the relevant statutory text.

As noted above, the Dodd-Frank Act was enacted, in part, with the intent to address the risks to the financial stability of the United States posed by entities engaged in security-based swap activity, to promote transparency in the U.S. financial system, and to protect counterparties to such transactions. These purposes, considered together with the specific statutory requirement, lead us to conclude that it is appropriate to impose the statutory requirements, and rules or regulations thereunder, on security-based swap activity occurring within the United States even if certain conduct in connection with the security-based swap also occurs in part outside the United States.

Contrary to the views expressed by some commenters, we do not agree that the location of risk alone should necessarily determine the scope of an appropriate territorial application of every Title VII requirement, given that the definition and the relevant regulatory regime address not only risk but other concerns as well, as just described. For example, neither the statutory definition of “security-based swap dealer,” our subsequent further definition of the term pursuant to section 712(d) of the Dodd-Frank Act, nor the regulatory requirements applicable to security-based swap dealers focus solely on risk to the U.S. financial system.

We believe that this approach to territorial application of Title VII provides a reasonable means of helping to ensure that our regulatory framework focuses on security-based swap activity that is most likely to raise the concerns that Congress intended to address in Title VII, including the potential effects of security-based swap activity on U.S. market participants, on the financial stability of the United States, on the transparency of the U.S. financial markets, and on the protection of counterparties. Persons that engage in relevant conduct, as identified through this analysis, within the United States are not, in our view, “transact[ing] a business in security-based swaps without the jurisdiction of the United States,” and thus are properly subject to regulation under Title VII.

(b) Territorial Approach to Application of Title VII Security-Based Swap Dealer Registration Requirements

In determining whether specific transactions should be included in a person's dealer de minimis calculation, we begin by looking to the statutory text to identify the type of dealing activity that the statute describes as relevant to a person's status as a security-based swap dealer. Section 3(a)(71) of the Exchange Act defines security-based swap dealer as a person that engages in any of the following types of activity:

(i) Holding oneself out as a dealer in security-based swaps,

(ii) making a market in security-based swaps,

(iii) regularly entering into security-based swaps with counterparties as an ordinary course of business for one's own account, or

(iv) engaging in any activity causing oneself to be commonly known in the trade as a dealer in security-based swaps.

In accordance with the authority provided by section 712(d)(1) of the Dodd-Frank Act, which provides that the CFTC and the Commission shall by rule further define, among other things, “security-based swap dealer,” we further interpreted the statutory definition by identifying the types of activities that are relevant in determining whether a person is a security-based swap dealer. Pursuant to this further definition, indicia of security-based swap dealing activity include any of the following activities:

• Providing liquidity to market professionals or other persons in connection with security-based swaps;
• seeking to profit by providing liquidity in connection with security-based swaps,
• providing advice in connection with security-based swaps or structuring security-based swaps;
• having a regular clientele and actively soliciting clients;
• using inter-dealer brokers; and
• acting as a market maker on an organized security-based swap exchange or trading system.

As the foregoing lists illustrate, both the statutory text and our interpretation further defining the statutory term include within the security-based swap dealer definition a range of activities. In the Intermediary Definitions Adopting Release, we stated that transactions arising from dealing activity, as identified by the indicia described above, would generally be subject to relevant Title VII requirements applicable to dealers, including that such transactions be included in a person's calculations for purposes of the dealer de minimis calculations. Our territorial approach applying Title VII to dealing activity similarly looks to whether any of the activities described above occur within the United States, and not simply to the location of the risk, as some commenters suggested is required under section 30(c) of the Exchange Act. To the extent that such activity does occur within the United States, the person engaged in such activity, in our view, is transacting a business in security-based swaps within the United States, and therefore applying Title VII to the activity by, among other things, requiring the person to include transactions arising from such activity in its de minimis calculation is consistent with a territorial approach, even if some of this activity (or other activity bearing the indicia of dealing activity) relating to the transaction also occurs outside the United States.

This approach is consistent with the purposes of the dealer definition and the de minimis exception as they relate to dealer regulation under Title VII. The de minimis exception excludes from the dealer registration requirement those entities that may engage in dealing activity but that do so in amounts that may not raise, to a degree that warrants application of security-based swap dealer requirements, the risk, counterparty protection, or other concerns that the dealer registration and regulatory framework were intended to address. On the other hand, dealing activity, as identified by the types of activities described above, carried out within the United States at levels exceeding the de minimis threshold is likely to raise these concerns, which would be addressed by requiring persons engaged in that volume of dealing activity to register as security-based swap dealers under Title VII and to comply with relevant requirements applicable to security-based swap dealers. Accordingly, to the extent that a person engages in dealing activity within the United States that results in transactions in a notional amount exceeding the applicable de minimis threshold, it is appropriate to require the person to register as a security-based swap dealer.

i. Dealing Activity of U.S. Persons

Under the foregoing analysis and consistent with our proposal, when a U.S. person as defined under this final rule engages in dealing activity, it necessarily engages in such activity within the United States, even when it enters into such transactions through a foreign branch or office. As discussed in further detail below, the definition of “U.S. person” in the final rule is intended, in part, to identify those persons for whom it is reasonable to infer that a significant portion of their financial and legal relationships are likely to exist within the United States and that it is therefore reasonable to conclude that risk arising from their security-based swap activities could manifest itself within the United States, regardless of the location of their counterparties, given the ongoing nature of the obligations that result from security-based swap transactions.

Wherever a U.S. person enters into a transaction in a dealing capacity, it is the U.S. person as a whole that is holding itself out as a dealer in security-based swaps, given that the financial resources of the entire person stand behind any dealing activity of the U.S. person, both at the time it enters into the transaction and for the life of the contract, even when the U.S. person enters into the transaction through a foreign branch or office. Moreover, the U.S. person as a whole seeks to profit by providing liquidity and engaging in market-making in security-based swaps, and the financial resources of the entire person enable it to provide liquidity and engage in market-making in connection with security-based swaps. Its dealing counterparties will look to the entire U.S. person, even when the U.S. person enters into the transaction through a foreign branch or office, for performance on the transaction. The entire U.S. person assumes, and stands behind, the obligations arising from the resulting agreement and is directly exposed to liability arising from non-performance of the non-U.S. person.

For these reasons, in our view a person does not hold itself out as a security-based swap dealer as anything other than a single person even when it enters into transactions through its foreign branch or office. Because the foreign branch generally could not operate as a dealer absent the financial and other resources of the entire U.S. person, its dealing activity with all of its counterparties, including dealing activity conducted through its foreign branch or office, is best characterized as occurring, at least in part, within the United States and should therefore be included in the person's de minimis threshold calculation.

ii. Dealing Transactions of Non-U.S. Persons That Are Subject to Recourse Guarantees by Their U.S. Affiliates

In the proposing release, we explained that we preliminarily believed that a territorial approach consistent with the text and purposes of the Dodd-Frank Act encompasses transactions involving a non-U.S. person counterparty whose dealing activity is guaranteed by a U.S. person. However, because we proposed to treat non-U.S. persons receiving a guarantee on their security-based swap transactions from a U.S. person like any other non-U.S. person for purposes of the de minimis exception (i.e., requiring them to include in their calculations only dealing activity involving U.S.-person counterparties or transactions conducted within the United States), we did not elaborate specifically on how the presence of a guarantee related to a territorial application of the dealer definition, including the de minimis exception. Because our final rule requires transactions of non-U.S. persons whose obligations under the security-based swap are subject to recourse guarantees enforceable against their U.S. affiliates to be included in the dealer de minimis calculation of the non-U.S. person, we address it here.

In our view, a non-U.S. person engaged in dealing activity, to the extent that one or more transactions arising from such activity are guaranteed by a U.S. person, is engaged in relevant activity for purposes of the security-based swap dealer definition within the United States, with respect to those transactions. By virtue of the guarantee, the non-U.S. person effectively acts together with the U.S. person to engage in the dealing activity that results in the transactions, and the non-U.S. person's dealing activity with respect to such transactions cannot reasonably be isolated from the U.S. person's activity in providing the guarantee. The U.S.-person guarantor together with the non-U.S. person whose dealing activity it guarantees, and not just the non-U.S. person, may seek to profit by providing liquidity and engaging in market-making in security-based swaps, and the non-U.S. person provides liquidity and engages in market-making in connection with security-based swaps by drawing on the U.S. person's financial resources. The non-U.S. person's counterparty, pursuant to the recourse guarantee, looks to both the non-U.S. person and its U.S. guarantor, which is responsible for performance on the transaction that is part of the non-U.S. person's dealing activity. In sum, the non-U.S. person is engaged in the United States in relevant dealing activity identified in the statutory definition and in our jointly adopted further definition of “security-based swap dealer.”

Moreover, the economic reality of the non-U.S. person's dealing activity, where the resulting transactions are guaranteed by a U.S. person, is identical, in relevant respects, to a transaction entered into directly by the U.S. guarantor. By virtue of the guarantee, transactions arising from the non-U.S. person's dealing activity result in risk from the transaction being borne by a U.S. person (the guarantor, which is responsible for the transactions it guarantees in a manner similar to a direct counterparty to the transactions) and potentially the U.S. financial system in a manner similar to a dealing transaction entered into directly by a U.S. person. As with transactions entered into directly by a U.S. person, transactions for which a counterparty has a right of recourse against a U.S. person create risk to a U.S. person and potentially the U.S. financial system regardless of the location of the counterparty.

Our interpretation of the statutory text of the definition, as well as our further definition of the term, as it applies to these entities is consistent with the purposes of Title VII, as discussed above. The exposure of the U.S. guarantor creates risk to U.S. persons and potentially to the U.S. financial system via the guarantor to a comparable degree as if the transaction were entered into directly by a U.S. person. We understand that in some circumstances a counterparty may choose not to enter into a security-based swap transaction (or may not do so on the same terms) with a non-U.S. subsidiary of a U.S. person when that non-U.S. subsidiary is acting in a dealing capacity to the extent that its dealing activity is not subject to a recourse guarantee by a U.S. affiliate, absent other circumstances (e.g., adequate capitalization of the hitherto-guaranteed affiliate).

One commenter noted that U.S. guarantors may provide guarantees for a variety of reasons, including to satisfy regulatory requirements, to “manage capital treatment across an entity,” and to “avoid negative credit rating consequences,” and argued that a guarantee may therefore not create risk within the United States. Absent the creation of such risk, this commenter further argued that a guarantee creates “no nexus for purposes of section 30(c) of the Exchange Act.” However, regardless of the motivation for providing the guarantee, the non-U.S. person's dealing activity still occurs within the United States and creates risk within the United States in the manner described above. The commenter provided no evidence that the motivation for providing a guarantee affects this analysis: It neither alters the risk created within the United States by such a guarantee when it is provided by a U.S. person nor affects the economic reality of the transaction. Moreover, even if a person provides guarantees not in response to counterparty demands but to satisfy regulatory requirements or to avoid negative credit rating consequences, the very reasons for issuing the guarantee suggest that the non-U.S. person would not be able to engage in dealing activity, or to do so on the same terms, without the guarantee.

In sum, the guarantee provided by a U.S. person poses risk to U.S. persons and potentially to the U.S. financial system, and both the non-U.S. person whose dealing activity is guaranteed and its counterparty rely on the creditworthiness of the U.S. guarantor when entering into a security-based swap transaction and for the duration of the security-based swap. The economic reality of this transaction, even though entered into by a non-U.S. person, is substantially identical, in relevant respects, to a transaction entered into directly by a U.S. person. Accordingly, in our view, it is consistent with both the statutory text and with the purposes of the statute to identify such transactions as occurring within the United States for purposes of Title VII.

iii. Dealing Activity of Other Non-U.S. Persons

In our proposal, we stated that non-U.S. persons engaging in dealing activity would be required to count toward their de minimis thresholds only transactions arising from their dealing activity with U.S. persons or dealing activity otherwise conducted within the United States. Under the approach described above, and consistent with our proposal, we believe that a non-U.S. person engaged in dealing activity with U.S. persons engages in relevant activity for purposes of the security-based swap dealer definition within the United States.

Dealing activity of non-U.S. persons that involves counterparties who are U.S. persons, as that term is defined in the final rule, necessarily involves the performance by the non-U.S. person of relevant activity under the “security-based swap dealer” definition at least in part within the United States. For example, in our view, a non-U.S. person engaging in dealing activity with a U.S. person is holding itself out as a dealer in security-based swaps within the United States. Similarly, by entering into a transaction with a U.S. person in a dealing capacity, it is seeking to profit by providing liquidity within the United States and possibly engaging in market-making in security-based swaps within the United States, given that its decision to engage in dealing activity with U.S. persons, as defined by the rule, affects the liquidity of the security-based swap market within the United States. Particularly at volumes in excess of the de minimis threshold, entering into security-based swap transactions in a dealing capacity with U.S. persons likely is the type of activity that would cause a non-U.S. person “to be commonly known in the trade as a dealer in security-based swaps” within the United States, that constitutes “regularly entering into security-based swaps with counterparties as an ordinary course of business for one's own account” within the United States, and that permits a reasonable inference that it has a regular clientele and actively solicits clients within the United States.

Our application of the statute to non-U.S. persons is consistent with the purposes of Title VII, as discussed above. U.S. persons incur risks arising from this dealing activity, which in turn potentially creates risk to other market participants and the U.S. financial system more generally, and transactions with U.S. persons raise counterparty protection and market transparency concerns that Title VII is intended to address. Accordingly, we believe that the dealing activity of a non-U.S. person that involves a U.S.-person counterparty is appropriately characterized as occurring, at least in part, within the United States.

(c) Territorial Approach to Application of Title VII Major Security-Based Swap Participant Registration Requirements

As in our territorial approach to the security-based swap dealer definition (including the de minimis exception) described above, our territorial approach to the application of the major security-based swap participant definition looks first to the statutory text to identify the types of activity that are relevant for purposes of the definition. Section 3(a)(67) of the Exchange Act provides that a major security-based swap participant is any person who is not a dealer and who satisfies one or more of the following requirements:

(i) Maintains a substantial position in security-based swaps for any of the major security-based swap categories, excluding certain positions;

(ii) has outstanding security-based swaps that create substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets; or

(iii) is a highly leveraged financial entity that maintains substantial position in outstanding security-based swaps in any major security-based swap category.

The statute directs us to further define, jointly with the CFTC, “major security-based swap participant” and separately provides us with authority to “define . . . the term `substantial position' at the threshold that the Commission determines to be prudent for the effective monitoring, management, and oversight of entities that are systemically important or can significantly impact the financial system of the United States.”

Pursuant to these provisions, we further interpreted this definition by, among other things, defining what constitutes a “substantial position” and “substantial counterparty exposure” for purposes of the major security-based swap participant definition. In doing so, we set forth calculation methodologies and thresholds for each and adopted rules requiring persons that exceeded these thresholds to register as major security-based swap participants. These thresholds were designed to identify persons that were likely to pose counterparty credit risks, as such risks are “more closely linked to the statutory criteria that the definition focuses on entities that are `systemically important' or can `significantly impact' the U.S. financial system.” We also noted that our definition of “substantial position” was intended to address the risk that would be posed by the default of multiple entities close in time and the aggregate risks presented by a person's security-based swap activity, as these considerations reflect the market risk concerns expressly identified in the statute.

The statutory focus of the major security-based swap participant definition differs from that of security-based swap dealer, in that the security-based swap dealer definition focuses on activity that may raise the concerns that dealer regulation is intended to address, while the major security-based swap participant definition focuses on positions that may raise systemic risk concerns within the United States. Accordingly, a territorial approach to application of the definition of major security-based swap participant involves identifying security-based swap positions that exist within the United States. In our view, and consistent with the approach taken in our proposal, a security-based swap position exists within the United States when it is held by or with a U.S. person, or when it is subject to a recourse guarantee against a U.S. person, as the risks associated with such positions are borne within the United States, and given the involvement of U.S. persons may, at the thresholds established for the major security-based swap participant definition, give rise to the types of systemic risk within the United States that major security-based swap regulation is intended to address. To the extent that a position exists within the United States in this sense, we believe that it is appropriate under a territorial approach to require a market participant, whether a U.S. person or otherwise, that is a counterparty or guarantor with respect to that position, to include that position in its major security-based swap participant threshold calculations, wherever the security-based swap was entered into.

(d) Regulations Necessary or Appropriate To Prevent Evasion of Title VII

Consistent with our proposal, we interpret section 30(c) of the Exchange Act as not requiring us to find that actual evasion has occurred or is occurring to invoke our authority to reach activity “without the jurisdiction of the United States” or to limit application of Title VII to security-based swap activity “without the jurisdiction of the United States” only to business that is transacted in a way that is purposefully intended to evade Title VII. Section 30(c) of the Exchange Act authorizes the Commission to apply Title VII to persons transacting a business “without the jurisdiction of the United States” if they contravene rules that the Commission has prescribed as “necessary or appropriate to prevent the evasion of any provision” of Title VII. The focus of this provision is not whether such rules impose Title VII requirements only on entities engaged in evasive activity but whether the rules are generally “necessary or appropriate” to prevent potential evasion of Title VII. In other words, section 30(c) of the Exchange Act permits us to impose prophylactic rules intended to prevent possible purposeful evasion, even though such rules may affect or prohibit some non-evasive conduct. Moreover, exercising the section 30(c) authority does not require us to draw a distinction between conduct “without the jurisdiction of the United States” that is purposely evasive as opposed to identical conduct that was motivated by some non-evasive purpose. Indeed, to interpret section 30(c) authority otherwise could create a bifurcated regulatory regime where the same conduct is treated differently based on parties' underlying purpose for engaging in it, which could create extraordinary oversight challenges involving difficult subjective considerations concerning parties' true intentions in entering any given transaction or establishing particular business structures, and could create significant competitive advantages for incumbent firms. Thus, we read the statute to permit us to prescribe such rules to conduct without the jurisdiction of the United States, even if those rules would also apply to a market participant that has been transacting business through a pre-existing market structure, such as a foreign branch or foreign affiliate whose positions are guaranteed by the market participant, established for valid business purposes, provided the proposed rule or guidance is designed to prevent possibly evasive conduct.

C. Principles Guiding Final Approach To Applying “Security-Based Swap Dealer” and “Major Security-Based Swap Participant” Definitions in the Cross-Border Context

As in our proposal, our final rules and guidance reflect our careful consideration of the global nature of the security-based swap market and the types of risks created by security-based swap activity to the U.S. financial system and market participants and other concerns that the dealer and major security-based swap participant definitions were intended to address, as well as the needs of a well-functioning security-based swap market. We also have been guided by the purpose of Title VII and the applicable requirements of the Exchange Act, including the following:

• Economic Impacts—The Exchange Act requires the Commission to consider the impact of our rulemakings on efficiency, competition, and capital formation.

• Counterparty Protection—The Dodd-Frank Act adds provisions to the Exchange Act relating to counterparty protection, particularly with respect to “special entities.”

• Transparency—The Dodd-Frank Act was intended to promote transparency in the U.S. financial system.

• Risk to the U.S. Financial System—The Dodd-Frank Act was intended to promote, among other things, the financial stability of the United States by limiting/mitigating risks to the financial system.

• Anti-Evasion—The Dodd-Frank Act amends the Exchange Act to provide the Commission with authority to prescribe rules and regulations as necessary or appropriate to prevent the evasion of any provision of the Exchange Act that was added by the Dodd-Frank Act.

• Consultation and Coordination with Other U.S. Regulators—In connection with implementation of Title VII, the Dodd Frank Act requires the Commission to consult and coordinate with the CFTC and prudential regulators for the purpose of ensuring “regulatory consistency and comparability, to the extent possible.”

• Consistent International Standards—To promote effective and consistent global regulation of swaps and security-based swaps, the Dodd-Frank Act requires the Commission and the CFTC to consult and coordinate with foreign regulatory authorities on the “establishment of consistent international standards” with respect to the regulation of swaps and security-based swaps. In this regard, the Commission recognizes that regulators in other jurisdictions are currently engaged in implementing their own regulatory reforms of the OTC derivatives markets and that our application of Title VII to cross-border activities may affect the policy decisions of these other regulators as they seek to address potential conflicts or overlaps in the regulatory requirements that apply to market participants under their authority.

At times, these principles reinforce one another; at other times, they may be in tension. For instance, regulating risk posed to the United States may, depending on the final rules, make it more costly for U.S.-based firms to conduct security-based swap business, particularly in foreign markets, compared to foreign firms; it could make foreign firms less willing to deal with U.S. persons; and it could discourage foreign firms from carrying out security-based swap dealing activity through branches or offices located in the United States. On the other hand, providing U.S. persons greater access to foreign security-based swap markets may, depending on the final rules, fail to appropriately address the risks posed to the United States from transactions conducted in part outside the United States or create opportunities for market participants to evade the application of Title VII, particularly until such time as other jurisdictions adopt similar comprehensive and comparable derivative regulations.

Balancing these sometimes competing principles has been complicated by the fact that Title VII imposes a new regulatory regime in a global marketplace. Title VII establishes reforms that will have implications for entities that compete internationally in the global security-based swap market. We have generally sought, in accordance with the statutory factors described above, to avoid creating opportunities for market participants to evade Title VII requirements, whether by restructuring their business or other means, or the potential for overlapping or conflicting regulations. We also have considered the needs for a well-functioning security-based swap market and for avoiding disruption that may reduce liquidity, competition, efficiency, transparency, or stability in the security-based swap market.

III. Baseline

To assess the economic impact of the final rules described in this release, we are using as our baseline the security-based swap market as it exists at the time of this release, including applicable rules we have already adopted but excluding rules that we have proposed but not yet finalized. The analysis includes the statutory and regulatory provisions that currently govern the security-based swap market pursuant to the Dodd-Frank Act. We acknowledge limitations in the degree to which we can quantitatively characterize the current state of the security-based swap market. As we describe in more detail below, because the available data on security-based swap transactions do not cover the entire market, we have developed an understanding of market activity using a sample that includes only certain portions of the market.

A. Current Security-Based Swap Market

Our analysis of the state of the current security-based swap market is based on data obtained from DTCC-TIW, especially data regarding the activity of market participants in the single-name CDS market during the period from 2008 to 2012. While other repositories may collect data on transactions in total return swaps on equity and debt, we do not currently have access to such data for these products (or other products that are security-based swaps). We have previously noted that the definition of security-based swaps is not limited to single-name CDS but we believe that the single-name CDS data are sufficiently representative of the market and therefore can directly inform the analysis of the state of the current security-based swap market. Additionally, the data for index CDS encompass both broad-based security indices and narrow-based security indices, and “security-based swap” in relevant part encompasses swaps based on single securities or reference entities or on narrow-based security indices. Accordingly, with the exception of the analysis regarding the degree of overlap between participation in the single-name CDS market and the index CDS market (cross-market activity), our analysis below does not include data regarding index CDS.

We believe that the data underlying our analysis here provide reasonably comprehensive information regarding the single-name CDS transactions and composition of the single-name CDS market participants. We note that the data available to us from DTCC-TIW do not encompass those CDS transactions that both: (i) Do not involve U.S. counterparties; and (ii) are based on non-U.S. reference entities. Notwithstanding this limitation, we believe that the DTCC-TIW data provide sufficient information to identify the types of market participants active in the security-based swap market and the general pattern of dealing within that market.

1. Security-Based Swap Market Participants

A key characteristic of security-based swap activity is that it is concentrated among a relatively small number of entities that engage in dealing activities. In addition to these entities, thousands of other participants appear as counterparties to security-based swap contracts in our sample, and include, but are not limited to, investment companies, pension funds, private (hedge) funds, sovereign entities, and industrial companies. We observe that most non-dealer users of security-based swaps do not engage directly in the trading of swaps, but use dealers, banks, or investment advisers as intermediaries or agents to establish their positions. Based on an analysis of the counterparties to trades reported to the DTCC-TIW, there are 1,695 entities that engaged directly in trading between November 2006 and December 2012.

Table 1, below, highlights that more than three-quarters of these entities (DTCC-defined “firms” shown in DTCC-TIW, which we refer to here as “transacting agents”) were identified as investment advisers, of which approximately 40 percent (about 30 percent of all transacting agents) were registered investment advisers under the Investment Advisers Act of 1940 (“Investment Advisers Act”). Although investment advisers comprise the vast majority of transacting agents, the transactions they executed account for only 10.8 percent of all single-name CDS trading activity reported to the DTCC-TIW, measured by number of transaction-sides (each transaction has two transaction sides, i.e., two transaction counterparties). The vast majority of transactions (81.9 percent) measured by number of transaction-sides were executed by ISDA-recognized dealers.

Principal holders of CDS risk exposure are represented by “accounts” in the DTCC-TIW. The staff's analysis of these accounts in DTCC-TIW shows that the 1,695 transacting agents classified in Table 1 represent over 9,238 principal risk holders. Table 2, below, classifies these principal risk holders by their counterparty type and whether they are represented by a registered or unregistered investment adviser. For instance, 256 banks in Table 1 allocated transactions across 364 accounts, of which 25 were represented by investment advisers. In the remaining 339 instances, banks traded for their own accounts. Meanwhile, 17 ISDA-recognized dealers in Table 1 allocated transactions across 65 accounts.

Among the accounts, there are 1,000 Dodd-Frank Act-defined special entities and 570 investment companies registered under the Investment Company Act of 1940. Private funds comprise the largest type of account holders that we were able to classify, and although not verified through a recognized database, most of the funds we were not able to classify appear to be private funds.

(a) Dealing Structures

Security-based swap dealers use a variety of business models and legal structures to engage in dealing business with counterparties in jurisdictions all around the world. As we noted in the proposal, both U.S.-based and foreign-based entities use certain dealing structures for a variety of legal, tax, strategic, and business reasons. Dealers may use a variety of structures in part to reduce risk and enhance credit protection based on the particular characteristics of each entity's business.

Bank and non-bank holding companies may use subsidiaries to deal with counterparties. Further, dealers may rely on multiple sales forces to originate security-based swap transactions. For example, a U.S. bank dealer may use a sales force in its U.S. home office to originate security-based swap transactions in the United States and use separate sales forces spread across foreign branches to originate security-based swap transactions with counterparties in foreign markets.

In some situations, an entity's performance under security-based swaps may be supported by a guarantee provided by an affiliate. More generally, guarantees may take the form of a blanket guarantee of an affiliate's performance on all security-based swap contracts, or a guarantee may apply only to a specified transaction or counterparty. Guarantees may give counterparties to the dealer direct recourse to the holding company or another affiliate for its dealer-affiliate's obligations under security-based swaps for which that dealer-affiliate acts as counterparty.

(b) Participant Domiciles

The security-based swap market is global in scope, with counterparties located across multiple jurisdictions. As depicted in Figure 1, the domicile of new accounts participating in the market has shifted over time.

Over time a greater share of accounts entering the market either have a foreign domicile, or have a foreign domicile while being managed by a U.S. person. The increase in foreign accounts may reflect an increase in participation by foreign accountholders while the increase in foreign accounts managed by U.S. persons may reflect the flexibility with which market participants can restructure their market participation in response to regulatory intervention, competitive pressures, and other stimuli. There are, however, alternative explanations for the shifts in new account domicile we observe in Figure 1. Changes in the domicile of new accounts through time may reflect improvements in reporting by market participants to DTCC-TIW. Additionally, because the data only include accounts that are domiciled in the United States, transact with U.S.-domiciled counterparties, or transact in single-name CDS with U.S. reference entities, changes in the domicile of new accounts may reflect increased transaction activity between U.S. and non-U.S. counterparties.

A U.S.-based holding company may conduct dealing activity through a foreign subsidiary that faces both U.S. and foreign counterparties. Similarly, foreign dealers may choose to deal with U.S. and foreign counterparties through U.S. subsidiaries. Non-dealer users of security-based swaps may participate in the market using an agent in their home country or abroad. An investment adviser located in one jurisdiction may transact in security-based swaps on behalf of beneficial owners that reside in another.

The various layers separating origination from booking by dealers, and management from ownership by non-dealer users, highlights the potential distinctions between the location where a transaction is arranged, negotiated, or executed, the location where economic decisions are made by managers on behalf of beneficial owners, and the jurisdiction ultimately bearing the financial risks associated with the security-based swap transaction that results. As a corollary, a participant in the security-based swap market may be exposed to counterparty risk from a jurisdiction that is different from the market center in which it participates.

(c) Current Estimates of Dealers and Major Participants

In the Intermediary Definitions Adopting Release, we estimated, based on an analysis of DTCC-TIW data, that out of more than 1,000 entities engaged in single-name CDS activity worldwide in 2011, 166 entities engaged in single-name CDS activity at a sufficiently high level that they would be expected to incur assessment costs to determine whether they meet the “security-based swap dealer” definition. Analysis of those data further indicated that potentially 50 entities may engage in dealing activity that would exceed the de minimis threshold and thus ultimately have to register as security-based swap dealers.

Analysis of more recent data regarding the single-name CDS market using the same methodology suggests comparable results that are consistent with the reduction in transaction volume noted below. In particular, single-name CDS data from 2012 indicate that out of more than 1,000 entities engaged in single-name CDS activity, approximately 145 engaged in single-name CDS activity at a level high enough such that they may be expected to perform the dealer-trader analysis prescribed under the security-based swap dealer definition. These data suggest that, consistent with the Intermediary Definitions Adopting Release analysis, up to approximately 50 entities would engage in dealing activity that would exceed the de minimis threshold.

Additionally, in the Intermediary Definitions Adopting Release, we estimated, based on position data from DTCC-TIW for 2011, that as many as 12 entities would be likely to perform substantial position and substantial counterparty exposure tests, and thus incur assessment costs, prescribed under the major security-based swap participant definition. Of these 12 firms, we estimated that the number of persons with positions sufficiently large to bring them within the scope of the definition of major security-based swap participant likely would be fewer than five. Although we did not specify how the major security-based swap participant definition would apply to foreign persons in the Intermediary Definitions Adopting Release, our approach in estimating the assessment costs caused by our final definition used available single-name CDS data as a proxy for the market as a whole, and assumed that all potential major security-based swap participants would be required to include in their threshold calculations all positions with all counterparties.

Analysis of more recent data regarding the single-name CDS market suggests comparable results. In particular, single-name CDS data from 2012 indicate that out of over 1,100 DTCC-TIW firms holding positions in single-name CDS activity and not expected to register as security-based swap dealers, nine had worldwide single-name CDS positions at a level high enough such that they may be expected to perform the major security-based swap participant threshold analysis prescribed under the security-based swap dealer definition. Analysis based on these more recent data is consistent with the prior conclusion that five or fewer entities would be likely to register as major security-based swap participants.

2. Levels of Security-Based Swap Trading Activity

Single-name CDS contracts make up the vast majority of security-based swap products and most are written on corporate issuers, corporate securities, sovereign countries, or sovereign debt (reference entities and reference securities). Figure 2 below describes the percentage of global, notional transaction volume in North American corporate single-name CDS reported to the DTCC-TIW between January 2008 and December 2012, separated by whether transactions are between two ISDA-recognized dealers (interdealer transactions) or whether a transaction has at least one non-dealer counterparty.

The level of trading activity with respect to North American corporate single-name CDS in terms of notional volume has declined from more than $5 trillion in 2008 to approximately $2 trillion in 2012. While notional volume has declined over the past five years, the share of interdealer transactions has remained fairly constant and interdealer transactions continue to represent the bulk of trading activity, whether measured in terms of notional value or number of transactions (see Figure 2).

Against this backdrop of declining North American corporate single-name CDS activity, about half of the trading activity in North American corporate single-name CDS reflected in the set of data we analyzed was between counterparties domiciled in the United States and counterparties domiciled abroad. Basing counterparty domicile on the self-reported registered office location of the DTCC-TIW accounts, the Commission estimates that only 13 percent of the global transaction volume by notional volume between 2008 and 2012 was between two U.S.-domiciled counterparties, compared to 48 percent entered into between one U.S.-domiciled counterparty and a foreign-domiciled counterparty and 39 percent entered into between two foreign-domiciled counterparties (see Figure 3).

When the domicile of DTCC-TIW accounts are instead defined according to the domicile of their ultimate parents, headquarters, or home offices (e.g., classifying a foreign bank branch or foreign subsidiary of a U.S. entity as domiciled in the United States), the fraction of transactions entered into between two U.S.-domiciled counterparties increases to 29 percent, and to 53 percent for transactions entered into between a U.S.-domiciled counterparty and a foreign-domiciled counterparty.

Differences in classifications across different definitions of domicile illustrate the effect of participant structures that operate across jurisdictions. Notably, the proportion of activity between two foreign-domiciled counterparties drops from 39 percent to 18 percent when domicile is defined as the ultimate parent's domicile. As noted earlier, foreign subsidiaries of U.S. parent companies and foreign branches of U.S. banks, and U.S. subsidiaries of foreign parent companies and U.S. branches of foreign banks may transact with U.S. and foreign counterparties. However, this decrease in share suggests that the activity of foreign subsidiaries of U.S. firms and foreign branches of U.S. banks is generally higher than the activity of U.S. subsidiaries of foreign firms and U.S. branches of foreign banks.

By either of those definitions of domicile, the data indicate that a large fraction of North American corporate single-name CDS transaction volume is entered into between counterparties domiciled in two different jurisdictions or between counterparties domiciled outside the United States. For the purpose of establishing an economic baseline, this observation indicates that a large fraction of security-based swap activity would be affected by the scope of any cross-border approach we take in applying the Title VII requirements. Further, the large fraction of North American corporate single-name CDS transactions between U.S.-domiciled and foreign-domiciled counterparties also highlights the extent to which security-based swap activity transfers risk across geographical boundaries, both facilitating risk sharing among market participants and allowing for risk transmission between jurisdictions.

B. Global Regulatory Efforts

Efforts to regulate the swaps market are underway not only in the United States but also abroad. In 2009, leaders of the G20—whose membership includes the United States, 18 other countries, and the EU—called for global improvements in the functioning, transparency, and regulatory oversight of OTC derivatives markets agreeing that “all standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties (“CCPs”) by end-2012 at the latest. OTC derivatives contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.” In subsequent summits, the G20 leaders have reiterated their commitment to OTC derivatives regulatory reform and encouraged international consultation in developing standards for these markets. The FSB monitors implementation of OTC derivatives reforms and provides progress reports to the G20.

Pursuant to these commitments, jurisdictions with major OTC derivatives markets have taken steps toward substantive regulation of these markets, though the pace of regulation varies. This suggests that many foreign participants will face substantive regulation of their security-based swap activities that is intended to implement the G20 objectives and that may therefore address concerns similar to those addressed by rules the Commission has proposed but not yet adopted.

Foreign legislative and regulatory efforts have focused on five general areas: Requiring post-trade reporting of transactions data for regulatory purposes, moving OTC derivatives onto organized trading platforms, requiring central clearing of OTC derivatives, establishing or enhancing capital requirements, and establishing or enhancing margin requirements for OTC derivatives transactions.

The first two areas of regulation should help improve transparency in OTC derivatives markets, both to regulators and market participants. Regulatory transaction reporting requirements have entered into force in a number of jurisdictions including the EU, Hong Kong SAR, Japan, and Singapore, and other jurisdictions are in the process of proposing legislation and rules to implement these requirements. The European Parliament has adopted legislation for markets in financial instruments that addresses trading OTC derivatives on regulated trading platforms. This legislation also should promote post-trade public transparency in OTC derivatives markets by requiring the price, volume, and time of OTC derivatives transactions conducted on these regulated trading platforms to be made public in as close to real time as technically possible.

