The SEC to define “swap execution facilities”With the enactment of the Dodd-Frank Act, a new type of regulated marketplace was created known as “swap execution facilities” (“SEFs”) for which the Act established a comprehensive regulatory framework that would require swaps to be executed either on an exchange or on a SEF. The SEFs are defined under Dodd-Frank as a “trading system or platform in which multiple participants have the ability to execute or trade security-based swaps by accepting bids and offers made by multiple participants in the facility or system.” SEFs are a new category of markets, regulated by the Commission, where security-based swaps can be traded.
The SEC, recently, voted unanimously to propose rules defining SEFs and establishing their registration requirements. In a statement by SEC Chairman, Mary L. Schapiro, she explained that the four-part proposal would: 1. Provide a definition for a security-based swap execution facility – outlining what types of markets would meet the definition; 2. Address what it means for a security-based swap to be “made available to trade” on a SEF or an exchange; 3. Implement the 14 core principles detailed in Dodd-Frank (listed below); and 4. Establish a registration process for SEFs that would provide comprehensive information for the Commission to evaluate applications for registration.
The SEFs would be required to:
- Comply with the core principles and any requirement the Commission may impose.
- Establish and enforce rules governing, among other things, the terms and conditions of security-based swaps traded on their markets; any limitation on access to the facility; trading, trade processing and participation; and the operation of the facility.
- Permit trading only in security-based swaps that are not readily susceptible to manipulation.
- Establish rules for entering, executing and processing trades and to monitor trading to prevent manipulation, price distortion, and disruptions through surveillance, including real-time trade monitoring and trade reconstructions.
- Have systems to capture information necessary to carry out its regulatory responsibilities and share the collected information with the Commission upon request.
- Have rules and procedures to ensure the financial integrity of security-based swaps entered on or through the facility, including the clearance and settlement of security-based swaps.
- Have rules allowing it to exercise emergency authority, in consultation with the Commission, including the authority to suspend or curtail trading or liquidate or transfer open positions in any security-based swap.
- Make public post-trade information (including price, trading volume, and other trading data) in a timely manner to the extent prescribed by the Commission.
- Maintain records of activity relating to the facility’s business, including a complete audit, for a period of five years and to report such information to the Commission, upon request.
- Not take any action that imposes any material anticompetitive burden on trading or clearing.
- Have rules designed to minimize and resolve conflicts of interest.
- Have sufficient financial, operational, and managerial resources to conduct its operations and fulfill its regulatory responsibilities.
- Establish a risk analysis and oversight program to identify and minimize sources of operational risk and to establish emergency procedures, backup facilities, and a disaster recovery plan, and to maintain such efforts, including through periodic tests of such resources.
- Have a chief compliance officer that performs certain duties relating to the oversight and compliance monitoring of the security-based SEF and that submits annual compliance and financial reports to the Commission.
The SEC has already engaged in several rulemakings related to the derivatives market which include: defining security-based swap terms, establishing reporting rules, rules on data repositories, fraud prevention, swap conflict, and reporting of pre-enactment security-based swaps. Public comments on this recent proposal should be sent to the Commission by April 4, 2011.