SEC Proposes ‘Security-Based Swap Execution Facility’ Rules

As part of the Securities and Exchange Commission’s (SEC’s) ongoing mission to create more transparency in markets in the U.S., the SEC voted unanimously on Wednesday in favor of proposing rules on “security-based swap execution facilities (SEFs).”

The SEC will define, set requirements for registration and set forth “duties and core principles,” for the security-based SEFs, according to an announcement and fact sheet released Wednesday.

The Dodd-Frank Act tasked the SEC with implementing a “framework” for regulating security-based swaps, which the SEC says “currently trade exclusively in the over-the-counter markets with little transparency or oversight,” according to the release.

Part of the intent of the framework is to provide places for the swaps to trade and access for more entities to trade them, providing better pricing and liquidity, as well as oversight. 

“Trading on registered security-based SEFs rather than in the over-the-counter markets should serve to enhance the transparency, efficiency, and competitiveness of the trading of security-based swaps,” said SEC Chairman Mary Schapiro (left), in remarks for an SEC Open Meeting on Wednesday.

The proposed rules will “interpret” the Dodd-Frank Act’s definition of “security-based SEFs;” outline “registration requirements” and how to file “rule changes and new products with the SEC,” and provide exemptions for security-based SEFs from the definition of "exchange" and from “most regulation as a broker.”

The SEC's proposed interpretation of the security-based SEF definition says, “a security-based SEF would be a system or platform that allows more than one participant to interact with the trading interest of more than one other participant on the system or platform.” More than one type of system or platform could qualify.

On registration of SEFs, the rules propose that a security-based SEF could file “Form SB SEF” with the SEC to register, amend it each year and update the filing when information “becomes inaccurate.”

The SEC set out 14 "core principles" for registered security-based SEFs:

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.

Comments should be sent to the SEC by April 4.