Regulation of derivatives central clearing, capital requirements, and margin requirements aims to improve management of financial risks in these markets. Japan has rules in force mandating central clearing of certain OTC derivatives transactions. The EU has its legislation in place but has not yet made any determinations of specific OTC derivatives transactions subject to mandatory central clearing. Most other jurisdictions are still in the process of formulating their legal frameworks that govern central clearing. While the EU is the only major foreign jurisdiction that has initiated the process of drafting rules to implement margin requirements for OTC derivatives transactions, we understand that several other jurisdictions anticipate taking steps towards implementing such requirements.

C. Cross-Market Participation

Persons registered as security-based swap dealers or major security-based swap participants are likely also to engage in swap activity, which is subject to regulation by the CFTC. In the release proposing registration requirements for security-based swap dealers and major security-based swap participants, we estimated, based on our experience and understanding of the swap and security-based swap markets that of the 55 firms that might register as security-based swap dealers or major security-based swap participants, approximately 35 would also register with the CFTC as swap dealers or major swap participants.

This overlap reflects the relationship between single-name CDS contracts, which are security-based swaps, and index CDS contracts, which may be swaps or security-based swaps. A single-name CDS contract covers default events for a single reference entity or reference security. These entities and securities are often part of broad-based indices on which market participants write index CDS contracts. Index CDS contracts and related products make payouts that are contingent on the default of index components and allow participants in these instruments to gain exposure to the credit risk of the basket of reference entities that comprise the index, which is a function of the credit risk of the index components. As a result of this construction, a default event for a reference entity that is an index component will result in payoffs on both single-name CDS written on the reference entity and index CDS written on indices that contain the reference entity. Because of this relationship between the payoffs of single-name CDS and index CDS products, prices of these products depend upon one another. This dependence is particularly strong between index CDS contracts and single-name CDS contracts written on index components.

Because payoffs associated with these single-name CDS and index CDS are dependent, hedging opportunities exist across these markets. Participants who sell protection on reference entities through a series of single-name CDS transactions can lay off some of the credit risk of their resulting positions by buying protection on an index that includes a subset of those reference entities. Participants that are active in one market are likely to be active in the other. Commission staff analysis of approximately 4,400 DTCC-TIW accounts that participated in the market for single-name CDS in 2012 revealed that approximately 2,700 of those accounts, or 61 percent, also participated in the market for index CDS. Of the accounts that participated in both markets, data regarding transactions in 2012 suggest that, conditional on an account transacting in notional volume of index CDS in the top third of accounts, the probability of the same account landing in the top third of accounts in terms of single-name CDS notional volume is approximately 62 percent; by contrast, the probability of the same account landing in the bottom third of accounts in terms of single-name CDS notional volume is only 14 percent.

In an effort to comply with CFTC rules and applicable statutory provisions in the cross-border context, swap market participants, many of whom, as discussed above, likely also participate in the security-based swap market, may have already changed some market practices. Although a commenter suggested that swap market participants have already conformed their business practices to the CFTC's approach to cross-border regulation, the commenter did not supply particular details as to the scope of that operations restructuring. We believe, however, based on these comments, it is likely that all participants who preliminarily believe they may be subject to the CFTC's registration requirements will have expended resources to build systems and infrastructure that will permit them to determine and then record the U.S.-person status of their counterparties consistent with applicable requirements, as interpreted by the CFTC Cross-Border Guidance.

The CFTC's rules and cross-border guidance have likely influenced the information that market participants collect and maintain about the swap transactions they enter into and the counterparties they face. For example, the CFTC's guidance describes a majority-ownership approach for collective investment vehicles that are offered to U.S. persons, contemplating that managers of these vehicles would assess, on an ongoing basis, the proportion of ownership by U.S. persons. As another example, the CFTC's guidance articulates an approach by which all swap transactions by a non-U.S. person that rely on guarantees from U.S. affiliates would generally count against that non-U.S. person's dealer de minimis exception.

Thus, as discussed in more detail in sections IV.I.2 and V.H.2 below, the adoption of rules that would seek similar information from security-based swap market participants as the CFTC seeks from swap market participants, may allow such participants to use infrastructure already in place as a result of CFTC regulation to comply with Commission regulation. Among those entities that participate in both markets, entities that are able to apply to security-based swap activity new capabilities they have built in order to comply with requirements applicable to cross-border swap activity may experience lower costs associated with assessing which cross-border security-based swap activity counts against the dealer de minimis exception or towards the major participant threshold, relative to those that are unable to redeploy such capabilities. The Commission remains sensitive to the fact that in cases where its final rules differ from the CFTC approach, additional outlays related to information collection and storage may be required even of market participants that conformed to the CFTC's guidance regarding the applicable cross-border requirements. These costs are discussed in sections IV.I.1 and V.H.1(b).

IV. Cross-Border Application of Dealer De Minimis Exception

A. Overview

The Exchange Act excepts from designation as “security-based swap dealer” entities that engage in a “ de minimis” quantity of security-based swap dealing activity with or on behalf of customers. Under the final rules adopted in the Intermediary Definitions Adopting Release, a person may take advantage of that exception if, in connection with CDS that constitute security-based swaps, the person's dealing activity over the preceding 12 months does not exceed a gross notional amount of $3 billion, subject to a phase-in level of $8 billion. The phase-in level will remain in place until—following a study regarding the definitions of “security-based swap dealer” and “major security-based swap participant”—the Commission either terminates the phase-in period or establishes an alternative threshold following rulemaking.

To apply the exception to cross-border dealing activity, the Cross-Border Proposing Release would have required that a U.S. person count against the de minimis thresholds all of its security-based swap dealing activity, including transactions conducted through a foreign branch of a U.S. bank. Non-U.S. persons, in contrast, would have included only dealing transactions entered into with U.S. persons other than foreign branches of U.S. banks, plus dealing transactions where the transaction is “conducted within the United States.” To implement, within the cross-border context, the existing rule that requires a person to aggregate the dealing activity of its affiliates against its own de minimis thresholds, the proposal would have required a person to count: (i) dealing transactions by its affiliates that are U.S. persons; and (ii) dealing transactions by non-U.S. affiliates that either are entered into with U.S. persons other than foreign branches, or that are conducted within the United States. The proposal further would have permitted a person to exclude, from the de minimis analysis, transactions by affiliates that are registered security-based swap dealers, provided that the person's dealing activity is “operationally independent” from the registered dealer's dealing activity. The proposal, moreover, set forth definitions relevant to the application of the de minimis exception in the cross-border context, including proposed definitions of the terms “U.S. person” and “transaction conducted within the United States.”

Commenters raised issues related to various aspects of this proposed approach to application of the de minimis exception in the cross-border context. As discussed below, these include issues regarding: the scope of the “U.S. person” definition, the proposal to require counting of certain “transactions conducted within the United States” between two non-U.S. persons, the treatment of the dealing activity of non-U.S. persons that is guaranteed by U.S. persons, and the application of the exception to non-U.S. persons whose counterparties are foreign branches of U.S. banks. Some commenters also urged us to more closely harmonize particular aspects of our proposal with the CFTC Cross-Border Guidance.

After considering commenters' views regarding the cross-border application of the de minimis exception, we are adopting final rules that have been modified from the proposal in certain important respects. While these changes are discussed in more detail below, key elements include:

• Modifications to the proposed definition of “U.S. person”;
• Provisions to distinguish non-U.S. persons' dealing activity involving security-based swaps that are guaranteed by their U.S. affiliates from such non-U.S. persons' other dealing activity for purposes of the de minimis exception, by requiring a non-U.S. person to count against the de minimis thresholds all dealing activity involving security-based swaps for which its counterparty has rights of recourse against a U.S. guarantor that is affiliated with the non-U.S. person;
• Provisions to distinguish non-U.S. persons that act as conduit affiliates (by entering into certain security-based swap transactions on behalf of their U.S. affiliates) from other non-U.S. persons for purposes of the de minimis exception, in that conduit affiliates are required to count all of their dealing activity against the de minimis thresholds regardless of counterparty;
• Modifications to the application of the de minimis exception to dealing activity by non-U.S. persons when the counterparty is the foreign branch of a U.S. bank.
• The addition of an exclusion related to cleared, anonymous transactions; and
• Modifications of the proposed aggregation provisions, in part by removing the “operational independence” condition to excluding dealing positions of affiliates that are registered dealers.

The final rules we are adopting reflect a territorial approach that is generally consistent with the principles that the Commission traditionally has followed with respect to the registration of brokers and dealers under the Exchange Act. Under this territorial approach, registration and other requirements applicable to brokers and dealers generally are triggered by a broker or dealer physically operating in the United States, even if its activities are directed solely toward non-U.S. persons outside the United States. The territorial approach further generally requires broker-dealer registration by foreign brokers or dealers that, from outside the United States, induce or attempt to induce securities transactions by persons within the United States—but not when such foreign brokers or dealers conduct their activities entirely outside the United States.

In the cross-border context, moreover, the application of the “security-based swap dealer” definition and its de minimis exception remains subject to general principles that we addressed in the Intermediary Definitions Adopting Release. Accordingly, the term “person” as used in the “security-based swap dealer” definition and in the Commission's rules implementing the de minimis exception should be interpreted to refer to a particular legal person, meaning that a trading desk, department, office, branch or other discrete business unit that is not a separately organized legal person will not be viewed as a security-based swap dealer. As a result, a legal person with a branch, agency, or office that is engaged in dealing activity above the de minimis threshold is required to register as a security-based swap dealer, even if the legal person's dealing activity is limited to such branch, agency, or office.

Cross-border security-based swap transactions also are subject to the principle that transactions between majority-owned affiliates need not be considered for purposes of determining whether a person is a dealer.

As discussed below, these final rules and guidance do not address the proposed provisions regarding the cross-border application of the dealer definition to “transactions conducted within the United States,” as defined in the Cross-Border Proposing Release. We anticipate soliciting additional public comment on potential approaches for applying the dealer definition to non-U.S. persons in connection with activity between two non-U.S. persons where one or both are conducting dealing activity that occurs within the United States.

B. Application of De Minimis Exception to Dealing Activities of U.S. Persons

1. Proposed Approach and Commenters' Views

Under the proposal, a U.S. person would have counted all of its security-based swap dealing activity against the de minimis thresholds, including transactions that it conducted through a foreign branch. Although some persons who submitted comments in connection with the Intermediary Definitions Adopting Release expressed the view that dealing activity by foreign branches should not be counted as part of a U.S. person's de minimis calculation, we did not propose such an approach. Moreover, commenters to the Cross-Border Proposing Release did not specifically express opposition to this aspect of the proposal, although several commenters addressed related issues regarding the proposed scope of the “U.S. person” definition.

2. Final Rule

Consistent with the proposal, the final rules require U.S. persons to apply all of their dealing transactions against the de minimis thresholds, including activity they conduct through their foreign branches. Such dealing transactions must be counted regardless of where they are arranged, negotiated, or executed.

As discussed above, it is our view that any dealing activity undertaken by a U.S. person, as defined in this final rule, occurs at least in part within the United States and therefore warrants the application of Title VII regardless of where particular aspects of dealing activity are conducted. Whenever a U.S. person enters into a security-based swap in a dealing capacity, it is the U.S. person as a whole—and not merely any applicable foreign branch or office of that U.S. person—that holds itself out as a dealer in security-based swaps. It is the U.S. person as a whole that seeks to profit by providing liquidity and making a market in security-based swaps, and it is the financial resources of the U.S. person as a whole that enable it to do so. Even if the U.S. person engages in dealing activity through a foreign branch or office, its dealing counterparties will look to the entire U.S. person—and not merely its foreign branch or office—for performance on the transaction, and the U.S. person as a whole assumes and stands behind the obligations arising from the security-based swap, thereby creating risk to the U.S. person and potentially to the U.S. financial system. A dealer that is organized or has its principal place of business in the United States thus cannot hold itself out as anything other than a single person, and generally cannot operate as a dealer absent the financial and other resources of that single person. Accordingly, we conclude that U.S. persons that engage in security-based swap dealing activity through foreign branches or offices should be subject to the regulatory framework for dealers even if those U.S. persons deal exclusively with non-U.S. persons.

C. Definition of “U.S. Person”

1. Proposed Approach

Consistent with our territorial approach to application of Title VII to cross-border security-based swap activity, our Cross-Border Proposal defined “U.S. person” to mean:

• Any natural person resident in the United States;
• Any partnership, corporation, trust, or other legal person organized or incorporated under the laws of the United States or having its principal place of business in the United States; and

• Any account (whether discretionary or non-discretionary) of a U.S. person.

The Commission also proposed that the term “U.S. person” would exclude the following international organizations: the International Monetary Fund (“IMF”), the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans.

This proposed definition of “U.S. person” generally followed an approach to defining U.S. person that is similar to that used by the Commission in other contexts, though it was tailored to the specific goals of Title VII. As we noted in the proposal, we sought with the proposed definition to identify those types of individuals or entities whose security-based swap activity is likely to impact the U.S. market even if they transact with security-based swap dealers that are not U.S. persons and to identify those types of individuals or entities that are part of the U.S. security-based swap market and should receive the protections of Title VII.

2. Commenters' Views

We received extensive comments on our proposed definition of “U.S. person.” In these comments, many commenters also expressed their views on the interpretation of “U.S. person” in the CFTC Cross-Border Guidance. As explained in more detail below, several commenters emphasized that we should minimize divergence from the CFTC's approach, including by adding certain elements to our definition of “U.S. person” that we had not proposed. Many commenters also identified specific elements of the CFTC interpretation that we should not adopt in our final rule.

(a) Definition of “U.S. Person” Generally

Several commenters expressed the view that our proposed definition of “U.S. person” was clear, objective, and territorial in scope. At the same time, many commenters, including some who expressed agreement with our proposed approach, urged us to adopt, in whole or in part, a definition of “U.S. person” that is consistent with the interpretation of “U.S. person” in the CFTC Cross-Border Guidance. In contrast, two commenters disagreed with our approach as being underinclusive and urged us to define U.S. person more broadly than the CFTC had interpreted it. Two commenters addressed whether our “U.S. person” definition should follow the U.S. person analysis in Regulation S.

(b) Treatment of Investment Vehicles

In response to our questions about whether our proposed definition of “U.S. person” provided sufficient guidance to investment vehicles and similar legal persons, commenters generally requested guidance but expressed a range of views as to what guidance we should provide. One commenter requested that we ensure that foreign investment vehicles with a “U.S. nexus” be considered U.S. persons. This commenter expressed support for what it described as our “complementary” proposed approach that would have required legal persons, including investment vehicles, to perform a principal place of business assessment to determine whether they are U.S. persons, and would have subjected all transactions conducted within the United States to Title VII requirements. One commenter conversely argued that a “principal place of business” test for investment vehicles would be inappropriate.

Several commenters requested that we provide additional guidance regarding the application of the “principal place of business” test to investment vehicles. Some commenters specifically requested that we avoid diverging from the CFTC's interpretation of “U.S. person” in our own final definition. One commenter urged us to help ensure that market participants are able to make rational and consistent determinations regarding the U.S.-person status of investment vehicles, and suggested that an appropriate test would look to the location of the person responsible for the fund's operational management, which the commenter identified as the person that establishes the investment vehicle and selects persons to carry out functions on behalf of the vehicle, as opposed to the person responsible for the fund's investment management activities. Another commenter requested guidance regarding the application of the “principal place of business” test, while expressing support for using an approach similar to the CFTC Cross-Border Guidance. One commenter requested that the location of an asset manager retained by a person not be the sole factor used to determine the person's principal place of business or U.S.-person status.

A few commenters responded to our question whether the proposed definition should encompass funds that are majority-owned by U.S. persons, as the CFTC's interpretation does, with two commenters advocating against and three advocating in favor of such an approach. One of the commenters that opposed such a test urged, however, that if we were to adopt such a test, the test be identical to the approach taken by the CFTC.

One commenter suggested that we adopt the CFTC's approach by which collective investment vehicles that are offered publicly only to non-U.S. persons, and not offered to U.S. persons, would not generally be considered “U.S. persons.” Another commenter urged that the definition exclude “non-U.S. regulated funds” that are offered publicly only to non-U.S. persons but are offered privately to U.S. persons in certain specific circumstances.

(c) Treatment of Legal Persons More Generally

Two commenters urged us to include in the definition of “U.S. person” guaranteed subsidiaries and affiliates of U.S. persons. Alternatively, these commenters suggested that we should require dealing transactions with such persons to be included in the dealing counterparty's security-based swap dealer de minimis calculation. However, another commenter supported our proposed approach not to look to whether a person's transactions are guaranteed by a U.S. person for purposes of determining that person's U.S.-person status, stating that our proposal to address such risk through major security-based swap participant registration was sufficient.

One commenter suggested that the Commission follow the CFTC in including in its final “U.S. person” definition legal persons that are directly or indirectly majority-owned by one or more U.S. persons who bear unlimited responsibility for the obligations of that legal person, stating that such a provision is necessary to prevent evasion of Title VII.

One commenter expressed support for a principal place of business component to the “U.S. person” definition as set forth in our proposal. Several commenters requested that the Commission provide additional guidance regarding relevant factors in identifying a legal person's principal place of business. One commenter suggested that the location of a company's headquarters should be determinative and that a particular legal person should have only one principal place of business.

Several commenters suggested that the Commission harmonize its approach to determining a person's principal place of business to the approach in the CFTC Cross-Border Guidance, while at least one commenter suggested that the Commission work with the CFTC to develop a new, common definition. At least two commenters, on the other hand, objected to the use of a “principal place of business” test. One commenter suggested an alternative approach that would establish criteria for this determination, such as quantitative thresholds, and would also consider not requiring a principal place of business analysis if the jurisdiction of incorporation has an acceptable regulatory framework. Another commenter stated that a U.S. branch of a person established in another jurisdiction should not be considered to have its principal place of business in the United States. Another suggested that requiring a principal place of business analysis represented a departure from the Commission's stated territorial approach to U.S. person.

Several commenters recommended that, if the Commission were to adopt a “principal place” of business test in its “U.S. person” definition, market participants be allowed to rely on a counterparty's representations as to the counterparty's principal place of business. Another suggested that the test look to information found in the public filings of a public company or, with respect to a private company, the location of its business.

(d) Accounts

One commenter supported the Commission's proposal for determining the U.S.-person status of an account, which would look to whether the owner of the account itself is a U.S. person, but suggested that the Commission provide bright-line thresholds to clarify that de minimis ownership by U.S. persons would not cause the account to be considered a U.S. person. The commenter further requested that the Commission clarify that the “account” prong of the “U.S. person” definition would not apply to collective investment vehicles but was intended to capture persons that should be considered U.S. persons even though they are conducting trades, as the direct counterparty, through an account.

(e) International Organizations

A number of commenters expressed support for the Commission's proposal to exclude certain international organizations (e.g., multilateral development banks, or “MDBs”) from the “U.S. person” definition. Three commenters specifically requested that the Commission list all such institutions that would be excluded from the “U.S. person” definition, similar to the approach the CFTC took in its guidance, rather than refer to “other similar international organizations.” These commenters also argued that certain organizations have absolute immunity under federal law and should be excluded from regulation under Title VII entirely. Three commenters requested that affiliates of MDBs and similar organizations also be excluded from the definition of “U.S. person.”

(f) Status Representations

Some commenters requested that a potential dealer expressly be permitted to rely on a counterparty representation to fulfill its diligence requirements in determining whether its counterparty is a U.S. person under the final rule. Several commenters, as discussed above, specifically requested that we permit reliance on representations as to a person's principal place of business. Two commenters requested that market participants be permitted to rely on the representations prepared by counterparties under the CFTC Cross-Border Guidance.

3. Final Rule

Consistent with the proposal, we are adopting a final definition of “U.S. person” that continues to reflect a territorial approach to the application of Title VII and is in most respects unchanged from the proposal. In response to comments, the final definition reflects certain changes intended to clarify the scope of the definition. Also in response to comments, we are adopting a general definition of “principal place of business” and a specific application of the term to externally managed investment vehicles. We are also adding a prong relating specifically to the U.S.-person status of estates.

The final rule defines “U.S. person” to mean:

• Any natural person resident in the United States;
• Any partnership, corporation, trust, investment vehicle, or other legal person organized, incorporated, or established under the laws of the United States or having its principal place of business in the United States;
• Any account (whether discretionary or non-discretionary) of a U.S. person; or
• Any estate of a decedent who was a resident of the United States at the time of death.

The final rule defines “principal place of business” to mean “the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person.” It also provides that, with respect to an externally managed investment vehicle, this location “is the office from which the manager of the vehicle primarily directs, controls, and coordinates the investment activities of the vehicle.”

Also consistent with the proposal, the final definition excludes the following international organizations from the definition of “U.S. person”: The IMF, the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans.

To address commenters' requests, the final rule also has been revised from the proposal to provide that a person may rely on a counterparty's representation regarding its status as a U.S. person, unless such person knows, or has reason to know, that the representation is inaccurate.

Although one commenter requested that we use a definition of “U.S. person” that is consistent with Regulation S, we are declining to do so for the reasons described in our Cross-Border Proposing Release. We acknowledge that many market participants are accustomed to Regulation S and may find such a definition relatively easy to implement. As we discussed in our proposal, however, Regulation S addresses different concerns from those addressed by Title VII. In light of these differences, the Commission believes that adopting the definition of “U.S. person” in Regulation S would not achieve the goals of Title VII and that a definition of U.S. person specifically tailored to the regulatory objectives it is meant to serve, as we are adopting here, is appropriate.

(a) Natural Persons

As in our proposed definition, the final definition of “U.S. person” provides that any natural person resident in the United States is a U.S. person. This definition encompasses persons resident within the United States regardless of the individual's citizenship status, but it does not encompass individuals who are resident abroad, even if they possess U.S. citizenship.

As we noted in the proposal, it is consistent with the approach we have taken in prior rulemakings relating to the cross-border application of certain similar regulatory requirements to subject natural persons residing within the United States to our regulatory framework. Moreover, we believe that natural persons residing within the United States who engage in security-based swap transactions are likely to raise the types of concerns intended to be addressed by Title VII, including those related to risk, transparency, and counterparty protection. We believe that it is reasonable to infer that a significant portion of such persons' financial and legal relationships are likely to exist within the United States and that it is therefore reasonable to conclude that risks arising from the security-based swap activities of such persons could manifest themselves within the United States, regardless of the location of their counterparties.

(b) Corporations, Organizations, Trusts, Investment Vehicles, and Other Legal Persons

The final definition of “U.S. person” as applied to legal persons has been modified to clarify certain aspects of the rule. Also, in response to comments, we are adopting a definition of “principal place of business.” In general, the scope of the definition as applied to legal persons does not differ materially from the scope of our proposal.

i. Entities Incorporated, Organized, or Established Under U.S. Law

As with the proposed rule, the final definition provides that any partnership, corporation, trust, or other legal person organized or incorporated under the laws of the United States or having its principal place of business in the United States would be a U.S. person. The final definition also includes two changes that are intended to make explicit certain concepts that were implicit in the proposed definition. First, the final rule provides that a legal person “established” under the laws of the United States is a U.S. person, just as if it had been “organized” or “incorporated” under the laws of the United States. This change is intended to clarify the Commission's intention that any person formed in any manner under the laws of the United States will be a U.S. person for purposes of Title VII.

Second, the final rule adds an express reference to “investment vehicle” in the non-exclusive list of legal persons to clarify that any such person, however formed, will be treated as a U.S. person for purposes of Title VII if it is organized, incorporated, or established under the laws of the United States or has its principal place of business in the United States. Investment vehicles are commonly established as partnerships, trusts, or limited liability entities and, therefore, fall within the scope of the rule as proposed. However, given the significant role that such vehicles have played and likely will continue to play in the security-based swap market, we believe that the final rule should incorporate an express reference to such vehicles to avoid any ambiguity regarding whether the definition of “U.S. person,” including the principal place of business component of that definition, applies to them.

As noted in our proposal, we have previously looked to where a legal person is organized, incorporated, or established to determine whether it is a U.S. person. We continue to believe that place of organization, incorporation, or establishment is relevant in the context of Title VII. In our view, the decision of a corporation, trustee, or other person to organize under the laws of the United States indicates a degree of involvement in the U.S. economy or legal system that warrants subjecting it to security-based swap dealer or major security-based swap participant registration requirements under Title VII if its security-based swap dealing activity or its security-based swap positions exceed the relevant thresholds. We believe that it is reasonable to infer that an entity incorporated, organized, or established under the laws of the United States is likely to have a significant portion of its financial and legal relationships in the United States and that it is therefore reasonable to conclude that the risks arising from its security-based swap activities are likely to manifest themselves in the United States, regardless of the location of its counterparties. Accordingly, the final rule retains this element of the definition.

As under the proposal, the final definition determines a legal person's status at the entity level and thus applies to the entire legal person, including any foreign operations that are part of the U.S. legal person. Consistent with this approach, a foreign branch, agency, or office of a U.S. person is treated as part of a U.S. person, as it lacks the legal independence to be considered a non-U.S. person for purposes of Title VII even if its head office is physically located within the United States. We continue to believe that there is no basis to treat security-based swap transactions or positions of a foreign branch, agency, or office of a U.S. person differently from similar transactions or positions of the home office for purposes of the dealer de minimis or major security-based swap participant threshold calculations, given that the legal obligations and economic risks associated with such transactions or positions directly affect the entire U.S. person.

Under the final definition, the status of a legal person as a U.S. person has no bearing on whether separately incorporated or organized legal persons in its affiliated corporate group are U.S. persons. Accordingly, a foreign subsidiary of a U.S. person is not a U.S. person merely by virtue of its relationship with its U.S. parent. Similarly, a foreign person with a U.S. subsidiary is not a U.S. person simply by virtue of its relationship with its U.S. subsidiary. Although two commenters urged that most foreign affiliates of U.S. persons be treated as U.S. persons themselves, we continue to believe that it is appropriate for each affiliate to determine its U.S.-person status independently, given the distinct legal status of each of the affiliates, and that such status should turn on each affiliate's place of incorporation, organization, or establishment, or on its principal place of business. We recognize that certain foreign persons, including foreign persons whose security-based swap activity is subject to a recourse guarantee against a U.S. person, may create risk to persons within the United States such as counterparties or guarantors. We continue to believe, however, that, to the extent that such persons are established under the laws of a foreign jurisdiction and have their principal place of business abroad, they should not be included in the definition of “U.S. person.” As discussed in further detail below, we believe that our final rules regarding application of the dealer de minimis exception and the major security-based swap participant thresholds adequately address concerns about the treatment of these persons under the dealer and major participant definitions without categorizing them as U.S. persons.

ii. Entities Having Their Principal Place of Business in the United States

a. In General

Consistent with our proposal, we are defining “U.S. person” to include persons that are organized, incorporated, or established abroad, but have their principal place of business in the United States. For purposes of this final rule, and in response to commenters' request for further guidance, we are defining “principal place of business” generally to mean “the location from which the officers, partners, or managers of the legal person primarily direct, control, and coordinate the activities of the legal person.” As with the “U.S. person” definition more generally, our definition of “principal place of business” is intended to identify the location where a significant portion of the person's financial and legal relationships would be likely to exist, and we think it is reasonable to assume, for purposes of this final rule, that this location also generally corresponds to the location from which the activities of the person are primarily directed, controlled, and coordinated. In our view, to the extent that this location is within the United States, it is reasonable to conclude that the risks arising from that entity's security-based swap activity could manifest themselves within the United States, regardless of location of its counterparties.

This definition is intended to help market participants make rational and consistent determinations regarding whether their (or their counterparty's) principal place of business is in the United States. Under the final rule, the principal place of business is in the United States if the location from which the overall business activities of the entity are primarily directed, controlled, and coordinated is within the United States. With the exception of externally managed entities, as discussed further below, we expect that for most entities the location of these officers, partners, or managers generally would correspond to the location of the person's headquarters or main office.

Although we recognize that several commenters objected to including a “principal place of business” test in our definition of “U.S. person,” we believe that a definition that focused solely on whether a legal person is organized, incorporated, or established in the United States could encourage some entities to move their place of incorporation to a non-U.S. jurisdiction to avoid complying with Title VII, while maintaining their principal place of business—and thus, reasonably likely, risks arising from their security-based swap transactions—in the United States. Moreover, we believe that a definition of “U.S. person” that did not incorporate a “principal place of business” element potentially would result in certain entities falling outside the Title VII regulatory framework, even though the nature of their legal and financial relationships in the United States is, as a general matter, indistinguishable from that of entities incorporated, organized, or established in the United States. Given that such entities raise the types of concerns that Title VII was intended to address, we believe it is both appropriate under our territorial approach and consistent with the purposes of Title VII to treat such entities as U.S. persons for purposes of the final rule.

We also have considered the suggestion by one commenter that “principal place of business” be defined to incorporate certain quantitative thresholds and an exception for firms whose jurisdiction of incorporation has an acceptable regulatory framework in place. However, we do not believe such thresholds are necessary. Because the analysis is applied on an entity-wide basis, consistent with our entity-based approach generally, the “principal place of business” analysis generally will not encompass companies incorporated, organized, or established outside the United States merely because they have an office or branch within the United States. Similarly, we do not believe that the determination whether a legal person's jurisdiction of incorporation, organization, or establishment has an acceptable regulatory framework is relevant to the question whether a specific person has its principal place of business in the United States any more than it would be relevant for a person incorporated within the United States but subject to regulation abroad. The question whether such a company should be permitted to fulfill relevant Title VII requirements by complying with the law of the jurisdiction in which it is incorporated, organized, or established is a separate issue that may be addressed in a separate substituted compliance determination.

Finally, we recognize that one commenter suggested that a “principal place of business” test should look to the location of personnel directing the security-based swap activity of the entity, but we are not convinced that the location of such personnel, without more, would necessarily correspond to the location of a significant portion of the entity's financial and legal relationships, which is the focus of our “U.S. person” definition. We also note that a focus on the location of personnel directing the entity's security-based swap activity would provide an incentive for market participants to move such personnel outside the United States while maintaining their executive offices, and the bulk of their operations, within the United States. Such restructuring would allow an entity to avoid application of Title VII to its security-based swap activities while continuing to maintain a significant portion of its financial and legal relationships within the United States, leaving unchanged the likelihood that risks arising from its security-based swap activity could manifest themselves within the United States while avoiding application of Title VII to such activities.

b. Externally Managed Investment Vehicles

Application of the “principal place of business” test to externally managed investment vehicles presents certain challenges not present when determining the principal place of business of an operating company or other internally managed legal person. For example, an operating company generally will carry out key functions (including directing, controlling, and coordinating its business activities) on its own behalf and generally will have offices through which these functions are performed. Responsibility for key functions of an externally managed investment vehicle, on the other hand, generally will be allocated to one or more separate persons (such as external managers, or other agents), with few or no functions carried out through an office of the vehicle itself. Further complicating the application of this definition is the organizational and operational diversity of such vehicles.

Notwithstanding these challenges, we also recognize that externally managed investment vehicle are active participants in the security-based swap market and, in our view, should be treated as U.S. persons if their operations are primarily directed, controlled, and coordinated from a location within the United States. For example, we understand that a significant portion of the investment vehicles that participate in the security-based swap market are private funds such as hedge funds. We have observed that such private funds commonly may be organized under non-U.S. law—frequently in the Cayman Islands—but are managed by investment advisers headquartered in the United States. We also understand that those advisers commonly manage or direct the investment activities of these vehicles, including the arrangement of security-based swaps, through locations within the United States. We further understand that a significant portion of the financial and legal relationships of such vehicles, as a general matter, are in the United States, including some combination of equity ownership by managers (or their affiliates) and outside investors, credit relationships with prime brokers and other lenders, and relationships with other market participants and service providers. These vehicles, therefore, raise concerns that are similar to those raised by the security-based swap activities of market participants that are incorporated, established, or organized in the United States. Over the past two decades, failures of investment vehicles of various types organized under foreign law, but directed, controlled, or coordinated from within the United States have had significant negative impact on U.S. financial institutions, potentially threatening the stability of the U.S. financial system more generally. We believe that it is reasonable to expect that the security-based swap activities of such vehicles may pose similar risks.

To address the unique characteristics of externally managed investment vehicles, we are including in our definition of “principal place of business” language specifying that an externally managed investment vehicle's principal place of business is “the office from which the manager of the vehicle primarily directs, controls, and coordinates the investment activities of the vehicle.” This definition directs market participants to consider where the activities of an externally managed investment vehicle generally are directed, controlled, and coordinated, even if this conduct is performed by one or more legally separate persons. For an investment vehicle, for example, the primary manager is responsible for directing, controlling, and coordinating the overall activity of the vehicle, such that the business of the vehicle, such as its investment and financing activity, is principally carried out at the location of the primary manager. Such an investment vehicle's principal place of business under the final rule would be the location from which the manager carries out those responsibilities.

As noted above, at least one commenter suggested that a “principal place of business” test should look to the location of personnel directing the security-based swap activity of the vehicle. Although we believe that the manager responsible for directing, controlling, and coordinating the activities of the externally managed investment vehicle also would generally be responsible for directing, controlling, and coordinating the security-based swap activity of such vehicle, we do not believe that an externally managed vehicle should be excluded from the U.S. person definition merely because the manager that otherwise directs, controls, and coordinates its activity has effectively shifted responsibility for the security-based swap activity of the externally managed vehicle to a non-U.S. person. As noted above, such an approach would provide an incentive to move responsibility for the security-based swap activity of externally managed vehicles outside the United States while retaining control of all other activities relating to management of such vehicles within the United States. As with the “principal place of business” definition more generally, and for similar reasons, we believe that the definition of “principal place of business” set forth in the final rule with respect to externally managed vehicles is consistent with our territorial approach to application of Title VII. We also note, however, that for the reasons just discussed the final definition's focus on where the activity of the vehicle as a whole is primarily directed, controlled, and coordinated, as opposed to a focus on its security-based swap activity, is in our view necessary or appropriate to prevent the evasion of Title VII.

In our proposal, we stated that we did not think that the U.S.-person status of a commodity pool operator (“CPO”) or fund adviser (as opposed to the fund actually entering into the transaction) was in itself relevant in determining the U.S.-person status of an investment vehicle. Although the definition of “principal place of business” we are adopting in this final rule may lead to similar classifications of investment vehicles for purposes of the “U.S. person” definition as a test that looked to the U.S.-person status of a CPO or fund adviser, we believe that the definition we are adopting is more appropriately designed to capture externally managed investment vehicles that raise the kinds of concerns that Title VII was intended to address. Moreover, we note that mere retention of an asset manager that is a U.S. person, without more, would not necessarily bring an offshore investment vehicle or other person within the scope of the “U.S. person” definition. However, where an asset manager, whether or not a U.S. person, is primarily responsible for directing, controlling, and coordinating the activities of an externally managed vehicle and carries out this responsibility within the United States, we believe that it is reasonable to include the externally managed vehicle in the definition of “U.S. person” and to require foreign dealers to include dealing activity with such vehicles in their de minimis threshold calculations.

iii. Fund Ownership

Some commenters urged us to include in the definition investment vehicles that are majority-owned by U.S. persons. One of these commenters noted that the CFTC had reasoned that “`passive investment vehicles'” designed to “`achieve the investment objectives of their beneficial owner'” were distinguishable from majority-owned entities that are “`separate, active operating businesses.' ” We are not persuaded, however, that this distinction between investment vehicles and operating companies warrants treating ownership interests in these two types of entities differently for purposes of the “U.S. person” definition, particularly given that the exposure of investors in a collective investment vehicle engaging in security-based swap transactions typically is capped at the amount of their investment and such investors generally are unlikely to seek to make the investment vehicle's counterparties whole for reputational or other reasons in the event of a default. We do not believe risks created through ownership interests in collective investment vehicles are the types of risks that Title VII is intended to address with respect to security-based swaps.

Because we are not adopting an ownership test for funds, we are also not following the suggestion of some commenters that we exclude from the “U.S. person” definition investment vehicles that are offered publicly only to non-U.S. persons and are not offered to U.S. persons. Although we recognize that the CFTC reasoned that such investment vehicles would generally not be within its interpretation of “U.S. person,” we do not believe that it would be relevant under our final definition, which does not focus on an investment vehicle's ownership by U.S. persons.

(c) Accounts

The final definition of “U.S. person” continues to mean “any account (whether discretionary or not) of a U.S. person,” irrespective of whether the person at which the account is held or maintained is a U.S. person. As a general matter, we expect that market participants will determine their U.S.-person status under the prongs of that definition relating to natural persons or to legal persons. This “account” prong of the definition is intended to clarify that a person's status for purposes of this rule generally does not differ depending on whether the person enters into security-based swap transactions through an account, or depending on whether the account is held or maintained at a U.S. person or a non-U.S. person intermediary or financial institution.

Consistent with the overall approach to the definition of “U.S. person,” our focus under the “account” prong of this definition is on the party that actually bears the risk arising from the security-based swap transactions. Accordingly, an account owned solely by one or more U.S. persons is a U.S. person, even if it is held or maintained at a foreign financial institution or other person that is itself not a U.S. person; an account owned solely by one or more non-U.S. persons is not a U.S. person, even if it is held or maintained at a U.S. financial institution or other person that is itself a U.S. person. For purposes of this “account” prong of the “U.S. person” definition, account ownership is evaluated only with respect to direct beneficial owners of the account. Because the status of an account turns on the status of the account's beneficial owners, the status of any nominees of an account is irrelevant in determining whether the account is a U.S. person under the final rule.

Where an account is owned by both U.S. persons and non-U.S. persons, the U.S.-person status of the account, as a general matter, should turn on whether any U.S.-person owner of the account incurs obligations under the security-based swap. Consistent with the approach to U.S.-person and non-U.S.-person accounts described above, neither the status of the fiduciary or other person managing the account, nor the discretionary or non-discretionary nature of the account, nor the status of the person at which the account is held or maintained are relevant in determining the account's U.S.-person status.

(d) Estates

The final rule incorporates a new prong that expressly includes certain estates within the definition of “U.S. person.” Under the final rule any estate of a natural person who was a resident of the United States at the time of death is itself a U.S. person. Our proposed rule did not expressly address estates because we did not believe that they typically engage in security-based swap activity and, to the extent that they do, their U.S.-person status would have been determined under the standard applicable to any legal person under our proposed rule. We received no comments in response to our questions regarding whether we should adopt a final rule that expressly addresses estates or that reflects the CFTC's proposed approach.

We continue to believe that estates are not likely to be significant participants in the security-based swap market, but we also believe that, given the unique characteristics of estates, it is appropriate to include in the “U.S. person” definition an express reference to estates of decedents who were residents of the United States at the time of death. This element of our final definition reflects similar considerations to those that informed our inclusion of natural persons who are residents of the United States within the scope of that definition. We noted above that the security-based swap activity of a natural person who is a resident of the United States raises the types of risks that Title VII is intended to address, given that person's residence status and likely financial and legal relationships, and we expect that the estate of a natural person who was a resident of the United States at the time of his or her death is likely to operate within the same relationships that warranted subjecting such transactions to Title VII during the life of the decedent.

(e) Certain International Organizations

As under the proposal, the final rule expressly excludes certain international organizations from the definition of U.S. person. This list includes “the [IMF], the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, and their agencies and pension plans, and any other similar international organizations, their agencies and pension plans.” Although these organizations may have headquarters in the United States, the Commission continues to believe that their status as international organizations warrants excluding them from the definition of “U.S. person.”

4. Representations Regarding U.S.-Person Status

Our proposed definition of “U.S. person” did not expressly provide that parties could rely on representations from their counterparties as to their counterparties' U.S.-person status, although we did anticipate that parties likely would request such representations. On further consideration, we believe that market participants would benefit from an express provision permitting reliance on such representations. Accordingly, under the final rule, a person need not consider its counterparty to be a U.S. person for purposes of Title VII if that person receives a representation from the counterparty that the counterparty does not satisfy the criteria set forth in Exchange Act rule 3a71-3(a)(4)(i), unless such person knows or has reason to know that the representation is not accurate. For purposes of the final rule a person would have reason to know the representation is not accurate if a reasonable person should know, under all of the facts of which the person is aware, that it is not accurate.

Expressly permitting market participants to rely on such representations in the “U.S. person” definition should help mitigate challenges that could arise in determining a counterparty's U.S.-person status under the final rule. It permits the party best positioned to make this determination to perform an analysis of its own U.S.-person status and convey, in the form of a representation, the results of that analysis to its counterparty. In addition, such representations should help reduce the potential for inconsistent classification and treatment of a person by its counterparties and promote uniform application of Title VII.

The final rule reflects a constructive knowledge standard for reliance. Under this standard, a counterparty is permitted to rely on a representation, unless the person knows or has reason to know that the representation is inaccurate. A person would have reason to know the representation is not accurate for purposes of the final rule if a reasonable person should know, under all of the facts of which the person is aware, that it is not accurate. We believe that this “know or have reason to know” standard should help ensure that potential security-based swap dealers and major security-based swap participants do not disregard facts that call into question the validity of the representation.

D. Application of De Minimis Exception to Dealing Activities of Conduit Affiliates

1. Proposed Approach and Commenters' Views

The Cross-Border Proposing Release did not include requirements specific to “conduit affiliates” or other non-U.S. persons that enter into security-based swap transactions on behalf of their U.S. affiliates. Instead, the proposal would have treated those entities like other non-U.S. persons, and required them to count, against the de minimis thresholds, only their dealing transactions with U.S. persons other than foreign branches, and their dealing transactions conducted in the United States. The proposal also noted that the general rule implementing the de minimis exception excludes transactions between majority-owned affiliates from the analysis.

The proposal acknowledged the difference between its approach and the CFTC's approach in its proposed cross-border guidance, which encompassed special provisions for foreign affiliates that act as conduits for U.S. persons. We thus cited the CFTC's proposed approach toward conduit affiliates in requesting comment regarding whether the Commission should follow a similar approach. We also requested comment as to whether the Commission should, consistent with the CFTC's proposed approach, require a person that operates a “central booking system”—whereby security-based swaps are booked to a single legal person—be subject to applicable dealer registration requirements as if the person had entered into the security-based swaps directly. More generally, we requested comment as to whether foreign affiliates of U.S. persons, such as majority-owned subsidiaries of U.S. parents, should be considered to be U.S. persons.

One commenter took the view that the Commission's rules should not make use of the conduit affiliate concept notwithstanding its use in the CFTC Cross-Border Guidance, stating that the concept lacks any statutory or regulatory authority, would not advance efforts to reduce systemic risk, and, if applied to end-users, would interfere with internal risk allocations within a corporate group. In contrast, one commenter depicted conduit affiliates as being a type of person that is subject to a de facto guarantee by a U.S. affiliate and that should thus be treated as a U.S. person, and also argued that the dealer registration requirement should apply to other types of entities subject to a de facto guarantee.

One commenter further opposed the adoption of an approach that would require a “central booking system” or any other affiliate to register as a security-based swap dealer based solely on its inter-affiliate security-based swap transactions, arguing that such an approach would tie registration requirements to firms' internal risk management practices, and would hamper the ability to manage risk across a multinational enterprise.

2. Final Rule

The final rule distinguishes “conduit affiliates” from other non-U.S. persons by requiring such entities to count all of their dealing transactions against the de minimis thresholds, regardless of the counterparty. As discussed below, for these purposes a “conduit affiliate” is a non-U.S. affiliate of a U.S. person that enters into security-based swaps with non-U.S. persons, or with certain foreign branches of U.S. banks, on behalf of one or more of its U.S. affiliates (other than U.S. affiliates that are registered as security-based swap dealers or major security-based swap participants), and enters into offsetting transactions with its U.S. affiliates to transfer the risks and benefits of those security-based swaps.

After careful consideration, we believe that requiring such conduit affiliates to count their dealing transactions against the de minimis thresholds is appropriate to help ensure that non-U.S. persons do not facilitate the evasion of registration requirements under Dodd-Frank by participating in arrangements whereby a non-U.S. person engages in security-based swap activity outside the United States on behalf of a U.S. affiliate that is not a registered security-based swap dealer or major security-based swap participant, and the U.S. affiliate assumes economic risks and benefits of those positions by entering into offsetting transactions with the non-U.S. affiliate. Absent such a requirement that conduit affiliates count their dealing transactions for purposes of the de minimis exception, a U.S. person may be able to effectively engage in unregistered dealing activity involving non-U.S. persons by having a non-U.S. affiliate enter into dealing transactions with other non-U.S. persons (which would not be counted against the de minimis thresholds because both counterparties are non-U.S. persons) or with foreign branches of U.S. banks that are registered as security-based swap dealers (which would not be counted against the de minimis thresholds because of an exclusion for dealing transactions with foreign branches of U.S. banks that are registered as security-based swap dealers). The U.S. person could enter into offsetting transactions with those non-U.S. affiliates, and those offsetting transactions would not be counted against the de minimis thresholds due to the inter-affiliate exception to the dealer analysis.

Accordingly, in our view, requiring conduit affiliates to count their dealing transactions against the thresholds is necessary or appropriate to prevent the evasion of any provision of the amendments made to the Exchange Act by Title VII for the reasons given above. We believe that this requirement is appropriately tailored to prevent the evasion of the dealer requirements, while preserving participants' flexibility in managing risk exposures through inter-affiliate transactions.

In light of the anti-evasion rationale for this use of the conduit affiliate concept, which is consistent with our statutory anti-evasion authority, we are not persuaded by a commenter's view that the use of the concept is outside of our authority. We also are not persuaded by that commenter's suggestion that the use of the conduit affiliate concept would not advance risk-mitigation goals, given that the concept can be expected to help ensure that the provisions of Title VII applicable to dealers (including risk mitigation provisions such as margin and capital requirements) are implemented, which can be expected to produce risk mitigation benefits.

At the same time, we recognize the significance of commenter concerns that the use of the “conduit affiliate” concept or the use of a “central booking system” approach to registration could impede efficient risk management practices. The conduit affiliate concept serves as a prophylactic anti-evasion measure, and we do not believe that any entities currently act as conduit affiliates in the security-based swap market, particularly given that a framework for the comprehensive regulation of security-based swaps did not exist prior to the enactment of Title VII, suggesting that market participants would have had no incentives to use such arrangements for evasive purposes.

Moreover, in light of this anti-evasion purpose, the definition of “conduit affiliate” does not include entities that may otherwise engage in relevant activity on behalf of affiliated U.S. persons that are registered with the Commission as security-based swap dealers or major security-based swap participants, as we do not believe that transactions involving these types of registered entities and their foreign affiliates raise the types of evasion concerns that the conduit affiliate concept is designed to address.

In addition, in the context of the dealer de minimis exception, the relevant rules would require the conduit affiliate to count only its dealing transactions. The rules accordingly distinguish dealing activity by a conduit affiliate from a corporate group's use of affiliates for non-dealing purposes, such as a corporate group's use of a single affiliated person to enter into transactions with the market for risk management not involving dealing activity (accompanied by offsetting inter-affiliate transactions that place the economic substance of the instrument into another person within the group). The requirement we are adopting here—under which a conduit affiliate will count only its dealing transactions against the de minimis thresholds—is not expected to impact persons that enter into security-based swaps with affiliates for non-dealing purposes.

Consistent with these goals, the final rule defines “conduit affiliate” in part as a non-U.S. person that directly or indirectly is majority-owned by one or more U.S. persons. To be a conduit affiliate, moreover, such a person must in the regular course of business enter into in security-based swaps with one or more other non-U.S. persons or with foreign branches of U.S. banks that are registered as security-based swap dealers, for the purposes of hedging or mitigating risks faced by, or otherwise taking positions on behalf of, one or more U.S. persons (other than U.S. persons that are registered as security-based swap dealers or major security-based swap participants) that control, are controlled by, or are under common control with the potential conduit affiliate, and enter into offsetting security-based swaps or other arrangements with such affiliated U.S. persons to transfer risks and benefits of those security-based swaps.

E. Application of De Minimis Exception to Dealing Activities of Other Non-U.S. Persons

As noted above, the proposal would have required non-U.S. persons to count, against the de minimis thresholds, only their dealing transactions involving U.S. persons other than foreign branches, and their dealing transactions conducted within the United States.

Aside from issues related to conduit affiliates, addressed above, commenters discussed other issues regarding the application of the de minimis exception to the dealing activities of non-U.S. persons, particularly relating to: (i) Dealing transactions of non-U.S. persons that are guaranteed by their U.S. affiliates; (ii) activities within the United States; and (iii) dealing activities of other non-U.S. persons whose counterparties are U.S. persons (including foreign branches of U.S. banks) or non-U.S. persons guaranteed by U.S. persons. We are addressing those groups of issues separately, given the distinct issues relevant to each. As discussed below, the final rule requires non-U.S. persons (apart from the conduit affiliates addressed above) to count all of their dealing transactions where: (1) The transaction is subject to a recourse guarantee against a U.S. affiliate of the non-U.S. person; or (2) the counterparty to the transaction is a U.S. person, other than the foreign branch of a registered security-based swap dealer.

1. Dealing Transactions of Non-U.S. Persons That Are Subject to Recourse Guarantees by Their U.S. Affiliates

(a) Proposed Approach and Commenters' Views

Under the proposal, a non-U.S. person's transactions involving security-based swaps guaranteed by its U.S. affiliate would have been treated the same as other transactions of non-U.S. persons for purposes of the de minimis exception. In other words, the non-U.S. guaranteed affiliate would have counted, against the de minimis thresholds, only its dealing transactions involving U.S. persons other than foreign branches, and its dealing transactions otherwise conducted within the United States.

In the Cross-Border Proposing Release, we solicited comment regarding whether the “U.S. person” definition should incorporate foreign entities that are guaranteed by their U.S. affiliates. We also expressed the preliminary view that the primary risk related to such guaranteed transactions of non-U.S. persons was the risk posed to the United States via the guarantee from a U.S. person, rather than the dealing activity occurring between two non-U.S. persons outside the United States, and sought to address this risk via the proposed attribution principles in the “major security-based swap participant” definition, and we also expressed the view that the use of the major participant definition effectively would address those regulatory concerns.

Two commenters supported an alternative approach to require such guaranteed non-U.S. persons to count all of their dealing transactions against the thresholds. One commenter stated that non-U.S. persons that receive guarantees from U.S. persons should count all of their dealing transactions toward the de minimis thresholds, arguing that the failure to do so would be inconsistent with the resulting flow of risk to the United States and that major participant regulation was not the appropriate means of addressing those risks. Another commenter took the position that the proposed approach would provide a loophole whereby U.S. entities trading in security-based swaps could avoid regulation under the Dodd-Frank Act. Both commenters further suggested that affiliates of U.S. persons be presumed to be beneficiaries of guarantees, with the presumption potentially subject to rebuttal if there is notice that no guarantee would be provided.

One comment letter did not explicitly address this issue, but did support the Commission's proposed approach not to require non-U.S. persons to aggregate the dealing transactions of their U.S.-guaranteed affiliates against the de minimis thresholds, stating that this would pose too tenuous a nexus with the U.S. to justify registration.

(b) Final Rule

Under the final rule, a non-U.S. person (other than a conduit affiliate, as discussed above) must count, against the de minimis thresholds, any security-based swap transaction connected with its dealing activity for which, in connection with that particular security-based swap, the counterparty to the security-based swap has rights of recourse against a U.S. person that is controlling, controlled by, or under common control with the non-U.S. person. For these purposes, the counterparty would be deemed to have a right of recourse against a U.S. affiliate of the non-U.S. person if the counterparty has a conditional or unconditional legally enforceable right, in whole or in part, to receive payments from, or otherwise collect from, the U.S. affiliate in connection with the non-U.S. person's obligations under the security-based swap.

We understand that such rights may arise in a variety of contexts. For example, a counterparty would have such a right of recourse against the U.S. person if the applicable arrangement provides the counterparty the legally enforceable right to demand payment from the U.S. person in connection with the security-based swap, without conditioning that right upon the non-U.S. person's non-performance or requiring that the counterparty first make a demand on the non-U.S. person. A counterparty also would have such a right of recourse if the counterparty itself could exercise legally enforceable rights of collection against the U.S. person in connection with the security-based swap, even when such rights are conditioned upon the non-U.S. person's insolvency or failure to meet its obligations under the security-based swap, and/or are conditioned upon the counterparty first being required to take legal action against the non-U.S. person to enforce its rights of collection.

The terms of the guarantee need not necessarily be included within the security-based swap documentation or even otherwise reduced to writing (so long as legally enforceable rights are created under the laws of the relevant jurisdiction); for instance, such rights of recourse would arise when the counterparty, as a matter of law in the relevant jurisdiction, would have rights to payment and/or collection that may arise in connection with the non-U.S. person's obligations under the security-based swap that are enforceable. We would view the transactions of a non-U.S. person as subject to a recourse guarantee if at least one U.S. person (either individually or jointly and severally with others) bears unlimited responsibility for the non-U.S. person's obligations, including the non-U.S. person's obligations to security-based swap counterparties. Such arrangements may include those associated with foreign unlimited companies or unlimited liability companies with at least one U.S.-person member or shareholder, general partnerships with at least one U.S.-person general partner, or entities formed under similar arrangements such that at least one U.S. persons bears unlimited responsibility for the non-U.S. person's liabilities. In our view, the nature of the legal arrangement between the U.S. person and the non-U.S. person—which makes the U.S. person responsible for the obligations of the non-U.S. person—is appropriately characterized as a recourse guarantee, absent countervailing factors. More generally, a recourse guarantee is present if, in connection with the security-based swap, the counterparty itself has a legally enforceable right to payment or collection from the U.S. person, regardless of the form of the arrangement that provides such a legally enforceable right to payment or collection.

Accordingly, the final rule clarifies that for these purposes a counterparty would have rights of recourse against the U.S. person “if the counterparty has a conditional or unconditional legally enforceable right, in whole or in part, to receive payments from, or otherwise collect from, the U.S. person in connection with the security-based swap.”

In revising the proposal, we have been influenced by commenter concerns that the proposed approach could allow non-U.S. persons to conduct a dealing business involving security-based swaps that are guaranteed by a U.S. affiliate without being regulated as a dealer, even though the guarantee exposes the U.S. person guarantor to risk in connection with the dealing activity.

This final rule also reflects our conclusion that a non-U.S. person—to the extent it engages in dealing activity involving security-based swaps subject to a recourse guarantee by its U.S. affiliate—engages in dealing activity that occurs, at least in part, within the United States. As discussed above, the economic reality is that by virtue of the guarantee the non-U.S. person effectively acts together with its U.S. affiliate to engage in the dealing activity that results in the transactions, and the non-U.S. person's dealing activity cannot reasonably be isolated from the U.S. person's activity in providing the guarantee. The U.S. person guarantor together with the non-U.S. person whose dealing activity it guarantees jointly may seek to profit by providing liquidity and otherwise engaging in dealing activity in security-based swaps, and it is the U.S. guarantor's financial resources that enable the guarantor to help its affiliate provide liquidity and otherwise engage in dealing activity. It is reasonable to assume that the counterparties of the non-U.S. person whose dealing activity is guaranteed look to both the non-U.S. person and the U.S. guarantor for performance on the security-based swap. Moreover, the U.S. guarantor bears risks arising from any security-based swap between the non-U.S. person whose dealing activity it guarantees and that affiliate's counterparties, wherever located.

This approach is consistent with the purposes of Title VII. The exposure of the U.S. guarantor creates risk to U.S. persons and potentially to the U.S. financial system via the guarantor to a comparable degree as if that U.S. person had directly entered into the transactions that constituted dealing activity by the affiliate. In many cases the counterparty to the non-U.S. person whose dealing activity is guaranteed may not enter into the transaction with that non-U.S. person, or may not do so on the same terms, absent the guarantee. The U.S. guarantor usually undertakes obligations with respect to the security-based swap regardless of whether that non-U.S. person ultimately defaults in connection with the security-based swap.

In requiring non-U.S. persons whose dealing involves security-based swaps that are guaranteed by a U.S. person to apply those dealing transactions against the de minimis thresholds, the final rule further reflects the fact that the economic reality of an offshore dealing business using such non-U.S. persons may be similar or identical to an offshore dealing business carried out through a foreign branch. In both cases the risk of the dealing activity has directly been placed into the United States, and non-U.S. counterparties generally may be expected to look to a U.S. person's creditworthiness in deciding whether to enter into the transaction with the guarantor's non-U.S. affiliate or the foreign branch (and on what terms). The final rule thus should help apply dealer regulation in similar ways to differing organizational structures that serve similar economic purposes, and help avoid disparities in applying dealer regulation to differing arrangements that pose similar risks to the United States.

We believe, moreover, that this final rule is necessary or appropriate as a prophylactic measure to help prevent the evasion of the provisions of the Exchange Act that were added by the Dodd-Frank Act, and thus help ensure that the relevant purposes of the Dodd-Frank Act are not undermined. Without this rule, U.S. persons may have a strong incentive to evade dealer regulation under Title VII simply by conducting their dealing activity via a guaranteed affiliate, while the economic reality of transactions arising from that activity—including the risks these transactions introduce to the U.S. market—would be no different in most respects than transactions directly entered into by U.S. persons. In other words, for example, if a U.S. entity engaged in security-based swap dealing wanted to either avoid registration or otherwise have its security-based swap transactions with foreign counterparties be outside the various Title VII requirements with respect to those transactions, it could establish an overseas affiliate and simply extend a payment guarantee. The purpose for doing so would be to evade the requirements of Title VII and the incentives to do so could be high, making it necessary and appropriate to invoke our Title VII authority, because the economic reality of these transactions would be no different in most respects, including the risks these transactions could introduce to the U.S. market. Arrangements between a U.S. person and a non-U.S. person that, as a matter of law in the relevant jurisdiction, make the U.S. person responsible for the non-U.S. person's liabilities may create similarly strong incentives to restructure business operations to avoid the application of Title VII by providing the economic equivalent of an express guarantee through an arrangement that under relevant law provides the non-U.S. person counterparty with direct recourse against the U.S. person. For these reasons, we believe that it is necessary and appropriate to adopt this rule pursuant to our anti-evasion authority under Exchange Act section 30(c).

Compared to the proposal, this approach also more fully accounts for differences between the regulatory regimes applicable to security-based swap dealers and major security-based swap participants. The definition of “major security-based swap participant” focuses on systemic risk issues, in that it particularly targets persons that maintain “substantial positions” that are “systemically important,” or that pose “substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets.” The thresholds associated with the major participant definition reflect that systemic risk focus. The dealer definition, in contrast, is activity-focused, addresses the significance of a person's dealing activity only via the de minimis exception, and addresses regulatory interests apart from risk. Accordingly, upon further consideration, we believe that availability of major participant regulation does not mitigate the above considerations regarding risk and regulatory treatment of similar business models, and those considerations are better addressed by counting dealing activities guaranteed by U.S. affiliates against the de minimis thresholds of the non-U.S. persons whose transactions are subject to the guarantees.

In adopting these provisions, we acknowledge that the final rule does not go as far as some commenters have requested, in that it does not require a non-U.S. person to count its dealing transactions involving security-based swaps that do not grant its counterparty a recourse guarantee against the U.S. affiliate of that non-U.S. person, even if the U.S. affiliate is subject to a recourse guarantee with respect to other security-based swaps of the same non-U.S. person. The final rule also does not incorporate the suggestion from certain commenters that we should treat U.S. entities and their affiliates as equivalent for purposes of the cross-border implementation of Title VII. The final rule further does not incorporate the suggestion that affiliates of a U.S. person should be presumed to be recipients of de facto guarantees, which could be rebutted via disclosure.

Those commenters raise important concerns regarding the possibility that, even absent explicit financial support arrangements, U.S. entities that are affiliated with non-U.S. persons for reputational reasons may determine that they must support their non-U.S. affiliates at times of crisis. In those commenters' view, such considerations impose risks upon U.S. markets even absent explicit legal obligations. As a result, the commenters suggest that foreign affiliates of U.S. entities should have to count all their dealing transactions against the de minimis thresholds, or that such foreign affiliates should be deemed to be “U.S. persons” for purposes of Title VII.

Our modification requiring these non-U.S. persons to count certain of their dealing transactions with non-U.S. persons against the de minimis thresholds partially addresses those commenter concerns. We also recognize that there may be circumstances in which a U.S. person provides its foreign affiliate with non-recourse support that is not specifically linked to particular instruments or to derivatives activities generally. Our final rule, however, targets recourse-based arrangements whereby the counterparties to the non-U.S. affiliate would be particularly likely to look to the U.S. person for satisfaction of some or all of the obligations arising under the security-based swap. On balance, we believe that an approach that focuses on the presence of recourse arrangements appropriately addresses dealing activities that have a particularly direct effect on the U.S. market, as well as the ability of a U.S. person to use such guarantees to conduct a security-based swap dealing business as an alternative to using a foreign branch.

This is not to say that more general financial support arrangements do not also pose risks to U.S. persons and potentially to the U.S. financial system, including risks posed by the activity of non-U.S. persons to their U.S. parents or affiliates. However, we believe that this focus on recourse guarantees appropriately addresses the most direct risks posed by such guarantee arrangements to U.S. persons and potentially to the U.S. financial system. We also note that Congress has provided additional regulatory tools apart from Title VII to address such risks. Indeed, in enacting the Dodd-Frank Act, Congress provided general tools—not merely tools focusing on derivatives activities—to address the risks associated with U.S.-based financial groups as a whole, including the risks posed by such groups' non-guaranteed foreign affiliates engaged in financial services business. This holistic approach to risks that could flow back to the United States may reflect the fact that financial services activities apart from security-based swaps constitute the great majority of such groups' overall financial activities outside the United States that can produce such risks. The regulatory tools substantially enhanced by the Dodd-Frank Act to better address these cross-border risks posed by financial services activities other than security-based swaps and such tools include globally consolidated capital requirements (including enhanced capital and leverage standards, group-wide single-counterparty credit limits, and capital surcharges for firms with particularly high levels of risk), and globally consolidated liquidity and risk management standards (including stress testing, debt-to-equity limitations, living will requirement, and timely remediation measures). By accounting for risks at the consolidated level, these tools address risks posed by guaranteed and non-guaranteed subsidiaries within U.S.-based financial groups, regardless of whether the subsidiaries are based in the United States or outside the United States. Our focus on recourse guarantees appropriately targets the concerns raised by security-based swap activity that Title VII was intended to address, recognizing that Congress has established other regulatory tools that are specifically intended, and better suited, to address risks to bank holding companies and financial holding companies, arising from the financial services activities of a foreign affiliate of those holding companies where the foreign affiliate does not engage in security-based swap activity in the United States.

Conversely, one commenter implicitly appeared to oppose any requirement that non-U.S. persons count their guaranteed transactions carried out in a dealing capacity with non-U.S. person counterparties against their de minimis thresholds. For the reasons discussed above, however, we believe that the targeted counting required by the final rule is appropriate to reflect activity involving security-based swaps that occurs in the United States and presents risks to U.S. persons and potentially to the U.S. financial system.

Finally, in adopting these provisions we recognize that the CFTC Cross-Border Guidance appears to broadly opine that non-U.S. persons who receive any express guarantee from a U.S. affiliate should, as a general matter, count all of their dealing activity against the de minimis thresholds, regardless of whether a counterparty has recourse against the U.S. person in connection with the swap. Our final rule is more targeted than the CFTC approach, in that our final rule requires a non-U.S. guaranteed affiliate to count only those dealing transactions for which the counterparty to the security-based swap has recourse against a U.S. person that is affiliated with the non-U.S. person. This reflects our decision to focus the application of the de minimis exception on recourse arrangements involving security-based swaps, while recognizing that some non-recourse arrangements could influence a U.S. person to provide financial support to non-U.S. persons and thereby present risk to the U.S. person and potential risk to the U.S. financial system.

2. Dealing Transactions of Non-U.S. Persons Involving U.S. and Other Counterparties

(a) Proposed Approach and Commenters' Views

Under the proposal, non-U.S. persons also would be required to count their dealing transactions entered into with a U.S. person, other than a foreign branch. As discussed below, this proposed exclusion for transactions in which the counterparty is a foreign branch reflected concerns regarding U.S. banks being limited in their access to foreign counterparties when conducting dealing activity through their foreign branches.

The proposal solicited comment regarding whether non-U.S. persons should be required to count, towards their de minimis thresholds, transactions with U.S. persons or with foreign branches of U.S. banks. It also solicited comment regarding whether non-U.S. persons should be required to count the dealing transactions they enter into with registered security-based swap dealers, and regarding whether non-U.S. persons should be able to conduct dealing transactions within the United States without registering if their transactions are with a registered security-based swap dealer.

Two commenters took the position that non-U.S. persons should have to count their transactions with foreign branches of U.S. banks against the de minimis thresholds, noting that those foreign branches themselves fall within the “U.S. person” definition, and stating that excluding those transactions would serve as a loophole from regulation. In contrast, one commenter stated that such transactions should be excluded from the de minimis analysis even if U.S. personnel are involved in soliciting, negotiating, executing or booking the transaction.

Commenters also addressed the application of the exception to non-U.S. persons' dealing activities involving counterparties that are guaranteed affiliates of non-U.S. persons. The proposal did not require such transactions to be counted. One commenter expressed support for the fact that our proposal, unlike the CFTC's guidance, did not require non-U.S. persons to count certain transactions with non-U.S. counterparties that are guaranteed by U.S. persons. On the other hand, one commenter stated that non-U.S. persons should count against the thresholds security-based swaps entered into with guaranteed affiliates and subsidiaries of U.S. persons if those affiliates and subsidiaries are not included within the “U.S. person” definition. Also, as noted above, that commenter and one other commenter generally suggested that the presence of explicit or implicit guarantees of foreign affiliates should trigger application of the Exchange Act.

(b) Final Rule

The final rule has been modified from the proposal to require non-U.S. persons (other than conduit affiliates ) to count, against the de minimis thresholds, their dealing transactions with U.S. persons other than certain transactions with the foreign branches of registered security-based swap dealers. The proposal would have excluded all of the non-U.S. person's transactions with a foreign branch (other than “transactions conducted within the United States”) regardless of the branch's registration status.

The requirement that such non-U.S. persons must count their dealing transactions with U.S. persons against the de minimis thresholds reflects the fact that dealing activity involving counterparties who are U.S. persons necessarily involves the performance, at least in part, of dealing activity within the United States. As discussed above, a non-U.S. person engaged in dealing activity with U.S. persons in an amount sufficient to implicate the de minimis thresholds reasonably can be concluded to constitute dealing activity within the United States by virtue of indicating that the non-U.S. person is commonly known in the trade as a security-based swap dealer within the United States, and that the non-U.S. person is regularly entering into security-based swaps as an ordinary course of business within the United States. Similarly, that non-U.S. person seeks to profit by, among other things, providing liquidity within the United States and engaging in market making in security-based swaps within the United States, and its decision to engage in dealing activity with U.S. persons affects the liquidity of the security-based swap market within the United States. U.S. persons incur risks arising from this dealing activity, which in turn potentially creates risk to the U.S. financial system more generally. Transactions with U.S. persons further raise market transparency and counterparty protection concerns that Title VII is intended to address. Accordingly, the dealing activity of such a non-U.S. person is best characterized as occurring, at least in part, within the United States to the extent that the dealing activity involves a U.S. person. No commenters to the Cross-Border Proposing Release expressed opposition to generally requiring non-U.S. persons to count their dealing transactions with U.S. persons (other than comments regarding transactions with foreign branches, as discussed below).

The final rule permits such non-U.S. persons not to count certain dealing transactions conducted through a foreign branch of a counterparty that is a U.S. bank as part of the de minimis analysis. For this exclusion to be effective, persons located within the United States cannot be involved in arranging, negotiating, or executing the transaction. Moreover—and in contrast to the proposal—the counterparty bank must be registered as a security-based swap dealer, unless the transaction occurs prior to 60 days following the effective date of final rules providing for the registration of security-based swap dealers. Registration of the counterparty U.S. bank would not be required for the exclusion to be effective before then, given that the non-U.S. person would not be able to know with certainty whether the U.S. bank in the future would register with the Commission as a security-based swap dealer.

As we noted in the proposal, although a foreign branch is part of a “U.S. person,” and dealing transactions with foreign branches pose risk to the U.S. financial system, requiring non-U.S. persons to count transactions with foreign branches “could limit access of U.S. banks to non-U.S. counterparties when they conduct their foreign security-based swap dealing activity through foreign branches because non-U.S. persons may not be willing to enter into transactions with them in order to avoid being required to register as a security-based swap dealer.” We continue to believe that generally permitting a non-U.S. person not to count those types of transactions that do not involve U.S. personnel against the thresholds thus should help avoid the disparate treatment of foreign branches that engage in security-based swap dealing activity and that seek to access offshore dealing services, compared to other persons that engage in security-based swap dealing activities outside the U.S.

The final rule differs from the proposal in that the final rule permits a non-U.S. person not to count its transactions with a foreign branch of a U.S. person against the de minimis thresholds only when the foreign branch is part of a registered security-based swap dealer (or for a temporary period of time prior to 60 days prior to the effectiveness of the dealer registration requirements), rather than transactions with any foreign branch. This tailoring of the proposal seeks to balance the above concerns that the proposed approach would result in disparate treatment of foreign branches and U.S. persons having inadequate access to liquidity located outside the United States, against the purposes of dealer regulation under Title VII. This consideration of competing interests results in an approach that will help to focus the application of the de minimis exception in such a way as to ensure that a registered security-based swap dealer is involved in the transaction, and thus that relevant Title VII provisions applicable to dealers (such as margin requirements) will apply to the transaction. This manner of focusing the exclusion also is consistent with the approach taken by the CFTC in its cross-border guidance.

In adopting an exclusion for certain transactions with foreign branches, we recognize that some commenters opposed having any such exclusion for a non-U.S. person's transactions with a foreign branch, stating that the breadth of the proposed exclusion would facilitate the avoidance of the Dodd-Frank Act even while U.S. entities incur the risks of transactions with foreign entities, and that the exclusion would be based on a “scare tactic.” We nonetheless believe that this approach is justified by concerns about disparate treatment, along with associated liquidity concerns. We also note that the modification of the proposal—such that transactions with foreign branches are excluded only if the foreign branch is part of a registered dealer—should help address concerns that the exclusion would promote evasion of the dealer requirements. Also, as discussed below, a transaction would not constitute a “transaction conducted through a foreign branch” if personnel located in the United States were responsible for arranging, negotiating or executing the transaction.

We also recognize that commenters took the view that such an exclusion is inconsistent with the fact that foreign branches fall within the “U.S. person” definition. In our view, the exclusion does not disregard the U.S.-person status of foreign branches. Instead, as discussed above, we believe that this exclusion is appropriate to address market concerns regarding disparate treatment of the dealing activity of foreign branches, notwithstanding that U.S.-person status.

We also have considered the view of one commenter that all of a non-U.S. person's transactions with foreign branches should be excluded from the analysis, even if U.S. personnel are involved in soliciting, negotiating, executing or booking the transaction. As discussed elsewhere, we conclude that a non-U.S. person's dealing transactions within the United States should be counted against the thresholds. More generally, for the reasons addressed above we conclude that the proposed exclusion related to a non-U.S. person's transactions with a foreign branch should be narrowed—not widened.

The final rule retains the proposed definition of “foreign branch,” which encompasses any branch of a U.S. bank that is located outside the United States, operates for valid business reasons, and is engaged in the business of banking and is subject to substantive banking regulation in the jurisdiction where it is located. As discussed in the Cross-Border Proposing Release, we believe these factors appropriately focus on the location of the branch, the nature of its business and its regulation in a foreign jurisdiction.

The final rule modifies the proposed definition of “transaction conducted through a foreign branch” to provide that the definition addresses transactions that are arranged, negotiated, and executed by a U.S. person through a foreign branch if both: (a) The foreign branch is the counterparty to the transaction; and (b) the security-based swap transaction is arranged, negotiated, and executed on behalf of the foreign branch solely by persons located outside the United States. We believe that this definition identifies the functions associated with foreign branch activity in a manner that appropriately focuses the exclusion for non-U.S. person's transactions toward situations in which the branch performs the core dealing functions outside the United States.

Similar to the proposal, the final definition of “transaction conducted through a foreign branch” also states that a person need not consider its counterparty's activities in connection with the transaction—i.e., where its counterparty's personnel arranged, negotiated and executed the transaction—if the person received a representation from the counterparty that the transaction is arranged, negotiated, and executed on behalf of the branch solely by persons located outside the United States, unless the person knows or has reason to know that the representation is not accurate. For these purposes a person would have reason to know the representation is not accurate if a reasonable person should know, under all of the facts of which the person is aware, that it is not accurate. This is intended to help address operational difficulties that a non-U.S. person otherwise could face in investigating the activities of its counterparty to ensure compliance with the rule.

Separately, the final rule, consistent with the proposal, does not require such non-U.S. persons to count, against the de minimis thresholds, their dealing transactions with non-U.S. persons whose security-based swap transactions are guaranteed by a U.S. person. We recognize the significance of commenter concerns regarding the risk posed to the United States by such security-based swaps, and regarding the potential use of such guaranteed affiliates to evade the Dodd-Frank Act. We nonetheless believe that such concerns are adequately addressed by the requirement that guaranteed affiliates count their own dealing activity against the de minimis thresholds when the counterparty has recourse to a U.S. person. Although there can remain residual risk to U.S. markets associated with the security-based swaps involving such non-U.S. guaranteed affiliates, we do not believe that such risk is significant enough to warrant a requirement that non-U.S. persons count all of their dealing activity involving such non-U.S. guaranteed affiliates against their own de minimis thresholds. In this regard we note that such a requirement would necessitate certain non-U.S. persons to incur compliance costs associated with assessing whether their counterparties are guaranteed affiliates. For similar reasons, the final rule does not require such non-U.S. persons to count, against the thresholds, their dealing transactions involving non-U.S. persons that are conduit affiliates.

F. Application of the Exception's Aggregation Principles to Cross-Border Dealing Activity

1. Proposed Approach and Commenters' Views

The Cross-Border Proposing Release also addressed the cross-border implementation of a previously adopted rule requiring a person to count dealing transactions by its affiliates against its own de minimis thresholds. Under the proposal, a person engaged in dealing activity would have had to count: (i) Dealing transactions by its U.S. affiliates, including transactions conducted through a foreign branch; and (ii) all dealing transactions of its non-U.S. affiliates where the counterparty is a U.S. person other than a foreign branch, or where the transaction is conducted within the United States.

In the Cross-Border Proposing Release we took the view that the approach would be consistent with the Dodd-Frank Act's statutory focus on the U.S. security-based swap market, in that the dealing of a person's U.S. affiliates would impact the U.S. financial system regardless of the location of the affiliate's counterparty, but that the dealing of a person's non-U.S. affiliates with other non-U.S. persons outside the United States would not impact the U.S. financial system to the same extent. We also took the view that the aggregation approach would minimize the opportunity for a person to evasively engage in large amounts of dealing activity, and that the approach would be in accordance with other aspects of the proposal governing which transactions would be applied against the thresholds.

The proposal separately would have permitted a person not to include, as part of the de minimis analysis, transactions by an affiliate that is registered as a security-based swap dealer, so long as the person's dealing activity is “operationally independent” of the dealer's activity. For these purposes, the person and its registered dealer affiliate would be considered to be “operationally independent” if the two entities maintained separate sales and trading functions, operations (including separate back offices) and risk management.

This aspect of the proposal recognized that any person affiliated with a registered dealer otherwise would have to count the registered affiliate's dealing activity against the person's own de minimis thresholds, which likely would require the person to register as a dealer if it engages in any dealing activity. We stated in the Cross-Border Proposing Release that, in our preliminary view, this outcome of preventing all affiliates of a dealer from taking advantage of the de minimis exception would not be consistent with the statutory purpose of the exception. We noted, moreover, that this scenario would not appear to raise the anti-evasion concerns at the core of the aggregation provisions, given that it would apply only where a corporate group already included a registered dealer subject to Commission oversight.

A number of commenters opposed the operational independence condition to the proposed exclusion, arguing that it would hinder operational efficiency—including the use of group-wide risk management—without any countervailing benefit, and that the requirement was vague and would impede the growth of different business models. Commenters also pointed out that, in the parallel discussion in the CFTC's cross-border guidance, the CFTC did not interpret its cross-border statute as requiring operational independence. One of these commenters further opposed the use of any aggregation requirement in connection with the de minimis exception. One commenter expressed particular concerns regarding the application of aggregation principles in connection with joint venture arrangements involving dealer shareholders. One commenter supported the proposed approach as an anti-evasion safeguard. One commenter suggested we eliminate the “operationally independent” requirement but, to prevent evasion of the dealer requirements, prohibit a registered dealer from using an unregistered affiliate as a booking vehicle.

2. Final Rule

The final rule governing aggregation, like the proposal, generally applies the principles that govern the counting of a person's own dealing activity to also determine how the person must count its affiliates' dealing activities for purposes of the de minimis exception. Accordingly, the rule has been modified from the proposal to be consistent with changes to the proposed provisions regarding the counting of a person's dealing activity.

Moreover, the final rule modifies the exclusion from having to aggregate the dealing transactions of a person's registered dealer affiliate from the proposal, both to remove the operational independence condition and to address situations in which a person's affiliate has exceeded the de minimis thresholds but is in the process of registering as a dealer.

(a) General Provisions Regarding Aggregation of Cross-Border Transactions

The final rule, like the proposal, provides in part that if a person engages in dealing transactions counted against the de minimis thresholds, the person also must count all dealing transactions in which any U.S. person controlling, controlled by, or under common control with the person engages, including transactions conducted through a foreign branch. The final rule has been revised from the proposal to further provide that the person should count all dealing transactions of its conduit affiliates. Finally, the final rule has been modified from the proposal to provide that the person must count all dealing transactions of non-U.S. person affiliates that: (a) Are entered into with U.S. persons other than the foreign branches of registered dealers; or (b) constitute dealing activity subject to a guarantee giving the non-U.S. person's counterparty rights of recourse against a U.S. person affiliated with the non-U.S. person.

These modifications from the proposal are consistent with similar modifications made to the rules regarding the counting of a person's own transactions for purposes of the de minimis exception, and reflect the risk concerns and interests discussed above. The aggregation requirement serves to prevent evasion of the dealer registration requirements by persons that otherwise may seek to avoid dealer registration by simply dividing up dealing activity in excess of the de minimis thresholds among multiple affiliates. In keeping with that purpose, in the cross-border context it is appropriate to require a person's affiliates to count the same dealing transactions that the person itself would be required to count for purposes of the de minimis exception—unless, as discussed below, the person is registered as a dealer. Because this approach incorporates the direct counting standards discussed above, we believe that the approach implements the de minimis exception in a manner that is consistent with the Dodd-Frank Act's focus on the U.S. security-based swap market.

(b) Application to Dealing Activities of Registered Affiliates

In addition, we are adopting an exception which provides that a person need not count against the de minimis thresholds the security-based swap transactions of an affiliate that either is: (1) Registered with the Commission as a dealer; or (2) deemed not to be a dealer pursuant to the provisions of Exchange Act rule 3a71-2(b), which addresses persons who have exceeded the de minimis thresholds but are in the process of registering.

In part, this final rule has been modified from the proposal by removing the proposed operational independence condition. After considering the views of several commenters that the proposed operational independence condition would tend to inhibit operational efficiencies, we are persuaded that excluding the condition from the final rule would help facilitate efficiency and avoid deterring beneficial group-wide risk management practices. In this regard we also note that even with the removal of the proposed operational independence condition, the aggregation provisions would prevent a corporate group from cumulatively engaging in aggregate relevant dealing activity—outside of its registered dealers—in excess of the de minimis thresholds.

The final rule also has been modified from the proposal to permit a person to rely on this provision if its affiliate is in the process of registering as a dealer. The de minimis rule generally provides that a person that is not registered as a dealer but that no longer falls below the applicable de minimis thresholds nonetheless will be deemed not to be a dealer until the earlier of the date in which it submits a complete application for registration as a dealer, or two months after the end of the month that it becomes no longer able to take advantage of the exception. That provision was intended to avoid market disruption in conjunction with the registration process. Upon further consideration, we similarly believe that the provision at issue here should allow a person not to count the transactions of its affiliates that are in the process of registering as dealers, to avoid market disruption that may otherwise result due to the prospect of a person intermittently exceeding the de minimis thresholds when its affiliates are in the process of registering. Such situations, moreover, would not appear to provide practical opportunities for corporate groups to evade dealer registration by dividing dealing activities among multiple affiliates.

G. Exception for Cleared Anonymous Transactions

1. Proposed Approach and Commenters' Views

Three commenters expressed the view that the Commission's final rules should include a provision similar to an aspect of the CFTC Cross-Border Guidance, which stated the CFTC's view that certain dealing transactions that are executed anonymously and cleared generally would not be counted against the de minimis thresholds. One commenter particularly emphasized that market participants would not have information available regarding a counterparty's identity in an anonymous transaction, and suggested that the prospect of becoming subject to dealer registration could deter non-U.S. liquidity providers from participating on security-based swap markets that provide access to U.S. persons.

2. Final Rule

After considering commenter views we have concluded that this type of exception is appropriate, particularly given that the final de minimis rules turn in part on the domicile of the counterparty to the non-U.S. person, and this information would be unavailable to the non-U.S. person that is a counterparty to a cleared anonymous transaction. Absent such an exception, it is possible that execution facilities would exclude U.S. market participants to prevent their non-U.S. members from having to face the prospect of dealer regulation, which could impair market liquidity and increase costs and risks.

For those reasons, the final rule has been revised from the proposal to except, from having to be counted against the de minimis thresholds, certain security-based swap transactions that a non-U.S. person enters into anonymously on an execution facility or national securities exchange and that are cleared through a clearing agency.

In particular, the final rule in part provides that a non-U.S. person need not count such cleared anonymous transactions against the threshold, unless the non-U.S. person is a conduit affiliate. In addition, the final rule permits an affiliate (that itself may be a U.S. or non-U.S. person) of such a non-U.S. person not to count such transactions of the non-U.S. person against the affiliate's own thresholds for purposes of the aggregation provisions, unless the non-U.S. person is a conduit affiliate.

The exception is not available when the non-U.S. person is a conduit affiliate because conduit affiliates are required to count all of their dealing transaction against the thresholds regardless of whether their counterparty is a U.S. or a non-U.S. person. As a result, the anonymous nature of the transaction would not cause implementation issues for conduit affiliates.

For purposes of the exception, a transaction would be “anonymous” only if the counterparty to the transaction in fact is unknown to the non-U.S. person prior to the transaction. The transaction would not be “anonymous” if, for example, a person submitted the transaction to an execution facility after accepting a request for quotation from a known counterparty or a known group of potential counterparties, even if the process of submitting the transaction itself did not involve a named counterparty.

H. Additional Issues

1. Particular Activities and Entities

Commenters to the Cross-Border Proposing Release raised issues regarding the application of the dealer registration requirement to limited security-based swap activities by certain “run-off” entities, and in the context of portfolio compression. Those issues are not unique to the cross-border context, and are outside of the scope of this release. We generally note, moreover, that in the Intermediary Definitions Adopting Release we considered and rejected certain requests for categorical exclusions from dealer definition. With regard to issues regarding the relevance of those or other activities to the de minimis analysis, we generally note that the dealer registration requirement necessarily distinguishes between a person's dealing and non-dealing activities.

2. Foreign Public Sector Financial Institutions and Government-Related Entities

As discussed above, the final rule defining “U.S. person” (like the proposed definition of that term) specifically excludes several foreign public sector financial institutions and their agencies and pension plans, and more generally excludes any other similar international organization and its agencies and pension plans. Certain commenters requested that we take further action to address the application of the dealer definition and its de minimis exception to security-based swap activities involving such foreign public sector financial institutions. Those commenters in part stated that such organizations should not be required to register as security-based swap dealers, and that those organizations' affiliates should be considered immune from domestic regulation to the same extent as the organizations themselves. In our view, however, such issues are outside the scope of this release, given that the source of any such privileges and immunities is found outside of the Dodd-Frank Act and the federal securities laws.

Separately, commenters stated that non-U.S. persons should not have to count their dealing transactions involving those organizations against the non-U.S. persons' dealer de minimis thresholds, on the grounds that counting such transactions would constitute the impermissible regulation of such organizations even if those were “transactions conducted within the United States.” As noted below, we have determined not to include the “transaction conducted within the United States” provisions in this final rule. With that said, we do not concur with the suggestion that counting a person's dealing transactions with such organizations against the de minimis thresholds—when otherwise provided for by the rules—involves the regulation of such organizations. Requiring a person to count, against the de minimis thresholds, the person's dealing transactions involving such an international organization as counterparty simply reflects the application of the federal securities laws to that person and its dealing activities, and does not constitute the regulation of the international organization. A person's security-based swap dealing transaction with such an international organization accordingly are considered the same, for purposes of applying the de minimis thresholds and other Title VII requirements, as a dealing transaction with some other non-U.S. person counterparty.

Finally, two commenters stated that they should not be subject to the possibility of dealer regulation for comity reasons, on the grounds that they are arms of a foreign government. We believe that such issues best are addressed on a case-by-case basis, but we generally note that the prospect of dealer regulation is relevant only to the extent that a person engages in dealing activity.

I. Economic Analysis of the Final Cross-Border Dealer De Minimis Rule

These final rules and guidance regarding the cross-border implementation of the de minimis exception to the “security-based swap dealer” definition will affect the costs and benefits of dealer regulation by determining which dealing transactions will be counted against the exception's thresholds. The cross-border rules have the potential to be important in determining the extent to which the risk mitigation and other benefits of Title VII (such as market transparency and customer protection) are achieved, given the core role that dealers play within the security-based swap market and the market's cross-border nature.

Commenters addressed the associated cost-benefit issues from a variety of perspectives. Some directly addressed the link between the cross-border scope of the dealer definition and the associated costs and benefits, by arguing that cost-benefit principles warranted greater harmonization with approaches taken by the CFTC or foreign regulators. Commenters also addressed the need for cost-benefit analysis, or questioned the adequacy of the Cross-Border Proposal's cost-benefit assessment. Other comments that addressed the dealer definition implicate the tradeoff between the costs and benefits associated with the definition's scope, even when the commenters did not directly address the economic analysis in the Cross-Border Proposing Release or otherwise explicitly raise cost-benefit considerations.

We have taken economic effects into account in adopting these final cross-border rules and providing guidance. In doing so, we believe that a narrow application of dealer regulation under Title VII—such as one that is limited to dealing activity that might be viewed as occurring solely within the United States—would not be sufficient to achieve the purposes of Title VII in light of the attributes of the security-based swap market, including the market's global nature, the concentration of dealing activity, the key role played by dealers and the risks posed by dealers via their legal and financial relationships. At the same time, we recognize that the cross-border application of Title VII has the potential to reduce liquidity within the U.S. market to the extent it increases the costs of entering into security-based swaps or provides incentives for particular market participants to avoid the U.S. market by operating wholly outside the Title VII framework.

The cross-border rules applying the “security-based swap dealer” definition to cross-border dealing activity implicate two categories of costs and benefits. First, certain current and future participants in the security-based swap market will incur assessment costs in connection with determining whether they fall within the “security-based swap dealer” definition and thus would have to register with the Commission.

Second, the registration and regulation of some entities as security-based swap dealers will lead to programmatic costs and benefits arising as a consequence of the Title VII requirements that apply to registered security-based swap dealers, such as the capital, margin, and business conduct requirements. These requirements may be expected to impose certain costs on participants acting as dealers, but also to produce benefits to the market and its participants, including counterparty protections and risk-mitigation benefits.

We discuss the programmatic and assessment costs and benefits associated with the final rules more fully below. We also discuss the economic impact of certain potential alternatives to the approach taken by the final rules.

1. Programmatic Costs and Benefits

(a) Cost-Benefit Considerations of the Final Rules

Exchange Act rules 3a71-3, 3a71-4, and 3a71-5 will permit market participants to exclude certain dealing transactions from their de minimis calculations, and thus may cause particular entities that engage in certain dealing activities not to be regulated as security-based swap dealers. The rules accordingly may be expected to affect the programmatic costs and benefits associated with the regulation of security-based swap dealers under Title VII, given that those costs and benefits are determined in part by which persons will be regulated as security-based swap dealers.

This does not mean that there is a one-to-one relationship between a person not being a “security-based swap dealer” as a result of these cross-border rules, and the resulting change to programmatic benefits and costs. Indeed, although these rules may determine which particular entities will be regulated as dealers, it does not follow that total programmatic costs and benefits will vary by an amount proportional to the volume of those entities' dealing activity. As the Commission explained in the Intermediary Definitions Adopting Release, some of the costs and benefits of regulating dealers may be fixed, while others may be variable depending on a particular person's security-based swap dealing activity. In practice, the programmatic benefits associated with the regulation of persons engaged in security-based swap dealing activity—in other words, the expected transparency, customer protection and market efficiency objectives associated with dealer regulation—likely will vary depending on the type and nature of those persons' dealing activity, including the degree to which those persons engage in security-based swap dealing activity within the United States or in a manner likely to give rise to Title VII concerns within the United States.

We believe that the cross-border rules we are adopting today will focus the regulation of security-based swap dealers under Title VII upon those entities that engage in security-based swap transactions that occur in the United States, or on the prevention of evasion. Our definition of “security-based swap dealer” seeks to capture those entities for which regulation of security-based swap activity is warranted due to the nature of their activities with other market participants. Specifically, we have focused the rules on those market participants that are likely to have financial and legal relationships within the United States. This set of entities includes those that currently provide liquidity to U.S. persons as market makers in the OTC security-based swap market and those that trade with U.S. persons as market makers for security-based swaps on organized trading venues. Regulation of these entities will mitigate risk and promote stability for U.S. persons and potentially the U.S. financial markets by increasing the likelihood that they are able to meet their obligations under security-based swap contracts against counterparties with ties to the U.S. financial system once they are subject to the final adopted rules regarding the requirements applicable to dealers (rules establishing capital and margin requirements for registered security-based swap dealers). Furthermore, regulation of these entities as dealers may enable them to continue to provide liquidity to their counterparties, particularly in times when the markets are under financial stress and their counterparties may struggle to meet their financial obligations. We also believe that regulation of these entities will further other goals of Title VII, particularly as we consider future substantive regulation of the security-based swap market. In other words, these requirements will direct the application of the de minimis thresholds—which themselves are the product of cost-benefit considerations—toward those dealing activities in U.S. financial markets that most directly implicate the purposes of Title VII. As such, these rules reflect our assessment and evaluation of those programmatic costs and benefits:

• Dealing by U.S. persons—The “U.S. person” definition captures entities whose security-based swap activities pose risks to the United States that may raise the concerns intended to be addressed by Title VII, regardless of the status of their counterparty. The requirement that U.S. persons, including foreign branches, count all of their dealing transactions against the de minimis thresholds reflects the domestic nature of their dealing activity, particularly given that it is the financial resources of the entire person that enable it to engage in dealing activity.

• Dealing by guaranteed affiliates of U.S. persons—The requirement that non-U.S. persons count all their dealing transactions that are subject to a recourse guarantee by a U.S. affiliate, even when the counterparty is another non-U.S. person, reflects the domestic nature of that activity and the risks that those recourse guarantees pose to U.S. persons and potentially to the U.S. financial system via the U.S. person guarantor.

• Dealing by other non-U.S. persons with U.S.-person counterparties—The general requirement that non-U.S. persons count their dealing transactions with counterparties that are U.S. persons reflects the domestic nature of that activity and the concerns raised by the performance of dealing activity within the United States, impacts on U.S. market liquidity, risks that this dealing activity poses to U.S. persons and potentially toward the U.S. financial system as a whole, and counterparty and market transparency concerns. This general requirement is limited, however, as it does not extend to transactions with foreign branches of U.S. banks that are registered as dealers, or to certain cleared anonymous transactions. While those excluded transactions also involve the performance, at least in part, of relevant dealing activity within the United States, implicate Title VII concerns, and import risk into the United States—and their counting against the thresholds thus would be consistent with achieving the programmatic benefits of dealer regulation—their exclusion is nevertheless warranted by considerations regarding market access by U.S. persons (in the case of transactions with certain foreign branches of U.S. banks) and by considerations regarding information availability and market liquidity (in the case of the exclusion for cleared anonymous transactions).

• Anti-evasion provisions—The requirement that conduit affiliates count all of their dealing activities against the thresholds, and the cross-border application of the aggregation requirements related to the de minimis exception, both reflect targeted efforts to prevent evasion of the security-based swap dealer requirements of Title VII. We are adopting a definition of “conduit affiliate” that excludes affiliates of registered security-based swap dealers and major security-based swap participants to avoid imposing costs on registered persons in situations where the types of evasion concerns that the conduit affiliate definition is intended to address are minimal.

In short, these final rules apply the de minimis thresholds—which themselves reflect cost-benefit considerations —to cross-border security-based swap activity in a way that directs the focus of dealer regulation toward those entities whose security-based swap dealing activities most fully implicate the purposes of Title VII, or that is reasonably designed to prevent evasion of dealer regulation under Title VII.

In the Cross-Border Proposing Release, we concluded that “[t]o the extent that an entity engaged in dealing activity wholly outside the United States poses risks to the U.S. financial system, we preliminarily believe that subjecting it to dealer registration and the related requirements would not generate the types of programmatic benefits that Title VII dealer regulation is intended to produce, as the dealing activity of such entity poses risks to counterparties outside the United States.” These final rules and guidance regarding which transactions are to be counted against the de minimis thresholds are consistent with that principle, although in part they reflect a further assessment of the programmatic benefits resulting from the application of dealer regulation to non-U.S. persons when there is a recourse guarantee against a U.S. affiliate, including the benefits resulting from the application of financial responsibility requirements imposed upon registered security-based swap dealers. In this regard, the final rules and guidance reflect a reconsideration of our earlier conclusion that the risks to U.S. persons arising from such guarantees could adequately be addressed by the regulation of major security-based swap participants. In addition, these final rules and guidance more fully account for anti-evasion concerns associated with the potential for a U.S. person to engage in dealing activity using a guaranteed non-U.S. affiliate that is economically equivalent to the U.S. person itself entering into those dealing transactions.

(b) Evaluation of Programmatic Impacts

In setting the de minimis thresholds as part of the Intermediary Definitions Adopting Release, we attempted to identify a level of dealing activity that would identify and capture the entities for which the Title VII dealer requirements are most appropriate, without imposing the costs of Title VII on those entities for which regulation currently may not be justified in light of the purposes of the statute. We particularly took into account data regarding the activities of participants in the security-based swap market, including data regarding activity suggestive of dealing. Based on this analysis, we estimated that up to 50 entities in the security-based swap market might register as security-based swap dealers. Those estimates—made outside of the context the cross-border application of the dealer definition—provide a baseline against which the Commission can analyze the programmatic costs and benefits and assessment costs of the final rules applying the de minimis exception to cross-border activities.

We believe the methodology used in the Intermediary Definitions Adopting Release also is appropriate for considering the potential programmatic costs and benefits associated with the final cross-border rules. This methodology particularly can help provide context as to how rules regarding the cross-border application of the de minimis exception may change the number of entities that must register as security-based swap dealers, and thus help provide perspective regarding the corresponding impact on the programmatic costs and benefits of Title VII. Applying that methodology to 2012 data regarding the single-name CDS market suggests that under these final rules approximately 50 entities may have to register as dealers—a number that is consistent with our estimates as part of the Intermediary Definitions Adopting Release.

We recognize that there are limitations to using this methodology to consider the potential programmatic impact of the cross-border rules. These include limitations associated with the fact that the available data does not extend to all types of security-based swaps, and challenges in extrapolating transaction data into inferences of dealing activity. Also, the available single-name CDS data in certain regards potentially may lead the impact of these rules to be underestimated or overestimated:

• The Commission's access to data on CDS that are written on non-U.S. reference entities does not extend to data regarding transactions between two counterparties that are not domiciled in the United States, or guaranteed by a person domiciled in the United States. More generally, the Commission's access to data also does not extend to transactions among affiliated entities. The available data thus does not extend to the activities of non-U.S. conduit affiliates, to the extent that they engage in transactions with non-U.S. persons (that themselves are not the subject of a guarantee), and potentially makes the assessment underinclusive to the extent that conduit affiliates engaged in dealing activity during the relevant period.

• The available data also does not specifically distinguish those transactions of non-U.S. persons that are subject to a guarantee by a U.S. person, and other (non-guaranteed) transactions by such non-U.S. persons. As a result, we have assumed that all foreign subsidiaries of U.S. persons rely on guarantees for all transactions, which potentially overestimates the level of transaction activity that would count toward de minimis thresholds for U.S. persons with foreign subsidiaries.

Separately, the programmatic costs and benefits associated with the implementation of these rules cannot be quantified with any degree of precision because the full range of the de minimis exception's effects on the programmatic costs and benefits also will reflect final rules—which have yet to be finalized—implementing the Title VII entity-level and transaction-level requirements applicable to security-based swap dealers.

In addition, the programmatic benefits and costs associated with the cross-border application of the de minimis exception may change as market participants modify their business structure or practices in response to these rules. To avoid the prospect of being regulated as a security-based swap dealer, some market participants may restructure their businesses or take other steps (such as avoiding engaging in security-based swap activities involving U.S. persons) to avoid having their dealing transactions counted against the de minimis thresholds. Other market participants may take similar steps in response to counterparty demands. We understand that some market participants already have taken these types of steps to restructure their derivatives operations in response to the implementation of Title VII requirements related to swaps. More fundamentally, there are inherent challenges associated with attempting to quantify the risk-mitigation and other benefits of financial regulation. The programmatic impact of these rules may further reflect the fact that certain entities that are deemed to be security-based swap dealers, and hence are subject to the applicable Title VII dealer requirements, separately may be subject to other regulatory requirements that are analogous to the security-based swap dealer requirements. For example, we recognize that certain entities that are deemed to be security-based swap dealers pursuant to these rules also may be registered as swap dealers with the CFTC, pursuant to the CEA. Those entities' compliance with CFTC requirements applicable to swap dealers potentially may mitigate the programmatic effect of these rules—in terms of both costs and benefits—to the extent that those CFTC requirements are comparable with the SEC's yet-to-be-finalized substantive rules applicable to security-based swap dealers. The potential availability of substituted compliance, whereby a market participant may comply with a Title VII security-based swap dealer requirement by complying with a comparable requirement of a foreign financial regulator, also may affect the final programmatic impact of these rules.

In general, however, and consistent with our territorial approach, we believe that these rules are targeted appropriately, and do not apply dealer regulation to those entities that have a more limited involvement in the U.S. financial system and hence whose regulation as a security-based swap dealer under Title VII would be less linked to programmatic benefits (i.e., non-U.S. persons that engage in security-based swap dealing activity entirely, or almost entirely, outside the United States with non-U.S. persons or with certain foreign branches), while applying dealer regulation to those entities whose dealing activity would be more likely to produce programmatic benefits under Title VII. The nexus between specific aspects of these requirements and the programmatic costs and benefits also is addressed below in connection with our consideration of various alternatives to the approach taken in the final rules.

Finally, we recognize that the U.S. market participants and transactions regulated under Title VII are a subset of the overall global security-based swap market and that shocks to risk or liquidity arising from a foreign entity's dealing activity outside the United States may spill into the United States. Such spillover risks associated with dealing activity that falls outside the scope of Title VII have the potential to affect U.S. persons and the U.S. financial system either through a foreign entity's transactions with foreign entities, which, in turn, transact with U.S. persons (and may, as a result, be registered security-based swap dealers or major security-based swap participants), or through membership in a clearing agency that may provide CCP services in the United States or have a U.S. person as a clearing member. We also have considered these spillovers in connection with our analysis of the effects of these final cross-border rules on efficiency, competition and capital formation.

2. Assessment Costs

The analysis of how these cross-border rules will affect the assessment costs associated with the “security-based swap dealer” definition and its de minimis exception is related to the assessment cost analysis described in the Intermediary Definitions Adopting Release, but must also account for certain issues specific to these cross-border rules. While in certain regards those assessment costs can more readily be estimated than the programmatic effects discussed above, the assessment costs associated with the cross-border application of the Title VII dealer requirements will be considerably smaller in significance than those programmatic effects.

The Intermediary Definitions Adopting Release addressed how certain market participants whose security-based swap activities exceed or are not materially below the de minimis threshold may be expected to incur assessment costs in connection with the dealer analysis. In that release we estimated that 166 entities—out of over one thousand U.S. and non-U.S. entities that engaged in single-name CDS transactions in 2011—had more than $2 billion in single-name CDS transactions over the previous 12 months, and as a result would engage in the dealer analysis. Based on those numbers, and assuming that that all of those entities retain outside counsel to analyze their status under the security-based swap dealer definition, including the de minimis exception, we estimated that the legal costs associated with assessing market participants' potential status as security-based swap dealers may approach $4.2 million.

Application of these cross-border rules to the de minimis exception can be expected to affect the assessment costs that market participants will incur. In part, certain non-U.S. persons may be expected to incur personnel costs and legal costs—beyond the legal costs addressed as part of the Intermediary Definitions Adopting Release—associated with analyzing these cross-border rules and developing systems and procedures to assess which transactions would have to be counted against the de minimis thresholds (or with the purpose of avoiding activities within the United States that would be sufficient to meet the applicable thresholds). On the other hand, while certain market participants also would incur additional legal costs associated with the dealer determination (i.e., the assessment of whether particular activities constitute dealing activity for purposes of the analysis) addressed in the Intermediary Definitions Adopting Release, the application of the cross-border rules may reduce the number of entities that incur such legal costs.

In adopting these rules we estimate the assessment costs that market participants may incur as a result. As discussed below, however, these costs in practice may be mitigated in large part by steps that market participants already have taken in response to other regulatory initiatives, including the CFTC Cross-Border Guidance.

(a) Legal Costs

The implementation of these cross-border rules in some circumstances has the potential to change the legal costs identified in the Intermediary Definitions Adopting Release, including by adding new categories of legal costs that non-U.S. persons may incur in connection with applying the de minimis exception in the cross-border context.

Legal costs related to application of the dealer-trader distinction—As discussed in the Intermediary Definitions Adopting Release, certain market participants will incur assessment costs relating to performing the analysis as to whether their security-based swap activities constitute dealing. For purposes of that release we assumed that only entities with more than $2 billion in security-based swap transactions over the previous 12 months would be likely to engage in the full dealer analysis, and, based on analysis of single-name CDS data, we concluded that there were 166 market participants that would meet those criteria.

In the cross-border context, we believe that some non-U.S. persons that have more than $2 billion in total security-based swap transactions over the previous 12 months nonetheless may be expected to forgo the costs of performing the dealing activity analysis, if only a comparatively low volume of their security-based swap activity involves U.S. counterparties or otherwise potentially needs to be counted against the de minimis thresholds. In particular, we believe that it is unlikely that non-U.S. persons would engage in the dealer analysis (and hence would not be likely to incur such legal costs described in the Intermediary Definitions Adopting Release) if over the previous 12 months they have less than $2 billion in security-based swap transactions that potentially would have to be counted against the thresholds.

Available data from 2012 indicates that 218 entities worldwide (147 of which are domiciled in the United States and 71 domiciled elsewhere) had security-based swap activity, with all counterparties, of $2 billion or more. Of those 218 entities 202 had total activity of $2 billion or more that—to the extent it constituted dealing activity—would appear to have to be counted against the de minimis thresholds. Those 202 entities consisted of 147 entities domiciled in the United States (which would have to count all of their dealing transactions), and 55 entities domiciled elsewhere that have $2 billion in transactions with U.S. counterparties or that otherwise may have to be counted for purposes of the de minimis analysis. To the extent that all 202 of those entities engage in the legal analysis related to which of their security-based swap activities constitutes dealing under the dealer-trader distinction (while recognizing that some such entities may conclude that, based on the nature of their business, they engage in dealing activities and that no such additional analysis is necessary), and assuming that such analyses amount to $30,000 per entity, those 202 entities would incur a total of approximately $6.1 million in such legal costs.

Legal costs related to systems and analysis—As noted above, out of the 218 entities that had total security-based swap activity of $2 billion or more in 2012, 71 are domiciled outside of the United States. Upon further consideration (and in addition to the estimates in the Cross-Border Proposing Release), we also believe that it is reasonable to conclude that those 71 entities may have to incur one-time legal expenses related to the development of systems and analysis expenses—discussed below—to identify which of their total security-based swap transactions potentially must be counted for purposes of the de minimis analysis consistent with these cross-border rules. This additional cost estimate reflects the fact that the development of such systems and procedures must address cross-border rules that require accounting for factors such as whether an entity's security-based swaps are subject to guarantees from affiliated U.S. persons, and whether its counterparties are U.S. persons. We estimate that such legal costs would amount to approximately $30,400 per entity, and that those 60 entities would incur total costs of approximately $2.2 million.

(b) Costs Related to Systems, Analysis, and Representations

Transaction-monitoring systems—The elements introduced by the final cross-border rules may cause certain non-U.S. persons to implement systems to identify whether their dealing transactions exceed the de minimis thresholds. Such systems may reflect the need for non-U.S. persons to: (i) identify whether their dealing counterparties are “U.S. persons”; (ii) determine whether their dealing transactions with a U.S. person constitutes “transactions conducted through a foreign branch” (which itself requires consideration of whether their counterparty is a “foreign branch”) and—of those—determine which transactions involve a foreign branch of a U.S. bank that itself is registered as a security-based swap dealer; (iii) determine whether particular transactions are subject to a recourse guarantee against a U.S. affiliate; (iv) evaluate the applicability of the aggregation principles; and (v) evaluate the availability of the exception for cleared anonymous transactions.

In general, we believe that the costs of such systems should be similar to the costs estimated in the Intermediary Definitions Adopting Release for a system to monitor positions for purposes of the major security-based swap participant thresholds. In both cases -the assessment of dealer status in the cross-border context and the assessment of major participant status—such systems would have to flag a person's security-based swaps against the specific criteria embedded in the final rules, and then compare the cumulative amount of security-based swaps that meet those criteria against regulatory thresholds. Based on the methodology set forth in the Intermediary Definitions Adopting Release related to systems associated with the major participant analysis, we estimate that such systems would be associated with one-time programming costs of $14,904 and ongoing annual systems costs of $16,612 per entity.

Analysis of counterparty status, including representations—Non-U.S. market participants also would be likely to incur costs arising from the need to assess the potential U.S.-person status of their counterparties, and in some cases to obtain and maintain records related to representations regarding their counterparties' U.S.-person status. We anticipate that non-U.S. persons are likely to review existing information (e.g., information already available in connection with account opening materials and “know your customer” practices) to assess whether their counterparties are U.S. persons. Non-U.S. persons at times may also request and maintain representations from their counterparties to help determine or confirm their counterparties' status. Accordingly, in our view, such assessment costs primarily would encompass one-time costs to review and assess existing information regarding counterparty domicile, principal place of business, and other factors relevant to potential U.S.-person status, as well as one-time costs associated with requesting and collecting representations from counterparties. The Commission believes that such one-time costs would be approximately $732 thousand per firm.

Monitoring of counterparty status—In addition, market participants may be expected to adapt the systems described above to monitor the status of their counterparties for purposes of their future security-based swap activities. Such refinements would permit these systems to maintain records of counterparty status for purposes of conducting the de minimis assessments (e.g., representations regarding a counterparty's U.S.-person status, or whether a counterparty's transaction through a foreign branch involve U.S. personnel), such as by monitoring for the presence of existing representations, to obviate the need to request representations on a transaction-by-transaction basis. Market participants also may need to monitor for the presence of information that may indicate that the representation they have received are outdated or otherwise are not valid. We estimate that this would require one-time costs of approximately $12,436 per firm.

Summary of system, analysis and representation costs—In sum, we estimate that the costs that certain non-U.S. market participants would incur in connection with systems, analysis of counterparty status and representations in connection with these cross-border rules would be approximately $759 thousand in one-time costs, and their estimated annual ongoing costs would be $16,612. The available data provided by the DTCC-TIW, subject to the limitations associated with the use of data analysis discussed above, suggests that such costs may be incurred by 71 non-U.S. domiciled entities with total annual activity of at least $2 billion. Assuming that each of these 71 entities concludes it has a need to monitor the above categories of information in connection with its security-based swap activities, we estimate that the total one-time industry-wide costs associated with establishing such systems would amount to approximately $54 million, and total annual ongoing costs would amount to approximately $1.2 million.

(c) Overall Considerations Related to Assessment Costs

In sum, we believe that the effect of these final cross-border rules would be an increase over the amounts that otherwise would be incurred by certain non-U.S. market participants, both in terms of additional categories of legal costs and in terms of the need to develop certain systems and procedures.

Requiring certain non-U.S. persons to incur such assessment costs is an unavoidable adjunct to the implementation of a set of rules that are appropriately tailored to apply the “security-based swap dealer” definition under Title VII to a global security-based swap market in a way that yields the important transparency, accountability, and counterparty protection benefits associated with dealer regulation under Title VII. The alternative—avoiding application of the Title VII dealer requirements to non-U.S. persons—would be inappropriate because, in our view, the dealing activity of non-U.S. persons required to count their dealing activity under these final rules constitutes part of the U.S. financial system. The benefits that arise from Title VII regulatory requirements, including risk management and transparency benefits associated with dealer regulation accordingly could be undermined if a significant portion of U.S. dealing activity by non-U.S. persons were excluded from the Title VII framework. In certain respects, however, decisions embedded in these final rules are designed to avoid imposing assessment costs upon market participants.

It is important to recognize that our estimates of the assessment costs associated with these rules in practice may tend to overestimate that costs that market participants actually will incur as a result of these rules. This is because in practice, the assessment costs associated with the cross-border scope of the dealer definition (like the potential programmatic effects of that cross-border scope) may be tempered to the extent that the assessments that market participants conduct in connection with their security-based swap activities correspond to the assessments they otherwise would follow due to other regulatory requirements or business practices. Significantly, we understand that a substantial number of market participants already have engaged in assessment activities—including activities to determine whether their counterparties are U.S. persons—conforming to the requirements applicable to swaps. Given our expectation that persons that are not “U.S. persons” under the CFTC's policy (as set forth in its cross-border guidance) generally also would not be “U.S. persons” under our rules, certain market participants may reasonably determine that as part of the implementation of the rules we are adopting today they need not duplicate work already done in connection with implementing the CFTC's swaps regulations. In this regard we recognize the significance of commenter views emphasizing the importance of harmonization with the CFTC to control the costs associated with assessments under Title VII. We acknowledge that, to the extent our final rules differ from the CFTC's approach—especially if they were to require counting of transactions that would not be captured by the requirements applicable to swaps in the cross-border context, or were to require the collection and/or consideration of information that is materially different from that collected under the CFTC's approach—market participants may face higher costs than if regulations were identical. As discussed in connection with the specific aspects of these rules, however, we believe that such differences are justified, as are any associated assessment (or programmatic) costs.

Finally, we also anticipate that certain market participants that wish to limit the possibility of being regulated as a dealer under Title VII, including the programmatic and assessment costs associated with the dealer definition, may choose to structure their business to avoid engaging in dealing transactions with U.S. persons (other than foreign branches of banks registered with the Commission as dealers).

3. Alternative Approaches

As discussed above, the final rules incorporate a number of provisions designed to focus Title VII dealer regulation upon those persons that engage in the performance of security-based swap dealing activity within the United States in excess of the de minimis thresholds, taking into account the mitigation of risks to U.S. persons and potentially to the U.S. financial markets, as well as other purposes of Title VII.

In adopting these final rules we have considered alternative approaches suggested by commenters, including the economic effects of following such alternative approaches. In considering the economic impact of potential alternatives, we have sought to isolate the individual alternatives to the extent practicable, while recognizing that many of those alternatives are not mutually exclusive.

We further have considered such potential alternatives in light of the methodologies discussed above, by assessing the extent to which following particular alternatives would be expected to increase or decrease the number of entities that ultimately would be expected to be regulated as dealers under the final rules, as well as the corresponding economic impact. As discussed below, however, analysis of the available data standing alone would tend to suggest that various alternative approaches suggested by commenters would not produce large changes in the numbers of market participants that may have to be regulated as security-based swap dealers. These results are subject to the above limitations, however, including limitations regarding the ability to quantitatively assess how market participants may adjust their future activities in response to the rules we adopt or for independent reasons. Accordingly, while such analyses provide some context regarding alternatives, their use as tools for illustrating the economic effects of such alternatives is limited.

(a) Dealing Activity by Foreign Branches of U.S. Banks

The final rules require U.S. banks to count all dealing transactions of their foreign branches against the de minimis thresholds, even when the counterparty is a non-U.S. person or another foreign branch of a U.S. person. Certain commenters to the rules addressed in the Intermediary Definitions Adopting Release had expressed the view that such transactions by foreign branches should not have to count their dealing transactions involving non-U.S. persons. For the reasons discussed above, we believe that it is appropriate for the analysis to include dealing transactions conducted through foreign branches to the same extent as other dealing transactions by U.S. persons.

Adopting such an alternative approach potentially could provide market participants that are U.S. persons with incentives to execute higher volumes through their foreign branches. Such an outcome may be expected in part to reduce the programmatic and assessment costs associated with dealer regulation under Title VII. Such an outcome also would be expected to reduce the programmatic benefits associated with dealer regulation, given that those U.S. banks (and potentially the U.S. financial system) would incur risks via their foreign branches equivalent to the risk that might arise from transactions of U.S. banks that are not conducted through foreign branches, but without the additional oversight (including risk mitigation requirements such as capital and margin requirements) that comes from regulation as a dealer.

Using the 2012 data to assess the impact associated with this alternative does not indicate a change to our conservative estimate that up to 50 entities potentially would register as security-based swap dealers. This assessment, as well as the other assessments of alternatives discussed below, is subject to the limitations discussed above, including limitations regarding the ability to assess how market participants would change their activities in response to the final rules.

(b) Dealing Activity by Guaranteed Affiliates of U.S. Persons

The final rules require a non-U.S. person to count, against the de minimis thresholds, dealing transactions for which the non-U.S. person's performance in connection with the transaction is subject to a recourse guarantee against a U.S. affiliate of the non-U.S. person. Although the proposal instead would have treated such guaranteed affiliates like any other non-U.S. persons, we believe that this provision is appropriate for the reasons discussed above, including that such recourse guarantees pose risks to U.S. persons and potentially to the U.S. financial system via the U.S. guarantor.

This aspect of the final rules reflects a middle ground between commenter views, given that some commenters opposed any consideration of guarantees as part of the dealer analysis, while others expressed the view that all affiliates of a U.S. person should be assumed to be the beneficiary of a de facto guarantee from the U.S. person and, absent a showing otherwise, should have to count all of their dealing activity against the thresholds. This diversity of commenter views suggests a range of potential alternatives to the final rules—including one alternative in which the final rules do not address guarantees at all, as well as alternatives in which (based on the concept of a de facto guarantee) all affiliates of a U.S. person, or at least all affiliates within a U.S.-based holding company structure, should have to count their dealing activity against the thresholds (with a potential exception if they demonstrate to the market that there will be no guarantee). For the reasons discussed above, we believe that the approach taken by the final rules is appropriate.

Following such alternative approaches could be expected to lead to disparate economic effects depending on which approach is followed. On the one hand, an approach that does not require counting against the thresholds of a non-U.S. person's transactions with non-U.S. counterparties that are guaranteed by their U.S. affiliates would help provide incentives for greater use of guarantees by U.S. persons, with an increase of the associated risk flowing to the United States. On the other hand, an approach that requires the conditional or unconditional counting of transactions by all affiliates of U.S. persons could provide incentives for certain non-U.S. holding companies to limit or eliminate relationships with U.S.-based affiliates, even if these affiliates perform functions unrelated to security-based swap activity. Additionally, a more limited approach that requires counting by non-U.S. subsidiaries of U.S. holding companies could reduce liquidity in the security-based swap market even if such a subsidiary's participation does not depend on the financial position or backing of its parent.

Data assessment of the first alternative does not indicate a change to our estimate that up to 50 entities may be expected to register with the Commission as security-based swap dealers. The available data does not permit us to assess the other approaches, whereby all affiliates within a U.S.-based holding company, or all affiliates of any U.S. person generally, should have to count their dealing activity against the thresholds.

(c) Dealing by Conduit Affiliates

The final rules require that conduit affiliates of U.S. persons count all of their dealing transactions against the de minimis thresholds. The available data does not permit us to identify which market participants currently engage in security-based swap dealing activity on behalf of U.S. affiliates, and hence would be deemed to be conduit affiliates. Accordingly, we are limited in our ability to quantify the economic impact of this anti-evasion provision.

The economic effects of not including these provisions—and instead treating conduit affiliates the same as other non-U.S. persons—has the potential to be significant, as it would remove a tool that should help to deter market participants from seeking to evade dealer regulation through arrangements whereby U.S. persons effectively engage in dealing activity with non-U.S. persons via back-to-back transactions involving non-U.S. affiliates. Following that alternative thus may partially impair the effective functioning of the Title VII dealer requirements, and lead risk and liquidity to concentrate outside of the U.S. market.

Another potential alternative approach to addressing such evasive activity could be to narrow the inter-affiliate exception to having to count dealing transactions against the de minimis thresholds, such as by making the exception unavailable when non-U.S. persons transact with their U.S. affiliates. Such an alternative approach may be expected to reduce the ability of corporate groups to use central market-facing entities to facilitate the group's security-based swap activities, and as such may increase the costs faced by such entities (e.g., by requiring additional entities to directly face the market and hence negotiate master agreements with dealers and other counterparties). We believe that the more targeted approach of incorporating the conduit affiliate concept would achieve comparable anti-evasion purposes with less cost and disruption.

(d) Dealing Activity by Non-U.S. Counterparties With Foreign Branches of U.S. Banks and Certain Other Counterparties

The final rules require non-U.S. persons to count, against the thresholds, their dealing transactions involving counterparties that are foreign branches of U.S. banks unless the U.S. bank is registered as a security-based swap dealer and unless no U.S.-based personnel of the counterparty are involved in arranging, negotiating and executing the transaction. This reflects a change from the proposal, which would have excluded all such transactions with a foreign branch regardless of whether the U.S. bank was registered as a dealer. The change appropriately takes into consideration the benefits of having relevant Title VII provisions applicable to dealers apply to the transaction against the liquidity and disparate treatment rationales underlying the exclusion.

This aspect of the final rules reflects a middle ground between commenter views regarding transactions with foreign branches, given that some commenters expressed the view that all transactions with foreign branches should be counted against a non-U.S. person's de minimis threshold, while another commenter took the view that no such transaction should be counted. This suggests at least two possible alternatives to the final rule—one in which all transactions with foreign branches are excluded from being counted against the thresholds, and one in which all transactions with foreign branches are counted against the thresholds (just like other transactions with U.S. person counterparties).

The effect of adopting the first alternative—whereby all transactions with foreign branches are excluded from being counted—could provide U.S. market participants that are not registered as dealers with incentives to execute higher volumes of security-based swaps through their foreign branches, resulting in higher amounts of risk being transmitted to the United States without the risk-mitigating attributes of having a registered dealer involved in the transaction. Adopting the second alternative—whereby all of a non-U.S. person's transactions with foreign branches are counted regardless of the registration status of the U.S. counterparty—would raise the potential for disparate impacts upon U.S. persons trading with foreign branches, along with associated concerns about liquidity impacts.

The available data allows for estimates related to both potential alternatives subject to the limitations discussed above, and neither alternative would be expected to indicate a change to our assessment that up to 50 entities may be expected to register with the Commission as security-based swap dealers.

The final rules also incorporate definitions of “foreign branch” and “transaction conducted through a foreign branch” that potentially could be modified to reflect alternative approaches. While we do not believe that the economic impact of following such alternatives is readily quantifiable given the available data, we generally believe that any such effects would be limited, particularly in light of our understanding that few, if any, U.S. persons currently may participate in the single-name CDS market through their foreign branches.

Separately, the final rules do not require non-U.S. persons to count their dealing transactions with non-U.S. counterparties. Potential alternatives to that approach could be to require non-U.S. persons to count their dealing transactions with counterparties that are guaranteed affiliates of U.S. persons (at least with regard to transactions subject to the guarantees), or their dealing transactions with counterparties that are conduit affiliates. The alternative approach of requiring non-U.S. persons to count dealing transactions with either or both of those types of non-U.S. counterparties potentially would increase the programmatic benefits associated with Title VII dealer regulation, by applying the risk mitigating aspects of dealer regulation (such as capital and margin requirements) to the dealer counterparties of persons whose security-based swap activities directly affect the United States, while recognizing that such risk mitigating benefits would be more attenuated than those that are associated with the final rules' approach of directly counting dealing transactions of such guaranteed and conduit affiliates. On the other hand, requiring non-U.S. persons to count such transactions would be expected to increase assessment costs by requiring such persons to evaluate and track whether their non-U.S. counterparties are guaranteed or conduit affiliates. Also, to the extent such an alternative approach causes non-U.S. dealers to avoid entering into transactions with affiliates of U.S. persons to avoid the need to conduct such assessments, the approach could reduce the liquidity available to corporate groups with U.S. affiliates, and further could provide an incentive for such corporate groups to move their security-based swap activity entirely outside the United States (which could impair the transparency goals of Title VII).

As we discussed in the Cross-Border Proposing Release, another potential approach related to the treatment of non-U.S. persons' dealing activities would be to not require the registration of non-U.S. persons that engage in dealing activity with U.S. person counterparties through an affiliated U.S. person intermediary. In our view, such an approach would reduce the programmatic benefits associated with dealer regulation under Title VII, and would raise particular concerns related to financial responsibility and counterparty risk, as well as create risk to U.S. persons and potentially to the U.S. financial system.

(e) “U.S. Person” Definition

The “U.S. person” definition used by the final rules seeks to identify those persons for whom it is reasonable to infer that a significant portion of their financial and legal relationships are likely to exist within the United States and for whom it is therefore reasonable to conclude that risks arising from their security-based swap activities could manifest themselves within the United States, regardless of location of their counterparties. Because the definition incorporates decisions regarding a range of issues, the definition potentially is associated with a number of alternative approaches that could influence the final rules' economic impact.

A particularly significant element of this definition addresses the treatment of investment vehicles. Under the final rule, a fund is a “U.S. person” if the vehicle is organized, incorporated or established within the United States, or if its principal place of business is in the United States, which we are interpreting to mean that the primary locus of the investment vehicle's day-to-day operations is within the United States. One potential alternative approach to this element would be to make use of a narrower definition that does not use a principal place of business test for investment vehicles, and hence does not encompass vehicles that are not established, incorporated, or organized within the United States, even if the primary locus of their day-to-day operations is located here. Another potential approach would be to focus the meaning of “principal place of business” on the location where the operational management activities of the fund are carried out, without regard to the location of the fund's managers.

Similarly, another potential alternative approach to the “U.S. person” definition would be for the definition not to incorporate a principal place of business test for operating companies. Under such an alternative approach, an operating company would not fall within the “U.S. person” definition if it is not organized, incorporated or established within the United States, even if the officers or directors who direct, control and coordinate the operating company's overall business activities are located in the United States.

Following an alternative approach whereby the “U.S. person” definition did not encompass a “principal place of business” test, or whereby the definition followed a narrower such test with regard to particular types of market participants, may be expected to reduce the programmatic costs and benefits associated with dealer regulation, in that it may lead certain non-U.S. persons not to have to register as dealers notwithstanding dealing activities with such counterparties above the de minimis thresholds. Such an alternative approach also may promote market participants' use of such counterparties that are closely linked to the United States but that are not organized, incorporated or established within the United States, or that do not have operational management activities within the United States, in lieu of entering into security-based swaps with U.S. persons. While such an approach may be expected to reduce programmatic costs, it also would reduce the programmatic risk mitigation and other benefits of dealer regulation under Title VII given that the “principal place of business” test helps to identify persons for which the risks associated with their security-based swap activities can manifest themselves within the United States. Such an alternative approach may also be expected to reduce assessment costs incurred by non-U.S. persons, although such assessment costs in any event would be reduced by the ability of non-U.S. persons to rely on a counterparty's representation that the counterparty is not a U.S. person.

Aside from those issues related to the use of a “principal place of business” test, other aspects of the “U.S. person” definition also may affect the programmatic costs and benefits and assessment costs associated with dealer regulation. For example, the final rules do not encompass funds that are majority-owned by U.S. persons, although two commenters supported such an approach. Also, the final “U.S. person” definition does not exclude investment vehicles that are offered publicly only to non-U.S. persons and are not offered to U.S. persons, although some commenters also supported this type of exclusion.

For the reasons detailed above, we believe that including majority-owned funds within the definition of “U.S. person” would be likely to increase programmatic costs (by causing more investment funds to be subject to Title VII requirements) as well as assessment costs, while not significantly increasing programmatic benefits given our view that the composition of a fund's beneficial owners is not likely to have significant bearing on the degree of risk that the fund's security-based swap activity poses to the U.S. financial system. Moreover, for the reasons discussed above, we also believe that an exclusion for publicly offered funds that are offered only to non-U.S. persons and not offered to U.S. persons, while likely to reduce programmatic costs, would also reduce programmatic benefits, by excluding certain funds from the definition of U.S. person based on factors that we do not believe are directly relevant to the degree of risk a fund's security-based swap activities are likely to pose to U.S. persons and potentially to the U.S. financial system.

Apart from those potential alternatives regarding the treatment of majority-owned funds and of investment vehicles offered only to non-U.S. persons, an additional alternative approach would be for the Commission simply to adopt the CFTC's interpretation of “U.S. person.” We do not believe that following that alternative approach would be expected to have a significant effect on programmatic costs and benefits, given the substantive similarities between the CFTC's interpretation and our final rule. Adopting such an alternative approach, however, could have an impact on assessment costs. We particularly are mindful that some commenters requested that we adopt a consistent definition notwithstanding their views regarding specific features of the definition, in part because they believed that differences between our definition of “U.S. person” and the CFTC's interpretation of that term would significantly increase costs associated with determining whether they or their counterparties are U.S. persons for purposes of Title VII. We recognize that differences between the two definitions could lead certain market participants to incur additional costs that they would not incur in the presence of identical definitions. At the same time, we are adopting definitions of “U.S. person” and “principal place of business” that should be relatively simple and straightforward to implement, which should mitigate commenters' concerns about the costs associated with different approaches to these terms. More generally, for the reasons discussed above we believe that the definitions we are adopting are the appropriate definitions for the cross-border implementation of Title VII in the security-based swap context.

In addition, as discussed above, the final “U.S. person” definition does not follow an approach similar to the one used in Regulation S. Because such an alternative approach would treat certain foreign branches of U.S. persons as non-U.S. persons, notwithstanding the entity-wide nature of the associated risks, following such an approach would be expected to reduce programmatic benefits by causing Title VII dealer regulation not to apply to certain dealing activities that occur in the United States and pose direct risks to U.S. persons. Although such an alternative approach potentially could impact assessment costs, given that certain market participants may already be familiar with the parameters of such a Regulation S approach, in our view the “U.S. person” definition we are adopting is more appropriate and simpler than an approach based on Regulation S.

Another potential alternative approach for addressing the “U.S. person” definition would be for the definition not to include the exclusion we are adopting with regard to specified international organizations. The alternative approach of not explicitly excluding such organizations from the definition could be expected to increase assessment costs—as counterparties to such organizations would have to consider those organizations' potential status as U.S. persons, which would implicate analysis of the privileges and immunities granted such persons under U.S. law—without likely countervailing programmatic benefits.

The available data suggests that an alternative in which offshore funds managed by U.S. persons are excluded from de minimis calculations by non-U.S. persons would not be expected to indicate a change to our assessment that up to 50 entities may be expected to register with the Commission as security-based swap dealers. We do not believe that other alternative approaches to the “U.S. person” definition are readily susceptible to quantitative analysis that would illustrate their potential programmatic and assessment effects.

(f) Aggregation Requirement

The final rules apply the de minimis exception's aggregation requirement to cross-border activities in a way that reflects the same principles that govern when non-U.S. persons must directly count their dealing activity against the thresholds. The final rules thus have been revised from the proposal to incorporate other aspects of the way that the final rules require counting of particular transactions against the thresholds. The final rules further have been modified from the proposal to remove the proposed “operational independence” condition to the exclusion that permits a person not to count transactions of its affiliates that are registered as security-based swap dealers. These rules—like the incorporation of the aggregation requirement as part of the Intermediary Definitions Adopting Release—are intended to avoid evasion of the Title VII dealer requirements.

The final rules regarding the aggregation provision represent a middle ground between commenter views. One commenter specifically supported the proposal's “operational independence” condition that would limit when a person could exclude the dealing transactions of affiliates that are registered as dealers. On the other hand, other commenters opposed any application of the aggregation provisions in the cross-border context (as well as more generally). This suggests at least two alternatives—one in which the “operational independence” condition is retained, and one in which the aggregation requirement is further limited to only require U.S. persons to count dealing activities of affiliated U.S. persons.

The economic impact of retaining the proposed operational independence condition potentially would reduce efficiencies and deter beneficial group-wide risk management practices. Conversely, the impact of the alternative approach of further limiting the aggregation requirement, such that it addresses only affiliated U.S. persons, would facilitate market participants' evasion of the dealer regulation requirement by dividing their dealing activity among multiple non-U.S. entities.

The economic impact of the alternative approach of retaining the “operational independence” condition is not readily susceptible to quantification, given the lack of data regarding the extent to which affiliates that engage in security-based swap activities jointly make use of back office, risk management, sales or trades, or other functions. Analysis of data related to the alternate approach under which the requirement would be further limited to aggregating transactions of affiliated U.S. persons would not be expected to indicate a change to our assessment that up to 50 entities may be expected to register with the Commission as security-based swap dealers, subject to the limitations discussed above.

(g) Exception for Cleared Anonymous Transactions

The final rules include an exception whereby non-U.S. persons need not count, against the thresholds, transactions that are entered into anonymously and are cleared. This exception reflects limits on the potential availability of relevant information to non-U.S. persons, as well as potential impacts on liquidity that may result absent such an exception.

The likely impact of the alternative approach of not including such an exception could be to deter the development of anonymous trading platforms, or to reduce U.S. persons' ability to participate in such platforms. In this regard the alternative can be expected to help reduce the programmatic benefits of Title VII. The impact of the alternative approach of not including this type of exception is not readily susceptible to quantification.

V. Cross-Border Application of Major Security-Based Swap Participant Thresholds

A. Overview

The statutory definition of “major security-based swap participant” encompasses persons that are not dealers but that nonetheless could pose a high degree of risk to the U.S. financial system. The statutory focus of the “major security-based swap participant” definition differs from that of the “security-based swap dealer” definition, in that the latter focuses on activity that may raise the concerns that dealer regulation is intended to address, while the former focuses on positions that may raise systemic risk concerns within the United States. The definition focuses on systemic risk issues by targeting persons that maintain “substantial positions” that are “systemically important,” or whose positions create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets.” The statute further directed us to define the term “substantial position” at the “threshold that the Commission determines to be prudent for the effective monitoring, management, and oversight of entities that are systemically important or can significantly impact the financial system of the United States.”

In the Intermediary Definitions Adopting Release, we, together with the CFTC, adopted rules defining what constitutes a “substantial position” and “substantial counterparty exposure.” In doing so, we concentrated on identifying persons whose large security-based swap positions pose market risks that are significant enough that it is prudent to regulate and monitor those persons. The definition incorporates a current exposure test and a potential future exposure test designed to identify such persons.

We addressed the application of the major participant definition to cross-border security-based swaps in the Cross-Border Proposing Release, proposing that a U.S. person consider all security-based swap positions entered into by it, and also proposing that a non-U.S. person consider only its positions with U.S. persons but not its positions with other non-U.S. counterparties, even if the positions are entered into within the United States or the non-U.S. counterparties are guaranteed by a U.S. person.

In the proposal, we also explained our preliminary view on the application in the cross-border context of the general principles regarding attribution, which were set forth in guidance in the Intermediary Definitions Adopting Release. Specifically, we stated that a person's security-based swap positions must be attributed to a parent, affiliate, or guarantor for purposes of the major security-based swap participant analysis to the extent that the counterparties to those positions have recourse to that parent, affiliate, or guarantor in connection with the position. This treatment was intended to reflect the risk focus of the major security-based swap participant definition by providing that entities will be regulated as major security-based swap participants when the guarantees they provide pose a sufficiently high level of risk to the U.S. financial system.

Commenters raised several issues related to the proposed approach for applying the major security-based swap participant definition to cross-border security-based swaps. As discussed below, these include issues regarding: the treatment of a non-U.S. person's positions with foreign branches of U.S. banks, the treatment of guarantees, and the treatment of entities with legacy positions. Commenters also requested that the Commission generally harmonize its rules and guidance with the CFTC's Cross-Border Guidance.

After considering commenters' views, we are adopting final rules that have been modified from the proposal in certain important respects. As addressed in further detail below, key changes to the proposal include:

• A requirement that a conduit affiliate, as defined above, must include in its major security-based swap participant threshold calculations all of its security-based swap positions;
• A requirement that a non-U.S. person other than a conduit affiliate must include in its major security-based swap participant threshold calculations all of its security-based swap positions for which its counterparty has rights of recourse against a U.S. person; and
• A modification to the proposed requirement that a non-U.S. person must include in its major security-based swap participant threshold calculations security-based swap positions with foreign branches of U.S. banks.

Our approach to the application of the major security-based swap participant definition in the cross-border context incorporates certain principles that also apply in the context of the dealer definition and that are set forth in the Intermediary Definitions Adopting Release. First, as in the Intermediary Definitions Adopting Release, we interpret the term “person” to refer to a particular legal person, meaning that we view a trading desk, department, office, branch, or other discrete business unit that is not a separately organized legal person as a part of the legal person that enters into security-based swap positions. Thus, a legal person with a branch, agency, or office that exceeds the major security-based swap participant thresholds is required to register as a major security-based swap participant as a legal person, even if the legal person's positions are limited to such branch, agency, or office. In addition, consistent with rules adopted in the Intermediary Definitions Adopting Release, cross-border security-based swap positions between majority-owned affiliates will not be considered for purposes of determining whether the person as a whole is a major security-based swap participant.

B. Application of the Major Security-Based Swap Participant Definition to U.S. Persons

1. Proposed Approach and Commenters' Views

Under the proposal, a U.S. person would have considered all of its security-based swap positions for purposes of the major participant analysis. Commenters did not comment on this aspect of the proposed approach, although, as discussed above, several commenters addressed the proposed scope of the “U.S. person” definition.

2. Final Rule

Consistent with the proposal, the final rules require a U.S. person to consider all of its security-based swap positions in its major security-based swap participant threshold calculations. The final rule incorporates the definition of “U.S. person” used in the context of a security-based swap dealer's de minimis calculation.

As discussed above, in our view, the security-based swap positions of a U.S. person exist in the United States and raise, at the thresholds set forth in our further definition of major security-based swap participant, risks to the stability of the U.S. financial system or of U.S. entities, including those that may be systemically important. As noted above, it is the U.S. person as a whole and not merely a foreign branch or office that bears the risk of the security-based swap. Accordingly, it is consistent with our territorial approach to require a U.S. person to include all of its security-based swap positions in its major security-based swap participant threshold calculations.

C. Application of the Major Security-Based Swap Participant Definition to Conduit Affiliates

1. Proposed Approach and Commenters' Views

The proposal would have treated non-U.S. persons acting as “conduits” for their U.S. affiliates the same as any other non-U.S. person for purposes of the major participant analysis, and, as such would have required those persons to include in their major participant threshold calculations only positions with U.S. persons.

The proposal solicited comment regarding whether a non-U.S. person's major participant analysis should incorporate security-based swaps other than those entered into with U.S. persons. Also, as discussed above, the proposal requested comment on the use of the conduit affiliate concept and the treatment of entities that operate a “central booking system”.

As discussed above, two commenters opposed applying the “conduit affiliate” definition to entities that serve as “central booking systems” for a corporate group, noting that the “central booking systems” are used to manage internal risk. The commenters argued that applying the conduit affiliate definition in this manner would tie regulatory requirements to firms' internal risk management practices, and would hamper the firms' ability to manage risk across a multinational enterprise. Another commenter suggested that conduit affiliates are the recipients of a de facto guarantee from their U.S. affiliates and thus should be treated as U.S. persons.

2. Final Rule

The final rule modifies the proposal to require conduit affiliates to include all of their security-based swap positions in their major participant threshold calculations. Consistent with the dealer de minimis rules, a “conduit affiliate” is a non-U.S. affiliate of a U.S. person that enters into security-based swaps with non-U.S. persons, or with foreign branches of U.S. banks that are registered security-based swap dealers, on behalf of one or more of its U.S. affiliates (other than U.S. affiliates that are registered as security-based swap dealers or major security-based swap participants ), and enters into offsetting transactions with its U.S. affiliates to transfer risks and benefits of those security-based swaps.

After careful consideration and as discussed in the context of the dealer de minimis exception, we believe that requiring such conduit affiliates to include their positions in their major participant threshold calculations is consistent with our statutory anti-evasion authority and necessary or appropriate to help ensure that non-U.S. persons do not facilitate the evasion of major participant regulation under the Dodd-Frank Act. Absent a requirement that conduit affiliates include their positions in the threshold calculations, a U.S. person may be able to evade registration requirements under the Dodd-Frank Act by participating in arrangements whereby a non-U.S. person engages in security-based swap activity outside the United States on behalf of a U.S. affiliate that is not a registered security-based swap dealer or major security-based swap participant. The U.S. person could enter into offsetting transactions with the non-U.S. affiliate, thereby assuming the risks and benefits of those positions. Requiring conduit affiliates to include their positions in their major participant threshold calculations will help guard against evasion of major participant regulation and the risk that such entities could pose to the U.S. financial system.

In this context, as in the dealer context, we recognize the significance of commenters' concerns that the “conduit affiliate” concept may impede efficient risk management procedures, such as the use of central booking entities. As in the context of the de minimis exception to the dealer analysis, the “conduit affiliate” definition serves as a prophylactic anti-evasion measure, and we do not believe that any entities currently act as conduit affiliates in the security-based swap market, particularly given that a framework for the comprehensive regulation of security-based swaps did not exist prior to the enactment of Title VII, suggesting that market participants would have had no incentives to use such arrangements for evasive purposes.

Moreover, we believe that commenter concerns may be mitigated by certain features of the major participant analysis and that, to the extent risk mitigation procedures such as “central booking systems” are impacted by the final rules on conduit affiliates, such anticipated impact is appropriate given the purpose of the major participant definition to identify entities that may pose significant risk to the market. As discussed in the Intermediary Definitions Adopting Release, we believe the major participant thresholds are high enough that they will not affect entities, including centralized hedging facilities, of any but the largest security-based swap users. We would not expect that centralized hedging facilities would generally hold positions at the level of the major participant thresholds. Further, the first test in the major security-based swap participant definition, which calculates whether a person maintains a “substantial position,” excludes positions held for hedging or mitigating commercial risk. In the Intermediary Definitions Adopting Release, we explained that the exclusion includes hedging on behalf of a majority-owned affiliate, such as a centralized hedging facility. We believe this exclusion in the first test of the major participant definition is likely to lessen the impact that the conduit affiliate rules will have on centralized hedging facilities.

In addition to these features of the major security-based swap participant definition that we anticipate will mitigate the impact of the conduit affiliate rules on risk mitigation practices, we believe the focus of the major participant definition on the degree of risk to the U.S. financial system justifies regulation of certain entities that perform this function if they maintain positions at a level that may pose sufficient risk to trigger the major participant definition, regardless of the nature of their security-based swap activity.

For the foregoing reasons, we believe that the final rules regarding conduit affiliates are necessary or appropriate to prevent the evasion of any provision of the amendments made to the Exchange Act by Title VII and appropriately target potentially evasive scenarios that present the level of risk that the major security-based swap participant definition is intended to address.

D. Application to Other Non-U.S. Persons

The proposed rules would have required a non-U.S. person to include in its major security-based swap participant analysis all positions with U.S. persons, including foreign branches of U.S. banks. A non-U.S. person would not have had to include its security-based swap positions with non-U.S. person counterparties, even if such positions were guaranteed by another person. A few commenters criticized the proposed requirement that a non-U.S. person include its positions with foreign branches of U.S. banks in its calculation thresholds. Regarding the treatment of a non-U.S. person whose positions with non-U.S. persons are guaranteed by a U.S. person, one commenter supported our proposed approach not to require the person whose position is guaranteed to include such guaranteed positions in its calculation, while other commenters requested that such entities be treated as U.S. persons. The final rules applying the major participant definition to non-U.S. persons are tailored to address the market impact and risk that we believe a person's security-based swap positions would pose to the U.S. financial system.

1. Positions With U.S. Persons Other Than Foreign Branches of U.S. Banks

(a) Proposed Approach and Commenters' Views

As noted above, the proposed rules would have required a non-U.S. person to include in its major security-based swap participant threshold calculations all positions with U.S. persons, including foreign branches of U.S. banks. The proposal stated that requiring non-U.S. persons to include their positions with U.S. persons, as defined in the proposal, would “provide an appropriate indication of the degree of default risk proposed by such non-U.S. person's security-based swap positions to the U.S. financial system,” by accounting for such non-U.S. person's outward exposures to U.S. persons. One commenter objected to the proposal's approach to look to the U.S.-person status of a clearing agency when a non-U.S. person enters into a security-based swap that is cleared and novated through a clearing agency. In the proposal, we explained that we would consider the clearing agency as the non-U.S. person's counterparty and because the clearing agency is a U.S. person we would require such novated security-based swap to be included in the non-U.S. person's major security-based swap participant calculation threshold calculations. The commenter objected, arguing that the location of clearing should be irrelevant for purposes of determining major security-based swap participant status. Although some commenters took issue with the scope of the “U.S. person” definition, as described above, commenters did not otherwise address this specific requirement within the application of the major security-based swap participant definition.

(b) Final Rule

The final rule, like the proposal, generally requires that non-U.S. persons (apart from the conduit affiliates, which are addressed above) include in their major security-based swap participant threshold calculations their positions with U.S. persons.

Generally requiring non-U.S. persons to consider their security-based swap positions with U.S. persons (except for positions with foreign branches of registered security-based swap dealers, as discussed below) will help ensure that persons whose positions are likely to pose a risk to the U.S. financial system at the relevant thresholds are subject to regulation as a major security-based swap participant. Security-based swap positions involving a U.S.-person counterparty exist within the United States by virtue of being undertaken with a counterparty that is a U.S. person. For these reasons, positions entered into with U.S. persons are likely to raise, at the thresholds set forth in our further definition of major security-based swap participant, risks to the stability of the U.S. financial system or of U.S. entities, including those that may be systemically important.

While we considered one commenter's concern that the location of clearing should not be relevant for purposes of determining a non-U.S. person's major security-based swap participant status, we continue to believe that, as such positions are cleared through a U.S.-person clearing agency, they exist within the United States and create risk in the United States of the type the major security-based swap participant definition is intended to address. We note, in response to commenters' opinions about the risk-mitigating effects of central clearing, and the additional level of rigor that clearing agencies may have with regards to the process and procedures for collecting daily margin, that the final rules further defining “substantial position” provide that the potential future exposure associated with positions that are subject to central clearing by a registered or exempt clearing agency is equal to 0.1 times the potential future exposure that would otherwise be calculated. This treatment reflects our view that clearing the security-based swap substantially mitigates the risk of such positions but cannot eliminate such risk. We believe that this previously adopted provision may provide additional incentives for market participants to clear their positions through registered or exempt clearing agencies, and that the requirement to include such positions in the major security-based swap participant threshold calculations should not discourage market participants from clearing positions through U.S.-based clearing agencies.

2. Positions With Foreign Branches of U.S. Banks

(a) Proposed Approach and Commenters' Views

As noted above, the proposal would have required non-U.S. persons to include their positions with U.S. persons in their threshold calculations. This requirement would have extended to positions with foreign branches of U.S. banks. Two commenters criticized the proposal's requirement that a non-U.S. person would need to include positions with foreign branches of U.S. banks. One of these commenters suggested that the Commission adopt the CFTC policy, which set forth an exception generally permitting a non-U.S. person that is a non-financial entity to exclude from its calculation positions with foreign branches of U.S. banks that are registered swap dealers. One of the commenters suggested that if the Commission did not allow all non-U.S. persons to exclude transactions with foreign branches of U.S. banks from their calculation, the Commission should at least adopt the approach taken by the CFTC in its cross-border guidance of allowing a non-U.S. person that is a financial entity to exclude transactions, subject to certain additional conditions, with foreign branches of U.S. banks that are registered security-based swap dealers.

(b) Final Rule

The final rule has been modified from the proposal to require non-U.S. persons (other than conduit affiliates, as discussed above) to count, against their major security-based swap participant threshold calculations, their positions with U.S. persons other than positions with foreign branches of registered security-based swap dealers. The proposal would have required non-U.S. persons to all include their positions with U.S. persons in their threshold calculations, including any positions with foreign branches of U.S. banks.

The final rule permits non-U.S. persons not to count certain positions that arise from transactions conducted through a foreign branch of a counterparty that is a U.S. bank. For this exclusion to be effective, persons located within the United States cannot be involved in arranging, negotiating, or executing the transaction. Moreover, the counterparty bank must be registered as a security-based swap dealer, unless the transaction occurs prior to 60 days following the effective date of final rules providing for the registration of security-based swap dealers. Registration of the counterparty U.S. bank would not be required for the exclusion to be effective before then, given that the non-U.S. person would not be able to know with certainty whether the U.S. bank in the future would register with the Commission as a security-based swap dealer.

We believe that the revision to the proposal allowing for an exclusion from counting positions that arise from transactions conducted through foreign branches of registered security-based swap dealers appropriately accounts for the risk in the U.S. financial system created by such positions. In our view, the risk of such positions is lessened when the U.S. bank itself is registered with the Commission as a security-based swap dealer because the U.S. bank, and its transactions, will be subject to the relevant Title VII provisions applicable to security-based swap dealers (for example, margin and reporting requirements). The exception is also consistent with our application of the dealer de minimis exception in our final rule, which requires non-U.S. persons, other than conduit affiliates, to include in their de minimis threshold calculations dealing transactions with U.S. persons other than the foreign branch of a registered security-based swap dealer (or for a temporary period of time prior to 60 days prior to the effectiveness of the dealer registration rules).

The final rule should help mitigate concerns that non-U.S. persons will limit or stop trading with foreign branches of U.S. banks for fear of too easily triggering major security-based swap participant registration requirements under Title VII. Moreover, the inclusion of this exception in our final rule addresses comments expressing concern that non-U.S. persons would have to include positions with foreign branches of U.S. banks in their major security-based swap participant threshold calculations. We also note that the exception reduces divergence between our major participant threshold calculation and that outlined in the CFTC's guidance, as requested by commenters.

3. Positions of Non-U.S. Persons That Are Subject to Recourse Guarantees by a U.S. Person

(a) Proposed Approach and Commenters' Views

The proposal would have not required a non-U.S. person to count towards its major security-based swap participant calculation thresholds, those positions that it entered into with non-U.S. persons, regardless of whether the counterparty to the position has a right of recourse against a U.S. person under the security-based swap. To address the risk posed by the existence of a recourse guarantee against a U.S. person, the proposal would have required that all security-based swaps entered into by a non-U.S. person and guaranteed by a U.S. person be attributed to such U.S. person guarantor for purposes of determining such U.S. person guarantor's major security-based swap participant status.

As noted above, one commenter supported the Commission's proposed approach not to require a non-U.S. person whose positions with other non-U.S. persons are subject to a recourse guarantee from a U.S. person, to include such guaranteed positions in its own major participant threshold calculations, expressing support for using the major security-based swap participant attribution requirements to address the risk posed to the U.S. markets by such guarantees. Two commenters argued that non-U.S. persons whose positions are guaranteed by U.S. persons should be treated as U.S. persons for purposes of the major participant threshold calculations, which would require them to include all their positions in their major participant threshold calculations. Additionally, although commenters did not refer specifically to the application of the major security-based swap participant definition, some commenters requested that the Commission generally harmonize its approach to cross-border activities with that of the CFTC.

(b) Final Rule

We are adopting a final rule that requires a non-U.S. person to include in its major security-based swap participant threshold calculations those positions for which the non-U.S. person's counterparty has rights of recourse against a U.S. person. We believe that when a U.S. person guarantees a position, the position exists within the United States and poses risk to the U.S. person guarantor, and the non-U.S. person that enters directly into the position should be required to include the position in its major security-based swap participant threshold calculations. The final rule will also help to apply major participant regulation in a consistent manner to differing organizational structures that serve similar economic purposes, and help avoid disparities in applying major participant regulation to differing arrangements that pose similar risks to the United States.

Accordingly, the final rule modifies the proposal by requiring a non-U.S. person to include in its major security-based swap participant threshold calculations security-based swap positions for which a counterparty to the security-based swap has legally enforceable rights of recourse against a U.S. person, even if a non-U.S. person is counterparty to the security-based swap. For these purposes, and as addressed in the context of de minimis exception to the “security-based swap dealer” definition, the counterparty would be deemed to have a right of recourse against a U.S. person if the counterparty has a conditional or unconditional legally enforceable right, in whole or in part, to receive payments from, or otherwise collect from, a U.S. person in connection with the non-U.S. person's obligations under the security-based swap.

We understand that such rights may arise in a variety of contexts. For example, a counterparty would have such a right of recourse against the U.S. person if the applicable arrangement provides the counterparty the legally enforceable right to demand payment from the U.S. person in connection with the security-based swap, without conditioning that right upon the non-U.S. person's non-performance or requiring that the counterparty first make a demand on the non-U.S. person. A counterparty also would have such a right of recourse if the counterparty itself could exercise legally enforceable rights of collection against the U.S. person in connection with the security-based swap, even when such rights are conditioned upon the non-U.S. person's insolvency or failure to meet its obligations under the security-based swap, and/or are conditioned upon the counterparty first being required to take legal action against the non-U.S. person to enforce its rights of collection.

The terms of the guarantee need not necessarily be included within the security-based swap documentation or even otherwise reduced to writing (so long as legally enforceable rights are created under the laws of the relevant jurisdiction); for instance, such rights of recourse would arise when the counterparty, as a matter of law in the relevant jurisdiction, would have rights to payment and/or collection that may arise in connection with the non-U.S. person's obligations under the security-based swap that are enforceable. We would view the positions of a non-U.S. person as subject to a recourse guarantee if at least one U.S. person (either individually or jointly and severally with others) bears unlimited responsibility for the non-U.S. person's obligations, including the non-U.S. person's obligations to security-based swap counterparties. Such arrangements may include those associated with foreign unlimited companies or unlimited liability companies with at least one U.S.-person member or shareholder, general partnerships with at least one U.S.-person general partner, or entities formed under similar arrangements such that at least one U.S. persons bears unlimited responsibility for the non-U.S. person's liabilities. In our view, the nature of the legal arrangement between the U.S. person and the non-U.S. person—which makes the U.S. person responsible for the obligations of the non-U.S. person—is appropriately characterized as a recourse guarantee, absent countervailing factors. More generally, a recourse guarantee is present if, in connection with the security-based swap, the counterparty itself has a legally enforceable right to payment or collection from the U.S. person, regardless of the form of the arrangement that provides such an enforceable right to payment or collection.

In light of comments received and upon further consideration, we believe that the revised approach addresses, in a targeted manner, the risk to the U.S. financial system posed by entities whose counterparties are able to turn to a U.S. person for performance of the non-U.S. person's obligations under a security-based swap position. We believe our final approach strikes an appropriate balance by directly regulating a non-U.S. person that enters into a position with a counterparty that has a recourse guarantee against a U.S. person, while not treating that non-U.S. person as a U.S. person.

The final rule reflects our conclusion that a non-U.S. person—to the extent it enters into security-based swap positions subject to a recourse guarantee by a U.S. person—enters into security-based swap positions that exist within the United States. The economic reality of such positions is that by virtue of the guarantee the non-U.S. person effectively acts together with a U.S. person to engage in the security-based swap activity that results in the positions, and the non-U.S. person's positions cannot reasonably be isolated from the U.S. person's engagement in providing the guarantee. Both the guarantor and guaranteed entity are involved in the position and may jointly seek to profit by engaging in such security-based swap positions. The final rule echoes our approach, consistent with our approach to regulation of security-based swap dealers that, to the extent that a single non-U.S. person is responsible for positions within the United States (whether by entering into positions with U.S.-person counterparties or for which its non-U.S. person counterparties have recourse against a U.S. person) that rise above the major participant thresholds, the entity that directly enters into such positions should be required to register as a major security-based swap participant and should be subject to direct regulation as a major security-based swap participant.

The final rules regarding positions for which a counterparty to the position has rights of recourse against a U.S. person aim to apply major participant regulation in similar ways to differing organizational structures that serve similar economic purposes, such as positions entered into by a non-U.S. person that are subject to a recourse guarantee by a U.S. person and security-based swap positions carried out through a foreign branch of a U.S. person. These two differing organizational structures serve similar economic purposes and thus should be treated similarly.

As discussed below, we have maintained the proposed approach requiring a U.S. person to attribute to itself any position of a non-U.S. person for which the non-U.S. person's counterparty has rights of recourse against the U.S. person. This attribution requirement further reflects the focus of the major security-based swap participant definition on positions that may raise systemic risk concerns within the United States. Such positions exist within the United States by virtue of the U.S. person's guarantee, which transmits risk to the U.S. financial system to the extent obligations are owed under the security-based swap by the guaranteed non-U.S. person because the non-U.S. person's counterparty may seek recourse from the U.S. person guaranteeing the position. Additionally, the economic reality of this position, even though entered into by a non-U.S. person, is substantially identical, in relevant respects, to a transaction entered into directly by the U.S. guarantor, because a U.S. person is participating directly in the transaction. For these reasons the attribution requirement, which is consistent with our territorial approach and the approach taken in the proposal, reflects the focus of the major security-based swap participant definition.

We note that, consistent with our proposal, we are not requiring non-U.S. persons to include in their major security-based swap participant threshold calculations positions for which they (as opposed to their counterparties) have a guarantee creating a right of recourse against a U.S. person. As we noted in the proposal, non-U.S. persons with a right of recourse against a U.S. person pursuant to a security-based swap do not pose a direct risk to the person providing a guarantee, as that person's failure generally will not trigger any obligations under the guarantee.

E. Attribution

The Cross-Border Proposing Release stated the preliminary view that a person's security-based swap positions in the cross-border context would be attributed to a parent, other affiliate, or guarantor for purposes of the major participant analysis to the extent that the person's counterparties in those positions have recourse to that parent, other affiliate, or guarantor in connection with the position. Positions would not be attributed in the absence of recourse.

The final rules codify the proposed guidance related to attribution of guaranteed positions to provide clarity to market participants. We continue to believe that a U.S. person should attribute to itself any positions of a non-U.S. person for which the non-U.S. person's counterparty has rights of recourse against the U.S. person, as the position exists within the United States by virtue of the U.S. person guarantor's involvement in the position. Similarly, a non-U.S. person should attribute to itself any positions of a U.S. person for which that U.S. person's counterparty has rights of recourse against the non-U.S. person. We also continue to believe that when a non-U.S. person guarantor has extended a recourse guarantee on the obligations of a U.S. person, those positions exist within the United States by virtue of the guaranteed U.S. person's involvement in the positions as a direct counterparty to the transaction and therefore the positions should be attributed to the non-U.S. person guarantor that is participating in that position through providing its guarantee. The final rules requiring attribution also aim to apply major participant regulation in similar ways to differing organizational structures that serve similar economic purposes, thus helping to ensure that the relevant purposes of the Dodd-Frank Act are not undermined.

1. Positions Attributed to U.S. Person Guarantors

(a) Proposed Approach and Commenters' Views

Our preliminary view was that a U.S. person would attribute to itself all security-based swap positions for which it provides a guarantee for performance on the obligations of a non-U.S. person, other than in limited circumstances. We noted that the proposed approach did not alter the guidance regarding attribution that was adopted in the Intermediary Definitions Adopting Release, but proposed an approach in the cross-border context applying the principles set forth in the Intermediary Definitions Adopting Release. This attribution standard was based on our preliminary view that, when a U.S. person acts as a guarantor of a position of a non-U.S. person, the guarantee creates risks within the United States whether the underlying security-based swaps that they guarantee are entered into with U.S. persons or with non-U.S. persons. One commenter argued that attribution is beyond the scope of section 30(c) of the Exchange Act. One commenter argued that our preliminary view regarding attribution for entities guaranteed by U.S. persons would result in “double-counting” and that security-based swap positions should only be attributed to a U.S. guarantor where the direct counterparty to the security-based swap is not otherwise required to count those positions toward its own calculation.

(b) Final Rule

We are adopting rules that codify the preliminary views set forth in our proposal: A U.S. person is required to attribute to itself any security-based swap position of a non-U.S. person for which the non-U.S. person's counterparty to the security-based swap has rights of recourse against that U.S. person. Although we considered commenters' objections to our proposed attribution requirement, we continue to believe that this approach is necessary because, as stated in the Intermediary Definitions Adopting Release, attribution is intended to reflect the risk posed to the U.S. financial system when a counterparty to a position has recourse against a U.S. person. The final rule also includes a note to clarify that a U.S. person is still expected to attribute to itself positions of other U.S. persons for which the counterparty to that U.S. person has a recourse guarantee against the U.S.-person guarantor, as explained in interpretation in the Intermediary Definitions Adopting Release.

We believe that attribution of positions to guarantors is consistent with Exchange Act section 30(c), notwithstanding the argument by one commenter that attribution to a guarantor “extends beyond the intended limits of [s]ection 30(c) of the Exchange Act.” As we discuss in more detail above, the major security-based swap participant definition focuses on positions that may raise systemic risk concerns within the United States. It is our view that a security-based swap position exists within the United States when it is held by or with a U.S. person, or when a counterparty to the security-based swap has recourse against a U.S. person, as the risks associated with such positions are borne within the United States, and given the involvement of U.S. persons may, at the thresholds established for the major security-based swap participant definition, give rise to the types of systemic risk within the United States that major security-based swap participant regulation is intended to address.

As discussed above, the final rules regarding positions for which a counterparty to the position has rights of recourse against a U.S. person aim to apply major participant regulation to in similar ways to differing organizational structures that serve similar economic purposes, including structures such as security-based swap positions entered into by a non-U.S. person that are subject to a recourse guarantee by a U.S. person and security-based swap positions carried out through a foreign branch.

While we recognize one commenter's concern that attribution would require “double counting” certain positions, we do not agree with that commenter's assertion that the final rule constitutes double-counting, given that both entities assume the risk of the position by either entering into it directly or by guaranteeing it. Because both entities are involved in the position that poses risk to the U.S. financial system, both entities are required to include it in their respective major participant threshold calculations, at least until the entity whose position is guaranteed is required to register as a major security-based swap participant.

2. Positions Attributed to Non-U.S. Person Guarantors

(a) Proposed Approach and Commenters' Views

In the proposal, we expressed our preliminary view that a non-U.S. person that provides a recourse guarantee for performance on the obligations of a U.S. person should attribute to itself the security-based swap positions of the U.S. person that are subject to guarantees by the non-U.S. person. However, when a non-U.S. person provides a guarantee to another non-U.S. person, the non-U.S. person providing the guarantee would have been required to attribute to itself only those positions for which a U.S. person counterparty has rights of recourse against the non-U.S. person guarantor under the security-based swap. As noted above, one commenter argued that attribution is beyond the scope of section 30(c) of the Exchange Act.

(b) Final Rule

Consistent with our preliminary view, the final rule requires a non-U.S. person to attribute to itself any security-based swap positions of a U.S. person that are subject to a guarantee by the non-U.S. person. In other words, the non-U.S. person guarantor will attribute to itself all security-based swap positions of the U.S. person for which a counterparty of the U.S. person has rights of recourse against the non-U.S. person guaranteeing the position. The rule reflects our view that the guarantee may enable the U.S. person to enter into significantly more security-based swap positions with both U.S.-person and non-U.S. person counterparties than it would be able to absent the guarantee, increasing the risk that such persons could incur, amplifying the risk of the non-U.S. person's inability to carry out its obligations under the guarantee.

Under the final rule, if a U.S. person in a transaction with a non-U.S. person counterparty has rights of recourse against another non-U.S. person under the security-based swap, the non-U.S. person guaranteeing the transaction must attribute the security-based swap to itself for purposes of its major security-based swap participant threshold calculations. We note that, consistent with the rule requiring non-U.S. persons to count positions entered into with U.S. persons, a non-U.S. person that attributes a position of another non-U.S. person to itself does not need to attribute to itself positions arising from a transaction conducted through a foreign branch of the U.S.-person counterparty when the counterparty is a registered security-based swap dealer or positions arising from a transaction conducted through a foreign branch of a U.S.-person counterparty, when the transaction is entered into prior to 60 days following the earliest date on which registration of security-based swap dealers is first required.

As explained above, we believe that attribution of positions to guarantors is consistent with Exchange Act section 30(c), notwithstanding the argument by one commenter that attribution to a guarantor “goes beyond the intended limits of section 30(c) of the Exchange Act.” As we discuss in more detail above, the major security-based swap participant definition focuses on positions that may raise systemic risk concerns within the United States. It is our view that a security-based swap position exists within the United States when it is held by or with a U.S. person, or when it is guaranteed by a U.S. person, as the risks associated with such positions are borne within the United States, and given the involvement of U.S. persons may give rise, at the thresholds established for the major security-based swap participant definition, to the types of systemic risk within the United States that major security-based swap participant regulation is intended to address.

The final rules requiring non-U.S. persons to attribute certain positions to themselves for purposes of calculating their own major security-based swap participant calculation thresholds aims to apply major participant regulation in similar ways to differing organizational structures that serve similar economic purposes. For example, when a U.S. person has rights of recourse against a non-U.S. person, the economic reality of the position is substantially identical, in relevant respects, to a position entered into directly by the non-U.S. person with the U.S. person. The relevant attribution requirements reflect that a non-U.S. person would need to include such positions were it to enter into them directly.

3. Limited Circumstances Where Attribution of Guaranteed Security-Based Swap Positions Does Not Apply

(a) Proposed Approach and Commenters' Views

The proposal stated our preliminary view that a guarantor would not be required to attribute to itself the security-based swap positions it guarantees, and, therefore, may exclude those positions from its threshold calculations, if the person whose positions it guarantees is already subject to capital regulation by the Commission or the CFTC (for example, by virtue of being regulated as a swap dealer, security-based swap dealer, major swap participant, major security-based swap participant, FCMs, brokers, or dealers), is regulated as a bank in the United States, or is subject to capital standards adopted by its home country supervisor that are consistent in all respects with the Capital Accord of the Basel Committee on Banking Supervision (“Basel Accord”). This preliminary view applied both to U.S. persons and non-U.S. persons that are subject to registration and regulation in the enumerated categories. Our preliminary view was that such consistent foreign regulatory capital requirements would adequately address the risks arising from such positions, making it unnecessary to separately address the risks associated with guarantees of those same positions. We noted that this approach was consistent with the capital standards of the prudential regulators with respect to foreign banks that are bank holding companies subject to the Federal Reserve Board of Governors' supervision.

One commenter supported our preliminary view that a non-U.S. person's guaranteed positions would not be attributed to the guarantor if the guaranteed non-U.S. person is subject to capital regulation by the Commission, the CFTC, or capital standards in its home jurisdiction that are consistent with the Basel Accord. Another commenter sought clarification that a U.S. guarantor will not be required to attribute transactions of guaranteed entities while the guaranteed person's registration as a major security-based swap participant is pending.

(b) Final Rules

Although the final rules require, in some circumstances, both the guarantor and the guaranteed person to include guaranteed positions in their respective major security-based swap participant threshold calculations, the final rules do not require a guarantor to attribute guaranteed positions to itself when the guaranteed person is subject to capital regulation by the Commission or the CFTC (including, but not limited to regulation as a swap dealer, major swap participant, security-based swap dealer, major security-based swap participant, futures commission merchant, broker, or dealer). This codifies our preliminary view. The final rule, moreover, does not require a guarantor to attribute to itself positions that it guarantees when the guaranteed person is regulated as a bank in the United States, or is subject to capital standards adopted by its home country supervisor that are consistent in all respects with the Basel Accord. Consistent with our preliminary view, we believe that consistent foreign regulatory capital requirements would adequately address the risks arising from such positions, making it unnecessary to separately address the risks associated with guarantees of those same positions. We continue to view such regulatory treatment as adequate to address the risks that the attribution requirement is intended to address. We also note that this approach is consistent with the capital standards of the prudential regulators with respect to foreign banks that are bank holding companies subject to the Federal Reserve Board of Governors' supervision.

As noted above, one commenter requested that a U.S. guarantor not be required to attribute to itself a person's positions for which it provides a guarantee while that person's registration as a major security-based swap participant is pending. Upon further consideration, we believe that it is appropriate to permit a guarantor not to attribute the positions of such entities to itself. This change will mitigate market disruption that may otherwise result due to the prospect of a person intermittently exceeding the major participant threshold when a person that it guarantees is in the process of registering as a major security-based swap participant. This approach is also consistent with the approach under the application of the de minimis exception that allows a person not to count the transactions of its affiliates that are in the process of registering as dealers.

F. Other Issues Related to the Application of the Major Security-Based Swap Participant Definition

1. Threshold for Registration as a Major Security-Based Swap Participant

One commenter commented generally that the threshold for having to register as a major-security-based swap participant is too high. This threshold, however, was adopted in the Intermediary Definitions Adopting Release and is not under consideration in this rulemaking. In addition, the Intermediary Definitions Adopting Release provided that the Commission staff will prepare a report subsequent to the effectiveness of the security-based swap reporting requirements that will examine a number of aspects of our definitional rules and related interpretations, including relevant major security-based swap participant thresholds.

2. Entities That Maintain Legacy Portfolios

The Cross-Border Proposing Release did not address the treatment of legacy portfolios, but we stated in the Intermediary Definitions Adopting Release that “the fact that these entities no longer engage in new swap or security-based swap transactions does not overcome the fact that entities that are major participants will have portfolios that are quite large and could pose systemic risk to the U.S. financial system.” Based on this understanding, the Commissions jointly determined that such entities should not be excluded from major participant regulation but explained that the Commissions would pay particular attention to special issues raised by the application of substantive rules to those legacy portfolios.

In the Commission's proposed capital and margin requirements, we proposed exceptions from certain account equity requirements, such as collection of margin, for non-bank security-based swap dealers' and non-bank major security-based swap participants' accounts holding legacy security-based swaps and we requested comment on these proposals. As explained in the Intermediary Definitions Adopting Release, we may entertain requests for relief or guidance on a case-by-case basis. One commenter requested that, at a minimum, the Commission provide flexibility in any requirements that require a person to register as a major security-based swap participant solely due to activity related to its legacy portfolios. With respect to the activities of financial guaranty insurers, one commenter suggested that amendments made to an existing insured security-based swap or entry into a new security-based swap with the same or a substituted counterparty in connection with loss mitigation or risk reduction efforts, should receive the same regulatory treatment given to legacy portfolio security-based swaps because such security-based swaps do not increase notional exposure.

In the context of the cross-border application of the major security-based swap participant definition, we are maintaining our approach to legacy portfolios as described in the Intermediary Definitions Adopting Release and are not excluding entities that maintain legacy portfolios from the major security-based swap participant definition. Given the foregoing, we are not adopting an exclusion from the cross-border application of the major security-based swap participant definition for entities that maintain legacy portfolios.

G. Foreign Public Sector Financial Institutions and Government-Related Entities

In the Cross-Border Proposing Release, we did not propose to specifically address the treatment of entities such as foreign central banks, international financial institutions, multilateral development banks, and sovereign wealth funds in the context of the major security-based swap participant definition and instead sought comment regarding the types, levels, and natures of security-based swap activity that such organizations regularly engage in in order to allow us to better understand the roles of these organizations in the security-based swap markets.

The final rule defining “U.S. person” (like the proposed definition of that term) specifically excludes several foreign public sector financial institutions and their agencies and pension plans, and more generally excludes any other similar international organization and its agencies and pension plans. As explained in the context of the de minimis exception, certain commenters requested that we take further action to address the application of the dealer definition and its de minimis exception to security-based swap activities involving such organizations. Additionally, we noted that two commenters stated that they should not be subject to the possibility of dealer regulation for comity reasons, on the grounds that they were arms of a foreign government. Commenters did not make arguments specific to the application of the major security-based swap participant definition but articulated their arguments in conjunction with their arguments related to the application of the dealer definition. However, one commenter explained that, though it understands that multilateral development banks do not currently engage in security-based swap at the level that would trigger major security-based swap participant registration, even if they did, regulation would violate their privileges and immunities.

As discussed in the context of the de minimis exception, it is our view that such issues are outside the scope of this release given that the source of any such privileges and immunities is found outside of the Dodd-Frank Act and the federal securities laws.

Similar to the discussion in the context of the de minimis exception, commenters also stated that non-U.S. persons should not have to count their security-based swap positions involving these organizations against their major security-based swap participant threshold calculations on the basis that counting such positions would constitute the impermissible regulation of such organizations. As discussed in the context of the de minimis exception, we do not agree with the suggestion that counting a person's positions with such organizations against the major participant calculation thresholds—when otherwise provided for by the rules—involves the regulation of such organizations. Requiring a person to count, against their major participant calculation thresholds, the person's positions involving such an international organization as counterparty simply reflects the application of the federal securities laws to that person and its positions, and does not constitute the regulation of the international organization. A person's security-based swap positions with such an international organization are considered the same, for purposes of applying the major participant calculation thresholds and other Title VII requirements, as a position with some other non-U.S. person counterparty.

H. Economic Analysis of Final Rules Regarding “Major Security-Based Swap Participants”

These final rules and guidance regarding the cross-border implementation of the application of the definition of major security-based swap participants will affect the costs and benefits of major security-based swap participant regulation by determining which positions will be counted against a market participant's major security-based swap participant calculation thresholds. The cross-border rules have the potential to be important in determining the extent to which the risk mitigation and other benefits of Title VII are achieved, by identifying those market participants with sufficiently large exposures to raise the types of systemic risk concerns that the major security-based swap participant definition was intended to address.

As discussed in the context of the cost-benefit analysis of the application of the de minimis exception in the cross-border context, commenters addressed cost-benefit issues from a variety of perspectives, including arguing that cost-benefit principles warranted greater harmonization with the approaches taken by the CFTC or foreign regulators. Commenters, however, did not separately address cost-benefit issues related to the application of the major security-based swap participant definition.

We have taken economic effects into account in adopting these final cross-border rules and providing guidance. Because security-based swap contracts are associated with complex risks and the markets are highly interconnected, we believe that positions that exist within the United States, which are most likely to expose the U.S. financial system to financial risk, should generally be included in the major security-based swap participant threshold calculations. At the same time, we recognize that the cross-border application of Title VII has the potential to reduce liquidity within the U.S. market to the extent it increases the costs of entering into security-based swaps or provides incentives for particular market participants to avoid the U.S. market to operate wholly outside the Title VII framework.

As addressed in the analysis of the costs and benefits of our application of the de minimis rule, the application of the major security-based swap participant definition implicates two types of costs and benefits: assessment costs and programmatic costs and benefits. First, certain current and future participants in the security-based swap market will incur assessment costs in connection with determining whether they fall within the “major security-based swap participant” definition and thus would have to register with the Commission.

Second, the registration and regulation of some entities as major security-based swap participants will lead to programmatic costs and benefits arising as a consequence of the Title VII requirements that apply to registered major security-based swap participants.

We discuss these costs and benefits associated with the final rules more fully below. We also discuss the economic impact of certain potential alternatives to the approach taken in the final rules.

1. Programmatic Costs and Benefits

(a) Cost-Benefit Considerations of the Final Rules

Exchange Act rule 3a67-10 will permit market participants to exclude certain of their positions from their major security-based swap participant threshold calculations, and thus may cause particular entities that engage in security-based swap transactions not to be regulated as major security-based swap participants. The rules accordingly may be expected to affect the programmatic costs and benefits associated with the regulation of major security-based swap participants under Title VII, given that those costs and benefits are determined in part by which persons will be regulated as major security-based swap participants.

As discussed in the context of the application of the de minimis exception, this does not mean that there is a one-to-one relationship between a person not being a “major security-based swap participant” as a result of these cross-border rules, and the resulting change to programmatic benefits and costs. In practice, we believe that these rules will focus the regulation of major security-based swap participants on those market participants whose security-based swap positions may expose the U.S. financial system to the levels of risk we identified as warranting regulation as a major security-based swap participant in the Intermediary Definitions Adopting Release, or on the prevention of evasion. To the extent that a person's positions within the United States remain below these thresholds, we believe that regulating it as a major security-based swap participant under Title VII would be less likely to produce the types of programmatic benefits that Title VII was intended to address. In other words, these requirements will direct the application of the major security-based swap participant definition—which itself is the product of cost-benefit considerations—towards those entities whose security-based swap positions are most likely to pose the type and level of risk to the U.S. financial system that Title VII was intended to mitigate.

As such, the rules reflect our assessment and evaluation of programmatic costs and benefits:

• Positions of U.S. persons—Requiring U.S. persons, as defined in the final rules (including the foreign branches of such persons), to include all of their positions in their major participant threshold calculations, addresses risks that these positions pose to the U.S. financial system.
• Positions guaranteed by U.S. persons—Requiring non-U.S. persons to include in their major security-based swap participant threshold calculations all their positions that are guaranteed by a U.S. person, where their counterparties have recourse to the guarantor, reflects both the economic reality of the position—that the position exists within the United States—and addresses the risks posed to the U.S. financial system by the positions of such persons that are guaranteed by U.S. persons.

• Positions with U.S.-person counterparties—Requiring non-U.S. persons to include their positions with counterparties that are U.S. persons, unless the positions are with a foreign branch of a registered security-based swap dealer, addresses risks to the U.S. financial system arising from positions entered into with U.S. persons.

• Attribution of certain positions to guarantors of performance under a security-based swap—Requiring guarantors of performance under security-based swaps to attribute to themselves, for purposes of their own major security-based swap participant threshold calculations, positions that they guarantee, addresses risks that guarantees pose to the U.S. financial system. To the extent that the guarantee involves a position within the United States or brings a position within the United States, our final rules would typically require attribution to the guarantor. These requirements are intended to help ensure that positions that pose risks to the U.S. financial system are included in the guarantor's major participant threshold calculations.

• Positions subject to anti-evasion provisions—Requiring conduit affiliates to include all of their positions in their major participant threshold calculations addresses, in a targeted manner, the potential for evasion of the major security-based swap participant requirements of Title VII. As noted above we are adopting a definition of “conduit affiliate” that excludes affiliates of registered security-based swap dealers and major security-based swap participants to avoid imposing costs on registered persons in situations that would not appear to implicate the types of evasion concerns that the conduit affiliate definition is intended to address.

In short, these final rules apply the major security-based swap participant definition—which itself reflects cost-benefit considerations —to cross-border security-based swap positions in a way that directs the focus of major participant regulation toward those entities whose security-based swap positions may expose the U.S. financial system to the levels of risk we identified as warranting regulation as a major security-based swap participant.

(b) Evaluation of Programmatic Impacts

In defining “substantial position” and “substantial counterparty exposure” as part of the Intermediary Definitions Adopting Release, we sought to capture persons whose security-based swap positions pose sufficient risk to counterparties and the markets generally that regulation as a market participant was warranted, without imposing costs of Title VII on those entities for which regulation currently may not be justified in light of the purposes of the statute. As discussed above in the context of the dealer analysis, we estimated in the Intermediary Definitions Adopting Release that, under those rules, approximately 12 entities had outstanding positions large enough that they would likely carry out threshold calculations and that fewer than five entities, and potentially zero, would ultimately be required to register as major security-based swap participants. Those estimates provide a baseline against which the Commission can analyze the programmatic costs and benefits and assessment costs of the final rules applying the major security-based swap participant definition to cross-border activities.

We believe the methodology used in the Intermediary Definitions Adopting Release also is appropriate for considering the potential programmatic costs and benefits associated with the final cross-border rules. This methodology particularly can help provide context as to how rules regarding the cross-border application of the definition of major security-based swap participant may change the number of entities that must register as major security-based swap participants, and thus help provide perspective regarding the corresponding impact on the programmatic costs and benefits of Title VII. Applying that methodology to 2012 data regarding the single-name CDS market suggests that under these final rules five or fewer entities may have to register as major security-based swap participants—a number that is consistent with our estimates in the Intermediary Definitions Adopting Release.

The factors that are described in more detail in section IV.I.1(b) regarding the application of the de minimis exception are also relevant to and may impact the programmatic benefits and costs associated with the implementation of the cross-border application of the major security-based swap participant definition. Those factors include limitations of the methodology and data used, the impact of the not yet finalized rules implementing Title VII entity-level and transaction-level requirements applicable to major security-based swap participants, market participants' modifications to their business structure or practices in response to the final rules, and the impact on market participants of other regulatory requirements that are analogous to the major security-based swap participant requirements.

In general, however, and consistent with our territorial approach, we believe that these rules are targeted appropriately and do not apply major security-based swap participant regulation to those entities whose positions have a more limited impact on the U.S. financial system and hence whose regulation as a major security-based swap participant under Title VII would be less linked to programmatic benefits (i.e., non-U.S. persons that engage in security-based swap transactions entirely, or almost entirely, outside the United States with non-U.S. persons or with certain foreign branches), while applying major participant regulation to those entities whose positions would be more likely to produce programmatic benefits under Title VII. The nexus between specific aspects of these requirements and the programmatic costs and benefits also is addressed below in connection with our consideration of various alternatives to the approach taken in the final rules.

Finally, as discussed in the context of the de minimis exception, we recognize that the U.S. market participants and positions regulated under Title VII are a subset of the overall global security-based swap market and that shocks to risk or liquidity arising from a foreign entity's positions outside the United States may spill into the United States. We also have considered these spillovers in connection with our analysis of the effects of these final cross-border rules on efficiency, competition, and capital formation.

2. Assessment Costs

The analysis of how these cross-border rules will affect the assessment costs associated with the “major security-based swap participant” definition is related to the assessment cost analysis described in the Intermediary Definitions Adopting Release, but must also account for certain issues specific to these cross-border rules. While in certain regards those assessment costs can more readily be estimated than the programmatic effects discussed above, the assessment costs associated with the cross-border application of the Title VII major participant requirements will be considerably less significant than those programmatic effects.

The Intermediary Definitions Adopting Release addressed how certain market participants could be expected to incur costs in connection with their determination of whether they have a “substantial position” in security-based swaps or pose “substantial counterparty exposure” created by their security-based swaps, which is necessary for determining whether they are major security-based swap participants. In that release we estimated that as many as 12 entities would likely perceive the need to perform these calculations, given the size of their security-based swap positions. We preliminarily believed that entities that perceive the need to perform the threshold calculations as a result of the proposed rules and guidance set forth in the Cross-Border Proposing Release would incur only relatively minor incremental costs to those described in the Intermediary Definitions Adopting Release. Based on the estimate that no more than 12 entities would perceive the need to engage in the analysis of whether they are a major security-based swap participant, we estimated that the total legal costs associated with evaluating the various elements of the definition may approach $360,000.

As discussed in the context of the de minimis exception, application of these cross-border rules can be expected to affect the assessment costs that market participants will incur. In part, certain non-U.S. persons may be expected to incur personnel costs and legal costs—beyond the legal costs addressed as part of the Intermediary Definitions Adopting Release—associated with analyzing these cross-border rules and developing systems and procedures to assess which transactions would have to be counted against the major security-based swap participant calculation thresholds (or with the purpose of avoiding positions that pose risk to the United States financial system that would be sufficient to meet the applicable thresholds). On the other hand, while certain market participants also would incur additional legal costs associated with the major security-based swap participant determination (i.e., the assessment of whether particular positions should be included in the major participant threshold calculations) addressed in the Intermediary Definitions Adopting Release, the application of the cross-border rules may reduce the number of entities that incur such legal costs.

In adopting these rules we estimate the assessment costs that market participants may incur as a result. As discussed below, however, these costs in practice may be mitigated in large part by steps that market participants already have taken in response to other regulatory initiatives, including compliance actions taken in connection with the requirements applicable to swaps.

(a) Legal Costs

The implementation of these cross-border rules in some circumstances has the potential to change the legal costs identified in the Intermediary Definitions Adopting Release, including by adding new categories of legal costs that non-U.S. persons may incur in connection with applying the major security-based swap participant definition in the cross-border context.

Legal costs related to the cross-border application of major security-based swap participant definition—As discussed in the Intermediary Definitions Adopting Release, certain market participants will incur assessment costs related to the analysis of whether their positions rise to the levels set by the major security-based swap participant definition. For purposes of that release, we assumed that entities with aggregate gross notional single-name CDS positions exceeding $25 billion may identify a need to perform the major participant analysis. Based on that figure, we estimated that 12 entities would perceive the need to perform the major participant analysis.

Under the final rules described above, available data from 2012 indicates that approximately nine persons will have relevant positions exceeding $25 billion, and we continue to believe that firms whose positions exceed this amount will be likely to perform the major participant threshold analysis. Of those nine, five entities are not domiciled in the United States. Consistent with our view in the proposing release, we expect that non-U.S. firms in this set will incur additional costs beyond those described in the Intermediary Definitions Adopting Release. These additional costs would arise due to information that non-U.S. market participants would have to collect and maintain in order to calculate the size of positions that count towards the major participant thresholds. Consistent with our analysis in the Intermediary Definitions Adopting Release, we believe that it is reasonable to conclude that at least some entities with security-based swap positions approaching the major participant thresholds are likely to seek legal counsel for interpretation of various aspects of the rules pertaining to the major participant definition. Though the costs associated with obtaining such legal services would vary depending on the facts and circumstances regarding an entity's positions, we believe that $40,000 is a reasonable estimate of the upper end of the range of the costs of obtaining the services of outside counsel in undertaking the legal analysis of the entity's status as a major security-based swap participant.

Legal costs related to systems analysis—As noted in the assessment cost analysis related to the de minimis exception (and in addition to the estimates in the Cross-Border Proposing Release), we believe that it is reasonable to conclude that those five entities not domiciled in the United States may have to incur one-time legal expenses related to the development of systems and analysis expenses—discussed below—to identify which of their security-based swap positions potentially must be counted for purposes of the major security-based swap participant analysis, consistent with these cross-border rules. As in the dealer context, this additional cost estimate reflects the fact that the development of such systems and procedures must address cross-border rules that require accounting for factors such as whether an entity's security-based swaps are subject to guarantees from U.S. persons, whether its counterparties are U.S. persons, and, specific to the major security-based swap participant analysis, whether the entity must attribute the position to itself pursuant to the attribution rules. As in the analysis of assessment costs related to the dealer definition, we estimate that such legal costs would amount to approximately $30,400 per entity, and that those five entities would incur total costs of approximately $152,000.

(b) Costs Related to New Systems, Analysis, and Representations

Transaction-monitoring systems—The elements introduced by the final cross-border rules may cause certain non-U.S. persons to implement systems to identify whether their positions exceed the major security-based swap participant calculation thresholds. Such systems may reflect the need for non-U.S. persons to: (i) identify whether their counterparties are “U.S. persons”; (ii) determine whether their positions with U.S. persons arise from transactions conducted through a foreign branch (which itself requires consideration of whether their counterparty is a “foreign branch”) and—of those—determine which positions involve a foreign branch of a U.S. bank that itself is a registered security-based swap dealer; (iii) determine whether particular positions are subject to a recourse guarantee against a U.S. person; and (iv) evaluate the applicability of the attribution rules. Our estimates for the required systems are the same in the major participant analysis as they are in the dealer analysis: one-time programming costs of $14,904 and ongoing annual systems costs of $16,612 per entity.

Analysis of counterparty status, including representations—As discussed in the context of the de minimis exception, non-U.S. market participants would be likely to incur costs arising from the need to assess the potential U.S.-person status of their counterparties, which we would typically expect to be dealers, and in some cases to obtain and maintain records related to representations regarding their counterparty's U.S.-person status. We anticipate that non-U.S. persons are likely to review existing information about their counterparties to assess whether those counterparties are U.S. persons. Non-U.S. persons at times may also request and maintain representations from their dealer and non-dealer counterparties to help determine or confirm their counterparties' status. Accordingly, as in the discussion of dealer assessment costs, in our view, such assessment costs primarily would encompass one-time costs to review and assess existing information regarding counterparty domicile, principal place of business, and other factors relevant to potential U.S.-person status, as well as one-time costs associated with requesting and collecting representations from counterparties. The costs associated with representations in the context of the major participant analysis would be one-time costs of approximately $24,200 per firm.

Monitoring of counterparty status—Also as addressed in the context of the de minimis exception, market participants may be expected to adapt their systems to monitor the status of their counterparties for purposes of future security-based swap activities, which would allow market participants to maintain records of counterparty status for purposes of conducting the major participant assessment. Market participants also may need to monitor for the presence of information that may indicate that the representations they have received are outdated or otherwise are not valid. The costs associated with adapting the systems described above to monitor the status of their counterparties for purposes of their future security-based swaps would be the same as the costs in the dealer analysis: one-time costs of approximately $12,436.

Summary of systems, analysis, and representation costs—The summary of costs that certain non-U.S. market participants would incur in connection with systems, analysis of counterparty status and representations in connection with these cross-border rules would be approximately $51,500 in one-time costs and $16,612 in estimated annual ongoing costs. Based on our estimate, subject to the limitations associated with the use of data analysis discussed above, that five non-U.S. domiciled entities will incur these assessment costs, we estimate that the total one-time industry-wide costs associated with establishing such systems would amount to approximately $257,500 and total ongoing costs would amount to approximately $83,100.

(c) Overall Considerations Related to Assessment Costs

In sum, we believe that the effect of these final cross-border rules would be an increase over the amounts that otherwise would be incurred by certain non-U.S. market participants, both in terms of additional categories of legal costs and in terms of the need to develop certain systems and procedures. As discussed in the context of the assessment costs applicable to the dealer analysis, we believe that requiring certain non-U.S. persons to incur such assessment costs is an unavoidable adjunct to the implementation of a set of rules that are appropriately tailored to apply the “major security-based swap participant” definition under Title VII to a global security-based swap market in a way that yields the relevant benefits associated with the regulation of major participants and achieves the benefits of Title VII. The benefits of Title VII's regulatory requirements applicable to major security-based swap participants could be undermined if a significant portion of positions held by non-U.S. persons that impose risk on the U.S. financial system were excluded from the Title VII framework. In certain respects, however, decisions embedded in these final rules are designed to avoid imposing assessment costs upon market participants.

As explained in the context of the analysis for dealers, we recognize that our estimates of assessment costs may result in an overestimation as such costs may be tempered to the extent that market participants' assessments correspond to the assessments they otherwise would follow due to other regulatory requirements or business practices, particularly with respect to assessments they may have made regarding the U.S.-person status of their counterparties.

Also as noted in the dealer discussion, we acknowledge that certain aspects of the final rules may differ from those of the CFTC, which may result in higher costs for market participants, but we believe that such differences are justified and we discuss those differences in the substantive discussions of the specific rules. We also recognize other factors that may impact the assessment costs for potential major security-based swap participants, such as the possibility that certain market participants will choose to restructure their business to avoid major security-based swap participant regulation.

3. Alternative Approaches

As discussed above, the final rules incorporate a number of provisions designed to focus Title VII major security-based swap participant regulation upon those persons whose security-based swap positions may raise the risks within the United States that the major participant definition was intended to address.

In adopting these final rules we have considered alternative approaches suggested by commenters, including the economic effects of following such alternative approaches. In considering the economic impact of potential alternatives, we have sought to isolate the individual alternatives to the extent practicable, while recognizing that many of those alternatives are not mutually exclusive.

We further have considered such potential alternatives in light of the methodologies discussed above, by assessing the extent to which following particular alternatives would be expected to increase or decrease the number of entities that ultimately would be expected to be regulated as major security-based swap participants under the final rules, as well as the corresponding economic impact. Analysis of the available data would tend to suggest that various alternative approaches suggested by commenters would not produce any changes in the numbers of market participants that may have to be regulated as major security-based swap participants. These results are subject to the above limitations, however, including limitations regarding the ability to quantitatively assess how market participants may adjust their future activities in response to the rules we adopt or for independent reasons. Accordingly, while such analyses provide some context regarding alternatives, their use as tools for illustrating the economic effects of such alternatives is limited.

(a) Security-Based Swap Positions Held by Foreign Branches of U.S. Banks

As with the final rules in the context of the de minimis exception, the final rules applying the major security-based swap participant definition require U.S. banks to count all positions of their foreign branches against the major participant calculation thresholds, even when the counterparty is a non-U.S. person or another foreign branch of a U.S. person. The proposed definition of “U.S. person” plays a central role in the application of Title VII in the cross-border context, directly affecting which positions a person must include in its major security-based swap participant threshold calculations and ultimately, the number of entities that will register as major security-based swap participants. An alternative approach would permit U.S. persons not to include the positions of their foreign branches in their major security based swap participant calculation thresholds. As discussed above, we believe our approach to U.S. persons as described above, is consistent with our overall territorial approach to the application of Title VII requirements to the cross-border security-based swap market, because it requires that major security-based swap participant calculation thresholds include the positions of such persons that are most likely to cause risk to the U.S. financial system at the threshold levels set in the major security-based swap participant definition. For the reasons discussed above, we believe that it is appropriate for a U.S. person to include in its calculation thresholds positions conducted through foreign branches to the same extent as other positions held by U.S. persons.

As in the dealer analysis, using the 2012 data to assess the impact associated with this alternative does not indicate a change to our estimate that up to five entities potentially would register as major security-based swap participants, and the analysis is subject to the limitations discussed in the context of the dealer analysis. Adopting an alternative approach that does not require foreign branches to count their positions with non-U.S. persons could incentivize U.S. persons to execute higher volumes through their branches.

(b) Positions of Non-U.S. Persons for Which the Counterparty Has Rights of Recourse Against a U.S. Person

The final rules require a non-U.S. person to count, against its major security-based swap participant calculation thresholds, positions for which the non-U.S. person's performance in connection with the transaction is subject to a recourse guarantee against a U.S. person. Although the proposal instead would have treated such guaranteed affiliates like any other non-U.S. persons, we believe that this provision is appropriate for the reasons discussed above, including the fact that such recourse guarantees pose risks to the U.S. financial system via the guarantor.

This aspect of the final rules reflects a middle ground between commenter views, as is discussed above regarding the approach taken in the dealer analysis. The same two alternatives that are presented in the analysis of alternatives to the approach to the dealer final rules are relevant to the discussion of the application of the major security-based swap participant definition—one alternative in which the final rules do not address guarantees at all, and one in which (based on the concept of a de facto guarantee) all affiliates of a U.S. person should have to count their security-based swap positions against the calculation thresholds, with a potential exception if they demonstrate to the market that there will be no guarantee. A third alternative and the approach taken in the proposal would require the non-U.S. person to include in its threshold calculations only those positions with U.S. persons that are not guaranteed but would require those positions that are guaranteed to be attributed to the U.S. person guarantor for purposes of its own threshold calculations.

The analysis of the first two alternatives discussed in the context of the application of the dealer requirements above also applies in the context of applying the major security-based swap participant definition. The third alternative, which is the approach taken in the proposal, may have reduced programmatic benefits by increasing the likelihood that, even when a person exceeds the thresholds by virtue of its own positions, which exist within the United States by virtue of the U.S. person guarantor, it will not be subject to direct regulation as a major participant. Under the proposed approach, only the U.S. person guarantor would have counted the positions for which the non-U.S. person's counterparty had rights of recourse against the U.S. person, meaning that such positions would not be accounted for in the major participant threshold calculations of the entity that directly enters into the positions. The economic reality of such positions is that by virtue of the guarantee the non-U.S. person effectively acts together with a U.S. person to engage in the security-based swap activity that results in the positions, and the non-U.S. person's positions cannot reasonably be isolated from the U.S. person's engagement in providing the guarantee. The final rule reflects this economic reality by requiring the non-U.S. person whose position is guaranteed to include such positions in its major security-based swap participant threshold calculations.

For the foregoing reasons, we believe that the approach taken in the final rules is appropriate. We note that an assessment of the data regarding the first alternative does not indicate a change in the number of entities that may be expected to register as major security-based swap participants. Due to data limitations that prevent us from identifying which individual transactions of non-U.S. persons are subject to guarantees by U.S. persons and data limitations preventing us from obtaining information about the single-name security-based swap transactions of non-U.S. domiciled persons for single-name CDS involving a non-U.S. reference entity, the available data does not enable us to assess the second and third alternatives.

(c) Positions of Conduit Affiliates

The final rules require conduit affiliates to count all of their security-based swap positions in their major security-based swap participant threshold calculations. The available data does not permit us to identify which market participants would be deemed conduit affiliates. As explained in the corollary discussion in the dealer analysis, we believe the alternative of not requiring such entities to count their positions would remove a tool that should help to deter market participants from seeking to evade regulation.

As addressed in the dealer analysis another alternative to address such evasive activity could be to narrow the inter-affiliate exception, such as by making the exception unavailable when non-U.S. persons enter into positions with their U.S. affiliates. While this alternative may be expected to reduce costs to such entities, we believe the final rules will achieve comparable anti-evasion purposes with less cost and disruption.

(d) Positions of Non-U.S. Persons With Foreign Branches of U.S. Banks and Certain Other Counterparties

The final rules require non-U.S. persons to include their positions arising from transactions conducted through foreign branches of U.S. banks unless the U.S. bank is registered as a security-based swap dealer. This reflects a change from the proposal, which would have required non-U.S. persons to include all positions with foreign branches of U.S. banks without exception. The final approach, as in the context of the dealer analysis, reflects a middle ground between commenter views, which provided two alternatives: that all positions arising from transactions conducted through foreign branches be counted or that no such position be counted against a non-U.S. person's major security-based swap participant calculation thresholds. Adopting the first alternative requiring non-U.S. persons to include all positions with foreign branches would raise the potential for disparate impacts upon U.S. persons with foreign branches, along with associated concerns about liquidity impacts. Adopting the second alternative excluding all such positions from being counted, could incentivize U.S. market participants that are not registered as dealers to execute higher volumes of security-based swaps through their foreign branches, resulting in higher levels of risk being transmitted to the United States without the risk-mitigating attributes of having a registered dealer involved in the position.

The available data related to these alternatives is subject to the limitations discussed above and does not indicate a change to our assessment of the number of entities that may be expected to register as major security-based swap participants.

Another alternative approach would require non-U.S. persons to include in their major security-based swap participant threshold calculations those positions for which they have rights of recourse against a U.S. person or their positions with counterparties that are conduit affiliates. We believe that the positions of such non-U.S. persons do not transmit risk to the United States in the same way as if the potential major security-based swap participant is the entity whose performance is guaranteed by a U.S. person because the default of the non-U.S. person who holds the right of recourse against the U.S. person guarantor will not impact the outward exposure of the U.S. person or the non-U.S. person whose position is guaranteed. While these alternatives may potentially increase programmatic benefits associated with Title VII major participant regulation, they would also likely increase assessment costs by requiring such non-U.S. persons to evaluate and track whether they have a right of recourse against a U.S. person, potentially reducing liquidity available to U.S. corporate groups that provide guarantees to non-U.S. persons. We note that, under the final rules regarding guaranteed positions, the entity involved in the position with the closest connection to the United States, the non-U.S. person whose position is guaranteed, as well as the U.S. guarantor itself, will already be including the position in each of their calculations. Thus we believe such benefits would be more attenuated than those associated with the final rules' approach of directly counting the positions of such guaranteed non-U.S. persons. Accordingly, we do not believe these alternatives would generate significant additional programmatic benefits.

(e) Attribution

i. Attribution to U.S. Persons

Our final attribution approach requires U.S. persons to include, for purposes of their major security-based swap participant calculation thresholds, those positions for which a non-U.S. person's counterparty has rights of recourse against the U.S. person.

An alternative approach would not require a U.S. person to include such positions in its threshold calculations. This alternative potentially reduces the programmatic costs and benefits of major participant regulation because it would reduce the number of positions that U.S. guarantors would include in their calculations. By reducing the costs associated with providing guarantees, such an alternative could reduce the barriers to participation in the security-based swap market faced by participants who might benefit from risk sharing afforded by security-based swap positions but cannot credibly provide sufficient information for their counterparties to assess creditworthiness. We further believe that such an approach would only reduce the assessment costs associated with major participant regulation to the extent that U.S. guarantors do not have private incentives in place to collect information about positions they guarantee.

As noted in section V.D.3, however, we believe it is important to account for the risk to the U.S. financial system transmitted by such guaranteed positions. Ensuring that a U.S. person counts positions of potentially several entities whose counterparties have rights of recourse against it, where each of those entities may be individually below the major participant threshold, will generate the types of benefits that Title VII was intended to produce. The benefits of including these positions are significant because, through the U.S. guarantor, these positions expose the U.S. financial system to the type of risk that the definition of major security-based swap participant is intended to address.

ii. Attribution to Non-U.S. Persons

Under the final rules a non-U.S. person must include security-based swap positions of a U.S. person for which that person's counterparty has rights of recourse against the non-U.S. person, and security-based swap positions of another non-U.S. person that are with a U.S.-person counterparty who has rights of recourse against the non-U.S. person that is the potential major security-based swap participant.

An alternative approach to these requirements would be to not require non-U.S. persons to include such positions, even when those positions are entered into by U.S. persons or when a U.S. person has a right of recourse against them under those positions. Not requiring these positions to be attributed to the non-U.S. person could reduce assessment costs for non-U.S. persons and potentially result in fewer non-U.S. persons ultimately registering as major security-based swap participants. This alternative potentially improves risk sharing by U.S. persons who must rely on guarantees in order to participate in the security-based swap market by reducing the costs incurred by non-U.S. person guarantors. It likely would, however, also reduce programmatic benefits to the extent that non-U.S. persons that guarantee positions within the United States of multiple entities, each of which is below the major participant threshold, are not required to include such positions in their own calculations.

Such non-U.S. persons who provide guarantees ultimately bear the risk of positions they guarantee, and the aggregate risk exposure of the U.S. financial system to a non-U.S. person guarantor varies more directly with the notional amount of positions involving U.S. persons that are guaranteed than with the number of entities to which it provides guarantees. As a result, the Commission believes it is appropriate to apply attribution requirements that treat non-U.S. person guarantors of positions to which U.S. persons are counterparties as if they were direct counterparties. With respect to guarantees provided by non-U.S. persons to U.S. persons, the Commission believes it is appropriate to attribute guaranteed positions because U.S. persons bear the risk that non-U.S. person guarantors will be unable to fulfill obligations under the guarantees they provide.

(f) Positions Cleared Through a Clearing Agency in the United States

The final approach requires non-U.S. persons to include in their major participant threshold calculations those positions that are entered into with U.S. persons, including positions that are cleared through a registered clearing agency in the United States. An alternative raised by a commenter suggested that the location of clearing not be relevant for purposes of determining whether a non-U.S. person is a major security-based swap participant. This alternative would ignore the risk that is posed to the U.S. financial system by positions cleared through a U.S.-person clearing agency, and would be inconsistent with the general approach that all positions with U.S. counterparties should be counted towards the major security-based swap participant threshold calculation. For this reason, we believe the alternative would ignore important programmatic benefits that are incorporated in the final approach.

(g) Foreign Government-Related Entities

Several commenters suggested that foreign government-related entities, such as sovereign wealth funds and MDBs, should be excluded from the U.S. person, security-based swap dealer, and major security-based swap participant definitions. 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 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, 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. To the extent that such entities do enter into security-based swaps with U.S. persons, however, we believe such requiring such entities to include those positions in their major participant threshold calculations will generate programmatic benefits, as such positions introduce risk into the United States of the type title VII intended to address.

VI. Substituted Compliance Procedural Rule

A. Proposed Approach and Commenters' Views

The Cross-Border Proposing Release addressed a range of substantive issues regarding the potential availability of substituted compliance, whereby a market participant could satisfy certain Title VII obligations by complying with comparable foreign requirements. These included issues regarding which requirements might be satisfied via substituted compliance, and regarding the showings necessary to obtain a substituted compliance order from the Commission.

The release also proposed to amend the Commission's Rules of General Application to establish procedures for considering substituted compliance requests, similar to the procedures that the Commission uses to consider exemptive order applications under section 36 of the Exchange Act. Among other aspects, proposed Exchange Act rule 0-13 would require that substituted compliance applications be in writing and include any supporting documentation necessary to make the application complete—“including information regarding applicable requirements established by the foreign financial regulatory authority or authorities, as well as the methods used by the foreign financial regulatory authority or authorities to monitor compliance with such rules”—and that applications cite applicable precedent. The proposed rule also stated that the Commission may choose to publish requests in the Federal Register, and stated that requestors may seek confidential treatment. We preliminarily concluded that those proposed procedures would provide sufficient guidance regarding the submission process. We also solicited comment regarding the sufficiency of the guidance provided by the proposed rule, and regarding whether foreign regulatory authorities should be able to submit substituted compliance requests.

One commenter raised concerns that the proposed availability of confidential treatment “would foreclose any public comment, debate or analysis of the applicant's claims about the foreign regulatory regime, leading to an industry-led process.” That commenter urged us to disallow confidential treatment of applications, and to invite public comment as foreign jurisdictions are considered for comparability.”

Commenters also asked for greater clarity regarding the information to be provided in connection with substituted compliance requests. Commenters also asked that the Commission coordinate with the CFTC and foreign regulators in making substituted compliance determinations.

Other commenters addressed a related issue regarding whether foreign regulators could submit substituted compliance requests. Proposed Exchange Act rule 3a71-5, regarding substituted compliance for foreign security-based swap dealers, specified that such requests may be filed by a foreign security-based swap dealer or group of dealers. A number of commenters took the contrasting position that foreign regulators should be able to submit substituted compliance requests. Some commenters further stated that such requests solely should be submitted by foreign regulators. Two commenters particularly emphasized the importance of the Commission's substituted compliance assessments taking into account foreign enforcement and supervisory practices.

B. Final Rule

In large part, we expect to address issues regarding the availability of substituted compliance as part of future rulemakings, in conjunction with considering the cross-border application of the relevant substantive rules. As discussed above, we believe that it is appropriate to address issues regarding the cross-border application of the substantive requirements under Title VII in conjunction with considering the final rules to implement those substantive requirements, as substituted compliance potentially will constitute an integral part of the final approach toward cross-border application.

At this time, however, we believe that it is appropriate to adopt a final rule to address the procedures for submitting substituted compliance requests. Using the same general procedural requirements would facilitate the efficient consideration of substituted compliance requests. Proposed Exchange Act rule 0-13, moreover, is sufficiently flexible to accommodate requests related to a range of regulatory requirements, even when the requirements necessitate different approaches toward substituted compliance.

Accordingly, we are adopting Exchange Act rule 0-13 largely as proposed. In response to commenter input, however, the final rule has been modified from the proposal to provide that a request for a substituted compliance order may be submitted either by a party that potentially would comply with requirements under the Exchange Act pursuant to a substituted compliance order, or by a relevant foreign financial regulatory authority or authorities. We are persuaded that allowing foreign regulators to submit such requests would promote the completeness of requests and promote efficiency in the process for considering such requests, in light of foreign regulators' expertise regarding their domestic regulatory system, including the effectiveness of their compliance and enforcement mechanisms, and to allow for a single point of contact to facilitate the consideration of substituted compliance requests associated with the jurisdiction. We are not, however, foreclosing the ability of a market participant itself to submit a request that it be able to comply with Exchange Act requirements pursuant to a substituted compliance order.

The final rule further revises the proposal to provide that applications should include supporting documentation regarding the methods that foreign financial regulatory authorities use to enforce compliance with the applicable rules. This type of information—which we expect would be best provided by the relevant foreign regulator—is consistent with the fact that our substituted compliance assessments will not be limited to a comparison of applicable rules and their underlying goals, but also will take into account the capability of a foreign financial regulatory authority to monitor compliance with its rules and take appropriate enforcement action in response to violations of such rules.

Finally, the final rule revises the proposal by removing a provision that would have stated that requestors may seek confidential treatment of their application to the extent provided by Exchange Act rule 200.81. This change reflects the fact that under the final rules substituted compliance applications may be submitted by foreign financial regulatory authorities, and recognizes the importance of having the assessment consider potentially sensitive information regarding a foreign regime's compliance and enforcement capabilities and practices. Accordingly, requests for confidential treatment may be submitted pursuant to any applicable provisions governing confidentiality under the Exchange Act. We expect confidential treatment requests will seek protection for privileged information obtained from foreign regulators. Recognizing the significance of commenter concerns regarding the need for public comment, debate and analysis of substituted compliance requests, moreover, rule 0-13 provides that the Commission shall provide public notice of requests and solicit public comment when a complete application has been submitted. We recognize that public comment regarding substituted compliance requests may be helpful to our consideration of particular requests.

In adopting rule 0-13, we recognize that the requirement that an application “include any supporting documents necessary to make the application complete” implicates commenter concerns regarding the need for further guidance regarding what information must be submitted as part of substituted compliance requests. We expect to address such issues regarding supporting documentation in the future, as we consider the potential availability of substituted compliance in connection with particular Title VII requirements.

C. Economic Analysis

The availability of substituted compliance has the potential to impact the interplay between programmatic costs and benefits associated with the Title VII regulation of security-based swap dealers and major security-based swap participants, as well as those associated with other Title VII requirements. For example, substituted compliance potentially may permit the risk management and other programmatic benefits of dealer regulation to be achieved while avoiding costs that market participants otherwise may incur. At the same time, the process of making substituted compliance requests may cause certain market participants to incur extra costs, although that possibility may be obviated in part by the provision that permits foreign financial authorities to make such requests.

As discussed throughout this release, the security-based swap market is a global market that is subject to regulatory requirements that may vary by jurisdiction. As a result, market participants that operate globally potentially could be subject to overlapping or conflicting regulations. If Title VII requirements for non-U.S. market participants conflict with regulations in local jurisdictions, Title VII could act as a barrier to entry to the U.S. security-based swap market. In such cases, allowing market participants to comply with Title VII via substituted compliance could act as a mechanism to preserve access for non-U.S. persons to the U.S. security-based swap market, reducing the likelihood that non-U.S. persons exit the U.S. market entirely. Therefore, we expect that substituted compliance—so long as it is conditioned on a foreign regime's comparability to the relevant requirements under the Dodd-Frank Act, and on the foreign regime having adequate compliance and enforcement capabilities—would help preserve access and competition in the U.S. market, and thus benefit non-dealer participants in the security-based swap market.

Although the costs associated with the process of making substituted compliance request may be uncertain at this time, the decision to request substituted compliance is purely voluntary. To the extent such requests are made by market participants, moreover, such participants would request substituted compliance only if, in their own assessment, compliance with applicable requirements under a foreign regulatory system was less costly than compliance with both the foreign regulatory regime and the relevant Title VII requirement. Even after a substituted compliance determination is made, market participants would only choose substituted compliance if the private benefits they expect to receive from participating in the U.S. market exceeds the private costs they expect to bear, including any conditions the Commission may attach to the substituted compliance determination. Where substituted compliance increases the number of dealers or other participants in the U.S. security-based swap market, or prevents existing participants from leaving the U.S. market, this may help mitigate the programmatic costs associated with the applicable Title VII requirements, while helping to ensure that the associated programmatic benefits are achieved.

The costs particularly associated with making substituted compliance requests, as well as the general costs and benefits associated with allowing substituted compliance, may be expected to vary between the various categories of Title VII requirements. Relevant considerations may include: whether (and to what extent) substituted compliance is permitted in connection with a requirement; the relevant information required to demonstrate consistency between the foreign regulatory requirements and the Commission's analogous dealer requirements; the relevant information required to demonstrate the adequacy of the foreign regime's compliance and enforcement mechanisms; and whether substituted compliance requests are made by market participants or by foreign regulatory authorities. These factors limit our ability to further predict the economic consequences of this procedural rule.

We recognize that commenters have asked that the Commission coordinate with the CFTC and foreign regulators in making substituted compliance determinations. As discussed above, the Commission is subject to obligations to consult and coordinate with the CFTC and foreign regulators in connection with Title VII. Our revision of the final rule to permit foreign regulators to submit substituted compliance requests also helps address goals of increased coordination. Moreover, our substituted compliance assessments regarding particular requirements applicable to security-based swap dealers also as appropriate may take into account the way that other regulators address similar issues, subject to the need for any allowance of substituted compliance to be predicated on the extent to which compliance with another regulatory regime will help achieve the goals of Title VII.

VII. Antifraud Authority

A. Final Rule

The provisions of the rules and guidance, discussed above, do not limit the cross-border reach of the antifraud provisions or other provisions of the federal securities laws that are not specifically addressed by this release.

In section 929P(b) of the Dodd-Frank Act, Congress added provisions to the federal securities laws confirming the Commission's broad cross-border antifraud authority. Congress enacted section 929P(b) in the wake of the Supreme Court's decision in Morrison v. National Australia Bank, which created uncertainty about the Commission's cross-border enforcement authority under the antifraud provisions of the federal securities laws. Before Morrison, the federal courts of appeals for nearly four decades had construed the antifraud provisions to reach cross-border securities frauds when the fraud either involved significant conduct within the United States causing injury to overseas investors, or had substantial foreseeable effects on investors or markets within the United States. With respect to the Commission's enforcement authority, section 929P(b) codified the courts of appeals' prior interpretation of the scope of the antifraud provisions' cross-border reach. Section 929P(b) also made clear that the scope of subject-matter jurisdiction was coextensive with the cross-border reach of the antifraud provisions.

Specifically, the Commission's antifraud enforcement authority under section 17(a) of the Securities Act and the antifraud provisions of the Exchange Act—including sections 9(j) and 10(b)—extends to “(1) conduct within the United States that constitutes significant steps in furtherance of [the antifraud violation], even if the securities transaction occurs outside the United States and involves only foreign investors,” and “(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Similarly, the Commission's enforcement authority under section 206 of the Investment Advisers Act applies broadly to reach “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the violation is committed by a foreign adviser and involves only foreign investors,” and “(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”

Although no commenters challenged the Commission's interpretation of its cross-border antifraud authority, we are aware that a federal district court recently expressed the view that the statutory language may be unclear. We therefore have determined to adopt a rule that clearly sets forth our interpretation of the Commission's cross-border antifraud authority. We believe that our interpretation is not only the better reading of the antifraud authorities and the statutory text added by section 929P(b), but that our reading is consistent with section 929P(b)'s legislative history and purpose.

Further, we believe that our interpretation of the cross-border antifraud enforcement authority best advances the strong interest of the United States in applying the antifraud provisions to cross-border frauds that implicate U.S. territory, U.S. markets, U.S. investors, other U.S. market participants, or other U.S. interests. We believe that our interpretation of the cross-border antifraud authority is necessary to ensure honest securities markets and high ethical standards in the U.S. securities industry, and thereby to promote confidence in our securities markets among both domestic and foreign investors. Our interpretation of the cross-border antifraud authority will also allow us to better protect U.S. investors from securities frauds executed outside of the United States where those frauds may involve non-domestic securities transactions but nonetheless threaten to produce, foreseeably do produce, or were otherwise intended to produce effects upon U.S. markets, U.S. investors, other U.S. market participants, or other U.S. interests.

B. Economic Analysis

This rule is designed to ensure the antifraud provisions of the securities laws are provided broad cross-border reach. Effective cross-border enforcement of the antifraud provisions should help detect and deter or stop transnational securities frauds the final rule may mitigate inefficiencies in allocation of capital. For example, by directly diverting financial resources from more productive projects to less productive projects, serious transnational securities frauds can generate welfare losses.

Further, in the absence of the cross-border application of the antifraud provisions, the perceived risk of fraud may indirectly result in less efficient capital allocation if it reduces investors' trust in the securities market. Additionally, given the global nature of the securities market, ensuring that antifraud provisions of the securities laws have cross-border reach will reduce the likelihood of a fragmented market. As a result of reduced ambiguity over the degree to which they are protected from fraud, U.S. market participants will have fewer incentives to avoid cross-border activity because, as explained above, they will have increased confidence in the integrity of the market. Through this channel, the final rules support a market that provides greater opportunities for U.S. market participants to share risks with market participants in other jurisdictions.

VIII. Impacts on Efficiency, Competition, and Capital Formation

In developing our approach to the cross-border application of the Title VII security-based swap dealer and major participant definitions, we have focused on meeting the goals of Title VII, including the promotion of the financial stability of the United States, by the improvement of accountability and transparency in the U.S. financial system and the protection of counterparties to security-based swaps. We also have considered the effects of our policy choices on competition, efficiency, and capital formation as mandated under section 3(f) of the Exchange Act. That section requires us, whenever we engage in rulemaking pursuant to the Exchange Act and are required to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. In addition, section 23(a)(2) of the Exchange Act requires us, when making rules under the Exchange Act, to consider the impact such rules would have on competition. Section 23(a)(2) also prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.

In this section, we focus particularly on these effects. In adopting these final rules, we recognize that the most significant impact of the cross-border implementation of the dealer and major participant definitions will derive from the role of the definitions in determining which market entities are subject to security-based swap dealer and major security-based swap participant regulation under Title VII and which entities are not. That is, the scope of the final definitions will affect the ultimate regulatory costs and benefits that will accompany the full implementation of Title VII rules aimed at increasing transparency, accountability, and financial stability. Furthermore, the final cross-border rules may create incentives for market participants, including dealers as well as non-dealers and other non-registered entities who transact with dealers, to structure their businesses to operate wholly outside of the Title VII framework. This incentive may be particularly strong for entities at the boundaries of the definitions—for example, entities with relatively limited contact with U.S. persons—for whom the benefits of operating outside of Title VII may exceed the costs of restructuring or forgoing trading opportunities with U.S. counterparties.

A. Competition

As noted above, a key goal of Title VII of the Dodd-Frank Act is to promote the financial stability of the United States by improving accountability and transparency in the financial system. To that end, Title VII imposes new regulatory requirements on market participants who register as security-based swap dealers or major participants. The final cross-border implementation of the dealer and major participant definitions discussed in this release, including the cross-border implementation of the de minimis exception, will likely affect competition in the U.S. security-based swap market and potentially change the set of available counterparties that would compete for business and provide liquidity to U.S. market participants. Though these substantive Title VII requirements have not been finalized, application of Title VII to registered dealers and major participants may directly affect the competitive landscape of the security-based swap market.

As detailed above, the security-based swap market is a global, interconnected market. Within this global market, foreign and domestic dealers compete for business from counterparties, while non-dealers (including major participants) that participate in the market use security-based swaps for purposes that can include speculation and hedging. Because the market for security-based swaps is a global market and some participants may not engage in relevant security-based swap activity within the United States, the rules we adopt pursuant to Title VII will not reach all participants or all transactions in the global market. We are aware that application of rules to a subset of participants in the worldwide security-based swap market would change the costs and benefits of market participation for one group (those that engage in relevant security-based swap activity within the United States) relative to another (those that do not) and therefore create competitive effects.

More specifically, in addition to requiring U.S. dealers to register, our final rules implementing the cross-border approach to the security-based swap dealer definition would generally apply dealer registration and other Title VII requirements to non-U.S. entities that conduct dealing activity (as defined in the Intermediary Definitions Adopting Release) in excess of the de minimis threshold, but where calculation of the threshold depends on various features of the person's transactions (e.g., whether the person's counterparty is a U.S. or non-U.S. person, whether the transaction is guaranteed by a U.S. person, whether the counterparty is a registered or non-registered foreign branch of a U.S. person, and whether the person is a conduit affiliate of a U.S. person). Similarly, our final rules implementing cross-border application of the major security-based swap participant definition would apply major participant registration and other Title VII requirements to entities that have exposures to U.S. persons that exceed the major participant thresholds (as defined in the Intermediary Definitions Adopting Release). Given the approach we are adopting with respect to application of the dealer de minimis and major participant threshold calculation requirements, U.S. persons should have no incentive to favor a non-U.S. person counterparty over a U.S.-person counterparty.

However, we recognize that the final rule treats U.S. persons and different types of non-U.S. persons differently. Unless their dealing activity is guaranteed by a U.S. person, non-U.S. persons may exclude from their de minimis calculations dealing activity with other non-U.S. persons. Similarly, unless their security-based swap activity is guaranteed by a U.S. person, non-U.S. persons may exclude from their major participant threshold calculations their positions with non-U.S. persons. U.S. persons, non-U.S. persons whose security-based swap transactions are guaranteed by a U.S. person, and conduit affiliates cannot exclude such transactions or positions from their own calculations. This differential treatment makes it more likely that non-U.S. persons will not be subject to the regulatory requirements associated with dealer and major participant registration. Furthermore, because transactions with U.S. persons in excess of the de minimis and major participant thresholds trigger registration requirements, non-U.S. dealers and other market participants may be reluctant to trade with U.S. counterparties or clear security-based swap transactions through U.S. person clearing agencies because of the potential application of Title VII regulation. For example, our final rules may produce competitive frictions insofar as market participants prefer to clear transactions using non-U.S. person clearing agencies who may have U.S. person members instead of U.S. person clearing agencies, because only positions held against the latter would count against their major participant thresholds. Indeed, some entities may determine that the compliance costs arising from the requirements of Title VII warrant exiting the security-based swap market in the United States entirely. Non-U.S. persons may find this option more attractive than U.S. persons because they may find it easier to structure their foreign business so as to prevent it from falling within the scope of Title VII. However, U.S. entities may also have an incentive to establish separately-capitalized foreign subsidiaries to conduct their security-based swap operations, since such subsidiaries would qualify as non-U.S. persons. In this case, the cross-border application of Title VII rules may affect participants depending on their size, as larger participants could be better-equipped to set up offshore vehicles enabling them to transact as non-U.S. persons.

To the extent that entities engaged in dealing activity exit the U.S. security-based swap market, the end result could be a U.S. market where fewer intermediaries compete less intensively for business. These exits could result in higher spreads and reduced liquidity, and could affect the ability and willingness of non-dealers within the United States to engage in security-based swaps. The concentrated nature of dealing activity suggests that there are high barriers to entry in connection with security-based swap dealing activity, which could preclude the ability of new dealers to enter the security-based swap market and compete away spreads.

Notwithstanding the potential that our final rule may reduce competition, the Commission believes it appropriate to require U.S. persons to count all dealing transactions towards the de minimis threshold and all positions toward the major security-based swap participant thresholds, given the potential for these transactions to create risk to U.S. persons and in the U.S. financial system. We also note that it is uncertain that such requirements will reduce competition. In fact, the final rule may enhance competition among dealers, as the Title VII regulatory requirements and the ability to meet the standards set by Title VII may allow registered dealers to credibly signal high quality, better risk management, and better counterparty protection relative to foreign unregistered dealers that compete for the same order flow. In this scenario, non-dealers in the U.S. market may be willing to pay higher prices for higher-quality services in regulated markets, and registration requirements may separate high-quality intermediaries that are willing and able to register from low-quality firms that are not. Furthermore, while dealers and speculative traders may prefer to transact in opaque markets, transparency requirements that apply to U.S. dealers and transactions that occur within the scope of Title VII may be attractive to hedgers and other market participants who do not benefit from opacity. Therefore, Title VII requirements may promote liquidity in the U.S.; liquid markets should attract additional participants, thereby enhancing risk sharing and making markets more competitive. These regulatory benefits could mitigate the competitive burdens imposed by the proposed and anticipated final cross-border rules and substantive Title VII requirements applicable to registered security-based swap dealers by, for example, reducing incentives for firms to exit the market.

Similarly, the cross-border application of the de minimis exception could reduce the number of entities likely to exit the U.S. market entirely because it would enable an established foreign entity to transact a de minimis amount of security-based swap dealing activity in the U.S. market before it determines whether to expand its U.S. business and become a registered security-based swap dealer. However, since the ability of smaller entities to access the U.S. security-based swap market without registration would be limited to conducting dealing activity below the de minimis threshold, these entities would have an incentive to curtail their security-based swap dealing activity with U.S. persons as they approach the de minimis threshold to avoid dealer registration requirements.

Finally, incentives to restructure ultimately depend on future regulatory developments, both with respect to final Title VII rules and foreign regulatory frameworks; the differences in regulatory requirements across jurisdictions; and strategic interactions with non-dealer participants. For example, although pre-and post-trade transparency requirements provide a number of benefits both to financial markets and the real economy, dealers benefit from operating in opaque markets. To the extent that foreign jurisdictions require only regulatory reporting, without public dissemination requirements, dealers may wish to operate in jurisdictions where they can continue to benefit from opaque markets.

Other market participants, however, may prefer transparency, and the availability of transparent trading venues that result from Title VII pre- and post-trade transparency requirements could shift market power away from dealers. If non-dealer market participants are able to demand transparent trade execution, the incentives to restructure may be tempered, particularly if transparent venues attract liquidity away from opaque markets. Ultimately, the effects of transparency requirements on dealers' incentives to restructure depend on differences across jurisdictions, as well as whether non-dealer participants prefer transparency. These preferences may, in turn, depend on motives for trading among non-dealers. Hedgers and participants that need liquidity may prefer transparent venues while participants who believe they have private information about asset values may prefer opaque markets that allow them to trade more profitably on their information.

The potential restructurings and exits described above may impact competition in the U.S. market in different ways. On one hand, the ability to restructure one's business rather than exit the U.S. market entirely to avoid application of Title VII to a person's non-U.S. operations may reduce the number of entities that exit the market, thus mitigating the negative effects on competition described above. On the other hand, U.S. non-dealers may find that the only foreign security-based swap dealers that are willing to deal with them are those whose security-based swap business is sufficiently large to afford the costs of restructuring as well as registration and the ensuing compliance costs associated with applicable Title VII requirements. To the extent that smaller dealers continue to have an incentive to exit the market, the overall level of competition in the market may decline.

Moreover, regardless of the response of dealers to our approach, we cannot preclude the possibility that large non-dealer financial entities and other non-dealer market participants in the United States, such as investment funds, who have the resources to restructure their business also may pursue restructuring and move part of their business offshore in order to transact with dealers outside the reach of Title VII, either because liquidity has moved offshore or because these participants want to avoid Title VII requirements (such as transparency requirements) that may reveal information about trading strategies. This may reduce liquidity within the U.S. market and provide additional incentives for U.S. persons and non-U.S. persons to shift a higher proportion of their security-based swap business offshore, further reducing the level of competition within the United States. In this scenario, the competitive frictions caused by the application, in the cross-border context, of a de minimis threshold for dealing activity may affect the ability of small market participants of security-based swaps to access the security-based swap market more than large ones, as smaller participants are less likely to have the resources that would enable or justify a restructuring of their business.

In addition to the global nature of the security-based swap market and the implications for the reach of Title VII dealer and major participant registration requirements, we also noted above the current opacity of the over-the-counter derivatives market and the informational advantage that dealers currently have over non-dealers. By having greater private order flow information, dealers are in a position to make more-informed assessments of market values and can use that information to extract rents from less-informed counterparties. While this issue will be the focus of future Commission rulemaking covering pre- and post-trade transparency, we note that the final rule to exclude cleared, anonymous transactions from the de minimis threshold for non-U.S. persons has implications for competition in the security-based swap market. Because cleared, anonymous transactions will not trigger registration requirements, the exclusion strengthens incentives for trading in transparent venues, reducing market power and the competitive advantage currently enjoyed by dealers over non-dealer market participants. Furthermore, while Title VII rules governing clearing, trade execution, and trade reporting have not been finalized, providing stronger incentives to trade on transparent venues and through CCPs increases the likelihood that the benefits of Title VII, including increased transparency and reduced potential for risk spillovers, will be realized.

The overall effects of the final approach described in this release on competition among dealing entities in the U.S. security-based swap market will depend on the way market participants ultimately respond to different elements of Title VII. Application of the dealer and major participant registration requirements may create incentives for dealers and market participants to favor non-U.S. counterparties; incentives to restructure due to inconsistent regulatory requirements may increase concentration among security-based swap dealers providing services to U.S. non-dealers. However, registration and compliance with Title VII may signal high quality and mitigate the incentive to restructure and exit U.S. markets for intermediaries with the ability to meet the standards set by Title VII. Furthermore, if hedgers and other market participants who do not benefit from opacity demand transparency and counterparty protections that come from trading with a registered dealer, dealers may prefer to register if serving this market is profitable. Finally, while fewer dealing entities could lead to decreased competition and wider spreads in the security-based swap market, exclusion of cleared, anonymous trades from the de minimis threshold strengthen incentives to trade in transparent venues, reducing the ability of dealing entities to post wider spreads and reducing the competitive advantage over access to information enjoyed by dealers.

B. Efficiency

As noted above, in adopting the rules and guidance discussed in this release, we are required to consider whether these actions would promote efficiency. In significant part, the effect of these rules on efficiency is linked to the effect of these rules on competition. Definitional rules that promote, or do not unduly restrict, competition can be accompanied by regulatory benefits that minimize the risk of liquidity crises, aggregate capital shortfalls, and other manifestations of contagion. Furthermore, by reducing the costs that individual market participants impose on others through their trades—that is, by imposing registration requirements and substantive regulations on dealers and major participants who, by virtue of the volume of their transactions, their number of counterparties, and their aggregate positions and exposures, are most likely to contribute to risk spillovers—the rules promote efficiency within the market. Generally, rules and interpretations that promote competitive capital markets can be expected to promote the efficient allocation of risk, capital, and other resources by facilitating price discovery and reducing costs associated with dislocations in the market for security-based swaps.

As discussed several times throughout this release, the global nature of the security-based swap market suggests that the regulatory framework adopted under Title VII may not reach all participants or all transactions. Additionally, differing regulatory timelines and differences in regulatory scope may moderate the benefits flowing from Title VII. In particular, if other regulatory regimes offer more opacity in transactions, those who are most harmed by transparency (including dealers who currently benefit from privately observing order flow) have incentives to restructure their business to operate abroad or otherwise take advantage of regulatory gaps. Restructuring itself, while potentially optimal for an individual participant, represents a form of inefficiency for the overall market in that firms expend resources simply to circumvent regulation and not for any productive purpose.

More importantly, altering business models to take advantage of looser regulatory regimes undermines other efficiency benefits to Title VII. For example, U.S. dealers may have an incentive to restructure their businesses by setting up separately capitalized entities in non-U.S. jurisdictions, through which they would continue their dealing operations in order to take advantage of the rules applicable to non-U.S. persons. As discussed above, if some market participants choose to operate wholly outside of the Title VII regulatory framework, risk and liquidity may concentrate in less regulated, opaque corners of the market, undermining the benefits of Title VII. Moreover, insofar as the types of restructuring contemplated above purely constitute attempts at arbitraging regulations, including regulations applied to registered dealers, such as capital and reporting regulations, they represent a use of resources that could potentially be put to more productive uses. Ultimately, the incentive to restructure, and the corresponding loss of benefits, depends on the extent to which other jurisdictions implement comprehensive OTC derivatives regulations. If foreign jurisdictions subject security-based swap transactions to regulatory oversight consistent with Title VII, the ability to arbitrage regulations will be limited.

Nevertheless, two features of our rules adopted today may mitigate the incentive for market participants to undermine the benefits of Title VII through inefficient restructuring or evasion. First, the requirement that conduit affiliates count all dealing activity towards the de minimis threshold closes one potential path for evasion. We have tailored the application of these requirements in connection with affiliates of registered security-based swap dealers and major security-based swap participants, as we do not believe that transactions involving these types of registered entities and their foreign affiliates raise the types of evasion concerns that the conduit affiliate concept is designed to address. Second, the exclusion of cleared, anonymous transactions from the de minimis threshold for non-U.S. persons strengthens incentives for trading in transparent venues, reducing the incentive to trade in opaque corners of the market in order to avoid the reach of Title VII. Strengthening incentives for non-U.S. persons to trade in transparent venues reduces the likelihood that liquidity will fragment to opaque corners of the market and increases the likelihood that risks that non-U.S. persons present to the U.S. financial system will be covered by the Title VII regulatory framework. Furthermore, shifting trades to transparent venues produces benefits associated with pre- and post-trade price transparency, including more efficient valuations of financial assets.

Finally, we received several comments from outside commenters urging us to harmonize our final rules with interpretations set forth in the CFTC's guidance. While our final rules track the CFTC's guidance in many respects—for example, in the treatment of conduit affiliates, the treatment of transactions with foreign branches, and the exclusion for cleared, anonymous transactions from non-U.S. persons' de minimis calculations—we are not adopting rules identical to the policies and interpretations in the guidance. For example, our treatment of investment funds with respect to the U.S. person definition differs from the CFTC's, which, in addition to looking to the location of incorporation and principal place of business, considers majority-ownership. While we acknowledge the benefits of harmonization, we believe our rules meet the goals of Title VII while appropriately minimizing the costs to security-based swap market participants. More specifically, our rules are designed to capture transactions and entities that pose risk to U.S. persons and potentially to the U.S. financial system, while excluding those transactions and entities that do not warrant regulation under Title VII. In the case of investment funds, we have decided not to look to majority-ownership for determining U.S.-person status, notwithstanding that the CFTC Cross-Border Guidance articulates such an approach. Our belief is that, by adopting an approach that generally focuses on the location of economic decisions made on behalf of a fund, we are more accurately measuring whether a fund poses risks to U.S. persons and to the U.S. financial system of the type that Title VII was intended to address. Nevertheless, we acknowledge that different regulations for swaps and security-based swaps may create inefficiencies for market participants due to conflicting or overlapping requirements, particularly for those participants who deal in both swaps and security-based swaps.

C. Capital Formation

We believe that many aspects of the final cross-border approach to the dealer and major participant definitions are likely to promote capital formation, by focusing dealer and major participant regulation on activity and entities that are most likely to serve as conduits of risk to U.S. persons and potentially to the U.S. financial system. We also believe that applying the full range of Title VII requirements to this group of entities will increase the likelihood that the benefits of Title VII, including increased transparency, accountability, and financial stability, will be realized. To the extent that these requirements reduce asymmetric information about market valuations, we expect that a security-based swap market with enhanced transparency and enhanced regulatory oversight may facilitate entry by a wide range of market participants seeking to engage in a broad range of hedging and trading activities.

Additionally, strengthening incentives for non-U.S. persons to trade in transparent venues encourages market participants to express their true valuations for security-based swaps; information revealed through transparent trades allows market participants to derive more-informed assessments with respect to asset valuations, leading to more efficient capital allocation. This should be true for the underlying assets as well. That is, information learned from security-based swap trading provides signals not only about security-based swap valuation, but also about the value of the reference assets underlying the swap. Similarly, we expect transparency to benefit the real economy as well. Transparent prices provide better signals about the quality of a business investment, promoting capital formation in the real economy by helping managers to make more-informed decisions and making it easier for firms to obtain new financing for new business opportunities.

However, the Commission recognizes that, to the extent that the cross-border implementation of the dealer and major participant definitions encourages inefficient restructuring or results in market fragmentation, the final rules may impair capital formation and result in a redistribution of capital across jurisdictional boundaries. We note that, unlike in the proposed rules, we are requiring non-U.S. persons with U.S. guarantees to include all transactions that benefit from a U.S. guarantee in their de minimis calculations. Similarly, we are requiring conduit affiliates to include all transactions in their de minimis calculations, whether with a U.S. person or not. Inclusion of these transactions will limit the risk these participants pose to U.S. persons and to the U.S. financial system. More generally, the definition of “U.S. person” mitigates the risk of contagion affecting U.S. markets as a result of cross-border swap activity. To the extent that future substantive regulation under Title VII is conditioned on entities' registration status, this definition may also improve transparency and provide increased customer protection for U.S. persons who participate in the security-based swap market. Nevertheless, expanding the scope of transactions that must be included in these calculations may also increase the scope of potential market fragmentation, to the extent that it raises the costs that market participants will incur if they engage in security-based swap activity through guaranteed non-U.S. persons or conduit affiliates.

IX. Paperwork Reduction Act

A. Introduction

The Paperwork Reduction Act of 1995 (“PRA”) imposes certain requirements on Federal agencies in connection with their conducting or sponsoring any “collection of information.” An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number. In addition, 44 U.S.C. 3507(a)(1)(D) provides that before adopting (or revising) a collection of information requirement, an agency must, among other things, publish a notice in the Federal Register stating that the agency has submitted the proposed collection of information to the Office of Management and Budget (“OMB”) and setting forth certain required information, including: (1) A title for the collection of information; (2) a summary of the collection of information; (3) a brief description of the need for the information and the proposed use of the information; (4) a description of the likely respondents and proposed frequency of response to the collection of information; (5) an estimate of the paperwork burden that shall result from the collection of information; and (6) notice that comments may be submitted to the agency and director of OMB.

In the Cross-Border Proposing Release, we identified a number of proposed rules that contained “collection of information requirements” within the meaning of the PRA. The majority of those proposed rules and forms are outside of the scope of the dealer and major participant definitions at issue in this release. In two areas, however, Exchange Act rule 3a71-3 which we are adopting today contains collections of information requirements. First, the rule's definition of “transaction conducted through a foreign branch,” which we are adopting largely as proposed, contains a representation provision that constitutes a collection of information. Moreover, the rule's final definition of “U.S. person” incorporates, as an addition to the proposal, a representation provision that constitutes a collection of information. Commenters did not address Paperwork Reduction Act issues in connection with the proposal.

The Commission previously submitted proposed rule 3a71-3, as well as certain other rules proposed as part of the Cross-Border Proposing Release, to OMB for review in accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. The title of the collection related to proposed rule 3a71-3 is “Reliance on Counterparty Representations Regarding Activity Within the United States.” OMB has not yet assigned Control Numbers in connection with rule 3a71-3 or the other rules submitted in connection with the proposal.

B. Reliance on Counterparty Representations Regarding Transactions Conducted Through a Foreign Branch

1. Summary of Collection of Information

When determining whether a security-based swap transaction constitutes a “transaction conducted through a foreign branch,” a person may rely on its counterparty's representation that the transaction “was arranged, negotiated, and executed on behalf of the foreign branch solely by persons located outside the United States, unless such person knows or has reason to know that the representation is not accurate.”

2. Proposed Use of Information

Under the final rules, a non-U.S. person need not count, against the applicable thresholds of the dealer exception and the major security-based swap participant definition, dealing transactions with foreign branches of U.S. banks that are registered as security-based swap dealers. For these purposes, the foreign branch must be the counterparty to the security-based swap transaction, and the transaction must be arranged, negotiated, and executed on behalf of the foreign branch solely by persons located outside the United States.

As discussed in the Cross-Border Proposing Release, the Commission acknowledges that verifying whether a security-based swap transaction falls within the definition of “transaction conducted through a foreign branch” could require significant due diligence. The definition's representation provision would mitigate the operational difficulties and costs that otherwise could arise in connection with investigating the activities of a counterparty to ensure compliance with the corresponding rules.

These representations would be provided voluntarily by the counterparties to certain security-based swap transactions to other counterparties; therefore, the Commission would not typically receive confidential information as a result of this collection of information. However, to the extent that the Commission receives confidential information described in this representation provision through our examination and oversight program, an investigation, or some other means, such information would be kept confidential, subject to the provisions of applicable law.

3. Respondents

Based on our understanding of the OTC derivatives markets, including the size of the market, the number of counterparties that are active in the market, and how market participants currently structure security-based swap transactions, the Commission estimates that up to 15 entities that are registered as security-based swap dealers may include a representation that a security-based swap is a “transaction conducted through a foreign branch” in their trading relationship documentation (e.g., the schedule to a master agreement).

4. Total Initial and Annual Reporting and Recordkeeping Burdens

The estimates in this section reflect the Commission's experience with burden estimates for similar requirements and discussions by our staff with market participants. The Commission believes that, in most cases, the representations associated with the definition of “transaction conducted through a foreign branch” would be made through amendments to the parties' existing trading documentation (e.g., the schedule to a master agreement). Because these representations relate to new regulatory requirements, the Commission anticipates that counterparties may elect to develop and incorporate these representations in trading documentation soon after the effective date of the Commission's security-based swap regulations, rather than incorporating specific language on a transactional basis. The Commission believes that parties would be able to adopt, where appropriate, standardized language across all of their security-based swap trading relationships. This language may be developed by individual firms or through a combination of trade associations and industry working groups.

The Commission estimates the maximum total paperwork burden associated with developing new representations would be, for each U.S. bank registered as a security-based swap dealer that may make such representations, no more than five hours, and up to $2,000 for the services of outside professionals, for an estimate of approximately 75 hours and $30,000 across all security-based swap counterparties that may make such representations. This estimate assumes little or no reliance on standardized disclosure language.

The Commission expects that the majority of the burden associated with the new disclosure requirements will be experienced during the first year as language is developed and trading documentation is amended. After the new representations are developed and incorporated into trading documentation, the Commission believes that the annual paperwork burden associated with this requirement would be no more than approximately 10 hours per counterparty for verifying representations with existing counterparties and onboarding new counterparties, for a maximum of approximately 150 hours across all applicable security-based swap counterparties.

C. Reliance on Counterparty Representations Regarding Non-U.S. Person Status

1. Summary of Collection of Information

When determining whether its counterparty is a U.S. person for purposes of the application of the dealer and major participant analyses, a person may rely on its counterparty's representation that the counterparty does not meet the applicable criteria to be a U.S. person, unless the person knows or has reason to know that the representation is not accurate.

2. Proposed Use of Information

Under the final rules, a non-U.S. person's dealer and major participant analysis require it to determine whether its security-based swap counterparties are U.S. persons because certain security-based swaps in which the counterparty is not a U.S. person will not have to be counted against the applicable thresholds.

The Commission recognizes that the “U.S. person” definition encompasses a number of distinct components, and that in some circumstances verifying whether a security-based swap counterparty is a “U.S. person” could require significant due diligence. As a result, the final rules have added a representation provision to that definition, to help mitigate the operational difficulties and costs that could arise in connection with investigating the status of a counterparty.

As with the representations associated with the “transaction conducted through a foreign branch” definition, these representations would be provided voluntarily by the counterparties to certain security-based swap transactions to other counterparties. The Commission would not typically receive confidential information as a result of this collection of information. However, to the extent that the Commission receives confidential information described in this representation provision through our examination and oversight program, an investigation, or some other means, such information would be kept confidential, subject to the provisions of applicable law.

3. Respondents

Based on our understanding of the OTC derivatives markets, including the domiciles of counterparties that are active in the market, the Commission estimates that up to 2400 entities may provide representations that they do not meet the criteria necessary to be U.S. persons.

4. Total Initial and Annual Reporting and Recordkeeping Burdens

The estimates in this section reflect the Commission's experience with burden estimates for similar requirements and discussions by our staff with market participants. Consistent with the discussion above related to the representation provision of the “transaction conducted through a foreign branch” definition, the Commission believes that in most cases the representations associated with the “U.S. person” definition would be made through amendments to the parties' existing trading documentation (e.g., the schedule to a master agreement). Here too, because these representations relate to new regulatory requirements, the Commission anticipates that counterparties may elect to develop and incorporate these representations in trading documentation soon after the effective date of the Commission's security-based swap regulations, rather than incorporating specific language on a transactional basis. The Commission believes that parties would be able to adopt, where appropriate, standardized language across all of their security-based swap trading relationships. This language may be developed by individual firms or through a combination of trade associations and industry working groups.

As above, the Commission estimates the maximum total paperwork burden associated with developing new representations would be, for each counterparty that may make such representations, no more than five hours and up to $2,000 for the services of outside professionals, for a maximum of approximately 12,000 hours and $4.8 million across all security-based swap counterparties that may make such representations. This estimate assumes little or no reliance on standardized disclosure language.

The Commission expects that the majority of the burden associated with the new disclosure requirements will be experienced during the first year as language is developed and trading documentation is amended. After the new representations are developed and incorporated into trading documentation, the Commission believes that the annual paperwork burden associated with this requirement would be no more than approximately 10 hours per counterparty for verifying representations with existing counterparties and onboarding new counterparties, for a maximum of approximately 24,000 hours across all applicable security-based swap counterparties.

X. Regulatory Flexibility Act Certification

The Regulatory Flexibility Act (“RFA”) requires Federal agencies, in promulgating rules, to consider the impact of those rules on small entities. Section 603(a) of the Administrative Procedure Act, as amended by the RFA, generally requires the Commission to undertake a regulatory flexibility analysis of all proposed rules, or proposed rule amendments, to determine the impact of such rulemaking on “small entities.” Section 605(b) of the RFA provides that this requirement shall not apply to any proposed rule or proposed rule amendment which, if adopted, would not have a significant economic impact on a substantial number of small entities.

For purposes of Commission rulemaking in connection with the RFA, a small entity includes: (1) When used with reference to an “issuer” or a “person,” other than an investment company, an “issuer” or “person” that, on the last day of its most recent fiscal year, had total assets of $5 million or less; or (2) a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to Rule 17a-5(d) under the Exchange Act, or, if not required to file such statements, a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and is not affiliated with any person (other than a natural person) that is not a small business or small organization. Under the standards adopted by the Small Business Administration, small entities in the finance and insurance industry include the following: (i) For entities engaged in credit intermediation and related activities, entities with $175 million or less in assets; (ii) for entities engaged in non-depository credit intermediation and certain other activities, entities with $7 million or less in annual receipts; (iii) for entities engaged in financial investments and related activities, entities with $7 million or less in annual receipts; (iv) for insurance carriers and entities engaged in related activities, entities with $7 million or less in annual receipts; and (v) for funds, trusts, and other financial vehicles, entities with $7 million or less in annual receipts.

The Cross-Border Proposal stated that, based on feedback from industry participants and our own information about the security-based swap markets, we preliminarily believed that non-U.S. entities that would be required to register and be regulated as security-based swap dealers and major security-based swap participants exceed the thresholds defining “small entities” set out above. Thus, we noted that we preliminarily believed it is unlikely that the proposed rules regarding registration of security-based swap dealers and major security-based swap market participants would have a significant economic impact any small entity. As a result, we certified that the proposed rules would not have a significant economic impact on a substantial number of small entities for purposes of the RFA and requested written comments regarding this certification.

While we received comment letters that addressed cost issues in connection with the proposed rules, we did not receive any comments that specifically addressed whether the rules applying the definitions of “security-based swap dealer” or “major security-based swap participant” to the cross-border context would have a significant economic impact on small entities.

We continue to believe that the types of entities that would engage in more than a de minimis amount of dealing activity involving security-based swaps—which generally would be major banks—would not be “small entities” for purposes of the RFA. Similarly, we believe that only the largest financial companies would be likely to develop security-based swap exposures of the size that would be required to cross the major security-based swap participant definition thresholds. Accordingly, the SEC certifies that the final rules applying the definitions of “security-based swap dealer” or “major security-based swap participant” to the cross-border context will not have a significant economic impact on a substantial number of small entities for purposes of the RFA.

XI. Effective Date and Implementation

These final rules will be effective 60 days following publication in the Federal Register.

If any provision of these rules, or the application thereof to any person or circumstance, is held to be invalid, such invalidity shall not affect other provisions or application of such provisions to other persons or circumstances that can be given effect without the invalid provision or application.

Because Exchange Act rules 3a67-10 and 3a71-3 through 3a71-5 address the application of the dealer and major participant definitions to cross-border security-based swap activities, those rules will not immediately impose requirements upon market participants even after the rules become effective. In the Intermediary Definitions Adopting Release, we noted that because the Commission has not yet promulgated final rules implementing the substantive requirements imposed on dealers and major participants by Title VII, persons determined to be dealers or major participants under the regulations adopted in that release need not register as such until the dates provided in the Commission's final rules regarding security-based swap dealer and major security-based swap participant registration requirements, and will not be subject to the requirements applicable to those dealers and major participants until the dates provided in the applicable final rules. Those principles apply here too.

Although Exchange Act rule 0-13—regarding the procedures for the submission of substituted compliance requests—also will become effective at that time, we would not expect to receive any such requests until relevant substantive rulemakings have been completed. Those rulemakings are necessary to determine when substituted compliance may be available, and to promulgate the requirements against which we may assess comparability for purposes of making substituted compliance determinations.

Statutory Authority and Text of Final Rules

Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and particularly, sections 3(b), 23(a)(1), and 30(c) thereof, sections 761(b), and 929P(b) of the Dodd-Frank Act, the SEC is adopting rules 0-13, 3a67-10, 3a71-3, 3a71-4, and 3a71-5 under the Exchange Act, and the SEC is adding Part 250 to chapter II of Title 17 of the Code of Federal Regulations.

List of Subjects

17 CFR Part 240

• Brokers
• Confidential business information
• Fraud
• Reporting and recordkeeping requirements
• Securities

17 CFR Parts 241 and 250

• Securities

Text of Final Rules

For the reasons stated in the preamble, the SEC is amending Title 17, Chapter II, of the Code of Federal Regulations as follows:

PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934

1. The general authority citation for part 240 continues to read, and a sectional authority is added in numerical order to read as follows:

Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4, 78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq., and 8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); and 18 U.S.C. 1350, unless otherwise noted.

Sections 240.3a67-10, 240.3a71-3, 240.3a71-4, and 240.3a71-5 are also issued under Pub. L. 111-203, section 761(b), 124 Stat. 1754 (2010), and 15 U.S.C. 78dd(c).

2. Add § 240.0-13 to read as follows:

3. Add § 240-3a67-10 to read as follows:

4. Add §§ 240.3a71-3, 240.3a71-4, and 240.3a71-5 to read as follows:

PART 241—INTERPRETIVE RELEASES RELATING TO THE SECURITIES EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER

5. Part 241 is amended by adding Release No. 34-72472 to the list of interpretive releases as follows:

6. Part 250, consisting of § 250.1, is added to read as follows:

PART 250—CROSS-BORDER ANTIFRAUD LAW-ENFORCEMENT AUTHORITY

Authority: 15 U.S.C. 77s, 77v(c), 78w, 78aa(b), 80b-11, and 80b-14(b).

[FR Doc. 2014-15337 Filed 7-3-14; 8:45 am]

Editorial Note:

Proposed rule document 2014-15337 was originally published on pages 39067 through 39162 in the issue of Wednesday, July 9, 2014. In that publication the footnotes contained erroneous entries. The corrected document is republished in its entirety.